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ADM | 4 | 2,023 | 2024-03-12 09:00:00 | Operator: Good morning, and welcome to the ADM Fourth Quarter 2023 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Hello, and welcome to ADM's fourth quarter and full year 2023 earnings conference call. Our prepared remarks today will be led by Juan Luciano our Board Chair and Chief Executive Officer and Ismael Roig, our Interim Chief Financial Officer. We've prepared presentation slides to supplement our remarks on the call today which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan, and good morning to all who have joined for today's call. I realize we're holding this call later than we have in the past and we appreciate your patience as we have managed through our internal investigation and worked expeditiously to complete our 10-K filing. Before we start the business update, I want to provide some perspective on the additional release that we issued this morning on the progress we have made in our internal investigation, which is being led by the Audit Committee of the Board of Directors. ADM has historically disclosed in the footnotes to our financial statements that intersegment sales have been recorded at amounts approximating market. In connection with our internal investigation, we've corrected certain intersegment sales that occurred between our Nutrition reporting segment and our Ag Services & Oilseeds and Carbohydrate Solutions reporting segments that were not recorded at amounts approximating market. The adjustments have no impact on our consolidated balance sheets, statement of earnings, comprehensive income or loss or cash flows. In addition, we determined that the adjustments are not material to our consolidated financial statements taken as a whole for any period. We also confirmed that these adjustments did not change the achievement levels under our incentive plans. Further detail is included in the Form 10-K we filed this morning. Throughout this process, we have continued to operate the business and drive our strategic priorities forward. While our internal investigation is substantially complete, we continue to cooperate with the Securities and Exchange Commission and the Department of Justice, and we hope you understand that we will not be taking questions related to these matters on the call today. We will provide updates on this matter in the future as appropriate. Please turn to Slide 4 where we have captured our fourth quarter and full year financial highlights. Today, ADM reported fourth quarter adjusted earnings per share of $1.36, and adjusted segment operating profit of $1.4 billion. Our full year adjusted earnings per share were $6.98, the second best EPS in our history, and our adjusted segment operating profit was $6.2 billion. Our trailing fourth quarter adjusted ROIC was 12.2%, making another year of ROIC performance above our 10% target. Our full year operating cash flow before working capital was $4.7 billion. Our strong cash flow and disciplined management of our balance sheet continues to allow us to invest in our business and return cash to shareholders. In total, we returned $3.7 billion to our shareholders in the forms of dividends and share repurchases in 2023. In January, with the expectation of continued strong cash flows in 2024, we announced an 11% increase in our quarterly dividend, raising our dividend to $0.50 per share, which marks 92 years of uninterrupted dividends and over 51 consecutive years of annual dividend increases. Today, we also announced that our Board has authorized the additional repurchase of up to $2 billion in shares in 2024 under ADM's existing share repurchase program. Our performance for 2023 shows the overall effectiveness of our strategy, where our broad portfolio of business is combined to deliver resilient results for the year. Despite a more challenging operating environment, we maintained strong earnings and ROIC while delivering key strategic accomplishments across the enterprise. Next slide please. To put our 2023 results into perspective, at the end of 2021, we provided a roadmap to create value and growth returns by getting closer to customers and highlighted where we expected to perform on several important strategic metrics by 2025. As I look at our two-year track record over these 2025 objectives, we have delivered adjusted earnings per share at the top end of our $6 to $7 per share EPs objective. We have also continued to deliver ROIC above our 10% target.
Green Bison: Let's turn to Slide 6, which I summarize our priorities for value creation in 2024. We continue building a stronger company for the future and to support this, we have identified three key priorities for 2024. One, managing the cycle; two, nutrition recovery; and three, enhanced return of cash to shareholders. Let's take a closer look at each of these areas of focus. We know that 2024 will be a more challenging year that we faced in 2022 and 2023. We see tailwinds that supported a portion of our performance over the past few years changing direction, making our continued progress on our strategic metrics more reliant than ever on our productivity and innovation agenda. In 2024, we will continue to focus on those strategic initiatives that provide strong growth prospects. Our destination marketing efforts continue to bring us closer to our customers and enable us to serve them in a differentiated capacity and we continue to expand. In 2023, we added three new offices across Asia and the Middle East, and in 2024 we plan to add two to four more. Through this ongoing expansion, we expect to achieve 6% growth in our destination market in volumes. Direct farmer buying has been steadily increasing over the past several years and provides ADM an opportunity to maximize value for both sides by creating efficiencies through working directly together. We plan to take this even further in 2024, leveraging our network of more than 200,000 farmer relationships to grow direct origination volumes year-over-year by about 10%. And as our customers strive to decarbonize their own products and services, we are seeing a steady increase in the financial returns generated by our own decarbonization efforts from Regen Ag partnerships to lowering the carbon footprint of our operations. The pace of this is accelerating as we move into 2024. Tied to these strategic initiatives, we continue to build capacity to serve growing customer demand. I mentioned earlier the opening of our Green Bison soy processing facility as well as the expansion of our Marshall, Minnesota starch facility. These capacity additions support growing demand for a wide variety of sustainable products and solutions, from renewable fuels to industrial products. And connected to our productivity efforts, we have formally launched a 2024 program we call the Drive for Execution Excellence within the organization. Over the years, we have consistently encouraged our ADM colleagues to identify and execute both cost saving and cash generation ideas. We've developed processes and systems through our prior transformation programs and now those are ramping up for another cycle. As part of this, we have already commissioned more than 300 projects and plan to see $500 million in traceable cost savings over the next two years across all aspects of our enterprise, from operations to supply chain to corporate costs. Now let's discuss our plans within the Nutrition business. We're calling this section, of course, nutrition recovery for a reason. Nutrition had a very difficult year with results well below our expectations, and we have been working aggressively to change this and return to growth. For Nutrition, 2023 representing a combination of challenging market forces, some specific non-recurring events and some misses on demand fulfillment. And while market forces such as customer destocking as well as softer demand for plant-based proteins are not within our control, we're already taking action on the areas we can improve. Many of the supply issues are the result of the complexity built into the Nutrition business over time. In our zeal to meet our customers' needs, we have created one of the strongest pantries in the industry. This added complexity in our operations and supply chain that at times impacted our ability to efficiently fulfill demand. To address this, we have made important changes to drive simplification across the Nutrition business that will ease the pressure on our overall supply chain and dramatically improve our demand fulfillment performance. First, we have created a stronger division of duty across operations leadership and added new leaders with a strong expertise in supply chain management. We have also taken steps to build our COE expertise back into the core business, helping make our overall supply chain capabilities more agile and responsive to commercial demand signals. We have also engaged third party experts to help identify further opportunities for operational excellence improvements across our largest facilities. We have also greatly simplified the product and production line landscape to further achieve operational and supply efficiency, reducing the brands we are presenting to customers by two thirds and downsizing about 17% of our SKUs alongside the strategic production line simplification. A recent example of this is the closure of more than 20 Animal Nutrition production lines in 2023, now better serving the product mix and supply chain efficiency of the business. We're also optimizing our Nutrition business portfolio, leveraging our experience in both large scale and bolt-on acquisitions. We have enhanced our approach to M&A integration to increase value creation as we focus more on the integration of recent acquisitions than new targets. We continue to assess our portfolio for a strategic fit, making surgical decisions to achieve the returns targets we expect. For example, during Q4, we took action on two JVs that were not expected to meet our returns criteria. We're proud to see how the team with new leadership has rallied around this recovery plan, which is already showing signs of improvement as we move through the first quarter of the year. Recent trends suggest that destocking impacts in beverages are subsiding and we are well positioned to capture recovering demand in 2024 as evidenced by the strong demand we are seeing in flavors. After heightening our operational efficiency, we've seen steady increases in shipping volumes and productions throughout the course of the last month. And in Animal Nutrition, we have seen another quarter of sequential improvement in the base of the business, which excludes amino acids and pet solutions and early indications in the first quarter of 2024 suggest that this will continue. Importantly, our nutrition value proposition continues to be well received by customers as evidenced by our robust opportunity pipeline and industry leading win rates across key categories like flavors, dietary supplements and pep. ADM's customer centricity and agile innovation capabilities, supported through our creation, design and development expertise, differentiates us. We continue to believe that Nutrition has an important role in ADM's integrated business model. Beyond adding value to the ingredients produced by our AS&O and carbohydrate solution businesses, Nutrition is innovating to address evolving consumer needs and is connecting us more closely with a growing customer base. Finally, I'll turn attention to the capital allocation strategy that continues to guide our strategic cash deployment decisions. As noted, we announced today that the Board has authorized the repurchase of up to an additional $2 billion in shares through the remainder of the year, including $1 billion in shares to be executed through an accelerated share repurchase program as soon as practical. This will total $6.4 billion in repurchases executed since 2022 and coupled with the already announced 11% dividend growth, this is aligned with our commitment to a balanced capital allocation approach. So, combined, we believe these three areas of focus set ADM to perform well in a challenging external operating environment in 2024. I would now like to turn the call over to Ismael for more detail on the results of the operations. Ishmael?
Ismael Roig: Thank you, Juan. Let's start on Slide 7 which provides overall segment operating income and EPS for 2023. Overall, we delivered the second highest earnings in company history, overcoming a challenging operating environment. Adjusted segment operating profit was $6.2 billion for the full year, a 6% decrease versus the prior year. At a high level, operating profit was primarily down year-over-year in Ag Services & Oilseeds and Nutrition. In the other segment, which includes ADMIS and Captive Insurance, we had a significant increase in operating profit. Adjusted earnings per share were $6.98 for the year. Improved pricing in Carbohydrate Solutions and Nutrition, as well as positive impacts from mark to market timing in AS&O more than offset the impact of lower crush margins, leading to a $0.70 per share improvement versus the prior year. Volume improvement in AS&O was more than offset by volume declines in Carbohydrate Solutions and Nutrition, resulting in a $0.29 per share reduction in EPS versus the prior year. Higher manufacturing costs partially related to unplanned downtime at the Decatur complex led to a $0.41 per share decrease versus the prior year. And lower equity earnings primarily related to Wilmar attributed a $0.46 per share decrease versus the prior year. Increased corporate costs related to higher interest rates and the 1ADM implementation partially offset by higher ADMIS results drove a $0.30 per share versus the prior year. For other, benefits from share repurchases were more than offset by negative impacts related to a higher adjusted income tax rate and cycling one-time benefits from the Legal Recovery and Biofuel Producer Recovery program, leading to a $0.18 per share decrease versus the prior year. Moving to Slide 8, let's look at our segment performance for AS&O. For the full year, AS&O delivered $4.1 billion in segment operating profit, 8% lower than the record level in 2022. Ag Services segment operating profit was 15% lower versus the prior year as reduced origination volume and margins in North America were partially offset by record South American origination volumes. In global trade, destabilization of trade flows led to lower results compared to an exceptional 2022. Crushing segment operating profit for the full year was $346 million lower versus the prior year as improved process volumes were more than offset by lower crush margins and higher manufacturing costs. Refined Products and Other results were $469 million higher, resulting in a record year. Results were driven by higher volumes and margins in biodiesel. Market volatility drove positive timing impacts of approximately $235 million, compared to negative timing impacts of $90 million in the prior year. Equity earnings for Wilmar were $303 million in 2023, approximately 45% lower than the prior year. Now let's move to Slide 9 and look at Carbohydrate Solutions. For the full year Carbohydrate Solutions segment operating profit was $1.4 billion 3% lower versus the record prior year. In the Starches and Sweeteners segment higher pricing and mix were offset by weaker volumes and lower corn co-product values. The teams executed well in a dynamic environment, posting a record year in Wheat Milling. In Vantage Corn Processing strong exports and steady domestic demand and blending rates supported ethanol production and robust margins. The prior year also included onetime benefits of $50 million related to the USDA Biofuel Producer Recovery program. We also continue to make significant progress on our BioSolutions strategic initiative, delivering revenue growth well ahead of our 15% plus target. Please now turn to Slide 10. In Nutrition, revenues of $7.2 billion for the full year were 6% lower versus the prior year. Demand headwinds and destocking impacts, coupled with operational challenges related to the ERP systems integration pressured volumes. This more than offset price and mixed benefits as well as positive currency impacts. In Human Nutrition volumes declined due to lower market demand for plant-based proteins, destocking impacts in beverages, and operational challenges related to the ERP system implantation. This was partially offset by improved price and mix in flavors and texture and pricing in specialty ingredients. In Animal Nutrition, lower complete feed and premix volumes, the normalization of amino acid markets and demand fulfillment challenges in Pet Solutions led to lower revenue versus 2022. Now please turn to Slide 11. For the full year Nutrition segment operating profit was $427 million, 36% lower versus the prior year. Human Nutrition results of $417 million were 25% lower than the prior year as weaker volumes as well as increased costs related to operational challenges from the ERP implementation and unplanned Decatur downtime at Decatur East were partially offset by higher pricing. Animal nutrition results of $10 million were 91% lower compared to the prior year, primarily driven by lower volumes and the normalization of amino acid pricing. When bridging from 2022, our performance can be characterized in three buckets, market forces, one-time items, and operational challenges. Market forces accounted for a majority of the deterioration in 2023 and as previously mentioned, this was mostly related to lower demand and plant-based proteins, destocking impacts in beverages and lower premix and completely demand which impacted volumes across the industry.
SAVAN: Lastly, we also had our own operation struggles that impacted our ability to deliver on the strong demand that we have created. The implementation of ERP systems over the course of the year led to complications in shipping and producing products, negatively impacting both volumes and manufacturing costs. Over the past month, we have seen a steady improvement in operations and are confident that we will see volumes lost in 2023 come back in 2024. Now please turn to Slide 12. For the full year Other segment operating profit was $375 million, up 125% compared to the prior year. ADM Investor Services results improved on higher net interest income. Higher Captive Insurance results on new program premiums were partially offset by higher claim losses. In corporate for the full year, net interest expense increased year-over-year on higher short-term interest rates. Unallocated corporate cost increased versus the prior year on higher global technology spend to support digital transformation efforts. Other corporate was unfavorable compared to the prior year due to one-time investment valuation losses of approximately $57 million. Please turn to Slide 13. Over the last two years the company has generated significant cash flow that have bolstered our balance sheet and provided us with financial flexibility to drive long-term growth. In 2023 we again had strong cash flow of $4.7 billion which were actualized in line with our balanced capital allocation framework. 30% or approximately $1.5 billion of cash flows were reinvested in the business to support growth and modernize our assets, including investments in new capacity and the digitization of our existing asset footprint. Our cash flows also supported significant capital return in 2023 with nearly 30% earnings going to dividends and nearly 60% of cash flows or about $2.7 billion going to shareholders via share repurchases. In 2024 we expect to hold capital expenditures to a level aligned with depreciation and amortization with focus spend around the safety and reliability of assets. We also intend to manage working capital needs prudently limiting M&A beyond previously announced transactions and focusing our team on cost savings and cash generation initiatives through the drive for Execution Excellence. As Juan mentioned earlier, our priorities for cash deployment in 2024 will remain focused around the shareholder. We finished the year with strong momentum in terms of returning cash, repurchasing nearly 1.6 billion of shares in Q4 and nearly 330 million of shares so far in Q1. Over the course of the year, we intend to actualize 2 billion of additional share repurchases, with 1 billion being executed through an accelerated share repurchase program as soon as practical. Now, let's transition to a discussion of guidance for 2024 on Slide 14 please. In 2024, global grain and oil seed supply is expected to increase as anticipated improvements in weather should support larger production levels in key South American countries. Assuming commodity prices ease for recent highs and trade flows adjust to the dislocations created over the past two years, we anticipate global soybean crush margins will moderate in 2024, likely moving into a range of $35 per metric ton to $60 per metric ton. From the demand side, we continue to expect vegetable oil demand growth from renewable diesel and low single digit soybean mill demand growth to support structural margin improvement. We expect adjusted earnings per share to be in the range of $5.25 per share to $6.25 per share, representing an 18% decline from prior year at the midpoint. Now breaking down our expectations by segment for 2024, let's turn to Slide 15. In AS&O, we anticipate the first quarter to be lower and the full year to also be lower versus comparable prior periods as increased global commodity supply and normalization of margins will weigh on the segment. We anticipate global soy crush margins within the range of $35 per metric ton to $60 per metric ton as the market balances better soybean availability against increased crush and renewable diesel capacity. Our Operational Excellence efforts and the ramp up of our Green Bison facility should lead to mid-to-high single digit improvement in our process volumes. We expect significantly lower biodiesel margins in 2023, timing gains to reverse as contracts are executed. In Carbohydrate Solutions, we anticipate the first quarter to be lower versus the prior year. For the full year, we anticipate another strong year, but slightly lower than 2023 as the improved volumes and margins in Sweeteners and Starches could be offset by weaker ethanol. For nutrition, the first quarter is expected to be lower versus the prior year as we face headwinds from a normalizing texturants market, fixed costs associated with operational challenges related to the Decatur East and protein volumes. However, for the full year we expect Nutrition to begin its path to recovery. We anticipate conversion of our significant pipeline opportunities in Human and Animal Nutrition to yield mid-single-digit revenue growth. We assume market normalization in texturants to be a headwind in 2024. We do not anticipate the significant one-time events of 2023 to recur. Back to you, Juan.
Juan Luciano: Thank you, Ismael. Please turn to Slide 16. In summary, let me once again share the three priorities for our year ahead. We will continue our efforts across the business to drive our productivity and innovation portfolio of projects, taking advantage of capacity gains we have made and ensure that our teams are generating and executing on our drive for Execution Excellence. We continue to take aggressive actions in the nutrition business to ensure that it can deliver on the areas of growth that we have continued to build into our opportunity pipeline. This includes supporting the operational changes we have introduced, driving simplifications through our products and brands, and ensuring that our business portfolio is tuned to best achieve our return expectations. And we're also actively managing our balanced capital allocation strategy, both prudently investing in the business while growing our dividends and accelerating our share repurchase program to return more to shareholders in the near-term. I believe strongly in the powerful role ADM plays as a leader in the agriculture supply chain, and that our ability to bring partners together across the value chain will be critical to driving future transformation in the food, feed, fuel and industrial markets we serve. I want to express my gratitude to the ADM team for their dedication, hard work and resourcefulness. I'm confident in our ability to deliver solid results as we move into 2024 and continue to pave a path for long-term profit growth. Operator, please open the line for questions now.
Operator: Thank you. [Operator Instructions] Our first question comes from Adam Samuelson of Goldman Sachs. Adam, the line is yours.
Adam Samuelson: Yes, thank you. Good morning, everyone.
Juan Luciano: Good morning, Adam. How are you?
Adam Samuelson: Good morning. Good. So I guess my question is really around framing the go-forward outlook in terms of the cyclical versus the pieces that ADM controls. And you had the targets from the 2021 Investor Day still on the slides of returns and earnings per share. The outperformance the last couple of years has been largely cyclically driven in AS&O, whereas some of the investments and the items under your own control, particularly Nutrition, have not performed up to expectations. As we think about 2024 that's at least the cyclical parts are reversing, at least in part. Can you Juan put a little bit more finer point on how you think about 2024 versus normalized earnings for the business and maybe quantify the path forward in Nutrition beyond this year as you work to earn a return on the substantial investments you've actually made in that business?
Juan Luciano: Yes. Thank you, Adam. So let's take each of the businesses in the portfolio. So when we think about Ag Services and Oilseeds, as you said, we had a spectacular performance over the last couple of years, taking full advantage of the opportunities in the market. But we forecasted in 2021 that margins were going to moderate, although they were going to stay higher than historical averages and we are seeing that. We see the moderation and we see even crush margins, 35 to 60, that we are forecasting are higher than average. We have not stayed quiet waiting for the cycle to reverse. We have been adjusting our business model. You heard me saying about destination marketing, something we didn't have a few years ago, and we continue to grow that. That gives us extra margins and now we are forecasting that we continue to expand and we're going to grow those volumes 6% this year and that programs continue as we expand into new geographies in the Middle East and Southeast Asia. When you think also about the Regen program, Regen AG program that we have with our customers, we are helping our CPG customers with their Scope 3 emissions and we are working together with the farmers and that program is the leading program in the industry and continues to grow. We are also doing everything in the value chain. We're looking at farmer direct. That's an ability for us to get efficiencies between us and the producer, the way we buy grain. So of course, we get an advantage with that as the producer as well. And we're planning to increase our volumes 10%, leveraging on the 200,000 farmer relationships we have around the world. Of course, we have expanded capacity. We are expanding crush in Latin America. We are expanding crush in North America with Spiritwood. So I would say when you take that, plus our operational improvements, if you will, what we call the push for excellence, that was going to be the productivity and innovation agenda that were going to help us navigate through this. We see 2024 still as a strong year for Ag Services and Oilseeds, it's going to be lower, but it's still going to be a strong year. Of course, the market has priced a lot of the extra capacity and the higher argentine crop into the crush margins. But we still see the ability of the market to absorb all that capacity with a strong mill growth and with a strong demand for oils. So that on the Ag Services and Oilseeds side. On the Carb Solutions side, this business has been very stable over the last few years. It has had a very good 2022 and 2023. We are expecting a very good 2024, maybe slightly lower, but still very, very good. We had a good program for good contract renewals in 2024. We are happy with the margins. We have maintained margins for the most part, and we have gained some volumes, so volumes are strong. The milling business has been going, had a record year last year, and it continues to drive very strong. I think both businesses have a little bit of a lower contribution from feed products, where margins have decreased a little bit, but BioSolutions, as Ismael mentioned, continues to grow, is growing beyond 15% per year. And all their decarbonization things that we're saying, we see more and more demand for everything that carb solutions can bring to the table in that area. So we feel very good about that. Always the question mark in the year maybe is ethanol, but we're seeing right now, Adam, ethanol, the arbitrage to export from the U.S. is open to everywhere in the world. So it's just a matter of adjusting our capacity and the U.S. capacity to get more dehydrated ethanol, if you will, to be able to export, to adjust the humidity content, if you will. So, I think we'd export well north of maybe 1.5, 1.6 billion gallons for this year. That should bode well for recovery of margins as we go into the year. And then you take nutrition. Nutrition has been a growth story for many years, and we certainly stumbled in 2023. I mentioned some of the reasons. Some of the reasons were, there was a big destocking after all the COVID and all the supply chain issues that the industry have, the industry stopped. And now we went through lower inflation and this talking about that. So we had to go that in beverages, which drives flavors, which is our biggest engine for growth, if you will. Of course, we knew into the year that plant-based proteins, we have moderated our expectations for growth on that will still grow, but it's not going to be beyond 10%. So it's still going to be an attractive mid-single-digit growth, if you will. But we knew that, and then we had continued growth in continued good demand in pet and health and wellness and Animal Nutrition has been improving their P&L, doing a lot of self-help from the June P&L. It's been improving all the year. So unfortunately we get to the Q4 and we had several events in Q4. We have several one offs. We needed to take action on a couple of joint ventures and we addressed that. We needed to take a revaluation of an investment because of the end evaluation and we took that in the Q4. And then we have some issues on our own performance that we needed to implement 1ADM as much as we prepared for that. We had some problems with some of the modules. It was a successful implementation, but some of the modules that were about shipping products gave us trouble during the last quarter of the year. So when you have all that combination, it gave us a very bad quarter. We continue to see 2024 a year of growth or recovery, if you will, from the 2023 value. And from there, we should continue to march on our commitment to nutrition. Our ability to fulfill or to deliver a value proposition that resonates with customers continue to be evidenced by our growing pipeline, both in Animal and Human Nutrition, and our conversion rate we have benchmarked this is industry leading conversion rate. So we know we are winning. We need to adjust our own internal processes to make sure we deliver that. And we have done that heavily in the last -- second half of last year, and we have seen that during January and February that we are delivering much better than we did last year. So with that, I still look confident at the numbers, at the overall number for the company that we gave you for 2025. As I said on the onset, we are ahead on what we scheduled. From an EPS perspective, we are above 10% in ROIC and we have purchased already more than the $5 billion of share that we have estimated for 2025. So it's never going to be a straight line from here to 2025. But we have a resilient portfolio that can help us see that those numbers for the overall portfolio are still possible, as it was in December 2021. Sorry for the long answer. It's a large company.
Operator: [Operator Instructions] Our next question comes from Tom Palmer of Citi. Tom, please go ahead.
Tom Palmer: Good morning. Thanks for the question. I wanted to dig in a bit more on crush margins and your $35 to $60 global soybean crush outlook. Maybe just to frame it, where were global crush margins last year? Where are crush margins currently? When we consider different regions of the world, and then as we think about the items that could drive to the upper or lower end of this year's range, what are kind of the key items you're looking at? Thank you.
Juan Luciano: Yes, thank you, Tom. So, as we said before, Ismael mentioning his remarks, we expect crush margins between $35 to $60 for this year, they were about $70 per ton, maybe last year. I think it's fair to say that the market has completely priced or baked all the bad news into the crush margins are we having today? So, I would say board crush has moved significantly lower in the last month as the market probably gained more confidence in the availability of products, especially soybean meal, particularly when you think about Argentina now having sites on a crop that may be 50 million tons. And the U.S. crush industry also has performed very well. And the market continued to look forward to the second quarter of the year when they're going to have basically three offers for meal. That hasn't happened last year. So if you remember, last year, after Brazil finished in exporting, the U.S. became the only global, only gaming town, if you will. And that increased soybean meal values around the world, which makes soybean meal expensive, if you will for the Russian. We see that in the U.S., we saw, at least for ADM, we saw five consecutive months of record exports for soybean meal in the U.S. And the U.S. industry saw similar situation. So now with the correction in this, we expect that soybean meal will gain back into the Russians. Of course, feeding with meat pros and not soybean milk is not the optimal way to feed. So now that soybean milk has corrected, we expect that to happen. At the end of the day, Tom, the way I think about where crush is going to happen in the world is going to happen in both places where you have bean availability and where you have a domestic oil market. If you think of Brazil, Brazil is having B14 started in March. And that has helped with the margins of domestic oil for us in Brazil. And of course, you have a big crop, so you're going to have the bean availability and the domestic market. And then it will be the U.S. in which you have all the need of soybean oil to go into renewable green diesel and biodiesel and we have, of course, the bin availability. So we think that crush will favor those two places.
Operator: Thank you. Our next question comes from Andrew Strelzik of BMO. Andrew, please go ahead.
Andrew Strelzik: Hey, good morning. Thanks for taking the questions. I guess ultimately, my question is about 2025 and whether you view 2024 as kind of the trough here from an earnings perspective in terms of the cycle. And if I just follow up on maybe you made some comments at the end of the response to Adam about 2025. I didn't know if that was specific to the metrics around nutrition or the prior earnings guidance that you had talked about. If you could just kind of clarify the way that you're thinking about that is this 2024 an earnings number from, which you would expect to grow, and then the 2025 comments with that. Thanks.
Juan Luciano: Yes. Andrew, first of all, my comment before to Tom's question was the overall number that we gave for the company for 2025 in 2021. We still believe that number is there. I think that that number was never going to be a destination for ADM, was a milestone, if you will. And as we are reviewing our five-year plan that we do every year we see us breaking through that number. So in that sense, I expect 2024 to be a down year versus 2023 hopefully 2025 will be a positive year versus 2024. There is a cycle here that needs to happen, Andrew, that I described below, soybean mill will get cheaper. All the oil activities related to B-14 or RGD needs to grow. All that needs to happen and how long that adjustment takes, how long it takes for meal to be low enough to increase demand and for flat prices to be low enough to maybe make the farmer correct a little bit. They are planting all that process we know historically happens, when exactly it's going to happen. Does it happen in a calendar year? Doesn't happen in six months. Does it happen in a year is hard to say. But we continue to build a company that has more optionality, that's more resilience for the future. So as the cycle moderates, we continue to have more ability to bring more to the P&L. So we think with that, I'm optimistic about 2025 being better than 2024.
Operator: Thank you. Our next question comes from Ben Bienvenu of Stephens. Ben, the line is yours.
Ben Bienvenu: Good morning.
Juan Luciano: Good morning, Ben.
Ben Bienvenu: Juan, I want to ask, as we think about the morning, I want to ask as we think about 2024 for the nutrition segment, you note that you expect mid-single digit revenue growth, operating profit to be higher over year. I think the natural inference would be that the operating profit growth is up by less than 5% or mid-single digit revenue growth. Is that true? And then as you referenced in kind of the cadence and your expectations for the first quarter, this is a trajectory of recovery that will build throughout the year in 2024. You talk about pipeline conversion. Are there residual headwinds, discontinuities from the Decatur complex still in the first quarter? Help us think through the sequencing of the development of return to growth and nutrition.
Juan Luciano: Yes, good question, Ben. Let me give you the puts and takes, if you will, on nutrition as we look at 2024. So as Ismael said in his remarks, about half of the headwinds that we faced last year were market. That means that half of them were in the other two buckets, the non-recurring events, if you will, and those by nature we hope that we're not going to have going forward. And I think Ismael qualified them about $60 million something give or take. And then the other ones were like some of the demand fulfillment issues that I explained how we have worked aggressively to correct. And we have seen good indication of that over the first two months of this year. So I would say those are the positive that we don't expect all that to happen again in 2024. You put on top of that a single digit revenue growth, mid-single digit revenue growth because of the pipeline that we have and the conversion of that pipeline. And that tends to happen every year. Then, as you described, we have to have to face a correction of texturizing prices that were exceptionally high last year. We're not going to have that. So that will be part of the negative side, if you will. And certainly, as we go through the year, we still need to bring Decatur East plant back into operations, and that will have a tail of a cost. So I would say the year will be driven by a strong recovery in Animal Nutrition, in flavors, and hopefully pet with some tailwinds in the specialty ingredients. That's how we see.
Operator: Our next question comes from Ben Theurer of Barclays. Ben, please go ahead.
Ben Theurer: Yes. Good morning and thank you very much for taking my question. Juan, Ismael wanted to follow-up on carbohydrate solutions because that obviously, as you've highlighted, has been a very solid performer last year. Even the outlook looks very promising still in comparison to maybe some of the other segments for 2024. And I wanted to understand where you are within your different asset bases, be it on the ethanol side, but also particularly Starches and Sweeteners for the need to invest into the business. Where are you in terms of capacity and what do you need to potentially allocate money to in order to keep that business up where it is, or potentially further grow it as it has gained significance within the consolidated ADM results? Thank you.
Juan Luciano: Yes, Ben, I'm glad you're highlighting carb solution. They had a spectacular year. They deserve recognition and they've done a fantastic job of transforming their business into a very resilient and stable business. The assets let me take it by pieces. The milling business. Milling is an old business that has some old assets. And over the last few years, we have been doing -- the team has been doing a terrific job of shutting down some assets and consolidating those in new facilities like Mendota that we launched last year. That is the best and the newest wheat milling plant in the world. So we are happy with the way they have done that. They continue to do so. So that business is in good shape. When we look at the wet mills, we continue to invest in part of the wet mills. Unlikely that we're going to build a new wet mill, as you can understand, but that business continue to be reinvested in. It's a business that is a large business has a large asset footprint. And at the moment there is a lot of capital being associated with the path to decarbonize all these assets. So as you heard, we have a lot of efforts in trying to get pipelines to try to monetize some of our CO2 that come from the biogenic CO2 that come from the ethanol plants. So and I would say we have expanded Marshall because BioSolutions is growing at north of 15% per year. So we needed capacity. So the Marshall expansion is about 50% expansion to the final starch capacity that we have there. And that will help a lot with that. I would say the year is exciting as it is developing. It has solid margins. It has so far solid volumes. It had a little bit of a rough January because of the bad weather. We have ice in the plants and freezing weather. But February, March, things look good. And we think that that business has the opportunity to get some tailwinds from lower energy cost and maybe chemicals cost as the year go by. And that's a big energy hog, that business. So that could be an advantage and a tailwind coming later in the year.
Operator: Our next question comes from Manav Gupta of UBS. Manav, please go ahead.
Manav Gupta: Thank you. I just had a quick question. When we look at the carb, recent proposals and then we look at the 45g, it looks both at the federal level and at certain state levels there is a desire to lower the amount of renewable diesel being produced from vegetable oil. And I'm just trying to understand, do you see that as some kind of a headwind whereby eventually the demand for soybean oil from the renewable diesel or biodiesel industry could actually decline versus what we are seeing or you think this is just passing and the demand eventually will rise again as we move along?
Juan Luciano: Yes. Thank you, Manav, for the question. Listen, I think the path is clear for RGD, that RGD will need vegetable oils. When you think about how Europe is doing, Europe not having a raw crop for that, Europe needs cooking oil, waste oils, and they will capture that. The U.S. will have to be fed with soybean oil, canola oil. And we see that commitment to be firm over the years. All these capacities being built, it cannot be filled with anything else. So we feel that is a strong trend ahead of us.
Operator: Our next question comes from Salvator Tiano of Bank of America. Salvator, please go ahead.
Salvator Tiano: Yes, thank you very much. I just want to go back to the 2025 target of $6, $7 in EPS. I mean, that is obviously double digit EPS growth and I understand buybacks play a role into that. But given the comments about controllables versus cyclicals, it seems really tough to imagine getting back there. Can you provide a little bit some of the key components and key buckets that you think will get you there in terms of its segment and specific numbers as detailed as possible?
Ismael Roig: Yes, Salvator listen, a little bit of what I explained early on Adam's question. I think that we will see how the cycle plays in ASNO. As I said, I think that lower prices have this ability to incentivate demand. At this point in time If you think about soybean meal demand, we are forecasting a very strong soybean meal demand, maybe higher than USDA levels, higher than GDP. When you think about Southeast Asian economies recovering and with inflation moderating, purchasing power is improving, tourism is improving in all those areas, you have at the moment very high prices of beef that's favoring pork and chicken. You have protein margins for chicken being better at that. So we think that soybean meal will gain in the Russian. So when we look at all that, we see the soy oil demand very strong in domestic consumption, but also for biofuels, and then we see the meal demand very strong. We think that this correction should be probably short term for crash and that should come back again. I cannot make a prediction on the timing of that, but we know how the cycle plays. So whether it's calendar year this or six months later or a quarter earlier, it's not for me to venture into those guesses. I think that carb solutions between the exceptional job they are doing on managing their mature businesses and the growth that they are getting through decarbonization and BioSolutions, you will see that ahead of us. Again, we just bring in the Marshall expansion. That's not something that it was in our forecast last year. So we're going to have it more in the next three quarters, if you will, of the year, Spiritwood again, and some of the crash capacity we brought in Brazil, and then you see nutrition. That nutrition was not a contributor, certainly a big contributor to growth in 2023, but we expect it to be back to growth in 2024 and 2025. So those are kind of the buckets, if you will, that I see at the moment.
Operator: Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Steven, the line is yours.
Steven Haynes: Hey, good morning. Thanks for taking my question. Maybe just to come back to nutrition, I think in your prepared remarks you talked about some portfolio refreshment going on there and was wondering if you could maybe size, the scope of that. Are you thinking more kind of product line oriented here, or is this kind of more at the business level where you might be looking to monetize something? Thank you.
Juan Luciano: Yes, Steven, listen, let me give you my thinking on that and the way we approach these things. So we always look, every time we do our five year plan, we take a look at those units that whether they are not returning, given our return expectations to date, we're not forecasting it to do it in the medium term. And those are the ones that we tend to take action. So we took action with a couple of joint ventures, as I mentioned, and then we look at every unit that is underperforming. What we do first is we try to bring them to performance. So we make sure that if there are some things that are self-inflicted, if you will, we correct those things. Once we correct those things, and then we have visibility to what could happen over the next two or three years, then we decide as a part of portfolio whether they belong in nutrition or they belong in another part of ADM, or they belong outside ADM. So that's a regular process. We done, we done it in the past with fertilizers, Latin America, we've done it in the past. We divested Bolivia. We divested cocoa and chocolate. So we've done this, and now we've done it with a couple of joint ventures. We've done it also. Ismael has done it in his previous job as an Animal Nutrition leader with some of the lines in Animal Nutrition that we cut, like 20 lines around the world. So sometimes we have exited countries. So it's a regular process that at times, maybe when you have a stumble like we had in nutrition, you look a little bit deeper, because now, all of a sudden, you have more businesses at lower performance. So we really want to see, is it worth investing in some of those? So we're in that process. So, nothing to announce today, but we continue to look at that very deeply.
Ismael Roig: Just a couple of complimentary comments, because not only have we had some experience historically, as Juan correctly mentions, with [indiscernible] and fertilizer, but certainly the Animal Nutrition was a good precursor to some of the thinking that we have now in mind for the whole of our nutrition business. In the sense that usually when you acquire these businesses, they come with footprint allocations, labs, farms, in our cases, and warehouses, that when you aggregate them, start aggregate them across a number of different acquisitions, you realize that there are overlaps. And what we noticed is that there was a significant opportunity in Animal Nutrition to significantly simplify the portfolio by reducing the number of labs, reducing the number of SKUs of plants. And we've seen those benefits. They've been occurring since the second half of 2023. And I think that some of that thinking, as we have built this organization via a multiplicity of acquisitions, lends itself now to a pause and reflection, in light of the successes that we've had with this, to apply it more broadly to all of the portfolio. So that's where our capital prudence is going to come in, by focusing on ensuring that we improve our asset base while returning cash to our shareholders.
Steven Haynes: Thank you, Ismael.
Operator: Thank you. Our next question comes from Dushyant Ailani of Jefferies. Dushyant, please go ahead.
Dushyant Ailani: Thank you for squeezing me in. I just wanted to quickly talk about biodiesel margins going forward. Your thoughts just around the system, both in the U.S. and internationally, just how do we frame our thoughts around that and capacity as well?
Juan Luciano: Yes. Thank you, Dushyant. Well, all useful biofuel production is, as I said, is expected to grow in Brazil. We're going to go to B14, so there are many countries that are increasing their mandates, whether it's Indonesia and all that. When you look at the overall balances around the world, you see plantations in Southeast Asia getting older, the trees getting older, so maybe less production of palm oil. So you're going to see biodiesel mandates increasing around the world and less competitive pressure, if you will, for palm oil. So you're going to see the pressure on vegetable oil. So we think that that will continue to be a strong leg of the crash, biodiesel in particular. Biodiesel margins are better right now for us in Europe. They have moderated significantly in the U.S., and we expect them to be good, but not as good as they used to be in the U.S. So that will be a little bit of a headwind for us in 2024. But margins are better in Brazil and in Europe. Thank you.
Operator: Thank you. With that, we have no further questions, so I'll hand back to the management team for any closing remarks.
Megan Britt: Thank you for joining us today. Please feel free to follow up with me, if you have any other questions. Have a good day and thanks for your time and interest in ADM.
Operator: Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the ADM Fourth Quarter 2023 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Hello, and welcome to ADM's fourth quarter and full year 2023 earnings conference call. Our prepared remarks today will be led by Juan Luciano our Board Chair and Chief Executive Officer and Ismael Roig, our Interim Chief Financial Officer. We've prepared presentation slides to supplement our remarks on the call today which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan, and good morning to all who have joined for today's call. I realize we're holding this call later than we have in the past and we appreciate your patience as we have managed through our internal investigation and worked expeditiously to complete our 10-K filing. Before we start the business update, I want to provide some perspective on the additional release that we issued this morning on the progress we have made in our internal investigation, which is being led by the Audit Committee of the Board of Directors. ADM has historically disclosed in the footnotes to our financial statements that intersegment sales have been recorded at amounts approximating market. In connection with our internal investigation, we've corrected certain intersegment sales that occurred between our Nutrition reporting segment and our Ag Services & Oilseeds and Carbohydrate Solutions reporting segments that were not recorded at amounts approximating market. The adjustments have no impact on our consolidated balance sheets, statement of earnings, comprehensive income or loss or cash flows. In addition, we determined that the adjustments are not material to our consolidated financial statements taken as a whole for any period. We also confirmed that these adjustments did not change the achievement levels under our incentive plans. Further detail is included in the Form 10-K we filed this morning. Throughout this process, we have continued to operate the business and drive our strategic priorities forward. While our internal investigation is substantially complete, we continue to cooperate with the Securities and Exchange Commission and the Department of Justice, and we hope you understand that we will not be taking questions related to these matters on the call today. We will provide updates on this matter in the future as appropriate. Please turn to Slide 4 where we have captured our fourth quarter and full year financial highlights. Today, ADM reported fourth quarter adjusted earnings per share of $1.36, and adjusted segment operating profit of $1.4 billion. Our full year adjusted earnings per share were $6.98, the second best EPS in our history, and our adjusted segment operating profit was $6.2 billion. Our trailing fourth quarter adjusted ROIC was 12.2%, making another year of ROIC performance above our 10% target. Our full year operating cash flow before working capital was $4.7 billion. Our strong cash flow and disciplined management of our balance sheet continues to allow us to invest in our business and return cash to shareholders. In total, we returned $3.7 billion to our shareholders in the forms of dividends and share repurchases in 2023. In January, with the expectation of continued strong cash flows in 2024, we announced an 11% increase in our quarterly dividend, raising our dividend to $0.50 per share, which marks 92 years of uninterrupted dividends and over 51 consecutive years of annual dividend increases. Today, we also announced that our Board has authorized the additional repurchase of up to $2 billion in shares in 2024 under ADM's existing share repurchase program. Our performance for 2023 shows the overall effectiveness of our strategy, where our broad portfolio of business is combined to deliver resilient results for the year. Despite a more challenging operating environment, we maintained strong earnings and ROIC while delivering key strategic accomplishments across the enterprise. Next slide please. To put our 2023 results into perspective, at the end of 2021, we provided a roadmap to create value and growth returns by getting closer to customers and highlighted where we expected to perform on several important strategic metrics by 2025. As I look at our two-year track record over these 2025 objectives, we have delivered adjusted earnings per share at the top end of our $6 to $7 per share EPs objective. We have also continued to deliver ROIC above our 10% target."
},
{
"speaker": "Green Bison",
"text": "Let's turn to Slide 6, which I summarize our priorities for value creation in 2024. We continue building a stronger company for the future and to support this, we have identified three key priorities for 2024. One, managing the cycle; two, nutrition recovery; and three, enhanced return of cash to shareholders. Let's take a closer look at each of these areas of focus. We know that 2024 will be a more challenging year that we faced in 2022 and 2023. We see tailwinds that supported a portion of our performance over the past few years changing direction, making our continued progress on our strategic metrics more reliant than ever on our productivity and innovation agenda. In 2024, we will continue to focus on those strategic initiatives that provide strong growth prospects. Our destination marketing efforts continue to bring us closer to our customers and enable us to serve them in a differentiated capacity and we continue to expand. In 2023, we added three new offices across Asia and the Middle East, and in 2024 we plan to add two to four more. Through this ongoing expansion, we expect to achieve 6% growth in our destination market in volumes. Direct farmer buying has been steadily increasing over the past several years and provides ADM an opportunity to maximize value for both sides by creating efficiencies through working directly together. We plan to take this even further in 2024, leveraging our network of more than 200,000 farmer relationships to grow direct origination volumes year-over-year by about 10%. And as our customers strive to decarbonize their own products and services, we are seeing a steady increase in the financial returns generated by our own decarbonization efforts from Regen Ag partnerships to lowering the carbon footprint of our operations. The pace of this is accelerating as we move into 2024. Tied to these strategic initiatives, we continue to build capacity to serve growing customer demand. I mentioned earlier the opening of our Green Bison soy processing facility as well as the expansion of our Marshall, Minnesota starch facility. These capacity additions support growing demand for a wide variety of sustainable products and solutions, from renewable fuels to industrial products. And connected to our productivity efforts, we have formally launched a 2024 program we call the Drive for Execution Excellence within the organization. Over the years, we have consistently encouraged our ADM colleagues to identify and execute both cost saving and cash generation ideas. We've developed processes and systems through our prior transformation programs and now those are ramping up for another cycle. As part of this, we have already commissioned more than 300 projects and plan to see $500 million in traceable cost savings over the next two years across all aspects of our enterprise, from operations to supply chain to corporate costs. Now let's discuss our plans within the Nutrition business. We're calling this section, of course, nutrition recovery for a reason. Nutrition had a very difficult year with results well below our expectations, and we have been working aggressively to change this and return to growth. For Nutrition, 2023 representing a combination of challenging market forces, some specific non-recurring events and some misses on demand fulfillment. And while market forces such as customer destocking as well as softer demand for plant-based proteins are not within our control, we're already taking action on the areas we can improve. Many of the supply issues are the result of the complexity built into the Nutrition business over time. In our zeal to meet our customers' needs, we have created one of the strongest pantries in the industry. This added complexity in our operations and supply chain that at times impacted our ability to efficiently fulfill demand. To address this, we have made important changes to drive simplification across the Nutrition business that will ease the pressure on our overall supply chain and dramatically improve our demand fulfillment performance. First, we have created a stronger division of duty across operations leadership and added new leaders with a strong expertise in supply chain management. We have also taken steps to build our COE expertise back into the core business, helping make our overall supply chain capabilities more agile and responsive to commercial demand signals. We have also engaged third party experts to help identify further opportunities for operational excellence improvements across our largest facilities. We have also greatly simplified the product and production line landscape to further achieve operational and supply efficiency, reducing the brands we are presenting to customers by two thirds and downsizing about 17% of our SKUs alongside the strategic production line simplification. A recent example of this is the closure of more than 20 Animal Nutrition production lines in 2023, now better serving the product mix and supply chain efficiency of the business. We're also optimizing our Nutrition business portfolio, leveraging our experience in both large scale and bolt-on acquisitions. We have enhanced our approach to M&A integration to increase value creation as we focus more on the integration of recent acquisitions than new targets. We continue to assess our portfolio for a strategic fit, making surgical decisions to achieve the returns targets we expect. For example, during Q4, we took action on two JVs that were not expected to meet our returns criteria. We're proud to see how the team with new leadership has rallied around this recovery plan, which is already showing signs of improvement as we move through the first quarter of the year. Recent trends suggest that destocking impacts in beverages are subsiding and we are well positioned to capture recovering demand in 2024 as evidenced by the strong demand we are seeing in flavors. After heightening our operational efficiency, we've seen steady increases in shipping volumes and productions throughout the course of the last month. And in Animal Nutrition, we have seen another quarter of sequential improvement in the base of the business, which excludes amino acids and pet solutions and early indications in the first quarter of 2024 suggest that this will continue. Importantly, our nutrition value proposition continues to be well received by customers as evidenced by our robust opportunity pipeline and industry leading win rates across key categories like flavors, dietary supplements and pep. ADM's customer centricity and agile innovation capabilities, supported through our creation, design and development expertise, differentiates us. We continue to believe that Nutrition has an important role in ADM's integrated business model. Beyond adding value to the ingredients produced by our AS&O and carbohydrate solution businesses, Nutrition is innovating to address evolving consumer needs and is connecting us more closely with a growing customer base. Finally, I'll turn attention to the capital allocation strategy that continues to guide our strategic cash deployment decisions. As noted, we announced today that the Board has authorized the repurchase of up to an additional $2 billion in shares through the remainder of the year, including $1 billion in shares to be executed through an accelerated share repurchase program as soon as practical. This will total $6.4 billion in repurchases executed since 2022 and coupled with the already announced 11% dividend growth, this is aligned with our commitment to a balanced capital allocation approach. So, combined, we believe these three areas of focus set ADM to perform well in a challenging external operating environment in 2024. I would now like to turn the call over to Ismael for more detail on the results of the operations. Ishmael?"
},
{
"speaker": "Ismael Roig",
"text": "Thank you, Juan. Let's start on Slide 7 which provides overall segment operating income and EPS for 2023. Overall, we delivered the second highest earnings in company history, overcoming a challenging operating environment. Adjusted segment operating profit was $6.2 billion for the full year, a 6% decrease versus the prior year. At a high level, operating profit was primarily down year-over-year in Ag Services & Oilseeds and Nutrition. In the other segment, which includes ADMIS and Captive Insurance, we had a significant increase in operating profit. Adjusted earnings per share were $6.98 for the year. Improved pricing in Carbohydrate Solutions and Nutrition, as well as positive impacts from mark to market timing in AS&O more than offset the impact of lower crush margins, leading to a $0.70 per share improvement versus the prior year. Volume improvement in AS&O was more than offset by volume declines in Carbohydrate Solutions and Nutrition, resulting in a $0.29 per share reduction in EPS versus the prior year. Higher manufacturing costs partially related to unplanned downtime at the Decatur complex led to a $0.41 per share decrease versus the prior year. And lower equity earnings primarily related to Wilmar attributed a $0.46 per share decrease versus the prior year. Increased corporate costs related to higher interest rates and the 1ADM implementation partially offset by higher ADMIS results drove a $0.30 per share versus the prior year. For other, benefits from share repurchases were more than offset by negative impacts related to a higher adjusted income tax rate and cycling one-time benefits from the Legal Recovery and Biofuel Producer Recovery program, leading to a $0.18 per share decrease versus the prior year. Moving to Slide 8, let's look at our segment performance for AS&O. For the full year, AS&O delivered $4.1 billion in segment operating profit, 8% lower than the record level in 2022. Ag Services segment operating profit was 15% lower versus the prior year as reduced origination volume and margins in North America were partially offset by record South American origination volumes. In global trade, destabilization of trade flows led to lower results compared to an exceptional 2022. Crushing segment operating profit for the full year was $346 million lower versus the prior year as improved process volumes were more than offset by lower crush margins and higher manufacturing costs. Refined Products and Other results were $469 million higher, resulting in a record year. Results were driven by higher volumes and margins in biodiesel. Market volatility drove positive timing impacts of approximately $235 million, compared to negative timing impacts of $90 million in the prior year. Equity earnings for Wilmar were $303 million in 2023, approximately 45% lower than the prior year. Now let's move to Slide 9 and look at Carbohydrate Solutions. For the full year Carbohydrate Solutions segment operating profit was $1.4 billion 3% lower versus the record prior year. In the Starches and Sweeteners segment higher pricing and mix were offset by weaker volumes and lower corn co-product values. The teams executed well in a dynamic environment, posting a record year in Wheat Milling. In Vantage Corn Processing strong exports and steady domestic demand and blending rates supported ethanol production and robust margins. The prior year also included onetime benefits of $50 million related to the USDA Biofuel Producer Recovery program. We also continue to make significant progress on our BioSolutions strategic initiative, delivering revenue growth well ahead of our 15% plus target. Please now turn to Slide 10. In Nutrition, revenues of $7.2 billion for the full year were 6% lower versus the prior year. Demand headwinds and destocking impacts, coupled with operational challenges related to the ERP systems integration pressured volumes. This more than offset price and mixed benefits as well as positive currency impacts. In Human Nutrition volumes declined due to lower market demand for plant-based proteins, destocking impacts in beverages, and operational challenges related to the ERP system implantation. This was partially offset by improved price and mix in flavors and texture and pricing in specialty ingredients. In Animal Nutrition, lower complete feed and premix volumes, the normalization of amino acid markets and demand fulfillment challenges in Pet Solutions led to lower revenue versus 2022. Now please turn to Slide 11. For the full year Nutrition segment operating profit was $427 million, 36% lower versus the prior year. Human Nutrition results of $417 million were 25% lower than the prior year as weaker volumes as well as increased costs related to operational challenges from the ERP implementation and unplanned Decatur downtime at Decatur East were partially offset by higher pricing. Animal nutrition results of $10 million were 91% lower compared to the prior year, primarily driven by lower volumes and the normalization of amino acid pricing. When bridging from 2022, our performance can be characterized in three buckets, market forces, one-time items, and operational challenges. Market forces accounted for a majority of the deterioration in 2023 and as previously mentioned, this was mostly related to lower demand and plant-based proteins, destocking impacts in beverages and lower premix and completely demand which impacted volumes across the industry."
},
{
"speaker": "SAVAN",
"text": "Lastly, we also had our own operation struggles that impacted our ability to deliver on the strong demand that we have created. The implementation of ERP systems over the course of the year led to complications in shipping and producing products, negatively impacting both volumes and manufacturing costs. Over the past month, we have seen a steady improvement in operations and are confident that we will see volumes lost in 2023 come back in 2024. Now please turn to Slide 12. For the full year Other segment operating profit was $375 million, up 125% compared to the prior year. ADM Investor Services results improved on higher net interest income. Higher Captive Insurance results on new program premiums were partially offset by higher claim losses. In corporate for the full year, net interest expense increased year-over-year on higher short-term interest rates. Unallocated corporate cost increased versus the prior year on higher global technology spend to support digital transformation efforts. Other corporate was unfavorable compared to the prior year due to one-time investment valuation losses of approximately $57 million. Please turn to Slide 13. Over the last two years the company has generated significant cash flow that have bolstered our balance sheet and provided us with financial flexibility to drive long-term growth. In 2023 we again had strong cash flow of $4.7 billion which were actualized in line with our balanced capital allocation framework. 30% or approximately $1.5 billion of cash flows were reinvested in the business to support growth and modernize our assets, including investments in new capacity and the digitization of our existing asset footprint. Our cash flows also supported significant capital return in 2023 with nearly 30% earnings going to dividends and nearly 60% of cash flows or about $2.7 billion going to shareholders via share repurchases. In 2024 we expect to hold capital expenditures to a level aligned with depreciation and amortization with focus spend around the safety and reliability of assets. We also intend to manage working capital needs prudently limiting M&A beyond previously announced transactions and focusing our team on cost savings and cash generation initiatives through the drive for Execution Excellence. As Juan mentioned earlier, our priorities for cash deployment in 2024 will remain focused around the shareholder. We finished the year with strong momentum in terms of returning cash, repurchasing nearly 1.6 billion of shares in Q4 and nearly 330 million of shares so far in Q1. Over the course of the year, we intend to actualize 2 billion of additional share repurchases, with 1 billion being executed through an accelerated share repurchase program as soon as practical. Now, let's transition to a discussion of guidance for 2024 on Slide 14 please. In 2024, global grain and oil seed supply is expected to increase as anticipated improvements in weather should support larger production levels in key South American countries. Assuming commodity prices ease for recent highs and trade flows adjust to the dislocations created over the past two years, we anticipate global soybean crush margins will moderate in 2024, likely moving into a range of $35 per metric ton to $60 per metric ton. From the demand side, we continue to expect vegetable oil demand growth from renewable diesel and low single digit soybean mill demand growth to support structural margin improvement. We expect adjusted earnings per share to be in the range of $5.25 per share to $6.25 per share, representing an 18% decline from prior year at the midpoint. Now breaking down our expectations by segment for 2024, let's turn to Slide 15. In AS&O, we anticipate the first quarter to be lower and the full year to also be lower versus comparable prior periods as increased global commodity supply and normalization of margins will weigh on the segment. We anticipate global soy crush margins within the range of $35 per metric ton to $60 per metric ton as the market balances better soybean availability against increased crush and renewable diesel capacity. Our Operational Excellence efforts and the ramp up of our Green Bison facility should lead to mid-to-high single digit improvement in our process volumes. We expect significantly lower biodiesel margins in 2023, timing gains to reverse as contracts are executed. In Carbohydrate Solutions, we anticipate the first quarter to be lower versus the prior year. For the full year, we anticipate another strong year, but slightly lower than 2023 as the improved volumes and margins in Sweeteners and Starches could be offset by weaker ethanol. For nutrition, the first quarter is expected to be lower versus the prior year as we face headwinds from a normalizing texturants market, fixed costs associated with operational challenges related to the Decatur East and protein volumes. However, for the full year we expect Nutrition to begin its path to recovery. We anticipate conversion of our significant pipeline opportunities in Human and Animal Nutrition to yield mid-single-digit revenue growth. We assume market normalization in texturants to be a headwind in 2024. We do not anticipate the significant one-time events of 2023 to recur. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Ismael. Please turn to Slide 16. In summary, let me once again share the three priorities for our year ahead. We will continue our efforts across the business to drive our productivity and innovation portfolio of projects, taking advantage of capacity gains we have made and ensure that our teams are generating and executing on our drive for Execution Excellence. We continue to take aggressive actions in the nutrition business to ensure that it can deliver on the areas of growth that we have continued to build into our opportunity pipeline. This includes supporting the operational changes we have introduced, driving simplifications through our products and brands, and ensuring that our business portfolio is tuned to best achieve our return expectations. And we're also actively managing our balanced capital allocation strategy, both prudently investing in the business while growing our dividends and accelerating our share repurchase program to return more to shareholders in the near-term. I believe strongly in the powerful role ADM plays as a leader in the agriculture supply chain, and that our ability to bring partners together across the value chain will be critical to driving future transformation in the food, feed, fuel and industrial markets we serve. I want to express my gratitude to the ADM team for their dedication, hard work and resourcefulness. I'm confident in our ability to deliver solid results as we move into 2024 and continue to pave a path for long-term profit growth. Operator, please open the line for questions now."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Adam Samuelson of Goldman Sachs. Adam, the line is yours."
},
{
"speaker": "Adam Samuelson",
"text": "Yes, thank you. Good morning, everyone."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Adam. How are you?"
},
{
"speaker": "Adam Samuelson",
"text": "Good morning. Good. So I guess my question is really around framing the go-forward outlook in terms of the cyclical versus the pieces that ADM controls. And you had the targets from the 2021 Investor Day still on the slides of returns and earnings per share. The outperformance the last couple of years has been largely cyclically driven in AS&O, whereas some of the investments and the items under your own control, particularly Nutrition, have not performed up to expectations. As we think about 2024 that's at least the cyclical parts are reversing, at least in part. Can you Juan put a little bit more finer point on how you think about 2024 versus normalized earnings for the business and maybe quantify the path forward in Nutrition beyond this year as you work to earn a return on the substantial investments you've actually made in that business?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Adam. So let's take each of the businesses in the portfolio. So when we think about Ag Services and Oilseeds, as you said, we had a spectacular performance over the last couple of years, taking full advantage of the opportunities in the market. But we forecasted in 2021 that margins were going to moderate, although they were going to stay higher than historical averages and we are seeing that. We see the moderation and we see even crush margins, 35 to 60, that we are forecasting are higher than average. We have not stayed quiet waiting for the cycle to reverse. We have been adjusting our business model. You heard me saying about destination marketing, something we didn't have a few years ago, and we continue to grow that. That gives us extra margins and now we are forecasting that we continue to expand and we're going to grow those volumes 6% this year and that programs continue as we expand into new geographies in the Middle East and Southeast Asia. When you think also about the Regen program, Regen AG program that we have with our customers, we are helping our CPG customers with their Scope 3 emissions and we are working together with the farmers and that program is the leading program in the industry and continues to grow. We are also doing everything in the value chain. We're looking at farmer direct. That's an ability for us to get efficiencies between us and the producer, the way we buy grain. So of course, we get an advantage with that as the producer as well. And we're planning to increase our volumes 10%, leveraging on the 200,000 farmer relationships we have around the world. Of course, we have expanded capacity. We are expanding crush in Latin America. We are expanding crush in North America with Spiritwood. So I would say when you take that, plus our operational improvements, if you will, what we call the push for excellence, that was going to be the productivity and innovation agenda that were going to help us navigate through this. We see 2024 still as a strong year for Ag Services and Oilseeds, it's going to be lower, but it's still going to be a strong year. Of course, the market has priced a lot of the extra capacity and the higher argentine crop into the crush margins. But we still see the ability of the market to absorb all that capacity with a strong mill growth and with a strong demand for oils. So that on the Ag Services and Oilseeds side. On the Carb Solutions side, this business has been very stable over the last few years. It has had a very good 2022 and 2023. We are expecting a very good 2024, maybe slightly lower, but still very, very good. We had a good program for good contract renewals in 2024. We are happy with the margins. We have maintained margins for the most part, and we have gained some volumes, so volumes are strong. The milling business has been going, had a record year last year, and it continues to drive very strong. I think both businesses have a little bit of a lower contribution from feed products, where margins have decreased a little bit, but BioSolutions, as Ismael mentioned, continues to grow, is growing beyond 15% per year. And all their decarbonization things that we're saying, we see more and more demand for everything that carb solutions can bring to the table in that area. So we feel very good about that. Always the question mark in the year maybe is ethanol, but we're seeing right now, Adam, ethanol, the arbitrage to export from the U.S. is open to everywhere in the world. So it's just a matter of adjusting our capacity and the U.S. capacity to get more dehydrated ethanol, if you will, to be able to export, to adjust the humidity content, if you will. So, I think we'd export well north of maybe 1.5, 1.6 billion gallons for this year. That should bode well for recovery of margins as we go into the year. And then you take nutrition. Nutrition has been a growth story for many years, and we certainly stumbled in 2023. I mentioned some of the reasons. Some of the reasons were, there was a big destocking after all the COVID and all the supply chain issues that the industry have, the industry stopped. And now we went through lower inflation and this talking about that. So we had to go that in beverages, which drives flavors, which is our biggest engine for growth, if you will. Of course, we knew into the year that plant-based proteins, we have moderated our expectations for growth on that will still grow, but it's not going to be beyond 10%. So it's still going to be an attractive mid-single-digit growth, if you will. But we knew that, and then we had continued growth in continued good demand in pet and health and wellness and Animal Nutrition has been improving their P&L, doing a lot of self-help from the June P&L. It's been improving all the year. So unfortunately we get to the Q4 and we had several events in Q4. We have several one offs. We needed to take action on a couple of joint ventures and we addressed that. We needed to take a revaluation of an investment because of the end evaluation and we took that in the Q4. And then we have some issues on our own performance that we needed to implement 1ADM as much as we prepared for that. We had some problems with some of the modules. It was a successful implementation, but some of the modules that were about shipping products gave us trouble during the last quarter of the year. So when you have all that combination, it gave us a very bad quarter. We continue to see 2024 a year of growth or recovery, if you will, from the 2023 value. And from there, we should continue to march on our commitment to nutrition. Our ability to fulfill or to deliver a value proposition that resonates with customers continue to be evidenced by our growing pipeline, both in Animal and Human Nutrition, and our conversion rate we have benchmarked this is industry leading conversion rate. So we know we are winning. We need to adjust our own internal processes to make sure we deliver that. And we have done that heavily in the last -- second half of last year, and we have seen that during January and February that we are delivering much better than we did last year. So with that, I still look confident at the numbers, at the overall number for the company that we gave you for 2025. As I said on the onset, we are ahead on what we scheduled. From an EPS perspective, we are above 10% in ROIC and we have purchased already more than the $5 billion of share that we have estimated for 2025. So it's never going to be a straight line from here to 2025. But we have a resilient portfolio that can help us see that those numbers for the overall portfolio are still possible, as it was in December 2021. Sorry for the long answer. It's a large company."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Tom Palmer of Citi. Tom, please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "Good morning. Thanks for the question. I wanted to dig in a bit more on crush margins and your $35 to $60 global soybean crush outlook. Maybe just to frame it, where were global crush margins last year? Where are crush margins currently? When we consider different regions of the world, and then as we think about the items that could drive to the upper or lower end of this year's range, what are kind of the key items you're looking at? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Tom. So, as we said before, Ismael mentioning his remarks, we expect crush margins between $35 to $60 for this year, they were about $70 per ton, maybe last year. I think it's fair to say that the market has completely priced or baked all the bad news into the crush margins are we having today? So, I would say board crush has moved significantly lower in the last month as the market probably gained more confidence in the availability of products, especially soybean meal, particularly when you think about Argentina now having sites on a crop that may be 50 million tons. And the U.S. crush industry also has performed very well. And the market continued to look forward to the second quarter of the year when they're going to have basically three offers for meal. That hasn't happened last year. So if you remember, last year, after Brazil finished in exporting, the U.S. became the only global, only gaming town, if you will. And that increased soybean meal values around the world, which makes soybean meal expensive, if you will for the Russian. We see that in the U.S., we saw, at least for ADM, we saw five consecutive months of record exports for soybean meal in the U.S. And the U.S. industry saw similar situation. So now with the correction in this, we expect that soybean meal will gain back into the Russians. Of course, feeding with meat pros and not soybean milk is not the optimal way to feed. So now that soybean milk has corrected, we expect that to happen. At the end of the day, Tom, the way I think about where crush is going to happen in the world is going to happen in both places where you have bean availability and where you have a domestic oil market. If you think of Brazil, Brazil is having B14 started in March. And that has helped with the margins of domestic oil for us in Brazil. And of course, you have a big crop, so you're going to have the bean availability and the domestic market. And then it will be the U.S. in which you have all the need of soybean oil to go into renewable green diesel and biodiesel and we have, of course, the bin availability. So we think that crush will favor those two places."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Andrew Strelzik of BMO. Andrew, please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "Hey, good morning. Thanks for taking the questions. I guess ultimately, my question is about 2025 and whether you view 2024 as kind of the trough here from an earnings perspective in terms of the cycle. And if I just follow up on maybe you made some comments at the end of the response to Adam about 2025. I didn't know if that was specific to the metrics around nutrition or the prior earnings guidance that you had talked about. If you could just kind of clarify the way that you're thinking about that is this 2024 an earnings number from, which you would expect to grow, and then the 2025 comments with that. Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Andrew, first of all, my comment before to Tom's question was the overall number that we gave for the company for 2025 in 2021. We still believe that number is there. I think that that number was never going to be a destination for ADM, was a milestone, if you will. And as we are reviewing our five-year plan that we do every year we see us breaking through that number. So in that sense, I expect 2024 to be a down year versus 2023 hopefully 2025 will be a positive year versus 2024. There is a cycle here that needs to happen, Andrew, that I described below, soybean mill will get cheaper. All the oil activities related to B-14 or RGD needs to grow. All that needs to happen and how long that adjustment takes, how long it takes for meal to be low enough to increase demand and for flat prices to be low enough to maybe make the farmer correct a little bit. They are planting all that process we know historically happens, when exactly it's going to happen. Does it happen in a calendar year? Doesn't happen in six months. Does it happen in a year is hard to say. But we continue to build a company that has more optionality, that's more resilience for the future. So as the cycle moderates, we continue to have more ability to bring more to the P&L. So we think with that, I'm optimistic about 2025 being better than 2024."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Bienvenu of Stephens. Ben, the line is yours."
},
{
"speaker": "Ben Bienvenu",
"text": "Good morning."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Ben."
},
{
"speaker": "Ben Bienvenu",
"text": "Juan, I want to ask, as we think about the morning, I want to ask as we think about 2024 for the nutrition segment, you note that you expect mid-single digit revenue growth, operating profit to be higher over year. I think the natural inference would be that the operating profit growth is up by less than 5% or mid-single digit revenue growth. Is that true? And then as you referenced in kind of the cadence and your expectations for the first quarter, this is a trajectory of recovery that will build throughout the year in 2024. You talk about pipeline conversion. Are there residual headwinds, discontinuities from the Decatur complex still in the first quarter? Help us think through the sequencing of the development of return to growth and nutrition."
},
{
"speaker": "Juan Luciano",
"text": "Yes, good question, Ben. Let me give you the puts and takes, if you will, on nutrition as we look at 2024. So as Ismael said in his remarks, about half of the headwinds that we faced last year were market. That means that half of them were in the other two buckets, the non-recurring events, if you will, and those by nature we hope that we're not going to have going forward. And I think Ismael qualified them about $60 million something give or take. And then the other ones were like some of the demand fulfillment issues that I explained how we have worked aggressively to correct. And we have seen good indication of that over the first two months of this year. So I would say those are the positive that we don't expect all that to happen again in 2024. You put on top of that a single digit revenue growth, mid-single digit revenue growth because of the pipeline that we have and the conversion of that pipeline. And that tends to happen every year. Then, as you described, we have to have to face a correction of texturizing prices that were exceptionally high last year. We're not going to have that. So that will be part of the negative side, if you will. And certainly, as we go through the year, we still need to bring Decatur East plant back into operations, and that will have a tail of a cost. So I would say the year will be driven by a strong recovery in Animal Nutrition, in flavors, and hopefully pet with some tailwinds in the specialty ingredients. That's how we see."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ben Theurer of Barclays. Ben, please go ahead."
},
{
"speaker": "Ben Theurer",
"text": "Yes. Good morning and thank you very much for taking my question. Juan, Ismael wanted to follow-up on carbohydrate solutions because that obviously, as you've highlighted, has been a very solid performer last year. Even the outlook looks very promising still in comparison to maybe some of the other segments for 2024. And I wanted to understand where you are within your different asset bases, be it on the ethanol side, but also particularly Starches and Sweeteners for the need to invest into the business. Where are you in terms of capacity and what do you need to potentially allocate money to in order to keep that business up where it is, or potentially further grow it as it has gained significance within the consolidated ADM results? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, Ben, I'm glad you're highlighting carb solution. They had a spectacular year. They deserve recognition and they've done a fantastic job of transforming their business into a very resilient and stable business. The assets let me take it by pieces. The milling business. Milling is an old business that has some old assets. And over the last few years, we have been doing -- the team has been doing a terrific job of shutting down some assets and consolidating those in new facilities like Mendota that we launched last year. That is the best and the newest wheat milling plant in the world. So we are happy with the way they have done that. They continue to do so. So that business is in good shape. When we look at the wet mills, we continue to invest in part of the wet mills. Unlikely that we're going to build a new wet mill, as you can understand, but that business continue to be reinvested in. It's a business that is a large business has a large asset footprint. And at the moment there is a lot of capital being associated with the path to decarbonize all these assets. So as you heard, we have a lot of efforts in trying to get pipelines to try to monetize some of our CO2 that come from the biogenic CO2 that come from the ethanol plants. So and I would say we have expanded Marshall because BioSolutions is growing at north of 15% per year. So we needed capacity. So the Marshall expansion is about 50% expansion to the final starch capacity that we have there. And that will help a lot with that. I would say the year is exciting as it is developing. It has solid margins. It has so far solid volumes. It had a little bit of a rough January because of the bad weather. We have ice in the plants and freezing weather. But February, March, things look good. And we think that that business has the opportunity to get some tailwinds from lower energy cost and maybe chemicals cost as the year go by. And that's a big energy hog, that business. So that could be an advantage and a tailwind coming later in the year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Manav Gupta of UBS. Manav, please go ahead."
},
{
"speaker": "Manav Gupta",
"text": "Thank you. I just had a quick question. When we look at the carb, recent proposals and then we look at the 45g, it looks both at the federal level and at certain state levels there is a desire to lower the amount of renewable diesel being produced from vegetable oil. And I'm just trying to understand, do you see that as some kind of a headwind whereby eventually the demand for soybean oil from the renewable diesel or biodiesel industry could actually decline versus what we are seeing or you think this is just passing and the demand eventually will rise again as we move along?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Manav, for the question. Listen, I think the path is clear for RGD, that RGD will need vegetable oils. When you think about how Europe is doing, Europe not having a raw crop for that, Europe needs cooking oil, waste oils, and they will capture that. The U.S. will have to be fed with soybean oil, canola oil. And we see that commitment to be firm over the years. All these capacities being built, it cannot be filled with anything else. So we feel that is a strong trend ahead of us."
},
{
"speaker": "Operator",
"text": "Our next question comes from Salvator Tiano of Bank of America. Salvator, please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "Yes, thank you very much. I just want to go back to the 2025 target of $6, $7 in EPS. I mean, that is obviously double digit EPS growth and I understand buybacks play a role into that. But given the comments about controllables versus cyclicals, it seems really tough to imagine getting back there. Can you provide a little bit some of the key components and key buckets that you think will get you there in terms of its segment and specific numbers as detailed as possible?"
},
{
"speaker": "Ismael Roig",
"text": "Yes, Salvator listen, a little bit of what I explained early on Adam's question. I think that we will see how the cycle plays in ASNO. As I said, I think that lower prices have this ability to incentivate demand. At this point in time If you think about soybean meal demand, we are forecasting a very strong soybean meal demand, maybe higher than USDA levels, higher than GDP. When you think about Southeast Asian economies recovering and with inflation moderating, purchasing power is improving, tourism is improving in all those areas, you have at the moment very high prices of beef that's favoring pork and chicken. You have protein margins for chicken being better at that. So we think that soybean meal will gain in the Russian. So when we look at all that, we see the soy oil demand very strong in domestic consumption, but also for biofuels, and then we see the meal demand very strong. We think that this correction should be probably short term for crash and that should come back again. I cannot make a prediction on the timing of that, but we know how the cycle plays. So whether it's calendar year this or six months later or a quarter earlier, it's not for me to venture into those guesses. I think that carb solutions between the exceptional job they are doing on managing their mature businesses and the growth that they are getting through decarbonization and BioSolutions, you will see that ahead of us. Again, we just bring in the Marshall expansion. That's not something that it was in our forecast last year. So we're going to have it more in the next three quarters, if you will, of the year, Spiritwood again, and some of the crash capacity we brought in Brazil, and then you see nutrition. That nutrition was not a contributor, certainly a big contributor to growth in 2023, but we expect it to be back to growth in 2024 and 2025. So those are kind of the buckets, if you will, that I see at the moment."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Steven, the line is yours."
},
{
"speaker": "Steven Haynes",
"text": "Hey, good morning. Thanks for taking my question. Maybe just to come back to nutrition, I think in your prepared remarks you talked about some portfolio refreshment going on there and was wondering if you could maybe size, the scope of that. Are you thinking more kind of product line oriented here, or is this kind of more at the business level where you might be looking to monetize something? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, Steven, listen, let me give you my thinking on that and the way we approach these things. So we always look, every time we do our five year plan, we take a look at those units that whether they are not returning, given our return expectations to date, we're not forecasting it to do it in the medium term. And those are the ones that we tend to take action. So we took action with a couple of joint ventures, as I mentioned, and then we look at every unit that is underperforming. What we do first is we try to bring them to performance. So we make sure that if there are some things that are self-inflicted, if you will, we correct those things. Once we correct those things, and then we have visibility to what could happen over the next two or three years, then we decide as a part of portfolio whether they belong in nutrition or they belong in another part of ADM, or they belong outside ADM. So that's a regular process. We done, we done it in the past with fertilizers, Latin America, we've done it in the past. We divested Bolivia. We divested cocoa and chocolate. So we've done this, and now we've done it with a couple of joint ventures. We've done it also. Ismael has done it in his previous job as an Animal Nutrition leader with some of the lines in Animal Nutrition that we cut, like 20 lines around the world. So sometimes we have exited countries. So it's a regular process that at times, maybe when you have a stumble like we had in nutrition, you look a little bit deeper, because now, all of a sudden, you have more businesses at lower performance. So we really want to see, is it worth investing in some of those? So we're in that process. So, nothing to announce today, but we continue to look at that very deeply."
},
{
"speaker": "Ismael Roig",
"text": "Just a couple of complimentary comments, because not only have we had some experience historically, as Juan correctly mentions, with [indiscernible] and fertilizer, but certainly the Animal Nutrition was a good precursor to some of the thinking that we have now in mind for the whole of our nutrition business. In the sense that usually when you acquire these businesses, they come with footprint allocations, labs, farms, in our cases, and warehouses, that when you aggregate them, start aggregate them across a number of different acquisitions, you realize that there are overlaps. And what we noticed is that there was a significant opportunity in Animal Nutrition to significantly simplify the portfolio by reducing the number of labs, reducing the number of SKUs of plants. And we've seen those benefits. They've been occurring since the second half of 2023. And I think that some of that thinking, as we have built this organization via a multiplicity of acquisitions, lends itself now to a pause and reflection, in light of the successes that we've had with this, to apply it more broadly to all of the portfolio. So that's where our capital prudence is going to come in, by focusing on ensuring that we improve our asset base while returning cash to our shareholders."
},
{
"speaker": "Steven Haynes",
"text": "Thank you, Ismael."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Dushyant Ailani of Jefferies. Dushyant, please go ahead."
},
{
"speaker": "Dushyant Ailani",
"text": "Thank you for squeezing me in. I just wanted to quickly talk about biodiesel margins going forward. Your thoughts just around the system, both in the U.S. and internationally, just how do we frame our thoughts around that and capacity as well?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Dushyant. Well, all useful biofuel production is, as I said, is expected to grow in Brazil. We're going to go to B14, so there are many countries that are increasing their mandates, whether it's Indonesia and all that. When you look at the overall balances around the world, you see plantations in Southeast Asia getting older, the trees getting older, so maybe less production of palm oil. So you're going to see biodiesel mandates increasing around the world and less competitive pressure, if you will, for palm oil. So you're going to see the pressure on vegetable oil. So we think that that will continue to be a strong leg of the crash, biodiesel in particular. Biodiesel margins are better right now for us in Europe. They have moderated significantly in the U.S., and we expect them to be good, but not as good as they used to be in the U.S. So that will be a little bit of a headwind for us in 2024. But margins are better in Brazil and in Europe. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. With that, we have no further questions, so I'll hand back to the management team for any closing remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you for joining us today. Please feel free to follow up with me, if you have any other questions. Have a good day and thanks for your time and interest in ADM."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 3 | 2,023 | 2023-10-24 09:00:00 | Operator: Good morning, and welcome to the ADM Third Quarter 2023 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Thank you, Alex. Hello, and welcome to the third quarter earnings webcast for ADM. Starting tomorrow, a replay of this webcast will be available on our Investor Relations website. Please turn to Slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today's webcast, our Chairman and Chief Executive Officer, Juan Luciano will discuss our third quarter results and share some recent accomplishments on our strategic priorities. Our Chief Financial Officer, Vikram Luthar will review segment level performance and provide an update on our cash generation and capital allocation actions. Juan will have some closing remarks, and then, he and Vikram will take your questions. Please turn to Slide 3. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan and good morning to all who have joined for today's call. Today, ADM reported third quarter adjusted earnings per share of $1.63 with an adjusted segment operating profit of $1.5 billion. Year-to-date, this equates to an adjusted earnings per share of $5.62, that will represent ADM's second best EPS year achieved in just the first nine months and an adjusted operating profit of $4.8 billion. Our trailing four quarter average adjusted ROIC was 13.2%. This result reflect yet another strong quarter for ADM. I'm proud of the team's nimble execution against our strategic plan while adjusting our business model in light of both global macro trends and the evolving needs of our customers. The global market is increasingly dynamic with factors that create both opportunities and challenges for ADM to address. Consumer behavior has shown growing variability, spending more in some categories, while slow in spending in others. And our team has a proven ability to manage through these and the impacts of geopolitical tensions, inflationary pressures and the constantly adjusting balances of commodity supply and demand. Within each business, we are focused on navigating these external factors carefully, while we're also building on the momentum we've seen through the year-to-date. As we look ahead, we are on track to exceed our 2023 previous expectations for the total company. In Ag Services & Oilseeds, we saw the accelerated energy transition support strong demand for vegetable oil, leading to a solid crush environment. We leveraged our flexible logistics footprint to manage Brazil's record crop and our Global Trade franchise to best match supply to demand worldwide. In Carb (ph) Solutions, we delivered a record third quarter on the strength of solid margins in starches, sweeteners, and flower, as well as robust ethanol demand that help us drive strong volumes and margins. In Nutrition, Flavors growth continued to outpace the market, while we both grew and executed on our revenue opportunity pipeline. The deliberate productivity and cost management actions we have taken in Animal Nutrition are enabling improved performance as we also see market volume recovery and we continue to navigate pockets of soft demand in certain categories of the Nutrition portfolio. Next slide, please. One of ADM's greatest competitive advantages is the breadth and integration of our business model, reaching from farm to fork. 2023 has offered several examples that of how we are creating new areas of growth in each business units. On the farm, ADM has one of the largest and most sophisticated global origination networks, connecting with hundreds of thousand farmer partners worldwide. We have unique and deep relationships with the people and technologies that are shaping the future of agriculture. So as more of our customers are looking for traceable, sustainable crop sources in their own supply chains, we are a natural connector and influencer. We are proud to have announced partnership with PepsiCo, Nestle and Carlsberg, and have a target of 4 million regenerative acres and goal by 2025. The carbon equivalent of power in more than 100,000 homes a year. Moving into production, as the pace of energy transition accelerates, demand for renewables fuel sources is growing rapidly and ADM is in a leading position to capitalize on this trend. With our Spiritwood JV with Marathon currently being commissioned, we are ready to fit the production of a targeted 75 million gallons of renewable green diesel per year. We have announced the Broadwing Energy Project, delivering lower emission power source and a critical part of lowering our carbon emissions used to power Decatur operations. And we're innovating to deliver a new low-carbon intensity products within the fast growing BioSolutions portfolio. And as we connect to the consumer, we're working closely with our customers to serve the challenges of their consumers, whether it's sustainable solutions, the latest flavor or a cost effective ingredient replacement or explore in the future of nutrition through work with ADM Ventures partners like Air Protein and Nourished. And we have differentiated our offerings with the next-generation of evidence-based health and wellness solution. With the world's largest probiotic manufacturing facility in Valencia, more than 50 clinical trials underway and a growing team of deep scientific experts, we are well positioned for the expanding demand for functional foods and personalized nutrition. And to efficiently execute on all areas of growth while maintaining an efficient cost structure, we continue to vigilantly focus on productivity, as well as the culture that let our ADM colleagues bring their best every day. Across our global organization, we're standardizing processes and systems through One ADM and modernizing our operations through digital transformation, driving greater efficiencies while enabling the best use of our workforce and production capacity. Our planned modernization program continues to deliver impressive operational benefits, including advanced analytics and safety improvements across the 17 operations facilities currently in implementation phase. With more than 70 plants in the scope, the planned recurring cost savings associated with automation across our footprint in 2024 is already nearing $20 million per year. Our cultural efforts are the critical foundation for all of these strategic initiatives. We have ramped up our focus on a culture of caring, specifically in regards to the safety of our colleagues. This is our top priority. And our recent performance in this area has not lived up to our expectations. We are committed to taking action to improve and have already begun to do so with the assistance of both internal and external experts. We will do better. By actively managing productivity, innovation and culture and aligning work to the interconnected trends in food security, health and wellbeing and sustainability, ADM is well positioned for sustainable long-term profit growth across new and adjacent avenues. And with the strong performance in 2023 and a constructive expectation for the remainder of the year, we are again raising our full-year earnings outlook. For a deeper look at our Q3 performance, let me hand over to Vikram, who will cover results of operations.
Vikram Luthar: Thank you, Juan. Please turn to Slide 5. The Ag Services and Oilseeds team once again delivered solid results in an increasingly dynamic environment by leveraging our experience, scale and integrated global footprint. Ag Services results were lower than the strong third quarter of 2022. South American origination results were higher year-over-year as our team delivered significantly higher volumes and margins on strong export demand. Prior investments in port capabilities have enabled us to structurally grow our earnings while capitalizing on a stronger margin environment across the region. North American results were lower year-over-year as a result of the shift of export demand to Brazil, due to the large crop there as well as low water levels in the U.S. river system, limiting volume and barge capacity. Effective risk management, combined with higher volumes and margins in Global trade led to strong results. However, much lower than the record quarter last year. The current quarter also included a $48 million insurance settlement related to damages from Hurricane Ida. In Crushing, we delivered another strong quarter, but lower than the prior year as global crush margins remained healthy, but lower than the very strong levels of a year ago. Our strong results were led by North America, as the crush margin environment remains well supported by structurally higher demand for vegetable oils. We officially opened our new crush facility in Spiritwood, North Dakota to meet growing demand. We are currently in the commissioning process and expected to be running at full rates in early November, adding an additional 1.5 million metric tons of crush capacity per year. In EMEA, we continue to optimize our flex capacity to prioritize crush of higher margin softseed, in line with market opportunities. In the quarter, there were large net positive mark-to-market timing effects which were lower than the net positive impacts in the prior year quarter. Refined Products and other posted another strong quarter, higher than the prior year period, results were led by solid volumes and margins in North America. In EMEA, robust export demand for biodiesel and domestic demand for food oil drove higher results versus the prior year. In the quarter, there were large net positive mark-to-market timing effects, which are expected to reverse as contracts execute in future periods. Equity earnings from Wilmar was significantly lower versus the third quarter of 2022. Looking ahead, for the fourth quarter in Ag Services and Oilseeds, we anticipate strong results that are slightly lower than last year, excluding the $110 million legal settlement in the ag services subsegment from the fourth quarter of 2022. We expect Ag Services results to be in line with the prior year, excluding the legal settlement. We anticipate similar year-over-year North American export volumes, a competitive South American export program and continued strong performance from global trade. We forecast our crushing subsegment will deliver strong results similar to the prior year. We expect robust soy and canola crush margins and with the ramping of our Spiritwood operations higher volumes. We expect RPO to perform well, but be significantly below last year as positive timing impacts from prior quarters are expected to reverse. Slide 6, please. Carbohydrate Solutions delivered an outstanding quarter that was significantly higher than the prior year, enabled by the ongoing optimization of our production and supply chain network. The starches and sweeteners subsegment were higher year-over-year on a healthy demand and strong margin environment across starches, sweeteners, wheat flour and ethanol. Our team generated new customer wins and delivered double-digit growth year-to-date in our BioSolutions platform. As Juan touched on earlier, we also signed a formal agreement with Broadwing Energy to provide lower emissions power to Decatur facility, extending our ability to provide low carbon solutions across the value chain. In the Vantage Corn Processors subsegment, our team executed well in a strong ethanol demand and margin environment, leading to significantly higher year-over-year results. Looking ahead for the fourth quarter, we expect steady demand and margins for our starches, sweeteners and wheat flower products. We remain constructive on ethanol margins driven by solid domestic demand and healthy U.S. exports, supported by lower competing exports from Brazil due to higher sugar prices. We anticipate results to be similar to the prior year period, but with upside potential if the current ethanol margin structure holds. On Slide 7. In Nutrition, strong results in Flavors, health and wellness and recovery in the base Animal Nutrition business were more than offset by continued lower demand for plant-based proteins and persistent demand fulfillment challenges in pet solutions. Flavors reported impressive results in a complex operating environment, delivering a 29% growth in operating profit on a constant currency basis. Results were led by pricing actions in EMEA and strong win rates in North America. During the quarter, we also implemented a successful go-live of our One ADM project in the EMEA region across 18 locations in 12 countries. This represents a significant milestone as we continue to harness digital across the enterprise to drive productivity gains. In Specialty Ingredients, weak market demand, particularly in the alternate meat category, inventory adjustments and unplanned downtime resulting from the recent Decatur incident led to significantly lower year-over-year results. The plant-based protein market has been experiencing destocking and consumer demand softness over the course of the year that will likely persist into next year. Given these recent market dynamics, we have re-scoped our Decatur protein modernization investment project to better match the expected lower growth demand environment. Also, we are leveraging our expertise in creation, design and development to differentiate our product offerings to serve evolving consumer needs. These adjustments will enable a faster pivot to higher growth and more resilient categories such as specialized nutrition, which have synergies across the nutrition portfolio, and we are rapidly building this revenue pipeline. Health & Wellness results were higher year-over-year due to double-digit bioactives sales and a favorable impact related to the revised commercial agreement with Spiber. During the quarter, we realized a significant expansion in our revenue pipeline, reinforcing the demand for evidence-based solutions. In Animal Nutrition, we are beginning to see the cost optimization actions and the expansion of offerings in the specialty feed and ingredient space from earlier this year, driving improved performance. However, the recovery in the base business was more than offset by normalized year-over-year amino acids margins as well as lower profit contribution from the Pet Solutions business. Looking forward, we anticipate flavors to finish the year strong, driven by growth in EMEA and North America. Health & wellness operating profit is expected to finish similar to last year. Animal Nutrition operating profit is expected to continue to recover sequentially quarter-over-quarter. Specialty Ingredients operating profit is expected to be down significantly, impacted by the recent Decatur East incident and demand softness. All in, we now expect full year 2023 operating profit for Nutrition to be around $600 million. While our results in 2023 have been below our expectations, we expect nutrition to return to growth in 2024. We will continue to build on the Flavors momentum from 2023. Health & wellness should maintain its steady performance. The cost actions in the shopper pivot to higher-margin products will enable Animal Nutrition to drive growth, further reinforced by improved go-to-market capabilities. Lastly, for SI, we will work aggressively to restart operational capabilities at Decatur East to minimize the impact in 2024. Slide 8, please. Other business results were significantly higher than the prior year quarter due to improved ADM investor services earnings on higher net interest income. Captive insurance results were slightly lower on higher claim settlements partially offset by premiums from new programs. In corporate results, net interest expense for the quarter increased year-over-year, primarily on higher short-term interest rates. Unallocated corporate costs of $298 million were higher versus the prior year on higher global technology spend to support our digital transformation efforts. Other corporate was favorable versus the prior year, primarily due to foreign currency hedges. We still forecast corporate cost to be approximately $1.5 billion for the year. The effective tax rate for the third quarter of 2023 was approximately 20% higher than the prior year primarily due to a change in the geographic mix of earnings. For the full year, we still expect our effective tax rate to be between 16% and 19%. Next slide, please. Through the third quarter, we had strong operating cash flows before working capital of $3.8 billion. We continue to invest in the business, allocating $1.1 billion to capital expenditures and have returned $1.9 billion to shareholders through share repurchases and dividends. We have ample liquidity with over $13 billion of cash and available credit, and our balance sheet is very strong, with an adjusted net debt-to-EBITDA leverage ratio of 0.9. Our fortress balance sheet gives us the financial flexibility to drive our long-term strategic agenda while also returning capital to shareholders and is also a competitive advantage, particularly in a higher for longer interest rate environment. We have completed $1.1 billion of share repurchases through Q3 and expect to increase the pace of repurchases in Q4. Even with the softness in nutrition, and lower-than-expected profit contributions from Wilmar. We are raising our 2023 earnings outlook again and now anticipate full year EPS in excess of $7 per share. Juan?
Juan Luciano: Thank you, Vikram. As we close today's call, let me share a few thoughts about how we're seeing our efforts in 2023 position ADM to continue solid progression into 2024. External factors that influence ADM's forward look are closely aligned to the enduring macro trends we have positioned ourselves to be nimble in managing. We continue to see the interconnectivity across food security, health and well-being and sustainability having an amplifying effect across the industries we serve. More frequent extreme weather, extreme weather, geopolitical events and the recent pandemic have all highlighted the criticality of food security within those geographies and for the regions that are served by their agricultural exports. Connected to this, we see areas of supply abundance growing as evidenced by Brazil's record recent crop cycles and areas of need shifting. In some cases, this has resulted in either more domestic consumption in countries like the U.S. or elevated import demand situations where our unparalleled global asset base and deep experience are critical. Government policies beginning to support new demand patterns, whether based on a move to more renewable energy sources or an effort to increase regenerative agriculture supply. Science continues to accelerate innovation in Nutrition with an ever-present consumer interest in turning their food, beverage and supplement consumption to their personal health and dietary needs. Beyond the challenges and opportunities connected to these external factors, we believe ADM is positioned to leverage productivity and innovation to build momentum in the coming year, a continuation of the strategic efforts we have been driving throughout 2023. We anticipate our Services and Oilseeds continue to leverage its extended value chain and deliver structural changes to demand. We anticipate that crush margins will remain healthy while our productivity measures enable us to have a more efficient cost structure. We continue to drive opportunistic extension of our destination marketing scope, grow our regenerative agriculture acres and partnerships, and expand our renewable fuels feedstock production. In Carb Solutions, the compounding effects of our transformative investments coupled with early contracting for starches and sweeteners and what we believe to be a positive ethanol environment are setting up for another strong year in 2024. For Nutrition, we expect continued growth in our revenue opportunity pipeline with significant conversions continuing as we move past some near-term demand weakness. Our expanding results in flavors continue to signal acceleration across our broader portfolio. We expect the positive revenue growth trends in Health & Wellness to drive into next year, and we're already pivoting Specialty Ingredients towards high potential areas like alternative daily and specialized nutrition. Our actions in Animal Nutrition are delivering a positive impact and sustained opportunity growth, which we believe will expand further through the segment in the coming year. And by applying our commercial excellence efforts to this portfolio, we are focusing on the value of innovation in the specialty parts of the business. In closing, I want to express my gratitude to the ADM team for their dedication, hard work and resourcefulness. With the momentum we have been building upon the foundation for growth we have established, I am confident in our ability to continue to deliver solid results as we move into 2024 and continue to pave a path for long-term profit growth. Thank you. Operator, please open the line for questions.
Operator: Thank you. [Operator Instructions] Our first question for today comes from Andrew Strelzik of BMO Capital Markets. Andrew, your line is now open. Please go ahead.
Andrew Strelzik: Good morning. Thanks for taking the question. I guess I wanted to ask about the U.S. crush margin outlook. You commented that you expect crush margins to remain healthy. And I guess this is really a question about 2024 where the U.S. broadcast features have come down. What's your perspective on what's going on there? Do you think that the crush capacity that's coming on is having an impact, or how is that being absorbed? I guess, just trying to frame your commentary around momentum with what's going on in crush? Thanks.
Juan Luciano: Yeah. Thank you, Andrew. Listen, our perspective have not changed. If anything, the perspective that we have for the market has been confirmed by what we're saying. Of course, it's a very dynamic environment with the market trying to balance a lot of issues, whether it's more availability of products, more demand, the Argentine situation. We have seen board crush explode back to near the highs recently. And this is just only a reflection of the incredible demand that is coming for soybean meal into the U.S. This drives the board crush has -- it was mill driven maybe before it was oil driven, this was mill driven. You see Argentina situation, they are getting to the end of their inventory. There are probably enough beans at this point for crushers to run until November. So what we see the export book of the U.S. for soybean meal is a record export book from the U.S., something that is higher than over the last 10 years. So I think that, that will continue well into Q1 of 2024. And fundamentally, what has changed, and you have that, if you were island of strong crush margins in the U.S. is this demand for oil. We see crush margins have been a little bit lower for soybean, certainly in Brazil or in Europe, and it’s because some of the oil prices have declined. But in the U.S. with the new demand for renewable green diesel and the new – all the new capacity coming, we expect that to remain strong for years to come. So we will continue to be very constructive at our crush margins in the U.S.
Andrew Strelzik: Great. Thank you very much.
Juan Luciano: You’re welcome.
Operator: Thank you. Our next question comes from Ben Theurer of Barclays. Ben, your line is now open. Please go ahead.
Ben Theurer: Yeah. Good morning. Juan, Vikram, thanks for taking my question. Wanted to follow up on Nutrition and the updated guidance calling that roughly $600 million op income for the year. Help us understand if you can, putting that into context to what just a while ago, we've talked about the path to make this business a $1 billion operating income business. What has gone into the wrong direction and what do you still need to correct to bring this business back on track to make it a $1 billion contributor? Thank you.
Vikram Luthar: Yeah. Thanks for the question, Ben. So let's take it by different business lines. So in flavors, as I mentioned, Q3 had a very strong performance. And if you actually look year-to-date, Flavors operating profit is up 16%. And I think that's been a very important growth engine, and typically, the sales cycle in Flavors tends to be shorter than some of our other product portfolios. So just keep that in mind, that momentum is building and we see that momentum through our revenue pipeline, which is increasing month-over-month, we anticipate momentum in Q4 and frankly, continuing into 2024. The other aspect is EBITDA margins of Flavors is also increasing. It's not just revenue growth. The profit is also as a consequence of EBITDA margin expansion. And finally, Flavors contribution year-to-date overall as a part of nutrition profitability is a little over 50%. So important to keep that as a back of your mind as we think about the future. The second part of the Human Nutrition business, Health & Wellness. Health & Wellness have been steady. Actually, the dietary supplements market, which was a little bit of a headwind has -- we see the destocking tend to see the bit, and we are optimistic about the outlook next year. The other thing that Juan mentioned is the evidence-based portfolio of ingredients is expanding and our ability to apply that into functional food and solutions gives us confidence and that business to continue growing into next year and beyond. Specialty Ingredients. Actually, it's a tale of two cities within Specialty Ingredients. There's a texturants (ph) portfolio that has done exceptionally well because of expansion of margins. We don't talk much about that, but because it's a smaller part of the business, but that has performed exceptionally well this year. The challenge has been on the plant-based protein market. And the plant-based protein is driven by market softness, right? There is a softness in the market, and we've gone down as a consequence of what's happening in the market. What we are doing from that perspective is pivoting the portfolio into some of the more resilient categories like specialized nutrition like or to dairy. It doesn't happen overnight. But remember, we -- through our CD&E capabilities, it allows us to pivot our product portfolio into the categories that are growing, and we will do that. We are in the process of doing that. What happened in the interim is the Decatur East incident. What that's created is a challenge in terms of white flake production for specialty proteins in North America. So that's been a drag that we clearly had not foreseen and that drag is going to continue into 2024. So within Human Nutrition, Flavors performing exceptionally well outpacing the market, Health & Wellness study, SI is kind of in line with market, further exacerbated by the recent Decatur East incident. Then step into Animal Nutrition, what happens with amino acids. We were coming off very high margins in 2022. The good news is, we are going to reset in a much more normalized margin levels in 2023. So therefore, '24 onwards, we won't have that lapping impact of higher amino acid margins. But if you exclude amino acid margins, the base Animal Nutrition business, excluding pet solutions, we talked about all the actions of business is undertaking to optimize costs as well as drive focus on Specialty Ingredients, that is being recognized in performance. We are seeing the benefits of that and you'll see sequential quarter-over-quarter growth. So that, we feel very good about this in Q4 as well as going forward. Ag Solutions, demand creation remains solid, that category has been fantastic. We've had challenges in demand fulfillment in North America, and particularly, we talked about that primarily in the recent acquisition that we did in 2021. Those are still lingering, but we have very clear action plans, and we feel confident that by the end of this year and early next year, we will be able to more than offset that. So all in all, combined with that a new innovation, we feel pretty confident that nutrition will return to growth in 2024. And albeit maybe at a slightly lower growth rate than we had anticipated before. But getting to $1 billion is definitely within the horizon. It may not happen in the next year or in year falling, but definitely in the near term or in the medium term.
Ben Theurer: Thank you.
Operator: Thank you. Our next question comes from Tom Palmer of JPMorgan. Tom, your line is now open. Please go ahead.
Tom Palmer: Good morning and thanks for the question. The details on the crush moves, I think Andrew's question was helpful. But maybe we could dig a little bit more into what's happening on the oil side. I mean we have seen soybean oil prices come down over the past couple of months. The futures curve does suggest some continued pressure as we move into '24. It sounds like you have plenty of visibility that demand is very strong on this side, but maybe just some color on what might have caused this downward price move and whether it's more temporary in nature in your view?
Juan Luciano: Yeah. Thank you, Tom. Listen, North America refining margins are lower in this quarter. I think if you look at last year, the high priced oils were impacted by supply chain disruptions from the Russia-Ukraine war. So I would say this is a more normalized environment. We have also some positive timing impacts due to the pronounced RIN and HVO market movements, pulling forward some of those gains. I would say when we look at the forward quarter, we see remain refining margins to remain strong, but maybe a decline from the elevated highs we saw in 2022 on the early part of this year. Biodiesel margins are also coming out of the highs, as maybe the RIN value component of margin has declined as the industry is building a bank of rings. So we still have not seen a significant pull from the RD demand that it's been building but we maintain our expectation of how much it's going to be built there. So we think that is coming. The other thing you need to think about oil is that demand for food oil is very strong and has rebounded. And there are expectations now that with El Nino, we might have and with the natural maturity of the plantations in the -- in Southeast Asia that we might have a little bit less supply of palm oil and all that. So although, we are coming off the highs, we continue to be constructive about margin stabilizing at a strong level in the RPO area.
Tom Palmer: Right. Thank you.
Operator: Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Your line is open. Please go ahead.
Adam Samuelson: Yes. Thank you. Good morning, everyone. I was hoping to -- maybe dig in on the Carb Solutions outlook and maybe if you could just parse the non-ethanol pieces a little bit more. And I think in the prepared remarks, you alluded to kind of a favorable start to contracting in North America sweeteners and starches and maybe elaborate on what you are actually seeing there, maybe better frame kind of the incremental capital investments to come in that business. Obviously, there's a lot of transformation work happening in that business. That's not all much kind of come to fruition in the near term, but better contextualize kind of what the actual level of investment that you've already committed to there, there is? And if I could just ask a clarifying question on the last point on RPO. How much was the timing benefit in the third quarter?
Vikram Luthar: About $95 million.
Adam Samuelson: Thank you.
Vikram Luthar: So on the Carb Solutions question, Adam, I think it's important to just frame it. The liquid sweetener volumes have been steady. And this has happened throughout this year. Almost every quarter, we've said that. So the demand has been pretty resilient, and the margin structure has been strong. The other thing that's actually helpful is strong exports to Mexico as well as higher sugar prices. The specialty volumes in North America have been a bit soft, but with the improved mix and pricing, our margins have actually expanded. The BioSolutions market, we're actually extending into new applications, and that revenue growth year-to-date is 23%. Wheat flour demand has been resilient. The optimization I referred to in my comments, has actually helped improve the cost structure and expand margins. As on all you know what's going on in ethanol. It as goes, the margin structure there is very supportive given domestic demand, blend economics, strong U.S. exports, as well as the fact that we've got a significant -- actually higher domestic driving miles. Now when you think about next year, I mean we're well set up for the Q4 '23, and I already talked about that. It's a little early to say, but based on the strong finish that we anticipated in 2023, and early '24 contracting in North America, sweeter and starches, we are optimistic for solid volumes and our ability to actually maintain and potentially even expand margins in our core starches and sweeteners portfolio. We'll tell you more in our February call, but going in, the outlook is constructive and similarly for ethanol, that tends to be volatile. But right now, the general trends to be supportive of a higher-for-longer ethanol margin environment.
Adam Samuelson: Thank you.
Operator: Thank you. Our next question comes from Ben Bienvenu of Stephens. Ben, your line is now open. Please go ahead.
Ben Bienvenu: Thanks so much. Good morning, everybody. I have kind of a two-pronged question. One is -- one, you've kind of hit bits and pieces and Vikram as well with the nutrition commentary of the overall business outlook into 2024. The kind of implicit takeaway is, we should still expect kind of very strong and above what, I guess, we would think of as mid-cycle earnings power in 2024, albeit it's early to make that call in 2024. So correct me if I'm wrong there. But two, when you think about allocating capital at this point in the cycle, how does that change, if at all, with what you've been doing over the last several years, and you've been picking up your buyback activity, how should we be thinking about that as we move through this period of time as well? Thank you.
Juan Luciano: Yeah. Thank you, Ben. Good question. Listen, we see 2024 with a lot of optimism. We're working through the plan right now, as you can imagine at this time of the year. We continue to see the strength of Ag Services and Oilseeds and Carb Solutions continuing. Ag Services and Oilseeds, we have seen some fundamental structural changes. And I think that that's a multiyear trend. So we're going to see higher crush margins, at least in the United States for quite a while. And our Ag Services business continued to grow around the world in the -- with the strength of destination marketing and that exacerbated concern about food security that bring -- brought by all the geopolitics and the weather events and the pandemic and all that continues and continue to enhance margins for us to the service we provide around the world. So we see that business being very solid and very strong contributor. Carb Solutions, I think that Vikram touched a little bit on the dynamics of the contracting for next year. But beyond that, I think that you have to remember that we are having different uses. We are finding new demand for those products that will do two things, will grow as revenue into new categories like, we're seeing in BioSolutions that is growing double-digits. But it's also going to tighten up the supply for the existing products. So that will be constructive to margins over time, and we've seen that already, so those are the two. And I think Nutrition and Vikram went into a lot of detail into that and all the different pieces. And we're very confident we're going to go back to growth next year. This year, maybe you call it the past that refreshes, we took a pause this year. But the fundamental innovation engine that we have, that's our differentiation. That continues to resonate strongly, whether it's in Health & Wellness in what we are seeing in Flavors or the specialty pieces of Animal Nutrition or the demand generation impact, where the markets are normal and we apply that properly, we are winning more than our fair share, and we're growing faster than the competitors. So we see that with a lot of optimism for next year. When we think about how that correlates to our thinking of how to deploy capital, the priority to deploying capital is in our investment plan, and we have been doing that both in OpEx and in CapEx. Unfortunately, CapEx continues to be higher, inflationary pressure there, whether it's non-power or supply of raw materials, make us take a second look at a lot of the capital. And I think that Vikram has reflected on some of the adjustments that we made, maybe to Specialty Ingredients and other. So we're taking a look at that, and we're reviewing as always in our capital discipline on every project. But we have many opportunities in front of us, and we're going to continue to fund them. We have increased our return to shareholders. Certainly, our cash flow generation is very strong. And to be honest, when we see some of the pivot we are doing even in Carb solution with some of these opportunities, they are not hugely loading our CapEx, if you will. Some of these things where there is the pipeline for decarbonization is with partners, whether it's the LG Chem or other joint ventures are also partnerships. So it's not that taxing in our CapEx budget, if you will. So we think that we're going to continue to increase the return to shareholders. And we've been opportunistic looking at, of course, the M&A environment. And to be candid, we participate in many. We have many items on the fire, but the reality is that valuations have not come down, and we plan to continue to keep our discipline in that regard. So we continue to be opportunistic in that and we look at that. I think Vikram will make a comment on this one.
Vikram Luthar: Yeah. I think also in terms of buybacks, good to remind everyone that if you remember in our 2021 Investor Day, we talked about $5 billion of buybacks over the next four years through 2025. If you combine what we've done last year and this year, we've done almost about $2.6 billion of buyback, so we are ahead of that pace. And as I mentioned in my comments and as Juan said, if we don't see compelling valuations and given our discipline, we probably at these trading levels, price levels, we probably are going to buy back a little more aggressively, and you probably will see a stronger pace of buybacks in Q4 as a consequence of some of those factors.
Ben Bienvenu: Okay. Very good. Thanks so much.
Vikram Luthar: Thank you, Ben.
Operator: Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is open. Please go ahead.
Salvator Tiano: Thank you very much. I want to ask a little bit about the carbonization and the work you're trying to do Decatur. And I think when we -- you were talking about the 7 million tons of you're trying to sequester per year, the idea is that some of these will come from other facilities where you probably need to build pipelines. I'm just wondering, we're seeing a lot of issues with permitting and other issues with CO2 pipelines in other regions. Could this -- could you face similar issues and could this affect the total amount you will be able to request your indicator or on the other hand, could this actually be an opportunity and people that were relying on some other pipelines like Navigator 1 (ph) may come to you and use your indicator wells for sequestration?
Juan Luciano: Yeah. Thank you, Salvator for the question. This is a very important initiative for ADM. And it's something that, as you know, we have started like 10 years ago, so it's something that we have a lot of experience in, and we're leveraging that experience and that head start, if you will, in our ability to inject carbon into the lower surfaces in our facility at Decatur. We have a couple of wells there, and we're planning, as you said, to create five more injection wells over the next few years. It is true part of that will be bringing biogenic CO2 generated by our ethanol plants through pipelines. And we are working already in two of those pipelines. We have already submitted permits for all that. Those permits have been accepted. So they are complete. They are in the process of being studied and analyzed, and we are reviewing also with our partners the right of way and acquisitions and all those type of agreements. Of course, as any industry that is breaking ground the pioneer suffer sometimes with the regulatory environment and having to adjust all that. So we're working closely with the authorities across different states and in terms of trying to align the regulatory framework to the needs of decarbonization and to the desires of the Department of Energy and the Department of Agriculture to have a smart agriculture in the U.S. and decarbonize that. So work in progress, as you said, we have seen the news that you do. And you can take two tax that we might suffer a similar fate or that we will have less competition as you described. At this point in time, we don’t have any bad news to report other than we continue forward with our efforts, and we will update you in the next call.
Salvator Tiano: Thank you very much.
Operator: Thank you. Our next question comes from Davis Sunderland of Baird. Davis, your line is now open. Please go ahead.
Davis Sunderland: Hey. Good morning, team. Thank you for the time and thank you for taking my question.
Juan Luciano: You’re welcome.
Davis Sunderland: Juan you already talked about it a little bit, but I just wanted to ask if you could expand a little bit more on the ethanol and renewable diesel supply and demand environment, maybe what you're seeing for '24 and beyond? And if you anticipate any incremental changes in consumer behavior over that time? Thank you very much.
Juan Luciano: Yeah, Davis. Listen, in ethanol, we think ethanol is going to have a very constructive environment, very high sugar prices are driving Brazilians to produce a lot of sugar versus ethanol, so we're going to have less inputs of ethanol, biofuels mandates are growing around the world, whether it's more ethanol or more biodiesel. So we see Brazil going up 1% per year in that regard. And we see ethanol continues to have very good export. It has a very good value to other [indiscernible] that normally, they go for like $2.50 per gallon. So we have a big advantage around the world. And for people that want to increase the octane in their gasoline. Ethanol is a very cheap [indiscernible] around the world. So the U.S. is the best producer of that, will continue to increase. So you can see export having maybe a floor of 1.4 billion gallons going into 1.5 million. So that's very good. When we look at renewable green diesel, there has been no changes on how we see renewal diesel growth in the medium term, which is to get to around 5 billion gallons in the U.S. by 2025, 2026. Of course, we're a global company, we see that becoming 7 billion to 8 billion gallons by maybe -- and maybe 14 billion, 15 billion gallons of renewable green diesel and SAF online by 2026 and 2027. So we are at the very early innings of all these biofuel demand that is coming, whether it’s again for renewable green diesel or the promise of decarbonization that SAF brings to aviation that it doesn’t have any other valid options right now. So again, we’re going to be a player that speedy good shows that. We’re going to bring 1.5 million tons of capacity that will feed 75 million gallons of RGV. So we expect the others will deliver as we have delivered Spiritwood. So this is an industry we’re building that we’re excited about.
Davis Sunderland: Thank you very much.
Juan Luciano: You’re welcome.
Operator: Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Steven, your line is now open. Please go ahead.
Steven Haynes: Hey. Thank you for taking my question. I wanted to just ask a question on the guidance. I think previously, you're kind of saying $7 with some upside and now you're saying in excess of $7. So maybe if you could just kind of help us, I don't know, maybe quantify the difference in the two guidances and size, the upside piece would be helpful. Thank you.
Vikram Luthar: Well, so I think the first thing to note is, when in Q2, we said around $7 for potential -- with potential for more upside. And what we have seen saying right now is that potential upside is coming through, and that's why we're raising our guidance in excess of $7. But if you step back, Steven, think about what's happened between Q2 and Q3. One is, clearly, nutrition has been softer. We had guided to it similar in Q2. Now we are guiding to around $600 million. So you know, by definition, there's a compensation in other parts of the business. And when you think about the compensation relative to our Q2, that's probably going to come partially from AS&O and partially from CS. And we gave some guidance on AS&O for Q4 and also some guidance for CS. CS to be rough relatively flat versus Q4, barring any continued expansion in ethanol margins, so that could be upside in CS. And in AS&O, we have some puts and takes in RPO in particular, and one went through this. We expect that to be weaker than Q4 of last year just because we expect these mark-to-market timing gains we realized in Q3 to be rolling off. And then in Ag Services, it’s going to be generally flat, excluding the legal settlement that was a onetime thing in Q4 of last year. And then in crush, it’s going to be strong. And I think Juan talked about that we are continuing to be constructive about the cross outlook particularly in the U.S. going forward, given some of the structural demand changes related to renewable green diesel in particular.
Steven Haynes: Thank you
Operator: Thank you. At this time, we currently have no further questions. So I'll hand back to Ms. Britt for any further remarks.
Megan Britt: Thank you for joining us today. Please feel free to follow up with me if you have any other questions. Have a good day, and thanks for your time and interest in ADM.
Operator: Thank you for joining today's call. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the ADM Third Quarter 2023 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Thank you, Alex. Hello, and welcome to the third quarter earnings webcast for ADM. Starting tomorrow, a replay of this webcast will be available on our Investor Relations website. Please turn to Slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today's webcast, our Chairman and Chief Executive Officer, Juan Luciano will discuss our third quarter results and share some recent accomplishments on our strategic priorities. Our Chief Financial Officer, Vikram Luthar will review segment level performance and provide an update on our cash generation and capital allocation actions. Juan will have some closing remarks, and then, he and Vikram will take your questions. Please turn to Slide 3. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan and good morning to all who have joined for today's call. Today, ADM reported third quarter adjusted earnings per share of $1.63 with an adjusted segment operating profit of $1.5 billion. Year-to-date, this equates to an adjusted earnings per share of $5.62, that will represent ADM's second best EPS year achieved in just the first nine months and an adjusted operating profit of $4.8 billion. Our trailing four quarter average adjusted ROIC was 13.2%. This result reflect yet another strong quarter for ADM. I'm proud of the team's nimble execution against our strategic plan while adjusting our business model in light of both global macro trends and the evolving needs of our customers. The global market is increasingly dynamic with factors that create both opportunities and challenges for ADM to address. Consumer behavior has shown growing variability, spending more in some categories, while slow in spending in others. And our team has a proven ability to manage through these and the impacts of geopolitical tensions, inflationary pressures and the constantly adjusting balances of commodity supply and demand. Within each business, we are focused on navigating these external factors carefully, while we're also building on the momentum we've seen through the year-to-date. As we look ahead, we are on track to exceed our 2023 previous expectations for the total company. In Ag Services & Oilseeds, we saw the accelerated energy transition support strong demand for vegetable oil, leading to a solid crush environment. We leveraged our flexible logistics footprint to manage Brazil's record crop and our Global Trade franchise to best match supply to demand worldwide. In Carb (ph) Solutions, we delivered a record third quarter on the strength of solid margins in starches, sweeteners, and flower, as well as robust ethanol demand that help us drive strong volumes and margins. In Nutrition, Flavors growth continued to outpace the market, while we both grew and executed on our revenue opportunity pipeline. The deliberate productivity and cost management actions we have taken in Animal Nutrition are enabling improved performance as we also see market volume recovery and we continue to navigate pockets of soft demand in certain categories of the Nutrition portfolio. Next slide, please. One of ADM's greatest competitive advantages is the breadth and integration of our business model, reaching from farm to fork. 2023 has offered several examples that of how we are creating new areas of growth in each business units. On the farm, ADM has one of the largest and most sophisticated global origination networks, connecting with hundreds of thousand farmer partners worldwide. We have unique and deep relationships with the people and technologies that are shaping the future of agriculture. So as more of our customers are looking for traceable, sustainable crop sources in their own supply chains, we are a natural connector and influencer. We are proud to have announced partnership with PepsiCo, Nestle and Carlsberg, and have a target of 4 million regenerative acres and goal by 2025. The carbon equivalent of power in more than 100,000 homes a year. Moving into production, as the pace of energy transition accelerates, demand for renewables fuel sources is growing rapidly and ADM is in a leading position to capitalize on this trend. With our Spiritwood JV with Marathon currently being commissioned, we are ready to fit the production of a targeted 75 million gallons of renewable green diesel per year. We have announced the Broadwing Energy Project, delivering lower emission power source and a critical part of lowering our carbon emissions used to power Decatur operations. And we're innovating to deliver a new low-carbon intensity products within the fast growing BioSolutions portfolio. And as we connect to the consumer, we're working closely with our customers to serve the challenges of their consumers, whether it's sustainable solutions, the latest flavor or a cost effective ingredient replacement or explore in the future of nutrition through work with ADM Ventures partners like Air Protein and Nourished. And we have differentiated our offerings with the next-generation of evidence-based health and wellness solution. With the world's largest probiotic manufacturing facility in Valencia, more than 50 clinical trials underway and a growing team of deep scientific experts, we are well positioned for the expanding demand for functional foods and personalized nutrition. And to efficiently execute on all areas of growth while maintaining an efficient cost structure, we continue to vigilantly focus on productivity, as well as the culture that let our ADM colleagues bring their best every day. Across our global organization, we're standardizing processes and systems through One ADM and modernizing our operations through digital transformation, driving greater efficiencies while enabling the best use of our workforce and production capacity. Our planned modernization program continues to deliver impressive operational benefits, including advanced analytics and safety improvements across the 17 operations facilities currently in implementation phase. With more than 70 plants in the scope, the planned recurring cost savings associated with automation across our footprint in 2024 is already nearing $20 million per year. Our cultural efforts are the critical foundation for all of these strategic initiatives. We have ramped up our focus on a culture of caring, specifically in regards to the safety of our colleagues. This is our top priority. And our recent performance in this area has not lived up to our expectations. We are committed to taking action to improve and have already begun to do so with the assistance of both internal and external experts. We will do better. By actively managing productivity, innovation and culture and aligning work to the interconnected trends in food security, health and wellbeing and sustainability, ADM is well positioned for sustainable long-term profit growth across new and adjacent avenues. And with the strong performance in 2023 and a constructive expectation for the remainder of the year, we are again raising our full-year earnings outlook. For a deeper look at our Q3 performance, let me hand over to Vikram, who will cover results of operations."
},
{
"speaker": "Vikram Luthar",
"text": "Thank you, Juan. Please turn to Slide 5. The Ag Services and Oilseeds team once again delivered solid results in an increasingly dynamic environment by leveraging our experience, scale and integrated global footprint. Ag Services results were lower than the strong third quarter of 2022. South American origination results were higher year-over-year as our team delivered significantly higher volumes and margins on strong export demand. Prior investments in port capabilities have enabled us to structurally grow our earnings while capitalizing on a stronger margin environment across the region. North American results were lower year-over-year as a result of the shift of export demand to Brazil, due to the large crop there as well as low water levels in the U.S. river system, limiting volume and barge capacity. Effective risk management, combined with higher volumes and margins in Global trade led to strong results. However, much lower than the record quarter last year. The current quarter also included a $48 million insurance settlement related to damages from Hurricane Ida. In Crushing, we delivered another strong quarter, but lower than the prior year as global crush margins remained healthy, but lower than the very strong levels of a year ago. Our strong results were led by North America, as the crush margin environment remains well supported by structurally higher demand for vegetable oils. We officially opened our new crush facility in Spiritwood, North Dakota to meet growing demand. We are currently in the commissioning process and expected to be running at full rates in early November, adding an additional 1.5 million metric tons of crush capacity per year. In EMEA, we continue to optimize our flex capacity to prioritize crush of higher margin softseed, in line with market opportunities. In the quarter, there were large net positive mark-to-market timing effects which were lower than the net positive impacts in the prior year quarter. Refined Products and other posted another strong quarter, higher than the prior year period, results were led by solid volumes and margins in North America. In EMEA, robust export demand for biodiesel and domestic demand for food oil drove higher results versus the prior year. In the quarter, there were large net positive mark-to-market timing effects, which are expected to reverse as contracts execute in future periods. Equity earnings from Wilmar was significantly lower versus the third quarter of 2022. Looking ahead, for the fourth quarter in Ag Services and Oilseeds, we anticipate strong results that are slightly lower than last year, excluding the $110 million legal settlement in the ag services subsegment from the fourth quarter of 2022. We expect Ag Services results to be in line with the prior year, excluding the legal settlement. We anticipate similar year-over-year North American export volumes, a competitive South American export program and continued strong performance from global trade. We forecast our crushing subsegment will deliver strong results similar to the prior year. We expect robust soy and canola crush margins and with the ramping of our Spiritwood operations higher volumes. We expect RPO to perform well, but be significantly below last year as positive timing impacts from prior quarters are expected to reverse. Slide 6, please. Carbohydrate Solutions delivered an outstanding quarter that was significantly higher than the prior year, enabled by the ongoing optimization of our production and supply chain network. The starches and sweeteners subsegment were higher year-over-year on a healthy demand and strong margin environment across starches, sweeteners, wheat flour and ethanol. Our team generated new customer wins and delivered double-digit growth year-to-date in our BioSolutions platform. As Juan touched on earlier, we also signed a formal agreement with Broadwing Energy to provide lower emissions power to Decatur facility, extending our ability to provide low carbon solutions across the value chain. In the Vantage Corn Processors subsegment, our team executed well in a strong ethanol demand and margin environment, leading to significantly higher year-over-year results. Looking ahead for the fourth quarter, we expect steady demand and margins for our starches, sweeteners and wheat flower products. We remain constructive on ethanol margins driven by solid domestic demand and healthy U.S. exports, supported by lower competing exports from Brazil due to higher sugar prices. We anticipate results to be similar to the prior year period, but with upside potential if the current ethanol margin structure holds. On Slide 7. In Nutrition, strong results in Flavors, health and wellness and recovery in the base Animal Nutrition business were more than offset by continued lower demand for plant-based proteins and persistent demand fulfillment challenges in pet solutions. Flavors reported impressive results in a complex operating environment, delivering a 29% growth in operating profit on a constant currency basis. Results were led by pricing actions in EMEA and strong win rates in North America. During the quarter, we also implemented a successful go-live of our One ADM project in the EMEA region across 18 locations in 12 countries. This represents a significant milestone as we continue to harness digital across the enterprise to drive productivity gains. In Specialty Ingredients, weak market demand, particularly in the alternate meat category, inventory adjustments and unplanned downtime resulting from the recent Decatur incident led to significantly lower year-over-year results. The plant-based protein market has been experiencing destocking and consumer demand softness over the course of the year that will likely persist into next year. Given these recent market dynamics, we have re-scoped our Decatur protein modernization investment project to better match the expected lower growth demand environment. Also, we are leveraging our expertise in creation, design and development to differentiate our product offerings to serve evolving consumer needs. These adjustments will enable a faster pivot to higher growth and more resilient categories such as specialized nutrition, which have synergies across the nutrition portfolio, and we are rapidly building this revenue pipeline. Health & Wellness results were higher year-over-year due to double-digit bioactives sales and a favorable impact related to the revised commercial agreement with Spiber. During the quarter, we realized a significant expansion in our revenue pipeline, reinforcing the demand for evidence-based solutions. In Animal Nutrition, we are beginning to see the cost optimization actions and the expansion of offerings in the specialty feed and ingredient space from earlier this year, driving improved performance. However, the recovery in the base business was more than offset by normalized year-over-year amino acids margins as well as lower profit contribution from the Pet Solutions business. Looking forward, we anticipate flavors to finish the year strong, driven by growth in EMEA and North America. Health & wellness operating profit is expected to finish similar to last year. Animal Nutrition operating profit is expected to continue to recover sequentially quarter-over-quarter. Specialty Ingredients operating profit is expected to be down significantly, impacted by the recent Decatur East incident and demand softness. All in, we now expect full year 2023 operating profit for Nutrition to be around $600 million. While our results in 2023 have been below our expectations, we expect nutrition to return to growth in 2024. We will continue to build on the Flavors momentum from 2023. Health & wellness should maintain its steady performance. The cost actions in the shopper pivot to higher-margin products will enable Animal Nutrition to drive growth, further reinforced by improved go-to-market capabilities. Lastly, for SI, we will work aggressively to restart operational capabilities at Decatur East to minimize the impact in 2024. Slide 8, please. Other business results were significantly higher than the prior year quarter due to improved ADM investor services earnings on higher net interest income. Captive insurance results were slightly lower on higher claim settlements partially offset by premiums from new programs. In corporate results, net interest expense for the quarter increased year-over-year, primarily on higher short-term interest rates. Unallocated corporate costs of $298 million were higher versus the prior year on higher global technology spend to support our digital transformation efforts. Other corporate was favorable versus the prior year, primarily due to foreign currency hedges. We still forecast corporate cost to be approximately $1.5 billion for the year. The effective tax rate for the third quarter of 2023 was approximately 20% higher than the prior year primarily due to a change in the geographic mix of earnings. For the full year, we still expect our effective tax rate to be between 16% and 19%. Next slide, please. Through the third quarter, we had strong operating cash flows before working capital of $3.8 billion. We continue to invest in the business, allocating $1.1 billion to capital expenditures and have returned $1.9 billion to shareholders through share repurchases and dividends. We have ample liquidity with over $13 billion of cash and available credit, and our balance sheet is very strong, with an adjusted net debt-to-EBITDA leverage ratio of 0.9. Our fortress balance sheet gives us the financial flexibility to drive our long-term strategic agenda while also returning capital to shareholders and is also a competitive advantage, particularly in a higher for longer interest rate environment. We have completed $1.1 billion of share repurchases through Q3 and expect to increase the pace of repurchases in Q4. Even with the softness in nutrition, and lower-than-expected profit contributions from Wilmar. We are raising our 2023 earnings outlook again and now anticipate full year EPS in excess of $7 per share. Juan?"
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Vikram. As we close today's call, let me share a few thoughts about how we're seeing our efforts in 2023 position ADM to continue solid progression into 2024. External factors that influence ADM's forward look are closely aligned to the enduring macro trends we have positioned ourselves to be nimble in managing. We continue to see the interconnectivity across food security, health and well-being and sustainability having an amplifying effect across the industries we serve. More frequent extreme weather, extreme weather, geopolitical events and the recent pandemic have all highlighted the criticality of food security within those geographies and for the regions that are served by their agricultural exports. Connected to this, we see areas of supply abundance growing as evidenced by Brazil's record recent crop cycles and areas of need shifting. In some cases, this has resulted in either more domestic consumption in countries like the U.S. or elevated import demand situations where our unparalleled global asset base and deep experience are critical. Government policies beginning to support new demand patterns, whether based on a move to more renewable energy sources or an effort to increase regenerative agriculture supply. Science continues to accelerate innovation in Nutrition with an ever-present consumer interest in turning their food, beverage and supplement consumption to their personal health and dietary needs. Beyond the challenges and opportunities connected to these external factors, we believe ADM is positioned to leverage productivity and innovation to build momentum in the coming year, a continuation of the strategic efforts we have been driving throughout 2023. We anticipate our Services and Oilseeds continue to leverage its extended value chain and deliver structural changes to demand. We anticipate that crush margins will remain healthy while our productivity measures enable us to have a more efficient cost structure. We continue to drive opportunistic extension of our destination marketing scope, grow our regenerative agriculture acres and partnerships, and expand our renewable fuels feedstock production. In Carb Solutions, the compounding effects of our transformative investments coupled with early contracting for starches and sweeteners and what we believe to be a positive ethanol environment are setting up for another strong year in 2024. For Nutrition, we expect continued growth in our revenue opportunity pipeline with significant conversions continuing as we move past some near-term demand weakness. Our expanding results in flavors continue to signal acceleration across our broader portfolio. We expect the positive revenue growth trends in Health & Wellness to drive into next year, and we're already pivoting Specialty Ingredients towards high potential areas like alternative daily and specialized nutrition. Our actions in Animal Nutrition are delivering a positive impact and sustained opportunity growth, which we believe will expand further through the segment in the coming year. And by applying our commercial excellence efforts to this portfolio, we are focusing on the value of innovation in the specialty parts of the business. In closing, I want to express my gratitude to the ADM team for their dedication, hard work and resourcefulness. With the momentum we have been building upon the foundation for growth we have established, I am confident in our ability to continue to deliver solid results as we move into 2024 and continue to pave a path for long-term profit growth. Thank you. Operator, please open the line for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question for today comes from Andrew Strelzik of BMO Capital Markets. Andrew, your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "Good morning. Thanks for taking the question. I guess I wanted to ask about the U.S. crush margin outlook. You commented that you expect crush margins to remain healthy. And I guess this is really a question about 2024 where the U.S. broadcast features have come down. What's your perspective on what's going on there? Do you think that the crush capacity that's coming on is having an impact, or how is that being absorbed? I guess, just trying to frame your commentary around momentum with what's going on in crush? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yeah. Thank you, Andrew. Listen, our perspective have not changed. If anything, the perspective that we have for the market has been confirmed by what we're saying. Of course, it's a very dynamic environment with the market trying to balance a lot of issues, whether it's more availability of products, more demand, the Argentine situation. We have seen board crush explode back to near the highs recently. And this is just only a reflection of the incredible demand that is coming for soybean meal into the U.S. This drives the board crush has -- it was mill driven maybe before it was oil driven, this was mill driven. You see Argentina situation, they are getting to the end of their inventory. There are probably enough beans at this point for crushers to run until November. So what we see the export book of the U.S. for soybean meal is a record export book from the U.S., something that is higher than over the last 10 years. So I think that, that will continue well into Q1 of 2024. And fundamentally, what has changed, and you have that, if you were island of strong crush margins in the U.S. is this demand for oil. We see crush margins have been a little bit lower for soybean, certainly in Brazil or in Europe, and it’s because some of the oil prices have declined. But in the U.S. with the new demand for renewable green diesel and the new – all the new capacity coming, we expect that to remain strong for years to come. So we will continue to be very constructive at our crush margins in the U.S."
},
{
"speaker": "Andrew Strelzik",
"text": "Great. Thank you very much."
},
{
"speaker": "Juan Luciano",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Theurer of Barclays. Ben, your line is now open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"text": "Yeah. Good morning. Juan, Vikram, thanks for taking my question. Wanted to follow up on Nutrition and the updated guidance calling that roughly $600 million op income for the year. Help us understand if you can, putting that into context to what just a while ago, we've talked about the path to make this business a $1 billion operating income business. What has gone into the wrong direction and what do you still need to correct to bring this business back on track to make it a $1 billion contributor? Thank you."
},
{
"speaker": "Vikram Luthar",
"text": "Yeah. Thanks for the question, Ben. So let's take it by different business lines. So in flavors, as I mentioned, Q3 had a very strong performance. And if you actually look year-to-date, Flavors operating profit is up 16%. And I think that's been a very important growth engine, and typically, the sales cycle in Flavors tends to be shorter than some of our other product portfolios. So just keep that in mind, that momentum is building and we see that momentum through our revenue pipeline, which is increasing month-over-month, we anticipate momentum in Q4 and frankly, continuing into 2024. The other aspect is EBITDA margins of Flavors is also increasing. It's not just revenue growth. The profit is also as a consequence of EBITDA margin expansion. And finally, Flavors contribution year-to-date overall as a part of nutrition profitability is a little over 50%. So important to keep that as a back of your mind as we think about the future. The second part of the Human Nutrition business, Health & Wellness. Health & Wellness have been steady. Actually, the dietary supplements market, which was a little bit of a headwind has -- we see the destocking tend to see the bit, and we are optimistic about the outlook next year. The other thing that Juan mentioned is the evidence-based portfolio of ingredients is expanding and our ability to apply that into functional food and solutions gives us confidence and that business to continue growing into next year and beyond. Specialty Ingredients. Actually, it's a tale of two cities within Specialty Ingredients. There's a texturants (ph) portfolio that has done exceptionally well because of expansion of margins. We don't talk much about that, but because it's a smaller part of the business, but that has performed exceptionally well this year. The challenge has been on the plant-based protein market. And the plant-based protein is driven by market softness, right? There is a softness in the market, and we've gone down as a consequence of what's happening in the market. What we are doing from that perspective is pivoting the portfolio into some of the more resilient categories like specialized nutrition like or to dairy. It doesn't happen overnight. But remember, we -- through our CD&E capabilities, it allows us to pivot our product portfolio into the categories that are growing, and we will do that. We are in the process of doing that. What happened in the interim is the Decatur East incident. What that's created is a challenge in terms of white flake production for specialty proteins in North America. So that's been a drag that we clearly had not foreseen and that drag is going to continue into 2024. So within Human Nutrition, Flavors performing exceptionally well outpacing the market, Health & Wellness study, SI is kind of in line with market, further exacerbated by the recent Decatur East incident. Then step into Animal Nutrition, what happens with amino acids. We were coming off very high margins in 2022. The good news is, we are going to reset in a much more normalized margin levels in 2023. So therefore, '24 onwards, we won't have that lapping impact of higher amino acid margins. But if you exclude amino acid margins, the base Animal Nutrition business, excluding pet solutions, we talked about all the actions of business is undertaking to optimize costs as well as drive focus on Specialty Ingredients, that is being recognized in performance. We are seeing the benefits of that and you'll see sequential quarter-over-quarter growth. So that, we feel very good about this in Q4 as well as going forward. Ag Solutions, demand creation remains solid, that category has been fantastic. We've had challenges in demand fulfillment in North America, and particularly, we talked about that primarily in the recent acquisition that we did in 2021. Those are still lingering, but we have very clear action plans, and we feel confident that by the end of this year and early next year, we will be able to more than offset that. So all in all, combined with that a new innovation, we feel pretty confident that nutrition will return to growth in 2024. And albeit maybe at a slightly lower growth rate than we had anticipated before. But getting to $1 billion is definitely within the horizon. It may not happen in the next year or in year falling, but definitely in the near term or in the medium term."
},
{
"speaker": "Ben Theurer",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tom Palmer of JPMorgan. Tom, your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "Good morning and thanks for the question. The details on the crush moves, I think Andrew's question was helpful. But maybe we could dig a little bit more into what's happening on the oil side. I mean we have seen soybean oil prices come down over the past couple of months. The futures curve does suggest some continued pressure as we move into '24. It sounds like you have plenty of visibility that demand is very strong on this side, but maybe just some color on what might have caused this downward price move and whether it's more temporary in nature in your view?"
},
{
"speaker": "Juan Luciano",
"text": "Yeah. Thank you, Tom. Listen, North America refining margins are lower in this quarter. I think if you look at last year, the high priced oils were impacted by supply chain disruptions from the Russia-Ukraine war. So I would say this is a more normalized environment. We have also some positive timing impacts due to the pronounced RIN and HVO market movements, pulling forward some of those gains. I would say when we look at the forward quarter, we see remain refining margins to remain strong, but maybe a decline from the elevated highs we saw in 2022 on the early part of this year. Biodiesel margins are also coming out of the highs, as maybe the RIN value component of margin has declined as the industry is building a bank of rings. So we still have not seen a significant pull from the RD demand that it's been building but we maintain our expectation of how much it's going to be built there. So we think that is coming. The other thing you need to think about oil is that demand for food oil is very strong and has rebounded. And there are expectations now that with El Nino, we might have and with the natural maturity of the plantations in the -- in Southeast Asia that we might have a little bit less supply of palm oil and all that. So although, we are coming off the highs, we continue to be constructive about margin stabilizing at a strong level in the RPO area."
},
{
"speaker": "Tom Palmer",
"text": "Right. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Your line is open. Please go ahead."
},
{
"speaker": "Adam Samuelson",
"text": "Yes. Thank you. Good morning, everyone. I was hoping to -- maybe dig in on the Carb Solutions outlook and maybe if you could just parse the non-ethanol pieces a little bit more. And I think in the prepared remarks, you alluded to kind of a favorable start to contracting in North America sweeteners and starches and maybe elaborate on what you are actually seeing there, maybe better frame kind of the incremental capital investments to come in that business. Obviously, there's a lot of transformation work happening in that business. That's not all much kind of come to fruition in the near term, but better contextualize kind of what the actual level of investment that you've already committed to there, there is? And if I could just ask a clarifying question on the last point on RPO. How much was the timing benefit in the third quarter?"
},
{
"speaker": "Vikram Luthar",
"text": "About $95 million."
},
{
"speaker": "Adam Samuelson",
"text": "Thank you."
},
{
"speaker": "Vikram Luthar",
"text": "So on the Carb Solutions question, Adam, I think it's important to just frame it. The liquid sweetener volumes have been steady. And this has happened throughout this year. Almost every quarter, we've said that. So the demand has been pretty resilient, and the margin structure has been strong. The other thing that's actually helpful is strong exports to Mexico as well as higher sugar prices. The specialty volumes in North America have been a bit soft, but with the improved mix and pricing, our margins have actually expanded. The BioSolutions market, we're actually extending into new applications, and that revenue growth year-to-date is 23%. Wheat flour demand has been resilient. The optimization I referred to in my comments, has actually helped improve the cost structure and expand margins. As on all you know what's going on in ethanol. It as goes, the margin structure there is very supportive given domestic demand, blend economics, strong U.S. exports, as well as the fact that we've got a significant -- actually higher domestic driving miles. Now when you think about next year, I mean we're well set up for the Q4 '23, and I already talked about that. It's a little early to say, but based on the strong finish that we anticipated in 2023, and early '24 contracting in North America, sweeter and starches, we are optimistic for solid volumes and our ability to actually maintain and potentially even expand margins in our core starches and sweeteners portfolio. We'll tell you more in our February call, but going in, the outlook is constructive and similarly for ethanol, that tends to be volatile. But right now, the general trends to be supportive of a higher-for-longer ethanol margin environment."
},
{
"speaker": "Adam Samuelson",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Bienvenu of Stephens. Ben, your line is now open. Please go ahead."
},
{
"speaker": "Ben Bienvenu",
"text": "Thanks so much. Good morning, everybody. I have kind of a two-pronged question. One is -- one, you've kind of hit bits and pieces and Vikram as well with the nutrition commentary of the overall business outlook into 2024. The kind of implicit takeaway is, we should still expect kind of very strong and above what, I guess, we would think of as mid-cycle earnings power in 2024, albeit it's early to make that call in 2024. So correct me if I'm wrong there. But two, when you think about allocating capital at this point in the cycle, how does that change, if at all, with what you've been doing over the last several years, and you've been picking up your buyback activity, how should we be thinking about that as we move through this period of time as well? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yeah. Thank you, Ben. Good question. Listen, we see 2024 with a lot of optimism. We're working through the plan right now, as you can imagine at this time of the year. We continue to see the strength of Ag Services and Oilseeds and Carb Solutions continuing. Ag Services and Oilseeds, we have seen some fundamental structural changes. And I think that that's a multiyear trend. So we're going to see higher crush margins, at least in the United States for quite a while. And our Ag Services business continued to grow around the world in the -- with the strength of destination marketing and that exacerbated concern about food security that bring -- brought by all the geopolitics and the weather events and the pandemic and all that continues and continue to enhance margins for us to the service we provide around the world. So we see that business being very solid and very strong contributor. Carb Solutions, I think that Vikram touched a little bit on the dynamics of the contracting for next year. But beyond that, I think that you have to remember that we are having different uses. We are finding new demand for those products that will do two things, will grow as revenue into new categories like, we're seeing in BioSolutions that is growing double-digits. But it's also going to tighten up the supply for the existing products. So that will be constructive to margins over time, and we've seen that already, so those are the two. And I think Nutrition and Vikram went into a lot of detail into that and all the different pieces. And we're very confident we're going to go back to growth next year. This year, maybe you call it the past that refreshes, we took a pause this year. But the fundamental innovation engine that we have, that's our differentiation. That continues to resonate strongly, whether it's in Health & Wellness in what we are seeing in Flavors or the specialty pieces of Animal Nutrition or the demand generation impact, where the markets are normal and we apply that properly, we are winning more than our fair share, and we're growing faster than the competitors. So we see that with a lot of optimism for next year. When we think about how that correlates to our thinking of how to deploy capital, the priority to deploying capital is in our investment plan, and we have been doing that both in OpEx and in CapEx. Unfortunately, CapEx continues to be higher, inflationary pressure there, whether it's non-power or supply of raw materials, make us take a second look at a lot of the capital. And I think that Vikram has reflected on some of the adjustments that we made, maybe to Specialty Ingredients and other. So we're taking a look at that, and we're reviewing as always in our capital discipline on every project. But we have many opportunities in front of us, and we're going to continue to fund them. We have increased our return to shareholders. Certainly, our cash flow generation is very strong. And to be honest, when we see some of the pivot we are doing even in Carb solution with some of these opportunities, they are not hugely loading our CapEx, if you will. Some of these things where there is the pipeline for decarbonization is with partners, whether it's the LG Chem or other joint ventures are also partnerships. So it's not that taxing in our CapEx budget, if you will. So we think that we're going to continue to increase the return to shareholders. And we've been opportunistic looking at, of course, the M&A environment. And to be candid, we participate in many. We have many items on the fire, but the reality is that valuations have not come down, and we plan to continue to keep our discipline in that regard. So we continue to be opportunistic in that and we look at that. I think Vikram will make a comment on this one."
},
{
"speaker": "Vikram Luthar",
"text": "Yeah. I think also in terms of buybacks, good to remind everyone that if you remember in our 2021 Investor Day, we talked about $5 billion of buybacks over the next four years through 2025. If you combine what we've done last year and this year, we've done almost about $2.6 billion of buyback, so we are ahead of that pace. And as I mentioned in my comments and as Juan said, if we don't see compelling valuations and given our discipline, we probably at these trading levels, price levels, we probably are going to buy back a little more aggressively, and you probably will see a stronger pace of buybacks in Q4 as a consequence of some of those factors."
},
{
"speaker": "Ben Bienvenu",
"text": "Okay. Very good. Thanks so much."
},
{
"speaker": "Vikram Luthar",
"text": "Thank you, Ben."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "Thank you very much. I want to ask a little bit about the carbonization and the work you're trying to do Decatur. And I think when we -- you were talking about the 7 million tons of you're trying to sequester per year, the idea is that some of these will come from other facilities where you probably need to build pipelines. I'm just wondering, we're seeing a lot of issues with permitting and other issues with CO2 pipelines in other regions. Could this -- could you face similar issues and could this affect the total amount you will be able to request your indicator or on the other hand, could this actually be an opportunity and people that were relying on some other pipelines like Navigator 1 (ph) may come to you and use your indicator wells for sequestration?"
},
{
"speaker": "Juan Luciano",
"text": "Yeah. Thank you, Salvator for the question. This is a very important initiative for ADM. And it's something that, as you know, we have started like 10 years ago, so it's something that we have a lot of experience in, and we're leveraging that experience and that head start, if you will, in our ability to inject carbon into the lower surfaces in our facility at Decatur. We have a couple of wells there, and we're planning, as you said, to create five more injection wells over the next few years. It is true part of that will be bringing biogenic CO2 generated by our ethanol plants through pipelines. And we are working already in two of those pipelines. We have already submitted permits for all that. Those permits have been accepted. So they are complete. They are in the process of being studied and analyzed, and we are reviewing also with our partners the right of way and acquisitions and all those type of agreements. Of course, as any industry that is breaking ground the pioneer suffer sometimes with the regulatory environment and having to adjust all that. So we're working closely with the authorities across different states and in terms of trying to align the regulatory framework to the needs of decarbonization and to the desires of the Department of Energy and the Department of Agriculture to have a smart agriculture in the U.S. and decarbonize that. So work in progress, as you said, we have seen the news that you do. And you can take two tax that we might suffer a similar fate or that we will have less competition as you described. At this point in time, we don’t have any bad news to report other than we continue forward with our efforts, and we will update you in the next call."
},
{
"speaker": "Salvator Tiano",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Davis Sunderland of Baird. Davis, your line is now open. Please go ahead."
},
{
"speaker": "Davis Sunderland",
"text": "Hey. Good morning, team. Thank you for the time and thank you for taking my question."
},
{
"speaker": "Juan Luciano",
"text": "You’re welcome."
},
{
"speaker": "Davis Sunderland",
"text": "Juan you already talked about it a little bit, but I just wanted to ask if you could expand a little bit more on the ethanol and renewable diesel supply and demand environment, maybe what you're seeing for '24 and beyond? And if you anticipate any incremental changes in consumer behavior over that time? Thank you very much."
},
{
"speaker": "Juan Luciano",
"text": "Yeah, Davis. Listen, in ethanol, we think ethanol is going to have a very constructive environment, very high sugar prices are driving Brazilians to produce a lot of sugar versus ethanol, so we're going to have less inputs of ethanol, biofuels mandates are growing around the world, whether it's more ethanol or more biodiesel. So we see Brazil going up 1% per year in that regard. And we see ethanol continues to have very good export. It has a very good value to other [indiscernible] that normally, they go for like $2.50 per gallon. So we have a big advantage around the world. And for people that want to increase the octane in their gasoline. Ethanol is a very cheap [indiscernible] around the world. So the U.S. is the best producer of that, will continue to increase. So you can see export having maybe a floor of 1.4 billion gallons going into 1.5 million. So that's very good. When we look at renewable green diesel, there has been no changes on how we see renewal diesel growth in the medium term, which is to get to around 5 billion gallons in the U.S. by 2025, 2026. Of course, we're a global company, we see that becoming 7 billion to 8 billion gallons by maybe -- and maybe 14 billion, 15 billion gallons of renewable green diesel and SAF online by 2026 and 2027. So we are at the very early innings of all these biofuel demand that is coming, whether it’s again for renewable green diesel or the promise of decarbonization that SAF brings to aviation that it doesn’t have any other valid options right now. So again, we’re going to be a player that speedy good shows that. We’re going to bring 1.5 million tons of capacity that will feed 75 million gallons of RGV. So we expect the others will deliver as we have delivered Spiritwood. So this is an industry we’re building that we’re excited about."
},
{
"speaker": "Davis Sunderland",
"text": "Thank you very much."
},
{
"speaker": "Juan Luciano",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Steven, your line is now open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"text": "Hey. Thank you for taking my question. I wanted to just ask a question on the guidance. I think previously, you're kind of saying $7 with some upside and now you're saying in excess of $7. So maybe if you could just kind of help us, I don't know, maybe quantify the difference in the two guidances and size, the upside piece would be helpful. Thank you."
},
{
"speaker": "Vikram Luthar",
"text": "Well, so I think the first thing to note is, when in Q2, we said around $7 for potential -- with potential for more upside. And what we have seen saying right now is that potential upside is coming through, and that's why we're raising our guidance in excess of $7. But if you step back, Steven, think about what's happened between Q2 and Q3. One is, clearly, nutrition has been softer. We had guided to it similar in Q2. Now we are guiding to around $600 million. So you know, by definition, there's a compensation in other parts of the business. And when you think about the compensation relative to our Q2, that's probably going to come partially from AS&O and partially from CS. And we gave some guidance on AS&O for Q4 and also some guidance for CS. CS to be rough relatively flat versus Q4, barring any continued expansion in ethanol margins, so that could be upside in CS. And in AS&O, we have some puts and takes in RPO in particular, and one went through this. We expect that to be weaker than Q4 of last year just because we expect these mark-to-market timing gains we realized in Q3 to be rolling off. And then in Ag Services, it’s going to be generally flat, excluding the legal settlement that was a onetime thing in Q4 of last year. And then in crush, it’s going to be strong. And I think Juan talked about that we are continuing to be constructive about the cross outlook particularly in the U.S. going forward, given some of the structural demand changes related to renewable green diesel in particular."
},
{
"speaker": "Steven Haynes",
"text": "Thank you"
},
{
"speaker": "Operator",
"text": "Thank you. At this time, we currently have no further questions. So I'll hand back to Ms. Britt for any further remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you for joining us today. Please feel free to follow up with me if you have any other questions. Have a good day, and thanks for your time and interest in ADM."
},
{
"speaker": "Operator",
"text": "Thank you for joining today's call. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 2 | 2,023 | 2023-07-25 09:00:00 | Operator: Good morning, and welcome to the ADM Second Quarter 2023 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Thank you, Alex. Hello, and welcome to the second quarter earnings webcast for ADM. Starting tomorrow, a replay of this webcast will be available on our Investor Relations website. Please turn to Slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted, under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano, will discuss our second quarter results, share progress highlights on our first half accomplishment and provide perspective on our outlook for the second half. Our Chief Financial Officer, Vikram Luthar, will review segment level performance for the quarter and first half and provide an update on our cash generation and capital allocation actions. Juan will have some closing remarks, and then he and Vikram will take your questions. Please turn to Slide 3. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan, and thanks to those who have joined us for today's call. Today, ADM reported second quarter adjusted earnings per share of $1.89 with an adjusted segment operating profit of $1.6 billion. Combined with first quarter results, this equates to a first half adjusted earnings per share of $3.98 and an adjusted operating profit of $3.4 billion. Our trailing fourth quarter average adjusted ROIC was 13.8%. The first half of 2023 has probably unfolded as we expected and our financial performance nearly replicates the record results from the first half of last year, even as we face a more challenging macroeconomic and demand environment to start the year. Through active positioning, strong margin management and leveraging our geographically diverse end-to-end supply chain network, we maintain our earnings power and a strong ROIC performance bolstered by key strategic accomplishments across the enterprise. Please turn to Slide 4. Let me highlight just a few across the business. In Ag Services & Oilseeds, our team leveraged past investments in port capabilities to produce record origination volumes out of our Brazilian facilities, expanded our regenerative agriculture partnerships and leverage our ability to flex crush capacity to capitalize on higher canola crush margins. In the latter instance, we flexed more than 300,000 tons of capacity and captured an additional $40 per metric ton of margin. In Carbohydrate Solutions, strategic investments in optimization and modernization allowed our team to manage increased demand for liquid sweeteners, drive growth in BioSolutions revenue and operating profit and produced record results in our milling and international corn businesses. In Nutrition, our unique go-to-market strategy continues to drive a larger sales pipeline and deliver double-digit growth in the Flavors business, thanks to an impressive performance in EMEA and new wins in North America. When you combine all of these aspects across ADM's full business portfolio, it's clear how we are able to convert challenges in one geography, product or business segment into value drivers in another. Next slide, please. Let's review the factors that we see as important drivers for a strong second half finish in 2023. We expect continued strength in Brazil origination for the remainder of the year. Our past strategic investments in port facilities in Brazil optimize origination network and deep connection to our global trade and destination marketing teams will allow us to export strong volumes, capitalizing on the record Brazilian soybean and corn crops. Biofuels demand continues to remain strong. Through the first half of the year, we saw robust margins from biodiesel, strong demand for ethanol and an increasing demand for vegetable oil from renewable green diesel and we expect this trends to continue in the second half. Our Spiritwood, North Dakota processing facilities is scheduled to start up in Q4, adding 1.5 million metric tons of annual soy crush capacity to our portfolio and producing low carbon intensity soybean oil for our JV partner Marathon's nearby renewable diesel facility. Projects like this will support growing demand for renewable diesel and sustainable aviation fuel throughout the industry. We also see continued resilience in food demand for core products. We expect the continued solid margin and volume environment for sweeteners, starches and flours. We are beginning to convert our pipeline of wins in Human Nutrition into operating profit. Well, there are some factors that have hindered growth in the portfolio, we believe positive momentum from Flavors is a predictor of a healthy rebound. We also see continued commodity market dislocations in the second half. ADM has the unique ability to execute with agility in a dynamic environment. Our team utilizes our unparalleled global asset footprint and end-to-end supply chain to adapt to evolving market conditions and meet global food security needs while driving strong returns. Lastly, our balance sheet remains healthy, and we are flexing it toward organic investments and opportunistic share buybacks. We continue to deploy capital to drive organic productivity and innovation-oriented programs such as Spiritwood, Valencia and Marshall as well as invest in our plant automation efforts and our broad decarbonization initiatives. And our $1 billion in share repurchases in the first half highlights our confidence in the strong cash generation and growth potential of our company. As we look at the back half of the year, we intend to continue our share repurchase program. We feel that these factors are fundamental drivers of our strong second half performance. I am proud of how our team has delivered halfway through the year and even more excited about the opportunities presented in the second half and what our team can deliver. Taking collectively, we are raising our earnings expectations for full year 2023. With that, let me turn it over to Vikram, who will go into more detail on the results of operations. Vikram?
Vikram Luthar: Thank you, Juan. Please turn to Slide 6. The Ag Services & Oilseeds team continues to deliver exceptional results in a dynamic environment, leading to an extremely strong performance in the first half of 2023, surpassing the outstanding first half of the prior year. Q2 results were strong, but slightly below the prior year period. Ag Services results were in line with the strong second quarter of 2022. South American origination results were higher year-over-year as the team delivered record volumes and higher margins on strong export demand, leveraging our strategic investments to expand port capacity to capitalize on the record Brazilian soybean crop. Results for North America origination was slightly lower year-over-year, driven by lower export volumes due to large South America suppliers. Our execution in destination marketing as well as effective risk management continue to deliver strong global trade results, though lower than the record quarter last year. In our crushing subsegment, results were much lower than the record result from the second quarter last year. Global soy crush margins remained strong but were lower year-over-year in all regions due to softer demand for both meal and oil and a tight U.S. soybean carryout. This was partially offset by strong softseed margins and higher volumes supported by a strong Canadian canola crop and use of our flex capacity in EMEA. Additionally, there were approximately $195 million of negative mark-to-market timing effects in the current quarter that are expected to reverse as the contracts execute in future periods. Refined products and other results were significantly higher than the prior year period, achieving a record second quarter. North America results were higher, driven by strong food oil demand and improved biodiesel volumes. In EMEA, strong export demand for biodiesel and domestic food oil demand supported stronger margins. Additionally, there were approximately $90 million of positive mark-to-market timing effects in the current quarter that are expected to reverse as the contracts execute in future periods. Equity earnings from Wilmar were lower versus the second quarter of 2022. Looking ahead for the third quarter, we anticipate solid results in Ag Services & Oilseeds. We expect strong demand for grain exports to be heavily weighted towards South America and our Brazilian origination footprint. We anticipate strong volumes and margins for soy and canola crush based on the tight Argentine crop and improving demand outlook for meal and oil. We expect RPO to perform well but have significant reversals of timing impacts from the second quarter, leading to lower net execution margins. Slide 7, please. Carbohydrate Solutions delivered strong results in Q2, but lower than the record second quarter of last year. The Starches and Sweeteners subsegment, including ethanol production from our wet mills, capitalized on a solid demand environment during the quarter. North America Starches and Sweeteners delivered volumes and margins similar to the prior years, and ethanol margins were solid as industry stocks moderated but lower relative to the prior year. Q2 results were negatively impacted due to unplanned downtime at one of our corn germ plants. In EMEA, the team effectively managed margins to deliver improved results. The global wheat milling business posted higher margins, supported by steady customer demand. BioSolutions continued on its excellent growth trajectory with 22% revenue growth year-over-year. Vantage Corn Processors results were lower due to lower year-over-year ethanol margins. The prior year period also includes a onetime $50 million benefit from the USDA biofuel producer recovery program. We continue to make progress on our initiatives to decarbonize the Carbohydrate Solutions footprint including our definitive agreement with Tallgrass to sequester carbon from our Columbus, Nebraska facility and continued progress on decarbonizing our decade complex through additional carbon capture and sequestration wells, as well as ultra-low-carbon intensity, electricity and steam generation. These are key steps in enabling us to produce low CI feedstocks for use in many applications for our major CPG customers and underpinning our growth opportunities, such as SAS, BioSolutions and our lactic acid polylactic acid joint venture with LG Chem. Looking ahead for the third quarter, we expect continued steady demand in margins for our starches, sweeteners and wheat flour products. Ethanol margins are also expected to remain solid. On Slide 8, Nutrition results were significantly lower than the prior year's record quarter. Human Nutrition results were slightly up year-over-year on a constant currency basis. Our Flavors business posted record results in Q2, growing revenues and EBITDA margins due to improved mix and pricing in EMEA, as well as improving demand in North America. Flavors will be a significant growth engine for Human Nutrition for the remainder of the year and will act as a pace setter for the rest of our portfolio. Customer innovation in beverage is beginning to accelerate, and our value proposition is driving our sales pipeline to its largest ever. Growth in Flavors was offset by lower year-over-year results in Specialty Ingredients. While there has been softening of demand for plant-based proteins, particularly for the alternative meat space, other categories like alternative dairy snacks and baked goods as well as specialized nutrition are providing growth opportunities. Although still a small OP contributor, Health and Wellness is seeing demand recovery in probiotics and is benefiting from geographic expansion opportunities offered through ADM's global footprint and customer relationships. Our largest challenge in 2023 has been in the Animal Nutrition business were significantly lower amino acid margins and softer global feed demand has affected volumes driving much lower results. Over the past several months, we have made important adjustments to align the business to this environment, including simplifying our brands and go-to-market strategy, consolidating facilities and optimizing our footprint, rightsizing the workforce in association with these changes and aligning the reporting structure to enhance synergies. We are also refocusing our efforts to increase offerings in the higher-margin specialty feed and ingredients areas. We believe these actions will lead to improved commercial and operational performance, supporting profitable growth when market fundamentals improve. When looking at Nutrition as a whole, we now expect 2023 results to be similar to the prior years, as we expect growth in Human Nutrition to be offset by lower results in Animal Nutrition. However, given the increase in customer innovation we've seen in our Flavors business and our recent wins in pipeline growth across Human Nutrition, as well as the actions we are taking in Animal Nutrition, we remain confident about the future outlook and growth prospects for Nutrition. Slide 9, please. Other business results were significantly higher than the prior year quarter due to improved ADM investor services earnings on higher net interest income. Captive insurance improved on premiums from new programs, partially offset by increased claim settlements. In corporate results, net interest expense for the quarter increased year-over-year, primarily on higher short-term interest rates. Unallocated corporate costs of $262 million was similar versus the prior year as lower health insurance costs were offset by increased global technology spend. Other corporate was unfavorable versus the prior year, primarily due to foreign currency hedges. We still project corporate costs to be approximately $1.5 billion for the year. The effective tax rate for the second quarter was -- of 2023 was approximately 18%, in line with the prior year. For the full year, we still expect our effective tax rate to be between 16% and 19%. Next slide, please. Through the second quarter, we had strong operating cash flows before working capital of $2.5 billion. We allocated $600 million to capital expenditures as well as returned $1.5 billion to shareholders through share repurchases and dividends. We continue to have ample liquidity with nearly $13 billion of cash and available credit, and our leverage ratio are low with an adjusted net debt-to-EBITDA ratio at 1.0. Our strong balance sheet and credit ratings provide a stable financial footing for ADM to pursue our strategic growth initiatives while also returning capital to shareholders. We still anticipate $1.3 billion of capital expenditures in 2023. As Juan mentioned, we have already completed the $1 billion of share repurchases that we announced in January this year. We intend to continue our share repurchase program, subject to other strategic uses of capital. Based on our very strong first half, we are raising our full year earnings outlook to around $7 per share with potential for even more upside. Juan?
Juan Luciano: Thank you, Vikram. As we wrap up today's call, let me highlight a few opportunities that we're excited about as ADM continues to execute our strategic agenda, where we're seeing value generation today and have plans to accelerate. Let's start with digitization and automation. Our ongoing work to modernize and automate our operations is ramping up. Our eight current implementations across North America and Europe are generating millions in run rate benefits. And we have 10 more starting in Q3 with the expectation of similar scalable benefits. Our 1ADM program is accelerating our decision-making and analytics capabilities across the company, helping us find faster path to productivity. With our HR systems now in place globally, our next milestone is bringing part of the Nutrition flavors business on board. In LatAm, we have implemented technology to optimize trade and commercial processes while digitizing freight and logistics contracting. All of this is helping us reduce costs and make better, faster decisions to deliver value to ADM and our customers. Sustainability and decarbonization have opened new avenues for growth across the enterprise while ensuring we are taking the necessary actions on our own footprint. Our STRIVE 35 program continues to deliver important progress, and our recent sustainability report shows our efforts in greenhouse gas emissions, waste reduction, no deforestation and crop traceability achieving targets ahead of plan. As we continue to support our most significant customers with carbon advantage crop sources, we recently announced regenerative Ag program targets of 2 million acres in 2023 with an additional 2 million acres by 2025. With the recent Tallgrass agreement and permit submissions, CO2 from ADM facilities in Nebraska, Iowa and Illinois is now targeted to be captured and stored safely and permanently underground within our expand indicator CCS well capacity. This helps decarbonize our customers' value chains and our own across important opportunity spaces like BioSolutions and sustainable aviation fuel. And we are continuing to invest in the next phase of innovation. Our new Decatur protein solution center is engaged in ADM's world-class science and technology capabilities to deliver on tomorrow's most important consumer nutrition trends. Collaboration between ADM and our ventures partners take us beyond today's alternative protein sources to help address critical areas of sustainability, wellness and affordability. Leveraging our deep fermentation expertise and capacity is positioning us to scale the next generation of food, feed, fuel, fabrics and other industrial products with key partners. The combination of technology alongside global trends in sustainability, food security and well-being is transforming the food and agriculture industry at the fastest pace since the last century. And ADM is at the forefront of this transformation and connected growth opportunities, which give us even more confidence in our long-range growth plans. Thank you for your time today. Vikram and I look forward to your questions. Alex, please open the line.
Operator: Thank you. [Operator Instructions] Our first question for today comes from Ben Theurer from Barclays. Ben, your line is now open. Please go ahead.
Ben Theurer: Thank you very much. Good morning, Juan. Good morning, Vikram.
Juan Luciano: Good morning.
Vikram Luthar: Good morning.
Ben Theurer: So I'd like to -- just a general question on obviously, like the puts and takes. You're raising your guidance at the higher end of what 6% to 7% was now around 7%. And obviously, you had a very strong first half, but then at the same time, you're looking for a little more softness in Nutrition. So maybe help us understand how you feel about just macro picture in general demand? What are the geopolitical assumptions that you have behind your outlook and how you feel about second half and then also beyond maybe into 2024, as it relates to general demand in an environment where we're in right now. Thank you.
Juan Luciano: Sure, Ben. Yes, of course, first of all, we're very proud of the results we accomplished in the quarter and in the first half. And certainly, we are more confident about the environment ahead of us for ADM. I would say -- let me highlight some of the reasons for that. Certainly, crush margins have started to pick up as we predicted before. They continue to get better. Board crush has been firmer and mill basis has been stronger and BIM basis have dropped in the U.S. as we have anticipated. I think there is a shift in which the world needs more protein, then we need more mill, and we can cover for Argentina shortcomings this year. So that is happening as we predicted. And certainly, it's going to be very good for Q3 and Q4. I think we're seeing these huge crops in Brazil. We see the Brazilian port congestion driving a lower interior basis and allowing us to procure cheaper grains, giving margins to those companies that have invested in the infrastructure to be able to capitalize on that, which we did, both in Santos and in Barcarena in Brazil. So, that's playing very well for us. The last time we talked, ethanol inventories were around 25 million to 26 million barrels. Now we are at the end of June at about 22 million. There is -- we see a strong spot demand for ethanol and corn tough to buy. So that has made margins strengthen, and they are holding. So we are positive about ethanol margins continued in that regard. We continue to see this trend in biofuels and we have a strong book on biodiesel for the quarter. So we feel good about that. We are seeing lower recession challenges and the U.S. consumer very resilient, and that's bringing resiliency in our core products for food demand. And we see that in carb solutions, whether it's sweeteners and starches or whether it's in milling. So as you highlighted, of course, and Vikram went deep into that, the issues in Nutrition, I would say we feel good about how our value proposition continues to resonate in flavors. Flavors is more beverage kind of business, if you will. The innovation happens a little bit faster there. So we see our pipeline continues to grow. That bodes very well for what we know the potential revenue is in 2024. So again, we continue to align the company to these big three trends, food security that with all the geopolitics and the weather makes ADM assets more valuable and gives us more margin in destination marketing services, for example. We see health and well-being, and that continues to show in all the flavors innovation that we're seeing with our customers. And we see the sustainability trend driving all these opportunities in decarbonization. I would say we shouldn't forget when we mentioned this, that either in automation on decarbonization, we are at the early innings of multiyear progress for the industry and for ADM. So I think that we feel very good about '23 and we feel even better about the future.
Ben Theurer: Perfect. Thank you, very much.
Operator: Thank you. Our next question for today comes from Ben Bienvenu from Stephens. Ben, your line is now open. Please go ahead.
Ben Bienvenu: Hi, good morning, everybody. Thanks for taking my question.
Juan Luciano: Good morning, Ben.
Ben Bienvenu: I want to just follow-up just on the -- good morning, on the Nutrition business and maybe to the extent that you can talk a little bit about the cadence as we move through the back half of the year. I appreciate the updated comments on overall results being flat year-over-year. But there's -- with Animal Nutrition expected to be down year-over-year, there's a pretty substantial ramp in the human side of things. Maybe if you could talk a little bit about the visibility that you have into that? And then to the extent you can parse between 3Q and 4Q as you see it today, that would be helpful.
Vikram Luthar: Yes, Ben. So I think let's just take a few minutes to talk about why our guide has gone from 10% growth to flat. Animal Nutrition cyclical weakness is persisting for longer than we anticipated. Consumers continue to trade down from higher value, more feed intensive to lower value, less feed intensive proteins. Reformulation to reduce feed cost is also impacting volumes. Plant-based proteins, particularly in the alternative meats continues to be softer than anticipated. The destocking actually is still continuing in that category. And the broader market growth has also moderated, which we had signaled before. Third, the demand fulfillment challenge in pet solutions are taking longer than anticipated resolve. The delay was driven primarily by slower than anticipated integration of the recent small business acquisition that we made in North America. And if you remember, we had COVID, and that delayed also the integration. So we're working through that. But what are we doing? And that's important as you think about the back half as well as the future. Flavors. Strong pipeline and win rates. We talked about the largest ever pipeline we've had. Flavors actually grew profits in the first half 9%, 20% in Q2. So that's a very good sign of the recovery we are seeing in parts of the Human Nutrition business. The other thing that's important to note, Flavors actually contributed almost 50% of the overall operating profit for Nutrition in the first half. So that's an important signal as you think about the future growth of Nutrition. Yes, that was primarily driven in the beverage category, but we see green shoots of opportunity in the food category as well. In the SI side, we are leveraging our CD&D capabilities to accelerate penetration into some of the faster-growing categories. I mentioned alternative spaces, alternative meat has been soft but alternative dairy and some of the other categories actually growing. And we are launching our Decatur protein innovation center in Q3. All that, given our CD&D capabilities allows us to pivot to categories that are growing. And that sometimes takes time. So we anticipate that recovery possibly to come in more in the 2024 time frame, less in the back half of this year. In Animal Nutrition, we are taking actions to improve margins, cost and product and footprint rationalization to improve margins and also to drive profitable growth as the markets recover. So we feel good about the recovery as the market recovers. And in parallel, what we are doing is looking at the specialty part of our Animal Nutrition portfolio to leverage our Human Nutrition, CD&D and go-to-market capabilities to be able to drive increased penetration there. On the pet side, demand creation is going to take a little longer, possibly into the back half of this year and into 2024. But overall, we clearly see signs of recovery, and our forward outlook for Nutrition is still strong and robust in terms of growth. This year, given some of the challenges we faced, we expect it to be similar to last year. Juan, I don't know if you want to add some longer-term perspective.
Juan Luciano: Listen, Ben, as Vikram said, we continue to be very positive. We look at this -- remember, when we started the Nutrition business, which we're still trying to build into the best nutrition company in the world, we ask our team that we're going to measure them by two factors. One was growing faster than market and in markets where the customers are still moving and innovation is coming, like in Flavors, we've seen that we're growing faster than market, and you can see it by the double-digit growth that we have so far. And then the other thing that we said was EBITDA margin on sales growing, and we grew EBITDA marginal sales in Flavors. So I think that in the others, I think Vikram has -- this industry is going through a difficult destocking year and there has been some self-inflicted things like the integration of this small facility in Pet. So I think we're working through some of our growing pains as we build the portfolio. But I think the important thing is our innovation system, our value proposition to bring new recipes to customers faster than anybody else continues to outperform the industry and that we're seeing in the results. When customers have projects like in beverage and all that, we excel. When customers are flat or destocking, it takes a little longer. We still expect the trajectory to be similar in that regard.
Ben Bienvenu: Okay. Very good. My second question is on Starches and Sweeteners. You noted similar volumes and margins in the second quarter. You did have a plant that was down unexpectedly. Could you talk about the impact of that that's discrete to the second quarter? And then you point to solid margins for sweetener, starches and flour in the back half of this year, would you expect -- would you characterize that more specifically as similar margins and volumes again? Or do you expect an improvement in the back half of the year? Thank you.
Vikram Luthar: Sure. So Ben, let's talk about the germ crush facility outage. In April, we had an incident at one of our grain elevators at the West plant within ADM's processing complex indicator. This negatively impacted the Carbohydrate Solutions Q2 results by a significant amount. Germ was actually sold into feed markets as our wet mills were slow to reduce the overall exposure to germ, lowering also ethanol production volumes at a time when ethanol margins were strong. We anticipate this to come back in Q4. So yes, Q2 was impacted. I won't get into the specifics but the fact that it was significant enough for us to call it out means it was a meaningful number. But it is going to come back in Q4. So therefore, based on that, you can expect some seasonality, some shift from Q2 to Q4 as a consequence of that. But for the full year, we still remain very -- the outlook for the full year still remains very strong. The sweeteners and starch and actually also the growth of milling volumes have been very resilient. We've seen some softening in the specialty side of the portfolio, but that's been more than offset by mix and margins. So I'd say, overall, the outlook is solid. And yes, we did have a material impact, a significant impact due to the corn germ in Q2.
Ben Bienvenu: Okay. Thanks and congratulations.
Vikram Luthar: Thank you.
Operator: Thank you. Our next question comes from Tom Palmer of JPMorgan. Tom, your line is now open. Please go ahead.
Tom Palmer: Good morning, and thanks for the question.
Juan Luciano: Good morning.
Tom Palmer: Perhaps we could just talk through the moving pieces as we migrate to the North America harvest. We've seen crush margins in the U.S. strengthen, especially in the past month or so. Looks like we've seen maybe just a little bit of a beginning in other regions of the world. I think often, when you see our weaker-than-expected supply coming out of the country, other regions of the world often benefit. And at least up to this point, and I know we're ahead of the harvest, we haven't seen that necessarily in margins. I mean, how do you guys think about as we think about the balance of the year, kind of regional expectations for crush progressing?
Juan Luciano: Yes. Thank you, Tom. As I said before, I think that when you see the world needs more protein and certainly, we can see that given the Argentine GAAP , which is they produce probably 20 million, 25 million tons less soybeans and maybe the world was expecting them to produce, that's reallocating crush, we are locating crush to two places; we are locating crush to Brazil and reallocating crush to U.S. So of course, the time of that is different. And so we see that in the margins that we see for the U.S. coming into Q3 and then Q4. Demand continues to be strong for meal. There won't be so much protein that is not going to just be soybean meal, but there's going to be other types of protein feed, whether it's feed wheat and all that. So when you take that, combined with the increased demand from fuels, but also oils for food consumption. If we expect soybean oil demand to go up like 8%, it's like about 6% coming from food and maybe 2% coming from fuel. But my point is crush margins are supported from everywhere. Of course, as the world gets to try to cover for these soybeans, the margins will be where you are closer to the physical product to have access to the physical soybeans. And that's where ADM footprint and ADM combined with origination and global trade where we excel. So I think the team had a great first half, and they are expecting a great second half. And we don't see anything that can derail this for quite some time. I hope that provides some perspective.
Operator: Thank you. Our next question comes from Manav Gupta of UBS. Your line is now open. Please go ahead.
Manav Gupta: Hi. My quick question here is we are in the second phase where a number of new plants on the R&D side will start up in the second half of this year including one of your partners, which is starting up a bigger plant on the West Coast. So I'm just trying to understand from the demand perspective of soyabean oil, do you expect a much stronger demand environment than what we saw in the first half of this year?
Juan Luciano: Yes, I think that we have all these plants that are coming that have been announced. And of course, we're looking all the time at the probability of those plants coming. Sometimes when you build in an industry, not everything comes at the right time. But as you said before, there are two or three large plants coming now in the second half, and that will continue to increase the demand. Of course, our plant in - from our partner comes with our crush capacity as well that we're building, this 1.5 million tons per year. So -- but Manav, when we look at these we believe that, at the end of the day, that demand will come through. At the end of the day, we will have enough crush for soybean oil to participate being maybe 60% of the overall pool of feedstock needed. And we think that the industry will continue to grow, but we continue to need to attract other feedstocks for us to fulfill this potential. So the industry is going to get tight. You're going to need capacity, technology and capabilities, if you will, in order to deliver that, but that's the way you make progress, building a new industry and going through an energy transition. But that's very favorable for ADM. And I think that we're very pleased to bring in Spiritwood on time for the harvest, on budget. So we are very pleased the way the team has managed that implementation.
Operator: Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Adam, your line is now open. Please go ahead.
Adam Samuelson: Yes. Thank you. Good morning, everyone.
Juan Luciano: Good morning, Adam.
Vikram Luthar: Hi.
Adam Samuelson: Hi. So I guess my first question, maybe coming back to Nutrition. As I think about the revised outlook for the year, profit now flat. How should we think about the pathway 2024, 2025 and kind of the achievability of the prior 2025 target, I believe, $1.2 billion of OP in that segment? And maybe the split between human and animal within that, clearly animal has been more pressured than Human Nutrition. So just help me think about kind of as we think about the 2023 targets, kind of where you are relative to what was implied in your plans to get to the 2025 goals? Thanks.
Juan Luciano: Yes. So when we put the 2025 goals, let me go back on the comments I made before. When we look at our plans, we look at how do we grow faster than market and how do we implement projects and target applications to continue to grow EBITDA margin on sales. The two businesses, Animal Nutrition and Human Nutrition had different profiles and different goals in that regard, so when you see the final number is a combination of all those plans roll out. In the Human Nutrition, margins are much higher and is continue to make it better and more stickier to customers as we develop better solutions. In Animal Nutrition was a margin up story since they were coming from lower margins. So when you think about our numbers are a combination of applying our growing faster than market and our EBITDA margin on sales to a market number. Of course, this industry, as you can see by ourselves and our competitors is having through tough times, whether it is because customers are either not innovating fast enough or destocking at this point in time and making sure they have their supply chains in order. So to the extent that those projections are going to be reduced, our percentages of applied to those numbers will be a smaller number. So we haven't gone through that because, to be honest, we are looking at how do we address our current challenges. So we're not that worried about 2025 right now, we want to make sure we make all the adjustments that we need to make. And maybe as we talk about the adjustment, let me talk about the adjustment, let me talk a little bit about Animal Nutrition. Animal Nutrition, as we become more into the business, if you will. We know there is a commodity part, and there is a specialty part. The specialty part matches very well with the -- what the playbook that we have in the human side. And that part is growing and we will continue to accelerate. And Vikram said before, we are repurposing resources to add more of that. There is a commodity part of that, that at the beginning, when we put the two businesses together, we thought it was going to be a good way to open doors, if you will, for the innovation but they have different dynamics. And so we are looking at those different dynamics and how do we need to readjust either the capacities or some of the people associated with that and the intensity of resources in that part as the specialty part is not coming as fast as we thought. So we need to deal with the volatility of the commodity part while the specialty part is a little bit slower. So as those things balance, we are adding productivity to the commodity part of animal, and we are adding more resources to the specialty part in animal and I think that we believe that, that will take us to, again, a growth rate into 2024 for those business. We're going through that. We will cover all that also, Adam in Investor Day as we will have developed more plants. But rest assured, we're very active in our interventions, and we're testing different options in order for us to manage this better. This is also sometimes difficult to characterize on something specific and apply it globally because we have operations in Southeast Asia. We have operations in Brazil. We have operations in Mexico and Europe, in the U.S. And all those things have to be put together and not all the dynamics in all those markets go perfectly aligned and synchronized. So that's why I think we need a little bit more granularity in December to be able to articulate that, which is a little bit more difficult to portray in a call without any numbers or slides.
Operator: Thank you. Our next question comes from Andrew Strelzik from BMO. Andrew, your line is now open. Please go ahead.
Andrew Strelzik: Hi, good morning. Thanks for taking the question. I wanted to ask about your view on the Ag Services strength durability. It seems like we've got tighter global grain supplies than we maybe thought we were going to Refined oils premiums that are out record. Crush margins, obviously, in the U.S. that are very strong. I know maybe Argentina comes back next year. But it doesn't feel like these are things that even though you guide for just 2023 things that would end just because of the calendar flips. And so how long do you think the strength in Ag services can continue for? What I guess, maybe are the risks because it seems like the setup should extend. So curious for your perspective there. Thanks.
Juan Luciano: Yes. Thank you, Andrew. We have had two great years of crops in Brazil, and we're probably going to have a strong crop in the U.S. Volumes are good for us. So we like when there are volumes. But of course, the world has become, as you said, more complicated place where is geopolitics and we can see, unfortunately, what is transpiring in the Black Sea or the weather that has become more violent and more volatile. So we go from a very dry La Nina that impacted a lot of locations around the world and then we may go into a more extreme El Nino, and you can see the temperature, record temperatures that we are dealing with right now. So I would say all that volatility and all that uncertainty increases the value of our investments. When we invest more ports in Brazil, we see the leverage that, that has today. Of course, we're going to probably export a little bit less from the U.S. because we're going to export more from Brazil. And that probably is not going to offset each other perfectly. So maybe Ag Services earnings will be down a little bit based on that. But on the other hand, the big availability of crops in the U.S. will help our processing businesses. If you look at the strength in oils, it is because soybean basis are lower as soybean mill bases have strengthened. So, that's where we get the margin expansion. The world also is going into decarbonization, and that's affecting also the grain industry. The grain industry -- and we are leading that with our regeneration program in regen Ag, but more and more people want crops grow in a certain way. And the claims for deforestation limits are also increasing. So I would say you see a future in which maybe less land will be brought into production as we are climbing in the number of people in the world into 10 billion people. But it's not just the number of people. If you think about the protein consumption, the U.S. - in the U.S., we consumed about 270 pounds per year per capita of proteins. China is about 170. The world, on average, is a 100. So if the world was to get to the average of China, we need 70 pounds per person per year. If we were to get to the level of the U.S., you can need 170. That's a huge amount of grain that needs to be produced in not an expanding significant amount of land. So there is a lot that we will have to go through. So you will continue to have, given the weather and the geopolitics, you continue to have pockets of tightness where our footprint in the world, all the plants that we've been blessed with and the ports and the logistic assets and our destination marketing people and our origination marketing people, they will be more valuable into the future, no doubt, as we try to secure food for the global population.
Operator: Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Please go ahead.
Salvator Tiano: Yes. Thank you very much. On the crush margins, can you provide a little bit more color on why -- in setting aside, of course, Argentina, why Brazil and Europe, the margins have come down recently. And also, now with the crush margin curve having gone up, at least the U.S. substantially, where do you stand in your forward hedging book for the balance of the year? And what's kind of your approach going forward?
Juan Luciano: Okay. Yes, Salvator. So as you said, crush margins have weakened maybe in recent weeks to maybe $20 to $30 in Europe, especially this is a good transition through all to new crop in the U.S. and global oil basis maybe have weakened a little bit with firmer U.S. oil. We continue to bring biodiesel from there. So that continues to add value to the European businesses. But maybe the protein industry is a little bit weaker in Europe. In Brazil, I think Brazil, if I have to say something, maybe Brazil is trying to figure out how to accommodate all the production of soybean and corn, that they have. So there are a lot of logistics challenges in Brazil. And I think that has made -- has pressure the beans basis country side. And soybean oil, I would say, is pressure in Brazil because of lack of domestic demand. Brazil is one of those places where you have export market, but you also have a domestic market. And I would say right now, domestic market, maybe for soybean oil is a little bit weak. And without the huge benefit that we have with the biofuels policies here in the U.S. and Brazil may be a little bit weaker. But I would say, realistically, those are the two places that will pick up the slack that Argentina or the gap that Argentina left. So those are where the beans are. So we expect high crushing rates for both Brazil and the U.S.
Operator: Thank you. Our final question for today comes from Steve Haynes of Morgan Stanley. Steve, your line is now open. Please go ahead.
Steve Haynes: Hi. Thanks for taking my question. Just maybe two quick ones on Nutrition. First, are you able to maybe put a dollar amount to the cost savings the various kind of actions you're taking on the animal side of things in regards to kind of what's baked into the 2023 guide. And then secondly, could you just -- maybe just a quick -- a little bit more detail on what some of the inventory losses were on the Pet Solutions? Thank you.
Vikram Luthar: Yes. So on the Animal Nutrition side, yes, we've taken a lot of the actions over the course of latter part of last year as well as ongoing this year. I'm not going to call out specific numbers, but I'll tell you the vast majority of those results should be realized in the back half of the year. So it's going to be obviously analyzed as you think about it. But -- so the full benefit would likely come in 2024. So you should see an uplift as a consequence of those actions coming on a full year basis in 2024, but you'll see a partial benefit clearly in 2023 as well. On the inventory losses related to Pet that we called out, it was, again, some of the acquired inventory as part of the integration of this facility that we had referenced, where we've had some integration challenges with the small business that we acquired in 2021. So it is related to some of that acquired inventory and some contamination that we saw. So that's -- it was it was material enough to Pet solutions. That's the reason we called it out, clearly not material from an overall ADM perspective.
Operator: Thank you. At this time, we currently have no further questions. So I'll hand back to Megan Britt for any further remarks.
Megan Britt: Thank you for joining us today. Please feel free to follow-up with me if you have any additional questions. Have a good day, and thanks for your time and interest in ADM.
Operator: Thank you for joining today's call. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the ADM Second Quarter 2023 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Thank you, Alex. Hello, and welcome to the second quarter earnings webcast for ADM. Starting tomorrow, a replay of this webcast will be available on our Investor Relations website. Please turn to Slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted, under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano, will discuss our second quarter results, share progress highlights on our first half accomplishment and provide perspective on our outlook for the second half. Our Chief Financial Officer, Vikram Luthar, will review segment level performance for the quarter and first half and provide an update on our cash generation and capital allocation actions. Juan will have some closing remarks, and then he and Vikram will take your questions. Please turn to Slide 3. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan, and thanks to those who have joined us for today's call. Today, ADM reported second quarter adjusted earnings per share of $1.89 with an adjusted segment operating profit of $1.6 billion. Combined with first quarter results, this equates to a first half adjusted earnings per share of $3.98 and an adjusted operating profit of $3.4 billion. Our trailing fourth quarter average adjusted ROIC was 13.8%. The first half of 2023 has probably unfolded as we expected and our financial performance nearly replicates the record results from the first half of last year, even as we face a more challenging macroeconomic and demand environment to start the year. Through active positioning, strong margin management and leveraging our geographically diverse end-to-end supply chain network, we maintain our earnings power and a strong ROIC performance bolstered by key strategic accomplishments across the enterprise. Please turn to Slide 4. Let me highlight just a few across the business. In Ag Services & Oilseeds, our team leveraged past investments in port capabilities to produce record origination volumes out of our Brazilian facilities, expanded our regenerative agriculture partnerships and leverage our ability to flex crush capacity to capitalize on higher canola crush margins. In the latter instance, we flexed more than 300,000 tons of capacity and captured an additional $40 per metric ton of margin. In Carbohydrate Solutions, strategic investments in optimization and modernization allowed our team to manage increased demand for liquid sweeteners, drive growth in BioSolutions revenue and operating profit and produced record results in our milling and international corn businesses. In Nutrition, our unique go-to-market strategy continues to drive a larger sales pipeline and deliver double-digit growth in the Flavors business, thanks to an impressive performance in EMEA and new wins in North America. When you combine all of these aspects across ADM's full business portfolio, it's clear how we are able to convert challenges in one geography, product or business segment into value drivers in another. Next slide, please. Let's review the factors that we see as important drivers for a strong second half finish in 2023. We expect continued strength in Brazil origination for the remainder of the year. Our past strategic investments in port facilities in Brazil optimize origination network and deep connection to our global trade and destination marketing teams will allow us to export strong volumes, capitalizing on the record Brazilian soybean and corn crops. Biofuels demand continues to remain strong. Through the first half of the year, we saw robust margins from biodiesel, strong demand for ethanol and an increasing demand for vegetable oil from renewable green diesel and we expect this trends to continue in the second half. Our Spiritwood, North Dakota processing facilities is scheduled to start up in Q4, adding 1.5 million metric tons of annual soy crush capacity to our portfolio and producing low carbon intensity soybean oil for our JV partner Marathon's nearby renewable diesel facility. Projects like this will support growing demand for renewable diesel and sustainable aviation fuel throughout the industry. We also see continued resilience in food demand for core products. We expect the continued solid margin and volume environment for sweeteners, starches and flours. We are beginning to convert our pipeline of wins in Human Nutrition into operating profit. Well, there are some factors that have hindered growth in the portfolio, we believe positive momentum from Flavors is a predictor of a healthy rebound. We also see continued commodity market dislocations in the second half. ADM has the unique ability to execute with agility in a dynamic environment. Our team utilizes our unparalleled global asset footprint and end-to-end supply chain to adapt to evolving market conditions and meet global food security needs while driving strong returns. Lastly, our balance sheet remains healthy, and we are flexing it toward organic investments and opportunistic share buybacks. We continue to deploy capital to drive organic productivity and innovation-oriented programs such as Spiritwood, Valencia and Marshall as well as invest in our plant automation efforts and our broad decarbonization initiatives. And our $1 billion in share repurchases in the first half highlights our confidence in the strong cash generation and growth potential of our company. As we look at the back half of the year, we intend to continue our share repurchase program. We feel that these factors are fundamental drivers of our strong second half performance. I am proud of how our team has delivered halfway through the year and even more excited about the opportunities presented in the second half and what our team can deliver. Taking collectively, we are raising our earnings expectations for full year 2023. With that, let me turn it over to Vikram, who will go into more detail on the results of operations. Vikram?"
},
{
"speaker": "Vikram Luthar",
"text": "Thank you, Juan. Please turn to Slide 6. The Ag Services & Oilseeds team continues to deliver exceptional results in a dynamic environment, leading to an extremely strong performance in the first half of 2023, surpassing the outstanding first half of the prior year. Q2 results were strong, but slightly below the prior year period. Ag Services results were in line with the strong second quarter of 2022. South American origination results were higher year-over-year as the team delivered record volumes and higher margins on strong export demand, leveraging our strategic investments to expand port capacity to capitalize on the record Brazilian soybean crop. Results for North America origination was slightly lower year-over-year, driven by lower export volumes due to large South America suppliers. Our execution in destination marketing as well as effective risk management continue to deliver strong global trade results, though lower than the record quarter last year. In our crushing subsegment, results were much lower than the record result from the second quarter last year. Global soy crush margins remained strong but were lower year-over-year in all regions due to softer demand for both meal and oil and a tight U.S. soybean carryout. This was partially offset by strong softseed margins and higher volumes supported by a strong Canadian canola crop and use of our flex capacity in EMEA. Additionally, there were approximately $195 million of negative mark-to-market timing effects in the current quarter that are expected to reverse as the contracts execute in future periods. Refined products and other results were significantly higher than the prior year period, achieving a record second quarter. North America results were higher, driven by strong food oil demand and improved biodiesel volumes. In EMEA, strong export demand for biodiesel and domestic food oil demand supported stronger margins. Additionally, there were approximately $90 million of positive mark-to-market timing effects in the current quarter that are expected to reverse as the contracts execute in future periods. Equity earnings from Wilmar were lower versus the second quarter of 2022. Looking ahead for the third quarter, we anticipate solid results in Ag Services & Oilseeds. We expect strong demand for grain exports to be heavily weighted towards South America and our Brazilian origination footprint. We anticipate strong volumes and margins for soy and canola crush based on the tight Argentine crop and improving demand outlook for meal and oil. We expect RPO to perform well but have significant reversals of timing impacts from the second quarter, leading to lower net execution margins. Slide 7, please. Carbohydrate Solutions delivered strong results in Q2, but lower than the record second quarter of last year. The Starches and Sweeteners subsegment, including ethanol production from our wet mills, capitalized on a solid demand environment during the quarter. North America Starches and Sweeteners delivered volumes and margins similar to the prior years, and ethanol margins were solid as industry stocks moderated but lower relative to the prior year. Q2 results were negatively impacted due to unplanned downtime at one of our corn germ plants. In EMEA, the team effectively managed margins to deliver improved results. The global wheat milling business posted higher margins, supported by steady customer demand. BioSolutions continued on its excellent growth trajectory with 22% revenue growth year-over-year. Vantage Corn Processors results were lower due to lower year-over-year ethanol margins. The prior year period also includes a onetime $50 million benefit from the USDA biofuel producer recovery program. We continue to make progress on our initiatives to decarbonize the Carbohydrate Solutions footprint including our definitive agreement with Tallgrass to sequester carbon from our Columbus, Nebraska facility and continued progress on decarbonizing our decade complex through additional carbon capture and sequestration wells, as well as ultra-low-carbon intensity, electricity and steam generation. These are key steps in enabling us to produce low CI feedstocks for use in many applications for our major CPG customers and underpinning our growth opportunities, such as SAS, BioSolutions and our lactic acid polylactic acid joint venture with LG Chem. Looking ahead for the third quarter, we expect continued steady demand in margins for our starches, sweeteners and wheat flour products. Ethanol margins are also expected to remain solid. On Slide 8, Nutrition results were significantly lower than the prior year's record quarter. Human Nutrition results were slightly up year-over-year on a constant currency basis. Our Flavors business posted record results in Q2, growing revenues and EBITDA margins due to improved mix and pricing in EMEA, as well as improving demand in North America. Flavors will be a significant growth engine for Human Nutrition for the remainder of the year and will act as a pace setter for the rest of our portfolio. Customer innovation in beverage is beginning to accelerate, and our value proposition is driving our sales pipeline to its largest ever. Growth in Flavors was offset by lower year-over-year results in Specialty Ingredients. While there has been softening of demand for plant-based proteins, particularly for the alternative meat space, other categories like alternative dairy snacks and baked goods as well as specialized nutrition are providing growth opportunities. Although still a small OP contributor, Health and Wellness is seeing demand recovery in probiotics and is benefiting from geographic expansion opportunities offered through ADM's global footprint and customer relationships. Our largest challenge in 2023 has been in the Animal Nutrition business were significantly lower amino acid margins and softer global feed demand has affected volumes driving much lower results. Over the past several months, we have made important adjustments to align the business to this environment, including simplifying our brands and go-to-market strategy, consolidating facilities and optimizing our footprint, rightsizing the workforce in association with these changes and aligning the reporting structure to enhance synergies. We are also refocusing our efforts to increase offerings in the higher-margin specialty feed and ingredients areas. We believe these actions will lead to improved commercial and operational performance, supporting profitable growth when market fundamentals improve. When looking at Nutrition as a whole, we now expect 2023 results to be similar to the prior years, as we expect growth in Human Nutrition to be offset by lower results in Animal Nutrition. However, given the increase in customer innovation we've seen in our Flavors business and our recent wins in pipeline growth across Human Nutrition, as well as the actions we are taking in Animal Nutrition, we remain confident about the future outlook and growth prospects for Nutrition. Slide 9, please. Other business results were significantly higher than the prior year quarter due to improved ADM investor services earnings on higher net interest income. Captive insurance improved on premiums from new programs, partially offset by increased claim settlements. In corporate results, net interest expense for the quarter increased year-over-year, primarily on higher short-term interest rates. Unallocated corporate costs of $262 million was similar versus the prior year as lower health insurance costs were offset by increased global technology spend. Other corporate was unfavorable versus the prior year, primarily due to foreign currency hedges. We still project corporate costs to be approximately $1.5 billion for the year. The effective tax rate for the second quarter was -- of 2023 was approximately 18%, in line with the prior year. For the full year, we still expect our effective tax rate to be between 16% and 19%. Next slide, please. Through the second quarter, we had strong operating cash flows before working capital of $2.5 billion. We allocated $600 million to capital expenditures as well as returned $1.5 billion to shareholders through share repurchases and dividends. We continue to have ample liquidity with nearly $13 billion of cash and available credit, and our leverage ratio are low with an adjusted net debt-to-EBITDA ratio at 1.0. Our strong balance sheet and credit ratings provide a stable financial footing for ADM to pursue our strategic growth initiatives while also returning capital to shareholders. We still anticipate $1.3 billion of capital expenditures in 2023. As Juan mentioned, we have already completed the $1 billion of share repurchases that we announced in January this year. We intend to continue our share repurchase program, subject to other strategic uses of capital. Based on our very strong first half, we are raising our full year earnings outlook to around $7 per share with potential for even more upside. Juan?"
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Vikram. As we wrap up today's call, let me highlight a few opportunities that we're excited about as ADM continues to execute our strategic agenda, where we're seeing value generation today and have plans to accelerate. Let's start with digitization and automation. Our ongoing work to modernize and automate our operations is ramping up. Our eight current implementations across North America and Europe are generating millions in run rate benefits. And we have 10 more starting in Q3 with the expectation of similar scalable benefits. Our 1ADM program is accelerating our decision-making and analytics capabilities across the company, helping us find faster path to productivity. With our HR systems now in place globally, our next milestone is bringing part of the Nutrition flavors business on board. In LatAm, we have implemented technology to optimize trade and commercial processes while digitizing freight and logistics contracting. All of this is helping us reduce costs and make better, faster decisions to deliver value to ADM and our customers. Sustainability and decarbonization have opened new avenues for growth across the enterprise while ensuring we are taking the necessary actions on our own footprint. Our STRIVE 35 program continues to deliver important progress, and our recent sustainability report shows our efforts in greenhouse gas emissions, waste reduction, no deforestation and crop traceability achieving targets ahead of plan. As we continue to support our most significant customers with carbon advantage crop sources, we recently announced regenerative Ag program targets of 2 million acres in 2023 with an additional 2 million acres by 2025. With the recent Tallgrass agreement and permit submissions, CO2 from ADM facilities in Nebraska, Iowa and Illinois is now targeted to be captured and stored safely and permanently underground within our expand indicator CCS well capacity. This helps decarbonize our customers' value chains and our own across important opportunity spaces like BioSolutions and sustainable aviation fuel. And we are continuing to invest in the next phase of innovation. Our new Decatur protein solution center is engaged in ADM's world-class science and technology capabilities to deliver on tomorrow's most important consumer nutrition trends. Collaboration between ADM and our ventures partners take us beyond today's alternative protein sources to help address critical areas of sustainability, wellness and affordability. Leveraging our deep fermentation expertise and capacity is positioning us to scale the next generation of food, feed, fuel, fabrics and other industrial products with key partners. The combination of technology alongside global trends in sustainability, food security and well-being is transforming the food and agriculture industry at the fastest pace since the last century. And ADM is at the forefront of this transformation and connected growth opportunities, which give us even more confidence in our long-range growth plans. Thank you for your time today. Vikram and I look forward to your questions. Alex, please open the line."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question for today comes from Ben Theurer from Barclays. Ben, your line is now open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"text": "Thank you very much. Good morning, Juan. Good morning, Vikram."
},
{
"speaker": "Juan Luciano",
"text": "Good morning."
},
{
"speaker": "Vikram Luthar",
"text": "Good morning."
},
{
"speaker": "Ben Theurer",
"text": "So I'd like to -- just a general question on obviously, like the puts and takes. You're raising your guidance at the higher end of what 6% to 7% was now around 7%. And obviously, you had a very strong first half, but then at the same time, you're looking for a little more softness in Nutrition. So maybe help us understand how you feel about just macro picture in general demand? What are the geopolitical assumptions that you have behind your outlook and how you feel about second half and then also beyond maybe into 2024, as it relates to general demand in an environment where we're in right now. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Sure, Ben. Yes, of course, first of all, we're very proud of the results we accomplished in the quarter and in the first half. And certainly, we are more confident about the environment ahead of us for ADM. I would say -- let me highlight some of the reasons for that. Certainly, crush margins have started to pick up as we predicted before. They continue to get better. Board crush has been firmer and mill basis has been stronger and BIM basis have dropped in the U.S. as we have anticipated. I think there is a shift in which the world needs more protein, then we need more mill, and we can cover for Argentina shortcomings this year. So that is happening as we predicted. And certainly, it's going to be very good for Q3 and Q4. I think we're seeing these huge crops in Brazil. We see the Brazilian port congestion driving a lower interior basis and allowing us to procure cheaper grains, giving margins to those companies that have invested in the infrastructure to be able to capitalize on that, which we did, both in Santos and in Barcarena in Brazil. So, that's playing very well for us. The last time we talked, ethanol inventories were around 25 million to 26 million barrels. Now we are at the end of June at about 22 million. There is -- we see a strong spot demand for ethanol and corn tough to buy. So that has made margins strengthen, and they are holding. So we are positive about ethanol margins continued in that regard. We continue to see this trend in biofuels and we have a strong book on biodiesel for the quarter. So we feel good about that. We are seeing lower recession challenges and the U.S. consumer very resilient, and that's bringing resiliency in our core products for food demand. And we see that in carb solutions, whether it's sweeteners and starches or whether it's in milling. So as you highlighted, of course, and Vikram went deep into that, the issues in Nutrition, I would say we feel good about how our value proposition continues to resonate in flavors. Flavors is more beverage kind of business, if you will. The innovation happens a little bit faster there. So we see our pipeline continues to grow. That bodes very well for what we know the potential revenue is in 2024. So again, we continue to align the company to these big three trends, food security that with all the geopolitics and the weather makes ADM assets more valuable and gives us more margin in destination marketing services, for example. We see health and well-being, and that continues to show in all the flavors innovation that we're seeing with our customers. And we see the sustainability trend driving all these opportunities in decarbonization. I would say we shouldn't forget when we mentioned this, that either in automation on decarbonization, we are at the early innings of multiyear progress for the industry and for ADM. So I think that we feel very good about '23 and we feel even better about the future."
},
{
"speaker": "Ben Theurer",
"text": "Perfect. Thank you, very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question for today comes from Ben Bienvenu from Stephens. Ben, your line is now open. Please go ahead."
},
{
"speaker": "Ben Bienvenu",
"text": "Hi, good morning, everybody. Thanks for taking my question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Ben."
},
{
"speaker": "Ben Bienvenu",
"text": "I want to just follow-up just on the -- good morning, on the Nutrition business and maybe to the extent that you can talk a little bit about the cadence as we move through the back half of the year. I appreciate the updated comments on overall results being flat year-over-year. But there's -- with Animal Nutrition expected to be down year-over-year, there's a pretty substantial ramp in the human side of things. Maybe if you could talk a little bit about the visibility that you have into that? And then to the extent you can parse between 3Q and 4Q as you see it today, that would be helpful."
},
{
"speaker": "Vikram Luthar",
"text": "Yes, Ben. So I think let's just take a few minutes to talk about why our guide has gone from 10% growth to flat. Animal Nutrition cyclical weakness is persisting for longer than we anticipated. Consumers continue to trade down from higher value, more feed intensive to lower value, less feed intensive proteins. Reformulation to reduce feed cost is also impacting volumes. Plant-based proteins, particularly in the alternative meats continues to be softer than anticipated. The destocking actually is still continuing in that category. And the broader market growth has also moderated, which we had signaled before. Third, the demand fulfillment challenge in pet solutions are taking longer than anticipated resolve. The delay was driven primarily by slower than anticipated integration of the recent small business acquisition that we made in North America. And if you remember, we had COVID, and that delayed also the integration. So we're working through that. But what are we doing? And that's important as you think about the back half as well as the future. Flavors. Strong pipeline and win rates. We talked about the largest ever pipeline we've had. Flavors actually grew profits in the first half 9%, 20% in Q2. So that's a very good sign of the recovery we are seeing in parts of the Human Nutrition business. The other thing that's important to note, Flavors actually contributed almost 50% of the overall operating profit for Nutrition in the first half. So that's an important signal as you think about the future growth of Nutrition. Yes, that was primarily driven in the beverage category, but we see green shoots of opportunity in the food category as well. In the SI side, we are leveraging our CD&D capabilities to accelerate penetration into some of the faster-growing categories. I mentioned alternative spaces, alternative meat has been soft but alternative dairy and some of the other categories actually growing. And we are launching our Decatur protein innovation center in Q3. All that, given our CD&D capabilities allows us to pivot to categories that are growing. And that sometimes takes time. So we anticipate that recovery possibly to come in more in the 2024 time frame, less in the back half of this year. In Animal Nutrition, we are taking actions to improve margins, cost and product and footprint rationalization to improve margins and also to drive profitable growth as the markets recover. So we feel good about the recovery as the market recovers. And in parallel, what we are doing is looking at the specialty part of our Animal Nutrition portfolio to leverage our Human Nutrition, CD&D and go-to-market capabilities to be able to drive increased penetration there. On the pet side, demand creation is going to take a little longer, possibly into the back half of this year and into 2024. But overall, we clearly see signs of recovery, and our forward outlook for Nutrition is still strong and robust in terms of growth. This year, given some of the challenges we faced, we expect it to be similar to last year. Juan, I don't know if you want to add some longer-term perspective."
},
{
"speaker": "Juan Luciano",
"text": "Listen, Ben, as Vikram said, we continue to be very positive. We look at this -- remember, when we started the Nutrition business, which we're still trying to build into the best nutrition company in the world, we ask our team that we're going to measure them by two factors. One was growing faster than market and in markets where the customers are still moving and innovation is coming, like in Flavors, we've seen that we're growing faster than market, and you can see it by the double-digit growth that we have so far. And then the other thing that we said was EBITDA margin on sales growing, and we grew EBITDA marginal sales in Flavors. So I think that in the others, I think Vikram has -- this industry is going through a difficult destocking year and there has been some self-inflicted things like the integration of this small facility in Pet. So I think we're working through some of our growing pains as we build the portfolio. But I think the important thing is our innovation system, our value proposition to bring new recipes to customers faster than anybody else continues to outperform the industry and that we're seeing in the results. When customers have projects like in beverage and all that, we excel. When customers are flat or destocking, it takes a little longer. We still expect the trajectory to be similar in that regard."
},
{
"speaker": "Ben Bienvenu",
"text": "Okay. Very good. My second question is on Starches and Sweeteners. You noted similar volumes and margins in the second quarter. You did have a plant that was down unexpectedly. Could you talk about the impact of that that's discrete to the second quarter? And then you point to solid margins for sweetener, starches and flour in the back half of this year, would you expect -- would you characterize that more specifically as similar margins and volumes again? Or do you expect an improvement in the back half of the year? Thank you."
},
{
"speaker": "Vikram Luthar",
"text": "Sure. So Ben, let's talk about the germ crush facility outage. In April, we had an incident at one of our grain elevators at the West plant within ADM's processing complex indicator. This negatively impacted the Carbohydrate Solutions Q2 results by a significant amount. Germ was actually sold into feed markets as our wet mills were slow to reduce the overall exposure to germ, lowering also ethanol production volumes at a time when ethanol margins were strong. We anticipate this to come back in Q4. So yes, Q2 was impacted. I won't get into the specifics but the fact that it was significant enough for us to call it out means it was a meaningful number. But it is going to come back in Q4. So therefore, based on that, you can expect some seasonality, some shift from Q2 to Q4 as a consequence of that. But for the full year, we still remain very -- the outlook for the full year still remains very strong. The sweeteners and starch and actually also the growth of milling volumes have been very resilient. We've seen some softening in the specialty side of the portfolio, but that's been more than offset by mix and margins. So I'd say, overall, the outlook is solid. And yes, we did have a material impact, a significant impact due to the corn germ in Q2."
},
{
"speaker": "Ben Bienvenu",
"text": "Okay. Thanks and congratulations."
},
{
"speaker": "Vikram Luthar",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tom Palmer of JPMorgan. Tom, your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "Good morning, and thanks for the question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning."
},
{
"speaker": "Tom Palmer",
"text": "Perhaps we could just talk through the moving pieces as we migrate to the North America harvest. We've seen crush margins in the U.S. strengthen, especially in the past month or so. Looks like we've seen maybe just a little bit of a beginning in other regions of the world. I think often, when you see our weaker-than-expected supply coming out of the country, other regions of the world often benefit. And at least up to this point, and I know we're ahead of the harvest, we haven't seen that necessarily in margins. I mean, how do you guys think about as we think about the balance of the year, kind of regional expectations for crush progressing?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Tom. As I said before, I think that when you see the world needs more protein and certainly, we can see that given the Argentine GAAP , which is they produce probably 20 million, 25 million tons less soybeans and maybe the world was expecting them to produce, that's reallocating crush, we are locating crush to two places; we are locating crush to Brazil and reallocating crush to U.S. So of course, the time of that is different. And so we see that in the margins that we see for the U.S. coming into Q3 and then Q4. Demand continues to be strong for meal. There won't be so much protein that is not going to just be soybean meal, but there's going to be other types of protein feed, whether it's feed wheat and all that. So when you take that, combined with the increased demand from fuels, but also oils for food consumption. If we expect soybean oil demand to go up like 8%, it's like about 6% coming from food and maybe 2% coming from fuel. But my point is crush margins are supported from everywhere. Of course, as the world gets to try to cover for these soybeans, the margins will be where you are closer to the physical product to have access to the physical soybeans. And that's where ADM footprint and ADM combined with origination and global trade where we excel. So I think the team had a great first half, and they are expecting a great second half. And we don't see anything that can derail this for quite some time. I hope that provides some perspective."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Manav Gupta of UBS. Your line is now open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"text": "Hi. My quick question here is we are in the second phase where a number of new plants on the R&D side will start up in the second half of this year including one of your partners, which is starting up a bigger plant on the West Coast. So I'm just trying to understand from the demand perspective of soyabean oil, do you expect a much stronger demand environment than what we saw in the first half of this year?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, I think that we have all these plants that are coming that have been announced. And of course, we're looking all the time at the probability of those plants coming. Sometimes when you build in an industry, not everything comes at the right time. But as you said before, there are two or three large plants coming now in the second half, and that will continue to increase the demand. Of course, our plant in - from our partner comes with our crush capacity as well that we're building, this 1.5 million tons per year. So -- but Manav, when we look at these we believe that, at the end of the day, that demand will come through. At the end of the day, we will have enough crush for soybean oil to participate being maybe 60% of the overall pool of feedstock needed. And we think that the industry will continue to grow, but we continue to need to attract other feedstocks for us to fulfill this potential. So the industry is going to get tight. You're going to need capacity, technology and capabilities, if you will, in order to deliver that, but that's the way you make progress, building a new industry and going through an energy transition. But that's very favorable for ADM. And I think that we're very pleased to bring in Spiritwood on time for the harvest, on budget. So we are very pleased the way the team has managed that implementation."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Adam, your line is now open. Please go ahead."
},
{
"speaker": "Adam Samuelson",
"text": "Yes. Thank you. Good morning, everyone."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Adam."
},
{
"speaker": "Vikram Luthar",
"text": "Hi."
},
{
"speaker": "Adam Samuelson",
"text": "Hi. So I guess my first question, maybe coming back to Nutrition. As I think about the revised outlook for the year, profit now flat. How should we think about the pathway 2024, 2025 and kind of the achievability of the prior 2025 target, I believe, $1.2 billion of OP in that segment? And maybe the split between human and animal within that, clearly animal has been more pressured than Human Nutrition. So just help me think about kind of as we think about the 2023 targets, kind of where you are relative to what was implied in your plans to get to the 2025 goals? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. So when we put the 2025 goals, let me go back on the comments I made before. When we look at our plans, we look at how do we grow faster than market and how do we implement projects and target applications to continue to grow EBITDA margin on sales. The two businesses, Animal Nutrition and Human Nutrition had different profiles and different goals in that regard, so when you see the final number is a combination of all those plans roll out. In the Human Nutrition, margins are much higher and is continue to make it better and more stickier to customers as we develop better solutions. In Animal Nutrition was a margin up story since they were coming from lower margins. So when you think about our numbers are a combination of applying our growing faster than market and our EBITDA margin on sales to a market number. Of course, this industry, as you can see by ourselves and our competitors is having through tough times, whether it is because customers are either not innovating fast enough or destocking at this point in time and making sure they have their supply chains in order. So to the extent that those projections are going to be reduced, our percentages of applied to those numbers will be a smaller number. So we haven't gone through that because, to be honest, we are looking at how do we address our current challenges. So we're not that worried about 2025 right now, we want to make sure we make all the adjustments that we need to make. And maybe as we talk about the adjustment, let me talk about the adjustment, let me talk a little bit about Animal Nutrition. Animal Nutrition, as we become more into the business, if you will. We know there is a commodity part, and there is a specialty part. The specialty part matches very well with the -- what the playbook that we have in the human side. And that part is growing and we will continue to accelerate. And Vikram said before, we are repurposing resources to add more of that. There is a commodity part of that, that at the beginning, when we put the two businesses together, we thought it was going to be a good way to open doors, if you will, for the innovation but they have different dynamics. And so we are looking at those different dynamics and how do we need to readjust either the capacities or some of the people associated with that and the intensity of resources in that part as the specialty part is not coming as fast as we thought. So we need to deal with the volatility of the commodity part while the specialty part is a little bit slower. So as those things balance, we are adding productivity to the commodity part of animal, and we are adding more resources to the specialty part in animal and I think that we believe that, that will take us to, again, a growth rate into 2024 for those business. We're going through that. We will cover all that also, Adam in Investor Day as we will have developed more plants. But rest assured, we're very active in our interventions, and we're testing different options in order for us to manage this better. This is also sometimes difficult to characterize on something specific and apply it globally because we have operations in Southeast Asia. We have operations in Brazil. We have operations in Mexico and Europe, in the U.S. And all those things have to be put together and not all the dynamics in all those markets go perfectly aligned and synchronized. So that's why I think we need a little bit more granularity in December to be able to articulate that, which is a little bit more difficult to portray in a call without any numbers or slides."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Andrew Strelzik from BMO. Andrew, your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "Hi, good morning. Thanks for taking the question. I wanted to ask about your view on the Ag Services strength durability. It seems like we've got tighter global grain supplies than we maybe thought we were going to Refined oils premiums that are out record. Crush margins, obviously, in the U.S. that are very strong. I know maybe Argentina comes back next year. But it doesn't feel like these are things that even though you guide for just 2023 things that would end just because of the calendar flips. And so how long do you think the strength in Ag services can continue for? What I guess, maybe are the risks because it seems like the setup should extend. So curious for your perspective there. Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Andrew. We have had two great years of crops in Brazil, and we're probably going to have a strong crop in the U.S. Volumes are good for us. So we like when there are volumes. But of course, the world has become, as you said, more complicated place where is geopolitics and we can see, unfortunately, what is transpiring in the Black Sea or the weather that has become more violent and more volatile. So we go from a very dry La Nina that impacted a lot of locations around the world and then we may go into a more extreme El Nino, and you can see the temperature, record temperatures that we are dealing with right now. So I would say all that volatility and all that uncertainty increases the value of our investments. When we invest more ports in Brazil, we see the leverage that, that has today. Of course, we're going to probably export a little bit less from the U.S. because we're going to export more from Brazil. And that probably is not going to offset each other perfectly. So maybe Ag Services earnings will be down a little bit based on that. But on the other hand, the big availability of crops in the U.S. will help our processing businesses. If you look at the strength in oils, it is because soybean basis are lower as soybean mill bases have strengthened. So, that's where we get the margin expansion. The world also is going into decarbonization, and that's affecting also the grain industry. The grain industry -- and we are leading that with our regeneration program in regen Ag, but more and more people want crops grow in a certain way. And the claims for deforestation limits are also increasing. So I would say you see a future in which maybe less land will be brought into production as we are climbing in the number of people in the world into 10 billion people. But it's not just the number of people. If you think about the protein consumption, the U.S. - in the U.S., we consumed about 270 pounds per year per capita of proteins. China is about 170. The world, on average, is a 100. So if the world was to get to the average of China, we need 70 pounds per person per year. If we were to get to the level of the U.S., you can need 170. That's a huge amount of grain that needs to be produced in not an expanding significant amount of land. So there is a lot that we will have to go through. So you will continue to have, given the weather and the geopolitics, you continue to have pockets of tightness where our footprint in the world, all the plants that we've been blessed with and the ports and the logistic assets and our destination marketing people and our origination marketing people, they will be more valuable into the future, no doubt, as we try to secure food for the global population."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "Yes. Thank you very much. On the crush margins, can you provide a little bit more color on why -- in setting aside, of course, Argentina, why Brazil and Europe, the margins have come down recently. And also, now with the crush margin curve having gone up, at least the U.S. substantially, where do you stand in your forward hedging book for the balance of the year? And what's kind of your approach going forward?"
},
{
"speaker": "Juan Luciano",
"text": "Okay. Yes, Salvator. So as you said, crush margins have weakened maybe in recent weeks to maybe $20 to $30 in Europe, especially this is a good transition through all to new crop in the U.S. and global oil basis maybe have weakened a little bit with firmer U.S. oil. We continue to bring biodiesel from there. So that continues to add value to the European businesses. But maybe the protein industry is a little bit weaker in Europe. In Brazil, I think Brazil, if I have to say something, maybe Brazil is trying to figure out how to accommodate all the production of soybean and corn, that they have. So there are a lot of logistics challenges in Brazil. And I think that has made -- has pressure the beans basis country side. And soybean oil, I would say, is pressure in Brazil because of lack of domestic demand. Brazil is one of those places where you have export market, but you also have a domestic market. And I would say right now, domestic market, maybe for soybean oil is a little bit weak. And without the huge benefit that we have with the biofuels policies here in the U.S. and Brazil may be a little bit weaker. But I would say, realistically, those are the two places that will pick up the slack that Argentina or the gap that Argentina left. So those are where the beans are. So we expect high crushing rates for both Brazil and the U.S."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question for today comes from Steve Haynes of Morgan Stanley. Steve, your line is now open. Please go ahead."
},
{
"speaker": "Steve Haynes",
"text": "Hi. Thanks for taking my question. Just maybe two quick ones on Nutrition. First, are you able to maybe put a dollar amount to the cost savings the various kind of actions you're taking on the animal side of things in regards to kind of what's baked into the 2023 guide. And then secondly, could you just -- maybe just a quick -- a little bit more detail on what some of the inventory losses were on the Pet Solutions? Thank you."
},
{
"speaker": "Vikram Luthar",
"text": "Yes. So on the Animal Nutrition side, yes, we've taken a lot of the actions over the course of latter part of last year as well as ongoing this year. I'm not going to call out specific numbers, but I'll tell you the vast majority of those results should be realized in the back half of the year. So it's going to be obviously analyzed as you think about it. But -- so the full benefit would likely come in 2024. So you should see an uplift as a consequence of those actions coming on a full year basis in 2024, but you'll see a partial benefit clearly in 2023 as well. On the inventory losses related to Pet that we called out, it was, again, some of the acquired inventory as part of the integration of this facility that we had referenced, where we've had some integration challenges with the small business that we acquired in 2021. So it is related to some of that acquired inventory and some contamination that we saw. So that's -- it was it was material enough to Pet solutions. That's the reason we called it out, clearly not material from an overall ADM perspective."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, we currently have no further questions. So I'll hand back to Megan Britt for any further remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you for joining us today. Please feel free to follow-up with me if you have any additional questions. Have a good day, and thanks for your time and interest in ADM."
},
{
"speaker": "Operator",
"text": "Thank you for joining today's call. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 1 | 2,023 | 2023-04-25 02:00:00 | Operator: Good morning, and welcome to the ADM First Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Thank you, Bailey. Hello, and welcome to the first quarter earnings webcast for ADM. Starting tomorrow, a replay of this webcast will be available on our Investor Relations website. Please turn to Slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano, will discuss our first quarter results, provide ADM’s perspective on the current market backdrop and share progress highlights on our strategic priorities for the year. Our Chief Financial Officer, Vikram Luthar, will review the drivers of our financial performance at the segment level and review our cash generation and capital allocation results. Juan will have some closing remarks, and then he and Vikram will take your questions. Please turn to Slide 3. I’ll now turn the call over to Juan.
Juan Luciano: Thank you, Megan. And thanks to all those joining us for the call today. This morning, ADM reported strong first quarter adjusted earnings per share of $2.09, with an adjusted segment operating profit of $1.7 billion and a trailing fourth quarter average adjusted ROIC of 14%. Our performance demonstrates once again the advantage of ADM’s uniquely integrated value chain and broad portfolio. Along with the team’s ability to respond nimbly to opportunities aligned to the three enduring trends of food security, health and well-being and sustainability. All of this was achieved in a fluid economic environment where ripple effects are being felt from both inflationary and recessionary pressures, shifts in global demand and trade activity and the ongoing war in Ukraine. Our team continues to find ways to rise above these challenges and meet our customers’ needs for consistency, quality and innovation at every turn across our business units. We have wrapped up Q1 with a strong balance sheet, healthy cash flows, and we are on track for our 2023 and long-term strategic growth plans and we continue to pursue growth opportunities and increase shareholder returns in alignment with our disciplined capital allocation framework. This quarter, we also announced several exciting milestones in our continued growth and innovation strategy, including the opening of the world’s first probiotic and postbiotics production facility in Valencia, Spain, which increases our global production capacity by a factor of five. Agreements with ADM ventures, partners, BrightFit [ph] and Believer Meats to advance innovations in gut microbiome and cell-based meat respectively. And our definitive agreement with Tallgrass to pave the way for carbon capture from ADM’s Columbus, Nebraska complex furthering our decarbonization agenda. Beyond the financial highlights of the quarter, we are proud to be named one of Fortune’s Most Admired Companies for the 15th year running. And to receive our fourth consecutive Ethisphere award as one of the world’s most ethical companies. It’s an honor to be recognized externally and it continues to demonstrate that ADM’s culture and people are the engine behind our operational and financial success. As we look back on the quarter, I’d like to review it in the context of the 2023 framing we discussed in Q4’s call and provide a few brief updates. Slide 4, please. In January, we reviewed several factors that underpinned our confident outlook for 2023, and these same factors will continue to shape our performance throughout the year. The supply and demand situation remains fundamentally solid with some normalization of supply alongside shift in both the products driving demand and the origins providing supply. Supply and transportation constraints in the Black Sea region, severe drought in Argentina, the record Brazilian crop and a resurgence of demand in China post lockdown have allowed our team to take full advantage of our global footprint. Broad-based food demand remains resilient across key geographies. And we did, we are seeing solid volumes and strong operating margins across vegetable oils, flavors, sweeteners, starches and wheat milling. Demand for biodiesel and renewable green diesel is robust, driving continued strong gross margins. The strong biofuel demand and continued expectation for growth supports our investment in new crush capacity like the additional 150,000 bushels per day from our Spiritwood, North Dakota facility scheduled to come online in time for the 2023 harvest. Nutrition’s growth trajectory for the year remains on course with a double-digit increase in our human nutrition pipeline compared to this point in 2022. As noted, we expect this growth to be significantly weighted to the back half of the year, as we manage through some destocking impacts in beverage, lower margins in amino acids and the broader demand fulfillment challenges we discussed in the last quarter. It’s important to recognize that our team delivered strong Q1 results despite constantly evolving macroeconomic conditions. ADM’s ability to remain agile and apply the principles of productivity and innovation continues to position us well in a dynamic external environment. Let me take a moment to dig deeper into examples of how we are applying our productivity playbook across the organization and how decarbonization is helping us find paths for both innovation and growth. Slide 5, please. From a productivity perspective, we have continued to focus attention on automation within many of our key operations facilities. Automation not only accelerates the modernization of our manufacturing footprint, it is helping us deliver significant savings at the enterprise level. Whether we are reducing chemicals usage, delivering yield improvements or supporting operational reliability, our automation program now has a plan to scale cost improvements across our most critical operational assets over the next several years. Eight of our plans are currently underway and we expect that most of these will complete their automation implementation by year-end. And we are seeing operational and financial impacts immediately following implementation. Our most recent implementation in SEDA Rapeseed [ph] is already generating millions of dollars in efficiencies in just the first few months, confirming the double-digit returns we expect to see from these proceeds. As a whole, the impact on operating profit is significant with a target run rate of approximately $200 million per year when implementations are complete at more than 70 facilities over the next seven years. This is only one example of productivity measures we are undertaking to ensure ADM maintains agility given the levels of uncertainty in the external environment. Each of our businesses and functions is identifying opportunities to drive efficiency at the scale, while maintaining a focus on growth. Our decarbonization journey continues to move at a rapid pace and is allowing us to showcase innovation in action. Our advantaged position in alternative fuels production has prepared us for the demand cycle that continues to rise across biodiesel and renewable diesel. We continue to explore strategic options to convert ethanol into sustainable aviation fuel. The multibillion dollar addressable opportunity represented by SAF alone highlights the criticality of access to low-carbon feedstocks at a scale exponentially higher than what is available today. This is why we are prioritizing the decarbonization of our Decatur complex as the first critical step in unlocking significant value. Last year, we announced one of the world’s first, ultra-low emissions power plants would be built adjacent to our Decatur processing complex, supplying ADM with low emissions steam and electricity. This leverages our world-class facility that has been successfully sequestered in CO2 for more than a decade. ADM is a pioneering carbon capture and sequestration, and we are extending that expertise with a plan to triple the number of CCS wells in the Decatur area and sequester up to seven million metric tons of CO2 per year. This positions ADM as a clear leader in the ability to supply customers with low-carbon feedstocks and accelerate the decarbonization of their own value chain. And we think this is just the beginning. I’ll speak more about how we are defining that next phase as we wrap up. Now I would like to turn the call over to Vikram to talk about our business performance. Vikram?
Vikram Luthar: Thank you, Juan. Please turn to Slide 6. The Ag Services & Oilseeds team had an outstanding start to 2023, with significantly higher year-over-year results in Q1. Ag Services results were much higher than the first quarter of 2022. In South American origination, excellent risk management and higher export demand due to the record Brazilian soybean crop drove significantly higher year-over-year results. In North America, origination results were also higher, driven by stronger soybean exports. In global trade, solid margins and efficient execution led to strong results. Crushing results were in line with the first quarter last year. In North America, the team executed well, capitalizing on historically strong soybean and softseed crush margins that were supported by robust demand for renewable fuels. In EMEA, crush margins were lower year-over-year as trade flows adjusted from the dislocations caused last year by the war in Ukraine. Additionally, there were approximately $240 million of positive timing effects during the quarter, which included both expected reversals of prior timing losses as we executed the business as well as a positive impact of about $100 million pulled forward from future periods as crush margins declined at the end of the quarter. Refined products and other results were substantially higher than the prior year period. North America biodiesel results were higher with record volumes and strong margins, supported by favorable blend economics and tight diesel stocks. In EMEA, domestic demand for food, oil and export demand for biodiesel drove strong margins. Equity earnings from Wilmar were lower versus the first quarter of 2022. Looking ahead for the second quarter, we expect RPO to continue its strong performance. Crushing is expected to be strong, but lower than the prior year based on current crush margins. We do not expect last year’s significant volatility that impacted energy and grain trade flows to reoccur in Ag Services. Slide 7, please. Carbohydrate Solutions delivered solid results in Q1, though lower than the very strong first quarter of the prior year. The Starches and Sweeteners subsegment capitalized on solid demand in the quarter. North America Starches and Sweeteners delivered strong volumes and margins. Ethanol margins, pressured by high industry stock levels, were down relative to the same quarter last year. In EMEA, the team effectively managed margins in a dynamic operating environment to deliver improved results. The global wheat milling business posted much higher margins driven by robust customer demand. BioSolutions continued on its strong growth trajectory with revenues increasing by over 20% year-over-year. Vantage Corn Processors’ results were significantly lower due to weaker ethanol margins. Looking ahead, for the second quarter, we expect resilient demand and strong margins for our Starches and Sweeteners products. Ethanol margins, while improving, are expected to remain below last year. Of note, we also recognized a $50 million benefit from a biofuel producer tax credit in the prior year quarter that will not repeat. On Slide 8, Nutrition results were significantly lower year-over-year versus the record prior year quarter. Human Nutrition results were in line with the first quarter of 2022 as the business continued to manage demand fulfillment challenges and destocking in certain categories. Flavors results were slightly lower than the prior year as strong results in EMEA were offset by lower results in North America. Specialty Ingredients results were higher year-over-year, driven by healthy margins. Health and Wellness was lower year-over-year. In Animal Nutrition, results were significantly lower compared to the same quarter last year, primarily due to much lower margins in amino acids. The Animal Nutrition business, excluding PET, is expected to face challenging demand conditions over the course of the year, and we are taking actions to mitigate the impact. These actions include targeted cost reductions, refining our go-to-market strategy with a more customer-centric approach, optimizing our production footprint, particularly in EMEA and refocusing resources on our strongest growth categories. Looking ahead for the second quarter, we expect year-over-year profit growth at Human Nutrition, while Animal Nutrition will still be lapping the higher amino acid margins from the prior year. For the full year, we expect to achieve 10% plus constant currency operating profit growth in Nutrition, led by Human Nutrition. And with continued recovery in demand fulfillment and reduced destocking effects, we remain optimistic about our Human Nutrition sales pipeline and growth opportunities. As we noted before, operating profit growth will be heavily weighted to the second half of the year. Slide 9, please. Other business results were significantly higher than the prior year quarter due to improved ADM investor services earnings on higher interest income. Captive insurance results were in line with the prior year. In Corporate, unallocated corporate costs of $248 million were higher year-over-year due primarily to higher financing and centers of excellence costs. Other corporate was unfavorable versus the prior year due to the absence of an ADM Ventures, investment revaluation gain, partially offset by higher contribution from foreign currency hedges. We still project corporate costs to be approximately $1.5 billion for the year. Net interest expense for the quarter increased $27 million year-over-year due primarily to higher short-term interest rates. The effective tax rate for the first quarter of 2023 was approximately 16%, in line with the prior year. For the full year, we still expect our effective tax rate to be between 16% and 19%. Next slide, please. In the first quarter, we had strong operating cash flows before working capital of $1.3 billion. We allocated $325 million to capital expenditures as well as returned $600 million to shareholders through share repurchases and dividends. We continue to have ample liquidity with nearly $10 billion of cash and available credit. And our adjusted net debt-to-EBITDA leverage ratio of 1.2 is well below our 2.5x threshold. Our strong balance sheet and single A credit rating provide a stable financial footing for ADM to pursue our strategic growth initiatives, while also returning capital to shareholders. In 2023, we still anticipate $1.3 billion of capital expenditures and $1 billion of opportunistic buybacks subject to other strategic uses of capital. Juan?
Juan Luciano: Thank you, Vikram. Before we wrap up today, I wanted to share some insights into how we're thinking about the remainder of 2023 and how we are positioning the company to take on the next phase of opportunities. We are confident that ADM will be able to deliver on our plans for 2023 despite some pockets of soft demand. Supply and demand shift are allowing ADM to flex our integrated value chain, in support of another strong year of results. We continue to advance partnership agreements with major players across multiple industries from regenerative agriculture to alternative proteins, to sustainable fuels, to plant-based industrial and personal care products. All of these partnerships are supporting ADM as we evolve at pace with the external environment to capture new growth opportunities. We see accelerated upsides emerging from product areas like biosolutions expected to grow at double-digit rates again this year. We have significant production capacity coming online within the year across our three businesses to support continued demand growth. And we're driving forward the broad-based decarbonization agenda in our Decatur complex, which is unlocking both near-term and long-range value for our customers across multiple industries. With a combination of solid business performance in the core business, along with the strong growth opportunities across our value chain, we expect that we will be able to deliver between $6 to $7 in earnings per share in 2023 and based on the strength of our balance sheet and cash position, we continue to pursue opportunities to deliver both near-term value to shareholders while positioning ADM for its next phase of growth. We're anticipating an in-depth review of the opportunities we see and the path ahead with the investment community in the fourth quarter. We'll share more details on this event in the coming months. Thank you for your time today, Vikram and I look forward to answering any questions you may have. With that, Bailey, please open the line for questions.
Operator: Thank you. [Operator Instructions] Our first question today comes from the line of Tom Palmer from JP Morgan. Please go ahead, Tom. Your line is now open.
Tom Palmer: Good morning and thank you for the question.
Juan Luciano: Good morning, Tom.
Tom Palmer: Wanted to ask on – maybe ask how you're thinking about earnings cadence this year, in the crushing sub-segment. So your earnings presentation notes, soybean crush margins have dipped lately in several regions of the world, but we also can see, right, the U.S. features curve points to stronger margins in the second half of the year. So maybe just, should we be looking at the second quarter coming in below the first quarter and then a potential bounce for the second half of the year or is the second quarter perhaps looking a bit better for you than industry curves might suggest?
Juan Luciano: I think you're right in your assessment that maybe second quarter will come a little bit lower and then right, crush margins will raise for the second part of the year. In the coming quarter, crush is expected to remain strong, but lower than the prior year period, as you said, based on covering crush margins as well as impact from mark-to-market that pull profits into Q1. Remember those $100 million that Vikram mentioned before. So margins will remain solid, but again, lower probably than the prior year while canola crush margins look to be improved in the upside. If you think about the whole year, crush is position for another extremely strong year in 2023, the fundamentals of the business remain strong and the structural changes are driving increased demand for both vegetable oil and meal. In 2022, remember, Tom, we have significant dislocations around the world. Likewise, 2023 will be influenced by any new dislocations which may or may not happen. Remember that while Argentina and South America is crushing hard now, Argentina will probably run out of beans given their small crop, later in the year. And at that point in time, certainly the market will have to cover for that lack of meal being exported from Argentina. We think that's where the U.S. crush margins will pick up, and that's what the curves are showing. So I think with record world soybean production, we expect soybean meal will gain in the inclusions in global – Russians and we are going to have also on our own side, we're going to have a Spiritwood coming in at the end of Q3. And also we are going to have Paraguay coming back online at that point and Ukraine also. So when you think about this operational improvements and higher refining volumes and strong refining margins we are due for a very, very strong year in ag services and oilseeds in 2023. Bailey, any other questions?
Operator: Hi. Thank you. The next question today comes from the line of Adam Samuelson from Goldman Sachs. Please go ahead. Your line is now open.
Adam Samuelson: Yes, thank you. Good morning, everyone.
Juan Luciano: Good morning, Adam.
Adam Samuelson: Hi. I was hoping to talk a little bit more on nutrition and maybe get a little bit more color on kind of the confidence of the recovery and profits as you see it through the year. Sounds like that's pretty heavily skewed towards the human side and I guess, I'm just trying to make sure I understand kind of how much of that is a function of the comps getting easy and flapping some of the price costs and supply chain challenges late last year. Actual market growth beneficial from some of the new capacity and the volume that you can bring to bear and then as well help us think about on the animal side, kind of the growth in pet versus the pressures you're seeing on amino acids and some of the legacy in your businesses?
Juan Luciano: Yes, Adam. So this is no different from what we signaled in the Q4 call. We had clearly indicated that the first half nutrition is going to be weak and the strength is going to come in the second half. So let's break it down. In human nutrition, as we mentioned, we've got a strong pipeline and actually customers are looking for more and more innovation, and that plays to our strengths, given our broad capabilities and our suite of ingredients. So we see a very robust pipeline, double-digit increase in pipeline and increasing win rates. So that's point number one. Point number two is that destocking effects should neutralize, we expect inventory levels to come back to regular levels. And then the third is also you relate the demand fulfillment challenges, which we experienced mainly in the back half of last year. We are working through that. We need to expect most of these issues to be resolved in the second half of this year. So a combination of a very strong pipeline, less destocking, as well as less demand fulfillment challenges gives us confidence for back half loaded growth and human nutrition. We'll still have growth in the second quarter. We expect maybe mid single-digit growth in the second quarter. So you can see the progress roughly flat in Q1, mid single-digit growth in Q2, and the back half should be significantly higher versus the back half of last year, which was challenged by demand fulfillment. Then on animal nutrition on the pet side, we still have double-digit growth in pipeline, so we see that category continue to be strong if you remember, we signal demand fulfillment challenges also in pet. We expect also that to be addressed over the course of this year, mainly in the second half, we are expecting some new capacity also to come online in the second half for pet. So we feel pretty good about pet. On the animal nutrition side, that's been challenged because we had significant contribution from amino acids in Q1, Q2, and also Q3 of last year. So we are lapping those margins, so it's going to take time and that's why it's going to be back half loaded. We also see weakness generally in feed demand as feed customers are looking at reformulation and consumers are going from higher value protein to lower value protein, but we are taking actions while volume is anticipated, be flat to slightly lower. We are working to improve margins by very, very targeted cost actions and as well as go-to-market actions that I referenced. So we feel good about the back half on animal nutrition from a turnaround perspective. So that's the reason why nutrition is shaping up to be a second half story for the reasons I cited, but we feel strong and good about the 10% plus constant currency OP growth in nutrition for 2023.
Operator: The next question today comes from the line of Ben Theurer from Barclays. Please go ahead, Ben. Your line is now open.
Ben Theurer: Perfect. Thank you very much and Vikram and Juan, congrats on the results.
Juan Luciano: Thank you, Ben.
Ben Theurer: So my questions just coming back a little bit to the ag service and oilseeds business, and I wanted to dig in a little more detail if you could share your outlook as it relates to the service piece of the equation, which obviously has been a very strong performer and we continue to see like the global disruption, but you're seeing some signs of improvements. I just want to understand how you feel about the renewal of the Russia, Ukraine grain deal but also in context with everything that's shaping up in the world, the demand versus the supply side, and where you see buckets of opportunity, maybe some market share gains and what are the risks particularly to your current outlook. Thank you.
Juan Luciano: Yes, thank you, Ben. A full question there. So listen, ag service has delivered another very, very strong quarter this year. It was strong in South America, it was strong in North America. It was strong at the global trade through all our destination marketing facilities. So when you look at the Q2, of course, in Q1 we were able to export a little bit more than maybe Brazil couldn't do it because of some of the rains and the delays. We think that in Q2 and Brazil will probably take over being the large crop that they have and the cheapest origin. Destination marketing was still holding margins there. It is an important activity around the world. You describe the risks associated. When we think about the year, the year hinges a lot in the recovery of demand in China lockdowns, the ups and downs of the crops around the world. We still have to deal with an Argentine disaster in terms of crops, and with the Brazil that has very strong crop. That is creating changes in the trade flows. So all of a sudden, we are sending beans from the U.S. to Europe to transform into biodiesel and bringing the biodiesel back, but also Brazil is sending beans to Argentina; Brazil, maybe sending a little bit of both or beans here. So there is a lot of changes in that, and that's ADM normally takes advantage of our huge footprint and normally our footprint and our ability to execute on those trade flows become an advantage. So you're going to see that in ag services around the year. I said there are two pivoting things this year. One is, again China demand coming out of lockdown. The second is the ability of Ukraine to continue to export as we have been doing during since August last year. Of course, the corridor has been renewed as ADM, we will always do our best to make sure that that continuous and export source for the Ukrainians, remember that that part of the world owns 25% of all the black rich soil in the world. So it's a very important condition – very important production area. So the corridor has been renewed, but of course, there are differences between Ukrainians view and Russian views at this point in time. And unfortunately, we have seen over the last week at the inspection of vessels being reduced to maybe a few days per week. So we remain hopeful and we remain ready to help to do this. I think that what we need to think fundamentally, the corridor is all about the availability of bringing that production. What I worry or the accessibility better said, what I worry is about the availability of the crop. This prolonged conflict is hurting the Ukrainian farmers and is hurting the Russian farmers. Both are dealing with issues, and I think that the expectation should be the conflict not resolved for production out of this area to come lower over the coming years, regardless of the export corridor. So I think, again, short-term and accessibility issue, long-term or medium-term, I worry more about availability and creating the pockets of tension again.
Operator: Thank you. The next question today comes from the line of Andrew Strelzik from BMO Capital Markets. Andrew, please go ahead. Your line is now open.
Andrew Strelzik: Hey, good morning. Thanks for taking the questions. My first one is on the refined products segment, which came in much, much stronger than we anticipated. And when I look at the dynamics that you called out on biodiesel and some of the other things, it seems like a lot of those are still very much in place. Is it possible that that is a more sustainable, I guess not run rate, but more achievable again in the second quarter? Are there things that have changed that would prevent that from happening?
Juan Luciano: Yes, Andrew. I think we feel pretty good or that we will execute very well in this segment and probably exceed last year's performance. We have good visibility given the book that we have. So demand continues to be there strong and we continue to execute well. We see the margins and they continue to be there with us. So there has been some comments about maybe a slower ramp up of some facilities. It's very difficult to predict, the ramp up of specific facilities, but when you look at all the data, you see all that material coming, soybean oil will continue to be a key feedstock for this. It's impossible to develop all this industry without the participation of soybean oil. Now we have a path for canola oil to get to that source. U.S. biodiesel production was up 8% in Q1. Renewable diesel production was up like 61% versus the previous year. We continue to flex our system to be able to bring biodiesel from Europe to benefit the U.S. industry. And as I said before, we expect a year that will be better than last year. And given the affordable book that we have, we have visibility into that. So we feel very confident about this, Andrew.
Operator: Thank you. The next question today comes from the line of Ben Bienvenu from Stephens. Please go ahead, Ben. Your line is now open.
Ben Bienvenu: Hey, thank you so much for taking the question. Good morning, everybody.
Juan Luciano: Good morning, Ben,
Ben Bienvenu: I want to ask about the starches and sweeteners business. You called out strong core results, good volumes and good margins. Obviously the segment was weighed on by weaker ethanol results. Could you talk a little bit about the overall backdrop that you're seeing through the balance of the year and would operating profit have been up in the first quarter, excluding the headwinds from ethanol?
Vikram Luthar: Well, so on starches and sweeteners, you're right. Let's break it down. The liquid sweetener part of the portfolio, we see resilient demand and strong margins given the good contracting we had last year, and we also see increased volumes from Mexico, which helps the business. The other thing that should help over the course of the year is higher sugar prices. While, you know, we don't have a lot of spot business, but to the extent we do that should be supportive of margins and the liquid sweetener side of the portfolio. The specialty side, we are seeing strong margins, but some softness in the volumes. That's also part of sweeteners and starches. In the biosolutions, when you think about the mix of the portfolio, we are moving more and more towards the BioSolutions business. And that had very strong performance consistently over the last few years and again in Q1 with 20-plus percent growth in revenue and anticipated to continue at that clip for the course of this year. So at a high level Sweeteners and Starches, good volumes and robust margins, so it should give us confidence that we'll have a very good year again in 2023. Now with respect to ethanol, that remains the most volatile part of our portfolio, Q1 was soft. We think Q2 is going to be a little better, although lower than Q2 of last year. We had the biofuel tax credit, which we referenced, which will not repeat. But we also see some green shoots on the ethanol side. We are more constructive about the outlook of ethanol for the rest of the year. Why, for a few reasons. One is, we see ethanol stock levels coming off their peaks from earlier in Q1. Two, we continue to see good export demand. Think about what's happening even in Japan and India. So our export demand should be in the 1.2 billion, 1.4 billion gallons, which is consistent with what we saw last year. We also see higher blending rates. I think blend rates have trended slightly up. Gasoline demand continues to be strong given the strong blend economics. So in short, while we think ethanol will likely be low from an absolute margin perspective versus last year, we're still constructive generally for the rest of the year. So overall, we see a pretty strong year for Carbohydrate Solutions business.
Operator: Thank you. The next question today comes from the line of Eric Larson from Seaport Global Securities. Please go ahead. Your line is now open.
Eric Larson: Yes. Good morning everybody, and congratulations on a good quarter.
Juan Luciano: Thank you, Eric. Good morning.
Eric Larson: So this probably comes – I can't remember the last time I actually asked an ethanol question, but my – one of my questions today is on ethanol. So the outlook going into 2024, actually looks better because we now have – we now have a year potentially, hopefully, year-end or year-round E15 blending, which I know it's a disappointment, it's in 2024, not '20 – starting in 2023, but that could consume another 1.5 billion or 2 billion bushels of corn. So the outlook for ethanol, this year I appreciate Vikram's comments. But wouldn't you expect maybe that your demand would be better starting in 2024? And now you'll have some confidence that the retailers can put infrastructure in and put the pumps in for E15. So is that too optimistic on my part?
Juan Luciano: Yes, Eric, let me take you a little bit higher because the gyrations of ethanol up and down sometimes get confused, but we invest for the long-term here. So fundamentally if you think about the last IPCC [ph] report, it strongly argue that it's going to be difficult for humanity to stay in the 1.5 degree hitting that we should try to achieve based on the Paris agreement. If you think about that, then adaptation is what all companies and all governments are thinking about. Biofuels and bioproducts like biomaterials or biosolutions are a key part of that adaptation. So whether it's ethanol – whether it's ethanol getting in a pathway to SAF, whether it's renewable green diesel, whether it is biodiesel that's going to be a big part of the future. And ADM's strong position in that and competitive advantage will shine through. We see the same thing as we position ourselves for biosolutions or biomaterials. Again, this is just – you're going to see governments, you're going to see companies, you're going to see everybody having to work together to achieve this energy transition, if you will, and to be able to keep climate change to a level that is manageable. But you have to think biofuels will be an important part of the future. U.S. will be a key player in biofuel and ADM will be absolutely in a strong position to deliver on that. Thank you.
Operator: Thank you. The next question today comes from the line of Manav Gupta from UBS. Please go ahead, Manav. Your line is now open.
Manav Gupta: Quick question guys. Help us understand just a little bit what caused the crush margins to come in so sharply. We entered this year thinking a lot of new RD capacity will start up and soybean prices will actually move up. They've actually moved down. Was it like too much prebuying happening in 4Q? What caused this pullback in soybean oil prices? And then vegetables, so as we look at the vegetable oil prices, refined product prices are still at a significant premium to unrefined which technically benefits you a lot. So your outlook for the spread between refined and refined vegetable oils? Thank you.
Vikram Luthar: Yes. So on the crush margins, as Juan noted, clearly, as you can also see in the curve right now, Q2 looks soft. And the reason is because of the expectation of a certain delay in renewable green diesel capacity. Just to be clear, we remain confident that renewable green diesel capacity is going to increase by about 1 billion gallons in 2023. The time line has just been pushed back to the second half of this year. So therefore, you see a little bit of softness in the nearby as a consequence of that. The other aspect is also related to what's happening in Argentina. In Argentina, there given – there's more beans given what's happened with the soy dollar for at least part of Q2, there's more crush capacity, if you may, that's coming online, and that's also helping reduce a little bit of the nearby crush. What's going to happen in Argentina by May or June time frame, they're going to run out of beans. So that export is not going to be available. So that should be supportive of crush margins beyond Q2. And that's why you see the slight inverse in the curve in the nearby and then recovering in the back half of the year. So that's really all that happened. It was transitory, nothing that is more than that is the delay in renewable green diesel capacity as well as what's happening in Argentina – in Argentina.
Operator: Thank you. The next question today comes from the line of Steven Haynes from Morgan Stanley. Steven, please go ahead. Your line is now open.
Steven Haynes: Hey. Thanks for taking my question. I wanted to ask on the carbon capture discussion earlier in the call and the plans to kind of triple the well capacity. Do you know kind of a time line for when that might be completed? And how much capital you're going to be putting behind that initiative?
Juan Luciano: Yes. So at the moment, we operate one well, we're going to activate the second well and then bring five new wells. Each well from a capital perspective is not a big burden. It's something about $15 million to $20 million per well depending on the cost of metals and all that. So we probably are in the high end of $20 million in the low end or something like $12 million to $15 million. The time line every time we need to have a well finished is about three months. So it's relatively quickly. The issue is you need to go through regulatory approvals and that's where we are working where government affairs team is working heavily with dedicator area and with some of the farmers in the area. So again, it could happen relatively quickly, probably within the next couple of years, if you will, not a big burden from a capital perspective, but will significantly increase our ability to pump CO2 underground. As I said, if today we have about 1 million tons, give or take per year, this will take us to 7 million, and it will be a significant boost to the decarbonization of Decatur and Decatur becoming through supplier of low-carbon intensity feedstocks for many industries.
Operator: Thank you. The next question today comes from the line of Ben Kallo from Baird. Please go ahead, Ben. Your line is now open.
Ben Kallo: Hey. Thank you, guys for taking my question. Maybe could we touch just going back to renewable diesel and crush capacity coming online? Could you just remind us about the North Dakota Facility? And if there's offtakes there or if we potentially get to a position when it comes online for the 2023 harvest where you're going to have excess crush capacity out there with others coming online and if there's further delays? And then maybe could you touch on just RVO and any kind of expectations around timing there and thoughts around if anything would be revised? Thank you guys.
Juan Luciano: Thank you, Ben. Thank you for the question. Yes, as you said, coming along with the development of the industry, ADM wants to be pressed bringing crush capacity. We're doing that, as you know in a partnership with an oil company. So they have the ability to move that product to make it into the fuel market. We have the responsibility to move, of course, the meal for which we've been working on. The plant is coming thankfully on time and on schedule to be with us by the harvest. So about the Q3, as I said in my remarks, the 150,000 tons bushels per day of crush capacity. We look at the industry. I always mentioned or I mentioned before that we look at this plant and project for two years to make sure that capacity was coming on stream prudently. We see now the industry. We see all the capacity that is coming, is all needed to be able to supply this I think the renewal diesel industry is still going to have an issue how to get feedstock for that. So that will be the issue for a while. I think that will make meal – U.S. meal very competitive in the world markets and the U.S. is planning to take share, we are part of that plan as well. So we feel comfortable about the cadence at which the plants are coming. Maybe some of our renewable diesel plants are coming a little bit slower than expected. Every project has its issues. Thankfully, ours is not delayed. But if others are, I think it's going to facilitate a little bit the digestion of all this capacity that is coming because we need to get the fit for that. I think Vikram will cover the second part of your question on RVOs.
Vikram Luthar: Yes. As you know, Ben, in December the RVO proposal that came out was largely constructive for the biofuels industry and we appreciated the multiyear proposal as well as the strong support for conventional ethanol. We, however, did note in our testimony and written comments to the EPA, the opportunity for improvement in the advanced category of biomass-based diesel. And it's important to note that does not, in any way change our assessment of the strong renewable diesel capacity growth this year and beyond. And this is going to come out in June. We expect that the EPA is going to consider the feedback they've got from the industry, and we are constructive about what that outlook is going to look like. But nevertheless, we are confident about the growth of the renewable diesel capacity and the ongoing benefit and impact for crush margins going forward.
Operator: Thank you. Your final question today comes from the line of Salvator Tiano from Bank of America. Please go ahead, Salvator. Your line is now open.
Salvator Tiano: Yes. Thank you very much. I want to go back to the Ag Service segment and understand a couple of things. So firstly, when I go back to the transcript last quarter, your initial expectations were for earnings to be down versus last year, if I remember correctly. And instead, they were up 35%. So, you mentioned a lot of dislocations but I just want to understand what actually differed versus your January expectations firstly for Q1? And secondly, you made the comment that Q2 earnings for Ag Services will be lower year-on-year. And I think that's pretty much what everybody expected given the situation with Ukraine last year. I just want to frame a little bit with regard to Q1 where you may $350 million profit. How do you expect Q2 Ag Services to be versus Q1? And especially given that Brazil is still selling – farmers have still sold far less soybeans than last year. Does this mean that you can see a very big boost in Q2 from these – from these trade flows? Thank you very much.
Juan Luciano: Thank you, Salvator, for the question. So as you said, Ag Services has a very, very good first quarter. This team continues to deliver and outperform sometimes on our own expectations. If you think about global trade and all the issues around the world sometimes are difficult to estimate, if you will but our team with their ability to connect, if you will origins with destinations and especially with the investments that we have made over the years on destination markets and allow us to capture more volume at higher margins than maybe in the past. They have had also a very disciplined risk management and very effective one, which we expect from them, but sometimes it's not that easy to deliver in this volatile world. Great execution in Australia, great execution on the Black Sea, origination program and again a solid margins at destination. South America were probably another bright point for us. They capture higher volumes and margins. We were very well positioned on a crop that was very large and on a farmer that was undersold. So we position ourselves properly, and we get the rewards from that. And North America benefited from a strong risk management and a strong bean export programs. Again, Brazil was a little bit delay with some of the rains and all that in terms of their harvest. So the U.S. extended the window a little bit more. Now Brazil, we think – if you think about second quarter and what we're predicting it to be a little bit lower is we're not going to have – if you think about second quarter last year, the same volatility that we have because of Ukraine at that point in time. And the world was starting and the world was a little bit stunned on what we do now. Now we know what do we do? We have channels to export; the product is flowing for the most part. As I warned in my previous question, I think we're more worried about the productivity of the farmers of Ukraine and Russia eventually later on. But I think for this year, we have the ability to export that. We expect robust North American corn exports until Brazil second con crop is available. And then I think that North America will lap until Brazil run out of core. So we have lower North American soy exports expected in the second quarter because Brazil will take that place. So it's a little bit the shift if you will. And the decrease of that shift to be honest, Salvator sometimes are marked by the logistics issues. Brazil has a large corn crop and soybean crop, and it needs to be able to move that to the ports and being able to ship it. And then you have the Ukraine issue we discussed before. So those are the puts and takes. In general, as I said, the unit is performing very well, performed exceptionally well in the first quarter. We expect them to perform stronger in the second quarter, but maybe not as strong as second quarter last year. Thank you.
Operator: Thank you. This concludes today's question-and-answer session. I'd like to pass the conference over to Megan Britt for closing remarks.
Megan Britt: Thank you for joining us today. Please feel free to follow-up with me if you have any additional questions. Have a good day, and thanks for your time and interest in ADM.
Operator: This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the ADM First Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Thank you, Bailey. Hello, and welcome to the first quarter earnings webcast for ADM. Starting tomorrow, a replay of this webcast will be available on our Investor Relations website. Please turn to Slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano, will discuss our first quarter results, provide ADM’s perspective on the current market backdrop and share progress highlights on our strategic priorities for the year. Our Chief Financial Officer, Vikram Luthar, will review the drivers of our financial performance at the segment level and review our cash generation and capital allocation results. Juan will have some closing remarks, and then he and Vikram will take your questions. Please turn to Slide 3. I’ll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan. And thanks to all those joining us for the call today. This morning, ADM reported strong first quarter adjusted earnings per share of $2.09, with an adjusted segment operating profit of $1.7 billion and a trailing fourth quarter average adjusted ROIC of 14%. Our performance demonstrates once again the advantage of ADM’s uniquely integrated value chain and broad portfolio. Along with the team’s ability to respond nimbly to opportunities aligned to the three enduring trends of food security, health and well-being and sustainability. All of this was achieved in a fluid economic environment where ripple effects are being felt from both inflationary and recessionary pressures, shifts in global demand and trade activity and the ongoing war in Ukraine. Our team continues to find ways to rise above these challenges and meet our customers’ needs for consistency, quality and innovation at every turn across our business units. We have wrapped up Q1 with a strong balance sheet, healthy cash flows, and we are on track for our 2023 and long-term strategic growth plans and we continue to pursue growth opportunities and increase shareholder returns in alignment with our disciplined capital allocation framework. This quarter, we also announced several exciting milestones in our continued growth and innovation strategy, including the opening of the world’s first probiotic and postbiotics production facility in Valencia, Spain, which increases our global production capacity by a factor of five. Agreements with ADM ventures, partners, BrightFit [ph] and Believer Meats to advance innovations in gut microbiome and cell-based meat respectively. And our definitive agreement with Tallgrass to pave the way for carbon capture from ADM’s Columbus, Nebraska complex furthering our decarbonization agenda. Beyond the financial highlights of the quarter, we are proud to be named one of Fortune’s Most Admired Companies for the 15th year running. And to receive our fourth consecutive Ethisphere award as one of the world’s most ethical companies. It’s an honor to be recognized externally and it continues to demonstrate that ADM’s culture and people are the engine behind our operational and financial success. As we look back on the quarter, I’d like to review it in the context of the 2023 framing we discussed in Q4’s call and provide a few brief updates. Slide 4, please. In January, we reviewed several factors that underpinned our confident outlook for 2023, and these same factors will continue to shape our performance throughout the year. The supply and demand situation remains fundamentally solid with some normalization of supply alongside shift in both the products driving demand and the origins providing supply. Supply and transportation constraints in the Black Sea region, severe drought in Argentina, the record Brazilian crop and a resurgence of demand in China post lockdown have allowed our team to take full advantage of our global footprint. Broad-based food demand remains resilient across key geographies. And we did, we are seeing solid volumes and strong operating margins across vegetable oils, flavors, sweeteners, starches and wheat milling. Demand for biodiesel and renewable green diesel is robust, driving continued strong gross margins. The strong biofuel demand and continued expectation for growth supports our investment in new crush capacity like the additional 150,000 bushels per day from our Spiritwood, North Dakota facility scheduled to come online in time for the 2023 harvest. Nutrition’s growth trajectory for the year remains on course with a double-digit increase in our human nutrition pipeline compared to this point in 2022. As noted, we expect this growth to be significantly weighted to the back half of the year, as we manage through some destocking impacts in beverage, lower margins in amino acids and the broader demand fulfillment challenges we discussed in the last quarter. It’s important to recognize that our team delivered strong Q1 results despite constantly evolving macroeconomic conditions. ADM’s ability to remain agile and apply the principles of productivity and innovation continues to position us well in a dynamic external environment. Let me take a moment to dig deeper into examples of how we are applying our productivity playbook across the organization and how decarbonization is helping us find paths for both innovation and growth. Slide 5, please. From a productivity perspective, we have continued to focus attention on automation within many of our key operations facilities. Automation not only accelerates the modernization of our manufacturing footprint, it is helping us deliver significant savings at the enterprise level. Whether we are reducing chemicals usage, delivering yield improvements or supporting operational reliability, our automation program now has a plan to scale cost improvements across our most critical operational assets over the next several years. Eight of our plans are currently underway and we expect that most of these will complete their automation implementation by year-end. And we are seeing operational and financial impacts immediately following implementation. Our most recent implementation in SEDA Rapeseed [ph] is already generating millions of dollars in efficiencies in just the first few months, confirming the double-digit returns we expect to see from these proceeds. As a whole, the impact on operating profit is significant with a target run rate of approximately $200 million per year when implementations are complete at more than 70 facilities over the next seven years. This is only one example of productivity measures we are undertaking to ensure ADM maintains agility given the levels of uncertainty in the external environment. Each of our businesses and functions is identifying opportunities to drive efficiency at the scale, while maintaining a focus on growth. Our decarbonization journey continues to move at a rapid pace and is allowing us to showcase innovation in action. Our advantaged position in alternative fuels production has prepared us for the demand cycle that continues to rise across biodiesel and renewable diesel. We continue to explore strategic options to convert ethanol into sustainable aviation fuel. The multibillion dollar addressable opportunity represented by SAF alone highlights the criticality of access to low-carbon feedstocks at a scale exponentially higher than what is available today. This is why we are prioritizing the decarbonization of our Decatur complex as the first critical step in unlocking significant value. Last year, we announced one of the world’s first, ultra-low emissions power plants would be built adjacent to our Decatur processing complex, supplying ADM with low emissions steam and electricity. This leverages our world-class facility that has been successfully sequestered in CO2 for more than a decade. ADM is a pioneering carbon capture and sequestration, and we are extending that expertise with a plan to triple the number of CCS wells in the Decatur area and sequester up to seven million metric tons of CO2 per year. This positions ADM as a clear leader in the ability to supply customers with low-carbon feedstocks and accelerate the decarbonization of their own value chain. And we think this is just the beginning. I’ll speak more about how we are defining that next phase as we wrap up. Now I would like to turn the call over to Vikram to talk about our business performance. Vikram?"
},
{
"speaker": "Vikram Luthar",
"text": "Thank you, Juan. Please turn to Slide 6. The Ag Services & Oilseeds team had an outstanding start to 2023, with significantly higher year-over-year results in Q1. Ag Services results were much higher than the first quarter of 2022. In South American origination, excellent risk management and higher export demand due to the record Brazilian soybean crop drove significantly higher year-over-year results. In North America, origination results were also higher, driven by stronger soybean exports. In global trade, solid margins and efficient execution led to strong results. Crushing results were in line with the first quarter last year. In North America, the team executed well, capitalizing on historically strong soybean and softseed crush margins that were supported by robust demand for renewable fuels. In EMEA, crush margins were lower year-over-year as trade flows adjusted from the dislocations caused last year by the war in Ukraine. Additionally, there were approximately $240 million of positive timing effects during the quarter, which included both expected reversals of prior timing losses as we executed the business as well as a positive impact of about $100 million pulled forward from future periods as crush margins declined at the end of the quarter. Refined products and other results were substantially higher than the prior year period. North America biodiesel results were higher with record volumes and strong margins, supported by favorable blend economics and tight diesel stocks. In EMEA, domestic demand for food, oil and export demand for biodiesel drove strong margins. Equity earnings from Wilmar were lower versus the first quarter of 2022. Looking ahead for the second quarter, we expect RPO to continue its strong performance. Crushing is expected to be strong, but lower than the prior year based on current crush margins. We do not expect last year’s significant volatility that impacted energy and grain trade flows to reoccur in Ag Services. Slide 7, please. Carbohydrate Solutions delivered solid results in Q1, though lower than the very strong first quarter of the prior year. The Starches and Sweeteners subsegment capitalized on solid demand in the quarter. North America Starches and Sweeteners delivered strong volumes and margins. Ethanol margins, pressured by high industry stock levels, were down relative to the same quarter last year. In EMEA, the team effectively managed margins in a dynamic operating environment to deliver improved results. The global wheat milling business posted much higher margins driven by robust customer demand. BioSolutions continued on its strong growth trajectory with revenues increasing by over 20% year-over-year. Vantage Corn Processors’ results were significantly lower due to weaker ethanol margins. Looking ahead, for the second quarter, we expect resilient demand and strong margins for our Starches and Sweeteners products. Ethanol margins, while improving, are expected to remain below last year. Of note, we also recognized a $50 million benefit from a biofuel producer tax credit in the prior year quarter that will not repeat. On Slide 8, Nutrition results were significantly lower year-over-year versus the record prior year quarter. Human Nutrition results were in line with the first quarter of 2022 as the business continued to manage demand fulfillment challenges and destocking in certain categories. Flavors results were slightly lower than the prior year as strong results in EMEA were offset by lower results in North America. Specialty Ingredients results were higher year-over-year, driven by healthy margins. Health and Wellness was lower year-over-year. In Animal Nutrition, results were significantly lower compared to the same quarter last year, primarily due to much lower margins in amino acids. The Animal Nutrition business, excluding PET, is expected to face challenging demand conditions over the course of the year, and we are taking actions to mitigate the impact. These actions include targeted cost reductions, refining our go-to-market strategy with a more customer-centric approach, optimizing our production footprint, particularly in EMEA and refocusing resources on our strongest growth categories. Looking ahead for the second quarter, we expect year-over-year profit growth at Human Nutrition, while Animal Nutrition will still be lapping the higher amino acid margins from the prior year. For the full year, we expect to achieve 10% plus constant currency operating profit growth in Nutrition, led by Human Nutrition. And with continued recovery in demand fulfillment and reduced destocking effects, we remain optimistic about our Human Nutrition sales pipeline and growth opportunities. As we noted before, operating profit growth will be heavily weighted to the second half of the year. Slide 9, please. Other business results were significantly higher than the prior year quarter due to improved ADM investor services earnings on higher interest income. Captive insurance results were in line with the prior year. In Corporate, unallocated corporate costs of $248 million were higher year-over-year due primarily to higher financing and centers of excellence costs. Other corporate was unfavorable versus the prior year due to the absence of an ADM Ventures, investment revaluation gain, partially offset by higher contribution from foreign currency hedges. We still project corporate costs to be approximately $1.5 billion for the year. Net interest expense for the quarter increased $27 million year-over-year due primarily to higher short-term interest rates. The effective tax rate for the first quarter of 2023 was approximately 16%, in line with the prior year. For the full year, we still expect our effective tax rate to be between 16% and 19%. Next slide, please. In the first quarter, we had strong operating cash flows before working capital of $1.3 billion. We allocated $325 million to capital expenditures as well as returned $600 million to shareholders through share repurchases and dividends. We continue to have ample liquidity with nearly $10 billion of cash and available credit. And our adjusted net debt-to-EBITDA leverage ratio of 1.2 is well below our 2.5x threshold. Our strong balance sheet and single A credit rating provide a stable financial footing for ADM to pursue our strategic growth initiatives, while also returning capital to shareholders. In 2023, we still anticipate $1.3 billion of capital expenditures and $1 billion of opportunistic buybacks subject to other strategic uses of capital. Juan?"
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Vikram. Before we wrap up today, I wanted to share some insights into how we're thinking about the remainder of 2023 and how we are positioning the company to take on the next phase of opportunities. We are confident that ADM will be able to deliver on our plans for 2023 despite some pockets of soft demand. Supply and demand shift are allowing ADM to flex our integrated value chain, in support of another strong year of results. We continue to advance partnership agreements with major players across multiple industries from regenerative agriculture to alternative proteins, to sustainable fuels, to plant-based industrial and personal care products. All of these partnerships are supporting ADM as we evolve at pace with the external environment to capture new growth opportunities. We see accelerated upsides emerging from product areas like biosolutions expected to grow at double-digit rates again this year. We have significant production capacity coming online within the year across our three businesses to support continued demand growth. And we're driving forward the broad-based decarbonization agenda in our Decatur complex, which is unlocking both near-term and long-range value for our customers across multiple industries. With a combination of solid business performance in the core business, along with the strong growth opportunities across our value chain, we expect that we will be able to deliver between $6 to $7 in earnings per share in 2023 and based on the strength of our balance sheet and cash position, we continue to pursue opportunities to deliver both near-term value to shareholders while positioning ADM for its next phase of growth. We're anticipating an in-depth review of the opportunities we see and the path ahead with the investment community in the fourth quarter. We'll share more details on this event in the coming months. Thank you for your time today, Vikram and I look forward to answering any questions you may have. With that, Bailey, please open the line for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question today comes from the line of Tom Palmer from JP Morgan. Please go ahead, Tom. Your line is now open."
},
{
"speaker": "Tom Palmer",
"text": "Good morning and thank you for the question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Tom."
},
{
"speaker": "Tom Palmer",
"text": "Wanted to ask on – maybe ask how you're thinking about earnings cadence this year, in the crushing sub-segment. So your earnings presentation notes, soybean crush margins have dipped lately in several regions of the world, but we also can see, right, the U.S. features curve points to stronger margins in the second half of the year. So maybe just, should we be looking at the second quarter coming in below the first quarter and then a potential bounce for the second half of the year or is the second quarter perhaps looking a bit better for you than industry curves might suggest?"
},
{
"speaker": "Juan Luciano",
"text": "I think you're right in your assessment that maybe second quarter will come a little bit lower and then right, crush margins will raise for the second part of the year. In the coming quarter, crush is expected to remain strong, but lower than the prior year period, as you said, based on covering crush margins as well as impact from mark-to-market that pull profits into Q1. Remember those $100 million that Vikram mentioned before. So margins will remain solid, but again, lower probably than the prior year while canola crush margins look to be improved in the upside. If you think about the whole year, crush is position for another extremely strong year in 2023, the fundamentals of the business remain strong and the structural changes are driving increased demand for both vegetable oil and meal. In 2022, remember, Tom, we have significant dislocations around the world. Likewise, 2023 will be influenced by any new dislocations which may or may not happen. Remember that while Argentina and South America is crushing hard now, Argentina will probably run out of beans given their small crop, later in the year. And at that point in time, certainly the market will have to cover for that lack of meal being exported from Argentina. We think that's where the U.S. crush margins will pick up, and that's what the curves are showing. So I think with record world soybean production, we expect soybean meal will gain in the inclusions in global – Russians and we are going to have also on our own side, we're going to have a Spiritwood coming in at the end of Q3. And also we are going to have Paraguay coming back online at that point and Ukraine also. So when you think about this operational improvements and higher refining volumes and strong refining margins we are due for a very, very strong year in ag services and oilseeds in 2023. Bailey, any other questions?"
},
{
"speaker": "Operator",
"text": "Hi. Thank you. The next question today comes from the line of Adam Samuelson from Goldman Sachs. Please go ahead. Your line is now open."
},
{
"speaker": "Adam Samuelson",
"text": "Yes, thank you. Good morning, everyone."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Adam."
},
{
"speaker": "Adam Samuelson",
"text": "Hi. I was hoping to talk a little bit more on nutrition and maybe get a little bit more color on kind of the confidence of the recovery and profits as you see it through the year. Sounds like that's pretty heavily skewed towards the human side and I guess, I'm just trying to make sure I understand kind of how much of that is a function of the comps getting easy and flapping some of the price costs and supply chain challenges late last year. Actual market growth beneficial from some of the new capacity and the volume that you can bring to bear and then as well help us think about on the animal side, kind of the growth in pet versus the pressures you're seeing on amino acids and some of the legacy in your businesses?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, Adam. So this is no different from what we signaled in the Q4 call. We had clearly indicated that the first half nutrition is going to be weak and the strength is going to come in the second half. So let's break it down. In human nutrition, as we mentioned, we've got a strong pipeline and actually customers are looking for more and more innovation, and that plays to our strengths, given our broad capabilities and our suite of ingredients. So we see a very robust pipeline, double-digit increase in pipeline and increasing win rates. So that's point number one. Point number two is that destocking effects should neutralize, we expect inventory levels to come back to regular levels. And then the third is also you relate the demand fulfillment challenges, which we experienced mainly in the back half of last year. We are working through that. We need to expect most of these issues to be resolved in the second half of this year. So a combination of a very strong pipeline, less destocking, as well as less demand fulfillment challenges gives us confidence for back half loaded growth and human nutrition. We'll still have growth in the second quarter. We expect maybe mid single-digit growth in the second quarter. So you can see the progress roughly flat in Q1, mid single-digit growth in Q2, and the back half should be significantly higher versus the back half of last year, which was challenged by demand fulfillment. Then on animal nutrition on the pet side, we still have double-digit growth in pipeline, so we see that category continue to be strong if you remember, we signal demand fulfillment challenges also in pet. We expect also that to be addressed over the course of this year, mainly in the second half, we are expecting some new capacity also to come online in the second half for pet. So we feel pretty good about pet. On the animal nutrition side, that's been challenged because we had significant contribution from amino acids in Q1, Q2, and also Q3 of last year. So we are lapping those margins, so it's going to take time and that's why it's going to be back half loaded. We also see weakness generally in feed demand as feed customers are looking at reformulation and consumers are going from higher value protein to lower value protein, but we are taking actions while volume is anticipated, be flat to slightly lower. We are working to improve margins by very, very targeted cost actions and as well as go-to-market actions that I referenced. So we feel good about the back half on animal nutrition from a turnaround perspective. So that's the reason why nutrition is shaping up to be a second half story for the reasons I cited, but we feel strong and good about the 10% plus constant currency OP growth in nutrition for 2023."
},
{
"speaker": "Operator",
"text": "The next question today comes from the line of Ben Theurer from Barclays. Please go ahead, Ben. Your line is now open."
},
{
"speaker": "Ben Theurer",
"text": "Perfect. Thank you very much and Vikram and Juan, congrats on the results."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Ben."
},
{
"speaker": "Ben Theurer",
"text": "So my questions just coming back a little bit to the ag service and oilseeds business, and I wanted to dig in a little more detail if you could share your outlook as it relates to the service piece of the equation, which obviously has been a very strong performer and we continue to see like the global disruption, but you're seeing some signs of improvements. I just want to understand how you feel about the renewal of the Russia, Ukraine grain deal but also in context with everything that's shaping up in the world, the demand versus the supply side, and where you see buckets of opportunity, maybe some market share gains and what are the risks particularly to your current outlook. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Ben. A full question there. So listen, ag service has delivered another very, very strong quarter this year. It was strong in South America, it was strong in North America. It was strong at the global trade through all our destination marketing facilities. So when you look at the Q2, of course, in Q1 we were able to export a little bit more than maybe Brazil couldn't do it because of some of the rains and the delays. We think that in Q2 and Brazil will probably take over being the large crop that they have and the cheapest origin. Destination marketing was still holding margins there. It is an important activity around the world. You describe the risks associated. When we think about the year, the year hinges a lot in the recovery of demand in China lockdowns, the ups and downs of the crops around the world. We still have to deal with an Argentine disaster in terms of crops, and with the Brazil that has very strong crop. That is creating changes in the trade flows. So all of a sudden, we are sending beans from the U.S. to Europe to transform into biodiesel and bringing the biodiesel back, but also Brazil is sending beans to Argentina; Brazil, maybe sending a little bit of both or beans here. So there is a lot of changes in that, and that's ADM normally takes advantage of our huge footprint and normally our footprint and our ability to execute on those trade flows become an advantage. So you're going to see that in ag services around the year. I said there are two pivoting things this year. One is, again China demand coming out of lockdown. The second is the ability of Ukraine to continue to export as we have been doing during since August last year. Of course, the corridor has been renewed as ADM, we will always do our best to make sure that that continuous and export source for the Ukrainians, remember that that part of the world owns 25% of all the black rich soil in the world. So it's a very important condition – very important production area. So the corridor has been renewed, but of course, there are differences between Ukrainians view and Russian views at this point in time. And unfortunately, we have seen over the last week at the inspection of vessels being reduced to maybe a few days per week. So we remain hopeful and we remain ready to help to do this. I think that what we need to think fundamentally, the corridor is all about the availability of bringing that production. What I worry or the accessibility better said, what I worry is about the availability of the crop. This prolonged conflict is hurting the Ukrainian farmers and is hurting the Russian farmers. Both are dealing with issues, and I think that the expectation should be the conflict not resolved for production out of this area to come lower over the coming years, regardless of the export corridor. So I think, again, short-term and accessibility issue, long-term or medium-term, I worry more about availability and creating the pockets of tension again."
},
{
"speaker": "Operator",
"text": "Thank you. The next question today comes from the line of Andrew Strelzik from BMO Capital Markets. Andrew, please go ahead. Your line is now open."
},
{
"speaker": "Andrew Strelzik",
"text": "Hey, good morning. Thanks for taking the questions. My first one is on the refined products segment, which came in much, much stronger than we anticipated. And when I look at the dynamics that you called out on biodiesel and some of the other things, it seems like a lot of those are still very much in place. Is it possible that that is a more sustainable, I guess not run rate, but more achievable again in the second quarter? Are there things that have changed that would prevent that from happening?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, Andrew. I think we feel pretty good or that we will execute very well in this segment and probably exceed last year's performance. We have good visibility given the book that we have. So demand continues to be there strong and we continue to execute well. We see the margins and they continue to be there with us. So there has been some comments about maybe a slower ramp up of some facilities. It's very difficult to predict, the ramp up of specific facilities, but when you look at all the data, you see all that material coming, soybean oil will continue to be a key feedstock for this. It's impossible to develop all this industry without the participation of soybean oil. Now we have a path for canola oil to get to that source. U.S. biodiesel production was up 8% in Q1. Renewable diesel production was up like 61% versus the previous year. We continue to flex our system to be able to bring biodiesel from Europe to benefit the U.S. industry. And as I said before, we expect a year that will be better than last year. And given the affordable book that we have, we have visibility into that. So we feel very confident about this, Andrew."
},
{
"speaker": "Operator",
"text": "Thank you. The next question today comes from the line of Ben Bienvenu from Stephens. Please go ahead, Ben. Your line is now open."
},
{
"speaker": "Ben Bienvenu",
"text": "Hey, thank you so much for taking the question. Good morning, everybody."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Ben,"
},
{
"speaker": "Ben Bienvenu",
"text": "I want to ask about the starches and sweeteners business. You called out strong core results, good volumes and good margins. Obviously the segment was weighed on by weaker ethanol results. Could you talk a little bit about the overall backdrop that you're seeing through the balance of the year and would operating profit have been up in the first quarter, excluding the headwinds from ethanol?"
},
{
"speaker": "Vikram Luthar",
"text": "Well, so on starches and sweeteners, you're right. Let's break it down. The liquid sweetener part of the portfolio, we see resilient demand and strong margins given the good contracting we had last year, and we also see increased volumes from Mexico, which helps the business. The other thing that should help over the course of the year is higher sugar prices. While, you know, we don't have a lot of spot business, but to the extent we do that should be supportive of margins and the liquid sweetener side of the portfolio. The specialty side, we are seeing strong margins, but some softness in the volumes. That's also part of sweeteners and starches. In the biosolutions, when you think about the mix of the portfolio, we are moving more and more towards the BioSolutions business. And that had very strong performance consistently over the last few years and again in Q1 with 20-plus percent growth in revenue and anticipated to continue at that clip for the course of this year. So at a high level Sweeteners and Starches, good volumes and robust margins, so it should give us confidence that we'll have a very good year again in 2023. Now with respect to ethanol, that remains the most volatile part of our portfolio, Q1 was soft. We think Q2 is going to be a little better, although lower than Q2 of last year. We had the biofuel tax credit, which we referenced, which will not repeat. But we also see some green shoots on the ethanol side. We are more constructive about the outlook of ethanol for the rest of the year. Why, for a few reasons. One is, we see ethanol stock levels coming off their peaks from earlier in Q1. Two, we continue to see good export demand. Think about what's happening even in Japan and India. So our export demand should be in the 1.2 billion, 1.4 billion gallons, which is consistent with what we saw last year. We also see higher blending rates. I think blend rates have trended slightly up. Gasoline demand continues to be strong given the strong blend economics. So in short, while we think ethanol will likely be low from an absolute margin perspective versus last year, we're still constructive generally for the rest of the year. So overall, we see a pretty strong year for Carbohydrate Solutions business."
},
{
"speaker": "Operator",
"text": "Thank you. The next question today comes from the line of Eric Larson from Seaport Global Securities. Please go ahead. Your line is now open."
},
{
"speaker": "Eric Larson",
"text": "Yes. Good morning everybody, and congratulations on a good quarter."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Eric. Good morning."
},
{
"speaker": "Eric Larson",
"text": "So this probably comes – I can't remember the last time I actually asked an ethanol question, but my – one of my questions today is on ethanol. So the outlook going into 2024, actually looks better because we now have – we now have a year potentially, hopefully, year-end or year-round E15 blending, which I know it's a disappointment, it's in 2024, not '20 – starting in 2023, but that could consume another 1.5 billion or 2 billion bushels of corn. So the outlook for ethanol, this year I appreciate Vikram's comments. But wouldn't you expect maybe that your demand would be better starting in 2024? And now you'll have some confidence that the retailers can put infrastructure in and put the pumps in for E15. So is that too optimistic on my part?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, Eric, let me take you a little bit higher because the gyrations of ethanol up and down sometimes get confused, but we invest for the long-term here. So fundamentally if you think about the last IPCC [ph] report, it strongly argue that it's going to be difficult for humanity to stay in the 1.5 degree hitting that we should try to achieve based on the Paris agreement. If you think about that, then adaptation is what all companies and all governments are thinking about. Biofuels and bioproducts like biomaterials or biosolutions are a key part of that adaptation. So whether it's ethanol – whether it's ethanol getting in a pathway to SAF, whether it's renewable green diesel, whether it is biodiesel that's going to be a big part of the future. And ADM's strong position in that and competitive advantage will shine through. We see the same thing as we position ourselves for biosolutions or biomaterials. Again, this is just – you're going to see governments, you're going to see companies, you're going to see everybody having to work together to achieve this energy transition, if you will, and to be able to keep climate change to a level that is manageable. But you have to think biofuels will be an important part of the future. U.S. will be a key player in biofuel and ADM will be absolutely in a strong position to deliver on that. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. The next question today comes from the line of Manav Gupta from UBS. Please go ahead, Manav. Your line is now open."
},
{
"speaker": "Manav Gupta",
"text": "Quick question guys. Help us understand just a little bit what caused the crush margins to come in so sharply. We entered this year thinking a lot of new RD capacity will start up and soybean prices will actually move up. They've actually moved down. Was it like too much prebuying happening in 4Q? What caused this pullback in soybean oil prices? And then vegetables, so as we look at the vegetable oil prices, refined product prices are still at a significant premium to unrefined which technically benefits you a lot. So your outlook for the spread between refined and refined vegetable oils? Thank you."
},
{
"speaker": "Vikram Luthar",
"text": "Yes. So on the crush margins, as Juan noted, clearly, as you can also see in the curve right now, Q2 looks soft. And the reason is because of the expectation of a certain delay in renewable green diesel capacity. Just to be clear, we remain confident that renewable green diesel capacity is going to increase by about 1 billion gallons in 2023. The time line has just been pushed back to the second half of this year. So therefore, you see a little bit of softness in the nearby as a consequence of that. The other aspect is also related to what's happening in Argentina. In Argentina, there given – there's more beans given what's happened with the soy dollar for at least part of Q2, there's more crush capacity, if you may, that's coming online, and that's also helping reduce a little bit of the nearby crush. What's going to happen in Argentina by May or June time frame, they're going to run out of beans. So that export is not going to be available. So that should be supportive of crush margins beyond Q2. And that's why you see the slight inverse in the curve in the nearby and then recovering in the back half of the year. So that's really all that happened. It was transitory, nothing that is more than that is the delay in renewable green diesel capacity as well as what's happening in Argentina – in Argentina."
},
{
"speaker": "Operator",
"text": "Thank you. The next question today comes from the line of Steven Haynes from Morgan Stanley. Steven, please go ahead. Your line is now open."
},
{
"speaker": "Steven Haynes",
"text": "Hey. Thanks for taking my question. I wanted to ask on the carbon capture discussion earlier in the call and the plans to kind of triple the well capacity. Do you know kind of a time line for when that might be completed? And how much capital you're going to be putting behind that initiative?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. So at the moment, we operate one well, we're going to activate the second well and then bring five new wells. Each well from a capital perspective is not a big burden. It's something about $15 million to $20 million per well depending on the cost of metals and all that. So we probably are in the high end of $20 million in the low end or something like $12 million to $15 million. The time line every time we need to have a well finished is about three months. So it's relatively quickly. The issue is you need to go through regulatory approvals and that's where we are working where government affairs team is working heavily with dedicator area and with some of the farmers in the area. So again, it could happen relatively quickly, probably within the next couple of years, if you will, not a big burden from a capital perspective, but will significantly increase our ability to pump CO2 underground. As I said, if today we have about 1 million tons, give or take per year, this will take us to 7 million, and it will be a significant boost to the decarbonization of Decatur and Decatur becoming through supplier of low-carbon intensity feedstocks for many industries."
},
{
"speaker": "Operator",
"text": "Thank you. The next question today comes from the line of Ben Kallo from Baird. Please go ahead, Ben. Your line is now open."
},
{
"speaker": "Ben Kallo",
"text": "Hey. Thank you, guys for taking my question. Maybe could we touch just going back to renewable diesel and crush capacity coming online? Could you just remind us about the North Dakota Facility? And if there's offtakes there or if we potentially get to a position when it comes online for the 2023 harvest where you're going to have excess crush capacity out there with others coming online and if there's further delays? And then maybe could you touch on just RVO and any kind of expectations around timing there and thoughts around if anything would be revised? Thank you guys."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Ben. Thank you for the question. Yes, as you said, coming along with the development of the industry, ADM wants to be pressed bringing crush capacity. We're doing that, as you know in a partnership with an oil company. So they have the ability to move that product to make it into the fuel market. We have the responsibility to move, of course, the meal for which we've been working on. The plant is coming thankfully on time and on schedule to be with us by the harvest. So about the Q3, as I said in my remarks, the 150,000 tons bushels per day of crush capacity. We look at the industry. I always mentioned or I mentioned before that we look at this plant and project for two years to make sure that capacity was coming on stream prudently. We see now the industry. We see all the capacity that is coming, is all needed to be able to supply this I think the renewal diesel industry is still going to have an issue how to get feedstock for that. So that will be the issue for a while. I think that will make meal – U.S. meal very competitive in the world markets and the U.S. is planning to take share, we are part of that plan as well. So we feel comfortable about the cadence at which the plants are coming. Maybe some of our renewable diesel plants are coming a little bit slower than expected. Every project has its issues. Thankfully, ours is not delayed. But if others are, I think it's going to facilitate a little bit the digestion of all this capacity that is coming because we need to get the fit for that. I think Vikram will cover the second part of your question on RVOs."
},
{
"speaker": "Vikram Luthar",
"text": "Yes. As you know, Ben, in December the RVO proposal that came out was largely constructive for the biofuels industry and we appreciated the multiyear proposal as well as the strong support for conventional ethanol. We, however, did note in our testimony and written comments to the EPA, the opportunity for improvement in the advanced category of biomass-based diesel. And it's important to note that does not, in any way change our assessment of the strong renewable diesel capacity growth this year and beyond. And this is going to come out in June. We expect that the EPA is going to consider the feedback they've got from the industry, and we are constructive about what that outlook is going to look like. But nevertheless, we are confident about the growth of the renewable diesel capacity and the ongoing benefit and impact for crush margins going forward."
},
{
"speaker": "Operator",
"text": "Thank you. Your final question today comes from the line of Salvator Tiano from Bank of America. Please go ahead, Salvator. Your line is now open."
},
{
"speaker": "Salvator Tiano",
"text": "Yes. Thank you very much. I want to go back to the Ag Service segment and understand a couple of things. So firstly, when I go back to the transcript last quarter, your initial expectations were for earnings to be down versus last year, if I remember correctly. And instead, they were up 35%. So, you mentioned a lot of dislocations but I just want to understand what actually differed versus your January expectations firstly for Q1? And secondly, you made the comment that Q2 earnings for Ag Services will be lower year-on-year. And I think that's pretty much what everybody expected given the situation with Ukraine last year. I just want to frame a little bit with regard to Q1 where you may $350 million profit. How do you expect Q2 Ag Services to be versus Q1? And especially given that Brazil is still selling – farmers have still sold far less soybeans than last year. Does this mean that you can see a very big boost in Q2 from these – from these trade flows? Thank you very much."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Salvator, for the question. So as you said, Ag Services has a very, very good first quarter. This team continues to deliver and outperform sometimes on our own expectations. If you think about global trade and all the issues around the world sometimes are difficult to estimate, if you will but our team with their ability to connect, if you will origins with destinations and especially with the investments that we have made over the years on destination markets and allow us to capture more volume at higher margins than maybe in the past. They have had also a very disciplined risk management and very effective one, which we expect from them, but sometimes it's not that easy to deliver in this volatile world. Great execution in Australia, great execution on the Black Sea, origination program and again a solid margins at destination. South America were probably another bright point for us. They capture higher volumes and margins. We were very well positioned on a crop that was very large and on a farmer that was undersold. So we position ourselves properly, and we get the rewards from that. And North America benefited from a strong risk management and a strong bean export programs. Again, Brazil was a little bit delay with some of the rains and all that in terms of their harvest. So the U.S. extended the window a little bit more. Now Brazil, we think – if you think about second quarter and what we're predicting it to be a little bit lower is we're not going to have – if you think about second quarter last year, the same volatility that we have because of Ukraine at that point in time. And the world was starting and the world was a little bit stunned on what we do now. Now we know what do we do? We have channels to export; the product is flowing for the most part. As I warned in my previous question, I think we're more worried about the productivity of the farmers of Ukraine and Russia eventually later on. But I think for this year, we have the ability to export that. We expect robust North American corn exports until Brazil second con crop is available. And then I think that North America will lap until Brazil run out of core. So we have lower North American soy exports expected in the second quarter because Brazil will take that place. So it's a little bit the shift if you will. And the decrease of that shift to be honest, Salvator sometimes are marked by the logistics issues. Brazil has a large corn crop and soybean crop, and it needs to be able to move that to the ports and being able to ship it. And then you have the Ukraine issue we discussed before. So those are the puts and takes. In general, as I said, the unit is performing very well, performed exceptionally well in the first quarter. We expect them to perform stronger in the second quarter, but maybe not as strong as second quarter last year. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's question-and-answer session. I'd like to pass the conference over to Megan Britt for closing remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you for joining us today. Please feel free to follow-up with me if you have any additional questions. Have a good day, and thanks for your time and interest in ADM."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 4 | 2,024 | 2025-02-04 10:00:00 | Operator: Good morning, and welcome to ADM Fourth Quarter 2024 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Welcome to the fourth quarter earnings conference call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on filed with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. Unless otherwise required by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available on our earnings press release and presentation slides, which can be found in the Investor Relations section of the ADM website. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan. Hello, and welcome to all of who have joined the call. Please turn to slide four where we have captured our fourth quarter and full-year performance highlights. Today, ADM reported fourth quarter adjusted earnings per share of $1.14, and full-year adjusted earnings per share of $4.74, in line with the midpoint of our guidance for the full-year. Total segment operating profit was $1.1 billion for the fourth quarter and $4.2 billion for the full-year. Our trailing four-quarter adjusted ROIC was 8.3%. And cash flow from operations before working capital changes was $3.3 billion. Though 2024 presented a variety of challenges, our diligent focus on improving operation has made a positive impact across the network. We achieved strong crush volumes in canola and rapeseed, as well as our -- in our LATAM region. We made progress in addressing challenges in North America in soy assets, reducing unplanned downtime, and improving crush volumes in the month of December. We successfully ramped up run rates to meet demand at our Spiritwood facility over the course of 2024. We achieved a strong year in Starches & Sweeteners, where improved plant performance led to 3% higher production volume year-over-year, helping several product lines in our North America business set operating profit records. We made progress in addressing demand fulfillment challenges in EMEA flavors, while successfully integrating two new flavors acquisitions announced in early 2024. We improved our safety record significantly with a more than 35% year-over-year reduction in Tier 1 and 2 process safety incidents across our global network. In addition, we advanced key innovation initiatives in areas such as biosolutions and health & wellness, continuing to support growing customer demand in these parts of the business. And through this, we were able to maintain a strong balance sheet to ensure continued investment in the business and return of cash to shareholders and earlier today we announced an increase in our quarterly dividend making our 93rd consecutive year of uninterrupted dividends. As we wrap up 2024, we are encouraged that we're gaining operational momentum and we see opportunities to drive additional value. But we also recognize that the external environment continues to pose uncertainties and challenges. Please turn to slide five. We've entered 2025 knowing that we need to remain agile to manage through shifts in both trade and regulatory policy around the world along with the related impacts on geographic supply and demand. With a global asset base and constantly evolving product innovation, our team is prepared to pivot as needed to support the resiliency of the Ag, food, energy and industrial sectors we serve. We're taking these factors into account as we define our business priorities for 2025 with an emphasis on continuing to improve in the areas we control. First, we are focused on execution and cost management. Having made progress on the issues that impacted North American soy operations, we are applying that experience to the broader global network to drive further operational improvement and cost reductions. Similarly, we are applying what we learned from addressing demand fulfillment challenges in EMEA flavors to drive improvements in similarly challenged areas such as pet nutrition. We're actively managing our sourcing efforts to take advantage of lower pricing in many of our core input costs such as chemicals and energy. This cost agenda has also supported realigning our focus on data analytics to identify and assess new savings opportunities quickly. We're aggressively managing our SG&A and corporate cost as we make shifts in the business portfolio and lean into our strengthening digital capabilities. We have been diligent in finding ways to prioritize our own organization's work which has highlighted opportunities to eliminate non-critical third-party spend and structurally align our organization against our most critical efforts. As part of this prioritization effort, we announced that we're taking targeted action across both business and corporate functions to reduce approximately 600 to 700 roles including approximately 150 unfilled positions. Decisions impacting our team members are never easy to make and we are ensuring these colleagues are receiving transition support and an opportunity to apply for other critical roles within the company. In total, we anticipate the result of these cost actions to deliver in the range of $500 million to $750 million over the next three to five years with $200 million to $300 million in 2025. In conjunction with improving our cost position, our second focus is on strategic simplification. As a company that has grown substantially over the past decade, we are continually evaluating how our portfolio balances the evolving needs of our customers, our expectations to achieve our returns objectives, and our ability to be the most efficient operators of each part of the business. Both the current external environment and our performance in specific business segments and geographies over the past few years have highlighted additional opportunities to strategically assess how we are focusing our operational capabilities. With this, we are considering a phased approach to areas of potential simplification looking at our business through a variety of lenses with a particular focus on places where we see a history of performance challenges, deteriorating demand and or excess capacity that do not have a clear path to improvement, assets that may require capital investment that does not meet our expected returns objectives, opportunities for targeted synergy acceleration including potential closures and divestiture where we see an overlapping capabilities and asset footprint, determining who is the best owner/operator for assets that might not be assessed as critical to ADM's future growth trajectory. And along with these, we are ensuring our organization, both our colleagues and strategic partners, are aligned and focused on the most critical sources of value. We have currently identified a pipeline of approximately $2 billion in portfolio opportunities. And we will execute on this over time with the objective of maximizing value for ADM shareholders. Please turn to slide six, where we will talk about two more areas of focus in 2025 associated with capital management. First, as we look at the strategic growth opportunities, we will continue to invest in value drivers. Our strategy continues to be based on the balance of both productivity and innovation, And growth-oriented organic investment remains part of that equation. We've highlighted areas where investments have been paying off over the past year, from our modernization and digitization efforts across our facilities, to the ramp-up of additional capacities such as Spiritwood to support renewable diesel demand, to the global partnerships we have announced in regen ag, supporting farmers' resiliency. All of these represent targeted areas where our business segments are evolving with our customers and finding ways to deliver a strong return on our investments. Looking now to 2025 and beyond, we will continue to make targeted investments in part of the portfolio where we can drive further growth and differentiation, whether that's continuing plant digitization and upgrading our equipment to enhance operating leverage, expanding destination marketing volumes in targeted markets, continuing to build out our decarbonization solution portfolio, or supporting the continued evolution of the biofuels and energy sector. Investments in areas such as biosolutions, destination marketing, and biotics have helped us to drive double-digit growth and serves as a model for new investments. The portfolio above represents proven winners that are not only organically improving ADM, but also helping us establish foundations for the next wave of growth. We will also continue to return cash to shareholders through our traditional channels. In 2024, we kept our focus on returning capital to shareholders through repurchases and dividends, all while maintaining our leverage ratio at our desired target. We have extended our existing share repurchase program by 100 million shares, which we will approach opportunistically and to address dilution. We've announced another dividend increase, continuing the cycle of annual increases for over 50 consecutive years. And through this, we expect to maintain a leverage ratio of approximately 2.0 times. To summarize, looking across the focus areas for 2025, we are committed to continuing to improving the areas we control, and we feel confident that this will allow ADM to deal with external uncertainties and challenges while positioning the company for long-term success. Our team has managed our business through multiple challenging windows of time over nearly 125 years. And I fully expect us to rise to the occasion again in 2025. With that, I will hand it over to Monish to share a deeper dive on 2024 financial results and our 2025 outlook.
Monish Patolawala: Thank you, Juan. Please turn to slide seven. Before jumping into segment performance, let me quickly recap some of the financial highlights for the fourth quarter and full-year 2024. While the fourth quarter played out largely as expected, we experienced negative pressure from market conditions later in December. For the full-year, we finished within our previously guided adjusted earnings per share range. The team remained focused on key self-help actions to finish the year and enter into 2025 on a stronger footing. Now, transitioning into highlights on segment performance and starting with AS&O. To start, let me provide some perspective on the broader market environment and the dynamics that shaped the fourth quarter. The operating landscape was challenging in the fourth quarter, with biofuel and trade policy uncertainty at the forefront. Ample global supplies, higher crush rates from Argentina, and uncertainty in biofuel and trade policy negatively impacted the crush environment. We also experienced high manufacturing costs. As a result, soybean and canola crush execution margins were approximately $10 per ton and $20 per ton lower respectively versus the prior period. Also included in the fourth quarter results for our crushing subsegment were $52 million of insurance proceeds related to the partial settlement of the Decatur East and Decatur West insurance claims. Increased pretreatment capacity at renewable diesel facilities as well as the continued elevated import levels of used cooking oil also weighed on both biodiesel and refining margins during the quarter. From a food oil perspective, we continue to experience softer demand from customers as they looked to cut costs. The origination environment was supportive in North America as the logistical challenges related to the U.S. river level eased compared to the prior year. Overall, against this backdrop, AS&O segment operating profit for the fourth quarter was $644 million, down 32% compared to the prior year period. For the full-year, AS&O's segment operating profit for the fourth quarter was $644 million down 32% compared to the prior year period. For the full-year AS&O segment operating profit of $2.4 billion was 40% lower versus the prior year. Looking at subsegment performance for the full-year, Ag Services' subsegment operating profit of $715 million was 39% lower versus the prior year, driven primarily by lower South American origination volumes and margins, in part due to industry take or pay contracts. The stabilization of trade flows also led to fewer opportunities in our global trade business. Crushing subsegment operating profit of $844 million was 35% lower versus the prior year as ample global supplies drove more balanced supply and demand conditions, which negatively impacted margins throughout the year. Executed crush margins were approximately $10 per ton lower versus the prior year in soybean and approximately $15 per ton lower in canola versus the prior year. There were net negative timing impacts of approximately $165 million year-over-year. The full-year also included $76 million of insurance proceeds for the partial settlement of the Decatur East and Decatur West claims related to the incidents in 2023. Refined products and other subsegment operating profit of $552 million was 58% lower compared to the prior year as increased pretreatment capacity at renewable diesel facilities, higher imports of used cooking oil, aggressive competition among food oil suppliers to serve customer demand, and biofuel policy uncertainty negatively impacted margins. There were net negative timing impacts of approximately $430 million year-over-year. Equity earnings from the company's investment in Wilmar was $336 million for the full-year, 11% higher compared to the prior year. Turning to slide eight, carbohydrate solutions unfolded as expected in the fourth quarter as operating profit was largely in line with the prior year. The results reflected robust demand for ethanol; however, higher industry production drove a lower margin environment. Results also reflected strong North American starches and sweeteners performance, as well as $37 million of insurance proceeds related to both the partial settlement of the Decatur East and Decatur West insurance claims. For the full-year 2024, carbohydrate solution segment operating profit of $1.4 billion was flat compared to the prior year. Starches and sweeteners subsegment operating profit of $1.3 billion was slightly higher compared to the prior year, as strong volumes and margins in North America were offset by weaker co-product values and lower margins in EMEA and ethanol. The full-year also included $84 million of insurance proceeds for the partial settlement of the Decatur East and Decatur West claims related to the incidents in 2023. Vantage Corn Processes subsegment Operating profit of $33 million was 28% lower compared to the prior year as lower margins due to the higher industry production more than offset robust demand for ethanol exports. Turning to slide nine, in the fourth quarter in the nutrition segment, weaker consumer demand and ongoing headwinds from unplanned downtime at Decatur East drove lower organic revenues. Operating profit was $88 million in the fourth quarter, higher year-over-year due to improved mix, lapping the negative non-recurring items in the prior year and insurance recoveries of $46 million related to the partial settlement of the Decatur East insurance claim. The quarter also included a negative impact due to higher cost of goods sold associated with the termination of an unfavorable supply agreement. Fully on nutrition revenues was $7.3 billion up 2% compared to the prior year. On an organic basis, revenue was down 3%. Human nutrition revenue was roughly flat organically as headwinds related to the unplanned downtime and down time at Decatur East and texturants pricing offset improved mix and volumes in flavors and health and wealth. Animal nutrition revenue declined due to unfavorable mix, negative currency impacts in Brazil and lower volumes due to demand fulfillment challenges. Full-year nutrition segment operating profit of $386 million was 10% lower versus the prior year. Human nutrition subsegment operating profit of $327 million was 22% lower compared to the prior year, primarily driven by unplanned downtime at Decatur East and higher manufacturing costs, partially offset by improved performance in the health and wellness business, favorable mix in the flavors business, and M&A contributions. The human nutrition subsegment full-year results also included $71 million of insurance proceeds for the partial settlement of the Decatur East claim related to an incident in 2023. Animal nutrition subsegment operating profit of $59 million was higher than the prior year due to higher margins supported by cost optimization actions to improve mix and an increase in volume. Please turn to slide 10. In 2024, the company generated cash flow from operations before working capital of approximately $3.3 billion, down 30% relative to the prior year due to lower total segment operating profit. Despite the decline, solid cash generation supported our ability to invest in our business and return excess cash to shareholders. In 2024, the company returned $3.3 billion in the form of dividends and share repurchases allocated $1.6 billion to capital expenditures to support the reliability of our assets and cost efficiencies, and approximately $1 billion to M&A announced in 2023 and completed in January 2024. Our strong capital structure remains a critical differentiator for the company. We will continue to seek opportunities to further strengthen our balance sheet to provide us financial flexibility to organically invest in the business to enhance returns and create long-term value. As Juan mentioned, targeted portfolio simplification actions, including consolidation and divestitures, will help align our focus on value creation. At the same time, we remain committed to returning cash to shareholders and will look to offset dilution and opportunistically seek share repurchases. We recently announced an increase in our quarterly dividend as well as an extension of our share repurchase program which is up to an additional 100 million shares over the next five-year period. Please turn to slide 11. We have already touched on some of the external market dynamics that we navigated in December, and several of these dynamics are expected to persist and create pressure on our first-half results for 2025, particularly for our AS&O segment. These include market headwinds related to U.S. biofuel policy uncertainty that had negatively impacted U.S. vegetable oil demand and biodiesel margins, higher global soybean stock levels and an increase in Argentinian crush rates, which have pressured global soybean meal values, and trade policy uncertainty with Canada and China, which has driven volatility for canola crush margins. Taken together, these factors are driving significantly lower meal and vegetable oil values, which is reflected by replacement crush margins in North America near $40 per metric ton for soybean and $50 per metric ton for canola. In both cases, these are well below the levels that we experienced in the first-half of last year. As we look to the second-half of 2025, we see signs that make us optimistic about margin improvement over the course of the year. One clear indication is board crush value signaling a carry in the market in the second-half. Additionally, as we progress through the year, we expect policy uncertainty to clear and strong fundamentals to support better crush and biodiesel margins. In particular, we expect clarity on 45Z guidance to support strong U.S. demand for crop-based vegetable oil. We also expect expansion of global biofuels policy to support global vegetable oil demand. Key examples include Brazil with increases in biodiesel mandates and the newly implemented SAF mandates in Europe. Lastly, we expect improvement in the livestock sector to support robust meal demand. Overall, with the market set up into 2025, we are focused on operational improvements and accelerating cost savings to partially mitigate the less favorable market conditions and be in an excellent position to capture opportunities in the second-half. Turning to slide 12, we have provided details that support our 2025 outlook for each segment for the first quarter and the full-year. Starting with Ag services and oil sales, in the first quarter, we expect segment operating profits to be down approximately 50% relative to the prior year period, led by declines in crushing and RPO. On crushing, we anticipate both soybean and canola execution crush margins to be significantly lower than the prior year period. In RPO, lower biodiesel margins are expected to drive significantly lower operating profit for the subsegment in the first quarter compared to the prior year period. For the full-year, we expect AS&O segment operating profit to be below to similar with 2024. Operational improvement should support higher volumes and lower manufacturing costs, which will partially offset the impact of lower margins for the segment. For the full-year, we expect soybean crush execution margins to range from $45 to $55 per ton, down approximately $5 per ton at the midpoint versus the prior year. We expect canola crush execution margins to range from $50 to $70 per ton, down approximately $20 per ton at the midpoint compared to the prior year. For RPO, we expect operating profit to be down significantly compared to the prior year. We expect insurance recoveries related to the Decatur East claim of $25 million compared to the total recoveries of $76 million in 2024. In carbohydrate solutions for the first quarter, we expect segment operating profit to be low by approximately 5% to 15% compared to the prior year period. Strong margins and volumes in North American starches and sweeteners are likely to be offset by lower results in the EMEA region as higher corn costs and increased competition negatively impact margins. In ethanol, robust export demand is likely to support strong volumes. However, higher industry run rates are expected to result in break-even ethanol EBITDA margins. For the full-year, we expect lower carbohydrate solution segment operating profit relative to the prior year period, as strong volumes and margins in North America expected to be more than offset by margin moderation in EMEA and ethanol. For the year, we anticipate ethanol EBITDA margins to be in the range of $0.05 to $0.10, down approximately $0.10 at the midpoint compared to the prior year. We expect insurance recovery of approximately $10 million compared to the insurance recovery of $84 million in 2024. In nutrition, we expect first quarter operating profit to be down 50% compared to the prior year period. We expect to face higher raw material costs and negative impacts associated with continued downtime at Decatur East. We also expect lower demand for plant based protein, higher insurance costs and increased competition in texturants to drive lower margins in the segment. Notably, excluding the effects of $46 million of insurance proceeds we received in the fourth quarter of 2024, we expect Nutrition operating profit to be approximately flat sequentially in the first quarter. For the full-year, we anticipate Nutrition operating profit to be higher compared to the prior year with low to mid-single-digit revenue growth led by our Flavors business. Strong performance from recent acquisitions and improved supply chain execution is expected to support increased volume and an improvement in cost in human nutrition, helping to offset the headwinds associated with the ramp-up of operations at Decatur East. In animal nutrition, we anticipate continued mix benefits from cost optimization actions as well as an improvement in profitability of our Pet business. We expect insurance recovery of approximately $25 million compared to insurance recovery of $71 million in 2024. Now looking at the consolidated outlook on slide 13, earlier today, we announced that we expect adjusted earnings per share to be between $4 to $4.75 per share. In considering this range, it is important to keep in mind the following: We expect lower margins in AS&O and carb sol to create a material headwind. Our focus on improved execution and cost should produce $200 million to $300 million of cost out, which includes the benefit of lower manufacturing and SG&A costs. We expect to reverse the negative take or pay impact in Ag Services from last year. We also anticipate less insurance proceeds in 2025. We currently expect approximately $60 million in 2025, with approximately 60% coming from reinsurance. This is compared to total insurance recoveries of $231 million in 2024 with approximately $133 million coming from reinsurance in 2024. Looking at our other guidance metrics, we anticipate corporate costs to be within the range of $1.7 billion to $1.8 billion. We expect the benefit of cost actions and a decline in net interest expense in corporate to be more than offset by the elevated legal costs and the reversal of performance based reduction in incentive compensation relative to 2024. In other, we expect lower results in ADMIS compared to the prior year due to lower interest rates. We expect capital expenditures to be in the range of $1.5 billion to $1.7 billion and we expect D&A to be approximately $1.2 billion. We expect our effective tax rate to be higher in 2025 in the range of 21% to 23% due to the sunset of the biodiesel tax credit, a shift in geographic mix of earnings and an expansion in the global minimum tax. Lastly, we expect diluted weighted average shares outstanding to be approximately 483 million shares and our leverage ratio to be approximately 2 for the full-year. To conclude, I want to take a moment to thank our ADM colleagues for their focus, adaptability and contributions through the close of 2024. These organizational efforts have been critical in driving progress and meeting challenges head on. As we navigate 2025, our focus will remain on what is within our control. A full commitment to remediating the material weakness and making strides to strengthen our internal controls, driving execution to improve operational performance and lower costs while sustaining functional excellence unlocking additional capital to drive value and position the company for long-term success. These efforts position us in our ability to navigate the current dynamic environment and reinforce our confidence in delivering on our commitment. Before I turn it back to Juan, I wanted to briefly mention a leadership transition we announced last week and that officially will take effect on March 1. Carrie Nichol is joining us as our new Vice President and Chief Accounting Officer. She joined us from Cargill, where she served as Senior Vice President, Chief Accounting Officer and Global Process Leader. I am excited to make this important addition to our leadership team, and I look forward to working with her. Back to you, Juan.
Juan Luciano: Thanks, Monish. I'll briefly close by recapping our focus as we continue the path into 2025. With the uncertainty we've noticed in the external environment, ADM is prioritizing an internal focus on the areas we can best control. While administering this self-help we'll remain agile and ready for opportunities that may present themselves along the way. Our focus on execution and cost management will drive savings to the bottom line while ensuring that we're managing our assets and overall network as effectively as possible. Our focus on strategic simplification will deliver opportunities to optimize our portfolio and organization around those areas that deliver strongest returns and where we are the strongest operators. Our focus on strategic growth will allow us to organically invest in proven winners while also ensuring our business are ready for the future. And our focus on capital discipline will position us to continue the return of cash to shareholders through dividends and selective share repurchases. We are confident that this equation sets ADM up for success in 2025 and ensures we have necessary optionality in both the short and medium term while keeping our eyes on longer term opportunities ahead. With that, we'll take your questions now. Operator, please open the line.
Operator: Thank you. [Operator Instructions] Our first question for today comes from Tom Palmer of Citi. Your line is now open. Please go ahead.
Tom Palmer: Good morning, and thanks for the question.
Juan Luciano: Good morning, Tom.
Tom Palmer: Just on the nutrition segment, I wanted to make sure I understood the expected profit recovery. It implies a pretty big inflection as the year progresses. You noted 1Q has some maybe heightened headwinds. It sounds like at least for the second quarter, I wasn't sure if it was second quarter or for the full-year, the start up at Decatur's noted as a headwind. And then, you've got the insurance headwind, especially in the second-half. So, just trying to understand what really drives that inflection. Is it the belief that end markets get better? Is this cost savings plan maybe more concentrated in this part of the business? Thanks.
Juan Luciano: Yes. Thank you, Tom, for the question. Listen, nutrition has a big self-help story inside themselves as we have in ADM of course. But I think the main issue for Nutrition is you need to think about like three different buckets. There is one bucket that is the Decaturist plant, which is Specialty Ingredients, that is a big headwind and until we can bring the plant back that will continue to be. So, that is going to happen in the first quarter. Hopefully the plant will be back in the second quarter we expect, and that will naturally bring an improvement to the results. The other bucket is a bucket that it continues to go very well, which is, if you think about flavors and if you think about biotics, those businesses are going very well. They are growing. They have grown 7% and 10% respectively in revenue in 2024. So that's going to continue and that's basically execution of their pipeline, and their pipeline is very robust and very good. And I would say, the third bucket is you have this steady improvement month-over-month, quarter-after-quarter of animal nutrition, which is not a revenue story, but it's a margin improvement story. So, you have three different things, and when you put them altogether, we see a strong recovery in the last-half of the year for nutrition.
Monish Patolawala: Tom, just to add, and I know you already picked it up, but just for math, when you look at it sequentially, so you're right, Q1 starts softer. Sequentially, after adjusting for the insurance recovery, which we have $46 million, we expect those results to be pretty much in line, Q1 equals Q4. And as Juan mentioned, the manufacturing cost, all the self-help starts kicking in, in the second quarter to fourth quarter.
Tom Palmer: Understood. Thank you.
Operator: Thank you. Our next question comes from Andrew Strelzik of BMO. Your line is now open. Please go ahead.
Andrew Strelzik: Hey, good morning. Thanks for taking the question. I wanted to ask now that we've got the -- hey, how are you? I wanted to ask about your view on vegetable oil demand, soybean oil demand in particular. Now that we have the 45Z guidance kind of behind us to a certain extent and the imported UCO that's not going to qualify for tax credits. In kind of your first-half, back-half, a summary there slide, you gave what I would say is a reasonably constructive outlook for vegetable oil demanded. So I guess, I'm just curious for how you think about the puts and the takes around that because I know there's a lot of concern in the market. And then, kind of subsequent to that, as you think about all the uncertainty that's impacting the first quarter, is there a way to think about kind of the first-half, back half, earnings split relative to what is typical for you guys? Thanks.
Juan Luciano: Yes, thank you, Andrew. A lot to unpack there, so yes, we received guidance from 45Z in January and I think it was constructive, but it's still a lot is in the air. We still need to get finalized that guidance. Probably, it's not going to happen until the end of Q1 and by that time we might have sold already Q2. So we have to see how that evolves. So we have to be cautious with that. On the other hand, when you do the math that probably implies an extra maybe 0.5 million tons of oil demand by Yuko that's not going to qualify for this. Our team anticipates that soybean oil share will be up from 35% to 40% and maybe Yuko down from 20% to 14%. So, I think that this is a year in which right now the Ag Services and Oilseeds Industry is trying to digest this extra capacity, if you will, extra production because we have North America, we have Brazil and we have Argentina producing -- crushing a lot and also this big uncertainty not only on tariffs for imported products, but also the policy uncertainty around biofuels. We think that as these policy uncertainties start to clear through the year, we're going to see margins improving and you can see that in the current in the market for crush going forward. We are excited about the manufacturing improvements we're going to have and we are excited about the fundamental demand that when these clouds of uncertainty regulatory will clear, you will see that the livestock area is very strong and soybean meal continues to be the most beneficial feeding material, so that's maximizing the rations at the moment. So, USDA is thinking meal growth probably 5.5%, maybe we have even some upside to that number potentially. And then you have this area of all the mandates that are coming around the world. I think Monish referred before in his previous remark about SAF in Europe, but also it's Indonesia, also it's Brazil increasing their biofuels mandate. So and when we clear 45Z, we're going to have that extra demand from the U.S. So, we see a first-half, second-half different pattern than other years and very hard to quantify what else on one and the other, because it will depend more on government and clarifying the regulatory environment, which we can only adjust to, but we cannot manage.
Andrew Strelzik: Great. Thank you very much.
Operator: Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead.
Ben Theurer: Perfect. Thank you very much and good morning. Just wanted to follow-up on your guidance cadence for Ag Service and Oilseeds, similar to what Tom had on Nutrition. But as we look at it, obviously, Q1 is very tough comp and you already indicated that to be 50% down. But then in order to get to just slightly below 25 levels as your guidance indicates, that would mean that 2Q onwards; we should see improving trends on a year-over-year basis. And I just would like to understand if you can help us reconcile that with lower insurance proceeds, but then at the same time you assume canola and soybean crush to be lower for the year? So, I just wanted to understand what is else in there that helps us to get those profits in line to below versus '24 with such a tough start in 1Q?
Juan Luciano: Yes, I think the -- then -- part of the tough start in the Q is because although you see some canola margins maybe rebounded recently, when we put our book, we put our book at lower numbers, because we put itthere in Q4. So, maybe our Q1 is even lower than maybe what current conditions may indicate. When we think about crush margins approximately around $40 in Q1, we are expecting full-year crush margins in the range of $45 to $55 per ton for soy. That's about $5 lower than the average of last year, and canola $50 to %70 that's probably 20 bucks lower than last year. And again, you have to include here all the improvements that we expected in manufacturing for the business. If you recall, last year we were doing a lot of project automation and digitization in the carb solutions area. And I mentioned before that we have run an experiment with the oil seed plant in Brazil. And now, we have the result of that experiment. And we are bringing some of those learning. So, we expect a lot of self-help coming to Ag services and oil seed. And we also expect destination marketing to grow our internal -- our direct farming procurements also to improve or to grow this year. So, -- and as I said, mill is going to be strong. And soybean oil should become significantly better in the second-half of the year so.
Monish Patolawala: And Ben, I would add to Juan's comments. Just when you think about RPO or biofuels and what clarity that gets. That should allow the second-half to be far stronger than the first-half. And Juan already mentioned, when you look at the forward curve that carries is pretty strong in the second-half. And we are open for business quite a lot in the second-half. So, hopefully, we are positioned to take advantage--
Juan Luciano: To capture that, yes.
Monish Patolawala: To capture as that goes, so, all that put together, why you start pretty soft in Q1. And then, you move yourself up. But you're right. It's a second-half story. And that's what we'll have to watch. Multiple factors -- as you're watching, we are watching the same. Whether it's weather whether it is the crop yields et cetera. So, as we know more, we'll keep you posted. But that's how we see it right now.
Juan Luciano: One of the things also, Ben, as I forgot is we don't have the negative takeoff pace that we had last year in Brazil. So, we don't expect them this year. So, that would be a positive also for this year.
Ben Theurer: Okay.
Operator: Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead.
Heather Jones: Morning. Thanks for the question.
Juan Luciano: Good morning, Heather.
Heather Jones: I wanted to ask I -- good morning. Just wanted to first of all clarify that your guidance doesn't include any expected impact from tariffs, and then secondly, even if it doesn't include it, if you could just flesh out how that would look for you guys? How you have to be thinking about the impact from operations, particularly in North America? Thanks.
Juan Luciano:
a: The China retaliatory measures doesn't include agricultural products at this point in time. So, it's difficult to know. I think in the short term, our teams are making sure that they are doing everything possible to avoid the short-term impact. I think medium-term and long-term trade flows seem to stabilize. But of course, we saw in 2018 how the corn imports from China were reduced by almost like 9 million tons from the U.S. Whether that's going to be something that's going to happen again or not, we'll have to see. Again, when you think about the power of ADM in terms of our origination in so many parts of the world and our destination marketing in so many parts of the world, it provides an optionality that few companies have in order to be able to capitalize on any environment. We don't know if net-net it will be a positive or a negative, but we will go through as we went in 2018.
Heather Jones: Thanks so much.
Juan Luciano: You're welcome.
Operator: Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead.
Steven Haynes: Hey, good morning, and thank you for taking my question. I wanted to come back to Argentina and their recent export tax revision across the soy crush complex, and if you could just briefly, I guess, talk about how you think that's going to impact your businesses and then how maybe you see that policy evolving after turn because I think that's kind of when they had framed the current revision period for. So, thank you.
Juan Luciano: Yes, thank you for the question, Steven. So, let me -- this policy was implemented, as you said, effective until June 30. Very difficult what's going to happen after that, because it depends more on microeconomics of Argentina, so it will depend on many, many factors. I would say, until then, we haven't seen a big impact yet, mostly because they are still going through the harvest and through the planting. Second, because and I'm a farmer in Argentina, we're all worried about the weather in Argentina and the crop in certain places doesn't look terrific. We need rains that are expected to come, but those rains may just stabilize the yields but not being able to turn around that. And then, there are details about the implementation of this regulation that we need to be observing. Before all this, you needed to bring the dollars into Argentina 30 days after your shipment. Right now, if you want to qualify for this reduction in exports, you need to commit that you're going to bring the dollars of 95% of all the amount within 15 days of issuing the license. So, before you have 30 days from shipment, now you have to bring the money 15 days after you get the export license. So that's a big financing change in the thing that I don't know how it's going to impact. So we will have to see in April with the farmer's seeds on top of their harvest and they have from April to May to June to be able to play this how much it's going to be. At this point in time, we haven't felt much.
Steven Haynes: Thank you.
Juan Luciano: Welcome.
Operator: Our next question comes from Pooran Sharma of Stephens. Your line is now open. Please go ahead.
Pooran Sharma: Great. Thanks for the question. I wanted to see if we could unpack 45Z guidance a little bit. I know there's been, the situation's fluid. Biden provided interim guidance, but I think there's a little bit left with final guidance. To my understanding, the biofuels industry with interim guidance is able to accrue tax credits, but I think you need final guidance to have them paid out. So we've seen some smaller operators already seize shutter production. We just weren't sure about the larger producers. So I wanted to kind of get your take on 45Z guidance and then the State of the Union on the biofuels industry.
Juan Luciano: Yes, let's see if I can provide some clarity to that. First of all, this is preliminary guidance and of course it needs to be ratified after the comment period and then we need to see what the Trump administration will decide on this. So this still needs to be played out. I would say with the removal the blenders tax credit, margins have been significantly impacted. And so, you may see some small producers that in the absence of all these, when they are not integrated and are isolated plants, they have shut down. We were expecting to do that. Our integrated facilities, all our facilities are integrated, have allowed us to continue to operate, although we see the impact in Q1 margins that we're going to have as we have Q4 margins. So the industry definitely needs to bring some margin back into it. More importantly, we need to bring clarity because lack of clarity has pulled people off the market. What we know is the administration of President Trump strongly supports the farmers and having an output for the farmers' production. And I think that in that sense, a strong biofuel policy, a strong export policy, a strong bio-solutions type of product are all going to be very supportive.
Pooran Sharma: Great. I appreciate the color.
Juan Luciano: Thank you.
Operator: Thank you. Our next question comes from Manav Gupta of UBS. The line is now open. Please go ahead.
Manav Gupta: Good morning. I'm sorry I dropped off briefly. So if somebody has already asked this, I apologize. But Monish, your key priorities when you took over, your focus was one on operational rigor and second, ensuring there are no material weakness in financial reporting, and what's the progress been on those two fronts? Thank you.
Monish Patolawala: Yes, thank you, Manav. I would say on both, and I'll start with the material weakness. As I said at the end of my prepared remarks, that is one item that we are very heavily focused on, which I am focused on. And the progress on that, and I'll start by just saying, when we talked to you three call, and you had asked the question, I said the company had enhanced the design and controls and documentation of inter-segment sales. So we have continued to do that this quarter. We have continued to provide a lot of training to our personnel around the reporting and recognition of inter-segment sales. We have enhanced and tested a lot of controls, and we need to continue to make sure that is sustained for a period of time before we can lift the material weakness. And that's what the teams are focused on. We also made an announcement where we've got Carrie Nichol who's joining us, the Chief Accounting Officer, who was from a similar role in Cargill. And I'm excited to have her on board and my partner to help me continue this journey that we have started on remediating our material weakness. To answer your question on operating rigor, you can see that we've made progress. In Juan's comments, you can hear that some of the items where we have done root cause in our manufacturing facilities have given yielded results. In December, we saw good outputs in some of our plants in North America. We also saw progress in EMEA, in our flavors business, in nutrition. And as a part of that whole thing, Manav, and as we look at the opportunities, Juan and I announced that we have a plan to get $500 million to $750 million of cost out over the next three to five years. It's going to come from multiple places. Number one is driving efficiencies in our manufacturing facilities. Number two is going after costs with our third parties. And number three is controlling SG&A and some of the actions we're going to take there. Adding on to that on the other side is the simplification agenda. So as we continue to drive portfolio simplification, we see an opportunity to continue to drive margin enhancement in there too. At some of these facilities, whether you talk about consolidations or targeted divestiture, should allow us also benefit in there. We are going to do all of this while at the same time battling a lot more around the inflationary environment, whether it's the energy complex, as well as labor inflation or general inflation that continues to stay. So, focused on it, Juan said it, I've said it, it's a big self-help agenda. We know the environment that we are going into 2025. And I think the team is quite confident that we can execute this cost-out plan that we have got over the next three to five years.
Manav Gupta: Thank you so much for the update.
Operator: Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Your line is now open. Please go ahead.
Salvator Tiano: Yes, thank you very much. I want to go back to nutrition specifically for Q4. So your commentary was pretty positive in that human nutrition had higher volume and pricing versus last year. But if we adjust for last year's write-down, I think you would have made 39 million human nutrition, whereas this year without the insurance, you would have made only 15 million. So it looks like the performance even with M&A was quite worse, so I cannot reconcile the two. Can you provide a little bit more color on why margins were so lower and perhaps quantify the impact of this contract cancellation in Q4?
Monish Patolawala: Yes, I think when you look at it, yes, we've made progress on the growth in human nutrition, but the biggest piece that still continues to be a headwind is the specialty ingredients business. When you look at the continued inefficiencies from the downtime at Decatur East, the higher insurance premiums that we are seeing, as well as the lower pricing for texturants and demand, all put together is where we landed up for the fourth quarter. And going into 2025, we look at the same and say, when you look at Q1 and we say it's sequentially flat when you adjust for the insurance proceeds, the biggest driver there again on a year-over-year basis is the specialty ingredients. And so getting that plant back online in Q2 2025 and then doing all the self-help actions that Ian and his team are doing in nutrition will help us continue to grow nutrition's P&L in 2025.
Salvator Tiano: Thank you. Just to understand though here, the fire indicator happened I think August or September last year, meaning that you should have lapsed, at least in my understanding, you should have lapsed the inefficiencies and the problems already in Q4. So that shouldn't have been an issue versus Q4 of '24 or it shouldn't be an issue in Q1 '25 versus what you posted this year?
Monish Patolawala: Well, we had inventory going into Q4 of '23, and that allowed to reduce some of the impact that was there on a year-over-year basis. But also prices and the kind of tech spend that have come down, yes.
Salvator Tiano: Okay, perfect. Thank you very much.
Operator: Thank you. Due to time, we'll take no further questions, so I'll hand back to Megan Britt for any further remarks.
Megan Britt: Thank you so much for joining the call today. If you have additional questions, please feel free to reach out directly to me. Have a wonderful rest of your day.
Operator: Thank you all for joining today's call. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to ADM Fourth Quarter 2024 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Welcome to the fourth quarter earnings conference call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on filed with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. Unless otherwise required by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available on our earnings press release and presentation slides, which can be found in the Investor Relations section of the ADM website. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan. Hello, and welcome to all of who have joined the call. Please turn to slide four where we have captured our fourth quarter and full-year performance highlights. Today, ADM reported fourth quarter adjusted earnings per share of $1.14, and full-year adjusted earnings per share of $4.74, in line with the midpoint of our guidance for the full-year. Total segment operating profit was $1.1 billion for the fourth quarter and $4.2 billion for the full-year. Our trailing four-quarter adjusted ROIC was 8.3%. And cash flow from operations before working capital changes was $3.3 billion. Though 2024 presented a variety of challenges, our diligent focus on improving operation has made a positive impact across the network. We achieved strong crush volumes in canola and rapeseed, as well as our -- in our LATAM region. We made progress in addressing challenges in North America in soy assets, reducing unplanned downtime, and improving crush volumes in the month of December. We successfully ramped up run rates to meet demand at our Spiritwood facility over the course of 2024. We achieved a strong year in Starches & Sweeteners, where improved plant performance led to 3% higher production volume year-over-year, helping several product lines in our North America business set operating profit records. We made progress in addressing demand fulfillment challenges in EMEA flavors, while successfully integrating two new flavors acquisitions announced in early 2024. We improved our safety record significantly with a more than 35% year-over-year reduction in Tier 1 and 2 process safety incidents across our global network. In addition, we advanced key innovation initiatives in areas such as biosolutions and health & wellness, continuing to support growing customer demand in these parts of the business. And through this, we were able to maintain a strong balance sheet to ensure continued investment in the business and return of cash to shareholders and earlier today we announced an increase in our quarterly dividend making our 93rd consecutive year of uninterrupted dividends. As we wrap up 2024, we are encouraged that we're gaining operational momentum and we see opportunities to drive additional value. But we also recognize that the external environment continues to pose uncertainties and challenges. Please turn to slide five. We've entered 2025 knowing that we need to remain agile to manage through shifts in both trade and regulatory policy around the world along with the related impacts on geographic supply and demand. With a global asset base and constantly evolving product innovation, our team is prepared to pivot as needed to support the resiliency of the Ag, food, energy and industrial sectors we serve. We're taking these factors into account as we define our business priorities for 2025 with an emphasis on continuing to improve in the areas we control. First, we are focused on execution and cost management. Having made progress on the issues that impacted North American soy operations, we are applying that experience to the broader global network to drive further operational improvement and cost reductions. Similarly, we are applying what we learned from addressing demand fulfillment challenges in EMEA flavors to drive improvements in similarly challenged areas such as pet nutrition. We're actively managing our sourcing efforts to take advantage of lower pricing in many of our core input costs such as chemicals and energy. This cost agenda has also supported realigning our focus on data analytics to identify and assess new savings opportunities quickly. We're aggressively managing our SG&A and corporate cost as we make shifts in the business portfolio and lean into our strengthening digital capabilities. We have been diligent in finding ways to prioritize our own organization's work which has highlighted opportunities to eliminate non-critical third-party spend and structurally align our organization against our most critical efforts. As part of this prioritization effort, we announced that we're taking targeted action across both business and corporate functions to reduce approximately 600 to 700 roles including approximately 150 unfilled positions. Decisions impacting our team members are never easy to make and we are ensuring these colleagues are receiving transition support and an opportunity to apply for other critical roles within the company. In total, we anticipate the result of these cost actions to deliver in the range of $500 million to $750 million over the next three to five years with $200 million to $300 million in 2025. In conjunction with improving our cost position, our second focus is on strategic simplification. As a company that has grown substantially over the past decade, we are continually evaluating how our portfolio balances the evolving needs of our customers, our expectations to achieve our returns objectives, and our ability to be the most efficient operators of each part of the business. Both the current external environment and our performance in specific business segments and geographies over the past few years have highlighted additional opportunities to strategically assess how we are focusing our operational capabilities. With this, we are considering a phased approach to areas of potential simplification looking at our business through a variety of lenses with a particular focus on places where we see a history of performance challenges, deteriorating demand and or excess capacity that do not have a clear path to improvement, assets that may require capital investment that does not meet our expected returns objectives, opportunities for targeted synergy acceleration including potential closures and divestiture where we see an overlapping capabilities and asset footprint, determining who is the best owner/operator for assets that might not be assessed as critical to ADM's future growth trajectory. And along with these, we are ensuring our organization, both our colleagues and strategic partners, are aligned and focused on the most critical sources of value. We have currently identified a pipeline of approximately $2 billion in portfolio opportunities. And we will execute on this over time with the objective of maximizing value for ADM shareholders. Please turn to slide six, where we will talk about two more areas of focus in 2025 associated with capital management. First, as we look at the strategic growth opportunities, we will continue to invest in value drivers. Our strategy continues to be based on the balance of both productivity and innovation, And growth-oriented organic investment remains part of that equation. We've highlighted areas where investments have been paying off over the past year, from our modernization and digitization efforts across our facilities, to the ramp-up of additional capacities such as Spiritwood to support renewable diesel demand, to the global partnerships we have announced in regen ag, supporting farmers' resiliency. All of these represent targeted areas where our business segments are evolving with our customers and finding ways to deliver a strong return on our investments. Looking now to 2025 and beyond, we will continue to make targeted investments in part of the portfolio where we can drive further growth and differentiation, whether that's continuing plant digitization and upgrading our equipment to enhance operating leverage, expanding destination marketing volumes in targeted markets, continuing to build out our decarbonization solution portfolio, or supporting the continued evolution of the biofuels and energy sector. Investments in areas such as biosolutions, destination marketing, and biotics have helped us to drive double-digit growth and serves as a model for new investments. The portfolio above represents proven winners that are not only organically improving ADM, but also helping us establish foundations for the next wave of growth. We will also continue to return cash to shareholders through our traditional channels. In 2024, we kept our focus on returning capital to shareholders through repurchases and dividends, all while maintaining our leverage ratio at our desired target. We have extended our existing share repurchase program by 100 million shares, which we will approach opportunistically and to address dilution. We've announced another dividend increase, continuing the cycle of annual increases for over 50 consecutive years. And through this, we expect to maintain a leverage ratio of approximately 2.0 times. To summarize, looking across the focus areas for 2025, we are committed to continuing to improving the areas we control, and we feel confident that this will allow ADM to deal with external uncertainties and challenges while positioning the company for long-term success. Our team has managed our business through multiple challenging windows of time over nearly 125 years. And I fully expect us to rise to the occasion again in 2025. With that, I will hand it over to Monish to share a deeper dive on 2024 financial results and our 2025 outlook."
},
{
"speaker": "Monish Patolawala",
"text": "Thank you, Juan. Please turn to slide seven. Before jumping into segment performance, let me quickly recap some of the financial highlights for the fourth quarter and full-year 2024. While the fourth quarter played out largely as expected, we experienced negative pressure from market conditions later in December. For the full-year, we finished within our previously guided adjusted earnings per share range. The team remained focused on key self-help actions to finish the year and enter into 2025 on a stronger footing. Now, transitioning into highlights on segment performance and starting with AS&O. To start, let me provide some perspective on the broader market environment and the dynamics that shaped the fourth quarter. The operating landscape was challenging in the fourth quarter, with biofuel and trade policy uncertainty at the forefront. Ample global supplies, higher crush rates from Argentina, and uncertainty in biofuel and trade policy negatively impacted the crush environment. We also experienced high manufacturing costs. As a result, soybean and canola crush execution margins were approximately $10 per ton and $20 per ton lower respectively versus the prior period. Also included in the fourth quarter results for our crushing subsegment were $52 million of insurance proceeds related to the partial settlement of the Decatur East and Decatur West insurance claims. Increased pretreatment capacity at renewable diesel facilities as well as the continued elevated import levels of used cooking oil also weighed on both biodiesel and refining margins during the quarter. From a food oil perspective, we continue to experience softer demand from customers as they looked to cut costs. The origination environment was supportive in North America as the logistical challenges related to the U.S. river level eased compared to the prior year. Overall, against this backdrop, AS&O segment operating profit for the fourth quarter was $644 million, down 32% compared to the prior year period. For the full-year, AS&O's segment operating profit for the fourth quarter was $644 million down 32% compared to the prior year period. For the full-year AS&O segment operating profit of $2.4 billion was 40% lower versus the prior year. Looking at subsegment performance for the full-year, Ag Services' subsegment operating profit of $715 million was 39% lower versus the prior year, driven primarily by lower South American origination volumes and margins, in part due to industry take or pay contracts. The stabilization of trade flows also led to fewer opportunities in our global trade business. Crushing subsegment operating profit of $844 million was 35% lower versus the prior year as ample global supplies drove more balanced supply and demand conditions, which negatively impacted margins throughout the year. Executed crush margins were approximately $10 per ton lower versus the prior year in soybean and approximately $15 per ton lower in canola versus the prior year. There were net negative timing impacts of approximately $165 million year-over-year. The full-year also included $76 million of insurance proceeds for the partial settlement of the Decatur East and Decatur West claims related to the incidents in 2023. Refined products and other subsegment operating profit of $552 million was 58% lower compared to the prior year as increased pretreatment capacity at renewable diesel facilities, higher imports of used cooking oil, aggressive competition among food oil suppliers to serve customer demand, and biofuel policy uncertainty negatively impacted margins. There were net negative timing impacts of approximately $430 million year-over-year. Equity earnings from the company's investment in Wilmar was $336 million for the full-year, 11% higher compared to the prior year. Turning to slide eight, carbohydrate solutions unfolded as expected in the fourth quarter as operating profit was largely in line with the prior year. The results reflected robust demand for ethanol; however, higher industry production drove a lower margin environment. Results also reflected strong North American starches and sweeteners performance, as well as $37 million of insurance proceeds related to both the partial settlement of the Decatur East and Decatur West insurance claims. For the full-year 2024, carbohydrate solution segment operating profit of $1.4 billion was flat compared to the prior year. Starches and sweeteners subsegment operating profit of $1.3 billion was slightly higher compared to the prior year, as strong volumes and margins in North America were offset by weaker co-product values and lower margins in EMEA and ethanol. The full-year also included $84 million of insurance proceeds for the partial settlement of the Decatur East and Decatur West claims related to the incidents in 2023. Vantage Corn Processes subsegment Operating profit of $33 million was 28% lower compared to the prior year as lower margins due to the higher industry production more than offset robust demand for ethanol exports. Turning to slide nine, in the fourth quarter in the nutrition segment, weaker consumer demand and ongoing headwinds from unplanned downtime at Decatur East drove lower organic revenues. Operating profit was $88 million in the fourth quarter, higher year-over-year due to improved mix, lapping the negative non-recurring items in the prior year and insurance recoveries of $46 million related to the partial settlement of the Decatur East insurance claim. The quarter also included a negative impact due to higher cost of goods sold associated with the termination of an unfavorable supply agreement. Fully on nutrition revenues was $7.3 billion up 2% compared to the prior year. On an organic basis, revenue was down 3%. Human nutrition revenue was roughly flat organically as headwinds related to the unplanned downtime and down time at Decatur East and texturants pricing offset improved mix and volumes in flavors and health and wealth. Animal nutrition revenue declined due to unfavorable mix, negative currency impacts in Brazil and lower volumes due to demand fulfillment challenges. Full-year nutrition segment operating profit of $386 million was 10% lower versus the prior year. Human nutrition subsegment operating profit of $327 million was 22% lower compared to the prior year, primarily driven by unplanned downtime at Decatur East and higher manufacturing costs, partially offset by improved performance in the health and wellness business, favorable mix in the flavors business, and M&A contributions. The human nutrition subsegment full-year results also included $71 million of insurance proceeds for the partial settlement of the Decatur East claim related to an incident in 2023. Animal nutrition subsegment operating profit of $59 million was higher than the prior year due to higher margins supported by cost optimization actions to improve mix and an increase in volume. Please turn to slide 10. In 2024, the company generated cash flow from operations before working capital of approximately $3.3 billion, down 30% relative to the prior year due to lower total segment operating profit. Despite the decline, solid cash generation supported our ability to invest in our business and return excess cash to shareholders. In 2024, the company returned $3.3 billion in the form of dividends and share repurchases allocated $1.6 billion to capital expenditures to support the reliability of our assets and cost efficiencies, and approximately $1 billion to M&A announced in 2023 and completed in January 2024. Our strong capital structure remains a critical differentiator for the company. We will continue to seek opportunities to further strengthen our balance sheet to provide us financial flexibility to organically invest in the business to enhance returns and create long-term value. As Juan mentioned, targeted portfolio simplification actions, including consolidation and divestitures, will help align our focus on value creation. At the same time, we remain committed to returning cash to shareholders and will look to offset dilution and opportunistically seek share repurchases. We recently announced an increase in our quarterly dividend as well as an extension of our share repurchase program which is up to an additional 100 million shares over the next five-year period. Please turn to slide 11. We have already touched on some of the external market dynamics that we navigated in December, and several of these dynamics are expected to persist and create pressure on our first-half results for 2025, particularly for our AS&O segment. These include market headwinds related to U.S. biofuel policy uncertainty that had negatively impacted U.S. vegetable oil demand and biodiesel margins, higher global soybean stock levels and an increase in Argentinian crush rates, which have pressured global soybean meal values, and trade policy uncertainty with Canada and China, which has driven volatility for canola crush margins. Taken together, these factors are driving significantly lower meal and vegetable oil values, which is reflected by replacement crush margins in North America near $40 per metric ton for soybean and $50 per metric ton for canola. In both cases, these are well below the levels that we experienced in the first-half of last year. As we look to the second-half of 2025, we see signs that make us optimistic about margin improvement over the course of the year. One clear indication is board crush value signaling a carry in the market in the second-half. Additionally, as we progress through the year, we expect policy uncertainty to clear and strong fundamentals to support better crush and biodiesel margins. In particular, we expect clarity on 45Z guidance to support strong U.S. demand for crop-based vegetable oil. We also expect expansion of global biofuels policy to support global vegetable oil demand. Key examples include Brazil with increases in biodiesel mandates and the newly implemented SAF mandates in Europe. Lastly, we expect improvement in the livestock sector to support robust meal demand. Overall, with the market set up into 2025, we are focused on operational improvements and accelerating cost savings to partially mitigate the less favorable market conditions and be in an excellent position to capture opportunities in the second-half. Turning to slide 12, we have provided details that support our 2025 outlook for each segment for the first quarter and the full-year. Starting with Ag services and oil sales, in the first quarter, we expect segment operating profits to be down approximately 50% relative to the prior year period, led by declines in crushing and RPO. On crushing, we anticipate both soybean and canola execution crush margins to be significantly lower than the prior year period. In RPO, lower biodiesel margins are expected to drive significantly lower operating profit for the subsegment in the first quarter compared to the prior year period. For the full-year, we expect AS&O segment operating profit to be below to similar with 2024. Operational improvement should support higher volumes and lower manufacturing costs, which will partially offset the impact of lower margins for the segment. For the full-year, we expect soybean crush execution margins to range from $45 to $55 per ton, down approximately $5 per ton at the midpoint versus the prior year. We expect canola crush execution margins to range from $50 to $70 per ton, down approximately $20 per ton at the midpoint compared to the prior year. For RPO, we expect operating profit to be down significantly compared to the prior year. We expect insurance recoveries related to the Decatur East claim of $25 million compared to the total recoveries of $76 million in 2024. In carbohydrate solutions for the first quarter, we expect segment operating profit to be low by approximately 5% to 15% compared to the prior year period. Strong margins and volumes in North American starches and sweeteners are likely to be offset by lower results in the EMEA region as higher corn costs and increased competition negatively impact margins. In ethanol, robust export demand is likely to support strong volumes. However, higher industry run rates are expected to result in break-even ethanol EBITDA margins. For the full-year, we expect lower carbohydrate solution segment operating profit relative to the prior year period, as strong volumes and margins in North America expected to be more than offset by margin moderation in EMEA and ethanol. For the year, we anticipate ethanol EBITDA margins to be in the range of $0.05 to $0.10, down approximately $0.10 at the midpoint compared to the prior year. We expect insurance recovery of approximately $10 million compared to the insurance recovery of $84 million in 2024. In nutrition, we expect first quarter operating profit to be down 50% compared to the prior year period. We expect to face higher raw material costs and negative impacts associated with continued downtime at Decatur East. We also expect lower demand for plant based protein, higher insurance costs and increased competition in texturants to drive lower margins in the segment. Notably, excluding the effects of $46 million of insurance proceeds we received in the fourth quarter of 2024, we expect Nutrition operating profit to be approximately flat sequentially in the first quarter. For the full-year, we anticipate Nutrition operating profit to be higher compared to the prior year with low to mid-single-digit revenue growth led by our Flavors business. Strong performance from recent acquisitions and improved supply chain execution is expected to support increased volume and an improvement in cost in human nutrition, helping to offset the headwinds associated with the ramp-up of operations at Decatur East. In animal nutrition, we anticipate continued mix benefits from cost optimization actions as well as an improvement in profitability of our Pet business. We expect insurance recovery of approximately $25 million compared to insurance recovery of $71 million in 2024. Now looking at the consolidated outlook on slide 13, earlier today, we announced that we expect adjusted earnings per share to be between $4 to $4.75 per share. In considering this range, it is important to keep in mind the following: We expect lower margins in AS&O and carb sol to create a material headwind. Our focus on improved execution and cost should produce $200 million to $300 million of cost out, which includes the benefit of lower manufacturing and SG&A costs. We expect to reverse the negative take or pay impact in Ag Services from last year. We also anticipate less insurance proceeds in 2025. We currently expect approximately $60 million in 2025, with approximately 60% coming from reinsurance. This is compared to total insurance recoveries of $231 million in 2024 with approximately $133 million coming from reinsurance in 2024. Looking at our other guidance metrics, we anticipate corporate costs to be within the range of $1.7 billion to $1.8 billion. We expect the benefit of cost actions and a decline in net interest expense in corporate to be more than offset by the elevated legal costs and the reversal of performance based reduction in incentive compensation relative to 2024. In other, we expect lower results in ADMIS compared to the prior year due to lower interest rates. We expect capital expenditures to be in the range of $1.5 billion to $1.7 billion and we expect D&A to be approximately $1.2 billion. We expect our effective tax rate to be higher in 2025 in the range of 21% to 23% due to the sunset of the biodiesel tax credit, a shift in geographic mix of earnings and an expansion in the global minimum tax. Lastly, we expect diluted weighted average shares outstanding to be approximately 483 million shares and our leverage ratio to be approximately 2 for the full-year. To conclude, I want to take a moment to thank our ADM colleagues for their focus, adaptability and contributions through the close of 2024. These organizational efforts have been critical in driving progress and meeting challenges head on. As we navigate 2025, our focus will remain on what is within our control. A full commitment to remediating the material weakness and making strides to strengthen our internal controls, driving execution to improve operational performance and lower costs while sustaining functional excellence unlocking additional capital to drive value and position the company for long-term success. These efforts position us in our ability to navigate the current dynamic environment and reinforce our confidence in delivering on our commitment. Before I turn it back to Juan, I wanted to briefly mention a leadership transition we announced last week and that officially will take effect on March 1. Carrie Nichol is joining us as our new Vice President and Chief Accounting Officer. She joined us from Cargill, where she served as Senior Vice President, Chief Accounting Officer and Global Process Leader. I am excited to make this important addition to our leadership team, and I look forward to working with her. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thanks, Monish. I'll briefly close by recapping our focus as we continue the path into 2025. With the uncertainty we've noticed in the external environment, ADM is prioritizing an internal focus on the areas we can best control. While administering this self-help we'll remain agile and ready for opportunities that may present themselves along the way. Our focus on execution and cost management will drive savings to the bottom line while ensuring that we're managing our assets and overall network as effectively as possible. Our focus on strategic simplification will deliver opportunities to optimize our portfolio and organization around those areas that deliver strongest returns and where we are the strongest operators. Our focus on strategic growth will allow us to organically invest in proven winners while also ensuring our business are ready for the future. And our focus on capital discipline will position us to continue the return of cash to shareholders through dividends and selective share repurchases. We are confident that this equation sets ADM up for success in 2025 and ensures we have necessary optionality in both the short and medium term while keeping our eyes on longer term opportunities ahead. With that, we'll take your questions now. Operator, please open the line."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question for today comes from Tom Palmer of Citi. Your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "Good morning, and thanks for the question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Tom."
},
{
"speaker": "Tom Palmer",
"text": "Just on the nutrition segment, I wanted to make sure I understood the expected profit recovery. It implies a pretty big inflection as the year progresses. You noted 1Q has some maybe heightened headwinds. It sounds like at least for the second quarter, I wasn't sure if it was second quarter or for the full-year, the start up at Decatur's noted as a headwind. And then, you've got the insurance headwind, especially in the second-half. So, just trying to understand what really drives that inflection. Is it the belief that end markets get better? Is this cost savings plan maybe more concentrated in this part of the business? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Tom, for the question. Listen, nutrition has a big self-help story inside themselves as we have in ADM of course. But I think the main issue for Nutrition is you need to think about like three different buckets. There is one bucket that is the Decaturist plant, which is Specialty Ingredients, that is a big headwind and until we can bring the plant back that will continue to be. So, that is going to happen in the first quarter. Hopefully the plant will be back in the second quarter we expect, and that will naturally bring an improvement to the results. The other bucket is a bucket that it continues to go very well, which is, if you think about flavors and if you think about biotics, those businesses are going very well. They are growing. They have grown 7% and 10% respectively in revenue in 2024. So that's going to continue and that's basically execution of their pipeline, and their pipeline is very robust and very good. And I would say, the third bucket is you have this steady improvement month-over-month, quarter-after-quarter of animal nutrition, which is not a revenue story, but it's a margin improvement story. So, you have three different things, and when you put them altogether, we see a strong recovery in the last-half of the year for nutrition."
},
{
"speaker": "Monish Patolawala",
"text": "Tom, just to add, and I know you already picked it up, but just for math, when you look at it sequentially, so you're right, Q1 starts softer. Sequentially, after adjusting for the insurance recovery, which we have $46 million, we expect those results to be pretty much in line, Q1 equals Q4. And as Juan mentioned, the manufacturing cost, all the self-help starts kicking in, in the second quarter to fourth quarter."
},
{
"speaker": "Tom Palmer",
"text": "Understood. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Andrew Strelzik of BMO. Your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "Hey, good morning. Thanks for taking the question. I wanted to ask now that we've got the -- hey, how are you? I wanted to ask about your view on vegetable oil demand, soybean oil demand in particular. Now that we have the 45Z guidance kind of behind us to a certain extent and the imported UCO that's not going to qualify for tax credits. In kind of your first-half, back-half, a summary there slide, you gave what I would say is a reasonably constructive outlook for vegetable oil demanded. So I guess, I'm just curious for how you think about the puts and the takes around that because I know there's a lot of concern in the market. And then, kind of subsequent to that, as you think about all the uncertainty that's impacting the first quarter, is there a way to think about kind of the first-half, back half, earnings split relative to what is typical for you guys? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Andrew. A lot to unpack there, so yes, we received guidance from 45Z in January and I think it was constructive, but it's still a lot is in the air. We still need to get finalized that guidance. Probably, it's not going to happen until the end of Q1 and by that time we might have sold already Q2. So we have to see how that evolves. So we have to be cautious with that. On the other hand, when you do the math that probably implies an extra maybe 0.5 million tons of oil demand by Yuko that's not going to qualify for this. Our team anticipates that soybean oil share will be up from 35% to 40% and maybe Yuko down from 20% to 14%. So, I think that this is a year in which right now the Ag Services and Oilseeds Industry is trying to digest this extra capacity, if you will, extra production because we have North America, we have Brazil and we have Argentina producing -- crushing a lot and also this big uncertainty not only on tariffs for imported products, but also the policy uncertainty around biofuels. We think that as these policy uncertainties start to clear through the year, we're going to see margins improving and you can see that in the current in the market for crush going forward. We are excited about the manufacturing improvements we're going to have and we are excited about the fundamental demand that when these clouds of uncertainty regulatory will clear, you will see that the livestock area is very strong and soybean meal continues to be the most beneficial feeding material, so that's maximizing the rations at the moment. So, USDA is thinking meal growth probably 5.5%, maybe we have even some upside to that number potentially. And then you have this area of all the mandates that are coming around the world. I think Monish referred before in his previous remark about SAF in Europe, but also it's Indonesia, also it's Brazil increasing their biofuels mandate. So and when we clear 45Z, we're going to have that extra demand from the U.S. So, we see a first-half, second-half different pattern than other years and very hard to quantify what else on one and the other, because it will depend more on government and clarifying the regulatory environment, which we can only adjust to, but we cannot manage."
},
{
"speaker": "Andrew Strelzik",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"text": "Perfect. Thank you very much and good morning. Just wanted to follow-up on your guidance cadence for Ag Service and Oilseeds, similar to what Tom had on Nutrition. But as we look at it, obviously, Q1 is very tough comp and you already indicated that to be 50% down. But then in order to get to just slightly below 25 levels as your guidance indicates, that would mean that 2Q onwards; we should see improving trends on a year-over-year basis. And I just would like to understand if you can help us reconcile that with lower insurance proceeds, but then at the same time you assume canola and soybean crush to be lower for the year? So, I just wanted to understand what is else in there that helps us to get those profits in line to below versus '24 with such a tough start in 1Q?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, I think the -- then -- part of the tough start in the Q is because although you see some canola margins maybe rebounded recently, when we put our book, we put our book at lower numbers, because we put itthere in Q4. So, maybe our Q1 is even lower than maybe what current conditions may indicate. When we think about crush margins approximately around $40 in Q1, we are expecting full-year crush margins in the range of $45 to $55 per ton for soy. That's about $5 lower than the average of last year, and canola $50 to %70 that's probably 20 bucks lower than last year. And again, you have to include here all the improvements that we expected in manufacturing for the business. If you recall, last year we were doing a lot of project automation and digitization in the carb solutions area. And I mentioned before that we have run an experiment with the oil seed plant in Brazil. And now, we have the result of that experiment. And we are bringing some of those learning. So, we expect a lot of self-help coming to Ag services and oil seed. And we also expect destination marketing to grow our internal -- our direct farming procurements also to improve or to grow this year. So, -- and as I said, mill is going to be strong. And soybean oil should become significantly better in the second-half of the year so."
},
{
"speaker": "Monish Patolawala",
"text": "And Ben, I would add to Juan's comments. Just when you think about RPO or biofuels and what clarity that gets. That should allow the second-half to be far stronger than the first-half. And Juan already mentioned, when you look at the forward curve that carries is pretty strong in the second-half. And we are open for business quite a lot in the second-half. So, hopefully, we are positioned to take advantage--"
},
{
"speaker": "Juan Luciano",
"text": "To capture that, yes."
},
{
"speaker": "Monish Patolawala",
"text": "To capture as that goes, so, all that put together, why you start pretty soft in Q1. And then, you move yourself up. But you're right. It's a second-half story. And that's what we'll have to watch. Multiple factors -- as you're watching, we are watching the same. Whether it's weather whether it is the crop yields et cetera. So, as we know more, we'll keep you posted. But that's how we see it right now."
},
{
"speaker": "Juan Luciano",
"text": "One of the things also, Ben, as I forgot is we don't have the negative takeoff pace that we had last year in Brazil. So, we don't expect them this year. So, that would be a positive also for this year."
},
{
"speaker": "Ben Theurer",
"text": "Okay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"text": "Morning. Thanks for the question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Heather."
},
{
"speaker": "Heather Jones",
"text": "I wanted to ask I -- good morning. Just wanted to first of all clarify that your guidance doesn't include any expected impact from tariffs, and then secondly, even if it doesn't include it, if you could just flesh out how that would look for you guys? How you have to be thinking about the impact from operations, particularly in North America? Thanks."
},
{
"speaker": "Juan Luciano",
"text": ""
},
{
"speaker": "a",
"text": "The China retaliatory measures doesn't include agricultural products at this point in time. So, it's difficult to know. I think in the short term, our teams are making sure that they are doing everything possible to avoid the short-term impact. I think medium-term and long-term trade flows seem to stabilize. But of course, we saw in 2018 how the corn imports from China were reduced by almost like 9 million tons from the U.S. Whether that's going to be something that's going to happen again or not, we'll have to see. Again, when you think about the power of ADM in terms of our origination in so many parts of the world and our destination marketing in so many parts of the world, it provides an optionality that few companies have in order to be able to capitalize on any environment. We don't know if net-net it will be a positive or a negative, but we will go through as we went in 2018."
},
{
"speaker": "Heather Jones",
"text": "Thanks so much."
},
{
"speaker": "Juan Luciano",
"text": "You're welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"text": "Hey, good morning, and thank you for taking my question. I wanted to come back to Argentina and their recent export tax revision across the soy crush complex, and if you could just briefly, I guess, talk about how you think that's going to impact your businesses and then how maybe you see that policy evolving after turn because I think that's kind of when they had framed the current revision period for. So, thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you for the question, Steven. So, let me -- this policy was implemented, as you said, effective until June 30. Very difficult what's going to happen after that, because it depends more on microeconomics of Argentina, so it will depend on many, many factors. I would say, until then, we haven't seen a big impact yet, mostly because they are still going through the harvest and through the planting. Second, because and I'm a farmer in Argentina, we're all worried about the weather in Argentina and the crop in certain places doesn't look terrific. We need rains that are expected to come, but those rains may just stabilize the yields but not being able to turn around that. And then, there are details about the implementation of this regulation that we need to be observing. Before all this, you needed to bring the dollars into Argentina 30 days after your shipment. Right now, if you want to qualify for this reduction in exports, you need to commit that you're going to bring the dollars of 95% of all the amount within 15 days of issuing the license. So, before you have 30 days from shipment, now you have to bring the money 15 days after you get the export license. So that's a big financing change in the thing that I don't know how it's going to impact. So we will have to see in April with the farmer's seeds on top of their harvest and they have from April to May to June to be able to play this how much it's going to be. At this point in time, we haven't felt much."
},
{
"speaker": "Steven Haynes",
"text": "Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Welcome."
},
{
"speaker": "Operator",
"text": "Our next question comes from Pooran Sharma of Stephens. Your line is now open. Please go ahead."
},
{
"speaker": "Pooran Sharma",
"text": "Great. Thanks for the question. I wanted to see if we could unpack 45Z guidance a little bit. I know there's been, the situation's fluid. Biden provided interim guidance, but I think there's a little bit left with final guidance. To my understanding, the biofuels industry with interim guidance is able to accrue tax credits, but I think you need final guidance to have them paid out. So we've seen some smaller operators already seize shutter production. We just weren't sure about the larger producers. So I wanted to kind of get your take on 45Z guidance and then the State of the Union on the biofuels industry."
},
{
"speaker": "Juan Luciano",
"text": "Yes, let's see if I can provide some clarity to that. First of all, this is preliminary guidance and of course it needs to be ratified after the comment period and then we need to see what the Trump administration will decide on this. So this still needs to be played out. I would say with the removal the blenders tax credit, margins have been significantly impacted. And so, you may see some small producers that in the absence of all these, when they are not integrated and are isolated plants, they have shut down. We were expecting to do that. Our integrated facilities, all our facilities are integrated, have allowed us to continue to operate, although we see the impact in Q1 margins that we're going to have as we have Q4 margins. So the industry definitely needs to bring some margin back into it. More importantly, we need to bring clarity because lack of clarity has pulled people off the market. What we know is the administration of President Trump strongly supports the farmers and having an output for the farmers' production. And I think that in that sense, a strong biofuel policy, a strong export policy, a strong bio-solutions type of product are all going to be very supportive."
},
{
"speaker": "Pooran Sharma",
"text": "Great. I appreciate the color."
},
{
"speaker": "Juan Luciano",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Manav Gupta of UBS. The line is now open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"text": "Good morning. I'm sorry I dropped off briefly. So if somebody has already asked this, I apologize. But Monish, your key priorities when you took over, your focus was one on operational rigor and second, ensuring there are no material weakness in financial reporting, and what's the progress been on those two fronts? Thank you."
},
{
"speaker": "Monish Patolawala",
"text": "Yes, thank you, Manav. I would say on both, and I'll start with the material weakness. As I said at the end of my prepared remarks, that is one item that we are very heavily focused on, which I am focused on. And the progress on that, and I'll start by just saying, when we talked to you three call, and you had asked the question, I said the company had enhanced the design and controls and documentation of inter-segment sales. So we have continued to do that this quarter. We have continued to provide a lot of training to our personnel around the reporting and recognition of inter-segment sales. We have enhanced and tested a lot of controls, and we need to continue to make sure that is sustained for a period of time before we can lift the material weakness. And that's what the teams are focused on. We also made an announcement where we've got Carrie Nichol who's joining us, the Chief Accounting Officer, who was from a similar role in Cargill. And I'm excited to have her on board and my partner to help me continue this journey that we have started on remediating our material weakness. To answer your question on operating rigor, you can see that we've made progress. In Juan's comments, you can hear that some of the items where we have done root cause in our manufacturing facilities have given yielded results. In December, we saw good outputs in some of our plants in North America. We also saw progress in EMEA, in our flavors business, in nutrition. And as a part of that whole thing, Manav, and as we look at the opportunities, Juan and I announced that we have a plan to get $500 million to $750 million of cost out over the next three to five years. It's going to come from multiple places. Number one is driving efficiencies in our manufacturing facilities. Number two is going after costs with our third parties. And number three is controlling SG&A and some of the actions we're going to take there. Adding on to that on the other side is the simplification agenda. So as we continue to drive portfolio simplification, we see an opportunity to continue to drive margin enhancement in there too. At some of these facilities, whether you talk about consolidations or targeted divestiture, should allow us also benefit in there. We are going to do all of this while at the same time battling a lot more around the inflationary environment, whether it's the energy complex, as well as labor inflation or general inflation that continues to stay. So, focused on it, Juan said it, I've said it, it's a big self-help agenda. We know the environment that we are going into 2025. And I think the team is quite confident that we can execute this cost-out plan that we have got over the next three to five years."
},
{
"speaker": "Manav Gupta",
"text": "Thank you so much for the update."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "Yes, thank you very much. I want to go back to nutrition specifically for Q4. So your commentary was pretty positive in that human nutrition had higher volume and pricing versus last year. But if we adjust for last year's write-down, I think you would have made 39 million human nutrition, whereas this year without the insurance, you would have made only 15 million. So it looks like the performance even with M&A was quite worse, so I cannot reconcile the two. Can you provide a little bit more color on why margins were so lower and perhaps quantify the impact of this contract cancellation in Q4?"
},
{
"speaker": "Monish Patolawala",
"text": "Yes, I think when you look at it, yes, we've made progress on the growth in human nutrition, but the biggest piece that still continues to be a headwind is the specialty ingredients business. When you look at the continued inefficiencies from the downtime at Decatur East, the higher insurance premiums that we are seeing, as well as the lower pricing for texturants and demand, all put together is where we landed up for the fourth quarter. And going into 2025, we look at the same and say, when you look at Q1 and we say it's sequentially flat when you adjust for the insurance proceeds, the biggest driver there again on a year-over-year basis is the specialty ingredients. And so getting that plant back online in Q2 2025 and then doing all the self-help actions that Ian and his team are doing in nutrition will help us continue to grow nutrition's P&L in 2025."
},
{
"speaker": "Salvator Tiano",
"text": "Thank you. Just to understand though here, the fire indicator happened I think August or September last year, meaning that you should have lapsed, at least in my understanding, you should have lapsed the inefficiencies and the problems already in Q4. So that shouldn't have been an issue versus Q4 of '24 or it shouldn't be an issue in Q1 '25 versus what you posted this year?"
},
{
"speaker": "Monish Patolawala",
"text": "Well, we had inventory going into Q4 of '23, and that allowed to reduce some of the impact that was there on a year-over-year basis. But also prices and the kind of tech spend that have come down, yes."
},
{
"speaker": "Salvator Tiano",
"text": "Okay, perfect. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Due to time, we'll take no further questions, so I'll hand back to Megan Britt for any further remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you so much for joining the call today. If you have additional questions, please feel free to reach out directly to me. Have a wonderful rest of your day."
},
{
"speaker": "Operator",
"text": "Thank you all for joining today's call. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 3 | 2,024 | 2024-12-03 09:00:00 | Operator: Good morning and welcome to ADM's Third Quarter 2024 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, this conference call is being recorded. I’d now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Hello and welcome to the third quarter earnings call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the investor relations sections of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. To the extent permitted by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available on our earnings press release and presentation slides, which can be found in the investor relations section of the ADM website. Please turn to slide four. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan. Hello and welcome to all who have joined the call. We sincerely appreciate your patience as we work expeditiously to amend the company's fiscal year 2023 Form 10-K and Form 10-Qs for the first and second quarters of 2024. We are pleased to now be able to share more context about our 2024 year-to-date financial results and our outlook. Even that we are holding this call later than usual, we're also in a position to provide qualitative color on how the fourth quarter is progressing. To start, let's recap our financial results for the company. ADM reported third quarter adjusted earnings per share of $1.09 and a total segment operating profit of $1 billion. This brings adjusted earnings per share to $3.61 and our total segment operating profit to $3.2 billion year-to-date for 2024. Our trailing four-quarter adjusted ROIC was 8.8%. Although we made progress on several important initiatives in 2024, this results are not consistent with the high bar that we have set for our team. While we have seen a decline in our total segment operating profit and a decline in operating cash flow before working capital changes, due to lower net earnings relative to the prior year period, discipline management of our balance sheet continues to allow us to invest in our business and return cash to shareholders. In total, we have returned $3.1 billion to our shareholders with $744 million in the form of dividends and $2.3 billion in share repurchases year-to-date in 2024. Next slide, please. Entering 2024, we laid out key priorities for value creation based on the year we saw ahead of us. And as we moved into the fourth quarter, it's clear that certain expectations have not all play out as anticipated. The global commodity landscape has continued to shift. Stronger-than-expected supply has driven commodity prices down further than anticipated. Canola crash margins have been negatively impacted by regulatory uncertainty and higher seed prices. In addition, China has begun to increase local commodity production and has had a slower pace of demand recovery, negatively impacting the trade of certain commodities and uptake of animal nutrition solutions. We're also seeing the trailing effects of inflation in part of our business. Some new nutrition projects have been delayed as some customers look for opportunities to manage costs by simplifying their consumer offerings. We have also seen some softness in demand in other end markets such as pet treats and energy drinks where consumers are prioritizing their discretionary spending. The global regulatory environment has led to additional uncertainties. Programs such as EUDR and the U.S. producers tax credit are still not fully in place, which has left various stakeholders in the Ag supply-chain without the confidence of a clear path forward. Beyond these external factors creating downward pressure, we're also managing through a balance of both positive and challenging results across our own operational environment. In carbohydrate solutions, we've been able to improve production throughout the network, in part due to advancements in automation and digitization at the plant level, as well as by finding synergies across our milling network. We've seen similar improvements in our crush facilities in LatAm and EMEA, but this has been offset today by the fact that opportunities previously identified in some of our U.S. plants have been taking longer-than-expected to be completed. However, in October, we began to see improvements in unplanned downtime in our U.S. facilities. Nutrition has continued to manage through the downtime of our Decatur East facility, where our expected ramp up has been delayed from the end of 2024 to the first quarter of 2025 as safe restoration of operations is a top priority. And while the integration of our most recent Flavor acquisitions has driven positive results, we have experienced demand fulfillment issues due to the complexity of other integration efforts. We believe that our business is well-positioned to grow alongside enduring global trends such as the expansion of functional food and beverage alternatives, the replacement of petroleum-based products across multiple industries and the broader opportunity associated with decarbonization. As we look at the near-term in 2025, however, we anticipate that we could still be managing through a challenging cycle, and we have already begun taking necessary productivity actions with a clear focus on cost and cash management. This slide highlights several of the areas we have already taken action on in 2024, along with additional actions we are aggressively driving at the end of the year. As we manage through the current cycle, we've seen success in delivering expansion across strategic initiatives such as regen ag, BioSolutions and destination marketing, which achieved record volume handled in October, supporting supply and demand needs through increasing capacity. This is example in our Spiritwood facility, which has achieved near full run-rates in the month of October. And in ramping up the drive for execution excellence program, which has already begun to deliver toward our cost-saving goals. Moving forward, as we expand our focus on procurement and execution excellence, we believe that we can double this program's target cost savings over the next few years. In addition, the automation and digitization efforts that have already achieved millions in cost savings are being scoped and accelerated across the other plants in our footprint. Turning to Nutrition's recovery efforts. To-date we have strengthened our operational leadership, driven simplification and optimization opportunities and continued to expand our pipeline and win rates in part of the portfolio such as flavors. These efforts are now being supplemented to increase the pace of recovery. We have placed additional focus on demand generation, supply-chain improvement and rightsizing our production to better flex to the needs of the dynamic demand environment. And finally, from a strategic capital allocation perspective, we have already accelerated our return of cash to shareholders this year in the form of share repurchases and dividends. Going forward, we're being extremely prudent on focusing our attention on cash generation opportunities, while considering specific portfolio optimization efforts to simplify operations, enhance our focus and drive an improvement in ROIC. Along with all these actions, Monish joining as CFO has already brought new perspectives to the team. We are using his experience to help identify and accelerate paths for continuous recovery. With this, let me pass to Monish for a more detailed financial review. Monish?
Monish Patolawala: Thank you, Juan. First, I would like to take a moment to say how excited I am to be joining the ADM team at such an important point in the company's trajectory. While I've only been on the job for a few months, I have enjoyed the opportunity to personally engage with our teams and learn the company. I want to thank all my ADM colleagues for their warm welcome. Turning to Slide 6. On a year-to-date basis, AS&O segment operating profit of $1.8 billion was 42% lower versus the prior year period as ample supplies out of South America have driven lower commodity prices and margins across the segment. Ag services sub-segment operating profit of $461 was 52% lower versus the prior year, driven by lower South American origination margins and volumes, in part due to industry take-or-pay contracts. The stabilization of trade flows has also led to fewer opportunities in our global trade business, leading to lower results. Crushing sub-segment operating profit of $632 million was 30% lower versus the prior year period. Slower farmer selling and lower crush rates in Argentina, coupled with solid demand has supported soy crush margins leading to a year-to-date executed soy crush margin of approximately $50 per metric ton, which is lower, compared to the prior year. While year-to-date executed canola crush margins are lower by approximately $15 per ton, compared to the prior year, margins have moderated significantly in the second-half of the year so far, as higher seed prices and regulatory uncertainty drove lower margins. There were net negative timing impacts of approximately $120 million year-over-year. In the refined products and other sub segment, increased pre-treatment capacity at renewable diesel facilities and higher imports of used cooking oil has negatively impacted both refining and biodiesel margins, leading to sub-segment operating profit that was 58% lower versus the prior year. There were net negative timing impacts of approximately $360 million year-over-year. As we look forward, we anticipate AS&O fourth quarter results to be lower than the prior year quarter. The seasonal shift to our North American weighted footprint and strong North American crop should be supportive of volumes. But recent elevation margins are below the levels we expected when we put our guidance in place in November. In crushing, the ramp-up of our Spiritwood facility is expected to support high-single-digit volume improvement. However, we expect lower results due to lower soya and canola crush margins versus the prior year. The addition of new pre-treatment capacity has continued to weigh on margins within the RPO business and on the food oil side, margins for free-to-sell opportunities have been under pressure, due to increased competition. Based on the information available today, we also anticipate 100% reinsurance proceeds of approximately $50 million in the fourth quarter related to both Decatur West and East. We continue to monitor the impact of uncertainty related to regulation and trade flows on the operating environment as we look forward to the end of the year. Year-to-date, carbohydrate solutions segment operating profit of $1.1 billion in the year-to-date period was roughly in line with the prior year as lower margins in the EMEA region and ethanol were mostly offset by strong volumes and improved manufacturing costs. As we look forward, a strong North American corn supply and robust export demand is export expected to be supportive of VCP. However, North American ethanol production continues to outpace demand, driving lower margins. We expect to see solid demand and margins in North American starches and sweeteners as we finish the year. Wheat milling margins are expected to moderate from elevated prior-year levels. Based on information available today, we also anticipate 100% reinsured insurance proceeds in the fourth quarter related to both Decatur East and West incident of approximately $35 million. Taken together, we anticipate the carbohydrate solutions fourth quarter results to be in line with the prior year period. Year-to-date, revenues from nutrition were $5.6 billion, up 2%, compared to the prior year. On an organic basis, segment revenue was down 3%. Human nutrition was flat organically as headwinds related to Decatur East and texturants pricing offset growth in flavors and health and wellness. Animal nutrition revenue declined 5%, driven by unfavorable mix, negative currency impacts in Brazil and low volumes due to demand fulfillment challenges. Year-to-date nutrition sub-segment operating profit of $298 million was 32% lower versus the prior year. Human nutrition results of $265 million were 40% lower, compared to the prior year period, primarily driven by unplanned downtime at Decatur East. Animal nutrition results of $33 million were slightly higher, compared to the prior year, due to an improvement in margins. As we finish the year, we expect continued weak consumer demand, lower texturants prices and ongoing operational challenges to be a headwind. And as Juan previously mentioned, we now anticipate the start-up of our Decatur East facility to be delayed until the first quarter of 2025. We expect the impact of prolonged downtime at Decatur East to be partially offset by 100% reinsurance proceeds in the fourth quarter of approximately $50 million based on the information available today. We expect animal nutrition results in the fourth quarter to be better than the prior year with tailwinds from our turnaround efforts and as we continue to work through operational challenges in pet solutions. Taken together, we expect nutrition results for the fourth quarter likely lower than the third quarter of 2024, but to be higher than the prior year, which had negative impact of approximately $64 million in non-recurring items. Please turn to slide seven. Year-to-date in 2024 the company has generated cash flow from operations before working capital of approximately $2.3 billion, down relative to the same period last year, due to lower segment operating profit. Despite the decline, solid cash generation has supported our ability to invest in our business and return excess cash to shareholders. Year-to-date, the company has returned $3.1 billion in cash in the form of dividends and share repurchases. Allocated $1.1 billion to capital expenditures and nearly $1 billion to M&A announced in 2023 and completed in January 2024. Our capital structure continues to provide the financial flexibility to invest in our business and return capital to shareholders. We continue to see opportunities to drive enhanced cash generation through operating improvements both in our facilities and through better management of working capital. We believe investing in organic opportunities gives us the best return. While we will always look at opportunistic M&A as a way to enhance return, it is essential that we prioritize maximizing returns from the assets that we have already acquired and also ensuring that we are the best owners of all our assets. Now let's transition to a discussion of guidance for 2024 on slide eight. In early November, we announced that we lowered our full-year 2024 adjusted earnings per share guidance to the range of $4.50 per share to $5 per share. The lowering of our guide takes into account our year-to-date results and headwinds from slow market demand and internal operational challenges. Additionally, we now anticipate our corporate cost to be within the range of $1.7 billion to $1.8 billion, primarily due to lower incentive compensation and our corporate net interest expense to be in the range of $475 million to $525 million. We now expect capital expenditures to be approximately $1.5 billion. We are also increasing our effective tax-rate guidance to the range of 20% to 22%, due to the non-deductible impairment of Wilmar taken in the third quarter. Our expectations for our leverage ratio and D&A are unchanged. Let's turn to slide nine to close the call with a reflection on the key priorities that we are driving with our team to deliver improvement and enhance return. First, my top priority is ensuring integrity and accuracy in our internal controls and financial reporting. I echo Juan's earlier statement and add my particular thanks for the extraordinary efforts of our team to amend and file the restated financials for fiscal year 2023 Form 10-K and Form 10-Qs for the first and second quarters of 2024. We are continuing to focus on implementing enhancements to our internal controls to remediate the previously identified material weakness and are taking action to enhance the integrity and accuracy within internal controls and financial reporting related to intersegment sales. Among other things, the design and documentation of the execution of pricing and measurement and reporting controls for segment disclosure purposes and projected financial information used in impairment analysis have been enhanced and the testing of these controls will continue throughout the balance of the year. Further, training for relevant personnel on the measurement of intersegment sales and application of relevant accounting guidance to intersegment sales has been provided and remains ongoing. In the broader category of improving focus and execution, the team will remain adaptable and focus on items within our control. On the cost side, we are optimizing our cost structure and enhancing operational resilience initiatives. In this vein, we have the opportunity to create a more cohesive digital strategy. Today, we have invested in numerous efforts to improve our systems and enable a more digital footing for our business. However, we have the opportunity to connect these efforts to accelerate outcomes around how we serve our customers, operate our assets and run the enterprise, while also delivering structural cost improvement. Similarly, we have room in our portfolio and broader asset network to optimize through targeted divestitures or rationalization and we are evaluating numerous actions that we could take to improve our footprint performance and generate cash. We will also maintain a sharp focus on working capital management to further strengthen our cash position. Lastly, we'll remain disciplined in capital allocation, seeking opportunities to drive ROIC and enhance returns. I see maintaining our capital discipline as essential to value creation. We will work to ensure that we maintain a healthy balance sheet that continues to create strong cash flow and that we rigor investment opportunities appropriately by applying a stage-gated model to ensure that we are achieving key milestones and meeting our return objectives to continue to invest. In closing, I want to take a moment to thank our ADM colleagues for their hard work and dedication this quarter. I am optimistic that today we can successfully tackle the challenges and seize the opportunities as we continue to execute our strategy and focus on delivering value for our shareholders. With that, we look forward to taking your questions. Operator, please open the line for our first question.
Operator: Thank you. [Operator Instructions] First question comes from Andrew Strelzik with BMO. Your line is open. Please go ahead.
Andrew Strelzik: Hey, good morning. Thanks for taking the questions and I appreciate all the color you gave on the outlook and the strategy. I was hoping that you could help reconcile the decline in U.S. crush margins over the last several weeks. You have now a U.S. crush margin curve that's much lower in the nearby than in the spring, which is abnormal. You have soybean meal delivery certificates issued last week by some of the commercials, which I also believe is abnormal. So I guess the question is, what does all of this tell us about where crush margins are headed and how much visibility do you have on crush into next year compared to what you would typically have for this time of year? Thanks.
Juan Luciano: Yes. Thank you, Andrew. As you said, board crash rallied steadily from the lows in Q3, but has come under pressure in November. And it's basically a combination of things. First of all, demand for the products have been very good. Demand for meal is good, demand for oil around the world is good. But you see during November, we have the Argentine farmers started to sell again. So we've seen higher crush rates in Argentina. There are high crush rates in Brazil and NOPA here in North America, all our plants have been running well, so we have high crush in October. When you combine that with the regulatory uncertainty now we have in the oil side, that has created the problems that we have. The U.S. is exporting oil, the U.S. is exporting mill, but there is more pressure in the system with more crush being put and less regulatory clarity. So that's why overall message, Andrew, is as we look forward here, we think that given the soft markets and the regulatory uncertainty, our focus in ADM is on the things that we can control on the double down on productivity, looking at all our efforts in trying to control cost and cash and certainly portfolio management. So that's kind of our priority for the year. The markets remain robust. Soybean meal is the most competitive feed out there. So demand is strong and oil is needed for the biofuels market and oil is needed for human consumption. So I think that when we clear the regulatory environment or regulatory uncertainty, if you will, I think you're going to see things normalizing a bit.
Andrew Strelzik: Okay. And sorry, if I could just quickly follow up. Given all of the internal actions that you guys are focused on as you kind of navigate the cycle, and if I were to kind of exclude some of the insurance dynamics from this year and maybe from next year as well, do you think that this is kind of an earnings base from which you would expect those actions to drive earnings growth in 2025 or do you think about it as still kind of navigating through kind of a muddled environment as we get through the regulatory dynamics, how do you think about kind of this year and actions that you're taking in the ability to grow in '25? Thanks.
Juan Luciano: Yes. I think it's important never to lose an opportunity to get yourself extra feet. So we are taking this decline in margins as an opportunity to review everything from ADM and accelerate all the decisions that were already ongoing. So I will, you know it's too early in the year. There are too many unknowns, Andrew, to especially on the regulatory front to make a forecast for the year. But we know that focusing on the things we can control continue to drive cash flows, that's an important thing for our shareholders and that will improve returns.
Monish Patolawala: Andrew, I echo what Juan just said, it's back to the basics of cash cost and capital. And that's what we are focused on right now. Lot of opportunities head-down, get 2024 closed and we'll come back when we're ready to discuss 2025. But we know the environment is going to be soft and that's why the teams are controlling what they control.
Operator: Our next question comes from Tom Palmer with Citi. Your line is open. Please go ahead.
Tom Palmer: Good morning. Thanks for the question. I just wanted to enquire on the nutrition side of the business. We've seen some changes in terms of the animal nutrition business, I think from a cost-savings standpoint that's driven some improved profitability. What about on the human nutrition side? Is there just given some of the end-markets maybe haven't progressed the way you once anticipated thought to kind of resizing that business? And maybe how much of an opportunity might that be as we think about the coming year? Thanks.
Juan Luciano: Yes, thank you, Tom, for the question. Listen, I think I will take it by pieces. If you take human nutrition, you have to separate. We have a big issue with the plant that is down. That plant is a significant cost. It was down for a full-year, now it's going to be down for the first quarter. And so that's an issue that is a little bit of extraordinary that we're fixing, and we thank all the engineers and everybody working expeditiously to bring it back safe. On the rest of the business is the flavors business and the health and wellness business, we continue to see opportunities. We've seen in the positive side, if you will, we've seen growth of flavors -- revenue flavors in Europe of about 7% like-for-like, so organic growth year-to-date. We have seen 5% in North America. These are not the growth rate that we were expected when we started the year because there has been some categories like energy drinks where although still growing, is growing at less -- at lower rates than we expected at the beginning of the year and our customers have expected at the beginning of the year. Some launches has been postponed, but still is a robust category and we still see growth. But as you said, we are adjusting a little bit our supply-chain to make sure we match the new realities. When you look at the other piece of human nutrition, which is health and wellness, the probiotics part, which is the part there that is the future, it is the growth part has grown so far 14% year-over-year on a revenue side, and even higher than that in operating profit side. So I think that there are good signs, but we continue to flex this. This is a year in which, as you understand, nutrition is not where we want them to be, and we are working hard to fix it. But there are on the customer side, there are positive signs that makes us believe that when we put some of these supply issues behind, we're going to see the results coming to the P&L in a bigger way.
Tom Palmer: Okay. Thank you. And just on the capital allocation, it sounds like there was some mention in the prepared remarks of maybe some focus on discipline, but there was also some commentary maybe on the crush side about some unexpected downtime. Is there may be an elevated maintenance CapEx cycle needed in the crush operation to kind of get it to the operational levels that you desire? And if so, might we expect maybe less of a step-down in CapEx next year just given that or maybe I'm overstating it? A - Juan Luciano No, listen, CapEx for next year will be solid CapEx, if you will. We have many plants, we have grown the company and we need to make sure those plants stay in good shape. But also there are opportunities for automation and digitization that we are adding to that. If you look at the oilseeds plants, Europe and Latin America have been operating very, very well. We have a handful of plants in North America that have given us problems over the summer, and I'm happy to report that they are doing better in October, they are doing better in November. But we have some issues that took a little bit longer to fix than we thought and we put the resources to do so.
Operator: Our next question comes from Ben Theurer with Barclays. Your line is open. Please go ahead.
Ben Theurer: Yes, good morning, and thanks for taking question. Good morning. So just wanted to like kind of get a little bit maybe your sensitivities around the implied guidance for the fourth quarter and taking a little bit of an advantage that we're early in December and already two months have gone past. Clearly, if we look at it implied low-end versus high-end, it's very widespread? So maybe help us understand and frame a little bit what are the risks getting closer to the lower end, which would be implied a little less than $1 versus the higher piece closer to $140, just to kind of understand where we're shaking out and where you think things are going out considering that two months are in?
Juan Luciano: Yes. Thank you, Ben. So let me give you the puts and takes for the quarter and you can build it from there. I think in -- if you think about the grain business ag services, of course, this is the quarter in which the volumes come to North America for exports. And we see good volumes. China is buying for Q4, beans, Europe is buying corn for Q1. But we have -- although we have good volumes, we have not seen the margin expansion that maybe we have forecasted a couple of quarters or a couple of months ago. River logistics are good for December. We will have to monitor the weather for Q1, but so far so good. And calories in the market should help our interior assets. On a global trade perspective, volumes are strong and lower commodity prices are supporting feeding animals globally. So destination marketing margins are holding. On the crush side, I described before the decline in crush margins, you know, a lot of uncertainty about biofuels policy, of course. This margin compression could create timing depending on where prices are at the end of the year, we could see positive timing. So we will not be able to call that until we see the end of December. We have been selling our biodiesel book, but of course, it goes out to December. Unfortunately, with the lack of clarity over next year, you know, you could think that if we continue to crush at these levels, maybe oil inventories will climb and something we'll have to give for next -- for the first quarter. At this point, there is not a lot of margin for independent non-integrated plants to run in the first quarter. So you know, we may see a spike of RINs later in the quarter and we might have to maybe as industry slowdown crash in the first quarter. On a carb solutions perspective, it's kind of steady, if you will. Margins are good, volumes are good, manufacturing is operating well, so we get -- we are cranking on all the cost savings. We have implemented some of the automation projects that's given us benefits to that. So I would say we should see a little bit ethanol margins are always the variable here. They are slightly on the breakeven side. So hopefully, we finish the year strong there. And then on the nutrition side, we certainly, as Monish was saying in the outlook, we've seen improvements in animal nutrition, we've seen a balance of some revenue growth, but also some one-offs that we needed to address in the human side. So I will say better than last year, slightly lower than maybe the previous quarter, and we are putting all our efforts in finishing that plant, so we can have a 2025 cleaner of all those extra costs.
Monish Patolawala: Just a couple more for you Ben is -- can I just add a couple more?
Ben Theurer: Yes, yes.
Monish Patolawala: For insurance proceeds that is a partial settlement right now. If you add the three segments I gave you, in the fourth quarter, there is an assumption that we will get 100% reinsurance proceeds of $135 million. So that's the other variable. And then back on nutrition, what Juan said just for disclosure, currently based on where the team is seeing, we think with M&A, it's low-single-digit growth in the fourth quarter. And on an organic basis, it's low-single-digits negative growth. And so that's the other piece. I just wanted to add to what Juan said. Thank you.
Ben Theurer: And to clarify, those insurance just similar as in the third quarter that will basically then be deducted in other, correct?
Monish Patolawala: No, these are all 100% reinsurance proceeds, Ben. So they will -- so our captive insurance has reinsurance cover. And so we expect to get $135 million as a partial settlement for the Decatur East. And this will continue into '25 and '26 as we -- yes, it's different than 3Q where the captive was paying for it. Now we are expecting reinsurance proceeds.
Ben Theurer: Okay. Perfect. That explains a lot. Thank you.
Operator: We now turn to Heather Jones with Heather Jones Research. Your line is open. Please go ahead.
Heather Jones: Good morning. Thanks for the question.
Juan Luciano: Good morning, Heather.
Heather Jones: So you guys talked -- good morning. So you all have talked a lot about the challenging cycle we're in and as far as looking to '25, but wanted to get a sense of, I mean, what are some things that could be givebacks in '25. So I was just wondering if you could quantify how much take or pay hit you guys in '24? And then the cost impact of all the unplanned downtimes that presumably as you've gotten these plants running better, you should get back that's separate from the crush curve. So I was just wondering if you could first quantify those couple of things for me.
Juan Luciano: Yes, I would say, I'm not sure I have all of them top of my head for the full year, Heather. But let me say the following. I agree with you. I think and on the take or pay, first of all, we learned our lesson. So we're going to act differently, I think as ourselves and you know maybe even the whole industry. I think also the weather in Brazil is very good. So we expect to have probably 170 million tons type of crop next year that will avoid these issues. I will say all these resets in 2025, so we still have very little exposure of our take or pay. But I don't have top of my head what was the whole thing. And then on the manufacturing side, we have issues mostly in the Q3, I would say. Some of the plans when we look at our capacity, when we were down, sometimes it was things like Paraguay because we didn't have margins, so we shut it down ourselves. And then sometimes it was Ukraine or other plants like that. We had a plant in Des Moines, Iowa that we were a little bit waiting for a permit, so we couldn't bring it back. So there are improvements there. I don't know if Monish you have some numbers in your head. I will hesitate to quantify them myself. But...
Monish Patolawala: Yes, so I would just on take or pay, Heather, it's year-to-date, it's approximately $40 million of impact. We'll have to see what 2025 brings and what the volume and what the revised take or pay contracts look like. And then on the downtime, again, it comes down to the teams are focused on trying to get that up. The cost has gone up per cost per ton, but I would not quantify that right now. I would just wait through as we get to, there should be upside as these plants start running, but I would not quantify because it's not like a systemic down of X over months, it's puts and takes of downtime.
Heather Jones: Right.
Juan Luciano: One thing, Heather, that you need to consider, sorry, in the manufacturing is we implemented our automation projects in the carb solutions business first because we run a pilot and it was good return. So we extended that. Now we have finished our first pilot in the oilseeds plant in one plant in Brazil, and the results are very encouraging. Based on those results, we might do the same thing than now that we did in automation in carb solutions into the oilseeds plant. That had given us improvements in not only yields, but also energy savings and you know, ex-same losses and things like that. So there is an upside there as well as we go into -- we're going to implement all of these in -- I think we have 15 projects going into 2025 for this. So I think that you should see that as a positive for us.
Monish Patolawala: And Heather, I would add to Juan's piece on this is everyone looks at downtime and says cycle up or cycle down. What the team is actually doing is a very good lean-based approach. So they're actually going into deep root cause, looking at what equipment caused the failure, why did it caused the failure? Is there a way to automate? Is there a way to digitize? So in the long run, I put this under the pillar of operational excellence. Our factory should continue to run better in the longer term, and we'll put in the right appropriate of CapEx needed to make sure that we can over the long-term have sustained operating leverage from our factories.
Heather Jones: Okay. Thank you. My follow-up is just, do you have an estimate of how much reinsurance proceeds will be in '25 and '26? I think you said it will continue into '26. So just give us a sense of what those just rough numbers, what those numbers will look like?
Monish Patolawala: Yes. So I'll start with just the overall possible loss that is there. And again, this is very preliminary. The teams are still working it through. But we believe Decatur West should be approximately in the $100 million of loss and Decatur East should be in the $300 million to $400 million of loss. We've got $95 million in Q3. We expect to get $135 million, give or take in Q4. We expect that in 2025, we should be somewhere in that $50 million to $100 million range and then and the rest will work over the next. Now all of this is based on information we have right now, all of this is based on still working through with the actuaries, with the insurance companies, et cetera. And our goal is to continue working it and we'll keep you posted as we get to know more, but this is truly based on what we know as of right now.
Operator: We now turn to Manav Gupta with UBS. Your line is open. Please go ahead.
Manav Gupta: My question specifically is to you, Monish. You have been in the seat for some time, but looking at the next 12 months to 24 months, Monish, what are your key priorities? What are you going to be most focused on for the next couple of years to make ADM a stronger company?
Monish Patolawala: Yes. First, Manav, I'll just say, yes, I've been here slightly over 90-days and it's been a blast to be here. It's a fantastic team. I've got a chance to go see some farms, I've got a chance to go see our operations. I've got a chance to go meet the teams in the field and it's a very exciting time to be here. I would tell you on my priorities, as I think about it, as I said in my prepared remarks, my first priority is the integrity and -- of our financial statements and remediating the material weakness. The team has already done a lot of work, but there's a lot more we can do in improving our processes, our internal controls and our systems. And that's what I'm focused in with the IT team and the finance teams to make sure that we have systems that can support all the reporting and all the revised pricing et cetera for intersegment sales. So that's one item. Then I come to the second piece, which is driving cash cost and capital. As Juan mentioned and I have said, there is a lot of opportunity here to control what we control and therefore, we are doubling down on our productivity efforts. And I'm working with the teams on multiple areas that we can simplify our business, reduce our cost, take advantage of our procurement savings as we should be getting into a slightly deflationary environment, while at the same time making sure that we are having functional excellence, which is we are delivering from the center what really the businesses need. So we are following a zero-based approach in certain of our functions. We are looking at all the cost and saying, what are we doing? Do we get the value for it or not. Similarly, when it thinks about capital, you've heard about capital allocation. When you think about CapEx, it's a stage-gate model. So making sure that we are investing in areas because there are tremendous opportunities for investment available to us, but at the same time, making sure that we're getting a return and we're going to follow a stage-gate approach, which means we'll fund you a little bit, we'll see what the return looks like at that point in time. If you hit the milestones, you get the next funding, otherwise, the money goes to somebody else. So create some internal tension to make sure that everyone is fighting for the last dollar of CapEx that's available. Then I go into digital and I think there's tremendous opportunity for you. The Kristy and team who's our CIO has done a really nice job. The company has done a nice job of improving the infrastructure that we have. We still have a long way to go in that, but I feel there's also a chance here to accelerate some of the ability to use data and data analytics to drive business outcomes. So that's another priority of mine. And then I would tell you back to portfolio. The company has always said they will look at portfolio. I've said that too in my prepared remarks in my three-month plus year, I've seen there are opportunities here that we are working on to make sure we simplify our portfolio. And I look at it from a simple lens of do I have a market and do I have a right to win first. And if I do, am I the rightful owner of that asset and what return are we getting. And Juan and I have spent quite some time together on talking about this. He has always been open to portfolio, and we are going to continue working on that. So Manav, I don't know if I answered your question, long answer to your short question, but lot of priorities. And then I'll end with where I started, which is back to the basics. You got to drive cost, cash and capital in this environment where we know that the commodity cycle may not be our best friend. So self-help is truly our best friend and that's what the teams are working on. So hopefully answered your question.
Manav Gupta: No, you absolutely did. My very quick follow-up and this is more on the policy side. We saw some news that there are some changes to China export taxes as it relates to UCO and maybe Chinese UCO will make its way less to the global markets. There's a little bit of possibility that President Trump might impose some tariffs on anyways UCO coming into the U.S. So I'm just trying to understand from the perspective of ADM, if China exports less Yuko to the global markets, how does -- how can that help ADM?
Juan Luciano: Yes, thank you. Well, you see Manav what happened when the flood of UCO came into the U.S., so then basically soybean oil or canola oil lost percentage, it lost share as a percentage of feedstocks, if you will. And there were a lot of concerns on the origin of some of these UCO. And there have been a lot of questions by people about making sure we verify that origin, especially when you start seeing big palm oil producing countries being big exporters of UCO also. So I think part of that is to make sure that whoever is playing here is playing with the right rules. So I don't know about the regulation. There are a lot of speculation at this point in time about regulations. We just want a level-playing field. We just want to work on products that are real what they say they are. And I think that's what we aim for is transparency in the rules. Then we play by the rules.
Operator: Our next question comes from Steven Haynes with Morgan Stanley. Your line is open. Please go ahead.
Steven Haynes: Hey, good morning. Thanks for taking my question. Maybe just coming back to the cost side of things. I think your SG&A is up quite a bit this year and accelerating a bit, maybe more than kind of what would be implied by normal inflation. So I guess when we're thinking about that kind of ramp-up this year, what are some of the key drivers there? And then how are we supposed to think about that going into next year pairing with your comments about you know more focus on controlling cost. Thank you.
Juan Luciano: So I'll just start with answering the question on what's driving the increase in SG&A, there are couple of drivers here. One is the higher litigation costs that we have in defending the or sorry, the higher litigation costs that we have with the material weakness that we have. So that's number one. Number two is the company has invested in digital transformation over the last few years and that's the cost that is increasing there to support the transformation of our ERPs. Number three is we got higher interest cost that we have, which is also reported -- sorry, you were just asking SG&A, not corporate. So those are my two big drivers that drive it, which is GT and then some litigation costs. We also have normal merit increase that goes into that, but that's partially offset by the lower incentive compensation that as we see the results of the company right now, you're going to see lower. So when you look at all of that back to your question also what are we going to do about all of this, as I said, a couple of things is, we need to continue investing in digital transformation as we go through that. Secondly, I would tell you that as we work through some of the zero-based budgeting exercises that we have here, we need to make sure that where there is opportunities, there is value being added for those activities, that's what we are working on. And then the third piece that is an add to the cost, which is M&A, so as we have bought four companies that closed in 2024, you get added cost that of course comes through into SG&A, but that's also where we have to keep looking at and saying making sure the synergies for those M&As are coming through too. So I would say in the long-run, when I look at this, this is where we clearly have an opportunity to continue driving our focus on cost. And I would do cost in two places. One is cost in SG&A. The second cost is our manufacturing cost, which Juan has already talked about and I've talked about where we should be able to keep driving efficiencies, which should help us reduce cost.
Steven Haynes: Okay. Thank you.
Operator: We now turn to Tami Zakaria with JP Morgan. Your line is open. Please go ahead.
Tami Zakaria: Hi, good morning. Thank you so much. My question is on crush volumes. I think I saw on your slide you expect high single-digit percent type volume growth in the fourth quarter. So I'm just curious, is that a good starting point for next year barring any policy developments or can you share any initial thoughts on how you're thinking about volumes?
Juan Luciano: Yes, I would say, as you said, if you take the regulatory uncertainty out and what's going to happen with people adjusting their crush because of their blender tax credit to producer tax credit issue, whenever that's going to be solved, I think that, that level that we are disclosing is probably a reasonable level on normal conditions, if you will, yes. And that basically is just the addition of Spiritwood -- is the addition of Spiritwood that is running at full capacity basically, almost full capacity.
Tami Zakaria: Understood. That's helpful. And then just following up on that tariff question from earlier, are you preparing for any either positive or negative impacts should the incoming new administration slap tariffs on foreign imports maybe starting in January, do you see any immediate opportunities or even risks to your business when initial tariffs go into effect?
Juan Luciano: Yes, of course, our business is running a lot of scenario planning for what could happen. Normally, what we see in these circumstances is the trade flows adjust. At the end of the day, you continue to have certain demand in the world, is just satisfied in a different way. So that's where in those situations is where the footprint, the global footprint and the team of ADM normally shines because it allows us with a lot of agility to repurpose those trade flows to take advantage of the conditions. So we are remaining agile, and again doing a lot of scenario planning to be ready.
Tami Zakaria: Understood. Thank you.
Juan Luciano: You're welcome.
Operator: We now turn to Salvator Tiano with Bank of America. Your line is open. Please go ahead.
Salvator Tiano: Yes, thank you very much. You did make a comment early in the call about China increasing production of certain commodities that is impacting trade. And I was just wondering if you can talk a little bit more about that, what are these commodities you're talking about, and whether this is something that's more cyclical like higher crop production because of favorable weather or something more structural certainly more policy, I guess driven that could impact global trade in the longer-term?
Juan Luciano: Yes, I think that China has shown this year that they wanted to encourage or incentivate their local corn production. And as such, they have reduced their -- they have to reduce their imports of corn. I think in -- that's probably what I was referring to, their imports of corn this year are going to be lower. I think in terms of soybeans, the situation is slightly different. I think they are preparing for the eventuality of having to or having to have, you know, tariffs or whatever. So they've been buying and they've been refreshing their reserves. So I think that in that sense the amount that they imported has been about the same. I would say it was more the corn comment.
Salvator Tiano: Okay, perfect. And just want to follow-up a little bit on to ask about the depreciation in the Brazilian reis recently. And I'm just wondering what impact could this have most of your bottom line in Q4, but especially in 2025, given that's now under -- it's now over six.
Juan Luciano: I think, Salvador, the biggest impact that happened with devaluations in Latin America is how they impact farmer selling. You see it in Argentina now that the currency and/or the spread with the you know the two exchange rates is just 10%, the farmer is a more normal seller, if you will, when they need cash and more a steady seller. In Brazil, now with the devaluation, the farmer has been more reluctant seller, if you will. So I would say when you look at Latin America, that's probably what impacts us the most is the ability of the farmer to be pressed to be a commercializer of grain.
Operator: We have no further questions. I'll now hand back to Megan Britt for any final remarks.
Megan Britt: Thank you so much for joining the call today and for your interest in ADM. Please feel free to follow-up directly with me if you have any additional questions.
Operator: Ladies and gentlemen, today's call has now concluded. We'd like to thank for your participation. You may now disconnect your lines. | [
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"speaker": "Operator",
"text": "Good morning and welcome to ADM's Third Quarter 2024 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, this conference call is being recorded. I’d now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Hello and welcome to the third quarter earnings call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the investor relations sections of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. To the extent permitted by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available on our earnings press release and presentation slides, which can be found in the investor relations section of the ADM website. Please turn to slide four. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan. Hello and welcome to all who have joined the call. We sincerely appreciate your patience as we work expeditiously to amend the company's fiscal year 2023 Form 10-K and Form 10-Qs for the first and second quarters of 2024. We are pleased to now be able to share more context about our 2024 year-to-date financial results and our outlook. Even that we are holding this call later than usual, we're also in a position to provide qualitative color on how the fourth quarter is progressing. To start, let's recap our financial results for the company. ADM reported third quarter adjusted earnings per share of $1.09 and a total segment operating profit of $1 billion. This brings adjusted earnings per share to $3.61 and our total segment operating profit to $3.2 billion year-to-date for 2024. Our trailing four-quarter adjusted ROIC was 8.8%. Although we made progress on several important initiatives in 2024, this results are not consistent with the high bar that we have set for our team. While we have seen a decline in our total segment operating profit and a decline in operating cash flow before working capital changes, due to lower net earnings relative to the prior year period, discipline management of our balance sheet continues to allow us to invest in our business and return cash to shareholders. In total, we have returned $3.1 billion to our shareholders with $744 million in the form of dividends and $2.3 billion in share repurchases year-to-date in 2024. Next slide, please. Entering 2024, we laid out key priorities for value creation based on the year we saw ahead of us. And as we moved into the fourth quarter, it's clear that certain expectations have not all play out as anticipated. The global commodity landscape has continued to shift. Stronger-than-expected supply has driven commodity prices down further than anticipated. Canola crash margins have been negatively impacted by regulatory uncertainty and higher seed prices. In addition, China has begun to increase local commodity production and has had a slower pace of demand recovery, negatively impacting the trade of certain commodities and uptake of animal nutrition solutions. We're also seeing the trailing effects of inflation in part of our business. Some new nutrition projects have been delayed as some customers look for opportunities to manage costs by simplifying their consumer offerings. We have also seen some softness in demand in other end markets such as pet treats and energy drinks where consumers are prioritizing their discretionary spending. The global regulatory environment has led to additional uncertainties. Programs such as EUDR and the U.S. producers tax credit are still not fully in place, which has left various stakeholders in the Ag supply-chain without the confidence of a clear path forward. Beyond these external factors creating downward pressure, we're also managing through a balance of both positive and challenging results across our own operational environment. In carbohydrate solutions, we've been able to improve production throughout the network, in part due to advancements in automation and digitization at the plant level, as well as by finding synergies across our milling network. We've seen similar improvements in our crush facilities in LatAm and EMEA, but this has been offset today by the fact that opportunities previously identified in some of our U.S. plants have been taking longer-than-expected to be completed. However, in October, we began to see improvements in unplanned downtime in our U.S. facilities. Nutrition has continued to manage through the downtime of our Decatur East facility, where our expected ramp up has been delayed from the end of 2024 to the first quarter of 2025 as safe restoration of operations is a top priority. And while the integration of our most recent Flavor acquisitions has driven positive results, we have experienced demand fulfillment issues due to the complexity of other integration efforts. We believe that our business is well-positioned to grow alongside enduring global trends such as the expansion of functional food and beverage alternatives, the replacement of petroleum-based products across multiple industries and the broader opportunity associated with decarbonization. As we look at the near-term in 2025, however, we anticipate that we could still be managing through a challenging cycle, and we have already begun taking necessary productivity actions with a clear focus on cost and cash management. This slide highlights several of the areas we have already taken action on in 2024, along with additional actions we are aggressively driving at the end of the year. As we manage through the current cycle, we've seen success in delivering expansion across strategic initiatives such as regen ag, BioSolutions and destination marketing, which achieved record volume handled in October, supporting supply and demand needs through increasing capacity. This is example in our Spiritwood facility, which has achieved near full run-rates in the month of October. And in ramping up the drive for execution excellence program, which has already begun to deliver toward our cost-saving goals. Moving forward, as we expand our focus on procurement and execution excellence, we believe that we can double this program's target cost savings over the next few years. In addition, the automation and digitization efforts that have already achieved millions in cost savings are being scoped and accelerated across the other plants in our footprint. Turning to Nutrition's recovery efforts. To-date we have strengthened our operational leadership, driven simplification and optimization opportunities and continued to expand our pipeline and win rates in part of the portfolio such as flavors. These efforts are now being supplemented to increase the pace of recovery. We have placed additional focus on demand generation, supply-chain improvement and rightsizing our production to better flex to the needs of the dynamic demand environment. And finally, from a strategic capital allocation perspective, we have already accelerated our return of cash to shareholders this year in the form of share repurchases and dividends. Going forward, we're being extremely prudent on focusing our attention on cash generation opportunities, while considering specific portfolio optimization efforts to simplify operations, enhance our focus and drive an improvement in ROIC. Along with all these actions, Monish joining as CFO has already brought new perspectives to the team. We are using his experience to help identify and accelerate paths for continuous recovery. With this, let me pass to Monish for a more detailed financial review. Monish?"
},
{
"speaker": "Monish Patolawala",
"text": "Thank you, Juan. First, I would like to take a moment to say how excited I am to be joining the ADM team at such an important point in the company's trajectory. While I've only been on the job for a few months, I have enjoyed the opportunity to personally engage with our teams and learn the company. I want to thank all my ADM colleagues for their warm welcome. Turning to Slide 6. On a year-to-date basis, AS&O segment operating profit of $1.8 billion was 42% lower versus the prior year period as ample supplies out of South America have driven lower commodity prices and margins across the segment. Ag services sub-segment operating profit of $461 was 52% lower versus the prior year, driven by lower South American origination margins and volumes, in part due to industry take-or-pay contracts. The stabilization of trade flows has also led to fewer opportunities in our global trade business, leading to lower results. Crushing sub-segment operating profit of $632 million was 30% lower versus the prior year period. Slower farmer selling and lower crush rates in Argentina, coupled with solid demand has supported soy crush margins leading to a year-to-date executed soy crush margin of approximately $50 per metric ton, which is lower, compared to the prior year. While year-to-date executed canola crush margins are lower by approximately $15 per ton, compared to the prior year, margins have moderated significantly in the second-half of the year so far, as higher seed prices and regulatory uncertainty drove lower margins. There were net negative timing impacts of approximately $120 million year-over-year. In the refined products and other sub segment, increased pre-treatment capacity at renewable diesel facilities and higher imports of used cooking oil has negatively impacted both refining and biodiesel margins, leading to sub-segment operating profit that was 58% lower versus the prior year. There were net negative timing impacts of approximately $360 million year-over-year. As we look forward, we anticipate AS&O fourth quarter results to be lower than the prior year quarter. The seasonal shift to our North American weighted footprint and strong North American crop should be supportive of volumes. But recent elevation margins are below the levels we expected when we put our guidance in place in November. In crushing, the ramp-up of our Spiritwood facility is expected to support high-single-digit volume improvement. However, we expect lower results due to lower soya and canola crush margins versus the prior year. The addition of new pre-treatment capacity has continued to weigh on margins within the RPO business and on the food oil side, margins for free-to-sell opportunities have been under pressure, due to increased competition. Based on the information available today, we also anticipate 100% reinsurance proceeds of approximately $50 million in the fourth quarter related to both Decatur West and East. We continue to monitor the impact of uncertainty related to regulation and trade flows on the operating environment as we look forward to the end of the year. Year-to-date, carbohydrate solutions segment operating profit of $1.1 billion in the year-to-date period was roughly in line with the prior year as lower margins in the EMEA region and ethanol were mostly offset by strong volumes and improved manufacturing costs. As we look forward, a strong North American corn supply and robust export demand is export expected to be supportive of VCP. However, North American ethanol production continues to outpace demand, driving lower margins. We expect to see solid demand and margins in North American starches and sweeteners as we finish the year. Wheat milling margins are expected to moderate from elevated prior-year levels. Based on information available today, we also anticipate 100% reinsured insurance proceeds in the fourth quarter related to both Decatur East and West incident of approximately $35 million. Taken together, we anticipate the carbohydrate solutions fourth quarter results to be in line with the prior year period. Year-to-date, revenues from nutrition were $5.6 billion, up 2%, compared to the prior year. On an organic basis, segment revenue was down 3%. Human nutrition was flat organically as headwinds related to Decatur East and texturants pricing offset growth in flavors and health and wellness. Animal nutrition revenue declined 5%, driven by unfavorable mix, negative currency impacts in Brazil and low volumes due to demand fulfillment challenges. Year-to-date nutrition sub-segment operating profit of $298 million was 32% lower versus the prior year. Human nutrition results of $265 million were 40% lower, compared to the prior year period, primarily driven by unplanned downtime at Decatur East. Animal nutrition results of $33 million were slightly higher, compared to the prior year, due to an improvement in margins. As we finish the year, we expect continued weak consumer demand, lower texturants prices and ongoing operational challenges to be a headwind. And as Juan previously mentioned, we now anticipate the start-up of our Decatur East facility to be delayed until the first quarter of 2025. We expect the impact of prolonged downtime at Decatur East to be partially offset by 100% reinsurance proceeds in the fourth quarter of approximately $50 million based on the information available today. We expect animal nutrition results in the fourth quarter to be better than the prior year with tailwinds from our turnaround efforts and as we continue to work through operational challenges in pet solutions. Taken together, we expect nutrition results for the fourth quarter likely lower than the third quarter of 2024, but to be higher than the prior year, which had negative impact of approximately $64 million in non-recurring items. Please turn to slide seven. Year-to-date in 2024 the company has generated cash flow from operations before working capital of approximately $2.3 billion, down relative to the same period last year, due to lower segment operating profit. Despite the decline, solid cash generation has supported our ability to invest in our business and return excess cash to shareholders. Year-to-date, the company has returned $3.1 billion in cash in the form of dividends and share repurchases. Allocated $1.1 billion to capital expenditures and nearly $1 billion to M&A announced in 2023 and completed in January 2024. Our capital structure continues to provide the financial flexibility to invest in our business and return capital to shareholders. We continue to see opportunities to drive enhanced cash generation through operating improvements both in our facilities and through better management of working capital. We believe investing in organic opportunities gives us the best return. While we will always look at opportunistic M&A as a way to enhance return, it is essential that we prioritize maximizing returns from the assets that we have already acquired and also ensuring that we are the best owners of all our assets. Now let's transition to a discussion of guidance for 2024 on slide eight. In early November, we announced that we lowered our full-year 2024 adjusted earnings per share guidance to the range of $4.50 per share to $5 per share. The lowering of our guide takes into account our year-to-date results and headwinds from slow market demand and internal operational challenges. Additionally, we now anticipate our corporate cost to be within the range of $1.7 billion to $1.8 billion, primarily due to lower incentive compensation and our corporate net interest expense to be in the range of $475 million to $525 million. We now expect capital expenditures to be approximately $1.5 billion. We are also increasing our effective tax-rate guidance to the range of 20% to 22%, due to the non-deductible impairment of Wilmar taken in the third quarter. Our expectations for our leverage ratio and D&A are unchanged. Let's turn to slide nine to close the call with a reflection on the key priorities that we are driving with our team to deliver improvement and enhance return. First, my top priority is ensuring integrity and accuracy in our internal controls and financial reporting. I echo Juan's earlier statement and add my particular thanks for the extraordinary efforts of our team to amend and file the restated financials for fiscal year 2023 Form 10-K and Form 10-Qs for the first and second quarters of 2024. We are continuing to focus on implementing enhancements to our internal controls to remediate the previously identified material weakness and are taking action to enhance the integrity and accuracy within internal controls and financial reporting related to intersegment sales. Among other things, the design and documentation of the execution of pricing and measurement and reporting controls for segment disclosure purposes and projected financial information used in impairment analysis have been enhanced and the testing of these controls will continue throughout the balance of the year. Further, training for relevant personnel on the measurement of intersegment sales and application of relevant accounting guidance to intersegment sales has been provided and remains ongoing. In the broader category of improving focus and execution, the team will remain adaptable and focus on items within our control. On the cost side, we are optimizing our cost structure and enhancing operational resilience initiatives. In this vein, we have the opportunity to create a more cohesive digital strategy. Today, we have invested in numerous efforts to improve our systems and enable a more digital footing for our business. However, we have the opportunity to connect these efforts to accelerate outcomes around how we serve our customers, operate our assets and run the enterprise, while also delivering structural cost improvement. Similarly, we have room in our portfolio and broader asset network to optimize through targeted divestitures or rationalization and we are evaluating numerous actions that we could take to improve our footprint performance and generate cash. We will also maintain a sharp focus on working capital management to further strengthen our cash position. Lastly, we'll remain disciplined in capital allocation, seeking opportunities to drive ROIC and enhance returns. I see maintaining our capital discipline as essential to value creation. We will work to ensure that we maintain a healthy balance sheet that continues to create strong cash flow and that we rigor investment opportunities appropriately by applying a stage-gated model to ensure that we are achieving key milestones and meeting our return objectives to continue to invest. In closing, I want to take a moment to thank our ADM colleagues for their hard work and dedication this quarter. I am optimistic that today we can successfully tackle the challenges and seize the opportunities as we continue to execute our strategy and focus on delivering value for our shareholders. With that, we look forward to taking your questions. Operator, please open the line for our first question."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] First question comes from Andrew Strelzik with BMO. Your line is open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "Hey, good morning. Thanks for taking the questions and I appreciate all the color you gave on the outlook and the strategy. I was hoping that you could help reconcile the decline in U.S. crush margins over the last several weeks. You have now a U.S. crush margin curve that's much lower in the nearby than in the spring, which is abnormal. You have soybean meal delivery certificates issued last week by some of the commercials, which I also believe is abnormal. So I guess the question is, what does all of this tell us about where crush margins are headed and how much visibility do you have on crush into next year compared to what you would typically have for this time of year? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Andrew. As you said, board crash rallied steadily from the lows in Q3, but has come under pressure in November. And it's basically a combination of things. First of all, demand for the products have been very good. Demand for meal is good, demand for oil around the world is good. But you see during November, we have the Argentine farmers started to sell again. So we've seen higher crush rates in Argentina. There are high crush rates in Brazil and NOPA here in North America, all our plants have been running well, so we have high crush in October. When you combine that with the regulatory uncertainty now we have in the oil side, that has created the problems that we have. The U.S. is exporting oil, the U.S. is exporting mill, but there is more pressure in the system with more crush being put and less regulatory clarity. So that's why overall message, Andrew, is as we look forward here, we think that given the soft markets and the regulatory uncertainty, our focus in ADM is on the things that we can control on the double down on productivity, looking at all our efforts in trying to control cost and cash and certainly portfolio management. So that's kind of our priority for the year. The markets remain robust. Soybean meal is the most competitive feed out there. So demand is strong and oil is needed for the biofuels market and oil is needed for human consumption. So I think that when we clear the regulatory environment or regulatory uncertainty, if you will, I think you're going to see things normalizing a bit."
},
{
"speaker": "Andrew Strelzik",
"text": "Okay. And sorry, if I could just quickly follow up. Given all of the internal actions that you guys are focused on as you kind of navigate the cycle, and if I were to kind of exclude some of the insurance dynamics from this year and maybe from next year as well, do you think that this is kind of an earnings base from which you would expect those actions to drive earnings growth in 2025 or do you think about it as still kind of navigating through kind of a muddled environment as we get through the regulatory dynamics, how do you think about kind of this year and actions that you're taking in the ability to grow in '25? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. I think it's important never to lose an opportunity to get yourself extra feet. So we are taking this decline in margins as an opportunity to review everything from ADM and accelerate all the decisions that were already ongoing. So I will, you know it's too early in the year. There are too many unknowns, Andrew, to especially on the regulatory front to make a forecast for the year. But we know that focusing on the things we can control continue to drive cash flows, that's an important thing for our shareholders and that will improve returns."
},
{
"speaker": "Monish Patolawala",
"text": "Andrew, I echo what Juan just said, it's back to the basics of cash cost and capital. And that's what we are focused on right now. Lot of opportunities head-down, get 2024 closed and we'll come back when we're ready to discuss 2025. But we know the environment is going to be soft and that's why the teams are controlling what they control."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tom Palmer with Citi. Your line is open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "Good morning. Thanks for the question. I just wanted to enquire on the nutrition side of the business. We've seen some changes in terms of the animal nutrition business, I think from a cost-savings standpoint that's driven some improved profitability. What about on the human nutrition side? Is there just given some of the end-markets maybe haven't progressed the way you once anticipated thought to kind of resizing that business? And maybe how much of an opportunity might that be as we think about the coming year? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Tom, for the question. Listen, I think I will take it by pieces. If you take human nutrition, you have to separate. We have a big issue with the plant that is down. That plant is a significant cost. It was down for a full-year, now it's going to be down for the first quarter. And so that's an issue that is a little bit of extraordinary that we're fixing, and we thank all the engineers and everybody working expeditiously to bring it back safe. On the rest of the business is the flavors business and the health and wellness business, we continue to see opportunities. We've seen in the positive side, if you will, we've seen growth of flavors -- revenue flavors in Europe of about 7% like-for-like, so organic growth year-to-date. We have seen 5% in North America. These are not the growth rate that we were expected when we started the year because there has been some categories like energy drinks where although still growing, is growing at less -- at lower rates than we expected at the beginning of the year and our customers have expected at the beginning of the year. Some launches has been postponed, but still is a robust category and we still see growth. But as you said, we are adjusting a little bit our supply-chain to make sure we match the new realities. When you look at the other piece of human nutrition, which is health and wellness, the probiotics part, which is the part there that is the future, it is the growth part has grown so far 14% year-over-year on a revenue side, and even higher than that in operating profit side. So I think that there are good signs, but we continue to flex this. This is a year in which, as you understand, nutrition is not where we want them to be, and we are working hard to fix it. But there are on the customer side, there are positive signs that makes us believe that when we put some of these supply issues behind, we're going to see the results coming to the P&L in a bigger way."
},
{
"speaker": "Tom Palmer",
"text": "Okay. Thank you. And just on the capital allocation, it sounds like there was some mention in the prepared remarks of maybe some focus on discipline, but there was also some commentary maybe on the crush side about some unexpected downtime. Is there may be an elevated maintenance CapEx cycle needed in the crush operation to kind of get it to the operational levels that you desire? And if so, might we expect maybe less of a step-down in CapEx next year just given that or maybe I'm overstating it? A - Juan Luciano No, listen, CapEx for next year will be solid CapEx, if you will. We have many plants, we have grown the company and we need to make sure those plants stay in good shape. But also there are opportunities for automation and digitization that we are adding to that. If you look at the oilseeds plants, Europe and Latin America have been operating very, very well. We have a handful of plants in North America that have given us problems over the summer, and I'm happy to report that they are doing better in October, they are doing better in November. But we have some issues that took a little bit longer to fix than we thought and we put the resources to do so."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ben Theurer with Barclays. Your line is open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"text": "Yes, good morning, and thanks for taking question. Good morning. So just wanted to like kind of get a little bit maybe your sensitivities around the implied guidance for the fourth quarter and taking a little bit of an advantage that we're early in December and already two months have gone past. Clearly, if we look at it implied low-end versus high-end, it's very widespread? So maybe help us understand and frame a little bit what are the risks getting closer to the lower end, which would be implied a little less than $1 versus the higher piece closer to $140, just to kind of understand where we're shaking out and where you think things are going out considering that two months are in?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Ben. So let me give you the puts and takes for the quarter and you can build it from there. I think in -- if you think about the grain business ag services, of course, this is the quarter in which the volumes come to North America for exports. And we see good volumes. China is buying for Q4, beans, Europe is buying corn for Q1. But we have -- although we have good volumes, we have not seen the margin expansion that maybe we have forecasted a couple of quarters or a couple of months ago. River logistics are good for December. We will have to monitor the weather for Q1, but so far so good. And calories in the market should help our interior assets. On a global trade perspective, volumes are strong and lower commodity prices are supporting feeding animals globally. So destination marketing margins are holding. On the crush side, I described before the decline in crush margins, you know, a lot of uncertainty about biofuels policy, of course. This margin compression could create timing depending on where prices are at the end of the year, we could see positive timing. So we will not be able to call that until we see the end of December. We have been selling our biodiesel book, but of course, it goes out to December. Unfortunately, with the lack of clarity over next year, you know, you could think that if we continue to crush at these levels, maybe oil inventories will climb and something we'll have to give for next -- for the first quarter. At this point, there is not a lot of margin for independent non-integrated plants to run in the first quarter. So you know, we may see a spike of RINs later in the quarter and we might have to maybe as industry slowdown crash in the first quarter. On a carb solutions perspective, it's kind of steady, if you will. Margins are good, volumes are good, manufacturing is operating well, so we get -- we are cranking on all the cost savings. We have implemented some of the automation projects that's given us benefits to that. So I would say we should see a little bit ethanol margins are always the variable here. They are slightly on the breakeven side. So hopefully, we finish the year strong there. And then on the nutrition side, we certainly, as Monish was saying in the outlook, we've seen improvements in animal nutrition, we've seen a balance of some revenue growth, but also some one-offs that we needed to address in the human side. So I will say better than last year, slightly lower than maybe the previous quarter, and we are putting all our efforts in finishing that plant, so we can have a 2025 cleaner of all those extra costs."
},
{
"speaker": "Monish Patolawala",
"text": "Just a couple more for you Ben is -- can I just add a couple more?"
},
{
"speaker": "Ben Theurer",
"text": "Yes, yes."
},
{
"speaker": "Monish Patolawala",
"text": "For insurance proceeds that is a partial settlement right now. If you add the three segments I gave you, in the fourth quarter, there is an assumption that we will get 100% reinsurance proceeds of $135 million. So that's the other variable. And then back on nutrition, what Juan said just for disclosure, currently based on where the team is seeing, we think with M&A, it's low-single-digit growth in the fourth quarter. And on an organic basis, it's low-single-digits negative growth. And so that's the other piece. I just wanted to add to what Juan said. Thank you."
},
{
"speaker": "Ben Theurer",
"text": "And to clarify, those insurance just similar as in the third quarter that will basically then be deducted in other, correct?"
},
{
"speaker": "Monish Patolawala",
"text": "No, these are all 100% reinsurance proceeds, Ben. So they will -- so our captive insurance has reinsurance cover. And so we expect to get $135 million as a partial settlement for the Decatur East. And this will continue into '25 and '26 as we -- yes, it's different than 3Q where the captive was paying for it. Now we are expecting reinsurance proceeds."
},
{
"speaker": "Ben Theurer",
"text": "Okay. Perfect. That explains a lot. Thank you."
},
{
"speaker": "Operator",
"text": "We now turn to Heather Jones with Heather Jones Research. Your line is open. Please go ahead."
},
{
"speaker": "Heather Jones",
"text": "Good morning. Thanks for the question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning, Heather."
},
{
"speaker": "Heather Jones",
"text": "So you guys talked -- good morning. So you all have talked a lot about the challenging cycle we're in and as far as looking to '25, but wanted to get a sense of, I mean, what are some things that could be givebacks in '25. So I was just wondering if you could quantify how much take or pay hit you guys in '24? And then the cost impact of all the unplanned downtimes that presumably as you've gotten these plants running better, you should get back that's separate from the crush curve. So I was just wondering if you could first quantify those couple of things for me."
},
{
"speaker": "Juan Luciano",
"text": "Yes, I would say, I'm not sure I have all of them top of my head for the full year, Heather. But let me say the following. I agree with you. I think and on the take or pay, first of all, we learned our lesson. So we're going to act differently, I think as ourselves and you know maybe even the whole industry. I think also the weather in Brazil is very good. So we expect to have probably 170 million tons type of crop next year that will avoid these issues. I will say all these resets in 2025, so we still have very little exposure of our take or pay. But I don't have top of my head what was the whole thing. And then on the manufacturing side, we have issues mostly in the Q3, I would say. Some of the plans when we look at our capacity, when we were down, sometimes it was things like Paraguay because we didn't have margins, so we shut it down ourselves. And then sometimes it was Ukraine or other plants like that. We had a plant in Des Moines, Iowa that we were a little bit waiting for a permit, so we couldn't bring it back. So there are improvements there. I don't know if Monish you have some numbers in your head. I will hesitate to quantify them myself. But..."
},
{
"speaker": "Monish Patolawala",
"text": "Yes, so I would just on take or pay, Heather, it's year-to-date, it's approximately $40 million of impact. We'll have to see what 2025 brings and what the volume and what the revised take or pay contracts look like. And then on the downtime, again, it comes down to the teams are focused on trying to get that up. The cost has gone up per cost per ton, but I would not quantify that right now. I would just wait through as we get to, there should be upside as these plants start running, but I would not quantify because it's not like a systemic down of X over months, it's puts and takes of downtime."
},
{
"speaker": "Heather Jones",
"text": "Right."
},
{
"speaker": "Juan Luciano",
"text": "One thing, Heather, that you need to consider, sorry, in the manufacturing is we implemented our automation projects in the carb solutions business first because we run a pilot and it was good return. So we extended that. Now we have finished our first pilot in the oilseeds plant in one plant in Brazil, and the results are very encouraging. Based on those results, we might do the same thing than now that we did in automation in carb solutions into the oilseeds plant. That had given us improvements in not only yields, but also energy savings and you know, ex-same losses and things like that. So there is an upside there as well as we go into -- we're going to implement all of these in -- I think we have 15 projects going into 2025 for this. So I think that you should see that as a positive for us."
},
{
"speaker": "Monish Patolawala",
"text": "And Heather, I would add to Juan's piece on this is everyone looks at downtime and says cycle up or cycle down. What the team is actually doing is a very good lean-based approach. So they're actually going into deep root cause, looking at what equipment caused the failure, why did it caused the failure? Is there a way to automate? Is there a way to digitize? So in the long run, I put this under the pillar of operational excellence. Our factory should continue to run better in the longer term, and we'll put in the right appropriate of CapEx needed to make sure that we can over the long-term have sustained operating leverage from our factories."
},
{
"speaker": "Heather Jones",
"text": "Okay. Thank you. My follow-up is just, do you have an estimate of how much reinsurance proceeds will be in '25 and '26? I think you said it will continue into '26. So just give us a sense of what those just rough numbers, what those numbers will look like?"
},
{
"speaker": "Monish Patolawala",
"text": "Yes. So I'll start with just the overall possible loss that is there. And again, this is very preliminary. The teams are still working it through. But we believe Decatur West should be approximately in the $100 million of loss and Decatur East should be in the $300 million to $400 million of loss. We've got $95 million in Q3. We expect to get $135 million, give or take in Q4. We expect that in 2025, we should be somewhere in that $50 million to $100 million range and then and the rest will work over the next. Now all of this is based on information we have right now, all of this is based on still working through with the actuaries, with the insurance companies, et cetera. And our goal is to continue working it and we'll keep you posted as we get to know more, but this is truly based on what we know as of right now."
},
{
"speaker": "Operator",
"text": "We now turn to Manav Gupta with UBS. Your line is open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"text": "My question specifically is to you, Monish. You have been in the seat for some time, but looking at the next 12 months to 24 months, Monish, what are your key priorities? What are you going to be most focused on for the next couple of years to make ADM a stronger company?"
},
{
"speaker": "Monish Patolawala",
"text": "Yes. First, Manav, I'll just say, yes, I've been here slightly over 90-days and it's been a blast to be here. It's a fantastic team. I've got a chance to go see some farms, I've got a chance to go see our operations. I've got a chance to go meet the teams in the field and it's a very exciting time to be here. I would tell you on my priorities, as I think about it, as I said in my prepared remarks, my first priority is the integrity and -- of our financial statements and remediating the material weakness. The team has already done a lot of work, but there's a lot more we can do in improving our processes, our internal controls and our systems. And that's what I'm focused in with the IT team and the finance teams to make sure that we have systems that can support all the reporting and all the revised pricing et cetera for intersegment sales. So that's one item. Then I come to the second piece, which is driving cash cost and capital. As Juan mentioned and I have said, there is a lot of opportunity here to control what we control and therefore, we are doubling down on our productivity efforts. And I'm working with the teams on multiple areas that we can simplify our business, reduce our cost, take advantage of our procurement savings as we should be getting into a slightly deflationary environment, while at the same time making sure that we are having functional excellence, which is we are delivering from the center what really the businesses need. So we are following a zero-based approach in certain of our functions. We are looking at all the cost and saying, what are we doing? Do we get the value for it or not. Similarly, when it thinks about capital, you've heard about capital allocation. When you think about CapEx, it's a stage-gate model. So making sure that we are investing in areas because there are tremendous opportunities for investment available to us, but at the same time, making sure that we're getting a return and we're going to follow a stage-gate approach, which means we'll fund you a little bit, we'll see what the return looks like at that point in time. If you hit the milestones, you get the next funding, otherwise, the money goes to somebody else. So create some internal tension to make sure that everyone is fighting for the last dollar of CapEx that's available. Then I go into digital and I think there's tremendous opportunity for you. The Kristy and team who's our CIO has done a really nice job. The company has done a nice job of improving the infrastructure that we have. We still have a long way to go in that, but I feel there's also a chance here to accelerate some of the ability to use data and data analytics to drive business outcomes. So that's another priority of mine. And then I would tell you back to portfolio. The company has always said they will look at portfolio. I've said that too in my prepared remarks in my three-month plus year, I've seen there are opportunities here that we are working on to make sure we simplify our portfolio. And I look at it from a simple lens of do I have a market and do I have a right to win first. And if I do, am I the rightful owner of that asset and what return are we getting. And Juan and I have spent quite some time together on talking about this. He has always been open to portfolio, and we are going to continue working on that. So Manav, I don't know if I answered your question, long answer to your short question, but lot of priorities. And then I'll end with where I started, which is back to the basics. You got to drive cost, cash and capital in this environment where we know that the commodity cycle may not be our best friend. So self-help is truly our best friend and that's what the teams are working on. So hopefully answered your question."
},
{
"speaker": "Manav Gupta",
"text": "No, you absolutely did. My very quick follow-up and this is more on the policy side. We saw some news that there are some changes to China export taxes as it relates to UCO and maybe Chinese UCO will make its way less to the global markets. There's a little bit of possibility that President Trump might impose some tariffs on anyways UCO coming into the U.S. So I'm just trying to understand from the perspective of ADM, if China exports less Yuko to the global markets, how does -- how can that help ADM?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you. Well, you see Manav what happened when the flood of UCO came into the U.S., so then basically soybean oil or canola oil lost percentage, it lost share as a percentage of feedstocks, if you will. And there were a lot of concerns on the origin of some of these UCO. And there have been a lot of questions by people about making sure we verify that origin, especially when you start seeing big palm oil producing countries being big exporters of UCO also. So I think part of that is to make sure that whoever is playing here is playing with the right rules. So I don't know about the regulation. There are a lot of speculation at this point in time about regulations. We just want a level-playing field. We just want to work on products that are real what they say they are. And I think that's what we aim for is transparency in the rules. Then we play by the rules."
},
{
"speaker": "Operator",
"text": "Our next question comes from Steven Haynes with Morgan Stanley. Your line is open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"text": "Hey, good morning. Thanks for taking my question. Maybe just coming back to the cost side of things. I think your SG&A is up quite a bit this year and accelerating a bit, maybe more than kind of what would be implied by normal inflation. So I guess when we're thinking about that kind of ramp-up this year, what are some of the key drivers there? And then how are we supposed to think about that going into next year pairing with your comments about you know more focus on controlling cost. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "So I'll just start with answering the question on what's driving the increase in SG&A, there are couple of drivers here. One is the higher litigation costs that we have in defending the or sorry, the higher litigation costs that we have with the material weakness that we have. So that's number one. Number two is the company has invested in digital transformation over the last few years and that's the cost that is increasing there to support the transformation of our ERPs. Number three is we got higher interest cost that we have, which is also reported -- sorry, you were just asking SG&A, not corporate. So those are my two big drivers that drive it, which is GT and then some litigation costs. We also have normal merit increase that goes into that, but that's partially offset by the lower incentive compensation that as we see the results of the company right now, you're going to see lower. So when you look at all of that back to your question also what are we going to do about all of this, as I said, a couple of things is, we need to continue investing in digital transformation as we go through that. Secondly, I would tell you that as we work through some of the zero-based budgeting exercises that we have here, we need to make sure that where there is opportunities, there is value being added for those activities, that's what we are working on. And then the third piece that is an add to the cost, which is M&A, so as we have bought four companies that closed in 2024, you get added cost that of course comes through into SG&A, but that's also where we have to keep looking at and saying making sure the synergies for those M&As are coming through too. So I would say in the long-run, when I look at this, this is where we clearly have an opportunity to continue driving our focus on cost. And I would do cost in two places. One is cost in SG&A. The second cost is our manufacturing cost, which Juan has already talked about and I've talked about where we should be able to keep driving efficiencies, which should help us reduce cost."
},
{
"speaker": "Steven Haynes",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "We now turn to Tami Zakaria with JP Morgan. Your line is open. Please go ahead."
},
{
"speaker": "Tami Zakaria",
"text": "Hi, good morning. Thank you so much. My question is on crush volumes. I think I saw on your slide you expect high single-digit percent type volume growth in the fourth quarter. So I'm just curious, is that a good starting point for next year barring any policy developments or can you share any initial thoughts on how you're thinking about volumes?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, I would say, as you said, if you take the regulatory uncertainty out and what's going to happen with people adjusting their crush because of their blender tax credit to producer tax credit issue, whenever that's going to be solved, I think that, that level that we are disclosing is probably a reasonable level on normal conditions, if you will, yes. And that basically is just the addition of Spiritwood -- is the addition of Spiritwood that is running at full capacity basically, almost full capacity."
},
{
"speaker": "Tami Zakaria",
"text": "Understood. That's helpful. And then just following up on that tariff question from earlier, are you preparing for any either positive or negative impacts should the incoming new administration slap tariffs on foreign imports maybe starting in January, do you see any immediate opportunities or even risks to your business when initial tariffs go into effect?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, of course, our business is running a lot of scenario planning for what could happen. Normally, what we see in these circumstances is the trade flows adjust. At the end of the day, you continue to have certain demand in the world, is just satisfied in a different way. So that's where in those situations is where the footprint, the global footprint and the team of ADM normally shines because it allows us with a lot of agility to repurpose those trade flows to take advantage of the conditions. So we are remaining agile, and again doing a lot of scenario planning to be ready."
},
{
"speaker": "Tami Zakaria",
"text": "Understood. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "You're welcome."
},
{
"speaker": "Operator",
"text": "We now turn to Salvator Tiano with Bank of America. Your line is open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "Yes, thank you very much. You did make a comment early in the call about China increasing production of certain commodities that is impacting trade. And I was just wondering if you can talk a little bit more about that, what are these commodities you're talking about, and whether this is something that's more cyclical like higher crop production because of favorable weather or something more structural certainly more policy, I guess driven that could impact global trade in the longer-term?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, I think that China has shown this year that they wanted to encourage or incentivate their local corn production. And as such, they have reduced their -- they have to reduce their imports of corn. I think in -- that's probably what I was referring to, their imports of corn this year are going to be lower. I think in terms of soybeans, the situation is slightly different. I think they are preparing for the eventuality of having to or having to have, you know, tariffs or whatever. So they've been buying and they've been refreshing their reserves. So I think that in that sense the amount that they imported has been about the same. I would say it was more the corn comment."
},
{
"speaker": "Salvator Tiano",
"text": "Okay, perfect. And just want to follow-up a little bit on to ask about the depreciation in the Brazilian reis recently. And I'm just wondering what impact could this have most of your bottom line in Q4, but especially in 2025, given that's now under -- it's now over six."
},
{
"speaker": "Juan Luciano",
"text": "I think, Salvador, the biggest impact that happened with devaluations in Latin America is how they impact farmer selling. You see it in Argentina now that the currency and/or the spread with the you know the two exchange rates is just 10%, the farmer is a more normal seller, if you will, when they need cash and more a steady seller. In Brazil, now with the devaluation, the farmer has been more reluctant seller, if you will. So I would say when you look at Latin America, that's probably what impacts us the most is the ability of the farmer to be pressed to be a commercializer of grain."
},
{
"speaker": "Operator",
"text": "We have no further questions. I'll now hand back to Megan Britt for any final remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you so much for joining the call today and for your interest in ADM. Please feel free to follow-up directly with me if you have any additional questions."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, today's call has now concluded. We'd like to thank for your participation. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 2 | 2,024 | 2024-07-30 09:00:00 | Operator: Good morning and welcome to ADM's Second Quarter 2024 Earnings Conference Call. All lines have been placed on listen-only mode to prevent any background noise. [Operator Instructions] As a reminder, this conference call is being recorded. I now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Thank you, Eliot. Hello and welcome to the Second Quarter Earnings Webcast for ADM. Starring to tomorrow a replay of this webcast will be available on our Investor Relations website. Please turn to slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on filed with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano will discuss our second quarter results and share recent accomplishment on our strategic priority. Our Chief Financial Officer, Ismael Roig will review segment level performance and provide an update on our cash generation and capital allocation action. Juan will have some closing remarks and then he and Ismael will take your questions. Please turn to slide 4. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan and good morning to all of who have joined for today’s call. Today, ADM report its second quarter adjusted earnings per share of $1.03 with an adjusted segment operating profit of $1 billion. Our trailing four quarter average adjusted ROIC was 9.7%. We delivered a strong cash flow from operations before working capital at $1.7 billion. Year-to-date, this equates to an adjusted earnings per share of $2.49 and an adjusted segment operating profit of $2.3 billion. Our team delivered solid results in challenging market conditions, highlighting the efforts of our teams across the business to manage through the commodity down cycle while putting our nutrition business on a path to recovery. Additionally, we saw signs of improving fundamentals within crush and ethanol later in the quarter, positioning us for a strong second half. We're also flexing our capital allocation strategy to return cash to shareholders, completing our planned share repurchases for the quarter and delivering our 370th consecutive quarterly dividend. Next slide, please. Let's start by reviewing the top-line results of our business units alongside our efforts to manage the cycle through productivity and innovation. Our service analysis results are significantly lower than the record results of prior years due to the ongoing rebalancing of the supply and demand environment and overall lower farmer selling. In anticipation of this year's challenges, we focus on driving stronger production volumes and actively leveraging our footprint to match supply to demand around the globe. We've also focused on differentiation opportunities, extending margins and growing volumes by more than 20% year-over-year in areas like destination marketing, achieving our targeted run rate in our Green Bison JV for renewable green diesel feedstocks, and bringing new solutions to our customers through innovations such as our recent EUDR-compliant fully traceable soybean program and the expansion of our regenerative agriculture partnerships and acreage. These regenec programs highlight our leadership in this space. ABM was named the finalist in Fast Company's world changing ideas in May. And just last week we released our second annual regenec report detailing the data backed results we are achieving across our global operations. Carbohydrate Solutions have continued the solid performance trajectory driven by strong margins for sweeteners, starches, and flour with higher volumes year-over-year. Ethanol margins also strengthened as industry production tried to keep pace with robust export and domestic demand. Along with this performance, we are continuing to drive innovation-based growth through the sustainability centered evolution of the business. We have delivered 7% year-to-date volume expansion across our BioSolutions platform, increased starch capacity in our Marshall, Minnesota facility to meet growing demand from food, beverage, and industrial customers, and in a milestone for our strategic partnership, Solugen recently broke ground on a 500,000 square foot biomanufacturing facility that will use ADM source dextrose for applications in water treatment, agriculture, energy, and home and personal care. Within our productivity agenda, the drive for execution excellence is continuing to deliver simplification and cost-saving opportunities across the enterprise. In Q2, we advance hundreds of projects that put us clearly on the path to the plan $500 million in cost reduction over the next two years. We are accelerating these efforts and expect to see a significant portion of these savings by the end of 2024. Our focus on returning nutrition to its growth trajectory is also taking hold, and we are seeing sequential top-line improvement as compared to our previous two quarters. While we are experiencing some downward pressure with texture and some protein demand, we draw strong growth in health and wellness sales, along with flavor sales growth, and excellent contributions from our recent acquisitions. In our targeted areas of focus, we are continuing to make progress. We continue to improve demand fulfillment for Flavors in our EMEA region, following the implementation of one ADM. We're optimizing cost across the Animal Nutrition portfolio, building the foundation to drive continued sequential improvement across the core of the segment. The use of our refined M&A playbook with our recent flavor acquisitions has proven to be an important accelerator to integration and the ongoing growth of our leading global Flavors business. And our innovation agenda is paying off, driving Human Nutrition revenues up 6% year-to-date, driven by flavors and our science-backed health and wellness portfolio. Our capital allocation efforts continued through the second quarter as we completed our planned shared repurchases and announced our most recent dividend. We have already returned $2.8 billion of capital to shareholders to date. The second quarter marked an important point in our efforts to manage through the market realities of 2024 and deliver on our priorities. Across all three businesses, we are evolving to drive new pockets of growth in the near term while positioning ADM to take full advantage of macro trends of sustainability, health and well-being, and food security in the longer term. As we continue to drive operational excellence and make progress on our key priorities, we have confidence in our full year expectations despite uncertainties in the external environment. Before I hand over to Ismael for a detailed review of our second quarter results, I would like to first thank him for his leadership and guidance as Interim CFO through the first half of the year. It's the hallmark of ADM leaders to step up when our organization asks for their support, and Ismael has shown that his experience, passion, and knowledge of our business set him apart as one of our best. We are excited to be welcoming Monish Patolawala to ADM as our new CFO in August, and know Ismael has important work to do as he returns to lead EMEA and Animal Nutrition's continued growth. Ismael, over to you.
Ismael Roig : Thank you, Juan. Let me begin by sharing my own thanks and congratulations for what our finance team has accomplished over the first six months of this year. As a 20-plus year employee of the company, I have seen amazing things our colleagues can accomplish when we work collectively to achieve them. And this was, again, the reality as I stepped in as Interim CFO. I'm proud to have served the company in this capacity over the last several months, and I'm excited to welcome and support Monish as he joins the team. For the second quarter ended June 30th, 2024, earnings per share on a GAAP basis were $0.98. Segment operating profit on a GAAP basis was $1 billion and included charges of $7 million, or approximately $0.01 per share related to impairments. Adjusted segment operating profit was $1 billion for the second quarter, a 37% decrease versus the prior year period. Adjusted earnings per share were $1.03. Lower pricing and execution margins led to a decline of $1.03 per share versus the prior year period, largely reflecting the impact of lower crush and origination margins. Volume improvement represented a $0.19 per share increase versus the prior year period, primarily reflecting higher volumes in AS&O and Carbohydrate Solutions. Higher costs of $0.07 per share were primarily related to $0.06 per share of unplanned downtime at Decatur East. Share repurchases represented a $0.10 per share increase versus the prior year. During the quarter, there was approximately a $0.02 per share negative impact from mark-to-market timing in the AS&O segment. Please turn to slide 7. For the second quarter, the Ag Services & Oilseeds Team delivered $459 million in operating profit, reflecting on a challenging operating environment compared to the prior year. On a year-over-year basis, mark-to-market timing for the segment was relatively muted. As Juan mentioned, strong supplies out of South America have led to a rebalancing of the supply and demand environment, while also shifting export market competitiveness from North America to South America. These ample supplies have also pressured commodity prices compared to the past two years, resulting in slower-than-expected farmer selling relative to last year and the five year averages. From the demand side, inclusion rates for meal continue to be robust, supporting domestic and export demand. Oil values were pressured during the quarter as imports of used cooking oil as a feedstock for renewable diesel continue to grow. Ag Services results were lower than the prior year, primarily driven by lower results in South American origination, as lower farmers selling due to a smaller-than-expected crop in Mato Grosso and higher logistic costs related to industry take or pay contracts led to lower margins. North America origination saw lower volumes and margins as strong crop yields out of both Brazil and Argentina led to a shift in export competitiveness to South America, as well as limited carries and trading opportunities. As we began the quarter, global demand for both meal and oil remained strong. However, the return of Argentinian crush combined with the increased imports of used cooking oil also weighed on crush margins. As we progress later in the quarter, slower farmers selling in Argentina brought tighter S&D dynamics, driving an improvement in both crush. The team performed well in this environment, leading to an executed soy crush margin of approximately $45 per metric ton for the quarter. While fundamentals supported improving crush margins as we expected, the more balanced S&D environment led to lower margins versus the prior year, translating to lower results. During the quarter, there were approximately $15 million of negative timing impacts versus negative timing impacts of approximately $195 million in the comparable period. In refined products and other, results were lowered due primarily to the reversal of prior positive mark-to-market timing impacts. In North America, increased pretreatment capacity at renewable diesel plants and higher imports of used cooking oil caused refining margins to ease relative to the record levels of last year. The biodiesel margin structure has also come off of record levels versus the prior year as a result of lower LCFS credits and RIN values. During the quarter, there were approximately $90 million of negative timing impacts versus positive timing impacts of approximately $90 million in the comparable period. Equity earnings from Wilmar of $60 million were lower compared to the prior year quarter. Moving to slide 8, the Carbohydrate Solutions team executed well, delivering $357 million in operating profit for the second quarter, which was higher versus the prior year. Industry fundamentals in the Starches & Sweeteners space continue to be supported by strong sweetener demand and an improving starch market. Within ethanol, markets became more constructive as we advanced later in the quarter and stocks moved lower, firming up both domestic and export margins. Demand for ethanol remained robust, supported by summer driving season in the U.S., solid domestic blending rates and export demand. The Starches & Sweeteners subsegment results were higher year-over-year as strong margins and volumes in North America were partially upset by lower margins in the EMEA region as they came off historically high levels. And our operational excellence efforts have helped streamline our processes and overall efficiencies, leading to improved cost positions. In the Vantage Corn Processing subsegment, strong export demand for ethanol supported solid ethanol margins, leading to higher year-over-year results. Moving to slide 9. Nutrition revenues were $1.9 billion for the second quarter, up 3% on a year-over-year basis and sequentially improved from the first quarter. Our Human Nutrition subsegment grew 10% year-over-year, as strong M&A revenue contributions as well as improved volumes and mix and flavors, combined with strong growth in our health and wellness business, more than upset headwinds from lower pricing in the texturants market and lower plant-based protein demand. Our Animal Nutrition subsegment had lower revenues versus the prior year, as lower pricing and mix was partially upset by improved volumes in the base business. Please turn to slide 10. The second quarter marked another quarter of progress with sequential improvement in operating profit for the Nutrition business, when comparing to the prior year quarter, Human Nutrition results were lower, primarily driven by unplanned downtime at Decatur East and lower texturants pricing in the specialty ingredients business. Within Flavors, we have continued to improve operations, which has led to higher shipments sequentially. In Animal Nutrition, results were higher versus the prior year, as improved execution in the base business has led to higher volumes, and cost-optimization actions and lower commodity prices helped support margins, partially upset by lower pet solutions performance in North America and Brazil. Turning to slide 11. For the second quarter, Other segment operating profit was $96 million, up 12% compared to the prior year period, supported by higher captive insurance results due to lower claim activity. ADM investor services results decreased on lower interest income. In corporate for the second quarter, an allocated corporate cost increased on higher global technology investments to support digital transformation efforts, increased legal fees, and increased securitization fees. Turning to our balance sheet and cash flows on slide 12, through the second quarter, the company has continued to generate healthy cash flows with $1.7 billion of operating cash flow before working capital. Our current leverage ratio is now within our targeted range, reflecting our disciplined approach to balance sheet management and robust cash flow generation. With robust financial flexibility, we have been able to support both strategic initiatives to support long-term growth and also leverage excess cash for enhanced shareholder returns. During the quarter, we repurchased over 16 million shares through our open market repurchase program, returning approximately $1 billion of capital, thus making the completion of our targeted $2.3 billion of share repurchases for the year. In total, we have returned $2.8 billion of capital to shareholders through repurchases and dividends so far in 2024. We also continue to invest in the business with an enhanced focus on the reliability of our asset performance, allocating $700 million to capital expenditures. Now breaking down our expectations for the third quarter by segment on slide 13, in AS&O we anticipate the third quarter to be lower versus the prior year, but improved from the cyclical low margin environment from the second quarter. We anticipate demand for both meal and oil to remain robust and support crush margins, however, likely lower than the levels in the prior year. We anticipate improved process volumes in the third quarter as we enhance our focus on operational excellence across our network, and as our Green Bison JV achieves full run rates. It is also important to note the prior year period also included a $48 million insurance recovery related to damages from Hurricane Ida. In Carbohydrate Solutions, we anticipate a strong third quarter, but lower than the prior year as wheat milling margins moderate off elevated levels. Network optimization and operational excellence will continue to support strong earnings in the second half. We anticipate solid demand for ethanol both domestically and in the export markets, and upside opportunities could be presented if fundamentals hold. In Nutrition, we expect the third quarter to be higher than the prior year period. The team is systematically optimizing the organizational and operational structure across both Human and Animal Nutrition, which are expected to continue to yield cost benefits throughout the year. Coupling this with our efforts to convert pipeline opportunities and drive improved volumes, we anticipate to see continued sequential improvement in the Nutrition business throughout the year. Turning to slide 14 to discuss our full year guidance assumptions. We anticipated increased crop production in South America would lead to lower margins across the AS&O segment in 2024. And the global soybean crush margins would likely be in the range of $35 per metric ton to $60 per metric ton for the year, with performance around the midpoint determined by the strength of soybean meal and oil demand. Though the larger crop production in South America did materialize, we experienced slower than average farmers selling in that region, as well as fewer merchandising opportunities in North America through the first half, which weighed negatively on margins in act services. We expect these dynamics to continue to pressure margins in our third quarter. On soybean crush margins, we continue to see robust soybean meal demand based on solid livestock margins and some supply tightness among competing feedstuffs. From the soybean oil side, we expect that as renewable diesel production continues to grow in the second half, the demand for vegetable oil will remain well supported. And with the prospects of a large crop in North America, we perceive increased opportunities for our interior elevator network and processing plants within Oilseeds and Carbohydrates Solutions in the second half. Taking this all together, our expected crush margin remains unchanged from $35 per metric ton to $60 per metric ton, with recent fundamentals supporting margins above the midpoint. With the first half results largely in line and balancing an improving crush environment with less opportunities and merchandising in the second half, our 2024 earnings per share range remains unchanged. Looking at the other metrics included in our total consolidated guidance, our full year 2024 indications remain unchanged. Back to you, Juan.
Juan Luciano : Thank you, Ismael. As we think about the rest of 2024 and the lead-up to 2025, we remain optimistic about ADM's ability to execute against our priorities while remaining agile in an evolving environment. The pressures of the current commodity cycle do not seem to be demand-driven, as we see continued robust demand for meal and oil. We will continue to focus on how we can actively manage our global footprint to best match these realities moving through the remainder of the year. Our processing capacities are improving through the year across our production operations, including the ramp-up of Green Bison to full capacity and growing production in Ukraine. And our forward book indicates that ADM is well-positioned to drive value through improved margin opportunities as we move into the back half of the year. AS&O results have remained robust, and we expect solid demand through 2024. Assuming fundamentals hold, we have an opportunity for upside in this part of the business through the year. Our initiatives to manage through the current cycle are expanding additional margin opportunities and opening up new channels to our customers, whether in the growth of destination marketing, the expansion of digital technologies focused on farmer needs, the extension of our Regen Act programs and partnerships, or the growth of our BioSolutions platform. So as market conditions improve, ADM has even more exciting platforms for growth and differences. As noted, we expect to see a significant portion of the planned $500 million cost savings driven by the drive for execution excellence to be realized by the end of this initial year of the program, setting up for potential upside in 2025 as more projects are identified and executed. Our Nutrition business have move beyond green shoots of positive momentum. We now see cyclical improvement across the broader portfolio, flavors, health and wellness, animal nutrition. As this continues through year end, we expect a return to growth that will continue and expand in 2025. In short, progress against our priorities, along with our experienced team's ability to pivot in response to an ever changing external environment, give us confidence in a solid close to the year and set ADM up well for a continued growth trajectory for our full business in 2025. Thank you. Operator, please open the line for questions.
Operator: [Operator Instructions] Our first question comes from Andrew Strelzik with BMO.
Andrew Strelzik: Hey, good morning. Thanks for taking the questions. I guess I wanted to ask about the guidance. It seems like you tempered a little bit the language on the AS&O side. And nothing else really was changed, and you kept the EPS guidance. And so I guess I'm curious if there are kind of any other underlying offsets, or if you're thinking about kind of the range differently at all. And maybe, as we've seen more crush margin strength materialized through the year, how much visibility you have to that?
Juan Luciano : Yes, thank you, Andrew. Listen, as you know, we have three businesses. Ag Services, I know it is in this, what we call a transition year, if you will, a rebalancing year from tight supplies to more comfortable S&D. So we expected to have a Q2 that was facing challenging conditions, which we did. And I think we navigated well. As we look at the rest of the year and the improvements we have over the quarter in terms of crush margins, we are executing at this point in time, even outside the range of $35 to $60 per metric ton that we gave so. But of course, when you think about our forecast for Ag Services & Oilseeds was heavily weighted on Q4. So to a certain degree, until we can put more businesses into Q4, it's probably that we have the same kind of visibility we had before. That's where we decided not to touch the range. On the other hand, Carb Solutions continue to be improving. And I think that as Ismael said in his remarks, if current ethanol margins that have improved over the quarter continue to stay that way, we could have an upside there. And certainly Nutrition continues to make significant improvements year-over-year now versus just being sequential before. So we're optimistic about the second half. We just didn't want to change the guidance at this point in time since it's heavily loaded towards Q4.
Operator: We now turn to Tom Palmer with Citi.
Tom Palmer: Good morning, and thanks for the question. I wanted to ask on the Nutrition side, you reiterated the outlook for a second profit to increase year-over-year for the full year. I first just wanted to confirm that this is after adding back the write-down in the fourth quarter, so off I think kind of a $495 billion base. And then second, I wondered if you could elaborate a bit on the key drivers of these improvements over the next couple of quarters. The implication would seem to be that 3Q is up year-over-year. And sorry, the implication of 3Q being up year-over-year, would it seem to imply like a pretty meaningful increase between 2Q and 3Q. I think historically we've seen the opposite where 2Q is a bit more reasonably strong. So just any help on that sequential improvement and then off just the base that we're looking to grow as we look at this year. Thank you.
Juan Luciano : Yes, Tom. Yes, the base is what you describe, you are correct in your assumption there. Let me give you some feel here. The sequential improvement continues in the business, as we said, and that's when we start looking at Q3, it looks like it's going to be year-over-year improvement, which marks a significant improvement in Q3 versus Q2. If I go through the different segments, if you will, Flavors continues to do well. I think the business is up in sales 6%, excluding M&A. Of course, it's still reeling with some higher cost because of all the demand fulfillment improvements we needed to make. But demand is coming back to normal, recovering after this tuck-in period. So we feel good about our pipeline there. We feel good about our prospects for Flavor. Specialty ingredients continue to have a challenge in time. Demand is often we are working through our plant issues. Also, we have the issue of texturants or more specifically emulsifiers in that area are coming down after significant record prices last year, if you will. Health and wellness continue to be very strong. Biotic sales growth is up to 22%. And I think that the pipeline there and the prospects continue to be very strong. When you think about Animal sector, in Animal Nutrition, excluding pet, improvement continues. And based on a strong self-help plan, so it's pretty much under our control, so we feel good about that. Pet Solutions is finding mixed results around the globe. If, I would say, Brazil market conditions continue to be challenging, North America, specifically the US, is still having some demand fulfillment issues. But we are looking good in terms of the improvements we are making towards Q3. And Mexico, our B2C business continues to be very strong. So I would say, overall, with the exception of specialty ingredients, which is the weak part, the rest of the business is looking good. So we expect significant improvements sequentially. And I will start making them improvements year-over-year.
Operator: Our next question comes from Heather Jones with Heather Jones Research.
Heather Jones: Good morning. Thanks for the question. I just wanted to ask about oilseed process volumes. So they were up 1% for the quarter. But in Q1, they were up nearly 9%. And you remarked that utilization of Spiritwood was full for the quarter. So, I was just wondering if there were one-time issues during the quarter and if so, there's been rectified in order to reach all mid to high single-digit growth outlook for the year.
Juan Luciano : Yes. Thank you, Heather. As you said, yes, Spiritwood is performing very well, so is coming up in volumes. Traditionally, I would say in North America, when we have our low part of the cycle in North America, where South America has all the capacity, we take shutdowns in anticipation of demand not being very strong and we want to have our plants ready for the harvest. So, I think that's a traditional seasonal slowdown that we do. So, nothing unusual in that regard.
Operator: Our next question comes from Adam Samuelson with Goldman Sachs.
Adam Samuelson: Yes, thank you. Good morning, everyone. I was hoping to maybe drill in on some of the cost and productivity initiatives that you have underway right now. And I think, one, there's a target of $500 million savings by the end of 2025, kind of split between the two years. Can you maybe provide an update on what you've realized to date in 2024, what the 2024 savings kind of are expected to be on a net basis and maybe any additional color in terms of where within the portfolio those are actually hitting the P&L? I really appreciate it. Thank you.
Juan Luciano : Yes, thank you, Adam, for the question. Yes, we're very proud of how this initiative that we put together at the beginning of the year has continued to accelerate. So far, we are on track. If you think about $500 million in over two years. That's about %125 million per half. We delivered about $127 million in the first half. So we're pretty much on track there. But this group of activities and projects and ideas continue to accelerate. So that's not going to be linear. It's going to be an accelerated bringing up to the P&L and to the bottom line. So we feel very good about it. We are very confident that our forecast shows that we're going to deliver on the $500 million way before the two year mark. With regard to what's the distribution of that, of course, sometimes when you have more bigger manufacturing units or bigger energy consumption, like in Carb Solutions, you have more opportunities to bring that. So I would say, if I were to name a ranking today. Initially, out of the gate, we see more in Carb Solutions and Nutrition because of some of the improvements we needed to make in demand fulfillment, and maybe Ag Services & Oilseeds having to pick a momentum during the second half, so we will see that. So but overall, I think good distribution of projects around the four geographies and the three businesses, and again, catching momentum when you have a big organization that you need to promote all these activities, so not everybody starts at the same time, so we feel very good by being on track, and again, we think ahead of schedule for our $500 million over two years.
Operator: Our next question comes from Ben Theurer with Barclays.
Ben Theurer: Hi, yes, good morning, Juan, Ismael. Thanks for taking my question. I wanted to go back to the Nutrition business and just understand a little bit what your cadence is into the back half as the Decatur East plan is going to come back in. You've selected the $25 million higher fixed cost observation. We just wanted to understand how immediately are you going to be able to gain this back, so as we move into the ramp-up of this, the East part of Decatur, how should we think about those cost headwinds that we've seen over the past? Is that to be recovered in ‘24, or is that more of the ‘25 thing? Thank you.
Ismael Roig : Yes, thank you for the question. From the point of view of plant protein, we do expect the plants to come online again in Q4, so we will see some of that recovery coming in. I think as we look at the second half, we significantly pulled quite a bit of volume out in 2023 as a result, obviously, of the Decatur East facility, but also, we had in demand fulfillment. So I did report -- we did report a 3% revenue growth, as we look into the second half, we are seeing an acceleration of that, and we expect to grow, to be on track to deliver roughly in the mid-single digit growth when we bring back some of these facilities and demand fulfillment capabilities that we had lost in the second half of ‘23.
Juan Luciano : I would say that maybe complimenting Ismael, I think is a ’25 impact not very much ’24 impact given in the Q4 so.
Operator: Our next question comes from Manav Gupta with UBS.
Manav Gupta: Hi. A quick question. We are seeing a very strong rebound in ethanol margins, and it's just seasonal. Is it what's else going out there? Do you think this sustains itself in the second half, and then how does that position you well in the Sweeteners and Starches business across in the second half? Thank you.
Juan Luciano : Yes, thank you, Manav, for the question. We have been seeing for a while that exports have been increasing year-over-year, so ethanol continues to be one of the cheapest alkoxylates out there, and it's very competitive with gasoline in many parts of the world. So we have seen a strong domestic demand because of miles driven in the U.S., especially now with the summer. We have been seeing good blending in the U.S. I think the price of ethanol is very competitive to encourage blending. And we have seen exports at levels that we've never seen before, probably north of 1.7, maybe even 1.9 billion gallons per year. So I think that was a very logical kind of when you see that the strong demand was very logical, that prices will rebound. And, again, we don't see any change for now. It will depend on how much the U.S. produces, of course, of ethanol. But at this point in time, margins are holding, and we think that it bodes well for a strong Q3. In terms of Sweeteners and Starches, that business continues to have very robust volumes and very good margins. If anything, you can see a little bit of a pullback of the energy complex, if you will. That bodes well for manufacturing costs, because these are big facilities that consume a lot of energy. So natural gas prices being close to $2 is a little bit of a tailwind for us. So, Carb Solution is having a very good year so, and we expect that to continue.
Ismael Roig : I'd like to compliment on the Sweeteners & Starches side, as you know, there's been a fairly low corn crop in Mexico, and that has certainly helped with exports of sweetener and starches products into Mexico. So it's created a demand pool into Mexico that has helped the overall market structure for our business in North America.
Operator: We now turn to Salvator Tiano with Bank of America.
Salvator Tiano: Thank you very much. I just wanted to clarify a little bit on the crush margins. So again, I think you made in your prepared remarks a comment that soybean crush margins were $45 per ton in Q2, and at least based on the report, EBITDA, I don't know if I'm missing something, and I may not be fully comparable, but it looks like your crush margins per ton were much, much lower than that. So what am I missing here? Are you easier, I guess, benchmarked the way you're presenting the $35 to $60 material different from what we would see, for example, on Bloomberg synthetic margin? And you made also the comment that you recently executed the trades, I guess, above the top end of the range, above $60. So can you elaborate a little bit on that? Are we talking about just one of trades, or is it something that you're actually consistently generating so far in Q3?
Juan Luciano : Sure. Let me clarify for you. First of all, the $45 per ton is the $45 per ton we made this year. So we can work offline to walk you through the arithmetic, if you will, but there's nothing strange on that. If I go around the world, if you will, on crush margins, at this point between $60 to $70 in the US, that's where we are making businesses, about similar margins for soy in Europe, Brazil may be something between $10 and $50 depending on their domestic plants or export plants, China, $20 to $25, that kind of the margin environment. I would say when we started the quarter, we were doing margins in the low end of our range and as maybe Argentine farmers did not sell, as maybe the industry was expecting, we saw more demand for soybean milk coming into North America that make an improvement in our crush margins, so we finished the quarter a little bit better than maybe we thought, about the $45 per ton. We are selling, we said before that we were relatively open going out. We have some of the Q3 sold, what we don't have sold, we are selling at about $60 to $70 per ton. So that's the crush realities at this point in time. So I think that then we're going to leap into Q4 where we have hopefully a very large crop here in the US. Crops look terrific so far in the US, so we expect to have plenty of raw materials in that. And demand for soybean milk continues to be strong around the world and I think low prices have incentivated demand. Demand is driven a lot by poultry, as you know, and soybean milk has been increasing in the Russians. And then on the oil side, we continue to see a little bit more RGG plants coming on the stream on the second half, so that will bode well as well. So we are positive about crush margins for the rest of the year for North America.
Operator: We now turn to Dushyant Ailani with Jefferies.
Dushyant Ailani: Hi. Can you hear me? Yes. Thank you for taking my question. I just want to talk on the CapEx guide. I think it's improved or it’s increased by about $300 million. I just wanted to see what's driving that.
Ismael Roig : Yes. I think CapEx is always, the prioritization of CapEx is always NDE, so maintenance and safety and quality we do first. So whatever the plants need at any point in time. So that's a bottom up, roll up of their respective needs. Then we fill it up with cost projects, which the execution excellence challenge that we have to deliver $500 million and bring in more ideas, some of those ideas require CapEx. So you can see that growing and then there are growth projects around the world. So I would say nothing specifically is a little bit of everybody else executing on their plans. So I would say nothing. There is a little bit of CapEx inflation as well in our numbers because things are a little bit more expensive than maybe they were two years ago.
Operator: Our next question comes from Steven Haynes with Morgan Stanley.
Steven Haynes: Hey, good morning. Thanks for taking my question. I wanted to come back to Argentina. You mentioned it's kind of been a bit of a tailwind kind of towards the end of the second quarter on some slower than expected farmer selling. So how are you kind of thinking about how that evolves over the balance of the year and what's you kind of helps us think about the risk Argentia kind of coming back into the market in a more meaningful way going forward? Thank you.
Juan Luciano : Yes. So what happened in Argentina, there was a big expectation for the unification of the exchange rate. And of course that hasn't happened so far. On the contrary, the GAAP has increased to about 50% or 55%. So at this point in time, when you combine low commodity prices because of all the abundant production and then the exchange rate, it's not very favorable for the farmer to sell. So the farmer in Argentina is selling a little bit more corn but trying to hold the beans. Will the government, so the question is, will the government be able to unify the exchange rate? I think the government's priorities right now is to fight inflation. And that was the whole plan. So they don't have a lot of room to maneuver to change something because the moment you divide, you change the exchange rate, everything is translated into prices. And the priority right now is to control prices. So I think this is for the good of Argentina long-term as a country, but I think short term will present a problem for the farmer to sell. So I think the farmer will hold as much as possible unless there is a special program that the government rolls out that they don't seem to have a lot of latitude to do so at this point in time. So I think we need to be cautious about the thinking that a lot of the crop will come as a glut to Argentina. It hasn't happened so far.
Operator: We have a follow up question from Heather Jones with Heather Jones Research.
Heather Jones: Thanks for taking the follow up. I wanted to ask about the Chinese UCO into the U .S. situation. So our understanding is those are slow some and then there is an expectation that with Europe imposing anti-dumping duties on Chinese biodiesel that China may shift more of their UCO to that market and not as much as the U.S. And just wondering what you all are seeing there and how you are expecting that to evolve throughout the year?
Juan Luciano : Yes, thank you, Heather. So of course there was a lot of noise by the industry about the prospects of maybe some adulterated or not quite truly UCO coming into the U.S. and checking for that. So we have seen some significant moderation of that coming. I don't want to pinpoint a particular reason, but part of that what you mentioned maybe in Europe is true as well. Europe will not allow raw crops to be part of that. So as they start to build SIF, they will have to use more UCO. So it's naturally that some of those flows would move to Europe. The current North American feedstock market is better balanced after the situation we have in Q1. So I think also we saw palm oil going up in prices. So I think that it's bodes better for soybean oil going forward for the U.S.
Operator: We have another follow-up from Salvator Tiano with Bank of America.
Salvator Tiano: Yes. Thank you very much. I just want to ask about the ethanol outlook, and I know you talked about a lot of factors here, but clearly your commentary on the starches and sweeteners, which include, I guess, the wet meals, was more negative, saying about lower ethanol margins year-on-year, whereas VCP, being the dry meals, it was much, much higher year-on-year. So can you discuss a little bit the differentiation there, and it seems like a lot of the delta is from the export side. So essentially, are you seeing different pricing, different margins from the exports, and as they become a much more important part of the ethanol mix, which we weren't used to in the past, is this something that besides being a driver of demand and operating rates, is it something that's margin accretive, or do the netbacks tend to be lower for export ethanol?
Juan Luciano : Yes, there are several factors, Salvator, here in place. So first of all, the ethanol margins are the ethanol margins, and they are better right now. They are probably twice as big as they were at the beginning of the quarter. There are some particular export markets where we can export as a premium, and we're taking advantage on that. I don't have top of my head where we export those from in terms of plants. But at this point in time, I would say the challenge, not the challenge, but maybe the activity has been on the logistics side to make sure that we can fulfill all the exports and we can get the materials to the ports, because, as you said, and I said before, demand has been very strong, and margins are very good, so we need to take advantage on that. Plants are running well. As I said, costs are coming a little bit lower, so this all bodes well for the forecast. And there's no reason for demand to change significantly outside of the world. We have a basket of countries where we are exporting is very well balanced. So at this point in time, we're looking at Q3 with optimism.
Operator: We have another follow-up from Andrew Strelzik with BMO.
Andrew Strelzik: Great. Thank you. I wanted to just get your perspective on broader biofuels policy. As we get deeper into the back part of the year here, we're getting close to some upcoming upcoming changes obviously the PTC maybe decisions around the RBO import export dynamic so just was curious for some updated thoughts about how those policy shifts will impact your business and whether you think there's risk on the timing of some of those things getting done. It feels like some of the timing around biofuels policy has been a moving target in a number of different ways. So just curious for how you're thinking about that progressing and impacting your business from here? Thanks.
Juan Luciano : Yes. I think all these regulatory frameworks creates movements and uncertainty, the more clarity the industry can have of course the better. I think you have to think about the message around biodiesel blenders credit to a producer credit is, at the end of the day we still have a higher mandate for 2025 and a real deficit in 2024. So I think that you have to think that vegetables oil will be part of the solution to filling that mandate, ultimately the pie is getting bigger here and not the vegetable oil should be gaining on the low CI products especially now that California's CFS credits have come down a little bit. So I think that the problem with these are the short terms gyrations of that is very difficult to know what's going to happen Q4 so maybe we have accelerated buying in Q4 maybe we have a little bit of a slowdown in Q1. But I think overall as we look at that overall policy is constructive for all these and we see more demand and the pie getting bigger. So I think it's all positive for crush margins in the medium or long term calling it by quarter is more difficult.
Operator: We have no further questions, so I'll now hand back to Megan Britt for closing remarks.
Megan Britt : Thank you for joining us today. Please feel free to follow up with me if you have additional questions. Have a good day and thanks for your time and interest in ADM.
Operator: Ladies and gentlemen, today's call is now concluded. We'd like to thank you for your participation. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning and welcome to ADM's Second Quarter 2024 Earnings Conference Call. All lines have been placed on listen-only mode to prevent any background noise. [Operator Instructions] As a reminder, this conference call is being recorded. I now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Thank you, Eliot. Hello and welcome to the Second Quarter Earnings Webcast for ADM. Starring to tomorrow a replay of this webcast will be available on our Investor Relations website. Please turn to slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on filed with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano will discuss our second quarter results and share recent accomplishment on our strategic priority. Our Chief Financial Officer, Ismael Roig will review segment level performance and provide an update on our cash generation and capital allocation action. Juan will have some closing remarks and then he and Ismael will take your questions. Please turn to slide 4. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan and good morning to all of who have joined for today’s call. Today, ADM report its second quarter adjusted earnings per share of $1.03 with an adjusted segment operating profit of $1 billion. Our trailing four quarter average adjusted ROIC was 9.7%. We delivered a strong cash flow from operations before working capital at $1.7 billion. Year-to-date, this equates to an adjusted earnings per share of $2.49 and an adjusted segment operating profit of $2.3 billion. Our team delivered solid results in challenging market conditions, highlighting the efforts of our teams across the business to manage through the commodity down cycle while putting our nutrition business on a path to recovery. Additionally, we saw signs of improving fundamentals within crush and ethanol later in the quarter, positioning us for a strong second half. We're also flexing our capital allocation strategy to return cash to shareholders, completing our planned share repurchases for the quarter and delivering our 370th consecutive quarterly dividend. Next slide, please. Let's start by reviewing the top-line results of our business units alongside our efforts to manage the cycle through productivity and innovation. Our service analysis results are significantly lower than the record results of prior years due to the ongoing rebalancing of the supply and demand environment and overall lower farmer selling. In anticipation of this year's challenges, we focus on driving stronger production volumes and actively leveraging our footprint to match supply to demand around the globe. We've also focused on differentiation opportunities, extending margins and growing volumes by more than 20% year-over-year in areas like destination marketing, achieving our targeted run rate in our Green Bison JV for renewable green diesel feedstocks, and bringing new solutions to our customers through innovations such as our recent EUDR-compliant fully traceable soybean program and the expansion of our regenerative agriculture partnerships and acreage. These regenec programs highlight our leadership in this space. ABM was named the finalist in Fast Company's world changing ideas in May. And just last week we released our second annual regenec report detailing the data backed results we are achieving across our global operations. Carbohydrate Solutions have continued the solid performance trajectory driven by strong margins for sweeteners, starches, and flour with higher volumes year-over-year. Ethanol margins also strengthened as industry production tried to keep pace with robust export and domestic demand. Along with this performance, we are continuing to drive innovation-based growth through the sustainability centered evolution of the business. We have delivered 7% year-to-date volume expansion across our BioSolutions platform, increased starch capacity in our Marshall, Minnesota facility to meet growing demand from food, beverage, and industrial customers, and in a milestone for our strategic partnership, Solugen recently broke ground on a 500,000 square foot biomanufacturing facility that will use ADM source dextrose for applications in water treatment, agriculture, energy, and home and personal care. Within our productivity agenda, the drive for execution excellence is continuing to deliver simplification and cost-saving opportunities across the enterprise. In Q2, we advance hundreds of projects that put us clearly on the path to the plan $500 million in cost reduction over the next two years. We are accelerating these efforts and expect to see a significant portion of these savings by the end of 2024. Our focus on returning nutrition to its growth trajectory is also taking hold, and we are seeing sequential top-line improvement as compared to our previous two quarters. While we are experiencing some downward pressure with texture and some protein demand, we draw strong growth in health and wellness sales, along with flavor sales growth, and excellent contributions from our recent acquisitions. In our targeted areas of focus, we are continuing to make progress. We continue to improve demand fulfillment for Flavors in our EMEA region, following the implementation of one ADM. We're optimizing cost across the Animal Nutrition portfolio, building the foundation to drive continued sequential improvement across the core of the segment. The use of our refined M&A playbook with our recent flavor acquisitions has proven to be an important accelerator to integration and the ongoing growth of our leading global Flavors business. And our innovation agenda is paying off, driving Human Nutrition revenues up 6% year-to-date, driven by flavors and our science-backed health and wellness portfolio. Our capital allocation efforts continued through the second quarter as we completed our planned shared repurchases and announced our most recent dividend. We have already returned $2.8 billion of capital to shareholders to date. The second quarter marked an important point in our efforts to manage through the market realities of 2024 and deliver on our priorities. Across all three businesses, we are evolving to drive new pockets of growth in the near term while positioning ADM to take full advantage of macro trends of sustainability, health and well-being, and food security in the longer term. As we continue to drive operational excellence and make progress on our key priorities, we have confidence in our full year expectations despite uncertainties in the external environment. Before I hand over to Ismael for a detailed review of our second quarter results, I would like to first thank him for his leadership and guidance as Interim CFO through the first half of the year. It's the hallmark of ADM leaders to step up when our organization asks for their support, and Ismael has shown that his experience, passion, and knowledge of our business set him apart as one of our best. We are excited to be welcoming Monish Patolawala to ADM as our new CFO in August, and know Ismael has important work to do as he returns to lead EMEA and Animal Nutrition's continued growth. Ismael, over to you."
},
{
"speaker": "Ismael Roig",
"text": "Thank you, Juan. Let me begin by sharing my own thanks and congratulations for what our finance team has accomplished over the first six months of this year. As a 20-plus year employee of the company, I have seen amazing things our colleagues can accomplish when we work collectively to achieve them. And this was, again, the reality as I stepped in as Interim CFO. I'm proud to have served the company in this capacity over the last several months, and I'm excited to welcome and support Monish as he joins the team. For the second quarter ended June 30th, 2024, earnings per share on a GAAP basis were $0.98. Segment operating profit on a GAAP basis was $1 billion and included charges of $7 million, or approximately $0.01 per share related to impairments. Adjusted segment operating profit was $1 billion for the second quarter, a 37% decrease versus the prior year period. Adjusted earnings per share were $1.03. Lower pricing and execution margins led to a decline of $1.03 per share versus the prior year period, largely reflecting the impact of lower crush and origination margins. Volume improvement represented a $0.19 per share increase versus the prior year period, primarily reflecting higher volumes in AS&O and Carbohydrate Solutions. Higher costs of $0.07 per share were primarily related to $0.06 per share of unplanned downtime at Decatur East. Share repurchases represented a $0.10 per share increase versus the prior year. During the quarter, there was approximately a $0.02 per share negative impact from mark-to-market timing in the AS&O segment. Please turn to slide 7. For the second quarter, the Ag Services & Oilseeds Team delivered $459 million in operating profit, reflecting on a challenging operating environment compared to the prior year. On a year-over-year basis, mark-to-market timing for the segment was relatively muted. As Juan mentioned, strong supplies out of South America have led to a rebalancing of the supply and demand environment, while also shifting export market competitiveness from North America to South America. These ample supplies have also pressured commodity prices compared to the past two years, resulting in slower-than-expected farmer selling relative to last year and the five year averages. From the demand side, inclusion rates for meal continue to be robust, supporting domestic and export demand. Oil values were pressured during the quarter as imports of used cooking oil as a feedstock for renewable diesel continue to grow. Ag Services results were lower than the prior year, primarily driven by lower results in South American origination, as lower farmers selling due to a smaller-than-expected crop in Mato Grosso and higher logistic costs related to industry take or pay contracts led to lower margins. North America origination saw lower volumes and margins as strong crop yields out of both Brazil and Argentina led to a shift in export competitiveness to South America, as well as limited carries and trading opportunities. As we began the quarter, global demand for both meal and oil remained strong. However, the return of Argentinian crush combined with the increased imports of used cooking oil also weighed on crush margins. As we progress later in the quarter, slower farmers selling in Argentina brought tighter S&D dynamics, driving an improvement in both crush. The team performed well in this environment, leading to an executed soy crush margin of approximately $45 per metric ton for the quarter. While fundamentals supported improving crush margins as we expected, the more balanced S&D environment led to lower margins versus the prior year, translating to lower results. During the quarter, there were approximately $15 million of negative timing impacts versus negative timing impacts of approximately $195 million in the comparable period. In refined products and other, results were lowered due primarily to the reversal of prior positive mark-to-market timing impacts. In North America, increased pretreatment capacity at renewable diesel plants and higher imports of used cooking oil caused refining margins to ease relative to the record levels of last year. The biodiesel margin structure has also come off of record levels versus the prior year as a result of lower LCFS credits and RIN values. During the quarter, there were approximately $90 million of negative timing impacts versus positive timing impacts of approximately $90 million in the comparable period. Equity earnings from Wilmar of $60 million were lower compared to the prior year quarter. Moving to slide 8, the Carbohydrate Solutions team executed well, delivering $357 million in operating profit for the second quarter, which was higher versus the prior year. Industry fundamentals in the Starches & Sweeteners space continue to be supported by strong sweetener demand and an improving starch market. Within ethanol, markets became more constructive as we advanced later in the quarter and stocks moved lower, firming up both domestic and export margins. Demand for ethanol remained robust, supported by summer driving season in the U.S., solid domestic blending rates and export demand. The Starches & Sweeteners subsegment results were higher year-over-year as strong margins and volumes in North America were partially upset by lower margins in the EMEA region as they came off historically high levels. And our operational excellence efforts have helped streamline our processes and overall efficiencies, leading to improved cost positions. In the Vantage Corn Processing subsegment, strong export demand for ethanol supported solid ethanol margins, leading to higher year-over-year results. Moving to slide 9. Nutrition revenues were $1.9 billion for the second quarter, up 3% on a year-over-year basis and sequentially improved from the first quarter. Our Human Nutrition subsegment grew 10% year-over-year, as strong M&A revenue contributions as well as improved volumes and mix and flavors, combined with strong growth in our health and wellness business, more than upset headwinds from lower pricing in the texturants market and lower plant-based protein demand. Our Animal Nutrition subsegment had lower revenues versus the prior year, as lower pricing and mix was partially upset by improved volumes in the base business. Please turn to slide 10. The second quarter marked another quarter of progress with sequential improvement in operating profit for the Nutrition business, when comparing to the prior year quarter, Human Nutrition results were lower, primarily driven by unplanned downtime at Decatur East and lower texturants pricing in the specialty ingredients business. Within Flavors, we have continued to improve operations, which has led to higher shipments sequentially. In Animal Nutrition, results were higher versus the prior year, as improved execution in the base business has led to higher volumes, and cost-optimization actions and lower commodity prices helped support margins, partially upset by lower pet solutions performance in North America and Brazil. Turning to slide 11. For the second quarter, Other segment operating profit was $96 million, up 12% compared to the prior year period, supported by higher captive insurance results due to lower claim activity. ADM investor services results decreased on lower interest income. In corporate for the second quarter, an allocated corporate cost increased on higher global technology investments to support digital transformation efforts, increased legal fees, and increased securitization fees. Turning to our balance sheet and cash flows on slide 12, through the second quarter, the company has continued to generate healthy cash flows with $1.7 billion of operating cash flow before working capital. Our current leverage ratio is now within our targeted range, reflecting our disciplined approach to balance sheet management and robust cash flow generation. With robust financial flexibility, we have been able to support both strategic initiatives to support long-term growth and also leverage excess cash for enhanced shareholder returns. During the quarter, we repurchased over 16 million shares through our open market repurchase program, returning approximately $1 billion of capital, thus making the completion of our targeted $2.3 billion of share repurchases for the year. In total, we have returned $2.8 billion of capital to shareholders through repurchases and dividends so far in 2024. We also continue to invest in the business with an enhanced focus on the reliability of our asset performance, allocating $700 million to capital expenditures. Now breaking down our expectations for the third quarter by segment on slide 13, in AS&O we anticipate the third quarter to be lower versus the prior year, but improved from the cyclical low margin environment from the second quarter. We anticipate demand for both meal and oil to remain robust and support crush margins, however, likely lower than the levels in the prior year. We anticipate improved process volumes in the third quarter as we enhance our focus on operational excellence across our network, and as our Green Bison JV achieves full run rates. It is also important to note the prior year period also included a $48 million insurance recovery related to damages from Hurricane Ida. In Carbohydrate Solutions, we anticipate a strong third quarter, but lower than the prior year as wheat milling margins moderate off elevated levels. Network optimization and operational excellence will continue to support strong earnings in the second half. We anticipate solid demand for ethanol both domestically and in the export markets, and upside opportunities could be presented if fundamentals hold. In Nutrition, we expect the third quarter to be higher than the prior year period. The team is systematically optimizing the organizational and operational structure across both Human and Animal Nutrition, which are expected to continue to yield cost benefits throughout the year. Coupling this with our efforts to convert pipeline opportunities and drive improved volumes, we anticipate to see continued sequential improvement in the Nutrition business throughout the year. Turning to slide 14 to discuss our full year guidance assumptions. We anticipated increased crop production in South America would lead to lower margins across the AS&O segment in 2024. And the global soybean crush margins would likely be in the range of $35 per metric ton to $60 per metric ton for the year, with performance around the midpoint determined by the strength of soybean meal and oil demand. Though the larger crop production in South America did materialize, we experienced slower than average farmers selling in that region, as well as fewer merchandising opportunities in North America through the first half, which weighed negatively on margins in act services. We expect these dynamics to continue to pressure margins in our third quarter. On soybean crush margins, we continue to see robust soybean meal demand based on solid livestock margins and some supply tightness among competing feedstuffs. From the soybean oil side, we expect that as renewable diesel production continues to grow in the second half, the demand for vegetable oil will remain well supported. And with the prospects of a large crop in North America, we perceive increased opportunities for our interior elevator network and processing plants within Oilseeds and Carbohydrates Solutions in the second half. Taking this all together, our expected crush margin remains unchanged from $35 per metric ton to $60 per metric ton, with recent fundamentals supporting margins above the midpoint. With the first half results largely in line and balancing an improving crush environment with less opportunities and merchandising in the second half, our 2024 earnings per share range remains unchanged. Looking at the other metrics included in our total consolidated guidance, our full year 2024 indications remain unchanged. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Ismael. As we think about the rest of 2024 and the lead-up to 2025, we remain optimistic about ADM's ability to execute against our priorities while remaining agile in an evolving environment. The pressures of the current commodity cycle do not seem to be demand-driven, as we see continued robust demand for meal and oil. We will continue to focus on how we can actively manage our global footprint to best match these realities moving through the remainder of the year. Our processing capacities are improving through the year across our production operations, including the ramp-up of Green Bison to full capacity and growing production in Ukraine. And our forward book indicates that ADM is well-positioned to drive value through improved margin opportunities as we move into the back half of the year. AS&O results have remained robust, and we expect solid demand through 2024. Assuming fundamentals hold, we have an opportunity for upside in this part of the business through the year. Our initiatives to manage through the current cycle are expanding additional margin opportunities and opening up new channels to our customers, whether in the growth of destination marketing, the expansion of digital technologies focused on farmer needs, the extension of our Regen Act programs and partnerships, or the growth of our BioSolutions platform. So as market conditions improve, ADM has even more exciting platforms for growth and differences. As noted, we expect to see a significant portion of the planned $500 million cost savings driven by the drive for execution excellence to be realized by the end of this initial year of the program, setting up for potential upside in 2025 as more projects are identified and executed. Our Nutrition business have move beyond green shoots of positive momentum. We now see cyclical improvement across the broader portfolio, flavors, health and wellness, animal nutrition. As this continues through year end, we expect a return to growth that will continue and expand in 2025. In short, progress against our priorities, along with our experienced team's ability to pivot in response to an ever changing external environment, give us confidence in a solid close to the year and set ADM up well for a continued growth trajectory for our full business in 2025. Thank you. Operator, please open the line for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Andrew Strelzik with BMO."
},
{
"speaker": "Andrew Strelzik",
"text": "Hey, good morning. Thanks for taking the questions. I guess I wanted to ask about the guidance. It seems like you tempered a little bit the language on the AS&O side. And nothing else really was changed, and you kept the EPS guidance. And so I guess I'm curious if there are kind of any other underlying offsets, or if you're thinking about kind of the range differently at all. And maybe, as we've seen more crush margin strength materialized through the year, how much visibility you have to that?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Andrew. Listen, as you know, we have three businesses. Ag Services, I know it is in this, what we call a transition year, if you will, a rebalancing year from tight supplies to more comfortable S&D. So we expected to have a Q2 that was facing challenging conditions, which we did. And I think we navigated well. As we look at the rest of the year and the improvements we have over the quarter in terms of crush margins, we are executing at this point in time, even outside the range of $35 to $60 per metric ton that we gave so. But of course, when you think about our forecast for Ag Services & Oilseeds was heavily weighted on Q4. So to a certain degree, until we can put more businesses into Q4, it's probably that we have the same kind of visibility we had before. That's where we decided not to touch the range. On the other hand, Carb Solutions continue to be improving. And I think that as Ismael said in his remarks, if current ethanol margins that have improved over the quarter continue to stay that way, we could have an upside there. And certainly Nutrition continues to make significant improvements year-over-year now versus just being sequential before. So we're optimistic about the second half. We just didn't want to change the guidance at this point in time since it's heavily loaded towards Q4."
},
{
"speaker": "Operator",
"text": "We now turn to Tom Palmer with Citi."
},
{
"speaker": "Tom Palmer",
"text": "Good morning, and thanks for the question. I wanted to ask on the Nutrition side, you reiterated the outlook for a second profit to increase year-over-year for the full year. I first just wanted to confirm that this is after adding back the write-down in the fourth quarter, so off I think kind of a $495 billion base. And then second, I wondered if you could elaborate a bit on the key drivers of these improvements over the next couple of quarters. The implication would seem to be that 3Q is up year-over-year. And sorry, the implication of 3Q being up year-over-year, would it seem to imply like a pretty meaningful increase between 2Q and 3Q. I think historically we've seen the opposite where 2Q is a bit more reasonably strong. So just any help on that sequential improvement and then off just the base that we're looking to grow as we look at this year. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, Tom. Yes, the base is what you describe, you are correct in your assumption there. Let me give you some feel here. The sequential improvement continues in the business, as we said, and that's when we start looking at Q3, it looks like it's going to be year-over-year improvement, which marks a significant improvement in Q3 versus Q2. If I go through the different segments, if you will, Flavors continues to do well. I think the business is up in sales 6%, excluding M&A. Of course, it's still reeling with some higher cost because of all the demand fulfillment improvements we needed to make. But demand is coming back to normal, recovering after this tuck-in period. So we feel good about our pipeline there. We feel good about our prospects for Flavor. Specialty ingredients continue to have a challenge in time. Demand is often we are working through our plant issues. Also, we have the issue of texturants or more specifically emulsifiers in that area are coming down after significant record prices last year, if you will. Health and wellness continue to be very strong. Biotic sales growth is up to 22%. And I think that the pipeline there and the prospects continue to be very strong. When you think about Animal sector, in Animal Nutrition, excluding pet, improvement continues. And based on a strong self-help plan, so it's pretty much under our control, so we feel good about that. Pet Solutions is finding mixed results around the globe. If, I would say, Brazil market conditions continue to be challenging, North America, specifically the US, is still having some demand fulfillment issues. But we are looking good in terms of the improvements we are making towards Q3. And Mexico, our B2C business continues to be very strong. So I would say, overall, with the exception of specialty ingredients, which is the weak part, the rest of the business is looking good. So we expect significant improvements sequentially. And I will start making them improvements year-over-year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Heather Jones with Heather Jones Research."
},
{
"speaker": "Heather Jones",
"text": "Good morning. Thanks for the question. I just wanted to ask about oilseed process volumes. So they were up 1% for the quarter. But in Q1, they were up nearly 9%. And you remarked that utilization of Spiritwood was full for the quarter. So, I was just wondering if there were one-time issues during the quarter and if so, there's been rectified in order to reach all mid to high single-digit growth outlook for the year."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Heather. As you said, yes, Spiritwood is performing very well, so is coming up in volumes. Traditionally, I would say in North America, when we have our low part of the cycle in North America, where South America has all the capacity, we take shutdowns in anticipation of demand not being very strong and we want to have our plants ready for the harvest. So, I think that's a traditional seasonal slowdown that we do. So, nothing unusual in that regard."
},
{
"speaker": "Operator",
"text": "Our next question comes from Adam Samuelson with Goldman Sachs."
},
{
"speaker": "Adam Samuelson",
"text": "Yes, thank you. Good morning, everyone. I was hoping to maybe drill in on some of the cost and productivity initiatives that you have underway right now. And I think, one, there's a target of $500 million savings by the end of 2025, kind of split between the two years. Can you maybe provide an update on what you've realized to date in 2024, what the 2024 savings kind of are expected to be on a net basis and maybe any additional color in terms of where within the portfolio those are actually hitting the P&L? I really appreciate it. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Adam, for the question. Yes, we're very proud of how this initiative that we put together at the beginning of the year has continued to accelerate. So far, we are on track. If you think about $500 million in over two years. That's about %125 million per half. We delivered about $127 million in the first half. So we're pretty much on track there. But this group of activities and projects and ideas continue to accelerate. So that's not going to be linear. It's going to be an accelerated bringing up to the P&L and to the bottom line. So we feel very good about it. We are very confident that our forecast shows that we're going to deliver on the $500 million way before the two year mark. With regard to what's the distribution of that, of course, sometimes when you have more bigger manufacturing units or bigger energy consumption, like in Carb Solutions, you have more opportunities to bring that. So I would say, if I were to name a ranking today. Initially, out of the gate, we see more in Carb Solutions and Nutrition because of some of the improvements we needed to make in demand fulfillment, and maybe Ag Services & Oilseeds having to pick a momentum during the second half, so we will see that. So but overall, I think good distribution of projects around the four geographies and the three businesses, and again, catching momentum when you have a big organization that you need to promote all these activities, so not everybody starts at the same time, so we feel very good by being on track, and again, we think ahead of schedule for our $500 million over two years."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ben Theurer with Barclays."
},
{
"speaker": "Ben Theurer",
"text": "Hi, yes, good morning, Juan, Ismael. Thanks for taking my question. I wanted to go back to the Nutrition business and just understand a little bit what your cadence is into the back half as the Decatur East plan is going to come back in. You've selected the $25 million higher fixed cost observation. We just wanted to understand how immediately are you going to be able to gain this back, so as we move into the ramp-up of this, the East part of Decatur, how should we think about those cost headwinds that we've seen over the past? Is that to be recovered in ‘24, or is that more of the ‘25 thing? Thank you."
},
{
"speaker": "Ismael Roig",
"text": "Yes, thank you for the question. From the point of view of plant protein, we do expect the plants to come online again in Q4, so we will see some of that recovery coming in. I think as we look at the second half, we significantly pulled quite a bit of volume out in 2023 as a result, obviously, of the Decatur East facility, but also, we had in demand fulfillment. So I did report -- we did report a 3% revenue growth, as we look into the second half, we are seeing an acceleration of that, and we expect to grow, to be on track to deliver roughly in the mid-single digit growth when we bring back some of these facilities and demand fulfillment capabilities that we had lost in the second half of ‘23."
},
{
"speaker": "Juan Luciano",
"text": "I would say that maybe complimenting Ismael, I think is a ’25 impact not very much ’24 impact given in the Q4 so."
},
{
"speaker": "Operator",
"text": "Our next question comes from Manav Gupta with UBS."
},
{
"speaker": "Manav Gupta",
"text": "Hi. A quick question. We are seeing a very strong rebound in ethanol margins, and it's just seasonal. Is it what's else going out there? Do you think this sustains itself in the second half, and then how does that position you well in the Sweeteners and Starches business across in the second half? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Manav, for the question. We have been seeing for a while that exports have been increasing year-over-year, so ethanol continues to be one of the cheapest alkoxylates out there, and it's very competitive with gasoline in many parts of the world. So we have seen a strong domestic demand because of miles driven in the U.S., especially now with the summer. We have been seeing good blending in the U.S. I think the price of ethanol is very competitive to encourage blending. And we have seen exports at levels that we've never seen before, probably north of 1.7, maybe even 1.9 billion gallons per year. So I think that was a very logical kind of when you see that the strong demand was very logical, that prices will rebound. And, again, we don't see any change for now. It will depend on how much the U.S. produces, of course, of ethanol. But at this point in time, margins are holding, and we think that it bodes well for a strong Q3. In terms of Sweeteners and Starches, that business continues to have very robust volumes and very good margins. If anything, you can see a little bit of a pullback of the energy complex, if you will. That bodes well for manufacturing costs, because these are big facilities that consume a lot of energy. So natural gas prices being close to $2 is a little bit of a tailwind for us. So, Carb Solution is having a very good year so, and we expect that to continue."
},
{
"speaker": "Ismael Roig",
"text": "I'd like to compliment on the Sweeteners & Starches side, as you know, there's been a fairly low corn crop in Mexico, and that has certainly helped with exports of sweetener and starches products into Mexico. So it's created a demand pool into Mexico that has helped the overall market structure for our business in North America."
},
{
"speaker": "Operator",
"text": "We now turn to Salvator Tiano with Bank of America."
},
{
"speaker": "Salvator Tiano",
"text": "Thank you very much. I just wanted to clarify a little bit on the crush margins. So again, I think you made in your prepared remarks a comment that soybean crush margins were $45 per ton in Q2, and at least based on the report, EBITDA, I don't know if I'm missing something, and I may not be fully comparable, but it looks like your crush margins per ton were much, much lower than that. So what am I missing here? Are you easier, I guess, benchmarked the way you're presenting the $35 to $60 material different from what we would see, for example, on Bloomberg synthetic margin? And you made also the comment that you recently executed the trades, I guess, above the top end of the range, above $60. So can you elaborate a little bit on that? Are we talking about just one of trades, or is it something that you're actually consistently generating so far in Q3?"
},
{
"speaker": "Juan Luciano",
"text": "Sure. Let me clarify for you. First of all, the $45 per ton is the $45 per ton we made this year. So we can work offline to walk you through the arithmetic, if you will, but there's nothing strange on that. If I go around the world, if you will, on crush margins, at this point between $60 to $70 in the US, that's where we are making businesses, about similar margins for soy in Europe, Brazil may be something between $10 and $50 depending on their domestic plants or export plants, China, $20 to $25, that kind of the margin environment. I would say when we started the quarter, we were doing margins in the low end of our range and as maybe Argentine farmers did not sell, as maybe the industry was expecting, we saw more demand for soybean milk coming into North America that make an improvement in our crush margins, so we finished the quarter a little bit better than maybe we thought, about the $45 per ton. We are selling, we said before that we were relatively open going out. We have some of the Q3 sold, what we don't have sold, we are selling at about $60 to $70 per ton. So that's the crush realities at this point in time. So I think that then we're going to leap into Q4 where we have hopefully a very large crop here in the US. Crops look terrific so far in the US, so we expect to have plenty of raw materials in that. And demand for soybean milk continues to be strong around the world and I think low prices have incentivated demand. Demand is driven a lot by poultry, as you know, and soybean milk has been increasing in the Russians. And then on the oil side, we continue to see a little bit more RGG plants coming on the stream on the second half, so that will bode well as well. So we are positive about crush margins for the rest of the year for North America."
},
{
"speaker": "Operator",
"text": "We now turn to Dushyant Ailani with Jefferies."
},
{
"speaker": "Dushyant Ailani",
"text": "Hi. Can you hear me? Yes. Thank you for taking my question. I just want to talk on the CapEx guide. I think it's improved or it’s increased by about $300 million. I just wanted to see what's driving that."
},
{
"speaker": "Ismael Roig",
"text": "Yes. I think CapEx is always, the prioritization of CapEx is always NDE, so maintenance and safety and quality we do first. So whatever the plants need at any point in time. So that's a bottom up, roll up of their respective needs. Then we fill it up with cost projects, which the execution excellence challenge that we have to deliver $500 million and bring in more ideas, some of those ideas require CapEx. So you can see that growing and then there are growth projects around the world. So I would say nothing specifically is a little bit of everybody else executing on their plans. So I would say nothing. There is a little bit of CapEx inflation as well in our numbers because things are a little bit more expensive than maybe they were two years ago."
},
{
"speaker": "Operator",
"text": "Our next question comes from Steven Haynes with Morgan Stanley."
},
{
"speaker": "Steven Haynes",
"text": "Hey, good morning. Thanks for taking my question. I wanted to come back to Argentina. You mentioned it's kind of been a bit of a tailwind kind of towards the end of the second quarter on some slower than expected farmer selling. So how are you kind of thinking about how that evolves over the balance of the year and what's you kind of helps us think about the risk Argentia kind of coming back into the market in a more meaningful way going forward? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes. So what happened in Argentina, there was a big expectation for the unification of the exchange rate. And of course that hasn't happened so far. On the contrary, the GAAP has increased to about 50% or 55%. So at this point in time, when you combine low commodity prices because of all the abundant production and then the exchange rate, it's not very favorable for the farmer to sell. So the farmer in Argentina is selling a little bit more corn but trying to hold the beans. Will the government, so the question is, will the government be able to unify the exchange rate? I think the government's priorities right now is to fight inflation. And that was the whole plan. So they don't have a lot of room to maneuver to change something because the moment you divide, you change the exchange rate, everything is translated into prices. And the priority right now is to control prices. So I think this is for the good of Argentina long-term as a country, but I think short term will present a problem for the farmer to sell. So I think the farmer will hold as much as possible unless there is a special program that the government rolls out that they don't seem to have a lot of latitude to do so at this point in time. So I think we need to be cautious about the thinking that a lot of the crop will come as a glut to Argentina. It hasn't happened so far."
},
{
"speaker": "Operator",
"text": "We have a follow up question from Heather Jones with Heather Jones Research."
},
{
"speaker": "Heather Jones",
"text": "Thanks for taking the follow up. I wanted to ask about the Chinese UCO into the U .S. situation. So our understanding is those are slow some and then there is an expectation that with Europe imposing anti-dumping duties on Chinese biodiesel that China may shift more of their UCO to that market and not as much as the U.S. And just wondering what you all are seeing there and how you are expecting that to evolve throughout the year?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, thank you, Heather. So of course there was a lot of noise by the industry about the prospects of maybe some adulterated or not quite truly UCO coming into the U.S. and checking for that. So we have seen some significant moderation of that coming. I don't want to pinpoint a particular reason, but part of that what you mentioned maybe in Europe is true as well. Europe will not allow raw crops to be part of that. So as they start to build SIF, they will have to use more UCO. So it's naturally that some of those flows would move to Europe. The current North American feedstock market is better balanced after the situation we have in Q1. So I think also we saw palm oil going up in prices. So I think that it's bodes better for soybean oil going forward for the U.S."
},
{
"speaker": "Operator",
"text": "We have another follow-up from Salvator Tiano with Bank of America."
},
{
"speaker": "Salvator Tiano",
"text": "Yes. Thank you very much. I just want to ask about the ethanol outlook, and I know you talked about a lot of factors here, but clearly your commentary on the starches and sweeteners, which include, I guess, the wet meals, was more negative, saying about lower ethanol margins year-on-year, whereas VCP, being the dry meals, it was much, much higher year-on-year. So can you discuss a little bit the differentiation there, and it seems like a lot of the delta is from the export side. So essentially, are you seeing different pricing, different margins from the exports, and as they become a much more important part of the ethanol mix, which we weren't used to in the past, is this something that besides being a driver of demand and operating rates, is it something that's margin accretive, or do the netbacks tend to be lower for export ethanol?"
},
{
"speaker": "Juan Luciano",
"text": "Yes, there are several factors, Salvator, here in place. So first of all, the ethanol margins are the ethanol margins, and they are better right now. They are probably twice as big as they were at the beginning of the quarter. There are some particular export markets where we can export as a premium, and we're taking advantage on that. I don't have top of my head where we export those from in terms of plants. But at this point in time, I would say the challenge, not the challenge, but maybe the activity has been on the logistics side to make sure that we can fulfill all the exports and we can get the materials to the ports, because, as you said, and I said before, demand has been very strong, and margins are very good, so we need to take advantage on that. Plants are running well. As I said, costs are coming a little bit lower, so this all bodes well for the forecast. And there's no reason for demand to change significantly outside of the world. We have a basket of countries where we are exporting is very well balanced. So at this point in time, we're looking at Q3 with optimism."
},
{
"speaker": "Operator",
"text": "We have another follow-up from Andrew Strelzik with BMO."
},
{
"speaker": "Andrew Strelzik",
"text": "Great. Thank you. I wanted to just get your perspective on broader biofuels policy. As we get deeper into the back part of the year here, we're getting close to some upcoming upcoming changes obviously the PTC maybe decisions around the RBO import export dynamic so just was curious for some updated thoughts about how those policy shifts will impact your business and whether you think there's risk on the timing of some of those things getting done. It feels like some of the timing around biofuels policy has been a moving target in a number of different ways. So just curious for how you're thinking about that progressing and impacting your business from here? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. I think all these regulatory frameworks creates movements and uncertainty, the more clarity the industry can have of course the better. I think you have to think about the message around biodiesel blenders credit to a producer credit is, at the end of the day we still have a higher mandate for 2025 and a real deficit in 2024. So I think that you have to think that vegetables oil will be part of the solution to filling that mandate, ultimately the pie is getting bigger here and not the vegetable oil should be gaining on the low CI products especially now that California's CFS credits have come down a little bit. So I think that the problem with these are the short terms gyrations of that is very difficult to know what's going to happen Q4 so maybe we have accelerated buying in Q4 maybe we have a little bit of a slowdown in Q1. But I think overall as we look at that overall policy is constructive for all these and we see more demand and the pie getting bigger. So I think it's all positive for crush margins in the medium or long term calling it by quarter is more difficult."
},
{
"speaker": "Operator",
"text": "We have no further questions, so I'll now hand back to Megan Britt for closing remarks."
},
{
"speaker": "Megan Britt",
"text": "Thank you for joining us today. Please feel free to follow up with me if you have additional questions. Have a good day and thanks for your time and interest in ADM."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, today's call is now concluded. We'd like to thank you for your participation. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 1 | 2,024 | 2024-04-30 09:00:00 | Megan Britt: Hello and welcome to ADM's first quarter 2024 earnings conference call. Our prepared remarks today will be led by Juan Luciano, our Board Chair and Chief Executive Officer, and Ismael Roig, our Interim Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the investor relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan. Today, ADM reported first quarter adjusted earnings per share of $1.46, adjusted segment operated profits of $1.3 billion, and a trailing fourth quarter average adjusted ROIC of 11.2%. Our first quarter operating cash flow before working capital was $900 million. In a year where the buildup of grain and oil seeds supply is expected to create pressure on margins, our teams are proactively taking action to manage through the cycle, driving structural earnings, ROIC, and cash flow generation. Our strong performance and disciplined management of our balance sheet continue to allow us to invest in our business and return cash to shareholders. Next slide, please. Last month, we laid out three priorities for value creation in 2024. One, managing through the cycle. Two, nutrition recovery. And three, enhanced return of cash to shareholders. We made progress on each of these priorities in the first quarter. Our efforts to manage through the cycle highlight ADM's ability to mitigate challenging headwinds while building structurally on enduring global trends, such as sustainability. To share a few examples of progress in the first quarter, we have been ramping up production at our Green Bison joint venture with Marathon, with increased volumes and utilization in [indiscernible]. And we're expecting to be at sustained full run rates for harvest this fall. We're continuing to evolve the carbohydrate solutions business through decarbonization, driving nearly 10% volume growth in bio solutions in Q1, while managing solid demand across the core business. Driven by increasing demand for sustainable resource feedstocks and solutions, we are announcing today that we're not only exceeded our 2023 goal of 2 million acres in our regenerative ag programs, we have also increased our 2025 acreage goal from 4 million to 5 million acres. This growth highlights the leadership role ADM is playing across the regenerative ag landscape, which is built upon the longstanding relationships we have with our more than 200,000 farmers partners. The Drive for Excellence program is focused on uncovering efficiency and effectiveness opportunities across ADM, taking action to improve outcomes and deliver cost savings. To-date, we have generated a pipeline of nearly 1,200 validated proposals. Many of these are already delivering results. For example, colleagues in Thailand had developed Chatbot to automate processing of thousands of logistic transactions previously done with a manual process, reducing errors and dramatically improving operating performance. Colleagues in Spain have released capacity in our Valencia extract facility by more than 35% by adjusting the extraction time. These projects and more like this will support us in achieving our aggressive cost savings objective of $500 million over the next two years. Moving to nutrition, the team is focused on actions across all areas of planned recovery, and we've seen expected sequential improvement coming out of the fourth quarter. The impact of these actions will accelerate in the back half of the year, consistent with what we mentioned in the last earnings call. Let me provide a few examples of progress we're making across the targeted areas. Our focus on operations and supply chain has helped us debottleneck some of our demand fulfillment challenges, particularly in EMEA Flavors, where the team has rallied to adjust our fulfillment processes following the go-live of 1ADM and improved volumes delivered sequentially. We're leveraging our improved M&A playbook to support the integration of our most recent Flavor acquisitions and now forecast better results than the initial deal model estimates. To increase speed, agility, and responsiveness to customer needs while delivering more wins across each market segment, we have fine-tuned our go-to-market and COE organizations to best align to demand. Looking to our capital allocation efforts, we have maintained our balanced capital allocation approach while leveraging excess cash flow for enhanced returns to shareholders. We returned a significant amount of cash to shareholders to date as we repurchased more than 20 million shares. As mentioned last month, our focus for excess capital deployment will remain centered on the shareholders. In summary, we are making measurable progress across each of our three major priority areas in 2024, which is setting us up well to navigate the market headwinds we are facing this year and delivering in line with our expectations. I would now like to turn the call over to Ismael for more detail on the first quarter financial results. Ismael?
Ismael Roig: Thank you, Juan. Let's start on Slide six, which provides overall segment operating profit and EPS for the first quarter of 2024. Adjusted segment operating profit was $1.3 billion for the first quarter, a 24% decrease versus the prior year. At a high level, operating profit was primarily down year-over-year in ag services and oil seeds and nutrition. In the other segment, which includes ADMIS and Captive Insurance, we had a 25% increase in operating profit. Adjusted earnings per share were $1.46 for the quarter. Lower pricing and execution margins primarily driven by margin normalization in the AS&O business led to a $1 per share decrease. This includes lower mark-to-market impact in AS&O of approximately $0.38 per share. Our enhanced focus on operational excellence and improving the reliability of our assets, as well as the ramp-up of our Green Bison JV, led to volume improvement in the AS&O segment, resulting in a $0.20 per share increase in EPS versus the prior year. Lower manufacturing costs and input costs led to a $0.15 per share increase versus the prior year, partially offset by negative impacts associated with unplanned downtime at our Decatur East facility. Higher equity earnings, primarily related to Wilmar, attributed a $0.07 per share increase versus the prior year. Increased corporate costs related to the 1ADM implementation and legal fees drove a decrease of $0.11 per share versus the prior year. In other, benefits from share repurchases more than offset negative impacts related to a higher adjusted income tax rate, leading to a $0.06 per share increase versus the prior year. Moving to Slide seven, let's look at our segment performance for AS&O. For the first quarter, the AS&O team delivered $864 million in operating profit, reflecting increasing headwinds from lower commodity prices and ample supplies, partially offset by improvements in process volumes and manufacturing costs, as we enhanced our focus on items within our control. The Ag Services subsegment operating profit was lower versus the prior year, primarily due to the stabilization of trade flows leading to lower global trade and risk management results. Slower farmer selling also negatively impacted export volumes and margins in South America. Crushing subsegment operating profit for the quarter of $232 million was lower versus the prior year. Increased imports of used cooking oil and the anticipation of large South American supplies negatively impacted North American soy crush margins, more than offsetting the benefits from improved process volumes and lower manufacturing costs. There were positive mark-to-market timing impacts during the quarter of approximately $40 million versus positive timing impacts of approximately $240 million in the first quarter of 2023. Refined products and other subsegment results were $157 million. Results were driven by weaker North American refining margins due to the increased imports of used cooking oil, as well as negative mark-to-market timing impacts of approximately $30 million versus positive impacts of approximately $40 million in the prior year. Equity earnings from Willmar were $149 million during the first quarter, higher than the prior year. Moving to Slide eight, let's look at carbohydrate solutions. For the first quarter of 2024, carbohydrate solution segment operating profit was $248 million. The team executed well in a solid demand environment, as well as advance our BioSolutions platform with strong volume growth. Turning to the subsegments. In the starches and sweeteners subsegment, strong starches and sweeteners margins in North America were offset by pressured domestic ethanol margins due to strong industry production and elevated stocks, as well as moderating margins in the EMEA region. In the vantage corn processing subsegment, strong export demand for sustainably certified ethanol supported both volumes and improved margins, leading to an improvement in year-over-year results. Please turn to Slide nine. Nutrition revenues were $1.8 billion for the quarter. In the human nutrition subsegment, strong M&A revenue contributions from our recent acquisitions, as well as price and mixed benefits in flavors, were partially offset by lower volumes in plant-based proteins and normalizing pricing in the texturants markets. Our animal nutrition subsegment had lower revenues versus the prior year, driven by lower pricing and mix. Demand creation has remained strong and provided significant revenue pipeline opportunities. We anticipate steady improvement in demand fulfillment throughout the course of the year, recovering a significant portion of volumes in the second half of the year. Please turn to Slide 10. While we have room to go on our commitment to restore the growth trajectory of the nutrition business, we believe Q1 was an important first step, showing sequential improvement from a challenged fourth quarter, evidencing progress in our operations. For the first quarter, nutrition segment operating profit was $84 million. Human nutrition subsegment results of $76 million were lower than the prior year, driven primarily from headwinds in the specialty ingredients business due to higher fixed cost absorption at Decatur East and normalizing texturants pricing. Animal nutrition subsegment results of $8 million were higher compared to the prior year, primarily driven by cost optimization efforts and lower commodity prices supporting margins. Please turn to Slide 11. For the first quarter, other segment operating profit was $121 million, up 25% compared to the prior year. The improvement was largely driven by improved Captive Insurance results on higher program premiums and lower claim losses. In corporate, unallocated corporate costs increased versus the prior year on higher global technology investments to support digital transformation efforts, as well as increased legal fees. Other corporate was unfavorable compared to the prior year due to an investment valuation loss of approximately $18 million. Please turn to Slide 12. With healthy cash flows and a strong balance sheet, we have maintained our balanced capital allocation approach while leveraging excess cash flow for enhanced returns to shareholders. We entered 2024 with momentum, which has allowed us to return $1.3 billion to shareholders via repurchases during the quarter, with $1 billion being executed through an accelerated share repurchase program. We intend to actualize the additional $1 billion of share repurchases approved last quarter throughout the remainder of the year. We still anticipate capital expenditures will be held at a level aligned with depreciation and amortization, focused largely on investments to secure reliability of asset performance through modernization and digitization efforts. Now, let's transition to a discussion on our full year guidance on Slide 13. Our first quarter results were largely in line with expectations, and in turn, our 2024 planning assumptions and EPS guidance remain unchanged. We are raising our corporate net interest expense guidance from approximately $500 million to approximately $525 million, as the Federal Reserve has signaled that the probability of interest rate cuts in 2024 has decreased. Last month, we mentioned that the global grain and oil seeds supply is expected to increase as anticipated improvements in weather would support larger production levels in key South American countries. With this, we anticipate that commodity prices will continue to ease from the recent highs of the past two years and that trade flows will adjust at the dislocations. As a result, we anticipate the global soybean crush margins would moderate in 2024, likely moving into a range of $35 per metric ton to $60 per metric ton. During the first quarter, the team executed well on a strong forward book supported by meal demand, leading to executed soy crush margins of approximately $55 per metric ton. As we look today, we see that the forward curves reflect the assumption of ample South American supplies and the return of Argentinian production, specifically in Q2 and Q3. While the supply side certainly has pushed forward curves to the lower end of that range in the near term, we remain constructive from the demand side. We continue to expect vegetable oil demand growth from renewable diesel as large facilities ramp up in Q2 and Q3, despite the increase in imports of used cooking oil. From the soybean meal side, lower soybean meal prices are incentivizing demand, supporting producer profitability and, in turn, leading to higher inclusion rates. Now moving to the breakdown of expectations by segment for Q2 2024 on Slide 14. In AS&O, we anticipate the second quarter to be significantly lower versus elevated prior year levels. We anticipate our average global soy crush margin to be towards the lower end of the guided range during the second quarter as the market balances strong soybean availability against increased crush capacity. We still remain confident in our full year planning assumptions as we move through the seasonally lower middle of the year as the world pivots to South American production. In carbohydrate solutions, we anticipate the second quarter to be higher versus the prior year, driven by solid demand and margins in North American starches and sweeteners, partially offset by moderating margins in wheat milling and international corn milling after elevated results in the prior year period. We anticipate solid demand for ethanol, both domestically and in the export markets, similar to the prior year. For nutrition, the second quarter is expected to be lower versus the prior year as we face headwinds in specialty ingredients. We anticipate to see another quarter of sequential improvement as we continue to make progress in demand fulfillment. Back to you, Juan.
Juan Luciano: Thank you, Ismael. Please turn to Slide 15. As you can see, our team is continuing to improve execution excellence across our strategic and operational priorities, which requires a level of agility that is a hallmark of ADM's workforce. We're focusing the organization on a combination of productivity and innovation to help offset increasingly challenging market conditions based on growing commodity supply. Our teams are looking for every opportunity to manage what we can control, remaining nimble to adjust quickly to external circumstances while advancing our strategy. When we look ahead to the rest of the year, our business priorities in 2024 put us in a position to manage through this cycle. Through the differentiation and evolution of our business models in ag services and oil seeds and carb solutions, our drive for excellence program, the recovery of our nutrition business, and continued focus on shareholder returns, we have confidence in our outlook for the full year. Thanks for your time today. We look forward to taking your questions. Operator, please open the line for questions.
Operator: Thank you. [Operator Instructions] Our first question for today comes from Andrew Strelzik of BMO. Andrew, your line is now open. Please go ahead.
Andrew Strelzik: I guess I wanted to ask about the interplay. I wanted to ask about the interplay between US and South America crops and timing and farmer selling in terms of the implications for crush margins and how you're thinking about that. It seems like we've got some delayed farmer selling out of South America that could push out the timing to which that crop comes to market. And so I guess I'm just curious how you're thinking about the balance there and ultimately kind of the confidence that you have as we get into the back part of the year that you see crush margins consistent with your expectations. Thanks.
Juan Luciano: Yes. Thank you, Andrew. So what we're seeing in South America at the moment, Brazil has had a little bit of a better selling last couple of weeks from the farmer perspective, given that with the harvest and also some of the devaluation of the real. So we've seen the crush margins there for Q2 improving a little bit around our portfolio of products. In Argentina, a little bit more difficult to read, Argentina with the economic plans and the uncertainty about how the government navigates through the difficult times. There are also a lot of, even when the farmer may agree to sell, there are some strikes, like right now, there are some strikes in Argentina that are popping through every sector of the economy. So a little bit more difficult to predict, but the reality is all that crop will come to the market. And we're starting to see that in crush margins, and you can see that. So what Ismael was reading in his remark is that, we highlighted a range of crush for the year. We operated in the first quarter, mostly in the higher part of that range, we will move in the second and third quarter, as traditionally happened when South America has a big crop, toward the low end of that range. And then we see at the end of the year, September onward, when we have a crop here in the U.S., where our margins will recover. So that's the way we see the year. We continue to see a strong meal demand as soybean meal becomes cheaper, and it gets more favor in the inclusions, especially when we see some maybe bottom out of profitability from the poultry sector. So that bodes well for our demand. And we have new RGD plants coming in on the stream in the U.S., whether it's Q2 or Q4, that will bring like another half a million ton more of soybean oil demand for the U.S. And don't forget that Brazil increased their mandate to B14, which represents another half a million tons of soybean oil. So all in all, I think that all that oil demand and meal demand will be important to bring back crush margins to the higher part of the range at the end of the year.
Operator: Thank you. Our next question comes from Ben Bienvenu of Stephens Inc. Your line is now open. Please go ahead.
Ben Bienvenu: So I want to ask in the carbohydrate solution segment, you point to a pretty robust outlook for the remainder of the year for starches and sweeteners. In particular, you call out strong volumes. That's a bit of a recovery from what we saw last year. Can you talk about some of the dynamics that you're seeing around volume and the pace of recovery that you're seeing in volume that makes you call out this year?
Juan Luciano: Yes. I would say we've seen strong demand, I would say, I don't know, strong or solid demand across all our segments. Margins have been good. We continue to get a lift on margins by the reduction in chemicals, the reduction in energy prices, a little bit better operations of our facilities. And I would say the main difference maybe versus last year was the last year we have exceptional margins in international milling and also in the corn business in Europe. Those have moderated a little bit, but still the business remained very strong. So I would say all the sweeteners and starches contracted for the year, we're pleased with it. And we expect strong exports to Mexico, other countries pulling well. So I would say, we feel strongly about having a Q2 that's going to be better than last year. So all in all, the uncertainty continues to stay on the ethanol side in which we are cautiously optimistic that, the maintenance systems will balance inventories, if you will, and lift a little bit of margins there. But for the rest of the business, rest of the business is operating very solidly.
Operator: Thank you. Our next question comes from Tom Palmer of Citi. Your line is now open. Please go ahead.
Tom Palmer: I wanted to maybe dive in a little more on refined products. You noted lower biodiesel margin expectations for the year and then in prepared remarks and pressure from imported used cooking oil. I guess, what do you see on more of a regional basis when we think about those refined spreads and more pressured U.S. and other places? And then you did have some timing gains a year ago. We saw a bit of an unwind in 1Q. Just any help on the expected progression of those as we move through 2024? Thanks.
Juan Luciano: Yes. So let me deconstruct a little bit the RPO part. The difference in Q1, so results were lower significantly than last year where we had the record year. Main reason for that is North America, as you described, the imports of used cooking oil negatively impacted North America refining margins. Actually, in EMEA, our results were higher. We executed on the strong biodiesel margins. And I would say refining there is in line with the prior year. I would say we have additional volumes that offset a little bit lower refining premiums. South American results in biodiesel and packages, margins are stronger in the current year, supported by, as I said, increased biodiesel mandate. That's half a million tons per year of new demand that really impacted that. So overall, I think the dynamic will be similar for second quarter in which you will see refining margins lower in North America and crush margins and refining margins a little bit better in South America.
Tom Palmer: Thanks. And just any help on the timing, Juan?
Juan Luciano: Oh, yes. Well, year-over-year, there was a $72 million negative of net timing impacts in Q1. So we had a negative mark-to-market this quarter of $30 million versus the previous year where we had a positive of 42. So that's the arithmetics, if you will, of that.
Operator: Thank you. Our next question comes from Manav Gupta of UBS. Your line is now open. Please go ahead.
Manav Gupta: Good morning. My only question is, can you provide the path to the full restart of the Decatur East plant? Like where are we in the restart regulatory or construction, if you could help us out with that? Thank you very much.
Juan Luciano: Yes, Manav. Good morning. Listen, there's a lot of activity going on there. But we have said, I think this is something we've got nutrition is going to carry as a headwind during the whole year. We expect that plant reasonably to be operating in Q4. I cannot provide any more details or granularity on that as we're going through all the projects, but I would say as soon as we have more specifics, we will be updating all you guys on that. But at this point in time, I think you need to think that the headwinds for nutrition in specialty ingredients and a lot of that driven by this will carry through the year.
Operator: Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead.
Heather Jones: I was just hoping you could help me. I just want to discuss the crush margin outlook a little more specifically on the soy side. So thank you for the cadence information you provided earlier. But I just wanted to dig in a little bit more. So at present, the curve for the U.S. has margins below the range. And then on a cash basis, in certain regions, they're materially below that 35. So when I think about the rest of the year, are y'all assuming that regions like Brazil and Europe are going to provide a material uplift to offset the U.S.? Or is it you think the increased soybean oil demand, et cetera., will make U.S. margins materially better than the curve is indicating at present? So just trying to think about how you all are thinking about that.
Juan Luciano: Yes. Heather, good to hear from you. Listen, the way we're seeing it at the moment, so North America, as we said, Q2 and probably Q3 will move to the lower part of the range. Then as we come through the year and we get more beans here in the U.S. and we get more renewable green diesel volume coming from probably 1 billion gallon more of capacity that's coming, we think that, that and inclusion rates will drive Q4 higher. In the Q2, Q3 area, if you will, we see right now, crush margins in Brazil have gotten better across all our plants, not only the domestic ones, but also the export ones. So as the farmer has been selling a little bit more, as you get more through the harvest there in Latin America, farmers start to move a little bit more volume. In Brazil, it was helped by the devaluation. So we saw that easing the pressure that we have in getting beans and helping crush margins. Europe, we expect it to be around $40 per ton, so it's a little bit in the middle of the pack. China, we don't have a lot of visibility in China, but it seems to be very spot in China at the moment. So it's a little bit hand to mouth over there. So in general, as I said, we see for ADM, at least, a big correction going into the second quarter, also a soft third quarter, and then we start to see coming back up in the Q4. But mostly, the curve of the U.S., if you will, with a little bit moderation provided by the other areas.
Operator: Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Please go ahead.
Salvator Tiano: I wanted to ask a little bit about ethanol. And specifically, it seems like your commentary on ethanol was a little bit different between starches and sweeteners and VCP. It seems like you talked about lower ethanol margins in the former and better ethanol demand margins, et cetera, in VCP. So can you clarify why this, I guess, ethanol margins from the 2 different types of mills diverged? And also specifically, what are you seeing on the ethanol export front, and why is that benefiting VCP more than Starches and Sweeteners?
Juan Luciano: Yes. The reference we made to that is because VCP results were helped by stronger export demand for sustainably certified ethanol, and we get a premium for sustainably certified ethanol. So that supported volumes and margins. In general, Salvator, ethanol is a very cheap oxygenate, so it's getting a lot of demand from the rest of the world. So exports are expected to be north of 1.5 billion gallons. And blending demand inside the U.S. domestically has been good. It's just that this is the time of the year in which the plants have produced a lot. I always said the plants are exothermic. So in a time of cold temperature, they produce a lot, and that's a time where we drive the least. So now we're going into more the maintenance period of those plants. And I think that inventories for the industry, we hope will come a little bit more into balance, and we expect that to higher driving miles during the summer to balance margins a little bit better. But we expect for the whole year for exports to remain very healthy.
Operator: Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead.
Ben Theurer: Just wanted to follow up on some of the initiatives you're doing within the Nutrition business. And Juan, you talked about it at the beginning as it relates to like just simplification, portfolio optimization. So as you've looked through the assets and obviously, it's been volatile here and somewhat soft, obviously impacted by some of the onetime items. But as you think about Nutrition going forward and past some of the issues with the plant downtime, et cetera. How do you want to structure this business? Where do you want to take it to? What do you think is going to be the Nutrition, call it, maybe 2.0 version in 2 to 3 years time? What's the contribution, animal, human? How should we think about this?
Juan Luciano: Yes. Good question. Listen, if you see the sequential improvement that we have had right now, is we're taking a lot of the one-offs we received last year or even in Q4 out of the picture, if you will. Some of them completely. Some of them, they're going to continue to improve as the business improve the reliability of our supply, if you will. I would say, in the short-term, you need to be able to see through some of the headwinds that we will get in revenue because of the correction of raw materials. So there are some parts of the Nutrition business, what we call Specialty Ingredients, if you will, that were either related to proteins or emulsifiers. Those things tend to correct revenue because they are related to soy or corn at the end of the day, so they moderate. And that business is a business that from a volume perspective, there is a reshuffle of the demand in terms of plant-based proteins. And there's a lot of exciting stuff that the industry is doing. Listen, there is a lot of emerging technologies, novel ingredients and new culinary techniques that will come to revitalize that demand over time, but that's a shift that we're going through and you're not going to see that in 2024. But that's something that, long term, we still believe in that piece. Right now, in the present time, flavor, we continue to see strong demand for flavor, whether it's in North America or whether it's in Europe. To the extent that we can release our supply constraints, we will be able to capitalize more on that. And U.S. has been doing better, faster than maybe Europe, and we're correcting those things in Europe but we feel strongly about that. On the Health & Wellness perspective, biotics continues to excel. Biotics have increased OP by like 100% in the first quarter. So we're doing very well. We're getting some headwinds from the fibers perspective, but I think that's a matter of competitive materials. But over time, fibers has a very positive prognosis as all of us are trying to incorporate more protein and fibers in our diet and reduce fats and sugar that's where the world nutrition trends are moving. And then when you think about the Animal Nutrition side, Animal Nutrition is probably the most undervalued, if you will, story given their potential. Because we are doing a lot of self-help, and that self-help continues to be seen in the P&L. But some of the protein sector issues have impacted the demand there. I would say there in the Animal Nutrition area is where we're probably going to see more of the refinement of the portfolio, if you will, just because there are unevenness across sectors in terms of our ability to achieve the right returns on the long-term. So in some part of the sectors, it's more like self-help. In other parts, it's more innovation driven. And even if you go to things like pet, where the demand is very strong, there are pieces of the world that are doing exceptionally well for us like Mexico. There are pieces where demand is very strong, like in North America, so maybe we need to fix some supply issues. And there are parts of the world, like maybe like South America, where structurally it becomes a little bit more difficult to make money. So we are applying different recipes to the different parts of the world. But I still see a very complete Nutrition business, if you will, going forward, more focus on the maybe fewer platforms, fewer customers to be able to execute our pipeline faster. Maybe in the past, we have a big pipeline with a percentage of conversion that we expect it to be higher on a maybe a more focused, concentrated pipeline. That's the way I tend to think about it.
Ismael Roig: Can I offer a complementary view? I just wanted to offer you a complementary view on Juan's comments with regard to Animal Nutrition, but I think it also applies to the broader portfolio, which is I fully agree with Juan in the sense that the base business in Animal Nutrition is now experiencing the benefits of the cost improvement programs that we put in place, and we've seen that evolution quarter-on-quarter. But to Juan's observations on a going-forward basis, you will see a business that is looking to become more focused on the specialty side of its portfolio. As Juan alluded to at the beginning, part of the revenue calculation for the platform is partly impacted by the fact that there is a soy mill commodity component to some of the products that are produced. Over time, it's a business that will evolve to become more specialty focused, more higher margin focused. I think it bodes well for the growth and margin structure of that business as we look forward into 2025.
Operator: Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead.
Steven Haynes: Maybe just two quick follow-ups on Nutrition. So I think your income was down slightly and based on your kind of prior comments about there being some price component, were your volumes, I guess, organic volumes, positive in the quarter? That would be the first one. And then the second question is on the full year, you mentioned that the recent M&A is kind of coming in ahead of your kind of deal model expectations. How much operating profit contribution are you baking into the full year guide from M&A? Thank you.
Juan Luciano: Yes. Thank you, Steven. So let me tell me that we are very pleased with the 2 M&As. The 2 M&As contributed to revenue in the first quarter and not yet to OP because of start-up costs and all that. But we still expect revenue, even despite the headwinds that I mentioned before relative to commodity prices, moderating in some of our less specialty categories. We expect revenue growth to be in the range of mid-single digit for full year. We expect probably operating profit to be a little bit better than that given that our cost should be down year-over-year. So what was the other question there?
Ismael Roig: Yes. So in terms of overall volume, volume was a complementary question. Overall, we've seen volume hold up well. The exception to that would be, obviously, the Specialty Ingredients business and specifically, the impacts of the Decatur East plant. But all of the other elements of our business have generally performed well volume-wise. So you've seen a bit of a deterioration of the volume on a revenue basis, but you have seen a general improvement except for the SI business when it came to volume.
Operator: Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Your line is now open. Please go ahead.
Adam Samuelson: So I guess I got two questions. Maybe first, as we think about the outlook for the year where you talked about improvement in soy meal demand and inclusion ratios later in the year. Can you maybe help us be a bit more specific? Just that doesn't seem to you as implied by the curves. Most forecasts on poultry supply in different parts of the world don't really project a sizable uptick in production. So could you just help us a little bit on the areas where you're actually seeing that or getting that signal from your feed customers? And then an unrelated question, as I think about some of the cost actions and productivity savings that you've targeted for this year and next. Would love if you could maybe a bit more specificity to the areas where the $500 million are really coming from, both in terms of the category of spend, but also whether they're in the operating segments or in corporate unallocated as we think about the outlook for the next couple of years. Thank you.
Juan Luciano: Yes, sure. Adam, listen, I think what you need to realize, so first of all, we are early in the year, of course, and we are making predictions on Q4. So this is a transition period for the industry, if you will. We're going from a couple of years of tight supplies to ample supplies. So we're seeing here a customer base that is very uncovered, if you will, farmer selling that is a little slow. And we're going to go through that transition. On top of that, you have a proteins industry that was in the unprofitable territory, if you will, and still is for certain for, if you will, beef or some parts of pork, but now it seemed to have based and seeing growth trends in poultry. So we see that in different parts of the world, whether it's in Thailand, in Turkey, in other parts of the world. But I think the main issue is that pricing is doing its effect. So you see some trade flows changing. We see some soybean oil being exported out of the U.S., as we see used cooking oil coming into the U.S. We're starting to see maybe Brazil becoming less of an exporter of soybean oil, maybe more competition in mills, but the U.S. is still very competitive in mill. So I think that we will have to see all that shift during the year. What we are seeing is we're looking at our customers, we're looking at our book. And we just think that, again, with 1 billion gallon more of RGD capacity in the U.S. with 500,000 tons more soybean oil coming from the biodiesel mandate in Brazil, that will be a very big determinant of crush margins for the year. With that, I think Ismael will cover the drive for excellence profitability.
Ismael Roig: Yes. Adam, on the drive for excellence, we're actually quite encouraged by the progress. As Juan mentioned during the remarks, we have more than 1,200 initiatives, but they can be grouped into substantial areas or themes of effort and focus, working on plant process optimization, working on business process optimization, also very important on supply chain and demand fulfillment , which is part of the challenges that we've had in Nutrition. So these would be the large buckets that we're working on. And we've seen the platform progress very well. And we have at least about 1/3rd line of sight of the $500 million already for 2024. So we're very encouraged about the ability of this drive for excellence impacting 2024 already in the measures that I've just outlined.
Operator: Thank you. Our next question comes from Ben Kallo of Baird. Your line is now open. Please go ahead.
Ben Kallo: Just how do we think about or you think about the dynamic of the blenders tax credit changing over to a producers tax credit and the carbon intensity being a factor for overall soy oil demand in the U.S. next year?
Juan Luciano: Yes. Thank you, Ben, for the question. So as you know, the $1 blenders tax credit will expire at the end of '24 and transition to a production tax credit. And this will be administered by the US Treasury. They issued guidance on, I think, at the end of last year that will allow the use of grid CA modeling in addition to CORSIA. Of course, we favor including grid. We're successful in grid being officially included. We're still delayed in the EPA ruling on that. So I think that we have been doing a lot of advocacy in encouraging government officials to make sure that we remove this uncertainty out of the equation here. I think that a transition without guidance of whether the crop-based biofuels will generate credits will create a very difficult price discovery mechanism in the coming months, as participants are trying to begin locking 2025 volume. So I think that's an important clarification that needs to happen. These are industries that are investing in the U.S., and I think that providing regulatory certainty are very important for those investments to come to fruition on time and as expected.
Ben Kallo: Just a follow-up there. What are you seeing with the renewable diesel refiners, producers in terms of them transitioning to using waste fats or other materials?
Juan Luciano: Yes. Listen, there is a reality in the world that palm oil production is flat and not being able to cope with demand. So we know that the U.S. and renewable green diesel was going to have to be met with a lot of feedstocks, of which soybean oil is an important component. But of course, the industry is trying to gather every kind of feedstock that they can find. And there was inventory of used cooking oil. The U.S. has imported a lot of that, but still is not going to be enough because how much are you going to grow the used cook oil inventory around the world to supply, as I said, an industry is going to have 1 billion gallon more capacity this year. So we still expect that we are adjusting to these temporary imports of used cook oil. But we still expect that soybean oil will recover their percentage of the used from maybe 30% to again, the 40% we used to be.
Operator: Thank you. Our next question comes from Salvator Tiano of Bank of America. Your line is now open. Please go ahead.
Salvator Tiano: I just had a follow-up. So as we look a little bit into a couple of items, can you help us understand the Green Bison contribution now? So for example, the process volume growth that you showed, roughly how much came from that? And also, I believe you had the $10 million non-controlling interest loss. Well, I guess, the JV, among others, are the loss. So how much, I guess, of that was the Green Bison JV, and at which point do you expect it to turn into a profitable JV on a net income basis, so for that NCI line?
Juan Luciano: Yes. Salvator, maybe I give you what I have at the top of my mind. But we were very pleased with the increase in volumes in oilseeds or in crush during the first quarter. It was 9% increase. Part of that was Spiritwood coming online, part of that were our plants improvements in general across the footprint. Part of that was Paraguay and Ukraine also coming to crush. So that all happened at different points in the quarter. So I don't have a full recollection of what happened to what volume at any part of the quarter. The Green Bison joint venture will be a contributor to profit during 2024. So it's ramping up. It's going to get to full capacity very soon. So it will be a meaningful contributor. I don't have top of my head what was the contribution on first quarter, to be honest.
Operator: Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead.
Heather Jones: Just wanted to ask really quickly what exactly you're doing for the dry mills as far as sustainability sourcing? And the doubling of your region acreage, is that related to like proactively getting ahead of this EU deforestation regime or more stringent carb requirements? Just wondering what's driving that?
Juan Luciano: Yes. So Heather, in carb solutions, we have a whole decarbonization strategy. Actually, across ADM, we have a decarbonization strategy, driven partly by our Strive 35 goals that we need to decarbonize ourselves, part driven by our customers and the need for either awaiting Scope 3 emissions from the side of our customers, but also by providing some low carbon intensity characteristics of some of our products that has also commanding a premium out there. So what are we doing? We are working on increasing our carbon capture sequestration. We're going to go from 2 wells, 1 well and 1 experimental well, but let's say 2 wells to 7 wells, so we're going to be able to increase significantly our capacity. And let me remind you, we have already captured 4.5 million tons of CO2 in the last 10 years that we've been operating. So that has been successful. For the dry mills specifically, what we're doing is we are building pipelines to bring that to our carbon capture and sequestration units indicator. We have 1 pipeline that has been ongoing, the project, and we are looking for solutions for the other dry mills. So that's what is happening. The second part of the question, Heather, I'm not remembering exactly what...
Heather Jones: I was just wondering about the region.
Juan Luciano: Oh, yes.
Heather Jones: Yes, on the region acreage, just wondering, is that doubling in anticipation of like the EU deforestation regime or more stringent carb standards? Just wondering what's driving that. Or is it all voluntary market-driven growth?
Juan Luciano: Yes. I would say there is excitement on both sides. There is excitement on the farmer side to adhere to all these practices, but there's also a lot of demand pull from the customer side in terms of we continue to sign contracts for more of these as people need to, again, have an answer to their Scope 3. So we have been setting goals, and we have been beating those goals and increasing those goals. Now we have expanded that to Europe and Latin America, and we continue to see demand for these activities around the world. And to be honest, the team has been doing an excellent job. So I think that this program is perceived as the leading program in the world there.
Operator: Thank you. At this time, we currently have no further questions. So I'll hand back to Juan Luciano for any further remarks.
Juan Luciano : Okay. Thank you. Thank you, everyone, for joining us today and for your interest in ADM, and have a great day.
Ismael Roig: Thank you.
Operator: Thank you for joining today's call. You can now disconnect your lines. | [
{
"speaker": "Megan Britt",
"text": "Hello and welcome to ADM's first quarter 2024 earnings conference call. Our prepared remarks today will be led by Juan Luciano, our Board Chair and Chief Executive Officer, and Ismael Roig, our Interim Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the investor relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan. Today, ADM reported first quarter adjusted earnings per share of $1.46, adjusted segment operated profits of $1.3 billion, and a trailing fourth quarter average adjusted ROIC of 11.2%. Our first quarter operating cash flow before working capital was $900 million. In a year where the buildup of grain and oil seeds supply is expected to create pressure on margins, our teams are proactively taking action to manage through the cycle, driving structural earnings, ROIC, and cash flow generation. Our strong performance and disciplined management of our balance sheet continue to allow us to invest in our business and return cash to shareholders. Next slide, please. Last month, we laid out three priorities for value creation in 2024. One, managing through the cycle. Two, nutrition recovery. And three, enhanced return of cash to shareholders. We made progress on each of these priorities in the first quarter. Our efforts to manage through the cycle highlight ADM's ability to mitigate challenging headwinds while building structurally on enduring global trends, such as sustainability. To share a few examples of progress in the first quarter, we have been ramping up production at our Green Bison joint venture with Marathon, with increased volumes and utilization in [indiscernible]. And we're expecting to be at sustained full run rates for harvest this fall. We're continuing to evolve the carbohydrate solutions business through decarbonization, driving nearly 10% volume growth in bio solutions in Q1, while managing solid demand across the core business. Driven by increasing demand for sustainable resource feedstocks and solutions, we are announcing today that we're not only exceeded our 2023 goal of 2 million acres in our regenerative ag programs, we have also increased our 2025 acreage goal from 4 million to 5 million acres. This growth highlights the leadership role ADM is playing across the regenerative ag landscape, which is built upon the longstanding relationships we have with our more than 200,000 farmers partners. The Drive for Excellence program is focused on uncovering efficiency and effectiveness opportunities across ADM, taking action to improve outcomes and deliver cost savings. To-date, we have generated a pipeline of nearly 1,200 validated proposals. Many of these are already delivering results. For example, colleagues in Thailand had developed Chatbot to automate processing of thousands of logistic transactions previously done with a manual process, reducing errors and dramatically improving operating performance. Colleagues in Spain have released capacity in our Valencia extract facility by more than 35% by adjusting the extraction time. These projects and more like this will support us in achieving our aggressive cost savings objective of $500 million over the next two years. Moving to nutrition, the team is focused on actions across all areas of planned recovery, and we've seen expected sequential improvement coming out of the fourth quarter. The impact of these actions will accelerate in the back half of the year, consistent with what we mentioned in the last earnings call. Let me provide a few examples of progress we're making across the targeted areas. Our focus on operations and supply chain has helped us debottleneck some of our demand fulfillment challenges, particularly in EMEA Flavors, where the team has rallied to adjust our fulfillment processes following the go-live of 1ADM and improved volumes delivered sequentially. We're leveraging our improved M&A playbook to support the integration of our most recent Flavor acquisitions and now forecast better results than the initial deal model estimates. To increase speed, agility, and responsiveness to customer needs while delivering more wins across each market segment, we have fine-tuned our go-to-market and COE organizations to best align to demand. Looking to our capital allocation efforts, we have maintained our balanced capital allocation approach while leveraging excess cash flow for enhanced returns to shareholders. We returned a significant amount of cash to shareholders to date as we repurchased more than 20 million shares. As mentioned last month, our focus for excess capital deployment will remain centered on the shareholders. In summary, we are making measurable progress across each of our three major priority areas in 2024, which is setting us up well to navigate the market headwinds we are facing this year and delivering in line with our expectations. I would now like to turn the call over to Ismael for more detail on the first quarter financial results. Ismael?"
},
{
"speaker": "Ismael Roig",
"text": "Thank you, Juan. Let's start on Slide six, which provides overall segment operating profit and EPS for the first quarter of 2024. Adjusted segment operating profit was $1.3 billion for the first quarter, a 24% decrease versus the prior year. At a high level, operating profit was primarily down year-over-year in ag services and oil seeds and nutrition. In the other segment, which includes ADMIS and Captive Insurance, we had a 25% increase in operating profit. Adjusted earnings per share were $1.46 for the quarter. Lower pricing and execution margins primarily driven by margin normalization in the AS&O business led to a $1 per share decrease. This includes lower mark-to-market impact in AS&O of approximately $0.38 per share. Our enhanced focus on operational excellence and improving the reliability of our assets, as well as the ramp-up of our Green Bison JV, led to volume improvement in the AS&O segment, resulting in a $0.20 per share increase in EPS versus the prior year. Lower manufacturing costs and input costs led to a $0.15 per share increase versus the prior year, partially offset by negative impacts associated with unplanned downtime at our Decatur East facility. Higher equity earnings, primarily related to Wilmar, attributed a $0.07 per share increase versus the prior year. Increased corporate costs related to the 1ADM implementation and legal fees drove a decrease of $0.11 per share versus the prior year. In other, benefits from share repurchases more than offset negative impacts related to a higher adjusted income tax rate, leading to a $0.06 per share increase versus the prior year. Moving to Slide seven, let's look at our segment performance for AS&O. For the first quarter, the AS&O team delivered $864 million in operating profit, reflecting increasing headwinds from lower commodity prices and ample supplies, partially offset by improvements in process volumes and manufacturing costs, as we enhanced our focus on items within our control. The Ag Services subsegment operating profit was lower versus the prior year, primarily due to the stabilization of trade flows leading to lower global trade and risk management results. Slower farmer selling also negatively impacted export volumes and margins in South America. Crushing subsegment operating profit for the quarter of $232 million was lower versus the prior year. Increased imports of used cooking oil and the anticipation of large South American supplies negatively impacted North American soy crush margins, more than offsetting the benefits from improved process volumes and lower manufacturing costs. There were positive mark-to-market timing impacts during the quarter of approximately $40 million versus positive timing impacts of approximately $240 million in the first quarter of 2023. Refined products and other subsegment results were $157 million. Results were driven by weaker North American refining margins due to the increased imports of used cooking oil, as well as negative mark-to-market timing impacts of approximately $30 million versus positive impacts of approximately $40 million in the prior year. Equity earnings from Willmar were $149 million during the first quarter, higher than the prior year. Moving to Slide eight, let's look at carbohydrate solutions. For the first quarter of 2024, carbohydrate solution segment operating profit was $248 million. The team executed well in a solid demand environment, as well as advance our BioSolutions platform with strong volume growth. Turning to the subsegments. In the starches and sweeteners subsegment, strong starches and sweeteners margins in North America were offset by pressured domestic ethanol margins due to strong industry production and elevated stocks, as well as moderating margins in the EMEA region. In the vantage corn processing subsegment, strong export demand for sustainably certified ethanol supported both volumes and improved margins, leading to an improvement in year-over-year results. Please turn to Slide nine. Nutrition revenues were $1.8 billion for the quarter. In the human nutrition subsegment, strong M&A revenue contributions from our recent acquisitions, as well as price and mixed benefits in flavors, were partially offset by lower volumes in plant-based proteins and normalizing pricing in the texturants markets. Our animal nutrition subsegment had lower revenues versus the prior year, driven by lower pricing and mix. Demand creation has remained strong and provided significant revenue pipeline opportunities. We anticipate steady improvement in demand fulfillment throughout the course of the year, recovering a significant portion of volumes in the second half of the year. Please turn to Slide 10. While we have room to go on our commitment to restore the growth trajectory of the nutrition business, we believe Q1 was an important first step, showing sequential improvement from a challenged fourth quarter, evidencing progress in our operations. For the first quarter, nutrition segment operating profit was $84 million. Human nutrition subsegment results of $76 million were lower than the prior year, driven primarily from headwinds in the specialty ingredients business due to higher fixed cost absorption at Decatur East and normalizing texturants pricing. Animal nutrition subsegment results of $8 million were higher compared to the prior year, primarily driven by cost optimization efforts and lower commodity prices supporting margins. Please turn to Slide 11. For the first quarter, other segment operating profit was $121 million, up 25% compared to the prior year. The improvement was largely driven by improved Captive Insurance results on higher program premiums and lower claim losses. In corporate, unallocated corporate costs increased versus the prior year on higher global technology investments to support digital transformation efforts, as well as increased legal fees. Other corporate was unfavorable compared to the prior year due to an investment valuation loss of approximately $18 million. Please turn to Slide 12. With healthy cash flows and a strong balance sheet, we have maintained our balanced capital allocation approach while leveraging excess cash flow for enhanced returns to shareholders. We entered 2024 with momentum, which has allowed us to return $1.3 billion to shareholders via repurchases during the quarter, with $1 billion being executed through an accelerated share repurchase program. We intend to actualize the additional $1 billion of share repurchases approved last quarter throughout the remainder of the year. We still anticipate capital expenditures will be held at a level aligned with depreciation and amortization, focused largely on investments to secure reliability of asset performance through modernization and digitization efforts. Now, let's transition to a discussion on our full year guidance on Slide 13. Our first quarter results were largely in line with expectations, and in turn, our 2024 planning assumptions and EPS guidance remain unchanged. We are raising our corporate net interest expense guidance from approximately $500 million to approximately $525 million, as the Federal Reserve has signaled that the probability of interest rate cuts in 2024 has decreased. Last month, we mentioned that the global grain and oil seeds supply is expected to increase as anticipated improvements in weather would support larger production levels in key South American countries. With this, we anticipate that commodity prices will continue to ease from the recent highs of the past two years and that trade flows will adjust at the dislocations. As a result, we anticipate the global soybean crush margins would moderate in 2024, likely moving into a range of $35 per metric ton to $60 per metric ton. During the first quarter, the team executed well on a strong forward book supported by meal demand, leading to executed soy crush margins of approximately $55 per metric ton. As we look today, we see that the forward curves reflect the assumption of ample South American supplies and the return of Argentinian production, specifically in Q2 and Q3. While the supply side certainly has pushed forward curves to the lower end of that range in the near term, we remain constructive from the demand side. We continue to expect vegetable oil demand growth from renewable diesel as large facilities ramp up in Q2 and Q3, despite the increase in imports of used cooking oil. From the soybean meal side, lower soybean meal prices are incentivizing demand, supporting producer profitability and, in turn, leading to higher inclusion rates. Now moving to the breakdown of expectations by segment for Q2 2024 on Slide 14. In AS&O, we anticipate the second quarter to be significantly lower versus elevated prior year levels. We anticipate our average global soy crush margin to be towards the lower end of the guided range during the second quarter as the market balances strong soybean availability against increased crush capacity. We still remain confident in our full year planning assumptions as we move through the seasonally lower middle of the year as the world pivots to South American production. In carbohydrate solutions, we anticipate the second quarter to be higher versus the prior year, driven by solid demand and margins in North American starches and sweeteners, partially offset by moderating margins in wheat milling and international corn milling after elevated results in the prior year period. We anticipate solid demand for ethanol, both domestically and in the export markets, similar to the prior year. For nutrition, the second quarter is expected to be lower versus the prior year as we face headwinds in specialty ingredients. We anticipate to see another quarter of sequential improvement as we continue to make progress in demand fulfillment. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Ismael. Please turn to Slide 15. As you can see, our team is continuing to improve execution excellence across our strategic and operational priorities, which requires a level of agility that is a hallmark of ADM's workforce. We're focusing the organization on a combination of productivity and innovation to help offset increasingly challenging market conditions based on growing commodity supply. Our teams are looking for every opportunity to manage what we can control, remaining nimble to adjust quickly to external circumstances while advancing our strategy. When we look ahead to the rest of the year, our business priorities in 2024 put us in a position to manage through this cycle. Through the differentiation and evolution of our business models in ag services and oil seeds and carb solutions, our drive for excellence program, the recovery of our nutrition business, and continued focus on shareholder returns, we have confidence in our outlook for the full year. Thanks for your time today. We look forward to taking your questions. Operator, please open the line for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question for today comes from Andrew Strelzik of BMO. Andrew, your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "I guess I wanted to ask about the interplay. I wanted to ask about the interplay between US and South America crops and timing and farmer selling in terms of the implications for crush margins and how you're thinking about that. It seems like we've got some delayed farmer selling out of South America that could push out the timing to which that crop comes to market. And so I guess I'm just curious how you're thinking about the balance there and ultimately kind of the confidence that you have as we get into the back part of the year that you see crush margins consistent with your expectations. Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Andrew. So what we're seeing in South America at the moment, Brazil has had a little bit of a better selling last couple of weeks from the farmer perspective, given that with the harvest and also some of the devaluation of the real. So we've seen the crush margins there for Q2 improving a little bit around our portfolio of products. In Argentina, a little bit more difficult to read, Argentina with the economic plans and the uncertainty about how the government navigates through the difficult times. There are also a lot of, even when the farmer may agree to sell, there are some strikes, like right now, there are some strikes in Argentina that are popping through every sector of the economy. So a little bit more difficult to predict, but the reality is all that crop will come to the market. And we're starting to see that in crush margins, and you can see that. So what Ismael was reading in his remark is that, we highlighted a range of crush for the year. We operated in the first quarter, mostly in the higher part of that range, we will move in the second and third quarter, as traditionally happened when South America has a big crop, toward the low end of that range. And then we see at the end of the year, September onward, when we have a crop here in the U.S., where our margins will recover. So that's the way we see the year. We continue to see a strong meal demand as soybean meal becomes cheaper, and it gets more favor in the inclusions, especially when we see some maybe bottom out of profitability from the poultry sector. So that bodes well for our demand. And we have new RGD plants coming in on the stream in the U.S., whether it's Q2 or Q4, that will bring like another half a million ton more of soybean oil demand for the U.S. And don't forget that Brazil increased their mandate to B14, which represents another half a million tons of soybean oil. So all in all, I think that all that oil demand and meal demand will be important to bring back crush margins to the higher part of the range at the end of the year."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Bienvenu of Stephens Inc. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Bienvenu",
"text": "So I want to ask in the carbohydrate solution segment, you point to a pretty robust outlook for the remainder of the year for starches and sweeteners. In particular, you call out strong volumes. That's a bit of a recovery from what we saw last year. Can you talk about some of the dynamics that you're seeing around volume and the pace of recovery that you're seeing in volume that makes you call out this year?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. I would say we've seen strong demand, I would say, I don't know, strong or solid demand across all our segments. Margins have been good. We continue to get a lift on margins by the reduction in chemicals, the reduction in energy prices, a little bit better operations of our facilities. And I would say the main difference maybe versus last year was the last year we have exceptional margins in international milling and also in the corn business in Europe. Those have moderated a little bit, but still the business remained very strong. So I would say all the sweeteners and starches contracted for the year, we're pleased with it. And we expect strong exports to Mexico, other countries pulling well. So I would say, we feel strongly about having a Q2 that's going to be better than last year. So all in all, the uncertainty continues to stay on the ethanol side in which we are cautiously optimistic that, the maintenance systems will balance inventories, if you will, and lift a little bit of margins there. But for the rest of the business, rest of the business is operating very solidly."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tom Palmer of Citi. Your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "I wanted to maybe dive in a little more on refined products. You noted lower biodiesel margin expectations for the year and then in prepared remarks and pressure from imported used cooking oil. I guess, what do you see on more of a regional basis when we think about those refined spreads and more pressured U.S. and other places? And then you did have some timing gains a year ago. We saw a bit of an unwind in 1Q. Just any help on the expected progression of those as we move through 2024? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. So let me deconstruct a little bit the RPO part. The difference in Q1, so results were lower significantly than last year where we had the record year. Main reason for that is North America, as you described, the imports of used cooking oil negatively impacted North America refining margins. Actually, in EMEA, our results were higher. We executed on the strong biodiesel margins. And I would say refining there is in line with the prior year. I would say we have additional volumes that offset a little bit lower refining premiums. South American results in biodiesel and packages, margins are stronger in the current year, supported by, as I said, increased biodiesel mandate. That's half a million tons per year of new demand that really impacted that. So overall, I think the dynamic will be similar for second quarter in which you will see refining margins lower in North America and crush margins and refining margins a little bit better in South America."
},
{
"speaker": "Tom Palmer",
"text": "Thanks. And just any help on the timing, Juan?"
},
{
"speaker": "Juan Luciano",
"text": "Oh, yes. Well, year-over-year, there was a $72 million negative of net timing impacts in Q1. So we had a negative mark-to-market this quarter of $30 million versus the previous year where we had a positive of 42. So that's the arithmetics, if you will, of that."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Manav Gupta of UBS. Your line is now open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"text": "Good morning. My only question is, can you provide the path to the full restart of the Decatur East plant? Like where are we in the restart regulatory or construction, if you could help us out with that? Thank you very much."
},
{
"speaker": "Juan Luciano",
"text": "Yes, Manav. Good morning. Listen, there's a lot of activity going on there. But we have said, I think this is something we've got nutrition is going to carry as a headwind during the whole year. We expect that plant reasonably to be operating in Q4. I cannot provide any more details or granularity on that as we're going through all the projects, but I would say as soon as we have more specifics, we will be updating all you guys on that. But at this point in time, I think you need to think that the headwinds for nutrition in specialty ingredients and a lot of that driven by this will carry through the year."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"text": "I was just hoping you could help me. I just want to discuss the crush margin outlook a little more specifically on the soy side. So thank you for the cadence information you provided earlier. But I just wanted to dig in a little bit more. So at present, the curve for the U.S. has margins below the range. And then on a cash basis, in certain regions, they're materially below that 35. So when I think about the rest of the year, are y'all assuming that regions like Brazil and Europe are going to provide a material uplift to offset the U.S.? Or is it you think the increased soybean oil demand, et cetera., will make U.S. margins materially better than the curve is indicating at present? So just trying to think about how you all are thinking about that."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Heather, good to hear from you. Listen, the way we're seeing it at the moment, so North America, as we said, Q2 and probably Q3 will move to the lower part of the range. Then as we come through the year and we get more beans here in the U.S. and we get more renewable green diesel volume coming from probably 1 billion gallon more of capacity that's coming, we think that, that and inclusion rates will drive Q4 higher. In the Q2, Q3 area, if you will, we see right now, crush margins in Brazil have gotten better across all our plants, not only the domestic ones, but also the export ones. So as the farmer has been selling a little bit more, as you get more through the harvest there in Latin America, farmers start to move a little bit more volume. In Brazil, it was helped by the devaluation. So we saw that easing the pressure that we have in getting beans and helping crush margins. Europe, we expect it to be around $40 per ton, so it's a little bit in the middle of the pack. China, we don't have a lot of visibility in China, but it seems to be very spot in China at the moment. So it's a little bit hand to mouth over there. So in general, as I said, we see for ADM, at least, a big correction going into the second quarter, also a soft third quarter, and then we start to see coming back up in the Q4. But mostly, the curve of the U.S., if you will, with a little bit moderation provided by the other areas."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "I wanted to ask a little bit about ethanol. And specifically, it seems like your commentary on ethanol was a little bit different between starches and sweeteners and VCP. It seems like you talked about lower ethanol margins in the former and better ethanol demand margins, et cetera, in VCP. So can you clarify why this, I guess, ethanol margins from the 2 different types of mills diverged? And also specifically, what are you seeing on the ethanol export front, and why is that benefiting VCP more than Starches and Sweeteners?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. The reference we made to that is because VCP results were helped by stronger export demand for sustainably certified ethanol, and we get a premium for sustainably certified ethanol. So that supported volumes and margins. In general, Salvator, ethanol is a very cheap oxygenate, so it's getting a lot of demand from the rest of the world. So exports are expected to be north of 1.5 billion gallons. And blending demand inside the U.S. domestically has been good. It's just that this is the time of the year in which the plants have produced a lot. I always said the plants are exothermic. So in a time of cold temperature, they produce a lot, and that's a time where we drive the least. So now we're going into more the maintenance period of those plants. And I think that inventories for the industry, we hope will come a little bit more into balance, and we expect that to higher driving miles during the summer to balance margins a little bit better. But we expect for the whole year for exports to remain very healthy."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"text": "Just wanted to follow up on some of the initiatives you're doing within the Nutrition business. And Juan, you talked about it at the beginning as it relates to like just simplification, portfolio optimization. So as you've looked through the assets and obviously, it's been volatile here and somewhat soft, obviously impacted by some of the onetime items. But as you think about Nutrition going forward and past some of the issues with the plant downtime, et cetera. How do you want to structure this business? Where do you want to take it to? What do you think is going to be the Nutrition, call it, maybe 2.0 version in 2 to 3 years time? What's the contribution, animal, human? How should we think about this?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Good question. Listen, if you see the sequential improvement that we have had right now, is we're taking a lot of the one-offs we received last year or even in Q4 out of the picture, if you will. Some of them completely. Some of them, they're going to continue to improve as the business improve the reliability of our supply, if you will. I would say, in the short-term, you need to be able to see through some of the headwinds that we will get in revenue because of the correction of raw materials. So there are some parts of the Nutrition business, what we call Specialty Ingredients, if you will, that were either related to proteins or emulsifiers. Those things tend to correct revenue because they are related to soy or corn at the end of the day, so they moderate. And that business is a business that from a volume perspective, there is a reshuffle of the demand in terms of plant-based proteins. And there's a lot of exciting stuff that the industry is doing. Listen, there is a lot of emerging technologies, novel ingredients and new culinary techniques that will come to revitalize that demand over time, but that's a shift that we're going through and you're not going to see that in 2024. But that's something that, long term, we still believe in that piece. Right now, in the present time, flavor, we continue to see strong demand for flavor, whether it's in North America or whether it's in Europe. To the extent that we can release our supply constraints, we will be able to capitalize more on that. And U.S. has been doing better, faster than maybe Europe, and we're correcting those things in Europe but we feel strongly about that. On the Health & Wellness perspective, biotics continues to excel. Biotics have increased OP by like 100% in the first quarter. So we're doing very well. We're getting some headwinds from the fibers perspective, but I think that's a matter of competitive materials. But over time, fibers has a very positive prognosis as all of us are trying to incorporate more protein and fibers in our diet and reduce fats and sugar that's where the world nutrition trends are moving. And then when you think about the Animal Nutrition side, Animal Nutrition is probably the most undervalued, if you will, story given their potential. Because we are doing a lot of self-help, and that self-help continues to be seen in the P&L. But some of the protein sector issues have impacted the demand there. I would say there in the Animal Nutrition area is where we're probably going to see more of the refinement of the portfolio, if you will, just because there are unevenness across sectors in terms of our ability to achieve the right returns on the long-term. So in some part of the sectors, it's more like self-help. In other parts, it's more innovation driven. And even if you go to things like pet, where the demand is very strong, there are pieces of the world that are doing exceptionally well for us like Mexico. There are pieces where demand is very strong, like in North America, so maybe we need to fix some supply issues. And there are parts of the world, like maybe like South America, where structurally it becomes a little bit more difficult to make money. So we are applying different recipes to the different parts of the world. But I still see a very complete Nutrition business, if you will, going forward, more focus on the maybe fewer platforms, fewer customers to be able to execute our pipeline faster. Maybe in the past, we have a big pipeline with a percentage of conversion that we expect it to be higher on a maybe a more focused, concentrated pipeline. That's the way I tend to think about it."
},
{
"speaker": "Ismael Roig",
"text": "Can I offer a complementary view? I just wanted to offer you a complementary view on Juan's comments with regard to Animal Nutrition, but I think it also applies to the broader portfolio, which is I fully agree with Juan in the sense that the base business in Animal Nutrition is now experiencing the benefits of the cost improvement programs that we put in place, and we've seen that evolution quarter-on-quarter. But to Juan's observations on a going-forward basis, you will see a business that is looking to become more focused on the specialty side of its portfolio. As Juan alluded to at the beginning, part of the revenue calculation for the platform is partly impacted by the fact that there is a soy mill commodity component to some of the products that are produced. Over time, it's a business that will evolve to become more specialty focused, more higher margin focused. I think it bodes well for the growth and margin structure of that business as we look forward into 2025."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"text": "Maybe just two quick follow-ups on Nutrition. So I think your income was down slightly and based on your kind of prior comments about there being some price component, were your volumes, I guess, organic volumes, positive in the quarter? That would be the first one. And then the second question is on the full year, you mentioned that the recent M&A is kind of coming in ahead of your kind of deal model expectations. How much operating profit contribution are you baking into the full year guide from M&A? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Steven. So let me tell me that we are very pleased with the 2 M&As. The 2 M&As contributed to revenue in the first quarter and not yet to OP because of start-up costs and all that. But we still expect revenue, even despite the headwinds that I mentioned before relative to commodity prices, moderating in some of our less specialty categories. We expect revenue growth to be in the range of mid-single digit for full year. We expect probably operating profit to be a little bit better than that given that our cost should be down year-over-year. So what was the other question there?"
},
{
"speaker": "Ismael Roig",
"text": "Yes. So in terms of overall volume, volume was a complementary question. Overall, we've seen volume hold up well. The exception to that would be, obviously, the Specialty Ingredients business and specifically, the impacts of the Decatur East plant. But all of the other elements of our business have generally performed well volume-wise. So you've seen a bit of a deterioration of the volume on a revenue basis, but you have seen a general improvement except for the SI business when it came to volume."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Your line is now open. Please go ahead."
},
{
"speaker": "Adam Samuelson",
"text": "So I guess I got two questions. Maybe first, as we think about the outlook for the year where you talked about improvement in soy meal demand and inclusion ratios later in the year. Can you maybe help us be a bit more specific? Just that doesn't seem to you as implied by the curves. Most forecasts on poultry supply in different parts of the world don't really project a sizable uptick in production. So could you just help us a little bit on the areas where you're actually seeing that or getting that signal from your feed customers? And then an unrelated question, as I think about some of the cost actions and productivity savings that you've targeted for this year and next. Would love if you could maybe a bit more specificity to the areas where the $500 million are really coming from, both in terms of the category of spend, but also whether they're in the operating segments or in corporate unallocated as we think about the outlook for the next couple of years. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, sure. Adam, listen, I think what you need to realize, so first of all, we are early in the year, of course, and we are making predictions on Q4. So this is a transition period for the industry, if you will. We're going from a couple of years of tight supplies to ample supplies. So we're seeing here a customer base that is very uncovered, if you will, farmer selling that is a little slow. And we're going to go through that transition. On top of that, you have a proteins industry that was in the unprofitable territory, if you will, and still is for certain for, if you will, beef or some parts of pork, but now it seemed to have based and seeing growth trends in poultry. So we see that in different parts of the world, whether it's in Thailand, in Turkey, in other parts of the world. But I think the main issue is that pricing is doing its effect. So you see some trade flows changing. We see some soybean oil being exported out of the U.S., as we see used cooking oil coming into the U.S. We're starting to see maybe Brazil becoming less of an exporter of soybean oil, maybe more competition in mills, but the U.S. is still very competitive in mill. So I think that we will have to see all that shift during the year. What we are seeing is we're looking at our customers, we're looking at our book. And we just think that, again, with 1 billion gallon more of RGD capacity in the U.S. with 500,000 tons more soybean oil coming from the biodiesel mandate in Brazil, that will be a very big determinant of crush margins for the year. With that, I think Ismael will cover the drive for excellence profitability."
},
{
"speaker": "Ismael Roig",
"text": "Yes. Adam, on the drive for excellence, we're actually quite encouraged by the progress. As Juan mentioned during the remarks, we have more than 1,200 initiatives, but they can be grouped into substantial areas or themes of effort and focus, working on plant process optimization, working on business process optimization, also very important on supply chain and demand fulfillment , which is part of the challenges that we've had in Nutrition. So these would be the large buckets that we're working on. And we've seen the platform progress very well. And we have at least about 1/3rd line of sight of the $500 million already for 2024. So we're very encouraged about the ability of this drive for excellence impacting 2024 already in the measures that I've just outlined."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Kallo of Baird. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Kallo",
"text": "Just how do we think about or you think about the dynamic of the blenders tax credit changing over to a producers tax credit and the carbon intensity being a factor for overall soy oil demand in the U.S. next year?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Ben, for the question. So as you know, the $1 blenders tax credit will expire at the end of '24 and transition to a production tax credit. And this will be administered by the US Treasury. They issued guidance on, I think, at the end of last year that will allow the use of grid CA modeling in addition to CORSIA. Of course, we favor including grid. We're successful in grid being officially included. We're still delayed in the EPA ruling on that. So I think that we have been doing a lot of advocacy in encouraging government officials to make sure that we remove this uncertainty out of the equation here. I think that a transition without guidance of whether the crop-based biofuels will generate credits will create a very difficult price discovery mechanism in the coming months, as participants are trying to begin locking 2025 volume. So I think that's an important clarification that needs to happen. These are industries that are investing in the U.S., and I think that providing regulatory certainty are very important for those investments to come to fruition on time and as expected."
},
{
"speaker": "Ben Kallo",
"text": "Just a follow-up there. What are you seeing with the renewable diesel refiners, producers in terms of them transitioning to using waste fats or other materials?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Listen, there is a reality in the world that palm oil production is flat and not being able to cope with demand. So we know that the U.S. and renewable green diesel was going to have to be met with a lot of feedstocks, of which soybean oil is an important component. But of course, the industry is trying to gather every kind of feedstock that they can find. And there was inventory of used cooking oil. The U.S. has imported a lot of that, but still is not going to be enough because how much are you going to grow the used cook oil inventory around the world to supply, as I said, an industry is going to have 1 billion gallon more capacity this year. So we still expect that we are adjusting to these temporary imports of used cook oil. But we still expect that soybean oil will recover their percentage of the used from maybe 30% to again, the 40% we used to be."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Salvator Tiano of Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "I just had a follow-up. So as we look a little bit into a couple of items, can you help us understand the Green Bison contribution now? So for example, the process volume growth that you showed, roughly how much came from that? And also, I believe you had the $10 million non-controlling interest loss. Well, I guess, the JV, among others, are the loss. So how much, I guess, of that was the Green Bison JV, and at which point do you expect it to turn into a profitable JV on a net income basis, so for that NCI line?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Salvator, maybe I give you what I have at the top of my mind. But we were very pleased with the increase in volumes in oilseeds or in crush during the first quarter. It was 9% increase. Part of that was Spiritwood coming online, part of that were our plants improvements in general across the footprint. Part of that was Paraguay and Ukraine also coming to crush. So that all happened at different points in the quarter. So I don't have a full recollection of what happened to what volume at any part of the quarter. The Green Bison joint venture will be a contributor to profit during 2024. So it's ramping up. It's going to get to full capacity very soon. So it will be a meaningful contributor. I don't have top of my head what was the contribution on first quarter, to be honest."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"text": "Just wanted to ask really quickly what exactly you're doing for the dry mills as far as sustainability sourcing? And the doubling of your region acreage, is that related to like proactively getting ahead of this EU deforestation regime or more stringent carb requirements? Just wondering what's driving that?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. So Heather, in carb solutions, we have a whole decarbonization strategy. Actually, across ADM, we have a decarbonization strategy, driven partly by our Strive 35 goals that we need to decarbonize ourselves, part driven by our customers and the need for either awaiting Scope 3 emissions from the side of our customers, but also by providing some low carbon intensity characteristics of some of our products that has also commanding a premium out there. So what are we doing? We are working on increasing our carbon capture sequestration. We're going to go from 2 wells, 1 well and 1 experimental well, but let's say 2 wells to 7 wells, so we're going to be able to increase significantly our capacity. And let me remind you, we have already captured 4.5 million tons of CO2 in the last 10 years that we've been operating. So that has been successful. For the dry mills specifically, what we're doing is we are building pipelines to bring that to our carbon capture and sequestration units indicator. We have 1 pipeline that has been ongoing, the project, and we are looking for solutions for the other dry mills. So that's what is happening. The second part of the question, Heather, I'm not remembering exactly what..."
},
{
"speaker": "Heather Jones",
"text": "I was just wondering about the region."
},
{
"speaker": "Juan Luciano",
"text": "Oh, yes."
},
{
"speaker": "Heather Jones",
"text": "Yes, on the region acreage, just wondering, is that doubling in anticipation of like the EU deforestation regime or more stringent carb standards? Just wondering what's driving that. Or is it all voluntary market-driven growth?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. I would say there is excitement on both sides. There is excitement on the farmer side to adhere to all these practices, but there's also a lot of demand pull from the customer side in terms of we continue to sign contracts for more of these as people need to, again, have an answer to their Scope 3. So we have been setting goals, and we have been beating those goals and increasing those goals. Now we have expanded that to Europe and Latin America, and we continue to see demand for these activities around the world. And to be honest, the team has been doing an excellent job. So I think that this program is perceived as the leading program in the world there."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, we currently have no further questions. So I'll hand back to Juan Luciano for any further remarks."
},
{
"speaker": "Juan Luciano",
"text": "Okay. Thank you. Thank you, everyone, for joining us today and for your interest in ADM, and have a great day."
},
{
"speaker": "Ismael Roig",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you for joining today's call. You can now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADM | 1 | 2,025 | 2025-05-06 10:00:00 | Operator: Good morning, and welcome to the ADM First Quarter 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin.
Megan Britt: Welcome to the first quarter earnings conference call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. Unless otherwise required by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available in our earnings press release and presentation slides, which can be found in the Investor Relations section of the ADM website. I'll now turn the call over to Juan.
Juan Luciano: Thank you, Megan. Hello, and welcome to all who have joined the call. Please turn to Slide 4. Today, ADM reported adjusted earnings per share of $0.70. Total segment operating profit was $747 million for the quarter. Our trailing fourth quarter adjusted ROIC was 7%, and cash flow from operations before working capital changes was $439 million. ADM's first quarter results were aligned with our outlook and market expectations and our business operated well in a dynamic external environment. With uncertainty related to global trade and regulatory policy continuing to have an impact on the business, we were able to drive positive momentum in focused areas. Our Carbohydrate Solutions team delivered solid results supported by positive margins in sweeteners, along with strong execution in ethanol. Nutrition's performance in the first quarter, specifically in our Flavors and Animal Nutrition portfolios, is on a path to recovery. We also made important progress in getting our Decatur East facility back online as it moves into the final stages of recommissioning. Ag Services and Oilseeds was impacted by challenging conditions and overall market uncertainty and took actions to drive organizational realignment and network optimization. And thanks to our team's continued diligence in safety, I'm pleased to report that our Q1 total recordable incident rate was the lowest it has been in the history of ADM. These examples highlight our team's ability to drive our strategy forward, while focusing attention on the self-help and execution excellence agenda we outlined earlier in the year. Let's take a closer look at our progress in the first quarter. Please turn to Slide 5. In our last call, we shared a slate of self-help activities to enable us to deliver on execution and cost goals, drive simplification and strategic growth while maintaining continued capital discipline. We're taking a balanced approach to these efforts across the business. Let me share a few highlights. From a cost perspective, we made important progress on our target of $500 million to $750 million in cost savings over the next three to five years. This included a targeted workforce reduction to align our organization to our most critical priorities, along with a thorough review of third-party consulting spend. With this, we are seeing a reduction in our overall SG&A costs. We made the strategic decisions to deliver optimization across the network, including the recently announced closure of our Kershaw, South Carolina crush facility, exit of domestic trading operations in China and Dubai as well as the consolidation of several grain warehouses. We don't take actions that impact our colleagues and the communities where we operate lightly. I have engaged with these groups to clearly explain the rationale for our decisions and provide them with necessary transition support. We're also addressing challenges with operations uptime from our North America soy assets and we are now live with Decatur East and expect to have the plant at full run rate by the end of the second quarter. The focus on our Nutrition business is beginning to show positive results. Addressing demand fulfillment issues and leveraging our innovation capabilities in Flavors has supported a strong year-over-year operating profit. We've unlocked both simplification and growth potential in our recent Mitsubishi MOU announcement, focusing our combined teams on what they do best. We advance automation and digitization across our global manufacturing network, scaling successful pilots, improving reliability and efficiency and driving over a dozen new projects to deliver cost savings and smarter operations. We continue to invest in R&D related to health and wellness solutions. And in February, we announced a partnership with Asahi Global Foods Corporation to distribute an innovative postbiotic design to address challenges with the stress, mood and sleep. The expansion of our Regen Ag partnership and BioSolutions business is playing an important role in driving farmer resiliency, creating new high-value avenues for the sale of differentiated crops. Underpinning all this work, we remain focused on capital discipline and actively managing traditional channels to return cash to shareholders. As we look ahead to the remainder of the year, this self-help agenda will be critical to positioning ADM to manage through what continues to be an uncertain external landscape. We remain confident in our team's ability to take the balance of actions needed to support the result that matches the high expectations we have set for ourselves. Our team is keeping close to our customers and remain alert to both the challenges and the opportunities that we're seeing in the market. We're taking full advantage of the breadth of the investment we have made in our business over the past decade and the agility that provides. From our crush and export capabilities across the U.S., Argentina and Brazil to our expansive origination network to our expertise in formulation to our portfolio of ingredients, including all natural colors and flavors, all of these add to ADM's ability to support rapidly evolving needs. With that, let me hand it over to Monish to share a deeper dive into first quarter financial results and our 2025 outlook.
Monish Patolawala: Thank you, Juan. Please turn to Slide 6. To start, let me provide some perspective on the operating backdrop that shaped the first quarter for the AS&O segment. As we expected, market disruptions related to biofuel policy uncertainty negatively impacted biodiesel and renewable diesel margins and U.S. vegetable oil demand. We also experienced higher global soybean stock levels and an increase in Argentinian crush rates, which pressured global soybean meal value. Additionally, trade policy uncertainty, particularly with Canada and China, created volatility throughout the quarter for canola meal and oil. Taken together, these factors resulted in significantly lower meal and vegetable oil values, pulling down margins across our businesses. Overall, against this backdrop, AS&O segment operating profit for the first quarter was $412 million, down 52% compared to the prior year quarter with declines across all subsegments. In the Ag Services subsegment, operating profit was $159 million, down 31% versus the prior year quarter, driven primarily by lower North American origination export volumes as order flow was impacted by trade policy uncertainty. North American origination results also reflect the additional expense of $34 million recorded in the period for anticipated export duty. Global trade results were lower relative to the same quarter last year, largely due to the negative timing impact, partially offset by higher destination marketing volumes and margins. Total net timing impacts were approximately $48 million year-over-year. In the crushing subsegment, operating profit was $47 million, down 85%. Consistent with the previously provided outlook, both global soybean and canola crush execution margins was significantly lower than the prior year quarter. Global executed crush margins were approximately $13 per ton lower in soybeans compared to the prior year quarter and approximately $40 per ton lower in canola. By region, crush margins were down significantly in North America. North America soybean crush margins were negatively impacted by additional capacity from new crushing facilities and lower soybean oil demand stemming from biofuel policy uncertainty. North America canola crush margins were negatively impacted by trade policy uncertainty and lower canola oil demand for biofuel production. There were net negative timing impacts of approximately $36 million year-over-year. In the Refined Products and Other subsegment, operating profit was $134 million, down 21% compared to the prior year quarter due to lower biodiesel and refining margins. In EMEA, margins declined due to significantly lower biodiesel export volume. In North America, refining margins were negatively impacted by additional industry crush capacity and lower demand for vegetable oil due to biofuel policy uncertainty. There were net positive timing impacts of approximately $34 million year-over-year. Equity earnings on the company's investment in Wilmar was $72 million, down 52% compared to the prior year quarter. Overall, during a challenging quarter, the AS&O team executed on operational improvement like plant and network consolidation and took actions to accelerate cost savings, starting with targeted organization realignment to partially mitigate the less favorable market conditions and be in an excellent position to capture opportunities as we move through the remainder of the year. Turning to Slide 7. For the first quarter, Carbohydrate Solutions segment operating profit was $240 million, down 3% compared to the prior year quarter. Operating profit for this segment came in slightly ahead of our previously provided segment guidance for the quarter. In the Starches and Sweeteners subsegment, operating profit was $207 million, down 21% compared to the prior year quarter. In North America, S&S results were lower due to lower starch margins from demand softness in the paper and corrugated markets, as well as lower North American wet mill ethanol results due to lower ethanol margins. In EMEA, S&S volumes and margins declined as higher corn costs and increased competition negatively impacted results. As a partial offset, North American liquid sweetener margins improved relative to the prior year quarter due to better product mix. Global wheat milling margins and volumes also improved relative to the prior year quarter, largely due to volume growth with key customers. In the Vantage Corn Processors subsegment, operating profit was $33 million, up compared to the prior year quarter due to higher ethanol volumes and improved ethanol margins relative to the prior year quarter. Overall, ethanol EBITDA margins per gallon were slightly negative in the quarter. Turning to Slide 8. In the first quarter, Nutrition segment revenues were $1.8 billion, down 1% compared to the prior year quarter, primarily due to negative currency impact. Human Nutrition revenue was up 4% due to strong Flavors growth and M&A, which offset headwinds related to supply chain challenges from Decatur East. Animal Nutrition revenue was down 6% as negative currency impacts and lower volumes offset mix benefits. Nutrition segment operating profit was $95 million for the first quarter, up 13% versus the prior year quarter. Human Nutrition subsegment operating profit was $75 million, down 1% compared to the prior year quarter as improved performance in Flavors was more than offset by declines in specialty, ingredients and health and wellness. Animal Nutrition subsegment operating profit of $20 million was higher than the prior year quarter due to higher margins supported by ongoing turnaround actions. Please turn to Slide 9. Through the end of the first quarter, the company generated cash flow from operations before working capital of approximately $439 million, down relative to the prior quarter due to lower total segment operating profit. Solid cash generation and our strong balance sheet remain a critical differentiator for the company. We will continue to seek opportunities to further strengthen our balance sheet to provide financial flexibility to organically invest in the business to enhance returns and create long-term value. We are also taking actions to ensure working capital excellence through stronger rigor on working capital planning, inventory rationalization, improvement of key account payable metrics and more timely collection of past due balances. At the same time, we remain committed to returning cash to shareholders and we returned $247 million to shareholders in the form of dividends in the quarter. Turning to Slide 10. We have provided details to support our 2025 consolidated outlook. Earlier today, we affirmed our full year adjusted EPS guidance. We continue to expect adjusted earnings per share to be between $4 to $4.75 per share, though we now expect to be at the lower end of the guidance range given the current market backdrop. In particular, we remain cautious about our second half outlook for crush margin improvement as current domestic crush replacement margins are below our outlook. With the uncertainty related to tariff policy and macroeconomic conditions, we are not providing segment operating profit guidance for future quarters. We are providing directional guidance at the segment level for the full year. Our directional guidance for operating profit for the full year for Carbohydrate Solutions and Nutrition has not changed from our previously provided indication. With performance to date and continued pressure on crush margins in the second quarter, we are lowering our directional guidance for AS&O for the full year to be lower than the prior year. As an additional data point, current crush margins for the second quarter are trending lower than the first quarter. I also want to share some updates on our overall assumption. We still expect better crush and biodiesel margins in the second half of the year as clarity on renewable volume obligation or RVO is expected to support strong U.S. demand for crop-based vegetable oil. We also expect to deliver our $200 million to $300 million cost savings target for the year, and have already taken several actions that are delivering savings. We are working thoughtfully to accelerate saving realization where possible. We have seen some signs of weakening customer demand, particularly in Carb Solutions and have lowered our volume expectations for select markets and products. While we are not embedding any significant macroeconomic slowdown in our guide, we are actively monitoring consumer demand. To conclude, as we navigate 2025, our focus will remain on what is within our control. A full commitment to remediating the material weakness and making strides to strengthen our internal controls, driving execution, to improve operational performance and lower cost while sustaining functional excellence, simplifying our portfolio to enhance focus on core competencies while unlocking additional capital to drive value and position the company for long-term success. These efforts position us in our ability to navigate the current dynamic environment and reinforce our confidence in delivering on our commitments. Before I hand it back to Juan, I want to take a few minutes to thank all my ADM colleagues for their dedication and focus in delivering for our customers and helping to create long-term value for our shareholders. Back to you, Juan.
Juan Luciano: Thanks, Monish. I'll briefly close by recapping our focus as we continue the path into 2025. As I said at the top of the call, we will continue to focus on both execution, agility and our self-help agenda. Our teams are monitoring the evolving geopolitical and macroeconomic landscape, and they are taking actions as we get more clarity about both the short and long-term situation. Importantly, we are leveraging cost management, strategic simplification, targeted investments and capital discipline to ensure we are prepared for a multitude of scenarios. The potential impacts on our mitigating actions look different for each part of the business. For Carbohydrate Solutions and Nutrition, we are paying close attention to overall consumer sentiment and the potential for an economic slowdown to mitigate against this, we're taking aggressive action on our manufacturing and SG&A costs. In Nutrition, specifically, we are focused on getting our East plant fully ramped up, optimizing our Animal Nutrition business model, leveraging our leading specialty ingredients portfolio, including all natural colors and flavors, and ensuring we are continuing to execute against a healthy opportunity pipeline in flavors and health and wellness. For Ag Services and Oilseeds, we are monitoring the global trade and biofuel policy environment to ensure that we can enable the export market for our vast origination footprint and take advantage of improving demand conditions later in the year. On trade policy, we have seen positive signals with both delays in implementing tariffs to potential avoidance of tariffs and counter tariffs. The decision regarding USTR's Section 301 proposal have mitigated some of the potential impact of transporting commodity products between China and the U.S. And more broadly, for China exports, we will need to see where things stand as we approach the U.S. soybean harvest in the October to December period. Beyond trade, strong policy support for biofuels, including clarity on RVO is expected to support strong U.S. demand for crop-based vegetable oils. In this business, beyond general market improvements, we will continue our focus on both cost management and strategic simplification self-help efforts to manage through uncertainty. As noted by Monish, these factors support our confidence in our full year guidance for 2025, though with current fundamentals, we will be at the lower end of our range. We are a U.S. company that is fundamental to the global food, feed and energy supply chains, connecting consumers with farmers to fuel the world and keep the U.S. agriculture sector competitive. We have a long track record of navigating cycles and are focused on resiliency, which comes from our unparalleled asset network and our employees' commitment to excellence. As in the past, regardless of external challenges and market disruptions, ADM is working with our farmers and customers to be a source of strengthening the economy, always fulfilling our mission to unlock the power of nature, to enrich the quality of life. With that, we'll take your questions now. Operator, please open the line.
Operator: Thank you. [Operator Instructions] Our first question for today comes from Tom Palmer of Citi. Your line is now open. Please go ahead.
Tom Palmer: Good morning and thanks for the question. Maybe just to start out, I wanted to ask on your expectation for the RPO and how this guides your outlook for 2025? So when we think about biodiesel margins in the back half of the year, should we be thinking that we could see a return to last year's levels? When we look at crush margins, is the assumption that we could see a return to kind of the original guidance, which I think was $45 to $55 per metric ton per soy and $50 to $70 for canola. Just any help on kind of the shape of the year in terms of the second half and how the RVO influences that. Thank you.
Juan Luciano: Yes. Thank you, Tom, for the question. As you pointed out, we see a strong RVO as the most important driver for the biofuel outlook. We understand that the RVO's role is being developed, and we are engaged with the administration on the important role of the RFS and strong RVOs to support the domestic market for U.S. farmers, and to support a strong American energy independent. And we are confident that EPS is a priority. So of course, at the moment, the industry is not running at rates to satisfy mandated volumes. And we expect, and the logic implies that margins need to go up to bring run rates higher in the second half. When we go to crush, and we're probably going to see that by RINs improving as we go forward. When we go to crush, we have seen strong demand for soybean meal. Of course, there has been a strong crush rates in Argentina, Brazil and the U.S. But we've seen that leg is supportive. Of course, when we cannot produce all these biofuels in the U.S., oil goes to fight with -- for export markets. And that's the weak leg at this point in time. So we expect that with RVOs coming back, we will be able to come back to the original expectations and maybe we had at the beginning of the year.
Monish Patolawala: Just from a math perspective, since you asked specific comp. First quarter we -- as my script says, we ended $13 below last year, so around $40, $43 in Q1. In soy, canola was last year, was around $100. So we are somewhere -- we were $40, $35 to $40 lower. Q2 is currently trending lower than Q1 from a crush rate perspective. Part of it is timing because we do get book on before the quarter is in. So Q2 is lower both in canola and in soy. And then as Juan said, we are expecting a ramp-up in the second half. Of course, now it's going to be a wider range because Q1 and Q2 are lower. So when we originally said we would be in the 40 to -- we had said 45 to 55, we are now saying $40 to $65 for the year on soy and then canola, we had said 50 to 70, we are at the 45 to 65. So as Juan explained it, when we do come back in the second half, you would come back to margins that we had originally expected. But since the first half is lower, the total number gets impacted. So hopefully, I answered your question.
Tom Palmer: Thank you. That was very helpful.
Operator: Thank you. Our next question comes from Andrew Strelzik of BMO. Your line is now open. Please go ahead.
Andrew Strelzik: Hi, good morning. Thanks for taking my question.
Juan Luciano: Good morning.
Andrew Strelzik: I actually wanted to follow up on the RVO. Good morning. Just wanted to follow up on the kind of RVO line of questioning. Is there a specific RVO kind of number or range that you're assuming to get to those types of outcomes or how do you maybe think about that, number one? And number two, just more broadly, what is a positive RVO outcome for ADM? Is there like a breakeven RVO above which you see it as a positive outcome below, which is negative. We've obviously seen the reporting north of $5 billion. So I'm just curious how you think about maybe the range of outcomes and how it impacts your business? Thanks.
Juan Luciano: Yes. Thank you, Andrew. I would say the industry ask to a certain degree is like $5.2 billion of biomass-based biodiesel and maybe $15 billion conventional, so a total of $25 billion, $25.5 billion I think, as I said, we are engaged with administration. We understand that the EPA understands the importance of this. It helps with all the priorities the administration has set up, which is to help the agricultural farming. We need to do that by expanding export markets but also by solidifying internal consumption and biofuel is an excellent way to do that, and also to improve energy dominance, which another objective. So we're engaged. I mean we finished -- as you know, the guidance on all these ended on the 90-day comment period ended in April. So we are expecting that the administration is tackling these hopefully soon. So -- but the industry depends on that.
Monish Patolawala: Just Andrew, I'll build on you asked the impact to ADM for like -- I'll just talk second half of 2025, because the assumption is that replacement margins would move up. So if replacement margins did not move up between now to the end of the year, then that's a $0.50 additional headwind. So that's the impact that we are counting on a recovery in the second half from an RVO perspective or from crush margins, which is heavily driven by what RVOs become.
Andrew Strelzik: Got it. Thank you very much.
Operator: Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead.
Heather Jones: Morning. Thank you for the question. I had a question about RPO. So I know there was a -- I think it was a $34 million year-on-year positive timing benefit. But even adjusted for that, given how weak the environment was in the U.S. and the lower -- much lower export volumes out of EMEA. Just curious what drove the strength there? And I know it's significantly lower than the past few years, but prior to the RD rush we saw over the past few years, I mean that was a pretty good showing. But just wondering what were the positives in that given the very challenged backdrop here in the U.S.?
Juan Luciano: So Heather, I would say, yes, in the short run, it was a little better. But when you look at it for the whole year and how our guide is based, I would say, in total, we still continue to see RPO to be softer. And you have seen most of the items, biodiesel margins have already come off significantly. And part of it is driven by just extra volume, pretreatment capacity, et cetera. In EMEA, the margins are also significantly lower than the prior year, where again, we experienced benefits from U.S. SME market flows. And then third, when you just think about the backdrop with the implementation of 45Z as well as all the extra refining capacity that exists, that will continue to weigh on margins. So I would say, in total, taken together, RPO will be significantly low versus the prior year. And that's what we had thought coming into the year, and that's what we continue to think sitting as of right now.
Heather Jones: Okay. Thank you.
Operator: Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead.
Rahi Parikh: Hi everyone. This is Rahi on for Ben. Thank you so much for the color today. Just regarding tariffs, can you give us more color on trade flow shift, i.e., how you're replacing Chinese demand? And maybe how much of a drop in volume was related to China and Ag Services. Do you have a percentage of profit or revenue that normally relates to China? Thank you so much.
Juan Luciano: Yes. Hi Rahi, listen, at the end of the day, I would say, if you look at Q1. If you think how all these tariffs or this thing has settled, the impact has not been that significant in Q1. Probably the biggest impact we have had has been from speculation about what the USTR Section 301 maritime issue was going to be. But in reality, when USTR issued a ruling, it basically almost removed all the risk from agricultural experts. So we've been pleased to see the administration have paused for 90 days, the implementation of some of these, while we still try to negotiate agreements with the different parties. But if you think about Mexico and Canada export tariffs, basically 98% of our products are exempt from that. So we didn't feel any impact there. Corn, Europe, they delayed the retaliation on corn until July and in soybean until December. And although on China, we escalated, the reality is the U.S. is not going to be competitive to China for the second and third quarter because that's when Brazil and Argentina become most competitive. And we come back in October when there is the U.S. harvest. So we have until then to see how this clarifies. So that's where we see the situation today. Again, we are working as you said how to offset the impact of that, for us. We work directly in the U.S. with 60,000 farmers. It's important for them the access to export markets. So there are going to be export markets where we're going to be gaining share. Remember also that China has moved to Brazil to a certain, -- to a bigger extent in the previous issue with trade in 2017 or 2018. So the reliance on U.S. export into China is not that big, probably for soybeans is in the range of 20 million tons, if you will, if that were the total impact. And then I think China export, so I think that that's the impact at this point in time, we were pleased to see, as I said, USTR Section 301, was sold favorably for agricultural experts.
Rahi Parikh: Okay. Thank you so much.
Juan Luciano: You're welcome.
Operator: Thank you. Our next question comes from Pooran Sharma of Stephens. Your line is now open. Please go ahead. Sorry, Pooran, your line is now open. Please go ahead.
Pooran Sharma: Apologies about that. Hi, good morning. Thanks for taking the question, here. Just wanted to ask about the soy crush industry. Just with all the announcements with new crush capacity coming online in North America and then just with the weak fundamental backdrop that we've had over the last several months, how have you heard of any signs of rationalization or signs of pause in adding this new capacity in the industry? Do you anticipate anything to come online or be delayed in 2026 and beyond?
Juan Luciano: Yes. Listen, we can speculate for what others are doing. I mean we try to manage what we can control. As you heard in the prepared remarks, I mean we are in the process of shutting down one of our plants in Kershaw. And I think we continue to see -- continue to check for the competitiveness of our plants. We have a lot of self-help agenda to try to continue to improve that. Volumes have been improving there on an unplanned nature. Of course, the industry will take some plant shutdowns when demand is not there. We have seen it also in biodiesel where a lot of the nonintegrated plants have to go down. I think it's important to know that all these capacity, the crush capacity has been brought to comply with the expected RVO mandates, and that's what we think is so important to bring clarity into that because we were in the process of building a renewable green diesel industry and everybody built in anticipation of that supporting U.S. manufacturing. So I think it's important that at the moment we clarify the rules, all this capacity that has been invested in will make sense.
Pooran Sharma: Thank you.
Operator: Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead.
Steven Haynes: Good morning. And thanks for taking my question. I wanted to ask on Argentina, cited as a headwind for crush in the quarter. But we've been kind of seeing some headlines that farmer selling there is off to a historically slow start. So maybe you could just put a finer point around what you've assumed for the commercialization of that crop for the balance of the year as it relates to the guidance? Thank you.
Juan Luciano: Yes, Steven. In Argentina, the farmer basically kept about 7 million tons of the old crop waiting for the valuation that in reality did not happen. So I would say, you should expect now the farmer to become a little bit more regular commercializer of the crop as they need to take advantage of the tax advantages they get from the government before they expire in about two months. So I think you're going to see a little bit of an acceleration. But yes, as an Argentine farmer myself, we withheld about 7 million tons of this expecting a devaluation that didn't come.
Steven Haynes: Thank you.
Operator: Thank you. Our next question comes from Tami Zakaria of JPMorgan. Your line is now open. Please go ahead.
Tami Zakaria: Hi. Good morning. Thank you so much. So my question is on Starches and Sweeteners. Could you comment what volume growth was for S&S in the quarter? And more importantly, what volume growth you expect for the full year? I heard you say you're seeing some weakness in some customer demand and adjusted volume outlook because of that. So any thoughts on volume growth as we think about 2025?
Juan Luciano: Yes. Thank you for the question, Tami. Listen, when I think about the overall Carb Solutions business, and we have said our guidance was slightly lower than last year, and we are reiterating that guidance. We see, in general, solid demand, solid volumes and margins across the business. There are some pockets of weakness here or there. One, our results in Europe, are going to be a little bit lower because we have higher corn costs in Europe and a little bit lower volumes. And there is some weakness in Starches in either the paper industry, maybe not running in all cylinders, and some of the exports to Mexico with all this uncertainty about tariffs or no tariffs, I think that maybe some of the exports from the U.S. to Mexico has been a little bit soft in March, maybe picking up a little bit in April. So I would say the overall tone is in general solid but not very robust, if you will.
Tami Zakaria: Understood. Thank you.
Juan Luciano: You're welcome.
Operator: Thank you. Our next question comes from Salvator Tiano of Bank of America. Your line is now open. Please go ahead.
Salvator Tiano: Yes. Good morning. I want to ask about a couple a couple of things that -- to clarify a couple of things about your Q1 earnings and the outlook. In VCP, firstly, you had some pretty solid operating income, even though AS&O margins by calculations were at multiyear lows. So how was it so much better both year-on-year and quarter-on-quarter? And how should we think about it for the rest of the year? And similarly, on Nutrition, I think the Q1 guidance was for a 50% drop year-on-year and said you delivered 13% growth. So what was the difference versus expectations? And does this mean that the full year directional guidance that you reiterated now implies much stronger earnings growth than before?
Juan Luciano: Yes. Thank you, Salvator. So let me take that by pieces. So on the ethanol side, as you pointed out, I think our team outperformed the markets and the industry. I think it was good risk management by the team. So, kudos to the team. In general, we see, hopefully, margins improving over the year for ethanol. But ethanol in this environment is a little bit of a question mark. We believe that ethanol could potentially see some benefits from higher exports as some of these trade agreements get resolved, because there are opportunities as a very cheap oxygenate for ethanol to make it into blends around the world. When we think about Nutrition, I think we've been highlighting that we've been doing a lot of foundational improvements in Nutrition. And at one point in time, they start to come into the P&L. So we started to see the fruits of some of these improvements. I think that our value proposition continues to resonate strongly in the Flavor area, in the Health & Wellness area, especially Health & Wellness, a lot of the biotics coming into play. They do very well there. I think we have had a lot of successes or we are working a lot in terms of things like Ag replacement or Ag extension, data replacement, Beverage industry continues to favor some of our solutions. And we have seen a lot of activity and requests for our line of natural colors. And we see our teams engaging with our customers on that. So it was purely driven by the improvement in Flavors, the strength in Health & Wellness and also improvements in Animal Nutrition. Animal Nutrition, although not a revenue growth story, it's a margin improvement story, and the team has been working hard at that. And we started to see the improvements to that as well. Of course, Specialty Ingredients has been the downside of Nutrition and the headwind, and we have been to report that finally, the East plant is being commissioned right now. So it's starting to operate. And we expect that to be a positive year-over-year for the second half of the year if the plant gets to full capacity.
Monish Patolawala: Salvator, just one more for you on ethanol cadence, we were slightly below breakeven in Q1. And we expect to be slightly above breakeven in Q2 based on where we are today.
Salvator Tiano: Thank you, Monish.
Monish Patolawala: Thank you.
Operator: Thank you. Our final question for today comes from Manav Gupta of UBS. Manav, your line is now open. Please go ahead.
Manav Gupta: Good morning guys. I just wanted to confirm, Decatur would be fully restarted by the second quarter. So should we assume some contribution for the second quarter? Or should we assume the contribution starting in second half? And remind us of all the benefits for the company once this plant is fully up and running and operational. Thank you.
Juan Luciano: Yes, Manav. I think you should consider, given that it is a very complex plant that the impact will be in the second half of the year. So the plant is ramping up capacity right now, but effectively, it will impact the P&L in the second half. And we have said before, the impact of this plant being down was about $25 million per quarter for Nutrition, so that's kind of the expectation for the second half of the year.
Manav Gupta: Thank you.
Juan Luciano: Thank you, Manav.
Operator: Thank you. At this time, I will now turn the call back to Megan Britt, for any further remarks.
Megan Britt: We'd like to thank everyone for joining the call today and for their ongoing interest in ADM. If there are additional questions following the call today, please feel free to reach out directly to me. Have a wonderful rest of your day.
Operator: Thank you all for joining today's call. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the ADM First Quarter 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"text": "Welcome to the first quarter earnings conference call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. Unless otherwise required by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available in our earnings press release and presentation slides, which can be found in the Investor Relations section of the ADM website. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Megan. Hello, and welcome to all who have joined the call. Please turn to Slide 4. Today, ADM reported adjusted earnings per share of $0.70. Total segment operating profit was $747 million for the quarter. Our trailing fourth quarter adjusted ROIC was 7%, and cash flow from operations before working capital changes was $439 million. ADM's first quarter results were aligned with our outlook and market expectations and our business operated well in a dynamic external environment. With uncertainty related to global trade and regulatory policy continuing to have an impact on the business, we were able to drive positive momentum in focused areas. Our Carbohydrate Solutions team delivered solid results supported by positive margins in sweeteners, along with strong execution in ethanol. Nutrition's performance in the first quarter, specifically in our Flavors and Animal Nutrition portfolios, is on a path to recovery. We also made important progress in getting our Decatur East facility back online as it moves into the final stages of recommissioning. Ag Services and Oilseeds was impacted by challenging conditions and overall market uncertainty and took actions to drive organizational realignment and network optimization. And thanks to our team's continued diligence in safety, I'm pleased to report that our Q1 total recordable incident rate was the lowest it has been in the history of ADM. These examples highlight our team's ability to drive our strategy forward, while focusing attention on the self-help and execution excellence agenda we outlined earlier in the year. Let's take a closer look at our progress in the first quarter. Please turn to Slide 5. In our last call, we shared a slate of self-help activities to enable us to deliver on execution and cost goals, drive simplification and strategic growth while maintaining continued capital discipline. We're taking a balanced approach to these efforts across the business. Let me share a few highlights. From a cost perspective, we made important progress on our target of $500 million to $750 million in cost savings over the next three to five years. This included a targeted workforce reduction to align our organization to our most critical priorities, along with a thorough review of third-party consulting spend. With this, we are seeing a reduction in our overall SG&A costs. We made the strategic decisions to deliver optimization across the network, including the recently announced closure of our Kershaw, South Carolina crush facility, exit of domestic trading operations in China and Dubai as well as the consolidation of several grain warehouses. We don't take actions that impact our colleagues and the communities where we operate lightly. I have engaged with these groups to clearly explain the rationale for our decisions and provide them with necessary transition support. We're also addressing challenges with operations uptime from our North America soy assets and we are now live with Decatur East and expect to have the plant at full run rate by the end of the second quarter. The focus on our Nutrition business is beginning to show positive results. Addressing demand fulfillment issues and leveraging our innovation capabilities in Flavors has supported a strong year-over-year operating profit. We've unlocked both simplification and growth potential in our recent Mitsubishi MOU announcement, focusing our combined teams on what they do best. We advance automation and digitization across our global manufacturing network, scaling successful pilots, improving reliability and efficiency and driving over a dozen new projects to deliver cost savings and smarter operations. We continue to invest in R&D related to health and wellness solutions. And in February, we announced a partnership with Asahi Global Foods Corporation to distribute an innovative postbiotic design to address challenges with the stress, mood and sleep. The expansion of our Regen Ag partnership and BioSolutions business is playing an important role in driving farmer resiliency, creating new high-value avenues for the sale of differentiated crops. Underpinning all this work, we remain focused on capital discipline and actively managing traditional channels to return cash to shareholders. As we look ahead to the remainder of the year, this self-help agenda will be critical to positioning ADM to manage through what continues to be an uncertain external landscape. We remain confident in our team's ability to take the balance of actions needed to support the result that matches the high expectations we have set for ourselves. Our team is keeping close to our customers and remain alert to both the challenges and the opportunities that we're seeing in the market. We're taking full advantage of the breadth of the investment we have made in our business over the past decade and the agility that provides. From our crush and export capabilities across the U.S., Argentina and Brazil to our expansive origination network to our expertise in formulation to our portfolio of ingredients, including all natural colors and flavors, all of these add to ADM's ability to support rapidly evolving needs. With that, let me hand it over to Monish to share a deeper dive into first quarter financial results and our 2025 outlook."
},
{
"speaker": "Monish Patolawala",
"text": "Thank you, Juan. Please turn to Slide 6. To start, let me provide some perspective on the operating backdrop that shaped the first quarter for the AS&O segment. As we expected, market disruptions related to biofuel policy uncertainty negatively impacted biodiesel and renewable diesel margins and U.S. vegetable oil demand. We also experienced higher global soybean stock levels and an increase in Argentinian crush rates, which pressured global soybean meal value. Additionally, trade policy uncertainty, particularly with Canada and China, created volatility throughout the quarter for canola meal and oil. Taken together, these factors resulted in significantly lower meal and vegetable oil values, pulling down margins across our businesses. Overall, against this backdrop, AS&O segment operating profit for the first quarter was $412 million, down 52% compared to the prior year quarter with declines across all subsegments. In the Ag Services subsegment, operating profit was $159 million, down 31% versus the prior year quarter, driven primarily by lower North American origination export volumes as order flow was impacted by trade policy uncertainty. North American origination results also reflect the additional expense of $34 million recorded in the period for anticipated export duty. Global trade results were lower relative to the same quarter last year, largely due to the negative timing impact, partially offset by higher destination marketing volumes and margins. Total net timing impacts were approximately $48 million year-over-year. In the crushing subsegment, operating profit was $47 million, down 85%. Consistent with the previously provided outlook, both global soybean and canola crush execution margins was significantly lower than the prior year quarter. Global executed crush margins were approximately $13 per ton lower in soybeans compared to the prior year quarter and approximately $40 per ton lower in canola. By region, crush margins were down significantly in North America. North America soybean crush margins were negatively impacted by additional capacity from new crushing facilities and lower soybean oil demand stemming from biofuel policy uncertainty. North America canola crush margins were negatively impacted by trade policy uncertainty and lower canola oil demand for biofuel production. There were net negative timing impacts of approximately $36 million year-over-year. In the Refined Products and Other subsegment, operating profit was $134 million, down 21% compared to the prior year quarter due to lower biodiesel and refining margins. In EMEA, margins declined due to significantly lower biodiesel export volume. In North America, refining margins were negatively impacted by additional industry crush capacity and lower demand for vegetable oil due to biofuel policy uncertainty. There were net positive timing impacts of approximately $34 million year-over-year. Equity earnings on the company's investment in Wilmar was $72 million, down 52% compared to the prior year quarter. Overall, during a challenging quarter, the AS&O team executed on operational improvement like plant and network consolidation and took actions to accelerate cost savings, starting with targeted organization realignment to partially mitigate the less favorable market conditions and be in an excellent position to capture opportunities as we move through the remainder of the year. Turning to Slide 7. For the first quarter, Carbohydrate Solutions segment operating profit was $240 million, down 3% compared to the prior year quarter. Operating profit for this segment came in slightly ahead of our previously provided segment guidance for the quarter. In the Starches and Sweeteners subsegment, operating profit was $207 million, down 21% compared to the prior year quarter. In North America, S&S results were lower due to lower starch margins from demand softness in the paper and corrugated markets, as well as lower North American wet mill ethanol results due to lower ethanol margins. In EMEA, S&S volumes and margins declined as higher corn costs and increased competition negatively impacted results. As a partial offset, North American liquid sweetener margins improved relative to the prior year quarter due to better product mix. Global wheat milling margins and volumes also improved relative to the prior year quarter, largely due to volume growth with key customers. In the Vantage Corn Processors subsegment, operating profit was $33 million, up compared to the prior year quarter due to higher ethanol volumes and improved ethanol margins relative to the prior year quarter. Overall, ethanol EBITDA margins per gallon were slightly negative in the quarter. Turning to Slide 8. In the first quarter, Nutrition segment revenues were $1.8 billion, down 1% compared to the prior year quarter, primarily due to negative currency impact. Human Nutrition revenue was up 4% due to strong Flavors growth and M&A, which offset headwinds related to supply chain challenges from Decatur East. Animal Nutrition revenue was down 6% as negative currency impacts and lower volumes offset mix benefits. Nutrition segment operating profit was $95 million for the first quarter, up 13% versus the prior year quarter. Human Nutrition subsegment operating profit was $75 million, down 1% compared to the prior year quarter as improved performance in Flavors was more than offset by declines in specialty, ingredients and health and wellness. Animal Nutrition subsegment operating profit of $20 million was higher than the prior year quarter due to higher margins supported by ongoing turnaround actions. Please turn to Slide 9. Through the end of the first quarter, the company generated cash flow from operations before working capital of approximately $439 million, down relative to the prior quarter due to lower total segment operating profit. Solid cash generation and our strong balance sheet remain a critical differentiator for the company. We will continue to seek opportunities to further strengthen our balance sheet to provide financial flexibility to organically invest in the business to enhance returns and create long-term value. We are also taking actions to ensure working capital excellence through stronger rigor on working capital planning, inventory rationalization, improvement of key account payable metrics and more timely collection of past due balances. At the same time, we remain committed to returning cash to shareholders and we returned $247 million to shareholders in the form of dividends in the quarter. Turning to Slide 10. We have provided details to support our 2025 consolidated outlook. Earlier today, we affirmed our full year adjusted EPS guidance. We continue to expect adjusted earnings per share to be between $4 to $4.75 per share, though we now expect to be at the lower end of the guidance range given the current market backdrop. In particular, we remain cautious about our second half outlook for crush margin improvement as current domestic crush replacement margins are below our outlook. With the uncertainty related to tariff policy and macroeconomic conditions, we are not providing segment operating profit guidance for future quarters. We are providing directional guidance at the segment level for the full year. Our directional guidance for operating profit for the full year for Carbohydrate Solutions and Nutrition has not changed from our previously provided indication. With performance to date and continued pressure on crush margins in the second quarter, we are lowering our directional guidance for AS&O for the full year to be lower than the prior year. As an additional data point, current crush margins for the second quarter are trending lower than the first quarter. I also want to share some updates on our overall assumption. We still expect better crush and biodiesel margins in the second half of the year as clarity on renewable volume obligation or RVO is expected to support strong U.S. demand for crop-based vegetable oil. We also expect to deliver our $200 million to $300 million cost savings target for the year, and have already taken several actions that are delivering savings. We are working thoughtfully to accelerate saving realization where possible. We have seen some signs of weakening customer demand, particularly in Carb Solutions and have lowered our volume expectations for select markets and products. While we are not embedding any significant macroeconomic slowdown in our guide, we are actively monitoring consumer demand. To conclude, as we navigate 2025, our focus will remain on what is within our control. A full commitment to remediating the material weakness and making strides to strengthen our internal controls, driving execution, to improve operational performance and lower cost while sustaining functional excellence, simplifying our portfolio to enhance focus on core competencies while unlocking additional capital to drive value and position the company for long-term success. These efforts position us in our ability to navigate the current dynamic environment and reinforce our confidence in delivering on our commitments. Before I hand it back to Juan, I want to take a few minutes to thank all my ADM colleagues for their dedication and focus in delivering for our customers and helping to create long-term value for our shareholders. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"text": "Thanks, Monish. I'll briefly close by recapping our focus as we continue the path into 2025. As I said at the top of the call, we will continue to focus on both execution, agility and our self-help agenda. Our teams are monitoring the evolving geopolitical and macroeconomic landscape, and they are taking actions as we get more clarity about both the short and long-term situation. Importantly, we are leveraging cost management, strategic simplification, targeted investments and capital discipline to ensure we are prepared for a multitude of scenarios. The potential impacts on our mitigating actions look different for each part of the business. For Carbohydrate Solutions and Nutrition, we are paying close attention to overall consumer sentiment and the potential for an economic slowdown to mitigate against this, we're taking aggressive action on our manufacturing and SG&A costs. In Nutrition, specifically, we are focused on getting our East plant fully ramped up, optimizing our Animal Nutrition business model, leveraging our leading specialty ingredients portfolio, including all natural colors and flavors, and ensuring we are continuing to execute against a healthy opportunity pipeline in flavors and health and wellness. For Ag Services and Oilseeds, we are monitoring the global trade and biofuel policy environment to ensure that we can enable the export market for our vast origination footprint and take advantage of improving demand conditions later in the year. On trade policy, we have seen positive signals with both delays in implementing tariffs to potential avoidance of tariffs and counter tariffs. The decision regarding USTR's Section 301 proposal have mitigated some of the potential impact of transporting commodity products between China and the U.S. And more broadly, for China exports, we will need to see where things stand as we approach the U.S. soybean harvest in the October to December period. Beyond trade, strong policy support for biofuels, including clarity on RVO is expected to support strong U.S. demand for crop-based vegetable oils. In this business, beyond general market improvements, we will continue our focus on both cost management and strategic simplification self-help efforts to manage through uncertainty. As noted by Monish, these factors support our confidence in our full year guidance for 2025, though with current fundamentals, we will be at the lower end of our range. We are a U.S. company that is fundamental to the global food, feed and energy supply chains, connecting consumers with farmers to fuel the world and keep the U.S. agriculture sector competitive. We have a long track record of navigating cycles and are focused on resiliency, which comes from our unparalleled asset network and our employees' commitment to excellence. As in the past, regardless of external challenges and market disruptions, ADM is working with our farmers and customers to be a source of strengthening the economy, always fulfilling our mission to unlock the power of nature, to enrich the quality of life. With that, we'll take your questions now. Operator, please open the line."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question for today comes from Tom Palmer of Citi. Your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"text": "Good morning and thanks for the question. Maybe just to start out, I wanted to ask on your expectation for the RPO and how this guides your outlook for 2025? So when we think about biodiesel margins in the back half of the year, should we be thinking that we could see a return to last year's levels? When we look at crush margins, is the assumption that we could see a return to kind of the original guidance, which I think was $45 to $55 per metric ton per soy and $50 to $70 for canola. Just any help on kind of the shape of the year in terms of the second half and how the RVO influences that. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Tom, for the question. As you pointed out, we see a strong RVO as the most important driver for the biofuel outlook. We understand that the RVO's role is being developed, and we are engaged with the administration on the important role of the RFS and strong RVOs to support the domestic market for U.S. farmers, and to support a strong American energy independent. And we are confident that EPS is a priority. So of course, at the moment, the industry is not running at rates to satisfy mandated volumes. And we expect, and the logic implies that margins need to go up to bring run rates higher in the second half. When we go to crush, and we're probably going to see that by RINs improving as we go forward. When we go to crush, we have seen strong demand for soybean meal. Of course, there has been a strong crush rates in Argentina, Brazil and the U.S. But we've seen that leg is supportive. Of course, when we cannot produce all these biofuels in the U.S., oil goes to fight with -- for export markets. And that's the weak leg at this point in time. So we expect that with RVOs coming back, we will be able to come back to the original expectations and maybe we had at the beginning of the year."
},
{
"speaker": "Monish Patolawala",
"text": "Just from a math perspective, since you asked specific comp. First quarter we -- as my script says, we ended $13 below last year, so around $40, $43 in Q1. In soy, canola was last year, was around $100. So we are somewhere -- we were $40, $35 to $40 lower. Q2 is currently trending lower than Q1 from a crush rate perspective. Part of it is timing because we do get book on before the quarter is in. So Q2 is lower both in canola and in soy. And then as Juan said, we are expecting a ramp-up in the second half. Of course, now it's going to be a wider range because Q1 and Q2 are lower. So when we originally said we would be in the 40 to -- we had said 45 to 55, we are now saying $40 to $65 for the year on soy and then canola, we had said 50 to 70, we are at the 45 to 65. So as Juan explained it, when we do come back in the second half, you would come back to margins that we had originally expected. But since the first half is lower, the total number gets impacted. So hopefully, I answered your question."
},
{
"speaker": "Tom Palmer",
"text": "Thank you. That was very helpful."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Andrew Strelzik of BMO. Your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"text": "Hi, good morning. Thanks for taking my question."
},
{
"speaker": "Juan Luciano",
"text": "Good morning."
},
{
"speaker": "Andrew Strelzik",
"text": "I actually wanted to follow up on the RVO. Good morning. Just wanted to follow up on the kind of RVO line of questioning. Is there a specific RVO kind of number or range that you're assuming to get to those types of outcomes or how do you maybe think about that, number one? And number two, just more broadly, what is a positive RVO outcome for ADM? Is there like a breakeven RVO above which you see it as a positive outcome below, which is negative. We've obviously seen the reporting north of $5 billion. So I'm just curious how you think about maybe the range of outcomes and how it impacts your business? Thanks."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Andrew. I would say the industry ask to a certain degree is like $5.2 billion of biomass-based biodiesel and maybe $15 billion conventional, so a total of $25 billion, $25.5 billion I think, as I said, we are engaged with administration. We understand that the EPA understands the importance of this. It helps with all the priorities the administration has set up, which is to help the agricultural farming. We need to do that by expanding export markets but also by solidifying internal consumption and biofuel is an excellent way to do that, and also to improve energy dominance, which another objective. So we're engaged. I mean we finished -- as you know, the guidance on all these ended on the 90-day comment period ended in April. So we are expecting that the administration is tackling these hopefully soon. So -- but the industry depends on that."
},
{
"speaker": "Monish Patolawala",
"text": "Just Andrew, I'll build on you asked the impact to ADM for like -- I'll just talk second half of 2025, because the assumption is that replacement margins would move up. So if replacement margins did not move up between now to the end of the year, then that's a $0.50 additional headwind. So that's the impact that we are counting on a recovery in the second half from an RVO perspective or from crush margins, which is heavily driven by what RVOs become."
},
{
"speaker": "Andrew Strelzik",
"text": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"text": "Morning. Thank you for the question. I had a question about RPO. So I know there was a -- I think it was a $34 million year-on-year positive timing benefit. But even adjusted for that, given how weak the environment was in the U.S. and the lower -- much lower export volumes out of EMEA. Just curious what drove the strength there? And I know it's significantly lower than the past few years, but prior to the RD rush we saw over the past few years, I mean that was a pretty good showing. But just wondering what were the positives in that given the very challenged backdrop here in the U.S.?"
},
{
"speaker": "Juan Luciano",
"text": "So Heather, I would say, yes, in the short run, it was a little better. But when you look at it for the whole year and how our guide is based, I would say, in total, we still continue to see RPO to be softer. And you have seen most of the items, biodiesel margins have already come off significantly. And part of it is driven by just extra volume, pretreatment capacity, et cetera. In EMEA, the margins are also significantly lower than the prior year, where again, we experienced benefits from U.S. SME market flows. And then third, when you just think about the backdrop with the implementation of 45Z as well as all the extra refining capacity that exists, that will continue to weigh on margins. So I would say, in total, taken together, RPO will be significantly low versus the prior year. And that's what we had thought coming into the year, and that's what we continue to think sitting as of right now."
},
{
"speaker": "Heather Jones",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead."
},
{
"speaker": "Rahi Parikh",
"text": "Hi everyone. This is Rahi on for Ben. Thank you so much for the color today. Just regarding tariffs, can you give us more color on trade flow shift, i.e., how you're replacing Chinese demand? And maybe how much of a drop in volume was related to China and Ag Services. Do you have a percentage of profit or revenue that normally relates to China? Thank you so much."
},
{
"speaker": "Juan Luciano",
"text": "Yes. Hi Rahi, listen, at the end of the day, I would say, if you look at Q1. If you think how all these tariffs or this thing has settled, the impact has not been that significant in Q1. Probably the biggest impact we have had has been from speculation about what the USTR Section 301 maritime issue was going to be. But in reality, when USTR issued a ruling, it basically almost removed all the risk from agricultural experts. So we've been pleased to see the administration have paused for 90 days, the implementation of some of these, while we still try to negotiate agreements with the different parties. But if you think about Mexico and Canada export tariffs, basically 98% of our products are exempt from that. So we didn't feel any impact there. Corn, Europe, they delayed the retaliation on corn until July and in soybean until December. And although on China, we escalated, the reality is the U.S. is not going to be competitive to China for the second and third quarter because that's when Brazil and Argentina become most competitive. And we come back in October when there is the U.S. harvest. So we have until then to see how this clarifies. So that's where we see the situation today. Again, we are working as you said how to offset the impact of that, for us. We work directly in the U.S. with 60,000 farmers. It's important for them the access to export markets. So there are going to be export markets where we're going to be gaining share. Remember also that China has moved to Brazil to a certain, -- to a bigger extent in the previous issue with trade in 2017 or 2018. So the reliance on U.S. export into China is not that big, probably for soybeans is in the range of 20 million tons, if you will, if that were the total impact. And then I think China export, so I think that that's the impact at this point in time, we were pleased to see, as I said, USTR Section 301, was sold favorably for agricultural experts."
},
{
"speaker": "Rahi Parikh",
"text": "Okay. Thank you so much."
},
{
"speaker": "Juan Luciano",
"text": "You're welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Pooran Sharma of Stephens. Your line is now open. Please go ahead. Sorry, Pooran, your line is now open. Please go ahead."
},
{
"speaker": "Pooran Sharma",
"text": "Apologies about that. Hi, good morning. Thanks for taking the question, here. Just wanted to ask about the soy crush industry. Just with all the announcements with new crush capacity coming online in North America and then just with the weak fundamental backdrop that we've had over the last several months, how have you heard of any signs of rationalization or signs of pause in adding this new capacity in the industry? Do you anticipate anything to come online or be delayed in 2026 and beyond?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Listen, we can speculate for what others are doing. I mean we try to manage what we can control. As you heard in the prepared remarks, I mean we are in the process of shutting down one of our plants in Kershaw. And I think we continue to see -- continue to check for the competitiveness of our plants. We have a lot of self-help agenda to try to continue to improve that. Volumes have been improving there on an unplanned nature. Of course, the industry will take some plant shutdowns when demand is not there. We have seen it also in biodiesel where a lot of the nonintegrated plants have to go down. I think it's important to know that all these capacity, the crush capacity has been brought to comply with the expected RVO mandates, and that's what we think is so important to bring clarity into that because we were in the process of building a renewable green diesel industry and everybody built in anticipation of that supporting U.S. manufacturing. So I think it's important that at the moment we clarify the rules, all this capacity that has been invested in will make sense."
},
{
"speaker": "Pooran Sharma",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"text": "Good morning. And thanks for taking my question. I wanted to ask on Argentina, cited as a headwind for crush in the quarter. But we've been kind of seeing some headlines that farmer selling there is off to a historically slow start. So maybe you could just put a finer point around what you've assumed for the commercialization of that crop for the balance of the year as it relates to the guidance? Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, Steven. In Argentina, the farmer basically kept about 7 million tons of the old crop waiting for the valuation that in reality did not happen. So I would say, you should expect now the farmer to become a little bit more regular commercializer of the crop as they need to take advantage of the tax advantages they get from the government before they expire in about two months. So I think you're going to see a little bit of an acceleration. But yes, as an Argentine farmer myself, we withheld about 7 million tons of this expecting a devaluation that didn't come."
},
{
"speaker": "Steven Haynes",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tami Zakaria of JPMorgan. Your line is now open. Please go ahead."
},
{
"speaker": "Tami Zakaria",
"text": "Hi. Good morning. Thank you so much. So my question is on Starches and Sweeteners. Could you comment what volume growth was for S&S in the quarter? And more importantly, what volume growth you expect for the full year? I heard you say you're seeing some weakness in some customer demand and adjusted volume outlook because of that. So any thoughts on volume growth as we think about 2025?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you for the question, Tami. Listen, when I think about the overall Carb Solutions business, and we have said our guidance was slightly lower than last year, and we are reiterating that guidance. We see, in general, solid demand, solid volumes and margins across the business. There are some pockets of weakness here or there. One, our results in Europe, are going to be a little bit lower because we have higher corn costs in Europe and a little bit lower volumes. And there is some weakness in Starches in either the paper industry, maybe not running in all cylinders, and some of the exports to Mexico with all this uncertainty about tariffs or no tariffs, I think that maybe some of the exports from the U.S. to Mexico has been a little bit soft in March, maybe picking up a little bit in April. So I would say the overall tone is in general solid but not very robust, if you will."
},
{
"speaker": "Tami Zakaria",
"text": "Understood. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "You're welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Salvator Tiano of Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"text": "Yes. Good morning. I want to ask about a couple a couple of things that -- to clarify a couple of things about your Q1 earnings and the outlook. In VCP, firstly, you had some pretty solid operating income, even though AS&O margins by calculations were at multiyear lows. So how was it so much better both year-on-year and quarter-on-quarter? And how should we think about it for the rest of the year? And similarly, on Nutrition, I think the Q1 guidance was for a 50% drop year-on-year and said you delivered 13% growth. So what was the difference versus expectations? And does this mean that the full year directional guidance that you reiterated now implies much stronger earnings growth than before?"
},
{
"speaker": "Juan Luciano",
"text": "Yes. Thank you, Salvator. So let me take that by pieces. So on the ethanol side, as you pointed out, I think our team outperformed the markets and the industry. I think it was good risk management by the team. So, kudos to the team. In general, we see, hopefully, margins improving over the year for ethanol. But ethanol in this environment is a little bit of a question mark. We believe that ethanol could potentially see some benefits from higher exports as some of these trade agreements get resolved, because there are opportunities as a very cheap oxygenate for ethanol to make it into blends around the world. When we think about Nutrition, I think we've been highlighting that we've been doing a lot of foundational improvements in Nutrition. And at one point in time, they start to come into the P&L. So we started to see the fruits of some of these improvements. I think that our value proposition continues to resonate strongly in the Flavor area, in the Health & Wellness area, especially Health & Wellness, a lot of the biotics coming into play. They do very well there. I think we have had a lot of successes or we are working a lot in terms of things like Ag replacement or Ag extension, data replacement, Beverage industry continues to favor some of our solutions. And we have seen a lot of activity and requests for our line of natural colors. And we see our teams engaging with our customers on that. So it was purely driven by the improvement in Flavors, the strength in Health & Wellness and also improvements in Animal Nutrition. Animal Nutrition, although not a revenue growth story, it's a margin improvement story, and the team has been working hard at that. And we started to see the improvements to that as well. Of course, Specialty Ingredients has been the downside of Nutrition and the headwind, and we have been to report that finally, the East plant is being commissioned right now. So it's starting to operate. And we expect that to be a positive year-over-year for the second half of the year if the plant gets to full capacity."
},
{
"speaker": "Monish Patolawala",
"text": "Salvator, just one more for you on ethanol cadence, we were slightly below breakeven in Q1. And we expect to be slightly above breakeven in Q2 based on where we are today."
},
{
"speaker": "Salvator Tiano",
"text": "Thank you, Monish."
},
{
"speaker": "Monish Patolawala",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question for today comes from Manav Gupta of UBS. Manav, your line is now open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"text": "Good morning guys. I just wanted to confirm, Decatur would be fully restarted by the second quarter. So should we assume some contribution for the second quarter? Or should we assume the contribution starting in second half? And remind us of all the benefits for the company once this plant is fully up and running and operational. Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Yes, Manav. I think you should consider, given that it is a very complex plant that the impact will be in the second half of the year. So the plant is ramping up capacity right now, but effectively, it will impact the P&L in the second half. And we have said before, the impact of this plant being down was about $25 million per quarter for Nutrition, so that's kind of the expectation for the second half of the year."
},
{
"speaker": "Manav Gupta",
"text": "Thank you."
},
{
"speaker": "Juan Luciano",
"text": "Thank you, Manav."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, I will now turn the call back to Megan Britt, for any further remarks."
},
{
"speaker": "Megan Britt",
"text": "We'd like to thank everyone for joining the call today and for their ongoing interest in ADM. If there are additional questions following the call today, please feel free to reach out directly to me. Have a wonderful rest of your day."
},
{
"speaker": "Operator",
"text": "Thank you all for joining today's call. You may now disconnect your lines."
}
] | Archer-Daniels-Midland Company | 251,704 |
ADP | 4 | 2,020 | 2020-07-29 08:30:00 | Operator: Good morning. My name is Crystal and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Fourth Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Crystal. Good morning, everyone and thank you for joining ADP’s fourth quarter fiscal 2020 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the fourth quarter of fiscal 2020. The earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompany today’s call as well as our quarterly history of revenue and pre-tax earnings by reportable segment. During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures, can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. As always, please do not hesitate to reach out should you have any questions. And with that, let me now turn the call over to Carlos.
Carlos Rodriguez: Thank you, Dany and thank you everyone for joining the call. This morning, we reported our fourth quarter and fiscal 2020 results. Although we ended the year – this year against significant headwinds related to COVID-19, we believe we executed well over the course of the last 12 months. And our product offerings remain well positioned to support sustainable long-term revenue growth as we continue to help companies and their workforces through all types of environments. For the quarter, we delivered revenue of $3.4 billion, down 3% reported and 2% organic constant currency, which was better than our expectations. And for the full year, we delivered revenue of $14.6 billion, up 3% reported and 4% organic constant currency. Our adjusted EBIT margin increased 10 basis points in the quarter and increased 60 basis points for the full year, well ahead of our expectations as we managed our expense base prudently to absorb the impact of a decline in revenue in the fourth quarter, while simultaneously providing an elevated level of service to our clients. With this revenue and margin performance, our adjusted EPS growth was flat for the quarter and up 9% for the year. Considering the unprecedented and evolving macroeconomic situation, we are very pleased with our execution in the quarter and our current positioning as employment continues to gradually recover from the steep declines our clients have experienced. The global health crisis from COVID-19 has clearly evolved over these past few months. And I will start today’s discussion by providing a brief update on the trends we have experienced. When we reported our fiscal third quarter results in April, we were just starting to see some preliminary signs of stabilization after weeks of rapid deterioration, more specifically, across our own data sources, including weekly payroll, clock-in volume, job postings and background screenings. There were multiple indications that we were reaching the trough. Now 3 months later, we do believe we saw conditions bottom in late April. Whereas our pays per control was trending down mid-teens in April, it has since improved to be down about 10% as we exited the quarter. And for the full quarter, pays per control was down 10.8% better than we had contemplated in our outlook. Last quarter, we also discussed our expectation for elevated out-of-business losses in May and June. Those losses ultimately developed in line with our expectations. This yielded a decline in our retention rate of 20 basis points to 90.5% for the full year. Though if not for the elevated out-of-business losses in Q4, we believe our retention rate would have been up for the year. In fact, despite these losses in Q4 for fiscal 2020, we tied an all-time high retention for our mid-market and hitting multi-year high in our up-market. Looking ahead, what we have been encouraged by signs that the economic distress brought about by COVID-19 has started to ease in certain countries and several U.S. states. We are seeing continued or even increasing distress in others. And over the past several weeks, we have seen the pace of employment recovery slow. Accordingly, as we set our expectations for the coming year, we believe that the worst is behind us. But the global economic recovery over the coming quarters will be gradual. Kathleen will discuss some of our specific macroeconomic assumptions in more detail. I’d like to turn now to Employer Services new business bookings. We reported a decline of 21% for the year, which was in line with our revised outlook despite the limited visibility we had in making that forecast. And although this represents a significant decline, the actual execution by our sales force was better than what this reported growth rate suggests. As we mentioned last quarter, there are two components to our bookings figure. Our gross bookings we actually sold in the quarter and adjustments for previously required bookings. Our gross bookings sold in Q4, while down significantly, came in ahead of our forecast, and most importantly, exited the quarter with improving momentum. This gives us confidence that buying behavior is continuing to trend in the right direction, which we believe will drive further bookings recovery in the coming quarters. Furthermore, our sales force has continued to adapt to this virtual sales environment as we have invested in training, stayed agile on sales messaging, and continued to foster our channel relationships. We are also continuing to see week-on-week improvement in leading indicators, such as referrals, appointments per salesperson and demos scheduled. In addition to these gross bookings, we regularly adjust bookings we have previously recognized if for example, a client is no longer expected to start within the original estimated timeframe or starting with fewer employees than originally anticipated. These backlog adjustments are ordinarily immaterial to our bookings growth. But as we said last quarter, COVID-19 is causing some clients to delay implementations or to start with fewer employees than we originally signed. We made a larger backlog adjustment in Q4 than previously planned. And this offset the better underlying sales performance we experienced. Looking ahead, we expect we will likely see negative bookings growth in the first half of fiscal 2021 as we are still selling into an unfavorable macro environment. We expect growth to be flat to positive in Q3 with much more substantial growth in Q4 driving full year bookings growth of flat to up 10%. Beyond fiscal 2021, a key priority will be getting our sales productivity back to or above its previous level. Within our control are the investments we make. And in fiscal 2021, we are planning to continue investing in product innovation, digital sales capabilities and leading-edge sales tools to drive sales productivity higher. In addition, at this point, we are planning to add modestly to the size of our sales force. And together, we believe these investments will position us well to return to our previous – to our prior new business bookings growth trend line as client buying behavior continues to normalize. Factors beyond our control, including overall GDP trends, as well as the timing and scope of workers returning to their job sites, were in the meantime likely continue to impact our bookings. Moving on, service has remained critical to our clients. Our clients look to us for support and guidance in navigating through the complexities of key HR challenges and regulatory change. And our goal has been to serve as a trusted partner as they faced COVID-19. Our clients have responded very positively to the robust service we have provided. And that in turn has led to record NPS scores in June as a direct outcome of our commitment to providing a successful level of service. And we expect this favorable NPS trend to have positive implications for us in the years ahead. In response to the initial surge in service volumes related to COVID-19, we redeployed hundreds of sales and implementation associates to help meet the service need. While average resolution time spent per service requests remains elevated as our clients work through complex issues, we have now seen our service request volume return to more normal levels. And we are happy to report that we have now deployed most of these associates back to their sales and implementation rules. We continue to keep watch on proposed legislation that could drive another surge in client service demand and we remain prepared for such a scenario. We also continue to serve our clients through product innovation. During the quarter, we rolled out a range of solutions to help our clients through the crisis and prepare for the recovery. We implemented over 1,000 feature changes in response to 2,000 legislative updates in 60 countries. And we also had over 400,000 clients run over 2 million Paycheck Protection Program reports for a total loan volume of approximately $115 billion. Many of those clients have also now run the necessary reports to apply for their loans to be forgiven. Looking ahead, a key product focus is enabling safe return to the workplace. And we are offering tools, including touchless and voice-enabled clocking, health attestation and enhanced scheduling and analytics to help clients manage their workforces as they resume workplace operations. We continually progress on our other major product initiatives, including the rollout of our next-gen HCM platform and payroll engines. 2 weeks ago, we won yet another award for our next-gen HCM solution, the Ventana Annual Digital Innovation award. And we remain excited about its rollout. Perhaps more importantly, despite shifting our workforce to remote environment, we remain on track to hit our R&D development roadmap milestones. And just this quarter, we piloted next-gen HCM and payroll in Australia. Our product team also launched our new workforce management solution in the down-market, like a new time kiosk in the Apple App Store. And we went general availability with Wisely Direct in our mid-market and down-market. Now, taking a step back, I’d like to say that in every challenge, there is a potential for upside and COVID-19 is no exception. We believe that the nature of this shock in which businesses of all sizes have faced major uncertainties in managing their employees, have made an HCM partnership they have with ADP got much more valuable. And as companies emerge from this crisis, we expect them to see even more clearly the benefits of investing in robust, secure HCM offerings that include expertise and service to support their mission-critical activities. So, although COVID-19 has created temporary headwinds in our growth, past experience has taught us to stand firm regarding our investments in strategy as part of our commitment to drive long-term sustainable growth. The strength of our business model and balance sheet allow us to do exactly that. And we are well-positioned in our product, service and go-to-market strategy. Last, before turning it over to Kathleen, I would like to quickly touch on our plans for our own associates. Last quarter, we discussed having over 98% of our workforce operating virtually, including our sales force and we have been pleased with that transition and their overall performance in this environment. While we are well-positioned to continue operating this way, we are in the early stages of bringing back a small portion of our workforce to the office on a volunteer-only basis. And I am actually pleased to join you today from our Roseland headquarters, which we opened just this Monday. Our sales force will continue to primarily engage with prospects and clients virtually, but they are beginning to conduct face-to-face meetings in some geographies, to the extent that they and our clients and prospects are ready to do so. And with all that said, I would like to once again take a moment to recognize our associates for their outstanding effort and the sacrifices they have made. I understand the monumental task of managing work and home life is a complex situation. And I also know it’s not easy. A heartfelt thanks to our associates and leaders for their commitment. I will now turn it over to Kathleen.
Kathleen Winters: Thank you, Carlos and good morning everyone. During the quarter, our revenues declined as we felt the full brunt of a double-digit decline in employment among our clients combined with other recession-driven headwinds. But we believe we executed well and are well-positioned to do so for the quarters ahead. For the fourth quarter, our revenue decline of 3% reported and 2% organic constant currency was ahead of our expectations as pays per control and PEO performance were better than we have planned. Our adjusted EBIT margin was up 10 basis points in the quarter also well ahead of our expectations. We took certain costs actions in the quarter continue to benefit from cost savings related to our ongoing transformation initiatives and also benefited from lower selling expenses, which together offset the margin impact from the loss of high margin revenues related to COVID-19. Our adjusted effective tax rate decreased 210 basis points to 22.9% compared to the fourth quarter of fiscal 2019. And our adjusted diluted earnings per share was flat at $1.14 as lower year-over-year revenues were offset by modest margin expansion, a lower tax rate and a lower share count compared to a year ago. We ended fiscal 2020 with revenue growth of 3% reported and 4% organic constant currency. Adjusted EBIT margins up 60 basis points and adjusted EPS growth of 9%, all in a solid year, particularly given the significant decline in economic activity and employment that we faced over the last few months. As I move on to ES segment results, it’s important to emphasize how resilient the business performance was in the context of unprecedented headwinds, including a 10.8% decline in pays per control and a 22% drop in client funds interest revenue. During the quarter, our Employer Services revenue declined 6% on a reported basis and 5% on an organic constant currency basis in line with our expectations as better underlying growth was offset by incremental FX drag. Our client fund balance declined 8% in the fourth quarter, reflecting lower pays per control, lower state unemployment insurance rates, payroll tax deferrals amongst some of our clients, and the continued lapping of the closure of our Netherlands money movement operation in October of 2019. Combining that balance decline with a 30 basis point decline in average yields drove our client funds revenue to decline by 22% to $115 million. For the full year, our ES revenue was up 1% reported and 2% organic constant currency, a solid performance. Employer Services margins were flat for the quarter, well ahead as our most recent expectations. We had the impact of lower revenues at relatively high incremental margins as we discussed last quarter offset by prudent cost control measures across all categories. ES margins were up 60 basis points for the full year. Moving on to PEO, also solid performance given the circumstances. Our total PEO segment revenues increased nearly 4% for the quarter to $1.1 billion and average worksite employees declined 3% to $548,000. This revenue and worksite employee growth, were both ahead of our expectations driven by better retention performance and pass-through revenue. Same-store employment at our PEO clients performed in line with our expectations of a mid single-digit decline and as expected was more resilient than the average client in our ES segment. Revenues, excluding zero margin benefits pass-throughs, declined 5%. And in addition to being driven by lower worksite employees, it continued to include pressure from lower workers’ compensation and SUI costs and related pricing. PEO margin declined 450 basis points in the quarter. This included about 530 basis points of unfavorability from the net expense in ADP indemnity of approximately $34 million, which contrasts to the $22 million benefit we had in last year’s fourth quarter. As a reminder, we had experienced favorable worker’s comp claim trends over the past several years which translated to favorable reserve adjustments in ADP indemnity. Those trends remain positive, but not as much as what we factor in our most recent reinsurance agreements. And as a result, we had a slight true-up the other way this year. Let me turn now to our outlook for fiscal 2021. I will start by discussing some of the specific U.S. macro driven assumptions that underpin our guidance. The data for these assumptions is a combination of our own trend data and third-party macroeconomic forecast and we believe we are utilizing a balanced outlook. First, our pays per control outlook. We are assuming a decline in average pays per control of 3% to 4% for the year, driven by decline in the high single-digit range for the first half of the year, improving to a decline of mid single-digit by Q3, followed by a rebound to positive mid to high single-digit growth in the fourth quarter. This outlook corresponds to a gradual improvement in the employment picture through the fiscal year though it did not contemplate a full employment recovery. To help translate this trend into a single number you can anchor to, our guidance contemplates the U.S. getting to approximately 7% unemployment by June of 2021. Second, out-of-business losses. Our retention was negatively impacted by losses in its most recent quarter, as we had a number of clients turn inactive, but after monitoring and assessing, we decided to write-off as losses. While we believe government stimulus programs have helped many small businesses, we continue to see some companies in an inactive state where they are not paying employees. And we expect continued elevated losses in the early part of fiscal 2021 as restrictions and lower demand in certain industries continue to drive fall out. As a result, we are setting our expectation for ES retention to decline by another 50 to 100 basis points over this coming fiscal year. Lastly, on client fund interest. As discussed last quarter, our client balance growth is being impacted by the combination of a decline in pays per control, lower new business bookings and out-of-business losses and we had some modest pressure from companies taking advantage of the payroll tax deferral provision of the CARES Act. We are assuming a client funds balance of 6% to 8% for the year. And like pays per control, we expect it to be negative for the first three quarters and then return to growth in Q4. We expect our average yield to decline as well. As a reminder in Q4, we temporarily suspended our purchases of new securities and reinvestment of maturing securities in our client funds portfolio. And earlier this month, we resumed reinvesting. We have over $5 billion in securities maturing in fiscal 2021, yielding on average over 2% and we expect to reinvest them at prevailing yields that are well below that level. As a result, we expect our average client funds yield to be down 50 basis points to 1.6% for the year. With this combination of lower balance and yields, we expect interest income on client funds to be $390 million to $400 million, down about $150 million versus fiscal 2020 and we expect interest income from our extended investment strategy to be $430 million to $440 million, down about $125 million versus fiscal 2020. With that said, without the benefit of our client investment strategy, which utilizes laddered maturities, we believe the headwind to fiscal 2020 would have been even greater. Having covered the major macro topics for fiscal 2021 let me share with you how we are deploying our downturn playbook to manage expenses. We have concentrated on areas where we have excess capacity and on reducing discretionary costs, while maintaining investment in sales, products and our associates. And as we emphasized last quarter, we continue to have the strong cash flow profile and balance sheet strength to withstand impacts to our revenue without taking immediate actions on our investments. We said we would be thoughtful and strategic in assessing the most prudent path forward, a path that balances positioning for recovery against near-term margin performance. We have now had a quarter to assess our business capacity and needs. And during the fourth quarter, we identified businesses across ADP, where unfortunately, we didn’t believe a recovery was likely in the near-term and therefore had excess capacity in service and implementation. In addition to taking specific headcount actions, we have further tightened on non-essential spend, including T&E and other discretionary spend. We are also continuing to move forward with our transformation initiatives. For the past few years, we have highlighted for you some of the discrete material initiatives that we have worked on and their estimated level of benefits. In fiscal 2019, we executed on our voluntary early retirement program, which yielded over $150 million in annual run-rate benefits. In fiscal 2020, we executed on our workforce optimization program and a procurement initiative, which together yielded approximately $150 million in annual run-rate savings against our original expectations of $100 million. For fiscal 2021, we have two important initiatives to call out. First, we are moving forward with a digital transformation initiative that leverages many of the capabilities we highlighted at our February 2020 Innovation Day, primarily to optimize our implementation and service in addition to enhancing efficiency in other parts of the organization. As examples, we are further utilizing automation in the implementation process, deploying additional self-service features throughout our platform, broadening the use of guided assist tools and expanding the use of chat and chatbot. We expect this to be a multi-year effort as we work to optimize large parts of our service delivery model. Our innovation agenda is running full speed ahead and that includes innovation in our client engagement. We also expanded our procurement transformation initiative and expect further benefit for fiscal 2021. We have reassessed our real estate footprint and although we had already closed over 70 subscale locations as part of our service alignment initiative in recent years. We recently closed several additional locations, including a large office in New Jersey. We will continue to evaluate whether there was further opportunity for location consolidation. Between these two initiatives, our digital transformation initiative and the expansion of our procurement initiative we expect to realize a combined $125 million in savings during fiscal 2021, with over a $150 million in run-rate savings exiting the year. Let’s now turn to our outlook for fiscal 2021. We will start with the ES segment. We expect a decline of 3% to 5% in revenue for the full year driven by our outlook for a decline in pays per control, balance and yield pressure in our client funds interest portfolio as well as pressure from new business bookings and elevated out-of-business losses. Compared to what we just experienced in the fourth quarter, we expect the first half of fiscal 2021 to experience a slightly greater revenue decline as the incremental impact from lower sales out-of-business losses and lower client funds interest more than offset the gradual recovery in pays per control that we are anticipating. We expect revenue growth to improve modestly in Q3 and then turn positive in Q4. We expect our margin in the Employer Services segment to be down about 300 basis points for the year. And as a reminder, the revenues we lose from pays per control, out-of-business losses, and client funds interest are all high margin. As with revenue, we are expecting a decline in ES margin during the first three quarters and an increase in the fourth quarter. For our PEO, we expect revenue down 2% to up 2% for the full year with average worksite employee count flat to down 3% driven by similar factors as our ES segment, namely headwinds and same-store employment, out-of-business losses and bookings pressure. We expect average worksite employee growth to be negative during the first three quarters and turn positive in Q4. Our revenues, excluding zero margin pass-throughs, are expected to be down 1% to 4% and we continue to expect lower workers’ compensation and SUI pricing. For PEO margin, we expect to be down about 100 basis points in fiscal 2021 driven in part by drag from higher zero margin pass-through revenues partially offset by a favorable compare for ADP Indemnity. With these segment outlooks, we now anticipate total ADP revenue to decline 1% to 4% in fiscal 2021 and we anticipate our adjusted EBIT margin to be down about 300 basis points as the benefits from our continued expense management and transformation initiatives are partially offsetting the detrimental impact – margin impact of expected lost revenue due to COVID-19 as well as the investments we continue to make. We anticipate our adjusted effective tax rate to be 23.1%. This rate includes less than 10 basis points of estimated excess tax benefit from stock-based compensation related to restricted stock vesting in Q1 of fiscal ‘21. But it does not include any estimated tax benefit related to potential stock option exercises given the dependency of that benefit on the timing of those exercises. Last quarter, we temporarily suspended our share repurchases as we decided it would be prudent to wait for stabilization of the overall environment. At this point, we anticipate resuming our share repurchase program at some point this fiscal year subject to market conditions and we have a slight net share count reduction contemplated in our guidance. And as a result of our outlook for lower revenue and margins and higher tax offset partially by lower share count, we currently expect adjusted diluted earnings per share to decline 13% to 18% in fiscal 2021. As most of you are aware, we also have $1 billion in notes due September of this year. At this point, we expect to issue new debt in the coming weeks or months depending on market conditions. I would like to conclude by saying that although COVID-19 is putting pressure on our financial performance, we believe this is transitory and the long-term prospects for ADP are no way diminished and may even be enhanced by the current environment. For fiscal 2021, we are remaining focused on opportunities for innovation and growth while taking a deliberate balanced approach to managing expenses and we are confident in our long-term growth prospects. I look forward to updating you on our progress. With that, I will turn it over to the operator for Q&A.
Operator: Thank you. [Operator Instructions] And our first question comes from Mark Marcon from Baird. Your line is open.
Mark Marcon: Good morning. Thanks for taking my questions. One key one is just from a bookings perspective as you look out over the coming year and you gave us a bit of a sense for the cadence that you expect – which of the new solutions do you expect to see the greatest traction from? Which ones are you the most excited about and which ones could be the most incremental from a really long-term perspective?
Carlos Rodriguez: Well, I think from an incremental standpoint – to start off with the last part of the question from a long-term standpoint, I think some of the investments we have made in some of our next-gen solutions, I think for me has to be one of the most optimistic in terms of potentially moving the needle from an incrementality standpoint right, because we already have a very large, as you know, bookings number and anything that we can add on top of that goes into the top of the funnel in terms of revenue growth. And that’s really was the reason for these investments is to really move the needle competitively and to improve our position from a differentiation standpoint. And so the early signs of course now somewhat temporarily interrupted by COVID-19 were positive in terms of the traction we are getting both with our next-gen HCM platform as well as with our next-gen payroll platform. So that’s kind of where I feel the most optimistic in terms of the long-term. In terms of kind of the cadence and more kind of the short to medium-term in terms of next year – really the fourth quarter is an important part as we have kind of been alluding to here in our prepared comments and some of that is really clearly the pace of the recovery. So, there is – we have an expectation, which I think is in line with generally accepted I think forecast, if you will. And you heard kind of as a proxy, the expectation that unemployment reach a certain stage by the end of the fiscal year end, those things are all proxies for GDP growth and you guys all have plenty of access to your own firms’ economic forecast and so forth. So, the second half is really the key for us from a bookings standpoint. And there aside from the incrementality question, this issue that we have around for example, adjusting to our – adjustments to our gross bookings is an important one, because to the extent that the recovery continues on the pace we expect, it would help us a lot if we would be – if we can start and continue to implement clients that were previously sold and that – so clearly one positive would be that, that doesn’t degrade any further, because in full transparency, we mentioned that in our prepared statements that’s a concern under this kind of environment, but there is potential upside as well there. So there is downside and there is upside there as well. But when you see the incredible decrease in activity in just a couple of months following the beginning of the crisis, it takes a while for that – those buckets to get filled up again in terms of leads, then turning into first deployments, then turning into presentations to clients. So, that whole process of how the sales evolution goes is critical for us in the second half. And the places that were hurt the most, which in our case and some of it is perhaps just because of the nature of the crisis that the down-market was hit very, very hard in terms of pays per control and also just declines in activity, but also came back, frankly surprisingly – you can’t call it strong because it is still down year-over-year, but I think the bookings performance in the down market has been I think gratifying. And so if we continue on that trend, that would be good news for the second half of the year. And then we expect based on the current trends that the mid-market and the up market will then kind of follow suit as the kind of pipeline leading indicators that we mentioned translate into actual bookings and actual sales. So I guess, the short story is the things that were the hardest hit are the things that – in the initial stages are the things that should have, in our opinion, the biggest rebound in the second half. And then on top of that obviously, our new product investments I think are a source of optimism for us. We’ve also invested in I think you heard us mention Workforce Management in the down market. I mean, we have a lot of things going on. You can see it in our investments in technology over the last four to five years and obviously some of those things are longer-term like the next-gen stuff. Some of it has been we have been investment phase for 6 to 12 months and we expect those things to translate now into new sales. So I don’t know if you heard our tone over the last several years, we pivoted to investing more in product and particularly more around Agile technology and that hopefully gives us some firepower here in terms of our bookings incrementality going into this year, but also into the following years as well.
Mark Marcon: Great.
Kathleen Winters: Mark, yes, just to add a little bit more there in terms of by each segment for sure we are expecting sales growth across each of the segments in fiscal ‘21. And as Carlos said, down market seems to be resilient and has trended up since we were at the low point several weeks ago but down market has been trending up earlier. And then during the latter part of the year, we would expect up markets and international for that matter to continue along those lines, but for sure expecting sales growth across all segments. And to Carlos’ point, from a long-term incremental perspective, certainly expecting Next-Gen HCM to be a driver there, but our strategic platforms in the near-term RUN and Workforce Now have been performing really well in the market and we expect them to continue to perform really well in the market as we recover through this.
Mark Marcon: Great. Just as a follow-up, could you just give us an update in terms of where we stand in terms of the number of implementations on next-gen HCM or sometimes known as Lifion and also next-gen payroll this percentage of the client base has been converted?
Carlos Rodriguez: So on next-gen HCM, you could probably appreciate for two, three months, that wasn’t really something that a lot of companies were focused on and for that matter us [indiscernible] unfortunate. But the good news is we did actually start a client just a week ago. So that is a ray of sunshine in what was otherwise a lot of dark clouds. So we had a number of clients that were set to be implemented in our fourth fiscal quarter, which delayed and one of those actually started here already in the early part of the first quarter. So that is encouraging but we are not that different from where we were before. So call it still a handful, I think we have like seven or eight clients live somewhere in that neighborhood on next-gen HCM. On next-gen payroll, there the target at the beginning from a piloting standpoint really was – clients are not quite the same size of next-gen HCM. So it’s a slightly different dynamic and it’s – and we’re making, in terms of numbers of clients more progress, but it doesn’t mean that the product necessarily is making more progress. It’s just the difference between the markets we’re serving. Next-gen HCM is really in the early stages aimed more at the mid-market, if you will, than really the up market even though we expect it to be our next-gen payroll engine across our mid-market and up market in the initial stages, it’s really mid-market. So I think we have somewhere around 100 clients sold. And I think maybe that same number implemented, if I’m not mistaken.
Kathleen Winters: That’s right.
Carlos Rodriguez: So we’re making some good progress there. And there the pace is a little bit better in the sense that we didn’t come to a complete stop on next-gen payroll and we continue to implement clients there and kind of move forward. But it’s a – this is a very challenging situation for our clients and we really need to kind of help them get through this situation and the crisis not necessarily press them to get started as quickly as possible although that’s obviously our desire from our standpoint.
Mark Marcon: Of course. Thank you.
Operator: Thank you. Our next question comes from Ramsey El-Assal from Barclays. Your line is open. Please check if your line is on mute.
Ramsey El-Assal: Can you hear me now?
Carlos Rodriguez: Yes, we can hear. Yep, go ahead.
Danyal Hussain: Yes, go ahead. We can hear you, if you?
Ramsey El-Assal: Hello, hello.
Operator: Pardon me, sir. Please proceed with your question. And we will move on to our next question. Our next question comes from David Togut from Evercore ISI.
David Togut: Thank you. Good morning. Could you characterize the gross bookings performance in the June quarter prior to the backlog adjustment?
Carlos Rodriguez: Yes, I mean I think we – we’re just trying to give a nod to our sales force in terms of – they were – they performed better than we clearly had forecasted and that we gave in terms of color, commentary during this same earnings call or during the earnings call of the last quarter, but they were still down significantly. So at the end of the day, we just want to make sure that you guys got the right impression that we weren’t disappointed and that we didn’t do worse than we expected. But from a mechanical number standpoint – think still down somewhere around 50% like if that’s a fair characterization. I don’t know if Kathleen has any more color there?
Kathleen Winters: Yes, no, the gross bookings were slightly positive to what we had expected. The approximately, down 50% is right, which is what we have been anticipating. And then the backlog adjustment, which actually is part of our normal process factored into the overall bookings number being down slightly more than that for the fourth quarter.
David Togut: Got it. And just as my follow-up, assuming the employment recovery proceeds as you have laid out Kathleen negative 7% unemployment by the end of FY ‘21, would you expect to be back on your sort of normalized growth path by FY ‘22?
Kathleen Winters: Yes, go ahead Carlos.
Carlos Rodriguez: No, go ahead, go ahead.
Kathleen Winters: It’s a great question in terms of when do we return to previous levels of growth and profitability. And as you pointed out, a lot really depends on the shape of the recovery. And look, we have taken the best view we can and tried to share with you what we are thinking about that in terms of the shape of that recovery. But it really is going to depend on that. Last recession, it took a couple of years for sales and retention and revenue growth to return to the pre-recession levels. Now, is it going to look exactly like it looked last time? We don’t know. This crisis is different. The make-up of ADP is different. So, I hate to say it, but it’s going to depend on a lot of factors but returning to those previous growth rates certainly will not be in fiscal ‘21 based on what we see right now and we will update you as things change and as we go through the current year.
Carlos Rodriguez: I think, maybe just add a little bit of – just in terms of my own observations from looking at the kind of the quarterly cadence, if you will and how – what the implications are for FY ‘22, it really depends on – are we thinking about sales? Are we thinking about revenue? Are we thinking about profit growth? And they are all kind of different buckets. But I guess and to Kathleen’s point, it really all depends – if this is unlike the financial crisis, not a two or three, the financial crisis really was – you go back and think about it, the kind of mini crisis that occurred over the course of the following two or three years. Remember, we had the European debt crisis. We had a number of things that elongated that situation, but that could happen here as well, and we are of course not scientists and we don’t know exactly what’s going to happen. But we’re using kind of the same forecast that I think all of you are using and if you make those assumptions around when the healthcare crisis passes, i.e., vaccines and therapeutics and so forth. If you follow that path then FY ‘22, when we exit in the fourth quarter of FY ‘21 – from a mathematical standpoint – I think you used the term growth rates, the growth rates are going to look pretty good in terms of as you exit from a booking standpoint and then starting maybe with profitability in the first quarter of FY ‘22 because in the fourth quarter of FY ‘21 we saw some NDE expense. But some of that – frankly is really the comparisons. So we have three quarters in FY ‘22 that are going to look pretty good. Because if we still think that the first couple of quarters of FY ‘21 are still impacted pretty significantly by COVID and by the first couple of quarters of FY ‘22 you don’t have that impact you are going to have some I hope some really good tailwinds on some of these growth numbers. But the key for me was looking at absolute booking dollars in the fourth quarter of ‘21 compared to the fourth quarter of ‘19 because obviously ‘20 is not a good comparison and looking also at our absolute profitability in the fourth quarter of ‘21 and our revenue in the fourth quarter of ‘21. And again, I feel some sense of optimism about ‘22 based on those exit rate assumptions with a capital assumption because this is – we are a long way away from having certainty and you have seen how fluid the situation has been. But I think the math I think works kind of favorably once we get through fiscal year ‘21 and particularly when we get through the first three quarters of fiscal year ‘21.
David Togut: Understood. Greatly appreciated.
Operator: Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open.
Jason Kupferberg: Thanks, good morning guys. Just wanted to start with kind of a high-level question on the fiscal ‘21 guide, I mean, we have got revenue down modestly, but obviously EPS down quite a bit and that’s being driven by a little bit of tax, but really the 300 bps of EBIT margin decline. And I guess it looks like the transformation savings should largely offset the hit to float income. So, are we really just down to kind of isolating this against decremental margins that maybe people didn’t appreciate the – kind of the severity of or are there other factors there? Because I just think at a high level people were surprised to see how much EPS is going to be down relative to revenue for the current fiscal year?
Carlos Rodriguez: Let me take a crack at a couple of high level things. And then Kathleen probably can provide some additional maybe detail to help in terms of quantify some of the stuff. But we – I’m not sure if it was clear from our comments last quarter or this quarter but having been through these types of – not through a healthcare crisis but I personally have been through dot com downturn, Y2K at ADP, 9/11 and the Global Financial Crisis. And our Board is a Board that is long-term oriented and it feels like despite how horrible the situation is, it feels like this situation is transitory and so one of the things that we have as a first principle is to maintain our level of investment. That doesn’t mean that we are not prudent around our expenses and I think we have been and I think Kathleen gave you some examples of some of the things that that we are doing. But we are going to add to our sales head count next year, which might surprise some people and maybe not something that you were expecting. And the problem is that when you model only one fiscal year for a company like ADP or recurring revenue model, if you decrease your sales cost or even your investment in product and technology, it actually looks quite favorable. And you can probably offset quite a bit of revenue decline. The question is, is that really the right thing to do long-term? We don’t believe that it is and so that’s one factor, philosophically. The second factor is that even though we clearly have some decline in the number of clients, the nature of the revenues that are going down is very high margin. So you mentioned client funds interest, but we also have another decrease from a comparison standpoint ‘20 to ‘21 in pays per control, which is call it 100% margin as well. And there is very little work related to the number of worksite, I am sorry, the number of employees paid by our clients. Our work is – workload is generally driven by number of clients and then as we have all now observed in the last quarter also driven a lot by the regulatory environment. And so the amount of work has not decreased much and in some cases has increased on behalf of our clients. And again, that’s a place where we could cut some of that support. And then it would lead to lower NPS scores and we probably would have retention go down, but the single most important driver of financial value for ADP is client retention and lifetime value. To lose clients and then have to go sell them again and implement them again makes absolutely no sense and all the experience we – that I have and we have and our Board has tells us to kind of stand firm and make sure that – that doesn’t mean that we ignore the realities around us. If we thought that this was a permanent decrease in capacity of the economy or in terms of the global outlook, and then it was going to last two, three, four years, we probably would be behaving differently, but that’s not our expectation, that’s not our – that’s not the way that we are managing the company. There’s also a couple of other items I think that mathematically may be not helping us and maybe Kathleen can help a little bit with some of those sure.
Kathleen Winters: Yes. Look, on the surface the guide to 300 basis point decline on the surface may sound like a lot, but there’s a lot going on in there. When you take it apart, I think it’s really – and you put it into the kind of buckets, I think you will see how we arrived at that guidance and that expectation, right? As we’ve talked about and as you know we’ve got obviously a substantial impact from loss – a very high margin revenue, right? We’ve got that high margin revenue. We’ve got clients on interest, which is a hurt on margin year-over-year. We also have growth in zero margin pass-throughs, which falls right to the bottom line from a margin perspective. That’s going to be a significant hurt for us where it hasn’t been as much in the past. And the continued investment along the lines of – look, we think it’s prudent and smart to take to continue our long-term view and to continue to invest in sales and in product. We are committed to that level of investment so that’s a hurt. And then you do have, as you pointed out, the transformation and other cost actions that we’ve been taking that only partially offset that. So I would think about it in those buckets in terms of, look, you’ve got this high margin revenue. You’ve got some other things that fall right to the bottom line like zero margin pass-throughs and client funds interest. You’ve got the commitment to continuing to invest and quite frankly, I think we have been executing really well from a transformation perspective and also in terms of looking at – as we navigate through this period the excess capacity cost that we have and being really smart about addressing those.
Carlos Rodriguez: But I guess let me – just to provide a little bit of color on kind of our view because I learned the hard way from my two predecessors about some of these things. So if you just look at the sales engine aspect of our business and you look at it over multiple years, you can actually do the math that if our – if we decreased our head count, call it 5% or even if we just kept it flat and you assume the productivity continued on kind of its normal trend, which is a big assumption, but if you even – if you assume that, you can see the impact that has on revenue growth from multiple years down the road. So obviously, if you expect that you’re not going to be able to ever return to the same kind of sales productivity you had before, then you have to do something differently, but that’s not the expectation we have right now. And it’s critical to our growth in ‘22, ‘23, and ‘24 for us to maintain our investment in our sales engine. Not to mention in our product and our technology and a few other places as well.
Jason Kupferberg: Okay. Yes, that’s really good color. For my follow-up, I wanted to ask just about retention. I know you are forecasting the 50 bps to 100 bps decline this year. I wanted to see if we can get a sense of how that compares to how you exited the June quarter on that metric? And I’m really just trying to get a sense of whether you are forecasting acceleration in churn over the next few quarters or more of just kind of a stable and steady pace of churn?
Carlos Rodriguez: Again, let me give you some maybe philosophical, high-level comments and then Kathleen, maybe can give you some color around the fourth quarter and some of the assumptions. So in general, we have been, and I’ve been again, having been through multiple downturns and crises, I have been surprised by the resilience of our retention and we think there could be a number of factors here. One of them could be all of the government stimulus, the Paycheck Protection Program, all these things might – these are all new things compared to the past that might be helping. There is also the potential that some clients are frozen in place, if you will, like, we’ve talked about how difficult our bookings have been. I think logic would tell me that that’s probably happening across multiple industries and multiple competitors. And so we would be – actually dishonest not to assume that that might be helping our retention in some parts of our business like the mid-market and the up-market because in the down-market it’s really driven more by out of business. So having said all that, I would say that a lot of these things are really about timing because if there continues to be government stimulus and there continues to be optimism about this being transitory, then I think this kind of holds. And you have probably some additional fallout in the downmarket as a result of out of business and so forth, but you don’t have kind of a major downturn or a collapse in retention. And that’s kind of where I am today that we are expecting what I would say is – I would consider these to be reasonable and modest declines in retention when you compare them to other downturns that we have some data on and some history about.
Kathleen Winters: Yes, and we did do a lot of work around and analysis around what happened in the last recession and what happened to retention by segment. And I think we have got a pretty balanced view if you look at the decline in retention that we experienced in Q4 and what we are guiding to and expecting and planning for in fiscal ‘21. It’s basically in line with the retention pressure that we had during the last recession. So we will see. I mean, it’s really hard to predict. And to tell what level of support the PPP program has had and is going to have, but that’s our best view right now.
Carlos Rodriguez: I think – I don’t literally don’t give it. But I think I feel like this is an environment where transparency is probably not a bad idea just to give you like – like, that’s why we gave you kind of the gross bookings number besides the net bookings number because you guys need to model this stuff so you can understand what’s happening here. But think the fourth quarter somewhere around couple of hundred basis point decline in retention, which I think again all things considered, I thought was, and most of that decline frankly came in the down-market. So, that to me feels like better than I would have expected 3 months before that.
Jason Kupferberg: Okay. Alright, well, we appreciate all the disclosure. Thank you, guys.
Operator: Thank you. Our next question comes from Tien-tsin Huang from JPMorgan. Your line is open.
Tien-tsin Huang: Hi, thanks so much for all this detail. Just on the transformation initiatives, I caught all the details there. How about looking beyond those two initiatives? Are there any other potential actions that you could take, anything that could be material over a similar size?
Carlos Rodriguez: Again, I will maybe give some high-level comments and let, I think Kathleen give some additional detail. We have a very large menu of things that we can do. This company has a very, very long history of navigating through multiple changes in environments and multiple economic circumstances and now I think we will add to our repertoire managing through a major health crisis and a pandemic. And so, we have – I don’t know how else to put it. We have a huge number of things that we could do, if necessary, and when necessary. This is an incredibly resilient business model. I recognize that this is unusual for ADP to be down the way we are, but it is what it is in terms of the economic circumstances around us. But believe me; we have a number of levers. So as I said, like some of these things are – and our business model are somewhat self-correcting. If in the unlikely event, there was a belief that there was a permanent impairment of kind of global economic GDP or growth vis-à-vis other industries or other companies, I think that we are in somewhat of a better place because the amount of money that we spend on NDE and on implementation alone would, at least for the short-term, would certainly enhance our bottom line and help us from a margin standpoint. That’s not what we want because the real value to be created here is through growth – like, through profitable growth, not by kind of shrinking our way into profitability. But we have no intentions of allowing ourselves to underperform, if you will, on a long-term basis below what we have delivered for many, many decades. And that’s what ‘21 is all about. But if circumstances change, we have a very long list and quite a lot of variable expense in our P&L and a very strong balance sheet and a very strong cash position.
Kathleen Winters: So, Tien-tsin, thank you for the question, it’s a logical question because when you think about kind of the past and the history over the last several years, right, in terms of what we’ve been driving from a transformation perspective, you can see that we have had these – several kind of big major initiatives over the last several years, right. We had Service Alignment Initiative first. We have a Voluntary Early Retirement program. We told you about the workforce optimization and then the procurement and now the procurement continues and we have shared with you our work that we have doing around digital transformation. The question, what comes next? Quite frankly, I think there is a lot of runway and we have a lot to do from a digital standpoint and also from a procurement standpoint. It does get harder as you go, I will say, but there is a lot to do there. And a lot of the digital projects, first of all, the digital is certainly focused on our service and implementation, because there is opportunity there, but it is across the entire company. So every single segment and every single department, whether you are front-office or your back-office is tasked with thinking about digital transformation, automation, how do you make the work more efficient, how do you take work out? There is runway there. So I expect that you will hear us talking about that for some time to come. The procurement, well, it does get harder as you go. What I would say is, in an environment like this that we are in right now, in a downturn, it does present some procurement opportunities that may be didn’t exist a year ago – when you actually – when you go back and you are negotiating with vendors and suppliers and so forth. So we have got real work to do there. And as you heard us say in the prepared comments, we have expanded procurement to make sure we are capturing all the opportunities. From a real estate perspective in terms of, look, the environment has changed. The way the world is working has changed. Let’s make sure we are thinking about our real estate footprint in a fresh modern, forward-looking way to ensure we are utilizing the assets that we have to the fullest extent possible. We are understanding how we are going to get work done in the future. We are understanding how we can utilize mobility models where it makes sense to do that. So we have got a lot of work and some really good work to do here from a digital procurement real estate perspective.
Carlos Rodriguez: And just one last comment on that, the other thing that maybe is under-appreciated but it’s worth mentioning here because again, we are typically not talking about these things as they are more longer-term, but if your question was really more about what’s potentially next, longer-term and not just in ‘21, our next-gen investments are the largest potential digital transformation effort we have ever undergone. And we always focus on them around what they are going to do in terms of our winning in the marketplace and our sales growth and our revenue growth. But trust me when I tell you that the business cases for those investments and the progress we have been making over all these years, there’s an enormous expectation for, call it automation, call it efficiency, whatever you want to call it and we don’t usually talk about our tax engine, we talk about HCM and payroll. But one of those next-gen investments is our tax engine, which again there, the early signs – we already have a couple of hundred thousand clients migrated onto that platform. And when you see how quickly we are able to make these legislative changes in that platform and the cost structure and the cost of support again, I would be very optimistic that one of the largest transformation efforts we will be talking about in the future when we look backwards is these next-generation investments. I am hoping they are also going to lead to big growth incrementality and winning more market share in the marketplace, but do not underestimate the value of these investments in terms of our back-office and also our cost structure.
Tien-tsin Huang: Yes. No, thank you for that. That’s very complete answer. If you don’t mind, just one quick follow-up, you mentioned the legislative changes and a lot of the work and effort that you have put into that. And Carlos, I know I ask you this all the time. So I am going to ask you again, could we see more demand? I know you mentioned improved bookings momentum that you started to see, but could you see more demand for the service model in general here? I don’t know where you are seeing maybe some switching from or more demand for work but again election year, lot of complexity, probably more changes coming. Could that help you here?
Carlos Rodriguez: I mean, I don’t see how it can’t. So and usually, I am not that optimistic or that definitive because if it were only the election, I would say, we will have to wait and see. But I don’t, again, I am not usually a pontificator, but I just don’t see how companies after all this don’t reassess not just kind of how they do HCM and payroll and so forth, but so many other parts of their business model where continuity and resiliency and so forth are critical and that applies to the smallest client to the very largest clients. I think that for a lot of us, I don’t think we are the only ones or the only industry or space where that’s going to be a tailwind but it’s hard to believe that this in a positive. Now, in what quarter and how do I qualify that because you have GDP going down, I don’t know, 30-something-percent in the second quarter. Even if people were thinking about that, that wasn’t really going to be a factor certainly in the fourth quarter. The question is how does that net out in the math, right, because you want to somehow be able to parse that out and understand how much of is incremental. And I can’t necessarily do that scientifically but intellectually, it’s hard to believe that it is in a tailwind going forward for us. And then on the election side, we like – we generally like change because – and it doesn’t matter whether one party versus the other. We are apolitical as a company. But usually when there’s change there is change and for employers. Employers are an instrument of policy of the government, it’s how public policy gets effectuated whether it’s through tax or all the various safety policies and – you are seeing all these changes in leave policies now to help manage through the health crisis. So that’s all incredible, I think opportunity for us to help our clients and when there is opportunity to help clients, that’s opportunity to sell new business as well.
Tien-tsin Huang: Yes, agreed. Thank you. Have a safe rest of the summer. Thanks.
Carlos Rodriguez: Thank you. You too.
Operator: Thank you. Our next question comes from Bryan Keane from Deutsche Bank. Your line is open.
Bryan Keane: Hi, guys. Good morning. I just wanted to ask take another crack on the margin question and looking at it from this perspective. The fourth quarter margin in ES was impressive to bring it to flat and you took a lot of the brunt of the hit. Just thinking about that fourth quarter versus the guide of down 300 basis points, I guess I am a little surprised that it doesn’t hold up better. Can you just contrast the margins in the fourth quarter being flat versus down 300 basis points from that perspective?
Carlos Rodriguez: Sure. I mean, I think some of it is – Kathleen will go through some of the math but the client funds interest impact is much bigger I think going forward than it was in the fourth quarter because of the laddering that we do in our portfolio. The impact for example of bookings – we still had a lot of business starting because remember, there is a lag between bookings and starts. So I think you would all be very surprised by how much. Even though we had some delays in some – particularly for larger clients, we started a lot of business in the fourth quarter also and as kind of bookings decline now the starts and the amount of revenue that goes into the run rate declines as well as you move forward. And so you get that sales number back up again. So I think there are a number of just kind of mathematical realities that I think that hit us in the next two or three quarters in comparison the fourth quarter. But I think that, again, we are not going to do that, like, we are not going to provide quarterly guidance, but I would encourage you to attempt to do either a first half or a second half based on the tone that you are hearing from us or even attempt to do it by quarter because the view that we have of the fourth quarter, again assuming the assumptions are correct, I think paints a very different picture than the picture may be that you are getting by looking at a ‘21 number. I would also argue that when we talk about ‘21, its fiscal ‘21, which happens to be only 6 months of ‘21. For every other company out there when you talk about ‘21, you are talking about the beginning of January of ‘21 where everybody expects everything already to be back to normal and that is – in terms of assumption of things being back to normal. So it’s a little bit maybe tricky in terms of the thought process and the math. But I don’t know if Kathleen has anything to add on that?
Kathleen Winters: Yes, I mean, yes, it’s a little bit hard to say, okay, compare one quarter to a full year particularly in a year like this when there is so much going on and there’s so much linearity aspect in fiscal ‘21. But what I will say is in Q4 we did have sales expense, our NDE was actually a little bit of a help in Q4 versus it ends up being a surge so that’s kind of one difference one to the other. And the other thing is, from a transformation perspective in terms of benefits and how the benefits flow, well, certainly being a favorable and a help for us in each year in fiscal ‘20 and in fiscal ‘21, in Q4 there is a pretty substantial impact favorability from transformation if you were to compare it to a full year fiscal ‘21. So it’s kind of a math of how it all falls out in a quarter versus in a full year. But again, think about fiscal ‘20 as sorry, fiscal ‘21 as look, you have got this high margin revenue. You have got top line stuff that falls right to the bottom line being the zero margin pass-through and the client funds interest. You have got our continued commitment to investments. So you have got that from sales expense partially offset by continued transformation work.
Bryan Keane: Got it. That’s helpful. And then just a quick follow-up, the elevated out-of-business losses, just trying to get a sense of how that’s compared in past recessions and then how much more do we have to go on that? I mean have you written down the majority of it and there’s just a little bit left over because I know in fiscal year ‘21 you are saying there will be some more losses. So just trying to get an impact of magnitude of previous recessions and how much is left? Thanks.
Carlos Rodriguez: So that really comes through in the retention. So it’s not really, we don’t quote, unquote, write it down, right? So that really comes through in terms of the losses from a retention standpoint. We have like maybe others some clients that have quote, unquote stopped processing and, but they are still there, and so there is a question of which of those clients come back and which of those clients don’t come back. But we have modeled in the down-market, this is really a down-market issue. We hope that it’s a down-market issue. At least in prior economic cycle that’s been the case. And I think you see it reflected in our retention rate, but it’s very, very hard for us to say with any level of certainty, how that’s going to exactly play out in the future. We have looked at all the prior downturns, and we know that there’s probably some out of business that’s still there that’s going to occur. And a lot of this is, in this case is going to depend on government stimulus and whether there continues to be some support for small business or not and also just the overall level of GDP and obviously the overall pace of recovery in terms of people going back to spending on products that help small businesses survive.
Bryan Keane: Okay, thank you.
Operator: Thank you. Our next question comes from Lisa Ellis from MoffettNathanson. Your line is open.
Lisa Ellis: Hi, good morning guys. I apologize. I am going to ask one more question on margins. Just a clarification on the backside because I think that may be the effect of the de-leveraging related to pays per control, I think a little bit steeper than we were expecting, etcetera. Is the implication of that that coming out of this as we get back to better employment levels late in ‘21 that you would see a sort of similar snapback, is that the way we should be thinking about it as unemployment improves? I mean, when we are looking out into FY ‘22 or are there reasons that we wouldn’t expect that to happen? Thanks.
Carlos Rodriguez: No, I think that’s right. And again, hate to go back to, because I think I would encourage you like I am doing the focus on both growth rates, but also, because I know they are important in terms of models and so forth, but absolute numbers as well because if pays per control doesn’t grow in the fourth quarter of fiscal year ‘22 we have a serious problem; like if there’s not a big snapback of that number, like if there isn’t a huge snapback of bookings, we have serious problems. And so the only thing that we think is not something that we want to model improving is interest rates because it just doesn’t feel like is a basis for doing that, but I think if you take reasonable assumptions based on economic forecast, you do have a fairly significant snapback in terms of growth rates, if you will or improvement percentages. The question then is, what does that mean in terms of absolute numbers? And so if you still have 7% unemployment, by definition that unemployment rate is still higher than it was in the, call it third quarter of fiscal year ‘20 and that has some implications in terms of absolute level if you will, of pays per control and we have kind of modeled that in to our assumptions but for sure there’s snapback in the numbers. There is no denying.
Lisa Ellis: Good. Okay, alright. And then just my follow-up is related to the PEO; as you are seeing because I know you don’t – your bookings are yes, related bookings so just a kind of question on demand environment for the PEO. As you are seeing companies adjusting now to the crisis and to the recession how is demand acting for the PEO? Meaning is it positive, because companies are looking to variabilize cost or are you seeing some companies move away from the PEO because of reducing benefits? What does that demand outlook look like? Thank you.
Carlos Rodriguez: I think the demand so far. Our experience in the PEO has been that it was kind of in line with the rest of the business. It looked a little more resilient in April, which you may have heard that tone from us but then May and June, pretty much in line with what was happening across, yes, In terms of bookings demand. And I think some of that is because of just the sales cycle. If you think about the PEO the sales cycle resembles more the up-market. The lower end of the up-market than it does the down-market, even though the average client size is small and that’s because it’s a high involvement product and high involvement sale because you are basically turning over all of your HCM including your benefits your workers’ comp, etcetera. So, I think that’s what we have seen in the short term. If you look at again 20, 25 years worth of history, I can’t even believe I have been doing this for that long, but I started my career in the PEO and every time there is an economic cycle or a change, whether it’s dot com or financial crisis, whenever there is a lot of theories. And I think the secular demand and growth of the PEO doesn’t seem to be impacted by many things. So I would still expect that kind of solution to have a lot of legs for small and mid-size clients for a long time to come. In the interim, there could be ups and downs, because as you said if companies are quote unquote hunkering down and don’t want to offer benefits – at least in our PEO part of the value proposition is benefits and so – but so far when you look at sales results, lead generation activity, etcetera, there is no reason to believe that the PEO won’t recover in the same way that we expect the rest of the business to recover from a booking standpoint.
Lisa Ellis: Terrific. Thanks guys.
Operator: Thank you. Our next question comes from Steven Wald from Morgan Stanley. Your line is open.
Steven Wald: Great, thanks for taking my question. Could we just – coming at some of the implicit assumptions under the guidance another angle. Just curious what you guys thoughts are in terms of what you are seeing conditions on the ground wise in terms of geographic concentration. I mean certainly some parts of the country are more open than others, some industries are doing better than others, I guess, I am just curious if you guys could sort of separate out how you guys are thinking about that on the go-forward and the unevenness of the recovery and what that means for your client base? I know you have talked about being diversified, but certainly there is a quite disparate experience level across the country right now.
Carlos Rodriguez: It’s a great question. I think you probably saw in our comments that we said that we observed in our data that there has been a slowdown in the last few weeks, so we are looking at the data weekly and we do look at it geographically, both globally in terms of by country but also within the U.S. by state. And as you would expect part of the challenge in the last several weeks and months has been in the places where you have seen some of the comeback in terms of the virus. The resurgence of the virus in kind of the southern states and also Texas and California, but nothing back to kind of the full shutdown that we saw in April, which is in line with what you are all seeing as well in the news and so forth. This is more about leveling off of growth rather than kind of a decline. So we have seen it in the same metrics that I talked about in the last quarter. So, I can see it in like the number of job postings and screenings and so forth that have – that were on an upward trend line and frankly it was certainly not a V, but it was a nice upwardly sloped trend language then it was translating into improved employment both in our numbers, but also in the government reported numbers, but we have seen a plateauing of that as of the last 2 or 3 weeks. And so that’s something that we – fortunately we re-looked at our assumptions for fiscal year ‘21 the assumptions we have for pays per control for the first quarter are around what the pays per control exit growth rate was for the fourth quarter and based on this kind of plateauing that feels like the right place for us to be. And the problem is we don’t want to necessarily go tweak the second quarter, the third quarter and the fourth quarter, because as you have seen over the last 3 or 4 months, 3 or 4 months ago we were actually thinking about opening our office in Orlando – in Maitland, Orlando, because everything was fine in Florida and nothing was happening in Florida and we didn’t know what the hell we were going to do in New Jersey and New York. And as we sit here today I am sitting in the office in New Jersey and we are not opening anything in Florida. So, I think it’s unfortunately a very fluid situation and you just have to keep an eye on all of these assumptions both at the macro level, but as you said, we have very detailed information and a heat map by state. And I would say that what you are hearing and seeing in the news is what we are seeing in the data. But what that’s translating into is a plateauing or a leveling off of employment short-term so far, not a decline.
Steven Wald: That’s very helpful. Maybe if I could just squeeze a quick follow-up in here. Carlos, I think you have laid out at your Innovation Day earlier this year that the addressable market ADP sits in, it’s about $150 billion of revenue a year growing at 5% to 6%. Obviously, that’s changed given COVID, but I am just curious to get any updated thoughts you have around maybe where that stands today? But if you can really speak to where it stands today given the fluidity of the situation, how we are thinking about it coming out of it given your comments and Kathleen’s comments about the enhanced opportunity for the space you are in?
Carlos Rodriguez: Listen there is a lot of smart analysts out there and industry analysts out there that would probably be better answering that question. And they probably are going to need a little bit more time and information to answer that question. But I will answer it the same way that I answered it earlier today, which is I don’t know by how much, but it’s hard to believe that past the transitory nature of the situation that, that growth rate for the industry isn’t at least what it is if not higher because and again, I am not trying to be arrogant that, that is only for HCM, but there are other industries that I think have, shouldn’t have tailwind from these events, where the acceleration of people to using cloud services and using what I would consider to be outsourced services so that you can focus on your core business, but also have resiliency. I think and also so that you can improve efficiency and you can improve productivity of your workforce and improve engagement of your workforce. All of those things I think are going to get tailwind and it’s across multiple technology sectors that I think are going to probably benefit on a longer term on a medium term and longer term basis from this unfortunate situation.
Steven Wald: Great. Thanks for taking the questions.
Carlos Rodriguez: Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Thanks. So just a couple of final thoughts. One is I know I said it before, but we have navigated through a lot of issues over many decades. I have had the experience of being through several myself, whether it’s the dotcom recession, what happened after 9/11, the global financial crisis, because in that case, it was really a synchronized global downturn and now this health crisis. And the one thing that I would say about ADP’s business model regardless of I know the focus here is on the short-term, but if you stay focused on the long-term, it’s an incredibly resilient business model, financial model, but also business model. The value of our products and our services is key and one small anecdote, I think we may have mentioned it in the last call. But as kind of this crisis unfolded we had to become like many other parts of the economy, we had to go and talk to governors and leaders, including the White House to make sure that we were deemed an essential service, because we needed to stay in operation. And so I don’t know what better sign there is of a resilient long-term model than to be considered an essential service, because we definitely – we definitely are. We are glad we were there to help our clients will still be there to help our clients. But I think that speaks volumes to the long-term viability and also upside of the business that we are a critical service an essential service to the economy and to our clients. We are proud of that. And I am proud of what our associates did to live up to that expectation. And as to the next year again, I would just encourage everyone to think through kind of first half second half or even by quarter because at least for me assuming that we stay on the trajectory that we are on, which I realize is fluid, but with those assumptions the fourth quarter exit rate of FY ‘21 is really what I am focused on and not necessarily the short-term results of the first few quarters of FY ‘21 although we are going to do our best to perform as well as we can throughout that as well. And lastly, I know Kathleen said in her comments, but we are very proud to have delivered $1.5 billion in cash back to the dividends and $1 billion through buybacks through, which I think is also another sign of the incredible resilience. And I think cash flow generation capability of this business model in this kind of short-term hit that we are having to revenues and to profitability, I don’t believe will impair our ability to continue that tradition of returning cash to our shareholders. And for that, I want to say that I appreciate the patience of our shareholders as well and all of you. And I thank you today for listening to us and for all your questions. And I wish you all a very safe summer as well. Thank you.
Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for participating and you may now disconnect. Everyone, have a wonderful day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Crystal and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Fourth Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Crystal. Good morning, everyone and thank you for joining ADP’s fourth quarter fiscal 2020 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the fourth quarter of fiscal 2020. The earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompany today’s call as well as our quarterly history of revenue and pre-tax earnings by reportable segment. During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures, can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. As always, please do not hesitate to reach out should you have any questions. And with that, let me now turn the call over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Dany and thank you everyone for joining the call. This morning, we reported our fourth quarter and fiscal 2020 results. Although we ended the year – this year against significant headwinds related to COVID-19, we believe we executed well over the course of the last 12 months. And our product offerings remain well positioned to support sustainable long-term revenue growth as we continue to help companies and their workforces through all types of environments. For the quarter, we delivered revenue of $3.4 billion, down 3% reported and 2% organic constant currency, which was better than our expectations. And for the full year, we delivered revenue of $14.6 billion, up 3% reported and 4% organic constant currency. Our adjusted EBIT margin increased 10 basis points in the quarter and increased 60 basis points for the full year, well ahead of our expectations as we managed our expense base prudently to absorb the impact of a decline in revenue in the fourth quarter, while simultaneously providing an elevated level of service to our clients. With this revenue and margin performance, our adjusted EPS growth was flat for the quarter and up 9% for the year. Considering the unprecedented and evolving macroeconomic situation, we are very pleased with our execution in the quarter and our current positioning as employment continues to gradually recover from the steep declines our clients have experienced. The global health crisis from COVID-19 has clearly evolved over these past few months. And I will start today’s discussion by providing a brief update on the trends we have experienced. When we reported our fiscal third quarter results in April, we were just starting to see some preliminary signs of stabilization after weeks of rapid deterioration, more specifically, across our own data sources, including weekly payroll, clock-in volume, job postings and background screenings. There were multiple indications that we were reaching the trough. Now 3 months later, we do believe we saw conditions bottom in late April. Whereas our pays per control was trending down mid-teens in April, it has since improved to be down about 10% as we exited the quarter. And for the full quarter, pays per control was down 10.8% better than we had contemplated in our outlook. Last quarter, we also discussed our expectation for elevated out-of-business losses in May and June. Those losses ultimately developed in line with our expectations. This yielded a decline in our retention rate of 20 basis points to 90.5% for the full year. Though if not for the elevated out-of-business losses in Q4, we believe our retention rate would have been up for the year. In fact, despite these losses in Q4 for fiscal 2020, we tied an all-time high retention for our mid-market and hitting multi-year high in our up-market. Looking ahead, what we have been encouraged by signs that the economic distress brought about by COVID-19 has started to ease in certain countries and several U.S. states. We are seeing continued or even increasing distress in others. And over the past several weeks, we have seen the pace of employment recovery slow. Accordingly, as we set our expectations for the coming year, we believe that the worst is behind us. But the global economic recovery over the coming quarters will be gradual. Kathleen will discuss some of our specific macroeconomic assumptions in more detail. I’d like to turn now to Employer Services new business bookings. We reported a decline of 21% for the year, which was in line with our revised outlook despite the limited visibility we had in making that forecast. And although this represents a significant decline, the actual execution by our sales force was better than what this reported growth rate suggests. As we mentioned last quarter, there are two components to our bookings figure. Our gross bookings we actually sold in the quarter and adjustments for previously required bookings. Our gross bookings sold in Q4, while down significantly, came in ahead of our forecast, and most importantly, exited the quarter with improving momentum. This gives us confidence that buying behavior is continuing to trend in the right direction, which we believe will drive further bookings recovery in the coming quarters. Furthermore, our sales force has continued to adapt to this virtual sales environment as we have invested in training, stayed agile on sales messaging, and continued to foster our channel relationships. We are also continuing to see week-on-week improvement in leading indicators, such as referrals, appointments per salesperson and demos scheduled. In addition to these gross bookings, we regularly adjust bookings we have previously recognized if for example, a client is no longer expected to start within the original estimated timeframe or starting with fewer employees than originally anticipated. These backlog adjustments are ordinarily immaterial to our bookings growth. But as we said last quarter, COVID-19 is causing some clients to delay implementations or to start with fewer employees than we originally signed. We made a larger backlog adjustment in Q4 than previously planned. And this offset the better underlying sales performance we experienced. Looking ahead, we expect we will likely see negative bookings growth in the first half of fiscal 2021 as we are still selling into an unfavorable macro environment. We expect growth to be flat to positive in Q3 with much more substantial growth in Q4 driving full year bookings growth of flat to up 10%. Beyond fiscal 2021, a key priority will be getting our sales productivity back to or above its previous level. Within our control are the investments we make. And in fiscal 2021, we are planning to continue investing in product innovation, digital sales capabilities and leading-edge sales tools to drive sales productivity higher. In addition, at this point, we are planning to add modestly to the size of our sales force. And together, we believe these investments will position us well to return to our previous – to our prior new business bookings growth trend line as client buying behavior continues to normalize. Factors beyond our control, including overall GDP trends, as well as the timing and scope of workers returning to their job sites, were in the meantime likely continue to impact our bookings. Moving on, service has remained critical to our clients. Our clients look to us for support and guidance in navigating through the complexities of key HR challenges and regulatory change. And our goal has been to serve as a trusted partner as they faced COVID-19. Our clients have responded very positively to the robust service we have provided. And that in turn has led to record NPS scores in June as a direct outcome of our commitment to providing a successful level of service. And we expect this favorable NPS trend to have positive implications for us in the years ahead. In response to the initial surge in service volumes related to COVID-19, we redeployed hundreds of sales and implementation associates to help meet the service need. While average resolution time spent per service requests remains elevated as our clients work through complex issues, we have now seen our service request volume return to more normal levels. And we are happy to report that we have now deployed most of these associates back to their sales and implementation rules. We continue to keep watch on proposed legislation that could drive another surge in client service demand and we remain prepared for such a scenario. We also continue to serve our clients through product innovation. During the quarter, we rolled out a range of solutions to help our clients through the crisis and prepare for the recovery. We implemented over 1,000 feature changes in response to 2,000 legislative updates in 60 countries. And we also had over 400,000 clients run over 2 million Paycheck Protection Program reports for a total loan volume of approximately $115 billion. Many of those clients have also now run the necessary reports to apply for their loans to be forgiven. Looking ahead, a key product focus is enabling safe return to the workplace. And we are offering tools, including touchless and voice-enabled clocking, health attestation and enhanced scheduling and analytics to help clients manage their workforces as they resume workplace operations. We continually progress on our other major product initiatives, including the rollout of our next-gen HCM platform and payroll engines. 2 weeks ago, we won yet another award for our next-gen HCM solution, the Ventana Annual Digital Innovation award. And we remain excited about its rollout. Perhaps more importantly, despite shifting our workforce to remote environment, we remain on track to hit our R&D development roadmap milestones. And just this quarter, we piloted next-gen HCM and payroll in Australia. Our product team also launched our new workforce management solution in the down-market, like a new time kiosk in the Apple App Store. And we went general availability with Wisely Direct in our mid-market and down-market. Now, taking a step back, I’d like to say that in every challenge, there is a potential for upside and COVID-19 is no exception. We believe that the nature of this shock in which businesses of all sizes have faced major uncertainties in managing their employees, have made an HCM partnership they have with ADP got much more valuable. And as companies emerge from this crisis, we expect them to see even more clearly the benefits of investing in robust, secure HCM offerings that include expertise and service to support their mission-critical activities. So, although COVID-19 has created temporary headwinds in our growth, past experience has taught us to stand firm regarding our investments in strategy as part of our commitment to drive long-term sustainable growth. The strength of our business model and balance sheet allow us to do exactly that. And we are well-positioned in our product, service and go-to-market strategy. Last, before turning it over to Kathleen, I would like to quickly touch on our plans for our own associates. Last quarter, we discussed having over 98% of our workforce operating virtually, including our sales force and we have been pleased with that transition and their overall performance in this environment. While we are well-positioned to continue operating this way, we are in the early stages of bringing back a small portion of our workforce to the office on a volunteer-only basis. And I am actually pleased to join you today from our Roseland headquarters, which we opened just this Monday. Our sales force will continue to primarily engage with prospects and clients virtually, but they are beginning to conduct face-to-face meetings in some geographies, to the extent that they and our clients and prospects are ready to do so. And with all that said, I would like to once again take a moment to recognize our associates for their outstanding effort and the sacrifices they have made. I understand the monumental task of managing work and home life is a complex situation. And I also know it’s not easy. A heartfelt thanks to our associates and leaders for their commitment. I will now turn it over to Kathleen."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos and good morning everyone. During the quarter, our revenues declined as we felt the full brunt of a double-digit decline in employment among our clients combined with other recession-driven headwinds. But we believe we executed well and are well-positioned to do so for the quarters ahead. For the fourth quarter, our revenue decline of 3% reported and 2% organic constant currency was ahead of our expectations as pays per control and PEO performance were better than we have planned. Our adjusted EBIT margin was up 10 basis points in the quarter also well ahead of our expectations. We took certain costs actions in the quarter continue to benefit from cost savings related to our ongoing transformation initiatives and also benefited from lower selling expenses, which together offset the margin impact from the loss of high margin revenues related to COVID-19. Our adjusted effective tax rate decreased 210 basis points to 22.9% compared to the fourth quarter of fiscal 2019. And our adjusted diluted earnings per share was flat at $1.14 as lower year-over-year revenues were offset by modest margin expansion, a lower tax rate and a lower share count compared to a year ago. We ended fiscal 2020 with revenue growth of 3% reported and 4% organic constant currency. Adjusted EBIT margins up 60 basis points and adjusted EPS growth of 9%, all in a solid year, particularly given the significant decline in economic activity and employment that we faced over the last few months. As I move on to ES segment results, it’s important to emphasize how resilient the business performance was in the context of unprecedented headwinds, including a 10.8% decline in pays per control and a 22% drop in client funds interest revenue. During the quarter, our Employer Services revenue declined 6% on a reported basis and 5% on an organic constant currency basis in line with our expectations as better underlying growth was offset by incremental FX drag. Our client fund balance declined 8% in the fourth quarter, reflecting lower pays per control, lower state unemployment insurance rates, payroll tax deferrals amongst some of our clients, and the continued lapping of the closure of our Netherlands money movement operation in October of 2019. Combining that balance decline with a 30 basis point decline in average yields drove our client funds revenue to decline by 22% to $115 million. For the full year, our ES revenue was up 1% reported and 2% organic constant currency, a solid performance. Employer Services margins were flat for the quarter, well ahead as our most recent expectations. We had the impact of lower revenues at relatively high incremental margins as we discussed last quarter offset by prudent cost control measures across all categories. ES margins were up 60 basis points for the full year. Moving on to PEO, also solid performance given the circumstances. Our total PEO segment revenues increased nearly 4% for the quarter to $1.1 billion and average worksite employees declined 3% to $548,000. This revenue and worksite employee growth, were both ahead of our expectations driven by better retention performance and pass-through revenue. Same-store employment at our PEO clients performed in line with our expectations of a mid single-digit decline and as expected was more resilient than the average client in our ES segment. Revenues, excluding zero margin benefits pass-throughs, declined 5%. And in addition to being driven by lower worksite employees, it continued to include pressure from lower workers’ compensation and SUI costs and related pricing. PEO margin declined 450 basis points in the quarter. This included about 530 basis points of unfavorability from the net expense in ADP indemnity of approximately $34 million, which contrasts to the $22 million benefit we had in last year’s fourth quarter. As a reminder, we had experienced favorable worker’s comp claim trends over the past several years which translated to favorable reserve adjustments in ADP indemnity. Those trends remain positive, but not as much as what we factor in our most recent reinsurance agreements. And as a result, we had a slight true-up the other way this year. Let me turn now to our outlook for fiscal 2021. I will start by discussing some of the specific U.S. macro driven assumptions that underpin our guidance. The data for these assumptions is a combination of our own trend data and third-party macroeconomic forecast and we believe we are utilizing a balanced outlook. First, our pays per control outlook. We are assuming a decline in average pays per control of 3% to 4% for the year, driven by decline in the high single-digit range for the first half of the year, improving to a decline of mid single-digit by Q3, followed by a rebound to positive mid to high single-digit growth in the fourth quarter. This outlook corresponds to a gradual improvement in the employment picture through the fiscal year though it did not contemplate a full employment recovery. To help translate this trend into a single number you can anchor to, our guidance contemplates the U.S. getting to approximately 7% unemployment by June of 2021. Second, out-of-business losses. Our retention was negatively impacted by losses in its most recent quarter, as we had a number of clients turn inactive, but after monitoring and assessing, we decided to write-off as losses. While we believe government stimulus programs have helped many small businesses, we continue to see some companies in an inactive state where they are not paying employees. And we expect continued elevated losses in the early part of fiscal 2021 as restrictions and lower demand in certain industries continue to drive fall out. As a result, we are setting our expectation for ES retention to decline by another 50 to 100 basis points over this coming fiscal year. Lastly, on client fund interest. As discussed last quarter, our client balance growth is being impacted by the combination of a decline in pays per control, lower new business bookings and out-of-business losses and we had some modest pressure from companies taking advantage of the payroll tax deferral provision of the CARES Act. We are assuming a client funds balance of 6% to 8% for the year. And like pays per control, we expect it to be negative for the first three quarters and then return to growth in Q4. We expect our average yield to decline as well. As a reminder in Q4, we temporarily suspended our purchases of new securities and reinvestment of maturing securities in our client funds portfolio. And earlier this month, we resumed reinvesting. We have over $5 billion in securities maturing in fiscal 2021, yielding on average over 2% and we expect to reinvest them at prevailing yields that are well below that level. As a result, we expect our average client funds yield to be down 50 basis points to 1.6% for the year. With this combination of lower balance and yields, we expect interest income on client funds to be $390 million to $400 million, down about $150 million versus fiscal 2020 and we expect interest income from our extended investment strategy to be $430 million to $440 million, down about $125 million versus fiscal 2020. With that said, without the benefit of our client investment strategy, which utilizes laddered maturities, we believe the headwind to fiscal 2020 would have been even greater. Having covered the major macro topics for fiscal 2021 let me share with you how we are deploying our downturn playbook to manage expenses. We have concentrated on areas where we have excess capacity and on reducing discretionary costs, while maintaining investment in sales, products and our associates. And as we emphasized last quarter, we continue to have the strong cash flow profile and balance sheet strength to withstand impacts to our revenue without taking immediate actions on our investments. We said we would be thoughtful and strategic in assessing the most prudent path forward, a path that balances positioning for recovery against near-term margin performance. We have now had a quarter to assess our business capacity and needs. And during the fourth quarter, we identified businesses across ADP, where unfortunately, we didn’t believe a recovery was likely in the near-term and therefore had excess capacity in service and implementation. In addition to taking specific headcount actions, we have further tightened on non-essential spend, including T&E and other discretionary spend. We are also continuing to move forward with our transformation initiatives. For the past few years, we have highlighted for you some of the discrete material initiatives that we have worked on and their estimated level of benefits. In fiscal 2019, we executed on our voluntary early retirement program, which yielded over $150 million in annual run-rate benefits. In fiscal 2020, we executed on our workforce optimization program and a procurement initiative, which together yielded approximately $150 million in annual run-rate savings against our original expectations of $100 million. For fiscal 2021, we have two important initiatives to call out. First, we are moving forward with a digital transformation initiative that leverages many of the capabilities we highlighted at our February 2020 Innovation Day, primarily to optimize our implementation and service in addition to enhancing efficiency in other parts of the organization. As examples, we are further utilizing automation in the implementation process, deploying additional self-service features throughout our platform, broadening the use of guided assist tools and expanding the use of chat and chatbot. We expect this to be a multi-year effort as we work to optimize large parts of our service delivery model. Our innovation agenda is running full speed ahead and that includes innovation in our client engagement. We also expanded our procurement transformation initiative and expect further benefit for fiscal 2021. We have reassessed our real estate footprint and although we had already closed over 70 subscale locations as part of our service alignment initiative in recent years. We recently closed several additional locations, including a large office in New Jersey. We will continue to evaluate whether there was further opportunity for location consolidation. Between these two initiatives, our digital transformation initiative and the expansion of our procurement initiative we expect to realize a combined $125 million in savings during fiscal 2021, with over a $150 million in run-rate savings exiting the year. Let’s now turn to our outlook for fiscal 2021. We will start with the ES segment. We expect a decline of 3% to 5% in revenue for the full year driven by our outlook for a decline in pays per control, balance and yield pressure in our client funds interest portfolio as well as pressure from new business bookings and elevated out-of-business losses. Compared to what we just experienced in the fourth quarter, we expect the first half of fiscal 2021 to experience a slightly greater revenue decline as the incremental impact from lower sales out-of-business losses and lower client funds interest more than offset the gradual recovery in pays per control that we are anticipating. We expect revenue growth to improve modestly in Q3 and then turn positive in Q4. We expect our margin in the Employer Services segment to be down about 300 basis points for the year. And as a reminder, the revenues we lose from pays per control, out-of-business losses, and client funds interest are all high margin. As with revenue, we are expecting a decline in ES margin during the first three quarters and an increase in the fourth quarter. For our PEO, we expect revenue down 2% to up 2% for the full year with average worksite employee count flat to down 3% driven by similar factors as our ES segment, namely headwinds and same-store employment, out-of-business losses and bookings pressure. We expect average worksite employee growth to be negative during the first three quarters and turn positive in Q4. Our revenues, excluding zero margin pass-throughs, are expected to be down 1% to 4% and we continue to expect lower workers’ compensation and SUI pricing. For PEO margin, we expect to be down about 100 basis points in fiscal 2021 driven in part by drag from higher zero margin pass-through revenues partially offset by a favorable compare for ADP Indemnity. With these segment outlooks, we now anticipate total ADP revenue to decline 1% to 4% in fiscal 2021 and we anticipate our adjusted EBIT margin to be down about 300 basis points as the benefits from our continued expense management and transformation initiatives are partially offsetting the detrimental impact – margin impact of expected lost revenue due to COVID-19 as well as the investments we continue to make. We anticipate our adjusted effective tax rate to be 23.1%. This rate includes less than 10 basis points of estimated excess tax benefit from stock-based compensation related to restricted stock vesting in Q1 of fiscal ‘21. But it does not include any estimated tax benefit related to potential stock option exercises given the dependency of that benefit on the timing of those exercises. Last quarter, we temporarily suspended our share repurchases as we decided it would be prudent to wait for stabilization of the overall environment. At this point, we anticipate resuming our share repurchase program at some point this fiscal year subject to market conditions and we have a slight net share count reduction contemplated in our guidance. And as a result of our outlook for lower revenue and margins and higher tax offset partially by lower share count, we currently expect adjusted diluted earnings per share to decline 13% to 18% in fiscal 2021. As most of you are aware, we also have $1 billion in notes due September of this year. At this point, we expect to issue new debt in the coming weeks or months depending on market conditions. I would like to conclude by saying that although COVID-19 is putting pressure on our financial performance, we believe this is transitory and the long-term prospects for ADP are no way diminished and may even be enhanced by the current environment. For fiscal 2021, we are remaining focused on opportunities for innovation and growth while taking a deliberate balanced approach to managing expenses and we are confident in our long-term growth prospects. I look forward to updating you on our progress. With that, I will turn it over to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] And our first question comes from Mark Marcon from Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning. Thanks for taking my questions. One key one is just from a bookings perspective as you look out over the coming year and you gave us a bit of a sense for the cadence that you expect – which of the new solutions do you expect to see the greatest traction from? Which ones are you the most excited about and which ones could be the most incremental from a really long-term perspective?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I think from an incremental standpoint – to start off with the last part of the question from a long-term standpoint, I think some of the investments we have made in some of our next-gen solutions, I think for me has to be one of the most optimistic in terms of potentially moving the needle from an incrementality standpoint right, because we already have a very large, as you know, bookings number and anything that we can add on top of that goes into the top of the funnel in terms of revenue growth. And that’s really was the reason for these investments is to really move the needle competitively and to improve our position from a differentiation standpoint. And so the early signs of course now somewhat temporarily interrupted by COVID-19 were positive in terms of the traction we are getting both with our next-gen HCM platform as well as with our next-gen payroll platform. So that’s kind of where I feel the most optimistic in terms of the long-term. In terms of kind of the cadence and more kind of the short to medium-term in terms of next year – really the fourth quarter is an important part as we have kind of been alluding to here in our prepared comments and some of that is really clearly the pace of the recovery. So, there is – we have an expectation, which I think is in line with generally accepted I think forecast, if you will. And you heard kind of as a proxy, the expectation that unemployment reach a certain stage by the end of the fiscal year end, those things are all proxies for GDP growth and you guys all have plenty of access to your own firms’ economic forecast and so forth. So, the second half is really the key for us from a bookings standpoint. And there aside from the incrementality question, this issue that we have around for example, adjusting to our – adjustments to our gross bookings is an important one, because to the extent that the recovery continues on the pace we expect, it would help us a lot if we would be – if we can start and continue to implement clients that were previously sold and that – so clearly one positive would be that, that doesn’t degrade any further, because in full transparency, we mentioned that in our prepared statements that’s a concern under this kind of environment, but there is potential upside as well there. So there is downside and there is upside there as well. But when you see the incredible decrease in activity in just a couple of months following the beginning of the crisis, it takes a while for that – those buckets to get filled up again in terms of leads, then turning into first deployments, then turning into presentations to clients. So, that whole process of how the sales evolution goes is critical for us in the second half. And the places that were hurt the most, which in our case and some of it is perhaps just because of the nature of the crisis that the down-market was hit very, very hard in terms of pays per control and also just declines in activity, but also came back, frankly surprisingly – you can’t call it strong because it is still down year-over-year, but I think the bookings performance in the down market has been I think gratifying. And so if we continue on that trend, that would be good news for the second half of the year. And then we expect based on the current trends that the mid-market and the up market will then kind of follow suit as the kind of pipeline leading indicators that we mentioned translate into actual bookings and actual sales. So I guess, the short story is the things that were the hardest hit are the things that – in the initial stages are the things that should have, in our opinion, the biggest rebound in the second half. And then on top of that obviously, our new product investments I think are a source of optimism for us. We’ve also invested in I think you heard us mention Workforce Management in the down market. I mean, we have a lot of things going on. You can see it in our investments in technology over the last four to five years and obviously some of those things are longer-term like the next-gen stuff. Some of it has been we have been investment phase for 6 to 12 months and we expect those things to translate now into new sales. So I don’t know if you heard our tone over the last several years, we pivoted to investing more in product and particularly more around Agile technology and that hopefully gives us some firepower here in terms of our bookings incrementality going into this year, but also into the following years as well."
},
{
"speaker": "Mark Marcon",
"text": "Great."
},
{
"speaker": "Kathleen Winters",
"text": "Mark, yes, just to add a little bit more there in terms of by each segment for sure we are expecting sales growth across each of the segments in fiscal ‘21. And as Carlos said, down market seems to be resilient and has trended up since we were at the low point several weeks ago but down market has been trending up earlier. And then during the latter part of the year, we would expect up markets and international for that matter to continue along those lines, but for sure expecting sales growth across all segments. And to Carlos’ point, from a long-term incremental perspective, certainly expecting Next-Gen HCM to be a driver there, but our strategic platforms in the near-term RUN and Workforce Now have been performing really well in the market and we expect them to continue to perform really well in the market as we recover through this."
},
{
"speaker": "Mark Marcon",
"text": "Great. Just as a follow-up, could you just give us an update in terms of where we stand in terms of the number of implementations on next-gen HCM or sometimes known as Lifion and also next-gen payroll this percentage of the client base has been converted?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So on next-gen HCM, you could probably appreciate for two, three months, that wasn’t really something that a lot of companies were focused on and for that matter us [indiscernible] unfortunate. But the good news is we did actually start a client just a week ago. So that is a ray of sunshine in what was otherwise a lot of dark clouds. So we had a number of clients that were set to be implemented in our fourth fiscal quarter, which delayed and one of those actually started here already in the early part of the first quarter. So that is encouraging but we are not that different from where we were before. So call it still a handful, I think we have like seven or eight clients live somewhere in that neighborhood on next-gen HCM. On next-gen payroll, there the target at the beginning from a piloting standpoint really was – clients are not quite the same size of next-gen HCM. So it’s a slightly different dynamic and it’s – and we’re making, in terms of numbers of clients more progress, but it doesn’t mean that the product necessarily is making more progress. It’s just the difference between the markets we’re serving. Next-gen HCM is really in the early stages aimed more at the mid-market, if you will, than really the up market even though we expect it to be our next-gen payroll engine across our mid-market and up market in the initial stages, it’s really mid-market. So I think we have somewhere around 100 clients sold. And I think maybe that same number implemented, if I’m not mistaken."
},
{
"speaker": "Kathleen Winters",
"text": "That’s right."
},
{
"speaker": "Carlos Rodriguez",
"text": "So we’re making some good progress there. And there the pace is a little bit better in the sense that we didn’t come to a complete stop on next-gen payroll and we continue to implement clients there and kind of move forward. But it’s a – this is a very challenging situation for our clients and we really need to kind of help them get through this situation and the crisis not necessarily press them to get started as quickly as possible although that’s obviously our desire from our standpoint."
},
{
"speaker": "Mark Marcon",
"text": "Of course. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal from Barclays. Your line is open. Please check if your line is on mute."
},
{
"speaker": "Ramsey El-Assal",
"text": "Can you hear me now?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, we can hear. Yep, go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Yes, go ahead. We can hear you, if you?"
},
{
"speaker": "Ramsey El-Assal",
"text": "Hello, hello."
},
{
"speaker": "Operator",
"text": "Pardon me, sir. Please proceed with your question. And we will move on to our next question. Our next question comes from David Togut from Evercore ISI."
},
{
"speaker": "David Togut",
"text": "Thank you. Good morning. Could you characterize the gross bookings performance in the June quarter prior to the backlog adjustment?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I mean I think we – we’re just trying to give a nod to our sales force in terms of – they were – they performed better than we clearly had forecasted and that we gave in terms of color, commentary during this same earnings call or during the earnings call of the last quarter, but they were still down significantly. So at the end of the day, we just want to make sure that you guys got the right impression that we weren’t disappointed and that we didn’t do worse than we expected. But from a mechanical number standpoint – think still down somewhere around 50% like if that’s a fair characterization. I don’t know if Kathleen has any more color there?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes, no, the gross bookings were slightly positive to what we had expected. The approximately, down 50% is right, which is what we have been anticipating. And then the backlog adjustment, which actually is part of our normal process factored into the overall bookings number being down slightly more than that for the fourth quarter."
},
{
"speaker": "David Togut",
"text": "Got it. And just as my follow-up, assuming the employment recovery proceeds as you have laid out Kathleen negative 7% unemployment by the end of FY ‘21, would you expect to be back on your sort of normalized growth path by FY ‘22?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes, go ahead Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "No, go ahead, go ahead."
},
{
"speaker": "Kathleen Winters",
"text": "It’s a great question in terms of when do we return to previous levels of growth and profitability. And as you pointed out, a lot really depends on the shape of the recovery. And look, we have taken the best view we can and tried to share with you what we are thinking about that in terms of the shape of that recovery. But it really is going to depend on that. Last recession, it took a couple of years for sales and retention and revenue growth to return to the pre-recession levels. Now, is it going to look exactly like it looked last time? We don’t know. This crisis is different. The make-up of ADP is different. So, I hate to say it, but it’s going to depend on a lot of factors but returning to those previous growth rates certainly will not be in fiscal ‘21 based on what we see right now and we will update you as things change and as we go through the current year."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think, maybe just add a little bit of – just in terms of my own observations from looking at the kind of the quarterly cadence, if you will and how – what the implications are for FY ‘22, it really depends on – are we thinking about sales? Are we thinking about revenue? Are we thinking about profit growth? And they are all kind of different buckets. But I guess and to Kathleen’s point, it really all depends – if this is unlike the financial crisis, not a two or three, the financial crisis really was – you go back and think about it, the kind of mini crisis that occurred over the course of the following two or three years. Remember, we had the European debt crisis. We had a number of things that elongated that situation, but that could happen here as well, and we are of course not scientists and we don’t know exactly what’s going to happen. But we’re using kind of the same forecast that I think all of you are using and if you make those assumptions around when the healthcare crisis passes, i.e., vaccines and therapeutics and so forth. If you follow that path then FY ‘22, when we exit in the fourth quarter of FY ‘21 – from a mathematical standpoint – I think you used the term growth rates, the growth rates are going to look pretty good in terms of as you exit from a booking standpoint and then starting maybe with profitability in the first quarter of FY ‘22 because in the fourth quarter of FY ‘21 we saw some NDE expense. But some of that – frankly is really the comparisons. So we have three quarters in FY ‘22 that are going to look pretty good. Because if we still think that the first couple of quarters of FY ‘21 are still impacted pretty significantly by COVID and by the first couple of quarters of FY ‘22 you don’t have that impact you are going to have some I hope some really good tailwinds on some of these growth numbers. But the key for me was looking at absolute booking dollars in the fourth quarter of ‘21 compared to the fourth quarter of ‘19 because obviously ‘20 is not a good comparison and looking also at our absolute profitability in the fourth quarter of ‘21 and our revenue in the fourth quarter of ‘21. And again, I feel some sense of optimism about ‘22 based on those exit rate assumptions with a capital assumption because this is – we are a long way away from having certainty and you have seen how fluid the situation has been. But I think the math I think works kind of favorably once we get through fiscal year ‘21 and particularly when we get through the first three quarters of fiscal year ‘21."
},
{
"speaker": "David Togut",
"text": "Understood. Greatly appreciated."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Thanks, good morning guys. Just wanted to start with kind of a high-level question on the fiscal ‘21 guide, I mean, we have got revenue down modestly, but obviously EPS down quite a bit and that’s being driven by a little bit of tax, but really the 300 bps of EBIT margin decline. And I guess it looks like the transformation savings should largely offset the hit to float income. So, are we really just down to kind of isolating this against decremental margins that maybe people didn’t appreciate the – kind of the severity of or are there other factors there? Because I just think at a high level people were surprised to see how much EPS is going to be down relative to revenue for the current fiscal year?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Let me take a crack at a couple of high level things. And then Kathleen probably can provide some additional maybe detail to help in terms of quantify some of the stuff. But we – I’m not sure if it was clear from our comments last quarter or this quarter but having been through these types of – not through a healthcare crisis but I personally have been through dot com downturn, Y2K at ADP, 9/11 and the Global Financial Crisis. And our Board is a Board that is long-term oriented and it feels like despite how horrible the situation is, it feels like this situation is transitory and so one of the things that we have as a first principle is to maintain our level of investment. That doesn’t mean that we are not prudent around our expenses and I think we have been and I think Kathleen gave you some examples of some of the things that that we are doing. But we are going to add to our sales head count next year, which might surprise some people and maybe not something that you were expecting. And the problem is that when you model only one fiscal year for a company like ADP or recurring revenue model, if you decrease your sales cost or even your investment in product and technology, it actually looks quite favorable. And you can probably offset quite a bit of revenue decline. The question is, is that really the right thing to do long-term? We don’t believe that it is and so that’s one factor, philosophically. The second factor is that even though we clearly have some decline in the number of clients, the nature of the revenues that are going down is very high margin. So you mentioned client funds interest, but we also have another decrease from a comparison standpoint ‘20 to ‘21 in pays per control, which is call it 100% margin as well. And there is very little work related to the number of worksite, I am sorry, the number of employees paid by our clients. Our work is – workload is generally driven by number of clients and then as we have all now observed in the last quarter also driven a lot by the regulatory environment. And so the amount of work has not decreased much and in some cases has increased on behalf of our clients. And again, that’s a place where we could cut some of that support. And then it would lead to lower NPS scores and we probably would have retention go down, but the single most important driver of financial value for ADP is client retention and lifetime value. To lose clients and then have to go sell them again and implement them again makes absolutely no sense and all the experience we – that I have and we have and our Board has tells us to kind of stand firm and make sure that – that doesn’t mean that we ignore the realities around us. If we thought that this was a permanent decrease in capacity of the economy or in terms of the global outlook, and then it was going to last two, three, four years, we probably would be behaving differently, but that’s not our expectation, that’s not our – that’s not the way that we are managing the company. There’s also a couple of other items I think that mathematically may be not helping us and maybe Kathleen can help a little bit with some of those sure."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. Look, on the surface the guide to 300 basis point decline on the surface may sound like a lot, but there’s a lot going on in there. When you take it apart, I think it’s really – and you put it into the kind of buckets, I think you will see how we arrived at that guidance and that expectation, right? As we’ve talked about and as you know we’ve got obviously a substantial impact from loss – a very high margin revenue, right? We’ve got that high margin revenue. We’ve got clients on interest, which is a hurt on margin year-over-year. We also have growth in zero margin pass-throughs, which falls right to the bottom line from a margin perspective. That’s going to be a significant hurt for us where it hasn’t been as much in the past. And the continued investment along the lines of – look, we think it’s prudent and smart to take to continue our long-term view and to continue to invest in sales and in product. We are committed to that level of investment so that’s a hurt. And then you do have, as you pointed out, the transformation and other cost actions that we’ve been taking that only partially offset that. So I would think about it in those buckets in terms of, look, you’ve got this high margin revenue. You’ve got some other things that fall right to the bottom line like zero margin pass-throughs and client funds interest. You’ve got the commitment to continuing to invest and quite frankly, I think we have been executing really well from a transformation perspective and also in terms of looking at – as we navigate through this period the excess capacity cost that we have and being really smart about addressing those."
},
{
"speaker": "Carlos Rodriguez",
"text": "But I guess let me – just to provide a little bit of color on kind of our view because I learned the hard way from my two predecessors about some of these things. So if you just look at the sales engine aspect of our business and you look at it over multiple years, you can actually do the math that if our – if we decreased our head count, call it 5% or even if we just kept it flat and you assume the productivity continued on kind of its normal trend, which is a big assumption, but if you even – if you assume that, you can see the impact that has on revenue growth from multiple years down the road. So obviously, if you expect that you’re not going to be able to ever return to the same kind of sales productivity you had before, then you have to do something differently, but that’s not the expectation we have right now. And it’s critical to our growth in ‘22, ‘23, and ‘24 for us to maintain our investment in our sales engine. Not to mention in our product and our technology and a few other places as well."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay. Yes, that’s really good color. For my follow-up, I wanted to ask just about retention. I know you are forecasting the 50 bps to 100 bps decline this year. I wanted to see if we can get a sense of how that compares to how you exited the June quarter on that metric? And I’m really just trying to get a sense of whether you are forecasting acceleration in churn over the next few quarters or more of just kind of a stable and steady pace of churn?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Again, let me give you some maybe philosophical, high-level comments and then Kathleen, maybe can give you some color around the fourth quarter and some of the assumptions. So in general, we have been, and I’ve been again, having been through multiple downturns and crises, I have been surprised by the resilience of our retention and we think there could be a number of factors here. One of them could be all of the government stimulus, the Paycheck Protection Program, all these things might – these are all new things compared to the past that might be helping. There is also the potential that some clients are frozen in place, if you will, like, we’ve talked about how difficult our bookings have been. I think logic would tell me that that’s probably happening across multiple industries and multiple competitors. And so we would be – actually dishonest not to assume that that might be helping our retention in some parts of our business like the mid-market and the up-market because in the down-market it’s really driven more by out of business. So having said all that, I would say that a lot of these things are really about timing because if there continues to be government stimulus and there continues to be optimism about this being transitory, then I think this kind of holds. And you have probably some additional fallout in the downmarket as a result of out of business and so forth, but you don’t have kind of a major downturn or a collapse in retention. And that’s kind of where I am today that we are expecting what I would say is – I would consider these to be reasonable and modest declines in retention when you compare them to other downturns that we have some data on and some history about."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, and we did do a lot of work around and analysis around what happened in the last recession and what happened to retention by segment. And I think we have got a pretty balanced view if you look at the decline in retention that we experienced in Q4 and what we are guiding to and expecting and planning for in fiscal ‘21. It’s basically in line with the retention pressure that we had during the last recession. So we will see. I mean, it’s really hard to predict. And to tell what level of support the PPP program has had and is going to have, but that’s our best view right now."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think – I don’t literally don’t give it. But I think I feel like this is an environment where transparency is probably not a bad idea just to give you like – like, that’s why we gave you kind of the gross bookings number besides the net bookings number because you guys need to model this stuff so you can understand what’s happening here. But think the fourth quarter somewhere around couple of hundred basis point decline in retention, which I think again all things considered, I thought was, and most of that decline frankly came in the down-market. So, that to me feels like better than I would have expected 3 months before that."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay. Alright, well, we appreciate all the disclosure. Thank you, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-tsin Huang from JPMorgan. Your line is open."
},
{
"speaker": "Tien-tsin Huang",
"text": "Hi, thanks so much for all this detail. Just on the transformation initiatives, I caught all the details there. How about looking beyond those two initiatives? Are there any other potential actions that you could take, anything that could be material over a similar size?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Again, I will maybe give some high-level comments and let, I think Kathleen give some additional detail. We have a very large menu of things that we can do. This company has a very, very long history of navigating through multiple changes in environments and multiple economic circumstances and now I think we will add to our repertoire managing through a major health crisis and a pandemic. And so, we have – I don’t know how else to put it. We have a huge number of things that we could do, if necessary, and when necessary. This is an incredibly resilient business model. I recognize that this is unusual for ADP to be down the way we are, but it is what it is in terms of the economic circumstances around us. But believe me; we have a number of levers. So as I said, like some of these things are – and our business model are somewhat self-correcting. If in the unlikely event, there was a belief that there was a permanent impairment of kind of global economic GDP or growth vis-à-vis other industries or other companies, I think that we are in somewhat of a better place because the amount of money that we spend on NDE and on implementation alone would, at least for the short-term, would certainly enhance our bottom line and help us from a margin standpoint. That’s not what we want because the real value to be created here is through growth – like, through profitable growth, not by kind of shrinking our way into profitability. But we have no intentions of allowing ourselves to underperform, if you will, on a long-term basis below what we have delivered for many, many decades. And that’s what ‘21 is all about. But if circumstances change, we have a very long list and quite a lot of variable expense in our P&L and a very strong balance sheet and a very strong cash position."
},
{
"speaker": "Kathleen Winters",
"text": "So, Tien-tsin, thank you for the question, it’s a logical question because when you think about kind of the past and the history over the last several years, right, in terms of what we’ve been driving from a transformation perspective, you can see that we have had these – several kind of big major initiatives over the last several years, right. We had Service Alignment Initiative first. We have a Voluntary Early Retirement program. We told you about the workforce optimization and then the procurement and now the procurement continues and we have shared with you our work that we have doing around digital transformation. The question, what comes next? Quite frankly, I think there is a lot of runway and we have a lot to do from a digital standpoint and also from a procurement standpoint. It does get harder as you go, I will say, but there is a lot to do there. And a lot of the digital projects, first of all, the digital is certainly focused on our service and implementation, because there is opportunity there, but it is across the entire company. So every single segment and every single department, whether you are front-office or your back-office is tasked with thinking about digital transformation, automation, how do you make the work more efficient, how do you take work out? There is runway there. So I expect that you will hear us talking about that for some time to come. The procurement, well, it does get harder as you go. What I would say is, in an environment like this that we are in right now, in a downturn, it does present some procurement opportunities that may be didn’t exist a year ago – when you actually – when you go back and you are negotiating with vendors and suppliers and so forth. So we have got real work to do there. And as you heard us say in the prepared comments, we have expanded procurement to make sure we are capturing all the opportunities. From a real estate perspective in terms of, look, the environment has changed. The way the world is working has changed. Let’s make sure we are thinking about our real estate footprint in a fresh modern, forward-looking way to ensure we are utilizing the assets that we have to the fullest extent possible. We are understanding how we are going to get work done in the future. We are understanding how we can utilize mobility models where it makes sense to do that. So we have got a lot of work and some really good work to do here from a digital procurement real estate perspective."
},
{
"speaker": "Carlos Rodriguez",
"text": "And just one last comment on that, the other thing that maybe is under-appreciated but it’s worth mentioning here because again, we are typically not talking about these things as they are more longer-term, but if your question was really more about what’s potentially next, longer-term and not just in ‘21, our next-gen investments are the largest potential digital transformation effort we have ever undergone. And we always focus on them around what they are going to do in terms of our winning in the marketplace and our sales growth and our revenue growth. But trust me when I tell you that the business cases for those investments and the progress we have been making over all these years, there’s an enormous expectation for, call it automation, call it efficiency, whatever you want to call it and we don’t usually talk about our tax engine, we talk about HCM and payroll. But one of those next-gen investments is our tax engine, which again there, the early signs – we already have a couple of hundred thousand clients migrated onto that platform. And when you see how quickly we are able to make these legislative changes in that platform and the cost structure and the cost of support again, I would be very optimistic that one of the largest transformation efforts we will be talking about in the future when we look backwards is these next-generation investments. I am hoping they are also going to lead to big growth incrementality and winning more market share in the marketplace, but do not underestimate the value of these investments in terms of our back-office and also our cost structure."
},
{
"speaker": "Tien-tsin Huang",
"text": "Yes. No, thank you for that. That’s very complete answer. If you don’t mind, just one quick follow-up, you mentioned the legislative changes and a lot of the work and effort that you have put into that. And Carlos, I know I ask you this all the time. So I am going to ask you again, could we see more demand? I know you mentioned improved bookings momentum that you started to see, but could you see more demand for the service model in general here? I don’t know where you are seeing maybe some switching from or more demand for work but again election year, lot of complexity, probably more changes coming. Could that help you here?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I mean, I don’t see how it can’t. So and usually, I am not that optimistic or that definitive because if it were only the election, I would say, we will have to wait and see. But I don’t, again, I am not usually a pontificator, but I just don’t see how companies after all this don’t reassess not just kind of how they do HCM and payroll and so forth, but so many other parts of their business model where continuity and resiliency and so forth are critical and that applies to the smallest client to the very largest clients. I think that for a lot of us, I don’t think we are the only ones or the only industry or space where that’s going to be a tailwind but it’s hard to believe that this in a positive. Now, in what quarter and how do I qualify that because you have GDP going down, I don’t know, 30-something-percent in the second quarter. Even if people were thinking about that, that wasn’t really going to be a factor certainly in the fourth quarter. The question is how does that net out in the math, right, because you want to somehow be able to parse that out and understand how much of is incremental. And I can’t necessarily do that scientifically but intellectually, it’s hard to believe that it is in a tailwind going forward for us. And then on the election side, we like – we generally like change because – and it doesn’t matter whether one party versus the other. We are apolitical as a company. But usually when there’s change there is change and for employers. Employers are an instrument of policy of the government, it’s how public policy gets effectuated whether it’s through tax or all the various safety policies and – you are seeing all these changes in leave policies now to help manage through the health crisis. So that’s all incredible, I think opportunity for us to help our clients and when there is opportunity to help clients, that’s opportunity to sell new business as well."
},
{
"speaker": "Tien-tsin Huang",
"text": "Yes, agreed. Thank you. Have a safe rest of the summer. Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you. You too."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane from Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, guys. Good morning. I just wanted to ask take another crack on the margin question and looking at it from this perspective. The fourth quarter margin in ES was impressive to bring it to flat and you took a lot of the brunt of the hit. Just thinking about that fourth quarter versus the guide of down 300 basis points, I guess I am a little surprised that it doesn’t hold up better. Can you just contrast the margins in the fourth quarter being flat versus down 300 basis points from that perspective?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. I mean, I think some of it is – Kathleen will go through some of the math but the client funds interest impact is much bigger I think going forward than it was in the fourth quarter because of the laddering that we do in our portfolio. The impact for example of bookings – we still had a lot of business starting because remember, there is a lag between bookings and starts. So I think you would all be very surprised by how much. Even though we had some delays in some – particularly for larger clients, we started a lot of business in the fourth quarter also and as kind of bookings decline now the starts and the amount of revenue that goes into the run rate declines as well as you move forward. And so you get that sales number back up again. So I think there are a number of just kind of mathematical realities that I think that hit us in the next two or three quarters in comparison the fourth quarter. But I think that, again, we are not going to do that, like, we are not going to provide quarterly guidance, but I would encourage you to attempt to do either a first half or a second half based on the tone that you are hearing from us or even attempt to do it by quarter because the view that we have of the fourth quarter, again assuming the assumptions are correct, I think paints a very different picture than the picture may be that you are getting by looking at a ‘21 number. I would also argue that when we talk about ‘21, its fiscal ‘21, which happens to be only 6 months of ‘21. For every other company out there when you talk about ‘21, you are talking about the beginning of January of ‘21 where everybody expects everything already to be back to normal and that is – in terms of assumption of things being back to normal. So it’s a little bit maybe tricky in terms of the thought process and the math. But I don’t know if Kathleen has anything to add on that?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes, I mean, yes, it’s a little bit hard to say, okay, compare one quarter to a full year particularly in a year like this when there is so much going on and there’s so much linearity aspect in fiscal ‘21. But what I will say is in Q4 we did have sales expense, our NDE was actually a little bit of a help in Q4 versus it ends up being a surge so that’s kind of one difference one to the other. And the other thing is, from a transformation perspective in terms of benefits and how the benefits flow, well, certainly being a favorable and a help for us in each year in fiscal ‘20 and in fiscal ‘21, in Q4 there is a pretty substantial impact favorability from transformation if you were to compare it to a full year fiscal ‘21. So it’s kind of a math of how it all falls out in a quarter versus in a full year. But again, think about fiscal ‘20 as sorry, fiscal ‘21 as look, you have got this high margin revenue. You have got top line stuff that falls right to the bottom line being the zero margin pass-through and the client funds interest. You have got our continued commitment to investments. So you have got that from sales expense partially offset by continued transformation work."
},
{
"speaker": "Bryan Keane",
"text": "Got it. That’s helpful. And then just a quick follow-up, the elevated out-of-business losses, just trying to get a sense of how that’s compared in past recessions and then how much more do we have to go on that? I mean have you written down the majority of it and there’s just a little bit left over because I know in fiscal year ‘21 you are saying there will be some more losses. So just trying to get an impact of magnitude of previous recessions and how much is left? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "So that really comes through in the retention. So it’s not really, we don’t quote, unquote, write it down, right? So that really comes through in terms of the losses from a retention standpoint. We have like maybe others some clients that have quote, unquote stopped processing and, but they are still there, and so there is a question of which of those clients come back and which of those clients don’t come back. But we have modeled in the down-market, this is really a down-market issue. We hope that it’s a down-market issue. At least in prior economic cycle that’s been the case. And I think you see it reflected in our retention rate, but it’s very, very hard for us to say with any level of certainty, how that’s going to exactly play out in the future. We have looked at all the prior downturns, and we know that there’s probably some out of business that’s still there that’s going to occur. And a lot of this is, in this case is going to depend on government stimulus and whether there continues to be some support for small business or not and also just the overall level of GDP and obviously the overall pace of recovery in terms of people going back to spending on products that help small businesses survive."
},
{
"speaker": "Bryan Keane",
"text": "Okay, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Lisa Ellis from MoffettNathanson. Your line is open."
},
{
"speaker": "Lisa Ellis",
"text": "Hi, good morning guys. I apologize. I am going to ask one more question on margins. Just a clarification on the backside because I think that may be the effect of the de-leveraging related to pays per control, I think a little bit steeper than we were expecting, etcetera. Is the implication of that that coming out of this as we get back to better employment levels late in ‘21 that you would see a sort of similar snapback, is that the way we should be thinking about it as unemployment improves? I mean, when we are looking out into FY ‘22 or are there reasons that we wouldn’t expect that to happen? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "No, I think that’s right. And again, hate to go back to, because I think I would encourage you like I am doing the focus on both growth rates, but also, because I know they are important in terms of models and so forth, but absolute numbers as well because if pays per control doesn’t grow in the fourth quarter of fiscal year ‘22 we have a serious problem; like if there’s not a big snapback of that number, like if there isn’t a huge snapback of bookings, we have serious problems. And so the only thing that we think is not something that we want to model improving is interest rates because it just doesn’t feel like is a basis for doing that, but I think if you take reasonable assumptions based on economic forecast, you do have a fairly significant snapback in terms of growth rates, if you will or improvement percentages. The question then is, what does that mean in terms of absolute numbers? And so if you still have 7% unemployment, by definition that unemployment rate is still higher than it was in the, call it third quarter of fiscal year ‘20 and that has some implications in terms of absolute level if you will, of pays per control and we have kind of modeled that in to our assumptions but for sure there’s snapback in the numbers. There is no denying."
},
{
"speaker": "Lisa Ellis",
"text": "Good. Okay, alright. And then just my follow-up is related to the PEO; as you are seeing because I know you don’t – your bookings are yes, related bookings so just a kind of question on demand environment for the PEO. As you are seeing companies adjusting now to the crisis and to the recession how is demand acting for the PEO? Meaning is it positive, because companies are looking to variabilize cost or are you seeing some companies move away from the PEO because of reducing benefits? What does that demand outlook look like? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think the demand so far. Our experience in the PEO has been that it was kind of in line with the rest of the business. It looked a little more resilient in April, which you may have heard that tone from us but then May and June, pretty much in line with what was happening across, yes, In terms of bookings demand. And I think some of that is because of just the sales cycle. If you think about the PEO the sales cycle resembles more the up-market. The lower end of the up-market than it does the down-market, even though the average client size is small and that’s because it’s a high involvement product and high involvement sale because you are basically turning over all of your HCM including your benefits your workers’ comp, etcetera. So, I think that’s what we have seen in the short term. If you look at again 20, 25 years worth of history, I can’t even believe I have been doing this for that long, but I started my career in the PEO and every time there is an economic cycle or a change, whether it’s dot com or financial crisis, whenever there is a lot of theories. And I think the secular demand and growth of the PEO doesn’t seem to be impacted by many things. So I would still expect that kind of solution to have a lot of legs for small and mid-size clients for a long time to come. In the interim, there could be ups and downs, because as you said if companies are quote unquote hunkering down and don’t want to offer benefits – at least in our PEO part of the value proposition is benefits and so – but so far when you look at sales results, lead generation activity, etcetera, there is no reason to believe that the PEO won’t recover in the same way that we expect the rest of the business to recover from a booking standpoint."
},
{
"speaker": "Lisa Ellis",
"text": "Terrific. Thanks guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Wald from Morgan Stanley. Your line is open."
},
{
"speaker": "Steven Wald",
"text": "Great, thanks for taking my question. Could we just – coming at some of the implicit assumptions under the guidance another angle. Just curious what you guys thoughts are in terms of what you are seeing conditions on the ground wise in terms of geographic concentration. I mean certainly some parts of the country are more open than others, some industries are doing better than others, I guess, I am just curious if you guys could sort of separate out how you guys are thinking about that on the go-forward and the unevenness of the recovery and what that means for your client base? I know you have talked about being diversified, but certainly there is a quite disparate experience level across the country right now."
},
{
"speaker": "Carlos Rodriguez",
"text": "It’s a great question. I think you probably saw in our comments that we said that we observed in our data that there has been a slowdown in the last few weeks, so we are looking at the data weekly and we do look at it geographically, both globally in terms of by country but also within the U.S. by state. And as you would expect part of the challenge in the last several weeks and months has been in the places where you have seen some of the comeback in terms of the virus. The resurgence of the virus in kind of the southern states and also Texas and California, but nothing back to kind of the full shutdown that we saw in April, which is in line with what you are all seeing as well in the news and so forth. This is more about leveling off of growth rather than kind of a decline. So we have seen it in the same metrics that I talked about in the last quarter. So, I can see it in like the number of job postings and screenings and so forth that have – that were on an upward trend line and frankly it was certainly not a V, but it was a nice upwardly sloped trend language then it was translating into improved employment both in our numbers, but also in the government reported numbers, but we have seen a plateauing of that as of the last 2 or 3 weeks. And so that’s something that we – fortunately we re-looked at our assumptions for fiscal year ‘21 the assumptions we have for pays per control for the first quarter are around what the pays per control exit growth rate was for the fourth quarter and based on this kind of plateauing that feels like the right place for us to be. And the problem is we don’t want to necessarily go tweak the second quarter, the third quarter and the fourth quarter, because as you have seen over the last 3 or 4 months, 3 or 4 months ago we were actually thinking about opening our office in Orlando – in Maitland, Orlando, because everything was fine in Florida and nothing was happening in Florida and we didn’t know what the hell we were going to do in New Jersey and New York. And as we sit here today I am sitting in the office in New Jersey and we are not opening anything in Florida. So, I think it’s unfortunately a very fluid situation and you just have to keep an eye on all of these assumptions both at the macro level, but as you said, we have very detailed information and a heat map by state. And I would say that what you are hearing and seeing in the news is what we are seeing in the data. But what that’s translating into is a plateauing or a leveling off of employment short-term so far, not a decline."
},
{
"speaker": "Steven Wald",
"text": "That’s very helpful. Maybe if I could just squeeze a quick follow-up in here. Carlos, I think you have laid out at your Innovation Day earlier this year that the addressable market ADP sits in, it’s about $150 billion of revenue a year growing at 5% to 6%. Obviously, that’s changed given COVID, but I am just curious to get any updated thoughts you have around maybe where that stands today? But if you can really speak to where it stands today given the fluidity of the situation, how we are thinking about it coming out of it given your comments and Kathleen’s comments about the enhanced opportunity for the space you are in?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Listen there is a lot of smart analysts out there and industry analysts out there that would probably be better answering that question. And they probably are going to need a little bit more time and information to answer that question. But I will answer it the same way that I answered it earlier today, which is I don’t know by how much, but it’s hard to believe that past the transitory nature of the situation that, that growth rate for the industry isn’t at least what it is if not higher because and again, I am not trying to be arrogant that, that is only for HCM, but there are other industries that I think have, shouldn’t have tailwind from these events, where the acceleration of people to using cloud services and using what I would consider to be outsourced services so that you can focus on your core business, but also have resiliency. I think and also so that you can improve efficiency and you can improve productivity of your workforce and improve engagement of your workforce. All of those things I think are going to get tailwind and it’s across multiple technology sectors that I think are going to probably benefit on a longer term on a medium term and longer term basis from this unfortunate situation."
},
{
"speaker": "Steven Wald",
"text": "Great. Thanks for taking the questions."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thanks. So just a couple of final thoughts. One is I know I said it before, but we have navigated through a lot of issues over many decades. I have had the experience of being through several myself, whether it’s the dotcom recession, what happened after 9/11, the global financial crisis, because in that case, it was really a synchronized global downturn and now this health crisis. And the one thing that I would say about ADP’s business model regardless of I know the focus here is on the short-term, but if you stay focused on the long-term, it’s an incredibly resilient business model, financial model, but also business model. The value of our products and our services is key and one small anecdote, I think we may have mentioned it in the last call. But as kind of this crisis unfolded we had to become like many other parts of the economy, we had to go and talk to governors and leaders, including the White House to make sure that we were deemed an essential service, because we needed to stay in operation. And so I don’t know what better sign there is of a resilient long-term model than to be considered an essential service, because we definitely – we definitely are. We are glad we were there to help our clients will still be there to help our clients. But I think that speaks volumes to the long-term viability and also upside of the business that we are a critical service an essential service to the economy and to our clients. We are proud of that. And I am proud of what our associates did to live up to that expectation. And as to the next year again, I would just encourage everyone to think through kind of first half second half or even by quarter because at least for me assuming that we stay on the trajectory that we are on, which I realize is fluid, but with those assumptions the fourth quarter exit rate of FY ‘21 is really what I am focused on and not necessarily the short-term results of the first few quarters of FY ‘21 although we are going to do our best to perform as well as we can throughout that as well. And lastly, I know Kathleen said in her comments, but we are very proud to have delivered $1.5 billion in cash back to the dividends and $1 billion through buybacks through, which I think is also another sign of the incredible resilience. And I think cash flow generation capability of this business model in this kind of short-term hit that we are having to revenues and to profitability, I don’t believe will impair our ability to continue that tradition of returning cash to our shareholders. And for that, I want to say that I appreciate the patience of our shareholders as well and all of you. And I thank you today for listening to us and for all your questions. And I wish you all a very safe summer as well. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s conference call. Thank you for participating and you may now disconnect. Everyone, have a wonderful day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 3 | 2,020 | 2020-04-29 08:30:00 | Operator: Good morning. My name is Shannon, and I will be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] Thank you, I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Shannon. Good morning, everyone, and thank you for joining ADP's Third Quarter Fiscal 2020 Earnings Call and Webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.Earlier this morning, we released our results for the third quarter of fiscal 2020. The earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompany today’s call as well as our quarterly history of revenue and pretax earnings by reportable segment.During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description and the timing of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measure, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and as such, involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. As always, please do not hesitate to reach out should you have any questions. And with that, let me now turn the call over to Carlos.
Carlos Rodriguez: Thank you, Danny and thank everyone for joining our call. Before we can, I want to first say that our thoughts and prayers are with those who have been or know someone who has been impacted by COVID-19. Every day we hear about how much of a challenge it has been for employers and workers alike, including our own.I'd like to recognize our associates for rising to the challenge and delivering exceptional service to our clients despite the extraordinary circumstances they've had to face. To them, I want to say thank you. For our discussion today, we'll spend a little less time talking about the third quarter and more time on the current operating climate. And I'd like to offer a couple of upfront points.First is that ADP is not immune to the global pandemics impact on the labor market, but while we may make tactical adjustments as we navigate through this crisis, we believe our long-term strategy is unaffected and we remain optimistic about how we're positioned over the coming years, once the business environment and our clients return to more normal operations. The second point is that we will continue to serve our clients in the way we know best, by offering the tools, resources, and support they need to manage their business and their workforce through all types of operating environments, including this challenging one.With that said, this morning we reported our third quarter fiscal 2020 results with revenue of $4 billion up 6% reported and organic constant currency and in line with our expectations. We expanded our adjusted EBIT margin by 60 basis points in the quarter, which was ahead of our expectations, even though it included an unplanned [$50] [ph] million global associate assistance payment in response to COVID-19. And with the solid revenue and margin performance, we were pleased to deliver 8% adjusted diluted EPS growth, which was also a slightly ahead of our expectations coming into the quarter.Turning now to the current situation, I'd like to take a few minutes to go deeper on how COVID-19 has affected our operations and what we've done to respond. As the situation evolved over the past couple of months, we focused first on the safety of our associates. In March, we took steps to quickly shift over 50,000 of our associates to work from home and now have approximately 98% of our workforce working remotely in a secure manner. In doing so, we leveraged our previous investments in business resiliency and in addition we ordered thousands of laptops, expanded remote access capacity, provided at home internet and for those critical personnel that needed to work onsite, we took steps to ensure their safety while they perform those essential onsite tasks. This was a huge undertaking by our global IT, security and legal, and HR organizations and I'm extremely proud of their execution.We also worked with our critical third-party service providers to ensure they were positioned to continue to support us. In March, we also had our field sales force shifts from in-person to a virtual sales model, and while that's not an ideal circumstance for some of our quota carriers, they're making the most of the situation. While we were executing on these business resiliency plans, we also worked nonstop to address our client's needs to ensure uninterrupted service across our HCM solutions. We provide a mission critical service and process payroll for one in six Americans and over 40 million workers around the world, and to offer immediate support we’ve provided a number of online resources including an employer preparedness toolkit and webinars attended by tens of thousands of clients. We also quickly made available for free the payroll costs and headcount reports necessary to apply for forgivable loans under the Paycheck Protection Program of the CARES Act and these reports have been downloaded hundreds of thousands of times.Service is more important than ever in times like this. We saw call volumes increased significantly beginning in March and have nearly 2 million inbound requests across our service channels in a matter of weeks, with clients looking for help with a variety of issues including adding custom pay codes related to COVID-19, redirecting checks to different locations and requesting new time tracking hardware that doesn't require physical contact. In many cases they were simply seeking general guidance in understanding new legislation. To meet our client's needs we retrained and quickly redeployed hundreds of associates to where they were needed most. And our service and IT teams worked quickly to digest and translate new legislation from the many jurisdictions around the world into our global payroll, time and attendance and other systems in a short period of time to allow our clients to comply with and benefit from these changes in legislation.As the environment for companies continues to evolve, whether due to legislative changes or operational realities, we at ADP are committed to supporting our clients to help them best navigate those changes. As we communicated in an open letter to U.S. policy leaders, ADP stands ready to facilitate current and future initiative that provides support to our clients and their workers. And in support of our local communities, ADP has made over $2 million in donations to relief efforts, including a dedicated relief fund for ADP associates that needed assistance as well as donations of medical supplies for hospitals, food banks, and their workers.With all that said, the significant impact of COVID-19 is having on a broader economy, is in turn having an effect on our reported metrics, in a much more abrupt fashion as compared to previous macro economic slowdowns. You can see this in our Employer Services new business bookings metric. This quarter we reported a decrease of 9%, as we saw bookings declined significantly and rapidly in mid-March when we typically would have expected to close many deals for the quarter. These results were of course well below our expectations coming into the quarter and while some of our businesses performed slightly better than others in March, the weakness was generally broad-based as the health crisis is affecting companies of all sizes and regions including internationally.We believe the impact to bookings stems from two factors. First is the buying behavior of our clients and prospects. As with prior uncertain economic environments, our clients and prospects have become time and resource-constrained and are faced with reassessing their own operations to best ride out the impact of this health crisis. And although our products support mission-critical functions, making decisions about additional HCM services or making the decision to switch from another vendor to ADP can get put off to a later time. Even in circumstances where decisions have already been made, clients are understandably delaying implementation which can also cause us to adjust down the bookings we record. The general change in behavior is common in recessionary periods and we are certainly not surprised to see it this time. It's clearly happening in a more abrupt manner compared to what we've experienced in the past.Second, as I mentioned earlier, there have naturally been constraints that limited the activity of our salesforce. What we have been able to lean more heavily on an inside sales strategy and virtual interactions by our field sales force. There has still been a reduction in our salesforce productivity. Our sales organization is experienced and resilient and we will continue to work hard in the fourth quarter. Because of a variety of factors which we believe will have an outside impact on the fourth quarter booking, including the effectiveness of the Paycheck Protection Program in supporting small to mid-sized businesses and how quickly our clients can adapt to working in this new environment and resume more normal buying behavior, there is clearly a very wide range of outcomes.But to calibrate your expectations, we are guiding for a full year ES New Business Bookings, our ES New Business bookings to be down 20% which implies our fourth quarter bookings will be down by more than 50%. With all that said, we remain confident in our product portfolio and optimistic about our ability to drive sustained growth in ES bookings in a sounder economic environment.I now like to spend a minute or two on some of the other macro driven trends we've observed in our client base. Our pays per control metric, which represents employee growth for a broad subset of our client base was solid through February, but decelerated to a slight negative growth by the end of March, averaging 1.9% growth for the quarter. Early in April, we saw it deteriorate further to a double digit negative decline, with the steepest decline among smaller businesses. For context, this level of pays per controlled decline is significantly worse than even the worst quarter in the financial crisis, underscoring that it's hard to compare this environment even against the past recessions. While we hope that legislation aimed at preserving employment will drive a recovery in pays per control, we had not seen it through mid-April.On retention, we were actually pleased with our performance in the third quarter, with both third quarter and year-to-date retention performance better than our expectations and ahead of pays per our previous annual guidance. We set all time third quarter retention record in our down market and mid-market businesses, as client satisfaction scores were at or near all time highs and as the benefits of our technology and migration strategy over the past several years continue to bear fruit. But clearly, out-of-business losses are a concern for the fourth quarter and beyond. And although they have not yet meaningfully picked up by the end of March or even into April, early indicators of stress in our client base have shown up and we expect deterioration in retention in May and June.Kathleen will share some of the assumptions for the fourth quarter when she goes through the outlook. I'd like to pivot now from the current macro environment and focus on our strategy and what we're doing to drive longer term value for our clients.At ADP, we remained steadfast in our commitment to lead in the HCM industry with best-in-class technology and service. At our February, Innovation Day we shared an update with many of you about the innovation we are driving across our key strategic and next gen solutions. The HCM industry is an exciting place with constant change and we will continue to invest to position ourselves to meet the evolving needs of our clients over not just the coming years but the coming decade.At Innovation Day, we've covered several topics and I'd like to reframe a few of our key products against today's backdrop. With ADP RUN we help small businesses manage their essential HR tasks from basic payroll to a full HCM suite. We highlighted our push-to-drive digital sales and onboarding capabilities1 which is especially relevant in today's environment and we also highlighted innovations in automating service and implementation which relieves pressure on our service organization. We discussed Workforce Now and our public cloud native version that we are pairing with our next gen payroll engine, which utilizes a fully transparent policy-based model for improved implementation, maintenance and self service as well as continuous payroll calculations for clients looking for on-demand pay options.We also talked about Wisely and the ease of use and the financial tools that make an attractive –attractive way to get paid. And just this month we made Wisely Direct available to our mid-market Workforce Now clients, which we believe will be beneficial to the many workers in our base that still get paid by a paper check. And of course we discussed our next gen HCM, which we believe represents a big step ahead of current offerings in the market and for which we remain excited about scaling and selling more broadly.Before I turn it over to Kathleen, I'd like to take a moment to once again thank our associates. This health crisis and the resulting economic fallout hasn't been easy on anyone, but our associates have really stepped up to ensure we continue to provide our clients with the support they need, and our clients and I appreciate it, Kathleen, I'll turn it over to you now.
Kathleen Winters: Thank you, Carlos and good morning everyone. As Carlos mentioned, we were generally pleased with our execution in Q3 and our financial results were not significantly impacted by COVID-19, with the exception of New Business Bookings. We expect Q4, however, to be challenging on a few fronts. And I will cover this when I go through our guidance.This quarter’s revenue growth of 6% reported and organic constant currency was in line with our expectations. Our adjusted EBIT margin was up 60 basis points compared to the third quarter of fiscal 2019, even though it included a $50 million cost of a global associate assistance payment related to COVID-19 which we disclosed in an 8-K several weeks ago. Excluding this, our margin performance was even further ahead of our expectations and continued to benefit from a combination of cost savings related to our transformation initiatives and operating efficiencies, as well as lower than expected incentive compensation expenses. These benefits were partially offset by growth in PEO zero-margin benefits pass-through expenses and amortization expense, as well as certain other expenses related to COVID-19. Our adjusted effective tax rate increased 30 basis points to 23.8% compared to the third quarter of fiscal 2019, and adjusted diluted earnings per share increased 8% to $1.92 driven by revenue growth and margin expansion, as well as fewer shares outstanding compared to a year ago.Moving on to segment results. In our Employer Services Segment, revenues grew 3% reported and 4% organic constant currency, reflecting steady underlying performance with strong retention trends offset by continued FX pressure and a growing headwind from interest income. Interest income on client funds declined 5%, and average yield on client funds declined 20 basis points to 2% offsetting growth in average client funds balances of 4% to $31.3 billion. This growth in balances was driven by a combination of client growth, wage inflation and growth in our pays per control in the quarter, partially offset by lower SUI collections and the closure of our Netherlands money movement operation earlier this year. Our Employer Services same-store pays per control metric in the U.S. was 1.9% for the third quarter and I’ll talk a bit more about the trends we’re seeing in a moment. Employer Services margins increased 100 basis points in the quarter, ahead of expectations and driven by many of the same factors I mentioned earlier when discussing our consolidated results.Our PEO segment revenues grew 11% for the quarter to $1.2 billion, and average worksite employees grew 7% to $595,000 ahead of our expectations and driven by strong year-to-date new business bookings. We were pleased with this re-acceleration in our Worksite Employee growth in the third quarter and believe we would have been positioned for further acceleration exiting the year if not for COVID-19. Revenues excluding zero margin benefits pass-through grew 9% to $490 million and continue to include pressure from lower workers' compensation and SUI costs and related pricing. PEO margin expanded 10 basis points in the quarter in-line with our expectations.Let me now turn to our outlook for the remainder of the year. I'll start by discussing some of the specific macro driven factors that affect our financial performance. I'll caveat by saying that we're clearly operating in an evolving and uncertain situation and we're using data currently available to us to make reasonable assumptions on which we are basing our guidance.First out-of-business losses, we expect our retention to be impacted by elevated out-of-business losses in Q4 and although the federal government is providing stimulus to help companies continue operating, we're seeing clear strain on our client base and have observed certain leading indicators; such as companies going inactive and no running payroll, many of whom will restart their operations at some point, but some of whom we expect will not. Based on our experience with these leading indicators, we are building in an expectation for additional losses in our fourth quarter outlook and as a result we're lowering our full-year retention guidance to be down 30 basis points to 50 basis points despite running ahead of our expectations on a year-to-date basis.Next, pays per control. We exited March with negative pays per control growth and in April it deteriorated to a double-digit decline. We were assuming a 2% to 2.5% pays per control decline for the full year, which implies a mid-teens decline for Q4. As a reminder of how this affects us, we have varied contracts throughout our businesses that blend base fees and per employee fees and we also often utilize shared pricing and have certain annual revenues that are not as affected. As a result with our current mix of business, the direct revenue impact we expect to see is about 25 basis points in ES revenue growth for every 1% change in PPC. Some of our businesses are more sensitive to pays per control than others and so the precise neck that pays per control by business can drive the actual revenue impact higher or lower in any given period. This direct impact also doesn't include the impact from our volume based businesses like recruiting or payment cards.Finally, on client funds balances, through the combination of a challenging sales environment and anticipated increase in out of business losses, a decline in pays per control and potential decline in wages and hours worked we expect to see pressure in our balances in the near-term. Furthermore, the CARES Act has a provision that allows companies to defer the payment of the employer portion of payroll taxes, which represents less than 5% of our average client funds balance. But depending on the actual take rate of that provision, we could see further pressure on our balance growth. As a result of all these factors, we now expect 1% balance growth for the full year, which implies a low double-digit decline in the fourth quarter. To adjust the size of our client's fund investments to match expected changes in average client payroll and tax volumes.Beginning in March, we halted all new reinvestment of maturity in our client long and extended portfolios. And in April we took the additional step of selling approximately $1.2 billion of previously purchased securities in the client long and extended portfolios. This decision to suspend new purchases means our Q4 interest income forecast reflects a slightly greater skew to overnight rates than previously forecasted. Both the suspension of new purchases and the completed sale of securities is contemplated in our guidance. To be clear, these decisions represent tactical adjustments and do not represent a change to our overall client funds strategy.Let's now turn to our revised outlook for the full year and start with the ES segments. We are lowering our guidance to 1% to 2% revenue growth versus our prior outlook of 4%, driven mainly by an expectation of lower paid per control, new business booking, client fund interest and retention versus our prior outlook. Much of this lost revenue comes at high incremental margins and as a result and also due to additional costs related to COVID-19 we now expect our margin in the employer services segment to be down 25 to up 25 basis points.For our PEO, we saw good momentum up through the end of March and as I mentioned earlier, we believe we were on track for continued acceleration exiting the year, but are now layering in our expectation for layoffs and furloughs and additional out of business losses. As a reminder in our PEO segment, we earn revenues as a percent of the gross payroll we process and as a result we are more directly tied to changes in our client's head count and hours worked as compared to our employer services segment. As a result of these assumptions and our expectations for lower Q4 PEO sales, we are lowering our average work site employee growth expectations to 3% to 5% from 7% to 8% previously. We are likewise lowering our revenue guidance and now expect 5% to 7% PEO revenue growth in fiscal 2020 and 3% to 5% growth in PEO revenues excluding zero margin benefits pass-through.As we also discussed throughout the year, we continue to expect lower workers' compensation and SUI costs and related pricing to pressure our total PEO revenue growth. Though we could see those trends change in the coming years. For PEO margin, we now expect to be down 100 basis points to 125 basis points in fiscal 2020. As we noted in previous calls, this outlook continues include pressure from smaller favorable reserve adjustment that ADP Indemnity in fiscal 2020 compared to fiscal 2019, but we now expect about 75 basis points of pressure compared to our previous expectation of 50 basis points of pressure. So we still expect a slight benefit this year.With these changes to the segment, we now anticipate total revenue growth of about 3% in fiscal 2020 as compared to our previous outlook of 6%. This revenue outlook continues to assume slight FX unfavorability for fiscal 2020. As I mentioned, we anticipate our growth in average client funds balances to be about 1% compared to our previous outlook of 4% and we expect the average yield earn on our client funds investments to be about 2.1% compared to our previous outlook of 2.2%. We expect interest income on client funds to be $540 million to $550 million and for interest income from our extended investment strategy to be $550 million to $560 million.We anticipate our adjusted EBIT margin to be down 25 to up 25 basis points, as the benefits from our workforce optimization and procurement transformation initiatives are now being offset by the impact of expected loss of revenue due to COVID-19 as well as incremental expenses related to COVID-19 including the [$50] [ph million in global associate assistance payments.We now anticipate our adjusted effective tax rate to be 22.9%. The rate includes this quarters unplanned tax benefit from stock based compensation related to stock option exercises. It does not include any further estimated tax benefits related to potential future stock option exercises. As a result of our lower revenue and margin outlook, we now expect adjusted diluted earnings per share to grow 4% to 7% in fiscal 2020. In light of this revised 2020 guidance and multiple headwinds created by the global pandemic and the uncertain and evolving situation we are withdrawing the fiscal 2021 targets that we set out at our 2018 Investor Day as they are no longer appropriate to the current circumstances. However, we continue to believe in our long-term strategy and well positioned to continue to invest to execute this strategy.Finally, before I conclude, I'd like to talk about the strength of ADP’s business model and balance sheet. We have a highly cash generative business with low capital and the HCM Solutions we provide give critical support to our clients, HR and management functions, especially at times like these. In addition to having a resilient product and business model we also have a significant buffer between our free cash flow and our modest debt obligations and our cash to spend, this enables us to absorb the impact of downturns and continue to prioritize investments aligned with our longer term strategy as well as our commitments to shareholder friendly actions.So although our revenue growth can clearly be impacted by challenging macro conditions, our recurring revenue model and high retention rate positions us to continue the type of investments we highlighted at our innovation day even when times are tough. We will meanwhile continue to manage our cost base prudently. We have instituted hiring containment and started to execute on our recession playbook with a preplanned set of areas where we will see some of our expenses self-adjust, such as management and sales incentives and we will eliminate or defer non-essential staff. We're working through an evolving and uncertain situation and are formulating our approach for next year and we will of course provide you with our expectations and outlook for fiscal 2021 when we report our fourth quarter results. As always, expect us to be balanced in our approach.With that, I will pass it back to Carlos for some comments before we go to Q&A.
Carlos Rodriguez: Thanks, Kathleen. Before we move on to the Q&A, I just wanted to share with you an excerpt of one of the many notes we received from our clients that that captures how we want to define ourselves. This one said, we are a small business that has used ADP for quite a few years now, every time we call there has been a knowledgeable professional at ADP that immediately solves the problem and answers the question.We recently needed payroll data to apply for the COVID-19 payroll protection program. I immediately went to ADPs website to see how I should go about selecting and downloading the required payroll data. Imagine the relief when opening the screen there was a COVID-19 pop-up that proactively provided your clients with the payroll data needed, I was floored. This type of customer service is unheard of these days. We just want to tip our hats to everyone ADP for a great job. As this client suggests, the value of a true HCM partner becomes even more critical at times like these. And it continues to be our goal to exceed the expectations of our clients.And with that I'll turn it over to the operator for Q&A.
Operator: [Operator Instructions] We'll take our first question from the line of Ramsey El-Assal with Barclays. Please go ahead.
Ramsey El-Assal: Hi, thanks so much for taking my question. I hope you both are doing well. I wanted to ask about your visibility on the paycheck protection loan program in terms of, can you see that it's having the desired impact on businesses in the country? Are you seeing [indiscernible] terminated workers that are being brought back on book? And I guess just tying that back to your own performance or potential future performance, are you seeing the leading indicators of bankruptcy sort of staved-off a little bit in your book?
Carlos Rodriguez: Great question, we're obviously keeping our eye on that. Unfortunately what we have is really kind of limited anecdotal evidence that people are beginning to get money to be able to continue their payroll, they continue to pay people. As an example, a few days ago I was forwarded a letter that was sent to – an email that was sent to one of our associates from a client that was grateful for kind of the help that we gave them in applying for the loan and they sent a kind of a screenshot of their bank account that had $10 the previous day and then now had $84,000, like indicating that they have gotten their money from the SBA deposited into their commercial bank account. But I think as you've heard same as us in the press, the process has been given the magnitude of the scale of the challenge it's been a difficult process both for the SBA and I think for the banks, we've tried to do our part to help and we're optimistic and we're hopeful that it will make a difference and that there will be rehiring and that it will at least in some respects stop the furloughing and the elimination of jobs going forward. But unfortunately it's just a little too early for us to give you any kind of concrete evidence other than some anecdotal stories that money is making its way into the bank accounts of small businesses.
Ramsey El-Assal: Okay. Yes, that's helpful. Thank you. And then just a follow-up. In terms of your overall product strategy in the context of this crisis, are there any kind of adjustments you're having to make in terms of how you're thinking of new challenge, employees work from home, [indiscernible] time and attendance offering and also just on some of your major initiatives like Lifion? How’s the timeline, the market being impacted, how are you thinking about the product set sort of evolving from here on out?
Carlos Rodriguez: I mean, clearly we have to be nimble, and I think remain open to making further adjustments, but I think it's safe to say that if you go back over the course of decades, the concept of “outsourcing” and now what some people would call the SaaS models, which I think ADP was kind of one of the pioneers of, I think by definition, lend themselves to these kinds of remote work environments, whether it's for the technology people, because we generally obviously host and maintain and update the – all of the systems for our clients. But also through the variety of portals we have for our clients and the employees of our clients. All of the information that anyone needs is available online through all the tools we have to access that information, whether it's for the payroll practitioners or for the employees of our clients. Including, when you think about the app that we have for the employees of our clients to be able to check whether they've gotten paid, they can check their hours; they can make changes to 401(k). There's no really no need to move paper or for anyone to be in the office to do that kind of work. So clearly there will be things that we will learn and we'll probably hear in the early innings of this kind of new talent and how it might affect our products. But I think in general as an industry, it's not just for ADP, I think in general for us as an industry we're pretty well positioned I think for this kind of work environment.
Kathleen Winters: And I think if I could just, yes, if I could just add to that. I think you had asked about, I couldn't quite hear, but I think you had asked about Lifion and any updates to that and changes to our view on go-to-market. I would say over the longer term, while certainly this year looks like things have slowed down at least for a little bit, I'd say over the long-term, no change to how we're thinking about that. And we're got a handful of live clients. We're continuing to sell clients on and implement clients on Lifion, and we're encouraged about the long-term prospects there.
Carlos Rodriguez: Yes. It's clear, like every time that we have, whether it's an economic downturn or now this is obviously a new challenge, there's always questions about, will this drive greater adoption? I think intellectually it makes sense that this would drive greater outsourcing and greater adoption of a SaaS, but it's kind of hard to make that statement kind of where we are today, but theoretically and intellectually two or three years from now, there should be more demand and more people using SaaS solutions than there are today.
Ramsey El-Assal: That makes a lot of sense. Thanks so much for taking my questions.
Operator: Thank you. Our next question comes from the line Tien-Tsin Huang with JP Morgan. Your line is open.
Tien-Tsin Huang: Hi, thanks so much. Appreciate the extent of disclosure here. Just on the – some of the follow-up to Ramsey's question, just on the sales performance side, you mentioned productivity challenges in addition to the demand factors. What would you think you'll get your productivity back on track and align your sales to where you see the puck going next in terms of demand as it evolved?
Carlos Rodriguez: So we're trying to actually keep an eye on it week-to-week to get some sense of what levers there are still there. We clearly still have, our sales force is still selling and they're selling a lot of business, but at lower level than obviously we had expected and in lower levels and you compare it to the previous year. So unfortunately given the nature of the situation, it's kind of difficult to give you a kind of scientific or concrete answer. I think as we generate more information, I think probably for our guidance for next fiscal year, we'll be able to – I know that's not helpful to you today, but it's really a very difficult thing to talk about.We have a lot of, our salesforce was already what we call an inside salesforce and so we've proven that we can sell through insight selling, but we have some products that are what I would call high involvement decision sales. And it doesn't mean that those can't be done remotely. But it hasn't been the norm. So when you sell a very large complicated multinational solution, or frankly, even when you sell the PEO, historically there's been a relationship that's built there and a trust that gets built before that transaction gets consummated.So it clearly, this is – these are new and different times. So I don't think everyone is going to sit and wait around for everything to go back to normal before making decisions. But I think it's safe to assume, I think common sense would tell us that it's safe to assume that, there will be some level of hesitation and pull back in terms of decision making. Even though a good percentage of our salesforce is still outselling as they have before, although they're doing it virtually now.
Tien-Tsin Huang: Yes. Sure. So we'll check in with you on that again next quarter. So then my quick follow-up, both of you have talked about cost initiatives. You guys did much better than we thought on the margin side even with the [$50] [ph] million. But you've also both hinted at a pipeline of more cost take out, potentially pre the pandemic. So I'm curious, your willingness to pull incremental expense leavers maybe some chunkier stuff, is that available to you and are you willing to do that at this stage?
Carlos Rodriguez: So we did have a number of transformation initiatives underway. A lot of them were really around digital transformation efforts to kind of automate and improve the way our implementation or our services is delivered, which would create a better experience for our clients, the employees of our clients, frankly also for our associates that we thought would result in lower costs going forward. Yes, part of the challenge we have is as and again, every company may be different in terms of how they approach their level of support for their clients, but based on our model and the way we see ourselves playing a role, and frankly in society and with our clients, we've actually experienced quite an increase in volume and cost in the short-term.And so as an example, as the government rolled out the payroll protection program, we saw 40% to 50% spikes in inquiries right through whether it's phone or chat or by or by email. And so we had to work people overtime. We had to work people on weekends, which we're very grateful that people were willing to do, because you can imagine they've got lots of other concerns and distractions as this is all going on. And so we made a commitment that we're going to deliver to our clients through this and help them work through it, whether it's for themselves or for their employees. And unfortunately, I would say in the short-term, we actually have an increase in cost.Now, realistically that's not going to continue indefinitely. But every week that we said we think our call volumes and our workloads are going to go down, there's a new government program or a change in the government program, which by the way we think is great. I think that the efforts by the Fed and by policy makers, I think to help clients and their employees, I think is the right thing to do and we're very supportive. But as an example, there was just, as you know, there was an approval of an additional amount for the payroll protection program, which generates additional volume for us. By the way, I think the banks are in the same – probably in the same situation in terms of how having to handle kind of increase the volumes. And so we expect these levels to normalize and then to be in a position where we can reevaluate our cost structure, but again, given the timing of this call and where we are today, we really can't tell you that there has been a meaningful decline in our workloads. In fact, it's actually been an increase.
Tien-Tsin Huang: Got it. I appreciate the work behind...
Kathleen Winters: So, Tien-Tsin if I could just – let me just add a little bit more to that because I made some comments on our transformation efforts and transformation work even with the significant increase in service demand. So, even with this kind of very abrupt disruption and need to move our entire – practically our entire workforce to work from home. We will able to do that almost seamlessly. I mean, that worked really well through the huge, huge efforts of many of the different parts of the organization, from our technology groups to our HR to legal. I mean, it was a huge effort, but it worked well and so that we've been able to continue our normal processes, if you will around transformation work. There were certainly some projects that we have to look at and assess and say, okay, because of the big service demands we may need to slow down these.But our process in terms of tracking progress, continuing to execute, adjusting as necessary based on service demands and importantly continuing to look at pipeline of projects, that continue and I would just add one further comment that in particular in this environment, the ability to look at procurement and find procurement opportunities is potentially even greater today than it was, say three or four months ago.
Carlos Rodriguez: I think if I can just one more just comment, I think that the – the part of the challenge here is that we are – the nature of our company and our business and our Board is to not focus on one month or one quarter. And I think when you look at we're able to deliver just in this quarter in terms of margin improvement and we've been able to do in the last couple of years, I think demonstrates very clearly our ability to, I think achieve and take advantage of operating leverage and also to manage our cost very effectively.We've had a couple of years with a very modest, if any cost – true cost increases while revenues were growing at what for us is our very healthy rates. So I think we've demonstrated what we can, what we can do, but unfortunately we've been handed a very abrupt change here in the environment and we're going to handle it first to take care of our associates, next take care of our clients. And I think when we get through this transitory period, which we all know is transitory, now we don't know is a transitory for a month or two or is it transitory for six months. But either way it's not multiple years and we want to make sure that we continue to invest in our business, take care of our people and take care of our clients that when we come out of this, we come out of it as strong as we were before we went into it.
Tien-Tsin Huang: Yes. Very clear. It’s just the case. Thank you.
Operator: And the next question comes from the line of Kevin McVeigh with Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thank you and thanks for the guidance and obviously the tough environment. Any thoughts on, one question we get a lot is how much of the layoffs are going to be furlough versus structural? So just any sense within kind of the pace for control, how much of that would be potentially furloughed workers versus structural? Maybe start there?
Carlos Rodriguez: It's a great, question. So we have, as you know we operate in multiple countries and offer multiple segments; small business, midsize national accounts, but also in many countries and also multinational companies. And the policies that companies have around how they treat employees is going to vary from company-to-company and generally also varies from segment-to-segment. But what we can tell you is that, the way we count pays per control is very straightforward. It's whether or not someone got paid during that period of time that we're counting. And so we would not probably be able to give you a firm number of how many people are furloughed versus how many people are laid-off because we don't control necessarily that coding in the system. And clients can exercise some discretion about how they, I guess tagged some of their employees.But what we do know is that if somebody doesn't get paid, they don't get counted in pays for control. And if they do get paid, even if it's at a reduced wage, that does count and so that creates a number of challenges obviously. Because you could have reduced wage levels, which then doesn't negatively impact pays per control, but impacts the employees themselves. And may in some cases, impact our fees generally wouldn't other than in the PEO, but could impact our fees as well.So I would say that the best thing to do is to stick to – trying to use the pays per control metric as a way of building your models and using the guidance that we provided around 25 basis points of revenue growth, impact from each 1% change in pays per control. I think that gives you a very – we spent a lot of time pressure testing that assumption. I think Danny did a lot of work on it and I think that's a pretty solid way for you to look at things. So when you hear guidance from us about pays per control and you use that metric for your model, I think that's a much cleaner and easier way than to try to separate how many are furloughs versus how many are layoffs, et cetera, et cetera.
Kevin McVeigh: That's super helpful. And then I guess just a quick follow-up would be kind of coming out of this, obviously, in these type of events; you're really turn to in terms of the cavalry of the organization. Do you see any change competitively, particularly as obviously coming out of the last cycle much more service oriented as opposed to shift to the cloud in this one, but from a competitive perspective, any changes where you look to even build on that attrition number, longer term in terms of improvement?
Carlos Rodriguez: I think you do see some subtle differences in terms of company cultures and I think behavior. So as an example, one of the things that we have always, I think, trying to talk about is this willingness by us to really help our clients navigate through things, not just provide them the software solution. We actually took some responsibility for the outcomes of what they're trying to accomplish. And so the support we're providing around all these regulatory, I think is an example of that. That doesn't mean that other competitors aren't doing similar things.But as an example, some competitors would be more along the lines of providing tools online and directing clients to third parties or directing them to resources where they could get help versus in our case, we actually take the work on and we help our clients get to where they need to get in order to get their retention credit, tax credit, in order to get their payroll protection loan, in order to calculate in a few weeks or at least in a couple of months people are going to be needing help with calculating how to get forgiveness on those loans. I mean, there – this is a complicated environment by the way employment in general is always complicated. But this is a very complicated environment and having great tools and technology is incredibly important and we're totally committed to that. But I think it's undeniable that you also need extra help in these situations to help with questions and to help you navigate through the all the various regulatory hurdles.As an example, some of the legislation that was passed in the U.S., you have to really understand the interplay like, as an example, you can't take advantage of the deferral social security taxes and the payroll protection loans, but if you – you can take advantage of the social security deferrals up until you can get a loan, but then once it's forgiven, you can no longer defer your social security taxes. I mean those are things that are typically not well understood by our client base and I think just directing them to a website or to a tool, we don't think is really the – is the best way to help them.
Kevin McVeigh: That's awesome. Thank you.
Operator: Our next question comes from the line of Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. Hope your families are all well. I wanted to try on outlook here. Just understanding the material uncertainty, can you help us frame some initial fiscal 2021 guide posts in trying to think how we should be thinking about next year based on some of the implied 4Q run rates? So, any sense of visibility you have across the businesses or maybe thinking across client size would be helpful. Thanks.
Carlos Rodriguez: First of all, thanks for asking about our families. I hope yours is well also. Unfortunately, I mean it's a very fair question and I can understand why you're looking for any additional color. It's – as you can imagine, we struggled with even providing kind of fourth quarter metrics, because, two, three, four weeks ago, we had – or people had a certain view of how long “the issue is going to continue” and when things were going to open up again. And then it got more negative and now it feels like it's gotten more positive. So I think that it's very difficult for us to go really beyond the fourth quarter in this environment.We have to remain optimistic that things are going to “improve” but I think that we all have to take advantage of the time we have to wait and see how things play out, whether it's with the clients or with GDP or with the economy, or with these government programs, so that we can make more informed, I think, decisions about what 2021, I think, might look like. So I apologize for not being able to give you any additional color. But I think it would be a mistake to assume that the levels of activity that we've given you in the fourth quarter will continue into 2021, but it's also a mistake to assume that things are going to go back to normal at the beginning of 2021. And so we're going to keep an eye on the data and the information and do our best as we gather more information to give you a good view of what's going to happen in 2021 when we get there.
Kathleen Winters: Yes, maybe I could just add a few comments around the process and what we're doing in the data that we're looking at. Hence, while as Carlos said, we can't really give you the view right now or the exact guidepost, at least if you'll understand and know the process we're going that might help a little bit. So, look, things are, as Carlos said, it's extremely fluid right now. We're spending a lot of time studying and watching developments every single day and kind of looking at, I think about it in three steps if you will, in terms of first understanding what's happening from a pandemic standpoint and the epidemiology. Then understanding how that impacts the economy broadly around the world and then understanding how that impacts each of the business. So as we do that, obviously we're looking at numerous forecasts that I'm sure you all are looking at the same forecast that are being put out.But we're really spending a lot of time in parsing through those and kind of eliminating outliers and really utilizing the ones that we feel makes the most sense, and then applying that to you know, as I said, the implications for our business units and when you do that, as we've said largely PPC is going to be extremely significant driver for us. And then certainly the shape of the recovery from a new business booking standpoint will be critically important, so we're watching that as well as we see different regions and states kind of formulating and attempting the return to work.
Bryan Bergin: Okay. I appreciate that. Wanted on retention, the comments on the assumptions in 4Q, is the reduction wholly due to business closures. I'm curious if you're seeing any change in the competitive client loss.
Carlos Rodriguez: Well, I think based on the comments we gave you about the third quarter and the year-to-date, I think we're doing pretty well competitively, because I think our retention was up. I mean we don't talk about quarterly retention, but why not like everything's out the window in this kind of environment. But I think we were over 50 basis points improvement in the third quarter and through the year-to-date. I think we were well ahead of both the guidance, we had provided in our own internal expectations. So it's pretty clear that we were doing something right competitively.Our NPS scores are at record levels across most of our businesses. So again, the problem is this is not the time to brag and talk about the third quarter, but we really had incredible momentum coming into the third quarter on a number of fronts, but that's that and we're onto now figuring out how to deal with the future challenges, but I have no concerns about the solidity of our business on every front coming into the third quarter.
Bryan Bergin: Thank you. Be well.
Operator: Our next question comes from the line of Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Hi, good morning, Carlos. I was wondering, based on the data you're seeing and I realize this is so early in, but what kind of changes do you anticipate for the business, permanent changes or at least over the next 12 months to 18 months because of this current crisis?
Carlos Rodriguez: Well, over the next 12 months to 18 months is probably the right focus, because I mean, I think it'd be naive to think there aren't some things are going to change permanently, but I'm not sure I have that, that kind of crystal ball to be precise about that. But for the next 12 months to 18 months, because of the focus we have on our associates, it's unlikely that we will be going back to business as usual here in the next few months.Now the good news is we've adapted to the current work environment. So, but – I kind of concrete change in terms of the next 12 months, 18 months is we don't anticipate having a 100% of our workforce back working in these one locations and some of these other places where we have large populations of associates. And so that's a change that we have to make sure that we stay on top of, that we support our people and lead them remotely and virtually and help them kind of navigate through what's a very different way of working.Now obviously we plan on, as society kind of normalizes, we plan on coming along for the ride with us. So we do a lot of formulating plans as we speak, very preliminary plans around how do we slowly get back into some of our offices with limited number of personnel, but that's a change that we're definitely going to have to continue to live with for the next 12 months to 18 months. Now, what that means is that impacts our salesforce and so the question is, if the demand equation improves significantly and our salesforce is still working remotely, how can we make sure that they have the right tools and the right processes to continue to take advantage of the demand that's out there.Because we don't anticipate having large numbers of salespeople back in our offices, our salespeople, by definition, many of them are inside sales, but many of them are out in face-to-face transactions. And that's not something that's going to normalize in the next 12 months to 18 months. Sadly, I'm sad to report that of the number of associates that we had impacted by COVID-19, we were disproportionately impacted in our salesforce. So as we go back to normalization, we're going to be exceptionally careful about protecting our salesforce as well.
Kartik Mehta: And then just finally, Carlos, what do you think the recovery will look like, we've heard so much a V, a U, a L, I'm just interested in your perspective of what you're anticipating from a recovery?
Carlos Rodriguez: Well I think the – again, we're looking at, we get information from all of the usual places like Morgan Stanley is obviously our banks, so they've been very helpful in getting us their information, but we have access to information from a number of other sources. I don't want to say any of the names, so I don't hurt anybody's feelings, but all the usual banks we get the information from them. We have information from Moody's, by the way we also work with the fed. We work with treasury. We have a lot of sources of information to give us some sense of kind of where things are headed.The challenges that I don't think anyone has really well – I don't think, I know that no one has ever been through this. So there really aren't any great models other than using inputs like PMIs or consumer confidence and other metrics that tend to be many of the metrics that people use in these models are lagging indicators.And you have regression that gives you some sense of where the economy is headed. But, as I’ve seen myself in the last four to five weeks, you have to take any forecasts with a large grain of salt. So the best approach we think you can have right now is to remain flexible and agile about how you're planning and what you're planning for. If I were – if we had to make a bet today, we would say that, it's not going to be a V-shaped recovery and it's probably not going to be a U or an L, but it's going to be some other kind of shape where we obviously already had the precipitous decline. We’ve already seen some signs of some stabilization. So we have metrics that we track like in our HR systems of our clients.For example, new job postings or number of screenings that are done, like background checks and some of those metrics have actually begun to stabilize. So I think we've had the abrupt drop. Now the question is the recovery, it feels like that recovery will be not a V, but not an L. And so the difference between V and L is a check Mark. Like I think some people are out there quoting, by the way we have an economist on our board and he referred to as a Nike Swoosh, but that's probably a copyright or trademark violation. So I won't use the Nike Swoosh, but you get the idea of rough drop and hopefully a climb back up over some period of time. Hopefully that client is over the course of three to six months and not over the course of 12 months to 18 months.
Kartik Mehta: Thank you very much.
Operator: The next question comes from the line of David Grossman with Stifel. Your line is open.
David Grossman: Alright, thank you. Good morning. Carlos, I think you've addressed this in a couple of previous questions, but based on how this may play out coming out of the crisis and you talked just a moment ago about some possible structural changes at least in the intermediate term being work from home or virtual sales. How do you feel the way you're positioned, coming out of that versus where you were going into it and how do you view your ability to leverage that to your advantage? Is it structural or is it based on execution, I'm sure it's a combination of both, but if you could just give us a little more insight into how you're feeling about, what you can do with this crisis to really enhance your position both competitively and operationally.
Carlos Rodriguez: Well, look I think that some of this is philosophical. I think that I like everyone else when we were entering this space I was scared like everyone else's, not just personally for myself and my family, but also for the company and all of our associates and our clients that depend on us.And when you see the reaction and the ability of the organization to kind of get through it and not just get through it, but actually deliver a higher level of service and help with very complicated questions in a very complicated situation, which was changing in some cases on a daily basis with the regulatory landscape. I think it tells you something about the strength of the culture and of the company. And so that gives me, again, this is all intellectual philosophical, but I think it gives me great hope about how we emerge from this competitively.We already had incredibly strong momentum going in to the third quarter, as you saw from retention we think we have a strong product lineup that was beginning to get traction. One of the things we didn't talk about when someone asked the question about our competitive situation, like we had really good growth in client counts, particularly in Workforce Now and specifically in our mid-market business. So the combination of positive momentum and coming into this and then the reaction and the strength of the organization through this gives me great optimism and hope that we're going to come out of this stronger than any of our competitors.
Kathleen Winters: Yes. Let me just add to that – Yes, I would just add to that, in addition to the great service that we've been able to provide to our clients throughout this, which theoretically ideally should sustain or drive even better retention going-forward. I would say the strength of our balance sheet and the ability to continue to invest aligned with what we laid out at our Innovation Day for investing in our strategic products and Workforce Now and RUN and our next gen product, our ability to continue to do that throughout this should position us well.
David Grossman: Okay. That's it for me. Thanks very much. And be well.
Carlos Rodriguez: Thank you.
Operator: Our next question comes from the line of Steven Wald with Morgan Stanley, your line is open.
Steven Wald: Yes. Good morning. I hope you guys are safe and well, and thanks for the shout out from Morgan Stanley, a little bit around that subject. Maybe just starting off on some of the puts and takes of the segments, that you guys pointed to work site employee growth, still NPO versus lower pays per control and Employer Services just maybe run us through again because it's come up a lot in recent conversations around why the PEO should still be thought of as a employment-wise a little bit more defensive and how you guys see that tracking this downturn versus prior ones.
Carlos Rodriguez: I think the number one reason is really just structural in the sense that when you look at overall ADP, we have clients all the way from a single employee all the way to very large national accounts. And so as we've said – we said this obviously over multiple decades, our down market business tends to be the most sensitive to other business but also to decreases in pays per control. And so as we track this pays per control data, I think we've probably given you some of the color that the pays per control numbers are down more in the down market than they are in the mid and the up market.The PEO, at least in our case, the PEO tends to – the average sized client, just from a practical standpoint is 45 and we tend to – we try to stay away from clients that are under 10 employees. We have some clients obviously that are between five and 10 employees, but in general, the sweet spot of the PEO is kind of around 45, that's the average. And so it's just the nature of the structural difference of that business versus the others that the pays per control is not going to decline as much as the overall average, if you will, where you have some of that average being in the small business and in the small business market.And then the second more anecdotal comment would be the PEO clients. Our PEO clients, not every PEO clients, our PEO clients tend to provide health benefits or retirement plan, they tend to be kind of higher average wages in the average U.S. worker. And that makes sense because you're paying for the help that you get with maximizing and managing that Salesforce. So it tends to be attractive to a higher average wage employer that is very concerned with attracting the right people and retaining the right people. So that also tends to lead you in the direction of clients that are a little bit larger, maybe a little bit more financially capable of paying those fees, et cetera. So that – but that not – not sure that we can have a scientific way of proving that one, but for sure the average size client of a PEO, our PEO is larger than in our SBS business and hence the pays per control drop would logically be smaller.
Steven Wald: Got it. That's very helpful color. In terms of just a quick follow-up on capital management dividend, I know, both of you have mentioned the strength of the balance sheet, continued ongoing investment and cost cutting. But in terms of how we should think about things like the dividend and the safety there or your willingness to raise that, given the current environment or buybacks and other forms of acquisition that lower valuations, how are you guys thinking about that from a financial but also a strategic and sort of, I guess sensitivity to the times type of perspective.
Carlos Rodriguez: Okay. So I'm glad you asked that question, as I happened to talk to our Chairman yesterday, before this call because I figured somebody might ask that question. It's a tricky question because as you know, it's up to the board to decide on our dividend, but I can tell you this, that we had a board meeting on April 8, and the board approved an increase and a payment of our dividend. And they wouldn't have done that if they had concerns in the short or medium-term about our capital position or about our dividends.So again, without speaking for the board, I think we have a very long 45 year track record of paying and increasing our dividend. We have a strong balance sheet. We are a capital light business with strong cash generation. Our payout ratio is 55% to 60%, which I think gives us some room to be able to continue even with increases without running into any major capital constraints or restrictions on our investing. So I would feel optimistic that our board would be supportive of continuing the long track record. ADP has of 45 years as it stands. And I'll let Kathleen maybe make a comment or two about that as well.
Kathleen Winters: Yes, thank you. You covered it really well for us, I would just say in support of enabling the board to make dividend decisions, we in a normal basis do ongoing analysis and stress testing and have been continuing to do that through this environment. So we've been doing, looking really closely at that stress testing. So, I really don't have anything to add beyond what Carlos commented.
Steven Wald: Great. Thank you.
Operator: We have time for one more question. And that's from the line of Lisa Ellis from MoffettNathanson your line is open.
Lisa Ellis: Thank you. Thank you for squeezing me in and great to hear everybody's voices. Glad to hear you're well. Just a little bit of a follow-up on the PEO question. I mean, as you just highlighted the work site employees in PEO are a bit more resilient, because of the larger size of company, but the revenue guidance there is down more significantly in Q4, maybe like a tactical question just around what drives that in the short-term, but maybe a broader question, Carlos, for you coming from originally the PEO business, how should we think about how the PEO will act through a recession period? Do you expect increased demand for the PEO or some clients dropping out of the PEO? How do you think about that dynamic? Thank you.
Carlos Rodriguez: Great question, I'll let Danny pull up the calculator too, because I'm sure you're right about the dropping greater, there’s no intention, there's no signaling or anything intended there, maybe rounding or the math or something. But there's no magic formula there that we're trying to send some kind of message. I mean, we think the PEO business is solid and strong and I think tends to whether recession is better. Again, every time you have a recession, it's a different kind of recession. So we had a financial crisis last time, this time it's a health crisis. So I'm always cautious of making kind of bold definitive statements. But historically we've always worried about the PEO going into a recession or into a crisis being challenged, because it does tend to be a kind of a more expensive, if you will – solution, if you will, but it also provides an enrollment with higher amount of value, and during these types of situations, like for example, our PEO handles the questions not just of our clients, but of the employees of our clients.That's not what we generally do for our typical payroll. That helps our clients a lot and we leave them of a big burden and provide those employees a lot of confidences, a lot of real positives and good reasons why people want to stay on a PEO or why they want to be on a PEO even in a recessionary environment. So I would say that, in the prior recessions, the PEO was not immune, just like it's not this time from pays per control decreases and from some short-term disruptions with new bookings. But we've been impressed, I've been through now, I guess this is my third recession at ADP and at least the prior to the PEO performed on a relative basis as well, if not better than the rest of our business. And we would expect no different on a go forward basis.
Danyal Hussain: And Lisa, this is Danny just to add, because it's fairly in the weeds, which I love of course, but in addition to the impact from work site employees in the PEO we charge as a percent of payroll and so wages themselves, to the extent we have some workers working fewer hours within the PEO base that can have an impact and then even further in the weeds is, you can have a slight mix impact with respect to workers' comp. To the extent that certain industries have greater impact from pays per control and those had higher workers comp rate. So these are very subtle impacts, but together they’re kind of informed that guidance.
Lisa Ellis: Wonderful. Thank you. And then maybe my last one and Carlos, could you one to end on, as you're watching and maybe help us a little bit, what are the top, like literally one or two things that you are watching that you think are really going to impact as you're looking at your client base, the shape of the swoosh or the check mark are over these next couple of months?
Carlos Rodriguez: I think the first one that we're keeping our eye on is really these leading indicators, if you will. So this would be job postings and background checks. And so that I think is – those are I think the job postings is obvious in the sense that people aren't really going to post new positions if they think that things are not going to at some point improve. So to me, that's a sign that people are doing the same thing we're doing, which is we're conservative and we're cautious, but we have to be prepared for every eventuality in including the optimistic one.And so this increase in postings, job postings to me means that people are starting to think of, well, if in two, three, four weeks this state or this industry has some kind of opening, I need to make sure that I have the people available to handle that work, because these are business owners that obviously have to run their businesses.And then secondly, when they actually do that, then they actually have to put that person through the new hiring process which is the screening and selection. And so we're going to keep an eye on those two figures. Then closely behind that, I think is a – we have a very large workforce management business or some people would call time and attendance. And so that is also data that is very helpful in terms of seeing number of hours worked. It doesn’t always help you a lot with an exempt workforce, but for people who are paid hourly, it's a very good indicator that kind of cuts through the noise of furloughs and layoffs and so forth and so on, just kind of gives you some sense of “hours worked and whether that is increasing or not increasing” so that should show an upturn before we see upturns in other things, because people will take the existing people they have now and just have them work longer hours rather than adding additional people. So the addition of people will probably be the final I think sign of a of recovery, but we have a number of other indicators that we can look at that gives us an earlier view of where we're headed.
Lisa Ellis: Wonderful, thanks guys.
Operator: That concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: So it's hard to kind of find the words to close the call out and describe the situation that we're in. But trying to end on an optimistic note here, I've been now with ADP 20 years. And I've been through, I just mentioned two recessions, this is my third, been through Y2K, which most of the people on the call don't even remember. Danny, certainly doesn't remember Y2K, he was too young, through 9/11, we'd been through wars, we've been through multiple changes in technology, nobody was even talking about SaaS when I joined ADP. And every time we had a challenge it looked like that was a challenge that we couldn't overcome.But every time ADP overcame that challenge and it's no different, I think for the rest of – in this case, humanity because this is affecting not just the U.S. but it's affecting the entire world. People in ADP find a way to evolve and to adapt. So I have to be optimistic, we have a propensity to overcome. If not, we wouldn't be here talking to you today, whether it's us as human beings or us as a company. By the way, as I've said multiple times in other calls, we're 70 years old and I think as a company, and I think that tells you something, we're a part of a very long history of overcoming challenges and this one is going to be no different.And I'll leave you with something that I shared with our associates at the beginning of the crisis, which is something that our Founder, Henry Taub, I think established as a culture for the company that I think is appropriate. And he always told us and he told me because I knew him personally, he told me always take care of your associates and they will take care of your clients and everything else will take care of itself.So I really appreciate the support of all of you for ADP. Thank you for calling in and asking your questions and my best wishes to all of you for health and safety for you and your families. Thank you.
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Shannon, and I will be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] Thank you, I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Shannon. Good morning, everyone, and thank you for joining ADP's Third Quarter Fiscal 2020 Earnings Call and Webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.Earlier this morning, we released our results for the third quarter of fiscal 2020. The earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompany today’s call as well as our quarterly history of revenue and pretax earnings by reportable segment.During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description and the timing of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measure, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and as such, involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. As always, please do not hesitate to reach out should you have any questions. And with that, let me now turn the call over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny and thank everyone for joining our call. Before we can, I want to first say that our thoughts and prayers are with those who have been or know someone who has been impacted by COVID-19. Every day we hear about how much of a challenge it has been for employers and workers alike, including our own.I'd like to recognize our associates for rising to the challenge and delivering exceptional service to our clients despite the extraordinary circumstances they've had to face. To them, I want to say thank you. For our discussion today, we'll spend a little less time talking about the third quarter and more time on the current operating climate. And I'd like to offer a couple of upfront points.First is that ADP is not immune to the global pandemics impact on the labor market, but while we may make tactical adjustments as we navigate through this crisis, we believe our long-term strategy is unaffected and we remain optimistic about how we're positioned over the coming years, once the business environment and our clients return to more normal operations. The second point is that we will continue to serve our clients in the way we know best, by offering the tools, resources, and support they need to manage their business and their workforce through all types of operating environments, including this challenging one.With that said, this morning we reported our third quarter fiscal 2020 results with revenue of $4 billion up 6% reported and organic constant currency and in line with our expectations. We expanded our adjusted EBIT margin by 60 basis points in the quarter, which was ahead of our expectations, even though it included an unplanned [$50] [ph] million global associate assistance payment in response to COVID-19. And with the solid revenue and margin performance, we were pleased to deliver 8% adjusted diluted EPS growth, which was also a slightly ahead of our expectations coming into the quarter.Turning now to the current situation, I'd like to take a few minutes to go deeper on how COVID-19 has affected our operations and what we've done to respond. As the situation evolved over the past couple of months, we focused first on the safety of our associates. In March, we took steps to quickly shift over 50,000 of our associates to work from home and now have approximately 98% of our workforce working remotely in a secure manner. In doing so, we leveraged our previous investments in business resiliency and in addition we ordered thousands of laptops, expanded remote access capacity, provided at home internet and for those critical personnel that needed to work onsite, we took steps to ensure their safety while they perform those essential onsite tasks. This was a huge undertaking by our global IT, security and legal, and HR organizations and I'm extremely proud of their execution.We also worked with our critical third-party service providers to ensure they were positioned to continue to support us. In March, we also had our field sales force shifts from in-person to a virtual sales model, and while that's not an ideal circumstance for some of our quota carriers, they're making the most of the situation. While we were executing on these business resiliency plans, we also worked nonstop to address our client's needs to ensure uninterrupted service across our HCM solutions. We provide a mission critical service and process payroll for one in six Americans and over 40 million workers around the world, and to offer immediate support we’ve provided a number of online resources including an employer preparedness toolkit and webinars attended by tens of thousands of clients. We also quickly made available for free the payroll costs and headcount reports necessary to apply for forgivable loans under the Paycheck Protection Program of the CARES Act and these reports have been downloaded hundreds of thousands of times.Service is more important than ever in times like this. We saw call volumes increased significantly beginning in March and have nearly 2 million inbound requests across our service channels in a matter of weeks, with clients looking for help with a variety of issues including adding custom pay codes related to COVID-19, redirecting checks to different locations and requesting new time tracking hardware that doesn't require physical contact. In many cases they were simply seeking general guidance in understanding new legislation. To meet our client's needs we retrained and quickly redeployed hundreds of associates to where they were needed most. And our service and IT teams worked quickly to digest and translate new legislation from the many jurisdictions around the world into our global payroll, time and attendance and other systems in a short period of time to allow our clients to comply with and benefit from these changes in legislation.As the environment for companies continues to evolve, whether due to legislative changes or operational realities, we at ADP are committed to supporting our clients to help them best navigate those changes. As we communicated in an open letter to U.S. policy leaders, ADP stands ready to facilitate current and future initiative that provides support to our clients and their workers. And in support of our local communities, ADP has made over $2 million in donations to relief efforts, including a dedicated relief fund for ADP associates that needed assistance as well as donations of medical supplies for hospitals, food banks, and their workers.With all that said, the significant impact of COVID-19 is having on a broader economy, is in turn having an effect on our reported metrics, in a much more abrupt fashion as compared to previous macro economic slowdowns. You can see this in our Employer Services new business bookings metric. This quarter we reported a decrease of 9%, as we saw bookings declined significantly and rapidly in mid-March when we typically would have expected to close many deals for the quarter. These results were of course well below our expectations coming into the quarter and while some of our businesses performed slightly better than others in March, the weakness was generally broad-based as the health crisis is affecting companies of all sizes and regions including internationally.We believe the impact to bookings stems from two factors. First is the buying behavior of our clients and prospects. As with prior uncertain economic environments, our clients and prospects have become time and resource-constrained and are faced with reassessing their own operations to best ride out the impact of this health crisis. And although our products support mission-critical functions, making decisions about additional HCM services or making the decision to switch from another vendor to ADP can get put off to a later time. Even in circumstances where decisions have already been made, clients are understandably delaying implementation which can also cause us to adjust down the bookings we record. The general change in behavior is common in recessionary periods and we are certainly not surprised to see it this time. It's clearly happening in a more abrupt manner compared to what we've experienced in the past.Second, as I mentioned earlier, there have naturally been constraints that limited the activity of our salesforce. What we have been able to lean more heavily on an inside sales strategy and virtual interactions by our field sales force. There has still been a reduction in our salesforce productivity. Our sales organization is experienced and resilient and we will continue to work hard in the fourth quarter. Because of a variety of factors which we believe will have an outside impact on the fourth quarter booking, including the effectiveness of the Paycheck Protection Program in supporting small to mid-sized businesses and how quickly our clients can adapt to working in this new environment and resume more normal buying behavior, there is clearly a very wide range of outcomes.But to calibrate your expectations, we are guiding for a full year ES New Business Bookings, our ES New Business bookings to be down 20% which implies our fourth quarter bookings will be down by more than 50%. With all that said, we remain confident in our product portfolio and optimistic about our ability to drive sustained growth in ES bookings in a sounder economic environment.I now like to spend a minute or two on some of the other macro driven trends we've observed in our client base. Our pays per control metric, which represents employee growth for a broad subset of our client base was solid through February, but decelerated to a slight negative growth by the end of March, averaging 1.9% growth for the quarter. Early in April, we saw it deteriorate further to a double digit negative decline, with the steepest decline among smaller businesses. For context, this level of pays per controlled decline is significantly worse than even the worst quarter in the financial crisis, underscoring that it's hard to compare this environment even against the past recessions. While we hope that legislation aimed at preserving employment will drive a recovery in pays per control, we had not seen it through mid-April.On retention, we were actually pleased with our performance in the third quarter, with both third quarter and year-to-date retention performance better than our expectations and ahead of pays per our previous annual guidance. We set all time third quarter retention record in our down market and mid-market businesses, as client satisfaction scores were at or near all time highs and as the benefits of our technology and migration strategy over the past several years continue to bear fruit. But clearly, out-of-business losses are a concern for the fourth quarter and beyond. And although they have not yet meaningfully picked up by the end of March or even into April, early indicators of stress in our client base have shown up and we expect deterioration in retention in May and June.Kathleen will share some of the assumptions for the fourth quarter when she goes through the outlook. I'd like to pivot now from the current macro environment and focus on our strategy and what we're doing to drive longer term value for our clients.At ADP, we remained steadfast in our commitment to lead in the HCM industry with best-in-class technology and service. At our February, Innovation Day we shared an update with many of you about the innovation we are driving across our key strategic and next gen solutions. The HCM industry is an exciting place with constant change and we will continue to invest to position ourselves to meet the evolving needs of our clients over not just the coming years but the coming decade.At Innovation Day, we've covered several topics and I'd like to reframe a few of our key products against today's backdrop. With ADP RUN we help small businesses manage their essential HR tasks from basic payroll to a full HCM suite. We highlighted our push-to-drive digital sales and onboarding capabilities1 which is especially relevant in today's environment and we also highlighted innovations in automating service and implementation which relieves pressure on our service organization. We discussed Workforce Now and our public cloud native version that we are pairing with our next gen payroll engine, which utilizes a fully transparent policy-based model for improved implementation, maintenance and self service as well as continuous payroll calculations for clients looking for on-demand pay options.We also talked about Wisely and the ease of use and the financial tools that make an attractive –attractive way to get paid. And just this month we made Wisely Direct available to our mid-market Workforce Now clients, which we believe will be beneficial to the many workers in our base that still get paid by a paper check. And of course we discussed our next gen HCM, which we believe represents a big step ahead of current offerings in the market and for which we remain excited about scaling and selling more broadly.Before I turn it over to Kathleen, I'd like to take a moment to once again thank our associates. This health crisis and the resulting economic fallout hasn't been easy on anyone, but our associates have really stepped up to ensure we continue to provide our clients with the support they need, and our clients and I appreciate it, Kathleen, I'll turn it over to you now."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos and good morning everyone. As Carlos mentioned, we were generally pleased with our execution in Q3 and our financial results were not significantly impacted by COVID-19, with the exception of New Business Bookings. We expect Q4, however, to be challenging on a few fronts. And I will cover this when I go through our guidance.This quarter’s revenue growth of 6% reported and organic constant currency was in line with our expectations. Our adjusted EBIT margin was up 60 basis points compared to the third quarter of fiscal 2019, even though it included a $50 million cost of a global associate assistance payment related to COVID-19 which we disclosed in an 8-K several weeks ago. Excluding this, our margin performance was even further ahead of our expectations and continued to benefit from a combination of cost savings related to our transformation initiatives and operating efficiencies, as well as lower than expected incentive compensation expenses. These benefits were partially offset by growth in PEO zero-margin benefits pass-through expenses and amortization expense, as well as certain other expenses related to COVID-19. Our adjusted effective tax rate increased 30 basis points to 23.8% compared to the third quarter of fiscal 2019, and adjusted diluted earnings per share increased 8% to $1.92 driven by revenue growth and margin expansion, as well as fewer shares outstanding compared to a year ago.Moving on to segment results. In our Employer Services Segment, revenues grew 3% reported and 4% organic constant currency, reflecting steady underlying performance with strong retention trends offset by continued FX pressure and a growing headwind from interest income. Interest income on client funds declined 5%, and average yield on client funds declined 20 basis points to 2% offsetting growth in average client funds balances of 4% to $31.3 billion. This growth in balances was driven by a combination of client growth, wage inflation and growth in our pays per control in the quarter, partially offset by lower SUI collections and the closure of our Netherlands money movement operation earlier this year. Our Employer Services same-store pays per control metric in the U.S. was 1.9% for the third quarter and I’ll talk a bit more about the trends we’re seeing in a moment. Employer Services margins increased 100 basis points in the quarter, ahead of expectations and driven by many of the same factors I mentioned earlier when discussing our consolidated results.Our PEO segment revenues grew 11% for the quarter to $1.2 billion, and average worksite employees grew 7% to $595,000 ahead of our expectations and driven by strong year-to-date new business bookings. We were pleased with this re-acceleration in our Worksite Employee growth in the third quarter and believe we would have been positioned for further acceleration exiting the year if not for COVID-19. Revenues excluding zero margin benefits pass-through grew 9% to $490 million and continue to include pressure from lower workers' compensation and SUI costs and related pricing. PEO margin expanded 10 basis points in the quarter in-line with our expectations.Let me now turn to our outlook for the remainder of the year. I'll start by discussing some of the specific macro driven factors that affect our financial performance. I'll caveat by saying that we're clearly operating in an evolving and uncertain situation and we're using data currently available to us to make reasonable assumptions on which we are basing our guidance.First out-of-business losses, we expect our retention to be impacted by elevated out-of-business losses in Q4 and although the federal government is providing stimulus to help companies continue operating, we're seeing clear strain on our client base and have observed certain leading indicators; such as companies going inactive and no running payroll, many of whom will restart their operations at some point, but some of whom we expect will not. Based on our experience with these leading indicators, we are building in an expectation for additional losses in our fourth quarter outlook and as a result we're lowering our full-year retention guidance to be down 30 basis points to 50 basis points despite running ahead of our expectations on a year-to-date basis.Next, pays per control. We exited March with negative pays per control growth and in April it deteriorated to a double-digit decline. We were assuming a 2% to 2.5% pays per control decline for the full year, which implies a mid-teens decline for Q4. As a reminder of how this affects us, we have varied contracts throughout our businesses that blend base fees and per employee fees and we also often utilize shared pricing and have certain annual revenues that are not as affected. As a result with our current mix of business, the direct revenue impact we expect to see is about 25 basis points in ES revenue growth for every 1% change in PPC. Some of our businesses are more sensitive to pays per control than others and so the precise neck that pays per control by business can drive the actual revenue impact higher or lower in any given period. This direct impact also doesn't include the impact from our volume based businesses like recruiting or payment cards.Finally, on client funds balances, through the combination of a challenging sales environment and anticipated increase in out of business losses, a decline in pays per control and potential decline in wages and hours worked we expect to see pressure in our balances in the near-term. Furthermore, the CARES Act has a provision that allows companies to defer the payment of the employer portion of payroll taxes, which represents less than 5% of our average client funds balance. But depending on the actual take rate of that provision, we could see further pressure on our balance growth. As a result of all these factors, we now expect 1% balance growth for the full year, which implies a low double-digit decline in the fourth quarter. To adjust the size of our client's fund investments to match expected changes in average client payroll and tax volumes.Beginning in March, we halted all new reinvestment of maturity in our client long and extended portfolios. And in April we took the additional step of selling approximately $1.2 billion of previously purchased securities in the client long and extended portfolios. This decision to suspend new purchases means our Q4 interest income forecast reflects a slightly greater skew to overnight rates than previously forecasted. Both the suspension of new purchases and the completed sale of securities is contemplated in our guidance. To be clear, these decisions represent tactical adjustments and do not represent a change to our overall client funds strategy.Let's now turn to our revised outlook for the full year and start with the ES segments. We are lowering our guidance to 1% to 2% revenue growth versus our prior outlook of 4%, driven mainly by an expectation of lower paid per control, new business booking, client fund interest and retention versus our prior outlook. Much of this lost revenue comes at high incremental margins and as a result and also due to additional costs related to COVID-19 we now expect our margin in the employer services segment to be down 25 to up 25 basis points.For our PEO, we saw good momentum up through the end of March and as I mentioned earlier, we believe we were on track for continued acceleration exiting the year, but are now layering in our expectation for layoffs and furloughs and additional out of business losses. As a reminder in our PEO segment, we earn revenues as a percent of the gross payroll we process and as a result we are more directly tied to changes in our client's head count and hours worked as compared to our employer services segment. As a result of these assumptions and our expectations for lower Q4 PEO sales, we are lowering our average work site employee growth expectations to 3% to 5% from 7% to 8% previously. We are likewise lowering our revenue guidance and now expect 5% to 7% PEO revenue growth in fiscal 2020 and 3% to 5% growth in PEO revenues excluding zero margin benefits pass-through.As we also discussed throughout the year, we continue to expect lower workers' compensation and SUI costs and related pricing to pressure our total PEO revenue growth. Though we could see those trends change in the coming years. For PEO margin, we now expect to be down 100 basis points to 125 basis points in fiscal 2020. As we noted in previous calls, this outlook continues include pressure from smaller favorable reserve adjustment that ADP Indemnity in fiscal 2020 compared to fiscal 2019, but we now expect about 75 basis points of pressure compared to our previous expectation of 50 basis points of pressure. So we still expect a slight benefit this year.With these changes to the segment, we now anticipate total revenue growth of about 3% in fiscal 2020 as compared to our previous outlook of 6%. This revenue outlook continues to assume slight FX unfavorability for fiscal 2020. As I mentioned, we anticipate our growth in average client funds balances to be about 1% compared to our previous outlook of 4% and we expect the average yield earn on our client funds investments to be about 2.1% compared to our previous outlook of 2.2%. We expect interest income on client funds to be $540 million to $550 million and for interest income from our extended investment strategy to be $550 million to $560 million.We anticipate our adjusted EBIT margin to be down 25 to up 25 basis points, as the benefits from our workforce optimization and procurement transformation initiatives are now being offset by the impact of expected loss of revenue due to COVID-19 as well as incremental expenses related to COVID-19 including the [$50] [ph million in global associate assistance payments.We now anticipate our adjusted effective tax rate to be 22.9%. The rate includes this quarters unplanned tax benefit from stock based compensation related to stock option exercises. It does not include any further estimated tax benefits related to potential future stock option exercises. As a result of our lower revenue and margin outlook, we now expect adjusted diluted earnings per share to grow 4% to 7% in fiscal 2020. In light of this revised 2020 guidance and multiple headwinds created by the global pandemic and the uncertain and evolving situation we are withdrawing the fiscal 2021 targets that we set out at our 2018 Investor Day as they are no longer appropriate to the current circumstances. However, we continue to believe in our long-term strategy and well positioned to continue to invest to execute this strategy.Finally, before I conclude, I'd like to talk about the strength of ADP’s business model and balance sheet. We have a highly cash generative business with low capital and the HCM Solutions we provide give critical support to our clients, HR and management functions, especially at times like these. In addition to having a resilient product and business model we also have a significant buffer between our free cash flow and our modest debt obligations and our cash to spend, this enables us to absorb the impact of downturns and continue to prioritize investments aligned with our longer term strategy as well as our commitments to shareholder friendly actions.So although our revenue growth can clearly be impacted by challenging macro conditions, our recurring revenue model and high retention rate positions us to continue the type of investments we highlighted at our innovation day even when times are tough. We will meanwhile continue to manage our cost base prudently. We have instituted hiring containment and started to execute on our recession playbook with a preplanned set of areas where we will see some of our expenses self-adjust, such as management and sales incentives and we will eliminate or defer non-essential staff. We're working through an evolving and uncertain situation and are formulating our approach for next year and we will of course provide you with our expectations and outlook for fiscal 2021 when we report our fourth quarter results. As always, expect us to be balanced in our approach.With that, I will pass it back to Carlos for some comments before we go to Q&A."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thanks, Kathleen. Before we move on to the Q&A, I just wanted to share with you an excerpt of one of the many notes we received from our clients that that captures how we want to define ourselves. This one said, we are a small business that has used ADP for quite a few years now, every time we call there has been a knowledgeable professional at ADP that immediately solves the problem and answers the question.We recently needed payroll data to apply for the COVID-19 payroll protection program. I immediately went to ADPs website to see how I should go about selecting and downloading the required payroll data. Imagine the relief when opening the screen there was a COVID-19 pop-up that proactively provided your clients with the payroll data needed, I was floored. This type of customer service is unheard of these days. We just want to tip our hats to everyone ADP for a great job. As this client suggests, the value of a true HCM partner becomes even more critical at times like these. And it continues to be our goal to exceed the expectations of our clients.And with that I'll turn it over to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We'll take our first question from the line of Ramsey El-Assal with Barclays. Please go ahead."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thanks so much for taking my question. I hope you both are doing well. I wanted to ask about your visibility on the paycheck protection loan program in terms of, can you see that it's having the desired impact on businesses in the country? Are you seeing [indiscernible] terminated workers that are being brought back on book? And I guess just tying that back to your own performance or potential future performance, are you seeing the leading indicators of bankruptcy sort of staved-off a little bit in your book?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Great question, we're obviously keeping our eye on that. Unfortunately what we have is really kind of limited anecdotal evidence that people are beginning to get money to be able to continue their payroll, they continue to pay people. As an example, a few days ago I was forwarded a letter that was sent to – an email that was sent to one of our associates from a client that was grateful for kind of the help that we gave them in applying for the loan and they sent a kind of a screenshot of their bank account that had $10 the previous day and then now had $84,000, like indicating that they have gotten their money from the SBA deposited into their commercial bank account. But I think as you've heard same as us in the press, the process has been given the magnitude of the scale of the challenge it's been a difficult process both for the SBA and I think for the banks, we've tried to do our part to help and we're optimistic and we're hopeful that it will make a difference and that there will be rehiring and that it will at least in some respects stop the furloughing and the elimination of jobs going forward. But unfortunately it's just a little too early for us to give you any kind of concrete evidence other than some anecdotal stories that money is making its way into the bank accounts of small businesses."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. Yes, that's helpful. Thank you. And then just a follow-up. In terms of your overall product strategy in the context of this crisis, are there any kind of adjustments you're having to make in terms of how you're thinking of new challenge, employees work from home, [indiscernible] time and attendance offering and also just on some of your major initiatives like Lifion? How’s the timeline, the market being impacted, how are you thinking about the product set sort of evolving from here on out?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I mean, clearly we have to be nimble, and I think remain open to making further adjustments, but I think it's safe to say that if you go back over the course of decades, the concept of “outsourcing” and now what some people would call the SaaS models, which I think ADP was kind of one of the pioneers of, I think by definition, lend themselves to these kinds of remote work environments, whether it's for the technology people, because we generally obviously host and maintain and update the – all of the systems for our clients. But also through the variety of portals we have for our clients and the employees of our clients. All of the information that anyone needs is available online through all the tools we have to access that information, whether it's for the payroll practitioners or for the employees of our clients. Including, when you think about the app that we have for the employees of our clients to be able to check whether they've gotten paid, they can check their hours; they can make changes to 401(k). There's no really no need to move paper or for anyone to be in the office to do that kind of work. So clearly there will be things that we will learn and we'll probably hear in the early innings of this kind of new talent and how it might affect our products. But I think in general as an industry, it's not just for ADP, I think in general for us as an industry we're pretty well positioned I think for this kind of work environment."
},
{
"speaker": "Kathleen Winters",
"text": "And I think if I could just, yes, if I could just add to that. I think you had asked about, I couldn't quite hear, but I think you had asked about Lifion and any updates to that and changes to our view on go-to-market. I would say over the longer term, while certainly this year looks like things have slowed down at least for a little bit, I'd say over the long-term, no change to how we're thinking about that. And we're got a handful of live clients. We're continuing to sell clients on and implement clients on Lifion, and we're encouraged about the long-term prospects there."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. It's clear, like every time that we have, whether it's an economic downturn or now this is obviously a new challenge, there's always questions about, will this drive greater adoption? I think intellectually it makes sense that this would drive greater outsourcing and greater adoption of a SaaS, but it's kind of hard to make that statement kind of where we are today, but theoretically and intellectually two or three years from now, there should be more demand and more people using SaaS solutions than there are today."
},
{
"speaker": "Ramsey El-Assal",
"text": "That makes a lot of sense. Thanks so much for taking my questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line Tien-Tsin Huang with JP Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hi, thanks so much. Appreciate the extent of disclosure here. Just on the – some of the follow-up to Ramsey's question, just on the sales performance side, you mentioned productivity challenges in addition to the demand factors. What would you think you'll get your productivity back on track and align your sales to where you see the puck going next in terms of demand as it evolved?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So we're trying to actually keep an eye on it week-to-week to get some sense of what levers there are still there. We clearly still have, our sales force is still selling and they're selling a lot of business, but at lower level than obviously we had expected and in lower levels and you compare it to the previous year. So unfortunately given the nature of the situation, it's kind of difficult to give you a kind of scientific or concrete answer. I think as we generate more information, I think probably for our guidance for next fiscal year, we'll be able to – I know that's not helpful to you today, but it's really a very difficult thing to talk about.We have a lot of, our salesforce was already what we call an inside salesforce and so we've proven that we can sell through insight selling, but we have some products that are what I would call high involvement decision sales. And it doesn't mean that those can't be done remotely. But it hasn't been the norm. So when you sell a very large complicated multinational solution, or frankly, even when you sell the PEO, historically there's been a relationship that's built there and a trust that gets built before that transaction gets consummated.So it clearly, this is – these are new and different times. So I don't think everyone is going to sit and wait around for everything to go back to normal before making decisions. But I think it's safe to assume, I think common sense would tell us that it's safe to assume that, there will be some level of hesitation and pull back in terms of decision making. Even though a good percentage of our salesforce is still outselling as they have before, although they're doing it virtually now."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. Sure. So we'll check in with you on that again next quarter. So then my quick follow-up, both of you have talked about cost initiatives. You guys did much better than we thought on the margin side even with the [$50] [ph] million. But you've also both hinted at a pipeline of more cost take out, potentially pre the pandemic. So I'm curious, your willingness to pull incremental expense leavers maybe some chunkier stuff, is that available to you and are you willing to do that at this stage?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So we did have a number of transformation initiatives underway. A lot of them were really around digital transformation efforts to kind of automate and improve the way our implementation or our services is delivered, which would create a better experience for our clients, the employees of our clients, frankly also for our associates that we thought would result in lower costs going forward. Yes, part of the challenge we have is as and again, every company may be different in terms of how they approach their level of support for their clients, but based on our model and the way we see ourselves playing a role, and frankly in society and with our clients, we've actually experienced quite an increase in volume and cost in the short-term.And so as an example, as the government rolled out the payroll protection program, we saw 40% to 50% spikes in inquiries right through whether it's phone or chat or by or by email. And so we had to work people overtime. We had to work people on weekends, which we're very grateful that people were willing to do, because you can imagine they've got lots of other concerns and distractions as this is all going on. And so we made a commitment that we're going to deliver to our clients through this and help them work through it, whether it's for themselves or for their employees. And unfortunately, I would say in the short-term, we actually have an increase in cost.Now, realistically that's not going to continue indefinitely. But every week that we said we think our call volumes and our workloads are going to go down, there's a new government program or a change in the government program, which by the way we think is great. I think that the efforts by the Fed and by policy makers, I think to help clients and their employees, I think is the right thing to do and we're very supportive. But as an example, there was just, as you know, there was an approval of an additional amount for the payroll protection program, which generates additional volume for us. By the way, I think the banks are in the same – probably in the same situation in terms of how having to handle kind of increase the volumes. And so we expect these levels to normalize and then to be in a position where we can reevaluate our cost structure, but again, given the timing of this call and where we are today, we really can't tell you that there has been a meaningful decline in our workloads. In fact, it's actually been an increase."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Got it. I appreciate the work behind..."
},
{
"speaker": "Kathleen Winters",
"text": "So, Tien-Tsin if I could just – let me just add a little bit more to that because I made some comments on our transformation efforts and transformation work even with the significant increase in service demand. So, even with this kind of very abrupt disruption and need to move our entire – practically our entire workforce to work from home. We will able to do that almost seamlessly. I mean, that worked really well through the huge, huge efforts of many of the different parts of the organization, from our technology groups to our HR to legal. I mean, it was a huge effort, but it worked well and so that we've been able to continue our normal processes, if you will around transformation work. There were certainly some projects that we have to look at and assess and say, okay, because of the big service demands we may need to slow down these.But our process in terms of tracking progress, continuing to execute, adjusting as necessary based on service demands and importantly continuing to look at pipeline of projects, that continue and I would just add one further comment that in particular in this environment, the ability to look at procurement and find procurement opportunities is potentially even greater today than it was, say three or four months ago."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think if I can just one more just comment, I think that the – the part of the challenge here is that we are – the nature of our company and our business and our Board is to not focus on one month or one quarter. And I think when you look at we're able to deliver just in this quarter in terms of margin improvement and we've been able to do in the last couple of years, I think demonstrates very clearly our ability to, I think achieve and take advantage of operating leverage and also to manage our cost very effectively.We've had a couple of years with a very modest, if any cost – true cost increases while revenues were growing at what for us is our very healthy rates. So I think we've demonstrated what we can, what we can do, but unfortunately we've been handed a very abrupt change here in the environment and we're going to handle it first to take care of our associates, next take care of our clients. And I think when we get through this transitory period, which we all know is transitory, now we don't know is a transitory for a month or two or is it transitory for six months. But either way it's not multiple years and we want to make sure that we continue to invest in our business, take care of our people and take care of our clients that when we come out of this, we come out of it as strong as we were before we went into it."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. Very clear. It’s just the case. Thank you."
},
{
"speaker": "Operator",
"text": "And the next question comes from the line of Kevin McVeigh with Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thank you and thanks for the guidance and obviously the tough environment. Any thoughts on, one question we get a lot is how much of the layoffs are going to be furlough versus structural? So just any sense within kind of the pace for control, how much of that would be potentially furloughed workers versus structural? Maybe start there?"
},
{
"speaker": "Carlos Rodriguez",
"text": "It's a great, question. So we have, as you know we operate in multiple countries and offer multiple segments; small business, midsize national accounts, but also in many countries and also multinational companies. And the policies that companies have around how they treat employees is going to vary from company-to-company and generally also varies from segment-to-segment. But what we can tell you is that, the way we count pays per control is very straightforward. It's whether or not someone got paid during that period of time that we're counting. And so we would not probably be able to give you a firm number of how many people are furloughed versus how many people are laid-off because we don't control necessarily that coding in the system. And clients can exercise some discretion about how they, I guess tagged some of their employees.But what we do know is that if somebody doesn't get paid, they don't get counted in pays for control. And if they do get paid, even if it's at a reduced wage, that does count and so that creates a number of challenges obviously. Because you could have reduced wage levels, which then doesn't negatively impact pays per control, but impacts the employees themselves. And may in some cases, impact our fees generally wouldn't other than in the PEO, but could impact our fees as well.So I would say that the best thing to do is to stick to – trying to use the pays per control metric as a way of building your models and using the guidance that we provided around 25 basis points of revenue growth, impact from each 1% change in pays per control. I think that gives you a very – we spent a lot of time pressure testing that assumption. I think Danny did a lot of work on it and I think that's a pretty solid way for you to look at things. So when you hear guidance from us about pays per control and you use that metric for your model, I think that's a much cleaner and easier way than to try to separate how many are furloughs versus how many are layoffs, et cetera, et cetera."
},
{
"speaker": "Kevin McVeigh",
"text": "That's super helpful. And then I guess just a quick follow-up would be kind of coming out of this, obviously, in these type of events; you're really turn to in terms of the cavalry of the organization. Do you see any change competitively, particularly as obviously coming out of the last cycle much more service oriented as opposed to shift to the cloud in this one, but from a competitive perspective, any changes where you look to even build on that attrition number, longer term in terms of improvement?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think you do see some subtle differences in terms of company cultures and I think behavior. So as an example, one of the things that we have always, I think, trying to talk about is this willingness by us to really help our clients navigate through things, not just provide them the software solution. We actually took some responsibility for the outcomes of what they're trying to accomplish. And so the support we're providing around all these regulatory, I think is an example of that. That doesn't mean that other competitors aren't doing similar things.But as an example, some competitors would be more along the lines of providing tools online and directing clients to third parties or directing them to resources where they could get help versus in our case, we actually take the work on and we help our clients get to where they need to get in order to get their retention credit, tax credit, in order to get their payroll protection loan, in order to calculate in a few weeks or at least in a couple of months people are going to be needing help with calculating how to get forgiveness on those loans. I mean, there – this is a complicated environment by the way employment in general is always complicated. But this is a very complicated environment and having great tools and technology is incredibly important and we're totally committed to that. But I think it's undeniable that you also need extra help in these situations to help with questions and to help you navigate through the all the various regulatory hurdles.As an example, some of the legislation that was passed in the U.S., you have to really understand the interplay like, as an example, you can't take advantage of the deferral social security taxes and the payroll protection loans, but if you – you can take advantage of the social security deferrals up until you can get a loan, but then once it's forgiven, you can no longer defer your social security taxes. I mean those are things that are typically not well understood by our client base and I think just directing them to a website or to a tool, we don't think is really the – is the best way to help them."
},
{
"speaker": "Kevin McVeigh",
"text": "That's awesome. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. Hope your families are all well. I wanted to try on outlook here. Just understanding the material uncertainty, can you help us frame some initial fiscal 2021 guide posts in trying to think how we should be thinking about next year based on some of the implied 4Q run rates? So, any sense of visibility you have across the businesses or maybe thinking across client size would be helpful. Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "First of all, thanks for asking about our families. I hope yours is well also. Unfortunately, I mean it's a very fair question and I can understand why you're looking for any additional color. It's – as you can imagine, we struggled with even providing kind of fourth quarter metrics, because, two, three, four weeks ago, we had – or people had a certain view of how long “the issue is going to continue” and when things were going to open up again. And then it got more negative and now it feels like it's gotten more positive. So I think that it's very difficult for us to go really beyond the fourth quarter in this environment.We have to remain optimistic that things are going to “improve” but I think that we all have to take advantage of the time we have to wait and see how things play out, whether it's with the clients or with GDP or with the economy, or with these government programs, so that we can make more informed, I think, decisions about what 2021, I think, might look like. So I apologize for not being able to give you any additional color. But I think it would be a mistake to assume that the levels of activity that we've given you in the fourth quarter will continue into 2021, but it's also a mistake to assume that things are going to go back to normal at the beginning of 2021. And so we're going to keep an eye on the data and the information and do our best as we gather more information to give you a good view of what's going to happen in 2021 when we get there."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, maybe I could just add a few comments around the process and what we're doing in the data that we're looking at. Hence, while as Carlos said, we can't really give you the view right now or the exact guidepost, at least if you'll understand and know the process we're going that might help a little bit. So, look, things are, as Carlos said, it's extremely fluid right now. We're spending a lot of time studying and watching developments every single day and kind of looking at, I think about it in three steps if you will, in terms of first understanding what's happening from a pandemic standpoint and the epidemiology. Then understanding how that impacts the economy broadly around the world and then understanding how that impacts each of the business. So as we do that, obviously we're looking at numerous forecasts that I'm sure you all are looking at the same forecast that are being put out.But we're really spending a lot of time in parsing through those and kind of eliminating outliers and really utilizing the ones that we feel makes the most sense, and then applying that to you know, as I said, the implications for our business units and when you do that, as we've said largely PPC is going to be extremely significant driver for us. And then certainly the shape of the recovery from a new business booking standpoint will be critically important, so we're watching that as well as we see different regions and states kind of formulating and attempting the return to work."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. I appreciate that. Wanted on retention, the comments on the assumptions in 4Q, is the reduction wholly due to business closures. I'm curious if you're seeing any change in the competitive client loss."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I think based on the comments we gave you about the third quarter and the year-to-date, I think we're doing pretty well competitively, because I think our retention was up. I mean we don't talk about quarterly retention, but why not like everything's out the window in this kind of environment. But I think we were over 50 basis points improvement in the third quarter and through the year-to-date. I think we were well ahead of both the guidance, we had provided in our own internal expectations. So it's pretty clear that we were doing something right competitively.Our NPS scores are at record levels across most of our businesses. So again, the problem is this is not the time to brag and talk about the third quarter, but we really had incredible momentum coming into the third quarter on a number of fronts, but that's that and we're onto now figuring out how to deal with the future challenges, but I have no concerns about the solidity of our business on every front coming into the third quarter."
},
{
"speaker": "Bryan Bergin",
"text": "Thank you. Be well."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Hi, good morning, Carlos. I was wondering, based on the data you're seeing and I realize this is so early in, but what kind of changes do you anticipate for the business, permanent changes or at least over the next 12 months to 18 months because of this current crisis?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, over the next 12 months to 18 months is probably the right focus, because I mean, I think it'd be naive to think there aren't some things are going to change permanently, but I'm not sure I have that, that kind of crystal ball to be precise about that. But for the next 12 months to 18 months, because of the focus we have on our associates, it's unlikely that we will be going back to business as usual here in the next few months.Now the good news is we've adapted to the current work environment. So, but – I kind of concrete change in terms of the next 12 months, 18 months is we don't anticipate having a 100% of our workforce back working in these one locations and some of these other places where we have large populations of associates. And so that's a change that we have to make sure that we stay on top of, that we support our people and lead them remotely and virtually and help them kind of navigate through what's a very different way of working.Now obviously we plan on, as society kind of normalizes, we plan on coming along for the ride with us. So we do a lot of formulating plans as we speak, very preliminary plans around how do we slowly get back into some of our offices with limited number of personnel, but that's a change that we're definitely going to have to continue to live with for the next 12 months to 18 months. Now, what that means is that impacts our salesforce and so the question is, if the demand equation improves significantly and our salesforce is still working remotely, how can we make sure that they have the right tools and the right processes to continue to take advantage of the demand that's out there.Because we don't anticipate having large numbers of salespeople back in our offices, our salespeople, by definition, many of them are inside sales, but many of them are out in face-to-face transactions. And that's not something that's going to normalize in the next 12 months to 18 months. Sadly, I'm sad to report that of the number of associates that we had impacted by COVID-19, we were disproportionately impacted in our salesforce. So as we go back to normalization, we're going to be exceptionally careful about protecting our salesforce as well."
},
{
"speaker": "Kartik Mehta",
"text": "And then just finally, Carlos, what do you think the recovery will look like, we've heard so much a V, a U, a L, I'm just interested in your perspective of what you're anticipating from a recovery?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well I think the – again, we're looking at, we get information from all of the usual places like Morgan Stanley is obviously our banks, so they've been very helpful in getting us their information, but we have access to information from a number of other sources. I don't want to say any of the names, so I don't hurt anybody's feelings, but all the usual banks we get the information from them. We have information from Moody's, by the way we also work with the fed. We work with treasury. We have a lot of sources of information to give us some sense of kind of where things are headed.The challenges that I don't think anyone has really well – I don't think, I know that no one has ever been through this. So there really aren't any great models other than using inputs like PMIs or consumer confidence and other metrics that tend to be many of the metrics that people use in these models are lagging indicators.And you have regression that gives you some sense of where the economy is headed. But, as I’ve seen myself in the last four to five weeks, you have to take any forecasts with a large grain of salt. So the best approach we think you can have right now is to remain flexible and agile about how you're planning and what you're planning for. If I were – if we had to make a bet today, we would say that, it's not going to be a V-shaped recovery and it's probably not going to be a U or an L, but it's going to be some other kind of shape where we obviously already had the precipitous decline. We’ve already seen some signs of some stabilization. So we have metrics that we track like in our HR systems of our clients.For example, new job postings or number of screenings that are done, like background checks and some of those metrics have actually begun to stabilize. So I think we've had the abrupt drop. Now the question is the recovery, it feels like that recovery will be not a V, but not an L. And so the difference between V and L is a check Mark. Like I think some people are out there quoting, by the way we have an economist on our board and he referred to as a Nike Swoosh, but that's probably a copyright or trademark violation. So I won't use the Nike Swoosh, but you get the idea of rough drop and hopefully a climb back up over some period of time. Hopefully that client is over the course of three to six months and not over the course of 12 months to 18 months."
},
{
"speaker": "Kartik Mehta",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of David Grossman with Stifel. Your line is open."
},
{
"speaker": "David Grossman",
"text": "Alright, thank you. Good morning. Carlos, I think you've addressed this in a couple of previous questions, but based on how this may play out coming out of the crisis and you talked just a moment ago about some possible structural changes at least in the intermediate term being work from home or virtual sales. How do you feel the way you're positioned, coming out of that versus where you were going into it and how do you view your ability to leverage that to your advantage? Is it structural or is it based on execution, I'm sure it's a combination of both, but if you could just give us a little more insight into how you're feeling about, what you can do with this crisis to really enhance your position both competitively and operationally."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, look I think that some of this is philosophical. I think that I like everyone else when we were entering this space I was scared like everyone else's, not just personally for myself and my family, but also for the company and all of our associates and our clients that depend on us.And when you see the reaction and the ability of the organization to kind of get through it and not just get through it, but actually deliver a higher level of service and help with very complicated questions in a very complicated situation, which was changing in some cases on a daily basis with the regulatory landscape. I think it tells you something about the strength of the culture and of the company. And so that gives me, again, this is all intellectual philosophical, but I think it gives me great hope about how we emerge from this competitively.We already had incredibly strong momentum going in to the third quarter, as you saw from retention we think we have a strong product lineup that was beginning to get traction. One of the things we didn't talk about when someone asked the question about our competitive situation, like we had really good growth in client counts, particularly in Workforce Now and specifically in our mid-market business. So the combination of positive momentum and coming into this and then the reaction and the strength of the organization through this gives me great optimism and hope that we're going to come out of this stronger than any of our competitors."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. Let me just add to that – Yes, I would just add to that, in addition to the great service that we've been able to provide to our clients throughout this, which theoretically ideally should sustain or drive even better retention going-forward. I would say the strength of our balance sheet and the ability to continue to invest aligned with what we laid out at our Innovation Day for investing in our strategic products and Workforce Now and RUN and our next gen product, our ability to continue to do that throughout this should position us well."
},
{
"speaker": "David Grossman",
"text": "Okay. That's it for me. Thanks very much. And be well."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steven Wald with Morgan Stanley, your line is open."
},
{
"speaker": "Steven Wald",
"text": "Yes. Good morning. I hope you guys are safe and well, and thanks for the shout out from Morgan Stanley, a little bit around that subject. Maybe just starting off on some of the puts and takes of the segments, that you guys pointed to work site employee growth, still NPO versus lower pays per control and Employer Services just maybe run us through again because it's come up a lot in recent conversations around why the PEO should still be thought of as a employment-wise a little bit more defensive and how you guys see that tracking this downturn versus prior ones."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think the number one reason is really just structural in the sense that when you look at overall ADP, we have clients all the way from a single employee all the way to very large national accounts. And so as we've said – we said this obviously over multiple decades, our down market business tends to be the most sensitive to other business but also to decreases in pays per control. And so as we track this pays per control data, I think we've probably given you some of the color that the pays per control numbers are down more in the down market than they are in the mid and the up market.The PEO, at least in our case, the PEO tends to – the average sized client, just from a practical standpoint is 45 and we tend to – we try to stay away from clients that are under 10 employees. We have some clients obviously that are between five and 10 employees, but in general, the sweet spot of the PEO is kind of around 45, that's the average. And so it's just the nature of the structural difference of that business versus the others that the pays per control is not going to decline as much as the overall average, if you will, where you have some of that average being in the small business and in the small business market.And then the second more anecdotal comment would be the PEO clients. Our PEO clients, not every PEO clients, our PEO clients tend to provide health benefits or retirement plan, they tend to be kind of higher average wages in the average U.S. worker. And that makes sense because you're paying for the help that you get with maximizing and managing that Salesforce. So it tends to be attractive to a higher average wage employer that is very concerned with attracting the right people and retaining the right people. So that also tends to lead you in the direction of clients that are a little bit larger, maybe a little bit more financially capable of paying those fees, et cetera. So that – but that not – not sure that we can have a scientific way of proving that one, but for sure the average size client of a PEO, our PEO is larger than in our SBS business and hence the pays per control drop would logically be smaller."
},
{
"speaker": "Steven Wald",
"text": "Got it. That's very helpful color. In terms of just a quick follow-up on capital management dividend, I know, both of you have mentioned the strength of the balance sheet, continued ongoing investment and cost cutting. But in terms of how we should think about things like the dividend and the safety there or your willingness to raise that, given the current environment or buybacks and other forms of acquisition that lower valuations, how are you guys thinking about that from a financial but also a strategic and sort of, I guess sensitivity to the times type of perspective."
},
{
"speaker": "Carlos Rodriguez",
"text": "Okay. So I'm glad you asked that question, as I happened to talk to our Chairman yesterday, before this call because I figured somebody might ask that question. It's a tricky question because as you know, it's up to the board to decide on our dividend, but I can tell you this, that we had a board meeting on April 8, and the board approved an increase and a payment of our dividend. And they wouldn't have done that if they had concerns in the short or medium-term about our capital position or about our dividends.So again, without speaking for the board, I think we have a very long 45 year track record of paying and increasing our dividend. We have a strong balance sheet. We are a capital light business with strong cash generation. Our payout ratio is 55% to 60%, which I think gives us some room to be able to continue even with increases without running into any major capital constraints or restrictions on our investing. So I would feel optimistic that our board would be supportive of continuing the long track record. ADP has of 45 years as it stands. And I'll let Kathleen maybe make a comment or two about that as well."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, thank you. You covered it really well for us, I would just say in support of enabling the board to make dividend decisions, we in a normal basis do ongoing analysis and stress testing and have been continuing to do that through this environment. So we've been doing, looking really closely at that stress testing. So, I really don't have anything to add beyond what Carlos commented."
},
{
"speaker": "Steven Wald",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "We have time for one more question. And that's from the line of Lisa Ellis from MoffettNathanson your line is open."
},
{
"speaker": "Lisa Ellis",
"text": "Thank you. Thank you for squeezing me in and great to hear everybody's voices. Glad to hear you're well. Just a little bit of a follow-up on the PEO question. I mean, as you just highlighted the work site employees in PEO are a bit more resilient, because of the larger size of company, but the revenue guidance there is down more significantly in Q4, maybe like a tactical question just around what drives that in the short-term, but maybe a broader question, Carlos, for you coming from originally the PEO business, how should we think about how the PEO will act through a recession period? Do you expect increased demand for the PEO or some clients dropping out of the PEO? How do you think about that dynamic? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Great question, I'll let Danny pull up the calculator too, because I'm sure you're right about the dropping greater, there’s no intention, there's no signaling or anything intended there, maybe rounding or the math or something. But there's no magic formula there that we're trying to send some kind of message. I mean, we think the PEO business is solid and strong and I think tends to whether recession is better. Again, every time you have a recession, it's a different kind of recession. So we had a financial crisis last time, this time it's a health crisis. So I'm always cautious of making kind of bold definitive statements. But historically we've always worried about the PEO going into a recession or into a crisis being challenged, because it does tend to be a kind of a more expensive, if you will – solution, if you will, but it also provides an enrollment with higher amount of value, and during these types of situations, like for example, our PEO handles the questions not just of our clients, but of the employees of our clients.That's not what we generally do for our typical payroll. That helps our clients a lot and we leave them of a big burden and provide those employees a lot of confidences, a lot of real positives and good reasons why people want to stay on a PEO or why they want to be on a PEO even in a recessionary environment. So I would say that, in the prior recessions, the PEO was not immune, just like it's not this time from pays per control decreases and from some short-term disruptions with new bookings. But we've been impressed, I've been through now, I guess this is my third recession at ADP and at least the prior to the PEO performed on a relative basis as well, if not better than the rest of our business. And we would expect no different on a go forward basis."
},
{
"speaker": "Danyal Hussain",
"text": "And Lisa, this is Danny just to add, because it's fairly in the weeds, which I love of course, but in addition to the impact from work site employees in the PEO we charge as a percent of payroll and so wages themselves, to the extent we have some workers working fewer hours within the PEO base that can have an impact and then even further in the weeds is, you can have a slight mix impact with respect to workers' comp. To the extent that certain industries have greater impact from pays per control and those had higher workers comp rate. So these are very subtle impacts, but together they’re kind of informed that guidance."
},
{
"speaker": "Lisa Ellis",
"text": "Wonderful. Thank you. And then maybe my last one and Carlos, could you one to end on, as you're watching and maybe help us a little bit, what are the top, like literally one or two things that you are watching that you think are really going to impact as you're looking at your client base, the shape of the swoosh or the check mark are over these next couple of months?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think the first one that we're keeping our eye on is really these leading indicators, if you will. So this would be job postings and background checks. And so that I think is – those are I think the job postings is obvious in the sense that people aren't really going to post new positions if they think that things are not going to at some point improve. So to me, that's a sign that people are doing the same thing we're doing, which is we're conservative and we're cautious, but we have to be prepared for every eventuality in including the optimistic one.And so this increase in postings, job postings to me means that people are starting to think of, well, if in two, three, four weeks this state or this industry has some kind of opening, I need to make sure that I have the people available to handle that work, because these are business owners that obviously have to run their businesses.And then secondly, when they actually do that, then they actually have to put that person through the new hiring process which is the screening and selection. And so we're going to keep an eye on those two figures. Then closely behind that, I think is a – we have a very large workforce management business or some people would call time and attendance. And so that is also data that is very helpful in terms of seeing number of hours worked. It doesn’t always help you a lot with an exempt workforce, but for people who are paid hourly, it's a very good indicator that kind of cuts through the noise of furloughs and layoffs and so forth and so on, just kind of gives you some sense of “hours worked and whether that is increasing or not increasing” so that should show an upturn before we see upturns in other things, because people will take the existing people they have now and just have them work longer hours rather than adding additional people. So the addition of people will probably be the final I think sign of a of recovery, but we have a number of other indicators that we can look at that gives us an earlier view of where we're headed."
},
{
"speaker": "Lisa Ellis",
"text": "Wonderful, thanks guys."
},
{
"speaker": "Operator",
"text": "That concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "So it's hard to kind of find the words to close the call out and describe the situation that we're in. But trying to end on an optimistic note here, I've been now with ADP 20 years. And I've been through, I just mentioned two recessions, this is my third, been through Y2K, which most of the people on the call don't even remember. Danny, certainly doesn't remember Y2K, he was too young, through 9/11, we'd been through wars, we've been through multiple changes in technology, nobody was even talking about SaaS when I joined ADP. And every time we had a challenge it looked like that was a challenge that we couldn't overcome.But every time ADP overcame that challenge and it's no different, I think for the rest of – in this case, humanity because this is affecting not just the U.S. but it's affecting the entire world. People in ADP find a way to evolve and to adapt. So I have to be optimistic, we have a propensity to overcome. If not, we wouldn't be here talking to you today, whether it's us as human beings or us as a company. By the way, as I've said multiple times in other calls, we're 70 years old and I think as a company, and I think that tells you something, we're a part of a very long history of overcoming challenges and this one is going to be no different.And I'll leave you with something that I shared with our associates at the beginning of the crisis, which is something that our Founder, Henry Taub, I think established as a culture for the company that I think is appropriate. And he always told us and he told me because I knew him personally, he told me always take care of your associates and they will take care of your clients and everything else will take care of itself.So I really appreciate the support of all of you for ADP. Thank you for calling in and asking your questions and my best wishes to all of you for health and safety for you and your families. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 2 | 2,020 | 2020-01-29 09:33:00 | Operator: Good morning. My name is Crystal, and I’ll be your conference operator today. At this time, I would like to welcome everyone to ADP’s Second Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions].I will now turn the conference over to Mr. Christian Greyenbuhl, Vice President, Investor Relations. Please go ahead.
Christian Greyenbuhl: Thank you, Crystal, and good morning, everyone. And thank you for joining ADP’s second quarter fiscal 2020 earnings call and webcast. With me today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.Earlier this morning, we released our results for the second quarter of fiscal 2020. The earnings materials are available on the SEC’s Web site and our Investor Relations Web site at investors.adp.com where you will also find the investor presentation that accompanies today’s call as well as our quarterly history of revenue and pre-tax earnings by reportable segment.During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description and the timing of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measure can be found in our earnings release.Today’s call will also contain forward-looking statements that refer to future events and, as such, involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations.Before I turn the call over to Carlos, I’d like to remind you of our upcoming Innovation Day which is scheduled for February 10. We hope to see many of you there in person and for those who are unable to attend, you can find more details about how to view the event at investors.adp.com. We’re looking forward to sharing our progress on our investments and innovation as well as our vision for our HCM technology portfolio. As always, please do not hesitate to reach out should you have any questions.And with that, let me turn the call over to Carlos.
Carlos Rodriguez: Thank you, Christian, and thank you everyone for joining our call. This morning, we reported our second quarter fiscal 2020 results with revenue of 3.7 billion for the quarter, up 5% reported and organic constant currency. We are pleased with this revenue growth, which was slightly ahead of our expectations.Our adjusted EBIT margin increased 70 basis points for the quarter and was also slightly ahead of our expectations. Together with share buybacks and a lower adjusted effective tax rate, these results helped us deliver 13% adjusted EPS growth in this quarter. Overall, we are pleased with our progress through the first half of fiscal 2020 following a difficult compare with the first half of fiscal 2019.Moving on to operations and starting with new business bookings. This quarter, we continue to see strength in our Employer Services downmarket offerings and solid progress on the sales of our Workforce Now solutions. We were also particularly pleased to see strong double-digit bookings growth in our PEO.With that said, we are disappointed with our 3% Employer Services new business bookings growth for the quarter. This lower than expected growth was mainly the result of the same trends we saw in the first quarter with our international and multinational businesses, including delayed decisions for some of our larger multinational sales opportunities.As we have said before, given their size, these opportunities can have an outsized impact on our quarterly booking metric. With this in mind, we have narrowed our full year Employer Services new business bookings outlook and now expect 6% to 7% growth as compared to our previous guidance of 6% to 8% growth on last year’s 1.6 billion of Employer Services new business bookings. We continue to have a solid pipeline of opportunities and we remain confident in our ability to execute across our portfolio.Looking at client service, we continue to see good progress with overall strength in our net promoter scores and retention. As a result, we continue to expect our forecasted full year fiscal 2020 Employer Services revenue retention to increase 10 to 20 basis points.Now we’re halfway to fiscal 2020 and at the midpoint of our three-year targets we outlined at our June 2018 Investor Day. As we are also six months away from giving our fiscal 2021 guidance and we will not be giving any updated financial outlook at our upcoming Innovation Day, I want to take a few moments here to look back and share my thoughts on our progress since we provided that guidance.Let’s start with new business bookings. You will recall that our June 2018 Investor Day, we outlined that we were targeting growth for worldwide new business bookings growth of 7% to 9% through 2021. Though we no longer regularly report a worldwide bookings figure, which as a reminder includes the results of Employer Services and PEO segments together, we thought it would helpful in that context of a midpoint look back to share that we have seen 8% average quarter growth since the beginning of fiscal 2019.We are pleased with this worldwide bookings growth together with our improvements in Employer Services revenue retention and how they demonstrate the strength and stability of our business even as we’ve been going through meaningful transformation as an organization with a set of broad-based initiatives, including our Service Alignment Initiative in fiscal years 2017 and '18, our Voluntary Early Retirement Program in fiscal 2019 and most recently our Workforce Optimization and Procurement initiatives.Meanwhile, our quarterly average consolidated revenue grew 6% reported and organic constant currency over the past 18 months. As we look at some of the developments that have affected our recent growth relative to our expectations, we note that our PEO has not performed in line with our long-term expectations driven by lower than expected pass-through revenues and lower than planned worksite employee growth.Over the past several quarters, we have discussed some of the factors impacting PEO revenue growth, including the impacts from our sales incentives, recent retention unfavorability related to healthcare inflation and softness in workers’ compensation and state unemployment insurance rates.With the impact of these factors, our average growth over the past 18 months in average worksite employees was 8% as compared to our long-term expectation of 9% to 11%. And a contribution to revenue growth from pass-throughs was 1% compared to our long-term expectation of 1% to 3%.Despite the slight underperformance relative to our expectations, we are confident in the overall prospects of the PEO business and continue to see healthy demand for our offerings. Our PEO platform is the leading fully outsourced solution in the HCM market and we combine this with best-in-class HR business partners, which together helps deliver an unparalleled service experience.Stepping back now to total revenue, we are tracking at 6% average growth through six quarters. We have a solid playbook with a proven track record of driving sustained growth and we’ll continue to focus on delivering consistent strong bookings growth and retention performance as key priorities.And moving down the P&L, during this period we further solidified the foundations of our business as our associates continue to transform the way we work while also delivering innovative solutions to our clients.These transformation efforts along with our steady top line growth and the operating leverage in our model have helped deliver robust margin expansion and an average adjusted EBIT growth of 13% through the end of the second quarter of fiscal 2020, which is within the range of our fiscal 2021 target CAGR of 12.5% to 15.5%.This together with our disciplined share buybacks and a lower adjusted effective tax rate has driven adjusted EPS growth of 18%, which is tracking ahead of our targeted growth of 14.5% to 17.5% through fiscal 2021.As you can tell from our guidance for fiscal 2020, we currently anticipate ending the year within our fiscal 2021 three-year margin target range, one year ahead of schedule. This is no small accomplishment given our ongoing efforts to invest in the business for the long-term.Overall, I’m very pleased with our progress to date. The journey that we have embarked upon to simplify how we work, drive innovation and grow our business is a challenging one. However and more importantly, it is also providing us with great opportunities to demonstrate the value of our offerings to our clients as we continue to simplify the client experience.Through these collective efforts and with the continued strength of both our R&D organization and our worldwide sales force, we are enhancing the depth and scale of our ability to serve our clients wherever they do business with best-in-class products and solutions that fit their needs.Our clients in turn are recognizing these efforts as we continue to see improvements in both our net promoter scores as well as in our Employer Services revenue retention. It is due to the success of these efforts that we remain committed to additional shareholder friendly actions such as our recent dividend increases of nearly 45% over the past two years.Our track record of annual increases in our dividend puts us in a small minority with 30 other companies in the S&P 500 that have also grown their dividend for 45 consecutive years or more. As we look forward to the future, we remain confident that our strategy is the right one as we aim to further strengthen our resilient business model in order to drive sustainable long-term value for our shareholders.Before I turn it over to Kathleen for a detailed financial review, I want you to know how proud I am of the external recognitions that we received this quarter which reflect the strong corporate culture on which our business is built. As I reflect on our recent efforts, I'm especially proud that FORTUNE magazine again name us to their most admired companies list for the 14th consecutive time and also rank us number one in our sector. This is a remarkable achievement and a rewarding recognition for the efforts of our associates who are focused on providing our clients the best solutions both for today and for the future.I am also particularly pleased to see our efforts reflected in the Wall Street Journal’s Drucker Institute list of best managed companies where we were one of the biggest movers jumping 104 places into the top quartile. These are only some of the great recognitions that we are receiving for our efforts to create opportunities for all of our stakeholders.And with that, I’ll turn the call over to Kathleen for her commentary on our results and the fiscal 2020 outlook.
Kathleen Winters: Thank you, Carlos, and good morning, everyone. As Carlos mentioned, we’re pleased with our continued progress in delivering growth for our shareholders and this quarter was no exception. This quarter’s reported revenue growth of 5% and 6% organic constant currency is slightly ahead of our expectations and we’re particularly pleased given the difficult compare to our second quarter of fiscal 2019.Our adjusted EBIT increased 9% and adjusted EBIT margin was up 70 basis points compared to the second quarter of fiscal 2019, both also slightly ahead of expectations due to the timing of our progress across our multiple transformation initiative.Our margin improvement continues to benefit from a combination of cost savings related to our transformation initiative and operating efficiencies. These benefits were partially offset by growth in PEO zero-margin benefits pass-through expenses, increased selling and marketing expenses and amortization expense.Similar to the first quarter of fiscal 2020, we’re particularly pleased with our margin performance given the difficult compare that we faced in the first half of the year resulting from the outsized benefits in fiscal 2019 related to our Voluntary Early Retirement Program.Our adjusted effective tax rate decreased by 260 basis points to 22% compared to the second quarter of fiscal 2019. The decrease is in line with our expectations and was mainly due to the release of a valuation allowance related to foreign tax credit carry forwards.Adjusted diluting earnings per share grew 13% to $1.52 and in addition to benefiting from our revenue growth, margin expansion and a lower adjusted effective tax rate was also aided by fewer shares outstanding compared to a year ago.Moving on to Employer Services segment and interest on funds held for clients, Employer Services revenues were slightly ahead of expectations and grew 4% reported and organic constant currency. Interest income on client funds grew 7% and benefited from growth in average client funds balances of 6% to 25.1 billion. This growth in balances continues to be driven by a combination of client growth, wage inflation and growth in our pays per control.Our Employer Services same-store pays per control metric in the U.S. grew 2.2% for the second quarter. Employer Services margins increased 30 basis points in the quarter driven by the same factors that I mentioned earlier when discussing our consolidated results.Our PEO segment revenues grew 9% for the quarter to 1.1 billion and average worksite employees grew 6% to 579,000. Revenues, excluding zero-margin benefits pass-throughs, grew 7% to 412 million and continued to include pressure from lower workers’ compensation and SUI costs and related pricing.Our value proposition in the PEO remains strong as evidenced by our double-digit PEO new business bookings growth this quarter. Our midmarket sales channel continues to grow following the realignment of our sales incentives and we’re seeing continued signs of positive traction within our downmarket referral channel.With these factors in mind, we remain optimistic in our ability to reaccelerate the PEO in the latter part of fiscal 2020. Margins in the PEO decreased about 30 basis points for the quarter largely due to a difficult compare and an increase in selling expenses resulted from our strong quarterly new business bookings growth.Let's turn to the outlook for the full year and start with the PEO. With six months behind us now and our year-to-day average worksite employee growth and revenues tracking slightly below our expectations, we do not expect to achieve the higher end of our previous guidance range.As such, we are narrowing our guidance and now expect 9% to 10% PEO revenue growth in fiscal 2020 and 7% to 8% growth in PEO revenues, excluding zero-margin benefits pass-throughs, both driven by an anticipated growth of 7% to 8% in average worksite employees.As we also discussed last quarter, we continue to expect lower workers’ compensation and SUI cost and related pricing to pressure our total PEO revenue growth. For PEO margin, we continue to anticipate margins to be flat to down 25 basis points in fiscal 2020. As we noted in previous calls, this outlook continues to include approximately 50 basis points of pressure from smaller favorable reserve adjustments at ADP Indemnity in fiscal 2020 compared to fiscal 2019.Moving on, let’s take a look at Employer Services. We are narrowing our guidance to 4% revenue growth versus our prior outlook of 4% to 5% driven by a combination of continued unfavorability in FX and interest rates relative to our expectations coming into the year, and the lower bookings growth in the first half of fiscal 2020.We meanwhile continue to anticipate pays per control growth of about 2.5% and Employer Services revenue retention to improve 10 to 20 basis points. And we now expect Employer Services new business bookings growth of 6% to 7%. We continue to expect our margin in the Employer Services segment to expand by 100 to 125 basis points.We now anticipate total revenue growth of about 6% in fiscal 2020 as compared to our previous outlook of 6% to 7%. This revenue outlook continues to assume an elevated level of FX on favorability for fiscal 2020 relative to our expectations at the beginning of the year.We continue to anticipate our growth in average client fund balances to be about 4%, the average yield earned on our client fund investments to be about 2.2% and interest income on client funds to be between 570 million to 580 million. We also continue to expect interest income from our extended investment strategy to be 575 million to 585 million.We continue to anticipate our adjusted EBIT margin to expand 100 to 125 basis points. As a reminder, this guidance also continues to contemplate approximately 100 million in cost savings for fiscal 2020 related to our workforce optimization and procurement transformation initiatives.We now anticipate our adjusted effective tax rate to be 23.2%. The rate includes this quarter's unplanned tax benefit from stock-based compensation related to stock option exercises. It does not, however, include any further estimated tax benefit related to potential future stock option exercises given the dependency of that benefit on the timing of those exercises. We continue to expect adjusted diluted earnings per share to grow 12% to 14% in fiscal 2020.Finally, before we take your questions, I wanted to let you know that shortly after our February 10 Innovation Day, Christian will be moving on to take an international assignment as the General Manager of one of our European businesses. I want to thank Christian for his many contributions leading our Investor Relations program and also welcomed Danyal Hussain who many of you already know as our new Head of Investor Relations. Congratulations to both of you.With that, I will turn the call over to the operator to take your questions.
Operator: Thank you. [Operator Instructions]. And our first question comes from Kevin McVeigh from Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thanks. I think one of the things we’ve been focused on is the retention – the improvement in the retention. Can you give us any sense of how kind of the first half scaled relative to the full year guidance?
Carlos Rodriguez: I think you can tell from our comments that it obviously improved in the second quarter and we’ve tried to get away from – with the new guidance that we started providing I think was a year ago, we’re trying to get away from quarterly guidance but we are still committed to giving you kind of a sense of kind of where we are. And I think you can tell from my prepared comments that we had a good first quarter and we also had a good second quarter. So retention is definitely a positive for us like we talked about last year in terms of some of the bright spots, our midmarket business retention continues to improve and is on track to really get through this year close to record levels. So it’s very satisfying because we went through a very difficult time back in the day where we did all of the client upgrades and migrations and then with ACA at the same time, that was a business where we really had a real step back of retention. By the way, step back for us is a couple percentage points. Now we have recovered all of that and are kind of on track to get back to kind of where we were at record levels.
Kevin McVeigh: Understood. And then just --
Carlos Rodriguez: I’m sorry, another comment was I think we also in the first half have had good retention in the upmarket which was another place it’s been kind of a challenge for us over the last couple of years. So I think both of those businesses – when you combine them, they are a significant portion of our revenues and I think have a solid retention performance.
Kevin McVeigh: That’s super helpful. As a quick follow up, despite the revenue adjustment, seems like you’re maintaining the margin guidance. I guess what’s driving that outperformance given kind of the revenue adjustments in the PEO and I guess overall?
Carlos Rodriguez: We have – our business model is interesting because sometimes at least for the first half as you could tell we’re hoping and planning on a recovery in terms of our sales results for the second half. But in general we benefitted in the first half from an expense standpoint from having weaker new business bookings, because as you know our business has a little bit of a soft adjusting factor. Now the new 606 rules I think when you amortize some of these costs over time, they blunt some of that impact but there’s still some impact from that. So we did benefit from that and we just have a lot of good things going on from a margin standpoint. We really want to make sure that we focus on the growth as well, but we feel pretty good about the initiatives that we put in place call it last fiscal year that are impacting this year’s cost structure. And I think those – we talked about those as procurement initiatives, also the workforce optimization which was a delayering exercise where we reduced spends and control, so we took three layers out and increased spends across the board including all the way at the very highest levels where we had for us I would call it a significant decrease in overhead, if you will, in terms of – at our more senior levels. And so I think we’re benefitting from all of those items and that’s helping the margin. So we feel pretty good about where we are in terms of cost and margin. We have a lot of transformation initiatives around cost and margins and obviously we want to make sure that we focus on growth and new business bookings as well.
Kathleen Winters: Yes. Not too much to add to that. Carlos has covered a lot of the points, but we’re seeing the operating efficiency come through. We’re executing on the transformation projects that we have in flight right now. Saw a little bit better than expected margin expansion in the second quarter, primarily some timing on some of the transformation work. But look, the teams executing really nicely on that, particularly on the procurement side and we’re focused on continuing to do that and building the pipeline of additional opportunities.
Carlos Rodriguez: And just one little item in terms of color, you’ll see from the Q that credit to the organization – again, a lot of these transformation initiatives have been – some of them when we talk about them, they’re the big ones. We have dozens of other initiatives that are really improving the way we work automating things, taking out kind of non-value-added work. And when you look at our Q, you’ll see that really R&D and selling expense that have increased and we really are holding the line on the rest of our operating expenses due in large part to some of these initiatives that we have underway that are making work a little bit easier for our associates and also taking some of the work out. And so that’s the key because we want to make sure that we keep and we are keeping our NPS scores and our retention high. So that’s the magic formula there. I think keeping our expenses lower and improving margin if it results in lower client satisfaction, lower retention is not going to help us in the long term, but fortunately and again credit to the associates and to the management team, we’re actually pulling it off where we’re getting both of those things right now.
Kevin McVeigh: Super. Thank you.
Operator: Thank you. Our next question comes from Tien-tsin Huang from JPMorgan. Your line is open.
Tien-tsin Huang: Thanks. Good morning and congrats to Christian and Danny. I want to ask on – I guess a big picture question maybe for the team just balancing – you’re balancing the new tech investments, you just mentioned the transformation initiatives in the pipeline there, but just given that you’re early – you’re on track to get to your fiscal year targets this year – for fiscal '20, I’m sorry. Are you more willing to invest and stay in the short to midterm to maybe energize revenue growth and get that up a little bit more, or is your preference to still hit the higher end of your long-term margin target? Just trying to understand how you might be balancing revenue growth and margin expansion given where you are now?
Carlos Rodriguez: That’s a great question and I think our Board obviously has that discussion with us as well. And I think our Board is very long-term oriented. And so as much as we’re committed to hitting all individual components, it’s about balancing all of those factors to really create long-term sustainable growth. And we would love to have as much growth as possible. And when I think about where are some of those places that we could invest, as an example like in our sales organization, we are fully staffed. I think we’re probably a little bit ahead of our plans in terms of our headcount. So we clearly have some execution issues there, especially as we mentioned in our international and multinational businesses and some difficult compares over the last year, but we have really strong performance in the downmarket and in the midmarket and even in the domestic upmarket this quarter. So it doesn’t feel like we’re under investing. In fact, I’m pretty sure that we’re not under investing in sales and marketing. We also have a brand campaign that we’ve invested in over the last year which has added some expense. So I think we’ve put our money where our mouth is when it comes to sales and marketing. And then turning to the other obvious places where we could invest again for growth and product in our R&D organization, again, R&D grew but always say that we could spend more. But when I look at the year-over-year and even a three-year growth of our investments in our Next-Gen platforms and even some of the additional feature functionality that we’re adding to our existing product, including user experience, that’s again a place where our investments are growing. So you can see it from our depreciation and amortization line, when you see it in the Q and you can see it and hear it from our words that we are – you can see in our balance sheet in terms of capitalized software. So we believe that we are investing for the future and that we have – sometimes you have these timing issues because we do have a lot of enthusiasm, for example, about our Next-Gen platforms. But relative to the size of the company, this is the first year where we have – over the last 12 months is the first time we’ve actually got clients now live on our Next-Gen platforms, including Next-Gen payroll and Next-Gen HCM which we call Lifion. So we’re excited. We’re ahead of plan. But you have less than 10 clients on one of the platforms and call it 30 to 40 clients on another one of those platforms, so it just doesn’t make a difference yet in terms of the sales results or the revenue results, but it doesn’t dampen our enthusiasm around the future. So again, I guess the long and short of it is I don’t think it’s a lack of investment, but trust us that if we see an opportunity to invest for growth, we will take it.
Tien-tsin Huang: Understood. And then just maybe on that point with the U.S. bookings, it sounds like it’s more international again. So I’m curious if this is more cyclical or is there some very broad base or is it more – just a few select clients just looking for a decision, just trying to better understand the visibility here on the international side?
Carlos Rodriguez: I think the most obvious one in terms of because it’s easy to see and quantify is in our large Global View multinational deals, we had a very difficult compare. Now, of course, that means that 12 months ago we were celebrating getting those deals and those sales and also we talked about it that that was giving us tailwind at the time when I think we did, but we’d have to go back to the transcripts. And now unfortunately now we have a very difficult compare. Now we just had our rethink meeting, we call it rethink meeting where we have all of our large multinational prospects and clients and I think we walked away with a very solid pipeline and a lot of enthusiasm. And so we feel good about hopefully the second half. And whether it’s the second half or next year, but any less enthusiastic about our multinational solutions but we just have a very difficult compare. So that’s an obvious place. We do have a couple of what we call in-country or best-of-breed locations that are also having some challenges that I think also have some difficult compares. But it’s hard to point at any kind of cyclical or product issues, because we’ve been strengthening our products overseas as well and I think investing in our sales force. So again – and European economy in particular seems to be at a minimum stabilizing if not improving. So I don’t think we can point to anything cyclical which is why we remain optimistic about the turnaround.
Kathleen Winters: Yes. So maybe I’ll just add a little more color and talk about it in terms of kind of U.S. bookings overall. I guess what I’d say is that, look, as you go into the year there’s always going to be areas where you do better and areas where you do worse than you may have planned. And thus far into the year we’ve seen particular strength in downmarket as we’ve noted in our comments. And actually internationally we’ve also seen strength in our Celergo streamline product which was quite nice to see. And as you saw, the multinational Global View is where we were seeing really the slowness or the weakness for the last two quarters now. It’s hard to say that it’s – we’re not really seeing that it’s attributable to any change from an economic landscape or environment standpoint but more so just seeing delayed decision making and it’s taking time to get these larger and sometimes much more complex deals through the decision making process. So we’ve seen it two quarters in a row. The pipeline looks pretty decent. We’ve got some of these deals in the pipeline, but remains to be seen exactly how much longer it takes to get them closed.
Tien-tsin Huang: Okay. Thanks. See you in a couple of weeks.
Carlos Rodriguez: Thank you.
Operator: Thank you. Our next question comes from Ramsey El-Assal from Barclays. Your line is open.
Ramsey El-Assal: Hi, guys. Thanks for taking my question. Could I ask you to give us kind of a brief macro overview in terms of what you’re seeing in your various markets given everything that’s going on in the world today, any callouts or any changes in the environment?
Carlos Rodriguez: So when we look at – we have a few things that we obviously look at in terms of, call it economic macro indicators. The ones that are kind of relatively stable I would call them relatively stable or pace for control and wage growth and we look at obviously our own data as we get ready for this earnings call but we also have the ADP research institute that publishes its own kind of wage growth information and other factors around the economy. And I think all those signs positive point to what I would call stability. Our pace for control was slightly lower than it was the previous quarter in that trend, but we’ve seen that many times before where we go 2.5% one quarter and then we go a little bit lower the next quarter, but then it comes back to 2.5%. It does seem and we’ve been saying it and we’ve been wrong so far that as the labor markets tighten, there’s just not enough people available in the U.S. to continue to drive the kind of pace for control work that we’ve experienced. But obviously labor force participation has been ticking up slightly and for a variety of reasons that’s continued to hum along. And again, we see the same kind of indicators that all of you see around consumer spending, et cetera. So when we look across all of our domestic businesses, the pace for control growth seems to be a reasonable indictor that the economy is on stable ground. And wage growth we think should continue to accelerate, but that’s moderated slightly also for the last couple of quarters but it’s still at robust levels and should drive continued consumer spending and continued consumer confidence. We do look at pace for control also outside of the U.S. and I think there we again in our numbers see some signs of stabilization in Europe when it comes through on the unemployment and pace for control metrics there. So for us I think that everything looks – bankruptcies are – we’re seeing the same things at our own business that you see through external metrics. We don’t see any kind of elevation or increase in out of business or bankruptcies in our downmarket business, which is the canary in the coal mines, the first place you would see it. And our sales are also strong in the downmarket and the midmarket, so it doesn’t feel like the weakness we had this quarter is anything other than the lumpiness that we talked about around multinationals, because new business bookings would be another I think macro indicator that could weaken. We talked about our retention continuing to improve. Retention doesn’t improve in a bad economy, because it – that’s one of the things that really suffers as a result of out of business in a downmarket and that has stayed strong and solid. So no negatives that we can see in the macro.
Ramsey El-Assal: Okay. And you’ve sort of addressed this. Dovetailing with Kathleen's last answer and your answer just now, but can you talk a little bit about the competitive environment and that doesn’t manifesting itself as sort of pricing-related actions or an intensification of maybe more an increasing opposing bidders showing up for contract processes or new business models emerging out there. I’m just trying to explore whether there’s any other peripheral causes for some of I think what are timing-related delays in things like bookings especially maybe in Europe but elsewhere as well?
Carlos Rodriguez: Sure. So back to maybe a little bit of what Kathleen said about, there’s always – there’s positive and there’s negative. When it comes to competitors, it’s the same thing. We have a lot of competitors in each of our segments and some years we do better, some years we do worse, but we do have the overall balance of trade and our situation there is better. And you would think that based on our retention results and based on the comments we just gave you about new business bookings in our downmarket, midmarket and domestic upmarket business. So I think in North America I think if you look at those results, I would say our competitive situation has improved and it shows in our net balance of trade that we keep track of. Particular I would point out besides the continued strength in our downmarket business which has been growing market share here for a few years, if you look at our midmarket business, the last two quarters in particular were quite strong in terms of what we call new logos against a variety of competitors. But again, we can’t point to any one competitor because we have a large set of competitors. Some of them are geographically concentrated and some of them are national, but I think we’re very pleased with this quarter’s performance against those competitors in the midmarket. And then in the upmarket I would say that the addition of Workforce Now and call it the 1,000 to 5,000 range, so the lower end of our upmarket which we did a couple of years ago has really been an important generator of win-loss and balance of trade success for us in the upmarket. So we’ve had a robust growth in units and revenue and sales dollars from introduction of Workforce Now into that 1,000 to 5,000 which addresses a segment of the market where that platform really has a lot of appeal.
Ramsey El-Assal: That is super helpful. Thank you so much.
Operator: Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open.
Jason Kupferberg: Hi. Good morning, guys. I just want to drill in a little bit more on the commentary around the delayed decision making. Have you guys been down selected for these contracts already or is the actual RFP process still kind of dragging along?
Carlos Rodriguez: I wish I could tell you that I have that level of detail. I don’t. So this is really – it ties back to the comment I made before about we have a certain number of sales people in the field, we have a certain pipeline of dollars that we track year-over-year and we know what our sales results were the previous year in the same period whether it was the first quarter or the first two quarters of the year. So we are attributing the weakness to the late decision making. But this is not – we do have large contracts particularly in multinational and they definitely move the number from one quarter to the other, but we don’t have $50 million, $100 million contracts. It’s not that kind of business. So I don’t put – I know our sales leaders have that level of detail. I don’t have it available at my fingertips here.
Kathleen Winters: Yes, maybe you’re asking kind of have we seen any particular shift in where things are in terms of stages of the cycle and stages in the pipeline. Nothing that we’ve seen or heard that we can draw any conclusion from or point to any trends.
Carlos Rodriguez: But we do have pipeline of deals – sure, we went into rethink this year with more participants, more attendees and a larger pipeline of dollar opportunity than we had the previous year.
Jason Kupferberg: Right. I was just curious if you were just kind of waiting for some final signatures to make the bookings official or if it really is a matter of kind of just broader pipeline conversion. Just my second quick follow up just on the margins. You had the 70 bps up overall in the quarter, which was better than you expected, but at the segment level I know ES was up only 30 and PEO was down 30 if I’m not mistaken. So I think it was some of the below the line drivers that got you to the 70. Can you elaborate on those because I know you have some add backs in your adjusted EBIT margin calculation?
Carlos Rodriguez: Yes, I can help maybe a little bit with that. As you know, the transformation initiatives that we are undergoing right now, some of those are sort of back office facing as well. So if you think about procurement and the workforce optimization initiative, those will have impacts to items that what we would deem other in the segment review. So corporate functions, for example, that’s where the delta probably sits for you.
Jason Kupferberg: Okay, great. Thank you, guys.
Carlos Rodriguez: Thank you.
Operator: Thank you. Our next question comes from Mark Marcon from Baird. Your line is open.
Mark Marcon: Good morning. Let me add my congratulations to both Christian and Danny. With regards to the bookings, just looking ahead and thinking about the comparisons for the third and fourth quarters, are there things that we should think from a sequencing perspective in terms of they’re both – one’s up 10%, one’s up 11%. Is there anything that’s particular in one versus the other that would make it a more difficult comp or how should we think about the bookings over the next two quarters in terms of the sequencing?
Carlos Rodriguez: I think our number one goal is to obviously maintain the momentum we have in everything other than our international and multinational businesses. And again, these businesses not just because of the big ocean between them, they are fairly separate, right, in terms of how they’re managed in terms of sales and sales execution and so forth even though we have one worldwide sales organization. So we feel good that we’re going to be able to maintain the momentum we have in the rest of the business and then hopefully we get a little bit of tailwind with some of this stuff going our way in terms of the larger deals and some of the international stuff that we talked about. We do have in the second half, particularly in the last quarter, we do have a difficult compare because last year as you recall we purchased – it was a client-based acquisition – an acquisition of the company with a client-based acquisition of Wells Fargo’s payroll business and that helped our new business bookings and obviously translated into some revenue helping in a downmarket and it was part of what’s given us some tailwind from a revenue growth standpoint in that business. But since it was a client-based acquisition, it does – and it wasn’t an acquisition of a business, it does roll through our new business bookings and that was I believe in the fourth quarter.
Mark Marcon: That’s [indiscernible] and that’s part of the reason for asking the question. So arguably the third quarter should be a little bit of an easier comp.
Carlos Rodriguez: For some reason they never feel easy, but mathematically – you’re probably mathematically correct. But we have a lot of things that we’re cooking to make sure that we hit – obviously our intention is to achieve the guidance we provided and we don’t provide it lightly.
Mark Marcon: Great. And then, Carlos, obviously you’ve got a longstanding set of experiences with the PEO market. How are you feeling about the longer-term trajectory of the market? What are you thinking or ex pass-throughs, the sustainable growth rate is there? And what are you seeing on the competitive front? It seems like there’s a little bit more private capital that’s coming into the space. So just wondering how you’re thinking about that space and the legislative outlook there?
Carlos Rodriguez: Well, when you look at again the balance of trade information there, I feel pretty good about our competitive situation. So you always feel good about your own children, about your business, but you got to look at the facts, right. And I think the facts are pretty good for us in terms of our win-loss in our balance of trade. So that feels pretty good. And then the second thing that makes me feel really good particularly in this quarter versus last year and started to feel it last quarter is we really took a while to kind of filter through to make sure that we had our incentives properly aligned to make sure that our sales force is focused on obviously, number one, selling the right thing to our clients but making sure that they’re properly incented to make sure that the PEO is something that they raise, because it’s a difficult sale, because it’s a high involvement sale and so you have to have the right incentives in order for the sales force to really want to sell it. And so I think we did that and I think we talked about that. It’s got to be 12 months ago I think it was. So that feels like it’s starting to filter through and I think we talked about very strong double-digit new business bookings for the quarter which that’s the most important metric for the future to really give us confidence that the business model is still strong and intact. So that feels pretty good.
Mark Marcon: Terrific. Thank you.
Operator: Thank you. Our next question comes from Samad Samana from Jefferies. Your line is open.
Samad Samana: Hi. Good morning. Thanks for taking my question. So I wanted to maybe ask a question about what’s been going on in terms of bookings and how you’re thinking about guidance. Was guidance updated just to reflect what bookings has done so far this year or have you may be made some changes to the guidance framework to account for some more of the variability or variance that you’re seeing in multinational or international deals closing? So I guess is guidance more conservative or are you using the same framework that you’ve historically used? And then maybe just one follow up.
Carlos Rodriguez: Yes. Again, just a reminder just given the last comment that I made about the PEO that the guidance that we provide for bookings is ES only just to be clear. So if you look at our combination of our PEO and ES sales, it’s a better picture and a stronger picture in the first half than what our guidance would depict, because we provide guidance for the PEO based on average worksite employee growth, not on new business bookings. But having said that, I think the answer is just – this year like there’s no change in our thinking or our framework given that we just think there’s some large deal delays that I don’t think impact our deal in the future.
Kathleen Winters: Yes, no change in framework, no change in kind of the way we’re rolling up that forecast or the data we’re looking at. For example, we look at things like, okay, where’s business coming from in terms of by segment or by geography or new clients versus upsell to existing clients. We’re continuing to see fairly consistent trends in terms of the split between new and upsell. So no change in the framework. It’s more so just, look, we’ve seen slower out of the gates for two quarters now, lower than we expected in international. And so we thought it was – given that we’re six months into the year here, we thought it made sense to give you our best view. So, therefore, we narrowed the view for the year.
Carlos Rodriguez: Yes. Just one other comment in terms of something little bit quirky about as we changed our guidance to focus on ES worldwide bookings versus the PEO based on average worksite employees. The reason we gave you some color about the bookings for the PEO this quarter is even though we’re not going to change the way we do our guidance is in some respects what’s good for the PEO sometimes in the short term if business gets referred to the PEO, it can have in the short term a dampening effect on Employer Services. But we still had a great result in the downmarket and in the midmarket in Employer Services. So we definitely can’t point to that. But again, it is kind of important to keep in mind that it’s really the combination of those two that are driving overall ADP bookings and overall ADP revenue growth.
Samad Samana: Great. That’s helpful. And then maybe if I could just ask one follow up. I think there’s a lot of excitement around Lifion coming off of HR tech and ahead of the Innovation Day that the company is hosting. So I just wanted to see if there’s any early patterns in terms of customer profile, whether it’s by size or whether – what do you think about existing products that they’re using, whether it’s Vantage or Workforce Now, maybe where are you seeing the early adopters come from and any type of profile commentary you could give on that would be helpful? Thank you.
Carlos Rodriguez: So again, in our case everybody’s maybe approaches it differently, but we started off with smaller, less complex clients and now we’ve actually just sold I’ll call – consider it to be very large clients, so call it tens of thousands of employees. And so we’ve got a couple of very large sales that we’ve done and we have a bunch in the middle and then we have a few smaller ones that we did in the early days. Some of the business we’ve sold is obviously new logo, some of it has been as you mentioned off of some of our existing platforms. I don’t think that I can point to one particular platform and say that we’re not targeting – because we’re not trying to do migration or upgrades. We’re trying to go after clients that have the right profile and the right needs, right, so that we can make them happier ADP clients in the long term. So we know what the capabilities are of the platform and we try to target the clients and the prospects whether they’re internal or external in the appropriate manner. So I guess the best way to put it is it’s kind of across the board in terms of – from an internal view. And then in terms of industry or size of client, fortunately it’s also kind of a wide spread.
Samad Samana: Great. Thanks for taking my questions. I appreciate it.
Operator: Thank you. Our next question comes from David Togut from Evercore ISI. Your line is open.
David Togut: Thank you. Good morning. There have been a few questions on bookings already, but this seems to be the main question of the day. The one question that I’d like to explore here is you’re still in the critical selling season which typically runs December to February. So is there anything you see in your pipeline in the U.S. or confidence on international close rates that gives you the confidence that you can close this critical selling season in better shape that we’ve seen obviously in the second quarter and the first quarter bookings results?
Carlos Rodriguez: So again, at the risk of getting too much into the sausage making, if you remember like part of our business particularly downmarket and into some of our midmarket, we report our sales when they start. So they’re – like bookings and starts are basically equivalent. But when you get to very large deals, that’s where you’re really recognizing a sale and then the revenue starts at a later date. It could be six months, it could be 12 months. With a very large complex international deal, it could be 18 months later. So to your point about the critical selling season, pretty much now and done because January is the biggest month for us particularly for our downmarket business and the lower end of our midmarket business as well and the PEO. So just because of a natural cycle of the PEO, a large number of clients – by the way affect retention as well, but from a new business bookings standpoint January is the critical month for us. So the December-January period is the critical month for us in the PEO. And again, we’re in the middle of that quarter so it’s kind of hard to make comments about the quarter since the quarter isn’t done yet. But I think in a downmarket and in our PEO in particular, we had I’d say a good start to the quarter.
Kathleen Winters: Yes. The only other thing I would add and this is with regard to the ES bookings in particular, if you kind of look at the cadence of the year last year and this year and you look at six months year-to-date, we’re at about the same point this year as we were last year in comparison to where we ended the year.
David Togut: So in other words, you see enough in the pipeline at this point and expect to close rates that drive your expectation of the 6% to 7% bookings target. Is that accurate?
Carlos Rodriguez: I think that – again, that is a level of detail to say that we have specific things in the pipeline. I think just to reiterate what we said before, so the number one driver of our confidence in our sales results in most of our business is headcount and execution and we believe we’re fully staffed and we have that headcount in place. In the place where we’ve had the variability or the volatility, if you will, it does come down to what you’re describing which is RFPs, pipeline, et cetera. Yes, we do believe we have the pipeline and the visibility of that pipeline to feel that we will close the gap for the rest of the year. But that’s not – in our SBS business, in our downmarket business, it doesn’t work that way. It’s really more about the volume – it’s a volume business. It’s really related to having the proper amount of headcount, the right digital marketing tools and spend and again there we feel good and we feel confident.
David Togut: Understood. Thank you.
Operator: Thank you. Our next question comes from Jeff Silber from BMO Capital Markets. Your line is open.
Jeffrey Silber: Thanks so much. I’m apologizing for asking another bookings related question. I just wanted to clarify something. I’m assuming that most of your clients are in calendar year-end as opposed to your June year-end. When you talk about the late decision making, does this mean that decisions are being deferred until another year from now or is it something that could happen within the next quarter or so?
Carlos Rodriguez: So the good news for ADP is we have clients with all kinds of year-ends because we have a lot of clients. So really it spans the gamut. But you’re right that probably the average company in the U.S. has a calendar year-end. But I think most large companies and particularly multinationals which I would consider ADP to one of those, we typically when we are negotiating with a vendor for a large contract, we’d be focused more on their fiscal year-end rather than our own fiscal year-end. And so you’re right that there are some drivers around people’s budgets and so forth, but a lot of procurement departments tend to focus on the vendors year-end. And so we’ve seen historically – doesn’t mean that it will happen again this year – is that our fourth quarter for large domestic and especially for large multinational deals is a particularly important quarter because prospects are recognized that even though we’re not like a typical software company that negotiating towards a company’s fiscal year end at least in their minds tends to be a good time to sign deals or negotiate.
Jeffrey Silber: Okay. I appreciate that --
Christian Greyenbuhl: Sorry, Jeff, just one reminder. I know we said it before, but the 1% impact on an annual basis in business bookings equating to that 17 million, these multinational particularly Global View deals, you can imagine that if you take that on a quarterly basis, it does have – just to put it in perspective that outsized impact. So from a framing perspective, it is a pretty meaningful adjustment if you have some of these deals that flow in from one quarter to the next given that sensitivity.
Carlos Rodriguez: On the new business bookings results.
Christian Greyenbuhl: On the new business bookings results.
Carlos Rodriguez: Right. Because on revenue – as you just described, the irony of the situation is that it doesn’t have a big impact on revenue. We’re having issues with FX and with client funds interest in particular are hurting us. It’s not to deny that the bookings eventually will have some impact. The types of bookings that we have fallen short on in the first half are not particularly revenue impactful.
Jeffrey Silber: Okay, that’s helpful. I do appreciate the color on that. And then I know you don’t give quarterly guidance, but you called out I guess the comp on the “acquisition” of the Wells Fargo payroll business last year. Anything else to call out between 3Q and 4Q that might affect the cadence of those quarters? Thanks.
Carlos Rodriguez: In terms of new business bookings?
Jeffrey Silber: No, the overall business either revenues or margins?
Carlos Rodriguez: Well, again, back to revenues and margins, the client funds interest issue and again going back to kind of the three-year guidance that we gave a few years ago, again, obviously not expecting a lot of sympathy from this crowd, but we’re probably about $100 million less than where we expected to be in terms of client funds interest and we’re obviously able to overcoming some of that as we go forward. So that in the second half is actually going to according to what I’m seeing in terms of our forecast. That’s going to start to have an impact on revenue growth as well, not a huge impact but where we were getting call it 1% lift in terms of revenue growth last year in the second quarter, I think this second quarter it was a much smaller number and in the second half it goes to probably no help to actually hurting our revenue growth. So that’s a headwind for us. But when I really take out all these issues; FX, client funds interest and other kind of calendar noise issues, when you look at the net impact of new business bookings starts, not new business bookings sales but new business bookings starts minus losses. So if you take retention and new business that have started, if you compare last year’s second quarter to this year’s second quarter and hopefully the same thing continues into the second half, we have a slight acceleration. It’s not a huge acceleration, but a slight acceleration. So that’s what makes me feel good about the strength in the underlying business because there’s a lot of noise happening in between with calendar and remember last year, we also had a one-time item that we mentioned that we called SUI pull forward in the PEO and accounting change that we were obligated to make that helped the second quarter revenue growth. And so all those things you have to kind of separate all those and get down to the core of the business and how the core business is performing. And on that basis, I feel good about the quarter and I feel good about the second half.
Kathleen Winters: Yes, the only other thing I would add to your question about kind of quarterly linearity in the balance of the year. Just as a reminder, in the second half of last year we had much, much more margin expansion in Q3 than in Q4. So, therefore, tougher comps for us this year Q3 versus Q4 in terms of margin expansion. So while we don’t give quarterly guidance, I would expect not a whole lot in Q3 and then potentially much more in Q4.
Carlos Rodriguez: But again, back to like – in terms of what I mentioned in terms of some of these comparisons that were difficult versus last year’s second quarter, some of those things then get easier on a revenue standpoint, notwithstanding the issues from client funds interest as we pull forward actually helped last year’s second quarter, but depressed our third quarter. So that’s going to make an easier comparison. So we do expect slight improvement in our revenue growth in the second half.
Christian Greyenbuhl: And just a brief reminder of the fourth quarter, so as a reminder, so we did the client-based acquisition. So that added some amortization expense, which will lap in the fourth quarter and obviously it would increase booking expense related to the client-based acquisition as well. So just keep that in mind. And then we obviously launched our brand campaign I think in the third quarter, but most of that was really the expense was kicking off in the fourth quarter as well. So that will be lapped as well.
Jeffrey Silber: So I guess what you’re saying is you got some tailwinds in the fourth quarter.
Christian Greyenbuhl: Yes.
Jeffrey Silber: All right. Thank you for clarifying that. Thanks so much.
Operator: Thank you. And we have time for one final question. And our last question will come from Lisa Ellis from MoffettNathanson. Your line is open.
Lisa Ellis: Hi. Good morning, guys, and thanks for squeezing me in. Congrats to Christian and Danny from me as well. Carlos, you mentioned a couple of times and I think in the presentation the progress on both Lifion as well as the Next-Gen payroll and tax. Can you give an update on where you are on the deployments of the Next-Gen payroll and tax engines and how they’re impacting your business perhaps on the retention side or some of the other impacts? Thank you.
Carlos Rodriguez: Sure. Thanks. Very excited about the Next-Gen payroll as well as the back office tax, but the payroll engine even though it’s somewhat back office I think has some positive qualities in terms of potentially helping us both in terms of – in the future both around bookings but also around efficiency and cost. I think we have somewhere between 30 and 40 live clients in our Next Generation payroll platform suite. As you can imagine, in comparison to the size of ADP, it’s a relatively small impact in terms of revenue retention or any of the other actual metrics. But enormous amount of enthusiasm around what we’re doing there, both at the team level. I think the team is incredibly enthusiastic and I think the rest of the organization is very enthusiastic as well in terms of what we’re seeing in the early days, especially around the flexibility of how quickly we can, for example, make changes and that’s just related really to the investments in the platform itself. So we’ve already kind of experimented and I think we maybe talked about this in the past with kind of federation as you call it in trying to have others develop and build on that platform. We’ve done the same thing on Lifion. And so now we have a team, for example, in Australia that is actually built Australian payroll and we have one or two clients on that as well. And so we’re incredibly happy with what we’re seeing. We’re really happy that we have live clients and this is the first year that – again, even though it was, call it 30 to 40 clients, this was the first time we’ve gone through year-end. So we actually had to go through a year end and do all the year-end closing activities, W2s, et cetera. So it’s still very early days just because of the size of ADP, but if we were a start-up, this would be like really great news. Like this was the – if this was a discussion about a start-up like we’ve got now a lot of technical risk behind us, if you will, and now we have scaling and execution risk that’s still in front of us. But that’s a hell of a lot better than where we would have been two to three years ago, and I think it could really add to our competitiveness here in the long run, not to mention to help a lot in terms of our back office costs. On the tax side, that’s probably more focused on back office cost and efficiency, but that also has an impact on our associates in terms of their ability to deliver service and also the experience that our clients have when we do things like amendments and tax notices. And so, again, the news there is very positive. We have – I think it’s close to 140,000 to 150,000?
Kathleen Winters: Yes, about 140,000 clients.
Carlos Rodriguez: About 140,000 clients. Obviously, those are smaller downmarket clients in a limited number of jurisdictions. But I think we’ve now – we’re up to 20 – more than 20 jurisdictions. Jurisdictions by the way refers to number of states in addition to federal, places where we can actually do the taxes. And so I’d say that that’s progressing also very, very well. Again, a highly flexible platform that we’re very optimistic in terms of what it can do to us down the road and see no scaling issues so far in either of those platforms.
Lisa Ellis: Excellent. Thank you. That seems like a good point to end on. I’ll see you guys in a couple of weeks.
Carlos Rodriguez: Thank you very much.
Operator: Thank you. And this concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for any closing remarks.
Carlos Rodriguez: Thank you. So as you can tell, we’re pretty – we’re pleased with the progress we continue to make on both the financials but also on our strategy. Obviously as we keep saying over and over again, we’re trying to build on our success in the past but also transform for the future here so we can continue to deliver sustainable growth for many years to come.I also want to mention that this time of year as somebody mentioned about this being a busy time of the year for us from a sales standpoint, it’s also a very busy time for our associates who deliver service and also our year-end commitments to our clients. It’s very long hours and very hard work and I really appreciate the commitment of our associates. And again, it’s one of the great differentiators we have in terms of being able to deliver that level of service, especially at a very busy time of the year like we are right now.Obviously, we wouldn’t be able to be successful in the long run without strong products. And so when we have our Investor Day, we’re going to hopefully lay out a plan for you about how the sustainability of the strength of ADP will be I think helped by the investments we’ve been making over the last five years in our next generation products.So we look forward to spending time with you on February 10 to discuss all of these innovations that we’ve been investing in, in addition to the Next-Gen platform and also discussing a little bit of our vision for the future about how we expect work to change and the HCM industry to change.And with that, I want to thank you once again for your interest in ADP and for joining us today. Thank you.
Operator: Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Crystal, and I’ll be your conference operator today. At this time, I would like to welcome everyone to ADP’s Second Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions].I will now turn the conference over to Mr. Christian Greyenbuhl, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Christian Greyenbuhl",
"text": "Thank you, Crystal, and good morning, everyone. And thank you for joining ADP’s second quarter fiscal 2020 earnings call and webcast. With me today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.Earlier this morning, we released our results for the second quarter of fiscal 2020. The earnings materials are available on the SEC’s Web site and our Investor Relations Web site at investors.adp.com where you will also find the investor presentation that accompanies today’s call as well as our quarterly history of revenue and pre-tax earnings by reportable segment.During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description and the timing of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measure can be found in our earnings release.Today’s call will also contain forward-looking statements that refer to future events and, as such, involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations.Before I turn the call over to Carlos, I’d like to remind you of our upcoming Innovation Day which is scheduled for February 10. We hope to see many of you there in person and for those who are unable to attend, you can find more details about how to view the event at investors.adp.com. We’re looking forward to sharing our progress on our investments and innovation as well as our vision for our HCM technology portfolio. As always, please do not hesitate to reach out should you have any questions.And with that, let me turn the call over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Christian, and thank you everyone for joining our call. This morning, we reported our second quarter fiscal 2020 results with revenue of 3.7 billion for the quarter, up 5% reported and organic constant currency. We are pleased with this revenue growth, which was slightly ahead of our expectations.Our adjusted EBIT margin increased 70 basis points for the quarter and was also slightly ahead of our expectations. Together with share buybacks and a lower adjusted effective tax rate, these results helped us deliver 13% adjusted EPS growth in this quarter. Overall, we are pleased with our progress through the first half of fiscal 2020 following a difficult compare with the first half of fiscal 2019.Moving on to operations and starting with new business bookings. This quarter, we continue to see strength in our Employer Services downmarket offerings and solid progress on the sales of our Workforce Now solutions. We were also particularly pleased to see strong double-digit bookings growth in our PEO.With that said, we are disappointed with our 3% Employer Services new business bookings growth for the quarter. This lower than expected growth was mainly the result of the same trends we saw in the first quarter with our international and multinational businesses, including delayed decisions for some of our larger multinational sales opportunities.As we have said before, given their size, these opportunities can have an outsized impact on our quarterly booking metric. With this in mind, we have narrowed our full year Employer Services new business bookings outlook and now expect 6% to 7% growth as compared to our previous guidance of 6% to 8% growth on last year’s 1.6 billion of Employer Services new business bookings. We continue to have a solid pipeline of opportunities and we remain confident in our ability to execute across our portfolio.Looking at client service, we continue to see good progress with overall strength in our net promoter scores and retention. As a result, we continue to expect our forecasted full year fiscal 2020 Employer Services revenue retention to increase 10 to 20 basis points.Now we’re halfway to fiscal 2020 and at the midpoint of our three-year targets we outlined at our June 2018 Investor Day. As we are also six months away from giving our fiscal 2021 guidance and we will not be giving any updated financial outlook at our upcoming Innovation Day, I want to take a few moments here to look back and share my thoughts on our progress since we provided that guidance.Let’s start with new business bookings. You will recall that our June 2018 Investor Day, we outlined that we were targeting growth for worldwide new business bookings growth of 7% to 9% through 2021. Though we no longer regularly report a worldwide bookings figure, which as a reminder includes the results of Employer Services and PEO segments together, we thought it would helpful in that context of a midpoint look back to share that we have seen 8% average quarter growth since the beginning of fiscal 2019.We are pleased with this worldwide bookings growth together with our improvements in Employer Services revenue retention and how they demonstrate the strength and stability of our business even as we’ve been going through meaningful transformation as an organization with a set of broad-based initiatives, including our Service Alignment Initiative in fiscal years 2017 and '18, our Voluntary Early Retirement Program in fiscal 2019 and most recently our Workforce Optimization and Procurement initiatives.Meanwhile, our quarterly average consolidated revenue grew 6% reported and organic constant currency over the past 18 months. As we look at some of the developments that have affected our recent growth relative to our expectations, we note that our PEO has not performed in line with our long-term expectations driven by lower than expected pass-through revenues and lower than planned worksite employee growth.Over the past several quarters, we have discussed some of the factors impacting PEO revenue growth, including the impacts from our sales incentives, recent retention unfavorability related to healthcare inflation and softness in workers’ compensation and state unemployment insurance rates.With the impact of these factors, our average growth over the past 18 months in average worksite employees was 8% as compared to our long-term expectation of 9% to 11%. And a contribution to revenue growth from pass-throughs was 1% compared to our long-term expectation of 1% to 3%.Despite the slight underperformance relative to our expectations, we are confident in the overall prospects of the PEO business and continue to see healthy demand for our offerings. Our PEO platform is the leading fully outsourced solution in the HCM market and we combine this with best-in-class HR business partners, which together helps deliver an unparalleled service experience.Stepping back now to total revenue, we are tracking at 6% average growth through six quarters. We have a solid playbook with a proven track record of driving sustained growth and we’ll continue to focus on delivering consistent strong bookings growth and retention performance as key priorities.And moving down the P&L, during this period we further solidified the foundations of our business as our associates continue to transform the way we work while also delivering innovative solutions to our clients.These transformation efforts along with our steady top line growth and the operating leverage in our model have helped deliver robust margin expansion and an average adjusted EBIT growth of 13% through the end of the second quarter of fiscal 2020, which is within the range of our fiscal 2021 target CAGR of 12.5% to 15.5%.This together with our disciplined share buybacks and a lower adjusted effective tax rate has driven adjusted EPS growth of 18%, which is tracking ahead of our targeted growth of 14.5% to 17.5% through fiscal 2021.As you can tell from our guidance for fiscal 2020, we currently anticipate ending the year within our fiscal 2021 three-year margin target range, one year ahead of schedule. This is no small accomplishment given our ongoing efforts to invest in the business for the long-term.Overall, I’m very pleased with our progress to date. The journey that we have embarked upon to simplify how we work, drive innovation and grow our business is a challenging one. However and more importantly, it is also providing us with great opportunities to demonstrate the value of our offerings to our clients as we continue to simplify the client experience.Through these collective efforts and with the continued strength of both our R&D organization and our worldwide sales force, we are enhancing the depth and scale of our ability to serve our clients wherever they do business with best-in-class products and solutions that fit their needs.Our clients in turn are recognizing these efforts as we continue to see improvements in both our net promoter scores as well as in our Employer Services revenue retention. It is due to the success of these efforts that we remain committed to additional shareholder friendly actions such as our recent dividend increases of nearly 45% over the past two years.Our track record of annual increases in our dividend puts us in a small minority with 30 other companies in the S&P 500 that have also grown their dividend for 45 consecutive years or more. As we look forward to the future, we remain confident that our strategy is the right one as we aim to further strengthen our resilient business model in order to drive sustainable long-term value for our shareholders.Before I turn it over to Kathleen for a detailed financial review, I want you to know how proud I am of the external recognitions that we received this quarter which reflect the strong corporate culture on which our business is built. As I reflect on our recent efforts, I'm especially proud that FORTUNE magazine again name us to their most admired companies list for the 14th consecutive time and also rank us number one in our sector. This is a remarkable achievement and a rewarding recognition for the efforts of our associates who are focused on providing our clients the best solutions both for today and for the future.I am also particularly pleased to see our efforts reflected in the Wall Street Journal’s Drucker Institute list of best managed companies where we were one of the biggest movers jumping 104 places into the top quartile. These are only some of the great recognitions that we are receiving for our efforts to create opportunities for all of our stakeholders.And with that, I’ll turn the call over to Kathleen for her commentary on our results and the fiscal 2020 outlook."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos, and good morning, everyone. As Carlos mentioned, we’re pleased with our continued progress in delivering growth for our shareholders and this quarter was no exception. This quarter’s reported revenue growth of 5% and 6% organic constant currency is slightly ahead of our expectations and we’re particularly pleased given the difficult compare to our second quarter of fiscal 2019.Our adjusted EBIT increased 9% and adjusted EBIT margin was up 70 basis points compared to the second quarter of fiscal 2019, both also slightly ahead of expectations due to the timing of our progress across our multiple transformation initiative.Our margin improvement continues to benefit from a combination of cost savings related to our transformation initiative and operating efficiencies. These benefits were partially offset by growth in PEO zero-margin benefits pass-through expenses, increased selling and marketing expenses and amortization expense.Similar to the first quarter of fiscal 2020, we’re particularly pleased with our margin performance given the difficult compare that we faced in the first half of the year resulting from the outsized benefits in fiscal 2019 related to our Voluntary Early Retirement Program.Our adjusted effective tax rate decreased by 260 basis points to 22% compared to the second quarter of fiscal 2019. The decrease is in line with our expectations and was mainly due to the release of a valuation allowance related to foreign tax credit carry forwards.Adjusted diluting earnings per share grew 13% to $1.52 and in addition to benefiting from our revenue growth, margin expansion and a lower adjusted effective tax rate was also aided by fewer shares outstanding compared to a year ago.Moving on to Employer Services segment and interest on funds held for clients, Employer Services revenues were slightly ahead of expectations and grew 4% reported and organic constant currency. Interest income on client funds grew 7% and benefited from growth in average client funds balances of 6% to 25.1 billion. This growth in balances continues to be driven by a combination of client growth, wage inflation and growth in our pays per control.Our Employer Services same-store pays per control metric in the U.S. grew 2.2% for the second quarter. Employer Services margins increased 30 basis points in the quarter driven by the same factors that I mentioned earlier when discussing our consolidated results.Our PEO segment revenues grew 9% for the quarter to 1.1 billion and average worksite employees grew 6% to 579,000. Revenues, excluding zero-margin benefits pass-throughs, grew 7% to 412 million and continued to include pressure from lower workers’ compensation and SUI costs and related pricing.Our value proposition in the PEO remains strong as evidenced by our double-digit PEO new business bookings growth this quarter. Our midmarket sales channel continues to grow following the realignment of our sales incentives and we’re seeing continued signs of positive traction within our downmarket referral channel.With these factors in mind, we remain optimistic in our ability to reaccelerate the PEO in the latter part of fiscal 2020. Margins in the PEO decreased about 30 basis points for the quarter largely due to a difficult compare and an increase in selling expenses resulted from our strong quarterly new business bookings growth.Let's turn to the outlook for the full year and start with the PEO. With six months behind us now and our year-to-day average worksite employee growth and revenues tracking slightly below our expectations, we do not expect to achieve the higher end of our previous guidance range.As such, we are narrowing our guidance and now expect 9% to 10% PEO revenue growth in fiscal 2020 and 7% to 8% growth in PEO revenues, excluding zero-margin benefits pass-throughs, both driven by an anticipated growth of 7% to 8% in average worksite employees.As we also discussed last quarter, we continue to expect lower workers’ compensation and SUI cost and related pricing to pressure our total PEO revenue growth. For PEO margin, we continue to anticipate margins to be flat to down 25 basis points in fiscal 2020. As we noted in previous calls, this outlook continues to include approximately 50 basis points of pressure from smaller favorable reserve adjustments at ADP Indemnity in fiscal 2020 compared to fiscal 2019.Moving on, let’s take a look at Employer Services. We are narrowing our guidance to 4% revenue growth versus our prior outlook of 4% to 5% driven by a combination of continued unfavorability in FX and interest rates relative to our expectations coming into the year, and the lower bookings growth in the first half of fiscal 2020.We meanwhile continue to anticipate pays per control growth of about 2.5% and Employer Services revenue retention to improve 10 to 20 basis points. And we now expect Employer Services new business bookings growth of 6% to 7%. We continue to expect our margin in the Employer Services segment to expand by 100 to 125 basis points.We now anticipate total revenue growth of about 6% in fiscal 2020 as compared to our previous outlook of 6% to 7%. This revenue outlook continues to assume an elevated level of FX on favorability for fiscal 2020 relative to our expectations at the beginning of the year.We continue to anticipate our growth in average client fund balances to be about 4%, the average yield earned on our client fund investments to be about 2.2% and interest income on client funds to be between 570 million to 580 million. We also continue to expect interest income from our extended investment strategy to be 575 million to 585 million.We continue to anticipate our adjusted EBIT margin to expand 100 to 125 basis points. As a reminder, this guidance also continues to contemplate approximately 100 million in cost savings for fiscal 2020 related to our workforce optimization and procurement transformation initiatives.We now anticipate our adjusted effective tax rate to be 23.2%. The rate includes this quarter's unplanned tax benefit from stock-based compensation related to stock option exercises. It does not, however, include any further estimated tax benefit related to potential future stock option exercises given the dependency of that benefit on the timing of those exercises. We continue to expect adjusted diluted earnings per share to grow 12% to 14% in fiscal 2020.Finally, before we take your questions, I wanted to let you know that shortly after our February 10 Innovation Day, Christian will be moving on to take an international assignment as the General Manager of one of our European businesses. I want to thank Christian for his many contributions leading our Investor Relations program and also welcomed Danyal Hussain who many of you already know as our new Head of Investor Relations. Congratulations to both of you.With that, I will turn the call over to the operator to take your questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions]. And our first question comes from Kevin McVeigh from Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thanks. I think one of the things we’ve been focused on is the retention – the improvement in the retention. Can you give us any sense of how kind of the first half scaled relative to the full year guidance?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think you can tell from our comments that it obviously improved in the second quarter and we’ve tried to get away from – with the new guidance that we started providing I think was a year ago, we’re trying to get away from quarterly guidance but we are still committed to giving you kind of a sense of kind of where we are. And I think you can tell from my prepared comments that we had a good first quarter and we also had a good second quarter. So retention is definitely a positive for us like we talked about last year in terms of some of the bright spots, our midmarket business retention continues to improve and is on track to really get through this year close to record levels. So it’s very satisfying because we went through a very difficult time back in the day where we did all of the client upgrades and migrations and then with ACA at the same time, that was a business where we really had a real step back of retention. By the way, step back for us is a couple percentage points. Now we have recovered all of that and are kind of on track to get back to kind of where we were at record levels."
},
{
"speaker": "Kevin McVeigh",
"text": "Understood. And then just --"
},
{
"speaker": "Carlos Rodriguez",
"text": "I’m sorry, another comment was I think we also in the first half have had good retention in the upmarket which was another place it’s been kind of a challenge for us over the last couple of years. So I think both of those businesses – when you combine them, they are a significant portion of our revenues and I think have a solid retention performance."
},
{
"speaker": "Kevin McVeigh",
"text": "That’s super helpful. As a quick follow up, despite the revenue adjustment, seems like you’re maintaining the margin guidance. I guess what’s driving that outperformance given kind of the revenue adjustments in the PEO and I guess overall?"
},
{
"speaker": "Carlos Rodriguez",
"text": "We have – our business model is interesting because sometimes at least for the first half as you could tell we’re hoping and planning on a recovery in terms of our sales results for the second half. But in general we benefitted in the first half from an expense standpoint from having weaker new business bookings, because as you know our business has a little bit of a soft adjusting factor. Now the new 606 rules I think when you amortize some of these costs over time, they blunt some of that impact but there’s still some impact from that. So we did benefit from that and we just have a lot of good things going on from a margin standpoint. We really want to make sure that we focus on the growth as well, but we feel pretty good about the initiatives that we put in place call it last fiscal year that are impacting this year’s cost structure. And I think those – we talked about those as procurement initiatives, also the workforce optimization which was a delayering exercise where we reduced spends and control, so we took three layers out and increased spends across the board including all the way at the very highest levels where we had for us I would call it a significant decrease in overhead, if you will, in terms of – at our more senior levels. And so I think we’re benefitting from all of those items and that’s helping the margin. So we feel pretty good about where we are in terms of cost and margin. We have a lot of transformation initiatives around cost and margins and obviously we want to make sure that we focus on growth and new business bookings as well."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. Not too much to add to that. Carlos has covered a lot of the points, but we’re seeing the operating efficiency come through. We’re executing on the transformation projects that we have in flight right now. Saw a little bit better than expected margin expansion in the second quarter, primarily some timing on some of the transformation work. But look, the teams executing really nicely on that, particularly on the procurement side and we’re focused on continuing to do that and building the pipeline of additional opportunities."
},
{
"speaker": "Carlos Rodriguez",
"text": "And just one little item in terms of color, you’ll see from the Q that credit to the organization – again, a lot of these transformation initiatives have been – some of them when we talk about them, they’re the big ones. We have dozens of other initiatives that are really improving the way we work automating things, taking out kind of non-value-added work. And when you look at our Q, you’ll see that really R&D and selling expense that have increased and we really are holding the line on the rest of our operating expenses due in large part to some of these initiatives that we have underway that are making work a little bit easier for our associates and also taking some of the work out. And so that’s the key because we want to make sure that we keep and we are keeping our NPS scores and our retention high. So that’s the magic formula there. I think keeping our expenses lower and improving margin if it results in lower client satisfaction, lower retention is not going to help us in the long term, but fortunately and again credit to the associates and to the management team, we’re actually pulling it off where we’re getting both of those things right now."
},
{
"speaker": "Kevin McVeigh",
"text": "Super. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-tsin Huang from JPMorgan. Your line is open."
},
{
"speaker": "Tien-tsin Huang",
"text": "Thanks. Good morning and congrats to Christian and Danny. I want to ask on – I guess a big picture question maybe for the team just balancing – you’re balancing the new tech investments, you just mentioned the transformation initiatives in the pipeline there, but just given that you’re early – you’re on track to get to your fiscal year targets this year – for fiscal '20, I’m sorry. Are you more willing to invest and stay in the short to midterm to maybe energize revenue growth and get that up a little bit more, or is your preference to still hit the higher end of your long-term margin target? Just trying to understand how you might be balancing revenue growth and margin expansion given where you are now?"
},
{
"speaker": "Carlos Rodriguez",
"text": "That’s a great question and I think our Board obviously has that discussion with us as well. And I think our Board is very long-term oriented. And so as much as we’re committed to hitting all individual components, it’s about balancing all of those factors to really create long-term sustainable growth. And we would love to have as much growth as possible. And when I think about where are some of those places that we could invest, as an example like in our sales organization, we are fully staffed. I think we’re probably a little bit ahead of our plans in terms of our headcount. So we clearly have some execution issues there, especially as we mentioned in our international and multinational businesses and some difficult compares over the last year, but we have really strong performance in the downmarket and in the midmarket and even in the domestic upmarket this quarter. So it doesn’t feel like we’re under investing. In fact, I’m pretty sure that we’re not under investing in sales and marketing. We also have a brand campaign that we’ve invested in over the last year which has added some expense. So I think we’ve put our money where our mouth is when it comes to sales and marketing. And then turning to the other obvious places where we could invest again for growth and product in our R&D organization, again, R&D grew but always say that we could spend more. But when I look at the year-over-year and even a three-year growth of our investments in our Next-Gen platforms and even some of the additional feature functionality that we’re adding to our existing product, including user experience, that’s again a place where our investments are growing. So you can see it from our depreciation and amortization line, when you see it in the Q and you can see it and hear it from our words that we are – you can see in our balance sheet in terms of capitalized software. So we believe that we are investing for the future and that we have – sometimes you have these timing issues because we do have a lot of enthusiasm, for example, about our Next-Gen platforms. But relative to the size of the company, this is the first year where we have – over the last 12 months is the first time we’ve actually got clients now live on our Next-Gen platforms, including Next-Gen payroll and Next-Gen HCM which we call Lifion. So we’re excited. We’re ahead of plan. But you have less than 10 clients on one of the platforms and call it 30 to 40 clients on another one of those platforms, so it just doesn’t make a difference yet in terms of the sales results or the revenue results, but it doesn’t dampen our enthusiasm around the future. So again, I guess the long and short of it is I don’t think it’s a lack of investment, but trust us that if we see an opportunity to invest for growth, we will take it."
},
{
"speaker": "Tien-tsin Huang",
"text": "Understood. And then just maybe on that point with the U.S. bookings, it sounds like it’s more international again. So I’m curious if this is more cyclical or is there some very broad base or is it more – just a few select clients just looking for a decision, just trying to better understand the visibility here on the international side?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think the most obvious one in terms of because it’s easy to see and quantify is in our large Global View multinational deals, we had a very difficult compare. Now, of course, that means that 12 months ago we were celebrating getting those deals and those sales and also we talked about it that that was giving us tailwind at the time when I think we did, but we’d have to go back to the transcripts. And now unfortunately now we have a very difficult compare. Now we just had our rethink meeting, we call it rethink meeting where we have all of our large multinational prospects and clients and I think we walked away with a very solid pipeline and a lot of enthusiasm. And so we feel good about hopefully the second half. And whether it’s the second half or next year, but any less enthusiastic about our multinational solutions but we just have a very difficult compare. So that’s an obvious place. We do have a couple of what we call in-country or best-of-breed locations that are also having some challenges that I think also have some difficult compares. But it’s hard to point at any kind of cyclical or product issues, because we’ve been strengthening our products overseas as well and I think investing in our sales force. So again – and European economy in particular seems to be at a minimum stabilizing if not improving. So I don’t think we can point to anything cyclical which is why we remain optimistic about the turnaround."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. So maybe I’ll just add a little more color and talk about it in terms of kind of U.S. bookings overall. I guess what I’d say is that, look, as you go into the year there’s always going to be areas where you do better and areas where you do worse than you may have planned. And thus far into the year we’ve seen particular strength in downmarket as we’ve noted in our comments. And actually internationally we’ve also seen strength in our Celergo streamline product which was quite nice to see. And as you saw, the multinational Global View is where we were seeing really the slowness or the weakness for the last two quarters now. It’s hard to say that it’s – we’re not really seeing that it’s attributable to any change from an economic landscape or environment standpoint but more so just seeing delayed decision making and it’s taking time to get these larger and sometimes much more complex deals through the decision making process. So we’ve seen it two quarters in a row. The pipeline looks pretty decent. We’ve got some of these deals in the pipeline, but remains to be seen exactly how much longer it takes to get them closed."
},
{
"speaker": "Tien-tsin Huang",
"text": "Okay. Thanks. See you in a couple of weeks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal from Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, guys. Thanks for taking my question. Could I ask you to give us kind of a brief macro overview in terms of what you’re seeing in your various markets given everything that’s going on in the world today, any callouts or any changes in the environment?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So when we look at – we have a few things that we obviously look at in terms of, call it economic macro indicators. The ones that are kind of relatively stable I would call them relatively stable or pace for control and wage growth and we look at obviously our own data as we get ready for this earnings call but we also have the ADP research institute that publishes its own kind of wage growth information and other factors around the economy. And I think all those signs positive point to what I would call stability. Our pace for control was slightly lower than it was the previous quarter in that trend, but we’ve seen that many times before where we go 2.5% one quarter and then we go a little bit lower the next quarter, but then it comes back to 2.5%. It does seem and we’ve been saying it and we’ve been wrong so far that as the labor markets tighten, there’s just not enough people available in the U.S. to continue to drive the kind of pace for control work that we’ve experienced. But obviously labor force participation has been ticking up slightly and for a variety of reasons that’s continued to hum along. And again, we see the same kind of indicators that all of you see around consumer spending, et cetera. So when we look across all of our domestic businesses, the pace for control growth seems to be a reasonable indictor that the economy is on stable ground. And wage growth we think should continue to accelerate, but that’s moderated slightly also for the last couple of quarters but it’s still at robust levels and should drive continued consumer spending and continued consumer confidence. We do look at pace for control also outside of the U.S. and I think there we again in our numbers see some signs of stabilization in Europe when it comes through on the unemployment and pace for control metrics there. So for us I think that everything looks – bankruptcies are – we’re seeing the same things at our own business that you see through external metrics. We don’t see any kind of elevation or increase in out of business or bankruptcies in our downmarket business, which is the canary in the coal mines, the first place you would see it. And our sales are also strong in the downmarket and the midmarket, so it doesn’t feel like the weakness we had this quarter is anything other than the lumpiness that we talked about around multinationals, because new business bookings would be another I think macro indicator that could weaken. We talked about our retention continuing to improve. Retention doesn’t improve in a bad economy, because it – that’s one of the things that really suffers as a result of out of business in a downmarket and that has stayed strong and solid. So no negatives that we can see in the macro."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. And you’ve sort of addressed this. Dovetailing with Kathleen's last answer and your answer just now, but can you talk a little bit about the competitive environment and that doesn’t manifesting itself as sort of pricing-related actions or an intensification of maybe more an increasing opposing bidders showing up for contract processes or new business models emerging out there. I’m just trying to explore whether there’s any other peripheral causes for some of I think what are timing-related delays in things like bookings especially maybe in Europe but elsewhere as well?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. So back to maybe a little bit of what Kathleen said about, there’s always – there’s positive and there’s negative. When it comes to competitors, it’s the same thing. We have a lot of competitors in each of our segments and some years we do better, some years we do worse, but we do have the overall balance of trade and our situation there is better. And you would think that based on our retention results and based on the comments we just gave you about new business bookings in our downmarket, midmarket and domestic upmarket business. So I think in North America I think if you look at those results, I would say our competitive situation has improved and it shows in our net balance of trade that we keep track of. Particular I would point out besides the continued strength in our downmarket business which has been growing market share here for a few years, if you look at our midmarket business, the last two quarters in particular were quite strong in terms of what we call new logos against a variety of competitors. But again, we can’t point to any one competitor because we have a large set of competitors. Some of them are geographically concentrated and some of them are national, but I think we’re very pleased with this quarter’s performance against those competitors in the midmarket. And then in the upmarket I would say that the addition of Workforce Now and call it the 1,000 to 5,000 range, so the lower end of our upmarket which we did a couple of years ago has really been an important generator of win-loss and balance of trade success for us in the upmarket. So we’ve had a robust growth in units and revenue and sales dollars from introduction of Workforce Now into that 1,000 to 5,000 which addresses a segment of the market where that platform really has a lot of appeal."
},
{
"speaker": "Ramsey El-Assal",
"text": "That is super helpful. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Hi. Good morning, guys. I just want to drill in a little bit more on the commentary around the delayed decision making. Have you guys been down selected for these contracts already or is the actual RFP process still kind of dragging along?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I wish I could tell you that I have that level of detail. I don’t. So this is really – it ties back to the comment I made before about we have a certain number of sales people in the field, we have a certain pipeline of dollars that we track year-over-year and we know what our sales results were the previous year in the same period whether it was the first quarter or the first two quarters of the year. So we are attributing the weakness to the late decision making. But this is not – we do have large contracts particularly in multinational and they definitely move the number from one quarter to the other, but we don’t have $50 million, $100 million contracts. It’s not that kind of business. So I don’t put – I know our sales leaders have that level of detail. I don’t have it available at my fingertips here."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, maybe you’re asking kind of have we seen any particular shift in where things are in terms of stages of the cycle and stages in the pipeline. Nothing that we’ve seen or heard that we can draw any conclusion from or point to any trends."
},
{
"speaker": "Carlos Rodriguez",
"text": "But we do have pipeline of deals – sure, we went into rethink this year with more participants, more attendees and a larger pipeline of dollar opportunity than we had the previous year."
},
{
"speaker": "Jason Kupferberg",
"text": "Right. I was just curious if you were just kind of waiting for some final signatures to make the bookings official or if it really is a matter of kind of just broader pipeline conversion. Just my second quick follow up just on the margins. You had the 70 bps up overall in the quarter, which was better than you expected, but at the segment level I know ES was up only 30 and PEO was down 30 if I’m not mistaken. So I think it was some of the below the line drivers that got you to the 70. Can you elaborate on those because I know you have some add backs in your adjusted EBIT margin calculation?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I can help maybe a little bit with that. As you know, the transformation initiatives that we are undergoing right now, some of those are sort of back office facing as well. So if you think about procurement and the workforce optimization initiative, those will have impacts to items that what we would deem other in the segment review. So corporate functions, for example, that’s where the delta probably sits for you."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay, great. Thank you, guys."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon from Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning. Let me add my congratulations to both Christian and Danny. With regards to the bookings, just looking ahead and thinking about the comparisons for the third and fourth quarters, are there things that we should think from a sequencing perspective in terms of they’re both – one’s up 10%, one’s up 11%. Is there anything that’s particular in one versus the other that would make it a more difficult comp or how should we think about the bookings over the next two quarters in terms of the sequencing?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think our number one goal is to obviously maintain the momentum we have in everything other than our international and multinational businesses. And again, these businesses not just because of the big ocean between them, they are fairly separate, right, in terms of how they’re managed in terms of sales and sales execution and so forth even though we have one worldwide sales organization. So we feel good that we’re going to be able to maintain the momentum we have in the rest of the business and then hopefully we get a little bit of tailwind with some of this stuff going our way in terms of the larger deals and some of the international stuff that we talked about. We do have in the second half, particularly in the last quarter, we do have a difficult compare because last year as you recall we purchased – it was a client-based acquisition – an acquisition of the company with a client-based acquisition of Wells Fargo’s payroll business and that helped our new business bookings and obviously translated into some revenue helping in a downmarket and it was part of what’s given us some tailwind from a revenue growth standpoint in that business. But since it was a client-based acquisition, it does – and it wasn’t an acquisition of a business, it does roll through our new business bookings and that was I believe in the fourth quarter."
},
{
"speaker": "Mark Marcon",
"text": "That’s [indiscernible] and that’s part of the reason for asking the question. So arguably the third quarter should be a little bit of an easier comp."
},
{
"speaker": "Carlos Rodriguez",
"text": "For some reason they never feel easy, but mathematically – you’re probably mathematically correct. But we have a lot of things that we’re cooking to make sure that we hit – obviously our intention is to achieve the guidance we provided and we don’t provide it lightly."
},
{
"speaker": "Mark Marcon",
"text": "Great. And then, Carlos, obviously you’ve got a longstanding set of experiences with the PEO market. How are you feeling about the longer-term trajectory of the market? What are you thinking or ex pass-throughs, the sustainable growth rate is there? And what are you seeing on the competitive front? It seems like there’s a little bit more private capital that’s coming into the space. So just wondering how you’re thinking about that space and the legislative outlook there?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, when you look at again the balance of trade information there, I feel pretty good about our competitive situation. So you always feel good about your own children, about your business, but you got to look at the facts, right. And I think the facts are pretty good for us in terms of our win-loss in our balance of trade. So that feels pretty good. And then the second thing that makes me feel really good particularly in this quarter versus last year and started to feel it last quarter is we really took a while to kind of filter through to make sure that we had our incentives properly aligned to make sure that our sales force is focused on obviously, number one, selling the right thing to our clients but making sure that they’re properly incented to make sure that the PEO is something that they raise, because it’s a difficult sale, because it’s a high involvement sale and so you have to have the right incentives in order for the sales force to really want to sell it. And so I think we did that and I think we talked about that. It’s got to be 12 months ago I think it was. So that feels like it’s starting to filter through and I think we talked about very strong double-digit new business bookings for the quarter which that’s the most important metric for the future to really give us confidence that the business model is still strong and intact. So that feels pretty good."
},
{
"speaker": "Mark Marcon",
"text": "Terrific. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Samad Samana from Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi. Good morning. Thanks for taking my question. So I wanted to maybe ask a question about what’s been going on in terms of bookings and how you’re thinking about guidance. Was guidance updated just to reflect what bookings has done so far this year or have you may be made some changes to the guidance framework to account for some more of the variability or variance that you’re seeing in multinational or international deals closing? So I guess is guidance more conservative or are you using the same framework that you’ve historically used? And then maybe just one follow up."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. Again, just a reminder just given the last comment that I made about the PEO that the guidance that we provide for bookings is ES only just to be clear. So if you look at our combination of our PEO and ES sales, it’s a better picture and a stronger picture in the first half than what our guidance would depict, because we provide guidance for the PEO based on average worksite employee growth, not on new business bookings. But having said that, I think the answer is just – this year like there’s no change in our thinking or our framework given that we just think there’s some large deal delays that I don’t think impact our deal in the future."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, no change in framework, no change in kind of the way we’re rolling up that forecast or the data we’re looking at. For example, we look at things like, okay, where’s business coming from in terms of by segment or by geography or new clients versus upsell to existing clients. We’re continuing to see fairly consistent trends in terms of the split between new and upsell. So no change in the framework. It’s more so just, look, we’ve seen slower out of the gates for two quarters now, lower than we expected in international. And so we thought it was – given that we’re six months into the year here, we thought it made sense to give you our best view. So, therefore, we narrowed the view for the year."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. Just one other comment in terms of something little bit quirky about as we changed our guidance to focus on ES worldwide bookings versus the PEO based on average worksite employees. The reason we gave you some color about the bookings for the PEO this quarter is even though we’re not going to change the way we do our guidance is in some respects what’s good for the PEO sometimes in the short term if business gets referred to the PEO, it can have in the short term a dampening effect on Employer Services. But we still had a great result in the downmarket and in the midmarket in Employer Services. So we definitely can’t point to that. But again, it is kind of important to keep in mind that it’s really the combination of those two that are driving overall ADP bookings and overall ADP revenue growth."
},
{
"speaker": "Samad Samana",
"text": "Great. That’s helpful. And then maybe if I could just ask one follow up. I think there’s a lot of excitement around Lifion coming off of HR tech and ahead of the Innovation Day that the company is hosting. So I just wanted to see if there’s any early patterns in terms of customer profile, whether it’s by size or whether – what do you think about existing products that they’re using, whether it’s Vantage or Workforce Now, maybe where are you seeing the early adopters come from and any type of profile commentary you could give on that would be helpful? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "So again, in our case everybody’s maybe approaches it differently, but we started off with smaller, less complex clients and now we’ve actually just sold I’ll call – consider it to be very large clients, so call it tens of thousands of employees. And so we’ve got a couple of very large sales that we’ve done and we have a bunch in the middle and then we have a few smaller ones that we did in the early days. Some of the business we’ve sold is obviously new logo, some of it has been as you mentioned off of some of our existing platforms. I don’t think that I can point to one particular platform and say that we’re not targeting – because we’re not trying to do migration or upgrades. We’re trying to go after clients that have the right profile and the right needs, right, so that we can make them happier ADP clients in the long term. So we know what the capabilities are of the platform and we try to target the clients and the prospects whether they’re internal or external in the appropriate manner. So I guess the best way to put it is it’s kind of across the board in terms of – from an internal view. And then in terms of industry or size of client, fortunately it’s also kind of a wide spread."
},
{
"speaker": "Samad Samana",
"text": "Great. Thanks for taking my questions. I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from David Togut from Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you. Good morning. There have been a few questions on bookings already, but this seems to be the main question of the day. The one question that I’d like to explore here is you’re still in the critical selling season which typically runs December to February. So is there anything you see in your pipeline in the U.S. or confidence on international close rates that gives you the confidence that you can close this critical selling season in better shape that we’ve seen obviously in the second quarter and the first quarter bookings results?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So again, at the risk of getting too much into the sausage making, if you remember like part of our business particularly downmarket and into some of our midmarket, we report our sales when they start. So they’re – like bookings and starts are basically equivalent. But when you get to very large deals, that’s where you’re really recognizing a sale and then the revenue starts at a later date. It could be six months, it could be 12 months. With a very large complex international deal, it could be 18 months later. So to your point about the critical selling season, pretty much now and done because January is the biggest month for us particularly for our downmarket business and the lower end of our midmarket business as well and the PEO. So just because of a natural cycle of the PEO, a large number of clients – by the way affect retention as well, but from a new business bookings standpoint January is the critical month for us. So the December-January period is the critical month for us in the PEO. And again, we’re in the middle of that quarter so it’s kind of hard to make comments about the quarter since the quarter isn’t done yet. But I think in a downmarket and in our PEO in particular, we had I’d say a good start to the quarter."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. The only other thing I would add and this is with regard to the ES bookings in particular, if you kind of look at the cadence of the year last year and this year and you look at six months year-to-date, we’re at about the same point this year as we were last year in comparison to where we ended the year."
},
{
"speaker": "David Togut",
"text": "So in other words, you see enough in the pipeline at this point and expect to close rates that drive your expectation of the 6% to 7% bookings target. Is that accurate?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think that – again, that is a level of detail to say that we have specific things in the pipeline. I think just to reiterate what we said before, so the number one driver of our confidence in our sales results in most of our business is headcount and execution and we believe we’re fully staffed and we have that headcount in place. In the place where we’ve had the variability or the volatility, if you will, it does come down to what you’re describing which is RFPs, pipeline, et cetera. Yes, we do believe we have the pipeline and the visibility of that pipeline to feel that we will close the gap for the rest of the year. But that’s not – in our SBS business, in our downmarket business, it doesn’t work that way. It’s really more about the volume – it’s a volume business. It’s really related to having the proper amount of headcount, the right digital marketing tools and spend and again there we feel good and we feel confident."
},
{
"speaker": "David Togut",
"text": "Understood. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jeff Silber from BMO Capital Markets. Your line is open."
},
{
"speaker": "Jeffrey Silber",
"text": "Thanks so much. I’m apologizing for asking another bookings related question. I just wanted to clarify something. I’m assuming that most of your clients are in calendar year-end as opposed to your June year-end. When you talk about the late decision making, does this mean that decisions are being deferred until another year from now or is it something that could happen within the next quarter or so?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So the good news for ADP is we have clients with all kinds of year-ends because we have a lot of clients. So really it spans the gamut. But you’re right that probably the average company in the U.S. has a calendar year-end. But I think most large companies and particularly multinationals which I would consider ADP to one of those, we typically when we are negotiating with a vendor for a large contract, we’d be focused more on their fiscal year-end rather than our own fiscal year-end. And so you’re right that there are some drivers around people’s budgets and so forth, but a lot of procurement departments tend to focus on the vendors year-end. And so we’ve seen historically – doesn’t mean that it will happen again this year – is that our fourth quarter for large domestic and especially for large multinational deals is a particularly important quarter because prospects are recognized that even though we’re not like a typical software company that negotiating towards a company’s fiscal year end at least in their minds tends to be a good time to sign deals or negotiate."
},
{
"speaker": "Jeffrey Silber",
"text": "Okay. I appreciate that --"
},
{
"speaker": "Christian Greyenbuhl",
"text": "Sorry, Jeff, just one reminder. I know we said it before, but the 1% impact on an annual basis in business bookings equating to that 17 million, these multinational particularly Global View deals, you can imagine that if you take that on a quarterly basis, it does have – just to put it in perspective that outsized impact. So from a framing perspective, it is a pretty meaningful adjustment if you have some of these deals that flow in from one quarter to the next given that sensitivity."
},
{
"speaker": "Carlos Rodriguez",
"text": "On the new business bookings results."
},
{
"speaker": "Christian Greyenbuhl",
"text": "On the new business bookings results."
},
{
"speaker": "Carlos Rodriguez",
"text": "Right. Because on revenue – as you just described, the irony of the situation is that it doesn’t have a big impact on revenue. We’re having issues with FX and with client funds interest in particular are hurting us. It’s not to deny that the bookings eventually will have some impact. The types of bookings that we have fallen short on in the first half are not particularly revenue impactful."
},
{
"speaker": "Jeffrey Silber",
"text": "Okay, that’s helpful. I do appreciate the color on that. And then I know you don’t give quarterly guidance, but you called out I guess the comp on the “acquisition” of the Wells Fargo payroll business last year. Anything else to call out between 3Q and 4Q that might affect the cadence of those quarters? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "In terms of new business bookings?"
},
{
"speaker": "Jeffrey Silber",
"text": "No, the overall business either revenues or margins?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, again, back to revenues and margins, the client funds interest issue and again going back to kind of the three-year guidance that we gave a few years ago, again, obviously not expecting a lot of sympathy from this crowd, but we’re probably about $100 million less than where we expected to be in terms of client funds interest and we’re obviously able to overcoming some of that as we go forward. So that in the second half is actually going to according to what I’m seeing in terms of our forecast. That’s going to start to have an impact on revenue growth as well, not a huge impact but where we were getting call it 1% lift in terms of revenue growth last year in the second quarter, I think this second quarter it was a much smaller number and in the second half it goes to probably no help to actually hurting our revenue growth. So that’s a headwind for us. But when I really take out all these issues; FX, client funds interest and other kind of calendar noise issues, when you look at the net impact of new business bookings starts, not new business bookings sales but new business bookings starts minus losses. So if you take retention and new business that have started, if you compare last year’s second quarter to this year’s second quarter and hopefully the same thing continues into the second half, we have a slight acceleration. It’s not a huge acceleration, but a slight acceleration. So that’s what makes me feel good about the strength in the underlying business because there’s a lot of noise happening in between with calendar and remember last year, we also had a one-time item that we mentioned that we called SUI pull forward in the PEO and accounting change that we were obligated to make that helped the second quarter revenue growth. And so all those things you have to kind of separate all those and get down to the core of the business and how the core business is performing. And on that basis, I feel good about the quarter and I feel good about the second half."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, the only other thing I would add to your question about kind of quarterly linearity in the balance of the year. Just as a reminder, in the second half of last year we had much, much more margin expansion in Q3 than in Q4. So, therefore, tougher comps for us this year Q3 versus Q4 in terms of margin expansion. So while we don’t give quarterly guidance, I would expect not a whole lot in Q3 and then potentially much more in Q4."
},
{
"speaker": "Carlos Rodriguez",
"text": "But again, back to like – in terms of what I mentioned in terms of some of these comparisons that were difficult versus last year’s second quarter, some of those things then get easier on a revenue standpoint, notwithstanding the issues from client funds interest as we pull forward actually helped last year’s second quarter, but depressed our third quarter. So that’s going to make an easier comparison. So we do expect slight improvement in our revenue growth in the second half."
},
{
"speaker": "Christian Greyenbuhl",
"text": "And just a brief reminder of the fourth quarter, so as a reminder, so we did the client-based acquisition. So that added some amortization expense, which will lap in the fourth quarter and obviously it would increase booking expense related to the client-based acquisition as well. So just keep that in mind. And then we obviously launched our brand campaign I think in the third quarter, but most of that was really the expense was kicking off in the fourth quarter as well. So that will be lapped as well."
},
{
"speaker": "Jeffrey Silber",
"text": "So I guess what you’re saying is you got some tailwinds in the fourth quarter."
},
{
"speaker": "Christian Greyenbuhl",
"text": "Yes."
},
{
"speaker": "Jeffrey Silber",
"text": "All right. Thank you for clarifying that. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. And we have time for one final question. And our last question will come from Lisa Ellis from MoffettNathanson. Your line is open."
},
{
"speaker": "Lisa Ellis",
"text": "Hi. Good morning, guys, and thanks for squeezing me in. Congrats to Christian and Danny from me as well. Carlos, you mentioned a couple of times and I think in the presentation the progress on both Lifion as well as the Next-Gen payroll and tax. Can you give an update on where you are on the deployments of the Next-Gen payroll and tax engines and how they’re impacting your business perhaps on the retention side or some of the other impacts? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. Thanks. Very excited about the Next-Gen payroll as well as the back office tax, but the payroll engine even though it’s somewhat back office I think has some positive qualities in terms of potentially helping us both in terms of – in the future both around bookings but also around efficiency and cost. I think we have somewhere between 30 and 40 live clients in our Next Generation payroll platform suite. As you can imagine, in comparison to the size of ADP, it’s a relatively small impact in terms of revenue retention or any of the other actual metrics. But enormous amount of enthusiasm around what we’re doing there, both at the team level. I think the team is incredibly enthusiastic and I think the rest of the organization is very enthusiastic as well in terms of what we’re seeing in the early days, especially around the flexibility of how quickly we can, for example, make changes and that’s just related really to the investments in the platform itself. So we’ve already kind of experimented and I think we maybe talked about this in the past with kind of federation as you call it in trying to have others develop and build on that platform. We’ve done the same thing on Lifion. And so now we have a team, for example, in Australia that is actually built Australian payroll and we have one or two clients on that as well. And so we’re incredibly happy with what we’re seeing. We’re really happy that we have live clients and this is the first year that – again, even though it was, call it 30 to 40 clients, this was the first time we’ve gone through year-end. So we actually had to go through a year end and do all the year-end closing activities, W2s, et cetera. So it’s still very early days just because of the size of ADP, but if we were a start-up, this would be like really great news. Like this was the – if this was a discussion about a start-up like we’ve got now a lot of technical risk behind us, if you will, and now we have scaling and execution risk that’s still in front of us. But that’s a hell of a lot better than where we would have been two to three years ago, and I think it could really add to our competitiveness here in the long run, not to mention to help a lot in terms of our back office costs. On the tax side, that’s probably more focused on back office cost and efficiency, but that also has an impact on our associates in terms of their ability to deliver service and also the experience that our clients have when we do things like amendments and tax notices. And so, again, the news there is very positive. We have – I think it’s close to 140,000 to 150,000?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes, about 140,000 clients."
},
{
"speaker": "Carlos Rodriguez",
"text": "About 140,000 clients. Obviously, those are smaller downmarket clients in a limited number of jurisdictions. But I think we’ve now – we’re up to 20 – more than 20 jurisdictions. Jurisdictions by the way refers to number of states in addition to federal, places where we can actually do the taxes. And so I’d say that that’s progressing also very, very well. Again, a highly flexible platform that we’re very optimistic in terms of what it can do to us down the road and see no scaling issues so far in either of those platforms."
},
{
"speaker": "Lisa Ellis",
"text": "Excellent. Thank you. That seems like a good point to end on. I’ll see you guys in a couple of weeks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. And this concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for any closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you. So as you can tell, we’re pretty – we’re pleased with the progress we continue to make on both the financials but also on our strategy. Obviously as we keep saying over and over again, we’re trying to build on our success in the past but also transform for the future here so we can continue to deliver sustainable growth for many years to come.I also want to mention that this time of year as somebody mentioned about this being a busy time of the year for us from a sales standpoint, it’s also a very busy time for our associates who deliver service and also our year-end commitments to our clients. It’s very long hours and very hard work and I really appreciate the commitment of our associates. And again, it’s one of the great differentiators we have in terms of being able to deliver that level of service, especially at a very busy time of the year like we are right now.Obviously, we wouldn’t be able to be successful in the long run without strong products. And so when we have our Investor Day, we’re going to hopefully lay out a plan for you about how the sustainability of the strength of ADP will be I think helped by the investments we’ve been making over the last five years in our next generation products.So we look forward to spending time with you on February 10 to discuss all of these innovations that we’ve been investing in, in addition to the Next-Gen platform and also discussing a little bit of our vision for the future about how we expect work to change and the HCM industry to change.And with that, I want to thank you once again for your interest in ADP and for joining us today. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 1 | 2,020 | 2019-10-30 08:30:00 | Operator: Good morning. My name is Crystal, and I’ll be your conference operator. At this time, I would like to welcome everyone to ADP’s First Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]I will now turn the conference over to Mr. Christian Greyenbuhl, Vice President, Investor Relations. Please go ahead.
Christian Greyenbuhl: Thank you, Crystal. Good morning, everyone. And thank you for joining ADP’s first quarter fiscal 2020 earnings call and webcast. With me today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.Earlier this morning, we released our results for the first quarter of fiscal 2020. The earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today’s call as well as our quarterly history of revenue and pre-tax earnings by reportable segment.During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description and the timing of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measure can be found in our earnings release.Today’s call will also contain forward-looking statements that refer to future events and, as such, involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations.Before turning the call over to Carlos, you would have noticed in today’s earnings that we made a correction this quarter to certain PEOs zero margin pass-through revenues that we have previously reported on a gross basis and which going forward will be reported on a net basis.For consistency, we also revise prior periods and the total impact to fiscal 2019 revenues and operating expenses was $65 million. This does not materially impact our previously reported growth rates and does not impact consolidated earnings before income taxes, net earnings, consolidated financial condition or cash flows. To better assist you, we have also included the details of these adjustments in the appendix to the presentation that accompanies today’s call. Our supplemental schedule of quarterly history of revenue and pre-tax earnings by reportable segments also reflects the impacts of these changes.Accordingly, our reported results and full year outlook and the following commentary from both Carlos and Kathleen also fully reflect the impact of these adjustments. As always, please do not hesitate to reach out should you have any questions.And with that, let me turn the call over to Carlos.
Carlos Rodriguez: Thank you, Christian. And thank you everyone for joining our call. This morning we reported our first quarter fiscal 2020 results with revenue of $3.5 billion for the quarter, up 6% reported and organic constant currency. We are pleased with this revenue growth, which despite some higher than expected unfavorability in FX was in line with our expectations.Our efforts to enhance our operating efficiency along with your focus retention on transformation help us deliver 60 basis points of adjusted EBIT margin expansion for this quarter. This margin expansion was in line with our expectations and we are happy to see the progress that our associates continue to make in helping to improve our productivity, while also improving client satisfaction, particularly given the difficult margin compare given our strong performance in the first half of fiscal 2019.Together with share buybacks and a slightly lower than expected adjusted effective tax rate these results help us deliver 12% adjusted EPS growth this quarter, which was slightly ahead of our expectations.Moving on to Employer Services new business bookings, this quarter we saw solid growth across our US markets, which helped drive 6% growth in the quarter. With regard to our international and multinational sales opportunities, we did see some impact from timing as certain deals that were expected to close this quarter are now expected to close slightly later in the fiscal year. Nevertheless, we are maintaining our full year Employer Services new business bookings guidance of 6% to 8%.Now turning to Client Service. We continue to drive improvements in our client satisfaction scores across our businesses. And this quarter, we were especially pleased with our progress in the upmarket with improvements in both our implementation and overall client satisfaction scores.We continue to take positive steps to transform our service organization and enhance the client experience, and with this continued progress in mind, we remain confident in our forecasted full year fiscal 2020 retention increase of 10 basis points to 20 basis points.We are pleased with our start to fiscal 2020 and with the continued momentum in advancing our strategy to simplify how we do business, deliver innovative solutions for our clients and associates and drive sustainable long-term growth for our shareholders.We understand that a key element of building our success in the market is in the capacity to be agile and to anticipate and adopt to change. Innovation is at the core of this need and it’s a job that's never done. While we are incredibly excited about the solutions, we are delivering in the market today to help clients meet the needs of an evolving workforce, we're even more excited about the future. As the workforce continues to evolve, organizations are looking for ways to manage their entire workforce through a single user experience.Today companies of all sizes are using a variety of applications to get work done. What they need is an open HCM platform that allows easy integration with third-party solutions and is also flexible enough to handle the increasingly dynamic nature of work, one where workers are organized around how work happens in teams, often with individuals working on multiple teams at the same time. Aided by insights from the ADP Research Institute, our Next Gen HCM platform is designed at the core to address these needs.A few weeks ago I had the opportunity to attend the HR Technology conference in Las Vegas where our Next Gen HCM platform and used innovations took center stage. As I met with clients and HR professionals, I was incredibly proud of the reception and recognition that we received for delivering innovative solutions that address how and where work is done today.I was especially proud when our Next Gen HCM platform won both the HR Executive Top HR Product of the year award and the Awesome New Technology award, a remarkable achievement and a testament to ADP's commitment to innovation.Back in September, we also had the opportunity to showcase some of the differentiating features of ADP's Next Gen platform to HCM industry analysts when we hosted our 2019 Industry Analyst Day. At this event, we spent time sharing some of the more meaningful and differentiating elements of our technology, such as, the use of graph database technology that powers the unique ability to dynamically configure teams while enabling actionable data and insights around relationships or our meta data driven design approach that allows solutions to be tailored by the client via local rapid development through a drag-and-drop interface.In addition, our solution was designed from the beginning to be public cloud native. This among other advantages helps improve resiliency and uptime.Finally, our solution is designed to be global. Companies that are expanding globally, or that would like to more effectively manage their existing global workforce are an ideal target for ADP Next Gen HCM.We were equally proud and excited to see, the recognition our efforts from industry experts, at this event. And while it is great to receive these awards and to recognized by industry experts.It is even more rewarding when we see our efforts translate into recognition and acknowledgment from our clients and prospects. As we work to scale our solution and its capabilities, our Next Gen platform is also building momentum in the market and continues to progress in line with our expectations.As an example, earlier this quarter, at our Industry Analyst Day, we shared details of a successful go live with a 6,000 employee U.S. company that chose ADP's Next Gen HCM platform for its talent capabilities. And the ease of the ease of integration with the client's own internally developed on-boarding tool.At the same events, we were also pleased to share that we have recently signed a 65,000-employee global enterprise that was looking for an HCM platform, capable of handling its growing workforce.With that said, our focus on innovation is not limited to our Next Gen HCM platform. We have also increasing the leverage, machine learning to enhance our core strategic advantages in payroll and big data. As an example, we simplified 21 million raw job titles from our unmatched data like, and normalized them down to 2,400 job categories, ultimately enhancing both this functionality and accuracy of our ADP data cloud benchmarking.Customers are using our compensation and HR benchmark data to make substantial changes to their business. For example, one of our clients was able to leverage our turn over benchmark data, to identify opportunities for improvement, and ultimately to reduce their turnover by 20%.While another saw its front line managers use our Executive and Manager Insight’s mobile solution, to help reduce overtime cost by 6%. These equate to real multimillion dollar operational savings that are being enabled by ADP's data and products.Also to enhance the efficiency of our implementation organization, we are designing our NEXT GEN payroll engine to automatically recognize, convert and classify different formats, an input, from prior payrolls and so payroll policies.We believe that this will give us an advantage when we on board new clients, because it will enable the automation of various elements of the implementation process. And allow us to share best practices with our clients.And finally, we also continue to drive innovation for our frontline associates, in an effort to transform how we work, by reducing low value, client contacts, while still delivering value-added service.With this in mind, last year, our support organization and the downmarket rolled out expanded checkbox functionality, which today is capable of handling over 100 different inquiry types for our more than 640,000 small business clients.ADP's unique ability to meet the needs of clients and their workers today while anticipating their needs in the future, have been hallmarks of our success over the past 70 years. And I believe will driver sustained growth in the years to come.And with that, I’ll turn the call over to Kathleen, for commentary on our results and fiscal 2020 outlook.
Kathleen Winters: Thank you, Carlos. And good morning, everyone. As Carlos mentioned, we're pleased in transforming our business, in order to simplify, innovate and grow. Our strategy is working, and we are off to a solid start to the year.This morning, we reported first quarter revenue growth in line with our expectation, at 6% on a reported and organic constant currency basis, which includes a slightly greater amount of FX unfavorability than we previously anticipated.Our adjusted EBIT increased 8%, also in line with expectations. And adjusted EBIT margin was up 60 basis points compared to the first quarter of fiscal 2019. We're pleased with this margin improvement, which benefited from cost savings related to our workforce optimization and procurement transformation initiative as well as continued efficiencies within our IT infrastructure.These benefits were partially offset by incremental brand spend as well as selling, amortization and PEO pass-through expenses. This margin performance is particularly gratifying given the difficult margin compare that we faced in the first half of the year.As a reminder, this resulted from the very strong performance in the first half of fiscal 2019, resulting from the outside benefits related to our voluntary early-retirement program due to slower than anticipated plan to backfill at that time.Our adjusted effective tax rate decreased by 100 basis points to 21.2% compared to the first quarter of fiscal 2019. The decrease was mainly due to an increase in tax incentives related to lower R&D efforts and decreasing reserves from certain tax positions.Adjusted diluted earnings per share were 12% to $1.34. And in addition to benefiting to our benefiting to our revenue growth, margin expansion and a lower effective tax rate was also aided by fewer shares outstanding compared to a year ago.Let’s move now to our Employer Services segment and interest in funds held for client. Employer Services revenues were in line with expectations and grew 4% reported and 5% organic constant currency.Interest income on client funds grew 13% and benefited from a 10 basis point improvement in the average yield earned on our client fund investments to 2.3% and growth in average client fund balances of 7% to $23.7 billion.This growth in balances was driven by a combination of client growth, wage inflation and growth in our pays per control partially offset by lower SUI collections. Our Employer Services same-store pays per control metric in the U.S. grew 2.4% for the first quarter.Employer Services margins saw an increase of 50 basis points from the quarter. The increase in margins this quarter which enabled by the same factors I mentioned earlier when discussing our consolidated results.Our PEO segment revenues grew 8% for the quarter to $1.1 billion with average worksite employees growing 7% to 563,000. Revenues excluding zero margin benefits pass through grew 7% to $358 million and continued to include pressure from lower workers' compensation and SUI costs and related pricing.Margins decreased about 70 basis points for the quarter largely due to changes in ADP Indemnity loss reserve estimates, which drove about 60 basis points of pressure resulting from a smaller benefit in the first quarter of fiscal 2020 compared to fiscal 2019.As a reminder, with ADP Indemnity results not reported in the PEO, it is normal to expect some volatility in our quarterly PEO margins as a result of changes in our workers' compensation loss reserves.Let's turn to the outlook for the full year and start with a consolidated view. We continued to anticipate total revenue growth of 6% to 7% in fiscal 2020. This revenue outlook assumes a more elevated level of FX on favorability for the remainder of fiscal 2020 relative to our previous expectations.With the recent volatility and overlying fixed interest rates, we now assume interest income on client funds of $570 million to $580 million and interest income from our extended investment strategy is now expected to be $575 million to $585 million.With the continued negative interest rate environment in the Eurozone, we made the decision this quarter to wind down our two Eurozone related client money moving activities in France and the Netherlands.As a result, we have liquidated our Dutch client funds portfolio and we will be liquidating our French client portfolio by the end of fiscal year 2020. We therefore now anticipate our growth and average client funds balances to be about 4%, as compared to our previous forecast of 4% to 5%. This decision is excusive to France and the Netherlands.We continue to anticipate our adjusted EBIT margin to expand basis points 100 basis points to 125 basis points. And we now anticipate our adjusted effective tax rate to be 23.3%. The rate includes this quarter's unplanned tax benefit from stock-based compensation related to stock option exercises.It does not however include any further estimated tax benefit related to potential future stock option exercises given the dependency of that benefit on the timing of those exercises. With these slight adjustments to our outlook, we continue to expect adjusted diluted earnings per share to grow 12% to 14% in fiscal 2020.Moving on to the segments, let's take a look at Employer Services. We continue to expect 4% to 5% revenue growth in our Employer Services segment. This outlook includes the anticipated impact from my previous remarks regarding changes in FX and adjustments to our interest income on client funds outlook. We continue to anticipate pays per control growth of about 2.5%.We also continue to expect Employer Services new business bookings growth of 6% to 8% and for our Employer Services revenue retention to improve 10 basis points to 20 basis points. I'd like to remind you as I commented in the prior earnings call that there is volatility inherent in the quarterly Employer Services bookings metric from larger international and upmarket deals.And I’d also like to remind you the difficult compare in the fourth quarter of fiscal 2020 resulting from our strong performance in the fourth quarter of fiscal 2019 due in part to a client list acquisition.Moving onto margins. We continue to expect our margin in the Employer Services segment to expand by 100 basis points to 125 basis points. As a reminder with a difficult compare resulting from our strong margin performance in the first half of fiscal 2019, we continue to expect a much stronger margin increase in the latter half of fiscal 2020.Regarding our PEO segment, overall, our outlook remains unchanged. We continue to expect 9% to 11% PEO revenue growth in fiscal 2020 and 7% to 9% growth in PEO revenues excluding zero margin benefit pass-throughs, both driven by an anticipated growth of 7% to 9% in average worksite employees.Because of the slower growth in the fourth quarter of fiscal 2019, we continue to expect the growth in our average worksite employees to be at the lower end of our guidance range in the first half of the year with a gradual reacceleration of our growth rate as the year progresses.As we also discussed last quarter, we continue to expect lower workers' compensation and SUI cost and related pricing to pressure our total PEO revenue growth. For PEO margin, we continue to anticipate margins to be flat to down 25 basis points in fiscal 2020, which continues to include approximately 50 basis points of pressure from smaller favorable reserve adjustments in ADP Indemnity in fiscal 2020, compared to fiscal 2019.Before I hand the call over for Q&A, I'd like to share that on February 11, we will be hosting an Innovation Day, focused on technology, strategy and showcasing some of her latest innovations.A few of you have had the opportunity to see some of those developments during HR Tech. Others may have had a glimpse from some of the industry analyst notes, and tweets following our September Industry Analyst Day.The February 11th event would be specifically for the investment community, to share our product and service innovation, and have a dialogue around the progress that we continue to make, including how these innovations help to differentiate ADP in the market.We look forward to welcoming you then, and please be on the lookout, for further details in the near future.With that, I'll turn the call over to the operator to take your questions.
Operator: Thank you. [Operator Instructions] And our first question comes from Ramsey El-Assal from Barclays. Your line is open.
Unidentified Analyst: Hi, good morning. This is Damien on for Ramsey. I wanted to ask on the Employer Services bookings guidance. I know you both talked about it at lengths. But I just wanted to see if you could give anymore color on just the quarterly cadence.I know Kathleen you mentioned difficult comps coming up in Q4. But maybe just any granularity that you could give would be great. And then, just overall level of confidence to kind of get to the midpoint of that 6% to 8% guidance?
Carlos Rodriguez: I'll let maybe Kathleen make a comment as well. But again, I think if you that last year's pattern, our second quarter last year was soft. So that would be the easier compare. And the fourth quarter because of the acquisition of the client base acquisition from Wells Fargo, I think, it'll be a little more difficult.But we obviously try to apply some judgment on these things. And we obviously have information about individual unit performance and kind of what's happening across regions.And I think what we try to provide in some of the color our comments is that this quarter we had very strong, what I would call strong results in our core US businesses, SBS, major accounts and national accounts. And we really had some weakness with international and multinational. And we’ll look into the details of that. There were a few large deals in prior year, as well as some deals that didn't close in the first quarter as expected. So that would give us some confidence that I think, we’re still on track for the year, despite these kind of quarterly fluctuations.Because I think as Kathleen's said, and we said many times for us bookings is certainly more volatile than revenues. Obviously, we have the recurring revenue model. But on bookings the clock goes back to zero at the beginning of every quarter.But we see some underlying strength that gives us some optimism. But we did have some weakness in the international multinational and that is something that we’re looking at. I don't think that it's any major change in the economy, because it’s been kind of a difficult in the economic climate for a while in Europe where we have a large business. So, again as I look at the detail, it just looks like, typical lumpiness in our bookings.
Kathleen Winters: Yeah. I mean just to follow-up on with that. Look you’re always going to have some degree of lumpiness in your quarterly bookings number right, from at least a couple of things, right?If you’ve got larger multinational type deals, that's going to cost some lumpiness. And then you’ve got the year-over-year comps issue and you’ve got a tough comp or an easier comp. So you’ll always have a little bit of that going on. And so importantly, while the quarterly numbers obviously important I think even more important to look at a longer term trend, right?When you look at how we've been doing in particular with last year having a really strong and I think record, right, number of $1.6 billion for last year and then 8%. And then on top of that another what we think is a really solid number of 6% in Q1, when you look at that longer period of time, we’re actually feeling pretty pleased with the start to the year.Now there is of course always pockets that are stronger and others that are maybe a little slower out of the gate and Carlos mentioned on the outside of the US having a little bit of lumpiness there, but net-net we're pretty pleased with the start to the year.
Unidentified Analyst: Yeah. That makes sense, and great. Then maybe I’ll zoom out a little bit and ask on overall sort of product strategy at the large enterprise level. I just wanted to dig in and see how you see your products suite revolving there just sort of in the context of you continuing to invest advantage over time and then your strategy - your new strategy around the Lifion offering.
Carlos Rodriguez: Don't forget we also again one of the highlights for the quarter and frankly it's been a highlight in trying to kind of signal this. I am not sure how it has landed yet, but our decision to use Workforce Now with the lower end of the upmarket, so call it that 1,000 to 3,000 even though frankly it can go higher. We have a couple of clients that have 8, 9,000 employees that are on Workforce Now. But that decision has been great competitively in growth wise. So we are selling a lot of units in that kind of lower end of the upmarket.So the ability to use Workforce Now for - and it fits certain types of profiles clients and you can probably imagine generally speaking they are large, but simpler and Vantage clients would be more complex and have more complex needs like complex benefits and talent requirements and so forth.And Lifion it’s still obviously an early adopter type of product, even though we're getting great traction and we told you what - how we've done in terms of new sales given the size of ADP, it’s really Workforce Now and Vantage Now that are affecting the numbers in terms of the bookings and the revenue. And I think again in case I wasn't clear like that we had a good quarter even in national accounts in the upmarket primarily as a result of really good results from Workforce Now.So the strategy is the same strategy we’ve had all along, which is I think we’ve figured out that we have a really great solution for a segment of the market. I think last quarter, I mentioned that we have an external third-party do some analysis for us and in terms of segmenting the market, and as usual one solution doesn't fit the entire market. And what we found was that a pretty good size percentage of the market can be addressed by our Workforce Now solutions and that's what we're doing.And we were right. And the analysis was right. And we think the Vantage still addresses another segment of the market and Lifion is more kind of the emerging solution that we obviously have placed a lot of confidence and a lot of a - and a big bet on for the future. But as of today it's really not having a big impact on the numbers.And I also just in terms of just your question about market dynamic when we had this meeting in Las Vegas at the HR Tech Conference that I mentioned in my comments again, early positive signs we had for anyone who was there, I think some of our – some industry analysts and some financial analysts were there, I think, it was pretty clear that we are making an impact in the market. So our lead flow was multiples of what it has been in the past in the upmarket because of the interest in Lifion.But I just want to be cautious in terms of pace here because relative to our $15 billion in revenue, this is not next quarter or three quarters from now. But the signs are very, very positive in the long-term as Kathleen mentioned. If you focus on the long-term, I think, Lifion - the traction we're getting in Lifion is very, very encouraging.
Unidentified Analyst: Yeah. That's, that's really good. We'll keep watching. Thanks.
Operator: Thank you. Our next question comes from Kevin McVeigh from Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thank you. Hey, you’re able to reaffirm the revenue despite the lower client interest on kind of funds and extended investment. Was there any kind of offset there particularly given the incremental headwinds and FX? It seems like you're able to reaffirm the guide despite those couple of headwinds.
Carlos Rodriguez: You know, I think, it goes back to what we're saying about the some of the underlying performance of the business. So as an example, even though we don't give quarterly guidance on retention, you could tell from our comments, I hope that we felt pretty good about it this quarter, so that you could probably read into that it improved prior to - compared to last year's prior first quarter.And as I mentioned before retention if you do the math has a pretty outside impact on our business bookings in terms of revenue and frankly big impact on margin because for equal growth you don't have to implement as much business.And so there's a lot of different moving parts that go into the pot here, but I would point that one out as an area of strength. I think we've talked about the strong performance in our core U.S. businesses.So for the first quarter we had kind of our three core businesses performing very well in terms of bookings as well. So it's a process from the ground up of us building this forecast, first of plan and now the forecast and I think we have some optimism that we're still in that range.And but I just want to point out the retention story because three or four years ago when it was going the other way, I pointed out that it takes four to five points of sales growth of new business bookings growth to offset one point of retention just because of the way the math works. And so - now as retention - as you get a little bit of improvement in retention that helps a lot in terms of our growth rate.
Kathleen Winters: Yes. So as Carlos mentioned there's a couple of things that obviously gave us some headwind or unfavorably versus what we would have been expecting particularly the FX and the interest from client funds. However, when you look at operationally the fundamentals things look really good.As Carlos said retention is on a steady track upwards now gets harder and harder the higher up you go. But we're happy to see some level of increase in the first quarter here, and bookings were solid for the quarter.
Carlos Rodriguez: And I would just add on the client funds interest, we do have some of this - for the year it obviously has an impact as we guided - we gave you the information in terms of we are slightly below what we expected to be, but it's not a huge number for this fiscal year.
Kevin McVeigh: Great. And then just Carlos to highlight the retention a little bit more because obviously really nice progress there. Any sense of just the success across the enterprise versus the mid-market versus kind of downstream a little bit the range on those?
Carlos Rodriguez: Yes. I do have some sense. My sense is that, we're improving a lot. So we show some signs in terms of the win-loss, what we call balance of the trade, some encouraging signs particularly in our mid-market business.So again the mid-market now is performing - you got to be cautious because there's definitely a forward-looking statement. But it's performing according to the script, in the sense if you remember we took a lot of pain and lot of effort to migrate all of our clients on to one single strategic platform which is Workforce Now.And when you look at the history of what happened in our SBS downmarket business. When we did that, we were optimistic and hopeful that we would have the same kind of traction in our mid-market business. And it's beginning to show now.So we have improving retention now for it feels like six or seven quarters somewhere in that range. I am being told more. So once we kind of finish the migration and got through that difficulty. I think we have steady improvements in retention.This quarter was the second highest retention we've ever had, in our mid-market business. And in this quarter what was very encouraging is to see the level of activity in new business bookings. So, the combination of those two things gives us a feeling of optimism for what is - one of biggest and more profitable businesses.
Kevin McVeigh: Awesome, thank you.
Operator: Thank you. Our next question comes from David Togut from Evercore ISI. Your line is open.
David Togut: Thank you. Good morning. Could you comment on, the drivers that you expect to move your PEO revenue growth up from 8% in the recent quarter to 9% to 11% which is your guide for this year?And then, just as a follow-up at your Analyst Day last year you gave a multiyear guide of 12% to 14%, CAGR for your HRO business, and you're trending well below that now. Did you anticipate the time that the growth rates in the earlier year’s double-digits effectively, would slow towards the end of that period? Let's say, mid- to high single digits?
Carlos Rodriguez: Well if I can start with the second one first, since I was there in the analysts and not fair to ask Kathleen. I think we have built the guidance for or I guess the estimates for are three years. We had as I think we've mentioned this couple of times, we had certain expectations around our pass through revenue and inflation of those numbers that had some historical precedent, both around workers compensation and health care.And I think literally within two months of that, the picture changed, and we communicated that very clearly and very transparently and frankly, without any anxiety because it doesn't have any impact in our EPS. So if you remember the Investor Day, I think it June and I think when we had our August earnings call, I think, we brought down significantly for that year at least, the growth rate for the PEO mainly - primarily close to almost based on lower inflation.Now on top of that, we have had some slowdown in worksite employee growth, which is the core driver underneath of the real growth of the business. But I think a main driver of this differential from what we communicated at our Investor Day has been has been the lower inflation of the pass-through, which again doesn't concern us, in a big way because it’s zero margin and doesn't really affect our profitability in terms of in terms of dollars.In terms of your question about the behavior of the quarters and so forth, probably beyond the scope of this call but, it's just kind of math in terms of when we have our open enrollment for healthcare in kind of May, June timeframe which we’ve again communicated very transparently when that happens and what happens when that occurs, you tend to have some client churn.So that drops your worksite employee growth and obviously revenue growth for the PEO. And then as bookings continue to - assuming they continue to be robust, you start to build that up again. And then at the end of the calendar year-end, you have another event at year end where you have some churn in the client base in terms of clients that choose to leave at the end of the calendar year because that's more natural, but we also have historically a lot of bookings in January as well.So we've been doing this for 20 years and we see a difference or a change we would obviously communicate that. But I think we're just kind of dropping the numbers in as they are supposed to come in terms of -- based on historical trends.And David I would just add, so last quarter we did say that we would expect to start a year from the lower end of the range and then grow into the range as the year progresses because obviously, we started with a somewhat of a weaker ending worksite employee number in the fourth quarter last year.
Christian Greyenbuhl: And I think it's probably worth asking I mean, adding just again in full transparency, I think we said it last quarter our health care renewal was slightly higher than the previous year. So I wouldn't - it wasn't anything out of norm in terms of historical, but it was higher than the previous yearAnd when that - when we have that happen you tend to get more shoppers and more -- health care cause is a large part of what a small business pays in their overall cost structure of their workforce. And so they tend to shop and look around and so forth, and so we have a little bit more churn than I think that we have had in the prior year.The good news is for us is that we have that issue, but we've been dealing with that for 20 years, but we don’t think any risk on health care. So whatever we get in terms of price increases through the carriers, we pass those through 100% which is why we call zero margin pass-through.So that eliminates any risk or any surprises in the future, but it also means that you have to have frankly the courage to just pass those costs through and let the chips fall where they may.And the chips fell and I think you can see from the numbers that the chips didn't fall off the table, because there wasn't a collapse in the because of a huge slowdown, but we definitely had our speed bump and now it's really through new business bookings that we have to regain the momentum and kind of have that ramp up again and reacceleration of the growth rate.
David Togut: Understood. Thank you very much.
Operator: Thank you. Our next question comes from Bryan Bergin from Cowen. Your line is open.
Bryan Bergin: Hi. Good morning. Thank you. Carlos, wanted to ask your macro outlook on the current employment market. It sounds encouraging based on the performance of the business, but I'm curious how much of that is due to the improved competitive product position versus the underlying demand you might be saying?
Carlos Rodriguez: It's a great question because it's an important one for us to keep kind of asking ourselves, we do have some things that you know if they turn on us would put pressure on us, interest rates obviously is one of them, pays per control, et cetera.But we're also feeling pretty good about our product situation and I think our competitive situation in the marketplace going forward here. So it is -- that's going to be a very important question for us to stay focused on here for the next few quartersBut as of today, when you look at our lagging indicators so pays per control, it doesn't look like there's a slow down or a big issue, but if you look at the same things that everyone else would look at that we have access to and you have access to in terms of leading indicators like confidence indexes or NFIB/ISM - those types of things Michigan confidence.You know those, there’s some concern there and some reason for caution. In our numbers, the only place where we have seen some little bit of softness and pace for control and it doesn't get reflected in our and what we report because as we've disclosed prior this is our Autopay base which is a very large base of both large employers, midsize employers and smaller employers.But we have most of our employer in our run platform and there we've seen a slight down tick in pays per control growth over the prior year. It doesn't - when you look at over the 10-year history, I don't think it's anything to be alarmed by, but - when you look at other factors it certainly a cause for caution. I just happened to look I think, in the last couple of days at NFIB and that's softened significantly, but it's still well above recession levels.And so I think we’re all kind of trying to figure out the same thing here which is a soft patch or is it kind of a trend line. But with - the Fed easing and the consumer still strong like right now our plans are that we kind of work our way through this soft patch.
Bryan Bergin: Okay. That's helpful. And then Kathleen on just margin expansion progress, any further details you can share on the various transformation initiatives? And as you look across the various resources were you seeing the most yield, and anything surprising you as you've had just more time in the seat?
Kathleen Winters: Yes. Thanks for the question. Obviously, something that I'm really focused on in the organization is really very focused on as well. I mean just to kind of get some context and kind of big picture when you step back and take a look at what we've done in the last couple of years.I mean remember back in 2018, we were at margin rate of 20.7%, with a small amount of margin expansion in that year and then in 2019 when -- fiscal 2019, when we were executing on some really big and meaningful transformation initiatives.You saw that really outsized margin expansion of 160 basis points, and know -- as a reminder the guide for another 100 basis points to 125 basis points for fiscal 2020.So a track record here really consistent margin expansion. And as we start in fiscal 2020 with Q1 that 60 basis points of margin expansion we're really happy to see that and very happy that we're on track with how we planned the year.Now there's a lot of execution and a lot of work behind the scenes going on but I'd point out that number one as I started my comment there's a lot of energy around it and a lot of alignment. And that energy and alignment is around both executing what I call in-flight projects as well as developing the pipeline for the future. So that's really exciting.I talked about on the previous call that most of the margin expansion from a transformation perspective this year is coming from what we're calling workforce optimization and procurement initiatives both are very much on track from a workforce optimization standpoint.Think about that in terms of spans and layers exercise if you will and particularly targeted to management layers. So that's kind of on track and already executed with most of that benefit being in fiscal 2020 not much from that coming beyond fiscal 2020.And then procurement transformation there's a lot of projects there as we look at - across all parts of the organization and spend as we look at volume and we look at policy and we look at our ability to negotiate smartly with vendors and suppliers. There is opportunity there and there is a lot of execution going on.So a lot of work execution going on. So, a lot of work by the organization, we're happy with what the teams are currently doing and happy with the progress, but more to do.
Bryan Bergin: Thank you.
Carlos Rodriguez: Hi, Brian. I just - one thing just to add, as you think about the margin because your question I think was related to margins in particular. And obviously what's driving those. But last year, the first and second quarter but particularly the second quarter was a very strong growth in margin in that time.And just a reminder, we also had pressure from M&A at that time. So, just layer that one on to it as well when you think about margin cadence last year versus this year.
Bryan Bergin: All right. Thank you.
Operator: Thank you. Our next question comes from David Grossman from Stifel. Your line is open.
David Grossman: Thank you. Good morning. I wonder if I could just follow-up with a couple of questions on the PEO. Each of your kind of larger peers in that space have identified some type of incremental issue with their health insurance book in their most recent reports.And I know you mentioned, just higher health premiums and obviously you pass everything through in your model. But is there anything else, you're seeing in the market place that may be impacting the cost of delivering health insurance in the PEO industry?
Carlos Rodriguez: No.
David Grossman: All right. So for you, it's just the straight higher premium and not seeing anything else? I guess, you don't really see the claim that is around in terms of how claims may be impacting on a cost?
Carlos Rodriguez: You will see individual employee, claims data but we of course very, very carefully looking at claims data to get some sense with our carriers and partnership with our carriers, what's happening in terms of trends.Maybe I should be a little bit more, clear on this, premium increase issue. So, I'm not going to give you the exact numbers. I don't think we want to get down that rabbit hole. But the change from this renewal to the prior renewal was call it one to two percentage points higher, on average than the prior year. So if, the previous year the average renewal increase was 6% then the next year it was it was it was 7% or 8%.And that increase that year that was slightly higher was completely in line with the prior six or seven years. So it wasn't -- so there are some ups and downs. But the prior year was one that was actually exceptional. I think we were very clear about that. I think we talked about that in our calls, that we had a really great renewal on our health care on average I remember this is not one carrier. These are multiple carriers.We use a number of different carriers to make sure we have good coverage across the entire country. And so, that was unusual. And it helped us competitively. But I think this renewal was not out of line with historical norms and has nothing to do with any of that.I think anything that's happening around health care this probably has to do with people's underwriting policies and their own approach to bringing in business and repricing business, because it's not just about the business you bring in.But every year if you're self-insured or you're taking risk, you have the opportunity or the option of passing through or not passing through health care costs. And you actually have some judgment with your underwriters on what those costs are.And so that's generally typically what could create a problem in health care. But it doesn't appear to us that there's really anything happening broadly in the health care industry around PEOs.
David Grossman: And then just on your, just based on your commentary on workers comp. I mean I think the whole industry had a tailwind. So, if you look at this year's health increase plus the workers comp at a more normalized level, this is really a more typical year for you then right, I mean in terms of the PEO, in terms of those two items?
Carlos Rodriguez: I think that's right. That's fair. And I think on the workers comp, just again to be clear was a -- I think we were clear, but why don’t we say one more time, a smaller positive. So we're not having big surprises in terms of losses in workers comp or any kind of. And by the way we have very tight ship there in a sense that we have as we disclose in our 10-K, a collar that limits our risk in a fairly significant way. Caps are down side on workers comp. So we have reinsurance an individual claim and then we have a collar around overall loss estimates. So it's quite limited in terms of the volatility.I think the other thing that I would mention is that our business mix hasn't changed, so we look at that very carefully as well. So we looked at the mix of we call it white collar versus gray collar, but within those categories you have a lot of different industries and a lot of different categories of people and we don't see any major change there as well.
David Grossman: Got it. And just as a follow-up, is kind of a bigger picture for you question Carlos is that given a relatively low penetration rates for the industry and that you get a lot of your new clients from a client that is already using you for payroll.What are the major objections to somebody enrolling in the PEO particularly if they're an ADP payroll customer and you already have the payroll records so it kind of disruption and transition cost time and effort are substantially lower?
Carlos Rodriguez: I think it's - it goes back to like my first year marketing class in graduate school, which is high involvement decision, right. So the PEO to go to a small midsize business and tell them that you're going to create a co-employment relationship, you're taking over there healthcare plan, there’s workers' compensation remember all along the way there are as an example that could be a relationship with insurance agent or a broker that's been providing to health care in the workers comp for the last 10 years that gets this intermediated.You have to - payroll is hard enough to convince some of the payroll because people worry about – are you sure you are not going to make a mistake and make sure that it's going to go accurately, we obviously have an incredibly strong reputation on payroll that helps us.But the traditional business is you’re trying to convince someone to give you your payroll, now you're also trying to convince them to give you everything around their HR department.And so it's with a higher level of trust and it's again what I remember being taught is called a high involvement decision, which takes longer to make and is more difficult to make.So I honestly don't think that there is really anything that prevents clients from becoming PEO clients. And I think we've demonstrated over 20 years that we've convinced a lot of them.And so our board asks the same question you're asking, which can't you convince even more. And we're trying. Like, we continue to add improvements in the product. We continue to provide better tools. We continue to enhance our product. We continue to do all the things we can to make it more compelling and easier to use.As an example, I think we've kind of talked about this in the last 18 months, all new business now and the PEO starting in our Workforce Now platform which has higher functionality and provides the ability to satisfy slightly larger clients than we could before because it's a mid-market platform.And so there is a lot of things that we're doing to try to convince as many clients to come over to our PEO solution as possible. I think it's good for them and it's good for them and it's good for us but there's really nothing that I can point to other than kind of the difficulties of the convincing of the sale.
David Grossman: I got it. Very helpful. Thank you for that.
Operator: Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open.
Jason Kupferberg: Hey. Good morning, guys. I just wanted to pick-up on some of the margin commentary. I mean, as you rightfully pointed out the comparison there gets quite a bit harder actually in the second quarter. So just so that our expectations are properly calibrated. I mean do you expect margins to be up in the second quarter year-over-year?
Kathleen Winters: Yes. It's a really tough comp in Q2. Remember last fiscal year Q2, we had over 300 basis points of margin expansion. So it was going to be tough to expand in Q2. Maybe it's flat to slightly up slightly down. You know, hard to say exactly because there's so many moving parts.But the way I would think about is that the bulk of the expansion to come this fiscal year will come in the second half of the year.
Jason Kupferberg: Yes. Okay. That's fair. I mean just on the bookings front somewhat similar question except in reverse right? Because you’ve got the easy comp there in the second quarter. So do you need to be above the full year guidance range in the second quarter just to make sure that you stay on track to achieve the full year outlook? Because then obviously the comparisons here get a bit harder in the second half?
Kathleen Winters: Above the bookings guidance number in the second quarter?
Jason Kupferberg: You need to be above the full year range in Q2 just to keep yourself on track?
Kathleen Winters: Mathematically, yes. So you're absolutely right. I mean it’s to stay on that for the full year you’ll have more growth in the second quarter and then much less in Q4.
Jason Kupferberg: Right, right okay. And then just last quick one from me. What would be the drivers of the anticipated acceleration in the WSE growth during the balance of fiscal 2020?
Carlos Rodriguez: Selling more new clients than losing clients. It really goes back to the - I mean, I hate to I'm not trying to be a smart [indiscernible] but the it's really the pattern, I think, I talked about it a couple of questions ago that when we tell our open enrollment in May and June, we tend to experience some client turn. The sales don't accelerate necessarily at the same necessarily at the same time.And so you have seen that phenomenon happens sometimes at the end of the calendar year where you may lose a group of clients and then you bring on new clients at the beginning of the year, but then you also bring on - so clients tend to not leave at other times of year other than calendar year end and open enrollment which is May and June.That doesn't mean non leave, I'm just saying that the skewing is cued towards those two periods. And the sales are skewed differently. And the combination of those two things is what causes either growth or deceleration in worksite employee growth.
Kathleen Winters: Yes. Look on - any of the not any but like a lot of these metrics when you look at a very short period of time one quarter – you could have some one-off things happening. I saw - as I said earlier looking at these trends and a track record over time for things like bookings and worksite employee growth and even margin, right? Looking at the trend over time is helpful I find.
Carlos Rodriguez: But again in this case we also have - we have to hit our plan, obviously. I guess as usual when we have these calls, if we are giving you the numbers based on what we expect right now. So if we hit our new business bookings plans and retentions stays when we expected to stay then you would get the outcomes that we're talking about.But as Kathleen said, there's a lot of moving parts if three to six months from now, the economies in the tank and pays per control is declining, it's going to in the PEO in addition to ES and it less than ADP and that would create a headwind. But in the absence of any new information I think, we feel pretty good about the forecast we have.
Jason Kupferberg: Okay I appreciate it. Thank you.
Operator: Thank you. Our next question comes from Steven Wald from Morgan Stanley. Your line is open.
Steven Wald: Hey, good morning. Just maybe a follow-up a on the margin expansion path, looking beyond, sort of the next few quarters or even this year, I just wanted to talk about the messaging. And make sure we were getting a proper sense of the drivers there.I think a lot of the talk has been around workforce optimization and procurement over the next 12 months or so. But I think, one of the things you guys try to talk about is the tech improvements or your investments.As you build more this into your platform, as you're add even more into what you are doing on a day-to-day basis. Can you talk a little bit about, how that scale to you're adding or that scalable expense base that you're adding will show up in terms of cost reductions or margin improvement?
Carlos Rodriguez: Well, I think again back to like what Kathleen was talking about in terms of the math, some of it was really comparisons rather than anything that we're doing. And but we have to help people. We understand that it's important for you guys to understand that.So, just as a reminder last year what happened was, we had with the voluntary early retirement program, we had a good number of people taking that. And then the back fills that we had planned which was all planned, certain percentage of back fills were delayed.And so that impacted that year. We also got off to a very strong start for a couple of other reasons. We had other what we called quick wins at a time around transformation that help us get off to a strong start in the first half.And I think Kathleen talked about -- we had for us, like incredibly strong margin improvement. And so it's just a very difficult compare mathematically. As we've been going along, regardless of how the math works, we continue to work on a number of initiatives.And this year obviously we executed on this expand the layers initiative, and then we have a number of other projects around procurement is one of them but we also have a number kind of automation and digitization project that I think we're making some progress on. And when we have our industry - sorry our Analyst Day in February, we'll probably share a little bit more around some of those things that we're doing, because those are around transformation and innovation as well. So it's not just about innovating on the product side. But it's also innovating on the implementation and on the service side.And we’ve gotten some good traction in some of our businesses which are allows our productivity to improve while, still for our associates. While still improving our NPS scores and our client satisfaction which by the way were up again this quarter and no surprise the retention is improving.It’s usually a sign that client satisfaction is still high. So again trick here is you want to transform your cost structure, but you don't want to like lose all the clients in the meantime. And for now, we've been able to balance both of those and that's our plan here for the next year or two.
Steven Wald: Yes. Fair enough. And then, maybe just one quick follow-up, I noticed the buy back a little bit higher than we’ve seen last year or so. Just could you provide any commentary on how you're thinking about the pace there going forward?
Kathleen Winters: Yes. So really no change in terms of how we're thinking about that. And our strategy we talked about the intent to buy back 1% of the share base. And we've been executing along those lines, so, really no change.We look all the time at the market conditions and look if there is some opportunity where there is a big downturn in the market and we want to become more active. Maybe we'll do that, I don't know. But constantly we watch that, we look at it, we talked about it all the time, but as of now no particular change.
Carlos Rodriguez: Again, one little statistic, because we happen to notice these things when we prepare for these calls. Because now I get like seems like 20 years of information, so we’ve reduced our share count by 30% since the early 2000’s, and so we intend to continue to stay on that pace.And so obviously it's a marathon for a company like we're kind of proud that it's a marathon we've been around for seven years. And at 1% per year it adds up. And it certainly has added up in the last 20 years to the tune of a 30% share reduction.And I think that companies are in the different stage of development whether they're getting dilution and adding shares to their share count. We think we're going to win this marathon.
Steven Wald: All right. Great. Thanks.
Operator: Thank you. And we'll take our final question from Bryan Keane from Deutsche Bank. Your line is open.
Bryan Keane: Hi, guys. Just a quick - two quick clarifications. On the PEO margins it was below street, but it didn't sound like it was really below your expectations. And it sounds like there was a tougher comp to the ADP Indemnity. So could maybe just talk to that and how that looks going forward on the margin side?
Carlos Rodriguez: Yeah. No, I think that's a fair characterization. I think that as usual there’s – and we try to obviously be as straight as we can be because sometimes there is a slight disconnect between what we’re expecting versus since we don’t give quarterly guidance. But the results I think were on that specific topic, I think we're in line with our expectations.
Kathleen Winters: Yeah. It was definitely in line with how we expect to start the year.
Bryan Keane: And then just the cadence how we think about that going forward on the margin for PEO?
Carlos Rodriguez: That's a good question. I think that when you look at the annual guidance, I think it was down flat to 25 down…
Kathleen Winters: Down 25 basis points.
Carlos Rodriguez: Down to 25 basis points. I think that was the guidance. If you take our first quarter number, I would for now assume ratably margin improvement over the course of the rest of the year because these quarterly fluctuations in ADP Indemnity are not something that is - something that we can have a - we don't have any real visibility into that.And again, just as a reminder, part of why we've done this is, if you remember a couple of years ago, we had some criticism around our disclosures. So we had our client funds interest and Indemnity being handled in the kind of other category, which allowed us to not have these questions and not kind of makes up the results of those businesses.But as usual, there are two sides to every story. And so I think the criticism was those things really belong and the results of the business unit. Fair enough. So we made that change and now we are saddled with every quarter having to explain any kind of fluctuations here, because what really matters is the underlying health of the business.We don’t take enough risk in that business for it to matter. But you can get because of the size of the business, if you get a $5 million fluctuation which is what we had this quarter up or down, it affects the numbers, but it doesn't really say anything about what's happening in the underlying business.But it is what it is. We now report Indemnity in the PEO and we’re going to have to every quarter be able to give you that kind of color. And likewise in Employer Services we now have client funds interest. And so now that creates some variability in that business as well.
Kathleen Winters: Yeah, so with the down - with the flat to down 25 basis points and down 70 in Q1 you'll see that just mathematically it ramps. But again it's going to depend on the ADP Indemnity and how that comes through during the balance of the year.
Carlos Rodriguez: It was certainly easier when we didn't have ADP Indemnity in the PEO. But because nothing -- we've been doing that for 20 years. We've handled it. We’re not by the way we are handling exactly the same way we’ve always handled it. It’s just a different accounting report. That's all.
Operator: Thank you. And this does conclude our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for any closing remarks.
Carlos Rodriguez: Well, thanks very much. You can tell we feel pretty good about the start to 2020. We're obviously trying to change a lot of things. We’ve talked a lot about transformation. We'll share more with you when we have our Innovation Day here in February.But we’re focused on execution as I think Kathleen alluded to this there's still a lot of execution in front of us. But we still - we try continue to be focused on our clients and our associates. And our associates are doing a phenomenal job as evidenced by our continuing improvements in our NPS scores.Obviously, we felt good about what happened with HR Tech, with our Lifion debut. So I think that gives us some optimism. We're very excited about what's happening in the mid-market business here in the first quarter.So I - continue to be very proud of our organization and the resiliency of the organization and the transformation efforts that they continue to execute on. So we look forward to giving you more updates in the time to come. And we thank you for joining our call today. Thank you.
Operator: Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Crystal, and I’ll be your conference operator. At this time, I would like to welcome everyone to ADP’s First Quarter Fiscal 2020 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]I will now turn the conference over to Mr. Christian Greyenbuhl, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Christian Greyenbuhl",
"text": "Thank you, Crystal. Good morning, everyone. And thank you for joining ADP’s first quarter fiscal 2020 earnings call and webcast. With me today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.Earlier this morning, we released our results for the first quarter of fiscal 2020. The earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today’s call as well as our quarterly history of revenue and pre-tax earnings by reportable segment.During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description and the timing of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measure can be found in our earnings release.Today’s call will also contain forward-looking statements that refer to future events and, as such, involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations.Before turning the call over to Carlos, you would have noticed in today’s earnings that we made a correction this quarter to certain PEOs zero margin pass-through revenues that we have previously reported on a gross basis and which going forward will be reported on a net basis.For consistency, we also revise prior periods and the total impact to fiscal 2019 revenues and operating expenses was $65 million. This does not materially impact our previously reported growth rates and does not impact consolidated earnings before income taxes, net earnings, consolidated financial condition or cash flows. To better assist you, we have also included the details of these adjustments in the appendix to the presentation that accompanies today’s call. Our supplemental schedule of quarterly history of revenue and pre-tax earnings by reportable segments also reflects the impacts of these changes.Accordingly, our reported results and full year outlook and the following commentary from both Carlos and Kathleen also fully reflect the impact of these adjustments. As always, please do not hesitate to reach out should you have any questions.And with that, let me turn the call over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Christian. And thank you everyone for joining our call. This morning we reported our first quarter fiscal 2020 results with revenue of $3.5 billion for the quarter, up 6% reported and organic constant currency. We are pleased with this revenue growth, which despite some higher than expected unfavorability in FX was in line with our expectations.Our efforts to enhance our operating efficiency along with your focus retention on transformation help us deliver 60 basis points of adjusted EBIT margin expansion for this quarter. This margin expansion was in line with our expectations and we are happy to see the progress that our associates continue to make in helping to improve our productivity, while also improving client satisfaction, particularly given the difficult margin compare given our strong performance in the first half of fiscal 2019.Together with share buybacks and a slightly lower than expected adjusted effective tax rate these results help us deliver 12% adjusted EPS growth this quarter, which was slightly ahead of our expectations.Moving on to Employer Services new business bookings, this quarter we saw solid growth across our US markets, which helped drive 6% growth in the quarter. With regard to our international and multinational sales opportunities, we did see some impact from timing as certain deals that were expected to close this quarter are now expected to close slightly later in the fiscal year. Nevertheless, we are maintaining our full year Employer Services new business bookings guidance of 6% to 8%.Now turning to Client Service. We continue to drive improvements in our client satisfaction scores across our businesses. And this quarter, we were especially pleased with our progress in the upmarket with improvements in both our implementation and overall client satisfaction scores.We continue to take positive steps to transform our service organization and enhance the client experience, and with this continued progress in mind, we remain confident in our forecasted full year fiscal 2020 retention increase of 10 basis points to 20 basis points.We are pleased with our start to fiscal 2020 and with the continued momentum in advancing our strategy to simplify how we do business, deliver innovative solutions for our clients and associates and drive sustainable long-term growth for our shareholders.We understand that a key element of building our success in the market is in the capacity to be agile and to anticipate and adopt to change. Innovation is at the core of this need and it’s a job that's never done. While we are incredibly excited about the solutions, we are delivering in the market today to help clients meet the needs of an evolving workforce, we're even more excited about the future. As the workforce continues to evolve, organizations are looking for ways to manage their entire workforce through a single user experience.Today companies of all sizes are using a variety of applications to get work done. What they need is an open HCM platform that allows easy integration with third-party solutions and is also flexible enough to handle the increasingly dynamic nature of work, one where workers are organized around how work happens in teams, often with individuals working on multiple teams at the same time. Aided by insights from the ADP Research Institute, our Next Gen HCM platform is designed at the core to address these needs.A few weeks ago I had the opportunity to attend the HR Technology conference in Las Vegas where our Next Gen HCM platform and used innovations took center stage. As I met with clients and HR professionals, I was incredibly proud of the reception and recognition that we received for delivering innovative solutions that address how and where work is done today.I was especially proud when our Next Gen HCM platform won both the HR Executive Top HR Product of the year award and the Awesome New Technology award, a remarkable achievement and a testament to ADP's commitment to innovation.Back in September, we also had the opportunity to showcase some of the differentiating features of ADP's Next Gen platform to HCM industry analysts when we hosted our 2019 Industry Analyst Day. At this event, we spent time sharing some of the more meaningful and differentiating elements of our technology, such as, the use of graph database technology that powers the unique ability to dynamically configure teams while enabling actionable data and insights around relationships or our meta data driven design approach that allows solutions to be tailored by the client via local rapid development through a drag-and-drop interface.In addition, our solution was designed from the beginning to be public cloud native. This among other advantages helps improve resiliency and uptime.Finally, our solution is designed to be global. Companies that are expanding globally, or that would like to more effectively manage their existing global workforce are an ideal target for ADP Next Gen HCM.We were equally proud and excited to see, the recognition our efforts from industry experts, at this event. And while it is great to receive these awards and to recognized by industry experts.It is even more rewarding when we see our efforts translate into recognition and acknowledgment from our clients and prospects. As we work to scale our solution and its capabilities, our Next Gen platform is also building momentum in the market and continues to progress in line with our expectations.As an example, earlier this quarter, at our Industry Analyst Day, we shared details of a successful go live with a 6,000 employee U.S. company that chose ADP's Next Gen HCM platform for its talent capabilities. And the ease of the ease of integration with the client's own internally developed on-boarding tool.At the same events, we were also pleased to share that we have recently signed a 65,000-employee global enterprise that was looking for an HCM platform, capable of handling its growing workforce.With that said, our focus on innovation is not limited to our Next Gen HCM platform. We have also increasing the leverage, machine learning to enhance our core strategic advantages in payroll and big data. As an example, we simplified 21 million raw job titles from our unmatched data like, and normalized them down to 2,400 job categories, ultimately enhancing both this functionality and accuracy of our ADP data cloud benchmarking.Customers are using our compensation and HR benchmark data to make substantial changes to their business. For example, one of our clients was able to leverage our turn over benchmark data, to identify opportunities for improvement, and ultimately to reduce their turnover by 20%.While another saw its front line managers use our Executive and Manager Insight’s mobile solution, to help reduce overtime cost by 6%. These equate to real multimillion dollar operational savings that are being enabled by ADP's data and products.Also to enhance the efficiency of our implementation organization, we are designing our NEXT GEN payroll engine to automatically recognize, convert and classify different formats, an input, from prior payrolls and so payroll policies.We believe that this will give us an advantage when we on board new clients, because it will enable the automation of various elements of the implementation process. And allow us to share best practices with our clients.And finally, we also continue to drive innovation for our frontline associates, in an effort to transform how we work, by reducing low value, client contacts, while still delivering value-added service.With this in mind, last year, our support organization and the downmarket rolled out expanded checkbox functionality, which today is capable of handling over 100 different inquiry types for our more than 640,000 small business clients.ADP's unique ability to meet the needs of clients and their workers today while anticipating their needs in the future, have been hallmarks of our success over the past 70 years. And I believe will driver sustained growth in the years to come.And with that, I’ll turn the call over to Kathleen, for commentary on our results and fiscal 2020 outlook."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos. And good morning, everyone. As Carlos mentioned, we're pleased in transforming our business, in order to simplify, innovate and grow. Our strategy is working, and we are off to a solid start to the year.This morning, we reported first quarter revenue growth in line with our expectation, at 6% on a reported and organic constant currency basis, which includes a slightly greater amount of FX unfavorability than we previously anticipated.Our adjusted EBIT increased 8%, also in line with expectations. And adjusted EBIT margin was up 60 basis points compared to the first quarter of fiscal 2019. We're pleased with this margin improvement, which benefited from cost savings related to our workforce optimization and procurement transformation initiative as well as continued efficiencies within our IT infrastructure.These benefits were partially offset by incremental brand spend as well as selling, amortization and PEO pass-through expenses. This margin performance is particularly gratifying given the difficult margin compare that we faced in the first half of the year.As a reminder, this resulted from the very strong performance in the first half of fiscal 2019, resulting from the outside benefits related to our voluntary early-retirement program due to slower than anticipated plan to backfill at that time.Our adjusted effective tax rate decreased by 100 basis points to 21.2% compared to the first quarter of fiscal 2019. The decrease was mainly due to an increase in tax incentives related to lower R&D efforts and decreasing reserves from certain tax positions.Adjusted diluted earnings per share were 12% to $1.34. And in addition to benefiting to our benefiting to our revenue growth, margin expansion and a lower effective tax rate was also aided by fewer shares outstanding compared to a year ago.Let’s move now to our Employer Services segment and interest in funds held for client. Employer Services revenues were in line with expectations and grew 4% reported and 5% organic constant currency.Interest income on client funds grew 13% and benefited from a 10 basis point improvement in the average yield earned on our client fund investments to 2.3% and growth in average client fund balances of 7% to $23.7 billion.This growth in balances was driven by a combination of client growth, wage inflation and growth in our pays per control partially offset by lower SUI collections. Our Employer Services same-store pays per control metric in the U.S. grew 2.4% for the first quarter.Employer Services margins saw an increase of 50 basis points from the quarter. The increase in margins this quarter which enabled by the same factors I mentioned earlier when discussing our consolidated results.Our PEO segment revenues grew 8% for the quarter to $1.1 billion with average worksite employees growing 7% to 563,000. Revenues excluding zero margin benefits pass through grew 7% to $358 million and continued to include pressure from lower workers' compensation and SUI costs and related pricing.Margins decreased about 70 basis points for the quarter largely due to changes in ADP Indemnity loss reserve estimates, which drove about 60 basis points of pressure resulting from a smaller benefit in the first quarter of fiscal 2020 compared to fiscal 2019.As a reminder, with ADP Indemnity results not reported in the PEO, it is normal to expect some volatility in our quarterly PEO margins as a result of changes in our workers' compensation loss reserves.Let's turn to the outlook for the full year and start with a consolidated view. We continued to anticipate total revenue growth of 6% to 7% in fiscal 2020. This revenue outlook assumes a more elevated level of FX on favorability for the remainder of fiscal 2020 relative to our previous expectations.With the recent volatility and overlying fixed interest rates, we now assume interest income on client funds of $570 million to $580 million and interest income from our extended investment strategy is now expected to be $575 million to $585 million.With the continued negative interest rate environment in the Eurozone, we made the decision this quarter to wind down our two Eurozone related client money moving activities in France and the Netherlands.As a result, we have liquidated our Dutch client funds portfolio and we will be liquidating our French client portfolio by the end of fiscal year 2020. We therefore now anticipate our growth and average client funds balances to be about 4%, as compared to our previous forecast of 4% to 5%. This decision is excusive to France and the Netherlands.We continue to anticipate our adjusted EBIT margin to expand basis points 100 basis points to 125 basis points. And we now anticipate our adjusted effective tax rate to be 23.3%. The rate includes this quarter's unplanned tax benefit from stock-based compensation related to stock option exercises.It does not however include any further estimated tax benefit related to potential future stock option exercises given the dependency of that benefit on the timing of those exercises. With these slight adjustments to our outlook, we continue to expect adjusted diluted earnings per share to grow 12% to 14% in fiscal 2020.Moving on to the segments, let's take a look at Employer Services. We continue to expect 4% to 5% revenue growth in our Employer Services segment. This outlook includes the anticipated impact from my previous remarks regarding changes in FX and adjustments to our interest income on client funds outlook. We continue to anticipate pays per control growth of about 2.5%.We also continue to expect Employer Services new business bookings growth of 6% to 8% and for our Employer Services revenue retention to improve 10 basis points to 20 basis points. I'd like to remind you as I commented in the prior earnings call that there is volatility inherent in the quarterly Employer Services bookings metric from larger international and upmarket deals.And I’d also like to remind you the difficult compare in the fourth quarter of fiscal 2020 resulting from our strong performance in the fourth quarter of fiscal 2019 due in part to a client list acquisition.Moving onto margins. We continue to expect our margin in the Employer Services segment to expand by 100 basis points to 125 basis points. As a reminder with a difficult compare resulting from our strong margin performance in the first half of fiscal 2019, we continue to expect a much stronger margin increase in the latter half of fiscal 2020.Regarding our PEO segment, overall, our outlook remains unchanged. We continue to expect 9% to 11% PEO revenue growth in fiscal 2020 and 7% to 9% growth in PEO revenues excluding zero margin benefit pass-throughs, both driven by an anticipated growth of 7% to 9% in average worksite employees.Because of the slower growth in the fourth quarter of fiscal 2019, we continue to expect the growth in our average worksite employees to be at the lower end of our guidance range in the first half of the year with a gradual reacceleration of our growth rate as the year progresses.As we also discussed last quarter, we continue to expect lower workers' compensation and SUI cost and related pricing to pressure our total PEO revenue growth. For PEO margin, we continue to anticipate margins to be flat to down 25 basis points in fiscal 2020, which continues to include approximately 50 basis points of pressure from smaller favorable reserve adjustments in ADP Indemnity in fiscal 2020, compared to fiscal 2019.Before I hand the call over for Q&A, I'd like to share that on February 11, we will be hosting an Innovation Day, focused on technology, strategy and showcasing some of her latest innovations.A few of you have had the opportunity to see some of those developments during HR Tech. Others may have had a glimpse from some of the industry analyst notes, and tweets following our September Industry Analyst Day.The February 11th event would be specifically for the investment community, to share our product and service innovation, and have a dialogue around the progress that we continue to make, including how these innovations help to differentiate ADP in the market.We look forward to welcoming you then, and please be on the lookout, for further details in the near future.With that, I'll turn the call over to the operator to take your questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] And our first question comes from Ramsey El-Assal from Barclays. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi, good morning. This is Damien on for Ramsey. I wanted to ask on the Employer Services bookings guidance. I know you both talked about it at lengths. But I just wanted to see if you could give anymore color on just the quarterly cadence.I know Kathleen you mentioned difficult comps coming up in Q4. But maybe just any granularity that you could give would be great. And then, just overall level of confidence to kind of get to the midpoint of that 6% to 8% guidance?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I'll let maybe Kathleen make a comment as well. But again, I think if you that last year's pattern, our second quarter last year was soft. So that would be the easier compare. And the fourth quarter because of the acquisition of the client base acquisition from Wells Fargo, I think, it'll be a little more difficult.But we obviously try to apply some judgment on these things. And we obviously have information about individual unit performance and kind of what's happening across regions.And I think what we try to provide in some of the color our comments is that this quarter we had very strong, what I would call strong results in our core US businesses, SBS, major accounts and national accounts. And we really had some weakness with international and multinational. And we’ll look into the details of that. There were a few large deals in prior year, as well as some deals that didn't close in the first quarter as expected. So that would give us some confidence that I think, we’re still on track for the year, despite these kind of quarterly fluctuations.Because I think as Kathleen's said, and we said many times for us bookings is certainly more volatile than revenues. Obviously, we have the recurring revenue model. But on bookings the clock goes back to zero at the beginning of every quarter.But we see some underlying strength that gives us some optimism. But we did have some weakness in the international multinational and that is something that we’re looking at. I don't think that it's any major change in the economy, because it’s been kind of a difficult in the economic climate for a while in Europe where we have a large business. So, again as I look at the detail, it just looks like, typical lumpiness in our bookings."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. I mean just to follow-up on with that. Look you’re always going to have some degree of lumpiness in your quarterly bookings number right, from at least a couple of things, right?If you’ve got larger multinational type deals, that's going to cost some lumpiness. And then you’ve got the year-over-year comps issue and you’ve got a tough comp or an easier comp. So you’ll always have a little bit of that going on. And so importantly, while the quarterly numbers obviously important I think even more important to look at a longer term trend, right?When you look at how we've been doing in particular with last year having a really strong and I think record, right, number of $1.6 billion for last year and then 8%. And then on top of that another what we think is a really solid number of 6% in Q1, when you look at that longer period of time, we’re actually feeling pretty pleased with the start to the year.Now there is of course always pockets that are stronger and others that are maybe a little slower out of the gate and Carlos mentioned on the outside of the US having a little bit of lumpiness there, but net-net we're pretty pleased with the start to the year."
},
{
"speaker": "Unidentified Analyst",
"text": "Yeah. That makes sense, and great. Then maybe I’ll zoom out a little bit and ask on overall sort of product strategy at the large enterprise level. I just wanted to dig in and see how you see your products suite revolving there just sort of in the context of you continuing to invest advantage over time and then your strategy - your new strategy around the Lifion offering."
},
{
"speaker": "Carlos Rodriguez",
"text": "Don't forget we also again one of the highlights for the quarter and frankly it's been a highlight in trying to kind of signal this. I am not sure how it has landed yet, but our decision to use Workforce Now with the lower end of the upmarket, so call it that 1,000 to 3,000 even though frankly it can go higher. We have a couple of clients that have 8, 9,000 employees that are on Workforce Now. But that decision has been great competitively in growth wise. So we are selling a lot of units in that kind of lower end of the upmarket.So the ability to use Workforce Now for - and it fits certain types of profiles clients and you can probably imagine generally speaking they are large, but simpler and Vantage clients would be more complex and have more complex needs like complex benefits and talent requirements and so forth.And Lifion it’s still obviously an early adopter type of product, even though we're getting great traction and we told you what - how we've done in terms of new sales given the size of ADP, it’s really Workforce Now and Vantage Now that are affecting the numbers in terms of the bookings and the revenue. And I think again in case I wasn't clear like that we had a good quarter even in national accounts in the upmarket primarily as a result of really good results from Workforce Now.So the strategy is the same strategy we’ve had all along, which is I think we’ve figured out that we have a really great solution for a segment of the market. I think last quarter, I mentioned that we have an external third-party do some analysis for us and in terms of segmenting the market, and as usual one solution doesn't fit the entire market. And what we found was that a pretty good size percentage of the market can be addressed by our Workforce Now solutions and that's what we're doing.And we were right. And the analysis was right. And we think the Vantage still addresses another segment of the market and Lifion is more kind of the emerging solution that we obviously have placed a lot of confidence and a lot of a - and a big bet on for the future. But as of today it's really not having a big impact on the numbers.And I also just in terms of just your question about market dynamic when we had this meeting in Las Vegas at the HR Tech Conference that I mentioned in my comments again, early positive signs we had for anyone who was there, I think some of our – some industry analysts and some financial analysts were there, I think, it was pretty clear that we are making an impact in the market. So our lead flow was multiples of what it has been in the past in the upmarket because of the interest in Lifion.But I just want to be cautious in terms of pace here because relative to our $15 billion in revenue, this is not next quarter or three quarters from now. But the signs are very, very positive in the long-term as Kathleen mentioned. If you focus on the long-term, I think, Lifion - the traction we're getting in Lifion is very, very encouraging."
},
{
"speaker": "Unidentified Analyst",
"text": "Yeah. That's, that's really good. We'll keep watching. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh from Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thank you. Hey, you’re able to reaffirm the revenue despite the lower client interest on kind of funds and extended investment. Was there any kind of offset there particularly given the incremental headwinds and FX? It seems like you're able to reaffirm the guide despite those couple of headwinds."
},
{
"speaker": "Carlos Rodriguez",
"text": "You know, I think, it goes back to what we're saying about the some of the underlying performance of the business. So as an example, even though we don't give quarterly guidance on retention, you could tell from our comments, I hope that we felt pretty good about it this quarter, so that you could probably read into that it improved prior to - compared to last year's prior first quarter.And as I mentioned before retention if you do the math has a pretty outside impact on our business bookings in terms of revenue and frankly big impact on margin because for equal growth you don't have to implement as much business.And so there's a lot of different moving parts that go into the pot here, but I would point that one out as an area of strength. I think we've talked about the strong performance in our core U.S. businesses.So for the first quarter we had kind of our three core businesses performing very well in terms of bookings as well. So it's a process from the ground up of us building this forecast, first of plan and now the forecast and I think we have some optimism that we're still in that range.And but I just want to point out the retention story because three or four years ago when it was going the other way, I pointed out that it takes four to five points of sales growth of new business bookings growth to offset one point of retention just because of the way the math works. And so - now as retention - as you get a little bit of improvement in retention that helps a lot in terms of our growth rate."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. So as Carlos mentioned there's a couple of things that obviously gave us some headwind or unfavorably versus what we would have been expecting particularly the FX and the interest from client funds. However, when you look at operationally the fundamentals things look really good.As Carlos said retention is on a steady track upwards now gets harder and harder the higher up you go. But we're happy to see some level of increase in the first quarter here, and bookings were solid for the quarter."
},
{
"speaker": "Carlos Rodriguez",
"text": "And I would just add on the client funds interest, we do have some of this - for the year it obviously has an impact as we guided - we gave you the information in terms of we are slightly below what we expected to be, but it's not a huge number for this fiscal year."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. And then just Carlos to highlight the retention a little bit more because obviously really nice progress there. Any sense of just the success across the enterprise versus the mid-market versus kind of downstream a little bit the range on those?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. I do have some sense. My sense is that, we're improving a lot. So we show some signs in terms of the win-loss, what we call balance of the trade, some encouraging signs particularly in our mid-market business.So again the mid-market now is performing - you got to be cautious because there's definitely a forward-looking statement. But it's performing according to the script, in the sense if you remember we took a lot of pain and lot of effort to migrate all of our clients on to one single strategic platform which is Workforce Now.And when you look at the history of what happened in our SBS downmarket business. When we did that, we were optimistic and hopeful that we would have the same kind of traction in our mid-market business. And it's beginning to show now.So we have improving retention now for it feels like six or seven quarters somewhere in that range. I am being told more. So once we kind of finish the migration and got through that difficulty. I think we have steady improvements in retention.This quarter was the second highest retention we've ever had, in our mid-market business. And in this quarter what was very encouraging is to see the level of activity in new business bookings. So, the combination of those two things gives us a feeling of optimism for what is - one of biggest and more profitable businesses."
},
{
"speaker": "Kevin McVeigh",
"text": "Awesome, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from David Togut from Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you. Good morning. Could you comment on, the drivers that you expect to move your PEO revenue growth up from 8% in the recent quarter to 9% to 11% which is your guide for this year?And then, just as a follow-up at your Analyst Day last year you gave a multiyear guide of 12% to 14%, CAGR for your HRO business, and you're trending well below that now. Did you anticipate the time that the growth rates in the earlier year’s double-digits effectively, would slow towards the end of that period? Let's say, mid- to high single digits?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well if I can start with the second one first, since I was there in the analysts and not fair to ask Kathleen. I think we have built the guidance for or I guess the estimates for are three years. We had as I think we've mentioned this couple of times, we had certain expectations around our pass through revenue and inflation of those numbers that had some historical precedent, both around workers compensation and health care.And I think literally within two months of that, the picture changed, and we communicated that very clearly and very transparently and frankly, without any anxiety because it doesn't have any impact in our EPS. So if you remember the Investor Day, I think it June and I think when we had our August earnings call, I think, we brought down significantly for that year at least, the growth rate for the PEO mainly - primarily close to almost based on lower inflation.Now on top of that, we have had some slowdown in worksite employee growth, which is the core driver underneath of the real growth of the business. But I think a main driver of this differential from what we communicated at our Investor Day has been has been the lower inflation of the pass-through, which again doesn't concern us, in a big way because it’s zero margin and doesn't really affect our profitability in terms of in terms of dollars.In terms of your question about the behavior of the quarters and so forth, probably beyond the scope of this call but, it's just kind of math in terms of when we have our open enrollment for healthcare in kind of May, June timeframe which we’ve again communicated very transparently when that happens and what happens when that occurs, you tend to have some client churn.So that drops your worksite employee growth and obviously revenue growth for the PEO. And then as bookings continue to - assuming they continue to be robust, you start to build that up again. And then at the end of the calendar year-end, you have another event at year end where you have some churn in the client base in terms of clients that choose to leave at the end of the calendar year because that's more natural, but we also have historically a lot of bookings in January as well.So we've been doing this for 20 years and we see a difference or a change we would obviously communicate that. But I think we're just kind of dropping the numbers in as they are supposed to come in terms of -- based on historical trends.And David I would just add, so last quarter we did say that we would expect to start a year from the lower end of the range and then grow into the range as the year progresses because obviously, we started with a somewhat of a weaker ending worksite employee number in the fourth quarter last year."
},
{
"speaker": "Christian Greyenbuhl",
"text": "And I think it's probably worth asking I mean, adding just again in full transparency, I think we said it last quarter our health care renewal was slightly higher than the previous year. So I wouldn't - it wasn't anything out of norm in terms of historical, but it was higher than the previous yearAnd when that - when we have that happen you tend to get more shoppers and more -- health care cause is a large part of what a small business pays in their overall cost structure of their workforce. And so they tend to shop and look around and so forth, and so we have a little bit more churn than I think that we have had in the prior year.The good news is for us is that we have that issue, but we've been dealing with that for 20 years, but we don’t think any risk on health care. So whatever we get in terms of price increases through the carriers, we pass those through 100% which is why we call zero margin pass-through.So that eliminates any risk or any surprises in the future, but it also means that you have to have frankly the courage to just pass those costs through and let the chips fall where they may.And the chips fell and I think you can see from the numbers that the chips didn't fall off the table, because there wasn't a collapse in the because of a huge slowdown, but we definitely had our speed bump and now it's really through new business bookings that we have to regain the momentum and kind of have that ramp up again and reacceleration of the growth rate."
},
{
"speaker": "David Togut",
"text": "Understood. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin from Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi. Good morning. Thank you. Carlos, wanted to ask your macro outlook on the current employment market. It sounds encouraging based on the performance of the business, but I'm curious how much of that is due to the improved competitive product position versus the underlying demand you might be saying?"
},
{
"speaker": "Carlos Rodriguez",
"text": "It's a great question because it's an important one for us to keep kind of asking ourselves, we do have some things that you know if they turn on us would put pressure on us, interest rates obviously is one of them, pays per control, et cetera.But we're also feeling pretty good about our product situation and I think our competitive situation in the marketplace going forward here. So it is -- that's going to be a very important question for us to stay focused on here for the next few quartersBut as of today, when you look at our lagging indicators so pays per control, it doesn't look like there's a slow down or a big issue, but if you look at the same things that everyone else would look at that we have access to and you have access to in terms of leading indicators like confidence indexes or NFIB/ISM - those types of things Michigan confidence.You know those, there’s some concern there and some reason for caution. In our numbers, the only place where we have seen some little bit of softness and pace for control and it doesn't get reflected in our and what we report because as we've disclosed prior this is our Autopay base which is a very large base of both large employers, midsize employers and smaller employers.But we have most of our employer in our run platform and there we've seen a slight down tick in pays per control growth over the prior year. It doesn't - when you look at over the 10-year history, I don't think it's anything to be alarmed by, but - when you look at other factors it certainly a cause for caution. I just happened to look I think, in the last couple of days at NFIB and that's softened significantly, but it's still well above recession levels.And so I think we’re all kind of trying to figure out the same thing here which is a soft patch or is it kind of a trend line. But with - the Fed easing and the consumer still strong like right now our plans are that we kind of work our way through this soft patch."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. That's helpful. And then Kathleen on just margin expansion progress, any further details you can share on the various transformation initiatives? And as you look across the various resources were you seeing the most yield, and anything surprising you as you've had just more time in the seat?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes. Thanks for the question. Obviously, something that I'm really focused on in the organization is really very focused on as well. I mean just to kind of get some context and kind of big picture when you step back and take a look at what we've done in the last couple of years.I mean remember back in 2018, we were at margin rate of 20.7%, with a small amount of margin expansion in that year and then in 2019 when -- fiscal 2019, when we were executing on some really big and meaningful transformation initiatives.You saw that really outsized margin expansion of 160 basis points, and know -- as a reminder the guide for another 100 basis points to 125 basis points for fiscal 2020.So a track record here really consistent margin expansion. And as we start in fiscal 2020 with Q1 that 60 basis points of margin expansion we're really happy to see that and very happy that we're on track with how we planned the year.Now there's a lot of execution and a lot of work behind the scenes going on but I'd point out that number one as I started my comment there's a lot of energy around it and a lot of alignment. And that energy and alignment is around both executing what I call in-flight projects as well as developing the pipeline for the future. So that's really exciting.I talked about on the previous call that most of the margin expansion from a transformation perspective this year is coming from what we're calling workforce optimization and procurement initiatives both are very much on track from a workforce optimization standpoint.Think about that in terms of spans and layers exercise if you will and particularly targeted to management layers. So that's kind of on track and already executed with most of that benefit being in fiscal 2020 not much from that coming beyond fiscal 2020.And then procurement transformation there's a lot of projects there as we look at - across all parts of the organization and spend as we look at volume and we look at policy and we look at our ability to negotiate smartly with vendors and suppliers. There is opportunity there and there is a lot of execution going on.So a lot of work execution going on. So, a lot of work by the organization, we're happy with what the teams are currently doing and happy with the progress, but more to do."
},
{
"speaker": "Bryan Bergin",
"text": "Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Hi, Brian. I just - one thing just to add, as you think about the margin because your question I think was related to margins in particular. And obviously what's driving those. But last year, the first and second quarter but particularly the second quarter was a very strong growth in margin in that time.And just a reminder, we also had pressure from M&A at that time. So, just layer that one on to it as well when you think about margin cadence last year versus this year."
},
{
"speaker": "Bryan Bergin",
"text": "All right. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from David Grossman from Stifel. Your line is open."
},
{
"speaker": "David Grossman",
"text": "Thank you. Good morning. I wonder if I could just follow-up with a couple of questions on the PEO. Each of your kind of larger peers in that space have identified some type of incremental issue with their health insurance book in their most recent reports.And I know you mentioned, just higher health premiums and obviously you pass everything through in your model. But is there anything else, you're seeing in the market place that may be impacting the cost of delivering health insurance in the PEO industry?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No."
},
{
"speaker": "David Grossman",
"text": "All right. So for you, it's just the straight higher premium and not seeing anything else? I guess, you don't really see the claim that is around in terms of how claims may be impacting on a cost?"
},
{
"speaker": "Carlos Rodriguez",
"text": "You will see individual employee, claims data but we of course very, very carefully looking at claims data to get some sense with our carriers and partnership with our carriers, what's happening in terms of trends.Maybe I should be a little bit more, clear on this, premium increase issue. So, I'm not going to give you the exact numbers. I don't think we want to get down that rabbit hole. But the change from this renewal to the prior renewal was call it one to two percentage points higher, on average than the prior year. So if, the previous year the average renewal increase was 6% then the next year it was it was it was 7% or 8%.And that increase that year that was slightly higher was completely in line with the prior six or seven years. So it wasn't -- so there are some ups and downs. But the prior year was one that was actually exceptional. I think we were very clear about that. I think we talked about that in our calls, that we had a really great renewal on our health care on average I remember this is not one carrier. These are multiple carriers.We use a number of different carriers to make sure we have good coverage across the entire country. And so, that was unusual. And it helped us competitively. But I think this renewal was not out of line with historical norms and has nothing to do with any of that.I think anything that's happening around health care this probably has to do with people's underwriting policies and their own approach to bringing in business and repricing business, because it's not just about the business you bring in.But every year if you're self-insured or you're taking risk, you have the opportunity or the option of passing through or not passing through health care costs. And you actually have some judgment with your underwriters on what those costs are.And so that's generally typically what could create a problem in health care. But it doesn't appear to us that there's really anything happening broadly in the health care industry around PEOs."
},
{
"speaker": "David Grossman",
"text": "And then just on your, just based on your commentary on workers comp. I mean I think the whole industry had a tailwind. So, if you look at this year's health increase plus the workers comp at a more normalized level, this is really a more typical year for you then right, I mean in terms of the PEO, in terms of those two items?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think that's right. That's fair. And I think on the workers comp, just again to be clear was a -- I think we were clear, but why don’t we say one more time, a smaller positive. So we're not having big surprises in terms of losses in workers comp or any kind of. And by the way we have very tight ship there in a sense that we have as we disclose in our 10-K, a collar that limits our risk in a fairly significant way. Caps are down side on workers comp. So we have reinsurance an individual claim and then we have a collar around overall loss estimates. So it's quite limited in terms of the volatility.I think the other thing that I would mention is that our business mix hasn't changed, so we look at that very carefully as well. So we looked at the mix of we call it white collar versus gray collar, but within those categories you have a lot of different industries and a lot of different categories of people and we don't see any major change there as well."
},
{
"speaker": "David Grossman",
"text": "Got it. And just as a follow-up, is kind of a bigger picture for you question Carlos is that given a relatively low penetration rates for the industry and that you get a lot of your new clients from a client that is already using you for payroll.What are the major objections to somebody enrolling in the PEO particularly if they're an ADP payroll customer and you already have the payroll records so it kind of disruption and transition cost time and effort are substantially lower?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think it's - it goes back to like my first year marketing class in graduate school, which is high involvement decision, right. So the PEO to go to a small midsize business and tell them that you're going to create a co-employment relationship, you're taking over there healthcare plan, there’s workers' compensation remember all along the way there are as an example that could be a relationship with insurance agent or a broker that's been providing to health care in the workers comp for the last 10 years that gets this intermediated.You have to - payroll is hard enough to convince some of the payroll because people worry about – are you sure you are not going to make a mistake and make sure that it's going to go accurately, we obviously have an incredibly strong reputation on payroll that helps us.But the traditional business is you’re trying to convince someone to give you your payroll, now you're also trying to convince them to give you everything around their HR department.And so it's with a higher level of trust and it's again what I remember being taught is called a high involvement decision, which takes longer to make and is more difficult to make.So I honestly don't think that there is really anything that prevents clients from becoming PEO clients. And I think we've demonstrated over 20 years that we've convinced a lot of them.And so our board asks the same question you're asking, which can't you convince even more. And we're trying. Like, we continue to add improvements in the product. We continue to provide better tools. We continue to enhance our product. We continue to do all the things we can to make it more compelling and easier to use.As an example, I think we've kind of talked about this in the last 18 months, all new business now and the PEO starting in our Workforce Now platform which has higher functionality and provides the ability to satisfy slightly larger clients than we could before because it's a mid-market platform.And so there is a lot of things that we're doing to try to convince as many clients to come over to our PEO solution as possible. I think it's good for them and it's good for them and it's good for us but there's really nothing that I can point to other than kind of the difficulties of the convincing of the sale."
},
{
"speaker": "David Grossman",
"text": "I got it. Very helpful. Thank you for that."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Hey. Good morning, guys. I just wanted to pick-up on some of the margin commentary. I mean, as you rightfully pointed out the comparison there gets quite a bit harder actually in the second quarter. So just so that our expectations are properly calibrated. I mean do you expect margins to be up in the second quarter year-over-year?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes. It's a really tough comp in Q2. Remember last fiscal year Q2, we had over 300 basis points of margin expansion. So it was going to be tough to expand in Q2. Maybe it's flat to slightly up slightly down. You know, hard to say exactly because there's so many moving parts.But the way I would think about is that the bulk of the expansion to come this fiscal year will come in the second half of the year."
},
{
"speaker": "Jason Kupferberg",
"text": "Yes. Okay. That's fair. I mean just on the bookings front somewhat similar question except in reverse right? Because you’ve got the easy comp there in the second quarter. So do you need to be above the full year guidance range in the second quarter just to make sure that you stay on track to achieve the full year outlook? Because then obviously the comparisons here get a bit harder in the second half?"
},
{
"speaker": "Kathleen Winters",
"text": "Above the bookings guidance number in the second quarter?"
},
{
"speaker": "Jason Kupferberg",
"text": "You need to be above the full year range in Q2 just to keep yourself on track?"
},
{
"speaker": "Kathleen Winters",
"text": "Mathematically, yes. So you're absolutely right. I mean it’s to stay on that for the full year you’ll have more growth in the second quarter and then much less in Q4."
},
{
"speaker": "Jason Kupferberg",
"text": "Right, right okay. And then just last quick one from me. What would be the drivers of the anticipated acceleration in the WSE growth during the balance of fiscal 2020?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Selling more new clients than losing clients. It really goes back to the - I mean, I hate to I'm not trying to be a smart [indiscernible] but the it's really the pattern, I think, I talked about it a couple of questions ago that when we tell our open enrollment in May and June, we tend to experience some client turn. The sales don't accelerate necessarily at the same necessarily at the same time.And so you have seen that phenomenon happens sometimes at the end of the calendar year where you may lose a group of clients and then you bring on new clients at the beginning of the year, but then you also bring on - so clients tend to not leave at other times of year other than calendar year end and open enrollment which is May and June.That doesn't mean non leave, I'm just saying that the skewing is cued towards those two periods. And the sales are skewed differently. And the combination of those two things is what causes either growth or deceleration in worksite employee growth."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. Look on - any of the not any but like a lot of these metrics when you look at a very short period of time one quarter – you could have some one-off things happening. I saw - as I said earlier looking at these trends and a track record over time for things like bookings and worksite employee growth and even margin, right? Looking at the trend over time is helpful I find."
},
{
"speaker": "Carlos Rodriguez",
"text": "But again in this case we also have - we have to hit our plan, obviously. I guess as usual when we have these calls, if we are giving you the numbers based on what we expect right now. So if we hit our new business bookings plans and retentions stays when we expected to stay then you would get the outcomes that we're talking about.But as Kathleen said, there's a lot of moving parts if three to six months from now, the economies in the tank and pays per control is declining, it's going to in the PEO in addition to ES and it less than ADP and that would create a headwind. But in the absence of any new information I think, we feel pretty good about the forecast we have."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay I appreciate it. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Wald from Morgan Stanley. Your line is open."
},
{
"speaker": "Steven Wald",
"text": "Hey, good morning. Just maybe a follow-up a on the margin expansion path, looking beyond, sort of the next few quarters or even this year, I just wanted to talk about the messaging. And make sure we were getting a proper sense of the drivers there.I think a lot of the talk has been around workforce optimization and procurement over the next 12 months or so. But I think, one of the things you guys try to talk about is the tech improvements or your investments.As you build more this into your platform, as you're add even more into what you are doing on a day-to-day basis. Can you talk a little bit about, how that scale to you're adding or that scalable expense base that you're adding will show up in terms of cost reductions or margin improvement?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I think again back to like what Kathleen was talking about in terms of the math, some of it was really comparisons rather than anything that we're doing. And but we have to help people. We understand that it's important for you guys to understand that.So, just as a reminder last year what happened was, we had with the voluntary early retirement program, we had a good number of people taking that. And then the back fills that we had planned which was all planned, certain percentage of back fills were delayed.And so that impacted that year. We also got off to a very strong start for a couple of other reasons. We had other what we called quick wins at a time around transformation that help us get off to a strong start in the first half.And I think Kathleen talked about -- we had for us, like incredibly strong margin improvement. And so it's just a very difficult compare mathematically. As we've been going along, regardless of how the math works, we continue to work on a number of initiatives.And this year obviously we executed on this expand the layers initiative, and then we have a number of other projects around procurement is one of them but we also have a number kind of automation and digitization project that I think we're making some progress on. And when we have our industry - sorry our Analyst Day in February, we'll probably share a little bit more around some of those things that we're doing, because those are around transformation and innovation as well. So it's not just about innovating on the product side. But it's also innovating on the implementation and on the service side.And we’ve gotten some good traction in some of our businesses which are allows our productivity to improve while, still for our associates. While still improving our NPS scores and our client satisfaction which by the way were up again this quarter and no surprise the retention is improving.It’s usually a sign that client satisfaction is still high. So again trick here is you want to transform your cost structure, but you don't want to like lose all the clients in the meantime. And for now, we've been able to balance both of those and that's our plan here for the next year or two."
},
{
"speaker": "Steven Wald",
"text": "Yes. Fair enough. And then, maybe just one quick follow-up, I noticed the buy back a little bit higher than we’ve seen last year or so. Just could you provide any commentary on how you're thinking about the pace there going forward?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes. So really no change in terms of how we're thinking about that. And our strategy we talked about the intent to buy back 1% of the share base. And we've been executing along those lines, so, really no change.We look all the time at the market conditions and look if there is some opportunity where there is a big downturn in the market and we want to become more active. Maybe we'll do that, I don't know. But constantly we watch that, we look at it, we talked about it all the time, but as of now no particular change."
},
{
"speaker": "Carlos Rodriguez",
"text": "Again, one little statistic, because we happen to notice these things when we prepare for these calls. Because now I get like seems like 20 years of information, so we’ve reduced our share count by 30% since the early 2000’s, and so we intend to continue to stay on that pace.And so obviously it's a marathon for a company like we're kind of proud that it's a marathon we've been around for seven years. And at 1% per year it adds up. And it certainly has added up in the last 20 years to the tune of a 30% share reduction.And I think that companies are in the different stage of development whether they're getting dilution and adding shares to their share count. We think we're going to win this marathon."
},
{
"speaker": "Steven Wald",
"text": "All right. Great. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. And we'll take our final question from Bryan Keane from Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, guys. Just a quick - two quick clarifications. On the PEO margins it was below street, but it didn't sound like it was really below your expectations. And it sounds like there was a tougher comp to the ADP Indemnity. So could maybe just talk to that and how that looks going forward on the margin side?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yeah. No, I think that's a fair characterization. I think that as usual there’s – and we try to obviously be as straight as we can be because sometimes there is a slight disconnect between what we’re expecting versus since we don’t give quarterly guidance. But the results I think were on that specific topic, I think we're in line with our expectations."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. It was definitely in line with how we expect to start the year."
},
{
"speaker": "Bryan Keane",
"text": "And then just the cadence how we think about that going forward on the margin for PEO?"
},
{
"speaker": "Carlos Rodriguez",
"text": "That's a good question. I think that when you look at the annual guidance, I think it was down flat to 25 down…"
},
{
"speaker": "Kathleen Winters",
"text": "Down 25 basis points."
},
{
"speaker": "Carlos Rodriguez",
"text": "Down to 25 basis points. I think that was the guidance. If you take our first quarter number, I would for now assume ratably margin improvement over the course of the rest of the year because these quarterly fluctuations in ADP Indemnity are not something that is - something that we can have a - we don't have any real visibility into that.And again, just as a reminder, part of why we've done this is, if you remember a couple of years ago, we had some criticism around our disclosures. So we had our client funds interest and Indemnity being handled in the kind of other category, which allowed us to not have these questions and not kind of makes up the results of those businesses.But as usual, there are two sides to every story. And so I think the criticism was those things really belong and the results of the business unit. Fair enough. So we made that change and now we are saddled with every quarter having to explain any kind of fluctuations here, because what really matters is the underlying health of the business.We don’t take enough risk in that business for it to matter. But you can get because of the size of the business, if you get a $5 million fluctuation which is what we had this quarter up or down, it affects the numbers, but it doesn't really say anything about what's happening in the underlying business.But it is what it is. We now report Indemnity in the PEO and we’re going to have to every quarter be able to give you that kind of color. And likewise in Employer Services we now have client funds interest. And so now that creates some variability in that business as well."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah, so with the down - with the flat to down 25 basis points and down 70 in Q1 you'll see that just mathematically it ramps. But again it's going to depend on the ADP Indemnity and how that comes through during the balance of the year."
},
{
"speaker": "Carlos Rodriguez",
"text": "It was certainly easier when we didn't have ADP Indemnity in the PEO. But because nothing -- we've been doing that for 20 years. We've handled it. We’re not by the way we are handling exactly the same way we’ve always handled it. It’s just a different accounting report. That's all."
},
{
"speaker": "Operator",
"text": "Thank you. And this does conclude our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for any closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, thanks very much. You can tell we feel pretty good about the start to 2020. We're obviously trying to change a lot of things. We’ve talked a lot about transformation. We'll share more with you when we have our Innovation Day here in February.But we’re focused on execution as I think Kathleen alluded to this there's still a lot of execution in front of us. But we still - we try continue to be focused on our clients and our associates. And our associates are doing a phenomenal job as evidenced by our continuing improvements in our NPS scores.Obviously, we felt good about what happened with HR Tech, with our Lifion debut. So I think that gives us some optimism. We're very excited about what's happening in the mid-market business here in the first quarter.So I - continue to be very proud of our organization and the resiliency of the organization and the transformation efforts that they continue to execute on. So we look forward to giving you more updates in the time to come. And we thank you for joining our call today. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 4 | 2,021 | 2021-07-28 08:30:00 | Operator: Good morning. Ay name is Sarah, and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Fourth Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. I would now like to turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Sarah. And welcome everyone to ADP’s fourth quarter fiscal 2021 earnings call. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the fourth quarter and full year. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I’d also like to share that we intend to host our Investor Day on November 15th. At this time, we’re planning to keep it virtual for most of our attendees. But given positive reopening trends, we do have capacity here in our Roseland, New Jersey headquarters to host our sell side analysts live and we look forward to seeing our analyst community in person soon. With that, let me turn it over to Carlos.
Carlos Rodriguez: Thank you, Danny, and thank you everyone for joining our call. We reported very strong fourth quarter results, including 11% revenue growth and 5% adjusted diluted EPS growth, capping a year end which revenue and margin outperformed our expectations in every quarter. For the full year, we delivered 3% revenue growth, the high end of our guidance range, and I’m happy to say, we reached $15 billion in revenue, a big milestone for the company. As we’ve discussed all year, we took a consistent approach to investing this year, while also prudently managing expenses. As a result, our adjusted EBIT margin was down only slightly and we were able to deliver 2% adjusted diluted EPS growth for the year, ahead of our guidance and well ahead of our expectations at the start of the year. I’ll first cover some highlights from the quarter. Our new business bookings results were very strong and our momentum in the market continues to build. Compared to last year’s fourth quarter, we grew our Employer Services New Business Bookings by 174%, which was slightly ahead of our expectations. And for the full year, we delivered 23% growth in ES bookings, towards the higher end of our guidance. We are very pleased with this outcome from our sales team, which booked $1.5 billion in new business in a year with a high degree of economic uncertainty.
Kathleen Winters: Thank you, Carlos, and good morning, everyone. Our fourth quarter represented a strong close to the year, with 11% revenue growth on a reported basis and 9% growth on an organic constant currency basis, solidly ahead of our expectations. Our adjusted EBIT margin was down 120 basis points better than expected. And as a reminder, we did have some compare -- comparison pressure versus last year’s lower selling and incentive compensation expenses that drove the comparative decline. Our 5% adjusted diluted EPS growth was strong, and in addition to the revenue and margin performance benefited from share repurchases. For our Employer Services segment, revenues increased 10% on a reported basis and 8% on an organic constant currency basis, as we lapped last year’s pandemic affected Q4. We continued to see contributions from excellent retention, strong new business booking and growth in pays per control offset by lower client funds interest. ES margin was down 90 basis points due primarily to higher selling and incentive compensation expenses versus the prior year. Our PEO also had another very strong quarter. Average worksite employees increased to 616,000, up 12% on a year-over-year basis on both continued retention outperformance and contribution from solid employment growth. Our PEO revenue grew 12%, an impressive performance as we once again benefited from higher payroll for WSE, as well as stronger workers comp and SUI revenue for WSE compared to the prior year, partially offset by lower growth and zero margin pass-throughs. PEO margin was up 340 basis points in the quarter, due to an elevated worker’s compensation reserve true-up last year. We were very pleased with our strong finish to the year. For fiscal 2021, a year heavily impacted by a pandemic, we drove strong bookings growth, solid 3% revenue growth, delivered positive EPS growth and continue to invest for sustainable growth and digital transformation.
Operator: Thank you. We will take our first question on the line of Eugene Simuni with MoffettNathanson. Your line is now open.
Eugene Simuni: Good morning. Thank you for taking my question. Maybe to start with a little bit of a high level macro question, so Katelyn, you just highlighted that there is significant amount of secular growth that’s coming out in HR services industry from the pandemic? Can you speak a little bit more about where you guys are seeing the indications that the secular growth is actually helping, financial performance of ADP and how much of that is incorporated in your fiscal year 2022 guidance and where can we see that effect in the numbers?
Carlos Rodriguez: I think there are probably a couple of highlights. I think, Kathleen, probably has a couple of other, she would -- she can mention. But, like, I think, we mentioned in our prepared remarks, what we’re seeing around Workforce Management in terms of time tracking and scheduling and so forth. We also mentioned some of the products we’ve developed for Return to Workplace. So there are a number of things that are probably related to what’s likely to be a more hybrid work environment for white collar employees at least on a go-forward basis, which probably requires people to think about their investments in HCM in terms of what they can do to maximize, the recruiting and the retention and the engagement of that hybrid workforce. So I think that is one. The other one is, there’s always been a secular uptrend in terms of regulatory related and this is on a global basis, demand for HCM products. In other words, the more complexity there is around being an employer, the greater the demand for the wide array of services that we provide. That secular trend has probably gotten a bit of a boost based on in the U.S. the change in administrations, right, which we’ve had that secular growth for seven years that ADP has existed. But there are times where it’s stronger in terms of a tailwind and sometimes where it’s weaker. And I would say that we’re heading into strong secular tailwind here, as a result of some of the increased attention on regulatory actions. And you probably all saw, I think, it was yesterday, the day before, that the President signed number of executive orders, most of which are aimed at employer employee related relationships that increase the amount of tracking and reporting and compliance necessary on the part of employer. So those are a couple that I would mention. I think our retention rate also shows in -- an indirect way secular demand improving right in the sense that people have kind of rethought dropping or switching from their HCM vendors. But that one is a little difficult to be 100% sure about, because we do expect some normalization in that retention rate.
Kathleen Winters: Yeah. I think that really covers a lot of that. I mean to kind of summarize and categorize what Carlos said, when you think about the complexity, number one, of being employer, the ongoing and pretty significant changes that we see from a regulatory standpoint. So complexity, regulatory change, the dynamic environment as the way people work and employer relationship -- employer employee relationship changes, it’s a very dynamic environment. All of that is, you can just see in, the bookings number that we have. Our bookings, I’m sure we’ll get into the discussion on this, but the growth is pretty broad base. I mean, certainly, we saw some channels stronger than others, but it’s pretty broad base. And I think that’s because of all of this dynamic change and complexity that we see, and in particular, our comprehensive solutions that our outsourcing solutions have seen quite significant growth. So we’re really encouraged about the macro trends that we see in the space.
Carlos Rodriguez: And again, I think that, it’s all -- I’ve always never known what is defined the secular versus not secular. But the huge demand now for talent, what’s happening in the labor markets. Obviously, that’s a huge tailwind for all of us in the HCM space in terms of recruiting tools and engagement tools to try to hold on to people. But that could also be something that wanes in six months. That’s -- that one’s a little harder to tell. But generally speaking the war for talent has always been also a secular tailwind to our industry as well.
Eugene Simuni: Got it. Got it. Thank you. Great. And then for a follow up related and talking about the bookings growth and looking at your guidance for 10% to 16% growth next year. Can just quickly speak to kind of two or three key swing factors that you see that will define whether we’re going to end up on the lower end or higher end of that range, as we kind of turn the corner on the recovery and go through the spirit?
Carlos Rodriguez: Sure. So the -- actually I can probably give you a three that would probably account for kind of the way we think about this. So number one, obviously, is what we just talked about is the secular and cyclical tailwinds or headwinds. So if the economy continues with the momentum it’s got, we’re feeling pretty good. Obviously, if we end up having more challenges, because of the pandemic or otherwise, but right now the amount of -- even the existing government stimulus, even if there’s no additional stimulus is pretty strong and also the pent-up demand and all these -- the reopening. That feels like a very good backdrop for us from a bookings growth standpoint. And then, as long as we have that background or that backdrop that’s positive, it really comes down to really two things is sales force productivity at the Sales Quota Carrier level time, number of Sales Quota Carriers and I hate to be so simplistic, but at our size, because we have new products and we’re rolling out, you heard how excited we are about all the new things that we’re putting out there. But we sell a lot of business every year. So for a smaller company, when they end up having like a new product launch that can cause all kinds of growths, and by the way, likewise, if you don’t have any new products. But for us, what I would consider to be a steady-eddy. So we really grow through methodically improving and adding new products, making talking acquisitions, et cetera, a lot of us. But the key formula for us is we cannot hit our sales plan unless we have the headcount and we are continually improving our sales force productivity and that’s exactly what our plan is. And we have some good news over the last four quarters where our sales force productivity at the Average Quota Carrier level steadily improved throughout the year to reach 90% for the full year. But we exited the fourth quarter in kind of the mid-90%s, if you will, in comparison to pre-pandemic levels. So it feels like we’re getting back to the quote-unquote trend from an average sales productivity standpoint and if we can get back to that trend, and we deliver on our hill -- on our headcount additions, we should be able to hit our new business bookings number.
Eugene Simuni: Got it. Thank you very much.
Operator: Thank you. Our next question comes from a line of Pete Christiansen with Citi. Your line is now open.
Pete Christiansen: Good morning. Thanks for the question. Carlos, you talked about a lot of new logo wins this year, which is pretty impressive. But I was curious to hear how you think about how this may have changed your or ADP’s cross-sell, upsell opportunity set? I’d imagine the runway there is expanded quite a bit, and perhaps, how you are thinking about strategy, that land and expand strategy to really take advantage of this opportunity? Thank you.
Carlos Rodriguez: Yeah. So one of the -- in case somebody asked that we, one of the questions we sometimes get is and it’s related to what you’re asking is the mix of how much is new logo sales versus how much is add-on sales. And it’s really been very steady over many years. It was only during the ACA period where we had a little bit of a tilt more towards incremental add-on sales. But it’s -- for a long time been around 50-50 and it’s still kind of in that neighborhood. So that I think bodes well because the more clients we add, the more opportunities we have pursue that land and expand, I think, approach that you just described. So I would say that, we’re bullish on the opportunity to continue to go back to the new logos that we sold, which in many cases, we sell with multiple modules, but there’s always additional room for new products as well to go back to that existing client base. So I think that underlying logo growth, I think, is another kind of supportive factor, if you will, for a new business bookings, because we do get about 50% of our bookings from our existing client base.
Pete Christiansen: That’s helpful. And as a follow up, I was just hoping if you could juxtapose the GlobalView business versus the rest of ES. I know, they haven’t been totally in sync during this recovery. What are you seeing there of late trend wise? And as you look towards the outlook, is that part of the business considered or laggard behind the remainder of the ES or is there some variability there that investors should be aware of? Thank you.
Carlos Rodriguez: It’s actually a little bit of the opposite. Maybe we may have confused some people, I think, in prior calls. But I think, GlobalView is probably, could be at the top of our list in terms of performance this year, like, large multinational companies have been, I think, looking for ways. I think this pandemic rate -- raise probably some issues and concerns around control. I think for the HR leaders that probably raised some issues around engagement and making sure that you’re connected to your global workforce and that you had global reporting, et cetera. So there’s a lot of factors that probably went into what was incredibly strong demand and very positive sales growth. So I would say that, again, we don’t disclose individual product lines, but I would say, the GlobalView sales were one of the stronger line items, I think, for us. And I’ll add that to your question about differences between the businesses. I think all of our businesses really performed well. It’s kind of hard, it really come down to trying to point out which ones were spectacular versus just good. And I would say that GlobalView and even our International business really were standouts and I -- really it’s very impressive, because some of the situations in Europe, for example, were very challenging in terms of dealing with the pandemic, but I didn’t really stop people from looking for solutions and it didn’t stop our sales force from finding them, even though they had to do that from obviously from a remote workplace. So, I guess, summary is, GlobalView is a shining star for us.
Kathleen Winters: Yeah. They saw good momentum as we closed out the year. In fact, it was a particularly strong closed with a good number of multinational deals on GlobalView coming through at the end of the year and we’re looking at fiscal 2022 for them to be a big contributor again.
Carlos Rodriguez: And again just -- the only -- again, it doesn’t make a huge difference in the overall ADP revenue numbers. But these strong bookings remember will really translate into revenue and cause six months to 18 months, because these are large, typically large multinationals that take some time to implement. But that should be a positive thing for us kind of looking forward, if you will, in that six-month to 18-month horizon.
Pete Christiansen: Thank you. Great color and really nice execution. Good job. Thank you.
Carlos Rodriguez: Thank you.
Operator: Thank you. Our next question comes from the line of James Faucette with Morgan Stanley. Your line is now open.
James Faucette: Great. Thank you very much and good morning. I wanted to ask quickly and I think it’s tied into some of the comments you’ve made around your guidance. But specifically, how are you thinking about like the well-publicized difficulties employers are having attracting employees and that kind of thing? How is that factoring into your guidance and your formulation and are expecting resolution of that as we go through the fiscal year. Just trying to get a little bit of color how you’re putting the macro environment into forecasts?
Carlos Rodriguez: Well, I mean, I would probably put that in the bucket of secular tailwinds or cyclical tailwinds, depending on your view of whether it’s short-term or long-term. But it does seem like if this kind of resolves itself, let’s -- there’s a couple scenarios, but if it’s transitory in terms of the friction of getting people into the right job and then six months from now some of this has passed, by the time we get to that point, unemployment might be down into kind of the 4% to 5% range, which then creates a whole another wave of needs for employers in terms of finding talent and kind of fighting for talents over. So it feels to us like this is a multiyear cycle here where employers are going to be really scrambling to find people. I think that generally creates conversation opportunities. So we don’t have a magic formula necessary, and necessarily, we’re not a staffing firm. But we do have tools and we have technology, and we have people that can help our clients be more competitive as they look for solutions, as they look for the right employees in the right place at the right time at the right pay level. That’s our sweet spot. And so I’d say we’re right in the middle of this, what I would call, super cycle of demand for labor that is probably short-term related to kind of friction where people are just not in the right places and people are probably also some -- there’s some hesitation, still there’s issues with childcare and eldercare, there’s a number of factors. It is -- we assume like other economists that this will be -- that part will be transitory, but that the need for people will not be, given just the obvious low unemployment rate, which we will be at by the end of, call it, calendar year 2022.
James Faucette: That’s really helpful, Carlos. And then just as it relates to sales productivity, you highlighted that on your -- you’re expecting and seeing improvement there. At the same time -- and you indicated that there, you’re being able to get your salespeople in front of more accounts and potential accounts. How closely tied do you expect those two things to be as we go through the rest of the fiscal year?
Carlos Rodriguez: Again, this -- we’re uncharted territory. It’s a little hard to give a scientific answer, because this last year, we were not able to get in front of a lot of our process, actually most of our process until recently. And yeah, we delivered, I would say, very solid and strong bookings results. So I think some of this is really about us being able to adapt, which is our job to what the market wants, right, what the clients want and what the prospects want. And the fact of the matter is that about half of our -- half of the workforce out there, which probably translates into half of our clients, they actually kept going to workplaces, they kept making things, delivering things and going to workplaces. The rest of the some of us white collar employees didn’t. So that segment of the prospects and clients, they expect us to be available, if they want us to meet with them in person. We’re not going to go force anyone to meet in person. We’re happy to meet them if they want to be met, whether it’s virtually, online or in person. But we want to be ready for whatever the market wants and for whatever the market demands and that’s exactly our plan. But to answer your question, it’s really hard to know which factor is the most important factor. We think that being able and willing and available to meet in person with prospects is an important element of our sales success for fiscal 2022. But I can’t really put a number on it because we were successful in 2021 without doing that.
Kathleen Winters: Yeah. I think the key is that we’re going to have to make sure we can continue to be nimble just as we were in fiscal 2021, right? If there are certain regions or points in time where we might have to scale back a little bit in the face-to-face, I think we’re nimble enough to do that. We’ve proven we could do that. But we’re certainly ready and have been out there doing face-to-face and hope that that continues.
James Faucette: Thanks, Kathleen. Thanks, Carlos.
Carlos Rodriguez: Thank you.
Operator: Thank you. Our next question comes from the line of Dan Dolev with Mizuho. Your line is now open.
Dan Dolev: Hey, guys. Great results. Thanks for taking my questions. So, can you discuss how the retention has varied by sort of the three ES by the three sub-segments, SMB, mid-market and up market? And what happens to the SMBs once the PPP rolls off, so how should we think about kind of your guidance for retention versus like those three vectors? And then I have a very short follow up? Thanks.
Carlos Rodriguez: That’s a good question. I think, Kathleen, may probably have a little bit of additional color. But I would tell you that, this -- I think your insinuation that the PPP loans may have something to do with these elevated retention rates is something that we’ve heard kind of out there in the -- in terms of as a buzz. And again, that’s very hard to, like, put our finger on in terms of how to quantify that and what’s the impact? But for sure, one of the strongest areas we’ve had in retention is our down market business and that is why I think we’ve prudently planned for some give back on that next year. Having said that, I will tell you that, this year, fiscal 2021 and the two months before that were probably the greatest example of ADP’s business model in terms of ability to deliver. Now we call it service, you can call it compliance and call it whatever you want, but when the chips were down and people needed help and needed to talk to someone about their PPP loan and they weren’t calling their banker, they didn’t have to apply for a loan and they didn’t have to go through a bank, but you can go do your own channel checks to see how many banks were actually answering the phone or giving people advice, because they were completely overwhelmed as we were, but we actually figured out a way to handle it and we were there for our clients. And so, I think that, what we just did over the last year and I get it I’m a pragmatist, so memories are short and we have to continue to impress and continue to deliver for our clients. But I think we just proved to hundreds of thousands of clients, and hopefully, the prospects from a reputation standpoint that if you want to have someone who’s a partner, if ADP, if you want software, you can buy software. But if you want great technology and great software, but you want someone who’s going to be able to deliver on the service side, then you should be with ADP. And so I think that that’s going to have some -- there’s going to be some factor and hopefully allowing us to hold on to some of this retention on a more permanent basis, because I think the -- when the chips were down, I think, people saw the difference between not having someone that you could get help from and having someone that you can reach out to and get advice and get your problems -- major problem solved. But the bottomline is, we clearly are prudent and aware that some of this normalization could result in some lower retention rates, particularly in the down market, as you are, I think, alluding to.
Kathleen Winters: Yeah. I mean, that’s covered a lot of. In fiscal 2021, look, we saw strong retention across almost all of our channels, our businesses, particularly in small business and mid-market as well, though, and even actually on the international side where the retention is very high. We thought it’s a little bit higher there as well, too. So, pretty much strong across the Board. But look, we want to be prudent from a planning perspective and while we haven’t seen any change yet in terms of switching or along those lines. I do think it’s prudent to plan that there’s going to be, I’ll call it, a little bit of give back in fiscal 2022. I think we are going to hold on to some of the games. We’re certainly attempting to do that. We want to do that. But I do think it’s prudent to plan for a little bit of give back, which we’ve done and that would be primarily with regard to small business segment normalizing back to pre-pandemic levels.
Carlos Rodriguez: But to be clear, there’s no -- I’m not aware of a particular -- there’s nothing that ties a client to us or anyone else because of the PPP loans. What I’ve heard the theory that some people have somehow some kind of psychological thing that it’ll just make things more difficult if you switch and I -- I’m obviously not a small business owner. So we talk to small business owners. We’re just not hearing that. But it feels logical that could be a factor of that. But to be clear, there is no particular trigger that on November 15th we’re going to lose 100,000 clients because their PPP loans have been repaid or expired. That’s not the way the program work.
Dan Dolev: Understood. And then my quick follow up and I think it’s somewhat ties to this is the margin guidance. What I’m hearing this morning from investors is, it might be -- I don’t know maybe slight, maybe light of expectations. I mean, is that somewhat tied to the mix shift next year or is there anything else that you could call out on the margin guidance? Thanks.
Carlos Rodriguez: Well, listen, after 10 years of doing this, I’ve never heard anyone say that your margin guidance was too aggressive and too high. So let me just start off with that comment. And part of that is that we’re always trying to balance short-term and long-term investors. I’m not sure which one you were hearing from. But our intent here is to continue the machine, right, and the momentum that has led to multiple decades here of compounded growth and creation of value over a very long period of time and that requires delivering short-term results, as well as long-term results. And those long-term results, I think, require some investment including on the R&D side. But in particular this year, really the biggest factor is selling expense and sales investment, which has happened to us in the past, we’ve had other times and call it 2000, 2001 or 2002 and then, 2008, 2009, 2010, because I was around for those, where as we reaccelerate and take advantage of demand back to the secular growth opportunity. The way our business model works is we incur a lot of upfront selling and implementation expense. Now there’s some accounting rules that allow you to defer some of that. But generally speaking, you get elevated selling expenses and implementation expenses, and it’s pretty significant. So I would say that that is a significant part of what would have maybe otherwise been higher margins for 2022. But when that business then is on the books, that’s a high incremental margin business that then in 2023, 2024 and then for the next 12 years to 13 years, that’s how long we keep our clients on average creates an annuity. So as you can imagine, we never turn down the incremental opportunity to add business, never, because it is just the way the value creation model works. And we’re going to make hay while the sun is shining here. And with 6%, 7% GDP growth last quarter and what’s likely to be incredibly strong GDP in the next year or two, we’re going to take every possible opportunity. And unfortunately, that requires some selling expense and some implementation expense in addition to the ongoing investments in technology and some of the other things that we do.
Kathleen Winters: Yeah. So just big picture when you think about margin for next year and we’re very happy that we’re able to kind of guide to the 25 basis points to 50 basis points of margin expansion, I mean, look, we always look to do better than the plan, but that’s what we’re comfortable with. Right now, the way to think about it is, look, we’re going to have operating leverage to a greater extent in fiscal 2022, obviously, but we’ve also got the investments that we want to continue to make, as Carlos just articulated, in product, in sales and in digital transformation importantly. And we do have some offsets, Carlos mentioned, the sales expense. But we also have things like, Return to Office and ramping up T&E versus what we were -- where we were in fiscal 2021. So kind of all that goes into the mix, net-net, we’ve got this 25 basis points to 50 basis points margin expansion. We’re going to do our best to deliver on that and continue to work our digital transformation and if possible do even more.
Carlos Rodriguez: And one -- just one other factor, because if you have any doubts about ADP’s ability to drive margin, just one small thing hasn’t come up yet. But we had this like small little problem this year with interest rates, where it created $110 million headwind to net contribution and 100 -- almost $125 million in topline and bottomline in terms of client funds interest revenue. So our revenue growth would have been almost a point higher and our margin for this year in a pandemic would have been up 70 basis points instead of downside 40 basis points, had we not had that headwind. Now, we did have a headwind. So it’s always hard to say, if we didn’t have this and we didn’t have that. But that’s a pretty easy thing to isolate that has no operational -- nothing to do with operations, we have no control over and we have to just ride that cyclical wave, which hopefully that’s cyclical wave is heading in a very positive direction for us over the next two years to three years. But just want to make sure you understood that, because I think that tells you just how much control we have over our expenses and over our business model and over our long-term value creation objectives.
Kathleen Winters: And that perhaps our interest does continue to be headwind for us in fiscal 2022, very modest headwinds, compared to what we experienced in fiscal 2021, but it doesn’t help us, whereas in your past, it was a significant help to us.
Dan Dolev: Got it. Thank you for the detail. Appreciate it.
Carlos Rodriguez: Thank you.
Operator: Thank you. Our next question comes from a line of Ramsey El-Assal with Barclays. Your line is now open.
Ramsey El-Assal: Hi. Thanks for taking my question. I wanted to follow up on your comments on retention and you’re prudently planning for retention to increase if the market normalizes whether it does or not we’ll see. But can you describe your toolkit on the sales or technology side that you can use to prevent attrition and I’m sure a lot depends on the underlying sort of reasons for the attrition. But can you be more proactive on that front and sort of stem the tide of it if push comes to shove?
Carlos Rodriguez: Absolutely. I think, and again, I -- we probably have a couple of examples we could give of things that we’ve done over the last year. But it’s usually a methodical multiyear approach to making our products like, when we talk about innovation. Innovation is partly about new business bookings, but it’s also about making our solutions easy to use and more intuitive. And you’ve heard in our comments and we shouldn’t gloss over it, like, the UX experienced investments we’ve made in both RUN, but now in some of our other platforms is a significant factor in today’s world of whether or not a client sticks with you or not. So we get that. That’s why, however, many years ago, we kind of got it, and we said, we need to become a technology company in addition to the services company that we are in. So I’d say, number one is, you have to have great products, they have to be easy to use, and they have to have no friction. That will help with retention. I think the other things that I think you can point to are really just around availability. So our business model and our promise is not just technology and software, but it’s to help with compliance and is to help with advice and is to provide expertise. And that really means that we have to have well trained associates, who are there to answer questions, whether it’s chat, whether it’s by phone, it doesn’t matter, however, the client wants to reach us, but the stuff we do is complicated. And being an employer is complicated. And it requires help and you need to get the help from us or you can call an attorney, or you can call a consultant. But most people do not just do this stuff on their own and we happen to package the two things together, great technology with great service. So I say, if we have great technology and we have great service, we’re going to be able to hold on to hopefully a lot of that improvement we’ve had in retention, even if we have a little bit of give back in the down market.
Ramsey El-Assal: I see. Just not a question of running analytics at the right time, it’s really more of a longer term kind of blocking and tackling and product innovation approach.
Carlos Rodriguez: We run plenty of analytics too. So we have -- for example, we have a lot of data around, like, we track individual clients, how many times they call. We actually can monitor we have voice recognition that tells us, certain, keywords that people use when they’re, because we record all phone calls and that really gives us deep insight into clients that are at risk. And then we have special teams that can follow up with those clients to make sure that whatever problem they had has been resolved. But that’s -- I would call that trench warfare, which -- if you want to get into those details, I can go in the trenches with you. But we have very deep analytical tools that really give us a lot of insight. Like, for example, in our down market, I mean, our clients don’t call that often, because hopefully they don’t have problems very often, because we do a nice job of preventing problems. But one of our small business clients has -- we detect has multiple calls in a month, that requires a reach out to that client or a deeper investigation and a triage to make sure that we don’t lose that client, because that’s usually a sign that there’s something wrong with that client. And we have other techniques and other approaches and other tools to identify what we would call hotspots. We also monitor pricing very carefully when we do our price changes, which I guess is code for price increases. We do that very carefully using a lot of analytical tools to make sure that we do that in the smartest possible way, if you will, to maximize retention.
Ramsey El-Assal: Okay. Thanks for that. And a quick follow up for me. How would you characterize the demand environment for off cycle or on-demand payrolls, is it something that that you see getting quite a bit more popular or it will sort of remain kind of a niche service over time?
Carlos Rodriguez: No. I mean, it’s clearly popular, because I know a lot of people are talking about it and so that always leads to popularity, right? As soon as someone talks about it, it becomes popular. I think that it’s, again, like, a lot of things we’ve been saying over the last two years or three years, so many things are inevitable are going to happen and we’re preparing for them. So things like real time payroll. In this one that you’re referring to is kind of one that we just heard over the last couple of days. I think that we’ve been thinking about for many, many years and we have solutions, where if someone needs to get paid, like, for example, in California, if someone is terminated from their job, you have to give them their final paycheck like immediately and so that is difficult to do through the normal process. So we have solutions for that we’ve had for quite some time. And so I think the increasing popularity is probably more related to increasing discussion about it, but also to technological advances that allow more options, right in terms of instant payments and/or faster payments. So I would say the answer is, yes. That is an important thing. And for certain sectors, like, if you have a high turnover, hourly workforce, your ability to provide that solution is crucial. But we have that ability to provide that solution. But you can’t, for example, sell a client in California and not be able to provide instant pay upon termination. So it’s -- you have to have that.
Ramsey El-Assal: Got it. All right. Thanks so much.
Operator: Thank you. Our next question comes from a line of Bryan Bergin with Cowen. Your line is now open.
Bryan Bergin: Hi. Good morning. Thank you. Can you talk about how you’re thinking about the cadence of the pays per control projecting, you’ve assumed during fiscal 2022? And what does the 45% build imply in the base relative to pre-pandemic levels?
Carlos Rodriguez: We’re digging for that. I think the quarterly -- I mean, again, it’s probably, when you look at the comps, the fourth quarter will have weaker than expected growth. But I don’t know, Dan, if you have the…
Danyal Hussain: Yeah. Bryan, it’s just a mirror image of what we saw effectively last year. And so there’s a stronger Q1 performance PPC that’s baked into our assumptions and it gradually tails off. But we don’t have an explicit guidance for you on what this means for reported unemployment rate, the same way that we gave you that guidance last year at the outset.
Carlos Rodriguez: And the average for the year for pays control, I am going to refresh my memory is…
Danyal Hussain: 4% to 5%...
Carlos Rodriguez: 4% to 5%.
Kathleen Winters: Yeah.
Carlos Rodriguez: So you -- I would anticipate, if I were you, I would probably assume that for the fourth quarter is going to be back to, I don’t know, 2%, 3% or somewhere low -- somewhere in the lower range.
Danyal Hussain: Absolutely.
Carlos Rodriguez: Because we’re growing over the 8% and in the first three quarters, particularly the first quarter it’ll be higher.
Bryan Bergin: Okay. And follow up then on M&A. How are you thinking about areas of potential acquisitions for capabilities? And then also, can you comment on how the market has been for book of business acquisitions, curious COVID has changed that dynamic during fiscal 2021 and then to fiscal 2022?
Carlos Rodriguez: We’ve had actually pretty good success in terms of client base acquisitions. You -- again, you’re right, that I myself was surprised that there was an opportunity to do that and then we were able to execute on it. But we had one that I think we mentioned last year, in the fourth quarter and kind of spilled a little bit over into the first quarter, but it was mostly I think fourth quarter. We had one the year before that, that was significant also in the fourth quarter. And in this year, we’ve had a number of, what I would call, smaller ones, but they add up. And so I would say that the news there is good and is ongoing and we’ve created a nice ability to do these conversions and make it good for us in terms of growth. And back to the question around cross-sell, we usually have a much broader set of solutions than other people that we are making these acquisitions from, which creates upside opportunity, right, in terms of value creation for us. On the kind of overall M&A comment side, I would say that, we’ve -- where we’ve been most active is looking in some of our international locations in markets, where I think we have very little market share and we still have needs, for example, for add-on products, whereas in the U.S., we’re not really looking to add additional platforms for either benefits or payroll and so forth. So it really has to be things that are adjacent, right, in the HCM space, but not duplicative, because as you know, we’ve been on this kind of simplification push for many, many years and trying to build things organically and invest in technology organically. So that doesn’t mean that we won’t acquire because we have and a couple years -- we haven’t done anything for a couple of years. But we do welcome the opportunity to add additional ancillary benefits as long as they fit into our technology roadmap and they’re not disruptive or add-on and we’re not doing it just to get the quote-unquote revenue pop. But on the international side, we typically don’t have those factors at play as much and that’s a place where we’re still excited and we still see a lot of greenfield opportunity to expand through M&A.
Bryan Bergin: Okay. Thank you.
Operator: Thank you. Our next question comes from the line of Kartik Mehta with Northcoast Research. Your line is now open.
Kartik Mehta: Good morning, Carlos. You talked about the PEO business, obviously, it performed well in the fourth quarter and seems like trends are coming back. I’m wondering if you’ve seen any secular changes, I know that word maybe you don’t like, but any secular changes in demand for the product, or if you anticipate any changes, because what we’ve gone through with COVID?
Carlos Rodriguez: I mean, again, my experience tells me that, because I actually ran a business for many years at ADP and now I’ve been watching it for, I can’t believe I’m going to say this for 25 years. And when you get into this kind of economic environment, it’s usually a positive secular tailwind for, I guess, back to like, sometime I don’t like that word. But I would say that there have been positive secular trends for the PEO for 20 years to 30 years. And then they can get enhanced, I think, by cyclical factors, like, a strong economy. Like, so people sometimes say that the PEO will do well or outsourcing will do well, when there’s a recession, because people are looking to save money and that -- there’s some truth to that. But it’s not what the data supports or shows, right? It’s usually when you have very strong economic growth and strong GDP and people are scrambling for talent and they’re competing for offering the right benefits. That’s when PEOs and outsourcing tend to, I think, do better. So I would say that, based on experience, which you have to discount, because we just went through a pandemic. So most of our experiences, we should park somewhere outside the door, because we may end up being wrong. But all things being equal this kind of economic environment is usually very strong for the PEO. And as for the last 18 months, what we saw there is, it’s a long cycle sale and it’s a high involvement decision. So I think we’ve been clear that, we’ve had good great results there from a booking standpoint, and probably, better than we would have thought was possible, but definitely not as strong as yet in kind of the early stages of the recovery of our bookings. We expect that to reverse and that is our plan in 2022. In other words, we expect very strong bookings and strong recovery on the PEO. And we’re seeing some signs of that in the fourth quarter, because what happened is in this kind of hunkering down mode, we saw very high retention in our PEO, but not as much. It was more difficult to sell new clients, but the existing clients. I mean, it was unbelievable value that we delivered to them and because it was beyond just PPP loans. It was -- how do I downsize my workforce or how do I put people on furlough and what are the rules in this state around benefits. I mean, our people were busy. I mean all of our people or all of ADP were busy this year, while maybe other people were less busy, but our people were busy and in the PEO, they were extra busy. So I think that that bodes well. And those anecdotal stories and that reputation along with kind of some of these cyclical tailwinds, I think, bode well for the PEO here in the next year or two.
Kartik Mehta: And just as a follow up on the ES business, have you had to do anything out of the ordinary in terms of price competition or just providing promotions?
Carlos Rodriguez: Have we done anything, are you saying or is the market?
Kartik Mehta: Yeah. I guess have you had to do anything to come from because of what competition has done? So have you had to do anything out of the ordinary on the ES business?
Carlos Rodriguez: No.
Kartik Mehta: Perfect. Thank you.
Operator: Thank you. Our last question comes from the line of Mark Marcon with Baird. Your line is now open.
Mark Marcon: Hey. Good morning, everybody, and thanks for squeezing me in. I was wondering if you could talk a little bit about the strong bookings performance and just unpacking that, in terms of, where you -- I heard the 50-50 mix in terms of upsells versus new logos. But as it relates to new logos, where were you seeing the strongest success, was that down market in terms of the new business formations, was that across the Board and who do you think you were winning the most against?
Carlos Rodriguez: Well, we would always squeeze you in Mark. There’s no question about that. A couple of highlights. We think we mentioned in our prepared comments, but our non-PEO HRO solution. So these would be kind of mid-market and upmarket outsourcing solutions that are, what I would call more comprehensive, if you will. Really or probably one of the real highlights and I think that was, again, related probably to people realizing, probably, within months after the pandemic that, like this stuff is hard to do, especially if you have to pivot very quickly, right? You have to make sure your systems are still up like you can’t have a server in a closet somewhere that you’re using to run payroll, because you still do this internally. And then people who go to the office to key in the payroll, like this stuff is just a lot of people all of a sudden woke up and realized, from a business continuity standpoint and from a support standpoint, I need help, there needs to be more than just the software, right, and basic service. So these HRO solutions really were an incredible bright spot. And then, I think, definitely mentioned, our upmarket and our ESI bookings results were also very, very strong. Yes, new business formation helped in the down market and we’re very -- like we’re pleased with all of our results on booking side. It was across the Board very strong performance. But I would say that there were other places that had even stronger. When I talked about GlobalView, our Tax Filing and Compliance business, which does a lot of standalone business, where again, companies realize that having a bunch of people subscale doing this stuff, you don’t even know where they are and if they can get to the office or if they can do it from home, but it’s mission critical, are looking to outsource or did outsource a lot of that stuff to us. And then we did have a couple of, what I would call, volume-based businesses, like, employment verification and screening and a couple of things that, RPO also came back a little bit. But it was really across the Board, honestly, like. So those are a couple of just like…
Kathleen Winters: Yeah. Like a strong across the Board, Carlos said all those right points, in particular SBS really led the way, down market really led the way in recovery during the course of the years. And in fact, and you can correct me if I’m wrong on this, but I believe SBS had their biggest Q4 ever, including the Retirement and Insurance Solutions.
Carlos Rodriguez: Yeah. I wrote it down somewhere, but I can’t find it. I think we had records Q4 bookings in a number of different categories. But that’s also probably happens over the years to, where we have so many things were so broad, that there’s always a few bright spots. But honestly, compared to what we would have expected the beginning of this year, really, to be saying we had record bookings in any business line is really good news.
Mark Marcon: Okay. That’s fantastic. And just with regards to the new logos, in terms of if there wasn’t moving to an outsourcing solution that was previously done in-house, was there any sort of commonality with regards to competitive takeaways and wins that you ended up seeing as a source?
Carlos Rodriguez: I mean, I say that, when I looked -- when I look at the -- we call the balance of trade data. I would say that we -- again, I’d like to think we’re doing a little bit better. We don’t provide a lot of color and disclosure around, because I don’t think it’s helpful and I’m not looking to pick a fight with any specific competitor. But I would say that we’re pleased with our progress, like, we need the combination of stronger retention, which means we lose less to some of those competitors that you’re talking about and our strong bookings performance means we won more against some of those competitors. I think you’d probably paint the picture that there’s probably a few competitors where a balance of trade improved, which it did. And admittedly, in some couple of competitors, it didn’t, right, it stayed. But I don’t think there’s really any place where we went backwards, that I’m aware, I’m trying to think back. But I think the balanced trade situation, we’re very focused on this, we’re trying to become more focused on logos and units and more focused on our competitors, because our competitors are focused on us and we’re sick and tired of it.
Mark Marcon: Understood. And then, along those lines, you’ve made a number of product enhancements. Can you highlight it, a number of them, including in terms of Workforce Solutions, Workforce Planning, time and attendance? And then, obviously, highlighting Next Gen Payroll, just wondering, which ones do you think are going to have the greatest incremental contribution? I know it’s all leads to sales force productivity, but just, which ones should we look for the greatest benefit from?
Carlos Rodriguez: Well, that’s a tough one, because it’s like picking your favorite child.
Kathleen Winters: Yeah. I mean, I have a view. I think what we do…
Carlos Rodriguez: Yeah.
Kathleen Winters: … from an investment perspective in ongoing kind of refresh and modernization, and you act on all of our strategic platforms is critical. And we’re doing that all the time and that’s just critical to our ongoing satisfaction with our products, as we talked about earlier and our NPS score. So that constant refresh from a UX perspective is really, really important. But, Carlos, you may have other things you want to just highlight…
Carlos Rodriguez: No. I think that’s well said, because I’m excited about all of them. I think that the Next Gen Payroll is literally could be the biggest mover in the last multiple decades for ADP for us. But it really -- it’s really Workforce Now and Roll and other things that are in front of it that are critical and visible, right, because that’s really just an engine to gross net engine. But the added flexibility that it provides and the process improvement that it provides in the back office could be a step change game changer for ADP in terms of our competitiveness and in terms of our efficiency. But the truth is, stay client focus, I think, Kathleen is right. The most important thing the client sees is what they interact with, right? And I think that is mostly around the UX and our front end solution. So I think that’s probably the right place to focus.
Mark Marcon: Great. This Next Gen Payroll, what’s the plan for this year in terms of percentage of Workforce Now that ends up getting converted or that should be on it?
Carlos Rodriguez: We’re not really -- we’re probably dabbling in a few conversions, definitely not our number one priority yet. We started kind of in the lower end of our mid-market to begin with. So in call it the 50 to 150 is where we’re really, we call it core major accounts kind of in the lower end of major accounts. And we’re pretty happy as you can tell from our tone and what we’ve talked about in the last couple of quarters with our progress there. And we have a plan. I don’t think it’s really great for us to share it, because I think competitors listen to these calls, too. But we have a very methodical plan to eventually get to 100% of our core sales being a Next Gen Payroll, while at the same time, then gradually moving into the other parts of major accounts call it the 150 to 1000 and then selling 100% of those clients on to Next Gen Payroll. And then as we’re going along, we will start some conversions. But it’s not a huge priority for us, and remember Workforce Now is the front end on both of these. And this is all intended to be transparent. This is not one of those migrations that you heard about five years, seven years ago at ADP where we disrupt everything and that the clients are going to see very little change other than some enhancements in terms of self service capabilities. And other things that, obviously, we think are going to be net positives from both a selling and a client retention standpoint. But generally speaking, their experience will not change in a significant way.
Mark Marcon: Terrific. Congratulations.
Carlos Rodriguez: Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Well, thanks. I appreciate everybody joining the call today. I think in the prepared comments we talked about what a year this has been. I’m sure every company has the same view in terms of the challenges that they faced. But I’m just incredibly grateful to our associates for what they did, first and foremost, for our clients. When the chips were down, we really delivered. It started, obviously, in the fourth quarter of last year with all the government regulation changes that needed to be put in place and the huge volume of inquiries we were getting about PPP loans, et cetera. But it really continued into this fiscal year as well. And it was just an incredibly challenging environment, while people have personal challenges, right, including health challenges in their family. And so, again, I’m just -- I look back to, we’re a mission driven company and you can see it in the in the culture and I’m grateful for my predecessors and the culture that was built over all these decades that allowed us to, it wasn’t without incident and it wasn’t easy, but we really got through it. I think we delivered for our clients. We delivered for the economy, because we are a mission critical service in the economy. And I just couldn’t be prouder of our associates including our back office associates to support our frontline associates, as well as our sales force, who, as we talked about a lot today, continue to plow through and allow us to continue to grow our business, despite we’re unprecedented headwinds. So, but first and foremost, I’m just so glad that despite, obviously, we have some short-term challenges here with the new Delta variant and so forth. But I mean, clearly, we’re heading in the right direction and we are very optimistic both for ourselves, for our families, for our associates and for our clients and we look forward to better times ahead here over the next couple of quarters where inevitably we’ll have some ups and downs or some challenges here and there. But it’s great that everything is on the right track at least in the United States and we’re hoping that other parts of the world follow closely behind, given that we have very significant business in Europe, Asia and Latin America as well. And we appreciate your interest in ADP and your support and thank you for tuning in today.
Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning. Ay name is Sarah, and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Fourth Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. I would now like to turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Sarah. And welcome everyone to ADP’s fourth quarter fiscal 2021 earnings call. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the fourth quarter and full year. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I’d also like to share that we intend to host our Investor Day on November 15th. At this time, we’re planning to keep it virtual for most of our attendees. But given positive reopening trends, we do have capacity here in our Roseland, New Jersey headquarters to host our sell side analysts live and we look forward to seeing our analyst community in person soon. With that, let me turn it over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny, and thank you everyone for joining our call. We reported very strong fourth quarter results, including 11% revenue growth and 5% adjusted diluted EPS growth, capping a year end which revenue and margin outperformed our expectations in every quarter. For the full year, we delivered 3% revenue growth, the high end of our guidance range, and I’m happy to say, we reached $15 billion in revenue, a big milestone for the company. As we’ve discussed all year, we took a consistent approach to investing this year, while also prudently managing expenses. As a result, our adjusted EBIT margin was down only slightly and we were able to deliver 2% adjusted diluted EPS growth for the year, ahead of our guidance and well ahead of our expectations at the start of the year. I’ll first cover some highlights from the quarter. Our new business bookings results were very strong and our momentum in the market continues to build. Compared to last year’s fourth quarter, we grew our Employer Services New Business Bookings by 174%, which was slightly ahead of our expectations. And for the full year, we delivered 23% growth in ES bookings, towards the higher end of our guidance. We are very pleased with this outcome from our sales team, which booked $1.5 billion in new business in a year with a high degree of economic uncertainty."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos, and good morning, everyone. Our fourth quarter represented a strong close to the year, with 11% revenue growth on a reported basis and 9% growth on an organic constant currency basis, solidly ahead of our expectations. Our adjusted EBIT margin was down 120 basis points better than expected. And as a reminder, we did have some compare -- comparison pressure versus last year’s lower selling and incentive compensation expenses that drove the comparative decline. Our 5% adjusted diluted EPS growth was strong, and in addition to the revenue and margin performance benefited from share repurchases. For our Employer Services segment, revenues increased 10% on a reported basis and 8% on an organic constant currency basis, as we lapped last year’s pandemic affected Q4. We continued to see contributions from excellent retention, strong new business booking and growth in pays per control offset by lower client funds interest. ES margin was down 90 basis points due primarily to higher selling and incentive compensation expenses versus the prior year. Our PEO also had another very strong quarter. Average worksite employees increased to 616,000, up 12% on a year-over-year basis on both continued retention outperformance and contribution from solid employment growth. Our PEO revenue grew 12%, an impressive performance as we once again benefited from higher payroll for WSE, as well as stronger workers comp and SUI revenue for WSE compared to the prior year, partially offset by lower growth and zero margin pass-throughs. PEO margin was up 340 basis points in the quarter, due to an elevated worker’s compensation reserve true-up last year. We were very pleased with our strong finish to the year. For fiscal 2021, a year heavily impacted by a pandemic, we drove strong bookings growth, solid 3% revenue growth, delivered positive EPS growth and continue to invest for sustainable growth and digital transformation."
},
{
"speaker": "Operator",
"text": "Thank you. We will take our first question on the line of Eugene Simuni with MoffettNathanson. Your line is now open."
},
{
"speaker": "Eugene Simuni",
"text": "Good morning. Thank you for taking my question. Maybe to start with a little bit of a high level macro question, so Katelyn, you just highlighted that there is significant amount of secular growth that’s coming out in HR services industry from the pandemic? Can you speak a little bit more about where you guys are seeing the indications that the secular growth is actually helping, financial performance of ADP and how much of that is incorporated in your fiscal year 2022 guidance and where can we see that effect in the numbers?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think there are probably a couple of highlights. I think, Kathleen, probably has a couple of other, she would -- she can mention. But, like, I think, we mentioned in our prepared remarks, what we’re seeing around Workforce Management in terms of time tracking and scheduling and so forth. We also mentioned some of the products we’ve developed for Return to Workplace. So there are a number of things that are probably related to what’s likely to be a more hybrid work environment for white collar employees at least on a go-forward basis, which probably requires people to think about their investments in HCM in terms of what they can do to maximize, the recruiting and the retention and the engagement of that hybrid workforce. So I think that is one. The other one is, there’s always been a secular uptrend in terms of regulatory related and this is on a global basis, demand for HCM products. In other words, the more complexity there is around being an employer, the greater the demand for the wide array of services that we provide. That secular trend has probably gotten a bit of a boost based on in the U.S. the change in administrations, right, which we’ve had that secular growth for seven years that ADP has existed. But there are times where it’s stronger in terms of a tailwind and sometimes where it’s weaker. And I would say that we’re heading into strong secular tailwind here, as a result of some of the increased attention on regulatory actions. And you probably all saw, I think, it was yesterday, the day before, that the President signed number of executive orders, most of which are aimed at employer employee related relationships that increase the amount of tracking and reporting and compliance necessary on the part of employer. So those are a couple that I would mention. I think our retention rate also shows in -- an indirect way secular demand improving right in the sense that people have kind of rethought dropping or switching from their HCM vendors. But that one is a little difficult to be 100% sure about, because we do expect some normalization in that retention rate."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. I think that really covers a lot of that. I mean to kind of summarize and categorize what Carlos said, when you think about the complexity, number one, of being employer, the ongoing and pretty significant changes that we see from a regulatory standpoint. So complexity, regulatory change, the dynamic environment as the way people work and employer relationship -- employer employee relationship changes, it’s a very dynamic environment. All of that is, you can just see in, the bookings number that we have. Our bookings, I’m sure we’ll get into the discussion on this, but the growth is pretty broad base. I mean, certainly, we saw some channels stronger than others, but it’s pretty broad base. And I think that’s because of all of this dynamic change and complexity that we see, and in particular, our comprehensive solutions that our outsourcing solutions have seen quite significant growth. So we’re really encouraged about the macro trends that we see in the space."
},
{
"speaker": "Carlos Rodriguez",
"text": "And again, I think that, it’s all -- I’ve always never known what is defined the secular versus not secular. But the huge demand now for talent, what’s happening in the labor markets. Obviously, that’s a huge tailwind for all of us in the HCM space in terms of recruiting tools and engagement tools to try to hold on to people. But that could also be something that wanes in six months. That’s -- that one’s a little harder to tell. But generally speaking the war for talent has always been also a secular tailwind to our industry as well."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Got it. Thank you. Great. And then for a follow up related and talking about the bookings growth and looking at your guidance for 10% to 16% growth next year. Can just quickly speak to kind of two or three key swing factors that you see that will define whether we’re going to end up on the lower end or higher end of that range, as we kind of turn the corner on the recovery and go through the spirit?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. So the -- actually I can probably give you a three that would probably account for kind of the way we think about this. So number one, obviously, is what we just talked about is the secular and cyclical tailwinds or headwinds. So if the economy continues with the momentum it’s got, we’re feeling pretty good. Obviously, if we end up having more challenges, because of the pandemic or otherwise, but right now the amount of -- even the existing government stimulus, even if there’s no additional stimulus is pretty strong and also the pent-up demand and all these -- the reopening. That feels like a very good backdrop for us from a bookings growth standpoint. And then, as long as we have that background or that backdrop that’s positive, it really comes down to really two things is sales force productivity at the Sales Quota Carrier level time, number of Sales Quota Carriers and I hate to be so simplistic, but at our size, because we have new products and we’re rolling out, you heard how excited we are about all the new things that we’re putting out there. But we sell a lot of business every year. So for a smaller company, when they end up having like a new product launch that can cause all kinds of growths, and by the way, likewise, if you don’t have any new products. But for us, what I would consider to be a steady-eddy. So we really grow through methodically improving and adding new products, making talking acquisitions, et cetera, a lot of us. But the key formula for us is we cannot hit our sales plan unless we have the headcount and we are continually improving our sales force productivity and that’s exactly what our plan is. And we have some good news over the last four quarters where our sales force productivity at the Average Quota Carrier level steadily improved throughout the year to reach 90% for the full year. But we exited the fourth quarter in kind of the mid-90%s, if you will, in comparison to pre-pandemic levels. So it feels like we’re getting back to the quote-unquote trend from an average sales productivity standpoint and if we can get back to that trend, and we deliver on our hill -- on our headcount additions, we should be able to hit our new business bookings number."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from a line of Pete Christiansen with Citi. Your line is now open."
},
{
"speaker": "Pete Christiansen",
"text": "Good morning. Thanks for the question. Carlos, you talked about a lot of new logo wins this year, which is pretty impressive. But I was curious to hear how you think about how this may have changed your or ADP’s cross-sell, upsell opportunity set? I’d imagine the runway there is expanded quite a bit, and perhaps, how you are thinking about strategy, that land and expand strategy to really take advantage of this opportunity? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yeah. So one of the -- in case somebody asked that we, one of the questions we sometimes get is and it’s related to what you’re asking is the mix of how much is new logo sales versus how much is add-on sales. And it’s really been very steady over many years. It was only during the ACA period where we had a little bit of a tilt more towards incremental add-on sales. But it’s -- for a long time been around 50-50 and it’s still kind of in that neighborhood. So that I think bodes well because the more clients we add, the more opportunities we have pursue that land and expand, I think, approach that you just described. So I would say that, we’re bullish on the opportunity to continue to go back to the new logos that we sold, which in many cases, we sell with multiple modules, but there’s always additional room for new products as well to go back to that existing client base. So I think that underlying logo growth, I think, is another kind of supportive factor, if you will, for a new business bookings, because we do get about 50% of our bookings from our existing client base."
},
{
"speaker": "Pete Christiansen",
"text": "That’s helpful. And as a follow up, I was just hoping if you could juxtapose the GlobalView business versus the rest of ES. I know, they haven’t been totally in sync during this recovery. What are you seeing there of late trend wise? And as you look towards the outlook, is that part of the business considered or laggard behind the remainder of the ES or is there some variability there that investors should be aware of? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "It’s actually a little bit of the opposite. Maybe we may have confused some people, I think, in prior calls. But I think, GlobalView is probably, could be at the top of our list in terms of performance this year, like, large multinational companies have been, I think, looking for ways. I think this pandemic rate -- raise probably some issues and concerns around control. I think for the HR leaders that probably raised some issues around engagement and making sure that you’re connected to your global workforce and that you had global reporting, et cetera. So there’s a lot of factors that probably went into what was incredibly strong demand and very positive sales growth. So I would say that, again, we don’t disclose individual product lines, but I would say, the GlobalView sales were one of the stronger line items, I think, for us. And I’ll add that to your question about differences between the businesses. I think all of our businesses really performed well. It’s kind of hard, it really come down to trying to point out which ones were spectacular versus just good. And I would say that GlobalView and even our International business really were standouts and I -- really it’s very impressive, because some of the situations in Europe, for example, were very challenging in terms of dealing with the pandemic, but I didn’t really stop people from looking for solutions and it didn’t stop our sales force from finding them, even though they had to do that from obviously from a remote workplace. So, I guess, summary is, GlobalView is a shining star for us."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. They saw good momentum as we closed out the year. In fact, it was a particularly strong closed with a good number of multinational deals on GlobalView coming through at the end of the year and we’re looking at fiscal 2022 for them to be a big contributor again."
},
{
"speaker": "Carlos Rodriguez",
"text": "And again just -- the only -- again, it doesn’t make a huge difference in the overall ADP revenue numbers. But these strong bookings remember will really translate into revenue and cause six months to 18 months, because these are large, typically large multinationals that take some time to implement. But that should be a positive thing for us kind of looking forward, if you will, in that six-month to 18-month horizon."
},
{
"speaker": "Pete Christiansen",
"text": "Thank you. Great color and really nice execution. Good job. Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of James Faucette with Morgan Stanley. Your line is now open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you very much and good morning. I wanted to ask quickly and I think it’s tied into some of the comments you’ve made around your guidance. But specifically, how are you thinking about like the well-publicized difficulties employers are having attracting employees and that kind of thing? How is that factoring into your guidance and your formulation and are expecting resolution of that as we go through the fiscal year. Just trying to get a little bit of color how you’re putting the macro environment into forecasts?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I mean, I would probably put that in the bucket of secular tailwinds or cyclical tailwinds, depending on your view of whether it’s short-term or long-term. But it does seem like if this kind of resolves itself, let’s -- there’s a couple scenarios, but if it’s transitory in terms of the friction of getting people into the right job and then six months from now some of this has passed, by the time we get to that point, unemployment might be down into kind of the 4% to 5% range, which then creates a whole another wave of needs for employers in terms of finding talent and kind of fighting for talents over. So it feels to us like this is a multiyear cycle here where employers are going to be really scrambling to find people. I think that generally creates conversation opportunities. So we don’t have a magic formula necessary, and necessarily, we’re not a staffing firm. But we do have tools and we have technology, and we have people that can help our clients be more competitive as they look for solutions, as they look for the right employees in the right place at the right time at the right pay level. That’s our sweet spot. And so I’d say we’re right in the middle of this, what I would call, super cycle of demand for labor that is probably short-term related to kind of friction where people are just not in the right places and people are probably also some -- there’s some hesitation, still there’s issues with childcare and eldercare, there’s a number of factors. It is -- we assume like other economists that this will be -- that part will be transitory, but that the need for people will not be, given just the obvious low unemployment rate, which we will be at by the end of, call it, calendar year 2022."
},
{
"speaker": "James Faucette",
"text": "That’s really helpful, Carlos. And then just as it relates to sales productivity, you highlighted that on your -- you’re expecting and seeing improvement there. At the same time -- and you indicated that there, you’re being able to get your salespeople in front of more accounts and potential accounts. How closely tied do you expect those two things to be as we go through the rest of the fiscal year?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Again, this -- we’re uncharted territory. It’s a little hard to give a scientific answer, because this last year, we were not able to get in front of a lot of our process, actually most of our process until recently. And yeah, we delivered, I would say, very solid and strong bookings results. So I think some of this is really about us being able to adapt, which is our job to what the market wants, right, what the clients want and what the prospects want. And the fact of the matter is that about half of our -- half of the workforce out there, which probably translates into half of our clients, they actually kept going to workplaces, they kept making things, delivering things and going to workplaces. The rest of the some of us white collar employees didn’t. So that segment of the prospects and clients, they expect us to be available, if they want us to meet with them in person. We’re not going to go force anyone to meet in person. We’re happy to meet them if they want to be met, whether it’s virtually, online or in person. But we want to be ready for whatever the market wants and for whatever the market demands and that’s exactly our plan. But to answer your question, it’s really hard to know which factor is the most important factor. We think that being able and willing and available to meet in person with prospects is an important element of our sales success for fiscal 2022. But I can’t really put a number on it because we were successful in 2021 without doing that."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. I think the key is that we’re going to have to make sure we can continue to be nimble just as we were in fiscal 2021, right? If there are certain regions or points in time where we might have to scale back a little bit in the face-to-face, I think we’re nimble enough to do that. We’ve proven we could do that. But we’re certainly ready and have been out there doing face-to-face and hope that that continues."
},
{
"speaker": "James Faucette",
"text": "Thanks, Kathleen. Thanks, Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Dan Dolev with Mizuho. Your line is now open."
},
{
"speaker": "Dan Dolev",
"text": "Hey, guys. Great results. Thanks for taking my questions. So, can you discuss how the retention has varied by sort of the three ES by the three sub-segments, SMB, mid-market and up market? And what happens to the SMBs once the PPP rolls off, so how should we think about kind of your guidance for retention versus like those three vectors? And then I have a very short follow up? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "That’s a good question. I think, Kathleen, may probably have a little bit of additional color. But I would tell you that, this -- I think your insinuation that the PPP loans may have something to do with these elevated retention rates is something that we’ve heard kind of out there in the -- in terms of as a buzz. And again, that’s very hard to, like, put our finger on in terms of how to quantify that and what’s the impact? But for sure, one of the strongest areas we’ve had in retention is our down market business and that is why I think we’ve prudently planned for some give back on that next year. Having said that, I will tell you that, this year, fiscal 2021 and the two months before that were probably the greatest example of ADP’s business model in terms of ability to deliver. Now we call it service, you can call it compliance and call it whatever you want, but when the chips were down and people needed help and needed to talk to someone about their PPP loan and they weren’t calling their banker, they didn’t have to apply for a loan and they didn’t have to go through a bank, but you can go do your own channel checks to see how many banks were actually answering the phone or giving people advice, because they were completely overwhelmed as we were, but we actually figured out a way to handle it and we were there for our clients. And so, I think that, what we just did over the last year and I get it I’m a pragmatist, so memories are short and we have to continue to impress and continue to deliver for our clients. But I think we just proved to hundreds of thousands of clients, and hopefully, the prospects from a reputation standpoint that if you want to have someone who’s a partner, if ADP, if you want software, you can buy software. But if you want great technology and great software, but you want someone who’s going to be able to deliver on the service side, then you should be with ADP. And so I think that that’s going to have some -- there’s going to be some factor and hopefully allowing us to hold on to some of this retention on a more permanent basis, because I think the -- when the chips were down, I think, people saw the difference between not having someone that you could get help from and having someone that you can reach out to and get advice and get your problems -- major problem solved. But the bottomline is, we clearly are prudent and aware that some of this normalization could result in some lower retention rates, particularly in the down market, as you are, I think, alluding to."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. I mean, that’s covered a lot of. In fiscal 2021, look, we saw strong retention across almost all of our channels, our businesses, particularly in small business and mid-market as well, though, and even actually on the international side where the retention is very high. We thought it’s a little bit higher there as well, too. So, pretty much strong across the Board. But look, we want to be prudent from a planning perspective and while we haven’t seen any change yet in terms of switching or along those lines. I do think it’s prudent to plan that there’s going to be, I’ll call it, a little bit of give back in fiscal 2022. I think we are going to hold on to some of the games. We’re certainly attempting to do that. We want to do that. But I do think it’s prudent to plan for a little bit of give back, which we’ve done and that would be primarily with regard to small business segment normalizing back to pre-pandemic levels."
},
{
"speaker": "Carlos Rodriguez",
"text": "But to be clear, there’s no -- I’m not aware of a particular -- there’s nothing that ties a client to us or anyone else because of the PPP loans. What I’ve heard the theory that some people have somehow some kind of psychological thing that it’ll just make things more difficult if you switch and I -- I’m obviously not a small business owner. So we talk to small business owners. We’re just not hearing that. But it feels logical that could be a factor of that. But to be clear, there is no particular trigger that on November 15th we’re going to lose 100,000 clients because their PPP loans have been repaid or expired. That’s not the way the program work."
},
{
"speaker": "Dan Dolev",
"text": "Understood. And then my quick follow up and I think it’s somewhat ties to this is the margin guidance. What I’m hearing this morning from investors is, it might be -- I don’t know maybe slight, maybe light of expectations. I mean, is that somewhat tied to the mix shift next year or is there anything else that you could call out on the margin guidance? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, listen, after 10 years of doing this, I’ve never heard anyone say that your margin guidance was too aggressive and too high. So let me just start off with that comment. And part of that is that we’re always trying to balance short-term and long-term investors. I’m not sure which one you were hearing from. But our intent here is to continue the machine, right, and the momentum that has led to multiple decades here of compounded growth and creation of value over a very long period of time and that requires delivering short-term results, as well as long-term results. And those long-term results, I think, require some investment including on the R&D side. But in particular this year, really the biggest factor is selling expense and sales investment, which has happened to us in the past, we’ve had other times and call it 2000, 2001 or 2002 and then, 2008, 2009, 2010, because I was around for those, where as we reaccelerate and take advantage of demand back to the secular growth opportunity. The way our business model works is we incur a lot of upfront selling and implementation expense. Now there’s some accounting rules that allow you to defer some of that. But generally speaking, you get elevated selling expenses and implementation expenses, and it’s pretty significant. So I would say that that is a significant part of what would have maybe otherwise been higher margins for 2022. But when that business then is on the books, that’s a high incremental margin business that then in 2023, 2024 and then for the next 12 years to 13 years, that’s how long we keep our clients on average creates an annuity. So as you can imagine, we never turn down the incremental opportunity to add business, never, because it is just the way the value creation model works. And we’re going to make hay while the sun is shining here. And with 6%, 7% GDP growth last quarter and what’s likely to be incredibly strong GDP in the next year or two, we’re going to take every possible opportunity. And unfortunately, that requires some selling expense and some implementation expense in addition to the ongoing investments in technology and some of the other things that we do."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. So just big picture when you think about margin for next year and we’re very happy that we’re able to kind of guide to the 25 basis points to 50 basis points of margin expansion, I mean, look, we always look to do better than the plan, but that’s what we’re comfortable with. Right now, the way to think about it is, look, we’re going to have operating leverage to a greater extent in fiscal 2022, obviously, but we’ve also got the investments that we want to continue to make, as Carlos just articulated, in product, in sales and in digital transformation importantly. And we do have some offsets, Carlos mentioned, the sales expense. But we also have things like, Return to Office and ramping up T&E versus what we were -- where we were in fiscal 2021. So kind of all that goes into the mix, net-net, we’ve got this 25 basis points to 50 basis points margin expansion. We’re going to do our best to deliver on that and continue to work our digital transformation and if possible do even more."
},
{
"speaker": "Carlos Rodriguez",
"text": "And one -- just one other factor, because if you have any doubts about ADP’s ability to drive margin, just one small thing hasn’t come up yet. But we had this like small little problem this year with interest rates, where it created $110 million headwind to net contribution and 100 -- almost $125 million in topline and bottomline in terms of client funds interest revenue. So our revenue growth would have been almost a point higher and our margin for this year in a pandemic would have been up 70 basis points instead of downside 40 basis points, had we not had that headwind. Now, we did have a headwind. So it’s always hard to say, if we didn’t have this and we didn’t have that. But that’s a pretty easy thing to isolate that has no operational -- nothing to do with operations, we have no control over and we have to just ride that cyclical wave, which hopefully that’s cyclical wave is heading in a very positive direction for us over the next two years to three years. But just want to make sure you understood that, because I think that tells you just how much control we have over our expenses and over our business model and over our long-term value creation objectives."
},
{
"speaker": "Kathleen Winters",
"text": "And that perhaps our interest does continue to be headwind for us in fiscal 2022, very modest headwinds, compared to what we experienced in fiscal 2021, but it doesn’t help us, whereas in your past, it was a significant help to us."
},
{
"speaker": "Dan Dolev",
"text": "Got it. Thank you for the detail. Appreciate it."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from a line of Ramsey El-Assal with Barclays. Your line is now open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi. Thanks for taking my question. I wanted to follow up on your comments on retention and you’re prudently planning for retention to increase if the market normalizes whether it does or not we’ll see. But can you describe your toolkit on the sales or technology side that you can use to prevent attrition and I’m sure a lot depends on the underlying sort of reasons for the attrition. But can you be more proactive on that front and sort of stem the tide of it if push comes to shove?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Absolutely. I think, and again, I -- we probably have a couple of examples we could give of things that we’ve done over the last year. But it’s usually a methodical multiyear approach to making our products like, when we talk about innovation. Innovation is partly about new business bookings, but it’s also about making our solutions easy to use and more intuitive. And you’ve heard in our comments and we shouldn’t gloss over it, like, the UX experienced investments we’ve made in both RUN, but now in some of our other platforms is a significant factor in today’s world of whether or not a client sticks with you or not. So we get that. That’s why, however, many years ago, we kind of got it, and we said, we need to become a technology company in addition to the services company that we are in. So I’d say, number one is, you have to have great products, they have to be easy to use, and they have to have no friction. That will help with retention. I think the other things that I think you can point to are really just around availability. So our business model and our promise is not just technology and software, but it’s to help with compliance and is to help with advice and is to provide expertise. And that really means that we have to have well trained associates, who are there to answer questions, whether it’s chat, whether it’s by phone, it doesn’t matter, however, the client wants to reach us, but the stuff we do is complicated. And being an employer is complicated. And it requires help and you need to get the help from us or you can call an attorney, or you can call a consultant. But most people do not just do this stuff on their own and we happen to package the two things together, great technology with great service. So I say, if we have great technology and we have great service, we’re going to be able to hold on to hopefully a lot of that improvement we’ve had in retention, even if we have a little bit of give back in the down market."
},
{
"speaker": "Ramsey El-Assal",
"text": "I see. Just not a question of running analytics at the right time, it’s really more of a longer term kind of blocking and tackling and product innovation approach."
},
{
"speaker": "Carlos Rodriguez",
"text": "We run plenty of analytics too. So we have -- for example, we have a lot of data around, like, we track individual clients, how many times they call. We actually can monitor we have voice recognition that tells us, certain, keywords that people use when they’re, because we record all phone calls and that really gives us deep insight into clients that are at risk. And then we have special teams that can follow up with those clients to make sure that whatever problem they had has been resolved. But that’s -- I would call that trench warfare, which -- if you want to get into those details, I can go in the trenches with you. But we have very deep analytical tools that really give us a lot of insight. Like, for example, in our down market, I mean, our clients don’t call that often, because hopefully they don’t have problems very often, because we do a nice job of preventing problems. But one of our small business clients has -- we detect has multiple calls in a month, that requires a reach out to that client or a deeper investigation and a triage to make sure that we don’t lose that client, because that’s usually a sign that there’s something wrong with that client. And we have other techniques and other approaches and other tools to identify what we would call hotspots. We also monitor pricing very carefully when we do our price changes, which I guess is code for price increases. We do that very carefully using a lot of analytical tools to make sure that we do that in the smartest possible way, if you will, to maximize retention."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. Thanks for that. And a quick follow up for me. How would you characterize the demand environment for off cycle or on-demand payrolls, is it something that that you see getting quite a bit more popular or it will sort of remain kind of a niche service over time?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No. I mean, it’s clearly popular, because I know a lot of people are talking about it and so that always leads to popularity, right? As soon as someone talks about it, it becomes popular. I think that it’s, again, like, a lot of things we’ve been saying over the last two years or three years, so many things are inevitable are going to happen and we’re preparing for them. So things like real time payroll. In this one that you’re referring to is kind of one that we just heard over the last couple of days. I think that we’ve been thinking about for many, many years and we have solutions, where if someone needs to get paid, like, for example, in California, if someone is terminated from their job, you have to give them their final paycheck like immediately and so that is difficult to do through the normal process. So we have solutions for that we’ve had for quite some time. And so I think the increasing popularity is probably more related to increasing discussion about it, but also to technological advances that allow more options, right in terms of instant payments and/or faster payments. So I would say the answer is, yes. That is an important thing. And for certain sectors, like, if you have a high turnover, hourly workforce, your ability to provide that solution is crucial. But we have that ability to provide that solution. But you can’t, for example, sell a client in California and not be able to provide instant pay upon termination. So it’s -- you have to have that."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. All right. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from a line of Bryan Bergin with Cowen. Your line is now open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi. Good morning. Thank you. Can you talk about how you’re thinking about the cadence of the pays per control projecting, you’ve assumed during fiscal 2022? And what does the 45% build imply in the base relative to pre-pandemic levels?"
},
{
"speaker": "Carlos Rodriguez",
"text": "We’re digging for that. I think the quarterly -- I mean, again, it’s probably, when you look at the comps, the fourth quarter will have weaker than expected growth. But I don’t know, Dan, if you have the…"
},
{
"speaker": "Danyal Hussain",
"text": "Yeah. Bryan, it’s just a mirror image of what we saw effectively last year. And so there’s a stronger Q1 performance PPC that’s baked into our assumptions and it gradually tails off. But we don’t have an explicit guidance for you on what this means for reported unemployment rate, the same way that we gave you that guidance last year at the outset."
},
{
"speaker": "Carlos Rodriguez",
"text": "And the average for the year for pays control, I am going to refresh my memory is…"
},
{
"speaker": "Danyal Hussain",
"text": "4% to 5%..."
},
{
"speaker": "Carlos Rodriguez",
"text": "4% to 5%."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah."
},
{
"speaker": "Carlos Rodriguez",
"text": "So you -- I would anticipate, if I were you, I would probably assume that for the fourth quarter is going to be back to, I don’t know, 2%, 3% or somewhere low -- somewhere in the lower range."
},
{
"speaker": "Danyal Hussain",
"text": "Absolutely."
},
{
"speaker": "Carlos Rodriguez",
"text": "Because we’re growing over the 8% and in the first three quarters, particularly the first quarter it’ll be higher."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. And follow up then on M&A. How are you thinking about areas of potential acquisitions for capabilities? And then also, can you comment on how the market has been for book of business acquisitions, curious COVID has changed that dynamic during fiscal 2021 and then to fiscal 2022?"
},
{
"speaker": "Carlos Rodriguez",
"text": "We’ve had actually pretty good success in terms of client base acquisitions. You -- again, you’re right, that I myself was surprised that there was an opportunity to do that and then we were able to execute on it. But we had one that I think we mentioned last year, in the fourth quarter and kind of spilled a little bit over into the first quarter, but it was mostly I think fourth quarter. We had one the year before that, that was significant also in the fourth quarter. And in this year, we’ve had a number of, what I would call, smaller ones, but they add up. And so I would say that the news there is good and is ongoing and we’ve created a nice ability to do these conversions and make it good for us in terms of growth. And back to the question around cross-sell, we usually have a much broader set of solutions than other people that we are making these acquisitions from, which creates upside opportunity, right, in terms of value creation for us. On the kind of overall M&A comment side, I would say that, we’ve -- where we’ve been most active is looking in some of our international locations in markets, where I think we have very little market share and we still have needs, for example, for add-on products, whereas in the U.S., we’re not really looking to add additional platforms for either benefits or payroll and so forth. So it really has to be things that are adjacent, right, in the HCM space, but not duplicative, because as you know, we’ve been on this kind of simplification push for many, many years and trying to build things organically and invest in technology organically. So that doesn’t mean that we won’t acquire because we have and a couple years -- we haven’t done anything for a couple of years. But we do welcome the opportunity to add additional ancillary benefits as long as they fit into our technology roadmap and they’re not disruptive or add-on and we’re not doing it just to get the quote-unquote revenue pop. But on the international side, we typically don’t have those factors at play as much and that’s a place where we’re still excited and we still see a lot of greenfield opportunity to expand through M&A."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Kartik Mehta with Northcoast Research. Your line is now open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning, Carlos. You talked about the PEO business, obviously, it performed well in the fourth quarter and seems like trends are coming back. I’m wondering if you’ve seen any secular changes, I know that word maybe you don’t like, but any secular changes in demand for the product, or if you anticipate any changes, because what we’ve gone through with COVID?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I mean, again, my experience tells me that, because I actually ran a business for many years at ADP and now I’ve been watching it for, I can’t believe I’m going to say this for 25 years. And when you get into this kind of economic environment, it’s usually a positive secular tailwind for, I guess, back to like, sometime I don’t like that word. But I would say that there have been positive secular trends for the PEO for 20 years to 30 years. And then they can get enhanced, I think, by cyclical factors, like, a strong economy. Like, so people sometimes say that the PEO will do well or outsourcing will do well, when there’s a recession, because people are looking to save money and that -- there’s some truth to that. But it’s not what the data supports or shows, right? It’s usually when you have very strong economic growth and strong GDP and people are scrambling for talent and they’re competing for offering the right benefits. That’s when PEOs and outsourcing tend to, I think, do better. So I would say that, based on experience, which you have to discount, because we just went through a pandemic. So most of our experiences, we should park somewhere outside the door, because we may end up being wrong. But all things being equal this kind of economic environment is usually very strong for the PEO. And as for the last 18 months, what we saw there is, it’s a long cycle sale and it’s a high involvement decision. So I think we’ve been clear that, we’ve had good great results there from a booking standpoint, and probably, better than we would have thought was possible, but definitely not as strong as yet in kind of the early stages of the recovery of our bookings. We expect that to reverse and that is our plan in 2022. In other words, we expect very strong bookings and strong recovery on the PEO. And we’re seeing some signs of that in the fourth quarter, because what happened is in this kind of hunkering down mode, we saw very high retention in our PEO, but not as much. It was more difficult to sell new clients, but the existing clients. I mean, it was unbelievable value that we delivered to them and because it was beyond just PPP loans. It was -- how do I downsize my workforce or how do I put people on furlough and what are the rules in this state around benefits. I mean, our people were busy. I mean all of our people or all of ADP were busy this year, while maybe other people were less busy, but our people were busy and in the PEO, they were extra busy. So I think that that bodes well. And those anecdotal stories and that reputation along with kind of some of these cyclical tailwinds, I think, bode well for the PEO here in the next year or two."
},
{
"speaker": "Kartik Mehta",
"text": "And just as a follow up on the ES business, have you had to do anything out of the ordinary in terms of price competition or just providing promotions?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Have we done anything, are you saying or is the market?"
},
{
"speaker": "Kartik Mehta",
"text": "Yeah. I guess have you had to do anything to come from because of what competition has done? So have you had to do anything out of the ordinary on the ES business?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No."
},
{
"speaker": "Kartik Mehta",
"text": "Perfect. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our last question comes from the line of Mark Marcon with Baird. Your line is now open."
},
{
"speaker": "Mark Marcon",
"text": "Hey. Good morning, everybody, and thanks for squeezing me in. I was wondering if you could talk a little bit about the strong bookings performance and just unpacking that, in terms of, where you -- I heard the 50-50 mix in terms of upsells versus new logos. But as it relates to new logos, where were you seeing the strongest success, was that down market in terms of the new business formations, was that across the Board and who do you think you were winning the most against?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, we would always squeeze you in Mark. There’s no question about that. A couple of highlights. We think we mentioned in our prepared comments, but our non-PEO HRO solution. So these would be kind of mid-market and upmarket outsourcing solutions that are, what I would call more comprehensive, if you will. Really or probably one of the real highlights and I think that was, again, related probably to people realizing, probably, within months after the pandemic that, like this stuff is hard to do, especially if you have to pivot very quickly, right? You have to make sure your systems are still up like you can’t have a server in a closet somewhere that you’re using to run payroll, because you still do this internally. And then people who go to the office to key in the payroll, like this stuff is just a lot of people all of a sudden woke up and realized, from a business continuity standpoint and from a support standpoint, I need help, there needs to be more than just the software, right, and basic service. So these HRO solutions really were an incredible bright spot. And then, I think, definitely mentioned, our upmarket and our ESI bookings results were also very, very strong. Yes, new business formation helped in the down market and we’re very -- like we’re pleased with all of our results on booking side. It was across the Board very strong performance. But I would say that there were other places that had even stronger. When I talked about GlobalView, our Tax Filing and Compliance business, which does a lot of standalone business, where again, companies realize that having a bunch of people subscale doing this stuff, you don’t even know where they are and if they can get to the office or if they can do it from home, but it’s mission critical, are looking to outsource or did outsource a lot of that stuff to us. And then we did have a couple of, what I would call, volume-based businesses, like, employment verification and screening and a couple of things that, RPO also came back a little bit. But it was really across the Board, honestly, like. So those are a couple of just like…"
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. Like a strong across the Board, Carlos said all those right points, in particular SBS really led the way, down market really led the way in recovery during the course of the years. And in fact, and you can correct me if I’m wrong on this, but I believe SBS had their biggest Q4 ever, including the Retirement and Insurance Solutions."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yeah. I wrote it down somewhere, but I can’t find it. I think we had records Q4 bookings in a number of different categories. But that’s also probably happens over the years to, where we have so many things were so broad, that there’s always a few bright spots. But honestly, compared to what we would have expected the beginning of this year, really, to be saying we had record bookings in any business line is really good news."
},
{
"speaker": "Mark Marcon",
"text": "Okay. That’s fantastic. And just with regards to the new logos, in terms of if there wasn’t moving to an outsourcing solution that was previously done in-house, was there any sort of commonality with regards to competitive takeaways and wins that you ended up seeing as a source?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I mean, I say that, when I looked -- when I look at the -- we call the balance of trade data. I would say that we -- again, I’d like to think we’re doing a little bit better. We don’t provide a lot of color and disclosure around, because I don’t think it’s helpful and I’m not looking to pick a fight with any specific competitor. But I would say that we’re pleased with our progress, like, we need the combination of stronger retention, which means we lose less to some of those competitors that you’re talking about and our strong bookings performance means we won more against some of those competitors. I think you’d probably paint the picture that there’s probably a few competitors where a balance of trade improved, which it did. And admittedly, in some couple of competitors, it didn’t, right, it stayed. But I don’t think there’s really any place where we went backwards, that I’m aware, I’m trying to think back. But I think the balanced trade situation, we’re very focused on this, we’re trying to become more focused on logos and units and more focused on our competitors, because our competitors are focused on us and we’re sick and tired of it."
},
{
"speaker": "Mark Marcon",
"text": "Understood. And then, along those lines, you’ve made a number of product enhancements. Can you highlight it, a number of them, including in terms of Workforce Solutions, Workforce Planning, time and attendance? And then, obviously, highlighting Next Gen Payroll, just wondering, which ones do you think are going to have the greatest incremental contribution? I know it’s all leads to sales force productivity, but just, which ones should we look for the greatest benefit from?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, that’s a tough one, because it’s like picking your favorite child."
},
{
"speaker": "Kathleen Winters",
"text": "Yeah. I mean, I have a view. I think what we do…"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yeah."
},
{
"speaker": "Kathleen Winters",
"text": "… from an investment perspective in ongoing kind of refresh and modernization, and you act on all of our strategic platforms is critical. And we’re doing that all the time and that’s just critical to our ongoing satisfaction with our products, as we talked about earlier and our NPS score. So that constant refresh from a UX perspective is really, really important. But, Carlos, you may have other things you want to just highlight…"
},
{
"speaker": "Carlos Rodriguez",
"text": "No. I think that’s well said, because I’m excited about all of them. I think that the Next Gen Payroll is literally could be the biggest mover in the last multiple decades for ADP for us. But it really -- it’s really Workforce Now and Roll and other things that are in front of it that are critical and visible, right, because that’s really just an engine to gross net engine. But the added flexibility that it provides and the process improvement that it provides in the back office could be a step change game changer for ADP in terms of our competitiveness and in terms of our efficiency. But the truth is, stay client focus, I think, Kathleen is right. The most important thing the client sees is what they interact with, right? And I think that is mostly around the UX and our front end solution. So I think that’s probably the right place to focus."
},
{
"speaker": "Mark Marcon",
"text": "Great. This Next Gen Payroll, what’s the plan for this year in terms of percentage of Workforce Now that ends up getting converted or that should be on it?"
},
{
"speaker": "Carlos Rodriguez",
"text": "We’re not really -- we’re probably dabbling in a few conversions, definitely not our number one priority yet. We started kind of in the lower end of our mid-market to begin with. So in call it the 50 to 150 is where we’re really, we call it core major accounts kind of in the lower end of major accounts. And we’re pretty happy as you can tell from our tone and what we’ve talked about in the last couple of quarters with our progress there. And we have a plan. I don’t think it’s really great for us to share it, because I think competitors listen to these calls, too. But we have a very methodical plan to eventually get to 100% of our core sales being a Next Gen Payroll, while at the same time, then gradually moving into the other parts of major accounts call it the 150 to 1000 and then selling 100% of those clients on to Next Gen Payroll. And then as we’re going along, we will start some conversions. But it’s not a huge priority for us, and remember Workforce Now is the front end on both of these. And this is all intended to be transparent. This is not one of those migrations that you heard about five years, seven years ago at ADP where we disrupt everything and that the clients are going to see very little change other than some enhancements in terms of self service capabilities. And other things that, obviously, we think are going to be net positives from both a selling and a client retention standpoint. But generally speaking, their experience will not change in a significant way."
},
{
"speaker": "Mark Marcon",
"text": "Terrific. Congratulations."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, thanks. I appreciate everybody joining the call today. I think in the prepared comments we talked about what a year this has been. I’m sure every company has the same view in terms of the challenges that they faced. But I’m just incredibly grateful to our associates for what they did, first and foremost, for our clients. When the chips were down, we really delivered. It started, obviously, in the fourth quarter of last year with all the government regulation changes that needed to be put in place and the huge volume of inquiries we were getting about PPP loans, et cetera. But it really continued into this fiscal year as well. And it was just an incredibly challenging environment, while people have personal challenges, right, including health challenges in their family. And so, again, I’m just -- I look back to, we’re a mission driven company and you can see it in the in the culture and I’m grateful for my predecessors and the culture that was built over all these decades that allowed us to, it wasn’t without incident and it wasn’t easy, but we really got through it. I think we delivered for our clients. We delivered for the economy, because we are a mission critical service in the economy. And I just couldn’t be prouder of our associates including our back office associates to support our frontline associates, as well as our sales force, who, as we talked about a lot today, continue to plow through and allow us to continue to grow our business, despite we’re unprecedented headwinds. So, but first and foremost, I’m just so glad that despite, obviously, we have some short-term challenges here with the new Delta variant and so forth. But I mean, clearly, we’re heading in the right direction and we are very optimistic both for ourselves, for our families, for our associates and for our clients and we look forward to better times ahead here over the next couple of quarters where inevitably we’ll have some ups and downs or some challenges here and there. But it’s great that everything is on the right track at least in the United States and we’re hoping that other parts of the world follow closely behind, given that we have very significant business in Europe, Asia and Latin America as well. And we appreciate your interest in ADP and your support and thank you for tuning in today."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 3 | 2,021 | 2021-04-28 08:30:00 | Operator: Good morning, my name is Crystal, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks and will be a question-and-answer session. Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Crystal. Good morning everyone and thank you for joining ADP's third quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. And with that let me turn it over to Carlos.
Carlos Rodriguez: Thank you, Danny. And thank you everyone for joining our call. This morning, we reported another strong set of quarterly results that were ahead of our expectations. With revenue growth of 1% and adjusted EBIT margin down 90 basis points, combining for a modest adjusted diluted EPS decline of 2%. This of course was the final quarter, before we begin to lap the impact of the pandemic, and I'm very proud of our organization's ability to have delivered positive revenue and earnings growth for the first nine months of the fiscal year despite unprecedented challenges in the economy and the labor markets. I'll start with a review of some of our key performance drivers and an update on the operating environment, we've been experiencing. This quarter, our Employer Services New Business Bookings reaccelerated and we delivered 7% growth, a strong result for the team. The improved year-over-year growth compared to the second quarter was driven by every business unit. Importantly, we ended the quarter on a particularly strong note with record March sales performance that was well above pre-pandemic fiscal 2019 levels, which we see as a positive signal for client engagement in the quarters ahead. The selling environment will likely continue to evolve, month-to-month, and with differences on a regional basis as COVID cases and the reopening trajectories stabilize. We are optimistic that with vaccine deployment progressing steadily, our clients are in the best position since the pandemic started to begin making buying decisions again.
Kathleen Winters: Thank you, Carlos, and good morning everyone. Q3 represented another strong quarter for us with our performance on both revenues and margins driven by excellent execution across the organization. Our revenues grew 1% on both a reported and organic constant currency basis, which represented a slight acceleration versus Q2. We delivered this growth despite incremental drag from client funds interest versus Q2, as well as some incremental pressure related to our usual seasonal Q3 revenue drivers such as annual W-2 Form. I'll share more on these in a moment. As anticipated, we also experienced a margin decline as we continued to make additional growth in productivity investments and as we experienced a more significant client funds interest revenue decline compared to prior quarters, but the 90 basis points of margin decline was better than our expectations. Combining this revenue and margin performance, our adjusted EBIT was down 2% to $1.1 billion. Our adjusted effective tax rate increased slightly compared to the third quarter of fiscal 2020, as we had less contribution from excess tax benefit on stock comp, but our share count was lower year-over-year driven by share repurchases, and as a result, our adjusted diluted earnings per share of $1.89 was down a modest 2% versus last year. For our Employer Services segment, revenues declined 1% on a reported basis and 2% on an organic constant currency basis, demonstrating steady growth rates compared to last quarter, despite additional pressure from two sources as I just mentioned, both of which were fully anticipated. First, with greater pressure from client funds interest, our Q3 has a seasonally larger client funds balance than other quarters of the year and as a result, it skews more to cash and cash equivalent investments where interest rates have been pushed down to near zero. As a result, our client funds interest declined 32% versus last year with average yield down 70 basis points, more than offsetting our strong balance growth, which improved to 6%. Second with the headwind related to seasonal Q3 revenues like the annual Form W-2 which effectively makes our Q3 slightly more sensitive to pays per control and employment turnover trends and other quarters. Looking past these two headwinds, underlying ES performance showed sequential improvement driven in part by continued record level retention that was partially offset by slightly lower than expected pays per control. Employer Services Q3 margin was down 120 basis points compared to last year ahead of our expectations. We continue to invest in headcount to support our growing client base. We also started lapping lower incentive costs from last year and we experienced greater pressure from the lower client funds interest revenue compared to the first half of this year. But at the same time we kept our focus on prudent cost control and continue to execute on our transformation initiatives.
Operator: And we will take our first question from Ramsey El-Assal from Barclays. Your line is open.
Ramsey El-Assal: Hi, thanks so much for taking my question this morning. I wanted to ask about the increase in person engagement with the sales force, can you kind of contrast for us the productivity you're seeing from those in-person meetings relative to the remote meetings? Is that something that we should consider to be an incremental sort of driver of productivity maybe beyond what we were expecting, as we go forward?
Carlos Rodriguez: Yes, I think that's right. I think you would look at it really as incremental, because if you recall, like our first quarter, we had pretty robust sales results really with almost 100% of our sales force working virtually at that at that point. So we expect that the increased activity, if you listen to the tone of our comments that it's really incremental and hopefully gets us quickly back to the same productivity levels we were pre-pandemic, which we were approaching in the third and fourth quarter here, and then hopefully beyond that, because obviously part of our model before was that we expected some incremental improvement in productivity each year, in addition to increases in headcount and when you have combine those factors in addition to kind of new products and other things, that's what kind of drove our new business bookings growth, the combination of increases in headcount, and increases in productivity. So you're right, that's the path is this will help us get quickly back to our previous productivity and hopefully allow us to get above that, which is I think, important for us in terms of our long-term growth expectations.
Ramsey El-Assal: Okay. And I wonder if you could comment too, on the environment around potential tax reforms. As I recall when the corporate tax rates fell, that was translated into lower client interest balances for you or client funds balances for you. I know it's early days and everything needs to move through Congress, but can you comment on the degree to which some of these changes may or may not be factored in your budgeting process or what you're expecting here in terms of tax changes going forward in the impact on your business?
Carlos Rodriguez: I think for corporate, I think, if you're referring to really was clearly on the team, we've -- there's a lot of discussion about a lot of different things, including an increase in the kind of tax rate for the higher income individuals. But right now from -- And there's obviously discussion about capital gains taxes as well. But right now the thing that is probably most prevalent in discussions is corporate income tax rate, and I'm trying to think through I don't believe that there has really any direct impact on our balances obviously have an impact on ADP corporate itself, but I don't think that you have.
Danyal Hussain: Yes, you're definitely right about the individual tax brackets having an impact on our float balance. So, back when we had the previous corporate tax reform in the individual bracket changes, it was a headwind. I think about a percentage point or in that ballpark. So, in theory, what will drive the tailwind to our growth will depend on the actual change in rates here and what that means for overall individual income taxes. So it would be a contribution is not factored in to our outlook at this time, but obviously it's something we would benefit from.
Ramsey El-Assal: Terrific, thanks for taking my questions this morning.
Danyal Hussain: Thank you.
Operator: Thank you. Our next question comes from Dan Dolev from Mizuho. Your line is open.
Dan Dolev: Hi, good morning. Thanks for taking my question. I got -- just a quick housekeeping and then longer-term strategic question. You guiding I think to 4Q EPS slightly below the Street. Is there any margin pressure to call out in the fourth quarter?
Carlos Rodriguez: Well, I think if you -- from our prepared comments, you'd probably see that the pressures are what I would call self-inflicted in the sense that we believe is an opportunity for us to make some investments that improve our long-term growth prospects, both for '22 and beyond. And I think Kathleen particularly mentioned the two or three things that we're investing. And so the answer is no, there's no kind of mysterious margin pressure. In other words, the business continues to move in the right trajectory like almost every metric we have has improved in fact I say every metric we have has improved sequentially, even the pays per control, even though it was modest, it's still rounded to 6% down. We know now after watching the data at the beginning of Q4 that that's heading in the right direction and we can all tell from what's happening with unemployment but that-- that's going to also continue to improve fairly quickly here. So when you really kind of add it all together, like we're in a very strong position have very strong momentum and people who have known us for a long time, know that when we experience that we try to reinvest some of that and I think that's exactly what you're seeing in the fourth quarter. So I would say that those are conscious decisions that we are making.
Dan Dolev: Yes.
Kathleen Winters: And that's exactly right. And I'll just add in, in addition to what I think is smartly doing those investments in the fourth quarter and accelerating some of that, we've also got some year-over-year comp things going on right? As you would expect with selling having been down Q4 last year versus Q4 this year, we'd see incremental year-over-year selling expense in Q4 as well.
Dan Dolev: Got it. And just my follow up is, it was very impressed to see bookings kind of back to fiscal '19 levels. Really strong. Can you maybe talk a little bit about how Next-Gen Payroll engine is helping bookings?
Carlos Rodriguez: It's a relatively modest contribution because despite our level of excitement about really all of our Next-Gen platforms and even Roll, which you could argue that that's a NextGen solution as well. Again it's just because of the size and scale of our company like right now from a dollar impact standpoint, it's really not, that's not what's moving the needle really across the board, really in every business unit in every channel and every category, our bookings have been improving again sequentially every quarter and they continue to do that this quarter. So we believe that medium to long term, that's the key to us, sustaining kind of our multi-decade growth rates is these Next-gen platforms, but I just continue to caution everyone to because we want to give you the updates and we want to continue to focus on next-gen and I like, I appreciate the question important to kind of separate what's driving the quarters and what's driving the next fiscal year versus what's driving the next three to five years. And I would say that Next-gen payroll is going to be increasingly important in the next year or two from a bookings standpoint and we'll start to probably make a difference and will then give you that color in terms of what difference its making, but we should be cautious about revenue impact, just because of the recurring revenue model just takes a while for that to get into the revenue growth numbers, but it was positive, but really not. Now, we're really moved the needle.
Danyal Hussain: And I would just add that. We shared that we sold hundreds of clients on our Next-Gen Payroll engine with Workforce Now, just for context, that compares to typically few thousand clients that we sell in the mid-market. So it's still a piece of the overall puzzle. But as that scale to become the majority and then ultimately, all of our mid-market sales then you truly feel the incremental benefit.
Dan Dolev: Got it. So...
Carlos Rodriguez: That come is really the message there.
Dan Dolev: Thank you. Great stuff. Thanks.
Operator: Thank you. Our next question comes from Eugene Simuni from MoffettNathanson. Your line is open.
Eugene Simuni: Good morning. Thank you for taking my question. So I wanted to ask about down market and great to see the introduction of Roll to target the micro customers. I was hoping you can speak a little bit more broadly about evolution of competitive landscape through the pandemic down market, how RUN has done and kind of coming out of the pandemic, what opportunities exist for ADP to continue gaining share in the segment as I believe it has done prior to the pandemic?
Carlos Rodriguez: Well, I mean I think there is a number of moving parts. And I think it probably depends on people's current business model. So, as you know, our business model is really more about providing not just a software-based to support right support you call service, you can call it compliance, and I think what we saw this year with all of the activity that the government had around the various stimulus programs to help companies and individuals and so we're that created a lot of complexity for employers, it appears that we're entering into an environment where despite the pandemic hopefully fading, there will be increased levels of government activity around employment and incentives and that kind of that kind of thing. I think that's a good environment for ADP and for our down market business because most small businesses, don't have the time or the inclination to really focus on these things and to take care of these things. So it works for some clients and we believe that that's why we're rolling out Roll, no pun intended, but once you get to even a little bit slightly larger you do end up running into issues that you need help with and you need support and you need advice and much of that can be automated, but you still need it. So for example, a lot of our PPP support reports were automated. So it doesn't mean that somebody has to get on the phone and have a discussion about your PPP report, but you have to be focused on providing the support and the compliance in addition to just the software. So I think that helped us this year and again, so to answer your question, how do we believe we're set up competitively right now? I think we're set up excellently, competitively, because we now have very simple solutions for the micro-market where people want to self-buy, self-install, and don't have complexity and maybe don't have issues with taxes or compliance or don't want to ask questions, because it's not priced or built to ask questions. But we also have the ability to provide this assistance that is important for even small clients for sure it's important for mid-sized clients and for larger clients, but I think what really got highlighted this year is that small clients need a lot of help and need a lot of assistance and you can see it in our growth rates in our retention in our client satisfaction, like in all of our metrics in our small business division that we happen to be in the right place at the right time I think to be able to help our clients and then hopefully no benefit from the tailwind of the demand that that's going to create on a go-forward basis. So anyway long-winded way of saying, I think we're in a great position, because of our business model.
Eugene Simuni: Got it. Excellent. And then a quick follow-up from me on the global business. So just thinking about what we're seeing now, I think is strong kind of bifurcation of the recoveries in the US and abroad. Strong expectations for US recovery in your business in Global, is it growing, is it going slower? And is the implication that global might be kind of headwind to growth over the next couple of quarters?
Danyal Hussain: As usual for us, things are a little more when you peel the onion back, there is a little bit more complexity because you're just the image you have is correct, but it hasn't really, translated into the results, our results have actually been quite good internationally, both in terms of bookings as well as just the performance of the business overall in terms of revenue, pays per control et cetera. Some of that is that a large portion of our business is in Europe and there were a lot of government programs there as well to help companies and to prevent high levels of unemployment. And so for example, our pays per control metric never got to the negative levels that we saw in the US, in Europe, so that was a benefit. At the same time, our bookings have been quite strong and I have to admit that I've been looking for the explanation for that other than really good execution on the part of our sales force as they moved into a virtual environment because they had to sell virtually there as well. But I would say it's strong differentiation of our products. Again, the service aspect to our solutions, the ability to provide support and to provide compliance and help, all of those things probably helped our bookings performance internationally as well. So I would say that our global business actually is probably one of the bright spots. I would say despite what is obviously a very difficult environment, and we obviously feel for our businesses in not just Europe which now it happens to be improving again, particularly in the UK, but we're having challenges now in Toronto, we're having in Canada and in Brazil, we're having challenges. Obviously, as you know in India as well. But it's, it has not translated into negative results. So I think it's a testament to the resiliency and the strength of the business model. But I don't want to take anything away from the fact that it also obviously shows great execution by our international leaders as well.
Eugene Simuni: Got it. Thank you very much.
Operator: Thank you. Our next question comes from Bryan Bergin from Cowen. Your line is open. Please check that, your line is not on mute.
Bryan Bergin: Sorry about that. Question for you on ES versus PEO performance. It seems like pays per control appear to be a key difference, can you just dig in more on the at the mix aspects that seem to drive a pretty notable disparity of performance between those two. And should we expect that difference to persist in 4Q? Or do you expect more even performance?
Danyal Hussain: I don't believe we've provided Lake that data, so I'm surprised you came to that conclusion but we maybe it's part of our tone. So there isn't a huge difference between ES pays per control performance and PEO, they both have been improving every quarter sequentially and the PEO doesn't include -- we generally stay away from very, very small clients. So we don't have a lot of clients that are one to two employees or five employees. The average size client in the PEO, I think is somewhere around 40, and so by definition, it tends to skew a little bit bigger than maybe our average client size for sure for small business, so actually, I'm looking at these figures last night. And it makes perfect sense kind of where we are, which is that the PEO is performing a little bit better in terms of absolute level of pays per control and have been improving sequentially just as ES has as well. So, and again I'm probably not allowed to say this, I'm going to get in trouble, but last night I got a note from the PEO that we experienced the first positive pays per control week. Now, the problem with pays per control is that it does vary based on payroll cycles. So if you have weekly payrolls or by-weekly payroll so you and I can't read anything into that. It's the first time we've had a positive pays per control in any week over the last 12 months. So that's a very positive sign.
Bryan Bergin: Okay. And then just on margins, you should outperformance here in the quarter. But at the same time you've called out incremental headcount investments higher incentive comp, and I think elevated implementation costs, can you just talk about the drivers there and then how do we connect the elevated implementation cost with more efficient digital onboarding commentary?
Danyal Hussain: Well, the efficient digital onboarding, I think, we were pretty clear with a FPS, we would love to, at some point in the future, extend that into the mid-market and maybe someday into the upmarket. But as you know, like you know better than us, because you've talked a lot of the competitors, there's not a lot of digital on-boarding going on for example of large complex ERP installations, not to pick on any competitors, but it's pretty. I know the images that the stuff, all kinds of its installed itself, but most of many of our competitors use third-parties. So there is still quite a lot of implementation activity and expense, whether it's done by the seller of the solutions or if it's done by a third-party. We haven't have a model where we do a lot of it ourselves. And so as bookings pick up and demand picks up, we need to add to our capacity for implementation in particular in the mid-market, the upmarket and also global, which as I mentioned has been strong. So it doesn't mean that we're not adding in the down market also. But in our small business segment as we alluded to, and as I think you pointed out, the digital on-boarding capabilities obviously reduce the need to grow headcount as much as we otherwise would have. But even in small business, we have a lot of growth in bookings and so it's a matter of the trade-off of how much can we on-board digitally versus how much we still need some help with, in terms of people being involved in. In terms of some of the other items that, we alluded to, I mean, some of this is just kind of natural to the business model, as we bring on more clients, we obviously expect productivity improvements every year, whether it's in sales or implementation or everywhere, but we are seeing a recovery of our business and very strong GDP forecast, and so, we're anticipating improved prospects for bookings and for revenue and for growth, and we need to make sure that we have the right staffing levels based on the productivity metrics that and the productivity goals that we have to be able to handle that business, so we can maintain our high clients of level -- high level of client satisfaction that we've, that we've experienced. And then we have some natural growth in expenses like I think Kathleen alluded to sales expense is clearly something that grows as you have sales success and as sales grow year-over-year. So I wouldn't, I wouldn't read too much into it rather than that, we made some conscious decisions to reinvest in some specific things in the fourth quarter to really position us well for 22 and beyond, but most of this is just kind of natural stuff where, again, as our revenue growth picks up over time, we still have a great incremental margin business where we would expect to have good operating leverage as we grow those revenues.
Bryan Bergin: Okay, thank you.
Operator: Thank you. Our next question comes from Mark Marcon from Baird. Your line is open.
Mark Marcon: Good morning and thanks for taking my questions. Wondering if you can talk a little bit about the investments in Q4, just in terms of Next-gen, Wisely, marketing and advertising, just how much incremental spend will there be and are you seeing signs with regards to Wisely, that the interest is picking up and therefore, that's a great place to invest?
Carlos Rodriguez: I don't feel like it's appropriate to give you, I think you asked for the numbers, I don't know that how -- I think you can probably do the math yourself, like in terms of, when you look at the trajectory that we're on, you could probably back in into some rough this is not in the hundreds of millions of dollars again. But again I respect the short-term orientation that we have here in that you guys are trying to. But I would not read as much as you may be reading into these fourth quarter investors, as we've done this in all the way back to my, Gary taught me everything I know and you Gary, I think as well Mark. And we are a long-term oriented company. And we -- when we see opportunities to improve and to invest in things that are either going to drive our bookings or drive our client satisfaction or drive our efficiency, that's what we are going to do it. We've been doing that all along. So this is, it's not like we hadn't invested, we've been telling you that we've been investing for the last three quarters. And that was a conscious decision, we took a little bit of a bidding for that at the beginning of the year. Fortunately, we had positive surprises on the revenue side and on pays per control and other things, but we committed that we were going to invest through the downturn and that's what we've -- that's what we've done. And now, we feel like there are few things that we can do that I would call -- I don't want to call them housekeeping items -- But they're not -- These are not in the hundreds of millions of dollars, but they put some pressure on our fourth quarter margin. And we knew that it would create some questions even though, it really has nothing to do with 22 or kind of our future expectations of either revenue growth or operating leverage, but I guess I understand the question, but I don't think that maybe Danyal can give you a little bit more color, but I am not sure we giving you an exact number is probably the right approach.
Kathleen Winters: I mean you could -- Yes, I mean -- Sorry, Danyal, I would just I think about it as kind of these are tweaks to the amounts we're spending in Q4 versus kind of wholesale changes to the program here. So it's somewhat modest and what Carlos said it's not in the hundreds the millions of dollars here.
Mark Marcon: I appreciate it.
Danyal Hussain: your wisely question, Mark. The one thing we did see was stimulus drove some uptick in the card spent per card. Other than that, during the pandemic, there hasn't been any real notable changes in the Wisely growth trends. So really it's the per card economics that have seen a slight to tick up recently.
Carlos Rodriguez: Yes. And I think it's something that we've been excited about. But again, it was hard to get excited about, there was a lot of natural tailwind because people wanted more digitally oriented payment methods in the last three quarters, but from a focus standpoint like for the first couple of quarters of the year, we were focused on a lot of things, and this may not have made it all the way to the top of the list, but it was on a top of the list kind of pre-pandemic, if you recall, and so I think, I would see this is more of a re-emergence of some of the themes and some of the things that we had been talking about that excite us because I think the opportunity is a big ones, I'm glad that the team brought this forward in terms of as an investment opportunity because we were excited about it, call it 12 to 18 months ago, we should just as excited about it today. But admittedly, it wasn't our number one focus, and in the middle of the pandemic, if you will, at the beginning of the pandemic.
Kathleen Winters: Yes. And then just one last comment is we always look very hard at the timing and amount that we spend on marketing and advertising but with economic activity continuing to have momentum and pick up and client engagement picking up, we felt this was the right time to increase that a little bit as well.
Mark Marcon: I really appreciate that color. And it is completely consistent with the long-term track record. Going back to Art. Even before, Gary, can you talk a little bit about this Danyal or can you just remind us what the sensitivity on the pays per control to revenue is?
Danyal Hussain: It's 25 basis points of revenue impact for every 1 percentage point change in pays per control.
Mark Marcon: I appreciate that. Thank you.
Operator: Thank you. Our next question comes from Kevin McVeigh from Credit Suisse. Your line is open.
Kevin McVeigh: Great, thanks. Hey, Carlos, I think you alluded to kind of a record high on account none of us have sense about. Can you give us a sense of where that splits across enterprise mid-down market and how that sits relative to historical trends in the business?
Carlos Rodriguez: Yes, I can give you some -- I'll give you some color. We don't -- I don't think that's something that we've disclosed in terms of the actual breakdown by business, but I can give you a general ideas. So we had that 6% growth, the 900,000, and we had call it growth of somewhere around that for RUN, our WSN growth was around that as well. And global view was around that as well. So from a client -- pure client growth standpoint if you look at our strategic platforms, they kind of grew in the kind of that neighborhood from a client growth standpoint, which we see as really great news given the very difficult environment that we're in. Obviously, when you look at the mathematically, the overall growth rate and the overall number It's driven in large part by our small business division, because that's where we have the bulk of the absolute number of clients. But I wanted to give you a little bit of color around, if you look at WF, if you look at Workforce Now, across our multiple channels, just remember we start Workforce Now, just in the -- not just in the mid-market but we saw it in the upmarket, and we saw it in the PEO. The PEO platform as well, we also have that platform in Canada. And so that gives you some sense of Canada how well that platform is growing, which is really satisfying to us. So hopefully that helps a little bit.
Kevin McVeigh: Now, that's helpful. And then just on the retention, real quick, I think you took it up from the 125 basis points, up from 100 basis points. Can you just refine that a little bit, is that kind of the Q4 run rate or is that the full year number of this at being fourth quarter is even higher than that? Or is that infinite? The EPM number, and then just any thoughts you could just may be frame on a little bit more .
Carlos Rodriguez: You've stumped us.
Danyal Hussain: I think, we said in the opening remarks that it's on the Q3 performance being stronger than expected.
Carlos Rodriguez: Yes, I think it's generally it's been consistent like it's really frankly remarkable, which is why we keep emphasizing some caution because we hope there is no plan, we're not going to give it back and we're not hoping for give back. But in this business like people who've been following us for a long time, like when we have a 10 basis points to 20 basis point move in retention. It's a big deal. So to have this kind of retention on top of the retention that we had last year is pretty remarkable. And so we're pretty excited about it and I think the key for us is trying to determine like when I look at the retention figures, there is a lot of improvement in what's called the controllable losses. So the ones that are related to kind of service issues and so forth. So we're excited that we might be able to hold on to some of this gain, but at the same time, we're realistic enough to acknowledge that some of the stuff that was related to pan out of business and government stimulus there might be a little bit of give back there, but it's been pretty consistent like every -- It seems like every quarter, the improvement has been in that same neighborhood year-over-year, hence why we kind of tweak the full year because we're probably going to end up in the range that we gave you, which is a little higher than we had before, but it wasn't, we were trying to like send any kind of message about the fourth quarter in particular.
Kevin McVeigh: Helpful. Thank you.
Operator: Thank you. Our next question comes from Tien-Tsin Huang from JP Morgan. Your line is open.
Tien-Tsin Huang: Hey, thanks so much. I think a lot of good questions already. Just thinking about the retention feels like it's industry wide to some degree. So just trying to better understand your new sales, the reacceleration is it driven more from upselling, and in new business formation, and any surprises in the net switching over the balance of trade from a head-to-head standpoint?
Carlos Rodriguez: I don't have a lot to report on. We obviously watch all that stuff where you referring to the balance of trade. And as you said, it's hard for me to tell about retention in terms of the rest of the industry you guys would be the experts on that because my casual review of some 10-Ks makes it kind of hard to compare like some people would say retention of their annual recurring revenue cloud revenues, which is not the same as the retention for their company. So it's kind of hard for me to say, I mean, some of it I would say it's probably more variable than you think, based on what I'm seeing in terms of variability of growth rates, because it's clearly been a huge part of our ability to outperform. I mean this is a pretty remarkable revenue performance given what we've been through. And given the pays per control headcount and by the way, what we brought up yet, but we have a huge headwind on client funds interest, which is going to abate here in the fourth quarter and is going to abate next year as well. There may still be a little bit of headwind, but this was really the worst quarter that we had, and these nine months were bad and was $130 million drag just from client funds interest. So when you put everything into the pot, without really good strong retention, it's hard to outperform the way we have and we've done some work on the relative performances of us versus some of our competitors and we feel pretty good about that and about our -- to the potential for retention to be one of the needle movers there, making some other factors that I'm not, we're not, we haven't thought about, but no, I don't think there's anything else really big out there like we've done a little bit better against some of our -- the usual competitors that you know about, in terms of balance of trade but there's others that are still challenging for us. And so, net-net we're pretty comfortable with where we are and determined to continue to drive our growth. I think all of us are probably benefiting from overall economic growth. And the fact that it seems like maybe there are some either in-house or regional providers that are because you can see our, we're growing our units. In Workforce Now, and in RUN. And so, we're -- it seems like we're all have some ability to grow in this environment, which is I guess good for everyone.
Tien-Tsin Huang: Yeah, I'm glad you said all that, we shouldn't take it for granted. Just quickly on client satisfaction, notably higher would you attribute it Carlos more to the -- of course support efforts you guys have invested in, but the Next-gen platforms and some of the digital initiatives or are you also seeing just clients maybe building it more better goodwill with ADP spending more time with them during these tough times during the pandemic, just trying to understand, because it seems like it could be -- if it carries over we could see some compounding in the retention?
Carlos Rodriguez: Yes, I think it's a great question. And I -- we obviously we're trying to figure that out because it's very important to the long-term value creation of the company. And it's all the things you mentioned are you obviously know the business well enough that you hit on all the question is how much is each of those rates, like the last one that you mentioned about the goodwill, there is no question that of being there like there were two or three months where people could not talk to anyone other than us about what to do. Right? What to do about the PPP loans that the government was offering around tax credits, because if you buy software from someone, you can't call to ask them those questions, I just want to remind everyone, right, you can call them that we're about the software and you can send in a ticket to get your software issue resolved, but you can't call to ask about tax deferrals or tax credits or PPP reports or any of that kind of stuff. So we clearly built a lot of goodwill. But on the other hand business is business. And goodwill, it doesn't last forever, so we're not, planning a living off of that for the next five or 10 years. So that brings me back to kind of the basics of client satisfaction, which is we have to be there for our clients when they need us not just during the pandemic, but at all times. So I would say that the second major factor besides the goodwill that I mentioned and some of the digital initiatives to like making easier for our clients and improve our user experience is that we did not panic at the onset of the pandemic. And if you recall, we took some lumps for that because we really maintained our investments both not just in R&D, we maintained our investments in headcount and an implementation. That doesn't mean that we didn't have some drift down as a result of some turnover, which we did and our head count did decline because we had a temporarily a drop in volume, if you will, but that was really, really important right, to be able to kind of get through this period and be able to deliver on our commitments to our, clients and back to the comments I made about productivity before, that's one of those things that we watch very carefully because we want to improve productivity but we weren't -- we can't be naive and think that if our obviously if our headcount was 10% lower, we have higher net income, the problem is, what would your client satisfaction be and your retention. And so that's the magic right of being able to figure out what's that right balance and you have tools to figure that out, you have monitoring systems right to understand what the client satisfaction levels are in relation to how quickly you're getting back to people to resolve their problems for example and how well trained your people are. So there's a number of different factors that we look at, but the key is to be committed to delivering high levels of client service, which we are and I think we just proved it. If we can do it during the pandemic, we can do it anytime.
Tien-Tsin Huang: Yes. Got it. Thanks so much.
Operator: Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open.
Jason Kupferberg: Good morning, guys. Thanks. I just wanted to start with the bookings question just to make sure you've got the expectations right here, just trying to do the math on the Q4 implied guide. I think it would be about 90% growth. So I wanted to see if that's accurate, obviously you've got the super easy comp there and maybe as part of that can you just talk about some of the activity you've seen through the first month of the quarter. I mean I assume you've got pretty high visibility here, just given that you raised the low end of the full-year guidance range for the bookings?
Danyal Hussain: Hey, Jason. It's Danyal. You don't have the weightings by quarter. But what's implied for the fourth quarter is over a 100% bookings growth. And for example, we're tracking right in line with expectations.
Carlos Rodriguez: Yes, I would say that you should not read anything into that other than what we said, which is, we're still really positive. We believe we're going to continue to get sequential productivity improvements, but the percentage growth rate is really related to the base effects, really when you get down to whether it's 110 or . Not that, I know, you know, it's not that for. I think you're trying to get a number you using the percentage we get to the number. But, yes, yes, you should probably -- if I were you, I would look at maybe call it the second quarter or maybe 2019 fourth quarter or something has got to be something else that would give you something good as a proxy, right? Where we don't expect to be back at 100% productivity levels in the fourth quarter, but we should be getting close to like where we were in 2019, and there may be other small moving parts there from 2019. So I don't want to go out on a limb and say that's the right analog but anyway, I think that's hopefully helpful.
Jason Kupferberg: Yes. So it is -- your comp certainly would matter more. I just wanted to make sure people kind have the right numbers in their models for the quarter. And then just a quick follow-up on the pays per control, I think you mentioned it was a little worse than you anticipated in Q3 and you tempered your Q4 expectations a little bit. I'm just curious, which part of the portfolio is driving that? It just things maybe a little incongruous with the US employment data that we're seeing at a high level, which obviously has continued to outperform expectations?
Carlos Rodriguez: Yes, it's a 100% timing related because we can see in the data, we have other datasets like to show us, like for example, job postings and background checks, screenings and so forth. And so, you shouldn't read anything into it and we did not temper our fourth quarter at all, and in fact we kind of try to clarify that we kept the full year, the same despite the third quarter being a little bit softer in part because we think we're on the same positive trajectory that I think that we thought we were on. So we're seeing the same thing you're seeing in terms of employment and unemployment, and we would fully expect these pays per control numbers to improve rapidly here. And remember that we're talking today about numbers that were through the end of the third -- Sorry through the end of March and those numbers are for three months. Correct? So if you look at the third month in March is different than it was for January. And January, February, I know it's hard to remember to think back that far and how bad things were, that was a completely different picture and the picture we had in early April and maybe in the last, very last week of March. So I wouldn't, I wouldn't read anything into it other than timing.
Kathleen Winters: Yes. And you know just to clarity -- I were just to clarify, was just a slight tweak to the Q4 number and holding the full year at down 3% to 4%. So it's really kind of very minor tweaks.
Jason Kupferberg: Okay, perfect. Thank you, guys.
Operator: Thank you. And our next question comes from Pete Christiansen from Citi. Your line is open.
Pete Christiansen: Good morning, thanks for the question, Carlos. I think the high customer sat scores, the goodwill truly a testament to ADP's capabilities and certainly the service -- the service business model. But I guess clients' needs certainly change and we've been hearing from some of our other companies that talent acquisition has been I guess even more challenging than in the past and I recall at the last Analyst Day that ADP had really been making a lot of strides in improving its recruiting management tools so on and so forth. How would you, think that you, stack up competitively in that area, particularly in recruiting management tools and do you think that could be in another vehicle or vessel to maintain the high retention levels that you're currently experiencing?
Carlos Rodriguez: Absolutely. I think that you're right, I mean, some of this obviously is cyclical, right in the sense that 12 to 18 months ago people were looking for other tools, other than client acquisition tools. So you have to be careful about not kind of shifting with the necessarily to be consistently able to help people throughout the whole lifecycle of HCM and right now that happens to be an important one. And so I would say that there's two things, one is we build our own tools, as you said around recruitment management and we also have an RPO business, and we have other tools to help with the talent acquisition process. We also partner and we have some really strong partnerships. I'm not sure -- if I mentioned the names of the companies are not but the names that you hear a lot of kind of advertising about, we have a very strong integration and partnerships with some of those companies to really make it easy, in particular in small business, but also even in the mid-market for people to use those tools to really help with the recruiting needs that they that they have, but we feel we've been making, we have made significant investments in our recruitment management platform and our talent acquisition platforms, nothing to do with the pandemic, so that you could call it for tools, that we had done that before the pandemic, and we would expect that those would be contributors to our overall value proposition into our revenue -- Sorry, into our bookings growth because those are generally tools that create incrementality around your bookings number. In other words, what you can charge clients is typically there is a core set of solutions and then recruitment management, things like time and attendance will workforce management, those tend to be more incremental around the basic package, if you will, of HCM. So we're positive, we're bullish on it and I think we're very, just as a reminder, our app marketplace is creates a very easy and seamless way for people to use different solutions in HCM and this would be a category that we would have a lot of partners in that market app -- in that app marketplace that allow you to get all the other benefits, you mentioned about ADP's business model and still be able to fulfill your talent acquisition needs, if you don't believe that ADP has what you need, which we believe you do, but if you don't, you can always get it through one of our partners.
Pete Christiansen: That's helpful. And apologies if this was addressed earlier, but given the change in the yield curve, has there been any thoughts on potentially extending duration of the portfolio or any other investment selection choices as you head into '22?
Carlos Rodriguez: Probably not worth mentioning. The -- as you know in the yield curve, like right now kind of 5 and 7-year is a little bit better than two and three just because of the way the Fed is managing the curve, if you will. So I think there are always, I'll call them tactical opportunities. But no, I mean I think our duration has been in the same range since I've been CEO, and I would anticipate that not changing and we're not changing laddering strategy and we're not changing our client funds interest strategies. The good news is that it appears the worst is behind us in terms of drag from client funds interest which was painful. I think we had a $50 million drag just this quarter. So, again, not to beat a dead horse, but it just shows the strength of the business that we didn't mention that to you. And if we kind of overcame that drag $130 million for the year. So we're looking forward to better times ahead, and I did see an interesting chart. Again, I probably shouldn't say this, but we had $16 billion in balances in 2008 and we had $635 million in client funds interest. I'm sorry, $685 million not $635 million, in client funds interest. So just shows to you the magnitude, I mean, you all know what's happened to interest rates, but that was 2008, that wasn't like in a different century or in a different country like that was here, and so today, our balances are call it the mid $20 billion number for the year and that's the expectation, so I think you could probably do the math yourself in terms of, if we do believe that there's going to be some inflation here and if you look at the inflation breakevens and you look at some other things that are going on, We're looking forward to better times ahead for client funds interest.
Pete Christiansen: And the adjusted EBITDA margin was 19% back then. You're already above that, that's great, thank you so much.
Operator: Thank you. And we have time for one more question that comes from Jeff Silber from BMO Capital Markets. Your line is open.
Jeff Silber: My questions have already been asked.
Operator: Thank you. And this concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for any closing remarks.
Carlos Rodriguez: So as you can tell from our comments, we continue to, I think, have the same level of optimism, as we had last quarter and we're really, really thankful for the performance of our sales organization and also our frontline associates in terms of what they've been able to do for our clients and at the risk of ending on a negative note though, all of this positive, and all of this positivity and enthusiasm, we don't want to overlook the fact that we still have some challenges and some people still have some challenges in other parts of the world. This is a US headquartered company with over 80% of our revenues in the US. So that's probably why you're hearing all of this optimism, but we're not only in the US, we have associates in India, in Brazil, in Canada, and in Europe. And the situation is not the same there. Even though the businesses are performing well, we just as back in the spring of last year, it was enormous suffering and challenges here in the US among our associates, the same thing is happening for some of our associates in some other parts of the world, in particular in India. And we are not going to forget them, we're doing everything we can to help them. We appreciate what the US government is doing along with the Indian government and local governments to help as well. And we look forward to have helping them kind of get through the same difficult situation that we managed to get through and they too will have their vaccination rates pickup in all of those parts of the world and they too will emerge from the pandemic. But it's clear that it's going to take a little bit longer and we should all remember to be there to help them and support them in any way we can, and I think people will do exactly that. But, having said that, we are --close to seeing the situation in the rearview mirror here and we're really anxious to see our growth rates, we accelerate to kind of where we were pre-pandemic here at some point in the future and getting back to the business and to helping our clients with their challenges and helping our associates build careers and helping all of you and our other shareholders and stakeholders get a fair, a fair return for their investment. So again, as always, we appreciate your interest in ADP and we appreciate you tuning in and we will be back in a quarter with our outlook for fiscal year '22. Thank you!
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning, my name is Crystal, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks and will be a question-and-answer session. Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Crystal. Good morning everyone and thank you for joining ADP's third quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. And with that let me turn it over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny. And thank you everyone for joining our call. This morning, we reported another strong set of quarterly results that were ahead of our expectations. With revenue growth of 1% and adjusted EBIT margin down 90 basis points, combining for a modest adjusted diluted EPS decline of 2%. This of course was the final quarter, before we begin to lap the impact of the pandemic, and I'm very proud of our organization's ability to have delivered positive revenue and earnings growth for the first nine months of the fiscal year despite unprecedented challenges in the economy and the labor markets. I'll start with a review of some of our key performance drivers and an update on the operating environment, we've been experiencing. This quarter, our Employer Services New Business Bookings reaccelerated and we delivered 7% growth, a strong result for the team. The improved year-over-year growth compared to the second quarter was driven by every business unit. Importantly, we ended the quarter on a particularly strong note with record March sales performance that was well above pre-pandemic fiscal 2019 levels, which we see as a positive signal for client engagement in the quarters ahead. The selling environment will likely continue to evolve, month-to-month, and with differences on a regional basis as COVID cases and the reopening trajectories stabilize. We are optimistic that with vaccine deployment progressing steadily, our clients are in the best position since the pandemic started to begin making buying decisions again."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos, and good morning everyone. Q3 represented another strong quarter for us with our performance on both revenues and margins driven by excellent execution across the organization. Our revenues grew 1% on both a reported and organic constant currency basis, which represented a slight acceleration versus Q2. We delivered this growth despite incremental drag from client funds interest versus Q2, as well as some incremental pressure related to our usual seasonal Q3 revenue drivers such as annual W-2 Form. I'll share more on these in a moment. As anticipated, we also experienced a margin decline as we continued to make additional growth in productivity investments and as we experienced a more significant client funds interest revenue decline compared to prior quarters, but the 90 basis points of margin decline was better than our expectations. Combining this revenue and margin performance, our adjusted EBIT was down 2% to $1.1 billion. Our adjusted effective tax rate increased slightly compared to the third quarter of fiscal 2020, as we had less contribution from excess tax benefit on stock comp, but our share count was lower year-over-year driven by share repurchases, and as a result, our adjusted diluted earnings per share of $1.89 was down a modest 2% versus last year. For our Employer Services segment, revenues declined 1% on a reported basis and 2% on an organic constant currency basis, demonstrating steady growth rates compared to last quarter, despite additional pressure from two sources as I just mentioned, both of which were fully anticipated. First, with greater pressure from client funds interest, our Q3 has a seasonally larger client funds balance than other quarters of the year and as a result, it skews more to cash and cash equivalent investments where interest rates have been pushed down to near zero. As a result, our client funds interest declined 32% versus last year with average yield down 70 basis points, more than offsetting our strong balance growth, which improved to 6%. Second with the headwind related to seasonal Q3 revenues like the annual Form W-2 which effectively makes our Q3 slightly more sensitive to pays per control and employment turnover trends and other quarters. Looking past these two headwinds, underlying ES performance showed sequential improvement driven in part by continued record level retention that was partially offset by slightly lower than expected pays per control. Employer Services Q3 margin was down 120 basis points compared to last year ahead of our expectations. We continue to invest in headcount to support our growing client base. We also started lapping lower incentive costs from last year and we experienced greater pressure from the lower client funds interest revenue compared to the first half of this year. But at the same time we kept our focus on prudent cost control and continue to execute on our transformation initiatives."
},
{
"speaker": "Operator",
"text": "And we will take our first question from Ramsey El-Assal from Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thanks so much for taking my question this morning. I wanted to ask about the increase in person engagement with the sales force, can you kind of contrast for us the productivity you're seeing from those in-person meetings relative to the remote meetings? Is that something that we should consider to be an incremental sort of driver of productivity maybe beyond what we were expecting, as we go forward?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think that's right. I think you would look at it really as incremental, because if you recall, like our first quarter, we had pretty robust sales results really with almost 100% of our sales force working virtually at that at that point. So we expect that the increased activity, if you listen to the tone of our comments that it's really incremental and hopefully gets us quickly back to the same productivity levels we were pre-pandemic, which we were approaching in the third and fourth quarter here, and then hopefully beyond that, because obviously part of our model before was that we expected some incremental improvement in productivity each year, in addition to increases in headcount and when you have combine those factors in addition to kind of new products and other things, that's what kind of drove our new business bookings growth, the combination of increases in headcount, and increases in productivity. So you're right, that's the path is this will help us get quickly back to our previous productivity and hopefully allow us to get above that, which is I think, important for us in terms of our long-term growth expectations."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. And I wonder if you could comment too, on the environment around potential tax reforms. As I recall when the corporate tax rates fell, that was translated into lower client interest balances for you or client funds balances for you. I know it's early days and everything needs to move through Congress, but can you comment on the degree to which some of these changes may or may not be factored in your budgeting process or what you're expecting here in terms of tax changes going forward in the impact on your business?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think for corporate, I think, if you're referring to really was clearly on the team, we've -- there's a lot of discussion about a lot of different things, including an increase in the kind of tax rate for the higher income individuals. But right now from -- And there's obviously discussion about capital gains taxes as well. But right now the thing that is probably most prevalent in discussions is corporate income tax rate, and I'm trying to think through I don't believe that there has really any direct impact on our balances obviously have an impact on ADP corporate itself, but I don't think that you have."
},
{
"speaker": "Danyal Hussain",
"text": "Yes, you're definitely right about the individual tax brackets having an impact on our float balance. So, back when we had the previous corporate tax reform in the individual bracket changes, it was a headwind. I think about a percentage point or in that ballpark. So, in theory, what will drive the tailwind to our growth will depend on the actual change in rates here and what that means for overall individual income taxes. So it would be a contribution is not factored in to our outlook at this time, but obviously it's something we would benefit from."
},
{
"speaker": "Ramsey El-Assal",
"text": "Terrific, thanks for taking my questions this morning."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Dan Dolev from Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hi, good morning. Thanks for taking my question. I got -- just a quick housekeeping and then longer-term strategic question. You guiding I think to 4Q EPS slightly below the Street. Is there any margin pressure to call out in the fourth quarter?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I think if you -- from our prepared comments, you'd probably see that the pressures are what I would call self-inflicted in the sense that we believe is an opportunity for us to make some investments that improve our long-term growth prospects, both for '22 and beyond. And I think Kathleen particularly mentioned the two or three things that we're investing. And so the answer is no, there's no kind of mysterious margin pressure. In other words, the business continues to move in the right trajectory like almost every metric we have has improved in fact I say every metric we have has improved sequentially, even the pays per control, even though it was modest, it's still rounded to 6% down. We know now after watching the data at the beginning of Q4 that that's heading in the right direction and we can all tell from what's happening with unemployment but that-- that's going to also continue to improve fairly quickly here. So when you really kind of add it all together, like we're in a very strong position have very strong momentum and people who have known us for a long time, know that when we experience that we try to reinvest some of that and I think that's exactly what you're seeing in the fourth quarter. So I would say that those are conscious decisions that we are making."
},
{
"speaker": "Dan Dolev",
"text": "Yes."
},
{
"speaker": "Kathleen Winters",
"text": "And that's exactly right. And I'll just add in, in addition to what I think is smartly doing those investments in the fourth quarter and accelerating some of that, we've also got some year-over-year comp things going on right? As you would expect with selling having been down Q4 last year versus Q4 this year, we'd see incremental year-over-year selling expense in Q4 as well."
},
{
"speaker": "Dan Dolev",
"text": "Got it. And just my follow up is, it was very impressed to see bookings kind of back to fiscal '19 levels. Really strong. Can you maybe talk a little bit about how Next-Gen Payroll engine is helping bookings?"
},
{
"speaker": "Carlos Rodriguez",
"text": "It's a relatively modest contribution because despite our level of excitement about really all of our Next-Gen platforms and even Roll, which you could argue that that's a NextGen solution as well. Again it's just because of the size and scale of our company like right now from a dollar impact standpoint, it's really not, that's not what's moving the needle really across the board, really in every business unit in every channel and every category, our bookings have been improving again sequentially every quarter and they continue to do that this quarter. So we believe that medium to long term, that's the key to us, sustaining kind of our multi-decade growth rates is these Next-gen platforms, but I just continue to caution everyone to because we want to give you the updates and we want to continue to focus on next-gen and I like, I appreciate the question important to kind of separate what's driving the quarters and what's driving the next fiscal year versus what's driving the next three to five years. And I would say that Next-gen payroll is going to be increasingly important in the next year or two from a bookings standpoint and we'll start to probably make a difference and will then give you that color in terms of what difference its making, but we should be cautious about revenue impact, just because of the recurring revenue model just takes a while for that to get into the revenue growth numbers, but it was positive, but really not. Now, we're really moved the needle."
},
{
"speaker": "Danyal Hussain",
"text": "And I would just add that. We shared that we sold hundreds of clients on our Next-Gen Payroll engine with Workforce Now, just for context, that compares to typically few thousand clients that we sell in the mid-market. So it's still a piece of the overall puzzle. But as that scale to become the majority and then ultimately, all of our mid-market sales then you truly feel the incremental benefit."
},
{
"speaker": "Dan Dolev",
"text": "Got it. So..."
},
{
"speaker": "Carlos Rodriguez",
"text": "That come is really the message there."
},
{
"speaker": "Dan Dolev",
"text": "Thank you. Great stuff. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Eugene Simuni from MoffettNathanson. Your line is open."
},
{
"speaker": "Eugene Simuni",
"text": "Good morning. Thank you for taking my question. So I wanted to ask about down market and great to see the introduction of Roll to target the micro customers. I was hoping you can speak a little bit more broadly about evolution of competitive landscape through the pandemic down market, how RUN has done and kind of coming out of the pandemic, what opportunities exist for ADP to continue gaining share in the segment as I believe it has done prior to the pandemic?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I mean I think there is a number of moving parts. And I think it probably depends on people's current business model. So, as you know, our business model is really more about providing not just a software-based to support right support you call service, you can call it compliance, and I think what we saw this year with all of the activity that the government had around the various stimulus programs to help companies and individuals and so we're that created a lot of complexity for employers, it appears that we're entering into an environment where despite the pandemic hopefully fading, there will be increased levels of government activity around employment and incentives and that kind of that kind of thing. I think that's a good environment for ADP and for our down market business because most small businesses, don't have the time or the inclination to really focus on these things and to take care of these things. So it works for some clients and we believe that that's why we're rolling out Roll, no pun intended, but once you get to even a little bit slightly larger you do end up running into issues that you need help with and you need support and you need advice and much of that can be automated, but you still need it. So for example, a lot of our PPP support reports were automated. So it doesn't mean that somebody has to get on the phone and have a discussion about your PPP report, but you have to be focused on providing the support and the compliance in addition to just the software. So I think that helped us this year and again, so to answer your question, how do we believe we're set up competitively right now? I think we're set up excellently, competitively, because we now have very simple solutions for the micro-market where people want to self-buy, self-install, and don't have complexity and maybe don't have issues with taxes or compliance or don't want to ask questions, because it's not priced or built to ask questions. But we also have the ability to provide this assistance that is important for even small clients for sure it's important for mid-sized clients and for larger clients, but I think what really got highlighted this year is that small clients need a lot of help and need a lot of assistance and you can see it in our growth rates in our retention in our client satisfaction, like in all of our metrics in our small business division that we happen to be in the right place at the right time I think to be able to help our clients and then hopefully no benefit from the tailwind of the demand that that's going to create on a go-forward basis. So anyway long-winded way of saying, I think we're in a great position, because of our business model."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Excellent. And then a quick follow-up from me on the global business. So just thinking about what we're seeing now, I think is strong kind of bifurcation of the recoveries in the US and abroad. Strong expectations for US recovery in your business in Global, is it growing, is it going slower? And is the implication that global might be kind of headwind to growth over the next couple of quarters?"
},
{
"speaker": "Danyal Hussain",
"text": "As usual for us, things are a little more when you peel the onion back, there is a little bit more complexity because you're just the image you have is correct, but it hasn't really, translated into the results, our results have actually been quite good internationally, both in terms of bookings as well as just the performance of the business overall in terms of revenue, pays per control et cetera. Some of that is that a large portion of our business is in Europe and there were a lot of government programs there as well to help companies and to prevent high levels of unemployment. And so for example, our pays per control metric never got to the negative levels that we saw in the US, in Europe, so that was a benefit. At the same time, our bookings have been quite strong and I have to admit that I've been looking for the explanation for that other than really good execution on the part of our sales force as they moved into a virtual environment because they had to sell virtually there as well. But I would say it's strong differentiation of our products. Again, the service aspect to our solutions, the ability to provide support and to provide compliance and help, all of those things probably helped our bookings performance internationally as well. So I would say that our global business actually is probably one of the bright spots. I would say despite what is obviously a very difficult environment, and we obviously feel for our businesses in not just Europe which now it happens to be improving again, particularly in the UK, but we're having challenges now in Toronto, we're having in Canada and in Brazil, we're having challenges. Obviously, as you know in India as well. But it's, it has not translated into negative results. So I think it's a testament to the resiliency and the strength of the business model. But I don't want to take anything away from the fact that it also obviously shows great execution by our international leaders as well."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin from Cowen. Your line is open. Please check that, your line is not on mute."
},
{
"speaker": "Bryan Bergin",
"text": "Sorry about that. Question for you on ES versus PEO performance. It seems like pays per control appear to be a key difference, can you just dig in more on the at the mix aspects that seem to drive a pretty notable disparity of performance between those two. And should we expect that difference to persist in 4Q? Or do you expect more even performance?"
},
{
"speaker": "Danyal Hussain",
"text": "I don't believe we've provided Lake that data, so I'm surprised you came to that conclusion but we maybe it's part of our tone. So there isn't a huge difference between ES pays per control performance and PEO, they both have been improving every quarter sequentially and the PEO doesn't include -- we generally stay away from very, very small clients. So we don't have a lot of clients that are one to two employees or five employees. The average size client in the PEO, I think is somewhere around 40, and so by definition, it tends to skew a little bit bigger than maybe our average client size for sure for small business, so actually, I'm looking at these figures last night. And it makes perfect sense kind of where we are, which is that the PEO is performing a little bit better in terms of absolute level of pays per control and have been improving sequentially just as ES has as well. So, and again I'm probably not allowed to say this, I'm going to get in trouble, but last night I got a note from the PEO that we experienced the first positive pays per control week. Now, the problem with pays per control is that it does vary based on payroll cycles. So if you have weekly payrolls or by-weekly payroll so you and I can't read anything into that. It's the first time we've had a positive pays per control in any week over the last 12 months. So that's a very positive sign."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. And then just on margins, you should outperformance here in the quarter. But at the same time you've called out incremental headcount investments higher incentive comp, and I think elevated implementation costs, can you just talk about the drivers there and then how do we connect the elevated implementation cost with more efficient digital onboarding commentary?"
},
{
"speaker": "Danyal Hussain",
"text": "Well, the efficient digital onboarding, I think, we were pretty clear with a FPS, we would love to, at some point in the future, extend that into the mid-market and maybe someday into the upmarket. But as you know, like you know better than us, because you've talked a lot of the competitors, there's not a lot of digital on-boarding going on for example of large complex ERP installations, not to pick on any competitors, but it's pretty. I know the images that the stuff, all kinds of its installed itself, but most of many of our competitors use third-parties. So there is still quite a lot of implementation activity and expense, whether it's done by the seller of the solutions or if it's done by a third-party. We haven't have a model where we do a lot of it ourselves. And so as bookings pick up and demand picks up, we need to add to our capacity for implementation in particular in the mid-market, the upmarket and also global, which as I mentioned has been strong. So it doesn't mean that we're not adding in the down market also. But in our small business segment as we alluded to, and as I think you pointed out, the digital on-boarding capabilities obviously reduce the need to grow headcount as much as we otherwise would have. But even in small business, we have a lot of growth in bookings and so it's a matter of the trade-off of how much can we on-board digitally versus how much we still need some help with, in terms of people being involved in. In terms of some of the other items that, we alluded to, I mean, some of this is just kind of natural to the business model, as we bring on more clients, we obviously expect productivity improvements every year, whether it's in sales or implementation or everywhere, but we are seeing a recovery of our business and very strong GDP forecast, and so, we're anticipating improved prospects for bookings and for revenue and for growth, and we need to make sure that we have the right staffing levels based on the productivity metrics that and the productivity goals that we have to be able to handle that business, so we can maintain our high clients of level -- high level of client satisfaction that we've, that we've experienced. And then we have some natural growth in expenses like I think Kathleen alluded to sales expense is clearly something that grows as you have sales success and as sales grow year-over-year. So I wouldn't, I wouldn't read too much into it rather than that, we made some conscious decisions to reinvest in some specific things in the fourth quarter to really position us well for 22 and beyond, but most of this is just kind of natural stuff where, again, as our revenue growth picks up over time, we still have a great incremental margin business where we would expect to have good operating leverage as we grow those revenues."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon from Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning and thanks for taking my questions. Wondering if you can talk a little bit about the investments in Q4, just in terms of Next-gen, Wisely, marketing and advertising, just how much incremental spend will there be and are you seeing signs with regards to Wisely, that the interest is picking up and therefore, that's a great place to invest?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I don't feel like it's appropriate to give you, I think you asked for the numbers, I don't know that how -- I think you can probably do the math yourself, like in terms of, when you look at the trajectory that we're on, you could probably back in into some rough this is not in the hundreds of millions of dollars again. But again I respect the short-term orientation that we have here in that you guys are trying to. But I would not read as much as you may be reading into these fourth quarter investors, as we've done this in all the way back to my, Gary taught me everything I know and you Gary, I think as well Mark. And we are a long-term oriented company. And we -- when we see opportunities to improve and to invest in things that are either going to drive our bookings or drive our client satisfaction or drive our efficiency, that's what we are going to do it. We've been doing that all along. So this is, it's not like we hadn't invested, we've been telling you that we've been investing for the last three quarters. And that was a conscious decision, we took a little bit of a bidding for that at the beginning of the year. Fortunately, we had positive surprises on the revenue side and on pays per control and other things, but we committed that we were going to invest through the downturn and that's what we've -- that's what we've done. And now, we feel like there are few things that we can do that I would call -- I don't want to call them housekeeping items -- But they're not -- These are not in the hundreds of millions of dollars, but they put some pressure on our fourth quarter margin. And we knew that it would create some questions even though, it really has nothing to do with 22 or kind of our future expectations of either revenue growth or operating leverage, but I guess I understand the question, but I don't think that maybe Danyal can give you a little bit more color, but I am not sure we giving you an exact number is probably the right approach."
},
{
"speaker": "Kathleen Winters",
"text": "I mean you could -- Yes, I mean -- Sorry, Danyal, I would just I think about it as kind of these are tweaks to the amounts we're spending in Q4 versus kind of wholesale changes to the program here. So it's somewhat modest and what Carlos said it's not in the hundreds the millions of dollars here."
},
{
"speaker": "Mark Marcon",
"text": "I appreciate it."
},
{
"speaker": "Danyal Hussain",
"text": "your wisely question, Mark. The one thing we did see was stimulus drove some uptick in the card spent per card. Other than that, during the pandemic, there hasn't been any real notable changes in the Wisely growth trends. So really it's the per card economics that have seen a slight to tick up recently."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. And I think it's something that we've been excited about. But again, it was hard to get excited about, there was a lot of natural tailwind because people wanted more digitally oriented payment methods in the last three quarters, but from a focus standpoint like for the first couple of quarters of the year, we were focused on a lot of things, and this may not have made it all the way to the top of the list, but it was on a top of the list kind of pre-pandemic, if you recall, and so I think, I would see this is more of a re-emergence of some of the themes and some of the things that we had been talking about that excite us because I think the opportunity is a big ones, I'm glad that the team brought this forward in terms of as an investment opportunity because we were excited about it, call it 12 to 18 months ago, we should just as excited about it today. But admittedly, it wasn't our number one focus, and in the middle of the pandemic, if you will, at the beginning of the pandemic."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. And then just one last comment is we always look very hard at the timing and amount that we spend on marketing and advertising but with economic activity continuing to have momentum and pick up and client engagement picking up, we felt this was the right time to increase that a little bit as well."
},
{
"speaker": "Mark Marcon",
"text": "I really appreciate that color. And it is completely consistent with the long-term track record. Going back to Art. Even before, Gary, can you talk a little bit about this Danyal or can you just remind us what the sensitivity on the pays per control to revenue is?"
},
{
"speaker": "Danyal Hussain",
"text": "It's 25 basis points of revenue impact for every 1 percentage point change in pays per control."
},
{
"speaker": "Mark Marcon",
"text": "I appreciate that. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh from Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great, thanks. Hey, Carlos, I think you alluded to kind of a record high on account none of us have sense about. Can you give us a sense of where that splits across enterprise mid-down market and how that sits relative to historical trends in the business?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I can give you some -- I'll give you some color. We don't -- I don't think that's something that we've disclosed in terms of the actual breakdown by business, but I can give you a general ideas. So we had that 6% growth, the 900,000, and we had call it growth of somewhere around that for RUN, our WSN growth was around that as well. And global view was around that as well. So from a client -- pure client growth standpoint if you look at our strategic platforms, they kind of grew in the kind of that neighborhood from a client growth standpoint, which we see as really great news given the very difficult environment that we're in. Obviously, when you look at the mathematically, the overall growth rate and the overall number It's driven in large part by our small business division, because that's where we have the bulk of the absolute number of clients. But I wanted to give you a little bit of color around, if you look at WF, if you look at Workforce Now, across our multiple channels, just remember we start Workforce Now, just in the -- not just in the mid-market but we saw it in the upmarket, and we saw it in the PEO. The PEO platform as well, we also have that platform in Canada. And so that gives you some sense of Canada how well that platform is growing, which is really satisfying to us. So hopefully that helps a little bit."
},
{
"speaker": "Kevin McVeigh",
"text": "Now, that's helpful. And then just on the retention, real quick, I think you took it up from the 125 basis points, up from 100 basis points. Can you just refine that a little bit, is that kind of the Q4 run rate or is that the full year number of this at being fourth quarter is even higher than that? Or is that infinite? The EPM number, and then just any thoughts you could just may be frame on a little bit more ."
},
{
"speaker": "Carlos Rodriguez",
"text": "You've stumped us."
},
{
"speaker": "Danyal Hussain",
"text": "I think, we said in the opening remarks that it's on the Q3 performance being stronger than expected."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think it's generally it's been consistent like it's really frankly remarkable, which is why we keep emphasizing some caution because we hope there is no plan, we're not going to give it back and we're not hoping for give back. But in this business like people who've been following us for a long time, like when we have a 10 basis points to 20 basis point move in retention. It's a big deal. So to have this kind of retention on top of the retention that we had last year is pretty remarkable. And so we're pretty excited about it and I think the key for us is trying to determine like when I look at the retention figures, there is a lot of improvement in what's called the controllable losses. So the ones that are related to kind of service issues and so forth. So we're excited that we might be able to hold on to some of this gain, but at the same time, we're realistic enough to acknowledge that some of the stuff that was related to pan out of business and government stimulus there might be a little bit of give back there, but it's been pretty consistent like every -- It seems like every quarter, the improvement has been in that same neighborhood year-over-year, hence why we kind of tweak the full year because we're probably going to end up in the range that we gave you, which is a little higher than we had before, but it wasn't, we were trying to like send any kind of message about the fourth quarter in particular."
},
{
"speaker": "Kevin McVeigh",
"text": "Helpful. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang from JP Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hey, thanks so much. I think a lot of good questions already. Just thinking about the retention feels like it's industry wide to some degree. So just trying to better understand your new sales, the reacceleration is it driven more from upselling, and in new business formation, and any surprises in the net switching over the balance of trade from a head-to-head standpoint?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I don't have a lot to report on. We obviously watch all that stuff where you referring to the balance of trade. And as you said, it's hard for me to tell about retention in terms of the rest of the industry you guys would be the experts on that because my casual review of some 10-Ks makes it kind of hard to compare like some people would say retention of their annual recurring revenue cloud revenues, which is not the same as the retention for their company. So it's kind of hard for me to say, I mean, some of it I would say it's probably more variable than you think, based on what I'm seeing in terms of variability of growth rates, because it's clearly been a huge part of our ability to outperform. I mean this is a pretty remarkable revenue performance given what we've been through. And given the pays per control headcount and by the way, what we brought up yet, but we have a huge headwind on client funds interest, which is going to abate here in the fourth quarter and is going to abate next year as well. There may still be a little bit of headwind, but this was really the worst quarter that we had, and these nine months were bad and was $130 million drag just from client funds interest. So when you put everything into the pot, without really good strong retention, it's hard to outperform the way we have and we've done some work on the relative performances of us versus some of our competitors and we feel pretty good about that and about our -- to the potential for retention to be one of the needle movers there, making some other factors that I'm not, we're not, we haven't thought about, but no, I don't think there's anything else really big out there like we've done a little bit better against some of our -- the usual competitors that you know about, in terms of balance of trade but there's others that are still challenging for us. And so, net-net we're pretty comfortable with where we are and determined to continue to drive our growth. I think all of us are probably benefiting from overall economic growth. And the fact that it seems like maybe there are some either in-house or regional providers that are because you can see our, we're growing our units. In Workforce Now, and in RUN. And so, we're -- it seems like we're all have some ability to grow in this environment, which is I guess good for everyone."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yeah, I'm glad you said all that, we shouldn't take it for granted. Just quickly on client satisfaction, notably higher would you attribute it Carlos more to the -- of course support efforts you guys have invested in, but the Next-gen platforms and some of the digital initiatives or are you also seeing just clients maybe building it more better goodwill with ADP spending more time with them during these tough times during the pandemic, just trying to understand, because it seems like it could be -- if it carries over we could see some compounding in the retention?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think it's a great question. And I -- we obviously we're trying to figure that out because it's very important to the long-term value creation of the company. And it's all the things you mentioned are you obviously know the business well enough that you hit on all the question is how much is each of those rates, like the last one that you mentioned about the goodwill, there is no question that of being there like there were two or three months where people could not talk to anyone other than us about what to do. Right? What to do about the PPP loans that the government was offering around tax credits, because if you buy software from someone, you can't call to ask them those questions, I just want to remind everyone, right, you can call them that we're about the software and you can send in a ticket to get your software issue resolved, but you can't call to ask about tax deferrals or tax credits or PPP reports or any of that kind of stuff. So we clearly built a lot of goodwill. But on the other hand business is business. And goodwill, it doesn't last forever, so we're not, planning a living off of that for the next five or 10 years. So that brings me back to kind of the basics of client satisfaction, which is we have to be there for our clients when they need us not just during the pandemic, but at all times. So I would say that the second major factor besides the goodwill that I mentioned and some of the digital initiatives to like making easier for our clients and improve our user experience is that we did not panic at the onset of the pandemic. And if you recall, we took some lumps for that because we really maintained our investments both not just in R&D, we maintained our investments in headcount and an implementation. That doesn't mean that we didn't have some drift down as a result of some turnover, which we did and our head count did decline because we had a temporarily a drop in volume, if you will, but that was really, really important right, to be able to kind of get through this period and be able to deliver on our commitments to our, clients and back to the comments I made about productivity before, that's one of those things that we watch very carefully because we want to improve productivity but we weren't -- we can't be naive and think that if our obviously if our headcount was 10% lower, we have higher net income, the problem is, what would your client satisfaction be and your retention. And so that's the magic right of being able to figure out what's that right balance and you have tools to figure that out, you have monitoring systems right to understand what the client satisfaction levels are in relation to how quickly you're getting back to people to resolve their problems for example and how well trained your people are. So there's a number of different factors that we look at, but the key is to be committed to delivering high levels of client service, which we are and I think we just proved it. If we can do it during the pandemic, we can do it anytime."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. Got it. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Good morning, guys. Thanks. I just wanted to start with the bookings question just to make sure you've got the expectations right here, just trying to do the math on the Q4 implied guide. I think it would be about 90% growth. So I wanted to see if that's accurate, obviously you've got the super easy comp there and maybe as part of that can you just talk about some of the activity you've seen through the first month of the quarter. I mean I assume you've got pretty high visibility here, just given that you raised the low end of the full-year guidance range for the bookings?"
},
{
"speaker": "Danyal Hussain",
"text": "Hey, Jason. It's Danyal. You don't have the weightings by quarter. But what's implied for the fourth quarter is over a 100% bookings growth. And for example, we're tracking right in line with expectations."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I would say that you should not read anything into that other than what we said, which is, we're still really positive. We believe we're going to continue to get sequential productivity improvements, but the percentage growth rate is really related to the base effects, really when you get down to whether it's 110 or . Not that, I know, you know, it's not that for. I think you're trying to get a number you using the percentage we get to the number. But, yes, yes, you should probably -- if I were you, I would look at maybe call it the second quarter or maybe 2019 fourth quarter or something has got to be something else that would give you something good as a proxy, right? Where we don't expect to be back at 100% productivity levels in the fourth quarter, but we should be getting close to like where we were in 2019, and there may be other small moving parts there from 2019. So I don't want to go out on a limb and say that's the right analog but anyway, I think that's hopefully helpful."
},
{
"speaker": "Jason Kupferberg",
"text": "Yes. So it is -- your comp certainly would matter more. I just wanted to make sure people kind have the right numbers in their models for the quarter. And then just a quick follow-up on the pays per control, I think you mentioned it was a little worse than you anticipated in Q3 and you tempered your Q4 expectations a little bit. I'm just curious, which part of the portfolio is driving that? It just things maybe a little incongruous with the US employment data that we're seeing at a high level, which obviously has continued to outperform expectations?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, it's a 100% timing related because we can see in the data, we have other datasets like to show us, like for example, job postings and background checks, screenings and so forth. And so, you shouldn't read anything into it and we did not temper our fourth quarter at all, and in fact we kind of try to clarify that we kept the full year, the same despite the third quarter being a little bit softer in part because we think we're on the same positive trajectory that I think that we thought we were on. So we're seeing the same thing you're seeing in terms of employment and unemployment, and we would fully expect these pays per control numbers to improve rapidly here. And remember that we're talking today about numbers that were through the end of the third -- Sorry through the end of March and those numbers are for three months. Correct? So if you look at the third month in March is different than it was for January. And January, February, I know it's hard to remember to think back that far and how bad things were, that was a completely different picture and the picture we had in early April and maybe in the last, very last week of March. So I wouldn't, I wouldn't read anything into it other than timing."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. And you know just to clarity -- I were just to clarify, was just a slight tweak to the Q4 number and holding the full year at down 3% to 4%. So it's really kind of very minor tweaks."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay, perfect. Thank you, guys."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from Pete Christiansen from Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"text": "Good morning, thanks for the question, Carlos. I think the high customer sat scores, the goodwill truly a testament to ADP's capabilities and certainly the service -- the service business model. But I guess clients' needs certainly change and we've been hearing from some of our other companies that talent acquisition has been I guess even more challenging than in the past and I recall at the last Analyst Day that ADP had really been making a lot of strides in improving its recruiting management tools so on and so forth. How would you, think that you, stack up competitively in that area, particularly in recruiting management tools and do you think that could be in another vehicle or vessel to maintain the high retention levels that you're currently experiencing?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Absolutely. I think that you're right, I mean, some of this obviously is cyclical, right in the sense that 12 to 18 months ago people were looking for other tools, other than client acquisition tools. So you have to be careful about not kind of shifting with the necessarily to be consistently able to help people throughout the whole lifecycle of HCM and right now that happens to be an important one. And so I would say that there's two things, one is we build our own tools, as you said around recruitment management and we also have an RPO business, and we have other tools to help with the talent acquisition process. We also partner and we have some really strong partnerships. I'm not sure -- if I mentioned the names of the companies are not but the names that you hear a lot of kind of advertising about, we have a very strong integration and partnerships with some of those companies to really make it easy, in particular in small business, but also even in the mid-market for people to use those tools to really help with the recruiting needs that they that they have, but we feel we've been making, we have made significant investments in our recruitment management platform and our talent acquisition platforms, nothing to do with the pandemic, so that you could call it for tools, that we had done that before the pandemic, and we would expect that those would be contributors to our overall value proposition into our revenue -- Sorry, into our bookings growth because those are generally tools that create incrementality around your bookings number. In other words, what you can charge clients is typically there is a core set of solutions and then recruitment management, things like time and attendance will workforce management, those tend to be more incremental around the basic package, if you will, of HCM. So we're positive, we're bullish on it and I think we're very, just as a reminder, our app marketplace is creates a very easy and seamless way for people to use different solutions in HCM and this would be a category that we would have a lot of partners in that market app -- in that app marketplace that allow you to get all the other benefits, you mentioned about ADP's business model and still be able to fulfill your talent acquisition needs, if you don't believe that ADP has what you need, which we believe you do, but if you don't, you can always get it through one of our partners."
},
{
"speaker": "Pete Christiansen",
"text": "That's helpful. And apologies if this was addressed earlier, but given the change in the yield curve, has there been any thoughts on potentially extending duration of the portfolio or any other investment selection choices as you head into '22?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Probably not worth mentioning. The -- as you know in the yield curve, like right now kind of 5 and 7-year is a little bit better than two and three just because of the way the Fed is managing the curve, if you will. So I think there are always, I'll call them tactical opportunities. But no, I mean I think our duration has been in the same range since I've been CEO, and I would anticipate that not changing and we're not changing laddering strategy and we're not changing our client funds interest strategies. The good news is that it appears the worst is behind us in terms of drag from client funds interest which was painful. I think we had a $50 million drag just this quarter. So, again, not to beat a dead horse, but it just shows the strength of the business that we didn't mention that to you. And if we kind of overcame that drag $130 million for the year. So we're looking forward to better times ahead, and I did see an interesting chart. Again, I probably shouldn't say this, but we had $16 billion in balances in 2008 and we had $635 million in client funds interest. I'm sorry, $685 million not $635 million, in client funds interest. So just shows to you the magnitude, I mean, you all know what's happened to interest rates, but that was 2008, that wasn't like in a different century or in a different country like that was here, and so today, our balances are call it the mid $20 billion number for the year and that's the expectation, so I think you could probably do the math yourself in terms of, if we do believe that there's going to be some inflation here and if you look at the inflation breakevens and you look at some other things that are going on, We're looking forward to better times ahead for client funds interest."
},
{
"speaker": "Pete Christiansen",
"text": "And the adjusted EBITDA margin was 19% back then. You're already above that, that's great, thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. And we have time for one more question that comes from Jeff Silber from BMO Capital Markets. Your line is open."
},
{
"speaker": "Jeff Silber",
"text": "My questions have already been asked."
},
{
"speaker": "Operator",
"text": "Thank you. And this concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for any closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "So as you can tell from our comments, we continue to, I think, have the same level of optimism, as we had last quarter and we're really, really thankful for the performance of our sales organization and also our frontline associates in terms of what they've been able to do for our clients and at the risk of ending on a negative note though, all of this positive, and all of this positivity and enthusiasm, we don't want to overlook the fact that we still have some challenges and some people still have some challenges in other parts of the world. This is a US headquartered company with over 80% of our revenues in the US. So that's probably why you're hearing all of this optimism, but we're not only in the US, we have associates in India, in Brazil, in Canada, and in Europe. And the situation is not the same there. Even though the businesses are performing well, we just as back in the spring of last year, it was enormous suffering and challenges here in the US among our associates, the same thing is happening for some of our associates in some other parts of the world, in particular in India. And we are not going to forget them, we're doing everything we can to help them. We appreciate what the US government is doing along with the Indian government and local governments to help as well. And we look forward to have helping them kind of get through the same difficult situation that we managed to get through and they too will have their vaccination rates pickup in all of those parts of the world and they too will emerge from the pandemic. But it's clear that it's going to take a little bit longer and we should all remember to be there to help them and support them in any way we can, and I think people will do exactly that. But, having said that, we are --close to seeing the situation in the rearview mirror here and we're really anxious to see our growth rates, we accelerate to kind of where we were pre-pandemic here at some point in the future and getting back to the business and to helping our clients with their challenges and helping our associates build careers and helping all of you and our other shareholders and stakeholders get a fair, a fair return for their investment. So again, as always, we appreciate your interest in ADP and we appreciate you tuning in and we will be back in a quarter with our outlook for fiscal year '22. Thank you!"
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and you may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 2 | 2,021 | 2021-01-27 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. Thank you. I'll now turn the conference over to Mr. Danyal Hussain, Vice President Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Michelle. Good morning, everyone, and thank you for joining ADP's second quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer and Kathleen Winters, our Chief Financial Officer.
Carlos Rodriguez: Thank you, Danny, and thank you everyone for joining our call. This morning we reported results reflecting our continued strong business performance and momentum, with our second quarter revenue and margins both outperforming our expectations, as our business continued to demonstrate resilience in the face of ongoing economic headwinds. We reported revenue of $3.7 billion, up 1% on a reported basis and flat on an organic constant currency basis, with adjusted EBIT margin down 30 basis points. Coupled with a slight increase in the effective tax rate versus last year, our share count reduction our adjusted diluted EPS was flat versus last year, much better than the decrease we were expecting. During the second quarter, we continue to see signs of improvement in the overall operating environment, with the positive implications for pays per control, new business bookings and retention. Our pays per control metric performed slightly better than expected, as it improved sequentially to a decline of 6% versus the larger declines we experienced in Q1 in the latter part of fiscal 2020. Underlying employment trends in Q2 were consistent with what we experienced in Q1, with larger enterprises somewhat slower to show improvement, but with small and midsize businesses demonstrating a healthy level of hiring. We performed well on employer services new business bookings. Even though bookings declined 7% this quarter, this was well ahead of our initial expectations earlier this year, and in line with the revised expectations we communicated last quarter. And it's important to point out, that our new business bookings for the first half nearly matched last year's half, despite the very difficult environment.
Kathleen Winters: Thank you, Carlos, and good morning, everyone. Q2 was another strong quarter across every major business metric. While we will still see some pandemic related headwinds for the balance of the year, we are more confident in our outlook given we believe the toughest part is behind us. Our performance thus far into the year reaffirms the resilience of our business model, the strength of our product, and the ability of our sales and service teams to perform even in the toughest of environments. We remain confident in our ability to execute as we move forward. In the second quarter, our revenues grew 1% on a reported basis, flat on an organic constant currency basis, which is significantly better than our expectations coming into the year and better than even the revised expectations we had as of last quarter. Once again, ES retention rates represented favorability as did very strong performance from our PEO. We managed expenses prudently, while making important incremental growth and productivity investments and delivered margins that were better than our expectations. Our adjusted EBIT was down just 1% despite pressure from a decline in client funds interest. Our adjusted effective tax rate increased 20 basis points, compared to the second quarter of fiscal 2020. Our share count was lower year-over-year, driven by share repurchases. And as a result, our adjusted diluted earnings per share of $1.52 was flat versus last year second quarter. Moving on to the segments. For ES, our revenues declined 1% on a reported basis, and 2% on inorganic constant currency basis, representing continued sequential improvements driven by record level retention, and the more modest 6% decline in pays for control versus 9% last quarter. Client funds interest declined 23%, as average yield declined 50 basis points versus last year.
Operator: We'll take our first question from the line of Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. I'll ask two upfront here. So first on bookings, can you talk about composition of bookings in 2Q versus 1Q? And give us a sense if you can dissect the strongest and weakest demand across client size? And then, just looking at the SG&A level this quarter, can you comment on the drivers of the sequential dollar growth there? I heard the comments on accelerated investment. Is that primarily sales force headcount addition or other areas of spend?
Carlos Rodriguez: Sure, let me take the - I'll take the bookings maybe and I'll let Kathleen talk about the SG&A. On the bookings, and I think some of this is just the lumpiness if you will of the results, because there's no - there are a couple of things that happened but it's hard to call it a trend right, because we only have really two quarters if you will of post-pandemic results. But in essence, our mid-market business performed a lot better. So, workforce now and the mid-market business did much better in this quarter than in the last quarter. And then, if you remember, last quarter we talked about that we got some help from our international business and in particular we called out multinational deals, and that was I'm not sure we gave any color around that, but that was strong double-digits is the way I would put it, last quarter helped the last quarter's growth. And this quarter it was kind of slightly negative. Now in the context of what's happening in Europe, which really started to shut down and started to have challenges before the U.S. in terms of the resurgence of the virus, we're pretty happy with that. Like we're pretty proud of our sales teams over there that they were able to accomplish what they did in the second quarter, but sequentially it was not as strong as the help we got in the first quarter. We also had really strong bookings in the first quarter in our down-market business, we had some, what I would call modest help from some - what we call client conversions or we call client-based acquisitions, which we do on a regular basis, but they don't come in every single quarter, so we got a little bit of help from that. And I think I also mentioned last quarter, I think I've been doing this for nine years mentioning that whenever we have a strong finish to a year, we typically get off to a slower start. And the opposite is also true, when we have a really bad year, we tend to get off to a stronger start. A lot of our business is counted at the time of sale and start, but some of our businesses, as you know, like in the up market, there is some flexibility if you will in the sales force. We don't necessarily endorse that, but there is some flexibility for salespeople to book something in call it July versus in May. And because of the way the incentives work and so forth, sometimes we get a little bit of movement from sales into the next fiscal year, if we have a bad fiscal year and the opposite is also true. We'll have a strong fiscal year. We tend to have a hard time getting started in July. But I think we've been - so this is nothing new. We've been I think transparent, giving you all the kind of the color that we can around bookings. I will tell you that when we cut through all that, so we're trying to look at no different than you would do with for example, earnings, where we trying to see what's the core business doing excluding client funds interest, what's happening with the core business excluding pressure from pays per control. We do the same thing in bookings, like what's happening in the core underlying bookings. And we see very positive momentum there, in terms of lead generation, digital leads coming in activity by the sales force. So we're optimistic that the momentum will continue into the third and fourth quarter. Of course, the caveat being, the virus has to cooperate in terms of and the vaccine rollout has to continue to stay on track. But I think overall, if you cut through all the - it's not fair to call them onetime items, but if you cut through all the noise, our momentum in the second quarter, in terms of bookings was stronger than it was in the first quarter, even though it might not be what the reported number shows. And I'll let Kathleen talk about the SG&A.
Kathleen Winters: Sure. So on the SG&A side, I mean, you do have a lot of things within that SG&A. But I would think about it this way. The overall view or picture is that from a selling standpoint, I'll talk about kind of full year, and then we can talk about linearity. But from an overall standpoint, we continue to invest in sales, as we've mentioned, and that is both headcount investment, as well as continuing to look at marketing investment and doing some of that. So you've got that investment in sales, but you've also got the work we're doing around transformation, which would be offsetting that investment, as well as just discretionary cost control that we're very focused on doing as well. So kind of overall, you've got investment, headcount and marketing, you've got transformation work that we continue to do, and discretionary cost control. That does change if you look at or not change, but the SKU first half the second half is a little bit different, as we do have significant bookings growth in Q4, our expectation, and so of course, that's going to result in higher Q4 selling expense for us.
Bryan Bergin: Thank you.
Operator: Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi, guys. Good morning. Just want to make sure I understood, the employee service bookings for the quarter came in line with expectations, but you guys did decide to raise the full year. So just want to make sure I understand the pipeline, the visibility there that's causing that raise. And then on retention to record levels. Are you seeing anything in particular on the competition front that is having less of an impact in years past that's driving the higher retention? Thanks so much.
Carlos Rodriguez: Sure. On a pipeline question, we do have some visibility. But some of this is really about extrapolating momentum, because in the down market, it's really more about headcount and productivity than it is about pipeline or as in the M&C in the up market. I mean, I'm not telling you anything you wouldn't be able to figure out yourself. So we have a fair amount of visibility in some part of our business, but in other parts of our business, we based on our experience about productivity metrics and headcount and so forth, we have confidence, obviously, in the guidance that we're giving and the raise, otherwise we wouldn't be giving it. But, as couple of things that have changed since last quarter, last quarter we had - what we thought was much better results than we had expected, and we thought we had positive momentum and then on top of that, now we have a vaccine rollout. So that was not something that was it was talked about. But this is now a reality. We also had an election that was still in front of us and that's been resolved. We also thought and people speculated there would be more stimulus and now there is, even though there's even more stimulus being debated, just as a reminder, there was a $900 billion stimulus package that was approved. So I think if you look at what we try to do, we try to do a little bit of kind of correlation, regression, whatever you want to call it, between GDP and economic growth and our bookings, because we do believe there is some connection there. Like there's other things like the training of our sales force, the tools they have, the quality of the sales force, the turnover. But GDP is a powerful force and the GDP numbers are looking pretty strong here on a go forward basis, with perhaps the exception by some of our analysts out there of our third quarter, the quarter we're in right now. But if you look at fourth quarter, our fourth quarter or the first half of next fiscal year for us and then the next calendar year after that, I mean, even this full calendar year GDP expectation has been raised, I think, across the board by everyone. So I think it's partly visibility and pipeline and partly our experience that we know, for example, what a reasonable expectation is for productivity per DM per sales rep. We know how many sales reps we have, we know how many new ones we're hiring. We know what we're generating in terms of leads and digital marketing. And I think we put that all together and that comes out to our guidance. And so I think we're confident in it and we're actually very excited and positive that we were able to do that. And we're just glad that things are looking much better than they were last quarter and certainly better than they were looking in March and in April. On the…
Kathleen Winters: Bryan, if I could just interject the only other detail I'd add on all of that data that Carlos mentioned that we do look at an ongoing basis, is that when we look at the leading indicators in terms of the data we have, so appointments, referrals, demos, opportunities created, as you know, our sales team are inputting leads into the system. All of those are trending better going into the second half than they were before going into the year. And so we're feeling really very optimistic, as you can tell from the raised bookings guidance. We're feeling optimistic going into the second half of the year. In particular the digital leads are up significantly. So, again, just wanted to provide that transparency for you.
Carlos Rodriguez: And then on the on the retention side, I would say there's probably two data points that I would look at. The retention obviously is incredibly strong and it's going to be record retention for the year, assuming we have the guidance that we've just provided. We've never been at these retention levels. And I think there's a number of factors. I mean, I think our product set is much stronger and it's not just the products themselves, but it's our commitment to moving our clients onto our newer platform. So we have a lot more clients on newer platforms today than we had a year ago, two years ago, whether a quarter ago or a year ago, it's just a continuing progression that we've talked about now for many, many years. But we've made a lot of progress and we know that the retention on our new platforms is higher than on some of our older platforms. So that's helping. There's probably some tailwind from this pandemic related, we just can't put our finger on it. The clients are maybe not moving as much. But if you look at each business unit, like, for example, in our down market, the retention in our down market as a result of better product and better execution has been going up for probably six or seven years and is up almost 500 basis points pre pandemic, and that's gone up even more. So the fact that we've had this positive momentum in the down market, it's a similar story and Workforce Now, if not 500 basis points. But in the mid-market, we've also had three years of improving retention pre pandemic. So I think those are signs that there is something happening in terms of our execution and our product. So, execution is part of it as well, we have to deliver I think on the commitments we make to our clients to resolve issues for them, and answer questions and so. So, it's a combination of better service, excellent service and really better products and migrating clients, I think is helping. And then secondly, the other data point that I would point to which is really on the bookings side, a combination of bookings and retention that our balance of trade is improving with several of our major competitors for the first time in a while. I think, it's again, related to this effort that we've made to improve product, continue to deliver great service, on execution. And I think it's showing up now in some of these balance of trade numbers we're showing some improvement. So, the reason I bring that up is because balance of trade with the combination of what we're bringing in, in terms of from some of our competitors but also what we're losing to those same competitors. That's why we call it balance of trade. So, there's a number of metrics that would tell me that our competitive position is getting better, and then resulting obviously in higher retention and hopefully also growing booking here in the future.
Bryan Keane: Helpful. Thanks for taking the questions.
Operator: Your next question comes from Jeff Silber of BMO. Your line is open.
Jeff Silber: Thanks so much for taking my question. Two-part question, first is on pricing. I believe it was last quarter maybe the quarter before you talked a little bit about some of your competitors offering some pricing concessions declines. I'm just wondering if that's been continuing. And as a follow-up, I'm just wondering if you're seeing any diverging trends by geography, especially in certain areas where we're seeing higher COVID cases? Thanks.
Carlos Rodriguez: So, let me take the second one first on divergence. Yes, we would see what we would expect to see, because we are, I think, we're big enough that we kind of really escape again the gravitational pull of overall GDP, but also of specific geographic challenges. So, in Southern California for example, we did see some challenges in terms of our bookings in the down market and into the mid-market there. It's still impressive if we were able to sell as much as we did. As a footnote, we sold a lot of the say that we're flat, almost flat for us, it's at least, we're impressed with ourselves that our bookings are flat for the first half of the year versus last year. But there clearly are pockets of challenges. Southern California would be a challenge, the Midwest was and the Central part of the country was incredibly challenged for several months. But we had other places that things were better as a result of maybe more economic activity, or continuing opening regardless of the controversy around that. And then, again, Europe would be a place where I would call out where I think we started to encounter some real headwinds. So, the geographies were up and not just about U.S. it's also global. So, the answer is yes, and that you should assume that we would be impacted by whatever you're seeing in the news. And so, when you have hard lockdowns in very large metropolitan markets, that would affect us but fortunately, we're very diversified geographically and across segments. So, remember, we operate all the way from small to up market to international and so, we obviously we try to find a way to keep follow these things in balance, and have something helping us, when other things maybe working against us. So, we did see some of that volatility as you described. On the price side, so one of the things we did talk about last quarter, we did talk about competitors and what we heard anecdotally about competitor pricing action, but we also said last quarter that we didn't get any help from price last quarter. We did get a little bit of help. It was not significant but all around, I think was around 30 basis points of help, which is about normally what we would be getting and to the revenue growth help from price. And so, I think what tells you this, what we're trying to signal to you there is to tell you that it was appropriate for us to pause for call it, four to five months our normal price increases. By the way, our normal price increases would have been July 1st would have been one of the main times that we do price increases. And remember, our price increases are much more modest than they were five, 10 years ago. But at our scale, it does matter. But we delayed those price increases. It was not appropriate if you do that given the circumstances that we were under. But you fast forward to September, October, we felt that given the additional services that we were providing. So we're providing a number of incremental services at no additional cost to our clients that I believe our competitors are not providing. And so we thought that going back to our normal modest price increases was a reasonable thing to do and we did that. And you can see the impact on retention which has been none. And so that would be I think a good sign for us.
Jeff Silber: All right. That's great to hear. Thanks so much for the color.
Operator: Our next question comes from Pete Christensen of Citi. Your line is open.
Pete Christensen: Good morning. Thanks for the question. Nice trends here. Carlos, given the lifted view on ES bookings and retention, how would you characterize some of the trends you're seeing in the tax rate for additional - add-on modules, those sorts of things? And how should we think about the runway for the next two or three quarters? And how you see that evolving particularly with some of your new R&D developments, new product and all that?
Carlos Rodriguez: It's a great question, because there's still a lot of room for us there. We're very focused on market share and new unit growth. But we don't mind additional share of wallet and additional tax rate, because that's helpful too. And as you know, our bookings have generally been balanced for many, many years, about half of it coming from new logos, and half of it coming from incremental attach. So we love that business. I happen to be looking at those figures last night and it obviously varies by business unit. But as an example, in the mid-market, we're kind of in the 60% to 70% range, in terms of a tax rate for things like workforce management, which we used to call time and labor management, and benefits administration. And we have things like data cloud and other items that we can attach as well. But I think the best color to put on that is that there's still a lot of room. I mentioned how we are doing well, not just in our new strategic platforms, but we're also doing well on some of our products that we don't always talk about a lot on these calls like retirement services, insurance services where those tax rates are very low in comparison to what I think is the potential for our client base. Because when you have a tightly integrated solution, it really is a much better experience for our clients. So it's good for us, but it's also good for our clients, which is always an important thing. So I guess the color I would put there is we've got really good tax rates on some of the core HCM modules, like workforce management, then admin. So HR payroll, then admin, workforce management, those are kind of the core talent management is a place where we've been seeing growing tax rates, and there's a lot of room still there for people to adopt those solutions. So, we're very optimistic and this is a key strategy for - I think my predecessor before that, which has been great for us that we have a very broad industry. Part of our reason for concentrating on HCM and focusing the company away from some of the other businesses we have like a brokerage business, and dealer services and so forth is this is a growing robust space globally, and there's plenty of room to grow. We definitely want to still focused on off of market share and logo growth. But there's an enormous opportunity for us in terms of incremental tax rate.
Pete Christensen: Great. Thank you.
Operator: Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi. Good morning. Thanks for taking my questions. Maybe stepping back for a big picture question a little bit in a time machine. But if I think back to the Analyst Day in 2018 and some of the company's key initiatives around the service alignment and taking costs out of the business, and getting to call it mid-20s EBIT margin. I guess aside from the world being very different with what happened with COVID. But I'm curious Carlos if you could just think as far as those initiatives went and getting the margin structure of the business toward that. Would you say that were ex what happened with rates and what COVID? Would we be in that shape today? And I guess, maybe thinking forward, how should we think about the structural margins of this business post recovery? And can it be at those long-term levels that we talked about before? And then I have one follow-up.
Carlos Rodriguez: Yes. Let me give you a little bit of color on that, because, again, incidentally, I was doing my homework last night. So I did go back that's something that I actually have fresh on my mind. And then will correct me if I'm wrong. But I think our margin in '18, which you would have seen in that Analyst Day, was 20.7. And we're now, I think, forecasting for fiscal year '21, I'm not sure that we're forecasting it, but I think you can extrapolate based on our guidance. I'll just throw out a number. So call it 22.3, 22.5 somewhere in that range for fiscal year '21. That's with a significant drag from client funds interest, as you mentioned, and some drag from COVID as a result of slower than we would have thought or would have expected revenue growth. So I would say that on the margin side, we would be well ahead of what we talked about at Analyst Day, excluding these items. On the revenue side, clearly, we're not anywhere near that, hence why we had to withdraw that three-year guidance we had provided, because obviously the COVID headwinds with what happened with pays per control and just the economy in general made it very difficult. But again, it feels like this is a transitory event, as we've talked about now for two or three quarters, painful, devastating for many people, for our country, for the economy and for the world. But it is transitory and not an existential threat. And so we expect to get right back on the track that we were on before. And I happen to think that the fact that we're a couple hundred basis points higher in margin, even with everything that's happened than we were in '18, I think tells you something about the structural margin opportunity in the business. But, clearly a very important part of that picture is growth. We need to grow the business long-term, because growth does require investment and so you should be hearing from us as we care about margin and we think there's opportunity in terms of structural margins here going forward, but the most important thing we can do to drive long-term shareholder value here is to also grow the top-line. And we're focused on that.
Danyal Hussain: Just to clarify, Samad, our formal margin expectation is 22.0% to 22.5%.
Samad Samana: Great. Thanks, I appreciate. And that's why I asked it. To us, it sounds like the business is healthier adjusting for non-controllable factors. And maybe just as a follow-up on that on the booking in this quarter and just as you think about bookings for maybe the next couple of quarters. When you think about the performance, is there a way to think about it, in terms of driven by field reps versus digital inbound through marketing? Are there channels, so not by customer size, but are there channels that are doing better or worse in terms of bringing more customers into the top of the funnel, and driving new bookings?
Carlos Rodriguez: Yes, I think I'll tell you what…
Kathleen Winters: Maybe I'll just interject on before Carlos response to that one, and I want to interject and just follow-up a little bit on the margin story, because Carlos gave a really good kind of recap and summary of the last couple of years. When you think about, we're in the 20% margin, 20.7% to pre-COVID 23% with the various big initiatives that we pursued, and you've heard us talk about that over time. But I want to add that, one of those really important initiatives that we are now working very hard, is digital transformation which has been helping us, right. As we look at our transformation initiatives, we've talked about digital and procurement really driving a lot of the benefit, kind of today if you will, a lot of that procurement does get harder as you go, but from a digital transformation perspective, that's an initiative that we believe is going to be with us for some period of time, because these projects are not fast projects to execute, they do take time to execute, and so we're optimistic that we have got a pipeline of projects and that we will continue to yield benefits for us.
Carlos Rodriguez: Yes, and I think that, I'll just pile on to that. Your comment I think earlier after you asked question and you summarize my comments, the business is definitely performing much better than it looks, because we have, these client's funds interest headwind is not just the headwind on margin, it's a headwind on revenue growth as well. So almost a 4 percentage point. And as an example on a margin impact, our margin I think in ES would have been up and ADP overall, our margin would have been up 40 basis points instead of down 30 basis points for the quarter. So, clearly on a margin side, the picture is clouded and that picture will and the interest rate go up and down as you know, and everyone is always convince that rates are going to stay low forever, or they're going to stay high forever depending on where they are. But we believe that at a minimum that headwind will abate unless interest rates continue to go down and then turn negative for the next 10 years, which is very unlikely as we all I think, as we all know, at least in the U.S. that's unlikely. On your question about bookings, one thing that's important to note is we do have record leads through digital marketing coming in. So we have increased our investment in digital marketing, but we're very careful to do that to make sure that we're getting the proper ROI. But that is something that is certainly helping our sales force. But really the message for our sales force is that we want them to meet our client, the clients and the prospects where they want to be met. And they have all the tools, all modern tools that any sales force uses. I mean, the reality is, I said this before people steal our sales force. And so we have to understand we have the best sales force in the industry, there's no question about it, and they have all the tools they need to compete effectively. And they had obviously moved to being mostly a virtual sales force over the last six months. And we make sure they had the tools to be able to do that and that's where clients want it to be met. And if in six months, we anticipate that some of our up market and multinational clients will be okay having some digital meetings or virtual meetings, but they might want to have people visiting some of them again, we'll be ready for that as well, assuming that it's safe and that people are vaccinated. So, there are a number of channels that we can pursue, but you should understand that our strategy is really to meet the clients where they want to be met. As an example in the down market, our clients rely on trusted advisors like accountants and brokers, we have very, very strong partner relationships with those channels, and that's how we drive results in that channel. So it really varies channel by channel, but you should understand that we are pursuing every channel, every avenue including upping our digital marketing investments to make sure that, we're getting our fair share of that without throwing money away.
Samad Samana: Great. Thanks again for taking my questions. I really appreciate the thoughtful answers.
Operator: Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Good morning. Carlos, you talked about net gains. I'm wondering if that's related strictly to ADP having a better set of products, or is that related to the competition doing something else? And just my second question, you've talked a lot about the sales process. And I'm wondering, if you believe afterward, through this pandemic, get the vaccinations done, that fundamentally if the sales process will change, and that you'll use more digital versus face-to-face? Thank you.
Carlos Rodriguez: I think, I'm in the same camp as I think many other CEOs of companies that - and again, there's very - there are not a lot of companies like ADP that operate all the way from the down market into the up market. So there has to be balance here in terms of it's not one clear cut answer. But I'm in the camp, for example, in the up market with some of my other competitors, and CEOs who believe that, there will be face-to-face meetings again, and particularly sales meetings. But I'm also in the camp of believing with lots of others that we shouldn't assume that things are going to go back exactly the way they were before. Whether it's with the way people are working, or the way people are selling, we're going to have to adapt to what inevitably is going to be some change. Having said that, I believe I saw a statistic the other day that said that, prior to the pandemic about 10% of the U.S. workforce was working from home. And it went up to 33% at the worst part of the pandemic, and then came back down to 25%. And I kind of monitor this through other sources that show that ticked up slightly again the number of people working from home as this virus continued to surge. But you would expect that 25% to probably go back to 15%, 20%, but not probably back to 10%. But remember that the other 70% never worked from home. And today 75% of the people are not working from home. But that doesn't mean that we haven't learned new techniques. So for example, an initial meeting or a follow-up meeting, or maybe even an implementation meeting with our client, I think we've all learned that. It's much more effective to do that for both parties virtually. But it's hard to believe that we're going to go back exactly to where we were before. It's also very hard to believe that we're going to stay exactly the way we are today. And again, I hate to give you wishy-washy answer because I think we're going to have let that play out. But we are like lot of other things, we're maintaining optionality and equipping our sales force to be prepared for either of those eventualities. And I think you had a first part of that question that…
Kartik Mehta: Client growth, whether its product?
Carlos Rodriguez: Oh client. On the client growth side, again we are - I think I mentioned in one of my script, that all of our strategic platforms, so if you think about RUN, Workforce Now, Globalview, I forgot the other ones I mentioned, but the platforms that we are that are strategic that we're investing in, not just the Next Gen ones are all growing, and they are growing very robustly, and I don't want to people understand that. And part of the challenge is that, we have a large company and we have other things that maybe aren't growing as fast, or we have a drag from a platform that we're trying to get off of. And we unlike from others try to report the fact as they are. But maybe take a little bit of liberty what others are doing, and giving a little bit more color about just the things that are going well. But if you did that, like we'd only focused on the growth of, for example Next Gen, it would be 800% growth, or if we focused the growth of Workforce Now, across the board, not just in the mid-market, because we also use Workforce Now in the up market, and we use Workforce Now in our PEO, you would see robust growth even in the middle of a pandemic on a Workforce Now. So, I think we're making progress but we're a large organization with large market share and included that exposes our flanks, and we have to be very good at making sure that we protect our flanks which I think we're doing a good job of, as evidenced by retention. But when you look at the go-forward and the growth of our strategic platforms, there is a lot of reasons for optimism that we will I think be able to compete effectively on a go-forward basis. So, I am not sure I can give you lot more detail of that, because this is more detail than we normally give, because we like to just be straight shooters and the growth is what it is, whether it's on client counts or a revenue. But if you want a little bit of additional color underneath the covers, the strategic platforms are doing very well against our competitors.
Operator: Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hey, good morning, and thanks for taking my questions. So, questions basically about Next Gen payroll and Next Gen HCM. The first part is this, can you talk a little bit more, give us a little bit more color with regards to Next Gen Payroll just in terms of the number of clients that have been sold? What percentage of the existing Workforce Now base has been converted? And how you are thinking about that going through? And kind of what you're seeing in terms of the satisfaction, once you have that in place, you made some initial comments, that sounded really positive? And then the follow-up is this basically on Next Gen HCM, just in terms of what the outlook is there in terms of new sales and new bookings? Thanks you.
Carlos Rodriguez: Sure. Thanks for the question. We thought it was optimistic before prepare yourself, because the story on Next Gen Payroll and HCM is quite positive for us in terms of the future. If you look at Next Gen Payroll, we have I think close to a couple hundred let's say over 200 live clients. So not just old but live clients. We have over 500 that are sold. I think we said in our comments that you may not have picked up on that, we think that it's possible even though this is not scientifically provable that up to 25% of the sales we had so far of Next Gen Payroll we would not obtain without Next Gen Payroll. So I think that bodes well for I think our competitiveness and our market share. And our clients were to have call it somewhere around a couple 1,000, I think for this fiscal year. So, it's positive momentum, again the caveat there is with Next Gen HCM we are generally going after very large clients, and in the case of Next Gen Payroll, it is really a platform that solves our kind of Next Gen Payroll needs across the board and we started and call it the core of our mid-market. So, call it between 50 and a 150 employees really has been our focus. But having said that, it's still pretty impressive and we're pretty happy and pretty positive. Satisfaction levels are very high. And I think we just got great the momentum and the sales force is obviously incredibly excited. Even though, remember, this is still a back-end engine right. So it's still Workforce Now and in the future, it will be lifting on that are using high as an engine. But it does provide some additional benefits to the client and a lot of sizzle as well, as we know that matters as well, given some of our competitors I think have used sizzle in their sales process. And so, we're able to use some sizzle now with Next Gen Payroll. So very excited about that rollout and about the progress there. Our Next Gen HCM, you heard about our rollout in Mexico, which is really Next Gen HCM with Pay. So we have call it, a handful of clients now in four countries that are actually running on Next Gen HCM with Pay. Again, it's very early like to talk about only a handful of clients isn't a lot, but what was most encouraging is that in a couple of those situations we were able to use what we're calling a federated development process, which is one of the intentions whether we invest into the platform which to be able to build rapidly. So, the Mexico client was onboarded in from super messaging the building platform, getting the client and getting them onboarded in call it six to nine months. So very, very impressive for us to be able to do that. So, we're optimistic that this will continue to hopefully help us again competitively. And I think you also asked about how many clients we've migrated off of Workforce Now on to Pay, and remember that it's we're not migrating clients off of Workforce Now, we're just changing the underlying payroll engine that is still on the Workforce Now. And the outlook of that is I think not many, like this is mostly new logo sales in the case of Next Gen Payroll. Again, underneath Workforce Now. So, as we go to market, it's still Workforce Now with the Pay payroll engine beneath it. And again footnote, I think I said this last quarter, Workforce Now is a Next Gen platform. We don't talk about it that way, because we haven't been talking about it that way, but Workforce Now with Pay is a Next Gen platform.
Mark Marcon: Got it. I appreciate it. Sounds very optimistic. Thank you.
Operator: Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thank you. Hey, Kathleen, you talked about the digital transformation a couple times. We're in argue kind of in that process and I think the last number you'd referenced was about a $150 million benefit. Is that still the way to think about it in the 150 range? Or does that get accelerated based on some of the investments in your portfolio as a result of the Q2 outperformance?
Kathleen Winters: Yes, Kevin thanks for that question. That 150 still follows, that was our estimated benefit for the year, the current fiscal year from digital and other transformation efforts. Where are we in that journey? I'd say we're in the early days, early I mean, as I mentioned these projects are not chats to implement projects. These are not basically four months projects that you rollout. These are how do we secure or build the right tools to take work out of the system. How do we - well, some of it can be little faster like continuing to build that chatbox functionality and how many inquires and some of those to go faster. But some of them could be longer projects like, supporting our implementation teams with tools that we're building. So, my view is we're in the early innings here. We've had some good success thus far. We continue to stay very focused on building pipeline of projects. And if everything all part of the company that we expect and that we go to, to say, what are you doing to digitally transform what you do. How do you take work out of the system and its front office and its back office? So, we got a lot more work to do there, and I think that's a really good thing.
Kevin McVeigh: And then just one quick follow-up, maybe as it relates to that. How does that impact your addressable market, because I'd imagine it probably expands it in terms of average client size, things like that? Is there any way to frame what the transformation is going to mean, in terms of addressable market longer-term?
Carlos Rodriguez: It's a good question and something that we think about a lot, right, as I think one of the things we want to try to get is we talked about share of wallet, new logos, but we can expand our addressable market that is very helpful. And it really varies business by business. But as an example, we are, I think, in the early stages, I would say, still not ready. I think I'm not supposed to say anything about it. But we think that in the down market, there is part of the addressable market that we could do better with if we had a more kind of end-to-end digital product, if you will, in terms of - so this would be a complement to RUN, that would compete in a segment of the market that we don't compete in today. Likewise, if we go all the way to the up market and international with the acquisition of Celergo was intended to kind of bolster, I think, a market that is growing and that I think is expanded by our acquisition of Celergo. And the Next Gen platforms, if you will, are for sure intended to expand the addressable market. So for example, the Next Gen payroll engine, again with Workforce Now would probably be have more appeal to an in-house user, even though people don't think there's a lot of those left, there are still people who use kind of in-house software if you will. And I think that this Next Gen payroll platform combined with Workforce Now provides more control, which is something that for the last 20 years, when we survey the market, if you will to assess what's addressable, there was always this kind of outsourcing versus in-house. And I think what's happened is that, cloud technology has blurred that line, but there's still a line there. And the ability to have the payroll platform perform some other things that people want from a control standpoint when they're in-house, I think expands that addressable market. And then lastly, in terms of Next Gen HCM, I mean, clearly, the big play there and the big investment was to expand the addressable market in the up market for us, both the larger and more complex clients, but the clients who also had HR needs that, we were not necessarily able to satisfy with some of our older platforms. So definitely, I think, a lot of opportunity and it's a key focus of our strategy in terms of how we develop our products, is to expand the addressable market.
Kathleen Winters: Yes. Kevin, you can think about as our digital work, our digital transformation is meant to improve and accelerate on both top-line and from an efficiency productivity standpoint. From a top-line perspective, whether it's the addressable market and accessing that through Next Gen or other feature improvements that we're making, sales cycle time, shortening that cycle time to get something through the sales process. We're working on that in our PEO business, improving via digital work, improving service. So with improved service, therefore, improved NPS, therefore improved retention. So it's meant to target both acceleration from a top-line perspective and as we've talked about taking work out of the system and productivity.
Kevin McVeigh: Thanks so much.
Operator: We have time for one more question. And our last question comes from Tien-Tsin Huang of JP Morgan. Your line is open.
Tien-Tsin Huang: Thanks so much. Good results and I appreciate the very clear guidance as well. Just a question and a follow-up or clarification. Just on the KPIs, Carlos, that you're most focused on the second half. Just hearing everything you talked about, positive revisions to retention, bookings. I'm curious, if there are any underappreciated KPIs at this point of the cycle that we should be tracking to gauge the sustainability of the improvement that you're talking about, as we get through the second half of the year? And just a clarification, I think you touched upon it in the last comment here. Just the 25% of sales of Next Gen payroll that would not have been attained without it. Is - are you - are those clients on a cloud platform that are looking for a cloud like the controls and whatnot that you're talking about that that was the condition for considering? I'm just trying to understand why they didn't consider it before it if that makes sense?
Carlos Rodriguez: Yes, listen, I think unfortunately, I don't have that level of detail I'm afraid to say. We would probably maybe follow-up to give you a little more color that's why I tried to use the words not scientific. So our sales force - we are obviously very, very focused on the rollout of our Next Gen platforms. And so as we try to keep close communication and close tab with our sales force on how it's going, and they came to us and said, we think we got 25% more logos as a result of Next Gen Payroll than we would have gotten in the past. I'm guessing there are going to be a number of different reasons for that, including there maybe a little bit of a sizzle factor there, in terms of - because as you know, we run fully compliant payrolls. We help our clients with PPP loans. I mean we were able to do everything, like our existing platforms are the most robust, most comprehensive, most effective, I believe, of course, I'm biased in the industry. But there are incremental improvements, that give people whether it's the control aspect that I mentioned or the sizzle that help sales, and it's no different than you go buy a car and there is five different models of the same car. And people buy the five different cars but you have to have new cars every now and then, and I think it's every five years whatever that cycle is, and I think that's maybe some of what's happening here. But we'll try to get you a little bit of additional color if we can, but that was an intent to spark a kind of a new level of disclosure if you will about what percentage of our 25% came as a result of which feature. But we'll try to provide some color either in the interim, or certainly on the next call, when we're going to have many more clients on Next Gen Payroll, and we'll have a little bit more data for you. On the question you had about KPI's, I would say, you hit on all of them, like there's lot of important ones that you just touched on that we watch and that we share with you. The other ones that I think are important are ones around productivity both for sales, but also for our service and implementation associates. And in particular on sales, that's part of why we're talking about kind of the underlying trends improving, and us being so optimistic about the future is, there's no reason why our sales force can't get to the same productivity, they were pre-pandemic and then continue to increase that productivity as they had been doing for many, many years. And so that's one of those KPIs that we watch very carefully is what's happening to that sales force productivity number quarter-on-quarter, and what's it expected to do in the third quarter and in the fourth quarter, and luckily, it's on track and that's something that we watch very carefully. Likewise, the productivity per service rep and productivity of implementation, so as an example, how many new clients can an implementation rep on board, and these are all impacted by the digital transformation that Kathleen was talking about. Because our goal is to make it easier and better for our clients, and as a byproduct, hopefully reduce our operating expenses, not reduce our operating expenses, and then figure out what happens after that, because the most important driver of the long-term value here is client retention. And I can tell you that if we maintain these client retentions, you guys should go do the math on how much faster our revenue will grow on a normal steady state basis with the same bookings. It's pretty powerful. And obviously that's incremental revenue growth that doesn't have incremental sales expense or implementation expense. So the most important thing for us to do is to make good on our commitment to our clients. But having said that, those productivity metrics are important, too, in determining kind of our ability to drive margin into the future, because those are two big buckets of expense, our service and implementation costs. And again, that's another item where the KPI that would really be around not just NPFs and retention, but around productivity. And the good news there is that we've been showing really good productivity improvements, while we've also been driving very good retention, which speaks to the success of our digital transformation efforts.
Tien-Tsin Huang: Very clear. Thanks so much.
Operator: This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for closing remarks.
End of Q&A:
Carlos Rodriguez: Well, I think I mentioned already that it's hard to imagine where we were just a quarter ago, because I think on the same call a quarter ago, there was no vaccine, there was no stimulus approved and there was no new administration in Washington. We were still waiting for or looking forward to an election. So, besides all of the great things that our associates are doing in terms of execution, our sales force and all of our associates, in terms of helping our clients through this and helping each other, I just thank God for where we are today versus where we were last quarter, because we know now, I think we knew some of us knew that we would be okay eventually. But now, we know for sure that we're going to be okay in terms of our friends, our families, but also our economy and I think our companies and the things that we also value on the professional side. So, very excited about the prospects of getting through the next month or two, which I know we're going to be challenging for all of us, but also looking forward to much better times ahead to plenty of pent-up demand, to growth and productivity, to strong GDP and all the great things that are going to happen once we finally defeat the virus and move on. So I would just close by saying, thank you to the scientists, the pharmaceutical companies and everyone else who got us to where we are today and that continue to move us forward as a country and as a globe. And I appreciate you all joining the call and listening to us today. Thank you.
Operator: Ladies and gentlemen, this does conclude the program, you may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. Thank you. I'll now turn the conference over to Mr. Danyal Hussain, Vice President Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Michelle. Good morning, everyone, and thank you for joining ADP's second quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer and Kathleen Winters, our Chief Financial Officer."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny, and thank you everyone for joining our call. This morning we reported results reflecting our continued strong business performance and momentum, with our second quarter revenue and margins both outperforming our expectations, as our business continued to demonstrate resilience in the face of ongoing economic headwinds. We reported revenue of $3.7 billion, up 1% on a reported basis and flat on an organic constant currency basis, with adjusted EBIT margin down 30 basis points. Coupled with a slight increase in the effective tax rate versus last year, our share count reduction our adjusted diluted EPS was flat versus last year, much better than the decrease we were expecting. During the second quarter, we continue to see signs of improvement in the overall operating environment, with the positive implications for pays per control, new business bookings and retention. Our pays per control metric performed slightly better than expected, as it improved sequentially to a decline of 6% versus the larger declines we experienced in Q1 in the latter part of fiscal 2020. Underlying employment trends in Q2 were consistent with what we experienced in Q1, with larger enterprises somewhat slower to show improvement, but with small and midsize businesses demonstrating a healthy level of hiring. We performed well on employer services new business bookings. Even though bookings declined 7% this quarter, this was well ahead of our initial expectations earlier this year, and in line with the revised expectations we communicated last quarter. And it's important to point out, that our new business bookings for the first half nearly matched last year's half, despite the very difficult environment."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos, and good morning, everyone. Q2 was another strong quarter across every major business metric. While we will still see some pandemic related headwinds for the balance of the year, we are more confident in our outlook given we believe the toughest part is behind us. Our performance thus far into the year reaffirms the resilience of our business model, the strength of our product, and the ability of our sales and service teams to perform even in the toughest of environments. We remain confident in our ability to execute as we move forward. In the second quarter, our revenues grew 1% on a reported basis, flat on an organic constant currency basis, which is significantly better than our expectations coming into the year and better than even the revised expectations we had as of last quarter. Once again, ES retention rates represented favorability as did very strong performance from our PEO. We managed expenses prudently, while making important incremental growth and productivity investments and delivered margins that were better than our expectations. Our adjusted EBIT was down just 1% despite pressure from a decline in client funds interest. Our adjusted effective tax rate increased 20 basis points, compared to the second quarter of fiscal 2020. Our share count was lower year-over-year, driven by share repurchases. And as a result, our adjusted diluted earnings per share of $1.52 was flat versus last year second quarter. Moving on to the segments. For ES, our revenues declined 1% on a reported basis, and 2% on inorganic constant currency basis, representing continued sequential improvements driven by record level retention, and the more modest 6% decline in pays for control versus 9% last quarter. Client funds interest declined 23%, as average yield declined 50 basis points versus last year."
},
{
"speaker": "Operator",
"text": "We'll take our first question from the line of Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. I'll ask two upfront here. So first on bookings, can you talk about composition of bookings in 2Q versus 1Q? And give us a sense if you can dissect the strongest and weakest demand across client size? And then, just looking at the SG&A level this quarter, can you comment on the drivers of the sequential dollar growth there? I heard the comments on accelerated investment. Is that primarily sales force headcount addition or other areas of spend?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure, let me take the - I'll take the bookings maybe and I'll let Kathleen talk about the SG&A. On the bookings, and I think some of this is just the lumpiness if you will of the results, because there's no - there are a couple of things that happened but it's hard to call it a trend right, because we only have really two quarters if you will of post-pandemic results. But in essence, our mid-market business performed a lot better. So, workforce now and the mid-market business did much better in this quarter than in the last quarter. And then, if you remember, last quarter we talked about that we got some help from our international business and in particular we called out multinational deals, and that was I'm not sure we gave any color around that, but that was strong double-digits is the way I would put it, last quarter helped the last quarter's growth. And this quarter it was kind of slightly negative. Now in the context of what's happening in Europe, which really started to shut down and started to have challenges before the U.S. in terms of the resurgence of the virus, we're pretty happy with that. Like we're pretty proud of our sales teams over there that they were able to accomplish what they did in the second quarter, but sequentially it was not as strong as the help we got in the first quarter. We also had really strong bookings in the first quarter in our down-market business, we had some, what I would call modest help from some - what we call client conversions or we call client-based acquisitions, which we do on a regular basis, but they don't come in every single quarter, so we got a little bit of help from that. And I think I also mentioned last quarter, I think I've been doing this for nine years mentioning that whenever we have a strong finish to a year, we typically get off to a slower start. And the opposite is also true, when we have a really bad year, we tend to get off to a stronger start. A lot of our business is counted at the time of sale and start, but some of our businesses, as you know, like in the up market, there is some flexibility if you will in the sales force. We don't necessarily endorse that, but there is some flexibility for salespeople to book something in call it July versus in May. And because of the way the incentives work and so forth, sometimes we get a little bit of movement from sales into the next fiscal year, if we have a bad fiscal year and the opposite is also true. We'll have a strong fiscal year. We tend to have a hard time getting started in July. But I think we've been - so this is nothing new. We've been I think transparent, giving you all the kind of the color that we can around bookings. I will tell you that when we cut through all that, so we're trying to look at no different than you would do with for example, earnings, where we trying to see what's the core business doing excluding client funds interest, what's happening with the core business excluding pressure from pays per control. We do the same thing in bookings, like what's happening in the core underlying bookings. And we see very positive momentum there, in terms of lead generation, digital leads coming in activity by the sales force. So we're optimistic that the momentum will continue into the third and fourth quarter. Of course, the caveat being, the virus has to cooperate in terms of and the vaccine rollout has to continue to stay on track. But I think overall, if you cut through all the - it's not fair to call them onetime items, but if you cut through all the noise, our momentum in the second quarter, in terms of bookings was stronger than it was in the first quarter, even though it might not be what the reported number shows. And I'll let Kathleen talk about the SG&A."
},
{
"speaker": "Kathleen Winters",
"text": "Sure. So on the SG&A side, I mean, you do have a lot of things within that SG&A. But I would think about it this way. The overall view or picture is that from a selling standpoint, I'll talk about kind of full year, and then we can talk about linearity. But from an overall standpoint, we continue to invest in sales, as we've mentioned, and that is both headcount investment, as well as continuing to look at marketing investment and doing some of that. So you've got that investment in sales, but you've also got the work we're doing around transformation, which would be offsetting that investment, as well as just discretionary cost control that we're very focused on doing as well. So kind of overall, you've got investment, headcount and marketing, you've got transformation work that we continue to do, and discretionary cost control. That does change if you look at or not change, but the SKU first half the second half is a little bit different, as we do have significant bookings growth in Q4, our expectation, and so of course, that's going to result in higher Q4 selling expense for us."
},
{
"speaker": "Bryan Bergin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, guys. Good morning. Just want to make sure I understood, the employee service bookings for the quarter came in line with expectations, but you guys did decide to raise the full year. So just want to make sure I understand the pipeline, the visibility there that's causing that raise. And then on retention to record levels. Are you seeing anything in particular on the competition front that is having less of an impact in years past that's driving the higher retention? Thanks so much."
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. On a pipeline question, we do have some visibility. But some of this is really about extrapolating momentum, because in the down market, it's really more about headcount and productivity than it is about pipeline or as in the M&C in the up market. I mean, I'm not telling you anything you wouldn't be able to figure out yourself. So we have a fair amount of visibility in some part of our business, but in other parts of our business, we based on our experience about productivity metrics and headcount and so forth, we have confidence, obviously, in the guidance that we're giving and the raise, otherwise we wouldn't be giving it. But, as couple of things that have changed since last quarter, last quarter we had - what we thought was much better results than we had expected, and we thought we had positive momentum and then on top of that, now we have a vaccine rollout. So that was not something that was it was talked about. But this is now a reality. We also had an election that was still in front of us and that's been resolved. We also thought and people speculated there would be more stimulus and now there is, even though there's even more stimulus being debated, just as a reminder, there was a $900 billion stimulus package that was approved. So I think if you look at what we try to do, we try to do a little bit of kind of correlation, regression, whatever you want to call it, between GDP and economic growth and our bookings, because we do believe there is some connection there. Like there's other things like the training of our sales force, the tools they have, the quality of the sales force, the turnover. But GDP is a powerful force and the GDP numbers are looking pretty strong here on a go forward basis, with perhaps the exception by some of our analysts out there of our third quarter, the quarter we're in right now. But if you look at fourth quarter, our fourth quarter or the first half of next fiscal year for us and then the next calendar year after that, I mean, even this full calendar year GDP expectation has been raised, I think, across the board by everyone. So I think it's partly visibility and pipeline and partly our experience that we know, for example, what a reasonable expectation is for productivity per DM per sales rep. We know how many sales reps we have, we know how many new ones we're hiring. We know what we're generating in terms of leads and digital marketing. And I think we put that all together and that comes out to our guidance. And so I think we're confident in it and we're actually very excited and positive that we were able to do that. And we're just glad that things are looking much better than they were last quarter and certainly better than they were looking in March and in April. On the…"
},
{
"speaker": "Kathleen Winters",
"text": "Bryan, if I could just interject the only other detail I'd add on all of that data that Carlos mentioned that we do look at an ongoing basis, is that when we look at the leading indicators in terms of the data we have, so appointments, referrals, demos, opportunities created, as you know, our sales team are inputting leads into the system. All of those are trending better going into the second half than they were before going into the year. And so we're feeling really very optimistic, as you can tell from the raised bookings guidance. We're feeling optimistic going into the second half of the year. In particular the digital leads are up significantly. So, again, just wanted to provide that transparency for you."
},
{
"speaker": "Carlos Rodriguez",
"text": "And then on the on the retention side, I would say there's probably two data points that I would look at. The retention obviously is incredibly strong and it's going to be record retention for the year, assuming we have the guidance that we've just provided. We've never been at these retention levels. And I think there's a number of factors. I mean, I think our product set is much stronger and it's not just the products themselves, but it's our commitment to moving our clients onto our newer platform. So we have a lot more clients on newer platforms today than we had a year ago, two years ago, whether a quarter ago or a year ago, it's just a continuing progression that we've talked about now for many, many years. But we've made a lot of progress and we know that the retention on our new platforms is higher than on some of our older platforms. So that's helping. There's probably some tailwind from this pandemic related, we just can't put our finger on it. The clients are maybe not moving as much. But if you look at each business unit, like, for example, in our down market, the retention in our down market as a result of better product and better execution has been going up for probably six or seven years and is up almost 500 basis points pre pandemic, and that's gone up even more. So the fact that we've had this positive momentum in the down market, it's a similar story and Workforce Now, if not 500 basis points. But in the mid-market, we've also had three years of improving retention pre pandemic. So I think those are signs that there is something happening in terms of our execution and our product. So, execution is part of it as well, we have to deliver I think on the commitments we make to our clients to resolve issues for them, and answer questions and so. So, it's a combination of better service, excellent service and really better products and migrating clients, I think is helping. And then secondly, the other data point that I would point to which is really on the bookings side, a combination of bookings and retention that our balance of trade is improving with several of our major competitors for the first time in a while. I think, it's again, related to this effort that we've made to improve product, continue to deliver great service, on execution. And I think it's showing up now in some of these balance of trade numbers we're showing some improvement. So, the reason I bring that up is because balance of trade with the combination of what we're bringing in, in terms of from some of our competitors but also what we're losing to those same competitors. That's why we call it balance of trade. So, there's a number of metrics that would tell me that our competitive position is getting better, and then resulting obviously in higher retention and hopefully also growing booking here in the future."
},
{
"speaker": "Bryan Keane",
"text": "Helpful. Thanks for taking the questions."
},
{
"speaker": "Operator",
"text": "Your next question comes from Jeff Silber of BMO. Your line is open."
},
{
"speaker": "Jeff Silber",
"text": "Thanks so much for taking my question. Two-part question, first is on pricing. I believe it was last quarter maybe the quarter before you talked a little bit about some of your competitors offering some pricing concessions declines. I'm just wondering if that's been continuing. And as a follow-up, I'm just wondering if you're seeing any diverging trends by geography, especially in certain areas where we're seeing higher COVID cases? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "So, let me take the second one first on divergence. Yes, we would see what we would expect to see, because we are, I think, we're big enough that we kind of really escape again the gravitational pull of overall GDP, but also of specific geographic challenges. So, in Southern California for example, we did see some challenges in terms of our bookings in the down market and into the mid-market there. It's still impressive if we were able to sell as much as we did. As a footnote, we sold a lot of the say that we're flat, almost flat for us, it's at least, we're impressed with ourselves that our bookings are flat for the first half of the year versus last year. But there clearly are pockets of challenges. Southern California would be a challenge, the Midwest was and the Central part of the country was incredibly challenged for several months. But we had other places that things were better as a result of maybe more economic activity, or continuing opening regardless of the controversy around that. And then, again, Europe would be a place where I would call out where I think we started to encounter some real headwinds. So, the geographies were up and not just about U.S. it's also global. So, the answer is yes, and that you should assume that we would be impacted by whatever you're seeing in the news. And so, when you have hard lockdowns in very large metropolitan markets, that would affect us but fortunately, we're very diversified geographically and across segments. So, remember, we operate all the way from small to up market to international and so, we obviously we try to find a way to keep follow these things in balance, and have something helping us, when other things maybe working against us. So, we did see some of that volatility as you described. On the price side, so one of the things we did talk about last quarter, we did talk about competitors and what we heard anecdotally about competitor pricing action, but we also said last quarter that we didn't get any help from price last quarter. We did get a little bit of help. It was not significant but all around, I think was around 30 basis points of help, which is about normally what we would be getting and to the revenue growth help from price. And so, I think what tells you this, what we're trying to signal to you there is to tell you that it was appropriate for us to pause for call it, four to five months our normal price increases. By the way, our normal price increases would have been July 1st would have been one of the main times that we do price increases. And remember, our price increases are much more modest than they were five, 10 years ago. But at our scale, it does matter. But we delayed those price increases. It was not appropriate if you do that given the circumstances that we were under. But you fast forward to September, October, we felt that given the additional services that we were providing. So we're providing a number of incremental services at no additional cost to our clients that I believe our competitors are not providing. And so we thought that going back to our normal modest price increases was a reasonable thing to do and we did that. And you can see the impact on retention which has been none. And so that would be I think a good sign for us."
},
{
"speaker": "Jeff Silber",
"text": "All right. That's great to hear. Thanks so much for the color."
},
{
"speaker": "Operator",
"text": "Our next question comes from Pete Christensen of Citi. Your line is open."
},
{
"speaker": "Pete Christensen",
"text": "Good morning. Thanks for the question. Nice trends here. Carlos, given the lifted view on ES bookings and retention, how would you characterize some of the trends you're seeing in the tax rate for additional - add-on modules, those sorts of things? And how should we think about the runway for the next two or three quarters? And how you see that evolving particularly with some of your new R&D developments, new product and all that?"
},
{
"speaker": "Carlos Rodriguez",
"text": "It's a great question, because there's still a lot of room for us there. We're very focused on market share and new unit growth. But we don't mind additional share of wallet and additional tax rate, because that's helpful too. And as you know, our bookings have generally been balanced for many, many years, about half of it coming from new logos, and half of it coming from incremental attach. So we love that business. I happen to be looking at those figures last night and it obviously varies by business unit. But as an example, in the mid-market, we're kind of in the 60% to 70% range, in terms of a tax rate for things like workforce management, which we used to call time and labor management, and benefits administration. And we have things like data cloud and other items that we can attach as well. But I think the best color to put on that is that there's still a lot of room. I mentioned how we are doing well, not just in our new strategic platforms, but we're also doing well on some of our products that we don't always talk about a lot on these calls like retirement services, insurance services where those tax rates are very low in comparison to what I think is the potential for our client base. Because when you have a tightly integrated solution, it really is a much better experience for our clients. So it's good for us, but it's also good for our clients, which is always an important thing. So I guess the color I would put there is we've got really good tax rates on some of the core HCM modules, like workforce management, then admin. So HR payroll, then admin, workforce management, those are kind of the core talent management is a place where we've been seeing growing tax rates, and there's a lot of room still there for people to adopt those solutions. So, we're very optimistic and this is a key strategy for - I think my predecessor before that, which has been great for us that we have a very broad industry. Part of our reason for concentrating on HCM and focusing the company away from some of the other businesses we have like a brokerage business, and dealer services and so forth is this is a growing robust space globally, and there's plenty of room to grow. We definitely want to still focused on off of market share and logo growth. But there's an enormous opportunity for us in terms of incremental tax rate."
},
{
"speaker": "Pete Christensen",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi. Good morning. Thanks for taking my questions. Maybe stepping back for a big picture question a little bit in a time machine. But if I think back to the Analyst Day in 2018 and some of the company's key initiatives around the service alignment and taking costs out of the business, and getting to call it mid-20s EBIT margin. I guess aside from the world being very different with what happened with COVID. But I'm curious Carlos if you could just think as far as those initiatives went and getting the margin structure of the business toward that. Would you say that were ex what happened with rates and what COVID? Would we be in that shape today? And I guess, maybe thinking forward, how should we think about the structural margins of this business post recovery? And can it be at those long-term levels that we talked about before? And then I have one follow-up."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. Let me give you a little bit of color on that, because, again, incidentally, I was doing my homework last night. So I did go back that's something that I actually have fresh on my mind. And then will correct me if I'm wrong. But I think our margin in '18, which you would have seen in that Analyst Day, was 20.7. And we're now, I think, forecasting for fiscal year '21, I'm not sure that we're forecasting it, but I think you can extrapolate based on our guidance. I'll just throw out a number. So call it 22.3, 22.5 somewhere in that range for fiscal year '21. That's with a significant drag from client funds interest, as you mentioned, and some drag from COVID as a result of slower than we would have thought or would have expected revenue growth. So I would say that on the margin side, we would be well ahead of what we talked about at Analyst Day, excluding these items. On the revenue side, clearly, we're not anywhere near that, hence why we had to withdraw that three-year guidance we had provided, because obviously the COVID headwinds with what happened with pays per control and just the economy in general made it very difficult. But again, it feels like this is a transitory event, as we've talked about now for two or three quarters, painful, devastating for many people, for our country, for the economy and for the world. But it is transitory and not an existential threat. And so we expect to get right back on the track that we were on before. And I happen to think that the fact that we're a couple hundred basis points higher in margin, even with everything that's happened than we were in '18, I think tells you something about the structural margin opportunity in the business. But, clearly a very important part of that picture is growth. We need to grow the business long-term, because growth does require investment and so you should be hearing from us as we care about margin and we think there's opportunity in terms of structural margins here going forward, but the most important thing we can do to drive long-term shareholder value here is to also grow the top-line. And we're focused on that."
},
{
"speaker": "Danyal Hussain",
"text": "Just to clarify, Samad, our formal margin expectation is 22.0% to 22.5%."
},
{
"speaker": "Samad Samana",
"text": "Great. Thanks, I appreciate. And that's why I asked it. To us, it sounds like the business is healthier adjusting for non-controllable factors. And maybe just as a follow-up on that on the booking in this quarter and just as you think about bookings for maybe the next couple of quarters. When you think about the performance, is there a way to think about it, in terms of driven by field reps versus digital inbound through marketing? Are there channels, so not by customer size, but are there channels that are doing better or worse in terms of bringing more customers into the top of the funnel, and driving new bookings?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think I'll tell you what…"
},
{
"speaker": "Kathleen Winters",
"text": "Maybe I'll just interject on before Carlos response to that one, and I want to interject and just follow-up a little bit on the margin story, because Carlos gave a really good kind of recap and summary of the last couple of years. When you think about, we're in the 20% margin, 20.7% to pre-COVID 23% with the various big initiatives that we pursued, and you've heard us talk about that over time. But I want to add that, one of those really important initiatives that we are now working very hard, is digital transformation which has been helping us, right. As we look at our transformation initiatives, we've talked about digital and procurement really driving a lot of the benefit, kind of today if you will, a lot of that procurement does get harder as you go, but from a digital transformation perspective, that's an initiative that we believe is going to be with us for some period of time, because these projects are not fast projects to execute, they do take time to execute, and so we're optimistic that we have got a pipeline of projects and that we will continue to yield benefits for us."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, and I think that, I'll just pile on to that. Your comment I think earlier after you asked question and you summarize my comments, the business is definitely performing much better than it looks, because we have, these client's funds interest headwind is not just the headwind on margin, it's a headwind on revenue growth as well. So almost a 4 percentage point. And as an example on a margin impact, our margin I think in ES would have been up and ADP overall, our margin would have been up 40 basis points instead of down 30 basis points for the quarter. So, clearly on a margin side, the picture is clouded and that picture will and the interest rate go up and down as you know, and everyone is always convince that rates are going to stay low forever, or they're going to stay high forever depending on where they are. But we believe that at a minimum that headwind will abate unless interest rates continue to go down and then turn negative for the next 10 years, which is very unlikely as we all I think, as we all know, at least in the U.S. that's unlikely. On your question about bookings, one thing that's important to note is we do have record leads through digital marketing coming in. So we have increased our investment in digital marketing, but we're very careful to do that to make sure that we're getting the proper ROI. But that is something that is certainly helping our sales force. But really the message for our sales force is that we want them to meet our client, the clients and the prospects where they want to be met. And they have all the tools, all modern tools that any sales force uses. I mean, the reality is, I said this before people steal our sales force. And so we have to understand we have the best sales force in the industry, there's no question about it, and they have all the tools they need to compete effectively. And they had obviously moved to being mostly a virtual sales force over the last six months. And we make sure they had the tools to be able to do that and that's where clients want it to be met. And if in six months, we anticipate that some of our up market and multinational clients will be okay having some digital meetings or virtual meetings, but they might want to have people visiting some of them again, we'll be ready for that as well, assuming that it's safe and that people are vaccinated. So, there are a number of channels that we can pursue, but you should understand that our strategy is really to meet the clients where they want to be met. As an example in the down market, our clients rely on trusted advisors like accountants and brokers, we have very, very strong partner relationships with those channels, and that's how we drive results in that channel. So it really varies channel by channel, but you should understand that we are pursuing every channel, every avenue including upping our digital marketing investments to make sure that, we're getting our fair share of that without throwing money away."
},
{
"speaker": "Samad Samana",
"text": "Great. Thanks again for taking my questions. I really appreciate the thoughtful answers."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning. Carlos, you talked about net gains. I'm wondering if that's related strictly to ADP having a better set of products, or is that related to the competition doing something else? And just my second question, you've talked a lot about the sales process. And I'm wondering, if you believe afterward, through this pandemic, get the vaccinations done, that fundamentally if the sales process will change, and that you'll use more digital versus face-to-face? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think, I'm in the same camp as I think many other CEOs of companies that - and again, there's very - there are not a lot of companies like ADP that operate all the way from the down market into the up market. So there has to be balance here in terms of it's not one clear cut answer. But I'm in the camp, for example, in the up market with some of my other competitors, and CEOs who believe that, there will be face-to-face meetings again, and particularly sales meetings. But I'm also in the camp of believing with lots of others that we shouldn't assume that things are going to go back exactly the way they were before. Whether it's with the way people are working, or the way people are selling, we're going to have to adapt to what inevitably is going to be some change. Having said that, I believe I saw a statistic the other day that said that, prior to the pandemic about 10% of the U.S. workforce was working from home. And it went up to 33% at the worst part of the pandemic, and then came back down to 25%. And I kind of monitor this through other sources that show that ticked up slightly again the number of people working from home as this virus continued to surge. But you would expect that 25% to probably go back to 15%, 20%, but not probably back to 10%. But remember that the other 70% never worked from home. And today 75% of the people are not working from home. But that doesn't mean that we haven't learned new techniques. So for example, an initial meeting or a follow-up meeting, or maybe even an implementation meeting with our client, I think we've all learned that. It's much more effective to do that for both parties virtually. But it's hard to believe that we're going to go back exactly to where we were before. It's also very hard to believe that we're going to stay exactly the way we are today. And again, I hate to give you wishy-washy answer because I think we're going to have let that play out. But we are like lot of other things, we're maintaining optionality and equipping our sales force to be prepared for either of those eventualities. And I think you had a first part of that question that…"
},
{
"speaker": "Kartik Mehta",
"text": "Client growth, whether its product?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Oh client. On the client growth side, again we are - I think I mentioned in one of my script, that all of our strategic platforms, so if you think about RUN, Workforce Now, Globalview, I forgot the other ones I mentioned, but the platforms that we are that are strategic that we're investing in, not just the Next Gen ones are all growing, and they are growing very robustly, and I don't want to people understand that. And part of the challenge is that, we have a large company and we have other things that maybe aren't growing as fast, or we have a drag from a platform that we're trying to get off of. And we unlike from others try to report the fact as they are. But maybe take a little bit of liberty what others are doing, and giving a little bit more color about just the things that are going well. But if you did that, like we'd only focused on the growth of, for example Next Gen, it would be 800% growth, or if we focused the growth of Workforce Now, across the board, not just in the mid-market, because we also use Workforce Now in the up market, and we use Workforce Now in our PEO, you would see robust growth even in the middle of a pandemic on a Workforce Now. So, I think we're making progress but we're a large organization with large market share and included that exposes our flanks, and we have to be very good at making sure that we protect our flanks which I think we're doing a good job of, as evidenced by retention. But when you look at the go-forward and the growth of our strategic platforms, there is a lot of reasons for optimism that we will I think be able to compete effectively on a go-forward basis. So, I am not sure I can give you lot more detail of that, because this is more detail than we normally give, because we like to just be straight shooters and the growth is what it is, whether it's on client counts or a revenue. But if you want a little bit of additional color underneath the covers, the strategic platforms are doing very well against our competitors."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey, good morning, and thanks for taking my questions. So, questions basically about Next Gen payroll and Next Gen HCM. The first part is this, can you talk a little bit more, give us a little bit more color with regards to Next Gen Payroll just in terms of the number of clients that have been sold? What percentage of the existing Workforce Now base has been converted? And how you are thinking about that going through? And kind of what you're seeing in terms of the satisfaction, once you have that in place, you made some initial comments, that sounded really positive? And then the follow-up is this basically on Next Gen HCM, just in terms of what the outlook is there in terms of new sales and new bookings? Thanks you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. Thanks for the question. We thought it was optimistic before prepare yourself, because the story on Next Gen Payroll and HCM is quite positive for us in terms of the future. If you look at Next Gen Payroll, we have I think close to a couple hundred let's say over 200 live clients. So not just old but live clients. We have over 500 that are sold. I think we said in our comments that you may not have picked up on that, we think that it's possible even though this is not scientifically provable that up to 25% of the sales we had so far of Next Gen Payroll we would not obtain without Next Gen Payroll. So I think that bodes well for I think our competitiveness and our market share. And our clients were to have call it somewhere around a couple 1,000, I think for this fiscal year. So, it's positive momentum, again the caveat there is with Next Gen HCM we are generally going after very large clients, and in the case of Next Gen Payroll, it is really a platform that solves our kind of Next Gen Payroll needs across the board and we started and call it the core of our mid-market. So, call it between 50 and a 150 employees really has been our focus. But having said that, it's still pretty impressive and we're pretty happy and pretty positive. Satisfaction levels are very high. And I think we just got great the momentum and the sales force is obviously incredibly excited. Even though, remember, this is still a back-end engine right. So it's still Workforce Now and in the future, it will be lifting on that are using high as an engine. But it does provide some additional benefits to the client and a lot of sizzle as well, as we know that matters as well, given some of our competitors I think have used sizzle in their sales process. And so, we're able to use some sizzle now with Next Gen Payroll. So very excited about that rollout and about the progress there. Our Next Gen HCM, you heard about our rollout in Mexico, which is really Next Gen HCM with Pay. So we have call it, a handful of clients now in four countries that are actually running on Next Gen HCM with Pay. Again, it's very early like to talk about only a handful of clients isn't a lot, but what was most encouraging is that in a couple of those situations we were able to use what we're calling a federated development process, which is one of the intentions whether we invest into the platform which to be able to build rapidly. So, the Mexico client was onboarded in from super messaging the building platform, getting the client and getting them onboarded in call it six to nine months. So very, very impressive for us to be able to do that. So, we're optimistic that this will continue to hopefully help us again competitively. And I think you also asked about how many clients we've migrated off of Workforce Now on to Pay, and remember that it's we're not migrating clients off of Workforce Now, we're just changing the underlying payroll engine that is still on the Workforce Now. And the outlook of that is I think not many, like this is mostly new logo sales in the case of Next Gen Payroll. Again, underneath Workforce Now. So, as we go to market, it's still Workforce Now with the Pay payroll engine beneath it. And again footnote, I think I said this last quarter, Workforce Now is a Next Gen platform. We don't talk about it that way, because we haven't been talking about it that way, but Workforce Now with Pay is a Next Gen platform."
},
{
"speaker": "Mark Marcon",
"text": "Got it. I appreciate it. Sounds very optimistic. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thank you. Hey, Kathleen, you talked about the digital transformation a couple times. We're in argue kind of in that process and I think the last number you'd referenced was about a $150 million benefit. Is that still the way to think about it in the 150 range? Or does that get accelerated based on some of the investments in your portfolio as a result of the Q2 outperformance?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes, Kevin thanks for that question. That 150 still follows, that was our estimated benefit for the year, the current fiscal year from digital and other transformation efforts. Where are we in that journey? I'd say we're in the early days, early I mean, as I mentioned these projects are not chats to implement projects. These are not basically four months projects that you rollout. These are how do we secure or build the right tools to take work out of the system. How do we - well, some of it can be little faster like continuing to build that chatbox functionality and how many inquires and some of those to go faster. But some of them could be longer projects like, supporting our implementation teams with tools that we're building. So, my view is we're in the early innings here. We've had some good success thus far. We continue to stay very focused on building pipeline of projects. And if everything all part of the company that we expect and that we go to, to say, what are you doing to digitally transform what you do. How do you take work out of the system and its front office and its back office? So, we got a lot more work to do there, and I think that's a really good thing."
},
{
"speaker": "Kevin McVeigh",
"text": "And then just one quick follow-up, maybe as it relates to that. How does that impact your addressable market, because I'd imagine it probably expands it in terms of average client size, things like that? Is there any way to frame what the transformation is going to mean, in terms of addressable market longer-term?"
},
{
"speaker": "Carlos Rodriguez",
"text": "It's a good question and something that we think about a lot, right, as I think one of the things we want to try to get is we talked about share of wallet, new logos, but we can expand our addressable market that is very helpful. And it really varies business by business. But as an example, we are, I think, in the early stages, I would say, still not ready. I think I'm not supposed to say anything about it. But we think that in the down market, there is part of the addressable market that we could do better with if we had a more kind of end-to-end digital product, if you will, in terms of - so this would be a complement to RUN, that would compete in a segment of the market that we don't compete in today. Likewise, if we go all the way to the up market and international with the acquisition of Celergo was intended to kind of bolster, I think, a market that is growing and that I think is expanded by our acquisition of Celergo. And the Next Gen platforms, if you will, are for sure intended to expand the addressable market. So for example, the Next Gen payroll engine, again with Workforce Now would probably be have more appeal to an in-house user, even though people don't think there's a lot of those left, there are still people who use kind of in-house software if you will. And I think that this Next Gen payroll platform combined with Workforce Now provides more control, which is something that for the last 20 years, when we survey the market, if you will to assess what's addressable, there was always this kind of outsourcing versus in-house. And I think what's happened is that, cloud technology has blurred that line, but there's still a line there. And the ability to have the payroll platform perform some other things that people want from a control standpoint when they're in-house, I think expands that addressable market. And then lastly, in terms of Next Gen HCM, I mean, clearly, the big play there and the big investment was to expand the addressable market in the up market for us, both the larger and more complex clients, but the clients who also had HR needs that, we were not necessarily able to satisfy with some of our older platforms. So definitely, I think, a lot of opportunity and it's a key focus of our strategy in terms of how we develop our products, is to expand the addressable market."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. Kevin, you can think about as our digital work, our digital transformation is meant to improve and accelerate on both top-line and from an efficiency productivity standpoint. From a top-line perspective, whether it's the addressable market and accessing that through Next Gen or other feature improvements that we're making, sales cycle time, shortening that cycle time to get something through the sales process. We're working on that in our PEO business, improving via digital work, improving service. So with improved service, therefore, improved NPS, therefore improved retention. So it's meant to target both acceleration from a top-line perspective and as we've talked about taking work out of the system and productivity."
},
{
"speaker": "Kevin McVeigh",
"text": "Thanks so much."
},
{
"speaker": "Operator",
"text": "We have time for one more question. And our last question comes from Tien-Tsin Huang of JP Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thanks so much. Good results and I appreciate the very clear guidance as well. Just a question and a follow-up or clarification. Just on the KPIs, Carlos, that you're most focused on the second half. Just hearing everything you talked about, positive revisions to retention, bookings. I'm curious, if there are any underappreciated KPIs at this point of the cycle that we should be tracking to gauge the sustainability of the improvement that you're talking about, as we get through the second half of the year? And just a clarification, I think you touched upon it in the last comment here. Just the 25% of sales of Next Gen payroll that would not have been attained without it. Is - are you - are those clients on a cloud platform that are looking for a cloud like the controls and whatnot that you're talking about that that was the condition for considering? I'm just trying to understand why they didn't consider it before it if that makes sense?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, listen, I think unfortunately, I don't have that level of detail I'm afraid to say. We would probably maybe follow-up to give you a little more color that's why I tried to use the words not scientific. So our sales force - we are obviously very, very focused on the rollout of our Next Gen platforms. And so as we try to keep close communication and close tab with our sales force on how it's going, and they came to us and said, we think we got 25% more logos as a result of Next Gen Payroll than we would have gotten in the past. I'm guessing there are going to be a number of different reasons for that, including there maybe a little bit of a sizzle factor there, in terms of - because as you know, we run fully compliant payrolls. We help our clients with PPP loans. I mean we were able to do everything, like our existing platforms are the most robust, most comprehensive, most effective, I believe, of course, I'm biased in the industry. But there are incremental improvements, that give people whether it's the control aspect that I mentioned or the sizzle that help sales, and it's no different than you go buy a car and there is five different models of the same car. And people buy the five different cars but you have to have new cars every now and then, and I think it's every five years whatever that cycle is, and I think that's maybe some of what's happening here. But we'll try to get you a little bit of additional color if we can, but that was an intent to spark a kind of a new level of disclosure if you will about what percentage of our 25% came as a result of which feature. But we'll try to provide some color either in the interim, or certainly on the next call, when we're going to have many more clients on Next Gen Payroll, and we'll have a little bit more data for you. On the question you had about KPI's, I would say, you hit on all of them, like there's lot of important ones that you just touched on that we watch and that we share with you. The other ones that I think are important are ones around productivity both for sales, but also for our service and implementation associates. And in particular on sales, that's part of why we're talking about kind of the underlying trends improving, and us being so optimistic about the future is, there's no reason why our sales force can't get to the same productivity, they were pre-pandemic and then continue to increase that productivity as they had been doing for many, many years. And so that's one of those KPIs that we watch very carefully is what's happening to that sales force productivity number quarter-on-quarter, and what's it expected to do in the third quarter and in the fourth quarter, and luckily, it's on track and that's something that we watch very carefully. Likewise, the productivity per service rep and productivity of implementation, so as an example, how many new clients can an implementation rep on board, and these are all impacted by the digital transformation that Kathleen was talking about. Because our goal is to make it easier and better for our clients, and as a byproduct, hopefully reduce our operating expenses, not reduce our operating expenses, and then figure out what happens after that, because the most important driver of the long-term value here is client retention. And I can tell you that if we maintain these client retentions, you guys should go do the math on how much faster our revenue will grow on a normal steady state basis with the same bookings. It's pretty powerful. And obviously that's incremental revenue growth that doesn't have incremental sales expense or implementation expense. So the most important thing for us to do is to make good on our commitment to our clients. But having said that, those productivity metrics are important, too, in determining kind of our ability to drive margin into the future, because those are two big buckets of expense, our service and implementation costs. And again, that's another item where the KPI that would really be around not just NPFs and retention, but around productivity. And the good news there is that we've been showing really good productivity improvements, while we've also been driving very good retention, which speaks to the success of our digital transformation efforts."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Very clear. Thanks so much."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "End of Q&A",
"text": ""
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I think I mentioned already that it's hard to imagine where we were just a quarter ago, because I think on the same call a quarter ago, there was no vaccine, there was no stimulus approved and there was no new administration in Washington. We were still waiting for or looking forward to an election. So, besides all of the great things that our associates are doing in terms of execution, our sales force and all of our associates, in terms of helping our clients through this and helping each other, I just thank God for where we are today versus where we were last quarter, because we know now, I think we knew some of us knew that we would be okay eventually. But now, we know for sure that we're going to be okay in terms of our friends, our families, but also our economy and I think our companies and the things that we also value on the professional side. So, very excited about the prospects of getting through the next month or two, which I know we're going to be challenging for all of us, but also looking forward to much better times ahead to plenty of pent-up demand, to growth and productivity, to strong GDP and all the great things that are going to happen once we finally defeat the virus and move on. So I would just close by saying, thank you to the scientists, the pharmaceutical companies and everyone else who got us to where we are today and that continue to move us forward as a country and as a globe. And I appreciate you all joining the call and listening to us today. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this does conclude the program, you may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 1 | 2,021 | 2020-10-28 08:30:00 | Operator: Good morning. My name is Crystal, and I will be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded. And all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Crystal. Good morning, everyone, and thank you for joining ADP's first quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and on our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call as well as our quarterly history of revenue and pretax earnings by reportable segment. During our call today, we will reference non-GAAP financial measures which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. As always, please do not hesitate to reach out, should you have any questions. And with that, let me turn the call over to Carlos.
Carlos Rodriguez: Thank you, Danny, and thank you, everyone, for joining our call. This morning, we reported excellent first quarter fiscal 2021 results. I'm very pleased to say that across the board, we delivered a very strong start to the year that was well in excess of our expectations. For the quarter, we delivered revenue of $3.5 billion down just 1% on both reported and organic constant currency basis. And our adjusted EBIT margin was up 120 basis points, coupled with a slight increase in the effective tax rate versus last year in a share count reduction. Our adjusted diluted EPS grew 5%, much better than our expectation three months ago, which was for a meaningful decrease in EPS. On this call, we'll discuss the changes that drove ADP’s better-than-expected start the fiscal 2021. In Q1, macroeconomic conditions continued to gradually improve and we executed extremely well in several key categories, including better-than-expected sales performance, a continued commitment to client service and prudent expense management. Let me start by covering key macro related trends to provide context to our results. Specifically on pays per control, out-of-business losses and client funds interest. During the first quarter, pays per control, which as a reminder declined 11% in the fourth quarter was in line with our expectation for high single-digit decline with a year-over-year decline of 9%. And a continuation of the trend we saw into our fiscal 2020 year-end, employment small businesses continued to show the most improvement, while large businesses actually showed some degradation as we exited the first quarter. Out-of-business losses performed better-than-expected as small business losses stabilized and a substantial number of clients that had gone inactive last quarter have restarted processing activities over the last three months. Finally, average client funds interest rates declined in line with our expectations for the quarter, but client funds balances were favorable to our expectations, declining 7% compared to our double-digit expectation. With that said, let me shift to the highlights resulting from our own execution. We delivered positive 2% growth in employer services new business bookings, which was significantly ahead of our expectations and marked a record Q1 performance. As you may recall from our commentary last quarter, we did expect some amount of sequential improvement relative to our Q4 bookings performance as economic condition stabilized. However, we delivered a much faster reacceleration as our sales force started strong in July and carry that momentum through the end of the quarter. We attribute the rapid reacceleration to a few key factors. First, we did see our clients and prospects show greater willingness to engage and purchase. But second and most importantly, we took action by maintaining our overall investment in sales and marketing, applying our best-in-class inside sales expertise to continue training our field sales force and utilizing innovative demos and other HCM content to start conversations. We've designed a client acquisition funnel that is successful even in the current environment. Our teams delivered across the board. That's everything from the downmarket where RUN continues to grow. And in fact, we've now exceeded 700,000 RUN clients for the first-time surpassing pre-COVID levels to the mid-market, where we're seeing clients showing more interest in fully outsourced HRO solutions to the enterprise space, where we had strong traction in compliance-related solutions. Our international sales were also strong as we closed several larger deals that were previously put on hold as prospects were waiting for a more stable environment to proceed. And our tax rates on many of our solutions continue to increase as well. This quarter, our workforce management solutions also referred to as time and attendance reached the 90,000 milestone for the first-time. And we're pleased to see that continue to grow our revenue. Our revenue outperformance was also driven by stronger retention. We are very proud to report that we hit record employer services retention levels for a Q1 period and our performance likewise experienced – and our PEO performance likewise experienced stronger than expected retention. While our retention likely benefited from having some clients delayed decisions to switch HCM vendors, given elevated uncertainty, higher client satisfaction clearly contributed as well. You may recall that last quarter we delivered record NPS scores across our businesses. As we helped our clients manage through government programs like the PPP. This quarter, I'm happy to say that across our businesses, we either maintained or reached new record NPS levels. We believe these results show that our commitment to providing outstanding service to our clients is paying off and we'll continue to do so. Combination of stronger bookings and retention in Q1 drove better revenue performance and the high incremental profitability associated with those revenues plus prudent expense management ultimately drove stronger margin performance as well. This is another great example of execution by our associates. And in a few minutes, Kathleen will cover our margin performance in more detail. I'd like to now provide an update on the progress we continue to make in driving innovation. Earlier this month, as part of the annual HR Tech Conference, ADP was given the Top HR Product award. This marks a record-setting six consecutive year that we have been recognized at the conference for breakthrough technology innovations, which is representative of how we remain committed to leading the industry with the premier HCM technology. This year, we were recognized for our Next Gen Payroll engine. And as we highlighted in our February Innovation Day, the benefits of this new engine include a policy-based framework that enables easy self-service and powerful transparency that allows practitioners and employees to more easily understand the effects of regulatory policy or potential life changes and is designed to be scaled globally. We continue to deploy our Next Gen engine to the market and we added another 100 clients during the first quarter. We remain excited about expanding its availability and driving adoption. And the feedback so far has been overwhelmingly positive. Ultimately, we expect a higher level of satisfaction to generate even better retention and higher win rates, supporting our long-term revenue growth trajectory. And we continue to innovate throughout our ecosystem. This quarter, the ADP marketplace reached 500 app listings and we are pleased to offer an expanding suite of offerings as we continue to drive millions of daily API transactions for tens of thousands of clients that are current users. And just this past week, we hosted our Annual ADP Marketplace Partner Summit, where we further strengthened our partner relations and provided actionable ideas to help our partners grow their business. Also earlier in Q1, we released our Return to Workplace solution that helps clients bring their employees back to work safely through a comprehensive set of tools designed to streamline and manage the process. We now have thousands of clients using the Return to Workplace solution, and we expect usage to grow over time as more clients start to gradually bring their employees back to the office or the work site. As I said, we are very pleased with the start of the year. And I'd like to recognize our associates from sales to service implementation and all the others who support them for their continued efforts in outstanding performance during this time. They continue to come through for our clients when it matters most. And with that, I'll now turn the call over to Kathleen.
Kathleen Winters: Thank you, Carlos, and good morning, everyone. We had a great Q1 with the combination of gradually improving macroeconomic conditions and outstanding execution, driving better sales retention and overall volume. We do expect to continue to face a number of headwinds over the course of fiscal 2021, as the global economy continues to recover from the effects of the COVID-19 pandemic. But with our strong first quarter, we now see the potential for a better full year outcome compared to our outlook three months ago and our updated guidance reflects this view. For the first quarter, our revenue declined 1% on a reported and organic constant currency basis. Clearly a nice start out of the gate and better than we were expecting three months ago. Better bookings and retention rates were the main drivers of revenue favorability. And that coupled with expense favorability resulted in a year-over-year increase of 120 basis points in our adjusted EBIT margin. As you will recall, we anticipated that first quarter would have a modest acceleration in bookings compared to the previous quarter, but a greater year-over-year revenue decline than we experienced in the previous quarter. And that much of this loss revenue would be at very high margin. Instead, our booking swung to a year-over-year increase, revenues declined only modestly and our margins expanded even with the sales and implementation expense generated by a much stronger than expected bookings quarter. Several factors drove this margin favorability. First, with a more modest revenue decline than expected in Q1, we saw less associated margin pressure than expected. In addition, the better retention we had in Q1 also translated to lower bad debt expense than we had originally contemplated. We also continue to execute our downturn playbook with our entire organization carefully managing headcount and discretionary expenses. And lastly, we make great progress on our digital transformation and expanded procurement initiatives in Q1 and effectively reduced operating expenses and overhead faster than anticipated. We are encouraged by what we've seen so far and are making a modest increase in our expected full year cost benefit from these transformation initiatives. And now expect $150 million in benefit for fiscal 2021 up from $125 million. That revenue and margin performance together drove adjusted EBIT growth of 5%. Our adjusted effective tax rate increased 10 basis points compared to the first quarter of fiscal 2020 to 21.3%, driven by lower tax benefit on excess stock sensation. Our share count was lower year-over-year driven by both share repurchases that took place pre-COVID as well as the resumption of buybacks during the quarter. All of this combined to drive 5% growth in adjusted diluted earnings per share to $1.41, a great start to the year. Now, some detail on the segments. For ES, our revenues declined 3% on a reported basis and 3% on an organic constant currency basis. A great result considering this quarter included the effects of a 9% decline in pays per control and a 20% drop in client funds interest revenue, plus the impact from last quarter’s lower booking level. Our client funds balances were down only 7% better than the double-digit decline expected. And that outperformance was driven by the same bookings and retention related factors that supported revenue. The year-over-year decline in average balances continued to be impacted by lower pays per control, lower state unemployment insurance rates, continued payroll tax deferrals amongst some of our clients and the closure of our Netherlands money movement operation in October of 2019. Our average yield for our client funds interest declined by 30 basis points about in line with our expectations in this low interest rate environment. Employer services margin was up 120 basis points for the quarter, well ahead of our most recent expectations, driven by the same factors I mentioned earlier when discussing consolidated results. For PEO also a strong quarter out of the gate, our total PEO segment revenues increased 4% for the quarter to $1.1 billion and average work-site employees declined only 3% to 547,000. This revenue growth and work site employee performance were both ahead of our expectations, driven primarily by better retention and stronger than expected bookings in Q1. Same-store employment at our PEO clients performed in line with our expectations for mid-single digit decline steady from last quarter. Revenues excluding zero margin benefits pass-throughs declined 1%, and in addition to being driven by lower WSEs, it continued to include pressure from lower workers' compensation and SUI costs and related pricing. PEO margin increased 40 basis points in the quarter. This included about a 60 basis points of favoribility from ADP Indemnity pertaining to changes in the actuarial loss estimates. Let me now turn to our updated guidance for fiscal 2021. We are very encouraged by our strong Q1 performance. We are still somewhat cautious about the balance of the year. You'll see that the implied increase in guidance for the next three quarters builds in some ongoing momentum for the balance of the year, but does not anticipate the same level of outperformance we just experienced in Q1. This reflects both our confidence in the fundamental strengths of ADP, as well as a realistic assessment of the lingering uncertainties ahead for the global economy, including uncertainty around the rate of continued economic improvement, the labor participation rate and the timeline for a vaccine. For the details of our outlook, I'll start by updating you on some of our key macroeconomic assumptions. For pays per control, we continue to expect a decline of 3% to 4% for the year. And as we mentioned, pays per control performed approximately in line with our expectations in Q1. We continue to assume a modest pace of improvement from this point, with mid-to-high single digit decline in Q2, improving to a mid-single digit decline in Q3, followed by a mid-to-high single digit increase in Q4 on the easier compare. And as you are aware, the reported BLS unemployment rate has trended better than most people's expectations these past few months. But factors like a reduced labor force participation rate are creating an offset, which is why our pays per control has actually been in line so far. Out-of-business losses outperformed our expectations and contributed to our record Q1 retention levels. We are raising our retention guidance accordingly. While we have seen effectively no incremental pressure so far this year from increased bankruptcies among our clients with continued uncertainty as to further stimulus and strain in parts of the economy remaining from partial shutdowns. We believe it is still prudent to assume some effect from higher out-of-business losses in the coming quarters. On client funds interest, there is no material change to our expectation for average interest rates for the year, though we are revising our balanced growth higher, given the better start to the year with stronger sales and retention. We continue to expect the client funds balances to return to year-over-year growth in Q4. Let's now look at a revised fiscal 2021 guidance. I'll start with ES. We now expect revenue to be flat to down 2% for the full year versus our previous expectation for a decline of 3% to 5%. I'll break that down into some of its components. We now expect our new business bookings to be up 10% to 20% compared to our prior forecast of flat to up 10%. That 10% increase in guidance reflects the impact of our Q1 outperformance, as well as a slight increase in our bookings expectation over the rest of the year. We are still contemplating a modest year-over-year bookings decline in Q2, as instances of partial economic lockdowns in Europe, plus uncertainty from the U.S. election keep us somewhat cautious, but this Q2 outlook is certainly better than what we contemplated three months ago. We now expect our ES retention to be flat to down 50 basis points, versus down 50 to 100 basis points previously. As again we had stronger Q1 retention than expected and believe our strong client satisfaction will translate to continued strong controllable retention, that we continue to assume elevated out-of-business losses in Q2 and Q3. And for our client funds interest, which primarily impacts the results of our ES segment, we are raising our average balances expectation on the strong Q1 sales and retention performance and accordingly raising our client funds interest range by $10 million, now to $400 million to $410 million. We now expect our margin in the Employer Services segment to be down 100 basis points to 150 basis points for the year versus our prior forecast of down 300 basis points, driven by the stronger Q1 performance, a stronger revenue outlook and continued expense discipline. For our PEO, we now expect revenue to be flat to up 3% versus our previous forecast of down 2% to up 2%. And we expect an average worksite employee count down 1% to up 1% versus our previous forecast of flat to down 3%. We continue to expect average work-site employee growth to be negative during the first three quarters and turn positive in Q4. Our revenues excluding zero-margin pass-throughs are expected to be down 1% to up 1% versus our previous forecast of down 4% to down 1%. We continue to expect lower workers' compensation and SUI revenues on a per work site employee basis. For PEO margin, we now expect to be down 50 basis points to flat in fiscal 2021, versus our prior forecast for down 100 basis points, this increase in our guidance is driven by stronger revenues and a more favorable benefit from ADP Indemnity. Moving to our consolidated outlook. We now anticipate total ADP revenue to be down 1% to up 1% in fiscal 2021, versus down 4% to down 1% prior. And we anticipate our adjusted EBIT margin to be down 100 basis points to 150 basis points versus our prior guide of down 300 basis points. As I mentioned earlier, we now expect about $150 million in savings from the combination of our digital transformation, as well as our procurement transformation initiatives. And we will continue to manage our expense base prudently. As we saw in Q1, you should expect that further upside to our revenues, whether from macro-related factors or our own execution should drive upside to our margins as well. In August, we refinanced $1 billion of notes maturing in 2020. And as a result, we will benefit from approximately $5 million in interest expense savings this year. For our effective tax rate, we continue to anticipate 23.1% for the year. We resumed our share repurchases in Q1, and we assume a net share count reduction in our guidance. Net of all these changes, we are raising our adjusted diluted EPS guidance to a decline of 3% to 7%, which represents a much more modest decline, compared to our prior guidance of down 13% to 18%. I'd like to wrap up with a few comments on longer-term margins. To be clear, there has been no departure from our focused and consistent approach to continue to drive margins higher over the long-term. Looking beyond fiscal 2021, a continued economic recovery should support employment growth and above normal pays per control growth. And we would expect such a trend to contribute incremental margin uplift to our results, all else being equal. The impact of lower interest rates will also begin to moderate in the coming years. In addition to these macroeconomic factors, we expect our underlying margin performance to continue to be supplemented by our ongoing efforts to transform our organization and client service operations and to be supported long-term by Next Gen platforms that are more efficient and less expensive to maintain. As you have seen from our Q1 results, we are committed to protecting and driving margins, even as we maintain our steady approach to investing for the long-term. We remain confident in our long-term growth prospects and our ability to execute. And I look forward to continuing to update you on our progress. With that, I will turn it over to the operator for Q&A.
Operator: Thank you. [Operator Instructions] And our first question comes from David Togut from Evercore ISI. Your line is open.
David Togut: Thank you. Good morning and good to see the upgraded guidance. As we entered the critical year end selling season, I hear the caution around factors like partial lockdowns in Europe and the U.S. election. But can you give us some more detailed kind of insight around your expectations for new bookings potentially have RUN, Workforce Now, Vantage and our surveys of your customers pre-COVID, we were hearing a lot of demand for Workforce Now, especially into the bottom of the market up to 4,000 to 5,000 employees per company.
Carlos Rodriguez: Yes. I mean, I think that we'd like to be – given the momentum we just demonstrated, we'd like to be really optimistic, unfortunately, we all watch the same news and the backdrop in terms of these issues, it's not just Europe, I think there are some concerns here in the U.S. as well. And what we saw from April – March, April May, is that we stick to our story that our clients – if our clients are hunkering down and are unable to make decisions, it impacts us. So we remain positive because it doesn't feel like there's going to be a full lockdown across the board nationally like there was here in the U.S. last time. And we've clearly adapted, I mean we've – you can see it in the quarter, how much progress we've made in terms of being able to sell virtually and use online tools and really ramp up our digital marketing and a lot of other things that we can talk about that we've done to adjust our salesforce. But for us to tell you what our view is of RUN and Workforce Now and enterprise sales in the next two or three months, honestly is difficult other than to stick to our story around our guidance, which is really more about the full year and couching it in optimistic, positive and good execution terms, but also with some level of caution, because we're still dependent, I think on the healthcare situation and to some extent on the economy as well. One of the questions that you're not – you didn't ask, but I'm sure people are wondering is about this – question is stimulus. And that's another one that I wish we could tell you that we have kind of a scientific placeholder in our forecast around how much stimulus and whether there is stimulus or not and we don't – but that's another factor that I think would just create the kind of overall picture that would either be supportive or not supportive of our sales efforts, because clearly if you look at the last 20, 30 years of ADP, there is some general correlation between GDP and our sales results, our new business bookings. And that is impacted by not just the economic activity related to the healthcare crisis but also to things like stimulus, because obviously the government can offset down pressure on the economy, through stimulus as it just did, but there is also uncertainty around that as well. So I wish I could give you a more concrete, one thing I can tell you for sure is we're maintaining our sales investment, we're maintaining our optimism and we are gradually getting some people back into the field in terms of selling. And we're certainly pivoting in a big way in terms of using the large resources we already had with inside sales to really train a lot of our traditional field sales to be able to sell virtually. And I think you saw a great execution and great results in the quarter as a result of that.
Kathleen Winters: I'd just add one other thought here or comment here. In addition to what Carlos said, I mean, look, obviously we're very encouraged and we're optimistic because of the great outperformance in Q1. But as you heard us say, we're very cautious because of the various uncertainties that we mentioned. But I would also say, we're cautious because as we look back in history and as we look at how in other recessions, how we recovered from that. We do see a period of chopping as it's not all kind of a straight line up in terms of the recovery during the great financial recession after that, we had I believe it was six quarters of negative sales growth after that and it was quite choppy actually. So we're expecting there to be some choppiness here as well. So I just wanted you to be aware of that.
David Togut: Understood. As a follow-up, how do you see the current economic environment affecting the case for outsourcing of payroll and HR services? In other words do the economic challenges that businesses face make them want to focus more on their core business and outsource payroll and HR services?
Carlos Rodriguez: Yes. I mean, I think that's safe to assume that we would probably be on the side of the ledger of businesses that would benefit “under normal circumstances post pandemic”. So in other words, once we get through the transitory nature of the challenge, I don't see how it's not a positive backdrop for companies like ADP and outsourcers who help people, first of all, maintain business continuity, and second of all, focus on their core business as you imply. So I think it has to – again, but we have – what do we – how many points of growth is that, only history will tell, but we think it will – we think it’ll be a positive.
David Togut: Understood. Thanks very much.
Operator: Thank you. Our next question comes from Lisa Ellis from MoffettNathanson. Your line is open.
Lisa Ellis: Hi, good morning guys. Thanks for taking my question. Wow, the recovery in bookings is pretty fantastic. I know you provided a little color around using your inside sales to train your outside sales. Can you just even provide a little, like, what is your sales model looking like right now? To what extent are you using kind of digital marketing and digital onboarding? Can you just give a little bit more color around kind of what happened and what changed over the course of the three months to drive that recovery?
Carlos Rodriguez: Sure. I'm not sure that the call is long enough though to be able to give you all that, because one of the differences between us and some of our competitors, which I would see it as a positive, if I were all of you, is that we're very diversified both geographically and also across segments. So the answer unfortunately is complicated and it goes area-by-area. So in international for example, we're very happy with very strong results versus expectation, but also frankly, very strong results versus the prior year. But there were a few larger deals there, I think there were few global view deals that helped. And when you look at the core best of breed, like in-country solutions, we also outperform there versus expectations, but not as well in terms of versus the prior year, which is obviously understandable given the pandemic. So that's international. And then you move to the U.S. and the story in a downmarket is different and the midmarket is different than the upmarket. Although across the board, we were better than expected. But the growth year-over-year varied, because I think that's the biggest surprise, which we're frankly very excited about is that we have positive growth. But if you decompose it, it's a different story in each area. And we had tailwinds in the downmarket, I think as result of some big recovery that was probably some pent up demand, the PPP loans probably frankly saved a lot of small businesses and provided a lot of cash to small businesses to continue to kind of run their businesses and make decisions around purchasing solutions like what we provide to help them run their business better. So it really – by the way, our upmarket was also good and strong. So that was very encouraging the midmarket I think performed also better than our expectations. So I wish I could give you a simple answer. I personally see it as a positive, because if it was one thing that we could point to, I think it would be problematic because that could easily change overnight, but there really isn't, it's just a lot of execution across the board. I do think that we got a little bit of help, again, we don't have a scientific way of estimating it, but I've been consistent in the nine years that I've been in this job, because of knowing our culture and how we operate, the fact that our fiscal year ended where it did, we clearly had a little bit of pent up demand from call it May, June that carried over into July. I would say that, that was somewhat minor in this case, because getting companies to make decisions on your timeline is probably not as easy to do now as it has been in prior years. But historically when we have a bad year, we get off to a good start. And in some segments that didn't affect probably international business, didn't affect the downmarket, because the downmarket doesn't really have that ability to kind of hold off on something and started in the next fiscal year. But may have had a little bit of an impact. But we're pretty convinced that that's not a major story, but I thought I was important for me to be consistent, because I've been saying that for nine years, by the way, likewise, we have a blowout fourth quarter, we end up usually struggling at the beginning of the next fiscal year.
Lisa Ellis: Okay. And then for my follow-up, I know you called out the payroll engine and adding 100 additional clients this quarter. Can you just remind us or update us on sort of where you are in that overall rollout and what the kind of rate and pace of that is?
Carlos Rodriguez: So I think we have a total of a couple 100 clients, and I would describe that as still are very early compared to ADP’s size. So if we were a startup, you'd be really excited. And I think we have a $20 billion market cap right now with only 200 clients, given what I've been seeing in the market. But the reality is that relative to ADP size and given our profile as a company and so forth, you got to take it in context, but we can't help, but be excited, because two years, three years, five years, 10 years down the road, it's going to be a big difference maker. I think it is, and that was our plan, when we built the business case, we've been at it for three or four years, this is a global scalable new payroll engine, it's incredibly exciting in terms of what it's going to do in terms of feature functionality, and hopefully client satisfaction, but also cost to maintain, cost to develop. But as you know, we have approximately 800,000 clients, sorry, 900,000, that's not fair because RUN, this has nothing to do with RUN. But a large portion of ADP's business is still on our current versions of our payroll engine, which by the way, all of these payroll engines are transparent to the clients. I don't know if any of you guys understand that, but Workforce Now and Vantage and Lithion, and all of our products are the front ends are really what our clients experience. And it's just important to remember that this is not like the transitions we had with Workforce Now, or even with RUN, because this is a gross to net engine that is really kind of underneath the hood, if you will of what the clients are experiencing on the front end. So that's positive too, because we don't anticipate a major migration effort, if you will, when we get to that, which is still at some point in the future.
Lisa Ellis: Terrific. Thank you. Nice job.
Operator: Thank you. Our next question comes from Tien-tsin Huang from JP Morgan. Your line is open.
Tien-tsin Huang: Thanks so much. Good morning, really terrific new sales results. Just to add to what Lisa asked at the beginning there, just thinking about ROI on your sales investments. Did you lean in really hard in this quarter there, and I'm sure everyone was motivated to drive sales, but could we see more return on some incremental investments as you go throughout the fiscal year? I was trying to understand the timing of some of the investments you put in place, and also if there is any call-outs on pricing on new deals, especially on the enterprise side.
Kathleen Winters: Yes. So on the sales investment, what I would say is maybe think about two big buckets in terms of investment from a headcount perspective and continuing to invest in marketing and digital marketing. The headcount investment, we kind of try to do that on a very steady pace over time, and that's been consistent with how we've thought about it and approached it. It was somewhat modest headcount investment in Q1 and that will ramp up during the course of the year, we're planning to continue to focus on and do that. And for sure have committed funding and resources, if you will from a digital marketing perspective to help support the bookings.
Tien-tsin Huang: Terrific. And then on pricing, anything – any call outs there?
Carlos Rodriguez: No. It's really – we really don't see any – I'm sure I know we did and I think some of our competitors did things to try to help our clients. And even in some cases prospects like there was a couple of examples of people giving away like three free months. And I think one competitor was doing six free months, et cetera. But – and one competitor changed their pricing online, but then changed to back a couple months later. So I would say there is nothing to report. There is really very little change in the pricing environment. This is not – I don't think this is really a question of pricing. I don't think you can impact end demand in a significant way in this environment through that, that would not be – certainly would be our view, that’s not how to drive growth.
Tien-tsin Huang: Great to hear. Just my quick follow-up, just on PEO and sort of the sales outlook there, given some of the same caution and uncertainty with the election and maybe insurance. Do you – are you more bullish or less bullish on PEO here as we go into the second quarter here versus 90 days ago?
Carlos Rodriguez: I'm always bullish on the PEO. I was born in the PEO. And as you know, so the – I think the – as usual my answer has to be, if you look at the short-term, we have a lot of pressure in some parts of our business because of the healthcare situation. And the question is, do you want to look through that or do you want to stay focused on us, for example, in the PEO when you have clients shrinking, we from a discipline standpoint have some rules around that can sometimes affect – create adjustments, if you will, in our sales results, it puts pressure in the short-term on the sales results i.e., call it audits if you will. So if a client was sold and was valued at $1,000 and 12 months later, they're now valued at $900 because they're paying fewer people than we're collecting less revenue, which as you can imagine is happening with the majority of our clients that affects our PEO sales results. So I’d say that the fact that workers’ compensation, prices and costs have come down, which is part of the revenue picture, there is a lot of short-term transitory things. But I would say on a unit basis, our results were very good in the quarter. And we’re very happy with that. And I would say that again, if there is any businesses that are going to be even more from a pure positioning standpoint, stronger coming out of the pandemic, the comprehensive outsourcing businesses, which PEO is one of them should be very compelling value propositions, because, as people look back a year or two from now, they might be thinking, I really don't want to go through that again. I don't want to be figuring out how to process, forget about payroll, because that – we have that covered. But most people – a lot of our clients do not use us for health benefits, processing or management of open enrollment, they don't use us for time and attendance, they don't use us for workers' compensation and our comprehensive solutions take care of the entire picture. And I think if you're a small and mid-sized business, if I were you, I'd be thinking about making that change, maybe not right now, because you've got other things that you're focused on, but I think six to 12 months from now, I would expect people to be seriously considering any options they have to deal with multiple things that are very critical to the ongoing operations and to their employees, but they may not have thought of pre-pandemic.
Tien-tsin Huang: Got it. I was going to get you on the phone and start selling them. Thank you for that update.
Operator: Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open.
Mihir Bhatia: Hi, this is Mihir on the Jason. Thank you for taking our questions. Maybe I can just follow-up a little bit on bookings. If you could maybe just talk a little bit about trends you saw in a F1Q and what you're seeing even now, I guess, between small, medium and large. Anything different worth calling out that we should be considering? And then just relatedly on booking. Was there any negative booking adjustment in the F1Q booking numbers?
Carlos Rodriguez: I'm sorry, negative adjustment in which Q?
Mihir Bhatia: In the booking number this quarter – like in terms of booking number this quarter?
Carlos Rodriguez: No. We had a minor – I would say we had a minor, we talked about last quarter that we had taken some reserves because we expected to have – obviously clients that were going to cancel their orders and so forth to abuse laypersons terms. And I think that's exactly what happened. And I think our – we did reverse some of that reserve, but it was actually very much in line with the actual client. We had identified, we didn't do this kind of at a very high level. We had specific clients when we booked that reserve in our “bookings”, we had identified a list of clients that we thought were probably going to cancel in this first quarter. And I believe the two things…
Kathleen Winters: Yes, and so we utilized – we basically utilized a portion of that reserve, which is a normal course of how it happens. I guess Q4 was just an outsized amount for that, we call it the backlog adjustment. It's just outside obviously because of the COVID impact and a portion of that was utilized in Q1, but nothing significant other than that.
Carlos Rodriguez: I think it's safe to say it would not have made a difference. I mean, it clearly would've made a difference if we hadn't had the – but if you want to know what our gross bookings performance was, it was not affected by our gross bookings performance, it did not affect our gross bookings performance. You would have had basically the same picture.
Mihir Bhatia: Understood. And then just any trends between, just small, medium or large businesses, what you were seeing this quarter?
Carlos Rodriguez: Other than noise, I think we – probably the strongest performance was in the downmarket because much to everyone's surprise, there is strong business formation. And we saw that as kind of – we talked about that in our last call, remarkable recovery in small business very quickly at the beginning of the pandemic, both in terms of pace for control in kind of all categories, including this kind of new business formation. And I would probably add a note of caution there that to me is counterintuitive, and whenever in my career I've seen something that doesn't make sense, it generally – I think there is probably a little bit of payback at some point, I'm hoping I'm wrong, because if there is a relatively quick solution to the healthcare crisis, it's possible if the government managed to get small business through this relatively unscathed through PPP and all the other things that they've done. But in general it's a counterintuitive kind of situation. But we'll take it, it was positive.
Kathleen Winters: Yes. The other areas where we saw some particular strengths, and I think we mentioned already on the international side, particularly Canada was very strong for the quarter and also our compliance services area. So things like employment verification, unemployment claims, things like add more compliance of services related stuff saw a very strong performance in the quarter.
Carlos Rodriguez: Yes, it’s a great point. Like we don't always talk about some of these businesses that we have that are very good businesses, we call them standalone businesses. And we did have some good tailwinds from some of those businesses quarter. But again, I would tell you that they don't change the overall picture, but important to note that those were helpful.
Mihir Bhatia: Understood. And then just, if I could follow-up real quick on your EBIT margin guidance, you had a pretty nice raise in the guidance. And I was just wondering how much of that is driven by the stronger top line outlook versus changes in your expectations by expenses. I know you mentioned an extra $25 million in transformation savings, but were there other factors because it doesn't look like, it's just float income didn’t change all that much. So anything else if you could give us there? Thank you.
Carlos Rodriguez: I would say it's safe to assume that most of it is as a result of that. But that I don't want to take away from us in terms of our execution, because, if we have higher revenue, we also frankly have more clients more employees to pay. So to the extent that we believe we can hold the line on expenses, some companies, you have to cut expenses, in our case, we just have to hold the line and that's probably good news, but I would say that mathematically you're on the right track, which is – that's a big factor. The incremental revenue is – a lot of it is flowing to the bottom line and helping our margins.
Kathleen Winters: Yes, definitely that incremental high margin revenue is the biggest contributor, but also, as we said look, we've been really focused on making sure we're doing a good job on cost control. We're keeping a close watch on headcount. We talked about investment in sales, but other than sales we're really controlling everywhere else from a headcount perspective. Very tight on discretionary costs, transformation work is coming along very nicely. We did a little bit better with the higher retention, better on bad debt expense in Q1. We think we're cautious about that because we think it could come and hit us in Q2 and Q3. So we've built that into our expectation. But those were the contributors.
Mihir Bhatia: Thank you.
Operator: Thank you. Our next question comes from Ramsey El-Assal from Barclays. Your line is open.
Ramsey El-Assal: Hi, good morning. And thanks for taking my question. I wanted to ask about the contribution to bookings performance of delayed, kind of bookings getting realized this quarter versus sort of net new bookings. I'm just trying to understand the contribution from maybe sort of a backlog of delayed bookings and how material that was. And then also to just understand what it is, sort of a pipeline of these delays that should flow in, kind of continue to flow in as we get a little deeper into the year or was there more of sort of a one-time catch-up that happened in the quarter with some of these delayed deals, does that makes sense?
Carlos Rodriguez: I’d say the only place where it's really meaningful and quantifiable is probably in the international space where we had, I think I mentioned a few global view deals that were delayed if you will, but that's actually not a – I wouldn't call it, that's not something that was in the – necessarily in the backlog because we hadn't sold it yet. So we don't actually book a sale until it doesn't go into the backlog until we get a contract. And so these were things that were in process, if you will, or in the sales process. And maybe we thought it was going to close in May or June, but by the way, maybe it wouldn't have – even without a pandemic, like there's really no way to, this is all frankly speculation stuff that we do when we get into these kinds of conversations. But I say that's the place where a field like we had a few large deals that we thought were going to close in the fourth quarter and didn't, by the way, client decisions, not us trying to move them from one quarter to the other. We want to get businesses as fast as we can. So we are always trying to book everything as quickly as we can, but some client delays in the international space, it's really not honestly a factor in the downmarket and very small factor in the mid-market in terms of controllability. We can't really sway our clients that easily from one way to the other. Maybe a little bit of that in the upmarket and in international, but you really can't do that in a downmarket and the mid-market. So I would say, there's a difference between, I guess I'm not sure what the nature of the question is, but I think I already said that there could have been some – in some segments of our sales force, if you have a terrible year and you're in the last month and you're not going to make the year, there's sometimes the tendency for people to hold and start that business in July. But I think you saw in our comments that August and September were also strong. So it doesn't feel like – people don't like hold something from May and June, and then book it at the last day of September. They typically put it in the first week of July. And so again, based on my experience and what I've seen here over the years, there was probably a little bit of that didn't make a material difference in the sales results. And it is where it is. We had a great start and I think great execution. And besides us leaning into our sales investments, the really big difference maker here is our sales force leaned in to drive results, right. And we're incredibly grateful to them for that.
Ramsey El-Assal: All right, that helps a lot. I appreciate it. And just a quick follow-up on the – if you could give us an update on the rollout of the Next Gen HCM and the Payroll engines relative to, let's say three months ago or four months ago, how do you think COVID is going to impact the roll out of some of the Next Gen technologies? Is it going to be – you mentioned some delays, I think previously, but how is it looking now?
Carlos Rodriguez: Well, we had – I think we had a good quarter like – frankly, if any client to me is a good point. It's good news. And I think we had three or four. I think Danny probably…
Kathleen Winters: That’s right. Yes, we had a couple of them, good sales.
Carlos Rodriguez: We had some sales like closed. In other words, we got people to sign contracts in the quarter. Like, I don't know about anybody else, but I'm not spending a lot of contracts in this kind of environment. Like we just – the whole focus of this call is how we're focused on prudent expense management and trying to keep expenses down. So when people are coming to me, selling me things, I'm generally not a big signer on those types of things. So just shows, I think the value of – of our value proposition that people are still signing up because I think they believe that it will not only help them in the short-term, but that perhaps it can make them more efficient even in the short-term. So I think that is a good sign, right, of the strength of our products and the solutions and the pitch that we have. But that was good news. I mean, we were pleasantly surprised.
Kathleen Winters: And we have several dozen, I think in implementation, active implementations right now. So the sales are continuing, the backlog, the implementations continued to scale up. So really no significant or substantial change in the outlook.
Carlos Rodriguez: I think besides the sales, we actually started, I think a number of clients, three or four also.
Danyal Hussain: Yes. We're in the double-digits now.
Carlos Rodriguez: These are clients – we actually sold new clients, new contract that are now going to go into the implementation process, but we had clients that were in the implementation process, a few of which delayed starting in the fourth quarter, but then we started them here in the first quarter. So I would say that's all the news. And on Next Gen Payroll, you heard what we said and sold 100, which again, I think is pretty damn good news, like in this kind of environment.
Ramsey El-Assal: Agreed. I appreciate your answers. Thanks so much.
Operator: Thank you. Our next question comes from Steven Wald from Morgan Stanley. Your line is open.
Steven Wald: Great. Thank you. Good morning. So I'd love to come back to the margin. I know some be in over the head, but maybe just a couple of other sort of ways to look at it. It seems like the way you're all looking at it going forward is, if macro cooperates in the higher margin pieces of the revenue could drop to the bottom line and drive incremental upside from here. Is that the right way to think about it? And generally, should we assume that implicit in the remaining three quarters of the year, the lower margin implicit assumption for at least a couple of those quarters is really more dependent on the macro than it is on your piece of investment, which I think we maybe collectively thought was going to be more robust than the headwind relative to what it ended up being this quarter?
Carlos Rodriguez: Okay. So just to clarify, remember we outperformed not because we stopped investing or didn't invest as much as we said we were going to invest is because we outperformed on the top line, right. In terms of our revenue, even though some of it was clearly expense management and so forth. But I would say that the answer to that question is that, it's hard to wrap your head around our economic. I know it's hard because most companies don't operate this way, but for example, the better things get in terms of the macroeconomic, the more we're going to invest. And I know that's not going to make some people happy, but like for example, our fourth quarter, like our fourth quarter, like if things play out the way we planned in terms of the original guidances and we're not changing anything on you, but like our fourth quarter where we have easier comps, we would also expect to have great sales results, right. And those great sales results on a comp basis will also bring with them sales expense. And to the extent, we can get some of these clients started and our sales results improved, we're going to start also investing more and stepping on the accelerator and implementation expenses. So this is all carefully planned, carefully controlled as Kathleen was alluding to, like, this is not some kind of free-for-all in terms of expenses, but this is an amazing economic model. I don't know if you can see what we just delivered and what we're telling you that assuming that the situation cooperates with us, we probably will be either flat to slightly up in terms of revenue for the year. So that would mean that, we'll continue our streak of ADP of never being negative revenue growth, which is pretty remarkable, right. We had a massive decline in volume in the last quarter, massive declines in new business bookings. And you see now granted, this is not what we are targeting like, we'd like to have high single-digit revenue growth. So it's kind of weird that we're excited about flat, but it's all about the context and it's all about relativity. So it's really a great economic model, but the economic model is a long-term economic model. You have to invest in sales, implementation, and product to drive the results. This is not – we're not running the business quarter-to-quarter. And what that means is the minute we see the sunshine – the sun shining we're going to become boasted. It doesn't mean that our expenses are going to get out of control, but you will see our sales and our implementation expenses gradually come up. And along with that, some point our service expenses as well. But that's great because the most important driver of long-term value of this company is growth. It's not what the margin in next quarter or this year.
Steven Wald: I understood. Sorry.
Kathleen Winters: Yes, just some more color from my perspective. I mean, I would just say, look, we continue to be, as we always have been very, very focused on growth and efficiency and becoming more and more efficient every day. So we're going to continue to invest where it makes sense for growth and for efficiency. So we talked about sales headcount and continuing to support that investment, investment in product. And we invest in efficiency, all of the digital work that we're doing isn't, it doesn't come for free. You have to make investments to be able to drive that efficiency improvement. So we're focused on all of that and we're going to continue to do that.
Danyal Hussain: And Steve, just one last thing to tie it back to our guidance. You're right. Certain macro factors will have an outsized impact for the next two quarters. And so what we've contemplated is pressure in retention and pays per control, both of which come at high incremental margins. If ultimately those come out better than forecasted, as you suggest, they would represent upside to margin.
Carlos Rodriguez: There's a few others, like Kathleen mentioned bad debt expense is also something that, frankly has been shocking in the last six months where we've had, honestly like decreases in our bad debt expense, which makes no sense at all. So hopefully that will continue, but we didn't plan for that. I think we didn't roll forward three quarters of lower bad debt expense.
Steven Wald: Right. Okay. That's all very helpful. Thank you. And then maybe as my follow up there, I think it was asked a little bit before, but Carlos, you were just talking about it a little bit ago there of just kind of wanting to grow mid to high single-digits. If we rewind the tape back to January and you guys talked about the markets you were in and how you were growing, sort of seemed like the way to think about it was you were generally growing in line with the market. And I think your earlier comments indicated, next few years should be an uptick, but there's going to be choppiness of course. I guess I'm curious how you guys think of ADP's positioning relative to other platforms. And obviously, you had a really strong quarter. But for the last several years, you've seen a lot of other platforms growing, in excess off of much lower basis. I'm just curious how you think about it today versus six months ago versus a year ago. If we are to see this uptick in HCM demand and outsourcing demand, where you feel about ADP's positioning in that market?
Carlos Rodriguez: Well, I would answer that question just by saying that we just invested hundreds of millions of dollars in new platforms in our key markets, because we intend to take market share.
Steven Wald: Couldn't be clearer than that. Okay, I'll leave it there. Thanks guys.
Operator: Thank you. Our next question comes from Kevin McVeigh from Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thanks. Hey Kathleen, you talked about kind of out-of-business and the guidance looks like it calls for kind of elevated losses in Q2 and Q3. Did it bottom in Q1 and gets better? And then I guess just along those same lines, can you talk about, is there a way to also frame clients that are maybe still in business, but not processing at this point? So I guess, two different questions, just trying to get a sense of a, where the out-of-business did it bottom Q1 and then improves in Q2, Q3, and then as your way to frame no clients still in business that maybe aren't processing at this point?
Kathleen Winters: Yes. So on the first thing, the out-of-business, I would not say it bottomed at all. In fact, we did not see a significant impact from out-of-business in Q1. I think the shoe has yet to drop there is how I would say it. And that's what we are forecasting and guiding that we're going to see some pressure from that in Q2 and Q3. That come in Q2, is there more stimulus that helps support it and we don't see it in Q2 and maybe it doesn't come till Q3, I don't know, but we're planning, I think we're cautious about it. And we're planning to see that pressure in Q3 – Q2 and Q3, sorry.
Carlos Rodriguez: And on your question about clients not processing, we did mention that a number of small businesses restarted in the first quarter but there is still a sizeable chunk of companies that have gone inactive and remain in that state.
Danyal Hussain: And to be clear, there's just – in case there's a misunderstanding there that doesn't have – it has nothing to do with our business bookings, right. So that affects our revenue and affects our losses to some extent, but this is unrelated to business bookings. Because the word restart might confuse some people.
Kathleen Winters: Yes, so higher than it would be in a normal period. It's come down from where it was at the peak in probably April, May, June, it's come down from there, but it's still higher than normal situation.
Kevin McVeigh: Got it. And just to wrap that point, Carlos, it's fair to say that, with the stimulus, it probably helped those inactives a little bit that maybe would have fallen into bankruptcy. Is that a fair way to think about it too?
Carlos Rodriguez: No question about it.
Kevin McVeigh: Cool. And then just real quick, it looks like the midpoint of the revenue guidance for ES is a 300 basis point improvement versus 150 basis point improvement for the PEO, any puts and takes to – I know it's not one-to-one but is it just kind of the client mix that where you'd seen a little bit more upside on ES as opposed to PEO or just any thoughts around that?
Carlos Rodriguez: No. Other than – that's actually a great question, which we'll go back now and decompose that because we hadn't looked at it that way. At least, I hadn't. But I would say, my instinct would tell me that has more to do with how the operating plan is built than any macroeconomic or other major explanation. So I honestly, I wouldn't read much into that.
Kevin McVeigh: Okay. Thank you.
Operator: Thank you. And we'll take our last question from Mark Marcon from Baird. Your line is open.
Mark Marcon: Hey, good morning. And thanks for taking my question. Just with regards to the bookings performance this quarter. To what extent, do you think it was due to the sales force basically recalibrating and being able to get out and getting more at bats, relative to higher batting average. So, in terms of thinking about the win rates, and then I have a follow-up with regards to Next Gen.
Carlos Rodriguez: That's a great question. And I have some sense of that from looking at the data right from the quarter. And I would say that our win rates are in line, I think a little bit better in some cases against a few competitors, which makes us very happy. But I would say, there's not a lot to report there that is, I think good news, but consistent if you will, in general. So it's probably more the former, right, which is the at-bats. And you could almost use the – what I call it, the traffic analogy, right. So ever since the pandemic started, whenever I go out on the roads, I do the traffic check and traffic is much higher and has been much higher over the last two or three months than it was in March and April. And that probably has something to do with, talking to just people on the streets, but people on the streets turn into people buying things and people going to restaurants and people going back to their workplaces and so forth. So I hate to be so crass and so simplistic, but I think that ADP is a very large company, which we're very proud of. And the gravitational pull of GDP and economic activity is strong in both directions. And I think we benefited a lot from, I think it's safe to say better than most people. I mean, I think this is not an ADP issue. I think most economists have raised their expectations about GDP. Unemployment is lower than everyone thought, even though labor force participation is lower. In general, things are better than people thought they were going to be and call it, May, June at this point. And we have benefited from that. I think that's I wish I could take more credit and give you a more complicated answer, but I think that is actually what's happening. The traffic is up for sure.
Mark Marcon: Great. And then just a short-term and a long-term question, but the short-term one is basically just as we're here in the key fall selling season, how do you view, Carlos, the kind of the mixed dynamics with regards to, hey, there's more uncertainty there's – this resurgence with regards to COVID, there's the election, perhaps not a lack of stimulus, but at the same time, things are more complicated. HR is more central. How does that end up impacting kind of the new sales, the bookings expectation, just here in the core selling season. And then the longer term question is Next Gen Payroll, Lifion, they've gotten really nice awards. You've obviously been inhibited by the pandemic in terms of being able to go out there and talk about it with clients. But when things get a little bit back to normal, how would you expect the penetration of those elements to go over the next year, two years, three years? Like when would we see a bigger penetration? So as they've gotten really good rewards.
Carlos Rodriguez: Yes, I think on the first part of your question, it's of course – the last question, of course, has to be the downer question, because I think that that's a hard one for me to, I've been so optimistic the whole call, so I hate to like bring us all down. But based on what I'm seeing right now, both in the U.S. and in Europe. And the fact that this is our key selling season, I wish I could tell you that I'm incredibly excited and bullish and so forth. I just want to get through this damn thing, right. And get out to the other side. And I'm looking forward more to the third and fourth quarter and the fourth quarter and the next fiscal year than I am to the next two or three months, because the combination of the election with, I mean, you guys all see the same thing that we're seeing. And again, got to apply the test of common sense and the test of common sense would tell me that this is a, let's just try to keep us up beat, let's just call it a fluid situation.
Kathleen Winters: It's going to be choppy, right. I mean, we thought we'll cover it from the last recession that it was choppy. And I'm fully expecting it's going to be choppy this time around too, particularly right, we're in Q2. We're in the fall, going into the winter, it's cold, we've got areas where there's resurgences that people might be hunkering down again. So Q2 might be challenging, but even in normal situations, normal years, right. Bookings are going to be lumpy quarter-to-quarter. I'd focus more on the full year, the annual and the longer term view.
Carlos Rodriguez: And again, of course, we also thought that the first quarter was going to be terrible and it turned out to be home run. So they easily go the other way, but I'm a man, I’m like, I speak the truth, right. In terms of what I know and what I think at the time. And I spoke the truth in our last earnings call, and obviously I was wrong because things turned out to be much better. And I hope that happens here again, but that's my story. And I'm sticking to it, but one quarter or two quarters or three, it's not going to make a difference in ADP's long-term trajectory. What matters is the second part of your question, which is what do we intend to do? And what do we expect in terms of penetration rates and rollout of kind of our Next Gen platforms. And by the way, it's not just about Next Gen, I hope you guys understand that we are making some fairly sizeable investments, ongoing investments in Workforce Now. Workforce Now, now we have a version, if you will, I shouldn't call it a version, but Workforce Now is also on AWS in the cloud. So we've completely rebuilt Workforce Now to be as modern and as Next Gen, as Lifion and as our Next Gen Payroll engine. We also have been doing an enormous amount of work on RUN in the same vein, both at the guts of it in terms of the technology stack, but also on the user experience. You know what the investments we made in data cloud, you know, what we have with ADP marketplace, so this isn't an across the board increase in investment over methodically over the last six to seven years that I just summarize it by saying what I said once before, our intention is to have all of these things parlayed into taking market share and growing ADP faster than market and faster than the economy.
Mark Marcon: That's great. Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today's call. I’m pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Well, thank you all of you for listening. Again, in summary, I just want to, once again, I think compliment our associates and our leadership team for incredible execution in the short-term, but I hope you also heard our commitment to the long-term in both in terms of sales, R&D, client service and all the things that drive growth and long-term value for our shareholders. And hopefully, for all of you who represent them. We remain committed to expense management, the digital transformation, all the things that Kathleen said, but we are somewhat holds into obviously the circumstances around the economy and the healthcare crisis. But we remain optimistic that this is – and it's the reason for optimism, and this is a transitory situation that we're going to get through it, hopefully in the next three or six months to the point where things gradually start to get back to normal. And then ADP can get back to the normal growth rates that we're used to. So thank you again and appreciate, you’re supporting, you're listening to us. And I hope that all of you continue to stay healthy and safe. Thank you.
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Crystal, and I will be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded. And all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Crystal. Good morning, everyone, and thank you for joining ADP's first quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and on our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call as well as our quarterly history of revenue and pretax earnings by reportable segment. During our call today, we will reference non-GAAP financial measures which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. As always, please do not hesitate to reach out, should you have any questions. And with that, let me turn the call over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny, and thank you, everyone, for joining our call. This morning, we reported excellent first quarter fiscal 2021 results. I'm very pleased to say that across the board, we delivered a very strong start to the year that was well in excess of our expectations. For the quarter, we delivered revenue of $3.5 billion down just 1% on both reported and organic constant currency basis. And our adjusted EBIT margin was up 120 basis points, coupled with a slight increase in the effective tax rate versus last year in a share count reduction. Our adjusted diluted EPS grew 5%, much better than our expectation three months ago, which was for a meaningful decrease in EPS. On this call, we'll discuss the changes that drove ADP’s better-than-expected start the fiscal 2021. In Q1, macroeconomic conditions continued to gradually improve and we executed extremely well in several key categories, including better-than-expected sales performance, a continued commitment to client service and prudent expense management. Let me start by covering key macro related trends to provide context to our results. Specifically on pays per control, out-of-business losses and client funds interest. During the first quarter, pays per control, which as a reminder declined 11% in the fourth quarter was in line with our expectation for high single-digit decline with a year-over-year decline of 9%. And a continuation of the trend we saw into our fiscal 2020 year-end, employment small businesses continued to show the most improvement, while large businesses actually showed some degradation as we exited the first quarter. Out-of-business losses performed better-than-expected as small business losses stabilized and a substantial number of clients that had gone inactive last quarter have restarted processing activities over the last three months. Finally, average client funds interest rates declined in line with our expectations for the quarter, but client funds balances were favorable to our expectations, declining 7% compared to our double-digit expectation. With that said, let me shift to the highlights resulting from our own execution. We delivered positive 2% growth in employer services new business bookings, which was significantly ahead of our expectations and marked a record Q1 performance. As you may recall from our commentary last quarter, we did expect some amount of sequential improvement relative to our Q4 bookings performance as economic condition stabilized. However, we delivered a much faster reacceleration as our sales force started strong in July and carry that momentum through the end of the quarter. We attribute the rapid reacceleration to a few key factors. First, we did see our clients and prospects show greater willingness to engage and purchase. But second and most importantly, we took action by maintaining our overall investment in sales and marketing, applying our best-in-class inside sales expertise to continue training our field sales force and utilizing innovative demos and other HCM content to start conversations. We've designed a client acquisition funnel that is successful even in the current environment. Our teams delivered across the board. That's everything from the downmarket where RUN continues to grow. And in fact, we've now exceeded 700,000 RUN clients for the first-time surpassing pre-COVID levels to the mid-market, where we're seeing clients showing more interest in fully outsourced HRO solutions to the enterprise space, where we had strong traction in compliance-related solutions. Our international sales were also strong as we closed several larger deals that were previously put on hold as prospects were waiting for a more stable environment to proceed. And our tax rates on many of our solutions continue to increase as well. This quarter, our workforce management solutions also referred to as time and attendance reached the 90,000 milestone for the first-time. And we're pleased to see that continue to grow our revenue. Our revenue outperformance was also driven by stronger retention. We are very proud to report that we hit record employer services retention levels for a Q1 period and our performance likewise experienced – and our PEO performance likewise experienced stronger than expected retention. While our retention likely benefited from having some clients delayed decisions to switch HCM vendors, given elevated uncertainty, higher client satisfaction clearly contributed as well. You may recall that last quarter we delivered record NPS scores across our businesses. As we helped our clients manage through government programs like the PPP. This quarter, I'm happy to say that across our businesses, we either maintained or reached new record NPS levels. We believe these results show that our commitment to providing outstanding service to our clients is paying off and we'll continue to do so. Combination of stronger bookings and retention in Q1 drove better revenue performance and the high incremental profitability associated with those revenues plus prudent expense management ultimately drove stronger margin performance as well. This is another great example of execution by our associates. And in a few minutes, Kathleen will cover our margin performance in more detail. I'd like to now provide an update on the progress we continue to make in driving innovation. Earlier this month, as part of the annual HR Tech Conference, ADP was given the Top HR Product award. This marks a record-setting six consecutive year that we have been recognized at the conference for breakthrough technology innovations, which is representative of how we remain committed to leading the industry with the premier HCM technology. This year, we were recognized for our Next Gen Payroll engine. And as we highlighted in our February Innovation Day, the benefits of this new engine include a policy-based framework that enables easy self-service and powerful transparency that allows practitioners and employees to more easily understand the effects of regulatory policy or potential life changes and is designed to be scaled globally. We continue to deploy our Next Gen engine to the market and we added another 100 clients during the first quarter. We remain excited about expanding its availability and driving adoption. And the feedback so far has been overwhelmingly positive. Ultimately, we expect a higher level of satisfaction to generate even better retention and higher win rates, supporting our long-term revenue growth trajectory. And we continue to innovate throughout our ecosystem. This quarter, the ADP marketplace reached 500 app listings and we are pleased to offer an expanding suite of offerings as we continue to drive millions of daily API transactions for tens of thousands of clients that are current users. And just this past week, we hosted our Annual ADP Marketplace Partner Summit, where we further strengthened our partner relations and provided actionable ideas to help our partners grow their business. Also earlier in Q1, we released our Return to Workplace solution that helps clients bring their employees back to work safely through a comprehensive set of tools designed to streamline and manage the process. We now have thousands of clients using the Return to Workplace solution, and we expect usage to grow over time as more clients start to gradually bring their employees back to the office or the work site. As I said, we are very pleased with the start of the year. And I'd like to recognize our associates from sales to service implementation and all the others who support them for their continued efforts in outstanding performance during this time. They continue to come through for our clients when it matters most. And with that, I'll now turn the call over to Kathleen."
},
{
"speaker": "Kathleen Winters",
"text": "Thank you, Carlos, and good morning, everyone. We had a great Q1 with the combination of gradually improving macroeconomic conditions and outstanding execution, driving better sales retention and overall volume. We do expect to continue to face a number of headwinds over the course of fiscal 2021, as the global economy continues to recover from the effects of the COVID-19 pandemic. But with our strong first quarter, we now see the potential for a better full year outcome compared to our outlook three months ago and our updated guidance reflects this view. For the first quarter, our revenue declined 1% on a reported and organic constant currency basis. Clearly a nice start out of the gate and better than we were expecting three months ago. Better bookings and retention rates were the main drivers of revenue favorability. And that coupled with expense favorability resulted in a year-over-year increase of 120 basis points in our adjusted EBIT margin. As you will recall, we anticipated that first quarter would have a modest acceleration in bookings compared to the previous quarter, but a greater year-over-year revenue decline than we experienced in the previous quarter. And that much of this loss revenue would be at very high margin. Instead, our booking swung to a year-over-year increase, revenues declined only modestly and our margins expanded even with the sales and implementation expense generated by a much stronger than expected bookings quarter. Several factors drove this margin favorability. First, with a more modest revenue decline than expected in Q1, we saw less associated margin pressure than expected. In addition, the better retention we had in Q1 also translated to lower bad debt expense than we had originally contemplated. We also continue to execute our downturn playbook with our entire organization carefully managing headcount and discretionary expenses. And lastly, we make great progress on our digital transformation and expanded procurement initiatives in Q1 and effectively reduced operating expenses and overhead faster than anticipated. We are encouraged by what we've seen so far and are making a modest increase in our expected full year cost benefit from these transformation initiatives. And now expect $150 million in benefit for fiscal 2021 up from $125 million. That revenue and margin performance together drove adjusted EBIT growth of 5%. Our adjusted effective tax rate increased 10 basis points compared to the first quarter of fiscal 2020 to 21.3%, driven by lower tax benefit on excess stock sensation. Our share count was lower year-over-year driven by both share repurchases that took place pre-COVID as well as the resumption of buybacks during the quarter. All of this combined to drive 5% growth in adjusted diluted earnings per share to $1.41, a great start to the year. Now, some detail on the segments. For ES, our revenues declined 3% on a reported basis and 3% on an organic constant currency basis. A great result considering this quarter included the effects of a 9% decline in pays per control and a 20% drop in client funds interest revenue, plus the impact from last quarter’s lower booking level. Our client funds balances were down only 7% better than the double-digit decline expected. And that outperformance was driven by the same bookings and retention related factors that supported revenue. The year-over-year decline in average balances continued to be impacted by lower pays per control, lower state unemployment insurance rates, continued payroll tax deferrals amongst some of our clients and the closure of our Netherlands money movement operation in October of 2019. Our average yield for our client funds interest declined by 30 basis points about in line with our expectations in this low interest rate environment. Employer services margin was up 120 basis points for the quarter, well ahead of our most recent expectations, driven by the same factors I mentioned earlier when discussing consolidated results. For PEO also a strong quarter out of the gate, our total PEO segment revenues increased 4% for the quarter to $1.1 billion and average work-site employees declined only 3% to 547,000. This revenue growth and work site employee performance were both ahead of our expectations, driven primarily by better retention and stronger than expected bookings in Q1. Same-store employment at our PEO clients performed in line with our expectations for mid-single digit decline steady from last quarter. Revenues excluding zero margin benefits pass-throughs declined 1%, and in addition to being driven by lower WSEs, it continued to include pressure from lower workers' compensation and SUI costs and related pricing. PEO margin increased 40 basis points in the quarter. This included about a 60 basis points of favoribility from ADP Indemnity pertaining to changes in the actuarial loss estimates. Let me now turn to our updated guidance for fiscal 2021. We are very encouraged by our strong Q1 performance. We are still somewhat cautious about the balance of the year. You'll see that the implied increase in guidance for the next three quarters builds in some ongoing momentum for the balance of the year, but does not anticipate the same level of outperformance we just experienced in Q1. This reflects both our confidence in the fundamental strengths of ADP, as well as a realistic assessment of the lingering uncertainties ahead for the global economy, including uncertainty around the rate of continued economic improvement, the labor participation rate and the timeline for a vaccine. For the details of our outlook, I'll start by updating you on some of our key macroeconomic assumptions. For pays per control, we continue to expect a decline of 3% to 4% for the year. And as we mentioned, pays per control performed approximately in line with our expectations in Q1. We continue to assume a modest pace of improvement from this point, with mid-to-high single digit decline in Q2, improving to a mid-single digit decline in Q3, followed by a mid-to-high single digit increase in Q4 on the easier compare. And as you are aware, the reported BLS unemployment rate has trended better than most people's expectations these past few months. But factors like a reduced labor force participation rate are creating an offset, which is why our pays per control has actually been in line so far. Out-of-business losses outperformed our expectations and contributed to our record Q1 retention levels. We are raising our retention guidance accordingly. While we have seen effectively no incremental pressure so far this year from increased bankruptcies among our clients with continued uncertainty as to further stimulus and strain in parts of the economy remaining from partial shutdowns. We believe it is still prudent to assume some effect from higher out-of-business losses in the coming quarters. On client funds interest, there is no material change to our expectation for average interest rates for the year, though we are revising our balanced growth higher, given the better start to the year with stronger sales and retention. We continue to expect the client funds balances to return to year-over-year growth in Q4. Let's now look at a revised fiscal 2021 guidance. I'll start with ES. We now expect revenue to be flat to down 2% for the full year versus our previous expectation for a decline of 3% to 5%. I'll break that down into some of its components. We now expect our new business bookings to be up 10% to 20% compared to our prior forecast of flat to up 10%. That 10% increase in guidance reflects the impact of our Q1 outperformance, as well as a slight increase in our bookings expectation over the rest of the year. We are still contemplating a modest year-over-year bookings decline in Q2, as instances of partial economic lockdowns in Europe, plus uncertainty from the U.S. election keep us somewhat cautious, but this Q2 outlook is certainly better than what we contemplated three months ago. We now expect our ES retention to be flat to down 50 basis points, versus down 50 to 100 basis points previously. As again we had stronger Q1 retention than expected and believe our strong client satisfaction will translate to continued strong controllable retention, that we continue to assume elevated out-of-business losses in Q2 and Q3. And for our client funds interest, which primarily impacts the results of our ES segment, we are raising our average balances expectation on the strong Q1 sales and retention performance and accordingly raising our client funds interest range by $10 million, now to $400 million to $410 million. We now expect our margin in the Employer Services segment to be down 100 basis points to 150 basis points for the year versus our prior forecast of down 300 basis points, driven by the stronger Q1 performance, a stronger revenue outlook and continued expense discipline. For our PEO, we now expect revenue to be flat to up 3% versus our previous forecast of down 2% to up 2%. And we expect an average worksite employee count down 1% to up 1% versus our previous forecast of flat to down 3%. We continue to expect average work-site employee growth to be negative during the first three quarters and turn positive in Q4. Our revenues excluding zero-margin pass-throughs are expected to be down 1% to up 1% versus our previous forecast of down 4% to down 1%. We continue to expect lower workers' compensation and SUI revenues on a per work site employee basis. For PEO margin, we now expect to be down 50 basis points to flat in fiscal 2021, versus our prior forecast for down 100 basis points, this increase in our guidance is driven by stronger revenues and a more favorable benefit from ADP Indemnity. Moving to our consolidated outlook. We now anticipate total ADP revenue to be down 1% to up 1% in fiscal 2021, versus down 4% to down 1% prior. And we anticipate our adjusted EBIT margin to be down 100 basis points to 150 basis points versus our prior guide of down 300 basis points. As I mentioned earlier, we now expect about $150 million in savings from the combination of our digital transformation, as well as our procurement transformation initiatives. And we will continue to manage our expense base prudently. As we saw in Q1, you should expect that further upside to our revenues, whether from macro-related factors or our own execution should drive upside to our margins as well. In August, we refinanced $1 billion of notes maturing in 2020. And as a result, we will benefit from approximately $5 million in interest expense savings this year. For our effective tax rate, we continue to anticipate 23.1% for the year. We resumed our share repurchases in Q1, and we assume a net share count reduction in our guidance. Net of all these changes, we are raising our adjusted diluted EPS guidance to a decline of 3% to 7%, which represents a much more modest decline, compared to our prior guidance of down 13% to 18%. I'd like to wrap up with a few comments on longer-term margins. To be clear, there has been no departure from our focused and consistent approach to continue to drive margins higher over the long-term. Looking beyond fiscal 2021, a continued economic recovery should support employment growth and above normal pays per control growth. And we would expect such a trend to contribute incremental margin uplift to our results, all else being equal. The impact of lower interest rates will also begin to moderate in the coming years. In addition to these macroeconomic factors, we expect our underlying margin performance to continue to be supplemented by our ongoing efforts to transform our organization and client service operations and to be supported long-term by Next Gen platforms that are more efficient and less expensive to maintain. As you have seen from our Q1 results, we are committed to protecting and driving margins, even as we maintain our steady approach to investing for the long-term. We remain confident in our long-term growth prospects and our ability to execute. And I look forward to continuing to update you on our progress. With that, I will turn it over to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] And our first question comes from David Togut from Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you. Good morning and good to see the upgraded guidance. As we entered the critical year end selling season, I hear the caution around factors like partial lockdowns in Europe and the U.S. election. But can you give us some more detailed kind of insight around your expectations for new bookings potentially have RUN, Workforce Now, Vantage and our surveys of your customers pre-COVID, we were hearing a lot of demand for Workforce Now, especially into the bottom of the market up to 4,000 to 5,000 employees per company."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. I mean, I think that we'd like to be – given the momentum we just demonstrated, we'd like to be really optimistic, unfortunately, we all watch the same news and the backdrop in terms of these issues, it's not just Europe, I think there are some concerns here in the U.S. as well. And what we saw from April – March, April May, is that we stick to our story that our clients – if our clients are hunkering down and are unable to make decisions, it impacts us. So we remain positive because it doesn't feel like there's going to be a full lockdown across the board nationally like there was here in the U.S. last time. And we've clearly adapted, I mean we've – you can see it in the quarter, how much progress we've made in terms of being able to sell virtually and use online tools and really ramp up our digital marketing and a lot of other things that we can talk about that we've done to adjust our salesforce. But for us to tell you what our view is of RUN and Workforce Now and enterprise sales in the next two or three months, honestly is difficult other than to stick to our story around our guidance, which is really more about the full year and couching it in optimistic, positive and good execution terms, but also with some level of caution, because we're still dependent, I think on the healthcare situation and to some extent on the economy as well. One of the questions that you're not – you didn't ask, but I'm sure people are wondering is about this – question is stimulus. And that's another one that I wish we could tell you that we have kind of a scientific placeholder in our forecast around how much stimulus and whether there is stimulus or not and we don't – but that's another factor that I think would just create the kind of overall picture that would either be supportive or not supportive of our sales efforts, because clearly if you look at the last 20, 30 years of ADP, there is some general correlation between GDP and our sales results, our new business bookings. And that is impacted by not just the economic activity related to the healthcare crisis but also to things like stimulus, because obviously the government can offset down pressure on the economy, through stimulus as it just did, but there is also uncertainty around that as well. So I wish I could give you a more concrete, one thing I can tell you for sure is we're maintaining our sales investment, we're maintaining our optimism and we are gradually getting some people back into the field in terms of selling. And we're certainly pivoting in a big way in terms of using the large resources we already had with inside sales to really train a lot of our traditional field sales to be able to sell virtually. And I think you saw a great execution and great results in the quarter as a result of that."
},
{
"speaker": "Kathleen Winters",
"text": "I'd just add one other thought here or comment here. In addition to what Carlos said, I mean, look, obviously we're very encouraged and we're optimistic because of the great outperformance in Q1. But as you heard us say, we're very cautious because of the various uncertainties that we mentioned. But I would also say, we're cautious because as we look back in history and as we look at how in other recessions, how we recovered from that. We do see a period of chopping as it's not all kind of a straight line up in terms of the recovery during the great financial recession after that, we had I believe it was six quarters of negative sales growth after that and it was quite choppy actually. So we're expecting there to be some choppiness here as well. So I just wanted you to be aware of that."
},
{
"speaker": "David Togut",
"text": "Understood. As a follow-up, how do you see the current economic environment affecting the case for outsourcing of payroll and HR services? In other words do the economic challenges that businesses face make them want to focus more on their core business and outsource payroll and HR services?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. I mean, I think that's safe to assume that we would probably be on the side of the ledger of businesses that would benefit “under normal circumstances post pandemic”. So in other words, once we get through the transitory nature of the challenge, I don't see how it's not a positive backdrop for companies like ADP and outsourcers who help people, first of all, maintain business continuity, and second of all, focus on their core business as you imply. So I think it has to – again, but we have – what do we – how many points of growth is that, only history will tell, but we think it will – we think it’ll be a positive."
},
{
"speaker": "David Togut",
"text": "Understood. Thanks very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Lisa Ellis from MoffettNathanson. Your line is open."
},
{
"speaker": "Lisa Ellis",
"text": "Hi, good morning guys. Thanks for taking my question. Wow, the recovery in bookings is pretty fantastic. I know you provided a little color around using your inside sales to train your outside sales. Can you just even provide a little, like, what is your sales model looking like right now? To what extent are you using kind of digital marketing and digital onboarding? Can you just give a little bit more color around kind of what happened and what changed over the course of the three months to drive that recovery?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. I'm not sure that the call is long enough though to be able to give you all that, because one of the differences between us and some of our competitors, which I would see it as a positive, if I were all of you, is that we're very diversified both geographically and also across segments. So the answer unfortunately is complicated and it goes area-by-area. So in international for example, we're very happy with very strong results versus expectation, but also frankly, very strong results versus the prior year. But there were a few larger deals there, I think there were few global view deals that helped. And when you look at the core best of breed, like in-country solutions, we also outperform there versus expectations, but not as well in terms of versus the prior year, which is obviously understandable given the pandemic. So that's international. And then you move to the U.S. and the story in a downmarket is different and the midmarket is different than the upmarket. Although across the board, we were better than expected. But the growth year-over-year varied, because I think that's the biggest surprise, which we're frankly very excited about is that we have positive growth. But if you decompose it, it's a different story in each area. And we had tailwinds in the downmarket, I think as result of some big recovery that was probably some pent up demand, the PPP loans probably frankly saved a lot of small businesses and provided a lot of cash to small businesses to continue to kind of run their businesses and make decisions around purchasing solutions like what we provide to help them run their business better. So it really – by the way, our upmarket was also good and strong. So that was very encouraging the midmarket I think performed also better than our expectations. So I wish I could give you a simple answer. I personally see it as a positive, because if it was one thing that we could point to, I think it would be problematic because that could easily change overnight, but there really isn't, it's just a lot of execution across the board. I do think that we got a little bit of help, again, we don't have a scientific way of estimating it, but I've been consistent in the nine years that I've been in this job, because of knowing our culture and how we operate, the fact that our fiscal year ended where it did, we clearly had a little bit of pent up demand from call it May, June that carried over into July. I would say that, that was somewhat minor in this case, because getting companies to make decisions on your timeline is probably not as easy to do now as it has been in prior years. But historically when we have a bad year, we get off to a good start. And in some segments that didn't affect probably international business, didn't affect the downmarket, because the downmarket doesn't really have that ability to kind of hold off on something and started in the next fiscal year. But may have had a little bit of an impact. But we're pretty convinced that that's not a major story, but I thought I was important for me to be consistent, because I've been saying that for nine years, by the way, likewise, we have a blowout fourth quarter, we end up usually struggling at the beginning of the next fiscal year."
},
{
"speaker": "Lisa Ellis",
"text": "Okay. And then for my follow-up, I know you called out the payroll engine and adding 100 additional clients this quarter. Can you just remind us or update us on sort of where you are in that overall rollout and what the kind of rate and pace of that is?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So I think we have a total of a couple 100 clients, and I would describe that as still are very early compared to ADP’s size. So if we were a startup, you'd be really excited. And I think we have a $20 billion market cap right now with only 200 clients, given what I've been seeing in the market. But the reality is that relative to ADP size and given our profile as a company and so forth, you got to take it in context, but we can't help, but be excited, because two years, three years, five years, 10 years down the road, it's going to be a big difference maker. I think it is, and that was our plan, when we built the business case, we've been at it for three or four years, this is a global scalable new payroll engine, it's incredibly exciting in terms of what it's going to do in terms of feature functionality, and hopefully client satisfaction, but also cost to maintain, cost to develop. But as you know, we have approximately 800,000 clients, sorry, 900,000, that's not fair because RUN, this has nothing to do with RUN. But a large portion of ADP's business is still on our current versions of our payroll engine, which by the way, all of these payroll engines are transparent to the clients. I don't know if any of you guys understand that, but Workforce Now and Vantage and Lithion, and all of our products are the front ends are really what our clients experience. And it's just important to remember that this is not like the transitions we had with Workforce Now, or even with RUN, because this is a gross to net engine that is really kind of underneath the hood, if you will of what the clients are experiencing on the front end. So that's positive too, because we don't anticipate a major migration effort, if you will, when we get to that, which is still at some point in the future."
},
{
"speaker": "Lisa Ellis",
"text": "Terrific. Thank you. Nice job."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-tsin Huang from JP Morgan. Your line is open."
},
{
"speaker": "Tien-tsin Huang",
"text": "Thanks so much. Good morning, really terrific new sales results. Just to add to what Lisa asked at the beginning there, just thinking about ROI on your sales investments. Did you lean in really hard in this quarter there, and I'm sure everyone was motivated to drive sales, but could we see more return on some incremental investments as you go throughout the fiscal year? I was trying to understand the timing of some of the investments you put in place, and also if there is any call-outs on pricing on new deals, especially on the enterprise side."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. So on the sales investment, what I would say is maybe think about two big buckets in terms of investment from a headcount perspective and continuing to invest in marketing and digital marketing. The headcount investment, we kind of try to do that on a very steady pace over time, and that's been consistent with how we've thought about it and approached it. It was somewhat modest headcount investment in Q1 and that will ramp up during the course of the year, we're planning to continue to focus on and do that. And for sure have committed funding and resources, if you will from a digital marketing perspective to help support the bookings."
},
{
"speaker": "Tien-tsin Huang",
"text": "Terrific. And then on pricing, anything – any call outs there?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No. It's really – we really don't see any – I'm sure I know we did and I think some of our competitors did things to try to help our clients. And even in some cases prospects like there was a couple of examples of people giving away like three free months. And I think one competitor was doing six free months, et cetera. But – and one competitor changed their pricing online, but then changed to back a couple months later. So I would say there is nothing to report. There is really very little change in the pricing environment. This is not – I don't think this is really a question of pricing. I don't think you can impact end demand in a significant way in this environment through that, that would not be – certainly would be our view, that’s not how to drive growth."
},
{
"speaker": "Tien-tsin Huang",
"text": "Great to hear. Just my quick follow-up, just on PEO and sort of the sales outlook there, given some of the same caution and uncertainty with the election and maybe insurance. Do you – are you more bullish or less bullish on PEO here as we go into the second quarter here versus 90 days ago?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I'm always bullish on the PEO. I was born in the PEO. And as you know, so the – I think the – as usual my answer has to be, if you look at the short-term, we have a lot of pressure in some parts of our business because of the healthcare situation. And the question is, do you want to look through that or do you want to stay focused on us, for example, in the PEO when you have clients shrinking, we from a discipline standpoint have some rules around that can sometimes affect – create adjustments, if you will, in our sales results, it puts pressure in the short-term on the sales results i.e., call it audits if you will. So if a client was sold and was valued at $1,000 and 12 months later, they're now valued at $900 because they're paying fewer people than we're collecting less revenue, which as you can imagine is happening with the majority of our clients that affects our PEO sales results. So I’d say that the fact that workers’ compensation, prices and costs have come down, which is part of the revenue picture, there is a lot of short-term transitory things. But I would say on a unit basis, our results were very good in the quarter. And we’re very happy with that. And I would say that again, if there is any businesses that are going to be even more from a pure positioning standpoint, stronger coming out of the pandemic, the comprehensive outsourcing businesses, which PEO is one of them should be very compelling value propositions, because, as people look back a year or two from now, they might be thinking, I really don't want to go through that again. I don't want to be figuring out how to process, forget about payroll, because that – we have that covered. But most people – a lot of our clients do not use us for health benefits, processing or management of open enrollment, they don't use us for time and attendance, they don't use us for workers' compensation and our comprehensive solutions take care of the entire picture. And I think if you're a small and mid-sized business, if I were you, I'd be thinking about making that change, maybe not right now, because you've got other things that you're focused on, but I think six to 12 months from now, I would expect people to be seriously considering any options they have to deal with multiple things that are very critical to the ongoing operations and to their employees, but they may not have thought of pre-pandemic."
},
{
"speaker": "Tien-tsin Huang",
"text": "Got it. I was going to get you on the phone and start selling them. Thank you for that update."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg from Bank of America. Your line is open."
},
{
"speaker": "Mihir Bhatia",
"text": "Hi, this is Mihir on the Jason. Thank you for taking our questions. Maybe I can just follow-up a little bit on bookings. If you could maybe just talk a little bit about trends you saw in a F1Q and what you're seeing even now, I guess, between small, medium and large. Anything different worth calling out that we should be considering? And then just relatedly on booking. Was there any negative booking adjustment in the F1Q booking numbers?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I'm sorry, negative adjustment in which Q?"
},
{
"speaker": "Mihir Bhatia",
"text": "In the booking number this quarter – like in terms of booking number this quarter?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No. We had a minor – I would say we had a minor, we talked about last quarter that we had taken some reserves because we expected to have – obviously clients that were going to cancel their orders and so forth to abuse laypersons terms. And I think that's exactly what happened. And I think our – we did reverse some of that reserve, but it was actually very much in line with the actual client. We had identified, we didn't do this kind of at a very high level. We had specific clients when we booked that reserve in our “bookings”, we had identified a list of clients that we thought were probably going to cancel in this first quarter. And I believe the two things…"
},
{
"speaker": "Kathleen Winters",
"text": "Yes, and so we utilized – we basically utilized a portion of that reserve, which is a normal course of how it happens. I guess Q4 was just an outsized amount for that, we call it the backlog adjustment. It's just outside obviously because of the COVID impact and a portion of that was utilized in Q1, but nothing significant other than that."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think it's safe to say it would not have made a difference. I mean, it clearly would've made a difference if we hadn't had the – but if you want to know what our gross bookings performance was, it was not affected by our gross bookings performance, it did not affect our gross bookings performance. You would have had basically the same picture."
},
{
"speaker": "Mihir Bhatia",
"text": "Understood. And then just any trends between, just small, medium or large businesses, what you were seeing this quarter?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Other than noise, I think we – probably the strongest performance was in the downmarket because much to everyone's surprise, there is strong business formation. And we saw that as kind of – we talked about that in our last call, remarkable recovery in small business very quickly at the beginning of the pandemic, both in terms of pace for control in kind of all categories, including this kind of new business formation. And I would probably add a note of caution there that to me is counterintuitive, and whenever in my career I've seen something that doesn't make sense, it generally – I think there is probably a little bit of payback at some point, I'm hoping I'm wrong, because if there is a relatively quick solution to the healthcare crisis, it's possible if the government managed to get small business through this relatively unscathed through PPP and all the other things that they've done. But in general it's a counterintuitive kind of situation. But we'll take it, it was positive."
},
{
"speaker": "Kathleen Winters",
"text": "Yes. The other areas where we saw some particular strengths, and I think we mentioned already on the international side, particularly Canada was very strong for the quarter and also our compliance services area. So things like employment verification, unemployment claims, things like add more compliance of services related stuff saw a very strong performance in the quarter."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, it’s a great point. Like we don't always talk about some of these businesses that we have that are very good businesses, we call them standalone businesses. And we did have some good tailwinds from some of those businesses quarter. But again, I would tell you that they don't change the overall picture, but important to note that those were helpful."
},
{
"speaker": "Mihir Bhatia",
"text": "Understood. And then just, if I could follow-up real quick on your EBIT margin guidance, you had a pretty nice raise in the guidance. And I was just wondering how much of that is driven by the stronger top line outlook versus changes in your expectations by expenses. I know you mentioned an extra $25 million in transformation savings, but were there other factors because it doesn't look like, it's just float income didn’t change all that much. So anything else if you could give us there? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "I would say it's safe to assume that most of it is as a result of that. But that I don't want to take away from us in terms of our execution, because, if we have higher revenue, we also frankly have more clients more employees to pay. So to the extent that we believe we can hold the line on expenses, some companies, you have to cut expenses, in our case, we just have to hold the line and that's probably good news, but I would say that mathematically you're on the right track, which is – that's a big factor. The incremental revenue is – a lot of it is flowing to the bottom line and helping our margins."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, definitely that incremental high margin revenue is the biggest contributor, but also, as we said look, we've been really focused on making sure we're doing a good job on cost control. We're keeping a close watch on headcount. We talked about investment in sales, but other than sales we're really controlling everywhere else from a headcount perspective. Very tight on discretionary costs, transformation work is coming along very nicely. We did a little bit better with the higher retention, better on bad debt expense in Q1. We think we're cautious about that because we think it could come and hit us in Q2 and Q3. So we've built that into our expectation. But those were the contributors."
},
{
"speaker": "Mihir Bhatia",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal from Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, good morning. And thanks for taking my question. I wanted to ask about the contribution to bookings performance of delayed, kind of bookings getting realized this quarter versus sort of net new bookings. I'm just trying to understand the contribution from maybe sort of a backlog of delayed bookings and how material that was. And then also to just understand what it is, sort of a pipeline of these delays that should flow in, kind of continue to flow in as we get a little deeper into the year or was there more of sort of a one-time catch-up that happened in the quarter with some of these delayed deals, does that makes sense?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I’d say the only place where it's really meaningful and quantifiable is probably in the international space where we had, I think I mentioned a few global view deals that were delayed if you will, but that's actually not a – I wouldn't call it, that's not something that was in the – necessarily in the backlog because we hadn't sold it yet. So we don't actually book a sale until it doesn't go into the backlog until we get a contract. And so these were things that were in process, if you will, or in the sales process. And maybe we thought it was going to close in May or June, but by the way, maybe it wouldn't have – even without a pandemic, like there's really no way to, this is all frankly speculation stuff that we do when we get into these kinds of conversations. But I say that's the place where a field like we had a few large deals that we thought were going to close in the fourth quarter and didn't, by the way, client decisions, not us trying to move them from one quarter to the other. We want to get businesses as fast as we can. So we are always trying to book everything as quickly as we can, but some client delays in the international space, it's really not honestly a factor in the downmarket and very small factor in the mid-market in terms of controllability. We can't really sway our clients that easily from one way to the other. Maybe a little bit of that in the upmarket and in international, but you really can't do that in a downmarket and the mid-market. So I would say, there's a difference between, I guess I'm not sure what the nature of the question is, but I think I already said that there could have been some – in some segments of our sales force, if you have a terrible year and you're in the last month and you're not going to make the year, there's sometimes the tendency for people to hold and start that business in July. But I think you saw in our comments that August and September were also strong. So it doesn't feel like – people don't like hold something from May and June, and then book it at the last day of September. They typically put it in the first week of July. And so again, based on my experience and what I've seen here over the years, there was probably a little bit of that didn't make a material difference in the sales results. And it is where it is. We had a great start and I think great execution. And besides us leaning into our sales investments, the really big difference maker here is our sales force leaned in to drive results, right. And we're incredibly grateful to them for that."
},
{
"speaker": "Ramsey El-Assal",
"text": "All right, that helps a lot. I appreciate it. And just a quick follow-up on the – if you could give us an update on the rollout of the Next Gen HCM and the Payroll engines relative to, let's say three months ago or four months ago, how do you think COVID is going to impact the roll out of some of the Next Gen technologies? Is it going to be – you mentioned some delays, I think previously, but how is it looking now?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, we had – I think we had a good quarter like – frankly, if any client to me is a good point. It's good news. And I think we had three or four. I think Danny probably…"
},
{
"speaker": "Kathleen Winters",
"text": "That’s right. Yes, we had a couple of them, good sales."
},
{
"speaker": "Carlos Rodriguez",
"text": "We had some sales like closed. In other words, we got people to sign contracts in the quarter. Like, I don't know about anybody else, but I'm not spending a lot of contracts in this kind of environment. Like we just – the whole focus of this call is how we're focused on prudent expense management and trying to keep expenses down. So when people are coming to me, selling me things, I'm generally not a big signer on those types of things. So just shows, I think the value of – of our value proposition that people are still signing up because I think they believe that it will not only help them in the short-term, but that perhaps it can make them more efficient even in the short-term. So I think that is a good sign, right, of the strength of our products and the solutions and the pitch that we have. But that was good news. I mean, we were pleasantly surprised."
},
{
"speaker": "Kathleen Winters",
"text": "And we have several dozen, I think in implementation, active implementations right now. So the sales are continuing, the backlog, the implementations continued to scale up. So really no significant or substantial change in the outlook."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think besides the sales, we actually started, I think a number of clients, three or four also."
},
{
"speaker": "Danyal Hussain",
"text": "Yes. We're in the double-digits now."
},
{
"speaker": "Carlos Rodriguez",
"text": "These are clients – we actually sold new clients, new contract that are now going to go into the implementation process, but we had clients that were in the implementation process, a few of which delayed starting in the fourth quarter, but then we started them here in the first quarter. So I would say that's all the news. And on Next Gen Payroll, you heard what we said and sold 100, which again, I think is pretty damn good news, like in this kind of environment."
},
{
"speaker": "Ramsey El-Assal",
"text": "Agreed. I appreciate your answers. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steven Wald from Morgan Stanley. Your line is open."
},
{
"speaker": "Steven Wald",
"text": "Great. Thank you. Good morning. So I'd love to come back to the margin. I know some be in over the head, but maybe just a couple of other sort of ways to look at it. It seems like the way you're all looking at it going forward is, if macro cooperates in the higher margin pieces of the revenue could drop to the bottom line and drive incremental upside from here. Is that the right way to think about it? And generally, should we assume that implicit in the remaining three quarters of the year, the lower margin implicit assumption for at least a couple of those quarters is really more dependent on the macro than it is on your piece of investment, which I think we maybe collectively thought was going to be more robust than the headwind relative to what it ended up being this quarter?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Okay. So just to clarify, remember we outperformed not because we stopped investing or didn't invest as much as we said we were going to invest is because we outperformed on the top line, right. In terms of our revenue, even though some of it was clearly expense management and so forth. But I would say that the answer to that question is that, it's hard to wrap your head around our economic. I know it's hard because most companies don't operate this way, but for example, the better things get in terms of the macroeconomic, the more we're going to invest. And I know that's not going to make some people happy, but like for example, our fourth quarter, like our fourth quarter, like if things play out the way we planned in terms of the original guidances and we're not changing anything on you, but like our fourth quarter where we have easier comps, we would also expect to have great sales results, right. And those great sales results on a comp basis will also bring with them sales expense. And to the extent, we can get some of these clients started and our sales results improved, we're going to start also investing more and stepping on the accelerator and implementation expenses. So this is all carefully planned, carefully controlled as Kathleen was alluding to, like, this is not some kind of free-for-all in terms of expenses, but this is an amazing economic model. I don't know if you can see what we just delivered and what we're telling you that assuming that the situation cooperates with us, we probably will be either flat to slightly up in terms of revenue for the year. So that would mean that, we'll continue our streak of ADP of never being negative revenue growth, which is pretty remarkable, right. We had a massive decline in volume in the last quarter, massive declines in new business bookings. And you see now granted, this is not what we are targeting like, we'd like to have high single-digit revenue growth. So it's kind of weird that we're excited about flat, but it's all about the context and it's all about relativity. So it's really a great economic model, but the economic model is a long-term economic model. You have to invest in sales, implementation, and product to drive the results. This is not – we're not running the business quarter-to-quarter. And what that means is the minute we see the sunshine – the sun shining we're going to become boasted. It doesn't mean that our expenses are going to get out of control, but you will see our sales and our implementation expenses gradually come up. And along with that, some point our service expenses as well. But that's great because the most important driver of long-term value of this company is growth. It's not what the margin in next quarter or this year."
},
{
"speaker": "Steven Wald",
"text": "I understood. Sorry."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, just some more color from my perspective. I mean, I would just say, look, we continue to be, as we always have been very, very focused on growth and efficiency and becoming more and more efficient every day. So we're going to continue to invest where it makes sense for growth and for efficiency. So we talked about sales headcount and continuing to support that investment, investment in product. And we invest in efficiency, all of the digital work that we're doing isn't, it doesn't come for free. You have to make investments to be able to drive that efficiency improvement. So we're focused on all of that and we're going to continue to do that."
},
{
"speaker": "Danyal Hussain",
"text": "And Steve, just one last thing to tie it back to our guidance. You're right. Certain macro factors will have an outsized impact for the next two quarters. And so what we've contemplated is pressure in retention and pays per control, both of which come at high incremental margins. If ultimately those come out better than forecasted, as you suggest, they would represent upside to margin."
},
{
"speaker": "Carlos Rodriguez",
"text": "There's a few others, like Kathleen mentioned bad debt expense is also something that, frankly has been shocking in the last six months where we've had, honestly like decreases in our bad debt expense, which makes no sense at all. So hopefully that will continue, but we didn't plan for that. I think we didn't roll forward three quarters of lower bad debt expense."
},
{
"speaker": "Steven Wald",
"text": "Right. Okay. That's all very helpful. Thank you. And then maybe as my follow up there, I think it was asked a little bit before, but Carlos, you were just talking about it a little bit ago there of just kind of wanting to grow mid to high single-digits. If we rewind the tape back to January and you guys talked about the markets you were in and how you were growing, sort of seemed like the way to think about it was you were generally growing in line with the market. And I think your earlier comments indicated, next few years should be an uptick, but there's going to be choppiness of course. I guess I'm curious how you guys think of ADP's positioning relative to other platforms. And obviously, you had a really strong quarter. But for the last several years, you've seen a lot of other platforms growing, in excess off of much lower basis. I'm just curious how you think about it today versus six months ago versus a year ago. If we are to see this uptick in HCM demand and outsourcing demand, where you feel about ADP's positioning in that market?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I would answer that question just by saying that we just invested hundreds of millions of dollars in new platforms in our key markets, because we intend to take market share."
},
{
"speaker": "Steven Wald",
"text": "Couldn't be clearer than that. Okay, I'll leave it there. Thanks guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh from Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thanks. Hey Kathleen, you talked about kind of out-of-business and the guidance looks like it calls for kind of elevated losses in Q2 and Q3. Did it bottom in Q1 and gets better? And then I guess just along those same lines, can you talk about, is there a way to also frame clients that are maybe still in business, but not processing at this point? So I guess, two different questions, just trying to get a sense of a, where the out-of-business did it bottom Q1 and then improves in Q2, Q3, and then as your way to frame no clients still in business that maybe aren't processing at this point?"
},
{
"speaker": "Kathleen Winters",
"text": "Yes. So on the first thing, the out-of-business, I would not say it bottomed at all. In fact, we did not see a significant impact from out-of-business in Q1. I think the shoe has yet to drop there is how I would say it. And that's what we are forecasting and guiding that we're going to see some pressure from that in Q2 and Q3. That come in Q2, is there more stimulus that helps support it and we don't see it in Q2 and maybe it doesn't come till Q3, I don't know, but we're planning, I think we're cautious about it. And we're planning to see that pressure in Q3 – Q2 and Q3, sorry."
},
{
"speaker": "Carlos Rodriguez",
"text": "And on your question about clients not processing, we did mention that a number of small businesses restarted in the first quarter but there is still a sizeable chunk of companies that have gone inactive and remain in that state."
},
{
"speaker": "Danyal Hussain",
"text": "And to be clear, there's just – in case there's a misunderstanding there that doesn't have – it has nothing to do with our business bookings, right. So that affects our revenue and affects our losses to some extent, but this is unrelated to business bookings. Because the word restart might confuse some people."
},
{
"speaker": "Kathleen Winters",
"text": "Yes, so higher than it would be in a normal period. It's come down from where it was at the peak in probably April, May, June, it's come down from there, but it's still higher than normal situation."
},
{
"speaker": "Kevin McVeigh",
"text": "Got it. And just to wrap that point, Carlos, it's fair to say that, with the stimulus, it probably helped those inactives a little bit that maybe would have fallen into bankruptcy. Is that a fair way to think about it too?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No question about it."
},
{
"speaker": "Kevin McVeigh",
"text": "Cool. And then just real quick, it looks like the midpoint of the revenue guidance for ES is a 300 basis point improvement versus 150 basis point improvement for the PEO, any puts and takes to – I know it's not one-to-one but is it just kind of the client mix that where you'd seen a little bit more upside on ES as opposed to PEO or just any thoughts around that?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No. Other than – that's actually a great question, which we'll go back now and decompose that because we hadn't looked at it that way. At least, I hadn't. But I would say, my instinct would tell me that has more to do with how the operating plan is built than any macroeconomic or other major explanation. So I honestly, I wouldn't read much into that."
},
{
"speaker": "Kevin McVeigh",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. And we'll take our last question from Mark Marcon from Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey, good morning. And thanks for taking my question. Just with regards to the bookings performance this quarter. To what extent, do you think it was due to the sales force basically recalibrating and being able to get out and getting more at bats, relative to higher batting average. So, in terms of thinking about the win rates, and then I have a follow-up with regards to Next Gen."
},
{
"speaker": "Carlos Rodriguez",
"text": "That's a great question. And I have some sense of that from looking at the data right from the quarter. And I would say that our win rates are in line, I think a little bit better in some cases against a few competitors, which makes us very happy. But I would say, there's not a lot to report there that is, I think good news, but consistent if you will, in general. So it's probably more the former, right, which is the at-bats. And you could almost use the – what I call it, the traffic analogy, right. So ever since the pandemic started, whenever I go out on the roads, I do the traffic check and traffic is much higher and has been much higher over the last two or three months than it was in March and April. And that probably has something to do with, talking to just people on the streets, but people on the streets turn into people buying things and people going to restaurants and people going back to their workplaces and so forth. So I hate to be so crass and so simplistic, but I think that ADP is a very large company, which we're very proud of. And the gravitational pull of GDP and economic activity is strong in both directions. And I think we benefited a lot from, I think it's safe to say better than most people. I mean, I think this is not an ADP issue. I think most economists have raised their expectations about GDP. Unemployment is lower than everyone thought, even though labor force participation is lower. In general, things are better than people thought they were going to be and call it, May, June at this point. And we have benefited from that. I think that's I wish I could take more credit and give you a more complicated answer, but I think that is actually what's happening. The traffic is up for sure."
},
{
"speaker": "Mark Marcon",
"text": "Great. And then just a short-term and a long-term question, but the short-term one is basically just as we're here in the key fall selling season, how do you view, Carlos, the kind of the mixed dynamics with regards to, hey, there's more uncertainty there's – this resurgence with regards to COVID, there's the election, perhaps not a lack of stimulus, but at the same time, things are more complicated. HR is more central. How does that end up impacting kind of the new sales, the bookings expectation, just here in the core selling season. And then the longer term question is Next Gen Payroll, Lifion, they've gotten really nice awards. You've obviously been inhibited by the pandemic in terms of being able to go out there and talk about it with clients. But when things get a little bit back to normal, how would you expect the penetration of those elements to go over the next year, two years, three years? Like when would we see a bigger penetration? So as they've gotten really good rewards."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think on the first part of your question, it's of course – the last question, of course, has to be the downer question, because I think that that's a hard one for me to, I've been so optimistic the whole call, so I hate to like bring us all down. But based on what I'm seeing right now, both in the U.S. and in Europe. And the fact that this is our key selling season, I wish I could tell you that I'm incredibly excited and bullish and so forth. I just want to get through this damn thing, right. And get out to the other side. And I'm looking forward more to the third and fourth quarter and the fourth quarter and the next fiscal year than I am to the next two or three months, because the combination of the election with, I mean, you guys all see the same thing that we're seeing. And again, got to apply the test of common sense and the test of common sense would tell me that this is a, let's just try to keep us up beat, let's just call it a fluid situation."
},
{
"speaker": "Kathleen Winters",
"text": "It's going to be choppy, right. I mean, we thought we'll cover it from the last recession that it was choppy. And I'm fully expecting it's going to be choppy this time around too, particularly right, we're in Q2. We're in the fall, going into the winter, it's cold, we've got areas where there's resurgences that people might be hunkering down again. So Q2 might be challenging, but even in normal situations, normal years, right. Bookings are going to be lumpy quarter-to-quarter. I'd focus more on the full year, the annual and the longer term view."
},
{
"speaker": "Carlos Rodriguez",
"text": "And again, of course, we also thought that the first quarter was going to be terrible and it turned out to be home run. So they easily go the other way, but I'm a man, I’m like, I speak the truth, right. In terms of what I know and what I think at the time. And I spoke the truth in our last earnings call, and obviously I was wrong because things turned out to be much better. And I hope that happens here again, but that's my story. And I'm sticking to it, but one quarter or two quarters or three, it's not going to make a difference in ADP's long-term trajectory. What matters is the second part of your question, which is what do we intend to do? And what do we expect in terms of penetration rates and rollout of kind of our Next Gen platforms. And by the way, it's not just about Next Gen, I hope you guys understand that we are making some fairly sizeable investments, ongoing investments in Workforce Now. Workforce Now, now we have a version, if you will, I shouldn't call it a version, but Workforce Now is also on AWS in the cloud. So we've completely rebuilt Workforce Now to be as modern and as Next Gen, as Lifion and as our Next Gen Payroll engine. We also have been doing an enormous amount of work on RUN in the same vein, both at the guts of it in terms of the technology stack, but also on the user experience. You know what the investments we made in data cloud, you know, what we have with ADP marketplace, so this isn't an across the board increase in investment over methodically over the last six to seven years that I just summarize it by saying what I said once before, our intention is to have all of these things parlayed into taking market share and growing ADP faster than market and faster than the economy."
},
{
"speaker": "Mark Marcon",
"text": "That's great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today's call. I’m pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, thank you all of you for listening. Again, in summary, I just want to, once again, I think compliment our associates and our leadership team for incredible execution in the short-term, but I hope you also heard our commitment to the long-term in both in terms of sales, R&D, client service and all the things that drive growth and long-term value for our shareholders. And hopefully, for all of you who represent them. We remain committed to expense management, the digital transformation, all the things that Kathleen said, but we are somewhat holds into obviously the circumstances around the economy and the healthcare crisis. But we remain optimistic that this is – and it's the reason for optimism, and this is a transitory situation that we're going to get through it, hopefully in the next three or six months to the point where things gradually start to get back to normal. And then ADP can get back to the normal growth rates that we're used to. So thank you again and appreciate, you’re supporting, you're listening to us. And I hope that all of you continue to stay healthy and safe. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 4 | 2,022 | 2022-07-27 09:00:00 | Operator: Good morning. My name is Michelle and Iâll be your conference Operator. At this time, I would like to welcome everyone to ADPâs fourth quarter fiscal 2022 earnings call. I would like to inform you that this conference is being recorded. After the speakersâ presentation, we will conduct a question and answer session. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you Michelle, and apologies to everyone for the brief delay. Welcome everyone to ADPâs fourth quarter fiscal 2022 earnings call and webcast. Participating today are Carlos Rodriguez, our CEO, Maria Black, our President, and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies todayâs call. During our call, we will reference non-GAAP financial measures which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Todayâs call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. With that, let me turn it over to Carlos.
Carlos Rodriguez: Thank you Dany, and thank you everyone for joining our call. We finished our fiscal 2022 with a strong fourth quarter that featured 10% revenue growth and 12% organic constant currency revenue growth. We also delivered 170 basis points of adjusted EBIT margin expansion which helped drive 25% adjusted EPS growth, and for the full fiscal year 2022 we ended up with 10% revenue growth, 90 basis points of margin expansion, 16% adjusted EPS growth, and importantly we achieved record bookings and near record level retention, reflecting our strong position in the HCM market. Let me cover some highlights from the quarter and year before turning it over to Maria and Don for their perspectives. Starting with employer services new business bookings, we had a fantastic Q4 with growth accelerating from the prior quarter, resulting in our largest new business bookings quarter ever. With this strong finish, we were very pleased to have delivered 15 ES bookings growth for the year. Despite several sources of global uncertainty, including the ongoing effect of the pandemic, the conflict in Ukraine, inflation and concerns about global recession, our compelling site of HCM offerings has continued to resonate throughout the market. In total, we sold over $1.7 billion in ES new business bookings in fiscal 2022 and well over $2 billion when including the PEO, marking the first time weâve exceed $2 billion in bookings. Maria will talk more about the growth opportunities ahead, but clearly we are incredibly pleased with what is the best performance by our sales force that Iâve seen in my 20 years with ADP. Moving on, our full year ES retention of 92.1% was nearly flat versus last yearâs record level of 92.2% as we once again exceeded our expectations in the fourth quarter. Client retention is driven by several factors, including product and service quality, business mix, and macroeconomic factors, and our expectation at the start of fiscal 2022 called for macroeconomic factors like SMB out-of-business rates to drive some normalization in retention towards pre-pandemic levels. We did see some of that play out, but clearly less than anticipated. More importantly, our product and service teams have continued to deliver a best-in-class experience for our clients and particularly so on our modern and scaled platforms. We achieved record client satisfaction levels for the year and we once again set new record levels for retention in several of our businesses, including our midmarket, so although you will hear from Don that we are once again making an assumption for a modest amount of macroeconomic-related normalization and retention in fiscal 2023, we are excited to have delivered such a strong performance in fiscal 2022 and look forward to maintaining our retention rates at these historically high levels. Moving onto the employment picture, our pays per control growth metric was 7% for the quarter and 7% for the year, reflecting a persistently strong demand environment for labor among our clients that has continued to exceed our expectations. This growth has served as a testament to the resilience of our clients, and although we expect pays per control growth will naturally slow in coming quarters, employment conditions today remain strong with our client data suggesting that near term demand for labor remains healthy. Finally, our PEO business delivered another great quarter as it wrapped up a strong year. We had average worksite employee growth of 14% in Q4 and 15% for the year, and we were thrilled to have crossed the 700,000 worksite employee mark this quarter. As you know, I joined ADP two decades ago when ADP entered the PEO market through an acquisition, and as bullish as I was about the PEO industry back then, Iâm not sure I could have anticipated we would be here 20 years later still growing at this combination of pace and scale, but the ADP TotalSource team continues to deliver a great platform, great service and a great benefit experience for our PEO clients and there is plenty of opportunity for us in the years ahead to serve even more businesses. Taking a step back, fiscal 2022 was unique in a number of ways. We experienced strong demand with over $2 billion in worldwide new business bookings and near record level retention which together drove us to surpass 990,000 clients at year end, putting us on track to exceed a million clients any day now. At the same time, weâve had to manage this growth and volume with prudent headcount growth, given tight labor conditions. The way weâve been able to do is through efficiencies, of course, but also through plain hard work by our associates, and for that, I thank them for their efforts and for coming through for our clients once again. Iâll now turn it over to Maria.
Maria Black: Thank you Carlos. With fiscal â22 behind us, I want to take this opportunity to review where we stand on some key initiatives and provide an update on where we are heading in fiscal â23. At the core of our client experience is their interaction with our platform, and one product initiative we had talked about throughout fiscal â22 is our new unified user experience, which was designed to be more action-oriented and contextual and to move us from transaction-oriented applications to experience-oriented applications; in other words, more intuitive, better looking, faster, and more consistent across our solution. To achieve this, we have applied a research-driven approach informed by the data and insights we have gained in working with our nearly 1 million clients. Our focus has been to listen to our clients, learn from them, and utilize their input to design the best experience. In fiscal â22, we moved hundreds of thousands of clients over to this new user experience, including our clients on RUN, IHCM and next-gen HCM, as well as over 20,000 Workforce Now clients. We also moved the ADP mobile app over to the new UX. Feedback so far has been extremely positive and in fiscal â23, we plan to expand this rollout further to remaining Workforce Now clients as well as to additional modules and experiences within our key platforms. Workforce Now in particular has been exciting for us for a few reasons beyond user experience. First is its growing traction in the U.S. enterprise market. Just this quarter, ADP was rated for the first time an overall customerâs choice provider in Gardnerâs annual Voice of the Customer Study. This was the highest tier possible and was based on perspectives from end users with 1,000 or more employees and is a reflection of our continued momentum in selling Workforce Now to the lower end of the U.S. up market these past few years. This momentum builds on the already strong presence and traction Workforce Now has had in the U.S. midmarket in the HRO space and in Canada, all places where it is highly differentiated. Second is the continued roll-out of our next-gen payroll engine to a growing portion of our new Workforce Now clients. Our next-gen payroll engine not only benefits from having a global native and public cloud architecture but also empowers our platforms, like Workforce Now, to offer a better product experience and enables us to offer better service. We are incredibly excited for our payroll engine to continue to scale up to larger and more complex Workforce Now clients over the coming quarters. Finally, with talent and engagement an increasingly important aspect of the HCM suite, we continue to focus on our ability to help employers better connect with their employees. This quarter, we will launch a new offering that weâre calling Voice of the Employee, a robust employee survey and listening tool which leverages survey instruments from the ADP Research Institute to offer clients a way to seamlessly capture employee sentiment across the employee life cycle. One of the things I love about this solution is that it was born out of elevated client employee engagement our return to work workplace solutions have been able to drive, and it reflects the ability of our global product team to quickly identify an opportunity and develop a solution to meet a need in the market. Moving on, we made some exciting enhancements to the Wisely program this quarter. Most notably, we now offer Wisely self enrollment with full digital wallet capabilities for Apple and Google Pay, thereby allowing employees to instantly receive and start using their Wisely account without support from their employer and without having to wait for a physical card. We also expanded our earned wage access solution by offering a seamless one app solution for Wisely members through a deeper integration with one of our key partners. The offering enables employees to receive a portion of their earned wages prior to payday, and most importantly is free for employees who use Wisely. With these enhancements and more on the horizon, weâre incredibly excited about the growth prospects for Wisely and look forward to taking it from over 1.5 million active members today to an even larger portion of our U.S. payroll base over the coming years. During fiscal â22, we also highlighted the strength of our retirement services business, a key component of our HCM suite. We offer record keeping services, provide unbiased independent advisory services, and give our clients, their employees and financial advisors access to over 10,000 investment options from over 300 investment managers seamlessly integrated with our key platform and with the ADP mobile app. With over 125,000 retirement plan clients leveraging solutions, including 401-K, SIMPLE and SEP plans, we are proud of our scale today but even more excited about the significant opportunity in the market as we look to expand our market share within and beyond our payroll base of clients. Fiscal â22 was an incredibly strong year for our retirement services business and we are looking forward to another strong year. Finally, our next-gen HCM solution is getting closer to a broader rollout as we continue building on the implementation capacity for our pipeline of sold clients, as we shared at last yearâs investor day. While we are excited about all of these product enhancements and others too, products only drive growth when our sales and marketing organization can match it to a buyer and translate it into new business bookings, and to that end, we are excited about our sales and marketing momentum and the continued investments we have planned to drive growth this year. First, the product improvements I just mentioned, as well as many others, are all intended to drive higher win rates, an expanded breadth of offerings or higher price realization, and we fully expect our sales force to continue capitalizing on these opportunities. Second, we are making continued investment in both digital and traditional marketing into our brands and into our broad and growing partnership network. Third, we are excited to have invested at year end in sales headcount and are stepping into the new year with hundreds of additional quota carriers, and we expect to be able to grow our average sales headcount in the mid single digit range over fiscal â23. Continued execution on our product and our sales and marketing strategy is ultimately designed to drive sustainable growth, and for fiscal â23 we expect to drive ES bookings growth of 6% to 9% bracketing around our medium term target of 7% to 8% from investor day. Growth is a priority for us, and we look forward to continuing to update you on our progress. Now over to Don.
Don McGuire: Thank you Maria, and good morning everyone. Our Q4 represented a strong close to the year with 10% revenue growth on a reported basis and 12% growth on an organic constant currency basis, ahead of our expectations despite higher than expected FX headwinds from a strengthening dollar. Our adjusted EBIT margin was up 170 basis points, about in line with our expectations as leverage from strong revenue growth overcame higher selling expenses, PEO pass throughs, and growth investments like the sales headcount growth Maria just mentioned, and our robust revenue and margin performance drove 25% adjusted EPS growth for the quarter, supported by our ongoing return of cash to our investors via share repurchases. For the full year, revenue landed at 10% growth. We delivered 90 basis points of margin expansion, offsetting a few different sources of incremental expense over the course of the year, and adjusted EPS grew to $7.01, up about 16%. For our employer services segment, revenues in the quarter increased 8% on a reported basis and 9% on an organic constant currency basis. The stronger than expected revenue growth was a function of continued outperformance on key metrics like retention and pays per control, and our ES margin increase of 140 basis points was a bit lower than previously planned as a result of growing headcount faster than previously anticipated. For the full year, our ES revenues grew 8% on a reported basis and our ES margin increased 110 basis points. For our PEO, revenue in the quarter grew 16%, accelerating slightly from Q3. Average worksite employees increased 14% on a year-over-year basis to 704,000 as bookings, retention, and same store pays all continued to perform well. PEO margin was up 260 basis points in the quarter due in large part to favorable workersâ compensation reserve adjustments. For the full year, our PEO revenues and average worksite employees both grew 15%, at the high end of our guidance ranges, and our margin expanded 80 basis points. Iâll now turn to our outlook for fiscal 2023, beginning with some overall remarks. We have on the one hand an inflationary environment that is creating upward pressure on our expense base, and at the same time we recognize there is clearly concern about a potential upcoming global recession, or that we perhaps are already in one. On the other hand, our momentum entering fiscal â23 is strong and there are no obvious signs of near term strength, and if the marketâs forecast of higher interest rates holds, we are positioned to benefit from a continued rebound in interest income. Our focus for now will be to continue executing on our strategy, and to that end, we have been and will continue to be making investments in headcount where we perhaps didnât get a chance to last year in a tight labor market, and we also expect to deliver growth thatâs at or above our medium term annual objectives shared at the November â21 investor day. Onto the numbers, beginning with ES segment revenues, we expect growth of 6% to 8% driven by the following key assumptions. First, we expect our ES new business bookings growth to be 6% to 9%, which Maria covered. For ES retention, we finished the year at 92.1%, a touch below last yearâs record level, and we believe itâs prudent to anticipate some further normalization of business levels in fiscal â23 even while we maintain record retention levels in some of our other business units. Our initial assumption is for a decline of 25 to 50 basis points in ES retention for the year. For pays per control, with employment back near pre-pandemic levels, we anticipate a return to a more typical 2% to 3% growth range. We normally talk about price as contributing 50 basis points to our ES growth rate, but we expect that benefit to be around 100 to 150 basis points this year. For client funds interest revenue, we expect higher overnight interest rates and higher repurchase rates on maturing securities should combine with our continued balance growth to drive interest income up nicely. Our short funds portfolio, which is invested in overnight securities, will benefit assuming the Federal Open Market Committee increases the Fed funds rate over the course of this fiscal year, and our client extended and long portfolios will benefit as we reinvest maturing securities at an expected rate of about 3.3%. Between those two drivers, we expect average yield to increase from 1.4% in fiscal â22 to 2.2% in fiscal â23. We expect our client funds balances to grow 4% to 6%, supported by growth in clients, pays per control, and wages, and this is on top of a very robust 19% growth we experienced last year. Putting those together, we expect our client funds interest revenue to increase from $452 million in fiscal â22 to a range of $720 million to $740 million in fiscal â23. Meanwhile, the net impact from our client fund strategy will increase by a bit less, from $475 million in fiscal â22 to a range of $675 million to $695 million in fiscal â23, and as a reminder, this is the number that impacts our adjusted EBIT. The slightly lower growth here is due to the expected increase in short term borrowing costs which track the Feds fund rate. This borrowing enables us to ladder our portfolio and invest further out on the yield curve than we otherwise would. As we gradually reinvest our maturing securities, this gap between client funds revenue and the net impact from our client fund strategy should reverse and again become positive. Back to the ES revenue outlook, one more factor to consider is FX headwinds. Clearly with the year-over-year parity the dollar with a weaker pound and with about 20% of our ES segment revenue being generated outside the U.S., weâre factoring in a fair amount of FX headwind for fiscal â23 of well over 1%. For our ES margin, we expect an increase of 175 to 200 basis points. This coming year, our expense base will be increasing more than it does in a typical year, in part due to inflationary pressure on our overall wages and in part due to headcount growth, some of which we did late in fiscal â22 and some of which weâre planning for fiscal â23, but because our margins are benefiting from strong revenue growth outlook, including growth in client funds interest revenue, weâre pleased to be able to guide to this strong ES margin outlook. Moving onto the PEO segment, we expect PEO revenues and PEO revenues excluding zero margin pass through to grow 10% to 12%. The primary driver for our PEO revenue growth is our outlook for average worksite employee growth of 8% to 10%. That would represent a bit of a deceleration from last year, but of course we are contemplating much less contribution from same store pays per control in fiscal â23 compared to fiscal â22. This 8% to 10% growth compares to the high single digit target that we outlined at the investor day in November. We expect our PEO margin to be down 25 to up 25 basis points in fiscal â23 compared to a strong margin result in fiscal â22. Adding it all up, our consolidated revenue outlook is for 7% to 9% growth in fiscal â23 and our adjusted EBIT margin outlook is for expansion of 100 to 125 basis points. We expect our effective tax rate for fiscal â23 to increase slightly to about 23%, and we expect adjusted EPS growth of 13% to 16% supported by buybacks. Iâll make one comment on cadence - because we expect year-over-year headcount growth to be more significant early in the year and because the benefit from client funds interest will build as the year progresses, we expect adjusted EBIT margins to be down about 50 basis points in Q1 but then build steadily over the rest of the year. Iâll now turn it back to Michelle for Q&A.
Operator: Our first question comes from Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. I wanted to start with a demand question. Can you just talk about what youâve seen across client size as it relates to demand environment? I heard the continued optimism in the mid market. Can you talk a bit more about up market, down market, international, and then just give us a sense of booking cadence. It sounds like it accelerated through 4Q. Have you seen any change in pace as youâve gone through the first couple weeks here in July?
Maria Black: Yes, absolutely Bryan. Iâm happy to comment on both pieces. With respect to the overall strength that we saw in new business bookings both for the full year fiscal - very, very proud of the remarkable results, but for full year as well as the fourth quarter, and the strength was really broad-based. There was solid performance across each one of our markets. I think a few callouts that I would give, you highlighted the mid market. The mid market does continue to perform. We saw strength in our HRO offerings even beyond the PEO. The HRO was a strength for us. I know I mentioned it in the prepared remarks, but Iâd be remiss if I didnât mention retirement services again. We also saw results in Canada, which was fantastic to see as Canada definitely was impacted a bit more with the longer lockdowns from a pandemic perspective, and then I continue to highlight quarter after quarter the strength that weâre seeing in our down market and our RUN offer, so felt very pleased with the RUN. Then last but not least, on the international front, our international business had a tremendous year, so very confident in the results, very proud of the work of the sales organization. As we think about the demand environment right now, you asked about how did it progress throughout the quarter and how do we feel sitting here a few weeks into July. I suppose I canât necessarily comment on in quarter, but what I can comment on is we did see the results accelerate throughout the quarter, so while there was some macroeconomic things happening in the world, our demand actually accelerated as we closed out the quarter, so we saw significant strength specifically in the month of June - in fact, June was a record month for us ever, as was the quarter and as was the year, as mentioned. We feel good about the demand environment and the acceleration we saw throughout the quarter, and thank you for the questions.
Bryan Bergin: Okay, and then just a follow-up on margins. If things do slow down, can you just talk about the levers you have to insulate EBIT margins? It sounds like they have taken a healthy amount of resource additions. Can you talk about where youâre making those across the organization and then where you might have some discretion to throttle investment, should things slow down?
Don McGuire: Yes, itâs a very good question, so thank you for the question. I think as I mentioned in the remarks and the materials that we distributed, we were able to get our sales organization a little bit more than fully staffed going into the fourth quarter, and that makes us feel really good about the opportunity to step off into â23 with a fully staffed team, which is something that, as we mentioned in prior quarters, was a little bit more difficult to do during â22, so I think we feel really good about where we are with staffing particularly on the sales side. I would also say that, just following the business model that we have, if you look at the record sales we had particularly late in the fourth quarter, we need to make sure that we have fully staffed implementation resources to get those bookings generating revenue as quickly as they can, so we will be focused on that, and then of course just following through to the year-end process, need to make sure we can service all those additional clients as that time comes upon us in late December-January-February. We can do all those things. On the other hand, as I referenced and as weâre seeing in the media and elsewhere, everywhere is talk about a recession potentially coming, are we in one, etc. We still do have flexibility of course, and we can certainly temper the addition of headcount and temper our costs more generally should we think that thatâs necessary, if itâs something thatâs as a result of changes in the macro environment, so I think we still have lots of levers and I think weâve shown historically that we are able to navigate those waters pretty adeptly should that kind of situation arise.
Bryan Bergin: Okay, thank you.
Operator: Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open.
Kevin McVeigh: Great, thanks so much, and congratulations on the results. I donât know if this will be for Carlos or whomever, but it feels like the retention step-up is clearly a little more structural, just given the recent trends in â22 into â23. Is that a function of the next-gen payroll engine or just where are you seeing that success, because itâs clearly been a super, super outcome post COVID. I think part of our focus is whether or not that starts to normalize or not, but it feels like itâs at a structurally higher level.
Carlos Rodriguez: There probably are some structural factors just because we can see, obviously, where the retention is stronger, and I think as we mentioned, some of the macroeconomic readjustment that we expected in a down market, we saw some of it, just not as much as we expected. But if talk of recession is correct and business and bankruptcies and so forth probably will come back to some kind of normal level, which is why, as Don mentioned in his remarks, we once again plan for a slight decrease in retention in â23, thatâs really mainly in a down market in terms of the mix that it represents--the total represents of the mix, because everywhere else we really see some reasonable, what appear to be structural improvements. I wouldnât say that itâs really next-gen payroll because youâre really going to see that, the impact of that on sales and market share and so forth in the next couple of years because the majority of our clients are still not enjoying, I think, the benefits, even though over time they will of next-gen payroll, so thatâs really not--I just want to make I was clear on that, that that is not whatâs causing the retention improvements. But one thing I would point out is--I know this is a broken record, but we made this big transition from multiple platforms onto one in a down market 10 years ago, or a little bit more than that, and then more recently we went through a multi-year effort, which was painful to do that in the mid market. We have other things going on, like new UX and next-gen payroll, that those migrations and those consolidations in and of themselves have created some real structural tailwinds, I think, in terms of service, NPS, and ultimately on the retention standpoint. Itâs just a much more--an easier environment for our own folks to operate in, itâs easier for us to invest in less platforms versus more platforms. Itâs just a much better environment. As you know, we still have work to do in the up market, so thereâs still opportunity there, thereâs still some opportunity in employer services international as well, but we think these structural tailwinds that first helped us in the down market despite the macro, right, because the macro is really a cyclical issue, but overall excluding cycles, our retention in a down market is up--I said this before, itâs hundreds of basis points higher than it was 10 to 15 years ago, and now the mid market is at record levels and the NPS scores continue to be at record levels, and I donât think we anticipate that going back down. If anything, we see more opportunity there in the mid market, and our plan would be to continue to do that throughout other parts of ADP to add more structural tailwinds to our retention.
Kevin McVeigh: Super helpful. Then maybe this is for Don, it looks like the margin guidance, like 100, 125 basis points up from 90, given the leverage and float in pricing, it seems like really nice outcome on the pricing side. Is the offset kind of the cost inflation, and where is the cost inflation in the model in â23 relative to where itâs been historically?
Don McGuire: Yes, I think itâs a good observation. I think thereâs a few things driving it. Of course, we talked about more price than we historically have been able to take, and of course we do have the tailwinds, if you will, from the client fund interest, so. Certainly we need to remember that the reason weâre getting our interest rates is that weâre in a higher inflationary environment, so thatâs driving more cost base in wages. The other aspect is that we have called out, and we typically havenât called out FX in the past, but weâve certainly seen, I think what we would refer to as pretty dramatic changes in FX headwinds in the fourth quarter compared to what weâve seen in typical years, and so we thought that was important to call out. With 20% of our ES revenue being outside of the U.S. and denominated in Canadian dollars, euros, sterling, Australian dollars for that matter, I think all the currencies are essentially down. When you put all that stuff together, it certainly results in a little bit less at the top line dropping through to margins, so thatâs been our focus. The other thing Iâd say is that we do have a little bit of conservatism as we look to the back half. We have to take into account all the things weâre reading about and seeing and making sure that weâre thinking hard about how to prepare should something happen in the back half of the year, so I think those are the primary drivers, to answer your question.
Carlos Rodriguez: And if I could add one thing, because you mentioned also price, and itâs a big topic. I know for a lot of companies, thereâs a lot of questions about it, and I think itâs important for you to understand strategically at a very high level, regardless of how it flows into the numbers and so forth, our view on price, weâve said it for a couple of quarters now, is to kind of keep up with inflation, so I want to make sure itâs very clear that weâre not achieving our margin improvements for doing anything that would be unusual, because I think there might be some companies that are trying to make up revenue gaps or margin gaps with price because there is, quote-unquote, cover out there to do that. But I think when you do that, and I think Don has mentioned this before, that we operate in a competitive environment and we look at what competitors are doing and we look at whatâs happening in the world, and weâre long term thinkers here, so you should assume that our price increases were in line with whatâs happening with inflationary costs and not anything more than that, and not materially less than that.
Kevin McVeigh: Youâve been very consistent on that. Thank you.
Operator: Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi guys, good morning, and congrats on the numbers. I guess my question is looking at the midterm outlook for employer services back in November, I think we talked about a 6% growth rate, and you guys are going to be trending above that, 6% to 8%. With the strength in bookings growing over 15%, I just wonder if maybe the midterm outlook was a little low compared to what structurally is going on in the business model, that potentially the growth rate is faster than the 6% outlook that you gave over midterm.
Carlos Rodriguez: Well, I hope so. Iâll let Don comment in a moment, but again, just because Iâve been doing this for a long time, I canât get it out of my mind. The way the recurring revenue model kind of works is we love the 15%, and what you just described really comes through in the numbers. Itâs the difference between our bookings and our losses--our strong retention and our strong bookings, that the net of that contributed more to employer services revenue than ever seen in my tenure as CEO, and that is whatâs led to the deceleration you just described in ES revenue, so that net new business growth is really the way to grow the top line. Thereâs other factors in there, like pays per control, client funds interest, but thatâs the core of the business and weâre really happy with that. The challenge, of course, is that weâre not forecasting 15% bookings growth again next year, so I would just caution you, too. Now, the good news is that that increase in net new business is in our run rate now, and so we donât have to grow by as much the next year in terms of that net new business to further accelerate our revenue growth, but I would just caution you in terms of if you do that kind of math, itâs hard. Itâs hard to accelerate the revenue growth rate of this company. We just did it and it takes a combination of better retention and higher starts, higher sales and new business starting in the upcoming year, and that 15% really makes it huge difference. But you can see from our guidance that that is not our expectation next year in terms of bookings, and so you will experience hopefully additional acceleration of revenue growth in ES, but not by as much as you had from â22 to â23. Notwithstanding the fact that, remember, thereâs other things in there, moving parts like pays per control, client funds interest and so forth, some of which will give us tailwinds, some of which may be headwinds.
Don McGuire: Yes, so Carlos covered off all the main drivers there. Of course, I think just once again Iâd go back and mention the FX headwinds weâre experiencing. I think when you add that into the mix, I think youâd probably get to a place where weâre landing and what weâre anticipating guiding to for â23.
Bryan Keane: Got it, got it. Then let me ask you another popular question that everybodyâs getting, is just how the model might be different now versus previous recessions, just thinking about the resilience potential in the ADP model.
Carlos Rodriguez: I mean, Don again has, I think, a couple points he could probably make, but I would say as usual, thereâs probably some puts and takes. I mean, obviously I wouldnât be a CEO if I didnât say I think our model is better now than it was before, even though Iâve been through a couple cycles here myself, so itâs not that Iâm criticizing anything other than myself if Iâm saying that itâs better than it was before. But we just talked about the structural retention level, so even if we have a little bit of a drag in the down market, and by the way, the down market is a larger percent of our overall business than it was 10, 20 years ago, but still itâs structurally higher by several hundred basis points in and of itself, so even if it goes down a little bit and is a little bit bigger part of our mix, I think our retention is just going to hold up better, I would predict, in terms of--you know, depending obviously on the severity of the recession, so thatâs a huge help because the bigger--obviously the portion of the revenues that you retain each year, the less dependency you have on bookings in a recession, which tends to be the most sensitive. Historically when you look at GDP growth and all of our metrics besides pays per control, bookings is something that can be challenging in a severe recession, which to reiterate, we donât see. We read the same things everyone else reads and we know that Fed tightening will lead to a slower economic growth, but we really canât see it in our numbers. Our pays per control number in the fourth quarter was as strong as it was the whole year. When you look at the monthly initial unemployment claims, you look at the room that still is there in labor force participation, you look at the number of job openings in comparison to where it was historically, I just donât see it. There clearly are pockets that are happening. I think as part of readjustments because of COVID that are kind of confusing the landscape and thereâs clearly some kind of slowdown underway because it just happens when you have Fed tightening, but itâs not happening in the labor market, at least not yet.
Bryan Keane: Great, thanks for the color.
Operator: Our next question comes from Tien-tsing Huang with JP Morgan. Your line is open.
Tien-tsing Huang: Thank you so much. Really strong sales. I was just trying to think about attribution, the strength and how you would rank the factors there between better product set thatâs more relevant or better just productivity, expanded sales force, the cycle, or particular things around outsourcing taking over versus software. Any interesting observations on your side, Carlos or Maria?
Maria Black: Yes, thank you. Definitely tremendous strength that we saw. I think I called out a few areas. Definitely the strength that weâre seeing in our up market continues to excite us for the future. I think you asked about the attribution of strength, and I think it really was broad-based across the business, but I think from an execution standpoint, it really comes down to the execution of our sales organization and how theyâve been able to go to market, candidly, really over the last two years as it relates to navigating this evolving environment, but more specifically providing value to our clients in a more meaningful way, and we really have seen that evolve over this past year as weâve been really across each one of the segments, helping our clients navigate, as I mentioned, the evolving environment inclusive all the legislative changes. I think there is value weâre bringing. I think the strong execution in general across the sales organization and leveraging the entire ecosystem to bring that strength, right, which is everything from our marketing investments, our brand investments, I spoke earlier to the headcount investments, and so all of this together, I think has lent itself to tremendous execution and strength as it relates to the overall performance.
Carlos Rodriguez: The only thing I would add to that is Maria and I have been talking for the last 18 months about how--you know, one of the most important things for our sales organization was really to get productivity at the quota carrier level back to and then exceed from a trend line standpoint where it was, right, so when you think about whether itâs GDP trend or price trends or anything like that, youâve got to get back to where you were and then youâve got to get back on that same trend line, otherwise you leave a lot of money on the table, whether itâs the economy or ADPâs revenue and bookings growth. From an attribution standpoint, again this--I think itâs important for you to understand this color. We had unbelievable productivity growth, and thatâs why I said that this is the best performance Iâve ever seen by our sales force. Clearly some of it is because we were in recovery mode, but sales forces naturally generally have--not that I know, because I was never a sales person, but I guess Iâve been around long enough to be hopefully an honorary member, but when you tell a sales force, okay, youâve got to grow--weâre going to grow our headcount by a few percentage points and then weâve got to grow our productivity two or three percentage points, thatâs in a typical year, right, and thatâs hard in a typical year. When you tell a sales force, you have to grow your productivity close to 20%, even though itâs because it went down 20%, thatâs freaking hard to do, very hard to do psychologically. Anybody whoâs in sales, I think understands that, and so these percentage growth numbers that we have and the productivity growth numbers that we have, honestly, are incredibly just gratifying, because I really thought this was going to be hard. I was, of course, keeping my poker face on and just telling everybody, we have to do it, we have to do it, and we did it, so most of this growth came from productivity and not from headcount because, as weâve talked about, we actually had some challenges up until the fourth quarter in terms of achieving our headcount objectives, not by lack of trying, by the way, and not because we were trying to save money, because we were doing everything we could and it was just a difficult labor market. The good news is in the fourth quarter, as Maria has mentioned, we really did quite well and are in a great position headcount-wise now, but the â22 story is all about productivity, and that is an unbelievable accomplishment for our sales force, and itâs across the board.
Maria Black: It is, and just to provide some actual numbers to that, so we reported $1.7 billion in employer services bookings - that is a record, as mentioned, and it does exceed the other record which was pre-pandemic in fiscal â19 at $1.6 billion, and so that really in the end speaks to some of this additional productivity , if you will. But Carlos is spot on - we did initially tell the sales force people, we will add headcount and you have to grow faster, but in the end we didnât add the headcount and they grew that much faster, which is why I am very bullish and excited as we step into the fiscal year with more sellers, more active quota carriers to really couple this strength that weâve had in productivity with now finally more sellers to go get after it.
Tien-tsing Huang: Thatâs great. It must be gratifying for sure. Iâll stop there with that question. Thank you.
Operator: Our next question comes from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Hey guys. Really nice results. Iâm very happy to see the strength in the enterprise that you called out . Can you maybe tell us, like--I know you donât parse out the growth between--in ES, but if you did, weâd love to hear it in terms of the different sub-verticals. But on the bigger picture, can you tell us what types of firms--basically, are you now regaining share in some of those lower end of the large enterprise and sort of what size of firm itâs coming from and all these conversations . Thank you.
Carlos Rodriguez: Yes, I think you mentioned--we were having a little trouble catching the entire question, so maybe Iâll try to give a little bit of color and maybe you can repeat again, or ask us--ask the question again. But I think you said something about the lower end of the enterprise space and where the strength in sales was coming from, etc. I think just to repeat what Maria said, I think it is across the board, but that is one--the reason Iâm picking up on it, this is a really good news story for us, so our Workforce Now platform--you know, we made the strategic decision two or three years ago, it makes sense because it fits well in the lower end of the enterprise space, and itâs really been a home run for us there. Against certain competitors, itâs really very, very effective, and weâre selling a lot of units in that lower end of the up market space for us. As we continue with the rollout of next-gen HCM, which is really intended for further up market and eventually for global, in the meantime weâre really having a lot of success in the lower end of the up market with our Workforce Now platform. If you want to maybe repeat your question one more time, weâll give it another try.
Dan Dolev: No, I think that sort of answered the question. I wanted to know, and I apologize you couldnât hear me before, I wanted to know how the conversations are--you know, how the conversations are different today when youâre with those clients versus, say, three years ago, because Iâm sure there has been a tremendous change given the results.
Maria Black: There has been a tremendous--itâs a good observation, there has been tremendous change. I think Carlos hit the nail on the head - in the lower end of the up market, one of the reasons we cited the award and recognition we recently received from Gardner because the conversation around our offering, our Workforce Now in that lower end, is definitely resonating for several reasons. One is itâs a best-in-class product, as Gardner even acknowledges and the users that were surveyed for that award, but moreover, itâs also the speed by which we can execute and really take these enterprise customers and turn them into active clients, and so meeting a lot of different needs from a product perspective, from a timeline perspective. I think in the upper end of the market, certainly the conversation over the last three years has evolved. A big piece of that conversation is the global discussion and our ability to talk to much larger U.S. enterprise customers and other enterprise customers across the globe around our multi-country offerings and how weâre thinking about--how they are thinking about their strategic direction on HCM on the global front. I think the conversation continues to evolve on both ends of the spectrum of the up market, and weâre certainly in a position to have very formidable conversations and transformation discussions with our clients in that space.
Dan Dolev: Great, thank you, and excellent results as always.
Maria Black: Thank you.
Operator: Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hey, good morning Carlos, Maria and Don. Great to see all of the years of hard work really pay off here this year, so congratulations on the results. Wondering with regards to the new bookings - I mean, $2 billion in total, $1.7 billion in ES, how much of that is split between new logos relative to up-sells, and how would you characterize your expectations on that front for the coming year?
Maria Black: Thanks Mark, and thank you for acknowledging the strong performance in bookings. There is really no news to report here. I think weâve cited it for years - really, the split between new logos and client business really remains at that 50%, kind of 50/50 going forward, and thatâs really what we expect heading into fiscal â23.
Mark Marcon: Great, and then with regards to the forecast, Don, you gave us a bit of a cadence sense for margin. How would you characterize it for revenue, and specifically what Iâm interested in is you did mention the interest on client funds is going to be back end loaded, but at the same time, weâve got pays per control being modeled up 2% to 3%, even though people are starting to call for a potential recession and potentially a decline in employment, so Iâm wondering how are you thinking about that part of the model and are there any things that you would call out with regards to just revenue trends as we build out the models for the coming year?
Don McGuire: Yes, so Mark, just going back to the first part of your question, you mentioned the deceleration of margin that I mentioned, and of course we talked about the increase in sales headcount specifically because it is meaningful in quarter one of this year, in quarter one of â22, so we do think thatâs going to have a bit of a drag. There are, of course, some other factors - general inflation, general etc., and weâve taken price--Carlos described and took you through our price thinking, which is pretty consistent to what weâve discussed over the last number of quarters, so we do expect to see a little bit of deterioration in margin percentage through the first quarter, and I think thatâs understood. Then as interest rates continue to--or as interest rates go higher and as we have the opportunity, weâre going to see higher client fund interest for the last three quarters of the year, but overall weâre kind of looking at pretty even top line revenue quarter by quarter through the balance of the year. No big changes at all in terms of growth rates quarter by quarter through â23 compared to â22, so if youâre modeling growth, you can feel be comfortable to model consistent growth across the top lines quarter by quarter.
Carlos Rodriguez: And that doesnât mean that you should model, or that we modeled everything consistently throughout the quarter, so--because I do have to make a comment on your point that it sounded like you thought we were being aggressive, which would not be typical of us to model 2% to 3% pays per control when everyone is thinking thereâs going to be a recession. I would tell you that the fourth quarter, you saw what our pays per control growth was, and I can tell you that we have visibility into July and itâs hard to believe that for the whole year, it would be less than 2% to 3%, but then you can assume that if, for example, the first couple of months at least, since we have some visibility of that already, are in the 6% to 7% range, because thatâs where weâre kind of exiting, and you can do the math, right, so youâre probably--this is just to give you color in terms of what some of our assumptions are in our operating plan, because I think Don mentioned maybe a bit of conservatism on the back half. We probably have reasonable continuation of trends, because thatâs the way trends go, on pays per control in the first half, and then you would probably expect the second half of the year to have little to no pays per control growth, or somewhere in that neighborhood. Itâs also hard for us to model a big negative growth on pays per control just because of all the factors we mentioned in the labor market. That doesnât mean that wonât happen in â24 or late in â23, or at some point in history, but it doesnât seem likely over the course of our fiscal year. But weâre clearly expecting some slowdown in the second half.
Mark Marcon: Carlos, you read my mind in terms of just the way I was thinking about the characterization and then thinking, okay, this is probably what youâre thinking in terms of the way itâs going to unfold, so thatâs directly in line. Can I just ask one more question? On Workforce Now, would you expect next-gen payroll, whatâs the expectation in terms of the number of clients that would have next-gen payroll within the Workforce Now contingent by the end of the year?
Carlos Rodriguez: In terms of new business bookings, because obviously--we just want to make sure we answer the question correctly. It will only affect--obviously weâre not even talking about migrations yet, even though at some point that will happen--
Mark Marcon: Thatâs what I was asking. Are we going to do any migrations over the course of this year?
Carlos Rodriguez: No.
Mark Marcon: Okay, great. Thank you and congrats again.
Carlos Rodriguez: Thank you.
Operator: Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi there. Thanks for taking my question today. I wanted to ask if you are seeing or expect to see any divergence in the kind of hiring or macro--hiring environment or macro impact between the U.S. and Europe. I guess the broader question is, does your guidance assume a tougher environment in Europe relative to the U.S. or something similar?
Carlos Rodriguez: Don probably has the details, but I can give you some high level color. Pays per control growth--I know youâre not asking about historical, but as we gather the data, I just want to tell you that pays per control growth is very strong in employer services international as well, and part of that, of course, is because of what weâre coming off of, right, which were these lockdowns and these high unemployment rates across the globe. I would say international has performed similarly, but it is safe to assume that we see probably challenges given whatâs happening in the macro environment with energy costs and the war and so forth in our international business. I donât know, Don, if you have--
Don McGuire: No Carlos, I think those points are valid. Certainly what happens with energy on the continent in particular is going to have some impacts on the results, but beyond that--this is a little bit of the conundrum that we talked about earlier, about where we are versus what people are talking about. So as much as everyoneâs predicting a recession, etc., unemployment rates in the euro zone are at 6.1%, which is an all-time low. Unemployment rates in Canada are as low as they were even before I started working, in 1974. Unemployment rates in Australia are at a 50-year low, so weâve got this situation where there seems to be a lot of employment yet all this risk and worry about recession. To come back to your question, are we a little bit more concerned about what could happen in EMEA in particular as a result of whatâs going on with current prices, etc.? A little bit more concerned, yes. Did we think about that when we put our plans together? To some extent, yes.
Carlos Rodriguez: Don, you should point out that you started working in 1974 when you were 12 years old.
Don McGuire: Well, Iâd say .
Ramsey El-Assal: Thatâs very helpful. A follow-up question, just update us on M&A, capital allocation. Are you shifting your approach at all? Are you seeing incremental opportunity out there given the turmoil with valuations in the marketplace, potential acquisition targets, or is it just sort of steady as she goes in terms of no change?
Don McGuire: Yes, I think for now, itâs pretty much steady as she goes. I mean, certainly you can see the valuations have dropped across the board. Things that were really expensive in January are still just expensive. Things are still expensive, but theyâve come down off of historic highs, so thereâs not exactly what I would call a bunch of bargains out there. Thereâs also not a lot of people who are coming forward looking to sell their properties because prices are down, so I would say itâs steady as she goes and we will continue to do what weâve done and look for things that work for us strategically, look for adjacencies that make sense should they arise. But really, steady as she goes, really no change to our overall policy.
Ramsey El-Assal: Great, thanks so much.
Operator: Our next question comes from David Togut with Evercore ISI. Your line is open.
David Togut: Thank you, good morning. Don, you called out a 260 basis point margin increase in PEO year-over-year, in part driven by a favorable workersâ compensation reserve adjustment. How much was that adjustment, and how should we think about this item for fiscal â23?
Don McGuire: I guess the short answer is we get adjustments on a regular basis, and theyâve been favorable for us. We look at the workersâ compensation experience over a number of years and we get external third parties to do an assessment as to whether or not itâs appropriate to book any of those adjustments, and this year weâve been fortunate. We donât typically forecast those numbers in any great detail simply because we do have to rely on the experience rating that the insurance companies bring to us, and so without trying to disclose exactly what the numbers were, I would say they were favorable and weâll have to wait as the months go by to see whatâs going to happen in â23.
Carlos Rodriguez: Weâre disclosing it in our 10-K, so we can--
Danyal Hussain: Yes, it was $40 million for the quarter, David, in the K, and that compares to last yearâs about $5 million. Most of that was as we headed into the quarter in the forecast and guidance, so it wasnât a big departure from what we had expected.
Carlos Rodriguez: But I think what Don was trying to say, though, about â23 is that itâs clearly a headwind, right, so as we--as you do your modeling and you think about margins, itâs a headwind not because thereâs an operating performance issue or whatnot, itâs just because we had a big benefit in â22 and weâre not planning for a big benefit in â23, although weâre always hopeful that we will get some benefit. Thatâs historically been our experience, is that we do get some critical reserve release. Itâs probably not as big in â23 as in â22, but it might not be as big a headwind as it appears now, just because of the numbers.
David Togut: Appreciate that. Just as a quick follow-up, Don, in the guidance youâve given for extended investment strategy, client fund interest to be up about $200 million to $220 million year-over-year in fiscal â23, how should we think about the incremental margin on that additional revenue? Are you applying additional expenses against it or should we think about it flowing through at some set margin?
Don McGuire: Yes, so I think thereâs other things going on, of course. We mentioned the inflationary environment, which is why have the higher interest rates. We mentioned the FX headwinds we have, so all things in, weâre still expecting--weâre still very happy and very proud of the operating margin improvements weâre getting and we think we still have good opportunity for margin improvements ex-client fund interest going forward. Iâd say that right now, our expectations are for a pretty balanced incremental margin from both of those factors, so we are of course, as we mentioned--you know, we are spending some more money, weâre investing in sales headcount, we have higher costs as a result of inflation, some of it is offset by price, but we are letting a substantial amount fall to the bottom line but we are obviously in this for the long term, so weâll take the opportunity to invest in the business and make sure that we have the right balance between margin growth and preparing ourselves for continued success in the future years.
Carlos Rodriguez: But I think that stream of revenue, we would generally see it as 100% margin, just to be completely clear. If that your question, do we apply expenses against those revenues, the answer is I think weâve--it felt like a trick question because youâve known us for a long time and weâve been clear for a long--like, on the way down, we always say it 100% hurts us, right, because thereâs really no expenses that go away when that interest income goes away, so likewise we would want to be transparent and acknowledge that on the way up, itâs 100% margin. But I wasnât sure if it was a trick question or--it sounds like it was.
David Togut: No, it was just trying to understand how much of that incremental revenue would flow through to the bottom line since Don had talked a lot about investment initiatives, and you had underscored growth in sales force headcount. But thank you so much, very responsive. I appreciate it.
Danyal Hussain: David, I would just add one clarification. You said incremental revenue. We did make the point in the prepared remarks that itâs the net impact of the portfolio that would be 100% incremental margin, so there is a cost offset and itâs the short term borrowing cost associated with the portfolio strategy.
David Togut: Much appreciated, thank you.
Operator: We have time for one more question, and that question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, great. Thanks for squeezing me in. I just wanted to maybe circle back on the price increases. I know that inflation is a big driver of the maybe more than normal amount. Can you just maybe help us understand, would that put the company back on track if I think about deposit increases in maybe fiscal â21 during COVID, would it be linear from pre-COVID levels if we just thought about the price increases compounding or would it put you ahead of that because of inflation? Carlos, can you just remind us, do those price increases tend to stick if inflation starts to roll over?
Carlos Rodriguez: Yes, I think again strategically, and maybe Dany and Don can get more specific on the numbers, but I wouldnât characterize what we did as being out of step with the market. There was a pause for a few months, but our price increases--our intention was that our price increases during COVID were reflective of the inflation environment at that time as well. We did pause for a few months because, timing-wise, we just thought particularly in 2020 that it was inappropriate to be giving clients price increases one or two months into a global pandemic, but we eventually did some price increases but we did very modest price increases, because inflation was near zero for some period of time. I donât if that answers it. Iâm trying to be responsive, but I think in general, we are always trying to remain in step with the market and still be competitive, because our number one goal is to gain market share. The trap that is easy to fall into when youâre a large company like ours is you can take price and take it higher than maybe you should be. You can usually do that multiple times and you can do that for a while, but it just doesnât work forever because itâs just the law of economics and large numbers, and itâs because of competition. So our intention, itâs important for you to understand that strategically is we want to grow and we want to gain market share, and to do that, we have to be competitive in terms of our products, our service, and also our price, and thatâs--so itâs important when we do pricing actions, either on new business or on our existing book of business, that we remain in line with whatâs happening in the general market and with our competitors.
Samad Samana: Great, I appreciate that, and good to see the strong results.
Carlos Rodriguez: Thank you.
Operator: This concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Thank you. I think weâve--weâre very happy with the quarter, as weâve said. Iâm not sure what else I could say, other than what I said about our sales performance, which I think is definitely the best Iâve seen in a long time. We talked a lot about our retention and some of the structural issues that are happening there, so itâs hard to be more pleased about that. But I do want to reiterate again how happy we are with our organization and our team. First, we started with COVID and all the uncertainty that that created, everybody having to work from home, then we have all these regulatory changes, some of them very positive like the PPP loans, the ERPC that happened across the world, and while weâre then in the middle of that pandemic, weâre telling our associates that theyâve got to work weekends and nights because weâve got to keep up with all these regulatory changes and weâve got to help our clients. Then as soon as that starts to abate a little bit, we get this great reshuffling and we start having challenges, which we overcame in terms of being able to add to staffing and so forth, so we asked our associates to once again work harder, put in the extra effort, and every time weâve asked, theyâve come through for us, so--and theyâve come through, more importantly, for our clients. We really do provide critical services across the world to our clients, and it was very, very important for our organization to come through for our clients, and I just want to again thank our associates for making it through so many ups and downs, where we just keep asking for a little bit more and they keep delivering, so I want to thank them once again. Once again, thank you for your attention and your interest and the great questions, and we look forward to talking again in the next quarter. Thank you.
Operator: This concludes the program. You may now disconnect. Everyone have a great day. | [
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"text": "Good morning. My name is Michelle and Iâll be your conference Operator. At this time, I would like to welcome everyone to ADPâs fourth quarter fiscal 2022 earnings call. I would like to inform you that this conference is being recorded. After the speakersâ presentation, we will conduct a question and answer session. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
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{
"speaker": "Danyal Hussain",
"text": "Thank you Michelle, and apologies to everyone for the brief delay. Welcome everyone to ADPâs fourth quarter fiscal 2022 earnings call and webcast. Participating today are Carlos Rodriguez, our CEO, Maria Black, our President, and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies todayâs call. During our call, we will reference non-GAAP financial measures which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Todayâs call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. With that, let me turn it over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you Dany, and thank you everyone for joining our call. We finished our fiscal 2022 with a strong fourth quarter that featured 10% revenue growth and 12% organic constant currency revenue growth. We also delivered 170 basis points of adjusted EBIT margin expansion which helped drive 25% adjusted EPS growth, and for the full fiscal year 2022 we ended up with 10% revenue growth, 90 basis points of margin expansion, 16% adjusted EPS growth, and importantly we achieved record bookings and near record level retention, reflecting our strong position in the HCM market. Let me cover some highlights from the quarter and year before turning it over to Maria and Don for their perspectives. Starting with employer services new business bookings, we had a fantastic Q4 with growth accelerating from the prior quarter, resulting in our largest new business bookings quarter ever. With this strong finish, we were very pleased to have delivered 15 ES bookings growth for the year. Despite several sources of global uncertainty, including the ongoing effect of the pandemic, the conflict in Ukraine, inflation and concerns about global recession, our compelling site of HCM offerings has continued to resonate throughout the market. In total, we sold over $1.7 billion in ES new business bookings in fiscal 2022 and well over $2 billion when including the PEO, marking the first time weâve exceed $2 billion in bookings. Maria will talk more about the growth opportunities ahead, but clearly we are incredibly pleased with what is the best performance by our sales force that Iâve seen in my 20 years with ADP. Moving on, our full year ES retention of 92.1% was nearly flat versus last yearâs record level of 92.2% as we once again exceeded our expectations in the fourth quarter. Client retention is driven by several factors, including product and service quality, business mix, and macroeconomic factors, and our expectation at the start of fiscal 2022 called for macroeconomic factors like SMB out-of-business rates to drive some normalization in retention towards pre-pandemic levels. We did see some of that play out, but clearly less than anticipated. More importantly, our product and service teams have continued to deliver a best-in-class experience for our clients and particularly so on our modern and scaled platforms. We achieved record client satisfaction levels for the year and we once again set new record levels for retention in several of our businesses, including our midmarket, so although you will hear from Don that we are once again making an assumption for a modest amount of macroeconomic-related normalization and retention in fiscal 2023, we are excited to have delivered such a strong performance in fiscal 2022 and look forward to maintaining our retention rates at these historically high levels. Moving onto the employment picture, our pays per control growth metric was 7% for the quarter and 7% for the year, reflecting a persistently strong demand environment for labor among our clients that has continued to exceed our expectations. This growth has served as a testament to the resilience of our clients, and although we expect pays per control growth will naturally slow in coming quarters, employment conditions today remain strong with our client data suggesting that near term demand for labor remains healthy. Finally, our PEO business delivered another great quarter as it wrapped up a strong year. We had average worksite employee growth of 14% in Q4 and 15% for the year, and we were thrilled to have crossed the 700,000 worksite employee mark this quarter. As you know, I joined ADP two decades ago when ADP entered the PEO market through an acquisition, and as bullish as I was about the PEO industry back then, Iâm not sure I could have anticipated we would be here 20 years later still growing at this combination of pace and scale, but the ADP TotalSource team continues to deliver a great platform, great service and a great benefit experience for our PEO clients and there is plenty of opportunity for us in the years ahead to serve even more businesses. Taking a step back, fiscal 2022 was unique in a number of ways. We experienced strong demand with over $2 billion in worldwide new business bookings and near record level retention which together drove us to surpass 990,000 clients at year end, putting us on track to exceed a million clients any day now. At the same time, weâve had to manage this growth and volume with prudent headcount growth, given tight labor conditions. The way weâve been able to do is through efficiencies, of course, but also through plain hard work by our associates, and for that, I thank them for their efforts and for coming through for our clients once again. Iâll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you Carlos. With fiscal â22 behind us, I want to take this opportunity to review where we stand on some key initiatives and provide an update on where we are heading in fiscal â23. At the core of our client experience is their interaction with our platform, and one product initiative we had talked about throughout fiscal â22 is our new unified user experience, which was designed to be more action-oriented and contextual and to move us from transaction-oriented applications to experience-oriented applications; in other words, more intuitive, better looking, faster, and more consistent across our solution. To achieve this, we have applied a research-driven approach informed by the data and insights we have gained in working with our nearly 1 million clients. Our focus has been to listen to our clients, learn from them, and utilize their input to design the best experience. In fiscal â22, we moved hundreds of thousands of clients over to this new user experience, including our clients on RUN, IHCM and next-gen HCM, as well as over 20,000 Workforce Now clients. We also moved the ADP mobile app over to the new UX. Feedback so far has been extremely positive and in fiscal â23, we plan to expand this rollout further to remaining Workforce Now clients as well as to additional modules and experiences within our key platforms. Workforce Now in particular has been exciting for us for a few reasons beyond user experience. First is its growing traction in the U.S. enterprise market. Just this quarter, ADP was rated for the first time an overall customerâs choice provider in Gardnerâs annual Voice of the Customer Study. This was the highest tier possible and was based on perspectives from end users with 1,000 or more employees and is a reflection of our continued momentum in selling Workforce Now to the lower end of the U.S. up market these past few years. This momentum builds on the already strong presence and traction Workforce Now has had in the U.S. midmarket in the HRO space and in Canada, all places where it is highly differentiated. Second is the continued roll-out of our next-gen payroll engine to a growing portion of our new Workforce Now clients. Our next-gen payroll engine not only benefits from having a global native and public cloud architecture but also empowers our platforms, like Workforce Now, to offer a better product experience and enables us to offer better service. We are incredibly excited for our payroll engine to continue to scale up to larger and more complex Workforce Now clients over the coming quarters. Finally, with talent and engagement an increasingly important aspect of the HCM suite, we continue to focus on our ability to help employers better connect with their employees. This quarter, we will launch a new offering that weâre calling Voice of the Employee, a robust employee survey and listening tool which leverages survey instruments from the ADP Research Institute to offer clients a way to seamlessly capture employee sentiment across the employee life cycle. One of the things I love about this solution is that it was born out of elevated client employee engagement our return to work workplace solutions have been able to drive, and it reflects the ability of our global product team to quickly identify an opportunity and develop a solution to meet a need in the market. Moving on, we made some exciting enhancements to the Wisely program this quarter. Most notably, we now offer Wisely self enrollment with full digital wallet capabilities for Apple and Google Pay, thereby allowing employees to instantly receive and start using their Wisely account without support from their employer and without having to wait for a physical card. We also expanded our earned wage access solution by offering a seamless one app solution for Wisely members through a deeper integration with one of our key partners. The offering enables employees to receive a portion of their earned wages prior to payday, and most importantly is free for employees who use Wisely. With these enhancements and more on the horizon, weâre incredibly excited about the growth prospects for Wisely and look forward to taking it from over 1.5 million active members today to an even larger portion of our U.S. payroll base over the coming years. During fiscal â22, we also highlighted the strength of our retirement services business, a key component of our HCM suite. We offer record keeping services, provide unbiased independent advisory services, and give our clients, their employees and financial advisors access to over 10,000 investment options from over 300 investment managers seamlessly integrated with our key platform and with the ADP mobile app. With over 125,000 retirement plan clients leveraging solutions, including 401-K, SIMPLE and SEP plans, we are proud of our scale today but even more excited about the significant opportunity in the market as we look to expand our market share within and beyond our payroll base of clients. Fiscal â22 was an incredibly strong year for our retirement services business and we are looking forward to another strong year. Finally, our next-gen HCM solution is getting closer to a broader rollout as we continue building on the implementation capacity for our pipeline of sold clients, as we shared at last yearâs investor day. While we are excited about all of these product enhancements and others too, products only drive growth when our sales and marketing organization can match it to a buyer and translate it into new business bookings, and to that end, we are excited about our sales and marketing momentum and the continued investments we have planned to drive growth this year. First, the product improvements I just mentioned, as well as many others, are all intended to drive higher win rates, an expanded breadth of offerings or higher price realization, and we fully expect our sales force to continue capitalizing on these opportunities. Second, we are making continued investment in both digital and traditional marketing into our brands and into our broad and growing partnership network. Third, we are excited to have invested at year end in sales headcount and are stepping into the new year with hundreds of additional quota carriers, and we expect to be able to grow our average sales headcount in the mid single digit range over fiscal â23. Continued execution on our product and our sales and marketing strategy is ultimately designed to drive sustainable growth, and for fiscal â23 we expect to drive ES bookings growth of 6% to 9% bracketing around our medium term target of 7% to 8% from investor day. Growth is a priority for us, and we look forward to continuing to update you on our progress. Now over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you Maria, and good morning everyone. Our Q4 represented a strong close to the year with 10% revenue growth on a reported basis and 12% growth on an organic constant currency basis, ahead of our expectations despite higher than expected FX headwinds from a strengthening dollar. Our adjusted EBIT margin was up 170 basis points, about in line with our expectations as leverage from strong revenue growth overcame higher selling expenses, PEO pass throughs, and growth investments like the sales headcount growth Maria just mentioned, and our robust revenue and margin performance drove 25% adjusted EPS growth for the quarter, supported by our ongoing return of cash to our investors via share repurchases. For the full year, revenue landed at 10% growth. We delivered 90 basis points of margin expansion, offsetting a few different sources of incremental expense over the course of the year, and adjusted EPS grew to $7.01, up about 16%. For our employer services segment, revenues in the quarter increased 8% on a reported basis and 9% on an organic constant currency basis. The stronger than expected revenue growth was a function of continued outperformance on key metrics like retention and pays per control, and our ES margin increase of 140 basis points was a bit lower than previously planned as a result of growing headcount faster than previously anticipated. For the full year, our ES revenues grew 8% on a reported basis and our ES margin increased 110 basis points. For our PEO, revenue in the quarter grew 16%, accelerating slightly from Q3. Average worksite employees increased 14% on a year-over-year basis to 704,000 as bookings, retention, and same store pays all continued to perform well. PEO margin was up 260 basis points in the quarter due in large part to favorable workersâ compensation reserve adjustments. For the full year, our PEO revenues and average worksite employees both grew 15%, at the high end of our guidance ranges, and our margin expanded 80 basis points. Iâll now turn to our outlook for fiscal 2023, beginning with some overall remarks. We have on the one hand an inflationary environment that is creating upward pressure on our expense base, and at the same time we recognize there is clearly concern about a potential upcoming global recession, or that we perhaps are already in one. On the other hand, our momentum entering fiscal â23 is strong and there are no obvious signs of near term strength, and if the marketâs forecast of higher interest rates holds, we are positioned to benefit from a continued rebound in interest income. Our focus for now will be to continue executing on our strategy, and to that end, we have been and will continue to be making investments in headcount where we perhaps didnât get a chance to last year in a tight labor market, and we also expect to deliver growth thatâs at or above our medium term annual objectives shared at the November â21 investor day. Onto the numbers, beginning with ES segment revenues, we expect growth of 6% to 8% driven by the following key assumptions. First, we expect our ES new business bookings growth to be 6% to 9%, which Maria covered. For ES retention, we finished the year at 92.1%, a touch below last yearâs record level, and we believe itâs prudent to anticipate some further normalization of business levels in fiscal â23 even while we maintain record retention levels in some of our other business units. Our initial assumption is for a decline of 25 to 50 basis points in ES retention for the year. For pays per control, with employment back near pre-pandemic levels, we anticipate a return to a more typical 2% to 3% growth range. We normally talk about price as contributing 50 basis points to our ES growth rate, but we expect that benefit to be around 100 to 150 basis points this year. For client funds interest revenue, we expect higher overnight interest rates and higher repurchase rates on maturing securities should combine with our continued balance growth to drive interest income up nicely. Our short funds portfolio, which is invested in overnight securities, will benefit assuming the Federal Open Market Committee increases the Fed funds rate over the course of this fiscal year, and our client extended and long portfolios will benefit as we reinvest maturing securities at an expected rate of about 3.3%. Between those two drivers, we expect average yield to increase from 1.4% in fiscal â22 to 2.2% in fiscal â23. We expect our client funds balances to grow 4% to 6%, supported by growth in clients, pays per control, and wages, and this is on top of a very robust 19% growth we experienced last year. Putting those together, we expect our client funds interest revenue to increase from $452 million in fiscal â22 to a range of $720 million to $740 million in fiscal â23. Meanwhile, the net impact from our client fund strategy will increase by a bit less, from $475 million in fiscal â22 to a range of $675 million to $695 million in fiscal â23, and as a reminder, this is the number that impacts our adjusted EBIT. The slightly lower growth here is due to the expected increase in short term borrowing costs which track the Feds fund rate. This borrowing enables us to ladder our portfolio and invest further out on the yield curve than we otherwise would. As we gradually reinvest our maturing securities, this gap between client funds revenue and the net impact from our client fund strategy should reverse and again become positive. Back to the ES revenue outlook, one more factor to consider is FX headwinds. Clearly with the year-over-year parity the dollar with a weaker pound and with about 20% of our ES segment revenue being generated outside the U.S., weâre factoring in a fair amount of FX headwind for fiscal â23 of well over 1%. For our ES margin, we expect an increase of 175 to 200 basis points. This coming year, our expense base will be increasing more than it does in a typical year, in part due to inflationary pressure on our overall wages and in part due to headcount growth, some of which we did late in fiscal â22 and some of which weâre planning for fiscal â23, but because our margins are benefiting from strong revenue growth outlook, including growth in client funds interest revenue, weâre pleased to be able to guide to this strong ES margin outlook. Moving onto the PEO segment, we expect PEO revenues and PEO revenues excluding zero margin pass through to grow 10% to 12%. The primary driver for our PEO revenue growth is our outlook for average worksite employee growth of 8% to 10%. That would represent a bit of a deceleration from last year, but of course we are contemplating much less contribution from same store pays per control in fiscal â23 compared to fiscal â22. This 8% to 10% growth compares to the high single digit target that we outlined at the investor day in November. We expect our PEO margin to be down 25 to up 25 basis points in fiscal â23 compared to a strong margin result in fiscal â22. Adding it all up, our consolidated revenue outlook is for 7% to 9% growth in fiscal â23 and our adjusted EBIT margin outlook is for expansion of 100 to 125 basis points. We expect our effective tax rate for fiscal â23 to increase slightly to about 23%, and we expect adjusted EPS growth of 13% to 16% supported by buybacks. Iâll make one comment on cadence - because we expect year-over-year headcount growth to be more significant early in the year and because the benefit from client funds interest will build as the year progresses, we expect adjusted EBIT margins to be down about 50 basis points in Q1 but then build steadily over the rest of the year. Iâll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"text": "Our first question comes from Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. I wanted to start with a demand question. Can you just talk about what youâve seen across client size as it relates to demand environment? I heard the continued optimism in the mid market. Can you talk a bit more about up market, down market, international, and then just give us a sense of booking cadence. It sounds like it accelerated through 4Q. Have you seen any change in pace as youâve gone through the first couple weeks here in July?"
},
{
"speaker": "Maria Black",
"text": "Yes, absolutely Bryan. Iâm happy to comment on both pieces. With respect to the overall strength that we saw in new business bookings both for the full year fiscal - very, very proud of the remarkable results, but for full year as well as the fourth quarter, and the strength was really broad-based. There was solid performance across each one of our markets. I think a few callouts that I would give, you highlighted the mid market. The mid market does continue to perform. We saw strength in our HRO offerings even beyond the PEO. The HRO was a strength for us. I know I mentioned it in the prepared remarks, but Iâd be remiss if I didnât mention retirement services again. We also saw results in Canada, which was fantastic to see as Canada definitely was impacted a bit more with the longer lockdowns from a pandemic perspective, and then I continue to highlight quarter after quarter the strength that weâre seeing in our down market and our RUN offer, so felt very pleased with the RUN. Then last but not least, on the international front, our international business had a tremendous year, so very confident in the results, very proud of the work of the sales organization. As we think about the demand environment right now, you asked about how did it progress throughout the quarter and how do we feel sitting here a few weeks into July. I suppose I canât necessarily comment on in quarter, but what I can comment on is we did see the results accelerate throughout the quarter, so while there was some macroeconomic things happening in the world, our demand actually accelerated as we closed out the quarter, so we saw significant strength specifically in the month of June - in fact, June was a record month for us ever, as was the quarter and as was the year, as mentioned. We feel good about the demand environment and the acceleration we saw throughout the quarter, and thank you for the questions."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, and then just a follow-up on margins. If things do slow down, can you just talk about the levers you have to insulate EBIT margins? It sounds like they have taken a healthy amount of resource additions. Can you talk about where youâre making those across the organization and then where you might have some discretion to throttle investment, should things slow down?"
},
{
"speaker": "Don McGuire",
"text": "Yes, itâs a very good question, so thank you for the question. I think as I mentioned in the remarks and the materials that we distributed, we were able to get our sales organization a little bit more than fully staffed going into the fourth quarter, and that makes us feel really good about the opportunity to step off into â23 with a fully staffed team, which is something that, as we mentioned in prior quarters, was a little bit more difficult to do during â22, so I think we feel really good about where we are with staffing particularly on the sales side. I would also say that, just following the business model that we have, if you look at the record sales we had particularly late in the fourth quarter, we need to make sure that we have fully staffed implementation resources to get those bookings generating revenue as quickly as they can, so we will be focused on that, and then of course just following through to the year-end process, need to make sure we can service all those additional clients as that time comes upon us in late December-January-February. We can do all those things. On the other hand, as I referenced and as weâre seeing in the media and elsewhere, everywhere is talk about a recession potentially coming, are we in one, etc. We still do have flexibility of course, and we can certainly temper the addition of headcount and temper our costs more generally should we think that thatâs necessary, if itâs something thatâs as a result of changes in the macro environment, so I think we still have lots of levers and I think weâve shown historically that we are able to navigate those waters pretty adeptly should that kind of situation arise."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great, thanks so much, and congratulations on the results. I donât know if this will be for Carlos or whomever, but it feels like the retention step-up is clearly a little more structural, just given the recent trends in â22 into â23. Is that a function of the next-gen payroll engine or just where are you seeing that success, because itâs clearly been a super, super outcome post COVID. I think part of our focus is whether or not that starts to normalize or not, but it feels like itâs at a structurally higher level."
},
{
"speaker": "Carlos Rodriguez",
"text": "There probably are some structural factors just because we can see, obviously, where the retention is stronger, and I think as we mentioned, some of the macroeconomic readjustment that we expected in a down market, we saw some of it, just not as much as we expected. But if talk of recession is correct and business and bankruptcies and so forth probably will come back to some kind of normal level, which is why, as Don mentioned in his remarks, we once again plan for a slight decrease in retention in â23, thatâs really mainly in a down market in terms of the mix that it represents--the total represents of the mix, because everywhere else we really see some reasonable, what appear to be structural improvements. I wouldnât say that itâs really next-gen payroll because youâre really going to see that, the impact of that on sales and market share and so forth in the next couple of years because the majority of our clients are still not enjoying, I think, the benefits, even though over time they will of next-gen payroll, so thatâs really not--I just want to make I was clear on that, that that is not whatâs causing the retention improvements. But one thing I would point out is--I know this is a broken record, but we made this big transition from multiple platforms onto one in a down market 10 years ago, or a little bit more than that, and then more recently we went through a multi-year effort, which was painful to do that in the mid market. We have other things going on, like new UX and next-gen payroll, that those migrations and those consolidations in and of themselves have created some real structural tailwinds, I think, in terms of service, NPS, and ultimately on the retention standpoint. Itâs just a much more--an easier environment for our own folks to operate in, itâs easier for us to invest in less platforms versus more platforms. Itâs just a much better environment. As you know, we still have work to do in the up market, so thereâs still opportunity there, thereâs still some opportunity in employer services international as well, but we think these structural tailwinds that first helped us in the down market despite the macro, right, because the macro is really a cyclical issue, but overall excluding cycles, our retention in a down market is up--I said this before, itâs hundreds of basis points higher than it was 10 to 15 years ago, and now the mid market is at record levels and the NPS scores continue to be at record levels, and I donât think we anticipate that going back down. If anything, we see more opportunity there in the mid market, and our plan would be to continue to do that throughout other parts of ADP to add more structural tailwinds to our retention."
},
{
"speaker": "Kevin McVeigh",
"text": "Super helpful. Then maybe this is for Don, it looks like the margin guidance, like 100, 125 basis points up from 90, given the leverage and float in pricing, it seems like really nice outcome on the pricing side. Is the offset kind of the cost inflation, and where is the cost inflation in the model in â23 relative to where itâs been historically?"
},
{
"speaker": "Don McGuire",
"text": "Yes, I think itâs a good observation. I think thereâs a few things driving it. Of course, we talked about more price than we historically have been able to take, and of course we do have the tailwinds, if you will, from the client fund interest, so. Certainly we need to remember that the reason weâre getting our interest rates is that weâre in a higher inflationary environment, so thatâs driving more cost base in wages. The other aspect is that we have called out, and we typically havenât called out FX in the past, but weâve certainly seen, I think what we would refer to as pretty dramatic changes in FX headwinds in the fourth quarter compared to what weâve seen in typical years, and so we thought that was important to call out. With 20% of our ES revenue being outside of the U.S. and denominated in Canadian dollars, euros, sterling, Australian dollars for that matter, I think all the currencies are essentially down. When you put all that stuff together, it certainly results in a little bit less at the top line dropping through to margins, so thatâs been our focus. The other thing Iâd say is that we do have a little bit of conservatism as we look to the back half. We have to take into account all the things weâre reading about and seeing and making sure that weâre thinking hard about how to prepare should something happen in the back half of the year, so I think those are the primary drivers, to answer your question."
},
{
"speaker": "Carlos Rodriguez",
"text": "And if I could add one thing, because you mentioned also price, and itâs a big topic. I know for a lot of companies, thereâs a lot of questions about it, and I think itâs important for you to understand strategically at a very high level, regardless of how it flows into the numbers and so forth, our view on price, weâve said it for a couple of quarters now, is to kind of keep up with inflation, so I want to make sure itâs very clear that weâre not achieving our margin improvements for doing anything that would be unusual, because I think there might be some companies that are trying to make up revenue gaps or margin gaps with price because there is, quote-unquote, cover out there to do that. But I think when you do that, and I think Don has mentioned this before, that we operate in a competitive environment and we look at what competitors are doing and we look at whatâs happening in the world, and weâre long term thinkers here, so you should assume that our price increases were in line with whatâs happening with inflationary costs and not anything more than that, and not materially less than that."
},
{
"speaker": "Kevin McVeigh",
"text": "Youâve been very consistent on that. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi guys, good morning, and congrats on the numbers. I guess my question is looking at the midterm outlook for employer services back in November, I think we talked about a 6% growth rate, and you guys are going to be trending above that, 6% to 8%. With the strength in bookings growing over 15%, I just wonder if maybe the midterm outlook was a little low compared to what structurally is going on in the business model, that potentially the growth rate is faster than the 6% outlook that you gave over midterm."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, I hope so. Iâll let Don comment in a moment, but again, just because Iâve been doing this for a long time, I canât get it out of my mind. The way the recurring revenue model kind of works is we love the 15%, and what you just described really comes through in the numbers. Itâs the difference between our bookings and our losses--our strong retention and our strong bookings, that the net of that contributed more to employer services revenue than ever seen in my tenure as CEO, and that is whatâs led to the deceleration you just described in ES revenue, so that net new business growth is really the way to grow the top line. Thereâs other factors in there, like pays per control, client funds interest, but thatâs the core of the business and weâre really happy with that. The challenge, of course, is that weâre not forecasting 15% bookings growth again next year, so I would just caution you, too. Now, the good news is that that increase in net new business is in our run rate now, and so we donât have to grow by as much the next year in terms of that net new business to further accelerate our revenue growth, but I would just caution you in terms of if you do that kind of math, itâs hard. Itâs hard to accelerate the revenue growth rate of this company. We just did it and it takes a combination of better retention and higher starts, higher sales and new business starting in the upcoming year, and that 15% really makes it huge difference. But you can see from our guidance that that is not our expectation next year in terms of bookings, and so you will experience hopefully additional acceleration of revenue growth in ES, but not by as much as you had from â22 to â23. Notwithstanding the fact that, remember, thereâs other things in there, moving parts like pays per control, client funds interest and so forth, some of which will give us tailwinds, some of which may be headwinds."
},
{
"speaker": "Don McGuire",
"text": "Yes, so Carlos covered off all the main drivers there. Of course, I think just once again Iâd go back and mention the FX headwinds weâre experiencing. I think when you add that into the mix, I think youâd probably get to a place where weâre landing and what weâre anticipating guiding to for â23."
},
{
"speaker": "Bryan Keane",
"text": "Got it, got it. Then let me ask you another popular question that everybodyâs getting, is just how the model might be different now versus previous recessions, just thinking about the resilience potential in the ADP model."
},
{
"speaker": "Carlos Rodriguez",
"text": "I mean, Don again has, I think, a couple points he could probably make, but I would say as usual, thereâs probably some puts and takes. I mean, obviously I wouldnât be a CEO if I didnât say I think our model is better now than it was before, even though Iâve been through a couple cycles here myself, so itâs not that Iâm criticizing anything other than myself if Iâm saying that itâs better than it was before. But we just talked about the structural retention level, so even if we have a little bit of a drag in the down market, and by the way, the down market is a larger percent of our overall business than it was 10, 20 years ago, but still itâs structurally higher by several hundred basis points in and of itself, so even if it goes down a little bit and is a little bit bigger part of our mix, I think our retention is just going to hold up better, I would predict, in terms of--you know, depending obviously on the severity of the recession, so thatâs a huge help because the bigger--obviously the portion of the revenues that you retain each year, the less dependency you have on bookings in a recession, which tends to be the most sensitive. Historically when you look at GDP growth and all of our metrics besides pays per control, bookings is something that can be challenging in a severe recession, which to reiterate, we donât see. We read the same things everyone else reads and we know that Fed tightening will lead to a slower economic growth, but we really canât see it in our numbers. Our pays per control number in the fourth quarter was as strong as it was the whole year. When you look at the monthly initial unemployment claims, you look at the room that still is there in labor force participation, you look at the number of job openings in comparison to where it was historically, I just donât see it. There clearly are pockets that are happening. I think as part of readjustments because of COVID that are kind of confusing the landscape and thereâs clearly some kind of slowdown underway because it just happens when you have Fed tightening, but itâs not happening in the labor market, at least not yet."
},
{
"speaker": "Bryan Keane",
"text": "Great, thanks for the color."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tien-tsing Huang with JP Morgan. Your line is open."
},
{
"speaker": "Tien-tsing Huang",
"text": "Thank you so much. Really strong sales. I was just trying to think about attribution, the strength and how you would rank the factors there between better product set thatâs more relevant or better just productivity, expanded sales force, the cycle, or particular things around outsourcing taking over versus software. Any interesting observations on your side, Carlos or Maria?"
},
{
"speaker": "Maria Black",
"text": "Yes, thank you. Definitely tremendous strength that we saw. I think I called out a few areas. Definitely the strength that weâre seeing in our up market continues to excite us for the future. I think you asked about the attribution of strength, and I think it really was broad-based across the business, but I think from an execution standpoint, it really comes down to the execution of our sales organization and how theyâve been able to go to market, candidly, really over the last two years as it relates to navigating this evolving environment, but more specifically providing value to our clients in a more meaningful way, and we really have seen that evolve over this past year as weâve been really across each one of the segments, helping our clients navigate, as I mentioned, the evolving environment inclusive all the legislative changes. I think there is value weâre bringing. I think the strong execution in general across the sales organization and leveraging the entire ecosystem to bring that strength, right, which is everything from our marketing investments, our brand investments, I spoke earlier to the headcount investments, and so all of this together, I think has lent itself to tremendous execution and strength as it relates to the overall performance."
},
{
"speaker": "Carlos Rodriguez",
"text": "The only thing I would add to that is Maria and I have been talking for the last 18 months about how--you know, one of the most important things for our sales organization was really to get productivity at the quota carrier level back to and then exceed from a trend line standpoint where it was, right, so when you think about whether itâs GDP trend or price trends or anything like that, youâve got to get back to where you were and then youâve got to get back on that same trend line, otherwise you leave a lot of money on the table, whether itâs the economy or ADPâs revenue and bookings growth. From an attribution standpoint, again this--I think itâs important for you to understand this color. We had unbelievable productivity growth, and thatâs why I said that this is the best performance Iâve ever seen by our sales force. Clearly some of it is because we were in recovery mode, but sales forces naturally generally have--not that I know, because I was never a sales person, but I guess Iâve been around long enough to be hopefully an honorary member, but when you tell a sales force, okay, youâve got to grow--weâre going to grow our headcount by a few percentage points and then weâve got to grow our productivity two or three percentage points, thatâs in a typical year, right, and thatâs hard in a typical year. When you tell a sales force, you have to grow your productivity close to 20%, even though itâs because it went down 20%, thatâs freaking hard to do, very hard to do psychologically. Anybody whoâs in sales, I think understands that, and so these percentage growth numbers that we have and the productivity growth numbers that we have, honestly, are incredibly just gratifying, because I really thought this was going to be hard. I was, of course, keeping my poker face on and just telling everybody, we have to do it, we have to do it, and we did it, so most of this growth came from productivity and not from headcount because, as weâve talked about, we actually had some challenges up until the fourth quarter in terms of achieving our headcount objectives, not by lack of trying, by the way, and not because we were trying to save money, because we were doing everything we could and it was just a difficult labor market. The good news is in the fourth quarter, as Maria has mentioned, we really did quite well and are in a great position headcount-wise now, but the â22 story is all about productivity, and that is an unbelievable accomplishment for our sales force, and itâs across the board."
},
{
"speaker": "Maria Black",
"text": "It is, and just to provide some actual numbers to that, so we reported $1.7 billion in employer services bookings - that is a record, as mentioned, and it does exceed the other record which was pre-pandemic in fiscal â19 at $1.6 billion, and so that really in the end speaks to some of this additional productivity , if you will. But Carlos is spot on - we did initially tell the sales force people, we will add headcount and you have to grow faster, but in the end we didnât add the headcount and they grew that much faster, which is why I am very bullish and excited as we step into the fiscal year with more sellers, more active quota carriers to really couple this strength that weâve had in productivity with now finally more sellers to go get after it."
},
{
"speaker": "Tien-tsing Huang",
"text": "Thatâs great. It must be gratifying for sure. Iâll stop there with that question. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hey guys. Really nice results. Iâm very happy to see the strength in the enterprise that you called out . Can you maybe tell us, like--I know you donât parse out the growth between--in ES, but if you did, weâd love to hear it in terms of the different sub-verticals. But on the bigger picture, can you tell us what types of firms--basically, are you now regaining share in some of those lower end of the large enterprise and sort of what size of firm itâs coming from and all these conversations . Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think you mentioned--we were having a little trouble catching the entire question, so maybe Iâll try to give a little bit of color and maybe you can repeat again, or ask us--ask the question again. But I think you said something about the lower end of the enterprise space and where the strength in sales was coming from, etc. I think just to repeat what Maria said, I think it is across the board, but that is one--the reason Iâm picking up on it, this is a really good news story for us, so our Workforce Now platform--you know, we made the strategic decision two or three years ago, it makes sense because it fits well in the lower end of the enterprise space, and itâs really been a home run for us there. Against certain competitors, itâs really very, very effective, and weâre selling a lot of units in that lower end of the up market space for us. As we continue with the rollout of next-gen HCM, which is really intended for further up market and eventually for global, in the meantime weâre really having a lot of success in the lower end of the up market with our Workforce Now platform. If you want to maybe repeat your question one more time, weâll give it another try."
},
{
"speaker": "Dan Dolev",
"text": "No, I think that sort of answered the question. I wanted to know, and I apologize you couldnât hear me before, I wanted to know how the conversations are--you know, how the conversations are different today when youâre with those clients versus, say, three years ago, because Iâm sure there has been a tremendous change given the results."
},
{
"speaker": "Maria Black",
"text": "There has been a tremendous--itâs a good observation, there has been tremendous change. I think Carlos hit the nail on the head - in the lower end of the up market, one of the reasons we cited the award and recognition we recently received from Gardner because the conversation around our offering, our Workforce Now in that lower end, is definitely resonating for several reasons. One is itâs a best-in-class product, as Gardner even acknowledges and the users that were surveyed for that award, but moreover, itâs also the speed by which we can execute and really take these enterprise customers and turn them into active clients, and so meeting a lot of different needs from a product perspective, from a timeline perspective. I think in the upper end of the market, certainly the conversation over the last three years has evolved. A big piece of that conversation is the global discussion and our ability to talk to much larger U.S. enterprise customers and other enterprise customers across the globe around our multi-country offerings and how weâre thinking about--how they are thinking about their strategic direction on HCM on the global front. I think the conversation continues to evolve on both ends of the spectrum of the up market, and weâre certainly in a position to have very formidable conversations and transformation discussions with our clients in that space."
},
{
"speaker": "Dan Dolev",
"text": "Great, thank you, and excellent results as always."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey, good morning Carlos, Maria and Don. Great to see all of the years of hard work really pay off here this year, so congratulations on the results. Wondering with regards to the new bookings - I mean, $2 billion in total, $1.7 billion in ES, how much of that is split between new logos relative to up-sells, and how would you characterize your expectations on that front for the coming year?"
},
{
"speaker": "Maria Black",
"text": "Thanks Mark, and thank you for acknowledging the strong performance in bookings. There is really no news to report here. I think weâve cited it for years - really, the split between new logos and client business really remains at that 50%, kind of 50/50 going forward, and thatâs really what we expect heading into fiscal â23."
},
{
"speaker": "Mark Marcon",
"text": "Great, and then with regards to the forecast, Don, you gave us a bit of a cadence sense for margin. How would you characterize it for revenue, and specifically what Iâm interested in is you did mention the interest on client funds is going to be back end loaded, but at the same time, weâve got pays per control being modeled up 2% to 3%, even though people are starting to call for a potential recession and potentially a decline in employment, so Iâm wondering how are you thinking about that part of the model and are there any things that you would call out with regards to just revenue trends as we build out the models for the coming year?"
},
{
"speaker": "Don McGuire",
"text": "Yes, so Mark, just going back to the first part of your question, you mentioned the deceleration of margin that I mentioned, and of course we talked about the increase in sales headcount specifically because it is meaningful in quarter one of this year, in quarter one of â22, so we do think thatâs going to have a bit of a drag. There are, of course, some other factors - general inflation, general etc., and weâve taken price--Carlos described and took you through our price thinking, which is pretty consistent to what weâve discussed over the last number of quarters, so we do expect to see a little bit of deterioration in margin percentage through the first quarter, and I think thatâs understood. Then as interest rates continue to--or as interest rates go higher and as we have the opportunity, weâre going to see higher client fund interest for the last three quarters of the year, but overall weâre kind of looking at pretty even top line revenue quarter by quarter through the balance of the year. No big changes at all in terms of growth rates quarter by quarter through â23 compared to â22, so if youâre modeling growth, you can feel be comfortable to model consistent growth across the top lines quarter by quarter."
},
{
"speaker": "Carlos Rodriguez",
"text": "And that doesnât mean that you should model, or that we modeled everything consistently throughout the quarter, so--because I do have to make a comment on your point that it sounded like you thought we were being aggressive, which would not be typical of us to model 2% to 3% pays per control when everyone is thinking thereâs going to be a recession. I would tell you that the fourth quarter, you saw what our pays per control growth was, and I can tell you that we have visibility into July and itâs hard to believe that for the whole year, it would be less than 2% to 3%, but then you can assume that if, for example, the first couple of months at least, since we have some visibility of that already, are in the 6% to 7% range, because thatâs where weâre kind of exiting, and you can do the math, right, so youâre probably--this is just to give you color in terms of what some of our assumptions are in our operating plan, because I think Don mentioned maybe a bit of conservatism on the back half. We probably have reasonable continuation of trends, because thatâs the way trends go, on pays per control in the first half, and then you would probably expect the second half of the year to have little to no pays per control growth, or somewhere in that neighborhood. Itâs also hard for us to model a big negative growth on pays per control just because of all the factors we mentioned in the labor market. That doesnât mean that wonât happen in â24 or late in â23, or at some point in history, but it doesnât seem likely over the course of our fiscal year. But weâre clearly expecting some slowdown in the second half."
},
{
"speaker": "Mark Marcon",
"text": "Carlos, you read my mind in terms of just the way I was thinking about the characterization and then thinking, okay, this is probably what youâre thinking in terms of the way itâs going to unfold, so thatâs directly in line. Can I just ask one more question? On Workforce Now, would you expect next-gen payroll, whatâs the expectation in terms of the number of clients that would have next-gen payroll within the Workforce Now contingent by the end of the year?"
},
{
"speaker": "Carlos Rodriguez",
"text": "In terms of new business bookings, because obviously--we just want to make sure we answer the question correctly. It will only affect--obviously weâre not even talking about migrations yet, even though at some point that will happen--"
},
{
"speaker": "Mark Marcon",
"text": "Thatâs what I was asking. Are we going to do any migrations over the course of this year?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No."
},
{
"speaker": "Mark Marcon",
"text": "Okay, great. Thank you and congrats again."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi there. Thanks for taking my question today. I wanted to ask if you are seeing or expect to see any divergence in the kind of hiring or macro--hiring environment or macro impact between the U.S. and Europe. I guess the broader question is, does your guidance assume a tougher environment in Europe relative to the U.S. or something similar?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Don probably has the details, but I can give you some high level color. Pays per control growth--I know youâre not asking about historical, but as we gather the data, I just want to tell you that pays per control growth is very strong in employer services international as well, and part of that, of course, is because of what weâre coming off of, right, which were these lockdowns and these high unemployment rates across the globe. I would say international has performed similarly, but it is safe to assume that we see probably challenges given whatâs happening in the macro environment with energy costs and the war and so forth in our international business. I donât know, Don, if you have--"
},
{
"speaker": "Don McGuire",
"text": "No Carlos, I think those points are valid. Certainly what happens with energy on the continent in particular is going to have some impacts on the results, but beyond that--this is a little bit of the conundrum that we talked about earlier, about where we are versus what people are talking about. So as much as everyoneâs predicting a recession, etc., unemployment rates in the euro zone are at 6.1%, which is an all-time low. Unemployment rates in Canada are as low as they were even before I started working, in 1974. Unemployment rates in Australia are at a 50-year low, so weâve got this situation where there seems to be a lot of employment yet all this risk and worry about recession. To come back to your question, are we a little bit more concerned about what could happen in EMEA in particular as a result of whatâs going on with current prices, etc.? A little bit more concerned, yes. Did we think about that when we put our plans together? To some extent, yes."
},
{
"speaker": "Carlos Rodriguez",
"text": "Don, you should point out that you started working in 1974 when you were 12 years old."
},
{
"speaker": "Don McGuire",
"text": "Well, Iâd say ."
},
{
"speaker": "Ramsey El-Assal",
"text": "Thatâs very helpful. A follow-up question, just update us on M&A, capital allocation. Are you shifting your approach at all? Are you seeing incremental opportunity out there given the turmoil with valuations in the marketplace, potential acquisition targets, or is it just sort of steady as she goes in terms of no change?"
},
{
"speaker": "Don McGuire",
"text": "Yes, I think for now, itâs pretty much steady as she goes. I mean, certainly you can see the valuations have dropped across the board. Things that were really expensive in January are still just expensive. Things are still expensive, but theyâve come down off of historic highs, so thereâs not exactly what I would call a bunch of bargains out there. Thereâs also not a lot of people who are coming forward looking to sell their properties because prices are down, so I would say itâs steady as she goes and we will continue to do what weâve done and look for things that work for us strategically, look for adjacencies that make sense should they arise. But really, steady as she goes, really no change to our overall policy."
},
{
"speaker": "Ramsey El-Assal",
"text": "Great, thanks so much."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Togut with Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you, good morning. Don, you called out a 260 basis point margin increase in PEO year-over-year, in part driven by a favorable workersâ compensation reserve adjustment. How much was that adjustment, and how should we think about this item for fiscal â23?"
},
{
"speaker": "Don McGuire",
"text": "I guess the short answer is we get adjustments on a regular basis, and theyâve been favorable for us. We look at the workersâ compensation experience over a number of years and we get external third parties to do an assessment as to whether or not itâs appropriate to book any of those adjustments, and this year weâve been fortunate. We donât typically forecast those numbers in any great detail simply because we do have to rely on the experience rating that the insurance companies bring to us, and so without trying to disclose exactly what the numbers were, I would say they were favorable and weâll have to wait as the months go by to see whatâs going to happen in â23."
},
{
"speaker": "Carlos Rodriguez",
"text": "Weâre disclosing it in our 10-K, so we can--"
},
{
"speaker": "Danyal Hussain",
"text": "Yes, it was $40 million for the quarter, David, in the K, and that compares to last yearâs about $5 million. Most of that was as we headed into the quarter in the forecast and guidance, so it wasnât a big departure from what we had expected."
},
{
"speaker": "Carlos Rodriguez",
"text": "But I think what Don was trying to say, though, about â23 is that itâs clearly a headwind, right, so as we--as you do your modeling and you think about margins, itâs a headwind not because thereâs an operating performance issue or whatnot, itâs just because we had a big benefit in â22 and weâre not planning for a big benefit in â23, although weâre always hopeful that we will get some benefit. Thatâs historically been our experience, is that we do get some critical reserve release. Itâs probably not as big in â23 as in â22, but it might not be as big a headwind as it appears now, just because of the numbers."
},
{
"speaker": "David Togut",
"text": "Appreciate that. Just as a quick follow-up, Don, in the guidance youâve given for extended investment strategy, client fund interest to be up about $200 million to $220 million year-over-year in fiscal â23, how should we think about the incremental margin on that additional revenue? Are you applying additional expenses against it or should we think about it flowing through at some set margin?"
},
{
"speaker": "Don McGuire",
"text": "Yes, so I think thereâs other things going on, of course. We mentioned the inflationary environment, which is why have the higher interest rates. We mentioned the FX headwinds we have, so all things in, weâre still expecting--weâre still very happy and very proud of the operating margin improvements weâre getting and we think we still have good opportunity for margin improvements ex-client fund interest going forward. Iâd say that right now, our expectations are for a pretty balanced incremental margin from both of those factors, so we are of course, as we mentioned--you know, we are spending some more money, weâre investing in sales headcount, we have higher costs as a result of inflation, some of it is offset by price, but we are letting a substantial amount fall to the bottom line but we are obviously in this for the long term, so weâll take the opportunity to invest in the business and make sure that we have the right balance between margin growth and preparing ourselves for continued success in the future years."
},
{
"speaker": "Carlos Rodriguez",
"text": "But I think that stream of revenue, we would generally see it as 100% margin, just to be completely clear. If that your question, do we apply expenses against those revenues, the answer is I think weâve--it felt like a trick question because youâve known us for a long time and weâve been clear for a long--like, on the way down, we always say it 100% hurts us, right, because thereâs really no expenses that go away when that interest income goes away, so likewise we would want to be transparent and acknowledge that on the way up, itâs 100% margin. But I wasnât sure if it was a trick question or--it sounds like it was."
},
{
"speaker": "David Togut",
"text": "No, it was just trying to understand how much of that incremental revenue would flow through to the bottom line since Don had talked a lot about investment initiatives, and you had underscored growth in sales force headcount. But thank you so much, very responsive. I appreciate it."
},
{
"speaker": "Danyal Hussain",
"text": "David, I would just add one clarification. You said incremental revenue. We did make the point in the prepared remarks that itâs the net impact of the portfolio that would be 100% incremental margin, so there is a cost offset and itâs the short term borrowing cost associated with the portfolio strategy."
},
{
"speaker": "David Togut",
"text": "Much appreciated, thank you."
},
{
"speaker": "Operator",
"text": "We have time for one more question, and that question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, great. Thanks for squeezing me in. I just wanted to maybe circle back on the price increases. I know that inflation is a big driver of the maybe more than normal amount. Can you just maybe help us understand, would that put the company back on track if I think about deposit increases in maybe fiscal â21 during COVID, would it be linear from pre-COVID levels if we just thought about the price increases compounding or would it put you ahead of that because of inflation? Carlos, can you just remind us, do those price increases tend to stick if inflation starts to roll over?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think again strategically, and maybe Dany and Don can get more specific on the numbers, but I wouldnât characterize what we did as being out of step with the market. There was a pause for a few months, but our price increases--our intention was that our price increases during COVID were reflective of the inflation environment at that time as well. We did pause for a few months because, timing-wise, we just thought particularly in 2020 that it was inappropriate to be giving clients price increases one or two months into a global pandemic, but we eventually did some price increases but we did very modest price increases, because inflation was near zero for some period of time. I donât if that answers it. Iâm trying to be responsive, but I think in general, we are always trying to remain in step with the market and still be competitive, because our number one goal is to gain market share. The trap that is easy to fall into when youâre a large company like ours is you can take price and take it higher than maybe you should be. You can usually do that multiple times and you can do that for a while, but it just doesnât work forever because itâs just the law of economics and large numbers, and itâs because of competition. So our intention, itâs important for you to understand that strategically is we want to grow and we want to gain market share, and to do that, we have to be competitive in terms of our products, our service, and also our price, and thatâs--so itâs important when we do pricing actions, either on new business or on our existing book of business, that we remain in line with whatâs happening in the general market and with our competitors."
},
{
"speaker": "Samad Samana",
"text": "Great, I appreciate that, and good to see the strong results."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "This concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you. I think weâve--weâre very happy with the quarter, as weâve said. Iâm not sure what else I could say, other than what I said about our sales performance, which I think is definitely the best Iâve seen in a long time. We talked a lot about our retention and some of the structural issues that are happening there, so itâs hard to be more pleased about that. But I do want to reiterate again how happy we are with our organization and our team. First, we started with COVID and all the uncertainty that that created, everybody having to work from home, then we have all these regulatory changes, some of them very positive like the PPP loans, the ERPC that happened across the world, and while weâre then in the middle of that pandemic, weâre telling our associates that theyâve got to work weekends and nights because weâve got to keep up with all these regulatory changes and weâve got to help our clients. Then as soon as that starts to abate a little bit, we get this great reshuffling and we start having challenges, which we overcame in terms of being able to add to staffing and so forth, so we asked our associates to once again work harder, put in the extra effort, and every time weâve asked, theyâve come through for us, so--and theyâve come through, more importantly, for our clients. We really do provide critical services across the world to our clients, and it was very, very important for our organization to come through for our clients, and I just want to again thank our associates for making it through so many ups and downs, where we just keep asking for a little bit more and they keep delivering, so I want to thank them once again. Once again, thank you for your attention and your interest and the great questions, and we look forward to talking again in the next quarter. Thank you."
},
{
"speaker": "Operator",
"text": "This concludes the program. You may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 3 | 2,022 | 2022-04-27 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2022 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Michelle, and welcome everyone to ADP's third quarter fiscal 2022 earnings call. Participating today are Carlos Rodriguez, our CEO; Maria Black, our President; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. And with that, let me turn it to Carlos.
Carlos Rodriguez: Thank you, Danny, and thank you everyone for joining our call. We delivered exceptionally strong third quarter results, including revenue that accelerated to 10% growth on a reported basis and 11% growth on an organic constant currency basis, coupled with solid adjusted EBIT margin expansion. The strong outcome on both revenue and margin drove 17% growth in adjusted diluted EPS, well ahead of our expectations. Our clients have had new shortage of challenges in navigating the last 12 months, but through it all not only have they persevere but they have invested in their workforce to better support their employees and continue to grow their businesses. We're proud to support them in these efforts through our leading HCM technology and unrivaled expertise. This quarter, I'll provide high-level commentary on key business drivers, and then Maria will take us through some product and other updates. And as usual, Don will discuss the financials and our updated outlook. Let me start with Employer Services new business bookings. We are very pleased to have delivered another strong quarter of double-digit growth. This was a record level for the third quarter. And as we had hoped when we updated you last quarter, the Omicron variant was not a meaningful factor in our bookings performance, as third quarter growth accelerated from our first half levels towards the high end of our guidance range this quarter. Our clients continue to find tremendous value across our suite of offerings with our PEO and HR outsourcing, international and downmarket businesses, again, leading the way. We're pleased to narrow our ES bookings guidance higher, and we look forward to delivering this double-digit growth for the full year, which should position us well for fiscal 2023. Our employer services retention was also very strong this quarter. As you know, our third quarter is especially important for retention since we typically experience elevated switching with the start of the new calendar year. Accordingly, we were very pleased that rather than decreasing the quarter towards pre-pandemic levels like we anticipated, our retention actually increased further into record territory driven by incredible performance from our mid-market and international businesses, among others. As we've discussed for several quarters, the strong employee and client growth we've experienced have increased the demands on our implementation and service organization. We added to our headcount to keep up with this demand ahead of our busy year-end period. And as a result, we were able to maintain strong overall client satisfaction scores despite ongoing pressure from this elevated demand. With retention having outperformed our expectations so far this year, we believe we are now on pace to hold on to most of last year's retention gains and expect to remain at 92% retention for the year, down very slightly versus last year's record retention level. Moving on to Employer Services pace for control, our clients continue to steadily hire as workers enter or reenter the labor force and our pays per control growth of 7% for the quarter came in better than expected. Clearly, there are a number of factors at play when considering employment growth trends, but strong overall economic activity continues to keep demand for labor high, and we've been pleased to see labor force participation gradually recover over the course of the year. And one last highlight before I turn it over to Maria. Our PEO had another strong quarter with 16% average worksite employee growth and 14% revenue growth. As we've seen all year, growth in our PEO bookings was exceptionally strong as small and midsized businesses increasingly find value in turning over a meaningful portion of their HR function to ADP. And that strong bookings performance, coupled with robust employment growth within the PEO base has driven this very healthy double-digit revenue growth. And now let me turn it over to Maria.
Maria Black: Thank you, Carlos. It's great to be joining everyone for the call. Also some updates on a few key initiatives we have underway. One key product initiative is the rollout of our new unified user experience. And we made some great progress on this front. Earlier this year, we moved the RUN, iHCM and Next-Gen HCM client bases over to the new UX. Feedback has been strong with clients, especially upbeat about how easy we've made key HCM workflows. In January, we shared, we started the pilot of the new UX to Workforce Now and since then, we've expanded from a handful of clients to over 1,000, early feedback has also been overwhelmingly positive. In this quarter, we began the rollout of the new UX to the ADP Mobile app. The ADP Mobile app is an incredibly important part of the ADP suite with over 10 million active users. It is one of the top five most downloaded business apps in the Apple App Store and is available in over 20 languages. And we're excited to take our 4.7 star average user experience and make it even more insightful, intuitive, and proactive for our users. As we complete the new UX rollout over the coming months. Moving on, data continues to be one of our key differentiators in this quarter, we expanded our data offerings even further, as we launched pilot clients on our new global insight dashboard powered by DataCloud. This dashboard provides our GlobalView and Celergo clients with advanced analytics for their employee populations around the globe, leveraging the same award-winning analytics platform we have scaled across our U.S. mid and upmarket client bases. Last quarter, we mentioned you would hear a bit more about our marketing efforts here at ADP. At our Investor Day in November, I spoke about how for decades, ADP has reached prospects through our powerful direct sales force and how in more recent years, we have enhanced this direct channel with modern selling tools, a growing partner network, and with increased digital advertising. This quarter, we continued to advance our great momentum and expanded our overall brand investment with additional initiatives, including our first major athletic sponsorships, a group of eight impressive professional golfers featured across the LPGA, the PGA and the European Tour who together constitute team ADP. The ADP brand is a powerful asset and has come to be associated with professionalism, insightful and trustworthy data. And the premier technology and service we pride ourselves on, and we believe there's opportunity to continue investing in our brand while also pushing the frontier in digital marketing efforts to support our world-class sales force. And as a final call out, this quarter, we were pleased to host one of our marquee client events, ADP Meeting of the Minds in California, which was back in-person for the first time since 2019. This was our 37th Meeting of the Minds conference. And we took the opportunity to engage deeply with our enterprise clients on the changing world of work. What I love most about this event is as much as we enjoy sharing our perspective with our clients and showing them our latest HCM innovations, we also make the most of this opportunity by listening to and learning from them and having the event back in-person really makes a big difference. The third quarter was a terrific quarter overall, which you can see in our results and in the progress we made on key initiatives, we were recently named one of Fortune’s Most Admired Companies for the 16th year in a row. And we are proud of this honor because it highlights our culture of continuous improvement, our consistency and our focus on being a true partner to our clients. A big thank you to our associates who make this all happen. Now over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. For our third quarter, we delivered 10% revenue growth on a reported basis and 11% on an organic constant currency basis. This revenue growth in turn supported adjusted EBIT margin expansion of 50 basis points, which was much better than the decline we expected. We achieved that margin expansion despite incremental investments in headcount and compensation we discussed last quarter. Through the combination of this strong adjusted EBIT growth, a slightly lower tax rate and a lower share count, we were able to deliver a 17% increase in adjusted diluted earnings per share. Looking more closely at the segment results, our Employer Services revenue increased 8% on a reported basis and 9% on an organic currency basis. ES revenue has been supported all year long by strong retention and pays per control trends. And our double-digit bookings performance has been contributing nicely as well. In Q3, we also started to get a more meaningful contribution from client funds interest through the combination of our 15% client funds balance growth and an average yield that was nearly flat with the prior year. This year-over-year increase in client funds interest contributed about 0.5% to our revenue growth, which is a very nice outcome compared to the last several quarters. ES margin increased 120 basis points, well ahead of our expectations for the quarter and supported primarily by revenue growth. Moving on to the PEO segment. PEO revenue remains very strong and grew 14% in the quarter. Average worksite employee growth is the primary driver to PEO revenue and remained at a very robust 16%, reaching 688,000 average worksite employees for the quarter. We continue to benefit from the strong bookings growth we’ve seen all year long, as well as healthy retention and pays per control growth within the PEO client base. PEO revenue growth is a bit lower than worksite employee growth this quarter, which is fairly atypical, impacting revenue for worksite employee was a mix shift towards WSEs with a slightly lower average wage and lower benefits participation, representing continued normalization back towards a pre-pandemic mix. That said, it’s good to see a recovery in all parts of the workforce in our PEO. PEO margin was flat in the quarter and included higher selling expenses driven by our strong sales momentum. Moving on to our updated outlook for the year. For ES revenues, we are raising our guidance and now expect growth of about 7% up from our previous guidance of about 6%. There are a few drivers behind that increase. We are narrowing our ES bookings guidance higher to a range of 13% to 16% up from 12% to 16% prior. So far this year, we have realized and delivered solid double digit growth. Clearly, there was geopolitical uncertainty in Europe, as well as more general macro uncertainty. But notwithstanding those uncertainties, our outlook contemplates a strong Q4 with growth in the teens and we look forward to delivering a strong finish to the year. We are raising our employer services retention guidance, and now expected to be down only 20 basis points for the year versus our prior expectation of down 40 basis points. Our retention has held up extremely well so far this year, but at a prudence, we are assuming a modest decline in Q4 for the same reasons we’ve outlined all year long. For U.S. pays per control, we’re once again, raising our outlook and now expect 6% to 7% growth versus our prior expectation of 5% to 6% growth driven by the ongoing recovery in the labor force participation combined with steady demand for labor from our clients. We are also raising our client funds interest outlook slightly to a range of $450 million to $455 million up from our prior expectation of $440 million to $450 million. There’s no change to our 18% to 20% balance growth outlook with just a few months remaining in fiscal 2022, the benefit from higher new purchase rates for the recent yield curve shifts is modest. And therefore, we still expect yield to round to 1.4% for the year. Moving on to ES margin. We are raising our outlook to now expect margins to be up 100 to 125 basis points versus up 75 to 100 basis points prior. This increase is mainly driven by the stronger revenue outlook and margin performance in Q3 versus our expectations. Moving on to the PEO. We are narrowing our average worksite employee growth to 14% to 15% versus 13% to 15% prior driven by continued momentum in new business bookings. We are likewise narrowing total PEO revenue to 14% to 15% growth up from 13% to 15% growth prior. And we are raising PEO revenues, excluding zero margin pass-throughs to 15% to 17% growth from 14% to 16% growth prior. For PEO margin, we are raising our guidance to now expect margins to be up 25 to 50 basis points rather than flat to down 50 basis points for the year. That’s driven by an improvement in pass-through expenses, including more favorability from workers compensation compared to our prior outlook. Putting it together for our consolidated outlook, we now expect revenue to grow 9% to 10% up from 8% to 9% prior. For adjusted EBIT margin, we now expect an increase of 75 to 100 basis points, up from 50 to 75 basis points prior. We are making no change to our tax rate assumption. And we now expect growth in adjusted diluted earnings per share of 15% to 17% up from 12% to 14% prior. Before we move on to Q&A, I wanted to quickly touch on fiscal 2023. We’re still going through our planning process. And so we won’t be providing any specifics this time. Clearly, there are going to be some unique puts and takes for fiscal 2023, but overall, we feel very good about the momentum in the business and we will remain focused on our medium-term growth objectives that we laid out at our November Investors Day. We look forward to providing our outlook next quarter. Thank you. And I’ll turn – now turn it back to the operator for Q&A.
Operator: [Operator Instructions] We will take our first question from Peter Christiansen with Citi. Your line is open.
Peter Christiansen: Thank you and good morning and congrats on the solid execution this quarter, guys. Carlos, I had a question about for a number of quarters, we talked about ASO, HRO becoming a larger contributor to ES. Just wondering if you had any thoughts on how that’s contributing to the stickiness of retention at this point? And then as a follow-up, given all the UI upgrades you’ve given across the platform, how does that translate to growth to add-on services? I’m thinking even things like pay wisely, those sorts of ancillary value-added products. Thank you.
Carlos Rodriguez: Sure. I’ll take the first part and I’ll let Maria takes the second part. On the HRO business within ES, which as you know, is kind of our full outsourcing solutions or without the co-employment, the growth there has been quite robust on bookings, which obviously then is driving really robust growth in revenues. The interesting thing about that business, I mean, you have to – you almost have to call out. It’s nice to be able to do it publicly, just unbelievable execution because in our business, when you get that kind of growth, that quickly, it’s very, very hard to manage. But somehow they’ve managed to stay ahead into terms of headcount hiring for both implementation and service. And the business is just really performing incredibly well. Retention rates are holding up. Not just holding up, I think they are up versus the prior year, which was already a strong year. And I would say contributing to the overall improvement in retention and stickiness. So I would say that that is probably – I would get in trouble for saying this, because then I offend all the other businesses, but that’s got to be one of the star performers. Now the PEO obviously isn’t doing incredibly well. Also and you can see that as a separate segment, it’s a little harder to see the HRO business. It’s also getting big. I think if I’m not mistaken, it’s – probably never publicly disclosed it, but it’s getting close to $1 billion in revenue. So that’s a pretty solid business with again, without – I’m probably not right to give you too much detail, but revenue growth is strong double digits, very strong double digits with a two in front of it, let’s say. And bookings growth is incredibly robust as well, retention is strong. Just really performing very well.
Maria Black: With respect to the new user experience. So I mentioned a bit about it during my prepared remarks, very excited, obviously about the impact of the user experience across the entire portfolio. In terms of what it’s going to do with respect to attach, I think you mentioned wisely and other attach. It’s hard to tease out specifically the impact of the new user experience at this point in the quarter or even for the year as it relates to any material impacts to bookings or to attach. However, we definitely believe in what we’ve developed and the impact that’s going to make. So just to give a tiny bit more color. The new user experience is really based on a research driven design. That research driven design included our clients, as well as our prospects to create a user experience that’s very action-oriented and it’s navigation. What that means specifically is the ability to move through the process payroll, if you will or to your question, the ability to buy and attach in a very action-oriented navigation, which means you don’t really need to know what’s next in order to move through it. It also leverages artificial intelligence as well as machine learning to create a very personalized experience for the buyer or the user, if you will. So that it remembers how the specific individual likes to navigate through the system and serves it up that way in following subsequent sequences of usage. So the other part that we’re very excited I mentioned rolling out the new user experience across the ADP mobile app. The mobile experience, one of the things that will really become a competitive advantage for us is the fact that the mobile experience will be not just for the end user such as that person that would actually purchase wisely, but also for the practitioner. And so a fully web-enabled user experience using the new user interface will certainly lend itself to a better competitive advantage for us in the future. And so as you can tell by my commentary very excited what this is going to do for us both as it relates to our sellers being able to demo and gain volume there, as well as our buyers and clients being able to engage in something a lot more user friendly, so that we can attach more business.
Peter Christiansen: Thank you. Thank you, both. Congrats again, on the solid result.
Operator: Our next question comes from Tien-tsin Huang with JPMorgan. Your line is open. If your telephone is muted, please unmute.
Tien-tsin Huang: Forgive me. I’m sorry about that. Hope you can hear me now. Great results for sure. It looks like you’re taking some share again. On the PEO side, I just want to make sure I understood the PEO revenue growth coming in beneath WSE growth. I know you said it was unusual. Some of it was benefits participation and salary driven. But just trying to understand is that more of a mean reversion change that you’re talking about? Or is there a quality sort of focus that maybe we should honing in? I’m just trying to better understand that trend and if it might persist for some time.
Carlos Rodriguez: Listen, I’m glad for the question. And I’m also glad for the answer, right? Because mean reversion is my favorite term in business because when you get into large businesses and large economies, it’s a powerful force in the universe. And that’s exactly what it is. If you remember, this happened with some of the data that was reported by the Fed and by us in terms of employment. That in the initial stages of the pandemic, the jobs that went away the most quickly in terms of quantity were kind of lower wage jobs that in general don’t have high benefits participation rates. Even though our PEO is generally white collar to gray collar, we experienced the same thing there in the PEO. So ironically at that time, it looked like our benefits per employee – worksite employee were rising, but it was really because of the averages and because of the mix shift. And now we have this mean reversion where even though the white collar jobs are growing and wages are growing, like everything is going exactly as you would want and expect in the PEO. You have this unusual thing because of the pandemic with a lot more jobs coming back that are people who don’t have benefits. So it makes the benefits revenue grow slower than the worksite employee number. But it has nothing to do with any kind of policy change or change in kind of our philosophy or it’s really just a re-normal or a normalization back in my opinion to where we were before. We’re trying to assess kind of how long that takes and it’s probably another quarter or two. There’s a second factor that I think that’s contributing to this, which is that state unemployment rates are coming in a little bit lower than we had expected because some states because of the strong employment market, even though they initially raised unemployment rates, because they thought that were going to have big problems in terms of people filing for unemployment. Obviously now what’s happening, it’s going in the other direction. And a few large states have actually lowered unemployment rates. That’s not a – it’s a factor. It’s not a huge factor. I think that the mix shift issue is mathematically and this mean reversion is 95% of the explanation. By the way, we don’t necessarily mind it one way or the other, because as you know, we treat benefits revenue as a pass-through. So there’s really no profit and no margin. So it’s really not relevant for us in terms of how we manage the business. Other than we have to explain it to obviously our sales community.
Tien-tsin Huang: Yes. Thank you for the complete answer. It’s really helpful. Thanks.
Operator: Our next question comes from Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi. Good morning. Thank you. Question around bookings. So you cited an acceleration toward the high end of the range in 3Q and you were tracking below that in the first half of the year. So I’m curious, what were the key drivers of that better performance you saw in 3Q? Was it larger deals that were converting or some improvements in sales force productivity trends? And then just on the outlook for the fiscal year, it sounds like you are confident that momentum here is carrying through as well as, I guess, the removal of potential Omicron conservatism. So I just wanted to clarify if that was fair.
Maria Black: Fair enough. We did see strength in the third quarter. As you mentioned, we saw strength that was in line with the higher end of our full year guidance in the third quarter specifically. So an accelerated result. We expected that and we delivered that. We did see strength in our down market businesses. So specifically the RUN platform sales as well as retirement services. We also saw strength in our international business. And then last but not least, I think Carlos mentioned during his prepared remarks, the strength that we saw in PEO booking with the entire HRO portfolio, which is what’s reported in employer services did have specific strengths. So again, that’s the down market, RUN, retirement, international and the employer services, HRO that’s where we saw the strength in terms of how we feel stepping into the fourth quarter. In terms of end quarter, the strength that we saw was actually delivered toward the end of the quarter, if you will, in March. And that really gave us the confidence to narrow our guidance heading into the fourth quarter and feel optimistic as we step into the fourth quarter with respect to the overall macroenvironment. And so you mentioned the Omicron that we noded to last quarter. We didn’t see that materialize. And as we sit here today, the economic tailwinds that we see in the market, the challenges that businesses are facing with the increased complexity of new legislation and the tight labor market. There are a lot of things that are out that are giving us the confidence that we will continue to execute in the fourth quarter. And as such, we felt it right to narrow the guidance range to the 13% to 16% for the full year outlook.
Don McGuire: And just as a reminder, when we talk about bookings, I think Maria mentioned it, and I’m sure all of you remember that we really talk about ES bookings. So a couple years ago that we changed our approach to disclosures because we thought that disclosures in the PEO were better in a format where we really talked about growth of worksite employees. It’s very easy to kind of do the math in the PEO when you talk in those terms. But to be crystal clear, if PEO bookings were included in overall bookings, they would have been meaningfully higher for ADP.
Bryan Bergin: Okay. That’s helpful. And I know you don’t want to quantify fiscal 2023 outlook yet. I’ll give this a shot. What are some of the puts and takes we should be thinking about for next year? Anything you want to call out as it may relate to comps or dynamics from this fiscal year that may not necessarily carry forward?
Carlos Rodriguez: Yes. I think that first of all, no specifics for 2023, we’re going to wait until the next earnings call we have before we give more color on 2023. But as I said earlier, we’re very comfortable with the fundamentals and we think we’re in a good spot. We’ve overcome some of the challenges that we referenced last quarter in terms of making sure we’re appropriately staffed for the bigger business that we now have. We did that well going into the busiest quarter of the year. So that’s all in good shape. Certainly, you guys are probably better at the numbers than me on what’s the potential impact from flow balances, et cetera. Certainly, it’s pretty clear that we will have higher client fund interest next year. However, how much, we’re not quite sure yet, even though we’re seeing rates go up, certainly there’s lots of volatility in the rates. There’s certainly lots of things going on. But I’ll come back to the way I ended my prepared remarks and that was that we very much will be mindful of what we share with everybody at the Investor Day in November. And we will make sure that we have those targets in mind, as we prepare when we get ready to release more information on 2023.
Don McGuire: And it’s a non-GAAP term, but it’s safe to say that client funds interest will be up a lot.
Bryan Bergin: All right. Thank you very much.
Operator: Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open.
Eugene Simuni: Thank you. Good morning. I’ll start with a macro level question. So ADP obviously has its finger on the pulse with very large slides of the U.S. economist. So it’s always very interesting to hear you guys perspective on kind of real time read of what’s going on across the different pockets of your client base, especially now that we’re experiencing kind of volatile macroenvironment. Would you mind providing us with a little bit of that commentary what do you see in today across your client base markets of strength and weakness?
Carlos Rodriguez: Sure. As you know, obviously our commentary is generally focused on the labor markets. Like this morning, I was hearing reports about what’s happening with consumer spending, which is quite robust that obviously ends up having an impact on the labor markets, because people who are in the service sector or people who are serving consumers end up hiring people in order to fulfil that demand. But generally speaking, our comments are really around the labor markets. And as you can see from our pays per control growth, some of which is related to the previous question about comparisons, right? Like the comparisons are easier and they will get harder next year in terms of percentages. But the percentages don’t matter as much as the absolute numbers, right? And the absolute numbers are strong, I think are robust. And I think as we alluded to the labor market is almost fully recovered. We obviously keep an eye also on things like GDP, GDP growth. I mean, absolute GDP dollars have already surpassed pre-pandemic levels. And they’re kind of in line to get back to trend growth or exceed trend growth on a real basis, right? Because you have to factor in obviously the fact that we have some higher inflation now. I mean, our perspective generally is that the economy is very strong, like based on the things that we’re looking at in our business. But we obviously live in the real world that we have to think about the next quarter or two, but also about 12 months from now and 24 months from now. And Finance 101 would tell you that increase in interest rates that are expected from the Fed and that have already been priced in, which are helping our client fund interest on the two year, five year, seven year and 10 years, I think will all slow at some point the economy, which is the intention, I think of the federal reserve to get inflation under control. Having said all that, you have to make your own decisions on whether or not that will be navigated appropriately to a “soft landing”. But we had 10 years from 2011 through or call it 2010 through 2020 before, right before the pandemic of what I would call relatively, historically speaking reasonable growth in GDP call it 2%, 2.5% GDP growth, gradually recovering employment. So, if we go from 3% or 5% GDP growth, the 2.5% or 2%, we like that. And I think we’ve delivered some pretty outstanding results for all stakeholders during that kind of period of time. So we would not like a recession, just like no one else would like a recession. But I think if you believe that the best of is behind us that doesn’t necessarily need that things are not going to be good going forward. Because we – all the indicators we’re seeing right now are really strong underlying labor markets. And we also have in the U.S. an administration that will be in the seat for another call it three years, despite what happens in the midterms that is, generally more favorable towards employment regulation and – and that, I think, is a favorable tailwind for our business as well in terms of just on a macro – on a very macro level. So I think we like the environment. If the best scenario for us, frankly, which would be a homerun is that growth gradually slows not to the point where there's a recession, but where interest rates stay at the rates that they're at, particularly like kind of the three to five and the seven years, and that really is a pretty large tailwind for us from a bottom line standpoint.
Eugene Simuni: Got it. Got it. Thank you. Very, very helpful. And then quickly for my follow-up, staying with the macro theme, inflation is obviously running high, so maybe for Don. Can you give us a quick overview of how inflation you think influenced impacted your results this quarter? What were the puts and takes in the P&L from inflation?
Don McGuire: Yes. So we've done a couple of things over the last quarter, as we said, we were going to on the last call and we did an off-cycle salary increase to make sure that we kept our associates happy and whole. So that was positive. We also had some bonus programs and some sales conditions, accrued programs that were certainly anticipated and booked in the quarter. So we are – from a cost side, we were able to do those things and still deliver the improved margins. So we think that was very positive for us to do. The other side of this, of course, is price increases, and the two aspects of the price increases. Certainly, we haven't yet – although planned, we haven't yet initiated large price increases with our installed base. We will make sure that we do those things accordingly, reflecting inflation and most importantly reflecting to make sure that our clients still get great value from us in a competitive environment. And what we did do though and we signaled this in the last call as well, we have increased the pricing on some of our new offers, our new offer sales we – sales we had in the last quarter. But that's having a very minimal impact on Q3 and certainly won't have an enormous impact on the full year either. So we are making sure that we're focused on pricing both in the base and with new opportunities, new prospects and making sure that we're adjusting our wage levels to keep our employees and deliver the good service that we've delivered that is contributing to the high retention rate we have.
Carlos Rodriguez: And the only other thing that I would add that we may not always directly linked to inflation as I am beating the dead horse here, but the client funds interest, obviously, inflation is what's driving these higher interest rates. It also happens to also drive higher balances. A lot of our balances are driven by our tax business, but wages, some of those taxes capped, but for example federal withholding taxes are not necessarily capped. So the more people get paid, the more taxes we collect and have to remit to various agencies and wages are a portion of our float balances. And clearly, there is an impact from there. Overall wage inflation, forget about our own inflation that Don is referring to, but the inflation in our client base in terms of their own – the wages of their employees is really driving – is helping our balance growth for sure. But more importantly, it's obviously driving a belief that interest rates need to rise rather rapidly, which is now being already factored in into – even though the Fed controls obviously fed funds rate you can all see what's happening with the one year, two year, three year, five year and what the expectation is for and that's all related obviously directly to inflationary expectations.
Eugene Simuni: Got it. Got it. Very comprehensive. Thank you very much guys.
Operator: Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Good morning. I was just hoping maybe to get a little bit more on the pricing comments you made if you look at pricing and compared to what you anticipate getting and compared it to historical levels, what will be a good way to – are you able to kind of quantify that or maybe just a good way to think about the opportunity ADP has going forward?
Carlos Rodriguez: I think the safest thing for us to say right now because, as Don said, we really haven't finalized that yet as we have not finalized our 2023 operating plan. So I think Don was giving you kind of directional color, which is 100% accurate. We've been doing a lot of work, and Maria and the team have been doing a lot of work on what's the appropriate pricing policy, if you will. Don mentioned the fact that on new business, it's relatively easy because that's something that we control timing-wise, whereas price changes to the book of business, we have a cycle that we go through, and we decided not to do anything unnatural or out of cycle. So that that decision is still kind of in front of us. But I think Don used the word competitive, we do not live in a vacuum. And so, we are going to do what's appropriate based on what's happening with inflation, but also with what's happening with competitors. So we're going to be watching very carefully what everyone is doing from the – obviously from the sidelines since we obviously don't have any direct insight into what our competitors are doing. But you get competitive signaling and you get hearsay here and there. So we're looking at all those things, but it's safe – I guess the best way to describe it is whatever our price increase had been historically and it was probably consistent for almost 10 years in terms of kind of what we were telling you in terms of what it represented in as a percent of revenue. It's safe to say that that's going to be higher. And you kind of have to draw your own conclusions if inflation was 2% and now it's 4% to 5%, you could infer because our costs not just our wage cost, which Don alluded to, we've already had to kind of build in higher costs for our own associates. We have other costs. We have other services and other things that are being provided to us that are like every other company and we got to cover those costs. I think our philosophy is we would like to be in line with what's happening in the market.
Kartik Mehta: And then just, Don, one last question. Just on the float portfolio, any thoughts about changing how you manage it or going shorter or longer, just because of where rates are and the volatility at least in the near-term?
Don McGuire: We get this question often. And at the end of the day, we keep coming back to the same thing, and that's the safety diversification and liquidity of what we invest in. And so, it's unlikely we're going to make any major changes to the way we invest funds. I think we want to be – we want to certainly do well with our portfolio, but we also want to be prudent and so we'll continue to do that. So there's really no impeditive or imperative for us to make any changes to the way we've been managing those funds in the near, mid to long term.
Carlos Rodriguez: And I think it's also safe to say that our philosophy is that we run an HCM technology services company. And this is a really nice side benefit that for however long we've been in this business, we have this float income, and it goes up and down based on interest rates and the economy and so forth. And I think compared to ten years ago, it's a much smaller portion of our bottom line. And so, that is both good and bad, right. I would have enjoyed my life and my tenure a lot more had interest rates not been as low as they were for as long as they were. But having said all that, it puts us in a much better position where it's much more clear now that ADP's core earnings are not driven by fluctuations in interest rates. And the reason we ladder our portfolio is primarily because as Don said about safety and security and liquidity, but it's also because philosophically we're not trying to gain the market, we're not trying to time the market, we are running an HCM technology services business, and that's our focus.
Kartik Mehta: Thank you very much. I really appreciate it.
Operator: Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi, thanks for taking my question. Nice results on margins in the quarter. You guys beat our number pretty handily despite, I think, a headcount increase that – could you help us think through the puts and takes with that performance in terms of sales productivity or other drivers? And also sort of how you're thinking about those primary levers for margin expansion as we move forward?
Don McGuire: Yes. So as I said a few minutes ago, we're very happy with the ability to hire quite a number of service implementation people going into this – going into the third quarter because that's obviously the busiest time of our year. So we made sure that we got as many people in as we could and we did quite well. And I think the retention rates are suggesting that we've continued to do a good job on behalf of our clients because they're sticking around. So very, very positive. Going forward, I think as we – once again, you're coming back to the plan a little bit that we're still putting together. But certainly, as we continue to grow, we'll continue to make sure that we staffed accordingly. And really not too much color to add there other than we've been successful at the hiring as we said we would be and it's not going to – it's not going to change dramatically and have any different impact on our overall margin than what we anticipated. And I don't know the sales continue to go very well, doing very well. We've talked the last time about productivity and things reverting back to means. And I don't know, Maria, if you want to make a comment about sales productivity, we've had good results.
Maria Black: Yes, happy to add there. The investments that we're making into the overall sales ecosystem continue to be very balanced. So it's really all about the seller enablement. So as mentioned many times, we have this world-class sales force that's out there directly distributing our products and we enable them with an entire ecosystem of modern seller tools. That's definitely where we spent the last couple of years investing, especially as clients continue to pivot between wanting in-person and virtual. So seeing great productivity there, also seeing investments in brand and marketing and advertising. That's a big piece of the balanced approach that we take. And again, I don't see huge shifts in terms of the balanced approach that we're taking, but it is really an area that we continue to invest. I should mention to in that laundry list, digital advertising. So that's an area that we continue to see significant performance year-on-year in our down market and our mid-market in terms of the execution there. So all of these things are really about continuing the approach that we've had to enable the strong sales execution that we've seen this year and going forward.
Don McGuire: One last thing on margins that I would add because I think it's something that we've been for years talking about is just a reminder that the overall ADP margin does get impacted by the mix of PEO and the growth rate of PEO compared to Employer Services. So from a GAAP standpoint, we do include zero margin pass-throughs and we believe that's the right approach and I think the SEC believes that's the right approach. But I think clearly, if you took out zero margin pass-throughs from the PEO, you'd have a very different margin profile of that business and hence you would have a very different margin overall for ADP. I only raised that because it is important to look at those two separately because you do have a mix shift issue that happens that doesn't necessarily tell you what the underlying strength of those businesses are. And that sometimes helps us in terms of our story, sometimes it hurts us, but it's the appropriate thing to guide you to, to look at. Because in this case, for example, the underlying margin is much higher because of the pressure that we're getting from zero margin pass-through as a result of that mix.
Ramsey El-Assal: Okay. That's very helpful. And could you comment on or update us on your sort of M&A and/or capital allocation strategy? And just in the context of the current macro backdrop, are you seeing the opportunity, M&A opportunities change? Or how are you framing that up internally in terms of your priority – prioritization?
Don McGuire: Yes. So I'll just start with opportunities. Certainly, as always, there is no shortage of things floating around and things to assess and review, et cetera. So we continue to do that. But as Carlos has said and we've said over a long period of time, if we're ever going to do anything other than a tuck-in here and there, which we had – we did have one in Q2. But other than tuck-in here and there, we're very disciplined in making sure that we're just not adding additional products where we already have products and making sure that we can keep our portfolio as clean as possible. So we continue to look at opportunities and evaluate things and we will make the right choices when the time – should the time come. On the – just in terms of our overall philosophy, I don't think we've changed our philosophy. We continue to be committed to the share buybacks that we've committed to dividends in the 55% to 60% range, although we were a little bit higher. I think we were 61% last year, but we're committed to that 55% to 60% range. the – even though the markets are off, just back to opportunities for M& a little bit more, even though the markets are off a little bit, and I think that the valuations that are out there are still quite high, the expectations at a number of people, who are looking to do something with their current operations, their expectations really haven't adjusted to or reflected what we're seeing in the market. So it's not any easier yet, but we will watch, we will evaluate. And if we see something or things that make sense, we'll do. It's appropriate.
Ramsey El-Assal: Got it very well. Thanks so much.
Operator: Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Good morning and thanks for taking my questions. I wanted to dig in a little bit on the bookings commentary. Can you talk a little bit about with RUN? You saw strong growth there. How much of that was new businesses versus competitive takeaways? And how would you characterize the competitive takeaways? Are they from your biggest competitor in Rochester? Or are you seeing more from locals and regionals that haven't been able to keep up with the technology changes? Just any sort of depth there? And then can you also talk a little bit about the retirement service solutions that you have and what you're seeing there? And lastly, can you discuss a little bit what you're seeing with regards to Workforce Now and the mid-market?
Maria Black: So happy to be the one to start here in terms of the strength in bookings. So specifically to RUN, Mark, I think in terms of the commentary around the competitors in Rochester and others, what I would say there is our continued focus on competitive takeaways has not waned. In terms of the strength of actual RUN sales and bookings performance, it's partially anchored in the amount of new business formations that we've continued to see. And so, there is definitely strength there, but certainly not for a lack of interest in the competitive side of the house. To touch on retirement services for a minute as well since you asked about that, I would say there's definitely tailwinds there in terms of attach specific to our RUN portfolio. And so as you're aware, significant legislative changes that have happened in the retirement environment state by state, and that's yielded a tailwind for us in terms of the offer that we have and certainly that makes an impact in terms of our ability to sell new logos as well as competitive takeaways because the combination of RUN and retirement and that in this type of an environment is an incredibly compelling to compete out there in the market. So I don't know, Carlos, if you have anything else to add to that.
Carlos Rodriguez: No, I mean, we try to stay away from obviously any kind of – making comments about specific competitors, but I would say that specifically in SBS, we do watch this kind of balance of trade very carefully. And I think – I talk about it every quarter in terms of it's important to me, like one of the most important things for us in terms of long-term sustainability, and durability of our business is market share is really being able to grow units. We also love share of wallet and we love to sell additional business, et cetera, but that's important to us. And at least the figures that we're seeing in terms of our large national competitors, our balance of trade remains positive and improved in the third quarter versus the second quarter. So that to me tells me that I think we're still I think in a good place competitively and that we're doing all the right things, but having said that it's a very competitive market. There's no question about that. And everyone, I think has including some of our national competitors that have good products and good go-to-market strategies. And we are in the trenches every day competing in trench warfare with some of those competitors, we feel pretty good based on the data that we keep track of that we are doing well in terms of balance of trade and also in terms of market share.
Don McGuire: And Mark, you asked about Workforce Now bookings. So we shared color on some of this already, but in addition to the HRO business, which is doing really well and uses Workforce Now. And then the PEO business, which also uses Workforce Now, there's just the mid-market HCM solution, we didn't call it out, but that also did very well double-digit growth.
Carlos Rodriguez: And I think the other last one you asked about was retirement services. That business, as you probably know has some significant tailwinds because of regulatory changes that are going to get, they're going to become potentially GaelForce wins, in terms of with a new, I think it's called SECURE 2.0 or because I think the first one was the SECURE Act looks like it's going to make its way through Congress with bipartisan support and the first wave and the first version of that has already created some strong demand. In addition to what was already happening at the state level, where several states were requiring small businesses to mandatorily required to provide a retirement plan. So all those things are tailwinds for that business and that would be one of those businesses that I would describe as doing incredibly well, but trying to keep its head above water to meet demand. It's a good problem to have, trust me like I've been around long enough to know these are – this is a good problem to have. But it's still a problem. And so we're busy adding resources and trying to be appropriately staffed in our RF business, because it's definitely a growth engine.
Mark Marcon: Can you size it Carlos, in terms of – I mean, we're aware of the becoming GaelForce wins. Just wondering how meaningful it's going to end up being to you on the whole?
Carlos Rodriguez: I would say just general range. So you have some sense it's smaller than the HRO business, for example. So you shouldn't assume that we have $1 billion business, so you don't start getting too many images of grandeur. But it's a big business, call it maybe somewhere around half-ish of that business. I don't know, Danny, before I get into trouble, hundreds of millions of dollars. But growing, I think also at one of the faster rates, I think in terms of our businesses here and both for bookings and for revenue.
Mark Marcon: Great. And then the follow up is just, Carlos, you mentioned your non-GAAP description in terms of interest income on the float for next year, how much of that, when we take a look at the Analyst Day discussion and the margin discussions. We typically look at the margin expansion ex-float, how much of the float would you let flow through? I know you aren’t giving us the 2023 guidance, but just philosophically, how are you thinking about that?
Carlos Rodriguez: Well, first of all, philosophically, we don't hide anything. So as you know, there's a nice little schedule that we include that allows everyone to do the math. And so next quarter, I'm sure you're going to do the math. And you'll ask us how come you are or aren't allowing X percent to flow through because the math is actually fairly straightforward. We give you the balances that are maturing in that year, because since we ladder the only relevant issue is really what's maturing as well as new money invested in that year, which is what benefits from the higher rates since we hold to maturity. And you'll know we'll give you a forecast of what our balance growth is going to be. And we'll also give you a forecast of what yields are going to be in the next year. So you'll have all that math and it'll be very easy to do. And then what you'll have to do is quiz us on what the other side of the ledger in terms of what are the other factors in terms of that led to the final reported or in that case guided net income figures or EBIT figures. And I think one of the things that's changed from Investor Day is that there's no question that, interest rates are way up and client funds interests – our forecast for client funds interest would be much higher because you can do the math, just like we can, the other – the variable that we want to take another quarter to make sure that we think through and that we finalize our plans before we communicate is that inflation is also way up in multiple ways, including on wages as Don alluded to, right. So when we had Investor Day, we had not yet taken this action of an off-cycle merit increase or wage increase, we had not yet which we are now fully accrued for some of our incentive bonuses, which are driven primarily by performance, but come in handy when you are competing for talent and trying to hold on to talent. And so those are all things that we have to kind of weigh now. And then the last factor being, I think Don talked about price increases, where does that finally land will also have an impact. So, there's a few more moving parts then I think is typical for us. And I think it's important for us to make sure we add it all up and rack it all up. But one thing I can guarantee you is you will have transparency.
Mark Marcon: Always appreciate that. Thank you, Carlos.
Operator: Our next question comes from Jason Kupferberg with Bank of America. Your line is open.
Mihir Bhatia: Good morning. This is Mihir on for Jason. Thank you for taking a question. I wanted to ask about the competitive intensity and pricing actions. Maybe just talk a little bit about the pricing and promotional environment that you're seeing currently. Are we back at pre-pandemic levels in the pre-pandemic trends, any changes, worth calling out in the mix or aggressiveness of competitors and particular segments even, I know you compete across a lot of different segments, so anything you can help us there?
Maria Black: Yes. So Carlos alluded to the competitive intensity. I think you called it trench warfare and that's certainly the case. I think in terms of being back to pre-pandemic levels, with respect to pricing and promos, we're definitely seeing the competitive intensity that would be reflective of prior years, both as it relates to the trench warfare as well as the pricing element of it. So I think it's fair to assume that it's still very competitive. I think that's part of the reason that as we think about our price increases whether it's on the new business side or on the existing client base, we're being incredibly thoughtful market-by-market, call it country-by-country, segment-by-segment, product-by-product to ensure that we continue to remain thoughtful in terms of the overall price value equation that does keep us remaining in a competitive pricing environment. So I would say that the intensity has not waned. It continues and very formidable competitors out there, and we're confident that we continue to win in the market and that we continue to take a balanced approach on the price value equation.
Mihir Bhatia: Great. Thank you. And then just maybe turning to the growth in average worksite employees, can you talk about what is driving the strength you're seeing there? Is it in particular verticals? Is it broad based, any additional color you can provide there? Thank you.
Carlos Rodriguez: I mean, I think probably the biggest picture, the answer is no, there's no specific verticals or whatnot. We're too big and too diversified to really – it's not geographic or verticals or all that. It's basically very strong bookings with very good retention and also growth of the client base. This pays per control that we talk about in Employer Services, you have the same phenomenon in the PEO where the clients themselves are recovering, right and hiring at a faster rate than they would have been because they had either shrunk or hadn't hired during the pandemic. And so that is a tailwind also for the PEO, but the biggest factors are sales minus losses. And then what's happening with the base, which is obviously strong.
Mihir Bhatia: Thank you.
Operator: We have time for one last question and it comes from the line of James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thank you so much. I wanted to follow up on a question and it has to do with the competitive intensity, but I guess, previously you talked about, you had some expectation for slight retention deterioration, but that isn't playing out. And in fact, it seems like your outlook is improving. You mentioned mid-market and international are main contributors, but are you seeing anything also in terms of business closures in the down market that's performing better, or any other contributors that are helping out there?
Carlos Rodriguez: I think the best way to describe it, that by the way, was all accurate like we're really happy with international, but also in particular, the mid-market, I think we kind of underestimated as usual, there are multiple moving parts. So you had the pandemic at work. And so we were looking at kind of a historical trends and thoughts, there would be some normalization within the mid-market, but we also had forgotten that right before the pandemic, not right before but 12 to 18 months before the pandemic, we completed our migrations onto one single platform, which is our modern Workforce Now platform, huge process improvement initiatives that were led by John Ayala and the team there that really improved the underlying strength of that business, right. So then you get into the pandemic and you get that noise. Now you come out of the pandemic and there's no scientific way to pull all that apart, but it does feel like our mid-market business has a new floor, if you will, or a nut floor is not the right way to describe it, but a new level of retention that's higher than it was before, that's at least right now, the way it looks in our hope going forward, so that's really good news. The other item on the out of business that you're mentioning, which is really more of a down market question, we again our big subscribers to the school of common sense, and it's playing out kind of the way we expected, because if you look at the reported level of bankruptcies from government figures, they're pretty flat, but that really is not the way the small business market works that, everyone declares bankruptcy, like some people get into business and they stop their business and they never declare bankruptcy. So that is a good proxy and it's one indication, but it's not the only one. And so we have seen some normalization in that down market business because of what we call non-controllable losses, right, which would include out of business bankruptcies, all of the above. It's a big enough factor in that segment that it's impossible to believe that it wouldn't normalize, which is why we planned the way we did. The good news is that it hasn't normalized as fast as we thought. And the other part of our business, the controllable losses have performed better than we expected. And so net-net, we are in better shape than we thought, but just because you have the second best retention you've ever had, doesn't mean that it isn't down from the previous year. And so I just wanted to be crystal clear on that because others may have a different perspective on which would defy. I think finance one-one-one theories and so forth because the number of – the percentage of losses related to the economy and so forth are just significant in the down market. And so when you have this unbelievable tailwind, when you think about the amount of stimulus that was put in with PPP loans and so forth and stimulus checks, remember some of these small businesses are just like consumers, they're one person companies, or five person companies. And when they get a stimulus check, that's like a stimulus check going to their company, that stuff is all coming out of the system and interest rates are going up. It will normalize unfortunately, but you see the outcome net-net for us, which is still incredibly gratifying and way above what we would've expected.
Don McGuire: Just to clarify that, that second best comment James was with respect the down market only. Overall, it was an all-time high.
James Faucette: Yes, thanks for that. And then so does that – so should we interpret it then to mean like, as far as that we should still expect some deterioration particularly as that down market normalizes, because that hasn't happened maybe as fast as you thought, but the drivers are still there, whereas on the mid-market you're feeling better that your new platform can actually help prevent or improve that retention versus what you thought. So you kind of have one thing that's permanent and one that's still to happen and net-net, there may be still some deterioration, but not as much as you thought, is that a fair assessment?
Carlos Rodriguez: I think that is a fair assessment that you should stand by for further details next quarter for next calendar – next fiscal year, because I think we gave you enough color. What you just described is exactly what we expect to happen for the fourth quarter and you see the outcome in terms of our overall guidance for retention. But I think what's more important for you guys is I hope is not just next quarter, but the next year. And I think we'll have another several months of information by then. And we have some other businesses, I talked about the HRO business, our SBS business, I mean, there's other business that are frankly outperforming outside of kind of the economic factors and the mid-market business that are outperforming. So it's really not appropriate yet to jump to any conclusions, but I think your general thesis is exactly correct.
James Faucette: That's great. Thank you very much, everybody.
Operator: This concludes our question-and-answer portion for today. I’m pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Well, thanks for all of you for joining us today. I hate to end on a down note here, but I think it's important for us to acknowledge, what's happening in Ukraine and express our sympathies for the folks that are in the midst of that conflict. We obviously like everyone else would like to see the violence end. We have very small exposure from a revenue and business standpoint in Russia and Ukraine, but we do have quite a number of associates and a decent sized business in Eastern Europe. And so we would love to see this violence end and certainly not to spread, we've been doing our part along with some of our colleagues and other companies in the humanitarian efforts to provide relief to the people in Ukraine. But what's really been most gratifying to me is not just what been able to do through our foundation and through ADP, but what our associates have done globally kind of reaching into their own pocketbooks to help their fellow global citizens. We increased our match, our matching contribution amounts for associates who wanted to provide to various relief agencies. And we had the largest – I think reaction we've ever had to any global crisis. And it's obvious why, because when you see the pictures of what's going on and it's truly horrifying. And I mean, for me personally, to see people leaving everything behind and children and families having to flee is personally very painful. So our hearts go out to those folks and we pray that all of the leaders involved can come to some sort of resolution and end of violence. But with that, I will thank you once again for participating with us today. And we look forward to giving you all the information you're looking for fiscal year 2023 on the next earnings call. Thank you very much.
Operator: This concludes the program. You may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2022 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Michelle, and welcome everyone to ADP's third quarter fiscal 2022 earnings call. Participating today are Carlos Rodriguez, our CEO; Maria Black, our President; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. And with that, let me turn it to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny, and thank you everyone for joining our call. We delivered exceptionally strong third quarter results, including revenue that accelerated to 10% growth on a reported basis and 11% growth on an organic constant currency basis, coupled with solid adjusted EBIT margin expansion. The strong outcome on both revenue and margin drove 17% growth in adjusted diluted EPS, well ahead of our expectations. Our clients have had new shortage of challenges in navigating the last 12 months, but through it all not only have they persevere but they have invested in their workforce to better support their employees and continue to grow their businesses. We're proud to support them in these efforts through our leading HCM technology and unrivaled expertise. This quarter, I'll provide high-level commentary on key business drivers, and then Maria will take us through some product and other updates. And as usual, Don will discuss the financials and our updated outlook. Let me start with Employer Services new business bookings. We are very pleased to have delivered another strong quarter of double-digit growth. This was a record level for the third quarter. And as we had hoped when we updated you last quarter, the Omicron variant was not a meaningful factor in our bookings performance, as third quarter growth accelerated from our first half levels towards the high end of our guidance range this quarter. Our clients continue to find tremendous value across our suite of offerings with our PEO and HR outsourcing, international and downmarket businesses, again, leading the way. We're pleased to narrow our ES bookings guidance higher, and we look forward to delivering this double-digit growth for the full year, which should position us well for fiscal 2023. Our employer services retention was also very strong this quarter. As you know, our third quarter is especially important for retention since we typically experience elevated switching with the start of the new calendar year. Accordingly, we were very pleased that rather than decreasing the quarter towards pre-pandemic levels like we anticipated, our retention actually increased further into record territory driven by incredible performance from our mid-market and international businesses, among others. As we've discussed for several quarters, the strong employee and client growth we've experienced have increased the demands on our implementation and service organization. We added to our headcount to keep up with this demand ahead of our busy year-end period. And as a result, we were able to maintain strong overall client satisfaction scores despite ongoing pressure from this elevated demand. With retention having outperformed our expectations so far this year, we believe we are now on pace to hold on to most of last year's retention gains and expect to remain at 92% retention for the year, down very slightly versus last year's record retention level. Moving on to Employer Services pace for control, our clients continue to steadily hire as workers enter or reenter the labor force and our pays per control growth of 7% for the quarter came in better than expected. Clearly, there are a number of factors at play when considering employment growth trends, but strong overall economic activity continues to keep demand for labor high, and we've been pleased to see labor force participation gradually recover over the course of the year. And one last highlight before I turn it over to Maria. Our PEO had another strong quarter with 16% average worksite employee growth and 14% revenue growth. As we've seen all year, growth in our PEO bookings was exceptionally strong as small and midsized businesses increasingly find value in turning over a meaningful portion of their HR function to ADP. And that strong bookings performance, coupled with robust employment growth within the PEO base has driven this very healthy double-digit revenue growth. And now let me turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Carlos. It's great to be joining everyone for the call. Also some updates on a few key initiatives we have underway. One key product initiative is the rollout of our new unified user experience. And we made some great progress on this front. Earlier this year, we moved the RUN, iHCM and Next-Gen HCM client bases over to the new UX. Feedback has been strong with clients, especially upbeat about how easy we've made key HCM workflows. In January, we shared, we started the pilot of the new UX to Workforce Now and since then, we've expanded from a handful of clients to over 1,000, early feedback has also been overwhelmingly positive. In this quarter, we began the rollout of the new UX to the ADP Mobile app. The ADP Mobile app is an incredibly important part of the ADP suite with over 10 million active users. It is one of the top five most downloaded business apps in the Apple App Store and is available in over 20 languages. And we're excited to take our 4.7 star average user experience and make it even more insightful, intuitive, and proactive for our users. As we complete the new UX rollout over the coming months. Moving on, data continues to be one of our key differentiators in this quarter, we expanded our data offerings even further, as we launched pilot clients on our new global insight dashboard powered by DataCloud. This dashboard provides our GlobalView and Celergo clients with advanced analytics for their employee populations around the globe, leveraging the same award-winning analytics platform we have scaled across our U.S. mid and upmarket client bases. Last quarter, we mentioned you would hear a bit more about our marketing efforts here at ADP. At our Investor Day in November, I spoke about how for decades, ADP has reached prospects through our powerful direct sales force and how in more recent years, we have enhanced this direct channel with modern selling tools, a growing partner network, and with increased digital advertising. This quarter, we continued to advance our great momentum and expanded our overall brand investment with additional initiatives, including our first major athletic sponsorships, a group of eight impressive professional golfers featured across the LPGA, the PGA and the European Tour who together constitute team ADP. The ADP brand is a powerful asset and has come to be associated with professionalism, insightful and trustworthy data. And the premier technology and service we pride ourselves on, and we believe there's opportunity to continue investing in our brand while also pushing the frontier in digital marketing efforts to support our world-class sales force. And as a final call out, this quarter, we were pleased to host one of our marquee client events, ADP Meeting of the Minds in California, which was back in-person for the first time since 2019. This was our 37th Meeting of the Minds conference. And we took the opportunity to engage deeply with our enterprise clients on the changing world of work. What I love most about this event is as much as we enjoy sharing our perspective with our clients and showing them our latest HCM innovations, we also make the most of this opportunity by listening to and learning from them and having the event back in-person really makes a big difference. The third quarter was a terrific quarter overall, which you can see in our results and in the progress we made on key initiatives, we were recently named one of Fortune’s Most Admired Companies for the 16th year in a row. And we are proud of this honor because it highlights our culture of continuous improvement, our consistency and our focus on being a true partner to our clients. A big thank you to our associates who make this all happen. Now over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. For our third quarter, we delivered 10% revenue growth on a reported basis and 11% on an organic constant currency basis. This revenue growth in turn supported adjusted EBIT margin expansion of 50 basis points, which was much better than the decline we expected. We achieved that margin expansion despite incremental investments in headcount and compensation we discussed last quarter. Through the combination of this strong adjusted EBIT growth, a slightly lower tax rate and a lower share count, we were able to deliver a 17% increase in adjusted diluted earnings per share. Looking more closely at the segment results, our Employer Services revenue increased 8% on a reported basis and 9% on an organic currency basis. ES revenue has been supported all year long by strong retention and pays per control trends. And our double-digit bookings performance has been contributing nicely as well. In Q3, we also started to get a more meaningful contribution from client funds interest through the combination of our 15% client funds balance growth and an average yield that was nearly flat with the prior year. This year-over-year increase in client funds interest contributed about 0.5% to our revenue growth, which is a very nice outcome compared to the last several quarters. ES margin increased 120 basis points, well ahead of our expectations for the quarter and supported primarily by revenue growth. Moving on to the PEO segment. PEO revenue remains very strong and grew 14% in the quarter. Average worksite employee growth is the primary driver to PEO revenue and remained at a very robust 16%, reaching 688,000 average worksite employees for the quarter. We continue to benefit from the strong bookings growth we’ve seen all year long, as well as healthy retention and pays per control growth within the PEO client base. PEO revenue growth is a bit lower than worksite employee growth this quarter, which is fairly atypical, impacting revenue for worksite employee was a mix shift towards WSEs with a slightly lower average wage and lower benefits participation, representing continued normalization back towards a pre-pandemic mix. That said, it’s good to see a recovery in all parts of the workforce in our PEO. PEO margin was flat in the quarter and included higher selling expenses driven by our strong sales momentum. Moving on to our updated outlook for the year. For ES revenues, we are raising our guidance and now expect growth of about 7% up from our previous guidance of about 6%. There are a few drivers behind that increase. We are narrowing our ES bookings guidance higher to a range of 13% to 16% up from 12% to 16% prior. So far this year, we have realized and delivered solid double digit growth. Clearly, there was geopolitical uncertainty in Europe, as well as more general macro uncertainty. But notwithstanding those uncertainties, our outlook contemplates a strong Q4 with growth in the teens and we look forward to delivering a strong finish to the year. We are raising our employer services retention guidance, and now expected to be down only 20 basis points for the year versus our prior expectation of down 40 basis points. Our retention has held up extremely well so far this year, but at a prudence, we are assuming a modest decline in Q4 for the same reasons we’ve outlined all year long. For U.S. pays per control, we’re once again, raising our outlook and now expect 6% to 7% growth versus our prior expectation of 5% to 6% growth driven by the ongoing recovery in the labor force participation combined with steady demand for labor from our clients. We are also raising our client funds interest outlook slightly to a range of $450 million to $455 million up from our prior expectation of $440 million to $450 million. There’s no change to our 18% to 20% balance growth outlook with just a few months remaining in fiscal 2022, the benefit from higher new purchase rates for the recent yield curve shifts is modest. And therefore, we still expect yield to round to 1.4% for the year. Moving on to ES margin. We are raising our outlook to now expect margins to be up 100 to 125 basis points versus up 75 to 100 basis points prior. This increase is mainly driven by the stronger revenue outlook and margin performance in Q3 versus our expectations. Moving on to the PEO. We are narrowing our average worksite employee growth to 14% to 15% versus 13% to 15% prior driven by continued momentum in new business bookings. We are likewise narrowing total PEO revenue to 14% to 15% growth up from 13% to 15% growth prior. And we are raising PEO revenues, excluding zero margin pass-throughs to 15% to 17% growth from 14% to 16% growth prior. For PEO margin, we are raising our guidance to now expect margins to be up 25 to 50 basis points rather than flat to down 50 basis points for the year. That’s driven by an improvement in pass-through expenses, including more favorability from workers compensation compared to our prior outlook. Putting it together for our consolidated outlook, we now expect revenue to grow 9% to 10% up from 8% to 9% prior. For adjusted EBIT margin, we now expect an increase of 75 to 100 basis points, up from 50 to 75 basis points prior. We are making no change to our tax rate assumption. And we now expect growth in adjusted diluted earnings per share of 15% to 17% up from 12% to 14% prior. Before we move on to Q&A, I wanted to quickly touch on fiscal 2023. We’re still going through our planning process. And so we won’t be providing any specifics this time. Clearly, there are going to be some unique puts and takes for fiscal 2023, but overall, we feel very good about the momentum in the business and we will remain focused on our medium-term growth objectives that we laid out at our November Investors Day. We look forward to providing our outlook next quarter. Thank you. And I’ll turn – now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We will take our first question from Peter Christiansen with Citi. Your line is open."
},
{
"speaker": "Peter Christiansen",
"text": "Thank you and good morning and congrats on the solid execution this quarter, guys. Carlos, I had a question about for a number of quarters, we talked about ASO, HRO becoming a larger contributor to ES. Just wondering if you had any thoughts on how that’s contributing to the stickiness of retention at this point? And then as a follow-up, given all the UI upgrades you’ve given across the platform, how does that translate to growth to add-on services? I’m thinking even things like pay wisely, those sorts of ancillary value-added products. Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. I’ll take the first part and I’ll let Maria takes the second part. On the HRO business within ES, which as you know, is kind of our full outsourcing solutions or without the co-employment, the growth there has been quite robust on bookings, which obviously then is driving really robust growth in revenues. The interesting thing about that business, I mean, you have to – you almost have to call out. It’s nice to be able to do it publicly, just unbelievable execution because in our business, when you get that kind of growth, that quickly, it’s very, very hard to manage. But somehow they’ve managed to stay ahead into terms of headcount hiring for both implementation and service. And the business is just really performing incredibly well. Retention rates are holding up. Not just holding up, I think they are up versus the prior year, which was already a strong year. And I would say contributing to the overall improvement in retention and stickiness. So I would say that that is probably – I would get in trouble for saying this, because then I offend all the other businesses, but that’s got to be one of the star performers. Now the PEO obviously isn’t doing incredibly well. Also and you can see that as a separate segment, it’s a little harder to see the HRO business. It’s also getting big. I think if I’m not mistaken, it’s – probably never publicly disclosed it, but it’s getting close to $1 billion in revenue. So that’s a pretty solid business with again, without – I’m probably not right to give you too much detail, but revenue growth is strong double digits, very strong double digits with a two in front of it, let’s say. And bookings growth is incredibly robust as well, retention is strong. Just really performing very well."
},
{
"speaker": "Maria Black",
"text": "With respect to the new user experience. So I mentioned a bit about it during my prepared remarks, very excited, obviously about the impact of the user experience across the entire portfolio. In terms of what it’s going to do with respect to attach, I think you mentioned wisely and other attach. It’s hard to tease out specifically the impact of the new user experience at this point in the quarter or even for the year as it relates to any material impacts to bookings or to attach. However, we definitely believe in what we’ve developed and the impact that’s going to make. So just to give a tiny bit more color. The new user experience is really based on a research driven design. That research driven design included our clients, as well as our prospects to create a user experience that’s very action-oriented and it’s navigation. What that means specifically is the ability to move through the process payroll, if you will or to your question, the ability to buy and attach in a very action-oriented navigation, which means you don’t really need to know what’s next in order to move through it. It also leverages artificial intelligence as well as machine learning to create a very personalized experience for the buyer or the user, if you will. So that it remembers how the specific individual likes to navigate through the system and serves it up that way in following subsequent sequences of usage. So the other part that we’re very excited I mentioned rolling out the new user experience across the ADP mobile app. The mobile experience, one of the things that will really become a competitive advantage for us is the fact that the mobile experience will be not just for the end user such as that person that would actually purchase wisely, but also for the practitioner. And so a fully web-enabled user experience using the new user interface will certainly lend itself to a better competitive advantage for us in the future. And so as you can tell by my commentary very excited what this is going to do for us both as it relates to our sellers being able to demo and gain volume there, as well as our buyers and clients being able to engage in something a lot more user friendly, so that we can attach more business."
},
{
"speaker": "Peter Christiansen",
"text": "Thank you. Thank you, both. Congrats again, on the solid result."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tien-tsin Huang with JPMorgan. Your line is open. If your telephone is muted, please unmute."
},
{
"speaker": "Tien-tsin Huang",
"text": "Forgive me. I’m sorry about that. Hope you can hear me now. Great results for sure. It looks like you’re taking some share again. On the PEO side, I just want to make sure I understood the PEO revenue growth coming in beneath WSE growth. I know you said it was unusual. Some of it was benefits participation and salary driven. But just trying to understand is that more of a mean reversion change that you’re talking about? Or is there a quality sort of focus that maybe we should honing in? I’m just trying to better understand that trend and if it might persist for some time."
},
{
"speaker": "Carlos Rodriguez",
"text": "Listen, I’m glad for the question. And I’m also glad for the answer, right? Because mean reversion is my favorite term in business because when you get into large businesses and large economies, it’s a powerful force in the universe. And that’s exactly what it is. If you remember, this happened with some of the data that was reported by the Fed and by us in terms of employment. That in the initial stages of the pandemic, the jobs that went away the most quickly in terms of quantity were kind of lower wage jobs that in general don’t have high benefits participation rates. Even though our PEO is generally white collar to gray collar, we experienced the same thing there in the PEO. So ironically at that time, it looked like our benefits per employee – worksite employee were rising, but it was really because of the averages and because of the mix shift. And now we have this mean reversion where even though the white collar jobs are growing and wages are growing, like everything is going exactly as you would want and expect in the PEO. You have this unusual thing because of the pandemic with a lot more jobs coming back that are people who don’t have benefits. So it makes the benefits revenue grow slower than the worksite employee number. But it has nothing to do with any kind of policy change or change in kind of our philosophy or it’s really just a re-normal or a normalization back in my opinion to where we were before. We’re trying to assess kind of how long that takes and it’s probably another quarter or two. There’s a second factor that I think that’s contributing to this, which is that state unemployment rates are coming in a little bit lower than we had expected because some states because of the strong employment market, even though they initially raised unemployment rates, because they thought that were going to have big problems in terms of people filing for unemployment. Obviously now what’s happening, it’s going in the other direction. And a few large states have actually lowered unemployment rates. That’s not a – it’s a factor. It’s not a huge factor. I think that the mix shift issue is mathematically and this mean reversion is 95% of the explanation. By the way, we don’t necessarily mind it one way or the other, because as you know, we treat benefits revenue as a pass-through. So there’s really no profit and no margin. So it’s really not relevant for us in terms of how we manage the business. Other than we have to explain it to obviously our sales community."
},
{
"speaker": "Tien-tsin Huang",
"text": "Yes. Thank you for the complete answer. It’s really helpful. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi. Good morning. Thank you. Question around bookings. So you cited an acceleration toward the high end of the range in 3Q and you were tracking below that in the first half of the year. So I’m curious, what were the key drivers of that better performance you saw in 3Q? Was it larger deals that were converting or some improvements in sales force productivity trends? And then just on the outlook for the fiscal year, it sounds like you are confident that momentum here is carrying through as well as, I guess, the removal of potential Omicron conservatism. So I just wanted to clarify if that was fair."
},
{
"speaker": "Maria Black",
"text": "Fair enough. We did see strength in the third quarter. As you mentioned, we saw strength that was in line with the higher end of our full year guidance in the third quarter specifically. So an accelerated result. We expected that and we delivered that. We did see strength in our down market businesses. So specifically the RUN platform sales as well as retirement services. We also saw strength in our international business. And then last but not least, I think Carlos mentioned during his prepared remarks, the strength that we saw in PEO booking with the entire HRO portfolio, which is what’s reported in employer services did have specific strengths. So again, that’s the down market, RUN, retirement, international and the employer services, HRO that’s where we saw the strength in terms of how we feel stepping into the fourth quarter. In terms of end quarter, the strength that we saw was actually delivered toward the end of the quarter, if you will, in March. And that really gave us the confidence to narrow our guidance heading into the fourth quarter and feel optimistic as we step into the fourth quarter with respect to the overall macroenvironment. And so you mentioned the Omicron that we noded to last quarter. We didn’t see that materialize. And as we sit here today, the economic tailwinds that we see in the market, the challenges that businesses are facing with the increased complexity of new legislation and the tight labor market. There are a lot of things that are out that are giving us the confidence that we will continue to execute in the fourth quarter. And as such, we felt it right to narrow the guidance range to the 13% to 16% for the full year outlook."
},
{
"speaker": "Don McGuire",
"text": "And just as a reminder, when we talk about bookings, I think Maria mentioned it, and I’m sure all of you remember that we really talk about ES bookings. So a couple years ago that we changed our approach to disclosures because we thought that disclosures in the PEO were better in a format where we really talked about growth of worksite employees. It’s very easy to kind of do the math in the PEO when you talk in those terms. But to be crystal clear, if PEO bookings were included in overall bookings, they would have been meaningfully higher for ADP."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. That’s helpful. And I know you don’t want to quantify fiscal 2023 outlook yet. I’ll give this a shot. What are some of the puts and takes we should be thinking about for next year? Anything you want to call out as it may relate to comps or dynamics from this fiscal year that may not necessarily carry forward?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. I think that first of all, no specifics for 2023, we’re going to wait until the next earnings call we have before we give more color on 2023. But as I said earlier, we’re very comfortable with the fundamentals and we think we’re in a good spot. We’ve overcome some of the challenges that we referenced last quarter in terms of making sure we’re appropriately staffed for the bigger business that we now have. We did that well going into the busiest quarter of the year. So that’s all in good shape. Certainly, you guys are probably better at the numbers than me on what’s the potential impact from flow balances, et cetera. Certainly, it’s pretty clear that we will have higher client fund interest next year. However, how much, we’re not quite sure yet, even though we’re seeing rates go up, certainly there’s lots of volatility in the rates. There’s certainly lots of things going on. But I’ll come back to the way I ended my prepared remarks and that was that we very much will be mindful of what we share with everybody at the Investor Day in November. And we will make sure that we have those targets in mind, as we prepare when we get ready to release more information on 2023."
},
{
"speaker": "Don McGuire",
"text": "And it’s a non-GAAP term, but it’s safe to say that client funds interest will be up a lot."
},
{
"speaker": "Bryan Bergin",
"text": "All right. Thank you very much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open."
},
{
"speaker": "Eugene Simuni",
"text": "Thank you. Good morning. I’ll start with a macro level question. So ADP obviously has its finger on the pulse with very large slides of the U.S. economist. So it’s always very interesting to hear you guys perspective on kind of real time read of what’s going on across the different pockets of your client base, especially now that we’re experiencing kind of volatile macroenvironment. Would you mind providing us with a little bit of that commentary what do you see in today across your client base markets of strength and weakness?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. As you know, obviously our commentary is generally focused on the labor markets. Like this morning, I was hearing reports about what’s happening with consumer spending, which is quite robust that obviously ends up having an impact on the labor markets, because people who are in the service sector or people who are serving consumers end up hiring people in order to fulfil that demand. But generally speaking, our comments are really around the labor markets. And as you can see from our pays per control growth, some of which is related to the previous question about comparisons, right? Like the comparisons are easier and they will get harder next year in terms of percentages. But the percentages don’t matter as much as the absolute numbers, right? And the absolute numbers are strong, I think are robust. And I think as we alluded to the labor market is almost fully recovered. We obviously keep an eye also on things like GDP, GDP growth. I mean, absolute GDP dollars have already surpassed pre-pandemic levels. And they’re kind of in line to get back to trend growth or exceed trend growth on a real basis, right? Because you have to factor in obviously the fact that we have some higher inflation now. I mean, our perspective generally is that the economy is very strong, like based on the things that we’re looking at in our business. But we obviously live in the real world that we have to think about the next quarter or two, but also about 12 months from now and 24 months from now. And Finance 101 would tell you that increase in interest rates that are expected from the Fed and that have already been priced in, which are helping our client fund interest on the two year, five year, seven year and 10 years, I think will all slow at some point the economy, which is the intention, I think of the federal reserve to get inflation under control. Having said all that, you have to make your own decisions on whether or not that will be navigated appropriately to a “soft landing”. But we had 10 years from 2011 through or call it 2010 through 2020 before, right before the pandemic of what I would call relatively, historically speaking reasonable growth in GDP call it 2%, 2.5% GDP growth, gradually recovering employment. So, if we go from 3% or 5% GDP growth, the 2.5% or 2%, we like that. And I think we’ve delivered some pretty outstanding results for all stakeholders during that kind of period of time. So we would not like a recession, just like no one else would like a recession. But I think if you believe that the best of is behind us that doesn’t necessarily need that things are not going to be good going forward. Because we – all the indicators we’re seeing right now are really strong underlying labor markets. And we also have in the U.S. an administration that will be in the seat for another call it three years, despite what happens in the midterms that is, generally more favorable towards employment regulation and – and that, I think, is a favorable tailwind for our business as well in terms of just on a macro – on a very macro level. So I think we like the environment. If the best scenario for us, frankly, which would be a homerun is that growth gradually slows not to the point where there's a recession, but where interest rates stay at the rates that they're at, particularly like kind of the three to five and the seven years, and that really is a pretty large tailwind for us from a bottom line standpoint."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Got it. Thank you. Very, very helpful. And then quickly for my follow-up, staying with the macro theme, inflation is obviously running high, so maybe for Don. Can you give us a quick overview of how inflation you think influenced impacted your results this quarter? What were the puts and takes in the P&L from inflation?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So we've done a couple of things over the last quarter, as we said, we were going to on the last call and we did an off-cycle salary increase to make sure that we kept our associates happy and whole. So that was positive. We also had some bonus programs and some sales conditions, accrued programs that were certainly anticipated and booked in the quarter. So we are – from a cost side, we were able to do those things and still deliver the improved margins. So we think that was very positive for us to do. The other side of this, of course, is price increases, and the two aspects of the price increases. Certainly, we haven't yet – although planned, we haven't yet initiated large price increases with our installed base. We will make sure that we do those things accordingly, reflecting inflation and most importantly reflecting to make sure that our clients still get great value from us in a competitive environment. And what we did do though and we signaled this in the last call as well, we have increased the pricing on some of our new offers, our new offer sales we – sales we had in the last quarter. But that's having a very minimal impact on Q3 and certainly won't have an enormous impact on the full year either. So we are making sure that we're focused on pricing both in the base and with new opportunities, new prospects and making sure that we're adjusting our wage levels to keep our employees and deliver the good service that we've delivered that is contributing to the high retention rate we have."
},
{
"speaker": "Carlos Rodriguez",
"text": "And the only other thing that I would add that we may not always directly linked to inflation as I am beating the dead horse here, but the client funds interest, obviously, inflation is what's driving these higher interest rates. It also happens to also drive higher balances. A lot of our balances are driven by our tax business, but wages, some of those taxes capped, but for example federal withholding taxes are not necessarily capped. So the more people get paid, the more taxes we collect and have to remit to various agencies and wages are a portion of our float balances. And clearly, there is an impact from there. Overall wage inflation, forget about our own inflation that Don is referring to, but the inflation in our client base in terms of their own – the wages of their employees is really driving – is helping our balance growth for sure. But more importantly, it's obviously driving a belief that interest rates need to rise rather rapidly, which is now being already factored in into – even though the Fed controls obviously fed funds rate you can all see what's happening with the one year, two year, three year, five year and what the expectation is for and that's all related obviously directly to inflationary expectations."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Got it. Very comprehensive. Thank you very much guys."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning. I was just hoping maybe to get a little bit more on the pricing comments you made if you look at pricing and compared to what you anticipate getting and compared it to historical levels, what will be a good way to – are you able to kind of quantify that or maybe just a good way to think about the opportunity ADP has going forward?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think the safest thing for us to say right now because, as Don said, we really haven't finalized that yet as we have not finalized our 2023 operating plan. So I think Don was giving you kind of directional color, which is 100% accurate. We've been doing a lot of work, and Maria and the team have been doing a lot of work on what's the appropriate pricing policy, if you will. Don mentioned the fact that on new business, it's relatively easy because that's something that we control timing-wise, whereas price changes to the book of business, we have a cycle that we go through, and we decided not to do anything unnatural or out of cycle. So that that decision is still kind of in front of us. But I think Don used the word competitive, we do not live in a vacuum. And so, we are going to do what's appropriate based on what's happening with inflation, but also with what's happening with competitors. So we're going to be watching very carefully what everyone is doing from the – obviously from the sidelines since we obviously don't have any direct insight into what our competitors are doing. But you get competitive signaling and you get hearsay here and there. So we're looking at all those things, but it's safe – I guess the best way to describe it is whatever our price increase had been historically and it was probably consistent for almost 10 years in terms of kind of what we were telling you in terms of what it represented in as a percent of revenue. It's safe to say that that's going to be higher. And you kind of have to draw your own conclusions if inflation was 2% and now it's 4% to 5%, you could infer because our costs not just our wage cost, which Don alluded to, we've already had to kind of build in higher costs for our own associates. We have other costs. We have other services and other things that are being provided to us that are like every other company and we got to cover those costs. I think our philosophy is we would like to be in line with what's happening in the market."
},
{
"speaker": "Kartik Mehta",
"text": "And then just, Don, one last question. Just on the float portfolio, any thoughts about changing how you manage it or going shorter or longer, just because of where rates are and the volatility at least in the near-term?"
},
{
"speaker": "Don McGuire",
"text": "We get this question often. And at the end of the day, we keep coming back to the same thing, and that's the safety diversification and liquidity of what we invest in. And so, it's unlikely we're going to make any major changes to the way we invest funds. I think we want to be – we want to certainly do well with our portfolio, but we also want to be prudent and so we'll continue to do that. So there's really no impeditive or imperative for us to make any changes to the way we've been managing those funds in the near, mid to long term."
},
{
"speaker": "Carlos Rodriguez",
"text": "And I think it's also safe to say that our philosophy is that we run an HCM technology services company. And this is a really nice side benefit that for however long we've been in this business, we have this float income, and it goes up and down based on interest rates and the economy and so forth. And I think compared to ten years ago, it's a much smaller portion of our bottom line. And so, that is both good and bad, right. I would have enjoyed my life and my tenure a lot more had interest rates not been as low as they were for as long as they were. But having said all that, it puts us in a much better position where it's much more clear now that ADP's core earnings are not driven by fluctuations in interest rates. And the reason we ladder our portfolio is primarily because as Don said about safety and security and liquidity, but it's also because philosophically we're not trying to gain the market, we're not trying to time the market, we are running an HCM technology services business, and that's our focus."
},
{
"speaker": "Kartik Mehta",
"text": "Thank you very much. I really appreciate it."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thanks for taking my question. Nice results on margins in the quarter. You guys beat our number pretty handily despite, I think, a headcount increase that – could you help us think through the puts and takes with that performance in terms of sales productivity or other drivers? And also sort of how you're thinking about those primary levers for margin expansion as we move forward?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So as I said a few minutes ago, we're very happy with the ability to hire quite a number of service implementation people going into this – going into the third quarter because that's obviously the busiest time of our year. So we made sure that we got as many people in as we could and we did quite well. And I think the retention rates are suggesting that we've continued to do a good job on behalf of our clients because they're sticking around. So very, very positive. Going forward, I think as we – once again, you're coming back to the plan a little bit that we're still putting together. But certainly, as we continue to grow, we'll continue to make sure that we staffed accordingly. And really not too much color to add there other than we've been successful at the hiring as we said we would be and it's not going to – it's not going to change dramatically and have any different impact on our overall margin than what we anticipated. And I don't know the sales continue to go very well, doing very well. We've talked the last time about productivity and things reverting back to means. And I don't know, Maria, if you want to make a comment about sales productivity, we've had good results."
},
{
"speaker": "Maria Black",
"text": "Yes, happy to add there. The investments that we're making into the overall sales ecosystem continue to be very balanced. So it's really all about the seller enablement. So as mentioned many times, we have this world-class sales force that's out there directly distributing our products and we enable them with an entire ecosystem of modern seller tools. That's definitely where we spent the last couple of years investing, especially as clients continue to pivot between wanting in-person and virtual. So seeing great productivity there, also seeing investments in brand and marketing and advertising. That's a big piece of the balanced approach that we take. And again, I don't see huge shifts in terms of the balanced approach that we're taking, but it is really an area that we continue to invest. I should mention to in that laundry list, digital advertising. So that's an area that we continue to see significant performance year-on-year in our down market and our mid-market in terms of the execution there. So all of these things are really about continuing the approach that we've had to enable the strong sales execution that we've seen this year and going forward."
},
{
"speaker": "Don McGuire",
"text": "One last thing on margins that I would add because I think it's something that we've been for years talking about is just a reminder that the overall ADP margin does get impacted by the mix of PEO and the growth rate of PEO compared to Employer Services. So from a GAAP standpoint, we do include zero margin pass-throughs and we believe that's the right approach and I think the SEC believes that's the right approach. But I think clearly, if you took out zero margin pass-throughs from the PEO, you'd have a very different margin profile of that business and hence you would have a very different margin overall for ADP. I only raised that because it is important to look at those two separately because you do have a mix shift issue that happens that doesn't necessarily tell you what the underlying strength of those businesses are. And that sometimes helps us in terms of our story, sometimes it hurts us, but it's the appropriate thing to guide you to, to look at. Because in this case, for example, the underlying margin is much higher because of the pressure that we're getting from zero margin pass-through as a result of that mix."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. That's very helpful. And could you comment on or update us on your sort of M&A and/or capital allocation strategy? And just in the context of the current macro backdrop, are you seeing the opportunity, M&A opportunities change? Or how are you framing that up internally in terms of your priority – prioritization?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So I'll just start with opportunities. Certainly, as always, there is no shortage of things floating around and things to assess and review, et cetera. So we continue to do that. But as Carlos has said and we've said over a long period of time, if we're ever going to do anything other than a tuck-in here and there, which we had – we did have one in Q2. But other than tuck-in here and there, we're very disciplined in making sure that we're just not adding additional products where we already have products and making sure that we can keep our portfolio as clean as possible. So we continue to look at opportunities and evaluate things and we will make the right choices when the time – should the time come. On the – just in terms of our overall philosophy, I don't think we've changed our philosophy. We continue to be committed to the share buybacks that we've committed to dividends in the 55% to 60% range, although we were a little bit higher. I think we were 61% last year, but we're committed to that 55% to 60% range. the – even though the markets are off, just back to opportunities for M& a little bit more, even though the markets are off a little bit, and I think that the valuations that are out there are still quite high, the expectations at a number of people, who are looking to do something with their current operations, their expectations really haven't adjusted to or reflected what we're seeing in the market. So it's not any easier yet, but we will watch, we will evaluate. And if we see something or things that make sense, we'll do. It's appropriate."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it very well. Thanks so much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning and thanks for taking my questions. I wanted to dig in a little bit on the bookings commentary. Can you talk a little bit about with RUN? You saw strong growth there. How much of that was new businesses versus competitive takeaways? And how would you characterize the competitive takeaways? Are they from your biggest competitor in Rochester? Or are you seeing more from locals and regionals that haven't been able to keep up with the technology changes? Just any sort of depth there? And then can you also talk a little bit about the retirement service solutions that you have and what you're seeing there? And lastly, can you discuss a little bit what you're seeing with regards to Workforce Now and the mid-market?"
},
{
"speaker": "Maria Black",
"text": "So happy to be the one to start here in terms of the strength in bookings. So specifically to RUN, Mark, I think in terms of the commentary around the competitors in Rochester and others, what I would say there is our continued focus on competitive takeaways has not waned. In terms of the strength of actual RUN sales and bookings performance, it's partially anchored in the amount of new business formations that we've continued to see. And so, there is definitely strength there, but certainly not for a lack of interest in the competitive side of the house. To touch on retirement services for a minute as well since you asked about that, I would say there's definitely tailwinds there in terms of attach specific to our RUN portfolio. And so as you're aware, significant legislative changes that have happened in the retirement environment state by state, and that's yielded a tailwind for us in terms of the offer that we have and certainly that makes an impact in terms of our ability to sell new logos as well as competitive takeaways because the combination of RUN and retirement and that in this type of an environment is an incredibly compelling to compete out there in the market. So I don't know, Carlos, if you have anything else to add to that."
},
{
"speaker": "Carlos Rodriguez",
"text": "No, I mean, we try to stay away from obviously any kind of – making comments about specific competitors, but I would say that specifically in SBS, we do watch this kind of balance of trade very carefully. And I think – I talk about it every quarter in terms of it's important to me, like one of the most important things for us in terms of long-term sustainability, and durability of our business is market share is really being able to grow units. We also love share of wallet and we love to sell additional business, et cetera, but that's important to us. And at least the figures that we're seeing in terms of our large national competitors, our balance of trade remains positive and improved in the third quarter versus the second quarter. So that to me tells me that I think we're still I think in a good place competitively and that we're doing all the right things, but having said that it's a very competitive market. There's no question about that. And everyone, I think has including some of our national competitors that have good products and good go-to-market strategies. And we are in the trenches every day competing in trench warfare with some of those competitors, we feel pretty good based on the data that we keep track of that we are doing well in terms of balance of trade and also in terms of market share."
},
{
"speaker": "Don McGuire",
"text": "And Mark, you asked about Workforce Now bookings. So we shared color on some of this already, but in addition to the HRO business, which is doing really well and uses Workforce Now. And then the PEO business, which also uses Workforce Now, there's just the mid-market HCM solution, we didn't call it out, but that also did very well double-digit growth."
},
{
"speaker": "Carlos Rodriguez",
"text": "And I think the other last one you asked about was retirement services. That business, as you probably know has some significant tailwinds because of regulatory changes that are going to get, they're going to become potentially GaelForce wins, in terms of with a new, I think it's called SECURE 2.0 or because I think the first one was the SECURE Act looks like it's going to make its way through Congress with bipartisan support and the first wave and the first version of that has already created some strong demand. In addition to what was already happening at the state level, where several states were requiring small businesses to mandatorily required to provide a retirement plan. So all those things are tailwinds for that business and that would be one of those businesses that I would describe as doing incredibly well, but trying to keep its head above water to meet demand. It's a good problem to have, trust me like I've been around long enough to know these are – this is a good problem to have. But it's still a problem. And so we're busy adding resources and trying to be appropriately staffed in our RF business, because it's definitely a growth engine."
},
{
"speaker": "Mark Marcon",
"text": "Can you size it Carlos, in terms of – I mean, we're aware of the becoming GaelForce wins. Just wondering how meaningful it's going to end up being to you on the whole?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I would say just general range. So you have some sense it's smaller than the HRO business, for example. So you shouldn't assume that we have $1 billion business, so you don't start getting too many images of grandeur. But it's a big business, call it maybe somewhere around half-ish of that business. I don't know, Danny, before I get into trouble, hundreds of millions of dollars. But growing, I think also at one of the faster rates, I think in terms of our businesses here and both for bookings and for revenue."
},
{
"speaker": "Mark Marcon",
"text": "Great. And then the follow up is just, Carlos, you mentioned your non-GAAP description in terms of interest income on the float for next year, how much of that, when we take a look at the Analyst Day discussion and the margin discussions. We typically look at the margin expansion ex-float, how much of the float would you let flow through? I know you aren’t giving us the 2023 guidance, but just philosophically, how are you thinking about that?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, first of all, philosophically, we don't hide anything. So as you know, there's a nice little schedule that we include that allows everyone to do the math. And so next quarter, I'm sure you're going to do the math. And you'll ask us how come you are or aren't allowing X percent to flow through because the math is actually fairly straightforward. We give you the balances that are maturing in that year, because since we ladder the only relevant issue is really what's maturing as well as new money invested in that year, which is what benefits from the higher rates since we hold to maturity. And you'll know we'll give you a forecast of what our balance growth is going to be. And we'll also give you a forecast of what yields are going to be in the next year. So you'll have all that math and it'll be very easy to do. And then what you'll have to do is quiz us on what the other side of the ledger in terms of what are the other factors in terms of that led to the final reported or in that case guided net income figures or EBIT figures. And I think one of the things that's changed from Investor Day is that there's no question that, interest rates are way up and client funds interests – our forecast for client funds interest would be much higher because you can do the math, just like we can, the other – the variable that we want to take another quarter to make sure that we think through and that we finalize our plans before we communicate is that inflation is also way up in multiple ways, including on wages as Don alluded to, right. So when we had Investor Day, we had not yet taken this action of an off-cycle merit increase or wage increase, we had not yet which we are now fully accrued for some of our incentive bonuses, which are driven primarily by performance, but come in handy when you are competing for talent and trying to hold on to talent. And so those are all things that we have to kind of weigh now. And then the last factor being, I think Don talked about price increases, where does that finally land will also have an impact. So, there's a few more moving parts then I think is typical for us. And I think it's important for us to make sure we add it all up and rack it all up. But one thing I can guarantee you is you will have transparency."
},
{
"speaker": "Mark Marcon",
"text": "Always appreciate that. Thank you, Carlos."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Mihir Bhatia",
"text": "Good morning. This is Mihir on for Jason. Thank you for taking a question. I wanted to ask about the competitive intensity and pricing actions. Maybe just talk a little bit about the pricing and promotional environment that you're seeing currently. Are we back at pre-pandemic levels in the pre-pandemic trends, any changes, worth calling out in the mix or aggressiveness of competitors and particular segments even, I know you compete across a lot of different segments, so anything you can help us there?"
},
{
"speaker": "Maria Black",
"text": "Yes. So Carlos alluded to the competitive intensity. I think you called it trench warfare and that's certainly the case. I think in terms of being back to pre-pandemic levels, with respect to pricing and promos, we're definitely seeing the competitive intensity that would be reflective of prior years, both as it relates to the trench warfare as well as the pricing element of it. So I think it's fair to assume that it's still very competitive. I think that's part of the reason that as we think about our price increases whether it's on the new business side or on the existing client base, we're being incredibly thoughtful market-by-market, call it country-by-country, segment-by-segment, product-by-product to ensure that we continue to remain thoughtful in terms of the overall price value equation that does keep us remaining in a competitive pricing environment. So I would say that the intensity has not waned. It continues and very formidable competitors out there, and we're confident that we continue to win in the market and that we continue to take a balanced approach on the price value equation."
},
{
"speaker": "Mihir Bhatia",
"text": "Great. Thank you. And then just maybe turning to the growth in average worksite employees, can you talk about what is driving the strength you're seeing there? Is it in particular verticals? Is it broad based, any additional color you can provide there? Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "I mean, I think probably the biggest picture, the answer is no, there's no specific verticals or whatnot. We're too big and too diversified to really – it's not geographic or verticals or all that. It's basically very strong bookings with very good retention and also growth of the client base. This pays per control that we talk about in Employer Services, you have the same phenomenon in the PEO where the clients themselves are recovering, right and hiring at a faster rate than they would have been because they had either shrunk or hadn't hired during the pandemic. And so that is a tailwind also for the PEO, but the biggest factors are sales minus losses. And then what's happening with the base, which is obviously strong."
},
{
"speaker": "Mihir Bhatia",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "We have time for one last question and it comes from the line of James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you so much. I wanted to follow up on a question and it has to do with the competitive intensity, but I guess, previously you talked about, you had some expectation for slight retention deterioration, but that isn't playing out. And in fact, it seems like your outlook is improving. You mentioned mid-market and international are main contributors, but are you seeing anything also in terms of business closures in the down market that's performing better, or any other contributors that are helping out there?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think the best way to describe it, that by the way, was all accurate like we're really happy with international, but also in particular, the mid-market, I think we kind of underestimated as usual, there are multiple moving parts. So you had the pandemic at work. And so we were looking at kind of a historical trends and thoughts, there would be some normalization within the mid-market, but we also had forgotten that right before the pandemic, not right before but 12 to 18 months before the pandemic, we completed our migrations onto one single platform, which is our modern Workforce Now platform, huge process improvement initiatives that were led by John Ayala and the team there that really improved the underlying strength of that business, right. So then you get into the pandemic and you get that noise. Now you come out of the pandemic and there's no scientific way to pull all that apart, but it does feel like our mid-market business has a new floor, if you will, or a nut floor is not the right way to describe it, but a new level of retention that's higher than it was before, that's at least right now, the way it looks in our hope going forward, so that's really good news. The other item on the out of business that you're mentioning, which is really more of a down market question, we again our big subscribers to the school of common sense, and it's playing out kind of the way we expected, because if you look at the reported level of bankruptcies from government figures, they're pretty flat, but that really is not the way the small business market works that, everyone declares bankruptcy, like some people get into business and they stop their business and they never declare bankruptcy. So that is a good proxy and it's one indication, but it's not the only one. And so we have seen some normalization in that down market business because of what we call non-controllable losses, right, which would include out of business bankruptcies, all of the above. It's a big enough factor in that segment that it's impossible to believe that it wouldn't normalize, which is why we planned the way we did. The good news is that it hasn't normalized as fast as we thought. And the other part of our business, the controllable losses have performed better than we expected. And so net-net, we are in better shape than we thought, but just because you have the second best retention you've ever had, doesn't mean that it isn't down from the previous year. And so I just wanted to be crystal clear on that because others may have a different perspective on which would defy. I think finance one-one-one theories and so forth because the number of – the percentage of losses related to the economy and so forth are just significant in the down market. And so when you have this unbelievable tailwind, when you think about the amount of stimulus that was put in with PPP loans and so forth and stimulus checks, remember some of these small businesses are just like consumers, they're one person companies, or five person companies. And when they get a stimulus check, that's like a stimulus check going to their company, that stuff is all coming out of the system and interest rates are going up. It will normalize unfortunately, but you see the outcome net-net for us, which is still incredibly gratifying and way above what we would've expected."
},
{
"speaker": "Don McGuire",
"text": "Just to clarify that, that second best comment James was with respect the down market only. Overall, it was an all-time high."
},
{
"speaker": "James Faucette",
"text": "Yes, thanks for that. And then so does that – so should we interpret it then to mean like, as far as that we should still expect some deterioration particularly as that down market normalizes, because that hasn't happened maybe as fast as you thought, but the drivers are still there, whereas on the mid-market you're feeling better that your new platform can actually help prevent or improve that retention versus what you thought. So you kind of have one thing that's permanent and one that's still to happen and net-net, there may be still some deterioration, but not as much as you thought, is that a fair assessment?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think that is a fair assessment that you should stand by for further details next quarter for next calendar – next fiscal year, because I think we gave you enough color. What you just described is exactly what we expect to happen for the fourth quarter and you see the outcome in terms of our overall guidance for retention. But I think what's more important for you guys is I hope is not just next quarter, but the next year. And I think we'll have another several months of information by then. And we have some other businesses, I talked about the HRO business, our SBS business, I mean, there's other business that are frankly outperforming outside of kind of the economic factors and the mid-market business that are outperforming. So it's really not appropriate yet to jump to any conclusions, but I think your general thesis is exactly correct."
},
{
"speaker": "James Faucette",
"text": "That's great. Thank you very much, everybody."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer portion for today. I’m pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, thanks for all of you for joining us today. I hate to end on a down note here, but I think it's important for us to acknowledge, what's happening in Ukraine and express our sympathies for the folks that are in the midst of that conflict. We obviously like everyone else would like to see the violence end. We have very small exposure from a revenue and business standpoint in Russia and Ukraine, but we do have quite a number of associates and a decent sized business in Eastern Europe. And so we would love to see this violence end and certainly not to spread, we've been doing our part along with some of our colleagues and other companies in the humanitarian efforts to provide relief to the people in Ukraine. But what's really been most gratifying to me is not just what been able to do through our foundation and through ADP, but what our associates have done globally kind of reaching into their own pocketbooks to help their fellow global citizens. We increased our match, our matching contribution amounts for associates who wanted to provide to various relief agencies. And we had the largest – I think reaction we've ever had to any global crisis. And it's obvious why, because when you see the pictures of what's going on and it's truly horrifying. And I mean, for me personally, to see people leaving everything behind and children and families having to flee is personally very painful. So our hearts go out to those folks and we pray that all of the leaders involved can come to some sort of resolution and end of violence. But with that, I will thank you once again for participating with us today. And we look forward to giving you all the information you're looking for fiscal year 2023 on the next earnings call. Thank you very much."
},
{
"speaker": "Operator",
"text": "This concludes the program. You may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 2 | 2,022 | 2022-01-26 08:30:00 | Operator: Good morning. My name is Michelle and I’ll be your conference Operator. At this time, I would like to welcome everyone to ADP’s second quarter fiscal 2022 earnings call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. To withdraw your question, press the pound key. Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you Michelle and welcome everyone to ADP’s second quarter fiscal 2022 earnings call. Participating today are Carlos Rodriguez, our CEO, and Don McGuire, our CFO. Also joining us for Q&A is Maria Black, President of ADP. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures which we believe to be useful to investors and that excludes the impacts of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. With that, let me turn it over to Carlos.
Carlos Rodriguez: Thank you Dany, and thank you everyone for joining our call. We’re pleased to have delivered strong second quarter results, including 9% revenue growth, 20 basis points of adjusted EBIT margin expansion, and a 9% increase in adjusted diluted EPS, all ahead of our expectations. It remains a very dynamic and challenging business environment for our clients and prospects, but we believe the value of working with a trusted ACM partner with more than seven years of expertise is more compelling than ever, and we see evidence of this reflected in our continued sales momentum as well as our very high levels of client satisfaction and retention, which continue to drive upside to our results. As usual, let me start with some highlights from the quarter. Our employers services new business booking results were strong despite the onset of the omicron variant at the end of the quarter. We experienced a record Q2 booking level and like Q1, we were pleased to be ahead of pre-pandemic sales productivity levels. We experienced robust double-digit growth in nearly every one of our ES businesses, and as we saw earlier in the year, we experienced every stronger performance in our PEO segment, where demand is especially robust. As we outlined at our November investor day, the pandemic and the dynamic macroeconomic environment have made running HR more challenging for our clients. Today our clients navigate a tight labor market across their organizations, higher than usual worker turnover, new legislative requirements, and in many cases staffing challenges specifically within their payroll and HR departments. The strong broad-based demand across our ES and PEO segments reflect the fact that clients of all sizes are increasingly looking for greater levels of assistance and expertise to help address their needs, in some cases seeking our intuitive yet comprehensive software offerings while in other cases seeking a more fully outsourced solution. We believe we provide extraordinary value through all business environments, and today’s environment supports a continuation of a positive decades-long secular trend in global HCM. Moving onto employer services retention, we are pleased to have experienced continued strength. Although our retention in the quarter did decline very slightly versus last year’s elevated level, it declined by less than we had anticipated and would have represented a record Q2 if you were to exclude last year’s pandemic impacted retention levels. With overall client satisfaction once again reaching a record level this quarter, this strong retention is not surprising to us. Moreover, early January results look strong, giving us greater confidence for the rest of the year, and we are pleased to be raising our retention guidance once again. Our ES pays per control metric came in slightly better than expected at 6% growth in the quarter. We are very pleased to see the U.S. unemployment rate back below 4%, which reflects the U.S. economy’s ongoing improvement and resulting strong demand for workers. Meanwhile, labor force participation is gradually recovering and as it does, we should continue to benefit from higher than usual pays per control growth. Over the first half of the fiscal year, we’ve tracked ahead of our expectations and are now raising our pays per control outlook for the full year. In the second quarter, our PEO had stellar performance once again and was well ahead of our expectations with 15% revenue growth and 16% average worksite employee growth, representing acceleration from last quarter despite a slightly harder growth comparison. Across the board strength in our PEO continues to be driven by several factors, including better than expected retention and bookings contributing to client growth, better than expected hiring within the PEO client base, further adding to worksite employee growth, and better than expected wage levels further adding to revenue growth. While some of these tailwinds will normalize over time, we remain very confident in the outlook of our PEO business over the coming years. During our November investor day, we also outlined key aspects of our growth strategy by product and by business unit, and we are confident about sustaining healthy growth in our fast-growing businesses and optimistic about accelerating our growth in our businesses that continue to transition to our most modern offerings. One aspect of our growth strategy that we discussed is an overall greater focus on marketing, which we believe will allow us to better activate our existing scale distribution. We believe at ADP, we can deliver a lot of incremental value from tactical investments, and we look forward to sharing more in the very near future. One key product initiative we talked about during investor day that cuts across our businesses is the development of a new unified user experience, and in the second quarter we were pleased to have made further progress on this effort. As a reminder, we shared last quarter that we moved our Run client base over to the new ADP UX, and now only a quarter in, early indicators suggest that clients are in fact finding it more intuitive, resulting in fewer client service contacts. In Europe, we have been gradually transitioning our client base over to our award-winning IHCM platform, and in Q2 we seamlessly moved those clients over to the new ADP UX. We’re now very excited that just this month, we began our pilot of the new ADP user experience for Workforce Now, which when coupled with our next gen payroll engine makes for an even more differentiated offering for what is already a market-leading HCM solution in this target market. In terms of a few other highlights, I’m pleased to share that we reached a new milestone by running 1 million pay slips for a single client on a single day for the first time. At the other end of the spectrum, our Roll mobile app, which serves the micro segment, continues to outperform our initial expectations. In another milestone in calendar 2021, the ADP mobile app had over 1 billion log-ins, highlighting the growing amount of direct engagement we have with employees and managers around the world. To that point, this month our return to workplace mobile solution, part of the ADP mobile app, was awarded the Business Intelligence Group’s 2022 Big Innovation Award. As a final highlight, just this week we launched our bill pay feature in the Wisely app. Bill pay is free to Wisely users and fully integrated into the app, and has been a top requested feature from our user base. We believe this addition will further drive engagement and retention, and we look forward to continuing to expand the Wisely ecosystem. Overall, Q2 represented a solid outcome on both the financial front as well as with respect to key strategic initiatives. I’d like to thank our associates who continue to deliver these exceptional products and outstanding service to our clients, and I’ll now turn the call over to Don.
Don McGuire: Thank you Carlos, and good morning everyone. In the second quarter, we delivered 9% revenue growth on both a reported and organic constant currency basis. Our adjusted EBIT margin was up 20 basis points, better than planned, and supported by our better than expected revenue growth, offset partially by increased PEO pass-throughs and headcount growth in our implementation and service organizations. I’ll share more on this last point when I discuss our outlook. Our tax rate was up slightly in the quarter versus last year, driven by the lapping of a one-time international tax benefit we experienced last year. When including the benefit from share repurchases, we had a 9% increase in our adjusted diluted earnings per share. Moving onto the segments, our employer services revenue increased 6% on a reported basis and 7% on an organic constant currency basis. In addition to the strong bookings, retention trends, and pays per control performance Carlos outlined, our client funds interest grew for the first time since the pandemic started as lower average yield was offset by a tremendous 28% balance growth. This growth included some benefit from the lapping of last year’s deferred employer social security taxes and incremental benefit from the repayment of a portion of those employers’ social security taxes, which together contributed several points of growth in addition to the already robust growth from higher client count, employment growth, and higher wages. Our ES margin increased 40 basis points, ahead of our expectations for the quarter and supported by better than expected revenue performance. Moving on, our PEO continued to deliver exceptional performance with 15% revenue growth in the quarter. Average worksite employees accelerated to 16% year-over-year growth and reached 660,000 for the quarter. Key contributors were strong bookings and retention, as well as very healthy pays per control growth within the PEO client base. Revenues excluding zero-margin pass-throughs grew 18%, which was driven by worksite employee growth as well as higher average wages and higher SUI revenues per worksite employee. PEO margin was down 10 basis points in the quarter. Included in that figure was pressure from workers’ comp and SUI expenses due primarily to worker mix and wages. Moving on to our updated outlook for the year, for ES revenues we are narrowing our guidance and now expect growth of about 6%, the upper end of our previous guidance range of 5% to 6%. The primary drivers for our higher outlook are the stronger Q2 performance, our higher client funds interest outlook for the year, and higher pays per control growth, partially offset by an expectation from incremental FX headwind in the back half of this year on the recent strengthening of the U.S. dollar. For our client funds interest revenue, we’re raising our outlook by $20 million to a range of $440 million to $450 million. Like last quarter, we’re raising our balance growth assumption meaningfully to now expect growth of 18% to 20%, whereas our client funds yield expectation is unchanged despite the improvement in interest rates. This is primarily because our stronger than previously expected balance performance creates a temporary lag with greater short term investments before we purchase higher yielding fixed rate securities. For U.S. pays per control, we’re raising our outlook by 1% to now expect 5% to 6% growth. We continue to expect that a gradual ongoing recovery in labor force participation will support job growth, and the first half of the year was a bit ahead of expectations. In addition to client funds and pays per control, we are raising our retention guidance slightly and now expect it to be down 40 basis points for the year. Although we still anticipate some normalization in client switching activity, trends so far this year have been very positive, and January is looking like a continuation of that same strength. One thing we’re not changing at this time is our ES booking guidance. As Carlos outlined, our Q2 performance was strong, but bookings is one place where the evolving pandemic conditions and the omicron variant has potential to create noise, as we saw at the outset of the pandemic. Although we haven’t seen a material impact at this time, we still think it’s prudent to maintain a wide range of outcomes in our guidance. For our ES margin, we are making no change to our outlook of up 75 to 100 basis points. Although we are raising our revenue guidance and although some of that is coming from high margin revenues, like client funds interest and pays per control, at the same time we are now more fully caught up on implementation and service headcount after running a bit behind earlier this year and late last year. This investment in implementation and service teams is critical both because the current year-end period is important to our clients and their employees, and also as we look to get ahead of the needs of our growing client base. With the continued outperformance in retention, we’re now planning to grow our implementation and service teams slightly more than we had previously planned as we exit this fiscal year. In addition to this growth in personnel, we also took one-time compensation actions across our organization in recognition of broader inflation trends in the market. The incremental expenses associated with those actions are now included in our outlook. Although this tight labor market has created its own set of challenges for most companies, we are very pleased to have been able to grow our organization as much as we did these past few months, and the wage increases we layered in give us confidence regarding our staffing levels at a busy time of year. We are also pleased to have been able to support those changes without detriment to our existing guidance ranges. Moving onto the PEO, following the strong first half trends in both client growth and worksite employee growth, we are now expecting average worksite employees to grow 13% to 15%, and we are likewise raising our guidance for PEO revenues and revenues excluding zero-margin pass-throughs by two percentage points each. Our outlook will continue to be sensitive to employment trends within our PEO client base, as well as bookings and retention performance, so although we are currently contemplating growth to be a bit lower in the back half of the year, we could continue to see upside if the current robust trends persist. For PEO margin, we are making no change to our guidance of flat to down 50 basis points for the year. Although we are raising our revenue guidance, we are at the same time expecting higher SUI and workers’ comp expenses to create offsetting margin pressure. Putting it all together for our consolidated outlook, we now expect revenue to grow 8% to 9%. For adjusted EBIT margin, we continue to expect an increase of 50 to 75 basis points. As we shared earlier this year, we expect our margin improvement to be concentrated in the fourth quarter and expect our margin to be down in Q3, particularly following the recent personnel growth and wage increases. We’re making no change to our tax rate assumption. With these changes, we now expect growth in adjusted diluted earnings per share of 12% to 14%. Thank you, and I’ll now turn it back to Michelle for Q&A.
Operator: Our first question comes from Bryan Keane with DB. Your line is open.
Bryan Keane: Hi guys, congrats on the results. Just wanted to ask on the impact of omicron, especially in December and January. Is there any noticeable impact in sales or retention, or anything that you’d call out particularly from the rise that we’ve seen from the virus and omicron?
Carlos Rodriguez: I think you heard from our prepared comments that the answer was no, but when you think about the way the quarter works, the omicron really started to pick up in, I would say, middle to last December in terms of my recollection. It’s really incredible how fast things have changed with this, because now we’re back on the down slope in the northeast, it appears at least, in the U.S., so it’s pretty fast moving. But I would say that our answer is no, we didn’t see anything in the quarter that we just reported. Obviously we’re now in the next quarter and it’s kind of difficult to start talking about the next quarter, given we’re only, I think, three weeks into it, but you’ve seen probably multiple reports--I saw one this morning in the Journal about, I think it was the IMF or someone kind of lowering global growth and so forth, and some of it is obviously a result of omicron, there’s probably other factors as well. We do believe that we’re not immune from these kinds of things that ripple through the economy, including omicron, but the truth is we haven’t really seen a big impact yet. But if GDP growth--I think the GDP growth for the full calendar year, most people have kind of kept it in the same range, so I’m guessing that people have lowered their first quarter - talking about calendar quarters now - GDP growth forecasts slightly and probably increased, because I think it’s just a matter of pushing activity forward, because it does look like in a few weeks, things will start to, quote-unquote, normalize in at least a portion of the country, and then I think shortly thereafter economic activity should be robust again, as was, I think, predicted by a bunch of economists. So anyway, that’s a long way of saying not really, not yet, but we’re always careful to not assume that we are somehow insulated completely from what happens in the overall economy. If people are traveling a little bit less, for example our own associate population, we proactively asked--we were already back in the process of getting people back into our offices, and we went back in the other direction for about a month or two. That just lowers economic activity - people aren’t driving as much, they’re not going to lunch in a local area, etc., and those things have a ripple effect through the economy, but no signs of any major decrease in demand or economic activity from our numbers yet.
Bryan Keane: Got it, that’s helpful. Just as a follow-up, wanted to ask about the strength in the balance growth - I think it was up 22% last quarter, up 28% this quarter. I don’t know if you guys look at how much inflation could be driving that number as well, and any other call-outs--I know you raised the guide there, but just surprised at the strength there.
Don McGuire: Yes, we have had some growth. Certainly wages were a little bit of that, but also as we said in the prepared remarks, the big driver was the lapping from last year with the deferral, so certainly the deferrals represented a few points in the growth of those balances in the quarter, although even the deferrals were only for a few number of days towards the end of the month of December. Certainly we look at those, but as we said, we do expect the balance growth to continue and we expect it to be firm based on the pays per control and the increase in number of people working for our clients. I think that’s the biggest driver.
Carlos Rodriguez: And just in terms of a refresher, by deferrals, I think Don said in his remarks, there’s a social security tax deferral. Not everyone lives day to day like us, but it was a significant stimulus--part of the stimulus package, if you will, and those social security deferrals need to be repaid half--we just went through that, which is what helped us in terms of tailwind on balances, and the other half is next December 31. That’s something maybe to pencil in which would provide some support to our balances next year as well.
Bryan Keane: Okay, thanks for taking the questions.
Operator: Our next question comes from David Togut with Evercore ISI. Your line is open.
David Togut: Thank you, good morning. Could you unpack demand trends, looking at Run, Workforce Now, and Vantage HCM in the quarter and what’s embedded in your 12% to 16% ES bookings growth outlook? As a follow-up, if you could comment on your recent announcement that you’re expanding Workforce Now with international functionality, what sort of traction do you expect to see there? Thanks.
Maria Black: Yes, good morning, this is Maria. Thanks for the question, David, happy to comment on both. With respect to the overall performance in the quarter, as was stated in the prepared remarks, we had strong double-digit growth that did really go across our scaled offerings, specifically in the down market. We saw the strength in our Run platform, we saw the strength in our retirement solutions, definitely experienced strength in the Workforce Now platform. I’ll cover off on your second question as well as we get to the press release that we just issued. Additionally in the second quarter, we also saw strength in GlobalView, so very happy with our international contribution to the quarter, so that was really the strength across the double-digit growth that we saw in employer services. As it relates to the Workforce Now press release that I think we issued in the last couple days regarding the offer that now is on a global basis, the ability for our U.S.-based and Canadian-based companies to process payroll on the Workforce Now platform across multiple countries, in partnership with our Celergo offering. Very excited to have this offering, as you could imagine. Over the course of the last decade but certainly in the last couple years, the ability for mid-market customers to really be able to support international employees on their end is a growing demand, and we’re pretty excited to be able to satisfy that demand with this new offer.
David Togut: Thank you very much.
Operator: Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open.
Kevin McVeigh: Great, thanks so much. Carlos, I think you talked about improvement in retention against a still challenging environment overall. Can you maybe reconcile those comments a little bit because, all things equal, I would think tougher environment, maybe you have a little bit more pressure from a client perspective. Can you unpack that a little bit?
Carlos Rodriguez: Yes, I think what we’ve been saying for probably a few quarters now, it’s really not--maybe the tougher environment isn’t the right term. It’s tougher comparisons, because our thesis was that we’d gotten some tailwind from the pandemic--there were a lot of tailwinds in a lot of areas, but one of them was in retention. There’s less clients switching, and on top of that, there was also lower bankruptcy rates in down market, where it’s a significant portion of the turnover of our clients is, quote-unquote, out of business, so all the government stimulus and all the low switching, I think really elevated our retention. At the same time, our NPS scores and client satisfaction and all the feedback we’re getting from clients was very, very strong, so frankly it’s difficult to separate the two, so we planned for some moderation in our retention as a result of those tailwinds because those tailwinds are going to go away. I think they’re economically driven, and we’ve seen a little bit of that in our down market. I think we’ve also kind of alluded to that, that despite our continuing strong retention, it’s kind of generally playing out the way we expected, which is our down market SBS is a little--is down a little bit over the previous year, but other parts obviously are holding up well, if not improving, and the net of that is better than we expected and better than we had planned. The question is, are we going to be able to hold onto all of it? Our plan of course is to hold onto all of it, and that is why you saw in Don’s comments that we’re making sure we have the right levels of service, the right levels of implementation, because if we can achieve the forecast we have for retention for the year, which will be ahead of what our plan and our expectations were, that has a meaningful impact on our long term growth and value creation for the company.
Kevin McVeigh: That’s very helpful. Then I don’t know if this would be Carlos or Don, but could you remind us the rate sensitivity, 25 basis points, what that means? Then I guess I was surprised to see the boost in the extended investment strategy, just given I thought there was a little bit more of a lag effect on that, so maybe just--because obviously it’s been so long, we’ve been in front of a rate cycle, but just the dynamics of client funds relative to extended investment.
Don McGuire: Yes, why don’t I start with the second question first on the rate environment and what that means for us. Generally speaking, as you know, when the fund balances increase rapidly, we have to invest in short term items or short term instruments until we have the opportunity to invest in longer term instruments, and as a result, we don’t see as much pick-up as we would like to see. But I can certainly give you some sensitivity with respect to if we had a 25 basis point improvement in the rates in our short term investments only, that would translate into about $9 million of EBIT on a 12-month basis, so not hugely significant. On the other hand, if we saw that both in the short and the intermediate term, that 25 basis points over a 12-month period would translate into about $23 million of impact before taxes, so certainly that becomes meaningful. As we look to invest those funds longer term and as rates continue to go in what we’d say--I guess what we’d say is a better direction, I think we have some opportunity in the future; but at this point in time, we think that we’re not going to see a huge amount of improvement in the client fund interest over the balance of the second half. What we have talked about is in the forecast today.
Carlos Rodriguez: Kevin, could you clarify the question on the extended portion, where specifically you’re focused there?
Kevin McVeigh: I guess just the dynamics of the client funds interest revenue versus the extended investment strategy, what the timing difference is on those two in terms of when you’d see it, because obviously you saw a little bit of benefit from extended investment in term of the outlook, not as much on the client fund side, but is there a timing element to the extended versus the client funds.
Carlos Rodriguez: Well, if you’re talking about balance growth, the extended strategy balance growth is actually tied more to the volatility of cash flows on a year-to-year basis, so it has to do with our forecast of what our low balance is going to be in the year versus our average balance, which is a little bit different from the client funds forecast. Long term, yes, the extended balance would grow kind of in line with the client funds balance growth, but on a short term, year-to-year basis, there’s a whole more noise. That is actually driving the difference more so than the lag effect. The lag effect that Don was referring to has more to do with the growth in the client funds balances. When the growth is particularly high, it’s often hard for us to reinvest quickly given the number of opportunities there are in the market and so forth for the type of credit quality that we’re seeking, but we within a couple quarters can catch up, so it’s just a question of how quickly we can deploy those additional funds. I think the short answer is the net impact from our strategy, because there’s also a re-classing issue in terms of how we do it, in terms of accounting and so forth, so I think the right way to look at it is really what’s happening with yields, what’s happening with--overall, what’s happening with balance growth, and then what’s the net impact of our strategy, of our client fund strategy. I think on that front, the short answer is it’s looking pretty good. Just as an example, our Q1 re-investments were at about a 1% yield, so new purchases, and in Q2 they were 1.5%, so it’s been--you see the same thing we’ve seen. The moves in the two-years and the five-years are even more significant than the 10-years and so forth, so for us it’s the--you know, when we talk long, our version of long is three, five, seven, not beyond that, just because of the way we invest our portfolio, and on that front, you could not have a better environment in terms of wage inflation, balance growth and increases in interest rates. I would say we’re not ready to say anything yet about ’23 and ’24, but all this--there’s a lot of talk about mechanics in the short term or whatnot, because I know a lot of people are focused on the short term, but we’re more long term oriented and we could be in here for a multi-year tailwind finally from client funds interest in a meaningful way.
Kevin McVeigh: You’re going to have a high class margin problem, Carlos.
Carlos Rodriguez: Yes, listen - I’ve been waiting 10 years. I had hair when I started as CEO, and I remember telling the treasurer at the time, rates have to go up next year, and then next year I said rates have to go up next year, and here we are. But this time, dammit, I’m right!
Kevin McVeigh: Thank you.
Operator: Our next question comes from Tien-tsin Huang with JP Morgan. Your line is open.
Tien-tsin Huang: Thanks so much guys, good morning. Really good results, better base control, looking at better retention, in-line bookings, raising balance growth, and all that good stuff. I think of all of these as positive forces for margin expansion, right, so you’re keeping the margin the same, so is that just a function of the costs you discussed, or is that some conservatism as well? Just trying to better understand that.
Carlos Rodriguez: Well if the question is about conservatism, I’ll let Don handle it.
Tien-tsin Huang: Thank you. Thank you Carlos.
Don McGuire: Yes, so I think the answer is that we have got a pretty reasonable forecast in front of us, so I think we’re not being terribly conservative. But I think what you should consider, though, is that we raised our revenue by $150 million from the prior--from the prior forecast, and we’ve also raised our expenses by $115 million. If you start to break down those expenses, that $115 million of expense increase, you come pretty quickly to PEO pass-throughs - we had $48 million of that, so $48 million of that expense increase is really having a bit of a drag on our margins. Otherwise, I think our margins clearly would be better, but that’s really what’s preventing us, and that’s the reason we haven’t been able to do more on the margins. But I do think that all in, we’ve done a really good job of baking things into our guidance and firming up the expectations we set.
Tien-tsin Huang: No, for sure. It’s very good.
Carlos Rodriguez: Just one other thing, I think we should also add to your point in terms of tone, we want to make sure we’re clear here that we’re not insulated from the world. There is no question that there is pressure on costs, particularly around wages, and we are a technology services company so we have costs around R&D and so forth. We also have costs around the service side of our business, and you’ve heard in the prepared comments that Don mentioned that we’ve taken some actions that are what I’d call mid-cycle, so not the typical annual wage increases, because we felt we needed to do something to make sure that we held onto our people and that we were attracting the right kinds of people, so we are doing some things. Now, the good news on the other side of that coin, which I’m assuming will come up later as a question but may as well address it now, like some other industries but not every other industry, we do have a fair amount of, and the industry has shown, demonstrated historically and, I think, there are some recent signs from competitors that pricing is more elastic than in many industries. This is not a commodity business, and there’s a fair amount of room. The problem is you have to exercise that room very carefully because you want to remain competitive, and on and on and on. You’ve heard that story from us for many years too, that we really want to win in the market, we want higher retention rates, so we can’t just go around willy-nilly passing through price increases, but the fact is we can and we will if it’s driven by market forces and cost increases that are experienced across the board. We’re confident that our competitors will do the same thing, and some of them already are.
Tien-tsin Huang: You answered my follow-up on pricing. Thank you Carlos. Thank you Don.
Operator: Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning. Thanks for taking my questions. I wanted to maybe circle back to the PEO business and the strength there, it continues to perform really well. I was curious, can you remind us, when we think about the source of new bookings for PEO, how much of it is new to ADP for the first time versus conversions of potential existing customers in the SMB side of the base that you’re up-selling over to PEO? How should we think about the source of new bookings?
Carlos Rodriguez: I think it’s been pretty consistent for a long time at around 50%, right?
Maria Black: That’s right.
Carlos Rodriguez: It’s about half, that we kind of mine our own. It’s a combination of mining our own clients, but we also mine our own sales force. Our sales force is able to bring in obviously new clients straight onto the PEO, but we also have a very large installed base that, as you alluded to, we mine. I think it’s 50/50, if I’m not mistaken. It hasn’t really changed that much over the years.
Samad Samana: Great, that’s helpful. Then as I think about the consolidation of the base onto one UI, there’s clear user benefits to that, but how should we think about maybe--is there a tailwind to that on the gross margin side as more and more of the base is on a single UI from, I guess, a service or a maintenance standpoint in terms of spend going forward, and how should we think about that unfolding on the gross margin line?
Carlos Rodriguez: I think that’s a fair point - there’s a lot of things that we do that are intended to really, quote-unquote, standardize and to be able to get leverage, and this is clearly one of those where--you know, ADP historically was a little bit more fragmented in terms of our R&D, and we’ve been, starting with my predecessor, I think trying to become more unified, etc., and the user experience is one of those places where there was an obvious opportunity that I think will make us better competitively and allow us to invest our money more efficiently, and there clearly is some back end benefit to that from a margin standpoint. But I would say I’d be--I don’t think it would be true to say that that was the primary driver. There’s got to be some residual help from a margin standpoint and from an efficiency standpoint, but this is really about winning, about having the best products and having the best face to the market in terms of our--the best skin, if you will, on each of our products. It makes a difference, as you know. We get it, we’re a technology company now, and it matters a lot the experience that our--and it’s not just our clients. It used to be 20, 30 years ago, it was only the clients. Now the employees of our clients are obviously touching and interacting with our products, especially with the mobile app, and this user experience stuff matters a lot in terms of engagement.
Samad Samana: Great, helpful. Congratulations on the solid results.
Carlos Rodriguez: Thank you.
Operator: Our next question comes from Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi, good morning, thank you. First, I want to follow up on retention. Can you dig in a little bit more about the underlying drivers, so out of business closures versus competitive switching behaviors? When you think about the 40 basis point year-over-year decline you forecasted, how much is due to a pick-up in that closure rate versus competitive losses?
Carlos Rodriguez: Almost all of it is in the down market and related to normalization of economic factors, like closure rates. I don’t know that closure rate is the right word, but that’s one of the--that’s in that category, what we call--we track uncontrollable losses and controllable losses. Controllable losses would be around service and product, etc.; uncontrollable is the obvious, like bankruptcies, out of business, etc. What happened during the pandemic, it wasn’t just that bankruptcies went down. All the categories of uncontrollable losses went down, and there has been some normalization of that, not all the way back to pre-pandemic, but I would say that there’s really nothing that you could read into the numbers to tell you anything other than we have fantastic service, solid NPS scores, but there is some normalization in categories, specifically more down market. Everywhere else, I think our retention rates are good to improving and solid, and in many cases better than prior years. We have less tolerance in those other businesses because they’re not as economically sensitive, so we have less tolerance for the excuse that there’s going to be normalization there, because we now have a taste of what’s possible in retention in the mid-market and in international and in--although international has been strong all along and in the up-market, and we just want to maintain those retention levels. But it would be foolish in the down market to assume that there won’t be some economic factors and normalization - that’s what you see reflected in our forecast.
Bryan Bergin: Okay, makes sense. Then just on the PEO strength, so the sequential increase in worksite employees was really notable here. Can you just dig in a little bit more? I heard better units, so better retention, better bookings, but does seem like there’s been a release or a tipping point here around clients converting to this model. Can you just talk about that?
Carlos Rodriguez: Yes, I think that--we’re thrilled, just to be clear, but let me just give you a few, back to these comparisons in the pandemic and noise. Part of our headwind in the PEO sales, which by the way we’re positive and we’re good, but not as good as ES last year. I think we shared a little bit of color there that the average client size sold had come down a little bit, wages weren’t growing that much, so all of those things have an impact more on the PEO than they do in ES, particularly in some of the ES units. Those things have all turned in the other direction now, so the average size client is bigger in terms of clients sold, and that is meaningful, and then you have wage growth which flows through the PEO. It doesn’t flow through ES because the billing is not as a percent of wages, whereas in the PEO it is, and so we do have a number of tailwinds that are also helping. But the most important thing, which is maybe what you’re alluding to, is the average worksite employee growth, which kind of cuts through the inflation and the wage growth and all that, and that’s also robust but that’s getting assistance, like I just mentioned, from average size client being a little bit bigger in terms of new business bookings. Again, that’s great news, but it’s a little bit of a normalization because it’s actually back now, so it went down from where it was pre-pandemic, and now it’s back up about to where it was pre-pandemic, and hopefully, you know, you get 1% to 2% growth going forward, but right now it’s more than just 1% to 2% growth.
Bryan Bergin: Okay, thank you.
Operator: Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi there, thanks for taking my question today. I wanted to ask you about your HCM products and the cross-sell opportunity into your base of payroll customers, sort of an update in terms of where you are there and whether you could potentially accelerate that process.
Maria Black: Yes, so happy to comment on our HCM products and how our sellers go to market to drive the combination of new business bookings between new logos as well as add-on business, our HCM products from an attached perspective. As you can imagine, a lot of the investments that we’ve spoken about for several years in existing products, a lot of the investments that we’re making into our existing platforms - we just talked about the new UF and the impact that’s making in our down market and will continue to make, coupled with the investments that we’re making into our next gen products, are all investments that are anchored in a belief that we can continue to expand the offerings to our existing clients as well as new clients. Excited about the execution on each one of these initiatives and the impact that it will make to our bookings and the mix of bookings between new logos and HCM products attached.
Carlos Rodriguez: Our attach rates in general are pretty good, particularly in some categories like--we said this before, like our workforce management, we used to call it time and labor, those products tend to have high attach rates, and others have high attach rates, others have low attach rates. I think part of our opportunity for whatever the years to come is to not only sell new logos, which we’re now obsessed about because we want to grow market share, but share of wallet is a huge opportunity for us. The fact is, we have very low-ish penetration still in many of our categories and many of our products.
Ramsey El-Assal: Interesting, okay. Thank you for that. A follow-up for me is on M&A and balance sheet deployment here. Obviously a lot of the valuation multiples in the sector have pulled in quite a bit. I don’t know if the environment has created a situation where maybe you had a shopping list, a dream shopping list that maybe now you can go after that you couldn’t before. But maybe an update on whether--you know, on your capital allocation and specifically as it relates to M&A plans would be helpful.
Don McGuire: Yes, I think that there’s always things flowing across everybody’s desk and evaluations being done of opportunities, etc. While it’s true that the last few weeks haven’t been kind to some companies, I don’t we’ve really changed our objectives, and our objective is to make sure that anything that we seriously consider and we pursue has to fit the portfolio, so whether it’s--it just has to be either a geography extension of what we currently have or it has to be something that’s filling a product niche, and so we’re going to continue to work by those guidelines, if you will. If things become more affordable and something falls into those categories, certainly we’ll take the opportunity to look more seriously or to look a bit harder than we might have, say, three or four months ago. I don’t know, Carlos, if you want to expand on that?
Carlos Rodriguez: No, all I was thinking was that in some cases, if people pay us, we’ll buy their companies.
Ramsey El-Assal: All right, fantastic. I appreciate it. Thanks so much.
Carlos Rodriguez: And then we can clean them up.
Operator: Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Good morning everybody, and congratulations on the quarter. I was wondering, could you give us a couple of updates with regards to some of the products? In terms of next generation pay, to what extent has that been further rolled out? What’s the update there?
Carlos Rodriguez: I would say we had a really good, I think, first--I would call it year end, because when you get to the midmarket, which is next gen pay, as you know right now is really being sold in a portion of what we call the core part of the midmarket, so call it 50 to 150, and I think we’re at--we’re selling somewhere between 20%, 25% of our clients, of our new businesses coming in on the new platform, and we expect to be GA, I think it’s end of calendar--
Maria Black: This calendar year, that’s right.
Carlos Rodriguez: End of calendar year, so that’s kind of what we talked about at investor day. I would say that, call it December-January sales season, because a lot of those clients, they want to start clean on January 1, so it’s a fairly important point of the year in terms of judging where you are in terms of sales results and so forth, and we had a fairly good, I think, number of starts. We were happy, I would say, with the early January, late December, what I would starts results - in other words, those are clients that we sold previously, that we got started and we have up and running. We try and avoid getting into specifics of how many clients, because then every quarter you guys are going to ask us, but I’d say that that’s going really well and we’re on track for this GA by the end of the calendar quarter, and then we had a good start season for end of December, beginning of January.
Mark Marcon: That’s great. Then it sounds like--you know, one of the early comments that you gave, Carlos, was highlighting just the breadth, talking about how Roll is doing on the low end and then also mentioning that at one client, you had a million transactions in a single day, which is obviously impressive. Can you just give us a sense for in terms of Roll, how much is that--now that you’ve had some experience with it, how much more excited are you about that possibility and penetrating that micro part of the market? Then on the flipside, with the capabilities of being able to service companies globally and at huge scale, how does that expand the top end of the market?
Carlos Rodriguez: As you know, we’re a little bit different than most in the sense that we’re 100% all-in on HCM, and we cut across multiple segments and also geography, so that makes us a little bit unique, so you have to get excited within segment because--like, Roll is really exciting and we’re excited about that opportunity, but that is in that micro segment because if you take the other extreme example of that other client, like when we process a million--that client obviously has a million employees, and we processed their payroll and we processed a million paychecks on one day. That’s a lot of small Roll clients to make up for that. They’re excited about that, but Roll is excited about its role in the growth of ADP and in the marketplace in terms of our ability to compete and to create opportunities for us. It’s a little hard to compare. I guess it’s like when you have multiple children, you have to love them all and they’re all good looking and smart and so forth, and I think that’s the way I feel about Roll in the down market versus the up market versus GlobalView. They really are all, I think, performing quite well now, and I think we’re excited about the opportunity in each of those market segments. I’m trying not to give you a non-answer answer, but I think--I’m trying my hardest to give you something concrete, but it’s exciting because these are all--I mean, the growth rate, Dany won’t allow me to say it because as we were preparing for the call, if we were a start-up, we would be quoting growth rates for Roll that would make your eyes roll, but Dany won’t let me say it because it’s really, frankly, insignificant to a $15 billion company today, but it won’t be insignificant in five or 10 years.
Mark Marcon: I guess that’s what I was getting at, was on the--for example, in terms of Roll, when you first introduced it, you talked about it in a more modest manner, but it sounds like it’s getting really good traction, so I was just wondering if there was some way to capture how you’re thinking about how big that could eventually be.
Carlos Rodriguez: It’s definitely getting good traction. We’re definitely excited about it, but again you shouldn’t over--I’m not trying to over-play it because we have a very large organization, and you guys need to think about how all the pieces fit together, so that it fits into our forecast. Just from a dollar impact, I hate to go back to that, that product and that segment competes against certain competitors. We feel pretty good about what we’re going to be able to do there in terms of market share and growth, etc., but you should not be thinking about this as something that’s going to move ADP’s growth rate by one to two percentage points on the top line in the next year or two. That’s just not the way the math works. I wish it did. All of these things have to work together - next gen payroll, next gen HCM, Roll, GlobalView, Celergo. There are a lot of things - PEO - that have to come together for us to get to the numbers, and we like that. We’re, I think, a portfolio that, as you’ve seen, we manage pretty effectively, and the combination of all of those businesses having good success, some more than others at times, I think leads to the results that we are reporting and forecasting.
Mark Marcon: Appreciate that, thank you.
Operator: Our next question comes from Eugene Simuni with MoffetNathanson. Your line is open.
Eugene Sumuni: Thank you, good morning. Congrats on another strong quarter, guys. Wanted to ask about Wisely and your general personal finance product strategy. You highlighted the bill pay offering in your prepared remarks. Can you just remind us what are the next big milestones for this overall strategy, and I know it’s a small part of your portfolio, but will you at some point maybe start providing some metrics that can help us track the growth of this area like some businesses like that provide, such as number of cardholders, frequency of transactions, the amount spent, and so on? Thank you.
Maria Black: Yes, so happy to comment on the overall Wisely product strategy and where we’re heading with the opportunity - it’s incredibly exciting for us, and then we can talk through what those metrics could be to give some solid basis of growth over time. As it relates to the overall MyWisely app and the strategy we have within the Wisely portfolio, it is really a strategy that is anchored in financial management. That financial management in the app happens through education, budgeting, savings tools, rewards. What you heard today, which you just mentioned as well, which is the launch of our bill pay feature, we believe is significant. It’s exactly what we all probably use with respect to any type of an online bill pay, where you can scan the check and actually facilitate end-to-end bill processing through a mobile device, so that is all part of the MyWisely app and the overall financial management strategy - think financial wellness, etc. that we’ve employed. In addition to that, the other thing that’s forthcoming is the launch of our early wage access, our EWA as we refer to it, which is really that ability for our clients’ employees or employees to gain access to wages that they’ve earned as they earn them, so this is also a big piece to the overall equation with respect to the overall Wisely. Things that we’re monitoring actively right now, back to the question around how many cardholders, etc., certainly we’re looking at that. We’re looking at other types of what type of cardholders are using what feature functionality. There is some data that you could look at as it relates to how many reviews we have on the app, the quality of the app certainly supersedes some of the competition in the space. We’re pretty proud of the impact that our financial wellness tool, MyWisely app is creating in the market. I’ll let Dany or Carlos comment on cardholder tracking and when and if we’ll disclose that.
Carlos Rodriguez: Yes, I think we’ll--I mean, that’s a takeaway for us. We’ll see if there’s something else that we--I mean, we’re always open to suggestions and trying to be open-minded about disclosure, but again, this is not the same as the conversation about Roll, but as excited as we are about Wisely, we’re equally excited about things like Roll, and Wisely is much bigger than Roll. But again, relative--I hate to be a broken record, relative to the size of ADP, it wouldn’t be at the top of the list of the things that are going to drive the overall results, because again, a portfolio of so many different things that have to go right and that we have to get right in order to get growth on $15 billion. I think that business is probably--I’m trying to do the math in my head, it’s like 2%, 3% or smaller in terms of total--actually smaller than that, even, in terms of revenue. By the way, we want that, and it is growing faster than the line average. All the things you’re asking about are relevant, and those things would all help the overall growth rate of ADP, but it would be misleading--because I think others might have done that, where they make a bigger deal out of it than it really is, and maybe relative to their companies it is a big deal. Relative to us, we have lots of other things that we have to do and that have to go right, and us trying to pretend that--you know, if we tell you this is how much we get per card and then we start giving you math that if 100% of our clients got on the card, this is how much money we would have - I mean, we don’t need to do that, because that’s just distracting and silly, because first of all, it’s not going to happen, we’re not going to get 100 overnight, and it could take some time anyway. But we will take that away and think about what, if anything, we can do to give you a little more substance around progress around Wisely, because it’s exciting and we’re happy about it, but it’s not--there are other parts of our disclosure that would give you more indications like the things we’ve been talking about - pays per control, new business bookings, all those things overall are bigger drivers of our results.
Eugene Sumuni: Got it, thank you very much, guys.
Operator: Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Thank you very much, and good morning. Most of my questions have been answered, but I wanted to talk just a little bit about, or ask about strategy. In the past, you’ve mentioned customer service capabilities being a differentiator related to SaaS players. How should we think about the persistence of differentiated service levels as your own AI capability grows in importance and we look at the future of self service initiatives may cause your own services and service levels to look more like traditional SaaS players? I guess I’m just wondering how we should be thinking about that strategically and what the implications are in the business. I recognize it probably fits well within a few of your most recent comments, like it takes a while to move the needle, but would love to get a sense of where you think you’re going in those areas.
Carlos Rodriguez: It’s a great question because we--that’s a topic that comes up not just among the management team, but also from the board, because we clearly see the opportunity there. Again, we have a couple of advantages coming out of the gate, like we obviously have a lot of data, so we have a lot of information that can be used to provide, I think, more automated, if you will, whether it’s AI, machine learning, whatever term you want to use for it. You have to have information to be able to then monetize that or turn it into a value-add for the clients, which then can be monetized. We spent a fair amount of time on that. We’ve actually recently appointed someone to be our chief data officer, who is kind of overseeing and owning all of our data and then how we can marshal those resources to create the kinds of advantages that you’re talking about, which are really advantages for our clients so that we can be able to hold onto them longer, sell them more things, etc. Everything from the simplest things, like chat bots to real true AI, I think are things that we have already deployed and I think are in the process of growing and scaling, if you will, to take advantage of, and I think some of those you’ve seen around press releases, and we talked about some of them on investor day, but clearly there’s a lot more opportunity in front of us that we’ve already done in that area. I would say that that’s a great question and a substantial opportunity for us, that to the previous point about disclosure, we have to find a better way of giving more guidance or more disclosure around how that’s going and how it’s being leveraged, because it’s going to be meaningful, I think, over the next five to 10 years for ADP.
James Faucette: That’s great, appreciate it Carlos.
Operator: We have time for one more question. That question comes from Jason Kupferberg with Bank of America. Your line is open.
Jason Kupferberg: Thanks guys. I just wanted to start with the EPS guidance for fiscal ’22 - I guess we’re going up 1% at the midpoint, so call it $0.06. Just breaking that down, it looks like the raise in the float income expectations is about $0.04 of that, and presumably the rest revenue outlook. I just wanted to see if that math is correct.
Carlos Rodriguez: That sounds pretty good. I think that the theme--whether that’s exactly right or not, the theme you should hear is--I mean, it’s maybe a bad thing to end the call with, but you should understand that the second--we are investing, and this is not the first time you’ve heard this from ADP. The opportunity in front of us is big, like our bookings are growing, the economy is growing robustly despite the noise in terms of the stock market and so forth. This is a really good environment for us, and so we are preparing ourselves, and you should expect that that is going to lead to long term improvement in, hopefully, our growth rates and in our margins and so forth. Just don’t get distracted by the short term noise, because I think if the implication is it doesn’t seem like we raised the rest of whatever profit by much, the answer is you’re probably right, but it’s all the things we’ve been talking about during the call, which is we’re making sure that we keep up with the market in terms of wage growth, but we have price levers that we haven’t necessarily hit yet because we’re not a panicky company. We’re not going to tomorrow do an unplanned price increase to our base, but we have times that are natural and normal where we will do that, but we’re not going to wait to take action on wages and hiring and so forth until we get there, because that doesn’t make sense. We’re not some schleppy little company that needs to panic, so we’re going to do the right things and if there’s a timing, missed timing by a quarter or two, so be it. We think it’s still pretty damn good. When you think about the inflationary pressures we have and the fact that we’re still able to deliver the results that we are delivering and able to grow the way we’re delivering, we’re pretty damn proud of it. But admittedly, we’re feeling more pressure on the expenses now than we definitely felt, call it 18 months ago, right? It’s the opposite, and this is what happens in, quote-unquote comparisons, and when, you quote-unquote lap things and all that stuff that you guys like to look at. The pandemic hit and our expenses went down because we were very careful and very frugal and very stingy in terms of hiring and so forth, and our revenues never came down as much as everyone thought and as we thought, and we now have to go back up and make sure that we’re staffed, and at the same time wages started to increase and we have to now factor that into the picture. But we’re feeling pretty damn good about our execution and how we’re doing, but that is the way the numbers add up, is the way you described it.
Jason Kupferberg: Okay, those are all good points. Just last one from me, I wanted to see if you could elaborate a little bit on the competitive landscape, just what you’re seeing down market, midmarket, enterprise-wide. Interested in just any changes in the mix or the aggressiveness of any competitors across the spectrum. Thank you.
Carlos Rodriguez: Again, because we compete in so many different segments, there’s not--I don’t think there’s a broad sweep--I mean, some of our competitors only compete with us in one segment, so it’s hard to make a sweeping statement other than I think it’s business as usual. That may not be very exciting, but I don’t see--I don’t know, Maria, if you see any--there’s been no--I mean, I think when we look at our balance of trade, we’re pretty happy about a couple of people that we’ve been more focused on recently than maybe before, which we’re now doing better than before on. But as usual, there’s others that are now gaining ground on us, but I’d say that the general environment is stable and--what is it, the rising tide lifts all boats? It feels like the industry overall has a lot of, I don’t know, growth opportunity and we’re all getting our fair share and trying to steal each other’s share, but it’s a good environment. I don’t know if you have any--?
Maria Black: I concur. I would echo the sentiment on the overall HCM space and the environment, and I don’t think anything has materially changed. But we certainly intend to continue to win our fair share and more.
Jason Kupferberg: Okay, I appreciate that. Thanks guys.
Operator: This concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Thank you. Just back to the general economic conditions and what’s happening in the market and so forth, which is not something that we focus on, on a day-to-day basis, but the some of the things--we did have a little bit of a discussion and some questions on capital allocation, structure and so forth, that I would just--I can’t help but I’m obsessed with the dividend, and I love how no one asked about the dividend. Nobody cares about the dividend, but we may be entering an environment where it might matter again, so maybe someday I’ll get a question about the dividend, because I think we’re in our 47th year of consecutive increases in a dividend, and I think if you go back 10 years and you look at what our cost basis of the stock was and what the dividend yield, given today’s dividend, is on that cost basis five, 10 years ago, 15 years ago, 20 years ago, this company is a money machine, and clearly capital gains are important too but the focus changes, obviously, as the market environment changes. Listen, I’m not wishing a downdraft in the market - it hurts us as much as it hurts anyone else, but I like where ADP is positioned competitively and I like where we’re positioned in terms of our balance sheet, our dividend, and the way we allocate capital. But the most important thing I’m proud of is our associates, because every quarter now as we get further away from--despite omicron and so forth, clearly we’re in a much better place than we were before. We would not be where we are today without our associates, and I mentioned how we were understaffed for sure in the early times of the pandemic, because we felt like we had to be careful on the expense side, and as we were being careful, the workloads were increasing because of all the government regulation issues that were intended to help - and they did, all of the stimulus, and this was across the whole world. That created a ton of work for our people, of which we had fewer people, and I’m incredibly grateful and will forever be indebted for people stepping up and doing whatever it took to get our clients and get us through that difficult period. I’m so glad that we’re able to deliver on all of our commitments, because we were, I think, one important factor besides the Amazon trucks still running and other parts of the economy still functioning. I think we played a role in helping the world economy, I think, get through the pandemic, and our associates deserve all the credit for the role they played. With that, I appreciate you listening to us, and we look forward to catching up with you again in the next quarter. Thank you.
Operator: This concludes today’s conference. You may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I’ll be your conference Operator. At this time, I would like to welcome everyone to ADP’s second quarter fiscal 2022 earnings call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. To withdraw your question, press the pound key. Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you Michelle and welcome everyone to ADP’s second quarter fiscal 2022 earnings call. Participating today are Carlos Rodriguez, our CEO, and Don McGuire, our CFO. Also joining us for Q&A is Maria Black, President of ADP. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures which we believe to be useful to investors and that excludes the impacts of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. With that, let me turn it over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you Dany, and thank you everyone for joining our call. We’re pleased to have delivered strong second quarter results, including 9% revenue growth, 20 basis points of adjusted EBIT margin expansion, and a 9% increase in adjusted diluted EPS, all ahead of our expectations. It remains a very dynamic and challenging business environment for our clients and prospects, but we believe the value of working with a trusted ACM partner with more than seven years of expertise is more compelling than ever, and we see evidence of this reflected in our continued sales momentum as well as our very high levels of client satisfaction and retention, which continue to drive upside to our results. As usual, let me start with some highlights from the quarter. Our employers services new business booking results were strong despite the onset of the omicron variant at the end of the quarter. We experienced a record Q2 booking level and like Q1, we were pleased to be ahead of pre-pandemic sales productivity levels. We experienced robust double-digit growth in nearly every one of our ES businesses, and as we saw earlier in the year, we experienced every stronger performance in our PEO segment, where demand is especially robust. As we outlined at our November investor day, the pandemic and the dynamic macroeconomic environment have made running HR more challenging for our clients. Today our clients navigate a tight labor market across their organizations, higher than usual worker turnover, new legislative requirements, and in many cases staffing challenges specifically within their payroll and HR departments. The strong broad-based demand across our ES and PEO segments reflect the fact that clients of all sizes are increasingly looking for greater levels of assistance and expertise to help address their needs, in some cases seeking our intuitive yet comprehensive software offerings while in other cases seeking a more fully outsourced solution. We believe we provide extraordinary value through all business environments, and today’s environment supports a continuation of a positive decades-long secular trend in global HCM. Moving onto employer services retention, we are pleased to have experienced continued strength. Although our retention in the quarter did decline very slightly versus last year’s elevated level, it declined by less than we had anticipated and would have represented a record Q2 if you were to exclude last year’s pandemic impacted retention levels. With overall client satisfaction once again reaching a record level this quarter, this strong retention is not surprising to us. Moreover, early January results look strong, giving us greater confidence for the rest of the year, and we are pleased to be raising our retention guidance once again. Our ES pays per control metric came in slightly better than expected at 6% growth in the quarter. We are very pleased to see the U.S. unemployment rate back below 4%, which reflects the U.S. economy’s ongoing improvement and resulting strong demand for workers. Meanwhile, labor force participation is gradually recovering and as it does, we should continue to benefit from higher than usual pays per control growth. Over the first half of the fiscal year, we’ve tracked ahead of our expectations and are now raising our pays per control outlook for the full year. In the second quarter, our PEO had stellar performance once again and was well ahead of our expectations with 15% revenue growth and 16% average worksite employee growth, representing acceleration from last quarter despite a slightly harder growth comparison. Across the board strength in our PEO continues to be driven by several factors, including better than expected retention and bookings contributing to client growth, better than expected hiring within the PEO client base, further adding to worksite employee growth, and better than expected wage levels further adding to revenue growth. While some of these tailwinds will normalize over time, we remain very confident in the outlook of our PEO business over the coming years. During our November investor day, we also outlined key aspects of our growth strategy by product and by business unit, and we are confident about sustaining healthy growth in our fast-growing businesses and optimistic about accelerating our growth in our businesses that continue to transition to our most modern offerings. One aspect of our growth strategy that we discussed is an overall greater focus on marketing, which we believe will allow us to better activate our existing scale distribution. We believe at ADP, we can deliver a lot of incremental value from tactical investments, and we look forward to sharing more in the very near future. One key product initiative we talked about during investor day that cuts across our businesses is the development of a new unified user experience, and in the second quarter we were pleased to have made further progress on this effort. As a reminder, we shared last quarter that we moved our Run client base over to the new ADP UX, and now only a quarter in, early indicators suggest that clients are in fact finding it more intuitive, resulting in fewer client service contacts. In Europe, we have been gradually transitioning our client base over to our award-winning IHCM platform, and in Q2 we seamlessly moved those clients over to the new ADP UX. We’re now very excited that just this month, we began our pilot of the new ADP user experience for Workforce Now, which when coupled with our next gen payroll engine makes for an even more differentiated offering for what is already a market-leading HCM solution in this target market. In terms of a few other highlights, I’m pleased to share that we reached a new milestone by running 1 million pay slips for a single client on a single day for the first time. At the other end of the spectrum, our Roll mobile app, which serves the micro segment, continues to outperform our initial expectations. In another milestone in calendar 2021, the ADP mobile app had over 1 billion log-ins, highlighting the growing amount of direct engagement we have with employees and managers around the world. To that point, this month our return to workplace mobile solution, part of the ADP mobile app, was awarded the Business Intelligence Group’s 2022 Big Innovation Award. As a final highlight, just this week we launched our bill pay feature in the Wisely app. Bill pay is free to Wisely users and fully integrated into the app, and has been a top requested feature from our user base. We believe this addition will further drive engagement and retention, and we look forward to continuing to expand the Wisely ecosystem. Overall, Q2 represented a solid outcome on both the financial front as well as with respect to key strategic initiatives. I’d like to thank our associates who continue to deliver these exceptional products and outstanding service to our clients, and I’ll now turn the call over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you Carlos, and good morning everyone. In the second quarter, we delivered 9% revenue growth on both a reported and organic constant currency basis. Our adjusted EBIT margin was up 20 basis points, better than planned, and supported by our better than expected revenue growth, offset partially by increased PEO pass-throughs and headcount growth in our implementation and service organizations. I’ll share more on this last point when I discuss our outlook. Our tax rate was up slightly in the quarter versus last year, driven by the lapping of a one-time international tax benefit we experienced last year. When including the benefit from share repurchases, we had a 9% increase in our adjusted diluted earnings per share. Moving onto the segments, our employer services revenue increased 6% on a reported basis and 7% on an organic constant currency basis. In addition to the strong bookings, retention trends, and pays per control performance Carlos outlined, our client funds interest grew for the first time since the pandemic started as lower average yield was offset by a tremendous 28% balance growth. This growth included some benefit from the lapping of last year’s deferred employer social security taxes and incremental benefit from the repayment of a portion of those employers’ social security taxes, which together contributed several points of growth in addition to the already robust growth from higher client count, employment growth, and higher wages. Our ES margin increased 40 basis points, ahead of our expectations for the quarter and supported by better than expected revenue performance. Moving on, our PEO continued to deliver exceptional performance with 15% revenue growth in the quarter. Average worksite employees accelerated to 16% year-over-year growth and reached 660,000 for the quarter. Key contributors were strong bookings and retention, as well as very healthy pays per control growth within the PEO client base. Revenues excluding zero-margin pass-throughs grew 18%, which was driven by worksite employee growth as well as higher average wages and higher SUI revenues per worksite employee. PEO margin was down 10 basis points in the quarter. Included in that figure was pressure from workers’ comp and SUI expenses due primarily to worker mix and wages. Moving on to our updated outlook for the year, for ES revenues we are narrowing our guidance and now expect growth of about 6%, the upper end of our previous guidance range of 5% to 6%. The primary drivers for our higher outlook are the stronger Q2 performance, our higher client funds interest outlook for the year, and higher pays per control growth, partially offset by an expectation from incremental FX headwind in the back half of this year on the recent strengthening of the U.S. dollar. For our client funds interest revenue, we’re raising our outlook by $20 million to a range of $440 million to $450 million. Like last quarter, we’re raising our balance growth assumption meaningfully to now expect growth of 18% to 20%, whereas our client funds yield expectation is unchanged despite the improvement in interest rates. This is primarily because our stronger than previously expected balance performance creates a temporary lag with greater short term investments before we purchase higher yielding fixed rate securities. For U.S. pays per control, we’re raising our outlook by 1% to now expect 5% to 6% growth. We continue to expect that a gradual ongoing recovery in labor force participation will support job growth, and the first half of the year was a bit ahead of expectations. In addition to client funds and pays per control, we are raising our retention guidance slightly and now expect it to be down 40 basis points for the year. Although we still anticipate some normalization in client switching activity, trends so far this year have been very positive, and January is looking like a continuation of that same strength. One thing we’re not changing at this time is our ES booking guidance. As Carlos outlined, our Q2 performance was strong, but bookings is one place where the evolving pandemic conditions and the omicron variant has potential to create noise, as we saw at the outset of the pandemic. Although we haven’t seen a material impact at this time, we still think it’s prudent to maintain a wide range of outcomes in our guidance. For our ES margin, we are making no change to our outlook of up 75 to 100 basis points. Although we are raising our revenue guidance and although some of that is coming from high margin revenues, like client funds interest and pays per control, at the same time we are now more fully caught up on implementation and service headcount after running a bit behind earlier this year and late last year. This investment in implementation and service teams is critical both because the current year-end period is important to our clients and their employees, and also as we look to get ahead of the needs of our growing client base. With the continued outperformance in retention, we’re now planning to grow our implementation and service teams slightly more than we had previously planned as we exit this fiscal year. In addition to this growth in personnel, we also took one-time compensation actions across our organization in recognition of broader inflation trends in the market. The incremental expenses associated with those actions are now included in our outlook. Although this tight labor market has created its own set of challenges for most companies, we are very pleased to have been able to grow our organization as much as we did these past few months, and the wage increases we layered in give us confidence regarding our staffing levels at a busy time of year. We are also pleased to have been able to support those changes without detriment to our existing guidance ranges. Moving onto the PEO, following the strong first half trends in both client growth and worksite employee growth, we are now expecting average worksite employees to grow 13% to 15%, and we are likewise raising our guidance for PEO revenues and revenues excluding zero-margin pass-throughs by two percentage points each. Our outlook will continue to be sensitive to employment trends within our PEO client base, as well as bookings and retention performance, so although we are currently contemplating growth to be a bit lower in the back half of the year, we could continue to see upside if the current robust trends persist. For PEO margin, we are making no change to our guidance of flat to down 50 basis points for the year. Although we are raising our revenue guidance, we are at the same time expecting higher SUI and workers’ comp expenses to create offsetting margin pressure. Putting it all together for our consolidated outlook, we now expect revenue to grow 8% to 9%. For adjusted EBIT margin, we continue to expect an increase of 50 to 75 basis points. As we shared earlier this year, we expect our margin improvement to be concentrated in the fourth quarter and expect our margin to be down in Q3, particularly following the recent personnel growth and wage increases. We’re making no change to our tax rate assumption. With these changes, we now expect growth in adjusted diluted earnings per share of 12% to 14%. Thank you, and I’ll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"text": "Our first question comes from Bryan Keane with DB. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi guys, congrats on the results. Just wanted to ask on the impact of omicron, especially in December and January. Is there any noticeable impact in sales or retention, or anything that you’d call out particularly from the rise that we’ve seen from the virus and omicron?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think you heard from our prepared comments that the answer was no, but when you think about the way the quarter works, the omicron really started to pick up in, I would say, middle to last December in terms of my recollection. It’s really incredible how fast things have changed with this, because now we’re back on the down slope in the northeast, it appears at least, in the U.S., so it’s pretty fast moving. But I would say that our answer is no, we didn’t see anything in the quarter that we just reported. Obviously we’re now in the next quarter and it’s kind of difficult to start talking about the next quarter, given we’re only, I think, three weeks into it, but you’ve seen probably multiple reports--I saw one this morning in the Journal about, I think it was the IMF or someone kind of lowering global growth and so forth, and some of it is obviously a result of omicron, there’s probably other factors as well. We do believe that we’re not immune from these kinds of things that ripple through the economy, including omicron, but the truth is we haven’t really seen a big impact yet. But if GDP growth--I think the GDP growth for the full calendar year, most people have kind of kept it in the same range, so I’m guessing that people have lowered their first quarter - talking about calendar quarters now - GDP growth forecasts slightly and probably increased, because I think it’s just a matter of pushing activity forward, because it does look like in a few weeks, things will start to, quote-unquote, normalize in at least a portion of the country, and then I think shortly thereafter economic activity should be robust again, as was, I think, predicted by a bunch of economists. So anyway, that’s a long way of saying not really, not yet, but we’re always careful to not assume that we are somehow insulated completely from what happens in the overall economy. If people are traveling a little bit less, for example our own associate population, we proactively asked--we were already back in the process of getting people back into our offices, and we went back in the other direction for about a month or two. That just lowers economic activity - people aren’t driving as much, they’re not going to lunch in a local area, etc., and those things have a ripple effect through the economy, but no signs of any major decrease in demand or economic activity from our numbers yet."
},
{
"speaker": "Bryan Keane",
"text": "Got it, that’s helpful. Just as a follow-up, wanted to ask about the strength in the balance growth - I think it was up 22% last quarter, up 28% this quarter. I don’t know if you guys look at how much inflation could be driving that number as well, and any other call-outs--I know you raised the guide there, but just surprised at the strength there."
},
{
"speaker": "Don McGuire",
"text": "Yes, we have had some growth. Certainly wages were a little bit of that, but also as we said in the prepared remarks, the big driver was the lapping from last year with the deferral, so certainly the deferrals represented a few points in the growth of those balances in the quarter, although even the deferrals were only for a few number of days towards the end of the month of December. Certainly we look at those, but as we said, we do expect the balance growth to continue and we expect it to be firm based on the pays per control and the increase in number of people working for our clients. I think that’s the biggest driver."
},
{
"speaker": "Carlos Rodriguez",
"text": "And just in terms of a refresher, by deferrals, I think Don said in his remarks, there’s a social security tax deferral. Not everyone lives day to day like us, but it was a significant stimulus--part of the stimulus package, if you will, and those social security deferrals need to be repaid half--we just went through that, which is what helped us in terms of tailwind on balances, and the other half is next December 31. That’s something maybe to pencil in which would provide some support to our balances next year as well."
},
{
"speaker": "Bryan Keane",
"text": "Okay, thanks for taking the questions."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Togut with Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you, good morning. Could you unpack demand trends, looking at Run, Workforce Now, and Vantage HCM in the quarter and what’s embedded in your 12% to 16% ES bookings growth outlook? As a follow-up, if you could comment on your recent announcement that you’re expanding Workforce Now with international functionality, what sort of traction do you expect to see there? Thanks."
},
{
"speaker": "Maria Black",
"text": "Yes, good morning, this is Maria. Thanks for the question, David, happy to comment on both. With respect to the overall performance in the quarter, as was stated in the prepared remarks, we had strong double-digit growth that did really go across our scaled offerings, specifically in the down market. We saw the strength in our Run platform, we saw the strength in our retirement solutions, definitely experienced strength in the Workforce Now platform. I’ll cover off on your second question as well as we get to the press release that we just issued. Additionally in the second quarter, we also saw strength in GlobalView, so very happy with our international contribution to the quarter, so that was really the strength across the double-digit growth that we saw in employer services. As it relates to the Workforce Now press release that I think we issued in the last couple days regarding the offer that now is on a global basis, the ability for our U.S.-based and Canadian-based companies to process payroll on the Workforce Now platform across multiple countries, in partnership with our Celergo offering. Very excited to have this offering, as you could imagine. Over the course of the last decade but certainly in the last couple years, the ability for mid-market customers to really be able to support international employees on their end is a growing demand, and we’re pretty excited to be able to satisfy that demand with this new offer."
},
{
"speaker": "David Togut",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great, thanks so much. Carlos, I think you talked about improvement in retention against a still challenging environment overall. Can you maybe reconcile those comments a little bit because, all things equal, I would think tougher environment, maybe you have a little bit more pressure from a client perspective. Can you unpack that a little bit?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think what we’ve been saying for probably a few quarters now, it’s really not--maybe the tougher environment isn’t the right term. It’s tougher comparisons, because our thesis was that we’d gotten some tailwind from the pandemic--there were a lot of tailwinds in a lot of areas, but one of them was in retention. There’s less clients switching, and on top of that, there was also lower bankruptcy rates in down market, where it’s a significant portion of the turnover of our clients is, quote-unquote, out of business, so all the government stimulus and all the low switching, I think really elevated our retention. At the same time, our NPS scores and client satisfaction and all the feedback we’re getting from clients was very, very strong, so frankly it’s difficult to separate the two, so we planned for some moderation in our retention as a result of those tailwinds because those tailwinds are going to go away. I think they’re economically driven, and we’ve seen a little bit of that in our down market. I think we’ve also kind of alluded to that, that despite our continuing strong retention, it’s kind of generally playing out the way we expected, which is our down market SBS is a little--is down a little bit over the previous year, but other parts obviously are holding up well, if not improving, and the net of that is better than we expected and better than we had planned. The question is, are we going to be able to hold onto all of it? Our plan of course is to hold onto all of it, and that is why you saw in Don’s comments that we’re making sure we have the right levels of service, the right levels of implementation, because if we can achieve the forecast we have for retention for the year, which will be ahead of what our plan and our expectations were, that has a meaningful impact on our long term growth and value creation for the company."
},
{
"speaker": "Kevin McVeigh",
"text": "That’s very helpful. Then I don’t know if this would be Carlos or Don, but could you remind us the rate sensitivity, 25 basis points, what that means? Then I guess I was surprised to see the boost in the extended investment strategy, just given I thought there was a little bit more of a lag effect on that, so maybe just--because obviously it’s been so long, we’ve been in front of a rate cycle, but just the dynamics of client funds relative to extended investment."
},
{
"speaker": "Don McGuire",
"text": "Yes, why don’t I start with the second question first on the rate environment and what that means for us. Generally speaking, as you know, when the fund balances increase rapidly, we have to invest in short term items or short term instruments until we have the opportunity to invest in longer term instruments, and as a result, we don’t see as much pick-up as we would like to see. But I can certainly give you some sensitivity with respect to if we had a 25 basis point improvement in the rates in our short term investments only, that would translate into about $9 million of EBIT on a 12-month basis, so not hugely significant. On the other hand, if we saw that both in the short and the intermediate term, that 25 basis points over a 12-month period would translate into about $23 million of impact before taxes, so certainly that becomes meaningful. As we look to invest those funds longer term and as rates continue to go in what we’d say--I guess what we’d say is a better direction, I think we have some opportunity in the future; but at this point in time, we think that we’re not going to see a huge amount of improvement in the client fund interest over the balance of the second half. What we have talked about is in the forecast today."
},
{
"speaker": "Carlos Rodriguez",
"text": "Kevin, could you clarify the question on the extended portion, where specifically you’re focused there?"
},
{
"speaker": "Kevin McVeigh",
"text": "I guess just the dynamics of the client funds interest revenue versus the extended investment strategy, what the timing difference is on those two in terms of when you’d see it, because obviously you saw a little bit of benefit from extended investment in term of the outlook, not as much on the client fund side, but is there a timing element to the extended versus the client funds."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, if you’re talking about balance growth, the extended strategy balance growth is actually tied more to the volatility of cash flows on a year-to-year basis, so it has to do with our forecast of what our low balance is going to be in the year versus our average balance, which is a little bit different from the client funds forecast. Long term, yes, the extended balance would grow kind of in line with the client funds balance growth, but on a short term, year-to-year basis, there’s a whole more noise. That is actually driving the difference more so than the lag effect. The lag effect that Don was referring to has more to do with the growth in the client funds balances. When the growth is particularly high, it’s often hard for us to reinvest quickly given the number of opportunities there are in the market and so forth for the type of credit quality that we’re seeking, but we within a couple quarters can catch up, so it’s just a question of how quickly we can deploy those additional funds. I think the short answer is the net impact from our strategy, because there’s also a re-classing issue in terms of how we do it, in terms of accounting and so forth, so I think the right way to look at it is really what’s happening with yields, what’s happening with--overall, what’s happening with balance growth, and then what’s the net impact of our strategy, of our client fund strategy. I think on that front, the short answer is it’s looking pretty good. Just as an example, our Q1 re-investments were at about a 1% yield, so new purchases, and in Q2 they were 1.5%, so it’s been--you see the same thing we’ve seen. The moves in the two-years and the five-years are even more significant than the 10-years and so forth, so for us it’s the--you know, when we talk long, our version of long is three, five, seven, not beyond that, just because of the way we invest our portfolio, and on that front, you could not have a better environment in terms of wage inflation, balance growth and increases in interest rates. I would say we’re not ready to say anything yet about ’23 and ’24, but all this--there’s a lot of talk about mechanics in the short term or whatnot, because I know a lot of people are focused on the short term, but we’re more long term oriented and we could be in here for a multi-year tailwind finally from client funds interest in a meaningful way."
},
{
"speaker": "Kevin McVeigh",
"text": "You’re going to have a high class margin problem, Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, listen - I’ve been waiting 10 years. I had hair when I started as CEO, and I remember telling the treasurer at the time, rates have to go up next year, and then next year I said rates have to go up next year, and here we are. But this time, dammit, I’m right!"
},
{
"speaker": "Kevin McVeigh",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tien-tsin Huang with JP Morgan. Your line is open."
},
{
"speaker": "Tien-tsin Huang",
"text": "Thanks so much guys, good morning. Really good results, better base control, looking at better retention, in-line bookings, raising balance growth, and all that good stuff. I think of all of these as positive forces for margin expansion, right, so you’re keeping the margin the same, so is that just a function of the costs you discussed, or is that some conservatism as well? Just trying to better understand that."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well if the question is about conservatism, I’ll let Don handle it."
},
{
"speaker": "Tien-tsin Huang",
"text": "Thank you. Thank you Carlos."
},
{
"speaker": "Don McGuire",
"text": "Yes, so I think the answer is that we have got a pretty reasonable forecast in front of us, so I think we’re not being terribly conservative. But I think what you should consider, though, is that we raised our revenue by $150 million from the prior--from the prior forecast, and we’ve also raised our expenses by $115 million. If you start to break down those expenses, that $115 million of expense increase, you come pretty quickly to PEO pass-throughs - we had $48 million of that, so $48 million of that expense increase is really having a bit of a drag on our margins. Otherwise, I think our margins clearly would be better, but that’s really what’s preventing us, and that’s the reason we haven’t been able to do more on the margins. But I do think that all in, we’ve done a really good job of baking things into our guidance and firming up the expectations we set."
},
{
"speaker": "Tien-tsin Huang",
"text": "No, for sure. It’s very good."
},
{
"speaker": "Carlos Rodriguez",
"text": "Just one other thing, I think we should also add to your point in terms of tone, we want to make sure we’re clear here that we’re not insulated from the world. There is no question that there is pressure on costs, particularly around wages, and we are a technology services company so we have costs around R&D and so forth. We also have costs around the service side of our business, and you’ve heard in the prepared comments that Don mentioned that we’ve taken some actions that are what I’d call mid-cycle, so not the typical annual wage increases, because we felt we needed to do something to make sure that we held onto our people and that we were attracting the right kinds of people, so we are doing some things. Now, the good news on the other side of that coin, which I’m assuming will come up later as a question but may as well address it now, like some other industries but not every other industry, we do have a fair amount of, and the industry has shown, demonstrated historically and, I think, there are some recent signs from competitors that pricing is more elastic than in many industries. This is not a commodity business, and there’s a fair amount of room. The problem is you have to exercise that room very carefully because you want to remain competitive, and on and on and on. You’ve heard that story from us for many years too, that we really want to win in the market, we want higher retention rates, so we can’t just go around willy-nilly passing through price increases, but the fact is we can and we will if it’s driven by market forces and cost increases that are experienced across the board. We’re confident that our competitors will do the same thing, and some of them already are."
},
{
"speaker": "Tien-tsin Huang",
"text": "You answered my follow-up on pricing. Thank you Carlos. Thank you Don."
},
{
"speaker": "Operator",
"text": "Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning. Thanks for taking my questions. I wanted to maybe circle back to the PEO business and the strength there, it continues to perform really well. I was curious, can you remind us, when we think about the source of new bookings for PEO, how much of it is new to ADP for the first time versus conversions of potential existing customers in the SMB side of the base that you’re up-selling over to PEO? How should we think about the source of new bookings?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think it’s been pretty consistent for a long time at around 50%, right?"
},
{
"speaker": "Maria Black",
"text": "That’s right."
},
{
"speaker": "Carlos Rodriguez",
"text": "It’s about half, that we kind of mine our own. It’s a combination of mining our own clients, but we also mine our own sales force. Our sales force is able to bring in obviously new clients straight onto the PEO, but we also have a very large installed base that, as you alluded to, we mine. I think it’s 50/50, if I’m not mistaken. It hasn’t really changed that much over the years."
},
{
"speaker": "Samad Samana",
"text": "Great, that’s helpful. Then as I think about the consolidation of the base onto one UI, there’s clear user benefits to that, but how should we think about maybe--is there a tailwind to that on the gross margin side as more and more of the base is on a single UI from, I guess, a service or a maintenance standpoint in terms of spend going forward, and how should we think about that unfolding on the gross margin line?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think that’s a fair point - there’s a lot of things that we do that are intended to really, quote-unquote, standardize and to be able to get leverage, and this is clearly one of those where--you know, ADP historically was a little bit more fragmented in terms of our R&D, and we’ve been, starting with my predecessor, I think trying to become more unified, etc., and the user experience is one of those places where there was an obvious opportunity that I think will make us better competitively and allow us to invest our money more efficiently, and there clearly is some back end benefit to that from a margin standpoint. But I would say I’d be--I don’t think it would be true to say that that was the primary driver. There’s got to be some residual help from a margin standpoint and from an efficiency standpoint, but this is really about winning, about having the best products and having the best face to the market in terms of our--the best skin, if you will, on each of our products. It makes a difference, as you know. We get it, we’re a technology company now, and it matters a lot the experience that our--and it’s not just our clients. It used to be 20, 30 years ago, it was only the clients. Now the employees of our clients are obviously touching and interacting with our products, especially with the mobile app, and this user experience stuff matters a lot in terms of engagement."
},
{
"speaker": "Samad Samana",
"text": "Great, helpful. Congratulations on the solid results."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning, thank you. First, I want to follow up on retention. Can you dig in a little bit more about the underlying drivers, so out of business closures versus competitive switching behaviors? When you think about the 40 basis point year-over-year decline you forecasted, how much is due to a pick-up in that closure rate versus competitive losses?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Almost all of it is in the down market and related to normalization of economic factors, like closure rates. I don’t know that closure rate is the right word, but that’s one of the--that’s in that category, what we call--we track uncontrollable losses and controllable losses. Controllable losses would be around service and product, etc.; uncontrollable is the obvious, like bankruptcies, out of business, etc. What happened during the pandemic, it wasn’t just that bankruptcies went down. All the categories of uncontrollable losses went down, and there has been some normalization of that, not all the way back to pre-pandemic, but I would say that there’s really nothing that you could read into the numbers to tell you anything other than we have fantastic service, solid NPS scores, but there is some normalization in categories, specifically more down market. Everywhere else, I think our retention rates are good to improving and solid, and in many cases better than prior years. We have less tolerance in those other businesses because they’re not as economically sensitive, so we have less tolerance for the excuse that there’s going to be normalization there, because we now have a taste of what’s possible in retention in the mid-market and in international and in--although international has been strong all along and in the up-market, and we just want to maintain those retention levels. But it would be foolish in the down market to assume that there won’t be some economic factors and normalization - that’s what you see reflected in our forecast."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, makes sense. Then just on the PEO strength, so the sequential increase in worksite employees was really notable here. Can you just dig in a little bit more? I heard better units, so better retention, better bookings, but does seem like there’s been a release or a tipping point here around clients converting to this model. Can you just talk about that?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think that--we’re thrilled, just to be clear, but let me just give you a few, back to these comparisons in the pandemic and noise. Part of our headwind in the PEO sales, which by the way we’re positive and we’re good, but not as good as ES last year. I think we shared a little bit of color there that the average client size sold had come down a little bit, wages weren’t growing that much, so all of those things have an impact more on the PEO than they do in ES, particularly in some of the ES units. Those things have all turned in the other direction now, so the average size client is bigger in terms of clients sold, and that is meaningful, and then you have wage growth which flows through the PEO. It doesn’t flow through ES because the billing is not as a percent of wages, whereas in the PEO it is, and so we do have a number of tailwinds that are also helping. But the most important thing, which is maybe what you’re alluding to, is the average worksite employee growth, which kind of cuts through the inflation and the wage growth and all that, and that’s also robust but that’s getting assistance, like I just mentioned, from average size client being a little bit bigger in terms of new business bookings. Again, that’s great news, but it’s a little bit of a normalization because it’s actually back now, so it went down from where it was pre-pandemic, and now it’s back up about to where it was pre-pandemic, and hopefully, you know, you get 1% to 2% growth going forward, but right now it’s more than just 1% to 2% growth."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi there, thanks for taking my question today. I wanted to ask you about your HCM products and the cross-sell opportunity into your base of payroll customers, sort of an update in terms of where you are there and whether you could potentially accelerate that process."
},
{
"speaker": "Maria Black",
"text": "Yes, so happy to comment on our HCM products and how our sellers go to market to drive the combination of new business bookings between new logos as well as add-on business, our HCM products from an attached perspective. As you can imagine, a lot of the investments that we’ve spoken about for several years in existing products, a lot of the investments that we’re making into our existing platforms - we just talked about the new UF and the impact that’s making in our down market and will continue to make, coupled with the investments that we’re making into our next gen products, are all investments that are anchored in a belief that we can continue to expand the offerings to our existing clients as well as new clients. Excited about the execution on each one of these initiatives and the impact that it will make to our bookings and the mix of bookings between new logos and HCM products attached."
},
{
"speaker": "Carlos Rodriguez",
"text": "Our attach rates in general are pretty good, particularly in some categories like--we said this before, like our workforce management, we used to call it time and labor, those products tend to have high attach rates, and others have high attach rates, others have low attach rates. I think part of our opportunity for whatever the years to come is to not only sell new logos, which we’re now obsessed about because we want to grow market share, but share of wallet is a huge opportunity for us. The fact is, we have very low-ish penetration still in many of our categories and many of our products."
},
{
"speaker": "Ramsey El-Assal",
"text": "Interesting, okay. Thank you for that. A follow-up for me is on M&A and balance sheet deployment here. Obviously a lot of the valuation multiples in the sector have pulled in quite a bit. I don’t know if the environment has created a situation where maybe you had a shopping list, a dream shopping list that maybe now you can go after that you couldn’t before. But maybe an update on whether--you know, on your capital allocation and specifically as it relates to M&A plans would be helpful."
},
{
"speaker": "Don McGuire",
"text": "Yes, I think that there’s always things flowing across everybody’s desk and evaluations being done of opportunities, etc. While it’s true that the last few weeks haven’t been kind to some companies, I don’t we’ve really changed our objectives, and our objective is to make sure that anything that we seriously consider and we pursue has to fit the portfolio, so whether it’s--it just has to be either a geography extension of what we currently have or it has to be something that’s filling a product niche, and so we’re going to continue to work by those guidelines, if you will. If things become more affordable and something falls into those categories, certainly we’ll take the opportunity to look more seriously or to look a bit harder than we might have, say, three or four months ago. I don’t know, Carlos, if you want to expand on that?"
},
{
"speaker": "Carlos Rodriguez",
"text": "No, all I was thinking was that in some cases, if people pay us, we’ll buy their companies."
},
{
"speaker": "Ramsey El-Assal",
"text": "All right, fantastic. I appreciate it. Thanks so much."
},
{
"speaker": "Carlos Rodriguez",
"text": "And then we can clean them up."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning everybody, and congratulations on the quarter. I was wondering, could you give us a couple of updates with regards to some of the products? In terms of next generation pay, to what extent has that been further rolled out? What’s the update there?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I would say we had a really good, I think, first--I would call it year end, because when you get to the midmarket, which is next gen pay, as you know right now is really being sold in a portion of what we call the core part of the midmarket, so call it 50 to 150, and I think we’re at--we’re selling somewhere between 20%, 25% of our clients, of our new businesses coming in on the new platform, and we expect to be GA, I think it’s end of calendar--"
},
{
"speaker": "Maria Black",
"text": "This calendar year, that’s right."
},
{
"speaker": "Carlos Rodriguez",
"text": "End of calendar year, so that’s kind of what we talked about at investor day. I would say that, call it December-January sales season, because a lot of those clients, they want to start clean on January 1, so it’s a fairly important point of the year in terms of judging where you are in terms of sales results and so forth, and we had a fairly good, I think, number of starts. We were happy, I would say, with the early January, late December, what I would starts results - in other words, those are clients that we sold previously, that we got started and we have up and running. We try and avoid getting into specifics of how many clients, because then every quarter you guys are going to ask us, but I’d say that that’s going really well and we’re on track for this GA by the end of the calendar quarter, and then we had a good start season for end of December, beginning of January."
},
{
"speaker": "Mark Marcon",
"text": "That’s great. Then it sounds like--you know, one of the early comments that you gave, Carlos, was highlighting just the breadth, talking about how Roll is doing on the low end and then also mentioning that at one client, you had a million transactions in a single day, which is obviously impressive. Can you just give us a sense for in terms of Roll, how much is that--now that you’ve had some experience with it, how much more excited are you about that possibility and penetrating that micro part of the market? Then on the flipside, with the capabilities of being able to service companies globally and at huge scale, how does that expand the top end of the market?"
},
{
"speaker": "Carlos Rodriguez",
"text": "As you know, we’re a little bit different than most in the sense that we’re 100% all-in on HCM, and we cut across multiple segments and also geography, so that makes us a little bit unique, so you have to get excited within segment because--like, Roll is really exciting and we’re excited about that opportunity, but that is in that micro segment because if you take the other extreme example of that other client, like when we process a million--that client obviously has a million employees, and we processed their payroll and we processed a million paychecks on one day. That’s a lot of small Roll clients to make up for that. They’re excited about that, but Roll is excited about its role in the growth of ADP and in the marketplace in terms of our ability to compete and to create opportunities for us. It’s a little hard to compare. I guess it’s like when you have multiple children, you have to love them all and they’re all good looking and smart and so forth, and I think that’s the way I feel about Roll in the down market versus the up market versus GlobalView. They really are all, I think, performing quite well now, and I think we’re excited about the opportunity in each of those market segments. I’m trying not to give you a non-answer answer, but I think--I’m trying my hardest to give you something concrete, but it’s exciting because these are all--I mean, the growth rate, Dany won’t allow me to say it because as we were preparing for the call, if we were a start-up, we would be quoting growth rates for Roll that would make your eyes roll, but Dany won’t let me say it because it’s really, frankly, insignificant to a $15 billion company today, but it won’t be insignificant in five or 10 years."
},
{
"speaker": "Mark Marcon",
"text": "I guess that’s what I was getting at, was on the--for example, in terms of Roll, when you first introduced it, you talked about it in a more modest manner, but it sounds like it’s getting really good traction, so I was just wondering if there was some way to capture how you’re thinking about how big that could eventually be."
},
{
"speaker": "Carlos Rodriguez",
"text": "It’s definitely getting good traction. We’re definitely excited about it, but again you shouldn’t over--I’m not trying to over-play it because we have a very large organization, and you guys need to think about how all the pieces fit together, so that it fits into our forecast. Just from a dollar impact, I hate to go back to that, that product and that segment competes against certain competitors. We feel pretty good about what we’re going to be able to do there in terms of market share and growth, etc., but you should not be thinking about this as something that’s going to move ADP’s growth rate by one to two percentage points on the top line in the next year or two. That’s just not the way the math works. I wish it did. All of these things have to work together - next gen payroll, next gen HCM, Roll, GlobalView, Celergo. There are a lot of things - PEO - that have to come together for us to get to the numbers, and we like that. We’re, I think, a portfolio that, as you’ve seen, we manage pretty effectively, and the combination of all of those businesses having good success, some more than others at times, I think leads to the results that we are reporting and forecasting."
},
{
"speaker": "Mark Marcon",
"text": "Appreciate that, thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Eugene Simuni with MoffetNathanson. Your line is open."
},
{
"speaker": "Eugene Sumuni",
"text": "Thank you, good morning. Congrats on another strong quarter, guys. Wanted to ask about Wisely and your general personal finance product strategy. You highlighted the bill pay offering in your prepared remarks. Can you just remind us what are the next big milestones for this overall strategy, and I know it’s a small part of your portfolio, but will you at some point maybe start providing some metrics that can help us track the growth of this area like some businesses like that provide, such as number of cardholders, frequency of transactions, the amount spent, and so on? Thank you."
},
{
"speaker": "Maria Black",
"text": "Yes, so happy to comment on the overall Wisely product strategy and where we’re heading with the opportunity - it’s incredibly exciting for us, and then we can talk through what those metrics could be to give some solid basis of growth over time. As it relates to the overall MyWisely app and the strategy we have within the Wisely portfolio, it is really a strategy that is anchored in financial management. That financial management in the app happens through education, budgeting, savings tools, rewards. What you heard today, which you just mentioned as well, which is the launch of our bill pay feature, we believe is significant. It’s exactly what we all probably use with respect to any type of an online bill pay, where you can scan the check and actually facilitate end-to-end bill processing through a mobile device, so that is all part of the MyWisely app and the overall financial management strategy - think financial wellness, etc. that we’ve employed. In addition to that, the other thing that’s forthcoming is the launch of our early wage access, our EWA as we refer to it, which is really that ability for our clients’ employees or employees to gain access to wages that they’ve earned as they earn them, so this is also a big piece to the overall equation with respect to the overall Wisely. Things that we’re monitoring actively right now, back to the question around how many cardholders, etc., certainly we’re looking at that. We’re looking at other types of what type of cardholders are using what feature functionality. There is some data that you could look at as it relates to how many reviews we have on the app, the quality of the app certainly supersedes some of the competition in the space. We’re pretty proud of the impact that our financial wellness tool, MyWisely app is creating in the market. I’ll let Dany or Carlos comment on cardholder tracking and when and if we’ll disclose that."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, I think we’ll--I mean, that’s a takeaway for us. We’ll see if there’s something else that we--I mean, we’re always open to suggestions and trying to be open-minded about disclosure, but again, this is not the same as the conversation about Roll, but as excited as we are about Wisely, we’re equally excited about things like Roll, and Wisely is much bigger than Roll. But again, relative--I hate to be a broken record, relative to the size of ADP, it wouldn’t be at the top of the list of the things that are going to drive the overall results, because again, a portfolio of so many different things that have to go right and that we have to get right in order to get growth on $15 billion. I think that business is probably--I’m trying to do the math in my head, it’s like 2%, 3% or smaller in terms of total--actually smaller than that, even, in terms of revenue. By the way, we want that, and it is growing faster than the line average. All the things you’re asking about are relevant, and those things would all help the overall growth rate of ADP, but it would be misleading--because I think others might have done that, where they make a bigger deal out of it than it really is, and maybe relative to their companies it is a big deal. Relative to us, we have lots of other things that we have to do and that have to go right, and us trying to pretend that--you know, if we tell you this is how much we get per card and then we start giving you math that if 100% of our clients got on the card, this is how much money we would have - I mean, we don’t need to do that, because that’s just distracting and silly, because first of all, it’s not going to happen, we’re not going to get 100 overnight, and it could take some time anyway. But we will take that away and think about what, if anything, we can do to give you a little more substance around progress around Wisely, because it’s exciting and we’re happy about it, but it’s not--there are other parts of our disclosure that would give you more indications like the things we’ve been talking about - pays per control, new business bookings, all those things overall are bigger drivers of our results."
},
{
"speaker": "Eugene Sumuni",
"text": "Got it, thank you very much, guys."
},
{
"speaker": "Operator",
"text": "Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Thank you very much, and good morning. Most of my questions have been answered, but I wanted to talk just a little bit about, or ask about strategy. In the past, you’ve mentioned customer service capabilities being a differentiator related to SaaS players. How should we think about the persistence of differentiated service levels as your own AI capability grows in importance and we look at the future of self service initiatives may cause your own services and service levels to look more like traditional SaaS players? I guess I’m just wondering how we should be thinking about that strategically and what the implications are in the business. I recognize it probably fits well within a few of your most recent comments, like it takes a while to move the needle, but would love to get a sense of where you think you’re going in those areas."
},
{
"speaker": "Carlos Rodriguez",
"text": "It’s a great question because we--that’s a topic that comes up not just among the management team, but also from the board, because we clearly see the opportunity there. Again, we have a couple of advantages coming out of the gate, like we obviously have a lot of data, so we have a lot of information that can be used to provide, I think, more automated, if you will, whether it’s AI, machine learning, whatever term you want to use for it. You have to have information to be able to then monetize that or turn it into a value-add for the clients, which then can be monetized. We spent a fair amount of time on that. We’ve actually recently appointed someone to be our chief data officer, who is kind of overseeing and owning all of our data and then how we can marshal those resources to create the kinds of advantages that you’re talking about, which are really advantages for our clients so that we can be able to hold onto them longer, sell them more things, etc. Everything from the simplest things, like chat bots to real true AI, I think are things that we have already deployed and I think are in the process of growing and scaling, if you will, to take advantage of, and I think some of those you’ve seen around press releases, and we talked about some of them on investor day, but clearly there’s a lot more opportunity in front of us that we’ve already done in that area. I would say that that’s a great question and a substantial opportunity for us, that to the previous point about disclosure, we have to find a better way of giving more guidance or more disclosure around how that’s going and how it’s being leveraged, because it’s going to be meaningful, I think, over the next five to 10 years for ADP."
},
{
"speaker": "James Faucette",
"text": "That’s great, appreciate it Carlos."
},
{
"speaker": "Operator",
"text": "We have time for one more question. That question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Thanks guys. I just wanted to start with the EPS guidance for fiscal ’22 - I guess we’re going up 1% at the midpoint, so call it $0.06. Just breaking that down, it looks like the raise in the float income expectations is about $0.04 of that, and presumably the rest revenue outlook. I just wanted to see if that math is correct."
},
{
"speaker": "Carlos Rodriguez",
"text": "That sounds pretty good. I think that the theme--whether that’s exactly right or not, the theme you should hear is--I mean, it’s maybe a bad thing to end the call with, but you should understand that the second--we are investing, and this is not the first time you’ve heard this from ADP. The opportunity in front of us is big, like our bookings are growing, the economy is growing robustly despite the noise in terms of the stock market and so forth. This is a really good environment for us, and so we are preparing ourselves, and you should expect that that is going to lead to long term improvement in, hopefully, our growth rates and in our margins and so forth. Just don’t get distracted by the short term noise, because I think if the implication is it doesn’t seem like we raised the rest of whatever profit by much, the answer is you’re probably right, but it’s all the things we’ve been talking about during the call, which is we’re making sure that we keep up with the market in terms of wage growth, but we have price levers that we haven’t necessarily hit yet because we’re not a panicky company. We’re not going to tomorrow do an unplanned price increase to our base, but we have times that are natural and normal where we will do that, but we’re not going to wait to take action on wages and hiring and so forth until we get there, because that doesn’t make sense. We’re not some schleppy little company that needs to panic, so we’re going to do the right things and if there’s a timing, missed timing by a quarter or two, so be it. We think it’s still pretty damn good. When you think about the inflationary pressures we have and the fact that we’re still able to deliver the results that we are delivering and able to grow the way we’re delivering, we’re pretty damn proud of it. But admittedly, we’re feeling more pressure on the expenses now than we definitely felt, call it 18 months ago, right? It’s the opposite, and this is what happens in, quote-unquote comparisons, and when, you quote-unquote lap things and all that stuff that you guys like to look at. The pandemic hit and our expenses went down because we were very careful and very frugal and very stingy in terms of hiring and so forth, and our revenues never came down as much as everyone thought and as we thought, and we now have to go back up and make sure that we’re staffed, and at the same time wages started to increase and we have to now factor that into the picture. But we’re feeling pretty damn good about our execution and how we’re doing, but that is the way the numbers add up, is the way you described it."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay, those are all good points. Just last one from me, I wanted to see if you could elaborate a little bit on the competitive landscape, just what you’re seeing down market, midmarket, enterprise-wide. Interested in just any changes in the mix or the aggressiveness of any competitors across the spectrum. Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Again, because we compete in so many different segments, there’s not--I don’t think there’s a broad sweep--I mean, some of our competitors only compete with us in one segment, so it’s hard to make a sweeping statement other than I think it’s business as usual. That may not be very exciting, but I don’t see--I don’t know, Maria, if you see any--there’s been no--I mean, I think when we look at our balance of trade, we’re pretty happy about a couple of people that we’ve been more focused on recently than maybe before, which we’re now doing better than before on. But as usual, there’s others that are now gaining ground on us, but I’d say that the general environment is stable and--what is it, the rising tide lifts all boats? It feels like the industry overall has a lot of, I don’t know, growth opportunity and we’re all getting our fair share and trying to steal each other’s share, but it’s a good environment. I don’t know if you have any--?"
},
{
"speaker": "Maria Black",
"text": "I concur. I would echo the sentiment on the overall HCM space and the environment, and I don’t think anything has materially changed. But we certainly intend to continue to win our fair share and more."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay, I appreciate that. Thanks guys."
},
{
"speaker": "Operator",
"text": "This concludes our question and answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you. Just back to the general economic conditions and what’s happening in the market and so forth, which is not something that we focus on, on a day-to-day basis, but the some of the things--we did have a little bit of a discussion and some questions on capital allocation, structure and so forth, that I would just--I can’t help but I’m obsessed with the dividend, and I love how no one asked about the dividend. Nobody cares about the dividend, but we may be entering an environment where it might matter again, so maybe someday I’ll get a question about the dividend, because I think we’re in our 47th year of consecutive increases in a dividend, and I think if you go back 10 years and you look at what our cost basis of the stock was and what the dividend yield, given today’s dividend, is on that cost basis five, 10 years ago, 15 years ago, 20 years ago, this company is a money machine, and clearly capital gains are important too but the focus changes, obviously, as the market environment changes. Listen, I’m not wishing a downdraft in the market - it hurts us as much as it hurts anyone else, but I like where ADP is positioned competitively and I like where we’re positioned in terms of our balance sheet, our dividend, and the way we allocate capital. But the most important thing I’m proud of is our associates, because every quarter now as we get further away from--despite omicron and so forth, clearly we’re in a much better place than we were before. We would not be where we are today without our associates, and I mentioned how we were understaffed for sure in the early times of the pandemic, because we felt like we had to be careful on the expense side, and as we were being careful, the workloads were increasing because of all the government regulation issues that were intended to help - and they did, all of the stimulus, and this was across the whole world. That created a ton of work for our people, of which we had fewer people, and I’m incredibly grateful and will forever be indebted for people stepping up and doing whatever it took to get our clients and get us through that difficult period. I’m so glad that we’re able to deliver on all of our commitments, because we were, I think, one important factor besides the Amazon trucks still running and other parts of the economy still functioning. I think we played a role in helping the world economy, I think, get through the pandemic, and our associates deserve all the credit for the role they played. With that, I appreciate you listening to us, and we look forward to catching up with you again in the next quarter. Thank you."
},
{
"speaker": "Operator",
"text": "This concludes today’s conference. You may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 1 | 2,022 | 2021-10-27 08:30:00 | Operator: Good morning. My name is Michelle and I will be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2022 Earnings call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. I'll now turn the conference over to Mr. Daniel Hussain, Vice President Investor Relations. Please go ahead.
Danyal Hussain: Thank you Michelle. Good morning, everyone. And welcome to ADP's first quarter Fiscal 2022 Earnings calls. Participating today are Carlos Rodriguez, our President and CEO and Don Maguire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe is useful to investors. And that includes the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements, that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results, to differ materially from our current expectations. And with that, let me turn it over to Carlos. Thank you, Danny. And thank you, everyone for joining our call. I'd like to start by welcoming Don Mcguire, our new CFO. Don has been with ADP since 1998, when he joined the ADP Canada Team as a VP of Finance. He's held a series of roles with increasing responsibility, most recently serving as President of our international business, where he's done a phenomenal job of driving growth and profitability in a very complex environment. I know he's looking forward to meeting all of you.
Carlos Rodriguez : Now, moving on to the quarter. We're pleased to have delivered a very strong start to the year with 10% revenue growth and 140 basis points of margin expansion, resulting in 17% increase in adjusted diluted EPS. While we did expect our Q1 revenue growth to be above our prior full-year guidance range, this result was still above our initial forecast and underscores the strong position, we are in as we emerge from the pandemic. I'll let Don go through the details after I cover some highlights. Our ES new business bookings results for very strong, representing another record Q1 bookings amount. And we're ahead of our expectations, but our performance driven by continued strength in our HR portfolio, in our international business. With this impressive bookings performance across the enterprise, we're pleased to raise our ES bookings guidance for the year after just one quarter, as we're now feeling even more confident about our sales momentum. Even stronger was our CEO bookings performance, which was also well ahead of our expectations. And a key reason that we are raising our guidance for average worksite employee growth for the year, as Don will outline for you. As you will recall, we have been sharing our sales productivity trends over the course of the pandemic and I'm pleased to report that in Q1 we were well above pre -pandemic levels. We reached this result several months sooner than we expected, and we expect us to continue as we look ahead. Our ES retention remained incredibly strong as well. As we shared last quarter, we believed it was reasonable to assume a slight step back and retention from the record 92.2% level we experienced last year. But in Q1, we did not see meaningful deterioration. Instead, we actually saw further improvement in our overall ES retention to a new record Q1 level, despite amongst decline in our small business division, where out of business losses started to trend back to more normal levels compared to the below normal levels last year. We're continuing to assume a slight decline in our retention outlook for the year. But clearly, we are pleased with our performance so far in the upward revision in our retention outlook reflect the strong Q1 performance. Our ESP pays per control was solid with 7% growth in the quarter, about in line with our expectations. We feel that a number of questions these pass over months about what we think might drive workers back until the labor force. While we don't have an answer to that question, what we can tell you is that we continue to see positive trends. Our clients are eager to hire and we are seeing workers returned to the labor force, even if it's gradual. As a result, we expect to benefit from above-normal and above-normal level of pays per control growth over the course of the year. In addition to the very strong ES performance, our PEO delivered another stellar quarter with 15% revenue growth and 15% average worksite - employee growth. Even better than the high expectations we had coming into the quarter. There were multiple drivers to the outlook performance in the PEO, including the strong level of hiring within the client base, resilient retention, and the improved bookings performance I mentioned earlier. We're very pleased with the momentum we see building in the PEO. And we're raising our full-year guidance accordingly. In addition to the financial highlights, there are a few product highlights I wanted to share with you. First, I'm excited to share that we completed the initial roll out of our new user experience for RUN. As we shared with you last quarter, this represents the most comprehensive refresh we've done since the launch of RUN. And we're very proud that in a matter of a quarter, we were able to seamlessly move hundreds of thousands of clients to a new and better user experience. Early signs indicate the client satisfaction scores to trend even higher than the record levels we already have in our small business division. So it's a really great outcome and represents a very strong execution by the team. I'd like to also share that at the Annual HR Tech Conference a few weeks ago, our innovative diversity, equity and inclusion tool on a DataCloud platform was named a top HR product. This recognition adds to ADP's longstanding history of award wins at the conference, marking an unprecedented seven consecutive year ADP has been honored for its innovative HCM Technology. You can probably talk from the number of times we've highlighted DataCloud that our velocity of innovation has increased significantly there. With this solution as an example, we've seen over 50% of active users of the solution take action and realized positive impact on their measures. I'm proud that we provide solutions that drive real positive change for our clients. The 7 year track record demonstrates that innovation is part of ADP's DNA. And then we have a strong growing agile R&D team committed to delivering solutions in the market that continue to push the boundary of what HCM solutions can do for employers and employees. As I said before, we're very pleased with a fantastic start to the year. We look forward to sharing even more of the ADP story with you at the upcoming Investor Day in November. And now I will turn the call over to Dan for more detail on the quarter and the outlook.
Don Mcguire : Thank you, Carlos and everyone on the call good morning. And nice to meet you. Our first quarter represented a strong start to the year with 10% revenue growth on both a reported and organic constant currency basis. Our adjusted EBITDA margin was up a 140 basis points much better than expected, and was supported by higher revenue and overall cost containment. Our tax rate was up slightly in the quarter versus last year. But we also benefited from the elevated pace of share repurchases following our debt issuance in May, combined, those factors contributed to a 17% increase in our adjusted diluted earnings per share. Moving onto the segments, our Employer Services revenue increased 8% on a reported and organic constant currency basis. Our strong Q1, ES bookings guidance performance, and record retention contributed to this performance. Though, as a reminder, we did continue to lap some of the lower revenues we had last year in some of our volume-related businesses, including recruiting and background screening. Our clients finding interest represented only a slight headwind in the quarter, as our 40 point, basis point decline in average yield was offset by fantastic balanced growth of 22%, driven by client growth and planner growth, higher wages and the lapping of the payroll tax deferral last year. ES margin increased 150 basis points on strong revenue performance and overall cost containment. As Carlos mentioned, our PEO had another terrific quarter. Average worksite employees increased 15% year-over-year to $629,000 in revenues, excluding zero margin pass - throughs from 20%, supported once again, by favorable mix trends within the PEO employee base, as well as improving SUI rates. Total PEO revenue grew 15%, which included a modest drag from lower zero margin pass-through growth and worksite employee growth as expected. PEO margin was up 70 basis points in the quarter driven by operating leverage. Overall, our Q1 results reflect a very strong start to the year and delivered ahead of our expectations on practically all fronts. Let me now turn to our updated outlook for Fiscal 2022 for ES revenues, we now expect growth for 5% to 6% which we're raising 50 basis points at the midpoint. This is driven by several underlying factors. We're raising our expected range of ES new bookings growth to 12 to 16%. As we mentioned, we had a better-than-expected performance in Q1 and reached pre -pandemic productivity earlier than we had fore - casted. We haven't made significant changes to our rest of year outlook at this point, but if momentum remains as strong as we've seen it then we may see opportunity to deliver additional upside. We're also raising our ES retention and we're now assuming a decline of 50 basis points off of FY21 all-time highs versus our prior outlook of a decline of 75 basis points. As with bookings, this is primarily a function of the strong Q1 performance. Our continued assumption is that as clients continue to re-engage in the marketplace, we may experience a slight decline over the course of the year. We expect to have significantly more clarity once we get through the calendar year-end period. Where we typically see most of the switching activity. For U.S. pays per control. we're making no change to our outlook of 4% to 5% growth. We continue to expect a gradual recovery in the overall labor market, and the 7% growth in Q1 was about in line with our expectations. And then for our client funds interest revenue, we're raising our outlook by about $15 million to a range of $420 to $430 million, as we're raising our balanced growth assumptions by about 4%, to growth of 12 to 14%. Our outlook for client funds yield meanwhile is unchanged despite the improvement in the yield environment. Primarily, as our stronger balanced performance actually created a temporary mix shift to overnight investments until new securities are gradually purchased. But that said the favorable shift in the yield curve is clearly helpful to us and we'll certainly benefit our multiyear client funds outlook, all else equal. For ES margin, we now expect an increase of about 75 to 100 basis points, up from our prior range of 50 to 75 basis points. While we did outperform meaningfully on margin in Q1, we're also seeing some additional expenses over the rest of the year, including higher headcount in our outsourcing businesses. Meanwhile, we continue to expect transformation initiative benefits, including our digital transformation to offset a year-over-year increase in facilities, T&E expenses, and other return to office expenses. Moving onto the PEO, we now expect PEO revenues to grow 11 to 13%. Average worksite employees to grow 11 to 13% and revenues excluding 0 margin pass - throughs to grow 12 to 14%. This 2% point raise across-the-board is a function of both our strong Q1 bookings and overall performance, as well as an expectation from stronger hiring within our PEO base to contribute over the remainder of the year. RPO was very well-positioned to capitalize on growing levels of client demand coming out of the pandemic. And if we continue to drive outside booking performance over the rest of that of the year, that could represent further upside to our outlook. Following our strong start to the year, we now expect a range of flat to down 50 basis points for the year, for an improvement from our prior expectation of down 25 to 75 basis points on our margin. As a reminder, we are growing over a very strong margin results in fiscal 2021 and are also expecting elevated selling expenses this year from strong bookings performance, Turning them all together for our consolidated outlook, we now expect revenue to grow 7% to 8%. Following the strong 10% Q1 performance, we now expect the remaining quarters to grow closer to 7%, which is higher than our prior forecast. For adjusted EBITDA margin, we now expect an increase of 50 to 75 basis points. As we shared last quarter, we expect our margin improvement to be back-half-weighted. Most specifically, in the Fourth Quarter. Our current expectation is for a slight margin decline in Q2 and Q3. We're making no change to our tax rate assumption. And with these changes, we now expect growth in adjusted diluted earnings per share of 11% to 13%, as I think you've heard us say a couple of times now we are very pleased with our Q1 results and we're happy to be raising our guidance this early in the year. This is still a dynamic environment, and there are a wide range of potential outcomes. And we believe our guidance is appropriately balanced given these conditions. However, should our associates continue to drive better-than-expected sales results, client satisfaction, efficiency, and service and implementation. We would see opportunity to deliver additional upside to our outlook. Before to move in Q&A I wanted to share 2 things. First, I look forward to meeting everyone perhaps virtually for now. But eventually in-person as we get back out on the road to meet our shareholders and the investment community. And second is that we are very much looking forward to our upcoming Investor Day in a couple of weeks on November 15th. Having run one of our largest businesses for years, I can tell you there is always much happening here at ADP on the ground. And although it all tends to roll up to a very stable financial picture, I can tell you there's a lot of excitement among our associates for the things they're working on. We hope to share some of that excitement with you in November. And with that, I will now turn it back over to the Operator for Q&A.
Operator: We'll take our first question from the line of Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning and thanks for taking my questions, congrats on the really strong start to the new fiscal year. So Carlos, maybe I want unpack the drivers to the strength on the new bookings side, I know productivity is clearly one, but how should we think about -- how should we think about the product side and within the product portfolio where that strength was in terms of driving new bookings?
Carlos Rodriguez : So we -- even though what we really talked about is ES bookings, just want to start by saying that the PEO Bookings were incredibly strong. I don't know how else to put it. So I call it orders of magnitude in terms of growth rate higher than even the ES bookings growth for the quarter. That was really good to see. So that's kind of a sign to your question about products that I think the market is really searching for solutions coming out of this pandemic, that helped them with obviously people issues and sort of, but there's also a talent for -- so people are looking to obviously attract and retain people in this environment where every Company, including ADP, is going through some of these challenged in terms of retracting our own internal talent. And then you have another dynamic which is, if there are shortages of labor in various categories there we're hearing that there's also shortages of talent in kind of HCM category in general that should create a little bit of an advantage for the clinical outsourcers, right? So as you know, our model is, we provide great technology and software, but we also do the back-office work and we take accountability for outcomes. And I think when people are struggling to hire people to do the work in their HR department, or their payroll department, or their benefits department, we're here to help. And so I think those outsourcing solutions are getting a lot of tailwind. We also saw because of the easy comps and I think you've heard it in Dan 's comments. Some of the things like our recruitment process outsourcing business and our screening and selection business, which we're really at very low booking levels last year at the same time, have rebounded off for obvious reasons, incredibly well. But having said that, it was really across the board. We had very strong growth in workforce. Now, we had very strong growth in the up-market. We had strong growth even in a down-market. Although last at the same time, I think we mentioned that we had when we call client-base acquisition which is not technically M&A deal, but we were able to buy and large book of business that we converted, that really some of that flowed through our bookings. So I'd made that comparison a little harder on the SBS side, but if you back that out, it was equally strong on the SBS side as well. I would say that could give you a little bit of color, but it really was across the board. It just shows how connected we are to the economy and GDP when it comes to bookings, which is something that we've had the theory here for some -- for some years now, and we just have a very strong recovery in a very strong economy. And it's a great environment for our sales force.
Samad Samana: That's very helpful. And then, Don Maguire, maybe one for you on the retention side. So obviously it's -- it's really impactful into to raise the outlook one quarter and I think signals the strength that you're seeing. But just help unpack the slight uptick in the SMB side moving a little bit more towards normal in terms of business failure. Should we think that the offset there is even better-than-expected retention in the mid-market, or on the enterprise side? Can you maybe help us think about it across the customer size spectrum? How to balance those different moving parts?
Don Mcguire : Yes. Sure. I think it's fair to say and we commented on it that the retention is at an all-time record for our Q1. So that's fantastic and better than we had expected. The expectation as we went into the year was to see particularly in the smaller business statement, to see that slipped back a little. And indeed it has, but it hasn't slipped back nearly to the extent that we had anticipated. So we're even better there against what we had previously thought. Of course, then that means that we did have and continue to have good retention levels in the mid-market and the upmarket. So we expect that to -- we expect that to continue. However, as you know the cyclicality of our business and the seasonality of our business. We will need to get through the calendar year end, which is when we see most of the switching activity because of the drivers in new starts the year etc. So we are positive and we did take our retention estimate up for the year and we'll see if it holds and perhaps it's better than we expected.
Samad Samana: Great, thanks. And I look forward to seeing at the stand person and a few weeks.
Don Mcguire : Thank you.
Operator: Our next question comes from Jason Kupferberg with Bank of America. Please proceed.
Jason Kupferberg: Good morning and thank you for taking my questions. This is actually may hear about on for Jason. Don, firstly, congratulations on the role. Maybe you can talk a little bit about your priorities in the CFO role and how they could maybe look a little different than on the . And just relatedly, should we expect an update, the multiyear targets at next year's Analyst Day. And then I have a follow-up. Thank you.
Don Mcguire : Yes. So I guess what I would say is I've been with ADP for a long time now. And I guess what I observed in the roughly 23 years I've been with this Company is that ADP has always had a very strong financial organization with a strong finance leader. And I want to make sure that we continue that. I am sure we will. I think that the priorities that we have are well set out in our Strat plan previous Investor Days, etc. So we'll probably provide along with an update on those things that when we get together on November the 15th. But let's wait until then and I don't think you're going to see any dramatic changes. We pretty much have a well-discussed, and well-disclosed trajectory, and plan, and we will update you on that on November the 15th.
Jason Kupferberg: Understood. Thank you. And then just if I could ask about just sales for spend, just clearly seeing some very strong momentum in the market. So I was wondering if you have any plans for sales force growth in Fiscal 2022? And which part of the market those ads would be concentrated in. Also anything notable to call out in terms of just the mix of new logos versus cross-sells in your bookings for the quarter or in the forecast. Thank you.
Carlos Rodriguez : I think in this kind of environment, given the very first comments we made about the economy, and you have both the economy of the tailwind and you have now in the U.S. I think an administration that is kind of more inclined to regulation into, particularly employer regulation. And so you have, I think a very strong backdrop for what I would say is the foreseeable future. In that environment, historically, what ADP would do is we would add as much sales capacity as possible. That doesn't mean that we indiscriminately hire because we have people to hire and onboard and train and so forth. And we have to make those people effective. But I would say that we have a strong appetite for growing our sales force, but also for growing our investment in marketing. Whether it's digital marketing or more traditional advertising. And that's exactly what we plan to do. Having said that, I would tell you that we've had challenges like everyone else, in terms of hiring, it's a very difficult labor market. So I hope that we can fulfill those expectations, those dreams, if you will, of growing our sales force as fast as possible. But that's the only thing that I could see getting in the way. We obviously have the capital, we have the I think the desire and we have, I think the experience to be able to execute once we hire those people to get the sales, get the clients implemented, and then hopefully derive the benefits of that revenue for, in many cases 15-20 years, depending on which business unit you're in. And so I guess I would say strong appetite for both headcount growth, but also other investments in sales. Whether it's marketing, digital marketing, sales tools, all across-the-board.
Jason Kupferberg: Thank you.
Operator: Our next question comes from Tien-jian Huang with JP Morgan. Your line is open.
Tien Jian Huang: Thanks so much. Good results here. Just on the PEO side, I'm curious how much of the general improvement there is secular versus cyclical? And I know Carlos, you talked about putting more sales energy there as well. Just curious, what's changed?
Carlos Rodriguez : So the risk of -- because we had a strong feeling that the PEO business was going to be strong coming out of the pandemic. Because it's been strong coming out of prior economical recession. and those are the different recession. So I have to be careful about any specific predictions. But we had some challenges, I think coming out of the pandemic with the price that we're selling in the PEO were slightly smaller and just ballpark it around 10% smaller. So let's say that the average, I'm just going to make up the numbers. Let's say the average new clients over in the PEO with 3 worksite employees and all of a sudden, prior to the pandemic and that's been can quote, growing slightly over the years. All of a sudden it came down to like 27, so 10% decline. So even if you sell 10% more units, if the units are at 10% smaller, you basically end up in the same place. So that's a little bit of what we were expecting. We believe that a 100% related to the economy, and to what was happening with the pandemic. Now what we've seen in the recovery is both the unit growth is still strong as it was prior year, and now our unit size has recovered. And so the combination of those 2 things has created really, really strong growth in the first quarter in the PEO. The only caveat that I would add also is that we did have a transition into a new year, as you know, our fiscal year ended on June 30th. And in some cases, our businesses tend to perform really extremely well in the first quarter when they come out of a year where -- I wouldn't call it under-performance because it was still a good year last year, given the circumstances. But clearly the PEO, we were very, I think, clear that the PEO had been trailing, in terms of recovery when it comes to bookings, what we were seeing in EF. Now, as we expected, the horse race now -- the horse in the lead has changed. So now the PEO is the one leading the race.
Tien Jian Huang: Thank you, Carlos.
Operator: Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thank you and congrats on the results and Don Welcome. Hey, I wondered -- could you give us a sense, Carlos, from a sales perspective, despite the tight environment you're still delivering, is there any way to think about the go-to-market strategy this cycle as opposed to last that and how maybe technology and maybe more of a mix down-market helps drive that process. I guess what I'm saying is there more leverage in the sales force today than you've ever had, is there any way to maybe put some parameters around that?
Carlos Rodriguez : I think there is definitely more leverage in the sales force than we've ever had because -- I mean, I think maybe what you're alluding to our sales force like a lot of other of our competitors had to go to a 100% virtual for a number of months, and I'm sure every competitor handled differently in terms of how long they were virtual, versus when they went back in the field. But that process which we had been learning about for 20-25 years, like we have almost a third of our sales force already selling what we call insights sales. And so they were able to sell virtually. They had been in a building, but it didn't really matter whether they want the building or in their homes. They were still able to sell very effectively. That was an easy transition for that portion of our sales force, and then we really with the appropriate tools and some training and some learning from our inside sales force we really moved our entire sales force to sell virtually. So I think now we're really in a period where we're going to sell based on, however the client wants to be sold. And so if the client wants a combination of an initial video call on Zoom or WebEx, we'll do that. If the client once an in-person visits we'll do that if they want to close the deal with an in-person, but start with a video, we can do that. So I think there's no question that if Salesforce leverage has increased for us, but admittedly, probably for our competitors as well. Our reach has definitely been extended. There's no question about that in terms of tools, but also philosophically. I think we are now, I think able to sell in a, I mean to use a cliche and omnichannel way. We're also investing heavily in digital marketing. So you mentioned the down-market, I would just add that because of some of the comparisons to the down-market had that was not withdraw the sales results this quarter. It was actually all the other businesses. So but we do see the underlying strength in small business. But because of the difficult comparison, it's not reflected in the percentages. So not trying to minimize the strength in the momentum in the down-market, I'm trying to emphasize the strength everywhere else in the portfolio. And the rest of the portfolio also can benefit from digital tools, digital marketing, but it's not quite as leveraged as it is in the down market. So I think it's a combination of a lot of different things, but the overall, I think comment would be there's no question that there is increased leverage in the Salesforce and you're seeing it in terms of the productivity numbers. I mean it, we are frankly very positively surprised by the rebound in what we call average sales force productivity. So the actual sales rep level, how much are they selling today versus what were they selling in Fiscal year '19. And that is back to, and above that level, which is very pleasing to us.
Kevin McVeigh: That's helpful. And then just one real quick one on retention. What was the boost kind of all the Q1 over-performance because I know the Q2 December's big quarter in terms of retention, things like that or is it just more optimism over the balance of the year or a little of both? Is there any way to frame how much of that boost was maybe Q1 over-performance as opposed to how you're feeling over the balance of the year?
Don Mcguire : Maybe I will take that. I think our retention, certainly we're very happy with the Q1 record we have, but I think it's also heavily linked to the success we've had over the last few years with our improvements in NPS. And as our NPS continues to go on the right direction and improved, we're seeing general increases in retention to go along with that, I think that's what we would expect and that's what we want to see happen. So I think there is some relationship there. The -- with no doubt that the retention is very good and we're benefiting still I think from a little bit of some of the concerns coming out of the pandemic that clients may have about switching it during a time of still virtual for many. So we're benefiting from that as well and we acknowledge that. But as I said, we're very happy with the retention and the progress we're making with our products and our service that go along to driving those retention numbers. We will see a little bit of a step back perhaps in the down-market. But as we said so far, it's soft living up better than we expected.
Danyal Hussain: And just to clarify, because we did share in our prepared remarks that the raise which primarily a function of the Q1 results, obviously we have the stability in October as well.
Kevin McVeigh: That makes sense. Thank you.
Operator: Next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El Assal : Hi, Gentlemen. Thanks for taking my call this morning. I wanted to ask about margins and forgive me if you addressed this in some detail, I missed a bit of the call earlier, but it came in really strongest quarter well above our model, can you speak to the drivers of the beat and also to their sustainability as we move forward.
Carlos Rodriguez : Sure, let me start by saying that the margin in the first quarter was a record for us. And it was above last year as we just reported But if you go back to last year -- last year was above the prior year. It's quite impressive that we had margin improvement last year, given that we were one quarter into a pandemic. But it's even more impressive is that impressive that we had margin improvement again, having said that, up the victory lap. Then the other part of the comment is we had way higher revenue than we had anticipated, which is incredibly gratifying We're very happy about that, and it was really in both ES and PEO. And it was an a bunch of different places. Slightly better pace per control, retention was better. You heard all the comments. We have just a lot of things working in our favor here. The expenses have not caught up to the revenues and so right now, we are trying to add capacity, both for implementation and service, particularly ahead of our year-end period. And so like other companies, the most important thing for us is to be able to execute on our commitments to our clients, and to be able to start a business that we've sold. And so I would say that that's a dynamic that factored into the margin performance, but I don't want to take anything away from the organization or anything away from the operating leverage because it's pretty impressive what the organization was able to accomplish. But had we known where we were going to be in terms of top line and volumes, we would have more headcount today than we have. And there is some catching up to do. Now to put a fine point on that, don't think of, we have to add hundreds of millions dollars with expense, we're just a little bit behind, and that's why you see in case someone's asked it yet may as well address it head on for the rest of the year. When you look at the EPS and the guidance, we really not raising by much more than what we had in terms of our performance in Q1. And that's because we are going to continue to invest in both sales and distribution, but also in service and implementation. And that delay in hiring or deferred hiring helped us in terms of the margin in the first quarter, I strongly believe we still would've had a very strong margin performance in the first quarter, even had we hit our headcount numbers for service implementation and volume-related businesses. And I thought I should kind of put that out there because it seems like an obvious question as well.
Ramsey El Assal : That's great and I appreciate your candor there. Quick follow-up from me. I was wondering about the human resources and human capital management products. Can you talk about how the cross-selling process into your basic kit of kind of payroll customers is organized? I'm just trying to figure out sort of how you go about that cross-sell process. And I guess how much of a runway do you see for attach rates to those products?
Carlos Rodriguez : There really isn't a simple answer to that, to the first part. We'll come back to the -- I think the second question about the attach rates. Let me answer that one first. The attach rates are -- there's a couple of products where we have what I would call good attach rates, acceptable, which is saying as CEO speak for, they could always be higher. Like our benefit admin tools, our time and attendance systems. But most of our products and our worker's compensation tool in a down-market also has a high attach rate. But almost everything else that is quote, unquote, beyond payroll. So HCM in addition to kind of our core payroll solutions, we're way under penetrated in terms of attach rates. So there is a lot of potential, I think for that to improve as well. So on the first part of your question in terms of how we cross-sell, as I started saying, there isn't a simple answer because there isn't a simple answer. In some of our businesses, we have very distinct organizations like in the down-market, we have a large down-market sales force that works with accountants and other kind of third-party channels and also sell directly. And then we have a sales force that sells our retirement solutions are 401K products. And our insurance services solution, those are distinct sales forces that basically share leaves with each other, and they have incentives to do so. That down-market business also feeds business to our PEO through also incentives. But there is a separate and distinct sales force in the PEO as well. When you get into the up-market and into the mid-market, you start to get some portion of our sales force which is able to sell multiple products or whatever call bundles. But even then, you still have specialized sales forces in certain circumstances, depending on, I think the specialization or the complexity of the product. But in all cases, we have primary sales. What I would call primary sales people. So the quarterback, if you will, on an account. Now I'm talking about upmarket and mid-market and those quarterbacks are really in charge of making sure that when it's appropriate, and when a client has a need that we bring in our specialized sales people that have specific knowledge about some of our other HCM solutions. So I wish I could give you a simple answer, but that's actually part of the secret sauce, right? In terms of our ability to grow and outperform some of our competitors is to be able to do that well. And I'd like to say that I invented this, but this is something that goes all the way back to the Frank Wattenberg days and to my predecessors . And this is a well - oiled machine in terms of our sales and distribution. And specifically, you've just described about the cross-sell. And again, to put a fine point on it roughly 50 percent of our bookings come from cross-sell and roughly 50 percent of our bookings come from new logos each year.
Ramsey El Assal : Very helpful. Appreciate it. Thank you.
Operator: Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Carlos, I just wanted to get your thoughts. I know you talk to obviously a lot about new sales and I'm wondering, outside of this wage inflation that you're seeing. Is the cost to acquire clients going down, especially on the SMB side now that there is a new way to sell to them? Or do you think the cost to acquire clients as we move through this pandemic will go back to what it was?
Carlos Rodriguez : I wish I had a crystal ball in terms of answering where it's going to go. But I think just from a mathematical or technical standpoint, the cost of sale is definitely pulling down because of this productivity increase. So this is the same leverage that you're seeing in so many industries and so many businesses, including ours, on the revenue happens on the bookings as well. When you get higher volumes it basically indicates higher -- unless you add a lot of expense, by definition you get higher productivity. So you see us being reported in the press all the time about, how worker productivity is up. Well, hardly reason why worker productivity is up is because revenues of recovered, volumes have recovered, and it sustained people. Or you're adding a few more people now. Maybe people aren't focusing on, is that worker productivity went down, right as the pandemic kind of set in and people's revenues went down. So I hate to make it so simplistic, mathematically. But some of that is what's happening now. So you do have to be careful about jumping to any medium to long-term conclusions because right now our cost of sale compared to last year and the year before is definitely coming down as a result of a very large increase in bookings with how a similar increase in expenses. We still though are not back to where our cost of sale was pre -pandemic. And we hope to get there. But that will require even a little bit more productivity during this year. But that would be our expectation is that whether it's the GDP or interest rates or employment, that, there's regression to the mean here as they very large economy. ADP's large Company, but the economy is massive, and it tends to regress to the mean on a lot of things, and we also tend to regress to the mean s. So I think some of these things will work themselves out. And you have to just get past the base effects, and the comparisons, and so forth to really understand where you are, and we won't know that until we're on the other side unfortunately, I hate to say it.
Kartik Mehta: Thank you very much. Appreciate it.
Operator: Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Thank you very much and thanks for all the this morning. I guess maybe I just want to ask the obvious headline question and just wondering how the reported current tightness in the labor market, as factored into your guidance? And how are you anticipating on that changes through the coming fiscal year? And I guess maybe a product and service-related question tied to that. Are you seeing incremental sales opportunities with some of the tech that you can provide to your clients for hiring, etc. and is that having any impact on how you're thinking about your outlook and forecasts? Thanks.
Carlos Rodriguez : Thanks for the question. The second part of your question, I think kind of answers the first part. The answer is yes. Like, I think part -- again, hard to separate how much is just pure GDP growth, new business formation etc. But the last part of your question, there's no question that part of our growth is driven by what you are alluding to, which is everyone now is looking for help in terms of hiring, attracting people, and frankly, also trying to hold onto them. This is a great environment for us. The combination of strong GDP, an administration that is more inclined towards regulation, and then a tight labor market for people who do the things that we do. By that I mean, payroll staff and HR staff at prospects and our clients. That's all a very good backdrop for us. I'm assuming that -- this is not going to resolve itself overnight in terms of the tightness in the labor market. We should anticipate some tailwinds here and some help for some period of time, until that changes. And I hate to use the R word, but some day, at some point in the future, doesn't see m anywhere near future given what's going on with government stimulus and government policy. But someday that might change. But we don't see that on the horizon right now. On the very first part of your question though in terms of the tight labor markets, I would say the overwhelming impact of tight labor markets is positive on AEP. I mentioned one of the challenges we have, which is tight labor market affects our own internal associates in terms of we have to hire service people and implementation people, so it's harder for us like it is harder for anyone else. But that pale in comparison to the upside, like a tight labor market drive new bookings as we just talked about in the last part of your question. But it also could create inflationary pressures, which drives our balanced growth. It should drive interest rates higher, which is one of the most underappreciated stories, I think of ADP is the potential upside in our flow business. And the reason it's underestimated because it's done nothing for 10 years because they've been here for 10 years and has been nothing for pain and headwind. And just what I thought we were coming out of it, we go into a pandemic, and we get more pain, and race go even lower than they were before. But I'm pretty sure that it those changes any lower now. Although, I think we may have to file an AK after saying that. I'm making a statement on interest rates. But, whatever. Hover around here, go down a little bit there, but it feels pretty certain that the long-term, medium and long-term trend now for interest rates will be at least for gradual increases. And I'm not suggesting that there's still underlying demographics that may keep us from getting back to the same kind of 10-year rate that we had 15 years ago or ten years ago. But I think everyone knows when you look at real interest rates that there is upside on interest rate. So the tight labor market helps in a number of ways. It creates activity for our sales force. Every time there's activity and there's conversations, we're going to win our fair share. So that's a great backdrop. It creates opportunities for our balances. I think it creates opportunities for the PEO because some of our billings are actually driven by as a percentage of wages. And whenever you have wage inflation, if you are building on percent of wages, to some extent that will help, that's not So, like an infinite thing because we won't just allow our revenue to go up indefinitely. We'd have to adjust those rates but in the medium-term, we will see, I think, some tailwind from -- in the PEO from higher wages and wage growth, which is inevitable outcome of a tight labor market.
James Faucette: That's great color. Thank you.
Operator: Our next question comes from Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. I had to follow-up first on retention. Curious, within the record, 1Q retention performance, can you dig in a little bit more as far as the drivers there between the still lower out of business closures versus essentially better competitive win rates, And anything broadly, you can comment on around -- around clients switching behavior or client re engagement to assess HCM solutions?
Carlos Rodriguez : On the first -- on the first part, I'm not sure how much more color we can give you. We have a fair amount of detail in terms of losses and retention around, we call non-controlled the losses which are broadly speaking out of business, bankruptcies, etc. And those have started to trend back up again. They're not back to normal levels, but they started to trend back. I think that's not surprising because there's still a lot of liquidity, and a lot of stimulus if you will, even if it's not new stimulus. So when you have consumer spending doing what it's doing, and you have activity doing what it's doing. It tends to be supportive of small business rather than the normal turnover that you have that's natural in the small business sector. I guess with hindsight, like if 3 or 6 months ago, when we were putting together our plan, we'd had a crystal ball, we would've probably -- and we had experienced with the pandemic, we probably would have planned the downturn in retention to be slower. So we've been positively surprised by how long it's taking for those losses to regress back to normal. Having said that, we don't know that they're going to regress 100 % backs because there's other parts of our retention that are controllable. We call controllable. In our controllable losses, we see those going down as well. And I think Don made a common thing that should not be lost on you, which is that our client satisfaction scores as measured by NPS, are the highest they've ever been. And I give credit to the organization for during the pandemic, being able to get through what was an incredibly difficult time for them personally, in terms of they were trying to help our clients. But we also had a huge increase in volume because of all the government stimulus programs in the PPP loans, etc. And this happened all over the world, it wasn't just in the U.S.. And fortunately, we maintained relative stability in our headcount. We didn't do mass layoffs and let a bunch of people go. So the combination of maintaining investment and also being able to, to have people -- I don't know how to described it. Make a efforts to help our clients, we were able to maintain those NPS where that actually haven't go up. And there's staying at very strong levels, and we believe that there is a correlation between strong NPS and retention. So we may be able to see new record highs for retention on a permanent basis, but it's way too early to make that prediction.
Bryan Bergin: Okay. And then just follow-up on, on next-gen HCM platform. Can you provide an update on new sales there? Maybe the pipeline and sold clients versus lifelines, any metrics or updates you're willing to share?
Carlos Rodriguez : Sure. I think we talked about over the last couple of quarters as we kind of entered in the pandemic, we obviously had a couple of particularly large clients that we're in industries that were particularly hard hit. So we've got put on a little bit off course, if you will, in terms of our implementations and our starts. We also, I think, started to focus on implementation tools. I think we had -- I don't know how many set -- how many we said we had sold. And as we started implementing in starting these clients. We recognize that we still have some work to do in terms of implementation tools and making sure that if and when we want to use third-party integrators to help us with that, that we need to build out those tools. There has been quite a lot of focus on that effort. And we feel good about it. We actually -- I think we also talked about investments in the last quarter that we made to bring in some third-parties to help us with the evaluation. And in some cases, the build of that to make sure that as we now enter a hopefully a period of time where we can really accelerate the implementations and the growth and the starts of those clients. But it's fair to say, and I think we said in the last couple of quarters that our focused turn ed more to, making sure that we have a strong foundation and that we had the right implementation tools to be able to get the business started that we intend to have in the next year or 2, which is hopefully quite -- quite a lot of business. And you'll hear more details about this when we get to our Investor Day on November 15th.
Bryan Bergin: Okay. Thank you.
Operator: Our next question comes from Eugene Simuni with Moffett Nathanson. Your line is open.
Eugene Simuni: Hi, thank you very much for taking my questions. I have badge the couple in the PEO, so I'm asking upfront. One is that, if you look broadly at your HRO offerings, so PEO and non-PEO, can you compare and contrast for us a little bit to the PEO Solutions and non-PEO hopefully outsourced solutions, how are you seeing them growing relative to each other the demand? And are you seeing any switch in between clients who might be using that HRO Solutions without benefits switching into the PEO? So that will be the first one and the second, I was just curious. How are you positioning the be-all franchise to really win market share in a post-pandemic environment, given the secular growth seems to be very favorable. But how do you actually make sure that ADP wins share?
Carlos Rodriguez : So on the first -- on the first question, I think I said in my early comments that all of the HRO Solutions, the Corporal Outsourcing Solutions, are very, very strong across-the-board, right? Up-market because we have HRO Solutions in the up-market, we have in the mid-market, and we have them in the down-market. And in in the down market -- and in the mid-market, we have PEO, but we also have what you're alluding to, which is a non-core employment. What I would call -- we call it comprehensive services, as the name implies, it provides a kind of broader assortment of services in addition to our traditional software in our traditional tax and other services. There is to my knowledge a lot of switching from clients that are, what I would call typical clients of ADP that have payroll benefits and I'd then maybe TLM, etc., whether it's in a down-market in the mid-market into these HRO Solutions, there is not a lot to my knowledge of switching across because it typically. Again, if we're doing our job from a sales standpoint, you are really trying to find the right fit for the client. In some cases, the client wants you to do their benefits admin, and provide their benefits, provide the workers comp, and their 401-K. In other cases, the client wants you to only do the administrative back-office of the payroll department in the HR department which would be the non - PEO solutions. So I think if we do our job well, which I think we do in the sales process, and in the upgrade process, those clients tend to stay on those -- on whatever solution they have chosen. But to be clear, both of them are growing at this point at rates that are multiples of our growth in employer services. And so it's quite impressive in terms of the tailwind and the growth rates that we have in all of the HRO businesses. On the last part of your question, which I think was about positioning PEO in terms of market share and so forth. We have 600 and I think it's 630,000 roughly, we reported worksite employees, average worksite employees this last quarter. That's tripled, what it was 10 years ago in the first quarter of fiscal year 11. And so and that's a higher market share than it was 10 years ago. So I don't know how else to answer that question other than to say that we have a proven track record of execution to continue to drive growth in the PEO that's faster than the markets. So I don't think there's any question about our positioning or our ability to drive market share as evidenced by our ability to execute.
Eugene Simuni: Got it. Thank you.
Operator: And our last question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Good morning, Carlos and Don, look forward to working with you. On next-gen payroll can you give us an update in terms of the roll out there, please?
Carlos Rodriguez : So next-gen PEO, equally excited as we are about next-gen HCM in terms of what this holds for the future for ADP. The challenge for us in terms of as we communicate and on November 15th, we'll try to figure out a way to address this issue. Like, we have 15 billion in revenue. So as well as next-gen HCM are going and next-gen payroll is going, it just doesn't -- this is a future impact for ADP., so it's not in the next quarter. And I know you're not asking a question that's really about next quarter mark, but I think it was a good opportunity to kind of throw that out there. That -- what's driving the performance of ADP this quarter, this year, and for the next 2 to 3 years is not going to be that from a financial standpoint. But in terms of positioning the Company for the future, in terms of growth and creating competitive differentiation and the ability to drive new bookings, they're absolutely critical. So I would say that on those measurements we're still happy and excited by the progress we're seeing with both next-gen HCM, as well as next-gen payroll, we have not gone to general availability, so we're selling a lot of next-gen payroll, but we're only selling in what we call the core of major accounts right now of the mid-market, which is kind of 50 to 150 and this is no different in terms of the playbook that we use with our transition from our old platform to run in a down-market. And some of our more legacy platform in mid-market to then our next-gen Workforce Now version which we're on now. So we're doing the same thing with next-gen payroll and the same thing with next-gen HCM, which is we're doing very carefully that we have a very large installed base. And we are not -- We're going to eventually move some of those clients, and begin to move some of those clients. But we're happy with the business and the cash flow that we have, and the clients satisfaction scores that are record levels on our existing platform. So we do not have any -- this is not panicking. There's no sense of crisis, and there's no -- we have urgency, but no crisis, because I want to make sure people hear that. Like, I don't want you to think that we all have a sense of urgency because the faster we get these two solutions to scale, the faster we beat the competition.
Mark Marcon: I appreciate that, and thanks for the color there. On the PEO growth, can you talk a little bit about two different dimensions? 1 would be, the growth that you're seeing kind of in the established states relative to some of the less mature states and to what extent are you seeing less mature states really catch on? Particularly given the -- the legislative and regulatory backdrop. And then secondly, how should we think about just health insurance costs now that elective surgeries are starting to come back, elective procedures are starting to come back. What impact would that end up having just on the overall pricing? I know that you're not necessarily impacted directly from a margin perspective, but just thinking about the demand environment.
Carlos Rodriguez : It's a great question. I think the second part of question, so hopefully you'll forget about first part because we don't have -- we try to prepare for everything and that one, we'll have to follow-up with you on in terms of what regions or what states, we're strongest in terms of our sales. I'm going to suspect that they were all strong because honestly, like the PEO results were off the charts, there can't be any state that wasn't in strong double-digit growth. But we'll follow up on that question. On the healthcare rate question, you're right that we're not directly impacted, but you're also right to imply that we're indirectly impacted because it does matter, right? It matters to our clients what they're paying for healthcare. And I hate to be so simplistic, but I think what the actual regression to the mean and large economies -- the healthcare world and insurance companies are also similar in terms of they regress, right? So losses have an uncanny way of regressing to the mean. That's why I always caution people when all of a sudden someone thinks that they have this big decline in either workers comp costs or healthcare costs. It usually doesn't work that way. There's usually something that explains it and it usually regresses back to the mean. I think, if I can try to answer -- what I think is the implication of your question, there was a temporary decline in things like elective surgery, and frankly, healthcare in general. People even start to stop going to their primary care physicians and so forth, that decreased healthcare costs temporarily. And I hate to use that word transitory, that is now the favorite word it seems talk about inflation, but it's very clear that that was transitory and that healthcare costs will come back. And so I think to the extent you had below normal renewals, which would be our situation because we don't take risk on healthcare, so we wouldn't see it in our margins and in our cost structure. But to the extent that we had below normal renewals, we would expect those renewals to go back to normal because we would expect as healthcare costs go back to normal slowly, that those costs would have to be pass-through. When you look at the healthcare insurance companies, as much criticism as they get, they are largely pass-through entities. They're paying hospitals, and providers, and other healthcare costs, prescription drugs, etc. And it's really not a business where you can say, we can't pass this 10 percent increase in healthcare costs because their margins are even 10 percent. And so that business is very straightforward, which is they try to earn a markup or margin for doing what they do in terms of managing networks etc. But in the end, they have to pass those costs through. We have to also, because we're a passive entity as well. And I think those who take risk on healthcare will probably see those costs go up over some period of time.
Mark Marcon: Appreciate the comments. Look forward to seeing you on the 15th.
Carlos Rodriguez : Same here.
Operator: This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez : There's not much more I can say as we really had terrific results. I want to thank Don for joining and I think you're all going to be very happy to meet him and get the benefit of his experience in ADP more broadly, besides just in the finance organization. Because he has kind of real-world business experience within ADP as well. The -- I just want to end the way I usually end which is thanking our organization and particularly our front line associates because I'm not sure what's going on in other companies. but we would not be able to get our goals accomplished without people going above and beyond. I think we mentioned the tight labor market and that we're a little bit behind in terms of our hiring, that means our people are working extra hard. An economist said, that an increase in productivity, I'd say that's just people working hard. And we really appreciate it, our clients appreciate it. I think our shareholders appreciate it, and I don't think a lot listen to this call, but you should be aware of that, whether it's here in other companies, there's a lot of people out there that are pushing really hard to deliver. And many of us, whether we're as consumers or buyers of products and businesses and so we're frustrated by what's happening in terms of supply chain and some of these other things. But all I see is a bunch of people working really, really hard to try to fulfill the needs of our clients. And I think that's happening across the whole economy. And I think we'd show a little bit of patience with each other. Because this will all normalize as these variant now recedes, I mean, you're seeing already and some of the mobility data, things will slowly get back to normal. People will come back into the labor force. And this great economy that we have will function, the way it's supposed to function. But in the meantime, I want to thank our associates for what they've done so far, whether it's this last quarter and what they're going to have to do to get through this year-end, which is going to be very challenging given the volumes we have and the capacity we have. So for that, I thank them, but I also thank all of you for listening and for being supporters of ADP. Thank you.
Operator: And this concludes the program. You may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I will be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2022 Earnings call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. I'll now turn the conference over to Mr. Daniel Hussain, Vice President Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you Michelle. Good morning, everyone. And welcome to ADP's first quarter Fiscal 2022 Earnings calls. Participating today are Carlos Rodriguez, our President and CEO and Don Maguire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe is useful to investors. And that includes the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements, that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results, to differ materially from our current expectations. And with that, let me turn it over to Carlos. Thank you, Danny. And thank you, everyone for joining our call. I'd like to start by welcoming Don Mcguire, our new CFO. Don has been with ADP since 1998, when he joined the ADP Canada Team as a VP of Finance. He's held a series of roles with increasing responsibility, most recently serving as President of our international business, where he's done a phenomenal job of driving growth and profitability in a very complex environment. I know he's looking forward to meeting all of you."
},
{
"speaker": "Carlos Rodriguez",
"text": "Now, moving on to the quarter. We're pleased to have delivered a very strong start to the year with 10% revenue growth and 140 basis points of margin expansion, resulting in 17% increase in adjusted diluted EPS. While we did expect our Q1 revenue growth to be above our prior full-year guidance range, this result was still above our initial forecast and underscores the strong position, we are in as we emerge from the pandemic. I'll let Don go through the details after I cover some highlights. Our ES new business bookings results for very strong, representing another record Q1 bookings amount. And we're ahead of our expectations, but our performance driven by continued strength in our HR portfolio, in our international business. With this impressive bookings performance across the enterprise, we're pleased to raise our ES bookings guidance for the year after just one quarter, as we're now feeling even more confident about our sales momentum. Even stronger was our CEO bookings performance, which was also well ahead of our expectations. And a key reason that we are raising our guidance for average worksite employee growth for the year, as Don will outline for you. As you will recall, we have been sharing our sales productivity trends over the course of the pandemic and I'm pleased to report that in Q1 we were well above pre -pandemic levels. We reached this result several months sooner than we expected, and we expect us to continue as we look ahead. Our ES retention remained incredibly strong as well. As we shared last quarter, we believed it was reasonable to assume a slight step back and retention from the record 92.2% level we experienced last year. But in Q1, we did not see meaningful deterioration. Instead, we actually saw further improvement in our overall ES retention to a new record Q1 level, despite amongst decline in our small business division, where out of business losses started to trend back to more normal levels compared to the below normal levels last year. We're continuing to assume a slight decline in our retention outlook for the year. But clearly, we are pleased with our performance so far in the upward revision in our retention outlook reflect the strong Q1 performance. Our ESP pays per control was solid with 7% growth in the quarter, about in line with our expectations. We feel that a number of questions these pass over months about what we think might drive workers back until the labor force. While we don't have an answer to that question, what we can tell you is that we continue to see positive trends. Our clients are eager to hire and we are seeing workers returned to the labor force, even if it's gradual. As a result, we expect to benefit from above-normal and above-normal level of pays per control growth over the course of the year. In addition to the very strong ES performance, our PEO delivered another stellar quarter with 15% revenue growth and 15% average worksite - employee growth. Even better than the high expectations we had coming into the quarter. There were multiple drivers to the outlook performance in the PEO, including the strong level of hiring within the client base, resilient retention, and the improved bookings performance I mentioned earlier. We're very pleased with the momentum we see building in the PEO. And we're raising our full-year guidance accordingly. In addition to the financial highlights, there are a few product highlights I wanted to share with you. First, I'm excited to share that we completed the initial roll out of our new user experience for RUN. As we shared with you last quarter, this represents the most comprehensive refresh we've done since the launch of RUN. And we're very proud that in a matter of a quarter, we were able to seamlessly move hundreds of thousands of clients to a new and better user experience. Early signs indicate the client satisfaction scores to trend even higher than the record levels we already have in our small business division. So it's a really great outcome and represents a very strong execution by the team. I'd like to also share that at the Annual HR Tech Conference a few weeks ago, our innovative diversity, equity and inclusion tool on a DataCloud platform was named a top HR product. This recognition adds to ADP's longstanding history of award wins at the conference, marking an unprecedented seven consecutive year ADP has been honored for its innovative HCM Technology. You can probably talk from the number of times we've highlighted DataCloud that our velocity of innovation has increased significantly there. With this solution as an example, we've seen over 50% of active users of the solution take action and realized positive impact on their measures. I'm proud that we provide solutions that drive real positive change for our clients. The 7 year track record demonstrates that innovation is part of ADP's DNA. And then we have a strong growing agile R&D team committed to delivering solutions in the market that continue to push the boundary of what HCM solutions can do for employers and employees. As I said before, we're very pleased with a fantastic start to the year. We look forward to sharing even more of the ADP story with you at the upcoming Investor Day in November. And now I will turn the call over to Dan for more detail on the quarter and the outlook."
},
{
"speaker": "Don Mcguire",
"text": "Thank you, Carlos and everyone on the call good morning. And nice to meet you. Our first quarter represented a strong start to the year with 10% revenue growth on both a reported and organic constant currency basis. Our adjusted EBITDA margin was up a 140 basis points much better than expected, and was supported by higher revenue and overall cost containment. Our tax rate was up slightly in the quarter versus last year. But we also benefited from the elevated pace of share repurchases following our debt issuance in May, combined, those factors contributed to a 17% increase in our adjusted diluted earnings per share. Moving onto the segments, our Employer Services revenue increased 8% on a reported and organic constant currency basis. Our strong Q1, ES bookings guidance performance, and record retention contributed to this performance. Though, as a reminder, we did continue to lap some of the lower revenues we had last year in some of our volume-related businesses, including recruiting and background screening. Our clients finding interest represented only a slight headwind in the quarter, as our 40 point, basis point decline in average yield was offset by fantastic balanced growth of 22%, driven by client growth and planner growth, higher wages and the lapping of the payroll tax deferral last year. ES margin increased 150 basis points on strong revenue performance and overall cost containment. As Carlos mentioned, our PEO had another terrific quarter. Average worksite employees increased 15% year-over-year to $629,000 in revenues, excluding zero margin pass - throughs from 20%, supported once again, by favorable mix trends within the PEO employee base, as well as improving SUI rates. Total PEO revenue grew 15%, which included a modest drag from lower zero margin pass-through growth and worksite employee growth as expected. PEO margin was up 70 basis points in the quarter driven by operating leverage. Overall, our Q1 results reflect a very strong start to the year and delivered ahead of our expectations on practically all fronts. Let me now turn to our updated outlook for Fiscal 2022 for ES revenues, we now expect growth for 5% to 6% which we're raising 50 basis points at the midpoint. This is driven by several underlying factors. We're raising our expected range of ES new bookings growth to 12 to 16%. As we mentioned, we had a better-than-expected performance in Q1 and reached pre -pandemic productivity earlier than we had fore - casted. We haven't made significant changes to our rest of year outlook at this point, but if momentum remains as strong as we've seen it then we may see opportunity to deliver additional upside. We're also raising our ES retention and we're now assuming a decline of 50 basis points off of FY21 all-time highs versus our prior outlook of a decline of 75 basis points. As with bookings, this is primarily a function of the strong Q1 performance. Our continued assumption is that as clients continue to re-engage in the marketplace, we may experience a slight decline over the course of the year. We expect to have significantly more clarity once we get through the calendar year-end period. Where we typically see most of the switching activity. For U.S. pays per control. we're making no change to our outlook of 4% to 5% growth. We continue to expect a gradual recovery in the overall labor market, and the 7% growth in Q1 was about in line with our expectations. And then for our client funds interest revenue, we're raising our outlook by about $15 million to a range of $420 to $430 million, as we're raising our balanced growth assumptions by about 4%, to growth of 12 to 14%. Our outlook for client funds yield meanwhile is unchanged despite the improvement in the yield environment. Primarily, as our stronger balanced performance actually created a temporary mix shift to overnight investments until new securities are gradually purchased. But that said the favorable shift in the yield curve is clearly helpful to us and we'll certainly benefit our multiyear client funds outlook, all else equal. For ES margin, we now expect an increase of about 75 to 100 basis points, up from our prior range of 50 to 75 basis points. While we did outperform meaningfully on margin in Q1, we're also seeing some additional expenses over the rest of the year, including higher headcount in our outsourcing businesses. Meanwhile, we continue to expect transformation initiative benefits, including our digital transformation to offset a year-over-year increase in facilities, T&E expenses, and other return to office expenses. Moving onto the PEO, we now expect PEO revenues to grow 11 to 13%. Average worksite employees to grow 11 to 13% and revenues excluding 0 margin pass - throughs to grow 12 to 14%. This 2% point raise across-the-board is a function of both our strong Q1 bookings and overall performance, as well as an expectation from stronger hiring within our PEO base to contribute over the remainder of the year. RPO was very well-positioned to capitalize on growing levels of client demand coming out of the pandemic. And if we continue to drive outside booking performance over the rest of that of the year, that could represent further upside to our outlook. Following our strong start to the year, we now expect a range of flat to down 50 basis points for the year, for an improvement from our prior expectation of down 25 to 75 basis points on our margin. As a reminder, we are growing over a very strong margin results in fiscal 2021 and are also expecting elevated selling expenses this year from strong bookings performance, Turning them all together for our consolidated outlook, we now expect revenue to grow 7% to 8%. Following the strong 10% Q1 performance, we now expect the remaining quarters to grow closer to 7%, which is higher than our prior forecast. For adjusted EBITDA margin, we now expect an increase of 50 to 75 basis points. As we shared last quarter, we expect our margin improvement to be back-half-weighted. Most specifically, in the Fourth Quarter. Our current expectation is for a slight margin decline in Q2 and Q3. We're making no change to our tax rate assumption. And with these changes, we now expect growth in adjusted diluted earnings per share of 11% to 13%, as I think you've heard us say a couple of times now we are very pleased with our Q1 results and we're happy to be raising our guidance this early in the year. This is still a dynamic environment, and there are a wide range of potential outcomes. And we believe our guidance is appropriately balanced given these conditions. However, should our associates continue to drive better-than-expected sales results, client satisfaction, efficiency, and service and implementation. We would see opportunity to deliver additional upside to our outlook. Before to move in Q&A I wanted to share 2 things. First, I look forward to meeting everyone perhaps virtually for now. But eventually in-person as we get back out on the road to meet our shareholders and the investment community. And second is that we are very much looking forward to our upcoming Investor Day in a couple of weeks on November 15th. Having run one of our largest businesses for years, I can tell you there is always much happening here at ADP on the ground. And although it all tends to roll up to a very stable financial picture, I can tell you there's a lot of excitement among our associates for the things they're working on. We hope to share some of that excitement with you in November. And with that, I will now turn it back over to the Operator for Q&A."
},
{
"speaker": "Operator",
"text": "We'll take our first question from the line of Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning and thanks for taking my questions, congrats on the really strong start to the new fiscal year. So Carlos, maybe I want unpack the drivers to the strength on the new bookings side, I know productivity is clearly one, but how should we think about -- how should we think about the product side and within the product portfolio where that strength was in terms of driving new bookings?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So we -- even though what we really talked about is ES bookings, just want to start by saying that the PEO Bookings were incredibly strong. I don't know how else to put it. So I call it orders of magnitude in terms of growth rate higher than even the ES bookings growth for the quarter. That was really good to see. So that's kind of a sign to your question about products that I think the market is really searching for solutions coming out of this pandemic, that helped them with obviously people issues and sort of, but there's also a talent for -- so people are looking to obviously attract and retain people in this environment where every Company, including ADP, is going through some of these challenged in terms of retracting our own internal talent. And then you have another dynamic which is, if there are shortages of labor in various categories there we're hearing that there's also shortages of talent in kind of HCM category in general that should create a little bit of an advantage for the clinical outsourcers, right? So as you know, our model is, we provide great technology and software, but we also do the back-office work and we take accountability for outcomes. And I think when people are struggling to hire people to do the work in their HR department, or their payroll department, or their benefits department, we're here to help. And so I think those outsourcing solutions are getting a lot of tailwind. We also saw because of the easy comps and I think you've heard it in Dan 's comments. Some of the things like our recruitment process outsourcing business and our screening and selection business, which we're really at very low booking levels last year at the same time, have rebounded off for obvious reasons, incredibly well. But having said that, it was really across the board. We had very strong growth in workforce. Now, we had very strong growth in the up-market. We had strong growth even in a down-market. Although last at the same time, I think we mentioned that we had when we call client-base acquisition which is not technically M&A deal, but we were able to buy and large book of business that we converted, that really some of that flowed through our bookings. So I'd made that comparison a little harder on the SBS side, but if you back that out, it was equally strong on the SBS side as well. I would say that could give you a little bit of color, but it really was across the board. It just shows how connected we are to the economy and GDP when it comes to bookings, which is something that we've had the theory here for some -- for some years now, and we just have a very strong recovery in a very strong economy. And it's a great environment for our sales force."
},
{
"speaker": "Samad Samana",
"text": "That's very helpful. And then, Don Maguire, maybe one for you on the retention side. So obviously it's -- it's really impactful into to raise the outlook one quarter and I think signals the strength that you're seeing. But just help unpack the slight uptick in the SMB side moving a little bit more towards normal in terms of business failure. Should we think that the offset there is even better-than-expected retention in the mid-market, or on the enterprise side? Can you maybe help us think about it across the customer size spectrum? How to balance those different moving parts?"
},
{
"speaker": "Don Mcguire",
"text": "Yes. Sure. I think it's fair to say and we commented on it that the retention is at an all-time record for our Q1. So that's fantastic and better than we had expected. The expectation as we went into the year was to see particularly in the smaller business statement, to see that slipped back a little. And indeed it has, but it hasn't slipped back nearly to the extent that we had anticipated. So we're even better there against what we had previously thought. Of course, then that means that we did have and continue to have good retention levels in the mid-market and the upmarket. So we expect that to -- we expect that to continue. However, as you know the cyclicality of our business and the seasonality of our business. We will need to get through the calendar year end, which is when we see most of the switching activity because of the drivers in new starts the year etc. So we are positive and we did take our retention estimate up for the year and we'll see if it holds and perhaps it's better than we expected."
},
{
"speaker": "Samad Samana",
"text": "Great, thanks. And I look forward to seeing at the stand person and a few weeks."
},
{
"speaker": "Don Mcguire",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jason Kupferberg with Bank of America. Please proceed."
},
{
"speaker": "Jason Kupferberg",
"text": "Good morning and thank you for taking my questions. This is actually may hear about on for Jason. Don, firstly, congratulations on the role. Maybe you can talk a little bit about your priorities in the CFO role and how they could maybe look a little different than on the . And just relatedly, should we expect an update, the multiyear targets at next year's Analyst Day. And then I have a follow-up. Thank you."
},
{
"speaker": "Don Mcguire",
"text": "Yes. So I guess what I would say is I've been with ADP for a long time now. And I guess what I observed in the roughly 23 years I've been with this Company is that ADP has always had a very strong financial organization with a strong finance leader. And I want to make sure that we continue that. I am sure we will. I think that the priorities that we have are well set out in our Strat plan previous Investor Days, etc. So we'll probably provide along with an update on those things that when we get together on November the 15th. But let's wait until then and I don't think you're going to see any dramatic changes. We pretty much have a well-discussed, and well-disclosed trajectory, and plan, and we will update you on that on November the 15th."
},
{
"speaker": "Jason Kupferberg",
"text": "Understood. Thank you. And then just if I could ask about just sales for spend, just clearly seeing some very strong momentum in the market. So I was wondering if you have any plans for sales force growth in Fiscal 2022? And which part of the market those ads would be concentrated in. Also anything notable to call out in terms of just the mix of new logos versus cross-sells in your bookings for the quarter or in the forecast. Thank you."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think in this kind of environment, given the very first comments we made about the economy, and you have both the economy of the tailwind and you have now in the U.S. I think an administration that is kind of more inclined to regulation into, particularly employer regulation. And so you have, I think a very strong backdrop for what I would say is the foreseeable future. In that environment, historically, what ADP would do is we would add as much sales capacity as possible. That doesn't mean that we indiscriminately hire because we have people to hire and onboard and train and so forth. And we have to make those people effective. But I would say that we have a strong appetite for growing our sales force, but also for growing our investment in marketing. Whether it's digital marketing or more traditional advertising. And that's exactly what we plan to do. Having said that, I would tell you that we've had challenges like everyone else, in terms of hiring, it's a very difficult labor market. So I hope that we can fulfill those expectations, those dreams, if you will, of growing our sales force as fast as possible. But that's the only thing that I could see getting in the way. We obviously have the capital, we have the I think the desire and we have, I think the experience to be able to execute once we hire those people to get the sales, get the clients implemented, and then hopefully derive the benefits of that revenue for, in many cases 15-20 years, depending on which business unit you're in. And so I guess I would say strong appetite for both headcount growth, but also other investments in sales. Whether it's marketing, digital marketing, sales tools, all across-the-board."
},
{
"speaker": "Jason Kupferberg",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tien-jian Huang with JP Morgan. Your line is open."
},
{
"speaker": "Tien Jian Huang",
"text": "Thanks so much. Good results here. Just on the PEO side, I'm curious how much of the general improvement there is secular versus cyclical? And I know Carlos, you talked about putting more sales energy there as well. Just curious, what's changed?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So the risk of -- because we had a strong feeling that the PEO business was going to be strong coming out of the pandemic. Because it's been strong coming out of prior economical recession. and those are the different recession. So I have to be careful about any specific predictions. But we had some challenges, I think coming out of the pandemic with the price that we're selling in the PEO were slightly smaller and just ballpark it around 10% smaller. So let's say that the average, I'm just going to make up the numbers. Let's say the average new clients over in the PEO with 3 worksite employees and all of a sudden, prior to the pandemic and that's been can quote, growing slightly over the years. All of a sudden it came down to like 27, so 10% decline. So even if you sell 10% more units, if the units are at 10% smaller, you basically end up in the same place. So that's a little bit of what we were expecting. We believe that a 100% related to the economy, and to what was happening with the pandemic. Now what we've seen in the recovery is both the unit growth is still strong as it was prior year, and now our unit size has recovered. And so the combination of those 2 things has created really, really strong growth in the first quarter in the PEO. The only caveat that I would add also is that we did have a transition into a new year, as you know, our fiscal year ended on June 30th. And in some cases, our businesses tend to perform really extremely well in the first quarter when they come out of a year where -- I wouldn't call it under-performance because it was still a good year last year, given the circumstances. But clearly the PEO, we were very, I think, clear that the PEO had been trailing, in terms of recovery when it comes to bookings, what we were seeing in EF. Now, as we expected, the horse race now -- the horse in the lead has changed. So now the PEO is the one leading the race."
},
{
"speaker": "Tien Jian Huang",
"text": "Thank you, Carlos."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thank you and congrats on the results and Don Welcome. Hey, I wondered -- could you give us a sense, Carlos, from a sales perspective, despite the tight environment you're still delivering, is there any way to think about the go-to-market strategy this cycle as opposed to last that and how maybe technology and maybe more of a mix down-market helps drive that process. I guess what I'm saying is there more leverage in the sales force today than you've ever had, is there any way to maybe put some parameters around that?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I think there is definitely more leverage in the sales force than we've ever had because -- I mean, I think maybe what you're alluding to our sales force like a lot of other of our competitors had to go to a 100% virtual for a number of months, and I'm sure every competitor handled differently in terms of how long they were virtual, versus when they went back in the field. But that process which we had been learning about for 20-25 years, like we have almost a third of our sales force already selling what we call insights sales. And so they were able to sell virtually. They had been in a building, but it didn't really matter whether they want the building or in their homes. They were still able to sell very effectively. That was an easy transition for that portion of our sales force, and then we really with the appropriate tools and some training and some learning from our inside sales force we really moved our entire sales force to sell virtually. So I think now we're really in a period where we're going to sell based on, however the client wants to be sold. And so if the client wants a combination of an initial video call on Zoom or WebEx, we'll do that. If the client once an in-person visits we'll do that if they want to close the deal with an in-person, but start with a video, we can do that. So I think there's no question that if Salesforce leverage has increased for us, but admittedly, probably for our competitors as well. Our reach has definitely been extended. There's no question about that in terms of tools, but also philosophically. I think we are now, I think able to sell in a, I mean to use a cliche and omnichannel way. We're also investing heavily in digital marketing. So you mentioned the down-market, I would just add that because of some of the comparisons to the down-market had that was not withdraw the sales results this quarter. It was actually all the other businesses. So but we do see the underlying strength in small business. But because of the difficult comparison, it's not reflected in the percentages. So not trying to minimize the strength in the momentum in the down-market, I'm trying to emphasize the strength everywhere else in the portfolio. And the rest of the portfolio also can benefit from digital tools, digital marketing, but it's not quite as leveraged as it is in the down market. So I think it's a combination of a lot of different things, but the overall, I think comment would be there's no question that there is increased leverage in the Salesforce and you're seeing it in terms of the productivity numbers. I mean it, we are frankly very positively surprised by the rebound in what we call average sales force productivity. So the actual sales rep level, how much are they selling today versus what were they selling in Fiscal year '19. And that is back to, and above that level, which is very pleasing to us."
},
{
"speaker": "Kevin McVeigh",
"text": "That's helpful. And then just one real quick one on retention. What was the boost kind of all the Q1 over-performance because I know the Q2 December's big quarter in terms of retention, things like that or is it just more optimism over the balance of the year or a little of both? Is there any way to frame how much of that boost was maybe Q1 over-performance as opposed to how you're feeling over the balance of the year?"
},
{
"speaker": "Don Mcguire",
"text": "Maybe I will take that. I think our retention, certainly we're very happy with the Q1 record we have, but I think it's also heavily linked to the success we've had over the last few years with our improvements in NPS. And as our NPS continues to go on the right direction and improved, we're seeing general increases in retention to go along with that, I think that's what we would expect and that's what we want to see happen. So I think there is some relationship there. The -- with no doubt that the retention is very good and we're benefiting still I think from a little bit of some of the concerns coming out of the pandemic that clients may have about switching it during a time of still virtual for many. So we're benefiting from that as well and we acknowledge that. But as I said, we're very happy with the retention and the progress we're making with our products and our service that go along to driving those retention numbers. We will see a little bit of a step back perhaps in the down-market. But as we said so far, it's soft living up better than we expected."
},
{
"speaker": "Danyal Hussain",
"text": "And just to clarify, because we did share in our prepared remarks that the raise which primarily a function of the Q1 results, obviously we have the stability in October as well."
},
{
"speaker": "Kevin McVeigh",
"text": "That makes sense. Thank you."
},
{
"speaker": "Operator",
"text": "Next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El Assal",
"text": "Hi, Gentlemen. Thanks for taking my call this morning. I wanted to ask about margins and forgive me if you addressed this in some detail, I missed a bit of the call earlier, but it came in really strongest quarter well above our model, can you speak to the drivers of the beat and also to their sustainability as we move forward."
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure, let me start by saying that the margin in the first quarter was a record for us. And it was above last year as we just reported But if you go back to last year -- last year was above the prior year. It's quite impressive that we had margin improvement last year, given that we were one quarter into a pandemic. But it's even more impressive is that impressive that we had margin improvement again, having said that, up the victory lap. Then the other part of the comment is we had way higher revenue than we had anticipated, which is incredibly gratifying We're very happy about that, and it was really in both ES and PEO. And it was an a bunch of different places. Slightly better pace per control, retention was better. You heard all the comments. We have just a lot of things working in our favor here. The expenses have not caught up to the revenues and so right now, we are trying to add capacity, both for implementation and service, particularly ahead of our year-end period. And so like other companies, the most important thing for us is to be able to execute on our commitments to our clients, and to be able to start a business that we've sold. And so I would say that that's a dynamic that factored into the margin performance, but I don't want to take anything away from the organization or anything away from the operating leverage because it's pretty impressive what the organization was able to accomplish. But had we known where we were going to be in terms of top line and volumes, we would have more headcount today than we have. And there is some catching up to do. Now to put a fine point on that, don't think of, we have to add hundreds of millions dollars with expense, we're just a little bit behind, and that's why you see in case someone's asked it yet may as well address it head on for the rest of the year. When you look at the EPS and the guidance, we really not raising by much more than what we had in terms of our performance in Q1. And that's because we are going to continue to invest in both sales and distribution, but also in service and implementation. And that delay in hiring or deferred hiring helped us in terms of the margin in the first quarter, I strongly believe we still would've had a very strong margin performance in the first quarter, even had we hit our headcount numbers for service implementation and volume-related businesses. And I thought I should kind of put that out there because it seems like an obvious question as well."
},
{
"speaker": "Ramsey El Assal",
"text": "That's great and I appreciate your candor there. Quick follow-up from me. I was wondering about the human resources and human capital management products. Can you talk about how the cross-selling process into your basic kit of kind of payroll customers is organized? I'm just trying to figure out sort of how you go about that cross-sell process. And I guess how much of a runway do you see for attach rates to those products?"
},
{
"speaker": "Carlos Rodriguez",
"text": "There really isn't a simple answer to that, to the first part. We'll come back to the -- I think the second question about the attach rates. Let me answer that one first. The attach rates are -- there's a couple of products where we have what I would call good attach rates, acceptable, which is saying as CEO speak for, they could always be higher. Like our benefit admin tools, our time and attendance systems. But most of our products and our worker's compensation tool in a down-market also has a high attach rate. But almost everything else that is quote, unquote, beyond payroll. So HCM in addition to kind of our core payroll solutions, we're way under penetrated in terms of attach rates. So there is a lot of potential, I think for that to improve as well. So on the first part of your question in terms of how we cross-sell, as I started saying, there isn't a simple answer because there isn't a simple answer. In some of our businesses, we have very distinct organizations like in the down-market, we have a large down-market sales force that works with accountants and other kind of third-party channels and also sell directly. And then we have a sales force that sells our retirement solutions are 401K products. And our insurance services solution, those are distinct sales forces that basically share leaves with each other, and they have incentives to do so. That down-market business also feeds business to our PEO through also incentives. But there is a separate and distinct sales force in the PEO as well. When you get into the up-market and into the mid-market, you start to get some portion of our sales force which is able to sell multiple products or whatever call bundles. But even then, you still have specialized sales forces in certain circumstances, depending on, I think the specialization or the complexity of the product. But in all cases, we have primary sales. What I would call primary sales people. So the quarterback, if you will, on an account. Now I'm talking about upmarket and mid-market and those quarterbacks are really in charge of making sure that when it's appropriate, and when a client has a need that we bring in our specialized sales people that have specific knowledge about some of our other HCM solutions. So I wish I could give you a simple answer, but that's actually part of the secret sauce, right? In terms of our ability to grow and outperform some of our competitors is to be able to do that well. And I'd like to say that I invented this, but this is something that goes all the way back to the Frank Wattenberg days and to my predecessors . And this is a well - oiled machine in terms of our sales and distribution. And specifically, you've just described about the cross-sell. And again, to put a fine point on it roughly 50 percent of our bookings come from cross-sell and roughly 50 percent of our bookings come from new logos each year."
},
{
"speaker": "Ramsey El Assal",
"text": "Very helpful. Appreciate it. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Carlos, I just wanted to get your thoughts. I know you talk to obviously a lot about new sales and I'm wondering, outside of this wage inflation that you're seeing. Is the cost to acquire clients going down, especially on the SMB side now that there is a new way to sell to them? Or do you think the cost to acquire clients as we move through this pandemic will go back to what it was?"
},
{
"speaker": "Carlos Rodriguez",
"text": "I wish I had a crystal ball in terms of answering where it's going to go. But I think just from a mathematical or technical standpoint, the cost of sale is definitely pulling down because of this productivity increase. So this is the same leverage that you're seeing in so many industries and so many businesses, including ours, on the revenue happens on the bookings as well. When you get higher volumes it basically indicates higher -- unless you add a lot of expense, by definition you get higher productivity. So you see us being reported in the press all the time about, how worker productivity is up. Well, hardly reason why worker productivity is up is because revenues of recovered, volumes have recovered, and it sustained people. Or you're adding a few more people now. Maybe people aren't focusing on, is that worker productivity went down, right as the pandemic kind of set in and people's revenues went down. So I hate to make it so simplistic, mathematically. But some of that is what's happening now. So you do have to be careful about jumping to any medium to long-term conclusions because right now our cost of sale compared to last year and the year before is definitely coming down as a result of a very large increase in bookings with how a similar increase in expenses. We still though are not back to where our cost of sale was pre -pandemic. And we hope to get there. But that will require even a little bit more productivity during this year. But that would be our expectation is that whether it's the GDP or interest rates or employment, that, there's regression to the mean here as they very large economy. ADP's large Company, but the economy is massive, and it tends to regress to the mean on a lot of things, and we also tend to regress to the mean s. So I think some of these things will work themselves out. And you have to just get past the base effects, and the comparisons, and so forth to really understand where you are, and we won't know that until we're on the other side unfortunately, I hate to say it."
},
{
"speaker": "Kartik Mehta",
"text": "Thank you very much. Appreciate it."
},
{
"speaker": "Operator",
"text": "Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Thank you very much and thanks for all the this morning. I guess maybe I just want to ask the obvious headline question and just wondering how the reported current tightness in the labor market, as factored into your guidance? And how are you anticipating on that changes through the coming fiscal year? And I guess maybe a product and service-related question tied to that. Are you seeing incremental sales opportunities with some of the tech that you can provide to your clients for hiring, etc. and is that having any impact on how you're thinking about your outlook and forecasts? Thanks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thanks for the question. The second part of your question, I think kind of answers the first part. The answer is yes. Like, I think part -- again, hard to separate how much is just pure GDP growth, new business formation etc. But the last part of your question, there's no question that part of our growth is driven by what you are alluding to, which is everyone now is looking for help in terms of hiring, attracting people, and frankly, also trying to hold onto them. This is a great environment for us. The combination of strong GDP, an administration that is more inclined towards regulation, and then a tight labor market for people who do the things that we do. By that I mean, payroll staff and HR staff at prospects and our clients. That's all a very good backdrop for us. I'm assuming that -- this is not going to resolve itself overnight in terms of the tightness in the labor market. We should anticipate some tailwinds here and some help for some period of time, until that changes. And I hate to use the R word, but some day, at some point in the future, doesn't see m anywhere near future given what's going on with government stimulus and government policy. But someday that might change. But we don't see that on the horizon right now. On the very first part of your question though in terms of the tight labor markets, I would say the overwhelming impact of tight labor markets is positive on AEP. I mentioned one of the challenges we have, which is tight labor market affects our own internal associates in terms of we have to hire service people and implementation people, so it's harder for us like it is harder for anyone else. But that pale in comparison to the upside, like a tight labor market drive new bookings as we just talked about in the last part of your question. But it also could create inflationary pressures, which drives our balanced growth. It should drive interest rates higher, which is one of the most underappreciated stories, I think of ADP is the potential upside in our flow business. And the reason it's underestimated because it's done nothing for 10 years because they've been here for 10 years and has been nothing for pain and headwind. And just what I thought we were coming out of it, we go into a pandemic, and we get more pain, and race go even lower than they were before. But I'm pretty sure that it those changes any lower now. Although, I think we may have to file an AK after saying that. I'm making a statement on interest rates. But, whatever. Hover around here, go down a little bit there, but it feels pretty certain that the long-term, medium and long-term trend now for interest rates will be at least for gradual increases. And I'm not suggesting that there's still underlying demographics that may keep us from getting back to the same kind of 10-year rate that we had 15 years ago or ten years ago. But I think everyone knows when you look at real interest rates that there is upside on interest rate. So the tight labor market helps in a number of ways. It creates activity for our sales force. Every time there's activity and there's conversations, we're going to win our fair share. So that's a great backdrop. It creates opportunities for our balances. I think it creates opportunities for the PEO because some of our billings are actually driven by as a percentage of wages. And whenever you have wage inflation, if you are building on percent of wages, to some extent that will help, that's not So, like an infinite thing because we won't just allow our revenue to go up indefinitely. We'd have to adjust those rates but in the medium-term, we will see, I think, some tailwind from -- in the PEO from higher wages and wage growth, which is inevitable outcome of a tight labor market."
},
{
"speaker": "James Faucette",
"text": "That's great color. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. I had to follow-up first on retention. Curious, within the record, 1Q retention performance, can you dig in a little bit more as far as the drivers there between the still lower out of business closures versus essentially better competitive win rates, And anything broadly, you can comment on around -- around clients switching behavior or client re engagement to assess HCM solutions?"
},
{
"speaker": "Carlos Rodriguez",
"text": "On the first -- on the first part, I'm not sure how much more color we can give you. We have a fair amount of detail in terms of losses and retention around, we call non-controlled the losses which are broadly speaking out of business, bankruptcies, etc. And those have started to trend back up again. They're not back to normal levels, but they started to trend back. I think that's not surprising because there's still a lot of liquidity, and a lot of stimulus if you will, even if it's not new stimulus. So when you have consumer spending doing what it's doing, and you have activity doing what it's doing. It tends to be supportive of small business rather than the normal turnover that you have that's natural in the small business sector. I guess with hindsight, like if 3 or 6 months ago, when we were putting together our plan, we'd had a crystal ball, we would've probably -- and we had experienced with the pandemic, we probably would have planned the downturn in retention to be slower. So we've been positively surprised by how long it's taking for those losses to regress back to normal. Having said that, we don't know that they're going to regress 100 % backs because there's other parts of our retention that are controllable. We call controllable. In our controllable losses, we see those going down as well. And I think Don made a common thing that should not be lost on you, which is that our client satisfaction scores as measured by NPS, are the highest they've ever been. And I give credit to the organization for during the pandemic, being able to get through what was an incredibly difficult time for them personally, in terms of they were trying to help our clients. But we also had a huge increase in volume because of all the government stimulus programs in the PPP loans, etc. And this happened all over the world, it wasn't just in the U.S.. And fortunately, we maintained relative stability in our headcount. We didn't do mass layoffs and let a bunch of people go. So the combination of maintaining investment and also being able to, to have people -- I don't know how to described it. Make a efforts to help our clients, we were able to maintain those NPS where that actually haven't go up. And there's staying at very strong levels, and we believe that there is a correlation between strong NPS and retention. So we may be able to see new record highs for retention on a permanent basis, but it's way too early to make that prediction."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. And then just follow-up on, on next-gen HCM platform. Can you provide an update on new sales there? Maybe the pipeline and sold clients versus lifelines, any metrics or updates you're willing to share?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Sure. I think we talked about over the last couple of quarters as we kind of entered in the pandemic, we obviously had a couple of particularly large clients that we're in industries that were particularly hard hit. So we've got put on a little bit off course, if you will, in terms of our implementations and our starts. We also, I think, started to focus on implementation tools. I think we had -- I don't know how many set -- how many we said we had sold. And as we started implementing in starting these clients. We recognize that we still have some work to do in terms of implementation tools and making sure that if and when we want to use third-party integrators to help us with that, that we need to build out those tools. There has been quite a lot of focus on that effort. And we feel good about it. We actually -- I think we also talked about investments in the last quarter that we made to bring in some third-parties to help us with the evaluation. And in some cases, the build of that to make sure that as we now enter a hopefully a period of time where we can really accelerate the implementations and the growth and the starts of those clients. But it's fair to say, and I think we said in the last couple of quarters that our focused turn ed more to, making sure that we have a strong foundation and that we had the right implementation tools to be able to get the business started that we intend to have in the next year or 2, which is hopefully quite -- quite a lot of business. And you'll hear more details about this when we get to our Investor Day on November 15th."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Eugene Simuni with Moffett Nathanson. Your line is open."
},
{
"speaker": "Eugene Simuni",
"text": "Hi, thank you very much for taking my questions. I have badge the couple in the PEO, so I'm asking upfront. One is that, if you look broadly at your HRO offerings, so PEO and non-PEO, can you compare and contrast for us a little bit to the PEO Solutions and non-PEO hopefully outsourced solutions, how are you seeing them growing relative to each other the demand? And are you seeing any switch in between clients who might be using that HRO Solutions without benefits switching into the PEO? So that will be the first one and the second, I was just curious. How are you positioning the be-all franchise to really win market share in a post-pandemic environment, given the secular growth seems to be very favorable. But how do you actually make sure that ADP wins share?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So on the first -- on the first question, I think I said in my early comments that all of the HRO Solutions, the Corporal Outsourcing Solutions, are very, very strong across-the-board, right? Up-market because we have HRO Solutions in the up-market, we have in the mid-market, and we have them in the down-market. And in in the down market -- and in the mid-market, we have PEO, but we also have what you're alluding to, which is a non-core employment. What I would call -- we call it comprehensive services, as the name implies, it provides a kind of broader assortment of services in addition to our traditional software in our traditional tax and other services. There is to my knowledge a lot of switching from clients that are, what I would call typical clients of ADP that have payroll benefits and I'd then maybe TLM, etc., whether it's in a down-market in the mid-market into these HRO Solutions, there is not a lot to my knowledge of switching across because it typically. Again, if we're doing our job from a sales standpoint, you are really trying to find the right fit for the client. In some cases, the client wants you to do their benefits admin, and provide their benefits, provide the workers comp, and their 401-K. In other cases, the client wants you to only do the administrative back-office of the payroll department in the HR department which would be the non - PEO solutions. So I think if we do our job well, which I think we do in the sales process, and in the upgrade process, those clients tend to stay on those -- on whatever solution they have chosen. But to be clear, both of them are growing at this point at rates that are multiples of our growth in employer services. And so it's quite impressive in terms of the tailwind and the growth rates that we have in all of the HRO businesses. On the last part of your question, which I think was about positioning PEO in terms of market share and so forth. We have 600 and I think it's 630,000 roughly, we reported worksite employees, average worksite employees this last quarter. That's tripled, what it was 10 years ago in the first quarter of fiscal year 11. And so and that's a higher market share than it was 10 years ago. So I don't know how else to answer that question other than to say that we have a proven track record of execution to continue to drive growth in the PEO that's faster than the markets. So I don't think there's any question about our positioning or our ability to drive market share as evidenced by our ability to execute."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "And our last question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning, Carlos and Don, look forward to working with you. On next-gen payroll can you give us an update in terms of the roll out there, please?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So next-gen PEO, equally excited as we are about next-gen HCM in terms of what this holds for the future for ADP. The challenge for us in terms of as we communicate and on November 15th, we'll try to figure out a way to address this issue. Like, we have 15 billion in revenue. So as well as next-gen HCM are going and next-gen payroll is going, it just doesn't -- this is a future impact for ADP., so it's not in the next quarter. And I know you're not asking a question that's really about next quarter mark, but I think it was a good opportunity to kind of throw that out there. That -- what's driving the performance of ADP this quarter, this year, and for the next 2 to 3 years is not going to be that from a financial standpoint. But in terms of positioning the Company for the future, in terms of growth and creating competitive differentiation and the ability to drive new bookings, they're absolutely critical. So I would say that on those measurements we're still happy and excited by the progress we're seeing with both next-gen HCM, as well as next-gen payroll, we have not gone to general availability, so we're selling a lot of next-gen payroll, but we're only selling in what we call the core of major accounts right now of the mid-market, which is kind of 50 to 150 and this is no different in terms of the playbook that we use with our transition from our old platform to run in a down-market. And some of our more legacy platform in mid-market to then our next-gen Workforce Now version which we're on now. So we're doing the same thing with next-gen payroll and the same thing with next-gen HCM, which is we're doing very carefully that we have a very large installed base. And we are not -- We're going to eventually move some of those clients, and begin to move some of those clients. But we're happy with the business and the cash flow that we have, and the clients satisfaction scores that are record levels on our existing platform. So we do not have any -- this is not panicking. There's no sense of crisis, and there's no -- we have urgency, but no crisis, because I want to make sure people hear that. Like, I don't want you to think that we all have a sense of urgency because the faster we get these two solutions to scale, the faster we beat the competition."
},
{
"speaker": "Mark Marcon",
"text": "I appreciate that, and thanks for the color there. On the PEO growth, can you talk a little bit about two different dimensions? 1 would be, the growth that you're seeing kind of in the established states relative to some of the less mature states and to what extent are you seeing less mature states really catch on? Particularly given the -- the legislative and regulatory backdrop. And then secondly, how should we think about just health insurance costs now that elective surgeries are starting to come back, elective procedures are starting to come back. What impact would that end up having just on the overall pricing? I know that you're not necessarily impacted directly from a margin perspective, but just thinking about the demand environment."
},
{
"speaker": "Carlos Rodriguez",
"text": "It's a great question. I think the second part of question, so hopefully you'll forget about first part because we don't have -- we try to prepare for everything and that one, we'll have to follow-up with you on in terms of what regions or what states, we're strongest in terms of our sales. I'm going to suspect that they were all strong because honestly, like the PEO results were off the charts, there can't be any state that wasn't in strong double-digit growth. But we'll follow up on that question. On the healthcare rate question, you're right that we're not directly impacted, but you're also right to imply that we're indirectly impacted because it does matter, right? It matters to our clients what they're paying for healthcare. And I hate to be so simplistic, but I think what the actual regression to the mean and large economies -- the healthcare world and insurance companies are also similar in terms of they regress, right? So losses have an uncanny way of regressing to the mean. That's why I always caution people when all of a sudden someone thinks that they have this big decline in either workers comp costs or healthcare costs. It usually doesn't work that way. There's usually something that explains it and it usually regresses back to the mean. I think, if I can try to answer -- what I think is the implication of your question, there was a temporary decline in things like elective surgery, and frankly, healthcare in general. People even start to stop going to their primary care physicians and so forth, that decreased healthcare costs temporarily. And I hate to use that word transitory, that is now the favorite word it seems talk about inflation, but it's very clear that that was transitory and that healthcare costs will come back. And so I think to the extent you had below normal renewals, which would be our situation because we don't take risk on healthcare, so we wouldn't see it in our margins and in our cost structure. But to the extent that we had below normal renewals, we would expect those renewals to go back to normal because we would expect as healthcare costs go back to normal slowly, that those costs would have to be pass-through. When you look at the healthcare insurance companies, as much criticism as they get, they are largely pass-through entities. They're paying hospitals, and providers, and other healthcare costs, prescription drugs, etc. And it's really not a business where you can say, we can't pass this 10 percent increase in healthcare costs because their margins are even 10 percent. And so that business is very straightforward, which is they try to earn a markup or margin for doing what they do in terms of managing networks etc. But in the end, they have to pass those costs through. We have to also, because we're a passive entity as well. And I think those who take risk on healthcare will probably see those costs go up over some period of time."
},
{
"speaker": "Mark Marcon",
"text": "Appreciate the comments. Look forward to seeing you on the 15th."
},
{
"speaker": "Carlos Rodriguez",
"text": "Same here."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "There's not much more I can say as we really had terrific results. I want to thank Don for joining and I think you're all going to be very happy to meet him and get the benefit of his experience in ADP more broadly, besides just in the finance organization. Because he has kind of real-world business experience within ADP as well. The -- I just want to end the way I usually end which is thanking our organization and particularly our front line associates because I'm not sure what's going on in other companies. but we would not be able to get our goals accomplished without people going above and beyond. I think we mentioned the tight labor market and that we're a little bit behind in terms of our hiring, that means our people are working extra hard. An economist said, that an increase in productivity, I'd say that's just people working hard. And we really appreciate it, our clients appreciate it. I think our shareholders appreciate it, and I don't think a lot listen to this call, but you should be aware of that, whether it's here in other companies, there's a lot of people out there that are pushing really hard to deliver. And many of us, whether we're as consumers or buyers of products and businesses and so we're frustrated by what's happening in terms of supply chain and some of these other things. But all I see is a bunch of people working really, really hard to try to fulfill the needs of our clients. And I think that's happening across the whole economy. And I think we'd show a little bit of patience with each other. Because this will all normalize as these variant now recedes, I mean, you're seeing already and some of the mobility data, things will slowly get back to normal. People will come back into the labor force. And this great economy that we have will function, the way it's supposed to function. But in the meantime, I want to thank our associates for what they've done so far, whether it's this last quarter and what they're going to have to do to get through this year-end, which is going to be very challenging given the volumes we have and the capacity we have. So for that, I thank them, but I also thank all of you for listening and for being supporters of ADP. Thank you."
},
{
"speaker": "Operator",
"text": "And this concludes the program. You may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 4 | 2,023 | 2023-07-26 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Fourth Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. After prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I would now like to turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead.
Danny Hussain: Thank you, Michelle, and welcome everyone to ADP's fourth quarter fiscal 2023 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter and full year. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Danny, and thank you, everyone, for joining us. We closed out the year with a strong fourth quarter, that included 9% organic constant currency revenue growth, 270 basis points of adjusted EBIT margin expansion, and 26% adjusted EPS growth, and for a full year fiscal 2023, we delivered 10% organic constant currency revenue growth, 130 basis points of adjusted EBIT margin expansion and 17% adjusted EPS growth, representing another strong year for ADP. I'll start with some highlights from the quarter. Our worldwide sales and marketing team delivered exceptional Q4 Employer Services new business bookings growth that was well in excess of our expectations, with strong double-digit overall growth on top of a difficult comparison. The HCM demand environment has been healthy despite a gradually slowing macroeconomic backdrop and we have been capitalizing on this steady demand. Our strong bookings results were broad-based. We had continued strength in our down-market and Employer Services HRO offerings. We also had better-than-expected results in our midmarket, as well as a great finish from our compliance and international businesses. This Q4 performance brought our full year Employer Services bookings growth to 10% compared to our 6% to 9% guidance and our medium-term goal of 7% and 8% growth that we laid out at our 2021 Investor Day. We are, of course, thrilled with this result and excited to keep the momentum going. Our Employer Services retention rate was another highlight in Q4 and came in better than we expected. For the full year, we delivered a retention rate increase of 10 basis points and are back to our record level retention rate of 92.2%, all while absorbing the impact of normalization in the down-market out of business rates. This strong result was driven by record level retention rate, specifically in our U.S. midmarket and international businesses, and by record level overall client satisfaction across our major businesses in the fourth quarter. Our Employer Services pays per control growth was 3% for the quarter, as the overall labor market continued to show resilience, bringing the full year pays per control figure to 5%. We have been pleased all year to see such durable labor demand from our clients. And last, while our PEO revenue growth performed in line with our expectations this quarter, we were pleased to experience a further acceleration in PEO bookings with strong double-digit growth in Q4, representing another record level sales quarter. Moving on, while Don will cover our fiscal 2024 financial outlook, I wanted to spend a few minutes sharing our strategic priorities as we look ahead. Change and increase in complexity are secular growth drivers for the HCM industry and our breadth enables us to address nearly any HCM challenge our clients may face and meet them wherever they may be on our HR journey. From start-up to enterprise, from software-only to fully outsourced, and from local to global, we see a tremendous growth opportunity in front of us. And while our specific growth initiatives will vary by business, there are three key strategic priorities, which apply across all of ADP, that I see is critical to enabling our growth in the years ahead. The first strategic priority is to lead with best-in-class HCM technology. Put simply, our goal is to design, develop, and deliver the very best and most innovative solutions that will help our clients navigate the full lifecycle of employment from hiring employees to onboarding and training them, providing insurance for them, paying them, and filing payroll taxes, and even setting them up for retirement. As much as we offer today, we see an incredible opportunity to improve on our current and next-gen solutions, tactically use partnerships and inorganic means to further accelerate our pace of innovation and continue to offer industry-leading HCM products. And we expect to have a busy fiscal 2024. For U.S. small businesses, we are rolling out several product enhancements that will serve our 850,000 RUN clients, including a new tax ID registration service, learning management to help with small business employee training and an insurance and sector tool that utilizes AI to help clients manage their workers' compensation insurance policies and annual audits. For U.S. mid-sized businesses served by Workforce Now, our focus is to continue our great momentum in the deployment of our Next Gen Payroll and time engine and to drive our win rates and client satisfaction even higher. In the U.S. enterprise space, we expect to nearly finish the migrations of three of our remaining legacy platforms by the end of this fiscal year, representing an important step in our multi-year journey to move our clients to more modern platforms. We are also pleased to have advanced the velocity of our Next Gen HCM implementations and we expect our Next Gen HCM sales to contribute in a more meaningful way to our bookings growth in fiscal 2024. Outside the U.S., we intend to scale our iHCM midmarket platform in fiscal 2024, adding at least 1,000 clients over the course of the year. I am also incredibly excited to share that we will begin offering role outside the U.S. in fiscal 2024 to drive incremental growth. We plan to launch initially in two countries in Europe and expand its reach from there. And we intend to continue growing our Asia-Pacific business in part by leveraging our recent acquisition of a strong midmarket time product to supplement our existing payroll functionality. And across a few of our platforms, including Workforce Now and Roll, we intend to deploy GenAI-powered features to help our clients more quickly and easily tackle certain HR transactions. Our second strategic priority is to provide unmatched expertise and outsourcing to our clients. We pride ourselves on serving as a true partner to each and every one of our one million clients. Our culture of client service applies equally across our entire business from a basic payroll client to a fully outsourced client where we run part or all of the HR department. Our expertise and partnership approach has been key to ADP's winning formula for decades, and we will continue to lean into it. We expect that to manifest in a few ways in fiscal 2024. We have recently been piloting a number of tools powered by GenAI that can help our service and implementation associates deliver an even better client experience, and we will begin deploying these more broadly in early fiscal 2024. Given the significant number of clients we onboard and interact with every year, we expect to learn quite a bit this year about the longer-term benefits we and our clients might realize from GenAI. Meanwhile, demand for our HR outsourcing solutions remains very strong, and in fiscal 2024, we are focused on reaching new clients and further improving the experience for existing ones. Our Employer Services HRO businesses have been performing incredibly well and our focus for fiscal 2024 is to continue delivering strong bookings and keep client satisfaction and retention at current levels or perhaps even reach new record levels. And our focus for our PEO business in fiscal 2024 is to maintain our recent strong bookings momentum by continuing to add to our sales force headcount, grow our referral partner network and use data and machine learning to identify existing ADP clients who maybe a strong fit for an upgrade. Our third and final strategic priority is to leverage our global scale for the benefit of our clients. Our size and scale are unmatched in the industry. Across the globe, we not only offer robust platforms and a commitment to industry-leading service and expertise, but we also provide a scaled ecosystem and a unique on-the-ground presence in over 30 countries. This combination positions us to interact routinely with local governments and tax authorities, meet stringent certification and data requirements, and stay on top of complex and shifting legal requirements. Globally, we bring together our incredible data, an array of partners and integrated solutions, and one of the biggest and best business-to-business sales forces in the world to help our clients and prospects navigate the changing world of work. In fiscal 2024, we will continue to build on that scale for the benefit of our clients. Our GlobalView platform support hundreds of the world's largest multi-national companies with scaled workforces in over 40 countries and our Celergo platform helps us serve thousands more in up to 140 countries. In fiscal 2024, we expect to expand on both as we add additional countries to GlobalView's broad reach and as we potentially make tuck-in acquisitions to enhance our native in-country footprint. After establishing an ADP in-country presence in five new markets in 2023, we expect to expand further in fiscal 2024. Our world-class global scale distribution led by over 8,500 sellers is being supported by headcount and marketing investments in 2024, and as we've shared with you in the past few quarters, our sellers will continue to be paired with a best-in-class sales tech stack, which we plan to enhance with GenAI functionality in the coming months. And our ability to provide data-driven insights will continue to grow in fiscal 2024. ADP serves more clients and pays more people around the world than ever, and as we continue growing the number of employees we serve globally, the power of our insights will likewise continue to increase and benefit our clients. I am incredibly excited about these three strategic priorities for ADP and the differentiation and growth they will continue to drive. But before turning it over to Don, I wanted to take a moment to recognize our associates for their effort and performance over the course of this year. Our associates embody our core values, like insightful expertise, service excellence, and being results-driven. In fiscal 2023, ADP was recognized as the World's Most Admired Company by Fortune Magazine for the 17th consecutive year, signifying the incredibly strong culture we have and the important role we play in the world. Additionally, we were recently recognized, for the first time, as one of the Best Companies for Innovators by Fast Company, a true testament to the direction we are headed in. We owe these accolades as well as our strong consistent financial performance to the commitment and effort of our 63,000 associates that make-up the ADP family. With that, I'll turn it over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I'll start by expanding on Maria's comments around our Q4 results and then cover our fiscal 2024 financial outlook. Q4 performance is very strong overall, driving fiscal '23 results at or above our expectations. As Maria mentioned, these results reflected broad-based strength in Employer Services and PEO new business bookings, better-than-anticipated Employer Services retention and continued healthy Employer Services pays per control growth, yielding 10% organic constant currency revenue growth for the year and bringing us to $18 billion in revenue. For our Employer Services segment, revenue in the quarter increased 11% on both the reported and organic constant currency basis. This stronger-than-expected revenue growth was a function of continued outperformance in retention and pays per control growth as well as a better-than-anticipated contribution from client funds interest. Our ES margin expanded 480 basis points in the fourth quarter, which was broadly in line with our expectations. For the full year, our ES revenue grew 10% on a reported basis and 11% on an organic constant currency basis, and our ES margin expanded 190 basis points. Growth in client funds interest helped us in a year in which we added a fair amount to our product, service, and sales headcount, which has driven some fairly substantial benefits in sales, Net Promoter Score, and retention results. For our PEO, revenue increased 4% for the quarter, decelerating slightly from Q3, as we anticipated. Average worksite employees increased 3% on a year-over-year basis to 722,000, and has started to gradually reaccelerate, supported by very strong bookings growth in Q4. PEO margin contracted 110 basis points in the fourth quarter, in line with our expectations due in part to higher selling expenses. For the full year, our PEO revenue grew 8% and average worksite employees increased 6% and our margin expanded 60 basis points, all in line with our most recent guidance. I'll now turn to our outlook for fiscal '24. While the economic backdrop remains uncertain, we continue to believe we are well-positioned to deliver solid overall financial results, while also investing for future growth, consistent with the strategic priorities that Maria laid out. Our fiscal '24 outlook assumes a moderation in economic activity over the course of the year, but nothing dramatic. Beginning with ES segment revenue, we expect growth of 7% to 8% driven by the following key assumptions. We expect ES new business bookings growth of 4% to 7%, representing a solid growth after a particularly strong fiscal '23. For now, we're assuming a stronger first half and some moderation in second half bookings growth, which we think is prudent, given the limited visibility into the macro environment. For ES retention, we finished fiscal '23 at a record level of 92.2%, consistently outperforming our expectations throughout the year. We are, of course, very pleased with this performance as we overcame headwinds from higher down-market out of business levels with strength elsewhere. With that said, we are contemplating a 50 to 70 basis points ES retention decline for fiscal '24, due in part to an assumption that small business losses will increase slightly from where they are today as well as an assumption for general impact to our other businesses from a slowing economic backdrop. As we called out three months ago, we see the potential for below normal pays per control growth in fiscal '24 and our outlook assumes 1% to 2% growth for the year. We had a strong Q4, which gives us a solid starting point for growth and a gradual deceleration over the course of the year feels reasonable at this time. And after price contributed 150 basis points to our ES revenue growth in fiscal '23, we are anticipating a smaller contribution in fiscal '24, though still above our recent historical average contribution of around 50 basis points. And for client funds interest revenue, the interest rate backdrop has been dynamic these past few months, and is important to keep in mind that our client funds interest revenue forecast reflects the current forward yield curve, which will, of course, evolve as we move through fiscal '24. At this point, we expect our average yield to increase from 2.4% in fiscal '23 to 2.8% in fiscal '24. We, meanwhile, expect our average client funds balances to grow 2% to 3% in fiscal '24, this is a bit lower than recent trends, due primarily to more modest contribution from pays per control growth and an assumption for more moderate wage increases. Putting those together, we expect our client funds interest revenue to increase from $813 million in fiscal '23 to a range of $955 million to $975 million in fiscal '24. Meanwhile, we expect the net impact from our client fund strategy to increase from $730 million in fiscal '23 to a range of $815 million to $835 million in fiscal '24. For our ES margin, we expect an increase of 130 to 150 basis points, driven by operating leverage and contribution from client funds interest revenue, offset by continued investments across our strategic priorities. Moving on to the PEO segment. We expect PEO revenue and PEO revenue, excluding zero margin pass-through, to grow 3% to 5% in fiscal '24. The primary driver for our PEO revenue growth is our outlook for average worksite employee growth of 3% to 4%. This represents a gradual reacceleration from the 3% growth we're stepping off in Q4. Strong bookings performance has already contributed to accelerating client growth, but that has so far been offset by slowing pays per control growth. With continued strong bookings growth, our worksite employee growth should gradually accelerate as well. And as Maria shared, demand has been healthy and we remain confident in the long-term growth opportunity in PEO. We expect PEO margin to be down between 20 and 40 basis points in fiscal '24, due to anticipated higher selling expenses, as well as year-over-year headwind from a lower workers' compensation reserve release benefit than we experienced in fiscal '23. Adding it all up, our consolidated revenue outlook is for 6% to 7% growth in fiscal '24 and our adjusted EBIT margin outlook is for expansion of 60 to 80 basis points. We expect our effective tax rate for fiscal '24 to be around 23%. And we expect adjusted EPS growth of 10% to 12%, supported by buybacks. One quick note on cadence. At this point, we expect total revenue growth to be relatively consistent quarter-to-quarter. We expect our adjusted EBIT margin to be down slightly in Q1 on a year-over-year basis, and then build over the course of the year. Thank you, and I'll now turn it back to the operator for Q&A.
Operator: Thank you. [Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays. Your line is open.
Owen Callahan: Hi, this is Owen on for Ramsey. I appreciate you taking our question today. I was just curious more on kind of your PEO revenue guidance. I know you called out worksite employee growth weighing on growth there, but you expect double-digit kind of bookings growth and projects only 3% to 5% growth in PEO revenues for fiscal '24. I was just curious if you can provide any more color on that spread is any conservatism or if there are any other factors to consider there. Thank you.
Don McGuire: Hi, Owen, thanks. Yes, I'll answer the question. We had a very, very strong sales bookings result in Q4. So we're very happy with that, and we've seen the sales reaccelerate. I think as we said in the prepared comments, we are seeing continued growth in clients. I think if there is a challenge that we're facing a little bit as we're seeing a little bit softer pays per control growth in the PEO than we would have expected. But back to what we've been saying for some time, we think the underlying value proposition is very, very strong and we look to that business continue to grow for us and be a big part of our portfolio.
Owen Callahan: Understood. I appreciate that.
Operator: Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning. Congrats on the strong end to the fiscal year. Maybe first question, Maria, I thought it was - is very interesting about the announcement of moving Roll into new international markets. How should we think about maybe what the opportunity there looks like? How much different is the complexity around payroll processing in international markets versus the U.S. and have you included that in the bookings forecast for fiscal '24?
Maria Black: Yes, fair enough. Thanks, Samad, and I appreciate the congratulations on the quarter and the year. We're, obviously, pretty proud over here. So with respect to Roll, it is exciting. It's been an exciting product for us to rollout, no pun intended, across the down-market here in the U.S. We're excited to take it into international. As mentioned, the initial goal is to put it into two countries. And it is an incremental add for us because it's really initially into these two countries. We're thinking more kind of the down-market SMB space, which is an area of opportunity for us across many of the markets that we serve. But we're also excited about Roll long-term beyond that space. So excited to dip it into our international space as we continue the overall rollout of Roll. In terms of factoring it into the overall bookings, not really. I think the - by the time the launch happens and as we're thinking about the full year for our international business or full year for new business bookings, I'd be surprised if it ultimately makes a dent, but to us, it's really about the long-term value that that offer will bring as we seek to expand the addressable market for us into these various places. Last but not least, Samad, you mentioned the complexity of being international. And I have to tell you, I spoke to it a little bit in the prepared remarks. There's a lot that goes into being in each one of these countries. To your point, there is complexity country-by-country. Many countries put many of the states that are complex here in the U.S. to shame in terms of the complexity that provides, and that's everything from government entities, legal and tax attorneys, who's the tax authority and how do you get to them. We often think of it as an ecosystem. We think about it as kind of that final mile, if you will, and that's the complexity and that's what we've been building over the last couple of decades in our international business. So it's a lot more than dropping off software at a country border and hoping that it works. There's a lot to be said for the ecosystem around it. Again, whether it's tax authorities, data lodgement, things of that nature. So excited to take advantage of the footprint we've built and put in our product into that footprint as we expand Roll internationally.
Samad Samana: Very helpful. And then maybe just a quick follow-up for Don. I know you gave - you called out that broad-based strength that drove the bookings upside and you cited several specific factors. I guess, it would be helpful if you could maybe help us dimensionalize where the upside was relative to the company's own expectations at maybe the start of fiscal '23 and what you're carrying forward from what you saw in the fourth quarter into the FY '24 bookings outlook?
Don McGuire: Yes, thanks for the question. I'll start here and I think I'll turn over to Maria for the bookings. But we certainly saw strength across the Board. I think once again, in the prepared remarks, we called out the - our tax business and our international business. So they were very strong amongst all the ones that were strong and the down-market was also quite strong. So it was really a contribution from across the Board in the fourth quarter. We talked for some time about how the pipelines are healthy and whatnot, and you had questions before about times to get signatures on deals, et cetera, things came together in the fourth quarter and we were very, very pleased with the final result.
Maria Black: That's right. My only add to that comment would be, we stepped into the quarter with healthy pipelines, with a strong staffing position that was growing tenure. I have to tell you when I reflect on all the quarters that I've watched across our sales execution, generally speaking, you have a bunch of businesses that are outperforming and you have a few businesses that are perhaps being carried by those that are outperforming. What I have to tell you is, this was a broad-based strength across the entire organization sales implementation service with kind of an all-hands-on-deck execution, and that's really what it's all about. What I would attribute it to is incredible execution.
Samad Samana: Great. Thank you. Appreciate you taking my questions.
Operator: Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. I wanted to follow-up on U.S. bookings here. So you cited several areas of strength, midmarket compliance, international. On the midmarket, specifically, can you talk about what's driving that better-than-expected performance, do you think that's driving improved competitive performance versus kind of rising tide environment? And then just - I heard your comment on Next Gen HCM contributing more in the current fiscal year to bookings. Maybe talk about the initiatives in the product development that you think is going to drive that.
Maria Black: Good morning, Bryan. So I'll comment on both. The mid-market strength that we've seen and coming in a bit better than expected. It's been solid for quite some time. That's inclusive of our HRO offerings, and as you know, we've been speaking to those quite a bit in terms of the resonance of that value proposition in the market. So I think that adds to the overall strength that we have in the mid-market, which is the various flavors and offers that we have. I think the other is that we've made tremendous investments into that business. So we do have our next-generation payroll engine that the sales force is pretty excited about and we're seeing that in the wins that are coming in and just kind of the momentum there. I think the other is the amount of product investment and innovation that we've done in the mid-market, specifically referencing the investments we've made into the Workforce Now platform with the new UX and many of the things that I've been speaking to. And I think the other call out is it definitely helps on a new business bookings perspective, when the business on the other side, so service and NPS, if you will, as well as retention are firing on all cylinders. And that's exactly the case. We have record retention in our mid-market, and we have near-record MPS results across the mid-market. So really, really proud of the execution in that entire space. And that definitely fuels and feeds the ability for our sellers to get excited about everything that I just mentioned to go-to-market. Stepping into the question around next-gen HCM, I did make a reference to that. We've talked a lot over the last quarters about this year. And what we've been working on is scaling implementation, and that's exactly what we've done in that business. So, we were able to onboard a lot of the clients, that we had on our backlog. We've shortened the time of implementation, and we also saw additions to that backlog. So, we saw new sales in the fourth quarter of that next-generation HCM platform. We're really excited about the momentum as we step into '24. And as such, we believe that Next Gen HCM will be a larger contributor to bookings for us in the upcoming years than it was in '23, but we were pleased with what we saw in the fourth quarter and the momentum heading in.
Bryan Bergin: Okay. Understood. And then just on pricing, can you comment on where that ended up in fiscal '23 and what you're assuming in ES growth from a pricing standpoint in fiscal '24?
Don McGuire: Yes. So, we were happy with our price increase and retention. So as we've talked to many times, we want to make sure that we're not getting greedy. So, we did get about 150 basis points of price in the year. And we did that without the expense of seeing a decline in retention or NPS scores. And quite frankly, those NPS scores have stayed healthy despite the price increase. So as much as price increases can land well, they have landed well, and we're very happy with how that transpired throughout '23. For '24, we do expect to have price increases again. We do not think that we're going to be in the 150 basis point range. We're certainly going to be above our historical average of about 50 basis points. But once again, we'll watch closely and make sure that the underlying value proposition for our clients stays in place, and we'll take some price for sure, but not to the extent that we did in FY '23.
Bryan Bergin: Thank you very much.
Operator: Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang: Hi, thanks so much. Yes. With the great bookings here, I'm just thinking around the conversion. You mentioned implementation cycles. I'm just curious if you've seen any change from clients and their desire to implement. And then similarly, just maybe based on your comments there on next-gen HCM, I'd love to hear a little bit more around the appetite from your prospects to upgrade now at this point in the cycle. What's the pitch here given some of the macro uncertainty?
Maria Black: So, I think both of your questions, I just want to confirm, I'm hearing them the right way. I think they both kind of speak to the general sentiment around the demand environment.
Tien-Tsin Huang: Yes.
Maria Black: Is that kind of a good way to think about it in terms of decisions getting delayed and/or what's the appetite to, I suppose, by HCM in the current macro environment. And so, I'll comment on the general demand environment and feel free to follow-up with an additional question if I didn't cover what you wanted. But the way that I think about demand, and I've spoken to it quite a bit over the last couple of quarters. Demand remains strong, and that is very broad-based across the business. And so, if you think about the down market, you still have the strength of small business formations. You have the strength of hiring that's happening in the down market. And as such you have clients there needing to make decisions around our HCM offers in that space, right? So that's definitely a place that we've been winning, and we'll continue to lean in as warranted by the demand. The mid-market, as we talked about that a little bit earlier in terms of the overall demand there for the complexity that exists in that market. That's inclusive again of the solution we have around our HR outsourcing offerings. And so that's kind of the mid-market. So getting to your question, which is really about the enterprise space and perhaps even the MNC space, it is an area that we continue to watch as it relates to demand cycles, decision delays. And the main reason is those are really the places that you, as you're aware, have additional, perhaps signers, additional levels of approval, things of that nature. And what I would say, which is consistent with what we've been seeing, is that we are back to pre-pandemic levels. So deal cycles did shorten during the pandemic, and they elongated back the pre-pandemic. But it isn't something that we're seeing additional elongation beyond historical averages. And so to your point, though, it is an area that we consistently watch both in the enterprise space as well as in our international business, just to kind of see if the demand cycle is at the client's appetite to make buying decisions or implementation decisions during this time has changed thus far, we're not seeing it in a broad-based way. But it is an area we continue to monitor.
Tien-Tsin Huang: Okay. No, that's great. You answered it better than I asked the question. So thanks for that. Just on the - as a quick follow-up, just I heard a lot about the sales and the go-to-market investments that makes sense. Just how about R&D growth here in the upcoming year versus fiscal '23? How might growth be different? And also, how might the composition be different in terms of where you're placing your bets on R&D? Thanks, that's all I have.
Don McGuire: Yes. I think we have a number of projects that we've shared with you all over the past number of quarters. Those projects are well underway. We won't take a lot of time talking about specific Gen AI product projects, but I guess that would be a place that would anticipate I'll get a question we'll get a question for that later on in this call, given it's so topical. But generally, we're continuing our direction with the investments that we've described over the past number of quarters, and we continue to make good progress. We continue to have good delivery. The ability to take RUN to markets in Europe is an example of that, how investments in that development in that technology has increased. And by the way, that's part of our broader strategy that we've touched on many times, is to take some of these developments and make sure that they're global in nature as opposed to only local in nature. So nothing incredibly new, just a continuation of the great work and the great projects we have underway.
Tien-Tsin Huang: Thank you.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hi, good morning. And let me add my congratulations, particularly on the strong new bookings. Maria, you went through your three key strategic initiatives and all the subsections - of the various initiatives which ones are going to be the most impactful do you think from a near-term perspective? And then one specific question. Within the mid-market, you mentioned not only deploying next-gen payroll, but you also talked about the time engine. And I was wondering if you could elaborate a little bit on that?
Maria Black: Sure. And thank you, Mark. I appreciate the congratulations. So, I am very excited about the strategic priorities, as I outlined during the prepared remarks. I don't know that I was necessarily expecting to have to pick a favorite pillar or a - one that I expect to yield impact faster than another because I think broadly speaking, they apply across all of ADP, and they will depend a bit as it relates to kind of each business, right? And so, when I think about some of the product investments that we're making. Some of the things, the work that we've done and the impact, whether it's taking a product like roll internationally, which I mentioned earlier, will be short-term results, but some of the impact of continuing to build on the momentum we have in the mid-market with our next-generation payroll engine, as an example, where we have an ability to win differently, we see competitive advantages and differentiation there. I think that's an area that can have tremendous impact in short order. I think the other is Don did it first, which is he mentioned the likes of generative AI. And when I think about that, the Gen AI and applying it broadly across these pillars, I think there is opportunity for us in product that's pretty tremendous, whether it's solving real opportunities for our clients to become more efficient. We've talked a lot about that, whether that's things like job descriptions, performance reviews, things of that nature. But it also leads me kind of to that second pillar to your point around what will come short-term versus long-term. I think there's opportunity in the short-term that will make impact as well as the long-term, in terms of really applying generative AI across our expertise that we provide to our clients. And so, when I think about our ability to make it easier for our clients to engage with us or our associates to engage with our clients, some of the tools that - we have already deployed across various businesses and will further deploy into fiscal '24, such as - think of it almost as a copilot agent assist where we're helping our agents be more efficient. That's going to yield short-term results, if nothing else in client satisfaction. And again, we know happy clients lead to a longer staying clients that leads to more sales and the wheel, if you will. So, I think there are opportunities across all of the strategic priorities to have some impact us sooner than the long-term. But yes, I'm equally excited about all of them. And certainly, we spoke quite a bit about the global piece. In terms of the next-generation time engine, that is being developed in tandem with our next-generation payroll engine. And those two things are really about time and payroll sitting together in our mid-market. It is a based on the same backbone of technology. And so, we're very excited to take that more broadly across the mid-market as we continue to take the next generation payroll engine also more broadly crossed. And I think, both of those things will get feathered into the impact of our win rates, if you will, and our new business bookings in the mid-market throughout the course of '24.
Mark Marcon: That's great. And then, Don, you mentioned the margin expectations for the full year. And you mentioned that in the first quarter, it's probably going to be a little bit lower and then feather up over the course of the year. How much lower during the first quarter? And what's the driver there? And then how should we think about the pacing of the improvement quarter-to-quarter?
Don McGuire: Yes, Mark, thanks for the question. We're not looking at a big change in the first quarter, but just a couple of the drivers. Just to be clear. One, we do have some incremental investment in cost and headcount, et cetera. But the other big driver in the first quarter is it's a big borrowing quarter for us in our laddered client fund interest strategy. So that's going to put a little bit of pressure on the margin for the fourth - sorry, for the first quarter. And the margin will continue to build over the course of the year, and we will get the overall improvement that we expected, but more out of the three quarters as opposed to the first.
Mark Marcon: Great. Thank you.
Operator: Thank you. Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open.
Eugene Simuni: Thank you. Good morning, guys. I want to come back to the PEO for a second. So great to hear about strong PEO bookings in the fourth quarter and going into the New Year. Can you provide a bit more color on what helped generate this reacceleration in bookings? I know you talked in the past, Maria, about some of the actions you guys have taken to generate PEO sales, I would love to hear what caused the acceleration in bookings? And are those initiatives that as kind of levers you're pulling now completely pulled or is it still work in progress and will continue into FY '24?
Maria Black: Sure. Good morning, Eugene. PEO bookings, again, we're incredibly pleased with the results in the fourth quarter and the reacceleration. We also did see the reacceleration in the third quarter. So the back half of the PEO was exactly as you suggested. It was a lot of focus for the management team, and I'm really excited about how we came together to execute. And in terms of the overall demand trends in long-term, short term. I remain bullish on the overall value proposition of the PEO and the demand that it warrants. It's hard in that business to kind of pin down the demand trends, because there are so many variables. And in the PEO, it's not as simple as looking at just leads and number of request for proposals that are coming in, because as you know, not every client as a potential fits. So it's a little a little difficult to pin down kind of the various demand trends in the specificity outside of the overall belief in the demand environment. And there's a normal level of kind of variability as it relates to PEO bookings quarter-to-quarter, which also makes it hard to kind of spot various trends. Some of that has to do with the calendar year-end. Some of that has to do with when renewals happen. But nonetheless, there was a tremendous amount of focus and still remains. We remain very focused as a team across all of the leadership to make sure that we continue to drive the strong growth in bookings in the PEO in '24.
Eugene Simuni: Got it. Okay. Thank you. And then for my follow-up, probably for Don. We talked about margin costs a little bit. So you expect another year of robust margin improvement next year. But obviously, you're not going to have as much tailwind in revenue growth as you had this year. And if you kind of do some of the [bet and Roll] math, it looks like your adjusted OpEx will need to grow slower next year than it did this year for you to hit your goal. So just hoping maybe you can talk a little bit, what are, the areas of spend where you will temper next year or maybe pullback, especially if macro conditions are not as good as kind of we expect them to be?
Don McGuire: Yes. So thanks for the question. Let me start by what won't change. So what won't change is that we'll continue to make sure that we invest in key areas of the business to make sure that we can run it effectively. And with the strong bookings, we'll make sure that we have the people on the ground for implementation to get those deals up and running and generating revenue for us, et cetera. But in the last year, we did have pretty substantial growth in, over the last couple of years coming out of the pandemic. I can't believe we're still talking about the pandemic. But as we came out of the pandemic, we did have substantial growth in expenses in service, implementation, sales, et cetera. And while we do continue to expect to see some growth, we're not going to see as much growth in expenses in those areas. So that would be one of the areas that is going to make sure and you hit on it with respect to OpEx. We're not going to see the growth in OpEx expense that we saw in the prior year. The other contributor, of course, that will continue to contribute. I think, the yield curve is more favorable than it was the last time I spoke to you all. We will get contribution from client fund interest next year. But at the same time, it's not going to be to the extent that we did in '23. So that's also going to help with driving margins higher. But once again, not the same tailwind - tailwinds that we had in '23. I think those are the main items that are going to help us improve our margins going into next year.
Eugene Simuni: Got it. Very helpful. Yes perhaps.
Operator: Thank you. Our question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Hi, good morning guys. And thanks for taking my questions. Maybe, Don, first on the cadence of revenue growth. I know you said it should be relatively stable throughout the year, but wondering if you can maybe sort of parse that out between ES and PEO if there's any differences we should think about there?
Don McGuire: Yes. So, I think revenue growth is going to be - revenue growth is going to be pretty consistent throughout the year as we start the - as we start that big backlog that we now have as a result of that very, very strong fourth quarter bookings result. So, we will see consistency there. Likewise with PEO, it's going to be a bit of a slower burn as we did have strong sales in Q4. So, we did also talk about slightly lower pace control growth in the PEO business. So - but I don't think they're really going to be that different. I think, they're going to be pretty close if you think about the overall growth, and consolidate the results for the company not substantially different between the business units.
Danyal Hussain: Yes, Scott, there is a slightly different cadence for the two, it's not a huge difference. For PEO, we do expect an acceleration over the course of the year. So, the contribution we get from our bookings and from the improvements in retention, we're expecting gradually overcoming slowing pays per control that should lead to an accelerating PEO revenue growth. And on ES, we're expecting some deceleration assuming pay per control decelerate and assuming the contribution from client funds interest starts to fade gradually over the course of the year. So you end up with two different-looking ramps, but they offset and that what nets us to a very stable revenue growth overall.
Scott Wurtzel: Got it. It's very helpful. And then maybe just a follow-up on the Gen AI topic, going back to it. Obviously, there's a lot to sort of be excited about there. But just kind of wondering the magnitude of investment needed there, is that investment essentially all incremental to your investment plans for the year? Or have you had to maybe put some other projects on the back burner to focus a little more on Gen AI?
Maria Black: Yes. And so said differently, the good news is we just went through our strategic plan process in the last six months. And so, we had all of our priority sequence in all of our investments and incremental investments lined up. As we marry that to Gen AI, we have a very clear lens on where some projects may get enhanced and where some projects may look different and perhaps get replaced by a new way of thinking about it. And so candidly speaking, we're going through a lot of these opportunities at this juncture kind of thinking through the bets and there will be incremental investment. And there will be other investments that we repurposed to go do some of these things - in a new way. So, the answer is both.
Scott Wurtzel: Got it. Thanks guys. And congrats on the results.
Maria Black: Thank you.
Operator: Thank you. Our next question comes from Peter Christiansen with Citi. Your line is open.
Peter Christiansen: Thank you. Good morning. I'll also add to the congratulations ratio. Nice trends. Maria, a question on the international scaling effort here. I was just wondering if you could - in this context, if you could put some parameters on expected investment spend, I guess, over the next one to two years? And do you see M&A as an important contributor to the growth algorithm there?
Maria Black: Sure. You started with a question on international. So is the rest of your question about international or is it just in general?
Peter Christiansen: Correct.
Maria Black: About international. Yes. So, we have been, over the years, been making in-country decisions on investments. I talked a lot about the, call it, the feet on the street, the final mile of infrastructure that we have to support our international business. And so, we will continue to do that. That's inclusive of each year. We go into new markets and some of those are organic ways that we go into new markets. Some of those are actually partners that we ultimately end up at some point, call it, purchasing, if you will, or acquiring. And so, the answer is both organic and inorganic. That's kind of how we've built the business over the last 20 years. And we will continue where warranted to think about it both ways. And the decision criteria for us is really about speed. A lot of times, it's our clients that pulled us into incremental markets. When I think about the five markets that we went into this year or the two countries that we're heading into with global view, they're byproduct of clients that are choosing to pay employees in certain markets. And as such, for us, a lot of times the decision we make on how to get there, has a lot to do with speed. And as such, again, we will leverage both organic and inorganic ways to get there. So, I don't know, Don, you ran our international business for a very long time. I don't know if you want to add anything.
Don McGuire: Yes, maybe just to add, I think what we've been doing, Peter, over the last number of years is we have done a number of acquisitions. They've been mostly tuck-ins, but we did have three interesting ones over the last year. We acquired an Italian company that has a good budget payroll - budgeting software tool that's very prominent in the Italian market. We acquired our - so it streamlines [indiscernible] partner in South Africa. And we also want a very exciting mid-market time-and-attendance product called SecureX in out of Bangalore in India. So - and that product is available in India, most of Southeast Asia and the Middle East. So, I think that's a demonstration of what we've been doing, we've been looking at and focused on to continue to make sure we grow that footprint, and we do think it continues to be an exciting space for us.
Peter Christiansen: Thanks. That's great. And Don, just as a follow-up, last slide on the maturation schedule of client fund investments, super helpful. But as we think about intra-year investment turnover - should that correlate with the seasonal balance levels that we typically see?
Don McGuire: Yes. So I think as those - investments mature, you're going to see those investments reinvested at higher rates, and we do expect to see our average return go up over the course of the year. The current reinvestment schedules, overnights are reinvesting at 5%. The extended in the loan portfolios are being reinvested at about 4%.We don't expect to see a huge change in the mix. Although the average duration of our investments has shortened a little bit over the last couple of years. But you can pretty much look at those yields, look at the maturity schedule that we provided and then look at the composition of our portfolio across the overnight, the extended and the long and pretty much come to a conclusion or come to some numbers on where you think we're going to end up.
Peter Christiansen: Thanks. And just one quick one. How should we think about the duration strategy, I guess, for the next couple of quarters here now that the Fed is perhaps kind of like stabilized, but are - is there an effort to extend duration shorten it? Just any sense there would be helpful? And thank you.
Don McGuire: Yes. We've had this question a few times, and - the answer is we've been very successful with the strategy that we've had for the last 20 years. We certainly see that there is an opportunity cost not ever having everything in short today. At the same time, we do believe that the yield curve will normalize and the strategy we've had in place will come back and be beneficial to us over the longer term. So you shouldn't expect any significant change in our investment strategy.
Peter Christiansen: Very helpful. Thank you.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Thank you very much. I wanted to go back quickly on retention. I know you've touched on it a little bit. Last year, your initial outlook called for around 50 - minus 50 to minus 25 basis points of retention degradation. But that obviously didn't really play out. And this year, you're starting with a more conservative kind of minus 70 to minus 50. But I'm hoping you could speak to how much conservatism is embedded there? And what are the drivers that you're seeing as a reason to be a little bit more conservative to start than maybe you were last year even?
Maria Black: Yes, fair. It's a fair observation, James. Appreciate it. I think the we thought about - by the way, I wish I knew the answer, right? So the question you're asking which is how much conservatism is in there? And that's all to say and you hit the nail on the head, we set into this year guiding minus 25 to 50, we're stepping into fiscal '24 with a guide of minus 50 to 70 - and we hope - I'll end - or I'll start with, we're very happy with where things are. We're firing on all cylinders. We have many businesses that have record MPS results, record retention results and everything is good. And so as we step into the year, the way that we are modeling what you would see in pays per control. The way we're thinking about the potential macroeconomic tempering, if you will, specifically in the back half, is really a byproduct of how we see retention. Part of what we saw in the fourth quarter that led to the incredible results that we had was that the normalization that we've been seeing in the down-market, we did actually see the down market bounce a little bit. So even while it was down year-on-year, it came in stronger than we expected. And so we do anticipate that we may need to give some of that back, which is why we believe it was prudent to align our retention targets through our medium-term targets that we gave back in the Investor Day of 2021. So I wish I knew the answer to your question in terms of how much conservatism, why we are guiding to what we're guiding is really about the economic outlook, whether that's GDP, unemployment is still at record lows. We haven't seen unemployment rates that low since the 60s. And so our guess is as good as yours at some level, but we did build in some tempering of the economy in the back half, and that's really what's yielding that guide on the retention.
James Faucette: Great. I appreciate that color, Maria. That's really helpful and makes a lot of sense. I want to turn quickly also to M&A. You mentioned it in the prepared remarks, also, I mentioned it as part of at least some of your strategic initiatives. What are you seeing in terms of overall valuation levels? And what kind of things would you be targeting in terms of geography or product capabilities? Thanks a lot.
Don McGuire: Yes, James. So in terms of what we're targeting, what we're talking about, there's always things kicking around, of course, but we want to make sure that anything that we do acquire either fits well in the core and gives us additional capability, or it's something that really exceeds some functionality capability that we currently have, so that we're not stacking on more and more product on top of what we already have. The other area, of course, is to make sure that - we do things that are natural adjacencies - are very strong adjacencies to what we already do so that they fit well. And then thirdly, of course, is making sure that we can sell these things and run these things in a recurring model, so that we can sell them the way we sell everything else we sell today and operate them and expect to get revenue anticipation and good model from what we buy. So I think those are the things we think about. I think we're hearing a lot around valuations coming down in the press, certainly a little bit of a dearth of activity, if you will, in the M&A space these days. But we do have lots of conversations about acquisitions and whatnot. I still think, of course, everybody is looking to get a premium what they have. And we're trying to make sure that if we're going to buy something, we're paying the right price. But we don't actually get to the point of many of these conversations given the conditions that I stated at the front at the outset to actually have a view on overall valuations in the market. We likely get to talking about valuation in a very, very few number of cases. Remembering, of course, very, very few of the opportunities we get even get to that conversation. So I don't think I can say we have a general view. But we are focused on what we would have to pay and how things would fit into ADP.
James Faucette: That's great. I appreciate it.
Operator: Thank you. Our last question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Maria and Don, you've obviously talked a lot about the PEO and seems that the demand has really picked up. But I'm wondering, are you seeing any of your customers maybe taking a little bit of a breather now pointing to sign up for the PEO because of the uncertainty in the economy and that being maybe more expensive product?
Maria Black: The PEO has a tremendous value proposition. I think we always refer to ADP as an all-weather company. I would say the most durable of our all-weather businesses is the PEO. And a lot of that has to do with the ability to flex that value proposition in a downturn pretty quickly. So if you think about clients that are growing, they enjoy the PEO because it's a quick go-to-market. On the downside, if you will, as clients are potentially trying to work through economic headwinds, the PEO serves as a place that has a clear return on investment, has a total cost of ownership that's very again, very clear. And so I think it's a business that not to suggest that it's not impacted by a downturn, but it's a business that kind of works in both. What I would say is our sales force, we're able to pivot that narrative and that value proposition as warranted. I don't believe that has happened. So to answer the question, our clients at this point, hesitant to purchase something such as the PEO that's so comprehensive because of the macroeconomic challenges. And my view would be, no. I think that's substantiated by the record results that we had in the PEO bookings in the quarter. We also saw that strength in bookings in the third quarter. So I think that value proposition is holding firm. And I think it's a business that should - should the economic wins ever come to life that we've been expecting for so long. It's a business that can pivot pretty quickly and the demand for the offer remains.
Kartik Mehta: And then just a follow-up. Don, you talked about obviously pays per control and retention and maybe retention moderating as the year goes through. For pay per control, would you anticipate that just to get to flat by the end of the year? Or are you anticipating that, that could potentially go negative, and that's how you've built the guidance?
Don McGuire: No. We're certainly not anticipating this as you go negative. We do, though, think it's going to go to somewhere ever 1% to 2%, which is a little bit less than our historical average. However, I just want to make sure that everybody understands, we're exiting the year pretty healthily. So we figure we're off to a pretty good start, but we do expect that we're going to see a bit of a decline over the next three, four quarters. And once again, we're aligning ourselves to the best we can with unemployment forecasts and et cetera.
Danny Hussain: Karthik, if you're asking specifically about where we're exiting fiscal '24, then the pay per control is effectively decelerating from this kind of 3% range to something flatter.
Kartik Mehta: Okay. Perfect. Thanks Danny. I appreciate it.
Operator: Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks.
Maria Black: Thank you, and thank you, everyone, for joining today. As you've heard, Don and I, the entire leadership team we're incredibly pleased with fiscal '23, specifically the fourth quarter and the finish. So I'll kind of end where I started, which is, I want to take the opportunity to once again thank the associates that create this performance. It's an unbelievable magical thing to watch it all come together and deliver what we just delivered. And so my gratitude and I celebrate each and every one of them. I also want to thank all of the stakeholders, including all of you who listen today, appreciate the support. We're certainly excited for fiscal '24. So cheers to that.
Operator: Thank you for your participation. This concludes the program, and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Fourth Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. After prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I would now like to turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danny Hussain",
"text": "Thank you, Michelle, and welcome everyone to ADP's fourth quarter fiscal 2023 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter and full year. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
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"speaker": "Maria Black",
"text": "Thank you, Danny, and thank you, everyone, for joining us. We closed out the year with a strong fourth quarter, that included 9% organic constant currency revenue growth, 270 basis points of adjusted EBIT margin expansion, and 26% adjusted EPS growth, and for a full year fiscal 2023, we delivered 10% organic constant currency revenue growth, 130 basis points of adjusted EBIT margin expansion and 17% adjusted EPS growth, representing another strong year for ADP. I'll start with some highlights from the quarter. Our worldwide sales and marketing team delivered exceptional Q4 Employer Services new business bookings growth that was well in excess of our expectations, with strong double-digit overall growth on top of a difficult comparison. The HCM demand environment has been healthy despite a gradually slowing macroeconomic backdrop and we have been capitalizing on this steady demand. Our strong bookings results were broad-based. We had continued strength in our down-market and Employer Services HRO offerings. We also had better-than-expected results in our midmarket, as well as a great finish from our compliance and international businesses. This Q4 performance brought our full year Employer Services bookings growth to 10% compared to our 6% to 9% guidance and our medium-term goal of 7% and 8% growth that we laid out at our 2021 Investor Day. We are, of course, thrilled with this result and excited to keep the momentum going. Our Employer Services retention rate was another highlight in Q4 and came in better than we expected. For the full year, we delivered a retention rate increase of 10 basis points and are back to our record level retention rate of 92.2%, all while absorbing the impact of normalization in the down-market out of business rates. This strong result was driven by record level retention rate, specifically in our U.S. midmarket and international businesses, and by record level overall client satisfaction across our major businesses in the fourth quarter. Our Employer Services pays per control growth was 3% for the quarter, as the overall labor market continued to show resilience, bringing the full year pays per control figure to 5%. We have been pleased all year to see such durable labor demand from our clients. And last, while our PEO revenue growth performed in line with our expectations this quarter, we were pleased to experience a further acceleration in PEO bookings with strong double-digit growth in Q4, representing another record level sales quarter. Moving on, while Don will cover our fiscal 2024 financial outlook, I wanted to spend a few minutes sharing our strategic priorities as we look ahead. Change and increase in complexity are secular growth drivers for the HCM industry and our breadth enables us to address nearly any HCM challenge our clients may face and meet them wherever they may be on our HR journey. From start-up to enterprise, from software-only to fully outsourced, and from local to global, we see a tremendous growth opportunity in front of us. And while our specific growth initiatives will vary by business, there are three key strategic priorities, which apply across all of ADP, that I see is critical to enabling our growth in the years ahead. The first strategic priority is to lead with best-in-class HCM technology. Put simply, our goal is to design, develop, and deliver the very best and most innovative solutions that will help our clients navigate the full lifecycle of employment from hiring employees to onboarding and training them, providing insurance for them, paying them, and filing payroll taxes, and even setting them up for retirement. As much as we offer today, we see an incredible opportunity to improve on our current and next-gen solutions, tactically use partnerships and inorganic means to further accelerate our pace of innovation and continue to offer industry-leading HCM products. And we expect to have a busy fiscal 2024. For U.S. small businesses, we are rolling out several product enhancements that will serve our 850,000 RUN clients, including a new tax ID registration service, learning management to help with small business employee training and an insurance and sector tool that utilizes AI to help clients manage their workers' compensation insurance policies and annual audits. For U.S. mid-sized businesses served by Workforce Now, our focus is to continue our great momentum in the deployment of our Next Gen Payroll and time engine and to drive our win rates and client satisfaction even higher. In the U.S. enterprise space, we expect to nearly finish the migrations of three of our remaining legacy platforms by the end of this fiscal year, representing an important step in our multi-year journey to move our clients to more modern platforms. We are also pleased to have advanced the velocity of our Next Gen HCM implementations and we expect our Next Gen HCM sales to contribute in a more meaningful way to our bookings growth in fiscal 2024. Outside the U.S., we intend to scale our iHCM midmarket platform in fiscal 2024, adding at least 1,000 clients over the course of the year. I am also incredibly excited to share that we will begin offering role outside the U.S. in fiscal 2024 to drive incremental growth. We plan to launch initially in two countries in Europe and expand its reach from there. And we intend to continue growing our Asia-Pacific business in part by leveraging our recent acquisition of a strong midmarket time product to supplement our existing payroll functionality. And across a few of our platforms, including Workforce Now and Roll, we intend to deploy GenAI-powered features to help our clients more quickly and easily tackle certain HR transactions. Our second strategic priority is to provide unmatched expertise and outsourcing to our clients. We pride ourselves on serving as a true partner to each and every one of our one million clients. Our culture of client service applies equally across our entire business from a basic payroll client to a fully outsourced client where we run part or all of the HR department. Our expertise and partnership approach has been key to ADP's winning formula for decades, and we will continue to lean into it. We expect that to manifest in a few ways in fiscal 2024. We have recently been piloting a number of tools powered by GenAI that can help our service and implementation associates deliver an even better client experience, and we will begin deploying these more broadly in early fiscal 2024. Given the significant number of clients we onboard and interact with every year, we expect to learn quite a bit this year about the longer-term benefits we and our clients might realize from GenAI. Meanwhile, demand for our HR outsourcing solutions remains very strong, and in fiscal 2024, we are focused on reaching new clients and further improving the experience for existing ones. Our Employer Services HRO businesses have been performing incredibly well and our focus for fiscal 2024 is to continue delivering strong bookings and keep client satisfaction and retention at current levels or perhaps even reach new record levels. And our focus for our PEO business in fiscal 2024 is to maintain our recent strong bookings momentum by continuing to add to our sales force headcount, grow our referral partner network and use data and machine learning to identify existing ADP clients who maybe a strong fit for an upgrade. Our third and final strategic priority is to leverage our global scale for the benefit of our clients. Our size and scale are unmatched in the industry. Across the globe, we not only offer robust platforms and a commitment to industry-leading service and expertise, but we also provide a scaled ecosystem and a unique on-the-ground presence in over 30 countries. This combination positions us to interact routinely with local governments and tax authorities, meet stringent certification and data requirements, and stay on top of complex and shifting legal requirements. Globally, we bring together our incredible data, an array of partners and integrated solutions, and one of the biggest and best business-to-business sales forces in the world to help our clients and prospects navigate the changing world of work. In fiscal 2024, we will continue to build on that scale for the benefit of our clients. Our GlobalView platform support hundreds of the world's largest multi-national companies with scaled workforces in over 40 countries and our Celergo platform helps us serve thousands more in up to 140 countries. In fiscal 2024, we expect to expand on both as we add additional countries to GlobalView's broad reach and as we potentially make tuck-in acquisitions to enhance our native in-country footprint. After establishing an ADP in-country presence in five new markets in 2023, we expect to expand further in fiscal 2024. Our world-class global scale distribution led by over 8,500 sellers is being supported by headcount and marketing investments in 2024, and as we've shared with you in the past few quarters, our sellers will continue to be paired with a best-in-class sales tech stack, which we plan to enhance with GenAI functionality in the coming months. And our ability to provide data-driven insights will continue to grow in fiscal 2024. ADP serves more clients and pays more people around the world than ever, and as we continue growing the number of employees we serve globally, the power of our insights will likewise continue to increase and benefit our clients. I am incredibly excited about these three strategic priorities for ADP and the differentiation and growth they will continue to drive. But before turning it over to Don, I wanted to take a moment to recognize our associates for their effort and performance over the course of this year. Our associates embody our core values, like insightful expertise, service excellence, and being results-driven. In fiscal 2023, ADP was recognized as the World's Most Admired Company by Fortune Magazine for the 17th consecutive year, signifying the incredibly strong culture we have and the important role we play in the world. Additionally, we were recently recognized, for the first time, as one of the Best Companies for Innovators by Fast Company, a true testament to the direction we are headed in. We owe these accolades as well as our strong consistent financial performance to the commitment and effort of our 63,000 associates that make-up the ADP family. With that, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll start by expanding on Maria's comments around our Q4 results and then cover our fiscal 2024 financial outlook. Q4 performance is very strong overall, driving fiscal '23 results at or above our expectations. As Maria mentioned, these results reflected broad-based strength in Employer Services and PEO new business bookings, better-than-anticipated Employer Services retention and continued healthy Employer Services pays per control growth, yielding 10% organic constant currency revenue growth for the year and bringing us to $18 billion in revenue. For our Employer Services segment, revenue in the quarter increased 11% on both the reported and organic constant currency basis. This stronger-than-expected revenue growth was a function of continued outperformance in retention and pays per control growth as well as a better-than-anticipated contribution from client funds interest. Our ES margin expanded 480 basis points in the fourth quarter, which was broadly in line with our expectations. For the full year, our ES revenue grew 10% on a reported basis and 11% on an organic constant currency basis, and our ES margin expanded 190 basis points. Growth in client funds interest helped us in a year in which we added a fair amount to our product, service, and sales headcount, which has driven some fairly substantial benefits in sales, Net Promoter Score, and retention results. For our PEO, revenue increased 4% for the quarter, decelerating slightly from Q3, as we anticipated. Average worksite employees increased 3% on a year-over-year basis to 722,000, and has started to gradually reaccelerate, supported by very strong bookings growth in Q4. PEO margin contracted 110 basis points in the fourth quarter, in line with our expectations due in part to higher selling expenses. For the full year, our PEO revenue grew 8% and average worksite employees increased 6% and our margin expanded 60 basis points, all in line with our most recent guidance. I'll now turn to our outlook for fiscal '24. While the economic backdrop remains uncertain, we continue to believe we are well-positioned to deliver solid overall financial results, while also investing for future growth, consistent with the strategic priorities that Maria laid out. Our fiscal '24 outlook assumes a moderation in economic activity over the course of the year, but nothing dramatic. Beginning with ES segment revenue, we expect growth of 7% to 8% driven by the following key assumptions. We expect ES new business bookings growth of 4% to 7%, representing a solid growth after a particularly strong fiscal '23. For now, we're assuming a stronger first half and some moderation in second half bookings growth, which we think is prudent, given the limited visibility into the macro environment. For ES retention, we finished fiscal '23 at a record level of 92.2%, consistently outperforming our expectations throughout the year. We are, of course, very pleased with this performance as we overcame headwinds from higher down-market out of business levels with strength elsewhere. With that said, we are contemplating a 50 to 70 basis points ES retention decline for fiscal '24, due in part to an assumption that small business losses will increase slightly from where they are today as well as an assumption for general impact to our other businesses from a slowing economic backdrop. As we called out three months ago, we see the potential for below normal pays per control growth in fiscal '24 and our outlook assumes 1% to 2% growth for the year. We had a strong Q4, which gives us a solid starting point for growth and a gradual deceleration over the course of the year feels reasonable at this time. And after price contributed 150 basis points to our ES revenue growth in fiscal '23, we are anticipating a smaller contribution in fiscal '24, though still above our recent historical average contribution of around 50 basis points. And for client funds interest revenue, the interest rate backdrop has been dynamic these past few months, and is important to keep in mind that our client funds interest revenue forecast reflects the current forward yield curve, which will, of course, evolve as we move through fiscal '24. At this point, we expect our average yield to increase from 2.4% in fiscal '23 to 2.8% in fiscal '24. We, meanwhile, expect our average client funds balances to grow 2% to 3% in fiscal '24, this is a bit lower than recent trends, due primarily to more modest contribution from pays per control growth and an assumption for more moderate wage increases. Putting those together, we expect our client funds interest revenue to increase from $813 million in fiscal '23 to a range of $955 million to $975 million in fiscal '24. Meanwhile, we expect the net impact from our client fund strategy to increase from $730 million in fiscal '23 to a range of $815 million to $835 million in fiscal '24. For our ES margin, we expect an increase of 130 to 150 basis points, driven by operating leverage and contribution from client funds interest revenue, offset by continued investments across our strategic priorities. Moving on to the PEO segment. We expect PEO revenue and PEO revenue, excluding zero margin pass-through, to grow 3% to 5% in fiscal '24. The primary driver for our PEO revenue growth is our outlook for average worksite employee growth of 3% to 4%. This represents a gradual reacceleration from the 3% growth we're stepping off in Q4. Strong bookings performance has already contributed to accelerating client growth, but that has so far been offset by slowing pays per control growth. With continued strong bookings growth, our worksite employee growth should gradually accelerate as well. And as Maria shared, demand has been healthy and we remain confident in the long-term growth opportunity in PEO. We expect PEO margin to be down between 20 and 40 basis points in fiscal '24, due to anticipated higher selling expenses, as well as year-over-year headwind from a lower workers' compensation reserve release benefit than we experienced in fiscal '23. Adding it all up, our consolidated revenue outlook is for 6% to 7% growth in fiscal '24 and our adjusted EBIT margin outlook is for expansion of 60 to 80 basis points. We expect our effective tax rate for fiscal '24 to be around 23%. And we expect adjusted EPS growth of 10% to 12%, supported by buybacks. One quick note on cadence. At this point, we expect total revenue growth to be relatively consistent quarter-to-quarter. We expect our adjusted EBIT margin to be down slightly in Q1 on a year-over-year basis, and then build over the course of the year. Thank you, and I'll now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Owen Callahan",
"text": "Hi, this is Owen on for Ramsey. I appreciate you taking our question today. I was just curious more on kind of your PEO revenue guidance. I know you called out worksite employee growth weighing on growth there, but you expect double-digit kind of bookings growth and projects only 3% to 5% growth in PEO revenues for fiscal '24. I was just curious if you can provide any more color on that spread is any conservatism or if there are any other factors to consider there. Thank you."
},
{
"speaker": "Don McGuire",
"text": "Hi, Owen, thanks. Yes, I'll answer the question. We had a very, very strong sales bookings result in Q4. So we're very happy with that, and we've seen the sales reaccelerate. I think as we said in the prepared comments, we are seeing continued growth in clients. I think if there is a challenge that we're facing a little bit as we're seeing a little bit softer pays per control growth in the PEO than we would have expected. But back to what we've been saying for some time, we think the underlying value proposition is very, very strong and we look to that business continue to grow for us and be a big part of our portfolio."
},
{
"speaker": "Owen Callahan",
"text": "Understood. I appreciate that."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning. Congrats on the strong end to the fiscal year. Maybe first question, Maria, I thought it was - is very interesting about the announcement of moving Roll into new international markets. How should we think about maybe what the opportunity there looks like? How much different is the complexity around payroll processing in international markets versus the U.S. and have you included that in the bookings forecast for fiscal '24?"
},
{
"speaker": "Maria Black",
"text": "Yes, fair enough. Thanks, Samad, and I appreciate the congratulations on the quarter and the year. We're, obviously, pretty proud over here. So with respect to Roll, it is exciting. It's been an exciting product for us to rollout, no pun intended, across the down-market here in the U.S. We're excited to take it into international. As mentioned, the initial goal is to put it into two countries. And it is an incremental add for us because it's really initially into these two countries. We're thinking more kind of the down-market SMB space, which is an area of opportunity for us across many of the markets that we serve. But we're also excited about Roll long-term beyond that space. So excited to dip it into our international space as we continue the overall rollout of Roll. In terms of factoring it into the overall bookings, not really. I think the - by the time the launch happens and as we're thinking about the full year for our international business or full year for new business bookings, I'd be surprised if it ultimately makes a dent, but to us, it's really about the long-term value that that offer will bring as we seek to expand the addressable market for us into these various places. Last but not least, Samad, you mentioned the complexity of being international. And I have to tell you, I spoke to it a little bit in the prepared remarks. There's a lot that goes into being in each one of these countries. To your point, there is complexity country-by-country. Many countries put many of the states that are complex here in the U.S. to shame in terms of the complexity that provides, and that's everything from government entities, legal and tax attorneys, who's the tax authority and how do you get to them. We often think of it as an ecosystem. We think about it as kind of that final mile, if you will, and that's the complexity and that's what we've been building over the last couple of decades in our international business. So it's a lot more than dropping off software at a country border and hoping that it works. There's a lot to be said for the ecosystem around it. Again, whether it's tax authorities, data lodgement, things of that nature. So excited to take advantage of the footprint we've built and put in our product into that footprint as we expand Roll internationally."
},
{
"speaker": "Samad Samana",
"text": "Very helpful. And then maybe just a quick follow-up for Don. I know you gave - you called out that broad-based strength that drove the bookings upside and you cited several specific factors. I guess, it would be helpful if you could maybe help us dimensionalize where the upside was relative to the company's own expectations at maybe the start of fiscal '23 and what you're carrying forward from what you saw in the fourth quarter into the FY '24 bookings outlook?"
},
{
"speaker": "Don McGuire",
"text": "Yes, thanks for the question. I'll start here and I think I'll turn over to Maria for the bookings. But we certainly saw strength across the Board. I think once again, in the prepared remarks, we called out the - our tax business and our international business. So they were very strong amongst all the ones that were strong and the down-market was also quite strong. So it was really a contribution from across the Board in the fourth quarter. We talked for some time about how the pipelines are healthy and whatnot, and you had questions before about times to get signatures on deals, et cetera, things came together in the fourth quarter and we were very, very pleased with the final result."
},
{
"speaker": "Maria Black",
"text": "That's right. My only add to that comment would be, we stepped into the quarter with healthy pipelines, with a strong staffing position that was growing tenure. I have to tell you when I reflect on all the quarters that I've watched across our sales execution, generally speaking, you have a bunch of businesses that are outperforming and you have a few businesses that are perhaps being carried by those that are outperforming. What I have to tell you is, this was a broad-based strength across the entire organization sales implementation service with kind of an all-hands-on-deck execution, and that's really what it's all about. What I would attribute it to is incredible execution."
},
{
"speaker": "Samad Samana",
"text": "Great. Thank you. Appreciate you taking my questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. I wanted to follow-up on U.S. bookings here. So you cited several areas of strength, midmarket compliance, international. On the midmarket, specifically, can you talk about what's driving that better-than-expected performance, do you think that's driving improved competitive performance versus kind of rising tide environment? And then just - I heard your comment on Next Gen HCM contributing more in the current fiscal year to bookings. Maybe talk about the initiatives in the product development that you think is going to drive that."
},
{
"speaker": "Maria Black",
"text": "Good morning, Bryan. So I'll comment on both. The mid-market strength that we've seen and coming in a bit better than expected. It's been solid for quite some time. That's inclusive of our HRO offerings, and as you know, we've been speaking to those quite a bit in terms of the resonance of that value proposition in the market. So I think that adds to the overall strength that we have in the mid-market, which is the various flavors and offers that we have. I think the other is that we've made tremendous investments into that business. So we do have our next-generation payroll engine that the sales force is pretty excited about and we're seeing that in the wins that are coming in and just kind of the momentum there. I think the other is the amount of product investment and innovation that we've done in the mid-market, specifically referencing the investments we've made into the Workforce Now platform with the new UX and many of the things that I've been speaking to. And I think the other call out is it definitely helps on a new business bookings perspective, when the business on the other side, so service and NPS, if you will, as well as retention are firing on all cylinders. And that's exactly the case. We have record retention in our mid-market, and we have near-record MPS results across the mid-market. So really, really proud of the execution in that entire space. And that definitely fuels and feeds the ability for our sellers to get excited about everything that I just mentioned to go-to-market. Stepping into the question around next-gen HCM, I did make a reference to that. We've talked a lot over the last quarters about this year. And what we've been working on is scaling implementation, and that's exactly what we've done in that business. So, we were able to onboard a lot of the clients, that we had on our backlog. We've shortened the time of implementation, and we also saw additions to that backlog. So, we saw new sales in the fourth quarter of that next-generation HCM platform. We're really excited about the momentum as we step into '24. And as such, we believe that Next Gen HCM will be a larger contributor to bookings for us in the upcoming years than it was in '23, but we were pleased with what we saw in the fourth quarter and the momentum heading in."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Understood. And then just on pricing, can you comment on where that ended up in fiscal '23 and what you're assuming in ES growth from a pricing standpoint in fiscal '24?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So, we were happy with our price increase and retention. So as we've talked to many times, we want to make sure that we're not getting greedy. So, we did get about 150 basis points of price in the year. And we did that without the expense of seeing a decline in retention or NPS scores. And quite frankly, those NPS scores have stayed healthy despite the price increase. So as much as price increases can land well, they have landed well, and we're very happy with how that transpired throughout '23. For '24, we do expect to have price increases again. We do not think that we're going to be in the 150 basis point range. We're certainly going to be above our historical average of about 50 basis points. But once again, we'll watch closely and make sure that the underlying value proposition for our clients stays in place, and we'll take some price for sure, but not to the extent that we did in FY '23."
},
{
"speaker": "Bryan Bergin",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hi, thanks so much. Yes. With the great bookings here, I'm just thinking around the conversion. You mentioned implementation cycles. I'm just curious if you've seen any change from clients and their desire to implement. And then similarly, just maybe based on your comments there on next-gen HCM, I'd love to hear a little bit more around the appetite from your prospects to upgrade now at this point in the cycle. What's the pitch here given some of the macro uncertainty?"
},
{
"speaker": "Maria Black",
"text": "So, I think both of your questions, I just want to confirm, I'm hearing them the right way. I think they both kind of speak to the general sentiment around the demand environment."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes."
},
{
"speaker": "Maria Black",
"text": "Is that kind of a good way to think about it in terms of decisions getting delayed and/or what's the appetite to, I suppose, by HCM in the current macro environment. And so, I'll comment on the general demand environment and feel free to follow-up with an additional question if I didn't cover what you wanted. But the way that I think about demand, and I've spoken to it quite a bit over the last couple of quarters. Demand remains strong, and that is very broad-based across the business. And so, if you think about the down market, you still have the strength of small business formations. You have the strength of hiring that's happening in the down market. And as such you have clients there needing to make decisions around our HCM offers in that space, right? So that's definitely a place that we've been winning, and we'll continue to lean in as warranted by the demand. The mid-market, as we talked about that a little bit earlier in terms of the overall demand there for the complexity that exists in that market. That's inclusive again of the solution we have around our HR outsourcing offerings. And so that's kind of the mid-market. So getting to your question, which is really about the enterprise space and perhaps even the MNC space, it is an area that we continue to watch as it relates to demand cycles, decision delays. And the main reason is those are really the places that you, as you're aware, have additional, perhaps signers, additional levels of approval, things of that nature. And what I would say, which is consistent with what we've been seeing, is that we are back to pre-pandemic levels. So deal cycles did shorten during the pandemic, and they elongated back the pre-pandemic. But it isn't something that we're seeing additional elongation beyond historical averages. And so to your point, though, it is an area that we consistently watch both in the enterprise space as well as in our international business, just to kind of see if the demand cycle is at the client's appetite to make buying decisions or implementation decisions during this time has changed thus far, we're not seeing it in a broad-based way. But it is an area we continue to monitor."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Okay. No, that's great. You answered it better than I asked the question. So thanks for that. Just on the - as a quick follow-up, just I heard a lot about the sales and the go-to-market investments that makes sense. Just how about R&D growth here in the upcoming year versus fiscal '23? How might growth be different? And also, how might the composition be different in terms of where you're placing your bets on R&D? Thanks, that's all I have."
},
{
"speaker": "Don McGuire",
"text": "Yes. I think we have a number of projects that we've shared with you all over the past number of quarters. Those projects are well underway. We won't take a lot of time talking about specific Gen AI product projects, but I guess that would be a place that would anticipate I'll get a question we'll get a question for that later on in this call, given it's so topical. But generally, we're continuing our direction with the investments that we've described over the past number of quarters, and we continue to make good progress. We continue to have good delivery. The ability to take RUN to markets in Europe is an example of that, how investments in that development in that technology has increased. And by the way, that's part of our broader strategy that we've touched on many times, is to take some of these developments and make sure that they're global in nature as opposed to only local in nature. So nothing incredibly new, just a continuation of the great work and the great projects we have underway."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hi, good morning. And let me add my congratulations, particularly on the strong new bookings. Maria, you went through your three key strategic initiatives and all the subsections - of the various initiatives which ones are going to be the most impactful do you think from a near-term perspective? And then one specific question. Within the mid-market, you mentioned not only deploying next-gen payroll, but you also talked about the time engine. And I was wondering if you could elaborate a little bit on that?"
},
{
"speaker": "Maria Black",
"text": "Sure. And thank you, Mark. I appreciate the congratulations. So, I am very excited about the strategic priorities, as I outlined during the prepared remarks. I don't know that I was necessarily expecting to have to pick a favorite pillar or a - one that I expect to yield impact faster than another because I think broadly speaking, they apply across all of ADP, and they will depend a bit as it relates to kind of each business, right? And so, when I think about some of the product investments that we're making. Some of the things, the work that we've done and the impact, whether it's taking a product like roll internationally, which I mentioned earlier, will be short-term results, but some of the impact of continuing to build on the momentum we have in the mid-market with our next-generation payroll engine, as an example, where we have an ability to win differently, we see competitive advantages and differentiation there. I think that's an area that can have tremendous impact in short order. I think the other is Don did it first, which is he mentioned the likes of generative AI. And when I think about that, the Gen AI and applying it broadly across these pillars, I think there is opportunity for us in product that's pretty tremendous, whether it's solving real opportunities for our clients to become more efficient. We've talked a lot about that, whether that's things like job descriptions, performance reviews, things of that nature. But it also leads me kind of to that second pillar to your point around what will come short-term versus long-term. I think there's opportunity in the short-term that will make impact as well as the long-term, in terms of really applying generative AI across our expertise that we provide to our clients. And so, when I think about our ability to make it easier for our clients to engage with us or our associates to engage with our clients, some of the tools that - we have already deployed across various businesses and will further deploy into fiscal '24, such as - think of it almost as a copilot agent assist where we're helping our agents be more efficient. That's going to yield short-term results, if nothing else in client satisfaction. And again, we know happy clients lead to a longer staying clients that leads to more sales and the wheel, if you will. So, I think there are opportunities across all of the strategic priorities to have some impact us sooner than the long-term. But yes, I'm equally excited about all of them. And certainly, we spoke quite a bit about the global piece. In terms of the next-generation time engine, that is being developed in tandem with our next-generation payroll engine. And those two things are really about time and payroll sitting together in our mid-market. It is a based on the same backbone of technology. And so, we're very excited to take that more broadly across the mid-market as we continue to take the next generation payroll engine also more broadly crossed. And I think, both of those things will get feathered into the impact of our win rates, if you will, and our new business bookings in the mid-market throughout the course of '24."
},
{
"speaker": "Mark Marcon",
"text": "That's great. And then, Don, you mentioned the margin expectations for the full year. And you mentioned that in the first quarter, it's probably going to be a little bit lower and then feather up over the course of the year. How much lower during the first quarter? And what's the driver there? And then how should we think about the pacing of the improvement quarter-to-quarter?"
},
{
"speaker": "Don McGuire",
"text": "Yes, Mark, thanks for the question. We're not looking at a big change in the first quarter, but just a couple of the drivers. Just to be clear. One, we do have some incremental investment in cost and headcount, et cetera. But the other big driver in the first quarter is it's a big borrowing quarter for us in our laddered client fund interest strategy. So that's going to put a little bit of pressure on the margin for the fourth - sorry, for the first quarter. And the margin will continue to build over the course of the year, and we will get the overall improvement that we expected, but more out of the three quarters as opposed to the first."
},
{
"speaker": "Mark Marcon",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open."
},
{
"speaker": "Eugene Simuni",
"text": "Thank you. Good morning, guys. I want to come back to the PEO for a second. So great to hear about strong PEO bookings in the fourth quarter and going into the New Year. Can you provide a bit more color on what helped generate this reacceleration in bookings? I know you talked in the past, Maria, about some of the actions you guys have taken to generate PEO sales, I would love to hear what caused the acceleration in bookings? And are those initiatives that as kind of levers you're pulling now completely pulled or is it still work in progress and will continue into FY '24?"
},
{
"speaker": "Maria Black",
"text": "Sure. Good morning, Eugene. PEO bookings, again, we're incredibly pleased with the results in the fourth quarter and the reacceleration. We also did see the reacceleration in the third quarter. So the back half of the PEO was exactly as you suggested. It was a lot of focus for the management team, and I'm really excited about how we came together to execute. And in terms of the overall demand trends in long-term, short term. I remain bullish on the overall value proposition of the PEO and the demand that it warrants. It's hard in that business to kind of pin down the demand trends, because there are so many variables. And in the PEO, it's not as simple as looking at just leads and number of request for proposals that are coming in, because as you know, not every client as a potential fits. So it's a little a little difficult to pin down kind of the various demand trends in the specificity outside of the overall belief in the demand environment. And there's a normal level of kind of variability as it relates to PEO bookings quarter-to-quarter, which also makes it hard to kind of spot various trends. Some of that has to do with the calendar year-end. Some of that has to do with when renewals happen. But nonetheless, there was a tremendous amount of focus and still remains. We remain very focused as a team across all of the leadership to make sure that we continue to drive the strong growth in bookings in the PEO in '24."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Okay. Thank you. And then for my follow-up, probably for Don. We talked about margin costs a little bit. So you expect another year of robust margin improvement next year. But obviously, you're not going to have as much tailwind in revenue growth as you had this year. And if you kind of do some of the [bet and Roll] math, it looks like your adjusted OpEx will need to grow slower next year than it did this year for you to hit your goal. So just hoping maybe you can talk a little bit, what are, the areas of spend where you will temper next year or maybe pullback, especially if macro conditions are not as good as kind of we expect them to be?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So thanks for the question. Let me start by what won't change. So what won't change is that we'll continue to make sure that we invest in key areas of the business to make sure that we can run it effectively. And with the strong bookings, we'll make sure that we have the people on the ground for implementation to get those deals up and running and generating revenue for us, et cetera. But in the last year, we did have pretty substantial growth in, over the last couple of years coming out of the pandemic. I can't believe we're still talking about the pandemic. But as we came out of the pandemic, we did have substantial growth in expenses in service, implementation, sales, et cetera. And while we do continue to expect to see some growth, we're not going to see as much growth in expenses in those areas. So that would be one of the areas that is going to make sure and you hit on it with respect to OpEx. We're not going to see the growth in OpEx expense that we saw in the prior year. The other contributor, of course, that will continue to contribute. I think, the yield curve is more favorable than it was the last time I spoke to you all. We will get contribution from client fund interest next year. But at the same time, it's not going to be to the extent that we did in '23. So that's also going to help with driving margins higher. But once again, not the same tailwind - tailwinds that we had in '23. I think those are the main items that are going to help us improve our margins going into next year."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Very helpful. Yes perhaps."
},
{
"speaker": "Operator",
"text": "Thank you. Our question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Hi, good morning guys. And thanks for taking my questions. Maybe, Don, first on the cadence of revenue growth. I know you said it should be relatively stable throughout the year, but wondering if you can maybe sort of parse that out between ES and PEO if there's any differences we should think about there?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So, I think revenue growth is going to be - revenue growth is going to be pretty consistent throughout the year as we start the - as we start that big backlog that we now have as a result of that very, very strong fourth quarter bookings result. So, we will see consistency there. Likewise with PEO, it's going to be a bit of a slower burn as we did have strong sales in Q4. So, we did also talk about slightly lower pace control growth in the PEO business. So - but I don't think they're really going to be that different. I think, they're going to be pretty close if you think about the overall growth, and consolidate the results for the company not substantially different between the business units."
},
{
"speaker": "Danyal Hussain",
"text": "Yes, Scott, there is a slightly different cadence for the two, it's not a huge difference. For PEO, we do expect an acceleration over the course of the year. So, the contribution we get from our bookings and from the improvements in retention, we're expecting gradually overcoming slowing pays per control that should lead to an accelerating PEO revenue growth. And on ES, we're expecting some deceleration assuming pay per control decelerate and assuming the contribution from client funds interest starts to fade gradually over the course of the year. So you end up with two different-looking ramps, but they offset and that what nets us to a very stable revenue growth overall."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. It's very helpful. And then maybe just a follow-up on the Gen AI topic, going back to it. Obviously, there's a lot to sort of be excited about there. But just kind of wondering the magnitude of investment needed there, is that investment essentially all incremental to your investment plans for the year? Or have you had to maybe put some other projects on the back burner to focus a little more on Gen AI?"
},
{
"speaker": "Maria Black",
"text": "Yes. And so said differently, the good news is we just went through our strategic plan process in the last six months. And so, we had all of our priority sequence in all of our investments and incremental investments lined up. As we marry that to Gen AI, we have a very clear lens on where some projects may get enhanced and where some projects may look different and perhaps get replaced by a new way of thinking about it. And so candidly speaking, we're going through a lot of these opportunities at this juncture kind of thinking through the bets and there will be incremental investment. And there will be other investments that we repurposed to go do some of these things - in a new way. So, the answer is both."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. Thanks guys. And congrats on the results."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Peter Christiansen with Citi. Your line is open."
},
{
"speaker": "Peter Christiansen",
"text": "Thank you. Good morning. I'll also add to the congratulations ratio. Nice trends. Maria, a question on the international scaling effort here. I was just wondering if you could - in this context, if you could put some parameters on expected investment spend, I guess, over the next one to two years? And do you see M&A as an important contributor to the growth algorithm there?"
},
{
"speaker": "Maria Black",
"text": "Sure. You started with a question on international. So is the rest of your question about international or is it just in general?"
},
{
"speaker": "Peter Christiansen",
"text": "Correct."
},
{
"speaker": "Maria Black",
"text": "About international. Yes. So, we have been, over the years, been making in-country decisions on investments. I talked a lot about the, call it, the feet on the street, the final mile of infrastructure that we have to support our international business. And so, we will continue to do that. That's inclusive of each year. We go into new markets and some of those are organic ways that we go into new markets. Some of those are actually partners that we ultimately end up at some point, call it, purchasing, if you will, or acquiring. And so, the answer is both organic and inorganic. That's kind of how we've built the business over the last 20 years. And we will continue where warranted to think about it both ways. And the decision criteria for us is really about speed. A lot of times, it's our clients that pulled us into incremental markets. When I think about the five markets that we went into this year or the two countries that we're heading into with global view, they're byproduct of clients that are choosing to pay employees in certain markets. And as such, for us, a lot of times the decision we make on how to get there, has a lot to do with speed. And as such, again, we will leverage both organic and inorganic ways to get there. So, I don't know, Don, you ran our international business for a very long time. I don't know if you want to add anything."
},
{
"speaker": "Don McGuire",
"text": "Yes, maybe just to add, I think what we've been doing, Peter, over the last number of years is we have done a number of acquisitions. They've been mostly tuck-ins, but we did have three interesting ones over the last year. We acquired an Italian company that has a good budget payroll - budgeting software tool that's very prominent in the Italian market. We acquired our - so it streamlines [indiscernible] partner in South Africa. And we also want a very exciting mid-market time-and-attendance product called SecureX in out of Bangalore in India. So - and that product is available in India, most of Southeast Asia and the Middle East. So, I think that's a demonstration of what we've been doing, we've been looking at and focused on to continue to make sure we grow that footprint, and we do think it continues to be an exciting space for us."
},
{
"speaker": "Peter Christiansen",
"text": "Thanks. That's great. And Don, just as a follow-up, last slide on the maturation schedule of client fund investments, super helpful. But as we think about intra-year investment turnover - should that correlate with the seasonal balance levels that we typically see?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So I think as those - investments mature, you're going to see those investments reinvested at higher rates, and we do expect to see our average return go up over the course of the year. The current reinvestment schedules, overnights are reinvesting at 5%. The extended in the loan portfolios are being reinvested at about 4%.We don't expect to see a huge change in the mix. Although the average duration of our investments has shortened a little bit over the last couple of years. But you can pretty much look at those yields, look at the maturity schedule that we provided and then look at the composition of our portfolio across the overnight, the extended and the long and pretty much come to a conclusion or come to some numbers on where you think we're going to end up."
},
{
"speaker": "Peter Christiansen",
"text": "Thanks. And just one quick one. How should we think about the duration strategy, I guess, for the next couple of quarters here now that the Fed is perhaps kind of like stabilized, but are - is there an effort to extend duration shorten it? Just any sense there would be helpful? And thank you."
},
{
"speaker": "Don McGuire",
"text": "Yes. We've had this question a few times, and - the answer is we've been very successful with the strategy that we've had for the last 20 years. We certainly see that there is an opportunity cost not ever having everything in short today. At the same time, we do believe that the yield curve will normalize and the strategy we've had in place will come back and be beneficial to us over the longer term. So you shouldn't expect any significant change in our investment strategy."
},
{
"speaker": "Peter Christiansen",
"text": "Very helpful. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Thank you very much. I wanted to go back quickly on retention. I know you've touched on it a little bit. Last year, your initial outlook called for around 50 - minus 50 to minus 25 basis points of retention degradation. But that obviously didn't really play out. And this year, you're starting with a more conservative kind of minus 70 to minus 50. But I'm hoping you could speak to how much conservatism is embedded there? And what are the drivers that you're seeing as a reason to be a little bit more conservative to start than maybe you were last year even?"
},
{
"speaker": "Maria Black",
"text": "Yes, fair. It's a fair observation, James. Appreciate it. I think the we thought about - by the way, I wish I knew the answer, right? So the question you're asking which is how much conservatism is in there? And that's all to say and you hit the nail on the head, we set into this year guiding minus 25 to 50, we're stepping into fiscal '24 with a guide of minus 50 to 70 - and we hope - I'll end - or I'll start with, we're very happy with where things are. We're firing on all cylinders. We have many businesses that have record MPS results, record retention results and everything is good. And so as we step into the year, the way that we are modeling what you would see in pays per control. The way we're thinking about the potential macroeconomic tempering, if you will, specifically in the back half, is really a byproduct of how we see retention. Part of what we saw in the fourth quarter that led to the incredible results that we had was that the normalization that we've been seeing in the down-market, we did actually see the down market bounce a little bit. So even while it was down year-on-year, it came in stronger than we expected. And so we do anticipate that we may need to give some of that back, which is why we believe it was prudent to align our retention targets through our medium-term targets that we gave back in the Investor Day of 2021. So I wish I knew the answer to your question in terms of how much conservatism, why we are guiding to what we're guiding is really about the economic outlook, whether that's GDP, unemployment is still at record lows. We haven't seen unemployment rates that low since the 60s. And so our guess is as good as yours at some level, but we did build in some tempering of the economy in the back half, and that's really what's yielding that guide on the retention."
},
{
"speaker": "James Faucette",
"text": "Great. I appreciate that color, Maria. That's really helpful and makes a lot of sense. I want to turn quickly also to M&A. You mentioned it in the prepared remarks, also, I mentioned it as part of at least some of your strategic initiatives. What are you seeing in terms of overall valuation levels? And what kind of things would you be targeting in terms of geography or product capabilities? Thanks a lot."
},
{
"speaker": "Don McGuire",
"text": "Yes, James. So in terms of what we're targeting, what we're talking about, there's always things kicking around, of course, but we want to make sure that anything that we do acquire either fits well in the core and gives us additional capability, or it's something that really exceeds some functionality capability that we currently have, so that we're not stacking on more and more product on top of what we already have. The other area, of course, is to make sure that - we do things that are natural adjacencies - are very strong adjacencies to what we already do so that they fit well. And then thirdly, of course, is making sure that we can sell these things and run these things in a recurring model, so that we can sell them the way we sell everything else we sell today and operate them and expect to get revenue anticipation and good model from what we buy. So I think those are the things we think about. I think we're hearing a lot around valuations coming down in the press, certainly a little bit of a dearth of activity, if you will, in the M&A space these days. But we do have lots of conversations about acquisitions and whatnot. I still think, of course, everybody is looking to get a premium what they have. And we're trying to make sure that if we're going to buy something, we're paying the right price. But we don't actually get to the point of many of these conversations given the conditions that I stated at the front at the outset to actually have a view on overall valuations in the market. We likely get to talking about valuation in a very, very few number of cases. Remembering, of course, very, very few of the opportunities we get even get to that conversation. So I don't think I can say we have a general view. But we are focused on what we would have to pay and how things would fit into ADP."
},
{
"speaker": "James Faucette",
"text": "That's great. I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our last question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Maria and Don, you've obviously talked a lot about the PEO and seems that the demand has really picked up. But I'm wondering, are you seeing any of your customers maybe taking a little bit of a breather now pointing to sign up for the PEO because of the uncertainty in the economy and that being maybe more expensive product?"
},
{
"speaker": "Maria Black",
"text": "The PEO has a tremendous value proposition. I think we always refer to ADP as an all-weather company. I would say the most durable of our all-weather businesses is the PEO. And a lot of that has to do with the ability to flex that value proposition in a downturn pretty quickly. So if you think about clients that are growing, they enjoy the PEO because it's a quick go-to-market. On the downside, if you will, as clients are potentially trying to work through economic headwinds, the PEO serves as a place that has a clear return on investment, has a total cost of ownership that's very again, very clear. And so I think it's a business that not to suggest that it's not impacted by a downturn, but it's a business that kind of works in both. What I would say is our sales force, we're able to pivot that narrative and that value proposition as warranted. I don't believe that has happened. So to answer the question, our clients at this point, hesitant to purchase something such as the PEO that's so comprehensive because of the macroeconomic challenges. And my view would be, no. I think that's substantiated by the record results that we had in the PEO bookings in the quarter. We also saw that strength in bookings in the third quarter. So I think that value proposition is holding firm. And I think it's a business that should - should the economic wins ever come to life that we've been expecting for so long. It's a business that can pivot pretty quickly and the demand for the offer remains."
},
{
"speaker": "Kartik Mehta",
"text": "And then just a follow-up. Don, you talked about obviously pays per control and retention and maybe retention moderating as the year goes through. For pay per control, would you anticipate that just to get to flat by the end of the year? Or are you anticipating that, that could potentially go negative, and that's how you've built the guidance?"
},
{
"speaker": "Don McGuire",
"text": "No. We're certainly not anticipating this as you go negative. We do, though, think it's going to go to somewhere ever 1% to 2%, which is a little bit less than our historical average. However, I just want to make sure that everybody understands, we're exiting the year pretty healthily. So we figure we're off to a pretty good start, but we do expect that we're going to see a bit of a decline over the next three, four quarters. And once again, we're aligning ourselves to the best we can with unemployment forecasts and et cetera."
},
{
"speaker": "Danny Hussain",
"text": "Karthik, if you're asking specifically about where we're exiting fiscal '24, then the pay per control is effectively decelerating from this kind of 3% range to something flatter."
},
{
"speaker": "Kartik Mehta",
"text": "Okay. Perfect. Thanks Danny. I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Thank you, and thank you, everyone, for joining today. As you've heard, Don and I, the entire leadership team we're incredibly pleased with fiscal '23, specifically the fourth quarter and the finish. So I'll kind of end where I started, which is, I want to take the opportunity to once again thank the associates that create this performance. It's an unbelievable magical thing to watch it all come together and deliver what we just delivered. And so my gratitude and I celebrate each and every one of them. I also want to thank all of the stakeholders, including all of you who listen today, appreciate the support. We're certainly excited for fiscal '24. So cheers to that."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This concludes the program, and you may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 3 | 2,023 | 2023-04-26 08:30:00 | Operator: Good morning. My name is Michelle and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Third Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead.
Danny Hussain: Thank you, Michelle and welcome everyone to ADP’s third quarter fiscal 2023 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I will now turn it over to Maria.
Maria Black: Thank you, Danny and thank you everyone for joining us. For our third quarter, we delivered strong results, including 10% organic constant currency revenue growth, 110 basis points of adjusted EBIT margin expansion and 14% adjusted EPS growth. Our continued solid financial performance underscores the power of our innovative and mission-critical HCM solutions that serve over 1 million diverse clients around the world as well as our highly recurring revenue business model. As usual, I will start with some highlights from the quarter. The demand environment was healthy overall. And in Q3, we drove another quarter of solid Employer Services, new business bookings growth, representing a record Q3 bookings amount. Bookings performance continues to be particularly strong in our downmarket portfolio. In Q3, we sold and started over 60,000 new run clients, where a new user experience has helped us reach record level new client satisfaction rates these past few quarters. We also had strong bookings results in our insurance and retirement services offerings supported not only by legislative tailwinds, but also by the competitive positioning of our downmarket HCM ecosystem. Demand for our employer services HR outsourcing solutions remained high and we have recently reached the 10,000 client mark. We also saw continued booking strength in our compliance-oriented solutions, including tax remittance and wage payments, which have always been key differentiators for us. On a year-to-date basis, we are within our bookings guidance range and are trending in line with our expectations from the outset of the year and we look forward to finishing the year with a strong close. Our employer services retention rate came in better than expected once again. While we continue to experience normalization in our downmarket out of business rates, this was offset by the strong retention rates in our U.S. mid-market and international businesses, both of which continue to benefit from years of improving client satisfaction. As such, we are pleased to be raising our full year retention guidance. Our employer services paid for control grew 4% for the quarter and continues to decelerate at a very gradual pace. As we have seen for several quarters now, layoffs at many larger companies have been offset by the labor demand elsewhere, which in total has resulted in year-over-year employment growth. With this continued resilience, we are pleased to expect the higher end of our previous pays per control guidance range. Last, on our PEO, while growth in revenue and average works on employees continued to decelerate this quarter, we were pleased to see PEO bookings growth reaccelerate nicely in Q3, especially in March. This represented a much better performance than we experienced in Q2 and resulted in our largest quarter for PEO bookings ever. Despite the current inflationary environment and broad-based macroeconomic uncertainty, we are focused on our PEO sales execution and on delivering continued strong client satisfaction and we remain confident in the long-term secular growth opportunity. Stepping back, while we are pleased to be on track to deliver very strong full year financial results, we are even more excited about how we are leveraging our unmatched scale and decades of innovation experience to drive continued progress on our important modernization journey. We are making our solutions more powerful and easier to use and we are making our unparalleled insight and expertise more accessible than ever. In doing all this, we are delivering an experience that’s better for our clients, better for their employees and better for ADP. I mentioned the tens of thousands of new clients we onboarded in our downmarket, over a third of those clients utilized our digital onboarding experience, yielding a faster time to start, happier clients and greater productivity for our implementation team. We just completed our busy year-end period during which we helped our clients with over 75 million U.S. tax forms and to further enhance the client experience, we proactively service critical year-end data to our clients before they had to search for it. This not only reduced friction for them, but also reduced the number of calls and interactions with our service teams. For years, we have directly engaged and served our clients’ employees through channels like Wisely. As we focus on the overall employee experience we can offer, we continue to add valuable functionality like a savings envelope that employees have used to move more than $1 billion into savings over the last 12 months and a new financial wellness hub with tips, tools and education to drive better financial outcomes. With our new intelligent self-service solution, we are already interacting with over 3 million client employees per month through our action card feature. And our voice of employee solution is helping thousands of clients obtain better insights from their employee population, which can drive higher engagement and satisfaction for those employees. The opportunity to continue creating value and efficiency in the world of work is meaningful and we believe these modern approaches that reduce friction and exceed client expectations will help us deliver on that in the coming years. With that in mind, I want to provide some perspective on how we are strategically positioning ourselves to invest over the near-term given the economic backdrop. As we shared earlier this year, in fiscal 2023, we were impacted by higher wage inflation. We also added to our service and implementation capacity to meet the expectations of our growing client base and we invested throughout the year in sales and product. As we position for potential economic slowdown beyond this fiscal year, we are being thoughtful about how we prioritize our investments. At the same time, we are very much committed to our ongoing modernization journey, which is critical to our sustainable growth and that will require continued steady reinvestment into the business. In the coming quarters, I look forward to updating you on near-term growth priorities for ADP. Before turning it over to Don, I want to take a moment to recognize our associates for their continued focus on helping our clients through the many challenges they face each day, especially amid these uncertain times. Resiliency and partnerships represent core components of the ADP brand promise and are among the many reasons businesses around the world choose to partner with a leader in the industry. Our unrelenting support through years of growth, years of challenge and the years in between is something they have grown to count on and we are honored to support them. With that, I’ll turn it over to Don.
Don McGuire: Thank you, Maria and good morning everyone. I will provide some more details on our Q3 results and update you on our fiscal ‘23 outlook before briefly touching on fiscal ‘24. Let me jump straight into the segments, starting with Employer Services. ES segment revenue increased 11% on a reported basis and 12% on an organic constant currency basis, which is the strongest ES revenue growth we have experienced in quite some time. As Maria shared, ES new business bookings were solid and kept us on track with our full year outlook. We believe the full range of bookings outcomes is still on the table given the relative importance of Q4 bookings to our full year results. So we are not making any change to our guidance, but we do believe the middle of our guidance range feels most likely at this point. On ES retention, following another quarter of better-than-expected results, we are again revising our outlook and we now expect retention to be down only 10 to 20 basis points for the full year compared to our prior outlook of down 20 to 30 basis points. This again will be driven by retention decline in our down market from normalized out-of-business losses and is mostly offset by improved overall retention elsewhere. Pays per control remained strong in Q3 and we are raising our outlook to now assume about 4% pays per control growth for the year compared to our prior outlook for 3% to 4% growth. Client funds interest revenue increased in Q3 in line with our expectations and we are updating our full year outlook utilizing the latest forward yield curve, which in this case resulted in no major change. And on FX, we had about 1 percentage point of ES revenue headwinds in Q3 and there is no change to our outlook for a full year headwind of between 1% and 2%. Following our strong Q3 ES revenue growth, we are pleased to be raising our outlook once again to now expect about 9% growth, up from 8% to 9% before. Our ES margin increased 80 basis points in Q3, which was in line with our expectations. We are narrowing our full year outlook to now expect about 200 basis points of margin expansion and we still see significant opportunity to invest in sales, product and elsewhere throughout the organization to capitalize on the growth opportunity in front of us, which we are choosing to do at this juncture. Moving on to the PEO, we had 5% revenue growth driven by 3% growth in average works on employees. As a reminder, this deceleration is driven by a few factors, including slow pays per control growth, difficult comparisons versus record retention levels and softer recent bookings growth that we experienced the last 2 years. For this fiscal year, we now expect PEO revenue growth of about 8% with growth in average works on employees of about 6%, both at the lower end of our prior ranges. Maria mentioned the bookings reacceleration in Q3 and we are feeling upbeat about reaccelerating the revenue growth in the coming several quarters. This guidance update is mainly due to a tweak to our pays per control assumption within the PEO as it decelerated a bit more than we previously assumed, somewhat different from what we experienced in the ES segment. We are separately lowering our outlook for revenue, excluding zero margin pass-throughs to a range of 7% to 8% due mainly to lower SUI rates in Q3 than we previously anticipated. PEO margin increased 140 basis points in Q3, which was better than expected due primarily to continued favorable workers’ compensation reserve adjustments, which we had not assumed as well as the lower SUI costs I just mentioned and we are raising our outlook for PEO margin to now expect it to be up 50 to 75 basis points for fiscal ‘23. Putting it altogether, we still expect consolidated revenue growth of 8% to 9% in fiscal ‘23, but now believe it will be towards the higher end of that range. We are maintaining our outlook for adjusted EBIT margin expansion of 125 to 150 basis points and for a fiscal ‘23 effective tax rate of about 23%. And we now expect adjusted EPS growth of 16% to 17% and compared to our prior outlook of 15% to 17%. I also want to provide some early high level color on what to expect for next year. We are still going through our annual planning process, but there are a few things to consider at this point. First, assuming a slowing economic backdrop, pays per control could be at a below normal growth rate next year, among other potential macro considerations. I would also point out that while client funds interest appears positioned to give us some contribution to growth, based on the latest forward yield curve, it will likely be very modest. At the same time, we have good momentum in our ES bookings performance and ES retention and we are feeling upbeat about the continued opportunity to build on our decades of success. Thank you. And I’ll now turn it back to Michelle for Q&A.
Operator: Thank you. [Operator Instructions] We will take our first question from Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi, all. Good morning. Thank you. So Don, maybe just building on those last comments you had there, I am curious just any indications or call-outs worth mentioning as it relates to fiscal ‘24? Really in the context of the medium-term outlook that you have given in the past, just how should the Street consider the magnitude of potential impacts across some of these KPIs from a potentially slower macro environment?
Don McGuire: Yes, Brian, good morning. Thank you for the question. It’s still early. We are still in the middle of our planning process. I think we have a lot of things going in our favor sales. We are – we still have relatively high client fund interest. Pays per control have been good and strong. Bookings continue to be strong as we said earlier. So as we get into ‘24, I think we are going to be in a pretty healthy spot with what we know today. I guess the challenge we all have is trying to guess what’s coming in terms of the broader macro situation. We continue to see strong demand. Retention continues to be pretty good, although it’s normalizing a little bit in the down market as we did expect. But I think things feel pretty good at this juncture. So I am going to have to ask you to bear with us a little bit as we make our way through our plan and we stay tuned to what’s going on in the macro environment even closer as we get forward or closer to our July 1 beginning of the year.
Bryan Bergin: Okay. That’s fair. And just on the PEO, so works on employee view downtick and I think you were down sequentially in average works on employees. Can you just talk about what you are seeing in kind of the pays per control versus the retention aspect in the PEO? And with bookings reaccelerating, how long does the reconnection to improve growth take?
Don McGuire: So the – we did have, as you mentioned, we had a particularly strong PEO bookings month in March, which we are optimistic is going to continue and help us as we go forward. Certainly, we are going to have to see how those bookings continue through the balance of the year, trying to anticipate how those are going to actually result in revenue. Things do start relatively quickly in the PEO business, but it’s going to take some time once again to see how that stuff rolls from bookings into revenue. But we are pretty optimistic about how things went in the third quarter, especially with the finish and we do expect to see that reacceleration as quickly as we want to. And by the way, back to your earlier question a little bit, we talked about high single-digit growth in our mid-term view and we won’t be happy if we don’t get something like that.
Maria Black: Yes. I think, Brian, if I can just comment on the quarter-over-quarter real quick as I think you mentioned the sequential growth Q2 to Q3 and works on employees. That is something that obviously we noticed as well and as Don mentioned, from a medium-term perspective, we are definitely still committed from the medium-term to the works on employee growth that we have guided to for that. However, as it relates to kind of the quarter-over-quarter, we noticed the same thing that you noticed. And obviously, that’s not the ideal situation and we are hopeful that won’t be the case as you look sequentially on the quarter-to-quarter, Q3 to Q4, but also year-on-year. And I think that’s really a byproduct of timing and that timing is really about retention, right. So it’s really about, call it, third quarter retention results, which we have cited before were a bit softer than we expected. And as a result of that, you see the sequential piece to the quarter-on-quarter.
Bryan Bergin: Okay. Is that just a function of the type of client within PEO?
Maria Black: In terms of the type being.
Bryan Bergin: More white collar?
Maria Black: I don’t know that it’s a function of more white collar, I think it’s really a function of some of the feelings that we have post-pandemic as the renewals have really been kind of, call it, rippling through the business of the PEO. So it’s really a byproduct of some of the post-pandemic impact that we saw in the PEO. So it’s really a byproduct of the retention softness that we saw in the first quarter, in the second quarter and then quarter-on-quarter this past quarter. So I don’t think it’s necessarily a byproduct of – because retention continues, albeit it’s normalizing a bit in the down market. We do have very strong retention in the mid-market. We also have strong retention, albeit tiny bit less than last year in the down market. So I don’t really think it’s a byproduct of the client base or white collar, I think it’s really a byproduct of kind of a post-pandemic environment in the PEO.
Bryan Bergin: Okay, thank you.
Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi, good morning. Thanks for taking my questions. I guess just trying to look at Employer Services, really strong growth in the quarter, 12% organic. If you back into the guidance for fourth quarter, it looks like a little bit of a deceleration. I think you get to something around 8% growth. So just trying to understand the puts and takes there for the fourth quarter guide versus the strong results in the third quarter?
Don McGuire: Yes, thanks for the question. The biggest impact, I guess, in terms of growth would be we are going to continue to see strong growth from client fund interest in the fourth quarter. But certainly, Q3 is by far the strongest quarter just given the seasonality of tax receipts, etcetera, for us. So I think that would be one of the key drivers. And of course, we did mention as well that we expect to see pays per control growth coming down and softening a little bit, even though a bit higher than we expected to see. Last quarter, it is coming down. It’s certainly starting to moderate.
Bryan Keane: Got it. Got it. And then on the bookings side, although bookings were strong, I think you commented maybe towards the lower end of the range of 6% to 9% and just can you help us maybe think about how bookings will translate into future revenue growth for the employer services? If you can just remind us, just as we get our models set or start thinking about fiscal year ‘24.
Maria Black: Yes. So I’ll let Don comment on the – how the bookings kind of relate to the models on the revenue side. But from an overall bookings perspective, what we cited in the prepared remarks is that we do anticipate the middle of the range. So we did keep the range constant. So it’s constant with the outset of the year, it’s also constant with last quarter’s guidance. So we are keeping that 6% to 9% range. We do anticipate at this point, the middle of that range. And we feel pretty confident heading into the fourth quarter when we take a look at how we exited March, but also taking a look at the number of sellers we have, the investments we’ve made into the ecosystem and as those sellers ultimately gain tenure because we’re actually lapping a lot of new hires that we had, if you will, a year ago. So pretty excited as we step in the other part of that. Confidence is really about what we’re seeing as it relates to the overall pipeline. So pipelines are strong. That’s more of a, call it, enterprise and international or large deal type of comment. We’re seeing tremendous activity in the top of the funnel still upmarket. So the down market continues to shine for us, and that’s really supported by what we’re seeing in continued increases in new business formations. We’re also seeing those new business formations generate inbound leads. So we’re seeing good activity on the digital side. So feel confident as we step into the fourth quarter, and then I’ll let Don comment on how the – ultimately where we land in the fourth quarter and how that translates into revenue for us next year.
Don McGuire: Yes. So on the modeling side, roughly a 1% change in ES bookings growth impacts us in the $17 million to $20 million annually on revenue growth. So that’s kind of how we think about your models. I think that’s been pretty consistent.
Danny Hussain: Yes. And Brian, the timing is – it depends on the business. Obviously, strong performance in the downmarket will impact revenue much more quickly. And if you have strong global view sales at the other end of the extreme, that can take several months to even more than a year, in some cases, to roll in. So, typical rule of thumb for us is a couple of quarters to see the full impact. But of course, the bookings throughout the year have been pretty consistent for us. And so I wouldn’t expect any real callouts from the revenue timing standpoint.
Bryan Keane: Great. Alright, thanks for the color.
Operator: Thank you. Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open.
Eugene Simuni: Hi, guys. Good morning. Maria, I wanted to pick back up on your comments about the break down market. Maybe elaborate on that a little bit, what are the macro factors, your competitive positioning that’s still supporting that? And if you could contrast that for us a little bit with what’s going on in the mid-market. I know it’s still doing well. But if the question is, is there a path for mid-market to get to as strong of a point down market? And what are the levers that maybe you’re able to pull to get you there?
Maria Black: Absolutely. So I’ll start with the down market, just to kind of reiterate the strength we’re seeing there top of funnel. So we are very pleased with what we saw in the performance of the down market. That’s also inclusive of the down market ecosystem. So I think this is our run platform. I talked about the third quarter onboarding 60,000 clients. It’s pretty incredible. Those clients also, many of them have attach rates of our retirement services offering, our insurance services offering. So the entire down market portfolio it’s definitely performing well for us and has for quite some time. It is driven by what we’re seeing macro. And so you just kind of reiterate what we’ve seen as new business formations are up year-on-year, 8%, by the way, they are still up year on pandemic, as I call it. So they are actually if you look at current new business formations versus the year of 2019, right? So pre-pandemic, it’s actually 8,000 or so a week. This is all from the U.S. Census Bureau. So, from the standpoint of what we are seeing that kind of emanate into the pipelines and into the top of the funnel, we do have double-digit growth in our digital inbound leads, right. So I think these are at the OSEM ads, where ultimately clients are coming to us, and we’re meeting those clients with our inside sellers and the demand is there, the demand is strong. In terms of the mid-market, the mid-market was a bit softer this quarter than it was last quarter. That said, we also are very excited about the pipeline that we’re seeing in the mid-market that specifically call it the, the tech only, we do have strength in our Employer Services HR outsourcing offering, which also touches the mid-market. So combined, your question around, is there a path to see tremendous growth there between those businesses, we are seeing growth, and we are excited about our overall mid-market position from a competitive landscape. We do have our next-generation payroll engine that’s attached to about 30% to 40% of our mid-market new business sales. And what I will tell you is it’s resonating incredibly well in the market. It’s resonating with the sellers. That’s always a good sign when they like to talk about it and they like the demo it. It’s also resonating in terms of the competitive landscape and more wins. And so we feel that there is definitely a pass. That’s what we’re investing in, both in product and the ecosystem to have the mid-market be as an exciting of a story as the down market is for us.
Eugene Simuni: Got it. Very helpful color. Thank you. And then for my follow-up, I want to quickly come back to the PEO. Can you talk a little bit about the kind of the macro headwinds for the PEO order? I think we discussed last time, specifically the insurance attach rates, insurance premiums, kind of blocking PEO growth. Is that still a factor or not any long-term?
Maria Black: Yes. What I would say is that the PEO demand remains strong. And so we’re bullish about the secular tailwinds of the PEO. We’re bullish about the value proposition. As it relates to benefits and benefits attached. I know there is a lot of discussions, there are a lot of surveys out there from the likes of Kaiser, etcetera, as it relates to our clients making different choices. I think what we see within our base is perhaps some asks of that. And on the peripheral kind of on the margin, perhaps there is price sensitivity as it relates to benefits. What that really allows for is for our sellers just need to be, call it, more surgical as they go to market. But in terms of the value proposition of the PEO and benefits still being a big component of that, that is the case. We skew definitely a bit more white collar in our PEO. In addition to that, our model with a fully insured model is a little bit different. And so the companies that we attract our PEO are still companies that want to be employers of choice, and employers of choice especially in a macro environment, such as this one, where talent is still the name of the game. They want to offer benefits and benefits are a piece of that. So what I would say is we are not seeing huge signs. I think even if you take a look at the revenue [indiscernible], you would be able to see kind of what’s happening with benefit revenue. So there is not huge signs that there is a shift in benefits attractiveness. I think the shift that we see is just the sharpness that our sellers need to have as they position the value proposition and, call it, the right plans and the right rate to the right clients.
Eugene Simuni: Got it. Thank you very much.
Operator: Thank you. Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open.
Kevin McVeigh: Great. Thanks so much. Hey, Maria, I think you talked about 60,000 new run clients in the quarter. Can you help us dimensionalize that? Where would that typically be? And how should we kind of expect that to evolve going forward?
Maria Black: So the 60,000 clients that I mentioned are specific to our down market, specifically the run platform. So that’s actually 60,000 clients that we started. So where would they be? They would be all over the United States, if you will, from a – and I’m not trying to be funny about it, but it’s really pretty amazing effort if you think about the volume of clients, the throughput, if you will. They come to us through some of the things that we talked about today, new business formation, they also come to us through our channel ecosystem. So we’ve made a lot of investments into the relationships we have with our CPAs, with our banks. In terms of what does it look like quarter-on-quarter, stating the obvious the third quarter for us is obviously the highest volume quarter. So that’s why it’s kind of fun to give that shout out this quarter because, arguably, I would say that’s not a typical quarter for ADP as it relates to a number of units and the throughput because many of the starts do happen in January in that business. But they are kind of all over the place, and they come to us through the strength of our distribution model and the strength of our overall ecosystem. Does that answer the question, Kevin?
Kevin McVeigh: It did. I guess I was just – I know Q3 is a high watermark. How should we think about 60,000 maybe relative to Q3 of last year? Was it 40? I mean, just trying to understand like how the momentum is accelerating there? And then just what’s the profitability? Because it sounds like a third were digital onboarded, like the ones that are digitally onboarded, how much more profitable are those than a traditional client that’s onboarded? Just trying to get a sense of if we’re an inflection point in terms of the growth there.
Maria Black: Yes. Listen, I – fair enough. I don’t know that I meant to trip myself into giving a quarter-on-quarter number I would tell you is it’s higher than last quarter. It’s higher both in revenue, obviously and the performance. It’s also higher in share unit volume. So I suppose I’ll kind of leave it at that. In terms of the third that comes through the digital onboarding, what that yields is a few things, Kevin, one of which is better experience for the client, right? So our digital onboarded clients have very high, what we call, new business client NPS results, right? So – and when a client starts with us happier, it yields to a happier client long-term, which yields to a happier and more retentive clients. So I think in terms of what the, call it, margin profile or lifetime value of those clients look like over time, we’re still learning a bit about that, but it’s very optimistic for us as we’re seeing the results. I think the other is it also yields efficiency for our implementation organization, right? So if you think about having the ability to have these clients digitally onboarded allows the more complex onboardings, if you will, perhaps clients are coming to us with more complications around their taxes or maybe from a competitor or something that’s actually demands and implementation person to be involved at a much higher level, it allows their focus to remain there, which also should yield a better experience for those clients. So we’re also seeing that. So overall, we are seeing, and I cited it in the prepared remarks, we’re seeing new clients come on board happier. The digital ones are happier than the non-digital, but they are all happier than they were last year, which is a good thing for us as it relates to the retentive nature of those clients over time and what they will bring to us in terms of lifetime value.
Kevin McVeigh: Helpful. Thank you.
Operator: Thank you. And our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thanks very much. I wanted to quickly Maria, ask a clarifying question. On the mid-market, you kind of talked about some of the things that you’re doing there. But just to be clear, it sounds like from your perspective that it’s more issues or things that ADP can do to address versus macro? I just want to make sure understanding kind of your list of objectives and things to do in that segment.
Maria Black: Absolutely. The mid-market for us still has – and we’re still experiencing solid mid-market sales, right? And so I don’t – from my vantage point, I don’t think it’s necessarily the softness that we saw in Q3 versus Q2 with a byproduct of a macro type of environment. We’re paying close attention to demand cycles. We’re paying close attention to pipelines. In terms of – are there some cycles that are perhaps a tiny bit elongated, maybe, there might be some more approvals or approval layers involved, and there may be a little bit of cycle elongation. I would tell you, we’re not seeing that much of that in the mid-market, and it really looks more like ‘19, it looks more like pre-pandemic than it does necessarily something that would give us a belief that there is a macro concern in the mid-market. What I would say is on the macro side, it’s not getting any easier in the mid-market to be a client, right? And so if you think about the complex environment for the mid-market customers and clients, it does continue to increase. And so they are solving for hybrid work, they are solving for talent, they are starving for compliance, regulation. And they are turning to HCM providers such as us, to help with all of that. So I think the macro supports a very strong environment for the mid-market and we do continue to expect to have mid-market growth, including our HRO.
James Faucette: Got it. Got it. And then I guess maybe dovetailing with that, can you speak a little bit about the competitive environment? And any changes you’re seeing there? Or what are you seeing from customers? Is there a flight to quality versus maybe some of the regional players and what is the impact of newer entrants? Just can you give us kind of a state of the competitive landscape?
Maria Black: Sure. I would say the competitive landscape, one way to think about it is it actually hasn’t changed that much. So is there a flight to quality, sure. We’ve seen some of that, but it’s not material at this time as it relates to clients calling us and asking about the macro and what’s happening in the world. We’ve had a few of those calls just recently based on some things that have happened in the environment. But what I would say – when I think about the competitive environment, we look at this very closely. We just completed our strategic plan process, and we’ve been looking at our competitive position against all the major players, mid-market and others over the last handful of years in a surgical way. What I would offer is a few items, one of which is we have strong retention, specifically in the mid-market. We also have very strong retention in international. We have a near-record highs in NPS. And so I would say that our value proposition and our competitive positioning – it’s proof, if you will, if you look at the retention, from a balance of trade, we are also winning more away from our competitors than we have in years past. And so again, I think our position is about the same when I look at it year-on-year, but it’s getting perhaps a little bit better on the wind side. And I think that a lot of that does have to do with the quality that we’re providing, so inside kind of the NPS results. Certainly, the investments we’ve made, the investments into our organization to serve our clients better. Some of the things I talked about, new products that we’re leveraging, the likes of AI to actually drive self-service, to drive better experience for our clients, their employees and drive friction out. So I would say, investments into product. And then lastly, again, investments into new products that is creating better wins for us.
James Faucette: That’s great. Thank you so much for that color, Maria.
Maria Black: You bet.
Operator: Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Don, I know you gave preliminary FY ‘24 guidance. And one of the things you talked about is obviously pays for control moderating. But do you think – could there be an offset because inflation is still running high and there is a pricing opportunity for the company, especially on the payroll side?
Don McGuire: Yes, Kartik, it’s a good question. So certainly, talked about pays per control growth decelerating. We called that out. And we’ve also – I mentioned earlier, for ‘24, I think there is a risk that it decelerates further. So we will have to watch and see what happens there. On the inflation side and pricing, we’re still in the early days of our FY ‘24 plan. So we’re watching it carefully. I think we can say that we are happy with the impact of the results of the price pricing decisions we took in ‘23. We had those readily accepted, I guess, with – reflected by our higher NPS scores by our continued strong retention. So we have an ability to take price. But as we always come back to, we’re in this for the long haul with our clients, their long-term retention is the most important thing to us. So we need to make sure that we continue to have that good value proposition between what the absolute prices, how much price we can take, etcetera. But once again, Kartik, it’s definitely something we’re looking at and trying to evaluate as we get closer to putting the plan to bid.
Kartik Mehta: And then, Maria, just on the PEO side, could – is any of the attrition related to maybe customers deciding that they had a PEO and it just got too expensive for them. So they have decided to move out of the PEO for a while until they can get a better understanding of what’s happening in the economy. Any changes like that?
Maria Black: I would say that’s always the case. I think every year, as we go through renewals, as we go through the year-end cycle, you have clients that are choosing to buy into the PEO and you have clients that are choosing to exit the PEO. When I look at where we get our clients from, obviously, I think we’ve cited multiple times that about 50% of the new business that comes into the PEO comes from our existing ADP base that would suggest that at least 50% come from a non-PEO environment, and we somewhat tend to return them the same way. So that’s not to say that clients don’t, at times, we don’t trade customers between us and the other PEOs. But generally speaking, I think that’s always the case. I don’t believe there is a larger trend toward that this time than there has been in the past. I think, really, in the end, it’s really a byproduct again of kind of what we saw with the renewal post pandemic and what the impact of that as we headed into this selling cycle, if you will.
Kartik Mehta: Thank you very much. Appreciate it.
Operator: Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi, thanks for taking my question. I also wanted to follow-up on the PEO and particularly on the bookings reacceleration. I’m just curious how much of that reacceleration is sort of from a better kind of external demand environment versus changes in your sales strategy? I’m just trying to figure out how much is sort of push versus pull when it comes to that recovery. And I guess the underlying question is your confidence level that this reacceleration is a sustainable trend?
Maria Black: Fair. Thank you, Ramsey. We are excited about the PEO reacceleration, specifically what we saw in March and obviously, how we feel stepping into this final stretch. I think it is too early to comment on the finish, but the pipelines are strong. What I would tell you is that I’m bullish about the demand in the market for the PEO and the overall value proposition. So all things being equal, I think we’re positioned well as anybody else as it relates to the overall PEO, I guess, demand, if you will, right? So I don’t think it’s a – the reacceleration was really, in my mind, more a byproduct of top of funnel filling the pipeline. We made a lot of investments into our seller ecosystem and the PEO. We have incentives that we can pull. In addition to that, we’ve invested into – and I think I’ve talked about it a couple of times on these calls. We’ve invested into artificial intelligence that actually looks across our base to a project where we are actually looking at the ADP base to try to serve up the right, call it, PEO seller at the right time to the right ADP clients. So we’re getting smarter. I am not doing a good job saying it outside of we are getting smarter in terms of who we are actually targeting on the PEO using technology today that didn’t exist. So, I think all of that has kind of yielded to what I would say is a strong execution by the PEO sales team to drive the reacceleration that we would expect and that we are excited to see and optimistic that it will continue.
Ramsey El-Assal: Okay, great. And a quick follow-up, when you look across the business, are you seeing any vertical-specific areas of softness maybe tech or commercial real estate or financial services? Are there any worrisome kind of verticals that you are keeping an eye on?
Maria Black: Are you referring to the PEO specifically or the overall macro?
Ramsey El-Assal: I know. I should have been more clear. Just more broadly across the business, are there any – you guys have a pretty broad macro view. And I am just curious if there is any specific areas that are causing any concern in terms of recent trends?
Don McGuire: Yes. Maybe I will jump in. I think in terms of verticals, certainly seeing all the reports and reading all the things about commercial real estate that everyone else is. That’s – we look at the breadth and the distribution of our client base, it’s pretty broad. So, I am not so sure that we are seeing any particular verticals that are causing us any undue concern at this time. I would say, has been reported, Maria mentioned it in the prepared remarks, certainly, the enterprise space, the up-market space is where there has been a lot more layoffs announced, etcetera particularly in tech. So, we are looking at that. We have said in the past though that’s not the biggest part of our business. So, even though there is some more softness in that end of the market, it’s being more than offset by the success we are having in the down in the mid-market. So, from a particular vertical, nothing in particular.
Ramsey El-Assal: Okay. Thanks. Appreciate it.
Operator: Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Great. Good morning. Thanks for taking my questions. Maybe first one, Maria, just I wanted to maybe get a better understanding when you are talking about a change in maybe the investment – investing philosophy of the company just as you are adjusting to the macro environment evolving as well. Is that more around maybe pulling back on hiring? Is that more about maybe redirecting where resources are? Can you maybe just help us better understand what that translates into? And maybe how we should think about that impacting both the top and bottom line?
Maria Black: Yes. Thanks Samad and good morning. I am happy to talk about modernization. It’s one of my favorite topics as all of you are probably learning from my prepared remarks. And I think it’s important to think about the modernization journey we have been on and how it really can set us up for kind of future growth and future margin, if you will, as a company. And that’s really what it’s all about for us. I think we have been undergoing transformation. We have been undergoing modernization for years. I would actually suggest that ADP has been modernizing for the last 73 years as we have invested in technology to make things better for us as a business to become more efficient, and we have been investing in our clients and in product to make it easier for them. And so I think that’s not a new cycle. The way I think about modernization is really a client first lens, right. So, it’s really about all the things that I cited. It’s about taking out friction. The way I think about the investment, which is your question, Samad, is it’s an imperative for us to continue to invest in modernization because it’s the modernization that over time has really allowed us to reinvest in growth and reinvest in the business. And we are committed to a continued journey of growth and margin. And as a result of really the way we have been able to do this. So for us, it’s really about both. It’s really about the end, right. So, it’s about growth and margin expansion. And I think this virtuous cycle that we have been on really as a company for a very long time, which is we make things easier, we make them better. We become more efficient. We make things better for our clients, and that allows us to invest in growth and it allows us to invest in – back into our shareholders, if you will, in margins. So, it’s really an end story and it’s key to who ADP is and it will be a key for us as we go forward. In terms of the commentary that I made around how we are thinking about it and the macroeconomic backdrop, it is an important time to make sure we are making the right choices and the right trade-offs. I mentioned earlier, we have been in the middle of our strategic planning process the last quarter. And as we have gone through the business, if you will, end-to-end, rest assured that we are trying as a company to make the very best decisions to have the very best outcomes as it relates to growth and margin.
Samad Samana: Great. I appreciate that. And then just one quick follow-up for Don, I was just looking at the guidance by segments and the margin for ES, it looks like you have settled it out at the – within the range at the lower end. I am just curious maybe what drove that? Is that – is it purely float contribution driven, or is that more the result of just bookings being better, so expenses being pulled forward? Just help me understand why that was narrowed to the lower end of the range, please?
Don McGuire: Yes. I think there is a couple of things going on. One, certainly, we are continuing to benefit from bookings growth, retention, price pays per controllers all a little bit stronger. And we certainly are getting lots of tailwinds. We have lots of tailwinds in Q3, in particular, from client fund interest. So, that’s been very helpful for us. The things slow a little bit from a client from an interest perspective in Q4. So, that certainly is not as helpful as it was. And we are of course, as Maria just mentioned, we are taking advantage of some of those extra flow funds that we have to invest – reinvest in the business or continue to invest in the business on modernization. So, it’s all about I think trying to find the right balance and still delivering the – as we mentioned, higher end of the earnings per share prediction or guidance. So, it’s all to find the right balance, and we will continue to invest in modernization and deliver improvements as we go forward.
Samad Samana: Great. Appreciate taking my questions. Thank you.
Operator: Thank you. And our next question comes from David Togut with Evercore ISI. Your line is open.
David Togut: Thank you. Good morning. Could you walk through the 140 basis points of PEO margin expansion in Q3? It seems pretty notable given the deceleration in PEO revenue growth. And in particular, could you unpack the size of the workers’ compensation reserve release in Q3?
Danny Hussain: It was $17 million. You will see it in the Q compared to $7 million last year. So, it wasn’t a huge amount.
Don McGuire: But those are the two impacts. So, the biggest impact was the reserve adjustment on workers’ comp. And the other big item there is the lower SUI costs. So, there is virtually no margins on SUI. So, SUI comes down at the top, it certainly improves the margins. So, those would be the two major impacts on the margin improvement in PEO.
David Togut: Got it. And then just as a follow-up, Don, could you walk through your strategy on managing the tax filing float going forward? We have got a pretty steeply inverted yield curve right now, which means it’s actually more expensive for you to borrow in the commercial paper market and invest flow medium-term duration bonds. Are you thinking of shifting the investment portfolio at all in the year ahead?
Don McGuire: We have had that strategy in place for some 20 years or so. And we have realized about $2.8 billion of incremental benefit from that strategy. And so we have a strategy in place. We always revisit these strategies and look at them. It’s true that the yield curve is inverted for the seventh time in 50 years. How long that continues, not sure. But we will continue to look at that strategy and see what we need to do, if anything, to change it as we go forward. But it is something we have been committed to and we followed closely. Near-term, certainly we have benefited this quarter because of the inflow of funds in calendar Q1, there is a big balance or a big benefit there to us. So, as we go forward, we will continue to look at the opportunities and decide if we need to make any material changes to the investment strategy.
Danny Hussain: David, one point worth clarifying because this has come up before. If you look at the last slide of our earnings presentation, you will see a disaggregation of client short extended and long. And one thing I think is worth emphasizing is that we are net long exposed to the client short. In other words, if short-term interest rates went up and up and up, that would actually be beneficial to our earnings and our margins. It just shows up in two different places, which can often cause confusion. But it’s actually not hurtful to us to have these higher borrowing costs because we have more dollars invested long in the client short portfolio.
David Togut: Understood. Thank you.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Very good morning everybody. Maria, you talked about modernization. Can you talk about the areas of emphasis? And one area that I am particularly interested in is international and what you are seeing there in terms of opportunities? Thank you.
Maria Black: Sure. So overall, I think modernization is really about end-to-end. So, think of it as product and continuing to make investments in ensuring our products are next generation, if you will. And that’s certainly the case across many pieces of our portfolio, and you are well aware of the investments we are making in next-generation technology. I think product is a big piece of it. I think other is the internal modernization. So, that would be everything from go-to-market to call it, the seller ecosystem modernization. I think I have spoken to that quite a bit in the past as well as how we actually serve our clients. And again, we reference that today. So, kind of going back to modernization specifically in our opportunity in international, we are very excited about our position in international, very excited about the opportunity that we have. And this is definitely an area that we have been modernizing. So, if you think about each and every country that we serve over 140 countries today that we have offers over time, we have been modernizing the platforms, and we have been consolidating platforms. But to your point, Mark, that work is not done. And so we still have that journey that we have been on is the journey that we are going to continue. But as we do that, we are also focused on ensuring that we continue to make the investments to the platforms, and we continue to make the investments into the overall ecosystem of how we serve our clients international to really drive further, call it, opportunity. And so there are still places in international, and I will probably leave it with, we will be back next quarter to talk more about things such as our growth strategy. But I think as it relates to international all of that modernization should also yield a growth opportunity for us because it’s still a big world and there are places that we – even though we are in more countries than anybody else, there are countries that we don’t exist, there are segments within certain countries where our offer still has opportunity. And so we were incredibly excited about the overall international space where we are, the work that we are doing and where we are going.
Mark Marcon: That’s great. And Maria, can you talk a little bit about just what the appetite is? And obviously, it’s diverse across the globe. But broadly speaking, are you seeing a greater level of interest in terms of modernization of HR and HCM systems across the globe? Certainly has been an ongoing trend in the U.S. for quite some time. But just I am hearing from others that there is a pickup in terms of RFPs that are occurring things of that nature and that we could be at the early stages of higher levels of growth, international macro notwithstanding?
Maria Black: What I would suggest, Mark, is that over the last few years, the conversation in the international space has definitely shifted a bit, and I could suggest the same thing, which is that it’s picked up. And so that conversation today tends to lead with more of a global offer, global system of record kind of conversation. So, we walk in today and we have a conversation with a client more often than not about how many countries are you in and where can we help serve you and how can we tie it all together to make an ability for that client to really see across multiple countries and have more of a unified experience versus, I would say, perhaps 5 years, 10 years ago, it was more of a country-by-country conversation. Today, it’s more – it starts with a multi-country conversation. And so I think all of that suggests, but it appears you have heard from others, which is the narrative in the international is shifting. I think there is greater demand for HCM offerings in international as it relates to companies now that are more global than they have ever been. And certainly, the hybrid environment has accelerated that a bit. And the ability for companies to be able to see their workforces and make talent decisions, headcount decisions across multiple countries. That’s a very different conversation today than it was just a few years ago. And we see that when we have, we just recently, actually, this quarter, we had all of our international clients together at an event. And the topic is about their transformation. It’s about their HCM transformation and the partnership that we have with them to solve for them. And I think the beauty of ADP is that we have the ability to solve the MNC, the multi-country piece. And we also have the ability to solve the in-country. And a lot of times, for clients, it’s a mix of both. And so it’s really about the flexibility we have in our partnership options to serve these clients in a very unique way.
Mark Marcon: Perfect. Thank you.
Operator: Thank you. We have time for one more question. And that question comes from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang: Hey. Thank you so much and you covered a lot already. I just wanted on the down-market side, given the success in the bookings here. Just curious if that’s changing your thinking and investing more or even less, maybe in ASO versus PSO then the digital sales versus the seller ecosystem? I am curious as we are going into fiscal ‘24 here, if there is any maybe change in thinking in prioritization there?
Maria Black: So, we have leaned into the down market in terms of the investments we have made. So, when I think I referenced earlier the seller headcount as we head into the final stretch here and how pleased we are with the investments we have made in headcount and the ecosystem around them, so investments into the channels, things of that nature. And as all of that turns into more productivity because the headcount is actually gaining tenure. It is primarily setting those investments have been in the down-market. So again, think our SPF platform, the retirement services, insurance services, most of that also comes into our digital sales organization, also known as the inside sales. So, we are making investments into inside sales to really serve the down market. And what I would suggest is that from our viewpoint at this point, the demand is there. We have leaned into that demand and we will continue to lean into the demand to drive the growth that we are driving out of the down-market as long as it exists, if you will.
Tien-Tsin Huang: Yes. No, I am glad to hear it. If you don’t mind one more question. Just I have to ask you since you mentioned Maria with AI. We have been getting a lot of questions on generative AI and ChatGPT. You mentioned being smarter around serving up PEO when necessary at the right time. But just broadly speaking, how are you thinking about generative AI and how that might help you run your business better, both from a sales perspective, but also from a delivery perspective, support standpoint?
Maria Black: Yes. Thank you, Tien-Tsin. I am actually – I am thrilled you asked this question because I was counting on it during this call because it definitely seems like it’s the topic du jour. But the real answer is, just like everybody else, we are incredibly excited about generative AI. We have been very excited about AI for quite some time. You mentioned what we have been doing for our sellers in the PEO, that’s broad-based work that we have been doing for a long time and continued to invest in AI into making us more efficient. That example is about our sellers. We are making similar investments even with the new technologies that are out there to really look at how we can make our service associates as well as our sellers more productive. So, you think about all the things that an agent, if you will, does today to support a client and some of the generative AI tools that can drive a different level of efficiency. And we are very excited. We have I think it’s something around like 44 different work streams that are underway currently to take a look at different ways that we can leverage these tools internally. That’s also notwithstanding the opportunity that it creates for our industry, right. So, if you think about the HCM industry, there are still very many things inside of HCM that are administrative in nature in terms of whether it’s job descriptions, performance reviews, things that are maybe handbook, things that are very tactical that really a time pulled back the practitioner from doing what they want to do, which is be a strategic partner. And so we are really excited to put these tools also into our product for our clients and our practitioners to be able to lean into. So, all that said, we are very excited about the opportunity. One thing I would point out because it’s important, and it’s also very topical right now, which is that the good news is we have been doing a lot of this work. And as such, we have standards. We have a way to think about the ethical nature and that kind of comes at parity with who we are, given that we have the big data, if you will, behind ADP and the 40 million wage earners that we pay. And so when we think about all of this, also with the lens of doing it the right way and making sure that it’s applicable, it’s secure, it’s compliance, all the things that you would expect from ADP. But no doubt, Tien-Tsin, that we are excited about the opportunity it creates for us internally and the opportunity that it creates for us and our product to really serve the industry, right, and make this entire industry that much more strategic and not much more exciting. So, great question.
Tien-Tsin Huang: No. Hope to learn more soon – talk soon. Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks.
Maria Black: Thank you. So, first and foremost, thank you everybody for joining today. Really appreciate the questions and the interest. As you can imagine, I sit here one quarter into my new role as CEO and I get a lot of questions. Just last night, I got another text that said, how were the first 100 days, how is the first quarter, what have you been up to? And here is what I would offer. The third quarter for ADP, and you heard it in my tone today, you have heard it in my excitement about some of the volumes and the throughput, but the third quarter is really where you see ADP shine. And it is our finest quarter. You have year-end, you have busy season, you have selling season that all kind of come together. In this quarter, what I would say is adding some economic strangeness and questions about what’s happening in the world, and I would say that sitting here one quarter in, I couldn’t be more excited. I couldn’t be more pleased. I couldn’t be more grateful for the share execution of our associates. So, I felt the breadth and depth of ADP this quarter at its finest. And with that, I just want to take another minute to thank our associates for everything that they do to power this great company. I would also like to thank all of our partners and stakeholders and everyone on the call listening today. I couldn’t be more proud and more excited about this company. And with that, we will wrap up the call.
Operator: This concludes the program. You may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Third Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danny Hussain",
"text": "Thank you, Michelle and welcome everyone to ADP’s third quarter fiscal 2023 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I will now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Danny and thank you everyone for joining us. For our third quarter, we delivered strong results, including 10% organic constant currency revenue growth, 110 basis points of adjusted EBIT margin expansion and 14% adjusted EPS growth. Our continued solid financial performance underscores the power of our innovative and mission-critical HCM solutions that serve over 1 million diverse clients around the world as well as our highly recurring revenue business model. As usual, I will start with some highlights from the quarter. The demand environment was healthy overall. And in Q3, we drove another quarter of solid Employer Services, new business bookings growth, representing a record Q3 bookings amount. Bookings performance continues to be particularly strong in our downmarket portfolio. In Q3, we sold and started over 60,000 new run clients, where a new user experience has helped us reach record level new client satisfaction rates these past few quarters. We also had strong bookings results in our insurance and retirement services offerings supported not only by legislative tailwinds, but also by the competitive positioning of our downmarket HCM ecosystem. Demand for our employer services HR outsourcing solutions remained high and we have recently reached the 10,000 client mark. We also saw continued booking strength in our compliance-oriented solutions, including tax remittance and wage payments, which have always been key differentiators for us. On a year-to-date basis, we are within our bookings guidance range and are trending in line with our expectations from the outset of the year and we look forward to finishing the year with a strong close. Our employer services retention rate came in better than expected once again. While we continue to experience normalization in our downmarket out of business rates, this was offset by the strong retention rates in our U.S. mid-market and international businesses, both of which continue to benefit from years of improving client satisfaction. As such, we are pleased to be raising our full year retention guidance. Our employer services paid for control grew 4% for the quarter and continues to decelerate at a very gradual pace. As we have seen for several quarters now, layoffs at many larger companies have been offset by the labor demand elsewhere, which in total has resulted in year-over-year employment growth. With this continued resilience, we are pleased to expect the higher end of our previous pays per control guidance range. Last, on our PEO, while growth in revenue and average works on employees continued to decelerate this quarter, we were pleased to see PEO bookings growth reaccelerate nicely in Q3, especially in March. This represented a much better performance than we experienced in Q2 and resulted in our largest quarter for PEO bookings ever. Despite the current inflationary environment and broad-based macroeconomic uncertainty, we are focused on our PEO sales execution and on delivering continued strong client satisfaction and we remain confident in the long-term secular growth opportunity. Stepping back, while we are pleased to be on track to deliver very strong full year financial results, we are even more excited about how we are leveraging our unmatched scale and decades of innovation experience to drive continued progress on our important modernization journey. We are making our solutions more powerful and easier to use and we are making our unparalleled insight and expertise more accessible than ever. In doing all this, we are delivering an experience that’s better for our clients, better for their employees and better for ADP. I mentioned the tens of thousands of new clients we onboarded in our downmarket, over a third of those clients utilized our digital onboarding experience, yielding a faster time to start, happier clients and greater productivity for our implementation team. We just completed our busy year-end period during which we helped our clients with over 75 million U.S. tax forms and to further enhance the client experience, we proactively service critical year-end data to our clients before they had to search for it. This not only reduced friction for them, but also reduced the number of calls and interactions with our service teams. For years, we have directly engaged and served our clients’ employees through channels like Wisely. As we focus on the overall employee experience we can offer, we continue to add valuable functionality like a savings envelope that employees have used to move more than $1 billion into savings over the last 12 months and a new financial wellness hub with tips, tools and education to drive better financial outcomes. With our new intelligent self-service solution, we are already interacting with over 3 million client employees per month through our action card feature. And our voice of employee solution is helping thousands of clients obtain better insights from their employee population, which can drive higher engagement and satisfaction for those employees. The opportunity to continue creating value and efficiency in the world of work is meaningful and we believe these modern approaches that reduce friction and exceed client expectations will help us deliver on that in the coming years. With that in mind, I want to provide some perspective on how we are strategically positioning ourselves to invest over the near-term given the economic backdrop. As we shared earlier this year, in fiscal 2023, we were impacted by higher wage inflation. We also added to our service and implementation capacity to meet the expectations of our growing client base and we invested throughout the year in sales and product. As we position for potential economic slowdown beyond this fiscal year, we are being thoughtful about how we prioritize our investments. At the same time, we are very much committed to our ongoing modernization journey, which is critical to our sustainable growth and that will require continued steady reinvestment into the business. In the coming quarters, I look forward to updating you on near-term growth priorities for ADP. Before turning it over to Don, I want to take a moment to recognize our associates for their continued focus on helping our clients through the many challenges they face each day, especially amid these uncertain times. Resiliency and partnerships represent core components of the ADP brand promise and are among the many reasons businesses around the world choose to partner with a leader in the industry. Our unrelenting support through years of growth, years of challenge and the years in between is something they have grown to count on and we are honored to support them. With that, I’ll turn it over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria and good morning everyone. I will provide some more details on our Q3 results and update you on our fiscal ‘23 outlook before briefly touching on fiscal ‘24. Let me jump straight into the segments, starting with Employer Services. ES segment revenue increased 11% on a reported basis and 12% on an organic constant currency basis, which is the strongest ES revenue growth we have experienced in quite some time. As Maria shared, ES new business bookings were solid and kept us on track with our full year outlook. We believe the full range of bookings outcomes is still on the table given the relative importance of Q4 bookings to our full year results. So we are not making any change to our guidance, but we do believe the middle of our guidance range feels most likely at this point. On ES retention, following another quarter of better-than-expected results, we are again revising our outlook and we now expect retention to be down only 10 to 20 basis points for the full year compared to our prior outlook of down 20 to 30 basis points. This again will be driven by retention decline in our down market from normalized out-of-business losses and is mostly offset by improved overall retention elsewhere. Pays per control remained strong in Q3 and we are raising our outlook to now assume about 4% pays per control growth for the year compared to our prior outlook for 3% to 4% growth. Client funds interest revenue increased in Q3 in line with our expectations and we are updating our full year outlook utilizing the latest forward yield curve, which in this case resulted in no major change. And on FX, we had about 1 percentage point of ES revenue headwinds in Q3 and there is no change to our outlook for a full year headwind of between 1% and 2%. Following our strong Q3 ES revenue growth, we are pleased to be raising our outlook once again to now expect about 9% growth, up from 8% to 9% before. Our ES margin increased 80 basis points in Q3, which was in line with our expectations. We are narrowing our full year outlook to now expect about 200 basis points of margin expansion and we still see significant opportunity to invest in sales, product and elsewhere throughout the organization to capitalize on the growth opportunity in front of us, which we are choosing to do at this juncture. Moving on to the PEO, we had 5% revenue growth driven by 3% growth in average works on employees. As a reminder, this deceleration is driven by a few factors, including slow pays per control growth, difficult comparisons versus record retention levels and softer recent bookings growth that we experienced the last 2 years. For this fiscal year, we now expect PEO revenue growth of about 8% with growth in average works on employees of about 6%, both at the lower end of our prior ranges. Maria mentioned the bookings reacceleration in Q3 and we are feeling upbeat about reaccelerating the revenue growth in the coming several quarters. This guidance update is mainly due to a tweak to our pays per control assumption within the PEO as it decelerated a bit more than we previously assumed, somewhat different from what we experienced in the ES segment. We are separately lowering our outlook for revenue, excluding zero margin pass-throughs to a range of 7% to 8% due mainly to lower SUI rates in Q3 than we previously anticipated. PEO margin increased 140 basis points in Q3, which was better than expected due primarily to continued favorable workers’ compensation reserve adjustments, which we had not assumed as well as the lower SUI costs I just mentioned and we are raising our outlook for PEO margin to now expect it to be up 50 to 75 basis points for fiscal ‘23. Putting it altogether, we still expect consolidated revenue growth of 8% to 9% in fiscal ‘23, but now believe it will be towards the higher end of that range. We are maintaining our outlook for adjusted EBIT margin expansion of 125 to 150 basis points and for a fiscal ‘23 effective tax rate of about 23%. And we now expect adjusted EPS growth of 16% to 17% and compared to our prior outlook of 15% to 17%. I also want to provide some early high level color on what to expect for next year. We are still going through our annual planning process, but there are a few things to consider at this point. First, assuming a slowing economic backdrop, pays per control could be at a below normal growth rate next year, among other potential macro considerations. I would also point out that while client funds interest appears positioned to give us some contribution to growth, based on the latest forward yield curve, it will likely be very modest. At the same time, we have good momentum in our ES bookings performance and ES retention and we are feeling upbeat about the continued opportunity to build on our decades of success. Thank you. And I’ll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] We will take our first question from Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, all. Good morning. Thank you. So Don, maybe just building on those last comments you had there, I am curious just any indications or call-outs worth mentioning as it relates to fiscal ‘24? Really in the context of the medium-term outlook that you have given in the past, just how should the Street consider the magnitude of potential impacts across some of these KPIs from a potentially slower macro environment?"
},
{
"speaker": "Don McGuire",
"text": "Yes, Brian, good morning. Thank you for the question. It’s still early. We are still in the middle of our planning process. I think we have a lot of things going in our favor sales. We are – we still have relatively high client fund interest. Pays per control have been good and strong. Bookings continue to be strong as we said earlier. So as we get into ‘24, I think we are going to be in a pretty healthy spot with what we know today. I guess the challenge we all have is trying to guess what’s coming in terms of the broader macro situation. We continue to see strong demand. Retention continues to be pretty good, although it’s normalizing a little bit in the down market as we did expect. But I think things feel pretty good at this juncture. So I am going to have to ask you to bear with us a little bit as we make our way through our plan and we stay tuned to what’s going on in the macro environment even closer as we get forward or closer to our July 1 beginning of the year."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. That’s fair. And just on the PEO, so works on employee view downtick and I think you were down sequentially in average works on employees. Can you just talk about what you are seeing in kind of the pays per control versus the retention aspect in the PEO? And with bookings reaccelerating, how long does the reconnection to improve growth take?"
},
{
"speaker": "Don McGuire",
"text": "So the – we did have, as you mentioned, we had a particularly strong PEO bookings month in March, which we are optimistic is going to continue and help us as we go forward. Certainly, we are going to have to see how those bookings continue through the balance of the year, trying to anticipate how those are going to actually result in revenue. Things do start relatively quickly in the PEO business, but it’s going to take some time once again to see how that stuff rolls from bookings into revenue. But we are pretty optimistic about how things went in the third quarter, especially with the finish and we do expect to see that reacceleration as quickly as we want to. And by the way, back to your earlier question a little bit, we talked about high single-digit growth in our mid-term view and we won’t be happy if we don’t get something like that."
},
{
"speaker": "Maria Black",
"text": "Yes. I think, Brian, if I can just comment on the quarter-over-quarter real quick as I think you mentioned the sequential growth Q2 to Q3 and works on employees. That is something that obviously we noticed as well and as Don mentioned, from a medium-term perspective, we are definitely still committed from the medium-term to the works on employee growth that we have guided to for that. However, as it relates to kind of the quarter-over-quarter, we noticed the same thing that you noticed. And obviously, that’s not the ideal situation and we are hopeful that won’t be the case as you look sequentially on the quarter-to-quarter, Q3 to Q4, but also year-on-year. And I think that’s really a byproduct of timing and that timing is really about retention, right. So it’s really about, call it, third quarter retention results, which we have cited before were a bit softer than we expected. And as a result of that, you see the sequential piece to the quarter-on-quarter."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Is that just a function of the type of client within PEO?"
},
{
"speaker": "Maria Black",
"text": "In terms of the type being."
},
{
"speaker": "Bryan Bergin",
"text": "More white collar?"
},
{
"speaker": "Maria Black",
"text": "I don’t know that it’s a function of more white collar, I think it’s really a function of some of the feelings that we have post-pandemic as the renewals have really been kind of, call it, rippling through the business of the PEO. So it’s really a byproduct of some of the post-pandemic impact that we saw in the PEO. So it’s really a byproduct of the retention softness that we saw in the first quarter, in the second quarter and then quarter-on-quarter this past quarter. So I don’t think it’s necessarily a byproduct of – because retention continues, albeit it’s normalizing a bit in the down market. We do have very strong retention in the mid-market. We also have strong retention, albeit tiny bit less than last year in the down market. So I don’t really think it’s a byproduct of the client base or white collar, I think it’s really a byproduct of kind of a post-pandemic environment in the PEO."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, good morning. Thanks for taking my questions. I guess just trying to look at Employer Services, really strong growth in the quarter, 12% organic. If you back into the guidance for fourth quarter, it looks like a little bit of a deceleration. I think you get to something around 8% growth. So just trying to understand the puts and takes there for the fourth quarter guide versus the strong results in the third quarter?"
},
{
"speaker": "Don McGuire",
"text": "Yes, thanks for the question. The biggest impact, I guess, in terms of growth would be we are going to continue to see strong growth from client fund interest in the fourth quarter. But certainly, Q3 is by far the strongest quarter just given the seasonality of tax receipts, etcetera, for us. So I think that would be one of the key drivers. And of course, we did mention as well that we expect to see pays per control growth coming down and softening a little bit, even though a bit higher than we expected to see. Last quarter, it is coming down. It’s certainly starting to moderate."
},
{
"speaker": "Bryan Keane",
"text": "Got it. Got it. And then on the bookings side, although bookings were strong, I think you commented maybe towards the lower end of the range of 6% to 9% and just can you help us maybe think about how bookings will translate into future revenue growth for the employer services? If you can just remind us, just as we get our models set or start thinking about fiscal year ‘24."
},
{
"speaker": "Maria Black",
"text": "Yes. So I’ll let Don comment on the – how the bookings kind of relate to the models on the revenue side. But from an overall bookings perspective, what we cited in the prepared remarks is that we do anticipate the middle of the range. So we did keep the range constant. So it’s constant with the outset of the year, it’s also constant with last quarter’s guidance. So we are keeping that 6% to 9% range. We do anticipate at this point, the middle of that range. And we feel pretty confident heading into the fourth quarter when we take a look at how we exited March, but also taking a look at the number of sellers we have, the investments we’ve made into the ecosystem and as those sellers ultimately gain tenure because we’re actually lapping a lot of new hires that we had, if you will, a year ago. So pretty excited as we step in the other part of that. Confidence is really about what we’re seeing as it relates to the overall pipeline. So pipelines are strong. That’s more of a, call it, enterprise and international or large deal type of comment. We’re seeing tremendous activity in the top of the funnel still upmarket. So the down market continues to shine for us, and that’s really supported by what we’re seeing in continued increases in new business formations. We’re also seeing those new business formations generate inbound leads. So we’re seeing good activity on the digital side. So feel confident as we step into the fourth quarter, and then I’ll let Don comment on how the – ultimately where we land in the fourth quarter and how that translates into revenue for us next year."
},
{
"speaker": "Don McGuire",
"text": "Yes. So on the modeling side, roughly a 1% change in ES bookings growth impacts us in the $17 million to $20 million annually on revenue growth. So that’s kind of how we think about your models. I think that’s been pretty consistent."
},
{
"speaker": "Danny Hussain",
"text": "Yes. And Brian, the timing is – it depends on the business. Obviously, strong performance in the downmarket will impact revenue much more quickly. And if you have strong global view sales at the other end of the extreme, that can take several months to even more than a year, in some cases, to roll in. So, typical rule of thumb for us is a couple of quarters to see the full impact. But of course, the bookings throughout the year have been pretty consistent for us. And so I wouldn’t expect any real callouts from the revenue timing standpoint."
},
{
"speaker": "Bryan Keane",
"text": "Great. Alright, thanks for the color."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open."
},
{
"speaker": "Eugene Simuni",
"text": "Hi, guys. Good morning. Maria, I wanted to pick back up on your comments about the break down market. Maybe elaborate on that a little bit, what are the macro factors, your competitive positioning that’s still supporting that? And if you could contrast that for us a little bit with what’s going on in the mid-market. I know it’s still doing well. But if the question is, is there a path for mid-market to get to as strong of a point down market? And what are the levers that maybe you’re able to pull to get you there?"
},
{
"speaker": "Maria Black",
"text": "Absolutely. So I’ll start with the down market, just to kind of reiterate the strength we’re seeing there top of funnel. So we are very pleased with what we saw in the performance of the down market. That’s also inclusive of the down market ecosystem. So I think this is our run platform. I talked about the third quarter onboarding 60,000 clients. It’s pretty incredible. Those clients also, many of them have attach rates of our retirement services offering, our insurance services offering. So the entire down market portfolio it’s definitely performing well for us and has for quite some time. It is driven by what we’re seeing macro. And so you just kind of reiterate what we’ve seen as new business formations are up year-on-year, 8%, by the way, they are still up year on pandemic, as I call it. So they are actually if you look at current new business formations versus the year of 2019, right? So pre-pandemic, it’s actually 8,000 or so a week. This is all from the U.S. Census Bureau. So, from the standpoint of what we are seeing that kind of emanate into the pipelines and into the top of the funnel, we do have double-digit growth in our digital inbound leads, right. So I think these are at the OSEM ads, where ultimately clients are coming to us, and we’re meeting those clients with our inside sellers and the demand is there, the demand is strong. In terms of the mid-market, the mid-market was a bit softer this quarter than it was last quarter. That said, we also are very excited about the pipeline that we’re seeing in the mid-market that specifically call it the, the tech only, we do have strength in our Employer Services HR outsourcing offering, which also touches the mid-market. So combined, your question around, is there a path to see tremendous growth there between those businesses, we are seeing growth, and we are excited about our overall mid-market position from a competitive landscape. We do have our next-generation payroll engine that’s attached to about 30% to 40% of our mid-market new business sales. And what I will tell you is it’s resonating incredibly well in the market. It’s resonating with the sellers. That’s always a good sign when they like to talk about it and they like the demo it. It’s also resonating in terms of the competitive landscape and more wins. And so we feel that there is definitely a pass. That’s what we’re investing in, both in product and the ecosystem to have the mid-market be as an exciting of a story as the down market is for us."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Very helpful color. Thank you. And then for my follow-up, I want to quickly come back to the PEO. Can you talk a little bit about the kind of the macro headwinds for the PEO order? I think we discussed last time, specifically the insurance attach rates, insurance premiums, kind of blocking PEO growth. Is that still a factor or not any long-term?"
},
{
"speaker": "Maria Black",
"text": "Yes. What I would say is that the PEO demand remains strong. And so we’re bullish about the secular tailwinds of the PEO. We’re bullish about the value proposition. As it relates to benefits and benefits attached. I know there is a lot of discussions, there are a lot of surveys out there from the likes of Kaiser, etcetera, as it relates to our clients making different choices. I think what we see within our base is perhaps some asks of that. And on the peripheral kind of on the margin, perhaps there is price sensitivity as it relates to benefits. What that really allows for is for our sellers just need to be, call it, more surgical as they go to market. But in terms of the value proposition of the PEO and benefits still being a big component of that, that is the case. We skew definitely a bit more white collar in our PEO. In addition to that, our model with a fully insured model is a little bit different. And so the companies that we attract our PEO are still companies that want to be employers of choice, and employers of choice especially in a macro environment, such as this one, where talent is still the name of the game. They want to offer benefits and benefits are a piece of that. So what I would say is we are not seeing huge signs. I think even if you take a look at the revenue [indiscernible], you would be able to see kind of what’s happening with benefit revenue. So there is not huge signs that there is a shift in benefits attractiveness. I think the shift that we see is just the sharpness that our sellers need to have as they position the value proposition and, call it, the right plans and the right rate to the right clients."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thanks so much. Hey, Maria, I think you talked about 60,000 new run clients in the quarter. Can you help us dimensionalize that? Where would that typically be? And how should we kind of expect that to evolve going forward?"
},
{
"speaker": "Maria Black",
"text": "So the 60,000 clients that I mentioned are specific to our down market, specifically the run platform. So that’s actually 60,000 clients that we started. So where would they be? They would be all over the United States, if you will, from a – and I’m not trying to be funny about it, but it’s really pretty amazing effort if you think about the volume of clients, the throughput, if you will. They come to us through some of the things that we talked about today, new business formation, they also come to us through our channel ecosystem. So we’ve made a lot of investments into the relationships we have with our CPAs, with our banks. In terms of what does it look like quarter-on-quarter, stating the obvious the third quarter for us is obviously the highest volume quarter. So that’s why it’s kind of fun to give that shout out this quarter because, arguably, I would say that’s not a typical quarter for ADP as it relates to a number of units and the throughput because many of the starts do happen in January in that business. But they are kind of all over the place, and they come to us through the strength of our distribution model and the strength of our overall ecosystem. Does that answer the question, Kevin?"
},
{
"speaker": "Kevin McVeigh",
"text": "It did. I guess I was just – I know Q3 is a high watermark. How should we think about 60,000 maybe relative to Q3 of last year? Was it 40? I mean, just trying to understand like how the momentum is accelerating there? And then just what’s the profitability? Because it sounds like a third were digital onboarded, like the ones that are digitally onboarded, how much more profitable are those than a traditional client that’s onboarded? Just trying to get a sense of if we’re an inflection point in terms of the growth there."
},
{
"speaker": "Maria Black",
"text": "Yes. Listen, I – fair enough. I don’t know that I meant to trip myself into giving a quarter-on-quarter number I would tell you is it’s higher than last quarter. It’s higher both in revenue, obviously and the performance. It’s also higher in share unit volume. So I suppose I’ll kind of leave it at that. In terms of the third that comes through the digital onboarding, what that yields is a few things, Kevin, one of which is better experience for the client, right? So our digital onboarded clients have very high, what we call, new business client NPS results, right? So – and when a client starts with us happier, it yields to a happier client long-term, which yields to a happier and more retentive clients. So I think in terms of what the, call it, margin profile or lifetime value of those clients look like over time, we’re still learning a bit about that, but it’s very optimistic for us as we’re seeing the results. I think the other is it also yields efficiency for our implementation organization, right? So if you think about having the ability to have these clients digitally onboarded allows the more complex onboardings, if you will, perhaps clients are coming to us with more complications around their taxes or maybe from a competitor or something that’s actually demands and implementation person to be involved at a much higher level, it allows their focus to remain there, which also should yield a better experience for those clients. So we’re also seeing that. So overall, we are seeing, and I cited it in the prepared remarks, we’re seeing new clients come on board happier. The digital ones are happier than the non-digital, but they are all happier than they were last year, which is a good thing for us as it relates to the retentive nature of those clients over time and what they will bring to us in terms of lifetime value."
},
{
"speaker": "Kevin McVeigh",
"text": "Helpful. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thanks very much. I wanted to quickly Maria, ask a clarifying question. On the mid-market, you kind of talked about some of the things that you’re doing there. But just to be clear, it sounds like from your perspective that it’s more issues or things that ADP can do to address versus macro? I just want to make sure understanding kind of your list of objectives and things to do in that segment."
},
{
"speaker": "Maria Black",
"text": "Absolutely. The mid-market for us still has – and we’re still experiencing solid mid-market sales, right? And so I don’t – from my vantage point, I don’t think it’s necessarily the softness that we saw in Q3 versus Q2 with a byproduct of a macro type of environment. We’re paying close attention to demand cycles. We’re paying close attention to pipelines. In terms of – are there some cycles that are perhaps a tiny bit elongated, maybe, there might be some more approvals or approval layers involved, and there may be a little bit of cycle elongation. I would tell you, we’re not seeing that much of that in the mid-market, and it really looks more like ‘19, it looks more like pre-pandemic than it does necessarily something that would give us a belief that there is a macro concern in the mid-market. What I would say is on the macro side, it’s not getting any easier in the mid-market to be a client, right? And so if you think about the complex environment for the mid-market customers and clients, it does continue to increase. And so they are solving for hybrid work, they are solving for talent, they are starving for compliance, regulation. And they are turning to HCM providers such as us, to help with all of that. So I think the macro supports a very strong environment for the mid-market and we do continue to expect to have mid-market growth, including our HRO."
},
{
"speaker": "James Faucette",
"text": "Got it. Got it. And then I guess maybe dovetailing with that, can you speak a little bit about the competitive environment? And any changes you’re seeing there? Or what are you seeing from customers? Is there a flight to quality versus maybe some of the regional players and what is the impact of newer entrants? Just can you give us kind of a state of the competitive landscape?"
},
{
"speaker": "Maria Black",
"text": "Sure. I would say the competitive landscape, one way to think about it is it actually hasn’t changed that much. So is there a flight to quality, sure. We’ve seen some of that, but it’s not material at this time as it relates to clients calling us and asking about the macro and what’s happening in the world. We’ve had a few of those calls just recently based on some things that have happened in the environment. But what I would say – when I think about the competitive environment, we look at this very closely. We just completed our strategic plan process, and we’ve been looking at our competitive position against all the major players, mid-market and others over the last handful of years in a surgical way. What I would offer is a few items, one of which is we have strong retention, specifically in the mid-market. We also have very strong retention in international. We have a near-record highs in NPS. And so I would say that our value proposition and our competitive positioning – it’s proof, if you will, if you look at the retention, from a balance of trade, we are also winning more away from our competitors than we have in years past. And so again, I think our position is about the same when I look at it year-on-year, but it’s getting perhaps a little bit better on the wind side. And I think that a lot of that does have to do with the quality that we’re providing, so inside kind of the NPS results. Certainly, the investments we’ve made, the investments into our organization to serve our clients better. Some of the things I talked about, new products that we’re leveraging, the likes of AI to actually drive self-service, to drive better experience for our clients, their employees and drive friction out. So I would say, investments into product. And then lastly, again, investments into new products that is creating better wins for us."
},
{
"speaker": "James Faucette",
"text": "That’s great. Thank you so much for that color, Maria."
},
{
"speaker": "Maria Black",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Don, I know you gave preliminary FY ‘24 guidance. And one of the things you talked about is obviously pays for control moderating. But do you think – could there be an offset because inflation is still running high and there is a pricing opportunity for the company, especially on the payroll side?"
},
{
"speaker": "Don McGuire",
"text": "Yes, Kartik, it’s a good question. So certainly, talked about pays per control growth decelerating. We called that out. And we’ve also – I mentioned earlier, for ‘24, I think there is a risk that it decelerates further. So we will have to watch and see what happens there. On the inflation side and pricing, we’re still in the early days of our FY ‘24 plan. So we’re watching it carefully. I think we can say that we are happy with the impact of the results of the price pricing decisions we took in ‘23. We had those readily accepted, I guess, with – reflected by our higher NPS scores by our continued strong retention. So we have an ability to take price. But as we always come back to, we’re in this for the long haul with our clients, their long-term retention is the most important thing to us. So we need to make sure that we continue to have that good value proposition between what the absolute prices, how much price we can take, etcetera. But once again, Kartik, it’s definitely something we’re looking at and trying to evaluate as we get closer to putting the plan to bid."
},
{
"speaker": "Kartik Mehta",
"text": "And then, Maria, just on the PEO side, could – is any of the attrition related to maybe customers deciding that they had a PEO and it just got too expensive for them. So they have decided to move out of the PEO for a while until they can get a better understanding of what’s happening in the economy. Any changes like that?"
},
{
"speaker": "Maria Black",
"text": "I would say that’s always the case. I think every year, as we go through renewals, as we go through the year-end cycle, you have clients that are choosing to buy into the PEO and you have clients that are choosing to exit the PEO. When I look at where we get our clients from, obviously, I think we’ve cited multiple times that about 50% of the new business that comes into the PEO comes from our existing ADP base that would suggest that at least 50% come from a non-PEO environment, and we somewhat tend to return them the same way. So that’s not to say that clients don’t, at times, we don’t trade customers between us and the other PEOs. But generally speaking, I think that’s always the case. I don’t believe there is a larger trend toward that this time than there has been in the past. I think, really, in the end, it’s really a byproduct again of kind of what we saw with the renewal post pandemic and what the impact of that as we headed into this selling cycle, if you will."
},
{
"speaker": "Kartik Mehta",
"text": "Thank you very much. Appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thanks for taking my question. I also wanted to follow-up on the PEO and particularly on the bookings reacceleration. I’m just curious how much of that reacceleration is sort of from a better kind of external demand environment versus changes in your sales strategy? I’m just trying to figure out how much is sort of push versus pull when it comes to that recovery. And I guess the underlying question is your confidence level that this reacceleration is a sustainable trend?"
},
{
"speaker": "Maria Black",
"text": "Fair. Thank you, Ramsey. We are excited about the PEO reacceleration, specifically what we saw in March and obviously, how we feel stepping into this final stretch. I think it is too early to comment on the finish, but the pipelines are strong. What I would tell you is that I’m bullish about the demand in the market for the PEO and the overall value proposition. So all things being equal, I think we’re positioned well as anybody else as it relates to the overall PEO, I guess, demand, if you will, right? So I don’t think it’s a – the reacceleration was really, in my mind, more a byproduct of top of funnel filling the pipeline. We made a lot of investments into our seller ecosystem and the PEO. We have incentives that we can pull. In addition to that, we’ve invested into – and I think I’ve talked about it a couple of times on these calls. We’ve invested into artificial intelligence that actually looks across our base to a project where we are actually looking at the ADP base to try to serve up the right, call it, PEO seller at the right time to the right ADP clients. So we’re getting smarter. I am not doing a good job saying it outside of we are getting smarter in terms of who we are actually targeting on the PEO using technology today that didn’t exist. So, I think all of that has kind of yielded to what I would say is a strong execution by the PEO sales team to drive the reacceleration that we would expect and that we are excited to see and optimistic that it will continue."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay, great. And a quick follow-up, when you look across the business, are you seeing any vertical-specific areas of softness maybe tech or commercial real estate or financial services? Are there any worrisome kind of verticals that you are keeping an eye on?"
},
{
"speaker": "Maria Black",
"text": "Are you referring to the PEO specifically or the overall macro?"
},
{
"speaker": "Ramsey El-Assal",
"text": "I know. I should have been more clear. Just more broadly across the business, are there any – you guys have a pretty broad macro view. And I am just curious if there is any specific areas that are causing any concern in terms of recent trends?"
},
{
"speaker": "Don McGuire",
"text": "Yes. Maybe I will jump in. I think in terms of verticals, certainly seeing all the reports and reading all the things about commercial real estate that everyone else is. That’s – we look at the breadth and the distribution of our client base, it’s pretty broad. So, I am not so sure that we are seeing any particular verticals that are causing us any undue concern at this time. I would say, has been reported, Maria mentioned it in the prepared remarks, certainly, the enterprise space, the up-market space is where there has been a lot more layoffs announced, etcetera particularly in tech. So, we are looking at that. We have said in the past though that’s not the biggest part of our business. So, even though there is some more softness in that end of the market, it’s being more than offset by the success we are having in the down in the mid-market. So, from a particular vertical, nothing in particular."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. Thanks. Appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Great. Good morning. Thanks for taking my questions. Maybe first one, Maria, just I wanted to maybe get a better understanding when you are talking about a change in maybe the investment – investing philosophy of the company just as you are adjusting to the macro environment evolving as well. Is that more around maybe pulling back on hiring? Is that more about maybe redirecting where resources are? Can you maybe just help us better understand what that translates into? And maybe how we should think about that impacting both the top and bottom line?"
},
{
"speaker": "Maria Black",
"text": "Yes. Thanks Samad and good morning. I am happy to talk about modernization. It’s one of my favorite topics as all of you are probably learning from my prepared remarks. And I think it’s important to think about the modernization journey we have been on and how it really can set us up for kind of future growth and future margin, if you will, as a company. And that’s really what it’s all about for us. I think we have been undergoing transformation. We have been undergoing modernization for years. I would actually suggest that ADP has been modernizing for the last 73 years as we have invested in technology to make things better for us as a business to become more efficient, and we have been investing in our clients and in product to make it easier for them. And so I think that’s not a new cycle. The way I think about modernization is really a client first lens, right. So, it’s really about all the things that I cited. It’s about taking out friction. The way I think about the investment, which is your question, Samad, is it’s an imperative for us to continue to invest in modernization because it’s the modernization that over time has really allowed us to reinvest in growth and reinvest in the business. And we are committed to a continued journey of growth and margin. And as a result of really the way we have been able to do this. So for us, it’s really about both. It’s really about the end, right. So, it’s about growth and margin expansion. And I think this virtuous cycle that we have been on really as a company for a very long time, which is we make things easier, we make them better. We become more efficient. We make things better for our clients, and that allows us to invest in growth and it allows us to invest in – back into our shareholders, if you will, in margins. So, it’s really an end story and it’s key to who ADP is and it will be a key for us as we go forward. In terms of the commentary that I made around how we are thinking about it and the macroeconomic backdrop, it is an important time to make sure we are making the right choices and the right trade-offs. I mentioned earlier, we have been in the middle of our strategic planning process the last quarter. And as we have gone through the business, if you will, end-to-end, rest assured that we are trying as a company to make the very best decisions to have the very best outcomes as it relates to growth and margin."
},
{
"speaker": "Samad Samana",
"text": "Great. I appreciate that. And then just one quick follow-up for Don, I was just looking at the guidance by segments and the margin for ES, it looks like you have settled it out at the – within the range at the lower end. I am just curious maybe what drove that? Is that – is it purely float contribution driven, or is that more the result of just bookings being better, so expenses being pulled forward? Just help me understand why that was narrowed to the lower end of the range, please?"
},
{
"speaker": "Don McGuire",
"text": "Yes. I think there is a couple of things going on. One, certainly, we are continuing to benefit from bookings growth, retention, price pays per controllers all a little bit stronger. And we certainly are getting lots of tailwinds. We have lots of tailwinds in Q3, in particular, from client fund interest. So, that’s been very helpful for us. The things slow a little bit from a client from an interest perspective in Q4. So, that certainly is not as helpful as it was. And we are of course, as Maria just mentioned, we are taking advantage of some of those extra flow funds that we have to invest – reinvest in the business or continue to invest in the business on modernization. So, it’s all about I think trying to find the right balance and still delivering the – as we mentioned, higher end of the earnings per share prediction or guidance. So, it’s all to find the right balance, and we will continue to invest in modernization and deliver improvements as we go forward."
},
{
"speaker": "Samad Samana",
"text": "Great. Appreciate taking my questions. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from David Togut with Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you. Good morning. Could you walk through the 140 basis points of PEO margin expansion in Q3? It seems pretty notable given the deceleration in PEO revenue growth. And in particular, could you unpack the size of the workers’ compensation reserve release in Q3?"
},
{
"speaker": "Danny Hussain",
"text": "It was $17 million. You will see it in the Q compared to $7 million last year. So, it wasn’t a huge amount."
},
{
"speaker": "Don McGuire",
"text": "But those are the two impacts. So, the biggest impact was the reserve adjustment on workers’ comp. And the other big item there is the lower SUI costs. So, there is virtually no margins on SUI. So, SUI comes down at the top, it certainly improves the margins. So, those would be the two major impacts on the margin improvement in PEO."
},
{
"speaker": "David Togut",
"text": "Got it. And then just as a follow-up, Don, could you walk through your strategy on managing the tax filing float going forward? We have got a pretty steeply inverted yield curve right now, which means it’s actually more expensive for you to borrow in the commercial paper market and invest flow medium-term duration bonds. Are you thinking of shifting the investment portfolio at all in the year ahead?"
},
{
"speaker": "Don McGuire",
"text": "We have had that strategy in place for some 20 years or so. And we have realized about $2.8 billion of incremental benefit from that strategy. And so we have a strategy in place. We always revisit these strategies and look at them. It’s true that the yield curve is inverted for the seventh time in 50 years. How long that continues, not sure. But we will continue to look at that strategy and see what we need to do, if anything, to change it as we go forward. But it is something we have been committed to and we followed closely. Near-term, certainly we have benefited this quarter because of the inflow of funds in calendar Q1, there is a big balance or a big benefit there to us. So, as we go forward, we will continue to look at the opportunities and decide if we need to make any material changes to the investment strategy."
},
{
"speaker": "Danny Hussain",
"text": "David, one point worth clarifying because this has come up before. If you look at the last slide of our earnings presentation, you will see a disaggregation of client short extended and long. And one thing I think is worth emphasizing is that we are net long exposed to the client short. In other words, if short-term interest rates went up and up and up, that would actually be beneficial to our earnings and our margins. It just shows up in two different places, which can often cause confusion. But it’s actually not hurtful to us to have these higher borrowing costs because we have more dollars invested long in the client short portfolio."
},
{
"speaker": "David Togut",
"text": "Understood. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Very good morning everybody. Maria, you talked about modernization. Can you talk about the areas of emphasis? And one area that I am particularly interested in is international and what you are seeing there in terms of opportunities? Thank you."
},
{
"speaker": "Maria Black",
"text": "Sure. So overall, I think modernization is really about end-to-end. So, think of it as product and continuing to make investments in ensuring our products are next generation, if you will. And that’s certainly the case across many pieces of our portfolio, and you are well aware of the investments we are making in next-generation technology. I think product is a big piece of it. I think other is the internal modernization. So, that would be everything from go-to-market to call it, the seller ecosystem modernization. I think I have spoken to that quite a bit in the past as well as how we actually serve our clients. And again, we reference that today. So, kind of going back to modernization specifically in our opportunity in international, we are very excited about our position in international, very excited about the opportunity that we have. And this is definitely an area that we have been modernizing. So, if you think about each and every country that we serve over 140 countries today that we have offers over time, we have been modernizing the platforms, and we have been consolidating platforms. But to your point, Mark, that work is not done. And so we still have that journey that we have been on is the journey that we are going to continue. But as we do that, we are also focused on ensuring that we continue to make the investments to the platforms, and we continue to make the investments into the overall ecosystem of how we serve our clients international to really drive further, call it, opportunity. And so there are still places in international, and I will probably leave it with, we will be back next quarter to talk more about things such as our growth strategy. But I think as it relates to international all of that modernization should also yield a growth opportunity for us because it’s still a big world and there are places that we – even though we are in more countries than anybody else, there are countries that we don’t exist, there are segments within certain countries where our offer still has opportunity. And so we were incredibly excited about the overall international space where we are, the work that we are doing and where we are going."
},
{
"speaker": "Mark Marcon",
"text": "That’s great. And Maria, can you talk a little bit about just what the appetite is? And obviously, it’s diverse across the globe. But broadly speaking, are you seeing a greater level of interest in terms of modernization of HR and HCM systems across the globe? Certainly has been an ongoing trend in the U.S. for quite some time. But just I am hearing from others that there is a pickup in terms of RFPs that are occurring things of that nature and that we could be at the early stages of higher levels of growth, international macro notwithstanding?"
},
{
"speaker": "Maria Black",
"text": "What I would suggest, Mark, is that over the last few years, the conversation in the international space has definitely shifted a bit, and I could suggest the same thing, which is that it’s picked up. And so that conversation today tends to lead with more of a global offer, global system of record kind of conversation. So, we walk in today and we have a conversation with a client more often than not about how many countries are you in and where can we help serve you and how can we tie it all together to make an ability for that client to really see across multiple countries and have more of a unified experience versus, I would say, perhaps 5 years, 10 years ago, it was more of a country-by-country conversation. Today, it’s more – it starts with a multi-country conversation. And so I think all of that suggests, but it appears you have heard from others, which is the narrative in the international is shifting. I think there is greater demand for HCM offerings in international as it relates to companies now that are more global than they have ever been. And certainly, the hybrid environment has accelerated that a bit. And the ability for companies to be able to see their workforces and make talent decisions, headcount decisions across multiple countries. That’s a very different conversation today than it was just a few years ago. And we see that when we have, we just recently, actually, this quarter, we had all of our international clients together at an event. And the topic is about their transformation. It’s about their HCM transformation and the partnership that we have with them to solve for them. And I think the beauty of ADP is that we have the ability to solve the MNC, the multi-country piece. And we also have the ability to solve the in-country. And a lot of times, for clients, it’s a mix of both. And so it’s really about the flexibility we have in our partnership options to serve these clients in a very unique way."
},
{
"speaker": "Mark Marcon",
"text": "Perfect. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. We have time for one more question. And that question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hey. Thank you so much and you covered a lot already. I just wanted on the down-market side, given the success in the bookings here. Just curious if that’s changing your thinking and investing more or even less, maybe in ASO versus PSO then the digital sales versus the seller ecosystem? I am curious as we are going into fiscal ‘24 here, if there is any maybe change in thinking in prioritization there?"
},
{
"speaker": "Maria Black",
"text": "So, we have leaned into the down market in terms of the investments we have made. So, when I think I referenced earlier the seller headcount as we head into the final stretch here and how pleased we are with the investments we have made in headcount and the ecosystem around them, so investments into the channels, things of that nature. And as all of that turns into more productivity because the headcount is actually gaining tenure. It is primarily setting those investments have been in the down-market. So again, think our SPF platform, the retirement services, insurance services, most of that also comes into our digital sales organization, also known as the inside sales. So, we are making investments into inside sales to really serve the down market. And what I would suggest is that from our viewpoint at this point, the demand is there. We have leaned into that demand and we will continue to lean into the demand to drive the growth that we are driving out of the down-market as long as it exists, if you will."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. No, I am glad to hear it. If you don’t mind one more question. Just I have to ask you since you mentioned Maria with AI. We have been getting a lot of questions on generative AI and ChatGPT. You mentioned being smarter around serving up PEO when necessary at the right time. But just broadly speaking, how are you thinking about generative AI and how that might help you run your business better, both from a sales perspective, but also from a delivery perspective, support standpoint?"
},
{
"speaker": "Maria Black",
"text": "Yes. Thank you, Tien-Tsin. I am actually – I am thrilled you asked this question because I was counting on it during this call because it definitely seems like it’s the topic du jour. But the real answer is, just like everybody else, we are incredibly excited about generative AI. We have been very excited about AI for quite some time. You mentioned what we have been doing for our sellers in the PEO, that’s broad-based work that we have been doing for a long time and continued to invest in AI into making us more efficient. That example is about our sellers. We are making similar investments even with the new technologies that are out there to really look at how we can make our service associates as well as our sellers more productive. So, you think about all the things that an agent, if you will, does today to support a client and some of the generative AI tools that can drive a different level of efficiency. And we are very excited. We have I think it’s something around like 44 different work streams that are underway currently to take a look at different ways that we can leverage these tools internally. That’s also notwithstanding the opportunity that it creates for our industry, right. So, if you think about the HCM industry, there are still very many things inside of HCM that are administrative in nature in terms of whether it’s job descriptions, performance reviews, things that are maybe handbook, things that are very tactical that really a time pulled back the practitioner from doing what they want to do, which is be a strategic partner. And so we are really excited to put these tools also into our product for our clients and our practitioners to be able to lean into. So, all that said, we are very excited about the opportunity. One thing I would point out because it’s important, and it’s also very topical right now, which is that the good news is we have been doing a lot of this work. And as such, we have standards. We have a way to think about the ethical nature and that kind of comes at parity with who we are, given that we have the big data, if you will, behind ADP and the 40 million wage earners that we pay. And so when we think about all of this, also with the lens of doing it the right way and making sure that it’s applicable, it’s secure, it’s compliance, all the things that you would expect from ADP. But no doubt, Tien-Tsin, that we are excited about the opportunity it creates for us internally and the opportunity that it creates for us and our product to really serve the industry, right, and make this entire industry that much more strategic and not much more exciting. So, great question."
},
{
"speaker": "Tien-Tsin Huang",
"text": "No. Hope to learn more soon – talk soon. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Thank you. So, first and foremost, thank you everybody for joining today. Really appreciate the questions and the interest. As you can imagine, I sit here one quarter into my new role as CEO and I get a lot of questions. Just last night, I got another text that said, how were the first 100 days, how is the first quarter, what have you been up to? And here is what I would offer. The third quarter for ADP, and you heard it in my tone today, you have heard it in my excitement about some of the volumes and the throughput, but the third quarter is really where you see ADP shine. And it is our finest quarter. You have year-end, you have busy season, you have selling season that all kind of come together. In this quarter, what I would say is adding some economic strangeness and questions about what’s happening in the world, and I would say that sitting here one quarter in, I couldn’t be more excited. I couldn’t be more pleased. I couldn’t be more grateful for the share execution of our associates. So, I felt the breadth and depth of ADP this quarter at its finest. And with that, I just want to take another minute to thank our associates for everything that they do to power this great company. I would also like to thank all of our partners and stakeholders and everyone on the call listening today. I couldn’t be more proud and more excited about this company. And with that, we will wrap up the call."
},
{
"speaker": "Operator",
"text": "This concludes the program. You may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 2 | 2,023 | 2023-01-25 08:30:00 | Operator: Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session and instructions will be given at that time. I would now like to turn the call over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Michelle, and welcome everyone to ADP's Second Quarter Fiscal 2023 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with the reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll turn it over now to Maria.
Maria Black: Thank you, Danny, and thank you, everyone for joining us. ADP delivered strong Q2 results headlined by 10% organic constant currency revenue growth; 120 basis points of adjusted EBIT margin expansion; and 19% adjusted EPS growth. We continue to deliver exceptional value in the HCM market as we invest in ourselves and innovate to continuously meet and exceed the changing needs of our more than 1 million diverse global clients. I'll start with some highlights from the quarter. In Q2, we drove very strong ES new business bookings growth, which included an incredible finish in December. We have continued to see robust demand across our downmarket portfolio and our ES HRO offerings and our international sales performance, especially our GlobalView platform was much stronger in Q2 after a softer Q1. Overall, we are pleased with our sales results for the first half of the year, and although clients are still dealing with a number of uncertainties, our pipelines are healthy, and we feel well staffed, and well positioned to deliver solid bookings growth for the remainder of the year. Our ES retention was once again a source of outperformance with modest year-on-year improvement in Q2 overall despite continued normalization in down market out of business rates. This strong result was just shy of the record retention set during the pandemic and was led by our mid-market, our upmarket, and international businesses. And we're pleased to be taking our full year guidance up slightly. Our pays per control metric was 5% for the quarter, decelerating slightly from Q1 as we had anticipated. Job growth in the U.S. labor market has been slowing, but clearly remains solid, which you see reflected in our client base. Despite recent headlines noting job cuts by number of companies, we have yet to see broad-based softening in the labor market. Last, on our PEO, our growth in average worksite employees was solid at 8%. While we have been expecting growth to decelerate over the course of this year, the pace was a bit faster than we previously assumed and we're adjusting our outlook accordingly. With that said, demand for the PEO solution remains healthy. The secular growth opportunity is unchanged, and we are well positioned to reaccelerate our worksite employee growth. Stepping back from the quarter, I want to provide a quick update on our broader strategy. Over the last several years, you've heard us talk a lot about the modernization of our products. Our simpler user experience enhances ease of use for our key platforms like RUN and Workforce Now, and enables a more seamless integration to complementary solutions like insurance, retirement and payments. Our Next Gen Payroll engine is a prime example of how we're modernizing the back-end of our solutions, and we continue to offer it to a broader set of new mid-market clients. And brand new solutions like Roll in our Next Gen HCM platform position us to address certain HCM opportunities more fully than before. These product enhancements are designed to drive win rates and retention even higher, and we have tremendous opportunity in front of us. But our strategy has always been about much more than just offering HCM software. ADP clients want us to help them find, hire, pay, engage, and provide for the retirement of their workers in a thoughtful and compliant way. To truly solve for these needs, we are modernizing all aspects of the client relationship. That starts with product, but also extends to our go-to-market approach, how we onboard our clients, and even how we advise and support them on critical issues. We refer to this collective effort as our Modernization Journey. And as with our product journey, the opportunities here are incredible. We are removing friction and enhancing the client experience in many ways. In our U.S. down market, we continue to digitally onboard tens of thousands of clients every year, making onboarding easier for our clients and accelerating time to start. We have seen this success in the U.S. and we're beginning to scale the same capability in Canada. Our Intelligent Self-Service capability launched only last quarter is already helping a portion of our client base answer millions of questions from client employees through a completely automated process. And now in our international portfolio, we're implementing chatbots to reduce work for those clients as well. We continue to invest in our robust partner ecosystem, cultivating deep relationships and integrations with financial advisers, CPAs and benefits brokers to provide a seamless experience for our mutual clients. And we're using the power of our extensive data to deliver insights to bring greater value to clients from better aligning pays to market trends, to reducing the frequency and severity of workers compensation claims, to identifying tax credits and other legislative incentives. To bring this large-scale Modernization Journey to life, I'll speak to one of our fastest-growing businesses. ADP retirement services, which helps employers establish and administer retirement plans. Businesses today face a complex environment with significant legislative change and our clients look to us to help them navigate these changes, stay compliant and address talent challenges. For example, in the retirement space specifically, the recently passed SECURE Act 2.0 alone has over 90 provisions for businesses and employees to consider. And what we've designed makes life easy for our clients and partners, improves the financial wellness of their employees, and sets us apart in the market. Our robust 401(k) solution with thousands of different investment options is not only clean and intuitive, thanks to our new UX framework, but is also deeply integrated with RUN and Workforce Now. Our highly tenured, licensed, retirement services sales force understands our clients and understands which solutions to make a meaningful difference in a client's unique talent strategy. To expand on our partnerships with financial advisers, we recently developed a platform called Advisor Access, much like the Accountant Connect platform we developed for the CPA community years ago. This positions us better to serve our mutual clients and their employees. And our tax credit team, full of experts in their field, is there to help our clients or their CPAs apply for, and obtain the appropriate legislative incentives. Our goal in our Modernization Journey is to consistently improve the full end-to-end experience for our clients and their employees, which will in turn contribute to our long-term sustainable growth and profitability. We look forward to keeping you updated. And now over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the quarter and update you on our fiscal '23 outlook. Overall, we had a strong Q2 on both revenue and margins. If I can summarize, we had generally positive developments in our ES segment despite some incremental headwinds. Meanwhile, trends were a little softer than expected in our PEO. Let me focus on ES first, and I'll cover our results and outlook all at once. ES segment revenue increased 8% on a reported basis and 10% on an organic constant currency basis which was a good outcome for the quarter. Maria mentioned the strong new business bookings performance in Q2. Given the continued macroeconomic uncertainty, we think it's prudent to maintain our current guidance range for now, although, we feel well positioned for the back half. We also had near-record ES retention in Q2, with first half ES retention results up year-on-year, we're now revising our outlook and we expect retention to be down only 20 basis points to 30 basis points for the full year. This continues to assume normalization in out-of-business losses in our downmarket. Pays per control were in line with our expectation in Q2, but with better line of sight on Q3, we are now assuming less of a deceleration in pays per control over the back half than we did previously and are raising our outlook to now assumed 3% to 4% pays per control growth for the year. And on FX, we had about two percentage points of revenue headwind in Q2, but the outlook for the rest of the year is slightly improved, and we now expect full year headwind somewhere between 1% and 2%. Those are the bigger positive developments in ES revenue. There were few developments in the other direction as well. Client funds interest revenue was up nicely in Q2, but was actually a bit lighter than we had planned. This is primarily because yields pulled back slightly from where they were three months ago when we provided our prior outlook. We're also tweaking down our balance growth assumption now to 4% to 5% growth for the year due primarily to assumptions around average wage related to worker mix, tax rates as well as the impact of the lapping of the payroll tax deferral. Together, we are lowering the full year by $5 million at the midpoint for revenue and $15 million at the midpoint for net impact to our earnings. We also saw underperformance in some of our volume-based businesses like our recruitment outsourcing business and our employment verification business. Overall, though, we're feeling good about our ES revenue growth trajectory and are taking up our guidance by 1% to now expecting growth of 8% to 9% for the year. Our ES margin was up 170 basis points in Q2, which was in line with our expectations and there was no change for our full year outlook. As a reminder, we've invested in headcount in sales, product and other areas throughout the organization over the last several quarters as we see continued opportunity to win new clients and further increase satisfaction with existing clients. And although we may scale back as appropriate, at a high level, we feel comfortable with our staffing levels against the secular growth opportunity in front of us. Moving on to the PEO. We delivered 11% PEO revenue growth in Q2 with 8% growth in average worksite employees. As Maria shared, the PEO results came in a bit softer than expected. The PEO business continues to benefit from long-term tailwinds, but there was a lingering effect from the pandemic, which is still adding variability to our PEO results and outlook. We are, for example, lapping very strong results on retention, bookings and same-store pays. And while the overall trends are playing out consistent with our expectations, we continue to refine our assumptions about pays and magnitude. With that said, we still see a continued solid demand environment in the PEO and the team remains focused on reaccelerating worksite employee growth. For this fiscal year, we are lowering our PEO revenue outlook to 8% to 9%, driven by growth in average worksite employees of about 6% to 7%. PEO margin in Q2 was up 130 basis points about in line with our expectations, and we continue to expect PEO margin to be flat to up 25 basis points for fiscal 2023. Adding it all up, the favorable revision to our ES revenue outlook is largely offset by our lighter PEO revenue growth forecast. And so we continue to expect consolidated revenue growth of 8% to 9% in fiscal '23. We also maintain our outlook for adjusted EBIT margin expansion of 125 basis points to 150 basis points. We still expect our fiscal 2023 effective tax rate to be about 23%. And we continue to expect adjusted EPS growth of 15% to 17%, supported by our steady share repurchases. I'll just make one quick comment on cadence. We expect consolidated revenue growth to be relatively steady in Q3 from where we were in Q2. We expect margin expansion to be a bit more modest compared to what we experienced in Q2, closer to 50 basis points to 75 basis points of expansion. There were a few reasons, including the lapping of a onetime item last year, comparisons from a headcount perspective, and certain investments in sales and marketing that we're assuming for Q3. Again, there's no major change contemplated for the full year, but hopefully, this helps you think about Q3. Thank you, and I'll now turn it back to the operator for Q&A.
Operator: Thank you. [Operator Instructions] And we'll take our first question from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi. Good morning and thanks for taking my question. On PEO, you mentioned the lingering effects from the pandemic is having an impact. But I was just curious, is the macro environment and I guess, labor market trends impacting PEO differently than ES? Is there more -- is it a question of sensitivity to small versus large market clients? Is it vertical exposure? Or is this really something you see is as quite transient?
Maria Black: Thank you, Ramsey. I appreciate the question. So I'll try to cover all the ground on the PEO that you asked about. So specifically, what we saw with respect to the first half, we did see, as mentioned in the prepared remarks, we did see that booking did come in softer. We saw that retention came in a bit softer as well than our expectations. In terms of the lingering effect that we cited, all of our businesses had an impact from the pandemic. I would say the PEO is probably the one that had the most impact. If you think about all the drivers that constitute the PEO, it's everything from average wages to worker mix to paid unemployment to certainly the lines of insurance, workers' compensation and health benefits. So I would say it's the business that had the most impact as the pandemic came into the business. And as the pandemic gets flushing out, it is having a lingering effect on the business. I think you touched on what we're seeing with respect to pays per control in the PEO in the context of ES. But I would say is, pays per control is -- the growth rate is decelerating in the PEO. That was expected. If it contributes to the slighter softer performance in the first half and is contributing to the second half. But the two main drivers really behind the performance in the first half as well as the outlook for the second half are bookings and retention. One thing I would say, though, because I want to go back to the strength of that business. We have incredible faith in that business as it relates to the growth from a long-term outlook perspective. The demand is still there. In absolute form from a bookings perspective, the PEO did have growth year-on-year, albeit it was softer than ES and softer than our expectations.
Ramsey El-Assal: Got it. That was super helpful. Thank you. And just a quick follow-up for me. Tech layoffs have been -- tech sector layoffs have been in the headline recently. I know you guys have a very diversified business, but I thought I'd ask anyway. How exposed are you to that particular vertical? Are you feeling any kind of acute impact from all those headlines kind of layoffs in the technology sector?
Don McGuire: Yes, Ramsey, it's a good question. I think it's hard to avoid all the headlines that we're seeing day in, day out. And it's fair to say that there's been a number of large names that have announced major layoffs, I'd also with the -- tough to say that some of those clients are -- or some of those people making those layoffs are our clients. But those layoffs are happening around the world in some cases, they're not necessarily our clients in all of our markets. So I think it's fair to say that we have yet to see any significant impact from all those announcements. And I guess I'll just round it out by saying, we're still seeing stronger or strong demand. We've taken up our pays per control assumption for the back half. And we're doing that not just on our own internal perspective, but we're also looking at the BLS reports, the JOLTS reports. Everywhere you look continues to suggest that there's still strong demand for employment. Unemployment continues to be very low. Unemployment applications are still in record lows. They're not increasing. So the macro environment continues to be very, very favorable for us, irrespective of some of those headlines that we're seeing.
Ramsey El-Assal: Perfect. Thank you so much.
Operator: Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open.
Eugene Simuni: Thank you very much. Hi, Maria and Don. I wanted to ask about ES bookings. So it sounds like a positive commentary, strong performance there. I think you called out international as coming back strong versus last quarter and also downmarket. Can you talk a little bit about the mid-market? How are the trends there? And yes, I think the key question in everybody's mind is, are you seeing any signs of macro pressure on bookings as companies potentially pulling back their tech spending?
Maria Black: We were very pleased with our overall new business bookings for the second quarter. Definitely saw an acceleration in pipelines. I'll get the pipelines in a minute. I did cite the downmarket, the strength that we're seeing in the downmarket, that's really our entire downmarket portfolio. So thinking about our -- obviously, our RUN offering, but all the things that tether off of the RUN offer, which is the retirement services that I spoke to at length during the prepared remarks, Insurance Services. We did see strength in Employer Services HRO. And then last but not least, one of the other things that I was most pleased to see was the bounce back in international in the second quarter, both in pipelines as well as results. And that was, as mentioned really in our GlobalView space. So very happy with the results, very happy with the strengthening of pipelines. That's what gives us confidence, stepping into the back half as we think about heading toward our guidance of 6% to 9%. In terms of -- I think you also wanted to know about the mid-market because I didn't cite that specifically. We had very solid yes, very solid mid-market sales, and we continue to see the demand there as a byproduct that is certainly not getting easier for anyone to be an employer, both from a legislative perspective as well as a talent perspective. We have incredible strength in that business as it relates to the product investments we've made. So think about user experience to what we're attaching with the Next Generation Payroll engine. So we made good product enhancements. We had strong NPS. We have incredible retention results. So the mid-market in general had also a solid sales performance. What I would say is, as you contemplate the mid-market, don't forget that Employer Services HRO, the offer that we call Comprehensive Services fits squarely in that market, and that's an area that experienced tremendous growth during the pandemic, and that growth has sustained and is exceeding the overall Employer Services growth. So altogether, the net results for the mid-market are very, very solid for us.
Eugene Simuni: Got it. Got it. Very helpful. And then a quick follow-up for me on pays per control. Your number was very strong this quarter we thought, out from your expectations. But also keeps outperforming by 1 point or 2, kind of the broad measures of labor market growth in the U.S. like nonfarm payrolls. Remind us what's the driver of that? And how sustainable is that as the overall labor market slows down? Can you maintain that one to two point premium?
Don McGuire: Yes, it's a good question. But just to remind everyone that, that number is really a mid-market number. So we focus on the mid-market when we provide that pays per control number. And it has been strong. As I mentioned in the earlier answer with respect to the macro environment, the labor market continues to be strong. We're continuing to see our existing clients add employees. As Maria said, bookings are strong. And I think it's the kind of the $64,000 question about how long the labor market can continue to grow. Unemployment can stay so low as we look at some of the headlines and will those things start to converge at some point in the future. But for now, I think we're comfortable with what we've done in terms of taking up the pays per control growth for the back half.
Danyal Hussain: And Eugene, just to your point about that spread, having existed in the past, I think typically, we would have expected 2% to 3% pays per control growth in normal economic environment, and that compares to maybe 1% to 2% total employment growth. And that's a function of our clients in general being perhaps a bit healthier than the overall economy, but also the fact that total labor includes things like bankruptcies and new business formation. So it's a slightly different take on employment.
Eugene Simuni: Got it. Very helpful. Thank you, guys.
Operator: Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thank you so much. I wanted to quickly just revisit a little bit, I think you touched on it. But retention and it's an area where we had at least been expecting to see some normalization but -- especially from a company perspective, but it seems to continue to improve or tighten. Obviously, you made technology advancements, et cetera, but what are some other areas, if any, that you'd point to -- that are helping drive that retention performance.
Maria Black: Sure. Thanks, James. With respect to retention, we are very, very pleased by the strength that we've seen year-to-date. We cited, at the end of the first quarter, we had record retention. The second quarter was near record. If you look at the first half, it was a record. So we're very proud of the -- not to be a broken record, but the record retention and the strength that we saw -- and we believe that, it is a byproduct of the investments. I alluded to the investments we've made into the mid-market, as an example of the user experience. That's broad-based now across the RUN platform, our mobile app, our international offer, where we're also in international seeing record retention. So we believe a lot of these things are anchored in just really driving a better user experience, driving the product into a better place. I think the other is NPS. We have strong service results that's broad-based across the portfolio. I think we generated a tremendous amount of goodwill and value during the pandemic and how we chose to service our clients. And I think that value is -- has continued, and we see that in the results on the NPS side. So I think that's another place. You did touch on normalization. I think it's an important point to make. We do believe at this point, specifically in the down market, I think we even touched on it during the prepared remarks. We do believe that retention has normalized. When we normalize for average or adjust for average size client, we are back to the downmarket really having out of business and bankruptcies back to fiscal '18, fiscal '19 levels. So we do believe that the downmarket has normalized. So again, back to kind of the broader retention picture, it is a very strong one for us because we believe at this point, that is broad-based. And it's really a result of the investments and the service levels that we offer.
James Faucette: So Maria, that's an interesting point that you're already kind of at least what you think were -- where we should be from a attrition perspective, et cetera, at least compared to where we were pre-COVID. What are you seeing now from the competitive environment, especially, as we see companies expressing more concern. Are you seeing flight to quality versus some of the regional players or newer entrants? Is that helping you? Just love an update of how the competitive environment factors into what you're seeing overall?
Maria Black: The competitive environment is certainly -- on one hand, I could say it continues to evolve. On the other hand, I would tell you, if there's nothing really new to report. I think what we're seeing and we look very closely at our balance of trade, we look very closely at our win rate. We're measuring all these investments that we make and whether or not they're impacting things such as our balance of trade and such as our win rate. And what I would offer is that, there is a direct correlation between the places we're investing, whether that's the downmarket and our go-to-market brands, headcounts or in the mid-market into the product and the next-generation suite and the win rates that we have. And so we do believe that we're getting stronger in terms of our offer. And I think the record retention is a direct correlation to that.
James Faucette: Great. Thank you.
Operator: Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hey, good morning. Thanks for taking the questions. Maria, you mentioned there was a modernization initiative. I'm wondering if you can expand a little bit on that, just in terms of what we should expect over the next six to 18 months in terms of new offerings or increased offerings. And how would that end up impacting both from a revenue as well as from expense perspective? How should we think about that?
Maria Black: Sure. I love speaking about the investments we're making into the Modernization Journey. And so perhaps, I can offer the story around the next generation and how we're thinking about the impact of that over the next 16, 18 months from a revenue perspective. And maybe, Don, if you want to cover the margin side. So Mark, as it relates to our overall modernization initiatives, there is all the things that I talked about in the prepared remarks, which is around tools, technology, removing friction, taking work out. Last quarter alone, we talked about Intelligent Self-Service, Voice of the Employee. So these are bespoke features, functionality that were layering into our offers, and into our platforms to make them more competitive and bring more value to the market. With respect to the next generation platforms, I touched briefly on Next Generation HCM. We've given updates of that over time. And I think we continue to see us implement our backlog, continue to build scale, build implementation. Our goal would be -- to use your time horizon over the next 16 to 18 months that we would open the aperture to have that suite specifically sold across a broader set of the upmarket clients. In terms of the Next Generation Payroll, which is what we are offering attached to Workforce Now in the mid-market. We continue to make progress on Next Generation Payroll, pretty excited about that progress from a quarter perspective. Every quarter, there's an increase of the number of clients that we are attaching the Next Gen Payroll towards Workforce Now. So I think from Q4 to Q1, we had more. From Q1 to Q2 -- or Q2 to Q1, we had more. As continue again to attach more and more, we're running about 30% to 40% attached. So again, using your time frames over the next 16 -- six to 18 months, our goal would be to continue to more broadly offer and scale that offering across specifically, our mid-market. We're seeing, again, great signs on win rates, things like that. I think the other initiative I would speak to is Roll. Very excited about our project that we -- or it's not project, our product that we call Roll, which is really the downmarket product that we're offering to an incremental buyer that digital native. And so again, it's exceeding all of its project milestones. We're learning. We're continuing to understand how a digital buyer wants to consume payroll end-to-end in a digital capacity. And we believe over the next six to 18 months that we will learn more and as such, we will scale it across. In terms of the impacts to revenue, I would tell you, revenue over the next six to 18 months, I'm not sure that any of those projects will make a meaningful impact to the revenue. They certainly will make any meaningful impact to bookings. And as we onboard those clients, that will generate new revenue lines for us, whether that's an upmarket, our Next Gen HCM, it's a broader piece to the mid-market, our Next Gen Payroll. And then in the downmarket in the micro market that Roll addresses, it take a lot of units for it to make a meaningful revenue impact to the broader ADP. But that's the -- the excitement is really in the offers, and offers being able to drive win rates and retention and changing the competitive narrative. So with that, I'll kind of stop and I'll let Don speak to any margin impact.
Don McGuire: Yes, Mark, I'll just follow up on Maria's comments. I think the adoption of these products is exciting and doing well. And as we have the adoption increase quarter-to-quarter, we expect to see improvements in revenue from these new offers. But I think at the same time, the penetration rate within our 1 million existing clients is going to take some time to achieve. So the margin impacts from those new sales and those clients is going to take some time to make its way through to the bottom line, so to speak. But I would say that we -- you've heard us often speak about transformation of these calls over the last few years. And I would say that internally, I think our biggest transformation exercise, our biggest transformation opportunity is coming from these new products themselves. So we are excited about these new offers, and we do think they're going to -- they're going to help us out in the future.
Mark Marcon: That's terrific. Thank you. And then obviously, in the headlines, everybody is concerned about what could potentially occur from a macro perspective in terms of, if we go into a recession, ADP has obviously got a stellar long-term track record of navigating successfully through recessions. But I'm wondering, what's your philosophy going to be Maria, if we go into a recession in terms of thinking about expenses, margins, et cetera. Would you just focus on the long-term or would you do things in a short-term manner to adjust expenses?
Maria Black: We do have a recession playbook, if you will. I think the first thing that happens is, we adjust things such as our go-to-market. When you think about how we address talent needs on the way up in an economy, it's kind of the converse on the way down. So that's not to suggest that the business wouldn't be impacted. The things that would be impacted are things like bookings. And the reason I bring that up is, it is somewhat self-adjusting, right, as it relates to the action. So in the absence of bookings, there is also the absence of expense. So some of that self-adjust, thinking selling commissions, overall incentive comp. We could also, as a byproduct of that, if there's lower volume on the sales side coming in, we would have lower volume on the implementation side and potentially lower volume on the service side. And so there will be, maybe a pullback in hiring things of that nature. And these are all playbooks that we've run before, a few times in my lifetime. We may add that juncture, choose to prioritize key investments differently, depending on what's happening. But we're going and we're very committed to continuing the work we've been doing on Modernization and on transformation. And I think one of the big lessons for us whether it was this most recent pandemic downturn, if you will, an event or it was the last -- the financial crisis or even the -- I've been here long enough to be a part of the 2000, call it, dot-com, et cetera, bust. And what I would say is, our investments in growth will be maintained. I think that's the key is ensuring that we make smart decisions during a downturn so that when we come out of the downturn, we're positioned to execute quickly. I think we made some very wise decisions, specifically, on the go-to-market, on the seller side during the pandemic that allowed us -- we were lucky because it was short and steep and fast. And as everything opened back up, we were well positioned to take advantage of that market because of the investments that we continue to make. So to answer your question, I think most of the changes that we would make are somewhat self-adjusting in their nature, if bookings were impacted.
Mark Marcon: Perfect. Thank you.
Operator: Our next question comes from Bryan Bergin with Cowen. Your line is open.
Bryan Bergin: Hi. Good morning. Thank you. First one I had is on pricing. So just any change in view around ES pricing, any change in claim acceptance to the higher levels that I think you were contemplating when you entered the fiscal year, just given the macro?
Don McGuire: Yes, Bryan, thanks for the question. I think it's a relatively short answer. The fact is our prices are holding well. As a matter of fact, I would say that we are kind of at the high end of the guidance we gave previously, and we're comfortable with that. I think if we look at our retention, we look at our NPS scores, it appears that those price increases have been understood and accepted as well, as could be expected.
Bryan Bergin: Okay. Good to hear. And then on the international front. So can you just talk about what you saw in Europe here that drove the better performance in the quarter. And you cited U.S. pays per control here in the earnings material, what does that imply in the Europe base? So I'm curious not just on the employment level but also the demand, whether there's really any particular solutions that drove that better performance or different underlying behavior in that base versus U.S?
Maria Black: We were very pleased by the improvement that we saw in international bookings. It was driven mainly by our GlobalView offer and a bit of our in-country business. So very excited about what we saw specifically, as it relates to performance in the second quarter. But also about pipelines, right? So a quarter ago, I was on this call citing that we believe that there was some pipeline depletion that happened specifically in international. So pipelines that were pulled into last fiscal year. International was one of the businesses that had an incredibly strong fourth quarter finish. And so we did see a need during the first quarter to rebuild pipelines. The great news is those pipelines were rebuilt and we saw that execution in the second quarter. It's also what gives us optimism as we head into the back half. So very excited about international. And as optimistic as I am, it is an area that we're still continuing to watch for all the obvious things, I said. Last quarter, which is, there's still the crisis in the Ukraine. There's still the energy crisis. It is also an area that we see a tiny bit of pipeline aging. And so international remains a watch item for us, albeit, very excited about the pipeline build and the results in the second quarter. And I think you asked about pays per control in international?
Danyal Hussain: Yes. Bryan, pays per control for our international pays tends to be more subdued than what we have in the U.S. in both directions. And so early pandemic, it didn't fall very much at all. And in the recovery, subsequent, we had less growth there. So that's continued.
Don McGuire: Yes. So just maybe -- so the government programs that are in place and the kind of the social aspect, if you will, of European employment means that things don't go down very quickly. And as a result, they don't recover very quickly as well because they don't have much to recover from. So that's a good for consistency, if you will, continuity of earnings. So that's -- that works in our favor in these -- when times are trying.
Bryan Bergin: Okay. Makes sense. Thanks, guys.
Operator: Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang: Hey, thanks. Thanks so much. Sorry, hope you can hear me. Maria, I think I heard you say you were looking to reposition PEO growth. If that's the case, can you elaborate on that? I'm just trying to think if the implied second half growth in WSE volume within PEO, that's a good number to start from. As we look to next year, could growth get better or worse from there? Or how quickly can the repositioning, benefit of the volume outlook? Thank you.
Maria Black: The comment that I made was really about bookings. And so we are looking to reaccelerate bookings in the back half. For PEO, as mentioned, it was a bit softer in the first half. In terms of the question of when we anticipate the reacceleration, the well-positioned reacceleration and worksite employee growth, we don't anticipate that it will be in the next couple of quarters. So not a position to necessarily give guidance for next year. But we are lapping -- as mentioned in the remarks, we are lapping record retention, record bookings. And as some of that lapping happens, we believe we're well positioned to reaccelerate works on employee growth into next year.
Tien-Tsin Huang: Got it. Perfect. Thank you. And then just on Retirement Services, since you mentioned it, in your prepared remarks. Any update on penetration there across the major lines? And if there's any change in the outlook or the model there. Thank you.
Maria Black: Sure. So it's safe to say that business is outperforming its targets. It has great growth. We do have -- and last week, we talked about it, we do have 125,000 plans across that business. It's primarily an SMB space, a little bit into the mid-market and even upmarket. But nonetheless, if you just think of it in the SMB context and with the new SECURE Act and -- which is the 2.0 version of the 1.0 and all the state mandates. At this juncture, we have 125,000 of 800,000-ish RUN clients that take advantage of the offer. So you can kind of think about the opportunity in that way. That's not to suggest that every single one of those RUN clients could be a retirement plan, but even if we were to capture a bit of that. We do believe, and it's part of the reason I'm so excited about it is because it does continue to outperform its growth targets. And we believe there's tremendous runway for growth in Retirement Services over the coming years.
Tien-Tsin Huang: Thanks for that.
Operator: Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi. Good morning. Thanks for taking my questions. I just wanted to ask one on the volume-based parts of the businesses that you mentioned, particularly on the employment verification. I was just wondering if you could help us understand how much did that contribute? And what are the assumptions going forward? Are you assuming that there will just be less activity around employment verification? Or do you think it was just seasonally lower? Just how should we think about that since you called it out this quarter.
Don McGuire: Okay. So let me talk about the two volume businesses that we referenced in the prepared remarks. The first one would be the RPO business, the recruitment outsourcing. That business was down and that business is not a very big business for us. And most of it is focused in the upmarket. Most of the clients we have there are in the enterprise space. And I think that is an area, of course, where we are seeing something internally that correlates more with some of the headlines that we're seeing in the press. But it's not a very big business for us, and it did come down. On the employment verification business, of course, mostly and significantly related to the mortgage market. We don't share the number that EV business is part of our broader $1 billion comprehensive services business. It's meaningful for us. From a revenue perspective, it's more meaningful for us, if you will, from a margin perspective because it's above-average margin business. Hence, we called it out. But our expectations as we look forward is, we do expect there to be softness in the mortgage market in the back half of the year. And we've reflected those expectations and those forecasts into the numbers that we're sharing with you today.
Samad Samana: Great. And then maybe just a housekeeping question on the rate side. So just so we understand it. When the company gives the forward outlook for the float revenue guidance. Are you assuming -- I'm assuming the tenure that's come in at the short end of the curve has actually gone up. So is it -- should we assume that the tenure at current levels is what you're now forecasting going forward? I'm just trying to -- we're just trying to make sure that we get it correct, the inter-quarter moves and how we should think about that on the guidance of that.
Don McGuire: Yes. So since we presented -- since we gave guidance last quarter, rates have come down, particularly on the mid and the long rates. And even though short-term rates have increased, some of our short-term borrowing costs in our commercial paper program. So the rates that we're giving and the reason we take in our client fund interest forecast down a little bit at the midpoint, is to reflect those increased borrowing rates and the softening, if you will, of interest rates in the mid and the longer term.
Danyal Hussain: Yes. Samad, thanks for asking that question because I know we take a slightly different approach than some of our peers. But even when you think about the short end of the yield curve, what is currently baked into market expectations is also what baked into our outlook for the year. So even if the Fed raises rates, that does not necessarily suggest upside to what we had previously guided. And to Don's point, at the longer -- the mid and longer end of the yield curve, you actually saw a decline. And so we share in our earnings release the incremental yield on new purchases and that declined from, I think, 4.3% last quarter to 4.1% this quarter. So in other words, we're getting less in the mid and long end of the yield curve, and we're getting more or less what we expected in the short.
Samad Samana: Great. That's helpful. Thanks for clarifying that. Appreciate it.
Operator: And our last question comes from Jason Kupferberg with Bank of America. Your line is open.
Jason Kupferberg: Hey, thanks, guys. I wanted to come back on PEO for a second and maybe piggybacking on Tien-Tsin's question. Just as we think about the second half of the fiscal year. It looks like the revenue growth is going to come in 5%, 6%. And then you talked about getting to some easier comps and some reacceleration. But are you thinking any differently about the medium-term guide for PEO? I think that was 10% to 12% when you provided that at the Analyst Day.
Maria Black: So the medium-term guide, all of the medium-term guides were somewhat aspirational in their nature, and we're not sitting here today making changes to any of our medium-term guide. I think, again, when I think about the PEO outlook, just a reminder, because I said it earlier on the call, but I think it is an important point. The demand has been incredibly strong still for the PEO. It is still growing nicely through the second quarter. Technically was year-on-year growth. It just wasn't what we had expected, and it decelerated a bit earlier than we thought. And so when we think about kind of the back half of the PEO, we do expect bookings to reaccelerate. As mentioned, we expect works on employees to not accelerate in the coming quarters, but we're well positioned to do so as we lap the compares into next year. But I think the big piece -- by the way, even retention was healthy. Retention is right in line with really where it's been in the last decade. I spent a lot of years in that business. And I've seen this as nothing abnormal, if you will. It's really just the byproduct of some lingering effects from the pandemic, which is not that different than some of the strangeness that we experienced during ACA in that business. And so what I would say is, demand is healthy, bookings is healthy, just not as high as we wanted it to be on tough compares. Retention is healthy, just not as high as we wanted it to be, again, on tough compares. And we feel well positioned in that business to accelerate and very excited about its long-term growth opportunity for us.
Don McGuire: Yes. Sorry. And at the same time, remember, at Investor Day, we said that we were expecting high single-digit growth in average worksite employees. So I think we're still very much on that track and pretty much committed to that.
Jason Kupferberg: Okay. Appreciate that. Just wanted to follow up on -- so on the pays per control side, obviously, you upticked the guide there. But we have seen in the temp labor market, there's been some material declines in recent months. I'm just wondering how you guys think about the temp labor market relative to broader labor market conditions. And your business with some kind of potential lag? Just any views there would be helpful. Thanks.
Danyal Hussain: Yes. Jason, I think --
Don McGuire: Sorry, I will -- let me start. Maybe Danny can add some color. I think some of the leading indicators we look at -- so look at the JOLTS report, we look at the job postings, et cetera, those still seem to be healthy. It is -- I mean, the open positions, the until positions are certainly declining, but they still remain at healthy levels compared to pre-pandemic levels. So I think that would be an indicator we look at. And I think there's still some room there before they get back to what we saw pre-pandemic. So I guess we'll continue to pay attention to it. We're focused on it. But at this point in time, things still feel to be pretty healthy.
Danyal Hussain: Yes. Jason, exactly to that point. It's one of many leading indicators that we look at. And for sure, things are slowing, given where we are with employment and 3.5% unemployment rate. So it's not a question of whether we expect the monthly jobs growth to slow over the next several months, I think that's more or less assumed. But the question is, at these employment levels to get that type of growth is still a very healthy outcome. And so I think that's how we would characterize the overall environment today.
Jason Kupferberg: Okay. Thanks for the color guys. Appreciate it.
Operator: We have time for one more question, and that question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Good morning. Maybe Maria or Don, as you look at the PEO business and is -- are you seeing any more competition in the business? Could that be a part of maybe you're seeing? Or is this just that you need to reposition the business a little bit and the business was so strong that the comparisons are difficult.
Maria Black: I think the business was so strong. I think the compares were difficult. We plan for deceleration. It happened faster. We do not see a competitive change or landscape that exists. Again, in terms of where that business gets its business from, that 50-50 split between kind of new clients coming in as well as upgrades as well as where we actually return clients that leave. Certainly, there is PEO to PEO switching, but it's a very small piece to the overall results on the booking side or the impact on retention. And we're not seeing -- again, we look at balance of trade, we look at win rates and we do not see a meaningful change in the competitive landscape.
Kartik Mehta: And then maybe Don and Danny, I know you're talking about leading indicators and Don, you talked about the JOLTS report, and I assume we have lots of other statistics. But I'm wondering, are you able to look at the customers you have and the demand they see for employees? And if you kind of compare that to what you saw three, six months ago. Are you able to do that? And if so, maybe what you might see in that type of -- those type of statistics?
Don McGuire: Yes. I mean, I think the way we look at that, Kartik, is through the pays per control growth. And so as we went from 7% growth in Q1 down to 5% and we were looking to be a bit flatter in the back half, although we've become a little bit more optimistic on that as time has gone on. So I think that would be the key area where we kind of take a look and see what the demand is with our installed client base.
Danyal Hussain: Yes. Beyond that, Kartik, we do have some recruitment solutions beyond the recruitment outsourcing one that Don spoke about earlier. And so we have, for example, data on the total number of job postings that our clients have. And if you were to look back, that would typically track JOLTS, the trends would be very similar. Now that said, clearly, you could be in an environment where people have job postings and then they decide to pull them. So how accurate that is, how great of a leading indicator that is, it's hard to say. But at the same time, we have live data on pays per control as Don points out. So we know with precision how many people are being added week-to-week. That's healthy. The job postings are healthy. Granted there are some signs of deceleration, layoffs and temp, but the bigger picture is still healthy.
Kartik Mehta: Well thank you very much. I appreciate it.
Operator: This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks.
Maria Black: Thank you, Michelle, and thank you to all of you on the phone today for your thoughtful questions. As you heard from our tone today, very pleased with the first half, excited about how we're positioned for the second half against our updated guidance. Again, everything that we do every day is all about solving for clients in the world of work. And with that, I think it'd be appropriate for me to thank the 60,000 plus associates that are out there every day doing that work for our clients, for their workers and bringing meaningful value into the world of work and into the world of HCM. So thank you to all the associates. Thanks to all the analysts and the investors for your support and your continued support. We certainly appreciate it and we look forward to keeping you updated and speaking with you again soon. Thanks so much.
Operator: This concludes the program. You may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session and instructions will be given at that time. I would now like to turn the call over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Michelle, and welcome everyone to ADP's Second Quarter Fiscal 2023 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with the reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll turn it over now to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Danny, and thank you, everyone for joining us. ADP delivered strong Q2 results headlined by 10% organic constant currency revenue growth; 120 basis points of adjusted EBIT margin expansion; and 19% adjusted EPS growth. We continue to deliver exceptional value in the HCM market as we invest in ourselves and innovate to continuously meet and exceed the changing needs of our more than 1 million diverse global clients. I'll start with some highlights from the quarter. In Q2, we drove very strong ES new business bookings growth, which included an incredible finish in December. We have continued to see robust demand across our downmarket portfolio and our ES HRO offerings and our international sales performance, especially our GlobalView platform was much stronger in Q2 after a softer Q1. Overall, we are pleased with our sales results for the first half of the year, and although clients are still dealing with a number of uncertainties, our pipelines are healthy, and we feel well staffed, and well positioned to deliver solid bookings growth for the remainder of the year. Our ES retention was once again a source of outperformance with modest year-on-year improvement in Q2 overall despite continued normalization in down market out of business rates. This strong result was just shy of the record retention set during the pandemic and was led by our mid-market, our upmarket, and international businesses. And we're pleased to be taking our full year guidance up slightly. Our pays per control metric was 5% for the quarter, decelerating slightly from Q1 as we had anticipated. Job growth in the U.S. labor market has been slowing, but clearly remains solid, which you see reflected in our client base. Despite recent headlines noting job cuts by number of companies, we have yet to see broad-based softening in the labor market. Last, on our PEO, our growth in average worksite employees was solid at 8%. While we have been expecting growth to decelerate over the course of this year, the pace was a bit faster than we previously assumed and we're adjusting our outlook accordingly. With that said, demand for the PEO solution remains healthy. The secular growth opportunity is unchanged, and we are well positioned to reaccelerate our worksite employee growth. Stepping back from the quarter, I want to provide a quick update on our broader strategy. Over the last several years, you've heard us talk a lot about the modernization of our products. Our simpler user experience enhances ease of use for our key platforms like RUN and Workforce Now, and enables a more seamless integration to complementary solutions like insurance, retirement and payments. Our Next Gen Payroll engine is a prime example of how we're modernizing the back-end of our solutions, and we continue to offer it to a broader set of new mid-market clients. And brand new solutions like Roll in our Next Gen HCM platform position us to address certain HCM opportunities more fully than before. These product enhancements are designed to drive win rates and retention even higher, and we have tremendous opportunity in front of us. But our strategy has always been about much more than just offering HCM software. ADP clients want us to help them find, hire, pay, engage, and provide for the retirement of their workers in a thoughtful and compliant way. To truly solve for these needs, we are modernizing all aspects of the client relationship. That starts with product, but also extends to our go-to-market approach, how we onboard our clients, and even how we advise and support them on critical issues. We refer to this collective effort as our Modernization Journey. And as with our product journey, the opportunities here are incredible. We are removing friction and enhancing the client experience in many ways. In our U.S. down market, we continue to digitally onboard tens of thousands of clients every year, making onboarding easier for our clients and accelerating time to start. We have seen this success in the U.S. and we're beginning to scale the same capability in Canada. Our Intelligent Self-Service capability launched only last quarter is already helping a portion of our client base answer millions of questions from client employees through a completely automated process. And now in our international portfolio, we're implementing chatbots to reduce work for those clients as well. We continue to invest in our robust partner ecosystem, cultivating deep relationships and integrations with financial advisers, CPAs and benefits brokers to provide a seamless experience for our mutual clients. And we're using the power of our extensive data to deliver insights to bring greater value to clients from better aligning pays to market trends, to reducing the frequency and severity of workers compensation claims, to identifying tax credits and other legislative incentives. To bring this large-scale Modernization Journey to life, I'll speak to one of our fastest-growing businesses. ADP retirement services, which helps employers establish and administer retirement plans. Businesses today face a complex environment with significant legislative change and our clients look to us to help them navigate these changes, stay compliant and address talent challenges. For example, in the retirement space specifically, the recently passed SECURE Act 2.0 alone has over 90 provisions for businesses and employees to consider. And what we've designed makes life easy for our clients and partners, improves the financial wellness of their employees, and sets us apart in the market. Our robust 401(k) solution with thousands of different investment options is not only clean and intuitive, thanks to our new UX framework, but is also deeply integrated with RUN and Workforce Now. Our highly tenured, licensed, retirement services sales force understands our clients and understands which solutions to make a meaningful difference in a client's unique talent strategy. To expand on our partnerships with financial advisers, we recently developed a platform called Advisor Access, much like the Accountant Connect platform we developed for the CPA community years ago. This positions us better to serve our mutual clients and their employees. And our tax credit team, full of experts in their field, is there to help our clients or their CPAs apply for, and obtain the appropriate legislative incentives. Our goal in our Modernization Journey is to consistently improve the full end-to-end experience for our clients and their employees, which will in turn contribute to our long-term sustainable growth and profitability. We look forward to keeping you updated. And now over to Don."
},
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"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the quarter and update you on our fiscal '23 outlook. Overall, we had a strong Q2 on both revenue and margins. If I can summarize, we had generally positive developments in our ES segment despite some incremental headwinds. Meanwhile, trends were a little softer than expected in our PEO. Let me focus on ES first, and I'll cover our results and outlook all at once. ES segment revenue increased 8% on a reported basis and 10% on an organic constant currency basis which was a good outcome for the quarter. Maria mentioned the strong new business bookings performance in Q2. Given the continued macroeconomic uncertainty, we think it's prudent to maintain our current guidance range for now, although, we feel well positioned for the back half. We also had near-record ES retention in Q2, with first half ES retention results up year-on-year, we're now revising our outlook and we expect retention to be down only 20 basis points to 30 basis points for the full year. This continues to assume normalization in out-of-business losses in our downmarket. Pays per control were in line with our expectation in Q2, but with better line of sight on Q3, we are now assuming less of a deceleration in pays per control over the back half than we did previously and are raising our outlook to now assumed 3% to 4% pays per control growth for the year. And on FX, we had about two percentage points of revenue headwind in Q2, but the outlook for the rest of the year is slightly improved, and we now expect full year headwind somewhere between 1% and 2%. Those are the bigger positive developments in ES revenue. There were few developments in the other direction as well. Client funds interest revenue was up nicely in Q2, but was actually a bit lighter than we had planned. This is primarily because yields pulled back slightly from where they were three months ago when we provided our prior outlook. We're also tweaking down our balance growth assumption now to 4% to 5% growth for the year due primarily to assumptions around average wage related to worker mix, tax rates as well as the impact of the lapping of the payroll tax deferral. Together, we are lowering the full year by $5 million at the midpoint for revenue and $15 million at the midpoint for net impact to our earnings. We also saw underperformance in some of our volume-based businesses like our recruitment outsourcing business and our employment verification business. Overall, though, we're feeling good about our ES revenue growth trajectory and are taking up our guidance by 1% to now expecting growth of 8% to 9% for the year. Our ES margin was up 170 basis points in Q2, which was in line with our expectations and there was no change for our full year outlook. As a reminder, we've invested in headcount in sales, product and other areas throughout the organization over the last several quarters as we see continued opportunity to win new clients and further increase satisfaction with existing clients. And although we may scale back as appropriate, at a high level, we feel comfortable with our staffing levels against the secular growth opportunity in front of us. Moving on to the PEO. We delivered 11% PEO revenue growth in Q2 with 8% growth in average worksite employees. As Maria shared, the PEO results came in a bit softer than expected. The PEO business continues to benefit from long-term tailwinds, but there was a lingering effect from the pandemic, which is still adding variability to our PEO results and outlook. We are, for example, lapping very strong results on retention, bookings and same-store pays. And while the overall trends are playing out consistent with our expectations, we continue to refine our assumptions about pays and magnitude. With that said, we still see a continued solid demand environment in the PEO and the team remains focused on reaccelerating worksite employee growth. For this fiscal year, we are lowering our PEO revenue outlook to 8% to 9%, driven by growth in average worksite employees of about 6% to 7%. PEO margin in Q2 was up 130 basis points about in line with our expectations, and we continue to expect PEO margin to be flat to up 25 basis points for fiscal 2023. Adding it all up, the favorable revision to our ES revenue outlook is largely offset by our lighter PEO revenue growth forecast. And so we continue to expect consolidated revenue growth of 8% to 9% in fiscal '23. We also maintain our outlook for adjusted EBIT margin expansion of 125 basis points to 150 basis points. We still expect our fiscal 2023 effective tax rate to be about 23%. And we continue to expect adjusted EPS growth of 15% to 17%, supported by our steady share repurchases. I'll just make one quick comment on cadence. We expect consolidated revenue growth to be relatively steady in Q3 from where we were in Q2. We expect margin expansion to be a bit more modest compared to what we experienced in Q2, closer to 50 basis points to 75 basis points of expansion. There were a few reasons, including the lapping of a onetime item last year, comparisons from a headcount perspective, and certain investments in sales and marketing that we're assuming for Q3. Again, there's no major change contemplated for the full year, but hopefully, this helps you think about Q3. Thank you, and I'll now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] And we'll take our first question from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi. Good morning and thanks for taking my question. On PEO, you mentioned the lingering effects from the pandemic is having an impact. But I was just curious, is the macro environment and I guess, labor market trends impacting PEO differently than ES? Is there more -- is it a question of sensitivity to small versus large market clients? Is it vertical exposure? Or is this really something you see is as quite transient?"
},
{
"speaker": "Maria Black",
"text": "Thank you, Ramsey. I appreciate the question. So I'll try to cover all the ground on the PEO that you asked about. So specifically, what we saw with respect to the first half, we did see, as mentioned in the prepared remarks, we did see that booking did come in softer. We saw that retention came in a bit softer as well than our expectations. In terms of the lingering effect that we cited, all of our businesses had an impact from the pandemic. I would say the PEO is probably the one that had the most impact. If you think about all the drivers that constitute the PEO, it's everything from average wages to worker mix to paid unemployment to certainly the lines of insurance, workers' compensation and health benefits. So I would say it's the business that had the most impact as the pandemic came into the business. And as the pandemic gets flushing out, it is having a lingering effect on the business. I think you touched on what we're seeing with respect to pays per control in the PEO in the context of ES. But I would say is, pays per control is -- the growth rate is decelerating in the PEO. That was expected. If it contributes to the slighter softer performance in the first half and is contributing to the second half. But the two main drivers really behind the performance in the first half as well as the outlook for the second half are bookings and retention. One thing I would say, though, because I want to go back to the strength of that business. We have incredible faith in that business as it relates to the growth from a long-term outlook perspective. The demand is still there. In absolute form from a bookings perspective, the PEO did have growth year-on-year, albeit it was softer than ES and softer than our expectations."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. That was super helpful. Thank you. And just a quick follow-up for me. Tech layoffs have been -- tech sector layoffs have been in the headline recently. I know you guys have a very diversified business, but I thought I'd ask anyway. How exposed are you to that particular vertical? Are you feeling any kind of acute impact from all those headlines kind of layoffs in the technology sector?"
},
{
"speaker": "Don McGuire",
"text": "Yes, Ramsey, it's a good question. I think it's hard to avoid all the headlines that we're seeing day in, day out. And it's fair to say that there's been a number of large names that have announced major layoffs, I'd also with the -- tough to say that some of those clients are -- or some of those people making those layoffs are our clients. But those layoffs are happening around the world in some cases, they're not necessarily our clients in all of our markets. So I think it's fair to say that we have yet to see any significant impact from all those announcements. And I guess I'll just round it out by saying, we're still seeing stronger or strong demand. We've taken up our pays per control assumption for the back half. And we're doing that not just on our own internal perspective, but we're also looking at the BLS reports, the JOLTS reports. Everywhere you look continues to suggest that there's still strong demand for employment. Unemployment continues to be very low. Unemployment applications are still in record lows. They're not increasing. So the macro environment continues to be very, very favorable for us, irrespective of some of those headlines that we're seeing."
},
{
"speaker": "Ramsey El-Assal",
"text": "Perfect. Thank you so much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Eugene Simuni with MoffettNathanson. Your line is open."
},
{
"speaker": "Eugene Simuni",
"text": "Thank you very much. Hi, Maria and Don. I wanted to ask about ES bookings. So it sounds like a positive commentary, strong performance there. I think you called out international as coming back strong versus last quarter and also downmarket. Can you talk a little bit about the mid-market? How are the trends there? And yes, I think the key question in everybody's mind is, are you seeing any signs of macro pressure on bookings as companies potentially pulling back their tech spending?"
},
{
"speaker": "Maria Black",
"text": "We were very pleased with our overall new business bookings for the second quarter. Definitely saw an acceleration in pipelines. I'll get the pipelines in a minute. I did cite the downmarket, the strength that we're seeing in the downmarket, that's really our entire downmarket portfolio. So thinking about our -- obviously, our RUN offering, but all the things that tether off of the RUN offer, which is the retirement services that I spoke to at length during the prepared remarks, Insurance Services. We did see strength in Employer Services HRO. And then last but not least, one of the other things that I was most pleased to see was the bounce back in international in the second quarter, both in pipelines as well as results. And that was, as mentioned really in our GlobalView space. So very happy with the results, very happy with the strengthening of pipelines. That's what gives us confidence, stepping into the back half as we think about heading toward our guidance of 6% to 9%. In terms of -- I think you also wanted to know about the mid-market because I didn't cite that specifically. We had very solid yes, very solid mid-market sales, and we continue to see the demand there as a byproduct that is certainly not getting easier for anyone to be an employer, both from a legislative perspective as well as a talent perspective. We have incredible strength in that business as it relates to the product investments we've made. So think about user experience to what we're attaching with the Next Generation Payroll engine. So we made good product enhancements. We had strong NPS. We have incredible retention results. So the mid-market in general had also a solid sales performance. What I would say is, as you contemplate the mid-market, don't forget that Employer Services HRO, the offer that we call Comprehensive Services fits squarely in that market, and that's an area that experienced tremendous growth during the pandemic, and that growth has sustained and is exceeding the overall Employer Services growth. So altogether, the net results for the mid-market are very, very solid for us."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Got it. Very helpful. And then a quick follow-up for me on pays per control. Your number was very strong this quarter we thought, out from your expectations. But also keeps outperforming by 1 point or 2, kind of the broad measures of labor market growth in the U.S. like nonfarm payrolls. Remind us what's the driver of that? And how sustainable is that as the overall labor market slows down? Can you maintain that one to two point premium?"
},
{
"speaker": "Don McGuire",
"text": "Yes, it's a good question. But just to remind everyone that, that number is really a mid-market number. So we focus on the mid-market when we provide that pays per control number. And it has been strong. As I mentioned in the earlier answer with respect to the macro environment, the labor market continues to be strong. We're continuing to see our existing clients add employees. As Maria said, bookings are strong. And I think it's the kind of the $64,000 question about how long the labor market can continue to grow. Unemployment can stay so low as we look at some of the headlines and will those things start to converge at some point in the future. But for now, I think we're comfortable with what we've done in terms of taking up the pays per control growth for the back half."
},
{
"speaker": "Danyal Hussain",
"text": "And Eugene, just to your point about that spread, having existed in the past, I think typically, we would have expected 2% to 3% pays per control growth in normal economic environment, and that compares to maybe 1% to 2% total employment growth. And that's a function of our clients in general being perhaps a bit healthier than the overall economy, but also the fact that total labor includes things like bankruptcies and new business formation. So it's a slightly different take on employment."
},
{
"speaker": "Eugene Simuni",
"text": "Got it. Very helpful. Thank you, guys."
},
{
"speaker": "Operator",
"text": "Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you so much. I wanted to quickly just revisit a little bit, I think you touched on it. But retention and it's an area where we had at least been expecting to see some normalization but -- especially from a company perspective, but it seems to continue to improve or tighten. Obviously, you made technology advancements, et cetera, but what are some other areas, if any, that you'd point to -- that are helping drive that retention performance."
},
{
"speaker": "Maria Black",
"text": "Sure. Thanks, James. With respect to retention, we are very, very pleased by the strength that we've seen year-to-date. We cited, at the end of the first quarter, we had record retention. The second quarter was near record. If you look at the first half, it was a record. So we're very proud of the -- not to be a broken record, but the record retention and the strength that we saw -- and we believe that, it is a byproduct of the investments. I alluded to the investments we've made into the mid-market, as an example of the user experience. That's broad-based now across the RUN platform, our mobile app, our international offer, where we're also in international seeing record retention. So we believe a lot of these things are anchored in just really driving a better user experience, driving the product into a better place. I think the other is NPS. We have strong service results that's broad-based across the portfolio. I think we generated a tremendous amount of goodwill and value during the pandemic and how we chose to service our clients. And I think that value is -- has continued, and we see that in the results on the NPS side. So I think that's another place. You did touch on normalization. I think it's an important point to make. We do believe at this point, specifically in the down market, I think we even touched on it during the prepared remarks. We do believe that retention has normalized. When we normalize for average or adjust for average size client, we are back to the downmarket really having out of business and bankruptcies back to fiscal '18, fiscal '19 levels. So we do believe that the downmarket has normalized. So again, back to kind of the broader retention picture, it is a very strong one for us because we believe at this point, that is broad-based. And it's really a result of the investments and the service levels that we offer."
},
{
"speaker": "James Faucette",
"text": "So Maria, that's an interesting point that you're already kind of at least what you think were -- where we should be from a attrition perspective, et cetera, at least compared to where we were pre-COVID. What are you seeing now from the competitive environment, especially, as we see companies expressing more concern. Are you seeing flight to quality versus some of the regional players or newer entrants? Is that helping you? Just love an update of how the competitive environment factors into what you're seeing overall?"
},
{
"speaker": "Maria Black",
"text": "The competitive environment is certainly -- on one hand, I could say it continues to evolve. On the other hand, I would tell you, if there's nothing really new to report. I think what we're seeing and we look very closely at our balance of trade, we look very closely at our win rate. We're measuring all these investments that we make and whether or not they're impacting things such as our balance of trade and such as our win rate. And what I would offer is that, there is a direct correlation between the places we're investing, whether that's the downmarket and our go-to-market brands, headcounts or in the mid-market into the product and the next-generation suite and the win rates that we have. And so we do believe that we're getting stronger in terms of our offer. And I think the record retention is a direct correlation to that."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey, good morning. Thanks for taking the questions. Maria, you mentioned there was a modernization initiative. I'm wondering if you can expand a little bit on that, just in terms of what we should expect over the next six to 18 months in terms of new offerings or increased offerings. And how would that end up impacting both from a revenue as well as from expense perspective? How should we think about that?"
},
{
"speaker": "Maria Black",
"text": "Sure. I love speaking about the investments we're making into the Modernization Journey. And so perhaps, I can offer the story around the next generation and how we're thinking about the impact of that over the next 16, 18 months from a revenue perspective. And maybe, Don, if you want to cover the margin side. So Mark, as it relates to our overall modernization initiatives, there is all the things that I talked about in the prepared remarks, which is around tools, technology, removing friction, taking work out. Last quarter alone, we talked about Intelligent Self-Service, Voice of the Employee. So these are bespoke features, functionality that were layering into our offers, and into our platforms to make them more competitive and bring more value to the market. With respect to the next generation platforms, I touched briefly on Next Generation HCM. We've given updates of that over time. And I think we continue to see us implement our backlog, continue to build scale, build implementation. Our goal would be -- to use your time horizon over the next 16 to 18 months that we would open the aperture to have that suite specifically sold across a broader set of the upmarket clients. In terms of the Next Generation Payroll, which is what we are offering attached to Workforce Now in the mid-market. We continue to make progress on Next Generation Payroll, pretty excited about that progress from a quarter perspective. Every quarter, there's an increase of the number of clients that we are attaching the Next Gen Payroll towards Workforce Now. So I think from Q4 to Q1, we had more. From Q1 to Q2 -- or Q2 to Q1, we had more. As continue again to attach more and more, we're running about 30% to 40% attached. So again, using your time frames over the next 16 -- six to 18 months, our goal would be to continue to more broadly offer and scale that offering across specifically, our mid-market. We're seeing, again, great signs on win rates, things like that. I think the other initiative I would speak to is Roll. Very excited about our project that we -- or it's not project, our product that we call Roll, which is really the downmarket product that we're offering to an incremental buyer that digital native. And so again, it's exceeding all of its project milestones. We're learning. We're continuing to understand how a digital buyer wants to consume payroll end-to-end in a digital capacity. And we believe over the next six to 18 months that we will learn more and as such, we will scale it across. In terms of the impacts to revenue, I would tell you, revenue over the next six to 18 months, I'm not sure that any of those projects will make a meaningful impact to the revenue. They certainly will make any meaningful impact to bookings. And as we onboard those clients, that will generate new revenue lines for us, whether that's an upmarket, our Next Gen HCM, it's a broader piece to the mid-market, our Next Gen Payroll. And then in the downmarket in the micro market that Roll addresses, it take a lot of units for it to make a meaningful revenue impact to the broader ADP. But that's the -- the excitement is really in the offers, and offers being able to drive win rates and retention and changing the competitive narrative. So with that, I'll kind of stop and I'll let Don speak to any margin impact."
},
{
"speaker": "Don McGuire",
"text": "Yes, Mark, I'll just follow up on Maria's comments. I think the adoption of these products is exciting and doing well. And as we have the adoption increase quarter-to-quarter, we expect to see improvements in revenue from these new offers. But I think at the same time, the penetration rate within our 1 million existing clients is going to take some time to achieve. So the margin impacts from those new sales and those clients is going to take some time to make its way through to the bottom line, so to speak. But I would say that we -- you've heard us often speak about transformation of these calls over the last few years. And I would say that internally, I think our biggest transformation exercise, our biggest transformation opportunity is coming from these new products themselves. So we are excited about these new offers, and we do think they're going to -- they're going to help us out in the future."
},
{
"speaker": "Mark Marcon",
"text": "That's terrific. Thank you. And then obviously, in the headlines, everybody is concerned about what could potentially occur from a macro perspective in terms of, if we go into a recession, ADP has obviously got a stellar long-term track record of navigating successfully through recessions. But I'm wondering, what's your philosophy going to be Maria, if we go into a recession in terms of thinking about expenses, margins, et cetera. Would you just focus on the long-term or would you do things in a short-term manner to adjust expenses?"
},
{
"speaker": "Maria Black",
"text": "We do have a recession playbook, if you will. I think the first thing that happens is, we adjust things such as our go-to-market. When you think about how we address talent needs on the way up in an economy, it's kind of the converse on the way down. So that's not to suggest that the business wouldn't be impacted. The things that would be impacted are things like bookings. And the reason I bring that up is, it is somewhat self-adjusting, right, as it relates to the action. So in the absence of bookings, there is also the absence of expense. So some of that self-adjust, thinking selling commissions, overall incentive comp. We could also, as a byproduct of that, if there's lower volume on the sales side coming in, we would have lower volume on the implementation side and potentially lower volume on the service side. And so there will be, maybe a pullback in hiring things of that nature. And these are all playbooks that we've run before, a few times in my lifetime. We may add that juncture, choose to prioritize key investments differently, depending on what's happening. But we're going and we're very committed to continuing the work we've been doing on Modernization and on transformation. And I think one of the big lessons for us whether it was this most recent pandemic downturn, if you will, an event or it was the last -- the financial crisis or even the -- I've been here long enough to be a part of the 2000, call it, dot-com, et cetera, bust. And what I would say is, our investments in growth will be maintained. I think that's the key is ensuring that we make smart decisions during a downturn so that when we come out of the downturn, we're positioned to execute quickly. I think we made some very wise decisions, specifically, on the go-to-market, on the seller side during the pandemic that allowed us -- we were lucky because it was short and steep and fast. And as everything opened back up, we were well positioned to take advantage of that market because of the investments that we continue to make. So to answer your question, I think most of the changes that we would make are somewhat self-adjusting in their nature, if bookings were impacted."
},
{
"speaker": "Mark Marcon",
"text": "Perfect. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Bergin with Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi. Good morning. Thank you. First one I had is on pricing. So just any change in view around ES pricing, any change in claim acceptance to the higher levels that I think you were contemplating when you entered the fiscal year, just given the macro?"
},
{
"speaker": "Don McGuire",
"text": "Yes, Bryan, thanks for the question. I think it's a relatively short answer. The fact is our prices are holding well. As a matter of fact, I would say that we are kind of at the high end of the guidance we gave previously, and we're comfortable with that. I think if we look at our retention, we look at our NPS scores, it appears that those price increases have been understood and accepted as well, as could be expected."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Good to hear. And then on the international front. So can you just talk about what you saw in Europe here that drove the better performance in the quarter. And you cited U.S. pays per control here in the earnings material, what does that imply in the Europe base? So I'm curious not just on the employment level but also the demand, whether there's really any particular solutions that drove that better performance or different underlying behavior in that base versus U.S?"
},
{
"speaker": "Maria Black",
"text": "We were very pleased by the improvement that we saw in international bookings. It was driven mainly by our GlobalView offer and a bit of our in-country business. So very excited about what we saw specifically, as it relates to performance in the second quarter. But also about pipelines, right? So a quarter ago, I was on this call citing that we believe that there was some pipeline depletion that happened specifically in international. So pipelines that were pulled into last fiscal year. International was one of the businesses that had an incredibly strong fourth quarter finish. And so we did see a need during the first quarter to rebuild pipelines. The great news is those pipelines were rebuilt and we saw that execution in the second quarter. It's also what gives us optimism as we head into the back half. So very excited about international. And as optimistic as I am, it is an area that we're still continuing to watch for all the obvious things, I said. Last quarter, which is, there's still the crisis in the Ukraine. There's still the energy crisis. It is also an area that we see a tiny bit of pipeline aging. And so international remains a watch item for us, albeit, very excited about the pipeline build and the results in the second quarter. And I think you asked about pays per control in international?"
},
{
"speaker": "Danyal Hussain",
"text": "Yes. Bryan, pays per control for our international pays tends to be more subdued than what we have in the U.S. in both directions. And so early pandemic, it didn't fall very much at all. And in the recovery, subsequent, we had less growth there. So that's continued."
},
{
"speaker": "Don McGuire",
"text": "Yes. So just maybe -- so the government programs that are in place and the kind of the social aspect, if you will, of European employment means that things don't go down very quickly. And as a result, they don't recover very quickly as well because they don't have much to recover from. So that's a good for consistency, if you will, continuity of earnings. So that's -- that works in our favor in these -- when times are trying."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Makes sense. Thanks, guys."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hey, thanks. Thanks so much. Sorry, hope you can hear me. Maria, I think I heard you say you were looking to reposition PEO growth. If that's the case, can you elaborate on that? I'm just trying to think if the implied second half growth in WSE volume within PEO, that's a good number to start from. As we look to next year, could growth get better or worse from there? Or how quickly can the repositioning, benefit of the volume outlook? Thank you."
},
{
"speaker": "Maria Black",
"text": "The comment that I made was really about bookings. And so we are looking to reaccelerate bookings in the back half. For PEO, as mentioned, it was a bit softer in the first half. In terms of the question of when we anticipate the reacceleration, the well-positioned reacceleration and worksite employee growth, we don't anticipate that it will be in the next couple of quarters. So not a position to necessarily give guidance for next year. But we are lapping -- as mentioned in the remarks, we are lapping record retention, record bookings. And as some of that lapping happens, we believe we're well positioned to reaccelerate works on employee growth into next year."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Got it. Perfect. Thank you. And then just on Retirement Services, since you mentioned it, in your prepared remarks. Any update on penetration there across the major lines? And if there's any change in the outlook or the model there. Thank you."
},
{
"speaker": "Maria Black",
"text": "Sure. So it's safe to say that business is outperforming its targets. It has great growth. We do have -- and last week, we talked about it, we do have 125,000 plans across that business. It's primarily an SMB space, a little bit into the mid-market and even upmarket. But nonetheless, if you just think of it in the SMB context and with the new SECURE Act and -- which is the 2.0 version of the 1.0 and all the state mandates. At this juncture, we have 125,000 of 800,000-ish RUN clients that take advantage of the offer. So you can kind of think about the opportunity in that way. That's not to suggest that every single one of those RUN clients could be a retirement plan, but even if we were to capture a bit of that. We do believe, and it's part of the reason I'm so excited about it is because it does continue to outperform its growth targets. And we believe there's tremendous runway for growth in Retirement Services over the coming years."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thanks for that."
},
{
"speaker": "Operator",
"text": "Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi. Good morning. Thanks for taking my questions. I just wanted to ask one on the volume-based parts of the businesses that you mentioned, particularly on the employment verification. I was just wondering if you could help us understand how much did that contribute? And what are the assumptions going forward? Are you assuming that there will just be less activity around employment verification? Or do you think it was just seasonally lower? Just how should we think about that since you called it out this quarter."
},
{
"speaker": "Don McGuire",
"text": "Okay. So let me talk about the two volume businesses that we referenced in the prepared remarks. The first one would be the RPO business, the recruitment outsourcing. That business was down and that business is not a very big business for us. And most of it is focused in the upmarket. Most of the clients we have there are in the enterprise space. And I think that is an area, of course, where we are seeing something internally that correlates more with some of the headlines that we're seeing in the press. But it's not a very big business for us, and it did come down. On the employment verification business, of course, mostly and significantly related to the mortgage market. We don't share the number that EV business is part of our broader $1 billion comprehensive services business. It's meaningful for us. From a revenue perspective, it's more meaningful for us, if you will, from a margin perspective because it's above-average margin business. Hence, we called it out. But our expectations as we look forward is, we do expect there to be softness in the mortgage market in the back half of the year. And we've reflected those expectations and those forecasts into the numbers that we're sharing with you today."
},
{
"speaker": "Samad Samana",
"text": "Great. And then maybe just a housekeeping question on the rate side. So just so we understand it. When the company gives the forward outlook for the float revenue guidance. Are you assuming -- I'm assuming the tenure that's come in at the short end of the curve has actually gone up. So is it -- should we assume that the tenure at current levels is what you're now forecasting going forward? I'm just trying to -- we're just trying to make sure that we get it correct, the inter-quarter moves and how we should think about that on the guidance of that."
},
{
"speaker": "Don McGuire",
"text": "Yes. So since we presented -- since we gave guidance last quarter, rates have come down, particularly on the mid and the long rates. And even though short-term rates have increased, some of our short-term borrowing costs in our commercial paper program. So the rates that we're giving and the reason we take in our client fund interest forecast down a little bit at the midpoint, is to reflect those increased borrowing rates and the softening, if you will, of interest rates in the mid and the longer term."
},
{
"speaker": "Danyal Hussain",
"text": "Yes. Samad, thanks for asking that question because I know we take a slightly different approach than some of our peers. But even when you think about the short end of the yield curve, what is currently baked into market expectations is also what baked into our outlook for the year. So even if the Fed raises rates, that does not necessarily suggest upside to what we had previously guided. And to Don's point, at the longer -- the mid and longer end of the yield curve, you actually saw a decline. And so we share in our earnings release the incremental yield on new purchases and that declined from, I think, 4.3% last quarter to 4.1% this quarter. So in other words, we're getting less in the mid and long end of the yield curve, and we're getting more or less what we expected in the short."
},
{
"speaker": "Samad Samana",
"text": "Great. That's helpful. Thanks for clarifying that. Appreciate it."
},
{
"speaker": "Operator",
"text": "And our last question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Hey, thanks, guys. I wanted to come back on PEO for a second and maybe piggybacking on Tien-Tsin's question. Just as we think about the second half of the fiscal year. It looks like the revenue growth is going to come in 5%, 6%. And then you talked about getting to some easier comps and some reacceleration. But are you thinking any differently about the medium-term guide for PEO? I think that was 10% to 12% when you provided that at the Analyst Day."
},
{
"speaker": "Maria Black",
"text": "So the medium-term guide, all of the medium-term guides were somewhat aspirational in their nature, and we're not sitting here today making changes to any of our medium-term guide. I think, again, when I think about the PEO outlook, just a reminder, because I said it earlier on the call, but I think it is an important point. The demand has been incredibly strong still for the PEO. It is still growing nicely through the second quarter. Technically was year-on-year growth. It just wasn't what we had expected, and it decelerated a bit earlier than we thought. And so when we think about kind of the back half of the PEO, we do expect bookings to reaccelerate. As mentioned, we expect works on employees to not accelerate in the coming quarters, but we're well positioned to do so as we lap the compares into next year. But I think the big piece -- by the way, even retention was healthy. Retention is right in line with really where it's been in the last decade. I spent a lot of years in that business. And I've seen this as nothing abnormal, if you will. It's really just the byproduct of some lingering effects from the pandemic, which is not that different than some of the strangeness that we experienced during ACA in that business. And so what I would say is, demand is healthy, bookings is healthy, just not as high as we wanted it to be on tough compares. Retention is healthy, just not as high as we wanted it to be, again, on tough compares. And we feel well positioned in that business to accelerate and very excited about its long-term growth opportunity for us."
},
{
"speaker": "Don McGuire",
"text": "Yes. Sorry. And at the same time, remember, at Investor Day, we said that we were expecting high single-digit growth in average worksite employees. So I think we're still very much on that track and pretty much committed to that."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay. Appreciate that. Just wanted to follow up on -- so on the pays per control side, obviously, you upticked the guide there. But we have seen in the temp labor market, there's been some material declines in recent months. I'm just wondering how you guys think about the temp labor market relative to broader labor market conditions. And your business with some kind of potential lag? Just any views there would be helpful. Thanks."
},
{
"speaker": "Danyal Hussain",
"text": "Yes. Jason, I think --"
},
{
"speaker": "Don McGuire",
"text": "Sorry, I will -- let me start. Maybe Danny can add some color. I think some of the leading indicators we look at -- so look at the JOLTS report, we look at the job postings, et cetera, those still seem to be healthy. It is -- I mean, the open positions, the until positions are certainly declining, but they still remain at healthy levels compared to pre-pandemic levels. So I think that would be an indicator we look at. And I think there's still some room there before they get back to what we saw pre-pandemic. So I guess we'll continue to pay attention to it. We're focused on it. But at this point in time, things still feel to be pretty healthy."
},
{
"speaker": "Danyal Hussain",
"text": "Yes. Jason, exactly to that point. It's one of many leading indicators that we look at. And for sure, things are slowing, given where we are with employment and 3.5% unemployment rate. So it's not a question of whether we expect the monthly jobs growth to slow over the next several months, I think that's more or less assumed. But the question is, at these employment levels to get that type of growth is still a very healthy outcome. And so I think that's how we would characterize the overall environment today."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay. Thanks for the color guys. Appreciate it."
},
{
"speaker": "Operator",
"text": "We have time for one more question, and that question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning. Maybe Maria or Don, as you look at the PEO business and is -- are you seeing any more competition in the business? Could that be a part of maybe you're seeing? Or is this just that you need to reposition the business a little bit and the business was so strong that the comparisons are difficult."
},
{
"speaker": "Maria Black",
"text": "I think the business was so strong. I think the compares were difficult. We plan for deceleration. It happened faster. We do not see a competitive change or landscape that exists. Again, in terms of where that business gets its business from, that 50-50 split between kind of new clients coming in as well as upgrades as well as where we actually return clients that leave. Certainly, there is PEO to PEO switching, but it's a very small piece to the overall results on the booking side or the impact on retention. And we're not seeing -- again, we look at balance of trade, we look at win rates and we do not see a meaningful change in the competitive landscape."
},
{
"speaker": "Kartik Mehta",
"text": "And then maybe Don and Danny, I know you're talking about leading indicators and Don, you talked about the JOLTS report, and I assume we have lots of other statistics. But I'm wondering, are you able to look at the customers you have and the demand they see for employees? And if you kind of compare that to what you saw three, six months ago. Are you able to do that? And if so, maybe what you might see in that type of -- those type of statistics?"
},
{
"speaker": "Don McGuire",
"text": "Yes. I mean, I think the way we look at that, Kartik, is through the pays per control growth. And so as we went from 7% growth in Q1 down to 5% and we were looking to be a bit flatter in the back half, although we've become a little bit more optimistic on that as time has gone on. So I think that would be the key area where we kind of take a look and see what the demand is with our installed client base."
},
{
"speaker": "Danyal Hussain",
"text": "Yes. Beyond that, Kartik, we do have some recruitment solutions beyond the recruitment outsourcing one that Don spoke about earlier. And so we have, for example, data on the total number of job postings that our clients have. And if you were to look back, that would typically track JOLTS, the trends would be very similar. Now that said, clearly, you could be in an environment where people have job postings and then they decide to pull them. So how accurate that is, how great of a leading indicator that is, it's hard to say. But at the same time, we have live data on pays per control as Don points out. So we know with precision how many people are being added week-to-week. That's healthy. The job postings are healthy. Granted there are some signs of deceleration, layoffs and temp, but the bigger picture is still healthy."
},
{
"speaker": "Kartik Mehta",
"text": "Well thank you very much. I appreciate it."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Thank you, Michelle, and thank you to all of you on the phone today for your thoughtful questions. As you heard from our tone today, very pleased with the first half, excited about how we're positioned for the second half against our updated guidance. Again, everything that we do every day is all about solving for clients in the world of work. And with that, I think it'd be appropriate for me to thank the 60,000 plus associates that are out there every day doing that work for our clients, for their workers and bringing meaningful value into the world of work and into the world of HCM. So thank you to all the associates. Thanks to all the analysts and the investors for your support and your continued support. We certainly appreciate it and we look forward to keeping you updated and speaking with you again soon. Thanks so much."
},
{
"speaker": "Operator",
"text": "This concludes the program. You may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 1 | 2,023 | 2022-10-26 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter 2023 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Michelle, and welcome, everyone to ADP's first quarter fiscal 2023 earnings call. Participating today are Carlos Rodriguez, our CEO; Maria Black, our President; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. And with that, let me turn it over to Carlos.
Carlos Rodriguez: Thank you, Danny, and thanks, everybody, for joining the call. As you saw this morning in the news, we have a little bit more excitement than normal, but I promise you that 1.5 hours from now, we'll go back to our boring cells because we do have a business to run. But before I talk about the quarter, I thought it was appropriate to just share a few thoughts given the transition from me to Maria as our new CEO. As you know, I'm going to continue as Exec Chair, but obviously, that's going to be a role primarily to supporting Maria and also helping the Board and not really involved in day-to-day operations. So it's definitely going to be my last earnings call, which is hard to say because it’s been 44 earnings calls for me. But it's really been an incredible ride. Obviously, I could thank a lot of people. One person in particular that I do want to call out is John Jones, who is going to remain our Lead Independent Director. And the combination of John and Les Brun before him were incredible mentors to me, incredibly helpful in providing advice and guidance on behalf of the Board. And also, I'm proud to call them friends. And I also want to thank Gary Butler and Art Weinbach, my predecessors who gave me the opportunity to be here today and also help me a lot in terms of making me the person I am and the leader that I am today. I'm proud of a couple of things. I'll just mention a few. One of them is I'm proud of our growth. We doubled our revenues over the last 10 or 11 years. And today, as you know, we reached an important milestone of 1 million clients. So I appreciate -- I wish I could say that it was anything other than a coincidence. But however it happened. It's a great thing to have happened here on my last earnings call. We made it through a lot of challenges, economic. We went through, what I would call financial repression in terms of interest rates, which fortunately now we have a little bit of the opposite situation, which we'll talk about today. So there's many QEs. I think there were three QEs over my tenure. And then the final straw that almost broke the camel’s back was interest rates. Even on the 10-year going, I think it was like under 0.5% in the pandemic, which was really kind of incredible to see happen. We also made it through a pandemic that hopefully only happens every 100 years, and we had some dissident shareholders that also had some opinions about how to run ADP that we had to deal with. I'm also proud of our associates. I'm proud they've always said about their commitment to our clients and to ADP. There's something that my predecessors and the culture have around our client centricity, which is really remarkable, and our associates always step up to the plate and deliver in a business that, again, we don't get a lot of credit, and I know that we're not quite up there in terms of the list of first responders and people who save lives. But we do keep the economy going, and we do, I think, make sure that commerce worldwide operates smoothly. So our associates are the ones who get that done, and I'm proud of them. The person I'm most proud of is Maria. She's now been tested. She's prepared. She's been through a very thoughtful and long succession process, and she's going to be the -- what is only the seventh CEO of ADP. And I know that she's the right person starting from the ground up. I wish I could have said that because that's what makes this special, this place special. We love to bring in talent from the outside but we have some incredible people that grow up and know this place, understand this place and know how to make it continue to hum the way it's been humming for more than 70 years. Most importantly, she not only knows our industry, but she knows our clients' needs deeply and takes great interest in that. And that is going to serve us well, as well as for growth orientation, which I think is going to be very important for ADP's future. Last thing I'll say is that I recently told our team at a senior meeting that I tried -- I strive to be what I learned about many, many years ago, something called a servant leader. And I tried to be that way to my team and to my organization here at ADP. But I want all of you to know that I tried to be that also to all of you and to our shareholders, as much as I tried to be that way for our clients and our associates. It's been truly an honor of a lifetime to serve ADP’s CEO. And we are kind of a company that likes to fly under the radar. We kind of like it that way. So I know that nobody is going to write any books about us or they may not be even writing articles about us today, but this is one of the most successful commercial enterprises in history. All I have to do is go back and look at the track record. Most people don't do that. They don't go back and look at the 10-year to 20-year and, in our case, the 50 year. The company went public in 1961. I encourage you to look at our history, our results and our TSR and compare it to some of the greatest investors and investments of all time. And I think you'll see that ADP ranks right up at the top. Anybody who knows me knows how much I love sports and how -- what a sports -- I am. So I was trying to think of an analogy. And I feel like not only did I join the championship team, but I won the Super Bowl being here at ADP. It's really been an incredible ride. But right now, it's time to pass the torch. It's always great to have change, especially in a company like ADP because I know you can rely on our consistent, predictable results, but we also have to continue to grow for decades to come. And the only way to do that is to bring in fresh thinking and to have change. And that's exactly what we're doing with Maria. So before I talk about the quarter and the results, I'm going to turn it over to Maria and let her say a few things.
Maria Black: Thank you, Carlos. You mentioned servant leadership, and I have to say that you are truly the embodiment of servant leadership. You have always kept our North Star true, which is putting our clients and our associates first. And I know I speak on behalf of all of our stakeholders, our associates, our shareholders, the communities we serve and the 1 million clients now we have the honor of serving and thanking you for everything that you've done over the decade that you served as our CEO. So my sincere thank you to you, Carlos. I'm truly humbled and grateful for this opportunity and certainly for the confidence, Carlos that you've given me and that the Board has given me and entrusted me with this role. I am genuinely thrilled to lead ADP. You mentioned it, and it's true. I did start from the ground up. I started with this company 26 years ago, selling ADP's products and offering store-to-door. This ability to really see our clients from the front line has given me a vision and a true understanding of the client centricity that you mentioned that we embody as a company. And since selling 26 years ago door to door, I've served in roles all across ADP in sales and service, implementation, operations, including our PEO and SBS. I'm really, really proud of the role that we play in our clients' lives and how they trust us to really help them succeed in their HCM journey. For the last 73 years, we've had an amazing legacy and a culture. And that culture is really anchored in innovation and it's anchored in developing and providing technology and solutions that help address our clients' needs but also help address the needs of their workers. And I'm incredibly proud to be a part of that journey as we continue the modernization that we've been undergoing over the last few years. Of course, as you mentioned, none of this is possible without the 60,000 dedicated associates that we have that are at the center of absolutely everything that we deliver. I am committed to continuing to empower their great talent, which time and time again has reshaped the HCM industry through a relentless focus on again, solving our clients' needs and predicting their future needs. I'm also grounded by our history and our own beginning as a small business out of Paterson, New Jersey, founded by Henry Taub, a man who simply wanted to help local businesses. Then and now, I know and I feel deeply that this core value continues to define us as a company. So with that, thank you again, Carlos, and thank you to the Board. And now I will thank you in advance to all of our stakeholders in your confidence as we continue to build on ADP's incredibly strong results-oriented foundation. We continue to drive product innovation, leading technology. And more than anything, we continue deliver the consistent value creation that we're known for as the leader in the HCM industry. So with that, I think it's appropriate to turn it over to the results this quarter.
Carlos Rodriguez: Thanks, Maria. Speaking of consistent value creation, let me start talking a little bit about the results here so we can get to the questions. We got off to a really strong start in fiscal 2023, with strong results that reflected the momentum we've been building for several quarters now. In Q1, we delivered 10% revenue growth, 11% on an organic constant currency basis, and this was driven by strength in a number of our businesses. And on top of that, we delivered 30 basis points of adjusted EBIT margin expansion as our revenue outperformance helped us overcome elevated expense grow over from last year's first quarter as well as continued investments in the business, which we anticipated and communicated to you last quarter. We delivered 13% adjusted EPS growth in the quarter, and we remain well positioned as we move ahead for the rest of the year. I'll cover a few highlights for the quarter before I turn it back over to Maria. Our new business bookings, we showed continued momentum through Q1 with demand strongest in our downmarket offering like RUN and our retirement services businesses, and we also continue to see strong traction in our PEO solution. At the same time, bookings growth in our international business started a bit softer than we had hoped. We're continuing to watch the demand environment in international markets as clients and prospects there are dealing with a number of uncertainties, as you know. We are keeping an eye on the macroeconomic environment as well, but overall demand remains strong, and our pipeline looks solid. We'll share further updates on what we're seeing with bookings as we progress through the year. Our ES retention was very strong with a new overall Q1 record level led by great performance in our mid-market. We accomplished this year-over-year improvement despite further normalization in small business out of business rates in the quarter. We assume we will continue to experience normalization in out-of-business rates towards prepandemic levels as the year progresses, and we are clearly very pleased with the Q1 results and -- that were better than expected. Our pays to control metric was 6% for the quarter, in line with our expectations as strong hiring that our clients have conducted these past few quarters has carried through to strong pays per control growth this quarter. We continue to expect deceleration in pays per control growth later this year, and we've seen sequential employment growth begin to slow both in the National Employment Report and in public data. But that said, job postings and other leading indicators within our client base suggest that, at the very least in the short term, demand for labor will remain solid. And moving on to our PEO. We saw a modest deceleration in average worksite employee growth in the average worksite employee growth rate, which was anticipated, but the 12% growth was slightly ahead of our expectations for the quarter, and we're very pleased with that growth. Demand for both our PEO and our ES HRO offerings remains high as the value proposition for a fully outsourced model continues to resonate in the market. And in fact, our HRO businesses combine now to serve over 3 million worksite employees out of the 40 million total workers paid by ADP. Q1 not only provided a strong start to fiscal 2023 but also represented a major milestone in our company's history. As we -- as I mentioned earlier, we crossed the 1 million client mark during the quarter. What an incredible accomplishment. We accomplished this by driving improvement and growth on a consistent basis through decades of different employment cycles, business environments and technology shifts. It's a proud moment that was made possible only because of our relentless focus on meeting the needs of our clients, as Maria mentioned, both by delivering exceptional service and providing leading HCM technology. underpinning all of this is the dedication of our associates who ultimately make ADP a company it is today. As we look ahead, we recognize the need to remain agile in this unique and dynamic economic environment. And it is certainly our hope that inflation normalizes soon without significant harm to the global economy. But if macroeconomic conditions instead prove more challenging than we'd all like, we believe our stable business model should allow us to maintain our focus on innovation and our steady approach to investment, positioning us to continue driving long-term sustainable growth for many years to come. And it's for that reason that while I am incredibly excited to have reached 1 million clients, I'm even more excited about the opportunities ahead for ADP. And I'll now turn it over to our new CEO, Maria.
Maria Black: Thank you, Carlos. As I mentioned earlier, I am also proud of the collective efforts of our associates who made this achievement possible. One of the beauties of having 1 million clients and directly serving 3 million worksite employees in our HRO businesses is that we have unparalleled insight into the needs of the HR department, and we are putting that insight to work. I'm proud to share that, in September, we won the top HR product at annual HR Tech Conference for the eighth year in a row, this time for a new offering we're calling Intelligent Self-Service. HR departments today devote a significant amount of time to addressing questions from their workers to help better manage this volume of worker and practitioner interaction. Intelligent Self-Service uses predictive analytics to help proactively address common issues before workers need to contact or HR leaders. Not only does this solution ultimately improve the experience for the worker, but it further enables the practitioner to focus on more strategic items, which is a key objective for our clients. There are a few different components to Intelligent Self-Service. The first is something we're calling action cards, which you can think of as proactive nudges in the ADP mobile app that appear in the flow of work so that workers are alerted and encouraged to act when there's something they need to address such as a missed time punch or time card approval. Another component of the offering is our virtual assistant chatbot, which was previously available to our clients' HR practitioners but is now, for the first time, being expanded to workers as well in order to address their requests or questions. And the third piece is case management, which helps with more complex problems that require HR systems. This feature presents a streamlined way to create, manage and track workers' interactions with our HR experts and quickly get to the right experts based on the workers made. Intelligent Self-Service is designed to create a better HR experience and reduce work, and we believe we are designing a solution that can reduce our clients' case volume by 30% or more, which, of course, would be an incredibly value-add win for everyone. We have already rolled out some of these components and are in pilot for others, but the feedback so far has been very positive. I also want to give a quick Q1 update on our new user experience. As a reminder, our new user experience represents a significant enhancement we've been making to our scaled strategic platforms using new design principles to make them even more intuitive and more personal so our users can easily leverage our solutions to the fullest. Last year, we moved clients on RUN, iHCM and Next Gen HCM as well as the ADP Mobile app over to the new user experience. And later in the year, we also moved 20,000 Workforce Now clients to the new UX. Enhancing Workforce Now is especially important given how integral the platform is to so many of our businesses, and I'm pleased to now share we've taken that 20,000 clients last year to over 80,000 through the end of Q1 with essentially all of Workforce Now clients on this new enhanced experience. Among other user experience initiatives, we relaunched the ADP RUN mobile app with our new UX with managers and HR practitioners of small businesses running payroll and HR while on the go. This app is a powerful tool for them, and the relaunch has been a resounding success. You can see the app and the reviews for yourself, but it's doing phenomenally well with 4.9 stars on several thousand reviews representing meaningful improvement from the experience it is replacing. These are exactly the types of outcomes we had hoped to achieve with this user experience work, and we are very excited about continuing to roll out to more solutions within our key platforms. From our voice of employee offering, we mentioned last quarter to our new Intelligent Self-Service capability to our UX deployment into our ongoing Next Gen rollout, our product teams are busy and our clients are excited about the continued innovation at ADP and our overall modernization journey. We look forward to continuing to develop ways to provide more value to our clients and prospects in this dynamic HCM and economic environment and to ultimately deliver on our bookings growth goals for this year and beyond. And with that, over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. Our first quarter represented a strong start to the year with 10% revenue growth on a reported basis and 11% growth on an organic constant currency basis. Our EBIT margin was up 30 basis points, coming in above our expectations as strong overall revenue growth and growing clients fund interest revenue contribution as well as favorable workers' compensation reserve adjustments in our PEO overcame inflation-related cost pressures and higher-than-typical year-over-year headcount growth. Our robust revenue and margin performance combined to drive 13% adjusted EPS growth for the quarter supported by our ongoing return of cash to our investors via share repurchases. In our Employer Services segment, increased 9% on a reported and 11% on an organic constant currency basis. Key drivers to this growth were strong bookings and retention performance we delivered in recent quarters as well as solid contributions from price and pays per control. And of course, client funds interest, which mostly benefits the ES segment, grew nicely in Q1 with 39% growth driven by a healthy 9% balance growth and 40 basis point improvement in average yield. Partially offsetting that was FX, which was a slightly bigger headwind than we had anticipated. Our ES margin increase of 50 basis points was higher than planned primarily as a result of that strong revenue growth. For our PEO, revenue in the quarter grew 13%. Average worksite employees increased 12% on a year-over-year basis to $704,000 as bookings and same-store pays both continue to perform well, though the same-store pays contributed less than it did in recent quarters as we expected. PEO margin increased 80 basis points in the quarter due primarily to revenue growth and favorable workers' compensation reserve adjustments. Let me now turn to our updated outlook for fiscal '23. I think, overall, you'll find a very steady outlook compared to our prior guidance with upside due in part to higher interest rates. Beginning with the ES segment revenues, we now expect growth of 7% to 8% and driven by the following key assumptions. First, we continue to expect ES new business bookings to grow between 6% and 9%. And as Carlos covered, we see a stable overall demand environment at this time, but it's still early in the year. And with a wide range of outcomes and we will continue to watch for impact from a potentially slowing global economy as we progress from here. For ES retention, we were happy to deliver another strong quarter, but we believe it's prudent to anticipate further normalization of small business out of business rates as we move through fiscal '23. As such, at this time, we're leaving our outlook unchanged at down 25 basis points to 50 basis points. Meanwhile, we will look to maintain our strong retention levels in our other business units. For pays per control, we had healthy 6% growth in Q1, in line with expectations, and we continue to anticipate a return to a more typical 2% to 3% growth rate for the full year as employment growth moderates. As we discussed last quarter, our pays per control growth outlook assumes a deceleration in growth in Q2 and very little growth in the second half of fiscal '23. This could, of course, prove to be either too conservative or bullish depending on how macroeconomic factors develop, but it still feels like a reasonable assumption to make at this point. Last quarter, we spoke a bit about price, and there is no change to our expectation for price to contribute about 100 basis points to 150 basis points to our ES revenue growth in fiscal '23. Our clients understand these price increases and recognize that they reflect our own cost pressures. And for client funds interest revenue, we now expect higher average rates compared to our prior outlook. Our client funds short portfolio will continue to benefit as the Federal funds rate increases over the balance of the fiscal year, and our new investments in our client extended and loan portfolios are now expected to yield about 4.3%. Between those two drivers, we now expect the average yield on our client funds portfolio to be 2.4% in fiscal '23, which is about 20 basis points higher than our prior outlook. We continue to expect our client funds balances to grow 4% to 6%. And putting those together, we now expect our client funds interest revenue to increase to a range of $790 million to $810 million in fiscal '23, up $70 million from our prior outlook. Partially offsetting this revenue upside is higher short-term borrowing costs associated with our client funds extended strategy. With higher expected commercial paper and reverse repo rates over the rest of the year, we now expect the net impact from our client fund's extended strategy to be $720 million to $740 million in fiscal '23, up $45 million from our prior outlook. One last factor to consider is our ES -- in our ES revenue outlook is FX headwind, which has unfortunately become a more meaningful drag over the last three months. We're now factoring in an FX headwind closer to 2% for fiscal '23 ES revenue, up slightly from our prior assumption. For ES margin, we now expect an increase of 200 basis points to 225 basis points, up 25 basis points from our prior outlook. We continue to expect our margins to benefit from our strong revenue growth outlook, including growth in client funds interest revenue, and we're pleased to be able to increase our outlook accordingly. Moving on to the PEO segment, where we're making very few changes. We continue to expect PEO revenue and PEO revenue excluding zero margin pass-throughs to grow 10% to 12%. The primary driver for our PEO growth is our outlook for average worksite employee growth of 8% to 10%. We now expect PEO margin to be flat to up 25 basis points in fiscal '23, narrowing our prior range higher due in part to the strong Q1 margin performance. Adding it all up, we now expect consolidated revenue growth of 8% to 9% in fiscal '23 and adjusted EBIT margin expansion of 125 basis points to 150 basis points. We still expect our effective tax rate for fiscal '23 to be about 23%, and we now expect adjusted EPS growth of 15% to 17% supported by our steady share repurchases. And now I'll turn it back to the operator for Q&A.
Operator: [Operator Instructions] We will take our first question from Pete Christiansen with Citi.
Peter Christiansen : First, congrats to Maria. Looking forward to seeing your touch on strategic vision here and certainly to Carlos for such a successful tenure as CEO, particularly through some volatile events in the last couple of years, for sure. I just had a question as it relates to bookings trends certainly see that the outlook is held steady. And I know that we're kind of early in the selling season. But if there's any -- just wondering if you could put any color on any differentiating trends you're seeing at this point of the year, maybe perhaps versus the last year or two, maybe attach rates or on ancillary modules or even going to more outsourced models, seeing any changes in behavior there? And then as it relates to the pricing discussion that we just had, do you feel like you have any more room? It seems like your clients are responding well and things look good. But do you still -- do you think that there's potential upside to the pricing strategy? Sorry.
Maria Black : Thank you, Pete, and thank you for the well wishes. I certainly appreciate them. And as you mentioned, look forward to connecting with many of you around strategic vision going forward. With respect to bookings and really thinking through year-on-year changes in behavior, I'll comment on that, and then I'll turn it over to Don that can talk about whether or not we have more room on price. . But again, just to kind of confirm the overall outlook at 6% to 9%, we do feel confident in this outlook. When I think about how we planned for the year, and we were generally pleased with the results that we saw in the first quarter, in fact, they were actually technically a record from a year-on-year perspective. But the thing that makes us not necessarily call that out in that way and really speaking to the continued momentum, to your question, it's really about in the context of the records that we've had, in the past few quarters, it's really been broad-based across every bit of the portfolio. And as you heard in the prepared remarks this morning, we had significant strength in our downmarket offerings. Really pleased to see that across our RUN portfolio, the small business segment inclusive of our insurance offerings, retirement offerings. We also continue to have significant strength in our HRO offerings, inclusive of the PEO. So in terms of changing behavior, I see that as constant behavior as it relates to -- those are businesses that have had continued strength over several quarters and the value proposition, both downmarket and certainly into the HRO space has been good. I think the area, again, that we called out a little bit that we're keeping an eye on is really our international business. Now the good news with our international business is that it's a small contributor to our overall bookings. But when we look at what really happened with the international space, specifically for this quarter, we don't still actually see a macro impact. We see more of an impact of the strength that we had coming into or coming off of a record Q4. And so when you think about our upmarket business, specifically our international business, there are times that it's a bit lumpy as we pull deals forward to accelerate through the fourth quarter. And candidly, who wouldn't want to have an incredible finish and an incredible quarter? But as it has for several decades, I would say that does sometimes lend itself to some of those businesses needing -- continue to rebuild the pipeline. So that's really what we think is happening. But at the same time, we're very -- we're keeping an eye on specifically in Europe, what's happening in the Ukraine, what's happening with the energy crisis. Those are watch items for us. But just kind of reiterate, we don't see any macro overall trends. We don't see changes in behavior. We see the strength continuing in the downmarket and into our HRO and PEO offerings, and we were very, very pleased with the results this quarter, and they are record results in that respect.
Don McGuire : Yes. And with respect to the pricing, we've been very happy with our ability to execute the price increase in the way we did. And as we've said on prior calls, we're mindful of the fact that these are incremental costs for our clients as well, and we need to be competitive. So we made sure that we've price increased and passed on the costs we have in a way that keeps our customers with us for a very, very long time. Having said that, we said 100 basis points to 150 basis points. And I would tell you that, currently, we're pushing towards the upper end of that range in the price increase. So we've done very well against expectations and executed, as I said, well across the business. Of course, is there more available? Good question. If we look at our client base, particularly with the large clients, we do have contractual obligations that come due from time to time. And a number of those are tied to various price indices, et cetera. So that limits the ability to do anything beyond some of the pricing indices that drive or undermine or underlay, if you will, the price that we have. But I guess I would say we've been very happy with where we are now, and we'll always look to see if there's an opportunity. But I think that we want to make sure -- we will continue to make sure that we do what's best for ADP in the long term as opposed to being too overzealous, if you will, with short-term price increases.
Operator: Our next question comes from Tien-Tsin Huang with JPMorgan.
Tien-Tsin Huang : Great. Carlos, I want to say, again, again, grateful to have worked with you and share the time and learn from you from, I guess, over 40 earnings calls and meetings and stuff. So I appreciate that. And of course, congrats to Maria. I want to just ask, if you don't mind, 100% agree from the release, Carlos led the transition from payroll to HCM. So I know you can't tell us everything in terms of what's next here, but is it fair to think the focus might be more so on the employee now in addition to the employer, in addition to modernization, maybe data? Just maybe some thoughts there would be great. Love to hear it.
Carlos Rodriguez : I think that was for you, Maria, given that I'll be sitting on the beach.
Maria Black : Fair enough. Thank you for the chance to comment a little bit. Obviously, early days as it relates to -- I mean essentially starting as early days as it relates to having conversations around long-term strategy. I think the first thing I'd like to reiterate, I know I talked about my 26 years here. I have spent eight of those as part of the incredible management team that Carlos alluded to earlier, and that's been a part of the journey that we've been on as it relates to the overall modernization journey. So I think you mentioned the transition from payroll to HCM. That is a piece of that modernization. But in my mind, it's more broad-based than that. It's really been about the decisions we've made, everything from our strategic locations to early days of platform migrations to configuring our organization to really create a technology organization. We've been actively modernizing our service organization. You hear me speak about that all the time in terms of continuing the modernization of tools but also making sure that we're taking the work out for our clients. We've been making a transition to the public cloud. And then one of my favorite topics is the modern selling approach that we've been embarking upon that really, as we go on for many years as we found it inside sales, if you will, 20 years ago to the most recent during the pandemic, really focused on digital selling and meeting the buyers in a different way. So I think all of that is really about our modernization journey. And I think as I look forward into the next decade, if you will, in the next chapter, it is really about continuing the great work and the foundation that you mentioned that Carlos laid. I have a lot of passion around our clients. I have a lot of passion around the 40 million workers that they pay and how we can create value for each one of those stakeholders, both the workers as you mentioned, the clients' employees as well as our clients. And my ultimate goal, Carlos touched on it, I think I mentioned it as well upfront, when I think about client centricity and really solving meaningful things for our clients, I think the last decade in this modernization journey has really been about setting us up to be able to deliver value in a very different way for our clients. My goal would be to continue that journey and, in the end, make sure that our clients are in love with our products and in love with the experience that they have with ADP and the true evangelists of what it is that we bring. And I feel confident in how we've been set up to embark on that journey, and I look forward to sharing more with you on it as we move forward.
Operator: Our next question comes from Kevin McVeigh with Credit Suisse.
Kevin McVeigh : Great. And my congratulations all around as well. Carlos, I guess, why is now the right time? I mean you've done an amazing job, you're still incredibly young. Just any thoughts as to why transition now?
Carlos Rodriguez : Actually, it's a good question because, honestly, it's something that we started -- we were joking about it yesterday, that I started talking about this about 12 months after I became CEO. Not that I was trying to leave 12 months after I became CEO. But in case people haven't noticed, I'm like a business junky, right? So I just love business. I also love kind of the whole idea of like a successful commercial enterprise, and you have this kind of tension in this area of succession where the longer you are around, the more you know. There's some studies out there that show that beyond a certain amount of time is really when CEOs hit their stride. But then there's an equal amount of research that shows you move beyond a certain time, you become stale. You don't have any new ideas. You become enamored with your own ideas and thoughts. And so I have not written the book on this, but I read a lot of books on this. And my sense was that kind of beyond seven years was -- there was diminishing returns based on my "research." And you can see that I made it past that. And some of that was -- circumstances, I think, made it such because I didn't have any specific goal. Like I'm not trying to run out the door. My -- the only thing I want to do is the best thing for ADP, and the best thing in this case now for Maria and for our Board. And so this is a collective decision over -- I know it's hard to believe but really over a decade as to what the right timing was, who the right person was and how to position them for success and how to position the company for success. By the way, that also involves -- we had a very meaningful refreshment of our Board that, I think, is something that has to be taken into context because it's all a package, right? It's the right CEO, the right Board, the right Board leadership. And so I think that bringing the Board along, I think, required a little bit more time than I had expected. So that's a long way of saying I don't have any magic answers to what the right time is. What I know for sure is not the right way to do it. There's nothing to do with my age and whether I'm young or I'm old or whatnot. It has to be done when it's the right time and it's the best thing for ADP, and I think that's what we just did.
Kevin McVeigh : That makes a lot of sense. The numbers speak for themselves. So I'll leave it there. Congrats again.
Carlos Rodriguez : Thank you.
Operator: Our next question comes from Kartik Mehta with Northcoast Research.
Kartik Mehta : Carlos, just -- or Maria, just your thoughts on the economy. Obviously, I look at your results and things look good. I know you said maybe the second half, you're just being a little bit more cautious. But as you look at kind of the numbers now and you talk to your customers, just your thoughts on how the economy looks now and just kind of the outlook over the next six to nine months?
Carlos Rodriguez: So we obviously don't have the market cornered on economic forecast. We do have a reasonable amount of data, particularly on what I would call the near-term next few quarters, I would say. But when you look at the last two, three, five years, 10 years, really, as long as I've been doing this, you have to be really careful about taking economic forecasts at face value. So you have to be careful. You have to be prepared for all eventualities. And that's why we like to call ourselves an all-weather business model because I think we actually perform, I think, through a variety -- obviously, better in some than others. But I guess that's the way of saying we're not obsessed with economic forecast because if I had taken economic forecast at face value over the last three or four years, we would have made numerous mistakes. And I think all I have to do is go back. I know nobody does this because otherwise there wouldn't be -- economists wouldn't exist. But if you look at what economists forecast 12 months prior and then what actually happened or 20 months prior to what actually happened, that's not really the right way to run a business. But it doesn't inform our decisions right, and our planning. And as you mentioned, what happened this year in terms of our fiscal year planning is we thought -- kind of common sense told us that some of these things were going to happen like normalization of downmarket retention, right, towards hopefully still above pre-pandemic levels but not at the kind of levels they were when the government was providing so much support for small businesses that you could just see it in the data in terms of the drop in bankruptcies and out of business and so forth. So we expected some normalization there. Likewise, pays per control, it's not -- you just don't make numbers up. Like we -- if you assume that you reach kind of "full employment", and that the population and employment [Audio Gap] employable people is growing at a certain rate, you can kind of back into kind of a normalized pays per control rate, and then you sprinkle in a little bit -- maybe there's going to be some economic weakness in the back half. And I think what we signaled and what we have in our plan is, I think, kind of flattish pays per control growth, which to me personally is feeling conservative right now based on the -- we feel like we have this kind of continued strength into this quarter, and that typically doesn't fall off the cliff right away. But maybe that happens in the first quarter of '24 that it becomes flattish. I don't know. But I know that right now, there are definitely still -- we got back to what employment was pre pandemic, but the population also grew and the employable number of people grew. So labor force participation is still below where it was before. So there is definitely still room for some employment growth there. So this could be a very strange slowdown, right, or if you want to call it a recession, where it's, I think Danny calls it a labor full recession where it doesn't feel like employment, at least the stuff that we look at background checks, job postings, et cetera. I mean if you look at the jokes, you look at everything, there's still a lot of -- we had 260,000 jobs created -- and that wasn't 500,000, it wasn't 1 million, but in any other environment, that would be like an incredibly strong number, but it's clearly is clearly slowing, but everything we see is that the labor markets remain, again, in the time horizon that we have visibility to pretty strong or certainly not as strong as a year ago or when we were in the middle of the recovery from the pandemic, but that's really more of the comparisons than kind of anything underlying. So I think we're just heading back to kind of more normal rates, but in an unusual way where the labor market doesn't appear to be the leading the leader in the slowdown. It appears to be people spending less on stuff that they spent a lot of during the pandemic, if I can be bold. That might be like exercise bicycles. It might be things like grills, like -- and maybe even, unfortunately, for a company that's close to my heart, software, right, and some things that are -- that you have these kind of, unfortunately, fluctuations of demand that we've never seen before. And so the now how do you predict and forecast how that all kind of lands in the medium to longer term. It's very, very hard for any company to do. But specifically for us, labor is still strong. As long as labor is strong, our clients are still looking for tools to employ, to hire and to manage that labor. And we have this other little weird thing happening to us, which is really fantastic, which is interest rates are rising. And they’re rising in the face -- I mean, typically, when interest rates are rising, the economy is slowing, and that's exactly obviously what the intent of the Fed is. But right now, you're kind of at this point where we're getting this big tailwind from interest rates, and it doesn't feel like that's going to change again in the near term. It doesn't mean that rates won't stop increasing, but if rates stop increasing, like, for example, like in the spring of '23, and they stay there, home run for ADP. All of you and everybody internally here at ADP make fun of me when I used to talk about how our balances in 2008 were like $15 billion and they had grown to $30 billion, but our client funds interest had been cut almost by 2/3 because of interest rates. And I used to say, "Can you imagine if interest rates go back to where they -- near back to where they were back then, but our balance is now are $33 million and growing, I think it was 9.5% this quarter, wouldn't that be amazing?" And that's exactly what's happening. So I'm leaving a little bit of gas in the tank for Maria. Well, actually, I can't take credit for that. I appreciate Chairman Powell helped with that. But we -- I think we have some gas in the tank here with interest rates as well, which again, is a little unusual, but I don't know if you want to call it a hedge to our business model, but -- it's definitely welcome because we are -- as you know, we always carefully watch our expenses and everything in ADP, but it's a much better place to be from an ability to invest and an ability to weather when you have this significant tailwind, which is not a secret. I mean I think Don laid out the numbers, and you can do the math. It's a pretty big tailwind.
Operator: Our next question comes from Jason Kupferberg with Bank of America.
Jason Kupferberg: Congrats Maria. Congrats to Carlos as well. I had two questions. The first one, just, Maria, picking up on your comments around some of the Intelligent Self-Service offerings. I think you made mention of the potential for customer service cases to be cut by 30%. I was just curious to get a little more color around that, what might be the time line for achieving that goal. And is that any kind of rough proxy for how much your customer service costs could be reduced over time if this is successful?
Maria Black : Thank you, Jason, for the well wishes. And I'm actually -- I'm glad you asked this question because I wanted to make sure there's clarity around that 30%. And that 30%, just so we're all on the same page, it's really about our clients being able to save that time. So this is really about serving up, leveraging intelligence, artificial intelligence, machine learning. It's really serving us the most frequent interactions that can be either performed in a self-service capacity or really performed again through this case management and really taking the work out than necessarily, call it, taking the work out of our system. It's really about giving that 30% to our clients. In fairness, it is early days as we measure this. And when I say that, I'd say that lightly in that we did study this across our 3 million HR worksite employees, if I may call them that, that in terms of the most frequent cases that get served up and what that would yield in terms of a return to our clients. And that's where that 30% comes from. But as we launch this product and more and more adoption happens, we will be keeping a keen eye on that outcome to ensure that, that number remains true, and our hope is to continue to make progress and take more work out of our -- out of the system for our clients as they navigate the relationship between them and the practitioners and the workers.
Jason Kupferberg : Just one quick follow-up. Just if nothing had changed in the rate environment since the time of the last earnings call, would you guys have raised revenue or margin guidance for fiscal '23?
Don McGuire : I think it's -- certainly, the rates helped us. But just a couple of things to comment on. Certainly, we still we're performing well against our internal expectations on margin improvement. So we're still very focused on spend and efficiency of spend, et cetera. But I don't think that we would have been as -- we wouldn't have been as eager to raise expectations in the absence of interest rates, especially given it's still Q1, and we need a little bit of time to see how things progress over the next couple of quarters.
Carlos Rodriguez : Well, that's fair. But I'm pretty happy with the results because we -- Don, this is just the way our culture is. So everybody is talking about all the positives that we have, like interest income and so forth. But we had some headwinds as well. Like our T&E is up significantly. Remember, last -- it's hard to remember that last year, this quarter, I think we were still in the whole Omicron thing. It was just starting and we really hadn't opened up most of our buildings. I think our salespeople were for sure in the field but not traveling and spending the way they are now. By the way, we were very grateful that we have them back in the field. . So like there are a couple of things like T&E is the smallest of them. The biggest one is when you look at our headcount numbers, it hasn't come up yet, but our sales force is I think, more than fully staffed. And as you probably heard from our comments six to nine months ago, it was difficult to get there back then. Now not only are we fully staffed but our turnover is coming down across the board not just in sales but also across the rest of the organization. So all of a sudden, if you look at our headcount growth for this quarter, it is what I would call a peak and the highest I have ever seen since I've been here at ADP. That was necessary because there was some catch-up, which is why we -- I called it a grow-over issue from last year's first quarter, where we were definitely understaffed, didn't have enough people. And then all of a sudden, our revenues actually were outperforming. The number of clients is outperforming, and you know how important retention is to us. So we set to basically stop up across the Board implementation, service and sales. And that's when you had that whole great resignation thing happening at the same time. And it was -- I mean, again, I don't think most companies go around talking about this, but we were trying to hire as fast and as many people as we could at that point. The good news is we were successful. I think the better news is that puts us in, I think, in a good position in terms of staffing and sales, but also in terms of our service and implementation organizations. And now with declining turnover again, from a plan standpoint, besides planning for patient for control to be "flattish" in the second half, our headcount growth declines -- the growth of headcount declines every quarter for the next 4 quarters. And I think that, I think, should help us feel good about this quarter and also about the fiscal year. So I think technically, Don is correct. By the way, if you go back to ADP's 10-year history, this has been a weird two or three years like us not raising as we hadn't raised in the quarter, again, I don't know what you would have thought of that or what it would have meant, but I think that's pretty -- any maybe can confirm or tell me I'm wrong, but like we weren't in the habit of changing a lot in the first quarter because this is -- how can we say this is a predictable, stable business that we know what we're doing and then changing set every quarter. It doesn't make sense. Now we have a pandemic, that's a different story. Like we struggled like everyone else to kind of keep a handle on what things were happening -- how things were happening on the way down and also on the way back up. But this is going to be a much more stable environment. I would hope some of you would welcome that. But with 10%, 11% growth organic and our headwinds from expenses abating here a little bit, I think we're in a pretty good position.
Danyal Hussain : Jason, the only other thing I would point out is that in addition to interest becoming more favorable and contributing to most of the raise as you can calculate on your own, FX obviously also got worse. So in this parallel universe without a higher interest rate, we would perhaps be absorbing that higher FX and not changing the outlook.
Operator: Our next question comes from Bryan Bergin with Cowen.
Bryan Bergin : First congrats, Carlos, on your success; and Maria, on the promotion. I wanted to just start with a more specific follow-up on the bookings trends in the pipeline. Can you just give more color on what you're seeing in those forward sales indicators, lead volumes, sales cycles in recent weeks? And really just any discernible changes you've noticed there?
Carlos Rodriguez : Yes. I think Maria can talk about -- I think she's actually been looking into a lot of the details around pipeline disorder. The only thing that I would add is color commentary. I was trying to defer to Maria on kind of the big picture in terms of bookings. But since I've been doing this for a long time, 44 quarters and then many years kind of watching from, I guess, a year before that as not quite a year, but as President, and before that, I really paid close attention to all this stuff. And Maria mentioned it, but the problem with the crystal ball right now is that when we have the kind of finish we had, you saw how enthusiastic we were and how bullish we were in terms of our finish and whatnot. And almost predictably, when we have that kind of finish, about half of our business, we count the bookings when we sign a contract. And the other half, we only count the bookings once the client starts. And that portion of the business that -- like, by the way, that's the way most companies that sell to larger clients book their bookings, which is when you sign a contract. That's why it's called bookings. That has always been an issue when we have this very strong quarter and very strong finish, the pull-forward stuff has been driving me crazy forever because we have very strong incentives and what we call accelerators in terms of commissions and so forth that drive, and we want that because we want to get the revenue as quickly as possible, but that sometimes leads to kind of a weaker start. The problem here is that on top of that, now you have a macroeconomic challenge potentially, we definitely have a macroeconomic challenge in Europe. Luckily, it's not a huge part our bookings. So it's hard to differentiate. But what I would tell you, again, back to color, the businesses that we count the bookings when they start are mostly the downmarket businesses. So that would be SBS, PEO, et cetera. We had double-digit bookings growth in those businesses. That makes me think that it's unlikely that, all of a sudden, we have an economic whatever challenge or disaster because why would those businesses still be performing the way they are. But I would just -- a forward-looking statement, I would say I don't know for sure that that there isn't a problem in terms of demand or the economy or whatnot, but it doesn't feel from the first quarter like we could put our finger on something that says, holy cow, we have to put the kind of the red flag or the yellow warning flag up just yet. And I don't know, Maria, if you have comments in terms of a little bit more tangible…
Maria Black : Yes. Thank you, Carlos. He's right. Carlos is right. I've been studying deeply the pipeline specifically of these businesses that recognize bookings potentially have some of the pull forward into the fourth quarter. And that's primarily in the larger size type of organizations. And so in studying the pipeline kind of segment by segment, country by country, if you will, and deeply, it does appear that the pipelines are there, the pipelines are continuing to build when I think about deal cycle time, right? So you think about all the data points we are analyzing on a daily basis to really understand the question you're asking, Bryan, which is, is this an economic and macro, is this -- what is this. And the answer is, from a pipeline perspective, the pipelines are healthy. From a deal cycle time, let's go back to Carlos' commentary. It does appear that we did have a lot of pull forward, and there were potentially not enough days to pull things into the first quarter. And we have -- again, what does that really mean in the macro? It's really returning to more pre-pandemic levels. So these are not concerning deal cycle times. These are actually more normal deal cycle times, the ones that we saw pre-pandemic. What I'm referring to there is really there used to be a time that it did take a lot of time to move larger deals through the system because so many individuals are involved, whether that's on the contracting side, the legal side. During the pandemic, there was a deal acceleration that happened, and a lot of that has to do with us being stationary. That's no longer the case. We see that every day in terms of the world is back at work. And companies are reporting in the news, we are seeing incredible strength amongst our client base. We're seeing demand for HCM. There is 6% pays per control growth. So as Carlos mentioned earlier, the jobs are there. Our clients are growing. Our products and offerings fit right into that sweet spot that everybody is still trying to solve for, and our pipelines are healthy. So at this juncture, there really isn't a macro broad-based trend that we can see besides the watch areas we've called out. I think the only other comment I would make, I alluded to it earlier, and is please remember that when a quarter ago, we gave the guidance for the 6% to 9%. The way that we thought about the year, first and foremost, the first quarter is the lightest quarter for us from a pure dollar perspective. So it's the smaller contributor from a dollar perspective on the full year. The way that we planned the year, which we talked about on the 6% to 9% bookings guidance that we gave a quarter ago was really assuming some elements of a slowdown in the back half, specifically in the fourth quarter. So it's really about this quarter, i.e., the current one that we're in, which is the second quarter and the third quarter, and so in looking at where we stand today, we feel confident in the 6% to 9% in terms of how we plan for it. We didn't assume massive and severe recession, but we definitely have assumptions in there that we feel confident at this point that we can execute against.
Carlos Rodriguez : And one of the -- if I can just add like one of the beauties of our business model is that bookings are, for sure, an incredibly important thing, especially kind of over the longer term. But I mean, I hope it's obvious that, from a revenue standpoint, again, with visibility only for the next two, three quarters, we have -- it's really about converting prior sales, which were incredibly strong in prior bookings. I mean you saw what our bookings results were for the fourth quarter and for the year. So that's the stuff that now turns into revenue in those businesses where we recognize the booking at the time we sign a contract. So that -- it's just -- I know it's obvious but just a reminder because this business doesn't -- we're not selling widgets, where if you stop selling widgets, like all of a sudden you're back to zero next quarter, like the -- I think we have a solid revenue plan that I think reflects, as Maria said, what I think was already a pretty conservative number in terms of bookings growth, particularly in the back half of the year. So we may have other issues like FX on the negative side, clients fund interest may help even more or may help less, but I don't think the bookings issue is a fiscal '23 focus item in terms of impact on revenue.
Bryan Bergin : Okay. All right. A follow-up on retention then. It seems like it's fair to say you beat your plan in 1Q. But what do you attribute that 1Q success to? Was it more a function of a slower rate of SMB out-of-business losses? Or do you think it also did better on the controllable factors as well?
Carlos Rodriguez : It's really -- I think it's -- the controllable factors, I think, are the most satisfying part of the whole story because the story is kind of playing out a little bit the way we expected, which is small business is kind of in the process of kind of normalizing. But the really -- by the way, positive ironically in our international business, which might not be so ironic because the challenges economically, there are probably getting -- convincing people that they stay put. I don't want to say that it's not all great execution because we have a great leader in international, and we have the former great leader of international here, which is Don McGuire. So there's a lot of great things that have happened in that business that are probably powering some underlying improvement in retention. So some of it is probably inertia as a result of what's happening in the economic environment there. But the most satisfying part of the whole story here is what's happening in the mid-market, where I think some fundamental improvements that we made pre-pandemic, you remember all the pain in terms of the migrations and then the improvements in product, the UX experience improvements, all those things, it just seems like it's ratcheted up the "potential", the maximum potential retention, if you will, for our mid-market business, which was a record this quarter as well. Clearly, the down market -- the pace of normalization of the down market has some impact. But the big story, I think, this quarter was really the mid-market, and our international business has helped a lot on the retention side.
Danyal Hussain : Bryan, I'll just confirm the down market didn't really contribute to the outperformance versus our expectations. So the mid-market was clearly the bigger piece.
Operator: Our next question comes from Samad Samana with Jefferies.
Samad Samana : I'll congrats that is given so far as well. Maybe just a question. When I think about the transitioning of the Workforce Now base to the new UX and the progress there and -- market, how should we think about maybe that were going to translate into monetary benefits? Is that more of a benefit in gross margin for a lower cost to serve or just less back-end work or higher retention, all of the above? Just help us maybe map what the kind of economic outcome is from moving over to the new UX for ADP.
Maria Black : I have a lot of time for our new UX. I can't boast about it enough. And the majority of that reason is all of the above. We expect this to impact our clients' satisfaction, their retention, our ability to demo more, sell more. In terms of teasing out the specific results difficult, but the answer to your question is all of the above.
Samad Samana : Got you. And then maybe one for Don, any thoughts on locking in or changing duration with rates where they are? Just as I think if I look back historically at the presentation, yields currently are higher than they've been at kind of any time for even what the long end of the portfolio looks like. Any -- any view on changing duration? I know you guys get what the mix is, but I'm curious if it were locking it in for a longer duration.
Don McGuire : Yes, I'm going to start on this, but something tells me Carlos won't be able to resist following up on whatever I have to say here. So I guess I would say that the laddering strategy that was implemented a number of years ago has delivered great returns. And while I think everyone can see the temptation of changing the duration and trying to benefit more from short-term rates, rates will either normalize or they may even come down again at some point in the future. So this laddering strategy that's been deployed over the number of years has served us very well, and we expect it will continue to serve us well. And not to say that this question doesn't come up from time to time if we discuss it. But every time that we look at it, we -- you really either -- you're making a bet for today as opposed to for down the road. And given the positive experience we've had, it doesn't really behoove us to make any substantial changes to a policy and a program that has been doing very, very well. Carlos, I'm sure...
Carlos Rodriguez : I have nothing to add other than -- I obviously picked the right time to retire. Very well said. And because I think that encapsulates lots of other things where we focus more on the longer-term in the medium term rather than because, again, if rates do normalize, as you said, we're going to be very grateful that we -- that our extended portfolio that we took advantage of these "higher rates" that will help us for two, three, in some cases, five years down the road. So it's the right -- we're not a financial services company. We're not a bank, and that's not the kind of best that we're trying to make here. This is just -- happens to be a nice little windfall as a result of a business model that we have that allows us to kind of manage float income at a very, very large scale. And anyway, well said.
Samad Samana : I think we all appreciate the institutional continuity as the transition occurs.
Operator: Our next question comes from Mark Marcon with Baird.
Mark Marcon : Carlos, congratulations on a great tenure not just as CEO but everything that you did prior to that. And Maria, look forward to working with you and getting to know you even more over the coming years. I'm wondering, can you talk a little bit about how you're set up for this current fall selling season? Certainly, you've got a number of big product improvements. Which ones could we end up seeing like being incremental in terms of PEPM? And just how strong do you think the sales momentum could be? How are you thinking about your marketing efforts, particularly with all the improvements that you've got in place?
Maria Black : Yes. Thanks, Mark. And similarly, I look forward to spending more time together, and I've appreciated the time thus far that we spent together getting to know each other. So in terms of selling season, we do feel -- I think Carlos mentioned, I think the first call-out I would make, I know you asked specifically about products and contributions PEPM, but I think it's important to go back to the discussion that Carlos had around headcount. So I've been -- I spent some of last year and last fiscal year speaking about a flattish headcount growth as it related to sales. We committed to a -- business growth heading into the quarter, and I'm pleased to report, as Carlos alluded to, that we are ahead of those plans. And so what that means is that we have more quota carriers in the system as we head into selling season, significantly more than we expected but significantly more than last selling season. And that, in and of itself, is the biggest contributor that we have to our overall results as we think about the productivity of more people in the system and, as Carlos also mentioned, with tenure of those associates picking up the increase in productivity of our sellers as they lap the 10-year band. So I think that's the biggest variable I see. We do have a lot of amazing things as it relates to products in the system. Certainly, the new user experience being broad-based across all of the products gives the sellers an extra step in their momentum as they head into the end of the year as it relates to demos due to that nature. I mentioned some of the other products such as the voice of the employee and our Intelligent Self-Service, which both serve us up through our mid-market. So that mid-market value proposition is continuing to grow. The other is the strength that we are seeing in that PEO and the HRO are comprehensive and managed services business -- businesses as it relates to customers that are continuing to face the complexity. By the way, whether they are up market, in the mid-market or even down market needing more of those tools to navigate the complexity of being an employer, and so we see tremendous strength there. And so we're making good progress on our Next Gen. Very pleased to see specifically on our Next Gen Payroll how that's resonating in the mid-market with Workforce Now. And as we continue to increase the addressable area that we are able to target with those offerings undoubtedly will yield, as you suggested, greater sales, greater PEPM as well some of these enhanced features and products that are served up through our existing platforms that I've mentioned before.
Mark Marcon : That's great. And then with regards to Next Gen Payroll, can you give us an update in terms of what percentage of the new Workforce Now clients are now getting Next Gen Payroll?
Maria Black : Yes. So we are -- we committed to -- and I've been talking about kind of that 50% of our overall mid-market and Workforce Now clients, and we continue to make progress on that. So we're not entirely -- at the entire market that work with an outsource today. But each and every day, actually, in every release, we continue to clear the path for more and more opportunities to be able to participate in that Next Gen offering, which is truly the game changer for ADP as it relates to the innovation there.
Mark Marcon: That's terrific. And Carlos, in terms of sports analogy, maybe Don Shula might be appropriate, great track record. Congrats.
Carlos Rodriguez: Yes, listen, I appreciate that because I joke around with people that I used to actually watch TV and sports a long time ago, but there was like about a 20-year period where I have no idea what's going on. But I do know Don Shula and I know the goose egg defense, I think they were called to say, whatever the hell they were.
Mark Marcon: It was the no-name defense.
Carlos Rodriguez: So no-name defense. There you go there. I screwed it up. It was trying to prove that I actually knew something about sports and I blew it so. But I appreciate that. That's greatly appreciated. You're a class act yourself, Mark. Thank you.
Operator: We have time for one more question, and it comes from David Togut with Evercore ISI.
David Togut : Good morning, and congratulations, Carlos and Maria, Carlos, all the best for you in the next chapter. Don, a question for you on pays per control growth. 6%, clearly well above the 2% to 3% guide. But as you noted, contemplated, can you walk us through the sequencing of kind of pays per control in terms of what's embedded in the quarterly thought process as we go through FY '23?
Don McGuire : Yes. So I think we were happy with 6% growth in the first quarter. And once again, back to Carlos' earlier comments, if you had believed all the economic forecasts, you might not have been expecting to see that stronger growth in pays per control. But we do continue to see the pays per control growth moderating down in the first half of this year. And as we shared -- as I shared in the prior -- the prepared comments, we have virtually zero pays per control growth in the back half of the year. So we do expect that we should -- given the strength of the first quarter, the first half should be a little bit better. I think we've reflected that in some of our guidance here already. And as we go through the next few months, we will be in a position to better decide whether we think we're going to be bullish or bearish on what's going to happen in the back half. And quite frankly, I think we'd all like to be very bullish about what's going to happen based on the first quarter's results, but I think if we did that, we'd kind of look a little bit foolish given all the predictions and all the storm clouds that people are talking about. So 6% first quarter slowing for the first half and then essentially very little growth if any, in the back half is what we're looking at.
Carlos Rodriguez : Yes. And I think the simple math is, again, rather than getting into individual quarters because that talk about trying to like -- it's very hard to pin down that exact number. But I think ballpark, 6 for the first half, zero for the second half, gets you to 2 to 3 that you have for the full year. I mean that's probably the right -- obviously, the way we laid it out is slightly different than that but that's close enough, I think, for what you're trying to accomplish, I think.
David Togut : Appreciate that insight. Just as a quick follow-up. Looking at Slide [Audio Gap] zero, the 25 basis point increase for the full year. Can you walk us through how big the workers' compensation reserve adjustment was in the September quarter and how you expect that to trend through the year?
Don McGuire : Sure. I mean, I can give you the specific numbers, you'll see them later in the Q anyway. So the -- we had a $14 million positive adjustment in the first quarter, and that compares to a $10 million positive adjustment in the first quarter of last year. So not that significant, $4 million, give or take. So that's the -- those are the raw numbers. We do not expect to see as good a reserve release in this fiscal year as we saw last year. There's still several quarters to go through, and the actuarials let us know what those numbers are, but we are contemplating the same level of reserve adjustment or recovery as we did in FY '22.
Carlos Rodriguez : The only -- the other color commentary that I would add is, I think the PEO -- again, if you look at last year, it's obviously, we've seen, as expected, some deceleration, but I would call 12% employee growth is still pretty strong. That obviously requires investment, right, in terms of service, implementation expense, et cetera. And so I would say that the PEO is one of those places where we were really adding a lot in terms of expense and resources from a place where we were not where we needed to be, call it, last year's first quarter. So that's the poster child, I think, for this kind of grow-over expense situation that we have. But the good news is, I think, is we are -- we're staffed. Again, turnover is improving across the board in terms of all parts of ADP. And I'm talking to other CEOs, I think this is happening kind of across. Things are just kind of settling down. That helps a lot because improvements in tenure help a lot in terms of productivity and just getting the work done.
Operator: This concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks.
Carlos Rodriguez: Well, what can I say? Another disappointing quarter where no one asked about the dividend. So let me just say that if the Board -- obviously I don't want to get ahead of the Board, but if the Board approves a dividend increase in November, this will be our 48th year of increasing dividends, which I think is a pretty elite group out there. And if you look at our payout ratio and you assume the Board will want to stay in the same payout ratio, you can do the math in terms of what's going to happen with our dividend. I think people really way underestimate. I hope this doesn't become an environment where for the next 10 years people are very focused on dividends because that has its own negative implications. But if you look at over 50 years or 70 years or 100 years, dividends matter, right? And compounding growth of dividends matters a lot. If you look at ADP's return, I'm doing a little math since we went public, which is why I was bragging about this being one of the most successful commercial enterprises in history. And again, and all of you have the same HP 12C calculators, you do that math, it's a pretty important driver of overall returns. So I'm incredibly proud of that. Maria gets to be the person who will preside over the celebration, again, forward-looking statements assuming we get there, of reaching 50 years, which will make us a dividend king. And I think there's only like less than 15 companies that have accomplished that, and some pretty incredible names. So that's the only thing I want to talk about was the dividend and the one last comment I have is what I've always said, and I'll say it again, I'm incredibly grateful. I'm grateful to my team. I'm grateful to Maria. I'm grateful to the Board. But the people who really get all the work done are the people on the front lines here at ADP, the 60,000 associates that make everything happen for us. There's something that Henry Taub put in the water that has created this culture, a can-do culture of delivering consistent results, not just from a financial standpoint before our clients. I think it's just fundamental to what we do to our DNA. And I'm so proud of our associates in terms of what I've seen them do throughout my career here at ADP, but particularly over the last three years, which were unbelievably challenging. And I know many other companies and many other employees of other companies stepped up to the plate. So I know that we're not unique, but I don't know what I know, and I only know the people I know, and they're great people doing great things every day for our clients. And that -- doing that is what has delivered the results that you guys enjoy as investors. So never forget that it all starts with our associates. I thank you for listening. This is my last earnings call after 44 of them. And like I said, I won the Super Bowl, and I like the analogy to the Dolphins. I'm not sure that I had a perfect season ever. I made plenty of mistakes, I learned from them and made myself and ADP a better and stronger company, but I definitely feel like I have one of those Super Bowl rings on. So I may have to go buy something a little bit bigger in terms of jewelry, so I can brag about it. But thanks again for listening to me all these years, putting up with me. And as I said, to our leaders and to our associates that I remain their servant leader, I remain your servant leader now moving on to becoming a shareholder and also to a Director. Thank you very much.
Operator: Thank you for participating in today's program. You may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter 2023 Earnings Call. I would like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Michelle, and welcome, everyone to ADP's first quarter fiscal 2023 earnings call. Participating today are Carlos Rodriguez, our CEO; Maria Black, our President; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. And with that, let me turn it over to Carlos."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you, Danny, and thanks, everybody, for joining the call. As you saw this morning in the news, we have a little bit more excitement than normal, but I promise you that 1.5 hours from now, we'll go back to our boring cells because we do have a business to run. But before I talk about the quarter, I thought it was appropriate to just share a few thoughts given the transition from me to Maria as our new CEO. As you know, I'm going to continue as Exec Chair, but obviously, that's going to be a role primarily to supporting Maria and also helping the Board and not really involved in day-to-day operations. So it's definitely going to be my last earnings call, which is hard to say because it’s been 44 earnings calls for me. But it's really been an incredible ride. Obviously, I could thank a lot of people. One person in particular that I do want to call out is John Jones, who is going to remain our Lead Independent Director. And the combination of John and Les Brun before him were incredible mentors to me, incredibly helpful in providing advice and guidance on behalf of the Board. And also, I'm proud to call them friends. And I also want to thank Gary Butler and Art Weinbach, my predecessors who gave me the opportunity to be here today and also help me a lot in terms of making me the person I am and the leader that I am today. I'm proud of a couple of things. I'll just mention a few. One of them is I'm proud of our growth. We doubled our revenues over the last 10 or 11 years. And today, as you know, we reached an important milestone of 1 million clients. So I appreciate -- I wish I could say that it was anything other than a coincidence. But however it happened. It's a great thing to have happened here on my last earnings call. We made it through a lot of challenges, economic. We went through, what I would call financial repression in terms of interest rates, which fortunately now we have a little bit of the opposite situation, which we'll talk about today. So there's many QEs. I think there were three QEs over my tenure. And then the final straw that almost broke the camel’s back was interest rates. Even on the 10-year going, I think it was like under 0.5% in the pandemic, which was really kind of incredible to see happen. We also made it through a pandemic that hopefully only happens every 100 years, and we had some dissident shareholders that also had some opinions about how to run ADP that we had to deal with. I'm also proud of our associates. I'm proud they've always said about their commitment to our clients and to ADP. There's something that my predecessors and the culture have around our client centricity, which is really remarkable, and our associates always step up to the plate and deliver in a business that, again, we don't get a lot of credit, and I know that we're not quite up there in terms of the list of first responders and people who save lives. But we do keep the economy going, and we do, I think, make sure that commerce worldwide operates smoothly. So our associates are the ones who get that done, and I'm proud of them. The person I'm most proud of is Maria. She's now been tested. She's prepared. She's been through a very thoughtful and long succession process, and she's going to be the -- what is only the seventh CEO of ADP. And I know that she's the right person starting from the ground up. I wish I could have said that because that's what makes this special, this place special. We love to bring in talent from the outside but we have some incredible people that grow up and know this place, understand this place and know how to make it continue to hum the way it's been humming for more than 70 years. Most importantly, she not only knows our industry, but she knows our clients' needs deeply and takes great interest in that. And that is going to serve us well, as well as for growth orientation, which I think is going to be very important for ADP's future. Last thing I'll say is that I recently told our team at a senior meeting that I tried -- I strive to be what I learned about many, many years ago, something called a servant leader. And I tried to be that way to my team and to my organization here at ADP. But I want all of you to know that I tried to be that also to all of you and to our shareholders, as much as I tried to be that way for our clients and our associates. It's been truly an honor of a lifetime to serve ADP’s CEO. And we are kind of a company that likes to fly under the radar. We kind of like it that way. So I know that nobody is going to write any books about us or they may not be even writing articles about us today, but this is one of the most successful commercial enterprises in history. All I have to do is go back and look at the track record. Most people don't do that. They don't go back and look at the 10-year to 20-year and, in our case, the 50 year. The company went public in 1961. I encourage you to look at our history, our results and our TSR and compare it to some of the greatest investors and investments of all time. And I think you'll see that ADP ranks right up at the top. Anybody who knows me knows how much I love sports and how -- what a sports -- I am. So I was trying to think of an analogy. And I feel like not only did I join the championship team, but I won the Super Bowl being here at ADP. It's really been an incredible ride. But right now, it's time to pass the torch. It's always great to have change, especially in a company like ADP because I know you can rely on our consistent, predictable results, but we also have to continue to grow for decades to come. And the only way to do that is to bring in fresh thinking and to have change. And that's exactly what we're doing with Maria. So before I talk about the quarter and the results, I'm going to turn it over to Maria and let her say a few things."
},
{
"speaker": "Maria Black",
"text": "Thank you, Carlos. You mentioned servant leadership, and I have to say that you are truly the embodiment of servant leadership. You have always kept our North Star true, which is putting our clients and our associates first. And I know I speak on behalf of all of our stakeholders, our associates, our shareholders, the communities we serve and the 1 million clients now we have the honor of serving and thanking you for everything that you've done over the decade that you served as our CEO. So my sincere thank you to you, Carlos. I'm truly humbled and grateful for this opportunity and certainly for the confidence, Carlos that you've given me and that the Board has given me and entrusted me with this role. I am genuinely thrilled to lead ADP. You mentioned it, and it's true. I did start from the ground up. I started with this company 26 years ago, selling ADP's products and offering store-to-door. This ability to really see our clients from the front line has given me a vision and a true understanding of the client centricity that you mentioned that we embody as a company. And since selling 26 years ago door to door, I've served in roles all across ADP in sales and service, implementation, operations, including our PEO and SBS. I'm really, really proud of the role that we play in our clients' lives and how they trust us to really help them succeed in their HCM journey. For the last 73 years, we've had an amazing legacy and a culture. And that culture is really anchored in innovation and it's anchored in developing and providing technology and solutions that help address our clients' needs but also help address the needs of their workers. And I'm incredibly proud to be a part of that journey as we continue the modernization that we've been undergoing over the last few years. Of course, as you mentioned, none of this is possible without the 60,000 dedicated associates that we have that are at the center of absolutely everything that we deliver. I am committed to continuing to empower their great talent, which time and time again has reshaped the HCM industry through a relentless focus on again, solving our clients' needs and predicting their future needs. I'm also grounded by our history and our own beginning as a small business out of Paterson, New Jersey, founded by Henry Taub, a man who simply wanted to help local businesses. Then and now, I know and I feel deeply that this core value continues to define us as a company. So with that, thank you again, Carlos, and thank you to the Board. And now I will thank you in advance to all of our stakeholders in your confidence as we continue to build on ADP's incredibly strong results-oriented foundation. We continue to drive product innovation, leading technology. And more than anything, we continue deliver the consistent value creation that we're known for as the leader in the HCM industry. So with that, I think it's appropriate to turn it over to the results this quarter."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thanks, Maria. Speaking of consistent value creation, let me start talking a little bit about the results here so we can get to the questions. We got off to a really strong start in fiscal 2023, with strong results that reflected the momentum we've been building for several quarters now. In Q1, we delivered 10% revenue growth, 11% on an organic constant currency basis, and this was driven by strength in a number of our businesses. And on top of that, we delivered 30 basis points of adjusted EBIT margin expansion as our revenue outperformance helped us overcome elevated expense grow over from last year's first quarter as well as continued investments in the business, which we anticipated and communicated to you last quarter. We delivered 13% adjusted EPS growth in the quarter, and we remain well positioned as we move ahead for the rest of the year. I'll cover a few highlights for the quarter before I turn it back over to Maria. Our new business bookings, we showed continued momentum through Q1 with demand strongest in our downmarket offering like RUN and our retirement services businesses, and we also continue to see strong traction in our PEO solution. At the same time, bookings growth in our international business started a bit softer than we had hoped. We're continuing to watch the demand environment in international markets as clients and prospects there are dealing with a number of uncertainties, as you know. We are keeping an eye on the macroeconomic environment as well, but overall demand remains strong, and our pipeline looks solid. We'll share further updates on what we're seeing with bookings as we progress through the year. Our ES retention was very strong with a new overall Q1 record level led by great performance in our mid-market. We accomplished this year-over-year improvement despite further normalization in small business out of business rates in the quarter. We assume we will continue to experience normalization in out-of-business rates towards prepandemic levels as the year progresses, and we are clearly very pleased with the Q1 results and -- that were better than expected. Our pays to control metric was 6% for the quarter, in line with our expectations as strong hiring that our clients have conducted these past few quarters has carried through to strong pays per control growth this quarter. We continue to expect deceleration in pays per control growth later this year, and we've seen sequential employment growth begin to slow both in the National Employment Report and in public data. But that said, job postings and other leading indicators within our client base suggest that, at the very least in the short term, demand for labor will remain solid. And moving on to our PEO. We saw a modest deceleration in average worksite employee growth in the average worksite employee growth rate, which was anticipated, but the 12% growth was slightly ahead of our expectations for the quarter, and we're very pleased with that growth. Demand for both our PEO and our ES HRO offerings remains high as the value proposition for a fully outsourced model continues to resonate in the market. And in fact, our HRO businesses combine now to serve over 3 million worksite employees out of the 40 million total workers paid by ADP. Q1 not only provided a strong start to fiscal 2023 but also represented a major milestone in our company's history. As we -- as I mentioned earlier, we crossed the 1 million client mark during the quarter. What an incredible accomplishment. We accomplished this by driving improvement and growth on a consistent basis through decades of different employment cycles, business environments and technology shifts. It's a proud moment that was made possible only because of our relentless focus on meeting the needs of our clients, as Maria mentioned, both by delivering exceptional service and providing leading HCM technology. underpinning all of this is the dedication of our associates who ultimately make ADP a company it is today. As we look ahead, we recognize the need to remain agile in this unique and dynamic economic environment. And it is certainly our hope that inflation normalizes soon without significant harm to the global economy. But if macroeconomic conditions instead prove more challenging than we'd all like, we believe our stable business model should allow us to maintain our focus on innovation and our steady approach to investment, positioning us to continue driving long-term sustainable growth for many years to come. And it's for that reason that while I am incredibly excited to have reached 1 million clients, I'm even more excited about the opportunities ahead for ADP. And I'll now turn it over to our new CEO, Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Carlos. As I mentioned earlier, I am also proud of the collective efforts of our associates who made this achievement possible. One of the beauties of having 1 million clients and directly serving 3 million worksite employees in our HRO businesses is that we have unparalleled insight into the needs of the HR department, and we are putting that insight to work. I'm proud to share that, in September, we won the top HR product at annual HR Tech Conference for the eighth year in a row, this time for a new offering we're calling Intelligent Self-Service. HR departments today devote a significant amount of time to addressing questions from their workers to help better manage this volume of worker and practitioner interaction. Intelligent Self-Service uses predictive analytics to help proactively address common issues before workers need to contact or HR leaders. Not only does this solution ultimately improve the experience for the worker, but it further enables the practitioner to focus on more strategic items, which is a key objective for our clients. There are a few different components to Intelligent Self-Service. The first is something we're calling action cards, which you can think of as proactive nudges in the ADP mobile app that appear in the flow of work so that workers are alerted and encouraged to act when there's something they need to address such as a missed time punch or time card approval. Another component of the offering is our virtual assistant chatbot, which was previously available to our clients' HR practitioners but is now, for the first time, being expanded to workers as well in order to address their requests or questions. And the third piece is case management, which helps with more complex problems that require HR systems. This feature presents a streamlined way to create, manage and track workers' interactions with our HR experts and quickly get to the right experts based on the workers made. Intelligent Self-Service is designed to create a better HR experience and reduce work, and we believe we are designing a solution that can reduce our clients' case volume by 30% or more, which, of course, would be an incredibly value-add win for everyone. We have already rolled out some of these components and are in pilot for others, but the feedback so far has been very positive. I also want to give a quick Q1 update on our new user experience. As a reminder, our new user experience represents a significant enhancement we've been making to our scaled strategic platforms using new design principles to make them even more intuitive and more personal so our users can easily leverage our solutions to the fullest. Last year, we moved clients on RUN, iHCM and Next Gen HCM as well as the ADP Mobile app over to the new user experience. And later in the year, we also moved 20,000 Workforce Now clients to the new UX. Enhancing Workforce Now is especially important given how integral the platform is to so many of our businesses, and I'm pleased to now share we've taken that 20,000 clients last year to over 80,000 through the end of Q1 with essentially all of Workforce Now clients on this new enhanced experience. Among other user experience initiatives, we relaunched the ADP RUN mobile app with our new UX with managers and HR practitioners of small businesses running payroll and HR while on the go. This app is a powerful tool for them, and the relaunch has been a resounding success. You can see the app and the reviews for yourself, but it's doing phenomenally well with 4.9 stars on several thousand reviews representing meaningful improvement from the experience it is replacing. These are exactly the types of outcomes we had hoped to achieve with this user experience work, and we are very excited about continuing to roll out to more solutions within our key platforms. From our voice of employee offering, we mentioned last quarter to our new Intelligent Self-Service capability to our UX deployment into our ongoing Next Gen rollout, our product teams are busy and our clients are excited about the continued innovation at ADP and our overall modernization journey. We look forward to continuing to develop ways to provide more value to our clients and prospects in this dynamic HCM and economic environment and to ultimately deliver on our bookings growth goals for this year and beyond. And with that, over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. Our first quarter represented a strong start to the year with 10% revenue growth on a reported basis and 11% growth on an organic constant currency basis. Our EBIT margin was up 30 basis points, coming in above our expectations as strong overall revenue growth and growing clients fund interest revenue contribution as well as favorable workers' compensation reserve adjustments in our PEO overcame inflation-related cost pressures and higher-than-typical year-over-year headcount growth. Our robust revenue and margin performance combined to drive 13% adjusted EPS growth for the quarter supported by our ongoing return of cash to our investors via share repurchases. In our Employer Services segment, increased 9% on a reported and 11% on an organic constant currency basis. Key drivers to this growth were strong bookings and retention performance we delivered in recent quarters as well as solid contributions from price and pays per control. And of course, client funds interest, which mostly benefits the ES segment, grew nicely in Q1 with 39% growth driven by a healthy 9% balance growth and 40 basis point improvement in average yield. Partially offsetting that was FX, which was a slightly bigger headwind than we had anticipated. Our ES margin increase of 50 basis points was higher than planned primarily as a result of that strong revenue growth. For our PEO, revenue in the quarter grew 13%. Average worksite employees increased 12% on a year-over-year basis to $704,000 as bookings and same-store pays both continue to perform well, though the same-store pays contributed less than it did in recent quarters as we expected. PEO margin increased 80 basis points in the quarter due primarily to revenue growth and favorable workers' compensation reserve adjustments. Let me now turn to our updated outlook for fiscal '23. I think, overall, you'll find a very steady outlook compared to our prior guidance with upside due in part to higher interest rates. Beginning with the ES segment revenues, we now expect growth of 7% to 8% and driven by the following key assumptions. First, we continue to expect ES new business bookings to grow between 6% and 9%. And as Carlos covered, we see a stable overall demand environment at this time, but it's still early in the year. And with a wide range of outcomes and we will continue to watch for impact from a potentially slowing global economy as we progress from here. For ES retention, we were happy to deliver another strong quarter, but we believe it's prudent to anticipate further normalization of small business out of business rates as we move through fiscal '23. As such, at this time, we're leaving our outlook unchanged at down 25 basis points to 50 basis points. Meanwhile, we will look to maintain our strong retention levels in our other business units. For pays per control, we had healthy 6% growth in Q1, in line with expectations, and we continue to anticipate a return to a more typical 2% to 3% growth rate for the full year as employment growth moderates. As we discussed last quarter, our pays per control growth outlook assumes a deceleration in growth in Q2 and very little growth in the second half of fiscal '23. This could, of course, prove to be either too conservative or bullish depending on how macroeconomic factors develop, but it still feels like a reasonable assumption to make at this point. Last quarter, we spoke a bit about price, and there is no change to our expectation for price to contribute about 100 basis points to 150 basis points to our ES revenue growth in fiscal '23. Our clients understand these price increases and recognize that they reflect our own cost pressures. And for client funds interest revenue, we now expect higher average rates compared to our prior outlook. Our client funds short portfolio will continue to benefit as the Federal funds rate increases over the balance of the fiscal year, and our new investments in our client extended and loan portfolios are now expected to yield about 4.3%. Between those two drivers, we now expect the average yield on our client funds portfolio to be 2.4% in fiscal '23, which is about 20 basis points higher than our prior outlook. We continue to expect our client funds balances to grow 4% to 6%. And putting those together, we now expect our client funds interest revenue to increase to a range of $790 million to $810 million in fiscal '23, up $70 million from our prior outlook. Partially offsetting this revenue upside is higher short-term borrowing costs associated with our client funds extended strategy. With higher expected commercial paper and reverse repo rates over the rest of the year, we now expect the net impact from our client fund's extended strategy to be $720 million to $740 million in fiscal '23, up $45 million from our prior outlook. One last factor to consider is our ES -- in our ES revenue outlook is FX headwind, which has unfortunately become a more meaningful drag over the last three months. We're now factoring in an FX headwind closer to 2% for fiscal '23 ES revenue, up slightly from our prior assumption. For ES margin, we now expect an increase of 200 basis points to 225 basis points, up 25 basis points from our prior outlook. We continue to expect our margins to benefit from our strong revenue growth outlook, including growth in client funds interest revenue, and we're pleased to be able to increase our outlook accordingly. Moving on to the PEO segment, where we're making very few changes. We continue to expect PEO revenue and PEO revenue excluding zero margin pass-throughs to grow 10% to 12%. The primary driver for our PEO growth is our outlook for average worksite employee growth of 8% to 10%. We now expect PEO margin to be flat to up 25 basis points in fiscal '23, narrowing our prior range higher due in part to the strong Q1 margin performance. Adding it all up, we now expect consolidated revenue growth of 8% to 9% in fiscal '23 and adjusted EBIT margin expansion of 125 basis points to 150 basis points. We still expect our effective tax rate for fiscal '23 to be about 23%, and we now expect adjusted EPS growth of 15% to 17% supported by our steady share repurchases. And now I'll turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We will take our first question from Pete Christiansen with Citi."
},
{
"speaker": "Peter Christiansen",
"text": "First, congrats to Maria. Looking forward to seeing your touch on strategic vision here and certainly to Carlos for such a successful tenure as CEO, particularly through some volatile events in the last couple of years, for sure. I just had a question as it relates to bookings trends certainly see that the outlook is held steady. And I know that we're kind of early in the selling season. But if there's any -- just wondering if you could put any color on any differentiating trends you're seeing at this point of the year, maybe perhaps versus the last year or two, maybe attach rates or on ancillary modules or even going to more outsourced models, seeing any changes in behavior there? And then as it relates to the pricing discussion that we just had, do you feel like you have any more room? It seems like your clients are responding well and things look good. But do you still -- do you think that there's potential upside to the pricing strategy? Sorry."
},
{
"speaker": "Maria Black",
"text": "Thank you, Pete, and thank you for the well wishes. I certainly appreciate them. And as you mentioned, look forward to connecting with many of you around strategic vision going forward. With respect to bookings and really thinking through year-on-year changes in behavior, I'll comment on that, and then I'll turn it over to Don that can talk about whether or not we have more room on price. . But again, just to kind of confirm the overall outlook at 6% to 9%, we do feel confident in this outlook. When I think about how we planned for the year, and we were generally pleased with the results that we saw in the first quarter, in fact, they were actually technically a record from a year-on-year perspective. But the thing that makes us not necessarily call that out in that way and really speaking to the continued momentum, to your question, it's really about in the context of the records that we've had, in the past few quarters, it's really been broad-based across every bit of the portfolio. And as you heard in the prepared remarks this morning, we had significant strength in our downmarket offerings. Really pleased to see that across our RUN portfolio, the small business segment inclusive of our insurance offerings, retirement offerings. We also continue to have significant strength in our HRO offerings, inclusive of the PEO. So in terms of changing behavior, I see that as constant behavior as it relates to -- those are businesses that have had continued strength over several quarters and the value proposition, both downmarket and certainly into the HRO space has been good. I think the area, again, that we called out a little bit that we're keeping an eye on is really our international business. Now the good news with our international business is that it's a small contributor to our overall bookings. But when we look at what really happened with the international space, specifically for this quarter, we don't still actually see a macro impact. We see more of an impact of the strength that we had coming into or coming off of a record Q4. And so when you think about our upmarket business, specifically our international business, there are times that it's a bit lumpy as we pull deals forward to accelerate through the fourth quarter. And candidly, who wouldn't want to have an incredible finish and an incredible quarter? But as it has for several decades, I would say that does sometimes lend itself to some of those businesses needing -- continue to rebuild the pipeline. So that's really what we think is happening. But at the same time, we're very -- we're keeping an eye on specifically in Europe, what's happening in the Ukraine, what's happening with the energy crisis. Those are watch items for us. But just kind of reiterate, we don't see any macro overall trends. We don't see changes in behavior. We see the strength continuing in the downmarket and into our HRO and PEO offerings, and we were very, very pleased with the results this quarter, and they are record results in that respect."
},
{
"speaker": "Don McGuire",
"text": "Yes. And with respect to the pricing, we've been very happy with our ability to execute the price increase in the way we did. And as we've said on prior calls, we're mindful of the fact that these are incremental costs for our clients as well, and we need to be competitive. So we made sure that we've price increased and passed on the costs we have in a way that keeps our customers with us for a very, very long time. Having said that, we said 100 basis points to 150 basis points. And I would tell you that, currently, we're pushing towards the upper end of that range in the price increase. So we've done very well against expectations and executed, as I said, well across the business. Of course, is there more available? Good question. If we look at our client base, particularly with the large clients, we do have contractual obligations that come due from time to time. And a number of those are tied to various price indices, et cetera. So that limits the ability to do anything beyond some of the pricing indices that drive or undermine or underlay, if you will, the price that we have. But I guess I would say we've been very happy with where we are now, and we'll always look to see if there's an opportunity. But I think that we want to make sure -- we will continue to make sure that we do what's best for ADP in the long term as opposed to being too overzealous, if you will, with short-term price increases."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tien-Tsin Huang with JPMorgan."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Great. Carlos, I want to say, again, again, grateful to have worked with you and share the time and learn from you from, I guess, over 40 earnings calls and meetings and stuff. So I appreciate that. And of course, congrats to Maria. I want to just ask, if you don't mind, 100% agree from the release, Carlos led the transition from payroll to HCM. So I know you can't tell us everything in terms of what's next here, but is it fair to think the focus might be more so on the employee now in addition to the employer, in addition to modernization, maybe data? Just maybe some thoughts there would be great. Love to hear it."
},
{
"speaker": "Carlos Rodriguez",
"text": "I think that was for you, Maria, given that I'll be sitting on the beach."
},
{
"speaker": "Maria Black",
"text": "Fair enough. Thank you for the chance to comment a little bit. Obviously, early days as it relates to -- I mean essentially starting as early days as it relates to having conversations around long-term strategy. I think the first thing I'd like to reiterate, I know I talked about my 26 years here. I have spent eight of those as part of the incredible management team that Carlos alluded to earlier, and that's been a part of the journey that we've been on as it relates to the overall modernization journey. So I think you mentioned the transition from payroll to HCM. That is a piece of that modernization. But in my mind, it's more broad-based than that. It's really been about the decisions we've made, everything from our strategic locations to early days of platform migrations to configuring our organization to really create a technology organization. We've been actively modernizing our service organization. You hear me speak about that all the time in terms of continuing the modernization of tools but also making sure that we're taking the work out for our clients. We've been making a transition to the public cloud. And then one of my favorite topics is the modern selling approach that we've been embarking upon that really, as we go on for many years as we found it inside sales, if you will, 20 years ago to the most recent during the pandemic, really focused on digital selling and meeting the buyers in a different way. So I think all of that is really about our modernization journey. And I think as I look forward into the next decade, if you will, in the next chapter, it is really about continuing the great work and the foundation that you mentioned that Carlos laid. I have a lot of passion around our clients. I have a lot of passion around the 40 million workers that they pay and how we can create value for each one of those stakeholders, both the workers as you mentioned, the clients' employees as well as our clients. And my ultimate goal, Carlos touched on it, I think I mentioned it as well upfront, when I think about client centricity and really solving meaningful things for our clients, I think the last decade in this modernization journey has really been about setting us up to be able to deliver value in a very different way for our clients. My goal would be to continue that journey and, in the end, make sure that our clients are in love with our products and in love with the experience that they have with ADP and the true evangelists of what it is that we bring. And I feel confident in how we've been set up to embark on that journey, and I look forward to sharing more with you on it as we move forward."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kevin McVeigh with Credit Suisse."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. And my congratulations all around as well. Carlos, I guess, why is now the right time? I mean you've done an amazing job, you're still incredibly young. Just any thoughts as to why transition now?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Actually, it's a good question because, honestly, it's something that we started -- we were joking about it yesterday, that I started talking about this about 12 months after I became CEO. Not that I was trying to leave 12 months after I became CEO. But in case people haven't noticed, I'm like a business junky, right? So I just love business. I also love kind of the whole idea of like a successful commercial enterprise, and you have this kind of tension in this area of succession where the longer you are around, the more you know. There's some studies out there that show that beyond a certain amount of time is really when CEOs hit their stride. But then there's an equal amount of research that shows you move beyond a certain time, you become stale. You don't have any new ideas. You become enamored with your own ideas and thoughts. And so I have not written the book on this, but I read a lot of books on this. And my sense was that kind of beyond seven years was -- there was diminishing returns based on my \"research.\" And you can see that I made it past that. And some of that was -- circumstances, I think, made it such because I didn't have any specific goal. Like I'm not trying to run out the door. My -- the only thing I want to do is the best thing for ADP, and the best thing in this case now for Maria and for our Board. And so this is a collective decision over -- I know it's hard to believe but really over a decade as to what the right timing was, who the right person was and how to position them for success and how to position the company for success. By the way, that also involves -- we had a very meaningful refreshment of our Board that, I think, is something that has to be taken into context because it's all a package, right? It's the right CEO, the right Board, the right Board leadership. And so I think that bringing the Board along, I think, required a little bit more time than I had expected. So that's a long way of saying I don't have any magic answers to what the right time is. What I know for sure is not the right way to do it. There's nothing to do with my age and whether I'm young or I'm old or whatnot. It has to be done when it's the right time and it's the best thing for ADP, and I think that's what we just did."
},
{
"speaker": "Kevin McVeigh",
"text": "That makes a lot of sense. The numbers speak for themselves. So I'll leave it there. Congrats again."
},
{
"speaker": "Carlos Rodriguez",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kartik Mehta with Northcoast Research."
},
{
"speaker": "Kartik Mehta",
"text": "Carlos, just -- or Maria, just your thoughts on the economy. Obviously, I look at your results and things look good. I know you said maybe the second half, you're just being a little bit more cautious. But as you look at kind of the numbers now and you talk to your customers, just your thoughts on how the economy looks now and just kind of the outlook over the next six to nine months?"
},
{
"speaker": "Carlos Rodriguez",
"text": "So we obviously don't have the market cornered on economic forecast. We do have a reasonable amount of data, particularly on what I would call the near-term next few quarters, I would say. But when you look at the last two, three, five years, 10 years, really, as long as I've been doing this, you have to be really careful about taking economic forecasts at face value. So you have to be careful. You have to be prepared for all eventualities. And that's why we like to call ourselves an all-weather business model because I think we actually perform, I think, through a variety -- obviously, better in some than others. But I guess that's the way of saying we're not obsessed with economic forecast because if I had taken economic forecast at face value over the last three or four years, we would have made numerous mistakes. And I think all I have to do is go back. I know nobody does this because otherwise there wouldn't be -- economists wouldn't exist. But if you look at what economists forecast 12 months prior and then what actually happened or 20 months prior to what actually happened, that's not really the right way to run a business. But it doesn't inform our decisions right, and our planning. And as you mentioned, what happened this year in terms of our fiscal year planning is we thought -- kind of common sense told us that some of these things were going to happen like normalization of downmarket retention, right, towards hopefully still above pre-pandemic levels but not at the kind of levels they were when the government was providing so much support for small businesses that you could just see it in the data in terms of the drop in bankruptcies and out of business and so forth. So we expected some normalization there. Likewise, pays per control, it's not -- you just don't make numbers up. Like we -- if you assume that you reach kind of \"full employment\", and that the population and employment [Audio Gap] employable people is growing at a certain rate, you can kind of back into kind of a normalized pays per control rate, and then you sprinkle in a little bit -- maybe there's going to be some economic weakness in the back half. And I think what we signaled and what we have in our plan is, I think, kind of flattish pays per control growth, which to me personally is feeling conservative right now based on the -- we feel like we have this kind of continued strength into this quarter, and that typically doesn't fall off the cliff right away. But maybe that happens in the first quarter of '24 that it becomes flattish. I don't know. But I know that right now, there are definitely still -- we got back to what employment was pre pandemic, but the population also grew and the employable number of people grew. So labor force participation is still below where it was before. So there is definitely still room for some employment growth there. So this could be a very strange slowdown, right, or if you want to call it a recession, where it's, I think Danny calls it a labor full recession where it doesn't feel like employment, at least the stuff that we look at background checks, job postings, et cetera. I mean if you look at the jokes, you look at everything, there's still a lot of -- we had 260,000 jobs created -- and that wasn't 500,000, it wasn't 1 million, but in any other environment, that would be like an incredibly strong number, but it's clearly is clearly slowing, but everything we see is that the labor markets remain, again, in the time horizon that we have visibility to pretty strong or certainly not as strong as a year ago or when we were in the middle of the recovery from the pandemic, but that's really more of the comparisons than kind of anything underlying. So I think we're just heading back to kind of more normal rates, but in an unusual way where the labor market doesn't appear to be the leading the leader in the slowdown. It appears to be people spending less on stuff that they spent a lot of during the pandemic, if I can be bold. That might be like exercise bicycles. It might be things like grills, like -- and maybe even, unfortunately, for a company that's close to my heart, software, right, and some things that are -- that you have these kind of, unfortunately, fluctuations of demand that we've never seen before. And so the now how do you predict and forecast how that all kind of lands in the medium to longer term. It's very, very hard for any company to do. But specifically for us, labor is still strong. As long as labor is strong, our clients are still looking for tools to employ, to hire and to manage that labor. And we have this other little weird thing happening to us, which is really fantastic, which is interest rates are rising. And they’re rising in the face -- I mean, typically, when interest rates are rising, the economy is slowing, and that's exactly obviously what the intent of the Fed is. But right now, you're kind of at this point where we're getting this big tailwind from interest rates, and it doesn't feel like that's going to change again in the near term. It doesn't mean that rates won't stop increasing, but if rates stop increasing, like, for example, like in the spring of '23, and they stay there, home run for ADP. All of you and everybody internally here at ADP make fun of me when I used to talk about how our balances in 2008 were like $15 billion and they had grown to $30 billion, but our client funds interest had been cut almost by 2/3 because of interest rates. And I used to say, \"Can you imagine if interest rates go back to where they -- near back to where they were back then, but our balance is now are $33 million and growing, I think it was 9.5% this quarter, wouldn't that be amazing?\" And that's exactly what's happening. So I'm leaving a little bit of gas in the tank for Maria. Well, actually, I can't take credit for that. I appreciate Chairman Powell helped with that. But we -- I think we have some gas in the tank here with interest rates as well, which again, is a little unusual, but I don't know if you want to call it a hedge to our business model, but -- it's definitely welcome because we are -- as you know, we always carefully watch our expenses and everything in ADP, but it's a much better place to be from an ability to invest and an ability to weather when you have this significant tailwind, which is not a secret. I mean I think Don laid out the numbers, and you can do the math. It's a pretty big tailwind."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jason Kupferberg with Bank of America."
},
{
"speaker": "Jason Kupferberg",
"text": "Congrats Maria. Congrats to Carlos as well. I had two questions. The first one, just, Maria, picking up on your comments around some of the Intelligent Self-Service offerings. I think you made mention of the potential for customer service cases to be cut by 30%. I was just curious to get a little more color around that, what might be the time line for achieving that goal. And is that any kind of rough proxy for how much your customer service costs could be reduced over time if this is successful?"
},
{
"speaker": "Maria Black",
"text": "Thank you, Jason, for the well wishes. And I'm actually -- I'm glad you asked this question because I wanted to make sure there's clarity around that 30%. And that 30%, just so we're all on the same page, it's really about our clients being able to save that time. So this is really about serving up, leveraging intelligence, artificial intelligence, machine learning. It's really serving us the most frequent interactions that can be either performed in a self-service capacity or really performed again through this case management and really taking the work out than necessarily, call it, taking the work out of our system. It's really about giving that 30% to our clients. In fairness, it is early days as we measure this. And when I say that, I'd say that lightly in that we did study this across our 3 million HR worksite employees, if I may call them that, that in terms of the most frequent cases that get served up and what that would yield in terms of a return to our clients. And that's where that 30% comes from. But as we launch this product and more and more adoption happens, we will be keeping a keen eye on that outcome to ensure that, that number remains true, and our hope is to continue to make progress and take more work out of our -- out of the system for our clients as they navigate the relationship between them and the practitioners and the workers."
},
{
"speaker": "Jason Kupferberg",
"text": "Just one quick follow-up. Just if nothing had changed in the rate environment since the time of the last earnings call, would you guys have raised revenue or margin guidance for fiscal '23?"
},
{
"speaker": "Don McGuire",
"text": "I think it's -- certainly, the rates helped us. But just a couple of things to comment on. Certainly, we still we're performing well against our internal expectations on margin improvement. So we're still very focused on spend and efficiency of spend, et cetera. But I don't think that we would have been as -- we wouldn't have been as eager to raise expectations in the absence of interest rates, especially given it's still Q1, and we need a little bit of time to see how things progress over the next couple of quarters."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, that's fair. But I'm pretty happy with the results because we -- Don, this is just the way our culture is. So everybody is talking about all the positives that we have, like interest income and so forth. But we had some headwinds as well. Like our T&E is up significantly. Remember, last -- it's hard to remember that last year, this quarter, I think we were still in the whole Omicron thing. It was just starting and we really hadn't opened up most of our buildings. I think our salespeople were for sure in the field but not traveling and spending the way they are now. By the way, we were very grateful that we have them back in the field. . So like there are a couple of things like T&E is the smallest of them. The biggest one is when you look at our headcount numbers, it hasn't come up yet, but our sales force is I think, more than fully staffed. And as you probably heard from our comments six to nine months ago, it was difficult to get there back then. Now not only are we fully staffed but our turnover is coming down across the board not just in sales but also across the rest of the organization. So all of a sudden, if you look at our headcount growth for this quarter, it is what I would call a peak and the highest I have ever seen since I've been here at ADP. That was necessary because there was some catch-up, which is why we -- I called it a grow-over issue from last year's first quarter, where we were definitely understaffed, didn't have enough people. And then all of a sudden, our revenues actually were outperforming. The number of clients is outperforming, and you know how important retention is to us. So we set to basically stop up across the Board implementation, service and sales. And that's when you had that whole great resignation thing happening at the same time. And it was -- I mean, again, I don't think most companies go around talking about this, but we were trying to hire as fast and as many people as we could at that point. The good news is we were successful. I think the better news is that puts us in, I think, in a good position in terms of staffing and sales, but also in terms of our service and implementation organizations. And now with declining turnover again, from a plan standpoint, besides planning for patient for control to be \"flattish\" in the second half, our headcount growth declines -- the growth of headcount declines every quarter for the next 4 quarters. And I think that, I think, should help us feel good about this quarter and also about the fiscal year. So I think technically, Don is correct. By the way, if you go back to ADP's 10-year history, this has been a weird two or three years like us not raising as we hadn't raised in the quarter, again, I don't know what you would have thought of that or what it would have meant, but I think that's pretty -- any maybe can confirm or tell me I'm wrong, but like we weren't in the habit of changing a lot in the first quarter because this is -- how can we say this is a predictable, stable business that we know what we're doing and then changing set every quarter. It doesn't make sense. Now we have a pandemic, that's a different story. Like we struggled like everyone else to kind of keep a handle on what things were happening -- how things were happening on the way down and also on the way back up. But this is going to be a much more stable environment. I would hope some of you would welcome that. But with 10%, 11% growth organic and our headwinds from expenses abating here a little bit, I think we're in a pretty good position."
},
{
"speaker": "Danyal Hussain",
"text": "Jason, the only other thing I would point out is that in addition to interest becoming more favorable and contributing to most of the raise as you can calculate on your own, FX obviously also got worse. So in this parallel universe without a higher interest rate, we would perhaps be absorbing that higher FX and not changing the outlook."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bryan Bergin with Cowen."
},
{
"speaker": "Bryan Bergin",
"text": "First congrats, Carlos, on your success; and Maria, on the promotion. I wanted to just start with a more specific follow-up on the bookings trends in the pipeline. Can you just give more color on what you're seeing in those forward sales indicators, lead volumes, sales cycles in recent weeks? And really just any discernible changes you've noticed there?"
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. I think Maria can talk about -- I think she's actually been looking into a lot of the details around pipeline disorder. The only thing that I would add is color commentary. I was trying to defer to Maria on kind of the big picture in terms of bookings. But since I've been doing this for a long time, 44 quarters and then many years kind of watching from, I guess, a year before that as not quite a year, but as President, and before that, I really paid close attention to all this stuff. And Maria mentioned it, but the problem with the crystal ball right now is that when we have the kind of finish we had, you saw how enthusiastic we were and how bullish we were in terms of our finish and whatnot. And almost predictably, when we have that kind of finish, about half of our business, we count the bookings when we sign a contract. And the other half, we only count the bookings once the client starts. And that portion of the business that -- like, by the way, that's the way most companies that sell to larger clients book their bookings, which is when you sign a contract. That's why it's called bookings. That has always been an issue when we have this very strong quarter and very strong finish, the pull-forward stuff has been driving me crazy forever because we have very strong incentives and what we call accelerators in terms of commissions and so forth that drive, and we want that because we want to get the revenue as quickly as possible, but that sometimes leads to kind of a weaker start. The problem here is that on top of that, now you have a macroeconomic challenge potentially, we definitely have a macroeconomic challenge in Europe. Luckily, it's not a huge part our bookings. So it's hard to differentiate. But what I would tell you, again, back to color, the businesses that we count the bookings when they start are mostly the downmarket businesses. So that would be SBS, PEO, et cetera. We had double-digit bookings growth in those businesses. That makes me think that it's unlikely that, all of a sudden, we have an economic whatever challenge or disaster because why would those businesses still be performing the way they are. But I would just -- a forward-looking statement, I would say I don't know for sure that that there isn't a problem in terms of demand or the economy or whatnot, but it doesn't feel from the first quarter like we could put our finger on something that says, holy cow, we have to put the kind of the red flag or the yellow warning flag up just yet. And I don't know, Maria, if you have comments in terms of a little bit more tangible…"
},
{
"speaker": "Maria Black",
"text": "Yes. Thank you, Carlos. He's right. Carlos is right. I've been studying deeply the pipeline specifically of these businesses that recognize bookings potentially have some of the pull forward into the fourth quarter. And that's primarily in the larger size type of organizations. And so in studying the pipeline kind of segment by segment, country by country, if you will, and deeply, it does appear that the pipelines are there, the pipelines are continuing to build when I think about deal cycle time, right? So you think about all the data points we are analyzing on a daily basis to really understand the question you're asking, Bryan, which is, is this an economic and macro, is this -- what is this. And the answer is, from a pipeline perspective, the pipelines are healthy. From a deal cycle time, let's go back to Carlos' commentary. It does appear that we did have a lot of pull forward, and there were potentially not enough days to pull things into the first quarter. And we have -- again, what does that really mean in the macro? It's really returning to more pre-pandemic levels. So these are not concerning deal cycle times. These are actually more normal deal cycle times, the ones that we saw pre-pandemic. What I'm referring to there is really there used to be a time that it did take a lot of time to move larger deals through the system because so many individuals are involved, whether that's on the contracting side, the legal side. During the pandemic, there was a deal acceleration that happened, and a lot of that has to do with us being stationary. That's no longer the case. We see that every day in terms of the world is back at work. And companies are reporting in the news, we are seeing incredible strength amongst our client base. We're seeing demand for HCM. There is 6% pays per control growth. So as Carlos mentioned earlier, the jobs are there. Our clients are growing. Our products and offerings fit right into that sweet spot that everybody is still trying to solve for, and our pipelines are healthy. So at this juncture, there really isn't a macro broad-based trend that we can see besides the watch areas we've called out. I think the only other comment I would make, I alluded to it earlier, and is please remember that when a quarter ago, we gave the guidance for the 6% to 9%. The way that we thought about the year, first and foremost, the first quarter is the lightest quarter for us from a pure dollar perspective. So it's the smaller contributor from a dollar perspective on the full year. The way that we planned the year, which we talked about on the 6% to 9% bookings guidance that we gave a quarter ago was really assuming some elements of a slowdown in the back half, specifically in the fourth quarter. So it's really about this quarter, i.e., the current one that we're in, which is the second quarter and the third quarter, and so in looking at where we stand today, we feel confident in the 6% to 9% in terms of how we plan for it. We didn't assume massive and severe recession, but we definitely have assumptions in there that we feel confident at this point that we can execute against."
},
{
"speaker": "Carlos Rodriguez",
"text": "And one of the -- if I can just add like one of the beauties of our business model is that bookings are, for sure, an incredibly important thing, especially kind of over the longer term. But I mean, I hope it's obvious that, from a revenue standpoint, again, with visibility only for the next two, three quarters, we have -- it's really about converting prior sales, which were incredibly strong in prior bookings. I mean you saw what our bookings results were for the fourth quarter and for the year. So that's the stuff that now turns into revenue in those businesses where we recognize the booking at the time we sign a contract. So that -- it's just -- I know it's obvious but just a reminder because this business doesn't -- we're not selling widgets, where if you stop selling widgets, like all of a sudden you're back to zero next quarter, like the -- I think we have a solid revenue plan that I think reflects, as Maria said, what I think was already a pretty conservative number in terms of bookings growth, particularly in the back half of the year. So we may have other issues like FX on the negative side, clients fund interest may help even more or may help less, but I don't think the bookings issue is a fiscal '23 focus item in terms of impact on revenue."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. All right. A follow-up on retention then. It seems like it's fair to say you beat your plan in 1Q. But what do you attribute that 1Q success to? Was it more a function of a slower rate of SMB out-of-business losses? Or do you think it also did better on the controllable factors as well?"
},
{
"speaker": "Carlos Rodriguez",
"text": "It's really -- I think it's -- the controllable factors, I think, are the most satisfying part of the whole story because the story is kind of playing out a little bit the way we expected, which is small business is kind of in the process of kind of normalizing. But the really -- by the way, positive ironically in our international business, which might not be so ironic because the challenges economically, there are probably getting -- convincing people that they stay put. I don't want to say that it's not all great execution because we have a great leader in international, and we have the former great leader of international here, which is Don McGuire. So there's a lot of great things that have happened in that business that are probably powering some underlying improvement in retention. So some of it is probably inertia as a result of what's happening in the economic environment there. But the most satisfying part of the whole story here is what's happening in the mid-market, where I think some fundamental improvements that we made pre-pandemic, you remember all the pain in terms of the migrations and then the improvements in product, the UX experience improvements, all those things, it just seems like it's ratcheted up the \"potential\", the maximum potential retention, if you will, for our mid-market business, which was a record this quarter as well. Clearly, the down market -- the pace of normalization of the down market has some impact. But the big story, I think, this quarter was really the mid-market, and our international business has helped a lot on the retention side."
},
{
"speaker": "Danyal Hussain",
"text": "Bryan, I'll just confirm the down market didn't really contribute to the outperformance versus our expectations. So the mid-market was clearly the bigger piece."
},
{
"speaker": "Operator",
"text": "Our next question comes from Samad Samana with Jefferies."
},
{
"speaker": "Samad Samana",
"text": "I'll congrats that is given so far as well. Maybe just a question. When I think about the transitioning of the Workforce Now base to the new UX and the progress there and -- market, how should we think about maybe that were going to translate into monetary benefits? Is that more of a benefit in gross margin for a lower cost to serve or just less back-end work or higher retention, all of the above? Just help us maybe map what the kind of economic outcome is from moving over to the new UX for ADP."
},
{
"speaker": "Maria Black",
"text": "I have a lot of time for our new UX. I can't boast about it enough. And the majority of that reason is all of the above. We expect this to impact our clients' satisfaction, their retention, our ability to demo more, sell more. In terms of teasing out the specific results difficult, but the answer to your question is all of the above."
},
{
"speaker": "Samad Samana",
"text": "Got you. And then maybe one for Don, any thoughts on locking in or changing duration with rates where they are? Just as I think if I look back historically at the presentation, yields currently are higher than they've been at kind of any time for even what the long end of the portfolio looks like. Any -- any view on changing duration? I know you guys get what the mix is, but I'm curious if it were locking it in for a longer duration."
},
{
"speaker": "Don McGuire",
"text": "Yes, I'm going to start on this, but something tells me Carlos won't be able to resist following up on whatever I have to say here. So I guess I would say that the laddering strategy that was implemented a number of years ago has delivered great returns. And while I think everyone can see the temptation of changing the duration and trying to benefit more from short-term rates, rates will either normalize or they may even come down again at some point in the future. So this laddering strategy that's been deployed over the number of years has served us very well, and we expect it will continue to serve us well. And not to say that this question doesn't come up from time to time if we discuss it. But every time that we look at it, we -- you really either -- you're making a bet for today as opposed to for down the road. And given the positive experience we've had, it doesn't really behoove us to make any substantial changes to a policy and a program that has been doing very, very well. Carlos, I'm sure..."
},
{
"speaker": "Carlos Rodriguez",
"text": "I have nothing to add other than -- I obviously picked the right time to retire. Very well said. And because I think that encapsulates lots of other things where we focus more on the longer-term in the medium term rather than because, again, if rates do normalize, as you said, we're going to be very grateful that we -- that our extended portfolio that we took advantage of these \"higher rates\" that will help us for two, three, in some cases, five years down the road. So it's the right -- we're not a financial services company. We're not a bank, and that's not the kind of best that we're trying to make here. This is just -- happens to be a nice little windfall as a result of a business model that we have that allows us to kind of manage float income at a very, very large scale. And anyway, well said."
},
{
"speaker": "Samad Samana",
"text": "I think we all appreciate the institutional continuity as the transition occurs."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird."
},
{
"speaker": "Mark Marcon",
"text": "Carlos, congratulations on a great tenure not just as CEO but everything that you did prior to that. And Maria, look forward to working with you and getting to know you even more over the coming years. I'm wondering, can you talk a little bit about how you're set up for this current fall selling season? Certainly, you've got a number of big product improvements. Which ones could we end up seeing like being incremental in terms of PEPM? And just how strong do you think the sales momentum could be? How are you thinking about your marketing efforts, particularly with all the improvements that you've got in place?"
},
{
"speaker": "Maria Black",
"text": "Yes. Thanks, Mark. And similarly, I look forward to spending more time together, and I've appreciated the time thus far that we spent together getting to know each other. So in terms of selling season, we do feel -- I think Carlos mentioned, I think the first call-out I would make, I know you asked specifically about products and contributions PEPM, but I think it's important to go back to the discussion that Carlos had around headcount. So I've been -- I spent some of last year and last fiscal year speaking about a flattish headcount growth as it related to sales. We committed to a -- business growth heading into the quarter, and I'm pleased to report, as Carlos alluded to, that we are ahead of those plans. And so what that means is that we have more quota carriers in the system as we head into selling season, significantly more than we expected but significantly more than last selling season. And that, in and of itself, is the biggest contributor that we have to our overall results as we think about the productivity of more people in the system and, as Carlos also mentioned, with tenure of those associates picking up the increase in productivity of our sellers as they lap the 10-year band. So I think that's the biggest variable I see. We do have a lot of amazing things as it relates to products in the system. Certainly, the new user experience being broad-based across all of the products gives the sellers an extra step in their momentum as they head into the end of the year as it relates to demos due to that nature. I mentioned some of the other products such as the voice of the employee and our Intelligent Self-Service, which both serve us up through our mid-market. So that mid-market value proposition is continuing to grow. The other is the strength that we are seeing in that PEO and the HRO are comprehensive and managed services business -- businesses as it relates to customers that are continuing to face the complexity. By the way, whether they are up market, in the mid-market or even down market needing more of those tools to navigate the complexity of being an employer, and so we see tremendous strength there. And so we're making good progress on our Next Gen. Very pleased to see specifically on our Next Gen Payroll how that's resonating in the mid-market with Workforce Now. And as we continue to increase the addressable area that we are able to target with those offerings undoubtedly will yield, as you suggested, greater sales, greater PEPM as well some of these enhanced features and products that are served up through our existing platforms that I've mentioned before."
},
{
"speaker": "Mark Marcon",
"text": "That's great. And then with regards to Next Gen Payroll, can you give us an update in terms of what percentage of the new Workforce Now clients are now getting Next Gen Payroll?"
},
{
"speaker": "Maria Black",
"text": "Yes. So we are -- we committed to -- and I've been talking about kind of that 50% of our overall mid-market and Workforce Now clients, and we continue to make progress on that. So we're not entirely -- at the entire market that work with an outsource today. But each and every day, actually, in every release, we continue to clear the path for more and more opportunities to be able to participate in that Next Gen offering, which is truly the game changer for ADP as it relates to the innovation there."
},
{
"speaker": "Mark Marcon",
"text": "That's terrific. And Carlos, in terms of sports analogy, maybe Don Shula might be appropriate, great track record. Congrats."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes, listen, I appreciate that because I joke around with people that I used to actually watch TV and sports a long time ago, but there was like about a 20-year period where I have no idea what's going on. But I do know Don Shula and I know the goose egg defense, I think they were called to say, whatever the hell they were."
},
{
"speaker": "Mark Marcon",
"text": "It was the no-name defense."
},
{
"speaker": "Carlos Rodriguez",
"text": "So no-name defense. There you go there. I screwed it up. It was trying to prove that I actually knew something about sports and I blew it so. But I appreciate that. That's greatly appreciated. You're a class act yourself, Mark. Thank you."
},
{
"speaker": "Operator",
"text": "We have time for one more question, and it comes from David Togut with Evercore ISI."
},
{
"speaker": "David Togut",
"text": "Good morning, and congratulations, Carlos and Maria, Carlos, all the best for you in the next chapter. Don, a question for you on pays per control growth. 6%, clearly well above the 2% to 3% guide. But as you noted, contemplated, can you walk us through the sequencing of kind of pays per control in terms of what's embedded in the quarterly thought process as we go through FY '23?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So I think we were happy with 6% growth in the first quarter. And once again, back to Carlos' earlier comments, if you had believed all the economic forecasts, you might not have been expecting to see that stronger growth in pays per control. But we do continue to see the pays per control growth moderating down in the first half of this year. And as we shared -- as I shared in the prior -- the prepared comments, we have virtually zero pays per control growth in the back half of the year. So we do expect that we should -- given the strength of the first quarter, the first half should be a little bit better. I think we've reflected that in some of our guidance here already. And as we go through the next few months, we will be in a position to better decide whether we think we're going to be bullish or bearish on what's going to happen in the back half. And quite frankly, I think we'd all like to be very bullish about what's going to happen based on the first quarter's results, but I think if we did that, we'd kind of look a little bit foolish given all the predictions and all the storm clouds that people are talking about. So 6% first quarter slowing for the first half and then essentially very little growth if any, in the back half is what we're looking at."
},
{
"speaker": "Carlos Rodriguez",
"text": "Yes. And I think the simple math is, again, rather than getting into individual quarters because that talk about trying to like -- it's very hard to pin down that exact number. But I think ballpark, 6 for the first half, zero for the second half, gets you to 2 to 3 that you have for the full year. I mean that's probably the right -- obviously, the way we laid it out is slightly different than that but that's close enough, I think, for what you're trying to accomplish, I think."
},
{
"speaker": "David Togut",
"text": "Appreciate that insight. Just as a quick follow-up. Looking at Slide [Audio Gap] zero, the 25 basis point increase for the full year. Can you walk us through how big the workers' compensation reserve adjustment was in the September quarter and how you expect that to trend through the year?"
},
{
"speaker": "Don McGuire",
"text": "Sure. I mean, I can give you the specific numbers, you'll see them later in the Q anyway. So the -- we had a $14 million positive adjustment in the first quarter, and that compares to a $10 million positive adjustment in the first quarter of last year. So not that significant, $4 million, give or take. So that's the -- those are the raw numbers. We do not expect to see as good a reserve release in this fiscal year as we saw last year. There's still several quarters to go through, and the actuarials let us know what those numbers are, but we are contemplating the same level of reserve adjustment or recovery as we did in FY '22."
},
{
"speaker": "Carlos Rodriguez",
"text": "The only -- the other color commentary that I would add is, I think the PEO -- again, if you look at last year, it's obviously, we've seen, as expected, some deceleration, but I would call 12% employee growth is still pretty strong. That obviously requires investment, right, in terms of service, implementation expense, et cetera. And so I would say that the PEO is one of those places where we were really adding a lot in terms of expense and resources from a place where we were not where we needed to be, call it, last year's first quarter. So that's the poster child, I think, for this kind of grow-over expense situation that we have. But the good news is, I think, is we are -- we're staffed. Again, turnover is improving across the board in terms of all parts of ADP. And I'm talking to other CEOs, I think this is happening kind of across. Things are just kind of settling down. That helps a lot because improvements in tenure help a lot in terms of productivity and just getting the work done."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer portion for today. I am pleased to hand the program over to Carlos Rodriguez for closing remarks."
},
{
"speaker": "Carlos Rodriguez",
"text": "Well, what can I say? Another disappointing quarter where no one asked about the dividend. So let me just say that if the Board -- obviously I don't want to get ahead of the Board, but if the Board approves a dividend increase in November, this will be our 48th year of increasing dividends, which I think is a pretty elite group out there. And if you look at our payout ratio and you assume the Board will want to stay in the same payout ratio, you can do the math in terms of what's going to happen with our dividend. I think people really way underestimate. I hope this doesn't become an environment where for the next 10 years people are very focused on dividends because that has its own negative implications. But if you look at over 50 years or 70 years or 100 years, dividends matter, right? And compounding growth of dividends matters a lot. If you look at ADP's return, I'm doing a little math since we went public, which is why I was bragging about this being one of the most successful commercial enterprises in history. And again, and all of you have the same HP 12C calculators, you do that math, it's a pretty important driver of overall returns. So I'm incredibly proud of that. Maria gets to be the person who will preside over the celebration, again, forward-looking statements assuming we get there, of reaching 50 years, which will make us a dividend king. And I think there's only like less than 15 companies that have accomplished that, and some pretty incredible names. So that's the only thing I want to talk about was the dividend and the one last comment I have is what I've always said, and I'll say it again, I'm incredibly grateful. I'm grateful to my team. I'm grateful to Maria. I'm grateful to the Board. But the people who really get all the work done are the people on the front lines here at ADP, the 60,000 associates that make everything happen for us. There's something that Henry Taub put in the water that has created this culture, a can-do culture of delivering consistent results, not just from a financial standpoint before our clients. I think it's just fundamental to what we do to our DNA. And I'm so proud of our associates in terms of what I've seen them do throughout my career here at ADP, but particularly over the last three years, which were unbelievably challenging. And I know many other companies and many other employees of other companies stepped up to the plate. So I know that we're not unique, but I don't know what I know, and I only know the people I know, and they're great people doing great things every day for our clients. And that -- doing that is what has delivered the results that you guys enjoy as investors. So never forget that it all starts with our associates. I thank you for listening. This is my last earnings call after 44 of them. And like I said, I won the Super Bowl, and I like the analogy to the Dolphins. I'm not sure that I had a perfect season ever. I made plenty of mistakes, I learned from them and made myself and ADP a better and stronger company, but I definitely feel like I have one of those Super Bowl rings on. So I may have to go buy something a little bit bigger in terms of jewelry, so I can brag about it. But thanks again for listening to me all these years, putting up with me. And as I said, to our leaders and to our associates that I remain their servant leader, I remain your servant leader now moving on to becoming a shareholder and also to a Director. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you for participating in today's program. You may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 4 | 2,024 | 2024-07-31 08:30:00 | Operator: Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Fourth Quarter 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President of Investor Relations. Please go ahead.
Matthew Keating : Thank you, Michelle, and welcome, everyone to ADP's Fourth Quarter Fiscal 2024 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you also find the Investor Presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. The description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from current expectations. I'll now turn it over to Maria.
Maria Black : Thank you, Matt and good morning. Before we get started, I'd like to take a minute to thank Danyal Hussain for leading Investor Relations for these past several years. He helped lead us through the pandemic and helped Shepherd our CFO and CEO transitions during his time. With Danny moving on to a broader role, it is my pleasure to officially welcome Matt Keating to his first call. Congratulations to you both. We closed out the year with a strong fourth quarter that included 6% revenue growth, 80 basis points of adjusted EBIT margin expansion and 11% adjusted EPS growth. For fiscal 2024, we delivered 7% revenue growth, 70 basis points of adjusted EBIT margin expansion, and 12% adjusted EPS growth, representing another great year for ADP. I'm excited to share the progress we've made across our three strategic priorities, but first I'll start off with some additional highlights from our results. Our sales and marketing team delivered exceptional employer services, new business bookings in Q4, on top of a strong Q4 last year. This performance was broad based, showing continued strength in our small business portfolio, as well as our mid-market enterprise and international businesses. In fact, we sold and started more than 50,000 new small business clients during the quarter, which not only reflects the strength of our run solution, but also our reputation for commitment to strong service. Similarly, in the enterprise space, client interest in our next-gen HCM solution has exceeded expectations and resulted in strong Q4 sales, and we are excited to continue this great momentum. As a result of this exceptional performance, our fiscal 2024 employer services bookings growth came in at 7%, the high end of our 4% to 7% guidance range. This growth speaks to the power of ADP's unmatched distribution model, which remains a clear competitive advantage for us. With our new business pipeline even stronger than this time last year, we look forward to building on that momentum. Overall, our employer services retention came in better than expected for the year at 92%. We drove record level retention in our mid-market business for the second consecutive year in fiscal 2024. I'm also extremely proud to share that our client satisfaction scores for our total business reached new all-time highs for both the fourth quarter and full year. These results are a testament to the strength of our entire product portfolio and our commitment to supporting our clients. We are confident that these client satisfaction gains will support our retention results moving forward. Our employer services pays per control increased 2% both for the quarter and the full year. We were happy to have seen the resilience of the US Labor market, as our clients continued to hire employees at a moderate pace. Finally, our fourth quarter PEO revenue growth of 6% exceeded our expectations despite continued pressure from slowing client hiring activity. Our fiscal 2024 accomplishments extend far beyond our strong financial results. One year ago, I laid the foundation for our three strategic priorities that will guide our future growth. Now, I'd like to recap some of the great progress we made in each of these areas. Our first priority is to lead with best-in-class HCM technology. We had a very busy year on this front as we launched ADP Assist, our cross-platform solution powered by generative AI that transforms client data into actionable insights. This isn't just another technical solution, it's an experience that combines ADP's deep data set and expertise to empower HR professionals, leaders, and employees. We deployed ADP Assist across several of our platforms, including [Roll] (ph), RUN, Workforce Now, and next-gen HCM, with enhanced capabilities ranging from report creation to natural language search to initiating HR actions. These tools streamline daily tasks and are all powered by an easy-to-use search interface that is already receiving meaningful recognition in the field of generative AI. We are very proud to share that ADP Assist earned the Generative AI Innovation Award in the 2024 AI Breakthrough Awards, and we look forward to rolling out even more features in fiscal 2025. In addition to embedding generative AI in our products, we continued to advance our next-gen initiatives. Our active next-gen payroll client count increased by nearly 50% in fiscal 2024, and we grew our number of live next-gen HCM clients by more than 30% as we continued to improve implementation times. Our next priority is to provide unmatched expertise and outsourcing. Our approach to supporting our clients has been key to our winning formula for decades. And in fiscal 2024, we focused our efforts on implementing new technology that will help make an even greater impact for our clients. To further unlock the value of our expertise, we deployed generative AI tools like call summarization and real-time guidance to support our service associates. We also invested in generative AI and other automation capabilities for our implementation teams to reduce manual data entry and minimize the risk of error during implementation. For example, out of the 50,000 new RUN clients we sold and started during the fourth quarter, about half were digitally onboarded compared to a third of our new client onboarding and run this time last year. And as generative AI capabilities advance, we are excited to further accelerate this progress. Finally, we plan to provide additional tools to help our associates deliver better, faster service and allow our client satisfaction scores to continue reaching new record levels. Our third strategic priority is to benefit our clients with our global scale. Globally, we bring together an unmatched footprint, best-in-class integrated solutions, and industry-leading service and expertise to help our clients and their employees navigate the changing world of work. In fiscal 2024, we continued to leverage this global scale to strengthen our business. We extended our global footprint, acquiring the payroll business of our partner in Sweden, expanding the scope of our Celergo payroll offering to include Iceland, and further growing our on-the-ground presence in the APAC region. Our iHCM platform also continued to scale in several European countries and now serves more than 5,000 clients and pays more than 1 million client employees. Finally, we deepened our existing partnerships with several other leading technology providers to further simplify HCM processes and broaden the spectrum of support we can provide our clients. Next, I'd like to share some new client wins from Q4 to highlight how we're leading in workforce innovation and delivering value for our clients. In US Small business, we continue to successfully onboard new retirement services clients across multiple industry verticals. During the quarter, we added the plan of a Texas-based insurance agency, which was challenged by manual processes and the management of multiple providers. ADP's advanced technology and planned [fiduciary] (ph) solutions simplified the client's plan administration, reduced its manual oversight, and lowered its plan fees. The ADP team made the transition easy and stress-free by providing the client with critical management of the transfer process, as well as regular briefings on the plan set up. This is just one of the thousands of new clients who turn to our retirement services solution every year. In fact, we recently took the top spot as the nation's largest 401(k) record keeper by Total Plans and Total 401(k) Plans in the Plan Sponsor Magazine 2024 defined contribution Record Keeping Survey. We serve over 170,000 retirement services clients and it brings me great joy to see how ADP is helping employers address the retirement savings needs of so many Americans. We look forward to continuing the momentum in our retirement services business in fiscal 2025. In our HR outsourcing business, an orthopedic device company who had grown extensively through acquisition recognized it needed a deeper HR and technology infrastructure to support its future growth. So it turned to our comprehensive services support model to integrate its acquired companies onto a common platform. We look forward to supporting this client's current needs and helping it expand in the future. Additionally, comprehensive services cost a major milestone in fiscal 2024, generating more than $1 billion in revenue for the year. This business has come a long way since its launch in 2008, and we look forward to leaning into our outsourcing business as a differentiator. In US Enterprise, we welcomed one of the largest automotive dealers in the Midwest to our next-gen HCM platform. Following several years of rapid growth, this client wanted to reimagine their HCM strategy. To help, our team went on-site and conducted a deep review of its current practices and pain points. We developed a plan that would leverage our next-gen HCM platform, flexible position management structure and other advanced HCM tools to address the organization's current and future HR strategy. Our initial solution included HR, payroll, time, and benefits, and the client later added recruiting and talent management. We look forward to helping shape the future of their workforce together. Overall, we were extremely pleased with our strong financial and strategic outcomes this past year. In fiscal 2024, ADP was recognized as the world's most admired company by Fortune magazine for the 18th consecutive year, and we also celebrated our 30th straight year on the Fortune 500. As some of you may know, 2024 is also our 75th anniversary. As I reflect on ADP's enduring impact on the world of work, the one constant on our journey is our talented associates, be it the recent accolades we received or the 75 years of support for our clients, we owe our recognition and strong financial performance to our 64,000 dedicated associates who deliver the great products and exceptional experiences and continue to drive our client satisfaction scores to new highs. I want to take a moment to recognize them for their incredible contributions. Thank you for all you do for ADP and for our clients. And now I'll turn the call over to Don.
Don McGuire : Thank you, Maria. And good morning, everyone. I'll start by expanding on Maria's comments around our Q4 results and then cover our fiscal 2025 financial outlook. Q4 performance was very strong overall, helping to drive fiscal 2024 revenue and earnings growth towards the high end of our expectations. As previously mentioned, we benefited from broad-based strengths in employer services with exceptional new business bookings, better than anticipated retention, and stable pays per control growth. PEO revenue growth in the quarter also came in better than expected. Our strong Q4 results contributed to our full year revenue growth of 7%, bringing our fiscal 2024 revenue to $19.2 billion. For our employer services segment, revenue in the quarter increased 7% on both a reported and organic constant currency basis. These results were bolstered by a slightly better than expected contribution from client funds interest. Our ES margin expanded 220 basis points in the fourth quarter, which exceeded our expectation. For the full year, our ES revenue grew 8% on a reported basis and 7% on an organic constant currency basis, and our ES margin expanded 210 basis points. For the PEO segment, revenue increased 6% for the quarter as growth accelerated from Q3. Average worksite employees increased 3% on a year-over-year basis in the fourth quarter to 742,000. PEO margin contracted 240 basis points, slightly more than we anticipated due to higher operating expenses and unfavorable actuarial loss development in workers' compensation reserves. For the full year, PEO revenue grew 4%. Average worksite employees increased 2% and our margin contracted 150 basis points, with the margin contraction mostly due to less favorable actuarial loss development in workers' compensation reserves versus the prior year. Our fiscal 2024 PEO new business bookings growth rate also moderated from the prior year. I'll now share outlook for fiscal 2025. While the macro backdrop remains uncertain, we believe we are well positioned to deliver solid overall financial results while continuing to invest in our future growth consistent with our strategic priorities. Our fiscal 2025 outlook assumes some moderation in economic activity over the course of the year. Beginning with the ES segment, we expect revenue growth of 5% to 6%, driven by the following key assumptions. We expect ES new business bookings growth of 4% to 7%, representing solid growth after coming in at the high end of the same guidance in fiscal 2024. For ES retention, we forecast a 10 basis point to 30 basis point decline from the 92% result for fiscal 2024. We are encouraged by our recent record client satisfaction scores, but we think it's prudent to continue to expect some retention pressure from higher small business out of business levels and slightly slower economic growth overall. As we mentioned at our prior earnings call, we see the potential for below normal US pays per control growth in fiscal 2025. And our outlook assumes 1 to 2% growth for the year. This view is consistent with most economists forecast for continued moderation in US private sector payroll growth. After price contributed around 150 basis points to ES revenue growth in both fiscal 2023 and fiscal 2024, we anticipate a benefit closer to 100 basis points in fiscal 2025, which is in-line with the moderation in overall inflation. We also expect FX to transition from a modest tailwind to ES revenue growth in fiscal 2024 to a slight headwind in fiscal 2025. And for client funds interest revenue, the interest rate backdrop remains dynamic. And it's important to remember our client funds interest revenue forecast reflects the current forward yield curve, which is likely to continue to evolve as we move through fiscal 2025. At this point, we expect our average yield to increase from 2.9% in fiscal 2024 to 3.1% in fiscal 2025, which contemplates the market's expectations for short-term interest rates to decrease during the year. We expect our average client funds balances to grow 3% to 4% in fiscal 2025. Putting those together, we expect our client funds interest revenue to increase from $1.02 billion in fiscal 2024 to a range of $1.13 billion to $1.15 billion in fiscal 2025. Meanwhile, we expect net impact from our client fund strategy to increase to a range of $1 billion to $1.02 billion in fiscal 2025. We expect ES margin to increase 100 to 120 basis points in fiscal 2025, driven by operating leverage as well as continued contribution from client funds interest revenue partially offset by ongoing investments to advance our key strategic priorities. Moving on to the PEO segment, we expect PEO revenue to grow 4% to 6% and PEO revenue excluding zero margin pass-throughs to grow 3% to 4% in fiscal 2025. Our PEO revenue growth outlook assumes average worksite employee growth of 1% to 3%. This reflects our expectation for continued new business bookings growth and modestly better retention to be offset by declining PEO pays per control growth that remains below our historical experience. We expect PEO margin to decrease 90 to 110 basis points in fiscal 2025. This anticipated margin decline reflects our forecast for zero margin pass-throughs to grow faster than PEO revenue and increase in our workers' compensation costs and higher PEO selling expense from accelerating new business bookings growth. Adding it all up, our consolidated revenue outlook is for 5% to 6% growth in fiscal 2025. And our adjusted EBIT margin outlook is for expansion of 60 to 80 basis points. We expect our effective tax rate to be around 23%. And we expect fiscal 2025 adjusted EPS growth of 8% to 10% supported by buybacks. One quick note on our margin cadence. We anticipate adjusted EBIT margin expansion on a year-over-year basis to be more modest in the first half of the year before trends ramp in the second half of fiscal 2025. Thank you. And I'll now turn it back to Michelle for Q&A.
Operator: Thank you. [Operator Instructions] Our first question comes from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin: Hi. Good morning. Thank you. I want to start with bookings here. So, sounds like a pretty solid close to the year. Can you provide more color on the attribution of that bookings performance across the business? And in general, I guess when you're looking at demand into July, just any changes based on employer size or geography?
Maria Black: Sure, good morning, Bryan. Great to hear from you. I love talking about bookings, especially on the heels of what was truly an exceptional performance by the overall team in the fourth quarter. To answer the first part of the question, it was broad-based. So we did see strength across our growth in small business, mid-market, enterprise, and international. So we are really pleased with the momentum that we see as it relates to the overall receptivity to the offerings, to the product, to the execution, and really proud of how the team moved through the quarter, which led to the exceptional results at 7% for the year. In terms of the demand environment overall and what we see, what I would offer is that the HCM demand environment remains strong. One of the things that's unique about HCM is what we do, it's not a nice to have, it is actually an imperative for a company to run their business. They need to have their associates pay, they need HR tools, and certainly it's not getting any easier. Whether you're in the down-market, mid-market, up-market, to navigate being an employer. And as such, we fit squarely into that. So we feel good about the momentum stepping out of the quarter. We feel good about the demand environment stepping into the quarter. Pipelines from a year-on-year perspective look strong. So we're very optimistic and proud of the performance.
Bryan Bergin: Okay, I appreciate that. And then my follow-up, just on kind of pays per control performance here, can you compare and contrast the pays per control performance in ES versus what you're kind of seeing on the same store sale, PPC and PEO. And any cadence assumptions here as you go through 2025?
Don McGuire: Yeah, Bryan, I'll take that one. So as we look at pays per control, we do think that the labor market is still pretty resilient. I mean, there are a number of factors that we look to. And, you know, if you look at the BLS, you look at the unemployment rate, JOLTS Report came in the other day, it was down, but better than expected. Labor force participation still got some room to go, et cetera. So jobless claims are kind of neither here nor there. They're benign. So we think there's still continued good strength in the market. Having said that, we do think that pays per control is going to moderate. And we have said we're thinking 1% to 2%, as we go forward into 2025. I would say that we do expect that the pays per control growth in the PEO will be lower than it is in ES, but we are still optimistic that there's growth to be had, but certainly we expect ES to be somewhat stronger than we expect PEO.
Bryan Bergin: Thank you.
Operator: Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Oh, thanks guys for taking my question. You know just to touch again on ES, like I kind of want to know like how much of that strength is idiosyncratic and things that you're doing internally versus the macro. And then maybe the follow-up is again asking about the guidance and like maybe you can layout you know what could go well and what could go wrong in terms of the macro -- the underlying macro for the guide that would be it. Thank you.
Don McGuire: Yeah Dan. So you know just to follow up on that I would say that you could will unemployment remain as low as it has been? I think there's no indication that it's going to worsen. It's still at, you know, decade lows or comparable to decade lows. There is good strength, there seems to be good strength across the broader spectrum of new jobs. So the NER report came out earlier today and we're [continuing] (ph) to see new jobs. So I think that we put out there a PPC growth number that's realistic. What could change that? We could imagine all kinds of macro issues, but I prefer not to do any imagining. I think we're trying to do what we can based on what we know today. So I think that what we have today is pretty good. But as I mentioned earlier to Bryan's question, we certainly recognize that ES is likely to be stronger than PEO.
Maria Black: And Dan, if I can just add on the sales side, just with respect to -- are we driving the results as it being driven by Macro? My answer to you would be both. And so I think we have a strong demand environment. I touched on that during Bryan's question in terms of our offer and how squarely it fits into that demand environment. And that's really a broad-based execution across the entire business. So it is the investments we've made into our products. It is the best-in-class service that we have. We see that in the NPS results, by the way we see that in our retention results as well. And so I think we've been getting stronger and stronger. I think the value proposition of what we offer is an imperative for businesses. And then once again, I would say, yeah, we are executing incredibly well across the full spectrum of our sales differentiation. I mentioned in the prepared remarks, I consider it to be one of the greatest competitive advantages that ADP has. Part of that is our ability to canvas the entire market. So whether buyers trying to buy digitally, or they're trying to buy through a channel, or they're trying to buy the traditional way, like we show up at every single turn, and we lean right into that with the best product and the best service out there. And as a result of all of those things, I think we are executing very well.
Dan Dolev: Great results, Thank you.
Maria Black: Thank you.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thank you so much. I wanted to ask on competition. Some of our recent conversations with those in the industry have kind of indicated that there's been some meaningful price compression from some of your competitors, particularly in the mid and down market segments. Have you observed others getting more competitive on price or from your perspective, is it fairly status quo right now?
Maria Black: Good morning James. What I would offer is it is pretty status quo. We haven't really observed any of those meaningful price compression, things of that nature. Given how much we do compete, I think we would see – I’d say, that there is always some of that in terms of whether it is promotions and things that all of us run at various times throughout the year. But it doesn't seem atypical for me. And obviously, I've spent a lot of years watching the competitive landscape and the sales environment. So I haven't seen anything anomalous. I think the one thing that's changed, specifically in the competitive landscape is us. And so when I think about our ability to execute, and everything I just mentioned, best product, record retention, record NPS, incredible execution by sales. I think we are stronger than we've ever been. So I'd say, that's the shift. But from our purposes, it is still a competitive environment and we lean into it every single day.
James Faucette: Great. Glad to hear that. And then wondering if you can give a little bit more color on the composition of bookings, especially between enterprise, mid-market and down market. And also, what are you seeing in the international business? And how should we think about the potential uplift there over time, as price points in lower-cost regions continue to improve?
Maria Black: What I would offer is that the down market had incredible strength by the way on top of incredible strength last year. I think I mentioned -- or I did mention during the prepared remarks, we onboarded, we sold and started 50,000 new clients in small business in the fourth quarter alone. So we are officially got 890,000 of our 1.1 million clients are in that down market space. And so we continue just to see broad-based demand. And again, we’re executing very well on that. Our mid-market sales results were phenomenal. Just an incredible execution by the team. Again, our product has been getting newer and stronger, so feel really good about that. I mentioned also in the prepared remarks what we saw in the enterprise space, specifically with respect to our next-gen HCM offering. One of the reasons I'm so excited about this is that we are seeing record results, we are seeing more than we anticipated, quite significantly more than we anticipated. And we are not even at general availability yet. And what that suggests to me is that the market is ready for this offering -- the market is excited about this offering. We see clients wanting to buy in the enterprise space from ADP, and we are stepping into that opportunity. So that's kind of the distribution. Very strong strength. You asked about international specifically. International had a fantastic year overall. So it was really the story of four quarters. I think first quarter of last year was strong over year-on-year first quarter of 2023. Second quarter got even stronger. Third quarter got even stronger than that. And fourth quarter, you'll probably guess got even stronger than that. So overall, our international business had just a fantastic year as well.
James Faucette: That’s great. I appreciate all the color Maria.
Maria Black: Thanks.
Operator: Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi, thanks for taking my question. I wonder if you could comment on how you're thinking about the balance -- striking a balance between pricing and retention and just sort of also speak to your confidence level about being able to take that 100 basis points of pricing, which I think is more than you took sort of pre-pandemic, although less than you've been taking in this really inflationary environment. How are you -- how confident are you that you can take that without tipping retention in the wrong direction?
Don McGuire: Thanks for the question Ramsey. Yes, it is a great question because we always think really, really hard about pricing decisions and making sure that we don't get greedy. As we've shared on many occasions, what we are interested in is long-term clients and the lifetime value of those clients. So we are always very, very careful not to over rotate on price. And you are right, we have been able to take about 150 basis points in '23 and '24. And as we look to '25 and we looked at the moderating inflation environment, we thought that 100 basis points is realistic. If we go back pre '23 and back into the teens we were more on the 50 basis points range, but the inflation environment was very, very different then it was virtually not existent. So we are confident that we can get 100 basis points. We are confident that we can target it in the right places. So it is something that we think is a reasonable expectation for us to target.
Ramsey El-Assal: Okay. And a follow-up for me is about generative AI. And just if you could talk about how we should think about the long-term kind of opportunity there in terms of monetization. Is this ever something that could contribute to revenue directly? Or is this -- is generative AI sort of more something that will drive soft dollars to retention, new bookings? Obviously, there is an expense benefit internally. But I'm just curious about how you're framing it up over the long term.
Maria Black: It's a great question. My answer to you would be both. And so from a generative AI perspective, I know you know that I love to speak about it. I talked about it again at length just this morning during the prepared remarks. What I’d offer is that all across, whether it is the focus we have of putting generative AI, ADP Assist across and into each one of our products, or it is the work that we're doing with putting ADP Assist into the market to help practitioners, or help our own service associates and our sales associates, the way I think about it, first and foremost is exactly what you suggested, which is it should feed the ADP model. And in its most simplistic form when I think about this company and driving the recurring revenue model that we have, it is about sales, it is about retention, it is about product efficiency and it's about NPS. And those four metrics generative AI and everything that we are offering as it relates to ADP Assist should feed, call it the machine of our model, right? So we should have more sales, we should be able to keep clients. Why? Because they are happier and they have a better experience as it relates to NPS. And then in turn, we also drive efficiency. So I think that's the output and the outcome of a lot of the investments we are making. That said, as we look at all the use cases and both the short-term stuff that we're working on, as well as the long-term vision of what ultimately generative AI could look like in the coming years, we do see monetization opportunities. And each one of our business cases, as you can imagine, has clear goals of what it is that we are trying to accomplish, inclusive of revenue growth. I think it's too early to start sharing some of those broadly across the market. But certainly, that's a big piece of our strategy, as is making sure that we continue to drive the transformation type of opportunities that we've been driving for years as a company.
Ramsey El-Assal: Fantastic, thank you.
Operator: Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning. Thanks for taking my question. Don, maybe one for you. Just on the PEO guidance, and I apologize if this question is kind of a dumb question, but I just want to make sure I understood it. If I look back to last year, you had actually a slightly better WSE assumption, and you guided to 3% to 5%. And this year, you are assuming lower WSE growth but actually slightly better revenue growth. And I was just trying to reconcile those two things. Is retention assumptions the big difference there? Or is there some other mechanical thing, it is easier comps? I'm just trying to understand the PEO guidance this year versus last year.
Don McGuire: No, Samad, it is a great question. So there are a few things happening if you look forward to 2025, revenue is growing, but the biggest contributor to the revenue growth is zero margin pass-throughs. So that's the largest component, and that's what's happening there. And then, of course, we have mentioned earlier that pays per control are under pressure. So as I said in an earlier answer, 1% to 2% for ES, and we think more towards the low end of that for the PEO area. And then we have a little bit of pressure from workman's compensation on the margin. And I guess the third thing is we do continue to focus on the area to get sales reaccelerating. So we certainly have more selling expense baked in to that business to help drive the top-line and make sure we get to continue to grow our worksite employees.
Samad Samana: Understood. And Maria, if I take just one huge step back, the business is very strong right now, and it seems like that's happening in what is a backdrop that is slowing. And so I just was wondering, you've been at ADP for a long time, you've seen multiple cycles, can you just remind us that when you see a broader slowdown in the backdrop, just kind of how you still are able to drive value and what the performance of the business has historically been in these slowdown periods, because I think we are all impressed by the durability of the strength even as things may be slow in the backdrop?
Maria Black: Yes. Thanks, Samad. And you are right. I think the durability of what it is that we offer, I spoke to it a bit earlier in terms of the imperative of HCM, I think that durability also lends itself to a different environment should the macro change. So the sales force of ADP, if you will our offering is great in times of growth, it is great in times of steady, and it's also great as a conduit as there might be pressure in the employer environment. And so the value proposition, we have a playbook. We can adjust very, very quickly in terms of what it is that we offer and the demand environment -- as the demand environment shift. Now that said, should there be a huge decline in the macro, of course we will be impacted. One of the things that does end up getting impacted is bookings. But at the same time, from a standpoint of the self-adjustment of that value proposition, it’s very durable, and it is very durable, as a result of HCM being an imperative. And so we feel good about our ability to flex. And I've seen that, to your point Samad, I've been here a long time, as a student of ADP's great distribution, and I've seen that flex over time and have all the confidence that the team would do the same. I think maybe Don could also talk about the -- how that financial model, should something shift in the market, the financial model also self-adjusts as it relates to the playbook, if you will in a different macro.
Don McGuire: Yes, certainly. We've talked about this before. But if we go back a year or so, I think -- or maybe 18 months, the word recession was on people's lips a lot more frequently than it is today. I think the latest survey I've seen says that there is about a 28% probability of recession in the next 12 months. I'm sure that's some survey that the rest of you have read somewhere as well. So the good news is, it looks very unlikely that we are going to have a recession over the next 12 months. But certainly, as an all-weather company, what we do isn't discretionary. You have to do it. The levers we have, if sales slow commissions slow, if implementations slow, we don't need as much headcount, et cetera, et cetera. But I think, as we saw in 2008, it took a long time for ADP to find itself in a place that looked like a lot of adjustment. So we think that we can use those tools again should we need to. But I'll just finish with hopefully, that survey is correct and nobody is thinking about a recession in the next 12 months.
Samad Samana: Great. Appreciate. Have a good day. Thank you.
Operator: Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hi, good morning. And thanks for taking my questions. Congrats on the strong bookings in the fourth quarter as well as the really strong retention. I wanted to dive a little bit deeper into both. With regards to the strong bookings, Maria you cited on the small business side, RUN doing extremely well, getting 50,000 new clients. Can you talk a little bit about what the source of those clients are? Were those clients that were using competitive solutions? Were they brand-new business formations? How would you characterize that? Where are you seeing the strength and the takeaways from?
Maria Black: Sure. So on the down market specifically as it relates to bookings, the bookings again are broad-based, right? So where are we getting them? We are getting them from digital inbound, we're getting them from new businesses, we are getting them through the ecosystem of our channels, so clients that are engaging with banks, CPAs. Again, we canvass the entire market. That said, some of the things that we have seen, Mark year-on-year new business formations, it is still at an elevated rate, but it is pressurized. So sorry, year-on-year, it is minus 3%, but it's still elevated compared to norm. And so as a result of that, we did see less coming this time from new business formations. Now we had a lot come from new business formation, but we also saw an increase in balance of trade, some more coming from the competition. So what I would say is mix shifted a little bit in terms of how we broadly canvass the down market. All that rolled up to this incredible result of 50,000 units in the fourth quarter. So it is broad-based, but there are tiny bit of shifts within that to answer your question specifically.
Mark Marcon: Great. And then on next-gen HCM, you also mentioned a 50% pickup there in terms of new sales. And this is before you are fully GA. Can you talk a little bit about what the source of the wins are in terms of -- are these clients that are transitioning from older ADP platforms? Or are they coming from competitors? And if it's from competitors, what sort of competitors?
Maria Black: Sure. The answer is both and also head-to-head against competition. So some of them are ADP upgrades. We did see more new logos than we've seen before. So we are really excited about the net new wins to ADP. Some of those were wins and takeaways from enterprise competitors. Some of them were wins head-to-head against the same said enterprise competitors, which again is probably why I'm so optimistic about it, because it appears that the offer that we have is competing incredibly well in the market and clients are choosing ADP.
Mark Marcon: That's great. And then with regards to client retention, I know you are guiding prudently for a normalization. But it seems like your client satisfaction scores continue to trend up. How would you characterize the primary drivers of the improved client satisfaction? Is it the solution set? Or is it the service underlying, or a combination of both?
Maria Black: It is a combination of both. NPS is fantastic. So NPS for the quarter as well as the full year was a record. Almost every single business is at a record NPS. So what drives NPS? It is that both, right? So it is the investments we've made into our best-in-class products. And this is years that we've been making these investments and making our products newer and more modern taking friction out, making them more self-service. All of these things that go into having best-in-class HCM technology, those investments coupled with best-in-class service, is driving the broad NPS record that we have across the business. So as such, that is a direct correlator to a record retention. And so we are really proud of the 92%. You are right. We're prudently guiding into the year again. And the reason behind that is, as you know we've had this conversation many times, is that there is still perhaps some normalization that could happen, and also because we are executing at all-time highs almost across every single business. We just want to be thoughtful as we step into the year to make sure that the retention guide is prudent.
Mark Marcon: Got it. Thank you.
Maria Black : Thank you.
Operator: Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang: Hi. Perfect. Just want to extend on the retention, but more on the outlook side, if that's okay. Just any callouts expectation-wise across the segments, small, mid and large? I know you've commented on balance of trade already, but I didn't know if you are seeing anything different in terms of expectations on retention.
Maria Black: Yes, fair. What I would offer is it is the same reason that we guided into the year, this year the way that we did, this year that we just closed, it is expected potential normalization in the down market. Now I've been saying that for the last couple of years. It isn't -- yes I know. The down market isn't entirely normalized back to where it was pre-pandemic. Now I get that that's five years ago and it may be at some point, we all have to just suggest that it is the new normal. But we haven't seen an uptick in bankruptcies, out of business at the levels that we used to see in that business. And as such, we believe it is prudent that there could still be some of that normalization. So it's really the same thing that we've been suggesting. It just hasn't happened yet. And our goal would be of course, to not have it happen again.
Tien-Tsin Huang: Yes. And you did outperform, obviously the guidance you set last year this time, so okay. No, I just wanted to check. I think this -- again, you've said prudent and totally agree with that. Just my quick follow-up just is on the margin front. I know it is very typical margin expansion. I think you did call it last quarter, maybe a little bit more investment in G&A. Anything different in terms of incremental margin outlook for fiscal 2025? It does look like you have a workforce rebalancing in the fourth quarter as well. So I just want to make sure we call it the puts and takes there on the margin front. Thank you.
Don McGuire: Yes. So Tien-Tsin, thanks for the question. I think that we are always -- I'll start with where you ended there. We are always looking at the workforce and making sure we're -- we've got the right people in the right places and the right numbers of people in the right places. So we're always looking at that. I don't think there is any real specific callouts on the margin. I think that there are some Gen AI investments. These are modest, but they do attract 10, 20 bps here and there, so to speak. But they are modest all things considered. Certainly, the margin next year would get a little bit of pressure from lower pays per control from lower pricing increases and from lower client fund interest, specifically -- most specifically in the back half. But I think those are all things that we've called out and you can read through. So nothing abnormal.
Tien-Tsin Huang: Yes. No, glad to see it's typical. And congrats to Danny and Matt as well. Thanks guys.
Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi guys. Congrats on the quarter really strong in ES. On PEO, the bookings were accelerating and recovering in fiscal year '24 but moderated towards the end of the fiscal year. So just want to understand what changed in the marketplace there.
Maria Black: Sure. Thank you by the way. I appreciate the congrats. PEO bookings did moderate a bit in the back half. And from a year-on-year perspective, it did moderate as well. That said there was still strong growth in PEO bookings. And so from my vantage point, the demand equation is still incredibly strong for the PEO. It was a slight moderation year-on-year. We feel really solid about the demand for the offer, the value proposition of the offer, and we feel solid about pipelines in the PEO. And as you know, with pipelines in the PEO, it is more about activity in the market, new appointments, requests for proposals, things of that nature. So all the bellwether signals show that the PEO strength is still there, but it did moderate a bit in the back half.
Bryan Keane: Yes. And just a follow-up just with thinking what would it take to get PEO back to high single-digit or double-digit revenue growth that was targeted previously?
Don McGuire: Yes. Hi Bryan, I think it's going to take a little bit of time. And we were working, and as I mentioned earlier, we are seeing some more margin pressure in PEO, and some of that is because of the investments we are making in the sales force to make sure we can get those bookings going. But realistically, to get to kind of Investor Day guidance that we provided three years ago, it is going to take some time to build that back. So we are definitely focused on that, and we are definitely focused on getting there. Of course, if we were to see some reacceleration in the pays per control, that would put lots of wind in the sails, but it's going to take a little bit of time to get back to where we want to be.
Bryan Keane: No, that makes sense. And congrats again.
Maria Black : Thank you.
Operator: Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Good morning guys. Thank you for taking my questions. I wanted to go back to the margin guidance and just the context of seems like slower expansion in the first half versus second half. Wondering if you could maybe walk us through the drivers there. Is that more on the shape of revenue, or does it have anything to do on the cost side? Thank you.
Don McGuire: No. Good question, Scott. More on the shape of expenses. Revenue expectations throughout the year are pretty consistent quarter-to-quarter. It is really some spending patterns we have in the first half of the year, but really nothing specific to call out. Just want to give folks a heads up that we think we are going to be stronger in the back half than the first.
Scott Wurtzel: Got it. That makes sense. And just as a follow-up on the international side. I mean it seems like you're making some good traction on incremental countries and geographies. And we'd love to just kind of hear about your sort of expectations for international heading into this year, how much of it is a priority for you relative to maybe other investments in the business and where you're maybe seeing opportunities internationally.
Maria Black: Yes, fair, Scott. It is a very large priority for us. As you may remember, our third strategic priority is to benefit our clients with our global scale. International fits squarely into that strategic priority. We've been building this business for 50-some odd years. We are well ahead of the competition, as it relates to the number of countries that we serve on behalf of our clients, and moreover the infrastructure in those countries that we've built out. So we often speak to the final mile and all the things that we do to ensure that our clients have the ability to pay across very complex, sometimes large complex clients or countries, and sometimes very small complex countries. But certainly, it is a big piece of our offer. I think companies continue to want to think about their system of record from a global perspective, as they continue to have distributed workforces across the globe, as they continue to move supply chains in this world of globalization, as they have remote employees in smaller countries and around the world. We have this incredible network and ability to support clients today in what is 141 countries, and we continue to add more, as they become prudent in terms of the -- again, if it is the growth economies or where our clients are heading. But it is a big piece of our growth story. It's a big piece of our differentiation in the marketplace. And our multi-country MNC business is a clear competitive advantage for us in the international space.
Scott Wurtzel: Great. Thank you.
Operator: Our next question comes from Jason Kupferberg with Bank of America. Your line is open.
Caroline Latta: Hi. This is Caroline on for Jason. Thanks for taking our question. Can you talk about the duration of the portfolio? We were a little surprised to see that the F’25 average yield is expected to be up year-over-year based on the number of rate cuts being forecast. And maybe how you might be adjusting your investment strategy for the portfolio based on the interest rate outlook for the next 12 months.
Don McGuire: Caroline, thanks for the question. So we do have a laddered strategy. So if you actually refer to the -- I think, the last page of the earnings release, I think you can see the maturity schedule for our investments. And you can see that, for example in 2025, we have $6 billion that's maturing at roughly 2.2%, and our reinvestment at this point in time is 4.2%. So there's still lots of opportunity, and this is a place where ADP's laddering strategy shows its strength. It is fair to say that over the last couple of years, because of the inverted yield curve, we did have some opportunity cost by having this strategy. But I think we are very much seeing that as yield curves start to normalize, that we still have lots of opportunity for client funds interest growth. I’d just add to that that the portfolio is continuing to grow. It's growing 3% to 4% again next year, maybe not as much as it has in the past couple of years because wages have moderated a little bit, pays per control moderated a little bit. But we are still seeing good growth in that area. So we still have lots of opportunity. And the most important thing here, the most important comment I can make on this whole fund strategy, is that we base all of these commitments or all of these expectations on the current yield curve. We're not trying to outguess the market. We're looking at what the market in general has to say. And we are using those yield curves to put together our forecasts and our guidance on interest rates.
Caroline Latta : Okay, that’s helpful. Thank you so much.
Operator: Thank you. Our next question comes from Ashish Sabadra with RBC Capital Markets. Your line is open.
David Paige: Hi. This is David Paige on for Ashish. Thanks for taking our question. I just wanted to circle back to the workforce optimization charge that we had in the quarter of $42 million. Should we expect further workforce optimization in 2025? And if yes, how much of that there, what's the benefit to the EPS guidance for '25 as well? Thank you.
Don McGuire: David, as Maria has shared earlier, I mean, we're always looking to make sure that we've got the workforce at the size it needs to be and in the places it needs to be. So we made those difficult decisions that we had to make on behalf of some of those employees. But we always look at this. And if you look at ADP over the years, we've always done what needed to be done to go forward. So I would just leave it at that and say that we're very happy with the guidance we put out here and the margin guidance as well. So we will make sure that we do what we need to do to execute, and we'll see what the future brings. But as we sit here today, we've done what we need to do, and we are looking forward to the future.
David Paige: Great. Thank you.
Operator: Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Good morning. I know you've talked about the strength in bookings quite a bit. And I'm just wondering from an enterprise sales standpoint if there is been any change. Is the sales cycle lengthening at all? Are enterprises maybe asking to buy less modules they have in the past? Any kind of change or has it been pretty much status quo and really no change from a demand or a sales cycle standpoint?
Maria Black: Fair. It is a great question. I think we talked about it a bit last quarter and perhaps throughout the year, which is that we're really at a new normal, as it relates to the overall sales cycles. It is reminiscent of what it used to look like pre-pandemic. But arguably, there are more decision-makers involved. The process has elongated a bit from where it was during the height of the pandemic. But the deals are moving through the motions. I would say that they are moving through the motions pretty typically. But certainly, it's not as fast as it was at one point in time. But we're not seeing less modules. We are seeing a big conversation around global, a big conversation around global system of record, things of that nature, which again is where this next-gen HCM fits squarely into that demand. So the conversation shifted a bit, but that is not necessarily new news, Kartik. It's really what we've seen over the last couple of years, as a byproduct of how clients in that enterprise global space operate. So certainly, that's how we are leading what that best offer kind of across the enterprise and international space. But from a deal cycle standpoint, it is pretty similar to what we've seen throughout this year, which is more decision-makers involved and prudency, as it relates to the decisions that are being made, but not necessarily less modules or anything of that nature.
Kartik Mehta: And then just on the small business side, I mean as you look at the health of the small business, anything that is changing or anything that would give you concern just as people get worried about the economy, or change in behavior?
Maria Black: Yes. Great question. So we monitor so many of these things, right? So I spoke to one of them earlier, which is the pace of new business formation. That tends to be a bit bellwether. Again, it is still elevated from norms, but it is down year-on-year. We are also monitoring our own out of business. We are looking at clients that call it suspend payroll and how many are sitting in that type of capacity. These are all things and metrics that we've monitored for years to ensure that we are kind of seeing what is happening real time, if you will. What I would say is there are little pockets, very similar to the new business formation of kind of watch items that we have our eye on. None of it at this juncture gives us great pause. Quite the opposite. But at the same time, we are monitoring these things to make sure that we don't get surprised as it relates to the shift should there be one. But there hasn't been one yet.
Kartik Mehta: Perfect. Thank you so much. I really appreciate it.
Operator: Thank you. There are no further questions. I'd like to turn the call back over to Maria Black for any closing remarks.
Maria Black: Great. Thank you. So I will end where I started, which is I'd like to take this opportunity to thank our 64,000 associates. All of the results that Don and I have the pleasure of getting on this call to represent, they are a byproduct of 64,000 associates that are all incredibly committed to having the best-in-class technology, the best service, and the biggest, broadest global scale. And everything we do, whether it is from product innovation to our contracting process, to our sellers, to our service associates, it really takes the entire company being aligned on what I would suggest is a commitment to client and client centricity. In that spirit, I'd also like just to take a minute to thank our 1.1 million clients. I will tell you, as we celebrated the 75th anniversary of ADP, it was quite a remarkable moment to think about all the clients that we've impacted over 75 years and had the honor of contributing to their journeys of success and navigation. So definitely want to take a minute to honor all of our clients. And then last but not least, all of you who dialed-in today. I appreciate you joining us. I appreciate your interest and your investment in ADP. And I look forward to speaking with you soon.
Operator: Thank you for your participation. You may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Fourth Quarter 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Matthew Keating",
"text": "Thank you, Michelle, and welcome, everyone to ADP's Fourth Quarter Fiscal 2024 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you also find the Investor Presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. The description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Matt and good morning. Before we get started, I'd like to take a minute to thank Danyal Hussain for leading Investor Relations for these past several years. He helped lead us through the pandemic and helped Shepherd our CFO and CEO transitions during his time. With Danny moving on to a broader role, it is my pleasure to officially welcome Matt Keating to his first call. Congratulations to you both. We closed out the year with a strong fourth quarter that included 6% revenue growth, 80 basis points of adjusted EBIT margin expansion and 11% adjusted EPS growth. For fiscal 2024, we delivered 7% revenue growth, 70 basis points of adjusted EBIT margin expansion, and 12% adjusted EPS growth, representing another great year for ADP. I'm excited to share the progress we've made across our three strategic priorities, but first I'll start off with some additional highlights from our results. Our sales and marketing team delivered exceptional employer services, new business bookings in Q4, on top of a strong Q4 last year. This performance was broad based, showing continued strength in our small business portfolio, as well as our mid-market enterprise and international businesses. In fact, we sold and started more than 50,000 new small business clients during the quarter, which not only reflects the strength of our run solution, but also our reputation for commitment to strong service. Similarly, in the enterprise space, client interest in our next-gen HCM solution has exceeded expectations and resulted in strong Q4 sales, and we are excited to continue this great momentum. As a result of this exceptional performance, our fiscal 2024 employer services bookings growth came in at 7%, the high end of our 4% to 7% guidance range. This growth speaks to the power of ADP's unmatched distribution model, which remains a clear competitive advantage for us. With our new business pipeline even stronger than this time last year, we look forward to building on that momentum. Overall, our employer services retention came in better than expected for the year at 92%. We drove record level retention in our mid-market business for the second consecutive year in fiscal 2024. I'm also extremely proud to share that our client satisfaction scores for our total business reached new all-time highs for both the fourth quarter and full year. These results are a testament to the strength of our entire product portfolio and our commitment to supporting our clients. We are confident that these client satisfaction gains will support our retention results moving forward. Our employer services pays per control increased 2% both for the quarter and the full year. We were happy to have seen the resilience of the US Labor market, as our clients continued to hire employees at a moderate pace. Finally, our fourth quarter PEO revenue growth of 6% exceeded our expectations despite continued pressure from slowing client hiring activity. Our fiscal 2024 accomplishments extend far beyond our strong financial results. One year ago, I laid the foundation for our three strategic priorities that will guide our future growth. Now, I'd like to recap some of the great progress we made in each of these areas. Our first priority is to lead with best-in-class HCM technology. We had a very busy year on this front as we launched ADP Assist, our cross-platform solution powered by generative AI that transforms client data into actionable insights. This isn't just another technical solution, it's an experience that combines ADP's deep data set and expertise to empower HR professionals, leaders, and employees. We deployed ADP Assist across several of our platforms, including [Roll] (ph), RUN, Workforce Now, and next-gen HCM, with enhanced capabilities ranging from report creation to natural language search to initiating HR actions. These tools streamline daily tasks and are all powered by an easy-to-use search interface that is already receiving meaningful recognition in the field of generative AI. We are very proud to share that ADP Assist earned the Generative AI Innovation Award in the 2024 AI Breakthrough Awards, and we look forward to rolling out even more features in fiscal 2025. In addition to embedding generative AI in our products, we continued to advance our next-gen initiatives. Our active next-gen payroll client count increased by nearly 50% in fiscal 2024, and we grew our number of live next-gen HCM clients by more than 30% as we continued to improve implementation times. Our next priority is to provide unmatched expertise and outsourcing. Our approach to supporting our clients has been key to our winning formula for decades. And in fiscal 2024, we focused our efforts on implementing new technology that will help make an even greater impact for our clients. To further unlock the value of our expertise, we deployed generative AI tools like call summarization and real-time guidance to support our service associates. We also invested in generative AI and other automation capabilities for our implementation teams to reduce manual data entry and minimize the risk of error during implementation. For example, out of the 50,000 new RUN clients we sold and started during the fourth quarter, about half were digitally onboarded compared to a third of our new client onboarding and run this time last year. And as generative AI capabilities advance, we are excited to further accelerate this progress. Finally, we plan to provide additional tools to help our associates deliver better, faster service and allow our client satisfaction scores to continue reaching new record levels. Our third strategic priority is to benefit our clients with our global scale. Globally, we bring together an unmatched footprint, best-in-class integrated solutions, and industry-leading service and expertise to help our clients and their employees navigate the changing world of work. In fiscal 2024, we continued to leverage this global scale to strengthen our business. We extended our global footprint, acquiring the payroll business of our partner in Sweden, expanding the scope of our Celergo payroll offering to include Iceland, and further growing our on-the-ground presence in the APAC region. Our iHCM platform also continued to scale in several European countries and now serves more than 5,000 clients and pays more than 1 million client employees. Finally, we deepened our existing partnerships with several other leading technology providers to further simplify HCM processes and broaden the spectrum of support we can provide our clients. Next, I'd like to share some new client wins from Q4 to highlight how we're leading in workforce innovation and delivering value for our clients. In US Small business, we continue to successfully onboard new retirement services clients across multiple industry verticals. During the quarter, we added the plan of a Texas-based insurance agency, which was challenged by manual processes and the management of multiple providers. ADP's advanced technology and planned [fiduciary] (ph) solutions simplified the client's plan administration, reduced its manual oversight, and lowered its plan fees. The ADP team made the transition easy and stress-free by providing the client with critical management of the transfer process, as well as regular briefings on the plan set up. This is just one of the thousands of new clients who turn to our retirement services solution every year. In fact, we recently took the top spot as the nation's largest 401(k) record keeper by Total Plans and Total 401(k) Plans in the Plan Sponsor Magazine 2024 defined contribution Record Keeping Survey. We serve over 170,000 retirement services clients and it brings me great joy to see how ADP is helping employers address the retirement savings needs of so many Americans. We look forward to continuing the momentum in our retirement services business in fiscal 2025. In our HR outsourcing business, an orthopedic device company who had grown extensively through acquisition recognized it needed a deeper HR and technology infrastructure to support its future growth. So it turned to our comprehensive services support model to integrate its acquired companies onto a common platform. We look forward to supporting this client's current needs and helping it expand in the future. Additionally, comprehensive services cost a major milestone in fiscal 2024, generating more than $1 billion in revenue for the year. This business has come a long way since its launch in 2008, and we look forward to leaning into our outsourcing business as a differentiator. In US Enterprise, we welcomed one of the largest automotive dealers in the Midwest to our next-gen HCM platform. Following several years of rapid growth, this client wanted to reimagine their HCM strategy. To help, our team went on-site and conducted a deep review of its current practices and pain points. We developed a plan that would leverage our next-gen HCM platform, flexible position management structure and other advanced HCM tools to address the organization's current and future HR strategy. Our initial solution included HR, payroll, time, and benefits, and the client later added recruiting and talent management. We look forward to helping shape the future of their workforce together. Overall, we were extremely pleased with our strong financial and strategic outcomes this past year. In fiscal 2024, ADP was recognized as the world's most admired company by Fortune magazine for the 18th consecutive year, and we also celebrated our 30th straight year on the Fortune 500. As some of you may know, 2024 is also our 75th anniversary. As I reflect on ADP's enduring impact on the world of work, the one constant on our journey is our talented associates, be it the recent accolades we received or the 75 years of support for our clients, we owe our recognition and strong financial performance to our 64,000 dedicated associates who deliver the great products and exceptional experiences and continue to drive our client satisfaction scores to new highs. I want to take a moment to recognize them for their incredible contributions. Thank you for all you do for ADP and for our clients. And now I'll turn the call over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria. And good morning, everyone. I'll start by expanding on Maria's comments around our Q4 results and then cover our fiscal 2025 financial outlook. Q4 performance was very strong overall, helping to drive fiscal 2024 revenue and earnings growth towards the high end of our expectations. As previously mentioned, we benefited from broad-based strengths in employer services with exceptional new business bookings, better than anticipated retention, and stable pays per control growth. PEO revenue growth in the quarter also came in better than expected. Our strong Q4 results contributed to our full year revenue growth of 7%, bringing our fiscal 2024 revenue to $19.2 billion. For our employer services segment, revenue in the quarter increased 7% on both a reported and organic constant currency basis. These results were bolstered by a slightly better than expected contribution from client funds interest. Our ES margin expanded 220 basis points in the fourth quarter, which exceeded our expectation. For the full year, our ES revenue grew 8% on a reported basis and 7% on an organic constant currency basis, and our ES margin expanded 210 basis points. For the PEO segment, revenue increased 6% for the quarter as growth accelerated from Q3. Average worksite employees increased 3% on a year-over-year basis in the fourth quarter to 742,000. PEO margin contracted 240 basis points, slightly more than we anticipated due to higher operating expenses and unfavorable actuarial loss development in workers' compensation reserves. For the full year, PEO revenue grew 4%. Average worksite employees increased 2% and our margin contracted 150 basis points, with the margin contraction mostly due to less favorable actuarial loss development in workers' compensation reserves versus the prior year. Our fiscal 2024 PEO new business bookings growth rate also moderated from the prior year. I'll now share outlook for fiscal 2025. While the macro backdrop remains uncertain, we believe we are well positioned to deliver solid overall financial results while continuing to invest in our future growth consistent with our strategic priorities. Our fiscal 2025 outlook assumes some moderation in economic activity over the course of the year. Beginning with the ES segment, we expect revenue growth of 5% to 6%, driven by the following key assumptions. We expect ES new business bookings growth of 4% to 7%, representing solid growth after coming in at the high end of the same guidance in fiscal 2024. For ES retention, we forecast a 10 basis point to 30 basis point decline from the 92% result for fiscal 2024. We are encouraged by our recent record client satisfaction scores, but we think it's prudent to continue to expect some retention pressure from higher small business out of business levels and slightly slower economic growth overall. As we mentioned at our prior earnings call, we see the potential for below normal US pays per control growth in fiscal 2025. And our outlook assumes 1 to 2% growth for the year. This view is consistent with most economists forecast for continued moderation in US private sector payroll growth. After price contributed around 150 basis points to ES revenue growth in both fiscal 2023 and fiscal 2024, we anticipate a benefit closer to 100 basis points in fiscal 2025, which is in-line with the moderation in overall inflation. We also expect FX to transition from a modest tailwind to ES revenue growth in fiscal 2024 to a slight headwind in fiscal 2025. And for client funds interest revenue, the interest rate backdrop remains dynamic. And it's important to remember our client funds interest revenue forecast reflects the current forward yield curve, which is likely to continue to evolve as we move through fiscal 2025. At this point, we expect our average yield to increase from 2.9% in fiscal 2024 to 3.1% in fiscal 2025, which contemplates the market's expectations for short-term interest rates to decrease during the year. We expect our average client funds balances to grow 3% to 4% in fiscal 2025. Putting those together, we expect our client funds interest revenue to increase from $1.02 billion in fiscal 2024 to a range of $1.13 billion to $1.15 billion in fiscal 2025. Meanwhile, we expect net impact from our client fund strategy to increase to a range of $1 billion to $1.02 billion in fiscal 2025. We expect ES margin to increase 100 to 120 basis points in fiscal 2025, driven by operating leverage as well as continued contribution from client funds interest revenue partially offset by ongoing investments to advance our key strategic priorities. Moving on to the PEO segment, we expect PEO revenue to grow 4% to 6% and PEO revenue excluding zero margin pass-throughs to grow 3% to 4% in fiscal 2025. Our PEO revenue growth outlook assumes average worksite employee growth of 1% to 3%. This reflects our expectation for continued new business bookings growth and modestly better retention to be offset by declining PEO pays per control growth that remains below our historical experience. We expect PEO margin to decrease 90 to 110 basis points in fiscal 2025. This anticipated margin decline reflects our forecast for zero margin pass-throughs to grow faster than PEO revenue and increase in our workers' compensation costs and higher PEO selling expense from accelerating new business bookings growth. Adding it all up, our consolidated revenue outlook is for 5% to 6% growth in fiscal 2025. And our adjusted EBIT margin outlook is for expansion of 60 to 80 basis points. We expect our effective tax rate to be around 23%. And we expect fiscal 2025 adjusted EPS growth of 8% to 10% supported by buybacks. One quick note on our margin cadence. We anticipate adjusted EBIT margin expansion on a year-over-year basis to be more modest in the first half of the year before trends ramp in the second half of fiscal 2025. Thank you. And I'll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi. Good morning. Thank you. I want to start with bookings here. So, sounds like a pretty solid close to the year. Can you provide more color on the attribution of that bookings performance across the business? And in general, I guess when you're looking at demand into July, just any changes based on employer size or geography?"
},
{
"speaker": "Maria Black",
"text": "Sure, good morning, Bryan. Great to hear from you. I love talking about bookings, especially on the heels of what was truly an exceptional performance by the overall team in the fourth quarter. To answer the first part of the question, it was broad-based. So we did see strength across our growth in small business, mid-market, enterprise, and international. So we are really pleased with the momentum that we see as it relates to the overall receptivity to the offerings, to the product, to the execution, and really proud of how the team moved through the quarter, which led to the exceptional results at 7% for the year. In terms of the demand environment overall and what we see, what I would offer is that the HCM demand environment remains strong. One of the things that's unique about HCM is what we do, it's not a nice to have, it is actually an imperative for a company to run their business. They need to have their associates pay, they need HR tools, and certainly it's not getting any easier. Whether you're in the down-market, mid-market, up-market, to navigate being an employer. And as such, we fit squarely into that. So we feel good about the momentum stepping out of the quarter. We feel good about the demand environment stepping into the quarter. Pipelines from a year-on-year perspective look strong. So we're very optimistic and proud of the performance."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, I appreciate that. And then my follow-up, just on kind of pays per control performance here, can you compare and contrast the pays per control performance in ES versus what you're kind of seeing on the same store sale, PPC and PEO. And any cadence assumptions here as you go through 2025?"
},
{
"speaker": "Don McGuire",
"text": "Yeah, Bryan, I'll take that one. So as we look at pays per control, we do think that the labor market is still pretty resilient. I mean, there are a number of factors that we look to. And, you know, if you look at the BLS, you look at the unemployment rate, JOLTS Report came in the other day, it was down, but better than expected. Labor force participation still got some room to go, et cetera. So jobless claims are kind of neither here nor there. They're benign. So we think there's still continued good strength in the market. Having said that, we do think that pays per control is going to moderate. And we have said we're thinking 1% to 2%, as we go forward into 2025. I would say that we do expect that the pays per control growth in the PEO will be lower than it is in ES, but we are still optimistic that there's growth to be had, but certainly we expect ES to be somewhat stronger than we expect PEO."
},
{
"speaker": "Bryan Bergin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Oh, thanks guys for taking my question. You know just to touch again on ES, like I kind of want to know like how much of that strength is idiosyncratic and things that you're doing internally versus the macro. And then maybe the follow-up is again asking about the guidance and like maybe you can layout you know what could go well and what could go wrong in terms of the macro -- the underlying macro for the guide that would be it. Thank you."
},
{
"speaker": "Don McGuire",
"text": "Yeah Dan. So you know just to follow up on that I would say that you could will unemployment remain as low as it has been? I think there's no indication that it's going to worsen. It's still at, you know, decade lows or comparable to decade lows. There is good strength, there seems to be good strength across the broader spectrum of new jobs. So the NER report came out earlier today and we're [continuing] (ph) to see new jobs. So I think that we put out there a PPC growth number that's realistic. What could change that? We could imagine all kinds of macro issues, but I prefer not to do any imagining. I think we're trying to do what we can based on what we know today. So I think that what we have today is pretty good. But as I mentioned earlier to Bryan's question, we certainly recognize that ES is likely to be stronger than PEO."
},
{
"speaker": "Maria Black",
"text": "And Dan, if I can just add on the sales side, just with respect to -- are we driving the results as it being driven by Macro? My answer to you would be both. And so I think we have a strong demand environment. I touched on that during Bryan's question in terms of our offer and how squarely it fits into that demand environment. And that's really a broad-based execution across the entire business. So it is the investments we've made into our products. It is the best-in-class service that we have. We see that in the NPS results, by the way we see that in our retention results as well. And so I think we've been getting stronger and stronger. I think the value proposition of what we offer is an imperative for businesses. And then once again, I would say, yeah, we are executing incredibly well across the full spectrum of our sales differentiation. I mentioned in the prepared remarks, I consider it to be one of the greatest competitive advantages that ADP has. Part of that is our ability to canvas the entire market. So whether buyers trying to buy digitally, or they're trying to buy through a channel, or they're trying to buy the traditional way, like we show up at every single turn, and we lean right into that with the best product and the best service out there. And as a result of all of those things, I think we are executing very well."
},
{
"speaker": "Dan Dolev",
"text": "Great results, Thank you."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you so much. I wanted to ask on competition. Some of our recent conversations with those in the industry have kind of indicated that there's been some meaningful price compression from some of your competitors, particularly in the mid and down market segments. Have you observed others getting more competitive on price or from your perspective, is it fairly status quo right now?"
},
{
"speaker": "Maria Black",
"text": "Good morning James. What I would offer is it is pretty status quo. We haven't really observed any of those meaningful price compression, things of that nature. Given how much we do compete, I think we would see – I’d say, that there is always some of that in terms of whether it is promotions and things that all of us run at various times throughout the year. But it doesn't seem atypical for me. And obviously, I've spent a lot of years watching the competitive landscape and the sales environment. So I haven't seen anything anomalous. I think the one thing that's changed, specifically in the competitive landscape is us. And so when I think about our ability to execute, and everything I just mentioned, best product, record retention, record NPS, incredible execution by sales. I think we are stronger than we've ever been. So I'd say, that's the shift. But from our purposes, it is still a competitive environment and we lean into it every single day."
},
{
"speaker": "James Faucette",
"text": "Great. Glad to hear that. And then wondering if you can give a little bit more color on the composition of bookings, especially between enterprise, mid-market and down market. And also, what are you seeing in the international business? And how should we think about the potential uplift there over time, as price points in lower-cost regions continue to improve?"
},
{
"speaker": "Maria Black",
"text": "What I would offer is that the down market had incredible strength by the way on top of incredible strength last year. I think I mentioned -- or I did mention during the prepared remarks, we onboarded, we sold and started 50,000 new clients in small business in the fourth quarter alone. So we are officially got 890,000 of our 1.1 million clients are in that down market space. And so we continue just to see broad-based demand. And again, we’re executing very well on that. Our mid-market sales results were phenomenal. Just an incredible execution by the team. Again, our product has been getting newer and stronger, so feel really good about that. I mentioned also in the prepared remarks what we saw in the enterprise space, specifically with respect to our next-gen HCM offering. One of the reasons I'm so excited about this is that we are seeing record results, we are seeing more than we anticipated, quite significantly more than we anticipated. And we are not even at general availability yet. And what that suggests to me is that the market is ready for this offering -- the market is excited about this offering. We see clients wanting to buy in the enterprise space from ADP, and we are stepping into that opportunity. So that's kind of the distribution. Very strong strength. You asked about international specifically. International had a fantastic year overall. So it was really the story of four quarters. I think first quarter of last year was strong over year-on-year first quarter of 2023. Second quarter got even stronger. Third quarter got even stronger than that. And fourth quarter, you'll probably guess got even stronger than that. So overall, our international business had just a fantastic year as well."
},
{
"speaker": "James Faucette",
"text": "That’s great. I appreciate all the color Maria."
},
{
"speaker": "Maria Black",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thanks for taking my question. I wonder if you could comment on how you're thinking about the balance -- striking a balance between pricing and retention and just sort of also speak to your confidence level about being able to take that 100 basis points of pricing, which I think is more than you took sort of pre-pandemic, although less than you've been taking in this really inflationary environment. How are you -- how confident are you that you can take that without tipping retention in the wrong direction?"
},
{
"speaker": "Don McGuire",
"text": "Thanks for the question Ramsey. Yes, it is a great question because we always think really, really hard about pricing decisions and making sure that we don't get greedy. As we've shared on many occasions, what we are interested in is long-term clients and the lifetime value of those clients. So we are always very, very careful not to over rotate on price. And you are right, we have been able to take about 150 basis points in '23 and '24. And as we look to '25 and we looked at the moderating inflation environment, we thought that 100 basis points is realistic. If we go back pre '23 and back into the teens we were more on the 50 basis points range, but the inflation environment was very, very different then it was virtually not existent. So we are confident that we can get 100 basis points. We are confident that we can target it in the right places. So it is something that we think is a reasonable expectation for us to target."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay. And a follow-up for me is about generative AI. And just if you could talk about how we should think about the long-term kind of opportunity there in terms of monetization. Is this ever something that could contribute to revenue directly? Or is this -- is generative AI sort of more something that will drive soft dollars to retention, new bookings? Obviously, there is an expense benefit internally. But I'm just curious about how you're framing it up over the long term."
},
{
"speaker": "Maria Black",
"text": "It's a great question. My answer to you would be both. And so from a generative AI perspective, I know you know that I love to speak about it. I talked about it again at length just this morning during the prepared remarks. What I’d offer is that all across, whether it is the focus we have of putting generative AI, ADP Assist across and into each one of our products, or it is the work that we're doing with putting ADP Assist into the market to help practitioners, or help our own service associates and our sales associates, the way I think about it, first and foremost is exactly what you suggested, which is it should feed the ADP model. And in its most simplistic form when I think about this company and driving the recurring revenue model that we have, it is about sales, it is about retention, it is about product efficiency and it's about NPS. And those four metrics generative AI and everything that we are offering as it relates to ADP Assist should feed, call it the machine of our model, right? So we should have more sales, we should be able to keep clients. Why? Because they are happier and they have a better experience as it relates to NPS. And then in turn, we also drive efficiency. So I think that's the output and the outcome of a lot of the investments we are making. That said, as we look at all the use cases and both the short-term stuff that we're working on, as well as the long-term vision of what ultimately generative AI could look like in the coming years, we do see monetization opportunities. And each one of our business cases, as you can imagine, has clear goals of what it is that we are trying to accomplish, inclusive of revenue growth. I think it's too early to start sharing some of those broadly across the market. But certainly, that's a big piece of our strategy, as is making sure that we continue to drive the transformation type of opportunities that we've been driving for years as a company."
},
{
"speaker": "Ramsey El-Assal",
"text": "Fantastic, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning. Thanks for taking my question. Don, maybe one for you. Just on the PEO guidance, and I apologize if this question is kind of a dumb question, but I just want to make sure I understood it. If I look back to last year, you had actually a slightly better WSE assumption, and you guided to 3% to 5%. And this year, you are assuming lower WSE growth but actually slightly better revenue growth. And I was just trying to reconcile those two things. Is retention assumptions the big difference there? Or is there some other mechanical thing, it is easier comps? I'm just trying to understand the PEO guidance this year versus last year."
},
{
"speaker": "Don McGuire",
"text": "No, Samad, it is a great question. So there are a few things happening if you look forward to 2025, revenue is growing, but the biggest contributor to the revenue growth is zero margin pass-throughs. So that's the largest component, and that's what's happening there. And then, of course, we have mentioned earlier that pays per control are under pressure. So as I said in an earlier answer, 1% to 2% for ES, and we think more towards the low end of that for the PEO area. And then we have a little bit of pressure from workman's compensation on the margin. And I guess the third thing is we do continue to focus on the area to get sales reaccelerating. So we certainly have more selling expense baked in to that business to help drive the top-line and make sure we get to continue to grow our worksite employees."
},
{
"speaker": "Samad Samana",
"text": "Understood. And Maria, if I take just one huge step back, the business is very strong right now, and it seems like that's happening in what is a backdrop that is slowing. And so I just was wondering, you've been at ADP for a long time, you've seen multiple cycles, can you just remind us that when you see a broader slowdown in the backdrop, just kind of how you still are able to drive value and what the performance of the business has historically been in these slowdown periods, because I think we are all impressed by the durability of the strength even as things may be slow in the backdrop?"
},
{
"speaker": "Maria Black",
"text": "Yes. Thanks, Samad. And you are right. I think the durability of what it is that we offer, I spoke to it a bit earlier in terms of the imperative of HCM, I think that durability also lends itself to a different environment should the macro change. So the sales force of ADP, if you will our offering is great in times of growth, it is great in times of steady, and it's also great as a conduit as there might be pressure in the employer environment. And so the value proposition, we have a playbook. We can adjust very, very quickly in terms of what it is that we offer and the demand environment -- as the demand environment shift. Now that said, should there be a huge decline in the macro, of course we will be impacted. One of the things that does end up getting impacted is bookings. But at the same time, from a standpoint of the self-adjustment of that value proposition, it’s very durable, and it is very durable, as a result of HCM being an imperative. And so we feel good about our ability to flex. And I've seen that, to your point Samad, I've been here a long time, as a student of ADP's great distribution, and I've seen that flex over time and have all the confidence that the team would do the same. I think maybe Don could also talk about the -- how that financial model, should something shift in the market, the financial model also self-adjusts as it relates to the playbook, if you will in a different macro."
},
{
"speaker": "Don McGuire",
"text": "Yes, certainly. We've talked about this before. But if we go back a year or so, I think -- or maybe 18 months, the word recession was on people's lips a lot more frequently than it is today. I think the latest survey I've seen says that there is about a 28% probability of recession in the next 12 months. I'm sure that's some survey that the rest of you have read somewhere as well. So the good news is, it looks very unlikely that we are going to have a recession over the next 12 months. But certainly, as an all-weather company, what we do isn't discretionary. You have to do it. The levers we have, if sales slow commissions slow, if implementations slow, we don't need as much headcount, et cetera, et cetera. But I think, as we saw in 2008, it took a long time for ADP to find itself in a place that looked like a lot of adjustment. So we think that we can use those tools again should we need to. But I'll just finish with hopefully, that survey is correct and nobody is thinking about a recession in the next 12 months."
},
{
"speaker": "Samad Samana",
"text": "Great. Appreciate. Have a good day. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hi, good morning. And thanks for taking my questions. Congrats on the strong bookings in the fourth quarter as well as the really strong retention. I wanted to dive a little bit deeper into both. With regards to the strong bookings, Maria you cited on the small business side, RUN doing extremely well, getting 50,000 new clients. Can you talk a little bit about what the source of those clients are? Were those clients that were using competitive solutions? Were they brand-new business formations? How would you characterize that? Where are you seeing the strength and the takeaways from?"
},
{
"speaker": "Maria Black",
"text": "Sure. So on the down market specifically as it relates to bookings, the bookings again are broad-based, right? So where are we getting them? We are getting them from digital inbound, we're getting them from new businesses, we are getting them through the ecosystem of our channels, so clients that are engaging with banks, CPAs. Again, we canvass the entire market. That said, some of the things that we have seen, Mark year-on-year new business formations, it is still at an elevated rate, but it is pressurized. So sorry, year-on-year, it is minus 3%, but it's still elevated compared to norm. And so as a result of that, we did see less coming this time from new business formations. Now we had a lot come from new business formation, but we also saw an increase in balance of trade, some more coming from the competition. So what I would say is mix shifted a little bit in terms of how we broadly canvass the down market. All that rolled up to this incredible result of 50,000 units in the fourth quarter. So it is broad-based, but there are tiny bit of shifts within that to answer your question specifically."
},
{
"speaker": "Mark Marcon",
"text": "Great. And then on next-gen HCM, you also mentioned a 50% pickup there in terms of new sales. And this is before you are fully GA. Can you talk a little bit about what the source of the wins are in terms of -- are these clients that are transitioning from older ADP platforms? Or are they coming from competitors? And if it's from competitors, what sort of competitors?"
},
{
"speaker": "Maria Black",
"text": "Sure. The answer is both and also head-to-head against competition. So some of them are ADP upgrades. We did see more new logos than we've seen before. So we are really excited about the net new wins to ADP. Some of those were wins and takeaways from enterprise competitors. Some of them were wins head-to-head against the same said enterprise competitors, which again is probably why I'm so optimistic about it, because it appears that the offer that we have is competing incredibly well in the market and clients are choosing ADP."
},
{
"speaker": "Mark Marcon",
"text": "That's great. And then with regards to client retention, I know you are guiding prudently for a normalization. But it seems like your client satisfaction scores continue to trend up. How would you characterize the primary drivers of the improved client satisfaction? Is it the solution set? Or is it the service underlying, or a combination of both?"
},
{
"speaker": "Maria Black",
"text": "It is a combination of both. NPS is fantastic. So NPS for the quarter as well as the full year was a record. Almost every single business is at a record NPS. So what drives NPS? It is that both, right? So it is the investments we've made into our best-in-class products. And this is years that we've been making these investments and making our products newer and more modern taking friction out, making them more self-service. All of these things that go into having best-in-class HCM technology, those investments coupled with best-in-class service, is driving the broad NPS record that we have across the business. So as such, that is a direct correlator to a record retention. And so we are really proud of the 92%. You are right. We're prudently guiding into the year again. And the reason behind that is, as you know we've had this conversation many times, is that there is still perhaps some normalization that could happen, and also because we are executing at all-time highs almost across every single business. We just want to be thoughtful as we step into the year to make sure that the retention guide is prudent."
},
{
"speaker": "Mark Marcon",
"text": "Got it. Thank you."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hi. Perfect. Just want to extend on the retention, but more on the outlook side, if that's okay. Just any callouts expectation-wise across the segments, small, mid and large? I know you've commented on balance of trade already, but I didn't know if you are seeing anything different in terms of expectations on retention."
},
{
"speaker": "Maria Black",
"text": "Yes, fair. What I would offer is it is the same reason that we guided into the year, this year the way that we did, this year that we just closed, it is expected potential normalization in the down market. Now I've been saying that for the last couple of years. It isn't -- yes I know. The down market isn't entirely normalized back to where it was pre-pandemic. Now I get that that's five years ago and it may be at some point, we all have to just suggest that it is the new normal. But we haven't seen an uptick in bankruptcies, out of business at the levels that we used to see in that business. And as such, we believe it is prudent that there could still be some of that normalization. So it's really the same thing that we've been suggesting. It just hasn't happened yet. And our goal would be of course, to not have it happen again."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. And you did outperform, obviously the guidance you set last year this time, so okay. No, I just wanted to check. I think this -- again, you've said prudent and totally agree with that. Just my quick follow-up just is on the margin front. I know it is very typical margin expansion. I think you did call it last quarter, maybe a little bit more investment in G&A. Anything different in terms of incremental margin outlook for fiscal 2025? It does look like you have a workforce rebalancing in the fourth quarter as well. So I just want to make sure we call it the puts and takes there on the margin front. Thank you."
},
{
"speaker": "Don McGuire",
"text": "Yes. So Tien-Tsin, thanks for the question. I think that we are always -- I'll start with where you ended there. We are always looking at the workforce and making sure we're -- we've got the right people in the right places and the right numbers of people in the right places. So we're always looking at that. I don't think there is any real specific callouts on the margin. I think that there are some Gen AI investments. These are modest, but they do attract 10, 20 bps here and there, so to speak. But they are modest all things considered. Certainly, the margin next year would get a little bit of pressure from lower pays per control from lower pricing increases and from lower client fund interest, specifically -- most specifically in the back half. But I think those are all things that we've called out and you can read through. So nothing abnormal."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. No, glad to see it's typical. And congrats to Danny and Matt as well. Thanks guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi guys. Congrats on the quarter really strong in ES. On PEO, the bookings were accelerating and recovering in fiscal year '24 but moderated towards the end of the fiscal year. So just want to understand what changed in the marketplace there."
},
{
"speaker": "Maria Black",
"text": "Sure. Thank you by the way. I appreciate the congrats. PEO bookings did moderate a bit in the back half. And from a year-on-year perspective, it did moderate as well. That said there was still strong growth in PEO bookings. And so from my vantage point, the demand equation is still incredibly strong for the PEO. It was a slight moderation year-on-year. We feel really solid about the demand for the offer, the value proposition of the offer, and we feel solid about pipelines in the PEO. And as you know, with pipelines in the PEO, it is more about activity in the market, new appointments, requests for proposals, things of that nature. So all the bellwether signals show that the PEO strength is still there, but it did moderate a bit in the back half."
},
{
"speaker": "Bryan Keane",
"text": "Yes. And just a follow-up just with thinking what would it take to get PEO back to high single-digit or double-digit revenue growth that was targeted previously?"
},
{
"speaker": "Don McGuire",
"text": "Yes. Hi Bryan, I think it's going to take a little bit of time. And we were working, and as I mentioned earlier, we are seeing some more margin pressure in PEO, and some of that is because of the investments we are making in the sales force to make sure we can get those bookings going. But realistically, to get to kind of Investor Day guidance that we provided three years ago, it is going to take some time to build that back. So we are definitely focused on that, and we are definitely focused on getting there. Of course, if we were to see some reacceleration in the pays per control, that would put lots of wind in the sails, but it's going to take a little bit of time to get back to where we want to be."
},
{
"speaker": "Bryan Keane",
"text": "No, that makes sense. And congrats again."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Good morning guys. Thank you for taking my questions. I wanted to go back to the margin guidance and just the context of seems like slower expansion in the first half versus second half. Wondering if you could maybe walk us through the drivers there. Is that more on the shape of revenue, or does it have anything to do on the cost side? Thank you."
},
{
"speaker": "Don McGuire",
"text": "No. Good question, Scott. More on the shape of expenses. Revenue expectations throughout the year are pretty consistent quarter-to-quarter. It is really some spending patterns we have in the first half of the year, but really nothing specific to call out. Just want to give folks a heads up that we think we are going to be stronger in the back half than the first."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. That makes sense. And just as a follow-up on the international side. I mean it seems like you're making some good traction on incremental countries and geographies. And we'd love to just kind of hear about your sort of expectations for international heading into this year, how much of it is a priority for you relative to maybe other investments in the business and where you're maybe seeing opportunities internationally."
},
{
"speaker": "Maria Black",
"text": "Yes, fair, Scott. It is a very large priority for us. As you may remember, our third strategic priority is to benefit our clients with our global scale. International fits squarely into that strategic priority. We've been building this business for 50-some odd years. We are well ahead of the competition, as it relates to the number of countries that we serve on behalf of our clients, and moreover the infrastructure in those countries that we've built out. So we often speak to the final mile and all the things that we do to ensure that our clients have the ability to pay across very complex, sometimes large complex clients or countries, and sometimes very small complex countries. But certainly, it is a big piece of our offer. I think companies continue to want to think about their system of record from a global perspective, as they continue to have distributed workforces across the globe, as they continue to move supply chains in this world of globalization, as they have remote employees in smaller countries and around the world. We have this incredible network and ability to support clients today in what is 141 countries, and we continue to add more, as they become prudent in terms of the -- again, if it is the growth economies or where our clients are heading. But it is a big piece of our growth story. It's a big piece of our differentiation in the marketplace. And our multi-country MNC business is a clear competitive advantage for us in the international space."
},
{
"speaker": "Scott Wurtzel",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Caroline Latta",
"text": "Hi. This is Caroline on for Jason. Thanks for taking our question. Can you talk about the duration of the portfolio? We were a little surprised to see that the F’25 average yield is expected to be up year-over-year based on the number of rate cuts being forecast. And maybe how you might be adjusting your investment strategy for the portfolio based on the interest rate outlook for the next 12 months."
},
{
"speaker": "Don McGuire",
"text": "Caroline, thanks for the question. So we do have a laddered strategy. So if you actually refer to the -- I think, the last page of the earnings release, I think you can see the maturity schedule for our investments. And you can see that, for example in 2025, we have $6 billion that's maturing at roughly 2.2%, and our reinvestment at this point in time is 4.2%. So there's still lots of opportunity, and this is a place where ADP's laddering strategy shows its strength. It is fair to say that over the last couple of years, because of the inverted yield curve, we did have some opportunity cost by having this strategy. But I think we are very much seeing that as yield curves start to normalize, that we still have lots of opportunity for client funds interest growth. I’d just add to that that the portfolio is continuing to grow. It's growing 3% to 4% again next year, maybe not as much as it has in the past couple of years because wages have moderated a little bit, pays per control moderated a little bit. But we are still seeing good growth in that area. So we still have lots of opportunity. And the most important thing here, the most important comment I can make on this whole fund strategy, is that we base all of these commitments or all of these expectations on the current yield curve. We're not trying to outguess the market. We're looking at what the market in general has to say. And we are using those yield curves to put together our forecasts and our guidance on interest rates."
},
{
"speaker": "Caroline Latta",
"text": "Okay, that’s helpful. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ashish Sabadra with RBC Capital Markets. Your line is open."
},
{
"speaker": "David Paige",
"text": "Hi. This is David Paige on for Ashish. Thanks for taking our question. I just wanted to circle back to the workforce optimization charge that we had in the quarter of $42 million. Should we expect further workforce optimization in 2025? And if yes, how much of that there, what's the benefit to the EPS guidance for '25 as well? Thank you."
},
{
"speaker": "Don McGuire",
"text": "David, as Maria has shared earlier, I mean, we're always looking to make sure that we've got the workforce at the size it needs to be and in the places it needs to be. So we made those difficult decisions that we had to make on behalf of some of those employees. But we always look at this. And if you look at ADP over the years, we've always done what needed to be done to go forward. So I would just leave it at that and say that we're very happy with the guidance we put out here and the margin guidance as well. So we will make sure that we do what we need to do to execute, and we'll see what the future brings. But as we sit here today, we've done what we need to do, and we are looking forward to the future."
},
{
"speaker": "David Paige",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning. I know you've talked about the strength in bookings quite a bit. And I'm just wondering from an enterprise sales standpoint if there is been any change. Is the sales cycle lengthening at all? Are enterprises maybe asking to buy less modules they have in the past? Any kind of change or has it been pretty much status quo and really no change from a demand or a sales cycle standpoint?"
},
{
"speaker": "Maria Black",
"text": "Fair. It is a great question. I think we talked about it a bit last quarter and perhaps throughout the year, which is that we're really at a new normal, as it relates to the overall sales cycles. It is reminiscent of what it used to look like pre-pandemic. But arguably, there are more decision-makers involved. The process has elongated a bit from where it was during the height of the pandemic. But the deals are moving through the motions. I would say that they are moving through the motions pretty typically. But certainly, it's not as fast as it was at one point in time. But we're not seeing less modules. We are seeing a big conversation around global, a big conversation around global system of record, things of that nature, which again is where this next-gen HCM fits squarely into that demand. So the conversation shifted a bit, but that is not necessarily new news, Kartik. It's really what we've seen over the last couple of years, as a byproduct of how clients in that enterprise global space operate. So certainly, that's how we are leading what that best offer kind of across the enterprise and international space. But from a deal cycle standpoint, it is pretty similar to what we've seen throughout this year, which is more decision-makers involved and prudency, as it relates to the decisions that are being made, but not necessarily less modules or anything of that nature."
},
{
"speaker": "Kartik Mehta",
"text": "And then just on the small business side, I mean as you look at the health of the small business, anything that is changing or anything that would give you concern just as people get worried about the economy, or change in behavior?"
},
{
"speaker": "Maria Black",
"text": "Yes. Great question. So we monitor so many of these things, right? So I spoke to one of them earlier, which is the pace of new business formation. That tends to be a bit bellwether. Again, it is still elevated from norms, but it is down year-on-year. We are also monitoring our own out of business. We are looking at clients that call it suspend payroll and how many are sitting in that type of capacity. These are all things and metrics that we've monitored for years to ensure that we are kind of seeing what is happening real time, if you will. What I would say is there are little pockets, very similar to the new business formation of kind of watch items that we have our eye on. None of it at this juncture gives us great pause. Quite the opposite. But at the same time, we are monitoring these things to make sure that we don't get surprised as it relates to the shift should there be one. But there hasn't been one yet."
},
{
"speaker": "Kartik Mehta",
"text": "Perfect. Thank you so much. I really appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. There are no further questions. I'd like to turn the call back over to Maria Black for any closing remarks."
},
{
"speaker": "Maria Black",
"text": "Great. Thank you. So I will end where I started, which is I'd like to take this opportunity to thank our 64,000 associates. All of the results that Don and I have the pleasure of getting on this call to represent, they are a byproduct of 64,000 associates that are all incredibly committed to having the best-in-class technology, the best service, and the biggest, broadest global scale. And everything we do, whether it is from product innovation to our contracting process, to our sellers, to our service associates, it really takes the entire company being aligned on what I would suggest is a commitment to client and client centricity. In that spirit, I'd also like just to take a minute to thank our 1.1 million clients. I will tell you, as we celebrated the 75th anniversary of ADP, it was quite a remarkable moment to think about all the clients that we've impacted over 75 years and had the honor of contributing to their journeys of success and navigation. So definitely want to take a minute to honor all of our clients. And then last but not least, all of you who dialed-in today. I appreciate you joining us. I appreciate your interest and your investment in ADP. And I look forward to speaking with you soon."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. You may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 3 | 2,024 | 2024-05-01 08:30:00 | Operator: Good morning, my name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the call over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead.
Danny Hussain: Thank you, Michelle, and welcome everyone to ADP's third quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Danny, and thank you everyone for joining us. This morning, we reported strong 7% revenue growth and 14% adjusted diluted EPS growth for the third quarter as we continued to make progress delivering against our strategic priorities and as the labor market and the overall HCM business environment remained stable. I'll begin with a review of the quarter's results and provide a brief update on our strategy before turning it to Don to update you on our outlook and share some early considerations for next year. In Q3, we delivered solid Employer Services new business bookings growth reaching record bookings for our Q3 period and keeping us on track for our full-year outlook. We maintained momentum in our small business portfolio with particularly strong growth in our retirement services offering, and in Q3, we also delivered strong bookings results in our midmarket, enterprise and international businesses. With a steady demand backdrop and a healthy new business pipeline, we are focused on continuing to execute for the remainder of the year. Employer Services retention was very strong in the third quarter and once again exceeded our expectations also reaching a new record level for our Q3 period led by our midmarket business. Our overall retention continues to benefit from ongoing investments in our key platforms and from our commitment to delivering an exceptional client experience, which together helped our client satisfaction scores reach a new all-time high for our Q3. Our Employer Services pays per control growth was steady at 2% reflecting the resilient overall U.S. labor market and the fact that our clients continue to add to their workforces at a moderate pace, and our PEO revenue growth of 5% for the third quarter was in line with our expectations despite continued short-term pressure from below normal hiring activity we've been experiencing among those clients. Moving on to a broader update, we continue to push forward on our three strategic priorities, leading with the best HCM technology, unmatched service and expertise in a broader scale to ultimately deliver the best possible experience not just to the buyers of our products but everyone that engages with ADP. We are investing with purpose to deeply understand and deliver value to a vast set of personas from small business owners that count on us to HR professionals and executives of the largest global enterprises to millions of employees and gig workers around the world who engage with our solutions through CPAs, banks, brokers and other key partners to our thousands of dedicated service and implementation associates and to our sellers who represent ADP in the market every day. It's with these personas in mind that we continue pushing forward on our strategic priorities, and in Q3, we made steady progress. Our first priority is to lead with best-in-class HCM technology. We've been rolling out ADP Assist these past couple of quarters, which as a reminder will be embedded in our key platforms and utilizes GenAI to surface insights, aid decision-making and streamline day-to-day tasks for our clients and their employees. In Q3, we were very excited to begin piloting a new feature that enables our small business clients to not only leverage GenAI to answer questions and better understand how to initiate an HR action which we outlined in recent quarters but to actually allow them to issue commands to complete that HR action. For example, users can now type I need to rehire Alex or I would like to give Alex a leave of absence and are expedited through that workflow. Our second priority is to provide unmatched expertise in outsourcing. We continue to extend GenAI capabilities to a broader portion of our service associates, and in Q3, we started rolling out a new tool for some of our implementation teams. Now they can use GenAI to take in unstructured client employee data reducing manual data entry and minimizing errors during the implementation process. While it's still early, we are excited about its potential benefits. Our third priority is to benefit our clients with our global scale. The ADP marketplace remains a differentiator for us and is a perfect example of a benefit our clients receive from partnering with the leader in HCM. As a growing number of our hundreds of partners offer AI-enabled solutions, in Q3, we established ADP marketplace AI principles that require our partners to commit for the same type of responsible AI principles that govern our own products including human oversight, monitoring, explainability and mitigating bias. Our clients put a huge amount of trust in us and this is another example of how ADP strives to ensure the responsible use of AI throughout the ADP ecosystem. We also continued to extend our market-leading global scale, and in Q3, we reached 1 million paid employees on our I-HCM platform, which continues to scale in several countries in Europe and we made further progress in growing our presence in the APAC region, where we have recently been expanding our in-country payroll and workforce management presence in a number of markets. In 2024, we are celebrating our 75th anniversary and we pride ourselves on having built ourselves into a brand that truly matters to employers, their employees and the broader world of work. Our focus on our strategic priorities positions us to deliver more value than ever for our over 1 million current clients and to the tens of thousands of new clients we welcome to the ADP family every quarter. I'd like to highlight just a few of these new client wins from Q3 to give you an appreciation for the variety of ways in which we deliver value for them. In U.S. small business, we had a new Boutique Donut Shop referred to us from one of our CPA partners. The client chose ADP for the strength of our run platform, our reputation for great service, our strong relationship with our CPA and our ability to provide retirement services. Since this was a first time small business owner, our sales team even took the time to help the business owner set up their business the right way from guiding the client on obtaining a state tax ID to making sure the client obtained the appropriate workers compensation insurance. In U.S. midmarket, we won a multistate operator of rehabilitation centers, this client wasn't happy with our prior HCM provider and Workforce Now proved a much better fit. What makes me the most proud in this example is how one of our ADP marketplace partners played a key role in the decision to switch to ADP by independently highlighting the advantages we offered in terms of ease of integrations, a capability we have invested in over the years. In U.S. enterprise, we welcomed a large luxury resort that operates multiple hotels, restaurants and retail stores on site and was dissatisfied with the prior provider's level of client service. The client was so happy following their seamless ADP implementation, which included onsite training for their HR team that they accelerated their plans to add-on features like benefits, recruiting, onboarding, wage garnishment and tax credits. In our International business, one recent win was a leading airline that utilized ADP in certain countries and asked us to help better define their global payroll strategy. Ultimately, they expanded the scope of our services to include in additional 18 countries and started that rollout in the third quarter with plans to add other countries over the next year to enable true consolidated global reporting and analytics. And as a final example, our HRO team started a New York-based design firm after its leadership team recognized the company lacked the HR infrastructure required to adequately attract and retain the right talent. They turned to our PEO offering for truly comprehensive support, attracted by the breadth of our offering including features like the MyLife Advisors program, which supports employees as they make benefit in other important life decisions. We also advise this client in the development of a comprehensive benefits strategy to support their multigenerational workforce and help them attract the talent that they need to grow. As you can tell from these examples, it's often a combination of our technology, expertise and overall breadth that resonated with these businesses, and the result is incredible diversity in our client base and a resilient overall business model. We look forward to leaning in and delivering even greater differentiation in the market going forward. Overall, we were pleased with the strong financial and strategic outcomes in the third quarter. I'd like to thank our associates who continued to deliver exceptional products and service to our clients, in whose efforts drive these client wins and retention. Thank you again for all you do for ADP and for our clients. And now, I'll turn it over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I'll provide more color on our results for the quarter and our updated fiscal 2024 outlook. Overall, we reported a strong third quarter with our consolidated revenue growth and our adjusted EBIT margin coming in a bit above our expectations. The interest rate backdrop has improved since we last provided our full year outlook, so we are updating our outlook for that as well as making a few other changes, which I'll detail. I'll start with Employer Services. ES segment revenue grew 8% on a reported basis and 7% on an organic constant currency basis. As Maria shared, we had a good quarter in ES new business bookings with broad-based growth across our client segments. We have a tough compare in Q4 following last year's strong finish but with a steady HCM demand environment and healthy pipelines, we feel on track to deliver our 4% to 7% new business bookings growth outlook for the year. Also, as Maria mentioned earlier, our ES retention exceeded our expectations and increased slightly from last year. Given our continued strong retention performance, we are increasing our full-year retention outlook slightly, we now anticipate a 20 to 30 basis point decline in full year retention which is better than our prior forecast. ES pays per control growth held steady at 2% in Q3 and we now expect growth to round to 2% for the year, the high end of our prior 1% to 2% growth outlook, and client funds interest revenue exceed our expectations in Q3 due to higher average client funds balances and a slightly better average yield. We are revising our full-year client funds interest outlook to reflect our Q3 results and the increase in prevailing interest rates since our last update. We now expect fiscal '24 average client funds balance growth of about 3% and we are raising our expectations for client fund's interest revenue and net impact from our client fund's extended investment strategy. In total, there is no change to our fiscal '24 ES revenue growth forecast of 7% to 8%, although we are now likely to come in towards the higher end of that range. Our ES margin increased 230 basis points in Q3, driven both by operating leverage and the contribution from client funds interest revenue growth. With our strong Q3 results and the slightly more favorable client funds interest rate backdrop, we are raising our fiscal '24 ES margin outlook and now anticipate growth of 180 to 190 basis points. Moving onto the PEO. We had 5% revenue growth driven by 3% growth in average work site employees in the third quarter, representing slight acceleration from the first half of the year. These results were largely in line with our expectations and we were encouraged by the gradual stabilization in our PEO's pays per control growth which decelerated but only slightly from the prior quarter. We continued to anticipate soft pays per control growth through the end of the year and expect work-site employee growth to hold steady at about 3% keeping us on track for our full-year outlook for work-site employee growth of 2% to 3% and revenue growth of 3% to 4%. PEO margin decreased 220 basis points in Q3. As we shared last quarter, we expect this year's workers' compensation reserve release benefit to be significantly lower than what we experienced these last few years, and in particular, last year's $73 million benefit. We are updating our fiscal '24 outlook to now assume a minimal release benefit, and as a result, we are further revising our overall PEO margin expectation to be down 120 to 140 basis points in fiscal '24 versus our prior expectation for a decline of 80 to 100 basis points. Putting it all together, there is no change to our fiscal '24 consolidated revenue growth of 6% to 7%. With the two changes to segment margins, largely offsetting one another, we continue to expect our adjusted EBIT margin to increase by 60 to 70 basis points. We still anticipate an effective tax rate of around 23% and we continue to expect fiscal '24 adjusted EPS growth of 10% to 12% with the middle of that range still the most likely outcome. As we look ahead to fiscal '25, I wanted to share a couple of early thoughts at this point. First, give them the fullness of the labor market, we are planning for pays per control growth to once again be below normal levels next year and to decelerate modestly from this year's growth level in both ES and our PEO segments with the resulting revenue pressure more apparent in the PEO segment given its more direct revenue sensitivity to work-site employees. We will of course share those exact assumptions with you when we give our formal guidance in a few months. On the expense side, we are also planning to continue growing our GenAI related spend next year. As you've heard from us all year long, there are many ways we can put GenAI in the hands of all of the different stakeholders that work with or on behalf of ADP, including our client practitioners, their employees, our service and implementation teams, our sellers and our developers. These are critical investments and they are the right investments for ADP, but we expect the associated benefits and productivity of growth to phasing gradually over time likely representing overall margin pressure for the year. At the same time, we appear positioned for continued tailwind from interest rates, though the extent of this benefit will of course depend on how the yield curve continues to develop. As usual, we're focused primarily on maintaining good momentum in our new business bookings and maintaining our strong client satisfaction and retention and we remain upbeat about our strategy for the years ahead. And now over to Q&A.
Operator: Thank you. [Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays. Your line is open.
Owen Callahan: Hi, this is Owen on for Ramsey. Thanks for taking our question this morning. So, you're currently entering your open enrollment season for client benefit elections within the PEO. I was wondering if you could talk about trends you're seeing there thus far, you called out some stability in regard to insurance price inflation driving more attached rates, are you seeing any of this follow through? Any thoughts there might be helpful. Thanks.
Maria Black: Good morning. I was going to say good morning, Owen. How about I start and I'll let Don chime in. I think the comment would be, just to start, we are smack in the middle of our open enrollment season exactly as you suggested, and so, it's probably too early to make a call in terms of what that's going to look like from a full year perspective on the retention side. But overall, we have seen a bit, a tiny bit of PEO retention improvement this year and the compares are getting a bit easier and we do expect some improvement for the full year. So with that, I'll let Don chime in.
Don McGuire: Sorry, I jumped again there. So, Maria, thank you. Perfect answer. Thank you.
Owen Callahan: Great. Super helpful. And then, if I may, just on client retention continues to sort of surprise to the upside, I was wondering drivers there, I previously thought potentially fewer bankruptcies in the down market but any expectations more longer term might be helpful there?
Maria Black: Yes, absolutely. We're very pleased with the overall retention results. I think you see that in our revised outlook, you see that in the revision we made last quarter as well. And so, just to remind everybody just how well retention is going, fiscal '23 was a record, that record was really driven by the mid-market and international and the down market actually did decline a bit in fiscal '23 and we expect pretty much the same outlook, if you will, for full year '24, which is why we still have a down year-on-year retention result, but we're incredibly pleased with overall what we're seeing with client retention, that's really being led by a combination of things, one of which is the investments we made into product, the record results we have in terms of client satisfaction, that in and of itself was a record in the third quarter, along with retention. So, we're very, very pleased with that. As mentioned, there's still down market variability and there's down market out of business. We haven't seen it thus far this year but we still expect it to normalize a bit further. And then there's always normal variability in retention. So, we believe the retention guide is the appropriate one, but certainly we're very pleased with the record quarter and where we sit with retention thus far this year.
Owen Callahan: Great. Super helpful. Thank you.
Operator: Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open.
Zack Ajzenman: Hi, thanks. This is Zack Ajzenman on for Bryan. First question, just want to dig in on the ES revenue growth affirmation despite the higher retention at PPC views, heard that you might come in towards the higher end of the range, but perhaps you can elaborate on some of the underlying assumptions and any offset?
Don McGuire: Yes, so a couple of things, Zack. Maria already mentioned that retention is in very good shape for us, so certainly that's been helping and contributing to the revenue growth. And of course what's changed since last time around which is making us even more comfortable with saying we're going to be towards the higher end of the range is that client funds interest impact is very good. So, I think those are the two primary drivers to why we're more confident that we're going to see revenue come in towards the higher end of the seven to eight than we perhaps worth 90 days ago.
Zack Ajzenman: Got it. And a follow up on demand ES new business bookings affirmed at 4% to 7% growth, what are the strongest segments of the market and any notable changes to call out versus the second quarter?
Maria Black: Sure. So, first and foremost, we feel good about the overall demand environments. Companies are still hiring as we saw today and they're still investing as such in people, in HCM. The call outs, I made a few of them during the prepared remarks, but it's really -- the down market continues to impress us this quarter specifically in retirement services, so I'd make a call out there, it's quite fantastic to see that story and retirement services come together. We talked quite a bit about secular tailwinds in that space based on legislation that coupled with the investments we've been making, an incredible distribution execution, really great to see the retirement services leading the way. I think other areas that I would call out that have been remarkably strong is our mid-market as well as international. And so, again, similar story to retirement services, and that it's really a great story coming together between investments and execution, and enterprise also was strong for us for the quarter. And in terms of anything changing broad-based, we haven't really seen anything change in the demand environment. Quite candidly, we feel really strong as suggested by the overall hiring landscape and the labor demand.
Zack Ajzenman: Thanks very much.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hi, good morning, and thanks for the terrific updates. Client retention obviously really strong, obviously your scores continue to go up. Are there any areas that you would call out that are standing out in terms of driving the higher NPS scores and the higher client retention? Anything that you would particularly note?
Maria Black: Good morning, Mark. I would say to you mid-market on both of those. So, mid-market is driving the strong NPS scores to record highs. The mid-market is driving incredible retention. So that's the one call out. You can probably hear the optimism in my voice there because it's a fantastic story coming together, but I think overall retention is incredibly strong. The mid-market international in fiscal '23 were very strong, they continue to be strong, but that's really the one call out I would make is the mid-market.
Mark Marcon: Great. And then Maria there's one area that investors have been asking more about and you have -- you and ADP have the broadest outlook with regards to the space, so I'm asking this on the call, but some people wonder a little bit about saturation, your new bookings continue to grow but investors are asking a little bit more about like how much room do we have for new solutions or how many clients have already upgraded, things of that nature? Your results and the results of some of your peers continue to blow their concerns, but I'm wondering if you could address those?
Maria Black: Yes, absolutely, Mark. I'll give it a shot and certainly happy to have Don chime in. Maybe he can talk a little bit about our growth opportunity in international, but I think, broadly speaking, when you think about the total addressable market of the HCM space and where we all play and we all compete and it's highly competitive and there's been a lot of investments coming into the space over the past few years. What I would suggest is there's still tremendous amount of growth and growth upside for all of us, and as you mentioned, we continued to deliver that and the results that we see on the new business booking side. And so, I think overall there is still runway, there's still plenty of space. I think the part for us outside of our incredible distribution organization which has always been a competitive advantage in how we go to market, that distribution is also anchored to our ability to upsell to the base. So you mentioned this ability to upgrade and how much has upgraded and are we all the way there? What I would suggest to you is, we're still at about 50% as it relates to new business bookings coming from, call it, new business, net new business versus upgrades, which suggests to me that we still have a tremendous amount of opportunity even within our base. And that's a lot of the focus that we have as an organization, whether it's in the PEO getting smarter about which clients within employer services that we target to offer to the PEO or it's the work that we're doing on generative AI to try to get upsell and offering the right product to the right client at the right time. And in my mind, bending the curve and continuing to focus on attach rates whether that's on the point of sale or omni-attach at a later time is definitely an opportunity for us to continue to deliver bookings in a very broad market that still has a tremendous amount of opportunity for all of us, but moreover, where we continue to execute and deliver on that. So, I don't know, Don, if you want to comment a little bit on international in terms of the opportunity there?
Don McGuire: Yes, perhaps to add a little bit more color, I think we're very still very optimistic about growth opportunities beyond the U.S. or the North American market. So, Mark, I think we've talked before we're on the ground in 40 plus countries outside of the U.S. We're present in multiple segments in those markets as well. We've got some great things happening in Southeast Asia where we're rolling out a single platform across beginning in India but many countries surrounding India and the Southeast Asian market. We're excited, we often talk about the fact that we pay over a million people in India, every payroll, every payday. Price points are still a bit low, but we expect those things to work for us and work in our favor in the future. So, I think still lots and lots of opportunity for ADP from a growth perspective and certainly we don't worry about saturation being a limiter to our future.
Mark Marcon: That's what I thought. Thanks for -- appreciate the complete answers.
Operator: Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Hi, good morning, and thanks for taking my questions. I just wanted to go back to some of the early thoughts Don that you provided on fiscal '25 and talking about the GenAI investments and I think you had mentioned that there could be some margin pressure associated with that, and just wanted to clarify were you talking about potentially leading margin to be down year-over-year or are there other offsets with general operating leverage and interest income that can potentially offset the margin pressure from those investments? Thanks.
Don McGuire: Yes, Scott, thanks for the question. I think it's still early. I think the intent here was to give some very early guidance on what '25 could look like. So, we still expect to see some improvements in margins. It's just, do we expect to see as much of an improvement given some of the GenAI pressures, expense pressures that we may see. Of course, CFI, at this point in time, depending what the yield curve does, once again things have changed a fair bit in the last 90 days, and if I was to, not that I have a crystal ball, but I don't think many folks right now are expecting anything to change from the rates perspective in the U.S. before September, so I think we're going to get some tailwinds from that. So, we're not really trying to signal here -- not signaling a decline in our margins, what we're signaling perhaps is perhaps a slower growth in the margins as we look into '25.
Scott Wurtzel: Got it. That's super helpful. And then just wanted to go onto the PEO segment and going back to some of the verticals that we've talked about over the last year in technology and professional services, just wondering if you can update us on some of the trends you've seen there with pays per control growth. I mean, even looking at the employment report that you guys released this morning, it looks like professional services is stabilizing and increasing, but technology information seems a little bit choppy. So, just wondering if you can talk about trends in the PEO with respect to those verticals?
Don McGuire: Sure, so if I, you know, Maria talked a little bit about bookings, I think, so we've been, we were happy with our bookings. They softened a little bit in Q3, but we had a very, very strong Q2 on PEO bookings. We can move on kind of to the PPC growth. Back in Q1, it decelerated a little bit more than we anticipated, and a significant amount of that deceleration was attributed to the technology and professional services sector. And in Q2, that stabilized. So that was good for us. While there's still some headwinds in PPC, including from technology and service sectors, there were no surprises in Q3. So it's important to note that worksite employee growth accelerated, about 1% over Q2, despite the modest incremental pressure we had from PPC pressure. And so, and that, of course, is a function of the year-to-date booking success that we've had. So nothing really to call out. More stability, if you will, in PPC pressure than we've talked about previously.
Scott Wurtzel: Great, thanks, guys.
Operator: Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang: Thanks, good morning. Thanks for going through all this. Anything on the pricing side worth sharing, Maria? Just thinking about some of the peer commentary out there. Any call-outs or interesting observations?
Maria Black: In terms of, from a standpoint of our price, or pricing in the market from a demand?
Tien-Tsin Huang: Yes, your pricing, or as you're thinking about resetting prices as you go into the usual seasonal time changes, price changes, any thoughts there? So both for new renewals as well as new deal bids?
Maria Black: Yes, absolutely. So I think my general sentiments, and then Don can give the kind of a little more directional, but my general sentiments around price remain that we're very thoughtful, and very measured as it relates to how we think about price, whether that's on the new business side, or it's on the renewal side, as you mentioned. And so for us, it's about understanding kind of by segment. So you heard my commentary in the prepared remarks, just how broad and deep and diverse ADP is, with respect to our client base. As you can imagine, we think about a down market, price increased differently than perhaps an enterprise. Some of those are also long-term contracts that have indexes attached. And so all of that lends itself to a very surgical approach, right? To ensure that the price value equation remains the right one, for the market and for our clients. And obviously at the same time, what we're doing is also monitoring what's happening in the HCM space with respect to the peer group and pricing overall. And I would say from a competitive lens, we haven't seen anything unusual as it relates to price from us or the others, even though it continues to be a highly competitive environment. And so as such, our approach this year to price, which I'll let Don comment on, has been very thoughtful and I would expect us to take that same measured approach as we had into '25.
Don McGuire: Yes, so the price increase this year was relatively well-received. We're in the 100, 150 basis point range. We're closer to the 150. So happy with where we're at. But back to Maria's comments, we're in the middle of our planning cycle right now, and we'll look very carefully at that whole value equation, making sure that we keep our retention up. Our NPS is supporting that, and we'll make sure that we're mindful and thoughtful about what we do with pricing going forward.
Tien-Tsin Huang: Yes, no I'm sure it'd be thoughtful about it. Thank you for that. Just on the GenAI front, I respect the investments there. I'm curious if you were to classify it as either driving expense efficiency versus driving better sales efficiency, what are you really aiming for with some of these investments here for fiscal '25?
Maria Black: Oh. The answer is both. So I think it's really about solving for, again, all of the users that interact with ADP, right? So if you think about all the personas, our clients, our clients' employees, and our service agents, our sellers, it's really about putting GenAI in every part of our ecosystem. So in terms of what are we solving for, the answer is both. We're trying to drive greater service efficiency. I think, we've proven out that through digital transformation and taking friction out of our products and making those investments, we have the ability to drive up our NPS results and record client satisfaction tends to lead to similar record retention. So definitely working on ensuring that we're driving up retention. Obviously, the more happy clients we have, the easier it is for our sellers. We're also investing into generative AI for our sellers, to become more productive. So it is about service productivity. It's about seller productivity. It's about client experience. Client experience lends itself to retention. So I guess it's just one happy virtuous cycle, but I think - my answer is both, and all of it is what we hope to gain. Now, again, kind of back to the investments we're making and what Don alluded to in terms of any pressure we would have with respect to margin on those investments. Some of these investments, we know they're the right thing for ADP, but they will take time to ultimately garner all of the results, in all of these categories that I just mentioned. And so, as it stands today, we have some really exciting things that we're seeing. If you think about something, like call summarization that I've spoken about in the past. And we're shaving off roughly a minute per call, that doesn't probably sound that exciting. But you think about a minute per call over time, and you think about how many calls we take broadly across ADP in a given year. The math lends itself to over time, tremendous efficiency, and again, hopefully a better experience, right? So I think the answer is all of it. We're solving for all of it.
Tien-Tsin Huang: Understood. Thank you.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open.
Unidentified Analyst: Hi, everyone. It's [indiscernible] for James. Thanks for taking our question. Just one for me today. You mentioned coming in at the higher end of the range on ES for the full year, which makes sense given some of your commentary on booking strength, better retention, pace for control, improvement in the float benefit that we're seeing. But given all of those factors, it looks like ES in the quarter came broadly in line with our expectations, despite all of those tailwinds. So I'm curious, given your commentary about price coming in towards the higher end of your historical range, what does that imply just in terms of what you're seeing on the net new side, as well as cross-sell and upsell? Thanks.
Don McGuire: Yes, Michael, thanks for the question. I think that, first of all, the price, there's no change in that. I think we've been calling that out for most of the year, certainly in the one to 150 range. So not much of an incremental impact, if you will, for Q4 and therefore for the year in total. So not a lot of change from that. Yes, I mean, bookings, we called out, we're still in the hunt for delivering on the range as we declared, so we're still in that so. But not really a lot to drive incremental revenue, other than some of the float, but as the year shortens or we have fewer months, days left in the year, the impact from higher CFI is going to be somewhat muted as we look to finish the year.
Danny Hussain: Hi Michael, it's Danny. If you're wondering whether there is some offset somewhere else, there's a little bit from FX moving adversely relative to our prior expectations.
Unidentified Analyst: Got it. Thank you both.
Operator: Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open.
Pete Christiansen: Good morning. Thank you for the question. Maria, you gave great explanation of the wallet share opportunity that still left earlier, PEO, propensity modeling with GenAI and then international. I want to dig into the international side a little bit, particularly some of the newer markets that you're getting into. I'm just hoping you can give us a bit of a progress report on a lot of the last mile infrastructure that, you've been putting in place, go-to-market, ramping that up. And I'm just curious, should we think of like the deployment of PI, the next-gen payroll engine in the international, as a real catalyst - for the next leg of booking growth? Thank you. I appreciate it.
Maria Black: Yes, thanks, Pete. I think that was a solid like three, four questions in one. So I will, I'll do my best to weave through it here. But as Don mentioned, we're on the ground in 40 countries. We do payroll across 140 countries, inclusive of our partner network. In terms of the final mile or the last mile, as you referenced, the first thing I would comment on is we've building that 50 years. So when I think about international and everything we've done over the course of decades to build that infrastructure, it's a tremendous lead is what I would suggest. And you see that in our international bookings results, right? So we had a nice first quarter in international. We accelerated that in the second quarter. We had an even better Q3. A lot of that is being driven by our multinational growth. So think about our Celergo offering, our GlobalView offering. These were especially strong for us in the third quarter. And I do believe it's the overall demand environment coupled with - on the ground strategy, if you will, if you will. And by the way, the international pipelines remain healthy. And we believe it's going to position us for a solid Q4, but also next year. In terms of, where we continue to expand. I mentioned it in my prepared remarks. Asia-Pac or APAC is something that, our Asia business has been relatively modest, but we see significant growth over time. Obviously, that growth is a direct byproduct of our clients demand growth, as it relates to the activities of our clients and where they're moving associates, and where they're moving business. So, we believe that continuing to lean into Asia-Pac is important for us. And so as a result of that, we kind of are continuing to lean in there. I think we mentioned last quarter, the acquisition of a company in the Nordics, specifically in Sweden. So that's an area that also is a high growth area from a client perspective. And so I think, our strategy over time has been as we get further into a country and we see the demand, at times we will fold in our partners. And you've seen that obviously in the Nordics, and you've seen that in many countries prior to that. But that ecosystem is vast across 140 countries. Its decades of building that final mile. It's a clear competitive differentiator in the market. You can feel see and it's really palpable on the heels of the last earnings call. I was actually over at our rethink event, which is where we bring together a few hundred of our very largest global MNC clients. And the spirit of how we're executing in that market is really palpable, when you hear it directly from our clients. And I believe it's a tremendous opportunity for us to continue to drive growth. So I think, I covered all of that, Pete.
Pete Christiansen: Thank you, Maria. Just quick follow-up. Do you think that the deployment of next-gen payroll is a catalyst for going-to-market and some of those newer markets?
Maria Black: Yes, of course. So next-gen payroll, for sure, our intent is to continue to drive next-gen payroll, across various international markets. We have it deployed in a few of our markets today. And that coupled with these offers that again have the lead of Celergo going GlobalView over time, will just further the growth narrative and the story over there. But that is absolutely the intention and the strategic direction of next-gen payroll.
Pete Christiansen: Thank you for the comprehensive call.
Operator: Thank you. Our next question comes from Ashish Sabadra with the RBC Capital Markets. Your line is open.
David Paige: Hi. This is David Paige on Ashish. It was great to hear about your results and growth in the mid-market particles. I was wondering if you could just give a little bit of an overview on the competitive landscape there. Are you guys taking share or the entire market or just what's the outlook or the environment in terms of competition in the market? Thank you.
Maria Black: Yes, absolutely. So the mid-market is a great segment for us. It's certainly not getting any easier to be an employer in the mid-market. It's littered with complexity and all sorts of challenges to navigate, just even if you look at the last 30 days, you can see legislation that mid-market employers are having to navigate. And so it's a strong market. It is a highly competitive space. That's not new. I think for - from a competitive landscape perspective, it's always been competitive. And I don't know that we've seen a noticeable changes in the competitive landscape. What we have seen is incredible distribution, execution, incredible satisfaction, execution on our end. We've made great investments into the product set. It's winning in the market. You marry that strategy with great execution on the seller side and great execution on the retention side. That, to me, is what's changing in the mid-market is that we've gotten stronger.
David Paige: Great. Thank you.
Operator: Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open.
Unidentified Analyst: Hi. This is [Caroline Lada] on for Jason. Thanks for taking our question. Sorry to double down on price, but just given the way inflation isn't dropping off, maybe the way the market was hoping or expecting recently. Do you have any updated expectations about ADP, and like the broader peer group's ability to raise pricing heading into the fourth quarter, and 2025 without like significant pushback?
Don McGuire: Caroline, thanks for the question. I think it just comes - continues to come back to the same concepts, and that's making sure that we offer good value to our customers over a 10-plus year lifespan. So, we're always mindful of making sure that clients are getting good value, and that we keep those clients for a very, very long time. So it's that client life cycle of the total return on the entire life of a client. So, we're always very, very careful not to overstep on pricing. Having said that, we, of course, watch what the competition is doing. We have our ear to the ground. Our salespeople have their ear to the ground. We're trying to make sure and understand what's happening from the competition. So, we will continue to look at it. We'll continue to knock around some ideas, and some models and see what the impact could be. But I don't want to signal exactly what we think we're doing, because we're still, as I said earlier, in the midst of our planning cycle here. But we always look at it. We take price usually every year where we can, not including some of the contractual commitments we have with some of our larger clients, but just something we're very, very careful and cautious about doing shots a lot of color.
Unidentified Analyst: Awesome, thank you. That adds a lot of color.
Operator: Thank you. And our last question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Good morning. Maria, as you look at the mid-market and the success ADP is having, who are you winning market share from? Is it traditional payroll companies? Are there companies that are maybe using other software products that you wouldn't consider payroll companies? I'm just wondering where the success is coming from?
Maria Black: Everywhere. Candidly, listen, from a mid-market perspective, again, the demand is healthy. The competitive environment is competitive, and we continue to remain laser-focused on all of the competitors specifically. The ones that have been talking a lot about us over the last few years. And I think the way that we've been focused is really about the investments we've made, investments into a best-in-class product. Investments into focus on distribution investments into a digital transformation that's driving great client satisfaction. And so, that really has allowed us to have a winning story, as it relates to really all of the players.
Kartik Mehta: And then just one follow-up. Just on the PEO business, as you look at the long-term growth perspective of that business, obviously, there's been - a couple of things that happened that maybe have slowed the growth down in the last year or so. I'm wondering just your outlook on the PEO business and if you think anything has changed in that business, or demand for the product?
Maria Black: Yes. So I'm happy to start and certainly happy to have Don chime in too on the PEO. I'm always very, very bullish on the PEO value proposition. I've been close to that business for a long time, and I will tell you it's stronger than it's ever been. So despite the strangeness that we've had in the PEO, from a kind of the componentry heading into the pandemic, during the pandemic after the pandemic and then now, call it, a little bit post, post pandemic. What I would suggest to you is it has nothing to do with the fundamentals of that business, and what we would expect over time from a growth perspective long-term. And so the value proposition is strong. Nothing from our end has changed there, as it relates to the overall demand from the business. And we see that just in the - we continue to have 50% of our clients into the PEO coming from the base. So it's resonating with our existing clients. It's resonating with the open market, and it continues to be a very strong offering for us. So I don't know, Don, if you want to add anything there?
Don McGuire: Nothing to add then the value proposition is as strong as ever, and the fundamentals in the business are continue to be quite strong.
Kartik Mehta: Thank you very much. I really appreciate it.
Operator: Thank you. We have one more question from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Hi guys, thank you for taking my question. And apologies, I was on a different call. But I know it's kind of maybe early, but do you have any news about - your next fiscal year, maybe something like early views as we head into the fourth quarter? Thank you.
Don McGuire: Yes. Dan, just a couple of things, thinking about next year. We do think that it's early, so we didn't share too much, although we did say that the pace per control will continue to be under a little bit of pressure, given the fullness of the labor market. So that's kind of continuing story that we've been telling. We will continue some of our GenAI spending related spending, making the right investments for ADP. And of course, we're going to get some tailwind from interest rates. So I think those are the three primary things. And of course, we always remain very, very focused on bookings and our strong client retention and client experience. So, I think those would be the highlights for '25.
Dan Dolev: Okay. Appreciate it. And apologies again if this was already addressed. I was on a different call. I appreciate it.
Operator: Thank you. There are no further questions. I'd like to turn the call back over to Maria Black for any closing remarks.
Maria Black: Yes. Thank you, and thank you once again to everyone who joined us today, whether the full time or late. We always appreciate the questions, the interest, and we certainly look forward to speaking with all of you again soon, and look forward to the close of the year. Thanks.
Operator: Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good morning, my name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the call over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danny Hussain",
"text": "Thank you, Michelle, and welcome everyone to ADP's third quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Danny, and thank you everyone for joining us. This morning, we reported strong 7% revenue growth and 14% adjusted diluted EPS growth for the third quarter as we continued to make progress delivering against our strategic priorities and as the labor market and the overall HCM business environment remained stable. I'll begin with a review of the quarter's results and provide a brief update on our strategy before turning it to Don to update you on our outlook and share some early considerations for next year. In Q3, we delivered solid Employer Services new business bookings growth reaching record bookings for our Q3 period and keeping us on track for our full-year outlook. We maintained momentum in our small business portfolio with particularly strong growth in our retirement services offering, and in Q3, we also delivered strong bookings results in our midmarket, enterprise and international businesses. With a steady demand backdrop and a healthy new business pipeline, we are focused on continuing to execute for the remainder of the year. Employer Services retention was very strong in the third quarter and once again exceeded our expectations also reaching a new record level for our Q3 period led by our midmarket business. Our overall retention continues to benefit from ongoing investments in our key platforms and from our commitment to delivering an exceptional client experience, which together helped our client satisfaction scores reach a new all-time high for our Q3. Our Employer Services pays per control growth was steady at 2% reflecting the resilient overall U.S. labor market and the fact that our clients continue to add to their workforces at a moderate pace, and our PEO revenue growth of 5% for the third quarter was in line with our expectations despite continued short-term pressure from below normal hiring activity we've been experiencing among those clients. Moving on to a broader update, we continue to push forward on our three strategic priorities, leading with the best HCM technology, unmatched service and expertise in a broader scale to ultimately deliver the best possible experience not just to the buyers of our products but everyone that engages with ADP. We are investing with purpose to deeply understand and deliver value to a vast set of personas from small business owners that count on us to HR professionals and executives of the largest global enterprises to millions of employees and gig workers around the world who engage with our solutions through CPAs, banks, brokers and other key partners to our thousands of dedicated service and implementation associates and to our sellers who represent ADP in the market every day. It's with these personas in mind that we continue pushing forward on our strategic priorities, and in Q3, we made steady progress. Our first priority is to lead with best-in-class HCM technology. We've been rolling out ADP Assist these past couple of quarters, which as a reminder will be embedded in our key platforms and utilizes GenAI to surface insights, aid decision-making and streamline day-to-day tasks for our clients and their employees. In Q3, we were very excited to begin piloting a new feature that enables our small business clients to not only leverage GenAI to answer questions and better understand how to initiate an HR action which we outlined in recent quarters but to actually allow them to issue commands to complete that HR action. For example, users can now type I need to rehire Alex or I would like to give Alex a leave of absence and are expedited through that workflow. Our second priority is to provide unmatched expertise in outsourcing. We continue to extend GenAI capabilities to a broader portion of our service associates, and in Q3, we started rolling out a new tool for some of our implementation teams. Now they can use GenAI to take in unstructured client employee data reducing manual data entry and minimizing errors during the implementation process. While it's still early, we are excited about its potential benefits. Our third priority is to benefit our clients with our global scale. The ADP marketplace remains a differentiator for us and is a perfect example of a benefit our clients receive from partnering with the leader in HCM. As a growing number of our hundreds of partners offer AI-enabled solutions, in Q3, we established ADP marketplace AI principles that require our partners to commit for the same type of responsible AI principles that govern our own products including human oversight, monitoring, explainability and mitigating bias. Our clients put a huge amount of trust in us and this is another example of how ADP strives to ensure the responsible use of AI throughout the ADP ecosystem. We also continued to extend our market-leading global scale, and in Q3, we reached 1 million paid employees on our I-HCM platform, which continues to scale in several countries in Europe and we made further progress in growing our presence in the APAC region, where we have recently been expanding our in-country payroll and workforce management presence in a number of markets. In 2024, we are celebrating our 75th anniversary and we pride ourselves on having built ourselves into a brand that truly matters to employers, their employees and the broader world of work. Our focus on our strategic priorities positions us to deliver more value than ever for our over 1 million current clients and to the tens of thousands of new clients we welcome to the ADP family every quarter. I'd like to highlight just a few of these new client wins from Q3 to give you an appreciation for the variety of ways in which we deliver value for them. In U.S. small business, we had a new Boutique Donut Shop referred to us from one of our CPA partners. The client chose ADP for the strength of our run platform, our reputation for great service, our strong relationship with our CPA and our ability to provide retirement services. Since this was a first time small business owner, our sales team even took the time to help the business owner set up their business the right way from guiding the client on obtaining a state tax ID to making sure the client obtained the appropriate workers compensation insurance. In U.S. midmarket, we won a multistate operator of rehabilitation centers, this client wasn't happy with our prior HCM provider and Workforce Now proved a much better fit. What makes me the most proud in this example is how one of our ADP marketplace partners played a key role in the decision to switch to ADP by independently highlighting the advantages we offered in terms of ease of integrations, a capability we have invested in over the years. In U.S. enterprise, we welcomed a large luxury resort that operates multiple hotels, restaurants and retail stores on site and was dissatisfied with the prior provider's level of client service. The client was so happy following their seamless ADP implementation, which included onsite training for their HR team that they accelerated their plans to add-on features like benefits, recruiting, onboarding, wage garnishment and tax credits. In our International business, one recent win was a leading airline that utilized ADP in certain countries and asked us to help better define their global payroll strategy. Ultimately, they expanded the scope of our services to include in additional 18 countries and started that rollout in the third quarter with plans to add other countries over the next year to enable true consolidated global reporting and analytics. And as a final example, our HRO team started a New York-based design firm after its leadership team recognized the company lacked the HR infrastructure required to adequately attract and retain the right talent. They turned to our PEO offering for truly comprehensive support, attracted by the breadth of our offering including features like the MyLife Advisors program, which supports employees as they make benefit in other important life decisions. We also advise this client in the development of a comprehensive benefits strategy to support their multigenerational workforce and help them attract the talent that they need to grow. As you can tell from these examples, it's often a combination of our technology, expertise and overall breadth that resonated with these businesses, and the result is incredible diversity in our client base and a resilient overall business model. We look forward to leaning in and delivering even greater differentiation in the market going forward. Overall, we were pleased with the strong financial and strategic outcomes in the third quarter. I'd like to thank our associates who continued to deliver exceptional products and service to our clients, in whose efforts drive these client wins and retention. Thank you again for all you do for ADP and for our clients. And now, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll provide more color on our results for the quarter and our updated fiscal 2024 outlook. Overall, we reported a strong third quarter with our consolidated revenue growth and our adjusted EBIT margin coming in a bit above our expectations. The interest rate backdrop has improved since we last provided our full year outlook, so we are updating our outlook for that as well as making a few other changes, which I'll detail. I'll start with Employer Services. ES segment revenue grew 8% on a reported basis and 7% on an organic constant currency basis. As Maria shared, we had a good quarter in ES new business bookings with broad-based growth across our client segments. We have a tough compare in Q4 following last year's strong finish but with a steady HCM demand environment and healthy pipelines, we feel on track to deliver our 4% to 7% new business bookings growth outlook for the year. Also, as Maria mentioned earlier, our ES retention exceeded our expectations and increased slightly from last year. Given our continued strong retention performance, we are increasing our full-year retention outlook slightly, we now anticipate a 20 to 30 basis point decline in full year retention which is better than our prior forecast. ES pays per control growth held steady at 2% in Q3 and we now expect growth to round to 2% for the year, the high end of our prior 1% to 2% growth outlook, and client funds interest revenue exceed our expectations in Q3 due to higher average client funds balances and a slightly better average yield. We are revising our full-year client funds interest outlook to reflect our Q3 results and the increase in prevailing interest rates since our last update. We now expect fiscal '24 average client funds balance growth of about 3% and we are raising our expectations for client fund's interest revenue and net impact from our client fund's extended investment strategy. In total, there is no change to our fiscal '24 ES revenue growth forecast of 7% to 8%, although we are now likely to come in towards the higher end of that range. Our ES margin increased 230 basis points in Q3, driven both by operating leverage and the contribution from client funds interest revenue growth. With our strong Q3 results and the slightly more favorable client funds interest rate backdrop, we are raising our fiscal '24 ES margin outlook and now anticipate growth of 180 to 190 basis points. Moving onto the PEO. We had 5% revenue growth driven by 3% growth in average work site employees in the third quarter, representing slight acceleration from the first half of the year. These results were largely in line with our expectations and we were encouraged by the gradual stabilization in our PEO's pays per control growth which decelerated but only slightly from the prior quarter. We continued to anticipate soft pays per control growth through the end of the year and expect work-site employee growth to hold steady at about 3% keeping us on track for our full-year outlook for work-site employee growth of 2% to 3% and revenue growth of 3% to 4%. PEO margin decreased 220 basis points in Q3. As we shared last quarter, we expect this year's workers' compensation reserve release benefit to be significantly lower than what we experienced these last few years, and in particular, last year's $73 million benefit. We are updating our fiscal '24 outlook to now assume a minimal release benefit, and as a result, we are further revising our overall PEO margin expectation to be down 120 to 140 basis points in fiscal '24 versus our prior expectation for a decline of 80 to 100 basis points. Putting it all together, there is no change to our fiscal '24 consolidated revenue growth of 6% to 7%. With the two changes to segment margins, largely offsetting one another, we continue to expect our adjusted EBIT margin to increase by 60 to 70 basis points. We still anticipate an effective tax rate of around 23% and we continue to expect fiscal '24 adjusted EPS growth of 10% to 12% with the middle of that range still the most likely outcome. As we look ahead to fiscal '25, I wanted to share a couple of early thoughts at this point. First, give them the fullness of the labor market, we are planning for pays per control growth to once again be below normal levels next year and to decelerate modestly from this year's growth level in both ES and our PEO segments with the resulting revenue pressure more apparent in the PEO segment given its more direct revenue sensitivity to work-site employees. We will of course share those exact assumptions with you when we give our formal guidance in a few months. On the expense side, we are also planning to continue growing our GenAI related spend next year. As you've heard from us all year long, there are many ways we can put GenAI in the hands of all of the different stakeholders that work with or on behalf of ADP, including our client practitioners, their employees, our service and implementation teams, our sellers and our developers. These are critical investments and they are the right investments for ADP, but we expect the associated benefits and productivity of growth to phasing gradually over time likely representing overall margin pressure for the year. At the same time, we appear positioned for continued tailwind from interest rates, though the extent of this benefit will of course depend on how the yield curve continues to develop. As usual, we're focused primarily on maintaining good momentum in our new business bookings and maintaining our strong client satisfaction and retention and we remain upbeat about our strategy for the years ahead. And now over to Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Owen Callahan",
"text": "Hi, this is Owen on for Ramsey. Thanks for taking our question this morning. So, you're currently entering your open enrollment season for client benefit elections within the PEO. I was wondering if you could talk about trends you're seeing there thus far, you called out some stability in regard to insurance price inflation driving more attached rates, are you seeing any of this follow through? Any thoughts there might be helpful. Thanks."
},
{
"speaker": "Maria Black",
"text": "Good morning. I was going to say good morning, Owen. How about I start and I'll let Don chime in. I think the comment would be, just to start, we are smack in the middle of our open enrollment season exactly as you suggested, and so, it's probably too early to make a call in terms of what that's going to look like from a full year perspective on the retention side. But overall, we have seen a bit, a tiny bit of PEO retention improvement this year and the compares are getting a bit easier and we do expect some improvement for the full year. So with that, I'll let Don chime in."
},
{
"speaker": "Don McGuire",
"text": "Sorry, I jumped again there. So, Maria, thank you. Perfect answer. Thank you."
},
{
"speaker": "Owen Callahan",
"text": "Great. Super helpful. And then, if I may, just on client retention continues to sort of surprise to the upside, I was wondering drivers there, I previously thought potentially fewer bankruptcies in the down market but any expectations more longer term might be helpful there?"
},
{
"speaker": "Maria Black",
"text": "Yes, absolutely. We're very pleased with the overall retention results. I think you see that in our revised outlook, you see that in the revision we made last quarter as well. And so, just to remind everybody just how well retention is going, fiscal '23 was a record, that record was really driven by the mid-market and international and the down market actually did decline a bit in fiscal '23 and we expect pretty much the same outlook, if you will, for full year '24, which is why we still have a down year-on-year retention result, but we're incredibly pleased with overall what we're seeing with client retention, that's really being led by a combination of things, one of which is the investments we made into product, the record results we have in terms of client satisfaction, that in and of itself was a record in the third quarter, along with retention. So, we're very, very pleased with that. As mentioned, there's still down market variability and there's down market out of business. We haven't seen it thus far this year but we still expect it to normalize a bit further. And then there's always normal variability in retention. So, we believe the retention guide is the appropriate one, but certainly we're very pleased with the record quarter and where we sit with retention thus far this year."
},
{
"speaker": "Owen Callahan",
"text": "Great. Super helpful. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Zack Ajzenman",
"text": "Hi, thanks. This is Zack Ajzenman on for Bryan. First question, just want to dig in on the ES revenue growth affirmation despite the higher retention at PPC views, heard that you might come in towards the higher end of the range, but perhaps you can elaborate on some of the underlying assumptions and any offset?"
},
{
"speaker": "Don McGuire",
"text": "Yes, so a couple of things, Zack. Maria already mentioned that retention is in very good shape for us, so certainly that's been helping and contributing to the revenue growth. And of course what's changed since last time around which is making us even more comfortable with saying we're going to be towards the higher end of the range is that client funds interest impact is very good. So, I think those are the two primary drivers to why we're more confident that we're going to see revenue come in towards the higher end of the seven to eight than we perhaps worth 90 days ago."
},
{
"speaker": "Zack Ajzenman",
"text": "Got it. And a follow up on demand ES new business bookings affirmed at 4% to 7% growth, what are the strongest segments of the market and any notable changes to call out versus the second quarter?"
},
{
"speaker": "Maria Black",
"text": "Sure. So, first and foremost, we feel good about the overall demand environments. Companies are still hiring as we saw today and they're still investing as such in people, in HCM. The call outs, I made a few of them during the prepared remarks, but it's really -- the down market continues to impress us this quarter specifically in retirement services, so I'd make a call out there, it's quite fantastic to see that story and retirement services come together. We talked quite a bit about secular tailwinds in that space based on legislation that coupled with the investments we've been making, an incredible distribution execution, really great to see the retirement services leading the way. I think other areas that I would call out that have been remarkably strong is our mid-market as well as international. And so, again, similar story to retirement services, and that it's really a great story coming together between investments and execution, and enterprise also was strong for us for the quarter. And in terms of anything changing broad-based, we haven't really seen anything change in the demand environment. Quite candidly, we feel really strong as suggested by the overall hiring landscape and the labor demand."
},
{
"speaker": "Zack Ajzenman",
"text": "Thanks very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hi, good morning, and thanks for the terrific updates. Client retention obviously really strong, obviously your scores continue to go up. Are there any areas that you would call out that are standing out in terms of driving the higher NPS scores and the higher client retention? Anything that you would particularly note?"
},
{
"speaker": "Maria Black",
"text": "Good morning, Mark. I would say to you mid-market on both of those. So, mid-market is driving the strong NPS scores to record highs. The mid-market is driving incredible retention. So that's the one call out. You can probably hear the optimism in my voice there because it's a fantastic story coming together, but I think overall retention is incredibly strong. The mid-market international in fiscal '23 were very strong, they continue to be strong, but that's really the one call out I would make is the mid-market."
},
{
"speaker": "Mark Marcon",
"text": "Great. And then Maria there's one area that investors have been asking more about and you have -- you and ADP have the broadest outlook with regards to the space, so I'm asking this on the call, but some people wonder a little bit about saturation, your new bookings continue to grow but investors are asking a little bit more about like how much room do we have for new solutions or how many clients have already upgraded, things of that nature? Your results and the results of some of your peers continue to blow their concerns, but I'm wondering if you could address those?"
},
{
"speaker": "Maria Black",
"text": "Yes, absolutely, Mark. I'll give it a shot and certainly happy to have Don chime in. Maybe he can talk a little bit about our growth opportunity in international, but I think, broadly speaking, when you think about the total addressable market of the HCM space and where we all play and we all compete and it's highly competitive and there's been a lot of investments coming into the space over the past few years. What I would suggest is there's still tremendous amount of growth and growth upside for all of us, and as you mentioned, we continued to deliver that and the results that we see on the new business booking side. And so, I think overall there is still runway, there's still plenty of space. I think the part for us outside of our incredible distribution organization which has always been a competitive advantage in how we go to market, that distribution is also anchored to our ability to upsell to the base. So you mentioned this ability to upgrade and how much has upgraded and are we all the way there? What I would suggest to you is, we're still at about 50% as it relates to new business bookings coming from, call it, new business, net new business versus upgrades, which suggests to me that we still have a tremendous amount of opportunity even within our base. And that's a lot of the focus that we have as an organization, whether it's in the PEO getting smarter about which clients within employer services that we target to offer to the PEO or it's the work that we're doing on generative AI to try to get upsell and offering the right product to the right client at the right time. And in my mind, bending the curve and continuing to focus on attach rates whether that's on the point of sale or omni-attach at a later time is definitely an opportunity for us to continue to deliver bookings in a very broad market that still has a tremendous amount of opportunity for all of us, but moreover, where we continue to execute and deliver on that. So, I don't know, Don, if you want to comment a little bit on international in terms of the opportunity there?"
},
{
"speaker": "Don McGuire",
"text": "Yes, perhaps to add a little bit more color, I think we're very still very optimistic about growth opportunities beyond the U.S. or the North American market. So, Mark, I think we've talked before we're on the ground in 40 plus countries outside of the U.S. We're present in multiple segments in those markets as well. We've got some great things happening in Southeast Asia where we're rolling out a single platform across beginning in India but many countries surrounding India and the Southeast Asian market. We're excited, we often talk about the fact that we pay over a million people in India, every payroll, every payday. Price points are still a bit low, but we expect those things to work for us and work in our favor in the future. So, I think still lots and lots of opportunity for ADP from a growth perspective and certainly we don't worry about saturation being a limiter to our future."
},
{
"speaker": "Mark Marcon",
"text": "That's what I thought. Thanks for -- appreciate the complete answers."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Hi, good morning, and thanks for taking my questions. I just wanted to go back to some of the early thoughts Don that you provided on fiscal '25 and talking about the GenAI investments and I think you had mentioned that there could be some margin pressure associated with that, and just wanted to clarify were you talking about potentially leading margin to be down year-over-year or are there other offsets with general operating leverage and interest income that can potentially offset the margin pressure from those investments? Thanks."
},
{
"speaker": "Don McGuire",
"text": "Yes, Scott, thanks for the question. I think it's still early. I think the intent here was to give some very early guidance on what '25 could look like. So, we still expect to see some improvements in margins. It's just, do we expect to see as much of an improvement given some of the GenAI pressures, expense pressures that we may see. Of course, CFI, at this point in time, depending what the yield curve does, once again things have changed a fair bit in the last 90 days, and if I was to, not that I have a crystal ball, but I don't think many folks right now are expecting anything to change from the rates perspective in the U.S. before September, so I think we're going to get some tailwinds from that. So, we're not really trying to signal here -- not signaling a decline in our margins, what we're signaling perhaps is perhaps a slower growth in the margins as we look into '25."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. That's super helpful. And then just wanted to go onto the PEO segment and going back to some of the verticals that we've talked about over the last year in technology and professional services, just wondering if you can update us on some of the trends you've seen there with pays per control growth. I mean, even looking at the employment report that you guys released this morning, it looks like professional services is stabilizing and increasing, but technology information seems a little bit choppy. So, just wondering if you can talk about trends in the PEO with respect to those verticals?"
},
{
"speaker": "Don McGuire",
"text": "Sure, so if I, you know, Maria talked a little bit about bookings, I think, so we've been, we were happy with our bookings. They softened a little bit in Q3, but we had a very, very strong Q2 on PEO bookings. We can move on kind of to the PPC growth. Back in Q1, it decelerated a little bit more than we anticipated, and a significant amount of that deceleration was attributed to the technology and professional services sector. And in Q2, that stabilized. So that was good for us. While there's still some headwinds in PPC, including from technology and service sectors, there were no surprises in Q3. So it's important to note that worksite employee growth accelerated, about 1% over Q2, despite the modest incremental pressure we had from PPC pressure. And so, and that, of course, is a function of the year-to-date booking success that we've had. So nothing really to call out. More stability, if you will, in PPC pressure than we've talked about previously."
},
{
"speaker": "Scott Wurtzel",
"text": "Great, thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thanks, good morning. Thanks for going through all this. Anything on the pricing side worth sharing, Maria? Just thinking about some of the peer commentary out there. Any call-outs or interesting observations?"
},
{
"speaker": "Maria Black",
"text": "In terms of, from a standpoint of our price, or pricing in the market from a demand?"
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes, your pricing, or as you're thinking about resetting prices as you go into the usual seasonal time changes, price changes, any thoughts there? So both for new renewals as well as new deal bids?"
},
{
"speaker": "Maria Black",
"text": "Yes, absolutely. So I think my general sentiments, and then Don can give the kind of a little more directional, but my general sentiments around price remain that we're very thoughtful, and very measured as it relates to how we think about price, whether that's on the new business side, or it's on the renewal side, as you mentioned. And so for us, it's about understanding kind of by segment. So you heard my commentary in the prepared remarks, just how broad and deep and diverse ADP is, with respect to our client base. As you can imagine, we think about a down market, price increased differently than perhaps an enterprise. Some of those are also long-term contracts that have indexes attached. And so all of that lends itself to a very surgical approach, right? To ensure that the price value equation remains the right one, for the market and for our clients. And obviously at the same time, what we're doing is also monitoring what's happening in the HCM space with respect to the peer group and pricing overall. And I would say from a competitive lens, we haven't seen anything unusual as it relates to price from us or the others, even though it continues to be a highly competitive environment. And so as such, our approach this year to price, which I'll let Don comment on, has been very thoughtful and I would expect us to take that same measured approach as we had into '25."
},
{
"speaker": "Don McGuire",
"text": "Yes, so the price increase this year was relatively well-received. We're in the 100, 150 basis point range. We're closer to the 150. So happy with where we're at. But back to Maria's comments, we're in the middle of our planning cycle right now, and we'll look very carefully at that whole value equation, making sure that we keep our retention up. Our NPS is supporting that, and we'll make sure that we're mindful and thoughtful about what we do with pricing going forward."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes, no I'm sure it'd be thoughtful about it. Thank you for that. Just on the GenAI front, I respect the investments there. I'm curious if you were to classify it as either driving expense efficiency versus driving better sales efficiency, what are you really aiming for with some of these investments here for fiscal '25?"
},
{
"speaker": "Maria Black",
"text": "Oh. The answer is both. So I think it's really about solving for, again, all of the users that interact with ADP, right? So if you think about all the personas, our clients, our clients' employees, and our service agents, our sellers, it's really about putting GenAI in every part of our ecosystem. So in terms of what are we solving for, the answer is both. We're trying to drive greater service efficiency. I think, we've proven out that through digital transformation and taking friction out of our products and making those investments, we have the ability to drive up our NPS results and record client satisfaction tends to lead to similar record retention. So definitely working on ensuring that we're driving up retention. Obviously, the more happy clients we have, the easier it is for our sellers. We're also investing into generative AI for our sellers, to become more productive. So it is about service productivity. It's about seller productivity. It's about client experience. Client experience lends itself to retention. So I guess it's just one happy virtuous cycle, but I think - my answer is both, and all of it is what we hope to gain. Now, again, kind of back to the investments we're making and what Don alluded to in terms of any pressure we would have with respect to margin on those investments. Some of these investments, we know they're the right thing for ADP, but they will take time to ultimately garner all of the results, in all of these categories that I just mentioned. And so, as it stands today, we have some really exciting things that we're seeing. If you think about something, like call summarization that I've spoken about in the past. And we're shaving off roughly a minute per call, that doesn't probably sound that exciting. But you think about a minute per call over time, and you think about how many calls we take broadly across ADP in a given year. The math lends itself to over time, tremendous efficiency, and again, hopefully a better experience, right? So I think the answer is all of it. We're solving for all of it."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Understood. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi, everyone. It's [indiscernible] for James. Thanks for taking our question. Just one for me today. You mentioned coming in at the higher end of the range on ES for the full year, which makes sense given some of your commentary on booking strength, better retention, pace for control, improvement in the float benefit that we're seeing. But given all of those factors, it looks like ES in the quarter came broadly in line with our expectations, despite all of those tailwinds. So I'm curious, given your commentary about price coming in towards the higher end of your historical range, what does that imply just in terms of what you're seeing on the net new side, as well as cross-sell and upsell? Thanks."
},
{
"speaker": "Don McGuire",
"text": "Yes, Michael, thanks for the question. I think that, first of all, the price, there's no change in that. I think we've been calling that out for most of the year, certainly in the one to 150 range. So not much of an incremental impact, if you will, for Q4 and therefore for the year in total. So not a lot of change from that. Yes, I mean, bookings, we called out, we're still in the hunt for delivering on the range as we declared, so we're still in that so. But not really a lot to drive incremental revenue, other than some of the float, but as the year shortens or we have fewer months, days left in the year, the impact from higher CFI is going to be somewhat muted as we look to finish the year."
},
{
"speaker": "Danny Hussain",
"text": "Hi Michael, it's Danny. If you're wondering whether there is some offset somewhere else, there's a little bit from FX moving adversely relative to our prior expectations."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it. Thank you both."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"text": "Good morning. Thank you for the question. Maria, you gave great explanation of the wallet share opportunity that still left earlier, PEO, propensity modeling with GenAI and then international. I want to dig into the international side a little bit, particularly some of the newer markets that you're getting into. I'm just hoping you can give us a bit of a progress report on a lot of the last mile infrastructure that, you've been putting in place, go-to-market, ramping that up. And I'm just curious, should we think of like the deployment of PI, the next-gen payroll engine in the international, as a real catalyst - for the next leg of booking growth? Thank you. I appreciate it."
},
{
"speaker": "Maria Black",
"text": "Yes, thanks, Pete. I think that was a solid like three, four questions in one. So I will, I'll do my best to weave through it here. But as Don mentioned, we're on the ground in 40 countries. We do payroll across 140 countries, inclusive of our partner network. In terms of the final mile or the last mile, as you referenced, the first thing I would comment on is we've building that 50 years. So when I think about international and everything we've done over the course of decades to build that infrastructure, it's a tremendous lead is what I would suggest. And you see that in our international bookings results, right? So we had a nice first quarter in international. We accelerated that in the second quarter. We had an even better Q3. A lot of that is being driven by our multinational growth. So think about our Celergo offering, our GlobalView offering. These were especially strong for us in the third quarter. And I do believe it's the overall demand environment coupled with - on the ground strategy, if you will, if you will. And by the way, the international pipelines remain healthy. And we believe it's going to position us for a solid Q4, but also next year. In terms of, where we continue to expand. I mentioned it in my prepared remarks. Asia-Pac or APAC is something that, our Asia business has been relatively modest, but we see significant growth over time. Obviously, that growth is a direct byproduct of our clients demand growth, as it relates to the activities of our clients and where they're moving associates, and where they're moving business. So, we believe that continuing to lean into Asia-Pac is important for us. And so as a result of that, we kind of are continuing to lean in there. I think we mentioned last quarter, the acquisition of a company in the Nordics, specifically in Sweden. So that's an area that also is a high growth area from a client perspective. And so I think, our strategy over time has been as we get further into a country and we see the demand, at times we will fold in our partners. And you've seen that obviously in the Nordics, and you've seen that in many countries prior to that. But that ecosystem is vast across 140 countries. Its decades of building that final mile. It's a clear competitive differentiator in the market. You can feel see and it's really palpable on the heels of the last earnings call. I was actually over at our rethink event, which is where we bring together a few hundred of our very largest global MNC clients. And the spirit of how we're executing in that market is really palpable, when you hear it directly from our clients. And I believe it's a tremendous opportunity for us to continue to drive growth. So I think, I covered all of that, Pete."
},
{
"speaker": "Pete Christiansen",
"text": "Thank you, Maria. Just quick follow-up. Do you think that the deployment of next-gen payroll is a catalyst for going-to-market and some of those newer markets?"
},
{
"speaker": "Maria Black",
"text": "Yes, of course. So next-gen payroll, for sure, our intent is to continue to drive next-gen payroll, across various international markets. We have it deployed in a few of our markets today. And that coupled with these offers that again have the lead of Celergo going GlobalView over time, will just further the growth narrative and the story over there. But that is absolutely the intention and the strategic direction of next-gen payroll."
},
{
"speaker": "Pete Christiansen",
"text": "Thank you for the comprehensive call."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ashish Sabadra with the RBC Capital Markets. Your line is open."
},
{
"speaker": "David Paige",
"text": "Hi. This is David Paige on Ashish. It was great to hear about your results and growth in the mid-market particles. I was wondering if you could just give a little bit of an overview on the competitive landscape there. Are you guys taking share or the entire market or just what's the outlook or the environment in terms of competition in the market? Thank you."
},
{
"speaker": "Maria Black",
"text": "Yes, absolutely. So the mid-market is a great segment for us. It's certainly not getting any easier to be an employer in the mid-market. It's littered with complexity and all sorts of challenges to navigate, just even if you look at the last 30 days, you can see legislation that mid-market employers are having to navigate. And so it's a strong market. It is a highly competitive space. That's not new. I think for - from a competitive landscape perspective, it's always been competitive. And I don't know that we've seen a noticeable changes in the competitive landscape. What we have seen is incredible distribution, execution, incredible satisfaction, execution on our end. We've made great investments into the product set. It's winning in the market. You marry that strategy with great execution on the seller side and great execution on the retention side. That, to me, is what's changing in the mid-market is that we've gotten stronger."
},
{
"speaker": "David Paige",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi. This is [Caroline Lada] on for Jason. Thanks for taking our question. Sorry to double down on price, but just given the way inflation isn't dropping off, maybe the way the market was hoping or expecting recently. Do you have any updated expectations about ADP, and like the broader peer group's ability to raise pricing heading into the fourth quarter, and 2025 without like significant pushback?"
},
{
"speaker": "Don McGuire",
"text": "Caroline, thanks for the question. I think it just comes - continues to come back to the same concepts, and that's making sure that we offer good value to our customers over a 10-plus year lifespan. So, we're always mindful of making sure that clients are getting good value, and that we keep those clients for a very, very long time. So it's that client life cycle of the total return on the entire life of a client. So, we're always very, very careful not to overstep on pricing. Having said that, we, of course, watch what the competition is doing. We have our ear to the ground. Our salespeople have their ear to the ground. We're trying to make sure and understand what's happening from the competition. So, we will continue to look at it. We'll continue to knock around some ideas, and some models and see what the impact could be. But I don't want to signal exactly what we think we're doing, because we're still, as I said earlier, in the midst of our planning cycle here. But we always look at it. We take price usually every year where we can, not including some of the contractual commitments we have with some of our larger clients, but just something we're very, very careful and cautious about doing shots a lot of color."
},
{
"speaker": "Unidentified Analyst",
"text": "Awesome, thank you. That adds a lot of color."
},
{
"speaker": "Operator",
"text": "Thank you. And our last question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning. Maria, as you look at the mid-market and the success ADP is having, who are you winning market share from? Is it traditional payroll companies? Are there companies that are maybe using other software products that you wouldn't consider payroll companies? I'm just wondering where the success is coming from?"
},
{
"speaker": "Maria Black",
"text": "Everywhere. Candidly, listen, from a mid-market perspective, again, the demand is healthy. The competitive environment is competitive, and we continue to remain laser-focused on all of the competitors specifically. The ones that have been talking a lot about us over the last few years. And I think the way that we've been focused is really about the investments we've made, investments into a best-in-class product. Investments into focus on distribution investments into a digital transformation that's driving great client satisfaction. And so, that really has allowed us to have a winning story, as it relates to really all of the players."
},
{
"speaker": "Kartik Mehta",
"text": "And then just one follow-up. Just on the PEO business, as you look at the long-term growth perspective of that business, obviously, there's been - a couple of things that happened that maybe have slowed the growth down in the last year or so. I'm wondering just your outlook on the PEO business and if you think anything has changed in that business, or demand for the product?"
},
{
"speaker": "Maria Black",
"text": "Yes. So I'm happy to start and certainly happy to have Don chime in too on the PEO. I'm always very, very bullish on the PEO value proposition. I've been close to that business for a long time, and I will tell you it's stronger than it's ever been. So despite the strangeness that we've had in the PEO, from a kind of the componentry heading into the pandemic, during the pandemic after the pandemic and then now, call it, a little bit post, post pandemic. What I would suggest to you is it has nothing to do with the fundamentals of that business, and what we would expect over time from a growth perspective long-term. And so the value proposition is strong. Nothing from our end has changed there, as it relates to the overall demand from the business. And we see that just in the - we continue to have 50% of our clients into the PEO coming from the base. So it's resonating with our existing clients. It's resonating with the open market, and it continues to be a very strong offering for us. So I don't know, Don, if you want to add anything there?"
},
{
"speaker": "Don McGuire",
"text": "Nothing to add then the value proposition is as strong as ever, and the fundamentals in the business are continue to be quite strong."
},
{
"speaker": "Kartik Mehta",
"text": "Thank you very much. I really appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. We have one more question from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hi guys, thank you for taking my question. And apologies, I was on a different call. But I know it's kind of maybe early, but do you have any news about - your next fiscal year, maybe something like early views as we head into the fourth quarter? Thank you."
},
{
"speaker": "Don McGuire",
"text": "Yes. Dan, just a couple of things, thinking about next year. We do think that it's early, so we didn't share too much, although we did say that the pace per control will continue to be under a little bit of pressure, given the fullness of the labor market. So that's kind of continuing story that we've been telling. We will continue some of our GenAI spending related spending, making the right investments for ADP. And of course, we're going to get some tailwind from interest rates. So I think those are the three primary things. And of course, we always remain very, very focused on bookings and our strong client retention and client experience. So, I think those would be the highlights for '25."
},
{
"speaker": "Dan Dolev",
"text": "Okay. Appreciate it. And apologies again if this was already addressed. I was on a different call. I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. There are no further questions. I'd like to turn the call back over to Maria Black for any closing remarks."
},
{
"speaker": "Maria Black",
"text": "Yes. Thank you, and thank you once again to everyone who joined us today, whether the full time or late. We always appreciate the questions, the interest, and we certainly look forward to speaking with all of you again soon, and look forward to the close of the year. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 2 | 2,024 | 2024-01-31 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead.
Danny Hussain: Thank you, Michelle, and welcome, everyone, to ADP's second quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO, and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Danny, and thank you, everyone, for joining us. This morning, we reported strong second quarter results, including 6% revenue growth and 9% adjusted EPS growth. I'll begin with a review of the quarter's financial highlights, before providing an update on the progress we are making across our strategic priorities. We delivered solid Employer Services new business bookings in the second quarter, reaching a new record bookings volume for Q2, and keeping us on track for our full-year outlook. Growth was especially robust across our small business portfolio, and we also experience healthy growth in our mid-market and international business. With steady demand in HCM and a healthy new business pipeline at the end of the quarter, we look forward to the important selling season ahead. Employer Services retention was strong in the second quarter. Although it declined slightly compared to the prior year, we once again exceeded our expectations as we continue to benefit from a healthy overall business environment, and from our very high client satisfaction levels. Our Employer Services pays per control growth remained at 2% for the second quarter. The overall labor market remains resilient, and our clients continue to add employees at a moderate pace, which is resulting in a very gradual deceleration and pays per control growth. And last, our PEO revenue growth of 3% for the second quarter, was in line with our expectations, and we are very pleased to have delivered strong PEO new business bookings that were ahead of our expectations. Based on continued healthy activity levels, we feel good about our PEO bookings momentum, and we look forward to seeing a gradual re-acceleration of our PEO business in the second half of this fiscal year. Moving on to a broader update. During the second quarter, we launched a new brand advertising campaign themed, the next anything. The campaign highlights how the world of work is always changing, sometimes gradually, sometimes suddenly, and trusted business solutions must evolve with it. The theme aligns with our strategic priorities to give our clients the advantage of our leading technology, expertise, and scale. In Q2, we continue to push forward on our first strategic priority to lead with best-in-class HCM technology. A key part of that is the rollout of ADP Assist, our cross-platform solution powered by GenAI that proactively delivers actionable insights in plain language to enhance HR productivity, aid decision-making, and streamline day-to-day tasks for our clients and their employees. ADP Assist seamlessly integrates with ADP products across multiple platforms. Using an intuitive conversational interface, it provides valuable and contextual insights which touch every aspect of HR. For example, in addition to the features we shared with you last quarter, including our natural language reporting capability, in Q2, we integrated natural language search capabilities into our run platform, which allows it to understand intent behind the search terms and use GenAI to mine ADP's deep knowledge base to deliver easy to use and effective content. ADP Assist also helps clients validate payrolls and solve common employee challenges across HR, payroll, time, and benefits. It's a comprehensive experience that is trained on the industry's largest and deepest HCM dataset and our deep knowledge base to surface highly credible and actionable insights so that clients can make smarter decisions. We are excited about the roadmap ahead for all of our major solutions, and we expect it to help us build on the recognition we continue to earn in the market. In Q2 alone, we were pleased to be recognized for product leadership by three major industry analyst rankings. Everest Group named ADP the highest leader out of 27 providers in its multi-country payroll solutions PEAK Matrix report. NelsonHall identified ADP as a leader in its Payroll Services Vendor Evaluation and Assessment tool in all markets. And Ventana Research named us an exemplary leader across its North American, global, and payroll management buyers guide for performing the best and meeting overall product and customer experience requirements. Our second strategic priority is to provide unmatched expertise and outsourcing solutions. We shared last quarter that we were beginning to equip our associates with GenAI capabilities through our Agent Assist technology. In Q2, we expanded our call summarization deployment to a greater portion of our service associates and started to see productivity gains with shorter handle time and improved service quality. With our global service associates fielding millions of calls annually, we are incredibly excited to test ways to optimize those client interactions. Our third strategic priority is to benefit our clients through our global scale, and we continue to lean into this advantage. In Q2, we announced a strategic collaboration with Convera, a global business to business payments company to help our multi-country clients manage the complexity of global payroll and cross-border payments through an integrated platform. By combining Convera’s payment solutions with our global payroll expertise, we're enhancing the client experience by minimizing the need to access various banking platforms and improving payment accuracy, compliance, and security. We also announced the launch of ADP retirement trust services to support our growing retirement services business. Standing up our own trust services entity demonstrates our scale and commitment to our retirement clients, positioning us on par with financial industry leaders and ahead of HCM competitors that rely on third parties. This commitment can really matter to financial advisors, keeps data within ADP's trusted ecosystem, and provides a cost and price benefit to ADP and our clients over the long term. Our scale also affords us the opportunity to partner with other leading technology providers in innovative ways, and we continue to expand on many of those partnerships to provide our sales implementation and service teams with client-specific insights to quickly address market shifts, drive more personalized interactions, and deepen our overall client engagement. Overall, our second quarter represented strong outcomes on the financial front and with respect to our key strategic priorities. I'd like to thank our associates who continue to deliver exceptional products and outstanding service to our clients, particularly now, as many of them are in the middle of our most hectic time of year completing year-end work. I'm proud to share that their efforts help drive our overall Net Promoter Score to its highest level ever in the second quarter. Thank you again for all that you do for ADP and for our clients. And now, I'll turn it over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I'll provide more color on our results for the quarter, as well as our updated fiscal 2024 outlook. Overall, we reported a strong second quarter, with our consolidated revenue growth moderating in line with our expectations, and our adjusted EBIT margin coming in slightly better than expected. However, the interest rate backdrop has changed since we last provided our full-year outlook, and we are lightly tweaking our outlook, which I'll detail. I'll start with Employer Services. ES segment revenue increased 8% on a reported basis, and 7% on an organic constant currency basis, coming in slightly ahead of our expectations. As Maria shared, we continue to grow our ES new business bookings, resulting in a record second quarter bookings volume. Our small business portfolio and international business provided outsized growth contributions this quarter. And with a steady HCM demand environment and healthy pipelines, we feel on track for our 4% to 7% new business bookings growth outlook for the year. As mentioned earlier, our ES retention declined slightly in Q2 versus the prior year, but again exceeded our expectations. Given our first half retention outperformance, we are increasing our full-year retention outlook slightly. We now anticipate a 40 to 60 basis point decline in our full-year retention, which is 10 basis points better than our prior forecast. ES pays per control growth of 2% in Q2, was in line with our expectations, and we are maintaining our 1% to 2% growth outlook for the full-year. And client funds interest revenue increased in line with our expectations in Q2, as a slight decline in our average client funds balance, which we discussed last quarter, was more than offset by an increase in our average yield. However, we are revising our full-year client funds interest outlook lower to reflect the change in prevailing interest rates since our last update. We now expect fiscal 2024 client funds interest revenue of $985 million to $995 million, and we expect a net impact from our client funds extended investment strategy of $835 million to $845 million, representing a reduction of about $20 million at the midpoint. In total, there is no change to our fiscal 2024 ES revenue growth forecast of 7% to 8%. Our ES margin increased 170 basis points in Q2, driven by both operating leverage and contribution from client funds interest revenue growth, but reflecting the impact of a reduced client funds interest revenue forecast, as well as a slight increase in expected GenAI related spend, we are tweaking our fiscal 2024 ES margin outlook and now anticipate the lower end of our prior margin range. Moving on to the PEO, we had 3% revenue growth, driven by 2% growth in average work site employees in the second quarter. These metrics were in line with expectation, and we are encouraged to see signs of stabilization in our PEO pays per control growth. As Maria mentioned, our PEO new business bookings were very strong in Q2. With continued healthy activity levels, we continue to anticipate a gradual ramp in our work site employee growth in the back half of fiscal 2024, and we are maintaining our full-year growth outlook of 2% to 3%. PEO margin decreased 50 basis points in Q2. As we shared last quarter, we assume this year's workers' compensation reserve release benefit will be lower than last year's benefit, and we are further narrowing our PEO margin expectation to be down 80 to 100 basis points in fiscal 2024 versus our prior expectation of decline of 50 to 100 basis points. Putting it all together, there is no change to our fiscal 2024 consolidated revenue growth outlook of 6% to 7%. With the two changes to segment margin, we now expect our adjusted EBIT margin to increase by 60 to 70 basis points versus our prior outlook, for an increase of 60 to 80 basis points. We continue to expect an effective tax rate of around 23%, and we still anticipate fiscal 2024 adjusted EPS growth of 10% to 12%, with the middle of that range the most likely outcome given current assumptions. Thank you, and I'll now turn it back to the operator for Q&A.
Operator: Thank you. [Operator Instructions] We'll take our first question from Mark Marcon with Robert W. Baird. Your line is open.
Mark Marcon: Hey, good morning, and congratulations on all the accolades that you've gotten from the third-party reviewers. I'm wondering if you can talk a little bit about some of the initiatives. And specifically, one that stood out was the - was setting up your own trust. Can you talk a little bit about the investment there and how we should think about how that would end up unfolding? And what do you think some of the reactions would be with some of your third-party partners? Like, you've got bank partnerships and CPA partnerships and obviously benefit administration partnerships. How do you think they'll end up reacting? Thank you, Maria.
Maria Black: Thank you, Mark, and good morning. Appreciate the question and appreciate your well wishes on all of our recognition. Certainly excited to see across the board the recognition we mentioned during the prepared remarks, but also the continued momentum across all of our initiatives. Happy to comment on retirement trust services. It is really a demonstration of our scale. And so, when I think about what it means to our clients, what it means to the ecosystem that you mentioned, banks, CPAs, I think it's all incredibly positive. And trust services are a core component of any 401(k) plan. Given the size and scale of our retirement services business, what we found is that the pool of what's known as third-party trustees, if you will, that are capable of handling a business just of our size, is actually becoming shrinkingly more difficult, if you will, in terms of the number of providers that are able to offer standalone trust services to a retirement offering of our size. So, in terms of that, we made the decision to launch our in-house trust services. We believe that this is a great value to our clients, to the ecosystem. It puts us on par with other industry leaders and the financial services, and really a competitive advantage against some of our HCM competitors that continue to leverage these third-party trustees. So, for us, I think it's a big commitment to the business that we have, the retirement business that is, which really can matter to financial advisors, and as you said, CPAs and banks. Really by taking the trust services in-house, the implication is that we have better control over our costs. Ultimately, that yields a better price for our clients, a better service. We also have the ability to maintain all of the data inside of ADP's ecosystem, which as you know, is a big component of who ADP is in terms of data integrity and all those things. So, that's kind of the retirement trust services in a nutshell, Mark.
Mark Marcon: Terrific. thanks for that. And then just, it was noticeable that you basically are anticipating a lower level of decline in terms of the ES retention, which is coming off of record levels. To what extent is that due to an anticipation of lower levels of bankruptcies as opposed to just the improvement that you've been seeing in terms of your client service scores?
Maria Black: So, retention is going incredibly well, right? And we mentioned that in the remarks. Year-to-date retention has definitely been better than we expected. And so, I think things are fundamentally really healthy right now. One thing to keep in mind as kind of think about the outlook, is that we are, as you mentioned, we are coming off of some of the record highs that we've seen over the last several years. And while we believe that from specifically a down market perspective, we're close to being normalized back to fiscal 2019 trends, we do also anticipate some pressure in the back half from perhaps out of business and bankruptcies having more of a material impact. We haven't seen it to date, but we certainly want to ensure that we're cognizant of the fact and we believe it's prudent - given that we have retention running at such record levels, we believe it's prudent to plan for it in the back half to have some pressure. And obviously, just like any year, Mark, retention is always noisy until we have some normal variability and conservatism in the back half. Just like you, I'd like to think that there's opportunity there. I think only time will give us the answer to that, but that's kind of how we're thinking about the back half.
Mark Marcon: Really appreciate that, Maria. Thank you, and congratulations.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thank you very much. Appreciate all the detail this morning. I wanted to quickly just touch on PEO. You called out a strong acceleration in the business, but it looks like outlook for revenues was changed - you may have mentioned that, but I'm just trying to capture how much of that is timing issue versus the concentration you have in professional services and technology, which still seem a little bit soft, at least in the employment reports.
Don McGuire: Yes, James, thanks for that question. We've been happy to see the stabilization in the pays per control in those sectors, the financial services and technology sector. So, although there's still a little bit of noise there, it's certainly stabilized from what we saw in the prior quarter. So, that's positive. I do think that as we looked at our sales results, our bookings for PEO, we were very happy with the bookings. Maria mentioned that already very good. I think as we kind of put those together, the improvement in the pays per control and the improvement in our bookings, I think we're going to be heading towards that re-acceleration that we've been pointing to over the last couple of quarters in the PEO. But really just trying to get the impact of those two components, those variables, is really what's going to help us get that re-acceleration going.
Danny Hussain: And James, just to clarify, the pays per control, although it’s stabilizing, it's not providing any sort of upside versus our prior forecast. So, bookings are going well. It takes a quite a bit in terms of bookings to really drive a material change to the current year revenue, which you well understand. With pays per control still providing sequential, gradual drag, those two are sort of netting out to an inline outlook.
James Faucette: Got it. Thanks for that, Danny. And then quickly on AI, it seems like there's a little bit of incremental investment there and certainly a big focus on this call, but wondering about how we should think about the - how you're anticipating a return on that investment and over what kind of timeframe. And maybe more qualitatively, what kinds of paybacks, whether it's increased customer satisfaction or internal operations, et cetera. Thanks.
Maria Black: Yes, so I'll start on the on the AI side and tell you all the reasons again that I'm so excited about it. Maybe Don can give you a little bit about how we're thinking about the return on investments that we're making. So, just to remind everyone how we're thinking about AI, in its most simplistic way, I think about it really in three buckets, the first of which is product and innovation. So, putting generative AI into all of our innovation cycles. So, that's everything from product development to the features and functionality that I mentioned in the prepared remarks. And by the way, later this morning, we're actually issuing a press release that goes through some of our product and innovation, call it, philosophy and launches of products, right? So, some of what this press release speaks to is how we're thinking about and our design principles around making things easy, smart, and human within our product and innovation cycles to really drive things like payroll assist, things like ADP Assist into the market in a meaningful way. So, product is really kind of the first bucket. And as you'll see, we're making significant investments there. We do have ADP Assist now more broadly deployed across the product set, and we're seeing meaningful impact as it relates to our client experience on that. The second bucket is what I call efficiency and service efficiency. And this is really about giving all the same things that we're looking to give our clients to make their jobs easier and more effective and efficient, and giving those same tools to our associates. And so, we have Agent Assist. I'm pleased to say that from an Agent Assist perspective, we've more than doubled the number of associates today that are engaging in AI tools overall. Specifically, a big piece of that is anchored in Agent Assist and the things we're doing around call summarization. Again, I'll let Don comment on investments and return, but just to kind of give you a flavor of what we're talking about here, the feedback we're getting from our associates is, there are times we're shaving off a minute or two minutes by aiding things like call summarization. And while that probably seems minuscule, what I would offer to you is we have thousands of service associates, and we also have millions and millions of calls that we take every single year. And so, we're pretty optimistic and excited about a minute here and a minute there, and what that means from an incremental opportunity for us over time, right? So, we continue to lean into our service efficiency and really getting all of our associates more effective as it relates to their ability to engage with our clients. And then last but not least - by the way, I could go on and on and on all day on this topic, but last but not least and very, very important is how we're thinking about generative AI in our go-to market motions. And so, we have for years been at the tip of the spear of sales modernization. We have partnerships that are two decades old where we've always been leading the way with what it looks like to have a best-in-class modern distribution and sales force, and this is no different for us. So, we already have a broad set of our sellers leveraging tools along the lines of Generative AI, many of which are through our best-in-class vendors and partners that we have, and we're seeing great impact there. Things that I used to do myself at a personal level manually, such as pre-call planning, by the way, things like call summarization for prospecting, these are big items for us as it relates to our go-to-market motions, and we've just started scratching the surface. So, all in, really excited again. Just to kind of wrap it all up, I think it's about product, service efficiency, and our go-to-market motions. We are making active investments. Some of those investments are things that we've shifted that we were already working on in digital transformation. Some of it is incremental investments. And so, I think with that, I'll turn it over to Don who can kind of talk about how we're thinking about our incremental investments and moreover the return on that.
Don McGuire: Yes, so I think Maria just outlined some of the exciting areas that GenAI will have for us and some of the things that'll change, how they'll make the client experience better, how they'll help our associates, how they'll help us sell more, et cetera. But I would say at this point in time, what we're really talking about is some modest investments in GenAI. I think it's going to be a little while before we start to see returns from those things, but we certainly do anticipate returns. But in the near term right now, it's really a time for investing in these tools, et cetera, and we'll see those outcomes, those financial outcomes somewhere down the road.
James Faucette: That's great. Thank you both very much.
Operator: Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi there, and thanks for taking my question this morning. You guys called out higher seller expenses as just one component of the margin headwinds in PEO. I guess the question, is this just the cost to compete in PEO at this point? In other words, is it becoming more expensive to compete in PEO, or do you expect expense levels related to selling to sort of abate in a more normalized time period?
Don McGuire: Yes, I don't think there's - just to answer the question, there's nothing really unusual or fundamentally different about our selling expenses and how we go-to-market in the PEO. I think certainly as we see higher sales, as you know, we get a lot of our sales, half of our sales, give or take, from internal. So, some of that's a little bit of our internal housekeeping if you will, how we allocate expenses between business units, et cetera. But higher sales generally translate into higher selling expenses. So, really nothing fundamentally different in how we go-to-market. Certainly, not seeing any fundamental differences in the competitive landscape that's driving those expenses.
Ramsey El-Assal: Got it. Okay. And then one follow-up for me. In the context of the international product launches like Roll in Ireland, and also I guess the partnership you guys just announced with Convera, can you comment on the international value proposition itself, whether it's sort of largely the same as it is in the US, or are there distinctive products, needs, partnerships required in these markets that you guys sort of still need to build out to more fully execute on the international opportunity?
Don McGuire: Yes, I'll start, and Maria can add here in a second. So, as you know, you look at our revenue as - international revenue as a percentage the total, and it’s not where we'd like it to be, even though roughly 40% of the people we bear around world are in international. So, and the reason for that is that we have fundamentally different offers in the US. We have things like PEO. We also have money movement services, tax services, pretty much broadly distributed. Some of those offers don't have the same value proposition outside of the US market. So, our opportunity there is not quite the same. Perhaps it will be as time goes on, some of those services may be available in other markets, but as we speak today, they're not there. The value prop isn't the same. With respect to Convera as a partner, just to speak to that one a little bit, we have thousands of clients, and those thousands of clients have thousands of entities spread across multiple countries around the world. And if you think about the complexity and the difficulty of paying their people in some of these small countries and then getting the payments to the various social security providers in those countries, having somebody like Convera who can help a large European or a large US multinational manage the treasury function in those small countries around the world without having to set up all the banking, et cetera. So, someone like Convera acts as a great partner for us to facilitate those cross-border payments in a very - in a compliant way, et cetera. So, I think that's very positive for us. So, we do have some partners in international like Convera as I just mentioned, but we still see it as a great opportunity for us to continue to grow.
Maria Black: That's right. If I may, one of the things, I think what Don is suggesting is really the opportunity we have with international. And so, when you put it in the context of the business that we have in the US there, there is a tremendous opportunity for us to think more broadly in international partnerships as the one Don just outlined with Convera, is a big piece of that. What I would also add is that from an international perspective, we did call out the performance specifically in Q2 on international. That's, by the way, bookings. That's on the heels of a solid Q1. What I would offer as well, we have record retention. We have record customer experience and client experience in international. So, I think we have a tremendous value proposition in international. By the way, some of the recognition I cited during the prepared remarks is really about how best-in-class our offer is with respect to the international offering we have. So, that said, as Don mentioned, we're not satisfied. I think there's more opportunity to us to scale and grow our beyond payroll offerings, partnerships that are a big piece of that, but undoubtedly, we're performing and competing very, very well internationally.
Ramsey El-Assal: Fantastic. Sounds like good things ahead. Appreciate it.
Maria Black: Oh, you know what, let me just comment because you mentioned Roll in international, so I just thought I'd mention that really quickly, which is, we are very excited about the down market in international. Roll is one way that we're getting after that. And the pilot programs that we're running are teaching us a lot as we think about the down market and international.
Ramsey El-Assal: Okay, perfect. Thank you.
Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi guys, congrats on the solid results. Don, I just wanted to ask about average balances. I know we were expecting a little bit of a headwind from the payroll tax deferral. Maybe you can quantify that as part of the reason for the drop of balances down 2%. And then what's the go forward there we should expect? Is there a more of a headwind from the payroll tax deferral for balances and maybe expect a similar decline in the back half of this year?
Don McGuire: No, I think you were right to call out the payroll deferral, payroll tax deferral. That definitely was behind the decline quarter-to-quarter. We don't - that's now behind us. So, that's not going to be there. So, we are expecting 2% to 3% balanced growth throughout the balance of the year. So, we think that's very positive. I think the big callout though on the whole CFI program is just the fact that since we spoke last, five-year and 10-year interest rates are down about 80 bps on both of those. And so, I think that's a little bit of the headwind and that's roughly the $20 million or so that we're calling down the float number for the balance of the year. But still very optimistic about growth. Certainly, the reason that it's not growing as quickly perhaps as it did last year, we've certainly seen some moderation in wage growth, and we've talked about even though pays per control are behaving as we expected, they are certainly lower - pays per control growth is lower than it was in the back half, but will be lower in the back half of this year than it was in the back half of last year. So, those would be the major influencers, if you will, to the full balance as we go forward to the back half.
Bryan Keane: Got it. And is that part of the moving of the ES margins to the lower end of kind of the range you talked about? I think you talked about rates there. Just what was the surprise from three months ago on rates that that maybe caused you to push the margins towards the lower end or where you think the lower end, the new margin range?
Don McGuire: Yes, so, you're right. I think the float certainly is a component of us guiding to the middle of our range, for sure. So, that's a component. We don't try to second guess the markets. We use yield curves that are out there in the market to estimate what we think our returns are going to be. So, no real surprises, other than seeing what's happening in the overall market. And then we're taking the forward yield curves and applying those to our balances, and that's where we land.
Bryan Keane: Great. Thanks for taking the questions.
Operator: Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Great, thanks. Good morning, guys, and thank you for taking my questions. Maybe just wanted to start off on some trends that we've seen so far in the selling season. Seems like through 2Q it was pretty positive on the booking side, but maybe wondering how we've sort of tracked into 3Q, and then also what you've seen maybe from competitors, any changes in pricing, go-to-market strategy and all that would be helpful.
Maria Black: Yes, good morning, Scott. We feel good about the demand environment overall at this point. I think companies are still hiring. We saw that this morning actually as well. And companies are still investing in their people, their talent. They're investing in HR. I think there are a couple things I'd highlight to you. The down market, definitely companies are continuing to hire and they're continuing to buy. We had tremendous second quarter results. By the way, that business has been executing incredibly well really for many, many quarters. And that's our run offering, but it's also all the things that are attached to run. So, think insurance services, retirement services. All of the down market is doing incredibly well. To give you a little bit of a line of sight, because it is the 31st of January, so we do actually have a tiny bit of visibility specifically to the down market. And you asked about trends into the third quarter. What I would offer to you is January looks good. I think we're actually on track to onboard something close to like 30,000 units in that business alone in the month of January. And so, that's the size of some companies, if you will. So, it's pretty incredible to see the execution in the down market. We have solid pipelines really across the mid-market as well as off-market. The mid-market did incredibly well in the second quarter. From a competitive standpoint, I think we get a lot of questions around the competitive landscape. Has it shifted in the mid-market? What I would offer to you, it hasn't really shifted. It's been a competitive space per us for a long time. It's an area for us that we're executing very, very well. We have best-in-class products. We continue to take friction away from our clients, make it easy for our clients to engage with us. We know this based on our results and retention. We know this based on our results and record NPS. We had good bookings in the mid-market. So, I think the mid-market is solid and certainly not getting any easier for our clients to be employers in the mid-market. As it relates to the international space, I think I covered that already, so I won't touch much more on international, but a good Q2 on the heels of a good Q1. And then in our enterprise and upmarket space, this is an area that has normally, I think it's kind of the new normal on longer deal cycles that have more individuals involved in those cycles. We're paying close attention to it and certainly all the things that are happening kind of across that space. But I would suggest to you that we feel relatively solid about our pipelines and our ability to bring that business in the back half.
Scott Wurtzel: Great. That's helpful. And just a follow-up for Don, just on the float income guidance, sort of noticed a pretty notable increase on your outlook for the client short portfolio. So, just wondering if you can maybe give a little bit of color on sort of the changing geography on those investments for the balance of the year. Thanks.
Don McGuire: Yes, so maybe let me clarify that for you a little bit. So, really, we haven't changed our investment strategy at all. What we have done is we've tweaked a little bit the way we're going to - we were borrowing funds in the market day in, day out. So, what you're seeing is, we're actually entering the market a little bit early. So, instead of borrowing everything we need to on a peak borrowing day, we've simply spread the borrowing out over two, three days so that we can tap the market in a more - in a smoother way, if you will. And I think if you're looking at the average balances on that - on the appendix sheet that's in the release, you'll notice that that number's gone up in the short fair bit, but that's the driver. So, it's not a change in our investment strategy at all. It's just a change in a bit of a tweak in the way we're actually borrowing funds in the market when we need larger amounts of - when we have larger amounts of borrowing.
Scott Wurtzel: Great. Thanks, guys.
Operator: Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. First question I had is on EBIT margin. Can you comment on what drove the outperformance versus your view for that to be down I think in 2Q? I'm curious if that was an aspect of timing within the year versus better-than-expected efficiency. And I think, Don, I heard you mentioned some GenAI investments to come. Is that incremental spend versus the prior plan?
Don McGuire: So, yes, let me start - Bryan, let me start with the first part of your question. So, there was a little bit of modest revenue outperformance in the quarter. So, I think that was a contributor to the margin. And then we had some expenses. We always have focus on expenses. There's a few things, a little bit of bad debt, a little bit of headcount, et cetera, and perhaps a little bit of timing, but nothing significant to really call out as a contributor. In terms of the GenAI spend, yes, we are spending a little bit more than we said we were going to last quarter. So, we do have a bit of incremental spend. It's not a huge amount, but I know that lots of folks like to measure things in 10 bps. So, we are calling it out. Not an incredible amount, but a little bit more than we had said in the prior quarter.
Bryan Bergin: Okay. And then just I guess a follow-up then on GenAI and ADP Assist here. Is that a feature you're able to monetize directly or more so kind of an enhancement you're offering for free to drive the CSAT stores higher? And I guess understanding you're leaning into these developments, do you kind of view it - when you think about the monetization of GenAI products, is this a near-term dynamic or more so kind of feature and product differentiation that's a longer term monetization dynamic?
Maria Black: So, Bryan, ADP Assist is really the overarching, call it, brand, if you will, that we're leveraging to talk through all the things that we're putting into our product to make things easier. The way that I think about it is it’s really just the next phase of digital transformation for ADP using new tools and technology. So, said differently, our intention is not to charge to make things easier for our clients to do business. That is our commitment to our clients, always has been, is to make it as easy as possible to process payroll, to have accurate payrolls. And so, it's not a monetization effort as it stands. It's really about just leveraging the new technology to step change the digital transformation that we've had underway candidly, for many, many decades since the dawn of the computing era. So, that's kind of how we're thinking about ADP Assist. In terms of monetization in general, do I believe there's monetization as it relates to GenAI? Of course. I think it’s more about the dollar long term, right? So, I think about it - the dollars that we're putting in today will yield multiple dollars for us in years to come. So, there will be distinct monetization opportunities as we create new products into the market, as we think about various things of that nature, perhaps features and functionality. There will also be gains in sales and retention that will lead, in my mind, to investments that are proven today in GenAI to drive incremental bookings and retention over the long term. So, I think it's about putting a dollar in today with the belief that it will yield many dollars of margin to come, if you will, as well as bookings, et cetera.
Bryan Bergin: Okay, understood. Thank you.
Operator: Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning. Thanks for taking my questions. Maybe on the PEO business, I was curious, I know you guys called out some of the bigger verticals inside of the PEO business and that there's maybe some more softness there than you'd expected in technology and professional services. Any change in the exposure rather inside the PEO business or within like the big verticals? Are you guessing any change in the trends that you saw maybe over the last couple of quarters?
Maria Black: The trend in specifically professional services has stabilized. And so, I think Danny made the comment earlier, it's no longer contributing to the deceleration. So, it used to - the professional services cohort used to contribute to the acceleration of pays per control, then we found ourselves where it was contributing to a deceleration, and it's largely stabilized at this time.
Samad Samana: Got you. And just as you think about the pricing environment, I know that we're still not at when the company does the annual price increases, but as you think about maybe for new deals or for new customers that are onboarding, any change in the kind of price pressure or competitive nature of what your competitors are offering in terms of discounts or what ADP's is having to offer? And just as we look ahead to price increases, how are you thinking about this year's price increases?
Don McGuire: Yes, we're not really seeing any changes, Samad, in the price environment, the competitive environment. We think we're priced appropriately, and we've always acknowledged that we're a little bit of a premium to others. But we're happy with that because we think we offer better service and stability, et cetera. So, no real changes. You're right. It is a little bit early. The budget cycle kicks off here in the next six, eight weeks or so, and we'll certainly be looking at the pricing increases for next year and weighing all the regular factors, what's inflation been? We thought our price increases were very well received last year. We thought they were in line. So, we'll keep that in mind. But as always, we're always interested in the long-term value prop with our clients and being competitive in the market. So, we're always measured, I believe, when we think about the price increases that we do hand out to our clients.
Samad Samana: Great. Appreciate you taking my questions.
Operator: Thank you. Our next question comes from Kevin Mcveigh with UBS. Your line is open.
Kevin Mcveigh: Great. Thanks so much. Maria, I think you talked to kind of implementations a little bit. Can you remind us maybe what percentage of the revenue is done internally on implementations today, and if that's a shift philosophically, what that can be over the course of time? If I heard the remark right. Maybe I picked it up wrong, but just any incremental thoughts on that?
Don McGuire: Yes, I'll maybe - Kevin, you're a bit soft by the way, but you're a little bit hard to hear, but I think the question was what kind of revenue we derive from implementation, and is that …
Kevin Mcveigh: Yes.
Don McGuire: Yes, so it's not a substantial. Sub 10% of our overall revenue comes from setup - we internally call it setup fees. So, it's not a substantial amount.
Kevin Mcveigh: And then do you see that - Don, over time, does that become less if you outsource that? And is there any way to think about the margin impact from that initiative?
Don McGuire: Well, I mean, you also - so, no, I don't think there's a big opportunity there. We certainly have had conversations. We certainly have lots of folks who would like us to outsource our implementation because they think it's a revenue stream for them. We like to have that control over the client from sale-through to go live in service. Not to say that we won't work with third parties to help us from time to time, which we do. But it's really not that large a factor. Certainly, there's some money there to be had, but it's not that large a factor in the overall scheme of things. There's also some interesting accounting, of course, around implementation and setup fees and the deferral over the terms of the contract. So, once again, it would take a lot of changes to do anything, make any changes to the bottom-line financials in the near term.
Kevin Mcveigh: Helpful. Thank you.
Operator: Thank you. Our next question comes from Tien-Tsin Huang with J.P. Morgan. Your line is open.
Tien-Tsin Huang: Thanks so much. Good results here. Just want to dig in on your prior comments. I know a lot of people asked on PEO and the healthy activity there and the confidence in the acceleration. Is ADP doing anything differently, or is industry demand changing? I understand it’s not - it doesn't sound like there's a cost of pricing change there. So, I just want to make sure I understood that. Thanks.
Maria Black: Yes, good morning, and thank you. I am happy to talk about PEO bookings. I think as mentioned in the prepared remarks, we're very pleased with our PEO bookings. This really is the fourth quarter that we've seen positive PEO bookings momentum, and the Q2 specifically exceeded our expectations. Most of the pressure that we felt in the PEO has been a byproduct of kind of the pressure on pays per control and having to overcome that, which is why the focus on bookings has been so paramount for us. And certainly, we deliver that in the second quarter. In terms of from a demand perspective, I speak about the PEO all the time, as you know. I think the demand continues to be incredibly strong. I wouldn't suggest that there's anything unnatural that we are doing outside of a tremendous amount of focus across the enterprise to ensure that we're executing on the PEO booking side. But in terms of anything unnatural or demand changing, I think the value proposition, as I always say, is stronger than it's ever been. I think clients in that space are looking toward ADP to help them from a PEO value proposition. So, everything from payroll to benefits to navigating the complexity of being a business and having the ability to execute on a co-employment relationship. So, I would say the value proposition is as strong as it's ever been. I think it remains strong. The demand is there. The organization is focused on PEO bookings as an execution lever for us. And I'm pleased to see that we did just that in Q2, and we've really had - this marks the fourth quarter of positive bookings momentum from the PEO.
Tien-Tsin Huang: No, that's great. Thank you, Maria.
Operator: Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open.
Unidentified Analyst: Hi, this is Caroline (indiscernible) on for Jason. Thanks for taking our question. So, pays per control growth has been 2% quarterly through the first half, but the guide for full-year 2024 is still 1% to 2%. So, what are the drivers of the second half deceleration, or do you think that the high end has become more likely?
Don McGuire: Caroline, thanks for the question. We said we would go to - we'd be 1% to 2% for the year, and we certainly have that 1% to 2% range still in the back half. We're not really anticipating any slowdown in pays per control, but we certainly have it built in. So, perhaps we're a little bit conservative there. But as we sit here today, the employment demand continues to be robust, although still declining somewhat, but I think we're confident that in the back half, we're going to be declining a little bit, but still coming in on that 1% to 2% range for the year. Not really much more to say there other than employment demand, labor markets continue to be maybe a bit softer than they were, but as we saw this morning in our NER report, hirings still out there, still good growth. So, not a lot of extra color, I don't think, to add around pays per control.
Unidentified Analyst: Okay, great. Thank you.
Operator: Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Hey, guys, great results here. Just a strategic question, obviously if you look over the next 12 to 18 months, interest rates are coming down. There is a big debate out there on the ability to offset some of those headwinds in terms of revenue. Can you talk about maybe some idiosyncratic initiatives that you could do to offset the headwind from declining interest rates? Thank you so much.
Don McGuire: I think that's really a macro question. I guess the macro answer to that would be that if interest rates start to decline, we'll see an offsetting increase just in economic activity. And if we see that increase in economic activity, we should see revenue go up. We should see bookings opportunities go up, et cetera. So, I think that if interest rates come down - and there's lots of debates, whether it's two cuts or four cuts, et cetera, who knows, but if they do come down, we should certainly avoid the recession. Nobody's asked about a recession on the call today, so thank you. I think the consensus is that there's not going to be a recession. So, certainly any of the polls suggest that the economy's healthy with 3.3% GDP growth in the last report. So, if rates come down, the economy should remain healthy, and a healthy economy should help continue to contribute to our growth.
Danny Hussain: Dan, I'll just add also, our model involves reinvesting further out in the yield curve, and as you know, we're still reinvesting at higher rates than what's embedded in the securities that are rolling off. So, even if we do start to see short-term interest rates fall next year, which is obviously consensus at this point, a lot of that will be offset by the reinvestments that we have further out in the yield curve. And so, it's too early to be talking specifically about the interest rate outlook for next year, but we would just recommend you keep that in mind.
Don McGuire: Yes, that's fair. I think if you look at our reinvestments, our current reinvestments are still at 4%, which is higher than our average yield today. So, there still are opportunities. Our float is expected to continue to grow over the next 12, 24 months. Certainly, it's going to grow a little more slowly than we would've expected at the end of last quarter, but there's still upside from float, which is perhaps not as much upside.
Dan Dolev: Great. Great results, again. Thank you so much.
Operator: Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open.
Pete Christiansen: Thank you. Good morning. Two questions. Now that we fully lapped ERTC, I'm just curious if you've noticed any changes in client demands or competitive tactics, particularly in the down market?
Maria Black: Yes, good morning, Pete. The ERTC, as you know, and I think what you're referencing is the new deadline that was pulled forward five quarters actually. So, the deadline actually as it stands is potentially today. I think we're still waiting for the final kind of execution, if you will, of that new deadline. But arguably, we're having to execute on behalf of our clients with today in mind. And so, there's a tremendous amount of volume that we are pushing through on behalf of our clients, and it has put pressure into the system, which is hard to watch and witness, by the way, as it relates to the very clients that are supposed to be helped by this and the challenges that they're facing trying to navigate it. So, we're doing everything we can in our power to help and process these claims. In terms of financial impact for us as it relates to ERTC, it isn't a financial impact to us. I think it's very de minimis as it relates to our overall revenue, as it relates to our overall incremental. We really, from a standpoint of what we're looking toward, it's about supporting our clients. And so, I think some of our competitors have used it more as a business and a revenue than us as it relates to how we're thinking about it. But undoubtedly, the advancement of this deadline to today has not been ideal for really anyone engaged in it.
Pete Christiansen: That's helpful. And then I'm curious, the combination of HCM and payments functionality, has certainly been a theme. EWA is obviously a big portion of that and now cross border. Do you see opportunities to increase penetration there or to add more capabilities either through partnership, M&A, furthering payments, and I'm thinking perhaps even like in disbursements, those sorts of things? Thank you.
Maria Black: From a strategic standpoint, Pete, what I would offer is continuing to solve for our clients and employees and how they engage with us. If you imagine across ADP, we pay 41 million wage earners in the US. That's 25 million. I think last time we talked about our Wisely offering, what we disclosed was that we had 1.5 cardholders or something like that. So, to just kind of give you the opportunity scale of it, we believe there's tremendous opportunity to increase how we're engaging with our clients, whether that's through the likes of Wisely, it's through the likes of EWA, as you're suggesting, or it's any other type of payments and things that we can do to make it easier for our clients and employees to move through the world of work, right? And so, the way I think about it and the partnerships that we're actively out there in the market talking to and thinking about, anywhere we can add value in our clients and employee life and flow. So, as they move through their day and they clock in through ADP's mobile app, which by the way, we have 10 million users that are actively using our ADP mobile app, so as they're engaging with ADP, are there opportunities for us to insert value there? Whether that's things like EWA, it's things like payments, it's things like financial and wellness apps like the companion app we have through Wisely. These are all top of mind for us as we go through our strategic discussions and as we think about partnerships in the future for ADP.
Pete Christiansen: Thank you so much. Super helpful.
Operator: Thank you. We have time for one last question, and that question comes from Ashish Sabadra with RBC Capital Markets. Your line is open.
Ashish Sabadra: Thanks for taking my question. So, just a multipart question on PEO and following up on some of the commentary earlier on solid bookings and moderating PPC, sorry, paper control headwinds. As we look at the WSC growth, we have continued to see a sequential improvement there, better than what we saw last year. And just given the commentary, is it fair for us to assume that we should continue to see that improve as we go through the year? And then on revenue per WSC, I was wondering if you could comment on, looks like pricing trends are positive, but if you could comment on any other puts and takes participation, anything else that could help drive better revenue per works at employee. Thanks.
Maria Black: So, the answer to your question is, yes, we do expect that the booking contribution, coupled with a bit of stability on the pays per control side, coupled with retention getting more favorable on the back half, all of those things should lead to the re-acceleration that Don mentioned earlier, that we've been pointing to in the back half. I think in terms of other componentry within the PEO, you mentioned a few of them. There's payroll per works on employee. There's workers' compensation. There's State unemployment. Some of these things are things that we're still waiting to really see the outcomes. I'll give you an example. One of those is State unemployment in terms of - obviously, we sit here today forecasting what that looks like. Most of those rates are issued throughout this quarter. And so, while we have some line of sight, in the end, we don't know entirely what the State unemployment outcome - we do expect that it creates a little bit of a - rates are going down year-on-year again this year. But again, only time will tell. Sometimes the States, as an example, make very strange decisions that aren't always in line with what's happening from a broader labor and unemployment perspective. So, all that to say, I think - I don't know that I could sit here today and give you any componentry that seems strange or out of the norm. I think they're all things we're watching as we look toward the re-acceleration in the PEO in the back half.
Ashish Sabadra: That's very helpful color. Congrats on the solid results.
Operator: Thank you. I'd like to turn the call back over to Maria Black for any closing remarks.
Maria Black: Yes. So, really quickly, I think I'll end with how I ended my prepared remarks, which is a huge shout-out to all of the associates and the entire ecosystem across ADP. So, that's ADP associates, partners, channels, all of the stakeholders that really contributed to what was a good, solid Q2, but also a good, solid first half. I'm really excited about the back half and what we'll accomplish, not just in fiscal 2024, but moreover in calendar 2024. It's a time and it's an exciting year for ADP. This year is the year that we actually round our 75th anniversary. And then when I think about who this company is over the last seven decades and 75 years, I can't wait to see what we're going to do in the next 75. So, look forward to sharing in that celebration with all of you as we head into 2024 together. Thank you.
Operator: Thank you for your participation. This does include the program and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danny Hussain",
"text": "Thank you, Michelle, and welcome, everyone, to ADP's second quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO, and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Danny, and thank you, everyone, for joining us. This morning, we reported strong second quarter results, including 6% revenue growth and 9% adjusted EPS growth. I'll begin with a review of the quarter's financial highlights, before providing an update on the progress we are making across our strategic priorities. We delivered solid Employer Services new business bookings in the second quarter, reaching a new record bookings volume for Q2, and keeping us on track for our full-year outlook. Growth was especially robust across our small business portfolio, and we also experience healthy growth in our mid-market and international business. With steady demand in HCM and a healthy new business pipeline at the end of the quarter, we look forward to the important selling season ahead. Employer Services retention was strong in the second quarter. Although it declined slightly compared to the prior year, we once again exceeded our expectations as we continue to benefit from a healthy overall business environment, and from our very high client satisfaction levels. Our Employer Services pays per control growth remained at 2% for the second quarter. The overall labor market remains resilient, and our clients continue to add employees at a moderate pace, which is resulting in a very gradual deceleration and pays per control growth. And last, our PEO revenue growth of 3% for the second quarter, was in line with our expectations, and we are very pleased to have delivered strong PEO new business bookings that were ahead of our expectations. Based on continued healthy activity levels, we feel good about our PEO bookings momentum, and we look forward to seeing a gradual re-acceleration of our PEO business in the second half of this fiscal year. Moving on to a broader update. During the second quarter, we launched a new brand advertising campaign themed, the next anything. The campaign highlights how the world of work is always changing, sometimes gradually, sometimes suddenly, and trusted business solutions must evolve with it. The theme aligns with our strategic priorities to give our clients the advantage of our leading technology, expertise, and scale. In Q2, we continue to push forward on our first strategic priority to lead with best-in-class HCM technology. A key part of that is the rollout of ADP Assist, our cross-platform solution powered by GenAI that proactively delivers actionable insights in plain language to enhance HR productivity, aid decision-making, and streamline day-to-day tasks for our clients and their employees. ADP Assist seamlessly integrates with ADP products across multiple platforms. Using an intuitive conversational interface, it provides valuable and contextual insights which touch every aspect of HR. For example, in addition to the features we shared with you last quarter, including our natural language reporting capability, in Q2, we integrated natural language search capabilities into our run platform, which allows it to understand intent behind the search terms and use GenAI to mine ADP's deep knowledge base to deliver easy to use and effective content. ADP Assist also helps clients validate payrolls and solve common employee challenges across HR, payroll, time, and benefits. It's a comprehensive experience that is trained on the industry's largest and deepest HCM dataset and our deep knowledge base to surface highly credible and actionable insights so that clients can make smarter decisions. We are excited about the roadmap ahead for all of our major solutions, and we expect it to help us build on the recognition we continue to earn in the market. In Q2 alone, we were pleased to be recognized for product leadership by three major industry analyst rankings. Everest Group named ADP the highest leader out of 27 providers in its multi-country payroll solutions PEAK Matrix report. NelsonHall identified ADP as a leader in its Payroll Services Vendor Evaluation and Assessment tool in all markets. And Ventana Research named us an exemplary leader across its North American, global, and payroll management buyers guide for performing the best and meeting overall product and customer experience requirements. Our second strategic priority is to provide unmatched expertise and outsourcing solutions. We shared last quarter that we were beginning to equip our associates with GenAI capabilities through our Agent Assist technology. In Q2, we expanded our call summarization deployment to a greater portion of our service associates and started to see productivity gains with shorter handle time and improved service quality. With our global service associates fielding millions of calls annually, we are incredibly excited to test ways to optimize those client interactions. Our third strategic priority is to benefit our clients through our global scale, and we continue to lean into this advantage. In Q2, we announced a strategic collaboration with Convera, a global business to business payments company to help our multi-country clients manage the complexity of global payroll and cross-border payments through an integrated platform. By combining Convera’s payment solutions with our global payroll expertise, we're enhancing the client experience by minimizing the need to access various banking platforms and improving payment accuracy, compliance, and security. We also announced the launch of ADP retirement trust services to support our growing retirement services business. Standing up our own trust services entity demonstrates our scale and commitment to our retirement clients, positioning us on par with financial industry leaders and ahead of HCM competitors that rely on third parties. This commitment can really matter to financial advisors, keeps data within ADP's trusted ecosystem, and provides a cost and price benefit to ADP and our clients over the long term. Our scale also affords us the opportunity to partner with other leading technology providers in innovative ways, and we continue to expand on many of those partnerships to provide our sales implementation and service teams with client-specific insights to quickly address market shifts, drive more personalized interactions, and deepen our overall client engagement. Overall, our second quarter represented strong outcomes on the financial front and with respect to our key strategic priorities. I'd like to thank our associates who continue to deliver exceptional products and outstanding service to our clients, particularly now, as many of them are in the middle of our most hectic time of year completing year-end work. I'm proud to share that their efforts help drive our overall Net Promoter Score to its highest level ever in the second quarter. Thank you again for all that you do for ADP and for our clients. And now, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll provide more color on our results for the quarter, as well as our updated fiscal 2024 outlook. Overall, we reported a strong second quarter, with our consolidated revenue growth moderating in line with our expectations, and our adjusted EBIT margin coming in slightly better than expected. However, the interest rate backdrop has changed since we last provided our full-year outlook, and we are lightly tweaking our outlook, which I'll detail. I'll start with Employer Services. ES segment revenue increased 8% on a reported basis, and 7% on an organic constant currency basis, coming in slightly ahead of our expectations. As Maria shared, we continue to grow our ES new business bookings, resulting in a record second quarter bookings volume. Our small business portfolio and international business provided outsized growth contributions this quarter. And with a steady HCM demand environment and healthy pipelines, we feel on track for our 4% to 7% new business bookings growth outlook for the year. As mentioned earlier, our ES retention declined slightly in Q2 versus the prior year, but again exceeded our expectations. Given our first half retention outperformance, we are increasing our full-year retention outlook slightly. We now anticipate a 40 to 60 basis point decline in our full-year retention, which is 10 basis points better than our prior forecast. ES pays per control growth of 2% in Q2, was in line with our expectations, and we are maintaining our 1% to 2% growth outlook for the full-year. And client funds interest revenue increased in line with our expectations in Q2, as a slight decline in our average client funds balance, which we discussed last quarter, was more than offset by an increase in our average yield. However, we are revising our full-year client funds interest outlook lower to reflect the change in prevailing interest rates since our last update. We now expect fiscal 2024 client funds interest revenue of $985 million to $995 million, and we expect a net impact from our client funds extended investment strategy of $835 million to $845 million, representing a reduction of about $20 million at the midpoint. In total, there is no change to our fiscal 2024 ES revenue growth forecast of 7% to 8%. Our ES margin increased 170 basis points in Q2, driven by both operating leverage and contribution from client funds interest revenue growth, but reflecting the impact of a reduced client funds interest revenue forecast, as well as a slight increase in expected GenAI related spend, we are tweaking our fiscal 2024 ES margin outlook and now anticipate the lower end of our prior margin range. Moving on to the PEO, we had 3% revenue growth, driven by 2% growth in average work site employees in the second quarter. These metrics were in line with expectation, and we are encouraged to see signs of stabilization in our PEO pays per control growth. As Maria mentioned, our PEO new business bookings were very strong in Q2. With continued healthy activity levels, we continue to anticipate a gradual ramp in our work site employee growth in the back half of fiscal 2024, and we are maintaining our full-year growth outlook of 2% to 3%. PEO margin decreased 50 basis points in Q2. As we shared last quarter, we assume this year's workers' compensation reserve release benefit will be lower than last year's benefit, and we are further narrowing our PEO margin expectation to be down 80 to 100 basis points in fiscal 2024 versus our prior expectation of decline of 50 to 100 basis points. Putting it all together, there is no change to our fiscal 2024 consolidated revenue growth outlook of 6% to 7%. With the two changes to segment margin, we now expect our adjusted EBIT margin to increase by 60 to 70 basis points versus our prior outlook, for an increase of 60 to 80 basis points. We continue to expect an effective tax rate of around 23%, and we still anticipate fiscal 2024 adjusted EPS growth of 10% to 12%, with the middle of that range the most likely outcome given current assumptions. Thank you, and I'll now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] We'll take our first question from Mark Marcon with Robert W. Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey, good morning, and congratulations on all the accolades that you've gotten from the third-party reviewers. I'm wondering if you can talk a little bit about some of the initiatives. And specifically, one that stood out was the - was setting up your own trust. Can you talk a little bit about the investment there and how we should think about how that would end up unfolding? And what do you think some of the reactions would be with some of your third-party partners? Like, you've got bank partnerships and CPA partnerships and obviously benefit administration partnerships. How do you think they'll end up reacting? Thank you, Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Mark, and good morning. Appreciate the question and appreciate your well wishes on all of our recognition. Certainly excited to see across the board the recognition we mentioned during the prepared remarks, but also the continued momentum across all of our initiatives. Happy to comment on retirement trust services. It is really a demonstration of our scale. And so, when I think about what it means to our clients, what it means to the ecosystem that you mentioned, banks, CPAs, I think it's all incredibly positive. And trust services are a core component of any 401(k) plan. Given the size and scale of our retirement services business, what we found is that the pool of what's known as third-party trustees, if you will, that are capable of handling a business just of our size, is actually becoming shrinkingly more difficult, if you will, in terms of the number of providers that are able to offer standalone trust services to a retirement offering of our size. So, in terms of that, we made the decision to launch our in-house trust services. We believe that this is a great value to our clients, to the ecosystem. It puts us on par with other industry leaders and the financial services, and really a competitive advantage against some of our HCM competitors that continue to leverage these third-party trustees. So, for us, I think it's a big commitment to the business that we have, the retirement business that is, which really can matter to financial advisors, and as you said, CPAs and banks. Really by taking the trust services in-house, the implication is that we have better control over our costs. Ultimately, that yields a better price for our clients, a better service. We also have the ability to maintain all of the data inside of ADP's ecosystem, which as you know, is a big component of who ADP is in terms of data integrity and all those things. So, that's kind of the retirement trust services in a nutshell, Mark."
},
{
"speaker": "Mark Marcon",
"text": "Terrific. thanks for that. And then just, it was noticeable that you basically are anticipating a lower level of decline in terms of the ES retention, which is coming off of record levels. To what extent is that due to an anticipation of lower levels of bankruptcies as opposed to just the improvement that you've been seeing in terms of your client service scores?"
},
{
"speaker": "Maria Black",
"text": "So, retention is going incredibly well, right? And we mentioned that in the remarks. Year-to-date retention has definitely been better than we expected. And so, I think things are fundamentally really healthy right now. One thing to keep in mind as kind of think about the outlook, is that we are, as you mentioned, we are coming off of some of the record highs that we've seen over the last several years. And while we believe that from specifically a down market perspective, we're close to being normalized back to fiscal 2019 trends, we do also anticipate some pressure in the back half from perhaps out of business and bankruptcies having more of a material impact. We haven't seen it to date, but we certainly want to ensure that we're cognizant of the fact and we believe it's prudent - given that we have retention running at such record levels, we believe it's prudent to plan for it in the back half to have some pressure. And obviously, just like any year, Mark, retention is always noisy until we have some normal variability and conservatism in the back half. Just like you, I'd like to think that there's opportunity there. I think only time will give us the answer to that, but that's kind of how we're thinking about the back half."
},
{
"speaker": "Mark Marcon",
"text": "Really appreciate that, Maria. Thank you, and congratulations."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you very much. Appreciate all the detail this morning. I wanted to quickly just touch on PEO. You called out a strong acceleration in the business, but it looks like outlook for revenues was changed - you may have mentioned that, but I'm just trying to capture how much of that is timing issue versus the concentration you have in professional services and technology, which still seem a little bit soft, at least in the employment reports."
},
{
"speaker": "Don McGuire",
"text": "Yes, James, thanks for that question. We've been happy to see the stabilization in the pays per control in those sectors, the financial services and technology sector. So, although there's still a little bit of noise there, it's certainly stabilized from what we saw in the prior quarter. So, that's positive. I do think that as we looked at our sales results, our bookings for PEO, we were very happy with the bookings. Maria mentioned that already very good. I think as we kind of put those together, the improvement in the pays per control and the improvement in our bookings, I think we're going to be heading towards that re-acceleration that we've been pointing to over the last couple of quarters in the PEO. But really just trying to get the impact of those two components, those variables, is really what's going to help us get that re-acceleration going."
},
{
"speaker": "Danny Hussain",
"text": "And James, just to clarify, the pays per control, although it’s stabilizing, it's not providing any sort of upside versus our prior forecast. So, bookings are going well. It takes a quite a bit in terms of bookings to really drive a material change to the current year revenue, which you well understand. With pays per control still providing sequential, gradual drag, those two are sort of netting out to an inline outlook."
},
{
"speaker": "James Faucette",
"text": "Got it. Thanks for that, Danny. And then quickly on AI, it seems like there's a little bit of incremental investment there and certainly a big focus on this call, but wondering about how we should think about the - how you're anticipating a return on that investment and over what kind of timeframe. And maybe more qualitatively, what kinds of paybacks, whether it's increased customer satisfaction or internal operations, et cetera. Thanks."
},
{
"speaker": "Maria Black",
"text": "Yes, so I'll start on the on the AI side and tell you all the reasons again that I'm so excited about it. Maybe Don can give you a little bit about how we're thinking about the return on investments that we're making. So, just to remind everyone how we're thinking about AI, in its most simplistic way, I think about it really in three buckets, the first of which is product and innovation. So, putting generative AI into all of our innovation cycles. So, that's everything from product development to the features and functionality that I mentioned in the prepared remarks. And by the way, later this morning, we're actually issuing a press release that goes through some of our product and innovation, call it, philosophy and launches of products, right? So, some of what this press release speaks to is how we're thinking about and our design principles around making things easy, smart, and human within our product and innovation cycles to really drive things like payroll assist, things like ADP Assist into the market in a meaningful way. So, product is really kind of the first bucket. And as you'll see, we're making significant investments there. We do have ADP Assist now more broadly deployed across the product set, and we're seeing meaningful impact as it relates to our client experience on that. The second bucket is what I call efficiency and service efficiency. And this is really about giving all the same things that we're looking to give our clients to make their jobs easier and more effective and efficient, and giving those same tools to our associates. And so, we have Agent Assist. I'm pleased to say that from an Agent Assist perspective, we've more than doubled the number of associates today that are engaging in AI tools overall. Specifically, a big piece of that is anchored in Agent Assist and the things we're doing around call summarization. Again, I'll let Don comment on investments and return, but just to kind of give you a flavor of what we're talking about here, the feedback we're getting from our associates is, there are times we're shaving off a minute or two minutes by aiding things like call summarization. And while that probably seems minuscule, what I would offer to you is we have thousands of service associates, and we also have millions and millions of calls that we take every single year. And so, we're pretty optimistic and excited about a minute here and a minute there, and what that means from an incremental opportunity for us over time, right? So, we continue to lean into our service efficiency and really getting all of our associates more effective as it relates to their ability to engage with our clients. And then last but not least - by the way, I could go on and on and on all day on this topic, but last but not least and very, very important is how we're thinking about generative AI in our go-to market motions. And so, we have for years been at the tip of the spear of sales modernization. We have partnerships that are two decades old where we've always been leading the way with what it looks like to have a best-in-class modern distribution and sales force, and this is no different for us. So, we already have a broad set of our sellers leveraging tools along the lines of Generative AI, many of which are through our best-in-class vendors and partners that we have, and we're seeing great impact there. Things that I used to do myself at a personal level manually, such as pre-call planning, by the way, things like call summarization for prospecting, these are big items for us as it relates to our go-to-market motions, and we've just started scratching the surface. So, all in, really excited again. Just to kind of wrap it all up, I think it's about product, service efficiency, and our go-to-market motions. We are making active investments. Some of those investments are things that we've shifted that we were already working on in digital transformation. Some of it is incremental investments. And so, I think with that, I'll turn it over to Don who can kind of talk about how we're thinking about our incremental investments and moreover the return on that."
},
{
"speaker": "Don McGuire",
"text": "Yes, so I think Maria just outlined some of the exciting areas that GenAI will have for us and some of the things that'll change, how they'll make the client experience better, how they'll help our associates, how they'll help us sell more, et cetera. But I would say at this point in time, what we're really talking about is some modest investments in GenAI. I think it's going to be a little while before we start to see returns from those things, but we certainly do anticipate returns. But in the near term right now, it's really a time for investing in these tools, et cetera, and we'll see those outcomes, those financial outcomes somewhere down the road."
},
{
"speaker": "James Faucette",
"text": "That's great. Thank you both very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi there, and thanks for taking my question this morning. You guys called out higher seller expenses as just one component of the margin headwinds in PEO. I guess the question, is this just the cost to compete in PEO at this point? In other words, is it becoming more expensive to compete in PEO, or do you expect expense levels related to selling to sort of abate in a more normalized time period?"
},
{
"speaker": "Don McGuire",
"text": "Yes, I don't think there's - just to answer the question, there's nothing really unusual or fundamentally different about our selling expenses and how we go-to-market in the PEO. I think certainly as we see higher sales, as you know, we get a lot of our sales, half of our sales, give or take, from internal. So, some of that's a little bit of our internal housekeeping if you will, how we allocate expenses between business units, et cetera. But higher sales generally translate into higher selling expenses. So, really nothing fundamentally different in how we go-to-market. Certainly, not seeing any fundamental differences in the competitive landscape that's driving those expenses."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. Okay. And then one follow-up for me. In the context of the international product launches like Roll in Ireland, and also I guess the partnership you guys just announced with Convera, can you comment on the international value proposition itself, whether it's sort of largely the same as it is in the US, or are there distinctive products, needs, partnerships required in these markets that you guys sort of still need to build out to more fully execute on the international opportunity?"
},
{
"speaker": "Don McGuire",
"text": "Yes, I'll start, and Maria can add here in a second. So, as you know, you look at our revenue as - international revenue as a percentage the total, and it’s not where we'd like it to be, even though roughly 40% of the people we bear around world are in international. So, and the reason for that is that we have fundamentally different offers in the US. We have things like PEO. We also have money movement services, tax services, pretty much broadly distributed. Some of those offers don't have the same value proposition outside of the US market. So, our opportunity there is not quite the same. Perhaps it will be as time goes on, some of those services may be available in other markets, but as we speak today, they're not there. The value prop isn't the same. With respect to Convera as a partner, just to speak to that one a little bit, we have thousands of clients, and those thousands of clients have thousands of entities spread across multiple countries around the world. And if you think about the complexity and the difficulty of paying their people in some of these small countries and then getting the payments to the various social security providers in those countries, having somebody like Convera who can help a large European or a large US multinational manage the treasury function in those small countries around the world without having to set up all the banking, et cetera. So, someone like Convera acts as a great partner for us to facilitate those cross-border payments in a very - in a compliant way, et cetera. So, I think that's very positive for us. So, we do have some partners in international like Convera as I just mentioned, but we still see it as a great opportunity for us to continue to grow."
},
{
"speaker": "Maria Black",
"text": "That's right. If I may, one of the things, I think what Don is suggesting is really the opportunity we have with international. And so, when you put it in the context of the business that we have in the US there, there is a tremendous opportunity for us to think more broadly in international partnerships as the one Don just outlined with Convera, is a big piece of that. What I would also add is that from an international perspective, we did call out the performance specifically in Q2 on international. That's, by the way, bookings. That's on the heels of a solid Q1. What I would offer as well, we have record retention. We have record customer experience and client experience in international. So, I think we have a tremendous value proposition in international. By the way, some of the recognition I cited during the prepared remarks is really about how best-in-class our offer is with respect to the international offering we have. So, that said, as Don mentioned, we're not satisfied. I think there's more opportunity to us to scale and grow our beyond payroll offerings, partnerships that are a big piece of that, but undoubtedly, we're performing and competing very, very well internationally."
},
{
"speaker": "Ramsey El-Assal",
"text": "Fantastic. Sounds like good things ahead. Appreciate it."
},
{
"speaker": "Maria Black",
"text": "Oh, you know what, let me just comment because you mentioned Roll in international, so I just thought I'd mention that really quickly, which is, we are very excited about the down market in international. Roll is one way that we're getting after that. And the pilot programs that we're running are teaching us a lot as we think about the down market and international."
},
{
"speaker": "Ramsey El-Assal",
"text": "Okay, perfect. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi guys, congrats on the solid results. Don, I just wanted to ask about average balances. I know we were expecting a little bit of a headwind from the payroll tax deferral. Maybe you can quantify that as part of the reason for the drop of balances down 2%. And then what's the go forward there we should expect? Is there a more of a headwind from the payroll tax deferral for balances and maybe expect a similar decline in the back half of this year?"
},
{
"speaker": "Don McGuire",
"text": "No, I think you were right to call out the payroll deferral, payroll tax deferral. That definitely was behind the decline quarter-to-quarter. We don't - that's now behind us. So, that's not going to be there. So, we are expecting 2% to 3% balanced growth throughout the balance of the year. So, we think that's very positive. I think the big callout though on the whole CFI program is just the fact that since we spoke last, five-year and 10-year interest rates are down about 80 bps on both of those. And so, I think that's a little bit of the headwind and that's roughly the $20 million or so that we're calling down the float number for the balance of the year. But still very optimistic about growth. Certainly, the reason that it's not growing as quickly perhaps as it did last year, we've certainly seen some moderation in wage growth, and we've talked about even though pays per control are behaving as we expected, they are certainly lower - pays per control growth is lower than it was in the back half, but will be lower in the back half of this year than it was in the back half of last year. So, those would be the major influencers, if you will, to the full balance as we go forward to the back half."
},
{
"speaker": "Bryan Keane",
"text": "Got it. And is that part of the moving of the ES margins to the lower end of kind of the range you talked about? I think you talked about rates there. Just what was the surprise from three months ago on rates that that maybe caused you to push the margins towards the lower end or where you think the lower end, the new margin range?"
},
{
"speaker": "Don McGuire",
"text": "Yes, so, you're right. I think the float certainly is a component of us guiding to the middle of our range, for sure. So, that's a component. We don't try to second guess the markets. We use yield curves that are out there in the market to estimate what we think our returns are going to be. So, no real surprises, other than seeing what's happening in the overall market. And then we're taking the forward yield curves and applying those to our balances, and that's where we land."
},
{
"speaker": "Bryan Keane",
"text": "Great. Thanks for taking the questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Great, thanks. Good morning, guys, and thank you for taking my questions. Maybe just wanted to start off on some trends that we've seen so far in the selling season. Seems like through 2Q it was pretty positive on the booking side, but maybe wondering how we've sort of tracked into 3Q, and then also what you've seen maybe from competitors, any changes in pricing, go-to-market strategy and all that would be helpful."
},
{
"speaker": "Maria Black",
"text": "Yes, good morning, Scott. We feel good about the demand environment overall at this point. I think companies are still hiring. We saw that this morning actually as well. And companies are still investing in their people, their talent. They're investing in HR. I think there are a couple things I'd highlight to you. The down market, definitely companies are continuing to hire and they're continuing to buy. We had tremendous second quarter results. By the way, that business has been executing incredibly well really for many, many quarters. And that's our run offering, but it's also all the things that are attached to run. So, think insurance services, retirement services. All of the down market is doing incredibly well. To give you a little bit of a line of sight, because it is the 31st of January, so we do actually have a tiny bit of visibility specifically to the down market. And you asked about trends into the third quarter. What I would offer to you is January looks good. I think we're actually on track to onboard something close to like 30,000 units in that business alone in the month of January. And so, that's the size of some companies, if you will. So, it's pretty incredible to see the execution in the down market. We have solid pipelines really across the mid-market as well as off-market. The mid-market did incredibly well in the second quarter. From a competitive standpoint, I think we get a lot of questions around the competitive landscape. Has it shifted in the mid-market? What I would offer to you, it hasn't really shifted. It's been a competitive space per us for a long time. It's an area for us that we're executing very, very well. We have best-in-class products. We continue to take friction away from our clients, make it easy for our clients to engage with us. We know this based on our results and retention. We know this based on our results and record NPS. We had good bookings in the mid-market. So, I think the mid-market is solid and certainly not getting any easier for our clients to be employers in the mid-market. As it relates to the international space, I think I covered that already, so I won't touch much more on international, but a good Q2 on the heels of a good Q1. And then in our enterprise and upmarket space, this is an area that has normally, I think it's kind of the new normal on longer deal cycles that have more individuals involved in those cycles. We're paying close attention to it and certainly all the things that are happening kind of across that space. But I would suggest to you that we feel relatively solid about our pipelines and our ability to bring that business in the back half."
},
{
"speaker": "Scott Wurtzel",
"text": "Great. That's helpful. And just a follow-up for Don, just on the float income guidance, sort of noticed a pretty notable increase on your outlook for the client short portfolio. So, just wondering if you can maybe give a little bit of color on sort of the changing geography on those investments for the balance of the year. Thanks."
},
{
"speaker": "Don McGuire",
"text": "Yes, so maybe let me clarify that for you a little bit. So, really, we haven't changed our investment strategy at all. What we have done is we've tweaked a little bit the way we're going to - we were borrowing funds in the market day in, day out. So, what you're seeing is, we're actually entering the market a little bit early. So, instead of borrowing everything we need to on a peak borrowing day, we've simply spread the borrowing out over two, three days so that we can tap the market in a more - in a smoother way, if you will. And I think if you're looking at the average balances on that - on the appendix sheet that's in the release, you'll notice that that number's gone up in the short fair bit, but that's the driver. So, it's not a change in our investment strategy at all. It's just a change in a bit of a tweak in the way we're actually borrowing funds in the market when we need larger amounts of - when we have larger amounts of borrowing."
},
{
"speaker": "Scott Wurtzel",
"text": "Great. Thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. First question I had is on EBIT margin. Can you comment on what drove the outperformance versus your view for that to be down I think in 2Q? I'm curious if that was an aspect of timing within the year versus better-than-expected efficiency. And I think, Don, I heard you mentioned some GenAI investments to come. Is that incremental spend versus the prior plan?"
},
{
"speaker": "Don McGuire",
"text": "So, yes, let me start - Bryan, let me start with the first part of your question. So, there was a little bit of modest revenue outperformance in the quarter. So, I think that was a contributor to the margin. And then we had some expenses. We always have focus on expenses. There's a few things, a little bit of bad debt, a little bit of headcount, et cetera, and perhaps a little bit of timing, but nothing significant to really call out as a contributor. In terms of the GenAI spend, yes, we are spending a little bit more than we said we were going to last quarter. So, we do have a bit of incremental spend. It's not a huge amount, but I know that lots of folks like to measure things in 10 bps. So, we are calling it out. Not an incredible amount, but a little bit more than we had said in the prior quarter."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. And then just I guess a follow-up then on GenAI and ADP Assist here. Is that a feature you're able to monetize directly or more so kind of an enhancement you're offering for free to drive the CSAT stores higher? And I guess understanding you're leaning into these developments, do you kind of view it - when you think about the monetization of GenAI products, is this a near-term dynamic or more so kind of feature and product differentiation that's a longer term monetization dynamic?"
},
{
"speaker": "Maria Black",
"text": "So, Bryan, ADP Assist is really the overarching, call it, brand, if you will, that we're leveraging to talk through all the things that we're putting into our product to make things easier. The way that I think about it is it’s really just the next phase of digital transformation for ADP using new tools and technology. So, said differently, our intention is not to charge to make things easier for our clients to do business. That is our commitment to our clients, always has been, is to make it as easy as possible to process payroll, to have accurate payrolls. And so, it's not a monetization effort as it stands. It's really about just leveraging the new technology to step change the digital transformation that we've had underway candidly, for many, many decades since the dawn of the computing era. So, that's kind of how we're thinking about ADP Assist. In terms of monetization in general, do I believe there's monetization as it relates to GenAI? Of course. I think it’s more about the dollar long term, right? So, I think about it - the dollars that we're putting in today will yield multiple dollars for us in years to come. So, there will be distinct monetization opportunities as we create new products into the market, as we think about various things of that nature, perhaps features and functionality. There will also be gains in sales and retention that will lead, in my mind, to investments that are proven today in GenAI to drive incremental bookings and retention over the long term. So, I think it's about putting a dollar in today with the belief that it will yield many dollars of margin to come, if you will, as well as bookings, et cetera."
},
{
"speaker": "Bryan Bergin",
"text": "Okay, understood. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning. Thanks for taking my questions. Maybe on the PEO business, I was curious, I know you guys called out some of the bigger verticals inside of the PEO business and that there's maybe some more softness there than you'd expected in technology and professional services. Any change in the exposure rather inside the PEO business or within like the big verticals? Are you guessing any change in the trends that you saw maybe over the last couple of quarters?"
},
{
"speaker": "Maria Black",
"text": "The trend in specifically professional services has stabilized. And so, I think Danny made the comment earlier, it's no longer contributing to the deceleration. So, it used to - the professional services cohort used to contribute to the acceleration of pays per control, then we found ourselves where it was contributing to a deceleration, and it's largely stabilized at this time."
},
{
"speaker": "Samad Samana",
"text": "Got you. And just as you think about the pricing environment, I know that we're still not at when the company does the annual price increases, but as you think about maybe for new deals or for new customers that are onboarding, any change in the kind of price pressure or competitive nature of what your competitors are offering in terms of discounts or what ADP's is having to offer? And just as we look ahead to price increases, how are you thinking about this year's price increases?"
},
{
"speaker": "Don McGuire",
"text": "Yes, we're not really seeing any changes, Samad, in the price environment, the competitive environment. We think we're priced appropriately, and we've always acknowledged that we're a little bit of a premium to others. But we're happy with that because we think we offer better service and stability, et cetera. So, no real changes. You're right. It is a little bit early. The budget cycle kicks off here in the next six, eight weeks or so, and we'll certainly be looking at the pricing increases for next year and weighing all the regular factors, what's inflation been? We thought our price increases were very well received last year. We thought they were in line. So, we'll keep that in mind. But as always, we're always interested in the long-term value prop with our clients and being competitive in the market. So, we're always measured, I believe, when we think about the price increases that we do hand out to our clients."
},
{
"speaker": "Samad Samana",
"text": "Great. Appreciate you taking my questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin Mcveigh with UBS. Your line is open."
},
{
"speaker": "Kevin Mcveigh",
"text": "Great. Thanks so much. Maria, I think you talked to kind of implementations a little bit. Can you remind us maybe what percentage of the revenue is done internally on implementations today, and if that's a shift philosophically, what that can be over the course of time? If I heard the remark right. Maybe I picked it up wrong, but just any incremental thoughts on that?"
},
{
"speaker": "Don McGuire",
"text": "Yes, I'll maybe - Kevin, you're a bit soft by the way, but you're a little bit hard to hear, but I think the question was what kind of revenue we derive from implementation, and is that …"
},
{
"speaker": "Kevin Mcveigh",
"text": "Yes."
},
{
"speaker": "Don McGuire",
"text": "Yes, so it's not a substantial. Sub 10% of our overall revenue comes from setup - we internally call it setup fees. So, it's not a substantial amount."
},
{
"speaker": "Kevin Mcveigh",
"text": "And then do you see that - Don, over time, does that become less if you outsource that? And is there any way to think about the margin impact from that initiative?"
},
{
"speaker": "Don McGuire",
"text": "Well, I mean, you also - so, no, I don't think there's a big opportunity there. We certainly have had conversations. We certainly have lots of folks who would like us to outsource our implementation because they think it's a revenue stream for them. We like to have that control over the client from sale-through to go live in service. Not to say that we won't work with third parties to help us from time to time, which we do. But it's really not that large a factor. Certainly, there's some money there to be had, but it's not that large a factor in the overall scheme of things. There's also some interesting accounting, of course, around implementation and setup fees and the deferral over the terms of the contract. So, once again, it would take a lot of changes to do anything, make any changes to the bottom-line financials in the near term."
},
{
"speaker": "Kevin Mcveigh",
"text": "Helpful. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang with J.P. Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thanks so much. Good results here. Just want to dig in on your prior comments. I know a lot of people asked on PEO and the healthy activity there and the confidence in the acceleration. Is ADP doing anything differently, or is industry demand changing? I understand it’s not - it doesn't sound like there's a cost of pricing change there. So, I just want to make sure I understood that. Thanks."
},
{
"speaker": "Maria Black",
"text": "Yes, good morning, and thank you. I am happy to talk about PEO bookings. I think as mentioned in the prepared remarks, we're very pleased with our PEO bookings. This really is the fourth quarter that we've seen positive PEO bookings momentum, and the Q2 specifically exceeded our expectations. Most of the pressure that we felt in the PEO has been a byproduct of kind of the pressure on pays per control and having to overcome that, which is why the focus on bookings has been so paramount for us. And certainly, we deliver that in the second quarter. In terms of from a demand perspective, I speak about the PEO all the time, as you know. I think the demand continues to be incredibly strong. I wouldn't suggest that there's anything unnatural that we are doing outside of a tremendous amount of focus across the enterprise to ensure that we're executing on the PEO booking side. But in terms of anything unnatural or demand changing, I think the value proposition, as I always say, is stronger than it's ever been. I think clients in that space are looking toward ADP to help them from a PEO value proposition. So, everything from payroll to benefits to navigating the complexity of being a business and having the ability to execute on a co-employment relationship. So, I would say the value proposition is as strong as it's ever been. I think it remains strong. The demand is there. The organization is focused on PEO bookings as an execution lever for us. And I'm pleased to see that we did just that in Q2, and we've really had - this marks the fourth quarter of positive bookings momentum from the PEO."
},
{
"speaker": "Tien-Tsin Huang",
"text": "No, that's great. Thank you, Maria."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi, this is Caroline (indiscernible) on for Jason. Thanks for taking our question. So, pays per control growth has been 2% quarterly through the first half, but the guide for full-year 2024 is still 1% to 2%. So, what are the drivers of the second half deceleration, or do you think that the high end has become more likely?"
},
{
"speaker": "Don McGuire",
"text": "Caroline, thanks for the question. We said we would go to - we'd be 1% to 2% for the year, and we certainly have that 1% to 2% range still in the back half. We're not really anticipating any slowdown in pays per control, but we certainly have it built in. So, perhaps we're a little bit conservative there. But as we sit here today, the employment demand continues to be robust, although still declining somewhat, but I think we're confident that in the back half, we're going to be declining a little bit, but still coming in on that 1% to 2% range for the year. Not really much more to say there other than employment demand, labor markets continue to be maybe a bit softer than they were, but as we saw this morning in our NER report, hirings still out there, still good growth. So, not a lot of extra color, I don't think, to add around pays per control."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hey, guys, great results here. Just a strategic question, obviously if you look over the next 12 to 18 months, interest rates are coming down. There is a big debate out there on the ability to offset some of those headwinds in terms of revenue. Can you talk about maybe some idiosyncratic initiatives that you could do to offset the headwind from declining interest rates? Thank you so much."
},
{
"speaker": "Don McGuire",
"text": "I think that's really a macro question. I guess the macro answer to that would be that if interest rates start to decline, we'll see an offsetting increase just in economic activity. And if we see that increase in economic activity, we should see revenue go up. We should see bookings opportunities go up, et cetera. So, I think that if interest rates come down - and there's lots of debates, whether it's two cuts or four cuts, et cetera, who knows, but if they do come down, we should certainly avoid the recession. Nobody's asked about a recession on the call today, so thank you. I think the consensus is that there's not going to be a recession. So, certainly any of the polls suggest that the economy's healthy with 3.3% GDP growth in the last report. So, if rates come down, the economy should remain healthy, and a healthy economy should help continue to contribute to our growth."
},
{
"speaker": "Danny Hussain",
"text": "Dan, I'll just add also, our model involves reinvesting further out in the yield curve, and as you know, we're still reinvesting at higher rates than what's embedded in the securities that are rolling off. So, even if we do start to see short-term interest rates fall next year, which is obviously consensus at this point, a lot of that will be offset by the reinvestments that we have further out in the yield curve. And so, it's too early to be talking specifically about the interest rate outlook for next year, but we would just recommend you keep that in mind."
},
{
"speaker": "Don McGuire",
"text": "Yes, that's fair. I think if you look at our reinvestments, our current reinvestments are still at 4%, which is higher than our average yield today. So, there still are opportunities. Our float is expected to continue to grow over the next 12, 24 months. Certainly, it's going to grow a little more slowly than we would've expected at the end of last quarter, but there's still upside from float, which is perhaps not as much upside."
},
{
"speaker": "Dan Dolev",
"text": "Great. Great results, again. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"text": "Thank you. Good morning. Two questions. Now that we fully lapped ERTC, I'm just curious if you've noticed any changes in client demands or competitive tactics, particularly in the down market?"
},
{
"speaker": "Maria Black",
"text": "Yes, good morning, Pete. The ERTC, as you know, and I think what you're referencing is the new deadline that was pulled forward five quarters actually. So, the deadline actually as it stands is potentially today. I think we're still waiting for the final kind of execution, if you will, of that new deadline. But arguably, we're having to execute on behalf of our clients with today in mind. And so, there's a tremendous amount of volume that we are pushing through on behalf of our clients, and it has put pressure into the system, which is hard to watch and witness, by the way, as it relates to the very clients that are supposed to be helped by this and the challenges that they're facing trying to navigate it. So, we're doing everything we can in our power to help and process these claims. In terms of financial impact for us as it relates to ERTC, it isn't a financial impact to us. I think it's very de minimis as it relates to our overall revenue, as it relates to our overall incremental. We really, from a standpoint of what we're looking toward, it's about supporting our clients. And so, I think some of our competitors have used it more as a business and a revenue than us as it relates to how we're thinking about it. But undoubtedly, the advancement of this deadline to today has not been ideal for really anyone engaged in it."
},
{
"speaker": "Pete Christiansen",
"text": "That's helpful. And then I'm curious, the combination of HCM and payments functionality, has certainly been a theme. EWA is obviously a big portion of that and now cross border. Do you see opportunities to increase penetration there or to add more capabilities either through partnership, M&A, furthering payments, and I'm thinking perhaps even like in disbursements, those sorts of things? Thank you."
},
{
"speaker": "Maria Black",
"text": "From a strategic standpoint, Pete, what I would offer is continuing to solve for our clients and employees and how they engage with us. If you imagine across ADP, we pay 41 million wage earners in the US. That's 25 million. I think last time we talked about our Wisely offering, what we disclosed was that we had 1.5 cardholders or something like that. So, to just kind of give you the opportunity scale of it, we believe there's tremendous opportunity to increase how we're engaging with our clients, whether that's through the likes of Wisely, it's through the likes of EWA, as you're suggesting, or it's any other type of payments and things that we can do to make it easier for our clients and employees to move through the world of work, right? And so, the way I think about it and the partnerships that we're actively out there in the market talking to and thinking about, anywhere we can add value in our clients and employee life and flow. So, as they move through their day and they clock in through ADP's mobile app, which by the way, we have 10 million users that are actively using our ADP mobile app, so as they're engaging with ADP, are there opportunities for us to insert value there? Whether that's things like EWA, it's things like payments, it's things like financial and wellness apps like the companion app we have through Wisely. These are all top of mind for us as we go through our strategic discussions and as we think about partnerships in the future for ADP."
},
{
"speaker": "Pete Christiansen",
"text": "Thank you so much. Super helpful."
},
{
"speaker": "Operator",
"text": "Thank you. We have time for one last question, and that question comes from Ashish Sabadra with RBC Capital Markets. Your line is open."
},
{
"speaker": "Ashish Sabadra",
"text": "Thanks for taking my question. So, just a multipart question on PEO and following up on some of the commentary earlier on solid bookings and moderating PPC, sorry, paper control headwinds. As we look at the WSC growth, we have continued to see a sequential improvement there, better than what we saw last year. And just given the commentary, is it fair for us to assume that we should continue to see that improve as we go through the year? And then on revenue per WSC, I was wondering if you could comment on, looks like pricing trends are positive, but if you could comment on any other puts and takes participation, anything else that could help drive better revenue per works at employee. Thanks."
},
{
"speaker": "Maria Black",
"text": "So, the answer to your question is, yes, we do expect that the booking contribution, coupled with a bit of stability on the pays per control side, coupled with retention getting more favorable on the back half, all of those things should lead to the re-acceleration that Don mentioned earlier, that we've been pointing to in the back half. I think in terms of other componentry within the PEO, you mentioned a few of them. There's payroll per works on employee. There's workers' compensation. There's State unemployment. Some of these things are things that we're still waiting to really see the outcomes. I'll give you an example. One of those is State unemployment in terms of - obviously, we sit here today forecasting what that looks like. Most of those rates are issued throughout this quarter. And so, while we have some line of sight, in the end, we don't know entirely what the State unemployment outcome - we do expect that it creates a little bit of a - rates are going down year-on-year again this year. But again, only time will tell. Sometimes the States, as an example, make very strange decisions that aren't always in line with what's happening from a broader labor and unemployment perspective. So, all that to say, I think - I don't know that I could sit here today and give you any componentry that seems strange or out of the norm. I think they're all things we're watching as we look toward the re-acceleration in the PEO in the back half."
},
{
"speaker": "Ashish Sabadra",
"text": "That's very helpful color. Congrats on the solid results."
},
{
"speaker": "Operator",
"text": "Thank you. I'd like to turn the call back over to Maria Black for any closing remarks."
},
{
"speaker": "Maria Black",
"text": "Yes. So, really quickly, I think I'll end with how I ended my prepared remarks, which is a huge shout-out to all of the associates and the entire ecosystem across ADP. So, that's ADP associates, partners, channels, all of the stakeholders that really contributed to what was a good, solid Q2, but also a good, solid first half. I'm really excited about the back half and what we'll accomplish, not just in fiscal 2024, but moreover in calendar 2024. It's a time and it's an exciting year for ADP. This year is the year that we actually round our 75th anniversary. And then when I think about who this company is over the last seven decades and 75 years, I can't wait to see what we're going to do in the next 75. So, look forward to sharing in that celebration with all of you as we head into 2024 together. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does include the program and you may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 1 | 2,024 | 2023-10-25 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session, instructions will be given at that time. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain: Thank you, Michelle, and welcome everyone to ADP's first quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Danny, and thank you, everyone for joining us. This morning, we reported strong first quarter results, including 7% revenue growth and 12% adjusted EPS growth, and we made significant progress on the three strategic priorities we shared with you last quarter. Let me begin by quickly reviewing some of our financial highlights from the first quarter. We had a solid start to the year in Employer Services new business bookings with record-level volume for first quarter which was supported by a particularly strong September. Among our best performers were our small business portfolio and our compliance-oriented solutions. Overall demand in HCM has remained steady and we maintained a healthy new business pipeline at the end of the quarter across our business. Our Employer Services retention rate once again exceeded our expectations. Although, retention declined slightly versus the prior year, including in our small business portfolio, we continued to see resilience among our clients. More importantly, our overall NPS scores reached a new all-time high, positioning us to stay near these historically high retention levels. Our Employer Services pays per control growth was 2% for the first quarter as our clients continued to add employees at a pace that is gradually slowing. And our PEO revenue growth of 3% in the quarter was relatively stable versus last quarter, reflecting solid PEO bookings performance offset by deceleration in PEO pays per control growth. Don will speak to our updated guidance in a moment, but the demand environment for PEO as well as our other outsourcing services remains healthy. Moving on, we made meaningful progress across all three of our strategic priorities that we outlined last quarter. Let me start with an update on some actions we took in Q1 to lead with best-in-class HCM technology. First, we began embedding Gen AI features into our products. In Q1, we integrated Gen AI into Roll to further enhance its conversational UI and make it even easier for small business owners to quickly obtain customized Payroll and HR guidance. We also began rolling out ADP Assist, which delivers insights and recommendations to make complex HR work simple. We've enabled ADP Assist for select Workforce Now clients, beginning with a Report Assist feature that allows practitioners to easily extract the insights they're looking for. We look forward to continuing to build on the live feature set of ADP Assist to further enhance the experiences of both HR practitioners and employees. We also had some exciting product developments beyond AI. Our clients tell us they need personalized experiences and deep integrations to help them manage the complexity of running a business today. To help address this, we recently launched a new product called API Central, which enables businesses to easily and securely connect their ADP workforce data across systems using pre-populated APIs and tools. This is a feature our clients have increasingly asked for and we have already seen a strong uptake. In Q1, we complemented the launch of API Central with the acquisition of Sora, an intelligent workflow automation and data integration tool. Sora's unique capabilities will allow our clients to automate people processes by unifying various applications such as HR, IT, CRM, and more, creating a smarter and easier-to-use experience for our clients. In Q1, we also launched ADP Workforce Now for construction, a comprehensive offering designed to help clients with the unique payroll and HCM needs of the construction industry. This verticalized offering combines tailored Workforce Now capabilities and reporting with a team of dedicated specialists for the construction industry. While ADP has always served clients across the full spectrum of industries, construction stood out to us as a vertical with enough complexity to warrant a more tailored solution, and we're excited to further strengthen our offering in the mid-market. We also announced the launch of our corporate venture capital fund earlier this month, leading with best-in-class HCM technology requires that we stay attuned to the frontier of HCM innovation. And now, in addition to the organic efforts we are developing in ADP Ventures, we will invest in and partner with early-stage startups to strengthen our core business our core business and to extend into natural adjacencies. Two of our early investments focus on improving lifestyle benefits to drive associate engagement in simplifying the incredibly complex leave management process that businesses and their workers have to address. We're excited to build on these partnerships and develop new ones. Overall, Q1 was a very busy quarter on the product front with much of the work we're doing representing seeds of innovation that will position us to continue shaping the future of work. Our second strategic priority is to provide unmatched expertise and outsourcing solutions. In addition to launching the pilot of ADP Assist for our clients, we also launched the pilot of our new Agent Assist embedding Gen AI in the flow of work for ADP Associates. So far, we have enabled our call summarization capability to select associates. Thanks to this Agent Assist feature, those service associates no longer need to spend time writing up case notes after client calls, which should make our associates more effective and also allow us to quickly aggregate real-time client feedback to continuously improve our products. We are also piloting Agent Assist real-time guidance for our associates to help them with support content and guided workflows and to more easily share their accumulated knowledge in a way that's customized to individual client cases. We are excited to continue working toward additional Agent Assist features to help our implementation and service associates deliver better, faster service and to help our client satisfaction scores continue to reach new record levels. Our third strategic priority is to benefit our clients through our global scale, and in Q1, we expanded on this advantage. In August, we extended our leading global footprint by acquiring the payroll business of BTR, our longtime partner in Sweden. Acquisitions like this strengthen our multi-country payroll ecosystem while also positioning us to grow a local HCM business in countries with attractive growth prospects. In Q1, we launched Roll in Ireland, representing the beginning of an expansion into the European market, where we believe an AI-based payroll app coupled with our existing on the ground ecosystem will allow us to expand our SMB business outside the U.S. And during Q1, we also announced plans to deepen our existing partnership with Workday to deliver enhanced global payroll compliance and HR for the many clients we jointly serve around the world. Partnerships like this reflect our long-standing commitment to provide the personalization and overall experience our clients desire. Before turning it over to Don, I wanted to highlight a couple milestones in two of our businesses. Our suite of workforce management solutions, sometimes referred to as time and labor management, reached more than 125,000 clients in the first quarter, benefiting from a double-digit growth rate these last few years. Scheduling and precisely tracking time has become more important for employers over recent years in order to meet evolving legislative requirements, and we look forward to continuing to invest in our workforce management solutions to drive higher client attach rates. We also now serve more than 150,000 retirement services clients, which is up more than 20% from the 125,000 clients we served at the end of fiscal 2022. We anticipate growth for our retirement services business will remain strong in the years ahead as the provisions of the SECURE Act 2.0 and additional state mandates continue to phase in and as companies of all sizes continue to recognize the importance of positioning their workers well for their eventual retirement. I'm proud of our start to fiscal 2024 with both strong financial results and meaningful strategic progress. Our roadmap for the months ahead is keeping us incredibly busy. And with this in mind, I'd like to take a moment to recognize our associates across sales, service, implementation and technology whose efforts and outstanding performance are positioning us to consistently deliver for our clients and our shareholders. Thank you, all. With that, I'll turn it over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the quarter and update you on our fiscal '24 outlook. Overall, we had a solid Q1 and are not making changes to our consolidated outlook, but there are some moving pieces I'll cover. Let me start with Employer Services. ES segment revenue increased 9% on a reported basis and 8% on an organic constant currency basis, ahead of our expectations. As Maria shared, ES new business bookings had a solid start with especially strong growth in September. The demand environment is stable, our pipelines are healthy, and we are on track for our 4% to 7% growth guidance. Our ES retention did decline slightly in Q1 versus the prior year, but that was slightly better than we expected. At this point, we are maintaining our outlook for a 50 basis point to 70 basis point decline in full year retention, which continues to embed an expectation for small business losses to increase due to higher out of business rates. But if recent trends continue, then we would hope to outperform that range. ES pays per control growth was in line with our expectation in Q1. It decelerated modestly to 2%, and we expect this very gradual deceleration to continue in the coming quarters and are maintaining our outlook for 1% to 2% growth for the full year. Client funds interest revenue increased in line with our expectation in Q1, but we're raising our full year outlook based on the latest forward yield curve, which result in a modest increase in average yield to 2.9% from our prior expectation of 2.8%. We now expect client funds interest revenue as well as the net impact from our client funds extended strategy to be up $35 million from our prior outlook. Meanwhile, the U.S. dollar strengthened, representing a drag relative to our prior fiscal '24 revenue outlook. In total, our strong Q1 ES revenue growth combined with higher than expected client's funds revenue for the rest of the year effectively offset the adverse FX movement and we're maintaining our fiscal '24 ES revenue growth range of 7% to 8%. Our ES margin increased 220 basis points in Q1, driven by both operating leverage and contribution from client's funds interest revenue. For the full year, we are raising our fiscal '24 outlook to now anticipate an increase of 150 basis points to 170 basis points, which reflects the benefit of higher yields, partially offset by higher spend on Gen AI projects and usage, as well as a small amount of dilution from our recent acquisitions. Moving on to the PEO. We had 3% revenue growth driven by 2% growth in average worksite employees in Q1. As Maria mentioned earlier, our PEO bookings growth was solid, but pays for control growth continued to slow and was lower than expected, particularly for clients in the professional services and tech industries. This resulted in a slightly softer Q1 worksite employee count than we were anticipating. As a result, we now expect fiscal 2024 PEO revenue growth of 3% to 4% with growth in average worksite employees of 2% to 3%. Our PEO sales pipelines are healthy and we continue to forecast their worksite employee growth gradually ramping in the back half of fiscal '24. PEO margin decreased 90 basis points in Q1 which is more than we had planned. The decline was primarily driven by a lower workers' compensation reserve release benefit as well as higher selling expenses. We now expect PEO margin to be down between 50 basis points and 100 basis points in fiscal '24 with the continued assumption for higher selling expenses as well as year-over-year headwind from a lower workers' compensation reserve release benefit than we experienced in fiscal '23. Putting it all together, there is no change to our consolidated outlook, but I would like to share some color on cadence. In Q2, our client funds balanced growth will lightly impact the payroll tax deferral that we had in our average balance for the past two years, which creates some grow over pressure on our client's funds balance and will result in more modest ES margin expansion in Q2 than other quarters this year as well as a modest revenue impact. As a result, we expect consolidated revenue growth to moderate before accelerating slightly in the back half. And we expect adjusted EBIT margin to be down slightly before ramping in the back half of the year. This was already contemplated in our guidance at the outset of the year. So again, no change to our consolidated guidance. We continue to forecast fiscal '24 consolidated revenue growth of 6% to 7% with our adjusted EBIT margin expanding by 60 basis points to 80 basis points. We still expect our effective tax rate for fiscal '24 to be around 23% and we anticipate adjusted EPS growth of 10% to 12%. Thank you. And I'll now turn it back to Michelle for Q&A.
Operator: Thank you. [Operator Instructions] We'll take our first question from the line of Samad Samana with Jefferies. Please go ahead.
Samad Samana: Hi. Good morning. Thanks for taking my questions. Maybe first just want to double-click on the PEO side. I think that, the information you gave helps to understand some of what happened in the revised guidance, but maybe just help us understand what's giving that back half ramp confidence, especially, as you expect pays per control in the kind of broader macro to continue to decelerate. Where should we get the acceleration in the PEO WSEs? Is it purely based on bookings ramping? Is it based on an expectation that the base will stabilize? Maybe just dig into that a little bit further because they're moving in different directions.
Maria Black: You bet. So, good morning, Samad. It's Maria here. I thought I'd kind of break down your question with respect to the PEO, call it, double-click. So I'll start by commenting on the first quarter. So, I've mentioned, we did see deceleration in PEO pays per control. So as Don mentioned in the opening comments, that is a byproduct of what we're seeing in the pressure with respect to, as you know, that business tends to skew more into professional services technology. The pays per control deceleration is happening at a faster clip in those cohorts than the broader base. And so said differently, the pays per control growth in the PEO is decelerating faster than we expected and faster specifically in those cohorts. So in terms of the contributions, that is the contribution to the deceleration or the new guide to worksite employee growth that we're seeing in the first quarter. We did have strong bookings in PEO in the first quarter. That said, it did come in slightly below where we had hoped for, so it was still higher than overall employer services. It was a good quarter for the PEO and this is now the third quarter in a row that we've seen strength in bookings in the PEO. And that's important to note because really the strength in PEO bookings is what ultimately will yield the reacceleration that you're asking about in the back half. That coupled with kind of what we're seeing in retention. So while retention is stable and stabilizing inside the PEO, it isn't back to the high growth levels that we saw, call it, a couple of years ago in the last year or so, and as such as those compares continue to lap coupled with retention continuing to accelerate, if you will versus stabilize. We will see contributions from retention, we'll see more contributions from bookings and that's really why we anticipate the worksite employee guide for the year that we've given.
Samad Samana: Great. And Maria, I actually had a follow-up for you as well on the international side.
Maria Black: Yeah.
Samad Samana: After seeing the rollout of the product into Ireland. And I'm just curious, how should we think about the expansion beyond the U.S.? I know ADP already has a presence and it's a meaningful contributor to revenue, but just should we think about international maybe being an offset to some of the slowdown that we're seeing in U.S. revenue? Just how should we think about the cadence and impact as you move more international with your core HCM solutions versus just helping U.S. employers that already had an international presence?
Maria Black: Yeah. Absolutely. So I'll speak to Roll, which is what I commented on in the opening comments. So we did roll out, no pun (ph) unintended, our roll offering into Ireland. And it is an exciting bit for us, albeit it's very early days, right? It's actually only been a couple of weeks. But we're excited about it because it's the first of many countries where we intend on taking the, call it, very down market offering into our various countries throughout international. And it's really about marrying that product with what we see as still potentially greenfield opportunity within our international space and really leveraging the ecosystem that we have, that's everything from distribution to all the services call it around, the offers in various countries. So we're very excited about that. Now, in terms of the overall growth contributions in the short term of rolling out Roll into Ireland, I would say they're negligible. I would say even Roll over time this year, I think it would be, not a meaningful contributor to bookings. To me, I think this is really about a long-term investment that we're making across international and what we see as a continued opportunity for us. So you kind of mentioned is this companies that have a presence in Europe, that exist in the U.S. with folks working in or call it in international? And the answer is, this is both of that coupled also with a lot of our, what I would say, best-of-breed offerings in international. So we see growth opportunity really across the board in international and that's everything from the down market, which we're going after now with this new product offering of Roll. So we see it in the SMB space, we see it in our best-of-breed space and we also see it in our global MNC space. So really excited about the long-term growth opportunity that continues to be international. And while on international, I thought I would just mention because it's important to note, we did have a very strong quarter with respect to international, albeit that quarter is obviously off of a compare Q1 of last year that was less favorable, but it is on the heels of what was a very strong fourth quarter finish in international. And so, all the way around, I continue to be incredibly excited and optimistic about what it is that we can go accomplish and continue to build in our international offering.
Samad Samana: Great. Thanks so much for taking my questions.
Operator: Thank you. Our next question comes from Bryan Bergin with TD Cowen. Please go ahead.
Bryan Bergin: Hi. Good morning. Thank you. So, Maria, I was hoping if you can comment on just how you're seeing the overall macro situation evolve and maybe how that may affect demand? And if you can specifically unpack that within the ES segment, maybe talk about some of the areas that came in better than you expected versus any areas that may have been lighter or downtick versus the prior quarter.
Maria Black: Absolutely. Good morning, Bryan. So happy to comment on what we saw in the first quarter with respect to the overall performance of bookings, but also the demand. So I'll kind of start with the overall performance. I mentioned in the opening comments, we did see strength, continued strength in our down market, so really excited about that. Also saw tremendous strength in our compliance solutions offering. So think of it as all the stuff that hits compliance tax, things of that nature. So we're pleased with what we saw with respect to new business bookings. Those are the two that really outperformed. And it's exciting to see because really that entire down market offering and that's everything from our run offering to retirement services, insurance services, we continue to see tremendous strength there. We saw that all of last year and definitely the finish last year, and it makes me happy because it's a lot of the places that, well, good performance makes me happy regardless, but it's a lot of the places where we've been making meaningful investments both in the product as well as the distribution. So excited to see the continued performance there and the outperformance. The overall results do keep us in line with our full year guide. So excited to confirm that again here today. In terms of the overall demand environment and I feel like I've been saying this quarter-to-quarter, but we're not really seeing any major changes in demand. Demand is still strong, demand is still healthy. We see that in our bookings results. There are all sorts of other indicators that we look at in terms of pipelines, in the up-market, in the mid-market, certainly in the down-market. We're looking at things such as new appointments and kind of activity, excuse me, activity measures to really give us a guide on whether demand is strong. And I would tell you pipelines are healthy year-on-year and certainly activity is healthy. And so we don't see a big demand change again this quarter. In fact, it’s kind of the opposite stepping into the quarter on the heels of a strong September. We feel really good about where our pipeline sit year-on-year, which again is giving us the confidence in the full year guide. As always though, Bryan, we continue to keep an eye on the macro. We continue to keep an eye on our global space and international and making sure that we're understanding both any macroeconomic changes coupled with any demand environment that could shift given everything kind of going on in the world, if you will. So that's the current story on kind of pipelines demand in the quarter.
Don McGuire: Yeah, maybe..
Bryan Bergin: Okay.
Don McGuire: If I could add a couple of comments on the macro, certainly macro continues to be pretty positive. Unemployment rates continue to be near decade lows here in the United States. Unemployment rates around the world continue to be quite low. The discussion about whether or not we're going to be in a recession, I think the odds are now not for a recession. So soft landing is pretty much what is being anticipated. Interest rates are expected to have peaked here in the US. So I think all things considered, things are pretty positive. I think the one area that we put in our original guidance for the year and that we continue to look at is our guidance had in fact contemplated a slowing and pays per control growth. Maria mentioned that and talked about that in the PEO business, but we are confident. We are still seeing growth, albeit, we are seeing growth at a slower pace than we had previously. But once again, that was fully contemplated in our original guide for the year.
Bryan Bergin: Okay. That's helpful. Thanks, Don. My follow-up on the PEO. So heard you, the bookings are a little bit lighter than you expected to start, but you're also calling out, I think higher selling expenses impacting the PEO margins here year-over-year. So can you -- maybe talk about the puts and takes there driving that dynamic?
Maria Black: Specifically on PEO margins? I will let Don…
Don McGuire: No. But I think originally, Bryan, you mentioned bookings were lighter than expected. I think our bookings came in – our bookings came in pretty good, as Maria has mentioned.
Maria Black: Yeah. I think he's referencing the comment I made around PEO bookings was slightly lighter than expected. By the way, still higher than ES, which we expect to be the case throughout the balance of the year. So that's the kind of nuanced [Multiple Speakers]
Bryan Bergin: So the question there, you're also citing higher selling expenses impacting the PEO margin. So it seems like there's a bit of a disconnect there. Just trying to understand that.
Don McGuire: Yeah. So we had planned the year, we talked about the growth being stronger in the second half in bookings, sorry, in margins than in the first half. And certainly we have seen some investment and some higher selling expenses and we'll see in the first half than we will in the second half, but nothing really surprising. A little bit off, but certainly we're in line with what we expected.
Bryan Bergin: Okay. Thanks.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Please go ahead.
James Faucette: Great. Thanks. I wanted to ask just a couple of quick follow-up questions. First, I think the comment was made that you're still anticipating a bit worse performance in terms of out of business rates on a go-forward basis, but to-date those have been a little bit better than you had anticipated. Can you help provide some detail as to what you're seeing, why you think we're seeing better, survival rates, and kind of the things you may be looking at as indicators that could get worse on a go-forward basis.
Don McGuire: Yeah. Demand continues to be strong in the economy overall, and I think that's supporting what tends to be this view that we're not going to enter into a recession. At best, there's going to be a soft landing. So I think that strong demand environment, particularly consumer demand is keeping small business afloat. So when you also look at what we're seeing in terms of new business formations, there seems to be continued strength in new business formations. So generally I would say that the environment, irrespective of the higher interest rates, the environment continues to be favorable for small business, and I think that's translating itself into what looks to be lower out of business than contemplated now. We have continued, as we said in our original guide, and as we will reiterate or update here today, we have continued to think that we will see a little bit more normalization in other business. So we'd have contemplated that, but we think we are getting closer to where we think we're going to plateau or hit the bottom there. So I think we're very close, and once again, I think it just comes back to demand environment. It tends to be supporting the economy more broadly and more generally and small businesses benefiting from that as well.
Maria Black: Yeah. I think if I may, I think the only thing I would add is that it's still very early in the year, right? So when I think about retention, we did have a record level in fiscal '23. We were near that record level a year before, we were at that record level the year before that. And so we've had this tremendous strength. And I think Don is spot on in terms of all the reasons from a macro perspective that we've had that strength in terms of client retention. And so as that normalizes, we believe it's still prudent for us to have the retention guide that we have, which is really a byproduct of how we planned the year in the back half. So I think I got the question last quarter and so I'll answer it proactively this quarter, which is, are we just being conservative? And I think the answer to that question is, it's still early in the year. And so, if we do continue to outperform retention in the way that we outperformed in the first quarter, we hope that we will outperform for the full year. It's just early to take away that conservatism sitting here just, three short months into a very long year.
James Faucette: Yeah. And then, I want to go back to kind of a headline related question. You saw that -- you saw or you indicated that you'd seen kind of a 25,000 sequential improvement in retirement services and -- for clients, you alluded to some state mandates there, particularly around SECURE Act 2.0. Can you talk a little bit about what state mandates you've seen or that may be impacting that business or how long before we start to see benefit in their retirement services, post a new state mandate? So maybe we can help track headlines and anticipate like, how big of an impact any new requirements may have?
Maria Black: Absolutely. So I think I've spoken quite a bit to retirement services as well as the SECURE Act over the last year or so. And I will tell you, I was excited to report the new milestone today in part because that business continues to show strength, but also because it's a business that I know is adding tremendous value into the world of work. And so, it is an exciting time. It does come as a byproduct of the offering, the investments we've made into the offering, and also these state mandates, some of which are anchored into the SECURE Act at the federal level, some of which are anchored state by state. Candidly, I could probably spend an hour with you and go state by state in terms of all the various mandates. What we see over the next year or so is the threshold of companies that need to comply with the state mandates starts to creep into, call it, the further down market, if not the micro market. And so, as all these states, a lot of them being on the West Coast, if you're looking for headlines tracking states like California, as they continue to pull down at what level do you need to comply with the state mandates and/or the SECURE Act, the more opportunity we will have to ensure that we're helping our clients to solve for this piece, keep them compliant. But again, back to doing good in the world, it's also something that's bringing the value to each one of these employees that are engaging with these clients, so.
James Faucette: Great. Appreciate that color.
Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi, guys. Good morning. Just want to ask about the decline in PEO. Looking at the employee base of PEO declining versus not necessarily the case, looks like almost the opposite in the employer services. So just trying to think about the trends. And does, typically the trend you see in PEO bleed into employer services and why maybe it's been a little bit weaker for pays per control there in PEO versus employer?
Maria Black: Yeah. So just to clarify, pays per control in PEO is actually higher. We don't give that number, but it is actually higher than employer services. So I think the first piece suggests is that the bases are actually just different, right? So if you look at the pays per control across the broader ADP, it's really a reflection of a mix of industries. As I mentioned earlier, the PEO tends to skew, by design, by the way, for the offering. It's really -- the offering is the most valuable if you will to the cohorts that we offer it to, which tends to be more professional services, tech-oriented companies that want to offer employers or their employees benefits of choice, if you will, to be employers of choice. And so that skews that base slightly differently than the overall. And what we're seeing within the PEO base is a delineation between those cohorts and the rest of the base, if you will. So we cited it in the prepared remarks, but the deceleration that is happening at the PEO is still a byproduct of within that base having professional services and tech decelerating at a faster clip than the rest of the base. So to answer your question, does it bleed across? I think, we're already hearing these headlines in the market in terms of -- and we see it within our own ADP Research Institute data with respect to professional services and tech hiring being in a different position than the rest of the market. So I think I would suggest it's already been bleeding across. If you look at the last couple of quarters of that, by the way, that also tracks BLS data shows the same thing. You see it in wages. And so all of that to suggest, I would say, the trend we're seeing in the PEO is already in the macro, but the bases are slightly different, which is why you would feel it, the impact of it perhaps more significantly in the PEO PPC than you would in the broader PPC. That was a mouthful, by the way.
Bryan Keane: No that was helpful though. Thanks for that clarification. And then the other question I just had is the strength you saw in the ES new bookings especially in September and the way the pipeline looks, but you're not changing the total outlook of 4% to 7%. Just trying to figure out -- do you feel like you guys are maybe trending if things hold trending above the guidance range for bookings given the strength you saw in September in the pipeline and for SMB strength in the quarter?
Maria Black: Yeah. What I would offer is that I'm incredibly pleased with the results in the first quarter, especially on the heels of what was an incredible finish last year. And so the pattern that we saw in the first quarter and the strength in September is not a typical of the pattern we see in this -- the first quarter on the heels of an incredibly strong fourth quarter. And so I am excited about the first quarter results, I am excited about the strength in September. But the excitement is actually less about, call it, the finish in September and more about what we see on the year-on-year demand environment, what we see in activity, what we see stepping into this next quarter. And that does give us confidence into our full year guide at that 4% to 7%. What I would also offer though is it's a long year, and when you think about where the skewing, if you will, or the contribution of new business bookings happens for us on a full-year basis, it is in that third and fourth quarter. I'll much call it larger than the first and second quarter. And so we believe it's prudent to given the line of sight that we have today, just a quarter in. But we feel confident in the guide, we're excited about the performance, we're excited about how we're stepping into the quarter. The second quarter that is but we also still have an entire year ahead of us.
Bryan Keane: Got it. Thanks for taking the questions.
Maria Black: You bet. Thank you.
Operator: Thank you. Our next question comes from Ramsey El-Assal with Barclays. Please go ahead.
Ramsey El-Assal: Hi. Thanks for taking my question. Could you give us your latest thoughts on the competitive environment in PEO and how that's sort of evolving over time? I think there's somewhat slower than historical growth across the industry. Are there any signs that the market is, saturated with providers or is there any competitive overlay to PEO performance?
Maria Black: I would suggest that the PEO ASO conversation, if you will, or PEO HR outsourcing offerings kind of continues. I don't know that there's anything new to report, Ramsey. I think from my vantage point, it's always been a very competitive environment. We all have slightly different PEOs from one another. I think we talked a lot about ours today and the way that it skews to professional services and tech. I think you have others that skew to different types of industries. You also have other PEOs that perhaps are a bit more down market. We tend to skew a little bit more upmarket than some. And so I think all the PEOs look slightly different. I think we all know our models are also not identical in terms of how we actually go-to-market, whether it's through the strength that we have in the competitive advantage of being able to have ADP's client base contribute about 50% of those upgrades. So I think how we go to market, our models, never mind the models of, you know, fully insured to self-insured, et cetera. I think similar trends are within the ASO offerings, or some refer to them as HRO offerings. And so I think within there, you also have various models and various go-to-markets in terms of the, some competitors perhaps some -- have some flexibility or more movement between ASO and PEO than I think we've cited in the past. And so, I think all that to suggest I think the competitive environment is about the same and remains. I think I’m optimistic and expect growth in both our PEO bookings as well as our HRO and ASO offerings throughout the balance of this year. And so I think we remain very, very excited and optimistic about the growth of those -- all of our HR outsourcing offerings, both in this year as well as the long term.
Ramsey El-Assal: Got it. Okay. And a follow-up for me. Could I ask you to revisit those comments you made about higher selling expenses in PEO? What does that mean exactly? And also just I wanted to make sure I understood that, Don mentioned that, there's some expectations those may continue, but they're still, in essence, sort of a non-recurring step up in expenses. It's not a permanent step up in, in expenses in the segment.
Don McGuire: Yeah. We saw higher selling expenses in Q1 for the PEO, and we expect to see higher selling expenses year-over-year in the first half, but we do think that that's going to settle down into the second half. So we're not looking at the kind of growth that we saw last year. I think we commented quite extensively on the many, many salespeople we added into the business last year and had great success and allowed us to finish the year the way we did. So those folks are in place. So we are continuing to add some sellers. We will add though, most of those sellers in the first half and it's important to also, I think, call out here that, what we are seeing with our sellers is that we are getting much better retention within the seller community. So we are hoping and expecting to benefit from the improved tenure that we should see from the selling organization as we go through the balance of this year.
Ramsey El-Assal: I got it. So it's headcount-related primarily. That makes a lot of sense. Thanks so much.
Maria Black: Yeah. I think it's a timing thing. I think that's the…
Ramsey El-Assal: Got it.
Operator: Thank you. Our next question comes from Jason Kupferberg with Bank of America. Please go ahead.
Jason Kupferberg: Good morning, guys. Just staying on PEO for a second and maybe if we can just refresh a little bit here. I'm just thinking back to the Analyst Day two years ago, we thought it was a medium-term 10% to 12% grower. Now it's 2% to 3% at the moment. There was definitely some post-COVID normalization. But maybe just, Maria, if you want to take us back through the dynamics in terms of just how the business has evolved from your perspective? And is there a potential path back to double-digit growth for this business if the macro is a little bit more cooperative?
Maria Black: Yeah. So I'll let Don kind of speak to the medium-term targets and kind of the path back. But I think, from my vantage point, and I said it earlier today, that step one is the continued reacceleration of bookings. And so this is the third quarter that we're pleased and we did have a solid contribution of PEO bookings to the overall bookings picture in this quarter. That was the case last quarter, it was the case the quarter before. And I think the reason that I go to that is not just because it's the piece that will accelerate the growth and path us back to what our long-term goals and medium-term targets are with -- for that business. I think it's also because it speaks to the demand environment. It speaks to the value proposition and the strength of that offering that still exists in the market. And so I think that's a big piece of it. I think step two is the continued acceleration -- reacceleration of retention. So I mentioned that retention has been stable and as we reaccelerate retention back into that growth, that also will contribute to obviously the revenue. And then last but not least, Jason, you mentioned it, the macro headwinds, and I think I talked about the last couple quarters, how that's been the post-pandemic, call it, nuances that impacted that business. I think we talked a lot about the renewal over the last couple of quarters. Now we're seeing these trends in PPC. My view would be that all of the post-pandemic waves that have been, call it, flowing through the PEO and all the variables that make up that model. We're still seeing some of those case in point being really call it the reversion of what we saw several quarters ago, which was when professional services and tech was in a massive hiring boom, now we're seeing the opposite of that, right? So I think we still have some of these waves, kind of shuffling through or whether or going through -- flowing through the PEO. And if and when the macro changes with respect to that, that certainly will help reaccelerate that business as well. So in terms of the path back, I'll let Don kind of speak to the medium-term targets.
Don McGuire: Yeah. I think Maria covered it very comprehensively there. I would say that when we established the mid-term targets, I think a lot of things have changed since then, certainly the inflation environment and that we've seen in particular and Maria just mentioned professional services and technology, we saw incredible growth in those sector -- in those segments and growth beyond what we thought we -- or what we had predicted in the mid-term targets or spoken to. I think now we're seeing some reversion. We do, though, continue to be incredibly positive about that business. We think it definitely has a place, and we think that we will make our way back. But as Maria also said, it's a little bit early to forecast when we think we're going to get back to some of those mid-term target growth areas that we had discussed.
Jason Kupferberg: Understood. That's good color. Just a follow-up on float yield. It looks like it was actually a tick down slightly quarter-over-quarter here in Q1, amid a higher rate environment. But just curious what the callouts might be there.
Danyal Hussain: Hey, Jason. That just relates to the mix between short-term and extended in long. So in Q4, we were a little more levered to overnight partly because of this debt ceiling issue. We had to be deliberately skewed shorter duration. But in a typical Q1, we would generally have a lower short portfolio. And so there is seasonality in the average balance wouldn't read much into it. The year-over-year number is a much more relevant metric.
Jason Kupferberg: Thanks, guys.
Operator: Thank you. Our next question comes from Tien-Tsin Huang with JP Morgan. Your line is open.
Tien-Tsin Huang: Hi. Good morning. Forgive me, if I'm asking another clarification on the PEO side. Just --what the -- was the slight softness in the bookings also related to the PS and tech sectors and also with the pays per control within PEO, is that more of a healthcare participation issue or just labor weakness in those sectors?
Maria Black: I really apologize, you actually blipped out during the first part of your question. Would you mind just repeating -- yeah, there was a word missing so.
Tien-Tsin Huang: No, I probably didn't ask it very well. Just wanted to make sure the bookings softness on the PEO side, was that also in the professional services and tech sectors. And then also just on the pays of control, was is a labor weakness or health care participation?
Maria Black: Yeah. Listen, so I'm glad you're asking this question actually because I just want to reiterate, we were very pleased with our PEO bookings. And so there wasn't softness, there was strength and growth in the PEO quarter bookings. In terms of how we skewed the year, it was slightly lighter than we had positioned our planning, which is why it contributes the way that it does to the overall worksite employee growth. But, it's -- again, the worksite employee deceleration is really about the PPC story. And so I just want to reiterate, we were actually very pleased with the quarter from a PEO bookings perspective. In terms of the industries, I think it's a mix. I think we continue to see the PEO execute with respect to the industries that we target which tend to be into those categories. As it relates to, this comment around kind of within the PEO, the deceleration that is happening faster in professional services and technology versus the broader base of the PEO. Again, I don't want to give kind of the numbers of what that is, but it isn't like the entire base is sitting in professional services. It's just that subset, if you will, of the base. And it is really, again, kind of triangulate to the macro that we're seeing and the same type of data coming out of ADP Research Institute, out of the BLS and it's really about hiring. So it's less about, call it, layoffs and it's really where the professional services and tech industries, we're doing massive hiring, call it, a year ago, six quarters ago, it's really a lack of hiring that's happening in those businesses. Did I answer that question?
Tien-Tsin Huang: Yeah. [indiscernible]
Danyal Hussain: Tien-Tsin, just on the participation piece of it, the pay per control wouldn't be impacted by participation rate, but the reported revenue would be. So to the extent, workers are taking plans, cheaper plans or fewer plans. And there's a little bit of that. You do see it in the revenue per WSE, but the WSEs themselves wouldn't be impacted.
Tien-Tsin Huang: Thank you, Danny. I didn't ask it. Well, that's perfect. That's what I was looking for. On the -- we get questions around pricing as well. That's why I was asking about the participation side of things and if there's a difference there, it sounds like it isn't. On the international front, just my quick follow-up. Just I think Sweden was the call-out in terms of acquisition. Why is Sweden important to own? Just I'm not as familiar with some of the specific countries that you're targeting. And I'm curious if this is just part of a -- maybe a broader plan to aggregate international payroll.
Maria Black: Absolutely. So listen, I have to take this question because I think you may know that I'm actually -- I was born and partially raised in Sweden. So I thought it was prudent to make it the very first country that I announced. I'm actually completely kidding. This was obviously well in motion before my time. But I -- it sounds like I might be closer to Sweden than you are. And for us, it is an exciting time for us. We have had this partnership with BTR for quite some time for us to be able to acquire the payroll business of BTR is exciting because the Nordics are growing, and this does give us a physical footprint into Sweden, which allows us to expand further into the Nordics and really take advantage of the growth trajectory of those economies. So this is obviously payroll, but also in the beyond payroll opportunities that we will have in years to come. So really excited about the acquisition not just because it's near and dear to my heart, but moreover because the Nordics represent growth, and it's exciting to think about us having a physical presence there.
Tien-Tsin Huang: Thank you.
Operator: Thank you. Our next question comes from David Togut with Evercore ISI. Your line is open.
David Togut: Thank you. Good morning. You called out strength in ES bookings, particularly in the small business market with RUN. Could you provide some texture into the bookings trends you saw in mid-market with Workforce Now and then up-market with enterprise? And any insights you have into international bookings in the quarter would also be appreciated.
Maria Black: Absolutely. So yes, we did have great strength in the down markets, kind of moving on up in the mid-market. Certainly, we have continued solid demand in the mid-market. That's inclusive of our Workforce Now platform. It's also inclusive of our HR outsourcing offering. So I spoke a bit about the ASO models, the HRO models earlier in that mid-market also support -- is supported by the PEO. So we do see continued demand from the mid-market. I think the way I always think about it is not getting any easier for companies in that mid-market to navigate being an employer today. And so we expect continued strong mid-market growth. I think in the up-market, since you asked about the enterprise space, one of the call-outs we made last quarter was about the strength that we saw in our next-generation HCM offering, and we did see that strength continue into this quarter, which we think is fantastic. We also see strength in the pipeline in that space year-on-year. So excited about what we're hearing from our clients, the sentiments around the offerings that we have in the enterprise space. And then I think I touched a little bit on international earlier, but our international business did grow nicely in the first quarter. Again, it was a benefit of a little bit of an easier compare year-on-year. But we also had, as I mentioned, a really strong finish and a strong fiscal '23 in our international business. Again, what I measure is partly the results. But as I think about the look forward, it's really about pipelines and what I would say, our international pipeline year-on-year have a fair amount higher than they did a year ago, which gives us the strength to really feel good about our international bookings to remain healthy through fiscal '24.
David Togut: Thanks for that. Just as a quick follow-up, Don, you called out part of the 90 basis point margin decline in PEO being traced to a difficult comparison on workers' compensation reserve adjustments a year ago. Can you quantify for us how large those were as we think through the margin comparisons for Q2, Q3 and Q4 of FY ‘24 in PEO?
Don McGuire: Yeah. So as we've had very favorable reserve releases over the last number of years and somebody called out last year in the K, you would have seen the favorability there. So just to be clear, we are still seeing favorable reserve releases, but we are not seeing -- we didn't see the reserve release to the extent that we did Q1 to Q1 of the prior year. So the numbers will be in the Q, but it's about $6.2 million less than it was in the prior year. So that's the quantification of it. And if you kind of translate that into the margin, it's about 60 bps to 90 bps -- 60 bps of the 90 bps decline comes from the lower reserve release. Now once again, we think that we're going to continue to see reserve releases and were favorable as the actuaries get back to us and let us know what's happening, but we're not seeing any underlying changes or large changes that would lead us to be any less optimistic about seeing continued releases in the reserve.
Danyal Hussain: And David, sorry, just to clarify, it was a $6 million benefit in Q1, which is about $8 million less than the prior year.
David Togut: Got it. Thank you very much.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hey. Good morning, and thanks for taking my question. At HR tech, you got to see a lot of your new solutions, particularly focused on, the AI Assisted solutions. Maria, I'm wondering if you can talk a little bit about your philosophy with regards to, which solutions you would charge additional for -- how are you thinking about monetization? And then I've got a follow-up in terms of process improvement.
Maria Black: Sure. Good morning, Mark. I'm pretty excited about all of our new solutions that you would have seen at HR tech. So I think I'll take a minute to kind of think or talk through how I'm thinking about Gen AI in general, and then I'll tell you how I'm thinking about monetization because I think it'll make more sense on the other side. But when I think about Gen AI, I think it will impact everything. So the answer is it's going to be everywhere impacting everything that we do across the entire client life cycle. So it's about how we develop products. That's everything from developer co-pilot types of tools that everyone is talking about. It's about how Gen AI will be embedded into our product, it's about how we go-to-market and modern seller stuff that I've spoken about for years and how we actually have the ability now leveraging Gen AI to actually acquire clients. And then the most obvious being how we serve them, how we implement them, how we become more productive and make our clients more productive as we serve our clients. And so when I think about Gen AI, and I think most -- everyone has probably likened it to things like whether it's software or the Internet, I think my answer to you is, it will be in everything that we do and in the fabric of who we become. And so in terms of the monetization side, I think it's less about, charging a PEPM (ph) on a per feature. So let's say, you know, some of the things I talked about today, which probably doesn't sound that exciting, like report writing or if you look at the earnings release document, you'll see in there a job description that's pulled in the screenshot showing roles. So these things probably don't sound that exciting, but they're pretty exciting because they are the seeds of innovation, as I used earlier to really show what -- how Gen AI will interact with everything that we do kind of in the fabric. So said differently, Mark, like, I don't think we're going to be charging separately to get Gen AI job description written or Gen AI report written. I think it's really about continuing our innovation journey to do all the things we've always done, which is really about becoming more productive. It's about solving things for our clients and making them more productive. And I think that, to me, the fruits of that labor really end up in new business bookings, and they end up in retention. And so that's not to suggest that there may not be things. But I don't think it's really to me about $0.50 PEPM (ph) here and there. To me, it's really about the innovation journey we've been on. This just allows us to do it at a faster clip. And I'm really optimistic and excited about the things that we're seeing. In terms of other things that we're measuring, we actually have the entire organization rallied to engage in these tools. We actually have some goals that we put out there in terms of -- by the end of the year, how many of our associates that set across sales and implementation and service and technology that are engaging with these tools. Right now, they're sitting at already above 10% of our base of associates that have the ability to touch these tools are already playing with them. I would tell you our entire sales organization are comping up a bit because the digital sales or inside sales where we've deployed a lot of these modern tools over years, have an ability to become that much more productive, engaging our new prospects and new sales. So as you can probably tell, like, I literally could go on and on and on, but I think my answer to you is, it will be everywhere across the entire client life cycle that we have, and I'm very optimistic about the long-term implications of this on all the major metrics that make up this great business model.
Mark Marcon: That's terrific. And then with regards to just the productivity enhancement. I mean, particularly when we think about service and implementation, from a longer-term perspective, can you describe how much more efficient you think your service personnel could become? And how much efficiency you could end up gaining there and the implications from, continuous margin improvement as you continue to go along that journey? I know it's early days, but just how are you thinking about that?
Maria Black: Yeah. Listen, Mark, it is early days, right? And that's not for a lack of scoping it, right? So we have had because it's not as though we haven't had all of these business cases over many years on how to become more productive, and we've had machine learning and regular AI in our house for a long time. And this does give us a step change to that innovation. But it's still too early. I think to sit on an earnings call and commit numbers, but that's not for a lack of internally having scoping and line of sight to what we believe are pretty exciting goals for us to go chase. And again, some of those goals have existed for a long time, but now we have technology that I'm hopeful that we can actually finally crack the code on some of these really big enhancements that we see. But certainly, productivity is a big piece of it. I know I talked today about Agent Assist and this idea of call summarization. Again, it probably doesn't sound that exciting. But for someone who used to sit on the other side of that, you see whether it's a prospect call or a client call gets summarized and recapped into a very quick format that's usable. These are, hours and minutes of time. even on the seller side, we actually are launching something called rapid pre-call planning, and I think about the hours I used to spend 27 years ago, researching a company to get myself ready to go in and have a conversation with a prospect that brings value, enabling our sellers to have all of that productivity. So I think it's -- again, it's too early to give you exact hundreds of millions of dollars of types of quantifications. But arguably, we are actively looking kind of case by case and really picking the ones that we believe sequentially will be the most accretive to drive the most amount of productivity, the most amount of value back to our shareholders, but candidly, the most amount of value to our clients.
Mark Marcon: Terrific. Thank you.
Operator: Thank you. We have time for one more question and that question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Great. Good morning, guys, and thanks for squeezing me in here. Just on the launch of the construction vertical software. I'm just wondering, is this sort of part of a bigger shift to develop more vertical specific HCM solutions for your clients? I understand, construction may be a more complex vertical, but wondering if there's more of a vertical specific strategy that could develop beyond the construction vertical. Thanks.
Maria Black: So I'd like -- what you're suggesting, and I think the answer to that could be yes. And I think when I think about -- back to selling 27 years ago, I used to sell construction companies and the complexity that they have has always existed and candidly, a lot of the features and functionality that we have and are now pulling together to make it an actual solution for that vertical existed many years ago. And that's everything from things like job costing, obviously, compliance and reporting, think about certified, compliance type of reports for payroll, things of that nature. And so it's really about pulling it together and marrying it with a service organization that can support the complexity of that vertical. I think that, to me, is a big change, so we did add some features. But a lot of these things we've had, and we pulled them together and we're marrying it with the ecosystem of a dedicated service org that can actually really help the construction industry and this vertical saw the complexity of being in that industry. So I think what I would offer is that, it's an exciting time for the construction industry, specifically for our Workforce Now clients, and I see this, just as you suggested at the beginning of other places that we could pull together our existing tech with a dedicated type of service model and solve real challenges in the business for various verticals.
Scott Wurtzel: Got it. That's helpful. And just a quick follow-up. Just wondering if you can give an update on sort of Next Gen HCM and Next Gen Payroll, attach rates and how we're sort of trending there, relative to expectations?
Maria Black: So Next Gen Payroll. That was the question?
Scott Wurtzel: Both.
Maria Black: Both. Okay, just making sure I heard it right. So I think I touched base really quickly on Next Gen HCM. And I think I noted to the excitement that we have that we continue to see the strength in the Next Gen HCM offering into Q1. So we had a strong fourth quarter. What I would suggest is that we actually brought in more Next Gen HCM in the first quarter than we saw all of last fiscal year. But again, one quarter these things can sometimes be lumpy. But I think for me, it's really about the sentiment. And so we recently had an Analyst Day. We had a handful of our clients up on stage that, shared with us the impact, the platform is making for them. And as you would remember, we spent a lot of our discussions over the last year talking about scaling implementation, on-boarding the backlog. So pretty exciting to see some of that backlog that's no longer backlog on stage, speaking to the value proposition, and that's supported by continued strength which means our sellers are excited to continue to sell the Next Gen HCM offering. So I think that's all very, very positive. Similarly, we have continued focus in the Next Gen Payroll. And so what I would offer there as we continue to make headway. So as it's not deployed across the entire mid-market. We continue to make headway to solve for more complex features, things of that nature, that will pull it further into the upmarket of the mid-market. But as you know, that Next Gen Payroll engine is also what's attached to the Roll offer. So the other exciting part about that engine is it is the thing that's taking us into the SMB space internationally. So I feel really excited about the road map for that offering and the contributions that it's making into the mid-market today, but also into the long-term growth of the company internationally.
Scott Wurtzel: Awesome. I appreciate the color. Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Maria Black for closing remarks.
Maria Black: Yeah. So thank you, Michelle. And listen, it's hard for me not to sit here and reflect on a year ago. And so I was driving in this morning and feeling candidly a bit nostalgic because it's exactly one year ago that Carlos and I sat here and announced the transition of me becoming CEO of this amazing company. And so I'm incredibly nostalgic and proud today. I'm proud of our first quarter results. I'm really proud of the execution of the team, both with respect to the results, but also with everything that you heard in terms of the progress we are making on a very cohesive and strong strategic outline and priorities. But mostly what I would offer is that I remain incredibly humbled by the -- over 60,000 associates that I've had an opportunity to engage with over the last year who continue to make this company everything that it is and absolutely amazing. And I just wanted to say that I'd like to thank each and every one of them for inspiring me every day. So with that, that is the conclusion of our call and until we meet again.
Operator: Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session, instructions will be given at that time. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"text": "Thank you, Michelle, and welcome everyone to ADP's first quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Danny, and thank you, everyone for joining us. This morning, we reported strong first quarter results, including 7% revenue growth and 12% adjusted EPS growth, and we made significant progress on the three strategic priorities we shared with you last quarter. Let me begin by quickly reviewing some of our financial highlights from the first quarter. We had a solid start to the year in Employer Services new business bookings with record-level volume for first quarter which was supported by a particularly strong September. Among our best performers were our small business portfolio and our compliance-oriented solutions. Overall demand in HCM has remained steady and we maintained a healthy new business pipeline at the end of the quarter across our business. Our Employer Services retention rate once again exceeded our expectations. Although, retention declined slightly versus the prior year, including in our small business portfolio, we continued to see resilience among our clients. More importantly, our overall NPS scores reached a new all-time high, positioning us to stay near these historically high retention levels. Our Employer Services pays per control growth was 2% for the first quarter as our clients continued to add employees at a pace that is gradually slowing. And our PEO revenue growth of 3% in the quarter was relatively stable versus last quarter, reflecting solid PEO bookings performance offset by deceleration in PEO pays per control growth. Don will speak to our updated guidance in a moment, but the demand environment for PEO as well as our other outsourcing services remains healthy. Moving on, we made meaningful progress across all three of our strategic priorities that we outlined last quarter. Let me start with an update on some actions we took in Q1 to lead with best-in-class HCM technology. First, we began embedding Gen AI features into our products. In Q1, we integrated Gen AI into Roll to further enhance its conversational UI and make it even easier for small business owners to quickly obtain customized Payroll and HR guidance. We also began rolling out ADP Assist, which delivers insights and recommendations to make complex HR work simple. We've enabled ADP Assist for select Workforce Now clients, beginning with a Report Assist feature that allows practitioners to easily extract the insights they're looking for. We look forward to continuing to build on the live feature set of ADP Assist to further enhance the experiences of both HR practitioners and employees. We also had some exciting product developments beyond AI. Our clients tell us they need personalized experiences and deep integrations to help them manage the complexity of running a business today. To help address this, we recently launched a new product called API Central, which enables businesses to easily and securely connect their ADP workforce data across systems using pre-populated APIs and tools. This is a feature our clients have increasingly asked for and we have already seen a strong uptake. In Q1, we complemented the launch of API Central with the acquisition of Sora, an intelligent workflow automation and data integration tool. Sora's unique capabilities will allow our clients to automate people processes by unifying various applications such as HR, IT, CRM, and more, creating a smarter and easier-to-use experience for our clients. In Q1, we also launched ADP Workforce Now for construction, a comprehensive offering designed to help clients with the unique payroll and HCM needs of the construction industry. This verticalized offering combines tailored Workforce Now capabilities and reporting with a team of dedicated specialists for the construction industry. While ADP has always served clients across the full spectrum of industries, construction stood out to us as a vertical with enough complexity to warrant a more tailored solution, and we're excited to further strengthen our offering in the mid-market. We also announced the launch of our corporate venture capital fund earlier this month, leading with best-in-class HCM technology requires that we stay attuned to the frontier of HCM innovation. And now, in addition to the organic efforts we are developing in ADP Ventures, we will invest in and partner with early-stage startups to strengthen our core business our core business and to extend into natural adjacencies. Two of our early investments focus on improving lifestyle benefits to drive associate engagement in simplifying the incredibly complex leave management process that businesses and their workers have to address. We're excited to build on these partnerships and develop new ones. Overall, Q1 was a very busy quarter on the product front with much of the work we're doing representing seeds of innovation that will position us to continue shaping the future of work. Our second strategic priority is to provide unmatched expertise and outsourcing solutions. In addition to launching the pilot of ADP Assist for our clients, we also launched the pilot of our new Agent Assist embedding Gen AI in the flow of work for ADP Associates. So far, we have enabled our call summarization capability to select associates. Thanks to this Agent Assist feature, those service associates no longer need to spend time writing up case notes after client calls, which should make our associates more effective and also allow us to quickly aggregate real-time client feedback to continuously improve our products. We are also piloting Agent Assist real-time guidance for our associates to help them with support content and guided workflows and to more easily share their accumulated knowledge in a way that's customized to individual client cases. We are excited to continue working toward additional Agent Assist features to help our implementation and service associates deliver better, faster service and to help our client satisfaction scores continue to reach new record levels. Our third strategic priority is to benefit our clients through our global scale, and in Q1, we expanded on this advantage. In August, we extended our leading global footprint by acquiring the payroll business of BTR, our longtime partner in Sweden. Acquisitions like this strengthen our multi-country payroll ecosystem while also positioning us to grow a local HCM business in countries with attractive growth prospects. In Q1, we launched Roll in Ireland, representing the beginning of an expansion into the European market, where we believe an AI-based payroll app coupled with our existing on the ground ecosystem will allow us to expand our SMB business outside the U.S. And during Q1, we also announced plans to deepen our existing partnership with Workday to deliver enhanced global payroll compliance and HR for the many clients we jointly serve around the world. Partnerships like this reflect our long-standing commitment to provide the personalization and overall experience our clients desire. Before turning it over to Don, I wanted to highlight a couple milestones in two of our businesses. Our suite of workforce management solutions, sometimes referred to as time and labor management, reached more than 125,000 clients in the first quarter, benefiting from a double-digit growth rate these last few years. Scheduling and precisely tracking time has become more important for employers over recent years in order to meet evolving legislative requirements, and we look forward to continuing to invest in our workforce management solutions to drive higher client attach rates. We also now serve more than 150,000 retirement services clients, which is up more than 20% from the 125,000 clients we served at the end of fiscal 2022. We anticipate growth for our retirement services business will remain strong in the years ahead as the provisions of the SECURE Act 2.0 and additional state mandates continue to phase in and as companies of all sizes continue to recognize the importance of positioning their workers well for their eventual retirement. I'm proud of our start to fiscal 2024 with both strong financial results and meaningful strategic progress. Our roadmap for the months ahead is keeping us incredibly busy. And with this in mind, I'd like to take a moment to recognize our associates across sales, service, implementation and technology whose efforts and outstanding performance are positioning us to consistently deliver for our clients and our shareholders. Thank you, all. With that, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the quarter and update you on our fiscal '24 outlook. Overall, we had a solid Q1 and are not making changes to our consolidated outlook, but there are some moving pieces I'll cover. Let me start with Employer Services. ES segment revenue increased 9% on a reported basis and 8% on an organic constant currency basis, ahead of our expectations. As Maria shared, ES new business bookings had a solid start with especially strong growth in September. The demand environment is stable, our pipelines are healthy, and we are on track for our 4% to 7% growth guidance. Our ES retention did decline slightly in Q1 versus the prior year, but that was slightly better than we expected. At this point, we are maintaining our outlook for a 50 basis point to 70 basis point decline in full year retention, which continues to embed an expectation for small business losses to increase due to higher out of business rates. But if recent trends continue, then we would hope to outperform that range. ES pays per control growth was in line with our expectation in Q1. It decelerated modestly to 2%, and we expect this very gradual deceleration to continue in the coming quarters and are maintaining our outlook for 1% to 2% growth for the full year. Client funds interest revenue increased in line with our expectation in Q1, but we're raising our full year outlook based on the latest forward yield curve, which result in a modest increase in average yield to 2.9% from our prior expectation of 2.8%. We now expect client funds interest revenue as well as the net impact from our client funds extended strategy to be up $35 million from our prior outlook. Meanwhile, the U.S. dollar strengthened, representing a drag relative to our prior fiscal '24 revenue outlook. In total, our strong Q1 ES revenue growth combined with higher than expected client's funds revenue for the rest of the year effectively offset the adverse FX movement and we're maintaining our fiscal '24 ES revenue growth range of 7% to 8%. Our ES margin increased 220 basis points in Q1, driven by both operating leverage and contribution from client's funds interest revenue. For the full year, we are raising our fiscal '24 outlook to now anticipate an increase of 150 basis points to 170 basis points, which reflects the benefit of higher yields, partially offset by higher spend on Gen AI projects and usage, as well as a small amount of dilution from our recent acquisitions. Moving on to the PEO. We had 3% revenue growth driven by 2% growth in average worksite employees in Q1. As Maria mentioned earlier, our PEO bookings growth was solid, but pays for control growth continued to slow and was lower than expected, particularly for clients in the professional services and tech industries. This resulted in a slightly softer Q1 worksite employee count than we were anticipating. As a result, we now expect fiscal 2024 PEO revenue growth of 3% to 4% with growth in average worksite employees of 2% to 3%. Our PEO sales pipelines are healthy and we continue to forecast their worksite employee growth gradually ramping in the back half of fiscal '24. PEO margin decreased 90 basis points in Q1 which is more than we had planned. The decline was primarily driven by a lower workers' compensation reserve release benefit as well as higher selling expenses. We now expect PEO margin to be down between 50 basis points and 100 basis points in fiscal '24 with the continued assumption for higher selling expenses as well as year-over-year headwind from a lower workers' compensation reserve release benefit than we experienced in fiscal '23. Putting it all together, there is no change to our consolidated outlook, but I would like to share some color on cadence. In Q2, our client funds balanced growth will lightly impact the payroll tax deferral that we had in our average balance for the past two years, which creates some grow over pressure on our client's funds balance and will result in more modest ES margin expansion in Q2 than other quarters this year as well as a modest revenue impact. As a result, we expect consolidated revenue growth to moderate before accelerating slightly in the back half. And we expect adjusted EBIT margin to be down slightly before ramping in the back half of the year. This was already contemplated in our guidance at the outset of the year. So again, no change to our consolidated guidance. We continue to forecast fiscal '24 consolidated revenue growth of 6% to 7% with our adjusted EBIT margin expanding by 60 basis points to 80 basis points. We still expect our effective tax rate for fiscal '24 to be around 23% and we anticipate adjusted EPS growth of 10% to 12%. Thank you. And I'll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] We'll take our first question from the line of Samad Samana with Jefferies. Please go ahead."
},
{
"speaker": "Samad Samana",
"text": "Hi. Good morning. Thanks for taking my questions. Maybe first just want to double-click on the PEO side. I think that, the information you gave helps to understand some of what happened in the revised guidance, but maybe just help us understand what's giving that back half ramp confidence, especially, as you expect pays per control in the kind of broader macro to continue to decelerate. Where should we get the acceleration in the PEO WSEs? Is it purely based on bookings ramping? Is it based on an expectation that the base will stabilize? Maybe just dig into that a little bit further because they're moving in different directions."
},
{
"speaker": "Maria Black",
"text": "You bet. So, good morning, Samad. It's Maria here. I thought I'd kind of break down your question with respect to the PEO, call it, double-click. So I'll start by commenting on the first quarter. So, I've mentioned, we did see deceleration in PEO pays per control. So as Don mentioned in the opening comments, that is a byproduct of what we're seeing in the pressure with respect to, as you know, that business tends to skew more into professional services technology. The pays per control deceleration is happening at a faster clip in those cohorts than the broader base. And so said differently, the pays per control growth in the PEO is decelerating faster than we expected and faster specifically in those cohorts. So in terms of the contributions, that is the contribution to the deceleration or the new guide to worksite employee growth that we're seeing in the first quarter. We did have strong bookings in PEO in the first quarter. That said, it did come in slightly below where we had hoped for, so it was still higher than overall employer services. It was a good quarter for the PEO and this is now the third quarter in a row that we've seen strength in bookings in the PEO. And that's important to note because really the strength in PEO bookings is what ultimately will yield the reacceleration that you're asking about in the back half. That coupled with kind of what we're seeing in retention. So while retention is stable and stabilizing inside the PEO, it isn't back to the high growth levels that we saw, call it, a couple of years ago in the last year or so, and as such as those compares continue to lap coupled with retention continuing to accelerate, if you will versus stabilize. We will see contributions from retention, we'll see more contributions from bookings and that's really why we anticipate the worksite employee guide for the year that we've given."
},
{
"speaker": "Samad Samana",
"text": "Great. And Maria, I actually had a follow-up for you as well on the international side."
},
{
"speaker": "Maria Black",
"text": "Yeah."
},
{
"speaker": "Samad Samana",
"text": "After seeing the rollout of the product into Ireland. And I'm just curious, how should we think about the expansion beyond the U.S.? I know ADP already has a presence and it's a meaningful contributor to revenue, but just should we think about international maybe being an offset to some of the slowdown that we're seeing in U.S. revenue? Just how should we think about the cadence and impact as you move more international with your core HCM solutions versus just helping U.S. employers that already had an international presence?"
},
{
"speaker": "Maria Black",
"text": "Yeah. Absolutely. So I'll speak to Roll, which is what I commented on in the opening comments. So we did roll out, no pun (ph) unintended, our roll offering into Ireland. And it is an exciting bit for us, albeit it's very early days, right? It's actually only been a couple of weeks. But we're excited about it because it's the first of many countries where we intend on taking the, call it, very down market offering into our various countries throughout international. And it's really about marrying that product with what we see as still potentially greenfield opportunity within our international space and really leveraging the ecosystem that we have, that's everything from distribution to all the services call it around, the offers in various countries. So we're very excited about that. Now, in terms of the overall growth contributions in the short term of rolling out Roll into Ireland, I would say they're negligible. I would say even Roll over time this year, I think it would be, not a meaningful contributor to bookings. To me, I think this is really about a long-term investment that we're making across international and what we see as a continued opportunity for us. So you kind of mentioned is this companies that have a presence in Europe, that exist in the U.S. with folks working in or call it in international? And the answer is, this is both of that coupled also with a lot of our, what I would say, best-of-breed offerings in international. So we see growth opportunity really across the board in international and that's everything from the down market, which we're going after now with this new product offering of Roll. So we see it in the SMB space, we see it in our best-of-breed space and we also see it in our global MNC space. So really excited about the long-term growth opportunity that continues to be international. And while on international, I thought I would just mention because it's important to note, we did have a very strong quarter with respect to international, albeit that quarter is obviously off of a compare Q1 of last year that was less favorable, but it is on the heels of what was a very strong fourth quarter finish in international. And so, all the way around, I continue to be incredibly excited and optimistic about what it is that we can go accomplish and continue to build in our international offering."
},
{
"speaker": "Samad Samana",
"text": "Great. Thanks so much for taking my questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Please go ahead."
},
{
"speaker": "Bryan Bergin",
"text": "Hi. Good morning. Thank you. So, Maria, I was hoping if you can comment on just how you're seeing the overall macro situation evolve and maybe how that may affect demand? And if you can specifically unpack that within the ES segment, maybe talk about some of the areas that came in better than you expected versus any areas that may have been lighter or downtick versus the prior quarter."
},
{
"speaker": "Maria Black",
"text": "Absolutely. Good morning, Bryan. So happy to comment on what we saw in the first quarter with respect to the overall performance of bookings, but also the demand. So I'll kind of start with the overall performance. I mentioned in the opening comments, we did see strength, continued strength in our down market, so really excited about that. Also saw tremendous strength in our compliance solutions offering. So think of it as all the stuff that hits compliance tax, things of that nature. So we're pleased with what we saw with respect to new business bookings. Those are the two that really outperformed. And it's exciting to see because really that entire down market offering and that's everything from our run offering to retirement services, insurance services, we continue to see tremendous strength there. We saw that all of last year and definitely the finish last year, and it makes me happy because it's a lot of the places that, well, good performance makes me happy regardless, but it's a lot of the places where we've been making meaningful investments both in the product as well as the distribution. So excited to see the continued performance there and the outperformance. The overall results do keep us in line with our full year guide. So excited to confirm that again here today. In terms of the overall demand environment and I feel like I've been saying this quarter-to-quarter, but we're not really seeing any major changes in demand. Demand is still strong, demand is still healthy. We see that in our bookings results. There are all sorts of other indicators that we look at in terms of pipelines, in the up-market, in the mid-market, certainly in the down-market. We're looking at things such as new appointments and kind of activity, excuse me, activity measures to really give us a guide on whether demand is strong. And I would tell you pipelines are healthy year-on-year and certainly activity is healthy. And so we don't see a big demand change again this quarter. In fact, it’s kind of the opposite stepping into the quarter on the heels of a strong September. We feel really good about where our pipeline sit year-on-year, which again is giving us the confidence in the full year guide. As always though, Bryan, we continue to keep an eye on the macro. We continue to keep an eye on our global space and international and making sure that we're understanding both any macroeconomic changes coupled with any demand environment that could shift given everything kind of going on in the world, if you will. So that's the current story on kind of pipelines demand in the quarter."
},
{
"speaker": "Don McGuire",
"text": "Yeah, maybe.."
},
{
"speaker": "Bryan Bergin",
"text": "Okay."
},
{
"speaker": "Don McGuire",
"text": "If I could add a couple of comments on the macro, certainly macro continues to be pretty positive. Unemployment rates continue to be near decade lows here in the United States. Unemployment rates around the world continue to be quite low. The discussion about whether or not we're going to be in a recession, I think the odds are now not for a recession. So soft landing is pretty much what is being anticipated. Interest rates are expected to have peaked here in the US. So I think all things considered, things are pretty positive. I think the one area that we put in our original guidance for the year and that we continue to look at is our guidance had in fact contemplated a slowing and pays per control growth. Maria mentioned that and talked about that in the PEO business, but we are confident. We are still seeing growth, albeit, we are seeing growth at a slower pace than we had previously. But once again, that was fully contemplated in our original guide for the year."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. That's helpful. Thanks, Don. My follow-up on the PEO. So heard you, the bookings are a little bit lighter than you expected to start, but you're also calling out, I think higher selling expenses impacting the PEO margins here year-over-year. So can you -- maybe talk about the puts and takes there driving that dynamic?"
},
{
"speaker": "Maria Black",
"text": "Specifically on PEO margins? I will let Don…"
},
{
"speaker": "Don McGuire",
"text": "No. But I think originally, Bryan, you mentioned bookings were lighter than expected. I think our bookings came in – our bookings came in pretty good, as Maria has mentioned."
},
{
"speaker": "Maria Black",
"text": "Yeah. I think he's referencing the comment I made around PEO bookings was slightly lighter than expected. By the way, still higher than ES, which we expect to be the case throughout the balance of the year. So that's the kind of nuanced [Multiple Speakers]"
},
{
"speaker": "Bryan Bergin",
"text": "So the question there, you're also citing higher selling expenses impacting the PEO margin. So it seems like there's a bit of a disconnect there. Just trying to understand that."
},
{
"speaker": "Don McGuire",
"text": "Yeah. So we had planned the year, we talked about the growth being stronger in the second half in bookings, sorry, in margins than in the first half. And certainly we have seen some investment and some higher selling expenses and we'll see in the first half than we will in the second half, but nothing really surprising. A little bit off, but certainly we're in line with what we expected."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Please go ahead."
},
{
"speaker": "James Faucette",
"text": "Great. Thanks. I wanted to ask just a couple of quick follow-up questions. First, I think the comment was made that you're still anticipating a bit worse performance in terms of out of business rates on a go-forward basis, but to-date those have been a little bit better than you had anticipated. Can you help provide some detail as to what you're seeing, why you think we're seeing better, survival rates, and kind of the things you may be looking at as indicators that could get worse on a go-forward basis."
},
{
"speaker": "Don McGuire",
"text": "Yeah. Demand continues to be strong in the economy overall, and I think that's supporting what tends to be this view that we're not going to enter into a recession. At best, there's going to be a soft landing. So I think that strong demand environment, particularly consumer demand is keeping small business afloat. So when you also look at what we're seeing in terms of new business formations, there seems to be continued strength in new business formations. So generally I would say that the environment, irrespective of the higher interest rates, the environment continues to be favorable for small business, and I think that's translating itself into what looks to be lower out of business than contemplated now. We have continued, as we said in our original guide, and as we will reiterate or update here today, we have continued to think that we will see a little bit more normalization in other business. So we'd have contemplated that, but we think we are getting closer to where we think we're going to plateau or hit the bottom there. So I think we're very close, and once again, I think it just comes back to demand environment. It tends to be supporting the economy more broadly and more generally and small businesses benefiting from that as well."
},
{
"speaker": "Maria Black",
"text": "Yeah. I think if I may, I think the only thing I would add is that it's still very early in the year, right? So when I think about retention, we did have a record level in fiscal '23. We were near that record level a year before, we were at that record level the year before that. And so we've had this tremendous strength. And I think Don is spot on in terms of all the reasons from a macro perspective that we've had that strength in terms of client retention. And so as that normalizes, we believe it's still prudent for us to have the retention guide that we have, which is really a byproduct of how we planned the year in the back half. So I think I got the question last quarter and so I'll answer it proactively this quarter, which is, are we just being conservative? And I think the answer to that question is, it's still early in the year. And so, if we do continue to outperform retention in the way that we outperformed in the first quarter, we hope that we will outperform for the full year. It's just early to take away that conservatism sitting here just, three short months into a very long year."
},
{
"speaker": "James Faucette",
"text": "Yeah. And then, I want to go back to kind of a headline related question. You saw that -- you saw or you indicated that you'd seen kind of a 25,000 sequential improvement in retirement services and -- for clients, you alluded to some state mandates there, particularly around SECURE Act 2.0. Can you talk a little bit about what state mandates you've seen or that may be impacting that business or how long before we start to see benefit in their retirement services, post a new state mandate? So maybe we can help track headlines and anticipate like, how big of an impact any new requirements may have?"
},
{
"speaker": "Maria Black",
"text": "Absolutely. So I think I've spoken quite a bit to retirement services as well as the SECURE Act over the last year or so. And I will tell you, I was excited to report the new milestone today in part because that business continues to show strength, but also because it's a business that I know is adding tremendous value into the world of work. And so, it is an exciting time. It does come as a byproduct of the offering, the investments we've made into the offering, and also these state mandates, some of which are anchored into the SECURE Act at the federal level, some of which are anchored state by state. Candidly, I could probably spend an hour with you and go state by state in terms of all the various mandates. What we see over the next year or so is the threshold of companies that need to comply with the state mandates starts to creep into, call it, the further down market, if not the micro market. And so, as all these states, a lot of them being on the West Coast, if you're looking for headlines tracking states like California, as they continue to pull down at what level do you need to comply with the state mandates and/or the SECURE Act, the more opportunity we will have to ensure that we're helping our clients to solve for this piece, keep them compliant. But again, back to doing good in the world, it's also something that's bringing the value to each one of these employees that are engaging with these clients, so."
},
{
"speaker": "James Faucette",
"text": "Great. Appreciate that color."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, guys. Good morning. Just want to ask about the decline in PEO. Looking at the employee base of PEO declining versus not necessarily the case, looks like almost the opposite in the employer services. So just trying to think about the trends. And does, typically the trend you see in PEO bleed into employer services and why maybe it's been a little bit weaker for pays per control there in PEO versus employer?"
},
{
"speaker": "Maria Black",
"text": "Yeah. So just to clarify, pays per control in PEO is actually higher. We don't give that number, but it is actually higher than employer services. So I think the first piece suggests is that the bases are actually just different, right? So if you look at the pays per control across the broader ADP, it's really a reflection of a mix of industries. As I mentioned earlier, the PEO tends to skew, by design, by the way, for the offering. It's really -- the offering is the most valuable if you will to the cohorts that we offer it to, which tends to be more professional services, tech-oriented companies that want to offer employers or their employees benefits of choice, if you will, to be employers of choice. And so that skews that base slightly differently than the overall. And what we're seeing within the PEO base is a delineation between those cohorts and the rest of the base, if you will. So we cited it in the prepared remarks, but the deceleration that is happening at the PEO is still a byproduct of within that base having professional services and tech decelerating at a faster clip than the rest of the base. So to answer your question, does it bleed across? I think, we're already hearing these headlines in the market in terms of -- and we see it within our own ADP Research Institute data with respect to professional services and tech hiring being in a different position than the rest of the market. So I think I would suggest it's already been bleeding across. If you look at the last couple of quarters of that, by the way, that also tracks BLS data shows the same thing. You see it in wages. And so all of that to suggest, I would say, the trend we're seeing in the PEO is already in the macro, but the bases are slightly different, which is why you would feel it, the impact of it perhaps more significantly in the PEO PPC than you would in the broader PPC. That was a mouthful, by the way."
},
{
"speaker": "Bryan Keane",
"text": "No that was helpful though. Thanks for that clarification. And then the other question I just had is the strength you saw in the ES new bookings especially in September and the way the pipeline looks, but you're not changing the total outlook of 4% to 7%. Just trying to figure out -- do you feel like you guys are maybe trending if things hold trending above the guidance range for bookings given the strength you saw in September in the pipeline and for SMB strength in the quarter?"
},
{
"speaker": "Maria Black",
"text": "Yeah. What I would offer is that I'm incredibly pleased with the results in the first quarter, especially on the heels of what was an incredible finish last year. And so the pattern that we saw in the first quarter and the strength in September is not a typical of the pattern we see in this -- the first quarter on the heels of an incredibly strong fourth quarter. And so I am excited about the first quarter results, I am excited about the strength in September. But the excitement is actually less about, call it, the finish in September and more about what we see on the year-on-year demand environment, what we see in activity, what we see stepping into this next quarter. And that does give us confidence into our full year guide at that 4% to 7%. What I would also offer though is it's a long year, and when you think about where the skewing, if you will, or the contribution of new business bookings happens for us on a full-year basis, it is in that third and fourth quarter. I'll much call it larger than the first and second quarter. And so we believe it's prudent to given the line of sight that we have today, just a quarter in. But we feel confident in the guide, we're excited about the performance, we're excited about how we're stepping into the quarter. The second quarter that is but we also still have an entire year ahead of us."
},
{
"speaker": "Bryan Keane",
"text": "Got it. Thanks for taking the questions."
},
{
"speaker": "Maria Black",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Please go ahead."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi. Thanks for taking my question. Could you give us your latest thoughts on the competitive environment in PEO and how that's sort of evolving over time? I think there's somewhat slower than historical growth across the industry. Are there any signs that the market is, saturated with providers or is there any competitive overlay to PEO performance?"
},
{
"speaker": "Maria Black",
"text": "I would suggest that the PEO ASO conversation, if you will, or PEO HR outsourcing offerings kind of continues. I don't know that there's anything new to report, Ramsey. I think from my vantage point, it's always been a very competitive environment. We all have slightly different PEOs from one another. I think we talked a lot about ours today and the way that it skews to professional services and tech. I think you have others that skew to different types of industries. You also have other PEOs that perhaps are a bit more down market. We tend to skew a little bit more upmarket than some. And so I think all the PEOs look slightly different. I think we all know our models are also not identical in terms of how we actually go-to-market, whether it's through the strength that we have in the competitive advantage of being able to have ADP's client base contribute about 50% of those upgrades. So I think how we go to market, our models, never mind the models of, you know, fully insured to self-insured, et cetera. I think similar trends are within the ASO offerings, or some refer to them as HRO offerings. And so I think within there, you also have various models and various go-to-markets in terms of the, some competitors perhaps some -- have some flexibility or more movement between ASO and PEO than I think we've cited in the past. And so, I think all that to suggest I think the competitive environment is about the same and remains. I think I’m optimistic and expect growth in both our PEO bookings as well as our HRO and ASO offerings throughout the balance of this year. And so I think we remain very, very excited and optimistic about the growth of those -- all of our HR outsourcing offerings, both in this year as well as the long term."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. Okay. And a follow-up for me. Could I ask you to revisit those comments you made about higher selling expenses in PEO? What does that mean exactly? And also just I wanted to make sure I understood that, Don mentioned that, there's some expectations those may continue, but they're still, in essence, sort of a non-recurring step up in expenses. It's not a permanent step up in, in expenses in the segment."
},
{
"speaker": "Don McGuire",
"text": "Yeah. We saw higher selling expenses in Q1 for the PEO, and we expect to see higher selling expenses year-over-year in the first half, but we do think that that's going to settle down into the second half. So we're not looking at the kind of growth that we saw last year. I think we commented quite extensively on the many, many salespeople we added into the business last year and had great success and allowed us to finish the year the way we did. So those folks are in place. So we are continuing to add some sellers. We will add though, most of those sellers in the first half and it's important to also, I think, call out here that, what we are seeing with our sellers is that we are getting much better retention within the seller community. So we are hoping and expecting to benefit from the improved tenure that we should see from the selling organization as we go through the balance of this year."
},
{
"speaker": "Ramsey El-Assal",
"text": "I got it. So it's headcount-related primarily. That makes a lot of sense. Thanks so much."
},
{
"speaker": "Maria Black",
"text": "Yeah. I think it's a timing thing. I think that's the…"
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Please go ahead."
},
{
"speaker": "Jason Kupferberg",
"text": "Good morning, guys. Just staying on PEO for a second and maybe if we can just refresh a little bit here. I'm just thinking back to the Analyst Day two years ago, we thought it was a medium-term 10% to 12% grower. Now it's 2% to 3% at the moment. There was definitely some post-COVID normalization. But maybe just, Maria, if you want to take us back through the dynamics in terms of just how the business has evolved from your perspective? And is there a potential path back to double-digit growth for this business if the macro is a little bit more cooperative?"
},
{
"speaker": "Maria Black",
"text": "Yeah. So I'll let Don kind of speak to the medium-term targets and kind of the path back. But I think, from my vantage point, and I said it earlier today, that step one is the continued reacceleration of bookings. And so this is the third quarter that we're pleased and we did have a solid contribution of PEO bookings to the overall bookings picture in this quarter. That was the case last quarter, it was the case the quarter before. And I think the reason that I go to that is not just because it's the piece that will accelerate the growth and path us back to what our long-term goals and medium-term targets are with -- for that business. I think it's also because it speaks to the demand environment. It speaks to the value proposition and the strength of that offering that still exists in the market. And so I think that's a big piece of it. I think step two is the continued acceleration -- reacceleration of retention. So I mentioned that retention has been stable and as we reaccelerate retention back into that growth, that also will contribute to obviously the revenue. And then last but not least, Jason, you mentioned it, the macro headwinds, and I think I talked about the last couple quarters, how that's been the post-pandemic, call it, nuances that impacted that business. I think we talked a lot about the renewal over the last couple of quarters. Now we're seeing these trends in PPC. My view would be that all of the post-pandemic waves that have been, call it, flowing through the PEO and all the variables that make up that model. We're still seeing some of those case in point being really call it the reversion of what we saw several quarters ago, which was when professional services and tech was in a massive hiring boom, now we're seeing the opposite of that, right? So I think we still have some of these waves, kind of shuffling through or whether or going through -- flowing through the PEO. And if and when the macro changes with respect to that, that certainly will help reaccelerate that business as well. So in terms of the path back, I'll let Don kind of speak to the medium-term targets."
},
{
"speaker": "Don McGuire",
"text": "Yeah. I think Maria covered it very comprehensively there. I would say that when we established the mid-term targets, I think a lot of things have changed since then, certainly the inflation environment and that we've seen in particular and Maria just mentioned professional services and technology, we saw incredible growth in those sector -- in those segments and growth beyond what we thought we -- or what we had predicted in the mid-term targets or spoken to. I think now we're seeing some reversion. We do, though, continue to be incredibly positive about that business. We think it definitely has a place, and we think that we will make our way back. But as Maria also said, it's a little bit early to forecast when we think we're going to get back to some of those mid-term target growth areas that we had discussed."
},
{
"speaker": "Jason Kupferberg",
"text": "Understood. That's good color. Just a follow-up on float yield. It looks like it was actually a tick down slightly quarter-over-quarter here in Q1, amid a higher rate environment. But just curious what the callouts might be there."
},
{
"speaker": "Danyal Hussain",
"text": "Hey, Jason. That just relates to the mix between short-term and extended in long. So in Q4, we were a little more levered to overnight partly because of this debt ceiling issue. We had to be deliberately skewed shorter duration. But in a typical Q1, we would generally have a lower short portfolio. And so there is seasonality in the average balance wouldn't read much into it. The year-over-year number is a much more relevant metric."
},
{
"speaker": "Jason Kupferberg",
"text": "Thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang with JP Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hi. Good morning. Forgive me, if I'm asking another clarification on the PEO side. Just --what the -- was the slight softness in the bookings also related to the PS and tech sectors and also with the pays per control within PEO, is that more of a healthcare participation issue or just labor weakness in those sectors?"
},
{
"speaker": "Maria Black",
"text": "I really apologize, you actually blipped out during the first part of your question. Would you mind just repeating -- yeah, there was a word missing so."
},
{
"speaker": "Tien-Tsin Huang",
"text": "No, I probably didn't ask it very well. Just wanted to make sure the bookings softness on the PEO side, was that also in the professional services and tech sectors. And then also just on the pays of control, was is a labor weakness or health care participation?"
},
{
"speaker": "Maria Black",
"text": "Yeah. Listen, so I'm glad you're asking this question actually because I just want to reiterate, we were very pleased with our PEO bookings. And so there wasn't softness, there was strength and growth in the PEO quarter bookings. In terms of how we skewed the year, it was slightly lighter than we had positioned our planning, which is why it contributes the way that it does to the overall worksite employee growth. But, it's -- again, the worksite employee deceleration is really about the PPC story. And so I just want to reiterate, we were actually very pleased with the quarter from a PEO bookings perspective. In terms of the industries, I think it's a mix. I think we continue to see the PEO execute with respect to the industries that we target which tend to be into those categories. As it relates to, this comment around kind of within the PEO, the deceleration that is happening faster in professional services and technology versus the broader base of the PEO. Again, I don't want to give kind of the numbers of what that is, but it isn't like the entire base is sitting in professional services. It's just that subset, if you will, of the base. And it is really, again, kind of triangulate to the macro that we're seeing and the same type of data coming out of ADP Research Institute, out of the BLS and it's really about hiring. So it's less about, call it, layoffs and it's really where the professional services and tech industries, we're doing massive hiring, call it, a year ago, six quarters ago, it's really a lack of hiring that's happening in those businesses. Did I answer that question?"
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yeah. [indiscernible]"
},
{
"speaker": "Danyal Hussain",
"text": "Tien-Tsin, just on the participation piece of it, the pay per control wouldn't be impacted by participation rate, but the reported revenue would be. So to the extent, workers are taking plans, cheaper plans or fewer plans. And there's a little bit of that. You do see it in the revenue per WSE, but the WSEs themselves wouldn't be impacted."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thank you, Danny. I didn't ask it. Well, that's perfect. That's what I was looking for. On the -- we get questions around pricing as well. That's why I was asking about the participation side of things and if there's a difference there, it sounds like it isn't. On the international front, just my quick follow-up. Just I think Sweden was the call-out in terms of acquisition. Why is Sweden important to own? Just I'm not as familiar with some of the specific countries that you're targeting. And I'm curious if this is just part of a -- maybe a broader plan to aggregate international payroll."
},
{
"speaker": "Maria Black",
"text": "Absolutely. So listen, I have to take this question because I think you may know that I'm actually -- I was born and partially raised in Sweden. So I thought it was prudent to make it the very first country that I announced. I'm actually completely kidding. This was obviously well in motion before my time. But I -- it sounds like I might be closer to Sweden than you are. And for us, it is an exciting time for us. We have had this partnership with BTR for quite some time for us to be able to acquire the payroll business of BTR is exciting because the Nordics are growing, and this does give us a physical footprint into Sweden, which allows us to expand further into the Nordics and really take advantage of the growth trajectory of those economies. So this is obviously payroll, but also in the beyond payroll opportunities that we will have in years to come. So really excited about the acquisition not just because it's near and dear to my heart, but moreover because the Nordics represent growth, and it's exciting to think about us having a physical presence there."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from David Togut with Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"text": "Thank you. Good morning. You called out strength in ES bookings, particularly in the small business market with RUN. Could you provide some texture into the bookings trends you saw in mid-market with Workforce Now and then up-market with enterprise? And any insights you have into international bookings in the quarter would also be appreciated."
},
{
"speaker": "Maria Black",
"text": "Absolutely. So yes, we did have great strength in the down markets, kind of moving on up in the mid-market. Certainly, we have continued solid demand in the mid-market. That's inclusive of our Workforce Now platform. It's also inclusive of our HR outsourcing offering. So I spoke a bit about the ASO models, the HRO models earlier in that mid-market also support -- is supported by the PEO. So we do see continued demand from the mid-market. I think the way I always think about it is not getting any easier for companies in that mid-market to navigate being an employer today. And so we expect continued strong mid-market growth. I think in the up-market, since you asked about the enterprise space, one of the call-outs we made last quarter was about the strength that we saw in our next-generation HCM offering, and we did see that strength continue into this quarter, which we think is fantastic. We also see strength in the pipeline in that space year-on-year. So excited about what we're hearing from our clients, the sentiments around the offerings that we have in the enterprise space. And then I think I touched a little bit on international earlier, but our international business did grow nicely in the first quarter. Again, it was a benefit of a little bit of an easier compare year-on-year. But we also had, as I mentioned, a really strong finish and a strong fiscal '23 in our international business. Again, what I measure is partly the results. But as I think about the look forward, it's really about pipelines and what I would say, our international pipeline year-on-year have a fair amount higher than they did a year ago, which gives us the strength to really feel good about our international bookings to remain healthy through fiscal '24."
},
{
"speaker": "David Togut",
"text": "Thanks for that. Just as a quick follow-up, Don, you called out part of the 90 basis point margin decline in PEO being traced to a difficult comparison on workers' compensation reserve adjustments a year ago. Can you quantify for us how large those were as we think through the margin comparisons for Q2, Q3 and Q4 of FY ‘24 in PEO?"
},
{
"speaker": "Don McGuire",
"text": "Yeah. So as we've had very favorable reserve releases over the last number of years and somebody called out last year in the K, you would have seen the favorability there. So just to be clear, we are still seeing favorable reserve releases, but we are not seeing -- we didn't see the reserve release to the extent that we did Q1 to Q1 of the prior year. So the numbers will be in the Q, but it's about $6.2 million less than it was in the prior year. So that's the quantification of it. And if you kind of translate that into the margin, it's about 60 bps to 90 bps -- 60 bps of the 90 bps decline comes from the lower reserve release. Now once again, we think that we're going to continue to see reserve releases and were favorable as the actuaries get back to us and let us know what's happening, but we're not seeing any underlying changes or large changes that would lead us to be any less optimistic about seeing continued releases in the reserve."
},
{
"speaker": "Danyal Hussain",
"text": "And David, sorry, just to clarify, it was a $6 million benefit in Q1, which is about $8 million less than the prior year."
},
{
"speaker": "David Togut",
"text": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey. Good morning, and thanks for taking my question. At HR tech, you got to see a lot of your new solutions, particularly focused on, the AI Assisted solutions. Maria, I'm wondering if you can talk a little bit about your philosophy with regards to, which solutions you would charge additional for -- how are you thinking about monetization? And then I've got a follow-up in terms of process improvement."
},
{
"speaker": "Maria Black",
"text": "Sure. Good morning, Mark. I'm pretty excited about all of our new solutions that you would have seen at HR tech. So I think I'll take a minute to kind of think or talk through how I'm thinking about Gen AI in general, and then I'll tell you how I'm thinking about monetization because I think it'll make more sense on the other side. But when I think about Gen AI, I think it will impact everything. So the answer is it's going to be everywhere impacting everything that we do across the entire client life cycle. So it's about how we develop products. That's everything from developer co-pilot types of tools that everyone is talking about. It's about how Gen AI will be embedded into our product, it's about how we go-to-market and modern seller stuff that I've spoken about for years and how we actually have the ability now leveraging Gen AI to actually acquire clients. And then the most obvious being how we serve them, how we implement them, how we become more productive and make our clients more productive as we serve our clients. And so when I think about Gen AI, and I think most -- everyone has probably likened it to things like whether it's software or the Internet, I think my answer to you is, it will be in everything that we do and in the fabric of who we become. And so in terms of the monetization side, I think it's less about, charging a PEPM (ph) on a per feature. So let's say, you know, some of the things I talked about today, which probably doesn't sound that exciting, like report writing or if you look at the earnings release document, you'll see in there a job description that's pulled in the screenshot showing roles. So these things probably don't sound that exciting, but they're pretty exciting because they are the seeds of innovation, as I used earlier to really show what -- how Gen AI will interact with everything that we do kind of in the fabric. So said differently, Mark, like, I don't think we're going to be charging separately to get Gen AI job description written or Gen AI report written. I think it's really about continuing our innovation journey to do all the things we've always done, which is really about becoming more productive. It's about solving things for our clients and making them more productive. And I think that, to me, the fruits of that labor really end up in new business bookings, and they end up in retention. And so that's not to suggest that there may not be things. But I don't think it's really to me about $0.50 PEPM (ph) here and there. To me, it's really about the innovation journey we've been on. This just allows us to do it at a faster clip. And I'm really optimistic and excited about the things that we're seeing. In terms of other things that we're measuring, we actually have the entire organization rallied to engage in these tools. We actually have some goals that we put out there in terms of -- by the end of the year, how many of our associates that set across sales and implementation and service and technology that are engaging with these tools. Right now, they're sitting at already above 10% of our base of associates that have the ability to touch these tools are already playing with them. I would tell you our entire sales organization are comping up a bit because the digital sales or inside sales where we've deployed a lot of these modern tools over years, have an ability to become that much more productive, engaging our new prospects and new sales. So as you can probably tell, like, I literally could go on and on and on, but I think my answer to you is, it will be everywhere across the entire client life cycle that we have, and I'm very optimistic about the long-term implications of this on all the major metrics that make up this great business model."
},
{
"speaker": "Mark Marcon",
"text": "That's terrific. And then with regards to just the productivity enhancement. I mean, particularly when we think about service and implementation, from a longer-term perspective, can you describe how much more efficient you think your service personnel could become? And how much efficiency you could end up gaining there and the implications from, continuous margin improvement as you continue to go along that journey? I know it's early days, but just how are you thinking about that?"
},
{
"speaker": "Maria Black",
"text": "Yeah. Listen, Mark, it is early days, right? And that's not for a lack of scoping it, right? So we have had because it's not as though we haven't had all of these business cases over many years on how to become more productive, and we've had machine learning and regular AI in our house for a long time. And this does give us a step change to that innovation. But it's still too early. I think to sit on an earnings call and commit numbers, but that's not for a lack of internally having scoping and line of sight to what we believe are pretty exciting goals for us to go chase. And again, some of those goals have existed for a long time, but now we have technology that I'm hopeful that we can actually finally crack the code on some of these really big enhancements that we see. But certainly, productivity is a big piece of it. I know I talked today about Agent Assist and this idea of call summarization. Again, it probably doesn't sound that exciting. But for someone who used to sit on the other side of that, you see whether it's a prospect call or a client call gets summarized and recapped into a very quick format that's usable. These are, hours and minutes of time. even on the seller side, we actually are launching something called rapid pre-call planning, and I think about the hours I used to spend 27 years ago, researching a company to get myself ready to go in and have a conversation with a prospect that brings value, enabling our sellers to have all of that productivity. So I think it's -- again, it's too early to give you exact hundreds of millions of dollars of types of quantifications. But arguably, we are actively looking kind of case by case and really picking the ones that we believe sequentially will be the most accretive to drive the most amount of productivity, the most amount of value back to our shareholders, but candidly, the most amount of value to our clients."
},
{
"speaker": "Mark Marcon",
"text": "Terrific. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. We have time for one more question and that question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Great. Good morning, guys, and thanks for squeezing me in here. Just on the launch of the construction vertical software. I'm just wondering, is this sort of part of a bigger shift to develop more vertical specific HCM solutions for your clients? I understand, construction may be a more complex vertical, but wondering if there's more of a vertical specific strategy that could develop beyond the construction vertical. Thanks."
},
{
"speaker": "Maria Black",
"text": "So I'd like -- what you're suggesting, and I think the answer to that could be yes. And I think when I think about -- back to selling 27 years ago, I used to sell construction companies and the complexity that they have has always existed and candidly, a lot of the features and functionality that we have and are now pulling together to make it an actual solution for that vertical existed many years ago. And that's everything from things like job costing, obviously, compliance and reporting, think about certified, compliance type of reports for payroll, things of that nature. And so it's really about pulling it together and marrying it with a service organization that can support the complexity of that vertical. I think that, to me, is a big change, so we did add some features. But a lot of these things we've had, and we pulled them together and we're marrying it with the ecosystem of a dedicated service org that can actually really help the construction industry and this vertical saw the complexity of being in that industry. So I think what I would offer is that, it's an exciting time for the construction industry, specifically for our Workforce Now clients, and I see this, just as you suggested at the beginning of other places that we could pull together our existing tech with a dedicated type of service model and solve real challenges in the business for various verticals."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. That's helpful. And just a quick follow-up. Just wondering if you can give an update on sort of Next Gen HCM and Next Gen Payroll, attach rates and how we're sort of trending there, relative to expectations?"
},
{
"speaker": "Maria Black",
"text": "So Next Gen Payroll. That was the question?"
},
{
"speaker": "Scott Wurtzel",
"text": "Both."
},
{
"speaker": "Maria Black",
"text": "Both. Okay, just making sure I heard it right. So I think I touched base really quickly on Next Gen HCM. And I think I noted to the excitement that we have that we continue to see the strength in the Next Gen HCM offering into Q1. So we had a strong fourth quarter. What I would suggest is that we actually brought in more Next Gen HCM in the first quarter than we saw all of last fiscal year. But again, one quarter these things can sometimes be lumpy. But I think for me, it's really about the sentiment. And so we recently had an Analyst Day. We had a handful of our clients up on stage that, shared with us the impact, the platform is making for them. And as you would remember, we spent a lot of our discussions over the last year talking about scaling implementation, on-boarding the backlog. So pretty exciting to see some of that backlog that's no longer backlog on stage, speaking to the value proposition, and that's supported by continued strength which means our sellers are excited to continue to sell the Next Gen HCM offering. So I think that's all very, very positive. Similarly, we have continued focus in the Next Gen Payroll. And so what I would offer there as we continue to make headway. So as it's not deployed across the entire mid-market. We continue to make headway to solve for more complex features, things of that nature, that will pull it further into the upmarket of the mid-market. But as you know, that Next Gen Payroll engine is also what's attached to the Roll offer. So the other exciting part about that engine is it is the thing that's taking us into the SMB space internationally. So I feel really excited about the road map for that offering and the contributions that it's making into the mid-market today, but also into the long-term growth of the company internationally."
},
{
"speaker": "Scott Wurtzel",
"text": "Awesome. I appreciate the color. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Yeah. So thank you, Michelle. And listen, it's hard for me not to sit here and reflect on a year ago. And so I was driving in this morning and feeling candidly a bit nostalgic because it's exactly one year ago that Carlos and I sat here and announced the transition of me becoming CEO of this amazing company. And so I'm incredibly nostalgic and proud today. I'm proud of our first quarter results. I'm really proud of the execution of the team, both with respect to the results, but also with everything that you heard in terms of the progress we are making on a very cohesive and strong strategic outline and priorities. But mostly what I would offer is that I remain incredibly humbled by the -- over 60,000 associates that I've had an opportunity to engage with over the last year who continue to make this company everything that it is and absolutely amazing. And I just wanted to say that I'd like to thank each and every one of them for inspiring me every day. So with that, that is the conclusion of our call and until we meet again."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 3 | 2,025 | 2025-04-30 08:30:00 | Operator: Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter 2025 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President, Investor Relations. Please go ahead.
Matthew Keating: Thank you, Michelle, and welcome, everyone to ADP's third quarter fiscal 2025 earnings call. Participating today are Maria Black, our President and CEO; Don McGuire, our CFO; and Peter Hadley, our Treasurer. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Matt, and thank you, everyone, for joining us. Before discussing our third quarter results, I want to take a few moments to acknowledge this morning's press release announcing our CFO transition. Don McGuire has enjoyed a remarkable career at ADP. Initially joining ADP Canada in 1998 as Vice President of Finance, he would go on to profoundly shape our international business, serving in a number of key leadership roles around the world, including his 2018 appointment to the position of President, Employer Services International. In 2021, Don returned to his finance roots, taking on the role of ADP's CFO, where he has provided strong financial stewardship and valued strategic counsel. In particular, as I transitioned into my role as ADP's CEO, I'm honored to call him a colleague, and more importantly, a friend. Don, thank you from the bottom of my heart for your countless contributions to ADP. And with that, as part of our orderly succession planning, I'm excited to share that Peter Hadley will succeed Don as CFO, effective July 1st with Don assisting with this transition through the end of September. Many of you already know Peter through his participation in various investor meetings and calls over the course of the last year. He joined ADP in 2002 and is also a global citizen, having held roles in both finance and operations for ADP in Europe, Asia, and the United States, including as CFO of our international and enterprise business units, President of Asia Pacific, and most recently as Corporate Treasurer. Peter brings deep financial expertise, extensive knowledge of ADP and our industry and strong leadership and strategic skills to the position. You will have the opportunity to hear more from Peter at our Investor Day on June 12th. In the meantime, I hope you will all join me in wishing Don well and in welcoming Peter to the CFO role. Now onto our results. This morning, we reported solid third quarter results that included 6% revenue growth, 10 basis points of adjusted EBIT margin expansion, and 6% adjusted EPS growth. I am excited to share the progress we continue to make against our strategic priorities, but let's first review some additional financial highlights from the quarter. We delivered another solid quarter of Employer Services new business bookings growth. In particular, we were pleased with the results across our U.S. offerings with our small business mid-market and enterprise as well as compliance solutions offerings, all performing well. We meanwhile experienced a softer quarter for international bookings as a result of macroeconomic uncertainty in some of our key international markets. With healthy new business pipelines, we remain focused on delivering overall bookings growth within our guidance range. Employer Services retention, again modestly exceeded our expectations, declining slightly compared to the prior year. This continued strong retention performance reflects client satisfaction scores, reaching record highs for third quarter and on a fiscal year-to-date basis, with the most meaningful improvements coming from our enterprise, international and HRO businesses. Our U.S. clients continue to hire in the third quarter as our Employer Services pays per control growth remained at 1%. And last, PEO revenue growth of 7% exceeded our expectations, helped by higher wages, strong retention and continued growth in zero-margin pass-throughs. Now let's turn to our continued execution on our strategic priorities, which include leading with best-in-class HCM technology, providing unmatched expertise in outsourcing and benefiting our clients with our global scale. Our momentum with enterprise clients continued in the third quarter. New business bookings for ADP Lyric HCM increased substantially, and our pipeline for new Lyric business doubled compared to last year. Among the new clients to start a Lyric during the third quarter was a leading provider of home healthcare services with more than 36,000 employees. This client is now live with HR, payroll and time and plans to add recruiting and talent this quarter. We were also pleased with Workforce Software's new business bookings with ongoing strong interest for its time and attendance, absence management and scheduling tools from organizations across a variety of industry verticals and geographies. We continue to make progress in our work to tightly integrate the acquired Workforce Software business with key ADP HCM platforms. We further strengthened our global payroll capabilities with our acquisition of PEI in Mexico in the third quarter. Based in Mexico City, PEI has provided robust payroll solutions, HCM expertise and technology to local and multinational clients for 30 years and has been a valued ADP global payroll partner since 2009. By integrating PEI's payroll expertise in Mexico with ADP's global reach and comprehensive HCM solutions, we enhance the experience we can provide to our local and global clients. In addition to PEI's products and solutions, the acquisition added nearly 300 experienced associates who bring deep local expertise as we continue to pursue growth opportunities across the Latin America region. We supported our clients and partners by hosting a number of signature events during the third quarter. At the ADP ReThink event in Zurich, leaders from the world's largest organizations came together to share insights and lessons learned from their global transformations and to discuss challenges and opportunities in a rapidly changing HCM landscape. At the ADP Meeting of the Minds event in Las Vegas, we hosted enterprise clients from across all industries sizes and locations together with industry experts to focus on one important mission, making work better. And at our Accountant Connect Summits, we provided more than 10,000 partner attendees with access to thought leaders who are shaping the future of the accounting profession. During the third quarter, we also continued to advance our embedded payroll partnership with Fiserv, we are actively referring our clients and prospects to Fiserv's Clover point-of-sale solution, while Fiserv is referring its merchant clients to ADP's run payroll. We expect our sales to accelerate as we complete our product integration work this year, enabling us to offer a differentiated integrated solution. We are excited by this relationship as well as the broader opportunities we see to grow our embedded payroll solution over time. Finally, our focus on best-in-class HCM technology led to several recent awards, including RUN being named number one on G2's Best Software Products for Small Business, ADP Lyric HCM being named Data Solution of the Year for Human Resources and the 2025 Data Breakthrough Awards and ADP Assist being named a winner in the 2025 Artificial Intelligence Excellence Awards presented by Business Intelligence Group, earning recognition for driving innovation and possibilities in AI. We look forward to sharing more details around the strength of our product portfolio as well as our innovation roadmap at our upcoming Investor Day on June 12. Overall, we were pleased with our strong financial and strategic outcomes in Q3. I'd like to thank our associates who continue to deliver exceptional products and service to our clients and whose efforts drive our client wins, industry recognition and record client satisfaction levels. Thank you again for all that you do for ADP and for our clients. Don?
Don McGuire: Thanks, Maria, and good morning to everyone on the call. Before I start, I would just like to thank you, Maria, for the kind words. It has truly been a privilege to contribute to ADP's success over the years and to work alongside so many talented and committed colleagues. I am also happy to see ADP's CFO position being assumed by such a capable and innovative leader, and I look forward to working with Peter to ensure a seamless transition in the coming months. Now for some color on our results for the quarter and our updated fiscal 2025 guidance. Overall, we reported a solid third quarter with our consolidated revenue growth and adjusted EBIT margin coming in above our expectations. We are adjusting our full-year guidance to reflect our better-than-expected Q3 results as well as making a few other changes, which I'll detail. Let me begin with our Employer Services results and guidance. ES segment revenue increased 5% on a reported and organic constant currency basis in the third quarter. As Maria mentioned, ES new business bookings growth was solid given the current macroeconomic uncertainty, a recent softer international bookings and the importance of the fourth quarter a range of new business bookings outcomes remains for fiscal 2025, and we are reiterating our 4% to 7% growth guidance. With ES retention again coming in better-than-expected in Q3, we now forecast a decline of 20 basis points to flat for the year, which is better than our prior guidance. ES pays per control growth was 1% in Q3, and we now expect 1% growth for the full-year. Client funds interest revenue increased by more than we anticipated in Q3, driven by stronger average client funds balance growth. We are raising our full-year average client funds balance growth expectation to 5% to 6%. Our fiscal 2025 forecast ranges for client funds interest revenue and the net impact from our extended investment strategy each increased by $15 million at the midpoint. In total, there is no change to our fiscal 2025 ES revenue growth forecast of 6% to 7%. Our ES margin increased 20 basis points in the third quarter, and we are narrowing our fiscal 2025 ES margin guidance to now expect growth of 50 basis points to 60 basis points. Moving on to the PEO. We had 7% revenue growth and 2% average worksite employee growth. PEO revenue, excluding zero-margin pass-through growth of 8% was supported by higher wages and strong retention. PEO pays per control growth decelerated modestly from the second quarter. To reflect our Q3 results as well as the ongoing benefits anticipated from higher wages, we are increasing our full-year PEO revenue growth forecast to 6% to 7%, and PEO revenue, excluding zero-margin pass-through growth to 5% to 6%. We are maintaining our 2% to 3% average worksite employee growth guidance for the year. PEO margin was flat in the quarter as strong revenue growth and favorable actuarial loss development in workers' compensation reserves were offset by higher workers' compensation and SUI costs. We now expect PEO margin to decrease between 60 basis points and 80 basis points for the full-year, which is slightly better than our prior forecast. Putting it altogether, we are maintaining our fiscal 2025 guidance for consolidated revenue growth of 6% to 7% and now expect to come in towards the high end of this range. We are updating our adjusted EBIT margin expansion guidance to 40 basis points to 50 basis points. We continue to anticipate a full-year effective tax rate of around 23% and now expect fiscal 2025 adjusted EPS growth of 8% to 9%. As we look ahead to fiscal 2026, we wanted to share a few early thoughts. First, heightened levels of macro uncertainty are leading to projections for slower economic growth. With this in mind, we expect our pays per control growth to continue at below normal levels next year. We will also continue to monitor any impacts from the uncertainty in the global macro environment on international sales, particularly our larger multi-country deal activity. As a result of our laddering strategy, we remain positioned for continued tailwinds from our client funds portfolio as anticipated reinvestment rates remain above the average yield of our maturing securities, driving overall yields expected on the portfolio above fiscal 2025 levels. As always, we will remain focused on driving growth in our new business bookings, maintaining strong client satisfaction and retention levels and investing in our products and people to deliver sustainable revenue growth and margin expansion over time. Thank you, and I'll now turn it back to the operator for Q&A.
Operator: Thank you. [Operator Instructions] We will take our first question from the line of Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi, thank you for taking my question, and it's been great working with you, Don. Best of luck in the future and also congratulations to Peter. Maybe I could ask about the software international bookings that you called out, a little more color there? Is it sort of a particular regions, products? Any other color that you could give us there would be helpful.
Maria Black: Yes, sure. So good morning, Ramsey, and thanks for joining us today. So I'll comment on the international bookings. So overall, the international space had executed, and we have several quarters of consistent strength. And what we saw in Q3 was a bit of softness. And undoubtedly, we think the softness is anchored and uncertainty in the macro environment. That said, though, the international space in general, these are large deals. They tend to be lumpy. We have strong pipelines. So from a broad-based perspective, the pipelines are strong, both in country as well as the global view offers and things of that nature of the multi-country deals. However, we have a lot to get done, I guess, in the fourth quarter. So it is a little bit of a lumpy environment out there. These are lumpy deals, but the pipeline supports a solid finish to the year.
Ramsey El-Assal: Got it. Okay. Thank you. And also on the – you called out the Fiserv relationship. And I guess just more broadly on that embedded offering, what do you think of the growth opportunity there in the addressable market? Is there a large opportunity for embedded across potentially other distribution channels and partners?
Maria Black: Sure. So we are very, very excited about the Fiserv relationship. It is progressing well. This year, we are going to roll out the integration. I think there will be a leapfrog stage for both of us. So thus far, we're sharing referrals back and forth. We are perfecting the model from a distribution. So you imagine our distribution being folded together with their distribution across our go-to-market, but also across our bases, in terms of the over 1 million clients that we have in RUN. And I think they're shy of 1 million, but nonetheless, the overlap is not 100%. So there's a tremendous amount of opportunity for us to address each other's basis. And so we do think the game changer though will be when RUN is embedded into the Clover offer and CashFlow Central is embedded into the RUN offer. And that's forthcoming. So we're really excited about that. We do think that's big. That said, we also believe that there might be an opportunity to extend that reach across multiple additional ADP platforms. So think taking it into potentially the mid-market, into other countries. We're both global businesses. So we think the reach just even within Fiserv is meaningful for us. But to your question, beyond that, we're very excited about our embedded offer. We have it across a couple of other places. And in my mind, this is the proof point of really seeing how the integration can work from a technology perspective. But certainly, we are looking at other places that we have the ability to extend our reach through our embedded offering to really extend the total addressable market, if you will.
Ramsey El-Assal: Thank you.
Operator: Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Hey, guys. Great results, and it was a pleasure working with you, Don. I feel like everyone is a little bit confused. Results are great. You're talking about uncertainty. Some of the payment companies out there are still saying things are good. Can you maybe tell us a little bit more in terms of when we say uncertainty, how much is it holding back on hiring? Or is it just people are worried, like maybe just like concerns, maybe you could parse out concerns versus actual actions, I would say, from your clients that would I think really be helpful for investors.
Don McGuire: Yes. Dan, thanks for the comments, and thanks for the question. What we're seeing, we're seeing a lot of stability in our base. I mean the underlying economic factors are still pretty strong for us in terms of unemployment is low. And yes, we are still rounding down to 1% PPC growth, so people still are hiring. There's some of that happening. I think the uncertainty that we're seeing, though, as Maria mentioned earlier in the bookings comments is these very large deals that perhaps span multiple countries I think there's some apprehension there, if you will, to make decisions, although the pipelines are very strong, and these deals are always a long time in the making because they are complicated and complex and they do reach into several corners of the globe. But having said that, we're not terribly far off what we saw pre-pandemic, where it was always hard to find people to get signatures, et cetera. So we're still optimistic, and as we said, in our own base, things are still going well. We watch bankruptcies. We watch clients who are active, but not billing. So things seem to be pretty calm for us. But we can't deny that what we're hearing and what you're reading, we're all hearing. So hopefully, these things settle down. But in our own base and day-to-day business, things are still pretty strong.
Dan Dolev: That's great. Thank you. I think this definitely helped clarify what's out there. Really appreciated.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: First, Don, it's been pleasure working with you. Hope you have all the best and enjoying your retirement. And Peter, welcome. Maria, you mentioned international, and we just talked a little bit about the uncertainty. But I'm just wondering if you could delve a little bit more with regards to what you're seeing in terms of mid-market companies, the smaller companies that would typically use one. Are you hearing anything? Or is your – are your sales folks hearing anything about any sort of uncertainty pushing out delays? Or how is that impacting the PEO business we heard from a different player yesterday that ended up indicating that they were seeing a slowdown with regards to potential hires in their PEO business. So wondering about that? And then I've got a follow-up.
Maria Black: Sure. So I'll start. I think we talked a little bit about international. And Don shared that, broadly speaking, we feel solid about the pipelines, we feel solid about the execution. I think it's really about – we have a lot to get done as we always do in the fourth quarter. So I think with respect to the mid-market, the down market and the PEO and the rest of your question, Mark, broadly speaking, we're very pleased with our results this quarter. They're solid. And so I think from a distribution standpoint, we continue to execute. We continue to see that clients are investing in their people. So if you think about our industry versus what was shared earlier from Dan around, call it, the payments business, if you will. HCM is not discretionary as it relates to companies are investing in their people. They're investing in hiring. They're investing in talent and candidly, they have to pay people. And so we're not seeing from a distribution and HCM demand perspective. Demand feels okay. It feels as it relates to pipelines in the down market and PEO, we measure that more with respect to activity in terms of how many appointments or sellers are going on, how many RFPs are going through the PEO model. PEO bookings, there was growth in the third quarter. It was a little bit less than the second quarter. But at the same time, we have line of sight of good solid growth in the PEO to round out fiscal 2025. We also see good strength in the PEO and retention. So I think all things being equal, we feel good about the demand. It feels okay out there in the down market, mid-market, up-market, PEO, even in international has pipelines to support the broad range of bookings guidance that we have.
Don McGuire: Yes. Maybe, Maria, just to add on the PEO question, Mark, that you asked, our PEO bookings were good in the quarter. We were happy with them, and we did have a 2% worksite employee growth. So our pays per control were also a little bit better than we expected. So we were happy with PEO in the quarter for sure.
Mark Marcon: That's great. And then Maria, ADP has been doing a great job in terms of modernizing. Can you give us an update with regards to WorkForce Software in terms of that being integrated and maybe even a little bit more color with regards to Lyric? It sounds like things are going really well from that perspective.
Maria Black: They are, Mark. Things are going incredibly well. So the – just a reminder for everyone, we closed on that integration in October. We've been very busy since then. And so part of that busyness was the overlap of the pipelines and really seeing the go-to-market come together. It's also the integration of the overall offer and call it, the organization into ADP. So we are still working on the technology integration, and that's coming along incredibly well. We're really excited to see the sales force has come together. And from a go-to-market perspective, I know I mentioned our ReThink events, I mentioned our Meeting of the Minds event. I think the thing that I wouldn't say has surprised us, but has really pleased us since October is how well this offer is resonating with our large clients in the enterprise and in the global space. So we're really excited. In fact, we have a few wins that we were excited to see come through this quarter that candidly wouldn't have been wins without this offer in our portfolio, if you will. So we're really excited about the progress we've made. We're excited to see the integration come together, and I think it's going to continue to drive tremendous opportunity for us going forward.
Mark Marcon: Great. Thank you very much. Look forward to seeing you…
Maria Black: Yes.
Operator: Thank you. Our next question comes from Tien-tsin Huang with JPMorgan. Your line is open.
Tien-tsin Huang: Hey, thanks so much, and all the best to Don, of course. I wanted to ask on ES, it decelerated a couple of points and is running below the full-year range. I know you reiterated for the full-year and you're earning on the higher side in the first half. But just wanted to make sure I understood what the factors were there for the change.
Don McGuire: Yes, Tien-tsin, thank you. So on the revenue side, I think as we set up the third quarter, we mentioned that we had some poor calendar for us. So we had a bit of a stronger Q2 than Q3. So we expected that softness. There was a strengthening dollar that at that time that was causing us some grief. And we also expected that we were going to have some impact from declining short-term rates. So we positioned Q3 to be a bit softer. And then we actually did better in Q3 on the revenue side than we had anticipated because those things didn't come to fruition, but – or there was less impact. As we look forward to Q4, we do expect a little bit of reacceleration. There's no anomalies in the calendars. FX is a little bit more favorable. And of course, client fund balances are really making an impact. They're growing based on higher wages more positively than we had expected. But then if you look at the second half, we look at ES, and we think about margins that the real story on the margin side is that we would have had better acceleration in our margins. Certainly, we're getting some benefit from the higher rates. We are getting an offset to that, though. We said WorkForce Software integration was going to cost us about 50 bps, and we continue to think that's about the number for the full-year. So that's having an impact. So that's the other aspect, and FX should be a little bit less unfavorable on the compare in the fourth quarter. So I think those are really the drivers for ES.
Tien-tsin Huang: Okay. Thanks for the complete answer. I knew we had the leap year thing in there, but I just – yes, I wanted to make sure we called all that. Just my quick follow-up just on the PEI, the Mexico acquisition can you roughly size that for us? And I'm curious, can that be extended or pushed into other parts of the region, LatAm, et cetera?
Don McGuire: So PEI has been a long-time partner of ours since, I think, 2009. So it's been with us for quite some time. This is really a domestic Mexico company. It's important for us to – yes, so it's important for us to get in the ground. I don't even think it shows up in the cash flow statement. It was a sub-$10 million acquisition. So the company we've been working with for a very, very long time. But it's a very much domestic Mexico, but certainly, we're enthusiastic and hopeful that we can grow in the domestic Mexican market and use it – continue to use it as a Solergo partner as we have for many, many years now.
Maria Black: Yes. I think the only comment I would make is we're really excited about their deep expertise and obviously, the local contribution that it will make from a Mexico perspective, but we are also incredibly focused on our global expansion, and we have a big business in Brazil, a big business in Chile. I was there actually just a couple of weeks ago. So we continue to remain focused on overall international expansion, but specifically Latin America.
Tien-tsin Huang: Good. Thank you both.
Operator: Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you, and Don, congrats and best wishes and then Peter, we're looking forward to working with you. My first question is on 2026. So I appreciate the comments on PPC. I was hoping you just dig in a little bit more on early 2026 thoughts. Any important considerations on implied 4Q 2025 exit rates across the business that maybe stickier versus those that maybe at more risk? And can you remind us just how to think about relative installation in the business model in the face of a potential macro slowdown?
Don McGuire: Okay. I'll say a little bit about 2026 beyond what we said in the prepared remarks. I mean I think we wanted to make sure everyone understood the float impact and how our laddering strategy is going to work and if you have more detailed questions on that, you can certainly ask Peter, he's in the room here with us. So he can answer that question if – we want him to do that. But I think I also don't want to ruin Investor Day coming up on June 12. So not too much to say on 2026 beyond what we shared in the prepared comments. But I would say that when we think about the potential of a slowdown ADP, weather these types of storms many, many times, and our business is well insulated. So it took several quarters were to slowdown to – the prior slowdown to show itself in our results. So answered the question earlier, the business activity continues to be good. And so if things were to start to materialize or manifest themselves in a kind of a less positive economy, we would certainly see things in the pipeline, et cetera, the sales pipeline. But generally speaking, it takes quite a while for that to work its way through the ADP business model, which is very resilient as Maria said just a few minutes ago, we're not discretionary. So that works well for us. And then, of course, we have the levers that we've had in the past, and we can use them. There's some naturally self-correcting items like sales commissions, et cetera, if things were to progress or continue. There's implementations would be slower, et cetera, a number of things changing our focus on some of our R&D initiatives. So there's many things in many levers we can pull to soften any potential blows. And I think our history has shown that we've been able to do that on a pretty successful basis many times before.
Bryan Bergin: Okay. Okay. Understood. And on – follow-up on client hiring. So can you comment on what you saw as you move through the third quarter kind of month-to-month through 3Q and through April? And is there any notable variation by industries that may be more directly exposed to tariff versus not?
Don McGuire: No. I think generally, and I think I made the comment on the last call last quarter that we rounded down to 1%. We're still rounding down to 1%. And yes. So things are softer. In normal years, we go back 2016 to 2019 and we look at pays per control growth are in the 2% to 3% range. So at 1%, we're at the lower end. But there was nothing specific, no specific industries that kind of jumped out at us. So we would prefer to have higher PPC growth, of course, but it's still positive and rounding down to 1%.
Bryan Bergin: Okay. Thank you for the detail.
Operator: Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning. And I will echo the comments of many congrats Don and look forward to working with you as well. Peter and Maria, just maybe a question for you. When I think about the Lyric bookings pipeline, again, I think for the last several quarters, you cited much more optimistic about trends up market, specifically with Lyric plus rebrand. How much of that's from existing customers that are converting over to it versus gaining share from competitors as you've now kind of established a beachhead with some core customers there?
Maria Black: Yes. So it's a great question. So I should reiterate my incredible excitement and optimism for Lyric as a whole, not just the rebrand, which, by the way, it is an incredible brand. And certainly, the love the name Lyric but that offer is resonating really well. So we talked about the pipelines building. We don't delineate necessarily, we obviously know, but we don't disclose how much of the pipeline is upgrades and/or new business bookings or net new logos, if you will, but the answer is both. It is resonating really well with CHROs in the market. I would say at these events, be it ReThink and Meeting of the Minds that I mentioned, the excitement was there around Workforce software, but it is also there around Lyric and the combination of the two. And what I would say to you is CHROs are liking this modern offer because it is arguably the most modern technology that's out there at this point. It's human-centric in its design. It's adaptable. We consider it groundbreaking. It appears based on the response we're seeing in the market and in the pipelines that the market agrees with that sentiment. So yes, we're really, really optimistic about what we're seeing with the market receptivity and how that is resulting in the pipelines and the new business bookings that we've seen with Lyric and expect to continue through this year.
Samad Samana: Understood. And then maybe a follow-up, Don, just as I think about the commentary between what's going on with the core business and maybe some of the international softness that you've seen and then the kind of the macro side that you called out. If I take all that together, how should we think about maybe ADP's own hiring plans? Are you guys going to still track to maybe what you anticipated in terms of headcount growth for fiscal 2025? Or should we think about a change in either direction in terms of hiring more or less than you originally anticipated, especially as we contextualize it with what's happened maybe over the last several weeks.
Don McGuire: Yes. Samad, I think that we're not expecting to make any changes at this time. Things are going pretty well. The business is solid. So we have no changes to our plans. Of course, just building off the prior question from Bryan, if should something come up, then we will do it definitely slow hiring, et cetera. But as we sit here today, things are solid, and we have no changes to our plans as we actually go into our budgeting cycle next week. So we're full speed ahead and still optimistic.
Samad Samana: Great. Look forward to seeing you all in a few weeks at the Analyst Day.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thank you so much. And offer my congratulations to Don and Peter as well. I wanted to ask quickly on PEO. Just wondering how client behavior in the PEO segment has evolved regarding benefits enrollments? And are you seeing any shifts in preference towards lower cost benefit plans, particularly as there's a little bit of macro pressure, perceived macro pressure?
Don McGuire: Go ahead.
Maria Black: I was going to say – yes, so I guess we can both answer that, but I'll start. From a PEO perspective, listen, there's always some of that. We actually just completed our renewal cycle. And so we're really pleased with what we've seen with respect to our execution through that. The team has done an incredible job moving through the motions of that. But moreover, PEO retention was strong in the third quarter. We do anticipate a very modest tailwind, contributing, if you will, to the overall PEO results for 2025. There was a modest tailwind in 2024. So I think the retention of the PEO business speaks directly to the value of the value proposition within there, which is benefits, right? And so I think as it stands, we see stability, if not minor tick ups, if you will, in benefits attach, which are all good signs that the value proposition is resonating benefits is an important piece of that. A lot of that has to do with the cohorts, the industries that we sell our PEO offer to. So I think in general, the PEO, we're very pleased with the results on retention. We're pleased with how we've moved through the renewal cycles. Every cycle has some nuances, James, as it relates to what clients choose. But overall, what they're choosing is to stay with the PEO, and that's good news for us.
James Faucette: Got it. And maybe just like a more nuanced question or deeper dive. I mean clearly, you're executing well, et cetera. But is there anything that you can point to, I guess I'm just a little surprised because it seems like you guys are driving even better growth off of a higher base than a lot of your peers. And so just trying to get a sense of whether that's go-to-market, cross-sell specific offerings where you think you're differentiated? Just a little more color there. That’s all. Thank you.
Maria Black: Yes. So I think one of the things I always like to remind everyone of is that all PEOs are not created equal. I'd like to think we have the best one, of course. But moreover, it's the fact that our constructs are different, right? So we don't entirely all target the exact same industries. Some tend to skew more to white collar companies, some tend to skew to less professional type of companies, if you will. So I think we address different industries. We're not always all in the same exact states, if you will. And then I think the other piece is we're constructed difference. So one of the big differentiators, especially in, call it, volatile health benefit cycles is that we have a fully insured model. And so I think our model lends itself to more predictability, more stability. And that's a home run in times like this. So we're – I think we see some of that in our results. I also think the other piece, which you touched on, is distribution. We have there's – not every PEO has the luxury of having an additional sales distribution engine, which is the rest of the payroll sellers that's – as you know, 50% of the business that the PEO onboard comes from existing ADP clients. So the upsell, cross-sell, the go-to-market together with payroll sellers just the way that we distribute, I think, is, again, a home run. So I think our model is different, and I think it lends itself to better results.
James Faucette: That’s great. Thank you so much.
Operator: Thank you. Our next question comes from Caroline Latta with Bank of America. Your line is open.
Jason Kupferberg: Hi. This is actually Jason Kupferberg from Bank of America. Congrats to everybody. I wanted to maybe just start with a question, it might be more for Maria. But coming back to this topic of just bookings and sales cycles and the macro, the intersection of all that. Obviously, you talked about some of what you're seeing on the international side. Maybe just talk a little bit more about the U.S. Are you seeing any client hesitancy, particularly upmarket? Any changes just in the last month or two as the tariff uncertainty has skyrocketed. And to the extent the U.S. customers seem to be behaving differently than international. I would just be curious to get your perspective on why that might be the case? Thank you.
Maria Black: Yes, sure. So I think, broadly speaking, Jason, we're really pleased with our results. From a U.S. perspective, kind of moving through the motions of the down market we talked about. Clients are still investing in talent. The mid-market doesn't get any easier, it's still complex. So I think we see strength in the results. We see strength in the activities in the down market, mid-market. As you get into the enterprise space, pipelines are up year-on-year. We feel good about the enterprise clients in terms of the overall results and the pipelines, and we expect growth. What I will say is those very large clients in the enterprise space often do have that international reach, right? So as you get more global in the enterprise space, the multinational clients, I would say, again, there is a tiny bit of pipeline aging that we're seeing. Again, the pipeline substantiates the results. It's always lumpy. Q4 is big for us in that space. It always is. And so I think from a standpoint of where we are, we're executing against a very strong pipeline, both in the international space as well as in the enterprise space. We have an incredible offer with Lyric. We have an incredible offer combined with Workforce software. So I think we have a good story. We have good pipelines. We've got a lot to get done, but we haven't seen necessarily huge elongation of sales cycles. I think we talked a lot about the sales cycles being back to kind of pre-pandemic days. We're seeing – Don mentioned it earlier, more signatures, maybe a tiny bit of additional timelines, but all eyes on Q4 is the way we think about it. We have the pipeline and we need to execute against it.
Jason Kupferberg: Understood. I wanted to also get your latest views just on the competitive landscape, particularly down market. I mean we've been hearing a little more from some of the privately held cloud-based providers. So curious what you guys might be seeing on that front just in terms of win rates, pricing, et cetera?
Maria Black: Yes, I would say there's nothing new to call out. It's always competitive. Q4 is always competitive. There's always a lot happening in the down market with respect to the RUN platform and the mid-market with respect to the Workforce Now platform. And in the down market, we have an incredible story. We have almost 1 million clients on our RUN platform. We're extending our reach through our partner ecosystem. This partnership with Fiserv is – it's a big bet, but we're also – we believe it's a meaningful bet that's going to extend our distribution strength with theirs. So I think that's really exciting for us. So we have a winning offer. We have good results on client satisfaction. I think I mentioned that during the prepared remarks that's lending itself to a strong retention. So the down market story is there. I think in the mid-market, we have an incredible offer there in Workforce Now. We've made meaningful investments. We have strong NPS. We have strong retention. We have a winning offer in the mid-market. So I think it's always competitive, but I think we have best-in-class platforms, best-in-class execution, best-in-class service, and we see that through the results in retention and NPS.
Jason Kupferberg: Thank you. We’ll see you next month.
Maria Black: Yes.
Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi, good morning. I want to ask what percentage of bookings come from international?
Maria Black: Yes, it's a great question. It really marries our revenue. And I think the last disclosure we had, it's 88% of the revenue is in the domestic U.S. and the rest is outside of the U.S. And so it's a – think of it as a close correlation to that.
Bryan Keane: Got it. No, that's helpful. And then just thinking about the enterprise moving more to Lyric and Workforce Software Solutions. You talked a little bit about the drag on margins. I think it's 50 basis points this year. Just how do we think about margins in general going forward? Do we get that 50 basis points back into fiscal year 2026 and then the overall kind of margin profile Lyric and Workforce Solutions.
Don McGuire: Yes, it's a good question, Bryan. We don't get it all back. Certainly, the intangible amortization and the financing costs, which we've included in that 50 basis point number we give you, those don't go away. We do get some back certainly on the integration and deal expenses. So I wouldn't model too much into that because it's in the grand scheme of things, it's not an enormous number across the ES margin.
Bryan Keane: Got it. Okay. And congrats, Don. Amazing career. And Peter, welcome.
Operator: Thank you. Our next question comes from Kevin McVeigh with UBS. Your line is open.
Kevin McVeigh: Great. Thanks. And again, congratulations and pleasure, Don. I guess can we talk maybe just reconcile the improving retention with the lower pays per control? Is that a function of the client mix? Or what's driving that?
Maria Black: From the overall retention results and the pays per control, I think the overall results as it relates to how we're feeling with the retention guide. And so I think we're we've been executing well on retention. We continue to see kind of the improvements. And so we thought it was prudent to bring up the retention guide. And as it relates to the PPC side of it, I'll let Don kind of take that.
Don McGuire: Yes. So I think the big story on retention is a couple of things. One, we're very proud of the progress we've made in the NPS scores. They've been very, very strong for us. We continue to either hit records or very close to records and most of our business units are kind of at all-time highs, and that's across the board. So we think that's important. We also, of course, we're seeing a little bit less switching. I think things are a bit quieter in that regard. So people are hanging around because they like the service, the NPS is good. And as we look to the balance of the year, we think that perhaps not all of the normalization and other businesses, et cetera, has settled in, but we think substantially all of it has. So we continue to beat our retention guide quarter after quarter and there's only one quarter left. So I think we're a little bit more comfortable with the guide that we've given you, the improved guide we've given you for the balance of the year.
Kevin McVeigh: Helpful. And then just real quick on the client funds. It looks like you increased – it was a similar amount for kind of client funds and then the extended strategy as well. But obviously, the balances are a lot different in terms of average balances, anything that kind of explains just – because, again, you increased it by the same amount, but it's like 7:1. Anything that explains that?
Don McGuire: I think I'm going to give Peter an opportunity to speak here and answer that question as a Treasurer.
Peter Hadley: Thanks, Kevin. I mean, the balance increase is really driven by higher wage levels. So we had a strong bonus season in Q3. That's the time of the year where we do pick that up. So we hold a lot more short money, if you like, our client short portfolio. We have less borrowing. So that's really what drove the balances. The rate position hasn't really moved. And you can see from our schedules that. From a short-term rate perspective, we're relatively well hedged across the year, not so much by quarter but certainly across the year for short rates. So we are quite insulated from fluctuations in short-term rates between our clients shorten our borrowing levels. So I would say it's a balance of story, mainly driven by wages. And as a result, the balances have gone up. A point of balance is around $11 million or $12 million of revenue on a full-year basis. And the revenue guide went up and also we narrowed the range given there's only one quarter to go.
Kevin McVeigh: Helpful. Congratulations, Peter.
Peter Hadley: Thank you. Appreciate it.
Operator: Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Thank you. I know there's a ton of questions asked on international bookings, so I apologize for asking one more. But I want to get a sense, have you seen any pushback from ADP being an American company and maybe companies holding off a little bit until things settle down? Or is this just an issue of uncertainty?
Maria Black: Yes. So we're not, right? So from the standpoint of the conversations with respect to international, they're not about pushback on American companies. One reminder is that we have from a client – or from an ADP perspective, we have 80 peers on the ground in close to 50 countries, right? And our offers also are in-country in many of the 140 countries that we serve, right? So from the standpoint of how we serve our clients, we serve them sometimes from a global perspective, but we also serve them from a local perspective. I think Don and he can hear in a minute, talk to you about kind of the final mile and how all of that works. So that's certainly not the conversation in international. It's really about the large deals and how they move through the motions toward closure through the fourth quarter, the pipelines are there, but it's not reflective of us being a U.S. company by any stretch. So I don't know, Don, if you want to add.
Don McGuire: No, I think it's just important to comment that we're on the ground, and we serve our customers very, very locally and we're part of the fabric in these – in the social security ecosystem, the income tax ecosystem in many, many countries. So I don't think there's any pushback just based on the so-called nationality of the company, but I think it's more just the overall uncertainty that's driving any apprehension, if you will.
Kartik Mehta: And then just a follow-up on PPC on the PEO business. I know that there has been a difference between the ES, PPC and the PEO, PPC. This quarter, did that come a little bit closer? It sounds like they're both kind of getting close to 1% or just a matter of rounding?
Don McGuire: No, it's a good observation, Kartik. The PPCs did come quite close. As a matter of fact, to be candid, the PPC and PEO is a little bit stronger than it was in Employer Services. But you're right, they're both trending down to one.
Kartik Mehta: Okay. And Don, it’s been a pleasure working with you. Good luck with everything. And Peter, look forward to working with you.
Peter Hadley: Thank you.
Operator: Thank you. We have time for one last question. And our last question comes from Ashish Sabadra with RBC. Your line is open.
Ashish Sabadra: Thanks for taking my question. Just on POX pass-through revenue growth. There was like it grew 7%, 6% and 8% in the first three quarters. The 5% to 6% guidance for the full-year implies like a material slowdown. Is that just conservatism? Or are there some puts and takes as we get into the fourth quarter?
Don McGuire: Yes. I think there are some puts and takes. I mean, the revenue in the third quarter was better than we expected because we did have higher zero-margin pass-throughs, higher SUI. And of course, the retention was also a little bit better than we expected in the third quarter. So we do expect the fourth quarter to be a good and valuable contributor to us. But there's no major signals there.
Ashish Sabadra: That's very helpful color. And maybe just on the broader theme of GenAI, I was wondering if you could share any additional progress on that front? Thanks.
Maria Black: I'm so excited that you asked, it's amazing. We almost made it all the way through without a GenAI question. But listen, we're incredibly excited about the progress we're making with respect to our ADP Assist and the overall portfolio of Generative AI offers that we're putting into the market. I mentioned during the prepared remarks, the award that we won, and we're excited about that, but we're also excited about the entire strategy as we think about putting Generative AI into our product for our clients to use, for our service associates to use, for our sellers to use to actually help build products. So I think we have an incredible plan. It's still very early days, right? So the results that we see the awards that we're winning are fantastic. But I really look forward to how this evolves for us over the coming months and the coming years as we continue to unveil more and more functionality and continue to drive more and more efficiency in how we serve our clients.
Ashish Sabadra: That’s great color. And congrats to both Don and Peter. Thank you.
Don McGuire: Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks.
Maria Black: Thank you, and thank you, everyone, for joining us. I will echo the sentiments that I heard across all of the financial analysts this morning, which is a giant thank you to Don again, and congratulations to Peter. And of course, to our associates, I am so grateful for all that you do to support our clients to support each other as we did a little bit of a brand refresh over the last quarter and leans more heavily into our brand colors, I have to tell you all of our associates, all of you each and every day. You make me incredibly proud to be ADP [indiscernible]. Thank you.
Operator: Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter 2025 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Matthew Keating",
"text": "Thank you, Michelle, and welcome, everyone to ADP's third quarter fiscal 2025 earnings call. Participating today are Maria Black, our President and CEO; Don McGuire, our CFO; and Peter Hadley, our Treasurer. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Matt, and thank you, everyone, for joining us. Before discussing our third quarter results, I want to take a few moments to acknowledge this morning's press release announcing our CFO transition. Don McGuire has enjoyed a remarkable career at ADP. Initially joining ADP Canada in 1998 as Vice President of Finance, he would go on to profoundly shape our international business, serving in a number of key leadership roles around the world, including his 2018 appointment to the position of President, Employer Services International. In 2021, Don returned to his finance roots, taking on the role of ADP's CFO, where he has provided strong financial stewardship and valued strategic counsel. In particular, as I transitioned into my role as ADP's CEO, I'm honored to call him a colleague, and more importantly, a friend. Don, thank you from the bottom of my heart for your countless contributions to ADP. And with that, as part of our orderly succession planning, I'm excited to share that Peter Hadley will succeed Don as CFO, effective July 1st with Don assisting with this transition through the end of September. Many of you already know Peter through his participation in various investor meetings and calls over the course of the last year. He joined ADP in 2002 and is also a global citizen, having held roles in both finance and operations for ADP in Europe, Asia, and the United States, including as CFO of our international and enterprise business units, President of Asia Pacific, and most recently as Corporate Treasurer. Peter brings deep financial expertise, extensive knowledge of ADP and our industry and strong leadership and strategic skills to the position. You will have the opportunity to hear more from Peter at our Investor Day on June 12th. In the meantime, I hope you will all join me in wishing Don well and in welcoming Peter to the CFO role. Now onto our results. This morning, we reported solid third quarter results that included 6% revenue growth, 10 basis points of adjusted EBIT margin expansion, and 6% adjusted EPS growth. I am excited to share the progress we continue to make against our strategic priorities, but let's first review some additional financial highlights from the quarter. We delivered another solid quarter of Employer Services new business bookings growth. In particular, we were pleased with the results across our U.S. offerings with our small business mid-market and enterprise as well as compliance solutions offerings, all performing well. We meanwhile experienced a softer quarter for international bookings as a result of macroeconomic uncertainty in some of our key international markets. With healthy new business pipelines, we remain focused on delivering overall bookings growth within our guidance range. Employer Services retention, again modestly exceeded our expectations, declining slightly compared to the prior year. This continued strong retention performance reflects client satisfaction scores, reaching record highs for third quarter and on a fiscal year-to-date basis, with the most meaningful improvements coming from our enterprise, international and HRO businesses. Our U.S. clients continue to hire in the third quarter as our Employer Services pays per control growth remained at 1%. And last, PEO revenue growth of 7% exceeded our expectations, helped by higher wages, strong retention and continued growth in zero-margin pass-throughs. Now let's turn to our continued execution on our strategic priorities, which include leading with best-in-class HCM technology, providing unmatched expertise in outsourcing and benefiting our clients with our global scale. Our momentum with enterprise clients continued in the third quarter. New business bookings for ADP Lyric HCM increased substantially, and our pipeline for new Lyric business doubled compared to last year. Among the new clients to start a Lyric during the third quarter was a leading provider of home healthcare services with more than 36,000 employees. This client is now live with HR, payroll and time and plans to add recruiting and talent this quarter. We were also pleased with Workforce Software's new business bookings with ongoing strong interest for its time and attendance, absence management and scheduling tools from organizations across a variety of industry verticals and geographies. We continue to make progress in our work to tightly integrate the acquired Workforce Software business with key ADP HCM platforms. We further strengthened our global payroll capabilities with our acquisition of PEI in Mexico in the third quarter. Based in Mexico City, PEI has provided robust payroll solutions, HCM expertise and technology to local and multinational clients for 30 years and has been a valued ADP global payroll partner since 2009. By integrating PEI's payroll expertise in Mexico with ADP's global reach and comprehensive HCM solutions, we enhance the experience we can provide to our local and global clients. In addition to PEI's products and solutions, the acquisition added nearly 300 experienced associates who bring deep local expertise as we continue to pursue growth opportunities across the Latin America region. We supported our clients and partners by hosting a number of signature events during the third quarter. At the ADP ReThink event in Zurich, leaders from the world's largest organizations came together to share insights and lessons learned from their global transformations and to discuss challenges and opportunities in a rapidly changing HCM landscape. At the ADP Meeting of the Minds event in Las Vegas, we hosted enterprise clients from across all industries sizes and locations together with industry experts to focus on one important mission, making work better. And at our Accountant Connect Summits, we provided more than 10,000 partner attendees with access to thought leaders who are shaping the future of the accounting profession. During the third quarter, we also continued to advance our embedded payroll partnership with Fiserv, we are actively referring our clients and prospects to Fiserv's Clover point-of-sale solution, while Fiserv is referring its merchant clients to ADP's run payroll. We expect our sales to accelerate as we complete our product integration work this year, enabling us to offer a differentiated integrated solution. We are excited by this relationship as well as the broader opportunities we see to grow our embedded payroll solution over time. Finally, our focus on best-in-class HCM technology led to several recent awards, including RUN being named number one on G2's Best Software Products for Small Business, ADP Lyric HCM being named Data Solution of the Year for Human Resources and the 2025 Data Breakthrough Awards and ADP Assist being named a winner in the 2025 Artificial Intelligence Excellence Awards presented by Business Intelligence Group, earning recognition for driving innovation and possibilities in AI. We look forward to sharing more details around the strength of our product portfolio as well as our innovation roadmap at our upcoming Investor Day on June 12. Overall, we were pleased with our strong financial and strategic outcomes in Q3. I'd like to thank our associates who continue to deliver exceptional products and service to our clients and whose efforts drive our client wins, industry recognition and record client satisfaction levels. Thank you again for all that you do for ADP and for our clients. Don?"
},
{
"speaker": "Don McGuire",
"text": "Thanks, Maria, and good morning to everyone on the call. Before I start, I would just like to thank you, Maria, for the kind words. It has truly been a privilege to contribute to ADP's success over the years and to work alongside so many talented and committed colleagues. I am also happy to see ADP's CFO position being assumed by such a capable and innovative leader, and I look forward to working with Peter to ensure a seamless transition in the coming months. Now for some color on our results for the quarter and our updated fiscal 2025 guidance. Overall, we reported a solid third quarter with our consolidated revenue growth and adjusted EBIT margin coming in above our expectations. We are adjusting our full-year guidance to reflect our better-than-expected Q3 results as well as making a few other changes, which I'll detail. Let me begin with our Employer Services results and guidance. ES segment revenue increased 5% on a reported and organic constant currency basis in the third quarter. As Maria mentioned, ES new business bookings growth was solid given the current macroeconomic uncertainty, a recent softer international bookings and the importance of the fourth quarter a range of new business bookings outcomes remains for fiscal 2025, and we are reiterating our 4% to 7% growth guidance. With ES retention again coming in better-than-expected in Q3, we now forecast a decline of 20 basis points to flat for the year, which is better than our prior guidance. ES pays per control growth was 1% in Q3, and we now expect 1% growth for the full-year. Client funds interest revenue increased by more than we anticipated in Q3, driven by stronger average client funds balance growth. We are raising our full-year average client funds balance growth expectation to 5% to 6%. Our fiscal 2025 forecast ranges for client funds interest revenue and the net impact from our extended investment strategy each increased by $15 million at the midpoint. In total, there is no change to our fiscal 2025 ES revenue growth forecast of 6% to 7%. Our ES margin increased 20 basis points in the third quarter, and we are narrowing our fiscal 2025 ES margin guidance to now expect growth of 50 basis points to 60 basis points. Moving on to the PEO. We had 7% revenue growth and 2% average worksite employee growth. PEO revenue, excluding zero-margin pass-through growth of 8% was supported by higher wages and strong retention. PEO pays per control growth decelerated modestly from the second quarter. To reflect our Q3 results as well as the ongoing benefits anticipated from higher wages, we are increasing our full-year PEO revenue growth forecast to 6% to 7%, and PEO revenue, excluding zero-margin pass-through growth to 5% to 6%. We are maintaining our 2% to 3% average worksite employee growth guidance for the year. PEO margin was flat in the quarter as strong revenue growth and favorable actuarial loss development in workers' compensation reserves were offset by higher workers' compensation and SUI costs. We now expect PEO margin to decrease between 60 basis points and 80 basis points for the full-year, which is slightly better than our prior forecast. Putting it altogether, we are maintaining our fiscal 2025 guidance for consolidated revenue growth of 6% to 7% and now expect to come in towards the high end of this range. We are updating our adjusted EBIT margin expansion guidance to 40 basis points to 50 basis points. We continue to anticipate a full-year effective tax rate of around 23% and now expect fiscal 2025 adjusted EPS growth of 8% to 9%. As we look ahead to fiscal 2026, we wanted to share a few early thoughts. First, heightened levels of macro uncertainty are leading to projections for slower economic growth. With this in mind, we expect our pays per control growth to continue at below normal levels next year. We will also continue to monitor any impacts from the uncertainty in the global macro environment on international sales, particularly our larger multi-country deal activity. As a result of our laddering strategy, we remain positioned for continued tailwinds from our client funds portfolio as anticipated reinvestment rates remain above the average yield of our maturing securities, driving overall yields expected on the portfolio above fiscal 2025 levels. As always, we will remain focused on driving growth in our new business bookings, maintaining strong client satisfaction and retention levels and investing in our products and people to deliver sustainable revenue growth and margin expansion over time. Thank you, and I'll now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] We will take our first question from the line of Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thank you for taking my question, and it's been great working with you, Don. Best of luck in the future and also congratulations to Peter. Maybe I could ask about the software international bookings that you called out, a little more color there? Is it sort of a particular regions, products? Any other color that you could give us there would be helpful."
},
{
"speaker": "Maria Black",
"text": "Yes, sure. So good morning, Ramsey, and thanks for joining us today. So I'll comment on the international bookings. So overall, the international space had executed, and we have several quarters of consistent strength. And what we saw in Q3 was a bit of softness. And undoubtedly, we think the softness is anchored and uncertainty in the macro environment. That said, though, the international space in general, these are large deals. They tend to be lumpy. We have strong pipelines. So from a broad-based perspective, the pipelines are strong, both in country as well as the global view offers and things of that nature of the multi-country deals. However, we have a lot to get done, I guess, in the fourth quarter. So it is a little bit of a lumpy environment out there. These are lumpy deals, but the pipeline supports a solid finish to the year."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. Okay. Thank you. And also on the – you called out the Fiserv relationship. And I guess just more broadly on that embedded offering, what do you think of the growth opportunity there in the addressable market? Is there a large opportunity for embedded across potentially other distribution channels and partners?"
},
{
"speaker": "Maria Black",
"text": "Sure. So we are very, very excited about the Fiserv relationship. It is progressing well. This year, we are going to roll out the integration. I think there will be a leapfrog stage for both of us. So thus far, we're sharing referrals back and forth. We are perfecting the model from a distribution. So you imagine our distribution being folded together with their distribution across our go-to-market, but also across our bases, in terms of the over 1 million clients that we have in RUN. And I think they're shy of 1 million, but nonetheless, the overlap is not 100%. So there's a tremendous amount of opportunity for us to address each other's basis. And so we do think the game changer though will be when RUN is embedded into the Clover offer and CashFlow Central is embedded into the RUN offer. And that's forthcoming. So we're really excited about that. We do think that's big. That said, we also believe that there might be an opportunity to extend that reach across multiple additional ADP platforms. So think taking it into potentially the mid-market, into other countries. We're both global businesses. So we think the reach just even within Fiserv is meaningful for us. But to your question, beyond that, we're very excited about our embedded offer. We have it across a couple of other places. And in my mind, this is the proof point of really seeing how the integration can work from a technology perspective. But certainly, we are looking at other places that we have the ability to extend our reach through our embedded offering to really extend the total addressable market, if you will."
},
{
"speaker": "Ramsey El-Assal",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hey, guys. Great results, and it was a pleasure working with you, Don. I feel like everyone is a little bit confused. Results are great. You're talking about uncertainty. Some of the payment companies out there are still saying things are good. Can you maybe tell us a little bit more in terms of when we say uncertainty, how much is it holding back on hiring? Or is it just people are worried, like maybe just like concerns, maybe you could parse out concerns versus actual actions, I would say, from your clients that would I think really be helpful for investors."
},
{
"speaker": "Don McGuire",
"text": "Yes. Dan, thanks for the comments, and thanks for the question. What we're seeing, we're seeing a lot of stability in our base. I mean the underlying economic factors are still pretty strong for us in terms of unemployment is low. And yes, we are still rounding down to 1% PPC growth, so people still are hiring. There's some of that happening. I think the uncertainty that we're seeing, though, as Maria mentioned earlier in the bookings comments is these very large deals that perhaps span multiple countries I think there's some apprehension there, if you will, to make decisions, although the pipelines are very strong, and these deals are always a long time in the making because they are complicated and complex and they do reach into several corners of the globe. But having said that, we're not terribly far off what we saw pre-pandemic, where it was always hard to find people to get signatures, et cetera. So we're still optimistic, and as we said, in our own base, things are still going well. We watch bankruptcies. We watch clients who are active, but not billing. So things seem to be pretty calm for us. But we can't deny that what we're hearing and what you're reading, we're all hearing. So hopefully, these things settle down. But in our own base and day-to-day business, things are still pretty strong."
},
{
"speaker": "Dan Dolev",
"text": "That's great. Thank you. I think this definitely helped clarify what's out there. Really appreciated."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "First, Don, it's been pleasure working with you. Hope you have all the best and enjoying your retirement. And Peter, welcome. Maria, you mentioned international, and we just talked a little bit about the uncertainty. But I'm just wondering if you could delve a little bit more with regards to what you're seeing in terms of mid-market companies, the smaller companies that would typically use one. Are you hearing anything? Or is your – are your sales folks hearing anything about any sort of uncertainty pushing out delays? Or how is that impacting the PEO business we heard from a different player yesterday that ended up indicating that they were seeing a slowdown with regards to potential hires in their PEO business. So wondering about that? And then I've got a follow-up."
},
{
"speaker": "Maria Black",
"text": "Sure. So I'll start. I think we talked a little bit about international. And Don shared that, broadly speaking, we feel solid about the pipelines, we feel solid about the execution. I think it's really about – we have a lot to get done as we always do in the fourth quarter. So I think with respect to the mid-market, the down market and the PEO and the rest of your question, Mark, broadly speaking, we're very pleased with our results this quarter. They're solid. And so I think from a distribution standpoint, we continue to execute. We continue to see that clients are investing in their people. So if you think about our industry versus what was shared earlier from Dan around, call it, the payments business, if you will. HCM is not discretionary as it relates to companies are investing in their people. They're investing in hiring. They're investing in talent and candidly, they have to pay people. And so we're not seeing from a distribution and HCM demand perspective. Demand feels okay. It feels as it relates to pipelines in the down market and PEO, we measure that more with respect to activity in terms of how many appointments or sellers are going on, how many RFPs are going through the PEO model. PEO bookings, there was growth in the third quarter. It was a little bit less than the second quarter. But at the same time, we have line of sight of good solid growth in the PEO to round out fiscal 2025. We also see good strength in the PEO and retention. So I think all things being equal, we feel good about the demand. It feels okay out there in the down market, mid-market, up-market, PEO, even in international has pipelines to support the broad range of bookings guidance that we have."
},
{
"speaker": "Don McGuire",
"text": "Yes. Maybe, Maria, just to add on the PEO question, Mark, that you asked, our PEO bookings were good in the quarter. We were happy with them, and we did have a 2% worksite employee growth. So our pays per control were also a little bit better than we expected. So we were happy with PEO in the quarter for sure."
},
{
"speaker": "Mark Marcon",
"text": "That's great. And then Maria, ADP has been doing a great job in terms of modernizing. Can you give us an update with regards to WorkForce Software in terms of that being integrated and maybe even a little bit more color with regards to Lyric? It sounds like things are going really well from that perspective."
},
{
"speaker": "Maria Black",
"text": "They are, Mark. Things are going incredibly well. So the – just a reminder for everyone, we closed on that integration in October. We've been very busy since then. And so part of that busyness was the overlap of the pipelines and really seeing the go-to-market come together. It's also the integration of the overall offer and call it, the organization into ADP. So we are still working on the technology integration, and that's coming along incredibly well. We're really excited to see the sales force has come together. And from a go-to-market perspective, I know I mentioned our ReThink events, I mentioned our Meeting of the Minds event. I think the thing that I wouldn't say has surprised us, but has really pleased us since October is how well this offer is resonating with our large clients in the enterprise and in the global space. So we're really excited. In fact, we have a few wins that we were excited to see come through this quarter that candidly wouldn't have been wins without this offer in our portfolio, if you will. So we're really excited about the progress we've made. We're excited to see the integration come together, and I think it's going to continue to drive tremendous opportunity for us going forward."
},
{
"speaker": "Mark Marcon",
"text": "Great. Thank you very much. Look forward to seeing you…"
},
{
"speaker": "Maria Black",
"text": "Yes."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-tsin Huang",
"text": "Hey, thanks so much, and all the best to Don, of course. I wanted to ask on ES, it decelerated a couple of points and is running below the full-year range. I know you reiterated for the full-year and you're earning on the higher side in the first half. But just wanted to make sure I understood what the factors were there for the change."
},
{
"speaker": "Don McGuire",
"text": "Yes, Tien-tsin, thank you. So on the revenue side, I think as we set up the third quarter, we mentioned that we had some poor calendar for us. So we had a bit of a stronger Q2 than Q3. So we expected that softness. There was a strengthening dollar that at that time that was causing us some grief. And we also expected that we were going to have some impact from declining short-term rates. So we positioned Q3 to be a bit softer. And then we actually did better in Q3 on the revenue side than we had anticipated because those things didn't come to fruition, but – or there was less impact. As we look forward to Q4, we do expect a little bit of reacceleration. There's no anomalies in the calendars. FX is a little bit more favorable. And of course, client fund balances are really making an impact. They're growing based on higher wages more positively than we had expected. But then if you look at the second half, we look at ES, and we think about margins that the real story on the margin side is that we would have had better acceleration in our margins. Certainly, we're getting some benefit from the higher rates. We are getting an offset to that, though. We said WorkForce Software integration was going to cost us about 50 bps, and we continue to think that's about the number for the full-year. So that's having an impact. So that's the other aspect, and FX should be a little bit less unfavorable on the compare in the fourth quarter. So I think those are really the drivers for ES."
},
{
"speaker": "Tien-tsin Huang",
"text": "Okay. Thanks for the complete answer. I knew we had the leap year thing in there, but I just – yes, I wanted to make sure we called all that. Just my quick follow-up just on the PEI, the Mexico acquisition can you roughly size that for us? And I'm curious, can that be extended or pushed into other parts of the region, LatAm, et cetera?"
},
{
"speaker": "Don McGuire",
"text": "So PEI has been a long-time partner of ours since, I think, 2009. So it's been with us for quite some time. This is really a domestic Mexico company. It's important for us to – yes, so it's important for us to get in the ground. I don't even think it shows up in the cash flow statement. It was a sub-$10 million acquisition. So the company we've been working with for a very, very long time. But it's a very much domestic Mexico, but certainly, we're enthusiastic and hopeful that we can grow in the domestic Mexican market and use it – continue to use it as a Solergo partner as we have for many, many years now."
},
{
"speaker": "Maria Black",
"text": "Yes. I think the only comment I would make is we're really excited about their deep expertise and obviously, the local contribution that it will make from a Mexico perspective, but we are also incredibly focused on our global expansion, and we have a big business in Brazil, a big business in Chile. I was there actually just a couple of weeks ago. So we continue to remain focused on overall international expansion, but specifically Latin America."
},
{
"speaker": "Tien-tsin Huang",
"text": "Good. Thank you both."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you, and Don, congrats and best wishes and then Peter, we're looking forward to working with you. My first question is on 2026. So I appreciate the comments on PPC. I was hoping you just dig in a little bit more on early 2026 thoughts. Any important considerations on implied 4Q 2025 exit rates across the business that maybe stickier versus those that maybe at more risk? And can you remind us just how to think about relative installation in the business model in the face of a potential macro slowdown?"
},
{
"speaker": "Don McGuire",
"text": "Okay. I'll say a little bit about 2026 beyond what we said in the prepared remarks. I mean I think we wanted to make sure everyone understood the float impact and how our laddering strategy is going to work and if you have more detailed questions on that, you can certainly ask Peter, he's in the room here with us. So he can answer that question if – we want him to do that. But I think I also don't want to ruin Investor Day coming up on June 12. So not too much to say on 2026 beyond what we shared in the prepared comments. But I would say that when we think about the potential of a slowdown ADP, weather these types of storms many, many times, and our business is well insulated. So it took several quarters were to slowdown to – the prior slowdown to show itself in our results. So answered the question earlier, the business activity continues to be good. And so if things were to start to materialize or manifest themselves in a kind of a less positive economy, we would certainly see things in the pipeline, et cetera, the sales pipeline. But generally speaking, it takes quite a while for that to work its way through the ADP business model, which is very resilient as Maria said just a few minutes ago, we're not discretionary. So that works well for us. And then, of course, we have the levers that we've had in the past, and we can use them. There's some naturally self-correcting items like sales commissions, et cetera, if things were to progress or continue. There's implementations would be slower, et cetera, a number of things changing our focus on some of our R&D initiatives. So there's many things in many levers we can pull to soften any potential blows. And I think our history has shown that we've been able to do that on a pretty successful basis many times before."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Okay. Understood. And on – follow-up on client hiring. So can you comment on what you saw as you move through the third quarter kind of month-to-month through 3Q and through April? And is there any notable variation by industries that may be more directly exposed to tariff versus not?"
},
{
"speaker": "Don McGuire",
"text": "No. I think generally, and I think I made the comment on the last call last quarter that we rounded down to 1%. We're still rounding down to 1%. And yes. So things are softer. In normal years, we go back 2016 to 2019 and we look at pays per control growth are in the 2% to 3% range. So at 1%, we're at the lower end. But there was nothing specific, no specific industries that kind of jumped out at us. So we would prefer to have higher PPC growth, of course, but it's still positive and rounding down to 1%."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Thank you for the detail."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning. And I will echo the comments of many congrats Don and look forward to working with you as well. Peter and Maria, just maybe a question for you. When I think about the Lyric bookings pipeline, again, I think for the last several quarters, you cited much more optimistic about trends up market, specifically with Lyric plus rebrand. How much of that's from existing customers that are converting over to it versus gaining share from competitors as you've now kind of established a beachhead with some core customers there?"
},
{
"speaker": "Maria Black",
"text": "Yes. So it's a great question. So I should reiterate my incredible excitement and optimism for Lyric as a whole, not just the rebrand, which, by the way, it is an incredible brand. And certainly, the love the name Lyric but that offer is resonating really well. So we talked about the pipelines building. We don't delineate necessarily, we obviously know, but we don't disclose how much of the pipeline is upgrades and/or new business bookings or net new logos, if you will, but the answer is both. It is resonating really well with CHROs in the market. I would say at these events, be it ReThink and Meeting of the Minds that I mentioned, the excitement was there around Workforce software, but it is also there around Lyric and the combination of the two. And what I would say to you is CHROs are liking this modern offer because it is arguably the most modern technology that's out there at this point. It's human-centric in its design. It's adaptable. We consider it groundbreaking. It appears based on the response we're seeing in the market and in the pipelines that the market agrees with that sentiment. So yes, we're really, really optimistic about what we're seeing with the market receptivity and how that is resulting in the pipelines and the new business bookings that we've seen with Lyric and expect to continue through this year."
},
{
"speaker": "Samad Samana",
"text": "Understood. And then maybe a follow-up, Don, just as I think about the commentary between what's going on with the core business and maybe some of the international softness that you've seen and then the kind of the macro side that you called out. If I take all that together, how should we think about maybe ADP's own hiring plans? Are you guys going to still track to maybe what you anticipated in terms of headcount growth for fiscal 2025? Or should we think about a change in either direction in terms of hiring more or less than you originally anticipated, especially as we contextualize it with what's happened maybe over the last several weeks."
},
{
"speaker": "Don McGuire",
"text": "Yes. Samad, I think that we're not expecting to make any changes at this time. Things are going pretty well. The business is solid. So we have no changes to our plans. Of course, just building off the prior question from Bryan, if should something come up, then we will do it definitely slow hiring, et cetera. But as we sit here today, things are solid, and we have no changes to our plans as we actually go into our budgeting cycle next week. So we're full speed ahead and still optimistic."
},
{
"speaker": "Samad Samana",
"text": "Great. Look forward to seeing you all in a few weeks at the Analyst Day."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you so much. And offer my congratulations to Don and Peter as well. I wanted to ask quickly on PEO. Just wondering how client behavior in the PEO segment has evolved regarding benefits enrollments? And are you seeing any shifts in preference towards lower cost benefit plans, particularly as there's a little bit of macro pressure, perceived macro pressure?"
},
{
"speaker": "Don McGuire",
"text": "Go ahead."
},
{
"speaker": "Maria Black",
"text": "I was going to say – yes, so I guess we can both answer that, but I'll start. From a PEO perspective, listen, there's always some of that. We actually just completed our renewal cycle. And so we're really pleased with what we've seen with respect to our execution through that. The team has done an incredible job moving through the motions of that. But moreover, PEO retention was strong in the third quarter. We do anticipate a very modest tailwind, contributing, if you will, to the overall PEO results for 2025. There was a modest tailwind in 2024. So I think the retention of the PEO business speaks directly to the value of the value proposition within there, which is benefits, right? And so I think as it stands, we see stability, if not minor tick ups, if you will, in benefits attach, which are all good signs that the value proposition is resonating benefits is an important piece of that. A lot of that has to do with the cohorts, the industries that we sell our PEO offer to. So I think in general, the PEO, we're very pleased with the results on retention. We're pleased with how we've moved through the renewal cycles. Every cycle has some nuances, James, as it relates to what clients choose. But overall, what they're choosing is to stay with the PEO, and that's good news for us."
},
{
"speaker": "James Faucette",
"text": "Got it. And maybe just like a more nuanced question or deeper dive. I mean clearly, you're executing well, et cetera. But is there anything that you can point to, I guess I'm just a little surprised because it seems like you guys are driving even better growth off of a higher base than a lot of your peers. And so just trying to get a sense of whether that's go-to-market, cross-sell specific offerings where you think you're differentiated? Just a little more color there. That’s all. Thank you."
},
{
"speaker": "Maria Black",
"text": "Yes. So I think one of the things I always like to remind everyone of is that all PEOs are not created equal. I'd like to think we have the best one, of course. But moreover, it's the fact that our constructs are different, right? So we don't entirely all target the exact same industries. Some tend to skew more to white collar companies, some tend to skew to less professional type of companies, if you will. So I think we address different industries. We're not always all in the same exact states, if you will. And then I think the other piece is we're constructed difference. So one of the big differentiators, especially in, call it, volatile health benefit cycles is that we have a fully insured model. And so I think our model lends itself to more predictability, more stability. And that's a home run in times like this. So we're – I think we see some of that in our results. I also think the other piece, which you touched on, is distribution. We have there's – not every PEO has the luxury of having an additional sales distribution engine, which is the rest of the payroll sellers that's – as you know, 50% of the business that the PEO onboard comes from existing ADP clients. So the upsell, cross-sell, the go-to-market together with payroll sellers just the way that we distribute, I think, is, again, a home run. So I think our model is different, and I think it lends itself to better results."
},
{
"speaker": "James Faucette",
"text": "That’s great. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Caroline Latta with Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Hi. This is actually Jason Kupferberg from Bank of America. Congrats to everybody. I wanted to maybe just start with a question, it might be more for Maria. But coming back to this topic of just bookings and sales cycles and the macro, the intersection of all that. Obviously, you talked about some of what you're seeing on the international side. Maybe just talk a little bit more about the U.S. Are you seeing any client hesitancy, particularly upmarket? Any changes just in the last month or two as the tariff uncertainty has skyrocketed. And to the extent the U.S. customers seem to be behaving differently than international. I would just be curious to get your perspective on why that might be the case? Thank you."
},
{
"speaker": "Maria Black",
"text": "Yes, sure. So I think, broadly speaking, Jason, we're really pleased with our results. From a U.S. perspective, kind of moving through the motions of the down market we talked about. Clients are still investing in talent. The mid-market doesn't get any easier, it's still complex. So I think we see strength in the results. We see strength in the activities in the down market, mid-market. As you get into the enterprise space, pipelines are up year-on-year. We feel good about the enterprise clients in terms of the overall results and the pipelines, and we expect growth. What I will say is those very large clients in the enterprise space often do have that international reach, right? So as you get more global in the enterprise space, the multinational clients, I would say, again, there is a tiny bit of pipeline aging that we're seeing. Again, the pipeline substantiates the results. It's always lumpy. Q4 is big for us in that space. It always is. And so I think from a standpoint of where we are, we're executing against a very strong pipeline, both in the international space as well as in the enterprise space. We have an incredible offer with Lyric. We have an incredible offer combined with Workforce software. So I think we have a good story. We have good pipelines. We've got a lot to get done, but we haven't seen necessarily huge elongation of sales cycles. I think we talked a lot about the sales cycles being back to kind of pre-pandemic days. We're seeing – Don mentioned it earlier, more signatures, maybe a tiny bit of additional timelines, but all eyes on Q4 is the way we think about it. We have the pipeline and we need to execute against it."
},
{
"speaker": "Jason Kupferberg",
"text": "Understood. I wanted to also get your latest views just on the competitive landscape, particularly down market. I mean we've been hearing a little more from some of the privately held cloud-based providers. So curious what you guys might be seeing on that front just in terms of win rates, pricing, et cetera?"
},
{
"speaker": "Maria Black",
"text": "Yes, I would say there's nothing new to call out. It's always competitive. Q4 is always competitive. There's always a lot happening in the down market with respect to the RUN platform and the mid-market with respect to the Workforce Now platform. And in the down market, we have an incredible story. We have almost 1 million clients on our RUN platform. We're extending our reach through our partner ecosystem. This partnership with Fiserv is – it's a big bet, but we're also – we believe it's a meaningful bet that's going to extend our distribution strength with theirs. So I think that's really exciting for us. So we have a winning offer. We have good results on client satisfaction. I think I mentioned that during the prepared remarks that's lending itself to a strong retention. So the down market story is there. I think in the mid-market, we have an incredible offer there in Workforce Now. We've made meaningful investments. We have strong NPS. We have strong retention. We have a winning offer in the mid-market. So I think it's always competitive, but I think we have best-in-class platforms, best-in-class execution, best-in-class service, and we see that through the results in retention and NPS."
},
{
"speaker": "Jason Kupferberg",
"text": "Thank you. We’ll see you next month."
},
{
"speaker": "Maria Black",
"text": "Yes."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, good morning. I want to ask what percentage of bookings come from international?"
},
{
"speaker": "Maria Black",
"text": "Yes, it's a great question. It really marries our revenue. And I think the last disclosure we had, it's 88% of the revenue is in the domestic U.S. and the rest is outside of the U.S. And so it's a – think of it as a close correlation to that."
},
{
"speaker": "Bryan Keane",
"text": "Got it. No, that's helpful. And then just thinking about the enterprise moving more to Lyric and Workforce Software Solutions. You talked a little bit about the drag on margins. I think it's 50 basis points this year. Just how do we think about margins in general going forward? Do we get that 50 basis points back into fiscal year 2026 and then the overall kind of margin profile Lyric and Workforce Solutions."
},
{
"speaker": "Don McGuire",
"text": "Yes, it's a good question, Bryan. We don't get it all back. Certainly, the intangible amortization and the financing costs, which we've included in that 50 basis point number we give you, those don't go away. We do get some back certainly on the integration and deal expenses. So I wouldn't model too much into that because it's in the grand scheme of things, it's not an enormous number across the ES margin."
},
{
"speaker": "Bryan Keane",
"text": "Got it. Okay. And congrats, Don. Amazing career. And Peter, welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh with UBS. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thanks. And again, congratulations and pleasure, Don. I guess can we talk maybe just reconcile the improving retention with the lower pays per control? Is that a function of the client mix? Or what's driving that?"
},
{
"speaker": "Maria Black",
"text": "From the overall retention results and the pays per control, I think the overall results as it relates to how we're feeling with the retention guide. And so I think we're we've been executing well on retention. We continue to see kind of the improvements. And so we thought it was prudent to bring up the retention guide. And as it relates to the PPC side of it, I'll let Don kind of take that."
},
{
"speaker": "Don McGuire",
"text": "Yes. So I think the big story on retention is a couple of things. One, we're very proud of the progress we've made in the NPS scores. They've been very, very strong for us. We continue to either hit records or very close to records and most of our business units are kind of at all-time highs, and that's across the board. So we think that's important. We also, of course, we're seeing a little bit less switching. I think things are a bit quieter in that regard. So people are hanging around because they like the service, the NPS is good. And as we look to the balance of the year, we think that perhaps not all of the normalization and other businesses, et cetera, has settled in, but we think substantially all of it has. So we continue to beat our retention guide quarter after quarter and there's only one quarter left. So I think we're a little bit more comfortable with the guide that we've given you, the improved guide we've given you for the balance of the year."
},
{
"speaker": "Kevin McVeigh",
"text": "Helpful. And then just real quick on the client funds. It looks like you increased – it was a similar amount for kind of client funds and then the extended strategy as well. But obviously, the balances are a lot different in terms of average balances, anything that kind of explains just – because, again, you increased it by the same amount, but it's like 7:1. Anything that explains that?"
},
{
"speaker": "Don McGuire",
"text": "I think I'm going to give Peter an opportunity to speak here and answer that question as a Treasurer."
},
{
"speaker": "Peter Hadley",
"text": "Thanks, Kevin. I mean, the balance increase is really driven by higher wage levels. So we had a strong bonus season in Q3. That's the time of the year where we do pick that up. So we hold a lot more short money, if you like, our client short portfolio. We have less borrowing. So that's really what drove the balances. The rate position hasn't really moved. And you can see from our schedules that. From a short-term rate perspective, we're relatively well hedged across the year, not so much by quarter but certainly across the year for short rates. So we are quite insulated from fluctuations in short-term rates between our clients shorten our borrowing levels. So I would say it's a balance of story, mainly driven by wages. And as a result, the balances have gone up. A point of balance is around $11 million or $12 million of revenue on a full-year basis. And the revenue guide went up and also we narrowed the range given there's only one quarter to go."
},
{
"speaker": "Kevin McVeigh",
"text": "Helpful. Congratulations, Peter."
},
{
"speaker": "Peter Hadley",
"text": "Thank you. Appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Thank you. I know there's a ton of questions asked on international bookings, so I apologize for asking one more. But I want to get a sense, have you seen any pushback from ADP being an American company and maybe companies holding off a little bit until things settle down? Or is this just an issue of uncertainty?"
},
{
"speaker": "Maria Black",
"text": "Yes. So we're not, right? So from the standpoint of the conversations with respect to international, they're not about pushback on American companies. One reminder is that we have from a client – or from an ADP perspective, we have 80 peers on the ground in close to 50 countries, right? And our offers also are in-country in many of the 140 countries that we serve, right? So from the standpoint of how we serve our clients, we serve them sometimes from a global perspective, but we also serve them from a local perspective. I think Don and he can hear in a minute, talk to you about kind of the final mile and how all of that works. So that's certainly not the conversation in international. It's really about the large deals and how they move through the motions toward closure through the fourth quarter, the pipelines are there, but it's not reflective of us being a U.S. company by any stretch. So I don't know, Don, if you want to add."
},
{
"speaker": "Don McGuire",
"text": "No, I think it's just important to comment that we're on the ground, and we serve our customers very, very locally and we're part of the fabric in these – in the social security ecosystem, the income tax ecosystem in many, many countries. So I don't think there's any pushback just based on the so-called nationality of the company, but I think it's more just the overall uncertainty that's driving any apprehension, if you will."
},
{
"speaker": "Kartik Mehta",
"text": "And then just a follow-up on PPC on the PEO business. I know that there has been a difference between the ES, PPC and the PEO, PPC. This quarter, did that come a little bit closer? It sounds like they're both kind of getting close to 1% or just a matter of rounding?"
},
{
"speaker": "Don McGuire",
"text": "No, it's a good observation, Kartik. The PPCs did come quite close. As a matter of fact, to be candid, the PPC and PEO is a little bit stronger than it was in Employer Services. But you're right, they're both trending down to one."
},
{
"speaker": "Kartik Mehta",
"text": "Okay. And Don, it’s been a pleasure working with you. Good luck with everything. And Peter, look forward to working with you."
},
{
"speaker": "Peter Hadley",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. We have time for one last question. And our last question comes from Ashish Sabadra with RBC. Your line is open."
},
{
"speaker": "Ashish Sabadra",
"text": "Thanks for taking my question. Just on POX pass-through revenue growth. There was like it grew 7%, 6% and 8% in the first three quarters. The 5% to 6% guidance for the full-year implies like a material slowdown. Is that just conservatism? Or are there some puts and takes as we get into the fourth quarter?"
},
{
"speaker": "Don McGuire",
"text": "Yes. I think there are some puts and takes. I mean, the revenue in the third quarter was better than we expected because we did have higher zero-margin pass-throughs, higher SUI. And of course, the retention was also a little bit better than we expected in the third quarter. So we do expect the fourth quarter to be a good and valuable contributor to us. But there's no major signals there."
},
{
"speaker": "Ashish Sabadra",
"text": "That's very helpful color. And maybe just on the broader theme of GenAI, I was wondering if you could share any additional progress on that front? Thanks."
},
{
"speaker": "Maria Black",
"text": "I'm so excited that you asked, it's amazing. We almost made it all the way through without a GenAI question. But listen, we're incredibly excited about the progress we're making with respect to our ADP Assist and the overall portfolio of Generative AI offers that we're putting into the market. I mentioned during the prepared remarks, the award that we won, and we're excited about that, but we're also excited about the entire strategy as we think about putting Generative AI into our product for our clients to use, for our service associates to use, for our sellers to use to actually help build products. So I think we have an incredible plan. It's still very early days, right? So the results that we see the awards that we're winning are fantastic. But I really look forward to how this evolves for us over the coming months and the coming years as we continue to unveil more and more functionality and continue to drive more and more efficiency in how we serve our clients."
},
{
"speaker": "Ashish Sabadra",
"text": "That’s great color. And congrats to both Don and Peter. Thank you."
},
{
"speaker": "Don McGuire",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I am pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Thank you, and thank you, everyone, for joining us. I will echo the sentiments that I heard across all of the financial analysts this morning, which is a giant thank you to Don again, and congratulations to Peter. And of course, to our associates, I am so grateful for all that you do to support our clients to support each other as we did a little bit of a brand refresh over the last quarter and leans more heavily into our brand colors, I have to tell you all of our associates, all of you each and every day. You make me incredibly proud to be ADP [indiscernible]. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 2 | 2,025 | 2025-01-29 08:30:00 | Operator: Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter 2025 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President, Investor Relations. Please go ahead.
Matthew Keating: Thank you, Michelle, and welcome everyone to ADP's second quarter fiscal 2025 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our investor relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on the factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Matt, and thank you, everyone, for joining us. Before I cover our results, I'd like to take a moment to acknowledge those impacted by the devastating wildfires in Los Angeles. Our hearts go out to our clients, associates, community members, and everyone touched by this tragic situation. To begin, I'd like to highlight a significant milestone achieved during the second quarter. When ADP's Board of Directors approved the 10% increase to our quarterly dividend in November, it marked the 50th consecutive year in which we raised our dividend. We are now proud to be included among an elite group of dividend kings, a small number of publicly traded US companies with 50 or more consecutive years of dividend increases. This distinction is a testament to ADP's enduring business model and our ability to innovate over time and across economic cycles. We embrace this accomplishment and our role as a global HR technology leader and builder of a new era of workforce insight and innovation. We look forward to sharing more about where we've been and more importantly, where we're headed at our 2025 Investor Day, which will take place on June 12th. This morning, we reported strong second quarter results that included 8% revenue growth, 60 basis points of adjusted EBIT margin expansion, and 10% adjusted EPS growth. These results reflected strength across our Employer Services and PEO segments. I'll begin with some additional financial highlights before providing an update on the progress made across our strategic priorities. We delivered solid Employer Services new business bookings with record volumes for fiscal second quarter. Growth was notably strong across our HR outsourcing, compliance, and enterprise businesses as well as our small-business offerings. With the continued healthy demand backdrop and a new business pipeline that is up from this time last year, we look-forward to a strong second half of the year. Employer Services retention declined slightly compared to the prior year, but once again modestly exceeded our expectations. We continued to benefit from a strong overall business environment and very high client satisfaction levels. In fact, our client satisfaction levels reached a new all-time high in the second quarter and through the first half of our fiscal year. Employer Services pays per control increased 1% in Q2, decelerating from the 2% growth in Q1. The US labor market remains strong and our clients continue to hire, albeit at a slightly slower pace. Finally, PEO revenue growth of 8% was driven by strong PEO new business bookings and faster zero margin pass-through growth. Now, let's turn to our strategic priorities, where we delivered another quarter of considerable progress. During the second quarter, we announced a strategic partnership with Fiserv that brings Fiserv's leading small-business solutions, specifically Clover, its cloud-based point-of-sale and business management platform; and CashFlow Central, its accounts payables and receivables management platform together with Run, our industry-leading small-business payroll and HR solution. Helping small businesses thrive has been ADP's mission since day one and we are excited to partner with Fiserv to advance this goal and to support the millions of small businesses that drive the US economy. Through this partnership, ADP and Fiserv will offer US based small businesses access to an integrated all-in-one solution, combining the full power of Run and the Clover small-business management platform. In addition, CashFlow Central will be available to run clients, enabling our mutual customers to manage their cash flow more efficiently. These integrated solutions will make it easier than ever for small businesses to manage the flow of money into and out of their business, whether they are selling to customers, paying bills, or managing payroll. We initiated mutual client referrals to our respective offerings during the second quarter and our teams are working closely to deliver the integrated solution in the coming months. Our WorkForce Software acquisition, which closed in mid-October, is progressing well and in line with expectations. We are thrilled to have WorkForce Software's associates join ADP and our teams are working to integrate WorkForce Software's time and attendance, absence management and scheduling tools with key ADP HCM platforms. While that happens, the WorkForce Software team is focused on maintaining its momentum and delivering best-in-class solutions. And in Q2, we experienced healthy new business activity across our new WorkForce Software offering as well as our other existing Workforce Management solutions. In addition, we have already started to see new business opportunities that validate the growth anticipated from the combination. For example, WorkForce Software's enterprise-focused, industry-specific solutions are a strong fit for clients, allowing us to better compete and win in a wide range of industry verticals and geographies. Similarly, we are seeing opportunities to offer ADP HR and payroll solutions to WorkForce Software clients looking for a full suite HCM solution. With the addition of WorkForce Software, ADP is uniquely positioned to provide clients with a global HR payroll service and time solution and this value proposition is generating excitement in the marketplace. We remain confident in our opportunity to accelerate our growth in the Workforce Management and enterprise spaces. Following the successful introduction of ADP Lyric, our flexible, intelligent, and human-centric global HCM platform, the product continued to generate strong interest in the marketplace during the second quarter. Lyric's new business booking volumes increased again and its new business pipeline ended the quarter up significantly compared to last year. One client that started on Lyric in Q2 is a large recreation management company in the Midwest that operates nearly 20 parks, a nationally acclaimed zoo and nine golf courses. The client selected Lyric for a cutting-edge user experience and to simplify its personnel management activities and payroll processes. It went live with a full suite including HR, payroll time, benefits, recruiting and talent management and is very pleased with the outcome. Since Lyric is a global platform, we remain focused on expanding its already broad international reach to capitalize on what we see as a significant global opportunity. Before I turn the call over to Don, I want to take a moment to express my gratitude to our associates for their dedication and hard work. Their unyielding commitment to our clients inspires me each and every day. It is these efforts that continue to contribute to our record client satisfaction scores. Thank you again for all that you do for ADP, for each other and for our clients. Let's continue to build on our momentum and strive for even greater success together. Don?
Don McGuire: Thank you, Maria, and good morning, everyone. I'll start by providing some more color on our second quarter results and then update our fiscal 2025 outlook. Let me begin with our Employer Services results and outlook. ES segment revenue increased 8% on a reported and 7% on an organic constant-currency basis in the second quarter. As Maria mentioned, ES new business bookings growth was solid. With a healthy HCM demand backdrop and higher new business pipelines compared to last year, we are maintaining our 4% to 7% full year growth guidance. ES retention declined slightly in Q2 and we continue to forecast a modest decline of 10 basis points to 30 basis points for fiscal 2025. ES pays per control growth of 1% came in slightly below our expectations, but we are maintaining our forecast for 1% to 2% growth for the full year. Client funds interest revenue increased by more than we anticipated, driven mainly by stronger growth in average client funds balances. For the full year, we are increasing our forecast for client funds interest revenue and the net impact from our extended investment strategy by $25 million. Despite recent FX headwinds more than offsetting the increase to our client funds interest revenue forecast, we are maintaining our outlook for full year ES revenue growth of 6% to 7%. Our ES margin increased 90 basis points in the second quarter, reflecting operating leverage and client funds interest revenue growth. We continue to forecast ES margin increasing 40 basis points to 60 basis points for the full year. Moving to the PEO, revenue growth of 8% and average worksite employee growth of 3% slightly exceeded our expectations. Revenue growth benefited from strong new business bookings, accelerating zero margin pass-through growth, wage growth, and the timing of state unemployment insurance revenue. With continued healthy new business activity levels, we are maintaining our full year forecasts for PEO revenue growth of 5% to 6% and average worksite employee growth of 2% to 3%. PEO pays per control growth stabilized in Q2, but we continue to expect it to grow slightly slower than ES pays per control growth for the full year. PEO margin decreased by 140 basis points in the quarter, impacted by higher zero margin benefits pass-through revenue growth and an increase in workers' compensation in state unemployment insurance costs. We continue to expect PEO margin to decrease between 70 basis points and 90 basis points for the full year. Putting it all together, we are maintaining our fiscal 2025 outlook for consolidated revenue growth of 6% to 7% and adjusted EBIT margin expansion of 30 basis points to 50 basis points. We continue to expect a full-year effective tax rate of around 23%. Our fiscal 2025 adjusted EPS growth forecast of 7% to 9% is also unchanged. There are two cadence matters I would like to highlight. First, we mentioned the timing of PEO state unemployment insurance revenue and we likewise had some favorable revenue timing in our ES segment in Q2 related to the calendar. We expect these factors as well as the strengthening US dollar and the impact of lower short-term interest rates to result in a deceleration in both ES and total revenue growth in Q3, before growth trends reaccelerate in Q4. Second, we expect adjusted EBIT margin expansion and adjusted EPS growth to be lower in Q3 than in Q4 to reflect the lower revenue growth as well as the timing of integration expenses associated with the WorkForce Software acquisition. Thank you and I'll now turn it back to the operator for Q&A.
Operator: [Operator Instructions] Our first question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning, and thanks for taking my questions and great to see the strong end to the calendar year for last year, Maria and team. So, congrats on that. I guess, first question is just on the Fiserv partnership, that's obviously exciting news. Is that going to be referrals between the two organizations? Is there co-development on the product? And maybe just help us think about, is there any kind of revenue share associated with it? And should we see this as the beginning of more of an ISV-driven strategy? I know it's a multi-partner, but there's a lot there.
Maria Black: Yeah, sure. Good morning, Samad, and thank you for the accolades on the strong finish, certainly excited as well about it. With respect to the Fiserv relationship, we're incredibly pleased to enter into this relationship. If you think about our two organization, there are two companies that are anchored in serving the small-business market and have always believed in making things easier for that small-business owner to navigate being in business. So if you imagine two great companies coming together, two great distribution arms coming together to really solve what I believe are real things for real clients in the real world, if you will. So, to answer your question, we are at this point in a referral relationship back-and-forth. That's what we've done to date. But you're exactly right as we think about integration of the products long-term. And so the Run offering will be embedded inside of Clover and vice-versa. So, Clover will be embedded inside of Run. And so that ability to really have a joint offering from the technology side is what we're working on and what we -- what is to come, if you will. But thus far, we're really encouraged by what we're seeing so far with respect to the distribution arms, passing leads back and forth between the two great companies. I think you also asked is this the beginning of more relationships, and I think my answer would be, we believe in partnerships, we believe in ecosystem. Certainly, how we go to market, specifically in the down-market today is through the great strength of our distribution, but through that great strength of our channel partners, be it banks, be it the accountant channel and now be it this channel with Fiserv.
Samad Samana: Great. And then maybe just one follow-up. On the enterprise side, I know that with the rebranding to Lyric, there's been a lot of focus on that. You sounded very good about it last quarter. You called it out for bookings this quarter. Are you seeing -- is this kind of a clear inflection now? Is it fair to say that? And how should we think about maybe the impact of bookings or what's built into the forecast this year from the enterprise side of the business?
Maria Black: Sure. So, it is clear that Lyric is resonating really well in the marketplace. And just real quick for everyone, Lyric is the new name for our next-gen HCM solution and it is really anchored in flexibility, intelligence, it's human-centric in design. So, we believe it's a really strong product offering. I believe the market is a -- seeing that as well based on what we're seeing with respect to client adds, the pipeline building. I think the pipeline is incredibly strong year-on-year. We do expect Lyric to contribute to our growth this year from a new business bookings perspective. But again, it is still early days and so it will take some time to scale and for it to overall dent the financials of the organization. But the offering is resonating with our global enterprise clients and we're really excited in terms of the receptivity we're seeing in the market.
Samad Samana: Great. Thank you so much for taking my questions.
Operator: Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin: Hi, good morning. Thank you. The first question is on demand. So, it's good to hear the continuation of a healthy backdrop here. Can you double click on how that's progressed across the client segment size? And I'm curious that the calendar turned and just post US election, did you note any changes or anything just worth calling out in bookings specifically on what you see in the US versus international?
Maria Black: Sure, Bryan, and good morning. So, demand is strong. It's broad-based. We feel good about the overall HCM demand. We also clearly benefit from having a great sales and marketing organization. I would say across the various segments in the down-market, down-market companies, they're still hiring, they're still buying. They're still navigating being small-business owners as we just talked about. There are a couple of pockets. I think we're keeping a watchful eye on things like new business formations, which seems to have a little bit of pressure this fiscal year, but it's still at an elevated level, if you will, from a pre-pandemic standpoint. In the mid-market, we are seeing that strength in HR outsourcing, I mentioned that in the prepared remarks. And that's a differentiation for us in that mid-market space. Really excited to see the extension there. And then we've talked over the quarters about the investments we've made into our mid-market product, Workforce Now, the record NPS, the record retention. And so we have a nice mid-market story to meet that demand across the mid-market segment. I think with respect to global and upmarket, I tend to say every quarter, we're always keeping in a watchful eye just given the uncertainty in the global space and economic backdrops. But at this point, we don't see anything that would be alarming. And I think generally speaking, we feel really good and broad-based about the pipeline strength heading into the back-half. But as we all know, we're a back-half business. We have a lot to execute against. You asked about the new administration and anything that's changed. I think it's too early to call whether or not we're seeing a demand change as a result of the new administration. But the good news is, there seems to be a lot of activity and change is good for ADP. As companies navigate change, we're there to help them stay compliant. And so we're looking forward to helping our clients sort through what undoubtedly seems to be quite a bit of change.
Bryan Bergin: Yeah, for sure. Okay, appreciate all that detail. And then coming on the '25 outlook here. So, Don, appreciate the cadence clarifications. But for the full-year outlook, when we think about -- you affirmed the range on EPS growth, just any indications on kind of comfort levels within that range as you move through the second half? How should we be thinking about the EPS here as it relates to kind of float upside potential as the curve remains elevated versus potential FX headwinds from dollar strength?
Don McGuire: Yeah, Bryan, so I think you've touched on it right there at the end. It's the FX headwinds that are really causing us to see some slowdown. But I'd also say that particularly in the third quarter, which is by far our largest average daily balance time as the new taxes or sorry, as federal and state taxes kick in again at the start of the year, that's where we tend to have the highest balances. And all those funds or most of those funds are short and short-term rates are down 100 basis points year-on-year. So that's what's put more pressure on Q3, in particular, before it rebounds into Q4. So I think that's the trade-off. It's the FX headwinds are causing some grief. And then, of course, the short nature of the investment portfolio in the third quarter as a result of the various taxes we kicking in at the start of the calendar tax year.
Bryan Bergin: Okay. Okay, appreciate that and congrats on the 50 years of dividend increases.
Maria Black: Thank you.
Operator: Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi, thanks for taking my question this morning. Don, would you comment a bit further on the drivers of the implied slower PEO revenue growth in the back-half? I know there were some timing-related issues. Can you just sort of parse that out for us and help us understand a little better why that should decelerate the way you've implied it will?
Don McGuire: Well, we certainly have the SUI. We had talked a little bit also in the prepared remarks about the pull-forward of some SUI into Q2. So that was really just the way the calendar fell with New Year's Day happening when it did in the holiday, people processed at the back-end of Q2 as opposed to Q3. So that pulled some of the low-margin SUI into the second quarter as opposed to letting it fall into the third. And then, of course, we are in our renewals time, so we're looking at that pace per control and continue to be -- as we said, we expect pace per control growth in PEO to be a little bit slower than they were in there -- or they are in ES. Do you want to clarify in ES while I'm saying this though that we did round down to 1% pace per control growth in ES, we didn't round up, we rounded down. So pace per control growth was a little bit slower than expected, but it was still above the 1% rate. So I think those are really the primary drivers of what's slowing the PEO growth in the back-half.
Ramsey El-Assal: Got it. Okay. And then a follow up for me. In the context of the Paychex's Paycor acquisition, do you see any changes in the M&A environment or in your appetite to do deals?
Don McGuire: Yeah, I guess I'd say that our views on M&A really haven't changed. I think that over the years, the things we've looked at, we really haven't thought that regulatory environments really been an encumbrance to us doing anything. There's still incredible amount of fragmentation in the industry. So I think we're going to keep to our principles. We need to make sure that things that we acquire, complement our offerings and don't complement -- complicate them. But certainly, we continue to look. I mean, you should expect to see as we've done over the years, expect to see some tuck-ins are very important for us and they've contributed to us getting better control over our network, et cetera. So, you may see some of those going forward, but I don't think that there's going to be any changes based on potential new regulation that would result in us seeing a much different stance in M&A than we've had to date.
Ramsey El-Assal: Got it. All right. Thank you very much.
Operator: Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Great. Thank you very much. Appreciate all the time this morning. I want to ask quickly about retention. Last quarter, you flagged you saw a little bit of retention degradation, but it wasn't really specifically attributable to an uptick in small, medium-sized bankruptcies and instead kind of rather broad-based off-peak hiring levels. What specifically did you see in the quarter on that latter point? Are we seeing kind of hiring levels move around at all? And what's the assumption in the back-half for -- and is the assumption for the back-half that small to medium-sized business bankruptcies will pick-up again?
Maria Black: Yes, that is the assumption, James, in the back-half, and good morning. So, retention, as you noticed, we did beat modestly. Again, on retention, I'm very pleased to see that because the biggest piece is if we're beating modestly on retention, that does mean that ultimately small business owners are staying in business. So that makes me even more happy for them as well as our results. We did see a little bit of a degradation, if you will, in the down-market. So what we believe we're almost all the way normalized. We're not quite there. It declined. It declined modestly in the first quarter, declined modestly in the second quarter. That said, we do continue to beat. So based on what we're seeing and the fact that across each one of our segments, we've really been at that record retention levels, we believe it's prudent to keep our retention guide as is, but I'm optimistic as a -- I'm sure we all are to hope that specifically small businesses stay in business.
James Faucette: Great. Appreciate that. And then I wanted to do a little bit of a status check on some of your AI and machine learning driven initiatives. You guys have always been very front-footed on that and I know that kind of ebbs and flows as a topic. But I'm wondering if you can just give us an update on service and sales efficiency efforts with some of your GenAI projects. And if you have any examples that you could provide of how your GenAI initiatives are impacting client retention or sales productivity or any other metric you may want to touch on?
Maria Black: Yeah, sure. So, I'll start and I certainly welcome Don to chime in here with respect to the results that we're seeing, but we are laser-focused on our Generative AI strategy, on our overall approach. And just to kind of level set and remind everybody, the way that we've been thinking about it is really in three, call it, specific buckets, which is putting Generative AI into our products. That's what we call ADP Assist, that's making our products more usable and better for our clients. It's putting Generative AI into our service organization. So, think of that as Agent Assist, but that's part of the overall ADP Assist umbrella. And that specifically, James, kind of answers your question around service and things of that nature. Some of the things we've spoken about in the past that are already making meaningful impact are with respect to things like call summarization. So, I think I cited before that we're shaving off a minute per call, which may not sound that exciting to everybody that a minute per call, but when you take lots and lots of calls, it adds up pretty quickly. So, we continue to make meaningful impact on some of those tools. Other things we cited in the past, digital transformation as it relates to implementation. And so the small business organization is at really record levels as it relates to end-to-end digitally onboarding clients using new tools that are anchored in Generative AI. So that's kind of the service side. By the way, I could go on and on about this topic. Switching gears really quickly to the go-to-market. We've been undergoing a sales modernization effort and I'd argue for two decades. We have one of the most meaningful sales modernization tech stacks that exist. I think the likes of best-in-class technology to enable all our sellers. Some of the things that we've talked about is opportunity prioritization. So, think about putting the right lead in front of the right seller at the right time to drive value into the sales process. We're doing things like rapid pre-call planning. So this takes me back to my olden days when I used to have to pull everything up on the Internet or MapQuest and try to study what I should say to a certain client. These are all tools now that exist that are helping our sellers become more effective on their sales calls. And the way that you see that and quantify it, certainly, the end game there is more sales, but it's really this balance between as we invest into sales modernization and these various pieces of technology, it's really driving productivity. So we have a natural lift right now in productivity just based on the tenure that we're seeing in our sales organization. So if you imagine, as we're bringing on new associates, we're also building tenure in the existing sales force. So new associates are able to become more productive and existing associates are also able to become more productive. Part of that is anchored in tenure. A lot of that is anchored in these tools that we're investing in and the long-term output of that is more sales and more sales productivity. So, I think I've said a lot, but I'll offer Don if there was anything you wanted to add to that.
Don McGuire: No, I'd just add that we are seeing good efficiency and good productivity, but I would say that we still have these tools in many of our associates' hands, but there's still many more to get the tools. And when they get those tools, we expect to see even more positive results. So we'll watch the productivity improvements and hopefully we see those things reflected in the margin. Of course, we had made some minor investments in these tools themselves. So, the bottom-line impact is going to be over the longer-term and certainly not short-term, but very, very positive results from everything we're seeing and everything we're doing.
James Faucette: That's great. Thank you so much.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Hey, good morning, Maria and Don, and congratulations on the strong end of the calendar year and obviously the 50 years to -- for the whole organization. On the strategic side, with regards to Fiserv and Clover, it sounds really promising. How meaningful could it be? Like if we fast-forward on two or three years, how do you envision the partnership working? And could it be expanded above and beyond Run because I think for some clients, it might also be pretty relevant on the lower end of Workforce Now. So, I'm wondering how you're thinking about that. I know it's early days, but wondering if you can just give us a feel for that.
Maria Black: Sure, Mark. And first and foremost, thank you for the accolades on the 50 years. You've been a big part of that over the years. I appreciate all the interest you've had to help us along and certainly this interest in our go-forward strategy. I think you hit the nail on the head. We have all sorts of plans and visions, just how far we can go. Again, if you think about that down market ecosystem and how we go to market today, it is primarily through channels. I think we've cited in the past specific numbers around how we distribute through those channels, be it banks, be it CPAs, certainly through POS channels or merchant services channels such as Fiserv, this could be a meaningful channel for us. That is why we've engaged and we believe in it. So when I -- if I was to fast-forward five years, I think it's a channel that we speak to very similarly to the way that we speak to the accountants and the banks today. And I think about two -- again, great products, great companies and great distribution engines coming together to really drive that value into the overall small business space. Could it go beyond small business? I think the answer is little bit to be determined. I think that's something that as we see the traction in the down-market, we'll continue to challenge ourselves. Listen, I -- it's very simple for me. To me, it's -- the guiding principle is always about the client. And if we have an opportunity to solve real challenges for business owners, be it small, be it mid, be it up, upmarket, we're all about that and Fiserv is as well. And I think that's what makes this so exciting. So, anything we can do to make things easier to navigate being in business, we're here to help.
Mark Marcon: That's great. And then on WorkForce Software, it sounds like everything is going according to plan. As you think through the next fiscal year, how well integrated will it be by for fiscal '26 do you think? And how meaningful could that end up being with regards to the upmarket?
Maria Black: Sure, Mark. So, we are actively working through that from a plan perspective right now. So, I'm pleased to say everything is on track. We actually just rounded 100 days. It's amazing. Time flies when you're having fun. But last week, we celebrated 100 days in. And at this juncture what we've done is welcome the WorkForce Software associates. We folded them into the ADP family, really pleased to see how the milestones that we've accomplished in the first 100 days have come along and in there, thus far, it's really taking a look at the go-to-market. So, as we talked about last quarter, they have a meaningful set of clients. And so as we look at their client base and our client base and comparing pipelines, really that ability to go to market together to ensure that we're winning consistently on the workforce, software, and the time and labor management side. That's been a big piece of the focus. And then as you can imagine, working through the integration is really the next set of pieces. So I don't think we're in a spot yet to declare necessarily exactly by when, but that is a big piece of the work that is being done. And we're really excited about what this is going to mean to us from an opportunity in the WorkForce management space, but also in the enterprise space and the global space as we bring this product also together with the Lyric offering.
Mark Marcon: Terrific. Got tons of questions, but I'll leave it there. Congratulations again.
Maria Black: Thanks, Mark.
Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane: Hi, guys, good morning and congrats on the solid results. Just a clarification on the Fiserv partnership. Just on the economics, how do the economics exactly work between the two companies? Is it a percentage of sales as a one-time fee? Is it a recurring fee? Just curious on how that relationship works on both sides.
Maria Black: So, I don't know that we want to get into the specifics of exactly how we orchestrated it, but the answer in a broad sense is both. So there is a referral piece to it. There's also revenue-share over time that really drive the financials for both of us to make this an accretive proposition for us to go to market together.
Bryan Keane: Okay. That's helpful. And then just as a follow up, just thinking about selling season and targets for kind of new client growth and what is the pricing environment, what kind of pricing yield do you think you'll be able to get in the key new selling season?
Don McGuire: Yeah, Bryan, I don't think we're seeing anything unusual. The competitive environment continues to be pretty much the same. Nothing is happening. There's always promotions. We have promotions, other folks have promotions, et cetera, but things are feeling the same as they were previously. So not seeing anything unusual. In terms of price increases, for existing clients, as we said, we're targeting about 100 basis points this year, which is more than the 50 we've got historically, but less than 150 we got during the couple of years of heavy inflation, but -- and the 100 points -- 100 basis points is looking pretty attainable and our clients are staying with us as the retention rate shows. So, we think it's something that's achievable for us.
Bryan Keane: Okay, that's helpful. Thanks, guys.
Operator: Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open.
Jason Kupferberg: Thank you, guys. Good morning. I just wanted to start on bookings. The tone there continues to sound quite upbeat. I know the guidance for the year is unchanged at 4% to 7%. I was hoping you could talk qualitatively at least about how you're tracking to that guide this year versus last year. Just wondering whether or not the visibility on the full year bookings is higher now than it was at this time last year.
Maria Black: Yeah, perhaps the best way to answer that question is with respect to pipelines year-on-year. So the pipelines are in good shape overall. They are up year-on-year. Just to clarify, when we talk about pipelines, that's really of mid-market, upmarket international term, right, as you're able to actually see the longevity of a deal and how a deal is moving through the sales motions and we feel good about pipelines year-on-year. In the down-market, instead of pipelines, we really talk about things like activity, how many new appointments are we going on, how many RFPs are being handled in our PEO. So again, we feel good about the activities. We feel good about the RFPs. We feel good about the pipelines year-on-year heading into the back half. What I would say is all across -- and I mentioned it earlier, all across ADP, we are a back-half company as it relates to sales. So, we still have a lot of execution to get done, but we feel good with respect to our position year-on-year.
Jason Kupferberg: Understood. Okay. And then maybe one for Don. Appreciate all the moving parts here in the back half of the year. But can you just put maybe a finer point on Q3 versus Q4, how we should be thinking about revenue growth and margin cadence just so that we've got the pieces calibrated.
Don McGuire: Yeah. So just to reiterate, I think the -- I'll do these in order of importance. I think FX, number one is having a revenue impact, which of course will fall-through and have a margin impact. The CFI, of course, is a bit of a challenge given the 100 basis point drop and how much of the portfolio is in the short position. And, of course, in the third quarter, we're also really getting going here with all the integration expenses, whatnot with respect to WorkForce Software. I'll also call out now that when you see the 10-Q, you'll see a very detailed breakout of all the items that -- all the breakdown of the goodwill and all of the line items in the intangibles, et cetera. So you'll be able to have some very clear insight into amortization times, et cetera, and get a view of how that's going to look over the coming years. But certainly, we're going to see some softness in Q3 as a result of those factors. And then when you get back into Q4, we'll see growth accelerate a little bit more, but more slowing -- slower-growth in Q3, bit faster growth in Q4, bringing us to our reiterated guidance for the full year.
Jason Kupferberg: Okay. Thanks for that.
Operator: Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Hey, good morning, guys. Thank you for taking my questions. I wanted to start on the PEO segment. One of your peers have called out maybe some dynamics with clients opting into maybe lower cost benefit plans. So just wondering if you've been seeing any changes in benefits enrollment behavior recently.
Maria Black: So, not really, Scott. I think for our purposes, we're actually heading into our renewal season here in the back half of our fiscal year and the PEO. So a bit to be determined, if you will, but not really, not that -- not thus far. I think some of the PEOs, just to remind everybody, we're all somewhat structured differently. Some of us have ASO offerings, HRO offerings, some of us have different ways that we fund our health plans. As you know, the PEO, ADP total source, we're fully insured on the health side. And so the behaviors don't always match each other and we've really not called out those swings in the past. We do have an HR outsourcing offering. I mentioned it earlier. It has contributed great results from a bookings perspective and we expect that both from that offer as well as the PEO. So, I think we see strength across both and we don't really see the swings back and forth.
Scott Wurtzel: Got you. That's helpful. And then just as a follow up, Don, on the softer pace per control growth maybe relative to your expectations, was that in any specific pockets of your client base?
Don McGuire: No, it was pretty broad-based. It was not -- no specific industries or regions of the country, et cetera. Pretty broad-based.
Scott Wurtzel: Got it. Thanks, guys.
Operator: Thank you. Our next question comes from Tien-tsin Huang with JPMorgan. Your line is open.
Tien-tsin Huang: Hi, thanks so much. Yeah, so a couple quarters of really strong pipeline, I think you've mentioned. I'm just curious, do you see timely deal awards in the second half? And I don't know if I heard this, but are deal sizes getting larger in general? Just curious how the shape of the pipeline and the quality.
Maria Black: I would say deal sizes and timing on deals is relatively consistent. And so I think we've talked about several times over the last couple of years, we're kind of back to, I guess, the new normal or the old normal. So I think deal cycles move through motions very similar to how they operated prior to the pandemic. That's not to suggest that you don't hear every now and then strangeness in timing. Certainly, the holidays this year fell differently that had interesting impact to us both from a revenue perspective, but also interesting impact on the sales side, if you think about when deals kind of cross that line. But listen, large deals are sometimes lumpy as well. And so I would say, generally speaking, things seem to be moving through the motions that they usually do and it's really similar to how we think about the business pre-pandemic.
Tien-tsin Huang: Glad to hear it. Just on the consolidation side, Maria, just -- I feel like we've seen some SMB players invest in mid-market solutions.
Maria Black: Sure.
Tien-tsin Huang: Feels like an endorsement of the ADP's model. I don't know, do you see that as a trend? Love your thoughts on that.
Maria Black: Well, first -- yeah, first, I'll say, thanks. I'll take that. There's nothing better than the -- best form of flattery is when somebody copies you, right? So no, all kidding aside, listen, the -- I obviously know the consolidation that you're referencing. I think for our end, it does validate having a broad-based segment approach. The breadth and depth of ADP continues to shine. I would say you would say with respect to the two players that are consolidating, we fared well against both of them. We expect that we will continue from a balance of trade to fare well against both of them, who knows. Maybe it even presents itself to be a bit of an opportunity for us. But I think as it stands, we feel really strong about the position of our products and the best-in-class platforms that we have in each of the segments. So, the Run offering in the down-market, the Workforce Now offering across the mid-market and our HR outsourcing solutions inclusive of the PEO. And now with Lyric and WorkForce Software coming together, we feel really great about the offers that we have in each one of these segments.
Tien-tsin Huang: That's great. Thanks, Maria. And way to get MapQuest into the transcript, didn't expect that. Thanks.
Maria Black: Old school.
Tien-tsin Huang: Yes. Have a good day.
Operator: Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open.
Pete Christiansen: Thank you and good morning. A lot of good stuff here. Maria, I wanted to talk about -- dig a little bit in your thoughts longer-term perhaps on the adjacency of B2B payments, even treasury management solutions. Seems like a real natural adjacency for ADP. I know the company used -- ADP established ADP Trust Company a couple years ago. Just wondering how you think about that longer term. We've seen a couple integrations with some other companies, even cross -- even on the cross-border side with payroll. Just curious if you see this emerging as a real longer-term TAM expansion opportunity for ADP. Thank you.
Maria Black: Sure. Yeah, sure, Pete. By the way, I'll take that as an offer to join us at our Investor Day because I think we're pretty excited to talk about the future of our strategy. And certainly, we think a lot about the various things that you're referencing and we've looked, right? We've looked before -- by the way, we've been in the office of the CFO before. I think this adjacency partnership that we're entering into with Fiserv, I think we're going to learn a lot. I'll go back to what I said earlier, which is really putting the client at the center of that solve, which means if we have the ability to come together with other companies through partnership or perhaps even deeper integration or perhaps even shared ownership or full ownership to solve real problems, those are always things that we are batting around from a strategic standpoint. So, I suppose more to come. That's not by the way to suggest there's some giant unveil, but we're pretty excited to share some of the things that we're thinking about for the future for ADP. We actually haven't done an Investor Day since November of '21. And a lot has changed both in certainly how we are thinking about the business and some of the things that we've shared over the last couple years, but certainly the overall industry has changed and continues to evolve as well. So more to come, Pete, but certainly top-of-mind for us always.
Pete Christiansen: Thanks, Maria, super interesting. Looking forward to the Analyst Day.
Operator: Thank you. Our next question comes from Kevin McVeigh with UBS. Your line is open.
Kevin McVeigh: Great. Thanks so much. Hey, I think, Don, you talked about kind of trends in the back half with the reacceleration in Q4 as opposed to Q3. Any puts and takes on what drives that reacceleration? I think it was specifically around ES or maybe the business overall.
Don McGuire: Yeah. I think around -- it is around ES predominantly. I think the big difference is, is this -- the client funds interest. The Q3, of course, is where we have the largest short portfolio and we don't have that in Q4. So that is what's going to -- so the impact of the short-term interest rates are going to be somewhat less in Q4 than they will be in Q3. And I think that's a significant piece of the -- significant piece of the puzzle. The other part is that we do have some heavier expenses in Q3 where even though it's 100 days, we are still in the early days of the integration of WorkForce Software. So there's some heavier expenses in this coming quarter than there will be in the fourth quarter, but that's really about it. There's really nothing more detailed than that.
Kevin McVeigh: That's helpful. And then just real quick on the retention. I know typically the Q2, right, the December quarter or Q1 rather, just any thoughts on what quarter seasonally would have the most outsized retention? Just remind us, I know there's some seasonal impact just given the January start, just any thoughts around that?
Don McGuire: Yeah, I think the -- seasonally the retention tends to go up and down by quarter, but certainly it's in Q3, that's when all the switching happens and whatnot, so actually you'd see a bit of a dip, but of course, we compare the dip to the prior year's dip, et cetera. So, nothing there unusual. And as Maria said, we're -- even though we had a slight decline, we still -- we declined less than anticipated, less-than-expected and we're happy with that. It means people are staying in business and clients are staying because they're happy, NPS scores continue to be high. So, we're -- hopefully we'll see some opportunity in the retention score for the whole year, but we're certainly happy with where it's at right now.
Kevin McVeigh: Great. Thank you.
Operator: Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Hey, good morning. Don, you talked about pricing and pricing being about 100 basis points up versus 50 that it's historically been, maybe down from the 150 you saw previously. But I'm wondering, do you think the environment has changed 100 basis points, something you could see net pricing for the next couple of years? Or do you think we're just in a unique period where you're getting this little bit outsized pricing?
Don McGuire: Kartik, good morning. Thanks for the question. I think that's a difficult one to speculate on for me because I guess it depends on what you think the economic forecasts are saying. Some are saying we should expect higher inflation, but who knows, not sure. We haven't seen whether some of the policies that are being bandied about are really going to be put in force and drive inflation or not. So -- but I would say generally that if there's higher inflation, we will do our best or take the opportunity to continue to provide good value and make sure that we're passing our costs along. But it's -- once again, it's all about the long-term value of the client for us and we'll do what we need to do to make sure that we keep that retention rate up. That's the most important metric for us when it comes to the pricing.
Kartik Mehta: And just a follow up on the PEO. You've talked about pace per control being slightly lower in the PEO than ES. And I know that's kind of a more of a near-term phenomenon. Is there anything changing in that business or the industry where you could see this trend continue? Or is this just a bit of an anomaly where the pace per controller lower than the ES business?
Don McGuire: I think we've been talking for several quarters about PEO and we've been happy to talk the last couple of quarters about stabilization and improvement. So, hopefully things are going to go back and look better historically. As you know, the pace per control growth in the PEO has been better than it has been in the ES segment. But I think we're happy with where we're at right now and we'll see how it materializes, but I don't know if there's any particular drivers. I will say that for the quarter, we saw a stabilization across most of the industries where we provide the services. So that was a positive thing to see, in particular, or in the financial administrative, it's stabilized and that had been an area of weakness for us in the past, but it is stabilized. So, we are comfortable with where we're at and looking for it to improve.
Kartik Mehta: Perfect. Thank you very much. Appreciate the time.
Operator: Thank you. We have time for one last question and that question comes from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Hey, guys. Thanks for squeezing me in here. I did notice -- I know we talked -- you talked a lot about the macro, but I did notice a slight change in maybe language or formulation. I believe last quarter you said clients continue to hire at a moderate pace and now you're saying albeit at a slower pace. I just want to know maybe more about from your experience, you've obviously been doing this for a long time. When this slowing trend starts rolling, is it a trajectory that could change? Is this like a maybe just a hiatus? Just more like long-term perspective on this one would be great. And other than that, obviously, really strong results and yeah, love it. Thank you.
Don McGuire: Yeah, Dan, I guess I just -- I guess I'd answer that by saying that the macro-environment continues to be very, very strong and solid, the labor environment strong, 4.1% unemployment. I think the fundamentals are good and so I think that the hiring and companies still being profitable and there seems to be an awful lot of optimism in the US market in particular. So I think that all bodes well for pays per control and overall growth. And then, of course, we do have the opportunity that we also have operations outside of the US, so we can see opportunities there and manage the portfolio in that way. But I would say, I think really the only way to answer that question is just around the macro-environment that continues to be quite solid.
Dan Dolev: Got it. Thank you and congrats again on being a thought leader. HCM, looks like your competitors are taking a page off your book now. So, congrats again.
Maria Black: Thank you.
Operator: Thank you. This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Maria Black for closing remarks.
Maria Black: Thanks, Michelle, and thank you again to everyone for joining and for the compliments and the encouragement and the interest in ADP. I did want to share something very exciting, hot off the press. ADP has been named once again by Fortune magazine as for the 19th consecutive year on the distinguished list of being a World's Most Admired Company in 2025. This recognition for me means everything because it's a true testament to our associates that really make this company the great entity that it is serving so many clients across so many segments and so many markets in such a changing environment for our clients to navigate each and every day. So, I'm super proud to share this news with all of you and congratulations to all the ADPers on this well-earned accomplishment. Thanks.
Operator: Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter 2025 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Matthew Keating",
"text": "Thank you, Michelle, and welcome everyone to ADP's second quarter fiscal 2025 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our investor relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on the factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Matt, and thank you, everyone, for joining us. Before I cover our results, I'd like to take a moment to acknowledge those impacted by the devastating wildfires in Los Angeles. Our hearts go out to our clients, associates, community members, and everyone touched by this tragic situation. To begin, I'd like to highlight a significant milestone achieved during the second quarter. When ADP's Board of Directors approved the 10% increase to our quarterly dividend in November, it marked the 50th consecutive year in which we raised our dividend. We are now proud to be included among an elite group of dividend kings, a small number of publicly traded US companies with 50 or more consecutive years of dividend increases. This distinction is a testament to ADP's enduring business model and our ability to innovate over time and across economic cycles. We embrace this accomplishment and our role as a global HR technology leader and builder of a new era of workforce insight and innovation. We look forward to sharing more about where we've been and more importantly, where we're headed at our 2025 Investor Day, which will take place on June 12th. This morning, we reported strong second quarter results that included 8% revenue growth, 60 basis points of adjusted EBIT margin expansion, and 10% adjusted EPS growth. These results reflected strength across our Employer Services and PEO segments. I'll begin with some additional financial highlights before providing an update on the progress made across our strategic priorities. We delivered solid Employer Services new business bookings with record volumes for fiscal second quarter. Growth was notably strong across our HR outsourcing, compliance, and enterprise businesses as well as our small-business offerings. With the continued healthy demand backdrop and a new business pipeline that is up from this time last year, we look-forward to a strong second half of the year. Employer Services retention declined slightly compared to the prior year, but once again modestly exceeded our expectations. We continued to benefit from a strong overall business environment and very high client satisfaction levels. In fact, our client satisfaction levels reached a new all-time high in the second quarter and through the first half of our fiscal year. Employer Services pays per control increased 1% in Q2, decelerating from the 2% growth in Q1. The US labor market remains strong and our clients continue to hire, albeit at a slightly slower pace. Finally, PEO revenue growth of 8% was driven by strong PEO new business bookings and faster zero margin pass-through growth. Now, let's turn to our strategic priorities, where we delivered another quarter of considerable progress. During the second quarter, we announced a strategic partnership with Fiserv that brings Fiserv's leading small-business solutions, specifically Clover, its cloud-based point-of-sale and business management platform; and CashFlow Central, its accounts payables and receivables management platform together with Run, our industry-leading small-business payroll and HR solution. Helping small businesses thrive has been ADP's mission since day one and we are excited to partner with Fiserv to advance this goal and to support the millions of small businesses that drive the US economy. Through this partnership, ADP and Fiserv will offer US based small businesses access to an integrated all-in-one solution, combining the full power of Run and the Clover small-business management platform. In addition, CashFlow Central will be available to run clients, enabling our mutual customers to manage their cash flow more efficiently. These integrated solutions will make it easier than ever for small businesses to manage the flow of money into and out of their business, whether they are selling to customers, paying bills, or managing payroll. We initiated mutual client referrals to our respective offerings during the second quarter and our teams are working closely to deliver the integrated solution in the coming months. Our WorkForce Software acquisition, which closed in mid-October, is progressing well and in line with expectations. We are thrilled to have WorkForce Software's associates join ADP and our teams are working to integrate WorkForce Software's time and attendance, absence management and scheduling tools with key ADP HCM platforms. While that happens, the WorkForce Software team is focused on maintaining its momentum and delivering best-in-class solutions. And in Q2, we experienced healthy new business activity across our new WorkForce Software offering as well as our other existing Workforce Management solutions. In addition, we have already started to see new business opportunities that validate the growth anticipated from the combination. For example, WorkForce Software's enterprise-focused, industry-specific solutions are a strong fit for clients, allowing us to better compete and win in a wide range of industry verticals and geographies. Similarly, we are seeing opportunities to offer ADP HR and payroll solutions to WorkForce Software clients looking for a full suite HCM solution. With the addition of WorkForce Software, ADP is uniquely positioned to provide clients with a global HR payroll service and time solution and this value proposition is generating excitement in the marketplace. We remain confident in our opportunity to accelerate our growth in the Workforce Management and enterprise spaces. Following the successful introduction of ADP Lyric, our flexible, intelligent, and human-centric global HCM platform, the product continued to generate strong interest in the marketplace during the second quarter. Lyric's new business booking volumes increased again and its new business pipeline ended the quarter up significantly compared to last year. One client that started on Lyric in Q2 is a large recreation management company in the Midwest that operates nearly 20 parks, a nationally acclaimed zoo and nine golf courses. The client selected Lyric for a cutting-edge user experience and to simplify its personnel management activities and payroll processes. It went live with a full suite including HR, payroll time, benefits, recruiting and talent management and is very pleased with the outcome. Since Lyric is a global platform, we remain focused on expanding its already broad international reach to capitalize on what we see as a significant global opportunity. Before I turn the call over to Don, I want to take a moment to express my gratitude to our associates for their dedication and hard work. Their unyielding commitment to our clients inspires me each and every day. It is these efforts that continue to contribute to our record client satisfaction scores. Thank you again for all that you do for ADP, for each other and for our clients. Let's continue to build on our momentum and strive for even greater success together. Don?"
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll start by providing some more color on our second quarter results and then update our fiscal 2025 outlook. Let me begin with our Employer Services results and outlook. ES segment revenue increased 8% on a reported and 7% on an organic constant-currency basis in the second quarter. As Maria mentioned, ES new business bookings growth was solid. With a healthy HCM demand backdrop and higher new business pipelines compared to last year, we are maintaining our 4% to 7% full year growth guidance. ES retention declined slightly in Q2 and we continue to forecast a modest decline of 10 basis points to 30 basis points for fiscal 2025. ES pays per control growth of 1% came in slightly below our expectations, but we are maintaining our forecast for 1% to 2% growth for the full year. Client funds interest revenue increased by more than we anticipated, driven mainly by stronger growth in average client funds balances. For the full year, we are increasing our forecast for client funds interest revenue and the net impact from our extended investment strategy by $25 million. Despite recent FX headwinds more than offsetting the increase to our client funds interest revenue forecast, we are maintaining our outlook for full year ES revenue growth of 6% to 7%. Our ES margin increased 90 basis points in the second quarter, reflecting operating leverage and client funds interest revenue growth. We continue to forecast ES margin increasing 40 basis points to 60 basis points for the full year. Moving to the PEO, revenue growth of 8% and average worksite employee growth of 3% slightly exceeded our expectations. Revenue growth benefited from strong new business bookings, accelerating zero margin pass-through growth, wage growth, and the timing of state unemployment insurance revenue. With continued healthy new business activity levels, we are maintaining our full year forecasts for PEO revenue growth of 5% to 6% and average worksite employee growth of 2% to 3%. PEO pays per control growth stabilized in Q2, but we continue to expect it to grow slightly slower than ES pays per control growth for the full year. PEO margin decreased by 140 basis points in the quarter, impacted by higher zero margin benefits pass-through revenue growth and an increase in workers' compensation in state unemployment insurance costs. We continue to expect PEO margin to decrease between 70 basis points and 90 basis points for the full year. Putting it all together, we are maintaining our fiscal 2025 outlook for consolidated revenue growth of 6% to 7% and adjusted EBIT margin expansion of 30 basis points to 50 basis points. We continue to expect a full-year effective tax rate of around 23%. Our fiscal 2025 adjusted EPS growth forecast of 7% to 9% is also unchanged. There are two cadence matters I would like to highlight. First, we mentioned the timing of PEO state unemployment insurance revenue and we likewise had some favorable revenue timing in our ES segment in Q2 related to the calendar. We expect these factors as well as the strengthening US dollar and the impact of lower short-term interest rates to result in a deceleration in both ES and total revenue growth in Q3, before growth trends reaccelerate in Q4. Second, we expect adjusted EBIT margin expansion and adjusted EPS growth to be lower in Q3 than in Q4 to reflect the lower revenue growth as well as the timing of integration expenses associated with the WorkForce Software acquisition. Thank you and I'll now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning, and thanks for taking my questions and great to see the strong end to the calendar year for last year, Maria and team. So, congrats on that. I guess, first question is just on the Fiserv partnership, that's obviously exciting news. Is that going to be referrals between the two organizations? Is there co-development on the product? And maybe just help us think about, is there any kind of revenue share associated with it? And should we see this as the beginning of more of an ISV-driven strategy? I know it's a multi-partner, but there's a lot there."
},
{
"speaker": "Maria Black",
"text": "Yeah, sure. Good morning, Samad, and thank you for the accolades on the strong finish, certainly excited as well about it. With respect to the Fiserv relationship, we're incredibly pleased to enter into this relationship. If you think about our two organization, there are two companies that are anchored in serving the small-business market and have always believed in making things easier for that small-business owner to navigate being in business. So if you imagine two great companies coming together, two great distribution arms coming together to really solve what I believe are real things for real clients in the real world, if you will. So, to answer your question, we are at this point in a referral relationship back-and-forth. That's what we've done to date. But you're exactly right as we think about integration of the products long-term. And so the Run offering will be embedded inside of Clover and vice-versa. So, Clover will be embedded inside of Run. And so that ability to really have a joint offering from the technology side is what we're working on and what we -- what is to come, if you will. But thus far, we're really encouraged by what we're seeing so far with respect to the distribution arms, passing leads back and forth between the two great companies. I think you also asked is this the beginning of more relationships, and I think my answer would be, we believe in partnerships, we believe in ecosystem. Certainly, how we go to market, specifically in the down-market today is through the great strength of our distribution, but through that great strength of our channel partners, be it banks, be it the accountant channel and now be it this channel with Fiserv."
},
{
"speaker": "Samad Samana",
"text": "Great. And then maybe just one follow-up. On the enterprise side, I know that with the rebranding to Lyric, there's been a lot of focus on that. You sounded very good about it last quarter. You called it out for bookings this quarter. Are you seeing -- is this kind of a clear inflection now? Is it fair to say that? And how should we think about maybe the impact of bookings or what's built into the forecast this year from the enterprise side of the business?"
},
{
"speaker": "Maria Black",
"text": "Sure. So, it is clear that Lyric is resonating really well in the marketplace. And just real quick for everyone, Lyric is the new name for our next-gen HCM solution and it is really anchored in flexibility, intelligence, it's human-centric in design. So, we believe it's a really strong product offering. I believe the market is a -- seeing that as well based on what we're seeing with respect to client adds, the pipeline building. I think the pipeline is incredibly strong year-on-year. We do expect Lyric to contribute to our growth this year from a new business bookings perspective. But again, it is still early days and so it will take some time to scale and for it to overall dent the financials of the organization. But the offering is resonating with our global enterprise clients and we're really excited in terms of the receptivity we're seeing in the market."
},
{
"speaker": "Samad Samana",
"text": "Great. Thank you so much for taking my questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"text": "Hi, good morning. Thank you. The first question is on demand. So, it's good to hear the continuation of a healthy backdrop here. Can you double click on how that's progressed across the client segment size? And I'm curious that the calendar turned and just post US election, did you note any changes or anything just worth calling out in bookings specifically on what you see in the US versus international?"
},
{
"speaker": "Maria Black",
"text": "Sure, Bryan, and good morning. So, demand is strong. It's broad-based. We feel good about the overall HCM demand. We also clearly benefit from having a great sales and marketing organization. I would say across the various segments in the down-market, down-market companies, they're still hiring, they're still buying. They're still navigating being small-business owners as we just talked about. There are a couple of pockets. I think we're keeping a watchful eye on things like new business formations, which seems to have a little bit of pressure this fiscal year, but it's still at an elevated level, if you will, from a pre-pandemic standpoint. In the mid-market, we are seeing that strength in HR outsourcing, I mentioned that in the prepared remarks. And that's a differentiation for us in that mid-market space. Really excited to see the extension there. And then we've talked over the quarters about the investments we've made into our mid-market product, Workforce Now, the record NPS, the record retention. And so we have a nice mid-market story to meet that demand across the mid-market segment. I think with respect to global and upmarket, I tend to say every quarter, we're always keeping in a watchful eye just given the uncertainty in the global space and economic backdrops. But at this point, we don't see anything that would be alarming. And I think generally speaking, we feel really good and broad-based about the pipeline strength heading into the back-half. But as we all know, we're a back-half business. We have a lot to execute against. You asked about the new administration and anything that's changed. I think it's too early to call whether or not we're seeing a demand change as a result of the new administration. But the good news is, there seems to be a lot of activity and change is good for ADP. As companies navigate change, we're there to help them stay compliant. And so we're looking forward to helping our clients sort through what undoubtedly seems to be quite a bit of change."
},
{
"speaker": "Bryan Bergin",
"text": "Yeah, for sure. Okay, appreciate all that detail. And then coming on the '25 outlook here. So, Don, appreciate the cadence clarifications. But for the full-year outlook, when we think about -- you affirmed the range on EPS growth, just any indications on kind of comfort levels within that range as you move through the second half? How should we be thinking about the EPS here as it relates to kind of float upside potential as the curve remains elevated versus potential FX headwinds from dollar strength?"
},
{
"speaker": "Don McGuire",
"text": "Yeah, Bryan, so I think you've touched on it right there at the end. It's the FX headwinds that are really causing us to see some slowdown. But I'd also say that particularly in the third quarter, which is by far our largest average daily balance time as the new taxes or sorry, as federal and state taxes kick in again at the start of the year, that's where we tend to have the highest balances. And all those funds or most of those funds are short and short-term rates are down 100 basis points year-on-year. So that's what's put more pressure on Q3, in particular, before it rebounds into Q4. So I think that's the trade-off. It's the FX headwinds are causing some grief. And then, of course, the short nature of the investment portfolio in the third quarter as a result of the various taxes we kicking in at the start of the calendar tax year."
},
{
"speaker": "Bryan Bergin",
"text": "Okay. Okay, appreciate that and congrats on the 50 years of dividend increases."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi, thanks for taking my question this morning. Don, would you comment a bit further on the drivers of the implied slower PEO revenue growth in the back-half? I know there were some timing-related issues. Can you just sort of parse that out for us and help us understand a little better why that should decelerate the way you've implied it will?"
},
{
"speaker": "Don McGuire",
"text": "Well, we certainly have the SUI. We had talked a little bit also in the prepared remarks about the pull-forward of some SUI into Q2. So that was really just the way the calendar fell with New Year's Day happening when it did in the holiday, people processed at the back-end of Q2 as opposed to Q3. So that pulled some of the low-margin SUI into the second quarter as opposed to letting it fall into the third. And then, of course, we are in our renewals time, so we're looking at that pace per control and continue to be -- as we said, we expect pace per control growth in PEO to be a little bit slower than they were in there -- or they are in ES. Do you want to clarify in ES while I'm saying this though that we did round down to 1% pace per control growth in ES, we didn't round up, we rounded down. So pace per control growth was a little bit slower than expected, but it was still above the 1% rate. So I think those are really the primary drivers of what's slowing the PEO growth in the back-half."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. Okay. And then a follow up for me. In the context of the Paychex's Paycor acquisition, do you see any changes in the M&A environment or in your appetite to do deals?"
},
{
"speaker": "Don McGuire",
"text": "Yeah, I guess I'd say that our views on M&A really haven't changed. I think that over the years, the things we've looked at, we really haven't thought that regulatory environments really been an encumbrance to us doing anything. There's still incredible amount of fragmentation in the industry. So I think we're going to keep to our principles. We need to make sure that things that we acquire, complement our offerings and don't complement -- complicate them. But certainly, we continue to look. I mean, you should expect to see as we've done over the years, expect to see some tuck-ins are very important for us and they've contributed to us getting better control over our network, et cetera. So, you may see some of those going forward, but I don't think that there's going to be any changes based on potential new regulation that would result in us seeing a much different stance in M&A than we've had to date."
},
{
"speaker": "Ramsey El-Assal",
"text": "Got it. All right. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Great. Thank you very much. Appreciate all the time this morning. I want to ask quickly about retention. Last quarter, you flagged you saw a little bit of retention degradation, but it wasn't really specifically attributable to an uptick in small, medium-sized bankruptcies and instead kind of rather broad-based off-peak hiring levels. What specifically did you see in the quarter on that latter point? Are we seeing kind of hiring levels move around at all? And what's the assumption in the back-half for -- and is the assumption for the back-half that small to medium-sized business bankruptcies will pick-up again?"
},
{
"speaker": "Maria Black",
"text": "Yes, that is the assumption, James, in the back-half, and good morning. So, retention, as you noticed, we did beat modestly. Again, on retention, I'm very pleased to see that because the biggest piece is if we're beating modestly on retention, that does mean that ultimately small business owners are staying in business. So that makes me even more happy for them as well as our results. We did see a little bit of a degradation, if you will, in the down-market. So what we believe we're almost all the way normalized. We're not quite there. It declined. It declined modestly in the first quarter, declined modestly in the second quarter. That said, we do continue to beat. So based on what we're seeing and the fact that across each one of our segments, we've really been at that record retention levels, we believe it's prudent to keep our retention guide as is, but I'm optimistic as a -- I'm sure we all are to hope that specifically small businesses stay in business."
},
{
"speaker": "James Faucette",
"text": "Great. Appreciate that. And then I wanted to do a little bit of a status check on some of your AI and machine learning driven initiatives. You guys have always been very front-footed on that and I know that kind of ebbs and flows as a topic. But I'm wondering if you can just give us an update on service and sales efficiency efforts with some of your GenAI projects. And if you have any examples that you could provide of how your GenAI initiatives are impacting client retention or sales productivity or any other metric you may want to touch on?"
},
{
"speaker": "Maria Black",
"text": "Yeah, sure. So, I'll start and I certainly welcome Don to chime in here with respect to the results that we're seeing, but we are laser-focused on our Generative AI strategy, on our overall approach. And just to kind of level set and remind everybody, the way that we've been thinking about it is really in three, call it, specific buckets, which is putting Generative AI into our products. That's what we call ADP Assist, that's making our products more usable and better for our clients. It's putting Generative AI into our service organization. So, think of that as Agent Assist, but that's part of the overall ADP Assist umbrella. And that specifically, James, kind of answers your question around service and things of that nature. Some of the things we've spoken about in the past that are already making meaningful impact are with respect to things like call summarization. So, I think I cited before that we're shaving off a minute per call, which may not sound that exciting to everybody that a minute per call, but when you take lots and lots of calls, it adds up pretty quickly. So, we continue to make meaningful impact on some of those tools. Other things we cited in the past, digital transformation as it relates to implementation. And so the small business organization is at really record levels as it relates to end-to-end digitally onboarding clients using new tools that are anchored in Generative AI. So that's kind of the service side. By the way, I could go on and on about this topic. Switching gears really quickly to the go-to-market. We've been undergoing a sales modernization effort and I'd argue for two decades. We have one of the most meaningful sales modernization tech stacks that exist. I think the likes of best-in-class technology to enable all our sellers. Some of the things that we've talked about is opportunity prioritization. So, think about putting the right lead in front of the right seller at the right time to drive value into the sales process. We're doing things like rapid pre-call planning. So this takes me back to my olden days when I used to have to pull everything up on the Internet or MapQuest and try to study what I should say to a certain client. These are all tools now that exist that are helping our sellers become more effective on their sales calls. And the way that you see that and quantify it, certainly, the end game there is more sales, but it's really this balance between as we invest into sales modernization and these various pieces of technology, it's really driving productivity. So we have a natural lift right now in productivity just based on the tenure that we're seeing in our sales organization. So if you imagine, as we're bringing on new associates, we're also building tenure in the existing sales force. So new associates are able to become more productive and existing associates are also able to become more productive. Part of that is anchored in tenure. A lot of that is anchored in these tools that we're investing in and the long-term output of that is more sales and more sales productivity. So, I think I've said a lot, but I'll offer Don if there was anything you wanted to add to that."
},
{
"speaker": "Don McGuire",
"text": "No, I'd just add that we are seeing good efficiency and good productivity, but I would say that we still have these tools in many of our associates' hands, but there's still many more to get the tools. And when they get those tools, we expect to see even more positive results. So we'll watch the productivity improvements and hopefully we see those things reflected in the margin. Of course, we had made some minor investments in these tools themselves. So, the bottom-line impact is going to be over the longer-term and certainly not short-term, but very, very positive results from everything we're seeing and everything we're doing."
},
{
"speaker": "James Faucette",
"text": "That's great. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Hey, good morning, Maria and Don, and congratulations on the strong end of the calendar year and obviously the 50 years to -- for the whole organization. On the strategic side, with regards to Fiserv and Clover, it sounds really promising. How meaningful could it be? Like if we fast-forward on two or three years, how do you envision the partnership working? And could it be expanded above and beyond Run because I think for some clients, it might also be pretty relevant on the lower end of Workforce Now. So, I'm wondering how you're thinking about that. I know it's early days, but wondering if you can just give us a feel for that."
},
{
"speaker": "Maria Black",
"text": "Sure, Mark. And first and foremost, thank you for the accolades on the 50 years. You've been a big part of that over the years. I appreciate all the interest you've had to help us along and certainly this interest in our go-forward strategy. I think you hit the nail on the head. We have all sorts of plans and visions, just how far we can go. Again, if you think about that down market ecosystem and how we go to market today, it is primarily through channels. I think we've cited in the past specific numbers around how we distribute through those channels, be it banks, be it CPAs, certainly through POS channels or merchant services channels such as Fiserv, this could be a meaningful channel for us. That is why we've engaged and we believe in it. So when I -- if I was to fast-forward five years, I think it's a channel that we speak to very similarly to the way that we speak to the accountants and the banks today. And I think about two -- again, great products, great companies and great distribution engines coming together to really drive that value into the overall small business space. Could it go beyond small business? I think the answer is little bit to be determined. I think that's something that as we see the traction in the down-market, we'll continue to challenge ourselves. Listen, I -- it's very simple for me. To me, it's -- the guiding principle is always about the client. And if we have an opportunity to solve real challenges for business owners, be it small, be it mid, be it up, upmarket, we're all about that and Fiserv is as well. And I think that's what makes this so exciting. So, anything we can do to make things easier to navigate being in business, we're here to help."
},
{
"speaker": "Mark Marcon",
"text": "That's great. And then on WorkForce Software, it sounds like everything is going according to plan. As you think through the next fiscal year, how well integrated will it be by for fiscal '26 do you think? And how meaningful could that end up being with regards to the upmarket?"
},
{
"speaker": "Maria Black",
"text": "Sure, Mark. So, we are actively working through that from a plan perspective right now. So, I'm pleased to say everything is on track. We actually just rounded 100 days. It's amazing. Time flies when you're having fun. But last week, we celebrated 100 days in. And at this juncture what we've done is welcome the WorkForce Software associates. We folded them into the ADP family, really pleased to see how the milestones that we've accomplished in the first 100 days have come along and in there, thus far, it's really taking a look at the go-to-market. So, as we talked about last quarter, they have a meaningful set of clients. And so as we look at their client base and our client base and comparing pipelines, really that ability to go to market together to ensure that we're winning consistently on the workforce, software, and the time and labor management side. That's been a big piece of the focus. And then as you can imagine, working through the integration is really the next set of pieces. So I don't think we're in a spot yet to declare necessarily exactly by when, but that is a big piece of the work that is being done. And we're really excited about what this is going to mean to us from an opportunity in the WorkForce management space, but also in the enterprise space and the global space as we bring this product also together with the Lyric offering."
},
{
"speaker": "Mark Marcon",
"text": "Terrific. Got tons of questions, but I'll leave it there. Congratulations again."
},
{
"speaker": "Maria Black",
"text": "Thanks, Mark."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"text": "Hi, guys, good morning and congrats on the solid results. Just a clarification on the Fiserv partnership. Just on the economics, how do the economics exactly work between the two companies? Is it a percentage of sales as a one-time fee? Is it a recurring fee? Just curious on how that relationship works on both sides."
},
{
"speaker": "Maria Black",
"text": "So, I don't know that we want to get into the specifics of exactly how we orchestrated it, but the answer in a broad sense is both. So there is a referral piece to it. There's also revenue-share over time that really drive the financials for both of us to make this an accretive proposition for us to go to market together."
},
{
"speaker": "Bryan Keane",
"text": "Okay. That's helpful. And then just as a follow up, just thinking about selling season and targets for kind of new client growth and what is the pricing environment, what kind of pricing yield do you think you'll be able to get in the key new selling season?"
},
{
"speaker": "Don McGuire",
"text": "Yeah, Bryan, I don't think we're seeing anything unusual. The competitive environment continues to be pretty much the same. Nothing is happening. There's always promotions. We have promotions, other folks have promotions, et cetera, but things are feeling the same as they were previously. So not seeing anything unusual. In terms of price increases, for existing clients, as we said, we're targeting about 100 basis points this year, which is more than the 50 we've got historically, but less than 150 we got during the couple of years of heavy inflation, but -- and the 100 points -- 100 basis points is looking pretty attainable and our clients are staying with us as the retention rate shows. So, we think it's something that's achievable for us."
},
{
"speaker": "Bryan Keane",
"text": "Okay, that's helpful. Thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Jason Kupferberg",
"text": "Thank you, guys. Good morning. I just wanted to start on bookings. The tone there continues to sound quite upbeat. I know the guidance for the year is unchanged at 4% to 7%. I was hoping you could talk qualitatively at least about how you're tracking to that guide this year versus last year. Just wondering whether or not the visibility on the full year bookings is higher now than it was at this time last year."
},
{
"speaker": "Maria Black",
"text": "Yeah, perhaps the best way to answer that question is with respect to pipelines year-on-year. So the pipelines are in good shape overall. They are up year-on-year. Just to clarify, when we talk about pipelines, that's really of mid-market, upmarket international term, right, as you're able to actually see the longevity of a deal and how a deal is moving through the sales motions and we feel good about pipelines year-on-year. In the down-market, instead of pipelines, we really talk about things like activity, how many new appointments are we going on, how many RFPs are being handled in our PEO. So again, we feel good about the activities. We feel good about the RFPs. We feel good about the pipelines year-on-year heading into the back half. What I would say is all across -- and I mentioned it earlier, all across ADP, we are a back-half company as it relates to sales. So, we still have a lot of execution to get done, but we feel good with respect to our position year-on-year."
},
{
"speaker": "Jason Kupferberg",
"text": "Understood. Okay. And then maybe one for Don. Appreciate all the moving parts here in the back half of the year. But can you just put maybe a finer point on Q3 versus Q4, how we should be thinking about revenue growth and margin cadence just so that we've got the pieces calibrated."
},
{
"speaker": "Don McGuire",
"text": "Yeah. So just to reiterate, I think the -- I'll do these in order of importance. I think FX, number one is having a revenue impact, which of course will fall-through and have a margin impact. The CFI, of course, is a bit of a challenge given the 100 basis point drop and how much of the portfolio is in the short position. And, of course, in the third quarter, we're also really getting going here with all the integration expenses, whatnot with respect to WorkForce Software. I'll also call out now that when you see the 10-Q, you'll see a very detailed breakout of all the items that -- all the breakdown of the goodwill and all of the line items in the intangibles, et cetera. So you'll be able to have some very clear insight into amortization times, et cetera, and get a view of how that's going to look over the coming years. But certainly, we're going to see some softness in Q3 as a result of those factors. And then when you get back into Q4, we'll see growth accelerate a little bit more, but more slowing -- slower-growth in Q3, bit faster growth in Q4, bringing us to our reiterated guidance for the full year."
},
{
"speaker": "Jason Kupferberg",
"text": "Okay. Thanks for that."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Hey, good morning, guys. Thank you for taking my questions. I wanted to start on the PEO segment. One of your peers have called out maybe some dynamics with clients opting into maybe lower cost benefit plans. So just wondering if you've been seeing any changes in benefits enrollment behavior recently."
},
{
"speaker": "Maria Black",
"text": "So, not really, Scott. I think for our purposes, we're actually heading into our renewal season here in the back half of our fiscal year and the PEO. So a bit to be determined, if you will, but not really, not that -- not thus far. I think some of the PEOs, just to remind everybody, we're all somewhat structured differently. Some of us have ASO offerings, HRO offerings, some of us have different ways that we fund our health plans. As you know, the PEO, ADP total source, we're fully insured on the health side. And so the behaviors don't always match each other and we've really not called out those swings in the past. We do have an HR outsourcing offering. I mentioned it earlier. It has contributed great results from a bookings perspective and we expect that both from that offer as well as the PEO. So, I think we see strength across both and we don't really see the swings back and forth."
},
{
"speaker": "Scott Wurtzel",
"text": "Got you. That's helpful. And then just as a follow up, Don, on the softer pace per control growth maybe relative to your expectations, was that in any specific pockets of your client base?"
},
{
"speaker": "Don McGuire",
"text": "No, it was pretty broad-based. It was not -- no specific industries or regions of the country, et cetera. Pretty broad-based."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. Thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-tsin Huang",
"text": "Hi, thanks so much. Yeah, so a couple quarters of really strong pipeline, I think you've mentioned. I'm just curious, do you see timely deal awards in the second half? And I don't know if I heard this, but are deal sizes getting larger in general? Just curious how the shape of the pipeline and the quality."
},
{
"speaker": "Maria Black",
"text": "I would say deal sizes and timing on deals is relatively consistent. And so I think we've talked about several times over the last couple of years, we're kind of back to, I guess, the new normal or the old normal. So I think deal cycles move through motions very similar to how they operated prior to the pandemic. That's not to suggest that you don't hear every now and then strangeness in timing. Certainly, the holidays this year fell differently that had interesting impact to us both from a revenue perspective, but also interesting impact on the sales side, if you think about when deals kind of cross that line. But listen, large deals are sometimes lumpy as well. And so I would say, generally speaking, things seem to be moving through the motions that they usually do and it's really similar to how we think about the business pre-pandemic."
},
{
"speaker": "Tien-tsin Huang",
"text": "Glad to hear it. Just on the consolidation side, Maria, just -- I feel like we've seen some SMB players invest in mid-market solutions."
},
{
"speaker": "Maria Black",
"text": "Sure."
},
{
"speaker": "Tien-tsin Huang",
"text": "Feels like an endorsement of the ADP's model. I don't know, do you see that as a trend? Love your thoughts on that."
},
{
"speaker": "Maria Black",
"text": "Well, first -- yeah, first, I'll say, thanks. I'll take that. There's nothing better than the -- best form of flattery is when somebody copies you, right? So no, all kidding aside, listen, the -- I obviously know the consolidation that you're referencing. I think for our end, it does validate having a broad-based segment approach. The breadth and depth of ADP continues to shine. I would say you would say with respect to the two players that are consolidating, we fared well against both of them. We expect that we will continue from a balance of trade to fare well against both of them, who knows. Maybe it even presents itself to be a bit of an opportunity for us. But I think as it stands, we feel really strong about the position of our products and the best-in-class platforms that we have in each of the segments. So, the Run offering in the down-market, the Workforce Now offering across the mid-market and our HR outsourcing solutions inclusive of the PEO. And now with Lyric and WorkForce Software coming together, we feel really great about the offers that we have in each one of these segments."
},
{
"speaker": "Tien-tsin Huang",
"text": "That's great. Thanks, Maria. And way to get MapQuest into the transcript, didn't expect that. Thanks."
},
{
"speaker": "Maria Black",
"text": "Old school."
},
{
"speaker": "Tien-tsin Huang",
"text": "Yes. Have a good day."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"text": "Thank you and good morning. A lot of good stuff here. Maria, I wanted to talk about -- dig a little bit in your thoughts longer-term perhaps on the adjacency of B2B payments, even treasury management solutions. Seems like a real natural adjacency for ADP. I know the company used -- ADP established ADP Trust Company a couple years ago. Just wondering how you think about that longer term. We've seen a couple integrations with some other companies, even cross -- even on the cross-border side with payroll. Just curious if you see this emerging as a real longer-term TAM expansion opportunity for ADP. Thank you."
},
{
"speaker": "Maria Black",
"text": "Sure. Yeah, sure, Pete. By the way, I'll take that as an offer to join us at our Investor Day because I think we're pretty excited to talk about the future of our strategy. And certainly, we think a lot about the various things that you're referencing and we've looked, right? We've looked before -- by the way, we've been in the office of the CFO before. I think this adjacency partnership that we're entering into with Fiserv, I think we're going to learn a lot. I'll go back to what I said earlier, which is really putting the client at the center of that solve, which means if we have the ability to come together with other companies through partnership or perhaps even deeper integration or perhaps even shared ownership or full ownership to solve real problems, those are always things that we are batting around from a strategic standpoint. So, I suppose more to come. That's not by the way to suggest there's some giant unveil, but we're pretty excited to share some of the things that we're thinking about for the future for ADP. We actually haven't done an Investor Day since November of '21. And a lot has changed both in certainly how we are thinking about the business and some of the things that we've shared over the last couple years, but certainly the overall industry has changed and continues to evolve as well. So more to come, Pete, but certainly top-of-mind for us always."
},
{
"speaker": "Pete Christiansen",
"text": "Thanks, Maria, super interesting. Looking forward to the Analyst Day."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh with UBS. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thanks so much. Hey, I think, Don, you talked about kind of trends in the back half with the reacceleration in Q4 as opposed to Q3. Any puts and takes on what drives that reacceleration? I think it was specifically around ES or maybe the business overall."
},
{
"speaker": "Don McGuire",
"text": "Yeah. I think around -- it is around ES predominantly. I think the big difference is, is this -- the client funds interest. The Q3, of course, is where we have the largest short portfolio and we don't have that in Q4. So that is what's going to -- so the impact of the short-term interest rates are going to be somewhat less in Q4 than they will be in Q3. And I think that's a significant piece of the -- significant piece of the puzzle. The other part is that we do have some heavier expenses in Q3 where even though it's 100 days, we are still in the early days of the integration of WorkForce Software. So there's some heavier expenses in this coming quarter than there will be in the fourth quarter, but that's really about it. There's really nothing more detailed than that."
},
{
"speaker": "Kevin McVeigh",
"text": "That's helpful. And then just real quick on the retention. I know typically the Q2, right, the December quarter or Q1 rather, just any thoughts on what quarter seasonally would have the most outsized retention? Just remind us, I know there's some seasonal impact just given the January start, just any thoughts around that?"
},
{
"speaker": "Don McGuire",
"text": "Yeah, I think the -- seasonally the retention tends to go up and down by quarter, but certainly it's in Q3, that's when all the switching happens and whatnot, so actually you'd see a bit of a dip, but of course, we compare the dip to the prior year's dip, et cetera. So, nothing there unusual. And as Maria said, we're -- even though we had a slight decline, we still -- we declined less than anticipated, less-than-expected and we're happy with that. It means people are staying in business and clients are staying because they're happy, NPS scores continue to be high. So, we're -- hopefully we'll see some opportunity in the retention score for the whole year, but we're certainly happy with where it's at right now."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Hey, good morning. Don, you talked about pricing and pricing being about 100 basis points up versus 50 that it's historically been, maybe down from the 150 you saw previously. But I'm wondering, do you think the environment has changed 100 basis points, something you could see net pricing for the next couple of years? Or do you think we're just in a unique period where you're getting this little bit outsized pricing?"
},
{
"speaker": "Don McGuire",
"text": "Kartik, good morning. Thanks for the question. I think that's a difficult one to speculate on for me because I guess it depends on what you think the economic forecasts are saying. Some are saying we should expect higher inflation, but who knows, not sure. We haven't seen whether some of the policies that are being bandied about are really going to be put in force and drive inflation or not. So -- but I would say generally that if there's higher inflation, we will do our best or take the opportunity to continue to provide good value and make sure that we're passing our costs along. But it's -- once again, it's all about the long-term value of the client for us and we'll do what we need to do to make sure that we keep that retention rate up. That's the most important metric for us when it comes to the pricing."
},
{
"speaker": "Kartik Mehta",
"text": "And just a follow up on the PEO. You've talked about pace per control being slightly lower in the PEO than ES. And I know that's kind of a more of a near-term phenomenon. Is there anything changing in that business or the industry where you could see this trend continue? Or is this just a bit of an anomaly where the pace per controller lower than the ES business?"
},
{
"speaker": "Don McGuire",
"text": "I think we've been talking for several quarters about PEO and we've been happy to talk the last couple of quarters about stabilization and improvement. So, hopefully things are going to go back and look better historically. As you know, the pace per control growth in the PEO has been better than it has been in the ES segment. But I think we're happy with where we're at right now and we'll see how it materializes, but I don't know if there's any particular drivers. I will say that for the quarter, we saw a stabilization across most of the industries where we provide the services. So that was a positive thing to see, in particular, or in the financial administrative, it's stabilized and that had been an area of weakness for us in the past, but it is stabilized. So, we are comfortable with where we're at and looking for it to improve."
},
{
"speaker": "Kartik Mehta",
"text": "Perfect. Thank you very much. Appreciate the time."
},
{
"speaker": "Operator",
"text": "Thank you. We have time for one last question and that question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hey, guys. Thanks for squeezing me in here. I did notice -- I know we talked -- you talked a lot about the macro, but I did notice a slight change in maybe language or formulation. I believe last quarter you said clients continue to hire at a moderate pace and now you're saying albeit at a slower pace. I just want to know maybe more about from your experience, you've obviously been doing this for a long time. When this slowing trend starts rolling, is it a trajectory that could change? Is this like a maybe just a hiatus? Just more like long-term perspective on this one would be great. And other than that, obviously, really strong results and yeah, love it. Thank you."
},
{
"speaker": "Don McGuire",
"text": "Yeah, Dan, I guess I just -- I guess I'd answer that by saying that the macro-environment continues to be very, very strong and solid, the labor environment strong, 4.1% unemployment. I think the fundamentals are good and so I think that the hiring and companies still being profitable and there seems to be an awful lot of optimism in the US market in particular. So I think that all bodes well for pays per control and overall growth. And then, of course, we do have the opportunity that we also have operations outside of the US, so we can see opportunities there and manage the portfolio in that way. But I would say, I think really the only way to answer that question is just around the macro-environment that continues to be quite solid."
},
{
"speaker": "Dan Dolev",
"text": "Got it. Thank you and congrats again on being a thought leader. HCM, looks like your competitors are taking a page off your book now. So, congrats again."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Thanks, Michelle, and thank you again to everyone for joining and for the compliments and the encouragement and the interest in ADP. I did want to share something very exciting, hot off the press. ADP has been named once again by Fortune magazine as for the 19th consecutive year on the distinguished list of being a World's Most Admired Company in 2025. This recognition for me means everything because it's a true testament to our associates that really make this company the great entity that it is serving so many clients across so many segments and so many markets in such a changing environment for our clients to navigate each and every day. So, I'm super proud to share this news with all of you and congratulations to all the ADPers on this well-earned accomplishment. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADP | 1 | 2,025 | 2024-10-30 08:30:00 | Operator: Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter 2025 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President of Investor Relations. Please go ahead.
Matthew Keating: Thank you, Michelle, and welcome, everyone to ADP's First Quarter Fiscal 2025 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you also find the Investor Presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. The description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria.
Maria Black: Thank you, Matt, and thank you, everyone, for joining us. This morning, we reported strong first quarter results that included 7% revenue growth, 130 basis points of adjusted EBIT margin expansion and 12% adjusted EPS growth. I'm excited to share the considerable progress we made across our three strategic priorities in the quarter, but let me first begin with some additional financial highlights. We had a solid start to the year from an Employer Services new business bookings perspective, with record volume for our first quarter. This performance was broad-based as our small business portfolio benefited from our continued strength in Retirement Services. Our mid-market and HR Outsourcing businesses also showed good growth and our International business maintained its strong momentum from last year. Overall, HCM demand remained steady, and our new business pipelines were healthy at the end of the quarter. Our Q1 Employer Services retention rate exceeded our expectations and only declined slightly. Our overall client satisfaction score reached a new all-time high for our first quarter, driven by improvements in our mid-market, enterprise and HR Outsourcing businesses. Moving forward, we expect our record client satisfaction levels to continue to support our strong retention results. Employer Services pays per control increased 2% for the first quarter as our clients continue to hire employees at a moderate pace. Finally, PEO revenue growth of 7% and average worksite employee growth of 3% for the first quarter exceeded our expectations as strong PEO new business bookings growth more than offset the impact of modest further deceleration in PEO pays per control growth. We are very proud of our strong first quarter financial results and equally excited by the significant progress made across our strategic business priorities. As the needs of today's global workforce continues to shift, employers require dynamic Workforce Management Solutions that will help them maintain compliance and flexibility while engaging their employees. We continuously aim to offer solutions that will solve our clients' complex business challenges. As part of this approach, we recently acquired WorkForce Software, a leading Workforce Management Solutions provider that specializes in supporting large global enterprises. This acquisition expands our current array of time and attendance, absent management and scheduling tools and strengthens our ability to win in a highly attractive market. WorkForce Software is a leader in serving large complex organizations and their robust solutions can adapt to the dynamic needs of today's employers by offering tools that create resiliency, help drive optimal performance and make managing a global workforce easy. We are thrilled to bring together these capabilities as well as their trusted global support organization to broaden our suite of Workforce Management Solutions. Based in Michigan, WorkForce Software serves over 1,000 clients in more than 100 countries, including many well-known global brands. I'd like to officially welcome the members of the WorkForce Software team to ADP. Together, we will continue to drive the future of Workforce Management Innovation, and we are looking forward to all the great things we will accomplish. Additionally, in September, we introduced ADP Lyric, our flexible, intelligent and human-centric global HCM platform. Lyric is the new name for our Next-Gen HCM offering, which is designed to meet the evolving needs of the modern workforce. This is a differentiated offering combining global HR, global payroll and global service to adapt to unique structures and workflows and to offer employers a human-centric approach to managing their people. Thanks to its integrated Generative AI technology and the power of ADP's unmatched dataset, Lyric provides insights and intelligence like predictive analytics and anomaly detection to provide clients with personalized recommendations. Lyric is a global platform. It can support payroll in over 75 countries today and we are focused on expanding its international reach moving forward. Following its successful launch at this year's HR Tech Conference, we are seeing very strong interest in Lyric, and we look forward to sharing our future progress with you. The acquisition of WorkForce Software and the introduction of Lyric position us to provide our enterprise clients with a unique global HR, payroll, time and service solution. We continue to invest in Generative AI capabilities to enhance the experience of our clients and empower our associates. During the first quarter, we expanded access to our robust Generative AI-based service tools, which are designed to bring speed to our service interactions and improve the client experience. These tools seamlessly integrate productivity enhancing technologies like call summarization, virtual knowledge assist, and guided workflows for our associates so they can best support our clients. We expanded the use of these tools to our associates, supporting our small business clients in the first quarter. Early feedback is impressive and we look forward to continuing along this journey to drive productivity gains and even higher client satisfaction. We're also excited to share that we recently launched Intelligent Workflow Automation technology in Workforce Now. These dynamic workflows deliver a personalized and satisfying employee experience at pivotal moments in an employee's career like onboarding, while at the same time dramatically reducing manual work for HR practitioners. This functionality enhances the experience of mid-market clients and their employees on our Workforce Now platform and we look forward to adding similar capabilities to our other HCM platforms over time. These meaningful steps collectively demonstrate our continued focus on our three strategic priorities, which are to lead with best-in-class HCM technology, provide unmatched expertise in outsourcing and benefit our clients with our global scale. We remain confident in our ability to advance our strategic goals, drive our competitive differentiation and deliver strong financial results. And with that, I'd like to take a moment to recognize our associates whose efforts and outstanding performance are positioning us to consistently deliver for our clients and our shareholders. Thank you all. And now, I'll turn it over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the first quarter and then update our fiscal 2025 outlook, which now includes our WorkForce Software acquisition and our recent debt issuance. Let me begin with our Employer Services results and outlook. ES segment revenue increased 7% on both a reported basis and organic constant currency basis coming in ahead of our expectations. As Maria shared, ES new business bookings were solid to start the year. With a stable demand backdrop and healthy pipelines, we are maintaining our 4% to 7% full year growth guidance. ES retention declined slightly in Q1 versus the prior year, but still came in modestly better-than-anticipated. We are continuing to forecast a 10 basis point to 30 basis point decline in full year retention based on an expected increase in small business losses due to higher out of business rates. ES pays per control growth of 2% met our expectation for the quarter and we continue to forecast 1% to 2% growth for the full year. Client funds interest revenue increased a bit more than we anticipated in Q1, helped by stronger average client funds balance growth. While the yield curve has broadly declined since our last update, this impact is partially offset by our stronger client funds balance growth. For the full year, we are reducing our client funds interest revenue forecast by $10 million. However, we are maintaining our net impact from client funds extended investment strategy forecast as lower reinvestment rates are almost entirely offset by lower average borrowing costs. Based on our Q1 ES revenue growth performance and the expected contribution from the WorkForce Software acquisition, we are increasing our fiscal 2025 ES revenue growth range to 6% to 7%. Our ES margin increased 260 basis points in Q1, driven by both operating leverage and continued client funds interest revenue growth. On a full year basis, we're adjusting our ES margin outlook to incorporate the expected impact of the acquisition and now forecast an increase of 40 to 60 basis points for fiscal 2025. Moving on to the PEO, revenue growth of 7% and average worksite employee growth of 3% exceeded our expectations. As Maria mentioned, strong PEO new business bookings growth more than offset the impact of further modest deceleration in PEO pays per control growth. As a result, we now expect fiscal 2025 PEO revenue growth of 5% to 6% and average worksite employee growth of 2% to 3%, which at the midpoint of the ranges are each up 50 basis points from our prior forecasts. We continue to expect PEO pays per control growth to be slower than ES pays per control growth in fiscal 2025. PEO margin decreased 80 basis points in Q1, which is less than we anticipated due primarily to stronger revenue growth. The margin decline versus last year stemmed mainly from higher workers compensation program costs and higher zero margin benefits pass-through revenue growth. We now expect PEO margin to be down between 70 and 90 basis points in fiscal '25, which is 20 basis points better than our prior outlook. Putting it all together, we are increasing our fiscal 2025 consolidated revenue growth forecast to 6% to 7%. While we anticipate future revenue synergies from the WorkForce Software acquisition, we expect it to pressure our adjusted EBIT margin this fiscal year. We now forecast full year adjusted EBIT margin expansion of 30 to 50 basis points. In addition, in September, we enhanced our capital structure by issuing $1 billion in 10 year notes. And subsequently, our corporate interest expense will increase by about $40 million for fiscal 2025. We continue to expect a full year effective tax rate of around 23%. After incorporating the anticipated impacts of the acquisition and our recent debt issuance, we now forecast 7% to 9% adjusted EPS growth for fiscal 2025. Thank you. And I'll now turn it back to Michelle for Q&A.
Operator: Thank you. [Operator Instructions] Our first question comes from Bryan Bergin with TD Cowen. Your line is open.
Zack Ajzenman: This is Zack Ajzenman on for Bryan. First question is on Employer Services, just the demand and bookings backdrop. If you can just dig into the areas of strength in Q1 and kind of how it progressed through the quarter? And then we have a follow-up.
Maria Black: Sure. Good morning, Zach. Thanks for joining us today. So demand overall, we feel good about it. We feel good about the HCM demand. We had a great sales quarter. We have a great sales and marketing organization. It was solid and it was broad-based. I think from a demand perspective, I called out a few areas of strength, one of which is the Retirement Services offering in our down market. We continue to execute there against opportunity and our strategy. And so excited to see them continue the great progress. Certainly in the mid-market, our HR Outsourcing offerings as well. And then we saw continued strength in International. I think that's a great story on the heels of the strength that we saw in International all four quarters last year. So really pleased with the broad-based result. And I think the demand remains pretty consistent. I think the down-market, companies are still hiring and they're buying. I think in the mid-market, certainly not getting any easier. It's still very complex. We do also have those offerings beyond tech-only in the mid-market that extend our reach into the HR Outsourcing offerings. And you heard the PEO result was solid as well. So and again, we're always watching what's happening in the global space, which is why we continue to be as pleased as we are with the execution on new business bookings in International.
Zack Ajzenman: Got it. And then a follow-up on PEO retention. So it sounds like worksite employee retention came in above plan in Q1. As we think about the balance of the year, are you still anticipating an improvement in PEO worksite employee retention year-over-year growth for fiscal '25? And is it an offset -- enough to offset the decel and pays per control?
Maria Black: So the biggest contributor to the outperformance in worksite employees, average worksite employees was really bookings, right. So we did have a strong first quarter, albeit the first quarter for PEO is generally relatively light on the year, so we still have to execute that. And that is the focus. We've been laser-focused on accelerating PEO new business bookings that remains to be the case. That was the biggest contributor and that is the piece that can really overcome the deceleration in worksite employee pays per control or PEO pays per control. Retention does contribute. It contributes very modestly compared to new business bookings. That's really what we saw in fiscal '24 as well. We saw that retention was year-on-year up, but only contributed modestly and that's really what we expect for '25 as well.
Zack Ajzenman: Thank you.
Don McGuire: Yes. Maybe just to add some color to the -- maybe just add a little bit of color to that in terms of the pays per control growth, we do expect to see pays per control growth lower in PEO than in Employer Services. That's what we called out at the outset of the year. We're going to talk about, ES, I'm sure, later. But PEO is definitely showing growth but slowing growth.
Zack Ajzenman: Thanks.
Operator: Thank you. Our next question comes from Ashish Sabadra with RBC Capital Markets. Your line is open.
David Paige: Hi. Good morning. This is David Paige on for Ashish. Thanks for taking our question. I was wondering if we could double-click on the WorkForce Software business, maybe what's the financial profile in terms of revenue growth the annualized revenue and the margin profile? And then a follow-up after that. Thank you.
Maria Black: Yes. So David maybe I'll let Don talk through the financial element, but maybe before we do that, it's prudent to just kind of comment on the strategic rationale behind the acquisition. As you can imagine, we're pretty excited to have the opportunity to speak to it today. This is a company WorkForce Software that we've been aware of for quite some time, aware of their capabilities, aware of how they're able to support some very marquee clients. I think we talked about in the prepared remarks, they have, they serve about 1,000 companies around the world. These are marquee well-known global brands. So we're really excited about the product set. We're excited about the clients. But I have to tell you too, we're pretty excited about the organization as a whole. I was out there on October 15th, a couple of weeks ago for day one. And in addition to a fantastic product and a pretty marquee set of clients, it's also an incredible team. It's a great team with great domain expertise in this space. And so we're really excited to add this deep expertise to ADP's overall Workforce Management Solutions and how we incorporate that with our organization to really drive further opportunities. So this is a growth story for us about the future and we're pretty strategically excited about it. But with that, I'll let Don kind of walk you through the financial implications.
Don McGuire: Yes. So, David, I expect we're going to get this question later on. So maybe I'll just elaborate a little bit more on the impact of the WorkForce Software acquisition. So if you look at the -- we took up our revenue expectation, but on the ES side. Out of the 1% increase to our consolidated FY'25 revenue growth outlook, about half of that is coming from WorkForce Software and the remainder is coming from the strong results in the rest of the business. We had a good first quarter. And we're certainly expecting to see strength throughout the balance of the year as well. And this is certainly more a strategic transaction for us, as Maria just went through, gives us the ability to serve complex global companies with a much broader offer now HCM payroll service and now time to attendance or Workforce Management in that marketplace. And so when we move on and look at some of the additional expenses and some of the things that are causing some drag on our EPS expectations, we only closed the transaction about two weeks ago. So we're not going to be terribly precise on this point. So we do expect some modest pressure. It's important to remember the biggest pieces through are coming from debt intangibles, integration of the deal cost itself. So nothing unusual. I do want to point out that this is a very, it's a relatively small company with a relatively large capability. And when I say that, we're not expecting a significant amount of expense synergies from this transaction because they run themselves pretty lean and they're pretty effective. And then when you move on and you look at what we did in our -- to the midpoint of our ES margin and our adjusted EBIT margin were down 60 and 30 points respectively. And so the question could be is that all from WorkForce Software's anticipated drag? And the answer is actually more of the drag is coming from WorkForce Software. So the other businesses are compensating somewhat for that. So we do anticipate about a 0.5 point of EBIT margin pressure as a result of the transaction in fiscal '25. So if you -- if we look at the EPS growth as well, it's expected to be a bit more than 1% of the drag. So we've outperformed in other parts of the business, so we overcome some of that. And as I said earlier, most of the dilution is coming from integration costs, amortization of intangibles and interest expense. And then I'll jump ahead of the anticipated question I have and that is when do we think this is going to be accretive to ADP? And I think the short answer is, give us a couple of quarters to get things in line and we'll come back and we'll be very excited about sharing success stories and client wins over the next couple of quarters, but it's a bit early given this transaction only closed about two weeks ago.
David Paige: That's great. Very comprehensive for me. That's it for me. Thank you.
Operator: Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Mark Marcon: Good morning and thanks for the questions. First of all, congratulations on the first quarter results, really strong particularly. Maria, you mentioned client satisfaction scores are at all-time highs. Can you talk a little bit about some of the factors that drove that? And then I'd like to do a follow-up on WorkForce Software.
Maria Black: Yes. Good morning, Mark, and thank you very much for the congratulations. We're pretty excited about the quarter as well. To the NPS question that you had. So what I mentioned in the prepared remarks is we had an all-time high for a first quarter. And we did see strength. Again, it was broad-based. I think some of the call-outs that we've been making over the last couple of years, specifically as it relates to the business that really has been broad-based and it's been near record levels really kind of across the various businesses. I think we've talked quite a bit about the mid-market. We've talked about the last couple of years that we've been speaking to the mid-market. A lot of that mark comes from the investments we've been making in product, the investments we've been making in some of the tools that we provide to our service organization. I mentioned some of those as we extend the reach into the product and in Workforce Now. During the remarks, I also mentioned some of the other work that we've done in SBS specifically, the extension of Generative AI tools into the SBS service organization. And again, the thesis behind it and what it's proving itself to be true is the more we invest in making things easy for our clients and frictionless, the greater our NPS results, and it seems to be resulting in pretty favorable retention results as well. So from an NPS perspective, on a year-on-year basis, just kind of rounded out. We did see the mid-market, enterprise and HR Outsourcing businesses from a year-on-year perspective kind of have those biggest improvements, but from a broad-based perspective, I would say almost every business is at record levels. And year-on-year, it was a record for a first quarter.
Mark Marcon: Got it. We had a chance to demo the WalkMe tool within Lyric and that was pretty impressive. I imagine that's going to end up continuing the upward surge in terms of the NPS. Wondering with regards to WorkForce Software. What's the integration plan? I mean the strategic rationale seems fairly obvious. But just how long -- how soon will we be able to see you fully integrate them in terms of a go-to-market plan? When will you start doing joint sales? How much of their client base, which does include similar marquees already ADP clients? What are the opportunities with regards to potentially penetrating some of those that aren't? Can you talk a little bit about whether it's going to be domestic as well as international in terms of when you go to market and how quickly you can do that?
Maria Black: Yes, sure. By the way, I love every single one of your questions, Mark, because they're the exact same questions that we've all been asking ourselves as we looked at this great organization and also post the signature, if you will, as we really started comparing kind of what we all have. And so I think it's probably too early to comment on the exact overlap of clients, things of that nature. But if you imagine and you know full well the types of clients that ADP serves on a global, call it, enterprise perspective and you imagine that they have some of the most formidable marquee clients. You can only imagine that there's overlap there. So what we're focused on is exactly what you're referring to, which is adding this offering into our global and enterprise call it, go-to-market growth opportunity. We're pretty excited and you mentioned Lyric and what you saw with WalkMe with Lyric. I hope we get to the Lyric conversation today because we're really excited about where that is on the heels of HR Tech. If you imagine marrying Lyric to the great story now of WorkForce Software, that's an exciting opportunity for us as we extend our reach into that global MNC, call it, enterprise space. So that is the intention. It is an offer that's where it sits today. I think it does add to the plethora of offerings that ADP does have across our Workforce Management Solutions. So if you imagine, we have products already in that space. We also have partnerships in that space. We have products in the mid-market. We also have partnerships there. And certainly we have time and attendance offerings also in the down market, inclusive of, I think we have well over almost 100 marketplace partners in the down-market. So this offering is going to be a great addition to our overall suite, specifically in that global enterprise space. And that is a growth story for us, and it's married directly to our Lyric excitement. And so that's the intent and we're working through each and every one of the questions you asked as we speak.
Mark Marcon: Great. Look forward to hearing more on the progress. Thank you.
Maria Black: Thank you, Mark.
Operator: Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel: Great. Good morning, guys. Thanks for taking my question. I wanted to go back to the PEO segment to start and thought the results there were very encouraging, especially on the bookings side. So I would love to hear just a little bit about that bookings outperformance. And has there been any sort of change to the sales strategy to your benefits packaging and offering a little bit of a combination of both. Any color on that would be very helpful.
Maria Black: Sure. I think it's intense focus and execution. And so I think the team has been very focused. We've been speaking about this since the strangeness in the PEO post-pandemic. We've been very focused on reaccelerating bookings. And so I think it's great execution by the team. I think the offering, the value proposition, and I've been pretty bullish about this. Well, probably since about 1997. But listen, the PEO value proposition, it continues to only gain in strength. You mentioned health offerings and things of that nature that sits squarely in that space. If you are a company of the target market of our PEO in the industries that we target with our PEO offering here at ADP, you need the types of things that the PEO offers, that's best-in-class health benefits. It's a competitive workers' compensation program. It's best-in-class retirement services offerings. And so I think continuing to lean into that value proposition. And as I always say, and I said it earlier today, it's not getting any easier for those types of clients to be employers that's only getting more complex. And so I think we're aligning our sales organization to be laser-focused on it and I think it's a byproduct of strong execution.
Scott Wurtzel: Got it. That's helpful. And then just as a follow-up on the WorkForce Software acquisition. And as we sort of think about maybe incremental revenue opportunities. I mean is there -- I know it's an enterprise-focused solution. Is there an opportunity to maybe also bring this down to serve your mid-market customers as well?
Maria Black: So again, I think that's in the same bucket as Mark's question. I think that is a big piece of what we are working through at this time. I think they have across their thousand clients, they certainly have clients in that space. I think, again, the way I sort through it, if you again go back to the big plethora, I use that word to describe the varied offerings we have across each segment, down-market, mid-market, upmarket across each one of the global businesses, the in-country offerings. In fact, we were not too long ago, actually bought a time and attendance offering in Asia-Pac. And so we have organic and we have proprietary offerings. We partner and we go to market in this giant array of offerings and how we sort through that. I think the easiest way that I think about it is client by client. And so I think we kind of put the client at the center, making sure that we are allowing the best possible solutions for our clients. And certainly, as we absorb WorkForce Software's offerings into our ecosystem of time and attendance we will be taking a close look at the mid-market clients and making sure that, call it, client by client, they have the right offering at the right time.
Scott Wurtzel: Got it. Thank you.
Operator: Our next question comes from Samad Samana with Jefferies. Your line is open.
Samad Samana: Hi, good morning. Thank you for taking my questions and I'll echo the congrats on a good quarter. Don, maybe first one for you. Just as I think about the size of the WorkForce deal, it's one of your bigger transactions. Any signal in that, that we should take whether that's the company willing to be more acquisitive or if multiples are in a state where ADP is maybe ramping up M&A more broadly overall or is this a one-off as part of a strategy or kind of a broader signal? And then I have a follow-up for Maria.
Don McGuire: Okay. Samad, thanks for the question. Yes, in terms of absolute dollars, definitely one of the larger acquisitions or the largest acquisition ADP has ever done. Although I think the company is a lot bigger than it was when we did some of those acquisitions a number of years back. So I think it fits in squarely. I don't think our M&A be more precise than that. Our M&A strategy hasn't changed. We look for opportunities and we've been looking for opportunities for quite some time, but we need to make sure that they're additive. We need to make sure they complement our offer and they don't complicate our offer. Spent a lot of time over the last 10 years or so, cleaning up our portfolio and making sure we get fewer platforms to do the same thing. And so looking at things that are additive to us are in good tight adjacencies as this acquisition was and making sure that the business model, the recurring revenue model is particularly important to us the way we go to market, looking at all those things is important and will continue to be important to us. So we will continue to look. And if things show up that we think are going to be additive to us and we have an opportunity, we'll move again. But certainly we haven't really changed our philosophy at all on how we approach and what we're looking for in terms of M&A.
Samad Samana: Great. And then, Maria, just maybe a question on Lyric. This is something that investors have talked to us a lot about. Just thinking about how it builds on Lifion, which was a focus before. And with the rebranding, I guess, the question we've gotten is, is this, what was the evolutionary or revolutionary moment that led to the rebranding now? Is it product market fit is finally right, and maybe there's an inflection that we're reaching? Is it about from a go-to-market perspective like what led to it now at this particular moment? And should we see maybe an inflection in demand going forward?
Maria Black: I'm so glad you asked Samad. I've been excited to talk about Lyric for quite some time. So just to level set, just everyone's clear, Lyric is the new name for Next-Gen HCM. And I think we're all tired of saying Next Gen HCM. I think that was part of it. But all kidding aside, listen, we couldn't be more thrilled to bring ADP Lyric HCM into the market. Personally, I love the name. I think it's a name that evokes emotion. It speaks to the rhythm of what it looks like to be a worker in today's environment and making sure that's something that perhaps was static in the past that didn't have the right type of Lyrics to it ultimately comes alive with the name. And so I think it's the right name at the right time. I think to answer the why now. I think the world is ready for this next offer of HCM in this space. This product, it's flexible, it's intelligent. It's designed with humanity in mind. It's human-centric and its design is how we speak about it. And that is groundbreaking and that is orchestrated really around the person. And what that allows for things, as I mentioned earlier, such as flexible workflows. It allows for inserting Generative AI that can drive everything from anomaly detection to nudges. And so it is a unique offer and that it is married to, call it, the other strengths of ADP. It's a global HCM, global payroll and global service. That's unique and we're pretty excited. And so I think part of it is the market is ready. I think the other part is we're ready. And so as we unveil this, there's been tremendous demand from the clients. I think we saw in the heels of HR Tech. We saw great analyst reviews. Mark just mentioned seeing some of the functionality. And so I think the buzz is out there. We see that also in the pipelines. But as you can imagine, it's still early days. So it's going to take some time until it contributes to the overall ADP financials. But from a product perspective, it's the right product at the right time with the right name. We're pretty excited to lean into that growth story, marry it now to the WorkForce Software offering that we're folding in, I think, it's a great growth opportunity for ADP.
Samad Samana: Thank you as always. Appreciate it.
Maria Black: Thank you
Operator: Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal: Hi. Good morning and thanks for taking my question. Retention continues to outperform expectations. Can you update us on the drivers here, new products, technology, maybe fewer SMB bankruptcies. I'm not sure if that's still an important driver. And also what was the retention rate in the quarter?
Maria Black: Sure. So I think happy to talk about the drivers. I mentioned some of them earlier. Listen, all of the things that we're doing, best-in-class service, the investments we make into our product set, it is yielding a better experience. You see that directly on the NPS. NPS correlates to retention. So I'd like to think some of the results we have are structural. I will say that from an outperformance perspective in the first quarter, we did see, while retention was down slightly or declined slightly, we did see that the SBS or the small businesses held. And so our belief in how we're looking at the outlook for the rest of the year is that while we are almost normalized back to kind of the out of business rates from fiscal '19. We're not all the way normalized. And so we do still expect that there could be some pullback. Part of how we've also modeled it, so many of our businesses last year specifically, were at record highs on the retention. So I think we modeled kind of assuming that those businesses were at record highs, and we're assuming some pullback in the down market, specifically as it relates to out of business. Listen, we didn't see that in the first quarter. We're hoping that between the strength in small business, kind of the environment, coupled with strong execution on our strategic roadmap around best-in-class products and best-in-class service will ultimately yield continued favorability, but we believe at this time that the retention guide is prudent.
Ramsey El-Assal: Great. And a follow-up for me then is on PEO margins, they came in better than expected in the quarter and you listed your full year margin expectations for the segment. Could you elaborate on the main drivers there? And also for the full year, are you anticipating any reserve releases around workers' comp. As I recall I don't think that flowed in last year at this time. So I was curious.
Don McGuire: Yes. So Ramsey, firstly, the PEO margins were certainly better and really based on the struggle revenue that we had in the quarter. So stronger revenue based on stronger Worksite Employee growth and also some help from rates -- wage rates. So that was really the biggest driver for the improvement in margin in PEO. We did have a small release of $4 million in the quarter. And certainly, that contributed a little bit as well, but we are not anticipating to see releases for workers' compensation reserves as we did in prior years. So that is not something that we factored into our balance for the forecast. So strong Worksite Employees, strong growth in wage rates, strong growth in margin.
Ramsey El-Assal: Thank you so much.
Operator: Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang: Hey, thanks. You covered a lot already here. But I just want hoping Maria can elaborate on the strong pipeline comment. Any surprises or change in visibility across all of your markets, any change in decision-making, I know, we get a lot of questions up market around the elections. Can we see a little bit of a pause before we get back to normal that kind of thing.
Maria Black: So the answer to your question is really no change. So we exited the fourth quarter. We talked about strong pipelines. We're exiting this quarter, feeling confident in strong pipelines. We haven't seen any changes in buying behaviors as it relates to any of the things that are happening across the world if you will. That's not to suggest that we're not keeping a watchful eye. I think we've spoken about deal cycle, specifically in the upmarket because as you mentioned, that's where a lot of the questions come in the space. And I think we're in that new normal. I think it looks like it used to back in the pre-pandemic. And so I think it's just the normal cycle. Listen, as always, every quarter has a little bit of ebb and flow as it relates to some businesses. But I think overall, the strength was broad-based exiting the fourth quarter, exiting the first quarter and the strength on the pipeline side is also broad-based. And just a reminder, pipelines look different, in the down market, it's about net new appointments. It's about activities. It's about those things in the mid-market and into the enterprise space, obviously, these are year-on-year pipeline compares and we feel solid about the pipeline.
Tien-Tsin Huang: Terrific. Thanks for that. Just my quick follow-up. I know Mark and others asked about cross-sell potential synergies with WorkForce Software, but it's got some really nice logos going to the site when you first announced this. So is cross-sell an important consideration and decision to bring the asset in?
Maria Black: I think and by the way, of course, those logos are also very exciting and the many logos many would be familiar with from a marquee brand perspective. I think how we go to market together is an exciting story. So some of that will be the continued way that this company has been able to execute and win really marquee clients in the marketplace. I'd like to think it only helps them to have the scale and the brand of ADP behind them. And so in a more simple way to say it, if you think about global marquee clients going out to RFPs, the exciting part is we're going to get invited to all of their parties. And hopefully we get -- they get invited to all of our parties. And I think the strength between their product and our distribution and our scale and our brand, I think, leads us to be very optimistic on the growth narrative.
Tien-Tsin Huang: Yes. No, sounds like it. Thank you, Maria.
Operator: Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open.
Caroline Latta: Hi. This is Caroline Latta on for Jason. I just had a question on Generative AI. I know you mentioned progress on rolling out some of those initiatives. Do you have any call-outs on potential further investment and cadence of that over the coming year?
Don McGuire: Caroline, thanks for the question. No real. I'll start with no real call-out on further investments. We are continuing to invest modestly as we've shared over the last few quarters. And we are continuing to see good results. Maria touched on some of those earlier. Certainly, some of the call summarization tools that have been deployed already are showing good results. We've seen good results in our sales area, setting appointments, deciding which appointments to go to preparing for appointments, coaching salespeople when they're in live calls and we're continuing to see opportunities and success in our technology area, coding and some of the co-pilot tools that are available there. So really not a lot of incremental investment, really just continuing the course and looking to get more and more returns on the investments we've made over the coming quarters.
Caroline Latta: Really helpful. Thank you.
Operator: Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta: Good morning. Maria, you talked a little bit about the SMB and out of business, and you're anticipating maybe it hasn't completely normalized. But I'm wondering as you look at KPIs for your customers, what do you think about the health of small businesses? And if you've seen any change over the last few months?
Maria Black: Sure. Good morning, Kartik. So, yes, listen, it's pretty close to being normalized. We're almost there. In terms of the health of small businesses overall, we look at a lot of indexes. We look at other organizations that serve similar type of, call it, nondiscretionary offerings that we serve. I think overall health of small business is strong. There are a couple of watchout items. One of the ones that we pay close attention to is new business formations. And so while it's down year-on-year and it's down even fiscal year-to-date, that is a watch out item. That said, it's still elevated. So it's elevated from where, call it, used to sit, pre-pandemic. And so it's still arguably considered strong. So on one hand, it's strong. On the other hand, it's pulled back a tiny bit from the strength that it used to have. That's just one thing. But we look at all of these things. I think the general sentiment as it relates to demand across the down market and as it relates to the small business side is it continues to be strong. I think we spoke quite a bit about the down market last year and we continue to see good execution among small businesses and overall strength.
Kartik Mehta: And, Don, just a follow-up. Any thoughts on change of strategy for the portfolio? I know yields have been coming up a little bit. But I'm wondering if there's any thoughts on maybe changing some of the duration or just any other changes you might want to do for the portfolio based on kind of the yield?
Don McGuire: No, Kartik, we've looked at that, and we think we've benefited significantly on our laddering that we've done over the last 20 years or so. And we did have a bit of opportunity cost, as we've shared over the last couple of years as we've been dealing with an inverted yield curve. But that yield curve is slowly starting to normalize. So we should expect to see more benefit. We also called out in our, in the prepared remarks, we are taking our investment or client fund interest number down by $10 million, but we think the net impact because borrowing is less expensive now at the short end. We do think that we're going to be flat to our initial guidance for the year. So we don't see any compelling reason to change the structure of our portfolio.
Kartik Mehta: Perfect. Thank you very much. I appreciate it.
Operator: Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open.
Dan Dolev: Hey, guys. Really good results here. Thank you. Just a quick housekeeping question. Would you be able to quantify how much of the EBIT drag as a result of any incremental amortization?
Don McGuire: Well, I don't want to get into too much of the sausage making here, but we did disclose the value of the deal at $1.2 billion. And I think industry averages are somewhere in the neighborhood of 30%. So you can go from there and look at a seven to eight year amortization period and kind of figure it out. I'm sure all of you have done it already anyway. But rough numbers I think that would get you in the ballpark.
Dan Dolev: Okay. Got it. Thank you. And just a quick follow-up. I mean, you're doing really well on the top line. Can you maybe discuss a little bit of your pricing strategies and the pricing environment for the deals? And I'm sorry if it had already been asked, I joined late. Thank you.
Don McGuire: So pricing, we have had 100 to 150 basis points over the last couple of years. I think as inflation moderates somewhat, we're expecting to get closer to 100 basis points this year and that's where we're sitting. So really no changes to pricing strategy since we spoke last time. And we'll make a small color though on price. It had a small impact in our revenue for the quarter. We do have a couple of European countries where in the mid and the upmarket, the price increases are tied to various inflation indices and those indices came in higher. So we did get a little bit of contribution from price that we weren't expecting, but not a significant amount like literally in the 10 bp range for the quarter. So nothing significant. But no real change. No change for our pricing strategy.
Dan Dolev: Got it. Great results again. Thank you.
Maria Black: Thank you.
Operator: Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open.
Pete Christiansen: Good morning. Thanks for the question. Nice trends this quarter. One quick one on WorkForce Software and a bit of a housekeeping on top of that. Just curious, Maria, in terms of the, I understand the strategic rationale, I totally understand. You're still working through things. But if we think about the opportunity and framing that, is it more about new logo adds from their customer set or do you see upside more a function of scaling their solutions on your existing base, just the hypothesis there on sizing the upside opportunity.
Maria Black: Yes. Thanks, Pete. I think the answer to your question is both, right. But I think scaling their opportunity, leveraging a lot of ADP strength, our scale, our distribution, our brand. I also look at this, the Workforce Management Space, it's a sizable total addressable market, right. So if you look at it from a TAM perspective, the TAM sits in the billions. We serve a lot of that today. Some of those billions are obviously domestic. Some of those are in the international space. I also look at this as an area across the world that will continue to expand. And there I'm not talking about the next quarter or perhaps even the next year. When you think about the needs of global companies over the next decade, if you will, across ADP and what companies will look at as they try to solve for their global workforces and new ways and new places, I think, this is an area that is going to continue to grow in demand and having an offering that can grow and expand as that demand expands, I think, is all about the growth story of ADP both, call it, in quarter this year, but also about the future of the company. So really excited to more meaningfully step into this space. And I think that's what it's about. But certainly continuing their successful growth and our successful growth in this space. And in an ideal world, the execution here looks like that one plus one equals three, right, not two, so.
Pete Christiansen: Sure, sure. That makes a lot of sense there. And then a quick housekeeping modeling question for Don. Just curious plans for the assumed debt from the transaction. And if you could potentially size the interest expense impact to earnings for us, that would be helpful. Thank you.
Don McGuire: Well, I guess, I'd point you to our release. We issued $1 billion of notes earlier in the year at 4.75% and this transaction was $1.2 billion. So you can impute the interest there. I think it's yeah.
Pete Christiansen: Okay. Sorry about that. Thank you.
Operator: Thank you. Our next question comes from Kevin McVeigh with UBS. Your line is open.
Kevin McVeigh: Great. Thank you. Just one on the WorkForce acquisition. Any sense as that business scales, how much revenue it can contribute versus, I guess, what the multiplier effect could potentially be off of the acquired revenues you scale it across your existing client base?
Don McGuire: Good question and certainly a question that we looked at when we're putting our business case together and making the decision to pursue this company. But as I said earlier, it's a little bit early to start drawing out the expectations here. The excitement is palpable. The sales forces are able to work together. There are a lot of things you can't do until you actually have the deal signed. And so it's really been two weeks and a bit since that's happened. And I think the work teams are hard at it, trying to identify opportunities. And I think there's lots of opportunity, as Maria said earlier. We have clients, they don't have. They have clients, we don't have and there's a whole bunch of new logos out there that we can go pursue. And I think the great technology that came with WorkForce Software with ADP's financial strength behind it and more certainty perhaps in a smaller company is going to contribute to this growth here. So we're excited about it and we think there's going to be more, but a little bit early at this point to call out the numbers.
Kevin McVeigh: Okay. Thank you.
Operator: Thank you. Our next question comes from Zachary Gunn with FT Partners. Your line is open.
Zachary Gunn: Hey, there. Thanks for taking the question. I just wanted to go back to Lyric for a second. I understand it's still smaller going to take a bit to have a meaningful impact. Just wondering if there's any thought process of how long it will take before it starts to have a meaningful impact to numbers? And just any data points you can give around that? I know last quarter, I think there was some commentary of client count increasing 30% year-over-year. So just any commentary there would be great. Thanks.
Don McGuire: Yes. Zach, we're very excited about the live clients we have, and they continue to increase. And as Maria said, there was an awful lot of excitement coming out of HR Tech in Las Vegas. So the pipeline has increased pretty dramatically. Lots of work to do. Once again, it's going to take a little bit of time to move the needle. $20 billion of revenue. We're trying to move that needle a lot. It takes a lot. So once again give a little bit of time. And as we package up these offers, the Lyric and the WorkForce Software, along with our tax compliance and the other solutions we have, global payroll, we're expecting good things. But once again a little bit early to share specifics.
Operator: Thank you. We have time for one last question and that question comes from James Faucette with Morgan Stanley. Your line is open.
James Faucette: Thank you very much. Just had a couple of, I guess, nuanced questions. First, last quarter, you had suggested that PEO pays per control would be lower than that of Employer Services. With it downticking this quarter, do you still believe there's growth in PEO pays per control this year?
Don McGuire: Yes. So the short answer is, yes, we believe there's growth in PEO pays per control this year. There was growth in the quarter, and we expect it to be continued growth, but we do expect it to be softer than the 2% at the high end that we have for Employer Services. So, yes, growth, yes, lower than Employer Services.
James Faucette: Okay. Got it. I just want to make sure I understood that. And then following up and sorry if I missed this, but did you quantify Employer Services bookings growth for the quarter specifically? And it sounds like you're still pretty constructive on that front, but how you think about that for the full year range?
Don McGuire: No, we did not quantify for the quarter, and we're still sticking to our 4% to 7% guidance that we established at the outset of the year. As you know, things can get lumpy. But Maria said, we had a record first quarter on bookings, new business bookings, and we're comfortable with where we landed, and we're happy with the pipelines. Demand is strong. So we're still thinking that 4% to 7% range.
James Faucette: Got it. Got it. Thanks for the clarity there. And just maybe just one last question there is, what are some of the swing factors that would push you towards one end of that range either to the upside or to the lower end?
Don McGuire: It's all about execution. I think that demand remains strong. Demand for HCM remains strong, demand for payroll. We don't work in a nondiscretionary industry. People need what we have and what we sell. So we do think that demand is consistent and we'll have to watch and see how things go. We've got one quarter behind us. We're happy with the quarter, solid first quarter. But I can't think of any specific things other than massive macro changes, et cetera, which none of us are anticipating. Certainly, if we look at some of the GDP numbers, we look at the inflation numbers, we look at the labor numbers, they all point to pretty solid and stable demand. So I think we're going to stick with our 4% to 7% for the time being.
James Faucette: Okay, great. Appreciate all that detail.
Operator: Thank you. There are no further questions at this time. I'd like to turn the call back over to Maria Black for closing remarks.
Maria Black: Thanks, Michelle, and thank you, everyone, for joining us. I have to say it's not every day you get to get on and talk about such a solid quarter, both with respect to the overall performance of the business, but also making meaningful steps in our strategic priority agenda. So really excited about the quarter. I want to thank my team specifically. There's a lot that comes together to execute what we just did. I want to thank my team, I want to thank, obviously, the broader ADP organization, as I did earlier, really proud of the execution across the entire company. And then once again, welcome to WorkForce Software. Really excited to see where the future leads us. We're just getting started.
Operator: Thank you for your participation. You may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter 2025 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Matthew Keating",
"text": "Thank you, Michelle, and welcome, everyone to ADP's First Quarter Fiscal 2025 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you also find the Investor Presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. The description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"text": "Thank you, Matt, and thank you, everyone, for joining us. This morning, we reported strong first quarter results that included 7% revenue growth, 130 basis points of adjusted EBIT margin expansion and 12% adjusted EPS growth. I'm excited to share the considerable progress we made across our three strategic priorities in the quarter, but let me first begin with some additional financial highlights. We had a solid start to the year from an Employer Services new business bookings perspective, with record volume for our first quarter. This performance was broad-based as our small business portfolio benefited from our continued strength in Retirement Services. Our mid-market and HR Outsourcing businesses also showed good growth and our International business maintained its strong momentum from last year. Overall, HCM demand remained steady, and our new business pipelines were healthy at the end of the quarter. Our Q1 Employer Services retention rate exceeded our expectations and only declined slightly. Our overall client satisfaction score reached a new all-time high for our first quarter, driven by improvements in our mid-market, enterprise and HR Outsourcing businesses. Moving forward, we expect our record client satisfaction levels to continue to support our strong retention results. Employer Services pays per control increased 2% for the first quarter as our clients continue to hire employees at a moderate pace. Finally, PEO revenue growth of 7% and average worksite employee growth of 3% for the first quarter exceeded our expectations as strong PEO new business bookings growth more than offset the impact of modest further deceleration in PEO pays per control growth. We are very proud of our strong first quarter financial results and equally excited by the significant progress made across our strategic business priorities. As the needs of today's global workforce continues to shift, employers require dynamic Workforce Management Solutions that will help them maintain compliance and flexibility while engaging their employees. We continuously aim to offer solutions that will solve our clients' complex business challenges. As part of this approach, we recently acquired WorkForce Software, a leading Workforce Management Solutions provider that specializes in supporting large global enterprises. This acquisition expands our current array of time and attendance, absent management and scheduling tools and strengthens our ability to win in a highly attractive market. WorkForce Software is a leader in serving large complex organizations and their robust solutions can adapt to the dynamic needs of today's employers by offering tools that create resiliency, help drive optimal performance and make managing a global workforce easy. We are thrilled to bring together these capabilities as well as their trusted global support organization to broaden our suite of Workforce Management Solutions. Based in Michigan, WorkForce Software serves over 1,000 clients in more than 100 countries, including many well-known global brands. I'd like to officially welcome the members of the WorkForce Software team to ADP. Together, we will continue to drive the future of Workforce Management Innovation, and we are looking forward to all the great things we will accomplish. Additionally, in September, we introduced ADP Lyric, our flexible, intelligent and human-centric global HCM platform. Lyric is the new name for our Next-Gen HCM offering, which is designed to meet the evolving needs of the modern workforce. This is a differentiated offering combining global HR, global payroll and global service to adapt to unique structures and workflows and to offer employers a human-centric approach to managing their people. Thanks to its integrated Generative AI technology and the power of ADP's unmatched dataset, Lyric provides insights and intelligence like predictive analytics and anomaly detection to provide clients with personalized recommendations. Lyric is a global platform. It can support payroll in over 75 countries today and we are focused on expanding its international reach moving forward. Following its successful launch at this year's HR Tech Conference, we are seeing very strong interest in Lyric, and we look forward to sharing our future progress with you. The acquisition of WorkForce Software and the introduction of Lyric position us to provide our enterprise clients with a unique global HR, payroll, time and service solution. We continue to invest in Generative AI capabilities to enhance the experience of our clients and empower our associates. During the first quarter, we expanded access to our robust Generative AI-based service tools, which are designed to bring speed to our service interactions and improve the client experience. These tools seamlessly integrate productivity enhancing technologies like call summarization, virtual knowledge assist, and guided workflows for our associates so they can best support our clients. We expanded the use of these tools to our associates, supporting our small business clients in the first quarter. Early feedback is impressive and we look forward to continuing along this journey to drive productivity gains and even higher client satisfaction. We're also excited to share that we recently launched Intelligent Workflow Automation technology in Workforce Now. These dynamic workflows deliver a personalized and satisfying employee experience at pivotal moments in an employee's career like onboarding, while at the same time dramatically reducing manual work for HR practitioners. This functionality enhances the experience of mid-market clients and their employees on our Workforce Now platform and we look forward to adding similar capabilities to our other HCM platforms over time. These meaningful steps collectively demonstrate our continued focus on our three strategic priorities, which are to lead with best-in-class HCM technology, provide unmatched expertise in outsourcing and benefit our clients with our global scale. We remain confident in our ability to advance our strategic goals, drive our competitive differentiation and deliver strong financial results. And with that, I'd like to take a moment to recognize our associates whose efforts and outstanding performance are positioning us to consistently deliver for our clients and our shareholders. Thank you all. And now, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"text": "Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the first quarter and then update our fiscal 2025 outlook, which now includes our WorkForce Software acquisition and our recent debt issuance. Let me begin with our Employer Services results and outlook. ES segment revenue increased 7% on both a reported basis and organic constant currency basis coming in ahead of our expectations. As Maria shared, ES new business bookings were solid to start the year. With a stable demand backdrop and healthy pipelines, we are maintaining our 4% to 7% full year growth guidance. ES retention declined slightly in Q1 versus the prior year, but still came in modestly better-than-anticipated. We are continuing to forecast a 10 basis point to 30 basis point decline in full year retention based on an expected increase in small business losses due to higher out of business rates. ES pays per control growth of 2% met our expectation for the quarter and we continue to forecast 1% to 2% growth for the full year. Client funds interest revenue increased a bit more than we anticipated in Q1, helped by stronger average client funds balance growth. While the yield curve has broadly declined since our last update, this impact is partially offset by our stronger client funds balance growth. For the full year, we are reducing our client funds interest revenue forecast by $10 million. However, we are maintaining our net impact from client funds extended investment strategy forecast as lower reinvestment rates are almost entirely offset by lower average borrowing costs. Based on our Q1 ES revenue growth performance and the expected contribution from the WorkForce Software acquisition, we are increasing our fiscal 2025 ES revenue growth range to 6% to 7%. Our ES margin increased 260 basis points in Q1, driven by both operating leverage and continued client funds interest revenue growth. On a full year basis, we're adjusting our ES margin outlook to incorporate the expected impact of the acquisition and now forecast an increase of 40 to 60 basis points for fiscal 2025. Moving on to the PEO, revenue growth of 7% and average worksite employee growth of 3% exceeded our expectations. As Maria mentioned, strong PEO new business bookings growth more than offset the impact of further modest deceleration in PEO pays per control growth. As a result, we now expect fiscal 2025 PEO revenue growth of 5% to 6% and average worksite employee growth of 2% to 3%, which at the midpoint of the ranges are each up 50 basis points from our prior forecasts. We continue to expect PEO pays per control growth to be slower than ES pays per control growth in fiscal 2025. PEO margin decreased 80 basis points in Q1, which is less than we anticipated due primarily to stronger revenue growth. The margin decline versus last year stemmed mainly from higher workers compensation program costs and higher zero margin benefits pass-through revenue growth. We now expect PEO margin to be down between 70 and 90 basis points in fiscal '25, which is 20 basis points better than our prior outlook. Putting it all together, we are increasing our fiscal 2025 consolidated revenue growth forecast to 6% to 7%. While we anticipate future revenue synergies from the WorkForce Software acquisition, we expect it to pressure our adjusted EBIT margin this fiscal year. We now forecast full year adjusted EBIT margin expansion of 30 to 50 basis points. In addition, in September, we enhanced our capital structure by issuing $1 billion in 10 year notes. And subsequently, our corporate interest expense will increase by about $40 million for fiscal 2025. We continue to expect a full year effective tax rate of around 23%. After incorporating the anticipated impacts of the acquisition and our recent debt issuance, we now forecast 7% to 9% adjusted EPS growth for fiscal 2025. Thank you. And I'll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Zack Ajzenman",
"text": "This is Zack Ajzenman on for Bryan. First question is on Employer Services, just the demand and bookings backdrop. If you can just dig into the areas of strength in Q1 and kind of how it progressed through the quarter? And then we have a follow-up."
},
{
"speaker": "Maria Black",
"text": "Sure. Good morning, Zach. Thanks for joining us today. So demand overall, we feel good about it. We feel good about the HCM demand. We had a great sales quarter. We have a great sales and marketing organization. It was solid and it was broad-based. I think from a demand perspective, I called out a few areas of strength, one of which is the Retirement Services offering in our down market. We continue to execute there against opportunity and our strategy. And so excited to see them continue the great progress. Certainly in the mid-market, our HR Outsourcing offerings as well. And then we saw continued strength in International. I think that's a great story on the heels of the strength that we saw in International all four quarters last year. So really pleased with the broad-based result. And I think the demand remains pretty consistent. I think the down-market, companies are still hiring and they're buying. I think in the mid-market, certainly not getting any easier. It's still very complex. We do also have those offerings beyond tech-only in the mid-market that extend our reach into the HR Outsourcing offerings. And you heard the PEO result was solid as well. So and again, we're always watching what's happening in the global space, which is why we continue to be as pleased as we are with the execution on new business bookings in International."
},
{
"speaker": "Zack Ajzenman",
"text": "Got it. And then a follow-up on PEO retention. So it sounds like worksite employee retention came in above plan in Q1. As we think about the balance of the year, are you still anticipating an improvement in PEO worksite employee retention year-over-year growth for fiscal '25? And is it an offset -- enough to offset the decel and pays per control?"
},
{
"speaker": "Maria Black",
"text": "So the biggest contributor to the outperformance in worksite employees, average worksite employees was really bookings, right. So we did have a strong first quarter, albeit the first quarter for PEO is generally relatively light on the year, so we still have to execute that. And that is the focus. We've been laser-focused on accelerating PEO new business bookings that remains to be the case. That was the biggest contributor and that is the piece that can really overcome the deceleration in worksite employee pays per control or PEO pays per control. Retention does contribute. It contributes very modestly compared to new business bookings. That's really what we saw in fiscal '24 as well. We saw that retention was year-on-year up, but only contributed modestly and that's really what we expect for '25 as well."
},
{
"speaker": "Zack Ajzenman",
"text": "Thank you."
},
{
"speaker": "Don McGuire",
"text": "Yes. Maybe just to add some color to the -- maybe just add a little bit of color to that in terms of the pays per control growth, we do expect to see pays per control growth lower in PEO than in Employer Services. That's what we called out at the outset of the year. We're going to talk about, ES, I'm sure, later. But PEO is definitely showing growth but slowing growth."
},
{
"speaker": "Zack Ajzenman",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ashish Sabadra with RBC Capital Markets. Your line is open."
},
{
"speaker": "David Paige",
"text": "Hi. Good morning. This is David Paige on for Ashish. Thanks for taking our question. I was wondering if we could double-click on the WorkForce Software business, maybe what's the financial profile in terms of revenue growth the annualized revenue and the margin profile? And then a follow-up after that. Thank you."
},
{
"speaker": "Maria Black",
"text": "Yes. So David maybe I'll let Don talk through the financial element, but maybe before we do that, it's prudent to just kind of comment on the strategic rationale behind the acquisition. As you can imagine, we're pretty excited to have the opportunity to speak to it today. This is a company WorkForce Software that we've been aware of for quite some time, aware of their capabilities, aware of how they're able to support some very marquee clients. I think we talked about in the prepared remarks, they have, they serve about 1,000 companies around the world. These are marquee well-known global brands. So we're really excited about the product set. We're excited about the clients. But I have to tell you too, we're pretty excited about the organization as a whole. I was out there on October 15th, a couple of weeks ago for day one. And in addition to a fantastic product and a pretty marquee set of clients, it's also an incredible team. It's a great team with great domain expertise in this space. And so we're really excited to add this deep expertise to ADP's overall Workforce Management Solutions and how we incorporate that with our organization to really drive further opportunities. So this is a growth story for us about the future and we're pretty strategically excited about it. But with that, I'll let Don kind of walk you through the financial implications."
},
{
"speaker": "Don McGuire",
"text": "Yes. So, David, I expect we're going to get this question later on. So maybe I'll just elaborate a little bit more on the impact of the WorkForce Software acquisition. So if you look at the -- we took up our revenue expectation, but on the ES side. Out of the 1% increase to our consolidated FY'25 revenue growth outlook, about half of that is coming from WorkForce Software and the remainder is coming from the strong results in the rest of the business. We had a good first quarter. And we're certainly expecting to see strength throughout the balance of the year as well. And this is certainly more a strategic transaction for us, as Maria just went through, gives us the ability to serve complex global companies with a much broader offer now HCM payroll service and now time to attendance or Workforce Management in that marketplace. And so when we move on and look at some of the additional expenses and some of the things that are causing some drag on our EPS expectations, we only closed the transaction about two weeks ago. So we're not going to be terribly precise on this point. So we do expect some modest pressure. It's important to remember the biggest pieces through are coming from debt intangibles, integration of the deal cost itself. So nothing unusual. I do want to point out that this is a very, it's a relatively small company with a relatively large capability. And when I say that, we're not expecting a significant amount of expense synergies from this transaction because they run themselves pretty lean and they're pretty effective. And then when you move on and you look at what we did in our -- to the midpoint of our ES margin and our adjusted EBIT margin were down 60 and 30 points respectively. And so the question could be is that all from WorkForce Software's anticipated drag? And the answer is actually more of the drag is coming from WorkForce Software. So the other businesses are compensating somewhat for that. So we do anticipate about a 0.5 point of EBIT margin pressure as a result of the transaction in fiscal '25. So if you -- if we look at the EPS growth as well, it's expected to be a bit more than 1% of the drag. So we've outperformed in other parts of the business, so we overcome some of that. And as I said earlier, most of the dilution is coming from integration costs, amortization of intangibles and interest expense. And then I'll jump ahead of the anticipated question I have and that is when do we think this is going to be accretive to ADP? And I think the short answer is, give us a couple of quarters to get things in line and we'll come back and we'll be very excited about sharing success stories and client wins over the next couple of quarters, but it's a bit early given this transaction only closed about two weeks ago."
},
{
"speaker": "David Paige",
"text": "That's great. Very comprehensive for me. That's it for me. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"text": "Good morning and thanks for the questions. First of all, congratulations on the first quarter results, really strong particularly. Maria, you mentioned client satisfaction scores are at all-time highs. Can you talk a little bit about some of the factors that drove that? And then I'd like to do a follow-up on WorkForce Software."
},
{
"speaker": "Maria Black",
"text": "Yes. Good morning, Mark, and thank you very much for the congratulations. We're pretty excited about the quarter as well. To the NPS question that you had. So what I mentioned in the prepared remarks is we had an all-time high for a first quarter. And we did see strength. Again, it was broad-based. I think some of the call-outs that we've been making over the last couple of years, specifically as it relates to the business that really has been broad-based and it's been near record levels really kind of across the various businesses. I think we've talked quite a bit about the mid-market. We've talked about the last couple of years that we've been speaking to the mid-market. A lot of that mark comes from the investments we've been making in product, the investments we've been making in some of the tools that we provide to our service organization. I mentioned some of those as we extend the reach into the product and in Workforce Now. During the remarks, I also mentioned some of the other work that we've done in SBS specifically, the extension of Generative AI tools into the SBS service organization. And again, the thesis behind it and what it's proving itself to be true is the more we invest in making things easy for our clients and frictionless, the greater our NPS results, and it seems to be resulting in pretty favorable retention results as well. So from an NPS perspective, on a year-on-year basis, just kind of rounded out. We did see the mid-market, enterprise and HR Outsourcing businesses from a year-on-year perspective kind of have those biggest improvements, but from a broad-based perspective, I would say almost every business is at record levels. And year-on-year, it was a record for a first quarter."
},
{
"speaker": "Mark Marcon",
"text": "Got it. We had a chance to demo the WalkMe tool within Lyric and that was pretty impressive. I imagine that's going to end up continuing the upward surge in terms of the NPS. Wondering with regards to WorkForce Software. What's the integration plan? I mean the strategic rationale seems fairly obvious. But just how long -- how soon will we be able to see you fully integrate them in terms of a go-to-market plan? When will you start doing joint sales? How much of their client base, which does include similar marquees already ADP clients? What are the opportunities with regards to potentially penetrating some of those that aren't? Can you talk a little bit about whether it's going to be domestic as well as international in terms of when you go to market and how quickly you can do that?"
},
{
"speaker": "Maria Black",
"text": "Yes, sure. By the way, I love every single one of your questions, Mark, because they're the exact same questions that we've all been asking ourselves as we looked at this great organization and also post the signature, if you will, as we really started comparing kind of what we all have. And so I think it's probably too early to comment on the exact overlap of clients, things of that nature. But if you imagine and you know full well the types of clients that ADP serves on a global, call it, enterprise perspective and you imagine that they have some of the most formidable marquee clients. You can only imagine that there's overlap there. So what we're focused on is exactly what you're referring to, which is adding this offering into our global and enterprise call it, go-to-market growth opportunity. We're pretty excited and you mentioned Lyric and what you saw with WalkMe with Lyric. I hope we get to the Lyric conversation today because we're really excited about where that is on the heels of HR Tech. If you imagine marrying Lyric to the great story now of WorkForce Software, that's an exciting opportunity for us as we extend our reach into that global MNC, call it, enterprise space. So that is the intention. It is an offer that's where it sits today. I think it does add to the plethora of offerings that ADP does have across our Workforce Management Solutions. So if you imagine, we have products already in that space. We also have partnerships in that space. We have products in the mid-market. We also have partnerships there. And certainly we have time and attendance offerings also in the down market, inclusive of, I think we have well over almost 100 marketplace partners in the down-market. So this offering is going to be a great addition to our overall suite, specifically in that global enterprise space. And that is a growth story for us, and it's married directly to our Lyric excitement. And so that's the intent and we're working through each and every one of the questions you asked as we speak."
},
{
"speaker": "Mark Marcon",
"text": "Great. Look forward to hearing more on the progress. Thank you."
},
{
"speaker": "Maria Black",
"text": "Thank you, Mark."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"text": "Great. Good morning, guys. Thanks for taking my question. I wanted to go back to the PEO segment to start and thought the results there were very encouraging, especially on the bookings side. So I would love to hear just a little bit about that bookings outperformance. And has there been any sort of change to the sales strategy to your benefits packaging and offering a little bit of a combination of both. Any color on that would be very helpful."
},
{
"speaker": "Maria Black",
"text": "Sure. I think it's intense focus and execution. And so I think the team has been very focused. We've been speaking about this since the strangeness in the PEO post-pandemic. We've been very focused on reaccelerating bookings. And so I think it's great execution by the team. I think the offering, the value proposition, and I've been pretty bullish about this. Well, probably since about 1997. But listen, the PEO value proposition, it continues to only gain in strength. You mentioned health offerings and things of that nature that sits squarely in that space. If you are a company of the target market of our PEO in the industries that we target with our PEO offering here at ADP, you need the types of things that the PEO offers, that's best-in-class health benefits. It's a competitive workers' compensation program. It's best-in-class retirement services offerings. And so I think continuing to lean into that value proposition. And as I always say, and I said it earlier today, it's not getting any easier for those types of clients to be employers that's only getting more complex. And so I think we're aligning our sales organization to be laser-focused on it and I think it's a byproduct of strong execution."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. That's helpful. And then just as a follow-up on the WorkForce Software acquisition. And as we sort of think about maybe incremental revenue opportunities. I mean is there -- I know it's an enterprise-focused solution. Is there an opportunity to maybe also bring this down to serve your mid-market customers as well?"
},
{
"speaker": "Maria Black",
"text": "So again, I think that's in the same bucket as Mark's question. I think that is a big piece of what we are working through at this time. I think they have across their thousand clients, they certainly have clients in that space. I think, again, the way I sort through it, if you again go back to the big plethora, I use that word to describe the varied offerings we have across each segment, down-market, mid-market, upmarket across each one of the global businesses, the in-country offerings. In fact, we were not too long ago, actually bought a time and attendance offering in Asia-Pac. And so we have organic and we have proprietary offerings. We partner and we go to market in this giant array of offerings and how we sort through that. I think the easiest way that I think about it is client by client. And so I think we kind of put the client at the center, making sure that we are allowing the best possible solutions for our clients. And certainly, as we absorb WorkForce Software's offerings into our ecosystem of time and attendance we will be taking a close look at the mid-market clients and making sure that, call it, client by client, they have the right offering at the right time."
},
{
"speaker": "Scott Wurtzel",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"text": "Hi, good morning. Thank you for taking my questions and I'll echo the congrats on a good quarter. Don, maybe first one for you. Just as I think about the size of the WorkForce deal, it's one of your bigger transactions. Any signal in that, that we should take whether that's the company willing to be more acquisitive or if multiples are in a state where ADP is maybe ramping up M&A more broadly overall or is this a one-off as part of a strategy or kind of a broader signal? And then I have a follow-up for Maria."
},
{
"speaker": "Don McGuire",
"text": "Okay. Samad, thanks for the question. Yes, in terms of absolute dollars, definitely one of the larger acquisitions or the largest acquisition ADP has ever done. Although I think the company is a lot bigger than it was when we did some of those acquisitions a number of years back. So I think it fits in squarely. I don't think our M&A be more precise than that. Our M&A strategy hasn't changed. We look for opportunities and we've been looking for opportunities for quite some time, but we need to make sure that they're additive. We need to make sure they complement our offer and they don't complicate our offer. Spent a lot of time over the last 10 years or so, cleaning up our portfolio and making sure we get fewer platforms to do the same thing. And so looking at things that are additive to us are in good tight adjacencies as this acquisition was and making sure that the business model, the recurring revenue model is particularly important to us the way we go to market, looking at all those things is important and will continue to be important to us. So we will continue to look. And if things show up that we think are going to be additive to us and we have an opportunity, we'll move again. But certainly we haven't really changed our philosophy at all on how we approach and what we're looking for in terms of M&A."
},
{
"speaker": "Samad Samana",
"text": "Great. And then, Maria, just maybe a question on Lyric. This is something that investors have talked to us a lot about. Just thinking about how it builds on Lifion, which was a focus before. And with the rebranding, I guess, the question we've gotten is, is this, what was the evolutionary or revolutionary moment that led to the rebranding now? Is it product market fit is finally right, and maybe there's an inflection that we're reaching? Is it about from a go-to-market perspective like what led to it now at this particular moment? And should we see maybe an inflection in demand going forward?"
},
{
"speaker": "Maria Black",
"text": "I'm so glad you asked Samad. I've been excited to talk about Lyric for quite some time. So just to level set, just everyone's clear, Lyric is the new name for Next-Gen HCM. And I think we're all tired of saying Next Gen HCM. I think that was part of it. But all kidding aside, listen, we couldn't be more thrilled to bring ADP Lyric HCM into the market. Personally, I love the name. I think it's a name that evokes emotion. It speaks to the rhythm of what it looks like to be a worker in today's environment and making sure that's something that perhaps was static in the past that didn't have the right type of Lyrics to it ultimately comes alive with the name. And so I think it's the right name at the right time. I think to answer the why now. I think the world is ready for this next offer of HCM in this space. This product, it's flexible, it's intelligent. It's designed with humanity in mind. It's human-centric and its design is how we speak about it. And that is groundbreaking and that is orchestrated really around the person. And what that allows for things, as I mentioned earlier, such as flexible workflows. It allows for inserting Generative AI that can drive everything from anomaly detection to nudges. And so it is a unique offer and that it is married to, call it, the other strengths of ADP. It's a global HCM, global payroll and global service. That's unique and we're pretty excited. And so I think part of it is the market is ready. I think the other part is we're ready. And so as we unveil this, there's been tremendous demand from the clients. I think we saw in the heels of HR Tech. We saw great analyst reviews. Mark just mentioned seeing some of the functionality. And so I think the buzz is out there. We see that also in the pipelines. But as you can imagine, it's still early days. So it's going to take some time until it contributes to the overall ADP financials. But from a product perspective, it's the right product at the right time with the right name. We're pretty excited to lean into that growth story, marry it now to the WorkForce Software offering that we're folding in, I think, it's a great growth opportunity for ADP."
},
{
"speaker": "Samad Samana",
"text": "Thank you as always. Appreciate it."
},
{
"speaker": "Maria Black",
"text": "Thank you"
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"text": "Hi. Good morning and thanks for taking my question. Retention continues to outperform expectations. Can you update us on the drivers here, new products, technology, maybe fewer SMB bankruptcies. I'm not sure if that's still an important driver. And also what was the retention rate in the quarter?"
},
{
"speaker": "Maria Black",
"text": "Sure. So I think happy to talk about the drivers. I mentioned some of them earlier. Listen, all of the things that we're doing, best-in-class service, the investments we make into our product set, it is yielding a better experience. You see that directly on the NPS. NPS correlates to retention. So I'd like to think some of the results we have are structural. I will say that from an outperformance perspective in the first quarter, we did see, while retention was down slightly or declined slightly, we did see that the SBS or the small businesses held. And so our belief in how we're looking at the outlook for the rest of the year is that while we are almost normalized back to kind of the out of business rates from fiscal '19. We're not all the way normalized. And so we do still expect that there could be some pullback. Part of how we've also modeled it, so many of our businesses last year specifically, were at record highs on the retention. So I think we modeled kind of assuming that those businesses were at record highs, and we're assuming some pullback in the down market, specifically as it relates to out of business. Listen, we didn't see that in the first quarter. We're hoping that between the strength in small business, kind of the environment, coupled with strong execution on our strategic roadmap around best-in-class products and best-in-class service will ultimately yield continued favorability, but we believe at this time that the retention guide is prudent."
},
{
"speaker": "Ramsey El-Assal",
"text": "Great. And a follow-up for me then is on PEO margins, they came in better than expected in the quarter and you listed your full year margin expectations for the segment. Could you elaborate on the main drivers there? And also for the full year, are you anticipating any reserve releases around workers' comp. As I recall I don't think that flowed in last year at this time. So I was curious."
},
{
"speaker": "Don McGuire",
"text": "Yes. So Ramsey, firstly, the PEO margins were certainly better and really based on the struggle revenue that we had in the quarter. So stronger revenue based on stronger Worksite Employee growth and also some help from rates -- wage rates. So that was really the biggest driver for the improvement in margin in PEO. We did have a small release of $4 million in the quarter. And certainly, that contributed a little bit as well, but we are not anticipating to see releases for workers' compensation reserves as we did in prior years. So that is not something that we factored into our balance for the forecast. So strong Worksite Employees, strong growth in wage rates, strong growth in margin."
},
{
"speaker": "Ramsey El-Assal",
"text": "Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Hey, thanks. You covered a lot already here. But I just want hoping Maria can elaborate on the strong pipeline comment. Any surprises or change in visibility across all of your markets, any change in decision-making, I know, we get a lot of questions up market around the elections. Can we see a little bit of a pause before we get back to normal that kind of thing."
},
{
"speaker": "Maria Black",
"text": "So the answer to your question is really no change. So we exited the fourth quarter. We talked about strong pipelines. We're exiting this quarter, feeling confident in strong pipelines. We haven't seen any changes in buying behaviors as it relates to any of the things that are happening across the world if you will. That's not to suggest that we're not keeping a watchful eye. I think we've spoken about deal cycle, specifically in the upmarket because as you mentioned, that's where a lot of the questions come in the space. And I think we're in that new normal. I think it looks like it used to back in the pre-pandemic. And so I think it's just the normal cycle. Listen, as always, every quarter has a little bit of ebb and flow as it relates to some businesses. But I think overall, the strength was broad-based exiting the fourth quarter, exiting the first quarter and the strength on the pipeline side is also broad-based. And just a reminder, pipelines look different, in the down market, it's about net new appointments. It's about activities. It's about those things in the mid-market and into the enterprise space, obviously, these are year-on-year pipeline compares and we feel solid about the pipeline."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Terrific. Thanks for that. Just my quick follow-up. I know Mark and others asked about cross-sell potential synergies with WorkForce Software, but it's got some really nice logos going to the site when you first announced this. So is cross-sell an important consideration and decision to bring the asset in?"
},
{
"speaker": "Maria Black",
"text": "I think and by the way, of course, those logos are also very exciting and the many logos many would be familiar with from a marquee brand perspective. I think how we go to market together is an exciting story. So some of that will be the continued way that this company has been able to execute and win really marquee clients in the marketplace. I'd like to think it only helps them to have the scale and the brand of ADP behind them. And so in a more simple way to say it, if you think about global marquee clients going out to RFPs, the exciting part is we're going to get invited to all of their parties. And hopefully we get -- they get invited to all of our parties. And I think the strength between their product and our distribution and our scale and our brand, I think, leads us to be very optimistic on the growth narrative."
},
{
"speaker": "Tien-Tsin Huang",
"text": "Yes. No, sounds like it. Thank you, Maria."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Caroline Latta",
"text": "Hi. This is Caroline Latta on for Jason. I just had a question on Generative AI. I know you mentioned progress on rolling out some of those initiatives. Do you have any call-outs on potential further investment and cadence of that over the coming year?"
},
{
"speaker": "Don McGuire",
"text": "Caroline, thanks for the question. No real. I'll start with no real call-out on further investments. We are continuing to invest modestly as we've shared over the last few quarters. And we are continuing to see good results. Maria touched on some of those earlier. Certainly, some of the call summarization tools that have been deployed already are showing good results. We've seen good results in our sales area, setting appointments, deciding which appointments to go to preparing for appointments, coaching salespeople when they're in live calls and we're continuing to see opportunities and success in our technology area, coding and some of the co-pilot tools that are available there. So really not a lot of incremental investment, really just continuing the course and looking to get more and more returns on the investments we've made over the coming quarters."
},
{
"speaker": "Caroline Latta",
"text": "Really helpful. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"text": "Good morning. Maria, you talked a little bit about the SMB and out of business, and you're anticipating maybe it hasn't completely normalized. But I'm wondering as you look at KPIs for your customers, what do you think about the health of small businesses? And if you've seen any change over the last few months?"
},
{
"speaker": "Maria Black",
"text": "Sure. Good morning, Kartik. So, yes, listen, it's pretty close to being normalized. We're almost there. In terms of the health of small businesses overall, we look at a lot of indexes. We look at other organizations that serve similar type of, call it, nondiscretionary offerings that we serve. I think overall health of small business is strong. There are a couple of watchout items. One of the ones that we pay close attention to is new business formations. And so while it's down year-on-year and it's down even fiscal year-to-date, that is a watch out item. That said, it's still elevated. So it's elevated from where, call it, used to sit, pre-pandemic. And so it's still arguably considered strong. So on one hand, it's strong. On the other hand, it's pulled back a tiny bit from the strength that it used to have. That's just one thing. But we look at all of these things. I think the general sentiment as it relates to demand across the down market and as it relates to the small business side is it continues to be strong. I think we spoke quite a bit about the down market last year and we continue to see good execution among small businesses and overall strength."
},
{
"speaker": "Kartik Mehta",
"text": "And, Don, just a follow-up. Any thoughts on change of strategy for the portfolio? I know yields have been coming up a little bit. But I'm wondering if there's any thoughts on maybe changing some of the duration or just any other changes you might want to do for the portfolio based on kind of the yield?"
},
{
"speaker": "Don McGuire",
"text": "No, Kartik, we've looked at that, and we think we've benefited significantly on our laddering that we've done over the last 20 years or so. And we did have a bit of opportunity cost, as we've shared over the last couple of years as we've been dealing with an inverted yield curve. But that yield curve is slowly starting to normalize. So we should expect to see more benefit. We also called out in our, in the prepared remarks, we are taking our investment or client fund interest number down by $10 million, but we think the net impact because borrowing is less expensive now at the short end. We do think that we're going to be flat to our initial guidance for the year. So we don't see any compelling reason to change the structure of our portfolio."
},
{
"speaker": "Kartik Mehta",
"text": "Perfect. Thank you very much. I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"text": "Hey, guys. Really good results here. Thank you. Just a quick housekeeping question. Would you be able to quantify how much of the EBIT drag as a result of any incremental amortization?"
},
{
"speaker": "Don McGuire",
"text": "Well, I don't want to get into too much of the sausage making here, but we did disclose the value of the deal at $1.2 billion. And I think industry averages are somewhere in the neighborhood of 30%. So you can go from there and look at a seven to eight year amortization period and kind of figure it out. I'm sure all of you have done it already anyway. But rough numbers I think that would get you in the ballpark."
},
{
"speaker": "Dan Dolev",
"text": "Okay. Got it. Thank you. And just a quick follow-up. I mean, you're doing really well on the top line. Can you maybe discuss a little bit of your pricing strategies and the pricing environment for the deals? And I'm sorry if it had already been asked, I joined late. Thank you."
},
{
"speaker": "Don McGuire",
"text": "So pricing, we have had 100 to 150 basis points over the last couple of years. I think as inflation moderates somewhat, we're expecting to get closer to 100 basis points this year and that's where we're sitting. So really no changes to pricing strategy since we spoke last time. And we'll make a small color though on price. It had a small impact in our revenue for the quarter. We do have a couple of European countries where in the mid and the upmarket, the price increases are tied to various inflation indices and those indices came in higher. So we did get a little bit of contribution from price that we weren't expecting, but not a significant amount like literally in the 10 bp range for the quarter. So nothing significant. But no real change. No change for our pricing strategy."
},
{
"speaker": "Dan Dolev",
"text": "Got it. Great results again. Thank you."
},
{
"speaker": "Maria Black",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"text": "Good morning. Thanks for the question. Nice trends this quarter. One quick one on WorkForce Software and a bit of a housekeeping on top of that. Just curious, Maria, in terms of the, I understand the strategic rationale, I totally understand. You're still working through things. But if we think about the opportunity and framing that, is it more about new logo adds from their customer set or do you see upside more a function of scaling their solutions on your existing base, just the hypothesis there on sizing the upside opportunity."
},
{
"speaker": "Maria Black",
"text": "Yes. Thanks, Pete. I think the answer to your question is both, right. But I think scaling their opportunity, leveraging a lot of ADP strength, our scale, our distribution, our brand. I also look at this, the Workforce Management Space, it's a sizable total addressable market, right. So if you look at it from a TAM perspective, the TAM sits in the billions. We serve a lot of that today. Some of those billions are obviously domestic. Some of those are in the international space. I also look at this as an area across the world that will continue to expand. And there I'm not talking about the next quarter or perhaps even the next year. When you think about the needs of global companies over the next decade, if you will, across ADP and what companies will look at as they try to solve for their global workforces and new ways and new places, I think, this is an area that is going to continue to grow in demand and having an offering that can grow and expand as that demand expands, I think, is all about the growth story of ADP both, call it, in quarter this year, but also about the future of the company. So really excited to more meaningfully step into this space. And I think that's what it's about. But certainly continuing their successful growth and our successful growth in this space. And in an ideal world, the execution here looks like that one plus one equals three, right, not two, so."
},
{
"speaker": "Pete Christiansen",
"text": "Sure, sure. That makes a lot of sense there. And then a quick housekeeping modeling question for Don. Just curious plans for the assumed debt from the transaction. And if you could potentially size the interest expense impact to earnings for us, that would be helpful. Thank you."
},
{
"speaker": "Don McGuire",
"text": "Well, I guess, I'd point you to our release. We issued $1 billion of notes earlier in the year at 4.75% and this transaction was $1.2 billion. So you can impute the interest there. I think it's yeah."
},
{
"speaker": "Pete Christiansen",
"text": "Okay. Sorry about that. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kevin McVeigh with UBS. Your line is open."
},
{
"speaker": "Kevin McVeigh",
"text": "Great. Thank you. Just one on the WorkForce acquisition. Any sense as that business scales, how much revenue it can contribute versus, I guess, what the multiplier effect could potentially be off of the acquired revenues you scale it across your existing client base?"
},
{
"speaker": "Don McGuire",
"text": "Good question and certainly a question that we looked at when we're putting our business case together and making the decision to pursue this company. But as I said earlier, it's a little bit early to start drawing out the expectations here. The excitement is palpable. The sales forces are able to work together. There are a lot of things you can't do until you actually have the deal signed. And so it's really been two weeks and a bit since that's happened. And I think the work teams are hard at it, trying to identify opportunities. And I think there's lots of opportunity, as Maria said earlier. We have clients, they don't have. They have clients, we don't have and there's a whole bunch of new logos out there that we can go pursue. And I think the great technology that came with WorkForce Software with ADP's financial strength behind it and more certainty perhaps in a smaller company is going to contribute to this growth here. So we're excited about it and we think there's going to be more, but a little bit early at this point to call out the numbers."
},
{
"speaker": "Kevin McVeigh",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Zachary Gunn with FT Partners. Your line is open."
},
{
"speaker": "Zachary Gunn",
"text": "Hey, there. Thanks for taking the question. I just wanted to go back to Lyric for a second. I understand it's still smaller going to take a bit to have a meaningful impact. Just wondering if there's any thought process of how long it will take before it starts to have a meaningful impact to numbers? And just any data points you can give around that? I know last quarter, I think there was some commentary of client count increasing 30% year-over-year. So just any commentary there would be great. Thanks."
},
{
"speaker": "Don McGuire",
"text": "Yes. Zach, we're very excited about the live clients we have, and they continue to increase. And as Maria said, there was an awful lot of excitement coming out of HR Tech in Las Vegas. So the pipeline has increased pretty dramatically. Lots of work to do. Once again, it's going to take a little bit of time to move the needle. $20 billion of revenue. We're trying to move that needle a lot. It takes a lot. So once again give a little bit of time. And as we package up these offers, the Lyric and the WorkForce Software, along with our tax compliance and the other solutions we have, global payroll, we're expecting good things. But once again a little bit early to share specifics."
},
{
"speaker": "Operator",
"text": "Thank you. We have time for one last question and that question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"text": "Thank you very much. Just had a couple of, I guess, nuanced questions. First, last quarter, you had suggested that PEO pays per control would be lower than that of Employer Services. With it downticking this quarter, do you still believe there's growth in PEO pays per control this year?"
},
{
"speaker": "Don McGuire",
"text": "Yes. So the short answer is, yes, we believe there's growth in PEO pays per control this year. There was growth in the quarter, and we expect it to be continued growth, but we do expect it to be softer than the 2% at the high end that we have for Employer Services. So, yes, growth, yes, lower than Employer Services."
},
{
"speaker": "James Faucette",
"text": "Okay. Got it. I just want to make sure I understood that. And then following up and sorry if I missed this, but did you quantify Employer Services bookings growth for the quarter specifically? And it sounds like you're still pretty constructive on that front, but how you think about that for the full year range?"
},
{
"speaker": "Don McGuire",
"text": "No, we did not quantify for the quarter, and we're still sticking to our 4% to 7% guidance that we established at the outset of the year. As you know, things can get lumpy. But Maria said, we had a record first quarter on bookings, new business bookings, and we're comfortable with where we landed, and we're happy with the pipelines. Demand is strong. So we're still thinking that 4% to 7% range."
},
{
"speaker": "James Faucette",
"text": "Got it. Got it. Thanks for the clarity there. And just maybe just one last question there is, what are some of the swing factors that would push you towards one end of that range either to the upside or to the lower end?"
},
{
"speaker": "Don McGuire",
"text": "It's all about execution. I think that demand remains strong. Demand for HCM remains strong, demand for payroll. We don't work in a nondiscretionary industry. People need what we have and what we sell. So we do think that demand is consistent and we'll have to watch and see how things go. We've got one quarter behind us. We're happy with the quarter, solid first quarter. But I can't think of any specific things other than massive macro changes, et cetera, which none of us are anticipating. Certainly, if we look at some of the GDP numbers, we look at the inflation numbers, we look at the labor numbers, they all point to pretty solid and stable demand. So I think we're going to stick with our 4% to 7% for the time being."
},
{
"speaker": "James Faucette",
"text": "Okay, great. Appreciate all that detail."
},
{
"speaker": "Operator",
"text": "Thank you. There are no further questions at this time. I'd like to turn the call back over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"text": "Thanks, Michelle, and thank you, everyone, for joining us. I have to say it's not every day you get to get on and talk about such a solid quarter, both with respect to the overall performance of the business, but also making meaningful steps in our strategic priority agenda. So really excited about the quarter. I want to thank my team specifically. There's a lot that comes together to execute what we just did. I want to thank my team, I want to thank, obviously, the broader ADP organization, as I did earlier, really proud of the execution across the entire company. And then once again, welcome to WorkForce Software. Really excited to see where the future leads us. We're just getting started."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. You may now disconnect. Everyone have a great day."
}
] | Automatic Data Processing, Inc. | 126,269 |
ADSK | 4 | 2,020 | 2020-02-27 17:00:00 | Operator: Ladies and gentlemen, thank you for standing by. And welcome to the Q4 Fiscal Year 2020 Autodesk Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to you speaker today, Mr. Abhey Lamba, VP of Investor Relations. Thank you. Please go ahead sir.
Abhey Lamba: Thanks operator and good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter and full-year of fiscal 20. On the line is Andrew Anagnost, our CEO, and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at Autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our website following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results and strategies. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year on year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our investor relations website. And now I would like to turn the call over to Andrew.
Andrew Anagnost: Thanks, Abhey. We closed fiscal year 2020 with outstanding Q4 results with revenue, earnings and free cash flow coming in above expectations. Recurring revenue grew 29% and we delivered $1.36 billion in free cash flow for the year. Our results were driven by strong growth in all geographies. This was a landmark year for us in Construction as we absorbed our acquisitions and integrated our offerings under one platform – the Autodesk Construction Cloud. Subscriptions now represent around 85% of our revenue, and we exited the year with maintenance contributing less than 10%. Fiscal year 2020 marked the end of the business model transition for us, and we are entering fiscal 2021 firmly positioned to deliver strong, sustainable growth through fiscal 2023 and beyond. It was three years ago that we first communicated our fiscal 2020 free cash flow goal. We have delivered on that goal, which is a testament to the adaptability and focused execution of the Autodesk ecosystem, and the power of our products. I want to acknowledge and thank our employees, partners, customers, long-term investors and everyone who helped us achieve these results. While the path to delivering on our long-term targets was not always smooth, everyone who stayed with us and believed in the transition has been rewarded. Beyond that, the dramatically reduced upfront costs created by the subscription model have enabled a whole new class of customers to purchase our most powerful tools; opening up not only new opportunities for our business, but for the businesses of our customers as well. Before we get into our results and guidance, I want to mention that our thoughts are with those affected by the coronavirus. The safety and security of our employees is our top priority. We are also minimizing potential impact to our customers and partners. The events are not currently impacting our service levels for our customers or global R&D efforts. We will continue to monitor the situation and take precautionary steps. Now I will turn it over to Scott to give you more details on our results, and fiscal 2021 guidance. I’ll then return with a summary of some important recognitions we received, and insights on key drivers of our business, including updates on Construction, Manufacturing and our progress in monetizing noncompliant users before we open it up for Q&A.
Scott Herren: Thanks, Andrew. As you heard from Andrew we had strong performance across all metrics with revenue, earnings and free cash flow coming in above expectations. Demand in our end markets was strong as indicated by our robust billings and current RPO growth. And the sum of our revenue growth plus free cash flow margin for the year was 69%. Revenue growth in the quarter came in at 22%, versus a strong Q4 fiscal 2019, with acquisitions contributing three percentage points of the growth. Strength in revenue was driven by subscription revenue growth of 41%. For the full year, subscription revenue was up 53% and, as Andrew mentioned, subscriptions now represent approximately 85% of our revenue. With the success of our Maintenance-to-Subscription program, we exited the year with maintenance revenue contributing less than 10% of total. Total ARR came in at $3.43 billion, up 25%. Core ARR grew 21% and Cloud ARR grew 102% to $255 million. When adjusted for acquisitions, Cloud ARR grew an impressive 30% driven by strong performance of BIM 360 Design. Now that a year has passed since we completed the acquisitions, our entire Construction portfolio will be organic starting first quarter of fiscal 2021. Moving onto details by product and geography: Starting with AutoCAD and AutoCAD LT, revenue grew 24% in the fourth quarter, again versus a strong Q4 fiscal 2019 and 30% for the year. AEC grew 30% in Q4 and 35% for the year, while Manufacturing rose 15% in Q4 and 18% for the year. M&E was down 5% in the quarter, primarily due to a large upfront transaction in the fourth quarter of last year. M&E revenue was up 9% for the year. Geographically, we saw broad-based strength across all regions. Revenue grew 21% in the Americas and EMEA and 26% in APAC during the quarter. We also saw strength in direct revenue, which rose 26% versus last year, and represented 31% of our total sales, relatively in-line with the fourth quarter of last year. The strength in our direct business was driven by large enterprise business agreements and our digital sales. As we indicated in the past, we plan to provide an annual update on our subs and annualized revenue per subscription, or ARPS, performance. During the year, we grew total subscriptions 12% to 4.9 million, with subscription plan growing 26%. We added 181,000 cloud subscriptions due to strong adoption of our BIM 360 family products as well as 79,000 subscriptions from PlanGrid and BuildingConnected. ARPS grew by 11% for the year to $704 with Core ARPS growing by 10% to $798. With only one quarter left in our maintenance to subscription, or M2S, program we have approximately 400,000 maintenance subscriptions left. I am proud to share that we have converted over 1 million maintenance subscriptions to-date. We will be retiring maintenance after May 2021 and customers will have one last opportunity to renew their maintenance or trade-in their maintenance seat for a subscription between now and May 2021. Please refer to the slide deck posted on our Investor Relations website for additional details around the trade-in offer. As expected and consistent with last quarter, the maintenance conversion rate was 40%. And of those that migrated, upgrade rates came in at 26%. Net revenue retention rate was again within the 110% to 120% range, continuing to demonstrate the growing strategic value we deliver to our existing customers. Billings growth of 43% in the quarter and 55% for the year was driven by organic growth and as expected, the normalization of our multi-year contracts. The strength in our multi-year commitments from our customers is an indicator of the strategic importance and business critical nature of our products. Our long-term deferred revenue ended up slightly higher than we anticipated but our multi-year business is at a sustainable level and is not creating a headwind to our future free cash flows. In fiscal 2020, we delivered $1.36 billion in free cash flow with $684 million coming in the fourth quarter, delivering on a key goal we set out three years ago. We expect to post annual growth in our free cash flows through fiscal 2023 and beyond as net income will start driving a greater portion of our free cash flows versus deferred revenue. Our total remaining performance obligation of $3.6 billion is up 33% and our current remaining performance obligation of $2.4 billion grew 23%. On the margin front, we continue to realize significant operating leverage due to strong revenue growth and diligent expense management. For the full year, non-GAAP gross margins were very strong at 92%, up two percentage points from last year. Our non-GAAP operating margin expanded by 12 percentage points to 25%, we are on track to deliver further margin expansion and attain approximately 40% non-GAAP operating margin in fiscal 2023. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash. During the fourth quarter, we purchased a little over 1 million shares for $191 million at an average purchase price of $189.52 per share. During the year, we fully offset dilution from our equity plans, purchasing a total of 2.7 million shares for $456 million at an average purchase price of $168.63 per share. Now I’ll turn the discussion to our outlook. We have taken into account the current macro environment and potential risks involved with any disruptions. Our direct exposure to China is small, and our experience with past outbreaks showed limited impact to our sales. While we will continue to monitor the situation more broadly, we expect total revenue to grow by 20% to 22% in fiscal 2021 and expand non-GAAP operating margin by about five percentage points. During the year, we plan to deliver free cash flow in the range of $1.63 billion to $1.69 billion, up 20% to 24%. When looking at the quarterization of free cash flow for fiscal 2021, given normal seasonality and strength of payment collections and large deals signed in the fourth quarter, we expect about two-thirds of our free cash flow to be generated in the second half of the year. Looking at our guidance for the first quarter, our strength in the fourth quarter presents a tough sequential compare. Given our normal seasonality, other revenue in Q1 is expected to be about half as much as we experienced in Q4. The slide deck on our website has more details on modeling assumptions for the fiscal first quarter and full year 2021. Now, I’d like to turn it back to Andrew.
Andrew Anagnost: Thanks, Scott. We just closed a landmark fiscal year and delivered on the free cash flow target we set over three years ago when we began the business model transition. Now let me give you some details about what is happening across our business. First off, fiscal 2020 was not only a year of financial achievements, but also a year where we increasingly enabled our customers to realize more sustainable outcomes in their work. In fact, we were recognized by the Corporate Knights for being in the top five of the world’s most sustainable companies and Barron’s ranked us 10th on their list of 100 most sustainable companies, making us the highest-ranking software company on both lists. This recognition is not only a testament to how responsibly we run our own business, but, more importantly, how we help our customers meet their own sustainability goals, which brings me to construction. Our construction business had an outstanding year and ended the year with great momentum. We are looking at construction in a more connected way than ever before, and our offerings are resonating with our customers. The Autodesk Construction Cloud delivers advanced technology, a network of builders, and the power of predictive analytics to drive projects from the earliest phases of design, through planning, building and into operations. Customers are excited about the unified platform and are recognizing that the breadth, depth, and connectivity across our portfolio sets us apart from our competition. For example, CRB, a design-build firm with offices across the U.S. and internationally, was using each of our four products independently. When they understood our vision for Construction Cloud to deliver a unified solution that integrates workflows connecting the office, trailer and field, CRB signed an enterprise business agreement with Autodesk for the solutions offered under the Construction Cloud. They are aligned with our vision of a unified solution that provides the entire construction lifecycle, from design through long-term maintenance, with all the design and make data they need in one place so information is not siloed or lost, and work gets done more efficiently. Leveraging data efficiently is critical to CRB’s new project execution concept, ONEsolution, which brings time, cost, quality and safety benefits to everyone involved. We provide the only truly connected solution for construction, and during the quarter Metropolitan Mechanical Contractors, MMC, a Revit customer, decided to go with our construction solutions over our competitors. Based in Minnesota, MMC, is a single source solution for the design and build of complex mechanical systems focused on quality, speed and sustainable outcomes, all driving towards a lower cost of ownership. After completing a pilot with a competitor, MMC was ready to move forward with the competitor, but they gave us one shot to demo our solutions due to our leadership in design. After one demo, they chose our PlanGrid solution and also decided to increase the deal to include BuildingConnected, two, integral parts of the Autodesk Construction Cloud. The fast ramp time and the ability to own their data, no matter what system a general contractor uses, were key differentiators and they were impressed by the ease of pushing awarded bids to PlanGrid. Selling synergies between our acquired sales teams and the Autodesk sales team also showed strong momentum this year and we expect it to be a business growth driver for us both here in the U.S. and internationally in FY2021. During the quarter, one of the largest mechanical subcontractors in Australia increased their deployment of our solutions. Historically, the customer was using BIM 360 Docs on some projects and was interested in using either PlanGrid or BIM 360 on additional projects. Our team explained the value PlanGrid brings to the field and BIM 360 Docs brings to the office, highlighting the long-term vision. Wanting to make a long-term investment and recognizing the power behind the integration, the customers invested in our portfolio. As demonstrated by this example, we believe we are better positioned than any other vendor to capitalize on the international opportunity and we are aggressively investing in fiscal 2021 to expand our reach globally. Other notable accomplishments of the year for our construction business include; PlanGrid delivered over $100 million in ARR, beating the target we laid out at the beginning of the year. BuildingConnected crossed 1 million users. The acquired construction solutions were included in 45 enterprise deals. The product teams rolled out a comprehensive long-term product integration plan and over 300 enhancements. I’m very pleased with the progress our construction business made in fiscal 2020 and even more excited to continue building our world-class platform. We also made impressive strides in our core architecture market, where we continue to benefit from customers migrating from 2D to 3D design. Arcadis, a global design and consultancy firm headquartered in the Netherlands, substantially increased their engagement with us this quarter as they work to become a leader in AI-driven design. Involved in some of the world’s most complex projects, Arcadis is aggressively transitioning from 2D to 3D collaborative workflows using Revit, Civil 3D, InfraWorks, and BIM 360. And they are not stopping there. We are assisting in their adoption of Generative Design with Fusion 360 as they are re-imagining traditional processes, like facade design, by exploring the redesign of elements without restrictions of traditional design processes and manufacturability. Moving to manufacturing, we continue to gain share and delivered revenue growth of 15% for the quarter and 18% for the year. Our advanced technology solutions are enabling our customers to migrate from traditional workflows to operate more efficiently in the cloud. We added 20,000 Fusion 360 commercial subscriptions this year, establishing us as the leading cloud-based multi-tenant design and make solution provider in the market. During the quarter, Spinner Group, a German manufacturer of radio frequency technology, invested in our Product Design & Manufacturing Collection over SolidWorks. Their decision was driven by the comprehensive value of the collection and the ability to work with just one partner versus multiple vendors for various point products. In another example, one of the world’s iconic guitar manufacturers standardized on Fusion 360 for design, replacing SolidWorks and Rhino. The catalyst was collaboration as Fusion enables them to collaborate across their acoustic, electric and PCB divisions for the first time ever. We are also seeing our leadership in BIM drive business with building product manufacturers as they need to fabricate products for buildings designed by our solutions. A multinational company, well known in their industry for drywall gypsum boards, selected our Manufacturing Collection and our AEC Collection this quarter to extend their offerings from drywall to pre-manufactured building components in the industrialized construction market. Our design and manufacturing solutions enable them to develop machines and factories for production, and our AEC solutions enable them to connect and work collaboratively with their customers. Adoption of generative design is also continuing to drive business. For example, Goodyear used generative design to optimize an internally produced hand tool. They were able to cut production time, design the tool 4x faster and make the part 10x faster than would have been the case using a traditional machining process. And by combining additive manufacturing with CNC machining, they reduced their overall material costs and manufacturing time by 10x. Business results like these drove an increase in their EBA investment, as Goodyear continues to drive faster innovation in design and manufacturing. Given that we just finished the Oscars, I also want to highlight some of the success we are having in Media and Entertainment. Many Autodesk customers are recognized for their industry leading work throughout the year. One such example is LAIKA, an Oregon-based stop-motion animation studio, recently nominated for an Academy Award and winner of the 2020 Golden Globe for best animated feature. LAIKA uses the full breadth of the Autodesk media and entertainment portfolio including 3ds Max, Maya, and Shotgun Software. Now onto the progress with monetizing non-compliant users. Our ongoing investments in digital transformation have helped us significantly in this area. As one indicator of this, I am excited to share that this fiscal year we signed 62 license compliance deals over $500,000 per deal and 14 of those deals were over $1 million. This is almost three times the number we did in fiscal 2019. The deals were across all regions and almost 20% of the fiscal 2020 deals over $500,000 were in China. We are very pleased with our success in monetizing non-compliant users so far and this remains a key long-term growth driver and area of investment. Moving forward, one of the key steps we are taking is moving to plans for people instead of serial numbers. This will allow us to better serve our paying customers and will make our solutions harder to pirate. Plans based on named users will give our customers visibility into their usage data allowing them to optimize their license costs and enable us to better understand their needs. We moved our single user subscriptions to named users in fiscal 2020 and will now transition all of our multi-user subscriptions. This will mark the final milestone to becoming a true SaaS company giving us the ability to deliver incremental value and customized services to our customers. We are also introducing a premium plan that offers additional security, tailored administration capabilities, support, and reporting. Please refer to the appendix of the slide deck posted on our investor relations website for more details. To close, I would like to look back at the last few years and take a moment to highlight what we have accomplished. Three years ago, we set a free cash flow target of $1.4 billion. This year we delivered on that target. We did what we said we would do. We are executing well and know how to adapt and flex in changing market conditions. We know how to manage our journey and have proven that with our fiscal 2020 results. Looking out to fiscal 2023 and beyond, I am more confident than ever in our strategy and the team executing on it. We will continue to deliver great value to our customers with our connected and comprehensive platform in Construction. We expect to keep gaining share in the Manufacturing market as it moves to the cloud with less siloed workflows, and – over time, we are going to increasingly monetize the non-compliant user base. We look forward to seeing many of you at our Investor Day on March 25, where we will have more time to share our strategic initiatives. With that, operator, we’d now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia from Barclays Capital. Your line is now open.
Saket Kalia: Hey, Andrew. Hey, Scott. How are you guys doing? Thanks for taking my questions here.
Andrew Anagnost: Hey, Saket.
Scott Herren: Sure, Saket.
Saket Kalia: Hey, I’ll focus my questions on some of the pricing changes here and maybe start with you Andrew. You talked about the introduction of the standard and premium plan. Could you just dig into what types of customers you think would opt for premium and sort of broad brush? How big of your base could that premium plan sort of cohort be over time?
Andrew Anagnost: Yes. All right. So the standard plan already exists. So remember, the standard plan is just subscription we have today. And I think one of the ways you want to think about premium is kind of like a mini enterprise agreement without the consumption element. So it’s going to appeal to someone of our larger accounts that get service through the channel. And it’s going to appeal to them for a couple of reasons. First off, some of the things that are included in the premium plan, include Single Sign-on support throughout the directory. So this is the way that the customer can manage their names, user sets, and deployed Single Sign-on across it. It’s easier for them to manage the users. It’s more secure because you can turn on and turn off users really quickly. So that right there is a huge benefit. The other thing that we’re consolidating in, and this is something a lot of our customers already have, is something called an ETR, which stands for extra territorial rights. And that is a something we’ve always sold on top of our traditional licensing to allow them to distribute licenses to subsidiary areas outside of their – outside of where their corporate headquarters are, all right. So that’s another thing that’s included in there. Obviously, another thing that appeals to larger accounts that are serviced by our channel. The other thing that they’re going to get is analytics capability. All of our customers are going to get analytics capability, but what’s going to show up in the premium plan is much deeper. We’re actually going to be making proactive suggestions with some of the analytics about how they can optimize and get more out of their investment with Autodesk or optimize their investment with Autodesk more precisely than they do. They also get a slightly closer relationship with Autodesk through the support terms that we provide. So you can see that it’s going to appeal to larger accounts. I’m not going to give you a percentage of the base in terms of what that means, we could try. But that’s who it’s going to appeal to and I think you can see how we’ve naturally introduced it. At the same time that we’ve introduced a discussion around ending the multi-user licensing, because it allows you to manage named users a lot more effectively.
Saket Kalia: That makes sense. And that actually dovetails into my follow-up question for you, Scott. Can you just talk about that shift of multi-user to named user licensing? I guess, specifically, one of your studies or sort of anecdote shown on how many sort of named accounts there are for – our named users there are for each multi-user license, if that makes sense.
Scott Herren: Yes, yes, it does Saket. And as you imagine, that’s something we looked pretty hard at as we designed the end of sale of multi-user and what that trade in program would look like. And it runs right around two to one. In other words, two named users end up on average being served by one multi-user license. So that’s the reason we set the trade on program the way we did. I think for some customers they will end up needing a few more single users to support their base, if they were running a little hotter than that and for some they’ll probably make the trade in program and in the future there maybe a chance for them to either right size that or take the additional budget and hop into premium with that. So it’s a – it was designed at right around the average of what we see in terms of actual usage today.
Andrew Anagnost: Because you asked about that training program, I just want to make sure that we’re all clear about the why of that program. Because there’s a couple of customer wise and there’s a couple of Autodesk wise. From a customer standpoint, a lot of our multi-user customers are already have named user, named user licenses in their accounts. They’re living in what we’ve affectionately call hybrid hell inside the company, where they’re trying to manage two types of different systems. This will put them all on our new subscription backend. So it essentially brings all of these customers that live in hybrid environments into our new backend and provide them all the same analytics that the named users are getting. So there’s going to be a lot of customer benefits associated, especially when you layer on premium because of the control and security it’s going to give you. For Autodesk, this gets us one step further to retiring older systems that are based on serial numbers, systems that kind of, we have to maintain, systems that have sync issues that get in the way of us knowing about our customers. So we’re going to have more knowledge about our customers. We have more information about what they’re doing and we’re going to be able to service them a lot better.
Saket Kalia: Makes a lot of sense. Thanks guys.
Scott Herren: Thanks, Saket.
Operator: Thank you. Our next question comes from the line of Phil Winslow from Wells Fargo. Your line is now open.
Phil Winslow: Hey, thanks guys for taking my question and congrats on a great close of the year. Just wanted to focus in on the different industry verticals, that you sell into, obviously, manufacturing AEC and obviously there’s a difference sort of between geos there. I wonder if you could provide us as sort of some more color and sort of how you closed out the year there. And sort of how you’re thinking about the forward guidance, sort of industry vertical of geo. Thanks.
Scott Herren: Yes, thanks Phil. And you may not have had a chance to know, it’s a busy night for everyone, but we posted some details by both geography and by product family on the slide deck that’s on the website. And what you see is we were really strong in both, we were strong in all three geos, both in the quarter and for the full year and across all product sets. The one anomaly and we talked about this in the opening commentary was in Media & Entertainment, which actually showed a slight decline for the quarter year-on-year. And that was really driven by one large multi-year upfront transaction that was done in Q4 a year ago. That skewed that. For the full year, Media & Entertainment grew about 9%. So we really saw strength across the board. Our expectation looking into fiscal 2020, I mean, you can see we go from an overall revenue growth rate of about 27% this year to one that’s in the 20% to 22% range next year. Part of that is the – there was about three points of added inorganic growth to our fiscal 2020 numbers. So yes, it takes it down to about 24% compared to 20% to 22% next year, which is just the law of large numbers in absolute terms. We see growth in revenue and a strong percent growth next year as well. And any color you want to add, Andrew.
Andrew Anagnost: I mean the only color is our M&E business, because of its size. It just continues to be sensitive to large deals. It always has been because of its size and even the sub-segments within it are sensitive to large deals. That’s just the nature of that business.
Phil Winslow: Yes, got it. And then also just in terms of opportunity that the non-compliant users, obviously you called out some pretty significant change over. I mean, obviously at Analyst Day last year you talked about, I think it’s about $1.7 million, you’re still on the base. What do you think about just the growth that you saw in your overall user base this year? How much of it would you call for just core growth versus actually shifting those non-compliant users…
Andrew Anagnost: Most of it’s – yes. Sorry, sorry, Phil. Most of its core growth, Phil, so – but as I’ve said consistently over and over again, we’re getting better and better at talking to understanding and converting these non-compliant users. That’s why we gave you some of those stats as you can understand directionally, how this effort is going every year. It’s going to continue to get better and better and better. Our investment both from a system side and from our people side, in terms of people that actually handle directly non-compliant negotiations with customers are going up. So you’re going to see this consistent performance and most of that growth is just the core growth. But I hope you’re getting a sense for how this non-compliant usage starts to become quite an engine as we move forward.
Phil Winslow: Got it. I meant to say 12, not 1.7. Sorry about that. All right, thanks guys.
Andrew Anagnost: Thanks, Phil.
Operator: Thank you. Our next question comes from the line of Matt Hedberg from RBC Capital Markets. Your line is now open.
Matt Hedberg: Hey guys, thanks for taking my questions. Congrats on a really strong end of the year. I guess, for either Andrew or Scott, I’m curious – Andrew or Scott, I think you mentioned, you’re taking into account the current macro with the coronavirus and exposure to China is small. I guess I’m wondering, how you think about the broader APAC region Japan or other regions. And have you seen anything yet thus far a month into the quarter.
Andrew Anagnost: Yes. I’m glad you asked this question. First off, the whole coronavirus situations like the human situation, it’s kind of a human tragedy. And the best thing that can happen here for all of us is that it just gets resolved and contained relatively quickly and there’s a vaccine next year for the next flu season. But from a business perspective, how it impacts you is depends on your business. And we’ve looked pretty deeply at our business and here’s kind of a lay of the land I’ll give you. If you are a software vendor that’s exposed to big deals from especially large industrial that has kind of global supply chain disruption, you’re going to feel some effects from this, all right. That’s not us. In addition, if you’re in the travel industry, obviously, you’re going to feel some effects from this. But here’s what’s different about Autodesk and here’s why I want to help you understand how we look at the business and why we took into account from took into account some China FX in Q1. But we don’t see longer term effects at this point. Okay? Now I will say if this becomes a pandemic, all bets are off and we’ll have a different discussion. But right now our business is, is what we call it, almost micro-verticalized. We cut across lots of different verticals and it’s not just industrial verticals, it’s company size verticals. We go from the biggest to the smallest. Our business, especially in the first half of the year is not heavily dependent on large deals and at large companies that particularly large industrials. So we don’t see that kind of sensitivity in our business. But in addition, and I think this is super important for you to understand, it’s one of the great things about being an indirect company. Our business happens hyper-locally and what I mean by that is the VARs, especially in APAC, the transition, they transact with the customers, are actually new to the customers. All right? You’re not dealing with a situation where people travel or there’s a diaspora of salespeople heading in various directions to get the business done. Customers need our software and they need your software is now and the VARs are there. So this combination of this micro-verticalization, that spread across various companies of various sizes and its hyper locality of our business is why when SARS hit last round, we didn’t see much impact on our business. So, right now what we’ve done, we looked at China, obviously we just said alright more China, China was already having issues as well. So, we prudently looked at Q1 with regards to China and looked at the short term impact but we don’t see right now any other impacts in our business. Of course, like I said earlier, the pandemic hits we’ll have a different discussion, but right now I just want you to pay attention to that notion of highly verticalized micro verticals, different customer segments and hyper vocal, which is a great advantage of where we’re at.
Scott Herren: And Matt if could just tag on to that because there may be some confusion also with our Q1 guide relative to what’s out there and facts said. And of course, what’s in facts said is unguided, on a quarterly basis it’s interesting that it shows sequential growth. The consensus does from Q4, which of course is not what we experienced last year, since we’ve made the shift, last year we saw a sequential decline and even saw a sequential decline last year, despite the fact that Q4 of 2019 only had a month of PlanGrid included and Q1 had an entire quarter of PlanGrid included and we still saw a sequential decline. What drives that by the way, is not a recurring revenue decline and as we look at our guide for Q1 of fiscal 2021 we’re not seeing recurring revenue decline. What we are seeing is and we’ve talked about this in the past, this license and other line, it’s always the biggest in the fourth quarter. It has to do with largely to do with some products that we sell that we sell on a ratable basis. But the accounting still requires them to be recognized upfront. So, if you look at our license and other line in the fourth quarter, the quarter, we just announced it was $42 million. Now we think it’ll be about half that big in Q1. That’s really what’s driving the sequential decline. And so without commenting on how fast they got to nine, 10, I’ll tell you, it’s not a, we haven’t taken into account a significant headwind from coronavirus. We expect our recurring revenue to actually show a slight growth sequentially again.
Matt Hedberg: That’s fantastic. Great color. And then maybe just one more for you, Scott. You’re not guiding to ARR, which I think most of us expected. Given, it’s not a perfect metric for you guys like we saw on Q3. I’m just sort of curious if you could provide a little bit more color on that. And do you still think you’ll talk to like your fiscal 2023 ARR targets at some point.
Scott Herren: You know, Matt, we’re not talking about it and you nailed it. It’s because of some of the anomalies in the way we defined ARR and we talked about this extensively on the Q3 call in relation to our Q4 guide. It was a great metric as we were going through the transition and our P&L had a mix of significant amount of upfront plus ratable. You needed to see how we were building that recurring revenue base. At this point we’ve built a recurring revenue base of 96% of our total revenues. Right? So, doing ARR, which when I gave you an annual number was in effect saying that’s the fourth quarter recurring revenue and multiplying it by four. It didn’t accumulate through the year. That’s why we pulled back on the metric. I think you get as good, if not better, insight from just tracking revenue and knowing that 96% of that is recurring. You will still be able to calculate it, by the way. I don’t plan on focusing on it during these calls, but if you look at our P&L, remember the way we calculated ARR was subscription plus maintenance revenue actual reported for the quarter times four. We’ll continue to report in those line items. So you’ll continue to be able to track it if you want. I just think it’s a less reliable metric of where we’re headed, than revenue or current RPO, which you see in our results. Current RPO is up 23%.
Matt Hedberg: Super helpful. Well done.
Scott Herren: Thanks Matt.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is now open.
Jay Vleeschhouwer: Thank you. Good evening, Andrew. Scott, you used the word aggressively during your prepared remarks, I believe to refer to internal investments you’ll be making. And on that point you now have by far a record number of openings in sales related positions.
Andrew Anagnost: Truly?
Jay Vleeschhouwer: We counted. Yes, yes. By far the highest I’ve counted in eight years. And it’s for territorial account execs, named account, inside sales, license compliance. And so the question is how are you thinking about that as a principle cost driver to your expense targets this year? And more importantly the production or revenue production effects you would expect from that kind of substantial onboarding of sales capacity. Number two you used to give a metric prior to the transition of your annual license volume. And the last reported numbers in the way you used to calculate it, were about 600,000 to 650,000 licenses. If we continue to follow that method and impute the volume of your business, you are now, it seems well above those last given numbers from a few years ago. It would seem now the consumption of Autodesk product licenses putting in particular collections is now in the high six figures. So, well above prior levels. So would you concur with that calculation that your intrinsic demand consumption of Autodesk product is well above what it used to be under the old way of counting? And then finally with regard to the changes in pricing to a single user preference, would there be an implicit connection there, Andrew, to your view of an eventual consumption model? Can you get there only if you do in fact have this kind of named user pricing?
Andrew Anagnost: Wow, that was good. You asked two follow-ups to the question. Okay. So first off, let me, let me start back to your first question about investment. So I want, I’ll speak for Scott and then Scott can speak for Scott. I want to make sure you’re clear, we are not losing any of our spend discipline at all. All right? We’re actually investing below our capacity to kind of make sure that we’re staying in line with things here. You’re seeing some of the areas we’re investing in go-to-market, we’re also investing in R&D. We’re investing big in construction. That shouldn’t surprise you but we’re also investing in fusion. We’re investing in the architecture with some of the things we’re doing around generative and other types of things for architects and Revits, Revit as well. We’re also in investing in our digital infrastructure. So yes, we are investing, right? And we said we would invest, but we’re investing prudently, we’re investing smartly and we’re excited about it. All right. Because we see a lot of return from the investments we make and we’ve been very deliberate about this. Now on your second point about the licensed growth, I’m not going to comment specifically on that, but you know, I can, one thing I can tell you is that the lower upfront costs of our products and the way we’re going to market right now, it makes a difference. Okay. Too many people spend a lot of time talking to the customers that were our old maintenance customers and how this transition has been hard on them and they’re confused and they’re not sure, but there is a whole swath of customers that are just sitting there going, how did Autodesk stuff get so cheap? All right. And that seems to be the forgotten people and yes, they’re coming in, they’re excited about our products. Some of them are using Revit when they never thought they could use Revit or they’re using an Inventor or they’re using Max. And if you’ve seen some of the things we’ve done with Max where we have an indie version of Max and I mean there’s whole gamut of flexibility we’ve layered out there for people that really changes the way people buy our software and who is buying it and who’s paying for it. And it is an exciting change and yes, it has impacted on us. I’ll say more about the specifics of what you asked for there. Now your third question and I remembered all three. Now about this move to the named user. Look, we, it’s imperative for us to try to complete the transition to SaaS excellence to be a named user company. And once you get people to named users, you’re also getting them on our new subscription backend infrastructure, which is super important. And as you correctly said, that backend infrastructure provides new types of flexibility that weren’t available in the previous hybrid world of dangling on some of the serial number based systems and some of the other systems. So, what you’re going to see over the next 12 to 24 months is increasingly rolling out more flexibility to our customers with regards to how they can apply this named user capability in multiple ways. You mentioned, consumption, the premium plans kind of a layer in that direction. So you’re right in assuming that we’re going to be able to do a much more flexible thing with our customers as a result of what we’ve done. It’s been a heavy lift to get here. All right, it’s been an absolute heavy lift but we’re going to be 24 months from here and our customers are going to be looking back and say, I don’t know, what I was complaining about because this is a better way to engage with Autodesk. Scott, do you have something to add?
Scott Herren: I’d be remiss on your first question, if I didn’t add, besides we’re continuing to maintain spend discipline. It was – we built it up pretty diligently over the four years of staying flat in spend, that’s not going away. But I think you also have to look at the increased spend, not as increased spend, but we’re increasing margin. We’re at a point in our growth story where we can both increase spend to drive future growth and increase margin. So we added 12 points to our operating margins in fiscal 2020. You see the midpoint of our guide, we’re adding five more points to our op margin in fiscal 2021 and we’ve said, it’s going to be 40% by the time we get the fiscal 2023. So the conversation around spend, while interesting if what you’re looking for is where are we investing, that’s a good conversation to have. You should know and everyone should be confident. We continue to manage that very diligently.
Jay Vleeschhouwer: Thanks very much.
Scott Herren: You’re welcome.
Operator: Thank you. Our next question comes from the line of Heather Bellini from Goldman Sachs. Your line is now open.
Heather Bellini: Hi guys. Thanks for taking the question. I appreciate the time. Most of mine have been asked, but I just – I wanted to follow-up on the multi-user pricing, change that you had and totally understand, Andrew, your comments about kind of you need to go to a named user pricing model. But just wondering if there was anything you could share with us about maybe the impact that that helped drive in the quarter that just ended. And how you’re thinking about like what’s reactions been – what is the reaction been from customers who are going to convert to this so far? What’s their feedback to you on it? Thank you.
Andrew Anagnost: Good. So a great question, Heather. Good to hear from you. Let me give you some color here. So first off, we did increase the price of new multi-user licenses, new, all right. And renew is exactly the same price, right. So it was a 33% increase in multi-user. This is going to have a very little impact on our existing customers, right. The reason we did it was very simple between now and May, when the two for one starts in earnest, we’ve now set the price so that gaming is removed from the system. So what we didn’t want to see was this kind of like sudden hoarding of multi-user licenses heading into the May two for one. And that’s why we did this. It was basically a signal like, hey, here’s where we’re going. We’re heading into this new direction. We did not pull any materially significant business forward into Q4. This had no material effect on our Q4 results. And to be very clear, I’d repeat that, no material fact on our Q4 results. All right. This was purely a hygienic change to line up everything to the two for one offer. Most customers will not see a huge impact on this, except for the few that are going to be adding some multi-user licenses in there. It’s really too early to hear what customer impact is. We did hear from some of our early evangelists and as a result, we were able to kind of adjust some of the – some aspects of the program and do a few things that they kind of address some of their concerns but so far, it’s too early.
Heather Bellini: Great and then – I’m sorry, go ahead.
Scott Herren: A huge amount of pushback on that. Yes, this is Scott. I wouldn’t expect a huge amount of push back on that given that we designed it to be two for one, both in terms of price if you buy a new multi-user now, but at the trade end point because that’s what we see is the average number of single user or named users that are being served by a multi-user license. So it should be fairly neutral to most of our customers.
Heather Bellini: Okay, great. And then I just had one follow-up, if I may, just about the construction market and the deals you close there in the quarter, could you share with people kind of, is this typically a greenfield market where there is no incumbent provider except maybe excel or notebooks, or is this one where – when you’re closing business now it’s – is there any, any legacy replacement of a vendor and just kind of how do you look out and see the competitive environment? Thank you.
Andrew Anagnost: Yes. For the most part, you’re going in and you’re digitizing a process from scratch for them. Now we do have a competitor we compete with frequently. We’re winning and beating them more and more. And we’ve actually kicked them out of some of our accounts because our customers do not like their business model and that will increasingly make it easy to kick them out of our accounts. It’s just not a good long-term business model. So we do have competitors that go into the same accounts, but essentially what you’re doing is you’re replacing analog with digital and – or you’re replacing e-mail on mobile with devices with some kind of process and process control. Now as we get deeper and deeper into pre-construction planning, model based construction management, interdisciplinary digital twins and all of the things that kind of build out on this, you actually start fundamentally changing the customer’s processes. But Heather, you’re essentially right, you’re replacing analog with digital and that’s where the money is and that’s where we’re going.
Heather Bellini: Thank you.
Andrew Anagnost: You’re welcome.
Operator: Thank you. Our next question comes from the line of Brad Zelnick from Credit Suisse. Your line is now open.
Brad Zelnick: Fantastic. Thanks so much. And first, I just want to follow up on Heather’s question on construction. It’s great to see the enthusiasm in Construction Cloud. Can you talk about some of the learnings from combining the product portfolio and how you’ll be more competitive in fiscal 2021? And also how big of a component of your mix can Construction Cloud become as we approach your fiscal 2023 target?
Andrew Anagnost: Yes. Okay. So first let me ask you about the customer reaction, the Construction Cloud and one of the things we learned. So one of the first things we learned is that we had a winter in BIM 360 docs because what we did when we were building kind of this next-generation platform. And it just so happens that all the acquired solutions hook incredibly nicely into this platform, which is super important because if you want to compete both inside the infrastructure business, with the department of transportation and internationally, you need what’s called an ISO compliant common data environment, which is what docs is going to be providing for our customers. So it’s actually a huge competitive advantage to have this environment. And we learned pretty quickly that the work we were doing with docs really kind of played nicely into that. We also learned pretty quickly that we have a huge mobile advantage with what we’ve done with the PlanGrid products and what the PlanGrid team has done. And we’re leveraging that advantage and expanding it into other parts of our portfolio. We also discover that the building network of BuildingConnected that by the way, is getting integrated with PlanGrid and getting integrated with some of these other solutions is an amazingly important asset, not only to our customers, but to us in terms of understanding the construction climate. We also learned what it takes to go internationally, so one of the things that we’re well-positioned to do better than anyone and we’re investing pretty heavily in that international expansion for our construction portfolio. Construction and international business, it always has been, it’s local, but it’s also international. And between our investment and a common data environment, go-to-market stand up in various places, you’re going to see us start to grow internationally pretty significantly and there’s nobody that we compete with that can actually do some of the things that we’re doing there in terms of the construction environment. Now there was another part to your question. I want to make sure I answer it because I got carried away on what we learned. What was the second part of that, Brad?
Brad Zelnick: Second part was just asking how big of a component of your mix, Construction Cloud has become as we look to fiscal 2023?
Scott Herren: Yes, Brad. Thanks for that. I don’t certainly want to get into giving that kind of granularity on our fiscal 2023 guidance. I’ll give you a couple of comments though that we’ve said a few times in the past and still believe construction’s the next billion dollar business for Autodesk. What you see is on the – in the wake of the transactions we did in fourth quarter last, we’ve done a great job integrating those. We haven’t lost any momentum in those acquired companies. And in fact, have seen an updraft in our organic construction business as a result of that. So scrolling on a really nice path at this point, you’ve seen what the inorganic piece looks like in our results. Looking at our total cloud growth gives you a good sense because BIM 360 is the organic piece of our construction business and it’s the biggest piece of our cloud results. So you get an overall sense of where construction is headed for us. And it’s a sizable business and will continue to grow, but I don’t want to get into trying to give you a – you here’s the, let me start to break down the components of our fiscal 2023 targets.
Brad Zelnick: No, that’s helpful, Scott. I appreciate it. And if I could just sneak in a quick follow-up for you about long-term deferreds, which were much higher than we expected, just given your continued traction of multi-year, how should we think about long-term deferreds going forward, especially as you make changes to some of your multi-user products?
Scott Herren: No, that’s a great question. So thanks for asking that. And obviously, the long-term deferreds are a result of multi-year, right, of multi-year sales and we said this is the year we expect multi-year sales to revert back to the mean, right to what we have seen, when we sold multi-year on maintenance historically. And that’s what you see that one of the effects of that is of course, it drives long-term deferred revenue and that’s what you’re seeing in our results. I thought mid-year that this was going to get that long-term deferred as a percent of total deferred revenue would be in the mid-20% range. It’s a couple of points higher than that. As we’ve analyzed that and we’re keeping a close eye on how multi-year is running as we’ve analyzed it, it still feel like that’s at a sustainable level and it’s below what we saw with maintenance. When we offered almost the exact same offer for three years, paid upfront on maintenance, long-term deferred got up to 30% of total deferred at that point. I don’t see us getting to that level. In fact, I think long-term deferred moderates a bit looking at fiscal 2021 as a percent of total deferred versus where it is. But we’ll stay on top of that. And if to the extent we need to make an adjustment in that offering, we’ll make that adjustment. I certainly don’t want to see that run at a level that’s unattainable or unsustainable. I think, Brad, what may be implied in your question that you didn’t ask is, is this going to create a headwind for free cash flow. And so besides the comments I just made on kind of the steady state that I see multi-year getting to, bear in mind one other fact, and we’ve talked about this but not since last Investor Day, that as we look from fiscal 2020 out through fiscal 2023, more and more of our free cash flow, in fact the majority beginning of this year of our free cash flow will come from net income as opposed to coming off the balance sheet and growth in deferred revenue, right? So as we scale both the top line and improve our margins out through fiscal 2023 more and more of cash flow comes right off the P&L in net income versus coming in growth in deferred.
Andrew Anagnost: This is someplace where I have to chime in just a little bit since you mentioned the free cash flow ramp. One of the things I want to make sure we all kind of like think up on here, you look back three years, here we are three years later, okay, the business ended up free cash flow wise where we expected it to be. The path had numerous twists and turns, and numerous puts and takes. We modeled it according to certain assumptions. We adjusted those assumptions as we went along. We have an execution machine that knows how to adapt. I just want you to remember, when we give you three-year targets, we are fairly confident we know where we’re going and we know how the free cash flow is going to ramp and we know it’s going to continue to ramp. We also know how to adjust as we execute through here. And how to move forward and make sure things happen the way they need to happen. And I just told you before, the safest assumption is to assume we’re going to do what we tell you we’re going to do. And if there’s any kind of hidden things like Scott said in that question, I want you to know we’ve got our handles on the controls here for this business.
Brad Zelnick: Thank you for a very complete answer. Thank you.
Scott Herren: Sure. Thanks.
Operator: Thank you. Our next question comes from the line of Sterling Auty from JPMorgan. Your line is now open.
Sterling Auty: Yes. Thanks guys. Two questions on the construction area. The first one is, when you look at your solutions now, where are the biggest pockets of users in your customer base, so is it GC subcontractors, owners, et cetera? Just to understand where you’re seeing the biggest buying power at the moment?
Andrew Anagnost: Okay. So right now GCs are some of our biggest customers, subs are starting to ramp up quite significantly, all right? Because remember, with the BuildingConnected network, we have a lot of access to subs now. So you’re engaged with the subsea ecosystem in a way that where you were never before. GCs are the biggest buyers. But you’ll also be surprised interdisciplinary engineering firms are big buyers as well because of their intimate connection to construction planning processes and things associated with that. But, yes, starting with the GCs, that has been moving down markets quite significantly as we’ve matured.
Scott Herren: Yes, we gave an example, in the opening commentary of our significant subcontractor.
Sterling Auty: All right. And then the one follow-up would be there’s a lot of components that make up that construction ecosystem from project management to bid management to the financials, et cetera. Can you highlight with the solutions that you have, where do you think your biggest areas of strength within that group is today? And directionally, where do you see building out that portfolio?
Andrew Anagnost: Yes. So there’s two anchors of strength that we have that are pretty deep, one is field execution. We are by far massively advantage on the field execution side. The other area that is closer to the front end of the process is in preconstruction planning. There’s another area where we’ve brought tools and capabilities close to the building information model and all the things associated with that that are pretty powerful. Now there’s one kind of thin layer of technology where we’ve been playing catch up and actually it’s not really a very deep technological mode to be honest, but it’s in project management and in project costing. That’s something where we’ve been investing a lot, it’s where a lot of the R&D investment has gone. That gap is closing incredibly rapidly. The team is just pounding out enhancements and that’s the area we pay attention to because it’s not technologically sophisticated, but it’s important and it’s one of the areas that we’ve deployed to add those things and that’ll allow us to connect, feel the preconstruction planning in a way that other people simply can’t.
Sterling Auty: Understood. Thank you.
Operator: Thank you. Our next question comes from the line of Tyler Radke from Citi. Your line is now open.
Tyler Radke: Hey, thanks a lot for taking my question. So maybe you could just talk about this new pricing you’re doing on the multi-user that named user? And maybe just frame it in the context of some of the other pricing changes you’ve made. And in terms of financial benefit, what’s kind of the timeframe that you expect to see the uplift play out? And should we be thinking this is kind of a possible source of upside relative to the existing 2023 targets which were put out before this plan was announced? Thanks.
Andrew Anagnost: So, Tyler, are you referring to the premium plan or are you referring to the new multi-user price? The question I answered earlier. The pricing on multi-user, we don’t see a significant upside being generated by that. That was a tactical pricing action designed to prevent gaming as we headed into the two for one exchange in May. So it’s not – that is not an accretive change, Tyler, that’s going to drive business. The bigger story is the premium plan that layers on top of the multi-user plan that will be a long-term continuing opportunity for us. And it should be one of those things that increases your confidence in our ability to hit our FY2023 targets, all right? And I think that’s kind of the way you should look at it. Scott, did you want to add anything?
Scott Herren: No, I think that’s right. I think the gist of your question, Tyler, was around multi-user and we did touch on that earlier. And I think the only thing I’d add again is that the way we set the price and the trade in program around multi-user moving them all to named user was in sync with our analysis of how many named users today are being supported by a given multi-user. So it should be pretty much a wash for most of our multi-user customers.
Tyler Radke: Great. And as I think about the premium plan, sounds like that’s a multi-year event. I mean, as I think about the existing 2023 targets, I mean, those have been out there for a number of years now. Any chance that come Analyst Day that maybe we look at targets beyond that? Or what’s kind of your – how are you thinking about kind of long-term targets now that 2023 isn’t that far away?
Scott Herren: Yes, I’m not – I think I feel good about the targets that we’ve laid out for fiscal 2023. Let me start there. And we sort of glossed over it given all the other news that’s in the environment, but I’m pretty proud of the fact that we hit the number that we laid out three years ago for free cash flow at the end of fiscal 2021, which was no small task given the amount of transition we still had to go through and the changes we made in execution to get there. So we probably had to start there. That’s a big stake in the ground, a big milestone for us. Looking at fiscal 2023, I feel equally confident in our ability to hit the targets that we’ve got out there of $2.4 billion in free cash flow. Looking beyond that, I think we will continue to see the same trends that drive growth out through fiscal 2023, of course, extending beyond that. I think that relative magnitude of some of those will change. Obviously, construction will be a bigger driver as we go further out in time. I think where we’re headed with Fusion in the manufacturing world will become a bigger driver further out in time, but many of the same drivers that get us to those 2023 targets will extend well beyond fiscal 2023. I’m not inclined at this point to put another quantitative target out though beyond fiscal 2023.
Tyler Radke: Great. Thank you.
Scott Herren: Thanks, Tyler.
Operator: Thank you. At this time I’m showing no further questions. I would like to turn the call back over to Abhey Lamba for closing remarks.
Abhey Lamba: Thanks, operator, and thanks everyone for joining us today. We look forward to seeing you at our Analyst Day on March 25 at our San Francisco office. Please reach out if you have any questions following today’s call, I would like to register you for the Analyst Day. With that, we can end the call. Thank you.
Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. | [
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{
"speaker": "Abhey Lamba",
"text": "Thanks operator and good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter and full-year of fiscal 20. On the line is Andrew Anagnost, our CEO, and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at Autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our website following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results and strategies. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year on year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our investor relations website. And now I would like to turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Abhey. We closed fiscal year 2020 with outstanding Q4 results with revenue, earnings and free cash flow coming in above expectations. Recurring revenue grew 29% and we delivered $1.36 billion in free cash flow for the year. Our results were driven by strong growth in all geographies. This was a landmark year for us in Construction as we absorbed our acquisitions and integrated our offerings under one platform – the Autodesk Construction Cloud. Subscriptions now represent around 85% of our revenue, and we exited the year with maintenance contributing less than 10%. Fiscal year 2020 marked the end of the business model transition for us, and we are entering fiscal 2021 firmly positioned to deliver strong, sustainable growth through fiscal 2023 and beyond. It was three years ago that we first communicated our fiscal 2020 free cash flow goal. We have delivered on that goal, which is a testament to the adaptability and focused execution of the Autodesk ecosystem, and the power of our products. I want to acknowledge and thank our employees, partners, customers, long-term investors and everyone who helped us achieve these results. While the path to delivering on our long-term targets was not always smooth, everyone who stayed with us and believed in the transition has been rewarded. Beyond that, the dramatically reduced upfront costs created by the subscription model have enabled a whole new class of customers to purchase our most powerful tools; opening up not only new opportunities for our business, but for the businesses of our customers as well. Before we get into our results and guidance, I want to mention that our thoughts are with those affected by the coronavirus. The safety and security of our employees is our top priority. We are also minimizing potential impact to our customers and partners. The events are not currently impacting our service levels for our customers or global R&D efforts. We will continue to monitor the situation and take precautionary steps. Now I will turn it over to Scott to give you more details on our results, and fiscal 2021 guidance. I’ll then return with a summary of some important recognitions we received, and insights on key drivers of our business, including updates on Construction, Manufacturing and our progress in monetizing noncompliant users before we open it up for Q&A."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Andrew. As you heard from Andrew we had strong performance across all metrics with revenue, earnings and free cash flow coming in above expectations. Demand in our end markets was strong as indicated by our robust billings and current RPO growth. And the sum of our revenue growth plus free cash flow margin for the year was 69%. Revenue growth in the quarter came in at 22%, versus a strong Q4 fiscal 2019, with acquisitions contributing three percentage points of the growth. Strength in revenue was driven by subscription revenue growth of 41%. For the full year, subscription revenue was up 53% and, as Andrew mentioned, subscriptions now represent approximately 85% of our revenue. With the success of our Maintenance-to-Subscription program, we exited the year with maintenance revenue contributing less than 10% of total. Total ARR came in at $3.43 billion, up 25%. Core ARR grew 21% and Cloud ARR grew 102% to $255 million. When adjusted for acquisitions, Cloud ARR grew an impressive 30% driven by strong performance of BIM 360 Design. Now that a year has passed since we completed the acquisitions, our entire Construction portfolio will be organic starting first quarter of fiscal 2021. Moving onto details by product and geography: Starting with AutoCAD and AutoCAD LT, revenue grew 24% in the fourth quarter, again versus a strong Q4 fiscal 2019 and 30% for the year. AEC grew 30% in Q4 and 35% for the year, while Manufacturing rose 15% in Q4 and 18% for the year. M&E was down 5% in the quarter, primarily due to a large upfront transaction in the fourth quarter of last year. M&E revenue was up 9% for the year. Geographically, we saw broad-based strength across all regions. Revenue grew 21% in the Americas and EMEA and 26% in APAC during the quarter. We also saw strength in direct revenue, which rose 26% versus last year, and represented 31% of our total sales, relatively in-line with the fourth quarter of last year. The strength in our direct business was driven by large enterprise business agreements and our digital sales. As we indicated in the past, we plan to provide an annual update on our subs and annualized revenue per subscription, or ARPS, performance. During the year, we grew total subscriptions 12% to 4.9 million, with subscription plan growing 26%. We added 181,000 cloud subscriptions due to strong adoption of our BIM 360 family products as well as 79,000 subscriptions from PlanGrid and BuildingConnected. ARPS grew by 11% for the year to $704 with Core ARPS growing by 10% to $798. With only one quarter left in our maintenance to subscription, or M2S, program we have approximately 400,000 maintenance subscriptions left. I am proud to share that we have converted over 1 million maintenance subscriptions to-date. We will be retiring maintenance after May 2021 and customers will have one last opportunity to renew their maintenance or trade-in their maintenance seat for a subscription between now and May 2021. Please refer to the slide deck posted on our Investor Relations website for additional details around the trade-in offer. As expected and consistent with last quarter, the maintenance conversion rate was 40%. And of those that migrated, upgrade rates came in at 26%. Net revenue retention rate was again within the 110% to 120% range, continuing to demonstrate the growing strategic value we deliver to our existing customers. Billings growth of 43% in the quarter and 55% for the year was driven by organic growth and as expected, the normalization of our multi-year contracts. The strength in our multi-year commitments from our customers is an indicator of the strategic importance and business critical nature of our products. Our long-term deferred revenue ended up slightly higher than we anticipated but our multi-year business is at a sustainable level and is not creating a headwind to our future free cash flows. In fiscal 2020, we delivered $1.36 billion in free cash flow with $684 million coming in the fourth quarter, delivering on a key goal we set out three years ago. We expect to post annual growth in our free cash flows through fiscal 2023 and beyond as net income will start driving a greater portion of our free cash flows versus deferred revenue. Our total remaining performance obligation of $3.6 billion is up 33% and our current remaining performance obligation of $2.4 billion grew 23%. On the margin front, we continue to realize significant operating leverage due to strong revenue growth and diligent expense management. For the full year, non-GAAP gross margins were very strong at 92%, up two percentage points from last year. Our non-GAAP operating margin expanded by 12 percentage points to 25%, we are on track to deliver further margin expansion and attain approximately 40% non-GAAP operating margin in fiscal 2023. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash. During the fourth quarter, we purchased a little over 1 million shares for $191 million at an average purchase price of $189.52 per share. During the year, we fully offset dilution from our equity plans, purchasing a total of 2.7 million shares for $456 million at an average purchase price of $168.63 per share. Now I’ll turn the discussion to our outlook. We have taken into account the current macro environment and potential risks involved with any disruptions. Our direct exposure to China is small, and our experience with past outbreaks showed limited impact to our sales. While we will continue to monitor the situation more broadly, we expect total revenue to grow by 20% to 22% in fiscal 2021 and expand non-GAAP operating margin by about five percentage points. During the year, we plan to deliver free cash flow in the range of $1.63 billion to $1.69 billion, up 20% to 24%. When looking at the quarterization of free cash flow for fiscal 2021, given normal seasonality and strength of payment collections and large deals signed in the fourth quarter, we expect about two-thirds of our free cash flow to be generated in the second half of the year. Looking at our guidance for the first quarter, our strength in the fourth quarter presents a tough sequential compare. Given our normal seasonality, other revenue in Q1 is expected to be about half as much as we experienced in Q4. The slide deck on our website has more details on modeling assumptions for the fiscal first quarter and full year 2021. Now, I’d like to turn it back to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Scott. We just closed a landmark fiscal year and delivered on the free cash flow target we set over three years ago when we began the business model transition. Now let me give you some details about what is happening across our business. First off, fiscal 2020 was not only a year of financial achievements, but also a year where we increasingly enabled our customers to realize more sustainable outcomes in their work. In fact, we were recognized by the Corporate Knights for being in the top five of the world’s most sustainable companies and Barron’s ranked us 10th on their list of 100 most sustainable companies, making us the highest-ranking software company on both lists. This recognition is not only a testament to how responsibly we run our own business, but, more importantly, how we help our customers meet their own sustainability goals, which brings me to construction. Our construction business had an outstanding year and ended the year with great momentum. We are looking at construction in a more connected way than ever before, and our offerings are resonating with our customers. The Autodesk Construction Cloud delivers advanced technology, a network of builders, and the power of predictive analytics to drive projects from the earliest phases of design, through planning, building and into operations. Customers are excited about the unified platform and are recognizing that the breadth, depth, and connectivity across our portfolio sets us apart from our competition. For example, CRB, a design-build firm with offices across the U.S. and internationally, was using each of our four products independently. When they understood our vision for Construction Cloud to deliver a unified solution that integrates workflows connecting the office, trailer and field, CRB signed an enterprise business agreement with Autodesk for the solutions offered under the Construction Cloud. They are aligned with our vision of a unified solution that provides the entire construction lifecycle, from design through long-term maintenance, with all the design and make data they need in one place so information is not siloed or lost, and work gets done more efficiently. Leveraging data efficiently is critical to CRB’s new project execution concept, ONEsolution, which brings time, cost, quality and safety benefits to everyone involved. We provide the only truly connected solution for construction, and during the quarter Metropolitan Mechanical Contractors, MMC, a Revit customer, decided to go with our construction solutions over our competitors. Based in Minnesota, MMC, is a single source solution for the design and build of complex mechanical systems focused on quality, speed and sustainable outcomes, all driving towards a lower cost of ownership. After completing a pilot with a competitor, MMC was ready to move forward with the competitor, but they gave us one shot to demo our solutions due to our leadership in design. After one demo, they chose our PlanGrid solution and also decided to increase the deal to include BuildingConnected, two, integral parts of the Autodesk Construction Cloud. The fast ramp time and the ability to own their data, no matter what system a general contractor uses, were key differentiators and they were impressed by the ease of pushing awarded bids to PlanGrid. Selling synergies between our acquired sales teams and the Autodesk sales team also showed strong momentum this year and we expect it to be a business growth driver for us both here in the U.S. and internationally in FY2021. During the quarter, one of the largest mechanical subcontractors in Australia increased their deployment of our solutions. Historically, the customer was using BIM 360 Docs on some projects and was interested in using either PlanGrid or BIM 360 on additional projects. Our team explained the value PlanGrid brings to the field and BIM 360 Docs brings to the office, highlighting the long-term vision. Wanting to make a long-term investment and recognizing the power behind the integration, the customers invested in our portfolio. As demonstrated by this example, we believe we are better positioned than any other vendor to capitalize on the international opportunity and we are aggressively investing in fiscal 2021 to expand our reach globally. Other notable accomplishments of the year for our construction business include; PlanGrid delivered over $100 million in ARR, beating the target we laid out at the beginning of the year. BuildingConnected crossed 1 million users. The acquired construction solutions were included in 45 enterprise deals. The product teams rolled out a comprehensive long-term product integration plan and over 300 enhancements. I’m very pleased with the progress our construction business made in fiscal 2020 and even more excited to continue building our world-class platform. We also made impressive strides in our core architecture market, where we continue to benefit from customers migrating from 2D to 3D design. Arcadis, a global design and consultancy firm headquartered in the Netherlands, substantially increased their engagement with us this quarter as they work to become a leader in AI-driven design. Involved in some of the world’s most complex projects, Arcadis is aggressively transitioning from 2D to 3D collaborative workflows using Revit, Civil 3D, InfraWorks, and BIM 360. And they are not stopping there. We are assisting in their adoption of Generative Design with Fusion 360 as they are re-imagining traditional processes, like facade design, by exploring the redesign of elements without restrictions of traditional design processes and manufacturability. Moving to manufacturing, we continue to gain share and delivered revenue growth of 15% for the quarter and 18% for the year. Our advanced technology solutions are enabling our customers to migrate from traditional workflows to operate more efficiently in the cloud. We added 20,000 Fusion 360 commercial subscriptions this year, establishing us as the leading cloud-based multi-tenant design and make solution provider in the market. During the quarter, Spinner Group, a German manufacturer of radio frequency technology, invested in our Product Design & Manufacturing Collection over SolidWorks. Their decision was driven by the comprehensive value of the collection and the ability to work with just one partner versus multiple vendors for various point products. In another example, one of the world’s iconic guitar manufacturers standardized on Fusion 360 for design, replacing SolidWorks and Rhino. The catalyst was collaboration as Fusion enables them to collaborate across their acoustic, electric and PCB divisions for the first time ever. We are also seeing our leadership in BIM drive business with building product manufacturers as they need to fabricate products for buildings designed by our solutions. A multinational company, well known in their industry for drywall gypsum boards, selected our Manufacturing Collection and our AEC Collection this quarter to extend their offerings from drywall to pre-manufactured building components in the industrialized construction market. Our design and manufacturing solutions enable them to develop machines and factories for production, and our AEC solutions enable them to connect and work collaboratively with their customers. Adoption of generative design is also continuing to drive business. For example, Goodyear used generative design to optimize an internally produced hand tool. They were able to cut production time, design the tool 4x faster and make the part 10x faster than would have been the case using a traditional machining process. And by combining additive manufacturing with CNC machining, they reduced their overall material costs and manufacturing time by 10x. Business results like these drove an increase in their EBA investment, as Goodyear continues to drive faster innovation in design and manufacturing. Given that we just finished the Oscars, I also want to highlight some of the success we are having in Media and Entertainment. Many Autodesk customers are recognized for their industry leading work throughout the year. One such example is LAIKA, an Oregon-based stop-motion animation studio, recently nominated for an Academy Award and winner of the 2020 Golden Globe for best animated feature. LAIKA uses the full breadth of the Autodesk media and entertainment portfolio including 3ds Max, Maya, and Shotgun Software. Now onto the progress with monetizing non-compliant users. Our ongoing investments in digital transformation have helped us significantly in this area. As one indicator of this, I am excited to share that this fiscal year we signed 62 license compliance deals over $500,000 per deal and 14 of those deals were over $1 million. This is almost three times the number we did in fiscal 2019. The deals were across all regions and almost 20% of the fiscal 2020 deals over $500,000 were in China. We are very pleased with our success in monetizing non-compliant users so far and this remains a key long-term growth driver and area of investment. Moving forward, one of the key steps we are taking is moving to plans for people instead of serial numbers. This will allow us to better serve our paying customers and will make our solutions harder to pirate. Plans based on named users will give our customers visibility into their usage data allowing them to optimize their license costs and enable us to better understand their needs. We moved our single user subscriptions to named users in fiscal 2020 and will now transition all of our multi-user subscriptions. This will mark the final milestone to becoming a true SaaS company giving us the ability to deliver incremental value and customized services to our customers. We are also introducing a premium plan that offers additional security, tailored administration capabilities, support, and reporting. Please refer to the appendix of the slide deck posted on our investor relations website for more details. To close, I would like to look back at the last few years and take a moment to highlight what we have accomplished. Three years ago, we set a free cash flow target of $1.4 billion. This year we delivered on that target. We did what we said we would do. We are executing well and know how to adapt and flex in changing market conditions. We know how to manage our journey and have proven that with our fiscal 2020 results. Looking out to fiscal 2023 and beyond, I am more confident than ever in our strategy and the team executing on it. We will continue to deliver great value to our customers with our connected and comprehensive platform in Construction. We expect to keep gaining share in the Manufacturing market as it moves to the cloud with less siloed workflows, and – over time, we are going to increasingly monetize the non-compliant user base. We look forward to seeing many of you at our Investor Day on March 25, where we will have more time to share our strategic initiatives. With that, operator, we’d now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia from Barclays Capital. Your line is now open."
},
{
"speaker": "Saket Kalia",
"text": "Hey, Andrew. Hey, Scott. How are you guys doing? Thanks for taking my questions here."
},
{
"speaker": "Andrew Anagnost",
"text": "Hey, Saket."
},
{
"speaker": "Scott Herren",
"text": "Sure, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Hey, I’ll focus my questions on some of the pricing changes here and maybe start with you Andrew. You talked about the introduction of the standard and premium plan. Could you just dig into what types of customers you think would opt for premium and sort of broad brush? How big of your base could that premium plan sort of cohort be over time?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. All right. So the standard plan already exists. So remember, the standard plan is just subscription we have today. And I think one of the ways you want to think about premium is kind of like a mini enterprise agreement without the consumption element. So it’s going to appeal to someone of our larger accounts that get service through the channel. And it’s going to appeal to them for a couple of reasons. First off, some of the things that are included in the premium plan, include Single Sign-on support throughout the directory. So this is the way that the customer can manage their names, user sets, and deployed Single Sign-on across it. It’s easier for them to manage the users. It’s more secure because you can turn on and turn off users really quickly. So that right there is a huge benefit. The other thing that we’re consolidating in, and this is something a lot of our customers already have, is something called an ETR, which stands for extra territorial rights. And that is a something we’ve always sold on top of our traditional licensing to allow them to distribute licenses to subsidiary areas outside of their – outside of where their corporate headquarters are, all right. So that’s another thing that’s included in there. Obviously, another thing that appeals to larger accounts that are serviced by our channel. The other thing that they’re going to get is analytics capability. All of our customers are going to get analytics capability, but what’s going to show up in the premium plan is much deeper. We’re actually going to be making proactive suggestions with some of the analytics about how they can optimize and get more out of their investment with Autodesk or optimize their investment with Autodesk more precisely than they do. They also get a slightly closer relationship with Autodesk through the support terms that we provide. So you can see that it’s going to appeal to larger accounts. I’m not going to give you a percentage of the base in terms of what that means, we could try. But that’s who it’s going to appeal to and I think you can see how we’ve naturally introduced it. At the same time that we’ve introduced a discussion around ending the multi-user licensing, because it allows you to manage named users a lot more effectively."
},
{
"speaker": "Saket Kalia",
"text": "That makes sense. And that actually dovetails into my follow-up question for you, Scott. Can you just talk about that shift of multi-user to named user licensing? I guess, specifically, one of your studies or sort of anecdote shown on how many sort of named accounts there are for – our named users there are for each multi-user license, if that makes sense."
},
{
"speaker": "Scott Herren",
"text": "Yes, yes, it does Saket. And as you imagine, that’s something we looked pretty hard at as we designed the end of sale of multi-user and what that trade in program would look like. And it runs right around two to one. In other words, two named users end up on average being served by one multi-user license. So that’s the reason we set the trade on program the way we did. I think for some customers they will end up needing a few more single users to support their base, if they were running a little hotter than that and for some they’ll probably make the trade in program and in the future there maybe a chance for them to either right size that or take the additional budget and hop into premium with that. So it’s a – it was designed at right around the average of what we see in terms of actual usage today."
},
{
"speaker": "Andrew Anagnost",
"text": "Because you asked about that training program, I just want to make sure that we’re all clear about the why of that program. Because there’s a couple of customer wise and there’s a couple of Autodesk wise. From a customer standpoint, a lot of our multi-user customers are already have named user, named user licenses in their accounts. They’re living in what we’ve affectionately call hybrid hell inside the company, where they’re trying to manage two types of different systems. This will put them all on our new subscription backend. So it essentially brings all of these customers that live in hybrid environments into our new backend and provide them all the same analytics that the named users are getting. So there’s going to be a lot of customer benefits associated, especially when you layer on premium because of the control and security it’s going to give you. For Autodesk, this gets us one step further to retiring older systems that are based on serial numbers, systems that kind of, we have to maintain, systems that have sync issues that get in the way of us knowing about our customers. So we’re going to have more knowledge about our customers. We have more information about what they’re doing and we’re going to be able to service them a lot better."
},
{
"speaker": "Saket Kalia",
"text": "Makes a lot of sense. Thanks guys."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Saket."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Phil Winslow from Wells Fargo. Your line is now open."
},
{
"speaker": "Phil Winslow",
"text": "Hey, thanks guys for taking my question and congrats on a great close of the year. Just wanted to focus in on the different industry verticals, that you sell into, obviously, manufacturing AEC and obviously there’s a difference sort of between geos there. I wonder if you could provide us as sort of some more color and sort of how you closed out the year there. And sort of how you’re thinking about the forward guidance, sort of industry vertical of geo. Thanks."
},
{
"speaker": "Scott Herren",
"text": "Yes, thanks Phil. And you may not have had a chance to know, it’s a busy night for everyone, but we posted some details by both geography and by product family on the slide deck that’s on the website. And what you see is we were really strong in both, we were strong in all three geos, both in the quarter and for the full year and across all product sets. The one anomaly and we talked about this in the opening commentary was in Media & Entertainment, which actually showed a slight decline for the quarter year-on-year. And that was really driven by one large multi-year upfront transaction that was done in Q4 a year ago. That skewed that. For the full year, Media & Entertainment grew about 9%. So we really saw strength across the board. Our expectation looking into fiscal 2020, I mean, you can see we go from an overall revenue growth rate of about 27% this year to one that’s in the 20% to 22% range next year. Part of that is the – there was about three points of added inorganic growth to our fiscal 2020 numbers. So yes, it takes it down to about 24% compared to 20% to 22% next year, which is just the law of large numbers in absolute terms. We see growth in revenue and a strong percent growth next year as well. And any color you want to add, Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "I mean the only color is our M&E business, because of its size. It just continues to be sensitive to large deals. It always has been because of its size and even the sub-segments within it are sensitive to large deals. That’s just the nature of that business."
},
{
"speaker": "Phil Winslow",
"text": "Yes, got it. And then also just in terms of opportunity that the non-compliant users, obviously you called out some pretty significant change over. I mean, obviously at Analyst Day last year you talked about, I think it’s about $1.7 million, you’re still on the base. What do you think about just the growth that you saw in your overall user base this year? How much of it would you call for just core growth versus actually shifting those non-compliant users…"
},
{
"speaker": "Andrew Anagnost",
"text": "Most of it’s – yes. Sorry, sorry, Phil. Most of its core growth, Phil, so – but as I’ve said consistently over and over again, we’re getting better and better at talking to understanding and converting these non-compliant users. That’s why we gave you some of those stats as you can understand directionally, how this effort is going every year. It’s going to continue to get better and better and better. Our investment both from a system side and from our people side, in terms of people that actually handle directly non-compliant negotiations with customers are going up. So you’re going to see this consistent performance and most of that growth is just the core growth. But I hope you’re getting a sense for how this non-compliant usage starts to become quite an engine as we move forward."
},
{
"speaker": "Phil Winslow",
"text": "Got it. I meant to say 12, not 1.7. Sorry about that. All right, thanks guys."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Phil."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Matt Hedberg from RBC Capital Markets. Your line is now open."
},
{
"speaker": "Matt Hedberg",
"text": "Hey guys, thanks for taking my questions. Congrats on a really strong end of the year. I guess, for either Andrew or Scott, I’m curious – Andrew or Scott, I think you mentioned, you’re taking into account the current macro with the coronavirus and exposure to China is small. I guess I’m wondering, how you think about the broader APAC region Japan or other regions. And have you seen anything yet thus far a month into the quarter."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. I’m glad you asked this question. First off, the whole coronavirus situations like the human situation, it’s kind of a human tragedy. And the best thing that can happen here for all of us is that it just gets resolved and contained relatively quickly and there’s a vaccine next year for the next flu season. But from a business perspective, how it impacts you is depends on your business. And we’ve looked pretty deeply at our business and here’s kind of a lay of the land I’ll give you. If you are a software vendor that’s exposed to big deals from especially large industrial that has kind of global supply chain disruption, you’re going to feel some effects from this, all right. That’s not us. In addition, if you’re in the travel industry, obviously, you’re going to feel some effects from this. But here’s what’s different about Autodesk and here’s why I want to help you understand how we look at the business and why we took into account from took into account some China FX in Q1. But we don’t see longer term effects at this point. Okay? Now I will say if this becomes a pandemic, all bets are off and we’ll have a different discussion. But right now our business is, is what we call it, almost micro-verticalized. We cut across lots of different verticals and it’s not just industrial verticals, it’s company size verticals. We go from the biggest to the smallest. Our business, especially in the first half of the year is not heavily dependent on large deals and at large companies that particularly large industrials. So we don’t see that kind of sensitivity in our business. But in addition, and I think this is super important for you to understand, it’s one of the great things about being an indirect company. Our business happens hyper-locally and what I mean by that is the VARs, especially in APAC, the transition, they transact with the customers, are actually new to the customers. All right? You’re not dealing with a situation where people travel or there’s a diaspora of salespeople heading in various directions to get the business done. Customers need our software and they need your software is now and the VARs are there. So this combination of this micro-verticalization, that spread across various companies of various sizes and its hyper locality of our business is why when SARS hit last round, we didn’t see much impact on our business. So, right now what we’ve done, we looked at China, obviously we just said alright more China, China was already having issues as well. So, we prudently looked at Q1 with regards to China and looked at the short term impact but we don’t see right now any other impacts in our business. Of course, like I said earlier, the pandemic hits we’ll have a different discussion, but right now I just want you to pay attention to that notion of highly verticalized micro verticals, different customer segments and hyper vocal, which is a great advantage of where we’re at."
},
{
"speaker": "Scott Herren",
"text": "And Matt if could just tag on to that because there may be some confusion also with our Q1 guide relative to what’s out there and facts said. And of course, what’s in facts said is unguided, on a quarterly basis it’s interesting that it shows sequential growth. The consensus does from Q4, which of course is not what we experienced last year, since we’ve made the shift, last year we saw a sequential decline and even saw a sequential decline last year, despite the fact that Q4 of 2019 only had a month of PlanGrid included and Q1 had an entire quarter of PlanGrid included and we still saw a sequential decline. What drives that by the way, is not a recurring revenue decline and as we look at our guide for Q1 of fiscal 2021 we’re not seeing recurring revenue decline. What we are seeing is and we’ve talked about this in the past, this license and other line, it’s always the biggest in the fourth quarter. It has to do with largely to do with some products that we sell that we sell on a ratable basis. But the accounting still requires them to be recognized upfront. So, if you look at our license and other line in the fourth quarter, the quarter, we just announced it was $42 million. Now we think it’ll be about half that big in Q1. That’s really what’s driving the sequential decline. And so without commenting on how fast they got to nine, 10, I’ll tell you, it’s not a, we haven’t taken into account a significant headwind from coronavirus. We expect our recurring revenue to actually show a slight growth sequentially again."
},
{
"speaker": "Matt Hedberg",
"text": "That’s fantastic. Great color. And then maybe just one more for you, Scott. You’re not guiding to ARR, which I think most of us expected. Given, it’s not a perfect metric for you guys like we saw on Q3. I’m just sort of curious if you could provide a little bit more color on that. And do you still think you’ll talk to like your fiscal 2023 ARR targets at some point."
},
{
"speaker": "Scott Herren",
"text": "You know, Matt, we’re not talking about it and you nailed it. It’s because of some of the anomalies in the way we defined ARR and we talked about this extensively on the Q3 call in relation to our Q4 guide. It was a great metric as we were going through the transition and our P&L had a mix of significant amount of upfront plus ratable. You needed to see how we were building that recurring revenue base. At this point we’ve built a recurring revenue base of 96% of our total revenues. Right? So, doing ARR, which when I gave you an annual number was in effect saying that’s the fourth quarter recurring revenue and multiplying it by four. It didn’t accumulate through the year. That’s why we pulled back on the metric. I think you get as good, if not better, insight from just tracking revenue and knowing that 96% of that is recurring. You will still be able to calculate it, by the way. I don’t plan on focusing on it during these calls, but if you look at our P&L, remember the way we calculated ARR was subscription plus maintenance revenue actual reported for the quarter times four. We’ll continue to report in those line items. So you’ll continue to be able to track it if you want. I just think it’s a less reliable metric of where we’re headed, than revenue or current RPO, which you see in our results. Current RPO is up 23%."
},
{
"speaker": "Matt Hedberg",
"text": "Super helpful. Well done."
},
{
"speaker": "Scott Herren",
"text": "Thanks Matt."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is now open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening, Andrew. Scott, you used the word aggressively during your prepared remarks, I believe to refer to internal investments you’ll be making. And on that point you now have by far a record number of openings in sales related positions."
},
{
"speaker": "Andrew Anagnost",
"text": "Truly?"
},
{
"speaker": "Jay Vleeschhouwer",
"text": "We counted. Yes, yes. By far the highest I’ve counted in eight years. And it’s for territorial account execs, named account, inside sales, license compliance. And so the question is how are you thinking about that as a principle cost driver to your expense targets this year? And more importantly the production or revenue production effects you would expect from that kind of substantial onboarding of sales capacity. Number two you used to give a metric prior to the transition of your annual license volume. And the last reported numbers in the way you used to calculate it, were about 600,000 to 650,000 licenses. If we continue to follow that method and impute the volume of your business, you are now, it seems well above those last given numbers from a few years ago. It would seem now the consumption of Autodesk product licenses putting in particular collections is now in the high six figures. So, well above prior levels. So would you concur with that calculation that your intrinsic demand consumption of Autodesk product is well above what it used to be under the old way of counting? And then finally with regard to the changes in pricing to a single user preference, would there be an implicit connection there, Andrew, to your view of an eventual consumption model? Can you get there only if you do in fact have this kind of named user pricing?"
},
{
"speaker": "Andrew Anagnost",
"text": "Wow, that was good. You asked two follow-ups to the question. Okay. So first off, let me, let me start back to your first question about investment. So I want, I’ll speak for Scott and then Scott can speak for Scott. I want to make sure you’re clear, we are not losing any of our spend discipline at all. All right? We’re actually investing below our capacity to kind of make sure that we’re staying in line with things here. You’re seeing some of the areas we’re investing in go-to-market, we’re also investing in R&D. We’re investing big in construction. That shouldn’t surprise you but we’re also investing in fusion. We’re investing in the architecture with some of the things we’re doing around generative and other types of things for architects and Revits, Revit as well. We’re also in investing in our digital infrastructure. So yes, we are investing, right? And we said we would invest, but we’re investing prudently, we’re investing smartly and we’re excited about it. All right. Because we see a lot of return from the investments we make and we’ve been very deliberate about this. Now on your second point about the licensed growth, I’m not going to comment specifically on that, but you know, I can, one thing I can tell you is that the lower upfront costs of our products and the way we’re going to market right now, it makes a difference. Okay. Too many people spend a lot of time talking to the customers that were our old maintenance customers and how this transition has been hard on them and they’re confused and they’re not sure, but there is a whole swath of customers that are just sitting there going, how did Autodesk stuff get so cheap? All right. And that seems to be the forgotten people and yes, they’re coming in, they’re excited about our products. Some of them are using Revit when they never thought they could use Revit or they’re using an Inventor or they’re using Max. And if you’ve seen some of the things we’ve done with Max where we have an indie version of Max and I mean there’s whole gamut of flexibility we’ve layered out there for people that really changes the way people buy our software and who is buying it and who’s paying for it. And it is an exciting change and yes, it has impacted on us. I’ll say more about the specifics of what you asked for there. Now your third question and I remembered all three. Now about this move to the named user. Look, we, it’s imperative for us to try to complete the transition to SaaS excellence to be a named user company. And once you get people to named users, you’re also getting them on our new subscription backend infrastructure, which is super important. And as you correctly said, that backend infrastructure provides new types of flexibility that weren’t available in the previous hybrid world of dangling on some of the serial number based systems and some of the other systems. So, what you’re going to see over the next 12 to 24 months is increasingly rolling out more flexibility to our customers with regards to how they can apply this named user capability in multiple ways. You mentioned, consumption, the premium plans kind of a layer in that direction. So you’re right in assuming that we’re going to be able to do a much more flexible thing with our customers as a result of what we’ve done. It’s been a heavy lift to get here. All right, it’s been an absolute heavy lift but we’re going to be 24 months from here and our customers are going to be looking back and say, I don’t know, what I was complaining about because this is a better way to engage with Autodesk. Scott, do you have something to add?"
},
{
"speaker": "Scott Herren",
"text": "I’d be remiss on your first question, if I didn’t add, besides we’re continuing to maintain spend discipline. It was – we built it up pretty diligently over the four years of staying flat in spend, that’s not going away. But I think you also have to look at the increased spend, not as increased spend, but we’re increasing margin. We’re at a point in our growth story where we can both increase spend to drive future growth and increase margin. So we added 12 points to our operating margins in fiscal 2020. You see the midpoint of our guide, we’re adding five more points to our op margin in fiscal 2021 and we’ve said, it’s going to be 40% by the time we get the fiscal 2023. So the conversation around spend, while interesting if what you’re looking for is where are we investing, that’s a good conversation to have. You should know and everyone should be confident. We continue to manage that very diligently."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thanks very much."
},
{
"speaker": "Scott Herren",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Heather Bellini from Goldman Sachs. Your line is now open."
},
{
"speaker": "Heather Bellini",
"text": "Hi guys. Thanks for taking the question. I appreciate the time. Most of mine have been asked, but I just – I wanted to follow-up on the multi-user pricing, change that you had and totally understand, Andrew, your comments about kind of you need to go to a named user pricing model. But just wondering if there was anything you could share with us about maybe the impact that that helped drive in the quarter that just ended. And how you’re thinking about like what’s reactions been – what is the reaction been from customers who are going to convert to this so far? What’s their feedback to you on it? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Good. So a great question, Heather. Good to hear from you. Let me give you some color here. So first off, we did increase the price of new multi-user licenses, new, all right. And renew is exactly the same price, right. So it was a 33% increase in multi-user. This is going to have a very little impact on our existing customers, right. The reason we did it was very simple between now and May, when the two for one starts in earnest, we’ve now set the price so that gaming is removed from the system. So what we didn’t want to see was this kind of like sudden hoarding of multi-user licenses heading into the May two for one. And that’s why we did this. It was basically a signal like, hey, here’s where we’re going. We’re heading into this new direction. We did not pull any materially significant business forward into Q4. This had no material effect on our Q4 results. And to be very clear, I’d repeat that, no material fact on our Q4 results. All right. This was purely a hygienic change to line up everything to the two for one offer. Most customers will not see a huge impact on this, except for the few that are going to be adding some multi-user licenses in there. It’s really too early to hear what customer impact is. We did hear from some of our early evangelists and as a result, we were able to kind of adjust some of the – some aspects of the program and do a few things that they kind of address some of their concerns but so far, it’s too early."
},
{
"speaker": "Heather Bellini",
"text": "Great and then – I’m sorry, go ahead."
},
{
"speaker": "Scott Herren",
"text": "A huge amount of pushback on that. Yes, this is Scott. I wouldn’t expect a huge amount of push back on that given that we designed it to be two for one, both in terms of price if you buy a new multi-user now, but at the trade end point because that’s what we see is the average number of single user or named users that are being served by a multi-user license. So it should be fairly neutral to most of our customers."
},
{
"speaker": "Heather Bellini",
"text": "Okay, great. And then I just had one follow-up, if I may, just about the construction market and the deals you close there in the quarter, could you share with people kind of, is this typically a greenfield market where there is no incumbent provider except maybe excel or notebooks, or is this one where – when you’re closing business now it’s – is there any, any legacy replacement of a vendor and just kind of how do you look out and see the competitive environment? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. For the most part, you’re going in and you’re digitizing a process from scratch for them. Now we do have a competitor we compete with frequently. We’re winning and beating them more and more. And we’ve actually kicked them out of some of our accounts because our customers do not like their business model and that will increasingly make it easy to kick them out of our accounts. It’s just not a good long-term business model. So we do have competitors that go into the same accounts, but essentially what you’re doing is you’re replacing analog with digital and – or you’re replacing e-mail on mobile with devices with some kind of process and process control. Now as we get deeper and deeper into pre-construction planning, model based construction management, interdisciplinary digital twins and all of the things that kind of build out on this, you actually start fundamentally changing the customer’s processes. But Heather, you’re essentially right, you’re replacing analog with digital and that’s where the money is and that’s where we’re going."
},
{
"speaker": "Heather Bellini",
"text": "Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Brad Zelnick from Credit Suisse. Your line is now open."
},
{
"speaker": "Brad Zelnick",
"text": "Fantastic. Thanks so much. And first, I just want to follow up on Heather’s question on construction. It’s great to see the enthusiasm in Construction Cloud. Can you talk about some of the learnings from combining the product portfolio and how you’ll be more competitive in fiscal 2021? And also how big of a component of your mix can Construction Cloud become as we approach your fiscal 2023 target?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. So first let me ask you about the customer reaction, the Construction Cloud and one of the things we learned. So one of the first things we learned is that we had a winter in BIM 360 docs because what we did when we were building kind of this next-generation platform. And it just so happens that all the acquired solutions hook incredibly nicely into this platform, which is super important because if you want to compete both inside the infrastructure business, with the department of transportation and internationally, you need what’s called an ISO compliant common data environment, which is what docs is going to be providing for our customers. So it’s actually a huge competitive advantage to have this environment. And we learned pretty quickly that the work we were doing with docs really kind of played nicely into that. We also learned pretty quickly that we have a huge mobile advantage with what we’ve done with the PlanGrid products and what the PlanGrid team has done. And we’re leveraging that advantage and expanding it into other parts of our portfolio. We also discover that the building network of BuildingConnected that by the way, is getting integrated with PlanGrid and getting integrated with some of these other solutions is an amazingly important asset, not only to our customers, but to us in terms of understanding the construction climate. We also learned what it takes to go internationally, so one of the things that we’re well-positioned to do better than anyone and we’re investing pretty heavily in that international expansion for our construction portfolio. Construction and international business, it always has been, it’s local, but it’s also international. And between our investment and a common data environment, go-to-market stand up in various places, you’re going to see us start to grow internationally pretty significantly and there’s nobody that we compete with that can actually do some of the things that we’re doing there in terms of the construction environment. Now there was another part to your question. I want to make sure I answer it because I got carried away on what we learned. What was the second part of that, Brad?"
},
{
"speaker": "Brad Zelnick",
"text": "Second part was just asking how big of a component of your mix, Construction Cloud has become as we look to fiscal 2023?"
},
{
"speaker": "Scott Herren",
"text": "Yes, Brad. Thanks for that. I don’t certainly want to get into giving that kind of granularity on our fiscal 2023 guidance. I’ll give you a couple of comments though that we’ve said a few times in the past and still believe construction’s the next billion dollar business for Autodesk. What you see is on the – in the wake of the transactions we did in fourth quarter last, we’ve done a great job integrating those. We haven’t lost any momentum in those acquired companies. And in fact, have seen an updraft in our organic construction business as a result of that. So scrolling on a really nice path at this point, you’ve seen what the inorganic piece looks like in our results. Looking at our total cloud growth gives you a good sense because BIM 360 is the organic piece of our construction business and it’s the biggest piece of our cloud results. So you get an overall sense of where construction is headed for us. And it’s a sizable business and will continue to grow, but I don’t want to get into trying to give you a – you here’s the, let me start to break down the components of our fiscal 2023 targets."
},
{
"speaker": "Brad Zelnick",
"text": "No, that’s helpful, Scott. I appreciate it. And if I could just sneak in a quick follow-up for you about long-term deferreds, which were much higher than we expected, just given your continued traction of multi-year, how should we think about long-term deferreds going forward, especially as you make changes to some of your multi-user products?"
},
{
"speaker": "Scott Herren",
"text": "No, that’s a great question. So thanks for asking that. And obviously, the long-term deferreds are a result of multi-year, right, of multi-year sales and we said this is the year we expect multi-year sales to revert back to the mean, right to what we have seen, when we sold multi-year on maintenance historically. And that’s what you see that one of the effects of that is of course, it drives long-term deferred revenue and that’s what you’re seeing in our results. I thought mid-year that this was going to get that long-term deferred as a percent of total deferred revenue would be in the mid-20% range. It’s a couple of points higher than that. As we’ve analyzed that and we’re keeping a close eye on how multi-year is running as we’ve analyzed it, it still feel like that’s at a sustainable level and it’s below what we saw with maintenance. When we offered almost the exact same offer for three years, paid upfront on maintenance, long-term deferred got up to 30% of total deferred at that point. I don’t see us getting to that level. In fact, I think long-term deferred moderates a bit looking at fiscal 2021 as a percent of total deferred versus where it is. But we’ll stay on top of that. And if to the extent we need to make an adjustment in that offering, we’ll make that adjustment. I certainly don’t want to see that run at a level that’s unattainable or unsustainable. I think, Brad, what may be implied in your question that you didn’t ask is, is this going to create a headwind for free cash flow. And so besides the comments I just made on kind of the steady state that I see multi-year getting to, bear in mind one other fact, and we’ve talked about this but not since last Investor Day, that as we look from fiscal 2020 out through fiscal 2023, more and more of our free cash flow, in fact the majority beginning of this year of our free cash flow will come from net income as opposed to coming off the balance sheet and growth in deferred revenue, right? So as we scale both the top line and improve our margins out through fiscal 2023 more and more of cash flow comes right off the P&L in net income versus coming in growth in deferred."
},
{
"speaker": "Andrew Anagnost",
"text": "This is someplace where I have to chime in just a little bit since you mentioned the free cash flow ramp. One of the things I want to make sure we all kind of like think up on here, you look back three years, here we are three years later, okay, the business ended up free cash flow wise where we expected it to be. The path had numerous twists and turns, and numerous puts and takes. We modeled it according to certain assumptions. We adjusted those assumptions as we went along. We have an execution machine that knows how to adapt. I just want you to remember, when we give you three-year targets, we are fairly confident we know where we’re going and we know how the free cash flow is going to ramp and we know it’s going to continue to ramp. We also know how to adjust as we execute through here. And how to move forward and make sure things happen the way they need to happen. And I just told you before, the safest assumption is to assume we’re going to do what we tell you we’re going to do. And if there’s any kind of hidden things like Scott said in that question, I want you to know we’ve got our handles on the controls here for this business."
},
{
"speaker": "Brad Zelnick",
"text": "Thank you for a very complete answer. Thank you."
},
{
"speaker": "Scott Herren",
"text": "Sure. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Sterling Auty from JPMorgan. Your line is now open."
},
{
"speaker": "Sterling Auty",
"text": "Yes. Thanks guys. Two questions on the construction area. The first one is, when you look at your solutions now, where are the biggest pockets of users in your customer base, so is it GC subcontractors, owners, et cetera? Just to understand where you’re seeing the biggest buying power at the moment?"
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. So right now GCs are some of our biggest customers, subs are starting to ramp up quite significantly, all right? Because remember, with the BuildingConnected network, we have a lot of access to subs now. So you’re engaged with the subsea ecosystem in a way that where you were never before. GCs are the biggest buyers. But you’ll also be surprised interdisciplinary engineering firms are big buyers as well because of their intimate connection to construction planning processes and things associated with that. But, yes, starting with the GCs, that has been moving down markets quite significantly as we’ve matured."
},
{
"speaker": "Scott Herren",
"text": "Yes, we gave an example, in the opening commentary of our significant subcontractor."
},
{
"speaker": "Sterling Auty",
"text": "All right. And then the one follow-up would be there’s a lot of components that make up that construction ecosystem from project management to bid management to the financials, et cetera. Can you highlight with the solutions that you have, where do you think your biggest areas of strength within that group is today? And directionally, where do you see building out that portfolio?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So there’s two anchors of strength that we have that are pretty deep, one is field execution. We are by far massively advantage on the field execution side. The other area that is closer to the front end of the process is in preconstruction planning. There’s another area where we’ve brought tools and capabilities close to the building information model and all the things associated with that that are pretty powerful. Now there’s one kind of thin layer of technology where we’ve been playing catch up and actually it’s not really a very deep technological mode to be honest, but it’s in project management and in project costing. That’s something where we’ve been investing a lot, it’s where a lot of the R&D investment has gone. That gap is closing incredibly rapidly. The team is just pounding out enhancements and that’s the area we pay attention to because it’s not technologically sophisticated, but it’s important and it’s one of the areas that we’ve deployed to add those things and that’ll allow us to connect, feel the preconstruction planning in a way that other people simply can’t."
},
{
"speaker": "Sterling Auty",
"text": "Understood. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Tyler Radke from Citi. Your line is now open."
},
{
"speaker": "Tyler Radke",
"text": "Hey, thanks a lot for taking my question. So maybe you could just talk about this new pricing you’re doing on the multi-user that named user? And maybe just frame it in the context of some of the other pricing changes you’ve made. And in terms of financial benefit, what’s kind of the timeframe that you expect to see the uplift play out? And should we be thinking this is kind of a possible source of upside relative to the existing 2023 targets which were put out before this plan was announced? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "So, Tyler, are you referring to the premium plan or are you referring to the new multi-user price? The question I answered earlier. The pricing on multi-user, we don’t see a significant upside being generated by that. That was a tactical pricing action designed to prevent gaming as we headed into the two for one exchange in May. So it’s not – that is not an accretive change, Tyler, that’s going to drive business. The bigger story is the premium plan that layers on top of the multi-user plan that will be a long-term continuing opportunity for us. And it should be one of those things that increases your confidence in our ability to hit our FY2023 targets, all right? And I think that’s kind of the way you should look at it. Scott, did you want to add anything?"
},
{
"speaker": "Scott Herren",
"text": "No, I think that’s right. I think the gist of your question, Tyler, was around multi-user and we did touch on that earlier. And I think the only thing I’d add again is that the way we set the price and the trade in program around multi-user moving them all to named user was in sync with our analysis of how many named users today are being supported by a given multi-user. So it should be pretty much a wash for most of our multi-user customers."
},
{
"speaker": "Tyler Radke",
"text": "Great. And as I think about the premium plan, sounds like that’s a multi-year event. I mean, as I think about the existing 2023 targets, I mean, those have been out there for a number of years now. Any chance that come Analyst Day that maybe we look at targets beyond that? Or what’s kind of your – how are you thinking about kind of long-term targets now that 2023 isn’t that far away?"
},
{
"speaker": "Scott Herren",
"text": "Yes, I’m not – I think I feel good about the targets that we’ve laid out for fiscal 2023. Let me start there. And we sort of glossed over it given all the other news that’s in the environment, but I’m pretty proud of the fact that we hit the number that we laid out three years ago for free cash flow at the end of fiscal 2021, which was no small task given the amount of transition we still had to go through and the changes we made in execution to get there. So we probably had to start there. That’s a big stake in the ground, a big milestone for us. Looking at fiscal 2023, I feel equally confident in our ability to hit the targets that we’ve got out there of $2.4 billion in free cash flow. Looking beyond that, I think we will continue to see the same trends that drive growth out through fiscal 2023, of course, extending beyond that. I think that relative magnitude of some of those will change. Obviously, construction will be a bigger driver as we go further out in time. I think where we’re headed with Fusion in the manufacturing world will become a bigger driver further out in time, but many of the same drivers that get us to those 2023 targets will extend well beyond fiscal 2023. I’m not inclined at this point to put another quantitative target out though beyond fiscal 2023."
},
{
"speaker": "Tyler Radke",
"text": "Great. Thank you."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Tyler."
},
{
"speaker": "Operator",
"text": "Thank you. At this time I’m showing no further questions. I would like to turn the call back over to Abhey Lamba for closing remarks."
},
{
"speaker": "Abhey Lamba",
"text": "Thanks, operator, and thanks everyone for joining us today. We look forward to seeing you at our Analyst Day on March 25 at our San Francisco office. Please reach out if you have any questions following today’s call, I would like to register you for the Analyst Day. With that, we can end the call. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 3 | 2,020 | 2019-11-26 17:00:00 | Operator: Ladies and gentlemen, thank you for standing by. And welcome to the Autodesk Third Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to you speaker today, Mr. Abhey Lamba, Vice President of Investor Relations. Please go ahead sir.
Abhey Lamba: Thanks, Operator, and good afternoon. Thank you for joining our conference call to discuss the results of our third quarter of fiscal 2020. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can also find our earnings press release and a slide presentation on our Investor Relations Web site. We will also post a transcript of today's opening commentary on our Web site following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results, and strategies. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance, and unless otherwise noted each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in the press release of slide presentation on our Investor Relations Web site. And now, I would like to turn the call over to Andrew.
Andrew Anagnost: Thanks, Abhey. Building on our strong performance in Q2, we delivered another quarter of solid execution in results with revenue, billings, ARR, earnings, and free cash flow coming in ahead of expectations. For the first time we delivered over $1 billion in quarterly billings outside of a fourth quarter, and our last twelve months free cash flow came in at nearly $1 billion, breaking yet another company record. Broad based strength across our entire product portfolio and all geographic regions drove these results. We have strong momentum in Construction, are gaining share in Manufacturing, and we continue to make strides in converting the non-paying user base. Before we dig into details from the quarter, I want to recognize the hard work put in by the entire Autodesk team, especially our colleagues in the bay area who ensured that our business did not experience any disruptions despite our San Rafael office, and many employees’ homes being without power due to wildfires in the final days of the quarter. Our business continuity planning was flawless and the entire team went the extra mile to ensure that we did not miss a beat under very difficult circumstances. Now, let me turn it over to Scott to give you more details on our third quarter results as well as details of our fiscal 2020 guidance. I’ll then return with insights on key drivers of our business and provide an update on the progress of our strategic initiatives before we open it up for Q&A.
Scott Herren: Thanks, Andrew. As Andrew mentioned, revenue, billings, ARR, earnings and free cash flow all performed ahead of expectations during the third quarter. Revenue growth of 28% was driven by strength across the board, with subscription revenue as the biggest driver. Acquisitions from the fourth quarter of last year contributed four percentage points of growth. The revenue upside versus our guidance was largely driven by deals with up-front revenue recognition, including those with the federal government or that include certain products like Vault and VRED. Some of these transactions were targeted for the fourth quarter and closed early. Overall, we’re very pleased with our strong execution in the quarter. Total ARR grew by 28%, which is impressive in light of a tough year-on-year compare. Our Cloud ARR grew164% tied to strong performance in Construction. Excluding $113 million of ARR from acquisitions, growth in our organic cloud portfolio came in at 35%. BIM 360 Design was once again the biggest driver of our organic Cloud revenue growth, with strength across all regions. Indirect and direct revenue mix remained at 70% and 30% respectively. Revenue from our AutoCAD and AutoCAD LT products grew 29% in the third quarter. AEC revenue increased 36% and Manufacturing rose 15%. Geographically, we saw broad-based strength across all regions. Revenue grew 30% in Americas and APAC, while EMEA grew by 24%. Our maintenance to subscription program, or M2S, now in its third year, continued to yield great results. The M2S conversion rate increased to an all-time high of 40%. The uptick in the conversion rate was expected as our maintenance renewal prices increased by 20% in the second quarter, making it more cost-effective for customers to move to subscription. Of those that migrated, upgrade rates came in at 21% in line with expectations. Net revenue retention rate continued to be within the range of 110% to 120% during the third quarter, and we expect it to be within this range in Q4. Similar to Q1, some of the deeply discounted three-year subscriptions from a previous promotion came up for renewal. This group of customers renewed closer to list price, and we were pleased to see the total value from the entire cohort grow. Billings grew 55% to more than $1 billion. The growth was driven by our organic business, contributions from Construction, and the return of multi-year contracts closer to historical levels. We believe our customers’ willingness to make long-term commitments to our solutions underscores the business criticality of our products. And we are closely monitoring the rate of multi-year buying to ensure it doesn’t create a headwind to future cash flows. Remaining performance obligations, or RPO, which is the sum of billed and unbilled deferred revenues, rose 32% and 6% sequentially to almost $3 billion. Current RPO, which represents the future revenues under contract expected to be recognized over the next 12 months, was $2.1 billion, an increase of 23%. This is a solid leading indicator of the strength of our business. On the margin front, we realized significant operating leverage as we continue to execute in the growth phase of our journey. Non-GAAP gross margins were very strong at 92%, slightly up quarter over quarter and up two percentage points versus last year. Revenue growth, combined with our disciplined approach to expense management enabled us to expand our non-GAAP operating margin by 13 percentage points to 27%. We are on track to deliver further margin expansion in Q4 and approximately 40% non-GAAP operating margin in fiscal 2023. Moving to free cash flow, we generated $267 million in Q3. Over the last twelve months, we generated a record $972 million of free cash flow, demonstrating the power of our subscription model and strength of our products. Lastly, we continue to repurchase shares with our excess cash, which is consistent with our capital allocation strategy. During the third quarter, we repurchased 856,000 shares for $124 million at an average price of $144.49 per share. Year-to-date we have repurchased 1.7 million shares for $264 million at an average price of $156.16 per share. In addition, we paid down another $100 million on the term loan associated with the fourth quarter fiscal 2019 acquisitions and intend to repay the remaining $150 million by the end of fiscal 2020. Now I’ll turn the discussion to our outlook. Our view of global economic conditions and their impact on our business remains unchanged from last quarter. As you will soon hear from Andrew, customers continue to increase their spending on our products even in segments experiencing some near-term headwinds. Our full-year revenue outlook has been updated for the upside we experienced in the third quarter, partially offset by the early signing of some transactions initially targeted for the fourth quarter. At the mid-point of our updated guidance, we are calling for revenue and ARR growth to be approximately 27% and 25%, respectively. Additionally, currency is now expected to drive an incremental headwind of about $5 million to our full year revenue. We are adjusting our ARR outlook as some of the expected Q4 upfront subscription revenue was recognized in the third quarter. Additionally, fourth quarter ARR is being impacted modestly by the currency headwind. As a reminder, we calculate ARR by multiplying our reported quarterly subscription and maintenance revenues times four. Our billings forecast has been updated to reflect our strong performance and the momentum behind multi-year deals. We expect long term deferred revenue to be in the mid 20% range of total deferred revenue at the end of the year. Strong billings and operational execution are driving the upside to our free cash flow outlook for fiscal 2020, which is now expected to be $1.30 billion to $1.34 billion. Looking at our guidance for the fourth quarter, we expect total revenue to be in the range of $880 million to $895 million, and we expect non-GAAP EPS of $0.86 to $0.91. The earnings slide deck on the investor relations section of our website has more details as well as modeling assumptions. Looking out to fiscal 2021, we expect continued strength, with revenue and free cash flow growing in the low 20% range. In line with our normal practice, we will provide a more detailed fiscal 2021 forecast on our next earnings call. In summary, I want to remind everyone that since our business model shift, we have moved to a much more resilient business model that generates a very steady stream of revenues, less exposed to macro swings than when we were selling perpetual licenses. We are committed to driving revenue growth while expanding operating margins. We delivered revenue growth plus free cash flow margin of 62% in the last twelve months and plan to end the year at around 67%. Overall, I'm proud of our performance and are confident of delivering on our near-term and long-term targets. Now, I’d like to turn it back to Andrew.
Andrew Anagnost: Thanks, Scott. As you heard, resiliency of our business model combined with strong momentum in our products and great execution by the team helped deliver another outstanding quarter despite continued uncertainty in some parts of the world. In terms of the macro conditions, demand remained relatively in line with the second quarter. The business environment and our results improved slightly in the UK and central Europe, and our commercial business in China continues to perform well despite a slow down in state owned enterprises. During the quarter Robertson Group, one of the largest independently owned construction companies in the UK to cover the entire construction lifecycle, significantly increased their adoption of our BIM 360 portfolio. The company deployed our software on over 60 projects over the last three years and estimates a 28% increase in productivity. This is an incredible return on investment. We are thrilled to be partnering with a company prioritizing such impressive continuous improvement. In another example, one of the largest automotive parts suppliers in central Europe nearly doubled their EBA commitment with us this quarter. With the move to electric vehicles, the customer knows innovation is needed to stay ahead of the competition. So they are investing in retooling their factory and migrating from 2D to 3D. Our customers understand the benefits of investing in growth opportunities under all kinds of economic conditions. These examples underscore the importance of our products regardless of the macro environment as well as our customers' commitment to investing in technology to stay ahead of competitors. Last week, we hosted 12,000 people at Autodesk University and customers walked away excited about our current products and our vision for their industries. In fact, 32% more customers attended the conference this year than in the previous year. Across the board, customers are looking to Autodesk to help them digitally transform their businesses and make them more competitive. Before I go into strategic updates from the quarter, let me also acknowledge that, for the fifth consecutive year, AU Las Vegas was a carbon neutral event. This sustainable effort is reinforced and expanded by Autodesk’s commitment to achieve company carbon neutrality in 2020. We’re also delivering and continuing to investigate ways to help customers realize their sustainability goals through automation and insights in our technology. In fact, over the next few years, we intend to ramp up our financial commitment to this work by investing approximately 1% of operating profits in the Autodesk Foundation. Now, let me give you an update on some of the key initiatives, specifically our continued traction within Construction, gains in Manufacturing, and successes in monetizing our non-paying user base. These are the initiatives that continue to be key drivers of our business. In Construction, the breadth and depth of our product portfolio continues to make our offerings more compelling for our customers. In the last two years, the number of participants from the Construction industry at Autodesk University increased over seven-fold to approximately 3,500. At AU this year, we announced Autodesk Construction Cloud, which combines our advanced technology with the industry’s largest network of builders and powerful predictive insights to drive more productivity, predictability and profitability for companies across the construction lifecycle. Autodesk Construction Cloud is comprised of our best-of-breed construction solutions, Assemble, BuildingConnected, BIM 360 and PlanGrid, and connects these solutions with Autodesk’s unmatched design technology, such as AutoCAD, and our 3D modeling solutions Revit and Civil 3D. The announcement included more than 50 new product enhancements across the portfolio and deeper integrations, including powerful new artificial intelligence that helps construction teams identify and mitigate design risks before problems occur. Autodesk Construction Cloud is being well received by customers and supports our long-term plan. PlanGrid and BuildingConnected continued their momentum, delivering $113 million in ARR with growth coming from new customers as well as adoption by existing Autodesk customers. During the quarter, one of Australia’s largest construction and infrastructure companies expanded its relationship with us by adding PlanGrid and BIM 360 to its existing product set. The transaction resulted in the largest new product agreement for PlanGrid globally and the largest regional enterprise deal to date. We are helping the company adopt cloud-based technologies to improve project delivery and safety. The depth and breadth of our solutions, that many other vendors in the space cannot deliver, is very appealing to our customers. For example, we enhanced our relationship with EBC, one of Canada’s leading construction companies focused on infrastructure, buildings and natural resources, by adding BuildingConnected to their existing portfolio of Assemble and BIM 360 solutions. Our sales team demonstrated how we could help manage their systems more effectively and prepare them better for the future. We were able to meet their needs for the design and construction phases of the building lifecycle for both the commercial and infrastructure industry segments. We continue to focus our investments on infrastructure, which has performed well in prior downturns. This focus could offer us greater resiliency should the macro environment weaken. We recently announced availability of Collaboration for Civil 3D, which is now included with BIM 360 Design, and enables teams to collaborate on complex infrastructure projects. We also continue to gain market share in the infrastructure space. This quarter we significantly expanded our relationship with JR Group, made up of seven companies responsible for operating almost all of Japan’s inter-city and commuter rail services. As part of our strategic collaboration, all seven of the group’s companies will use our tools such as Revit, CIVIL 3D, and AutoCAD, over competitive offerings to develop a nationwide BIM rail standard. Moving to manufacturing, the business is performing extremely well as we continue to gain share from competitors with steady innovations in generative design and Fusion 360. We believe a large number of small and medium-sized businesses will look to upgrade their vendor stack over the next few years, which is a clear opportunity for us to grow market share. Similar to last quarter, we had a number of competitive displacements of SolidWorks, MasterCAM, and PTC Creo. For instance, a 3D display designer and manufacturer in North America replaced SolidWorks and MasterCAM with Fusion 360 because of its integrated design and CAM capabilities. In another instance, a manufacturer of plastic machined components in the UK displaced SolidWorks and another CAM vendor with Fusion 360 in their design and manufacturing workflow. The company was attracted to Fusion’s cloud based collaboration capabilities in addition to the integrated functionality and price point. Our success in Manufacturing is not limited to small and medium-sized businesses. We are making inroads in larger organizations as well. During the third quarter, Daifuku, chose Autodesk as the best design software partner to move from 2D to 3D solutions. Based in Japan, Daifuku is the worlds leading material handling systems supplier serving a variety of industries, including the manufacturing, distribution, airport, and automotive sectors. With its new EBA the company has standardized on Inventor as its 3D platform and is also considering Revit for future building initiatives. We continue to invest in our Manufacturing solutions, in fact, some of you might have seen the exciting news coming out of Adutodesk University last week. We announced a partnership with ANSYS and our customers will soon have an option to use ANSYS’ simulation solutions while running our industry leading generative design workflows in Fusion 360. We also announced the introduction of a new end to end, design-through-make workflow for electronics in Fusion 360; providing key capabilities such as integrated PCB design and thermal simulation. This is something our customers have been asking for as the market for smart products continues to grow. With Fusion 360, users can take those electronic ideas and physically produce them in the same product development environment, bypassing the current disconnects between design, simulation and manufacturing that make data importing and translation necessary. Lastly, we are looking forward to meeting some of you at our Manufacturing event at the Autodesk Technology Center in Birmingham UK on Monday, December 2nd. At that time, you'll learn even more about our solutions and strategy in the space. Now, let’s close with an update of our progress with digital transformation and how it is allowing us to monetize the non-compliant user base. Our investments in our digital infrastructure have given us unprecedented access to non-compliant users’ product usage patterns. We continue to learn more about these users and are in the process of expanding our compliance programs in additional regions. During the quarter, we signed 19 license compliance deals over $500,000, including three over $1 million. The mix of deals over $500,000 was equally distributed by region and one of the million dollar plus transactions was with a commercial entity in China. Our approach to creating positive experiences for our customers as they become compliant is paying dividends. For instance, one large manufacturer in central Europe was paying for less than 10 manufacturing collections and had some old perpetual licenses. Our data indicated much higher usage. We worked closely with our partner and senior management at the company to identify and fix the non-compliant usage, resulting in almost a million-dollar contract. The experience provided during the process has opened the door for us to discuss competitive displacement to further expand their usage as they now view us as a true partner rather than a software vendor. I am excited about our year to date performance and looking forward to a strong close to the year. We continue to execute well in Construction, and are making competitive inroads in Manufacturing with our innovative solutions. I am also proud of the strides we are making in converting the current non-paying users into subscribers. Twenty years ago, Autodesk was known as the AutoCAD Company, today through the rapidly growing install base of 3D products like Revit, Inventor, Maya, and Fusion 360, we lead the market in bringing the power of 3D modeling and the cloud to all the industries we serve. We are highly confident in Autodesk’s ability to capitalize on not only our near term market opportunity, but also our long-term opportunity connected to the rise of AI driven 3D modeling in the cloud. Because of this, we remain committed to delivering on our fiscal 2023 goals. With that, Operator, we'd now like to open the call up for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Saket Kalia with Barclays. Your line is open.
Saket Kalia: Hey, Andrew, hey Scott; thanks for taking my questions here.
Scott Herren: Hey, Saket.
Saket Kalia: Hey, Scott maybe just to start with you just on the ARR guide and the adjustment. It sounded like there was a little bit of a tie-in with the upfront deals that signed in the quarter. I guess the question is, were these upfront deals that were originally expected to come in as subscription, but then came in as upfront? I guess from an ARR perspective I just -- I imagine signing it in Q3 as a subscription wouldn't make as much of a difference to Q4 ARR, but I'd love to just understand the dynamic there around the upfront deals this quarter and how it sort of impacted the ARR outlook for the year?
Scott Herren: Yes. It's a great question, Saket. Thanks for putting it out there. I think you are probably not the only one scratching their heads. Here’s the way you got to think about it. The -- if you step back and think of the way we define ARR, its actual reported subscription plus maintenance revenue for the quarter. And then we annualized it by multiplying by four. So we'll give you a full-year ARR number. What we're really saying is, just what we think our Q4 subscription revenue numbers -- subscription and maintenance revenue number will be times four. What you saw in Q3 is we had a fair amount of upside in the revenue line versus the midpoint of guide revenue was $18 million higher than the midpoint. Some of what drove that was upfront revenue. We always have a little bit of upfront revenue. So we have a couple of products, smaller products that under ASC 606 don't qualify for ratable treatment. So we sell them just like a subscription. They look -- the economics of them looked like a subscription. The customer buys it. They have to renew in 12 months. But under 606 you have to claim on that revenue upfront. It's small product like Vault that fall in this category. What happened in Q3 is we had a handful of deals for this small product set that we felt were coming in Q4. Actually we got closed in Q3, and because they are upfront that revenue moved out of Q4 and into Q3. And there's no tail. There's no ongoing -- all of their revenue is recognized upfront. This happens every quarter, but this was particularly magnified where we had a handful of these deals that we thought were coming in Q4, actually came in Q3 instead. So, good news is Q3 looks super strong. The downside is that creates a headwind to the Q4 subscription and maintenance revenue and therefore to the Q4 ARR calculation. So it's kind of a combination of ASC 606 in the way it treats. So just a small subset of our products and then how that gets rippled through in the way we calculate ARR, which is actual reported revenue times four. What's important to remember is a couple of things. One is, the way the rev rec works is not necessarily -- it doesn't reflect the economics of the transaction. We sell these on a subscription basis and they look to our customers just like any other subscription. So there's changes there are isn’t reflective of any kind of change in the overall economics of our business. I think the second is, when you peel back the growth that we're going to see in subscription revenue this year and you can derive this from the guidance we just gave you, Saket, we see subscription revenue continuing to grow for the full year, because that's an accumulated metric. It's Q1 plus Q2, plus Q3, plus Q4. When revenue moves across quarter lines, it doesn't matter when you aggregate it to the full year. For the full-year we see subscription revenues growing into 29% to 30% range. So still feel strong about that. We just got this anomaly between kind of the way 606 treats a small subset of products and how that gets reflected in our ARR. That's what you see in the ARR guidance change.
Saket Kalia: Yes. Sure. That makes sense. It sounds like those Vault deals were maybe term subscriptions which under 606 kind of requires that that upfront…?
Scott Herren: It has more to do with the product, Saket, than the way we sell it. We sell it just like we sell every other product. 12 months you -- they pay us upfront. They get access to the product at the end of that 12-month period they either renew and continue to use the product or they don't renew and they lose access to the product. So it's really transparent to a customer. It's more -- some of the details of the offering itself under 606 don't qualify for ratable treatments.
Saket Kalia: Got it. If I can ask a quick follow-up for you, Andrew, just to get off accounting. I mean really interesting development in the CAD market. Just more talk about SaaS adoption. Obviously we saw Onshape got acquired. And clearly you compete here with tools like Fusion 360. But curious how you think about SaaS adoption in CAD? And what if anything that deals can mean for Autodesk competitively?
Andrew Anagnost: First off, let me just kind of say that I have a lot of respect for John Herstig and the work that he has done over the years. I’ve respect for Jim Heppelmann and the work he has done in the past. And I think there are important forces in this industry, but the way this is all coming down and characterized is just off. Okay. So let's talk about what we all agree on and what's happening, what's really happening in the markets. So here we all agree on. Multi-tenant SaaS is the future of our business. It's the future of the entire software because I have been saying this for seven years now, okay? Seven years and we've been executing on it for seven years. Fusion 360 is a multi-tenant SaaS offering with the SaaS business model. Here's the other thing we agree on. What does this SaaS means? It means three important things. Data; the cloud is going to revolutionize data flow in the manufacturing and product development industry. Is just going to revolutionize multi-disciplinary data flow, data flow across various parts of supply, it just going to revolutionize data flow, compute, compute power. We're able to deploy compute power through the cloud in ways we've never been able to before, what we do a [general] [ph] design, that's all computed off the desktop. It's all – that is all a cloud compute exercise. And then the last thing I think we all agree on that. We don't – I'll talk about this equally and some of us are actually executing on it, is that we can layer machine learning on top of this data layer and with this compute and we can start doing predictive analytics and all sorts of predictive and insightful studies on top of what people do. Some of our general design algorithms already incorporate machine learning with regards to how they integrate CAM. So we all agree on that. All right? It's the uniform - and we're all building that to some degree. We’re I think quite a bit ahead and I'll get to that in a minute But here is what we don't agree on is how you do it. All right? And there is a big difference between the way Fusion and Onshape works. Fusion has taken a strategy where we have a thin client which is a browser and we have a thick client which is installed on the desktop and worked on that cloud data layer. The thin client and thick clients see the world exactly the same. They can't operate without the cloud behind it. There are dead without it. The reason we have the thick client is we're solving an additional problem. It's end-to-end workflow all the way from design to CAM, electronics and all these things. So we're putting a huge amount of power in there that you want – if you want to get in there in order to solve the bigger problem. Onshape put CAD in the browser, a thin client. We knew from our thin client experiments early on, which is like seven years ago, that don't work, okay? That boat don't float. And one thing we've just seen from this acquisition is we were right. What was Onshape installed base? Eight years into this experiment, 5,000 subscribers. We did more than that. We added more subscribers to the Fusion base in Q3 than that entire installed base. So we're talking tens of thousands of paid Fusion subscribers. And we're talking about 5,000 subscribers for Onshape. We know exactly why, because that thin client only solution doesn't work. You need a thin client and a thick client. Sure the thick client will probably get thinner over time, but that's what you need today. And you also need a new business model with the different prices and the different options. So, we just have a different view of how to do it. And we're pretty convinced we're way ahead. I think the data now -- now that we can see the data, we're now confirming that we're way ahead. But that's kind of where we're at. We all see the world the same way. We're executing on it differently and the market is voting with its wallet.
Saket Kalia: Very helpful guys. Thank you.
Andrew Anagnost: Thanks, Saket.
Operator: Our next question comes from Sterling Auty with JPMorgan. Your line is open.
Sterling Auty: Yes. Thanks. Hi guys. I'm wondering at this part of the transition you mentioned the increase in the maintenance pricing, but what are the additional levers that you have to drive increases in ARR growth on a dollar basis moving forward?
Scott Herren: Sterling, it's a lot of the same factors that we've talked about. So, obviously the renewal base continues to grow. That renewal base comes to us at a better set the price realization than a net new does. We continue to drive growth out of construction. And you saw. We gave you some of the data points both in the opening commentary and in the press release. Construction business drove a $113 million of ARR in third quarter. So, we continue to see strong growth there as well. Well, the core basically grows to a certain degree every year. We've -- I'd say 6% to 8% growth in the core every year. So the same factors we've always talked about that will continue to drive that growth. I think one thing to bear in mind;, we're in year three of the M2S program. And maybe the very first cohort of interest customers we signed. We've locked in their price for three years depends at the end of that time we said they revert to the terminal price, which for that set of customers will be about 11% price increase. We begin to see the front edge of that even for the M2S base that's been locked in. It will start to ripple in the second quarter of next year. So, besides just our annual price increase rhythm that we've gotten on, there is a few embedded price increases that will be coming through over the next few years as well. So, piracy recapture, construction, renewal base growth into an embedded price increases is what will drive it longer-term.
Sterling Auty: Got it. And then the one follow-up would be your kind of surpassed already what you expect in terms of long-term deferred as the mix. You talked about the percentage of multiyear deals. What I'm kind of curious about is what is the collection terms that you're offering to drive some of the collection of these multiyear deals?
Scott Herren: You know, its standard three years upfront, 10% discount. I think you see most companies that sell on an annual subscription basis will offer that kind of 10% is obviously a bit better than the cost of money over three years, but not a whole lot more. And there's no extended ARR terms. There's nothing else that goes with that. What I'd say just to perhaps get it what's underneath your questions, Sterling is, we're monitoring that very carefully. And one of the reasons that I went ahead and gave you some headlights on fiscal 2021 both revenue growing in the low 20% range and free cash flow growing in the low 20% range is I didn't want there to be this building perception that because multi-years reverting to the mean, but that was somehow upgrading a headwind and we wouldn't be able to see the same kind of free cash flow growth next year. Obviously it's an outsized growth this year going from $300 million of free cash flow in fiscal 2019 to 1.3 billion to 1.34 billion this year. But we see that growing another 20% next year in fiscal 2021. So we're monitoring the multi-year -- the percent of sales multiyear very closely. And if we see it begin to run too hot where we think it's not sustainable and it will begin to create a headwind. We'll modify the offering.
Sterling Auty: Got it. Thank you.
Scott Herren: Thanks Sterling.
Operator: Our next question comes from Phil Winslow with Wells Fargo. Your line is open.
Phil Winslow: Hey, thanks guys for taking my question and congrats on a good quarter. Just question on the next year's outlook its building on your comments just now. When you think about the macro comments that you've made in terms of geographies, as well as the different verticals. How are you thinking about the puts and takes for 2021 and then just one quick follow-up to that?
Scott Herren: Yes. Did you say for 2021?
Phil Winslow: Yes.
Scott Herren: Yes. So first off let me comment on kind of how we view things since we talked last quarter. There really hasn't been a fundamental change in our view of the market right now. In fact, a few things got a little bit better, right? The UK and Germany are still performing below our expectations, but they're growing and they showed a slight improvement in Q4 relative – I mean, Q3. I can't see that far in the future yet. In Q3 relative to what we saw in Q2. The same goes for China. We're still not doing any business with the state-owned enterprises, but the business continued to grow just below our expectation. So we actually saw a little bit about firming up not a deterioration in the business, which is a good sign. Now as we look into next year, we're not seeing any fundamental change in the places where we've seen weakness. But more importantly, there's a trend going on that I want you to pay attention to which is a tailwind for us as we move into any situation that we see in the next year and how we feel about next year. People are moving more and more rapidly to the model-based solutions we're deploying and the cloud-based solutions we're deploying, because they see those as fundamental to their competitive shift. There are competitive dynamics. We're seeing a continued acceleration of BIM. That's going to continue into next year. BIM mandates, BIM project specs is going to continue. Inventor and Fusion 360 are growing as we head into next year. And the momentum on construction is solid. In addition to that one of the things that we always see as anti cyclical as we head into any kind of environment is infrastructure, and over the last year we've been investing in infrastructure capabilities in our products and a lot of those are going to show up next year and they're going to show up both with regards to some of our construction portfolio and some of our design portfolio. So we feel pretty good heading into next year. And that's one of the reasons why in the opening commentary we affirmed this low single-digits growth in free cash flow for next year.
Andrew Anagnost: Low 20.
Scott Herren: Yes. Low 20. Didn't did I say it's low 20. Sorry. Thank you for correcting. That would have been -- that would have - definitely have said somebody, that your low 20s -- to low 20% cash flow increase year-over-year.
Phil Winslow: Great. That's great color. Thank you. And then just a follow-up on that for Scott obviously you're not guiding to operating income or operating expenses, but also just help me think about sort of the framework for next year, because obviously this is investment year plus acquisitions, just high level, give us your thought process on the expense side. Then I will get back into queue.
Scott Herren: Okay. Alright. Thanks Phil on that. One of the things that we've said is we expected growth – spend growth and also COGS plus OpEx between 20 and 23 to be in this high single to low double-digit range. If you look at the growth we had this year spend growth and the guidance will be about 9%. But the overwhelming majority of that came via acquisition. So the organic business has been roughly flat now for about four years and there is some pent-up demand for increased sales capacity for continued investment in digitization. So, what I would model for fiscal 2021 is something towards the higher end of that low single to double-digit – sorry, high single to low double-digit range. So closer to the low double-digit range for fiscal 2021, but then averaging out in that high single to low double throughout fiscal 2023. Does that get what you're asking about that?
Phil Winslow: Yes. That's perfect. Thank you very much.
Scott Herren: Thanks, Phil.
Andrew Anagnost: We're experiencing some digit dyslexia here.
Operator: Thank you. And our next question comes from Heather Bellini with Goldman Sachs. Your line is open.
Heather Bellini: Great. Thank you. I guess just two quick ones, but one just following up on what Phil was just talking about. If you look out to next year would you say that the environment that you're expecting the environment to be stronger weaker or the same than what you had this year when you're when you're thinking about the puts and takes of everything you were just talking about? And then just was wondering how do you think about in the context of what you were just saying about expense growth. How do you think about managing operating margins if the macro-environment did start to go against you? I am just trying to think about the trade-off between driving growth versus protecting margins, if you could just share with us your philosophy there? Thank you.
Andrew Anagnost: So we absolutely expect things to stay fairly consistent heading into next year. I like to highlight the counter cyclical aspects of our business right now with regards to BIM mandates, with regards to the momentum around displacing SolidWorks and Mastercam and smaller accounts for fusion with regards to digitization and construction, with regards to infrastructure because these are important things to keep in mind. But our assumptions into next year is places where we saw our soft already continued to be soft relative to our expectations. And we're going to continue to see kind of the same thing heading into the rest of the markets. I'll let Scott comment on the investment model.
Scott Herren: Yes. The only thing I'd add to what Andrew just said before I jumping on spend management is, we do think by the way there continues to be an accelerating opportunity that's not necessarily tied to overall macro spend environment in areas like construction and the momentum that you see us gaining in piracy recapture. Understood management question, Heather, you see us really exercise good spend management muscles for four consecutive years at this point. I feel good about our ability to do that. I mentioned that there is pent-up demand for spend there is. But to the extent that we see the business beginning to trend lower than what we expected of course we'll tighten up on that front. I think it's a muscle that we built. That doesn't -- it's taken time. It doesn't go away overnight. So I think you can expect us to continue to be diligent in management. That said with the revenue growth we're expecting, next year we will not only grow revenues, we'll be able to grow spend and expand margins. We are expecting expanded operating margins next year versus this year. So I think we're pretty well-positioned from a spend management standpoint next year.
Heather Bellini: Great. Thank you.
Scott Herren: Thanks Heather.
Operator: Our next question comes from Jay Vleeschhouwer with Griffin Securities. Your line is open.
Jay Vleeschhouwer: Thank you and good evening. Andrew, I was pretty intrigued by your several references to infrastructure which is a business that as you know once upon a time the Company broke out and it looks as though it's still about a quarter to a third of your total AEC business even after including ACS. And so I'm wondering if that's a business that you might revert to reporting out in some way and also just talk about what you think the growth potential is of infrastructure as a proportion of the total legacy revenue? And then as follow-up longer-term question as well regarding your sales mix. That is to say your 50-50 mix expectations direct and indirect we'd have to wreck potentially be in the store. On that point could you talk about whether you're still confident in the stores becoming half of half or a quarter of the total. What are the limitations you think or risks to that trajectory of growth for the store? And if it doesn't come through how are you thinking about reverting spending or redirecting spending and sales development back towards named account direct and channel?
Andrew Anagnost: Okay. So you asked a couple of questions there. So let me let me start on the infrastructure questions. So, no, we're not going to be breaking out the business or providing any more color on what's percentage. But what I can tell you is that we've made some deliberate investments in rail and road, some of those have already shown up this year, more we're going to show up early next year that are targeted at where we believe some of the sweet spots in spending are going to be in areas where we have strength. You might have also noticed that we moved similar Civil 3D into the BIM 360 design environment. So now the same collaborative power that we have on Revit models is available for Civil 3D models. That's important. That was something that customers were looking for. And another thing we're doing that you'll start to see progress on is this notion of a common data environment, which is really important to infrastructure projects. And it's important to particularly infrastructure projects in Europe, but even in the U.S., people are really interested in these ISO-compliant, common data environment. That's going to be showing up really soon as well. So we have made some clear targeted investments that we believe allow us to go where the real opportunity is in that space. And on top of that, if you've been following what's happening with InfraWorks that products really growing up. And it's integration with Esri, and some of the things we've done there are actually pretty compelling and pretty interesting. Now with regards to the long-term targets, alright, so you're right. Right now about we're at 30% between direct and indirect. And the reason for that is not that the stores growing. The store is growing a lot, all right. It's still our fastest growing channel in the Company, okay? So, our digital direct channel is still the fastest-growing channel in the company. It's a fastest growing. Why isn't it showing more progress towards the goal? The truth the matter is, is that the channel grew well, too, all right. It grew robustly. And I think we should all celebrate that. And at the same time what happens is because right now the store is essentially majority an LT channel. That's not totally true because we sell the whole portfolio there. And we capture a lot of construction solutions usually direct. It's margin neutral right now, because the margin we make off of LT to the channel into the stores the same. So we're getting the same economics. That said, I'm not backing away at all from the 50-50 split or the 25 -- the half of that direct being from the digital direct channels. We're still going to achieve that. Remember, I always characterized that as a long-term target. And there's lots of things that haven't lit up yet that are going to help with that. Things associated with piracy recapture things associated with construction. There's a whole set of things over the next few years that are going to go into tip the balance on that number. So we're still confident. We're getting the economics we want. So we're getting the price realization. We want especially on the things that would most likely go digital direct. So we are still committed to that mix long term.
Jay Vleeschhouwer: Okay. Thank you.
Andrew Anagnost: You're welcome.
Scott Herren: Thanks Jay.
Andrew Anagnost: Thank you.
Operator: Our next question comes from Matt Hedberg with RBC Capital Markets. Your line is open.
Matt Hedberg: Hi guys. Thanks for taking my questions. The results of converting non-compliant users was impressive. I guess, first of all, was this the best quarter for converting these non-compliant users? And then on a go-forward basis should we expect more of the same as this cadence or are there additional steps that can, in fact, convert even more of these users?
Andrew Anagnost: So Matt, here here's a few things I wanted to characterize there. First off, we're absolutely on the plan that we always intended for this model. Every year we're taking a set of steps that we believe we are going to materially improve our penetration into the non-compliant base. And every year there'll be a set of new steps that we believe will provide some additional ramp-up in that space as well. So what do we do this year? We rolled out in product communication and tracking of how the priority of user journey -- the non-compliant user at journeys through the lifecycle of learning their non-compliant and what options they take as they travel through that cycle. We introduced those things we rolled it out throughout the year across more and more countries. And yes, we're seeing results that we expected primarily through two things. One, we're increasing better leads to our inside license compliance teams and we are converting people digitally as well through some of the digital communication. But the digital communication also creates these better leads. To put in context we have to kind of get a sense for what happened. Last year we did 21 deals over $500,000 in piracy whole entire year, 21 deals. In Q3 alone we did 19 deals over $500,000. So you can see yes, we are seeing increases in momentum. And there's a whole slew of things that we'll talk about later. There will be doing next year that will provide us to not only get even more intelligence on this space but make it more challenging for the base to jump to another pirated solution. Okay? And that will be a discussion for later. But this is to plan. Every year there's something that rolls out and every year we seem to be getting the results that we want from this program. And given what we know we're doing next year we feel confident we're going to continue to get the results we expect to get.
Matt Hedberg: Super helpful, Andrew. And then maybe, Scott just a quick one for you. On the multiyear renewals it's good to hear that, these are renewing closer to list price. Just a quick question, I wonder if you could comment on the churn you're seeing for these? Is it about what do you expect? That piece would be helpful.
Scott Herren: Yes. Matt it is. And to be clear what I was talking about it is if you remember in Q3 of fiscal 2018, as we started down this path of selling nothing but subscriptions, we offered a promotion for legacy customers turning in your perpetual license. And for a 50% discount you can get three years of the same product on product subscription. That was actually quite a successful. If you remember we get over 40,000 of those. That three-year term came due during this last quarter. While we saw, we expected there to be a higher than normal churn rate and we didn't see that. But the aggregate value of that customer set actually grew. So I think the promotion was quite successful. I've got people to try to move over to the product subscription and the aggregate value after renewal and they renewed closer to list, not in a 50% discount grow over that timeframe. So it was successful, but it did create a little bit of a headwind on our volume renewal basis.
Andrew Anagnost: On a unit basis.
Scott Herren: On a unit basis. Remember we started talking about renewal also as net revenue retention rate or sometimes I'll call it in our three -- and our three for the quarter continued to run in that 110% to 120% range overall. So this was -- it was accretive to that metric.
Matt Hedberg: That's great. Well done guys. Thanks Matt
Scott Herren: Thanks, Matt.
Operator: Keith Weiss with Morgan Stanley. Your line is open.
Hamza Fodderwala: Hey guys. It's Hamza Fodderwala in for Keith Weiss. Thank you for taking my question. I just wanted to go back to the fiscal 2020 ARR outlook. So it looks like it was lower by about a 0.5 at the midpoint part of that was FX. And some of that was upfront revenue. Any sense that we could get for the magnitude of the greater upfront revenue because I mean to me it seems like the macro situation in Europe and North America was sequentially better. So I guess why wouldn't that carry forward into Q4 and reaffirmed the 25% to 27% growth outlook that you gave last quarter?
Scott Herren: Yes. Tom, the amount of upfront revenue that moved from Q4 back into Q3 was about 5 million. So that was -- that contributed to the upside in Q3 revenue. But remember the way we do ARR, subscription revenue times four. That by itself was a $20 million headwind to ARR in the fourth quarter. The fact is – but remember, that's upfront revenue. So there is no tail of deferred once we put that in. And because of 606 we have the claim all that revenue upfront. There is no Q4 impact of those. It just moved from Q4 back into Q3. That you see the full-year revenue. We see we've guided that point up, because float revenue is an accumulated metric. It's one plus Q2 plus Q3 plus Q4. ARR just taken a snapshot of Q4 subscription and maintenance revenue and multiply by four. So the midpoint of that ARR guidance change was $30 million. Twenty of it was just driven by this effect was about $5 million of incremental headwind from FX and about the same amount of just product mix. Does that does that clear up in your mind the move from Q4 back to Q3 and why it's an impact to ARR?
Hamza Fodderwala: Yes. So i guess ex those changes, would ARR growth have been sort of reiterated if it wasn't for those onetime impact?
Scott Herren: Absolutely. Exactly. And the interesting thing about this Tom is, the economics of our business by the way are completely divorced from the rev ramp issue that we're talking about. The economics of the business are unchanged. It just between having the claim that as non-ratable upfront revenue and moving it back into Q3, and the way we define ARR as quarterly revenue. It's that combination that drove the change in Q4 ARR.
Andrew Anagnost: Yes. This is an interesting collision between the way we define ARR and the 606 accounting rules.
Hamza Fodderwala: Yes. It's always exciting. So I guess just one quick follow-up. So the billings obviously came in much stronger than expected. To what extent is the shift to multiyear deals performing better than you expected coming into the year? And should we expect that long-term DR mix to continue trending higher because it's already kind of around the mid-20% range of total that we've seen historically? That's it for me.
Scott Herren: Okay. Thanks for that too. Billings growth at 55% and over a $1 billion of billings in Q3 super strong. And the biggest factor driving that is the growth of our renewal base. That has nothing to do with multi-years. Is just the overall growth of renewal base. Beyond that the contribution from our construction business, construction continues to perform really well. With the noise around the ARR guide, we haven't really focused on the success of our construction business as much as we probably should have. It continues to perform really well and it's driving upside to our billings as well. Multi-year is part of it and you're right, we're already add long-term deferred at about 25% of total deferred. If you go back historically by the way, back into fiscal 2017 and 2018 before we began this transition, by long-term deferred ran as high as 30% of total deferred at one point. I don't think it gets back to that level. I think we keep it in this low to mid-20% range in terms of long-term as a percent of total. To the extent that it ran hot and I said this earlier in other words we were selling more multi-year than I thought we could sustain longer-term. I'd like to make a change in the offering. What I don't want to do is drive volatility and free cash flow because of the offering we've got out there for multiyear. At this point I don't think we've done that. But if it continued to accelerate that something we take a look at.
Hamza Fodderwala: Thank you very much.
Scott Herren: Sure.
Operator: Our next question comes from Brad Zelnick with Credit Suisse. Your line is open.
Brad Zelnick: Great. Thanks so much for fitting me. Andrew, you highlighted the launch of Autodesk Construction Cloud at AU this year. What excites you most about the offering? How is the customer feedback into the launch? And how do you see it driving growth next year?
Andrew Anagnost: Yes. What excites me a lot about this is the way we are unifying the whole entire stack around this common data environment and it's a real great return on the investment we made in BIM 360 docs, because that entire environment is becoming the common data environment and PlanGrid integrating into it, BuildingConnected integrating into it. The existing BIM 360 stack has already integrated into it. And everybody is looking at this insight internally within the development saying wow this is this is an amazing opportunity for us to bring these things together. So the whole ability to have a conversation with the customers about here's the umbrella brand and how we're bringing all these things together so that they actually communicate is a really exciting part of this. And I think it's going to come rapidly and customers are going to be delighted. When we rolled it out there were 50 new enhancements and there's a reason why those 50 new enhancements were in there is because we invested in acceleration of the integrations with respect to some of these things were moving faster not slowing down. I'm really excited about the pace of what's going on. I'm excited about what the team has been doing. And I'm frankly excited about how well we're winning in the market. People look at what we're doing. They look five years out at the landscape and they say okay I'm going to place my bet with Autodesk. And I think that's a credit to the team. I guess, credit to the momentum they've kept in here. And I think the whole story around construction cloud and the way they rolled it out and told you it is really a great piece of work by the team. So I'm really proud of them.
Brad Zelnick: Awesome. And Andrew, if I could just add another one for you. Your results seem to demonstrate continued success in executing on M&A. How should we think about your appetite for additional deals in both construction and manufacturing?
Andrew Anagnost: Well, we've always said that as we look out to the business we will continue to be acquisitive as we were in the past at the very least. We always look at the market for organic and inorganic opportunities. Right now we feel like our construction portfolio has most of what it needs. We're partnering aggressively. We could potentially do tech tuck-ins around the construction solution. As we look into other parts of the market you know we'll just have to wait and see. What you see as we've demonstrated an ability to capture significant inorganic targets integrate them and turn them into results. And I think that's one of the things you should notice regardless of whatever we do in the future that we become a serious machine around focusing around what are the real inorganic opportunities, how do we bring them in and then how do you make them successful. And that's our commitment to our customers and to the market.
Brad Zelnick: Excellent. Thanks so much.
Scott Herren: Thanks, Brad.
Operator: Thank you. And our last question comes from Jason Celino with KeyBanc Capital. Your line is open.
Jason Celino: Hey guys. Thanks for taking my question. Building off the last question about the construction cloud announcement, sounds like it's more of a branding grouping all your portfolio products. But what was some of the initial customer feedback that you've heard?
Scott Herren: Yes. The customer feedback has been really solid and here's why, because if the customers don't react to the branding, they don't spend a lot of energy on that, but they do is they react to what we do. All right. So we like the branding because it helps us communicate simply. We were not propagating multiple brands out there. It allows us to focus our go-to-market efforts. It allows us to communicate more precisely at the company. The customers pay attention to what have you done for me. And what they were excited about at the Connect and Construct Event and all the discussions there is the feature velocity. All right. They're seeing us delivering on the integrations that we said we were going to deliver and there are watching us closely. Every quarter they're going to see, do we do we say we're going to do? Do we do we said we were going to do. So that's what the customers are excited about. They really loved the fact that we're integrating to a common data environment and we're building an ISO standard excepted common data environment. That's something that everybody gets us sums up on. They're really excited with the increased scalability and performance on BIM 360 design which was an area where they were kind of pushing on us a little bit. So those are the kind of things that customers are paying attention to. The branding makes it easier for us to tell the world what we are doing, so that you're going to see us basically amplify that, but the customers care about what we do not what we say.
Jason Celino: Great. Appreciate the color. Thank you.
Scott Herren: Thanks Jason.
Operator: Thank you. And that ends our Q&A session for today. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day. | [
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"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. And welcome to the Autodesk Third Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to you speaker today, Mr. Abhey Lamba, Vice President of Investor Relations. Please go ahead sir."
},
{
"speaker": "Abhey Lamba",
"text": "Thanks, Operator, and good afternoon. Thank you for joining our conference call to discuss the results of our third quarter of fiscal 2020. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can also find our earnings press release and a slide presentation on our Investor Relations Web site. We will also post a transcript of today's opening commentary on our Web site following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results, and strategies. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance, and unless otherwise noted each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in the press release of slide presentation on our Investor Relations Web site. And now, I would like to turn the call over to Andrew."
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{
"speaker": "Andrew Anagnost",
"text": "Thanks, Abhey. Building on our strong performance in Q2, we delivered another quarter of solid execution in results with revenue, billings, ARR, earnings, and free cash flow coming in ahead of expectations. For the first time we delivered over $1 billion in quarterly billings outside of a fourth quarter, and our last twelve months free cash flow came in at nearly $1 billion, breaking yet another company record. Broad based strength across our entire product portfolio and all geographic regions drove these results. We have strong momentum in Construction, are gaining share in Manufacturing, and we continue to make strides in converting the non-paying user base. Before we dig into details from the quarter, I want to recognize the hard work put in by the entire Autodesk team, especially our colleagues in the bay area who ensured that our business did not experience any disruptions despite our San Rafael office, and many employees’ homes being without power due to wildfires in the final days of the quarter. Our business continuity planning was flawless and the entire team went the extra mile to ensure that we did not miss a beat under very difficult circumstances. Now, let me turn it over to Scott to give you more details on our third quarter results as well as details of our fiscal 2020 guidance. I’ll then return with insights on key drivers of our business and provide an update on the progress of our strategic initiatives before we open it up for Q&A."
},
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"speaker": "Scott Herren",
"text": "Thanks, Andrew. As Andrew mentioned, revenue, billings, ARR, earnings and free cash flow all performed ahead of expectations during the third quarter. Revenue growth of 28% was driven by strength across the board, with subscription revenue as the biggest driver. Acquisitions from the fourth quarter of last year contributed four percentage points of growth. The revenue upside versus our guidance was largely driven by deals with up-front revenue recognition, including those with the federal government or that include certain products like Vault and VRED. Some of these transactions were targeted for the fourth quarter and closed early. Overall, we’re very pleased with our strong execution in the quarter. Total ARR grew by 28%, which is impressive in light of a tough year-on-year compare. Our Cloud ARR grew164% tied to strong performance in Construction. Excluding $113 million of ARR from acquisitions, growth in our organic cloud portfolio came in at 35%. BIM 360 Design was once again the biggest driver of our organic Cloud revenue growth, with strength across all regions. Indirect and direct revenue mix remained at 70% and 30% respectively. Revenue from our AutoCAD and AutoCAD LT products grew 29% in the third quarter. AEC revenue increased 36% and Manufacturing rose 15%. Geographically, we saw broad-based strength across all regions. Revenue grew 30% in Americas and APAC, while EMEA grew by 24%. Our maintenance to subscription program, or M2S, now in its third year, continued to yield great results. The M2S conversion rate increased to an all-time high of 40%. The uptick in the conversion rate was expected as our maintenance renewal prices increased by 20% in the second quarter, making it more cost-effective for customers to move to subscription. Of those that migrated, upgrade rates came in at 21% in line with expectations. Net revenue retention rate continued to be within the range of 110% to 120% during the third quarter, and we expect it to be within this range in Q4. Similar to Q1, some of the deeply discounted three-year subscriptions from a previous promotion came up for renewal. This group of customers renewed closer to list price, and we were pleased to see the total value from the entire cohort grow. Billings grew 55% to more than $1 billion. The growth was driven by our organic business, contributions from Construction, and the return of multi-year contracts closer to historical levels. We believe our customers’ willingness to make long-term commitments to our solutions underscores the business criticality of our products. And we are closely monitoring the rate of multi-year buying to ensure it doesn’t create a headwind to future cash flows. Remaining performance obligations, or RPO, which is the sum of billed and unbilled deferred revenues, rose 32% and 6% sequentially to almost $3 billion. Current RPO, which represents the future revenues under contract expected to be recognized over the next 12 months, was $2.1 billion, an increase of 23%. This is a solid leading indicator of the strength of our business. On the margin front, we realized significant operating leverage as we continue to execute in the growth phase of our journey. Non-GAAP gross margins were very strong at 92%, slightly up quarter over quarter and up two percentage points versus last year. Revenue growth, combined with our disciplined approach to expense management enabled us to expand our non-GAAP operating margin by 13 percentage points to 27%. We are on track to deliver further margin expansion in Q4 and approximately 40% non-GAAP operating margin in fiscal 2023. Moving to free cash flow, we generated $267 million in Q3. Over the last twelve months, we generated a record $972 million of free cash flow, demonstrating the power of our subscription model and strength of our products. Lastly, we continue to repurchase shares with our excess cash, which is consistent with our capital allocation strategy. During the third quarter, we repurchased 856,000 shares for $124 million at an average price of $144.49 per share. Year-to-date we have repurchased 1.7 million shares for $264 million at an average price of $156.16 per share. In addition, we paid down another $100 million on the term loan associated with the fourth quarter fiscal 2019 acquisitions and intend to repay the remaining $150 million by the end of fiscal 2020. Now I’ll turn the discussion to our outlook. Our view of global economic conditions and their impact on our business remains unchanged from last quarter. As you will soon hear from Andrew, customers continue to increase their spending on our products even in segments experiencing some near-term headwinds. Our full-year revenue outlook has been updated for the upside we experienced in the third quarter, partially offset by the early signing of some transactions initially targeted for the fourth quarter. At the mid-point of our updated guidance, we are calling for revenue and ARR growth to be approximately 27% and 25%, respectively. Additionally, currency is now expected to drive an incremental headwind of about $5 million to our full year revenue. We are adjusting our ARR outlook as some of the expected Q4 upfront subscription revenue was recognized in the third quarter. Additionally, fourth quarter ARR is being impacted modestly by the currency headwind. As a reminder, we calculate ARR by multiplying our reported quarterly subscription and maintenance revenues times four. Our billings forecast has been updated to reflect our strong performance and the momentum behind multi-year deals. We expect long term deferred revenue to be in the mid 20% range of total deferred revenue at the end of the year. Strong billings and operational execution are driving the upside to our free cash flow outlook for fiscal 2020, which is now expected to be $1.30 billion to $1.34 billion. Looking at our guidance for the fourth quarter, we expect total revenue to be in the range of $880 million to $895 million, and we expect non-GAAP EPS of $0.86 to $0.91. The earnings slide deck on the investor relations section of our website has more details as well as modeling assumptions. Looking out to fiscal 2021, we expect continued strength, with revenue and free cash flow growing in the low 20% range. In line with our normal practice, we will provide a more detailed fiscal 2021 forecast on our next earnings call. In summary, I want to remind everyone that since our business model shift, we have moved to a much more resilient business model that generates a very steady stream of revenues, less exposed to macro swings than when we were selling perpetual licenses. We are committed to driving revenue growth while expanding operating margins. We delivered revenue growth plus free cash flow margin of 62% in the last twelve months and plan to end the year at around 67%. Overall, I'm proud of our performance and are confident of delivering on our near-term and long-term targets. Now, I’d like to turn it back to Andrew."
},
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"speaker": "Andrew Anagnost",
"text": "Thanks, Scott. As you heard, resiliency of our business model combined with strong momentum in our products and great execution by the team helped deliver another outstanding quarter despite continued uncertainty in some parts of the world. In terms of the macro conditions, demand remained relatively in line with the second quarter. The business environment and our results improved slightly in the UK and central Europe, and our commercial business in China continues to perform well despite a slow down in state owned enterprises. During the quarter Robertson Group, one of the largest independently owned construction companies in the UK to cover the entire construction lifecycle, significantly increased their adoption of our BIM 360 portfolio. The company deployed our software on over 60 projects over the last three years and estimates a 28% increase in productivity. This is an incredible return on investment. We are thrilled to be partnering with a company prioritizing such impressive continuous improvement. In another example, one of the largest automotive parts suppliers in central Europe nearly doubled their EBA commitment with us this quarter. With the move to electric vehicles, the customer knows innovation is needed to stay ahead of the competition. So they are investing in retooling their factory and migrating from 2D to 3D. Our customers understand the benefits of investing in growth opportunities under all kinds of economic conditions. These examples underscore the importance of our products regardless of the macro environment as well as our customers' commitment to investing in technology to stay ahead of competitors. Last week, we hosted 12,000 people at Autodesk University and customers walked away excited about our current products and our vision for their industries. In fact, 32% more customers attended the conference this year than in the previous year. Across the board, customers are looking to Autodesk to help them digitally transform their businesses and make them more competitive. Before I go into strategic updates from the quarter, let me also acknowledge that, for the fifth consecutive year, AU Las Vegas was a carbon neutral event. This sustainable effort is reinforced and expanded by Autodesk’s commitment to achieve company carbon neutrality in 2020. We’re also delivering and continuing to investigate ways to help customers realize their sustainability goals through automation and insights in our technology. In fact, over the next few years, we intend to ramp up our financial commitment to this work by investing approximately 1% of operating profits in the Autodesk Foundation. Now, let me give you an update on some of the key initiatives, specifically our continued traction within Construction, gains in Manufacturing, and successes in monetizing our non-paying user base. These are the initiatives that continue to be key drivers of our business. In Construction, the breadth and depth of our product portfolio continues to make our offerings more compelling for our customers. In the last two years, the number of participants from the Construction industry at Autodesk University increased over seven-fold to approximately 3,500. At AU this year, we announced Autodesk Construction Cloud, which combines our advanced technology with the industry’s largest network of builders and powerful predictive insights to drive more productivity, predictability and profitability for companies across the construction lifecycle. Autodesk Construction Cloud is comprised of our best-of-breed construction solutions, Assemble, BuildingConnected, BIM 360 and PlanGrid, and connects these solutions with Autodesk’s unmatched design technology, such as AutoCAD, and our 3D modeling solutions Revit and Civil 3D. The announcement included more than 50 new product enhancements across the portfolio and deeper integrations, including powerful new artificial intelligence that helps construction teams identify and mitigate design risks before problems occur. Autodesk Construction Cloud is being well received by customers and supports our long-term plan. PlanGrid and BuildingConnected continued their momentum, delivering $113 million in ARR with growth coming from new customers as well as adoption by existing Autodesk customers. During the quarter, one of Australia’s largest construction and infrastructure companies expanded its relationship with us by adding PlanGrid and BIM 360 to its existing product set. The transaction resulted in the largest new product agreement for PlanGrid globally and the largest regional enterprise deal to date. We are helping the company adopt cloud-based technologies to improve project delivery and safety. The depth and breadth of our solutions, that many other vendors in the space cannot deliver, is very appealing to our customers. For example, we enhanced our relationship with EBC, one of Canada’s leading construction companies focused on infrastructure, buildings and natural resources, by adding BuildingConnected to their existing portfolio of Assemble and BIM 360 solutions. Our sales team demonstrated how we could help manage their systems more effectively and prepare them better for the future. We were able to meet their needs for the design and construction phases of the building lifecycle for both the commercial and infrastructure industry segments. We continue to focus our investments on infrastructure, which has performed well in prior downturns. This focus could offer us greater resiliency should the macro environment weaken. We recently announced availability of Collaboration for Civil 3D, which is now included with BIM 360 Design, and enables teams to collaborate on complex infrastructure projects. We also continue to gain market share in the infrastructure space. This quarter we significantly expanded our relationship with JR Group, made up of seven companies responsible for operating almost all of Japan’s inter-city and commuter rail services. As part of our strategic collaboration, all seven of the group’s companies will use our tools such as Revit, CIVIL 3D, and AutoCAD, over competitive offerings to develop a nationwide BIM rail standard. Moving to manufacturing, the business is performing extremely well as we continue to gain share from competitors with steady innovations in generative design and Fusion 360. We believe a large number of small and medium-sized businesses will look to upgrade their vendor stack over the next few years, which is a clear opportunity for us to grow market share. Similar to last quarter, we had a number of competitive displacements of SolidWorks, MasterCAM, and PTC Creo. For instance, a 3D display designer and manufacturer in North America replaced SolidWorks and MasterCAM with Fusion 360 because of its integrated design and CAM capabilities. In another instance, a manufacturer of plastic machined components in the UK displaced SolidWorks and another CAM vendor with Fusion 360 in their design and manufacturing workflow. The company was attracted to Fusion’s cloud based collaboration capabilities in addition to the integrated functionality and price point. Our success in Manufacturing is not limited to small and medium-sized businesses. We are making inroads in larger organizations as well. During the third quarter, Daifuku, chose Autodesk as the best design software partner to move from 2D to 3D solutions. Based in Japan, Daifuku is the worlds leading material handling systems supplier serving a variety of industries, including the manufacturing, distribution, airport, and automotive sectors. With its new EBA the company has standardized on Inventor as its 3D platform and is also considering Revit for future building initiatives. We continue to invest in our Manufacturing solutions, in fact, some of you might have seen the exciting news coming out of Adutodesk University last week. We announced a partnership with ANSYS and our customers will soon have an option to use ANSYS’ simulation solutions while running our industry leading generative design workflows in Fusion 360. We also announced the introduction of a new end to end, design-through-make workflow for electronics in Fusion 360; providing key capabilities such as integrated PCB design and thermal simulation. This is something our customers have been asking for as the market for smart products continues to grow. With Fusion 360, users can take those electronic ideas and physically produce them in the same product development environment, bypassing the current disconnects between design, simulation and manufacturing that make data importing and translation necessary. Lastly, we are looking forward to meeting some of you at our Manufacturing event at the Autodesk Technology Center in Birmingham UK on Monday, December 2nd. At that time, you'll learn even more about our solutions and strategy in the space. Now, let’s close with an update of our progress with digital transformation and how it is allowing us to monetize the non-compliant user base. Our investments in our digital infrastructure have given us unprecedented access to non-compliant users’ product usage patterns. We continue to learn more about these users and are in the process of expanding our compliance programs in additional regions. During the quarter, we signed 19 license compliance deals over $500,000, including three over $1 million. The mix of deals over $500,000 was equally distributed by region and one of the million dollar plus transactions was with a commercial entity in China. Our approach to creating positive experiences for our customers as they become compliant is paying dividends. For instance, one large manufacturer in central Europe was paying for less than 10 manufacturing collections and had some old perpetual licenses. Our data indicated much higher usage. We worked closely with our partner and senior management at the company to identify and fix the non-compliant usage, resulting in almost a million-dollar contract. The experience provided during the process has opened the door for us to discuss competitive displacement to further expand their usage as they now view us as a true partner rather than a software vendor. I am excited about our year to date performance and looking forward to a strong close to the year. We continue to execute well in Construction, and are making competitive inroads in Manufacturing with our innovative solutions. I am also proud of the strides we are making in converting the current non-paying users into subscribers. Twenty years ago, Autodesk was known as the AutoCAD Company, today through the rapidly growing install base of 3D products like Revit, Inventor, Maya, and Fusion 360, we lead the market in bringing the power of 3D modeling and the cloud to all the industries we serve. We are highly confident in Autodesk’s ability to capitalize on not only our near term market opportunity, but also our long-term opportunity connected to the rise of AI driven 3D modeling in the cloud. Because of this, we remain committed to delivering on our fiscal 2023 goals. With that, Operator, we'd now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Saket Kalia with Barclays. Your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Hey, Andrew, hey Scott; thanks for taking my questions here."
},
{
"speaker": "Scott Herren",
"text": "Hey, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Hey, Scott maybe just to start with you just on the ARR guide and the adjustment. It sounded like there was a little bit of a tie-in with the upfront deals that signed in the quarter. I guess the question is, were these upfront deals that were originally expected to come in as subscription, but then came in as upfront? I guess from an ARR perspective I just -- I imagine signing it in Q3 as a subscription wouldn't make as much of a difference to Q4 ARR, but I'd love to just understand the dynamic there around the upfront deals this quarter and how it sort of impacted the ARR outlook for the year?"
},
{
"speaker": "Scott Herren",
"text": "Yes. It's a great question, Saket. Thanks for putting it out there. I think you are probably not the only one scratching their heads. Here’s the way you got to think about it. The -- if you step back and think of the way we define ARR, its actual reported subscription plus maintenance revenue for the quarter. And then we annualized it by multiplying by four. So we'll give you a full-year ARR number. What we're really saying is, just what we think our Q4 subscription revenue numbers -- subscription and maintenance revenue number will be times four. What you saw in Q3 is we had a fair amount of upside in the revenue line versus the midpoint of guide revenue was $18 million higher than the midpoint. Some of what drove that was upfront revenue. We always have a little bit of upfront revenue. So we have a couple of products, smaller products that under ASC 606 don't qualify for ratable treatment. So we sell them just like a subscription. They look -- the economics of them looked like a subscription. The customer buys it. They have to renew in 12 months. But under 606 you have to claim on that revenue upfront. It's small product like Vault that fall in this category. What happened in Q3 is we had a handful of deals for this small product set that we felt were coming in Q4. Actually we got closed in Q3, and because they are upfront that revenue moved out of Q4 and into Q3. And there's no tail. There's no ongoing -- all of their revenue is recognized upfront. This happens every quarter, but this was particularly magnified where we had a handful of these deals that we thought were coming in Q4, actually came in Q3 instead. So, good news is Q3 looks super strong. The downside is that creates a headwind to the Q4 subscription and maintenance revenue and therefore to the Q4 ARR calculation. So it's kind of a combination of ASC 606 in the way it treats. So just a small subset of our products and then how that gets rippled through in the way we calculate ARR, which is actual reported revenue times four. What's important to remember is a couple of things. One is, the way the rev rec works is not necessarily -- it doesn't reflect the economics of the transaction. We sell these on a subscription basis and they look to our customers just like any other subscription. So there's changes there are isn’t reflective of any kind of change in the overall economics of our business. I think the second is, when you peel back the growth that we're going to see in subscription revenue this year and you can derive this from the guidance we just gave you, Saket, we see subscription revenue continuing to grow for the full year, because that's an accumulated metric. It's Q1 plus Q2, plus Q3, plus Q4. When revenue moves across quarter lines, it doesn't matter when you aggregate it to the full year. For the full-year we see subscription revenues growing into 29% to 30% range. So still feel strong about that. We just got this anomaly between kind of the way 606 treats a small subset of products and how that gets reflected in our ARR. That's what you see in the ARR guidance change."
},
{
"speaker": "Saket Kalia",
"text": "Yes. Sure. That makes sense. It sounds like those Vault deals were maybe term subscriptions which under 606 kind of requires that that upfront…?"
},
{
"speaker": "Scott Herren",
"text": "It has more to do with the product, Saket, than the way we sell it. We sell it just like we sell every other product. 12 months you -- they pay us upfront. They get access to the product at the end of that 12-month period they either renew and continue to use the product or they don't renew and they lose access to the product. So it's really transparent to a customer. It's more -- some of the details of the offering itself under 606 don't qualify for ratable treatments."
},
{
"speaker": "Saket Kalia",
"text": "Got it. If I can ask a quick follow-up for you, Andrew, just to get off accounting. I mean really interesting development in the CAD market. Just more talk about SaaS adoption. Obviously we saw Onshape got acquired. And clearly you compete here with tools like Fusion 360. But curious how you think about SaaS adoption in CAD? And what if anything that deals can mean for Autodesk competitively?"
},
{
"speaker": "Andrew Anagnost",
"text": "First off, let me just kind of say that I have a lot of respect for John Herstig and the work that he has done over the years. I’ve respect for Jim Heppelmann and the work he has done in the past. And I think there are important forces in this industry, but the way this is all coming down and characterized is just off. Okay. So let's talk about what we all agree on and what's happening, what's really happening in the markets. So here we all agree on. Multi-tenant SaaS is the future of our business. It's the future of the entire software because I have been saying this for seven years now, okay? Seven years and we've been executing on it for seven years. Fusion 360 is a multi-tenant SaaS offering with the SaaS business model. Here's the other thing we agree on. What does this SaaS means? It means three important things. Data; the cloud is going to revolutionize data flow in the manufacturing and product development industry. Is just going to revolutionize multi-disciplinary data flow, data flow across various parts of supply, it just going to revolutionize data flow, compute, compute power. We're able to deploy compute power through the cloud in ways we've never been able to before, what we do a [general] [ph] design, that's all computed off the desktop. It's all – that is all a cloud compute exercise. And then the last thing I think we all agree on that. We don't – I'll talk about this equally and some of us are actually executing on it, is that we can layer machine learning on top of this data layer and with this compute and we can start doing predictive analytics and all sorts of predictive and insightful studies on top of what people do. Some of our general design algorithms already incorporate machine learning with regards to how they integrate CAM. So we all agree on that. All right? It's the uniform - and we're all building that to some degree. We’re I think quite a bit ahead and I'll get to that in a minute But here is what we don't agree on is how you do it. All right? And there is a big difference between the way Fusion and Onshape works. Fusion has taken a strategy where we have a thin client which is a browser and we have a thick client which is installed on the desktop and worked on that cloud data layer. The thin client and thick clients see the world exactly the same. They can't operate without the cloud behind it. There are dead without it. The reason we have the thick client is we're solving an additional problem. It's end-to-end workflow all the way from design to CAM, electronics and all these things. So we're putting a huge amount of power in there that you want – if you want to get in there in order to solve the bigger problem. Onshape put CAD in the browser, a thin client. We knew from our thin client experiments early on, which is like seven years ago, that don't work, okay? That boat don't float. And one thing we've just seen from this acquisition is we were right. What was Onshape installed base? Eight years into this experiment, 5,000 subscribers. We did more than that. We added more subscribers to the Fusion base in Q3 than that entire installed base. So we're talking tens of thousands of paid Fusion subscribers. And we're talking about 5,000 subscribers for Onshape. We know exactly why, because that thin client only solution doesn't work. You need a thin client and a thick client. Sure the thick client will probably get thinner over time, but that's what you need today. And you also need a new business model with the different prices and the different options. So, we just have a different view of how to do it. And we're pretty convinced we're way ahead. I think the data now -- now that we can see the data, we're now confirming that we're way ahead. But that's kind of where we're at. We all see the world the same way. We're executing on it differently and the market is voting with its wallet."
},
{
"speaker": "Saket Kalia",
"text": "Very helpful guys. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Saket."
},
{
"speaker": "Operator",
"text": "Our next question comes from Sterling Auty with JPMorgan. Your line is open."
},
{
"speaker": "Sterling Auty",
"text": "Yes. Thanks. Hi guys. I'm wondering at this part of the transition you mentioned the increase in the maintenance pricing, but what are the additional levers that you have to drive increases in ARR growth on a dollar basis moving forward?"
},
{
"speaker": "Scott Herren",
"text": "Sterling, it's a lot of the same factors that we've talked about. So, obviously the renewal base continues to grow. That renewal base comes to us at a better set the price realization than a net new does. We continue to drive growth out of construction. And you saw. We gave you some of the data points both in the opening commentary and in the press release. Construction business drove a $113 million of ARR in third quarter. So, we continue to see strong growth there as well. Well, the core basically grows to a certain degree every year. We've -- I'd say 6% to 8% growth in the core every year. So the same factors we've always talked about that will continue to drive that growth. I think one thing to bear in mind;, we're in year three of the M2S program. And maybe the very first cohort of interest customers we signed. We've locked in their price for three years depends at the end of that time we said they revert to the terminal price, which for that set of customers will be about 11% price increase. We begin to see the front edge of that even for the M2S base that's been locked in. It will start to ripple in the second quarter of next year. So, besides just our annual price increase rhythm that we've gotten on, there is a few embedded price increases that will be coming through over the next few years as well. So, piracy recapture, construction, renewal base growth into an embedded price increases is what will drive it longer-term."
},
{
"speaker": "Sterling Auty",
"text": "Got it. And then the one follow-up would be your kind of surpassed already what you expect in terms of long-term deferred as the mix. You talked about the percentage of multiyear deals. What I'm kind of curious about is what is the collection terms that you're offering to drive some of the collection of these multiyear deals?"
},
{
"speaker": "Scott Herren",
"text": "You know, its standard three years upfront, 10% discount. I think you see most companies that sell on an annual subscription basis will offer that kind of 10% is obviously a bit better than the cost of money over three years, but not a whole lot more. And there's no extended ARR terms. There's nothing else that goes with that. What I'd say just to perhaps get it what's underneath your questions, Sterling is, we're monitoring that very carefully. And one of the reasons that I went ahead and gave you some headlights on fiscal 2021 both revenue growing in the low 20% range and free cash flow growing in the low 20% range is I didn't want there to be this building perception that because multi-years reverting to the mean, but that was somehow upgrading a headwind and we wouldn't be able to see the same kind of free cash flow growth next year. Obviously it's an outsized growth this year going from $300 million of free cash flow in fiscal 2019 to 1.3 billion to 1.34 billion this year. But we see that growing another 20% next year in fiscal 2021. So we're monitoring the multi-year -- the percent of sales multiyear very closely. And if we see it begin to run too hot where we think it's not sustainable and it will begin to create a headwind. We'll modify the offering."
},
{
"speaker": "Sterling Auty",
"text": "Got it. Thank you."
},
{
"speaker": "Scott Herren",
"text": "Thanks Sterling."
},
{
"speaker": "Operator",
"text": "Our next question comes from Phil Winslow with Wells Fargo. Your line is open."
},
{
"speaker": "Phil Winslow",
"text": "Hey, thanks guys for taking my question and congrats on a good quarter. Just question on the next year's outlook its building on your comments just now. When you think about the macro comments that you've made in terms of geographies, as well as the different verticals. How are you thinking about the puts and takes for 2021 and then just one quick follow-up to that?"
},
{
"speaker": "Scott Herren",
"text": "Yes. Did you say for 2021?"
},
{
"speaker": "Phil Winslow",
"text": "Yes."
},
{
"speaker": "Scott Herren",
"text": "Yes. So first off let me comment on kind of how we view things since we talked last quarter. There really hasn't been a fundamental change in our view of the market right now. In fact, a few things got a little bit better, right? The UK and Germany are still performing below our expectations, but they're growing and they showed a slight improvement in Q4 relative – I mean, Q3. I can't see that far in the future yet. In Q3 relative to what we saw in Q2. The same goes for China. We're still not doing any business with the state-owned enterprises, but the business continued to grow just below our expectation. So we actually saw a little bit about firming up not a deterioration in the business, which is a good sign. Now as we look into next year, we're not seeing any fundamental change in the places where we've seen weakness. But more importantly, there's a trend going on that I want you to pay attention to which is a tailwind for us as we move into any situation that we see in the next year and how we feel about next year. People are moving more and more rapidly to the model-based solutions we're deploying and the cloud-based solutions we're deploying, because they see those as fundamental to their competitive shift. There are competitive dynamics. We're seeing a continued acceleration of BIM. That's going to continue into next year. BIM mandates, BIM project specs is going to continue. Inventor and Fusion 360 are growing as we head into next year. And the momentum on construction is solid. In addition to that one of the things that we always see as anti cyclical as we head into any kind of environment is infrastructure, and over the last year we've been investing in infrastructure capabilities in our products and a lot of those are going to show up next year and they're going to show up both with regards to some of our construction portfolio and some of our design portfolio. So we feel pretty good heading into next year. And that's one of the reasons why in the opening commentary we affirmed this low single-digits growth in free cash flow for next year."
},
{
"speaker": "Andrew Anagnost",
"text": "Low 20."
},
{
"speaker": "Scott Herren",
"text": "Yes. Low 20. Didn't did I say it's low 20. Sorry. Thank you for correcting. That would have been -- that would have - definitely have said somebody, that your low 20s -- to low 20% cash flow increase year-over-year."
},
{
"speaker": "Phil Winslow",
"text": "Great. That's great color. Thank you. And then just a follow-up on that for Scott obviously you're not guiding to operating income or operating expenses, but also just help me think about sort of the framework for next year, because obviously this is investment year plus acquisitions, just high level, give us your thought process on the expense side. Then I will get back into queue."
},
{
"speaker": "Scott Herren",
"text": "Okay. Alright. Thanks Phil on that. One of the things that we've said is we expected growth – spend growth and also COGS plus OpEx between 20 and 23 to be in this high single to low double-digit range. If you look at the growth we had this year spend growth and the guidance will be about 9%. But the overwhelming majority of that came via acquisition. So the organic business has been roughly flat now for about four years and there is some pent-up demand for increased sales capacity for continued investment in digitization. So, what I would model for fiscal 2021 is something towards the higher end of that low single to double-digit – sorry, high single to low double-digit range. So closer to the low double-digit range for fiscal 2021, but then averaging out in that high single to low double throughout fiscal 2023. Does that get what you're asking about that?"
},
{
"speaker": "Phil Winslow",
"text": "Yes. That's perfect. Thank you very much."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Phil."
},
{
"speaker": "Andrew Anagnost",
"text": "We're experiencing some digit dyslexia here."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from Heather Bellini with Goldman Sachs. Your line is open."
},
{
"speaker": "Heather Bellini",
"text": "Great. Thank you. I guess just two quick ones, but one just following up on what Phil was just talking about. If you look out to next year would you say that the environment that you're expecting the environment to be stronger weaker or the same than what you had this year when you're when you're thinking about the puts and takes of everything you were just talking about? And then just was wondering how do you think about in the context of what you were just saying about expense growth. How do you think about managing operating margins if the macro-environment did start to go against you? I am just trying to think about the trade-off between driving growth versus protecting margins, if you could just share with us your philosophy there? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "So we absolutely expect things to stay fairly consistent heading into next year. I like to highlight the counter cyclical aspects of our business right now with regards to BIM mandates, with regards to the momentum around displacing SolidWorks and Mastercam and smaller accounts for fusion with regards to digitization and construction, with regards to infrastructure because these are important things to keep in mind. But our assumptions into next year is places where we saw our soft already continued to be soft relative to our expectations. And we're going to continue to see kind of the same thing heading into the rest of the markets. I'll let Scott comment on the investment model."
},
{
"speaker": "Scott Herren",
"text": "Yes. The only thing I'd add to what Andrew just said before I jumping on spend management is, we do think by the way there continues to be an accelerating opportunity that's not necessarily tied to overall macro spend environment in areas like construction and the momentum that you see us gaining in piracy recapture. Understood management question, Heather, you see us really exercise good spend management muscles for four consecutive years at this point. I feel good about our ability to do that. I mentioned that there is pent-up demand for spend there is. But to the extent that we see the business beginning to trend lower than what we expected of course we'll tighten up on that front. I think it's a muscle that we built. That doesn't -- it's taken time. It doesn't go away overnight. So I think you can expect us to continue to be diligent in management. That said with the revenue growth we're expecting, next year we will not only grow revenues, we'll be able to grow spend and expand margins. We are expecting expanded operating margins next year versus this year. So I think we're pretty well-positioned from a spend management standpoint next year."
},
{
"speaker": "Heather Bellini",
"text": "Great. Thank you."
},
{
"speaker": "Scott Herren",
"text": "Thanks Heather."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jay Vleeschhouwer with Griffin Securities. Your line is open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you and good evening. Andrew, I was pretty intrigued by your several references to infrastructure which is a business that as you know once upon a time the Company broke out and it looks as though it's still about a quarter to a third of your total AEC business even after including ACS. And so I'm wondering if that's a business that you might revert to reporting out in some way and also just talk about what you think the growth potential is of infrastructure as a proportion of the total legacy revenue? And then as follow-up longer-term question as well regarding your sales mix. That is to say your 50-50 mix expectations direct and indirect we'd have to wreck potentially be in the store. On that point could you talk about whether you're still confident in the stores becoming half of half or a quarter of the total. What are the limitations you think or risks to that trajectory of growth for the store? And if it doesn't come through how are you thinking about reverting spending or redirecting spending and sales development back towards named account direct and channel?"
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. So you asked a couple of questions there. So let me let me start on the infrastructure questions. So, no, we're not going to be breaking out the business or providing any more color on what's percentage. But what I can tell you is that we've made some deliberate investments in rail and road, some of those have already shown up this year, more we're going to show up early next year that are targeted at where we believe some of the sweet spots in spending are going to be in areas where we have strength. You might have also noticed that we moved similar Civil 3D into the BIM 360 design environment. So now the same collaborative power that we have on Revit models is available for Civil 3D models. That's important. That was something that customers were looking for. And another thing we're doing that you'll start to see progress on is this notion of a common data environment, which is really important to infrastructure projects. And it's important to particularly infrastructure projects in Europe, but even in the U.S., people are really interested in these ISO-compliant, common data environment. That's going to be showing up really soon as well. So we have made some clear targeted investments that we believe allow us to go where the real opportunity is in that space. And on top of that, if you've been following what's happening with InfraWorks that products really growing up. And it's integration with Esri, and some of the things we've done there are actually pretty compelling and pretty interesting. Now with regards to the long-term targets, alright, so you're right. Right now about we're at 30% between direct and indirect. And the reason for that is not that the stores growing. The store is growing a lot, all right. It's still our fastest growing channel in the Company, okay? So, our digital direct channel is still the fastest-growing channel in the company. It's a fastest growing. Why isn't it showing more progress towards the goal? The truth the matter is, is that the channel grew well, too, all right. It grew robustly. And I think we should all celebrate that. And at the same time what happens is because right now the store is essentially majority an LT channel. That's not totally true because we sell the whole portfolio there. And we capture a lot of construction solutions usually direct. It's margin neutral right now, because the margin we make off of LT to the channel into the stores the same. So we're getting the same economics. That said, I'm not backing away at all from the 50-50 split or the 25 -- the half of that direct being from the digital direct channels. We're still going to achieve that. Remember, I always characterized that as a long-term target. And there's lots of things that haven't lit up yet that are going to help with that. Things associated with piracy recapture things associated with construction. There's a whole set of things over the next few years that are going to go into tip the balance on that number. So we're still confident. We're getting the economics we want. So we're getting the price realization. We want especially on the things that would most likely go digital direct. So we are still committed to that mix long term."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "You're welcome."
},
{
"speaker": "Scott Herren",
"text": "Thanks Jay."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Matt Hedberg with RBC Capital Markets. Your line is open."
},
{
"speaker": "Matt Hedberg",
"text": "Hi guys. Thanks for taking my questions. The results of converting non-compliant users was impressive. I guess, first of all, was this the best quarter for converting these non-compliant users? And then on a go-forward basis should we expect more of the same as this cadence or are there additional steps that can, in fact, convert even more of these users?"
},
{
"speaker": "Andrew Anagnost",
"text": "So Matt, here here's a few things I wanted to characterize there. First off, we're absolutely on the plan that we always intended for this model. Every year we're taking a set of steps that we believe we are going to materially improve our penetration into the non-compliant base. And every year there'll be a set of new steps that we believe will provide some additional ramp-up in that space as well. So what do we do this year? We rolled out in product communication and tracking of how the priority of user journey -- the non-compliant user at journeys through the lifecycle of learning their non-compliant and what options they take as they travel through that cycle. We introduced those things we rolled it out throughout the year across more and more countries. And yes, we're seeing results that we expected primarily through two things. One, we're increasing better leads to our inside license compliance teams and we are converting people digitally as well through some of the digital communication. But the digital communication also creates these better leads. To put in context we have to kind of get a sense for what happened. Last year we did 21 deals over $500,000 in piracy whole entire year, 21 deals. In Q3 alone we did 19 deals over $500,000. So you can see yes, we are seeing increases in momentum. And there's a whole slew of things that we'll talk about later. There will be doing next year that will provide us to not only get even more intelligence on this space but make it more challenging for the base to jump to another pirated solution. Okay? And that will be a discussion for later. But this is to plan. Every year there's something that rolls out and every year we seem to be getting the results that we want from this program. And given what we know we're doing next year we feel confident we're going to continue to get the results we expect to get."
},
{
"speaker": "Matt Hedberg",
"text": "Super helpful, Andrew. And then maybe, Scott just a quick one for you. On the multiyear renewals it's good to hear that, these are renewing closer to list price. Just a quick question, I wonder if you could comment on the churn you're seeing for these? Is it about what do you expect? That piece would be helpful."
},
{
"speaker": "Scott Herren",
"text": "Yes. Matt it is. And to be clear what I was talking about it is if you remember in Q3 of fiscal 2018, as we started down this path of selling nothing but subscriptions, we offered a promotion for legacy customers turning in your perpetual license. And for a 50% discount you can get three years of the same product on product subscription. That was actually quite a successful. If you remember we get over 40,000 of those. That three-year term came due during this last quarter. While we saw, we expected there to be a higher than normal churn rate and we didn't see that. But the aggregate value of that customer set actually grew. So I think the promotion was quite successful. I've got people to try to move over to the product subscription and the aggregate value after renewal and they renewed closer to list, not in a 50% discount grow over that timeframe. So it was successful, but it did create a little bit of a headwind on our volume renewal basis."
},
{
"speaker": "Andrew Anagnost",
"text": "On a unit basis."
},
{
"speaker": "Scott Herren",
"text": "On a unit basis. Remember we started talking about renewal also as net revenue retention rate or sometimes I'll call it in our three -- and our three for the quarter continued to run in that 110% to 120% range overall. So this was -- it was accretive to that metric."
},
{
"speaker": "Matt Hedberg",
"text": "That's great. Well done guys. Thanks Matt"
},
{
"speaker": "Scott Herren",
"text": "Thanks, Matt."
},
{
"speaker": "Operator",
"text": "Keith Weiss with Morgan Stanley. Your line is open."
},
{
"speaker": "Hamza Fodderwala",
"text": "Hey guys. It's Hamza Fodderwala in for Keith Weiss. Thank you for taking my question. I just wanted to go back to the fiscal 2020 ARR outlook. So it looks like it was lower by about a 0.5 at the midpoint part of that was FX. And some of that was upfront revenue. Any sense that we could get for the magnitude of the greater upfront revenue because I mean to me it seems like the macro situation in Europe and North America was sequentially better. So I guess why wouldn't that carry forward into Q4 and reaffirmed the 25% to 27% growth outlook that you gave last quarter?"
},
{
"speaker": "Scott Herren",
"text": "Yes. Tom, the amount of upfront revenue that moved from Q4 back into Q3 was about 5 million. So that was -- that contributed to the upside in Q3 revenue. But remember the way we do ARR, subscription revenue times four. That by itself was a $20 million headwind to ARR in the fourth quarter. The fact is – but remember, that's upfront revenue. So there is no tail of deferred once we put that in. And because of 606 we have the claim all that revenue upfront. There is no Q4 impact of those. It just moved from Q4 back into Q3. That you see the full-year revenue. We see we've guided that point up, because float revenue is an accumulated metric. It's one plus Q2 plus Q3 plus Q4. ARR just taken a snapshot of Q4 subscription and maintenance revenue and multiply by four. So the midpoint of that ARR guidance change was $30 million. Twenty of it was just driven by this effect was about $5 million of incremental headwind from FX and about the same amount of just product mix. Does that does that clear up in your mind the move from Q4 back to Q3 and why it's an impact to ARR?"
},
{
"speaker": "Hamza Fodderwala",
"text": "Yes. So i guess ex those changes, would ARR growth have been sort of reiterated if it wasn't for those onetime impact?"
},
{
"speaker": "Scott Herren",
"text": "Absolutely. Exactly. And the interesting thing about this Tom is, the economics of our business by the way are completely divorced from the rev ramp issue that we're talking about. The economics of the business are unchanged. It just between having the claim that as non-ratable upfront revenue and moving it back into Q3, and the way we define ARR as quarterly revenue. It's that combination that drove the change in Q4 ARR."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. This is an interesting collision between the way we define ARR and the 606 accounting rules."
},
{
"speaker": "Hamza Fodderwala",
"text": "Yes. It's always exciting. So I guess just one quick follow-up. So the billings obviously came in much stronger than expected. To what extent is the shift to multiyear deals performing better than you expected coming into the year? And should we expect that long-term DR mix to continue trending higher because it's already kind of around the mid-20% range of total that we've seen historically? That's it for me."
},
{
"speaker": "Scott Herren",
"text": "Okay. Thanks for that too. Billings growth at 55% and over a $1 billion of billings in Q3 super strong. And the biggest factor driving that is the growth of our renewal base. That has nothing to do with multi-years. Is just the overall growth of renewal base. Beyond that the contribution from our construction business, construction continues to perform really well. With the noise around the ARR guide, we haven't really focused on the success of our construction business as much as we probably should have. It continues to perform really well and it's driving upside to our billings as well. Multi-year is part of it and you're right, we're already add long-term deferred at about 25% of total deferred. If you go back historically by the way, back into fiscal 2017 and 2018 before we began this transition, by long-term deferred ran as high as 30% of total deferred at one point. I don't think it gets back to that level. I think we keep it in this low to mid-20% range in terms of long-term as a percent of total. To the extent that it ran hot and I said this earlier in other words we were selling more multi-year than I thought we could sustain longer-term. I'd like to make a change in the offering. What I don't want to do is drive volatility and free cash flow because of the offering we've got out there for multiyear. At this point I don't think we've done that. But if it continued to accelerate that something we take a look at."
},
{
"speaker": "Hamza Fodderwala",
"text": "Thank you very much."
},
{
"speaker": "Scott Herren",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brad Zelnick with Credit Suisse. Your line is open."
},
{
"speaker": "Brad Zelnick",
"text": "Great. Thanks so much for fitting me. Andrew, you highlighted the launch of Autodesk Construction Cloud at AU this year. What excites you most about the offering? How is the customer feedback into the launch? And how do you see it driving growth next year?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. What excites me a lot about this is the way we are unifying the whole entire stack around this common data environment and it's a real great return on the investment we made in BIM 360 docs, because that entire environment is becoming the common data environment and PlanGrid integrating into it, BuildingConnected integrating into it. The existing BIM 360 stack has already integrated into it. And everybody is looking at this insight internally within the development saying wow this is this is an amazing opportunity for us to bring these things together. So the whole ability to have a conversation with the customers about here's the umbrella brand and how we're bringing all these things together so that they actually communicate is a really exciting part of this. And I think it's going to come rapidly and customers are going to be delighted. When we rolled it out there were 50 new enhancements and there's a reason why those 50 new enhancements were in there is because we invested in acceleration of the integrations with respect to some of these things were moving faster not slowing down. I'm really excited about the pace of what's going on. I'm excited about what the team has been doing. And I'm frankly excited about how well we're winning in the market. People look at what we're doing. They look five years out at the landscape and they say okay I'm going to place my bet with Autodesk. And I think that's a credit to the team. I guess, credit to the momentum they've kept in here. And I think the whole story around construction cloud and the way they rolled it out and told you it is really a great piece of work by the team. So I'm really proud of them."
},
{
"speaker": "Brad Zelnick",
"text": "Awesome. And Andrew, if I could just add another one for you. Your results seem to demonstrate continued success in executing on M&A. How should we think about your appetite for additional deals in both construction and manufacturing?"
},
{
"speaker": "Andrew Anagnost",
"text": "Well, we've always said that as we look out to the business we will continue to be acquisitive as we were in the past at the very least. We always look at the market for organic and inorganic opportunities. Right now we feel like our construction portfolio has most of what it needs. We're partnering aggressively. We could potentially do tech tuck-ins around the construction solution. As we look into other parts of the market you know we'll just have to wait and see. What you see as we've demonstrated an ability to capture significant inorganic targets integrate them and turn them into results. And I think that's one of the things you should notice regardless of whatever we do in the future that we become a serious machine around focusing around what are the real inorganic opportunities, how do we bring them in and then how do you make them successful. And that's our commitment to our customers and to the market."
},
{
"speaker": "Brad Zelnick",
"text": "Excellent. Thanks so much."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Brad."
},
{
"speaker": "Operator",
"text": "Thank you. And our last question comes from Jason Celino with KeyBanc Capital. Your line is open."
},
{
"speaker": "Jason Celino",
"text": "Hey guys. Thanks for taking my question. Building off the last question about the construction cloud announcement, sounds like it's more of a branding grouping all your portfolio products. But what was some of the initial customer feedback that you've heard?"
},
{
"speaker": "Scott Herren",
"text": "Yes. The customer feedback has been really solid and here's why, because if the customers don't react to the branding, they don't spend a lot of energy on that, but they do is they react to what we do. All right. So we like the branding because it helps us communicate simply. We were not propagating multiple brands out there. It allows us to focus our go-to-market efforts. It allows us to communicate more precisely at the company. The customers pay attention to what have you done for me. And what they were excited about at the Connect and Construct Event and all the discussions there is the feature velocity. All right. They're seeing us delivering on the integrations that we said we were going to deliver and there are watching us closely. Every quarter they're going to see, do we do we say we're going to do? Do we do we said we were going to do. So that's what the customers are excited about. They really loved the fact that we're integrating to a common data environment and we're building an ISO standard excepted common data environment. That's something that everybody gets us sums up on. They're really excited with the increased scalability and performance on BIM 360 design which was an area where they were kind of pushing on us a little bit. So those are the kind of things that customers are paying attention to. The branding makes it easier for us to tell the world what we are doing, so that you're going to see us basically amplify that, but the customers care about what we do not what we say."
},
{
"speaker": "Jason Celino",
"text": "Great. Appreciate the color. Thank you."
},
{
"speaker": "Scott Herren",
"text": "Thanks Jason."
},
{
"speaker": "Operator",
"text": "Thank you. And that ends our Q&A session for today. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 2 | 2,020 | 2019-08-27 17:00:00 | Operator: Good day, ladies and gentlemen, and thank you for your patience. You've joined Autodesk Q2 Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Abhey Lamba, VP of Investor Relations. You may begin.
Abhey Lamba: Thanks, Operator, and good afternoon. Thank you for joining our conference call to discuss the results of our second quarter of fiscal '20. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can also find our earnings press release and a slide presentation on our Investor Relations Web site. We will also post a transcript of today's opening commentary on our Web site following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results, and strategies. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance, and unless otherwise noted each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in the press release of slide presentation on our Investor Relations Web site. And now, I would like to turn the call over to Andrew.
Andrew Anagnost: Thanks, Abhey. Our great momentum from the first quarter carried into the second quarter resulting in strong performance with revenue, billings, earnings, and free cash flow coming in ahead of expectations. We also crossed the $3 billion mark on ARR for the first time, which was driven by solid performance across all regions and products. Our last 12 months free cash flow of $731 million is the highest amount of free cash flow we have ever generated in a four-quarter period in the company's history. We performed well in the first-half of the year demonstrating focused execution and the strength of our recurring revenue model. Although we continue to execute well and are not materially impacted by current trade tensions and macro conditions, we are aware of the current business and geopolitical environment that is causing uncertainty in the market. As we look across the next six months, we are taking a prudent approach to our outlook for the remainder of fiscal '20. However, we think the uncertainty caused by macro-related events is only a short-term issue. We remain confident in our ability to achieve the fiscal '23 goals we have laid out for you. Our confidence is grounded in the value delivered by our products, their ability to help our customers differentiate via innovation and digitization, focused execution delivered by our partners and sales teams, and the significant strides we are making to capture the non-paying user community. I would also like to point out that although there are headlines of some impact from the current environment on a few industry verticals, like manufacturing, we outgrew competitors and gained share in this space. The construction industry is also holding steady, and continues to invest in innovative solutions, and we saw ongoing strength in construction this quarter. Before I offer you more color on strategic highlights during the quarter, let me first turn it over to Scott to give you more details on our second quarter results, as well as details of our updated fiscal '20 guidance. I'll then return with further insights on the key drivers of our business, including construction, manufacturing, and digital transformation before we open it up for Q&A.
Scott Herren: Thanks, Andrew. As Andrew mentioned, revenue, billings, earnings, and free cash flow all performed ahead of expectation during the second quarter. Overall demand in our end markets was solid during the quarter, as indicated by our strong billings and revenue growth. Growth was driven by both volume and pricing, which is a result of the strong uptake of our products by new users, as well as increased usage with existing customers. Sales volume of AutoCAD LT also remained strong. This has historically been a leading indicator of potential demand slowdown. And as you can see, revenue from our AutoCAD and AutoCAD LT products grew 31% in the second quarter. AEC and manufacturing revenue rose 37% and 20% respectively. Geographically we saw broad based strength across all regions. Revenue grew 32% in the Americas, 27% in EMEA, and 33% in APAC, with strength across almost all countries. We also saw strength in direct revenue, which rose 38% versus last year, and represented 30% of our total sales, up from 28% in the second quarter of last year. Before I comment on ARR, I want to remind you of how we define it. ARR is the annualized value of our actual recurring revenue for the quarter, or said another way, is the reported recurring revenue for the quarter multiplied by four. Total ARR of $3.1 billion continued to grow steadily, and was up 31%. Adjusting for our fourth quarter acquisitions total ARR was up 27%. Within core, ARR growth was roughly in line with total organic growth, and was driven by the strength in product subscriptions. In Cloud, ARR grew 175%, propelled by our strong performance in construction. Excluding $98 million of ARR from our fourth quarter acquisitions, growth in organic cloud ARR, which is primarily made up of BIM 360 and Fusion 360, increased from 43% in the first quarter to 45%, which is a record for that product set. We continue to make progress in our Maintenance to Subscription, or M2S program. The M2S conversion rate of the maintenance renewal opportunities migrating to product subscriptions was in the high 30% range in Q2, which is higher than our historical rate. This uptick in the conversion rate was in line with expectations as our maintenance renewal prices went up by 20% in the second quarter, which made it significantly more advantageous for customers to move to subscription. Of those that migrated, upgrade rates among eligible subscriptions remain within the historical range of 25% to 35%. Now, moving to net revenue retention rate, during Q2 the rate continued to be within the range of approximately 110% to 120%, and we expect it to be in this range for the remainder of fiscal '20. As a reminder, the net revenue retention rate measures the year-over-year change in ARR for the population of customers that existed one year ago or base customers. It's calculated by dividing the current period ARR related to those base customers by the total ARR from those customers one year ago. Moving to billings, we had $893 million of billings during the quarter, up 48%. The growth in billings was driven by strength in new customer billings and strong renewals with continued momentum in our core products. And as we have said in prior quarters in line with our plans, billings are also benefiting from a return to more normalized levels from multi-year agreements. Remaining Performance Obligations or RPO, which in the past we have referred to as total deferred revenue is the sum of both billed and unbilled deferred revenue, and rose 28% versus last year, and 3% sequentially to $2.8 billion. Current RPO, which represents the future revenues under contract expected to be recognized over the next 12 months was little over $2 billion, an increase of 23%. On the margin front, we realized significant operating leverage as we continue to execute in the growth phase of our journey. Non-GAAP gross margins of 92% were up two percentage points versus last year. Our disciplined approach to expense management combined with revenue growth enabled us to expand our non-GAAP operating margin by 14 percentage points to 23%, while absorbing two meaningful acquisitions. We realized significant leverage from our investments in sales and marketing and R&D initiatives during the quarter, and are on track to deliver significant margin expansions in fiscal '20 and further expand non-GAAP operating margin to approximately 40% in fiscal 2023. Moving to free cash flow, we generated $205 million in Q2. Over the last 12 months, we've generated a record $731 million of free cash flow, driven by growing net income and strong billings. Lastly, we continue to repurchase shares with our excess cash, which is consistent with our capital allocation strategy. During the second quarter, we repurchased 253,000 shares for $40 million at an average price of $159.54 per share. Almost all of our repurchase activity during the quarter was through our 10b5-1 plan, which we entered into before the most recent market volatility. Now I'll turn the discussion to our outlook. I'll start by saying that our view of global economic conditions and their impact on our business has been updated to reflect the current state of various trade disputes and the geopolitical environment and their potential impact on our customers. While we have not seen any material impact to our business, we are taking a prudent stance regarding customer spending environments in the U.K. due to Brexit, Central Europe due to a slowdown in the manufacturing industry there, and China due to trade tensions. These items individually are not material headwinds, but in aggregate are responsible for our guidance adjustment, which now reflects our current views based on what we know about the environment today. Our pipeline remains strong globally, including in these regions, we began noticing some changes in demand environments in these areas toward the end of July. As such, for these affected areas, we feel it's appropriate to adjust our expectations for the rest of the year. As you'll soon hear from Andrew, customers continue to increase their spending on our products even in these areas and our renewal rates are fairly steady. Additionally, we are now assuming more billings will occur later in the quarter for the remainder of the year. At the midpoint of our updated guidance, we're calling for revenue and ARR growth to be approximately 27% and 26% respectively, which speaks to the resiliency of our model versus prior cycles. The wider the normal range of our full-year guidance is a result of the greater uncertainty we're expecting over the second-half of the year. Additionally, currency now offers a headwind of about $10 million to our full-year revenues versus being neutral at the beginning of the year. As such, the low-end of our updated constant currency guidance is in line with the low-end of our initial outlook we shared with you at the beginning of the year, and it also reflects the potential for a slight deterioration in the environment from the current level. While our billings guidance has come down by about $50 million, billings are still expected to grow by approximately 50% or 40% after adjusting for the adoption of ASC 606 last year. This supports our view of strong demand for our products even in uncertain environments. Regarding free cash flow, the $50 million adjustments to $1.3 billion is primarily a result of our updated view of billings and their timing. We expect to achieve our original target of $1.35 billion trailing 12 months free cash flow during the first quarter of fiscal 2021, and while it's too early to give you a detailed color on fiscal 2021, we expect to continue growing billings, revenues, and free cash flows while expanding our margins. This is supported by what we're seeing in North America, especially in AEC, where our pipeline remains strong and we have more visibility into our business within Central Europe and China. Construction is also performing very well as we continue to increase the value we're bringing to our customers, and we continue to make strides with capturing revenue from non-paying users. Looking at our guidance for the third quarter, we expect total revenue to be in the range of $820 million to $830 million and we expect non-GAAP EPS of $0.70 to $0.74. Third quarter free cash flow is expected to be modestly above second quarter. The earnings slide deck on the Investor Relations section of our Web site has more details, as well as modeling assumptions for fiscal '20. In summary, I want to remind everyone that since our business model shift, we have moved to a much more resilient business model that generates a very steady stream of revenue that is less exposed to macro swings than when we were selling perpetual licenses. So while we are adjusting our fiscal '20 guidance slightly, we're still expecting revenue growth of 27% for the year, margin expansion of about 12 percentage points, and we're confident of delivering on our fiscal '23 targets. Now I'd like to turn it back to Andrew.
Andrew Anagnost: Thanks, Scott. As you heard me, we delivered very strong performance in the first-half of the year, and despite negative headlines from Europe and manufacturing, we are still seeing strong demand for our solutions. For example, a large European automobile company recently signed a new three-year Enterprise Business Agreement or EBA despite a more challenging macro backdrop for their industry. They see the new agreement as an investment design, and they know innovation is needed to stay ahead of the competition. They view Autodesk as a market leader in this area and counting us to provide new innovative design solutions such as generative design. The EBA also offers for them the flexibility to access our entire product portfolio, including products ranging from manufacturing and agency collections to Alias, 3Ds Max, Maya, and Walt, while at the same time representing a more than a 130% increase in annual contract value for us. We will continue to partner with them to ensure that they get maximum value out of our products and remain a leader in an industry that is undergoing significant change. Our customers know that at the end of every downturn is an upturn, and if they don't continue to innovate and use the latest technology tools throughout the cycle, they will be at a distinct disadvantage when growth returns. This underscores the importance of our products regardless of the macro environment as well as our customer's commitment to investing in technology to stay ahead as competitors. Now, let me give you an update on some key strategic growth initiatives, we are focused on, specifically our continued traction with construction, gains in manufacturing, and leveraging our digital transformation to capture the opportunity within our non-paying user base. These initiatives are key drivers of both our near and long-term business. In construction, BIM 360 was the primary driver of our organic growth in cloud led by BIM 360 Design & Build. Our customers are continually finding value in this offering, and the PlanGrid team continues to see strong momentum. For example, Tutor Perini, one of the largest general contractors in the U.S. selected PlanGrid over some competitor offerings for two 500 million key projects. The team wanted to provide real-time up-to-date documentation and plans to the field. Senior management for these projects had used PlanGrid before at a different firm, and this relationship provided an opportunity to demonstrate plan for its capabilities for these two projects. PlanGrid set up the projects by processing the drawings and pulling out title block information categorizing the drawings with tag and hyper-looking detail call-outs for 2,000 drawings in under an hour. This was an immediate time savings for Tutor Perini. Additionally, the field teams have access to new drawings, changes, RFIs, and some middles right away, and an easy-to-use interface. Going forward, we continue to look for opportunities to partner with Tutor Perini across all of their products and subsidiaries. BuildingConnected and Assemble also performed well as we continue to focus on integrating these offerings. During the quarter, we integrated BuildingConnected's bid management solution with PlanGrid technology, enabling the seamless transfer of data from pre-construction to the building process. The integration allows construction project managers to automatically push design and pre-construction files from BuildingConnected to PlanGrid, saving time, reducing errors and further enhancing the cost savings associated with using both platforms. And as you recall, we integrated Revit with PlanGrid with the launch of PlanGrid BIM last quarter and have received tremendously positive feedback from customers regarding the update. In the first quarter after its release, the product is also being used in over 650 projects by more than 300 customers. These integrations are steady steps towards providing Autodesk construction customers with integrated workflows that connect the office, trailer, and field. We are also continuing to see outstanding cross-selling with our recent construction acquisitions. For example, during the quarter, [indiscernible], an existing Autodesk customer expanded its relationship by adding BuildingConnected and Assemble solutions to reduce the time to open new locations and downtime to the construction updates and existing locations. And as a reminder, infrastructure is an area that we have seen in the past performed well during macro-related slowdowns, and we continue to focus efforts in this area. This quarter we secured a new Enterprise Business Agreement with Gannett Fleming. Gannett Fleming is a leading global engineering and architecture firm ranked Number 35 on the ENR top 500 design list. The Gannett Fleming Executive team considers a strategic partnership with Autodesk to be a distinct competitive advantage. With the EBA, Gannett Fleming now has direct access not only to the full portfolio of Autodesk technology, but also to a wide range of Autodesk services and expertise that will help them achieve their corporate growth and market expansion goals. On the manufacturing front, revenue grew 20% in the second quarter, despite a more challenging manufacturing environment in Europe. Customers are seeing the benefits of our differentiated solution, and we continue to gain market share, while displacing competitive offerings in this space. For example, during the second quarter, a leading Swiss watchmaker selected Autodesk design and manufacturing collection to replace SolidWorks, given the flexibility offered by solutions. In addition, our investments in general design and Fusion 360 have resulted in competitive displacements not only in the CAD market, but also in the Computer Aided Manufacturing or CAM space with our lower barrier to switching vendors. As a result, we see displacements of competitors like Mastercam, and once we're embedded in those customer's downstream processes, we are increasingly penetrating design activities within those same accounts. Customers pick Fusion over competitive offerings due to its integrated CAD/CAM functionality, its compatibility with other CAD tools, ease-of-use, and attractive pricing model. Now let's talk about progress with our digital transformation. Many of you recall that a key part of this transformation will increase the insight we have on our non-compliant user base. One of the initiatives we undertook to accomplish this started last year and has given us the ability to analyze usage patterns of our non-compliant users. Since last year, we have analyzed significant amount of data on these users, including how long they use the software and how their journey traverses across non-compliant usage to downloading free trials or using student additions. With this data, we can test different ways to convert them, including in-product messaging and leveraging our inside sales team. While still early in the conversion process, we have an increasing amount of data that allows us to take necessary actions to convert this large pool of potential customers. In the quarter, we expanded our pilot cases for in-product messaging to many international regions, and enhanced our license compliance initiatives using our sales teams as well as being email campaigns. These conversions resulted in multiple deals, including two over a $1 million, one of which was in China. Our billings from license compliance initiatives were up by approximately 65% versus last year, although on a small base. So, as you've heard, we made great progress this quarter that enabled us to finish the first-half of the year strong. We continue to execute well in construction, where IT spending remains strong. We are making competitive inroads and manufacturing with our innovative solutions and are making strides in converting the current 14 million non-paying users into subscribers. We are highly confident in Autodesk's ability to capitalize on our large market opportunity, and are committed to delivering our fiscal '23 goals. With that, Operator, we'd now like to open the call for questions.
Operator: Thank you, sir. [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your line is open.
Saket Kalia: Hi, guys. Thanks for taking my questions here.
Andrew Anagnost: Hi, Saket.
Saket Kalia: Hey, Scott. Hey, Andrew. Hey, Andrew, maybe just to start with you, slightly higher level question on the macro, I know we spoke about some of the regional items that we've seen, whether it was the U.K., China or Central Europe, but I want to maybe think about the macro from a different lens. Clearly a lot of concern out there about the manufacturing economy, and as we know, not all of Autodesk's business is levered to the manufacturing space, but for the part that is, can you just give us some color on the verticals that Autodesk sells into, whether that's auto or aerospace for example, just to sort of get a sense for where Autodesk kind of sits with regards to different sub-segments of manufacturing specifically?
Scott Herren: Hi, Saket. Before we jump into that, I'd like to clear out something. We've heard that there's some confusion in our guidance metrics from the press release footnotes. So, and what our current guidance for free cash flow for fiscal '20 is $1.3 billion, we get there by saying free cash flow -- or cash flow from operations will be $1.37 billion, you'd net out $70 million of free cash flow to get to $1.3 billion. So, I think the footnote created confusion that the $1.3 billion wasn't already netted for CapEx. It is. So it's $1.37 billion before CapEx as cash flow from ops, $1.3 billion is the free cash flow guide for the year. Okay, go ahead.
Saket Kalia: That's helpful. Thanks, Scott.
Andrew Anagnost: Yes, it's good to clarify. So, let me address your question about verticals in manufacturing in particular. All right, first off, just let me just frame a few things. Our manufacturing business actually did pretty well. We grew 20%, a lot better than any of our competitors. That has a lot to do with the way we're diversified. It also has a lot to do with the price points and the upfront -- the reduced upfront cost of our offerings are pretty attractive to a lot of people, and we're also seeing acceleration in the CAM space due to the Fusion 360 portfolio and the way it integrates design and CAM along with the generative capability. So, we're seeing pretty strong performance in manufacturing, but to your point about which verticals we are exposed, our biggest vertical in manufacturing is what we call industrial machinery, and this is machinery of all manner and type. It's machines you'll see inside automotive factories, but it's also machines you see that package cereal or to wrap toys, or to do any manner of things, make paper, and large industrial machines. It's our single biggest segment. Another really big segment for us is what's called building product manufacturers, and these are the people that build things that go into buildings, and they're also the people that build things that hang on buildings and prefabricate components of buildings, so think doors and windows manufacturers, think air conditioner manufacturers, think curtain wall manufacturers if you understand how skyscrapers are made. Our smallest level exposure is actually in the auto and aero space, where other competitors have deeper exposure in terms of the engineering processes. We are definitely big in auto in some of the more forward-looking aspects of the auto industry. So we're embedded deep in the design departments, which are several years ahead of where the current production is and where production volume is. And we're also working closely with a lot of autos and some of their next generation production workflows. I think you've seen some of the things we've been talking about with generative with regards some of the work we've done with GM and some of the other automotives to kind of help consolidated multiple parts in multipart assemblies into a single 3D printed part. And we're definitely engaged in some of that work, but that's some of the hierarchy of exposure we have to manufacturing. Make sense?
Saket Kalia: That does. That's really helpful. Scott, maybe for you for my follow-up, a little bit of a different topic, but I'd love to talk a little bit about the remaining maintenance business. Obviously this is the last year of M2S price increases, as you've mentioned before. And that maintenance ARR sort of continues to decline in that high 30% range. How do you sort of think about that decline in coming quarters? And maybe just speak to sort of the profile of your remaining maintenance customers. I guess with the last 25% price increase should we sort of start to see a step up in that maintenance base decline or should we kind of think about it kind chugging along the way it has so far. Any color there would be helpful.
Scott Herren: Yes, sure, Saket. So this is the year -- by the way, it's a 20% price increase, not 25%. But Q2 is the first full quarter that that third price increase that we announced three years ago, it went into effect at the beginning of Q2. This is our first quarter with that, and we actually had some interesting results. The conversion rate of -- maintenance rates that came up for renewal actually increased, which is what you'd expect with the staying on maintenance going up 20%, from what had been about a third of those that come up for renewal converting to something in the high 30% range for the quarter. So conversion rate increased, as expected. Interestingly for those that did elect to stay on maintenance, and some do, the renewal rate actually ticked up. I would've expected with the increase in price it to stay flat or maybe even decline, it actually, the renewal rate for maintenance for those that did not convert actually it ticked moderately, but ticked up slightly in the quarter. So we're seeing the exact same -- the behavior we expected when we laid out the M2S program. And at this point it's -- we have three more quarters to go, it'll actually overlap into the first quarter of next year before it's finished.
Saket Kalia: Got it. Very helpful, guys. Thanks.
Scott Herren: Thanks, Saket.
Andrew Anagnost: Thank you.
Operator: Thank you. Our next question comes from Phil Winslow of Wells Fargo. Your question, please.
Phil Winslow: Hey, thanks, guys for taking my question. Thanks for the commentary on Asia-Pacific and Europe. I wondered if you'd give is more color on what you're seeing in the U.S., particularly just into the quarter and in terms of the pipeline there, and particularly by vertical, that'd be very helpful. Thanks.
Andrew Anagnost: Yes, so the Americas and the U.S., in particular, were strong. We grew 32%. Our pipeline is solid in the U.S.; it's solid across the whole Americas. Our visibility is pretty good. We're seeing broad strength across all the segments. So we're not seeing any weakening in any kind of segment or by any types of vertical. So the U.S. business is looking solid. And it continues to look solid right now and until something changes in the environment. But we saw a great visibility in our pipeline to the U.S.
Scott Herren: Phil, the other comment that's worth adding on to that is, I think there was some concern that emerging markets might have underperformed during the quarter, and it's actually -- you have to dig into the appendix of our slides that we posted on our Web site, but you can see emerging markets actually grew north of 30%. And obviously there's -- a chunk of those emerging markets are in the Americas as well. So we continue to see, with the exceptions of three areas that we pointed out, we continue strength geographically across the board.
Phil Winslow: Got it. And also in terms of the breakdown, as Saket was saying, obviously your business is sort of like a matrix internationally and then by multiple verticals, and then multiple sort of sub-verticals within inside of those verticals. When you think about just manufacturing exposure versus, let's say, your commercial construction versus media and entertainment, is there one geography that's weighed more, let's say, towards your commercial construction and one more towards manufacturing? Any sort of color in sort of the…
Andrew Anagnost: Yes, absolutely. So that's an easy place, Phil, to give some color. So, construction, we're definitely leaned more towards the U.S., there's no doubt about it. On manufacturing we're definitely leaned more towards Europe. We've historically been more successful in Europe relative to competition than in the U.S. So when you see manufacturing slow down in Germany it slows down our overall manufacturing business. So Europe is definitely where we're more exposed in manufacturing. The U.S. is definitely where the bulk of business is for construction right now, though we're growing pretty quickly internationally on the construction side as well. But that's kind of the high-level breakdown.
Phil Winslow: Okay, great. Thanks, guys.
Scott Herren: Thanks, Phil.
Operator: Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your question, please.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, a quarter ago, on the call, you made some interesting remarks regarding what you're calling your early warning system, this was in the context that you were talking about digital infrastructure and your customer engagements team. The question is, what is that system telling you in terms of some of the key metrics that it's set up for in terms of usage and other metrics. And is it thus far a U.S. oriented system or is it giving you signals globally that are helping you? And then secondly, a longer-term technology or roadmap question. I made some comments on the call earlier about your integrations thus far with the ACS acquisitions and the BIM and Revit, and so forth. What about the roadmap however between AEC and manufacturing, if you're going to pursue industrialization of construction you have to have that cross-segment integration. You haven't really spoken about it much, but perhaps you can talk about that roadmap?
Andrew Anagnost: Okay, all very good questions, Jay. So, first, let me talk about the early warning system and what it's telling us. So it is broad geographically. It tells us about multiple products in multiple geographies. And one of the things -- and what it's also intended to do is give us a predictor scores that are at risk renewals so that we go take direct action with regards to at-risk renewals. What I can tell you at a high level is it's telling us is there's no slowdown in usage of our products, right. And in fact, usage continues to grow across all types of products and all manner of verticals. So we're not seeing any systematic declines in usage or usage activity [indiscernible]. Our pirates [ph] continue to use our products robustly, and as do our paying subscribers, but remember that the core part of that system is designed to help our teams understand which one of our accounts are most at risk for renewal. And yes, you're right, we watch things like activations, we watch things like product usage, and we watch other things like access to support that allow us to kind of score these customers in terms of risk, but it's global, and we're not seeing any changes in the usage trends, usage continues to go up globally. Now with regard to integration of the construction, I think you're actually pointing to a very important area, and it's one of the things that we're really focusing on behind the scenes, and it has to do with creating some workflows for the building product manufacturers, which includes, like I said earlier, curtain wall as well as the components that go inside of buildings. So what we've been working to do is expand the interlope between Revit and Inventor, so that you can actually take low-precision models from Revit, move them into the high-precision environment of Inventor, so that you can get -- do fabrication prep for things like curtain walls and other types of manufacturing components, and then actually move them back into revenue in the low-precision world in an account slated way, so the changes that happen inside of Inventor go back and update inside of the Revit model as well. We've been improving those integrations continuously behind the scenes. You're going to see more improvements in those integrations in Q4, and a continuing roadmap next year. It's not completing fully industrialized workflows for construction, but it's a prerequisite to making sure you have a good BIM to manufacturing or 3D solid modeling workflows, so that you can actually do some of these more complex interactions between a building information model and a 3D model for manufacturing purposes. So, we continue to work on those Revit and Inventor integrations, and you'll see acceleration in that area.
Jay Vleeschhouwer: Okay. Thanks, Andrew.
Andrew Anagnost: Thanks.
Operator: Next question comes from Heather Bellini of Goldman Sachs. Your line is open.
Heather Bellini: Great, thank you. Just a couple of questions here, Andrew, I just want to make sure that your tone and your conservatism, it seems like you're not seeing the weakness here, so to speak, but you're just being more conservative in your outlook. I just want to confirm that that's how we should be reading your comments. And then, I guess one of the other questions would be how we see growth trending, and churn and see growth, which may be a precursor to a slowdown if you think of the fact that your products are deployed as increased deployment as people are hired into the industry? And then I guess the follow-up from there would be just from a linearity perspective after last quarter when you said linearity was a little bit more backend loaded, I know you guys were going back to, assuming the same linearity in Q3 this year that you did last year, is that where it actually came out of? If you can give us some color there, that'd be great. Thank you.
Andrew Anagnost: All right. So, what I'll do is I'll answer your middle question first, then I'll answer your first question, second, and I'll let Scott answer the third, okay?
Heather Bellini: Thank you.
Andrew Anagnost: So, your middle -- it's okay, see growth ensuring, no change, all right. We're seeing the same kind of see growth, where our renewal rates are solid. In some places, we are seeing improvements. So, all of those trends are consistent right now with a fairly steady environment. Like we said earlier, we've seen some indications in certain specific markets that lead us to be a little bit more cautious, particularly Germany and manufacturing, U.K. and Brexit, and you know, the state-owned enterprises in China, we simply cannot engage with them, and that's going to put pressure on our expectations relative to those markets. Even though emerging in China is a small part of our business, it's a small percentage. Over a couple of quarters, we could easily add up to $5 million in missed expectations, but there is a lot of noise. You can all hear it, it's all going on, there's change -- there is something new every day, all right, all you have to do is checking Twitter feed. So, there're all sorts of noise, and what you see us doing, and I want to make sure we put this in context. What we did is we took the high-end of our guidance down. So, we narrowed the range. The low-end of our guide on a constant currency basis is unchanged. So, this is a prudent narrowing of the range to kind of reflect this noise we're seeing in the system. I think it's the right thing to do right now. I think it's appropriate, but even if you look at the worst case scenario on all of that, worst case scenario, we're coming in at 96%, at worst case of the numbers we set out there four years ago. I think that's pretty good. That's not just great modeling. It's actually great execution in flexible and adaptive execution, and it's that ability to kind of track the business to that kind of fidelity that gives us a lot of confidence in terms of what we're looking to see out in FY '23, and I want to make sure just since you asked the question, I want to reinforce a few things that are really important drivers around some of this stuff. First off, one just side comment, we could easily do some unnatural acts to hit that free cash flow number at what we stated previously in the last call. You wouldn't want us to do that. I have no interest in pushing an agenda in that direction, and we're just simply not going to do it. It's not good for the business, it's not good for the long-term health and for the long-term prospects of the business, and we have to pay attention to the long-term prospects of the business. So we're not going to do any a natural things to try to drive that free cash flow number up, and I think that's an important point. But the resilience in the model, because remember, as we move into next year the model transition is done, and we've got the resilience in the model us look out to FY '23, but look at just how the midpoint of the guide changed, half of that is due to currency FX, okay, a total complete short-term impact on our business. The other thing I wanted you to be aware of in terms of what's kind of guiding us with the conservatism, and we're at pipeline solid, we're looking out pipelines, we've got more visibility to our business than we've ever had before, the pipeline looks good in countries where we're historically having problems. I think you might remember a year ago we talked a lot about Japan, Japan is doing great. So, we're seeing things like that, but more importantly, as we look out beyond the FY '20 guide into some of the FY '23 things, construction is doing really well. We believe the construction is going to continue to do well during the downturn, IT spending construction continue to grow during the downturn last time. In '07 and '08, Revit continued to grow for us. I think you're going to see that same thing, our performance on non-compliant users is getting better and better, and also, let's just say there was a protracted downturn. Something interesting happens in those downturns, infrastructure spend tends to go up. We've gotten in front of that. We've done some things in our core design products and our construction portfolio to ensure that we're good partners to the infrastructure business. So, we intend to capitalize on any infrastructure spend that could come out of a protracted downturn. So, you're right, we are simply being conservative and we're being prudent, because of the noise out there in the system and because of the weakness we saw in some places, where they can have impact on our expectation, was correct. We're growing robustly in all those places. We just have higher expectations for those places, and I think it's the right time to make that kind of adjustment, and it's all short-term, but we're still very confident about what we can do in FY '23.
Scott Herren: And Heather, I think the other…
Heather Bellini: Yes, Scott.
Scott Herren: Yes, in other part of your triple questions, that was around linearity, and I think the thing that we are seeing in linearity, and again in Q2, which was consistent with our expectations in Q2 was more sales are happening a little bit later in the quarter than what we had experienced in the second-half of fiscal '19. So, it's more like the traditional linearity that we had in the first-half of fiscal '19, and that's now built into our forecast for the second-half of this year. So it has a couple of effects when you do that obviously, and Andrew has talked about this a big chunk of the adjusted in our guidance is all tied to FX, but holding out aside, as linearity pushes on a little bit, it has an effect on billings, where billings covered layer in a quarter, and then you end up collecting some of those billings is kind of during the current quarter and the following quarter. So there's a little bit of an effect on billings and an effect on free cash flow as well from linearity, but that's the way to think about it. The midpoint of the guide is 27% revenue growth, midpoint of the billings guide is 40% growth even normalized for the 606 implementation at the beginning of last year, and the midpoint of the guide is 12 points of margin expansion. So it's a strong year. We continue to feel good about the momentum in the business.
Heather Bellini: Great, thank you so much.
Scott Herren: Thanks, Heather.
Operator: Thank you. Our next question comes from Gal Munda of Berenberg Capital Management. Your line is open.
Gal Munda: Hi, thank you for taking my questions. The first one is just in the manufacturing side. We see the manufacturing is going below the AEC part of the business, and I was just wondering if it's macro-related or is it maybe got something to do with the comments you made around the shift to the new platform, you mentioned that Fusion 360 is gaining market share, you mentioned that Fusion 360 is growing very, very strongly, and I'm wondering whether Fusion 360 by taking market share is also potentially taking market share from some older solutions, they have like Inventor, which might provide kind of short-term headwind to the revenue there?
Andrew Anagnost: All right. So, Gal, let me let me kind of answer that and cover that. First off, we grew 20% manufacturing better than any of our competitors, all right, better than the market. So, our performance in manufacturing is actually very strong. The relative difference in the performance between manufacturing and AEC is simply due to the fact that AEC is stronger. What we're seeing in AEC is Revit is not only being adopted very robustly, it's actually being mandated, or BIM is being mandated in more and more countries and for more and more projects. Japan in particular is an interesting place, where historically BIM was slow to be adopted, and it's starting to see an acceleration of adoption, and you're seeing BIM mandates showing up in Japan as well. So I want to make sure that we understand the relative performance difference between those two things, and our performance relative to competitors in the overall market. Now, to your point about Fusion, one of the reasons why there is no cannibalization related to Fusion is because one every Inventor customer that's getting Inventor to the collection gets Fusion with it, all right, so they actually get both products. So, if you buy and subscribe to collection, you get all the things that are at collection, you actually get Fusion as well, and Fusion is a design app, can't do all the things that Inventor does. So there's very little kind of cross overlap between those two applications in terms of actually complete design things. The growth that you're seeing in Fusion is actually coming more from competitive swaps. We always like -- we've always given several examples of SolidWorks displacements, we've seen other placements as well, and this growth in the CAM space as well, where the integrated end-to-end solution and the price points are just really, really attractive. So, I just want to make sure that we put color on that, manufacturers doing great, the relative difference between AEC and manufacturing has to do with the fact that AEC is doing better, and it's doing better because of BIM mandates and BIM momentum, and we're not seeing any cannibalization from Fusion in our core Inventor business.
Gal Munda: Perfect, that's very helpful. And then just as a follow-up, could you comment a bit about the performance between the direct and indirect, so basically the channel and your own sales force, you basically mentioned that you had some significant EBA wins, maybe also comment a bit more on the e-commerce side of things, how the direct performance is going there?
Scott Herren: Yes. It's Scott, Gal. We talked about the mix being 70% through the channel, 30% direct, which is compared to 28% direct in Q2 of last year. So, it's grown a couple points. Our direct business actually grew 38% year-on-year. So we're seeing good strength in direct. Within EBA, as we continue to do most of our EBAs in the second-half of the year, and within that, most of them in the fourth quarter and the second-half of the year. So the EBA business while we had good traction with EBAs in Q2, the quarters where we really start to see a lot more EBA businesses late in Q3 and then through Q4. The e-commerce business or e-store is actually growing very nicely year-on-year, again, growing off a smaller base, but growing very nicely year-on-year, and that's part of our overall digital sales approach, right, it's not just put up a store and try to drive people to it. We also use the e-store as the backend transaction engine for a lot of our inside sales teams. So, we're seeing very nice growth through that whole digital sales channel, which comes to us at higher net revenue content to Autodesk. So, it's actually performing quite well.
Gal Munda: Thank you. Thanks for taking my questions.
Scott Herren: Thanks.
Andrew Anagnost: Thanks, Gal.
Operator: Thank you. Our next question comes from the line of Ken Talanian of Evercore ISI. Please go ahead.
Ken Talanian: Thanks for taking the question. Yes, as you think about the uncertainty related to the second-half, could you give us a sense for how you see the billings impact related to demand patterns and linearity differ if at all between the larger EBA type customers and the smaller volume-oriented ones? And along those lines, how should we think about the EBA renewal opportunity in the back-half of this year versus last?
Scott Herren: Yes. Ken, we always have -- as I just mentioned, we always have more EBAs in the second-half of the year and in particular, in the fourth quarter than we do in the first-half of the year. That was -- we know when those EBAs are coming up for renewal, and we have the best insight of any of our transactions on what's happening with the EBA. So, we have a good sense of when those are going to close. That said, as always it's been pretty accurately reflected in our outlook. What you see in terms of the adjustment in billings of $50 million adjustment in billings, first of all, in context, it's a $50 million adjustment at the midpoint on a number that's greater than $4 billion, right, so it's a little more than a 1% adjustment in the full-year billings, half of that $50 million roughly is strictly FX. The remainder is really localized around the three areas that we talked about, around the U.K. with concerns over Brexit, and we saw that actually much more so in July than we did in the first two months of the quarter; same with the slowdown in the manufacturing base in Germany, and then with the state-owned enterprises in China. So the adjustment in billings is really a reflection of FX, and then those three kind of localized effects that I think everyone's feeling, not just Autodesk.
Ken Talanian: Understood, and if I may, given that you've already reached about $98 million in ARR from your acquisitions, and I think you're targeting $100 million for the year, how are you kind of thinking about the contribution to the year now?
Scott Herren: Yes, super happy with the way the integration has gone, and Andrew, I'll let you comment on this as well talking about the numbers. I'm super pleased with that, and the $100 million that you referred to was really what we talked about the PlanGrid. So it'd be slightly higher when you add BuildingConnected to that as well. I feel like we're on track. I'm really happy with the way those have performed so far, it's -- those are two really significant transactions to pull-in in the same quarter, and not -- we haven't lost a bit of momentum at either one of those. So feeling good about construction business overall, and maybe the interesting point before I hand off to you, Andrew, is not only have we done well with the acquired products, the breadth of the portfolio we have in construction now has created an updraft for BIM 360, and we talked about our Cloud, our organic Cloud ARR growth at 45% for the quarter, BIM 360 is one of the big drivers of that. So, we continue to see not just success in construction with the acquired assets, but a bit of a halo effect, because of the breadth of that product portfolio on our organic BIM 360 products.
Andrew Anagnost: You took all my interesting points.
Scott Herren: Oh, I'm sorry.
Andrew Anagnost: Yes, look, the construction portfolio is performing really well. That is very unusual to get this kind of first-half, you know, first two quarter performance out of big acquisitions like that. We're happy. On the integration side, senior leaders from the acquired companies are taking senior positions inside the construction solutions team. So, we're seeing better and better alignment between those organizations. We have a lot of confidence in where we're going with these things. You see continuing stream of product integrations. Our customers are getting comfortable with our roadmap. The reason customers accelerated their purchasing of BIM 360 is because basically they just -- they see us saying, doing, and acting in all the right ways. So, they're doubling down at Autodesk, and that's nothing, but an excellent sign for how this business is going to grow into next year.
Ken Talanian: Great, thanks very much.
Andrew Anagnost: Thanks, Ken.
Operator: Thank you. Our next question comes from Zane Chrane of Bernstein Research. Your line is open.
Zane Chrane: Hi, thanks for taking the question. I just wanted to dig into manufacturing little bit more. The 20% growth in manufacturing revenue really was driven by ARR added in Q3 and Q4 of last year. If I look at the annualized value of manufacturing revenue based on the number of days in the quarter, it looks like it's down about $4 million or $5 million in ACV compared to what it was at the end of Q4. So, and that's in contrast to pretty strong incremental growth in manufacturing revenue each quarter of fiscal '19, is the weakness in first-half on that incremental manufacturing revenue added? Is that due to increased churn or lower expansion with existing customers, or just a pause and adoption due to the macro uncertainty? Thank you.
Scott Herren: Yes, it's neither, Zane. So, to be clear, the 20% growth in manufacturing is in line with the growth in manufacturing we've seen historically over the last two or three quarters, that we're not seeing -- even in the markets that we talked about, the three markets that we talked about having localized impact, we're showing strong double-digit growth even in Germany, which of course is a manufacturing-based economy…
Andrew Anagnost: In ACV.
Scott Herren: In ACV. So, we're not seeing that kind of -- I'm not exactly sure the math that you did there, we're not seeing -- we can pick it up offline, and we're not seeing any acceleration or deceleration, significant deceleration on the manufacturing side. Renewal rates look strong across the board. New product subscription growth with -- back to one of the questions that came up earlier was in line and actually slightly higher is what we've seen in the prior couple of quarters. So, the manufacturing space continues to perform well, and I think it's a bit of a standout relative to our peers that are far more manufacturing-focused when you look at that growth rate.
Andrew Anagnost: Yes, just even to comment on Germany, and we'll just talk about it from a pure ACV standpoint. The ACV growth in Germany was still double-digit, high double-digit growth. What we saw was a gap between our expectations, and the growth we were seeing as we headed into the end of the quarter. We have high expectations for that market, and those expectations were not getting met in the same kind of pattern that we would have expected in past quarters, but ACV is growing across the board manufacturing. So, I think maybe it's something that would be absolutely good to follow-up on and make sure we got the math right there.
Zane Chrane: Okay. Then the next -- just a quick question on the gap between the results versus your high expectations going in, is the gap more driven by lower expansion than you expected or less adoption from potential new customers?
Andrew Anagnost: Yes. So it is mostly a cross-sell and up-sell opportunity slowing down a little bit, you know, I'll give one example as we look out into the end of the second-half, accounts in some of the European countries where we expected to see EBA conversions are looking like -- the more going to be subscription sales versus the EBAs. So what we're seeing is a little bit of change in behavior at the EBA level and at the up-sell and cross-sell level, and that's really what's triggering our caution. And in terms of what we saw during the quarter, we expect a certain level of uptick in the ACV as we get towards the end of the quarter, and for the manufacturing in Germany, in particular, we didn't see that uptick in ACV. We're still doing great growing, but we didn't see the uptick we expected towards the numbers we want to see. We took that as an indicator of some slowness.
Zane Chrane: Very helpful, thank you.
Operator: Thank you. Our next question comes from Kash Rangan of Bank of America. Your line is open.
Kash Rangan: Hey, guys, thanks for being completely detailed and transparent with all the disclosures. I was also curious, given that we've not seen any meaningful turn in the business so far, how confident are you that we have levels at the estimates, or is it potential no -- rather revisions potential based on what you might uncover in the quarter or do you feel that you've seen enough and you've scrub the model enough to account for -- whatever it is that you saw in July and that we should be okay from this point onwards?
Andrew Anagnost: Yes. So obviously we spent a lot of time scrubbing the numbers and looking at this and making sure that we were looking at this in a prudent way. We feel confident that we've set the guide, right, I mean, obviously we're one tweet away from something changing, you know, unless something radical changes in the macro environment we feel pretty confident given our pipeline visibility to what we're guiding out there right now, and again I just want to reiterate what we did is we narrowed the range from the top-end down, the bottom the constant currency stayed the same, right, prudent measured action relative to what we're seeing out there. We think we've got it right, and look, if something comes from our field, something will come from that field, but we feel like we've got it right and we scrubbed our numbers. Scott, do you want to comment…
Scott Herren: Yes, the only thing I would add to that, Kash, and it's a great question and I appreciate you asking it, so we can talk about it on the call, is that -- as we started to analyze, not just where we're headed in the -- with the strength of our pipeline and the overall strength in our renewal rates, which the renewal rate is becoming a bigger and bigger part of our business. Net revenue retention stayed in the same range. Renewal rates on a volume basis if anything ticked up modestly of course that picked up slightly sequentially. So, I feel good about the core business, and we talked about the Remaining Performance Obligations, even the current RPO, right? So those are -- they're going to turn into revenue in the next 12 months, growing 23% year-on-year. Who knows what the next Tweet will say, but we feel like we've built in and everything that we can see at this point. Yes.
Kash Rangan: Thanks so much again, and appreciate the transparency.
Scott Herren: Yes. Thanks, Kash.
Operator: Thank you. Our next question comes from Richard Davis of Canaccord. Your question, please.
Richard Davis: Thanks. Two quick questions, one, you had a little bit of kind of work on rationalizing kind of the overlapping features between PlanGrid and some preexisting functionality, how far are you on that? And then on the second question would be share repurchase, I think you said 253,000, how much is left, and can you accelerate that, can you surge that, or what's up of that? Those are two simple questions. Thanks.
Andrew Anagnost: Yes, Richard, thank you for that. All right, so first off, let's talk about how we position the portfolio to our customers and port position the breadth of our portfolio. I made it very clear that the BIM 360 products that's going to focus on project management, project-centric workflows, and all the things associated with managing projects from start to finish, and integrating them into the pre-construction workflow. PlanGrid is going to focus on field execution and all the things associated with field execution and the capturing of information in around field execution and communicating that information back up into the global project management environment. We've made progress on multiple fronts. Like I said earlier, we've integrated BIM into PlanGrid, and so, there is BIM PlanGrid integration. We've also integrated some BuildingConnected bid management function into PlanGrid as well, but one of the really exciting things that we're working on, and it's part of the integration strategy is that both the PlanGrid team and the BIM 360 teams have seen the next generation building BIM 360-docs solution we built as being the foundation of what we call a Common Data Environment. This is something that's specked out in the AEC industry. It's called the CDE. And docs is going to be the foundation of our Common Data Environment and both PlanGrid and BIM -- and on all the other core BIM 360 functionality are integrating into that platform, which gives us a great steppingstone, not only to satisfy some pretty complicated requirements around Common Data Environment, but also to bring the products together more rapidly. So, you're going to hear a lot of things from us in the second-half of this year, in the first-half of next year about how these portfolios are coming together, but our customers get it, they understand, and they are buying in more to our solution because they see us acting in the direction of what we said we're going to do.
Scott Herren: And Richard, on your stock buyback question, you're spot on, so we spent $40 million during the quarter, year-to-date we spent $140 million. There is no change in our stance on cap allocation. So we'll continue to offset the core support the growth of the company first, took offset the dilution from our equity plans and then return excess cash to shareholders. We've been doing that pretty effectively with a more opportunistic buying pattern. So, our price grid is based on some Monte Carlo modeling that we do. And during the trading blackout window, of course we have to trade under 10b5-1 plan. Our trading blackout window began in early July, right before the most recent market volatility. So the grid that we had set up didn't necessarily reflect the volatility that we round up experiencing. At this point, I think you should definitely expect us to be back in the market buying back stock.
Richard Davis: Thank you so much.
Scott Herren: Yes. Thanks, Richard.
Operator: Thank you. Our next question comes from the line of Tyler Radke of Citi. Your line is open.
Tyler Radke: Hey, thanks for squeezing me in here. So, you talked about how you think some of these macro issues, there are only a temporary thing or a short-term thing, I guess what gives you the confidence there, and then as you think about your lowered expectations, is it fair to say it's all coming from manufacturing, or is there any reduction in your view on AEC? Thanks.
Andrew Anagnost: Yes. All right, so first off, again, let me just clarify a few things that give us confidence about the short-term impacts. One, half of the change in the midpoint of the guide is currency effect, okay. So, let's just make sure we're all level set on that, remember, it's currency effect, I think that's really important. The only thing that gives us a lot of confidence is our pipeline visibility. We have more visibility, because of the changes in some of the models that we have in terms of our go-to market model with the rise of our mid-market programs and some of our direct programs, we have quite a bit of visibility into our pipeline, and we can see into our pipeline, we see robust pipeline, we have visibility all the way through to the end of the year, and also visibility beyond that. So we feel pretty good that some of these things are short-term effects. All right. In addition, we don't see anything slowing down with regards to construction and with regards to our piracy conversion work. So, if we just -- if we just look at high-level, those things are all kind of short-term impacts on our business. All right, and what was the second part of your question, because I thought you asked another clarifying thing about what gave me confidence on the short-term?
Tyler Radke: Yes, that was just the confident that it's only a short-term macro part, and then on the -- I think you kind of answered it, but around the guidance, was it all a reduction in manufacturing, was there any reduction on AEC?
Andrew Anagnost: No. Yes, there is no incremental view in AEC. The change in guidance came from those FX effects and our view of the impacts of the softness we saw in manufacturing in Germany, the softness we saw in the U.K. and the gap between our potential in China and what we're actually able to execute on. Those are really the key drivers.
Tyler Radke: Okay, great. And if I could just sneak in one more for Scott, as you think about kind of some of the expense levers you have if you continue to see more softness, just what's kind of your willingness to maybe pull back on hiring, or being more conservatives, you have to keep free cash flow or profitability targets in place?
Scott Herren: Yes, it's a great question, Tyler. I think we've graphically demonstrated pretty effectively over the last four years, sound, spend, discipline. We continue to show to demonstrate sound, spend, discipline. We've effectively kept total spend flat for -- ex the acquisitions in Q4 we have total spend flat for four consecutive years. So, there will be a bit of an opportunity for us to take up spend at the same time we're increasing margins. If you look at this year, we talk about spend growth of 9% and margin growth of 12 percentage points of margin year-on-year. I expect margin to expand again into fiscal '21, although there is some pent-up demand percent having been flat for four consecutive years or some pent-up demand. So, spending will increase current course of speed, barring something significantly different happening in the overall macro environment spending will see a little bit of an increase again in fiscal '21.
Tyler Radke: Thank you.
Operator: Thank you. At this time, I'd like to turn the call back over to management for any closing remarks.
Abhey Lamba: Thanks for joining us. This concludes our conference call for today. If you have any questions, feel free to contact us. Thank you.
Operator: Thank you, sir. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good day, ladies and gentlemen, and thank you for your patience. You've joined Autodesk Q2 Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Abhey Lamba, VP of Investor Relations. You may begin."
},
{
"speaker": "Abhey Lamba",
"text": "Thanks, Operator, and good afternoon. Thank you for joining our conference call to discuss the results of our second quarter of fiscal '20. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can also find our earnings press release and a slide presentation on our Investor Relations Web site. We will also post a transcript of today's opening commentary on our Web site following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results, and strategies. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance, and unless otherwise noted each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in the press release of slide presentation on our Investor Relations Web site. And now, I would like to turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Abhey. Our great momentum from the first quarter carried into the second quarter resulting in strong performance with revenue, billings, earnings, and free cash flow coming in ahead of expectations. We also crossed the $3 billion mark on ARR for the first time, which was driven by solid performance across all regions and products. Our last 12 months free cash flow of $731 million is the highest amount of free cash flow we have ever generated in a four-quarter period in the company's history. We performed well in the first-half of the year demonstrating focused execution and the strength of our recurring revenue model. Although we continue to execute well and are not materially impacted by current trade tensions and macro conditions, we are aware of the current business and geopolitical environment that is causing uncertainty in the market. As we look across the next six months, we are taking a prudent approach to our outlook for the remainder of fiscal '20. However, we think the uncertainty caused by macro-related events is only a short-term issue. We remain confident in our ability to achieve the fiscal '23 goals we have laid out for you. Our confidence is grounded in the value delivered by our products, their ability to help our customers differentiate via innovation and digitization, focused execution delivered by our partners and sales teams, and the significant strides we are making to capture the non-paying user community. I would also like to point out that although there are headlines of some impact from the current environment on a few industry verticals, like manufacturing, we outgrew competitors and gained share in this space. The construction industry is also holding steady, and continues to invest in innovative solutions, and we saw ongoing strength in construction this quarter. Before I offer you more color on strategic highlights during the quarter, let me first turn it over to Scott to give you more details on our second quarter results, as well as details of our updated fiscal '20 guidance. I'll then return with further insights on the key drivers of our business, including construction, manufacturing, and digital transformation before we open it up for Q&A."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Andrew. As Andrew mentioned, revenue, billings, earnings, and free cash flow all performed ahead of expectation during the second quarter. Overall demand in our end markets was solid during the quarter, as indicated by our strong billings and revenue growth. Growth was driven by both volume and pricing, which is a result of the strong uptake of our products by new users, as well as increased usage with existing customers. Sales volume of AutoCAD LT also remained strong. This has historically been a leading indicator of potential demand slowdown. And as you can see, revenue from our AutoCAD and AutoCAD LT products grew 31% in the second quarter. AEC and manufacturing revenue rose 37% and 20% respectively. Geographically we saw broad based strength across all regions. Revenue grew 32% in the Americas, 27% in EMEA, and 33% in APAC, with strength across almost all countries. We also saw strength in direct revenue, which rose 38% versus last year, and represented 30% of our total sales, up from 28% in the second quarter of last year. Before I comment on ARR, I want to remind you of how we define it. ARR is the annualized value of our actual recurring revenue for the quarter, or said another way, is the reported recurring revenue for the quarter multiplied by four. Total ARR of $3.1 billion continued to grow steadily, and was up 31%. Adjusting for our fourth quarter acquisitions total ARR was up 27%. Within core, ARR growth was roughly in line with total organic growth, and was driven by the strength in product subscriptions. In Cloud, ARR grew 175%, propelled by our strong performance in construction. Excluding $98 million of ARR from our fourth quarter acquisitions, growth in organic cloud ARR, which is primarily made up of BIM 360 and Fusion 360, increased from 43% in the first quarter to 45%, which is a record for that product set. We continue to make progress in our Maintenance to Subscription, or M2S program. The M2S conversion rate of the maintenance renewal opportunities migrating to product subscriptions was in the high 30% range in Q2, which is higher than our historical rate. This uptick in the conversion rate was in line with expectations as our maintenance renewal prices went up by 20% in the second quarter, which made it significantly more advantageous for customers to move to subscription. Of those that migrated, upgrade rates among eligible subscriptions remain within the historical range of 25% to 35%. Now, moving to net revenue retention rate, during Q2 the rate continued to be within the range of approximately 110% to 120%, and we expect it to be in this range for the remainder of fiscal '20. As a reminder, the net revenue retention rate measures the year-over-year change in ARR for the population of customers that existed one year ago or base customers. It's calculated by dividing the current period ARR related to those base customers by the total ARR from those customers one year ago. Moving to billings, we had $893 million of billings during the quarter, up 48%. The growth in billings was driven by strength in new customer billings and strong renewals with continued momentum in our core products. And as we have said in prior quarters in line with our plans, billings are also benefiting from a return to more normalized levels from multi-year agreements. Remaining Performance Obligations or RPO, which in the past we have referred to as total deferred revenue is the sum of both billed and unbilled deferred revenue, and rose 28% versus last year, and 3% sequentially to $2.8 billion. Current RPO, which represents the future revenues under contract expected to be recognized over the next 12 months was little over $2 billion, an increase of 23%. On the margin front, we realized significant operating leverage as we continue to execute in the growth phase of our journey. Non-GAAP gross margins of 92% were up two percentage points versus last year. Our disciplined approach to expense management combined with revenue growth enabled us to expand our non-GAAP operating margin by 14 percentage points to 23%, while absorbing two meaningful acquisitions. We realized significant leverage from our investments in sales and marketing and R&D initiatives during the quarter, and are on track to deliver significant margin expansions in fiscal '20 and further expand non-GAAP operating margin to approximately 40% in fiscal 2023. Moving to free cash flow, we generated $205 million in Q2. Over the last 12 months, we've generated a record $731 million of free cash flow, driven by growing net income and strong billings. Lastly, we continue to repurchase shares with our excess cash, which is consistent with our capital allocation strategy. During the second quarter, we repurchased 253,000 shares for $40 million at an average price of $159.54 per share. Almost all of our repurchase activity during the quarter was through our 10b5-1 plan, which we entered into before the most recent market volatility. Now I'll turn the discussion to our outlook. I'll start by saying that our view of global economic conditions and their impact on our business has been updated to reflect the current state of various trade disputes and the geopolitical environment and their potential impact on our customers. While we have not seen any material impact to our business, we are taking a prudent stance regarding customer spending environments in the U.K. due to Brexit, Central Europe due to a slowdown in the manufacturing industry there, and China due to trade tensions. These items individually are not material headwinds, but in aggregate are responsible for our guidance adjustment, which now reflects our current views based on what we know about the environment today. Our pipeline remains strong globally, including in these regions, we began noticing some changes in demand environments in these areas toward the end of July. As such, for these affected areas, we feel it's appropriate to adjust our expectations for the rest of the year. As you'll soon hear from Andrew, customers continue to increase their spending on our products even in these areas and our renewal rates are fairly steady. Additionally, we are now assuming more billings will occur later in the quarter for the remainder of the year. At the midpoint of our updated guidance, we're calling for revenue and ARR growth to be approximately 27% and 26% respectively, which speaks to the resiliency of our model versus prior cycles. The wider the normal range of our full-year guidance is a result of the greater uncertainty we're expecting over the second-half of the year. Additionally, currency now offers a headwind of about $10 million to our full-year revenues versus being neutral at the beginning of the year. As such, the low-end of our updated constant currency guidance is in line with the low-end of our initial outlook we shared with you at the beginning of the year, and it also reflects the potential for a slight deterioration in the environment from the current level. While our billings guidance has come down by about $50 million, billings are still expected to grow by approximately 50% or 40% after adjusting for the adoption of ASC 606 last year. This supports our view of strong demand for our products even in uncertain environments. Regarding free cash flow, the $50 million adjustments to $1.3 billion is primarily a result of our updated view of billings and their timing. We expect to achieve our original target of $1.35 billion trailing 12 months free cash flow during the first quarter of fiscal 2021, and while it's too early to give you a detailed color on fiscal 2021, we expect to continue growing billings, revenues, and free cash flows while expanding our margins. This is supported by what we're seeing in North America, especially in AEC, where our pipeline remains strong and we have more visibility into our business within Central Europe and China. Construction is also performing very well as we continue to increase the value we're bringing to our customers, and we continue to make strides with capturing revenue from non-paying users. Looking at our guidance for the third quarter, we expect total revenue to be in the range of $820 million to $830 million and we expect non-GAAP EPS of $0.70 to $0.74. Third quarter free cash flow is expected to be modestly above second quarter. The earnings slide deck on the Investor Relations section of our Web site has more details, as well as modeling assumptions for fiscal '20. In summary, I want to remind everyone that since our business model shift, we have moved to a much more resilient business model that generates a very steady stream of revenue that is less exposed to macro swings than when we were selling perpetual licenses. So while we are adjusting our fiscal '20 guidance slightly, we're still expecting revenue growth of 27% for the year, margin expansion of about 12 percentage points, and we're confident of delivering on our fiscal '23 targets. Now I'd like to turn it back to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Scott. As you heard me, we delivered very strong performance in the first-half of the year, and despite negative headlines from Europe and manufacturing, we are still seeing strong demand for our solutions. For example, a large European automobile company recently signed a new three-year Enterprise Business Agreement or EBA despite a more challenging macro backdrop for their industry. They see the new agreement as an investment design, and they know innovation is needed to stay ahead of the competition. They view Autodesk as a market leader in this area and counting us to provide new innovative design solutions such as generative design. The EBA also offers for them the flexibility to access our entire product portfolio, including products ranging from manufacturing and agency collections to Alias, 3Ds Max, Maya, and Walt, while at the same time representing a more than a 130% increase in annual contract value for us. We will continue to partner with them to ensure that they get maximum value out of our products and remain a leader in an industry that is undergoing significant change. Our customers know that at the end of every downturn is an upturn, and if they don't continue to innovate and use the latest technology tools throughout the cycle, they will be at a distinct disadvantage when growth returns. This underscores the importance of our products regardless of the macro environment as well as our customer's commitment to investing in technology to stay ahead as competitors. Now, let me give you an update on some key strategic growth initiatives, we are focused on, specifically our continued traction with construction, gains in manufacturing, and leveraging our digital transformation to capture the opportunity within our non-paying user base. These initiatives are key drivers of both our near and long-term business. In construction, BIM 360 was the primary driver of our organic growth in cloud led by BIM 360 Design & Build. Our customers are continually finding value in this offering, and the PlanGrid team continues to see strong momentum. For example, Tutor Perini, one of the largest general contractors in the U.S. selected PlanGrid over some competitor offerings for two 500 million key projects. The team wanted to provide real-time up-to-date documentation and plans to the field. Senior management for these projects had used PlanGrid before at a different firm, and this relationship provided an opportunity to demonstrate plan for its capabilities for these two projects. PlanGrid set up the projects by processing the drawings and pulling out title block information categorizing the drawings with tag and hyper-looking detail call-outs for 2,000 drawings in under an hour. This was an immediate time savings for Tutor Perini. Additionally, the field teams have access to new drawings, changes, RFIs, and some middles right away, and an easy-to-use interface. Going forward, we continue to look for opportunities to partner with Tutor Perini across all of their products and subsidiaries. BuildingConnected and Assemble also performed well as we continue to focus on integrating these offerings. During the quarter, we integrated BuildingConnected's bid management solution with PlanGrid technology, enabling the seamless transfer of data from pre-construction to the building process. The integration allows construction project managers to automatically push design and pre-construction files from BuildingConnected to PlanGrid, saving time, reducing errors and further enhancing the cost savings associated with using both platforms. And as you recall, we integrated Revit with PlanGrid with the launch of PlanGrid BIM last quarter and have received tremendously positive feedback from customers regarding the update. In the first quarter after its release, the product is also being used in over 650 projects by more than 300 customers. These integrations are steady steps towards providing Autodesk construction customers with integrated workflows that connect the office, trailer, and field. We are also continuing to see outstanding cross-selling with our recent construction acquisitions. For example, during the quarter, [indiscernible], an existing Autodesk customer expanded its relationship by adding BuildingConnected and Assemble solutions to reduce the time to open new locations and downtime to the construction updates and existing locations. And as a reminder, infrastructure is an area that we have seen in the past performed well during macro-related slowdowns, and we continue to focus efforts in this area. This quarter we secured a new Enterprise Business Agreement with Gannett Fleming. Gannett Fleming is a leading global engineering and architecture firm ranked Number 35 on the ENR top 500 design list. The Gannett Fleming Executive team considers a strategic partnership with Autodesk to be a distinct competitive advantage. With the EBA, Gannett Fleming now has direct access not only to the full portfolio of Autodesk technology, but also to a wide range of Autodesk services and expertise that will help them achieve their corporate growth and market expansion goals. On the manufacturing front, revenue grew 20% in the second quarter, despite a more challenging manufacturing environment in Europe. Customers are seeing the benefits of our differentiated solution, and we continue to gain market share, while displacing competitive offerings in this space. For example, during the second quarter, a leading Swiss watchmaker selected Autodesk design and manufacturing collection to replace SolidWorks, given the flexibility offered by solutions. In addition, our investments in general design and Fusion 360 have resulted in competitive displacements not only in the CAD market, but also in the Computer Aided Manufacturing or CAM space with our lower barrier to switching vendors. As a result, we see displacements of competitors like Mastercam, and once we're embedded in those customer's downstream processes, we are increasingly penetrating design activities within those same accounts. Customers pick Fusion over competitive offerings due to its integrated CAD/CAM functionality, its compatibility with other CAD tools, ease-of-use, and attractive pricing model. Now let's talk about progress with our digital transformation. Many of you recall that a key part of this transformation will increase the insight we have on our non-compliant user base. One of the initiatives we undertook to accomplish this started last year and has given us the ability to analyze usage patterns of our non-compliant users. Since last year, we have analyzed significant amount of data on these users, including how long they use the software and how their journey traverses across non-compliant usage to downloading free trials or using student additions. With this data, we can test different ways to convert them, including in-product messaging and leveraging our inside sales team. While still early in the conversion process, we have an increasing amount of data that allows us to take necessary actions to convert this large pool of potential customers. In the quarter, we expanded our pilot cases for in-product messaging to many international regions, and enhanced our license compliance initiatives using our sales teams as well as being email campaigns. These conversions resulted in multiple deals, including two over a $1 million, one of which was in China. Our billings from license compliance initiatives were up by approximately 65% versus last year, although on a small base. So, as you've heard, we made great progress this quarter that enabled us to finish the first-half of the year strong. We continue to execute well in construction, where IT spending remains strong. We are making competitive inroads and manufacturing with our innovative solutions and are making strides in converting the current 14 million non-paying users into subscribers. We are highly confident in Autodesk's ability to capitalize on our large market opportunity, and are committed to delivering our fiscal '23 goals. With that, Operator, we'd now like to open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you, sir. [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Hi, guys. Thanks for taking my questions here."
},
{
"speaker": "Andrew Anagnost",
"text": "Hi, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Hey, Scott. Hey, Andrew. Hey, Andrew, maybe just to start with you, slightly higher level question on the macro, I know we spoke about some of the regional items that we've seen, whether it was the U.K., China or Central Europe, but I want to maybe think about the macro from a different lens. Clearly a lot of concern out there about the manufacturing economy, and as we know, not all of Autodesk's business is levered to the manufacturing space, but for the part that is, can you just give us some color on the verticals that Autodesk sells into, whether that's auto or aerospace for example, just to sort of get a sense for where Autodesk kind of sits with regards to different sub-segments of manufacturing specifically?"
},
{
"speaker": "Scott Herren",
"text": "Hi, Saket. Before we jump into that, I'd like to clear out something. We've heard that there's some confusion in our guidance metrics from the press release footnotes. So, and what our current guidance for free cash flow for fiscal '20 is $1.3 billion, we get there by saying free cash flow -- or cash flow from operations will be $1.37 billion, you'd net out $70 million of free cash flow to get to $1.3 billion. So, I think the footnote created confusion that the $1.3 billion wasn't already netted for CapEx. It is. So it's $1.37 billion before CapEx as cash flow from ops, $1.3 billion is the free cash flow guide for the year. Okay, go ahead."
},
{
"speaker": "Saket Kalia",
"text": "That's helpful. Thanks, Scott."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, it's good to clarify. So, let me address your question about verticals in manufacturing in particular. All right, first off, just let me just frame a few things. Our manufacturing business actually did pretty well. We grew 20%, a lot better than any of our competitors. That has a lot to do with the way we're diversified. It also has a lot to do with the price points and the upfront -- the reduced upfront cost of our offerings are pretty attractive to a lot of people, and we're also seeing acceleration in the CAM space due to the Fusion 360 portfolio and the way it integrates design and CAM along with the generative capability. So, we're seeing pretty strong performance in manufacturing, but to your point about which verticals we are exposed, our biggest vertical in manufacturing is what we call industrial machinery, and this is machinery of all manner and type. It's machines you'll see inside automotive factories, but it's also machines you see that package cereal or to wrap toys, or to do any manner of things, make paper, and large industrial machines. It's our single biggest segment. Another really big segment for us is what's called building product manufacturers, and these are the people that build things that go into buildings, and they're also the people that build things that hang on buildings and prefabricate components of buildings, so think doors and windows manufacturers, think air conditioner manufacturers, think curtain wall manufacturers if you understand how skyscrapers are made. Our smallest level exposure is actually in the auto and aero space, where other competitors have deeper exposure in terms of the engineering processes. We are definitely big in auto in some of the more forward-looking aspects of the auto industry. So we're embedded deep in the design departments, which are several years ahead of where the current production is and where production volume is. And we're also working closely with a lot of autos and some of their next generation production workflows. I think you've seen some of the things we've been talking about with generative with regards some of the work we've done with GM and some of the other automotives to kind of help consolidated multiple parts in multipart assemblies into a single 3D printed part. And we're definitely engaged in some of that work, but that's some of the hierarchy of exposure we have to manufacturing. Make sense?"
},
{
"speaker": "Saket Kalia",
"text": "That does. That's really helpful. Scott, maybe for you for my follow-up, a little bit of a different topic, but I'd love to talk a little bit about the remaining maintenance business. Obviously this is the last year of M2S price increases, as you've mentioned before. And that maintenance ARR sort of continues to decline in that high 30% range. How do you sort of think about that decline in coming quarters? And maybe just speak to sort of the profile of your remaining maintenance customers. I guess with the last 25% price increase should we sort of start to see a step up in that maintenance base decline or should we kind of think about it kind chugging along the way it has so far. Any color there would be helpful."
},
{
"speaker": "Scott Herren",
"text": "Yes, sure, Saket. So this is the year -- by the way, it's a 20% price increase, not 25%. But Q2 is the first full quarter that that third price increase that we announced three years ago, it went into effect at the beginning of Q2. This is our first quarter with that, and we actually had some interesting results. The conversion rate of -- maintenance rates that came up for renewal actually increased, which is what you'd expect with the staying on maintenance going up 20%, from what had been about a third of those that come up for renewal converting to something in the high 30% range for the quarter. So conversion rate increased, as expected. Interestingly for those that did elect to stay on maintenance, and some do, the renewal rate actually ticked up. I would've expected with the increase in price it to stay flat or maybe even decline, it actually, the renewal rate for maintenance for those that did not convert actually it ticked moderately, but ticked up slightly in the quarter. So we're seeing the exact same -- the behavior we expected when we laid out the M2S program. And at this point it's -- we have three more quarters to go, it'll actually overlap into the first quarter of next year before it's finished."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very helpful, guys. Thanks."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Saket."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Phil Winslow of Wells Fargo. Your question, please."
},
{
"speaker": "Phil Winslow",
"text": "Hey, thanks, guys for taking my question. Thanks for the commentary on Asia-Pacific and Europe. I wondered if you'd give is more color on what you're seeing in the U.S., particularly just into the quarter and in terms of the pipeline there, and particularly by vertical, that'd be very helpful. Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, so the Americas and the U.S., in particular, were strong. We grew 32%. Our pipeline is solid in the U.S.; it's solid across the whole Americas. Our visibility is pretty good. We're seeing broad strength across all the segments. So we're not seeing any weakening in any kind of segment or by any types of vertical. So the U.S. business is looking solid. And it continues to look solid right now and until something changes in the environment. But we saw a great visibility in our pipeline to the U.S."
},
{
"speaker": "Scott Herren",
"text": "Phil, the other comment that's worth adding on to that is, I think there was some concern that emerging markets might have underperformed during the quarter, and it's actually -- you have to dig into the appendix of our slides that we posted on our Web site, but you can see emerging markets actually grew north of 30%. And obviously there's -- a chunk of those emerging markets are in the Americas as well. So we continue to see, with the exceptions of three areas that we pointed out, we continue strength geographically across the board."
},
{
"speaker": "Phil Winslow",
"text": "Got it. And also in terms of the breakdown, as Saket was saying, obviously your business is sort of like a matrix internationally and then by multiple verticals, and then multiple sort of sub-verticals within inside of those verticals. When you think about just manufacturing exposure versus, let's say, your commercial construction versus media and entertainment, is there one geography that's weighed more, let's say, towards your commercial construction and one more towards manufacturing? Any sort of color in sort of the…"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, absolutely. So that's an easy place, Phil, to give some color. So, construction, we're definitely leaned more towards the U.S., there's no doubt about it. On manufacturing we're definitely leaned more towards Europe. We've historically been more successful in Europe relative to competition than in the U.S. So when you see manufacturing slow down in Germany it slows down our overall manufacturing business. So Europe is definitely where we're more exposed in manufacturing. The U.S. is definitely where the bulk of business is for construction right now, though we're growing pretty quickly internationally on the construction side as well. But that's kind of the high-level breakdown."
},
{
"speaker": "Phil Winslow",
"text": "Okay, great. Thanks, guys."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Phil."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your question, please."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, a quarter ago, on the call, you made some interesting remarks regarding what you're calling your early warning system, this was in the context that you were talking about digital infrastructure and your customer engagements team. The question is, what is that system telling you in terms of some of the key metrics that it's set up for in terms of usage and other metrics. And is it thus far a U.S. oriented system or is it giving you signals globally that are helping you? And then secondly, a longer-term technology or roadmap question. I made some comments on the call earlier about your integrations thus far with the ACS acquisitions and the BIM and Revit, and so forth. What about the roadmap however between AEC and manufacturing, if you're going to pursue industrialization of construction you have to have that cross-segment integration. You haven't really spoken about it much, but perhaps you can talk about that roadmap?"
},
{
"speaker": "Andrew Anagnost",
"text": "Okay, all very good questions, Jay. So, first, let me talk about the early warning system and what it's telling us. So it is broad geographically. It tells us about multiple products in multiple geographies. And one of the things -- and what it's also intended to do is give us a predictor scores that are at risk renewals so that we go take direct action with regards to at-risk renewals. What I can tell you at a high level is it's telling us is there's no slowdown in usage of our products, right. And in fact, usage continues to grow across all types of products and all manner of verticals. So we're not seeing any systematic declines in usage or usage activity [indiscernible]. Our pirates [ph] continue to use our products robustly, and as do our paying subscribers, but remember that the core part of that system is designed to help our teams understand which one of our accounts are most at risk for renewal. And yes, you're right, we watch things like activations, we watch things like product usage, and we watch other things like access to support that allow us to kind of score these customers in terms of risk, but it's global, and we're not seeing any changes in the usage trends, usage continues to go up globally. Now with regard to integration of the construction, I think you're actually pointing to a very important area, and it's one of the things that we're really focusing on behind the scenes, and it has to do with creating some workflows for the building product manufacturers, which includes, like I said earlier, curtain wall as well as the components that go inside of buildings. So what we've been working to do is expand the interlope between Revit and Inventor, so that you can actually take low-precision models from Revit, move them into the high-precision environment of Inventor, so that you can get -- do fabrication prep for things like curtain walls and other types of manufacturing components, and then actually move them back into revenue in the low-precision world in an account slated way, so the changes that happen inside of Inventor go back and update inside of the Revit model as well. We've been improving those integrations continuously behind the scenes. You're going to see more improvements in those integrations in Q4, and a continuing roadmap next year. It's not completing fully industrialized workflows for construction, but it's a prerequisite to making sure you have a good BIM to manufacturing or 3D solid modeling workflows, so that you can actually do some of these more complex interactions between a building information model and a 3D model for manufacturing purposes. So, we continue to work on those Revit and Inventor integrations, and you'll see acceleration in that area."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thanks, Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Next question comes from Heather Bellini of Goldman Sachs. Your line is open."
},
{
"speaker": "Heather Bellini",
"text": "Great, thank you. Just a couple of questions here, Andrew, I just want to make sure that your tone and your conservatism, it seems like you're not seeing the weakness here, so to speak, but you're just being more conservative in your outlook. I just want to confirm that that's how we should be reading your comments. And then, I guess one of the other questions would be how we see growth trending, and churn and see growth, which may be a precursor to a slowdown if you think of the fact that your products are deployed as increased deployment as people are hired into the industry? And then I guess the follow-up from there would be just from a linearity perspective after last quarter when you said linearity was a little bit more backend loaded, I know you guys were going back to, assuming the same linearity in Q3 this year that you did last year, is that where it actually came out of? If you can give us some color there, that'd be great. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "All right. So, what I'll do is I'll answer your middle question first, then I'll answer your first question, second, and I'll let Scott answer the third, okay?"
},
{
"speaker": "Heather Bellini",
"text": "Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "So, your middle -- it's okay, see growth ensuring, no change, all right. We're seeing the same kind of see growth, where our renewal rates are solid. In some places, we are seeing improvements. So, all of those trends are consistent right now with a fairly steady environment. Like we said earlier, we've seen some indications in certain specific markets that lead us to be a little bit more cautious, particularly Germany and manufacturing, U.K. and Brexit, and you know, the state-owned enterprises in China, we simply cannot engage with them, and that's going to put pressure on our expectations relative to those markets. Even though emerging in China is a small part of our business, it's a small percentage. Over a couple of quarters, we could easily add up to $5 million in missed expectations, but there is a lot of noise. You can all hear it, it's all going on, there's change -- there is something new every day, all right, all you have to do is checking Twitter feed. So, there're all sorts of noise, and what you see us doing, and I want to make sure we put this in context. What we did is we took the high-end of our guidance down. So, we narrowed the range. The low-end of our guide on a constant currency basis is unchanged. So, this is a prudent narrowing of the range to kind of reflect this noise we're seeing in the system. I think it's the right thing to do right now. I think it's appropriate, but even if you look at the worst case scenario on all of that, worst case scenario, we're coming in at 96%, at worst case of the numbers we set out there four years ago. I think that's pretty good. That's not just great modeling. It's actually great execution in flexible and adaptive execution, and it's that ability to kind of track the business to that kind of fidelity that gives us a lot of confidence in terms of what we're looking to see out in FY '23, and I want to make sure just since you asked the question, I want to reinforce a few things that are really important drivers around some of this stuff. First off, one just side comment, we could easily do some unnatural acts to hit that free cash flow number at what we stated previously in the last call. You wouldn't want us to do that. I have no interest in pushing an agenda in that direction, and we're just simply not going to do it. It's not good for the business, it's not good for the long-term health and for the long-term prospects of the business, and we have to pay attention to the long-term prospects of the business. So we're not going to do any a natural things to try to drive that free cash flow number up, and I think that's an important point. But the resilience in the model, because remember, as we move into next year the model transition is done, and we've got the resilience in the model us look out to FY '23, but look at just how the midpoint of the guide changed, half of that is due to currency FX, okay, a total complete short-term impact on our business. The other thing I wanted you to be aware of in terms of what's kind of guiding us with the conservatism, and we're at pipeline solid, we're looking out pipelines, we've got more visibility to our business than we've ever had before, the pipeline looks good in countries where we're historically having problems. I think you might remember a year ago we talked a lot about Japan, Japan is doing great. So, we're seeing things like that, but more importantly, as we look out beyond the FY '20 guide into some of the FY '23 things, construction is doing really well. We believe the construction is going to continue to do well during the downturn, IT spending construction continue to grow during the downturn last time. In '07 and '08, Revit continued to grow for us. I think you're going to see that same thing, our performance on non-compliant users is getting better and better, and also, let's just say there was a protracted downturn. Something interesting happens in those downturns, infrastructure spend tends to go up. We've gotten in front of that. We've done some things in our core design products and our construction portfolio to ensure that we're good partners to the infrastructure business. So, we intend to capitalize on any infrastructure spend that could come out of a protracted downturn. So, you're right, we are simply being conservative and we're being prudent, because of the noise out there in the system and because of the weakness we saw in some places, where they can have impact on our expectation, was correct. We're growing robustly in all those places. We just have higher expectations for those places, and I think it's the right time to make that kind of adjustment, and it's all short-term, but we're still very confident about what we can do in FY '23."
},
{
"speaker": "Scott Herren",
"text": "And Heather, I think the other…"
},
{
"speaker": "Heather Bellini",
"text": "Yes, Scott."
},
{
"speaker": "Scott Herren",
"text": "Yes, in other part of your triple questions, that was around linearity, and I think the thing that we are seeing in linearity, and again in Q2, which was consistent with our expectations in Q2 was more sales are happening a little bit later in the quarter than what we had experienced in the second-half of fiscal '19. So, it's more like the traditional linearity that we had in the first-half of fiscal '19, and that's now built into our forecast for the second-half of this year. So it has a couple of effects when you do that obviously, and Andrew has talked about this a big chunk of the adjusted in our guidance is all tied to FX, but holding out aside, as linearity pushes on a little bit, it has an effect on billings, where billings covered layer in a quarter, and then you end up collecting some of those billings is kind of during the current quarter and the following quarter. So there's a little bit of an effect on billings and an effect on free cash flow as well from linearity, but that's the way to think about it. The midpoint of the guide is 27% revenue growth, midpoint of the billings guide is 40% growth even normalized for the 606 implementation at the beginning of last year, and the midpoint of the guide is 12 points of margin expansion. So it's a strong year. We continue to feel good about the momentum in the business."
},
{
"speaker": "Heather Bellini",
"text": "Great, thank you so much."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Heather."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Gal Munda of Berenberg Capital Management. Your line is open."
},
{
"speaker": "Gal Munda",
"text": "Hi, thank you for taking my questions. The first one is just in the manufacturing side. We see the manufacturing is going below the AEC part of the business, and I was just wondering if it's macro-related or is it maybe got something to do with the comments you made around the shift to the new platform, you mentioned that Fusion 360 is gaining market share, you mentioned that Fusion 360 is growing very, very strongly, and I'm wondering whether Fusion 360 by taking market share is also potentially taking market share from some older solutions, they have like Inventor, which might provide kind of short-term headwind to the revenue there?"
},
{
"speaker": "Andrew Anagnost",
"text": "All right. So, Gal, let me let me kind of answer that and cover that. First off, we grew 20% manufacturing better than any of our competitors, all right, better than the market. So, our performance in manufacturing is actually very strong. The relative difference in the performance between manufacturing and AEC is simply due to the fact that AEC is stronger. What we're seeing in AEC is Revit is not only being adopted very robustly, it's actually being mandated, or BIM is being mandated in more and more countries and for more and more projects. Japan in particular is an interesting place, where historically BIM was slow to be adopted, and it's starting to see an acceleration of adoption, and you're seeing BIM mandates showing up in Japan as well. So I want to make sure that we understand the relative performance difference between those two things, and our performance relative to competitors in the overall market. Now, to your point about Fusion, one of the reasons why there is no cannibalization related to Fusion is because one every Inventor customer that's getting Inventor to the collection gets Fusion with it, all right, so they actually get both products. So, if you buy and subscribe to collection, you get all the things that are at collection, you actually get Fusion as well, and Fusion is a design app, can't do all the things that Inventor does. So there's very little kind of cross overlap between those two applications in terms of actually complete design things. The growth that you're seeing in Fusion is actually coming more from competitive swaps. We always like -- we've always given several examples of SolidWorks displacements, we've seen other placements as well, and this growth in the CAM space as well, where the integrated end-to-end solution and the price points are just really, really attractive. So, I just want to make sure that we put color on that, manufacturers doing great, the relative difference between AEC and manufacturing has to do with the fact that AEC is doing better, and it's doing better because of BIM mandates and BIM momentum, and we're not seeing any cannibalization from Fusion in our core Inventor business."
},
{
"speaker": "Gal Munda",
"text": "Perfect, that's very helpful. And then just as a follow-up, could you comment a bit about the performance between the direct and indirect, so basically the channel and your own sales force, you basically mentioned that you had some significant EBA wins, maybe also comment a bit more on the e-commerce side of things, how the direct performance is going there?"
},
{
"speaker": "Scott Herren",
"text": "Yes. It's Scott, Gal. We talked about the mix being 70% through the channel, 30% direct, which is compared to 28% direct in Q2 of last year. So, it's grown a couple points. Our direct business actually grew 38% year-on-year. So we're seeing good strength in direct. Within EBA, as we continue to do most of our EBAs in the second-half of the year, and within that, most of them in the fourth quarter and the second-half of the year. So the EBA business while we had good traction with EBAs in Q2, the quarters where we really start to see a lot more EBA businesses late in Q3 and then through Q4. The e-commerce business or e-store is actually growing very nicely year-on-year, again, growing off a smaller base, but growing very nicely year-on-year, and that's part of our overall digital sales approach, right, it's not just put up a store and try to drive people to it. We also use the e-store as the backend transaction engine for a lot of our inside sales teams. So, we're seeing very nice growth through that whole digital sales channel, which comes to us at higher net revenue content to Autodesk. So, it's actually performing quite well."
},
{
"speaker": "Gal Munda",
"text": "Thank you. Thanks for taking my questions."
},
{
"speaker": "Scott Herren",
"text": "Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Gal."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Ken Talanian of Evercore ISI. Please go ahead."
},
{
"speaker": "Ken Talanian",
"text": "Thanks for taking the question. Yes, as you think about the uncertainty related to the second-half, could you give us a sense for how you see the billings impact related to demand patterns and linearity differ if at all between the larger EBA type customers and the smaller volume-oriented ones? And along those lines, how should we think about the EBA renewal opportunity in the back-half of this year versus last?"
},
{
"speaker": "Scott Herren",
"text": "Yes. Ken, we always have -- as I just mentioned, we always have more EBAs in the second-half of the year and in particular, in the fourth quarter than we do in the first-half of the year. That was -- we know when those EBAs are coming up for renewal, and we have the best insight of any of our transactions on what's happening with the EBA. So, we have a good sense of when those are going to close. That said, as always it's been pretty accurately reflected in our outlook. What you see in terms of the adjustment in billings of $50 million adjustment in billings, first of all, in context, it's a $50 million adjustment at the midpoint on a number that's greater than $4 billion, right, so it's a little more than a 1% adjustment in the full-year billings, half of that $50 million roughly is strictly FX. The remainder is really localized around the three areas that we talked about, around the U.K. with concerns over Brexit, and we saw that actually much more so in July than we did in the first two months of the quarter; same with the slowdown in the manufacturing base in Germany, and then with the state-owned enterprises in China. So the adjustment in billings is really a reflection of FX, and then those three kind of localized effects that I think everyone's feeling, not just Autodesk."
},
{
"speaker": "Ken Talanian",
"text": "Understood, and if I may, given that you've already reached about $98 million in ARR from your acquisitions, and I think you're targeting $100 million for the year, how are you kind of thinking about the contribution to the year now?"
},
{
"speaker": "Scott Herren",
"text": "Yes, super happy with the way the integration has gone, and Andrew, I'll let you comment on this as well talking about the numbers. I'm super pleased with that, and the $100 million that you referred to was really what we talked about the PlanGrid. So it'd be slightly higher when you add BuildingConnected to that as well. I feel like we're on track. I'm really happy with the way those have performed so far, it's -- those are two really significant transactions to pull-in in the same quarter, and not -- we haven't lost a bit of momentum at either one of those. So feeling good about construction business overall, and maybe the interesting point before I hand off to you, Andrew, is not only have we done well with the acquired products, the breadth of the portfolio we have in construction now has created an updraft for BIM 360, and we talked about our Cloud, our organic Cloud ARR growth at 45% for the quarter, BIM 360 is one of the big drivers of that. So, we continue to see not just success in construction with the acquired assets, but a bit of a halo effect, because of the breadth of that product portfolio on our organic BIM 360 products."
},
{
"speaker": "Andrew Anagnost",
"text": "You took all my interesting points."
},
{
"speaker": "Scott Herren",
"text": "Oh, I'm sorry."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, look, the construction portfolio is performing really well. That is very unusual to get this kind of first-half, you know, first two quarter performance out of big acquisitions like that. We're happy. On the integration side, senior leaders from the acquired companies are taking senior positions inside the construction solutions team. So, we're seeing better and better alignment between those organizations. We have a lot of confidence in where we're going with these things. You see continuing stream of product integrations. Our customers are getting comfortable with our roadmap. The reason customers accelerated their purchasing of BIM 360 is because basically they just -- they see us saying, doing, and acting in all the right ways. So, they're doubling down at Autodesk, and that's nothing, but an excellent sign for how this business is going to grow into next year."
},
{
"speaker": "Ken Talanian",
"text": "Great, thanks very much."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Ken."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Zane Chrane of Bernstein Research. Your line is open."
},
{
"speaker": "Zane Chrane",
"text": "Hi, thanks for taking the question. I just wanted to dig into manufacturing little bit more. The 20% growth in manufacturing revenue really was driven by ARR added in Q3 and Q4 of last year. If I look at the annualized value of manufacturing revenue based on the number of days in the quarter, it looks like it's down about $4 million or $5 million in ACV compared to what it was at the end of Q4. So, and that's in contrast to pretty strong incremental growth in manufacturing revenue each quarter of fiscal '19, is the weakness in first-half on that incremental manufacturing revenue added? Is that due to increased churn or lower expansion with existing customers, or just a pause and adoption due to the macro uncertainty? Thank you."
},
{
"speaker": "Scott Herren",
"text": "Yes, it's neither, Zane. So, to be clear, the 20% growth in manufacturing is in line with the growth in manufacturing we've seen historically over the last two or three quarters, that we're not seeing -- even in the markets that we talked about, the three markets that we talked about having localized impact, we're showing strong double-digit growth even in Germany, which of course is a manufacturing-based economy…"
},
{
"speaker": "Andrew Anagnost",
"text": "In ACV."
},
{
"speaker": "Scott Herren",
"text": "In ACV. So, we're not seeing that kind of -- I'm not exactly sure the math that you did there, we're not seeing -- we can pick it up offline, and we're not seeing any acceleration or deceleration, significant deceleration on the manufacturing side. Renewal rates look strong across the board. New product subscription growth with -- back to one of the questions that came up earlier was in line and actually slightly higher is what we've seen in the prior couple of quarters. So, the manufacturing space continues to perform well, and I think it's a bit of a standout relative to our peers that are far more manufacturing-focused when you look at that growth rate."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, just even to comment on Germany, and we'll just talk about it from a pure ACV standpoint. The ACV growth in Germany was still double-digit, high double-digit growth. What we saw was a gap between our expectations, and the growth we were seeing as we headed into the end of the quarter. We have high expectations for that market, and those expectations were not getting met in the same kind of pattern that we would have expected in past quarters, but ACV is growing across the board manufacturing. So, I think maybe it's something that would be absolutely good to follow-up on and make sure we got the math right there."
},
{
"speaker": "Zane Chrane",
"text": "Okay. Then the next -- just a quick question on the gap between the results versus your high expectations going in, is the gap more driven by lower expansion than you expected or less adoption from potential new customers?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So it is mostly a cross-sell and up-sell opportunity slowing down a little bit, you know, I'll give one example as we look out into the end of the second-half, accounts in some of the European countries where we expected to see EBA conversions are looking like -- the more going to be subscription sales versus the EBAs. So what we're seeing is a little bit of change in behavior at the EBA level and at the up-sell and cross-sell level, and that's really what's triggering our caution. And in terms of what we saw during the quarter, we expect a certain level of uptick in the ACV as we get towards the end of the quarter, and for the manufacturing in Germany, in particular, we didn't see that uptick in ACV. We're still doing great growing, but we didn't see the uptick we expected towards the numbers we want to see. We took that as an indicator of some slowness."
},
{
"speaker": "Zane Chrane",
"text": "Very helpful, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Kash Rangan of Bank of America. Your line is open."
},
{
"speaker": "Kash Rangan",
"text": "Hey, guys, thanks for being completely detailed and transparent with all the disclosures. I was also curious, given that we've not seen any meaningful turn in the business so far, how confident are you that we have levels at the estimates, or is it potential no -- rather revisions potential based on what you might uncover in the quarter or do you feel that you've seen enough and you've scrub the model enough to account for -- whatever it is that you saw in July and that we should be okay from this point onwards?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So obviously we spent a lot of time scrubbing the numbers and looking at this and making sure that we were looking at this in a prudent way. We feel confident that we've set the guide, right, I mean, obviously we're one tweet away from something changing, you know, unless something radical changes in the macro environment we feel pretty confident given our pipeline visibility to what we're guiding out there right now, and again I just want to reiterate what we did is we narrowed the range from the top-end down, the bottom the constant currency stayed the same, right, prudent measured action relative to what we're seeing out there. We think we've got it right, and look, if something comes from our field, something will come from that field, but we feel like we've got it right and we scrubbed our numbers. Scott, do you want to comment…"
},
{
"speaker": "Scott Herren",
"text": "Yes, the only thing I would add to that, Kash, and it's a great question and I appreciate you asking it, so we can talk about it on the call, is that -- as we started to analyze, not just where we're headed in the -- with the strength of our pipeline and the overall strength in our renewal rates, which the renewal rate is becoming a bigger and bigger part of our business. Net revenue retention stayed in the same range. Renewal rates on a volume basis if anything ticked up modestly of course that picked up slightly sequentially. So, I feel good about the core business, and we talked about the Remaining Performance Obligations, even the current RPO, right? So those are -- they're going to turn into revenue in the next 12 months, growing 23% year-on-year. Who knows what the next Tweet will say, but we feel like we've built in and everything that we can see at this point. Yes."
},
{
"speaker": "Kash Rangan",
"text": "Thanks so much again, and appreciate the transparency."
},
{
"speaker": "Scott Herren",
"text": "Yes. Thanks, Kash."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Richard Davis of Canaccord. Your question, please."
},
{
"speaker": "Richard Davis",
"text": "Thanks. Two quick questions, one, you had a little bit of kind of work on rationalizing kind of the overlapping features between PlanGrid and some preexisting functionality, how far are you on that? And then on the second question would be share repurchase, I think you said 253,000, how much is left, and can you accelerate that, can you surge that, or what's up of that? Those are two simple questions. Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, Richard, thank you for that. All right, so first off, let's talk about how we position the portfolio to our customers and port position the breadth of our portfolio. I made it very clear that the BIM 360 products that's going to focus on project management, project-centric workflows, and all the things associated with managing projects from start to finish, and integrating them into the pre-construction workflow. PlanGrid is going to focus on field execution and all the things associated with field execution and the capturing of information in around field execution and communicating that information back up into the global project management environment. We've made progress on multiple fronts. Like I said earlier, we've integrated BIM into PlanGrid, and so, there is BIM PlanGrid integration. We've also integrated some BuildingConnected bid management function into PlanGrid as well, but one of the really exciting things that we're working on, and it's part of the integration strategy is that both the PlanGrid team and the BIM 360 teams have seen the next generation building BIM 360-docs solution we built as being the foundation of what we call a Common Data Environment. This is something that's specked out in the AEC industry. It's called the CDE. And docs is going to be the foundation of our Common Data Environment and both PlanGrid and BIM -- and on all the other core BIM 360 functionality are integrating into that platform, which gives us a great steppingstone, not only to satisfy some pretty complicated requirements around Common Data Environment, but also to bring the products together more rapidly. So, you're going to hear a lot of things from us in the second-half of this year, in the first-half of next year about how these portfolios are coming together, but our customers get it, they understand, and they are buying in more to our solution because they see us acting in the direction of what we said we're going to do."
},
{
"speaker": "Scott Herren",
"text": "And Richard, on your stock buyback question, you're spot on, so we spent $40 million during the quarter, year-to-date we spent $140 million. There is no change in our stance on cap allocation. So we'll continue to offset the core support the growth of the company first, took offset the dilution from our equity plans and then return excess cash to shareholders. We've been doing that pretty effectively with a more opportunistic buying pattern. So, our price grid is based on some Monte Carlo modeling that we do. And during the trading blackout window, of course we have to trade under 10b5-1 plan. Our trading blackout window began in early July, right before the most recent market volatility. So the grid that we had set up didn't necessarily reflect the volatility that we round up experiencing. At this point, I think you should definitely expect us to be back in the market buying back stock."
},
{
"speaker": "Richard Davis",
"text": "Thank you so much."
},
{
"speaker": "Scott Herren",
"text": "Yes. Thanks, Richard."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Your line is open."
},
{
"speaker": "Tyler Radke",
"text": "Hey, thanks for squeezing me in here. So, you talked about how you think some of these macro issues, there are only a temporary thing or a short-term thing, I guess what gives you the confidence there, and then as you think about your lowered expectations, is it fair to say it's all coming from manufacturing, or is there any reduction in your view on AEC? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. All right, so first off, again, let me just clarify a few things that give us confidence about the short-term impacts. One, half of the change in the midpoint of the guide is currency effect, okay. So, let's just make sure we're all level set on that, remember, it's currency effect, I think that's really important. The only thing that gives us a lot of confidence is our pipeline visibility. We have more visibility, because of the changes in some of the models that we have in terms of our go-to market model with the rise of our mid-market programs and some of our direct programs, we have quite a bit of visibility into our pipeline, and we can see into our pipeline, we see robust pipeline, we have visibility all the way through to the end of the year, and also visibility beyond that. So we feel pretty good that some of these things are short-term effects. All right. In addition, we don't see anything slowing down with regards to construction and with regards to our piracy conversion work. So, if we just -- if we just look at high-level, those things are all kind of short-term impacts on our business. All right, and what was the second part of your question, because I thought you asked another clarifying thing about what gave me confidence on the short-term?"
},
{
"speaker": "Tyler Radke",
"text": "Yes, that was just the confident that it's only a short-term macro part, and then on the -- I think you kind of answered it, but around the guidance, was it all a reduction in manufacturing, was there any reduction on AEC?"
},
{
"speaker": "Andrew Anagnost",
"text": "No. Yes, there is no incremental view in AEC. The change in guidance came from those FX effects and our view of the impacts of the softness we saw in manufacturing in Germany, the softness we saw in the U.K. and the gap between our potential in China and what we're actually able to execute on. Those are really the key drivers."
},
{
"speaker": "Tyler Radke",
"text": "Okay, great. And if I could just sneak in one more for Scott, as you think about kind of some of the expense levers you have if you continue to see more softness, just what's kind of your willingness to maybe pull back on hiring, or being more conservatives, you have to keep free cash flow or profitability targets in place?"
},
{
"speaker": "Scott Herren",
"text": "Yes, it's a great question, Tyler. I think we've graphically demonstrated pretty effectively over the last four years, sound, spend, discipline. We continue to show to demonstrate sound, spend, discipline. We've effectively kept total spend flat for -- ex the acquisitions in Q4 we have total spend flat for four consecutive years. So, there will be a bit of an opportunity for us to take up spend at the same time we're increasing margins. If you look at this year, we talk about spend growth of 9% and margin growth of 12 percentage points of margin year-on-year. I expect margin to expand again into fiscal '21, although there is some pent-up demand percent having been flat for four consecutive years or some pent-up demand. So, spending will increase current course of speed, barring something significantly different happening in the overall macro environment spending will see a little bit of an increase again in fiscal '21."
},
{
"speaker": "Tyler Radke",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, I'd like to turn the call back over to management for any closing remarks."
},
{
"speaker": "Abhey Lamba",
"text": "Thanks for joining us. This concludes our conference call for today. If you have any questions, feel free to contact us. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you, sir. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 1 | 2,020 | 2019-05-23 17:00:00 | Operator: Good day, ladies and gentlemen and thank you for your patience. You've joined Autodesk First Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to host, VP of Investor Relations, Abhey Lamba. Sir, you may begin.
Abhey Lamba: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the results of our first quarter of fiscal '20. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can also find our earnings press release and a slide presentation on our website, we will also post a transcript of today's opening commentary on our website following this call. During the course of this conference call, we may make forward-looking statements. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. And now, I would like to turn the call over to Andrew.
Andrew Anagnost: Thanks, Abhey. We started off fiscal '20 with great momentum, accentuated by continued acceleration of recent construction acquisitions and strong growth across all geographic regions. Our billings and free cash flow came in at or above expectations and reflect the strength of our business. We are on track with the integration of PlanGrid and BuildingConnected and have exciting achievements to share with you. Although, our first quarter revenue came in at the low end of our guidance range, we are on track to achieve our fiscal '20 ARR and free cash flow guidance and are reaffirming our fiscal '23 targets. Our pipeline for the rest of the year is strong and growing, and the underlying demand strength we've seen in prior quarters continues to drive growth in our business. There is no change to our view of the strength of the business or the current spending environment in our end markets. Before I offer you more color on strategic highlights during the quarter, let me turn it over to Scott to give you more details on our first quarter results as well as our guidance. I'll then return with further insights into some of the key drivers of our business, including construction, manufacturing and digital transformation, before we open it up to Q&A.
Scott Herren: Thanks Andrew. As Andrew mentioned, our leading indicators, billings and free cash flow, performed well. Total revenue of $735 million was up 31% and 28% excluding our recent acquisitions. It was within our planning assumptions, although at the low end of our guidance range. This was primarily driven by linearity, as we closed more business later in the quarter than anticipated, which affected the amount of ratable revenue recognized in the quarter. Overall demand in our end markets was robust, as indicated by our strong billings and revenue growth. Our subscription volume also grew steadily across the board. Sales volume of AutoCAD LT remained strong. And this has historically been a leading indicator of potential demand slowdown. As you can see, revenue from our AutoCAD and AutoCAD LT products grew 37% in the first quarter, slightly better than the 36% growth rate in Q4. AEC and manufacturing also rose 37% and 24%, respectively. Geographically, we saw broad-based strength across all regions. Revenue grew 35% in EMEA and APAC, and 27% in the Americas, with strength across almost all countries. We also saw strength in direct revenue, which rose 36% and represented 30% of our total sales, consistent with last year. Within direct, our e-store grew 45%. Looking at ARR, total ARR continued to grow quickly, up 33% versus last year to $2.8 billion. Adjusting for our recent acquisitions, total ARR was up 29%. Core ARR growth was in line with our total organic growth, while Cloud ARR grew 164%, propelled by strong performance in construction. Excluding the $83 million of ARR from our fourth quarter acquisitions, organic Cloud ARR, which is primarily made up of BIM 360 and Fusion 360, grew a record 43%. We continue to make progress with our maintenance to subscription, or M2S, program. The M2S conversion rate in Q1 was consistent with prior quarters, with approximately one-third of maintenance renewal opportunities migrating to product subscriptions. Of those that migrated, upgrade rates among eligible subscriptions remained within the historical range of 25% to 35%. As a reminder, this is the last year of the M2S program, and we are continuing to incentivize customers to convert. In addition to strong new customer billings, the growth in ARR was supported by continued expansion of our renewal base. And as we introduced at our Investor day in March, the net revenue retention rate is a key metric to monitor the health of our renewal base. Net revenue retention rate measures the year-over-year change in ARR for the population of customers that existed one year ago, or base customers. It's calculated by dividing the current period ARR related to those same base customers by the total ARR from one year ago. During Q1, the net revenue retention rate was within the fiscal '19 range of approximately 110% to 120%, and we expect it to be in this range throughout fiscal '20. In Q1, some of the deeply discounted subscriptions from our global field promotion we ran three years ago came up for renewal. We were very pleased with the renewal rates of this group of customers as they renewed closer to list price, and the total value from the entire cohort grew. Moving to billings, we had $798 million of billings during the quarter. On a normalized basis, billings rose about 40%. Recall that last year we adopted ASC 606, which resulted in adjustments of approximately $160 million to our deferred revenue balance and impacted billings, since billings are calculated by taking the sum of revenue plus the change in deferred revenue. The growth in billings was driven by strong renewals and continued momentum in our core products. We also benefited from some customers renewing early in the quarter due to upcoming price increases. Our recently acquired construction assets contributed nicely to the billings increase. And in line with our plans, multi-year contracts moved higher, helping our total billings. Recall that multi-year payments are good for our customers as they benefit from stable pricing and a single approval process. Our partners like them as they can sign higher contract values and maximize their cash flow. And we benefit from a more predictable revenue stream and upfront cash payments. The second and third year of those multiyear agreements are recorded in our long term deferred revenue, which grew by 12% and ended the quarter at 17% of the total deferred balance. As we indicated at our Analyst Day, we expect to end the year with a long term balance in the low 20% range of total deferred revenue, in line with the historical range. On the margin front, we realized significant operating leverage as we have entered the growth phase of our journey. Non-GAAP gross margins of 91% were up 140 basis points versus last year. Our disciplined approach to expense management combined with revenue growth enabled us to expand our non-GAAP operating margin by 13 percentage points to 18%, despite absorbing two significant acquisitions. Moving to free cash flow, we generated $207 million in Q1. Over the last twelve months, we have now generated $550 million of free cash flow, positioning us well to hit our full year target of $1.35 billion. Note that Q1 benefited from the very strong Q4 of fiscal '19 that we had. As you may recall, we had over $1 billion of billings during Q4, some of which was collected in the first quarter of fiscal '20. As such, I expect our free cash flow in Q2 to be down sequentially. We continue to repurchase shares with our excess cash, which is consistent with our capital allocation strategy. During the quarter, we repurchased 582,000 shares for $100 million at an average price of $171.84 per share. Now I'll turn the discussion to our outlook. I'll start by saying that our view of global economic conditions and their impact on our business is unchanged from the last several quarters. We are not seeing any noticeable impact from Brexit and the various trade and tariff disputes. For the full year, we are reiterating our fiscal '20 free cash flow outlook of approximately $1.35 billion as well as our outlook for ARR of about $3.5 billion, up 27% to 29%. In line with our initial plans, we expect billings of about $4.1 billion at the midpoint, driven by the strength of our renewal base, new subscription growth, continued normalization of multi-year billings, the flow through from unbilled deferred revenue, and our acquisitions. When looking at the quarterization of free cash flow for fiscal '20, we continue to expect about three-fourths of the free cash flow to be generated in the second half of the year. Looking at our guidance for the second quarter, we expect total revenue to be in the range of $782 million to $792 million, and we expect non-GAAP EPS of $0.59 to $0.63. The earnings slide deck on the Investor Relations section of our website has more details as well as modeling assumptions for the fiscal second quarter and for full year 2020. Now I'd like to turn it back to Andrew.
Andrew Anagnost: Thanks Scott. Now, let me give you an update on some of the key growth initiatives we highlighted at Investor Day, specifically progress made in construction, manufacturing and digital transformation. These initiatives are key drivers of our business both near and long-term. First, in construction, we are seeing continued strength across the portfolio as we execute on our strategy to deliver a comprehensive, integrated platform that seamlessly connects the office, the trailer, and the field. We had significant accomplishments during the quarter as we integrated PlanGrid and BuildingConnected into Autodesk. Both acquired companies showed impressive growth, which is important to call out considering that acquisitions typically see a slow down during the integration phase, whereas we experienced accelerating momentum. Post-close, we have won fifteen head-to-head bids against leading competitors in this space. Other milestones included the launch of our first product integration and the realization of revenue synergies. Q1 was the first full quarter where we had the entire construction portfolio in place, as we closed PlanGrid in December 2018 and BuildingConnected in January of this year. Feedback from customers has been very positive regarding the addition of these best-in-class solutions to our comprehensive construction portfolio, which now includes BIM 360, PlanGrid, Assemble Systems and BuildingConnected, in addition to the design tools we have always sold into that market. On the technology development front, we were able to accelerate the product roadmap for PlanGrid, which resulted in the introduction of PlanGrid BIM last month. This is a new product integration between Revit and PlanGrid that allows customers to immediately access BIM data in either 2D or 3D directly within PlanGrid on their mobile devices. We were able to deliver this frequently requested feature at an accelerated pace now that PlanGrid is part of Autodesk. In fact, when PlanGrid BIM was launched we hosted a webcast and the demand was 5x what PlanGrid had normally seen for prior product launches, and the number of customers who requested to be contacted by a sales person following the webinar was also more than 5x what they normally experience following a product-focused webinar. We've also seen synergies begin to develop on the sales front. For example, APTIM, a leading construction services vendor and joint customer of Autodesk and PlanGrid, tripled its PlanGrid users as part of the Enterprise Business Agreement for its Digital Foreman Initiative. Other Autodesk products they use include AutoCAD, Civil 3D, Plant 3D, Map 3D and Revit. And because we have been clear with our customers that PlanGrid will be focused on field execution and BIM 360 on project management, there are a lot of synergies between the two offerings that our customers have yet to realize. We are also seeing BuildingConnected thrive within the Autodesk construction ecosystem. Since the acquisition they have grown their user base from about 700,000 to over 800,000. Now, I'd like to elaborate on the impressive growth comment made earlier. When we made the acquisitions, I said that we were focused on keeping the strong sales momentum going, and that is exactly what happened. At PlanGrid, the sales teams are continuing to perform strongly with both new and existing customers. For example, they expanded their relationship with Rosendin Electric, a long standing PlanGrid customer with plus 6,000 employees and annual revenue of about $1.5 billion. The company recently extended its contract for three years and significantly expanded it, in part due to Autodesk's long-term vision. PlanGrid sales have also started to benefit from being part of the Autodesk family. During the quarter, Jacobs, a global leader in professional services sector and a long-standing Autodesk customer, decided to further enhance its relationship with us by adding PlanGrid to one of its divisions. In making this decision, Jacobs pointed to its current speed in the field, ease of use, and integration with the rest of the Autodesk suite as determining factors in adopting the software. The Company is currently utilizing PlanGrid on $1 billion infrastructure project. PlanGrid also ended Q1 with its largest ever pipeline of deals. And the momentum continued at BuildingConnected too. BuildingConnected has introduced new features that continue to make its platform more and more valuable to larger and larger portions of the market. In fact, they had their best quarter ever in Q1 in terms of new business and are seeing their flywheel continue to drive new business on both the general contractor and subcontractor side. BIM 360 also continues to demonstrate strong growth. In fact, our organic Cloud ARR, of which, BIM 360 is the largest component, was up 43% in Q1. This was driven by strength across the entire BIM 360 portfolio, especially BIM 360 Design, which is our real time collaboration tool for Revit users. We also saw both existing and new customers increase adoption of BIM 360. A good example here is WeWork, with 485 locations and 466,000 members around the world, WeWork provides spaces and services to help people work, learn and collaborate in more meaningful ways. They expanded their subscription with Autodesk this quarter and are one of our largest BIM 360 Design customers. We are excited to work with them and look forward to further enhancing our relationship over the coming years. Overall, all parts of our construction portfolio are performing at or above the plan and showing strong growth. I am extremely proud of all the teams involved. They remain focused and dedicated to helping Autodesk grow and drive positive change in the construction industry. And lastly, I wanted to note that for those looking to get a more in-depth view of our construction business, we are hosting an event on June 4th here in San Francisco, where you'll have the opportunity to hear directly from AECOM, Webcor and DPR in addition to our construction team regarding our portfolio and go-to market opportunity. I hope to see all of you there. On the manufacturing front, revenue grew 24% as customers see the benefits of our differentiated solution, we are gaining share and displacing competitive offerings in the space. For example, a large manufacturer of locomotives and rail equipment further expanded its relationship with us, they are in the process of deploying our manufacturing solutions across their various divisions and are relying on Inventor, our CAM solutions and factory design utilities to automate their workflows. Our solutions displaced competing our products due to our simplicity and short implementation cycles, which is in line with their rapid product introduction requirements. Our investments in generative design and Fusion 360 have resulted in more than 100% year-over-year growth in monthly active users for our commercial customers. Users love the cloud-based, comprehensive solution of Fusion 360 and it is disrupting the industry. Fusion 360 offers unprecedented value and out-of-the-box productivity for concept to production workflows, and that appeals to a large swath of our customers. A US-based specialty pharmaceutical company purchased Fusion 360 to replace SolidWorks for designing and manufacturing auto-injectors. After reviewing various options, they decided that Fusion 360 provided superior collaboration and data management capabilities in the cloud with no setup or maintenance complications. A Midwest metal fabrication company chose Fusion 360 to replace separate instances of CAD and CAM solutions. They were impressed by our integrated CAD/CAM functionality and collaboration features. With Fusion 360, they were able to replace CATIA, Creo, Mastercam, and PTC Windchill, allowing them to rely on fewer platforms and to promote collaboration. Then when it comes to digital transformation, we are seeing the positive impact it is having on our business. We are also making progress in using digitization internally as part of our plans to convert the large number of non-compliant users into paying customers. All new single user product subscriptions are already using identity-based authentication and we continue to move existing customers to this new system. We are on track to migrate all eligible single user subscriptions to identity-based authentication by the end of the current fiscal year, which will provide a much better user experience for our customers and help us in combating non-compliant usage of our software. Beyond that, we are already starting to see results from our efforts to engage directly with customers using non-compliant versions of our software and expect our ongoing learning to increase our effectiveness in FY '20 and beyond. As you heard, there's a lot of activity happening towards the growth initiatives highlighted at Investor Day across construction, manufacturing and digital transformation. These drivers, as well as the large opportunity we see in converting the current 14 million non-paying users into subscribers, should result in an acceleration in profitability and cash flow metrics and sustained growth going forward. We are highly confident in Autodesk's ability to capitalize on this large market opportunity and are committed to delivering our FY '20 and FY '23 targets. With that, operator, we'd like to open up the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of Phil Winslow of Wells Fargo. Your line is open.
Phil Winslow: Thanks for taking my question and congrats on great start to the year. I just wanted to drill into your comment about just the linearity of the quarter, Scott you mentioned that the quarter's billings and it was well within your assumed range with revenue at the low end just because of linearity, but your full year expectations are unchanged. Wonder if you could just drill into that, where was the linearity different was it something about specific industries or more geographies, and sort of how are you thinking about the go forward there?
Scott Herren: Yeah. Thanks, Phil. It was - it's certainly within the range of our guidance and our planning, $735 million was the low end of our guidance range. So it wasn't a significant variance from what our expectations were. So we did see those both Q3 and Q4 had - but I'll call better linearity. So earlier, linearity in each of those quarters, as we came into Q1, Q1 actually ended up with the linearity of similar to last Q1, as opposed to the improved linearity that we've seen in Q3, and Q4, which I guess is not really surprising, given that, beginning of the year, people don't have budgets yet, sales teams are going through sales kickoff, et cetera. So we ended up with the same linearity we had in Q1 a year ago as opposed to kind of the improved linearity we've seen in Q3 and Q4 and that's what pushed us to the low end of the range. I'll go ahead and answer your follow-up question, which is our assumption for Q2. On linearity is that it'll look more like Q2 '19 as opposed to the improved linearity that we saw in Q3 and Q4, it doesn't really have an effect on the full-year, you see full-year guidance remains unchanged, and you see, actually, Q2 guidance shows a pretty nice step-up sequentially as a result of getting some of that, and that came in a little bit later in the quarter, obviously we have it for the full quarter of Q2. So it doesn't really change our view at the year. That was a good strong start to the year. Just had linearity more in line with what we had seen a year ago as opposed to what we had seen in the prior two quarters.
Phil Winslow: Then just a follow up for Andrew. It was great to hear some of those wins on the PlanGrid side, BuildingConnected, wonder, if you can provide just more color on this early feedback you're getting now you provided some earlier, but how you think about bringing this into the product line and maybe even also using BuildingConnected even almost as a funnel for PlanGrid as well. Just some more color there that would be great.
Andrew Anagnost: Yes. So what was the second part you said about PlanGrid there Phil.
Phil Winslow: Sorry to say as a funnel, potentially you're seeing bid management, actually you've been using that as a sort of lead management, so to speak for PlanGrid?
Andrew Anagnost: That's exactly, and actually you've hit on one of the points that's important about this coming year. The PlainGrid folks and the BuildingConnected folks immediately found some synergies between how they approach the market and their individual businesses. So there's a strong flow of leads and discussion back and forth between those two teams, and that plays a pretty integral part. Remember, BuildingConnected has visibility to the whole entire project bidding environment within the US. And obviously, PlanGrid is super eager to go and talk to those projects about how they can improve site execution and effectiveness and success for their particular projects. So that's one of the big uplifts we're seeing is some of the connection between those two offerings. And frankly as we brought BuildingConnected in, we saw a very nice surge in their business. Like I said, they had their best Q1 ever in terms of new business, because people just like the fact that they're part of Autodesk and that - what they're focusing on with the bid management is - it's a good tool, they added a lot of features in there during Q1. And it's a solid result.
Operator: Our next question comes from the line of Saket Kalia of Barclays Capital. Your line is open.
Saket Kalia: Maybe first for you Andrew, just picking up off the last line of questioning on PlanGrid. Clearly, it seems like it's off to a good start. And I believe the initial approach here was to let them operate largely separately at least for the vast majority of sales. But it seems like you were able to really cross-sell to some mutual customers relatively early on. So can you just talk about how you sort of envision the combined company maybe looking by the end of this fiscal year PlangGrid plus Autodesk BuildingConnected, and within that maybe touch on the - just a very minor overlap you might have with some products with Autodesk versus PlanGrid, and how you plan on sort of handling that?
Andrew Anagnost: Yes. So first off, all let me comment on some of those synergies we found in shared accounts. So one of the things we did very quickly as we established how we were going to go-to market with our named account side of our business, and a lot of the places where we're seeing like joint shared updates in our named account business. So that was a place where we have a named account rep, where we can come in and say, hey, look you know what, we can augment your solution with PlanGrid and we can do some - we can get this project, put it up on PlanGrid, we can get this project put it up on BIM 360 that's where you're seeing a lot of collaboration, that fits within our standard salesforce, and it's functioning really well, and we have an interconnect strategy between those two, and a quarter retirement strategy that allows people to cross-sell and get benefit in terms of quarter retirement for both sides of the equation. Now what you see that PlanGrid team being highly effective at is doing land and expand in new accounts in the construction ecosystem. And we focus a lot of that team on going out and reaching construction companies that we historically did not touch. And that's where they're spending a lot of energy. So they leverage our named accounts team for some of these synergistic sales and they go out and they find new business out there using their existing infrastructure, which works very effectively. As we move across into the year, what you're going to see is basically - we're going to maintain that essential structure, but we're going to make sure that we coordinate sales more tightly within the Autodesk construction group as we move towards the end of the year. But we're going to continue to have that synergistic relationship between our named account program and the salesforce that sits inside of the construction group. And we just - we just think those synergies are going to increase as the year progresses. Remember, we just rolled out a tokenized version of PlanGrid as well, and you know how effective we are at driving usage within some of the named accounts underneath our EBA, so you're going to see that have a synergistic factor as well and it's all brand new. I mean, we're very, very early on, in that.
Saket Kalia: Maybe for you Scott, just to peel back the onion a little bit on ARR. It was actually a little funny, the maintenance ARR number actually came in a little bit below what I was expecting, but I think the consensus is actually a little bit higher. Maintenance at this point is getting to be such a small part of the business, but I guess maybe just to better help - better calibrate, maybe the pace of decline, any sort of idea for how we should think about that pace of decline in maintenance ARR, maybe through the rest of this year or some broad brushes?
Scott Herren: Yes. So it's a great question, Saket. The M2S program, of course, just entered its third year, right, at the beginning of Q2, we just entered the third year of the M2S program. And this is when the more significant price increase goes into effect for those who want to renew maintenance. Ahead of that what we've seen is the maintenance renewal rates, we're not talking subs in renewal rates anymore, but if we were the maintenance renewal rates have held up very nicely in that space. And so we continue to see both success with conversions. I said that on the - during the script that was in the range that it had been historically, of those that convert the upsell, the collections continues to be good. We're down to at this point just short of 700,000 maintenance customers left, and that I'm super pleased. We started this with a little more than 2 million maintenance subs, and we've now moved all but at about 700,000 over to product subscription. I think this year is the year where we'll see a lot more of the remainder move over. So what I would - my expectations is we'll continue to see good success with that moving over. And of those that elect to say - to stay what we have seen is the minus renewal rates are holding up nicely.
Operator: Next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your line is open.
Jay Vleeschhouwer: Andrew, let me start with you. One of the things that you've talked about with respect to digital infrastructure is your usage telemetry, your ability to observe and collect data about how customers are employing the products, particularly now the - it's mostly subscription. Can you talk about any trends or key observations that you're getting from the use of telemetry particularly in the growing collection space. Second question there's been quite a bit of commentary in the call thus far with regard to direct sales, and how you're handling the integration of the construction acquisitions. A broader question perhaps about customer engagement, you like some other companies have created a new customer success group, and this has become increasingly common in software. What do they do? And how do you measure the success of the customer success group?
Andrew Anagnost: So let me start with the first question about the kind of the insights we're seeing. So we'll - there's a few things I can tell you, one of the insights we're getting is, usage is continuing to go up, it's going up nicely across numerous product sets. And that's really great to see. The other thing we're seeing is that collections are seeing usage patterns better than the old suites in terms of how many products people are using, which shouldn't surprise you, because there's more offerings inside - more diverse offerings inside the collections and we're seeing some of those things. And one of the other things I'll tell you is that the ramp up of "new releases" that were moving away from what we would like to consider major releases. People are ramping up on to the latest capabilities relatively quickly including the people who don't pay us, which is important for us to talk about, because it says, that cohort of non-paying users continues to follow us into some of the newer capabilities. And I think that's important in terms of the future capability of capturing some of that opportunity as we move forward. So yes, we are seeing some more fidelity in terms of usage, and we are seeing some interesting trends and some things that looked a lot better than they were in the suite days. Now in terms of the customer engagement team. The first thing I want to talk about is what is the team measured on? They're measured on net revenue retention. Okay. That's their job. Their job is to go in there and renew and help grow those accounts, and that's the primary metric they track. They also have metrics around MPS for the interaction that they have with the customers, not kind of global MPSs, but relationship MPSs and network net promoter scores around the various interactions. But, primarily, we measure them on how well we capture money from the renewal base and net revenue retention in particular. The way they function is a function along the spectrum from low touch - low human touch digital relationships all the way up to high touch engagements. One of the digital infrastructures we built that's facing this team is what we call the early warning system, it's an umbrella of a lot of metrics that basically give this team a sense for how healthy an account is how healthy are they on their usage capabilities, how healthy are they on their adoption of learning tools, on other tools, has there been a drop off, and it helps them kind of spend their time with the accounts that need the most assistance and the most engagement with Autodesk. It is a new practice, we've beefed it up, it consolidates several things in the area, but I just want to emphasize the number one thing they're revenue - they're measured on is net revenue retention and that's how we track the success of that organization. Scott, do you want to add anything ?
Scott Herren: No. I think you nailed it. That's - We - the customer success team under Ray has actually done really nice job so far, and one of the things we mentioned Jay in the in the opening commentary is that our net revenue retention rate has stayed right in the range that we talked about at Investor Day. Last year, all year, it was in that approximately 110% to 120% range, and it stayed right there again in Q1. So Ray and his team are off to a really good start.
Operator: Our next question comes from Heather Bellini of Goldman Sachs. Your line is open.
Heather Bellini: I had a question about - I know your referenced to linearity in your prepared remarks. I was wondering, if you could share - if you noticed any impact or what you're hearing from your manufacturing customer base in the quarter just due to the kind of ongoing tariff war that seems to be going on, and if they've given you any sense of whether or not that's impacting their own spending plans? And also - I'm just also just because I'm getting asked myself, you obviously had very good outperformance, it seemed on long term deferred versus some people's expectations. Could you share with us kind of how did short-term DR track versus your expectations? And that's it. Thank you.
Andrew Anagnost: So I'll take the first part, then I'll hand the second part over to Scott. So you saw our manufacturing business grew quite nicely during the quarter, really strong growth. Now that doesn't mean we aren't hearing from our manufacturing customers that they're seeing pressure in terms of the commodities they use to build their products and things associated with that. They absolutely are. All of our customers are paying more for certain basic things to bring into their business. But you have to understand what we sell to them isn't a commodity, it isn't a metal or a fabrication or a supplier. It's a mission critical tool and it's a mission critical digital process. And a lot of our customers see these tools and expansion of their investment with us as helping them be more efficient and be more effective when they're seeing cost pressures rise in other areas. Like a lot of those competitive wins I talked about are really focused on consolidation of multiple tool sets into the single solution we offer, which is easier to deploy. It's lighter touch. It's got more and more end to end things, the different types of price points. So customers are actually looking to us to help them get more efficient, while they're seeing the cost of things that roll in the door to make their products go up. So we have not seen any kind of backing away of expenditures in our software space. We're seeing no signs of it. We haven't seen it yet, it doesn't mean things can't change. But we also - we do know that our customers are turning to us to make them more efficient. And I think that, that puts us in a good position when they're seeing the cost of other parts of their business go up. Now I'll turn it over to Scott for the second part.
Scott Herren: Sure. On the second one, it's interesting, Heather, of course what you see showing up in long-term deferred, the sequential growth. There's some of the success we're having in - having multi-year payments get closer to the mean that they had been in historically. We're still not quite there, right? So there's still a little more headroom in long-term deferred to get to what we talked about at Investor Day as that being kind of a low 20% range. If you look at the growth rate year-on-year, the long-term deferred grew 12%, short-term deferred actually grew 21% year-on-year. So we're seeing really nice performance as you'd expect when you see the billings line grow the way it as has. We're seeing really nice performance across the deferred revenue spectrum. When you add in unbilled, total deferred revenue grew 24% year-on-year. So it was obviously strong billings quarter that led to both good revenue results, but in particular, strong growth in deferred.
Operator: Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Your question please.
Matt Hedberg: Andrew, we continue to hear positive feedback from channel partners around generative design, it really transforming the whole design process. I know this remains a focus for you guys. Wondering about a little bit of an update there on this momentum and really customer receptivity to this - sort of this new way of designing ?
Andrew Anagnost: Yes. Well, there's a lot going on there, and we're rolling out a lot more in generative tools, especially to the Fusion platform. Manufacturer going to see some new capabilities in terms of generative geometry creation tied to 2.5 axis milling constraints and more of the mainstream kind of CNC applications the customers use. So we'll probably going to see a little bit of an explosion of use of some of these tools as we roll some of this out. But you're right, we're getting a lot of adoption. And the partners are excited about it, because they can go in and have a very, very differentiated discussion with their customers about what they can do with these tools. Now one of the things we're seeing, and I want to make sure that people understand this, because people thought, well, these are really advanced things, isn't just like 3D printing focused, and isn't this just for people that want to create organic shapes for 3D printing. The biggest usage right now that we're seeing with regards to generative design is people exploring new types of design options for things that they either had existing or they are building from scratch, and then taking those explorations and turning them into things they can build using their traditional manufacturing methods. So they're essentially using generative design as a tool to show them new solutions to problems that they wouldn't have naturally found in the first place. And that's one of the exciting things about what's going on right now is that, it's having a real impact in the mainstream customers and on the customers that are kind of looking out on the cutting edge of things. So you're absolutely right, there's lots of reasons to be excited and our partners are really getting engaged in our manufacturing portfolio, because of generative.
Matt Hedberg: And then maybe just a quick one for Scott, obviously, a lot of questions on the construction opportunity. I'm curious when you think about adding sales capacity to this year, how do you kind of think about into the overall pace, and then, how do you think about putting that sort of like more or so in the construction versus A&E or the manufacturing side, just sort of wondering about, just sort of how you kind of allocating your sales capacity adds this year ?
Scott Herren: Sure. Construction is such a massive opportunity for us Matt, it won't surprise you to hear that we rotate a lot of investment into it. Coming on the heels of the acquisitions we did in the fourth quarter, we've also increased spend in each of those. It wasn't the normal buy them and go through a bit of a downsizing, we've actually done the reverse. We've acquired those companies, integrated them nicely into Autodesk and at the same time increased the investment in construction. So great results out of the gate as Andrew mentioned in the opening commentary, and I think you can expect to see us at this level of performance, and what the market really beginning to turn this direction, you can expect to see us continue to invest in construction.
Operator: Our next question comes from the line of Ken Talanian of Evercore ISI. Your line is open.
Ken Talanian: So for the customers that are still on maintenance, do you have a sense for how the percentage of that group who might upgrade to collections compares to the folks who are already converted?
Scott Herren: What I'd say Ken is really haven't seen the needle move much on that. We've had great success at the point of people moving from maintenance over to product subscription, we've had great success having them kind of cross grade and instead of going single product to single product, going single product to collection. And that really hasn't changed over the last six quarters or eight quarters now that we've been tracking into us. So I'm not expecting a significant change. The one thing I would note in the demographic which is quite not surprising to you, the bigger customers that aren't EBA eligible, obviously the bigger customers that were on maintenance were some of the first to adopt into us and move over. It's not as bigger skew as you might think from the biggest to the smallest, but there is a little bit of a bias to the larger customers. As we get down to the smaller and smaller customers, we might see a point or two difference there, but I wouldn't expect it to be significant. Andrew, anything you'd add?
Andrew Anagnost: No. I think we've seen a consistent pattern, and we don't see anything that would indicate that changing. I agree with you. It's probably going to make a point or two different as we get deeper into that base. Just because of the size and because maybe a mix shift inside that what's left to the maintenance base.
Ken Talanian: And are you seeing any non-payer conversion from the shift to a serial number free licensing model.
Andrew Anagnost: We always see non-payer conversion every year. So one of the things I just have to say, because I say it every call, this non-paying conversion thing isn't going to be this big explosion, all right. It's an ongoing process. Some of these people have very clever ways. They continue to not pay us. But what I will tell you is that we've successfully rolled out some really interesting ways to have conversations with these customers and engage with them directly. And we are learning a lot that we think is going to play pretty significantly into our long-term strategy with regards to converting these people. We have direct engages with them. We can track where they go after an engagement whether or not, they continue to pirate or they pursue some kind of other path. So we're learning a lot. And that's what we expected to do this year. Every year, we convert non-paying users into users, every year, we convert more than we did the previous year. But more importantly, every year, we're learning more about how to effectively engage with these customers. And that should give you a really good feeling about the long-term growth prospects as we start looking at those 14 million non-paying users and converting them over the next few years.
Operator: Our next question comes from Sterling Auty of JPMorgan. Your line is open.
Sterling Auty: I think you gave commentary that you saw strength across geographies, obviously see the pie chart with the percentages. But just wondering for - about some colored commentary. Looking at the PMI results coming out of Europe today, there's been questions in other areas of software around possible squishing as here in North America, what are you seeing from just the macro by geography ?
Andrew Anagnost: So we're not seeing any kind of geography-based slowdowns. And by the way, the PMI in EMEA has actually been in contraction territory for a while. So it isn't like a new phenomena. And for us, we see the PMI as measuring a different side of the demand curve. It's much more focused on the purchasing of kind of the core assets that kind of go in the door and come out as product. We're selling efficiency in digital transformation. So right now, we - and what - actually let's just look back historically, we've never seen a strong correlation between the PMI and near-term impacts on our business. Long term, as the PMI phasing contraction territory, you absolutely, eventually would see an impact on our business. Short-term what people do is they tend to buy more of our software to try to invest in digitization and kind of getting their processes more aligned, more efficient. So we're not seeing any slowdown in any geographic areas. And the ongoing PMI results don't signal anything to us in terms of our demand environment.
Sterling Auty: And then one follow up, do you mind as where are we in terms of the various pricing or discount changes both on maintenance and other parts that you had outlined at the beginning of the transition. What changes recently went into effect if any? And what were the impacts?
Scott Herren: Yes. Sterling on the - you're talking about the maintenance to subscription program that we're - that we just began or if you remember, we started that program actually kind of middle of Q2 a couple of years ago. So we just began the third year of that. And at the third year, what we have said then and just went into effect at the beginning of May is the cost to convert - the price to convert would go up by 5%, the price through renew maintenance from last year, the price through new maintenance have got up 20%. So both of those increases went into effect in early May. So we're sitting three weeks into that right now, not expecting to see any significant change in terms of renewal rate. I do think at this point, it probably becomes a lot more attractive for those that have gone under maintenance, to actually make the conversion. Through the first quarter what we saw in conversion rates, as they kind of held in at that roughly a third that are converting at about the point of renewal. We'll see now with the difference in - pretty significant difference in price. We'll see how that goes in this quarter and through the end of the year.
Operator: Next question comes from the line of Matthew Broome of Mizuho. Your line is open.
Matthew Broome: You recently launched 2020 editions to AutoCAD, Revit and some other products. Just curious how early feedback has been for that. So that which new features you believe will have the biggest impact?
Andrew Anagnost: Yes. So like I said earlier, we've seen pretty rapid adoption of these capabilities as they rolled out, which actually bodes well for how customers are reacting to those things. I don't have any feedback on particular feature sets. Because we're working like a big lumps of areas, like in one area we're working on in Revit in particular, is on rail and things associated with rail and adding capabilities that make it more efficient for rail. So there's going to be lots of areas and each one of these products that are broadly accepted. But when it comes to AutoCAD in particular, customers are starting to embrace the multi-platform nature of what we've done with AutoCAD, and the way we're making it easy to integrate not only our own storage environments, but third-party storage environments like Dropbox and Box, and other types of environments, so that our customers can efficiently use AutoCAD data in multiple types of storage environments. One of the features we rolled out and it doesn't get a lot of visibility is that when a customer is inside the Dropbox environment, and they go and they click on a DWG files, it actually launches the AutoCAD - AutoCAD web, the viewer - and it put its full AutoCAD web, and it actually says, you are subscriber, if you're a subscriber they get the edit experience. But it is the - AutoCAD web version inside these applications, that kind of reach that we're getting with some of those things is actually exposing more and more customers to the power of the multi-platform view we've taken with some of these applications. So I think you're going to hear more and more about what we're doing there. On the Revit side, you're going to hear more and more about some of the things we're doing around rail and other areas, where we're extending the capabilities to be not just Revit, but in InfraWorks such as more specifically say it's on the InfraWorks side. You're going to hear more and more about some of those things as well. But those are some of the areas that are getting a lot of interest and a lot of traction.
Matthew Broome: And I guess, could you provide a brief update on the media and entertainment business. It looks like there was a little bit of revenue deceleration there during the quarter.
Andrew Anagnost: Yes. So there's a couple of things you want to know about the media and entertainment business. One, it's very sensitive to large deals. All right. So for instance in Q4, we had a couple of really big deals in M&E. So there was a quarter or a quarter change around media and entertainment just related those deals. Last Q1, we also had a big deal that came in. And like I said, the media and entertainment business of all our businesses is very sensitive to these large deals. So there is a quarter over compare to that large deal, but in addition and this is something I want you to pay attention to over a multi-quarter scenario, similar to what we did in our manufacturing business, we've retired certain products in that space that we're no longer collecting revenue on and you'll see some kind of year-over-year declines associated with that. So for instance, we don't charge for sketchbook anymore that product is out there, it's completely free, it's available to people to anybody who wants to use it. That, that money isn't in there anymore, and it shows up in the year-over-year. But those are things that are affecting the M&E business. We actually had a pretty robust M&E quarter, right? But as I said, there's sensitivity to large deals and this idea that we feel kind of retired certain products especially things like sketchbook that are going to have year-over-year impacts.
Operator: Our next question comes from Rob Oliver of Baird. Your line is open.
Rob Oliver: I wanted to take it back to the construction side if I could Andrew, and talk a little bit about the pricing side. I know you've said you guys favor the named user bundles. How is pricing playing out so far relative to your expectations coming in? And on those 15 deals in particular, where there was head-to-head competition, did price play a role at all? And then I have a very quick follow-up? Thanks.
Andrew Anagnost: Yes. So first off, like I said, we're really happy with the results of construction in Q1, we hit all our goals we're looking good heading into Q2, we're really happy with things that are going on. So let me tell you right out of the gate, that the pricing models are working in their form, but I think I know you're asking a different question. So like - when we go in against the competitor, let me tell you about the two things that help us win. The first thing is competitors just like the story, they see us with a best-in-class field execution solution at one end, they see us with a best-in-class design collaboration solution at the other end, all cloud-based. And they just look at us and when we tell them look, we're going to connect the building information model all the way from design through to site execution, and we're going to do it with these things in between, they believe us, and they see it and they expect it all of its functionality is going to roll out over time. And when we do things like accelerate the rollout of PlanGrid BIM into the PlanGrid environment as quickly as we did, people start to say, okay, thank you Autodesk, you're showing us the evidence that we're heading in the right direction. So they buy the vision, they buy Autodesk role, they don't see anybody else able to do this end-to-end kind of connection the way we're doing, and that's been something we've been consistent about. And yes, when they go in and look at the business model that we come to market with, they say look yours is a much more customer-friendly business model, this is one I can grow with. This business model over here is this going to penalize me as I grow. So yes, we do see those things. But I want to just make it clear, primary reason we win is the big story. And that's the thing that is getting customers excited. It's the thing that's engaging them, and it's the thing that's bringing more people into our ecosystem and we are seeing that.
Rob Oliver: And just as a quick follow up, and Andrew, you had mentioned on the last call and Scott just reiterated. Did you guys not only absorb the planned R&D at PlanGrid and BuildingConnected but you've ramped that R&D. And aside from platforming and integration, and this - and I apologize because this maybe leading on to the - to for the ramp of other areas that you're seeing from an end-user functionality perspective, that are interesting to you as a possible recipient of those R&D dollars. Thank you guys very much.
Andrew Anagnost: Yes. So one of the things, I want to make sure I reiterate. I mentioned this during the last call, but I think it bodes restating, we've definitely applied clear missions to the two product stacks and the two teams frankly and we've actually swapped people back and forth between the two teams. PlanGrid is very much focused on field execution and being the best-in-class tool for field execution. So they're looking to accelerate the roadmap that they had in place for field execution both customer-driven and internally-driven, and that's where they're spending their dollars. On BIM 360, we're focusing the BIM 360 team much more on closing all the gaps around project management and things associated with project management, RFI flow and all of the things that go - connected to that and then connecting those things back to the PlanGrid environment and the customer see a seamless flow. So we've - this mission-based assignment of teams has been super important. It has resulted in additional R&D dollars going in. We are absolutely accelerating PlanGrid's roadmap, not decelerating it, and we're accelerating BIM 360's roadmap with regards to project management capabilities. So that, that you will hear more about in June. But I think it's important to just reiterate, where we put the money and how we're spending it to moving forward because we really do want these solutions to survive, thrive, grow and connect together rapidly inside Autodesk. So we're committed to that and yes, we spend more and we brought them in and we got the results we wanted. So I think we're going to keep doing that.
Operator: Our next question comes from Kash Rangan of Bank of America. Your line is open.
Kash Rangan: My question Andrew for you is when you look at the maintenance subscription conversion program, can you just give us an update on how much of that installed base has accepted the price increase versus converting to subscriptions and what is left in that third bucket? Any strategy or plans you might have in place to convince the last set of holdouts to get on the program. Thank you very much.
Andrew Anagnost: Yes. So we never, we never expected that every subscription - that every maintenance customer was going to move to subscription during this program. I think one thing that's important to note is we basically converted two-thirds of them already at this point. So there's really only one-third of the subscription base left from when we started this program. And as we told you over and over again, we've - everyone we've moved, we're growing the value of those customers through consolidation and through other efforts associated with that. So we have to pause and look at well how far have we come here with regards to this program. And I think it's pretty impressive results given what we're trying to accomplish. We have always expected that by the end of the year, there were going to be a set of customers left in, and there are going to be a set of customers left in maintenance. But I think also what you heard from Scott earlier is that the renewal rates for maintenance are holding up quite well, incredibly well actually even with the price increases that are in front of customers. So customers are going with us along the journey. There are going to be some left at the end of the year still on maintenance, and we'll look at what we do in terms of working with those customers as we get to that point. But we're already two-thirds in there, we'll be more than two-thirds by the end of the year, we've been successful in increasing the value of those customers and most of those customers that have moved over are happy and the ones that are still on maintenance are renewing it at robust rates. So the program looks like a success to me.
Operator: Next question comes from Keith Weiss of Morgan Stanley. Your line is open.
Hamza Fodderwala: This is Hamza Fodderwala in for Keith Weiss. Just a couple of quick questions from my end. The first one, so the manufacturing revenue growth really accelerated this quarter and it's been up double-digits for a few quarters now. I'm just wondering what's the inflection point there as far as you starting to really put up growth that's faster than many of your peers, what's driving some of that share gain? And what's the roadmap there going forward?
Andrew Anagnost: So Hamza what you're seeing there is the strength that was always there underneath that you couldn't see, because of all the product retirements we did. Alright. So we've been doing this for several quarters in the core part of our business, which is one of the reasons why we're so excited about, how we're doing in manufacturing in general right now. You saw declines or slowness in the manufacturing business, because we retired a whole set of products. Some of them we just retired completely, some of them were transitioned into the collections environment, some of them were combined with other products, we did some large consolidations, and this resulted in some revenue that is essentially disappeared. But it showed up eventually in other places, so now what you're seeing is the underlying strength in the core manufacturing business that was always there. And we're - like I said excited about it and when you look at some of the things that are in the roadmap, what you're going to see is tighter and tighter coupling of this design to make workflows. You're going to see more showing up in Fusion with regards to end-to-end design all the way through to machining workflows and new generative algorithms that take not only 3D printing workflows, but - workflows for 2 axis, 2.5 axis, 3 axis milling operations and automating the geometry creation. You're also going to see more workflows between Inventor and Fusion. So that Inventor customers can take advantage of the downstream production workflows that are built inside a Fusion. Customers are starting to look inside the manufacturing and - the product design and manufacturing collection and they're cracking it open and they're seeing some things that they think are pretty amazing. That's part and parcel of what's driving our growth. Customers are consolidating on what we have because they see us. I can take these eight weird things that I had against consolidating this as one thing. And by the way I've got this cloud workflow that makes all my data problems a lot cleaner and it's just working. And I expect you'll see it to continue to work in the future. So I'm just happy you can now see the underlying strength in the business that we knew was there all along.
Hamza Fodderwala: And just a quick follow up. We did hear that there was a price increase on multi-user licenses in May. Just wondering if that caused any pull forward business from Q2 to Q1. That's it from me.
Scott Herren: So we did see and we referred to this a little bit in the opening commentary, Hamza. We did see a little bit of early renew activity, but really the same percent that we've seen historically. So if you add up our total sales what percent were early renews where you'd see people trying to front run the price increases earlier renews. So as we looked at that, it was really in line from a percentage basis with what we've seen historically. So I don't - I'm not anticipating any change or any kind of an impact to the full year model from that. Having said that, the change we made on multi-user pricing was really to do a better job capturing the value of what we're shipping with that you've seen us make kind of incremental changes in multi-user now for a couple of - couple of years in a row. And it's to better align the price with the value that's being delivered on multi-user.
Operator: At this time, I'd like to turn the call over to Abhey Lamba for closing remarks. Sir?
Abhey Lamba: Yes. Thank you for joining us this afternoon. If you have any questions, feel free to contact us. Thanks for joining us. Bye.
Operator: That does conclude our conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good day, ladies and gentlemen and thank you for your patience. You've joined Autodesk First Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to host, VP of Investor Relations, Abhey Lamba. Sir, you may begin."
},
{
"speaker": "Abhey Lamba",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the results of our first quarter of fiscal '20. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can also find our earnings press release and a slide presentation on our website, we will also post a transcript of today's opening commentary on our website following this call. During the course of this conference call, we may make forward-looking statements. These statements reflect our best judgment based on factors currently known to us. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. And now, I would like to turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Abhey. We started off fiscal '20 with great momentum, accentuated by continued acceleration of recent construction acquisitions and strong growth across all geographic regions. Our billings and free cash flow came in at or above expectations and reflect the strength of our business. We are on track with the integration of PlanGrid and BuildingConnected and have exciting achievements to share with you. Although, our first quarter revenue came in at the low end of our guidance range, we are on track to achieve our fiscal '20 ARR and free cash flow guidance and are reaffirming our fiscal '23 targets. Our pipeline for the rest of the year is strong and growing, and the underlying demand strength we've seen in prior quarters continues to drive growth in our business. There is no change to our view of the strength of the business or the current spending environment in our end markets. Before I offer you more color on strategic highlights during the quarter, let me turn it over to Scott to give you more details on our first quarter results as well as our guidance. I'll then return with further insights into some of the key drivers of our business, including construction, manufacturing and digital transformation, before we open it up to Q&A."
},
{
"speaker": "Scott Herren",
"text": "Thanks Andrew. As Andrew mentioned, our leading indicators, billings and free cash flow, performed well. Total revenue of $735 million was up 31% and 28% excluding our recent acquisitions. It was within our planning assumptions, although at the low end of our guidance range. This was primarily driven by linearity, as we closed more business later in the quarter than anticipated, which affected the amount of ratable revenue recognized in the quarter. Overall demand in our end markets was robust, as indicated by our strong billings and revenue growth. Our subscription volume also grew steadily across the board. Sales volume of AutoCAD LT remained strong. And this has historically been a leading indicator of potential demand slowdown. As you can see, revenue from our AutoCAD and AutoCAD LT products grew 37% in the first quarter, slightly better than the 36% growth rate in Q4. AEC and manufacturing also rose 37% and 24%, respectively. Geographically, we saw broad-based strength across all regions. Revenue grew 35% in EMEA and APAC, and 27% in the Americas, with strength across almost all countries. We also saw strength in direct revenue, which rose 36% and represented 30% of our total sales, consistent with last year. Within direct, our e-store grew 45%. Looking at ARR, total ARR continued to grow quickly, up 33% versus last year to $2.8 billion. Adjusting for our recent acquisitions, total ARR was up 29%. Core ARR growth was in line with our total organic growth, while Cloud ARR grew 164%, propelled by strong performance in construction. Excluding the $83 million of ARR from our fourth quarter acquisitions, organic Cloud ARR, which is primarily made up of BIM 360 and Fusion 360, grew a record 43%. We continue to make progress with our maintenance to subscription, or M2S, program. The M2S conversion rate in Q1 was consistent with prior quarters, with approximately one-third of maintenance renewal opportunities migrating to product subscriptions. Of those that migrated, upgrade rates among eligible subscriptions remained within the historical range of 25% to 35%. As a reminder, this is the last year of the M2S program, and we are continuing to incentivize customers to convert. In addition to strong new customer billings, the growth in ARR was supported by continued expansion of our renewal base. And as we introduced at our Investor day in March, the net revenue retention rate is a key metric to monitor the health of our renewal base. Net revenue retention rate measures the year-over-year change in ARR for the population of customers that existed one year ago, or base customers. It's calculated by dividing the current period ARR related to those same base customers by the total ARR from one year ago. During Q1, the net revenue retention rate was within the fiscal '19 range of approximately 110% to 120%, and we expect it to be in this range throughout fiscal '20. In Q1, some of the deeply discounted subscriptions from our global field promotion we ran three years ago came up for renewal. We were very pleased with the renewal rates of this group of customers as they renewed closer to list price, and the total value from the entire cohort grew. Moving to billings, we had $798 million of billings during the quarter. On a normalized basis, billings rose about 40%. Recall that last year we adopted ASC 606, which resulted in adjustments of approximately $160 million to our deferred revenue balance and impacted billings, since billings are calculated by taking the sum of revenue plus the change in deferred revenue. The growth in billings was driven by strong renewals and continued momentum in our core products. We also benefited from some customers renewing early in the quarter due to upcoming price increases. Our recently acquired construction assets contributed nicely to the billings increase. And in line with our plans, multi-year contracts moved higher, helping our total billings. Recall that multi-year payments are good for our customers as they benefit from stable pricing and a single approval process. Our partners like them as they can sign higher contract values and maximize their cash flow. And we benefit from a more predictable revenue stream and upfront cash payments. The second and third year of those multiyear agreements are recorded in our long term deferred revenue, which grew by 12% and ended the quarter at 17% of the total deferred balance. As we indicated at our Analyst Day, we expect to end the year with a long term balance in the low 20% range of total deferred revenue, in line with the historical range. On the margin front, we realized significant operating leverage as we have entered the growth phase of our journey. Non-GAAP gross margins of 91% were up 140 basis points versus last year. Our disciplined approach to expense management combined with revenue growth enabled us to expand our non-GAAP operating margin by 13 percentage points to 18%, despite absorbing two significant acquisitions. Moving to free cash flow, we generated $207 million in Q1. Over the last twelve months, we have now generated $550 million of free cash flow, positioning us well to hit our full year target of $1.35 billion. Note that Q1 benefited from the very strong Q4 of fiscal '19 that we had. As you may recall, we had over $1 billion of billings during Q4, some of which was collected in the first quarter of fiscal '20. As such, I expect our free cash flow in Q2 to be down sequentially. We continue to repurchase shares with our excess cash, which is consistent with our capital allocation strategy. During the quarter, we repurchased 582,000 shares for $100 million at an average price of $171.84 per share. Now I'll turn the discussion to our outlook. I'll start by saying that our view of global economic conditions and their impact on our business is unchanged from the last several quarters. We are not seeing any noticeable impact from Brexit and the various trade and tariff disputes. For the full year, we are reiterating our fiscal '20 free cash flow outlook of approximately $1.35 billion as well as our outlook for ARR of about $3.5 billion, up 27% to 29%. In line with our initial plans, we expect billings of about $4.1 billion at the midpoint, driven by the strength of our renewal base, new subscription growth, continued normalization of multi-year billings, the flow through from unbilled deferred revenue, and our acquisitions. When looking at the quarterization of free cash flow for fiscal '20, we continue to expect about three-fourths of the free cash flow to be generated in the second half of the year. Looking at our guidance for the second quarter, we expect total revenue to be in the range of $782 million to $792 million, and we expect non-GAAP EPS of $0.59 to $0.63. The earnings slide deck on the Investor Relations section of our website has more details as well as modeling assumptions for the fiscal second quarter and for full year 2020. Now I'd like to turn it back to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks Scott. Now, let me give you an update on some of the key growth initiatives we highlighted at Investor Day, specifically progress made in construction, manufacturing and digital transformation. These initiatives are key drivers of our business both near and long-term. First, in construction, we are seeing continued strength across the portfolio as we execute on our strategy to deliver a comprehensive, integrated platform that seamlessly connects the office, the trailer, and the field. We had significant accomplishments during the quarter as we integrated PlanGrid and BuildingConnected into Autodesk. Both acquired companies showed impressive growth, which is important to call out considering that acquisitions typically see a slow down during the integration phase, whereas we experienced accelerating momentum. Post-close, we have won fifteen head-to-head bids against leading competitors in this space. Other milestones included the launch of our first product integration and the realization of revenue synergies. Q1 was the first full quarter where we had the entire construction portfolio in place, as we closed PlanGrid in December 2018 and BuildingConnected in January of this year. Feedback from customers has been very positive regarding the addition of these best-in-class solutions to our comprehensive construction portfolio, which now includes BIM 360, PlanGrid, Assemble Systems and BuildingConnected, in addition to the design tools we have always sold into that market. On the technology development front, we were able to accelerate the product roadmap for PlanGrid, which resulted in the introduction of PlanGrid BIM last month. This is a new product integration between Revit and PlanGrid that allows customers to immediately access BIM data in either 2D or 3D directly within PlanGrid on their mobile devices. We were able to deliver this frequently requested feature at an accelerated pace now that PlanGrid is part of Autodesk. In fact, when PlanGrid BIM was launched we hosted a webcast and the demand was 5x what PlanGrid had normally seen for prior product launches, and the number of customers who requested to be contacted by a sales person following the webinar was also more than 5x what they normally experience following a product-focused webinar. We've also seen synergies begin to develop on the sales front. For example, APTIM, a leading construction services vendor and joint customer of Autodesk and PlanGrid, tripled its PlanGrid users as part of the Enterprise Business Agreement for its Digital Foreman Initiative. Other Autodesk products they use include AutoCAD, Civil 3D, Plant 3D, Map 3D and Revit. And because we have been clear with our customers that PlanGrid will be focused on field execution and BIM 360 on project management, there are a lot of synergies between the two offerings that our customers have yet to realize. We are also seeing BuildingConnected thrive within the Autodesk construction ecosystem. Since the acquisition they have grown their user base from about 700,000 to over 800,000. Now, I'd like to elaborate on the impressive growth comment made earlier. When we made the acquisitions, I said that we were focused on keeping the strong sales momentum going, and that is exactly what happened. At PlanGrid, the sales teams are continuing to perform strongly with both new and existing customers. For example, they expanded their relationship with Rosendin Electric, a long standing PlanGrid customer with plus 6,000 employees and annual revenue of about $1.5 billion. The company recently extended its contract for three years and significantly expanded it, in part due to Autodesk's long-term vision. PlanGrid sales have also started to benefit from being part of the Autodesk family. During the quarter, Jacobs, a global leader in professional services sector and a long-standing Autodesk customer, decided to further enhance its relationship with us by adding PlanGrid to one of its divisions. In making this decision, Jacobs pointed to its current speed in the field, ease of use, and integration with the rest of the Autodesk suite as determining factors in adopting the software. The Company is currently utilizing PlanGrid on $1 billion infrastructure project. PlanGrid also ended Q1 with its largest ever pipeline of deals. And the momentum continued at BuildingConnected too. BuildingConnected has introduced new features that continue to make its platform more and more valuable to larger and larger portions of the market. In fact, they had their best quarter ever in Q1 in terms of new business and are seeing their flywheel continue to drive new business on both the general contractor and subcontractor side. BIM 360 also continues to demonstrate strong growth. In fact, our organic Cloud ARR, of which, BIM 360 is the largest component, was up 43% in Q1. This was driven by strength across the entire BIM 360 portfolio, especially BIM 360 Design, which is our real time collaboration tool for Revit users. We also saw both existing and new customers increase adoption of BIM 360. A good example here is WeWork, with 485 locations and 466,000 members around the world, WeWork provides spaces and services to help people work, learn and collaborate in more meaningful ways. They expanded their subscription with Autodesk this quarter and are one of our largest BIM 360 Design customers. We are excited to work with them and look forward to further enhancing our relationship over the coming years. Overall, all parts of our construction portfolio are performing at or above the plan and showing strong growth. I am extremely proud of all the teams involved. They remain focused and dedicated to helping Autodesk grow and drive positive change in the construction industry. And lastly, I wanted to note that for those looking to get a more in-depth view of our construction business, we are hosting an event on June 4th here in San Francisco, where you'll have the opportunity to hear directly from AECOM, Webcor and DPR in addition to our construction team regarding our portfolio and go-to market opportunity. I hope to see all of you there. On the manufacturing front, revenue grew 24% as customers see the benefits of our differentiated solution, we are gaining share and displacing competitive offerings in the space. For example, a large manufacturer of locomotives and rail equipment further expanded its relationship with us, they are in the process of deploying our manufacturing solutions across their various divisions and are relying on Inventor, our CAM solutions and factory design utilities to automate their workflows. Our solutions displaced competing our products due to our simplicity and short implementation cycles, which is in line with their rapid product introduction requirements. Our investments in generative design and Fusion 360 have resulted in more than 100% year-over-year growth in monthly active users for our commercial customers. Users love the cloud-based, comprehensive solution of Fusion 360 and it is disrupting the industry. Fusion 360 offers unprecedented value and out-of-the-box productivity for concept to production workflows, and that appeals to a large swath of our customers. A US-based specialty pharmaceutical company purchased Fusion 360 to replace SolidWorks for designing and manufacturing auto-injectors. After reviewing various options, they decided that Fusion 360 provided superior collaboration and data management capabilities in the cloud with no setup or maintenance complications. A Midwest metal fabrication company chose Fusion 360 to replace separate instances of CAD and CAM solutions. They were impressed by our integrated CAD/CAM functionality and collaboration features. With Fusion 360, they were able to replace CATIA, Creo, Mastercam, and PTC Windchill, allowing them to rely on fewer platforms and to promote collaboration. Then when it comes to digital transformation, we are seeing the positive impact it is having on our business. We are also making progress in using digitization internally as part of our plans to convert the large number of non-compliant users into paying customers. All new single user product subscriptions are already using identity-based authentication and we continue to move existing customers to this new system. We are on track to migrate all eligible single user subscriptions to identity-based authentication by the end of the current fiscal year, which will provide a much better user experience for our customers and help us in combating non-compliant usage of our software. Beyond that, we are already starting to see results from our efforts to engage directly with customers using non-compliant versions of our software and expect our ongoing learning to increase our effectiveness in FY '20 and beyond. As you heard, there's a lot of activity happening towards the growth initiatives highlighted at Investor Day across construction, manufacturing and digital transformation. These drivers, as well as the large opportunity we see in converting the current 14 million non-paying users into subscribers, should result in an acceleration in profitability and cash flow metrics and sustained growth going forward. We are highly confident in Autodesk's ability to capitalize on this large market opportunity and are committed to delivering our FY '20 and FY '23 targets. With that, operator, we'd like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Phil Winslow of Wells Fargo. Your line is open."
},
{
"speaker": "Phil Winslow",
"text": "Thanks for taking my question and congrats on great start to the year. I just wanted to drill into your comment about just the linearity of the quarter, Scott you mentioned that the quarter's billings and it was well within your assumed range with revenue at the low end just because of linearity, but your full year expectations are unchanged. Wonder if you could just drill into that, where was the linearity different was it something about specific industries or more geographies, and sort of how are you thinking about the go forward there?"
},
{
"speaker": "Scott Herren",
"text": "Yeah. Thanks, Phil. It was - it's certainly within the range of our guidance and our planning, $735 million was the low end of our guidance range. So it wasn't a significant variance from what our expectations were. So we did see those both Q3 and Q4 had - but I'll call better linearity. So earlier, linearity in each of those quarters, as we came into Q1, Q1 actually ended up with the linearity of similar to last Q1, as opposed to the improved linearity that we've seen in Q3, and Q4, which I guess is not really surprising, given that, beginning of the year, people don't have budgets yet, sales teams are going through sales kickoff, et cetera. So we ended up with the same linearity we had in Q1 a year ago as opposed to kind of the improved linearity we've seen in Q3 and Q4 and that's what pushed us to the low end of the range. I'll go ahead and answer your follow-up question, which is our assumption for Q2. On linearity is that it'll look more like Q2 '19 as opposed to the improved linearity that we saw in Q3 and Q4, it doesn't really have an effect on the full-year, you see full-year guidance remains unchanged, and you see, actually, Q2 guidance shows a pretty nice step-up sequentially as a result of getting some of that, and that came in a little bit later in the quarter, obviously we have it for the full quarter of Q2. So it doesn't really change our view at the year. That was a good strong start to the year. Just had linearity more in line with what we had seen a year ago as opposed to what we had seen in the prior two quarters."
},
{
"speaker": "Phil Winslow",
"text": "Then just a follow up for Andrew. It was great to hear some of those wins on the PlanGrid side, BuildingConnected, wonder, if you can provide just more color on this early feedback you're getting now you provided some earlier, but how you think about bringing this into the product line and maybe even also using BuildingConnected even almost as a funnel for PlanGrid as well. Just some more color there that would be great."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So what was the second part you said about PlanGrid there Phil."
},
{
"speaker": "Phil Winslow",
"text": "Sorry to say as a funnel, potentially you're seeing bid management, actually you've been using that as a sort of lead management, so to speak for PlanGrid?"
},
{
"speaker": "Andrew Anagnost",
"text": "That's exactly, and actually you've hit on one of the points that's important about this coming year. The PlainGrid folks and the BuildingConnected folks immediately found some synergies between how they approach the market and their individual businesses. So there's a strong flow of leads and discussion back and forth between those two teams, and that plays a pretty integral part. Remember, BuildingConnected has visibility to the whole entire project bidding environment within the US. And obviously, PlanGrid is super eager to go and talk to those projects about how they can improve site execution and effectiveness and success for their particular projects. So that's one of the big uplifts we're seeing is some of the connection between those two offerings. And frankly as we brought BuildingConnected in, we saw a very nice surge in their business. Like I said, they had their best Q1 ever in terms of new business, because people just like the fact that they're part of Autodesk and that - what they're focusing on with the bid management is - it's a good tool, they added a lot of features in there during Q1. And it's a solid result."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Saket Kalia of Barclays Capital. Your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Maybe first for you Andrew, just picking up off the last line of questioning on PlanGrid. Clearly, it seems like it's off to a good start. And I believe the initial approach here was to let them operate largely separately at least for the vast majority of sales. But it seems like you were able to really cross-sell to some mutual customers relatively early on. So can you just talk about how you sort of envision the combined company maybe looking by the end of this fiscal year PlangGrid plus Autodesk BuildingConnected, and within that maybe touch on the - just a very minor overlap you might have with some products with Autodesk versus PlanGrid, and how you plan on sort of handling that?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, all let me comment on some of those synergies we found in shared accounts. So one of the things we did very quickly as we established how we were going to go-to market with our named account side of our business, and a lot of the places where we're seeing like joint shared updates in our named account business. So that was a place where we have a named account rep, where we can come in and say, hey, look you know what, we can augment your solution with PlanGrid and we can do some - we can get this project, put it up on PlanGrid, we can get this project put it up on BIM 360 that's where you're seeing a lot of collaboration, that fits within our standard salesforce, and it's functioning really well, and we have an interconnect strategy between those two, and a quarter retirement strategy that allows people to cross-sell and get benefit in terms of quarter retirement for both sides of the equation. Now what you see that PlanGrid team being highly effective at is doing land and expand in new accounts in the construction ecosystem. And we focus a lot of that team on going out and reaching construction companies that we historically did not touch. And that's where they're spending a lot of energy. So they leverage our named accounts team for some of these synergistic sales and they go out and they find new business out there using their existing infrastructure, which works very effectively. As we move across into the year, what you're going to see is basically - we're going to maintain that essential structure, but we're going to make sure that we coordinate sales more tightly within the Autodesk construction group as we move towards the end of the year. But we're going to continue to have that synergistic relationship between our named account program and the salesforce that sits inside of the construction group. And we just - we just think those synergies are going to increase as the year progresses. Remember, we just rolled out a tokenized version of PlanGrid as well, and you know how effective we are at driving usage within some of the named accounts underneath our EBA, so you're going to see that have a synergistic factor as well and it's all brand new. I mean, we're very, very early on, in that."
},
{
"speaker": "Saket Kalia",
"text": "Maybe for you Scott, just to peel back the onion a little bit on ARR. It was actually a little funny, the maintenance ARR number actually came in a little bit below what I was expecting, but I think the consensus is actually a little bit higher. Maintenance at this point is getting to be such a small part of the business, but I guess maybe just to better help - better calibrate, maybe the pace of decline, any sort of idea for how we should think about that pace of decline in maintenance ARR, maybe through the rest of this year or some broad brushes?"
},
{
"speaker": "Scott Herren",
"text": "Yes. So it's a great question, Saket. The M2S program, of course, just entered its third year, right, at the beginning of Q2, we just entered the third year of the M2S program. And this is when the more significant price increase goes into effect for those who want to renew maintenance. Ahead of that what we've seen is the maintenance renewal rates, we're not talking subs in renewal rates anymore, but if we were the maintenance renewal rates have held up very nicely in that space. And so we continue to see both success with conversions. I said that on the - during the script that was in the range that it had been historically, of those that convert the upsell, the collections continues to be good. We're down to at this point just short of 700,000 maintenance customers left, and that I'm super pleased. We started this with a little more than 2 million maintenance subs, and we've now moved all but at about 700,000 over to product subscription. I think this year is the year where we'll see a lot more of the remainder move over. So what I would - my expectations is we'll continue to see good success with that moving over. And of those that elect to say - to stay what we have seen is the minus renewal rates are holding up nicely."
},
{
"speaker": "Operator",
"text": "Next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your line is open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Andrew, let me start with you. One of the things that you've talked about with respect to digital infrastructure is your usage telemetry, your ability to observe and collect data about how customers are employing the products, particularly now the - it's mostly subscription. Can you talk about any trends or key observations that you're getting from the use of telemetry particularly in the growing collection space. Second question there's been quite a bit of commentary in the call thus far with regard to direct sales, and how you're handling the integration of the construction acquisitions. A broader question perhaps about customer engagement, you like some other companies have created a new customer success group, and this has become increasingly common in software. What do they do? And how do you measure the success of the customer success group?"
},
{
"speaker": "Andrew Anagnost",
"text": "So let me start with the first question about the kind of the insights we're seeing. So we'll - there's a few things I can tell you, one of the insights we're getting is, usage is continuing to go up, it's going up nicely across numerous product sets. And that's really great to see. The other thing we're seeing is that collections are seeing usage patterns better than the old suites in terms of how many products people are using, which shouldn't surprise you, because there's more offerings inside - more diverse offerings inside the collections and we're seeing some of those things. And one of the other things I'll tell you is that the ramp up of \"new releases\" that were moving away from what we would like to consider major releases. People are ramping up on to the latest capabilities relatively quickly including the people who don't pay us, which is important for us to talk about, because it says, that cohort of non-paying users continues to follow us into some of the newer capabilities. And I think that's important in terms of the future capability of capturing some of that opportunity as we move forward. So yes, we are seeing some more fidelity in terms of usage, and we are seeing some interesting trends and some things that looked a lot better than they were in the suite days. Now in terms of the customer engagement team. The first thing I want to talk about is what is the team measured on? They're measured on net revenue retention. Okay. That's their job. Their job is to go in there and renew and help grow those accounts, and that's the primary metric they track. They also have metrics around MPS for the interaction that they have with the customers, not kind of global MPSs, but relationship MPSs and network net promoter scores around the various interactions. But, primarily, we measure them on how well we capture money from the renewal base and net revenue retention in particular. The way they function is a function along the spectrum from low touch - low human touch digital relationships all the way up to high touch engagements. One of the digital infrastructures we built that's facing this team is what we call the early warning system, it's an umbrella of a lot of metrics that basically give this team a sense for how healthy an account is how healthy are they on their usage capabilities, how healthy are they on their adoption of learning tools, on other tools, has there been a drop off, and it helps them kind of spend their time with the accounts that need the most assistance and the most engagement with Autodesk. It is a new practice, we've beefed it up, it consolidates several things in the area, but I just want to emphasize the number one thing they're revenue - they're measured on is net revenue retention and that's how we track the success of that organization. Scott, do you want to add anything ?"
},
{
"speaker": "Scott Herren",
"text": "No. I think you nailed it. That's - We - the customer success team under Ray has actually done really nice job so far, and one of the things we mentioned Jay in the in the opening commentary is that our net revenue retention rate has stayed right in the range that we talked about at Investor Day. Last year, all year, it was in that approximately 110% to 120% range, and it stayed right there again in Q1. So Ray and his team are off to a really good start."
},
{
"speaker": "Operator",
"text": "Our next question comes from Heather Bellini of Goldman Sachs. Your line is open."
},
{
"speaker": "Heather Bellini",
"text": "I had a question about - I know your referenced to linearity in your prepared remarks. I was wondering, if you could share - if you noticed any impact or what you're hearing from your manufacturing customer base in the quarter just due to the kind of ongoing tariff war that seems to be going on, and if they've given you any sense of whether or not that's impacting their own spending plans? And also - I'm just also just because I'm getting asked myself, you obviously had very good outperformance, it seemed on long term deferred versus some people's expectations. Could you share with us kind of how did short-term DR track versus your expectations? And that's it. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "So I'll take the first part, then I'll hand the second part over to Scott. So you saw our manufacturing business grew quite nicely during the quarter, really strong growth. Now that doesn't mean we aren't hearing from our manufacturing customers that they're seeing pressure in terms of the commodities they use to build their products and things associated with that. They absolutely are. All of our customers are paying more for certain basic things to bring into their business. But you have to understand what we sell to them isn't a commodity, it isn't a metal or a fabrication or a supplier. It's a mission critical tool and it's a mission critical digital process. And a lot of our customers see these tools and expansion of their investment with us as helping them be more efficient and be more effective when they're seeing cost pressures rise in other areas. Like a lot of those competitive wins I talked about are really focused on consolidation of multiple tool sets into the single solution we offer, which is easier to deploy. It's lighter touch. It's got more and more end to end things, the different types of price points. So customers are actually looking to us to help them get more efficient, while they're seeing the cost of things that roll in the door to make their products go up. So we have not seen any kind of backing away of expenditures in our software space. We're seeing no signs of it. We haven't seen it yet, it doesn't mean things can't change. But we also - we do know that our customers are turning to us to make them more efficient. And I think that, that puts us in a good position when they're seeing the cost of other parts of their business go up. Now I'll turn it over to Scott for the second part."
},
{
"speaker": "Scott Herren",
"text": "Sure. On the second one, it's interesting, Heather, of course what you see showing up in long-term deferred, the sequential growth. There's some of the success we're having in - having multi-year payments get closer to the mean that they had been in historically. We're still not quite there, right? So there's still a little more headroom in long-term deferred to get to what we talked about at Investor Day as that being kind of a low 20% range. If you look at the growth rate year-on-year, the long-term deferred grew 12%, short-term deferred actually grew 21% year-on-year. So we're seeing really nice performance as you'd expect when you see the billings line grow the way it as has. We're seeing really nice performance across the deferred revenue spectrum. When you add in unbilled, total deferred revenue grew 24% year-on-year. So it was obviously strong billings quarter that led to both good revenue results, but in particular, strong growth in deferred."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Your question please."
},
{
"speaker": "Matt Hedberg",
"text": "Andrew, we continue to hear positive feedback from channel partners around generative design, it really transforming the whole design process. I know this remains a focus for you guys. Wondering about a little bit of an update there on this momentum and really customer receptivity to this - sort of this new way of designing ?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Well, there's a lot going on there, and we're rolling out a lot more in generative tools, especially to the Fusion platform. Manufacturer going to see some new capabilities in terms of generative geometry creation tied to 2.5 axis milling constraints and more of the mainstream kind of CNC applications the customers use. So we'll probably going to see a little bit of an explosion of use of some of these tools as we roll some of this out. But you're right, we're getting a lot of adoption. And the partners are excited about it, because they can go in and have a very, very differentiated discussion with their customers about what they can do with these tools. Now one of the things we're seeing, and I want to make sure that people understand this, because people thought, well, these are really advanced things, isn't just like 3D printing focused, and isn't this just for people that want to create organic shapes for 3D printing. The biggest usage right now that we're seeing with regards to generative design is people exploring new types of design options for things that they either had existing or they are building from scratch, and then taking those explorations and turning them into things they can build using their traditional manufacturing methods. So they're essentially using generative design as a tool to show them new solutions to problems that they wouldn't have naturally found in the first place. And that's one of the exciting things about what's going on right now is that, it's having a real impact in the mainstream customers and on the customers that are kind of looking out on the cutting edge of things. So you're absolutely right, there's lots of reasons to be excited and our partners are really getting engaged in our manufacturing portfolio, because of generative."
},
{
"speaker": "Matt Hedberg",
"text": "And then maybe just a quick one for Scott, obviously, a lot of questions on the construction opportunity. I'm curious when you think about adding sales capacity to this year, how do you kind of think about into the overall pace, and then, how do you think about putting that sort of like more or so in the construction versus A&E or the manufacturing side, just sort of wondering about, just sort of how you kind of allocating your sales capacity adds this year ?"
},
{
"speaker": "Scott Herren",
"text": "Sure. Construction is such a massive opportunity for us Matt, it won't surprise you to hear that we rotate a lot of investment into it. Coming on the heels of the acquisitions we did in the fourth quarter, we've also increased spend in each of those. It wasn't the normal buy them and go through a bit of a downsizing, we've actually done the reverse. We've acquired those companies, integrated them nicely into Autodesk and at the same time increased the investment in construction. So great results out of the gate as Andrew mentioned in the opening commentary, and I think you can expect to see us at this level of performance, and what the market really beginning to turn this direction, you can expect to see us continue to invest in construction."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Ken Talanian of Evercore ISI. Your line is open."
},
{
"speaker": "Ken Talanian",
"text": "So for the customers that are still on maintenance, do you have a sense for how the percentage of that group who might upgrade to collections compares to the folks who are already converted?"
},
{
"speaker": "Scott Herren",
"text": "What I'd say Ken is really haven't seen the needle move much on that. We've had great success at the point of people moving from maintenance over to product subscription, we've had great success having them kind of cross grade and instead of going single product to single product, going single product to collection. And that really hasn't changed over the last six quarters or eight quarters now that we've been tracking into us. So I'm not expecting a significant change. The one thing I would note in the demographic which is quite not surprising to you, the bigger customers that aren't EBA eligible, obviously the bigger customers that were on maintenance were some of the first to adopt into us and move over. It's not as bigger skew as you might think from the biggest to the smallest, but there is a little bit of a bias to the larger customers. As we get down to the smaller and smaller customers, we might see a point or two difference there, but I wouldn't expect it to be significant. Andrew, anything you'd add?"
},
{
"speaker": "Andrew Anagnost",
"text": "No. I think we've seen a consistent pattern, and we don't see anything that would indicate that changing. I agree with you. It's probably going to make a point or two different as we get deeper into that base. Just because of the size and because maybe a mix shift inside that what's left to the maintenance base."
},
{
"speaker": "Ken Talanian",
"text": "And are you seeing any non-payer conversion from the shift to a serial number free licensing model."
},
{
"speaker": "Andrew Anagnost",
"text": "We always see non-payer conversion every year. So one of the things I just have to say, because I say it every call, this non-paying conversion thing isn't going to be this big explosion, all right. It's an ongoing process. Some of these people have very clever ways. They continue to not pay us. But what I will tell you is that we've successfully rolled out some really interesting ways to have conversations with these customers and engage with them directly. And we are learning a lot that we think is going to play pretty significantly into our long-term strategy with regards to converting these people. We have direct engages with them. We can track where they go after an engagement whether or not, they continue to pirate or they pursue some kind of other path. So we're learning a lot. And that's what we expected to do this year. Every year, we convert non-paying users into users, every year, we convert more than we did the previous year. But more importantly, every year, we're learning more about how to effectively engage with these customers. And that should give you a really good feeling about the long-term growth prospects as we start looking at those 14 million non-paying users and converting them over the next few years."
},
{
"speaker": "Operator",
"text": "Our next question comes from Sterling Auty of JPMorgan. Your line is open."
},
{
"speaker": "Sterling Auty",
"text": "I think you gave commentary that you saw strength across geographies, obviously see the pie chart with the percentages. But just wondering for - about some colored commentary. Looking at the PMI results coming out of Europe today, there's been questions in other areas of software around possible squishing as here in North America, what are you seeing from just the macro by geography ?"
},
{
"speaker": "Andrew Anagnost",
"text": "So we're not seeing any kind of geography-based slowdowns. And by the way, the PMI in EMEA has actually been in contraction territory for a while. So it isn't like a new phenomena. And for us, we see the PMI as measuring a different side of the demand curve. It's much more focused on the purchasing of kind of the core assets that kind of go in the door and come out as product. We're selling efficiency in digital transformation. So right now, we - and what - actually let's just look back historically, we've never seen a strong correlation between the PMI and near-term impacts on our business. Long term, as the PMI phasing contraction territory, you absolutely, eventually would see an impact on our business. Short-term what people do is they tend to buy more of our software to try to invest in digitization and kind of getting their processes more aligned, more efficient. So we're not seeing any slowdown in any geographic areas. And the ongoing PMI results don't signal anything to us in terms of our demand environment."
},
{
"speaker": "Sterling Auty",
"text": "And then one follow up, do you mind as where are we in terms of the various pricing or discount changes both on maintenance and other parts that you had outlined at the beginning of the transition. What changes recently went into effect if any? And what were the impacts?"
},
{
"speaker": "Scott Herren",
"text": "Yes. Sterling on the - you're talking about the maintenance to subscription program that we're - that we just began or if you remember, we started that program actually kind of middle of Q2 a couple of years ago. So we just began the third year of that. And at the third year, what we have said then and just went into effect at the beginning of May is the cost to convert - the price to convert would go up by 5%, the price through renew maintenance from last year, the price through new maintenance have got up 20%. So both of those increases went into effect in early May. So we're sitting three weeks into that right now, not expecting to see any significant change in terms of renewal rate. I do think at this point, it probably becomes a lot more attractive for those that have gone under maintenance, to actually make the conversion. Through the first quarter what we saw in conversion rates, as they kind of held in at that roughly a third that are converting at about the point of renewal. We'll see now with the difference in - pretty significant difference in price. We'll see how that goes in this quarter and through the end of the year."
},
{
"speaker": "Operator",
"text": "Next question comes from the line of Matthew Broome of Mizuho. Your line is open."
},
{
"speaker": "Matthew Broome",
"text": "You recently launched 2020 editions to AutoCAD, Revit and some other products. Just curious how early feedback has been for that. So that which new features you believe will have the biggest impact?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So like I said earlier, we've seen pretty rapid adoption of these capabilities as they rolled out, which actually bodes well for how customers are reacting to those things. I don't have any feedback on particular feature sets. Because we're working like a big lumps of areas, like in one area we're working on in Revit in particular, is on rail and things associated with rail and adding capabilities that make it more efficient for rail. So there's going to be lots of areas and each one of these products that are broadly accepted. But when it comes to AutoCAD in particular, customers are starting to embrace the multi-platform nature of what we've done with AutoCAD, and the way we're making it easy to integrate not only our own storage environments, but third-party storage environments like Dropbox and Box, and other types of environments, so that our customers can efficiently use AutoCAD data in multiple types of storage environments. One of the features we rolled out and it doesn't get a lot of visibility is that when a customer is inside the Dropbox environment, and they go and they click on a DWG files, it actually launches the AutoCAD - AutoCAD web, the viewer - and it put its full AutoCAD web, and it actually says, you are subscriber, if you're a subscriber they get the edit experience. But it is the - AutoCAD web version inside these applications, that kind of reach that we're getting with some of those things is actually exposing more and more customers to the power of the multi-platform view we've taken with some of these applications. So I think you're going to hear more and more about what we're doing there. On the Revit side, you're going to hear more and more about some of the things we're doing around rail and other areas, where we're extending the capabilities to be not just Revit, but in InfraWorks such as more specifically say it's on the InfraWorks side. You're going to hear more and more about some of those things as well. But those are some of the areas that are getting a lot of interest and a lot of traction."
},
{
"speaker": "Matthew Broome",
"text": "And I guess, could you provide a brief update on the media and entertainment business. It looks like there was a little bit of revenue deceleration there during the quarter."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So there's a couple of things you want to know about the media and entertainment business. One, it's very sensitive to large deals. All right. So for instance in Q4, we had a couple of really big deals in M&E. So there was a quarter or a quarter change around media and entertainment just related those deals. Last Q1, we also had a big deal that came in. And like I said, the media and entertainment business of all our businesses is very sensitive to these large deals. So there is a quarter over compare to that large deal, but in addition and this is something I want you to pay attention to over a multi-quarter scenario, similar to what we did in our manufacturing business, we've retired certain products in that space that we're no longer collecting revenue on and you'll see some kind of year-over-year declines associated with that. So for instance, we don't charge for sketchbook anymore that product is out there, it's completely free, it's available to people to anybody who wants to use it. That, that money isn't in there anymore, and it shows up in the year-over-year. But those are things that are affecting the M&E business. We actually had a pretty robust M&E quarter, right? But as I said, there's sensitivity to large deals and this idea that we feel kind of retired certain products especially things like sketchbook that are going to have year-over-year impacts."
},
{
"speaker": "Operator",
"text": "Our next question comes from Rob Oliver of Baird. Your line is open."
},
{
"speaker": "Rob Oliver",
"text": "I wanted to take it back to the construction side if I could Andrew, and talk a little bit about the pricing side. I know you've said you guys favor the named user bundles. How is pricing playing out so far relative to your expectations coming in? And on those 15 deals in particular, where there was head-to-head competition, did price play a role at all? And then I have a very quick follow-up? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, like I said, we're really happy with the results of construction in Q1, we hit all our goals we're looking good heading into Q2, we're really happy with things that are going on. So let me tell you right out of the gate, that the pricing models are working in their form, but I think I know you're asking a different question. So like - when we go in against the competitor, let me tell you about the two things that help us win. The first thing is competitors just like the story, they see us with a best-in-class field execution solution at one end, they see us with a best-in-class design collaboration solution at the other end, all cloud-based. And they just look at us and when we tell them look, we're going to connect the building information model all the way from design through to site execution, and we're going to do it with these things in between, they believe us, and they see it and they expect it all of its functionality is going to roll out over time. And when we do things like accelerate the rollout of PlanGrid BIM into the PlanGrid environment as quickly as we did, people start to say, okay, thank you Autodesk, you're showing us the evidence that we're heading in the right direction. So they buy the vision, they buy Autodesk role, they don't see anybody else able to do this end-to-end kind of connection the way we're doing, and that's been something we've been consistent about. And yes, when they go in and look at the business model that we come to market with, they say look yours is a much more customer-friendly business model, this is one I can grow with. This business model over here is this going to penalize me as I grow. So yes, we do see those things. But I want to just make it clear, primary reason we win is the big story. And that's the thing that is getting customers excited. It's the thing that's engaging them, and it's the thing that's bringing more people into our ecosystem and we are seeing that."
},
{
"speaker": "Rob Oliver",
"text": "And just as a quick follow up, and Andrew, you had mentioned on the last call and Scott just reiterated. Did you guys not only absorb the planned R&D at PlanGrid and BuildingConnected but you've ramped that R&D. And aside from platforming and integration, and this - and I apologize because this maybe leading on to the - to for the ramp of other areas that you're seeing from an end-user functionality perspective, that are interesting to you as a possible recipient of those R&D dollars. Thank you guys very much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So one of the things, I want to make sure I reiterate. I mentioned this during the last call, but I think it bodes restating, we've definitely applied clear missions to the two product stacks and the two teams frankly and we've actually swapped people back and forth between the two teams. PlanGrid is very much focused on field execution and being the best-in-class tool for field execution. So they're looking to accelerate the roadmap that they had in place for field execution both customer-driven and internally-driven, and that's where they're spending their dollars. On BIM 360, we're focusing the BIM 360 team much more on closing all the gaps around project management and things associated with project management, RFI flow and all of the things that go - connected to that and then connecting those things back to the PlanGrid environment and the customer see a seamless flow. So we've - this mission-based assignment of teams has been super important. It has resulted in additional R&D dollars going in. We are absolutely accelerating PlanGrid's roadmap, not decelerating it, and we're accelerating BIM 360's roadmap with regards to project management capabilities. So that, that you will hear more about in June. But I think it's important to just reiterate, where we put the money and how we're spending it to moving forward because we really do want these solutions to survive, thrive, grow and connect together rapidly inside Autodesk. So we're committed to that and yes, we spend more and we brought them in and we got the results we wanted. So I think we're going to keep doing that."
},
{
"speaker": "Operator",
"text": "Our next question comes from Kash Rangan of Bank of America. Your line is open."
},
{
"speaker": "Kash Rangan",
"text": "My question Andrew for you is when you look at the maintenance subscription conversion program, can you just give us an update on how much of that installed base has accepted the price increase versus converting to subscriptions and what is left in that third bucket? Any strategy or plans you might have in place to convince the last set of holdouts to get on the program. Thank you very much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we never, we never expected that every subscription - that every maintenance customer was going to move to subscription during this program. I think one thing that's important to note is we basically converted two-thirds of them already at this point. So there's really only one-third of the subscription base left from when we started this program. And as we told you over and over again, we've - everyone we've moved, we're growing the value of those customers through consolidation and through other efforts associated with that. So we have to pause and look at well how far have we come here with regards to this program. And I think it's pretty impressive results given what we're trying to accomplish. We have always expected that by the end of the year, there were going to be a set of customers left in, and there are going to be a set of customers left in maintenance. But I think also what you heard from Scott earlier is that the renewal rates for maintenance are holding up quite well, incredibly well actually even with the price increases that are in front of customers. So customers are going with us along the journey. There are going to be some left at the end of the year still on maintenance, and we'll look at what we do in terms of working with those customers as we get to that point. But we're already two-thirds in there, we'll be more than two-thirds by the end of the year, we've been successful in increasing the value of those customers and most of those customers that have moved over are happy and the ones that are still on maintenance are renewing it at robust rates. So the program looks like a success to me."
},
{
"speaker": "Operator",
"text": "Next question comes from Keith Weiss of Morgan Stanley. Your line is open."
},
{
"speaker": "Hamza Fodderwala",
"text": "This is Hamza Fodderwala in for Keith Weiss. Just a couple of quick questions from my end. The first one, so the manufacturing revenue growth really accelerated this quarter and it's been up double-digits for a few quarters now. I'm just wondering what's the inflection point there as far as you starting to really put up growth that's faster than many of your peers, what's driving some of that share gain? And what's the roadmap there going forward?"
},
{
"speaker": "Andrew Anagnost",
"text": "So Hamza what you're seeing there is the strength that was always there underneath that you couldn't see, because of all the product retirements we did. Alright. So we've been doing this for several quarters in the core part of our business, which is one of the reasons why we're so excited about, how we're doing in manufacturing in general right now. You saw declines or slowness in the manufacturing business, because we retired a whole set of products. Some of them we just retired completely, some of them were transitioned into the collections environment, some of them were combined with other products, we did some large consolidations, and this resulted in some revenue that is essentially disappeared. But it showed up eventually in other places, so now what you're seeing is the underlying strength in the core manufacturing business that was always there. And we're - like I said excited about it and when you look at some of the things that are in the roadmap, what you're going to see is tighter and tighter coupling of this design to make workflows. You're going to see more showing up in Fusion with regards to end-to-end design all the way through to machining workflows and new generative algorithms that take not only 3D printing workflows, but - workflows for 2 axis, 2.5 axis, 3 axis milling operations and automating the geometry creation. You're also going to see more workflows between Inventor and Fusion. So that Inventor customers can take advantage of the downstream production workflows that are built inside a Fusion. Customers are starting to look inside the manufacturing and - the product design and manufacturing collection and they're cracking it open and they're seeing some things that they think are pretty amazing. That's part and parcel of what's driving our growth. Customers are consolidating on what we have because they see us. I can take these eight weird things that I had against consolidating this as one thing. And by the way I've got this cloud workflow that makes all my data problems a lot cleaner and it's just working. And I expect you'll see it to continue to work in the future. So I'm just happy you can now see the underlying strength in the business that we knew was there all along."
},
{
"speaker": "Hamza Fodderwala",
"text": "And just a quick follow up. We did hear that there was a price increase on multi-user licenses in May. Just wondering if that caused any pull forward business from Q2 to Q1. That's it from me."
},
{
"speaker": "Scott Herren",
"text": "So we did see and we referred to this a little bit in the opening commentary, Hamza. We did see a little bit of early renew activity, but really the same percent that we've seen historically. So if you add up our total sales what percent were early renews where you'd see people trying to front run the price increases earlier renews. So as we looked at that, it was really in line from a percentage basis with what we've seen historically. So I don't - I'm not anticipating any change or any kind of an impact to the full year model from that. Having said that, the change we made on multi-user pricing was really to do a better job capturing the value of what we're shipping with that you've seen us make kind of incremental changes in multi-user now for a couple of - couple of years in a row. And it's to better align the price with the value that's being delivered on multi-user."
},
{
"speaker": "Operator",
"text": "At this time, I'd like to turn the call over to Abhey Lamba for closing remarks. Sir?"
},
{
"speaker": "Abhey Lamba",
"text": "Yes. Thank you for joining us this afternoon. If you have any questions, feel free to contact us. Thanks for joining us. Bye."
},
{
"speaker": "Operator",
"text": "That does conclude our conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 4 | 2,021 | 2021-02-25 17:00:00 | Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Autodesk Fourth Quarter and Full Year 2021 Results Conference Call. [Operator Instructions] I would now like to hand the conference to your speaker today, Simon Mays-Smith, Vice President of Investor Relations. Please go ahead, sir.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter of fiscal year 2021. On the line with me is Andrew Anagnost, our CEO; Stephen Hope, Vice President and Chief Accounting Officer, and Abhey Lamba, our Vice President of Go-to-Market Finance. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, and strategies. These statements reflect our best judgment based on our currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numerical growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our investor relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. I hope you and your families remain safe and healthy. Before jumping into our fourth quarter and full-year results, I would like to again thank our employees and the families and communities that support them as well as our partners and customers, for their continued commitment during uncertain times. That commitment, combined with our resilient subscription business model and the secular shift to the cloud, enabled us to maintain momentum and exceed our goals. We generated strong growth, with full-year subscription revenue and remaining performance obligations or RPO up 26% and 19%, respectively. We also made significant progress toward digitizing AEC, converging design and make in manufacturing and converting non-compliant and legacy users. We signed a record number of new enterprise business agreements, or EBAs, in the fourth quarter. In fact, they were equal to the number we signed in the entirety of the previous year. That’s a testament both to our execution and growing partnership with our enterprise customers as we enable their digital transformations, demonstrated by enterprise BIM 360 usage nearly doubling year-over-year. While we made great strides this year, we intend to extend our leadership in the cloud and expand our presence in existing and adjacent industry verticals across the globe. The pending acquisition of Innovyze, which we announced yesterday and is expected to close later this quarter, is a great example of that intent. Innovyze is a global leader in water infrastructure simulation and modeling, serving many of the world’s largest utilities, the majority of the top ENR design firms, and other leading environmental and engineering consultancies. Innovyze enables water distribution networks and drainage systems to be more cost-effectively and sustainably designed and operated. Combined with CIVIL 3D, InfraWorks, Revit and Autodesk Construction Cloud, we would be able to provide end-to-end water and wastewater solutions across planning, design, construction and operations. With our existing capabilities in road and rail, and our partnership with Aurigo in capital planning, we now have end-to-end infrastructure solutions for facility owners and public sector agencies. Autodesk provides Innovyze with multiple opportunities to scale through enterprise, channel sales, and geographic expansion. We also intend to apply our expertise in navigating through a business model transition to drive additional growth in fiscal 2024 and beyond. I’m excited about the opportunities ahead, and look to the future with optimism. In the near-term, we expect the unwinding of uncertainty from vaccine availability and political stability to drive confidence and investment over the second half of the year. Over the long-term, Autodesk’s purpose to drive efficiency and sustainability has never been more relevant or urgent. In partnership with our customers, we have an unmatched capacity to drive efficiency and meet the global challenges of carbon emissions, embedded carbon, water scarcity and waste. And Autodesk is playing its part. We are on track to meet our commitment to be climate neutral and remain dedicated to being a resilient, diverse, and equitable company. We were most recently recognized by Barron’s as number four on their list of the world’s 100 most sustainable companies, and the highest-ranked software company. We are proud of our impact at Autodesk, and through our customers the impact we are making in the wider world. I’m also thrilled to announce two strong additions to my team. Debbie Clifford will be returning to Autodesk as Chief Financial Officer and Raji Arasu will be joining as Chief Technology Officer. Debbie is currently Chief Financial Officer at SurveyMonkey but spent the 13 years prior to that role in various financial leadership roles at Autodesk, including leading the internal business model transition team, engaging with many of you in support of our investor outreach, and as my finance business partner before I became CEO. With her leadership skills, expertise and passion for our mission, Autodesk’s finance team will not miss a beat. Raji joins us from Intuit, where she currently serves as Senior Vice President of their Platform and Services business. Prior to that, she was CTO for eBay subsidiary StubHub. At Autodesk, she will oversee and be responsible for the Autodesk’s technology and platform strategy, as well as being operationally responsible for the on-going development of our platform services. Raji will replace current Autodesk CTO Scott Borduin, who announced his intent to retire last year after more than 21 years of service to the company. Scott had two tours as Autodesk CEO, the prior one working for Carol Bartz and has not only contributed to the rise of Inventor and Fusion to the products they are today, but also as a passionate evangelist for Autodesk and our vision. Emblematic of his dedication to Autodesk, he moved out his retirement date so that he can help Raji during her transition into Autodesk. I’d like to give Scott a heartfelt thank you for all he’s done and is continuing to do. Before I provide insights into our strategic growth drivers, let me take you through the details of our quarterly and full-year performance, and the guidance for the next year. In an extraordinary year, we performed strongly across all metrics, perhaps best encapsulated by the sum of our revenue growth and free cash flow margin for the year equaling 51%. Several factors contributed to that strength in the fourth quarter, including, record EBAs, robust subscription renewal rates, accelerating digital sales, and continued sequential growth in new business. Total revenue growth in the quarter was 16%, both as reported and in constant currency, with subscription revenue growing by 22% and now representing approximately 91% of total revenue. There was approximately 2 percentage points of benefit to subscription and maintenance growth from upfront revenue recognition of some products that do not incorporate substantial cloud services. Looking at revenue by product and geography. AutoCAD and LT revenue grew 11% in the fourth quarter, and 16% for the year. AEC grew 18% in Q4, and 20% for the year. Manufacturing rose 17% in Q4, and 10% for the year. Even excluding the benefit from a strong performance in automotive EBAs, which include non-ratable VRED revenue, manufacturing grew double digits in the quarter. M&E grew 14% in the quarter, boosted by a strong performance from our collaboration platform, Shotgun, and was up 10% for the year. Geographically, revenue growth ticked up in all regions. Revenue grew 14% in the Americas, 13% in EMEA, and 23% in APAC during the quarter. We also saw strength in direct revenue, which rose 28% versus last year, and represented 34% of our total sales, up 3 percentage points from the fourth quarter of last year. The strength in our direct business was driven by some non-ratable products included in a few large EBAs and digital sales. During the year, we grew total subscriptions by 8% to 5.3 million. Excluding the multi-user trade-in program, total subscriptions grew 4% to 5.1 million. Subscription plan subscriptions grew 15%, and by 10% excluding the multi-user trade-in program. We added 130,000 make subscriptions due to the strong adoption of our BIM 360 family and Fusion 360 products. During Q4, our maintenance conversion and renewal rates declined sequentially, which was expected as we are entering the final stages of our maintenance-to-subscription program. With only one quarter left before this program retires, we have approximately 126,000 maintenance subscriptions remaining, accounting for approximately 3% of our revenue in the fourth quarter. I am proud to share that we have converted over 1.3 million maintenance subscriptions to date. At the end of the fourth quarter, the lion’s share of our commercial subscriptions were named users benefiting from easier access, usage data visibility and secure license management. We anticipate many of our remaining multi-user subscribers will make the transition to named users as the pandemic recedes, and we are now extending our 2:1 multi-user trade-in to August 2023 to enable that. As announced last November, we are also exploring consumption-based models to meet the needs of customers requiring flexible license usage. Our net revenue retention rate remained within the 100 to 110 percentage range we laid out in our guidance. Our product subscription renewal rates remained robust, reinforcing the business-critical nature of our products to our customers. Our billings were broadly level with last year, reflecting fewer multi-year sales, and our long-term deferred revenue was 26% of total deferred revenue in Q4. Our total RPO of $4.2 billion is up 19%, and our current RPO of $2.7 billion grew 16%. On margins, we continue to realize good operating leverage due to strong revenue growth and diligent expense management. For the full year, non-GAAP gross margins remained very strong at 93%, up 1 percentage point from last year, our non-GAAP operating margin increased by 5 percentage points to 29%. As you have seen in our press release, our GAAP results include a $679 million deferred tax asset valuation allowance released in the fourth quarter. This largely reflects the completion of our business model transition and the significant growth in our profitability. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash to offset dilution from our equity plans. During the fourth quarter, we purchased 530,000 shares for $157 million at an average price of approximately $295 per share. For the full year, we purchased 2.6 million shares for $549 million at an average price of approximately $208 per share. Now let me turn to our guidance, which does not include Innovyze. We expect an improving macro-economic environment during the year will result in accelerating growth in new business over the course of fiscal 2022. Usage trends during the fourth quarter remained above pre-COVID levels in most of Asia Pacific and Continental Europe and below pre-COVID levels in the U.S. and UK. We have seen an uptick in interest for multi-year deals, growing optimism in the channel, and gradual recovery in bid activity on BuildingConnected in the U.S. We expect product subscription renewal rates to continue to be very healthy, and our net revenue retention rate to remain between 100% and 110%. Given our subscription model, revenue growth will lag the improving sales environment. For fiscal 2022, we expect revenue to grow by 13% to 15%, margins to expand to between 31% and 32%, and free cash flow growth to reaccelerate to approximately 20%. When looking at the quarterization of free cash flow for fiscal 2022, we expect about three quarters of our free cash flow to again be generated in the second half of the year due to our macro-economic phasing assumptions and normal seasonality. As we noted last quarter, Vault revenue is becoming ratable for fiscal 2022 with the release of significant new mobile functionality in the first quarter, and this will reduce our revenue growth by about a percentage point over the year with the biggest impact in other revenue on the P&L and in the manufacturing product family. Looking at our guidance for the first quarter, normal seasonality is compounded by Vault ratability and one fewer calendar day versus Q1 fiscal 2021, which together reduces year-on-year revenue growth in the first quarter by about 2 percentage points. With improving macro-economic conditions and easing comparables, we expect our revenue growth to accelerate after the first quarter. The slide deck on our website has more details on modeling assumptions for the fiscal first quarter and full year 2022. We expect Innovyze to be accretive to revenue growth, broadly neutral to free cash flow and a headwind on reported operating margins in fiscal 2022 and 2023. We will provide additional details after the Innovyze transaction completes. Let me finish by giving you some details on the progress we made executing on our strategy to digitize AEC, converge design and make in manufacturing, and monetize non-compliant and legacy users. Earlier in February, we launched our Autodesk Construction Cloud platform, which unifies our organic and acquired AEC cloud offerings, and the data held within them, to enable a connected project ecosystem across design and construction. Underpinning the Autodesk Construction Cloud is our common data environment, Autodesk Docs; this provides seamless navigation, integrated workflows and project controls, and enables a single source of truth across the project lifecycle. Autodesk Build brings together the best of PlanGrid and BIM 360 with new functionality which, along with Autodesk Quantify and BIM Collaborate, creates a comprehensive suite of field construction and project management solutions. For our design customers, BIM Collaborate Pro extends the capabilities of BIM 360 Design on the new platform to create a more seamless exchange of project data between design and construction. Our strategy is to combine organic and acquired software in existing and adjacent verticals to create end-to-end, cloud-based solutions for our customers that drive efficiency and sustainability. We have pursued that strategy to create Autodesk Construction Cloud, we are pursuing that strategy in infrastructure with the acquisition of Innovyze, and we will continue to pursue that strategy in manufacturing. The reasons for, and benefits of this strategy, were clearly demonstrated in our fourth quarter results. Our growing partnership with our enterprise customers, as we enable their digital transformations, resulted both in a record number of new EBAs in the fourth quarter; and also strong expansion and renewal rates with existing EBA customers. We are seeing our new products, typically used by contractors, being increasingly adopted by design firms. For example, we expanded our agreement with Jacobs, the world’s largest design firm, to include Pype, PlanGrid, and Assemble to enable greater collaboration and more efficient workflows. Autodesk has been a trusted partner of Jacobs over the last 30 years, aligned with its mission to challenge today and reinvent tomorrow. Jacobs is also using Autodesk’s transformative services to help them deliver innovative solutions to their customers. For example, Autodesk and Jacobs partnered to deliver the world’s first generatively designed airport in Australia and, together, we are focused on leveraging generative design to solve other client challenges around the world. Environmental Air Systems, EAS, a full-service mechanical contractor and custom-built HVAC equipment manufacturer which is on the forefront of industrialized construction, increased its investment with Autodesk by replacing its existing project management tool with BIM 360. It is now able to leverage its existing investment in AEC Collections, and provide a comprehensive tool for its teams to collaborate and to connect the office and the field. And Tyréns, a leading sustainable urban development consultancy in Sweden, significantly expanded its strategic platform partnership with Autodesk. As Per Bjälnes, Tyréns Digital Strategy Manager for Business Area X, said, “Tyréns is at the leading edge of the digital transformation of the construction and maintenance industry. Digitalization enables smart building design, but requires secure data flows and seamless collaboration across a broad ecosystem of stakeholders during the construction and operations process. Autodesk’s Revit and BIM 360 Docs empowered us to create true digital representations, and now with Autodesk Forge we can leverage those assets as digital twins to create value for different stakeholders, such as a reduction of energy consumption, the prediction and optimization of maintenance, and new smart seamless end user services." We are also seeing benefits from our strategy in manufacturing. In the automotive sector, we now provide design software through our enterprise agreements to nearly all the largest global Automotive OEMs, and are extending our footprint beyond design into the factory. For example, our expanded partnership with Rivian, a global provider of electric adventure vehicles, now extends across facilities with Revit, BIM360, and PlanGrid; manufacturing with Inventor and generative design; and in the design studio with Alias, VRED, and Shotgun. We are able to support Rivian as it converts existing facilities to digital twins, optimizes its factory layout using generative design, improves energy efficiency through simulation, and enables collaboration and efficiency using a common data environment. Similarly, we are providing end-to-end support to our long-term customer, Transmashholding, TMH, which is the largest manufacturer of rolling stock and rail equipment in Russia and CIS, to accelerate its digital transformation and converge its design and make processes. TMH now builds trains in concept in Alias, designs and engineers in Inventor, optimizes in Fusion, produces in Powermill, and sells in VRED. Our market-leading cloud-based platform, Fusion 360, enjoyed another quarter of accelerating subscriptions, growing scale of deployments, and adding competitive displacements, ending the quarter with over 140,000 commercial subscriptions. Conturo Protoptyping, a machine shop based in Pittsburgh, recently expanded its relationship with Autodesk by adding more Fusion seats. Conturo is also adopting our recently launched machining extension, due to its integrated Design and CAM workflows, its advanced manufacturing capability, and the potential of generative design to reduce project timelines and solve design-for-manufacturing issues faster than ever before. In education, we continue to expand our footprint and replace traditional CAD competitors. With Tinkercad and Fusion 360 alone, Autodesk is now approaching 40 million education users worldwide. For example, all of University College London’s Mechanical Engineers switched to Fusion 360 during the fourth quarter. As Professor Tim Baker, MBE, who led the transition, said: “Covid-19 accelerated UCL’s transition to the cloud. By enabling collaborative, multi-disciplinary engineering, Fusion 360’s next-generation platform equips our graduates to become the world’s leading engineers of the future.” While all our software remains free for educators and students, graduates continue to bring Fusion 360 with them into the workplace, from startups through to the giants of manufacturing. While we have moderated our license compliance activity during the pandemic, we continue to work with existing and potential customers to ensure they pay for the software they use and comply with our terms of use. Our goal remains to give non-compliant and legacy users access to the benefits of subscription access through flexible models. During the quarter, we closed 23 deals over $500,000 dollars with our license compliance initiatives, 3 of which were over a $1 million. For example, a European customer became aware during its transition to named users that its employees were accessing licenses in regions outside of the contract scope. Our premium plan provided them with the flexibility to manage all licenses centrally, monitor usage to remain in compliance, and resulted in a $1 million-plus deal. And a leading supplier of industrial automation solutions based in Europe, who became a legacy customer 3 years ago, subscribed to our Product Design and Manufacturing Collection when we were able to demonstrate that recent workflow improvements and cloud enabled functionality would allow them to win more business by improving communication with their own customers, and improved efficiency through quicker layout in 2D and handover to 3D and visualization. In closing, we continue to build a stronger Autodesk for the long term. Our early and sustained organic and strategic investment in critical capabilities like cloud computing and cloud-based collaboration, combined with a successful transition to a SaaS business model, give us significant competitive advantages and confidence to grow in the double-digit range in the foreseeable future. We expect to have accelerating momentum during fiscal 2022 and we have multiple drivers that make us confident in our fiscal 2023 free cash flow target of $2.4 billion and double-digit growth thereafter. With that, Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia from Barclays. You may begin.
Saket Kalia: Okay, great. Thanks, Andrew for taking my questions here and congrats on the new additions to the team.
Andrew Anagnost: Thank you.
Saket Kalia: Maybe just to start you touched on this a little bit in your prepared remarks, Andrew, but can you just talk a little bit about how you’re thinking about new business recovery this year and maybe just broad brush, what verticals or GEOs might be stronger than others?
Andrew Anagnost: Yes. Thank you, Saket. I think that’s a really appropriate question to open up with. As you know, new business was down last year and that has a disproportionate impact on how we see revenue in Q1, but the way we look at it shaping up this year is Q1 is kind of the trough of the new business recovery. And we’re going to be accelerating our new business growth out through the year into the second half of the year. In fact, we really see a world where most of the new business that didn’t show up last year, kind of reemerges as we head through this year. So it’s important to see that business that disappeared last year didn’t disappear. It just got shifted out. In fact, you’re hearing a lot about the acceleration of digitization in multiple industries, and we’re seeing that in our space in spades as well. And I think if we look at particular sectors, it’s actually really going to be distributed across all the sectors and kind of similar ways. AEC is already investing really significantly ahead of the market in terms of their digitization efforts. You kind of saw early evidence of that with the EBA business we did. The record number EBAs we did in Q4 relative to previous years. In manufacturing, you kind of see the same accelerated interest in digitalization and new cloud-based workflows, especially surrounding what we’re seeing in fusion. The same goes in media entertainment. The media entertainment business, which was classically a laggard on some of these highly digital, highly cloud integrated workflows is moving to the cloud in a big way. Now, geographically kind of in a broad-brush, I kind of highlighted in the opening remarks that, we saw a broad recovery in Europe and Asia to pre-COVID levels of monthly active usage. And we saw a little bit of a lag in the U.S. and the UK. I think we’re going to see that kind of geographic fraternity new business in that cascade. It’s going to be strong in APAC. It’s going to get strong in Europe, and then it’s going to start to come back in the U.S. and the UK. Q1 will be the trough of this new business growth, and we’re going to accelerate right out of that into the rest of the year.
Saket Kalia: Got it. That’s really helpful. Maybe for a follow-up, understanding that Innovyze hasn’t closed, it isn’t included in guidance. Can you just give us some broad brushes on maybe how big that revenue scale there is, and maybe just touch on whether there are any significant differences in the business model versus Autodesk?
Andrew Anagnost: Yes. Differences in opportunities, Saket, so first off, let’s just kind of just level set on why we did Innovyze. I think we’ve been super clear that infrastructure is one of these really big growth opportunities for us long-term. Infrastructure projects take a long time to design and plan, and they last even longer after that. So an investment in infrastructure is an investment in the long-term health of Autodesk. And I think we just have to be super clear about that. Water was one of those areas where it would have taken us all a lot of time to catch up organically, whereas road and rail is an area we’ve been highlighting to you that we’ve been investing in organically with our portfolio and really making great strides there. When you look at the business at a high level, in terms of the differences and where the revenue is going to come from. So look, at a high level, Innovyze is going to be accretive to our revenue growth, roughly to a percentage point, as we head into this year that includes deferred revenue write-offs and the fact that we have a partial year in here, it’s probably going to be dilutive this year about a percentage point off of operating margin. But here’s the opportunity that I want to make sure you highlight. You actually poked out a little bit between the differences in our business model. Not only are we going to plug Innovyze into our sales engine, in terms of named accounts, channel sales and international expansion. We’re also going to apply our expertise on business model transformation to the Innovyze product portfolio. And I think that’s going to be an important transitional element of how we absorb Innovyze into the company. We’re good at this. We know how to do this, and we know how to navigate this. So what you’re going to see in FY 2023 is you’ll probably see a little bit of a depression of Innovyze’s revenue growth in isolation, because we’re going to be applying the business model transformation. And as you know, with the business model transformation, there’s downward pressure in revenue as a result, but acceleration of revenue as you head out onto the other side of the business model transformation. So if we look at FY 2023, it’s probably going to be neutral to the overall revenue growth of the company. It’s not going to touch the free cash flow number $2.4 billion is going to come out Innovyze or no Innovyze. And they’ll probably be a little bit more of a headwind operating margin, maybe between 1% and 2% as we go through the business model transformation, but a nice acceleration up to our double-digit growth standards as we head beyond FY 2023 to 2024, 2025 and 2026, which is kind of an extra bonus on top of what we’re going to be able to do, just to expand the core Innovyze water business, to capitalize on the increasing investment in infrastructure. So it’s a good question to talk about the differences in our business model, because there’s actually an opportunity there and a difference.
Saket Kalia: Very helpful, Andrew. Thanks again and congrats on the new additions to the team.
Operator: Our next question comes from line of Phil Winslow from Wells Fargo. You may begin.
Phil Winslow: Great. I thank everyone for taking my question and then congrats on a strong close to the year. And once again, congratulations on the new hires in particular. Great to have Debbie back. Really want to focus on the mix side of Autodesk. How do you think about it in a reopening scenario and given the fact that we have a lot of backlog of projects, particularly in the construction and infrastructure world you’re heading into this year, what is the opportunity for Autodesk to potentially accelerate adoption of some of the main functions, BuildingConnected, PlanGrid to try to help the industry work through this backlog?
Andrew Anagnost: Yes. So we actually started to see the early signs of that as we headed into Q4 as new business, starting to strengthen in our construction portfolio in particular. And we also saw it across the Fusion base, as well as people started to look at their manufacturing and the design to manufacturing operations. So we see a pretty significant opportunity here. Look in many ways, the pandemic gave us an opportunity to catch up and pull ahead a little bit here. Our portfolio is now best-in-class. Our development team did an incredible heavy lift and an amazing job unifying what was the best of PlanGrid, which with the best of what we had in BIM 360, we now have Autodesk Build on this foundation of Autodesk Docs. And there is no one that has a better office to trailer solution than we do. And I think if you go out there and you talk to customers and you talk to this space and they look at what we’ve done with Autodesk Build, you’re going to hear the same kind of feedback that we really built a great product, and that’s the product we’re going to be leading with on new business. It’s not that we won’t be leading on the acquired portfolio products as we continue to sell those, but we’re going to lead with Build, and we’re going to lead with Build in many places. And that’s going to give us a chance to not only drive a successful international expansion, but also continue to lap some of our competitors in the rest of the market, especially in places like the mid-market, but another one pieces of our secret sauce heading into the year, Phil, is the flexibility we offer on business models. We meet our customers wherever they are. And I think this is super important for you to pay attention to, we sell named user subscriptions. We sell site licenses. We sell project-based licensing when they want it. We sell consumption inside of EBAs, whatever they need for whatever project they’re pursuing. We have a model for them and a product for them. And I think that important convergence between the flexibility, which by the way, costs us complexity in the backend, but it’s worth it in terms of meeting the customers where they are. When you combine that with the products, we feel really, really optimistic about how we’re going to accelerate in this year and meet some of this demand. And our customers are looking for it. They want to digitize faster. They’re starting to increase their spending. And we think we’ve got the portfolio of products and the portfolio of purchasing options that makes it work. We’re not trying to force people into one kind of business model, and then maybe try to lock them in kind of places that they don’t want to be. So we feel pretty optimistic.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer.
Andrew Anagnost: No follow-up from Phil. So we didn’t get a follow-up here.
Operator: Not at this time. Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities. You may begin.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, the company has quite a lot on his plate, a very broad agenda. And the question is within the context of your three overarching strategic priorities, obviously making the numbers that you guided to now for fiscal 2022. Can you talk about some of the other critical programmatic executable that you are aiming for this year? For instance, in terms of a channel in terms of delivering on the platform, going live perhaps with PPU other critical technical milestones that you might care to talk about in terms of new products like Tandem and Spacemaker and so forth. And then secondly, on the last call, you noted that within your peer group, Autodesk is the largest R&D spender, which is the case, but could you talk in a little bit more detail about how you’re allocating R&D? Maybe talk about the priorities you’ve spoken of reinvesting in the AEC? And maybe talk about some of those critical investment priorities views in the R&D?
Andrew Anagnost: All right. So there was – it’s usually a multi-party question from Jay. All right. So let’s talk about some of the programmatic pieces here. Now I don’t want to take any thunder away from this year’s AU, which is where we talk a lot about, as you probably noticed with last day, you’re going to see more of a product announcement focused AU, as we move forward. So I don’t want to take any thunder away from that. But if you look at programmatically where we’re going to be leaning into, platform enhancements that bring design and make and industries together and create commonality across many of the industries we serve are going to be a particular lever that we’re to be moving with. We just hired a new CTO with a lot of platform strategy chops that we’re going to be leveraging to integrate some deeper platform capabilities into the company. We’re also going to be looking programmatically at the named user transition program, as you know, that was kind of a bumpy program last year. The customers really didn’t appreciate us introducing that into a pandemic year, and they really want to understand what their options are with regards to flexible usage and occasional use moving forward. For so look for us to explore those kinds of capabilities as we’ve extended out, what the deadline was in that program, which still makes that program being executed faster than maintenance subscription, but probably more on a timeline that fits with what our customers can absorb. So you’ll see us kind of look at those flexible options and explore some of those things with our customers. Now, if you look specifically at how we’re allocating investment, I mean – I think you saw what we did around the A in AEC. We acquired Spacemaker. We’re integrating that team, building up capabilities around that team, particularly around integrating machine learning and cloud-based platforms into the design process in architecture and engineering. So that investment is clear, we’ve highlighted it. You’ve just seen how we’re investing in infrastructure and civil infrastructure. We’ve already talked organically about road and rail. And now we’ve also talked about water and all of this kind of builds on top of what we’re doing with Construction Cloud. I haven’t talked a lot about what we’re going to be doing with manufacturing, but here’s what I can tell you. We’re very interested in the cloud transformation in manufacturing, and I think you’ll see us lean deeply into the cloud transformation around manufacturing more. We’ve invested pretty heavily there. Our investment is large in that whole portfolio, particularly in the Fusion portfolio. I think you’ll continue to see us to invest to that area. And as we head towards AU, you’ll hear exciting things about Fusion. You’ll hear exciting things about Tandem. You’ll hear exciting things about the platform for the company. And you’ll hear exciting things about how the AEC portfolio is starting to come together in a similar way that we brought together some of the construction portfolio acquisitions that we did previously. So look for us to kind of play across all those fields. Now, in terms of the breadth of what we’re doing, I think I might’ve talked about this last time. We reverticalized the company just recently in October. So now I have someone that’s responsible for the AEC execution. Again, that’s Amy Bunszel, Scott Reese working on the execution and product design and manufacturing, and Diana Colella working in the media and entertainment space, and they are working closely with me and the rest of the team to execute on these vertical priorities while we’ve also elevated platform up to a executive staff level, reporting directly to me, which will allow us to synergize the platform efforts more tightly with those things. So we’re doing this from an operational perspective, as well as from a strategic investment perspective.
Jay Vleeschhouwer: Okay. Thank you, Andrew.
Andrew Anagnost: You’re welcome.
Operator: And our next question comes from the line of Gal Munda from Berenberg Capital. You may begin.
Gal Munda: Hey, thank you for taking my questions. So the first one, I was just like to ask you, Andrew, when you kind of look at how the year played out in terms of the multi-years there or network licenses, versus what you expected. Is it fair to say that you’re kind of ride bang in the middle to that two to one thing that you expected and you’ve just extended the program to 2023. Does that mean that you’re kind of very comfortable with the way that this program is kind of converting and you think that it’s going to remain at that level where it’s not a significant headwind to the model?
Andrew Anagnost: Yes. So look, our original statements about this being neutral to the model, continue to hold. So there’s no change in that expectation. I think what you saw last year, and I think this is a natural thing, like there’s two sides of the bell curve, right? There is the size of the bell curve for which two for one is like, hey, that’s a no brainer for me. I’m going to take the two for one. And there’s a size of the bell curve for which two for one requires some more thought by the customer. More thought about – okay, wait a second. My usage is greater than two for one, Autodesk, what are you going to do to allow me to be flex a little bit more an EBA is too big for me. So what you saw early on is a lot of those people on the left side of the bell curve, the 50% of people that were up for renewal last year that said, hey, this is good for me. They moved quite rapidly through that, right? The extension is for the people that require more thought about how this is going to impact their business and how they’re going to adapt if their usage is greater than the two for one that the program had. So that’s one of the reasons why we’re working on the extension also to ensure that we have the new flexible models out there for them to explore. So there’s no change in our expectations, which regards to the impact on our business. It’s going to be over in the whole period of the program neutral in terms of impact to our business. Positive long-term in terms of experience for the customers.
Gal Munda: Yes. Absolutely. And then just the second as this follow-up. You mentioned that for this year, you, again, expecting kind of mid-20s long-term deferred revenue in terms of the, you said, no material contribution to free cash flow. When we look into more towards FY 2023 and then maybe even beyond that, we’re hearing this, multi-year licenses is still been very, very strong even during the pandemic. So what would be the normal rate that you kind of think about if you think maybe more longer term, not just next year and maybe the year after?
Andrew Anagnost: Yes. So Simon, remind me what we’re reverting. So one of the things we’re doing, and I want to make sure we’re super clear on this with regards to multi-year. With multi-year our expectations that are revert solely back to the mean here. All right and not try to exceed what we’ve done historically, okay? And I just want to make sure that we understand that and we can get ourselves grounded in that simple fact. We’re reverting back to the mean behavior and yes, as we ended last fiscal year, right, we saw quite an interesting pickup in multi-year, frankly, more than we expected, all right, given that we were still in the pandemic year, but if we look at where we want to be, it’s just a reversion back to the mean. And remember that the multi-year business is attractive to both our channel partners and our customers, because our channel partners liked to collect the cash up front. And our customers like to lock in the price protection for multiple years. And if you recall, reversion to the mean historically for our maintenance business was about 30% of the business, roughly speaking. We want to stay right within that domain and we will probably stay within that domain for the foreseeable future. And that was adjusted peak, not the mean, okay, a piece to 30%, not in the middle. The mean was probably somewhere in the mid-20’s.
Gal Munda: Got you. Thank you, Andrew.
Operator: Our next question will come from the line of Adam Borg from Stifel. You may begin.
Adam Borg: Great. Thanks for taking the question and also welcoming the new folks coming in. Maybe just a question on the net revenue retention rate. Obviously, the pandemic and speed of recovery will be the key input in the near-term. I was just curious, Andrew, if there’s any kind of initiatives you’re working on internally that can help drive net retention revenue rates back to the historical range. Thanks so much.
Andrew Anagnost: Yes. So we’re hitting the ranges that we’ve set for net revenue retention. And frankly, obviously there’s two things that drive net revenue retention, renewal rates and AOV renewal, and the ability to expand into accounts, right? And so we’re working both of those sides in terms of increasing renewal rates and increasing our ability to expand in accounts with the make solutions. So when we look at net revenue retention, remember, one of the things that we saw and I think we highlighted this a lot over the last year was how strong the renewal rates lasted throughout the – through the last year and how we continued to move forward. So we actually overperformed based on our expectations on renewal rates of the business. We continue to see – we continue to expect that to accelerate. But more importantly, the net revenue retention is going to be driven by more and more people incorporating our digital portfolios, Construction Cloud, Fusion, other types of products like that and also moving to BIM in the AEC space. So look for a lot of the increases in net revenue retention to be programmatically driven by the move to BIM, the move to digitize in the cloud – in Construction Cloud and the move to transform their manufacturing processes with Fusion 360 and other solutions like that.
Adam Borg: Great. Thanks again.
Operator: And our next question will come from the line of Sterling Auty from JPMorgan. You may begin.
Sterling Auty: Yes. Thanks. Hi, guys. Just one question from my side. In the context of the improving economy, I’m wondering what if anything you contemplated in that improvement in the business coming from the possibility of further stimulus spending from the government and in particular [Audio Dip]
Andrew Anagnost: We do not factor that in, okay. Governments move slowly, the money trickles down slowly. So we have not factored any of that into our plans and into our guides. That said, we do expect it to be an investment. You probably have heard that the American Society of Civil Engineers in the U.S. rated U.S. Infrastructure a D+. Other countries aren’t doing particularly well either. This is an area for investment and focus. And we expect to see some of that investment focus, but we haven’t factored this in.
Sterling Auty: Thank you.
Operator: Our next question will come from line of Joe Vruwink from Baird. You may begin.
Joe Vruwink: Great. Hi, everyone. One modeling question first and then one on the business. Just when looking at the first quarter guide, I think the revenue variance in terms of variance to consensus estimates that seems explained by the couple 100 basis points you talked about. But I’m wondering in terms of the EPS variance as a bit wider. Are there some discrete investments that take place in 1Q? Is this a function of the extra day thrown into the mix? Or I guess, the question is how do you see margins progressing throughout the year and as 1Q kind of different than just the normal cadence?
Andrew Anagnost: Yes. So this is a really important question. So let’s talk about Q1 and the shape of the curve and what actually drives revenue in Q1. So I think I said earlier, Q1 is actually at the trough of where we expect things to be. We’re going to accelerate quite rapidly out of Q1. But what actually drives the revenue guiding Q1? The most important thing is the revenue recognition. So let’s look at last year. Last year, we did not grow a new business to the degree, we expected to. In fact, we saw declines year-over-year in our new business. The impact of those declines in new business bookings in the previous year have a disproportionately large effect on Q1, but they worked themselves out relatively quickly as you move into Q2, Q3, Q4 and beyond. So we absolutely do have a somewhat more backend loaded year than we would in a classic Autodesk year, but not extremely disagreed simply because of the hole that was created. And I think I said earlier, the new business that we lost in last year, it didn’t disappear. It’s coming back and it’s coming back with a vengeance as we head into the next year. But there’s a couple of other little factors that affect Q1 disproportionally. And I think it’s really important that we all get grounded on some of these things. So the first one is, we have a set of products that because they are not yet cloud enabled to a certain degree are recognized upfront in the revenue – in the accounting rules. They have to be. We have been working hard to ensure that all of those products are cloud enabled and that will actually force them to be recognized ratably. One of the products that is moving from upfront recognition to ratable recognition is the Vault product family. And that Vault product family was providing quite a bit of upfront revenue recognition previously. And now, as we enter Q1, it’s all going to be recognized, ratably because Vault now has a mobile client, it now has other cloud enabled features in it. So that was all of a sudden a headwind to revenue recognition in Q1, but it works itself out as the year progresses, as the relatability progresses and the buildup progresses. And this is just the way a subscription business model works. So there’s some unusual sort of one-time headwinds to Q1 that unwind themselves fairly quickly. And Q1 is the trough and we will accelerate out of there, but it’s definitely related to the buildup of recognized revenue as we progress. So that – I hope that helps you understand a little bit more how Q1 works. Yes, there are some additional little details like Q1 is one day shorter this year, year-over-year. So it’s actually one less day of revenue in the quarter and it’s three days shorter than quarter-over-quarter. But those other things I talked about are much more important for understanding the Q1 guide and how it unwind as the year progresses. Make sense.
Joe Vruwink: It does. It does. Thank you. And if I can squeeze in one more. Just as you engage with your customers and they come back and you’re booking new business. But as they talked to you about the composition of what they see going forward and their view on how a non-res construction cycle might develop. What are you hearing in terms of similarities? The cycle is going to be like, out of 2008, 2009, out of 2001, 2002 or what are some of the differences that you’re hearing? And how did those similarities or differences impact Autodesk just given how your product portfolio has changed?
Andrew Anagnost: Yes. So remember, first off that we are distributed across almost all facets of the industry, and it’s important to realize that when one wobbles, another one pops up. And we’re absolutely seeing that pattern. So for instance, you see in commercial real estate development, you see a slowing of projects. You actually do see a rebooting of project that had been put on hold by the pandemic, but you see a slowing of new projects. But you see other new projects coming in the pipeline in terms of urban multi-family housing, suburban multi-family housing, other types of commercial real estate outside of dense urban areas. So we’re hearing a lot from customers about a shift in where their portfolios are moving to. One thing we are getting consistently though, is an ongoing focus on adopting certain aspects of our cloud portfolio, particularly, what we do with Autodesk Build collaborations. The collaboration tools for Revit models. We’re seeing a lot of increased adoption in that, we saw a lot of strength last year. We’re seeing some of that strength heading in. I think that’s going to be an important part of our portfolio moving forward, because not only does it allow for a seamless remote work, but it also allows for better downstream integration to the rest of the build process. So we’re seeing a lot of those tools being adopted, and we’re also seeing a lot more adoption of some of the cloud-based tools that we’re seeing in manufacturing. So the cloud is definitely front and center in terms of some of the growth areas in our portfolio, but do not underestimate BIM and the role of Revit in the digitization of AEC, it will continue to be a strong driver in the new world order, but it’s uneven. It cuts very across geographies, across segments. You definitely see differences in terms of where people are going to seeing things booting up and where they see things slowing down. But like every cycle we’ve ever seen, the money just shifts to somewhere else.
Joe Vruwink: Thank you.
Operator: Our next question comes from the line of Matt Hedberg from RBC Capital Markets. You may begin.
Matt Hedberg: Hi, guys, thanks for taking my questions, and that was really good color on Q1. I think that makes a ton of sense. And also my congrats to Debbie, it’s really good to see you back at Autodesk. I guess, Andrew now that we’re sort of unwinding uncertainty, I think that’s a term you’ve used before. When we think of the trajectory to 2023, I mean, I just would kind of like to get me to some high level thoughts there. And I guess even more so, beyond 2023, what’s the right way to think about that as we enter this new fiscal year.
Andrew Anagnost: Yes. So thank you for this question, right. And it’s an important question. So first off, I want to make sure that I just reiterate something I’ve said many times before. We model our business with super high fidelity, okay. And within those models, we never put forward our best case, right. We always had a buffer in there at some degree, buffers are great for like pandemic years. You love it when you have a buffer. Now, of course, as you get closer to events like FY2023 and things associated with that. The buffer gets smaller, but the accuracy of your model also gets better as well? So we have super – we have a lot of confidence in the buildup to FY2023, the $2.4 billion in free cash flow, the organic metrics surrounding our business and we also have a lot of confidence in the double-digit growth as we had beyond fiscal 2023. Fiscal 2023, isn’t some event, it’s just another milepost like fiscal 2020 was fiscal 2023 is. It’s another milepost on a journey, but there is ongoing growth in the double digit range out beyond fiscal 2023. Now I think one of the things people anchor on right now is what about this buildup from 2022 to 2023? One of the things I want to remind you is about the nature of how momentum is going to be exiting 2022. Remember, we’re going to be slightly more backend loaded in terms of the accumulation of revenue in new business heading into fiscal 2023, not dramatically backend loaded, but more backend loaded than we were traditionally be. We’re going to exit 2023 with quite a bit more momentum than the full year targets would indicate, all right, relatively speaking in terms of those outcomes. So we feel pretty confident with the momentum we’ll exit FY2023 with, and that we have the book of business from the renewal base, from the continuing digitization of AEC, from the continuing convergence of design and make and manufacturing, and to the conversion of non-compliant users to hit the numbers that we have in FY2023 and beyond. And we were confident in our models, we’re confident in the margin of error. We’re confident in the levers we can pull if we had to pull any. So we see line of sight to some of the organic goals that we’ve been talking about, and we continue to be confident even with what seems to be a big buildup from 2022 to 2023, you just have to pay attention to the momentum we have as we exit the full year 2022 into 2023.
Matt Hedberg: Super helpful, very clear. Thanks, Andrew.
Andrew Anagnost: No different than that 2019 to 2020 discussion that we had. I think like yesterday, but it was three years ago.
Matt Hedberg: It does. Thank you.
Operator: Our next question will come from the line of Keith Weiss from Morgan Stanley. You may begin.
Keith Weiss: [indiscernible] questions, I wanted to dig into the recovery. So our survey work shows expectations are getting a little bit pushed out from the kind of first half of 2022 to the next quarter end. We’ve heard from you and your peers on a slow recovery. So kind of what are you hearing from customers and what do they need to see in order to pick up the pace of recovery? And also where are the areas that you see there could be some risks that it could get further delayed. Thank you.
Andrew Anagnost: Yes. So first off, our customers have to invest ahead of their project load in order to be successful. Remember our tools show up not only in the execution phase and the make phase, but also very early in the early conceptual design phases. And one of the big areas of strength that we saw in Q4 was that large increase in enterprise business agreements. We see the record number of EBAs we saw is kind of an emblematic of customers investing in future digitalization capacity. So we expect to see that regardless of the situation in the markets right now. But our view continues to be Q1 the trough, the acceleration starts to come out of Q1, as we head out of the spring and into the summer. Right now there’s lots of uncertainty and you hear lots of buzz around variants and vaccine distributions. But I think all of us are smart enough to know that just like when we have these discussions about testing infrastructure and testing rollout and testing capacity, all these things work themselves out over a multi-month period in terms of distribution of vaccines, distribution of assignment of capacity and all the things associated with that. Now, if all of that stuff starts to crumble and fumble, of course, you end up in a new situation, but that is highly unlikely in this situation. And there’s much more alignment on trying to get the right things done. And that’s what we’re hearing from our customers more and more is they’re trying to invest ahead of the growth they see coming forward. So we’re pretty bullish as we head into the second half of the year and we’re pretty optimistic as we head into the summer. There’s always something that can derail this, a wobble in the vaccine distribution or something associated with that or some kind of rise of political uncertainty. But you know what, we can’t predict those things. And we don’t see those things. And what we see mostly are tailwinds right now, as we head out of Q1 and into Q2 and beyond.
Keith Weiss: Great. That’s super helpful. And then just to sneak one more in, your comments on the areas investment were certainly helpful. But just taking a step back, the Innovyze deal was one of the largest acquisitions to date. I believe it was above PlanGrid. So how should we just think about the kind of higher level framework for investing organically in R&D versus kind of the acquisitions as a source of innovation? Thank you.
Andrew Anagnost: Yes. So we tend to invest organically in innovations that either we’ve been invested – that we’ve been working on for a period of time, that it represents net new business opportunities that we will acquire to net new business opportunities where there’s like, no mature market yet. But we will tend to acquire in areas where we’re seeing long-term opportunities or opportunities for enhanced digitization or enhanced cloud capability in verticals where we might not have established vertical – businesses or sub verticals where we might not have established businesses. But make no bones about it. Our organic investment is very much driven on this convergence of design and make in both AEC and manufacturing. And on this convergence of manufacturing and construction across our industries, we’ve got a lot of organic focus and the innovation in those areas. We will acquire inorganically for innovation in certain cloud-based areas, but more likely, we’ll acquire for vertical specialization in areas where established businesses have created a presence.
Keith Weiss: Great. Thank you so much.
Operator: Thank you.
Andrew Anagnost: And I think Innovyze is indicative to that.
Operator: Unfortunately, that’s all the time we have for questions today. I’d like to turn the call back over to the speakers for any closing remarks.
Simon Mays-Smith: Thank you everyone for joining us. I know it’s a busy night for many of you. Look forward to catching up with you next quarter’s results. If you have any questions in the meantime, please contact us, simon.mays-smith@autodesk.com, look forward to chatting soon.
Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by, and welcome to the Autodesk Fourth Quarter and Full Year 2021 Results Conference Call. [Operator Instructions] I would now like to hand the conference to your speaker today, Simon Mays-Smith, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter of fiscal year 2021. On the line with me is Andrew Anagnost, our CEO; Stephen Hope, Vice President and Chief Accounting Officer, and Abhey Lamba, our Vice President of Go-to-Market Finance. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, and strategies. These statements reflect our best judgment based on our currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numerical growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our investor relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. I hope you and your families remain safe and healthy. Before jumping into our fourth quarter and full-year results, I would like to again thank our employees and the families and communities that support them as well as our partners and customers, for their continued commitment during uncertain times. That commitment, combined with our resilient subscription business model and the secular shift to the cloud, enabled us to maintain momentum and exceed our goals. We generated strong growth, with full-year subscription revenue and remaining performance obligations or RPO up 26% and 19%, respectively. We also made significant progress toward digitizing AEC, converging design and make in manufacturing and converting non-compliant and legacy users. We signed a record number of new enterprise business agreements, or EBAs, in the fourth quarter. In fact, they were equal to the number we signed in the entirety of the previous year. That’s a testament both to our execution and growing partnership with our enterprise customers as we enable their digital transformations, demonstrated by enterprise BIM 360 usage nearly doubling year-over-year. While we made great strides this year, we intend to extend our leadership in the cloud and expand our presence in existing and adjacent industry verticals across the globe. The pending acquisition of Innovyze, which we announced yesterday and is expected to close later this quarter, is a great example of that intent. Innovyze is a global leader in water infrastructure simulation and modeling, serving many of the world’s largest utilities, the majority of the top ENR design firms, and other leading environmental and engineering consultancies. Innovyze enables water distribution networks and drainage systems to be more cost-effectively and sustainably designed and operated. Combined with CIVIL 3D, InfraWorks, Revit and Autodesk Construction Cloud, we would be able to provide end-to-end water and wastewater solutions across planning, design, construction and operations. With our existing capabilities in road and rail, and our partnership with Aurigo in capital planning, we now have end-to-end infrastructure solutions for facility owners and public sector agencies. Autodesk provides Innovyze with multiple opportunities to scale through enterprise, channel sales, and geographic expansion. We also intend to apply our expertise in navigating through a business model transition to drive additional growth in fiscal 2024 and beyond. I’m excited about the opportunities ahead, and look to the future with optimism. In the near-term, we expect the unwinding of uncertainty from vaccine availability and political stability to drive confidence and investment over the second half of the year. Over the long-term, Autodesk’s purpose to drive efficiency and sustainability has never been more relevant or urgent. In partnership with our customers, we have an unmatched capacity to drive efficiency and meet the global challenges of carbon emissions, embedded carbon, water scarcity and waste. And Autodesk is playing its part. We are on track to meet our commitment to be climate neutral and remain dedicated to being a resilient, diverse, and equitable company. We were most recently recognized by Barron’s as number four on their list of the world’s 100 most sustainable companies, and the highest-ranked software company. We are proud of our impact at Autodesk, and through our customers the impact we are making in the wider world. I’m also thrilled to announce two strong additions to my team. Debbie Clifford will be returning to Autodesk as Chief Financial Officer and Raji Arasu will be joining as Chief Technology Officer. Debbie is currently Chief Financial Officer at SurveyMonkey but spent the 13 years prior to that role in various financial leadership roles at Autodesk, including leading the internal business model transition team, engaging with many of you in support of our investor outreach, and as my finance business partner before I became CEO. With her leadership skills, expertise and passion for our mission, Autodesk’s finance team will not miss a beat. Raji joins us from Intuit, where she currently serves as Senior Vice President of their Platform and Services business. Prior to that, she was CTO for eBay subsidiary StubHub. At Autodesk, she will oversee and be responsible for the Autodesk’s technology and platform strategy, as well as being operationally responsible for the on-going development of our platform services. Raji will replace current Autodesk CTO Scott Borduin, who announced his intent to retire last year after more than 21 years of service to the company. Scott had two tours as Autodesk CEO, the prior one working for Carol Bartz and has not only contributed to the rise of Inventor and Fusion to the products they are today, but also as a passionate evangelist for Autodesk and our vision. Emblematic of his dedication to Autodesk, he moved out his retirement date so that he can help Raji during her transition into Autodesk. I’d like to give Scott a heartfelt thank you for all he’s done and is continuing to do. Before I provide insights into our strategic growth drivers, let me take you through the details of our quarterly and full-year performance, and the guidance for the next year. In an extraordinary year, we performed strongly across all metrics, perhaps best encapsulated by the sum of our revenue growth and free cash flow margin for the year equaling 51%. Several factors contributed to that strength in the fourth quarter, including, record EBAs, robust subscription renewal rates, accelerating digital sales, and continued sequential growth in new business. Total revenue growth in the quarter was 16%, both as reported and in constant currency, with subscription revenue growing by 22% and now representing approximately 91% of total revenue. There was approximately 2 percentage points of benefit to subscription and maintenance growth from upfront revenue recognition of some products that do not incorporate substantial cloud services. Looking at revenue by product and geography. AutoCAD and LT revenue grew 11% in the fourth quarter, and 16% for the year. AEC grew 18% in Q4, and 20% for the year. Manufacturing rose 17% in Q4, and 10% for the year. Even excluding the benefit from a strong performance in automotive EBAs, which include non-ratable VRED revenue, manufacturing grew double digits in the quarter. M&E grew 14% in the quarter, boosted by a strong performance from our collaboration platform, Shotgun, and was up 10% for the year. Geographically, revenue growth ticked up in all regions. Revenue grew 14% in the Americas, 13% in EMEA, and 23% in APAC during the quarter. We also saw strength in direct revenue, which rose 28% versus last year, and represented 34% of our total sales, up 3 percentage points from the fourth quarter of last year. The strength in our direct business was driven by some non-ratable products included in a few large EBAs and digital sales. During the year, we grew total subscriptions by 8% to 5.3 million. Excluding the multi-user trade-in program, total subscriptions grew 4% to 5.1 million. Subscription plan subscriptions grew 15%, and by 10% excluding the multi-user trade-in program. We added 130,000 make subscriptions due to the strong adoption of our BIM 360 family and Fusion 360 products. During Q4, our maintenance conversion and renewal rates declined sequentially, which was expected as we are entering the final stages of our maintenance-to-subscription program. With only one quarter left before this program retires, we have approximately 126,000 maintenance subscriptions remaining, accounting for approximately 3% of our revenue in the fourth quarter. I am proud to share that we have converted over 1.3 million maintenance subscriptions to date. At the end of the fourth quarter, the lion’s share of our commercial subscriptions were named users benefiting from easier access, usage data visibility and secure license management. We anticipate many of our remaining multi-user subscribers will make the transition to named users as the pandemic recedes, and we are now extending our 2:1 multi-user trade-in to August 2023 to enable that. As announced last November, we are also exploring consumption-based models to meet the needs of customers requiring flexible license usage. Our net revenue retention rate remained within the 100 to 110 percentage range we laid out in our guidance. Our product subscription renewal rates remained robust, reinforcing the business-critical nature of our products to our customers. Our billings were broadly level with last year, reflecting fewer multi-year sales, and our long-term deferred revenue was 26% of total deferred revenue in Q4. Our total RPO of $4.2 billion is up 19%, and our current RPO of $2.7 billion grew 16%. On margins, we continue to realize good operating leverage due to strong revenue growth and diligent expense management. For the full year, non-GAAP gross margins remained very strong at 93%, up 1 percentage point from last year, our non-GAAP operating margin increased by 5 percentage points to 29%. As you have seen in our press release, our GAAP results include a $679 million deferred tax asset valuation allowance released in the fourth quarter. This largely reflects the completion of our business model transition and the significant growth in our profitability. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash to offset dilution from our equity plans. During the fourth quarter, we purchased 530,000 shares for $157 million at an average price of approximately $295 per share. For the full year, we purchased 2.6 million shares for $549 million at an average price of approximately $208 per share. Now let me turn to our guidance, which does not include Innovyze. We expect an improving macro-economic environment during the year will result in accelerating growth in new business over the course of fiscal 2022. Usage trends during the fourth quarter remained above pre-COVID levels in most of Asia Pacific and Continental Europe and below pre-COVID levels in the U.S. and UK. We have seen an uptick in interest for multi-year deals, growing optimism in the channel, and gradual recovery in bid activity on BuildingConnected in the U.S. We expect product subscription renewal rates to continue to be very healthy, and our net revenue retention rate to remain between 100% and 110%. Given our subscription model, revenue growth will lag the improving sales environment. For fiscal 2022, we expect revenue to grow by 13% to 15%, margins to expand to between 31% and 32%, and free cash flow growth to reaccelerate to approximately 20%. When looking at the quarterization of free cash flow for fiscal 2022, we expect about three quarters of our free cash flow to again be generated in the second half of the year due to our macro-economic phasing assumptions and normal seasonality. As we noted last quarter, Vault revenue is becoming ratable for fiscal 2022 with the release of significant new mobile functionality in the first quarter, and this will reduce our revenue growth by about a percentage point over the year with the biggest impact in other revenue on the P&L and in the manufacturing product family. Looking at our guidance for the first quarter, normal seasonality is compounded by Vault ratability and one fewer calendar day versus Q1 fiscal 2021, which together reduces year-on-year revenue growth in the first quarter by about 2 percentage points. With improving macro-economic conditions and easing comparables, we expect our revenue growth to accelerate after the first quarter. The slide deck on our website has more details on modeling assumptions for the fiscal first quarter and full year 2022. We expect Innovyze to be accretive to revenue growth, broadly neutral to free cash flow and a headwind on reported operating margins in fiscal 2022 and 2023. We will provide additional details after the Innovyze transaction completes. Let me finish by giving you some details on the progress we made executing on our strategy to digitize AEC, converge design and make in manufacturing, and monetize non-compliant and legacy users. Earlier in February, we launched our Autodesk Construction Cloud platform, which unifies our organic and acquired AEC cloud offerings, and the data held within them, to enable a connected project ecosystem across design and construction. Underpinning the Autodesk Construction Cloud is our common data environment, Autodesk Docs; this provides seamless navigation, integrated workflows and project controls, and enables a single source of truth across the project lifecycle. Autodesk Build brings together the best of PlanGrid and BIM 360 with new functionality which, along with Autodesk Quantify and BIM Collaborate, creates a comprehensive suite of field construction and project management solutions. For our design customers, BIM Collaborate Pro extends the capabilities of BIM 360 Design on the new platform to create a more seamless exchange of project data between design and construction. Our strategy is to combine organic and acquired software in existing and adjacent verticals to create end-to-end, cloud-based solutions for our customers that drive efficiency and sustainability. We have pursued that strategy to create Autodesk Construction Cloud, we are pursuing that strategy in infrastructure with the acquisition of Innovyze, and we will continue to pursue that strategy in manufacturing. The reasons for, and benefits of this strategy, were clearly demonstrated in our fourth quarter results. Our growing partnership with our enterprise customers, as we enable their digital transformations, resulted both in a record number of new EBAs in the fourth quarter; and also strong expansion and renewal rates with existing EBA customers. We are seeing our new products, typically used by contractors, being increasingly adopted by design firms. For example, we expanded our agreement with Jacobs, the world’s largest design firm, to include Pype, PlanGrid, and Assemble to enable greater collaboration and more efficient workflows. Autodesk has been a trusted partner of Jacobs over the last 30 years, aligned with its mission to challenge today and reinvent tomorrow. Jacobs is also using Autodesk’s transformative services to help them deliver innovative solutions to their customers. For example, Autodesk and Jacobs partnered to deliver the world’s first generatively designed airport in Australia and, together, we are focused on leveraging generative design to solve other client challenges around the world. Environmental Air Systems, EAS, a full-service mechanical contractor and custom-built HVAC equipment manufacturer which is on the forefront of industrialized construction, increased its investment with Autodesk by replacing its existing project management tool with BIM 360. It is now able to leverage its existing investment in AEC Collections, and provide a comprehensive tool for its teams to collaborate and to connect the office and the field. And Tyréns, a leading sustainable urban development consultancy in Sweden, significantly expanded its strategic platform partnership with Autodesk. As Per Bjälnes, Tyréns Digital Strategy Manager for Business Area X, said, “Tyréns is at the leading edge of the digital transformation of the construction and maintenance industry. Digitalization enables smart building design, but requires secure data flows and seamless collaboration across a broad ecosystem of stakeholders during the construction and operations process. Autodesk’s Revit and BIM 360 Docs empowered us to create true digital representations, and now with Autodesk Forge we can leverage those assets as digital twins to create value for different stakeholders, such as a reduction of energy consumption, the prediction and optimization of maintenance, and new smart seamless end user services.\" We are also seeing benefits from our strategy in manufacturing. In the automotive sector, we now provide design software through our enterprise agreements to nearly all the largest global Automotive OEMs, and are extending our footprint beyond design into the factory. For example, our expanded partnership with Rivian, a global provider of electric adventure vehicles, now extends across facilities with Revit, BIM360, and PlanGrid; manufacturing with Inventor and generative design; and in the design studio with Alias, VRED, and Shotgun. We are able to support Rivian as it converts existing facilities to digital twins, optimizes its factory layout using generative design, improves energy efficiency through simulation, and enables collaboration and efficiency using a common data environment. Similarly, we are providing end-to-end support to our long-term customer, Transmashholding, TMH, which is the largest manufacturer of rolling stock and rail equipment in Russia and CIS, to accelerate its digital transformation and converge its design and make processes. TMH now builds trains in concept in Alias, designs and engineers in Inventor, optimizes in Fusion, produces in Powermill, and sells in VRED. Our market-leading cloud-based platform, Fusion 360, enjoyed another quarter of accelerating subscriptions, growing scale of deployments, and adding competitive displacements, ending the quarter with over 140,000 commercial subscriptions. Conturo Protoptyping, a machine shop based in Pittsburgh, recently expanded its relationship with Autodesk by adding more Fusion seats. Conturo is also adopting our recently launched machining extension, due to its integrated Design and CAM workflows, its advanced manufacturing capability, and the potential of generative design to reduce project timelines and solve design-for-manufacturing issues faster than ever before. In education, we continue to expand our footprint and replace traditional CAD competitors. With Tinkercad and Fusion 360 alone, Autodesk is now approaching 40 million education users worldwide. For example, all of University College London’s Mechanical Engineers switched to Fusion 360 during the fourth quarter. As Professor Tim Baker, MBE, who led the transition, said: “Covid-19 accelerated UCL’s transition to the cloud. By enabling collaborative, multi-disciplinary engineering, Fusion 360’s next-generation platform equips our graduates to become the world’s leading engineers of the future.” While all our software remains free for educators and students, graduates continue to bring Fusion 360 with them into the workplace, from startups through to the giants of manufacturing. While we have moderated our license compliance activity during the pandemic, we continue to work with existing and potential customers to ensure they pay for the software they use and comply with our terms of use. Our goal remains to give non-compliant and legacy users access to the benefits of subscription access through flexible models. During the quarter, we closed 23 deals over $500,000 dollars with our license compliance initiatives, 3 of which were over a $1 million. For example, a European customer became aware during its transition to named users that its employees were accessing licenses in regions outside of the contract scope. Our premium plan provided them with the flexibility to manage all licenses centrally, monitor usage to remain in compliance, and resulted in a $1 million-plus deal. And a leading supplier of industrial automation solutions based in Europe, who became a legacy customer 3 years ago, subscribed to our Product Design and Manufacturing Collection when we were able to demonstrate that recent workflow improvements and cloud enabled functionality would allow them to win more business by improving communication with their own customers, and improved efficiency through quicker layout in 2D and handover to 3D and visualization. In closing, we continue to build a stronger Autodesk for the long term. Our early and sustained organic and strategic investment in critical capabilities like cloud computing and cloud-based collaboration, combined with a successful transition to a SaaS business model, give us significant competitive advantages and confidence to grow in the double-digit range in the foreseeable future. We expect to have accelerating momentum during fiscal 2022 and we have multiple drivers that make us confident in our fiscal 2023 free cash flow target of $2.4 billion and double-digit growth thereafter. With that, Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia from Barclays. You may begin."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Thanks, Andrew for taking my questions here and congrats on the new additions to the team."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you."
},
{
"speaker": "Saket Kalia",
"text": "Maybe just to start you touched on this a little bit in your prepared remarks, Andrew, but can you just talk a little bit about how you’re thinking about new business recovery this year and maybe just broad brush, what verticals or GEOs might be stronger than others?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Thank you, Saket. I think that’s a really appropriate question to open up with. As you know, new business was down last year and that has a disproportionate impact on how we see revenue in Q1, but the way we look at it shaping up this year is Q1 is kind of the trough of the new business recovery. And we’re going to be accelerating our new business growth out through the year into the second half of the year. In fact, we really see a world where most of the new business that didn’t show up last year, kind of reemerges as we head through this year. So it’s important to see that business that disappeared last year didn’t disappear. It just got shifted out. In fact, you’re hearing a lot about the acceleration of digitization in multiple industries, and we’re seeing that in our space in spades as well. And I think if we look at particular sectors, it’s actually really going to be distributed across all the sectors and kind of similar ways. AEC is already investing really significantly ahead of the market in terms of their digitization efforts. You kind of saw early evidence of that with the EBA business we did. The record number EBAs we did in Q4 relative to previous years. In manufacturing, you kind of see the same accelerated interest in digitalization and new cloud-based workflows, especially surrounding what we’re seeing in fusion. The same goes in media entertainment. The media entertainment business, which was classically a laggard on some of these highly digital, highly cloud integrated workflows is moving to the cloud in a big way. Now, geographically kind of in a broad-brush, I kind of highlighted in the opening remarks that, we saw a broad recovery in Europe and Asia to pre-COVID levels of monthly active usage. And we saw a little bit of a lag in the U.S. and the UK. I think we’re going to see that kind of geographic fraternity new business in that cascade. It’s going to be strong in APAC. It’s going to get strong in Europe, and then it’s going to start to come back in the U.S. and the UK. Q1 will be the trough of this new business growth, and we’re going to accelerate right out of that into the rest of the year."
},
{
"speaker": "Saket Kalia",
"text": "Got it. That’s really helpful. Maybe for a follow-up, understanding that Innovyze hasn’t closed, it isn’t included in guidance. Can you just give us some broad brushes on maybe how big that revenue scale there is, and maybe just touch on whether there are any significant differences in the business model versus Autodesk?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Differences in opportunities, Saket, so first off, let’s just kind of just level set on why we did Innovyze. I think we’ve been super clear that infrastructure is one of these really big growth opportunities for us long-term. Infrastructure projects take a long time to design and plan, and they last even longer after that. So an investment in infrastructure is an investment in the long-term health of Autodesk. And I think we just have to be super clear about that. Water was one of those areas where it would have taken us all a lot of time to catch up organically, whereas road and rail is an area we’ve been highlighting to you that we’ve been investing in organically with our portfolio and really making great strides there. When you look at the business at a high level, in terms of the differences and where the revenue is going to come from. So look, at a high level, Innovyze is going to be accretive to our revenue growth, roughly to a percentage point, as we head into this year that includes deferred revenue write-offs and the fact that we have a partial year in here, it’s probably going to be dilutive this year about a percentage point off of operating margin. But here’s the opportunity that I want to make sure you highlight. You actually poked out a little bit between the differences in our business model. Not only are we going to plug Innovyze into our sales engine, in terms of named accounts, channel sales and international expansion. We’re also going to apply our expertise on business model transformation to the Innovyze product portfolio. And I think that’s going to be an important transitional element of how we absorb Innovyze into the company. We’re good at this. We know how to do this, and we know how to navigate this. So what you’re going to see in FY 2023 is you’ll probably see a little bit of a depression of Innovyze’s revenue growth in isolation, because we’re going to be applying the business model transformation. And as you know, with the business model transformation, there’s downward pressure in revenue as a result, but acceleration of revenue as you head out onto the other side of the business model transformation. So if we look at FY 2023, it’s probably going to be neutral to the overall revenue growth of the company. It’s not going to touch the free cash flow number $2.4 billion is going to come out Innovyze or no Innovyze. And they’ll probably be a little bit more of a headwind operating margin, maybe between 1% and 2% as we go through the business model transformation, but a nice acceleration up to our double-digit growth standards as we head beyond FY 2023 to 2024, 2025 and 2026, which is kind of an extra bonus on top of what we’re going to be able to do, just to expand the core Innovyze water business, to capitalize on the increasing investment in infrastructure. So it’s a good question to talk about the differences in our business model, because there’s actually an opportunity there and a difference."
},
{
"speaker": "Saket Kalia",
"text": "Very helpful, Andrew. Thanks again and congrats on the new additions to the team."
},
{
"speaker": "Operator",
"text": "Our next question comes from line of Phil Winslow from Wells Fargo. You may begin."
},
{
"speaker": "Phil Winslow",
"text": "Great. I thank everyone for taking my question and then congrats on a strong close to the year. And once again, congratulations on the new hires in particular. Great to have Debbie back. Really want to focus on the mix side of Autodesk. How do you think about it in a reopening scenario and given the fact that we have a lot of backlog of projects, particularly in the construction and infrastructure world you’re heading into this year, what is the opportunity for Autodesk to potentially accelerate adoption of some of the main functions, BuildingConnected, PlanGrid to try to help the industry work through this backlog?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we actually started to see the early signs of that as we headed into Q4 as new business, starting to strengthen in our construction portfolio in particular. And we also saw it across the Fusion base, as well as people started to look at their manufacturing and the design to manufacturing operations. So we see a pretty significant opportunity here. Look in many ways, the pandemic gave us an opportunity to catch up and pull ahead a little bit here. Our portfolio is now best-in-class. Our development team did an incredible heavy lift and an amazing job unifying what was the best of PlanGrid, which with the best of what we had in BIM 360, we now have Autodesk Build on this foundation of Autodesk Docs. And there is no one that has a better office to trailer solution than we do. And I think if you go out there and you talk to customers and you talk to this space and they look at what we’ve done with Autodesk Build, you’re going to hear the same kind of feedback that we really built a great product, and that’s the product we’re going to be leading with on new business. It’s not that we won’t be leading on the acquired portfolio products as we continue to sell those, but we’re going to lead with Build, and we’re going to lead with Build in many places. And that’s going to give us a chance to not only drive a successful international expansion, but also continue to lap some of our competitors in the rest of the market, especially in places like the mid-market, but another one pieces of our secret sauce heading into the year, Phil, is the flexibility we offer on business models. We meet our customers wherever they are. And I think this is super important for you to pay attention to, we sell named user subscriptions. We sell site licenses. We sell project-based licensing when they want it. We sell consumption inside of EBAs, whatever they need for whatever project they’re pursuing. We have a model for them and a product for them. And I think that important convergence between the flexibility, which by the way, costs us complexity in the backend, but it’s worth it in terms of meeting the customers where they are. When you combine that with the products, we feel really, really optimistic about how we’re going to accelerate in this year and meet some of this demand. And our customers are looking for it. They want to digitize faster. They’re starting to increase their spending. And we think we’ve got the portfolio of products and the portfolio of purchasing options that makes it work. We’re not trying to force people into one kind of business model, and then maybe try to lock them in kind of places that they don’t want to be. So we feel pretty optimistic."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer."
},
{
"speaker": "Andrew Anagnost",
"text": "No follow-up from Phil. So we didn’t get a follow-up here."
},
{
"speaker": "Operator",
"text": "Not at this time. Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities. You may begin."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, the company has quite a lot on his plate, a very broad agenda. And the question is within the context of your three overarching strategic priorities, obviously making the numbers that you guided to now for fiscal 2022. Can you talk about some of the other critical programmatic executable that you are aiming for this year? For instance, in terms of a channel in terms of delivering on the platform, going live perhaps with PPU other critical technical milestones that you might care to talk about in terms of new products like Tandem and Spacemaker and so forth. And then secondly, on the last call, you noted that within your peer group, Autodesk is the largest R&D spender, which is the case, but could you talk in a little bit more detail about how you’re allocating R&D? Maybe talk about the priorities you’ve spoken of reinvesting in the AEC? And maybe talk about some of those critical investment priorities views in the R&D?"
},
{
"speaker": "Andrew Anagnost",
"text": "All right. So there was – it’s usually a multi-party question from Jay. All right. So let’s talk about some of the programmatic pieces here. Now I don’t want to take any thunder away from this year’s AU, which is where we talk a lot about, as you probably noticed with last day, you’re going to see more of a product announcement focused AU, as we move forward. So I don’t want to take any thunder away from that. But if you look at programmatically where we’re going to be leaning into, platform enhancements that bring design and make and industries together and create commonality across many of the industries we serve are going to be a particular lever that we’re to be moving with. We just hired a new CTO with a lot of platform strategy chops that we’re going to be leveraging to integrate some deeper platform capabilities into the company. We’re also going to be looking programmatically at the named user transition program, as you know, that was kind of a bumpy program last year. The customers really didn’t appreciate us introducing that into a pandemic year, and they really want to understand what their options are with regards to flexible usage and occasional use moving forward. For so look for us to explore those kinds of capabilities as we’ve extended out, what the deadline was in that program, which still makes that program being executed faster than maintenance subscription, but probably more on a timeline that fits with what our customers can absorb. So you’ll see us kind of look at those flexible options and explore some of those things with our customers. Now, if you look specifically at how we’re allocating investment, I mean – I think you saw what we did around the A in AEC. We acquired Spacemaker. We’re integrating that team, building up capabilities around that team, particularly around integrating machine learning and cloud-based platforms into the design process in architecture and engineering. So that investment is clear, we’ve highlighted it. You’ve just seen how we’re investing in infrastructure and civil infrastructure. We’ve already talked organically about road and rail. And now we’ve also talked about water and all of this kind of builds on top of what we’re doing with Construction Cloud. I haven’t talked a lot about what we’re going to be doing with manufacturing, but here’s what I can tell you. We’re very interested in the cloud transformation in manufacturing, and I think you’ll see us lean deeply into the cloud transformation around manufacturing more. We’ve invested pretty heavily there. Our investment is large in that whole portfolio, particularly in the Fusion portfolio. I think you’ll continue to see us to invest to that area. And as we head towards AU, you’ll hear exciting things about Fusion. You’ll hear exciting things about Tandem. You’ll hear exciting things about the platform for the company. And you’ll hear exciting things about how the AEC portfolio is starting to come together in a similar way that we brought together some of the construction portfolio acquisitions that we did previously. So look for us to kind of play across all those fields. Now, in terms of the breadth of what we’re doing, I think I might’ve talked about this last time. We reverticalized the company just recently in October. So now I have someone that’s responsible for the AEC execution. Again, that’s Amy Bunszel, Scott Reese working on the execution and product design and manufacturing, and Diana Colella working in the media and entertainment space, and they are working closely with me and the rest of the team to execute on these vertical priorities while we’ve also elevated platform up to a executive staff level, reporting directly to me, which will allow us to synergize the platform efforts more tightly with those things. So we’re doing this from an operational perspective, as well as from a strategic investment perspective."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thank you, Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "And our next question comes from the line of Gal Munda from Berenberg Capital. You may begin."
},
{
"speaker": "Gal Munda",
"text": "Hey, thank you for taking my questions. So the first one, I was just like to ask you, Andrew, when you kind of look at how the year played out in terms of the multi-years there or network licenses, versus what you expected. Is it fair to say that you’re kind of ride bang in the middle to that two to one thing that you expected and you’ve just extended the program to 2023. Does that mean that you’re kind of very comfortable with the way that this program is kind of converting and you think that it’s going to remain at that level where it’s not a significant headwind to the model?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So look, our original statements about this being neutral to the model, continue to hold. So there’s no change in that expectation. I think what you saw last year, and I think this is a natural thing, like there’s two sides of the bell curve, right? There is the size of the bell curve for which two for one is like, hey, that’s a no brainer for me. I’m going to take the two for one. And there’s a size of the bell curve for which two for one requires some more thought by the customer. More thought about – okay, wait a second. My usage is greater than two for one, Autodesk, what are you going to do to allow me to be flex a little bit more an EBA is too big for me. So what you saw early on is a lot of those people on the left side of the bell curve, the 50% of people that were up for renewal last year that said, hey, this is good for me. They moved quite rapidly through that, right? The extension is for the people that require more thought about how this is going to impact their business and how they’re going to adapt if their usage is greater than the two for one that the program had. So that’s one of the reasons why we’re working on the extension also to ensure that we have the new flexible models out there for them to explore. So there’s no change in our expectations, which regards to the impact on our business. It’s going to be over in the whole period of the program neutral in terms of impact to our business. Positive long-term in terms of experience for the customers."
},
{
"speaker": "Gal Munda",
"text": "Yes. Absolutely. And then just the second as this follow-up. You mentioned that for this year, you, again, expecting kind of mid-20s long-term deferred revenue in terms of the, you said, no material contribution to free cash flow. When we look into more towards FY 2023 and then maybe even beyond that, we’re hearing this, multi-year licenses is still been very, very strong even during the pandemic. So what would be the normal rate that you kind of think about if you think maybe more longer term, not just next year and maybe the year after?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Simon, remind me what we’re reverting. So one of the things we’re doing, and I want to make sure we’re super clear on this with regards to multi-year. With multi-year our expectations that are revert solely back to the mean here. All right and not try to exceed what we’ve done historically, okay? And I just want to make sure that we understand that and we can get ourselves grounded in that simple fact. We’re reverting back to the mean behavior and yes, as we ended last fiscal year, right, we saw quite an interesting pickup in multi-year, frankly, more than we expected, all right, given that we were still in the pandemic year, but if we look at where we want to be, it’s just a reversion back to the mean. And remember that the multi-year business is attractive to both our channel partners and our customers, because our channel partners liked to collect the cash up front. And our customers like to lock in the price protection for multiple years. And if you recall, reversion to the mean historically for our maintenance business was about 30% of the business, roughly speaking. We want to stay right within that domain and we will probably stay within that domain for the foreseeable future. And that was adjusted peak, not the mean, okay, a piece to 30%, not in the middle. The mean was probably somewhere in the mid-20’s."
},
{
"speaker": "Gal Munda",
"text": "Got you. Thank you, Andrew."
},
{
"speaker": "Operator",
"text": "Our next question will come from the line of Adam Borg from Stifel. You may begin."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks for taking the question and also welcoming the new folks coming in. Maybe just a question on the net revenue retention rate. Obviously, the pandemic and speed of recovery will be the key input in the near-term. I was just curious, Andrew, if there’s any kind of initiatives you’re working on internally that can help drive net retention revenue rates back to the historical range. Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we’re hitting the ranges that we’ve set for net revenue retention. And frankly, obviously there’s two things that drive net revenue retention, renewal rates and AOV renewal, and the ability to expand into accounts, right? And so we’re working both of those sides in terms of increasing renewal rates and increasing our ability to expand in accounts with the make solutions. So when we look at net revenue retention, remember, one of the things that we saw and I think we highlighted this a lot over the last year was how strong the renewal rates lasted throughout the – through the last year and how we continued to move forward. So we actually overperformed based on our expectations on renewal rates of the business. We continue to see – we continue to expect that to accelerate. But more importantly, the net revenue retention is going to be driven by more and more people incorporating our digital portfolios, Construction Cloud, Fusion, other types of products like that and also moving to BIM in the AEC space. So look for a lot of the increases in net revenue retention to be programmatically driven by the move to BIM, the move to digitize in the cloud – in Construction Cloud and the move to transform their manufacturing processes with Fusion 360 and other solutions like that."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks again."
},
{
"speaker": "Operator",
"text": "And our next question will come from the line of Sterling Auty from JPMorgan. You may begin."
},
{
"speaker": "Sterling Auty",
"text": "Yes. Thanks. Hi, guys. Just one question from my side. In the context of the improving economy, I’m wondering what if anything you contemplated in that improvement in the business coming from the possibility of further stimulus spending from the government and in particular [Audio Dip]"
},
{
"speaker": "Andrew Anagnost",
"text": "We do not factor that in, okay. Governments move slowly, the money trickles down slowly. So we have not factored any of that into our plans and into our guides. That said, we do expect it to be an investment. You probably have heard that the American Society of Civil Engineers in the U.S. rated U.S. Infrastructure a D+. Other countries aren’t doing particularly well either. This is an area for investment and focus. And we expect to see some of that investment focus, but we haven’t factored this in."
},
{
"speaker": "Sterling Auty",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from line of Joe Vruwink from Baird. You may begin."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi, everyone. One modeling question first and then one on the business. Just when looking at the first quarter guide, I think the revenue variance in terms of variance to consensus estimates that seems explained by the couple 100 basis points you talked about. But I’m wondering in terms of the EPS variance as a bit wider. Are there some discrete investments that take place in 1Q? Is this a function of the extra day thrown into the mix? Or I guess, the question is how do you see margins progressing throughout the year and as 1Q kind of different than just the normal cadence?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So this is a really important question. So let’s talk about Q1 and the shape of the curve and what actually drives revenue in Q1. So I think I said earlier, Q1 is actually at the trough of where we expect things to be. We’re going to accelerate quite rapidly out of Q1. But what actually drives the revenue guiding Q1? The most important thing is the revenue recognition. So let’s look at last year. Last year, we did not grow a new business to the degree, we expected to. In fact, we saw declines year-over-year in our new business. The impact of those declines in new business bookings in the previous year have a disproportionately large effect on Q1, but they worked themselves out relatively quickly as you move into Q2, Q3, Q4 and beyond. So we absolutely do have a somewhat more backend loaded year than we would in a classic Autodesk year, but not extremely disagreed simply because of the hole that was created. And I think I said earlier, the new business that we lost in last year, it didn’t disappear. It’s coming back and it’s coming back with a vengeance as we head into the next year. But there’s a couple of other little factors that affect Q1 disproportionally. And I think it’s really important that we all get grounded on some of these things. So the first one is, we have a set of products that because they are not yet cloud enabled to a certain degree are recognized upfront in the revenue – in the accounting rules. They have to be. We have been working hard to ensure that all of those products are cloud enabled and that will actually force them to be recognized ratably. One of the products that is moving from upfront recognition to ratable recognition is the Vault product family. And that Vault product family was providing quite a bit of upfront revenue recognition previously. And now, as we enter Q1, it’s all going to be recognized, ratably because Vault now has a mobile client, it now has other cloud enabled features in it. So that was all of a sudden a headwind to revenue recognition in Q1, but it works itself out as the year progresses, as the relatability progresses and the buildup progresses. And this is just the way a subscription business model works. So there’s some unusual sort of one-time headwinds to Q1 that unwind themselves fairly quickly. And Q1 is the trough and we will accelerate out of there, but it’s definitely related to the buildup of recognized revenue as we progress. So that – I hope that helps you understand a little bit more how Q1 works. Yes, there are some additional little details like Q1 is one day shorter this year, year-over-year. So it’s actually one less day of revenue in the quarter and it’s three days shorter than quarter-over-quarter. But those other things I talked about are much more important for understanding the Q1 guide and how it unwind as the year progresses. Make sense."
},
{
"speaker": "Joe Vruwink",
"text": "It does. It does. Thank you. And if I can squeeze in one more. Just as you engage with your customers and they come back and you’re booking new business. But as they talked to you about the composition of what they see going forward and their view on how a non-res construction cycle might develop. What are you hearing in terms of similarities? The cycle is going to be like, out of 2008, 2009, out of 2001, 2002 or what are some of the differences that you’re hearing? And how did those similarities or differences impact Autodesk just given how your product portfolio has changed?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So remember, first off that we are distributed across almost all facets of the industry, and it’s important to realize that when one wobbles, another one pops up. And we’re absolutely seeing that pattern. So for instance, you see in commercial real estate development, you see a slowing of projects. You actually do see a rebooting of project that had been put on hold by the pandemic, but you see a slowing of new projects. But you see other new projects coming in the pipeline in terms of urban multi-family housing, suburban multi-family housing, other types of commercial real estate outside of dense urban areas. So we’re hearing a lot from customers about a shift in where their portfolios are moving to. One thing we are getting consistently though, is an ongoing focus on adopting certain aspects of our cloud portfolio, particularly, what we do with Autodesk Build collaborations. The collaboration tools for Revit models. We’re seeing a lot of increased adoption in that, we saw a lot of strength last year. We’re seeing some of that strength heading in. I think that’s going to be an important part of our portfolio moving forward, because not only does it allow for a seamless remote work, but it also allows for better downstream integration to the rest of the build process. So we’re seeing a lot of those tools being adopted, and we’re also seeing a lot more adoption of some of the cloud-based tools that we’re seeing in manufacturing. So the cloud is definitely front and center in terms of some of the growth areas in our portfolio, but do not underestimate BIM and the role of Revit in the digitization of AEC, it will continue to be a strong driver in the new world order, but it’s uneven. It cuts very across geographies, across segments. You definitely see differences in terms of where people are going to seeing things booting up and where they see things slowing down. But like every cycle we’ve ever seen, the money just shifts to somewhere else."
},
{
"speaker": "Joe Vruwink",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Matt Hedberg from RBC Capital Markets. You may begin."
},
{
"speaker": "Matt Hedberg",
"text": "Hi, guys, thanks for taking my questions, and that was really good color on Q1. I think that makes a ton of sense. And also my congrats to Debbie, it’s really good to see you back at Autodesk. I guess, Andrew now that we’re sort of unwinding uncertainty, I think that’s a term you’ve used before. When we think of the trajectory to 2023, I mean, I just would kind of like to get me to some high level thoughts there. And I guess even more so, beyond 2023, what’s the right way to think about that as we enter this new fiscal year."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So thank you for this question, right. And it’s an important question. So first off, I want to make sure that I just reiterate something I’ve said many times before. We model our business with super high fidelity, okay. And within those models, we never put forward our best case, right. We always had a buffer in there at some degree, buffers are great for like pandemic years. You love it when you have a buffer. Now, of course, as you get closer to events like FY2023 and things associated with that. The buffer gets smaller, but the accuracy of your model also gets better as well? So we have super – we have a lot of confidence in the buildup to FY2023, the $2.4 billion in free cash flow, the organic metrics surrounding our business and we also have a lot of confidence in the double-digit growth as we had beyond fiscal 2023. Fiscal 2023, isn’t some event, it’s just another milepost like fiscal 2020 was fiscal 2023 is. It’s another milepost on a journey, but there is ongoing growth in the double digit range out beyond fiscal 2023. Now I think one of the things people anchor on right now is what about this buildup from 2022 to 2023? One of the things I want to remind you is about the nature of how momentum is going to be exiting 2022. Remember, we’re going to be slightly more backend loaded in terms of the accumulation of revenue in new business heading into fiscal 2023, not dramatically backend loaded, but more backend loaded than we were traditionally be. We’re going to exit 2023 with quite a bit more momentum than the full year targets would indicate, all right, relatively speaking in terms of those outcomes. So we feel pretty confident with the momentum we’ll exit FY2023 with, and that we have the book of business from the renewal base, from the continuing digitization of AEC, from the continuing convergence of design and make and manufacturing, and to the conversion of non-compliant users to hit the numbers that we have in FY2023 and beyond. And we were confident in our models, we’re confident in the margin of error. We’re confident in the levers we can pull if we had to pull any. So we see line of sight to some of the organic goals that we’ve been talking about, and we continue to be confident even with what seems to be a big buildup from 2022 to 2023, you just have to pay attention to the momentum we have as we exit the full year 2022 into 2023."
},
{
"speaker": "Matt Hedberg",
"text": "Super helpful, very clear. Thanks, Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "No different than that 2019 to 2020 discussion that we had. I think like yesterday, but it was three years ago."
},
{
"speaker": "Matt Hedberg",
"text": "It does. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from the line of Keith Weiss from Morgan Stanley. You may begin."
},
{
"speaker": "Keith Weiss",
"text": "[indiscernible] questions, I wanted to dig into the recovery. So our survey work shows expectations are getting a little bit pushed out from the kind of first half of 2022 to the next quarter end. We’ve heard from you and your peers on a slow recovery. So kind of what are you hearing from customers and what do they need to see in order to pick up the pace of recovery? And also where are the areas that you see there could be some risks that it could get further delayed. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, our customers have to invest ahead of their project load in order to be successful. Remember our tools show up not only in the execution phase and the make phase, but also very early in the early conceptual design phases. And one of the big areas of strength that we saw in Q4 was that large increase in enterprise business agreements. We see the record number of EBAs we saw is kind of an emblematic of customers investing in future digitalization capacity. So we expect to see that regardless of the situation in the markets right now. But our view continues to be Q1 the trough, the acceleration starts to come out of Q1, as we head out of the spring and into the summer. Right now there’s lots of uncertainty and you hear lots of buzz around variants and vaccine distributions. But I think all of us are smart enough to know that just like when we have these discussions about testing infrastructure and testing rollout and testing capacity, all these things work themselves out over a multi-month period in terms of distribution of vaccines, distribution of assignment of capacity and all the things associated with that. Now, if all of that stuff starts to crumble and fumble, of course, you end up in a new situation, but that is highly unlikely in this situation. And there’s much more alignment on trying to get the right things done. And that’s what we’re hearing from our customers more and more is they’re trying to invest ahead of the growth they see coming forward. So we’re pretty bullish as we head into the second half of the year and we’re pretty optimistic as we head into the summer. There’s always something that can derail this, a wobble in the vaccine distribution or something associated with that or some kind of rise of political uncertainty. But you know what, we can’t predict those things. And we don’t see those things. And what we see mostly are tailwinds right now, as we head out of Q1 and into Q2 and beyond."
},
{
"speaker": "Keith Weiss",
"text": "Great. That’s super helpful. And then just to sneak one more in, your comments on the areas investment were certainly helpful. But just taking a step back, the Innovyze deal was one of the largest acquisitions to date. I believe it was above PlanGrid. So how should we just think about the kind of higher level framework for investing organically in R&D versus kind of the acquisitions as a source of innovation? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we tend to invest organically in innovations that either we’ve been invested – that we’ve been working on for a period of time, that it represents net new business opportunities that we will acquire to net new business opportunities where there’s like, no mature market yet. But we will tend to acquire in areas where we’re seeing long-term opportunities or opportunities for enhanced digitization or enhanced cloud capability in verticals where we might not have established vertical – businesses or sub verticals where we might not have established businesses. But make no bones about it. Our organic investment is very much driven on this convergence of design and make in both AEC and manufacturing. And on this convergence of manufacturing and construction across our industries, we’ve got a lot of organic focus and the innovation in those areas. We will acquire inorganically for innovation in certain cloud-based areas, but more likely, we’ll acquire for vertical specialization in areas where established businesses have created a presence."
},
{
"speaker": "Keith Weiss",
"text": "Great. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "And I think Innovyze is indicative to that."
},
{
"speaker": "Operator",
"text": "Unfortunately, that’s all the time we have for questions today. I’d like to turn the call back over to the speakers for any closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you everyone for joining us. I know it’s a busy night for many of you. Look forward to catching up with you next quarter’s results. If you have any questions in the meantime, please contact us, simon.mays-smith@autodesk.com, look forward to chatting soon."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 3 | 2,021 | 2020-11-25 17:00:00 | Operator: Ladies and gentlemen, thank you for standing by. And welcome to the Q3 Fiscal Year 2021 Autodesk Earnings Conference Call. At this time, all participants’ lines are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Simon Mays-Smith, Vice President of Investor Relations. Thank you. Please go ahead, sir.
Simon Mays-Smith: Thanks, Operator, and good afternoon. Thank you for joining our conference call to discuss the results of our third quarter of fiscal year ‘21. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our investor relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. First off, I hope you and your families are remaining safe and healthy. Before jumping into our third quarter results, I would like to thank again our employees and the families and communities that support them, as well as our partners and customers, for their sustained commitment during uncertain times. That commitment was reflected in our execution, and demonstrated the resilience of our business model this past quarter. Together, they enabled us to deliver strong Q3 results - with billings, revenue, earnings and free cash flow coming in above expectations, despite the volatile macro-economic conditions resulting from the pandemic. I am pleased to see the acceleration of our SaaS business model, the secular shift to the cloud underpinning it and the competitive opportunities it brings. We have many miles of opportunity ahead of us. Our enterprise customers are undertaking their own digital transformation and by enabling that transformation, we are becoming a strategic partner rather than a software vendor. These strategic partnerships are broader than in the past, with our customers expanding their Autodesk product portfolios. Our third quarter results reflect this trend, as our enterprise deal activity with large customers accelerated. We closed some of the largest transactions in the company’s history, including a nine-digit deal. I am proud of our team’s execution, which positions us well entering the fourth quarter with a strong pipeline of deals. In the third quarter, we also saw the ebb and flow of the economic impact of the pandemic. As you know, our transition to the cloud means we are able to monitor the usage patterns of our products across the globe and see the positive correlation between increasing usage levels and new business growth in those regions. China, Korea, Japan, and most of Europe saw usage levels rise above pre-COVID levels. While usage trends in the U.S. and U.K. have not yet returned to pre-COVID levels, while they have stabilized in the U.S. and grown sequentially in the U.K. In line with the usage trends, our new business remains impacted by the pandemic, but the diversity of our revenue stream and customer base is helping us deliver strong results. And as you know, Scott has decided to take on the next challenge in his career by accepting the CFO role at Cisco, starting mid-December. Scott has played a huge role in driving the business over the last six years, helping Autodesk successfully navigate the business model transition. We are sad to see him leave, but we are also excited for him. Thank you, Scott, for your many contributions to Autodesk and I wish you continued success in the next chapter of your career. Scott is leaving behind a strong team to ensure smooth operations while we look for his replacement. We have started the search process, and it is my top priority in the near-term. Now, I’d like to turn it over to Scott to take you through the details of our quarterly performance, and guidance for the year. I will then come back to provide insights into our strategic growth drivers.
Scott Herren: Thanks, Andrew. I am leaving Autodesk with mixed emotions, as I am excited about what lies ahead for me, but also sad about leaving my colleagues at Autodesk. The last six years have been the most fun and rewarding of my entire career, as we have transformed the company from a traditional license revenue model to a cloud-based recurring revenue model. That transition is now complete and I leave knowing Autodesk is well-positioned for the future with leading positions in attractive markets and accelerating momentum. Looking at the quarter’s results, several factors contributed to our outperformance across all key metrics, including, strong enterprise deal activity, healthy subscription renewal rates, digital sales, a sequential improvement in new business trends, and foreign exchange rates. Total revenue growth came in at 13% as reported, 14% in constant currency, with subscription plan revenue growing by 24% and operating margin expanding by 3 percentage points. We previously told you we extended payment terms for customers impacted by the pandemic. The normalization of payment terms, combined with improving business trends and strong cash collections in Q3, helped drive healthy free cash flow of $340 million. Current RPO, which reflects committed revenue for the next twelve months, was up 16%, a slight improvement on the rate of growth we saw in the second quarter. Total RPO was up 21%. We again benefited from the diversity of our customer base. Business softness in certain areas, like the U.S. and parts of Europe, was offset by strength in other areas. Digital sales continued to drive double-digit billings growth through our online channel, supported by accelerated growth in our cloud-based Fusion offerings. We are developing broader strategic relationships with our enterprise customers with multiyear commitments. As is typical for most enterprise agreements, the nine-digit deal Andrew mentioned is a three-year commitment billed annually and did not have a meaningful impact on our revenue or cash flow during the third quarter. The run-rate business with our partners also continued to perform well. While we are seeing the traction of our transition to the named user business model, it results in a subset of our customers optimizing their installed base by reducing the number of named user seats needed after they take advantage of our 2-for-1 trade-in program. I am pleased to report that these overall trends are in line with our expectations. As we have said in the past, in aggregate, the transition to the named user model is a revenue-neutral event for us, but enables us to offer more value to our customers, in a similar way as other SaaS providers. Our net revenue retention rate remained within the 100% to 110% range we laid out in our guidance. Our product subscription renewal rates remained strong, reinforcing the critical nature of our products to our customers. As in the prior quarter, approximately 40% of the maintenance customers who came up for renewal converted to subscriptions. Our maintenance renewal rate declined sequentially, which was expected as we are nearing the end of our maintenance program. Industry collections remained a stable share of our total business in Q3. As anticipated, multiyear payments were down year-over-year, but we saw modest sequential improvement in the share of multiyear payments across each geography as customers continue to make long-term investments in our products. And finally, during the third quarter we spent $196 million to buy back 800,000 shares at an average price of approximately $231 per share. Year-to-date, we have repurchased 2.12 million shares at an average price of approximately $186 per share, for a total spend of $393 million. Now let me turn to our guidance. We are raising the low end of our full-year revenue guidance to a range of $3.750 billion to $3.765 billion, bringing the mid-point growth rate up to 15% year-over-year. We are also raising our non-GAAP operating margin outlook to the upper end of our prior range, a 4-point improvement from last year. Our fourth quarter performance will benefit from the strength in our third quarter results, but the business environment remains uncertain given the current wave of COVID cases. We expect product subscription renewal rates to continue to be very healthy. Churn on our maintenance offering will likely accelerate as we enter the final stages of ending our maintenance offering. And we expect our net revenue retention rate to remain between 100% and 110% for the quarter. Our pipeline entering the fourth quarter is strong, but we have assumed that new business and multiyear contracts will continue to be under pressure. The narrowing of our billings and free cash flow outlook range is primarily driven by moderating assumptions around multiyear and the uncertainty presented by the current environment. It’s the testament to the strategic value of our products to our customers, and the resiliency of our model, that we are still expecting to report 15% revenue growth despite the current economic headwinds. Looking out to our fiscal year 2022, we expect an improving macro-economic environment as we exit this year will result in accelerating growth in new business over the course of fiscal ‘22. Given our subscription model, revenue growth will lag the improving sales environment. As we have said in the past, the path to fiscal ‘23 will not be linear. We expect our fiscal ‘22 revenue growth to be low- to-mid-teens and free cash flow growth to re-accelerate to approximately 20%. We are confident in our fiscal ‘23 free cash flow target of $2.4 billion, as we will benefit from improving business momentum in fiscal ‘22 that will provide a tailwind to our revenue and free cash flow growth. In fiscal ‘23, we will also benefit from the renewals of our fiscal ‘20 transactions when we restarted multiyear payments for a part of our business. Beyond fiscal ‘23, our continued investment in cloud products and a subscription business model, backed by a strong balance sheet, give us a robust foundation and platform for double-digit growth. And now, I’d like to turn it back to Andrew.
Andrew Anagnost: Thank you, Scott. Our strong performance in Q3 once again demonstrates the advantages of our diverse customer base, resiliency of our employees, the power of our SaaS offerings, and the strength of our business model. At Autodesk University last week, we hosted approximately 100,000 customers and partners, and made a series of product and partnership announcements as well as our acquisition of Spacemaker, which closed yesterday and offers industry leading functionality to architects. Spacemaker will enable us to support Design professionals much earlier in their workflow, by harnessing AI to rapidly create and evaluate options for a building or urban development. Through automated data capture, smart design, decision support, and collaboration functionality, Spacemaker enables users to quickly generate, optimize and iterate on design. It also offers a fundamental shift in how we imagine and build cities in the future, and the time needed to evaluate various possible options. I encourage you to check out the demo from last week that is available on our website. We also announced the Autodesk Construction Cloud platform, which unifies our AEC cloud offerings and the data held within them, to enable a connected project ecosystem across design and construction. Underpinning the Autodesk Construction Cloud is our common data environment, Autodesk Docs. This provides seamless navigation, integrated workflows and project controls, and enables a single source of truth across the project lifecycle. Autodesk Build, Quantify, and BIM Collaborate bring together the best of PlanGrid and BIM 360, with new functionality to create a comprehensive field construction and project management solution. For our design customers, BIM Collaborate Pro extends the capabilities of BIM 360 Design on the new platform to create a more seamless exchange of project data between design and construction. During the quarter, Morgan Sindall, a leading construction group in the U.K., committed to Autodesk as their strategic platform partner. As Lee Ramsey, Morgan Sindall’s Digital Design Director, said, quote, as I researched all the marketplace solutions, Autodesk stood out to me. Autodesk Construction Cloud provides greater integration between different roles and functions, allowing data to be shared across projects, silos to be broken, and a vast amount of efficiency to be gained, end quote. The breadth of our AEC business has underpinned its resilient performance, and enabled it to be a net beneficiary from secular and cyclical trends. Despite many construction projects being interrupted, delayed, or navigating new ways of working because of the pandemic, we are still seeing year-on-year growth across all our construction offerings. Our cloud-based products enable our customers to navigate the cycle today, and to be more efficient and sustainable for tomorrow. Our office-based solutions continued to do well while our field-based solutions improved sequentially, boosted by several competitive wins. Customers continue to choose PlanGrid to digitize their processes because it is easy to use and they only pay for what they need. This quarter, our BIM 360 products set records for both worldwide weekly average users and projects. We also continue to see adoption with our larger customers and within the infrastructure industry. During the quarter, one of the world’s leading professional services firms which serves clients in the infrastructure and building sectors increased its investment with Autodesk. We have been partnering together for over 15 years and the renewal of our enterprise business agreement enables this firm to expand its use of BIM 360 and PlanGrid in order to adapt faster to industry changes and create new markets for its services. In another instance, Japan’s largest home builder, Daiwa House Industry Co, Ltd., renewed its enterprise business agreement with us. The company is making key investments in BIM, and has selected Autodesk to be its strategic innovation partner to achieve its goals for digital transformation, design for manufacturing, and industrialized construction. The company is adopting BIM at all levels of the organization, and has made a commitment to adopt additional Autodesk products, including BIM 360 Docs and Design, and PlanGrid. We are thrilled to be working with Daiwa House at the forefront of industrialized construction. Our cloud-based platform is also propelling growth in Manufacturing by enabling the convergence of Design and Make. On the commercial side, our market-leading cloud-based platform, Fusion 360, enjoyed another quarter of accelerating subscriptions, growing scale of deployments, and adding competitive displacements, to end the quarter with over 120,000 subscriptions. At AU, we introduced several extensions to Fusion 360 that further encourage adoption and usage of the platform by adding specialist functionality. As a reminder, extensions offer expanded tools and functionality that can be added on demand to the core Fusion 360 offering. This kind of functional flexibility and cost effectiveness enhances the value of our platform for designers, engineers and manufacturers. We also announced exciting partnerships with Sandvik Coromant and Rockwell Automation. With Sandvik Coromant, a metal cutting tools and services company, we took the first steps to realize a shared, long-term vision of accelerating the automation of manufacturing processes by making tool data and manufacturing recommendations available to users of Fusion 360. With Rockwell Automation, a provider of industrial automation and information technology, we combined factory layout capabilities available in our industry collection with their factory simulation tools. Together, these solutions will help our mutual customers digitally design and commission factories in less time and with greater efficiency. This quarter we also announced the acquisition of CAMplete, a leading provider of post-processing and machine simulation solutions. CAMplete bridges the gap between CAM programming and shop floor machine tool operation. It allows manufacturers to digitally simulate and verify the machine code that drives their production equipment before running it on the shop floor. This will enable our customers to identify potential problems, in a digital environment, at the programming phase that could otherwise scrap work or damage machine tools in production. During the quarter, a large multinational defense, security and aerospace company with an extensive global supply chain chose to increase its investment with Autodesk through an enterprise business agreement. To stay at the forefront of its industry, the company is using innovative manufacturing methods to save time and money and has set a target to 3D print approximately one third of the components in its new jet. As it radically changes the way it designs and builds, the company has selected Autodesk as a key strategic partner. The adoption of our products is also driving change throughout its supply chain, which must adopt new ways of working. With Fusion 360, it now has access to our advanced manufacturing solutions to help it realize its business goals. In education, we continue to expand our footprint. Tinkercad, our fully browser-based product development platform for aspiring designers, now has over 30 million users worldwide. Fusion 360 on Chromebooks is experiencing rapid adoption at high schools and universities and is replacing entry-level, browser-based CAD/CAM with professional-grade, career-accelerating Fusion 360. For instance, the University of Illinois at Urbana-Champaign has now switched to Fusion 360 across multiple departments, including biomedical engineering, systems engineering and mechanical engineering. We are seeing early adoption of our Premium plan, with customers taking advantage of the enhanced subscription offering at renewal. Many of our multi-user customers who are transitioning to the named user model are finding great value in the Premium plan, due to its advanced user analytics, single sign-on capabilities, and enhanced support. For example, Scheuch, a leader in the field of innovative air and environment technology, decided to commit to a long-term investment in Premium this quarter, primarily due to the SSO and user management capabilities. They see Autodesk as a strategic partner as it continues to harmonize its global IT infrastructure. Let me finish by updating you on our progress monetizing non-compliant users. We continue to be sensitive to the short-term economic pressure faced by our customers, but remain optimistic about the long-term opportunity as we demonstrate the value of our cloud-based platform to our customers. For example, in China, a customer which left us to try a lower cost competitor quickly returned due to AutoCAD’s superior functionality and invested further in Autodesk by purchasing collections for the first time to focus on growth. Our efforts to educate our customers about the benefits of staying compliant with our subscriptions are yielding results, as we are able to convert them to paying users in a customer friendly manner. During the quarter, we closed eight deals over $500,000 with our license compliance team. In closing, we continue to build a stronger Autodesk for the long-term. Our early and sustained organic and strategic investment in critical capabilities like cloud computing and cloud-based collaboration, combined with a successful transition to a SaaS business model, give us significant competitive advantages and confidence to grow in the double-digit range in the foreseeable future and we have multiple drivers that make us confident in our fiscal ‘23 free cash flow target of $2.4 billion. With that, Operator, we would now like to open the call up for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from the line of Saket Kalia from Barclays Capital. Your line is now open.
Saket Kalia: Okay. Great. Hey, guys. Thanks for taking my questions here, and Scott, congratulations on the next step. You will certainly be missed.
Scott Herren: Thanks, Saket.
Saket Kalia: Hey, Andrew, maybe first for you, a lot to talk about, but one of the questions that I feel like we got a little bit, especially during the months of October and November, were what potentially higher infrastructure spending spurred by the government could mean for Autodesk? And of course, we don’t know what that looks like yet or frankly even if it will happen, but I was wondering some of what you Autodesk maybe saw during the 2009 Recovery and Reinvestment Act as perhaps a frame of reference. Does that make sense?
Andrew Anagnost: Yeah. Saket, that makes sense. First off, let me start the question by being super clear. We don’t have any kind of projections around stimulus or the impact of stimulus on our business in any of our models, right? That stuff that we leave out because one does not want to leave themselves exposed to the vagaries of government. However, if we go back to ‘08 and ‘09, and I think, it’s important to remember this, one of the narratives about Autodesk in ‘08 and ‘09 is, oh, Autodesk is so exposed to the housing market. Oh, my gosh. And the reality was that Autodesk revenue recovered well, significantly faster than the housing market did and that was because of the distributed nature of our work and our customer base and the projects and the sectors that we cover. Infrastructure spending and stimulus spending back then absolutely helped because it created a pipeline of projects that were new, but we were already recovering before some of the stimulus showed up and I think it’s important to recognize that. If you look at what the impact might be if we actually see some of this show up and we actually see some important stimulus, obviously it’s going to increase the project pipelines of our customers and that’s always good for us. And it could see more adoption of our portfolio. It could be really good for the construction portfolio. But again, Saket, I want to make it super clear, we don’t model that kind of stuff in our outlook and we are not expecting it to hit our numbers.
Scott Herren: Yeah. Saket, the only other comment that I’d add on top of that is, let’s say, an infrastructure bill does get passed. It will take some time for that bill to turn into real projects and for those projects to get put out to bid and for that then to downstream start to drive our business. So even if that were to happen, let’s say, early in the new administration, I wouldn’t expect it to of have a material impact on fiscal ‘22 anyway.
Saket Kalia: Got it. That’s super helpful. Scott, maybe for my follow-up for you. Thanks for the early fiscal ‘22 guide. That’s very helpful. I guess with 20% free cash flow growth next year and that target of $2.4 billion fiscal ‘23, it looks like that acceleration of free cash flow that we are seeing here in fiscal ‘21 is -- actually, in fiscal ‘21 and ‘22 is going to continue into ‘23. Can you just talk a little about some of the drivers that might contribute to that? You touched on this a little in the prepared comments, so I am just wondering wonder if you could double click on it once more?
Scott Herren: Yeah. Sure, Saket. And by the way, you were one of the ones that got it right, actually, as I recall looking at your preview note for what to expect on fiscal ‘22. And as you know, we have been running multiple scenarios. I have been probably run driving my team crazy, running scenarios over the last nine months and in each case we run it not just for the impact of this fiscal year and next fiscal year out through fiscal ‘23 to even fiscal ‘25 and beyond. So to have a good sense of how the model responds to a variety of different scenarios, that’s part of what underpins our confidence in fiscal ‘23. But if you step back and say, what are the drivers behind that and I will start with the biggest driver. You have seen our renewal rates stay steady through this process and in fact even modestly we saw sequential increase in renewal rates, but given the size of our renewal base, that’s a big driver longer term. And we talked about the net revenue retention rate kind of staying in that 100% to 110% range even during the pandemic. So you take a big renewal base with a high renewal rate and 100% to 110% net revenue retention rate that drives a lot of growth. Add to that what we are seeing in cloud and the cloud products acceleration overall, we still have a pretty significant opportunity to convert nonpaying users of out in front of us and we built the leading portfolio, product portfolio in construction. So there is a -- and we have talked about again today about the success of our manufacturing business and where we are headed there and some of the traction we are beginning to get with Fusion 360 and the way we are monetizing that with some of the extension. So there’s a lot behind that. That’s what drives our confidence not just in this year and some of the early view I gave you of fiscal ‘22 but then how that ramps up out through fiscal ‘23. I think there’s two other quick things I’d like to add to that. We do -- we are seeing a modest improvement in economic activity right now that Andrew talked about. Certain countries are back to pre-COVID levels, but it’s not consistent. Our expectation is that we will see continued economic improvement through next year but that that will -- I doubt it’s going to be a straight line. I think that will be more pronounced in the second half of next year, which means the year will be a bit more back-end loaded. And that linearity affects not just revenue. It also affects when we collect cash. a lot of the sales of that momentum in the second half of the year will turn into fiscal ‘23 free cash flow. And then one other item that I want to get on the call so that you can build it into your model, we do see a cash tax impact year-on-year this year to next year of about $50 million to $60 million as our profitability has improved fairly significantly. So you add all those together, that’s what underpin our confidence, the early view of fiscal ‘22 cash flow and our confidence in $22.4 billion in fiscal ‘23.
Saket Kalia: Got it. That’s very helpful. Thanks, guys.
Scott Herren: Thanks, Saket.
Operator: Thank you. Our next question comes from Matt Hedberg from RBC Capital Markets. Your line is now open.
Matt Hedberg: Hey. Great, guys. Thanks for taking my questions and congrats on these numbers in a really difficult situation. I will also offer my congrats to Scott. It’s been great working with you, obviously, we will miss you at Autodesk, but congrats and best of luck. Andrew, I wanted to ask you about the nine-figure three-year renewal deal. That is super exciting. I guess I am wondering can you give us a bit of history on how that customer has grown to this level. And then maybe the opportunity for other enterprise deals of this caliber, given your sort of extended platform these days?
Andrew Anagnost: Yeah. So we actually broke records a couple of times during this quarter, so these deals are becoming more the norm than not in our quarters. And I want to tell you what essentially underpins all of these and I think it’s important and it’s the same dynamic in all of them. Our customers look three years out. They look at what they are trying to do internally, transformationally, with digital transformation or with the transition to BIM or with the transition to the cloud with Fusion and other things associated with that. And they ask themselves, okay, what are they going to need in an EBA in order to drive and maintain that expansion without coming back and renegotiating the contract with us again. That’s what’s powering this. A strategic discussion about what are the long-term adoption requirements of these customers. So for instance, a customer might see themselves expanding more into industrialized construction and applying both Inventor and Revit more broadly in their process, and they want to make sure they plan for that or they are going to expansion of Construction Cloud deeper into their processes. So they are planning for that. They are saying, well, I am using this much Construction Cloud this year. I am going to use this much next year, the year after that, the year after that. So this is what is driving these kinds of deals, this discussion about the three-year expansion of usage of our portfolio in these accounts and it’s not just usage across users, it’s usage across breadth of portfolio. Otherwise, you couldn’t see deals of this size coming through. That’s the dynamic that plays out in almost all of these deals that we are seeing. Make sense, Matt?
Matt Hedberg: Got it. Yeah. No. That’s super helpful. And then maybe just a double click on the SaaS side. I mean, Andrew, you talk to executives every day, and I guess, I think, we are all excited about the prospects of the vaccine. On those conversations, though, in a post-COVID world, I mean, do you get a sense that you have obviously had a lot of success with 360 SaaS today, but you think we could see even a bit of a slingshot effect as part of these larger deals, as customers really, effectively raise to embrace SaaS potentially for the next pandemic at some point?
Andrew Anagnost: Yeah. I actually think, it has -- it even goes beyond pandemic. It’s like once you have got a taste of it, you want more of it. It’s what’s going on too, okay? Because remember some of these customers, they were not broadly deploying our SaaS solutions prior to pandemic and what they are seeing now is you know what, this stuff is important, I need to get on it and I need to prepare for the future and this is how I am going to drive my digitization. So we are absolutely going to see continued growth in these SaaS platforms. It’s interesting that you mentioned the vaccine and things like that, because what we are seeing when we talk to executives right now is, everybody doesn’t see a change in the timeline of how this pandemic is going to play out. But all of us, what we are seeing is increasing reductions in uncertainty. It starts with vaccine conversations and then more than one vaccine and then it goes into, hey, the U.S. election is getting less uncertain, who is going to be the president is less uncertain. So this is progressive building of uncertainty being removed and customers are getting more and more comfortable about looking at their second half investment scenarios for next year and SaaS is in every one of those conversations, okay? And I think as long as we continue on this trajectory of uncertainty being removed, you are going to see people being increasingly comfortable with how they feel about the second half of next year.
Matt Hedberg: Super helpful. Thanks, guys.
Scott Herren: Thanks for the question, Matt.
Operator: Thank you. Our next question comes from the line of Philip Winslow from Wells Fargo. Your line is now open.
Philip Winslow: Hey, guys. Thanks for taking my question and congrats on this great quarter. And Scott, obviously it’s been a great pleasure working with you, not just at Autodesk, but going back to. We will definitely miss you my friend.
Scott Herren: Thanks, Phil.
Philip Winslow: The -- I got a question for you in terms of your the AEC portfolio, obviously, very diversified in terms of the sort of the stages of call it a building from design, planning, actual construction. And so I guess, sort of a two part question here, what are you seeing in sort of that portfolio right now and into Q4, then we are thinking about next fiscal year. How are you spending sort of the ebbs and flows of that portfolio to play out?
Andrew Anagnost: Yeah. Actually, Phil, you are pushing on an important competitive differentiator for us. The breadth of capability we have across the entire AEC cycle and the way we are integrating that information in the cloud is fairly unique, right? And what we are seeing and this is something that I think you will see progressively, again and again. Right now a lot of people are talking about digital twins and that’s a vocabulary that’s out there, obviously, we haven’t used that vocabulary very often. But what’s going on right now is BIM. 3D BIM is the original digital twin, right? And this whole discussion around digital twins and AEC and things associated with it is accelerating the dialogue around if I want to do digital twins, I have got to do BIM, because there’s no digital twin without a Building Information Model. And you are going to see a continuing ongoing acceleration of the usage of BIM up front in our portfolio. But then what we have layered on top of it is a couple of critical things that make the entire portfolio more valuable. You may have noticed we emphasized this notion in the new Construction Cloud platform around a common data environment and all the things that go along with that common data environment. That common data environment is not just SaaS based. It’s also ultimately going to be ISO compliant and it’s going to allow us to move that building information data all the way through the entire process. So you are going to see more and more adoption of what’s in Autodesk Build, all the way through from the preconstruction planning cycle to the construction site and that’s a pretty powerful differentiator for us. But the one last thing I want to mention to you, and we talked about this at AU and I want to make sure you paid attention to it, was the rollout of Tandem, Autodesk Tandem. And what was Tandem? So Tandem is, if digital twins start with BIM, Tandem is a way to bring BIM data together from multiple places. From our BIM models or our BIM information, from other third parties that are building controller information perhaps, from other BIM based data from other types of applications and bring it into a single aggregated view in the cloud that updates dynamically as the building project progresses. This puts us at the forefront of bringing the power of BIM to create digital twins to the ability to create digital twins in the cloud that actually represents the final state of the project no matter where all that project data comes from. So we are pretty excited about this progression and what it means for the company and I think you are going to see a lot of interest and uptake in the approach we are taking.
Philip Winslow: That’s awesome. That’s super exciting and an equally as exciting question for Scott, long-term deferred revenue. The -- how are you thinking about that next year, obviously, the guidance for this year is hanging out at the mid-20s? But how are you sort of modeling that when you are thinking about that cash flow for next year and the year after that?
Scott Herren: Yeah. I think for next year it stays in that range, Phil. I don’t want to get into too much forecasting of fiscal ‘22 until we get to the Q4 earnings call and obviously we can give you more detail at that point. But what we are seeing this year is kind of moderating assumptions around multiyear, and of course that’s what drives a lot of that long-term deferred. And so you see the sequential trends there are long-term. It hasn’t fallen off the floor. It hasn’t fallen off the desk and onto the floor. The multiyear rates are still there. But they are not as robust as we had seen historically in maintenance. I think ultimately it returns to that level. But frankly I don’t think the moderating multiyear that we see this year, there’s a big negative in the sense that given the strength of our renewal rates we will continue to get that, collect that cash. We will just collect it in the subsequent two years instead of collecting all three years upfront and we will collect it without the 10% discount that we put in as an incentive for those multiyear transactions. So think of it settling in where it is for the foreseeable future. Ultimately, I think there’s a little room for it to run.
Philip Winslow: Awesome. Thanks, guys, and congrats again on a great quarter.
Scott Herren: Thanks, Phil.
Andrew Anagnost: Thanks.
Operator: Thank you. Our next question comes from the line of Heather Bellini from Goldman Sachs. Your line is now open.
Heather Bellini: Great. Thank you so much, and Scott, I will echo my congratulations and to you as well, Andrew, for the company’s execution in this challenging macro environment. I wanted to ask two questions. One, if you could share with us kind of, I mean, the competitive positioning in construction, given your pricing model and how you might see some of the competitors responding? So if you could spend some time on that, maybe a little bit more on the differentiation if that’s gotten even wider over the course of the pandemic? And then also, if I look at your growth in Asia-Pac, you can see that was the best region in terms of growth. How far behind do you think the Americas is from the recovery and the solid growth that you are seeing in APAC? Thank you so much.
Andrew Anagnost: All right. So let me start with the competitive positioning on the construction. You are absolutely right, Heather, that the pandemic actually gave us an opportunity to lap our competition a bit. The slowdown definitely took the wind out of certain parts of the market. However, we didn’t slow down, we continued to invest and we put quite a bit of money into rolling out the unified platform. So what you see with Autodesk Build, which is what we are going to lead with in every new deal, we are leading with Autodesk Build over and over again, and we are going to lead internationally and we are going to lead in the U.S. with this, is a comprehensive project management and field management application that goes from design all the way through to site management, site execution and layers on the analytics associated with Construction IQ and some of the predictive skills, all built on top of Autodesk Docs. So this is a pretty significant change. That platform is highly competitive. As a matter of fact, it’s differentiated in numerous ways because of its end-to-end capabilities. In terms of pricing models, here’s what’s unique about us, Heather, and I think, it’s very important to remember this. No one in the industry is more flexible with the way we deliver these applications than Autodesk. So if you want to buy named users and deploy named users, we have got named users for you. That’s our primarily deployment model for most of our applications. If you want to pay based on project turnover, you can do that. If you want to play based on usage and consumption, you can do that. This flexibility is heavily coveted by our customers, and in fact, I think, this flexibility has been part and parcel of what’s allowed us to continue to expand the usage of the Construction Cloud even during what’s happened over the last year. So I think technologically we are now competitively differentiated, because we took the pandemic as a time to double down on the platform unification and get it out there and business model-wise we are differentiated. So we are feeling in a pretty strong competitive position as we head into the recovery next year across all the various markets. We love that we have tough competition in this space. We think it’s good for us. We think it’s good for our customers. But we are feeling really good about where we are at. Now, with regard to the Americas versus APAC, right, here’s what I will say. Usage ramped up fairly quickly in Asia-Pacific and like we say earlier, it’s definitely above pre-COVID levels in a lot of places, not everywhere but in a lot of places. The U.S. in particular just seemed to have stalled, all right. Usage hasn’t fallen back. It’s ramped up a little bit as time goes on. But it’s not seeing this kind of surge. I think we should just kind of hold tight for a little while and see what the levering out of the uncertainty does right now for the usage in the U.S., all right. Between the election results, between the good news about vaccines, between the potential that people see about stimulus in their project pipeline. I think we might start to see a change. So it will be interesting what we can talk about on the next earnings call. But I think the unwinding of uncertainty matters a lot in our markets.
Heather Bellini: Thank you so much.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is now open.
Jay Vleeschhouwer: Thank you. Andrew, starting with the nine-figure deal and returning to that subject, it’s especially interesting when we consider that once upon a time $100,000 deal was a big deal for Autodesk, so you are obviously now many orders of magnitude beyond that. But the question is, to the extent that there are now as we understand additional eight-figure deals in the pipeline. How are you thinking about your license management and customer success requirements and capacities that you need to invest in and ramp up to support what is obviously going to be a larger propensity for these kinds of deployments? And then returning to AU for a moment, you made some interesting remarks last week, having to do with some additional new possible opportunities for the company in manufacturing software, supply chain, even smart products you alluded to. Maybe talk about how seriously you mean to pursue those new things? And then for Scott, first, thank you for the last 25 quarters, and as you are going away question or a multi-part question, Andrew, earlier parsed the usage data by Geo. Could you do the same thing by perhaps standalone versus collections and perhaps even by vertical in terms of what you are seeing in the usage telemetry there?
Andrew Anagnost: Right. So it’s a classic Jay multipart question. All right. So, Jay, let me start with the license management piece. This is something we take particularly seriously and I am really glad you asked about it, because licensed management, the ability to manage these licenses is actually a value-add to our customers. They want to manage this investment in Autodesk assets as an enterprise asset, all right. And it’s super important in this space that we do this. One of the reasons we have been moving so quickly to retire legacy models in our user base is because that actually holds us back from delivering best-in-class license management for our customers. Every customer, every maintenance license that’s still out there, every multiuser license that’s still based on the old desktop paradigm versus what we want to do in the cloud paradigm is holding us back from deploying the systems in a way that help our customers manage these things holistically. The good news is that our EBA customers get a totally different dashboard on how they use our software and they are able to get more per user usage analytics and more data in terms of understanding their customer base. But this investment in the sheet of glass that our customers look through in terms of managing their relationship with Autodesk is something we have been doing ongoing for years and look for it to accelerate as we retire the last of these legacy business models and start unifying everything on a stack that really provides a high level of control to our customers and a high level of fidelity about what their actual usage is. We believe this is a value add of the portfolio and you will see us continue to invest in this. Now with manufacturing investments, I think, you want to just pay attention to what we are doing with Fusion and the areas we are targeting, because we think these are important areas that we want to pay attention to. We have integrated certain types of technology into Fusion. We want to augment and supplement and extend those so that Fusion is a professional grade solution surrounded by other professional grade solution that tackles significant growth markets inside the manufacturing vertical. Our first angle of attack was in the convergence of design and make and merging advanced manufacturing methods with advanced modeling methods. I think you are going to see us attack the convergence of mechanical engineering and electrical components inside designs. We have already started doing some of that things and we are going to do it in uniquely cloud way. We are going to do it with uniquely underpinnings of cloud compute and we are going to do it in highly differentiated ways, but also in ways that respect some of the tools our customers are using today.
Scott Herren: And Jay, I will jump in on the second part and I guess. Thank you for the congratulations on my 25th Autodesk earnings call. If I get this right, it’s your 125th Autodesk earnings call, a little bit of a difference there. History with the company. I would like to congratulate you as well. It’s interesting…
Jay Vleeschhouwer: Thank you.
Scott Herren: … if you look at the rates, we are seeing less of a differential by vertical and more of a differential by country. So in other words, if country acts is seeing nice robust growth, we see that in both the AEC and in the manufacturing side. If it’s continuing to be somewhat flat and stable, we see that again by vertical. So it’s, I’d say the better differentiator in usage is more, how is the region performing, how is the country performing, then it is within that country is it AEC or manufacturing. The industry collections versus standalone, I will just reiterate what I said in the opening commentary that industry collections continues to be a stable share of our overall business. So we are not seeing a significant mix shift there. Early on, we had seen a mix shift of the new sales more toward LTE and we talked about last quarter that that reverted back to the mean where it had been historically. So we are not seeing a significant mix shift at this point either way. The last thing that I’d add, because I know the detail of your spreadsheets and you probably already got everything laid out here, but to give you a sense on our new business growth and in particular, our product subscription new business growth, from a unit standpoint, no question, we have been impacted by the pandemic, more so in new business unit than in other places. That new business grew sequentially from Q2 to Q3 and that’s our expectation those units will grow again from Q3 to Q4. So just to give you a sense of how things are performing.
Jay Vleeschhouwer: Okay. Thanks very much both of you.
Andrew Anagnost: Thanks, Jay.
Scott Herren: Thanks.
Operator: Thank you. Our next question comes from the line of Brad Zelnick from Credit Suisse. Your line is now open.
Brad Zelnick: Great. Thanks so much. So, congrats all around, guys, particularly for Scott. Best of everything especially in your next chapter. And the topic for both of you, I wanted to ask you about innovation. The sheer amount of innovation on display at Autodesk University this year was -- I guess, I’d just say overflowing. So, Andrew, for you, the easy question. What excites you the most? And my parting gift for you, Scott, maybe a little more complex. How should we think about the pace of innovation going forward, because you’ve always talked about high-single, low double-digit spend growth, but we are below 7% year-to-date. So should we think about spend growth accelerating meaningfully to the high end of your range to recapture the tremendous opportunity ahead? Thanks.
Andrew Anagnost: All right. So Brad, I love this question. Innovation is absolutely hyper critical to everything we do. We believe we are powering lot of transformation and a lot of dialog in the industry right now. We are delighted to see our competitors start to talk like we have been talking for years and I think that’s a sign of the kind of innovation we are putting into the market. Here’s what I will tell you I am really excited about. I am excited about the merger of SaaS, cloud compute and machine learning and this transformational power for our industry, right? This is what gets me up every morning right now in terms of what we are going to be able to deliver for our customers. When we get more and more of their processes in the cloud, when we are computing more and more with their data -- with ever-decreasing compute costs in the cloud and layering on machine learning, we are going to be able to provide our customers with insights and productivity enhancements that are simply beyond anything they have imagined right now. And it gets me extremely excited to be part of driving that change into the industry and what it means. Now, I can talk about the individual technologies that play into all that, there’s lots. But if you talk at a high level about what gets me excited, it’s that. And one thing I think is before -- as a segue to Scott answering his questions, I think, it’s important for you to know that next year we are probably the largest R&D spender in our segment, all right, and I just want you to think about that. After all the discussions we had going through the business model transformation, to all of a sudden be talking about a world where nobody, probably nobody is spending as much in this space on R&D as Autodesk is. I think that is a fundamental change and a lot of innovation comes from that much spend. Scott?
Scott Herren: I am not sure what to add to that, Andrew. I think you said it exactly right. We are at a fortunate position, Brad. And thanks for your kind words, by the way. But we are at a fortunate position in the model where we can both grow spending and increase margins year-on-year. And so if you look at the midpoint of the updated guide for this year, for fiscal 2021, it implies just short of an 8% growth in total spend. So the cost of goods sold plus OpEx. Looking ahead, on top of that, we have invested pretty significantly and grown our investment in R&D, headcount for R&D for sales capacity this year in some of the areas that Andrew just touched on earlier in Jay’s question about building out our internal systems and our internal infrastructure. So we have invested quite a bit in innovation already this year that will obviously carry on into next year and we have made a handful of not large but strategic acquisitions to continue to fuel that innovation. So we -- I think long-term targeting double-digit revenue growth is somewhat dependent on us continuing to invest on the R&D side of things and I feel really good about the position we are in to be able to both drive that investment and an increase margins out through fiscal ‘23.
Brad Zelnick: Okay. Thanks very much. Happy holidays and we look forward to hosting you next week.
Scott Herren: Thanks, Brad.
Operator: Thank you. Our next question comes from the line of Keith Weiss from Morgan Stanley. Your line is now open.
Keith Weiss: Excellent. Thank you guys for taking the question. Scott, would it be out of line to try to convince you to stay at Autodesk? I mean, it’s a lot more interesting than like a networking company.
Scott Herren: I am not. I think the first…
Andrew Anagnost: Scott, enough like hard work, Keith, keep him.
Keith Weiss: Exactly. He’s a good one. You should have tried harder to keep him. And so, thank you, guys, for taking the question. On the quarter, again, two things I want to just get a little more color on. One is kind of like the pace of recovery that you guys are seeing and expecting. It seemed like earlier this year you might have thought it was going to come a little faster, given what you are seeing in Asia-Pac, maybe that’s spreading out a little bit. But with the turn in like the current RPO for this quarter, it looks like you guys are really actually the whole business is turning a corner here. So one, can you give us kind of your latest thinking on the shape of the recovery and kind of what’s assumed as we look into FY ‘22? And then carrying on that total spend commentary, a lot of companies that we talk to saw expense savings this year due to COVID and lower T&E spending and just were able to garner efficiencies in their overall business, some of which they need to give back in the year ahead as we get into a more normalized environment. Is there a big component of that in the Autodesk business that we should be thinking about when we are modeling margins into FY ‘22?
Scott Herren: Yeah. So, Keith, I will start and Andrew, you can add color to it. In terms of what we are seeing, we are seeing recovery. Andrew alluded to it and gave some of the specific countries where we are seeing recovery already and where we are at a level of activity that’s above pre-COVID rates. I think someone earlier highlighted APAC. APAC has been quite strong for us from that standpoint. We are seeing Continental Europe recover nicely as well. The -- our expectations for Q4 is that we will continue to see a modestly improving economic environment and as we look out at next year, I think, we will continue to see improvement. I am not sure it’s going to be a straight line improvement or especially given the current wave, but we will continue to see improvement and I expect by the second half of the year that we will see some pretty good recovery and economic activity that clearly will benefit us. So think of next year as being a little more back-end loaded and I think that’s part of what you see with the early look that we have given you on what revenue growth looks like this year. Q4, again, midpoint of the guide has revenue growth at about 12% and op margin for Q4 will be about in line with the full year at about 29%. I think looking out at next year you will see both of those grow. Revenue growth will increase from there and op margin will increase from there. On the specific COVID spend savings, I think, we have had the same savings that everyone has had. Obviously T&E travel expense has been a big savings for us. But as we look at -- events have gone more virtual, I think, that will continue. We have had modest amount of savings from the operations of our facilities, our offices. As we look at next year, I don’t expect that to be a significant year-on-year headwind. Travel of course will return. But we are going to build the budget such that I don’t expect it to come back anywhere near to where it was in, let’s say, calendar 2019 or in our fiscal ‘20. I think if nothing else we have learned, you don’t have to be face-to-face with a customer to get that final agreement. You don’t have to be face-to-face internally to get things done the way we need to get them done internally. So I think we will continue to see ongoing savings in T&E. It will step up from this year certainly but it’s not going to be a significant headwind for us on spend.
Keith Weiss: Got it. Super helpful. Thanks, guys.
Scott Herren: Thanks, Keith.
Operator: Thank you. Our next question comes from the line of Adam Borg from Stifel. Your line is now open.
Adam Borg: Hey, guys, and thanks for taking the question, and Scott, of course, congrats on the new role. Just on some announcements coming out of AU and talking a little more about Autodesk Build. You mentioned how you are leading with that going forward but you do have the big installed base on BIM 360 and PlanGrid. So I was just curious kind of what the migration path looks like for those assets to Autodesk Build? And maybe quickly as a follow-up on the Spacemaker acquisition, any commentary, Scott, on expectations for revenue growth? Thanks so much.
Andrew Anagnost: Yeah. All right. So let me start with the migration path. So for PlanGrid, for those customers that migrated from PlanGrid and ultimately migrated on Build. It’s actually not a heavy lift because of the way we built the application. PlanGrid’s huge innovation and huge value-add to the whole stack is a mobile experience. They are really good at it. So what we did is we basically used the PlanGrid experience and the PlanGrid team as the mobile experience for Build. So the move from PlanGrid to build is as a progression is not a heavy lift. Now you are right, we have a long tail of customers that are on BIM 360 Field, BIM 360 next-gen Field. Those customers over time are going to be migrating to Build at a pace that makes sense for them. But what we have done is we have created an environment that allowed them to shift as projects sunset and they go onto new projects. We have got a whole master plan with our customers success organization and construction on how you they move over time. We are not going to force anybody to move ahead of their time, but we have got a well-crafted plan for how we move these people. It’s more of a heavy lift for people that are on BIM 360 Field, less of a heavy lift for people who are on BIM 360 next gen which is where Docs -- Autodesk Docs was built off of and it’s a much smaller lift for PlanGrid customers.
Scott Herren: And Adam to your question on Spacemaker, I am super excited by the technology, and I don’t know if you had a chance to see it demoed at AU, but if you didn’t I’d highly recommend it, you have got to take a look at it. This is a — it’s obviously a tremendously exciting technology and some super talented people that we picked up with the Spacemaker acquisition. Impact financially is going to be nominal. It will actually be slightly dilutive and that’s built into our expectations for next year. There’s another effect that I probably should have mentioned earlier and I want to make sure I get it out on the call, though. The one thing that will change next year and it’s a slight headwind to us in terms of revenue growth year-on-year, we have almost all of our products are already ratable, right? But there’s a couple of really small products, one, Vault, that we talked about in the past, that did not get over the hurdle to get away from upfront revenue recognition. We have continued to work on that product. We have continued to do things that incorporate much more cloud based functionality and I think in the first part of next year Vault will flip from upfront rev rec to full ratable rev rec and that looks like it’s about a point of growth. Again, already built into kind of the early view that I gave you of the low-double, low- to mid-teens revenue growth for next year but the impact of Vault is built into that, obviously, it normalizes in fiscal 2023 because once it bucks ratable, the compare points are equivalent. But that’s one if you are building your model on that level of detail, I think of that being a bit of a headwind that’s already built into the early view of ‘22.
Adam Borg: Yeah. Great.
Andrew Anagnost: I will make some…
Adam Borg: Thanks again guys.
Andrew Anagnost: I will make one more comment on Spacemaker just because I kind of forgot to segue to you on that. But Spacemaker represents that perfect convergence of SaaS, cloud compute and machine learning into solving real world problems for our customers. I think you are going to see the impact on our business accumulate over time as the technology expands and as it connects itself deeper with Revit and other parts of the process. One of the things I love about the Spacemaker team is they have this philosophy of making multiple constituents more successful with their objectives and that’s the building owner, the developer making their investment more profitable. That’s the city making sure the impact on infrastructure is managed and controlled. And they also have a big customer or big stakeholder in this, is the environment and helping architects and city planners make more sustainable decisions in real time for how things are built. It’s the perfect example of how all these things come together to change the way people make design decisions and ultimately build decisions. So look for its impact to expand over time as that team starts hooking into other parts of our process, builds out their existing products and inevitably starts moving into other parts of the organization, which we always see with acquisitions like this.
Scott Herren: Yeah. There’s absolutely a lot of synergies that we see with Spacemaker coming in.
Adam Borg: Great. Thanks again.
Operator: Thank you. Our next question comes from the line of Steve Koenig from SMBC Nikko. Your line is now open.
Steve Koenig: Hey. Terrific. Thanks for squeezing me in, guys. I appreciate it. And Scott, best of luck to you and thanks for all the hard work you have done for us over the years. Definitely appreciate it.
Scott Herren: Yeah. Thanks. Thank you.
Steve Koenig: Cool. So I will just ask one question. Andrew, had you had some pretty open, transparent communications with customers this last quarter in terms of the letter that was written? And just in terms of looking at what those customers were asking for? They were very clearly asking for accelerating the roadmap in architecture and engineering design, which doesn’t seem like we talked a lot about on the call today, hasn’t been a focus. And if I read between the lines in that communication, the customers also seemed a bit frustrated with the transitions they have been going through from maintenance to subscriptions to collections and now to named users. And it just seems like there’s a little bit of dissonance between what they are asking for and what I am hearing from you on the call today and I’d love to get your thoughts on how -- why is that there may be misperception gap and what are you guys doing about it? And thanks very much.
Andrew Anagnost: Steve, there’s absolutely no dissidents. All right. One of the things I think I said consistently in the communication and I will take you back in communication is, we started investing in the road map for Revit well ahead of these communications, all right, from these customers, because we made a deliberate choice to invest in construction and not in Revit functionality for architects. So are these customers are going to thoroughly quickly start to see changes and additions to Revit from the investment we made actually at the end of last year. And I think you are missing something, we just spent several $100 million on the architecture segment of our space, all right. Spacemaker is squarely targeted at design and architecture and the founders of Spacemaker are architects, all right.
Steve Koenig: Okay.
Andrew Anagnost: This technology is right on the edge, and like I said, we just spent a lot of money to do this and this is right in the act. It’s something we have been looking at for a while. So no there’s no dissonance here in terms of where we are focused and where we are. With regard to the migration, look, you have got to -- when we started this migration with two -- something under 2 million maintenance customers. Most of those have come along with us. We never expected that all of them were going to come along with us happily. And what we are done is we have reached the end of the tale with some maintenance customers that are more frustrated with the changes than not. But at the same time we have added millions of other customers that weren’t able to afford some of our solutions before, because of the upfront cost of these solutions. So, yeah, maintenance customers that have been with us have seen lots of transition. They are not done yet. We haven’t retired all those models yet. But remember we started with less than 2 million of those. We are over 5 million subscribers right now. A fraction of those are from that maintenance base. We have to remember, let’s look at the big picture here as well as the small picture. I understand and I empathize the frustration of those customers who started on maintenance and journeyed with us. But we have reached so many more customers, so many more architecture firms, so many individual architects, so many people that couldn’t afford Revit, so many people that couldn’t afford that extra seed of AutoCAD, so many high growth companies, that if they add seats, they are actually spending less over five years than they would have with us adding seats in the perpetual model. That’s a big story and it’s transformative to the industry in terms of how much value people are able to get now. So let’s make sure we stay focused on the big picture here.
Steve Koenig: Cool. Well, I appreciate your thoughts and thanks again for the open communication. Good luck to you, Scott.
Scott Herren: Thanks, Steve.
Operator: This is all the time we have for Q&A today. I would like to turn the call back over to Simon Smith for closing remarks.
Simon Mays-Smith: Thank you, Gigi, and thanks, everyone, for joining us today. We are looking forward to seeing many of you at conferences over the next few weeks. Please do reach out to us if you have any follow ups on anything from this call. This concludes our call today. Thank you.
Operator: Ladies and gentlemen, this concludes today’s conference call. Thanks for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. And welcome to the Q3 Fiscal Year 2021 Autodesk Earnings Conference Call. At this time, all participants’ lines are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Simon Mays-Smith, Vice President of Investor Relations. Thank you. Please go ahead, sir."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, Operator, and good afternoon. Thank you for joining our conference call to discuss the results of our third quarter of fiscal year ‘21. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our investor relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. First off, I hope you and your families are remaining safe and healthy. Before jumping into our third quarter results, I would like to thank again our employees and the families and communities that support them, as well as our partners and customers, for their sustained commitment during uncertain times. That commitment was reflected in our execution, and demonstrated the resilience of our business model this past quarter. Together, they enabled us to deliver strong Q3 results - with billings, revenue, earnings and free cash flow coming in above expectations, despite the volatile macro-economic conditions resulting from the pandemic. I am pleased to see the acceleration of our SaaS business model, the secular shift to the cloud underpinning it and the competitive opportunities it brings. We have many miles of opportunity ahead of us. Our enterprise customers are undertaking their own digital transformation and by enabling that transformation, we are becoming a strategic partner rather than a software vendor. These strategic partnerships are broader than in the past, with our customers expanding their Autodesk product portfolios. Our third quarter results reflect this trend, as our enterprise deal activity with large customers accelerated. We closed some of the largest transactions in the company’s history, including a nine-digit deal. I am proud of our team’s execution, which positions us well entering the fourth quarter with a strong pipeline of deals. In the third quarter, we also saw the ebb and flow of the economic impact of the pandemic. As you know, our transition to the cloud means we are able to monitor the usage patterns of our products across the globe and see the positive correlation between increasing usage levels and new business growth in those regions. China, Korea, Japan, and most of Europe saw usage levels rise above pre-COVID levels. While usage trends in the U.S. and U.K. have not yet returned to pre-COVID levels, while they have stabilized in the U.S. and grown sequentially in the U.K. In line with the usage trends, our new business remains impacted by the pandemic, but the diversity of our revenue stream and customer base is helping us deliver strong results. And as you know, Scott has decided to take on the next challenge in his career by accepting the CFO role at Cisco, starting mid-December. Scott has played a huge role in driving the business over the last six years, helping Autodesk successfully navigate the business model transition. We are sad to see him leave, but we are also excited for him. Thank you, Scott, for your many contributions to Autodesk and I wish you continued success in the next chapter of your career. Scott is leaving behind a strong team to ensure smooth operations while we look for his replacement. We have started the search process, and it is my top priority in the near-term. Now, I’d like to turn it over to Scott to take you through the details of our quarterly performance, and guidance for the year. I will then come back to provide insights into our strategic growth drivers."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Andrew. I am leaving Autodesk with mixed emotions, as I am excited about what lies ahead for me, but also sad about leaving my colleagues at Autodesk. The last six years have been the most fun and rewarding of my entire career, as we have transformed the company from a traditional license revenue model to a cloud-based recurring revenue model. That transition is now complete and I leave knowing Autodesk is well-positioned for the future with leading positions in attractive markets and accelerating momentum. Looking at the quarter’s results, several factors contributed to our outperformance across all key metrics, including, strong enterprise deal activity, healthy subscription renewal rates, digital sales, a sequential improvement in new business trends, and foreign exchange rates. Total revenue growth came in at 13% as reported, 14% in constant currency, with subscription plan revenue growing by 24% and operating margin expanding by 3 percentage points. We previously told you we extended payment terms for customers impacted by the pandemic. The normalization of payment terms, combined with improving business trends and strong cash collections in Q3, helped drive healthy free cash flow of $340 million. Current RPO, which reflects committed revenue for the next twelve months, was up 16%, a slight improvement on the rate of growth we saw in the second quarter. Total RPO was up 21%. We again benefited from the diversity of our customer base. Business softness in certain areas, like the U.S. and parts of Europe, was offset by strength in other areas. Digital sales continued to drive double-digit billings growth through our online channel, supported by accelerated growth in our cloud-based Fusion offerings. We are developing broader strategic relationships with our enterprise customers with multiyear commitments. As is typical for most enterprise agreements, the nine-digit deal Andrew mentioned is a three-year commitment billed annually and did not have a meaningful impact on our revenue or cash flow during the third quarter. The run-rate business with our partners also continued to perform well. While we are seeing the traction of our transition to the named user business model, it results in a subset of our customers optimizing their installed base by reducing the number of named user seats needed after they take advantage of our 2-for-1 trade-in program. I am pleased to report that these overall trends are in line with our expectations. As we have said in the past, in aggregate, the transition to the named user model is a revenue-neutral event for us, but enables us to offer more value to our customers, in a similar way as other SaaS providers. Our net revenue retention rate remained within the 100% to 110% range we laid out in our guidance. Our product subscription renewal rates remained strong, reinforcing the critical nature of our products to our customers. As in the prior quarter, approximately 40% of the maintenance customers who came up for renewal converted to subscriptions. Our maintenance renewal rate declined sequentially, which was expected as we are nearing the end of our maintenance program. Industry collections remained a stable share of our total business in Q3. As anticipated, multiyear payments were down year-over-year, but we saw modest sequential improvement in the share of multiyear payments across each geography as customers continue to make long-term investments in our products. And finally, during the third quarter we spent $196 million to buy back 800,000 shares at an average price of approximately $231 per share. Year-to-date, we have repurchased 2.12 million shares at an average price of approximately $186 per share, for a total spend of $393 million. Now let me turn to our guidance. We are raising the low end of our full-year revenue guidance to a range of $3.750 billion to $3.765 billion, bringing the mid-point growth rate up to 15% year-over-year. We are also raising our non-GAAP operating margin outlook to the upper end of our prior range, a 4-point improvement from last year. Our fourth quarter performance will benefit from the strength in our third quarter results, but the business environment remains uncertain given the current wave of COVID cases. We expect product subscription renewal rates to continue to be very healthy. Churn on our maintenance offering will likely accelerate as we enter the final stages of ending our maintenance offering. And we expect our net revenue retention rate to remain between 100% and 110% for the quarter. Our pipeline entering the fourth quarter is strong, but we have assumed that new business and multiyear contracts will continue to be under pressure. The narrowing of our billings and free cash flow outlook range is primarily driven by moderating assumptions around multiyear and the uncertainty presented by the current environment. It’s the testament to the strategic value of our products to our customers, and the resiliency of our model, that we are still expecting to report 15% revenue growth despite the current economic headwinds. Looking out to our fiscal year 2022, we expect an improving macro-economic environment as we exit this year will result in accelerating growth in new business over the course of fiscal ‘22. Given our subscription model, revenue growth will lag the improving sales environment. As we have said in the past, the path to fiscal ‘23 will not be linear. We expect our fiscal ‘22 revenue growth to be low- to-mid-teens and free cash flow growth to re-accelerate to approximately 20%. We are confident in our fiscal ‘23 free cash flow target of $2.4 billion, as we will benefit from improving business momentum in fiscal ‘22 that will provide a tailwind to our revenue and free cash flow growth. In fiscal ‘23, we will also benefit from the renewals of our fiscal ‘20 transactions when we restarted multiyear payments for a part of our business. Beyond fiscal ‘23, our continued investment in cloud products and a subscription business model, backed by a strong balance sheet, give us a robust foundation and platform for double-digit growth. And now, I’d like to turn it back to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Scott. Our strong performance in Q3 once again demonstrates the advantages of our diverse customer base, resiliency of our employees, the power of our SaaS offerings, and the strength of our business model. At Autodesk University last week, we hosted approximately 100,000 customers and partners, and made a series of product and partnership announcements as well as our acquisition of Spacemaker, which closed yesterday and offers industry leading functionality to architects. Spacemaker will enable us to support Design professionals much earlier in their workflow, by harnessing AI to rapidly create and evaluate options for a building or urban development. Through automated data capture, smart design, decision support, and collaboration functionality, Spacemaker enables users to quickly generate, optimize and iterate on design. It also offers a fundamental shift in how we imagine and build cities in the future, and the time needed to evaluate various possible options. I encourage you to check out the demo from last week that is available on our website. We also announced the Autodesk Construction Cloud platform, which unifies our AEC cloud offerings and the data held within them, to enable a connected project ecosystem across design and construction. Underpinning the Autodesk Construction Cloud is our common data environment, Autodesk Docs. This provides seamless navigation, integrated workflows and project controls, and enables a single source of truth across the project lifecycle. Autodesk Build, Quantify, and BIM Collaborate bring together the best of PlanGrid and BIM 360, with new functionality to create a comprehensive field construction and project management solution. For our design customers, BIM Collaborate Pro extends the capabilities of BIM 360 Design on the new platform to create a more seamless exchange of project data between design and construction. During the quarter, Morgan Sindall, a leading construction group in the U.K., committed to Autodesk as their strategic platform partner. As Lee Ramsey, Morgan Sindall’s Digital Design Director, said, quote, as I researched all the marketplace solutions, Autodesk stood out to me. Autodesk Construction Cloud provides greater integration between different roles and functions, allowing data to be shared across projects, silos to be broken, and a vast amount of efficiency to be gained, end quote. The breadth of our AEC business has underpinned its resilient performance, and enabled it to be a net beneficiary from secular and cyclical trends. Despite many construction projects being interrupted, delayed, or navigating new ways of working because of the pandemic, we are still seeing year-on-year growth across all our construction offerings. Our cloud-based products enable our customers to navigate the cycle today, and to be more efficient and sustainable for tomorrow. Our office-based solutions continued to do well while our field-based solutions improved sequentially, boosted by several competitive wins. Customers continue to choose PlanGrid to digitize their processes because it is easy to use and they only pay for what they need. This quarter, our BIM 360 products set records for both worldwide weekly average users and projects. We also continue to see adoption with our larger customers and within the infrastructure industry. During the quarter, one of the world’s leading professional services firms which serves clients in the infrastructure and building sectors increased its investment with Autodesk. We have been partnering together for over 15 years and the renewal of our enterprise business agreement enables this firm to expand its use of BIM 360 and PlanGrid in order to adapt faster to industry changes and create new markets for its services. In another instance, Japan’s largest home builder, Daiwa House Industry Co, Ltd., renewed its enterprise business agreement with us. The company is making key investments in BIM, and has selected Autodesk to be its strategic innovation partner to achieve its goals for digital transformation, design for manufacturing, and industrialized construction. The company is adopting BIM at all levels of the organization, and has made a commitment to adopt additional Autodesk products, including BIM 360 Docs and Design, and PlanGrid. We are thrilled to be working with Daiwa House at the forefront of industrialized construction. Our cloud-based platform is also propelling growth in Manufacturing by enabling the convergence of Design and Make. On the commercial side, our market-leading cloud-based platform, Fusion 360, enjoyed another quarter of accelerating subscriptions, growing scale of deployments, and adding competitive displacements, to end the quarter with over 120,000 subscriptions. At AU, we introduced several extensions to Fusion 360 that further encourage adoption and usage of the platform by adding specialist functionality. As a reminder, extensions offer expanded tools and functionality that can be added on demand to the core Fusion 360 offering. This kind of functional flexibility and cost effectiveness enhances the value of our platform for designers, engineers and manufacturers. We also announced exciting partnerships with Sandvik Coromant and Rockwell Automation. With Sandvik Coromant, a metal cutting tools and services company, we took the first steps to realize a shared, long-term vision of accelerating the automation of manufacturing processes by making tool data and manufacturing recommendations available to users of Fusion 360. With Rockwell Automation, a provider of industrial automation and information technology, we combined factory layout capabilities available in our industry collection with their factory simulation tools. Together, these solutions will help our mutual customers digitally design and commission factories in less time and with greater efficiency. This quarter we also announced the acquisition of CAMplete, a leading provider of post-processing and machine simulation solutions. CAMplete bridges the gap between CAM programming and shop floor machine tool operation. It allows manufacturers to digitally simulate and verify the machine code that drives their production equipment before running it on the shop floor. This will enable our customers to identify potential problems, in a digital environment, at the programming phase that could otherwise scrap work or damage machine tools in production. During the quarter, a large multinational defense, security and aerospace company with an extensive global supply chain chose to increase its investment with Autodesk through an enterprise business agreement. To stay at the forefront of its industry, the company is using innovative manufacturing methods to save time and money and has set a target to 3D print approximately one third of the components in its new jet. As it radically changes the way it designs and builds, the company has selected Autodesk as a key strategic partner. The adoption of our products is also driving change throughout its supply chain, which must adopt new ways of working. With Fusion 360, it now has access to our advanced manufacturing solutions to help it realize its business goals. In education, we continue to expand our footprint. Tinkercad, our fully browser-based product development platform for aspiring designers, now has over 30 million users worldwide. Fusion 360 on Chromebooks is experiencing rapid adoption at high schools and universities and is replacing entry-level, browser-based CAD/CAM with professional-grade, career-accelerating Fusion 360. For instance, the University of Illinois at Urbana-Champaign has now switched to Fusion 360 across multiple departments, including biomedical engineering, systems engineering and mechanical engineering. We are seeing early adoption of our Premium plan, with customers taking advantage of the enhanced subscription offering at renewal. Many of our multi-user customers who are transitioning to the named user model are finding great value in the Premium plan, due to its advanced user analytics, single sign-on capabilities, and enhanced support. For example, Scheuch, a leader in the field of innovative air and environment technology, decided to commit to a long-term investment in Premium this quarter, primarily due to the SSO and user management capabilities. They see Autodesk as a strategic partner as it continues to harmonize its global IT infrastructure. Let me finish by updating you on our progress monetizing non-compliant users. We continue to be sensitive to the short-term economic pressure faced by our customers, but remain optimistic about the long-term opportunity as we demonstrate the value of our cloud-based platform to our customers. For example, in China, a customer which left us to try a lower cost competitor quickly returned due to AutoCAD’s superior functionality and invested further in Autodesk by purchasing collections for the first time to focus on growth. Our efforts to educate our customers about the benefits of staying compliant with our subscriptions are yielding results, as we are able to convert them to paying users in a customer friendly manner. During the quarter, we closed eight deals over $500,000 with our license compliance team. In closing, we continue to build a stronger Autodesk for the long-term. Our early and sustained organic and strategic investment in critical capabilities like cloud computing and cloud-based collaboration, combined with a successful transition to a SaaS business model, give us significant competitive advantages and confidence to grow in the double-digit range in the foreseeable future and we have multiple drivers that make us confident in our fiscal ‘23 free cash flow target of $2.4 billion. With that, Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from the line of Saket Kalia from Barclays Capital. Your line is now open."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hey, guys. Thanks for taking my questions here, and Scott, congratulations on the next step. You will certainly be missed."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Hey, Andrew, maybe first for you, a lot to talk about, but one of the questions that I feel like we got a little bit, especially during the months of October and November, were what potentially higher infrastructure spending spurred by the government could mean for Autodesk? And of course, we don’t know what that looks like yet or frankly even if it will happen, but I was wondering some of what you Autodesk maybe saw during the 2009 Recovery and Reinvestment Act as perhaps a frame of reference. Does that make sense?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. Saket, that makes sense. First off, let me start the question by being super clear. We don’t have any kind of projections around stimulus or the impact of stimulus on our business in any of our models, right? That stuff that we leave out because one does not want to leave themselves exposed to the vagaries of government. However, if we go back to ‘08 and ‘09, and I think, it’s important to remember this, one of the narratives about Autodesk in ‘08 and ‘09 is, oh, Autodesk is so exposed to the housing market. Oh, my gosh. And the reality was that Autodesk revenue recovered well, significantly faster than the housing market did and that was because of the distributed nature of our work and our customer base and the projects and the sectors that we cover. Infrastructure spending and stimulus spending back then absolutely helped because it created a pipeline of projects that were new, but we were already recovering before some of the stimulus showed up and I think it’s important to recognize that. If you look at what the impact might be if we actually see some of this show up and we actually see some important stimulus, obviously it’s going to increase the project pipelines of our customers and that’s always good for us. And it could see more adoption of our portfolio. It could be really good for the construction portfolio. But again, Saket, I want to make it super clear, we don’t model that kind of stuff in our outlook and we are not expecting it to hit our numbers."
},
{
"speaker": "Scott Herren",
"text": "Yeah. Saket, the only other comment that I’d add on top of that is, let’s say, an infrastructure bill does get passed. It will take some time for that bill to turn into real projects and for those projects to get put out to bid and for that then to downstream start to drive our business. So even if that were to happen, let’s say, early in the new administration, I wouldn’t expect it to of have a material impact on fiscal ‘22 anyway."
},
{
"speaker": "Saket Kalia",
"text": "Got it. That’s super helpful. Scott, maybe for my follow-up for you. Thanks for the early fiscal ‘22 guide. That’s very helpful. I guess with 20% free cash flow growth next year and that target of $2.4 billion fiscal ‘23, it looks like that acceleration of free cash flow that we are seeing here in fiscal ‘21 is -- actually, in fiscal ‘21 and ‘22 is going to continue into ‘23. Can you just talk a little about some of the drivers that might contribute to that? You touched on this a little in the prepared comments, so I am just wondering wonder if you could double click on it once more?"
},
{
"speaker": "Scott Herren",
"text": "Yeah. Sure, Saket. And by the way, you were one of the ones that got it right, actually, as I recall looking at your preview note for what to expect on fiscal ‘22. And as you know, we have been running multiple scenarios. I have been probably run driving my team crazy, running scenarios over the last nine months and in each case we run it not just for the impact of this fiscal year and next fiscal year out through fiscal ‘23 to even fiscal ‘25 and beyond. So to have a good sense of how the model responds to a variety of different scenarios, that’s part of what underpins our confidence in fiscal ‘23. But if you step back and say, what are the drivers behind that and I will start with the biggest driver. You have seen our renewal rates stay steady through this process and in fact even modestly we saw sequential increase in renewal rates, but given the size of our renewal base, that’s a big driver longer term. And we talked about the net revenue retention rate kind of staying in that 100% to 110% range even during the pandemic. So you take a big renewal base with a high renewal rate and 100% to 110% net revenue retention rate that drives a lot of growth. Add to that what we are seeing in cloud and the cloud products acceleration overall, we still have a pretty significant opportunity to convert nonpaying users of out in front of us and we built the leading portfolio, product portfolio in construction. So there is a -- and we have talked about again today about the success of our manufacturing business and where we are headed there and some of the traction we are beginning to get with Fusion 360 and the way we are monetizing that with some of the extension. So there’s a lot behind that. That’s what drives our confidence not just in this year and some of the early view I gave you of fiscal ‘22 but then how that ramps up out through fiscal ‘23. I think there’s two other quick things I’d like to add to that. We do -- we are seeing a modest improvement in economic activity right now that Andrew talked about. Certain countries are back to pre-COVID levels, but it’s not consistent. Our expectation is that we will see continued economic improvement through next year but that that will -- I doubt it’s going to be a straight line. I think that will be more pronounced in the second half of next year, which means the year will be a bit more back-end loaded. And that linearity affects not just revenue. It also affects when we collect cash. a lot of the sales of that momentum in the second half of the year will turn into fiscal ‘23 free cash flow. And then one other item that I want to get on the call so that you can build it into your model, we do see a cash tax impact year-on-year this year to next year of about $50 million to $60 million as our profitability has improved fairly significantly. So you add all those together, that’s what underpin our confidence, the early view of fiscal ‘22 cash flow and our confidence in $22.4 billion in fiscal ‘23."
},
{
"speaker": "Saket Kalia",
"text": "Got it. That’s very helpful. Thanks, guys."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Saket."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Matt Hedberg from RBC Capital Markets. Your line is now open."
},
{
"speaker": "Matt Hedberg",
"text": "Hey. Great, guys. Thanks for taking my questions and congrats on these numbers in a really difficult situation. I will also offer my congrats to Scott. It’s been great working with you, obviously, we will miss you at Autodesk, but congrats and best of luck. Andrew, I wanted to ask you about the nine-figure three-year renewal deal. That is super exciting. I guess I am wondering can you give us a bit of history on how that customer has grown to this level. And then maybe the opportunity for other enterprise deals of this caliber, given your sort of extended platform these days?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So we actually broke records a couple of times during this quarter, so these deals are becoming more the norm than not in our quarters. And I want to tell you what essentially underpins all of these and I think it’s important and it’s the same dynamic in all of them. Our customers look three years out. They look at what they are trying to do internally, transformationally, with digital transformation or with the transition to BIM or with the transition to the cloud with Fusion and other things associated with that. And they ask themselves, okay, what are they going to need in an EBA in order to drive and maintain that expansion without coming back and renegotiating the contract with us again. That’s what’s powering this. A strategic discussion about what are the long-term adoption requirements of these customers. So for instance, a customer might see themselves expanding more into industrialized construction and applying both Inventor and Revit more broadly in their process, and they want to make sure they plan for that or they are going to expansion of Construction Cloud deeper into their processes. So they are planning for that. They are saying, well, I am using this much Construction Cloud this year. I am going to use this much next year, the year after that, the year after that. So this is what is driving these kinds of deals, this discussion about the three-year expansion of usage of our portfolio in these accounts and it’s not just usage across users, it’s usage across breadth of portfolio. Otherwise, you couldn’t see deals of this size coming through. That’s the dynamic that plays out in almost all of these deals that we are seeing. Make sense, Matt?"
},
{
"speaker": "Matt Hedberg",
"text": "Got it. Yeah. No. That’s super helpful. And then maybe just a double click on the SaaS side. I mean, Andrew, you talk to executives every day, and I guess, I think, we are all excited about the prospects of the vaccine. On those conversations, though, in a post-COVID world, I mean, do you get a sense that you have obviously had a lot of success with 360 SaaS today, but you think we could see even a bit of a slingshot effect as part of these larger deals, as customers really, effectively raise to embrace SaaS potentially for the next pandemic at some point?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. I actually think, it has -- it even goes beyond pandemic. It’s like once you have got a taste of it, you want more of it. It’s what’s going on too, okay? Because remember some of these customers, they were not broadly deploying our SaaS solutions prior to pandemic and what they are seeing now is you know what, this stuff is important, I need to get on it and I need to prepare for the future and this is how I am going to drive my digitization. So we are absolutely going to see continued growth in these SaaS platforms. It’s interesting that you mentioned the vaccine and things like that, because what we are seeing when we talk to executives right now is, everybody doesn’t see a change in the timeline of how this pandemic is going to play out. But all of us, what we are seeing is increasing reductions in uncertainty. It starts with vaccine conversations and then more than one vaccine and then it goes into, hey, the U.S. election is getting less uncertain, who is going to be the president is less uncertain. So this is progressive building of uncertainty being removed and customers are getting more and more comfortable about looking at their second half investment scenarios for next year and SaaS is in every one of those conversations, okay? And I think as long as we continue on this trajectory of uncertainty being removed, you are going to see people being increasingly comfortable with how they feel about the second half of next year."
},
{
"speaker": "Matt Hedberg",
"text": "Super helpful. Thanks, guys."
},
{
"speaker": "Scott Herren",
"text": "Thanks for the question, Matt."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Philip Winslow from Wells Fargo. Your line is now open."
},
{
"speaker": "Philip Winslow",
"text": "Hey, guys. Thanks for taking my question and congrats on this great quarter. And Scott, obviously it’s been a great pleasure working with you, not just at Autodesk, but going back to. We will definitely miss you my friend."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Phil."
},
{
"speaker": "Philip Winslow",
"text": "The -- I got a question for you in terms of your the AEC portfolio, obviously, very diversified in terms of the sort of the stages of call it a building from design, planning, actual construction. And so I guess, sort of a two part question here, what are you seeing in sort of that portfolio right now and into Q4, then we are thinking about next fiscal year. How are you spending sort of the ebbs and flows of that portfolio to play out?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. Actually, Phil, you are pushing on an important competitive differentiator for us. The breadth of capability we have across the entire AEC cycle and the way we are integrating that information in the cloud is fairly unique, right? And what we are seeing and this is something that I think you will see progressively, again and again. Right now a lot of people are talking about digital twins and that’s a vocabulary that’s out there, obviously, we haven’t used that vocabulary very often. But what’s going on right now is BIM. 3D BIM is the original digital twin, right? And this whole discussion around digital twins and AEC and things associated with it is accelerating the dialogue around if I want to do digital twins, I have got to do BIM, because there’s no digital twin without a Building Information Model. And you are going to see a continuing ongoing acceleration of the usage of BIM up front in our portfolio. But then what we have layered on top of it is a couple of critical things that make the entire portfolio more valuable. You may have noticed we emphasized this notion in the new Construction Cloud platform around a common data environment and all the things that go along with that common data environment. That common data environment is not just SaaS based. It’s also ultimately going to be ISO compliant and it’s going to allow us to move that building information data all the way through the entire process. So you are going to see more and more adoption of what’s in Autodesk Build, all the way through from the preconstruction planning cycle to the construction site and that’s a pretty powerful differentiator for us. But the one last thing I want to mention to you, and we talked about this at AU and I want to make sure you paid attention to it, was the rollout of Tandem, Autodesk Tandem. And what was Tandem? So Tandem is, if digital twins start with BIM, Tandem is a way to bring BIM data together from multiple places. From our BIM models or our BIM information, from other third parties that are building controller information perhaps, from other BIM based data from other types of applications and bring it into a single aggregated view in the cloud that updates dynamically as the building project progresses. This puts us at the forefront of bringing the power of BIM to create digital twins to the ability to create digital twins in the cloud that actually represents the final state of the project no matter where all that project data comes from. So we are pretty excited about this progression and what it means for the company and I think you are going to see a lot of interest and uptake in the approach we are taking."
},
{
"speaker": "Philip Winslow",
"text": "That’s awesome. That’s super exciting and an equally as exciting question for Scott, long-term deferred revenue. The -- how are you thinking about that next year, obviously, the guidance for this year is hanging out at the mid-20s? But how are you sort of modeling that when you are thinking about that cash flow for next year and the year after that?"
},
{
"speaker": "Scott Herren",
"text": "Yeah. I think for next year it stays in that range, Phil. I don’t want to get into too much forecasting of fiscal ‘22 until we get to the Q4 earnings call and obviously we can give you more detail at that point. But what we are seeing this year is kind of moderating assumptions around multiyear, and of course that’s what drives a lot of that long-term deferred. And so you see the sequential trends there are long-term. It hasn’t fallen off the floor. It hasn’t fallen off the desk and onto the floor. The multiyear rates are still there. But they are not as robust as we had seen historically in maintenance. I think ultimately it returns to that level. But frankly I don’t think the moderating multiyear that we see this year, there’s a big negative in the sense that given the strength of our renewal rates we will continue to get that, collect that cash. We will just collect it in the subsequent two years instead of collecting all three years upfront and we will collect it without the 10% discount that we put in as an incentive for those multiyear transactions. So think of it settling in where it is for the foreseeable future. Ultimately, I think there’s a little room for it to run."
},
{
"speaker": "Philip Winslow",
"text": "Awesome. Thanks, guys, and congrats again on a great quarter."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Phil."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Heather Bellini from Goldman Sachs. Your line is now open."
},
{
"speaker": "Heather Bellini",
"text": "Great. Thank you so much, and Scott, I will echo my congratulations and to you as well, Andrew, for the company’s execution in this challenging macro environment. I wanted to ask two questions. One, if you could share with us kind of, I mean, the competitive positioning in construction, given your pricing model and how you might see some of the competitors responding? So if you could spend some time on that, maybe a little bit more on the differentiation if that’s gotten even wider over the course of the pandemic? And then also, if I look at your growth in Asia-Pac, you can see that was the best region in terms of growth. How far behind do you think the Americas is from the recovery and the solid growth that you are seeing in APAC? Thank you so much."
},
{
"speaker": "Andrew Anagnost",
"text": "All right. So let me start with the competitive positioning on the construction. You are absolutely right, Heather, that the pandemic actually gave us an opportunity to lap our competition a bit. The slowdown definitely took the wind out of certain parts of the market. However, we didn’t slow down, we continued to invest and we put quite a bit of money into rolling out the unified platform. So what you see with Autodesk Build, which is what we are going to lead with in every new deal, we are leading with Autodesk Build over and over again, and we are going to lead internationally and we are going to lead in the U.S. with this, is a comprehensive project management and field management application that goes from design all the way through to site management, site execution and layers on the analytics associated with Construction IQ and some of the predictive skills, all built on top of Autodesk Docs. So this is a pretty significant change. That platform is highly competitive. As a matter of fact, it’s differentiated in numerous ways because of its end-to-end capabilities. In terms of pricing models, here’s what’s unique about us, Heather, and I think, it’s very important to remember this. No one in the industry is more flexible with the way we deliver these applications than Autodesk. So if you want to buy named users and deploy named users, we have got named users for you. That’s our primarily deployment model for most of our applications. If you want to pay based on project turnover, you can do that. If you want to play based on usage and consumption, you can do that. This flexibility is heavily coveted by our customers, and in fact, I think, this flexibility has been part and parcel of what’s allowed us to continue to expand the usage of the Construction Cloud even during what’s happened over the last year. So I think technologically we are now competitively differentiated, because we took the pandemic as a time to double down on the platform unification and get it out there and business model-wise we are differentiated. So we are feeling in a pretty strong competitive position as we head into the recovery next year across all the various markets. We love that we have tough competition in this space. We think it’s good for us. We think it’s good for our customers. But we are feeling really good about where we are at. Now, with regard to the Americas versus APAC, right, here’s what I will say. Usage ramped up fairly quickly in Asia-Pacific and like we say earlier, it’s definitely above pre-COVID levels in a lot of places, not everywhere but in a lot of places. The U.S. in particular just seemed to have stalled, all right. Usage hasn’t fallen back. It’s ramped up a little bit as time goes on. But it’s not seeing this kind of surge. I think we should just kind of hold tight for a little while and see what the levering out of the uncertainty does right now for the usage in the U.S., all right. Between the election results, between the good news about vaccines, between the potential that people see about stimulus in their project pipeline. I think we might start to see a change. So it will be interesting what we can talk about on the next earnings call. But I think the unwinding of uncertainty matters a lot in our markets."
},
{
"speaker": "Heather Bellini",
"text": "Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is now open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Andrew, starting with the nine-figure deal and returning to that subject, it’s especially interesting when we consider that once upon a time $100,000 deal was a big deal for Autodesk, so you are obviously now many orders of magnitude beyond that. But the question is, to the extent that there are now as we understand additional eight-figure deals in the pipeline. How are you thinking about your license management and customer success requirements and capacities that you need to invest in and ramp up to support what is obviously going to be a larger propensity for these kinds of deployments? And then returning to AU for a moment, you made some interesting remarks last week, having to do with some additional new possible opportunities for the company in manufacturing software, supply chain, even smart products you alluded to. Maybe talk about how seriously you mean to pursue those new things? And then for Scott, first, thank you for the last 25 quarters, and as you are going away question or a multi-part question, Andrew, earlier parsed the usage data by Geo. Could you do the same thing by perhaps standalone versus collections and perhaps even by vertical in terms of what you are seeing in the usage telemetry there?"
},
{
"speaker": "Andrew Anagnost",
"text": "Right. So it’s a classic Jay multipart question. All right. So, Jay, let me start with the license management piece. This is something we take particularly seriously and I am really glad you asked about it, because licensed management, the ability to manage these licenses is actually a value-add to our customers. They want to manage this investment in Autodesk assets as an enterprise asset, all right. And it’s super important in this space that we do this. One of the reasons we have been moving so quickly to retire legacy models in our user base is because that actually holds us back from delivering best-in-class license management for our customers. Every customer, every maintenance license that’s still out there, every multiuser license that’s still based on the old desktop paradigm versus what we want to do in the cloud paradigm is holding us back from deploying the systems in a way that help our customers manage these things holistically. The good news is that our EBA customers get a totally different dashboard on how they use our software and they are able to get more per user usage analytics and more data in terms of understanding their customer base. But this investment in the sheet of glass that our customers look through in terms of managing their relationship with Autodesk is something we have been doing ongoing for years and look for it to accelerate as we retire the last of these legacy business models and start unifying everything on a stack that really provides a high level of control to our customers and a high level of fidelity about what their actual usage is. We believe this is a value add of the portfolio and you will see us continue to invest in this. Now with manufacturing investments, I think, you want to just pay attention to what we are doing with Fusion and the areas we are targeting, because we think these are important areas that we want to pay attention to. We have integrated certain types of technology into Fusion. We want to augment and supplement and extend those so that Fusion is a professional grade solution surrounded by other professional grade solution that tackles significant growth markets inside the manufacturing vertical. Our first angle of attack was in the convergence of design and make and merging advanced manufacturing methods with advanced modeling methods. I think you are going to see us attack the convergence of mechanical engineering and electrical components inside designs. We have already started doing some of that things and we are going to do it in uniquely cloud way. We are going to do it with uniquely underpinnings of cloud compute and we are going to do it in highly differentiated ways, but also in ways that respect some of the tools our customers are using today."
},
{
"speaker": "Scott Herren",
"text": "And Jay, I will jump in on the second part and I guess. Thank you for the congratulations on my 25th Autodesk earnings call. If I get this right, it’s your 125th Autodesk earnings call, a little bit of a difference there. History with the company. I would like to congratulate you as well. It’s interesting…"
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you."
},
{
"speaker": "Scott Herren",
"text": "… if you look at the rates, we are seeing less of a differential by vertical and more of a differential by country. So in other words, if country acts is seeing nice robust growth, we see that in both the AEC and in the manufacturing side. If it’s continuing to be somewhat flat and stable, we see that again by vertical. So it’s, I’d say the better differentiator in usage is more, how is the region performing, how is the country performing, then it is within that country is it AEC or manufacturing. The industry collections versus standalone, I will just reiterate what I said in the opening commentary that industry collections continues to be a stable share of our overall business. So we are not seeing a significant mix shift there. Early on, we had seen a mix shift of the new sales more toward LTE and we talked about last quarter that that reverted back to the mean where it had been historically. So we are not seeing a significant mix shift at this point either way. The last thing that I’d add, because I know the detail of your spreadsheets and you probably already got everything laid out here, but to give you a sense on our new business growth and in particular, our product subscription new business growth, from a unit standpoint, no question, we have been impacted by the pandemic, more so in new business unit than in other places. That new business grew sequentially from Q2 to Q3 and that’s our expectation those units will grow again from Q3 to Q4. So just to give you a sense of how things are performing."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thanks very much both of you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Jay."
},
{
"speaker": "Scott Herren",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Brad Zelnick from Credit Suisse. Your line is now open."
},
{
"speaker": "Brad Zelnick",
"text": "Great. Thanks so much. So, congrats all around, guys, particularly for Scott. Best of everything especially in your next chapter. And the topic for both of you, I wanted to ask you about innovation. The sheer amount of innovation on display at Autodesk University this year was -- I guess, I’d just say overflowing. So, Andrew, for you, the easy question. What excites you the most? And my parting gift for you, Scott, maybe a little more complex. How should we think about the pace of innovation going forward, because you’ve always talked about high-single, low double-digit spend growth, but we are below 7% year-to-date. So should we think about spend growth accelerating meaningfully to the high end of your range to recapture the tremendous opportunity ahead? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "All right. So Brad, I love this question. Innovation is absolutely hyper critical to everything we do. We believe we are powering lot of transformation and a lot of dialog in the industry right now. We are delighted to see our competitors start to talk like we have been talking for years and I think that’s a sign of the kind of innovation we are putting into the market. Here’s what I will tell you I am really excited about. I am excited about the merger of SaaS, cloud compute and machine learning and this transformational power for our industry, right? This is what gets me up every morning right now in terms of what we are going to be able to deliver for our customers. When we get more and more of their processes in the cloud, when we are computing more and more with their data -- with ever-decreasing compute costs in the cloud and layering on machine learning, we are going to be able to provide our customers with insights and productivity enhancements that are simply beyond anything they have imagined right now. And it gets me extremely excited to be part of driving that change into the industry and what it means. Now, I can talk about the individual technologies that play into all that, there’s lots. But if you talk at a high level about what gets me excited, it’s that. And one thing I think is before -- as a segue to Scott answering his questions, I think, it’s important for you to know that next year we are probably the largest R&D spender in our segment, all right, and I just want you to think about that. After all the discussions we had going through the business model transformation, to all of a sudden be talking about a world where nobody, probably nobody is spending as much in this space on R&D as Autodesk is. I think that is a fundamental change and a lot of innovation comes from that much spend. Scott?"
},
{
"speaker": "Scott Herren",
"text": "I am not sure what to add to that, Andrew. I think you said it exactly right. We are at a fortunate position, Brad. And thanks for your kind words, by the way. But we are at a fortunate position in the model where we can both grow spending and increase margins year-on-year. And so if you look at the midpoint of the updated guide for this year, for fiscal 2021, it implies just short of an 8% growth in total spend. So the cost of goods sold plus OpEx. Looking ahead, on top of that, we have invested pretty significantly and grown our investment in R&D, headcount for R&D for sales capacity this year in some of the areas that Andrew just touched on earlier in Jay’s question about building out our internal systems and our internal infrastructure. So we have invested quite a bit in innovation already this year that will obviously carry on into next year and we have made a handful of not large but strategic acquisitions to continue to fuel that innovation. So we -- I think long-term targeting double-digit revenue growth is somewhat dependent on us continuing to invest on the R&D side of things and I feel really good about the position we are in to be able to both drive that investment and an increase margins out through fiscal ‘23."
},
{
"speaker": "Brad Zelnick",
"text": "Okay. Thanks very much. Happy holidays and we look forward to hosting you next week."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Brad."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Keith Weiss from Morgan Stanley. Your line is now open."
},
{
"speaker": "Keith Weiss",
"text": "Excellent. Thank you guys for taking the question. Scott, would it be out of line to try to convince you to stay at Autodesk? I mean, it’s a lot more interesting than like a networking company."
},
{
"speaker": "Scott Herren",
"text": "I am not. I think the first…"
},
{
"speaker": "Andrew Anagnost",
"text": "Scott, enough like hard work, Keith, keep him."
},
{
"speaker": "Keith Weiss",
"text": "Exactly. He’s a good one. You should have tried harder to keep him. And so, thank you, guys, for taking the question. On the quarter, again, two things I want to just get a little more color on. One is kind of like the pace of recovery that you guys are seeing and expecting. It seemed like earlier this year you might have thought it was going to come a little faster, given what you are seeing in Asia-Pac, maybe that’s spreading out a little bit. But with the turn in like the current RPO for this quarter, it looks like you guys are really actually the whole business is turning a corner here. So one, can you give us kind of your latest thinking on the shape of the recovery and kind of what’s assumed as we look into FY ‘22? And then carrying on that total spend commentary, a lot of companies that we talk to saw expense savings this year due to COVID and lower T&E spending and just were able to garner efficiencies in their overall business, some of which they need to give back in the year ahead as we get into a more normalized environment. Is there a big component of that in the Autodesk business that we should be thinking about when we are modeling margins into FY ‘22?"
},
{
"speaker": "Scott Herren",
"text": "Yeah. So, Keith, I will start and Andrew, you can add color to it. In terms of what we are seeing, we are seeing recovery. Andrew alluded to it and gave some of the specific countries where we are seeing recovery already and where we are at a level of activity that’s above pre-COVID rates. I think someone earlier highlighted APAC. APAC has been quite strong for us from that standpoint. We are seeing Continental Europe recover nicely as well. The -- our expectations for Q4 is that we will continue to see a modestly improving economic environment and as we look out at next year, I think, we will continue to see improvement. I am not sure it’s going to be a straight line improvement or especially given the current wave, but we will continue to see improvement and I expect by the second half of the year that we will see some pretty good recovery and economic activity that clearly will benefit us. So think of next year as being a little more back-end loaded and I think that’s part of what you see with the early look that we have given you on what revenue growth looks like this year. Q4, again, midpoint of the guide has revenue growth at about 12% and op margin for Q4 will be about in line with the full year at about 29%. I think looking out at next year you will see both of those grow. Revenue growth will increase from there and op margin will increase from there. On the specific COVID spend savings, I think, we have had the same savings that everyone has had. Obviously T&E travel expense has been a big savings for us. But as we look at -- events have gone more virtual, I think, that will continue. We have had modest amount of savings from the operations of our facilities, our offices. As we look at next year, I don’t expect that to be a significant year-on-year headwind. Travel of course will return. But we are going to build the budget such that I don’t expect it to come back anywhere near to where it was in, let’s say, calendar 2019 or in our fiscal ‘20. I think if nothing else we have learned, you don’t have to be face-to-face with a customer to get that final agreement. You don’t have to be face-to-face internally to get things done the way we need to get them done internally. So I think we will continue to see ongoing savings in T&E. It will step up from this year certainly but it’s not going to be a significant headwind for us on spend."
},
{
"speaker": "Keith Weiss",
"text": "Got it. Super helpful. Thanks, guys."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Keith."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Adam Borg from Stifel. Your line is now open."
},
{
"speaker": "Adam Borg",
"text": "Hey, guys, and thanks for taking the question, and Scott, of course, congrats on the new role. Just on some announcements coming out of AU and talking a little more about Autodesk Build. You mentioned how you are leading with that going forward but you do have the big installed base on BIM 360 and PlanGrid. So I was just curious kind of what the migration path looks like for those assets to Autodesk Build? And maybe quickly as a follow-up on the Spacemaker acquisition, any commentary, Scott, on expectations for revenue growth? Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. All right. So let me start with the migration path. So for PlanGrid, for those customers that migrated from PlanGrid and ultimately migrated on Build. It’s actually not a heavy lift because of the way we built the application. PlanGrid’s huge innovation and huge value-add to the whole stack is a mobile experience. They are really good at it. So what we did is we basically used the PlanGrid experience and the PlanGrid team as the mobile experience for Build. So the move from PlanGrid to build is as a progression is not a heavy lift. Now you are right, we have a long tail of customers that are on BIM 360 Field, BIM 360 next-gen Field. Those customers over time are going to be migrating to Build at a pace that makes sense for them. But what we have done is we have created an environment that allowed them to shift as projects sunset and they go onto new projects. We have got a whole master plan with our customers success organization and construction on how you they move over time. We are not going to force anybody to move ahead of their time, but we have got a well-crafted plan for how we move these people. It’s more of a heavy lift for people that are on BIM 360 Field, less of a heavy lift for people who are on BIM 360 next gen which is where Docs -- Autodesk Docs was built off of and it’s a much smaller lift for PlanGrid customers."
},
{
"speaker": "Scott Herren",
"text": "And Adam to your question on Spacemaker, I am super excited by the technology, and I don’t know if you had a chance to see it demoed at AU, but if you didn’t I’d highly recommend it, you have got to take a look at it. This is a — it’s obviously a tremendously exciting technology and some super talented people that we picked up with the Spacemaker acquisition. Impact financially is going to be nominal. It will actually be slightly dilutive and that’s built into our expectations for next year. There’s another effect that I probably should have mentioned earlier and I want to make sure I get it out on the call, though. The one thing that will change next year and it’s a slight headwind to us in terms of revenue growth year-on-year, we have almost all of our products are already ratable, right? But there’s a couple of really small products, one, Vault, that we talked about in the past, that did not get over the hurdle to get away from upfront revenue recognition. We have continued to work on that product. We have continued to do things that incorporate much more cloud based functionality and I think in the first part of next year Vault will flip from upfront rev rec to full ratable rev rec and that looks like it’s about a point of growth. Again, already built into kind of the early view that I gave you of the low-double, low- to mid-teens revenue growth for next year but the impact of Vault is built into that, obviously, it normalizes in fiscal 2023 because once it bucks ratable, the compare points are equivalent. But that’s one if you are building your model on that level of detail, I think of that being a bit of a headwind that’s already built into the early view of ‘22."
},
{
"speaker": "Adam Borg",
"text": "Yeah. Great."
},
{
"speaker": "Andrew Anagnost",
"text": "I will make some…"
},
{
"speaker": "Adam Borg",
"text": "Thanks again guys."
},
{
"speaker": "Andrew Anagnost",
"text": "I will make one more comment on Spacemaker just because I kind of forgot to segue to you on that. But Spacemaker represents that perfect convergence of SaaS, cloud compute and machine learning into solving real world problems for our customers. I think you are going to see the impact on our business accumulate over time as the technology expands and as it connects itself deeper with Revit and other parts of the process. One of the things I love about the Spacemaker team is they have this philosophy of making multiple constituents more successful with their objectives and that’s the building owner, the developer making their investment more profitable. That’s the city making sure the impact on infrastructure is managed and controlled. And they also have a big customer or big stakeholder in this, is the environment and helping architects and city planners make more sustainable decisions in real time for how things are built. It’s the perfect example of how all these things come together to change the way people make design decisions and ultimately build decisions. So look for its impact to expand over time as that team starts hooking into other parts of our process, builds out their existing products and inevitably starts moving into other parts of the organization, which we always see with acquisitions like this."
},
{
"speaker": "Scott Herren",
"text": "Yeah. There’s absolutely a lot of synergies that we see with Spacemaker coming in."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks again."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Steve Koenig from SMBC Nikko. Your line is now open."
},
{
"speaker": "Steve Koenig",
"text": "Hey. Terrific. Thanks for squeezing me in, guys. I appreciate it. And Scott, best of luck to you and thanks for all the hard work you have done for us over the years. Definitely appreciate it."
},
{
"speaker": "Scott Herren",
"text": "Yeah. Thanks. Thank you."
},
{
"speaker": "Steve Koenig",
"text": "Cool. So I will just ask one question. Andrew, had you had some pretty open, transparent communications with customers this last quarter in terms of the letter that was written? And just in terms of looking at what those customers were asking for? They were very clearly asking for accelerating the roadmap in architecture and engineering design, which doesn’t seem like we talked a lot about on the call today, hasn’t been a focus. And if I read between the lines in that communication, the customers also seemed a bit frustrated with the transitions they have been going through from maintenance to subscriptions to collections and now to named users. And it just seems like there’s a little bit of dissonance between what they are asking for and what I am hearing from you on the call today and I’d love to get your thoughts on how -- why is that there may be misperception gap and what are you guys doing about it? And thanks very much."
},
{
"speaker": "Andrew Anagnost",
"text": "Steve, there’s absolutely no dissidents. All right. One of the things I think I said consistently in the communication and I will take you back in communication is, we started investing in the road map for Revit well ahead of these communications, all right, from these customers, because we made a deliberate choice to invest in construction and not in Revit functionality for architects. So are these customers are going to thoroughly quickly start to see changes and additions to Revit from the investment we made actually at the end of last year. And I think you are missing something, we just spent several $100 million on the architecture segment of our space, all right. Spacemaker is squarely targeted at design and architecture and the founders of Spacemaker are architects, all right."
},
{
"speaker": "Steve Koenig",
"text": "Okay."
},
{
"speaker": "Andrew Anagnost",
"text": "This technology is right on the edge, and like I said, we just spent a lot of money to do this and this is right in the act. It’s something we have been looking at for a while. So no there’s no dissonance here in terms of where we are focused and where we are. With regard to the migration, look, you have got to -- when we started this migration with two -- something under 2 million maintenance customers. Most of those have come along with us. We never expected that all of them were going to come along with us happily. And what we are done is we have reached the end of the tale with some maintenance customers that are more frustrated with the changes than not. But at the same time we have added millions of other customers that weren’t able to afford some of our solutions before, because of the upfront cost of these solutions. So, yeah, maintenance customers that have been with us have seen lots of transition. They are not done yet. We haven’t retired all those models yet. But remember we started with less than 2 million of those. We are over 5 million subscribers right now. A fraction of those are from that maintenance base. We have to remember, let’s look at the big picture here as well as the small picture. I understand and I empathize the frustration of those customers who started on maintenance and journeyed with us. But we have reached so many more customers, so many more architecture firms, so many individual architects, so many people that couldn’t afford Revit, so many people that couldn’t afford that extra seed of AutoCAD, so many high growth companies, that if they add seats, they are actually spending less over five years than they would have with us adding seats in the perpetual model. That’s a big story and it’s transformative to the industry in terms of how much value people are able to get now. So let’s make sure we stay focused on the big picture here."
},
{
"speaker": "Steve Koenig",
"text": "Cool. Well, I appreciate your thoughts and thanks again for the open communication. Good luck to you, Scott."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Steve."
},
{
"speaker": "Operator",
"text": "This is all the time we have for Q&A today. I would like to turn the call back over to Simon Smith for closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you, Gigi, and thanks, everyone, for joining us today. We are looking forward to seeing many of you at conferences over the next few weeks. Please do reach out to us if you have any follow ups on anything from this call. This concludes our call today. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s conference call. Thanks for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 2 | 2,021 | 2020-08-25 17:00:00 | Operator: Ladies and gentlemen, thank you for standing by. And welcome to the Autodesk Second Quarter Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference to your speaker today, Abhey Lamba, VP, Investor Relations. Please go ahead, sir.
Abhey Lamba: Thanks, operator. And good afternoon. Thank you for joining our conference call to discuss the results of our second quarter of fiscal year 2021. On the line is Andrew Anagnost, our CEO, and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors including developments in the COVID pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance. And unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in the press release or the slide presentation on our investor relations website. And now, I would like to turn the call over to Andrew.
Andrew Anagnost: Thank you, Abhey. To start, I hope everyone is safe and healthy as our world continues to be impacted by the COVID pandemic. Our priorities remain the safety and well-being of our employees, and the continued support of our customers, partners and communities. Before I dive into the quarter, I thank all of our employees for their efforts and persistence during these challenging times. The resiliency of our business model and solid execution helped us deliver strong Q2 results with revenue, earnings and free cash flow above expectations, even as we continue to operate in uncertain times. The secular trends that we have been investing in and preparing for, such as the adoption of cloud-based solutions, are accelerating and we are excited about our position in the market. While our competitors are just beginning to focus on similar trends, our investments from the last few years are already driving positive results. With the business model changes we have made, we continue to deliver significant value and functionality in the cloud. Because of this, and a few other aspects I'll discuss, we will be stronger on the other side of this pandemic. As indicated on the last call, we continue to closely monitor the usage patterns of our products across the globe, something we could not do historically. In China, Korea, and Japan, we are seeing usage above pre-COVID levels. In some areas of Europe, we continue to see a recovery as well. In the Americas, we experienced a slight uptick in usage for most key products in July. We are also seeing a positive correlation between usage trends and new business performance, which gives us confidence that the green shoots we see in usage will translate to improved new business performance in subsequent quarters. In all senses, work is changing, and our cloud collaboration products effectively connect project teams and workflows allowing businesses to thrive even when their employees and partners are working remotely. Usage of BIM 360 Design, our cloud collaboration tool, has accelerated with the adoption by Revit users almost doubling in the past year. We also continued to gain momentum in manufacturing of Fusion 360. We had the best quarter ever for subscription net additions with more than 10,000 in the quarter. The value of the cloud is becoming more and more apparent and cloud-based solutions are becoming a necessity. Our product subscription renewal rates improved steadily throughout Q2 as customers recognize the critical value our offerings bring to their businesses. Our new business was impacted by the current environment, but the strength of our pipeline entering the second half of the year, combined with execution in recovering countries, make us confident in our full-year targets. Now, I'd like to turn it over to Scott to take you through details of our quarterly performance and guidance for the year before I come back to provide insights into our strategic growth drivers.
Scott Herren: Thanks, Andrew. As you just heard, despite facing the economic headwinds from COVID, we had strong performance across all key metrics in the quarter. Total revenue growth in the quarter came in at 15% as reported, 16% at constant currency, with subscription plan revenue growing by 27% and operating margin expanding by 5 percentage points. Despite offering extended payment terms through the quarter, we delivered healthy free cash flow of $64 million. Current RPO, which reflects committed revenue for the next 12 months, is up 15% and total RPO is up 19%. Our ongoing investments in digital sales are yielding results as we saw strong double-digit billings growth through the online channel during the quarter. Our online sales are helping attract new customers to the Autodesk family, as nearly three out of four new customers in the quarter came in through e-commerce. Our run rate business came in strong during the quarter, while the pace of closing larger transactions slowed modestly. In Q2, our net revenue retention rate was within the 100% to 110% range we laid out in our previous guidance. As Andrew mentioned, we saw resilient renewal rates in the quarter. Digging deeper into our renewal rates, our product subscription renewal rates improved on a sequential basis, which is a strong endorsement of the strategic nature of our products and stickiness of our customer base in this new business model. We experienced a decline in maintenance renewal rates, as expected, since we announced the end of life of our maintenance offerings. With our transition to a subscription business model behind us, maintenance is only about 5% of our revenue. Similar to last quarter, more than 40% of the maintenance customers who came up for renewal converted to subscriptions. Our M2S revenue, combined with our maintenance revenue this quarter at $229 million, is close to 80% of our peak quarterly maintenance revenue in Q1 fiscal 2016. This speaks to the great success we have had with the program. In Q2, we also saw industry collections grow sequentially as a share of total new business. While multi-year payments are down year-over-year, toward the end of the second quarter, we saw a slight uptick in multi-year payments as customers continue to make long-term commitments to our products. APAC led the way in share of multi-year deals, consistent with the region's relatively strong performance in new business. As we anticipated, our second quarter new business activity was more impacted than in Q1, with new business declining in the range of mid-teens percent. In line with our commentary on the last call, we think the second quarter will be the most impacted by the pandemic. Our business is recovering in the markets that were impacted by the pandemic earlier on. However, some of our major markets like the US and UK have stabilized, but are yet to show meaningful improvement. As such, we continue with a wider-than-normal revenue range for the remainder of the year, while raising the midpoint of our guidance. Our updated guidance implies continued improvement in all of our end markets over the next two quarters and we expect the pace of closing larger transactions to improve. In addition to the impact of large deal activity, the range of our forecast factors in varying degrees of demand environment in the Americas, which includes our largest end market. At the upper end of our guidance range, we are modeling meaningful recovery in the region in the third quarter, with continued improvement in the fourth quarter. At the low end of the range, we anticipate a slower recovery in the third quarter and improvement in Q4. We are very pleased with the performance of our product subscription renewal rates in the second quarter and expect them to continue improving for the rest of the year. For the remaining maintenance base, we expect churn to further increase, but recall that we are in the final stages of ending our maintenance offering and the number of seats is small versus our total installed base. We expect our net revenue retention rate to remain between 100% and 110% for the rest of the year. Our full-year operating margin should expand by approximately 3 percentage points to 4.5 percentage points as we keep exercising our strong discipline around spend management, while continuing to invest in strategic priorities. Despite improving multi-year trends we experienced at the end of the quarter, we are taking a cautious view of their continued uptake in the second half of the year, which is impacting the upper end of our billings forecast range for the year. Our billings adjustment does not affect our free cash flow estimate of $1.3 billion to $1.4 billion for fiscal 2021 as we expect strong cash collections to continue. Finally, we are confident in our fiscal 2023 free cash flow target of $2.4 billion. And now, I'd like to turn it back to Andrew.
Andrew Anagnost : Thank you, Scott. I am proud of the team for what we accomplished in Q2. With the investments we have made over the last few years and our move to make everyone a named user, we are in the final stages of becoming a true SaaS provider and delivering a significant amount of capabilities in the cloud. We can now deliver enhanced value to our users and administrators. And our named user model enables our customers to operate efficiently in a remote work environment. Our transition to named users is off to a promising start, with some customers choosing to adopt it ahead of the launch earlier this month. Khatib & Alami, one of the largest construction and engineering consulting firms in the Middle East, saw the value in its ability to accelerate work from home and reached out to transition early. The transition to the named user model is not the only thing ensuring their business continuity while working from home. During the quarter, they increased their seats of BIM 360 Design, breaking silos and enabling their building and infrastructure teams to collaborate on Revit and Civil 3D models from different locations. During the quarter, we also launched our premium subscription plan, which would not have been possible without converting everyone to named users. We can now offer added security with single sign-on capabilities, ease of administration, and advanced product usage information for administrators. One of the first to make the investment in the premium plan was one of our long-time customers, Calibre Diona, a leading provider of professional infrastructure and built-environment solutions headquartered in Australia. The most compelling features for them are the single sign-on capability and the license usage visibility. Calibre Diona has been partnering with Autodesk for 20 years, and our products have enabled them to continue innovating to deliver valuable design and engineering solutions to their customers as both CAD technology and engineering practices have evolved from the drawing board to AutoCAD and now to BIM. This next phase of our journey will enable us to offer even greater value to our customers as a true cloud technology provider. Now, let me update you on our three key growth initiatives – accelerating digitization in AEC, convergence of design and make in manufacturing, and monetization of non-compliant and legacy users. Our AEC business has continued to be resilient. Our products enable more efficient communication and increased oversight as the industry works through additional steps in their processes, such as new shift paradigms and optimized site layouts. We continue to make investments in construction where we expect technology adoption to keep growing, especially as we exit the pandemic. We recently announced three notable investments. First, we acquired Pype, which closed this month, and will add significant value for Autodesk Construction Cloud users, allowing general contractors, subcontractors and owners to automate workflows such as submittals and project closeouts to increase overall productivity and reduce risk throughout the project lifecycle. Second, we also made a strategic investment in Bridgit. Bridgit offers workforce optimization solutions for contractors. Third, we expanded our existing relationship with Factory_OS. Factory_OS is helping us improve our products to support the convergence of construction and manufacturing, thereby advancing prefabrication, off site, and modular construction practices. We continue to enhance our project and cost management capabilities by improving connected workflows and cost tracking functionality. As you may recall, a large number of construction sites had shut down when we started the quarter. Sales of our construction solutions targeted at field activities started out slowly, but improved during the quarter as construction sites began to reopen. During the quarter, Saunders Construction, a top ENR 400 provider of comprehensive construction management and general contracting services, signed a three-year renewal expansion with us, citing their previous success with our products and the ongoing value we deliver in terms of productivity gains across the project lifecycle. Saunders has been successfully using Revit in coordination with BIM 360 Field and Glue, and Navisworks for field execution, and BIM coordination for years. This enabled Saunders to centralize their document management, connect their office and field teams, build out their quality and safety programs, minimize rework, and enable company enterprise reporting. With this agreement, they're now positioned to continue growing their deployment of our construction cloud with our dedicated support and we're excited to expand our partnership with them. Our BIM 360 Design solutions continued to perform strongly throughout the quarter as architects and contractors adjusted to the remote work environment and found immense value in its cloud-based collaboration capabilities. KPF, one of the largest architecture firms in New York City, with offices and projects all over the world, is also investing in BIM 360 solutions. James Brogan, Principal at KPF, said, "At KPF, collaborating effectively with global clients and design teams is critical to our success. As such, our partnership with Autodesk and the use of BIM 360 in conjunction with Revit, in particular, have become fundamental to our business, enabling us to efficiently manage design data across global teams and deliver world-class outcomes for our clients." We continue to make progress and provide more value to customers in the infrastructure space. During the quarter, one of the largest infrastructure design firms in the US renewed and expanded their enterprise business agreement, or EBA, with Autodesk. This customer is leveraging the EBA token offering to digitize the company and move traditional file-based workflows to data-driven design, leveraging the cloud and displacing competition. With the ever-growing need to work remotely, and in large project teams with multiple stakeholders, this customer is investing in Autodesk BIM 360 as the common data platform for managing project information, collaboration, and model coordination. This design customer also added PlanGrid to manage RFIs and submittals in the field, as well as Assemble for conditioning models for estimating and quantity takeoffs. As I mentioned earlier, Fusion is continuing to accelerate within our manufacturing portfolio and gaining traction with generative design. This quarter, Firefly Aerospace, a rocket and spacecraft company based in Austin, TX, committed to Autodesk over multiple competitors as their partner of choice for design, analysis, and manufacturing software because of efficiency gains realized in their design-to-make workflows and lightweighting opportunities provided by generative design. Their first launch vehicle has been designed and built using the entirety of Autodesk's Design and Make solutions and the team at Firefly is already thinking about how generative design can be used to optimize their designs further. In a market where reduction in weight directly correlates to a reduction in cost, generative design can not only firmly establish Firefly as a thought leader in their space, but also as the most economical launch platform on the market. Leveraging these advanced tools from Autodesk will enable them to stay one step ahead of the competition. Today, we announced that our existing advanced manufacturing technologies PowerMill, PowerShape, and PowerInspect will become part of the Fusion 360 platform. This complements our existing offering of Fusion 360 with FeatureCAM for production machining applications and also allows us to bring new advanced capabilities to our core Fusion 360 cloud-based software. This is a natural progression as we see high interest from customers to use next-generation design and manufacturing workflows in Fusion 360 alongside our advanced manufacturing tools. It is also a key step toward our long-standing vision of seamless collaboration between designers and engineers, uniting design and manufacturing under the power of a single cloud platform. In Q2, we also signed a deal with Nobel Biocare, which included subscriptions to PowerMill, PowerShape, and Fusion 360 with FeatureCAM. Headquartered in Switzerland, Nobel Biocare manufactures dental implants and CAD/CAM-based individualized prosthetics, and they receive orders for custom, single and multiple-unit implant restorations from all over the world. The custom restoration is manufactured from start to finish using Autodesk software and using our technology. Nobel Biocare has created a fully automated process that allows them to produce completely unique dental restorations, meeting the individual needs of their dental patients. We are the preferred vendor for building product manufacturers who need to design within the context of the building information model. During the quarter, we signed a new enterprise business agreement with one of the largest manufacturers of exterior building products in North America. Even amid an uncertain business climate, the US-based manufacturer is strategically investing and partnering with Autodesk to support their focus on innovation and industrialized construction. They are looking to Autodesk solutions, such as BIM 360, Revit and Inventor, to help them maximize efficiencies by digitally transforming and improving processes across the entire construction ecosystem. We also displaced a local competitor at a building product manufacturer in France due to our deep connection to BIM. The convergence of design and make in manufacturing is happening and our deep connection to BIM will enable us to win. Moving on to updates on our digital transformation and progress monetizing non-compliant users. We are confident in our ability to convert the long-term opportunity. However, in the short term, we continue to be mindful of the current environment and importance of working with non-compliant users in respectful and reasonable ways. In Q2, we closed three deals of more than $1 million each in the APAC region where business activity has returned to pre-COVID levels. Also during the quarter, we closed a deal with a design-build architecture firm in China, against a local, lower-cost competitor. A few quarters ago, the customer decided to make the switch away from AutoCAD solely based on cost savings, but their engineers continued to use our software due to the necessary functionality. We were able to convert them back to paying users based on the value our solutions provide. In closing, we are building a stronger Autodesk for the long term. We have a head start over our competition in critical capabilities like cloud computing and cloud-based collaboration and we will continue to invest in our strategic initiatives. There are multiple drivers that make us confident in our fiscal 2023 targets and beyond. First, digitization in AEC is going to accelerate in the coming years as companies seek to not only make current processes more resilient and efficient, but to support new industrial paradigms for construction. Second, the evolution of manufacturing to a more distributed network and cloud-based workflow is also going to accelerate significantly over the next few years and we have the industry's leading multi-tenant cloud-based solution to address the emerging customer needs that will shape demand. And third, our business model is more robust, adaptable and resilient than in the entire history of the company. This will allow us to not only invest in the future, but to do so with an eye to both revenue and margin growth. With that, operator, we'd now like to open the call up for questions.
Operator: Thank you. [Operator Instructions]. Our first question comes from Saket Kalia with Barclays.
Saket Kalia: Hey, Scott, maybe for you. Can you just talk about what you're seeing on customer preferences for different duration contracts? You touched on this a little bit in prepared remarks, but can you just talk about what you saw in terms of contract duration this quarter and how you're planning for that the rest of the year as we think about that change to the top end of the billings guide?
Scott Herren: You're spot on. And we said coming into the quarter, when we gave the previous guide, that we felt Q2 would be the toughest quarter of the year. And in particular, we thought we would see an impact on multi-year, and we've seen that at the very end of Q1. And we did see that. We saw an impact, although it didn't – the rate of customers buying multi-year didn't fall through the floor by any stretch, but it came down earlier in the quarter. And then, as the quarter went on, we saw it modestly improving each month throughout the quarter. So, the multi-year did take a hit and then improved throughout the quarter. But with that said, remember, when we rolled out that guidance and we described it, I think, in quite a bit of detail what would take us to the high end of the range versus the low end. And at the high end of the guidance ranges, we had assumed a swift recovery in the second half of the year. And that's exactly what we're seeing in some markets, but not in all of our markets. So, the adjustment in the billings guide is really driven by our expectation of less multi-year sales and a slightly slower recovery in the US and UK, as we talked about on the opening commentary.
Saket Kalia: Maybe for you, Andrew, for my follow up. A little bit sort of disconnected from the results a little bit. But you posted an interesting blog a couple weeks ago about Autodesk in the AEC industry. And I guess I just want to zero in on one part of it, which was the idea that architectural customers – you spent a lot of time, by the way, in your prepared remarks – may actually be paying less under the subscription model versus the old perpetual maintenance model. And so, I was just wondering if you could expand on that a little bit. And maybe address whether Autodesk is actually potentially leaving money on the table in the AEC industry.
Andrew Anagnost: Thanks for proving to me why this audience won't be as empathetic to some of those concerns that were expressed as other audiences. So, first off, let me just acknowledge something about the communications with the AEC industry, and the architects in particular. One, they have legitimate concerns about the functionality in Revit. And we take those incredibly seriously. And the fact is, is that from an architectural standpoint, Revit hasn't gotten a lot of incremental investment, a lot of the AEC investments have gone to construction, it's gone to revenue enhancements targeting the engineering component, the workflow – structural workflows, in particular. So, there's some real legitimate concerns there. The other concern they have is the move from multiuser to named users. These are large multi-user clients and they've seen multi-user prices drift up. They really want a pay per use model. We want them to have a pay per use model, which they would prefer to a cloud licensing. So, those are some things I just want to make sure that we acknowledge. And we're all on the same page with. But that said, like you said, and it was important that I make this clear, these customers come from a highly privileged, roughly 20% of our subscription base that moved from maintenance to subscription and have really pretty deep price protections, okay, relative to the rest of the base. And if you look at their expenditures over a five-year period, frankly, even over – moving out another five years, as they add seats, they are actually paying less to Autodesk than they would have under the old perpetual model. And that was a deliberate part of the transition, even as multiuser prices go up in everything. If you add up what they would have paid for us for adding users over time, they actually end up paying less over a five-year period and, frankly, as they add users over a 10-year period. We're not concerned about that. We went out very early on that we were going to take care of these maintenance customers that were out in front of us. We did that. Lots of debates with all of you about the maintenance subscription program and 10-year price lock. It wasn't exactly something that all of you were behind. Alright? But we think it was right. And yes, it has resulted in this. So, we're never going to be on the same page with this audience about that particular part of the equation. But remember, this is a shrinking bit of our subscription base, the protected 20% now. There'll be less than that later. But, over time, they pay less than they used to in the old perpetual model. It's true. But we're not worried about that. There's no concern there.
Operator: Our next question comes from Jay Vleeschhouwer with Griffin Securities.
Jay Vleeschhouwer: Question number one, Andrew, is about the intersection of what you've called three inevitabilities or eventualities in your business. Number one, collections in the cloud. Two, a consumption model. And then, three, an underlying rearchitecting of your platform. The product information model or whatever you're going to be calling it now, you are doing that underlying rearchitecting work. And so, in terms of connecting all of those things, how feasible or desirable might it be for you to re-segment the portfolio, not to go back to where you were pre-transition in terms of having dozens of SKUs and so forth, but perhaps you would have the opportunity to have some additional number of flavors, either standalone or perhaps new collections, configurations that you would be able to feasibly bring to market based on the new architecture, named user and so forth. So, the follow-up question. At the analyst meeting two months ago, you talked about your customer breakdown as consisting of named account, mid markets, strategic territory and plain vanilla territory. The question there is, could you talk about the performance in each of those four segments and how you're thinking about those for the remainder of the year and whether you're doing anything in terms of sales capacity and/or back-end margins? Thanks.
Andrew Anagnost: So, I'm going to take the first part of that, and I'm going to hand the second part of that to Scott. Right? So, Jay, you asked a very complicated, sophisticated question there. But let me kind of summarize it this way, right. The model that we're going to is a greater segmentation in some respects, but I want to keep pointing you back to the way Fusion is being architected and constructed. All right? Fusion has a subscription entry price. There's a set of functionality that people use frequently and that they're using to do a lot of their day to day work, but then there's a series of modules that they can reach out to and access on a need-based method. Okay? And you just noticed we added more of those recently to Fusion, from technology that was previously in the Delcam portfolio. This model of having a, for the lack of a better word, a vertical platform that's, for instance, in manufacturing, it's built on the product information model in the cloud; in AEC, it's going to be built on a building information model in the cloud; in media, it might be built on a media information model in the cloud and things associated with that. They will be able to pull the functionality they need as they need it. They'll pay a baseline subscription, and they'll pay per use for various things as they need them and as they need some of this advanced capability. So, if you think about it, is that a segmentation of our portfolio and an increase of SKUs? Maybe in some respects, but what it's designed to do is ensure that occasionally used functionalities of high value, they can get when they need it without having to get it all at once. That's the notion of collections in the cloud. It's collection in the cloud that they can use on an as-needed basis. So, when you look at what we're doing with Fusion, that really directionally captures where the model is going for all of our customers, ultimately. And it's all connected. You're right. Named user, necessary to do that because you have to name the user, so that you can track their usage and their needs and provide something to them specifically. That doesn't mean the named user can't be a large pool of named users that come in occasionally, which is something that people want in terms of consumption and pay per use, but it's also connected right back again to the underlying architecture of the products. And that's the future we're going to. Scott, off to you.
Scott Herren : Jay, let me let me take your question from the bottom up. If we start with territory – strategic territory, which tends to be our smaller accounts. It was actually quite strong. And we touched on this kind of qualitatively in the opening commentary. We saw good strength in that small customer set. And more so if you – instead of slicing it by customer size, slice it by geo, you can see the result. APAC was quite strong where we've seen the pandemic at first. They went through what they went through. As those markets reopened, we called out China, Korea and Japan as actually being above pre-COVID levels. So, seeing good strength in the smaller accounts and seeing good strength in APAC and then subsequently in continental Europe. As you work your way up to mid-market and name, name, it doesn't have a big Q2. That's where most of our EBAs sit. That's where all of our EBAs sit is in the name user – or I'm sorry, in the named account category. And that seems to be heavier in the second half of the year. So, we've actually got a very full pipeline of large transactions, large accounts, EBA renewals that are coming up. And those EBAs have close to 100% renewal rate. So, named did fine during the quarter, but Q2 is not a big quarter for named accounts. And mid-market was a little bit more tepid. And what I'd say there is, we had a lot of multi-user usage within the mid-market. And you've seen what we've done with the transition to named, moving away from multi-user and over to named. We didn't actually have that offer, that two for one offer active until the beginning of Q3. So, there's little bit of a pause in the mid-market as many of those mid-market accounts, by the way, doing what all of us are doing, kind of assessing their business and understanding their needs, but also had the impact of wanting to get to the transition to named program that we launched at the beginning of Q3. That's the right way to think about it by customer size.
Operator: The next question comes from Matt Hedberg with RBC Capital Markets.
Matthew Hedberg: Congrats on the results and really good to hear the strength in the renewal business. I guess, for either of you, maybe Scott, outside of the trends in multi-year that you alluded to in your answer to Saket's question earlier, I'm wondering if you could talk in a little bit more detail about how new business trends have progressed through the quarter? And maybe how August has trended versus last year? I know Andrew mentioned strengthened pipeline. Just wondering on that new business side, what gives you confidence there?
Scott Herren: I'll start on that, Andrew, and let you jump in and add some more color. What we saw in the new businesses is really in line with what our expectations were in those markets that have opened up. So, slice it first by geo, Matt. When you look at it by geo, APAC new business rates were the highest. Continental Europe, think about the way that the pandemic struck Continental Europe. Next, and the US and the UK, by the way, outside of Continental Europe, both feeling like they've stabilized. There's no further declines. And we see modest bump up, modest bump down. I'd say they're more stable than they are coming back out of it yet in those two markets. So, new business has kind of followed those trends. Andrew talked about their usage rates and we've been monitoring those usage rates around the world. And what we see is, as the usage rates come back, as the markets reopen, we see the new business come back at the same time. So, that's probably the right overall characterization for it. Andrew, anything you'd add to that?
Andrew Anagnost: The correlation between usage rates and then ultimate new business, it's proving out to be fairly tight. So, we expect to see that continue. We saw it in APAC. We watched go up. We're seeing it in Europe. Like we said earlier, we're seeing stability in the US and the UK. And we expect that, as that moves from stability to rising, we're going to see the same kind of uptick in new business. The two seem to be correlating quite well.
Matthew Hedberg: And then, AutoCAD and AutoCAD LT, I think they grew 18% in the quarter. Wonder if you can talk a bit more granularity about AutoCAD LT. I know that has actually been fairly strong for you thus far. And I know, historically, had been weaker in times of stress. Just Wondering how LT is holding up relatively in this market.
Andrew Anagnost: We used to talk about that as the canary in the coal mine for market dislocation at the low end. But subscription changes everything. The subscription price point for LT is a very attractive price point. And most of the customers that are buying it are very small businesses, small or very small, medium businesses. And it does what they need. So, they continue to buy in the space. People buy AutoCAD for the 3D and the APIs and the things that go associated with that. But the price point of LT has actually proven to be very attractive and very resilient during this time. And it's just one of the fundamental changes in the subscription model.
Operator: Our next question comes from Brad Zelnick with Credit Suisse.
Brad Zelnick: Andrew, I wanted to dig into manufacturing a bit more. The segment only grew 6% this quarter despite all of the good things happening with the convergence of design and make. Is there anything in particular that you'd call out as having a more pronounced impact in manufacturing?
Andrew Anagnost: Actually, we're growing faster than our biggest competitor in the space. So, I just want to make sure we get that in. Look, the space is doing well. Remember, we continued to grow strong last year. So, we had good strong growth coming into last year and next year. So, we're comparing 6% to a good year last year, not 6% to a bad year last year or something like that. So, we're actually happy with the performance we're seeing right now. And I think that's an important metric for us, especially what you see going on with regards to Fusion and the net adds around Fusion. So, we view this as a solid result, and it's only going to continue to get better. So, I think we're in a good position right now. Especially when you look at what we're comparing to from last year.
Brad Zelnick: That's fair. And maybe just in follow-up, can you talk about the strong performance of ecommerce channel? Are you seeing changes in the types of products customers are purchasing through this channel? And does this in any way change how you're thinking about the direct business longer term?
Andrew Anagnost: It doesn't fundamentally change our strategy. We're still trying to get that that digital direct online business up to 25% of our total business. So, our strategy hasn't fundamentally changed. The product mix does change a little bit. All right? They are buying additional products on this channel. But fundamentally, our strategy hasn't changed. But it has, obviously, held up incredibly well during this and customers have continued to buy. But the strategy, the fundamental strategy of where we're going and what we're trying to do, we want everything we sell available on the channel. And our goal is still to get it up to 25%.
Operator: Our next question comes from Phil Winslow with Wells Fargo.
Philip Winslow: Congrats on another strong quarter. I just want to focus in on AEC again. Obviously, you mentioned some of the slow starts or positive in projects at the beginning of the quarter. But if I look at your comments, you talked about competitive wins in project management in your 360. design uptake. Wondering if you could talk about just the puts and takes that you're seeing in the AEC vertical and how are you thinking about those as we go into the second half? Thanks.
Andrew Anagnost: The total business grew fairly well. All right? And I think we just want to make sure that we zero in on the things that are soft and the things that aren't. Let's talk specifically about construction. As I said in the opening commentary, the field area is where we see the softness. And right now, it's stabilizing and we expect to see field usage going up. And that's to be expected, given everything that happened with construction sites. But where we're seeing strength, and this is an important precursor to future business, right, because it's upfront in the process, is BIM 360 design and doc, which are part of the pipeline of loading the project flow. So, BIM 360 design, doc in particular, has seen robust growth during this entire period in the construction segment. Obviously, Revit continues to do well in this segment in terms of BIM in general doing well. So, I want to make sure that we pay attention to – the softness is really in the places where the hammers are hitting the wood or hitting the metal, depending on what you're building or the concrete is being poured. And it's not in the upfront part of the project and the project management, which is great for us, because we're bringing more people into the pipeline. And if all we were doing was being narrowly focused on the execution part, we would certainly be in deeper problems than we are right now in the field execution side. We have a broad portfolio that goes all the way from design through to pre-construction planning, and that part is continuing to see robust action.
Operator: Our next question comes from Koji Ikeda with Oppenheimer.
Koji Ikeda: Great quarter. Had a question on the Pype acquisition. Congrats on that acquisition. We've actually heard really great things about Pype technology out in the field. And my question is about the technology and the workflows that it will enhance in the construction cloud, really balancing against any potential overlap with other products within the construction cloud. So, I guess, from a high level, what are the key construction workflow enhancements coming from the Pype acquisition? And are there any technology overlaps with existing products? Thank you.
Andrew Anagnost: Obviously, Pype's in the project management area. And one of the key things it adds is a machine learning layer to the whole process of setting up and managing changes and requests and work orders in the process. Okay? So, what it's doing is it's shortening the time to work these close outs and these project activities upfront in the process. So, it's giving us technology that provides for faster turnaround, better project management, lower risk and better outcomes. That's really what it's doing. We certainly have some of these capabilities inside the core portfolio, but nothing as deep as what Pype has. Pype went a lot more deeply into the workflow and covers a lot more use cases than we do. And as you know, we were partnered with them throughout the process and we have lots of accounts where we were in there, Pype was in there and we worked really very closely with them to make sure that we were complementing our RFI workflows and not duplicating them. So, their whole process takes the RFI and similar workflow to a whole new level. And it's a pretty powerful combination for us. And like you said, our customers were pretty bullish on the technology as well, which is one of the reasons why we were bullish.
Koji Ikeda: And just maybe one follow-up on the big deals in Asia. Congrats again on the three big license compliance deals of over a million. Great news there. I guess, could you tell us maybe what the average contract duration was for those deals? And could you remind us, how does that deal type volume compare to prior periods, the three license deals? And I guess, really, from a big picture perspective, how many of these 1 million plus license compliance deals are out there in the world today? Thanks again for taking my questions.
Scott Herren: The reason for calling out those deals is not that they were particularly notable in terms of duration, et cetera. It's more to give you a sense of – we've talked about – out of deference to our customers and the position that many are put in in this economic environment, continuing to work the back end and drive the demand for our license compliance business, but to go a little bit more slowly at a time when markets are and our customers are under particular levels of stress. As we've seen those markets open back up, the reason to call out those is not only are they large, but they're also in markets that have recovered and that we are seeing come back. And as they do, we're getting right back on the – ensuring that we can monetize those non-compliant users. So, that was the purpose of calling them out, much more so than saying they were particularly lengthy in duration.
Operator: Our next question comes from Adam Borg with Stifel.
Adam Borg: I just had two quick ones. I guess first, just building off Matt's question earlier around AutoCAD LT, obviously, you mentioned the strength in AutoCAD LT given the price points. I just wanted to drill in. Are you seeing any customers optimize purchases? You talked about that last quarter. So, any trade-downs from either AutoCAD or industry collections? Any commentary there would be great. And just as a quick follow-up, just want to talk about partial renewal rates. I know you've talked about renewal rates being in line with expectations, but just any commentary around the partial renewal activity would be great.
Andrew Anagnost: I'll take the AutoCAD question And I'll hand the renewal rate question over to Scott. So, actually, we're not seeing that kind of behavior. What we're seeing is growth in all of these segments independent of each other. So, we're seeing customers sticking with collection. We're seeing customers buying AutoCAD for the first time. We're seeing customers buying LT for the first time. We're not seeing a lot of cross flow between the two. But remember, as time goes on, AutoCAD does get squeezed between collections and LT over the long period. And we expect that. That's something that we plan for, that we expect, we model. At some point, the AutoCAD as it is today gets squeezed between those two types of offerings. But right now, we're not seeing trade-up or trade-down. We're seeing people staying within the offerings they have, buying more of the offering they have and adding up in that respect. So, Scott, to the partial renewals.
Scott Herren: Just to put a finer point on what you just said, Andrew, if you look at our product mix in terms of the percent of sales that are LT versus AutoCAD versus collections and other, it's kind of reverted to its historical mean. So, we're not seeing a big shift between in product mix. To your question on partial renewals, we continue to obviously to monitor that closely because it's a good indicator of how are the – what's the employment health of our customers, right? So, a partial renewal is, I had 10 subscriptions, they all came due at the same point. But instead of renewing 10, I only renewed 9 or I renewed 8, right? And it gives us a sense of changes in their headcount. There's always a certain amount of that that happens in any given quarter. And what we talked about last quarter is we've monitored the rate of those as they come up, what percent of them are doing a partial renewal, and it really hadn't moved last quarter. And it's really materially the same again this quarter. So, we're not seeing a big change either up or down. I wouldn't expect it to go down from the base rate, but we're not seeing it increase from that base rate.
Operator: Our next question comes from Keith Weiss with Morgan Stanley.
Hamza Fodderwala: This is Hamza Fodderwala in for Keith Weiss. Andrew, I was hoping if you could give like an updated breakdown of the business between infrastructure, commercial, industrial construction. You talked a lot about industrial. Clearly, the macro seems to be rebounding. But we're still hearing a lot of uncertainty around the commercial segment. I think in the past, people have thought that Autodesk is quite tied to the commercial side. But, clearly, there's good growth in the other segments. So, I was wondering if you could give any view on your exposure through those three verticals and how you're seeing the macro in each of those?
Andrew Anagnost: We're not seeing any slowdown in our AEC business due to commercial dislocations that might be going on in various places right now. So, we talked about that a lot. Because there was this assumption that somehow commercial, especially commercial office buildings in urban areas are like a big part of our business. They're not, all right? And we're still kind of seeing strength in the AEC business outside of that. But I want to make sure we understand what's really happening in commercial right now. All right? Big urban projects are probably – either probably going to slow down or not be as frequent. However, what is happening in urban locations, there's still going to be a lot of reconfiguring work in commercial space. But also one of the things that that we're going to be seeing, and you can see this in some of some of the political discussions as well as some of the business discussions we're having, is that you're going to see more and more of these commercial type operations moving away from the urban centers to suburban centers and along transportation corridors, which we see not only as driving additional building activity, but additional infrastructure improvements as well. And these conversations are already ongoing in all sorts of legislatures and all sorts of places about building out along transportation corridors. It's certainly a big topic of conversation in California, and we expect to see more of that. So, no, we are not seeing softness in our business, and we don't see any future softness in our business as a result of what's happening with commercial activities right now.
Hamza Fodderwala: Scott, just a follow-up question for you. Obviously, stronger than expected Q2. Andrew spoke to an improving pipeline in the back half. Just wondering the reason for the high end of the revenue guide declining a bit versus last quarter. Was that – the explanation there similar to what you mentioned for billings earlier? I'm not sure I fully understood.
Scott Herren: No, it's slightly different, although it's got the same root cause. So, I'd start by saying, I'm really pleased with our results and proud of our execution in the second quarter. In an incredibly uncertain environment, to be able to produce the results that we just put up is something that I think we all take a lot of pride in. And as a result of that, as you saw, we raised the midpoint of our full-year revenue guide by $15 million. So, that's kind of the high level view. When you look at how we did that, we've pulled up the low end and slightly reduced the high end of that guidance range. I think your question is just about the slight reduction on the high end as we narrowed the range from what had been $100 million range. With only six months left, we narrowed it down to $60 million. We're seeing good trends in the markets that have moved into reopening. We talked about China, Korea and Japan. Product subs renewal rates are trending in the right direction. We mentioned the pipeline. The pipeline is very strong. There's still a fair amount of uncertainty, particularly in the US and in the UK. And so, as we weigh all that together, it's the combination of those factors that give us the confidence to raise our overall revenue guide by $15 million at the midpoint. But we had said the high end of that guidance range – and this is the point I talked about earlier, Hamza. At the high end of our guidance range, previously, we were expecting a swift recovery. And while we've seen that in some markets, we haven't seen that in all markets. And so, that's why narrowing just slightly from the high end of the revenue range made sense.
Operator: And our next question comes from Joe Vruwink with Baird.
Joe Vruwink: My question is on the product roadmap. Andrew, I thought the blog post you had recently was interesting because it kind of shows this mindfulness of striking a balance, investing in certain functionality and anything that maybe gets a pass in a given year you circle back to, which I think was the case with Revit architecture. I guess my question is more on the go forward. There's going to be this interplay now, not that it's new, but it's going to increase where you have your core Revit, Inventor users that are increasingly tapping into cloud functionality, and it's only going to go up now. Do you have to be mindful about certain things with this audience shifting to the cloud where maybe you shift your investment priorities or different things in the product portfolio receive greater investment? Any meaningful changes you foresee because of this kind of newer, structurally higher dynamic that's in place?
Andrew Anagnost: Shift is not correct – not necessarily the right word. What it really will be is where we put new dollars. So, for instance, at the beginning of this year, this whole concern around architecture and architects, this is something we saw coming because this has been a five plus year kind of tension around – with the architects. So, we actually increased investment in AutoCAD Architecture at the beginning of this year. So, we actually used incremental R&D dollars to increase investment in that space. What it will mean moving forward is how we deliberately choose where we add incremental investment, and we've been very rich and forthright with the construction space in terms of incremental investment. We're not going to shift money away from that. But as we add incremental investment into next year and year after that, we'll probably add more incremental investment into other places over time. So, rather than thinking about it as a shift, Joe, I think of it as, as we continue to add incremental investment, which we're in the enviable position to be able to do, we're spending more in R&D than we ever had in our history. And we have still room to invest more, we're just going to choose deliberately to add incremental investment in certain spaces, like we did at the beginning of this year for architecture.
Operator: Our next question comes from David Hynes with Canaccord.
David Hynes: Two questions from me. I'll start with you, Scott. Curious what the lag time was between the uptick in active use and then the resumption of demand that you saw in APAC? And I guess the question is, if the same held true in the Americas based on what you saw in July, when would you expect to see an uptick in demand here?
Scott Herren: I don't really want to get into parsing it quite that finely for you, David. What we did see is, as the usage ticked up, there was a bit of a lead time, but it's not measured in months. But there was a bit of a lead time between usage ticks up and when the actual new product sales pick up. And our expectation, not only have we seen that in APAC now, but we've seen the same phenomenon as the markets have reopened in Continental Europe. So, our expectation is as we get more into a reopening in the United States that we'll see that same thing here. I think the UK is dealing with a slightly separate issue than just the normal recovery from the pandemic.
David Hynes: Andrew, one for you. Curios what the education channel – I know it's not a revenue driver for Autodesk. But obviously, it's training future users. So, I'd be curious what you're seeing there, just given the uncertainty around back-to-school processes and enrollment numbers. Any color would be helpful.
Andrew Anagnost: Yeah. Education usage is up for us. All right? I think, frankly, the remote nature of work is kind of playing nicely into our strategy in certain areas, especially with regards to the cloud and how the cloud interacts with certain parts of the curriculum. Certainly, on the university side, Fusion is doing well because of its cloud foundation. And remember, we have Tinkercad in K-12. So, Tinkercad is getting more visibility in a lot of curriculums right now as well. So, education has done really well for us during the pandemic in terms of – it's not that we haven't seen declines in usage. We absolutely have. But it's rebounded back to usage levels that we had in pre-COVID days, which is a positive sign. And we're seeing gains in educational usage in places where the cloud is a priority for the usage paradigm.
Operator: And our last question comes from Jason Celino with KeyBanc Capital Markets.
Jason Celino: Maybe one quick one for Scott. More of a forward-looking question. I think there have been a lot of questions on what you're seeing in churn today. But, I guess, what are you building in the guidance? Because I think last quarter, you mentioned that you are building in some conservatism around that for the second half.
Scott Herren: Our expectation – I'm quite pleased, actually, with the way the renewal rates on products subscriptions, which is by far the biggest piece of our subscription base, has progressed throughout the quarter, and it's our expectation that we will continue to see slight improvements on that through the end of the year. That's kind of now looking across all countries. Obviously, it varies a bit by region as different regions are recovering from the economic impact of the shutdown differently. But I think, in aggregate, what the expectation should be, continued slight improvement in those renewal rates on product subs. Maintenance is quite small. It's not surprising to see churn rate increase on maintenance as we've now informally announced the end of life of maintenance. And it's kind of the last chance to either renew, convert or churn. And so, we're seeing an increase in both renew – I'm sorry, we're seeing an increase in both convert and churn at the same time, which is in line with our expectations. And of course, maintenance is quite a small element of our overall subscription base and our revenue base at this point. So, not surprising on that front. And I would expect to see that maintenance churn rate continue at a higher-than-normal level through the end of the year.
Jason Celino: One for Andrew really quick on Fusion 360. The net additions that you mentioned, any way to think about where those came from? Were they existing users or completely new users? And were they using cloud before?
Andrew Anagnost: It's kind of all of them. All right? There were existing users that added more. So, we've had expansion. We're getting bigger and bigger Fusion installations, which is a good sign. There are also new users at the low end of the market. We see a lot of users consolidating their CAM and design solutions at the low end of the market into Fusion and moving forward with Fusion. So, it's kind of a combination of all those things. We saw some users converting from some of our hobbyist versions to commercial versions. So, it's across the whole spectrum. But really, the big drivers are, we're selling more into accounts where we had it and we're selling more down market into accounts that are basically unifying their portfolios inside of their operations.
Operator: Thank you. And this is all the time we have for today. I would now like to turn the call back over to Abhey Lamba for closing remarks.
Abhey Lamba : Thank you, Joelle. And thanks, everyone, for joining us today. Please reach out to us if you want to follow-up on anything. This concludes our call for today. Thanks.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. And welcome to the Autodesk Second Quarter Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference to your speaker today, Abhey Lamba, VP, Investor Relations. Please go ahead, sir."
},
{
"speaker": "Abhey Lamba",
"text": "Thanks, operator. And good afternoon. Thank you for joining our conference call to discuss the results of our second quarter of fiscal year 2021. On the line is Andrew Anagnost, our CEO, and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors including developments in the COVID pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance. And unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in the press release or the slide presentation on our investor relations website. And now, I would like to turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Abhey. To start, I hope everyone is safe and healthy as our world continues to be impacted by the COVID pandemic. Our priorities remain the safety and well-being of our employees, and the continued support of our customers, partners and communities. Before I dive into the quarter, I thank all of our employees for their efforts and persistence during these challenging times. The resiliency of our business model and solid execution helped us deliver strong Q2 results with revenue, earnings and free cash flow above expectations, even as we continue to operate in uncertain times. The secular trends that we have been investing in and preparing for, such as the adoption of cloud-based solutions, are accelerating and we are excited about our position in the market. While our competitors are just beginning to focus on similar trends, our investments from the last few years are already driving positive results. With the business model changes we have made, we continue to deliver significant value and functionality in the cloud. Because of this, and a few other aspects I'll discuss, we will be stronger on the other side of this pandemic. As indicated on the last call, we continue to closely monitor the usage patterns of our products across the globe, something we could not do historically. In China, Korea, and Japan, we are seeing usage above pre-COVID levels. In some areas of Europe, we continue to see a recovery as well. In the Americas, we experienced a slight uptick in usage for most key products in July. We are also seeing a positive correlation between usage trends and new business performance, which gives us confidence that the green shoots we see in usage will translate to improved new business performance in subsequent quarters. In all senses, work is changing, and our cloud collaboration products effectively connect project teams and workflows allowing businesses to thrive even when their employees and partners are working remotely. Usage of BIM 360 Design, our cloud collaboration tool, has accelerated with the adoption by Revit users almost doubling in the past year. We also continued to gain momentum in manufacturing of Fusion 360. We had the best quarter ever for subscription net additions with more than 10,000 in the quarter. The value of the cloud is becoming more and more apparent and cloud-based solutions are becoming a necessity. Our product subscription renewal rates improved steadily throughout Q2 as customers recognize the critical value our offerings bring to their businesses. Our new business was impacted by the current environment, but the strength of our pipeline entering the second half of the year, combined with execution in recovering countries, make us confident in our full-year targets. Now, I'd like to turn it over to Scott to take you through details of our quarterly performance and guidance for the year before I come back to provide insights into our strategic growth drivers."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Andrew. As you just heard, despite facing the economic headwinds from COVID, we had strong performance across all key metrics in the quarter. Total revenue growth in the quarter came in at 15% as reported, 16% at constant currency, with subscription plan revenue growing by 27% and operating margin expanding by 5 percentage points. Despite offering extended payment terms through the quarter, we delivered healthy free cash flow of $64 million. Current RPO, which reflects committed revenue for the next 12 months, is up 15% and total RPO is up 19%. Our ongoing investments in digital sales are yielding results as we saw strong double-digit billings growth through the online channel during the quarter. Our online sales are helping attract new customers to the Autodesk family, as nearly three out of four new customers in the quarter came in through e-commerce. Our run rate business came in strong during the quarter, while the pace of closing larger transactions slowed modestly. In Q2, our net revenue retention rate was within the 100% to 110% range we laid out in our previous guidance. As Andrew mentioned, we saw resilient renewal rates in the quarter. Digging deeper into our renewal rates, our product subscription renewal rates improved on a sequential basis, which is a strong endorsement of the strategic nature of our products and stickiness of our customer base in this new business model. We experienced a decline in maintenance renewal rates, as expected, since we announced the end of life of our maintenance offerings. With our transition to a subscription business model behind us, maintenance is only about 5% of our revenue. Similar to last quarter, more than 40% of the maintenance customers who came up for renewal converted to subscriptions. Our M2S revenue, combined with our maintenance revenue this quarter at $229 million, is close to 80% of our peak quarterly maintenance revenue in Q1 fiscal 2016. This speaks to the great success we have had with the program. In Q2, we also saw industry collections grow sequentially as a share of total new business. While multi-year payments are down year-over-year, toward the end of the second quarter, we saw a slight uptick in multi-year payments as customers continue to make long-term commitments to our products. APAC led the way in share of multi-year deals, consistent with the region's relatively strong performance in new business. As we anticipated, our second quarter new business activity was more impacted than in Q1, with new business declining in the range of mid-teens percent. In line with our commentary on the last call, we think the second quarter will be the most impacted by the pandemic. Our business is recovering in the markets that were impacted by the pandemic earlier on. However, some of our major markets like the US and UK have stabilized, but are yet to show meaningful improvement. As such, we continue with a wider-than-normal revenue range for the remainder of the year, while raising the midpoint of our guidance. Our updated guidance implies continued improvement in all of our end markets over the next two quarters and we expect the pace of closing larger transactions to improve. In addition to the impact of large deal activity, the range of our forecast factors in varying degrees of demand environment in the Americas, which includes our largest end market. At the upper end of our guidance range, we are modeling meaningful recovery in the region in the third quarter, with continued improvement in the fourth quarter. At the low end of the range, we anticipate a slower recovery in the third quarter and improvement in Q4. We are very pleased with the performance of our product subscription renewal rates in the second quarter and expect them to continue improving for the rest of the year. For the remaining maintenance base, we expect churn to further increase, but recall that we are in the final stages of ending our maintenance offering and the number of seats is small versus our total installed base. We expect our net revenue retention rate to remain between 100% and 110% for the rest of the year. Our full-year operating margin should expand by approximately 3 percentage points to 4.5 percentage points as we keep exercising our strong discipline around spend management, while continuing to invest in strategic priorities. Despite improving multi-year trends we experienced at the end of the quarter, we are taking a cautious view of their continued uptake in the second half of the year, which is impacting the upper end of our billings forecast range for the year. Our billings adjustment does not affect our free cash flow estimate of $1.3 billion to $1.4 billion for fiscal 2021 as we expect strong cash collections to continue. Finally, we are confident in our fiscal 2023 free cash flow target of $2.4 billion. And now, I'd like to turn it back to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Scott. I am proud of the team for what we accomplished in Q2. With the investments we have made over the last few years and our move to make everyone a named user, we are in the final stages of becoming a true SaaS provider and delivering a significant amount of capabilities in the cloud. We can now deliver enhanced value to our users and administrators. And our named user model enables our customers to operate efficiently in a remote work environment. Our transition to named users is off to a promising start, with some customers choosing to adopt it ahead of the launch earlier this month. Khatib & Alami, one of the largest construction and engineering consulting firms in the Middle East, saw the value in its ability to accelerate work from home and reached out to transition early. The transition to the named user model is not the only thing ensuring their business continuity while working from home. During the quarter, they increased their seats of BIM 360 Design, breaking silos and enabling their building and infrastructure teams to collaborate on Revit and Civil 3D models from different locations. During the quarter, we also launched our premium subscription plan, which would not have been possible without converting everyone to named users. We can now offer added security with single sign-on capabilities, ease of administration, and advanced product usage information for administrators. One of the first to make the investment in the premium plan was one of our long-time customers, Calibre Diona, a leading provider of professional infrastructure and built-environment solutions headquartered in Australia. The most compelling features for them are the single sign-on capability and the license usage visibility. Calibre Diona has been partnering with Autodesk for 20 years, and our products have enabled them to continue innovating to deliver valuable design and engineering solutions to their customers as both CAD technology and engineering practices have evolved from the drawing board to AutoCAD and now to BIM. This next phase of our journey will enable us to offer even greater value to our customers as a true cloud technology provider. Now, let me update you on our three key growth initiatives – accelerating digitization in AEC, convergence of design and make in manufacturing, and monetization of non-compliant and legacy users. Our AEC business has continued to be resilient. Our products enable more efficient communication and increased oversight as the industry works through additional steps in their processes, such as new shift paradigms and optimized site layouts. We continue to make investments in construction where we expect technology adoption to keep growing, especially as we exit the pandemic. We recently announced three notable investments. First, we acquired Pype, which closed this month, and will add significant value for Autodesk Construction Cloud users, allowing general contractors, subcontractors and owners to automate workflows such as submittals and project closeouts to increase overall productivity and reduce risk throughout the project lifecycle. Second, we also made a strategic investment in Bridgit. Bridgit offers workforce optimization solutions for contractors. Third, we expanded our existing relationship with Factory_OS. Factory_OS is helping us improve our products to support the convergence of construction and manufacturing, thereby advancing prefabrication, off site, and modular construction practices. We continue to enhance our project and cost management capabilities by improving connected workflows and cost tracking functionality. As you may recall, a large number of construction sites had shut down when we started the quarter. Sales of our construction solutions targeted at field activities started out slowly, but improved during the quarter as construction sites began to reopen. During the quarter, Saunders Construction, a top ENR 400 provider of comprehensive construction management and general contracting services, signed a three-year renewal expansion with us, citing their previous success with our products and the ongoing value we deliver in terms of productivity gains across the project lifecycle. Saunders has been successfully using Revit in coordination with BIM 360 Field and Glue, and Navisworks for field execution, and BIM coordination for years. This enabled Saunders to centralize their document management, connect their office and field teams, build out their quality and safety programs, minimize rework, and enable company enterprise reporting. With this agreement, they're now positioned to continue growing their deployment of our construction cloud with our dedicated support and we're excited to expand our partnership with them. Our BIM 360 Design solutions continued to perform strongly throughout the quarter as architects and contractors adjusted to the remote work environment and found immense value in its cloud-based collaboration capabilities. KPF, one of the largest architecture firms in New York City, with offices and projects all over the world, is also investing in BIM 360 solutions. James Brogan, Principal at KPF, said, \"At KPF, collaborating effectively with global clients and design teams is critical to our success. As such, our partnership with Autodesk and the use of BIM 360 in conjunction with Revit, in particular, have become fundamental to our business, enabling us to efficiently manage design data across global teams and deliver world-class outcomes for our clients.\" We continue to make progress and provide more value to customers in the infrastructure space. During the quarter, one of the largest infrastructure design firms in the US renewed and expanded their enterprise business agreement, or EBA, with Autodesk. This customer is leveraging the EBA token offering to digitize the company and move traditional file-based workflows to data-driven design, leveraging the cloud and displacing competition. With the ever-growing need to work remotely, and in large project teams with multiple stakeholders, this customer is investing in Autodesk BIM 360 as the common data platform for managing project information, collaboration, and model coordination. This design customer also added PlanGrid to manage RFIs and submittals in the field, as well as Assemble for conditioning models for estimating and quantity takeoffs. As I mentioned earlier, Fusion is continuing to accelerate within our manufacturing portfolio and gaining traction with generative design. This quarter, Firefly Aerospace, a rocket and spacecraft company based in Austin, TX, committed to Autodesk over multiple competitors as their partner of choice for design, analysis, and manufacturing software because of efficiency gains realized in their design-to-make workflows and lightweighting opportunities provided by generative design. Their first launch vehicle has been designed and built using the entirety of Autodesk's Design and Make solutions and the team at Firefly is already thinking about how generative design can be used to optimize their designs further. In a market where reduction in weight directly correlates to a reduction in cost, generative design can not only firmly establish Firefly as a thought leader in their space, but also as the most economical launch platform on the market. Leveraging these advanced tools from Autodesk will enable them to stay one step ahead of the competition. Today, we announced that our existing advanced manufacturing technologies PowerMill, PowerShape, and PowerInspect will become part of the Fusion 360 platform. This complements our existing offering of Fusion 360 with FeatureCAM for production machining applications and also allows us to bring new advanced capabilities to our core Fusion 360 cloud-based software. This is a natural progression as we see high interest from customers to use next-generation design and manufacturing workflows in Fusion 360 alongside our advanced manufacturing tools. It is also a key step toward our long-standing vision of seamless collaboration between designers and engineers, uniting design and manufacturing under the power of a single cloud platform. In Q2, we also signed a deal with Nobel Biocare, which included subscriptions to PowerMill, PowerShape, and Fusion 360 with FeatureCAM. Headquartered in Switzerland, Nobel Biocare manufactures dental implants and CAD/CAM-based individualized prosthetics, and they receive orders for custom, single and multiple-unit implant restorations from all over the world. The custom restoration is manufactured from start to finish using Autodesk software and using our technology. Nobel Biocare has created a fully automated process that allows them to produce completely unique dental restorations, meeting the individual needs of their dental patients. We are the preferred vendor for building product manufacturers who need to design within the context of the building information model. During the quarter, we signed a new enterprise business agreement with one of the largest manufacturers of exterior building products in North America. Even amid an uncertain business climate, the US-based manufacturer is strategically investing and partnering with Autodesk to support their focus on innovation and industrialized construction. They are looking to Autodesk solutions, such as BIM 360, Revit and Inventor, to help them maximize efficiencies by digitally transforming and improving processes across the entire construction ecosystem. We also displaced a local competitor at a building product manufacturer in France due to our deep connection to BIM. The convergence of design and make in manufacturing is happening and our deep connection to BIM will enable us to win. Moving on to updates on our digital transformation and progress monetizing non-compliant users. We are confident in our ability to convert the long-term opportunity. However, in the short term, we continue to be mindful of the current environment and importance of working with non-compliant users in respectful and reasonable ways. In Q2, we closed three deals of more than $1 million each in the APAC region where business activity has returned to pre-COVID levels. Also during the quarter, we closed a deal with a design-build architecture firm in China, against a local, lower-cost competitor. A few quarters ago, the customer decided to make the switch away from AutoCAD solely based on cost savings, but their engineers continued to use our software due to the necessary functionality. We were able to convert them back to paying users based on the value our solutions provide. In closing, we are building a stronger Autodesk for the long term. We have a head start over our competition in critical capabilities like cloud computing and cloud-based collaboration and we will continue to invest in our strategic initiatives. There are multiple drivers that make us confident in our fiscal 2023 targets and beyond. First, digitization in AEC is going to accelerate in the coming years as companies seek to not only make current processes more resilient and efficient, but to support new industrial paradigms for construction. Second, the evolution of manufacturing to a more distributed network and cloud-based workflow is also going to accelerate significantly over the next few years and we have the industry's leading multi-tenant cloud-based solution to address the emerging customer needs that will shape demand. And third, our business model is more robust, adaptable and resilient than in the entire history of the company. This will allow us to not only invest in the future, but to do so with an eye to both revenue and margin growth. With that, operator, we'd now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions]. Our first question comes from Saket Kalia with Barclays."
},
{
"speaker": "Saket Kalia",
"text": "Hey, Scott, maybe for you. Can you just talk about what you're seeing on customer preferences for different duration contracts? You touched on this a little bit in prepared remarks, but can you just talk about what you saw in terms of contract duration this quarter and how you're planning for that the rest of the year as we think about that change to the top end of the billings guide?"
},
{
"speaker": "Scott Herren",
"text": "You're spot on. And we said coming into the quarter, when we gave the previous guide, that we felt Q2 would be the toughest quarter of the year. And in particular, we thought we would see an impact on multi-year, and we've seen that at the very end of Q1. And we did see that. We saw an impact, although it didn't – the rate of customers buying multi-year didn't fall through the floor by any stretch, but it came down earlier in the quarter. And then, as the quarter went on, we saw it modestly improving each month throughout the quarter. So, the multi-year did take a hit and then improved throughout the quarter. But with that said, remember, when we rolled out that guidance and we described it, I think, in quite a bit of detail what would take us to the high end of the range versus the low end. And at the high end of the guidance ranges, we had assumed a swift recovery in the second half of the year. And that's exactly what we're seeing in some markets, but not in all of our markets. So, the adjustment in the billings guide is really driven by our expectation of less multi-year sales and a slightly slower recovery in the US and UK, as we talked about on the opening commentary."
},
{
"speaker": "Saket Kalia",
"text": "Maybe for you, Andrew, for my follow up. A little bit sort of disconnected from the results a little bit. But you posted an interesting blog a couple weeks ago about Autodesk in the AEC industry. And I guess I just want to zero in on one part of it, which was the idea that architectural customers – you spent a lot of time, by the way, in your prepared remarks – may actually be paying less under the subscription model versus the old perpetual maintenance model. And so, I was just wondering if you could expand on that a little bit. And maybe address whether Autodesk is actually potentially leaving money on the table in the AEC industry."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks for proving to me why this audience won't be as empathetic to some of those concerns that were expressed as other audiences. So, first off, let me just acknowledge something about the communications with the AEC industry, and the architects in particular. One, they have legitimate concerns about the functionality in Revit. And we take those incredibly seriously. And the fact is, is that from an architectural standpoint, Revit hasn't gotten a lot of incremental investment, a lot of the AEC investments have gone to construction, it's gone to revenue enhancements targeting the engineering component, the workflow – structural workflows, in particular. So, there's some real legitimate concerns there. The other concern they have is the move from multiuser to named users. These are large multi-user clients and they've seen multi-user prices drift up. They really want a pay per use model. We want them to have a pay per use model, which they would prefer to a cloud licensing. So, those are some things I just want to make sure that we acknowledge. And we're all on the same page with. But that said, like you said, and it was important that I make this clear, these customers come from a highly privileged, roughly 20% of our subscription base that moved from maintenance to subscription and have really pretty deep price protections, okay, relative to the rest of the base. And if you look at their expenditures over a five-year period, frankly, even over – moving out another five years, as they add seats, they are actually paying less to Autodesk than they would have under the old perpetual model. And that was a deliberate part of the transition, even as multiuser prices go up in everything. If you add up what they would have paid for us for adding users over time, they actually end up paying less over a five-year period and, frankly, as they add users over a 10-year period. We're not concerned about that. We went out very early on that we were going to take care of these maintenance customers that were out in front of us. We did that. Lots of debates with all of you about the maintenance subscription program and 10-year price lock. It wasn't exactly something that all of you were behind. Alright? But we think it was right. And yes, it has resulted in this. So, we're never going to be on the same page with this audience about that particular part of the equation. But remember, this is a shrinking bit of our subscription base, the protected 20% now. There'll be less than that later. But, over time, they pay less than they used to in the old perpetual model. It's true. But we're not worried about that. There's no concern there."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jay Vleeschhouwer with Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Question number one, Andrew, is about the intersection of what you've called three inevitabilities or eventualities in your business. Number one, collections in the cloud. Two, a consumption model. And then, three, an underlying rearchitecting of your platform. The product information model or whatever you're going to be calling it now, you are doing that underlying rearchitecting work. And so, in terms of connecting all of those things, how feasible or desirable might it be for you to re-segment the portfolio, not to go back to where you were pre-transition in terms of having dozens of SKUs and so forth, but perhaps you would have the opportunity to have some additional number of flavors, either standalone or perhaps new collections, configurations that you would be able to feasibly bring to market based on the new architecture, named user and so forth. So, the follow-up question. At the analyst meeting two months ago, you talked about your customer breakdown as consisting of named account, mid markets, strategic territory and plain vanilla territory. The question there is, could you talk about the performance in each of those four segments and how you're thinking about those for the remainder of the year and whether you're doing anything in terms of sales capacity and/or back-end margins? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "So, I'm going to take the first part of that, and I'm going to hand the second part of that to Scott. Right? So, Jay, you asked a very complicated, sophisticated question there. But let me kind of summarize it this way, right. The model that we're going to is a greater segmentation in some respects, but I want to keep pointing you back to the way Fusion is being architected and constructed. All right? Fusion has a subscription entry price. There's a set of functionality that people use frequently and that they're using to do a lot of their day to day work, but then there's a series of modules that they can reach out to and access on a need-based method. Okay? And you just noticed we added more of those recently to Fusion, from technology that was previously in the Delcam portfolio. This model of having a, for the lack of a better word, a vertical platform that's, for instance, in manufacturing, it's built on the product information model in the cloud; in AEC, it's going to be built on a building information model in the cloud; in media, it might be built on a media information model in the cloud and things associated with that. They will be able to pull the functionality they need as they need it. They'll pay a baseline subscription, and they'll pay per use for various things as they need them and as they need some of this advanced capability. So, if you think about it, is that a segmentation of our portfolio and an increase of SKUs? Maybe in some respects, but what it's designed to do is ensure that occasionally used functionalities of high value, they can get when they need it without having to get it all at once. That's the notion of collections in the cloud. It's collection in the cloud that they can use on an as-needed basis. So, when you look at what we're doing with Fusion, that really directionally captures where the model is going for all of our customers, ultimately. And it's all connected. You're right. Named user, necessary to do that because you have to name the user, so that you can track their usage and their needs and provide something to them specifically. That doesn't mean the named user can't be a large pool of named users that come in occasionally, which is something that people want in terms of consumption and pay per use, but it's also connected right back again to the underlying architecture of the products. And that's the future we're going to. Scott, off to you."
},
{
"speaker": "Scott Herren",
"text": "Jay, let me let me take your question from the bottom up. If we start with territory – strategic territory, which tends to be our smaller accounts. It was actually quite strong. And we touched on this kind of qualitatively in the opening commentary. We saw good strength in that small customer set. And more so if you – instead of slicing it by customer size, slice it by geo, you can see the result. APAC was quite strong where we've seen the pandemic at first. They went through what they went through. As those markets reopened, we called out China, Korea and Japan as actually being above pre-COVID levels. So, seeing good strength in the smaller accounts and seeing good strength in APAC and then subsequently in continental Europe. As you work your way up to mid-market and name, name, it doesn't have a big Q2. That's where most of our EBAs sit. That's where all of our EBAs sit is in the name user – or I'm sorry, in the named account category. And that seems to be heavier in the second half of the year. So, we've actually got a very full pipeline of large transactions, large accounts, EBA renewals that are coming up. And those EBAs have close to 100% renewal rate. So, named did fine during the quarter, but Q2 is not a big quarter for named accounts. And mid-market was a little bit more tepid. And what I'd say there is, we had a lot of multi-user usage within the mid-market. And you've seen what we've done with the transition to named, moving away from multi-user and over to named. We didn't actually have that offer, that two for one offer active until the beginning of Q3. So, there's little bit of a pause in the mid-market as many of those mid-market accounts, by the way, doing what all of us are doing, kind of assessing their business and understanding their needs, but also had the impact of wanting to get to the transition to named program that we launched at the beginning of Q3. That's the right way to think about it by customer size."
},
{
"speaker": "Operator",
"text": "The next question comes from Matt Hedberg with RBC Capital Markets."
},
{
"speaker": "Matthew Hedberg",
"text": "Congrats on the results and really good to hear the strength in the renewal business. I guess, for either of you, maybe Scott, outside of the trends in multi-year that you alluded to in your answer to Saket's question earlier, I'm wondering if you could talk in a little bit more detail about how new business trends have progressed through the quarter? And maybe how August has trended versus last year? I know Andrew mentioned strengthened pipeline. Just wondering on that new business side, what gives you confidence there?"
},
{
"speaker": "Scott Herren",
"text": "I'll start on that, Andrew, and let you jump in and add some more color. What we saw in the new businesses is really in line with what our expectations were in those markets that have opened up. So, slice it first by geo, Matt. When you look at it by geo, APAC new business rates were the highest. Continental Europe, think about the way that the pandemic struck Continental Europe. Next, and the US and the UK, by the way, outside of Continental Europe, both feeling like they've stabilized. There's no further declines. And we see modest bump up, modest bump down. I'd say they're more stable than they are coming back out of it yet in those two markets. So, new business has kind of followed those trends. Andrew talked about their usage rates and we've been monitoring those usage rates around the world. And what we see is, as the usage rates come back, as the markets reopen, we see the new business come back at the same time. So, that's probably the right overall characterization for it. Andrew, anything you'd add to that?"
},
{
"speaker": "Andrew Anagnost",
"text": "The correlation between usage rates and then ultimate new business, it's proving out to be fairly tight. So, we expect to see that continue. We saw it in APAC. We watched go up. We're seeing it in Europe. Like we said earlier, we're seeing stability in the US and the UK. And we expect that, as that moves from stability to rising, we're going to see the same kind of uptick in new business. The two seem to be correlating quite well."
},
{
"speaker": "Matthew Hedberg",
"text": "And then, AutoCAD and AutoCAD LT, I think they grew 18% in the quarter. Wonder if you can talk a bit more granularity about AutoCAD LT. I know that has actually been fairly strong for you thus far. And I know, historically, had been weaker in times of stress. Just Wondering how LT is holding up relatively in this market."
},
{
"speaker": "Andrew Anagnost",
"text": "We used to talk about that as the canary in the coal mine for market dislocation at the low end. But subscription changes everything. The subscription price point for LT is a very attractive price point. And most of the customers that are buying it are very small businesses, small or very small, medium businesses. And it does what they need. So, they continue to buy in the space. People buy AutoCAD for the 3D and the APIs and the things that go associated with that. But the price point of LT has actually proven to be very attractive and very resilient during this time. And it's just one of the fundamental changes in the subscription model."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brad Zelnick with Credit Suisse."
},
{
"speaker": "Brad Zelnick",
"text": "Andrew, I wanted to dig into manufacturing a bit more. The segment only grew 6% this quarter despite all of the good things happening with the convergence of design and make. Is there anything in particular that you'd call out as having a more pronounced impact in manufacturing?"
},
{
"speaker": "Andrew Anagnost",
"text": "Actually, we're growing faster than our biggest competitor in the space. So, I just want to make sure we get that in. Look, the space is doing well. Remember, we continued to grow strong last year. So, we had good strong growth coming into last year and next year. So, we're comparing 6% to a good year last year, not 6% to a bad year last year or something like that. So, we're actually happy with the performance we're seeing right now. And I think that's an important metric for us, especially what you see going on with regards to Fusion and the net adds around Fusion. So, we view this as a solid result, and it's only going to continue to get better. So, I think we're in a good position right now. Especially when you look at what we're comparing to from last year."
},
{
"speaker": "Brad Zelnick",
"text": "That's fair. And maybe just in follow-up, can you talk about the strong performance of ecommerce channel? Are you seeing changes in the types of products customers are purchasing through this channel? And does this in any way change how you're thinking about the direct business longer term?"
},
{
"speaker": "Andrew Anagnost",
"text": "It doesn't fundamentally change our strategy. We're still trying to get that that digital direct online business up to 25% of our total business. So, our strategy hasn't fundamentally changed. The product mix does change a little bit. All right? They are buying additional products on this channel. But fundamentally, our strategy hasn't changed. But it has, obviously, held up incredibly well during this and customers have continued to buy. But the strategy, the fundamental strategy of where we're going and what we're trying to do, we want everything we sell available on the channel. And our goal is still to get it up to 25%."
},
{
"speaker": "Operator",
"text": "Our next question comes from Phil Winslow with Wells Fargo."
},
{
"speaker": "Philip Winslow",
"text": "Congrats on another strong quarter. I just want to focus in on AEC again. Obviously, you mentioned some of the slow starts or positive in projects at the beginning of the quarter. But if I look at your comments, you talked about competitive wins in project management in your 360. design uptake. Wondering if you could talk about just the puts and takes that you're seeing in the AEC vertical and how are you thinking about those as we go into the second half? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "The total business grew fairly well. All right? And I think we just want to make sure that we zero in on the things that are soft and the things that aren't. Let's talk specifically about construction. As I said in the opening commentary, the field area is where we see the softness. And right now, it's stabilizing and we expect to see field usage going up. And that's to be expected, given everything that happened with construction sites. But where we're seeing strength, and this is an important precursor to future business, right, because it's upfront in the process, is BIM 360 design and doc, which are part of the pipeline of loading the project flow. So, BIM 360 design, doc in particular, has seen robust growth during this entire period in the construction segment. Obviously, Revit continues to do well in this segment in terms of BIM in general doing well. So, I want to make sure that we pay attention to – the softness is really in the places where the hammers are hitting the wood or hitting the metal, depending on what you're building or the concrete is being poured. And it's not in the upfront part of the project and the project management, which is great for us, because we're bringing more people into the pipeline. And if all we were doing was being narrowly focused on the execution part, we would certainly be in deeper problems than we are right now in the field execution side. We have a broad portfolio that goes all the way from design through to pre-construction planning, and that part is continuing to see robust action."
},
{
"speaker": "Operator",
"text": "Our next question comes from Koji Ikeda with Oppenheimer."
},
{
"speaker": "Koji Ikeda",
"text": "Great quarter. Had a question on the Pype acquisition. Congrats on that acquisition. We've actually heard really great things about Pype technology out in the field. And my question is about the technology and the workflows that it will enhance in the construction cloud, really balancing against any potential overlap with other products within the construction cloud. So, I guess, from a high level, what are the key construction workflow enhancements coming from the Pype acquisition? And are there any technology overlaps with existing products? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Obviously, Pype's in the project management area. And one of the key things it adds is a machine learning layer to the whole process of setting up and managing changes and requests and work orders in the process. Okay? So, what it's doing is it's shortening the time to work these close outs and these project activities upfront in the process. So, it's giving us technology that provides for faster turnaround, better project management, lower risk and better outcomes. That's really what it's doing. We certainly have some of these capabilities inside the core portfolio, but nothing as deep as what Pype has. Pype went a lot more deeply into the workflow and covers a lot more use cases than we do. And as you know, we were partnered with them throughout the process and we have lots of accounts where we were in there, Pype was in there and we worked really very closely with them to make sure that we were complementing our RFI workflows and not duplicating them. So, their whole process takes the RFI and similar workflow to a whole new level. And it's a pretty powerful combination for us. And like you said, our customers were pretty bullish on the technology as well, which is one of the reasons why we were bullish."
},
{
"speaker": "Koji Ikeda",
"text": "And just maybe one follow-up on the big deals in Asia. Congrats again on the three big license compliance deals of over a million. Great news there. I guess, could you tell us maybe what the average contract duration was for those deals? And could you remind us, how does that deal type volume compare to prior periods, the three license deals? And I guess, really, from a big picture perspective, how many of these 1 million plus license compliance deals are out there in the world today? Thanks again for taking my questions."
},
{
"speaker": "Scott Herren",
"text": "The reason for calling out those deals is not that they were particularly notable in terms of duration, et cetera. It's more to give you a sense of – we've talked about – out of deference to our customers and the position that many are put in in this economic environment, continuing to work the back end and drive the demand for our license compliance business, but to go a little bit more slowly at a time when markets are and our customers are under particular levels of stress. As we've seen those markets open back up, the reason to call out those is not only are they large, but they're also in markets that have recovered and that we are seeing come back. And as they do, we're getting right back on the – ensuring that we can monetize those non-compliant users. So, that was the purpose of calling them out, much more so than saying they were particularly lengthy in duration."
},
{
"speaker": "Operator",
"text": "Our next question comes from Adam Borg with Stifel."
},
{
"speaker": "Adam Borg",
"text": "I just had two quick ones. I guess first, just building off Matt's question earlier around AutoCAD LT, obviously, you mentioned the strength in AutoCAD LT given the price points. I just wanted to drill in. Are you seeing any customers optimize purchases? You talked about that last quarter. So, any trade-downs from either AutoCAD or industry collections? Any commentary there would be great. And just as a quick follow-up, just want to talk about partial renewal rates. I know you've talked about renewal rates being in line with expectations, but just any commentary around the partial renewal activity would be great."
},
{
"speaker": "Andrew Anagnost",
"text": "I'll take the AutoCAD question And I'll hand the renewal rate question over to Scott. So, actually, we're not seeing that kind of behavior. What we're seeing is growth in all of these segments independent of each other. So, we're seeing customers sticking with collection. We're seeing customers buying AutoCAD for the first time. We're seeing customers buying LT for the first time. We're not seeing a lot of cross flow between the two. But remember, as time goes on, AutoCAD does get squeezed between collections and LT over the long period. And we expect that. That's something that we plan for, that we expect, we model. At some point, the AutoCAD as it is today gets squeezed between those two types of offerings. But right now, we're not seeing trade-up or trade-down. We're seeing people staying within the offerings they have, buying more of the offering they have and adding up in that respect. So, Scott, to the partial renewals."
},
{
"speaker": "Scott Herren",
"text": "Just to put a finer point on what you just said, Andrew, if you look at our product mix in terms of the percent of sales that are LT versus AutoCAD versus collections and other, it's kind of reverted to its historical mean. So, we're not seeing a big shift between in product mix. To your question on partial renewals, we continue to obviously to monitor that closely because it's a good indicator of how are the – what's the employment health of our customers, right? So, a partial renewal is, I had 10 subscriptions, they all came due at the same point. But instead of renewing 10, I only renewed 9 or I renewed 8, right? And it gives us a sense of changes in their headcount. There's always a certain amount of that that happens in any given quarter. And what we talked about last quarter is we've monitored the rate of those as they come up, what percent of them are doing a partial renewal, and it really hadn't moved last quarter. And it's really materially the same again this quarter. So, we're not seeing a big change either up or down. I wouldn't expect it to go down from the base rate, but we're not seeing it increase from that base rate."
},
{
"speaker": "Operator",
"text": "Our next question comes from Keith Weiss with Morgan Stanley."
},
{
"speaker": "Hamza Fodderwala",
"text": "This is Hamza Fodderwala in for Keith Weiss. Andrew, I was hoping if you could give like an updated breakdown of the business between infrastructure, commercial, industrial construction. You talked a lot about industrial. Clearly, the macro seems to be rebounding. But we're still hearing a lot of uncertainty around the commercial segment. I think in the past, people have thought that Autodesk is quite tied to the commercial side. But, clearly, there's good growth in the other segments. So, I was wondering if you could give any view on your exposure through those three verticals and how you're seeing the macro in each of those?"
},
{
"speaker": "Andrew Anagnost",
"text": "We're not seeing any slowdown in our AEC business due to commercial dislocations that might be going on in various places right now. So, we talked about that a lot. Because there was this assumption that somehow commercial, especially commercial office buildings in urban areas are like a big part of our business. They're not, all right? And we're still kind of seeing strength in the AEC business outside of that. But I want to make sure we understand what's really happening in commercial right now. All right? Big urban projects are probably – either probably going to slow down or not be as frequent. However, what is happening in urban locations, there's still going to be a lot of reconfiguring work in commercial space. But also one of the things that that we're going to be seeing, and you can see this in some of some of the political discussions as well as some of the business discussions we're having, is that you're going to see more and more of these commercial type operations moving away from the urban centers to suburban centers and along transportation corridors, which we see not only as driving additional building activity, but additional infrastructure improvements as well. And these conversations are already ongoing in all sorts of legislatures and all sorts of places about building out along transportation corridors. It's certainly a big topic of conversation in California, and we expect to see more of that. So, no, we are not seeing softness in our business, and we don't see any future softness in our business as a result of what's happening with commercial activities right now."
},
{
"speaker": "Hamza Fodderwala",
"text": "Scott, just a follow-up question for you. Obviously, stronger than expected Q2. Andrew spoke to an improving pipeline in the back half. Just wondering the reason for the high end of the revenue guide declining a bit versus last quarter. Was that – the explanation there similar to what you mentioned for billings earlier? I'm not sure I fully understood."
},
{
"speaker": "Scott Herren",
"text": "No, it's slightly different, although it's got the same root cause. So, I'd start by saying, I'm really pleased with our results and proud of our execution in the second quarter. In an incredibly uncertain environment, to be able to produce the results that we just put up is something that I think we all take a lot of pride in. And as a result of that, as you saw, we raised the midpoint of our full-year revenue guide by $15 million. So, that's kind of the high level view. When you look at how we did that, we've pulled up the low end and slightly reduced the high end of that guidance range. I think your question is just about the slight reduction on the high end as we narrowed the range from what had been $100 million range. With only six months left, we narrowed it down to $60 million. We're seeing good trends in the markets that have moved into reopening. We talked about China, Korea and Japan. Product subs renewal rates are trending in the right direction. We mentioned the pipeline. The pipeline is very strong. There's still a fair amount of uncertainty, particularly in the US and in the UK. And so, as we weigh all that together, it's the combination of those factors that give us the confidence to raise our overall revenue guide by $15 million at the midpoint. But we had said the high end of that guidance range – and this is the point I talked about earlier, Hamza. At the high end of our guidance range, previously, we were expecting a swift recovery. And while we've seen that in some markets, we haven't seen that in all markets. And so, that's why narrowing just slightly from the high end of the revenue range made sense."
},
{
"speaker": "Operator",
"text": "And our next question comes from Joe Vruwink with Baird."
},
{
"speaker": "Joe Vruwink",
"text": "My question is on the product roadmap. Andrew, I thought the blog post you had recently was interesting because it kind of shows this mindfulness of striking a balance, investing in certain functionality and anything that maybe gets a pass in a given year you circle back to, which I think was the case with Revit architecture. I guess my question is more on the go forward. There's going to be this interplay now, not that it's new, but it's going to increase where you have your core Revit, Inventor users that are increasingly tapping into cloud functionality, and it's only going to go up now. Do you have to be mindful about certain things with this audience shifting to the cloud where maybe you shift your investment priorities or different things in the product portfolio receive greater investment? Any meaningful changes you foresee because of this kind of newer, structurally higher dynamic that's in place?"
},
{
"speaker": "Andrew Anagnost",
"text": "Shift is not correct – not necessarily the right word. What it really will be is where we put new dollars. So, for instance, at the beginning of this year, this whole concern around architecture and architects, this is something we saw coming because this has been a five plus year kind of tension around – with the architects. So, we actually increased investment in AutoCAD Architecture at the beginning of this year. So, we actually used incremental R&D dollars to increase investment in that space. What it will mean moving forward is how we deliberately choose where we add incremental investment, and we've been very rich and forthright with the construction space in terms of incremental investment. We're not going to shift money away from that. But as we add incremental investment into next year and year after that, we'll probably add more incremental investment into other places over time. So, rather than thinking about it as a shift, Joe, I think of it as, as we continue to add incremental investment, which we're in the enviable position to be able to do, we're spending more in R&D than we ever had in our history. And we have still room to invest more, we're just going to choose deliberately to add incremental investment in certain spaces, like we did at the beginning of this year for architecture."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Hynes with Canaccord."
},
{
"speaker": "David Hynes",
"text": "Two questions from me. I'll start with you, Scott. Curious what the lag time was between the uptick in active use and then the resumption of demand that you saw in APAC? And I guess the question is, if the same held true in the Americas based on what you saw in July, when would you expect to see an uptick in demand here?"
},
{
"speaker": "Scott Herren",
"text": "I don't really want to get into parsing it quite that finely for you, David. What we did see is, as the usage ticked up, there was a bit of a lead time, but it's not measured in months. But there was a bit of a lead time between usage ticks up and when the actual new product sales pick up. And our expectation, not only have we seen that in APAC now, but we've seen the same phenomenon as the markets have reopened in Continental Europe. So, our expectation is as we get more into a reopening in the United States that we'll see that same thing here. I think the UK is dealing with a slightly separate issue than just the normal recovery from the pandemic."
},
{
"speaker": "David Hynes",
"text": "Andrew, one for you. Curios what the education channel – I know it's not a revenue driver for Autodesk. But obviously, it's training future users. So, I'd be curious what you're seeing there, just given the uncertainty around back-to-school processes and enrollment numbers. Any color would be helpful."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. Education usage is up for us. All right? I think, frankly, the remote nature of work is kind of playing nicely into our strategy in certain areas, especially with regards to the cloud and how the cloud interacts with certain parts of the curriculum. Certainly, on the university side, Fusion is doing well because of its cloud foundation. And remember, we have Tinkercad in K-12. So, Tinkercad is getting more visibility in a lot of curriculums right now as well. So, education has done really well for us during the pandemic in terms of – it's not that we haven't seen declines in usage. We absolutely have. But it's rebounded back to usage levels that we had in pre-COVID days, which is a positive sign. And we're seeing gains in educational usage in places where the cloud is a priority for the usage paradigm."
},
{
"speaker": "Operator",
"text": "And our last question comes from Jason Celino with KeyBanc Capital Markets."
},
{
"speaker": "Jason Celino",
"text": "Maybe one quick one for Scott. More of a forward-looking question. I think there have been a lot of questions on what you're seeing in churn today. But, I guess, what are you building in the guidance? Because I think last quarter, you mentioned that you are building in some conservatism around that for the second half."
},
{
"speaker": "Scott Herren",
"text": "Our expectation – I'm quite pleased, actually, with the way the renewal rates on products subscriptions, which is by far the biggest piece of our subscription base, has progressed throughout the quarter, and it's our expectation that we will continue to see slight improvements on that through the end of the year. That's kind of now looking across all countries. Obviously, it varies a bit by region as different regions are recovering from the economic impact of the shutdown differently. But I think, in aggregate, what the expectation should be, continued slight improvement in those renewal rates on product subs. Maintenance is quite small. It's not surprising to see churn rate increase on maintenance as we've now informally announced the end of life of maintenance. And it's kind of the last chance to either renew, convert or churn. And so, we're seeing an increase in both renew – I'm sorry, we're seeing an increase in both convert and churn at the same time, which is in line with our expectations. And of course, maintenance is quite a small element of our overall subscription base and our revenue base at this point. So, not surprising on that front. And I would expect to see that maintenance churn rate continue at a higher-than-normal level through the end of the year."
},
{
"speaker": "Jason Celino",
"text": "One for Andrew really quick on Fusion 360. The net additions that you mentioned, any way to think about where those came from? Were they existing users or completely new users? And were they using cloud before?"
},
{
"speaker": "Andrew Anagnost",
"text": "It's kind of all of them. All right? There were existing users that added more. So, we've had expansion. We're getting bigger and bigger Fusion installations, which is a good sign. There are also new users at the low end of the market. We see a lot of users consolidating their CAM and design solutions at the low end of the market into Fusion and moving forward with Fusion. So, it's kind of a combination of all those things. We saw some users converting from some of our hobbyist versions to commercial versions. So, it's across the whole spectrum. But really, the big drivers are, we're selling more into accounts where we had it and we're selling more down market into accounts that are basically unifying their portfolios inside of their operations."
},
{
"speaker": "Operator",
"text": "Thank you. And this is all the time we have for today. I would now like to turn the call back over to Abhey Lamba for closing remarks."
},
{
"speaker": "Abhey Lamba",
"text": "Thank you, Joelle. And thanks, everyone, for joining us today. Please reach out to us if you want to follow-up on anything. This concludes our call for today. Thanks."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 1 | 2,021 | 2020-05-27 17:00:00 | Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Autodesk First Quarter Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference to your speaker today, Abhey Lamba, Vice President, Investor Relations. Please go ahead, sir.
Abhey Lamba: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the results of our fiscal year 2021 first quarter results. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation, and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results, and related assumptions and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors, including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance, and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our Investor Relations website. Now I would like to turn the call over to Andrew.
Andrew Anagnost: Thank you, Abhey. To open, I want to thank all of the medical professionals and other essential workers who are confronting the impacts of the COVID-19 pandemic on the frontline. Their efforts are not only saving lives, but allowing many other people around the world to protect themselves, their families and their communities. Their efforts are truly heroic. Thank you for everything you do. Our thoughts are also with everyone affected by pandemic. And our priorities remain the safety and well-being of our employees, and the continued support of our customers, partners, and communities. Many of us, myself included are adopting multiple roles as we seek to juggle the demands of our professional and family lives in a world that has suddenly become most more complex, and more constrained. Personally I've had to learn how to home school my youngest child, and while I've always had a healthy respect for the work teachers do, I have developed an even deeper appreciation for the role teacher’s play in our societies. It takes a lot of patience and skill to help a young mind learn what it needs to learn. From a business operation standpoint, the transition to working remotely has been smooth. I am proud of how our employees and partners have balanced their personal lives with many commitments during these unprecedented times; many significant product upgrades were successfully released, thanks to our cloud-based operating infrastructure. One of the metrics we've been tracking closely is the weekly active users of our products, and since the pandemic started usage of our products dip slightly, but overall remained relatively steady. In China, usage dropped lot rapidly in February, but rebounded above pre-COVID levels by the end of March as business started reopening in the region. And it's no surprise we saw a major surge in usage of our cloud collaboration project – products, as people work from home and throughout the quarter. During the quarter and into May, renewal rates held relatively steady among our target markets, AEC revenue held up well, while we experienced a slowdown in the manufacturing space. The resiliency of our business is anchored by the diversity of our geographic regions and product offerings, our subscription -- business model and our indirect distribution model, which allows us to operate and adapt locally as economic conditions evolve in different geographic regions. During the quarter, we helped our customers accelerate their migration to the cloud and ease their transition to working from home. We also offered extended payment terms to alleviate their liquidity concerns. Please refer to the slide deck on our investor relations website for more details on these actions. I am incredibly proud of not only the way our employees rally to support each other in the company, but also how they rally to support our customers, our partners in the communities they live in. Without their resiliency, the resiliency of our business model wouldn't matter. With that, I'd like to turn it over to Scott now to take you through the details of our performance and guidance before I come back to provide insight into our strategic growth drivers.
Scott Herren: Thanks Andrew. Before I offer more details on the first quarter, I want to echo Andrew's comments thanking our heroes, battling the pandemic on the front lines. Our products, partnerships and expertise help many frontline organizations combat the pandemic, from the quick build and hospitals to manufacturing Personal Protective Equipment or PPE and the philanthropic support of global, national and local communities. My own daughter has just graduated with her nursing degree and will be on the front line next month. Availability of proper PPE for her and all the other superheroes and sprouts has been my biggest concern, so I'm particularly proud our desk has played a role in addressing that need. Our keyword performance was strong with total revenue growing by 20% subscription plan revenue grown by 35% and operating margin expanding by 10 percentage points. Total remaining performance obligations grew 27% and current remaining performance obligations grew by 18% to $2.4 billion in the quarter. We delivered free cash flow of $307 million and continue to repurchase our shares to offset solution. Typically I'll go through our results from the quarter in more detail, but today I'm going to focus on the COVID-19 impacts on our business and guidance. You can find additional details in our Q1 performance on our investor relations website. I do quickly want to mention that we have renamed what we previously called core business to design and what we previously called the cloud to make. The private labels cost to compute is almost all of our products have cloud enabled functionality. There is no change in the products that fit into each of these two categories. During the quarter renewal rate held relatively steady, whereas new business not surprisingly slowed down in the second half of Q1. However, the impact on our business has not been uniform by geography or industry. Our business is not only diverse from a geographic standpoint, but our products and customers are diverse as well. Many of you have asked about our exposure to small businesses, we generate approximately 10% to 15% of our revenues from small businesses to find those customers with less than 20 employees and with less than 15 students. Our net revenue retention rate is within the 110% to 120% range. One of the other metrics we track for customer stickiness is partial renewals, which is a measure of subscription renewals for some, but not all seats in the contract are renewed. Our partial renewal rate remained relatively steady as well. In prior downturns, AutoCAD LT was a leading indicator for demand. However, during the current slowdown, our mixed up AutoCAD LT moved higher, as some customers apparently chose to optimize their purchases. Lastly we saw a modest decrease in multi-year deals toward the end of the quarter, although many customers continued to move forward with multi year commitments, even in the current environment. Given the evolving business environment as a result of COVID-19, we are actively managing our spending, reducing travel and entertainment expense, monitoring our hiring rate, shifting the virtual events across the board, and rationalizing our marketing spend. We will continue to invest in critical areas such as R&D, construction, and digitizing the company to ensure our future success as we come out from a pandemic. Now let me turn to our expectations for the remainder of the year, our investment in cloud products and a subscription business model, backed by a strong balance sheet gives us a robust foundation to successfully navigate the economic challenges. Our full year guidance range is wider than normal due to ongoing uncertainty in the economic environment, it will have a more pronounced impact on our new business. Regarding trends during the year, we expect the second quarters new business activity to be the most impacted by the pandemic. Our pipeline entering the second quarter is strong and growing. But we're cautious about new business close rates. The upper end of our range assumes a swift recovery in new business in the third quarter and continued improvement into the fourth quarter with full year new unit volume growing lastly. At the lower end of the range, we are modeling deeper impact on second quarter sales, fall by a slower recovery in the third quarter and further improvement in the fourth with full year, new units posting a modest year-over-year decline. On the other hand, the majority of our business is renewals and we have not experienced the meaningful change in our renewal rate, which offers us resilience in an uncertain environment, still we are modeling a decline in renewal rates in the second quarter, out of an abundance of caution. Our low end and high end guidance scenarios differ in the extent of the drop in the second quarter and the pace of recovery later in the year. Given our strong renewal rates, we expect our net revenue retention rate to remain above 100%, but move below the current range of 110% to 120% for the rest of the year. The decision to reduce new product demand, we anticipate our billings will be impacted by a fewer multi-year transactions, the lower end of our billing guidance assumes a steeper decline in multi-year contracts, whereas the upper end is based on a more modest decline. The reduction in billings and the timing of large transactions are impacting our free cash flow expectations. Fiscal 2021 will be a significant and more backend loaded year, which will move some of the free cash flow from this year to next. We expect our full year operating margin to expand by approximately two to four percentage points. Looking at the second quarter forecast, we expect the pandemic to meaningfully impact our billings, which can be sequentially down by low double-digit percent. Additionally, our decision to offer extended payment terms to our customers for sales, up through early August, combined with a more backend loaded quarter will impact our Q2 free cash flow, which could end up being breakeven to slightly negative before accelerating in the second half of the year. Although our fiscal year 2021 results are being impacted by COVID-19, we are confident in our fiscal 2023 free cash flow target of $2.4 billion. Assuming the recovery starts by the end of this fiscal year. We build a resilient business model that will allow us to capitalize on multiple tailwinds, once we exit the current pandemic. And now I'd like to turn it back to Andrew.
Andrew Anagnost: Thank you, Scott. We expect all secular trends that we have been investing in for years to be accelerated during and beyond this pandemic. People are being forced to change the way they work, and in turn are experiencing the benefits that our cloud and subscription solutions have to offer these companies are not going to go back to how they worked before and digitization will be accelerated as businesses take all steps necessary to sure they are more resilient. Our investments over the last few years, combined with our ongoing focus on cloud-based offerings, leave us with a competitive advantage and well-positioned to help our customers, not only during this pandemic, but also in the new world that they will be working in when it is over. In fact, some of our biggest customers are already altering the mix of our products to lean more heavily into the cloud and digitization. Although AEC spending has held up well and work is continuing, some customers are seeing project delays, cancellations, and in some cases, job sites temporarily shut down. However, despite these realities, we have seen continued adoption of our construction offerings. For example, Media [ph] Construction, a general contractor in Southeastern United States, selected our products over a competitive construction management solution at their time of renewal. Their business is growing rapidly and price was becoming a concern with their current vendor. They needed a comprehensive solution that was fast and easy to implement. The multiyear deal started with PlanGrid for the field, evolved to include BIM 360 for the office and field connectivity and ultimately, included BuildingConnected for project bidding. Many construction sites were shut down temporarily, impacting our new business for field-focused solutions like PlanGrid. However, our products span the complete construction value chain and our collaboration products like BIM 360 Design and Docs experienced solid growth. Our extended access program allows customers to try out and experience the value of the cloud collaboration products at no cost for a limited period of time. We're seeing customers who are in the process of adoption accelerate their timelines. We are also seeing customers purchase additional seats directly through our digital store. Since early March, cumulative new commercial projects grew over 200% in BIM 360 Design and over 100% in BIM 360 Docs. This surge in usage has been a great test for our cloud product infrastructure, which has scaled up seamlessly. As you might recall, BIM 360 Design is the cloud collaboration tool that allows our customers to use our Design product anytime, anywhere with data stored in the cloud. Now that customers are experienced cloud-based solutions that allow them to work efficiently from anywhere, we do not think they will revert to previous ways of working. One of our largest customers, AECOM, significantly increased their adoption of BIM 360 and reached out to us beforehand to ensure that we were set up to support the increased usage. AECOM is the world's premier infrastructure firm. David Felker, CIO, Americas and Construction, recently commented, 'We're shifting rapidly to remote working, which is absolutely essential for the continuity of our business. Our strategic partnership with Autodesk and the BIM 360 Cloud platform, along with substantial investments in digital solutions and technology, have enabled our successful pivot to this new way of working. We forecast that our use of BIM 360 will continue to grow dramatically in the short-term and will become our new baseline for projects in the long-term.' We are not only helping our customers work remotely, we are also doing so quickly. When New Zealand went into lockdown overnight, we helped Warren and Mahoney Architects successfully mobilized their entire business to work from home in five days. In the process, they doubled their number of BIM 360 Design subscriptions. They told us they would not have been able to so successfully continue their business operations, while working from home without our support. And they also noted that all projects will be delivered using our platform going forward. We believe the current pandemic will accelerate digitization and automation in the AEC industry, as customers look to make their businesses more resilient. At the end of every downturn, there is an upturn, and businesses will need our products more than ever to stay competitive on the other side of this. One segment that has historically done well, as governments seek to provide stimulus, is infrastructure. During the quarter, we announced an alliance with Aurigo to better serve public and private owners. Capital project owners at Departments of Transportation, cities, counties and enterprises will benefit from this alliance, and we are already receiving positive feedback from customers. This quarter, we had a top architecture firm and a subsidiary of one the largest state owned enterprises in China choose our products over Bentley's. Their typical projects for domestic and international clients include healthcare infrastructure, stadiums, airports and skyscrapers. Autodesk's streamlined workloads and data compatibility allow them to collaborate across teams and bring digital design down to the construction service phase. Beyond that, they have already taken advantage of our products for generating optimized design schemes and are excited to use Generative Design in Revit, as we recently announced Generative Design is available in Revit 2021. As our customers plan to return to work safely, they need help redesigning space layouts in buildings, and this is one of the things Generative Design enables people to do effectively. Although, manufacturing has been impacted by supply chain disruptions and temporary factory shutdowns, our products are enabling customers to operate under evolving conditions. Customers use our solutions to develop new products and R&D continues even when production floors experience disruption. Automation and flexible supply chains will be vital to competitiveness in the future. Our products help customers work remotely in a distributed environment and collaborate among their divisions, customers and supply chains in the cloud. Fusion 360 is the leading comprehensive multi-tenant cloud CAD/CAM and PLM solution and continue to gain traction during this pandemic, as customers are reassessing their technology portfolios' readiness to cope with the demands of distributed work. In fact, April was the fastest-growing month for new user acquisition. A good example of this is that we closed a large stand-alone Fusion 360 deal with a big semiconductor company. Currently, they use the electronics design capabilities in Fusion for their printed circuit board design work. And we expect to further expand our presence with them due to the integrated functionality offered by our products at a more attractive price point. In addition, BASF, the largest chemical producer in the world, increased their EBA users of Fusion 360 to 2,000 during the quarter. They look forward to using Fusion 360 as a collaboration platform to improve the efficiency of communication between several teams, starting with equipment design and maintenance at one of their chemical plants. Growth remains strong, relative to our competition across manufacturing portfolio. Customers of our on-premise solutions report minimal disruption in the move to remote work, which has been supported by cloud features included in our subscription offering. During the quarter, we signed our first enterprise business agreement with an automobile manufacturer in China. The usage-based model was a good fit for the customer who needs flexible access to our expansive portfolio of products. COVID-19 was a catalyst for them to substantially increase their engagement with us. They made the decision to adopt the most efficient solution to ensure they stay competitive in their industry on the other side of this downturn. In addition to growing our presence in the commercial space, we continue to maintain our leadership in the education space, where future engineers are rapidly adopting our products. Our new-user acquisition in the education space, driven by Fusion 360 went up over 70% in April. Moving onto another high priority area for us, we are still making traction, monetizing non-compliant users. In terms of sales led initiatives, we are being sensitive to customer situations and are often deferring the final outreach, but this does not mean progress has stopped. The first deal we closed and move on after the business reopen was a license compliance transaction that we have been working on for many months prior to the pandemic. We closed an additional license compliance deal and competitive win over Bentley in Central America, and the customer is now piloting BIM 360 Docs. In closing, while all of us are impacted by the current pandemic, we are building a stronger Autodesk for the next year and beyond. We have a head start over our competition in critical capabilities like cloud computing and cloud-based collaboration, and we will continue to invest in our strategic initiatives. There are three key areas that make us confident in our fiscal 2023 targets and our growth after that. One, digitization in AEC is going to accelerate in the coming years as companies seek to adopt not only BIM, but a complete design to make workflows enabled by the cloud that not only make current processes more resilient and efficient but support new industrial paradigms for industrial paradigms for the construction site. Two, the evolution of manufacturing to a more distributed network and cloud-based workflow is also going to accelerate significantly over the next few years. And we have the industry's leading multi-tenant cloud-based solution to address the emerging customer needs that will -- and three, our business model is more robust, adaptable and resilient than in the entire history of the company. This will allow us to not only invest aggressively in the future, but do so with an eye to both revenue and margin growth. We look forward to virtually engaging with many of you at Investor Day on June 6th where we will have more time to share our strategic initiatives. With that, operator, we'd now like to open the call up for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Saket Kalia with Barclays Capital. Your line is now open.
Saket Kalia: Okay, great. Hey, thanks guys for taking my questions here. And I hope everyone's doing well. Andrew, maybe just to start with you. Thanks for the commentary just by area. I want to look at it from a different lens, and maybe see if you can talk about what you're seeing from your customers on engineering headcount and hiring. Now clearly, that situation is going to differ between manufacturing – between your manufacturing customers and your AEC customers. But I'm wondering, if you could give us some high-level observations just about how your customers are approaching headcount during these times?
Andrew Anagnost: Yes. Saket, I hope you're doing well as well. Look, there's – what I'll do is I'll give you some indirect measures of what we're seeing. If our customers were engaging in a lot of headcount reductions, what we would see is a tendency towards more partial renews in our base. We're not seeing that, all right, as we mentioned in the opening commentary. So we're not seeing this increase in partial renews which kind of talks to a stable employment base and a stable team environment. The other thing that we pay attention to is the whole notion of what's happening with weekly active users, okay? That's the real measure of economic activity happening on top of our applications. This is something we didn't have during the last downturn. We weren't able to monitor weekly active use of our desktop products. That weekly active usage, while it declined a little bit as we headed into this, is definitely starting to stabilize. So that's another indicator that tells us, look, people are hanging on to their R&D, their R&D and early project development team members. We're well in front of the process here on multiple factors, so people need to keep the people working on the stuff that uses our products in order to effectively meet the demand as they come out of this. So that's what we're seeing Saket.
Saket Kalia: That's really helpful. Scott, maybe for my follow-up for you, you touched on this a little bit in your prepared remarks, but I'm wondering if we could just flush it out a little bit more. Can you just talk about what you saw in the quarter on those multiyear paid-up subscriptions? And just talk about how you're thinking about that in the fiscal '21 free cash flow guide?
Scott Herren: Yes. Thanks, Saket. And I hope you and your family are staying safe too. It's such a bizarre time. What we did see -- the multiyear continues to be relatively strong. It was an interesting quarter. The beginning of the quarter was quite strong. Across the board, demand was strong. Multiyear was strong. It was really a continuation of a strong Q4. And then right around mid-March, we saw things slow down. And it slowed not evenly, as we talked about in the opening commentary. It slowed down little bit by – as countries were affected in a different rate. What we saw in multiyear is, we did see it come down a bit in the second half of the quarter, but not substantially. And you see that when you look at the total long-term deferred balance in relationship to the total deferred revenue balance. So while it did come down, a lot of our customers continue to see value in buying the multiyear. Our partners continue to see value in selling that. And of course, we get value because those are renewals that we don't have to chase, and it frees up sales capacity. So the triumvirate of good for customers, good for partners, good for us continues. I do expect to see some headwind on multiyear transactions through the second half of the year, and that's part of what is influencing the change in our guidance on billings and free cash flow as an expectation that multiyear will trend down through the year, certainly in the second quarter with some recovery towards the second half of the year.
Saket Kalia: That’s very helpful. Thanks guys.
Scott Herren: Thanks Saket.
Operator: Thank you. Our next question comes from Phil Winslow with Wells Fargo. Your line is now open.
Phil Winslow: Hi, thanks for taking my question. I'm glad to hear that you are well and hopefully that extends to your families and your team members. Question first for you Andrew, then a follow-up for Scott. Andrew, you talked about obviously the different phases of the construction life cycle and different products you have there. When you're talking to your customers, how do you think about sort of reopening, starting to sort of impact, call it the architecture side, your planning, construction etcetera. And considering the fact that you were on the AEC side, you seem to have a backlog of projects coming into the year, what are they saying to you in terms of restarting and where sort of that backlog is, especially when you think kind of guide go-forward basis? Then just one follow-up for Scott.
Andrew Anagnost: Yes. So the backlog comes in 2 forms. The first backlog is projects that were just put on hold and were about to go into the pipe, we hear a lot about that from our customers is that look, a lot bunch of products were just put on hold, until people know where they're at. Those projects are not going away. None of them are in any kind of category that would represent a pullback from the projects. So yes, at the front end in the design and kind of engineering side, there is definitely this queue of projects that were put on hold. The interesting thing on the downstream side and the construction side, what you saw was how in some municipalities, people actually stopped construction. Now those construction sites are coming back on right now. And in some places, construction never stopped, but they're not coming back on the same, all right? So what you're seeing is people are working with distancing, listing requirements on the construction site, so there's fewer people on the construction site and these people are working in more shifts, so what you're actually seeing is more pickup in the digital tools and an anticipation from our customers that they need more tools to digitally manage their sites as they stand up these construction sites. The same goes in manufacturing. Manufacturing, they – their biggest problem is that their output side will shut down. Their new product development and all the things that are going on there, none of that was stopping. They just couldn't push the units out because of various restrictions on them. That's all starting to open up as well. And that's what we're hearing from our customers. Frankly, the one segment of our customer base that still doesn't know what their – what their fate is is the people making films, TV and film. They're still struggling with when the sets are going to back up. The games, games, obviously, they never – they never saw a slowdown. So – but the people in the film business are still waiting for when the production is going to restart.
Phil Winslow: Okay. That was super helpful. And then Scott, just to follow-up. Obviously, we came into the year with a significant number of active users that weren't on subscription or maintenance. I wonder if you could tell us just sort of the trend that you saw in Q1 relative to last year in terms of conversion of those to paying subscribers and just how are you thinking about this year?
Scott Herren: Yes. It continues to be an enormous opportunity for us, Phil, and it's one that we'll continue to pursue out even beyond fiscal 2023. What we have seen during the quarter is – we talked about this on the fourth quarter call as well. We've gotten better at the data science at identifying those, passing on higher-quality leads. That's led to the productivity of those license compliance teams improving. And as the productivity improves, we're investing more headcount there. That trend continued into the first half of the quarter. I will tell you, as the economy got more difficult and as many of our customers face shutdown and very difficult situations, what we did do toward the second half of the quarter is, while we'll continue to pursue those transactions, we're not forcing a final transaction, a final outcome of that in many cases. So that pipeline continues to build. We continue to work that and build that up, and that's an opportunity that's still ahead of us in the second half of the year.
Phil Winslow: Great, thanks guys and stay safe.
Scott Herren: You too, Phil.
Andrew Anagnost: Thank you, Phil.
Operator: Thank you. Our next question comes from Heather Bellini with Goldman Sachs. Your line is now open.
Heather Bellini: Thank you very much, gentlemen for taking the question and glad to hear you and your families and the Autodesk employees are doing well. I just have two questions. First, Andrew, you mentioned the license compliance deal in Wuhan that you closed. But I also wanted to ask, given your global reach, how are you seeing business trends in parts of Asia, aside from that one, where the economies have maybe been open for a little while longer? And any commentary – I guess, there would be any commentary on how the first month of this quarter overall is tracking versus the month of April? And then I just had a follow-up for -- a follow-up one after that.
Andrew Anagnost: Yes. Okay, great. So, Heather, let me give you a little context. I'll kind of answer your question a little broader than you asked just so that you can a full set context. Scott said, we kind of entered Q1 with a roar. We had like a week to celebrate our success from fiscal year 2020. And then what happened is March hit, you saw China start to decline, you saw Korea follow suit. You saw a general decline in APAC, and then kind of Europe came online after that, started to decline, then the U.S. Here's what we saw, though, as things played out. China and Korea are rebounded, right? Monthly -- weekly, monthly active usage in China is now above the pre-COVID highs in that country. Korea returned and became stable. Japan was surprisingly steady through the entire crisis, all right, both from a business perspective -- from a business collections and from the weekly active usage numbers that we are tracking. And now what we're seeing is kind of the same kind of cascade happening in Europe. We're starting to see Europe weekly active usage is going up. New business is starting to go up. And you're seeing -- we're seeing a kind of a stabilization in the U.S., not any upward trajectory yet, but it's all cascading like that. And we saw that in our weekly active usage numbers. We're seeing it in our new business numbers. And another thing that stayed constant and stayed relatively steady was renewal rates. Now, we always told you that we anticipated renewal rates would decline slightly during a downturn. What happened was that renewal rates actually declined less than we expected. So, they've been -- they've held up incredibly well through this downturn, and that was consistent across geographies at all times during the crisis. There hasn't been some kind of sudden dip in renewal rates and some wavering. It's actually stayed like at a fairly consistent rate. The one thing I want to make sure you understand during the whole entire thing, our cloud products and our make products did incredibly well. Like, for instance, in March, during the heat of all of this, Fusion added 50,000 monthly active users in the month, right, in the heat of all of this, all right? We already told you about what was going on in BIM 360 Design and BIM 360 Docs, those products all did very well even through the downturn.
Heather Bellini: That's great. Thank you. And then just one quick follow-up for Scott, and I know you mentioned this in response to someone's question, I think, about long-term deferreds. But you had talked about, at one point, most recently, those being maybe as much as 25% of the total deferred revenue balance. I'm just wondering is there a level that you would set up at for this year that you think might be more reasonable.
Scott Herren: Yes. No, I think that's the right range, Heather. I think it ends up in the mid-20s. It had been slightly higher than that. You remember on the fourth quarter -- actually, on the third quarter and the fourth quarter call, I think there was concern that multiyear paid upfront product subs was going to run through hot and was going to create a problem for free cash flow this year. In fact, we thought this was going to be a year of stability as opposed to a year of a pandemic. And I have our multiyear offer actually on my watch list, because if I got the impression that it was running to an unstable level, so hot that we couldn't maintain that percent, I wanted to make changes to the offering to kind of tamp it down a bit. We haven't made any changes to the offer. At this point, I don't think we need to. It's the same, pay for three years upfront; get a 10% discount; that it's always been. We saw it in the second half of the year come down modestly. That's my expectation for the year and that will put long-term deferred in that mid-20% of total range.
Heather Bellini: Okay, great. Thank you so much gentlemen. Stay safe.
Scott Herren: You too. Thanks.
Andrew Anagnost: You too Heather.
Operator: Thank you. Our next question comes from Jay Vleeschhouwer with Griffin Securities. Your line is now open.
Jay Vleeschhouwer: Thank you. Good evening, Andrew and Scott. I'll ask both questions at once. So first, Andrew, you noted a number of trends and requirements that are being accelerated by the current situation. What are the implications of that, if any, for your sales and distribution model? You've been doing a lot of hiring or planned hiring for direct sales coverage, named accounts, inside sales, the store and so forth, and of course, working with the channel. So maybe you could talk about any implications there? And then secondly, looking past this current valley affecting business, looking to your longer-term road map, you've spoken, of course, often at AU, another occasions about your new platform plasma. What are the milestones for that internally that you'd be able to communicate over the next number of years in terms of its progress? And overlaying that at the applications layer, are there any major brands such as Revit or Inventor or anything else that you think would be prudent to rebuild or rewire in some way to take advantage of the new platform, in terms of collaboration, data orchestration, perhaps multi-core and multi-threading and all those good things. So a sales question and a technology question.
Andrew Anagnost: Okay. So let me start with the sales question. So as we've headed into this and looked at the year, as you've noticed, we've continued to invest. While we're not going to spend as much as we originally anticipated this year, we're continuing to invest in R&D and things that we think are core to our future and infrastructure. There are some areas that go-to-market we did continue to invest in, like international expansion for our construction solutions and things related to supporting the Fusion business. But, you're right, we probably slowed down a little bit on inside sales efforts when your inside sales teams, you don't want to hire inside sales teams when you're having trouble getting in touch with customers when they're working from home. So we slowed down some of those efforts, but there was no across-the-board slowdown in our go-to-market activity. In fact, what we did is, we prioritized those things that we thought were most important and invested there. And I think they all would make sense to you, in terms of what we're doing there. In terms of the longer-term growth, I think you're going to continue to see us invest in go-to-market internationally around our construction and cloud solutions. I think you're going to see us continue to invest in data centers and servers in our international locations that service our customers with some of our cloud solutions, because those are going to be in demand, all right? Now with regard to your second question, okay, we don't call it plasma anymore, by the way. It's a different name, which you'll get some view of later, probably around AU time frame. So I'm going to be careful about what I talk about there. But look, first off, I want to make sure you understand. There's a lot in our cloud, all right? A lot in our cloud platform, a lot that has been exposed, a lot that hasn't yet been exposed. Some of those things you're talking about allowing multidisciplinary collaboration, simultaneous access to a common model that updates based on different disciplines, but maintains control with, say, the architects or the engineers, you're going to hear a lot more about that in the coming months and probably around Autodesk University. So I'm not going to steal the thunder from that. What I will say at this point is, we've got a lot going on, and we're big believers in the app model. And what I mean by that is we believe that relatively modestly sized to big clients with a really robust cloud backend are the future. And we got there in a very informed way. So, for instance, Fusion has a big client. And – but it has a very, very, very fine-grained multitenant cloud data infrastructure hidden behind it. Fusion's cloud will get thinner – the client will get thinner over time. You could also see an evolution with Revit that's similar to that. That's going to take a little longer. And we made that choice very deliberately, Jay, because we've had lots of experience in pure browser-based applications. For instance, you might be aware that Tinkercad has 25 million users. Right now, in any given day, 11,000 people use Tinkercad. It's the K-12 de facto standard for 3D modeling out there. It's called Tinkercad, but it's actually an amazing tool. It is a multitenant browser-based solution, as is AutoCAD web, which has 50,000 monthly active users a month, all right, which does edit and the creation of drawings as well as collaboration on drawings. Both of those solutions taught us that thicker clients are better, all right. Not totally think clients, way thinner than our current desktop clients, way thinner, but like an app model. We learned this early on from our long years of experience with these pure browser-based tools. So that's why you see us doing that with Fusion. You'll see us do something similar in the AEC space over time. And it's winning because it helps get people to the cloud, but it has that same robust multitenant cloud database structure sitting underneath it.
Jay Vleeschhouwer: Thank you. I hope you do well.
Andrew Anagnost: You too, Jay.
Scott Herren: Thanks, Jay.
Operator: Thank you. Our next question comes from Matt Hedberg with RBC Capital Markets. Your line is now open.
Matt Hedberg: Hey, guys, thanks for taking my questions. I'm glad you guys are well. There's always a lot of questions on construction and all the improvements you made on a product perspective there, but want to talk a little bit more about the momentum in manufacturing. We do hear really good things about Fusion 360. And I know, Andrew, you called it out on the call being a real disruptive offering. Where are we in the momentum of that business? And relative to the investments that we've made in construction, are there many more that still need to happen in this particular part of your business?
Andrew Anagnost: In the manufacturing part or the construction part. You – I want to make sure I answer the question…
Matt Hedberg: Yeah, the manufacturing side.
Andrew Anagnost: Okay, good. Because – all right. So I'm glad you asked the question. Like I said, we're definitely seeing building momentum in that space. There's no doubt about it. Fusion is on fire. I said in March, it added 50,000 monthly active users. There's over 600,000 monthly active users on the application today, all right. It's in the very early stages of a revenue generation activity. I am going to save the total commercial subscriber base as a reveal for the Investor Day coming up. Suffice it to say, it's large, all right, and significant. In education, it's by far the leader. And by the way, it has a connectivity flow with Tinkercad. So we've got K-12 locked up with Tinkercad and Fusion's rapidly taking over post-secondary education and becoming more and more of a force in that space. I think you're going to see a lot of exciting things with Fusion over the next year, especially as we start to reveal the data layers that are hiding underneath the thick client that we use for the application. So I want to hold off a little bit until Investor Day. But I will tell you, in any given day, 60,000 people are using Fusion to solve real-world problems today. So I think it’s an exciting application. It has really significant potential for the future. We are way ahead of our competition, not only in functionality, but in low cloud power.
Scott Herren: So it's a bit of a teaser to get you into the Investor Day next week, Matt.
Matt Hedberg: Yeah, we’re looking forward to that. And then maybe a quick call for Scott, I know renewals were stable this quarter, which is great to hear. I wanted to ask about the [Technical Difficulty]....
Scott Herren: Matt, your voice is breaking up pretty badly. You started off fine and then I was guessing what your question is.
Matt Hedberg: Sorry about that. The joys of working from home. Just – the question is how are your customers doing today? And when you look at your '21 guidance, you talked about some expectations on renewal. But what are expectations for VSB renewals in your fiscal '21 guide?
Scott Herren: Yes. That's a great question because I think there's an expectation that, that segment, which we call to VSB, Very Small Business but to generalize that, think of that as a single site with 20 employees or less and 15 seats or less. And that segment for us typically drives somewhere between 10% and 15% of our sales. We're not seeing a difference in the renewal rate in that segment versus the segment right above that, up through enterprise. It's a bit surprising, frankly. I would have expected that we would have seen a bigger impact there, but we're not seeing that at this point. But bear in mind, as you could imagine we are running multiple scenarios constantly on the back end. And one of the things that I've had built into those scenarios is an expectation that we do see renewal rates move from where they are down modestly during the second quarter. And then the difference between the high end and the low end of our guidance range is sort of the rate of recovery of those. But just to be cautious, even though we're not seeing it yet, I am modeling that into the guide.
Matt Hedberg: Thanks a lot.
Scott Herren: Thanks Matt.
Operator: Thank you. Our next question comes from Steve Koenig with Wedbush Securities. Your line is now open.
Steve Koenig: Hi gentlemen, thanks for taking my question. I'll just ask two quick ones. I'll put them both out there. First one is, are you guys -- what are you seeing in terms of horizontal construction? Is there any positive impact? Or do you expect any tailwinds from the stimulus -- we'll call it, the stimulus spending. It's really the anti-recession spending the government is doing. So that's question number one? Question number two, can you give us any color around your assumptions behind new business, kind of looking back at my Autodesk model from the '09 period, your licenses -- if I recall correctly, we're down like mid 30%. It was pretty steep. And I'm wondering how relative to low and high-end of your guidance range, just maybe any color on assumptions you're making? Thanks very much guys.
Andrew Anagnost: Okay. Great. All right. So I'll start off and take the horizontal construction question. So we've been anticipating stimulus with regard to infrastructure for some time now and we've been investing in our core products for that, in particular, in road and rail. What you saw us recently do was engage in a partnership and an investment with Origo, and I mentioned that in the opening commentary. Origo is really, really strong in the early capital planning part of these types of projects, whereas we're really strong in the design and make parts. There's an overlap between our solutions, but they're very, very complementary. Between the functionality we've been building in our design portfolio and this partnership, it's designed to bring the departments of transportation forward in terms of their solution stacks for these various types infrastructure engagements. Right now, they're basically on really old stacks and fairly old technology, Aurigo is a born in the cloud company, most of our stack is rapidly moving to through the cloud. Obviously, the construction stack is entirely in the cloud. So we've been preparing for tailwinds around infrastructure for quite some time. We believe we're ready. We believe these partnerships we put in place are absolutely the right kind of thing. We're already seeing some returns from those partnerships in terms of engagements with various departments of transportation. So yes, we do anticipate a tailwind coming from stimulus related to infrastructure, and we've been preparing for it.
Scott Herren: And to the second question you had, Steve, I'll point you to – I'll tell you what our expectations are, but I'll also point you to the slide deck that we posted on the website at the same time. I know it's a busy night, and there are other companies reporting at the same time. We actually moved to today to try and avoid a lot of other company traffic to try to lighten the load on you guys a bit. So there's a slide there, but I'll tell you what our expectations are. At the low end of the guidance range, we expect – well, in both cases, we expect our new business to be most impacted in the second quarter. And then the divergence between the low end and the high end is the depth of the impact in the second quarter on new business and the rate of recovery, such that in the low end of the range we expect for the full year, we expect a slower recovery from the bottom in Q2, such that for the full year, there is a slight decline in new volume for the year. At the high end, a slightly less of an impact in Q2, a swifter recovery, such that for the full year, new unit volume actually grows modestly. And that's informed by what we're seeing as markets have reopened by monitoring, as Andrew said, what the weekly active usage rate looks like in each of our core markets and really getting an understanding the usage of our products by our customers. Things like our partial renewal rate staying strong, says, if I had 10 that came up for renewal and I renewed all 10, that means that I don't have a reduction in workforce. So I think the strength of the renewal base, plus the – our expectation on what new volume looks like is what differentiates the low end from the high end.
Andrew Anagnost: One more point, we're not seeing close to the levels of declines in new business we saw during the great financial crisis, okay, just to make sure there's too clear on that.
Steve Koenig: Got it. Cool. Thanks a lot, guys.
Operator: Thank you. Our next question comes from Sterling Auty with JPMorgan. Your line is now open.
Sterling Auty: Yes, thanks. Hi, guys. I know that some of the hardest industries like transportation are not maybe viewed as heavy design users, but any sense of your exposure to transportation, hospitality, hotels, et cetera, in that group?
Andrew Anagnost: Yes. Those segments tend to be users of things like LTE versus facilities planning and facilities layout. So they're – while they’re big companies, they generally tend to be downmarket users of our applications. It's a facilities usage play for us. So we don't have a lot of exposure to the main line of our business from those very hard hit industries in hospitality, transportation and in food services.
Sterling Auty: That's fair enough. And then one other question. Any thoughts in terms of what you think the impact from a number of companies I've already talked about, post COVID-19, maybe not bringing all the workers back and maybe we'll just see a change in the commercial real estate landscape permanently. Any thoughts in terms of how that might impact your business moving forward?
Andrew Anagnost: Yes. It's careful to kind of think about that question in an important way. First off, commercial business building, the commercial buildings and commercial office space, not a huge part of our business. However, I mean, we're living this -- personally, so I can speak to this with some knowledge about how this is working. There's a couple of trends, I think you need to be aware of. One, when people move to more work-from-home type environments, and we will probably have that on the other side as well, they're actually going to have less dense office space. So, for instance, the current requirements in terms of us getting back in our offices are going to require us to significantly de-densify some of our office space. So, people are not -- in the short-term, certainly, not going to require less office space, they're just going to have fewer people in it, spread out more widely over the next 12 to 18 months, okay? So, we have to be very clear on that, people will be coming into offices that are much less dense. That's where we're going. It's where a lot of our customers are going, and they're going to need to reconfigure those office spaces in unique ways. And we're helping them to do that with some of the general design tools. But on a bigger standpoint, okay, there's still going to be population growth. We're still going to have workers. There's still going to be a population that needs to come into an office, but how these offices are distributed and where they are may change. We've always been talking about a trend around urbanization, but we might be future talking about urbanization and suburbanization, where you're seeing this kind of spreading out away from dense urban centers into suburban centers that also have office space and high-rise living spaces. And then they're connected by infrastructure that requires them to have a hub-and-spoke kind of flow. So, there's a lot of ways that this plays out in the future, but in our projections and our view on this, people are going to be building more, not less. Where they build it may change.
Sterling Auty: Thank you.
Operator: Thank you. Our next question comes from Keith Weiss with Morgan Stanley. Your line is now open.
Hamza Fodderwala: Hi, this is Hamza in for Keith. Most of my questions have been answered, but just a couple of quick ones. For you, Scott, you mentioned -- so the low end of the guidance is implying that new unit volume sees a slight decline. Is there any instance where we could see maybe overall subscription growth -- subscriptions actually decline year-on-year? Or is that just basically net new sub adds?
Scott Herren: Yes. With the strength of our renewal rate, Hamza -- and at least I got your name right this time. With the strength of our overall renewal rate and the size of our renewal base, no, I don't see overall subs coming down. I think the new unit volume could see some pressure, and we're seeing that in the second half of Q1, but I don't see the aggregate coming down, no.
Hamza Fodderwala: Got it. And on the renewal rate, you mentioned it's been pretty stable. Any color you can give us as to how that has sort of trended versus sort of the historical range, I think sort of like mid to high 80%.
Scott Herren: Yes, it's stayed in the same range. It really stayed steady, Hamza, throughout the quarter. Even as the new business slowed down -- I talked about the difference between the first half of Q1 and the second half of Q1. Even as the new business slowed down during that timeframe, the renewal rates stayed pretty steady and stayed pretty steady across the board.
Hamza Fodderwala: Okay. Thank you very much.
Scott Herren: Welcome.
Operator: Thank you. Our next question comes from Adam Borg with Stifel. Your line is now open.
Adam Borg: Hey guys and thanks for taking the question. I'm glad to hear everyone's safe. Just a quick one on M&A philosophy. So, in the past, we've talked about large M&A being done on -- for the most part, on the AEC side and potential focus shifting to manufacturing. Just given the current potential market dislocations, I would love to hear your latest thoughts. And I have a follow-up.
Andrew Anagnost: Yes. So, specifically, I've talked about large M&A being done on the construction side, all right? I was very specific that we felt like we got the biggest pieces that we needed on the construction side. Certainly, we are going to continue to look at all our markets. With the shakeup that will likely be accelerated over the next five years in manufacturing, with supply people rethinking their supply chains and numerous things associated with that, I think, our focus on manufacturing will likely continue. But don't think that we won't look opportunistically at opportunities in AEC as well. The next 12 months could present themselves with all sorts of opportunities for organic and inorganic growth activity. Fortunately, we've got a good strong balance sheet. We've got a nice recurring revenue model. We're in a good position this year to act on something that we think could be appropriate for us. So we don't see anything immediately in our future.
Adam Borg: Got it. Got it. Thanks. And then just as a quick follow-up, multiuser licensing, I know that got pushed back till August. Just curious how conversations are going with customers, and any feedback or color there would be great. Thanks so much.
Andrew Anagnost: I got to tell you a story. I'm not going to use specifics. It just came in before -- while we're preparing for today. There was a customer that was desperate to get rid of their multiuser licenses and move to single-user licenses, because they need a two-factor after a malware attack. So we've had people, customers coming to us now realizing that named users are not a bad thing, all right? As a matter of fact, when you're trying to move from working in an office to distributing your workers all over the place, it's really nice that you can just download the software and log on and it works. And they saw us responding much faster to their work-from-home needs. So initially, before this crisis, we were getting a lot of noise about multiuser. A lot of that has started to die down. And in some cases, people are starting to realize that multiuser was not the panacea they thought it was for the problems they were having. And, in fact, it exposed them to other things. So I don't know if that will continue. Times could change, as we head out of this. But, right now, it's been an excellent opportunity for people to understand and for us to have a discussion about what does named user really gets you and what are the benefits. And we're seeing some of that right now. So it's still early days. We've only done a few multiuser conversions at this point, but there's some very interesting conversations around this.
Adam Borg: Great. Thanks, again.
Andrew Anagnost: You're welcome.
Scott Herren: Thanks Adam.
Andrew Anagnost: Thanks Adam. Stay safe.
Operator: Thank you. Our next question comes from Brad Zelnick with Credit Suisse. Your line is now open.
Brad Zelnick: Great. Thanks so much for fitting me in. And I'll echo all the well wishes all around. My question for you guys. It's good to see the strong usage of BIM 360 Design and Docs. How usage of this is temporary, given everyone working from home? And how much of it do you see as sustainable longer term? I mean, given the extended free trial, how are you thinking about page conversion?
Andrew Anagnost: Yes. So we didn't do the extended -- the only access program to drive paid convergence, as you know, we did it to help people work from home. However, our customers are being pretty definitive with us that their -- most of them are not going to go back to their old way of working. Remember, once they started up a project in these environments and found that the fluidity of what they can do and how they can work remotely, they're very unlikely to pull the project out of the system unless they feel like, I didn't really need any of that. We don't foresee that happening. In fact, one of the things I said in the opening commentary is that, AECOM was very explicit with us that we are moving to a more distributed model. With these things, we’re going to be increasing our usage. Are you ready Autodesk? And we told them, of course, definitively that we were. So, while some customer’s may revert back to their old way of working. We expect a significant number of them to come out of this changed. It's exposed them to something they really weren't aware that they could do previously.
Brad Zelnick: Thanks, Andrew. And maybe just a follow-up regarding the strength in retention relative to expectations. How much is due to a tight labor supply, forcing firms to hold on the talent and Autodesk subscriptions in anticipation of an economic recovery?
Scott Herren: Yeah. It's really hard to say, Brad, what the drivers are, if it’s a – I’m going to hang on to people even though I don’t have them put to use. I don’t think that’s the case. I think more and more – if you think about where our products are largely used in the process, it's less on -- at least today on the job site and on the manufacturing floor and more upstream in the design process. And that's had a lot less impact from the shutdown and the shelter-in-place that's taken place in the wake of the coronavirus. So I don't -- we're not sensing a significant change in headcount and we look at weekly active users. We look at, I think, one of the most compelling statistics is that partial renews had 10 seats only renewed nine, has held steady as well. And so I'm not -- we're not picking up that there's a change in the workforce or changing the work that needs to be done underneath the products.
Brad Zelnick: Great. Thanks.
Andrew Anagnost: The only thing -- remember, weekly active usage is starting to trend up in some of the places that were first hit by the pandemic. So we're seeing the opposite where people are actually starting to use more as they come to their side of this.
Brad Zelnick: Thank you.
Andrew Anagnost: Thanks for the question, Brad.
Operator: Thank you. Our next question comes from Jason Celino with KeyBanc. Your line is now open.
Jason Celino: Hey guys. Thank you for fitting me in and it's nice to hear from everyone. One quick one for Scott. As we think about the different ranges for the guidance, it looks like on the spend side, its coming down to about mid to high single-digit spend growth. How do you think about the low to mid – high end of the guide for toggling maybe some of the spend you might do?
Scott Herren: The spend -- so first of all, Jason, I hope you're keeping well as well. It's such a strange time. The areas of investment don't vary between the low end and high end of our range. We'll continue to invest in R&D, given the lead that we've got and the fact that as our customers are being forced to digitize more quickly as a result of the distributed workforce plays right to our strong suit, it plays right into some of the longer-term R&D investments we've been making over the last four or five years. So now is not the time to take the foot off the gas on R&D investments. We're also going to continue to invest in construction. I think that's proven to be a market that is dramatically underpenetrated by technology. And so there will be secular growth in that space. We'll continue to invest there. And we'll continue to invest in digitizing our own comp to provide some of the value-add that we can provide to your customers. There's no change in the core focus areas. We are continuing to be diligent about spend management, as you'd expect, and there are savings. You can back into the savings that are built into our spend stream based on the range of our guidance and get a sense, there's obviously P&E spending that's going away. And by the way, I don't think it ever returns to the levels it had been historically. If the last 3 months have shown us anything, it's that you don't have to be sitting across the table face-to-face with someone to conduct business, whether it's a sales transaction or a brainstorming session. So I don't expect that to fully come back. We've gotten some savings through rationalization of our marketing spend. We've moved many of our events to online. I think many of those will stay online. So there's -- there are some savings built into that and I think many of those will continue longer term. But the core areas that we're investing in, we're going to continue to invest in. And we're in a privileged position. So even with the level of disruption that is happening in the marketplace to be able to show double-digit revenue growth and market expansion through high end of our guidance. So I feel good about the decision that we're in.
Andrew Anagnost: Yes. That's factoring, that we are growing revenue and same time puts us in a fairly elite category. Given the acceleration of digitization we expect from the other side of this, this is the time you want us to be investing in R&D and the infrastructure that supports getting that R&D to the customers. And that's what we're going to do.
Jason Celino: Okay, great. Thank you. I appreciate the color and thanks again.
Andrew Anagnost: Thanks for the question, Jason.
Operator: Our next question comes from Zane Chrane with Bernstein Research. Your line is now open.
Zane Chrane: Hey guys, thanks for filling me in there and I appreciate it. I was impressed with the renewal rate, the net dollar renewal rate staying at 110% to 120% range. So I was wondering regarding the partial renewals holding study, do you have any idea of what portion of your customer base is maybe benefiting from the PPP loans? I'm wondering if churn could maybe tick up once the deadline for the employee retention passes and you have a little bit more layoffs from those customers with the PPP loans at some point in the future? And then secondly, you had pretty impressive bookings, especially when looking at current RPO, I'm just trying to reconcile that with the roughly flat billings growth for the full year. So I'm wondering, if you could what the average time deals tend to be in the pipeline before closing? And if you do have a weakening in the pipeline or the entry part of the pipeline, how many quarters does that take to show up, is it 2, 3, 4 quarters? Or is there any way to know that? Thank you.
Scott Herren: All right. That's a lot to cover there, Zane. I'll take the first one, and I'll let Andrew handle the pipeline sales cycle question. On the first one, of course, there's no way for us to know, but I think that you look at the benefit of that program, it was targeting smaller businesses. And those -- one of the stats that we gave earlier is small businesses and I'll define that as single-site, 20 employees or less and 15 seats or less, that small business segment has typically driven 10% to 15% of our total sales. So it's a smaller piece of our overall revenue stream. It's hard to know how many of them have benefited from kind of the short-term loan programs that have been rolled out and whether you call them stimulus or as Steve said earlier, avoidance of recession. What we do monitor though and Andrew talked about this earlier is, the active users -- the weekly active users of our product. And of course, we saw a strong dip as across the globe countries went into shelter request, but then we also see them come back, and I think that’s also shown sign that we are not seeing stimulus and by all across the board, of course the renewals it stayed inside and we have had another good time. So its hard to know, because its hard to give you a direct answer, but certainly, indicators that we’ll do. We we're not seeing that.
Andrew Anagnost: So with regards to the pipeline question, in terms of how things are going -- all right on general pipeline, so from a cascading, what we've seen in – in terms of new business is Asia is already starting to turn up, all right. So we’re already seeing the pipeline grow in APAC. We are starting to see signs of that in Europe. We haven't yet seen signs of it in the U.S. but given the cadence that we've seen around the pipeline from each region and by a country-by-country basis, watching not only the new business trends, but the weekly active user trends, which, by the way, presages the pipeline, we see building pipeline strength as you get further and further away from the start of the pandemic, which I think is a pretty positive sign for our business in terms of where we think we’re going. And it's why we feel the way we do about the potential for the year.
Scott Herren: Yes. I think the other bit of color that I'd add there is when you look at the change in our billings guide, multiyear clearly is having an effect on that. We've seen it slow a bit in the second half of the first quarter. And what I've built into the scenarios that we've modeled out is that it continues to pace low or to modestly come down, a couple of points from where it had been throughout the year. And that does create a headwind on the billings guide.
Zane Chrane: Got it. That's very helpful. Well, I wishing you guys have a strong and rapid recovery. Thanks very much.
Scott Herren: Thank you.
Operator: Thank you. We are now at the end of the time for the call. I would now like to turn the call back over to Abhey Lamba for closing remarks.
Abhey Lamba: Yes. Thanks, Joelle, and thanks, everybody, for joining us today. We look forward to seeing many of you at our Analyst Day next week on June 3. In the meantime, please reach out if you have any questions. Thanks for joining us today.
Andrew Anagnost: Thank you.
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. | [
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"text": "Ladies and gentlemen, thank you for standing by, and welcome to the Autodesk First Quarter Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference to your speaker today, Abhey Lamba, Vice President, Investor Relations. Please go ahead, sir."
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"speaker": "Abhey Lamba",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the results of our fiscal year 2021 first quarter results. On the line is Andrew Anagnost, our CEO; and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation, and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this conference call, we may make forward-looking statements about our outlook, future results, and related assumptions and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings for important risks and other factors, including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance, and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in the press release or the slide presentation on our Investor Relations website. Now I would like to turn the call over to Andrew."
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{
"speaker": "Andrew Anagnost",
"text": "Thank you, Abhey. To open, I want to thank all of the medical professionals and other essential workers who are confronting the impacts of the COVID-19 pandemic on the frontline. Their efforts are not only saving lives, but allowing many other people around the world to protect themselves, their families and their communities. Their efforts are truly heroic. Thank you for everything you do. Our thoughts are also with everyone affected by pandemic. And our priorities remain the safety and well-being of our employees, and the continued support of our customers, partners, and communities. Many of us, myself included are adopting multiple roles as we seek to juggle the demands of our professional and family lives in a world that has suddenly become most more complex, and more constrained. Personally I've had to learn how to home school my youngest child, and while I've always had a healthy respect for the work teachers do, I have developed an even deeper appreciation for the role teacher’s play in our societies. It takes a lot of patience and skill to help a young mind learn what it needs to learn. From a business operation standpoint, the transition to working remotely has been smooth. I am proud of how our employees and partners have balanced their personal lives with many commitments during these unprecedented times; many significant product upgrades were successfully released, thanks to our cloud-based operating infrastructure. One of the metrics we've been tracking closely is the weekly active users of our products, and since the pandemic started usage of our products dip slightly, but overall remained relatively steady. In China, usage dropped lot rapidly in February, but rebounded above pre-COVID levels by the end of March as business started reopening in the region. And it's no surprise we saw a major surge in usage of our cloud collaboration project – products, as people work from home and throughout the quarter. During the quarter and into May, renewal rates held relatively steady among our target markets, AEC revenue held up well, while we experienced a slowdown in the manufacturing space. The resiliency of our business is anchored by the diversity of our geographic regions and product offerings, our subscription -- business model and our indirect distribution model, which allows us to operate and adapt locally as economic conditions evolve in different geographic regions. During the quarter, we helped our customers accelerate their migration to the cloud and ease their transition to working from home. We also offered extended payment terms to alleviate their liquidity concerns. Please refer to the slide deck on our investor relations website for more details on these actions. I am incredibly proud of not only the way our employees rally to support each other in the company, but also how they rally to support our customers, our partners in the communities they live in. Without their resiliency, the resiliency of our business model wouldn't matter. With that, I'd like to turn it over to Scott now to take you through the details of our performance and guidance before I come back to provide insight into our strategic growth drivers."
},
{
"speaker": "Scott Herren",
"text": "Thanks Andrew. Before I offer more details on the first quarter, I want to echo Andrew's comments thanking our heroes, battling the pandemic on the front lines. Our products, partnerships and expertise help many frontline organizations combat the pandemic, from the quick build and hospitals to manufacturing Personal Protective Equipment or PPE and the philanthropic support of global, national and local communities. My own daughter has just graduated with her nursing degree and will be on the front line next month. Availability of proper PPE for her and all the other superheroes and sprouts has been my biggest concern, so I'm particularly proud our desk has played a role in addressing that need. Our keyword performance was strong with total revenue growing by 20% subscription plan revenue grown by 35% and operating margin expanding by 10 percentage points. Total remaining performance obligations grew 27% and current remaining performance obligations grew by 18% to $2.4 billion in the quarter. We delivered free cash flow of $307 million and continue to repurchase our shares to offset solution. Typically I'll go through our results from the quarter in more detail, but today I'm going to focus on the COVID-19 impacts on our business and guidance. You can find additional details in our Q1 performance on our investor relations website. I do quickly want to mention that we have renamed what we previously called core business to design and what we previously called the cloud to make. The private labels cost to compute is almost all of our products have cloud enabled functionality. There is no change in the products that fit into each of these two categories. During the quarter renewal rate held relatively steady, whereas new business not surprisingly slowed down in the second half of Q1. However, the impact on our business has not been uniform by geography or industry. Our business is not only diverse from a geographic standpoint, but our products and customers are diverse as well. Many of you have asked about our exposure to small businesses, we generate approximately 10% to 15% of our revenues from small businesses to find those customers with less than 20 employees and with less than 15 students. Our net revenue retention rate is within the 110% to 120% range. One of the other metrics we track for customer stickiness is partial renewals, which is a measure of subscription renewals for some, but not all seats in the contract are renewed. Our partial renewal rate remained relatively steady as well. In prior downturns, AutoCAD LT was a leading indicator for demand. However, during the current slowdown, our mixed up AutoCAD LT moved higher, as some customers apparently chose to optimize their purchases. Lastly we saw a modest decrease in multi-year deals toward the end of the quarter, although many customers continued to move forward with multi year commitments, even in the current environment. Given the evolving business environment as a result of COVID-19, we are actively managing our spending, reducing travel and entertainment expense, monitoring our hiring rate, shifting the virtual events across the board, and rationalizing our marketing spend. We will continue to invest in critical areas such as R&D, construction, and digitizing the company to ensure our future success as we come out from a pandemic. Now let me turn to our expectations for the remainder of the year, our investment in cloud products and a subscription business model, backed by a strong balance sheet gives us a robust foundation to successfully navigate the economic challenges. Our full year guidance range is wider than normal due to ongoing uncertainty in the economic environment, it will have a more pronounced impact on our new business. Regarding trends during the year, we expect the second quarters new business activity to be the most impacted by the pandemic. Our pipeline entering the second quarter is strong and growing. But we're cautious about new business close rates. The upper end of our range assumes a swift recovery in new business in the third quarter and continued improvement into the fourth quarter with full year new unit volume growing lastly. At the lower end of the range, we are modeling deeper impact on second quarter sales, fall by a slower recovery in the third quarter and further improvement in the fourth with full year, new units posting a modest year-over-year decline. On the other hand, the majority of our business is renewals and we have not experienced the meaningful change in our renewal rate, which offers us resilience in an uncertain environment, still we are modeling a decline in renewal rates in the second quarter, out of an abundance of caution. Our low end and high end guidance scenarios differ in the extent of the drop in the second quarter and the pace of recovery later in the year. Given our strong renewal rates, we expect our net revenue retention rate to remain above 100%, but move below the current range of 110% to 120% for the rest of the year. The decision to reduce new product demand, we anticipate our billings will be impacted by a fewer multi-year transactions, the lower end of our billing guidance assumes a steeper decline in multi-year contracts, whereas the upper end is based on a more modest decline. The reduction in billings and the timing of large transactions are impacting our free cash flow expectations. Fiscal 2021 will be a significant and more backend loaded year, which will move some of the free cash flow from this year to next. We expect our full year operating margin to expand by approximately two to four percentage points. Looking at the second quarter forecast, we expect the pandemic to meaningfully impact our billings, which can be sequentially down by low double-digit percent. Additionally, our decision to offer extended payment terms to our customers for sales, up through early August, combined with a more backend loaded quarter will impact our Q2 free cash flow, which could end up being breakeven to slightly negative before accelerating in the second half of the year. Although our fiscal year 2021 results are being impacted by COVID-19, we are confident in our fiscal 2023 free cash flow target of $2.4 billion. Assuming the recovery starts by the end of this fiscal year. We build a resilient business model that will allow us to capitalize on multiple tailwinds, once we exit the current pandemic. And now I'd like to turn it back to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Scott. We expect all secular trends that we have been investing in for years to be accelerated during and beyond this pandemic. People are being forced to change the way they work, and in turn are experiencing the benefits that our cloud and subscription solutions have to offer these companies are not going to go back to how they worked before and digitization will be accelerated as businesses take all steps necessary to sure they are more resilient. Our investments over the last few years, combined with our ongoing focus on cloud-based offerings, leave us with a competitive advantage and well-positioned to help our customers, not only during this pandemic, but also in the new world that they will be working in when it is over. In fact, some of our biggest customers are already altering the mix of our products to lean more heavily into the cloud and digitization. Although AEC spending has held up well and work is continuing, some customers are seeing project delays, cancellations, and in some cases, job sites temporarily shut down. However, despite these realities, we have seen continued adoption of our construction offerings. For example, Media [ph] Construction, a general contractor in Southeastern United States, selected our products over a competitive construction management solution at their time of renewal. Their business is growing rapidly and price was becoming a concern with their current vendor. They needed a comprehensive solution that was fast and easy to implement. The multiyear deal started with PlanGrid for the field, evolved to include BIM 360 for the office and field connectivity and ultimately, included BuildingConnected for project bidding. Many construction sites were shut down temporarily, impacting our new business for field-focused solutions like PlanGrid. However, our products span the complete construction value chain and our collaboration products like BIM 360 Design and Docs experienced solid growth. Our extended access program allows customers to try out and experience the value of the cloud collaboration products at no cost for a limited period of time. We're seeing customers who are in the process of adoption accelerate their timelines. We are also seeing customers purchase additional seats directly through our digital store. Since early March, cumulative new commercial projects grew over 200% in BIM 360 Design and over 100% in BIM 360 Docs. This surge in usage has been a great test for our cloud product infrastructure, which has scaled up seamlessly. As you might recall, BIM 360 Design is the cloud collaboration tool that allows our customers to use our Design product anytime, anywhere with data stored in the cloud. Now that customers are experienced cloud-based solutions that allow them to work efficiently from anywhere, we do not think they will revert to previous ways of working. One of our largest customers, AECOM, significantly increased their adoption of BIM 360 and reached out to us beforehand to ensure that we were set up to support the increased usage. AECOM is the world's premier infrastructure firm. David Felker, CIO, Americas and Construction, recently commented, 'We're shifting rapidly to remote working, which is absolutely essential for the continuity of our business. Our strategic partnership with Autodesk and the BIM 360 Cloud platform, along with substantial investments in digital solutions and technology, have enabled our successful pivot to this new way of working. We forecast that our use of BIM 360 will continue to grow dramatically in the short-term and will become our new baseline for projects in the long-term.' We are not only helping our customers work remotely, we are also doing so quickly. When New Zealand went into lockdown overnight, we helped Warren and Mahoney Architects successfully mobilized their entire business to work from home in five days. In the process, they doubled their number of BIM 360 Design subscriptions. They told us they would not have been able to so successfully continue their business operations, while working from home without our support. And they also noted that all projects will be delivered using our platform going forward. We believe the current pandemic will accelerate digitization and automation in the AEC industry, as customers look to make their businesses more resilient. At the end of every downturn, there is an upturn, and businesses will need our products more than ever to stay competitive on the other side of this. One segment that has historically done well, as governments seek to provide stimulus, is infrastructure. During the quarter, we announced an alliance with Aurigo to better serve public and private owners. Capital project owners at Departments of Transportation, cities, counties and enterprises will benefit from this alliance, and we are already receiving positive feedback from customers. This quarter, we had a top architecture firm and a subsidiary of one the largest state owned enterprises in China choose our products over Bentley's. Their typical projects for domestic and international clients include healthcare infrastructure, stadiums, airports and skyscrapers. Autodesk's streamlined workloads and data compatibility allow them to collaborate across teams and bring digital design down to the construction service phase. Beyond that, they have already taken advantage of our products for generating optimized design schemes and are excited to use Generative Design in Revit, as we recently announced Generative Design is available in Revit 2021. As our customers plan to return to work safely, they need help redesigning space layouts in buildings, and this is one of the things Generative Design enables people to do effectively. Although, manufacturing has been impacted by supply chain disruptions and temporary factory shutdowns, our products are enabling customers to operate under evolving conditions. Customers use our solutions to develop new products and R&D continues even when production floors experience disruption. Automation and flexible supply chains will be vital to competitiveness in the future. Our products help customers work remotely in a distributed environment and collaborate among their divisions, customers and supply chains in the cloud. Fusion 360 is the leading comprehensive multi-tenant cloud CAD/CAM and PLM solution and continue to gain traction during this pandemic, as customers are reassessing their technology portfolios' readiness to cope with the demands of distributed work. In fact, April was the fastest-growing month for new user acquisition. A good example of this is that we closed a large stand-alone Fusion 360 deal with a big semiconductor company. Currently, they use the electronics design capabilities in Fusion for their printed circuit board design work. And we expect to further expand our presence with them due to the integrated functionality offered by our products at a more attractive price point. In addition, BASF, the largest chemical producer in the world, increased their EBA users of Fusion 360 to 2,000 during the quarter. They look forward to using Fusion 360 as a collaboration platform to improve the efficiency of communication between several teams, starting with equipment design and maintenance at one of their chemical plants. Growth remains strong, relative to our competition across manufacturing portfolio. Customers of our on-premise solutions report minimal disruption in the move to remote work, which has been supported by cloud features included in our subscription offering. During the quarter, we signed our first enterprise business agreement with an automobile manufacturer in China. The usage-based model was a good fit for the customer who needs flexible access to our expansive portfolio of products. COVID-19 was a catalyst for them to substantially increase their engagement with us. They made the decision to adopt the most efficient solution to ensure they stay competitive in their industry on the other side of this downturn. In addition to growing our presence in the commercial space, we continue to maintain our leadership in the education space, where future engineers are rapidly adopting our products. Our new-user acquisition in the education space, driven by Fusion 360 went up over 70% in April. Moving onto another high priority area for us, we are still making traction, monetizing non-compliant users. In terms of sales led initiatives, we are being sensitive to customer situations and are often deferring the final outreach, but this does not mean progress has stopped. The first deal we closed and move on after the business reopen was a license compliance transaction that we have been working on for many months prior to the pandemic. We closed an additional license compliance deal and competitive win over Bentley in Central America, and the customer is now piloting BIM 360 Docs. In closing, while all of us are impacted by the current pandemic, we are building a stronger Autodesk for the next year and beyond. We have a head start over our competition in critical capabilities like cloud computing and cloud-based collaboration, and we will continue to invest in our strategic initiatives. There are three key areas that make us confident in our fiscal 2023 targets and our growth after that. One, digitization in AEC is going to accelerate in the coming years as companies seek to adopt not only BIM, but a complete design to make workflows enabled by the cloud that not only make current processes more resilient and efficient but support new industrial paradigms for industrial paradigms for the construction site. Two, the evolution of manufacturing to a more distributed network and cloud-based workflow is also going to accelerate significantly over the next few years. And we have the industry's leading multi-tenant cloud-based solution to address the emerging customer needs that will -- and three, our business model is more robust, adaptable and resilient than in the entire history of the company. This will allow us to not only invest aggressively in the future, but do so with an eye to both revenue and margin growth. We look forward to virtually engaging with many of you at Investor Day on June 6th where we will have more time to share our strategic initiatives. With that, operator, we'd now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Saket Kalia with Barclays Capital. Your line is now open."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hey, thanks guys for taking my questions here. And I hope everyone's doing well. Andrew, maybe just to start with you. Thanks for the commentary just by area. I want to look at it from a different lens, and maybe see if you can talk about what you're seeing from your customers on engineering headcount and hiring. Now clearly, that situation is going to differ between manufacturing – between your manufacturing customers and your AEC customers. But I'm wondering, if you could give us some high-level observations just about how your customers are approaching headcount during these times?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Saket, I hope you're doing well as well. Look, there's – what I'll do is I'll give you some indirect measures of what we're seeing. If our customers were engaging in a lot of headcount reductions, what we would see is a tendency towards more partial renews in our base. We're not seeing that, all right, as we mentioned in the opening commentary. So we're not seeing this increase in partial renews which kind of talks to a stable employment base and a stable team environment. The other thing that we pay attention to is the whole notion of what's happening with weekly active users, okay? That's the real measure of economic activity happening on top of our applications. This is something we didn't have during the last downturn. We weren't able to monitor weekly active use of our desktop products. That weekly active usage, while it declined a little bit as we headed into this, is definitely starting to stabilize. So that's another indicator that tells us, look, people are hanging on to their R&D, their R&D and early project development team members. We're well in front of the process here on multiple factors, so people need to keep the people working on the stuff that uses our products in order to effectively meet the demand as they come out of this. So that's what we're seeing Saket."
},
{
"speaker": "Saket Kalia",
"text": "That's really helpful. Scott, maybe for my follow-up for you, you touched on this a little bit in your prepared remarks, but I'm wondering if we could just flush it out a little bit more. Can you just talk about what you saw in the quarter on those multiyear paid-up subscriptions? And just talk about how you're thinking about that in the fiscal '21 free cash flow guide?"
},
{
"speaker": "Scott Herren",
"text": "Yes. Thanks, Saket. And I hope you and your family are staying safe too. It's such a bizarre time. What we did see -- the multiyear continues to be relatively strong. It was an interesting quarter. The beginning of the quarter was quite strong. Across the board, demand was strong. Multiyear was strong. It was really a continuation of a strong Q4. And then right around mid-March, we saw things slow down. And it slowed not evenly, as we talked about in the opening commentary. It slowed down little bit by – as countries were affected in a different rate. What we saw in multiyear is, we did see it come down a bit in the second half of the quarter, but not substantially. And you see that when you look at the total long-term deferred balance in relationship to the total deferred revenue balance. So while it did come down, a lot of our customers continue to see value in buying the multiyear. Our partners continue to see value in selling that. And of course, we get value because those are renewals that we don't have to chase, and it frees up sales capacity. So the triumvirate of good for customers, good for partners, good for us continues. I do expect to see some headwind on multiyear transactions through the second half of the year, and that's part of what is influencing the change in our guidance on billings and free cash flow as an expectation that multiyear will trend down through the year, certainly in the second quarter with some recovery towards the second half of the year."
},
{
"speaker": "Saket Kalia",
"text": "That’s very helpful. Thanks guys."
},
{
"speaker": "Scott Herren",
"text": "Thanks Saket."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Phil Winslow with Wells Fargo. Your line is now open."
},
{
"speaker": "Phil Winslow",
"text": "Hi, thanks for taking my question. I'm glad to hear that you are well and hopefully that extends to your families and your team members. Question first for you Andrew, then a follow-up for Scott. Andrew, you talked about obviously the different phases of the construction life cycle and different products you have there. When you're talking to your customers, how do you think about sort of reopening, starting to sort of impact, call it the architecture side, your planning, construction etcetera. And considering the fact that you were on the AEC side, you seem to have a backlog of projects coming into the year, what are they saying to you in terms of restarting and where sort of that backlog is, especially when you think kind of guide go-forward basis? Then just one follow-up for Scott."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So the backlog comes in 2 forms. The first backlog is projects that were just put on hold and were about to go into the pipe, we hear a lot about that from our customers is that look, a lot bunch of products were just put on hold, until people know where they're at. Those projects are not going away. None of them are in any kind of category that would represent a pullback from the projects. So yes, at the front end in the design and kind of engineering side, there is definitely this queue of projects that were put on hold. The interesting thing on the downstream side and the construction side, what you saw was how in some municipalities, people actually stopped construction. Now those construction sites are coming back on right now. And in some places, construction never stopped, but they're not coming back on the same, all right? So what you're seeing is people are working with distancing, listing requirements on the construction site, so there's fewer people on the construction site and these people are working in more shifts, so what you're actually seeing is more pickup in the digital tools and an anticipation from our customers that they need more tools to digitally manage their sites as they stand up these construction sites. The same goes in manufacturing. Manufacturing, they – their biggest problem is that their output side will shut down. Their new product development and all the things that are going on there, none of that was stopping. They just couldn't push the units out because of various restrictions on them. That's all starting to open up as well. And that's what we're hearing from our customers. Frankly, the one segment of our customer base that still doesn't know what their – what their fate is is the people making films, TV and film. They're still struggling with when the sets are going to back up. The games, games, obviously, they never – they never saw a slowdown. So – but the people in the film business are still waiting for when the production is going to restart."
},
{
"speaker": "Phil Winslow",
"text": "Okay. That was super helpful. And then Scott, just to follow-up. Obviously, we came into the year with a significant number of active users that weren't on subscription or maintenance. I wonder if you could tell us just sort of the trend that you saw in Q1 relative to last year in terms of conversion of those to paying subscribers and just how are you thinking about this year?"
},
{
"speaker": "Scott Herren",
"text": "Yes. It continues to be an enormous opportunity for us, Phil, and it's one that we'll continue to pursue out even beyond fiscal 2023. What we have seen during the quarter is – we talked about this on the fourth quarter call as well. We've gotten better at the data science at identifying those, passing on higher-quality leads. That's led to the productivity of those license compliance teams improving. And as the productivity improves, we're investing more headcount there. That trend continued into the first half of the quarter. I will tell you, as the economy got more difficult and as many of our customers face shutdown and very difficult situations, what we did do toward the second half of the quarter is, while we'll continue to pursue those transactions, we're not forcing a final transaction, a final outcome of that in many cases. So that pipeline continues to build. We continue to work that and build that up, and that's an opportunity that's still ahead of us in the second half of the year."
},
{
"speaker": "Phil Winslow",
"text": "Great, thanks guys and stay safe."
},
{
"speaker": "Scott Herren",
"text": "You too, Phil."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Phil."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Heather Bellini with Goldman Sachs. Your line is now open."
},
{
"speaker": "Heather Bellini",
"text": "Thank you very much, gentlemen for taking the question and glad to hear you and your families and the Autodesk employees are doing well. I just have two questions. First, Andrew, you mentioned the license compliance deal in Wuhan that you closed. But I also wanted to ask, given your global reach, how are you seeing business trends in parts of Asia, aside from that one, where the economies have maybe been open for a little while longer? And any commentary – I guess, there would be any commentary on how the first month of this quarter overall is tracking versus the month of April? And then I just had a follow-up for -- a follow-up one after that."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay, great. So, Heather, let me give you a little context. I'll kind of answer your question a little broader than you asked just so that you can a full set context. Scott said, we kind of entered Q1 with a roar. We had like a week to celebrate our success from fiscal year 2020. And then what happened is March hit, you saw China start to decline, you saw Korea follow suit. You saw a general decline in APAC, and then kind of Europe came online after that, started to decline, then the U.S. Here's what we saw, though, as things played out. China and Korea are rebounded, right? Monthly -- weekly, monthly active usage in China is now above the pre-COVID highs in that country. Korea returned and became stable. Japan was surprisingly steady through the entire crisis, all right, both from a business perspective -- from a business collections and from the weekly active usage numbers that we are tracking. And now what we're seeing is kind of the same kind of cascade happening in Europe. We're starting to see Europe weekly active usage is going up. New business is starting to go up. And you're seeing -- we're seeing a kind of a stabilization in the U.S., not any upward trajectory yet, but it's all cascading like that. And we saw that in our weekly active usage numbers. We're seeing it in our new business numbers. And another thing that stayed constant and stayed relatively steady was renewal rates. Now, we always told you that we anticipated renewal rates would decline slightly during a downturn. What happened was that renewal rates actually declined less than we expected. So, they've been -- they've held up incredibly well through this downturn, and that was consistent across geographies at all times during the crisis. There hasn't been some kind of sudden dip in renewal rates and some wavering. It's actually stayed like at a fairly consistent rate. The one thing I want to make sure you understand during the whole entire thing, our cloud products and our make products did incredibly well. Like, for instance, in March, during the heat of all of this, Fusion added 50,000 monthly active users in the month, right, in the heat of all of this, all right? We already told you about what was going on in BIM 360 Design and BIM 360 Docs, those products all did very well even through the downturn."
},
{
"speaker": "Heather Bellini",
"text": "That's great. Thank you. And then just one quick follow-up for Scott, and I know you mentioned this in response to someone's question, I think, about long-term deferreds. But you had talked about, at one point, most recently, those being maybe as much as 25% of the total deferred revenue balance. I'm just wondering is there a level that you would set up at for this year that you think might be more reasonable."
},
{
"speaker": "Scott Herren",
"text": "Yes. No, I think that's the right range, Heather. I think it ends up in the mid-20s. It had been slightly higher than that. You remember on the fourth quarter -- actually, on the third quarter and the fourth quarter call, I think there was concern that multiyear paid upfront product subs was going to run through hot and was going to create a problem for free cash flow this year. In fact, we thought this was going to be a year of stability as opposed to a year of a pandemic. And I have our multiyear offer actually on my watch list, because if I got the impression that it was running to an unstable level, so hot that we couldn't maintain that percent, I wanted to make changes to the offering to kind of tamp it down a bit. We haven't made any changes to the offer. At this point, I don't think we need to. It's the same, pay for three years upfront; get a 10% discount; that it's always been. We saw it in the second half of the year come down modestly. That's my expectation for the year and that will put long-term deferred in that mid-20% of total range."
},
{
"speaker": "Heather Bellini",
"text": "Okay, great. Thank you so much gentlemen. Stay safe."
},
{
"speaker": "Scott Herren",
"text": "You too. Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "You too Heather."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jay Vleeschhouwer with Griffin Securities. Your line is now open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening, Andrew and Scott. I'll ask both questions at once. So first, Andrew, you noted a number of trends and requirements that are being accelerated by the current situation. What are the implications of that, if any, for your sales and distribution model? You've been doing a lot of hiring or planned hiring for direct sales coverage, named accounts, inside sales, the store and so forth, and of course, working with the channel. So maybe you could talk about any implications there? And then secondly, looking past this current valley affecting business, looking to your longer-term road map, you've spoken, of course, often at AU, another occasions about your new platform plasma. What are the milestones for that internally that you'd be able to communicate over the next number of years in terms of its progress? And overlaying that at the applications layer, are there any major brands such as Revit or Inventor or anything else that you think would be prudent to rebuild or rewire in some way to take advantage of the new platform, in terms of collaboration, data orchestration, perhaps multi-core and multi-threading and all those good things. So a sales question and a technology question."
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. So let me start with the sales question. So as we've headed into this and looked at the year, as you've noticed, we've continued to invest. While we're not going to spend as much as we originally anticipated this year, we're continuing to invest in R&D and things that we think are core to our future and infrastructure. There are some areas that go-to-market we did continue to invest in, like international expansion for our construction solutions and things related to supporting the Fusion business. But, you're right, we probably slowed down a little bit on inside sales efforts when your inside sales teams, you don't want to hire inside sales teams when you're having trouble getting in touch with customers when they're working from home. So we slowed down some of those efforts, but there was no across-the-board slowdown in our go-to-market activity. In fact, what we did is, we prioritized those things that we thought were most important and invested there. And I think they all would make sense to you, in terms of what we're doing there. In terms of the longer-term growth, I think you're going to continue to see us invest in go-to-market internationally around our construction and cloud solutions. I think you're going to see us continue to invest in data centers and servers in our international locations that service our customers with some of our cloud solutions, because those are going to be in demand, all right? Now with regard to your second question, okay, we don't call it plasma anymore, by the way. It's a different name, which you'll get some view of later, probably around AU time frame. So I'm going to be careful about what I talk about there. But look, first off, I want to make sure you understand. There's a lot in our cloud, all right? A lot in our cloud platform, a lot that has been exposed, a lot that hasn't yet been exposed. Some of those things you're talking about allowing multidisciplinary collaboration, simultaneous access to a common model that updates based on different disciplines, but maintains control with, say, the architects or the engineers, you're going to hear a lot more about that in the coming months and probably around Autodesk University. So I'm not going to steal the thunder from that. What I will say at this point is, we've got a lot going on, and we're big believers in the app model. And what I mean by that is we believe that relatively modestly sized to big clients with a really robust cloud backend are the future. And we got there in a very informed way. So, for instance, Fusion has a big client. And – but it has a very, very, very fine-grained multitenant cloud data infrastructure hidden behind it. Fusion's cloud will get thinner – the client will get thinner over time. You could also see an evolution with Revit that's similar to that. That's going to take a little longer. And we made that choice very deliberately, Jay, because we've had lots of experience in pure browser-based applications. For instance, you might be aware that Tinkercad has 25 million users. Right now, in any given day, 11,000 people use Tinkercad. It's the K-12 de facto standard for 3D modeling out there. It's called Tinkercad, but it's actually an amazing tool. It is a multitenant browser-based solution, as is AutoCAD web, which has 50,000 monthly active users a month, all right, which does edit and the creation of drawings as well as collaboration on drawings. Both of those solutions taught us that thicker clients are better, all right. Not totally think clients, way thinner than our current desktop clients, way thinner, but like an app model. We learned this early on from our long years of experience with these pure browser-based tools. So that's why you see us doing that with Fusion. You'll see us do something similar in the AEC space over time. And it's winning because it helps get people to the cloud, but it has that same robust multitenant cloud database structure sitting underneath it."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. I hope you do well."
},
{
"speaker": "Andrew Anagnost",
"text": "You too, Jay."
},
{
"speaker": "Scott Herren",
"text": "Thanks, Jay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Matt Hedberg with RBC Capital Markets. Your line is now open."
},
{
"speaker": "Matt Hedberg",
"text": "Hey, guys, thanks for taking my questions. I'm glad you guys are well. There's always a lot of questions on construction and all the improvements you made on a product perspective there, but want to talk a little bit more about the momentum in manufacturing. We do hear really good things about Fusion 360. And I know, Andrew, you called it out on the call being a real disruptive offering. Where are we in the momentum of that business? And relative to the investments that we've made in construction, are there many more that still need to happen in this particular part of your business?"
},
{
"speaker": "Andrew Anagnost",
"text": "In the manufacturing part or the construction part. You – I want to make sure I answer the question…"
},
{
"speaker": "Matt Hedberg",
"text": "Yeah, the manufacturing side."
},
{
"speaker": "Andrew Anagnost",
"text": "Okay, good. Because – all right. So I'm glad you asked the question. Like I said, we're definitely seeing building momentum in that space. There's no doubt about it. Fusion is on fire. I said in March, it added 50,000 monthly active users. There's over 600,000 monthly active users on the application today, all right. It's in the very early stages of a revenue generation activity. I am going to save the total commercial subscriber base as a reveal for the Investor Day coming up. Suffice it to say, it's large, all right, and significant. In education, it's by far the leader. And by the way, it has a connectivity flow with Tinkercad. So we've got K-12 locked up with Tinkercad and Fusion's rapidly taking over post-secondary education and becoming more and more of a force in that space. I think you're going to see a lot of exciting things with Fusion over the next year, especially as we start to reveal the data layers that are hiding underneath the thick client that we use for the application. So I want to hold off a little bit until Investor Day. But I will tell you, in any given day, 60,000 people are using Fusion to solve real-world problems today. So I think it’s an exciting application. It has really significant potential for the future. We are way ahead of our competition, not only in functionality, but in low cloud power."
},
{
"speaker": "Scott Herren",
"text": "So it's a bit of a teaser to get you into the Investor Day next week, Matt."
},
{
"speaker": "Matt Hedberg",
"text": "Yeah, we’re looking forward to that. And then maybe a quick call for Scott, I know renewals were stable this quarter, which is great to hear. I wanted to ask about the [Technical Difficulty]...."
},
{
"speaker": "Scott Herren",
"text": "Matt, your voice is breaking up pretty badly. You started off fine and then I was guessing what your question is."
},
{
"speaker": "Matt Hedberg",
"text": "Sorry about that. The joys of working from home. Just – the question is how are your customers doing today? And when you look at your '21 guidance, you talked about some expectations on renewal. But what are expectations for VSB renewals in your fiscal '21 guide?"
},
{
"speaker": "Scott Herren",
"text": "Yes. That's a great question because I think there's an expectation that, that segment, which we call to VSB, Very Small Business but to generalize that, think of that as a single site with 20 employees or less and 15 seats or less. And that segment for us typically drives somewhere between 10% and 15% of our sales. We're not seeing a difference in the renewal rate in that segment versus the segment right above that, up through enterprise. It's a bit surprising, frankly. I would have expected that we would have seen a bigger impact there, but we're not seeing that at this point. But bear in mind, as you could imagine we are running multiple scenarios constantly on the back end. And one of the things that I've had built into those scenarios is an expectation that we do see renewal rates move from where they are down modestly during the second quarter. And then the difference between the high end and the low end of our guidance range is sort of the rate of recovery of those. But just to be cautious, even though we're not seeing it yet, I am modeling that into the guide."
},
{
"speaker": "Matt Hedberg",
"text": "Thanks a lot."
},
{
"speaker": "Scott Herren",
"text": "Thanks Matt."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steve Koenig with Wedbush Securities. Your line is now open."
},
{
"speaker": "Steve Koenig",
"text": "Hi gentlemen, thanks for taking my question. I'll just ask two quick ones. I'll put them both out there. First one is, are you guys -- what are you seeing in terms of horizontal construction? Is there any positive impact? Or do you expect any tailwinds from the stimulus -- we'll call it, the stimulus spending. It's really the anti-recession spending the government is doing. So that's question number one? Question number two, can you give us any color around your assumptions behind new business, kind of looking back at my Autodesk model from the '09 period, your licenses -- if I recall correctly, we're down like mid 30%. It was pretty steep. And I'm wondering how relative to low and high-end of your guidance range, just maybe any color on assumptions you're making? Thanks very much guys."
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. Great. All right. So I'll start off and take the horizontal construction question. So we've been anticipating stimulus with regard to infrastructure for some time now and we've been investing in our core products for that, in particular, in road and rail. What you saw us recently do was engage in a partnership and an investment with Origo, and I mentioned that in the opening commentary. Origo is really, really strong in the early capital planning part of these types of projects, whereas we're really strong in the design and make parts. There's an overlap between our solutions, but they're very, very complementary. Between the functionality we've been building in our design portfolio and this partnership, it's designed to bring the departments of transportation forward in terms of their solution stacks for these various types infrastructure engagements. Right now, they're basically on really old stacks and fairly old technology, Aurigo is a born in the cloud company, most of our stack is rapidly moving to through the cloud. Obviously, the construction stack is entirely in the cloud. So we've been preparing for tailwinds around infrastructure for quite some time. We believe we're ready. We believe these partnerships we put in place are absolutely the right kind of thing. We're already seeing some returns from those partnerships in terms of engagements with various departments of transportation. So yes, we do anticipate a tailwind coming from stimulus related to infrastructure, and we've been preparing for it."
},
{
"speaker": "Scott Herren",
"text": "And to the second question you had, Steve, I'll point you to – I'll tell you what our expectations are, but I'll also point you to the slide deck that we posted on the website at the same time. I know it's a busy night, and there are other companies reporting at the same time. We actually moved to today to try and avoid a lot of other company traffic to try to lighten the load on you guys a bit. So there's a slide there, but I'll tell you what our expectations are. At the low end of the guidance range, we expect – well, in both cases, we expect our new business to be most impacted in the second quarter. And then the divergence between the low end and the high end is the depth of the impact in the second quarter on new business and the rate of recovery, such that in the low end of the range we expect for the full year, we expect a slower recovery from the bottom in Q2, such that for the full year, there is a slight decline in new volume for the year. At the high end, a slightly less of an impact in Q2, a swifter recovery, such that for the full year, new unit volume actually grows modestly. And that's informed by what we're seeing as markets have reopened by monitoring, as Andrew said, what the weekly active usage rate looks like in each of our core markets and really getting an understanding the usage of our products by our customers. Things like our partial renewal rate staying strong, says, if I had 10 that came up for renewal and I renewed all 10, that means that I don't have a reduction in workforce. So I think the strength of the renewal base, plus the – our expectation on what new volume looks like is what differentiates the low end from the high end."
},
{
"speaker": "Andrew Anagnost",
"text": "One more point, we're not seeing close to the levels of declines in new business we saw during the great financial crisis, okay, just to make sure there's too clear on that."
},
{
"speaker": "Steve Koenig",
"text": "Got it. Cool. Thanks a lot, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Sterling Auty with JPMorgan. Your line is now open."
},
{
"speaker": "Sterling Auty",
"text": "Yes, thanks. Hi, guys. I know that some of the hardest industries like transportation are not maybe viewed as heavy design users, but any sense of your exposure to transportation, hospitality, hotels, et cetera, in that group?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Those segments tend to be users of things like LTE versus facilities planning and facilities layout. So they're – while they’re big companies, they generally tend to be downmarket users of our applications. It's a facilities usage play for us. So we don't have a lot of exposure to the main line of our business from those very hard hit industries in hospitality, transportation and in food services."
},
{
"speaker": "Sterling Auty",
"text": "That's fair enough. And then one other question. Any thoughts in terms of what you think the impact from a number of companies I've already talked about, post COVID-19, maybe not bringing all the workers back and maybe we'll just see a change in the commercial real estate landscape permanently. Any thoughts in terms of how that might impact your business moving forward?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. It's careful to kind of think about that question in an important way. First off, commercial business building, the commercial buildings and commercial office space, not a huge part of our business. However, I mean, we're living this -- personally, so I can speak to this with some knowledge about how this is working. There's a couple of trends, I think you need to be aware of. One, when people move to more work-from-home type environments, and we will probably have that on the other side as well, they're actually going to have less dense office space. So, for instance, the current requirements in terms of us getting back in our offices are going to require us to significantly de-densify some of our office space. So, people are not -- in the short-term, certainly, not going to require less office space, they're just going to have fewer people in it, spread out more widely over the next 12 to 18 months, okay? So, we have to be very clear on that, people will be coming into offices that are much less dense. That's where we're going. It's where a lot of our customers are going, and they're going to need to reconfigure those office spaces in unique ways. And we're helping them to do that with some of the general design tools. But on a bigger standpoint, okay, there's still going to be population growth. We're still going to have workers. There's still going to be a population that needs to come into an office, but how these offices are distributed and where they are may change. We've always been talking about a trend around urbanization, but we might be future talking about urbanization and suburbanization, where you're seeing this kind of spreading out away from dense urban centers into suburban centers that also have office space and high-rise living spaces. And then they're connected by infrastructure that requires them to have a hub-and-spoke kind of flow. So, there's a lot of ways that this plays out in the future, but in our projections and our view on this, people are going to be building more, not less. Where they build it may change."
},
{
"speaker": "Sterling Auty",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Keith Weiss with Morgan Stanley. Your line is now open."
},
{
"speaker": "Hamza Fodderwala",
"text": "Hi, this is Hamza in for Keith. Most of my questions have been answered, but just a couple of quick ones. For you, Scott, you mentioned -- so the low end of the guidance is implying that new unit volume sees a slight decline. Is there any instance where we could see maybe overall subscription growth -- subscriptions actually decline year-on-year? Or is that just basically net new sub adds?"
},
{
"speaker": "Scott Herren",
"text": "Yes. With the strength of our renewal rate, Hamza -- and at least I got your name right this time. With the strength of our overall renewal rate and the size of our renewal base, no, I don't see overall subs coming down. I think the new unit volume could see some pressure, and we're seeing that in the second half of Q1, but I don't see the aggregate coming down, no."
},
{
"speaker": "Hamza Fodderwala",
"text": "Got it. And on the renewal rate, you mentioned it's been pretty stable. Any color you can give us as to how that has sort of trended versus sort of the historical range, I think sort of like mid to high 80%."
},
{
"speaker": "Scott Herren",
"text": "Yes, it's stayed in the same range. It really stayed steady, Hamza, throughout the quarter. Even as the new business slowed down -- I talked about the difference between the first half of Q1 and the second half of Q1. Even as the new business slowed down during that timeframe, the renewal rates stayed pretty steady and stayed pretty steady across the board."
},
{
"speaker": "Hamza Fodderwala",
"text": "Okay. Thank you very much."
},
{
"speaker": "Scott Herren",
"text": "Welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Borg with Stifel. Your line is now open."
},
{
"speaker": "Adam Borg",
"text": "Hey guys and thanks for taking the question. I'm glad to hear everyone's safe. Just a quick one on M&A philosophy. So, in the past, we've talked about large M&A being done on -- for the most part, on the AEC side and potential focus shifting to manufacturing. Just given the current potential market dislocations, I would love to hear your latest thoughts. And I have a follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, specifically, I've talked about large M&A being done on the construction side, all right? I was very specific that we felt like we got the biggest pieces that we needed on the construction side. Certainly, we are going to continue to look at all our markets. With the shakeup that will likely be accelerated over the next five years in manufacturing, with supply people rethinking their supply chains and numerous things associated with that, I think, our focus on manufacturing will likely continue. But don't think that we won't look opportunistically at opportunities in AEC as well. The next 12 months could present themselves with all sorts of opportunities for organic and inorganic growth activity. Fortunately, we've got a good strong balance sheet. We've got a nice recurring revenue model. We're in a good position this year to act on something that we think could be appropriate for us. So we don't see anything immediately in our future."
},
{
"speaker": "Adam Borg",
"text": "Got it. Got it. Thanks. And then just as a quick follow-up, multiuser licensing, I know that got pushed back till August. Just curious how conversations are going with customers, and any feedback or color there would be great. Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "I got to tell you a story. I'm not going to use specifics. It just came in before -- while we're preparing for today. There was a customer that was desperate to get rid of their multiuser licenses and move to single-user licenses, because they need a two-factor after a malware attack. So we've had people, customers coming to us now realizing that named users are not a bad thing, all right? As a matter of fact, when you're trying to move from working in an office to distributing your workers all over the place, it's really nice that you can just download the software and log on and it works. And they saw us responding much faster to their work-from-home needs. So initially, before this crisis, we were getting a lot of noise about multiuser. A lot of that has started to die down. And in some cases, people are starting to realize that multiuser was not the panacea they thought it was for the problems they were having. And, in fact, it exposed them to other things. So I don't know if that will continue. Times could change, as we head out of this. But, right now, it's been an excellent opportunity for people to understand and for us to have a discussion about what does named user really gets you and what are the benefits. And we're seeing some of that right now. So it's still early days. We've only done a few multiuser conversions at this point, but there's some very interesting conversations around this."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks, again."
},
{
"speaker": "Andrew Anagnost",
"text": "You're welcome."
},
{
"speaker": "Scott Herren",
"text": "Thanks Adam."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks Adam. Stay safe."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Brad Zelnick with Credit Suisse. Your line is now open."
},
{
"speaker": "Brad Zelnick",
"text": "Great. Thanks so much for fitting me in. And I'll echo all the well wishes all around. My question for you guys. It's good to see the strong usage of BIM 360 Design and Docs. How usage of this is temporary, given everyone working from home? And how much of it do you see as sustainable longer term? I mean, given the extended free trial, how are you thinking about page conversion?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we didn't do the extended -- the only access program to drive paid convergence, as you know, we did it to help people work from home. However, our customers are being pretty definitive with us that their -- most of them are not going to go back to their old way of working. Remember, once they started up a project in these environments and found that the fluidity of what they can do and how they can work remotely, they're very unlikely to pull the project out of the system unless they feel like, I didn't really need any of that. We don't foresee that happening. In fact, one of the things I said in the opening commentary is that, AECOM was very explicit with us that we are moving to a more distributed model. With these things, we’re going to be increasing our usage. Are you ready Autodesk? And we told them, of course, definitively that we were. So, while some customer’s may revert back to their old way of working. We expect a significant number of them to come out of this changed. It's exposed them to something they really weren't aware that they could do previously."
},
{
"speaker": "Brad Zelnick",
"text": "Thanks, Andrew. And maybe just a follow-up regarding the strength in retention relative to expectations. How much is due to a tight labor supply, forcing firms to hold on the talent and Autodesk subscriptions in anticipation of an economic recovery?"
},
{
"speaker": "Scott Herren",
"text": "Yeah. It's really hard to say, Brad, what the drivers are, if it’s a – I’m going to hang on to people even though I don’t have them put to use. I don’t think that’s the case. I think more and more – if you think about where our products are largely used in the process, it's less on -- at least today on the job site and on the manufacturing floor and more upstream in the design process. And that's had a lot less impact from the shutdown and the shelter-in-place that's taken place in the wake of the coronavirus. So I don't -- we're not sensing a significant change in headcount and we look at weekly active users. We look at, I think, one of the most compelling statistics is that partial renews had 10 seats only renewed nine, has held steady as well. And so I'm not -- we're not picking up that there's a change in the workforce or changing the work that needs to be done underneath the products."
},
{
"speaker": "Brad Zelnick",
"text": "Great. Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "The only thing -- remember, weekly active usage is starting to trend up in some of the places that were first hit by the pandemic. So we're seeing the opposite where people are actually starting to use more as they come to their side of this."
},
{
"speaker": "Brad Zelnick",
"text": "Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks for the question, Brad."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Celino with KeyBanc. Your line is now open."
},
{
"speaker": "Jason Celino",
"text": "Hey guys. Thank you for fitting me in and it's nice to hear from everyone. One quick one for Scott. As we think about the different ranges for the guidance, it looks like on the spend side, its coming down to about mid to high single-digit spend growth. How do you think about the low to mid – high end of the guide for toggling maybe some of the spend you might do?"
},
{
"speaker": "Scott Herren",
"text": "The spend -- so first of all, Jason, I hope you're keeping well as well. It's such a strange time. The areas of investment don't vary between the low end and high end of our range. We'll continue to invest in R&D, given the lead that we've got and the fact that as our customers are being forced to digitize more quickly as a result of the distributed workforce plays right to our strong suit, it plays right into some of the longer-term R&D investments we've been making over the last four or five years. So now is not the time to take the foot off the gas on R&D investments. We're also going to continue to invest in construction. I think that's proven to be a market that is dramatically underpenetrated by technology. And so there will be secular growth in that space. We'll continue to invest there. And we'll continue to invest in digitizing our own comp to provide some of the value-add that we can provide to your customers. There's no change in the core focus areas. We are continuing to be diligent about spend management, as you'd expect, and there are savings. You can back into the savings that are built into our spend stream based on the range of our guidance and get a sense, there's obviously P&E spending that's going away. And by the way, I don't think it ever returns to the levels it had been historically. If the last 3 months have shown us anything, it's that you don't have to be sitting across the table face-to-face with someone to conduct business, whether it's a sales transaction or a brainstorming session. So I don't expect that to fully come back. We've gotten some savings through rationalization of our marketing spend. We've moved many of our events to online. I think many of those will stay online. So there's -- there are some savings built into that and I think many of those will continue longer term. But the core areas that we're investing in, we're going to continue to invest in. And we're in a privileged position. So even with the level of disruption that is happening in the marketplace to be able to show double-digit revenue growth and market expansion through high end of our guidance. So I feel good about the decision that we're in."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. That's factoring, that we are growing revenue and same time puts us in a fairly elite category. Given the acceleration of digitization we expect from the other side of this, this is the time you want us to be investing in R&D and the infrastructure that supports getting that R&D to the customers. And that's what we're going to do."
},
{
"speaker": "Jason Celino",
"text": "Okay, great. Thank you. I appreciate the color and thanks again."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks for the question, Jason."
},
{
"speaker": "Operator",
"text": "Our next question comes from Zane Chrane with Bernstein Research. Your line is now open."
},
{
"speaker": "Zane Chrane",
"text": "Hey guys, thanks for filling me in there and I appreciate it. I was impressed with the renewal rate, the net dollar renewal rate staying at 110% to 120% range. So I was wondering regarding the partial renewals holding study, do you have any idea of what portion of your customer base is maybe benefiting from the PPP loans? I'm wondering if churn could maybe tick up once the deadline for the employee retention passes and you have a little bit more layoffs from those customers with the PPP loans at some point in the future? And then secondly, you had pretty impressive bookings, especially when looking at current RPO, I'm just trying to reconcile that with the roughly flat billings growth for the full year. So I'm wondering, if you could what the average time deals tend to be in the pipeline before closing? And if you do have a weakening in the pipeline or the entry part of the pipeline, how many quarters does that take to show up, is it 2, 3, 4 quarters? Or is there any way to know that? Thank you."
},
{
"speaker": "Scott Herren",
"text": "All right. That's a lot to cover there, Zane. I'll take the first one, and I'll let Andrew handle the pipeline sales cycle question. On the first one, of course, there's no way for us to know, but I think that you look at the benefit of that program, it was targeting smaller businesses. And those -- one of the stats that we gave earlier is small businesses and I'll define that as single-site, 20 employees or less and 15 seats or less, that small business segment has typically driven 10% to 15% of our total sales. So it's a smaller piece of our overall revenue stream. It's hard to know how many of them have benefited from kind of the short-term loan programs that have been rolled out and whether you call them stimulus or as Steve said earlier, avoidance of recession. What we do monitor though and Andrew talked about this earlier is, the active users -- the weekly active users of our product. And of course, we saw a strong dip as across the globe countries went into shelter request, but then we also see them come back, and I think that’s also shown sign that we are not seeing stimulus and by all across the board, of course the renewals it stayed inside and we have had another good time. So its hard to know, because its hard to give you a direct answer, but certainly, indicators that we’ll do. We we're not seeing that."
},
{
"speaker": "Andrew Anagnost",
"text": "So with regards to the pipeline question, in terms of how things are going -- all right on general pipeline, so from a cascading, what we've seen in – in terms of new business is Asia is already starting to turn up, all right. So we’re already seeing the pipeline grow in APAC. We are starting to see signs of that in Europe. We haven't yet seen signs of it in the U.S. but given the cadence that we've seen around the pipeline from each region and by a country-by-country basis, watching not only the new business trends, but the weekly active user trends, which, by the way, presages the pipeline, we see building pipeline strength as you get further and further away from the start of the pandemic, which I think is a pretty positive sign for our business in terms of where we think we’re going. And it's why we feel the way we do about the potential for the year."
},
{
"speaker": "Scott Herren",
"text": "Yes. I think the other bit of color that I'd add there is when you look at the change in our billings guide, multiyear clearly is having an effect on that. We've seen it slow a bit in the second half of the first quarter. And what I've built into the scenarios that we've modeled out is that it continues to pace low or to modestly come down, a couple of points from where it had been throughout the year. And that does create a headwind on the billings guide."
},
{
"speaker": "Zane Chrane",
"text": "Got it. That's very helpful. Well, I wishing you guys have a strong and rapid recovery. Thanks very much."
},
{
"speaker": "Scott Herren",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. We are now at the end of the time for the call. I would now like to turn the call back over to Abhey Lamba for closing remarks."
},
{
"speaker": "Abhey Lamba",
"text": "Yes. Thanks, Joelle, and thanks, everybody, for joining us today. We look forward to seeing many of you at our Analyst Day next week on June 3. In the meantime, please reach out if you have any questions. Thanks for joining us today."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 4 | 2,022 | 2022-02-24 17:00:00 | Operator: Thank you for standing by and welcome to the Autodesk Fourth Quarter and Full Year Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Simon Mays-Smith, Vice President of Investor Relations. Please go ahead, sir.
Simon Mays-Smith: Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the fourth quarter and full year results of our fiscal '22. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our Chief Financial Officer. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K for important risks and other factors, including developments in the COVID-19 pandemic and the resulting impact on our business operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numerical growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon and welcome, everyone, to the call. Today, we reported record fourth quarter and full year revenue, non-GAAP operating margins and free cash flow. Our strong results and competitive performance were underpinned by some perennial factors. Our ability to deliver greater value to our customers and partners through consistent investment in our technology, workforce and business model and customer experience. Let me talk briefly about each of these as they are just as important to our future growth as they have been to our growth in the past. All of our technology investments, be it in 3D and BIM, enabling workflows in the cloud in generative design, in make and in newer verticals like water and construction. All of them connect siloed adjacent workflows in the cloud and lead our customers to new, more efficient and sustainable ways of working. At Autodesk University, we announced we were moving from products to platforms and capabilities and bringing those capabilities to any device anywhere to the cloud. Fusion 360 is the leading edge of this transition and our recent acquisitions of Prodsmart and CIMCO will enable us to further digitize and connect shop floor processes and manufacturing to help build connected factories while providing additional on-ramps into and usage of our manufacturing platform. Similarly, our acquisitions of Moxion and LoUPE enable us to connect Media and Entertainment workflows and data from postproduction to preproduction. With Media and Entertainment signing its largest ever EBA in the fourth quarter, the ability to connect preproduction workflows further expands our addressable TAM. We're also continuing to invest in our workforce, attract and retain the best talent in our industries and cultivate a shared sense of purpose and of diversity and belonging. We recently received recognition for that work with inclusion on the Corporate Knights index of the world's most sustainable companies and the highest possible score on the Human Rights Foundation's Corporate Equality Index. We are proud of our purpose and unique culture, one consequence of which is relatively low attrition compared to our technology peers. This is another source of competitive advantage in tight labor market. It also means that when gifted leaders like Scott Reese and Pascal Di Fronzo decide to climb their next mountains, we have a deep bench of internal talent like Jeff Kinder and Rebecca Pearce; and alumnae, like Ruth Ann Keene, to step into their shoes. And finally, business model and customer experience optimization. This includes the shift from perpetual licenses with maintenance to tiered subscription, the shift from desktop multiuser licenses to named user subscriptions and consumption. The shift from indirect to direct, the shift from front-end to back-end payments to channel partners. And most recently, the shift from upfront to annual billing, all of which enable us to better serve more customers in flexible and customized ways. As of February 1, we unified all customer and partner-facing activities, marketing, go-to-market, customer success and customer operations under our COO, Steve Blum to give us a better end-to-end view of the customer experience and to drive sustainable competitive advantage and growth. While the pandemic and its aftershocks, mean we will fall narrowly short of the financial targets set more than 5 years ago, we have made tremendous progress through consistent investment in our technology, our workforce and our business model and customer experience which have added adjacent use cases and usage in our ecosystem, growing our addressable market and our ability to realize it. Importantly, the pandemic has accelerated the structural growth drivers underpinning our future growth. We have robust momentum as we enter fiscal '23 and over the long term. Now, let me turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. In an extraordinary year, we performed strongly across all metrics, perhaps best summarized by the sum of revenue growth and free cash flow margin for the year which was 49%. Our fourth quarter results were strong. Several factors contributed to that, including robust renewal rates, strong growth in subscriptions and rapidly expanding digital sales. Total revenue grew 17% or about 2 percentage points less in constant currency, with subscription revenue growing by 18%. Looking at revenue by product; AutoCAD and AutoCAD LT revenue grew 20%, AEC revenue grew 17% and manufacturing revenue grew 4%. Recall that Vault became ratable in fiscal '22 and that manufacturing also benefited in Q4 last year from a strong performance in automotive EBAs which included significant upfront revenue. Excluding these impacts, manufacturing revenue grew in double digits in Q4. M&A revenue grew 38% which included some upfront revenue from its largest ever EBA. Even if you exclude upfront revenue, M&E grew more than 20% in Q4. Across the globe, revenue grew 18% in the Americas and 16% in both EMEA and APAC. Direct revenue increased 27% and represented 38% of total revenue, up from 34% last year due to strength from both enterprise and e-commerce. We had our best ever revenue quarter for digital sales which helped annual e-commerce sales surpass $0.5 billion for the first time. Our product subscription renewal rates remained at record highs. And our net revenue retention rate remained strongly within our 100% to 110% target range. Billings increased 13% to $1.7 billion, reflecting robust underlying demand but also a tough EBA comparison from last year. Total deferred revenue grew 13% to $3.8 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 12% and 15%, respectively and as expected, reflecting billings growth and the timing and volume of multiyear contracts which are typically on a 3-year cycle. Turning to the P&L. Non-GAAP gross margin remained broadly level at 93%, while non-GAAP operating margin increased by 5 percentage points to approximately 35%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margins declined by 6 percentage points to 12%, primarily due to lease-related charges of approximately $100 million which reflects the progress we've made to reduce our real estate footprint and to further our hybrid workforce strategy as we announced on our last call. We delivered record free cash flow in the quarter and for the full year of $716 million and $1.5 billion, respectively. Having completed our first sustainability bond last quarter at historically attractive rates, we continued to optimize our capital structure in Q4 by accelerating our share repurchase activity. Given the recent pullback in our share price, we opportunistically repurchased shares at a higher rate than previous quarters which allowed us to offset dilution in fiscal '22 and to get ahead of a sizable amount of our estimated dilution in fiscal '23. The net result was a slight reduction in our weighted average shares outstanding at the end of the year. During Q4, we purchased 2.3 million shares for $613 million at an average price of approximately $267 per share. For the full year, we repurchased nearly 4 million shares at an average price of approximately $276 per share for a total spend of just over $1 billion. You'll see us continue to be opportunistic with share buybacks but our capital allocation strategy is unchanged. We'll invest organically and inorganically to drive growth as well as purchase shares to offset dilution from our equity compensation plans over time. Now let me finish with guidance. On our last call, we signaled that we saw FX headwinds and macroeconomic uncertainty due to supply chain challenges, labor shortages and the ebb and flow of COVID. That perspective hasn't changed. So the risk we highlighted 3 months ago is now incorporated into our fiscal '23 outlook. Beyond that, we did see further strengthening of the U.S. dollar, resulting in a slight incremental FX headwind to our fiscal '23 expectations. To put it in numerical terms, our fiscal '22 revenue growth reflects a 2 percentage point currency tailwind which with FX movements in the last quarter, becomes a roughly 1 percentage point headwind to fiscal '23 revenue growth. Similarly, FX moves during the fourth quarter resulted in an approximately $30 million incremental headwind to fiscal '23 free cash flow. Beyond FX, we are obviously keeping a close eye on the geopolitical macroeconomic and policy environment. But having said all that, our strong momentum and competitive performance in fiscal '22 set us up well for fiscal '23. And we've assumed that market conditions in fiscal '23 are consistent with what we experienced in the second half of fiscal '22. We expect fiscal '23 revenue to be between $5.02 billion and $5.12 billion with growth of approximately 16% at the midpoint and which reflects an incremental 1 percentage point FX headwind, as I mentioned earlier. We expect non-GAAP operating margins to be approximately 37% and free cash flow to be between $2.13 billion and $2.21 billion. The midpoint of that range, $2.17 billion, implies 47% growth and reflects the incremental $30 million FX headwind that I mentioned earlier. The slide deck on our website has more details on modeling assumptions for Q1 and full year fiscal '23. The pandemic has reinforced the structural growth drivers underpinning our strategy and we remain confident in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that enable our customers to drive efficiency and sustainability. Structural growth drivers underpinning the strategy have been reinforced by the pandemic, including increased workflow convergence and platform standardization, a growing focus on distributed working in the cloud, automation and workforce productivity and also the growing importance of sustainability. Our model is scalable and extensible into adjacent verticals from architecture and engineering, through construction and owners from product engineering through product manufacturing and product data management. And as I stated earlier, with our consistent investment in our technology, our workforce and our business model and customer experience, we are well positioned to realize these opportunities. And so by both leading and partnering with our customers on new ways of working, we will grow too. For example, Goldbeck is one of Europe's largest commercial design and construction companies and a leading practitioner of industrialized construction and they use Inventor, Revit, Forge and generative design on our platform to implement their precast and modular system concept. By standardizing the invisible and customizing the visible, Goldbeck has been able to design and build highly customized and aesthetically pleasing buildings reliably, quickly and efficiently. Having unified around BIM, Goldbeck is now seeking to grow and connect beyond the design process to further improve efficiency and reduce waste through design automation during capital planning, for which it is trialing Spacemaker and great collaboration across design and build phases of construction using Autodesk Construction Cloud. With the launch of Autodesk Build, the introduction of an account-based pricing business model and distribution through our channel partners, we are extending our reach into the construction market. For example, Lee Lewis Construction, an ENR 400 general contractor from Texas, has been driving innovation through construction technology for over 45 years. In 2021, it began adopting capabilities of the Autodesk Construction Cloud, beginning with Assemble for Virtual Design & Construction with the end goal of a full replacement of their product management software with Autodesk Build. By having one platform for the full end-to-end construction workflow, Lee Lewis will be able to more efficiently deliver extraordinary results for their clients, from concept planning to ribbon cutting. With strong growth from Autodesk Build and the benefit of recently launched ACC bundles for preconstruction and construction operations, Autodesk Construction Cloud reported its best ever quarter and accelerating growth in the fourth quarter, entering FY '23 with strong momentum. We continue connecting the dots in infrastructure too, most recently through the acquisition of Innovyze. Sustainable water is an area of opportunity for Autodesk across the globe. For example, Thames Water owns and operates one of the oldest and most complicated water supply networks in Europe, supplying 9 million customers in London and the Thames Valley. With InfoWorks WS Pro and IWLive Pro from Innovyze and an ongoing recruitment drive to double the size of their internal hydraulic modeling team, it is building a modeling center of excellence with a library of hydraulic models that can be run in near real time. When connected and compared with telemetry, these dynamic digital twins will become powerful planning tools, enabling Thames Water's teams to gain near real-time insight into system performance, leading to improved outcomes for the customers of today and tomorrow. I'm very pleased to report that Innovyze had its best quarter ever. Turning to manufacturing; we sustained strong momentum in our manufacturing portfolio this quarter as we connect more workflows beyond the design studio and develop more on-ramps to our manufacturing platform. In automotive, we continue to grow our footprint beyond the design studio and into manufacturing-connected factories as automotive OEMs seek to break down work silos and shorten handoff and design cycles. For example, a multinational automobile company which designs and jointly manufactures premium electric cars operates in 4 countries across the world and is currently in the process of expanding to a further 20. With its new EBA signed in the fourth quarter, it is not only adding additional users of Alias and VRED, it is also partnering with our consulting teams and product experts to both extend its in-house manufacturing capabilities with Autodesk Moldflow and working on the rollout of ShotGrid globally to help seamlessly manage and collaborate across its end-to-end workflows. Our platform approach gives new customers multiple on-ramps into our cloud ecosystem. For example, a European-based start-up that creates smart charging systems for EVs worldwide use a competitor's product and design but was also running into collaboration challenges due to the rapid growth of its business. It shows Upchain as its cloud data management system because it is easy to install, is up and running out of the box and enables all users anywhere and on any device to collaborate on up-to-date data in real time. And it is easy to add new users and scale with the hyper growth of the company. These are also all attributes of Fusion 360 and we hope to earn the right to connect more workflows for Upchain users in the future. Fusion 360's commercial subscribers grew steadily, ending the quarter with 189,000 subscribers. Early demand for our new extensions, including machining, generative design and nesting and fabrication has been strong and there has been significant interest in our upcoming simulation and design extension. While we often think of education users taking Fusion 360 with them into the workforce, our commercial customers are also taking Fusion 360 into education to help train their future workforce. For example, Lawrence Equipment, as a member of the Pasadena City College Advisory Board, showed the college how Fusion 360 had helped innovate and improve its design and manufacturing workflows, resulting in greater operational efficiency, improved productivity and higher quality production. Upon adoption for its machine shop program, the college immediately found that students using Fusion 360 are spending less time learning how to use the software and more time on the machines, learning important machining skills. The students also better understood how their work affected the company. As a result, Lawrence Equipment can hire from a steady pool of highly qualified Pasadena City College graduate, a win-win. With sustained demand for compelling content and growing pressure to produce that content more efficiently, there is increased demand for content creation tools and cloud-enabled production workflows in the Media and Entertainment industries. As a result, Media and Entertainment finished the year strong as companies emerging from the pandemic sought to connect siloed workflows and remote teams. For example, Technicolor, a worldwide creative technology leader, has renewed its commitment to Autodesk content creation and production management tools, such as Maya and ShotGrid. By standardizing on common tools across its global studios, Technicolor can unleash the creative potential of its remote and distributed workforce. By efficiently and securely connecting teams, Technicolor can continue to serve the growing demand for compelling content, redefining what's possible for storytellers and audiences around the globe. And finally, we continue to enable more users to participate in our ecosystem more productively through business model innovation and our license compliance initiatives. With single sign-on for improved security and user level reporting, our premium plan enables our customers to manage their software usage across distributed sites more safely and efficiently. As we help our customers understand the details of how they use our solutions, the better we can ensure their success by efficiently and effectively implementing them. For example, the ZETA Group, with 17 subsidiaries worldwide, specializes in planning, automation, digitization and maintenance of customized biopharmaceutical facilities for aseptic process solution. ZETA was looking for better visibility into its employee software usage in either administration of subscribers. In Q4, it doubled the number of premium plan subscriptions to gain comprehensive employee level reporting for better insight and easier administration. That visibility into employee software usage and easier administration of subscribers also makes premium plans an attractive solution for customers seeking to remain license compliant. For example, after identifying that a multinational consumer product company based in the U.S. had gaps in its account plan, we worked with its team to run a diagnostic scan to ensure it had access to the latest and safest versions of our software. This process identified gaps in software availability and license mix. Our collaborative helpful approach enabled more users to access the latest versions of our software and upgrading to our premium plan made it easier to administer and manage access in the future. During the quarter, we closed 16 deals over $500,000 of our license compliance initiatives, 4 of which were over $1 million. As I said earlier, by both leading and partnering with our customers on new ways of working, we will grow too. And while there will certainly be twists and turns on the road ahead, in many ways, the pandemic has accelerated the future and increased my confidence in our strategy. Empowering innovators of design-and-make technology to achieve the new possible also enables them to build and manufacture efficiently and sustainably. We continue to execute well in challenging times and look forward to Autodesk's next 40 years of excitement and optimism. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Phil Winslow from Credit Suisse.
Philip Winslow: Andrew, just a question on you -- to you about the supply chain and the labor disruptions you talked about on the last call. I wonder if you could just give us an update on that. Just sort of what were you hearing from customers over the course of the past -- in 3 months? And then really, if you could particularly focus on the AEC vertical because one of the things you obviously did call out in the slides was record construction property news and accelerating growth there.
Andrew Anagnost: Yes. Thank you, Philip. Good to hear from you. So yes, so first, let me kind of frame it this way. What we saw was the kind of improvement we expected to see when we talked to you about this in Q3. So we saw some nice improvement. Our customers are saying they're feeling like they're coming out of some of these supply chain constraints. Our partners are echoing some of these things. We didn't see the off too much stick expectations we had at the beginning of the fiscal year when we expected to see acceleration in the second half. But what we saw was consistent with what we told you in Q3 in terms of the improving climate, all right? So I think with regards to AEC, in particular which, by the way, I highlighted last quarter as being the key place that was feeling the most supply chain and cost pressure in terms of in-flight projects, that's where we saw the improvement. And yes, we did have a record quarter in construction and we did end the quarter with some nice acceleration and momentum heading into next year. But consistent with what we said in Q3, all right?
Philip Winslow: Got it. And then, just in terms of the backlog of projects you've been talking about for a couple of years now. Any thoughts on what sort of the customers are telling you about that? Do you think they're going to get unstick and sort of taken care of, call it, over the next 12 months? Or how are they thinking about that backlog?
Andrew Anagnost: Yes. So what I can tell you is that we monitor bid board activity and we monitor the growth in active projects on Construction Cloud and BIM 360 Docs. And what we're seeing in bid board is we're seeing consistent growth in bidding activity and we're seeing an increasing number of monthly active projects on our cloud applications around Construction Cloud and BIM 360 Docs. Those are usually leading indicators of project activity and backlog getting turned into active projects. So we consider those good signs, all right, in terms of how the environment is moving.
Operator: Our next question comes from the line of Saket Kalia from Barclays.
Saket Kalia: Andrew, maybe for you, a big renewal year here in fiscal '23. As we start to see maybe some more of those 3-year product subscriptions come up for renewal this year, what's the data sort of showing, the preliminary data maybe, on sort of customers' willingness to renew at that same duration. And perhaps just as importantly, their willingness to sort of expand their usage from prior levels. Does that make sense?
Andrew Anagnost: Yes, it does make sense. And the short answer to this, Saket, is that the willingness to renew is the same, or in some cases, better than the willingness to renew the shorter duration contracts. So customers who like long-duration contracts, who like the price lock tend to continue to grab the price lock and move on. That's what we've seen this -- so far. Now in terms of their willingness to buy more during these things; well, that's going to depend on their individual circumstances. So I'm not going to give you any kind of specific numbers on how we're doing around their willingness to buy more. However, the net revenue to retention rates for the company are indicative of kind of how the global cohort of the company works with regards to this. So Debbie, would you like to add anything to that or comment on it?
Debbie Clifford: No, I think you covered it, Andrew.
Saket Kalia: Got it. Got it. Debbie, maybe for my follow-up for you. I mean, understanding that we're just starting out fiscal '23, I was wondering if you have any thoughts on how we'll be phasing out the multiyear product subscriptions in fiscal '24? And maybe just philosophically, how you think about the shape of that impact on cash flow now that we have a sort of revised fiscal '23 view. And again, I understand it's early but any thoughts on kind of how you think that works? And the best way to think about modeling that?
Debbie Clifford: Yes, sure. So we aren't giving specific guidance today for fiscal '24 and beyond as you know. But as you can imagine, it's a big area of focus for us. And we are retaining the framework that we set out at Investor Day, so let's just recap that again. It is double-digit revenue growth through fiscal '26, non-GAAP operating margins in the 38% to 40% range and double-digit compound annual growth in free cash flow through fiscal '26. Now that's after that expected decline in fiscal '24 when we institute our transition to annual billings for multiyear contracts. And as I mentioned in the prepared remarks, these metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Now in terms of the decline for free cash flow, specifically in fiscal '24, I know there's a lot of interest in both the magnitude of it and the slope of it. And while we're not providing specifics today, here's how I think you should think about it. If I start with the slope, the slope of the free cash flow decline and then its recovery is going to depend on the pace at which our customers adopt annual billings. Right now, we intend to offer our customers a choice but we're still working through the programmatic details. Our bias is going to be to go as quickly as possible. But we have customer, partner and operational constraints that we're working through as we navigate the transition. And then to give you an order of magnitude, I'd say, look at long-term deferred as a percent of total deferred back in fiscal '20. It was in that high 20s percent zone and we should see something similar in fiscal '23 because it's that same cohort that's coming up for renewal. And so then as we move to annual billings, eventually that long-term deferred will go away. And again, our bias is to move as quickly as possible but we're still working through the operational details. We'll give you updates on all of this as we progress through fiscal '23.
Andrew Anagnost: You know, Saket, one thing that -- oh sorry, Saket.
Saket Kalia: No, no, no. Please go ahead, Andrew. No, please.
Andrew Anagnost: One thing that excites me about this post annual billings transition is that the free cash flow starts tracking to the long-term strategic drivers that I really like talking about. The digital transformation drivers that we talked about at Investor Day, including in the adjacent industries we were going in, these things are going to be what tracked and drives the growth and the behavior of the free cash flow going forward, as well as labelling all those -- leveraging all those growth enablers around business models and around noncompliance. And also, don't forget, long term, our whole effort to monetize the long tail with not only with offerings like Flex but with new types of digital channels that reach deeper into places where we might not be reaching customers today. So that's the exciting thing about getting through this for me is the free cash flow tracks with those long-term strategic drivers. That's going to be a really great outcome for us.
Operator: Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities.
Jay Vleeschhouwer: Andrew, Debbie, your slide deck is interesting in disclosing the 6 million subscribers at the end of the fiscal year which indicates an increase of about 700,000 from the end of fiscal '21. Is it contemplated in your guidance for fiscal '23 that you might be able to add a similar, if not larger number to the sub space this year? Second question, your disclosure about the digital sales revenue rate is very interesting. Having grown now apparently to be the plurality of your direct revenue, is it your view Andrew, that the digital sales could become perhaps evenly split with the named accounts and EBA business? Or do you think named accounts and EBA remains the majority of the direct business?
Andrew Anagnost: Yes. All right. So first, let me address your first question. As you recall last year and this was on me, we had those up too much stick assessments of accelerating new business growth into the second half of the year, right? We're not assuming any of that moving into this year. We're assuming things stay exactly as they are and as the conditions that we see right now are. The exception I'll give to that is that in our guidance, we did not factor in war in Ukraine, how that might affect our business is completely unclear. I mean, I thought -- probably all of you heard President Biden's speech earlier today about some of his positions on this. But when it comes to looking at next year, we're assuming that current things move forward the way they are, right? And also, just remember, that some of those subscriber increases that you saw were a result of multiuser trade-ins as well, okay? I just want to make sure that we factor some of those things. But current course and speed is the general assumption here, right? Now with regards to digital sales. Digital sales is -- it's a great example. It's our fastest-growing channel. It's not growing at the expense of our partners. Our partners are growing robustly as well. It's also a great example of what we're doing with digital productivity for ourselves and for our sales force. The digital channel reaches customers that we believe we have not historically been serving well. And they have -- they are not only finding us and buying our existing offerings, they're also engaging on some of our more forward-looking offerings like Fusion 360. So that channel is going to continue to become more powerful. And as I've said many times before, as we look out to our long-term goal of half of our revenue being direct, half of that direct revenue is going to come from this digital channel. And clearly, you can see from the way -- what we've disclosed and the growth rates here, there is line of sight to those numbers over multiple years. And that channel is going to continue to help us reach deeper into the long tail. It's going to continue to benefit from the digital productivity tools we're building just to make our general overall sales force more productive. And I have high hopes for that channel in the future. Now Debbie, did you want to add anything about, for instance, since I mentioned the Ukraine situation, anything around the specifics about our exposure there? Or anything related to that? Or anything about the digital channel?
Debbie Clifford: Yes, sure. I'll cover Russia and the Ukraine. Just to be explicit, Russia and the Ukraine, they represented a bit less than 2 percentage points of our total revenue in fiscal '22. And we have similar assumptions in our fiscal '23 roll up. Obviously, events are unfolding live. That's a very fluid situation. It's a coincidence that our earnings call is today. So we haven't baked anything, any potential risk that might occur there into our guidance. We're going to be watching things closely because at this point, we don't know if there's any impact at all. We don't know if there is impact, if it would be localized to Russia and the Ukraine specifically or whether or not it becomes a broader impact across Europe and beyond. It's just too early for us to tell. What I would say, though, is that as we pointed out at our Investor Day, our business is more resilient now after the business model transition. So that's one positive in the midst of all this. But as you can imagine, it's obviously a situation that we're watching really closely and we'll continue to update you as we know more.
Andrew Anagnost: The net headline is, Jay, we've assumed that things are going to continue as they are current course and speed. There's no accelerations, no anticipated uplift or anything that we were looking for in the coming guidance or moving forward guidance.
Operator: Our next question comes from the line of Adam Borg from Stifel.
Adam Borg: Maybe just on the new product subscription growth in the quarter. Last quarter, you talked about that moderating to the mid-20s after kind of being in the 30% range in the first half of the year. I guess, how did that play out in 4Q? And I'm assuming, based on your prior comments Andrew, that whatever you saw in the back half of the year, you're assuming that going forward. But I'd love to hear a little bit more color, if you can, about how that played out in 4Q?
Andrew Anagnost: I'm going to let Debbie take that question, Adam.
Debbie Clifford: Yes. Sure. I'll go ahead and take this. So Adam, yes, we have been talking quite a bit about new volume and it is a metric that we monitor very closely. Our new volume growth decelerated a few points in Q4 and that's because of a tough comp versus Q4 last year but the growth was very healthy and it was in line with our expectations. And so that growth is effectively what we're considering as we build our guidance into next year and to just reiterate what Andrew has been saying, we're assuming that the demand environment, including that new volume growth, is built into our guidance and that there is no changes to the upside or the downside as we look ahead. But the bottom line answer is that the volume growth decelerated a few points but it was as we expected and still with very healthy growth.
Adam Borg: Great. That's really helpful. And maybe just as a quick follow-up. It's great to see the growing traction with Autodesk Construction Cloud. And kind of as you look forward a few years, maybe for you, Andrew, how expansive do you view the ACC opportunity relative to the current portfolio? And do you have any interest at all to go deeper into the financials aspects?
Andrew Anagnost: Yes. Certainly, at some point, yes. But look, I've always said that we believe the construction business is Autodesk's next billion dollar business. And I'd like to add just for those of you who are looking at these things, you're probably using make -- the make revenue growth as a proxy for what we're doing. I want to make sure that you remember that because we have a diversity of business models and we offer consumption models, account-based models, subscription models that we blend the actual ACC business between our design bucket and our make bucket. So, if you look at -- if you account for EBA impact on the make side of the business, the make side of the business grew about 30%, right? So we're looking at good robust growth here. I expect that growth to continue and I continue to say that construction is Autodesk's next billion dollar business and that should be the expectation in our group [ph].
Operator: Our next question comes from the line of Matthew Hedberg from RBC Capital Markets.
Matthew Hedberg: Andrew, obviously, it's great to hear the results on the Construction Cloud side. I'm wondering on the manufacturing side of your business, maybe using a baseball analogy, where do you think we are at in sort of the build-out of the manufacturing cloud business relative to maybe where you wanted to get to at some point?
Andrew Anagnost: Yes, it's a great question, Matt, because we're kind of in this transitional phase now, where we built out the technology, we've gotten to the early adopter audiences. We've established a strong stronghold, a strong base for the product, a strong kind of early market for Fusion. I mean, you heard in the opening commentary about the 189,000-plus subscribers. We're now moving into the phase of kind of trying to drive the acceleration of the growth in that space. I think we're early on. It's probably the third inning-or-so in the process, all right? We're starting off on a good base that's -- the threshold that we've got with subscribers here is, for those of you who know the history of this whole space, that is an excellent threshold to build on. That's usually where you start to cross the threshold of getting more and more material to the business. And we've had a leadership transition recently with Scott Reese taking a great job off to go work for GE, one of our customers, by the way which is always good, really happy for him. And Jeff Kinder is stepping in as part of the succession planning process there. And Jeff Kinder cares a lot about scaling and scaling growth and scaling transformation. And I think his skill set is going to provide some excellent capabilities in this next phase but it's still really early, all right? It's still third inning-ish in this game. And I think we should expect that to look like that. But over the next 5 years, again, this is going to be a significant driver of that growth that we've been talking about beyond fiscal '24.
Matthew Hedberg: That's great. And then maybe just as a quick follow-up. I think it was about a year ago, maybe when some of the supply chain questions first started coming up. We talked to a number of your partners who suggested that people were using Autodesk as a way to reduce waste and just become more efficient with tight supply markets. As you reflect back on the last year, I mean, do you think that actually played out? And do you think that remains a pretty critical driver, especially in the world of supply chain or just broad ESG concerns?
Andrew Anagnost: Yes, absolutely. It's only going to become more important. So we actually have really compelling stories of old line industrial companies using Fusion 360, for example, at its generative capability to actually lightweight and take out mass from products and reduce their material usage for things as simple as hydraulic equipment, all right? Real-world examples and we're seeing more and more of that. With regards to construction, every redo that you eliminate is a waste -- is a reduction in waste and carbon footprint for that particular project. And as you know, more and more, it's not becoming a choice for construction firms. It's becoming a requirement. There are more and more mandates about what the carbon footprint of a particular project has to be both this embedded carbon footprint and its lifetime carbon footprint. So this capability to reduce energy, select the right materials, reduce the amount of materials used is going to become a critical differentiator for lots of people. And it's really exciting to see some of these companies that you would never expect adopting some of our newest technology simply because it helps them address that key challenge for their businesses to be more sustainable and to be greener.
Operator: Our next question comes from the line of Joe Vruwink from Baird.
Joe Vruwink: First question was just more of a fact check on my part. But I'm wondering if the only change in the formal guidance you're providing today versus the preliminary view you provided last quarter, the only difference is just the strengthening in the dollar and the incremental FX headwind, is that correct?
Debbie Clifford: That's correct. The overall headline is that the numbers are consistent with what we talked about last call. We've just adjusted them for our latest FX assumptions. And that's causing about 1 point of headwind to revenue growth and another about $30 million in incremental headwind to free cash flow and that's been baked into the guidance.
Joe Vruwink: Okay. And then second question Andrew, I know you've said that AutoCAD maybe isn't the leading indicator that it once was but nevertheless, it did accelerate pretty nicely here at year-end. It might have been your fastest-growing business, if you've removed the upfront contribution from Media, so I'm just wondering if there's anything to kind of read between the lines there?
Andrew Anagnost: I think it's commensurate with an increase in monthly active usage which I still think is becoming a better proxy. So for instance, our total monthly active usage of all our products increased over 10% in Q4 year-over-year. So those 2 things correlate pretty closely. And I think that's still the proxy. But you're right, I think the AutoCAD performance is a result of that strong monthly active usage performance that we're starting to see heading into the fiscal year.
Operator: Our next question comes from the line of Steve Koenig from SMBC.
Steven Koenig: Was wondering about your -- in Q4, the kind of the elimination toning down the multiyear discounts. Kind of what was the reaction to that? And kind of how do you gauge what that will look like going forward? And then just for housekeeping, I missed the comment at the very start of the call about what drove -- the other line did very well. And I think there was some upfront revenue there. Could you just provide me that color again?
Debbie Clifford: Thanks, Steve. Just lots to unpack there but let's start at the top on multiyear. So yes, we did see a discount change from 10% to 5% in the past quarter. And obviously, when we adjust pricing, we do see some customers take advantage of the window and buy ahead of that when the price change goes into effect. We saw a similar behavior with this price adjustment and that's as expected. We're always going to be looking at ways to optimize our business. This is just one example of that. And I'd also say that the multiyear renewal rates remained firm even after that discount reduction. And then in terms of other revenue, yes. Other revenue tends to be a little bit of a mixed bag but the other revenue is in part what drove the beat in our Q4 revenue. And a piece of that -- the big piece of that is non-cloud-enabled products that we sell through our EBAs that are recognized upfront. We typically see our highest EBA volume in Q4. And depending on the composition of those deals, it can sometimes drive a slight surge in upfront revenue as a result and that's what we saw in Q4 in the beat in and what you're seeing in other. We continue to expect, however, that upfront and other is going to be a relatively small part of our business over time and that recurring revenue should be 95% or greater.
Operator: Our next question comes from the line of Sterling Auty from JPMorgan.
Sterling Auty: Debbie, I want to circle back to cash flow. You had made the mention that there are some constraints from customers and partners on shift to annual billings. Can you give us maybe a quick example of what some of those constraints might be? And why you might not just be able to rip off the Band-Aid and move quicker to annual billings now?
Debbie Clifford: Yes. So as I mentioned back at the Investor Day, we do -- the first part is operational. So we are upgrading our systems to be able to handle this volume of multiyear contracts with annual billings at scale our systems don't provide for that capability today and it's a major system overhaul that we're working on and it's going to take us some time. And we're looking at how fast we can create that capability and over what time period. Again, I'd say that our bias is that we execute on this transition right away when we get to fiscal '24 but it is going to take us time and continued investment in both dollars and people to make sure that our systems are set up for that. And so we're looking at that right now. The second piece that we talked about at Investor Day that still is important to us is that our partners are very important to Autodesk, very important to our growth, very important to -- in our ability to drive breadth and depth across the globe and engaging with customers. And our partners, we want to make sure that we work with them as we execute on this transition to make sure that we optimize not only for us and for our customers but also for those partners that are important to us. And so we're going to be looking at the programmatic details of that over the next year with an eye towards making sure that we've set ourselves up for success in the entire ecosystem as we get to that start of fiscal '24.
Sterling Auty: Understood. Makes sense. And then maybe one follow-up. Outside of the $30 million FX headwind on free cash flow for fiscal '23, how else would we kind of think about the bridge from the guidance that you've given to the previous long-term target that was there?
Debbie Clifford: Sure. So the previous long-term target was $2.4 billion. And on the last call, we talked about a couple of hundred million in risk to that, that was broken down roughly equally between the macro backdrop and FX. And then we have an incremental $30 million in FX now given the continued strengthening of the dollar in the last 90 days. So net-net, it's about $100 million in macro or business risk. Again, that we highlighted on the last call and then a total of $130 million risk from FX and that continued strengthening of the dollar and that's why you see the midpoint of the guide right there at that $2.17 billion.
Operator: Our next question comes from the line of Jason Celino from KeyBanc Capital.
Jason Celino: Maybe just a couple for Andrew. I kind of want to go a little deeper on the architecture side of your business and this is obviously your bread and butter. How would you describe kind of the end market environment right now for that segment? And then what kind of growth initiatives should we be thinking of for this year and long term?
Andrew Anagnost: Yes. So architecture is coming out of this situation as coming out of pandemic, you've seen that there -- the index that drives our architecture activity is going up consistently. So architects are feeling better about the future and architects are also investing more in BIM which is the critical part of their transition from 2D-based practices to 3D-based practices. So that trend is going to continue. That's part of the bigger long-term digitization trend that we're seeing in architecture, in particular. More and more people are moving to 3D processes, 3D BIM and they're looking to adopt Revit and tools like Revit more aggressively so that they can stay competitive in the new world of the market. It's also a lot of increased labor productivity for them. So they're going to be looking at some of these new tools that allow them to do more with the labor pool they have, especially in the tight labor market. So that's where we're looking at with construction. The ongoing digitization move to BIM, that's going to accelerate as architects continue to get more optimistic about their project pipeline. But all the data is out there saying that we're seeing a better pipeline for the architecture segment.
Jason Celino: Yes. And then when I kind of just think about the architecture job, is it unfair to think that maybe that role, in particular, has been hit maybe harder than some of the other jobs within AEC?
Andrew Anagnost: It certainly was hit harder early on. There's no doubt about it, all right? It was the least prepared for remote work because it was essentially an office-type profession. It has adapted. They have certainly adopted our cloud-based tools at a rate significantly higher than prior to the pandemic. So they've gotten on to BIM Collaborate and BIM Collaborate Pro at higher rates than we ever saw previously. So they're adapting but yes, early on in this, the pandemic and in the last few years, they were hit relatively harder. But they're coming back and they're adapting. They still have to build up their book of business, they still have to build up their cushion but that segment is absolutely coming back. And it's coming back in the cloud too.
Operator: Thank you. That's all the time we have for Q&A today. I'll now hand the program back to Simon Mays-Smith for any further remarks.
Simon Mays-Smith: Thanks, everyone, for coming along. If you have any further questions, please do get in touch with me. Otherwise, we'll look forward to updating you on our Q1 results call. Thanks so much.
Operator: Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day. | [
{
"speaker": "Operator",
"text": "Thank you for standing by and welcome to the Autodesk Fourth Quarter and Full Year Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Simon Mays-Smith, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the fourth quarter and full year results of our fiscal '22. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our Chief Financial Officer. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K for important risks and other factors, including developments in the COVID-19 pandemic and the resulting impact on our business operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numerical growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon and welcome, everyone, to the call. Today, we reported record fourth quarter and full year revenue, non-GAAP operating margins and free cash flow. Our strong results and competitive performance were underpinned by some perennial factors. Our ability to deliver greater value to our customers and partners through consistent investment in our technology, workforce and business model and customer experience. Let me talk briefly about each of these as they are just as important to our future growth as they have been to our growth in the past. All of our technology investments, be it in 3D and BIM, enabling workflows in the cloud in generative design, in make and in newer verticals like water and construction. All of them connect siloed adjacent workflows in the cloud and lead our customers to new, more efficient and sustainable ways of working. At Autodesk University, we announced we were moving from products to platforms and capabilities and bringing those capabilities to any device anywhere to the cloud. Fusion 360 is the leading edge of this transition and our recent acquisitions of Prodsmart and CIMCO will enable us to further digitize and connect shop floor processes and manufacturing to help build connected factories while providing additional on-ramps into and usage of our manufacturing platform. Similarly, our acquisitions of Moxion and LoUPE enable us to connect Media and Entertainment workflows and data from postproduction to preproduction. With Media and Entertainment signing its largest ever EBA in the fourth quarter, the ability to connect preproduction workflows further expands our addressable TAM. We're also continuing to invest in our workforce, attract and retain the best talent in our industries and cultivate a shared sense of purpose and of diversity and belonging. We recently received recognition for that work with inclusion on the Corporate Knights index of the world's most sustainable companies and the highest possible score on the Human Rights Foundation's Corporate Equality Index. We are proud of our purpose and unique culture, one consequence of which is relatively low attrition compared to our technology peers. This is another source of competitive advantage in tight labor market. It also means that when gifted leaders like Scott Reese and Pascal Di Fronzo decide to climb their next mountains, we have a deep bench of internal talent like Jeff Kinder and Rebecca Pearce; and alumnae, like Ruth Ann Keene, to step into their shoes. And finally, business model and customer experience optimization. This includes the shift from perpetual licenses with maintenance to tiered subscription, the shift from desktop multiuser licenses to named user subscriptions and consumption. The shift from indirect to direct, the shift from front-end to back-end payments to channel partners. And most recently, the shift from upfront to annual billing, all of which enable us to better serve more customers in flexible and customized ways. As of February 1, we unified all customer and partner-facing activities, marketing, go-to-market, customer success and customer operations under our COO, Steve Blum to give us a better end-to-end view of the customer experience and to drive sustainable competitive advantage and growth. While the pandemic and its aftershocks, mean we will fall narrowly short of the financial targets set more than 5 years ago, we have made tremendous progress through consistent investment in our technology, our workforce and our business model and customer experience which have added adjacent use cases and usage in our ecosystem, growing our addressable market and our ability to realize it. Importantly, the pandemic has accelerated the structural growth drivers underpinning our future growth. We have robust momentum as we enter fiscal '23 and over the long term. Now, let me turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. In an extraordinary year, we performed strongly across all metrics, perhaps best summarized by the sum of revenue growth and free cash flow margin for the year which was 49%. Our fourth quarter results were strong. Several factors contributed to that, including robust renewal rates, strong growth in subscriptions and rapidly expanding digital sales. Total revenue grew 17% or about 2 percentage points less in constant currency, with subscription revenue growing by 18%. Looking at revenue by product; AutoCAD and AutoCAD LT revenue grew 20%, AEC revenue grew 17% and manufacturing revenue grew 4%. Recall that Vault became ratable in fiscal '22 and that manufacturing also benefited in Q4 last year from a strong performance in automotive EBAs which included significant upfront revenue. Excluding these impacts, manufacturing revenue grew in double digits in Q4. M&A revenue grew 38% which included some upfront revenue from its largest ever EBA. Even if you exclude upfront revenue, M&E grew more than 20% in Q4. Across the globe, revenue grew 18% in the Americas and 16% in both EMEA and APAC. Direct revenue increased 27% and represented 38% of total revenue, up from 34% last year due to strength from both enterprise and e-commerce. We had our best ever revenue quarter for digital sales which helped annual e-commerce sales surpass $0.5 billion for the first time. Our product subscription renewal rates remained at record highs. And our net revenue retention rate remained strongly within our 100% to 110% target range. Billings increased 13% to $1.7 billion, reflecting robust underlying demand but also a tough EBA comparison from last year. Total deferred revenue grew 13% to $3.8 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 12% and 15%, respectively and as expected, reflecting billings growth and the timing and volume of multiyear contracts which are typically on a 3-year cycle. Turning to the P&L. Non-GAAP gross margin remained broadly level at 93%, while non-GAAP operating margin increased by 5 percentage points to approximately 35%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margins declined by 6 percentage points to 12%, primarily due to lease-related charges of approximately $100 million which reflects the progress we've made to reduce our real estate footprint and to further our hybrid workforce strategy as we announced on our last call. We delivered record free cash flow in the quarter and for the full year of $716 million and $1.5 billion, respectively. Having completed our first sustainability bond last quarter at historically attractive rates, we continued to optimize our capital structure in Q4 by accelerating our share repurchase activity. Given the recent pullback in our share price, we opportunistically repurchased shares at a higher rate than previous quarters which allowed us to offset dilution in fiscal '22 and to get ahead of a sizable amount of our estimated dilution in fiscal '23. The net result was a slight reduction in our weighted average shares outstanding at the end of the year. During Q4, we purchased 2.3 million shares for $613 million at an average price of approximately $267 per share. For the full year, we repurchased nearly 4 million shares at an average price of approximately $276 per share for a total spend of just over $1 billion. You'll see us continue to be opportunistic with share buybacks but our capital allocation strategy is unchanged. We'll invest organically and inorganically to drive growth as well as purchase shares to offset dilution from our equity compensation plans over time. Now let me finish with guidance. On our last call, we signaled that we saw FX headwinds and macroeconomic uncertainty due to supply chain challenges, labor shortages and the ebb and flow of COVID. That perspective hasn't changed. So the risk we highlighted 3 months ago is now incorporated into our fiscal '23 outlook. Beyond that, we did see further strengthening of the U.S. dollar, resulting in a slight incremental FX headwind to our fiscal '23 expectations. To put it in numerical terms, our fiscal '22 revenue growth reflects a 2 percentage point currency tailwind which with FX movements in the last quarter, becomes a roughly 1 percentage point headwind to fiscal '23 revenue growth. Similarly, FX moves during the fourth quarter resulted in an approximately $30 million incremental headwind to fiscal '23 free cash flow. Beyond FX, we are obviously keeping a close eye on the geopolitical macroeconomic and policy environment. But having said all that, our strong momentum and competitive performance in fiscal '22 set us up well for fiscal '23. And we've assumed that market conditions in fiscal '23 are consistent with what we experienced in the second half of fiscal '22. We expect fiscal '23 revenue to be between $5.02 billion and $5.12 billion with growth of approximately 16% at the midpoint and which reflects an incremental 1 percentage point FX headwind, as I mentioned earlier. We expect non-GAAP operating margins to be approximately 37% and free cash flow to be between $2.13 billion and $2.21 billion. The midpoint of that range, $2.17 billion, implies 47% growth and reflects the incremental $30 million FX headwind that I mentioned earlier. The slide deck on our website has more details on modeling assumptions for Q1 and full year fiscal '23. The pandemic has reinforced the structural growth drivers underpinning our strategy and we remain confident in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that enable our customers to drive efficiency and sustainability. Structural growth drivers underpinning the strategy have been reinforced by the pandemic, including increased workflow convergence and platform standardization, a growing focus on distributed working in the cloud, automation and workforce productivity and also the growing importance of sustainability. Our model is scalable and extensible into adjacent verticals from architecture and engineering, through construction and owners from product engineering through product manufacturing and product data management. And as I stated earlier, with our consistent investment in our technology, our workforce and our business model and customer experience, we are well positioned to realize these opportunities. And so by both leading and partnering with our customers on new ways of working, we will grow too. For example, Goldbeck is one of Europe's largest commercial design and construction companies and a leading practitioner of industrialized construction and they use Inventor, Revit, Forge and generative design on our platform to implement their precast and modular system concept. By standardizing the invisible and customizing the visible, Goldbeck has been able to design and build highly customized and aesthetically pleasing buildings reliably, quickly and efficiently. Having unified around BIM, Goldbeck is now seeking to grow and connect beyond the design process to further improve efficiency and reduce waste through design automation during capital planning, for which it is trialing Spacemaker and great collaboration across design and build phases of construction using Autodesk Construction Cloud. With the launch of Autodesk Build, the introduction of an account-based pricing business model and distribution through our channel partners, we are extending our reach into the construction market. For example, Lee Lewis Construction, an ENR 400 general contractor from Texas, has been driving innovation through construction technology for over 45 years. In 2021, it began adopting capabilities of the Autodesk Construction Cloud, beginning with Assemble for Virtual Design & Construction with the end goal of a full replacement of their product management software with Autodesk Build. By having one platform for the full end-to-end construction workflow, Lee Lewis will be able to more efficiently deliver extraordinary results for their clients, from concept planning to ribbon cutting. With strong growth from Autodesk Build and the benefit of recently launched ACC bundles for preconstruction and construction operations, Autodesk Construction Cloud reported its best ever quarter and accelerating growth in the fourth quarter, entering FY '23 with strong momentum. We continue connecting the dots in infrastructure too, most recently through the acquisition of Innovyze. Sustainable water is an area of opportunity for Autodesk across the globe. For example, Thames Water owns and operates one of the oldest and most complicated water supply networks in Europe, supplying 9 million customers in London and the Thames Valley. With InfoWorks WS Pro and IWLive Pro from Innovyze and an ongoing recruitment drive to double the size of their internal hydraulic modeling team, it is building a modeling center of excellence with a library of hydraulic models that can be run in near real time. When connected and compared with telemetry, these dynamic digital twins will become powerful planning tools, enabling Thames Water's teams to gain near real-time insight into system performance, leading to improved outcomes for the customers of today and tomorrow. I'm very pleased to report that Innovyze had its best quarter ever. Turning to manufacturing; we sustained strong momentum in our manufacturing portfolio this quarter as we connect more workflows beyond the design studio and develop more on-ramps to our manufacturing platform. In automotive, we continue to grow our footprint beyond the design studio and into manufacturing-connected factories as automotive OEMs seek to break down work silos and shorten handoff and design cycles. For example, a multinational automobile company which designs and jointly manufactures premium electric cars operates in 4 countries across the world and is currently in the process of expanding to a further 20. With its new EBA signed in the fourth quarter, it is not only adding additional users of Alias and VRED, it is also partnering with our consulting teams and product experts to both extend its in-house manufacturing capabilities with Autodesk Moldflow and working on the rollout of ShotGrid globally to help seamlessly manage and collaborate across its end-to-end workflows. Our platform approach gives new customers multiple on-ramps into our cloud ecosystem. For example, a European-based start-up that creates smart charging systems for EVs worldwide use a competitor's product and design but was also running into collaboration challenges due to the rapid growth of its business. It shows Upchain as its cloud data management system because it is easy to install, is up and running out of the box and enables all users anywhere and on any device to collaborate on up-to-date data in real time. And it is easy to add new users and scale with the hyper growth of the company. These are also all attributes of Fusion 360 and we hope to earn the right to connect more workflows for Upchain users in the future. Fusion 360's commercial subscribers grew steadily, ending the quarter with 189,000 subscribers. Early demand for our new extensions, including machining, generative design and nesting and fabrication has been strong and there has been significant interest in our upcoming simulation and design extension. While we often think of education users taking Fusion 360 with them into the workforce, our commercial customers are also taking Fusion 360 into education to help train their future workforce. For example, Lawrence Equipment, as a member of the Pasadena City College Advisory Board, showed the college how Fusion 360 had helped innovate and improve its design and manufacturing workflows, resulting in greater operational efficiency, improved productivity and higher quality production. Upon adoption for its machine shop program, the college immediately found that students using Fusion 360 are spending less time learning how to use the software and more time on the machines, learning important machining skills. The students also better understood how their work affected the company. As a result, Lawrence Equipment can hire from a steady pool of highly qualified Pasadena City College graduate, a win-win. With sustained demand for compelling content and growing pressure to produce that content more efficiently, there is increased demand for content creation tools and cloud-enabled production workflows in the Media and Entertainment industries. As a result, Media and Entertainment finished the year strong as companies emerging from the pandemic sought to connect siloed workflows and remote teams. For example, Technicolor, a worldwide creative technology leader, has renewed its commitment to Autodesk content creation and production management tools, such as Maya and ShotGrid. By standardizing on common tools across its global studios, Technicolor can unleash the creative potential of its remote and distributed workforce. By efficiently and securely connecting teams, Technicolor can continue to serve the growing demand for compelling content, redefining what's possible for storytellers and audiences around the globe. And finally, we continue to enable more users to participate in our ecosystem more productively through business model innovation and our license compliance initiatives. With single sign-on for improved security and user level reporting, our premium plan enables our customers to manage their software usage across distributed sites more safely and efficiently. As we help our customers understand the details of how they use our solutions, the better we can ensure their success by efficiently and effectively implementing them. For example, the ZETA Group, with 17 subsidiaries worldwide, specializes in planning, automation, digitization and maintenance of customized biopharmaceutical facilities for aseptic process solution. ZETA was looking for better visibility into its employee software usage in either administration of subscribers. In Q4, it doubled the number of premium plan subscriptions to gain comprehensive employee level reporting for better insight and easier administration. That visibility into employee software usage and easier administration of subscribers also makes premium plans an attractive solution for customers seeking to remain license compliant. For example, after identifying that a multinational consumer product company based in the U.S. had gaps in its account plan, we worked with its team to run a diagnostic scan to ensure it had access to the latest and safest versions of our software. This process identified gaps in software availability and license mix. Our collaborative helpful approach enabled more users to access the latest versions of our software and upgrading to our premium plan made it easier to administer and manage access in the future. During the quarter, we closed 16 deals over $500,000 of our license compliance initiatives, 4 of which were over $1 million. As I said earlier, by both leading and partnering with our customers on new ways of working, we will grow too. And while there will certainly be twists and turns on the road ahead, in many ways, the pandemic has accelerated the future and increased my confidence in our strategy. Empowering innovators of design-and-make technology to achieve the new possible also enables them to build and manufacture efficiently and sustainably. We continue to execute well in challenging times and look forward to Autodesk's next 40 years of excitement and optimism. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Phil Winslow from Credit Suisse."
},
{
"speaker": "Philip Winslow",
"text": "Andrew, just a question on you -- to you about the supply chain and the labor disruptions you talked about on the last call. I wonder if you could just give us an update on that. Just sort of what were you hearing from customers over the course of the past -- in 3 months? And then really, if you could particularly focus on the AEC vertical because one of the things you obviously did call out in the slides was record construction property news and accelerating growth there."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Thank you, Philip. Good to hear from you. So yes, so first, let me kind of frame it this way. What we saw was the kind of improvement we expected to see when we talked to you about this in Q3. So we saw some nice improvement. Our customers are saying they're feeling like they're coming out of some of these supply chain constraints. Our partners are echoing some of these things. We didn't see the off too much stick expectations we had at the beginning of the fiscal year when we expected to see acceleration in the second half. But what we saw was consistent with what we told you in Q3 in terms of the improving climate, all right? So I think with regards to AEC, in particular which, by the way, I highlighted last quarter as being the key place that was feeling the most supply chain and cost pressure in terms of in-flight projects, that's where we saw the improvement. And yes, we did have a record quarter in construction and we did end the quarter with some nice acceleration and momentum heading into next year. But consistent with what we said in Q3, all right?"
},
{
"speaker": "Philip Winslow",
"text": "Got it. And then, just in terms of the backlog of projects you've been talking about for a couple of years now. Any thoughts on what sort of the customers are telling you about that? Do you think they're going to get unstick and sort of taken care of, call it, over the next 12 months? Or how are they thinking about that backlog?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So what I can tell you is that we monitor bid board activity and we monitor the growth in active projects on Construction Cloud and BIM 360 Docs. And what we're seeing in bid board is we're seeing consistent growth in bidding activity and we're seeing an increasing number of monthly active projects on our cloud applications around Construction Cloud and BIM 360 Docs. Those are usually leading indicators of project activity and backlog getting turned into active projects. So we consider those good signs, all right, in terms of how the environment is moving."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Saket Kalia from Barclays."
},
{
"speaker": "Saket Kalia",
"text": "Andrew, maybe for you, a big renewal year here in fiscal '23. As we start to see maybe some more of those 3-year product subscriptions come up for renewal this year, what's the data sort of showing, the preliminary data maybe, on sort of customers' willingness to renew at that same duration. And perhaps just as importantly, their willingness to sort of expand their usage from prior levels. Does that make sense?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, it does make sense. And the short answer to this, Saket, is that the willingness to renew is the same, or in some cases, better than the willingness to renew the shorter duration contracts. So customers who like long-duration contracts, who like the price lock tend to continue to grab the price lock and move on. That's what we've seen this -- so far. Now in terms of their willingness to buy more during these things; well, that's going to depend on their individual circumstances. So I'm not going to give you any kind of specific numbers on how we're doing around their willingness to buy more. However, the net revenue to retention rates for the company are indicative of kind of how the global cohort of the company works with regards to this. So Debbie, would you like to add anything to that or comment on it?"
},
{
"speaker": "Debbie Clifford",
"text": "No, I think you covered it, Andrew."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Got it. Debbie, maybe for my follow-up for you. I mean, understanding that we're just starting out fiscal '23, I was wondering if you have any thoughts on how we'll be phasing out the multiyear product subscriptions in fiscal '24? And maybe just philosophically, how you think about the shape of that impact on cash flow now that we have a sort of revised fiscal '23 view. And again, I understand it's early but any thoughts on kind of how you think that works? And the best way to think about modeling that?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes, sure. So we aren't giving specific guidance today for fiscal '24 and beyond as you know. But as you can imagine, it's a big area of focus for us. And we are retaining the framework that we set out at Investor Day, so let's just recap that again. It is double-digit revenue growth through fiscal '26, non-GAAP operating margins in the 38% to 40% range and double-digit compound annual growth in free cash flow through fiscal '26. Now that's after that expected decline in fiscal '24 when we institute our transition to annual billings for multiyear contracts. And as I mentioned in the prepared remarks, these metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Now in terms of the decline for free cash flow, specifically in fiscal '24, I know there's a lot of interest in both the magnitude of it and the slope of it. And while we're not providing specifics today, here's how I think you should think about it. If I start with the slope, the slope of the free cash flow decline and then its recovery is going to depend on the pace at which our customers adopt annual billings. Right now, we intend to offer our customers a choice but we're still working through the programmatic details. Our bias is going to be to go as quickly as possible. But we have customer, partner and operational constraints that we're working through as we navigate the transition. And then to give you an order of magnitude, I'd say, look at long-term deferred as a percent of total deferred back in fiscal '20. It was in that high 20s percent zone and we should see something similar in fiscal '23 because it's that same cohort that's coming up for renewal. And so then as we move to annual billings, eventually that long-term deferred will go away. And again, our bias is to move as quickly as possible but we're still working through the operational details. We'll give you updates on all of this as we progress through fiscal '23."
},
{
"speaker": "Andrew Anagnost",
"text": "You know, Saket, one thing that -- oh sorry, Saket."
},
{
"speaker": "Saket Kalia",
"text": "No, no, no. Please go ahead, Andrew. No, please."
},
{
"speaker": "Andrew Anagnost",
"text": "One thing that excites me about this post annual billings transition is that the free cash flow starts tracking to the long-term strategic drivers that I really like talking about. The digital transformation drivers that we talked about at Investor Day, including in the adjacent industries we were going in, these things are going to be what tracked and drives the growth and the behavior of the free cash flow going forward, as well as labelling all those -- leveraging all those growth enablers around business models and around noncompliance. And also, don't forget, long term, our whole effort to monetize the long tail with not only with offerings like Flex but with new types of digital channels that reach deeper into places where we might not be reaching customers today. So that's the exciting thing about getting through this for me is the free cash flow tracks with those long-term strategic drivers. That's going to be a really great outcome for us."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jay Vleeschhouwer from Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Andrew, Debbie, your slide deck is interesting in disclosing the 6 million subscribers at the end of the fiscal year which indicates an increase of about 700,000 from the end of fiscal '21. Is it contemplated in your guidance for fiscal '23 that you might be able to add a similar, if not larger number to the sub space this year? Second question, your disclosure about the digital sales revenue rate is very interesting. Having grown now apparently to be the plurality of your direct revenue, is it your view Andrew, that the digital sales could become perhaps evenly split with the named accounts and EBA business? Or do you think named accounts and EBA remains the majority of the direct business?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. All right. So first, let me address your first question. As you recall last year and this was on me, we had those up too much stick assessments of accelerating new business growth into the second half of the year, right? We're not assuming any of that moving into this year. We're assuming things stay exactly as they are and as the conditions that we see right now are. The exception I'll give to that is that in our guidance, we did not factor in war in Ukraine, how that might affect our business is completely unclear. I mean, I thought -- probably all of you heard President Biden's speech earlier today about some of his positions on this. But when it comes to looking at next year, we're assuming that current things move forward the way they are, right? And also, just remember, that some of those subscriber increases that you saw were a result of multiuser trade-ins as well, okay? I just want to make sure that we factor some of those things. But current course and speed is the general assumption here, right? Now with regards to digital sales. Digital sales is -- it's a great example. It's our fastest-growing channel. It's not growing at the expense of our partners. Our partners are growing robustly as well. It's also a great example of what we're doing with digital productivity for ourselves and for our sales force. The digital channel reaches customers that we believe we have not historically been serving well. And they have -- they are not only finding us and buying our existing offerings, they're also engaging on some of our more forward-looking offerings like Fusion 360. So that channel is going to continue to become more powerful. And as I've said many times before, as we look out to our long-term goal of half of our revenue being direct, half of that direct revenue is going to come from this digital channel. And clearly, you can see from the way -- what we've disclosed and the growth rates here, there is line of sight to those numbers over multiple years. And that channel is going to continue to help us reach deeper into the long tail. It's going to continue to benefit from the digital productivity tools we're building just to make our general overall sales force more productive. And I have high hopes for that channel in the future. Now Debbie, did you want to add anything about, for instance, since I mentioned the Ukraine situation, anything around the specifics about our exposure there? Or anything related to that? Or anything about the digital channel?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes, sure. I'll cover Russia and the Ukraine. Just to be explicit, Russia and the Ukraine, they represented a bit less than 2 percentage points of our total revenue in fiscal '22. And we have similar assumptions in our fiscal '23 roll up. Obviously, events are unfolding live. That's a very fluid situation. It's a coincidence that our earnings call is today. So we haven't baked anything, any potential risk that might occur there into our guidance. We're going to be watching things closely because at this point, we don't know if there's any impact at all. We don't know if there is impact, if it would be localized to Russia and the Ukraine specifically or whether or not it becomes a broader impact across Europe and beyond. It's just too early for us to tell. What I would say, though, is that as we pointed out at our Investor Day, our business is more resilient now after the business model transition. So that's one positive in the midst of all this. But as you can imagine, it's obviously a situation that we're watching really closely and we'll continue to update you as we know more."
},
{
"speaker": "Andrew Anagnost",
"text": "The net headline is, Jay, we've assumed that things are going to continue as they are current course and speed. There's no accelerations, no anticipated uplift or anything that we were looking for in the coming guidance or moving forward guidance."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Adam Borg from Stifel."
},
{
"speaker": "Adam Borg",
"text": "Maybe just on the new product subscription growth in the quarter. Last quarter, you talked about that moderating to the mid-20s after kind of being in the 30% range in the first half of the year. I guess, how did that play out in 4Q? And I'm assuming, based on your prior comments Andrew, that whatever you saw in the back half of the year, you're assuming that going forward. But I'd love to hear a little bit more color, if you can, about how that played out in 4Q?"
},
{
"speaker": "Andrew Anagnost",
"text": "I'm going to let Debbie take that question, Adam."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. Sure. I'll go ahead and take this. So Adam, yes, we have been talking quite a bit about new volume and it is a metric that we monitor very closely. Our new volume growth decelerated a few points in Q4 and that's because of a tough comp versus Q4 last year but the growth was very healthy and it was in line with our expectations. And so that growth is effectively what we're considering as we build our guidance into next year and to just reiterate what Andrew has been saying, we're assuming that the demand environment, including that new volume growth, is built into our guidance and that there is no changes to the upside or the downside as we look ahead. But the bottom line answer is that the volume growth decelerated a few points but it was as we expected and still with very healthy growth."
},
{
"speaker": "Adam Borg",
"text": "Great. That's really helpful. And maybe just as a quick follow-up. It's great to see the growing traction with Autodesk Construction Cloud. And kind of as you look forward a few years, maybe for you, Andrew, how expansive do you view the ACC opportunity relative to the current portfolio? And do you have any interest at all to go deeper into the financials aspects?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Certainly, at some point, yes. But look, I've always said that we believe the construction business is Autodesk's next billion dollar business. And I'd like to add just for those of you who are looking at these things, you're probably using make -- the make revenue growth as a proxy for what we're doing. I want to make sure that you remember that because we have a diversity of business models and we offer consumption models, account-based models, subscription models that we blend the actual ACC business between our design bucket and our make bucket. So, if you look at -- if you account for EBA impact on the make side of the business, the make side of the business grew about 30%, right? So we're looking at good robust growth here. I expect that growth to continue and I continue to say that construction is Autodesk's next billion dollar business and that should be the expectation in our group [ph]."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Matthew Hedberg from RBC Capital Markets."
},
{
"speaker": "Matthew Hedberg",
"text": "Andrew, obviously, it's great to hear the results on the Construction Cloud side. I'm wondering on the manufacturing side of your business, maybe using a baseball analogy, where do you think we are at in sort of the build-out of the manufacturing cloud business relative to maybe where you wanted to get to at some point?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, it's a great question, Matt, because we're kind of in this transitional phase now, where we built out the technology, we've gotten to the early adopter audiences. We've established a strong stronghold, a strong base for the product, a strong kind of early market for Fusion. I mean, you heard in the opening commentary about the 189,000-plus subscribers. We're now moving into the phase of kind of trying to drive the acceleration of the growth in that space. I think we're early on. It's probably the third inning-or-so in the process, all right? We're starting off on a good base that's -- the threshold that we've got with subscribers here is, for those of you who know the history of this whole space, that is an excellent threshold to build on. That's usually where you start to cross the threshold of getting more and more material to the business. And we've had a leadership transition recently with Scott Reese taking a great job off to go work for GE, one of our customers, by the way which is always good, really happy for him. And Jeff Kinder is stepping in as part of the succession planning process there. And Jeff Kinder cares a lot about scaling and scaling growth and scaling transformation. And I think his skill set is going to provide some excellent capabilities in this next phase but it's still really early, all right? It's still third inning-ish in this game. And I think we should expect that to look like that. But over the next 5 years, again, this is going to be a significant driver of that growth that we've been talking about beyond fiscal '24."
},
{
"speaker": "Matthew Hedberg",
"text": "That's great. And then maybe just as a quick follow-up. I think it was about a year ago, maybe when some of the supply chain questions first started coming up. We talked to a number of your partners who suggested that people were using Autodesk as a way to reduce waste and just become more efficient with tight supply markets. As you reflect back on the last year, I mean, do you think that actually played out? And do you think that remains a pretty critical driver, especially in the world of supply chain or just broad ESG concerns?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, absolutely. It's only going to become more important. So we actually have really compelling stories of old line industrial companies using Fusion 360, for example, at its generative capability to actually lightweight and take out mass from products and reduce their material usage for things as simple as hydraulic equipment, all right? Real-world examples and we're seeing more and more of that. With regards to construction, every redo that you eliminate is a waste -- is a reduction in waste and carbon footprint for that particular project. And as you know, more and more, it's not becoming a choice for construction firms. It's becoming a requirement. There are more and more mandates about what the carbon footprint of a particular project has to be both this embedded carbon footprint and its lifetime carbon footprint. So this capability to reduce energy, select the right materials, reduce the amount of materials used is going to become a critical differentiator for lots of people. And it's really exciting to see some of these companies that you would never expect adopting some of our newest technology simply because it helps them address that key challenge for their businesses to be more sustainable and to be greener."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Joe Vruwink from Baird."
},
{
"speaker": "Joe Vruwink",
"text": "First question was just more of a fact check on my part. But I'm wondering if the only change in the formal guidance you're providing today versus the preliminary view you provided last quarter, the only difference is just the strengthening in the dollar and the incremental FX headwind, is that correct?"
},
{
"speaker": "Debbie Clifford",
"text": "That's correct. The overall headline is that the numbers are consistent with what we talked about last call. We've just adjusted them for our latest FX assumptions. And that's causing about 1 point of headwind to revenue growth and another about $30 million in incremental headwind to free cash flow and that's been baked into the guidance."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. And then second question Andrew, I know you've said that AutoCAD maybe isn't the leading indicator that it once was but nevertheless, it did accelerate pretty nicely here at year-end. It might have been your fastest-growing business, if you've removed the upfront contribution from Media, so I'm just wondering if there's anything to kind of read between the lines there?"
},
{
"speaker": "Andrew Anagnost",
"text": "I think it's commensurate with an increase in monthly active usage which I still think is becoming a better proxy. So for instance, our total monthly active usage of all our products increased over 10% in Q4 year-over-year. So those 2 things correlate pretty closely. And I think that's still the proxy. But you're right, I think the AutoCAD performance is a result of that strong monthly active usage performance that we're starting to see heading into the fiscal year."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steve Koenig from SMBC."
},
{
"speaker": "Steven Koenig",
"text": "Was wondering about your -- in Q4, the kind of the elimination toning down the multiyear discounts. Kind of what was the reaction to that? And kind of how do you gauge what that will look like going forward? And then just for housekeeping, I missed the comment at the very start of the call about what drove -- the other line did very well. And I think there was some upfront revenue there. Could you just provide me that color again?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Steve. Just lots to unpack there but let's start at the top on multiyear. So yes, we did see a discount change from 10% to 5% in the past quarter. And obviously, when we adjust pricing, we do see some customers take advantage of the window and buy ahead of that when the price change goes into effect. We saw a similar behavior with this price adjustment and that's as expected. We're always going to be looking at ways to optimize our business. This is just one example of that. And I'd also say that the multiyear renewal rates remained firm even after that discount reduction. And then in terms of other revenue, yes. Other revenue tends to be a little bit of a mixed bag but the other revenue is in part what drove the beat in our Q4 revenue. And a piece of that -- the big piece of that is non-cloud-enabled products that we sell through our EBAs that are recognized upfront. We typically see our highest EBA volume in Q4. And depending on the composition of those deals, it can sometimes drive a slight surge in upfront revenue as a result and that's what we saw in Q4 in the beat in and what you're seeing in other. We continue to expect, however, that upfront and other is going to be a relatively small part of our business over time and that recurring revenue should be 95% or greater."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Sterling Auty from JPMorgan."
},
{
"speaker": "Sterling Auty",
"text": "Debbie, I want to circle back to cash flow. You had made the mention that there are some constraints from customers and partners on shift to annual billings. Can you give us maybe a quick example of what some of those constraints might be? And why you might not just be able to rip off the Band-Aid and move quicker to annual billings now?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So as I mentioned back at the Investor Day, we do -- the first part is operational. So we are upgrading our systems to be able to handle this volume of multiyear contracts with annual billings at scale our systems don't provide for that capability today and it's a major system overhaul that we're working on and it's going to take us some time. And we're looking at how fast we can create that capability and over what time period. Again, I'd say that our bias is that we execute on this transition right away when we get to fiscal '24 but it is going to take us time and continued investment in both dollars and people to make sure that our systems are set up for that. And so we're looking at that right now. The second piece that we talked about at Investor Day that still is important to us is that our partners are very important to Autodesk, very important to our growth, very important to -- in our ability to drive breadth and depth across the globe and engaging with customers. And our partners, we want to make sure that we work with them as we execute on this transition to make sure that we optimize not only for us and for our customers but also for those partners that are important to us. And so we're going to be looking at the programmatic details of that over the next year with an eye towards making sure that we've set ourselves up for success in the entire ecosystem as we get to that start of fiscal '24."
},
{
"speaker": "Sterling Auty",
"text": "Understood. Makes sense. And then maybe one follow-up. Outside of the $30 million FX headwind on free cash flow for fiscal '23, how else would we kind of think about the bridge from the guidance that you've given to the previous long-term target that was there?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So the previous long-term target was $2.4 billion. And on the last call, we talked about a couple of hundred million in risk to that, that was broken down roughly equally between the macro backdrop and FX. And then we have an incremental $30 million in FX now given the continued strengthening of the dollar in the last 90 days. So net-net, it's about $100 million in macro or business risk. Again, that we highlighted on the last call and then a total of $130 million risk from FX and that continued strengthening of the dollar and that's why you see the midpoint of the guide right there at that $2.17 billion."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jason Celino from KeyBanc Capital."
},
{
"speaker": "Jason Celino",
"text": "Maybe just a couple for Andrew. I kind of want to go a little deeper on the architecture side of your business and this is obviously your bread and butter. How would you describe kind of the end market environment right now for that segment? And then what kind of growth initiatives should we be thinking of for this year and long term?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So architecture is coming out of this situation as coming out of pandemic, you've seen that there -- the index that drives our architecture activity is going up consistently. So architects are feeling better about the future and architects are also investing more in BIM which is the critical part of their transition from 2D-based practices to 3D-based practices. So that trend is going to continue. That's part of the bigger long-term digitization trend that we're seeing in architecture, in particular. More and more people are moving to 3D processes, 3D BIM and they're looking to adopt Revit and tools like Revit more aggressively so that they can stay competitive in the new world of the market. It's also a lot of increased labor productivity for them. So they're going to be looking at some of these new tools that allow them to do more with the labor pool they have, especially in the tight labor market. So that's where we're looking at with construction. The ongoing digitization move to BIM, that's going to accelerate as architects continue to get more optimistic about their project pipeline. But all the data is out there saying that we're seeing a better pipeline for the architecture segment."
},
{
"speaker": "Jason Celino",
"text": "Yes. And then when I kind of just think about the architecture job, is it unfair to think that maybe that role, in particular, has been hit maybe harder than some of the other jobs within AEC?"
},
{
"speaker": "Andrew Anagnost",
"text": "It certainly was hit harder early on. There's no doubt about it, all right? It was the least prepared for remote work because it was essentially an office-type profession. It has adapted. They have certainly adopted our cloud-based tools at a rate significantly higher than prior to the pandemic. So they've gotten on to BIM Collaborate and BIM Collaborate Pro at higher rates than we ever saw previously. So they're adapting but yes, early on in this, the pandemic and in the last few years, they were hit relatively harder. But they're coming back and they're adapting. They still have to build up their book of business, they still have to build up their cushion but that segment is absolutely coming back. And it's coming back in the cloud too."
},
{
"speaker": "Operator",
"text": "Thank you. That's all the time we have for Q&A today. I'll now hand the program back to Simon Mays-Smith for any further remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, everyone, for coming along. If you have any further questions, please do get in touch with me. Otherwise, we'll look forward to updating you on our Q1 results call. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 3 | 2,022 | 2021-11-23 17:00:00 | Operator: Thank you for standing by, and welcome to Autodesk Third Quarter Fiscal Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference may be recorded. [Operator Instructions] I would now like to hand the conference over to the VP of Investor Relations, Simon Mays-Smith. Please go ahead.
Simon Mays-Smith: Thanks operator and good afternoon. Thanks for joining our conference call to discuss the results of our third quarter of fiscal year 2022. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our Chief Financial Officer. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K, for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. Our third quarter results were strong, driven by one of our best-ever quarters for new subscriptions, record subscription renewal rates, a net revenue retention rate towards the high end of our range, and a solid competitive performance. We also grew RPO and billings 18% and 16% respectively, despite a tougher compare versus last year. Relative to the first and second quarters, the rate of improvement decelerated during the third quarter more than we expected. While demand is robust, we believe supply chain disruption and resulting inflationary pressures, a global labor shortage making it harder for our customers to staff new projects, and the ebb and flow of COVID are contributing to the deceleration, as well as documented country-specific disruption to AEC in China. Our conversations with customers and channel partners reinforce our view. We’re encouraged that embracing digital transformation to drive efficiency and sustainability remains a priority for our customers. Our end-to-end solutions, business model flexibility and platform position us well competitively and enable more customers to enter and remain in our ecosystem. As you heard at our recent Investor Day and at Autodesk University, we are rapidly innovating and optimizing our business to increase and realize the opportunity ahead. Notable milestones during the quarter included the launch of our Flex consumption model and our plans to combine technologies, connect processes, automate workflows, and unlock valuable insights for customers through our Forge platform. The recent report from the Intergovernmental Panel on Climate Change and the United Nations Climate Change COP26 meeting in Glasgow both underscored the urgency of reducing carbon in the earth’s atmosphere and the role that everyone, including corporations, needs to play. Sustainability needs to be designed, made and, in many cases, retrofitted in construction and manufacturing. This cannot be achieved efficiently or effectively without end-to-end software like ours to drive the process. This organizing principle affects not just how we deploy capital, for example through our investments to develop sustainable tools and our recent acquisition of Innovyze, but also how we source capital. Many of our largest equity holders already align to our sustainability goals and in the third quarter, we began to align our debt holders by issuing our first sustainability bond linked to our sustainability goals. Now, let me turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I’ll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. As Andrew said, our third quarter results were strong. Several factors contributed to that, including robust growth in new product subscriptions, rapidly expanding digital sales, and increasing subscription renewal rates. Total revenue growth in the quarter accelerated to 18%, and 17% in constant currency, with subscription revenue growing by 21%. Looking at revenue by product, the growth we saw was broad-based. AutoCAD and AutoCAD LT revenue grew 14%, AEC revenue grew 22%, and manufacturing revenue grew 16%. M&E revenue grew 17%. Across the globe, revenue grew 18% in the Americas, 19% in EMEA, and 18% in APAC. Direct revenue increased 34% and represented 35% of our total revenue, up from 31% last year, due to strength from both, enterprise and e-commerce. As you heard at our investor day, about three quarters of new customers to Autodesk are now generated through our digital channels, reflecting the strength of our simplified buying experiences. Our product subscription renewal rates reached record highs, and our net revenue retention rate was toward the high end of our 100% to 110% range. Billings increased 16% to $1.2 billion, reflecting robust underlying demand and a tough comparison versus last year when we signed two of our largest ever EBAs, including a nine-digit deal. Total deferred revenue grew 14% to $3.3 billion. Total RPO of $4.2 billion and current RPO of $2.9 billion grew 18% and 21%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin increased by 2 percentage points to approximately 32%, reflecting strong revenue growth and ongoing cost discipline. We delivered healthy free cash flow of $257 million during the quarter against a tough comparison from last year, which benefited from pandemic-related payment term extensions. Consistent with our capital allocation strategy, we continued to repurchase shares to offset dilution from our equity plans. During the third quarter, we purchased 980,000 shares for $287 million at an average price of approximately $293 per share. Year-to-date, we’ve repurchased 1.66 million shares at an average price of approximately $287 per share, for a total spend of $476 million. Looking forward, as Andrew said, we’re rapidly innovating and optimizing our business to realize the opportunities ahead. As we discussed last quarter, the shift of multi-year contracts to annual billings as we move into fiscal ‘24 will drive more predictable free cash flow and better price realization over time, which will make Autodesk a more valuable company. This quarter, we took steps to optimize our capital structure by issuing our first sustainability bond, which aligns our capital strategy with our sustainability goals while also extending our debt maturity profile by almost two years and reducing our weighted average cost of debt by 40 basis points. As we enter Q4, we intend to take steps to reduce our real-estate footprint because the pandemic has spurred changes in the way we work and we’ve moved to a hybrid workforce. As a result, we anticipate we will reduce the square footage of our facilities portfolio by approximately 20% worldwide and that we will take a GAAP-only charge of up to approximately $180 million, the bulk of which will be recognized over the next several months as we execute our plan. Optimizing our facilities costs will allow us to better deploy capital to further our strategy and drive growth. Now, let me finish with guidance. Demand was robust in Q3 and we expect it to remain so in Q4. However, as Andrew said, macroeconomic headwinds such as supply chain disruption and resulting inflationary pressures, a global labor shortage, the ebb and flow of COVID, and AEC in China are impacting the pace of our recovery. As an example, the growth in new product subscription volume decelerated from approximately 30% in the first half to mid-20s percent in Q3, which is more than normal seasonality and a tougher comparison versus last year would suggest. This dynamic drove strong billings growth in Q3 that, nonetheless, fell short of our expectations. In light of this macroeconomic uncertainty, as we enter Q4, we’re taking a pragmatic approach and are assuming that the supply chain, labor, COVID and country-specific challenges will persist. As a result, we’re reducing the mid-point of our billings and free cash flow guidance by approximately $150 million and $100 million, respectively, for full-year fiscal ‘22. Given the nature of our subscription business model and the greater degree of near-term visibility it provides to us and our expectation of continued strong spend discipline, the mid-point of our full-year revenue and margin guidance is broadly unchanged. We continue to target $2.4 billion of free cash flow in fiscal ‘23 in constant currency because we believe the current macro headwinds we’re seeing are transient. But if the growth deceleration and strengthened dollar continue through next year, we could see potential risk to that target of about $100 million to $200 million, based on what we know today. FX volatility is a big factor. Rate moves in the first half of the year created about $55 million in potential headwind to fiscal ‘23 cash flow. Since then and in the last 90 days alone, further rate moves created about another $45 million in potential headwind to cash flow. We’re obviously watching FX rates closely but it’s clear that if the current rates persist through next year, that risk could materialize in free cash flow. Beyond cash flow, if you further take the risk into account, revenue growth could end up at the low end of the CAGR we talked about at Investor Day and fiscal ‘23 margins could be impacted by about a point. We will, of course, update you on our next earnings call when we expect to have more visibility into any impacts from macro or FX movement on our fiscal ‘23 outlook. We remain optimistic about our growth potential beyond fiscal ‘23, continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range, and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Now, let me turn to our strategic growth initiatives. Sustained and purposeful innovation to enable digital transformation in the industries we serve has changed our relationships with our customers from software vendor to strategic partner. And that is enabling us to create more value through end-to-end, cloud-based solutions that connect data and workflows, and through business model evolution. Our model is scalable and extensible into adjacent verticals, from architecture and engineering, through construction and owners; and from product engineering, through product manufacturing and product data and lifecycle management. By helping our customers grow and navigate their digital transformation, we will grow, too. For example, Bouygues Construction and Colas are leading construction and infrastructure firms based in France with over 100,000 construction employees operating in 60 countries across the globe. In the third quarter, they significantly increased their commitment to Autodesk products such as Revit, AutoCAD and Civil 3D following an accelerated move to BIM and digital work flows over the last three years, which significantly increased monthly average users. Similarly, Obayashi Corporation, one of the largest construction firms in Japan, which operates in 16 countries worldwide, is accelerating its global consolidation around BIM and a unified 3D technology platform to enable greater efficiency and sustainability. In the third quarter, it expanded its EBA with us. Over the last two years, it has more than doubled the number of Revit users and expanded its usage of Autodesk Construction Cloud to connect workflows from design through construction. We are further extending our reach into the construction mid-market with the recent launch of Autodesk Build, introduction of an account-based pricing business model and distribution through our channel partners. For example, this quarter, Jacobsen Construction Company, an ENR 400 general contractor in the United States, was looking for a long-term technology partner and to consolidate around a single project management solution that would increase the efficiency of its field teams while also seamlessly integrating with its accounting solution. While it had previously used a competitor solution for some projects, Jacobsen ultimately chose Autodesk Construction Cloud because of Autodesk Build’s robust field and cost management functionality, and the opportunity to integrate it smoothly with existing technology. With new Autodesk Build features and capabilities launched every two months or so, and the recently launched ACC bundles for pre-construction and construction operations, we remain optimistic about the opportunities ahead. We’re connecting the dots in infrastructure, too. For example, the Administrator of Railway Infrastructures in Spain, or ADIF, selected Autodesk products over competitor offerings to support its digital transformation. Backed by our common data environment, ADIF will leverage the Autodesk Construction Cloud to collaborate on project information, on-site development, and model coordination to ensure efficient and accurate construction of their railway network. Infrastructure remains an important opportunity for Autodesk across the globe. Our end-to-end solutions, which boost the efficiency and sustainability of customers like ADIF, as well as our ability to seamlessly integrate vertical and horizontal design and construction, give us a competitive advantage. Much needed additional investment in infrastructure in the United States and across the globe will restore aging infrastructure and increase the productivity of the economy. Perhaps more consequentially in the long term, provisions in the U.S. infrastructure bill, which encourages Department of Transportation to digitize their processes, should accelerate adoption of digital workflows and enable all infrastructure investment to become more efficient and sustainable. Turning to manufacturing, we sustained strong momentum in our manufacturing portfolio this quarter. In automotive, we continue to grow our footprint, beyond the design studio into manufacturing and connected factories, as automotive OEMs seek to break down work silos and shorten hand-off and design cycles. Ford, one of the largest automotive OEMs in the world, renewed and expanded its EBA with Autodesk during the third quarter, growing users of Alias and VRED in design and AutoCAD, Inventor and Navisworks in manufacturing, while adding Autodesk Construction Cloud and Autodesk Build in facilities and manufacturing to enable field access to plant drawings during maintenance and operations and equipment change over. Fusion 360 commercial subscribers again grew strongly without any systematic sales promotions, ending the quarter with 175,000 subscribers. While still early days, our new extensions, including Machining, Generative Design, and Nesting & Fabrication are performing well and there is major interest in our upcoming simulation and design extensions. Fewer promotions and growing demand for Fusion 360’s extensions are enabling us to capture more of the potential market opportunity and accelerate our growth. Fast Radius is a leading digital manufacturing and supply chain company. The company’s proprietary Cloud Manufacturing Platform combines software and advanced microfactories that enable its customers to flexibly design, make and move certified parts. Fast Radius already uses several Autodesk products. This quarter, it added Fusion 360 with the Machining Extension to support its in-house CNC operation and integrate it alongside its existing additive manufacturing offering. Fusion 360 enables Fast Radius to program a wide variety of parts more quickly, resulting in faster product cycle times. Outside of commercial use, there is a large and rapidly growing ecosystem of users that are taking Fusion 360 from education and home into the workplace. These will fuel commercial usage in the future. As one measure of this ecosystem, we ended the third quarter with 1 million monthly active users, up over 50% year-over-year. And they are doing some amazing work. On September 12, the Technical University of Munich’s TUM Boring team beat more than 400 applicants and 12 finalists to win the inaugural Not-a-Boring Competition. As Haokun Zheng, one of five leads responsible for project operations, said: “Fusion 360’s cloud-based solution enabled our 60-member team to collaborate remotely during the pandemic and design and build an award-winning 40-foot long, 22-ton tunneling machine. Throughout the year, we were repeatedly told by industry experts that the timeline we were aiming for was borderline impossible. But Fusion 360’s ease of use and integrated CAD, CAM and FEM enabled rapid simulation and improved the speed and efficiency of the design workflow.” And finally, we continue to enable more users to participate in our ecosystem more productively, through business model innovation and our license compliance initiatives. For example, a sustainable building engineering design solutions consultant in Australia, which has been an Autodesk AEC customer for more than a decade, added our premium offering in the third quarter to enable it to better manage its subscriptions and provide more secure single sign on across multiple offices. Across Autodesk, the number of premium subscribers increased more than 500% year-over-year. And in the Middle East, a large telecoms company undertaking its own digital transformation was seeking to increase efficiency and sustainability by adopting BIM standards and streamlining digital workflows while also ensuring license compliance across a fragmented employee base. During the process, we became the trusted partner of choice resulting in a significant investment in AEC Collections, AutoCAD, Revit, and 3ds Max. Year-to-date, license compliance billings across Autodesk as a whole are up 20% when compared to the same period two years ago and almost 50% year-over-year. In speaking with customers, partners and employees, we are very optimistic about the future. They have demonstrated grit and determination, inspiration and innovation, and agility and transformation during the pandemic. And while there will certainly be twists and turns on the road ahead, in many ways the pandemic has accelerated the future and increased my confidence that we are on the right path. We are executing well in challenging times and believe we have only significant opportunities ahead of us. I am reminded again that Autodesk’s purpose has never been more important or urgent. Empowering innovators with design-and-make technology so that they can achieve the new possible also enables them to build and manufacture efficiently and sustainably. Together, we can meet the challenges posed by carbon, water, and waste while also advancing equity and access to the in-demand skills of the future. Autodesk’s central role in meeting these challenges underpins my confidence this year and my confidence in the future. Operator, we would now like to open the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays.
Saket Kalia: Okay, great. Hey, guys. Thanks for taking my questions here. Debbie, maybe we’ll just start with you. Just given some of the moving parts, I’d like to zoom in on the FY22 guidance a bit. You touched on this a little bit in your prepared remarks. But, can you just talk about what drove the change to guide in billings and free cash flow specifically? You talked about supply chain and FX. I was wondering if you could just go one level deeper. Just help us parse that out a little bit. Does that make sense?
Debbie Clifford: It does. And I think we’ll start with Andrew here.
Andrew Anagnost: Yes. Let me start and then Debbie and I will kind of tag team here on some of this. So first off, Saket, let’s make sure we all kind of level set on the business is strong. All right. You saw the numbers. We’re seeing tremendous growth. We’re seeing record renewal rates. We’re approaching net revenue retention rates at the high end of our guide, and they’re continuing to go up. That’s super important here. And we feel pretty good about where the business is going. So, the business is strong, and we’re seeing a lot of strength there. If you look at what we’re talking about here, we saw several things happened during the quarter, and we got this reinforced by our customers and by our channel partners. We saw deceleration in what we were seeing around monthly active usage and all things associated with that. And that then translated into to us kind of looking at our guide and looking at things going forward, and we pragmatically just assumed at this point that what we saw in the quarter is going to continue into Q4. And that’s what you’re seeing a pragmatic assessment that, hey, there’s kind of supply chain pressure, this inflationary pressure that’s kind of squeezing the margins of some of our customers is going to continue into Q4. If we look forward in terms of the guide in terms of what’s going on into next year, look, we assume two things. One, this interesting FX environment we’re in, which I want Debbie to kind of comment on again and kind of reinforce some of the things you said in the opening commentary, presents some potential risk. So, we want to flag those risks. In addition, if some of these supply chain issues bleed over into the beginning of next year, we wanted to flag some additional risk there, but there’s certainly a large currency headwind that we’re seeing. And I’d like Debbie to just kind of reiterate some of the things you said in the opening commentary, so we can all get on the same page about that.
Debbie Clifford: Yes. Let me go back to the fiscal ‘22 guide, first. Because I think one of the metrics that I talked about in the opening commentary pretty much says it all. And that is that for our new volume growth, we saw a 30% growth for the first half of fiscal ‘22; and then in Q3, it was in the mid-20s. So, it was still pretty strong growth. It just fell short of our expectations. As we look ahead, we did highlight the potential risks that we see to fiscal ‘23 free cash flow. And it’s true that FX, based on what we know today, is a big factor. It’s been highly volatile. The rate moves that we saw in the first half of the year created about $55 million in potential headwind to fiscal ‘23 cash flow. And since then and in the last 90 days alone, further rate moves created about another $45 million in potential headwind to cash flow. So, as you can imagine, we’re obviously watching FX rates closely. But it’s clear that if the current rates persist through next year, that risk could materialize in free cash flow. Our goal today was just to highlight the risk as we look ahead to next year. But it’s important to remind that overall, the strategy is working, and we have numerous growth levers to capitalize on over the long term.
Andrew Anagnost: We still see path -- constant currency path to $2.4 billion next year, but we want to flag these risk because we think that’s a prudent thing to do at this time, given what we’re seeing today right now. Not a guide. It’s a risk flag.
Saket Kalia: Understood. And I think that is prudent. Andrew, maybe just for the follow-up for you. Just maybe zoom out from the numbers and some of the moving parts as we start to think about next year and the years after. One of the things that I’d love to just get your view on is, now that we have an infrastructure bill in the U.S., can you just talk about a couple of the components that you feel could be particularly helpful for Autodesk’s business, and maybe when you think we start to see some of the benefit in your customer base?
Andrew Anagnost: Yes. So first off, let’s be very clear. We don’t have any infrastructure uplift built in any of our guidance or anything that we’re talking about right now, okay? These things play out over multiple years. This is a great bill. We’re really happy to see it. Included in the bill is a $100 million fund to accelerate investment in digital tools for Department of Transportation. We feel that that’s a good thing and it’s an important part of this bill from our perspective because it’s going to change the ecosystem. But these things play out over a long term. We’re certainly really happy about the fact that we have invested in water ahead of these critical investments in infrastructure because water is going to matter a lot. Clean water, water management in terms of flooding or storage of water, wastewater processing, all these things, water is going to be a big deal. So, we’re going to see our engagement in water projects probably increase over the next couple of years. But I want to make sure that we’re all clear that we don’t build these into our numbers right now, and we want to -- we’re going to wait and see how these things play out over the next couple of years, but we will absolutely see some of our investments in road, rail and water pay off over a multiyear period here. And we’re pretty excited about it. This bill was a long time coming. And I think the emphasis on digital transformation inside the infrastructure industry is going to be an important catalyst to modernizing and expanding what’s happening in our infrastructure and growth in the United States.
Operator: Our next question comes from Adam Borg of Stifel. Your line is open.
Adam Borg: Andrew, I’d love to kind of just go maybe another step deeper on what Saket was talking about. For much of the year, we’ve talked about this unwinding of uncertainty, and we talked about several factors today of where it sounds like certainty has -- uncertainty has kind of gotten higher again. Could you just talk maybe a little bit more about like an example or two of how supply chain issues or even pricing is impacting or inflation is having a direct impact on the ability to close deals? Just kind of help give an example like what’s happening from that. That would be really great.
Andrew Anagnost: Yes. Adam, it was an excellent question. So, let’s look kind of like back up to three months ago and set some of the context too, so that we kind of get a sense for this. Three months ago, we were heading into the quarter seeing strong renewal rates, projecting strong renewal rates heading in, we saw those strong renewal rates. We’re at record renewal rates. We’re continuing to see those things. We also saw monthly active usage increasing robustly, heading into the quarter. As the quarter progressed, that increase in monthly active usage decelerated a little bit. It continued to grow. It’s just the second derivative kind of went negative on us, and it didn’t continue to accelerate at the pace we expected to see. So, what’s driving that? For a lot of our customers, the book of business they’re seeing is robust. They have more demand than they’re actually able to fulfill on right now. And you can see it in all the indices and all the indicators. What you also saw during the quarter, these supply chain backlogs and these inflationary pressures peaked in the quarter and continued persistently throughout the quarter. So, while they have this big book of business, or they have existing ongoing projects, if you’re on the AEC side and say you’re on a fixed bid contract, you’re going to see margin pressure because your cost of goods to deliver the project that you’re working on is going up, as is your cost of labor and actually your labor pool is tight and constrained. So, you’re seeing all these factors increase -- pinching your margins and it’s affecting your buying behavior at some time. So, even in this environment, where we saw all of these forces, including the labor shortages and things associated with that, we actually continued to grow robustly, just not where we expected to. Now, if you’re on the manufacturing side, which you noticed we did very well and especially relative to our competitors. Even there, they’re not able to fulfill on all of the demand they have heading into their businesses. So, they’re not collecting cash as fast because they’re not shipping the products that they’re getting ordered from their customers. So, all of these things are playing out. It didn’t stop people from buying technology, but it certainly slowed down some of the activity relative to our expectations around people buying and investing in their technology portfolio. Does that make sense?
Adam Borg: Yes, that was really helpful. And maybe just as a quick follow-up. Obviously, at Analyst Day, we talked about some changes around billing terms, and you referenced it a little bit earlier in the call. Just curious how kind of early receptivity has been with customers as you kind of explained to them the changes that are coming?
Andrew Anagnost: Yes. So look, our moves with regards to changing billing terms and smoothing out our free cash flow trajectory over multiple years are unchanged by any of this. We believe this is right for the business. We believe it’s right for our customers. Customers are generally positive around these things because they prefer annual billings or in most cases, they don’t want to have to pay upfront if they don’t have to. Also, a lot of these things we’ve been talking about with regards to supply chain pressures, our view is pretty transient by us. These are not going to be persistent types of things. So, customers view these fairly well. Our partners are getting themselves around some of these activities right now. But, those plans are completely unchanged relative to anything we’re seeing right now, and it’s all full steam ahead on that transition.
Operator: Our next question comes from Jay Vleeschhouwer of Griffin Securities. Please go ahead.
Jay Vleeschhouwer: Andrew, let me start with the circumstantial question. And that is, are there any operational changes that you foresee having to make? You just said that the circumstances are perhaps transitory. But in terms of, let’s say, what you call your early warning system, your usage telemetry, anything along those lines that you feel need to be updated, modified, amended in some way to at least take account of the current circumstances. And then, the points you made with regard to customers having a robust pipeline themselves, do you expect to be able to recoup at some point or over time the delta in the billings guidance that you’ve given now for fiscal ‘22? Do you think that amount of billings can come back to Autodesk. And I have a follow-up for you.
Andrew Anagnost: Yes. So first off, let me comment on the tracking. So, we believe our tracking is good because it actually showed us the outcome as the quarter progressed. We saw the mean [ph] over of the growth in monthly active usage and the associated impact there. So, it wasn’t lifting the way we expected it to in the second half. In fact, like I said, the second derivative change it eat over a little bit. So, these predictors, these tracking mechanisms we have, I think are still valid. They’re powerful. They actually gave us indications of things that were going on. I think we’re also, frankly, tracking the inflationary environment a bit more right now, trying to make sure what’s happening with the goods and labor pool that our customers are engaging with. We’re going to be paying attention to that. There’s hopeful signs out there that some of this is loosening up in some respects, but we’re going to be watching that. Now, with regards with some of the business coming back, it is absolutely possible that that’s the case. Our customers are definitely looking at a backlog of projects and a backlog of orders and all the things associated with that. I think it’s prudent at this point for us to kind of -- with the information we have right now, assume that we’re just going to see kind of an ongoing kind of impact for these things until something changes. But it is possible that some of this could come back as a result of releasing pressure. But it’s not -- I don’t think it’s prudent right now to declare that. I think we should watch this because we were all kind of surprised by the pace at which these supply chain pressures put pressure on our customers.
Jay Vleeschhouwer: Right, understood. Now, for the longer term, looking past these circumstances, I’d like to ask you about something you said in your remarks at AU last month. You said "Autodesk will fundamentally shift how the Company delivers value." And my question for that is, was that another way simply of referring to subscriptions and consumption and flex, or were you referring to something else besides just the licensing model in terms of how you’re thinking about delivering that fundamental value over time?
Andrew Anagnost: Yes. Actually, Jay, that statement was not related to the business model as well. The business models will help facilitate delivering some of that value. What we were really talking about was how the platform and the tools are going to become these co-designers with our customers, how we’re going to be driving much more facilitated action with our customers through our products. There’s going to be a lot more real-time data visibility, real-time option visibility, real-time collaboration between the system and the designer or the engineer. That’s the major value driver change that we’re talking about. It’s not the business model changes per se. Those are enablers. They allow us to get some of this capability more effectively to a broader set of customers, which we’re actually pretty happy about. But, it’s that fundamental relationship with the product, this notion of co-designing with a computer and with a system that’s really going to change the way we deliver value.
Operator: Our next question comes from Gal Munda of Berenberg. Please go ahead.
Gal Munda: The first one, I’d just like to kind of focus on the reduced free cash flow outlook in ‘22 and then how that potentially translates in ‘23. The way I read or listened to your remarks was that FY23 risk, the change in outlook, so the risk is kind of all to do with the FX rates rather than the impact that you’re seeing on the lower billings for FY22. Is that correct to understand it that way, or do you think there is a carry-on momentum from lower billings of FY22 based on supply chain shortage and all that stuff into free cash flow for ‘23?
Debbie Clifford: Yes. So, the answer is -- it’s a bit of a mix. Go ahead, Andrew. Okay. The answer is that it’s a bit of a mix. So, the way to think about it, I highlighted risk of approximately $100 million to $200 million based on what we know today. And part of it relates to the subscription basis of our business model. So, given that billings are falling short of our expectations for this year, we’re flowing through that risk into the free cash flow that we’re talking about next year. And the other part of it is FX. So, it’s roughly half and half.
Gal Munda: That’s really helpful and very clear. Thank you. And then, I just want to really focus on the different drivers of that kind of changed outlook, especially for this year. The long-term deferred revenues of a portion of total deferred revenue is falling kind of just below that mid -- whatever we say, mid-20s in terms of like, let’s say, 23% is kind of towards the lower end of that. Is that something you’d expect in Q4 to kind of pick up towards the 25%, or do you think that the acceleration of the transition away from multiyear billings is also something that is really driving the outlook for the billings itself because the revenue numbers seem to be strong?
Debbie Clifford: Yes. So, the way that we think about deferred revenue and the long-term contribution to deferred revenue being in roughly about mid-20s is not going to change. So, what we’re seeing here is an impact from macro on our billings outlook for this year that we’re then highlighting risk as we get into next year. But, the proportion of our business from multiyear contracts built up front for this year and into next year is in line with our expectations. We’ve been monitoring the multiyear cohort this year. And even in Q3, it was quite strong. And so, that’s not something that’s changing. And so, the follow-on impact of deferred revenue is that that wouldn’t change as well. We still would see roughly 20% being that long-term deferred revenue.
Gal Munda: Okay. So, it doesn’t -- so the multiyear billings contribution change didn’t have any impact on the billings outlook change that you have?
Debbie Clifford: That’s correct. Yes.
Operator: Our next question comes from Matt Hedberg of RBC Capital Markets. Your question, please?
Matt Hedberg: Debbie, maybe just a clarification for you. I think you noted in your script that you believe the fiscal ‘20 to fiscal ‘23 revenue CAGR will be at the lower end of that 16% to 18% guide. If I do some quick math, does that imply fiscal ‘23 revenue will grow about 17%, per your comment?
Debbie Clifford: Well, you are interpreting correctly that I said that if the risk materializes that we’re seeing today, in our numbers, yes, next year, we would be at the low end of the revenue CAGR of 16% to 18% that we talked about at our Investor Day. And while we’re not providing specific guidance on revenue for next year, directionally, your math computes.
Matt Hedberg: Got it. Okay. And then, maybe just one other. I think we’re all kind of looking at cRPO as a helpful metric, kind of judge the business as well. And I know you don’t guide to cRPO, but any sort of commentary on how that might trend into 4Q?
Debbie Clifford: Yes. So, let’s start with Q3. The cRPO growth decelerated, mainly because of declining contribution from multiyear EBA deals that closed in fiscal ‘20 which are entering the final year of their term. That growth deceleration was in line with our expectations, and it’s something that we signaled on our last earnings call. We anticipate over time that the growth rates for cRPO and revenue will gradually converge over time. But also that that RPO growth rate is going to continue to be influenced by the timing and volume of EBAs. And so, given that Q4 is a big EBA quarter for us, that’s going to have a big impact on the growth rate next quarter.
Operator: Our next question comes from Phil Winslow of Credit Suisse.
Phil Winslow: Andrew, I just wanted to dig in a little bit on where you’re seeing those changes in the second derivative, particularly in the AEC side of the house. One of the things you talked about a lot is that as that Autodesk has solutions in different parts of the life cycle in the AEC world, planning, actually putting the nail on the wood, et cetera. When you look at those second derivatives, where did you see that in the life cycle? And how are you thinking about that in Q4?
Andrew Anagnost: Yes. So again, I want to make sure that we’re clear on some of these things. The business was very strong. And that second derivative was a slowing down of the acceleration that we were expecting to see coming into the second half of the year. So, it’s a slowing down, it’s not a decline. I just want to be super clear on that so that we can get all positioned on that. Now, in terms of where we think this is going to head out. We continue to think that these monthly active usage rates are going to continue to grow and that we’re going to continue to see increases associated with these things. We’re just prudently assuming that what we saw in Q3 continues into Q4 because based on what we wanted to see was like this uplift in monthly active usage at a higher rate than what we saw, it’s probably a safe bet to just assume this is going to coast into Q4. If something changes, if these pressures start to relieve and start to relax, we could absolutely see an improving environment. But the business is strong. The renewal rates are strong. The underlying fundamentals of the business are strong. The net retention revenue -- rates are strong. The slowdown was rather broad brush, except for the country-specific issues that we highlighted in China. So, there was no one product area that saw a slowing. But I want you to note something pretty important here. Look at the competitive position that we came out of this year, particularly in manufacturing and other places. We’re growing much more robustly than any of our competition in the space. It’s just we have high expectations and we wanted to see some of those high expectations fulfilled. So, that’s how we view this right now, and that’s how we’re viewing it heading into the rest of the year. Does that answer your question, or did you want to clarify something?
Phil Winslow: No, no. That’s helpful. Thank you. And then, also just help me drilling just in the markets by geography. I mean, obviously, we have the reported numbers, but anything you’d sort of call out within that whether it be by vertical, by geography, or how you’re thinking about Q4? And then, I’ll go back in the queue.
Andrew Anagnost: The one thing I’ll just highlight, say, we talked about the softness in China that was specifically in AEC. We actually did well in manufacturing in China. So softness was not uniform in China across all of our businesses. But in general, what we saw was a kind of a broad-brush impact. So I couldn’t point to onesie-twosies in any particular country that was kind of different or offset from anything else we were seeing. It was kind of a broader impact in kind of the slowing down of the acceleration that we saw.
Operator: Our next question comes from Joe Vruwink of Baird. Your question, please?
Joe Vruwink: I’m curious, is the persona of customer that you think about as being kind of key to Autodesk new business growth. Is that customer more susceptible to some of the macro issues you’re calling out? If I’m understanding all the detail right, the established base is growing nicely. There is moderation on the incremental growth. So, I suppose a question might be, are the risks of the latter starting to impact the former and starting to maybe trickle into the installed base at the same time.
Andrew Anagnost: That’s not what we’re seeing. If that’s what we were seeing, the net revenue retention rate trend that we saw during the quarter would have been different. So, I want to focus you back on. Remember, we came at the high end of our range on net revenue retention. And what that does is it shows a strong -- a kind of a strong affinity and willingness to keep upping their game with regards to our products and offering. And that does not often, okay? If anything, that’s continuing to strengthen. So, that feels really good. So, there’s really -- it really was affecting the new book of business, which kind of bleeds into the long tail of our business at some point into some level, which is to be expected in environments like this. Those who are most cash flow constrained, tend to slow their buying down the most. So, I don’t see any bleed over potential. In fact, in a lot of our newer businesses, we saw robust growth associated with some of these things. So, I do not see a crossover or a bleed over between these things. In fact, we continue to expect continued strengthening of net revenue retention rates in the base.
Joe Vruwink: Okay. That’s helpful. And then, on the supply chain topic. This was addressed at the Investor Day as maybe being a risk area, but also an opportunity perhaps for technology adoption. Even recently, it seems like engineering firms are acknowledging that hiring support bigger backlogs might be tough, but technology, again, could be an opportunity. So, I guess, the question is, how do you think about the new seat contribution for your growth algorithm in the context of double digits being sustainable? Would you expect a bigger contribution from the application and content side of the growth model and how to think about seats, given the current macro backdrop?
Andrew Anagnost: Yes. So, we absolutely think that we continue to see digitization tailwinds here. Okay? Customers are absolutely turning to technology to wrestle with some of these problems and solve some of these things. And if you look at the strategy around double-digit growth and where we’re going, you see a lot of things working. First off, let’s just pause, and I don’t want to say this too many times, but the business is doing strong and that’s setting a floor on some of our growth. Also, I wanted you to notice some of the things that happened with noncompliant revenue. We grew 50% year-over-year, reflecting the compare to kind of the slowdown we did in the COVID in the 2020 and around the pandemic, and we normalized the kind of like a 20-year -- 20% growth over the two-year period, which shows nice steady growth in some of these things. So, if you look at the business, you see a lot of things working really well. Now, if you look at the long-term trends that are going to contribute and be additive in terms of driving the double-digit growth, the digitization is there, the tailwinds continue, customers are telling us more and more, they want to go deeper, deeper, deeper in digitization. And we’re seeing strong adoption like for instance in construction with our largest EBA customers and some of our largest GCs. We’re seeing strong adoption of Construction Cloud or integrating Construction Cloud more deeply into some of these relationships. If you look at some of the incremental drivers we were talking about with regards to business model capabilities and some of the things associated, we’re continuing to see strong growth there in terms of new types of subscription models, noncompliant users. And then, when we talk about the long tail, while it’s really early days with the Flex model, and I want to make sure that we always say it’s early days with the Flex model. One of the things we’re seeing with Flex is exactly what we expected to see. We’re seeing a large percent of Flex business coming in is net new. Another chunk of Flex business coming in as these occasional usage buyers. People that classically bought network licenses previously. And another chunk of business where people trying and using more advanced products, products they weren’t going to use previously. Those trends are exactly the kind of trends we want to see with offerings like this. And as time goes on and we get more experience with Flex, we expect those trends to continue. So, all of the things that we’re pursuing to drive double-digit growth are working right now. And that’s what gives us confidence as we move forward into the FY ‘23, ‘24 and ‘25 and beyond, is that everything we’re doing right now is working. If something was showing softness or not working, then I wouldn’t have the confidence I have right now, but everything is working in terms of the things we’re pursuing. Is transient impacts that we’re seeing right now? They’re obvious. They’re systemic. Everybody is seeing them. You can measure them systematically in terms of what’s going on in These will pass. The question is when will they pass.
Operator: Our next question comes from Sterling Auty of JP Morgan.
Sterling Auty: Andrew, if you put yourself in the seat of the investor, we’re all seeing the headlines of the supply chain constraints, et cetera. But what, if you were an investor, would you be looking at to help us monitor to possibly get a handle on when some of these pressures are alleviating and your business is starting to inflect upward again?
Andrew Anagnost: Yes. Okay. So, you’re asking me to kind of be the predictor of when some of these supply chain pressures are going to unwind. Look, I’ll tell you what we’re...
Sterling Auty: No. I’m not asking for a time. I’m asking for what are some of the data points that would signal that it’s getting better...
Andrew Anagnost: Yes. Okay. So look, one of the data points we look at is the cost of freight. Okay? So, for instance, people are -- the cost of freight has been going up and up and up as you’ve been seeing this capacity compaction with regards to moving things. So that’s one metric if you just sit there and look at and say, hey, if the cost of freight goes down, that’s a sign that flow-through and throughput is starting to soften up. That’s one thing that’s out there. Another thing is some of the costs of the core commodities that our customers do, I mean, take the wood. I mean, I know that sounds true, but the cost of wood in some of our AECs, it’s a big deal. Right? If your cost of wood or wood-based materials goes up 20%, 30%, 40% on a fixed bid contract, what is that doing to your ability to execute? So, you look at cost of freight, you look at cost of wood and the things associated with that and those have direct impact. The cost of any commodity going into manufacturing is going to have impacts. The last thing that I think is really interesting with regards to manufacturing is some of these chip shipments starting to loosen up and allowing people to kind of finish their machines and make sure that the electronics are actually assembled and together. So, these are some of the things that all of us can look at to see how things are going. The cost of freight being right up there, the cost of wood and commodities associated with building things being out in front. We’re going to continue to look at the monthly active usage because for us, that’s a predictor of people doing more with the products, and that will probably follow some of these other indicators changing. Does that make sense, Sterling?
Sterling Auty: It does. Thank you.
Andrew Anagnost: You’re welcome.
Operator: Thank you. At this time, I’d like to turn the call back over to Simon Mays-Smith for closing remarks. Sir?
Simon Mays-Smith: Sorry. I was muted. I apologize. I’ll repeat myself. Thank you, Lateef. Thanks, everyone, for attending. We’ll look forward to catching up with you next quarter. If you have any follow-up questions, please do ping the IR team. In the meantime, have a very happy Thanksgiving and happy holidays. Thanks very much, everyone.
Operator: And this concludes today’s conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by, and welcome to Autodesk Third Quarter Fiscal Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference may be recorded. [Operator Instructions] I would now like to hand the conference over to the VP of Investor Relations, Simon Mays-Smith. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks operator and good afternoon. Thanks for joining our conference call to discuss the results of our third quarter of fiscal year 2022. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our Chief Financial Officer. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K, for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. Our third quarter results were strong, driven by one of our best-ever quarters for new subscriptions, record subscription renewal rates, a net revenue retention rate towards the high end of our range, and a solid competitive performance. We also grew RPO and billings 18% and 16% respectively, despite a tougher compare versus last year. Relative to the first and second quarters, the rate of improvement decelerated during the third quarter more than we expected. While demand is robust, we believe supply chain disruption and resulting inflationary pressures, a global labor shortage making it harder for our customers to staff new projects, and the ebb and flow of COVID are contributing to the deceleration, as well as documented country-specific disruption to AEC in China. Our conversations with customers and channel partners reinforce our view. We’re encouraged that embracing digital transformation to drive efficiency and sustainability remains a priority for our customers. Our end-to-end solutions, business model flexibility and platform position us well competitively and enable more customers to enter and remain in our ecosystem. As you heard at our recent Investor Day and at Autodesk University, we are rapidly innovating and optimizing our business to increase and realize the opportunity ahead. Notable milestones during the quarter included the launch of our Flex consumption model and our plans to combine technologies, connect processes, automate workflows, and unlock valuable insights for customers through our Forge platform. The recent report from the Intergovernmental Panel on Climate Change and the United Nations Climate Change COP26 meeting in Glasgow both underscored the urgency of reducing carbon in the earth’s atmosphere and the role that everyone, including corporations, needs to play. Sustainability needs to be designed, made and, in many cases, retrofitted in construction and manufacturing. This cannot be achieved efficiently or effectively without end-to-end software like ours to drive the process. This organizing principle affects not just how we deploy capital, for example through our investments to develop sustainable tools and our recent acquisition of Innovyze, but also how we source capital. Many of our largest equity holders already align to our sustainability goals and in the third quarter, we began to align our debt holders by issuing our first sustainability bond linked to our sustainability goals. Now, let me turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I’ll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. As Andrew said, our third quarter results were strong. Several factors contributed to that, including robust growth in new product subscriptions, rapidly expanding digital sales, and increasing subscription renewal rates. Total revenue growth in the quarter accelerated to 18%, and 17% in constant currency, with subscription revenue growing by 21%. Looking at revenue by product, the growth we saw was broad-based. AutoCAD and AutoCAD LT revenue grew 14%, AEC revenue grew 22%, and manufacturing revenue grew 16%. M&E revenue grew 17%. Across the globe, revenue grew 18% in the Americas, 19% in EMEA, and 18% in APAC. Direct revenue increased 34% and represented 35% of our total revenue, up from 31% last year, due to strength from both, enterprise and e-commerce. As you heard at our investor day, about three quarters of new customers to Autodesk are now generated through our digital channels, reflecting the strength of our simplified buying experiences. Our product subscription renewal rates reached record highs, and our net revenue retention rate was toward the high end of our 100% to 110% range. Billings increased 16% to $1.2 billion, reflecting robust underlying demand and a tough comparison versus last year when we signed two of our largest ever EBAs, including a nine-digit deal. Total deferred revenue grew 14% to $3.3 billion. Total RPO of $4.2 billion and current RPO of $2.9 billion grew 18% and 21%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin increased by 2 percentage points to approximately 32%, reflecting strong revenue growth and ongoing cost discipline. We delivered healthy free cash flow of $257 million during the quarter against a tough comparison from last year, which benefited from pandemic-related payment term extensions. Consistent with our capital allocation strategy, we continued to repurchase shares to offset dilution from our equity plans. During the third quarter, we purchased 980,000 shares for $287 million at an average price of approximately $293 per share. Year-to-date, we’ve repurchased 1.66 million shares at an average price of approximately $287 per share, for a total spend of $476 million. Looking forward, as Andrew said, we’re rapidly innovating and optimizing our business to realize the opportunities ahead. As we discussed last quarter, the shift of multi-year contracts to annual billings as we move into fiscal ‘24 will drive more predictable free cash flow and better price realization over time, which will make Autodesk a more valuable company. This quarter, we took steps to optimize our capital structure by issuing our first sustainability bond, which aligns our capital strategy with our sustainability goals while also extending our debt maturity profile by almost two years and reducing our weighted average cost of debt by 40 basis points. As we enter Q4, we intend to take steps to reduce our real-estate footprint because the pandemic has spurred changes in the way we work and we’ve moved to a hybrid workforce. As a result, we anticipate we will reduce the square footage of our facilities portfolio by approximately 20% worldwide and that we will take a GAAP-only charge of up to approximately $180 million, the bulk of which will be recognized over the next several months as we execute our plan. Optimizing our facilities costs will allow us to better deploy capital to further our strategy and drive growth. Now, let me finish with guidance. Demand was robust in Q3 and we expect it to remain so in Q4. However, as Andrew said, macroeconomic headwinds such as supply chain disruption and resulting inflationary pressures, a global labor shortage, the ebb and flow of COVID, and AEC in China are impacting the pace of our recovery. As an example, the growth in new product subscription volume decelerated from approximately 30% in the first half to mid-20s percent in Q3, which is more than normal seasonality and a tougher comparison versus last year would suggest. This dynamic drove strong billings growth in Q3 that, nonetheless, fell short of our expectations. In light of this macroeconomic uncertainty, as we enter Q4, we’re taking a pragmatic approach and are assuming that the supply chain, labor, COVID and country-specific challenges will persist. As a result, we’re reducing the mid-point of our billings and free cash flow guidance by approximately $150 million and $100 million, respectively, for full-year fiscal ‘22. Given the nature of our subscription business model and the greater degree of near-term visibility it provides to us and our expectation of continued strong spend discipline, the mid-point of our full-year revenue and margin guidance is broadly unchanged. We continue to target $2.4 billion of free cash flow in fiscal ‘23 in constant currency because we believe the current macro headwinds we’re seeing are transient. But if the growth deceleration and strengthened dollar continue through next year, we could see potential risk to that target of about $100 million to $200 million, based on what we know today. FX volatility is a big factor. Rate moves in the first half of the year created about $55 million in potential headwind to fiscal ‘23 cash flow. Since then and in the last 90 days alone, further rate moves created about another $45 million in potential headwind to cash flow. We’re obviously watching FX rates closely but it’s clear that if the current rates persist through next year, that risk could materialize in free cash flow. Beyond cash flow, if you further take the risk into account, revenue growth could end up at the low end of the CAGR we talked about at Investor Day and fiscal ‘23 margins could be impacted by about a point. We will, of course, update you on our next earnings call when we expect to have more visibility into any impacts from macro or FX movement on our fiscal ‘23 outlook. We remain optimistic about our growth potential beyond fiscal ‘23, continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range, and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Now, let me turn to our strategic growth initiatives. Sustained and purposeful innovation to enable digital transformation in the industries we serve has changed our relationships with our customers from software vendor to strategic partner. And that is enabling us to create more value through end-to-end, cloud-based solutions that connect data and workflows, and through business model evolution. Our model is scalable and extensible into adjacent verticals, from architecture and engineering, through construction and owners; and from product engineering, through product manufacturing and product data and lifecycle management. By helping our customers grow and navigate their digital transformation, we will grow, too. For example, Bouygues Construction and Colas are leading construction and infrastructure firms based in France with over 100,000 construction employees operating in 60 countries across the globe. In the third quarter, they significantly increased their commitment to Autodesk products such as Revit, AutoCAD and Civil 3D following an accelerated move to BIM and digital work flows over the last three years, which significantly increased monthly average users. Similarly, Obayashi Corporation, one of the largest construction firms in Japan, which operates in 16 countries worldwide, is accelerating its global consolidation around BIM and a unified 3D technology platform to enable greater efficiency and sustainability. In the third quarter, it expanded its EBA with us. Over the last two years, it has more than doubled the number of Revit users and expanded its usage of Autodesk Construction Cloud to connect workflows from design through construction. We are further extending our reach into the construction mid-market with the recent launch of Autodesk Build, introduction of an account-based pricing business model and distribution through our channel partners. For example, this quarter, Jacobsen Construction Company, an ENR 400 general contractor in the United States, was looking for a long-term technology partner and to consolidate around a single project management solution that would increase the efficiency of its field teams while also seamlessly integrating with its accounting solution. While it had previously used a competitor solution for some projects, Jacobsen ultimately chose Autodesk Construction Cloud because of Autodesk Build’s robust field and cost management functionality, and the opportunity to integrate it smoothly with existing technology. With new Autodesk Build features and capabilities launched every two months or so, and the recently launched ACC bundles for pre-construction and construction operations, we remain optimistic about the opportunities ahead. We’re connecting the dots in infrastructure, too. For example, the Administrator of Railway Infrastructures in Spain, or ADIF, selected Autodesk products over competitor offerings to support its digital transformation. Backed by our common data environment, ADIF will leverage the Autodesk Construction Cloud to collaborate on project information, on-site development, and model coordination to ensure efficient and accurate construction of their railway network. Infrastructure remains an important opportunity for Autodesk across the globe. Our end-to-end solutions, which boost the efficiency and sustainability of customers like ADIF, as well as our ability to seamlessly integrate vertical and horizontal design and construction, give us a competitive advantage. Much needed additional investment in infrastructure in the United States and across the globe will restore aging infrastructure and increase the productivity of the economy. Perhaps more consequentially in the long term, provisions in the U.S. infrastructure bill, which encourages Department of Transportation to digitize their processes, should accelerate adoption of digital workflows and enable all infrastructure investment to become more efficient and sustainable. Turning to manufacturing, we sustained strong momentum in our manufacturing portfolio this quarter. In automotive, we continue to grow our footprint, beyond the design studio into manufacturing and connected factories, as automotive OEMs seek to break down work silos and shorten hand-off and design cycles. Ford, one of the largest automotive OEMs in the world, renewed and expanded its EBA with Autodesk during the third quarter, growing users of Alias and VRED in design and AutoCAD, Inventor and Navisworks in manufacturing, while adding Autodesk Construction Cloud and Autodesk Build in facilities and manufacturing to enable field access to plant drawings during maintenance and operations and equipment change over. Fusion 360 commercial subscribers again grew strongly without any systematic sales promotions, ending the quarter with 175,000 subscribers. While still early days, our new extensions, including Machining, Generative Design, and Nesting & Fabrication are performing well and there is major interest in our upcoming simulation and design extensions. Fewer promotions and growing demand for Fusion 360’s extensions are enabling us to capture more of the potential market opportunity and accelerate our growth. Fast Radius is a leading digital manufacturing and supply chain company. The company’s proprietary Cloud Manufacturing Platform combines software and advanced microfactories that enable its customers to flexibly design, make and move certified parts. Fast Radius already uses several Autodesk products. This quarter, it added Fusion 360 with the Machining Extension to support its in-house CNC operation and integrate it alongside its existing additive manufacturing offering. Fusion 360 enables Fast Radius to program a wide variety of parts more quickly, resulting in faster product cycle times. Outside of commercial use, there is a large and rapidly growing ecosystem of users that are taking Fusion 360 from education and home into the workplace. These will fuel commercial usage in the future. As one measure of this ecosystem, we ended the third quarter with 1 million monthly active users, up over 50% year-over-year. And they are doing some amazing work. On September 12, the Technical University of Munich’s TUM Boring team beat more than 400 applicants and 12 finalists to win the inaugural Not-a-Boring Competition. As Haokun Zheng, one of five leads responsible for project operations, said: “Fusion 360’s cloud-based solution enabled our 60-member team to collaborate remotely during the pandemic and design and build an award-winning 40-foot long, 22-ton tunneling machine. Throughout the year, we were repeatedly told by industry experts that the timeline we were aiming for was borderline impossible. But Fusion 360’s ease of use and integrated CAD, CAM and FEM enabled rapid simulation and improved the speed and efficiency of the design workflow.” And finally, we continue to enable more users to participate in our ecosystem more productively, through business model innovation and our license compliance initiatives. For example, a sustainable building engineering design solutions consultant in Australia, which has been an Autodesk AEC customer for more than a decade, added our premium offering in the third quarter to enable it to better manage its subscriptions and provide more secure single sign on across multiple offices. Across Autodesk, the number of premium subscribers increased more than 500% year-over-year. And in the Middle East, a large telecoms company undertaking its own digital transformation was seeking to increase efficiency and sustainability by adopting BIM standards and streamlining digital workflows while also ensuring license compliance across a fragmented employee base. During the process, we became the trusted partner of choice resulting in a significant investment in AEC Collections, AutoCAD, Revit, and 3ds Max. Year-to-date, license compliance billings across Autodesk as a whole are up 20% when compared to the same period two years ago and almost 50% year-over-year. In speaking with customers, partners and employees, we are very optimistic about the future. They have demonstrated grit and determination, inspiration and innovation, and agility and transformation during the pandemic. And while there will certainly be twists and turns on the road ahead, in many ways the pandemic has accelerated the future and increased my confidence that we are on the right path. We are executing well in challenging times and believe we have only significant opportunities ahead of us. I am reminded again that Autodesk’s purpose has never been more important or urgent. Empowering innovators with design-and-make technology so that they can achieve the new possible also enables them to build and manufacture efficiently and sustainably. Together, we can meet the challenges posed by carbon, water, and waste while also advancing equity and access to the in-demand skills of the future. Autodesk’s central role in meeting these challenges underpins my confidence this year and my confidence in the future. Operator, we would now like to open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hey, guys. Thanks for taking my questions here. Debbie, maybe we’ll just start with you. Just given some of the moving parts, I’d like to zoom in on the FY22 guidance a bit. You touched on this a little bit in your prepared remarks. But, can you just talk about what drove the change to guide in billings and free cash flow specifically? You talked about supply chain and FX. I was wondering if you could just go one level deeper. Just help us parse that out a little bit. Does that make sense?"
},
{
"speaker": "Debbie Clifford",
"text": "It does. And I think we’ll start with Andrew here."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Let me start and then Debbie and I will kind of tag team here on some of this. So first off, Saket, let’s make sure we all kind of level set on the business is strong. All right. You saw the numbers. We’re seeing tremendous growth. We’re seeing record renewal rates. We’re approaching net revenue retention rates at the high end of our guide, and they’re continuing to go up. That’s super important here. And we feel pretty good about where the business is going. So, the business is strong, and we’re seeing a lot of strength there. If you look at what we’re talking about here, we saw several things happened during the quarter, and we got this reinforced by our customers and by our channel partners. We saw deceleration in what we were seeing around monthly active usage and all things associated with that. And that then translated into to us kind of looking at our guide and looking at things going forward, and we pragmatically just assumed at this point that what we saw in the quarter is going to continue into Q4. And that’s what you’re seeing a pragmatic assessment that, hey, there’s kind of supply chain pressure, this inflationary pressure that’s kind of squeezing the margins of some of our customers is going to continue into Q4. If we look forward in terms of the guide in terms of what’s going on into next year, look, we assume two things. One, this interesting FX environment we’re in, which I want Debbie to kind of comment on again and kind of reinforce some of the things you said in the opening commentary, presents some potential risk. So, we want to flag those risks. In addition, if some of these supply chain issues bleed over into the beginning of next year, we wanted to flag some additional risk there, but there’s certainly a large currency headwind that we’re seeing. And I’d like Debbie to just kind of reiterate some of the things you said in the opening commentary, so we can all get on the same page about that."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. Let me go back to the fiscal ‘22 guide, first. Because I think one of the metrics that I talked about in the opening commentary pretty much says it all. And that is that for our new volume growth, we saw a 30% growth for the first half of fiscal ‘22; and then in Q3, it was in the mid-20s. So, it was still pretty strong growth. It just fell short of our expectations. As we look ahead, we did highlight the potential risks that we see to fiscal ‘23 free cash flow. And it’s true that FX, based on what we know today, is a big factor. It’s been highly volatile. The rate moves that we saw in the first half of the year created about $55 million in potential headwind to fiscal ‘23 cash flow. And since then and in the last 90 days alone, further rate moves created about another $45 million in potential headwind to cash flow. So, as you can imagine, we’re obviously watching FX rates closely. But it’s clear that if the current rates persist through next year, that risk could materialize in free cash flow. Our goal today was just to highlight the risk as we look ahead to next year. But it’s important to remind that overall, the strategy is working, and we have numerous growth levers to capitalize on over the long term."
},
{
"speaker": "Andrew Anagnost",
"text": "We still see path -- constant currency path to $2.4 billion next year, but we want to flag these risk because we think that’s a prudent thing to do at this time, given what we’re seeing today right now. Not a guide. It’s a risk flag."
},
{
"speaker": "Saket Kalia",
"text": "Understood. And I think that is prudent. Andrew, maybe just for the follow-up for you. Just maybe zoom out from the numbers and some of the moving parts as we start to think about next year and the years after. One of the things that I’d love to just get your view on is, now that we have an infrastructure bill in the U.S., can you just talk about a couple of the components that you feel could be particularly helpful for Autodesk’s business, and maybe when you think we start to see some of the benefit in your customer base?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, let’s be very clear. We don’t have any infrastructure uplift built in any of our guidance or anything that we’re talking about right now, okay? These things play out over multiple years. This is a great bill. We’re really happy to see it. Included in the bill is a $100 million fund to accelerate investment in digital tools for Department of Transportation. We feel that that’s a good thing and it’s an important part of this bill from our perspective because it’s going to change the ecosystem. But these things play out over a long term. We’re certainly really happy about the fact that we have invested in water ahead of these critical investments in infrastructure because water is going to matter a lot. Clean water, water management in terms of flooding or storage of water, wastewater processing, all these things, water is going to be a big deal. So, we’re going to see our engagement in water projects probably increase over the next couple of years. But I want to make sure that we’re all clear that we don’t build these into our numbers right now, and we want to -- we’re going to wait and see how these things play out over the next couple of years, but we will absolutely see some of our investments in road, rail and water pay off over a multiyear period here. And we’re pretty excited about it. This bill was a long time coming. And I think the emphasis on digital transformation inside the infrastructure industry is going to be an important catalyst to modernizing and expanding what’s happening in our infrastructure and growth in the United States."
},
{
"speaker": "Operator",
"text": "Our next question comes from Adam Borg of Stifel. Your line is open."
},
{
"speaker": "Adam Borg",
"text": "Andrew, I’d love to kind of just go maybe another step deeper on what Saket was talking about. For much of the year, we’ve talked about this unwinding of uncertainty, and we talked about several factors today of where it sounds like certainty has -- uncertainty has kind of gotten higher again. Could you just talk maybe a little bit more about like an example or two of how supply chain issues or even pricing is impacting or inflation is having a direct impact on the ability to close deals? Just kind of help give an example like what’s happening from that. That would be really great."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Adam, it was an excellent question. So, let’s look kind of like back up to three months ago and set some of the context too, so that we kind of get a sense for this. Three months ago, we were heading into the quarter seeing strong renewal rates, projecting strong renewal rates heading in, we saw those strong renewal rates. We’re at record renewal rates. We’re continuing to see those things. We also saw monthly active usage increasing robustly, heading into the quarter. As the quarter progressed, that increase in monthly active usage decelerated a little bit. It continued to grow. It’s just the second derivative kind of went negative on us, and it didn’t continue to accelerate at the pace we expected to see. So, what’s driving that? For a lot of our customers, the book of business they’re seeing is robust. They have more demand than they’re actually able to fulfill on right now. And you can see it in all the indices and all the indicators. What you also saw during the quarter, these supply chain backlogs and these inflationary pressures peaked in the quarter and continued persistently throughout the quarter. So, while they have this big book of business, or they have existing ongoing projects, if you’re on the AEC side and say you’re on a fixed bid contract, you’re going to see margin pressure because your cost of goods to deliver the project that you’re working on is going up, as is your cost of labor and actually your labor pool is tight and constrained. So, you’re seeing all these factors increase -- pinching your margins and it’s affecting your buying behavior at some time. So, even in this environment, where we saw all of these forces, including the labor shortages and things associated with that, we actually continued to grow robustly, just not where we expected to. Now, if you’re on the manufacturing side, which you noticed we did very well and especially relative to our competitors. Even there, they’re not able to fulfill on all of the demand they have heading into their businesses. So, they’re not collecting cash as fast because they’re not shipping the products that they’re getting ordered from their customers. So, all of these things are playing out. It didn’t stop people from buying technology, but it certainly slowed down some of the activity relative to our expectations around people buying and investing in their technology portfolio. Does that make sense?"
},
{
"speaker": "Adam Borg",
"text": "Yes, that was really helpful. And maybe just as a quick follow-up. Obviously, at Analyst Day, we talked about some changes around billing terms, and you referenced it a little bit earlier in the call. Just curious how kind of early receptivity has been with customers as you kind of explained to them the changes that are coming?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So look, our moves with regards to changing billing terms and smoothing out our free cash flow trajectory over multiple years are unchanged by any of this. We believe this is right for the business. We believe it’s right for our customers. Customers are generally positive around these things because they prefer annual billings or in most cases, they don’t want to have to pay upfront if they don’t have to. Also, a lot of these things we’ve been talking about with regards to supply chain pressures, our view is pretty transient by us. These are not going to be persistent types of things. So, customers view these fairly well. Our partners are getting themselves around some of these activities right now. But, those plans are completely unchanged relative to anything we’re seeing right now, and it’s all full steam ahead on that transition."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jay Vleeschhouwer of Griffin Securities. Please go ahead."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Andrew, let me start with the circumstantial question. And that is, are there any operational changes that you foresee having to make? You just said that the circumstances are perhaps transitory. But in terms of, let’s say, what you call your early warning system, your usage telemetry, anything along those lines that you feel need to be updated, modified, amended in some way to at least take account of the current circumstances. And then, the points you made with regard to customers having a robust pipeline themselves, do you expect to be able to recoup at some point or over time the delta in the billings guidance that you’ve given now for fiscal ‘22? Do you think that amount of billings can come back to Autodesk. And I have a follow-up for you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, let me comment on the tracking. So, we believe our tracking is good because it actually showed us the outcome as the quarter progressed. We saw the mean [ph] over of the growth in monthly active usage and the associated impact there. So, it wasn’t lifting the way we expected it to in the second half. In fact, like I said, the second derivative change it eat over a little bit. So, these predictors, these tracking mechanisms we have, I think are still valid. They’re powerful. They actually gave us indications of things that were going on. I think we’re also, frankly, tracking the inflationary environment a bit more right now, trying to make sure what’s happening with the goods and labor pool that our customers are engaging with. We’re going to be paying attention to that. There’s hopeful signs out there that some of this is loosening up in some respects, but we’re going to be watching that. Now, with regards with some of the business coming back, it is absolutely possible that that’s the case. Our customers are definitely looking at a backlog of projects and a backlog of orders and all the things associated with that. I think it’s prudent at this point for us to kind of -- with the information we have right now, assume that we’re just going to see kind of an ongoing kind of impact for these things until something changes. But it is possible that some of this could come back as a result of releasing pressure. But it’s not -- I don’t think it’s prudent right now to declare that. I think we should watch this because we were all kind of surprised by the pace at which these supply chain pressures put pressure on our customers."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Right, understood. Now, for the longer term, looking past these circumstances, I’d like to ask you about something you said in your remarks at AU last month. You said \"Autodesk will fundamentally shift how the Company delivers value.\" And my question for that is, was that another way simply of referring to subscriptions and consumption and flex, or were you referring to something else besides just the licensing model in terms of how you’re thinking about delivering that fundamental value over time?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Actually, Jay, that statement was not related to the business model as well. The business models will help facilitate delivering some of that value. What we were really talking about was how the platform and the tools are going to become these co-designers with our customers, how we’re going to be driving much more facilitated action with our customers through our products. There’s going to be a lot more real-time data visibility, real-time option visibility, real-time collaboration between the system and the designer or the engineer. That’s the major value driver change that we’re talking about. It’s not the business model changes per se. Those are enablers. They allow us to get some of this capability more effectively to a broader set of customers, which we’re actually pretty happy about. But, it’s that fundamental relationship with the product, this notion of co-designing with a computer and with a system that’s really going to change the way we deliver value."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gal Munda of Berenberg. Please go ahead."
},
{
"speaker": "Gal Munda",
"text": "The first one, I’d just like to kind of focus on the reduced free cash flow outlook in ‘22 and then how that potentially translates in ‘23. The way I read or listened to your remarks was that FY23 risk, the change in outlook, so the risk is kind of all to do with the FX rates rather than the impact that you’re seeing on the lower billings for FY22. Is that correct to understand it that way, or do you think there is a carry-on momentum from lower billings of FY22 based on supply chain shortage and all that stuff into free cash flow for ‘23?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So, the answer is -- it’s a bit of a mix. Go ahead, Andrew. Okay. The answer is that it’s a bit of a mix. So, the way to think about it, I highlighted risk of approximately $100 million to $200 million based on what we know today. And part of it relates to the subscription basis of our business model. So, given that billings are falling short of our expectations for this year, we’re flowing through that risk into the free cash flow that we’re talking about next year. And the other part of it is FX. So, it’s roughly half and half."
},
{
"speaker": "Gal Munda",
"text": "That’s really helpful and very clear. Thank you. And then, I just want to really focus on the different drivers of that kind of changed outlook, especially for this year. The long-term deferred revenues of a portion of total deferred revenue is falling kind of just below that mid -- whatever we say, mid-20s in terms of like, let’s say, 23% is kind of towards the lower end of that. Is that something you’d expect in Q4 to kind of pick up towards the 25%, or do you think that the acceleration of the transition away from multiyear billings is also something that is really driving the outlook for the billings itself because the revenue numbers seem to be strong?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So, the way that we think about deferred revenue and the long-term contribution to deferred revenue being in roughly about mid-20s is not going to change. So, what we’re seeing here is an impact from macro on our billings outlook for this year that we’re then highlighting risk as we get into next year. But, the proportion of our business from multiyear contracts built up front for this year and into next year is in line with our expectations. We’ve been monitoring the multiyear cohort this year. And even in Q3, it was quite strong. And so, that’s not something that’s changing. And so, the follow-on impact of deferred revenue is that that wouldn’t change as well. We still would see roughly 20% being that long-term deferred revenue."
},
{
"speaker": "Gal Munda",
"text": "Okay. So, it doesn’t -- so the multiyear billings contribution change didn’t have any impact on the billings outlook change that you have?"
},
{
"speaker": "Debbie Clifford",
"text": "That’s correct. Yes."
},
{
"speaker": "Operator",
"text": "Our next question comes from Matt Hedberg of RBC Capital Markets. Your question, please?"
},
{
"speaker": "Matt Hedberg",
"text": "Debbie, maybe just a clarification for you. I think you noted in your script that you believe the fiscal ‘20 to fiscal ‘23 revenue CAGR will be at the lower end of that 16% to 18% guide. If I do some quick math, does that imply fiscal ‘23 revenue will grow about 17%, per your comment?"
},
{
"speaker": "Debbie Clifford",
"text": "Well, you are interpreting correctly that I said that if the risk materializes that we’re seeing today, in our numbers, yes, next year, we would be at the low end of the revenue CAGR of 16% to 18% that we talked about at our Investor Day. And while we’re not providing specific guidance on revenue for next year, directionally, your math computes."
},
{
"speaker": "Matt Hedberg",
"text": "Got it. Okay. And then, maybe just one other. I think we’re all kind of looking at cRPO as a helpful metric, kind of judge the business as well. And I know you don’t guide to cRPO, but any sort of commentary on how that might trend into 4Q?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So, let’s start with Q3. The cRPO growth decelerated, mainly because of declining contribution from multiyear EBA deals that closed in fiscal ‘20 which are entering the final year of their term. That growth deceleration was in line with our expectations, and it’s something that we signaled on our last earnings call. We anticipate over time that the growth rates for cRPO and revenue will gradually converge over time. But also that that RPO growth rate is going to continue to be influenced by the timing and volume of EBAs. And so, given that Q4 is a big EBA quarter for us, that’s going to have a big impact on the growth rate next quarter."
},
{
"speaker": "Operator",
"text": "Our next question comes from Phil Winslow of Credit Suisse."
},
{
"speaker": "Phil Winslow",
"text": "Andrew, I just wanted to dig in a little bit on where you’re seeing those changes in the second derivative, particularly in the AEC side of the house. One of the things you talked about a lot is that as that Autodesk has solutions in different parts of the life cycle in the AEC world, planning, actually putting the nail on the wood, et cetera. When you look at those second derivatives, where did you see that in the life cycle? And how are you thinking about that in Q4?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So again, I want to make sure that we’re clear on some of these things. The business was very strong. And that second derivative was a slowing down of the acceleration that we were expecting to see coming into the second half of the year. So, it’s a slowing down, it’s not a decline. I just want to be super clear on that so that we can get all positioned on that. Now, in terms of where we think this is going to head out. We continue to think that these monthly active usage rates are going to continue to grow and that we’re going to continue to see increases associated with these things. We’re just prudently assuming that what we saw in Q3 continues into Q4 because based on what we wanted to see was like this uplift in monthly active usage at a higher rate than what we saw, it’s probably a safe bet to just assume this is going to coast into Q4. If something changes, if these pressures start to relieve and start to relax, we could absolutely see an improving environment. But the business is strong. The renewal rates are strong. The underlying fundamentals of the business are strong. The net retention revenue -- rates are strong. The slowdown was rather broad brush, except for the country-specific issues that we highlighted in China. So, there was no one product area that saw a slowing. But I want you to note something pretty important here. Look at the competitive position that we came out of this year, particularly in manufacturing and other places. We’re growing much more robustly than any of our competition in the space. It’s just we have high expectations and we wanted to see some of those high expectations fulfilled. So, that’s how we view this right now, and that’s how we’re viewing it heading into the rest of the year. Does that answer your question, or did you want to clarify something?"
},
{
"speaker": "Phil Winslow",
"text": "No, no. That’s helpful. Thank you. And then, also just help me drilling just in the markets by geography. I mean, obviously, we have the reported numbers, but anything you’d sort of call out within that whether it be by vertical, by geography, or how you’re thinking about Q4? And then, I’ll go back in the queue."
},
{
"speaker": "Andrew Anagnost",
"text": "The one thing I’ll just highlight, say, we talked about the softness in China that was specifically in AEC. We actually did well in manufacturing in China. So softness was not uniform in China across all of our businesses. But in general, what we saw was a kind of a broad-brush impact. So I couldn’t point to onesie-twosies in any particular country that was kind of different or offset from anything else we were seeing. It was kind of a broader impact in kind of the slowing down of the acceleration that we saw."
},
{
"speaker": "Operator",
"text": "Our next question comes from Joe Vruwink of Baird. Your question, please?"
},
{
"speaker": "Joe Vruwink",
"text": "I’m curious, is the persona of customer that you think about as being kind of key to Autodesk new business growth. Is that customer more susceptible to some of the macro issues you’re calling out? If I’m understanding all the detail right, the established base is growing nicely. There is moderation on the incremental growth. So, I suppose a question might be, are the risks of the latter starting to impact the former and starting to maybe trickle into the installed base at the same time."
},
{
"speaker": "Andrew Anagnost",
"text": "That’s not what we’re seeing. If that’s what we were seeing, the net revenue retention rate trend that we saw during the quarter would have been different. So, I want to focus you back on. Remember, we came at the high end of our range on net revenue retention. And what that does is it shows a strong -- a kind of a strong affinity and willingness to keep upping their game with regards to our products and offering. And that does not often, okay? If anything, that’s continuing to strengthen. So, that feels really good. So, there’s really -- it really was affecting the new book of business, which kind of bleeds into the long tail of our business at some point into some level, which is to be expected in environments like this. Those who are most cash flow constrained, tend to slow their buying down the most. So, I don’t see any bleed over potential. In fact, in a lot of our newer businesses, we saw robust growth associated with some of these things. So, I do not see a crossover or a bleed over between these things. In fact, we continue to expect continued strengthening of net revenue retention rates in the base."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. That’s helpful. And then, on the supply chain topic. This was addressed at the Investor Day as maybe being a risk area, but also an opportunity perhaps for technology adoption. Even recently, it seems like engineering firms are acknowledging that hiring support bigger backlogs might be tough, but technology, again, could be an opportunity. So, I guess, the question is, how do you think about the new seat contribution for your growth algorithm in the context of double digits being sustainable? Would you expect a bigger contribution from the application and content side of the growth model and how to think about seats, given the current macro backdrop?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, we absolutely think that we continue to see digitization tailwinds here. Okay? Customers are absolutely turning to technology to wrestle with some of these problems and solve some of these things. And if you look at the strategy around double-digit growth and where we’re going, you see a lot of things working. First off, let’s just pause, and I don’t want to say this too many times, but the business is doing strong and that’s setting a floor on some of our growth. Also, I wanted you to notice some of the things that happened with noncompliant revenue. We grew 50% year-over-year, reflecting the compare to kind of the slowdown we did in the COVID in the 2020 and around the pandemic, and we normalized the kind of like a 20-year -- 20% growth over the two-year period, which shows nice steady growth in some of these things. So, if you look at the business, you see a lot of things working really well. Now, if you look at the long-term trends that are going to contribute and be additive in terms of driving the double-digit growth, the digitization is there, the tailwinds continue, customers are telling us more and more, they want to go deeper, deeper, deeper in digitization. And we’re seeing strong adoption like for instance in construction with our largest EBA customers and some of our largest GCs. We’re seeing strong adoption of Construction Cloud or integrating Construction Cloud more deeply into some of these relationships. If you look at some of the incremental drivers we were talking about with regards to business model capabilities and some of the things associated, we’re continuing to see strong growth there in terms of new types of subscription models, noncompliant users. And then, when we talk about the long tail, while it’s really early days with the Flex model, and I want to make sure that we always say it’s early days with the Flex model. One of the things we’re seeing with Flex is exactly what we expected to see. We’re seeing a large percent of Flex business coming in is net new. Another chunk of Flex business coming in as these occasional usage buyers. People that classically bought network licenses previously. And another chunk of business where people trying and using more advanced products, products they weren’t going to use previously. Those trends are exactly the kind of trends we want to see with offerings like this. And as time goes on and we get more experience with Flex, we expect those trends to continue. So, all of the things that we’re pursuing to drive double-digit growth are working right now. And that’s what gives us confidence as we move forward into the FY ‘23, ‘24 and ‘25 and beyond, is that everything we’re doing right now is working. If something was showing softness or not working, then I wouldn’t have the confidence I have right now, but everything is working in terms of the things we’re pursuing. Is transient impacts that we’re seeing right now? They’re obvious. They’re systemic. Everybody is seeing them. You can measure them systematically in terms of what’s going on in These will pass. The question is when will they pass."
},
{
"speaker": "Operator",
"text": "Our next question comes from Sterling Auty of JP Morgan."
},
{
"speaker": "Sterling Auty",
"text": "Andrew, if you put yourself in the seat of the investor, we’re all seeing the headlines of the supply chain constraints, et cetera. But what, if you were an investor, would you be looking at to help us monitor to possibly get a handle on when some of these pressures are alleviating and your business is starting to inflect upward again?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. So, you’re asking me to kind of be the predictor of when some of these supply chain pressures are going to unwind. Look, I’ll tell you what we’re..."
},
{
"speaker": "Sterling Auty",
"text": "No. I’m not asking for a time. I’m asking for what are some of the data points that would signal that it’s getting better..."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. So look, one of the data points we look at is the cost of freight. Okay? So, for instance, people are -- the cost of freight has been going up and up and up as you’ve been seeing this capacity compaction with regards to moving things. So that’s one metric if you just sit there and look at and say, hey, if the cost of freight goes down, that’s a sign that flow-through and throughput is starting to soften up. That’s one thing that’s out there. Another thing is some of the costs of the core commodities that our customers do, I mean, take the wood. I mean, I know that sounds true, but the cost of wood in some of our AECs, it’s a big deal. Right? If your cost of wood or wood-based materials goes up 20%, 30%, 40% on a fixed bid contract, what is that doing to your ability to execute? So, you look at cost of freight, you look at cost of wood and the things associated with that and those have direct impact. The cost of any commodity going into manufacturing is going to have impacts. The last thing that I think is really interesting with regards to manufacturing is some of these chip shipments starting to loosen up and allowing people to kind of finish their machines and make sure that the electronics are actually assembled and together. So, these are some of the things that all of us can look at to see how things are going. The cost of freight being right up there, the cost of wood and commodities associated with building things being out in front. We’re going to continue to look at the monthly active usage because for us, that’s a predictor of people doing more with the products, and that will probably follow some of these other indicators changing. Does that make sense, Sterling?"
},
{
"speaker": "Sterling Auty",
"text": "It does. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, I’d like to turn the call back over to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Sorry. I was muted. I apologize. I’ll repeat myself. Thank you, Lateef. Thanks, everyone, for attending. We’ll look forward to catching up with you next quarter. If you have any follow-up questions, please do ping the IR team. In the meantime, have a very happy Thanksgiving and happy holidays. Thanks very much, everyone."
},
{
"speaker": "Operator",
"text": "And this concludes today’s conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 2 | 2,022 | 2021-08-25 17:00:00 | Operator: Thank you for standing by. And welcome to Autodesk Q2, the fiscal year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your host, VP of Investor Relations, Simon Mays-Smith.
Simon Mays-Smith: Good afternoon. Thank you for joining our Conference Call to discuss the results of our Second Quarter of Fiscal Year 2022. On the line with me are Andrew Anagnost, our CEO,0, and Debbie Clifford, our Chief Financial Officer. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investment. You can find the earnings press release, slide presentation, and transcript of today's opening commentary on our investor relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results, and related assumptions, acquisitions, products, and product capabilities, and strategies. These statements reflect our best judgments based on our currently known factors, actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K for important risk factors and other factors, including developments in the COVID-19 pandemic, and the resulting impact in our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or viewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numerical growth changes as we discuss our financial performance and, unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or EXL financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. I hope you and your family remain safe and healthy. As we anticipated when we set out our guidance at the beginning of the year. Unwinding uncertainty resulted in increased business confidence, investment, and economic growth during our second quarter. This is reflected in strong product usage, which returned to pre - COVID levels across the globe increasing bid activity on Building Connected, which reached all-time highs, and greater channel partner confidence when combined with strong execution, a resilient subscription business model, and the continued secular shift to the cloud, our growth accelerated again in Q2 and generated further momentum //. RPO and billings grew 24% and 29% respectively, driven by strong new product subscription growth, renewal rates, and revenue retention. I am proud of what the team has accomplished so far this year. And again, I thank all of our employees, their families, our partners, and customers for their continued dedication, patience, and commitment. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. As Andrew mentioned, second-quarter results were strong. Several factors contributed to that strength, including robust growth in new product subscriptions, accelerating digital sales, and improving subscription renewal rates. In addition, [Indiscernible] and foreign exchange rates provided a modest tailwind of the quarter. Total revenue growth in the quarter accelerated to 16%, 14% in constant currency. With subscription revenue growing by 21%. Looking at revenue by product, AutoCAD and AutoCAD LT revenue grew 12%, AEC revenue grew 21%, and manufacturing revenue grew 12%. Excluding the impact of moving our bulk products to ratable revenue recognition, manufacturing revenue grew in the mid-teen’s percent, M&E revenue grew 10%. Across the globe, revenue grew 14% in the Americas, 16% in EMEA, and 21% in APAC. Direct revenue increased 31% and represented 34% of our total revenue up from 30% last year due to strength from both enterprise and e-commerce. As you'll hear more about at our Investor Day next week, about three-quarters of new customers Autodesk is now generated through our digital channels, reflecting our efforts to enable a simplified buying experience. Our products' subscription renewal rates remain strong and our net revenue retention rates remained within the 100% to 110% range. Billings accelerated 29% to 1 billion, reflecting strong underlying demand. And an easier comparison versus last year. Total deferred revenue grew 15% to 3.3 billion. The total RPO of 4.14 billion and current RPO of 2.85 billion both grew 24%. Current RPO growth was driven by strong new product sales during the quarter and the ongoing benefits from the record number of EVA s signed in the second half of last year. Excluding the contribution from Innovyze current RPO grew approximately 23%. non-GAAP gross margin remained broadly level at 92% while operating margin increased more than two percentage points to 31%, reflecting strong revenue growth and ongoing cost discipline. We delivered a healthy free cash flow of 186 million during the quarter, primarily driven by strong billings, growth. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash to offset dilution from our equity plans. During the second quarter, we purchased 164,000 shares for 46 million at an average price of approximately $283 per share. Year-to-date, we have repurchased 679,000 shares at an average price of approximately $278 per share for a total spend of $189 million. Now, I will turn to guidance. Consistent with the previous quarter, we expect that an improving economic environment during the year will result in strong growth in new business over the course of fiscal '22. We expect product subscription, volume, and renewal rates to continue to be healthy, and our net revenue retention rate to remain between 100% and 110%. With our strong start to the year, we are raising the low-end of our full-year revenue guidance to a range of 4.345 to 4.385 billion with the midpoint growth rate of 15% year-over-year. We're also raising our non-GAAP operating margin outlook to approximately 31%, and almost 2-point improvement from last year. Our strong start to the year means we're also shifting more of our EVA customers from multi-year paid-up-front to annual billings, which is good for them and good for Autodesk. Our EVA customers retained price certainty with a multi-year contract term, but annual billings give them a more predictable annual cash outlet. For Autodesk, we generate a more predictable cash flow and remove the discounts to generate upfront cash collections. While we had already assumed this change in fiscal '23, it has a modest impact on fiscal '22 billings and free cash flow. However, we expect it to drive more predictable free cash flow growth and better price realization over time, which will make Autodesk a more valuable Company. The shift of more of our EVA customers from multi-year paid upfront to annual billings and FX account for the change in our fiscal '22 to billings guidance and, with a one-time M&A related tax charge, our free cash flow guidance. As we look ahead, we're anticipating revenue growth to accelerate in Q3. Strong upfront revenues in Q4 last year and, with Vault now ratable, a smaller pool of non - ratable products create a tougher comparison in Q4 this year, which will reduce revenue growth a bit when compared to the third quarter. Also, our EVA strength in the second half of last year, including two of our largest-ever deals in q3 will impact RPO growth comparisons in the second half of our fiscal '22. The slide deck on our website has more details on modeling assumptions for the third fiscal quarter and full-year fiscal '22. As I shared last quarter, my initial focus after rejoining Autodesk was digging into our fiscal '22 budget and fiscal '23 financial goals. The strength we've seen in fiscal '22 combined with the significant cohort of multi-year products subscription contracts that we expect will renew in fiscal '23 set us up nicely to achieve our fiscal '23 revenue growth potentials and free cash flow goal. This past quarter, I turned my attention to our long-range financial plan with a particular focus on fiscal '24 and beyond. You'll hear more at our Investor Day next week but to set the stage today, our long-term strategic growth drivers and our flexible subscription business model give us the confidence we can achieve our goal of sustainable double-digit revenue and free cash flow growth beyond fiscal '24. Now, once we've achieved our fiscal '23 goals, we'll give you more details on our financial ambitions for fiscal '24 and beyond. But on the whole, we believe we have many exciting opportunities to drive growth by further expanding our addressable market into areas like construction and infrastructure, as well as by deepening the monetization of our user base. And we look forward to sharing more specifics with you at our Investor Day next week. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Now, let me turn to our strategic growth initiatives. Sustained and purposeful innovation to enable digital transformation in the industries we serve is changing our relationships with our customers. From software vendor to a strategic partner. And that is enabling us to create more value through end-to-end cloud-based solutions that connect data and workflows and business model evolution. By helping our customers grow, we will grow too. In AEC, digitalization trends are accelerating the need to connect all phases of design and construction with end-to-end cloud-based solutions. A great example this quarter was with an Asia-Pacific semiconductor manufacturer which is rapidly expanding its manufacturing capacity around the world. And looking for help to drive more efficient collaboration across projects stakeholders, as well as shorter design and delivery cycles. It invested in AEC collections to accomplish this goal and is now leveraging the power of Bim and our digital AEC workflows to achieve its expansion plan. This is a prime example of how Autodesk is positioned to help our customers as industries converged with this customer being a long-time user of our manufacturing products and now expanding its footprint with us in AEC. In construction, we believe the Autodesk construction cloud is the best end-to-end offerings across all phases of the construction lifecycle. Starting with our industry-leading pre-construction offerings. We help our customers seamlessly convert data into a construction plan, allowing our customers to condition and coordinate models early to aiding class detection, easily quantify the materials required for future construction, and leverage our Building Connected community to power the bidding process. As we turn to the field, Autodesk Build provides a single integrated solution for project management, field collaboration, quality, safety, and cost control, which is easier to deploy, adapt, and use. We just launched it in February, but we're already, we've already seen Autodesk Build in use on more than 11 thousand customer projects around the world by connecting project information and team. In one Common Data Environment and enables efficient collaboration while providing predictive analytics and insight that increased quality and safety while decreasing risks. As I mentioned earlier, we've transitioned to being a strategic partner to our customers, and in construction, that means evolving our business model. We provide. customers have more choice in how they buy. We offer both user and account-based pricing, which gives our customers the flexibility to decide how they want to engage with us on their digital journey. With our account-based pricing model, we're seeing significant benefits, driving as many users as possible to our construction platform. Once [Indiscernible] bills have been deployed on a project, we've made it frictionless for anyone involved in the project to get access to our platform within [Indiscernible]. This pattern is not unlike the evolution of Fusion 360 over the last few years. The more users we see on our platform, the more we learn, the better we make our products, and the more value we add to our customers. This quarter Metric construction, a top, E&R 400 general contractor in the U.S selected Autodesk Build for project management over competitive offerings. Pype per submittal management and BIM Collaborate Pro native class detection. As Andy Burd from Essar Construction said, "Autodesk Build comprehensive unified platform is industry-leading and by seamlessly connecting design with construction to increase our efficiency establishes a strong partnership foundation and further enables us to build better lives for our customers, communities in each other." Autodesk builds momentum is growing internationally to Stamm house is a leading retail shop construction and renovation Company in the Netherlands, which had already used AEC collections in general designed to optimize client retail space, reduce design and construction errors by 15%, and improve its ROI by 10%. This quarter, it invested in Autodesk Build a further increase efficiency, reduce waste, and add value for its clients by converging workflows from conceptual design to engineering and fabrication, while seamlessly collaborating with its clients. Our relationship with Stamm house demonstrates the value that digital construction processes can bring to customers around the world. With our significant international experience and resources, we're well-positioned to capitalize on this large growth opportunity. And we continue to invest to connect and converge adjacent industries to create value and help our customers achieve greater efficiency. During the quarter in advises info 360 cloud platform. We launched a beta version of info 360 assets, a cloud-based tool for the water industry is conditioned and performance monitoring and risk management processes. We also launched this Tandem digital twin program focused on harnessing the data from the design and construction process to create a repeatable and dynamic process with digital handover being the natural output of the project lifecycle. Turning to manufacturing, we continue to see strong momentum with our manufacturing portfolio this quarter, and we also saw the inclusion of Up chain in its first enterprise business agreement or EVA was one of our larger enterprise accounts. The convergence of design and make is accelerating, and we a0re seeing larger companies expand on our platform. For example, after using Fusion 360 and Moldflow to develop accurate digital manufacturing trends for injection molded parts, which is typically a very iterative, time-consuming, and expensive process; one of the largest American multinational medical devices at pharmaceutical companies renewed and expanded its EVA with us this quarter. They were able to significantly reduce the time and rework costs because they could anticipate, predict, and correct manufacturing issues before moving and production. We continue to see subscription growth for Fusion 360, with paying subscriptions now at 165,000. And the Fusion 360 extensions are helping to increase our average revenue per subscriber, and capture more potential opportunities. Turning the quarter, a U.S.-based global leader in the design, engineering, and manufacturing of woven wire mesh products, transitioned to Fusion 360 as their main design tool and invested in our manage extension. The combination of Fusion 360 and manage extensions has largely automated their design and change workflows, brought a new level of organization and efficiency from product design all the way through delivery. Our presence in education continues to expand to address the critical shortage in skilled labor. For example, a growing number of large German companies are replacing competitive solutions, and our training there and premises on Fusion 360 to prepare them for the future of work. In the second quarter, Energie Baden-Wurttemberg AG, EnBW, one of the biggest utility companies in Germany with 25 thousand employees, adopted Fusion 360 to train its 600 apprentices. EnBW and its apprentices will benefit from the Fusion 360 cloud collaboration platform serving all their CAD, CAM, and CAE needs while they are either on-site or remote. Education remains an important market for us. And we continue to broaden our reach with more than 43 million tinker CAD and Fusion 360 education users. We continue to make progress, transitioning all of our users had named users, giving customers more visibility into their usage data, and allowing us to better serve our paying customers while also making it harder for non-compliant users to access our software. The level Group is a full-cycle developer which specializes in business class complexes. During the quarter, it increases investment with Autodesk by consolidating all of its single and multi-user subscriptions and permanent licenses to collect. Trends with our premium plan and Autodesk Docs to enable more efficient collaboration and license management. And with the help of 247 technical support and a single sign-on capability level Group expects reduced design costs in the future. As our existing paying customers navigate the complexity of digital transitions, we can help them manage that complexity, improve efficiency and sustainability, and remain in license compliance. For example, one of the leading construction civil, industrial, and infrastructure service contractors in Vietnam invested in AEC collection and audited bills to balance project safety, efficiency, and quality, while also reducing environmental impact in waste. Our license compliance team helped them identify licensing gaps and ensure the installation of compliance software. We estimate that there are about 2 million non-compliant users within our paying customer base. During the quarter, we Closed 11 deals over $500,000 with our license compliance initiatives, 6 of which were over a million dollars. At the end of September, we will launch a new pay-as-you-go consumption model, called Flex. It matches the customer's cost with their usage. Flex is an important new way to purchase from us as we evolve our business models to offer more choice and flexibility. It serves the long tail of customers who want an option for occasional users that do not use subscriptions every day. It also lowers the barrier to entry for existing and new users to explore new products with minimal risk and upfront costs. And back to where I started. Sustained and purposeful innovation to digitally transform the industries we serve, is also transforming our relationship with our customers. From software vendor to a strategic partner. And enabling us to create more value for them through end-to-end cloud-based solutions, business model evolution, and connected data and workflows. By helping our customers grow, we will grow too. The pandemic has accelerated these trends and climate change is increasing the urgency. We will continue to invest to rise to the challenges ahead and seize the opportunities they present. In the meantime, we remain on track to achieve our fiscal '23 goals. Please join us at our virtual Investor Day next week, where we will have more time to share our strategic initiatives with you. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions]. Please stand by while we compile the Q&A roster. Our first question comes from the line of Saket Kalia of Barclays. Your line is open.
Saket Kalia: Okay, great. Hey guys, thanks for taking my questions here. Maybe just to start with you, Debbie, I'd love to dig a little deeper into the changes to billings and free cash flow this year. And maybe specifically, I was wondering if you could just help frame the size and impact of that change to EVA billings. And maybe as part of that, just talk about what sort of gives you the confidence in what's maybe just a little bit of a steeper ramp in cash flow growth now, implied for next, next year. Does that make sense?
Debbie Clifford: It does. Thanks. Saket. Thanks for the questions. So, we're seeing overall strength in the business and we continue to demonstrate discipline with our spending. So that's what's driving us to raise our guidance for revenue and margin for the year. For billings and free cash flow. I have covered the specifics in the opening commentary. The key point to take away is we're focused on making changes that are good for our customers and good for us, and shifting more EVA to annual billings helped us achieve that goal. Now, it makes sense. Customers because they retained price certainty by signing multiyear contracts, that by moving to annual billings, they get a more predictable annual cash outlay. Of course, the change is good for us too. We generate more predictable annual cash flows and we remove the discounts we see today to generate cash collections upfront. Most CBAs are already on annual billing terms. And also, we had already assumed that would all be on annual billing terms starting next year in our fiscal '23, we're making the change now because with the strong start to fiscal '22 we decided to get moving earlier to execute on the shift. But the overarching driver is that we're focused on optimizing our business and the change, as we said, is good for both our customers and for us. As a side note, the impact on our billing’s guidance is also pretty small. It's around a 1% point of impact to the total billings outlook. Now if I shift attention to the ramp to fiscal '24, we do see accelerating momentum and multiple drivers of growth regarding multi-years. I want to break it down a bit. We have two main pools of multi-years one for our EVAs and one for our base products subscription business. What I've talked about today so far is EVA and the ongoing shift to annual billings for that cohort. As we look ahead to next year, as I mentioned in the opening commentary, we have a material cohort of multi-year contracts that are coming up for renewal in our base products subscription business, renewing those contracts is one factor that drives us to 2.4 billion in cash flow next year and year-to-date this year, the proportion of multi-year renewals that we're seeing in that cohort is in line with our expectations. To that plus the strength in our topline year-to-date gives us confidence in the past to the 2.4 billion free cash flow target next year.
Saket Kalia: Okay, got it. That's very helpful. Andrew, maybe for you, just zooming out a little bit, a little bit more broadly. You talked a little bit about, in your prepared remarks and the press release, I think, you talked about sort of growing as your customers grow as well. And I think you've talked about some examples in your prepared remarks also. but I was just wondering if you can expand on that a little bit and maybe just connected back to the flexibility of the business model if you will.
Andrew Anagnost: Saket, specifically, what I did say was I said is as we help our customers grow, we will grow. And the reason I want to highlight that particular point here is a lot of the things that are going on with regards to us growing with our customers, is there increasing investment in digitalization. This is here to it's here to stay, it's continuing to accelerate. It's going to move forward next year and continue to accelerate. So, the digitization engagement with our customers is why we grow as we help them grow because digitization is going to help them grow. it's going to help to be more responsive. It's going to help them win more business. It's going to help them do a whole bunch of things that they were struggling to do previously, which is great for them and great for us. Now, the other thing I'd add there is we are also responding to the way they want to buy. I mean, I think you've noticed that we introduced Flex. We haven't rolled it out yet, that customers can't yet buy it, but we introduced the concept of Flex. And Flex is something that a lot of our customers have been waiting for as we've been moving away from our old multi-user paradigm to single-user. They've been waiting to see something that allows them to manage occasional use and maybe dive deeper into some of our more advanced digital technologies and integrate some of those things into their workflow. So, we're going to offer them the flexibility they've been looking for and we're going to mainstream and across a lot of our customer base in the mid-market. But the other piece I want to highlight about Flex, in particular, is that it's also a tool for reaching the long tail of our customers. Flex is going to allow us to not only help with smaller businesses that knew some of our tools, only a couple of times a month, but it's also going to help us with smaller customers or departments within larger customers that want to use a particular advanced tool on an occasional basis. It used to be back in the '90s when books like the long tail first came out that you'd attack the long tail with a set of discrete products. Tons of little products. The 2020 way of approaching that is having a business model that allows people to get access to a set of capabilities in an ever-growing platform of products, like what we're doing with Fusion. So, look for those things long-term can be important tools as we see forward. Things like Flex are not going to be short-term revenue drivers but they will be long-term like there. Digitization is the key underlying thing here. Our business models, and the way we are approaching some of our advanced platforms, are the enablers that allow our customers to digitize faster.
Saket Kalia: Got it, makes sense, thanks, guys.
Operator: Thank you. Our next question comes from Adam Borg of Stifel. Your line is open.
Adam Borg: Hey guys, and thanks so much for taking the questions. Maybe for you, Andrew. So, I'm sure we'll talk more on the broader strategy next week, but you've been very clear around this idea of convergence for some time, and earlier in the quarter there was the idea of converging mechanical CAD and electro CAD. How should we think about that going forward? And are we looking to do that more on the organic front with the Eagle or potential strategic partnerships or acquisitions, how should we think about that?
Andrew Anagnost: Yes. So excellent question. This convergence peace between mechanical design and electrical design is something we've absolutely had our eye on for quite some time. As you know, we bought Eagle several years back and we have now tightly integrated it into the Fusion platform. And we're doing some very, very interesting things around automation. And immigration between electronic PCB design and the associated mechanical designs that either contain it or actually interact with it in a smart product. So, we're already attacking that convergence organically with our products. You saw us look externally as well because we saw an opportunity. Did you accelerate the industry change? We believe these positives are going to converge. We believe the leading-edge customers are going to be driving and using converged processes. And we saw a vision match out there and we engaged in discussion around accelerating this change in the market. We're still going after that market with Fusion with Eagle and We have, and we're already moving up into the mid-market with some of these tools. So, this vision is not going away. This is a continuing and ongoing place for us to focus. And look for us to continually increase what we're doing with Eagle to make those convergences between mechanical and electrical design more fluid, more integrated, and frankly, more automated.
Adam Borg: That's really helpful. And maybe just a quick follow-up. So just staying on the Fusion 360 intimate manufacturing front, you've talked about in the past, a lot of success with Fusion 360, even in CAM space, replacing vendors like master CAM, and just curious if today's announcements of that getting acquired can help accelerate the opportunity or change the dynamics competitively in some way, thanks again.
Andrew Anagnost: I think one of the things you also saw is that got acquired there was a lot of visibility into the master camp business. And I think you can see that the business was not growing let's say, robustly as say Fusion is growing both from a user and billing standpoint. So, we're pretty confident that in the manufacturing side and the CAM side, we're doing a great job with Fusion. But we're also reaching deeper and deeper into people's entire process. A lot of the customers we're talking about publicizing out are people that have rolled out fusion across the entire process. One of the things that's also exciting, you're seeing these large subscription counts, 11,000 again -- breaking 11,000 again this quarter, but one of the other exciting aspects here is that our billings growth is actually growing faster than our subs growth, which is a result of the new extension strategy, which has continually added more. Good, a more advanced capability that people can buy on a pay-per-use basis or on a subscription basis to one of these extensions. So, we're continuing to see really good traction with Fusion. We're continuing to roll out new extensions. You will see more extensions coming out this year into next year, and you will also see us start to do some interesting new ones. Things from a platform perspective with Fusion as well. So, we're pretty bullish on Fusion. We feel pretty good about our position right here and we're continuing to see growth. And, and you're right, I think the acquisition of master Cam just shines a light on where the action is right now in this space.
Adam Borg: Excellent, thanks a lot for the color.
Operator: Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your line is open.
Jay Vleeschhouwer: Thank you. Good evening. Andrew. You mentioned that --
Andrew Anagnost: Got to get my pen ready for the three-part question. Okay. Pen's ready.
Jay Vleeschhouwer: Okay. So, you mentioned that usage is now at pre-pandemic levels. And the question it has to do with new products of volume. It's an easy comparison year-over-year versus last year. But would it be reasonable to say that the new products sub volume through the core of the business X EVA, X cloudy products XM2S is above levels of two years ago? And that our expectations for the remainder of this year, and I assume into next year, is that that will remain the case that you're now well above where you were two years ago in terms of that core product volume. And then similarly, for many years, LT was considered to be a good leading indicator, or barometer, of the business. Given the change in the profile of your product mix, your portfolio, plus the fact that order there seems to be encouraging full AutoCAD adoption in lieu of LT, you're clearly not encouraging LT. Is there some change in the barometers or indicators that you look to for the business?
Andrew Anagnost: Yeah. Okay. Great question. So let me address the first part. I was only a two-part question, Jay, you've disappointed me.
Jay Vleeschhouwer: I knew you'd say that.
Andrew Anagnost: So new products have some -- new product have up significantly. I'm not going to give you a specific, I'm not going to tell you if it's exactly back up to 2 years, but let's just say it's up significantly. Okay. We can't -- we couldn't be delivering the kind of performance we are delivering if it wasn't. It's been significantly higher than the overall growth of the business in terms of new products out, and it's continued to robustly grow moving forward, and we expect it to continue. So, you can imagine that our volumes are getting back up to the places we would have expected them to be before COVID ever hit, which is a good sign and a good outcome. And more and more, as you can see in this quarter, we generated a lot of that new volume through digital direct channels and channels that were direct to us, which is another interesting factor here. You are absolutely right. It used to be that LT, because of the price point and because of its exposure to small businesses, was a barometer of the health of our business. But the move to the subscription model is kind of scrambled out a little bit because people may have been buying LT exclusively for something or buying different products and other things like that. So that's why we began tracking in a deep way the monthly active, daily active users of our products in various countries, which has become, frankly, our core barometer. And I think you can agree that that is a much more robust indicator of the health of our business than, for instance, looking at LT sales and LT transactions.
Jay Vleeschhouwer: Okay
Andrew Anagnost: And it's also interesting to note, as commercial usage surges forward, [Indiscernible] non-compliant users, almost I [Indiscernible]. Right. So, it is not to disappoint you, but let me just ask you this. You made [Indiscernible] I knew -- here comes part three. Yeah, here we go. Exactly. You made a very interesting reference to a semiconductor facility in Asia that has become an AEC customer. And so, the question there looking ahead is, when you think about what Intel's going to be doing with [Indiscernible] and others in the semi-industry.
Jay Vleeschhouwer: If you looked at data center build-out and electric vehicle build-out, those are all mega commercial facilities. Do you do what's your pipeline looking like for any or all of those?
Andrew Anagnost: That's a very excellent point, Jay. All right. So, we're already big in the data-center pipeline. Dan is supercritical of some of these workflows. I have personally engaged with customers that I will not name and aim and see some amazing things they are doing with our tools on the data center front and on the factory front. So, we are actively engaged with deepening the penetration of them in all of those areas where people are standing up new factories and people are building new capacity. And you're right to talk about fab capacity for Intel and other places like that, then has matured to a point where when you combine especially not only with the capabilities of design and build, but ultimately you will see Tandem play a role in that space as well because Tandem as a digital twin allows us to do a handover long term, not yet, Tandem's relatively new to the market, but a digital handover to the owner for doing the lifetime management of the asset as well. So, look, that pipeline is robust and strong where we're already a big player in datacenter and new style factory stands ups in several sectors.
Jay Vleeschhouwer: Great. Thank you very much.
Operator: Thank you. Our next question comes from Gal Munda of Fanberg. Your line is open.
Gal Munda: Thank you for taking my question. And the first one is just around the way you are thinking of multi-year offerings going forward. We're carrying the -- towards the end of the year, you even in the product side, you're thinking about decreasing the discounts potentially. Is that something that could have an implication beyond the EVA, also going into product subscriptions to have lower multiyear going forward, or is there just something that you managing cash flow as we have been [Indiscernible], which is a big cohort of [Indiscernible] like you said?
Debbie Clifford: Thanks, Gal. I'll say again, our goal is to do what's best for our customers and what's best for us. You're right that we recently announced that we're reducing the discount on products subscription, multi-year contracts from 10% down to 5%. And we're doing it because we feel that the higher discount as necessary, the value proposition of a multi-year contract to our customers is the price certainty, not the discount. Of course, we benefit from the lower discount because we get higher price realization. But at the end of the day, the multi-year contracts reflect the strategic longer-term partnership with our customers. Now, we make small price changes like that all the time in order to optimize our business and to maximize the value for both our customers and for us. And this is just one example of that.
Gal Munda: I got you. That's really helpful. And then just the second question, we haven't had much about the network licenses and how the kind of the transition is going. What we started in the past over the last year, that obviously the first ones to hand them over, we're the ones that had entitlement that basically give them maybe more under the 2 for one or 1 for 2 effectively they give them more licenses than they need and the others will come later. Are you starting to see that tip of the iceberg effectively when it goes to the other way where people that are handing in their network licenses now are -- that's 2 for 1 exactly? Or even need to take extra entitlement in order to be compliant?
Andrew Anagnost: Gal, we are absolutely starting to see the tip of the iceberg on that part of the transition. And also Flex, which is something that a lot of those customers were waiting for because those customers were heavy users of our network licensed model, Flex in one of its forms replaces that old model. So, we're -- as Flex starts to reach the channel and reach the customers more directly, you're absolutely going to see a greater acceleration of that. Because they do have to ultimately transfer a name to every user to use Flex. But we're seeing the tip of the iceberg on that right now. Flex's availability -- broader availability as we move to the end of this year and into early next will also accelerate that trend as well, which will help us retire that old business model and get our customers on the more advanced management systems that underpin Flex.
Gal Munda: Got you. That's really helpful. Thank you so much, I appreciate it.
Operator: Thank you. Our next question comes from Matthew Hedberg of RBC Capital Markets. Your question, please.
Matthew Hedberg: Great. Thanks, guys. Andrew, I want to start with you. Given the U.S. federal infrastructure spending bill, one of the most often asked questions I get is really your exposure to infrastructure spending. I'm wondering is there any way that you can help, just roughly frame up the magnitude of that business. Or even perhaps how fast is it growing relative to your overall portfolio of businesses?
Andrew Anagnost: Yes. So, we don't break out the infrastructure of a business, so I can't give you a specific, but here's one of the things -- here's what I can tell you, and here are the philosophical statements I can make enough. One, we do not have any impact from a federal infrastructure bill built into our financial models, okay? So, the numbers we've given you, the concept, they're all business as usual based on our normal course and speed. So, I want to be super clear about that so we're all on the same page. However, we are big proponents of infrastructure spending and the need for infrastructure spending. And I think you're getting a sense just over the last few weeks and the last month, some of the critical drivers around what -- how serious it is when you have a decaying infrastructure. Look at California, right? California built water infrastructure for slow snow melts to catch water and have it dribble down from the melting snow and runoff to the coast and everybody was happy. That world is likely gone. And what people need to focus on is more reservoirs, different types of infrastructure to capture rainwater rather than rely on snowmelt. These were things that in some cases we're predictable 10 years ago, but we haven't made progress on. Also, look what's happening in Tennessee. Just last week, the horrible tragedies with these flash floods in the middle of Tennessee. Unprecedented levels of speed and severity of floods are all related to water infrastructure. All of these things are related to climate change. Some of them were predictable, some of them not. All of them are 10-year backlog now in many places. We have to build better across the board and we believe that our tools, our capabilities, the digital platforms we're deploying are going to help people build better. And when you look at how we're positioned to capitalize on this, which I can talk to you about. Look we have got the solution that goes from end-to-end with the capital planning engagement all the way to the user engagement with the vertical and horizontal components of construction and is in between. And I want to point to you some of our recent partnerships and acquisitions. On-road and rail, we partnered with Orgo to go after the Department of Transportation to help with the capital planning. We brought in a device that has the capital planning tool upfront in the water infrastructure process. And we also have a space maker, which we haven't talked a lot about, which helps in the real estate development side from the capital planning and allocation there. So, we're actually building out capabilities upfront through partnership and through technology. And then we have all this capability that we've integrated into the construction cloud as well to help with vertical and horizontal construction. So, we're ready. We're -- we've invested in the places that we think are critical and we think people need to invest in digital technology to not only to build what needs to be built but build it back better and build it back cheaper so that we can start closing out the backlog because there is a big backlog. So, there will be an opportunity here. It will be a long-term opportunity for the Company. It won't be short-term, but there will absolutely be an opportunity as people start to spin up these infrastructure projects.
Matthew Hedberg: That is super comprehensive. And as a sidebar, yes, it does feel like your acquisition of Innoviva's given the wording of the bill on the water was certainly timely. I wanted to go back to manufacturing just with another question. You noted in prior calls that Fusion 360 is near a tipping point and then another question on M-CAD and e-CAD, I'm just curious though, from a philosophical perspective, what's left for you to do within your manufacturing portfolio. In other words, is there much more white space left beyond what you've got, to sort of kind of getting a sense of where we're at in that sort of platform maturation?
Andrew Anagnost: Yes. So, there's always a little white space, okay? I think one of the things that are really important in terms of things we have to do. We have to finish integrating all the end-to-end capabilities, all right? We have to make sure that we've gotten all the capabilities completely integrated in a way that makes sense. We have to continue to dial down on things like general design and cloud-based and machine learning-based automation that automate workflows between some of these things. So even less sophisticated companies can take full advantage of highly sophisticated capabilities, which is a goal for us. Now, there's going to be another white space as we move down with regards to connecting to production planning. But on the shop floor not just moving geometry directly to the machine through general divine, but actually managing production flow and some of the things associated that in highly automated facilities. So, we'll probably explore some of those areas as we start building out the platform. But really, in terms of what things have to happen to continue to accelerate fusions growth, it's all about building out the core design capabilities because you've got a lot of touch points in there. We've got ReCap, we've got some really great partnerships around simulation which will deepen over time, and we've also got excellent manufacturing capabilities. As we deepen in to professionalize the design capabilities, you'll start to see more and more purchasing of sophisticated extensions on top of Fusion. So, look for Fusion to become a more significant revenue driver as we move beyond FY '23. Right now, we're focused on making sure that the platform's best-in-class, that that's cloud independence is strong, that we build off the strong foundation we have right now, and that we build out some of these core design capabilities. But there are little bits of white space in there around production management, around some of the integration s with other types of capabilities, around costing and estimating that is going to be interesting as well in the future.
Matthew Hedberg: Super helpful, thanks, guys.
Operator: Thank you. Our next question comes from Joe Vruwink of Baird. Your line is open.
Joe Vruwink: Great. Hi everyone. I wanted to start with the performance and the direct channel efforts. Obviously, you've had a goal to achieve 50% revenue share but it seems like in the last several quarters, it's just the movement to that level has accelerated a bit. Are there specific things you would maybe point to recently that help explain some of the acceleration? You've brought up enterprise and the e-store, is maybe one response more than the other? And how much is this factoring into the confidence you speak to entering the second half of this year?
Andrew Anagnost: Yeah. So, I think Debbie and I will both tag team just a little bit okay. So let me just talk about this at a high level. Some of these things are cyclical, by the way, okay? So, there will be quarter-to-quarter variations here. The fastest-growing channel we have in our business is the digital channel, all right. And more and more of our products, especially new products, especially for small businesses, are being [Indiscernible] as that channel. It's a big driver, and we've seen some acceleration there and we continue to see acceleration there. It's a very healthy channel and this is what we expected. We're certainly also being successful in our EVA business, which is driving up the percentage in certain quarters. But don't look for that to be a linear transition. We're going to get to the 50, it's going to take time. But there'll be some quarters where we're trending up, other quarters where we're trending a little bit down. But overall as you fit the line through over multiple years, it's going to be heading up in the right direction. There are some countries where we're getting very close to 50-50. and other places where we're very far away from it. So, you have to look at the business a little bit more discreetly as we get there, but don't look for this to be a straight line. Debbie, did you want to add anything?
Debbie Clifford: Sure. I think you captured it well, Andrew. As you said, there are two main parts. There's the enterprise or EVA business and there is our e-commerce channel. Now, the enterprise business is at a seasonal low in Q2, but we do have a strong pipeline. Andrew mentioned that it was the first quarter that we saw Upchain included in an EVA. So, we are building momentum and we anticipate that the bulk of our EVA selling will be in the back half of this year, like previous years. So, things are looking good there. On the e-commerce side, lots of growth there, we've been investing heavily. Last quarter, we talked about different things that we added, like more out of at -- added seek capabilities, more calls to action across the site. We continued to invest this quarter. Some examples of the changes that we made were our one-step resubscribe capabilities, so that expired customers can easily resubscribe. We have even more places for add a seek capabilities throughout the site, we launched a new Middle East site in June. So, a bunch of things and you'll just see us incrementally add more functionality, more ways to engage with Autodesk so that it's easier to do business with us. And that's going to be part of our success to drive growth through that channel.
Joe Vruwink: Okay. That's helpful. And then I wanted to maybe reconcile what sounds like a lot of strong trends and higher confidence in the second half. And still have the same high end of the revenue guidance, 16% growth intact for fiscal '22. Are there certain areas of the business where you look and it's still a bit held back, so it could be an opportunity for improvement over coming quarters, but maybe still not the full contributor that it could be?
Debbie Clifford: Oh, sorry, Andrew. And then you can chime in. I would say that, overall, we had a strong Q2 and we ended the quarter with strong momentum. And we raised our revenue guidance on the year to reflect that ongoing strength and what we've seen in the business for the year to date. Andrew mentioned all the leading indicators were strong, usage return to pre-COVID level, the construction backlog is back online. So, all we're seeing at this point is accelerating momentum. The only kind of knit piece that I would highlight in the back-half of this year is that typically in our Q4, we do see a bit more upfront revenue recognition for some of the products that we typically sell cyclically in that period, and that's a little bit of what you see in both Q3 and Q4 as we get to the back half of the year. But overall, just broad strength that we're seeing in the business and that led to the increase in the revenue guidance on the year.
Joe Vruwink: Okay. Great. Thank you.
Andrew Anagnost: Yeah. I think Debbie said it all.
Operator: Thank you. Our next question comes from Keith Weiss of Morgan Stanley. Your line is open.
Elizabeth Elliot: Hi, this is Elizabeth Elliot on for Keith Weiss. Thank you so much. I just have a few questions on the current RPO -based bookings growth, it looks like year-over-year growth slowed a bit from last quarter. So, wondering if you could just highlight some of what could be driving that and some of the trends that you are just seeing in new business demand versus what you saw maybe in the prior quarter. Thank you.
Debbie Clifford: So, thanks, Elizabeth. RPO growth was strong at 24% year-over-year and we really do see that as the leading indicator of what's happening in our overall business. Now, typically we see RPO, or what we see right now is that RPO growth shot up in Q4 because we had a very strong enterprise business agreement quarter. And so gradually, we're seeing that taper down over time. But overall, 24% growth is really solid performance in RPO when you'll start to see that bleed into revenue on the back half of the year.
Elizabeth Elliot: Got it. And then just one more ABI data for June noted some firms just weren't able to find enough from workers and not the challenge they've had talked about 60% of firms not being able to fill openings in the architectural staff. I was wondering if any issues in employment are a headwind for Autodesk, seats or are that a tailwind for you guys as firms just need to digitalize faster and improve productivity.
Andrew Anagnost: Sorry, can you repeat that question?
Elizabeth Elliot: Yes. The Architectural Billings Index data for June highlighted that some of the architectural staff, which having problems filling seats. And that being a headwind -- just employment being a headwind to sales from the demand capacity that they were seeing. So, I just wondering if employment headwinds in the overall macro marketing driving -- is that a headwind for Autodesk at all or is that actually a tailwind? As firms need to digitalize faster and improve productivity by adopting Autodesk software tool.
Andrew Anagnost: Okay, thank you. It's actually more of a tailwind because what our customers are struggling with is they're trying to do more with a smaller staff. And the more digital firms are able to do that, the fewer digital firms are struggling. The scarcity of labor is pervasive across multiple industries and multiple sectors. But we believe this is just another driver with regards to people adopting deeper digitization and digital technologies. And as you can see from the factor, some of our results and some of our new SEC volume. While you're hearing some of that in the ABI pressure with regards to their book of business, you're not seeing any kind of depressive impact in our new SEC volume. So, we expect long term this is going to be a tailwind around digitalization and not any kind of headwind for us.
Elizabeth Elliot: Okay. Thank you.
Operator: Thank you. Our next question comes from Jason Celino of KeyBanc. Your line is open.
Jason Celino: Hey, guys. Thanks for taking my questions. Nice acceleration on the mixing segment this quarter. And you mentioned that it was an all-time high for bid activity with Building Connected. Since Building Connected is kind of at the tip of the spear in terms of where they see visibility into the construction cycle, how should investors think about this engagement activity flowing through to the revenues?
Andrew Anagnost: I think you should think about it exactly the way you said it. It is a leading indicator of future on-site construction activity, all right? So not all of that activity will convert to people buying our construction tools. Because not all the activities are a good fit, but it is absolutely a leading indicator of shovels hitting the ground. And I think that's the way you should be interpreting it, and that's the way you should look at it. And that's the way we use it. And as we get deeper and deeper into Building Connected and deeper and deeper into how the bid board works, we'll be creating more internal indices to track and watch some of these things. But that -- what you said is how you should view this. It is a leading indicator of shovels in the dirt and future activities which some of that will translate into future purchases of on-site construction software tools.
Jason Celino: Okay, well, maybe to double-click on that a little bit. When we think about it from a timing perspective, or is most of -- any help you can share on the types and timing of projects?
Andrew Anagnost: No, I can't. I can't give you a lag indicator between increased bid activity on the bid board and the starting of new projects.
Jason Celino: Okay.
Andrew Anagnost: What that impact is.
Jason Celino: No words, but thank you.
Operator: Thank you. And that is all the time we have for Q&A. I'll now like to hand over the call to Simon Mays-Smith for closing remarks.
Simon Mays-Smith: Thank you. Latif. And thank you everyone for joining our Q2 fiscal '22 conference call. If you have any follow-up questions, please do contact the investor relations team and we look forward to seeing you all with our Investor Day on Wednesday, next week. Thanks very much. Goodbye.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by. And welcome to Autodesk Q2, the fiscal year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your host, VP of Investor Relations, Simon Mays-Smith."
},
{
"speaker": "Simon Mays-Smith",
"text": "Good afternoon. Thank you for joining our Conference Call to discuss the results of our Second Quarter of Fiscal Year 2022. On the line with me are Andrew Anagnost, our CEO,0, and Debbie Clifford, our Chief Financial Officer. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investment. You can find the earnings press release, slide presentation, and transcript of today's opening commentary on our investor relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results, and related assumptions, acquisitions, products, and product capabilities, and strategies. These statements reflect our best judgments based on our currently known factors, actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K for important risk factors and other factors, including developments in the COVID-19 pandemic, and the resulting impact in our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or viewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numerical growth changes as we discuss our financial performance and, unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or EXL financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. I hope you and your family remain safe and healthy. As we anticipated when we set out our guidance at the beginning of the year. Unwinding uncertainty resulted in increased business confidence, investment, and economic growth during our second quarter. This is reflected in strong product usage, which returned to pre - COVID levels across the globe increasing bid activity on Building Connected, which reached all-time highs, and greater channel partner confidence when combined with strong execution, a resilient subscription business model, and the continued secular shift to the cloud, our growth accelerated again in Q2 and generated further momentum //. RPO and billings grew 24% and 29% respectively, driven by strong new product subscription growth, renewal rates, and revenue retention. I am proud of what the team has accomplished so far this year. And again, I thank all of our employees, their families, our partners, and customers for their continued dedication, patience, and commitment. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. As Andrew mentioned, second-quarter results were strong. Several factors contributed to that strength, including robust growth in new product subscriptions, accelerating digital sales, and improving subscription renewal rates. In addition, [Indiscernible] and foreign exchange rates provided a modest tailwind of the quarter. Total revenue growth in the quarter accelerated to 16%, 14% in constant currency. With subscription revenue growing by 21%. Looking at revenue by product, AutoCAD and AutoCAD LT revenue grew 12%, AEC revenue grew 21%, and manufacturing revenue grew 12%. Excluding the impact of moving our bulk products to ratable revenue recognition, manufacturing revenue grew in the mid-teen’s percent, M&E revenue grew 10%. Across the globe, revenue grew 14% in the Americas, 16% in EMEA, and 21% in APAC. Direct revenue increased 31% and represented 34% of our total revenue up from 30% last year due to strength from both enterprise and e-commerce. As you'll hear more about at our Investor Day next week, about three-quarters of new customers Autodesk is now generated through our digital channels, reflecting our efforts to enable a simplified buying experience. Our products' subscription renewal rates remain strong and our net revenue retention rates remained within the 100% to 110% range. Billings accelerated 29% to 1 billion, reflecting strong underlying demand. And an easier comparison versus last year. Total deferred revenue grew 15% to 3.3 billion. The total RPO of 4.14 billion and current RPO of 2.85 billion both grew 24%. Current RPO growth was driven by strong new product sales during the quarter and the ongoing benefits from the record number of EVA s signed in the second half of last year. Excluding the contribution from Innovyze current RPO grew approximately 23%. non-GAAP gross margin remained broadly level at 92% while operating margin increased more than two percentage points to 31%, reflecting strong revenue growth and ongoing cost discipline. We delivered a healthy free cash flow of 186 million during the quarter, primarily driven by strong billings, growth. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash to offset dilution from our equity plans. During the second quarter, we purchased 164,000 shares for 46 million at an average price of approximately $283 per share. Year-to-date, we have repurchased 679,000 shares at an average price of approximately $278 per share for a total spend of $189 million. Now, I will turn to guidance. Consistent with the previous quarter, we expect that an improving economic environment during the year will result in strong growth in new business over the course of fiscal '22. We expect product subscription, volume, and renewal rates to continue to be healthy, and our net revenue retention rate to remain between 100% and 110%. With our strong start to the year, we are raising the low-end of our full-year revenue guidance to a range of 4.345 to 4.385 billion with the midpoint growth rate of 15% year-over-year. We're also raising our non-GAAP operating margin outlook to approximately 31%, and almost 2-point improvement from last year. Our strong start to the year means we're also shifting more of our EVA customers from multi-year paid-up-front to annual billings, which is good for them and good for Autodesk. Our EVA customers retained price certainty with a multi-year contract term, but annual billings give them a more predictable annual cash outlet. For Autodesk, we generate a more predictable cash flow and remove the discounts to generate upfront cash collections. While we had already assumed this change in fiscal '23, it has a modest impact on fiscal '22 billings and free cash flow. However, we expect it to drive more predictable free cash flow growth and better price realization over time, which will make Autodesk a more valuable Company. The shift of more of our EVA customers from multi-year paid upfront to annual billings and FX account for the change in our fiscal '22 to billings guidance and, with a one-time M&A related tax charge, our free cash flow guidance. As we look ahead, we're anticipating revenue growth to accelerate in Q3. Strong upfront revenues in Q4 last year and, with Vault now ratable, a smaller pool of non - ratable products create a tougher comparison in Q4 this year, which will reduce revenue growth a bit when compared to the third quarter. Also, our EVA strength in the second half of last year, including two of our largest-ever deals in q3 will impact RPO growth comparisons in the second half of our fiscal '22. The slide deck on our website has more details on modeling assumptions for the third fiscal quarter and full-year fiscal '22. As I shared last quarter, my initial focus after rejoining Autodesk was digging into our fiscal '22 budget and fiscal '23 financial goals. The strength we've seen in fiscal '22 combined with the significant cohort of multi-year products subscription contracts that we expect will renew in fiscal '23 set us up nicely to achieve our fiscal '23 revenue growth potentials and free cash flow goal. This past quarter, I turned my attention to our long-range financial plan with a particular focus on fiscal '24 and beyond. You'll hear more at our Investor Day next week but to set the stage today, our long-term strategic growth drivers and our flexible subscription business model give us the confidence we can achieve our goal of sustainable double-digit revenue and free cash flow growth beyond fiscal '24. Now, once we've achieved our fiscal '23 goals, we'll give you more details on our financial ambitions for fiscal '24 and beyond. But on the whole, we believe we have many exciting opportunities to drive growth by further expanding our addressable market into areas like construction and infrastructure, as well as by deepening the monetization of our user base. And we look forward to sharing more specifics with you at our Investor Day next week. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Now, let me turn to our strategic growth initiatives. Sustained and purposeful innovation to enable digital transformation in the industries we serve is changing our relationships with our customers. From software vendor to a strategic partner. And that is enabling us to create more value through end-to-end cloud-based solutions that connect data and workflows and business model evolution. By helping our customers grow, we will grow too. In AEC, digitalization trends are accelerating the need to connect all phases of design and construction with end-to-end cloud-based solutions. A great example this quarter was with an Asia-Pacific semiconductor manufacturer which is rapidly expanding its manufacturing capacity around the world. And looking for help to drive more efficient collaboration across projects stakeholders, as well as shorter design and delivery cycles. It invested in AEC collections to accomplish this goal and is now leveraging the power of Bim and our digital AEC workflows to achieve its expansion plan. This is a prime example of how Autodesk is positioned to help our customers as industries converged with this customer being a long-time user of our manufacturing products and now expanding its footprint with us in AEC. In construction, we believe the Autodesk construction cloud is the best end-to-end offerings across all phases of the construction lifecycle. Starting with our industry-leading pre-construction offerings. We help our customers seamlessly convert data into a construction plan, allowing our customers to condition and coordinate models early to aiding class detection, easily quantify the materials required for future construction, and leverage our Building Connected community to power the bidding process. As we turn to the field, Autodesk Build provides a single integrated solution for project management, field collaboration, quality, safety, and cost control, which is easier to deploy, adapt, and use. We just launched it in February, but we're already, we've already seen Autodesk Build in use on more than 11 thousand customer projects around the world by connecting project information and team. In one Common Data Environment and enables efficient collaboration while providing predictive analytics and insight that increased quality and safety while decreasing risks. As I mentioned earlier, we've transitioned to being a strategic partner to our customers, and in construction, that means evolving our business model. We provide. customers have more choice in how they buy. We offer both user and account-based pricing, which gives our customers the flexibility to decide how they want to engage with us on their digital journey. With our account-based pricing model, we're seeing significant benefits, driving as many users as possible to our construction platform. Once [Indiscernible] bills have been deployed on a project, we've made it frictionless for anyone involved in the project to get access to our platform within [Indiscernible]. This pattern is not unlike the evolution of Fusion 360 over the last few years. The more users we see on our platform, the more we learn, the better we make our products, and the more value we add to our customers. This quarter Metric construction, a top, E&R 400 general contractor in the U.S selected Autodesk Build for project management over competitive offerings. Pype per submittal management and BIM Collaborate Pro native class detection. As Andy Burd from Essar Construction said, \"Autodesk Build comprehensive unified platform is industry-leading and by seamlessly connecting design with construction to increase our efficiency establishes a strong partnership foundation and further enables us to build better lives for our customers, communities in each other.\" Autodesk builds momentum is growing internationally to Stamm house is a leading retail shop construction and renovation Company in the Netherlands, which had already used AEC collections in general designed to optimize client retail space, reduce design and construction errors by 15%, and improve its ROI by 10%. This quarter, it invested in Autodesk Build a further increase efficiency, reduce waste, and add value for its clients by converging workflows from conceptual design to engineering and fabrication, while seamlessly collaborating with its clients. Our relationship with Stamm house demonstrates the value that digital construction processes can bring to customers around the world. With our significant international experience and resources, we're well-positioned to capitalize on this large growth opportunity. And we continue to invest to connect and converge adjacent industries to create value and help our customers achieve greater efficiency. During the quarter in advises info 360 cloud platform. We launched a beta version of info 360 assets, a cloud-based tool for the water industry is conditioned and performance monitoring and risk management processes. We also launched this Tandem digital twin program focused on harnessing the data from the design and construction process to create a repeatable and dynamic process with digital handover being the natural output of the project lifecycle. Turning to manufacturing, we continue to see strong momentum with our manufacturing portfolio this quarter, and we also saw the inclusion of Up chain in its first enterprise business agreement or EVA was one of our larger enterprise accounts. The convergence of design and make is accelerating, and we a0re seeing larger companies expand on our platform. For example, after using Fusion 360 and Moldflow to develop accurate digital manufacturing trends for injection molded parts, which is typically a very iterative, time-consuming, and expensive process; one of the largest American multinational medical devices at pharmaceutical companies renewed and expanded its EVA with us this quarter. They were able to significantly reduce the time and rework costs because they could anticipate, predict, and correct manufacturing issues before moving and production. We continue to see subscription growth for Fusion 360, with paying subscriptions now at 165,000. And the Fusion 360 extensions are helping to increase our average revenue per subscriber, and capture more potential opportunities. Turning the quarter, a U.S.-based global leader in the design, engineering, and manufacturing of woven wire mesh products, transitioned to Fusion 360 as their main design tool and invested in our manage extension. The combination of Fusion 360 and manage extensions has largely automated their design and change workflows, brought a new level of organization and efficiency from product design all the way through delivery. Our presence in education continues to expand to address the critical shortage in skilled labor. For example, a growing number of large German companies are replacing competitive solutions, and our training there and premises on Fusion 360 to prepare them for the future of work. In the second quarter, Energie Baden-Wurttemberg AG, EnBW, one of the biggest utility companies in Germany with 25 thousand employees, adopted Fusion 360 to train its 600 apprentices. EnBW and its apprentices will benefit from the Fusion 360 cloud collaboration platform serving all their CAD, CAM, and CAE needs while they are either on-site or remote. Education remains an important market for us. And we continue to broaden our reach with more than 43 million tinker CAD and Fusion 360 education users. We continue to make progress, transitioning all of our users had named users, giving customers more visibility into their usage data, and allowing us to better serve our paying customers while also making it harder for non-compliant users to access our software. The level Group is a full-cycle developer which specializes in business class complexes. During the quarter, it increases investment with Autodesk by consolidating all of its single and multi-user subscriptions and permanent licenses to collect. Trends with our premium plan and Autodesk Docs to enable more efficient collaboration and license management. And with the help of 247 technical support and a single sign-on capability level Group expects reduced design costs in the future. As our existing paying customers navigate the complexity of digital transitions, we can help them manage that complexity, improve efficiency and sustainability, and remain in license compliance. For example, one of the leading construction civil, industrial, and infrastructure service contractors in Vietnam invested in AEC collection and audited bills to balance project safety, efficiency, and quality, while also reducing environmental impact in waste. Our license compliance team helped them identify licensing gaps and ensure the installation of compliance software. We estimate that there are about 2 million non-compliant users within our paying customer base. During the quarter, we Closed 11 deals over $500,000 with our license compliance initiatives, 6 of which were over a million dollars. At the end of September, we will launch a new pay-as-you-go consumption model, called Flex. It matches the customer's cost with their usage. Flex is an important new way to purchase from us as we evolve our business models to offer more choice and flexibility. It serves the long tail of customers who want an option for occasional users that do not use subscriptions every day. It also lowers the barrier to entry for existing and new users to explore new products with minimal risk and upfront costs. And back to where I started. Sustained and purposeful innovation to digitally transform the industries we serve, is also transforming our relationship with our customers. From software vendor to a strategic partner. And enabling us to create more value for them through end-to-end cloud-based solutions, business model evolution, and connected data and workflows. By helping our customers grow, we will grow too. The pandemic has accelerated these trends and climate change is increasing the urgency. We will continue to invest to rise to the challenges ahead and seize the opportunities they present. In the meantime, we remain on track to achieve our fiscal '23 goals. Please join us at our virtual Investor Day next week, where we will have more time to share our strategic initiatives with you. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Please stand by while we compile the Q&A roster. Our first question comes from the line of Saket Kalia of Barclays. Your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hey guys, thanks for taking my questions here. Maybe just to start with you, Debbie, I'd love to dig a little deeper into the changes to billings and free cash flow this year. And maybe specifically, I was wondering if you could just help frame the size and impact of that change to EVA billings. And maybe as part of that, just talk about what sort of gives you the confidence in what's maybe just a little bit of a steeper ramp in cash flow growth now, implied for next, next year. Does that make sense?"
},
{
"speaker": "Debbie Clifford",
"text": "It does. Thanks. Saket. Thanks for the questions. So, we're seeing overall strength in the business and we continue to demonstrate discipline with our spending. So that's what's driving us to raise our guidance for revenue and margin for the year. For billings and free cash flow. I have covered the specifics in the opening commentary. The key point to take away is we're focused on making changes that are good for our customers and good for us, and shifting more EVA to annual billings helped us achieve that goal. Now, it makes sense. Customers because they retained price certainty by signing multiyear contracts, that by moving to annual billings, they get a more predictable annual cash outlay. Of course, the change is good for us too. We generate more predictable annual cash flows and we remove the discounts we see today to generate cash collections upfront. Most CBAs are already on annual billing terms. And also, we had already assumed that would all be on annual billing terms starting next year in our fiscal '23, we're making the change now because with the strong start to fiscal '22 we decided to get moving earlier to execute on the shift. But the overarching driver is that we're focused on optimizing our business and the change, as we said, is good for both our customers and for us. As a side note, the impact on our billing’s guidance is also pretty small. It's around a 1% point of impact to the total billings outlook. Now if I shift attention to the ramp to fiscal '24, we do see accelerating momentum and multiple drivers of growth regarding multi-years. I want to break it down a bit. We have two main pools of multi-years one for our EVAs and one for our base products subscription business. What I've talked about today so far is EVA and the ongoing shift to annual billings for that cohort. As we look ahead to next year, as I mentioned in the opening commentary, we have a material cohort of multi-year contracts that are coming up for renewal in our base products subscription business, renewing those contracts is one factor that drives us to 2.4 billion in cash flow next year and year-to-date this year, the proportion of multi-year renewals that we're seeing in that cohort is in line with our expectations. To that plus the strength in our topline year-to-date gives us confidence in the past to the 2.4 billion free cash flow target next year."
},
{
"speaker": "Saket Kalia",
"text": "Okay, got it. That's very helpful. Andrew, maybe for you, just zooming out a little bit, a little bit more broadly. You talked a little bit about, in your prepared remarks and the press release, I think, you talked about sort of growing as your customers grow as well. And I think you've talked about some examples in your prepared remarks also. but I was just wondering if you can expand on that a little bit and maybe just connected back to the flexibility of the business model if you will."
},
{
"speaker": "Andrew Anagnost",
"text": "Saket, specifically, what I did say was I said is as we help our customers grow, we will grow. And the reason I want to highlight that particular point here is a lot of the things that are going on with regards to us growing with our customers, is there increasing investment in digitalization. This is here to it's here to stay, it's continuing to accelerate. It's going to move forward next year and continue to accelerate. So, the digitization engagement with our customers is why we grow as we help them grow because digitization is going to help them grow. it's going to help to be more responsive. It's going to help them win more business. It's going to help them do a whole bunch of things that they were struggling to do previously, which is great for them and great for us. Now, the other thing I'd add there is we are also responding to the way they want to buy. I mean, I think you've noticed that we introduced Flex. We haven't rolled it out yet, that customers can't yet buy it, but we introduced the concept of Flex. And Flex is something that a lot of our customers have been waiting for as we've been moving away from our old multi-user paradigm to single-user. They've been waiting to see something that allows them to manage occasional use and maybe dive deeper into some of our more advanced digital technologies and integrate some of those things into their workflow. So, we're going to offer them the flexibility they've been looking for and we're going to mainstream and across a lot of our customer base in the mid-market. But the other piece I want to highlight about Flex, in particular, is that it's also a tool for reaching the long tail of our customers. Flex is going to allow us to not only help with smaller businesses that knew some of our tools, only a couple of times a month, but it's also going to help us with smaller customers or departments within larger customers that want to use a particular advanced tool on an occasional basis. It used to be back in the '90s when books like the long tail first came out that you'd attack the long tail with a set of discrete products. Tons of little products. The 2020 way of approaching that is having a business model that allows people to get access to a set of capabilities in an ever-growing platform of products, like what we're doing with Fusion. So, look for those things long-term can be important tools as we see forward. Things like Flex are not going to be short-term revenue drivers but they will be long-term like there. Digitization is the key underlying thing here. Our business models, and the way we are approaching some of our advanced platforms, are the enablers that allow our customers to digitize faster."
},
{
"speaker": "Saket Kalia",
"text": "Got it, makes sense, thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Borg of Stifel. Your line is open."
},
{
"speaker": "Adam Borg",
"text": "Hey guys, and thanks so much for taking the questions. Maybe for you, Andrew. So, I'm sure we'll talk more on the broader strategy next week, but you've been very clear around this idea of convergence for some time, and earlier in the quarter there was the idea of converging mechanical CAD and electro CAD. How should we think about that going forward? And are we looking to do that more on the organic front with the Eagle or potential strategic partnerships or acquisitions, how should we think about that?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So excellent question. This convergence peace between mechanical design and electrical design is something we've absolutely had our eye on for quite some time. As you know, we bought Eagle several years back and we have now tightly integrated it into the Fusion platform. And we're doing some very, very interesting things around automation. And immigration between electronic PCB design and the associated mechanical designs that either contain it or actually interact with it in a smart product. So, we're already attacking that convergence organically with our products. You saw us look externally as well because we saw an opportunity. Did you accelerate the industry change? We believe these positives are going to converge. We believe the leading-edge customers are going to be driving and using converged processes. And we saw a vision match out there and we engaged in discussion around accelerating this change in the market. We're still going after that market with Fusion with Eagle and We have, and we're already moving up into the mid-market with some of these tools. So, this vision is not going away. This is a continuing and ongoing place for us to focus. And look for us to continually increase what we're doing with Eagle to make those convergences between mechanical and electrical design more fluid, more integrated, and frankly, more automated."
},
{
"speaker": "Adam Borg",
"text": "That's really helpful. And maybe just a quick follow-up. So just staying on the Fusion 360 intimate manufacturing front, you've talked about in the past, a lot of success with Fusion 360, even in CAM space, replacing vendors like master CAM, and just curious if today's announcements of that getting acquired can help accelerate the opportunity or change the dynamics competitively in some way, thanks again."
},
{
"speaker": "Andrew Anagnost",
"text": "I think one of the things you also saw is that got acquired there was a lot of visibility into the master camp business. And I think you can see that the business was not growing let's say, robustly as say Fusion is growing both from a user and billing standpoint. So, we're pretty confident that in the manufacturing side and the CAM side, we're doing a great job with Fusion. But we're also reaching deeper and deeper into people's entire process. A lot of the customers we're talking about publicizing out are people that have rolled out fusion across the entire process. One of the things that's also exciting, you're seeing these large subscription counts, 11,000 again -- breaking 11,000 again this quarter, but one of the other exciting aspects here is that our billings growth is actually growing faster than our subs growth, which is a result of the new extension strategy, which has continually added more. Good, a more advanced capability that people can buy on a pay-per-use basis or on a subscription basis to one of these extensions. So, we're continuing to see really good traction with Fusion. We're continuing to roll out new extensions. You will see more extensions coming out this year into next year, and you will also see us start to do some interesting new ones. Things from a platform perspective with Fusion as well. So, we're pretty bullish on Fusion. We feel pretty good about our position right here and we're continuing to see growth. And, and you're right, I think the acquisition of master Cam just shines a light on where the action is right now in this space."
},
{
"speaker": "Adam Borg",
"text": "Excellent, thanks a lot for the color."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your line is open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew. You mentioned that --"
},
{
"speaker": "Andrew Anagnost",
"text": "Got to get my pen ready for the three-part question. Okay. Pen's ready."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. So, you mentioned that usage is now at pre-pandemic levels. And the question it has to do with new products of volume. It's an easy comparison year-over-year versus last year. But would it be reasonable to say that the new products sub volume through the core of the business X EVA, X cloudy products XM2S is above levels of two years ago? And that our expectations for the remainder of this year, and I assume into next year, is that that will remain the case that you're now well above where you were two years ago in terms of that core product volume. And then similarly, for many years, LT was considered to be a good leading indicator, or barometer, of the business. Given the change in the profile of your product mix, your portfolio, plus the fact that order there seems to be encouraging full AutoCAD adoption in lieu of LT, you're clearly not encouraging LT. Is there some change in the barometers or indicators that you look to for the business?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. Okay. Great question. So let me address the first part. I was only a two-part question, Jay, you've disappointed me."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "I knew you'd say that."
},
{
"speaker": "Andrew Anagnost",
"text": "So new products have some -- new product have up significantly. I'm not going to give you a specific, I'm not going to tell you if it's exactly back up to 2 years, but let's just say it's up significantly. Okay. We can't -- we couldn't be delivering the kind of performance we are delivering if it wasn't. It's been significantly higher than the overall growth of the business in terms of new products out, and it's continued to robustly grow moving forward, and we expect it to continue. So, you can imagine that our volumes are getting back up to the places we would have expected them to be before COVID ever hit, which is a good sign and a good outcome. And more and more, as you can see in this quarter, we generated a lot of that new volume through digital direct channels and channels that were direct to us, which is another interesting factor here. You are absolutely right. It used to be that LT, because of the price point and because of its exposure to small businesses, was a barometer of the health of our business. But the move to the subscription model is kind of scrambled out a little bit because people may have been buying LT exclusively for something or buying different products and other things like that. So that's why we began tracking in a deep way the monthly active, daily active users of our products in various countries, which has become, frankly, our core barometer. And I think you can agree that that is a much more robust indicator of the health of our business than, for instance, looking at LT sales and LT transactions."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay"
},
{
"speaker": "Andrew Anagnost",
"text": "And it's also interesting to note, as commercial usage surges forward, [Indiscernible] non-compliant users, almost I [Indiscernible]. Right. So, it is not to disappoint you, but let me just ask you this. You made [Indiscernible] I knew -- here comes part three. Yeah, here we go. Exactly. You made a very interesting reference to a semiconductor facility in Asia that has become an AEC customer. And so, the question there looking ahead is, when you think about what Intel's going to be doing with [Indiscernible] and others in the semi-industry."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "If you looked at data center build-out and electric vehicle build-out, those are all mega commercial facilities. Do you do what's your pipeline looking like for any or all of those?"
},
{
"speaker": "Andrew Anagnost",
"text": "That's a very excellent point, Jay. All right. So, we're already big in the data-center pipeline. Dan is supercritical of some of these workflows. I have personally engaged with customers that I will not name and aim and see some amazing things they are doing with our tools on the data center front and on the factory front. So, we are actively engaged with deepening the penetration of them in all of those areas where people are standing up new factories and people are building new capacity. And you're right to talk about fab capacity for Intel and other places like that, then has matured to a point where when you combine especially not only with the capabilities of design and build, but ultimately you will see Tandem play a role in that space as well because Tandem as a digital twin allows us to do a handover long term, not yet, Tandem's relatively new to the market, but a digital handover to the owner for doing the lifetime management of the asset as well. So, look, that pipeline is robust and strong where we're already a big player in datacenter and new style factory stands ups in several sectors."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Gal Munda of Fanberg. Your line is open."
},
{
"speaker": "Gal Munda",
"text": "Thank you for taking my question. And the first one is just around the way you are thinking of multi-year offerings going forward. We're carrying the -- towards the end of the year, you even in the product side, you're thinking about decreasing the discounts potentially. Is that something that could have an implication beyond the EVA, also going into product subscriptions to have lower multiyear going forward, or is there just something that you managing cash flow as we have been [Indiscernible], which is a big cohort of [Indiscernible] like you said?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Gal. I'll say again, our goal is to do what's best for our customers and what's best for us. You're right that we recently announced that we're reducing the discount on products subscription, multi-year contracts from 10% down to 5%. And we're doing it because we feel that the higher discount as necessary, the value proposition of a multi-year contract to our customers is the price certainty, not the discount. Of course, we benefit from the lower discount because we get higher price realization. But at the end of the day, the multi-year contracts reflect the strategic longer-term partnership with our customers. Now, we make small price changes like that all the time in order to optimize our business and to maximize the value for both our customers and for us. And this is just one example of that."
},
{
"speaker": "Gal Munda",
"text": "I got you. That's really helpful. And then just the second question, we haven't had much about the network licenses and how the kind of the transition is going. What we started in the past over the last year, that obviously the first ones to hand them over, we're the ones that had entitlement that basically give them maybe more under the 2 for one or 1 for 2 effectively they give them more licenses than they need and the others will come later. Are you starting to see that tip of the iceberg effectively when it goes to the other way where people that are handing in their network licenses now are -- that's 2 for 1 exactly? Or even need to take extra entitlement in order to be compliant?"
},
{
"speaker": "Andrew Anagnost",
"text": "Gal, we are absolutely starting to see the tip of the iceberg on that part of the transition. And also Flex, which is something that a lot of those customers were waiting for because those customers were heavy users of our network licensed model, Flex in one of its forms replaces that old model. So, we're -- as Flex starts to reach the channel and reach the customers more directly, you're absolutely going to see a greater acceleration of that. Because they do have to ultimately transfer a name to every user to use Flex. But we're seeing the tip of the iceberg on that right now. Flex's availability -- broader availability as we move to the end of this year and into early next will also accelerate that trend as well, which will help us retire that old business model and get our customers on the more advanced management systems that underpin Flex."
},
{
"speaker": "Gal Munda",
"text": "Got you. That's really helpful. Thank you so much, I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Matthew Hedberg of RBC Capital Markets. Your question, please."
},
{
"speaker": "Matthew Hedberg",
"text": "Great. Thanks, guys. Andrew, I want to start with you. Given the U.S. federal infrastructure spending bill, one of the most often asked questions I get is really your exposure to infrastructure spending. I'm wondering is there any way that you can help, just roughly frame up the magnitude of that business. Or even perhaps how fast is it growing relative to your overall portfolio of businesses?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, we don't break out the infrastructure of a business, so I can't give you a specific, but here's one of the things -- here's what I can tell you, and here are the philosophical statements I can make enough. One, we do not have any impact from a federal infrastructure bill built into our financial models, okay? So, the numbers we've given you, the concept, they're all business as usual based on our normal course and speed. So, I want to be super clear about that so we're all on the same page. However, we are big proponents of infrastructure spending and the need for infrastructure spending. And I think you're getting a sense just over the last few weeks and the last month, some of the critical drivers around what -- how serious it is when you have a decaying infrastructure. Look at California, right? California built water infrastructure for slow snow melts to catch water and have it dribble down from the melting snow and runoff to the coast and everybody was happy. That world is likely gone. And what people need to focus on is more reservoirs, different types of infrastructure to capture rainwater rather than rely on snowmelt. These were things that in some cases we're predictable 10 years ago, but we haven't made progress on. Also, look what's happening in Tennessee. Just last week, the horrible tragedies with these flash floods in the middle of Tennessee. Unprecedented levels of speed and severity of floods are all related to water infrastructure. All of these things are related to climate change. Some of them were predictable, some of them not. All of them are 10-year backlog now in many places. We have to build better across the board and we believe that our tools, our capabilities, the digital platforms we're deploying are going to help people build better. And when you look at how we're positioned to capitalize on this, which I can talk to you about. Look we have got the solution that goes from end-to-end with the capital planning engagement all the way to the user engagement with the vertical and horizontal components of construction and is in between. And I want to point to you some of our recent partnerships and acquisitions. On-road and rail, we partnered with Orgo to go after the Department of Transportation to help with the capital planning. We brought in a device that has the capital planning tool upfront in the water infrastructure process. And we also have a space maker, which we haven't talked a lot about, which helps in the real estate development side from the capital planning and allocation there. So, we're actually building out capabilities upfront through partnership and through technology. And then we have all this capability that we've integrated into the construction cloud as well to help with vertical and horizontal construction. So, we're ready. We're -- we've invested in the places that we think are critical and we think people need to invest in digital technology to not only to build what needs to be built but build it back better and build it back cheaper so that we can start closing out the backlog because there is a big backlog. So, there will be an opportunity here. It will be a long-term opportunity for the Company. It won't be short-term, but there will absolutely be an opportunity as people start to spin up these infrastructure projects."
},
{
"speaker": "Matthew Hedberg",
"text": "That is super comprehensive. And as a sidebar, yes, it does feel like your acquisition of Innoviva's given the wording of the bill on the water was certainly timely. I wanted to go back to manufacturing just with another question. You noted in prior calls that Fusion 360 is near a tipping point and then another question on M-CAD and e-CAD, I'm just curious though, from a philosophical perspective, what's left for you to do within your manufacturing portfolio. In other words, is there much more white space left beyond what you've got, to sort of kind of getting a sense of where we're at in that sort of platform maturation?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, there's always a little white space, okay? I think one of the things that are really important in terms of things we have to do. We have to finish integrating all the end-to-end capabilities, all right? We have to make sure that we've gotten all the capabilities completely integrated in a way that makes sense. We have to continue to dial down on things like general design and cloud-based and machine learning-based automation that automate workflows between some of these things. So even less sophisticated companies can take full advantage of highly sophisticated capabilities, which is a goal for us. Now, there's going to be another white space as we move down with regards to connecting to production planning. But on the shop floor not just moving geometry directly to the machine through general divine, but actually managing production flow and some of the things associated that in highly automated facilities. So, we'll probably explore some of those areas as we start building out the platform. But really, in terms of what things have to happen to continue to accelerate fusions growth, it's all about building out the core design capabilities because you've got a lot of touch points in there. We've got ReCap, we've got some really great partnerships around simulation which will deepen over time, and we've also got excellent manufacturing capabilities. As we deepen in to professionalize the design capabilities, you'll start to see more and more purchasing of sophisticated extensions on top of Fusion. So, look for Fusion to become a more significant revenue driver as we move beyond FY '23. Right now, we're focused on making sure that the platform's best-in-class, that that's cloud independence is strong, that we build off the strong foundation we have right now, and that we build out some of these core design capabilities. But there are little bits of white space in there around production management, around some of the integration s with other types of capabilities, around costing and estimating that is going to be interesting as well in the future."
},
{
"speaker": "Matthew Hedberg",
"text": "Super helpful, thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Joe Vruwink of Baird. Your line is open."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi everyone. I wanted to start with the performance and the direct channel efforts. Obviously, you've had a goal to achieve 50% revenue share but it seems like in the last several quarters, it's just the movement to that level has accelerated a bit. Are there specific things you would maybe point to recently that help explain some of the acceleration? You've brought up enterprise and the e-store, is maybe one response more than the other? And how much is this factoring into the confidence you speak to entering the second half of this year?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So, I think Debbie and I will both tag team just a little bit okay. So let me just talk about this at a high level. Some of these things are cyclical, by the way, okay? So, there will be quarter-to-quarter variations here. The fastest-growing channel we have in our business is the digital channel, all right. And more and more of our products, especially new products, especially for small businesses, are being [Indiscernible] as that channel. It's a big driver, and we've seen some acceleration there and we continue to see acceleration there. It's a very healthy channel and this is what we expected. We're certainly also being successful in our EVA business, which is driving up the percentage in certain quarters. But don't look for that to be a linear transition. We're going to get to the 50, it's going to take time. But there'll be some quarters where we're trending up, other quarters where we're trending a little bit down. But overall as you fit the line through over multiple years, it's going to be heading up in the right direction. There are some countries where we're getting very close to 50-50. and other places where we're very far away from it. So, you have to look at the business a little bit more discreetly as we get there, but don't look for this to be a straight line. Debbie, did you want to add anything?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. I think you captured it well, Andrew. As you said, there are two main parts. There's the enterprise or EVA business and there is our e-commerce channel. Now, the enterprise business is at a seasonal low in Q2, but we do have a strong pipeline. Andrew mentioned that it was the first quarter that we saw Upchain included in an EVA. So, we are building momentum and we anticipate that the bulk of our EVA selling will be in the back half of this year, like previous years. So, things are looking good there. On the e-commerce side, lots of growth there, we've been investing heavily. Last quarter, we talked about different things that we added, like more out of at -- added seek capabilities, more calls to action across the site. We continued to invest this quarter. Some examples of the changes that we made were our one-step resubscribe capabilities, so that expired customers can easily resubscribe. We have even more places for add a seek capabilities throughout the site, we launched a new Middle East site in June. So, a bunch of things and you'll just see us incrementally add more functionality, more ways to engage with Autodesk so that it's easier to do business with us. And that's going to be part of our success to drive growth through that channel."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. That's helpful. And then I wanted to maybe reconcile what sounds like a lot of strong trends and higher confidence in the second half. And still have the same high end of the revenue guidance, 16% growth intact for fiscal '22. Are there certain areas of the business where you look and it's still a bit held back, so it could be an opportunity for improvement over coming quarters, but maybe still not the full contributor that it could be?"
},
{
"speaker": "Debbie Clifford",
"text": "Oh, sorry, Andrew. And then you can chime in. I would say that, overall, we had a strong Q2 and we ended the quarter with strong momentum. And we raised our revenue guidance on the year to reflect that ongoing strength and what we've seen in the business for the year to date. Andrew mentioned all the leading indicators were strong, usage return to pre-COVID level, the construction backlog is back online. So, all we're seeing at this point is accelerating momentum. The only kind of knit piece that I would highlight in the back-half of this year is that typically in our Q4, we do see a bit more upfront revenue recognition for some of the products that we typically sell cyclically in that period, and that's a little bit of what you see in both Q3 and Q4 as we get to the back half of the year. But overall, just broad strength that we're seeing in the business and that led to the increase in the revenue guidance on the year."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Great. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. I think Debbie said it all."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Keith Weiss of Morgan Stanley. Your line is open."
},
{
"speaker": "Elizabeth Elliot",
"text": "Hi, this is Elizabeth Elliot on for Keith Weiss. Thank you so much. I just have a few questions on the current RPO -based bookings growth, it looks like year-over-year growth slowed a bit from last quarter. So, wondering if you could just highlight some of what could be driving that and some of the trends that you are just seeing in new business demand versus what you saw maybe in the prior quarter. Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "So, thanks, Elizabeth. RPO growth was strong at 24% year-over-year and we really do see that as the leading indicator of what's happening in our overall business. Now, typically we see RPO, or what we see right now is that RPO growth shot up in Q4 because we had a very strong enterprise business agreement quarter. And so gradually, we're seeing that taper down over time. But overall, 24% growth is really solid performance in RPO when you'll start to see that bleed into revenue on the back half of the year."
},
{
"speaker": "Elizabeth Elliot",
"text": "Got it. And then just one more ABI data for June noted some firms just weren't able to find enough from workers and not the challenge they've had talked about 60% of firms not being able to fill openings in the architectural staff. I was wondering if any issues in employment are a headwind for Autodesk, seats or are that a tailwind for you guys as firms just need to digitalize faster and improve productivity."
},
{
"speaker": "Andrew Anagnost",
"text": "Sorry, can you repeat that question?"
},
{
"speaker": "Elizabeth Elliot",
"text": "Yes. The Architectural Billings Index data for June highlighted that some of the architectural staff, which having problems filling seats. And that being a headwind -- just employment being a headwind to sales from the demand capacity that they were seeing. So, I just wondering if employment headwinds in the overall macro marketing driving -- is that a headwind for Autodesk at all or is that actually a tailwind? As firms need to digitalize faster and improve productivity by adopting Autodesk software tool."
},
{
"speaker": "Andrew Anagnost",
"text": "Okay, thank you. It's actually more of a tailwind because what our customers are struggling with is they're trying to do more with a smaller staff. And the more digital firms are able to do that, the fewer digital firms are struggling. The scarcity of labor is pervasive across multiple industries and multiple sectors. But we believe this is just another driver with regards to people adopting deeper digitization and digital technologies. And as you can see from the factor, some of our results and some of our new SEC volume. While you're hearing some of that in the ABI pressure with regards to their book of business, you're not seeing any kind of depressive impact in our new SEC volume. So, we expect long term this is going to be a tailwind around digitalization and not any kind of headwind for us."
},
{
"speaker": "Elizabeth Elliot",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Celino of KeyBanc. Your line is open."
},
{
"speaker": "Jason Celino",
"text": "Hey, guys. Thanks for taking my questions. Nice acceleration on the mixing segment this quarter. And you mentioned that it was an all-time high for bid activity with Building Connected. Since Building Connected is kind of at the tip of the spear in terms of where they see visibility into the construction cycle, how should investors think about this engagement activity flowing through to the revenues?"
},
{
"speaker": "Andrew Anagnost",
"text": "I think you should think about it exactly the way you said it. It is a leading indicator of future on-site construction activity, all right? So not all of that activity will convert to people buying our construction tools. Because not all the activities are a good fit, but it is absolutely a leading indicator of shovels hitting the ground. And I think that's the way you should be interpreting it, and that's the way you should look at it. And that's the way we use it. And as we get deeper and deeper into Building Connected and deeper and deeper into how the bid board works, we'll be creating more internal indices to track and watch some of these things. But that -- what you said is how you should view this. It is a leading indicator of shovels in the dirt and future activities which some of that will translate into future purchases of on-site construction software tools."
},
{
"speaker": "Jason Celino",
"text": "Okay, well, maybe to double-click on that a little bit. When we think about it from a timing perspective, or is most of -- any help you can share on the types and timing of projects?"
},
{
"speaker": "Andrew Anagnost",
"text": "No, I can't. I can't give you a lag indicator between increased bid activity on the bid board and the starting of new projects."
},
{
"speaker": "Jason Celino",
"text": "Okay."
},
{
"speaker": "Andrew Anagnost",
"text": "What that impact is."
},
{
"speaker": "Jason Celino",
"text": "No words, but thank you."
},
{
"speaker": "Operator",
"text": "Thank you. And that is all the time we have for Q&A. I'll now like to hand over the call to Simon Mays-Smith for closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you. Latif. And thank you everyone for joining our Q2 fiscal '22 conference call. If you have any follow-up questions, please do contact the investor relations team and we look forward to seeing you all with our Investor Day on Wednesday, next week. Thanks very much. Goodbye."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 1 | 2,022 | 2021-05-27 17:00:00 | Operator: Good day, and thank you for standing by. Welcome to the Autodesk, Inc. Q1 2022 Earnings Conference Call. At this time, all participants are in a listen-only model. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Simon Mays-Smith, VP, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks operator, and good afternoon. Thank you for joining our conference call to discuss the results of our first quarter of fiscal year 2022. On the line with me are Andrew Anagnost, our CEO, and Debbie Clifford, our Chief Financial Officer. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K, for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. I hope you and your families remain safe and healthy. While parts of the world emerge from the pandemic, others are entering the eye of the storm. I especially want to acknowledge our colleagues, family and friends in India. We are thinking about you and we are helping wherever we can. Thank you to all our employees and their families, our partners, and customers for their continued resilience, patience, and commitment. Our first quarter marks an important inflection point. While solid execution, a resilient subscription business model, and continued secular shift to the cloud underpinned our strong first quarter results, waning uncertainty and growing confidence in our end markets generated momentum. Robust growth in new product subscriptions, combined with improving usage and renewal rates, accelerated billings and RPO growth to 10% and 22%, respectively. Together, these reinforce our confidence that we are through the revenue growth trough and on track to achieve our fiscal 2022 and 2023 goals. In mid-May, we completed the acquisition of Upchain, a cloud-native product-data and lifecycle management solution. Combined with existing Autodesk offerings like Fusion 360, Upchain will profoundly simplify data-sharing and collaboration for engineers, manufacturers, suppliers, and other product stakeholders, enabling customers to bring products to market faster and build a stronger supply chain. Its next-generation platform enables it to be rapidly deployed, scaled, maintained and updated without the expensive, inflexible and time-consuming integrations of legacy systems. We will grow Upchain through our enterprise and channel partnerships, and expect it to become a meaningful on-ramp for legacy design tools to the Fusion 360 cloud ecosystem and facilitate further expansion in adjacent verticals. As we highlighted in our recently published Impact Report, the convergence of design and make brings both greater efficiency and sustainability to buildings, and a broad range of manufactured goods, stretching from EVs and bicycles to high-performance skis and low-cost ventilators. While we are enabling customers to achieve their sustainability targets, we continue to lead by example, reaching our carbon-neutral goal across our business and value chain in fiscal 2021. The report also sets out new diversity, equity and inclusion goals. And while I am proud that 50% of Autodesk’s Board, and 45% of our Executive Team, are women, we can and will, do more both internally and through partnerships with organizations like JFFLabs externally. As we recently announced, Pascal Di Fronzo, Autodesk’s Executive Vice President of Corporate Affairs and Chief Legal Officer, will be retiring in December after 23 very successful years at the company. He has been a trusted counselor and steward of the company. His contributions to Autodesk are many and have been incredibly impactful, and I want to thank him for his dedication and wish him all the best in retirement. I am very excited to welcome Debbie back to Autodesk and will now turn the call over to her to take you through the details of our quarterly results and guidance for the year. I will then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. I am very excited to be back. Looking at the first quarter’s results, several factors contributed to our strong financial performance, including robust growth in new product subscriptions, accelerating digital sales, stronger than expected upfront revenue and improving subscription renewal rates. In addition, a one-month contribution from Innovyze and foreign exchange rates provided a modest tailwind to the quarter. Total revenue in the quarter grew 12% and 11% in constant currency, with subscription revenue growing by 18%. Looking at revenue by product and geography, AutoCAD and AutoCAD LT revenue grew 9%, AEC revenue grew 16%, and manufacturing revenue grew 8%. Excluding the impact of moving our Vault product to ratable revenue recognition, which we discussed last quarter, manufacturing revenue grew double digits. M&E revenue grew 5%. Across the globe, revenue grew 8% in the Americas, 11% in EMEA, and 20% in APAC. Direct revenue increased 25% and represented 33% of our total revenue, up from 30% last year due to strength from both enterprise and ecommerce. Our ecommerce sites had their highest new billings growth rate in two years driven by strong traffic growth and recent site enhancements. Reflecting the business-critical nature of our products to our customers, our net revenue retention rate remained within the 100% to 110% range and our product subscription renewal rates strengthened. Our billings accelerated 10% to $974 million. Total deferred revenue grew 11% to $3.35 billion. Short-term deferred revenue increased 17%, primarily reflecting growth in new product subscriptions and increasing renewal rates, but also the inclusion of Innovyze. This was partly offset by a smaller contribution from long-term deferred revenue resulting from fewer multi-year contracts when compared to last year. Total RPO of $4.23 billion, and current RPO of $2.86 billion, both grew 22%. Current RPO growth was primarily driven by the increase in short-term deferred revenue, but also by strong growth in enterprise business agreements and to a lesser extent, early renewals ahead of anticipated price increases. Excluding the contribution from early renewals and Innovyze, current RPO grew approximately 20%. Non-GAAP gross margin and operating margin remained strong at 92% and 28%, respectively, broadly level year-over-year and reflecting the trough in revenue growth relative to cost growth. We delivered healthy free cash flow of $316 million during the quarter driven by collections of prior quarter billings and strong results in the current quarter. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash to offset dilution from our equity plans. During the first quarter, we purchased 515,000 shares for $143 million at an average price of approximately $277 per share. Now I’ll shift to giving you my initial thoughts as CFO and then finish with our outlook. Since I rejoined Autodesk about two months ago, I’ve been focused on two things: First, reacquainting myself with everything Autodesk, the team, our strategy, and how we’ve evolved during my two years away; and second, I’ve been digging deep to gain a solid understanding of our fiscal 2022 budget and fiscal 2023 financial goals. On the first point, while much at Autodesk is familiar to me, I’ve been pleasantly surprised by how much has changed for the better reflecting the enormous progress Autodesk has made over the last two years. Autodesk has undergone a cultural revolution. There’s been a powerful shift in the company’s values and ways we work and the pace of decision-making has accelerated. As a company, we now benefit not only from the scale of our operation, but also from a newfound agility that is enabling our success in newer markets like construction and manufacturing in the cloud. I’m also struck by the compelling and expanding opportunities ahead of us. Digital transformation is happening now, it is real, and we are well-positioned to capitalize on that trend in the industries we serve. As I begin to turn my attention to our long-range financial plan, these initial learnings give me confidence in our growth potential in fiscal 2024 and beyond. Let me finish with our guidance, which now includes Innovyze and Upchain. We still expect that an improving economic environment during the year will result in strong growth in new business over the course of fiscal 2022. We expect product subscription renewal rates to continue to be healthy, and our net revenue retention rate to remain between 100% and 110%. Given our subscription model, revenue growth will lag the improving sales environment. We continue to expect about three quarters of our free cash flow to again be generated in the second half of the year due to our economic phasing assumptions and normal seasonality. For fiscal 2022, we are raising our full-year revenue guidance to a range of $4.305 billion to $4.385 billion, or a 14% to 16% increase over last year, reflecting a partial year contribution from acquisitions net of the deferred revenue write downs. Given our results are weighted in the second half, and Q1 is our seasonally smallest quarter, it’s obviously too early to change our view on the underlying trajectory of the year, but we are off to a good start. We expect non-GAAP operating margin to expand to between 30% and 31%, which includes approximately 1 percentage point of negative headwind from acquisitions. Finally, we still expect free cash flow to be around $1.6 billion with a broadly neutral impact from acquisitions. The slide deck on our website has more details on modeling assumptions for the second fiscal quarter and full-year 2022. With improving economic conditions and easier comparables, we still expect our first quarter revenue growth will be the trough. Our accelerating momentum in fiscal 2022 will propel us into fiscal 2023 and I am therefore confident in our fiscal 2023 revenue growth potential and free cash flow target of $2.4 billion. As I begin to look beyond fiscal 2023, the digital transformation of the industries we serve, our sustained investment in the cloud, and our flexible business model, give us a robust platform for double-digit growth. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Let me finish by giving you an update on our strategic growth initiatives. The secular trends we have been investing in for years have accelerated during the pandemic. The digitization of AEC, the convergence of design and make, and our expansion into adjacent verticals through organic investment and acquisitions are growing our total addressable market. The evolution of our business model, the value generated by the growing connectivity of our platform for new and legacy customers, and the hardening of our systems to non-compliant users, enable us to attract and retain more of that potential opportunity, growing our ecosystem and the usage and value we generate from it. Turning to AEC, our unique vision is to connect all the phases of construction with end-to-end, cloud-based solutions that combine horizontal data flow with best-in-class functionality to enable seamless collaboration from planning, design, pre-construction, construction, asset operations and maintenance. The breadth and depth of our solutions distinguish us in the market and we continue to build on that advantage through industry leading R&D, which we sustained through the pandemic and acquisitions. Our latest product releases reflect that. For example, Revit 2022 is a bridge to more open and interoperable ways of working that accelerate our design customers' digital transformation and improve communication of design intent across all disciplines and project phases. For construction teams, we released Autodesk Build, Autodesk Takeoff, and Autodesk BIM Collaborate, as well as product enhancements which further empower construction teams to drive better business outcomes such as winning more business, reducing rework, delivering projects on time and improving safety by connecting data, workflows and teams across the project lifecycle. As the construction backlog comes back online, and the new project pipeline builds, we are emerging from the pandemic stronger. This is reflected in our success during the quarter. For example, Burns & McDonnell is a family of companies bringing together an unmatched team of 7,600 engineers, construction professionals, architects, planners, technologists and scientists to design and build critical infrastructure projects. It is at the forefront of technology use and having invested in Revit and BIM 360 Design some time ago, most of its data is already in the cloud. Monthly Active Users or MAUs on Autodesk software have grown by 80% since 2018. This quarter, Burns & McDonnell renewed its Autodesk EBA and increased its investment with us, adding more cloud-based products from the Autodesk Construction portfolio, including Autodesk Build, Pype, Assemble, and Building Connected. Our unified common data platform enables it to move and collaborate seamlessly from design through construction and to implementation with common workflows across multiple, global practices. 1898 & Co., part of Burns & McDonnell and its future-focused consulting and technology solutions division, and it is a founding participant in our Tandem digital twin program. The Boldt Company is a $1 billion professional construction services firm in the U.S., focusing on integrated delivery of complex vertical construction projects that require extremely tight collaboration between stakeholders and integrated workflows between industry partners, the office and field. Boldt was already relying on BIM Collaborate Pro and PlanGrid when, this quarter, it selected Autodesk Build over a directly competitive construction project management solution and also invested in Pype. Autodesk Construction Cloud’s unified platform connects previously siloed data, reduces rework and saves time for Boldt across the company, enabling teams to easily manage projects from planning and design through to the field and handover. And MultiGreen, a real estate development and operating company specializing in sustainable and tech-enabled multifamily housing in high-growth and supply constrained markets, standardized on Autodesk Construction Cloud. In order to build more efficiently and sustainably, they knew they had to standardize on a single platform to connect their teams from concept and design through project completion and day-to-day operations. In addition to Revit, Inventor, BuildingConnected, Autodesk Takeoff and Autodesk Build, they will be using BIM 360's integration with the Embodied Carbon Calculator to analyze material carbon emissions with all of their data connected through our common data environment. In infrastructure, we released Civil 3D, InfraWorks, AutoCAD Map 3D, AutoCAD Plant 3D and ReCap Pro with enhancements in transportation, water, plant, land development and reality capture. Most importantly, we continue to mature our project delivery platform across design and construction to better support digital project execution that helps our customers increase operational efficiencies, make better design decisions, increase quality, and reduce cost and material waste. During the quarter, we received notice of an award in design from the Montana Department of Transportation. Instead of a competitor offering, they will now be using our AEC Collection, which includes Civil 3D, Revit, InfraWorks, Navisworks, ReCap and our Common Data Environment, Autodesk Docs. The Department was particularly impressed by connected bridge design workflows between Revit and InfraWorks that drive efficiency and sustainability. Turning to manufacturing, we’ve made significant organic investments in addition to Upchain. Inventor 2022 introduced new features and enhancements to speed up product development and interoperability with AutoCAD, Fusion 360 and Revit. In Fusion 360, we have introduced new functionality across the entire product development process and numerous integrated extensions that unlock advanced design and manufacturing technologies. In Vault, we introduced a new mobile application and web browser experience for engineers and non-CAD users to access their real-time data anywhere and on any device. The potential to converge design and make in the cloud is becoming more of a reality every day to our customers. Autodesk continues to lead that transition. AAC Technologies, the world's leading solutions provider for smart devices, grew its investment with Autodesk. Having struggled with data management and data integrations in their product lifecycle management using a competitor’s 3D modeling product, AAC Technologies switched to our Product Design and Manufacturing Collection with Vault to manage all their data. They found our connected workflows particularly attractive and believe they will improve productivity and collaboration across their teams and enable them to go-to-market more effectively by increasing flexibility in their supply chain. For data management, our customers can now choose Vault for on-prem and Upchain as they transition to the cloud. With the largest number of new commercial users in 2020, Fusion 360’s strong momentum continued, growing commercial subscriptions to 152,000 without any systematic cost promotions. While still early in its lifecycle, we believe Fusion 360 has reached an adoption tipping point and with extensions and Upchain, we are excited about its future. During the quarter, a UK-based design, manufacturer, and installer of architectural precast facades invested in Fusion 360 with its nesting and fabrication extension. By converging the design and manufacturing processes into a single unified experience in the cloud, Fusion 360 enables faster design, prototyping and go to market. By creating optimized and associative multi-sheet layouts for sheet metal and non-sheet metal parts in preparation for cutting on CNC machines, our nesting and fabrication extension helps them to significantly reduce waste. Last month, three students from Danville Community College in Virginia won the inaugural Project MFG National Championship, an advanced manufacturing competition, sponsored by the U.S. Department of Defense. Jeremiah Williams, Director for Integrated Machining Technology at Danville Community College said: “By testing a variety of advanced skills, like welding and multi-axis machining, as well as communication and teamwork, the Project MFG National Championship is one of the most challenging skilled trade competitions in the country. Fusion 360's next-generation platform enabled our team to complete all required and optional objectives, from prototype through to welding and machining the finished product, and to win this prestigious prize.” As announced last quarter, we extended our multi-user trade-in to August 2023, but we are still seeing customers convert and benefit from the transition to named user. SSP, one of the leading Integrated Design Offices in Germany, traded in their multi-user licenses with us this quarter and significantly increased their investment by purchasing additional AEC collections and premium subscriptions. In the process, they completely replaced a competitive design solution, standardizing their workflows on our cloud platform. The premium plan is especially valuable to them as they improve their site-to-site management using single sign-on which enables more digital collaboration, and efficiency while increasing employee satisfaction. While we continue to be sensitive as the economy recovers, we are successfully converting non-compliant users to paying customers with Q1 license compliance billings almost doubling year-over-year during the quarter. For example, a non-compliant customer converted into one of our largest premium customers to date. Over 500 branches in Indonesia made it difficult to track and manage software usage, and this customer was inadvertently using more licenses than it was paying for. After completing a self-audit, which confirmed the software gap, it purchased premium to help manage the complex roll-out of compliant licenses. They are now a happy premium customer with detailed usage insights and the ability to flexibly manage their licenses from headquarters across their entire branch network. Now let me finish with a story. Construction began on Notre Dame cathedral in 1163, but was not completed for more than 100 years. In a 12th century version of light weighting, Notre Dame was the first Gothic structure to use flying buttresses, which are slanted beams that support the heavy walls and ceilings that enable giant rose glass and stained-glass windows in large edifices with open-aired space beneath them. Following a catastrophic fire in 2019, the cathedral is being rebuilt with traditional and sustainable materials enhanced by next-generation Building Information Modeling provided by Autodesk. Combining traditional design and build know-how with modern workflow solutions, reconstruction is expected to be completed in 2024, in time to welcome athletes at the summer Olympics in Paris, and future generations from across the globe. I share this because, as the world rebuilds after the catastrophic impact of the pandemic, I am reminded again that Autodesk’s purpose to enable its customers to build and manufacture efficiently and sustainably has never been more important or urgent. Together, we can meet the generational challenges posed by carbon, water and waste. Autodesk’s central role in meeting these challenges underpins my confidence this year and my confidence in the future. With that, operator, we would like to open the call up for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is now open.
Jay Vleeschhouwer: Thank you. Good evening, Andrew and Debbie. Let me ask you, Andrew first, a couple of business and technology or technology evolution questions. You highlighted infrastructure, and the company has been in that business for many, many years and you’ll recall that once upon a time, it was in fact a reporting segment and maybe should be again at some point. Could you describe the main ways in which that business has evolved over the last number of years in terms of its scope or its customer base and what the vision really is for that business in terms of perhaps adding new types of customers, such as owner operators that have not really been a large part of your business profile to date? Secondly, since we're halfway between AU 2020 and AU 2021, could you update us on some of the important initiatives that you yourself highlighted during your Q&A session at AU six months ago? Namely, the Forge roadmap and its implications for you long-term, and then secondarily, sharing technology across the portfolio and across industries. In other words, leveraging your R&D more and more across the company in that respect?
Andrew Anagnost: Yes. All right, Jay. So let me start with the infrastructure discussion. So here's what's fundamentally staying with the business. One, we've been winning more and more department of transportation as we've progressed since the last time the infrastructure business was broken out. And what we did is we focused our organic portfolio very much on road and rail work, bridges, roads and rails, and created a lot of workflows between Civil 3D and InfraWorks and some of our specific tools. And we've been very happy with the progress we've been making there and we continue that organic investment targeting those pieces of infrastructure. We don't feel it needs to be broken out into a separate business because I think you might recall, since those days, we've moved our entire sales organization to account-based sales. So it's very easy to cover these types of customers with the kinds of support that we need to engage with them directly. Look, buttress next, as you can see with what we've been doing with Tandem and the digital twin work, and also with what we've required with Innovyze with their Info360 solution and some of the tools around there with digital twins for water waste management and water management, we are definitely moving closer to things that are directly relevant to owner operators, and you would expect to see us do more of that as time progresses, okay. So that kind of gives you a sense for what we are looking at and how we've gotten here. With regards to AU initiatives, I don't want to kind of preempt next day use announcements. But what I'll tell you is we continue to add additional capabilities to Forge into the APIs. And I think in this coming AU, you're going to hear me talk a lot more about some of the common experiences we are creating across some of our new environments that we are building for our various customers. So I want to hold onto some of that news as we move forward to the next AU. But the hint is there's some common data experiences. There's some common ways of managing and accessing projects that we are developing and deploying. All things that are relevant to making the platform more powerful for bringing together the various products that our customers use.
Jay Vleeschhouwer: Okay. For Debbie quickly, you highlighted strong growth in product subs. If you're able to look at that in absolute terms, how would that product subs level of business compare with, let's say the second and third quarter of last year, and perhaps even the fourth quarter. Are you now perhaps the highest level you've been in four or five quarters as far as product subs are concerned?
Debbie Clifford: The short answer is yes, we've returned to growth after a period of several quarters that were impacted by COVID. And so we're pleased with the growth that we saw in Q1 and that's evidenced in the revenue results.
Jay Vleeschhouwer: Thank you.
Operator: Thank you. Our next question comes from the line of Saket Kalia from Barclays. Your line is now open.
Saket Kalia: Okay. Great. Hey, can you hear me okay?
Debbie Clifford: Yes.
Saket Kalia: Excellent. Hey, thanks so much for taking my questions and welcome Debbie. Maybe first for you, Andrew, I'd love to dig into the new business acceleration you've touched on as we are starting this recovery. Maybe in particular, how much of this recovery do you feel is in demand? That is [the field is] tied to increased engineering hiring versus perhaps pent-up demand for tools post-pandemic just as we kind of think about the pace of this recovery going forward. Does that make sense?
Andrew Anagnost: Yes. It's hard for me to break it in – break it down into increased engineering hiring versus kind of pent-up demand. So I can't really give you a fine grain view on that. What I can tell you is that usage of some of our more engineering intensive products is going up pretty significantly, okay. And we talked a lot about usage every year with regards to how the monthly active usage and the daily active usage going in various countries. What we've seen is the majority of our countries are now at or above pre-COVID levels. The UK is now above pre-COVID levels. The U.S. still struggling a little bit to get above pre-COVID levels, but showing a lot of robust impact. You also noticed – I think you probably watch the indexes out there, the PMI and the ABI indexes in particular. We have always found those indexes to be lagging indicators of our business. So they actually tell us that something has already happened with the purchasing behavior of our customers. And what you've seen is those indices continuing to shift towards growth, which hints at Saket that it's the book of work that's going up. All right, which means people are going to hire more engineers, they're going to hire more people and they're going to engage – they're going to be using our products more. So it's probably driven mostly by hiring related to the book of business of our customers is going up. The indices seem to indicate that as a lagging indicator of what we've seen in terms of purchasing behavior and usage, but that's kind of as much granularity as I can give you on that.
Saket Kalia: That's super helpful, Andrew. Thanks. Maybe kind of follow-up for you Debbie, you touched on this a little bit in the prepared remarks. But I want to just talk about the acceleration in revenue this year. I think we get some of the drivers, but I'd love to sort of get your take and perhaps as part of that, your confidence in that growth lasting into fiscal 2023 and for that matter longer term as well?
Debbie Clifford: Thanks, Saket. I start by saying, so Q1 is our seasonally smallest quarter and our guidance assumes that we'll see improving results as the year progresses, which is consistent with what we're seeing. We're seeing uncertainty lessening, growing confidence from our customers and our channel and improving demand on our end markets, which is resulting in an accelerating growth in new business. We're also seeing increasing renewal rates, strong direct business, particularly through the e-store. Our total direct revenue grew 25% year-over-year in Q1, and now represents 33% of total revenue. We're also pleased that we're starting to see momentum and key indicators like RPO, which grew 22% year-over-year in Q1. And it's because of these factors that we're confident in the ramp during fiscal 2022. Now if I shift attention to fiscal 2023, and even beyond that, let me just break that down a little bit. I mentioned on the call that since I rejoined Autodesk, I've been focused on two primary things. The first is reacquainting myself with everything Autodesk, the team, the strategy, what's happened while I was away for a couple of years. And the second is digging deep to get a solid understanding of the fiscal 2022 budgets and our fiscal 2023 financial goals. It’s because of that work that I see significant opportunities for growth, including growing TAM from things like accelerating digitization in AEC, the convergence of design and make in manufacturing and expansion into adjacent verticals, like you saw us do recently with the acquisition of Innovyze that got us into water infrastructure. We're also focused on further monetizing our TAM in a variety of ways. Some examples include conversion of non-compliant users. Andrew mentioned that billings from non-compliant users almost doubled year-over-year in Q1, and we're seeing more direct selling as I just mentioned. And that direct selling gets us greater price realization. That is another growth driver for us. This is all against a macroeconomic backdrop that we see improving. And it's because of all of this that we're confident in our fiscal 2023 revenue growth potential and the free cash flow target of $2.4 billion in that period. Now I've been back for 90 days, less than 90 days actually, so next step for me is more work on the long range financial plan and getting a deeper understanding of our past in fiscal 2024 and beyond. Our goal is to drive double-digit growth using some kind of Rule of 40 type framework over time.
Saket Kalia: Very helpful. Thanks for your time guys.
Operator: Thank you. Our next question comes from the line of Adam Borg from Stifel. Your line is now open.
Adam Borg: Hey, guys, and thanks for taking the question. Maybe just on Upchain. So obviously, I know that just closed a few weeks back. I was just curious if you can talk more about the vision over time of integrating Upchain with Fusion and Forge and how we should even think about the convergence of both Vault and Upchain just given that the similarities obviously once on-prem and once in the cloud?
Andrew Anagnost: Yes. Excellent question, Adam. So as you know, Upchain is PLM and PDM, Product Data Management and Product Lifecycle Management in the cloud. So it's a fully cloud native application. It's got both Product Data Management and PLM. It understands both files and cloud information models like what power fusion, for example. Our vision for how this is going to work, if Fusion already has a stack built on its cloud information model, that goes all the way through simple data management up through into Product Lifecycle Management. Upchain will likely replace that capability within Fusion over time. But more importantly, what Upchain does is it supports a whole swath of legacy applications from our competitors and from other places. So what we're going to do is we're going to go into counts with legacy applications or where we see overlap with other applications and combined a Fusion stack and the Upchain stack to handle the whole swath of data our customers use. Now ultimately as well what we're going to do is we're going to integrate Upchain with Vault, so that Vault can now have a extension to the cloud. We're not going to force our Vault users to move from on-prem to the cloud. Vault is a very popular application, we sell a lot of it every quarter, and we're going to continue to update and maintain it. You might've noticed that we just released mobile and extension to it in some web extent – additional web extensions capability for Vault. So we continue to drive Vault, but we are going to integrate Vault and Upchain over time, which will give our Vault customers a path to putting all their data in the cloud as they see fit to do it. But we're not going to force that migration. So look for it to replace the guts of Fusion lifecycle over time and integrate with Fusion cloud information model and look for it to integrate with Vault over time and provide a path for Vault customers to the cloud. And then ultimately look for us to be going after legacy systems with a combination of our Fusion offering and Upchain capability to bring all the customer's data and all the applications the customer use together in one robust cloud environment.
Adam Borg: That's great. Andrew. Maybe just a quick follow-up just on the Autodesk Construction Cloud, you cited some nice examples of some customer wins in the quarter. Just as you think about that business over the course of the year, especially with the improving macro kind of, how are you thinking about that business as the year progresses? Thanks so much.
Andrew Anagnost: Yes. We have really high expectations for how that business progresses as the year progresses and we're getting – we're definitely getting some good indications. One of the things we watch are the bid, the activity on Bid Board through our BuildingConnected service. That activity has been going up in Q1. It's been progressively going up each month, which is great. So we see a lot of activity heading into there. Just like a lot of our businesses, we expect some of the new business to be backend loaded, but we're super happy with where we are right now. We had a good launch of Autodesk Build, it's getting good take-up and monthly active usage from some of our customers, new customers are embracing it. Our international expansion efforts that we put on hold last year because of the pandemic are now moving into full gear this year. Later this year, we rollout Autodesk Build to the channel and that's going to accelerate Build’s business. And one of the things I just want to highlight is why we're winning, okay, and why we continue to win business and why we're so incredibly confident about the future. Here's what customers tell us, right. The end-to-end solution that we offer all the way from planning, early planning through design, through pre-construction, through pre-construction planning to site execution all the way to digital handoff to actual maintenance and operations of the asset. Nobody has this, especially to the depth that we have in each one of those disciplines. The other thing that people are really excited about is the deep integration with BIM and in fact that it's a BIM-native platform. It speaks BIM from the get-go, it will always speak BIM, and it's really good at it. This is driving more and more displacement in competitive solutions and accounts where we overlap. And one of the other big things that we hear from customers is our business model flexibility, all right. Customers love that they can buy from us, where they need to buy from us and how they need to buy from us, all right. If you need a project-based license, we've got it. If you need a consumption-based model, we got it. If you need a per-user model, we got it. We adapt and flex our business model to whatever the particular customer's needs are or their ecosystems needs are. And we can do it anywhere in the world. So if we're dealing with an international customer, they know that when they standardize on us, they can get everywhere with the solution we do. So that's why we're winning. That's why we're bullish as we move into the next year and why we're excited about the construction market becoming hot and active again. The digitalization of this market a multi-year trend, there's lots of opportunity for lots of people, and we're seeing lots of validation in the direction we're heading. And I think it's going to be an exciting year for digital construction.
Adam Borg: Great. Thanks again.
Operator: Thank you. Our next question comes from the line of Joe Vruwink from Baird. Your line is now open.
Joseph Vruwink: Great. Hi, everyone. Maybe just to focus on Fusion 360. I think the first disclosure on commercial subs was about a year ago and 152,000 is up about 80% since then. Andrew, when you mentioned that business being at a tipping point or I think you might've surpassed the tipping point, is it just a function of scale and customer awareness now that the product is as large as it is, or are there other dynamics at play that you would point to as kind of supporting the business through this fiscal year?
Andrew Anagnost: Well, there's a lot of things. One, there's the increased interest in the cloud, all right. There's the simple network effect of people saying, you know what, I displaced my Mastercam solid works with Fusion and you should try that too. It's awesome. So we're getting that network effect of people basically encouraging each other to move forward and get off the legacy systems and move to the cloud with Fusion. So we're seeing some of that. We're also seeing, and this is super important. We're seeing increased purchases within accounts we penetrated previously, which means we're moving from kind of being a niche solution inside these companies or maybe a partially piloted solution to production. And that's also an important driver. And we expect these trends to continue this year and continue moving forward. And one of the really exciting things about this as we talk about growth beyond FY2023 and into FY2024 and FY2025 beyond, the early success we're seeing in Fusion right now is going to be a growth engine that continues to accelerate over the next five years. Especially as we start introducing our new design, our extensions, we already have one for advanced manufacturing. We have various other extensions. There's going to be new extensions in the second half of the year. Those extensions continue to be out there. We're particularly excited that we sold more Fusion than other applications in Q1 without any type of promotional activity. All of this points towards increasing customer demand for what we're doing.
Joseph Vruwink: Okay. That's great. And then just on the comment that in regards to your construction end markets, uncertainty is lessening. I appreciate no sale is ever easy. But are there things that become easier. The fact that license compliance billing seemed to have had a good quarter coinciding with a better backdrop. Is that something that accelerates as the year goes on or will you maybe point to other areas of your business as well?
Andrew Anagnost: I'm sorry, could you – you want to have a little bit for me on the last part of that, the part of the question what's the key point the question here, sorry.
Joseph Vruwink: With uncertainty lessening license compliance and having those conversations seems like that could be one area to benefit. Are there other areas as well?
Andrew Anagnost: Yes. Okay. So as I've said, many times license compliance is one of these areas that we're just going to build a steady drum beat on, all right. It's going to be the gift that keeps giving for years and years to come. We do not want to accelerate it unnaturally because we want to bring our customers along with us. We want to keep them happy, help them get compliant. You notice the story that I offered up in Indonesia about that, customer actually buying premium subscription as well as becoming compliant and being happy about how they were able to deploy it. That's the kind of outcomes we want from this solution. So we did see some acceleration. You saw the growth numbers in the opening commentary around non-compliant billings in Q1. But that was off of a Q1 that was previously off. So we had a really strong compare. Don't expect any hockey sticks though the Q1 of this year was better than the Q1 of fiscal 2020. So you're seeing continued growth, which is what we want to see is nice, steady growth in this business. But don't look for any hockey sticks this year. We're back to the path we were on previously.
Joseph Vruwink: Great. Thank you very much.
Andrew Anagnost: You’re welcome.
Operator: Thank you. Our next question comes from the line of Matt Hedberg from RBC Capital. Your line is now open.
Matthew Hedberg: Well, great. Thanks for taking my questions. Andrew, I wanted to go back to the construction site again. Obviously, the cost of building just continues to go up from a material spaces. I know you guys have talked about the amount of waste globally that comes from construction site. Is that having a positive impact on pipeline generation as a lot of these construction firms, I just have to think and customers have to become more – way more efficient. Is that a portion of your pipeline growth there?
Andrew Anagnost: Matt, that's a very astute observation, all right. It's too early to say the cost of – the increases in cost of material is driving increased focus on digitization. But it is one of those things that we have constantly highlighted as one of the reasons why the value chain for construction needs to digitize because when material prices have gone up the way they have, you can't afford to over purchase in waste materials. So I can't tell you precisely if this is one of the pipeline drivers. But I can tell you that we're mentioning it to customers, and we're having with customers about, hey, conversations with customers. You want to keep your material costs down, digitize, right. Plan for less waste, only order what you need. So it's definitely entering into the conversation. I think it's too early to say if it's driving acceleration in the pipeline. But I think it's likely that it is.
Matthew Hedberg: That's really great to hear. And then – thank you for that. And then Debbie, welcome from me as well. I guess, one of the questions that we always get, and I'm sure you get as well, is that sort of what gives you confidence in that kind of that hockey stick cash flow guide for fiscal 2023. Now you had a little bit of time to kind of reflect on the model. What's sort of your view on some of the major drivers? I know we've heard Scott talk about them in the past. But just sort of curious on your perspective that gives you really that confidence that was clear in your remarks?
Debbie Clifford: Yes, sure. Matt, good to talk to you too. In large part, it's a lot of the things that I mentioned before. I think it's the combination of a growing TAM as well as further monetization of our TAM. And so that continued digitization in AEC with more innovation in Revit with expanding BIM mandates and ongoing BIM proliferation around the world with the digitization of construction that Andrew just talked about. Even the infrastructure bill could be a wildcard for us. We're hopeful, although nothing is baked into our numbers at this point. But these are all the multiple growth drivers that give me confidence in the ramp. I think some of the other data points that we have out there, I'll repeat because these are the things frankly that I've been looking at to get my own sense of confidence into that ramp into fiscal 2023. The conversion of non-compliant users, the fact that those billings doubled in Q1, and we're seeing more success with that program, the fact that we are selling more direct, that's a driver of growth for us, and ultimately will translate to free cash flow over time. The improving macro economic backdrop, all of these factors combined are what gives me confidence in our ability to achieve our revenue growth potential in fiscal 2023, as well as that free cash flow number of $2.4 billion.
Matthew Hedberg: Thanks, Debbie.
Andrew Anagnost: Matt, I'll just reinforce some of the things that Debbie said because I don't think we can talk about this enough because – did you notice the list of things she gave there, right. There's a whole set of horizontal things just around the normal business, the non-compliance, the new types of subscription models, the rollouts of consumption, the accelerating growth in our end markets. All of that combined also with the strategic levers around digitization in AEC around the convergence of design and make of what we're seeing with Fusion, and then the whole move into new adjacencies that we're doing. Any one of those things could contribute to viable long-term growth. We have all of those levers to pull. All right, I just want to remind we have all those levers to pull. And in August, we're really good at picking and choosing the levers to pull when we need to pull them.
Matthew Hedberg: Sounds great. Thanks a lot guys.
Operator: Thank you. Our next question comes from the line of Sterling Auty from JPMorgan. Your line is now open.
Sterling Auty: Yes. Thanks. Hi, guys. One housekeeping one to start, can you be specific in terms of what the contribution to the guide is from the acquisitions?
Debbie Clifford: Sure, Sterling. The impact on the acquisitions was a one point increase to our revenue guidance range on the year, a one point decrease to our operating margin range on the year, and it was neutral to free cash flow. That's consistent with what we said on the last call.
Sterling Auty: All right. Perfect. And then, Andrew, as we think going forward is Fusion 360 always incremental to kind of the installed base of traditional seats or have you already started to see a little bit of conversion one to the other? And if that's the case, what kind of change does that have on kind of the ARR contribution?
Andrew Anagnost: Yes. So nobody is moving from Inventor to Fusion right now, okay. It's just not happening, all right. It's actually – most of the businesses about going after incremental seats inside of competitive accounts, especially down market. The one great thing about our strategy is most of the Inventor is bought through collections, which includes Fusion. So if an Inventor user does start to move to Fusion over time, they continue on the same subscription path we'll do. And what we'll do with our collections is some of the extensions that would be available to a vanilla Fusion user that they have to pay for would be included with the collections version. So essentially what you see is a kind of an AFP neutral conversion from Inventor to Fusion, but that's going to take a long time. Most of the Inventor customers are going to stay comfortably where they are. But when they do move, it's essentially AFP neutral in terms of impact on our ARR. It doesn't change the ARR trajectory not materially.
Sterling Auty: Excellent. Thank you.
Operator: Thank you. Our next question comes from the line of Jason Celino from KeyBanc Capital. Your line is now open.
Jason Celino: Great. Thanks for taking my questions. Maybe one, the ambitions in infrastructure, Andrew, you talked about the gains in roads and bridges with improvements to Civil 3D and the expansions in the water here. But how do you think about some of those other areas of infrastructure, maybe some of the electric utilities or other areas?
Andrew Anagnost: Yes. So right now, Jason, we're going to stay focused on road and rail and bridges and the things that go along with road and rail and water, that's going to be our focus area. There's a lot of exciting things happening with elastic grid designs and the electrification and things associated with that. We're not going to be focusing on that right now. We may in the future, but right now, if you look at – even if you look at where the infrastructure bill is going for instance. Most of it is going to the upgrading and expanding the deteriorating infrastructure we have in the company around road, rail, bridges, civil and water infrastructure. And that's going to be our sweet spot for awhile – wins in that respect.
Jason Celino: Okay. And then you also talked about the – why Autodesk wins in construction which was quite helpful. But you also alluded to the digitization opportunity there just being more broadly bigger. Maybe can you talk about how much of that TAM might be coming from pure greenfield versus displacements of legacy or in-house or other competitor tools? Thank you.
Andrew Anagnost: Yes. A lot of the TAM is greenfield. Really sometimes what you're competing with here is some kind of free tool and excel spreadsheets or a lack of any digital process whatsoever beyond emailing PDFs, right. So there's a lot of greenfield opportunity here in addition to kind of just flipping existing customers off of legacy systems or consolidating their systems. So there is a very robust long tail of growth here that's going to go on for years. That's why it's so exciting to see all the activity in this space because it's going to take a village to deal with digitize this entire market, and we're at the very, very early stages of this, which is great.
Jason Celino: Great. Appreciate the color. Thank you.
Operator: Thank you. Our next question comes from the line of Gal Munda from Berenberg. Your line is now open.
Gal Munda: Hi Andrew, hi Debbie and the team. Thanks for taking my questions. The first one, Andrew, maybe just a little bit on construction, new construction portfolio is really expanded and inspired very strong now. I'm just wondering, how should we think about the individual brands that you acquired between PlanGrid, Assemble, BuildingConnected, Pype on one side and then Autodesk Construction Cloud on the other side, in terms of user adoption. And do you see users that came in for individual brands now starting to kind of move towards the platform approach as well?
Andrew Anagnost: Yes. Excellent question, Gal. As you know, Gal, Autodesk Build and the Construction Cloud in general is the unification of all those brands and it's where we leave with new customers. Absolutely, when we're going out there chasing new businesses, Autodesk Build, it's all the capabilities that are built into Autodesk Build, it’s Autodesk Takeoff, it’s all of those tools associated with the Construction Cloud and that's where we lead. But we're also seeing people migrate off of the individual brands and move forward, all right. So we're seeing the same kind of thing happening incrementally. But that's not – we're going to let those people move at their own pace, right. So when they're choosing to move on to the consolidated cloud, they're doing that by choice. And as part of a process over time, we will ultimately migrate all of them to Construction Cloud and Autodesk Build. But right now, we're leading it with our new customers of Autodesk Build and helping customers consolidate on the Autodesk Build when they want to bring some of those old brands along with them. But all the best technology from all those brands is in the Construction Cloud now.
Gal Munda: Understood. Thank you. And maybe Debbie, just another question for you. I completely understand the Q1 is the smallest quarter in terms of new business generation and in terms of the [indiscernible] as well. So what I wanted to touch though so might not have been a good time to kind of organically think about raising the guidance for the year so early in the year. I'd like to just kind of take a step back and think about what happened during Q1 and what you're seeing so far in Q2. If that kind of a level of trading and recovery continues, we decide to say that you feel pretty confident about your full-year guidance then?
Debbie Clifford: I mean, we issued the guidance today that we feel comfortable with. And I would say that we certainly have a strong sense of optimism based on the results that we had in Q1, but it's just too early for us to change the underlying view on a year after only one quarter, but we're off to a good start.
Gal Munda: Got you. Thank you.
Operator: Thank you. That is all the time we have for Q&A today. I would like to turn the call back over to Simon Mays-Smith for closing remarks.
Simon Mays-Smith: Thank you, everyone for joining us. Look forward to chatting to you next quarter, updating you on our performance. If you have any questions in the meantime, please just ping me directly, happy to answer your questions. Thanks very much.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and thank you for standing by. Welcome to the Autodesk, Inc. Q1 2022 Earnings Conference Call. At this time, all participants are in a listen-only model. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Simon Mays-Smith, VP, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks operator, and good afternoon. Thank you for joining our conference call to discuss the results of our first quarter of fiscal year 2022. On the line with me are Andrew Anagnost, our CEO, and Debbie Clifford, our Chief Financial Officer. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During the course of this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities, and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K, for important risks and other factors including developments in the COVID-19 pandemic and the resulting impact on our business and operations that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote a number of numeric or growth changes as we discuss our financial performance and unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. I hope you and your families remain safe and healthy. While parts of the world emerge from the pandemic, others are entering the eye of the storm. I especially want to acknowledge our colleagues, family and friends in India. We are thinking about you and we are helping wherever we can. Thank you to all our employees and their families, our partners, and customers for their continued resilience, patience, and commitment. Our first quarter marks an important inflection point. While solid execution, a resilient subscription business model, and continued secular shift to the cloud underpinned our strong first quarter results, waning uncertainty and growing confidence in our end markets generated momentum. Robust growth in new product subscriptions, combined with improving usage and renewal rates, accelerated billings and RPO growth to 10% and 22%, respectively. Together, these reinforce our confidence that we are through the revenue growth trough and on track to achieve our fiscal 2022 and 2023 goals. In mid-May, we completed the acquisition of Upchain, a cloud-native product-data and lifecycle management solution. Combined with existing Autodesk offerings like Fusion 360, Upchain will profoundly simplify data-sharing and collaboration for engineers, manufacturers, suppliers, and other product stakeholders, enabling customers to bring products to market faster and build a stronger supply chain. Its next-generation platform enables it to be rapidly deployed, scaled, maintained and updated without the expensive, inflexible and time-consuming integrations of legacy systems. We will grow Upchain through our enterprise and channel partnerships, and expect it to become a meaningful on-ramp for legacy design tools to the Fusion 360 cloud ecosystem and facilitate further expansion in adjacent verticals. As we highlighted in our recently published Impact Report, the convergence of design and make brings both greater efficiency and sustainability to buildings, and a broad range of manufactured goods, stretching from EVs and bicycles to high-performance skis and low-cost ventilators. While we are enabling customers to achieve their sustainability targets, we continue to lead by example, reaching our carbon-neutral goal across our business and value chain in fiscal 2021. The report also sets out new diversity, equity and inclusion goals. And while I am proud that 50% of Autodesk’s Board, and 45% of our Executive Team, are women, we can and will, do more both internally and through partnerships with organizations like JFFLabs externally. As we recently announced, Pascal Di Fronzo, Autodesk’s Executive Vice President of Corporate Affairs and Chief Legal Officer, will be retiring in December after 23 very successful years at the company. He has been a trusted counselor and steward of the company. His contributions to Autodesk are many and have been incredibly impactful, and I want to thank him for his dedication and wish him all the best in retirement. I am very excited to welcome Debbie back to Autodesk and will now turn the call over to her to take you through the details of our quarterly results and guidance for the year. I will then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. I am very excited to be back. Looking at the first quarter’s results, several factors contributed to our strong financial performance, including robust growth in new product subscriptions, accelerating digital sales, stronger than expected upfront revenue and improving subscription renewal rates. In addition, a one-month contribution from Innovyze and foreign exchange rates provided a modest tailwind to the quarter. Total revenue in the quarter grew 12% and 11% in constant currency, with subscription revenue growing by 18%. Looking at revenue by product and geography, AutoCAD and AutoCAD LT revenue grew 9%, AEC revenue grew 16%, and manufacturing revenue grew 8%. Excluding the impact of moving our Vault product to ratable revenue recognition, which we discussed last quarter, manufacturing revenue grew double digits. M&E revenue grew 5%. Across the globe, revenue grew 8% in the Americas, 11% in EMEA, and 20% in APAC. Direct revenue increased 25% and represented 33% of our total revenue, up from 30% last year due to strength from both enterprise and ecommerce. Our ecommerce sites had their highest new billings growth rate in two years driven by strong traffic growth and recent site enhancements. Reflecting the business-critical nature of our products to our customers, our net revenue retention rate remained within the 100% to 110% range and our product subscription renewal rates strengthened. Our billings accelerated 10% to $974 million. Total deferred revenue grew 11% to $3.35 billion. Short-term deferred revenue increased 17%, primarily reflecting growth in new product subscriptions and increasing renewal rates, but also the inclusion of Innovyze. This was partly offset by a smaller contribution from long-term deferred revenue resulting from fewer multi-year contracts when compared to last year. Total RPO of $4.23 billion, and current RPO of $2.86 billion, both grew 22%. Current RPO growth was primarily driven by the increase in short-term deferred revenue, but also by strong growth in enterprise business agreements and to a lesser extent, early renewals ahead of anticipated price increases. Excluding the contribution from early renewals and Innovyze, current RPO grew approximately 20%. Non-GAAP gross margin and operating margin remained strong at 92% and 28%, respectively, broadly level year-over-year and reflecting the trough in revenue growth relative to cost growth. We delivered healthy free cash flow of $316 million during the quarter driven by collections of prior quarter billings and strong results in the current quarter. Consistent with our capital allocation strategy, we continued to repurchase shares with excess cash to offset dilution from our equity plans. During the first quarter, we purchased 515,000 shares for $143 million at an average price of approximately $277 per share. Now I’ll shift to giving you my initial thoughts as CFO and then finish with our outlook. Since I rejoined Autodesk about two months ago, I’ve been focused on two things: First, reacquainting myself with everything Autodesk, the team, our strategy, and how we’ve evolved during my two years away; and second, I’ve been digging deep to gain a solid understanding of our fiscal 2022 budget and fiscal 2023 financial goals. On the first point, while much at Autodesk is familiar to me, I’ve been pleasantly surprised by how much has changed for the better reflecting the enormous progress Autodesk has made over the last two years. Autodesk has undergone a cultural revolution. There’s been a powerful shift in the company’s values and ways we work and the pace of decision-making has accelerated. As a company, we now benefit not only from the scale of our operation, but also from a newfound agility that is enabling our success in newer markets like construction and manufacturing in the cloud. I’m also struck by the compelling and expanding opportunities ahead of us. Digital transformation is happening now, it is real, and we are well-positioned to capitalize on that trend in the industries we serve. As I begin to turn my attention to our long-range financial plan, these initial learnings give me confidence in our growth potential in fiscal 2024 and beyond. Let me finish with our guidance, which now includes Innovyze and Upchain. We still expect that an improving economic environment during the year will result in strong growth in new business over the course of fiscal 2022. We expect product subscription renewal rates to continue to be healthy, and our net revenue retention rate to remain between 100% and 110%. Given our subscription model, revenue growth will lag the improving sales environment. We continue to expect about three quarters of our free cash flow to again be generated in the second half of the year due to our economic phasing assumptions and normal seasonality. For fiscal 2022, we are raising our full-year revenue guidance to a range of $4.305 billion to $4.385 billion, or a 14% to 16% increase over last year, reflecting a partial year contribution from acquisitions net of the deferred revenue write downs. Given our results are weighted in the second half, and Q1 is our seasonally smallest quarter, it’s obviously too early to change our view on the underlying trajectory of the year, but we are off to a good start. We expect non-GAAP operating margin to expand to between 30% and 31%, which includes approximately 1 percentage point of negative headwind from acquisitions. Finally, we still expect free cash flow to be around $1.6 billion with a broadly neutral impact from acquisitions. The slide deck on our website has more details on modeling assumptions for the second fiscal quarter and full-year 2022. With improving economic conditions and easier comparables, we still expect our first quarter revenue growth will be the trough. Our accelerating momentum in fiscal 2022 will propel us into fiscal 2023 and I am therefore confident in our fiscal 2023 revenue growth potential and free cash flow target of $2.4 billion. As I begin to look beyond fiscal 2023, the digital transformation of the industries we serve, our sustained investment in the cloud, and our flexible business model, give us a robust platform for double-digit growth. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Let me finish by giving you an update on our strategic growth initiatives. The secular trends we have been investing in for years have accelerated during the pandemic. The digitization of AEC, the convergence of design and make, and our expansion into adjacent verticals through organic investment and acquisitions are growing our total addressable market. The evolution of our business model, the value generated by the growing connectivity of our platform for new and legacy customers, and the hardening of our systems to non-compliant users, enable us to attract and retain more of that potential opportunity, growing our ecosystem and the usage and value we generate from it. Turning to AEC, our unique vision is to connect all the phases of construction with end-to-end, cloud-based solutions that combine horizontal data flow with best-in-class functionality to enable seamless collaboration from planning, design, pre-construction, construction, asset operations and maintenance. The breadth and depth of our solutions distinguish us in the market and we continue to build on that advantage through industry leading R&D, which we sustained through the pandemic and acquisitions. Our latest product releases reflect that. For example, Revit 2022 is a bridge to more open and interoperable ways of working that accelerate our design customers' digital transformation and improve communication of design intent across all disciplines and project phases. For construction teams, we released Autodesk Build, Autodesk Takeoff, and Autodesk BIM Collaborate, as well as product enhancements which further empower construction teams to drive better business outcomes such as winning more business, reducing rework, delivering projects on time and improving safety by connecting data, workflows and teams across the project lifecycle. As the construction backlog comes back online, and the new project pipeline builds, we are emerging from the pandemic stronger. This is reflected in our success during the quarter. For example, Burns & McDonnell is a family of companies bringing together an unmatched team of 7,600 engineers, construction professionals, architects, planners, technologists and scientists to design and build critical infrastructure projects. It is at the forefront of technology use and having invested in Revit and BIM 360 Design some time ago, most of its data is already in the cloud. Monthly Active Users or MAUs on Autodesk software have grown by 80% since 2018. This quarter, Burns & McDonnell renewed its Autodesk EBA and increased its investment with us, adding more cloud-based products from the Autodesk Construction portfolio, including Autodesk Build, Pype, Assemble, and Building Connected. Our unified common data platform enables it to move and collaborate seamlessly from design through construction and to implementation with common workflows across multiple, global practices. 1898 & Co., part of Burns & McDonnell and its future-focused consulting and technology solutions division, and it is a founding participant in our Tandem digital twin program. The Boldt Company is a $1 billion professional construction services firm in the U.S., focusing on integrated delivery of complex vertical construction projects that require extremely tight collaboration between stakeholders and integrated workflows between industry partners, the office and field. Boldt was already relying on BIM Collaborate Pro and PlanGrid when, this quarter, it selected Autodesk Build over a directly competitive construction project management solution and also invested in Pype. Autodesk Construction Cloud’s unified platform connects previously siloed data, reduces rework and saves time for Boldt across the company, enabling teams to easily manage projects from planning and design through to the field and handover. And MultiGreen, a real estate development and operating company specializing in sustainable and tech-enabled multifamily housing in high-growth and supply constrained markets, standardized on Autodesk Construction Cloud. In order to build more efficiently and sustainably, they knew they had to standardize on a single platform to connect their teams from concept and design through project completion and day-to-day operations. In addition to Revit, Inventor, BuildingConnected, Autodesk Takeoff and Autodesk Build, they will be using BIM 360's integration with the Embodied Carbon Calculator to analyze material carbon emissions with all of their data connected through our common data environment. In infrastructure, we released Civil 3D, InfraWorks, AutoCAD Map 3D, AutoCAD Plant 3D and ReCap Pro with enhancements in transportation, water, plant, land development and reality capture. Most importantly, we continue to mature our project delivery platform across design and construction to better support digital project execution that helps our customers increase operational efficiencies, make better design decisions, increase quality, and reduce cost and material waste. During the quarter, we received notice of an award in design from the Montana Department of Transportation. Instead of a competitor offering, they will now be using our AEC Collection, which includes Civil 3D, Revit, InfraWorks, Navisworks, ReCap and our Common Data Environment, Autodesk Docs. The Department was particularly impressed by connected bridge design workflows between Revit and InfraWorks that drive efficiency and sustainability. Turning to manufacturing, we’ve made significant organic investments in addition to Upchain. Inventor 2022 introduced new features and enhancements to speed up product development and interoperability with AutoCAD, Fusion 360 and Revit. In Fusion 360, we have introduced new functionality across the entire product development process and numerous integrated extensions that unlock advanced design and manufacturing technologies. In Vault, we introduced a new mobile application and web browser experience for engineers and non-CAD users to access their real-time data anywhere and on any device. The potential to converge design and make in the cloud is becoming more of a reality every day to our customers. Autodesk continues to lead that transition. AAC Technologies, the world's leading solutions provider for smart devices, grew its investment with Autodesk. Having struggled with data management and data integrations in their product lifecycle management using a competitor’s 3D modeling product, AAC Technologies switched to our Product Design and Manufacturing Collection with Vault to manage all their data. They found our connected workflows particularly attractive and believe they will improve productivity and collaboration across their teams and enable them to go-to-market more effectively by increasing flexibility in their supply chain. For data management, our customers can now choose Vault for on-prem and Upchain as they transition to the cloud. With the largest number of new commercial users in 2020, Fusion 360’s strong momentum continued, growing commercial subscriptions to 152,000 without any systematic cost promotions. While still early in its lifecycle, we believe Fusion 360 has reached an adoption tipping point and with extensions and Upchain, we are excited about its future. During the quarter, a UK-based design, manufacturer, and installer of architectural precast facades invested in Fusion 360 with its nesting and fabrication extension. By converging the design and manufacturing processes into a single unified experience in the cloud, Fusion 360 enables faster design, prototyping and go to market. By creating optimized and associative multi-sheet layouts for sheet metal and non-sheet metal parts in preparation for cutting on CNC machines, our nesting and fabrication extension helps them to significantly reduce waste. Last month, three students from Danville Community College in Virginia won the inaugural Project MFG National Championship, an advanced manufacturing competition, sponsored by the U.S. Department of Defense. Jeremiah Williams, Director for Integrated Machining Technology at Danville Community College said: “By testing a variety of advanced skills, like welding and multi-axis machining, as well as communication and teamwork, the Project MFG National Championship is one of the most challenging skilled trade competitions in the country. Fusion 360's next-generation platform enabled our team to complete all required and optional objectives, from prototype through to welding and machining the finished product, and to win this prestigious prize.” As announced last quarter, we extended our multi-user trade-in to August 2023, but we are still seeing customers convert and benefit from the transition to named user. SSP, one of the leading Integrated Design Offices in Germany, traded in their multi-user licenses with us this quarter and significantly increased their investment by purchasing additional AEC collections and premium subscriptions. In the process, they completely replaced a competitive design solution, standardizing their workflows on our cloud platform. The premium plan is especially valuable to them as they improve their site-to-site management using single sign-on which enables more digital collaboration, and efficiency while increasing employee satisfaction. While we continue to be sensitive as the economy recovers, we are successfully converting non-compliant users to paying customers with Q1 license compliance billings almost doubling year-over-year during the quarter. For example, a non-compliant customer converted into one of our largest premium customers to date. Over 500 branches in Indonesia made it difficult to track and manage software usage, and this customer was inadvertently using more licenses than it was paying for. After completing a self-audit, which confirmed the software gap, it purchased premium to help manage the complex roll-out of compliant licenses. They are now a happy premium customer with detailed usage insights and the ability to flexibly manage their licenses from headquarters across their entire branch network. Now let me finish with a story. Construction began on Notre Dame cathedral in 1163, but was not completed for more than 100 years. In a 12th century version of light weighting, Notre Dame was the first Gothic structure to use flying buttresses, which are slanted beams that support the heavy walls and ceilings that enable giant rose glass and stained-glass windows in large edifices with open-aired space beneath them. Following a catastrophic fire in 2019, the cathedral is being rebuilt with traditional and sustainable materials enhanced by next-generation Building Information Modeling provided by Autodesk. Combining traditional design and build know-how with modern workflow solutions, reconstruction is expected to be completed in 2024, in time to welcome athletes at the summer Olympics in Paris, and future generations from across the globe. I share this because, as the world rebuilds after the catastrophic impact of the pandemic, I am reminded again that Autodesk’s purpose to enable its customers to build and manufacture efficiently and sustainably has never been more important or urgent. Together, we can meet the generational challenges posed by carbon, water and waste. Autodesk’s central role in meeting these challenges underpins my confidence this year and my confidence in the future. With that, operator, we would like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is now open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening, Andrew and Debbie. Let me ask you, Andrew first, a couple of business and technology or technology evolution questions. You highlighted infrastructure, and the company has been in that business for many, many years and you’ll recall that once upon a time, it was in fact a reporting segment and maybe should be again at some point. Could you describe the main ways in which that business has evolved over the last number of years in terms of its scope or its customer base and what the vision really is for that business in terms of perhaps adding new types of customers, such as owner operators that have not really been a large part of your business profile to date? Secondly, since we're halfway between AU 2020 and AU 2021, could you update us on some of the important initiatives that you yourself highlighted during your Q&A session at AU six months ago? Namely, the Forge roadmap and its implications for you long-term, and then secondarily, sharing technology across the portfolio and across industries. In other words, leveraging your R&D more and more across the company in that respect?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. All right, Jay. So let me start with the infrastructure discussion. So here's what's fundamentally staying with the business. One, we've been winning more and more department of transportation as we've progressed since the last time the infrastructure business was broken out. And what we did is we focused our organic portfolio very much on road and rail work, bridges, roads and rails, and created a lot of workflows between Civil 3D and InfraWorks and some of our specific tools. And we've been very happy with the progress we've been making there and we continue that organic investment targeting those pieces of infrastructure. We don't feel it needs to be broken out into a separate business because I think you might recall, since those days, we've moved our entire sales organization to account-based sales. So it's very easy to cover these types of customers with the kinds of support that we need to engage with them directly. Look, buttress next, as you can see with what we've been doing with Tandem and the digital twin work, and also with what we've required with Innovyze with their Info360 solution and some of the tools around there with digital twins for water waste management and water management, we are definitely moving closer to things that are directly relevant to owner operators, and you would expect to see us do more of that as time progresses, okay. So that kind of gives you a sense for what we are looking at and how we've gotten here. With regards to AU initiatives, I don't want to kind of preempt next day use announcements. But what I'll tell you is we continue to add additional capabilities to Forge into the APIs. And I think in this coming AU, you're going to hear me talk a lot more about some of the common experiences we are creating across some of our new environments that we are building for our various customers. So I want to hold onto some of that news as we move forward to the next AU. But the hint is there's some common data experiences. There's some common ways of managing and accessing projects that we are developing and deploying. All things that are relevant to making the platform more powerful for bringing together the various products that our customers use."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. For Debbie quickly, you highlighted strong growth in product subs. If you're able to look at that in absolute terms, how would that product subs level of business compare with, let's say the second and third quarter of last year, and perhaps even the fourth quarter. Are you now perhaps the highest level you've been in four or five quarters as far as product subs are concerned?"
},
{
"speaker": "Debbie Clifford",
"text": "The short answer is yes, we've returned to growth after a period of several quarters that were impacted by COVID. And so we're pleased with the growth that we saw in Q1 and that's evidenced in the revenue results."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Saket Kalia from Barclays. Your line is now open."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hey, can you hear me okay?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes."
},
{
"speaker": "Saket Kalia",
"text": "Excellent. Hey, thanks so much for taking my questions and welcome Debbie. Maybe first for you, Andrew, I'd love to dig into the new business acceleration you've touched on as we are starting this recovery. Maybe in particular, how much of this recovery do you feel is in demand? That is [the field is] tied to increased engineering hiring versus perhaps pent-up demand for tools post-pandemic just as we kind of think about the pace of this recovery going forward. Does that make sense?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. It's hard for me to break it in – break it down into increased engineering hiring versus kind of pent-up demand. So I can't really give you a fine grain view on that. What I can tell you is that usage of some of our more engineering intensive products is going up pretty significantly, okay. And we talked a lot about usage every year with regards to how the monthly active usage and the daily active usage going in various countries. What we've seen is the majority of our countries are now at or above pre-COVID levels. The UK is now above pre-COVID levels. The U.S. still struggling a little bit to get above pre-COVID levels, but showing a lot of robust impact. You also noticed – I think you probably watch the indexes out there, the PMI and the ABI indexes in particular. We have always found those indexes to be lagging indicators of our business. So they actually tell us that something has already happened with the purchasing behavior of our customers. And what you've seen is those indices continuing to shift towards growth, which hints at Saket that it's the book of work that's going up. All right, which means people are going to hire more engineers, they're going to hire more people and they're going to engage – they're going to be using our products more. So it's probably driven mostly by hiring related to the book of business of our customers is going up. The indices seem to indicate that as a lagging indicator of what we've seen in terms of purchasing behavior and usage, but that's kind of as much granularity as I can give you on that."
},
{
"speaker": "Saket Kalia",
"text": "That's super helpful, Andrew. Thanks. Maybe kind of follow-up for you Debbie, you touched on this a little bit in the prepared remarks. But I want to just talk about the acceleration in revenue this year. I think we get some of the drivers, but I'd love to sort of get your take and perhaps as part of that, your confidence in that growth lasting into fiscal 2023 and for that matter longer term as well?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Saket. I start by saying, so Q1 is our seasonally smallest quarter and our guidance assumes that we'll see improving results as the year progresses, which is consistent with what we're seeing. We're seeing uncertainty lessening, growing confidence from our customers and our channel and improving demand on our end markets, which is resulting in an accelerating growth in new business. We're also seeing increasing renewal rates, strong direct business, particularly through the e-store. Our total direct revenue grew 25% year-over-year in Q1, and now represents 33% of total revenue. We're also pleased that we're starting to see momentum and key indicators like RPO, which grew 22% year-over-year in Q1. And it's because of these factors that we're confident in the ramp during fiscal 2022. Now if I shift attention to fiscal 2023, and even beyond that, let me just break that down a little bit. I mentioned on the call that since I rejoined Autodesk, I've been focused on two primary things. The first is reacquainting myself with everything Autodesk, the team, the strategy, what's happened while I was away for a couple of years. And the second is digging deep to get a solid understanding of the fiscal 2022 budgets and our fiscal 2023 financial goals. It’s because of that work that I see significant opportunities for growth, including growing TAM from things like accelerating digitization in AEC, the convergence of design and make in manufacturing and expansion into adjacent verticals, like you saw us do recently with the acquisition of Innovyze that got us into water infrastructure. We're also focused on further monetizing our TAM in a variety of ways. Some examples include conversion of non-compliant users. Andrew mentioned that billings from non-compliant users almost doubled year-over-year in Q1, and we're seeing more direct selling as I just mentioned. And that direct selling gets us greater price realization. That is another growth driver for us. This is all against a macroeconomic backdrop that we see improving. And it's because of all of this that we're confident in our fiscal 2023 revenue growth potential and the free cash flow target of $2.4 billion in that period. Now I've been back for 90 days, less than 90 days actually, so next step for me is more work on the long range financial plan and getting a deeper understanding of our past in fiscal 2024 and beyond. Our goal is to drive double-digit growth using some kind of Rule of 40 type framework over time."
},
{
"speaker": "Saket Kalia",
"text": "Very helpful. Thanks for your time guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Adam Borg from Stifel. Your line is now open."
},
{
"speaker": "Adam Borg",
"text": "Hey, guys, and thanks for taking the question. Maybe just on Upchain. So obviously, I know that just closed a few weeks back. I was just curious if you can talk more about the vision over time of integrating Upchain with Fusion and Forge and how we should even think about the convergence of both Vault and Upchain just given that the similarities obviously once on-prem and once in the cloud?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Excellent question, Adam. So as you know, Upchain is PLM and PDM, Product Data Management and Product Lifecycle Management in the cloud. So it's a fully cloud native application. It's got both Product Data Management and PLM. It understands both files and cloud information models like what power fusion, for example. Our vision for how this is going to work, if Fusion already has a stack built on its cloud information model, that goes all the way through simple data management up through into Product Lifecycle Management. Upchain will likely replace that capability within Fusion over time. But more importantly, what Upchain does is it supports a whole swath of legacy applications from our competitors and from other places. So what we're going to do is we're going to go into counts with legacy applications or where we see overlap with other applications and combined a Fusion stack and the Upchain stack to handle the whole swath of data our customers use. Now ultimately as well what we're going to do is we're going to integrate Upchain with Vault, so that Vault can now have a extension to the cloud. We're not going to force our Vault users to move from on-prem to the cloud. Vault is a very popular application, we sell a lot of it every quarter, and we're going to continue to update and maintain it. You might've noticed that we just released mobile and extension to it in some web extent – additional web extensions capability for Vault. So we continue to drive Vault, but we are going to integrate Vault and Upchain over time, which will give our Vault customers a path to putting all their data in the cloud as they see fit to do it. But we're not going to force that migration. So look for it to replace the guts of Fusion lifecycle over time and integrate with Fusion cloud information model and look for it to integrate with Vault over time and provide a path for Vault customers to the cloud. And then ultimately look for us to be going after legacy systems with a combination of our Fusion offering and Upchain capability to bring all the customer's data and all the applications the customer use together in one robust cloud environment."
},
{
"speaker": "Adam Borg",
"text": "That's great. Andrew. Maybe just a quick follow-up just on the Autodesk Construction Cloud, you cited some nice examples of some customer wins in the quarter. Just as you think about that business over the course of the year, especially with the improving macro kind of, how are you thinking about that business as the year progresses? Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. We have really high expectations for how that business progresses as the year progresses and we're getting – we're definitely getting some good indications. One of the things we watch are the bid, the activity on Bid Board through our BuildingConnected service. That activity has been going up in Q1. It's been progressively going up each month, which is great. So we see a lot of activity heading into there. Just like a lot of our businesses, we expect some of the new business to be backend loaded, but we're super happy with where we are right now. We had a good launch of Autodesk Build, it's getting good take-up and monthly active usage from some of our customers, new customers are embracing it. Our international expansion efforts that we put on hold last year because of the pandemic are now moving into full gear this year. Later this year, we rollout Autodesk Build to the channel and that's going to accelerate Build’s business. And one of the things I just want to highlight is why we're winning, okay, and why we continue to win business and why we're so incredibly confident about the future. Here's what customers tell us, right. The end-to-end solution that we offer all the way from planning, early planning through design, through pre-construction, through pre-construction planning to site execution all the way to digital handoff to actual maintenance and operations of the asset. Nobody has this, especially to the depth that we have in each one of those disciplines. The other thing that people are really excited about is the deep integration with BIM and in fact that it's a BIM-native platform. It speaks BIM from the get-go, it will always speak BIM, and it's really good at it. This is driving more and more displacement in competitive solutions and accounts where we overlap. And one of the other big things that we hear from customers is our business model flexibility, all right. Customers love that they can buy from us, where they need to buy from us and how they need to buy from us, all right. If you need a project-based license, we've got it. If you need a consumption-based model, we got it. If you need a per-user model, we got it. We adapt and flex our business model to whatever the particular customer's needs are or their ecosystems needs are. And we can do it anywhere in the world. So if we're dealing with an international customer, they know that when they standardize on us, they can get everywhere with the solution we do. So that's why we're winning. That's why we're bullish as we move into the next year and why we're excited about the construction market becoming hot and active again. The digitalization of this market a multi-year trend, there's lots of opportunity for lots of people, and we're seeing lots of validation in the direction we're heading. And I think it's going to be an exciting year for digital construction."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks again."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Joe Vruwink from Baird. Your line is now open."
},
{
"speaker": "Joseph Vruwink",
"text": "Great. Hi, everyone. Maybe just to focus on Fusion 360. I think the first disclosure on commercial subs was about a year ago and 152,000 is up about 80% since then. Andrew, when you mentioned that business being at a tipping point or I think you might've surpassed the tipping point, is it just a function of scale and customer awareness now that the product is as large as it is, or are there other dynamics at play that you would point to as kind of supporting the business through this fiscal year?"
},
{
"speaker": "Andrew Anagnost",
"text": "Well, there's a lot of things. One, there's the increased interest in the cloud, all right. There's the simple network effect of people saying, you know what, I displaced my Mastercam solid works with Fusion and you should try that too. It's awesome. So we're getting that network effect of people basically encouraging each other to move forward and get off the legacy systems and move to the cloud with Fusion. So we're seeing some of that. We're also seeing, and this is super important. We're seeing increased purchases within accounts we penetrated previously, which means we're moving from kind of being a niche solution inside these companies or maybe a partially piloted solution to production. And that's also an important driver. And we expect these trends to continue this year and continue moving forward. And one of the really exciting things about this as we talk about growth beyond FY2023 and into FY2024 and FY2025 beyond, the early success we're seeing in Fusion right now is going to be a growth engine that continues to accelerate over the next five years. Especially as we start introducing our new design, our extensions, we already have one for advanced manufacturing. We have various other extensions. There's going to be new extensions in the second half of the year. Those extensions continue to be out there. We're particularly excited that we sold more Fusion than other applications in Q1 without any type of promotional activity. All of this points towards increasing customer demand for what we're doing."
},
{
"speaker": "Joseph Vruwink",
"text": "Okay. That's great. And then just on the comment that in regards to your construction end markets, uncertainty is lessening. I appreciate no sale is ever easy. But are there things that become easier. The fact that license compliance billing seemed to have had a good quarter coinciding with a better backdrop. Is that something that accelerates as the year goes on or will you maybe point to other areas of your business as well?"
},
{
"speaker": "Andrew Anagnost",
"text": "I'm sorry, could you – you want to have a little bit for me on the last part of that, the part of the question what's the key point the question here, sorry."
},
{
"speaker": "Joseph Vruwink",
"text": "With uncertainty lessening license compliance and having those conversations seems like that could be one area to benefit. Are there other areas as well?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. So as I've said, many times license compliance is one of these areas that we're just going to build a steady drum beat on, all right. It's going to be the gift that keeps giving for years and years to come. We do not want to accelerate it unnaturally because we want to bring our customers along with us. We want to keep them happy, help them get compliant. You notice the story that I offered up in Indonesia about that, customer actually buying premium subscription as well as becoming compliant and being happy about how they were able to deploy it. That's the kind of outcomes we want from this solution. So we did see some acceleration. You saw the growth numbers in the opening commentary around non-compliant billings in Q1. But that was off of a Q1 that was previously off. So we had a really strong compare. Don't expect any hockey sticks though the Q1 of this year was better than the Q1 of fiscal 2020. So you're seeing continued growth, which is what we want to see is nice, steady growth in this business. But don't look for any hockey sticks this year. We're back to the path we were on previously."
},
{
"speaker": "Joseph Vruwink",
"text": "Great. Thank you very much."
},
{
"speaker": "Andrew Anagnost",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Matt Hedberg from RBC Capital. Your line is now open."
},
{
"speaker": "Matthew Hedberg",
"text": "Well, great. Thanks for taking my questions. Andrew, I wanted to go back to the construction site again. Obviously, the cost of building just continues to go up from a material spaces. I know you guys have talked about the amount of waste globally that comes from construction site. Is that having a positive impact on pipeline generation as a lot of these construction firms, I just have to think and customers have to become more – way more efficient. Is that a portion of your pipeline growth there?"
},
{
"speaker": "Andrew Anagnost",
"text": "Matt, that's a very astute observation, all right. It's too early to say the cost of – the increases in cost of material is driving increased focus on digitization. But it is one of those things that we have constantly highlighted as one of the reasons why the value chain for construction needs to digitize because when material prices have gone up the way they have, you can't afford to over purchase in waste materials. So I can't tell you precisely if this is one of the pipeline drivers. But I can tell you that we're mentioning it to customers, and we're having with customers about, hey, conversations with customers. You want to keep your material costs down, digitize, right. Plan for less waste, only order what you need. So it's definitely entering into the conversation. I think it's too early to say if it's driving acceleration in the pipeline. But I think it's likely that it is."
},
{
"speaker": "Matthew Hedberg",
"text": "That's really great to hear. And then – thank you for that. And then Debbie, welcome from me as well. I guess, one of the questions that we always get, and I'm sure you get as well, is that sort of what gives you confidence in that kind of that hockey stick cash flow guide for fiscal 2023. Now you had a little bit of time to kind of reflect on the model. What's sort of your view on some of the major drivers? I know we've heard Scott talk about them in the past. But just sort of curious on your perspective that gives you really that confidence that was clear in your remarks?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes, sure. Matt, good to talk to you too. In large part, it's a lot of the things that I mentioned before. I think it's the combination of a growing TAM as well as further monetization of our TAM. And so that continued digitization in AEC with more innovation in Revit with expanding BIM mandates and ongoing BIM proliferation around the world with the digitization of construction that Andrew just talked about. Even the infrastructure bill could be a wildcard for us. We're hopeful, although nothing is baked into our numbers at this point. But these are all the multiple growth drivers that give me confidence in the ramp. I think some of the other data points that we have out there, I'll repeat because these are the things frankly that I've been looking at to get my own sense of confidence into that ramp into fiscal 2023. The conversion of non-compliant users, the fact that those billings doubled in Q1, and we're seeing more success with that program, the fact that we are selling more direct, that's a driver of growth for us, and ultimately will translate to free cash flow over time. The improving macro economic backdrop, all of these factors combined are what gives me confidence in our ability to achieve our revenue growth potential in fiscal 2023, as well as that free cash flow number of $2.4 billion."
},
{
"speaker": "Matthew Hedberg",
"text": "Thanks, Debbie."
},
{
"speaker": "Andrew Anagnost",
"text": "Matt, I'll just reinforce some of the things that Debbie said because I don't think we can talk about this enough because – did you notice the list of things she gave there, right. There's a whole set of horizontal things just around the normal business, the non-compliance, the new types of subscription models, the rollouts of consumption, the accelerating growth in our end markets. All of that combined also with the strategic levers around digitization in AEC around the convergence of design and make of what we're seeing with Fusion, and then the whole move into new adjacencies that we're doing. Any one of those things could contribute to viable long-term growth. We have all of those levers to pull. All right, I just want to remind we have all those levers to pull. And in August, we're really good at picking and choosing the levers to pull when we need to pull them."
},
{
"speaker": "Matthew Hedberg",
"text": "Sounds great. Thanks a lot guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Sterling Auty from JPMorgan. Your line is now open."
},
{
"speaker": "Sterling Auty",
"text": "Yes. Thanks. Hi, guys. One housekeeping one to start, can you be specific in terms of what the contribution to the guide is from the acquisitions?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure, Sterling. The impact on the acquisitions was a one point increase to our revenue guidance range on the year, a one point decrease to our operating margin range on the year, and it was neutral to free cash flow. That's consistent with what we said on the last call."
},
{
"speaker": "Sterling Auty",
"text": "All right. Perfect. And then, Andrew, as we think going forward is Fusion 360 always incremental to kind of the installed base of traditional seats or have you already started to see a little bit of conversion one to the other? And if that's the case, what kind of change does that have on kind of the ARR contribution?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So nobody is moving from Inventor to Fusion right now, okay. It's just not happening, all right. It's actually – most of the businesses about going after incremental seats inside of competitive accounts, especially down market. The one great thing about our strategy is most of the Inventor is bought through collections, which includes Fusion. So if an Inventor user does start to move to Fusion over time, they continue on the same subscription path we'll do. And what we'll do with our collections is some of the extensions that would be available to a vanilla Fusion user that they have to pay for would be included with the collections version. So essentially what you see is a kind of an AFP neutral conversion from Inventor to Fusion, but that's going to take a long time. Most of the Inventor customers are going to stay comfortably where they are. But when they do move, it's essentially AFP neutral in terms of impact on our ARR. It doesn't change the ARR trajectory not materially."
},
{
"speaker": "Sterling Auty",
"text": "Excellent. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jason Celino from KeyBanc Capital. Your line is now open."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks for taking my questions. Maybe one, the ambitions in infrastructure, Andrew, you talked about the gains in roads and bridges with improvements to Civil 3D and the expansions in the water here. But how do you think about some of those other areas of infrastructure, maybe some of the electric utilities or other areas?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So right now, Jason, we're going to stay focused on road and rail and bridges and the things that go along with road and rail and water, that's going to be our focus area. There's a lot of exciting things happening with elastic grid designs and the electrification and things associated with that. We're not going to be focusing on that right now. We may in the future, but right now, if you look at – even if you look at where the infrastructure bill is going for instance. Most of it is going to the upgrading and expanding the deteriorating infrastructure we have in the company around road, rail, bridges, civil and water infrastructure. And that's going to be our sweet spot for awhile – wins in that respect."
},
{
"speaker": "Jason Celino",
"text": "Okay. And then you also talked about the – why Autodesk wins in construction which was quite helpful. But you also alluded to the digitization opportunity there just being more broadly bigger. Maybe can you talk about how much of that TAM might be coming from pure greenfield versus displacements of legacy or in-house or other competitor tools? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. A lot of the TAM is greenfield. Really sometimes what you're competing with here is some kind of free tool and excel spreadsheets or a lack of any digital process whatsoever beyond emailing PDFs, right. So there's a lot of greenfield opportunity here in addition to kind of just flipping existing customers off of legacy systems or consolidating their systems. So there is a very robust long tail of growth here that's going to go on for years. That's why it's so exciting to see all the activity in this space because it's going to take a village to deal with digitize this entire market, and we're at the very, very early stages of this, which is great."
},
{
"speaker": "Jason Celino",
"text": "Great. Appreciate the color. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Gal Munda from Berenberg. Your line is now open."
},
{
"speaker": "Gal Munda",
"text": "Hi Andrew, hi Debbie and the team. Thanks for taking my questions. The first one, Andrew, maybe just a little bit on construction, new construction portfolio is really expanded and inspired very strong now. I'm just wondering, how should we think about the individual brands that you acquired between PlanGrid, Assemble, BuildingConnected, Pype on one side and then Autodesk Construction Cloud on the other side, in terms of user adoption. And do you see users that came in for individual brands now starting to kind of move towards the platform approach as well?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Excellent question, Gal. As you know, Gal, Autodesk Build and the Construction Cloud in general is the unification of all those brands and it's where we leave with new customers. Absolutely, when we're going out there chasing new businesses, Autodesk Build, it's all the capabilities that are built into Autodesk Build, it’s Autodesk Takeoff, it’s all of those tools associated with the Construction Cloud and that's where we lead. But we're also seeing people migrate off of the individual brands and move forward, all right. So we're seeing the same kind of thing happening incrementally. But that's not – we're going to let those people move at their own pace, right. So when they're choosing to move on to the consolidated cloud, they're doing that by choice. And as part of a process over time, we will ultimately migrate all of them to Construction Cloud and Autodesk Build. But right now, we're leading it with our new customers of Autodesk Build and helping customers consolidate on the Autodesk Build when they want to bring some of those old brands along with them. But all the best technology from all those brands is in the Construction Cloud now."
},
{
"speaker": "Gal Munda",
"text": "Understood. Thank you. And maybe Debbie, just another question for you. I completely understand the Q1 is the smallest quarter in terms of new business generation and in terms of the [indiscernible] as well. So what I wanted to touch though so might not have been a good time to kind of organically think about raising the guidance for the year so early in the year. I'd like to just kind of take a step back and think about what happened during Q1 and what you're seeing so far in Q2. If that kind of a level of trading and recovery continues, we decide to say that you feel pretty confident about your full-year guidance then?"
},
{
"speaker": "Debbie Clifford",
"text": "I mean, we issued the guidance today that we feel comfortable with. And I would say that we certainly have a strong sense of optimism based on the results that we had in Q1, but it's just too early for us to change the underlying view on a year after only one quarter, but we're off to a good start."
},
{
"speaker": "Gal Munda",
"text": "Got you. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. That is all the time we have for Q&A today. I would like to turn the call back over to Simon Mays-Smith for closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you, everyone for joining us. Look forward to chatting to you next quarter, updating you on our performance. If you have any questions in the meantime, please just ping me directly, happy to answer your questions. Thanks very much."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 4 | 2,023 | 2023-02-23 17:00:00 | Operator: Thank you for standing by and welcome to the Autodesk Fourth Quarter and Full Year Fiscal 2023 Results Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions]. I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss our fourth quarter and full year fiscal ’23 results. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings including our most recent Form 10-Q and the 10-K and the Form 8-K filed with today’s press release for important risk factors and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numerical growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or XL Financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. Autodesk’s strong financial and competitive performance in fiscal 2023, despite macroeconomic, policy, geopolitical and pandemic headwinds, is a testament to three enduring strengths: resilience, opportunity, and discipline. While we fell short of the fiscal ‘23 goals we set in 2016, our resilient business model and geographic, product, and customer diversification enabled us to deliver strong growth and report record fourth quarter and full-year revenue, GAAP and non-GAAP operating margin, and free cash flow. The sum of our revenue growth and free cash flow margin, a hallmark of the most valuable companies in the world, was 55% for the year. As we deliver next-generation technology and services to our customers, the transformation within and between the industries we serve will accelerate, generating significant new growth opportunities for Autodesk. We started seeing the shift towards connected digital workflows in the cloud in product design and manufacturing, then in architecture, followed by building engineering, and more recently construction. And we are now seeing growing momentum with owners. For example, in Q4 our partner, BLAM BIM, Launch Alliance, was selected by a consortium of 20 U.S. states, led by the Iowa Department of Transportation, to facilitate the migration from legacy 2D project delivery processes to data-rich BIM delivery processes, which are more efficient and sustainable. In anticipation of this, the Departments of Transportation involved are also completely reimagining project delivery and developing open standards for all infrastructure projects. Together, these 20 states encompass more than 60% of the U.S. population. Over time, we expect more states and more owners across the globe to connect more workflows in the cloud. Finally, our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. This enables Autodesk to remain sufficiently well invested to realize significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments in the future. Of course, discipline and focus mean not only consistent investment, but also constant optimization to ensure investment levels remain proportionate and directed at our largest opportunities. For example, Autodesk BIM Collaborate Pro for Civil 3D, which enables much more efficient collaboration on civil infrastructure projects, saw further significant enhancements in Q4. To support our work with public sector owners in the United States, Autodesk for Government expects to achieve FedRAMP Moderate Authorization soon, meaning that, through our partnership with the General Services Administration, customers will be able to start using our industry-leading cloud collaboration and document management tools that meet key security standards for U.S. Government projects. I’m also pleased to report that Innovyze had a record quarter, driven by adoption in a growing proportion of our Enterprise accounts, which contributed over a million dollars in four deals. Infrastructure is but one part of an expanding opportunity for Autodesk. There are so many more, and we’ll tell you about them at our Investor Day on March 22. But you can see some of the fruits of that opportunity already. We signed our largest-ever EBA in the fourth quarter, encompassing more personas and connecting more workflows in the cloud to drive efficiency and sustainability. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I’ll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. Our fourth quarter and full-year results were strong. Overall, the demand environment in Q4 remained consistent with Q3. The approaching transition from up-front to annual billings for multi-year contracts, and a large renewal cohort, provided a tailwind to billings and free cash flow. As Andrew mentioned, we continue to develop broader strategic partnerships with our customers and closed our largest deal to date during the quarter. The nine-digit deal is a multi-year commitment, billed annually, and did not have a meaningful impact on our financials during the quarter. Total revenue grew 9% as reported and 12% in constant currency, with subscription revenue growing by 11% as reported and 14% in constant currency. By product, AutoCAD and AutoCAD LT revenue grew 9% and AEC revenue grew 11%. Manufacturing revenue grew 4%, but was up mid-teens, excluding foreign exchange movements and upfront revenue. M&E revenue was down 10%. Recall that in Q4 last year, M&E won its largest-ever EBA, which included significant upfront revenue. Excluding up-front revenue, M&E grew 4%. Across the globe, revenue grew 13% in the Americas, 7% in EMEA and 4% in APAC. At constant exchange rates, EMEA and APAC grew 12% and 10%, respectively. Direct revenue increased 5% and represented 36% of total revenue. Strong underlying enterprise and e-commerce revenue growth was partly offset by foreign exchange movements and lower up-front revenue. Our product subscription renewal rates remained strong, and our net revenue retention rate remained comfortably within our 100% to 110% target range at constant exchange rates. Billings increased 28% to $2.1 billion, our first quarter over $2 billion, reflecting continued solid underlying demand and a tailwind from both our largest multi-year renewal cohort and the pending removal of the discount for multi-year contracts billed up front. Total deferred revenue grew 21% to $4.6 billion. Total RPO of $5.6 billion and current RPO of $3.5 billion grew 19% and 12%, respectively. About 2 percentage points of that current RPO growth was from early renewals. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%. Non-GAAP operating margin increased by 1 percentage point to approximately 36%, with ongoing cost discipline partly offset by revenue growth headwinds from foreign exchange movements. For the fiscal year, non-GAAP operating margin increased by 4 percentage points, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margin increased by 9 percentage points to approximately 21%. Recall in Q4 last year, we took a lease-related charge of approximately $100 million. That was part of our effort to reduce our real-estate footprint and to further our hybrid workforce strategy. For the fiscal year, GAAP operating margin increased by 6 percentage points. We delivered record free cash flow in the quarter and for the full year of more than $900 million and $2 billion, respectively, reflecting our strong billings growth. Turning to capital allocation, we continue to actively manage capital within our framework. As Andrew said, our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense. During Q4, we purchased 1.1 million shares for $210 million at an average price of approximately $193 per share. For the full year, we purchased 5.5 million shares for $1.1 billion at an average price of approximately $198 per share, and reduced total shares outstanding by 4 million. We retired a $350-million bond in December. Recall that we effectively refinanced this bond in October 2021 at historically low rates when we issued our first sustainability bond. Our average bond duration is now almost seven years. Now, let me turn to guidance. Our strong finish to fiscal ‘23 sets us up well for the year ahead. Overall end-market demand in Q4 fiscal ‘23 remained broadly consistent with Q3 fiscal ‘23. Channel partners remained cautiously optimistic, usage rates grew modestly, excluding Russia and China, and bid activity on BuildingConnected remained robust. As we said last quarter, foreign exchange movements will be a headwind to revenue growth and margins in fiscal ‘24. We expect FX to be about a 4-percentage point drag on reported revenue. We continue to expect the absence of recognized deferred revenue from Russia will be about a 1 percentage point drag to revenue growth. As we’ve highlighted before, most recently on our Q3 earnings call, the switch from up-front to annual billings for most multi-year customers creates a significant headwind for free cash flow in fiscal ‘24 and a smaller headwind in fiscal ‘25. You can see the impact on fiscal ‘24 in slide eight of our earnings deck. Change in deferred revenue increased fiscal 23 free cash flow by $790 million, but will reduce fiscal ‘24 free cash flow by approximately $300 million. The switch to annual billings for multi-year customers and a smaller multi-year renewal cohort are the key drivers of this $1.1 billion swing. The transition will also affect the linearity of free cash flow during the year, with Q1 fiscal ‘24 free cash flow benefiting from the strong billings in Q4 fiscal ‘23, and our largest billings quarters in the second half of the year proportionately more impacted by the switch to annual billings. While we expect many customers to switch to multi-year contracts billed annually, some may choose annual contracts instead. All else equal, if this were to occur, it would proportionately reduce the unbilled portion of our total remaining performance obligations and would negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged in this scenario. Annual renewals create more opportunities for us to drive adoption and upsell, but are without the price lock embedded in multi-year contracts. We'll keep you updated on this as the year progresses. Our cash tax rate will return to a more normalized level of approximately 31% in fiscal ‘24, up from 25% in fiscal ‘23. We accrued significant tax assets as a result of the operating losses we generated during our business model transition. Growing profitability and, more recently, rising effective tax rates across the globe, have accelerated the consumption of those tax attributes. Absent changes in tax policy, we expect our cash tax rate to remain in a range around 31% for the foreseeable future. Putting that all together, we expect fiscal ‘24 revenues to be between $5.36 billion and $5.46 billion, up about 8% at the mid-point, or about 13% at constant exchange rates and excluding the impact from Russia. We expect non-GAAP operating margins to be similar to fiscal ‘23 levels with constant currency margin improvement offset by FX headwinds. We expect free cash flow to be between $1.15 billion and $1.25 billion. The mid-point of that range, $1.2 billion, implies a 41 reduction in free cash flow compared to fiscal ‘23. As I outlined earlier, the key drivers of that reduction are: changes in long-term deferred revenue as a result of the shift to annual billings for multi-year customers and a smaller multi-year renewal cohort, FX, and our cash tax rate. The slide deck and Excel financials on our website have more details on fiscal ‘23 results and modeling assumptions for the full-year fiscal ‘24. At investor day, we’ll be looking beyond this year. As Andrew noted earlier, we remain in the relatively early innings of a transformational shift to the cloud to drive efficiency and sustainability. This is generating demand for cloud-based platforms and services, which break down the silos within and between the industries we serve. Autodesk is uniquely well-positioned to seize these opportunities and we will continue to invest with discipline and focus to realize that growth potential. While our subscription business model and geographic, product, and customer diversification give us resilience when compared to many other companies, we’re mindful that generational macroeconomic, policy, geopolitical, climate, and health uncertainty make the world more volatile and less predictable than in the past. Our business will grow somewhat faster in less volatile environments and somewhat slower in more volatile environments. Finally, we're not just looking to have industry-leading growth although we often do. Nor are we just looking to have industry-leading margins, although we often do. On average and over time, we are looking to have an industry-leading balance between growth and margins. And we often do. We think this balance between compounding growth and strong free cash flow margins, captured in the rule-of-40 framework, is the hallmark of the most valuable companies in the world. And we intend to remain one of them. With all this in mind, our target planning parameters over the next several years will be to grow revenue in the 10% to 15% range and generate free cash flow margins in the 30% to 35% range with a goal of reaching a "Rule of 40" ratio of 45% or more over time. The path to that 45% ratio will not be linear given the drag in fiscals ‘24 and ‘25 to long-term deferred revenue and free cash flow from the shift to annual billings of multi-year contracts. The rate of improvement will obviously also be somewhat determined by the macroeconomic backdrop. But, let me be clear, we’re managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering on disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achievement of this rule-of-45 goal, regardless of the macroeconomic backdrop. While macroeconomic and FX headwinds, along with sustained but disciplined investment in our products and platforms, will slow the rate of margin improvement, we continue to expect non-GAAP operating margins to be in the 38% to 40% range by fiscal ‘26, albeit more likely now in the lower half of that range. We continue to see scope for further margin growth thereafter. GAAP margins will further benefit from stock-based compensation as a percent of revenue trending down towards 10% and beyond over time. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end, cloud-based solutions that drive efficiency and sustainability for our customers. We’ll tell you more about our long-term vision and plans at our investor day on March 22. But let me finish by updating you on our progress in the fourth quarter. We continued to see strong growth in AEC, fueled by customers consolidating on our solutions to connect previously siloed workflows in the cloud. Sweco, Europe's leading architecture and engineering consultancy, is connecting our portfolio of products, from Spacemaker and Revit to Autodesk Construction Cloud and Innovyze, to streamline everything from transport and energy usage to lighting and water flows to ensure better transparency through the project lifecycle. Sweco has a thriving sustainability practice. Its new digital service, Carbon Cost Compass, which is built on Autodesk Platform Services, helps its customers model and calculate the carbon footprint and cost of different types of buildings. For our construction customers, we continue to benefit from our complete end-to-end BIM solutions which encompass design, preconstruction and field execution. In Q4, a mid-market general contractor in California, specializing in design-build projects, chose to replace a competitive project management offering with Autodesk Build as it looked to improve integration further and minimize conflict with their design processes. While highlighting Build’s cost management functionality as a differentiator, the customer ultimately chose Autodesk because of our long-standing and trusted partnership and shared vision on the future of construction. We continue to make excellent progress on our strategic initiatives which is driving accelerating adoption of Autodesk Construction Cloud. We added almost a thousand new logos again, drove continued rapid growth in Autodesk Build’s MAUs, and generated 3x quarter-on-quarter growth in our construction bundles, which combine multiple Autodesk Construction Cloud solutions and enable customers to standardize more rapidly on one platform. Outside the U.S., enabling our international channel partners to sell our construction portfolio continues to drive strong growth. We still see strong growth potential in construction and Autodesk remains uniquely well positioned to capture it. In manufacturing, Tata Steel, one of the world’s leading steel manufacturers, has used our solutions to increase efficiency and reduce costs in setting up new operations. To optimize effectively between its equipment, civil, structural, and plant infrastructure teams, Tata Steel uses Autodesk AEC and Manufacturing collections and Vault. Through the integration of data from various vendors on a single platform, Tata Steel leverages simulation and clash detection in a virtual environment, eliminating potential conflicts that can have a huge impact if they occur during physical installation. In Automotive, we continue to strengthen and expand our partnerships, both within and beyond the design studio, as OEMs transform and connect factories. A leading manufacturer in the U.S. expanded its EBA in Q4, leveraging the cutting-edge visualization technology in VRED Pro to more effectively process executive design reviews and reach final designs more quickly. Autodesk is now partnering with the customer as it renovates its factories for its new fleet of electric vehicles, ensuring it controls the construction flow and owns its own data by standardizing on Autodesk Construction Cloud. Customers are also beginning to merge their design, manufacturing and production management workflows with Fusion and Prodsmart. In Q4, a manufacturer based in the U.K., which has more than doubled in size in the last 18 months, switched from a competitor’s CAD tool to Fusion 360 and extensions for its integrated CAD and CAM capabilities. With Prodsmart as part of its connected platform, the customer can instantly generate a bill of materials after creating a design and link directly to inventories, eliminating tedious work and saving time for higher-value opportunities. We ended the quarter with 223,000 Fusion 360 subscribers, a number which does not include extensions where units increased more than 100% year-over-year. During the quarter, we launched the Signal Integrity Extension for Fusion, powered by Ansys, which enables designers to analyze their PCB electromagnetic performance, ensure compliant products and power a faster development cycle at lower costs. We continue to see strength in PLM, signing our largest-ever cloud data management deal and growing more than 30 percent in the quarter. In education, leading universities continue to modernize their courses ensuring students will learn the in-demand skills of the future. At Northumbria University, the prestigious “Design for Industry” program's students are now choosing to use Fusion 360 within their design process and across many of their modules along with real-world live projects led by industry partners. Their switch is primarily down to its ease of use and cross platform availability. While our software remains free for educators and students, tomorrow's design leaders are bringing Fusion 360 to new and established manufacturers. We will continue to evolve our business model offerings to match customer needs and enable users to participate in our ecosystem more productively. For example, a European manufacturer which operates in over 100 countries and six R&D facilities worldwide, transitioned to our Named User model with Premium Plan providing enhanced security from single sign-on and improved efficiency from 24/7 technical support. Our partners at Mensch and Maschine supported the transition with detailed knowledge and analysis of the customer usage behavior, resulting in an optimized flex token package for its occasional users; providing them with ongoing software access without requiring a full-time subscription. And finally, we continue to work with non-compliant users to find flexible and compliant solutions that ensure they have access to the most current and secure software. During the quarter, we closed nine deals over $1 million and 23 deals over $500,000 with our license compliance initiatives. Returning to where I started – resilience, opportunity, and discipline were important contributors to our fiscal ‘23 results and will remain the key drivers of our future success. We’re excited to share our plans with you at our investor day on March 22. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question please, Saket.
Saket Kalia: Okay, great. Good afternoon guys. Thanks for taking my questions here. Debbie, maybe for you. I was wondering if you could just give us a little bit more context about how you're thinking about fiscal '24 and beyond from a guidance perspective?
Debbie Clifford: Sure. Thanks, Saket. So first, the overall demand environment in Q4 was relatively consistent with what we saw in Q3. If I drill first into the specifics on the guide for billings, of course, we have multiyear to annual billings transition, that's creating a headwind as expected. The transition doesn't have an impact on revenue. It's just a change in billings frequency. On revenue, as we outlined last quarter, we're seeing a negative impact from FX and the Russia exit. Together, that represents 5 points of headwind to growth. If we normalize for that, the revenue growth range would be in the low teens. On margin, we're managing the flat margins on an as-reported basis year-over-year. That's consistent with what we said on the last call. We have a strong balance sheet. We have conviction in our strategy. So we want to continue to invest during the cycle so that we can maintain our momentum, but not so much so that we see a detriment to our margin outlook. And I want to point out that our margin guide on a constant currency basis represents improvement year-on-year. And then finally, on cash flow, the headwind to billings from the transition to annual billings has a downstream effect on cash flow, of course. As I mentioned in the opening commentary, the swing in long-term deferred revenue is having a negative impact of around $1.1 billion to $1.1 billion to fiscal '24 cash flow. That headwind is driven primarily by that switch to annual billings for multiyear customers. And if we take that with other factors like a lower multiyear renewal cohort and higher cash taxes, we get to that $1.2 billion guidance midpoint. Our goal is to set ourselves up for success in fiscal '24 and for the long-term. And it's that same sort of thinking that's driving how we're thinking about the longer-term financial model. On revenue, our target planning range of 10% to 15%, it remains in that double-digit territory. On margin, we're targeting a margin in the 38% to 40% range in the fiscal '23 to '26 window. But we said that because of the macro and FX headwinds that we're seeing, we think it's more likely now that it's going to be in the lower half of that range. And then on cash flow, we'll still work towards double-digit CAGR growth through fiscal '26, but it looks less likely though, given the impact of cash taxes, FX volatility and a stronger-than-expected fiscal '23 finish. As we look ahead, we're focused on managing the business to a Rule of 45 ratio or better, which after we get through this multiyear to annual billings transition, we think strikes the right balance between driving top line growth and delivering on disciplined profit and cash flow.
Saket Kalia: Got it. Got it. That's very helpful. Maybe a follow-up for you, Debbie, if I may. I guess now that the fiscal 2024 has finally arrived, if you will. Could you just maybe walk through a little bit of detail just on that impact of switching from upfront to annual billings for those multiyear contracts?
Debbie Clifford: Yes. It has finally arrived. It's nice to finally be having these conversations, Saket. So the transition to annual billings, the rollout is happening on schedule, our systems will be ready. We're assuming that we sell multiyear upfront through March 27. And then at the March 28 go-live that we only sell multiyear with annual billing terms in mature countries for our platinum and gold partners. That represents a significant majority of the eligible population. There's going to be some remaining multiyear upfront in the forecast beyond March 27. That's going to be coming primarily from eStore and emerging countries, but it's relatively small in comparison to the volume that we saw in fiscal '23. And as we move those populations to annual billings, we'll see a follow-on headwind to free cash flow in fiscal '25. It's consistent with what I said in the opening commentary that the past is not going to be linear. We're assuming that the same proportion of our business that's been multiyear remains multiyear. We think that the price lock that you get in a multiyear contract will entice our customers to continue to buy multiyear, especially in the inflationary environment that we're in. But of course, it's possible that some of our customers choose annual contracts rather than multiyear contracts with annual billings. That wouldn't impact billings or most other financial metrics in fiscal '24, but it would negatively impact the total RPO growth rate. At the end of the day, it's a win-win for us. If our customers choose to go with annual contracts, it gives us an opportunity to engage with them upon renewal to drive adoption and upsell and our renewal rates are strong. So this is something we'll keep you posted on as the year progresses.
Saket Kalia: Got it. Very clear. Looking forward to the Analyst Day, guys. Thank you.
Operator: Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your line is open, Jay.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, let me start with you. Your 10-Q for the third quarter had some new and intriguing language with regard to how you foresee the evolution of your sales model, specifically, your relationship with VARs and VADs and there's a lot of complexities in the language there. So perhaps you could talk about how you envision the evolution of your business in terms of the operational or fulfillment or license management effects that you foresee over time or the margin effects over time. And where you think your sales mix ultimately goes over the next number of years in terms of direct versus indirect? Then a follow-up.
Andrew Anagnost: Okay. Great. So I like the way you highlighted. This is an evolution. We've been evolving in a particular direction over time. Obviously, several years back, I talked about the 50-50 mix of direct and indirect and we've been driving a lot of growth in direct channels. We've been driving a lot of growth in direct enterprise business, and all of these things kind of like weave together into a longer-term plan. And now what you're seeing is doing is we're driving a lot more direct engagement with some of our value-added resellers. So some of the changes that you saw in there are preset staging more and more direct engagement with our value-added resellers and less, but smaller engagements and fewer engagements between intermediates and our value-added resellers, which makes total sense between the systems evolutions we've been executing on in the direction we're going. So long-term, we're still driving towards that same type of balance that we've been talking about. But as our systems improve, we're looking for different types of engagement models with our value-added reseller channel.
Jay Vleeschhouwer: Okay. Second question, the slide deck gives us the annual update on your installed base of subscription. The net increase was about $600,000 for the year, net of trade-ins. Looking ahead, how does your long-term growth model foresee the contribution of volume growth and particularly the effect as well of improving the richness of the mix, perhaps to more collections and so forth? And perhaps by end market. When you think about manufacturing, that volume looks like it's maybe 10th of your net new volume per year. So you have a lot of volume that has to come from other segments outside of manufacturing. So perhaps you could talk about that.
Debbie Clifford: Sure, I'll take that one, Jay. So we start at the top. Yes, subscriptions grew in a healthy way. I just want to remind, however, that there's a lot of variability in that metric, given that we have such a wide diversity of business models in play, things like Flex, EBAs, accounts pricing and so on and so forth. So it does make it less and less of a relevant metric for us to manage business performance. We're more focused on new and renewal ACV. They both posted solid growth in Q4. As we think about new ACV. That's the proxy for, I think, the spirit of your question. We generated across both volume and also stronger unit economics, things like price mix and partner margins. In general, historically, we've seen it come from roughly equally across those sources, and it kind of flexes up or down depending on the demand environment that we're in. We could see some puts and takes like when COVID hit, we saw more growth from volume because volume versus price because we were more sensitive to price increases at the time that the pandemic hit. And then obviously, when we're in a situation where we change prices at all, we might see more growth coming from price. But all in all, as we think about achieving some of the long-term growth parameters that I talked about, we're thinking about it as a roughly equal split across volume, price mix, ASP over time. Andrew, did you want to comment on the segment?
Andrew Anagnost: Thanks. Jay, your comment on statements, all right? As you know, and I know you're aware, as we look at the various segments you do business in, we're moving in a situation where we're getting deeply entrenched in both the design and make side of our customers' business. So we also pay attention to the fact that even within manufacturing and AEC and all these things, we're going to be adding a lot more subscribers in some of the downstream processes in other parts of the process, which is going to be an important engine even within some of the segments that you discussed. And I know you're aware of that. I just wanted to reinforce it a little bit.
Jay Vleeschhouwer: Very good. Thank you, both.
Operator: Our next question comes on the line of Adam Borg of Stifel. Your question please, Adam.
Adam Borg: Great. Thanks so much, for taking the question. Maybe Andrew, on Innovyze, it was interesting to hear and great to hear about the record quarter. We picked up some growing traction in our check. I'd love to hear a little bit more about what's driving this and where we are in the migration more broadly to subscription, given its more legacy business model? And then I have a follow-up.
Andrew Anagnost: Yes. So it's very early in the migration. But in general, Innovyze had a record quarter. And the biggest thing that was driving some of that record growth is that now Innovyze can be incorporated into a lot of our enterprise business agreements and in some of our engagement with our largest accounts. And guess what, there's a hunger for the solution. So there's a lot more direct engagement with customers around Innovyze that's really propelling the growth right now. We're still very much in the early stages of activating our channel. So we've activated our major accounts team, and we're still working to activate our channel. And the subscription transition, super early stages just starting, and that we'll give you updates on that as time goes on.
Adam Borg: Maybe just a quick follow-up on the macro. You guys are clear that things seem to be consistent quarter-over-quarter. I'd love to maybe just try go down one step deeper. Any observations around customers switching more to point solutions from collections or anything around RT or perhaps even more interest in Flex given the macro? Thanks so much.
Andrew Anagnost: Yes. So actually, there's pretty consistent customer behavior across segments and sizes of customers. So there's not any kind of switching behavior or downgrading behavior. And Flex tends to be to a large measure, and its very early days with Flex, tends to be incremental to our business rather than detrimental to our business. So in general, we're not seeing any kind of changes in mix as things go on. I will say, from a segment perspective, while all the segments grew, our larger customers grew faster than our smaller ones, but everybody was growing.
Adam Borg: Great. Thanks again.
Operator: Our next question comes from the line of Joe Vruwink of RW Baird. Your line is open, Joe.
Joseph Vruwink: I wanted to go back and give more detail on what you're doing with the public sector around project delivery. And I guess I'm curious how this compares to the evolution of the commercial side of your business. So maybe the analogy use, I think, BIM360 launched and 2012, and we got Construction Cloud in 2019 and here we are today is what you're announcing now or kind of the conversations you're having in the public space with owners it closer to 2012? Or is it kind of further along and has the potential to progress more quickly?
Andrew Anagnost: Joe, I think that's a very astute question. And I think you're pointing to some of the important things about what we're doing with public sector in general. You probably noticed in the opening commentary, our comments about FedRAMP things associated with that. All of these things, FedRAMP, are engagement with the infrastructure partner and DOTs that I talked about in the opening communicator, all of these are part and parcel of laying the groundwork for more and more modernization inside of these department of transportation and larger owners in terms of infrastructure, federal owners, European owners as well. All of that will continue to build out in a way very similar to what you described in terms of entering into construction. It's a longer-term play. It will take time. So it's still early innings in all of these things. But you can see increasing activity specifications coming out more and more within the Department of Transportation community and a desire to modernize the stacks. And that's a big push right now. A lot of these DOTs they're stuck in a different era of software and solutions, and they're looking to modernize and this isn't just true in the U.S. It's also true in Europe. We're engaging in more and more discussions with countries in the European Union about some of the BIM standards they're trying to drive into their infrastructure projects. And that's going to have a compounding effect on how people want to engage with different kinds of solutions in the infrastructure space, but still early journey.
Joseph Vruwink: Yes, great. That's helpful. And then, just on the 10% to 15% growth parameter, I guess, as I think about the backdrop in fiscal 2024, I wouldn't label it as easy. And yet the guidance, I think, calls for something closer to 12% organic. So I guess the question is what happens incrementally in kind of a planning scenario relative to a challenging backdrop in 2024, where 10% type growth becomes a plausible outcome?
Andrew Anagnost: Yes. So look, first off, let's comment about how resilient our business is and how we demonstrate that resilience over the last few years. We believe we've put everything in the right kind of scope, and we've aligned things pretty carefully. If we saw an environment where we saw downward pressure on our margin expectations for the year, we have levers within the company that we can pull that has nothing to do with layoffs or any of the things you're seeing in the rest of the tech sector that we could pull to ensure that we hit those targets. So we feel pretty confident about what we've laid out and how we could hit it even if there were changes in the economic environment. Debbie, do you want to add some commentary?
Debbie Clifford: Yes, sure. A couple of things I would say. First, overall, I mean, we're watching the macro backdrop closely, and I said that it was broadly unchanged. Europe was a bit better or U.S., a bit worse. Asia, about the same. So overall, on the whole, the demand environment was broadly similar. We've reflected all of that into our guidance. The leading indicators remain strong. And another way to think about it would be that if you look at revenue, the implied growth rate in Q4 of our fiscal '23 is 9%. If you extend that into fiscal '24 at another point of currency headwind, you're squarely at the guidance midpoint for fiscal '24. So we're kind of already at that rate. And we feel comfortable with the guidance that we've set.
Joseph Vruwink: Great. Thank you very much.
Operator: Our next question comes from the line of Michael Funk of Bank of America. Your question please, Michael
Michael Funk: Yes. Thank you for questions today. A couple if I could. So First, the noncompliant transition during the quarter was greater than we expected, a very strong rate. Just curious to kind of change in push versus pull strategy there? And then how additive type of growth that might be in fiscal '24 and beyond?
Andrew Anagnost: Yes. So there's no change in our approach to non-compliance, right? As I've said in many times, and I want to keep reinforcing, we continue to develop efficiencies. We continue to be able to identify to higher precision, who is actually non-compliant and who actually isn't and we're building up a steady base of business as we move forward. But we're not looking to accelerate it or push it harder or drive it in any particular direction. We're just allowing it to be kind of a steady incremental growth engine within our business and kind of continue to deliver year after year after year. And that will continue to be our strategy. One, we think it's the right thing to do for the company, the right thing to do for our customers. It gives our customers time to get themselves compliant because just the fact that we're out there engaged in compliance activity encourages people to ask themselves if they should be compliant there's other business levers here. And the more carefully we do this and the more incrementally, we do this, the better the outcome is for the entire ecosystem. So no real change in how we're approaching that.
Michael Funk: And then Debbie, you mentioned that the inflationary environment might affect how customers think about the shift for multiyear to annual. Just curious if the rising rate environment affects how you think about that shift from upfront payment for multiyear to annual bill. Does it change the math for you?
Debbie Clifford: It doesn't in any meaningful way, as I said. It's really a win-win for us because with annual contracts, we get an opportunity to engage with our customers upon renewal to drive upsell and make sure that there is adoption. Obviously, with a price lock and our customers signing on the multiyear contracts, we have a 100% renewal rate in any given period, but there's less of that opportunity to engage. So from our standpoint, it's a win-win.
Michael Funk: Great. Thank you, both.
Operator: Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Please go ahead, Matt.
Matthew Hedberg: Great. Thanks for taking my questions. Andrew, kind of a high-level one for you. You guys have been focused on generative design for a while now. And with all the news on AI recently, I'm wondering if you can kind of give us your perspective on how Autodesk plans to leverage AI and sort of the impact on design?
Andrew Anagnost: Yes. So ChatGPT has obviously given a massive amount of validation to the potential of AI. It is a particular horizontal solution, and we intend to leverage that horizontal solution in some of our solutions. In fact, you're probably aware that Microsoft and Satya Nadela himself demoed a natural language processing tool for generating manuscripts for both direct to my and for Fios, and it works fabulously, right? These are things that provide real leverage to our customers. However, one of the things I really want you to be aware of, Matt, is that the real vertical value comes when we start training on data that is directly used by our customers to do particular things or design or build something. And that comes at the user productivity level, the company productivity level and the ecosystem productivity level. And that's going to unlock a lot of potential as we develop things that cut across all of what our customers can do like generative design, by the way, but probably heading in even other directions. And that's going to take time to develop. It's going to take opportunities for us to engage with customers in terms of using some of their data. But I want you to pay attention to that long-term horizon on doing real training on customer data, which will be where the revolution comes from.
Matthew Hedberg: Got it. Got it. And then Debbie, sort of the question that I think a lot us are getting on from folks is the levels of conservatism in the guide? And I'm sure it's based on what you see today is how you're sort of building the forecast. But maybe just a little bit more granularity on how you're thinking about sales productivity, pipeline discount rates? Anything that sort of like provide a little bit more color there?
Debbie Clifford: Thanks, Matt. Look, I'd say that I don't have much to add versus what I've said already. The macro is broadly unchanged. Those leading indicators remain strong. Our business is going to grow faster and better environments and somewhat lower and worse environment. Our goal is to set ourselves up for success in fiscal '24 and for the long term.
Matthew Hedberg: Thank you.
Operator: Our next question comes from the line of Jason Celino of KeyBanc Capital. Please go ahead, Jason.
Jason Celino: Great. Thanks. Can you hear me. So actually, one question on the quarter. So it sounds like there was -- well, I guess, did you see strength in the business at the end of January? I'm just trying to understand how business was after that multiyear discount went away at the beginning of the month.
Debbie Clifford: Yes, the linearity of our business was not dissimilar to what we've seen in previous periods.
Jason Celino: Perfect. And then on the free cash flow commentary you gave, the 30% to 35% margin. That was for 2026 period, the period of '23 to '26. And does that include the headwinds you talked about, including the FX, the cash taxes, et cetera?
Debbie Clifford: So what I said was we have target planning parameters of 10% to 15% revenue growth and 30% to 35% free cash flow margin, all in pursuit of our goal of achieving a rule of 45-plus ratio over time. It's not time specific. If you look at our guidance for fiscal '24, that's at the trough of the transition for multiyear to annual billings, we'd be in the low 30s. And what we're saying is that we're going to go from the low 30s as we normalize over time towards our goal of achieving that 45% plus and that we intend to make meaningful progress against achieving that goal regardless of the macroeconomic backdrop.
Jason Celino: Perfect. No, that's very helpful. And I guess we'll learn more at the Analyst Day in a couple of weeks. Thanks.
Operator: Our next question comes from the line of Steve Tusa of JPMorgan. Your line is open, Steve.
Sam Yellen: Hi, it's Sam Yellen on for Steve Tusa. So in terms of the free cash flow bridge for next year, I know you guys have the deferred revenue and cash taxes. But is there anything else moving around maybe in working capital that we should considering the bridge?
Debbie Clifford: If you look at -- yes, if you look at Slide 8 of the deck that we put on our website is the move from multiyear upfront annual billings is the lower cohort. We have a lower cohort of multiyear contracts that come up for renewal, just cyclically in fiscal '24. It's FX movements and it's cash taxes. Those are the 4 drivers of the decline.
Sam Yellen: Got it. Thanks. And then in terms of the high single-digit revenue guidance for next year, how much of that is driven by price?
Debbie Clifford: We're not going to get into that level of specificity, I would say. I mean, as I mentioned when Jay was asking the question earlier, we kind of look at it as our goal be to drive a mix of volume and price mix, partner margin type contributions to growth. And so you can loosely consider that, that would be how we're thinking about it as we look at growth next year, too.
Sam Yellen: Thank you.
Operator: Our next question comes from the line of Sterling Auty of SVB MoffetNathanson. Your question please, sir.
Sterling Auty: Thanks guys. Just one question from my side. Can you guys help me understand which end market segments, manufacturing versus architecture, et cetera, are you seeing the biggest cyclical impact today? And what did you factor in on those trends into the guidance? Thank you.
Andrew Anagnost: Look, it's a hard question to answer because all of those segments are growing, all right? And the new business is growing in all those segments. So it's a nuanced question. One thing I will say is there's a different character of pushback from each one of those segments in terms of what they're seeing. What we're seeing in manufacturing is my costs are going up, my costs are going up and the costs are going up, right? And that is impacting their ability to deliver, frankly, on some impact on demand because they can't pass it all to the customers. They have trouble kind of fulfilling the demand with the cost factor. So I would say right now, the inflationary environment is putting more pressure on our manufacturing customers than it is on our ADC customers. So that's just one piece of color. In the AEC space, obviously, the material costs are a big issue for them. But they are continuing to struggle with labor shortages, capacity problems, the ability to kind of clear out the book of business, which is great because there's an overhang there's an overhang of business for them right now, and there still is. And that's true in manufacturing, too. There's still an overhang of delivery that has to happen. I'm still waiting for a part from my repaired car and it's maybe my cars bus has been months, can't get the part. All right. There's plenty of capacity challenges there as well. But in AEC, generally, there's still a backlog of book of business, labor shortages, capacity within some of these institute companies and construction firms, architecture firms, is getting in the way. So I hear capacity problems much more in the AEC segment which, by the way, is going to continue into time. Eventually, the capacity will clear out. And I hear inflationary pressures much more from our manufacturing customers. M&A, they don't care, it's all digital anyway. People are watching more and they're happy.
Sterling Auty: Thank you.
Operator: Our next question comes from the line of Steve Koenig of SMBC Nikko America. Your question please, Steve.
Steven Koenig: Great. Thank you. Hey Andrew, hey Debbie. Thanks for taking my questions. I want to build just a little bit more on Sterling's question here. I'm wondering, can you remind us in AEC, if you look across upstream and downstream. What's your kind of complexion related to commercial versus industrial versus residential design and construction? And then I'm really curious, given those interesting comments you just had, Andrew, about how you're seeing demand and capacity problems in that segment. What did you see in '08 when kind of the AEC activity slowed down? Was it more intense in one of those kind of sub-segments? And how do you think about how that could unfold over time? Is that as those capacity is just clear out and interest rates could begin to affect that sector broadly?
Andrew Anagnost: Yes. So that was a multilayer question. And now I have to remember the first part of the question, which was related to -- remind me about what your part A was?
Steven Koenig: Yes. Sorry, it was a little long winded. The complexion of your AEC.
Andrew Anagnost: Yes. Okay. So this is the -- always the question about which parts of the AEC ecosystem are we sensitive to. And here's the thing, and I always answer the question this way. The dollars always go somewhere, all right? So people were very concerned about 1.5 years ago, I was getting lots of questions about what's your exposure to commercial real estate, commercial real estate is going to slow down what happened in commercial real estate? It moved a retrofit and reconfigure all right? And a lot of commercial real estate spend is in is going on in retrofit and reconfigure. A lot of architecture firms are completely involved in that. And also, it's moved to multifamily residential and things associated with that due to other pressures inside the economy and inside municipalities. So the money shifts around all the time, right? And in terms of which segment is getting lit up. So we're not seeing any particular exposure in terms of slowdown to any particular segment because of the way this activity shifts, all right? And it's just one -- it's one of the interesting things about the ecosystem. There's always something that wasn't getting built or worked on that starts to get built or worked on when something else is out of the way, it's out of the queue, all right? And the commercial office of space is somewhat out of the queue and other things are moving into the queue and getting more attention. Now with regards to '08, it was a very different type of situation. If you recall what we thought in '08 was a massive slowdown at the low end of our business. And a matter of fact, it was a precipitous slowdown in the low end of our business with smaller firms not being able to get enough work. We don't see anything on the horizon that looks like that because of the backlog of business that's out there right now, there's just more people wanting to get things done than there is capacity to get the thing done in the ecosystem. So it's a very different situation where there was a kind of like the valve is shut off. There was no backlog, which to bleed through. Now we're in a world where we've got a lot of project backlog, a lot of pent-up demand, and it's just not the same situation that you saw in '08. It was very different world. And we're a very different company.
Steven Koenig: Yes, for sure. That’s helpful. I really appreciate the color. Thanks so much.
Operator: That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?
Simon Mays-Smith: Thanks, everyone. Sorry about that, having trouble finding my button. Looking forward to seeing you all the Investor Day in just in a month's time. If you have any questions, please e-mail me at simon@autodesk.com. Look forward to catching up again soon. Bye-bye.
Operator: And this concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by and welcome to the Autodesk Fourth Quarter and Full Year Fiscal 2023 Results Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions]. I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss our fourth quarter and full year fiscal ’23 results. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings including our most recent Form 10-Q and the 10-K and the Form 8-K filed with today’s press release for important risk factors and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numerical growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or XL Financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. Autodesk’s strong financial and competitive performance in fiscal 2023, despite macroeconomic, policy, geopolitical and pandemic headwinds, is a testament to three enduring strengths: resilience, opportunity, and discipline. While we fell short of the fiscal ‘23 goals we set in 2016, our resilient business model and geographic, product, and customer diversification enabled us to deliver strong growth and report record fourth quarter and full-year revenue, GAAP and non-GAAP operating margin, and free cash flow. The sum of our revenue growth and free cash flow margin, a hallmark of the most valuable companies in the world, was 55% for the year. As we deliver next-generation technology and services to our customers, the transformation within and between the industries we serve will accelerate, generating significant new growth opportunities for Autodesk. We started seeing the shift towards connected digital workflows in the cloud in product design and manufacturing, then in architecture, followed by building engineering, and more recently construction. And we are now seeing growing momentum with owners. For example, in Q4 our partner, BLAM BIM, Launch Alliance, was selected by a consortium of 20 U.S. states, led by the Iowa Department of Transportation, to facilitate the migration from legacy 2D project delivery processes to data-rich BIM delivery processes, which are more efficient and sustainable. In anticipation of this, the Departments of Transportation involved are also completely reimagining project delivery and developing open standards for all infrastructure projects. Together, these 20 states encompass more than 60% of the U.S. population. Over time, we expect more states and more owners across the globe to connect more workflows in the cloud. Finally, our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. This enables Autodesk to remain sufficiently well invested to realize significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments in the future. Of course, discipline and focus mean not only consistent investment, but also constant optimization to ensure investment levels remain proportionate and directed at our largest opportunities. For example, Autodesk BIM Collaborate Pro for Civil 3D, which enables much more efficient collaboration on civil infrastructure projects, saw further significant enhancements in Q4. To support our work with public sector owners in the United States, Autodesk for Government expects to achieve FedRAMP Moderate Authorization soon, meaning that, through our partnership with the General Services Administration, customers will be able to start using our industry-leading cloud collaboration and document management tools that meet key security standards for U.S. Government projects. I’m also pleased to report that Innovyze had a record quarter, driven by adoption in a growing proportion of our Enterprise accounts, which contributed over a million dollars in four deals. Infrastructure is but one part of an expanding opportunity for Autodesk. There are so many more, and we’ll tell you about them at our Investor Day on March 22. But you can see some of the fruits of that opportunity already. We signed our largest-ever EBA in the fourth quarter, encompassing more personas and connecting more workflows in the cloud to drive efficiency and sustainability. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I’ll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. Our fourth quarter and full-year results were strong. Overall, the demand environment in Q4 remained consistent with Q3. The approaching transition from up-front to annual billings for multi-year contracts, and a large renewal cohort, provided a tailwind to billings and free cash flow. As Andrew mentioned, we continue to develop broader strategic partnerships with our customers and closed our largest deal to date during the quarter. The nine-digit deal is a multi-year commitment, billed annually, and did not have a meaningful impact on our financials during the quarter. Total revenue grew 9% as reported and 12% in constant currency, with subscription revenue growing by 11% as reported and 14% in constant currency. By product, AutoCAD and AutoCAD LT revenue grew 9% and AEC revenue grew 11%. Manufacturing revenue grew 4%, but was up mid-teens, excluding foreign exchange movements and upfront revenue. M&E revenue was down 10%. Recall that in Q4 last year, M&E won its largest-ever EBA, which included significant upfront revenue. Excluding up-front revenue, M&E grew 4%. Across the globe, revenue grew 13% in the Americas, 7% in EMEA and 4% in APAC. At constant exchange rates, EMEA and APAC grew 12% and 10%, respectively. Direct revenue increased 5% and represented 36% of total revenue. Strong underlying enterprise and e-commerce revenue growth was partly offset by foreign exchange movements and lower up-front revenue. Our product subscription renewal rates remained strong, and our net revenue retention rate remained comfortably within our 100% to 110% target range at constant exchange rates. Billings increased 28% to $2.1 billion, our first quarter over $2 billion, reflecting continued solid underlying demand and a tailwind from both our largest multi-year renewal cohort and the pending removal of the discount for multi-year contracts billed up front. Total deferred revenue grew 21% to $4.6 billion. Total RPO of $5.6 billion and current RPO of $3.5 billion grew 19% and 12%, respectively. About 2 percentage points of that current RPO growth was from early renewals. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%. Non-GAAP operating margin increased by 1 percentage point to approximately 36%, with ongoing cost discipline partly offset by revenue growth headwinds from foreign exchange movements. For the fiscal year, non-GAAP operating margin increased by 4 percentage points, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margin increased by 9 percentage points to approximately 21%. Recall in Q4 last year, we took a lease-related charge of approximately $100 million. That was part of our effort to reduce our real-estate footprint and to further our hybrid workforce strategy. For the fiscal year, GAAP operating margin increased by 6 percentage points. We delivered record free cash flow in the quarter and for the full year of more than $900 million and $2 billion, respectively, reflecting our strong billings growth. Turning to capital allocation, we continue to actively manage capital within our framework. As Andrew said, our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense. During Q4, we purchased 1.1 million shares for $210 million at an average price of approximately $193 per share. For the full year, we purchased 5.5 million shares for $1.1 billion at an average price of approximately $198 per share, and reduced total shares outstanding by 4 million. We retired a $350-million bond in December. Recall that we effectively refinanced this bond in October 2021 at historically low rates when we issued our first sustainability bond. Our average bond duration is now almost seven years. Now, let me turn to guidance. Our strong finish to fiscal ‘23 sets us up well for the year ahead. Overall end-market demand in Q4 fiscal ‘23 remained broadly consistent with Q3 fiscal ‘23. Channel partners remained cautiously optimistic, usage rates grew modestly, excluding Russia and China, and bid activity on BuildingConnected remained robust. As we said last quarter, foreign exchange movements will be a headwind to revenue growth and margins in fiscal ‘24. We expect FX to be about a 4-percentage point drag on reported revenue. We continue to expect the absence of recognized deferred revenue from Russia will be about a 1 percentage point drag to revenue growth. As we’ve highlighted before, most recently on our Q3 earnings call, the switch from up-front to annual billings for most multi-year customers creates a significant headwind for free cash flow in fiscal ‘24 and a smaller headwind in fiscal ‘25. You can see the impact on fiscal ‘24 in slide eight of our earnings deck. Change in deferred revenue increased fiscal 23 free cash flow by $790 million, but will reduce fiscal ‘24 free cash flow by approximately $300 million. The switch to annual billings for multi-year customers and a smaller multi-year renewal cohort are the key drivers of this $1.1 billion swing. The transition will also affect the linearity of free cash flow during the year, with Q1 fiscal ‘24 free cash flow benefiting from the strong billings in Q4 fiscal ‘23, and our largest billings quarters in the second half of the year proportionately more impacted by the switch to annual billings. While we expect many customers to switch to multi-year contracts billed annually, some may choose annual contracts instead. All else equal, if this were to occur, it would proportionately reduce the unbilled portion of our total remaining performance obligations and would negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged in this scenario. Annual renewals create more opportunities for us to drive adoption and upsell, but are without the price lock embedded in multi-year contracts. We'll keep you updated on this as the year progresses. Our cash tax rate will return to a more normalized level of approximately 31% in fiscal ‘24, up from 25% in fiscal ‘23. We accrued significant tax assets as a result of the operating losses we generated during our business model transition. Growing profitability and, more recently, rising effective tax rates across the globe, have accelerated the consumption of those tax attributes. Absent changes in tax policy, we expect our cash tax rate to remain in a range around 31% for the foreseeable future. Putting that all together, we expect fiscal ‘24 revenues to be between $5.36 billion and $5.46 billion, up about 8% at the mid-point, or about 13% at constant exchange rates and excluding the impact from Russia. We expect non-GAAP operating margins to be similar to fiscal ‘23 levels with constant currency margin improvement offset by FX headwinds. We expect free cash flow to be between $1.15 billion and $1.25 billion. The mid-point of that range, $1.2 billion, implies a 41 reduction in free cash flow compared to fiscal ‘23. As I outlined earlier, the key drivers of that reduction are: changes in long-term deferred revenue as a result of the shift to annual billings for multi-year customers and a smaller multi-year renewal cohort, FX, and our cash tax rate. The slide deck and Excel financials on our website have more details on fiscal ‘23 results and modeling assumptions for the full-year fiscal ‘24. At investor day, we’ll be looking beyond this year. As Andrew noted earlier, we remain in the relatively early innings of a transformational shift to the cloud to drive efficiency and sustainability. This is generating demand for cloud-based platforms and services, which break down the silos within and between the industries we serve. Autodesk is uniquely well-positioned to seize these opportunities and we will continue to invest with discipline and focus to realize that growth potential. While our subscription business model and geographic, product, and customer diversification give us resilience when compared to many other companies, we’re mindful that generational macroeconomic, policy, geopolitical, climate, and health uncertainty make the world more volatile and less predictable than in the past. Our business will grow somewhat faster in less volatile environments and somewhat slower in more volatile environments. Finally, we're not just looking to have industry-leading growth although we often do. Nor are we just looking to have industry-leading margins, although we often do. On average and over time, we are looking to have an industry-leading balance between growth and margins. And we often do. We think this balance between compounding growth and strong free cash flow margins, captured in the rule-of-40 framework, is the hallmark of the most valuable companies in the world. And we intend to remain one of them. With all this in mind, our target planning parameters over the next several years will be to grow revenue in the 10% to 15% range and generate free cash flow margins in the 30% to 35% range with a goal of reaching a \"Rule of 40\" ratio of 45% or more over time. The path to that 45% ratio will not be linear given the drag in fiscals ‘24 and ‘25 to long-term deferred revenue and free cash flow from the shift to annual billings of multi-year contracts. The rate of improvement will obviously also be somewhat determined by the macroeconomic backdrop. But, let me be clear, we’re managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering on disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achievement of this rule-of-45 goal, regardless of the macroeconomic backdrop. While macroeconomic and FX headwinds, along with sustained but disciplined investment in our products and platforms, will slow the rate of margin improvement, we continue to expect non-GAAP operating margins to be in the 38% to 40% range by fiscal ‘26, albeit more likely now in the lower half of that range. We continue to see scope for further margin growth thereafter. GAAP margins will further benefit from stock-based compensation as a percent of revenue trending down towards 10% and beyond over time. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end, cloud-based solutions that drive efficiency and sustainability for our customers. We’ll tell you more about our long-term vision and plans at our investor day on March 22. But let me finish by updating you on our progress in the fourth quarter. We continued to see strong growth in AEC, fueled by customers consolidating on our solutions to connect previously siloed workflows in the cloud. Sweco, Europe's leading architecture and engineering consultancy, is connecting our portfolio of products, from Spacemaker and Revit to Autodesk Construction Cloud and Innovyze, to streamline everything from transport and energy usage to lighting and water flows to ensure better transparency through the project lifecycle. Sweco has a thriving sustainability practice. Its new digital service, Carbon Cost Compass, which is built on Autodesk Platform Services, helps its customers model and calculate the carbon footprint and cost of different types of buildings. For our construction customers, we continue to benefit from our complete end-to-end BIM solutions which encompass design, preconstruction and field execution. In Q4, a mid-market general contractor in California, specializing in design-build projects, chose to replace a competitive project management offering with Autodesk Build as it looked to improve integration further and minimize conflict with their design processes. While highlighting Build’s cost management functionality as a differentiator, the customer ultimately chose Autodesk because of our long-standing and trusted partnership and shared vision on the future of construction. We continue to make excellent progress on our strategic initiatives which is driving accelerating adoption of Autodesk Construction Cloud. We added almost a thousand new logos again, drove continued rapid growth in Autodesk Build’s MAUs, and generated 3x quarter-on-quarter growth in our construction bundles, which combine multiple Autodesk Construction Cloud solutions and enable customers to standardize more rapidly on one platform. Outside the U.S., enabling our international channel partners to sell our construction portfolio continues to drive strong growth. We still see strong growth potential in construction and Autodesk remains uniquely well positioned to capture it. In manufacturing, Tata Steel, one of the world’s leading steel manufacturers, has used our solutions to increase efficiency and reduce costs in setting up new operations. To optimize effectively between its equipment, civil, structural, and plant infrastructure teams, Tata Steel uses Autodesk AEC and Manufacturing collections and Vault. Through the integration of data from various vendors on a single platform, Tata Steel leverages simulation and clash detection in a virtual environment, eliminating potential conflicts that can have a huge impact if they occur during physical installation. In Automotive, we continue to strengthen and expand our partnerships, both within and beyond the design studio, as OEMs transform and connect factories. A leading manufacturer in the U.S. expanded its EBA in Q4, leveraging the cutting-edge visualization technology in VRED Pro to more effectively process executive design reviews and reach final designs more quickly. Autodesk is now partnering with the customer as it renovates its factories for its new fleet of electric vehicles, ensuring it controls the construction flow and owns its own data by standardizing on Autodesk Construction Cloud. Customers are also beginning to merge their design, manufacturing and production management workflows with Fusion and Prodsmart. In Q4, a manufacturer based in the U.K., which has more than doubled in size in the last 18 months, switched from a competitor’s CAD tool to Fusion 360 and extensions for its integrated CAD and CAM capabilities. With Prodsmart as part of its connected platform, the customer can instantly generate a bill of materials after creating a design and link directly to inventories, eliminating tedious work and saving time for higher-value opportunities. We ended the quarter with 223,000 Fusion 360 subscribers, a number which does not include extensions where units increased more than 100% year-over-year. During the quarter, we launched the Signal Integrity Extension for Fusion, powered by Ansys, which enables designers to analyze their PCB electromagnetic performance, ensure compliant products and power a faster development cycle at lower costs. We continue to see strength in PLM, signing our largest-ever cloud data management deal and growing more than 30 percent in the quarter. In education, leading universities continue to modernize their courses ensuring students will learn the in-demand skills of the future. At Northumbria University, the prestigious “Design for Industry” program's students are now choosing to use Fusion 360 within their design process and across many of their modules along with real-world live projects led by industry partners. Their switch is primarily down to its ease of use and cross platform availability. While our software remains free for educators and students, tomorrow's design leaders are bringing Fusion 360 to new and established manufacturers. We will continue to evolve our business model offerings to match customer needs and enable users to participate in our ecosystem more productively. For example, a European manufacturer which operates in over 100 countries and six R&D facilities worldwide, transitioned to our Named User model with Premium Plan providing enhanced security from single sign-on and improved efficiency from 24/7 technical support. Our partners at Mensch and Maschine supported the transition with detailed knowledge and analysis of the customer usage behavior, resulting in an optimized flex token package for its occasional users; providing them with ongoing software access without requiring a full-time subscription. And finally, we continue to work with non-compliant users to find flexible and compliant solutions that ensure they have access to the most current and secure software. During the quarter, we closed nine deals over $1 million and 23 deals over $500,000 with our license compliance initiatives. Returning to where I started – resilience, opportunity, and discipline were important contributors to our fiscal ‘23 results and will remain the key drivers of our future success. We’re excited to share our plans with you at our investor day on March 22. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question please, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Good afternoon guys. Thanks for taking my questions here. Debbie, maybe for you. I was wondering if you could just give us a little bit more context about how you're thinking about fiscal '24 and beyond from a guidance perspective?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. Thanks, Saket. So first, the overall demand environment in Q4 was relatively consistent with what we saw in Q3. If I drill first into the specifics on the guide for billings, of course, we have multiyear to annual billings transition, that's creating a headwind as expected. The transition doesn't have an impact on revenue. It's just a change in billings frequency. On revenue, as we outlined last quarter, we're seeing a negative impact from FX and the Russia exit. Together, that represents 5 points of headwind to growth. If we normalize for that, the revenue growth range would be in the low teens. On margin, we're managing the flat margins on an as-reported basis year-over-year. That's consistent with what we said on the last call. We have a strong balance sheet. We have conviction in our strategy. So we want to continue to invest during the cycle so that we can maintain our momentum, but not so much so that we see a detriment to our margin outlook. And I want to point out that our margin guide on a constant currency basis represents improvement year-on-year. And then finally, on cash flow, the headwind to billings from the transition to annual billings has a downstream effect on cash flow, of course. As I mentioned in the opening commentary, the swing in long-term deferred revenue is having a negative impact of around $1.1 billion to $1.1 billion to fiscal '24 cash flow. That headwind is driven primarily by that switch to annual billings for multiyear customers. And if we take that with other factors like a lower multiyear renewal cohort and higher cash taxes, we get to that $1.2 billion guidance midpoint. Our goal is to set ourselves up for success in fiscal '24 and for the long-term. And it's that same sort of thinking that's driving how we're thinking about the longer-term financial model. On revenue, our target planning range of 10% to 15%, it remains in that double-digit territory. On margin, we're targeting a margin in the 38% to 40% range in the fiscal '23 to '26 window. But we said that because of the macro and FX headwinds that we're seeing, we think it's more likely now that it's going to be in the lower half of that range. And then on cash flow, we'll still work towards double-digit CAGR growth through fiscal '26, but it looks less likely though, given the impact of cash taxes, FX volatility and a stronger-than-expected fiscal '23 finish. As we look ahead, we're focused on managing the business to a Rule of 45 ratio or better, which after we get through this multiyear to annual billings transition, we think strikes the right balance between driving top line growth and delivering on disciplined profit and cash flow."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Got it. That's very helpful. Maybe a follow-up for you, Debbie, if I may. I guess now that the fiscal 2024 has finally arrived, if you will. Could you just maybe walk through a little bit of detail just on that impact of switching from upfront to annual billings for those multiyear contracts?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. It has finally arrived. It's nice to finally be having these conversations, Saket. So the transition to annual billings, the rollout is happening on schedule, our systems will be ready. We're assuming that we sell multiyear upfront through March 27. And then at the March 28 go-live that we only sell multiyear with annual billing terms in mature countries for our platinum and gold partners. That represents a significant majority of the eligible population. There's going to be some remaining multiyear upfront in the forecast beyond March 27. That's going to be coming primarily from eStore and emerging countries, but it's relatively small in comparison to the volume that we saw in fiscal '23. And as we move those populations to annual billings, we'll see a follow-on headwind to free cash flow in fiscal '25. It's consistent with what I said in the opening commentary that the past is not going to be linear. We're assuming that the same proportion of our business that's been multiyear remains multiyear. We think that the price lock that you get in a multiyear contract will entice our customers to continue to buy multiyear, especially in the inflationary environment that we're in. But of course, it's possible that some of our customers choose annual contracts rather than multiyear contracts with annual billings. That wouldn't impact billings or most other financial metrics in fiscal '24, but it would negatively impact the total RPO growth rate. At the end of the day, it's a win-win for us. If our customers choose to go with annual contracts, it gives us an opportunity to engage with them upon renewal to drive adoption and upsell and our renewal rates are strong. So this is something we'll keep you posted on as the year progresses."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very clear. Looking forward to the Analyst Day, guys. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your line is open, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, let me start with you. Your 10-Q for the third quarter had some new and intriguing language with regard to how you foresee the evolution of your sales model, specifically, your relationship with VARs and VADs and there's a lot of complexities in the language there. So perhaps you could talk about how you envision the evolution of your business in terms of the operational or fulfillment or license management effects that you foresee over time or the margin effects over time. And where you think your sales mix ultimately goes over the next number of years in terms of direct versus indirect? Then a follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. Great. So I like the way you highlighted. This is an evolution. We've been evolving in a particular direction over time. Obviously, several years back, I talked about the 50-50 mix of direct and indirect and we've been driving a lot of growth in direct channels. We've been driving a lot of growth in direct enterprise business, and all of these things kind of like weave together into a longer-term plan. And now what you're seeing is doing is we're driving a lot more direct engagement with some of our value-added resellers. So some of the changes that you saw in there are preset staging more and more direct engagement with our value-added resellers and less, but smaller engagements and fewer engagements between intermediates and our value-added resellers, which makes total sense between the systems evolutions we've been executing on in the direction we're going. So long-term, we're still driving towards that same type of balance that we've been talking about. But as our systems improve, we're looking for different types of engagement models with our value-added reseller channel."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Second question, the slide deck gives us the annual update on your installed base of subscription. The net increase was about $600,000 for the year, net of trade-ins. Looking ahead, how does your long-term growth model foresee the contribution of volume growth and particularly the effect as well of improving the richness of the mix, perhaps to more collections and so forth? And perhaps by end market. When you think about manufacturing, that volume looks like it's maybe 10th of your net new volume per year. So you have a lot of volume that has to come from other segments outside of manufacturing. So perhaps you could talk about that."
},
{
"speaker": "Debbie Clifford",
"text": "Sure, I'll take that one, Jay. So we start at the top. Yes, subscriptions grew in a healthy way. I just want to remind, however, that there's a lot of variability in that metric, given that we have such a wide diversity of business models in play, things like Flex, EBAs, accounts pricing and so on and so forth. So it does make it less and less of a relevant metric for us to manage business performance. We're more focused on new and renewal ACV. They both posted solid growth in Q4. As we think about new ACV. That's the proxy for, I think, the spirit of your question. We generated across both volume and also stronger unit economics, things like price mix and partner margins. In general, historically, we've seen it come from roughly equally across those sources, and it kind of flexes up or down depending on the demand environment that we're in. We could see some puts and takes like when COVID hit, we saw more growth from volume because volume versus price because we were more sensitive to price increases at the time that the pandemic hit. And then obviously, when we're in a situation where we change prices at all, we might see more growth coming from price. But all in all, as we think about achieving some of the long-term growth parameters that I talked about, we're thinking about it as a roughly equal split across volume, price mix, ASP over time. Andrew, did you want to comment on the segment?"
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks. Jay, your comment on statements, all right? As you know, and I know you're aware, as we look at the various segments you do business in, we're moving in a situation where we're getting deeply entrenched in both the design and make side of our customers' business. So we also pay attention to the fact that even within manufacturing and AEC and all these things, we're going to be adding a lot more subscribers in some of the downstream processes in other parts of the process, which is going to be an important engine even within some of the segments that you discussed. And I know you're aware of that. I just wanted to reinforce it a little bit."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Very good. Thank you, both."
},
{
"speaker": "Operator",
"text": "Our next question comes on the line of Adam Borg of Stifel. Your question please, Adam."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks so much, for taking the question. Maybe Andrew, on Innovyze, it was interesting to hear and great to hear about the record quarter. We picked up some growing traction in our check. I'd love to hear a little bit more about what's driving this and where we are in the migration more broadly to subscription, given its more legacy business model? And then I have a follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So it's very early in the migration. But in general, Innovyze had a record quarter. And the biggest thing that was driving some of that record growth is that now Innovyze can be incorporated into a lot of our enterprise business agreements and in some of our engagement with our largest accounts. And guess what, there's a hunger for the solution. So there's a lot more direct engagement with customers around Innovyze that's really propelling the growth right now. We're still very much in the early stages of activating our channel. So we've activated our major accounts team, and we're still working to activate our channel. And the subscription transition, super early stages just starting, and that we'll give you updates on that as time goes on."
},
{
"speaker": "Adam Borg",
"text": "Maybe just a quick follow-up on the macro. You guys are clear that things seem to be consistent quarter-over-quarter. I'd love to maybe just try go down one step deeper. Any observations around customers switching more to point solutions from collections or anything around RT or perhaps even more interest in Flex given the macro? Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So actually, there's pretty consistent customer behavior across segments and sizes of customers. So there's not any kind of switching behavior or downgrading behavior. And Flex tends to be to a large measure, and its very early days with Flex, tends to be incremental to our business rather than detrimental to our business. So in general, we're not seeing any kind of changes in mix as things go on. I will say, from a segment perspective, while all the segments grew, our larger customers grew faster than our smaller ones, but everybody was growing."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks again."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Joe Vruwink of RW Baird. Your line is open, Joe."
},
{
"speaker": "Joseph Vruwink",
"text": "I wanted to go back and give more detail on what you're doing with the public sector around project delivery. And I guess I'm curious how this compares to the evolution of the commercial side of your business. So maybe the analogy use, I think, BIM360 launched and 2012, and we got Construction Cloud in 2019 and here we are today is what you're announcing now or kind of the conversations you're having in the public space with owners it closer to 2012? Or is it kind of further along and has the potential to progress more quickly?"
},
{
"speaker": "Andrew Anagnost",
"text": "Joe, I think that's a very astute question. And I think you're pointing to some of the important things about what we're doing with public sector in general. You probably noticed in the opening commentary, our comments about FedRAMP things associated with that. All of these things, FedRAMP, are engagement with the infrastructure partner and DOTs that I talked about in the opening communicator, all of these are part and parcel of laying the groundwork for more and more modernization inside of these department of transportation and larger owners in terms of infrastructure, federal owners, European owners as well. All of that will continue to build out in a way very similar to what you described in terms of entering into construction. It's a longer-term play. It will take time. So it's still early innings in all of these things. But you can see increasing activity specifications coming out more and more within the Department of Transportation community and a desire to modernize the stacks. And that's a big push right now. A lot of these DOTs they're stuck in a different era of software and solutions, and they're looking to modernize and this isn't just true in the U.S. It's also true in Europe. We're engaging in more and more discussions with countries in the European Union about some of the BIM standards they're trying to drive into their infrastructure projects. And that's going to have a compounding effect on how people want to engage with different kinds of solutions in the infrastructure space, but still early journey."
},
{
"speaker": "Joseph Vruwink",
"text": "Yes, great. That's helpful. And then, just on the 10% to 15% growth parameter, I guess, as I think about the backdrop in fiscal 2024, I wouldn't label it as easy. And yet the guidance, I think, calls for something closer to 12% organic. So I guess the question is what happens incrementally in kind of a planning scenario relative to a challenging backdrop in 2024, where 10% type growth becomes a plausible outcome?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So look, first off, let's comment about how resilient our business is and how we demonstrate that resilience over the last few years. We believe we've put everything in the right kind of scope, and we've aligned things pretty carefully. If we saw an environment where we saw downward pressure on our margin expectations for the year, we have levers within the company that we can pull that has nothing to do with layoffs or any of the things you're seeing in the rest of the tech sector that we could pull to ensure that we hit those targets. So we feel pretty confident about what we've laid out and how we could hit it even if there were changes in the economic environment. Debbie, do you want to add some commentary?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes, sure. A couple of things I would say. First, overall, I mean, we're watching the macro backdrop closely, and I said that it was broadly unchanged. Europe was a bit better or U.S., a bit worse. Asia, about the same. So overall, on the whole, the demand environment was broadly similar. We've reflected all of that into our guidance. The leading indicators remain strong. And another way to think about it would be that if you look at revenue, the implied growth rate in Q4 of our fiscal '23 is 9%. If you extend that into fiscal '24 at another point of currency headwind, you're squarely at the guidance midpoint for fiscal '24. So we're kind of already at that rate. And we feel comfortable with the guidance that we've set."
},
{
"speaker": "Joseph Vruwink",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Michael Funk of Bank of America. Your question please, Michael"
},
{
"speaker": "Michael Funk",
"text": "Yes. Thank you for questions today. A couple if I could. So First, the noncompliant transition during the quarter was greater than we expected, a very strong rate. Just curious to kind of change in push versus pull strategy there? And then how additive type of growth that might be in fiscal '24 and beyond?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So there's no change in our approach to non-compliance, right? As I've said in many times, and I want to keep reinforcing, we continue to develop efficiencies. We continue to be able to identify to higher precision, who is actually non-compliant and who actually isn't and we're building up a steady base of business as we move forward. But we're not looking to accelerate it or push it harder or drive it in any particular direction. We're just allowing it to be kind of a steady incremental growth engine within our business and kind of continue to deliver year after year after year. And that will continue to be our strategy. One, we think it's the right thing to do for the company, the right thing to do for our customers. It gives our customers time to get themselves compliant because just the fact that we're out there engaged in compliance activity encourages people to ask themselves if they should be compliant there's other business levers here. And the more carefully we do this and the more incrementally, we do this, the better the outcome is for the entire ecosystem. So no real change in how we're approaching that."
},
{
"speaker": "Michael Funk",
"text": "And then Debbie, you mentioned that the inflationary environment might affect how customers think about the shift for multiyear to annual. Just curious if the rising rate environment affects how you think about that shift from upfront payment for multiyear to annual bill. Does it change the math for you?"
},
{
"speaker": "Debbie Clifford",
"text": "It doesn't in any meaningful way, as I said. It's really a win-win for us because with annual contracts, we get an opportunity to engage with our customers upon renewal to drive upsell and make sure that there is adoption. Obviously, with a price lock and our customers signing on the multiyear contracts, we have a 100% renewal rate in any given period, but there's less of that opportunity to engage. So from our standpoint, it's a win-win."
},
{
"speaker": "Michael Funk",
"text": "Great. Thank you, both."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Please go ahead, Matt."
},
{
"speaker": "Matthew Hedberg",
"text": "Great. Thanks for taking my questions. Andrew, kind of a high-level one for you. You guys have been focused on generative design for a while now. And with all the news on AI recently, I'm wondering if you can kind of give us your perspective on how Autodesk plans to leverage AI and sort of the impact on design?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So ChatGPT has obviously given a massive amount of validation to the potential of AI. It is a particular horizontal solution, and we intend to leverage that horizontal solution in some of our solutions. In fact, you're probably aware that Microsoft and Satya Nadela himself demoed a natural language processing tool for generating manuscripts for both direct to my and for Fios, and it works fabulously, right? These are things that provide real leverage to our customers. However, one of the things I really want you to be aware of, Matt, is that the real vertical value comes when we start training on data that is directly used by our customers to do particular things or design or build something. And that comes at the user productivity level, the company productivity level and the ecosystem productivity level. And that's going to unlock a lot of potential as we develop things that cut across all of what our customers can do like generative design, by the way, but probably heading in even other directions. And that's going to take time to develop. It's going to take opportunities for us to engage with customers in terms of using some of their data. But I want you to pay attention to that long-term horizon on doing real training on customer data, which will be where the revolution comes from."
},
{
"speaker": "Matthew Hedberg",
"text": "Got it. Got it. And then Debbie, sort of the question that I think a lot us are getting on from folks is the levels of conservatism in the guide? And I'm sure it's based on what you see today is how you're sort of building the forecast. But maybe just a little bit more granularity on how you're thinking about sales productivity, pipeline discount rates? Anything that sort of like provide a little bit more color there?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Matt. Look, I'd say that I don't have much to add versus what I've said already. The macro is broadly unchanged. Those leading indicators remain strong. Our business is going to grow faster and better environments and somewhat lower and worse environment. Our goal is to set ourselves up for success in fiscal '24 and for the long term."
},
{
"speaker": "Matthew Hedberg",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jason Celino of KeyBanc Capital. Please go ahead, Jason."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks. Can you hear me. So actually, one question on the quarter. So it sounds like there was -- well, I guess, did you see strength in the business at the end of January? I'm just trying to understand how business was after that multiyear discount went away at the beginning of the month."
},
{
"speaker": "Debbie Clifford",
"text": "Yes, the linearity of our business was not dissimilar to what we've seen in previous periods."
},
{
"speaker": "Jason Celino",
"text": "Perfect. And then on the free cash flow commentary you gave, the 30% to 35% margin. That was for 2026 period, the period of '23 to '26. And does that include the headwinds you talked about, including the FX, the cash taxes, et cetera?"
},
{
"speaker": "Debbie Clifford",
"text": "So what I said was we have target planning parameters of 10% to 15% revenue growth and 30% to 35% free cash flow margin, all in pursuit of our goal of achieving a rule of 45-plus ratio over time. It's not time specific. If you look at our guidance for fiscal '24, that's at the trough of the transition for multiyear to annual billings, we'd be in the low 30s. And what we're saying is that we're going to go from the low 30s as we normalize over time towards our goal of achieving that 45% plus and that we intend to make meaningful progress against achieving that goal regardless of the macroeconomic backdrop."
},
{
"speaker": "Jason Celino",
"text": "Perfect. No, that's very helpful. And I guess we'll learn more at the Analyst Day in a couple of weeks. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steve Tusa of JPMorgan. Your line is open, Steve."
},
{
"speaker": "Sam Yellen",
"text": "Hi, it's Sam Yellen on for Steve Tusa. So in terms of the free cash flow bridge for next year, I know you guys have the deferred revenue and cash taxes. But is there anything else moving around maybe in working capital that we should considering the bridge?"
},
{
"speaker": "Debbie Clifford",
"text": "If you look at -- yes, if you look at Slide 8 of the deck that we put on our website is the move from multiyear upfront annual billings is the lower cohort. We have a lower cohort of multiyear contracts that come up for renewal, just cyclically in fiscal '24. It's FX movements and it's cash taxes. Those are the 4 drivers of the decline."
},
{
"speaker": "Sam Yellen",
"text": "Got it. Thanks. And then in terms of the high single-digit revenue guidance for next year, how much of that is driven by price?"
},
{
"speaker": "Debbie Clifford",
"text": "We're not going to get into that level of specificity, I would say. I mean, as I mentioned when Jay was asking the question earlier, we kind of look at it as our goal be to drive a mix of volume and price mix, partner margin type contributions to growth. And so you can loosely consider that, that would be how we're thinking about it as we look at growth next year, too."
},
{
"speaker": "Sam Yellen",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Sterling Auty of SVB MoffetNathanson. Your question please, sir."
},
{
"speaker": "Sterling Auty",
"text": "Thanks guys. Just one question from my side. Can you guys help me understand which end market segments, manufacturing versus architecture, et cetera, are you seeing the biggest cyclical impact today? And what did you factor in on those trends into the guidance? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Look, it's a hard question to answer because all of those segments are growing, all right? And the new business is growing in all those segments. So it's a nuanced question. One thing I will say is there's a different character of pushback from each one of those segments in terms of what they're seeing. What we're seeing in manufacturing is my costs are going up, my costs are going up and the costs are going up, right? And that is impacting their ability to deliver, frankly, on some impact on demand because they can't pass it all to the customers. They have trouble kind of fulfilling the demand with the cost factor. So I would say right now, the inflationary environment is putting more pressure on our manufacturing customers than it is on our ADC customers. So that's just one piece of color. In the AEC space, obviously, the material costs are a big issue for them. But they are continuing to struggle with labor shortages, capacity problems, the ability to kind of clear out the book of business, which is great because there's an overhang there's an overhang of business for them right now, and there still is. And that's true in manufacturing, too. There's still an overhang of delivery that has to happen. I'm still waiting for a part from my repaired car and it's maybe my cars bus has been months, can't get the part. All right. There's plenty of capacity challenges there as well. But in AEC, generally, there's still a backlog of book of business, labor shortages, capacity within some of these institute companies and construction firms, architecture firms, is getting in the way. So I hear capacity problems much more in the AEC segment which, by the way, is going to continue into time. Eventually, the capacity will clear out. And I hear inflationary pressures much more from our manufacturing customers. M&A, they don't care, it's all digital anyway. People are watching more and they're happy."
},
{
"speaker": "Sterling Auty",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steve Koenig of SMBC Nikko America. Your question please, Steve."
},
{
"speaker": "Steven Koenig",
"text": "Great. Thank you. Hey Andrew, hey Debbie. Thanks for taking my questions. I want to build just a little bit more on Sterling's question here. I'm wondering, can you remind us in AEC, if you look across upstream and downstream. What's your kind of complexion related to commercial versus industrial versus residential design and construction? And then I'm really curious, given those interesting comments you just had, Andrew, about how you're seeing demand and capacity problems in that segment. What did you see in '08 when kind of the AEC activity slowed down? Was it more intense in one of those kind of sub-segments? And how do you think about how that could unfold over time? Is that as those capacity is just clear out and interest rates could begin to affect that sector broadly?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So that was a multilayer question. And now I have to remember the first part of the question, which was related to -- remind me about what your part A was?"
},
{
"speaker": "Steven Koenig",
"text": "Yes. Sorry, it was a little long winded. The complexion of your AEC."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. So this is the -- always the question about which parts of the AEC ecosystem are we sensitive to. And here's the thing, and I always answer the question this way. The dollars always go somewhere, all right? So people were very concerned about 1.5 years ago, I was getting lots of questions about what's your exposure to commercial real estate, commercial real estate is going to slow down what happened in commercial real estate? It moved a retrofit and reconfigure all right? And a lot of commercial real estate spend is in is going on in retrofit and reconfigure. A lot of architecture firms are completely involved in that. And also, it's moved to multifamily residential and things associated with that due to other pressures inside the economy and inside municipalities. So the money shifts around all the time, right? And in terms of which segment is getting lit up. So we're not seeing any particular exposure in terms of slowdown to any particular segment because of the way this activity shifts, all right? And it's just one -- it's one of the interesting things about the ecosystem. There's always something that wasn't getting built or worked on that starts to get built or worked on when something else is out of the way, it's out of the queue, all right? And the commercial office of space is somewhat out of the queue and other things are moving into the queue and getting more attention. Now with regards to '08, it was a very different type of situation. If you recall what we thought in '08 was a massive slowdown at the low end of our business. And a matter of fact, it was a precipitous slowdown in the low end of our business with smaller firms not being able to get enough work. We don't see anything on the horizon that looks like that because of the backlog of business that's out there right now, there's just more people wanting to get things done than there is capacity to get the thing done in the ecosystem. So it's a very different situation where there was a kind of like the valve is shut off. There was no backlog, which to bleed through. Now we're in a world where we've got a lot of project backlog, a lot of pent-up demand, and it's just not the same situation that you saw in '08. It was very different world. And we're a very different company."
},
{
"speaker": "Steven Koenig",
"text": "Yes, for sure. That’s helpful. I really appreciate the color. Thanks so much."
},
{
"speaker": "Operator",
"text": "That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, everyone. Sorry about that, having trouble finding my button. Looking forward to seeing you all the Investor Day in just in a month's time. If you have any questions, please e-mail me at simon@autodesk.com. Look forward to catching up again soon. Bye-bye."
},
{
"speaker": "Operator",
"text": "And this concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 3 | 2,023 | 2022-11-22 17:00:00 | Operator: Thank you for standing by and welcome to the Autodesk Q3 Fiscal ‘23 Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now turn the conference over to your host Mr. Simon Mays-Smith, Vice President, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the third quarter results of our fiscal ‘23. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings including our most recent Form 10-Q and the Form 8-K filed with today’s press release for important risk factors and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numerical growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or XL Financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon and welcome everyone to the call. We again reported record third quarter revenue, non-GAAP operating margin and free cash flow. Encouragingly, the business is performing as we’d expect given secular growth tailwinds and macroeconomic, geopolitical policy and COVID-19-related headwinds. Subscription renewal rates remain resilient. Our competitive performance remains strong. Outside of Russia and China, new business growth slightly decelerated in the quarter, most notably in Europe, but overall growth remains good. And we see less demand for multiyear upfront and more demand for annual contracts than we expected. We are hopeful this is a positive signal for our transition next year to annual billings for multiyear contracts. Overall, our leading indicators are consistent with these trends. Channel partners remain optimistic, but with hints of caution. Usage rates continue to grow modestly in the U.S. and APAC, excluding China, but are flat in Europe, excluding Russia. And bid activity on BuildingConnected remains robust as the industry continues to work through its backlog. We are reinforcing the secular tailwinds to our business by accelerating the convergence of workflows within and between the industries we serve, creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. Our strategy is underpinned by disciplined and focused investments through the economic cycle, which enables Autodesk to remain well invested to realize the significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments later. In September, we hosted more than 10,000 customers and partners at Autodesk University. There was incredible energy, excitement and optimism for being together in person for the first time in 3 years. There was also palpable momentum behind the digital transformation of the industries we serve. At AU, we announced Fusion, Forma and Flow, our three industry clouds, which will connect data, teams and workflows in the cloud on our trusted platform. By increasing our engineering velocity, moving data from files to the cloud and expanding our third-party ecosystem, they will enable Autodesk to further increase customer value by delivering even greater efficiency and sustainability. I will now turn the call over to Debbie to take you through our third quarter financial performance and guidance for the fourth quarter and full fiscal year. I’ll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. In a more challenging macroeconomic environment, Autodesk performed in line with our expectations in the third quarter, excluding the impact of in-quarter currency movements on revenue. Resilient subscription renewal rates, healthy new business growth and a strong competitive performance were partly offset by geopolitical, macroeconomic, policy and COVID-19-related headwinds, foreign exchange movements and less demand for multiyear upfront and more demand for annual contracts than we expected. Total revenue grew 14% and 15% at constant exchange rates. By product, AutoCAD and AutoCAD LT revenue grew 10%. AEC and manufacturing revenue both grew 13% and M&E revenue grew 24%, partly driven by upfront revenue growth. By region, revenue grew 17% in the Americas, 10% in EMEA and 14% in APAC. At constant exchange rates, EMEA and APAC grew 12% and 18%, respectively. By channel, direct revenue increased 14%, representing 35% of total revenue, while indirect revenue grew 13%. Our product subscription renewal rates remain strong, and our net revenue retention rate was comfortably within our 100% to 110% target range. Billings increased 16% to $1.4 billion, reflecting continued solid underlying demand, partly offset by foreign exchange movements and a shift in mix from multiyear upfront to annual contracts versus expectations. Total deferred revenue grew 13% to $3.8 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 11% and 9%, respectively. At constant exchange rates, RPO and current RPO grew approximately 15% and 13%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 93%, while non-GAAP operating margin increased by 4 percentage points to approximately 36%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margin increased by 3 percentage points to approximately 20%. We delivered robust third quarter free cash flow of $460 million, up 79% year-over-year reflecting strong revenue growth, margin improvement and a larger multiyear upfront billing cohort. Turning to capital allocation, we continue to actively manage capital within our framework. As Andrew said, our organic and inorganic investments will remain disciplined and focused through the economic cycle. We will continue to offset dilution from our stock-based compensation program and to accelerate repurchases opportunistically when it makes sense to do so. Year-to-date, we purchased 4.4 million shares for $873 million at an average price of approximately $200 per share, which compared to last year contributed to a reduction in our diluted weighted average shares outstanding by approximately 5 million to 217 million shares. We also announced today that the Board has authorized a further $5 billion for share repurchases. And in December, we plan to retire a $350 million bond when it comes due. Recall that we effectively refinanced this bond last October at historically low rates when we issued our first sustainability bond. And related to that new sustainability bond, we published our first sustainability bond impact report about a month ago, which updates our progress. You can find the report on our Investor Relations website. Now let me finish with guidance. Andrew gave you a readout on the business and our markets at the beginning of the call. Our renewal business continues to be a highlight, reflecting the ongoing importance of our software in helping our customers achieve their goals. New business growth continues to be relatively stronger in North America with growth in EMEA and APAC outside of Russia and China, slightly decelerating, but overall growth remains good. And we’ve seen less demand for multiyear upfront and more demand for annual contracts than we expected. As we look ahead and as we’ve done in the past, our Q4 and fiscal ‘23 guidance assumes that market conditions remain consistent with what we saw as we exited Q3. The strengthening of the U.S. dollar during the quarter generated slight incremental FX headwinds, reducing full year billings and revenue by approximately $10 million and $5 million, respectively, for the remainder of fiscal ‘23. Bringing these factors together, the overall headline is that our fiscal ‘23 revenue, margin and earnings per share guidance remained close to the previous midpoint at constant exchange rates and comfortably within our previous guidance ranges. Our lower fiscal ‘23 billings and free cash flow guidance primarily reflects less demand for multiyear upfront and more demand for annual contracts than we expected. We’re narrowing the fiscal ‘23 revenue range to be between $4.99 billion and $5.005 billion. We continue to expect non-GAAP operating margin to be approximately 36%. And we expect free cash flow to be between $1.9 billion and $1.98 billion. The slide deck and updated Excel financials on our website have more details on modeling assumptions for the full year of fiscal ‘23. The challenges our customers face continue to evolve that reinforce the need for digital transformation, which gives us confidence in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our long-term revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. Fusion, Forma and Flow connect data, teams and workflows in the cloud on our trusted platform, making Autodesk rapidly scalable and extensible into adjacent verticals from architectural and engineering to construction and operations, from product engineering to product data management and product manufacturing. Our platform is also scalable and extensible between verticals with industrialized construction and into new workflows like XR. By accelerating the convergence of workflows within and between the industries we serve, we are also creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. In AEC, our customers continue to digitally transform their workflows to win new business and become more efficient and sustainable. For example, to support the city of Changwon smart city ambitions, the Changwon Architectural Design Institute, which operates across architecture, municipal engineering and city planning is standardizing on AEC collections and developing features to Revit APIs, which automate modeling, drawings and specification inspection. These will leverage the design institute’s expertise in BIM and enable faster and higher quality design, reduce error and waste during construction and build the digital twins for post-construction operation and maintenance. In a challenging market environment, the design institute has been able to win new business and capture new market through digital transformation. In construction, we are seeking to eliminate waste at the source rather than simply automating the process around it. By seamlessly connecting construction data and workflows both upstream with preconstruction and design and downstream to hand over, operations and maintenance bases to our digital twin, we are enabling a more connected and sustainable way of building. For example, after a leading mechanical contractor in the United States purchased a competitor’s construction management product a few years ago, communication and workflows between the design and field teams were disconnected, resulting in data fragmentation, less insight, more complicated reporting and ultimately low adoption of the process. To resolve these issues, it chose to consolidate all of its design to build workload on the integrated Autodesk platform, turning to Autodesk Build to streamline handoffs between detailing, the fab shop and the field. Our momentum in construction continues to grow. Across construction, we added almost 1,000 new logos with Autodesk Build’s monthly active users growing more than 60% quarter-over-quarter and becoming Autodesk’s largest construction products. In infrastructure, we see greater appetite from owners to accelerate their digital transformation to connect workflows from designed to make on the Autodesk platform. For example, to transform the speed, efficiency and sustainability of its network, one of the leading electricity network operators in Europe is accelerating its transformation from 2D to BIM and digital twins. In the third quarter, it signed its first EBA with Autodesk, adding Revit and Docs to enable it to upgrade the capacity of its substations and incorporate renewable power generation rapidly and safely. To accelerate maintenance workflows and reduce costs, the customer is in-sourcing the production of maintenance parts and using Fusion 360 as a platform for 3D printing. Turning to manufacturing, we have sustained good momentum in our manufacturing portfolio this quarter as we connected more workflows from design through to the shop floor, developed more on-ramps to our manufacturing platform and delivered new powerful tools and functionality to Fusion 360 extension. We continue to drive efficiency and sustainability for our customers and provide further resilience and competitiveness in uncertain times. For example, De Nora is an Italian multinational company specializing in electrochemistry and is a leader in sustainable technologies in the industrial green hydrogen production chain. It has been a longtime user of AutoCAD and Revit. Over the last few years, it accelerated its cloud strategy by replacing a competitor’s on-premise PLM solution with an integrated Vault and Fusion 360-managed solutions and improve the security of its data, enables seamless collaboration between product design and manufacturing and more easily onboard and integrate acquisitions. In Q3, it took another step in its digital transformation by firstly transitioning to named users and adding premium for better usage reporting, insights and single sign on security and secondly, by adding Flex to optimize consumption for its occasional users. Heineken is on a mission to become the best connected brewer as part of its evergreen strategy and is undergoing a digital transformation to ensure is prepared for the unforeseen challenges in an ever-changing world. To help, Autodesk has been supporting Heineken’s 3D printing initiative with an expanded adoption of Fusion 360 across a number of breweries. By designing and manufacturing their own equipment parts in-house, Heineken has been able to see a reduction in the replacement times of a number of parts from over 6 weeks to just 4 hours, significantly reducing downtime and lessening the carbon impact of shipping new parts when necessary. Scanship AS, a Vow Group company is a great example of how our customers are using our Fusion platform to generate sustainable outcomes efficiently and transparently for customers. It has developed technology that processes waste and purified wastewater providing valuable, sustainable and circular resources and clean energy to a wide range of customers. By consolidating on Fusion 360 managed with Upchain, Scanship AS will be able to connect data and workflows in the cloud to manage processes and collaborate more easily and efficiently, while also gaining greater transparency on its supply chain to deliver decarbonized products to its customers. Fusion 360’s commercial subscribers grew steadily, ending the quarter with 211,000 subscribers, with demand for extensions continuing to grow at an exceptional pace. Outside of commercial use, a rapidly growing ecosystem of students and hobbyists learning next-generation technology and workflows will take those skills with them into the workforce. We would like to congratulate students from over 57 countries who recently competed in the finals of the WorldSkills competition, aptly referred to as the Olympics for vocational skills. Students used the latest workflows and technologies from Fusion 360 and Autodesk Construction Cloud to compete in vocational disciplines such as mechanical engineering, additive manufacturing and digital construction. Sit Shun Le from Singapore, who won the gold medal for additive manufacturing, used Fusion 360 to find the optimum structure and then minimize the amount of materials used through additive manufacturing. All participants were able to hone their skills using next-generation technology. I am inspired by their ingenuity and optimistic about the innovation they will bring to the workforce of the future. And finally, we continue to work with customers to provide access to the most current and secure software through our license compliance initiatives. For example, we worked collaboratively with a large multinational manufacturing company seeking to adhere to the same software standards and ensure access to the latest and safest software for all its employees across the globe. We helped customers conduct a self-audit that identifies gaps in its operations in China and then crafted and optimized a bespoked subscription plan. As a result, we agreed to an approximately 5 million contracts in Q3, our largest ever license compliance agreement. During the quarter, we closed eight deals of $500,000 and four deals over $1 million. To close, subscription renewal rates and net revenue retention continue to compound. New business growth remains good, and our competitive performance remains strong. The business is performing as we’d expect given secular growth tailwinds and macroeconomic, geopolitical, policy and COVID-19 headwind. Our capital allocation will remain disciplined and focused through the cycle with organic investment and acquisitions accelerating our growth potential and competitive intensity and share buyback offsetting dilution. The breadth and depth of the market opportunity ahead of us is substantial, and our platform investments will expand that opportunity and realization of it. Operator, we would now like to open the call for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Saket Kalia of Barclays. Your line is open.
Saket Kalia: Okay. Great. Hey, Andrew. Hey, Debbie. Thanks for taking my questions here. Debbie, maybe we will start to start with you. I don’t want to put you on the spot here. But I guess just given the evolving macro and some of the other factors that we spoke about, is there anything that you want us to know high level on kind of how you’re thinking about fiscal ‘24 as we maybe fine-tune our models looking out?
Debbie Clifford: Hi, Saket. Hope you are doing great. So we will give formal guidance for fiscal ‘24 in February when we report on next quarter’s results. But here are some things to think about. First, on revenue. At this point, we expect some exogenous headwinds out of the gate. We will have about a 5-point-or-so incremental FX headwind. That’s because of the continued strengthening of the U.S. dollar and then another point of incremental headwind from exiting Russia. That’s going to make it tough for us to grow revenue beyond double digits. On margin, the revenue headwind creates margin growth headwinds, which likely means limited progress on reported margins in fiscal ‘24. Put another way, margins will look better at constant exchange rates. And then on free cash flow, FactSet consensus right now is a range of $1.2 billion to $1.7 billion. There is a couple of important things to consider. The first is the rate at which our customers transition to annual billings. And the second is the overall macroeconomic environment. We continue to be focused on executing on that transition as fast as possible because while the change is good for us, and it’s good for our customers, from a financial standpoint, we really want the noise behind us. So remember, the faster that we move the multiyear based annual billings, the greater the free cash flow headwind we will see in fiscal ‘24. On macro, we will, as usual, give our fiscal ‘24 guidance based on the macro conditions that we see as we exit fiscal ‘23.
Saket Kalia: Got it. Got it. That makes a lot of sense. Andrew, maybe for my follow-up for you, a lot of helpful commentary just on retention rates and sort of the pace of new business, I was wondering if you could just go one level deeper. And maybe we could just talk about how demand fared through the quarter? Most of the business, as I think we all know, is pretty high velocity. But I’m curious if you saw changing trends in pipeline or close rates or duration preferences towards the end of the quarter versus earlier? Any commentary there would be helpful.
Andrew Anagnost: Yes. Saket, good to hear from you. Alright. Look, Q3 was very much like Q2 and that the quarter was fairly consistent, right? What was different between Q3 and Q2 was the slowing down in Europe taking Russia out. And that was definitely something that was different about the quarters. But that was consistent across the entire quarter. There was no acceleration or change of that as you proceeded across the quarter. Europe was weak throughout the quarter. As were – some of the preferences with regards to multiyear billings, there was no kind of trend of more and more reluctance as you headed further and further down the quarter. So it’s a fairly consistent quarter with regards to all of those things and fairly consistent performance of the business across the quarter. So nothing that fundamentally changed in the quarter. Look, one of the things – another thing that was different about Q3 over Q2 is that we had some currency fluctuations towards the end. And that really is probably the only thing that was different, and those currency fluctuations were responsible for the majority of the small revenue miss.
Saket Kalia: Got it. Very helpful, guys. Thanks a lot for taking my questions here.
Operator: Thank you. Our next question comes from the line of Phil Winslow of Credit Suisse. [Operator Instructions] Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your line is open.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, for you, first, to follow-up on some comments you made regarding your strategy at AU and then allow a follow-up for Debbie. So at AU, you made some comments with regard to the various clouds that you’ve introduced, and you made an important distinction between the AEC cloud and the manufacturing cloud, namely that manufacturing cloud is more mature. It’s been out in the market perhaps longer. So what is your expectation for the maturity or development of the AEC cloud to get it to where you think it needs to be so it’ll be comparably mature or capable, the way the manufacturing cloud is, the way you described it at AU? And then for Debbie as a follow-up since the door was open to an FY ‘24 discussion, apart from everything else you’re doing programmatically, could you talk about some of the things that you’re going to be doing with regard to channel compensation in terms of margin structure, comping on annual versus multiyear and all those various things that you’re planning to implement and if those are going to have any effect on your margins and your cash flow?
Andrew Anagnost: Alright, Jay. So I’ll start with regards to the Forma evolution. It’s going to be kind of similar to what happened with Fusion, all right? And I’ll kind of tell it this way. When we started Fusion, we actually anchored Fusion on two things. We started Fusion upfront in the design process. You probably don’t remember the early days of Fusions, Fusion was actually a conceptual design application. It was highly focused on consumer products design and upfront design processes. And we started to bolting onto it the downstream processes close to the [indiscernible] manufacturing, and we started building cloud-based connections between those two and basically filling off the middle between those two bookends of manufacturing and conceptual design. Think of the evolution of Forma is very similar to that, right? The cloud – the Forma cloud is going to start off focusing on the upfront conceptual phases of design, helping architects, planners, developers, all types of people that have to deal with early conceptual decisions about utilization, space utilization, aligning and distributing various aspects of development or an individual building and helping them make some better decisions far upfront in the design. But it’s also going to work to integrate downstream to what we’re doing in Construction Cloud. So Construction Cloud will start getting very close to some of the early bits of what Forma does. And over time, what’s going to happen is Forma and Construction Cloud, Construction Cloud representing the downstream example of manufacturing, all the bits in between are going to be filled out on the same platform, similar to the evolution that we walked through with Fusion. And that will basically bring the entire process to the cloud over time, but continuously adding value to what our customers are doing today throughout the entire development and evolution of that cloud.
Debbie Clifford: And Jay, to your second question, channel compensation, the details, they are still in the works. But ultimately, how we think about engaging with our channel partners, engaging with our customers, how we think about the compensation programs, everything is about delivering value to our customers, driving adoption, driving customer satisfaction. So, examples of some of the things that you’ve seen us do historically are things like moving more front-end incentives to back-end incentives that mandate some kind of adoption metrics, things like that, again, all in service of trying to deliver value. And in terms of the impact on margins, well, we haven’t guided to margins next year, we haven’t guided specifically to anything next year other than some of the breadcrumbs that I just left you guys. But I would say that as we’ve said before, we’re committed to achieving our margin target in that 38% to 40% range in the fiscal ‘23 to ‘26 window.
Jay Vleeschhouwer: Thank you.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Phil Winslow of Credit Suisse. Your line is open.
Phil Winslow: Hi, thanks for taking my question. I should have one earlier. But Andrew, a question for you, then a follow-up for Debbie. One of the questions I think is about the cyclicality of the AEC industry. And as you mentioned, the industry entered this year with a backlog from 2020 and frankly, even 2019. But as you pointed out, the macroeconomic environment has obviously deteriorated. So my question is what are you seeing and hearing from this vertical, especially about sort of the go-forward pipeline, as you think about the software that Autodesk sells in the various spaces here, the design, plan, build and maintain? And then I’ll just wait to ask the question to Debbie. Thanks.
Andrew Anagnost: Yes. So first off, one thing continues to pressure the industry more than the demand, and it is the labor shortages and the capacity to execute. Construction companies still have a backlog of business. They are still struggling to execute through the business that they have. I’m sure you saw that some of the leading indicators of architectural buildings have gone or entered into a shrinking territory, which means that architects are going to see some decline in some of their buildings moving forward, but they also still have a backlog of business. So we’re still seeing customers saying, look, you know what, I have a pretty big pipeline of business that I haven’t executed on a queue of projects, and I still have capacity problems of getting through it. They are labor-related, they are material related, they are execution related. So we still have an overhang of backlog that’s going to continue into next year for a lot of our customers, and that’s what we’re hearing from our customers. That’s not to say they are not seeing pressure, and that’s not to say that they are not seeing some pressure in various segments. But they are still seeing a pretty good book of business for the next 12 to 18 months. Now as things continue, they’ll start to see kind of downward pressure in some of that backlog. But right now, they are all much more concerned about their ability to execute than they are about the book of business that they are accumulating.
Phil Winslow: Awesome. Thanks for that color. And then Debbie, just a follow-up on billings, at the beginning of the year, you talked about long-term deferred revenue, I think, being in the high 20s as a percentage of toll as you exit this year. I wonder if you could give us an update on that. And then in terms of next fiscal year, as you move towards 1-year billings, help us maybe quantify sort of the drawdown of long-term deferred revenue and the impact of that? Because obviously, you flagged the sell-side range right now of $1.2 billion to $1.7 billion, but obviously, that’s pretty broad. So maybe some color on the impact of long-term deferred next year would be helpful, too. Thanks.
Debbie Clifford: Yes. So overall, our messaging in these two areas hasn’t changed. So we were talking about long-term deferred as a percent of total deferred in that 20s range, and it’s going to continue to be there. The impact of our guidance adjustment for billings, a little over $100 million on a $5 billion number is not significant. And so we’re not anticipating that they will have a major impact on the metrics that you described. As we think about next year, I don’t have anything additional to share on how to think about the decline or what have you, other than to reiterate what I said before, and that is to think about the FactSet consensus that’s out there right now, that range of $1.2 billion to $1.7 billion. And then to reiterate that it’s really our goal to move as fast as possible because we really like to get this financial noise behind us.
Phil Winslow: Great. Thanks a lot.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Adam Borg of Stifel. Your line is open.
Adam Borg: Hey, guys. Thanks for taking the questions. First, for Andrew, and then a follow-up for Debbie. So just given the macro, are you seeing any trends of customers either – not necessarily upgrading to collections that otherwise or doing so earlier in the year? Or conversely, any trade downs from collections to point solutions or even LT? And then I have a follow-up.
Andrew Anagnost: Yes. Okay. Great. Adam. No, actually, there is no change in those demand preferences with regards to collections and what people are buying. The mix of state essentially is same, the renewal rate of the states pretty steady. If anything, what we’re seeing is softness in the low end of our business, which is what you would expect in a climate like this. LT growth has lowed, LT renewal rates have seen some pressure. That’s where we’re seeing things. The collections percentages, the collections renewal rates, these have remained steady throughout the year and throughout the quarter.
Adam Borg: Awesome. And maybe just for Debbie. So – and I don’t know if this is a harder question to answer, but if the multiyear mix came in line with your original expectations, how we think about the billings guide or even the billings results in the year, right? If it was the original mix that going into the quarter. Thanks again.
Debbie Clifford: If I understand your question correctly, if the proportion of our business that had been multiyear was in line with our expectations then we would have hit our original guide. And the fact that we’re seeing some in that cohort choose to move to annual billings or annual contracts, that’s making it so that we’re reducing the billings and free cash flow guide. But maybe – did I understand your question correctly?
Adam Borg: Super clear. Thanks again.
Debbie Clifford: Okay.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Stephen Tusa of JPMorgan. Your line is open.
Stephen Tusa: Hi, good evening, guys. How are you?
Andrew Anagnost: Good.
Stephen Tusa: Thanks. So I’m just – maybe I’m an idiot, but just like reading between the lines, the faster you guys move in the transition, all else equal, the lower the free cash flow next year will be, correct? Or are there other things moving around?
Debbie Clifford: The faster the transition, well, first, I want to continue to characterize that the impact of the numbers is relatively small, and it would have a minor follow-on implications to next year. But ultimately, what was built into our guidance was an expectation of a certain proportion of the business that was going to be multiyear upfront. A small portion of those customers have elected to be annual. So rather than it being a negative impact to next year, it would be a very slight positive impact to next year because we would have annual billings next year that weren’t in the form of a multiyear upfront transaction this year. But I want to continue to reiterate that the impact is relatively small. The impact to our billings guidance this year is relatively small. And if you think about the scale of the free cash flow number next year, I want to go back to that range that I was talking about that FactSet consensus range of $1.2 billion to $1.7 billion. And our goal really is to move the totality of the multiyear base to annual billings as fast as possible. And the faster we go, the greater that headwind is going to be to free cash flow next year.
Stephen Tusa: Yes, I was – yes, exactly. I was asking about ‘24. Basically, you’re kind of telling us $1.2 billion to $1.7 billion and then you’re reiterating that you’re going to try and move as fast as possible. So it was just much more of a ‘24 question, which you just, I think, answered.
Debbie Clifford: Okay. Great.
Stephen Tusa: Right. The faster you move, the more impact you have next year?
Debbie Clifford: Correct. Yes.
Stephen Tusa: Yes. Okay. That’s super helpful. And any color on kind of the I guess, the drop-through on bookings – or sorry, billings when I look at free cash flow it’s like 85% to free cash flow, That’s, I guess – just it drops through with your gross margin. I would assume you don’t really manage that on a quarterly basis. So it makes some sense. I am I looking at that the right way? Or is there something on the cost line that moves around and mitigates that decline in billings?
Debbie Clifford: No. I think you are thinking about it in a directionally accurate way. The billings reduction then has a follow-on implication to the free cash flow reduction. There is nothing else going on there.
Stephen Tusa: Yes, okay. Great. Thanks a lot for the color. Really appreciate it.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Michael Funk of Bank of America. Your line is open.
Michael Funk: Yes. Thank you for the questions. So you mentioned a few times trying to incentivize the shift from multiyear to annual. So first, what are you doing to incentivize that? I guess second, what drove the different customer behavior this quarter than expected with the shift? And I guess third part, same question, is how quickly do you believe that you can transition your base over to annual as we think about trying to model out the free cash flow impact?
Debbie Clifford: Okay. So let’s – taking detailed note. So in terms of the incentives, the incentives for both our channel partners – well, for our channel partners are still in place. So that’s part of the programmatic details that we are working through right now as we engage with our partners and we execute on the transition. Remember, a substantial majority of that transition is going to be next year in our fiscal ‘24, and that’s why those details are still in flight. On the customer side, what they have historically had a discount of anywhere from 10% to 5% to have a multiyear contract that’s invoiced and collected upfront and that discount goes away. So the incentive is not there necessarily in the future for those customers to be trying to pay for upfront. And we think based on the feedback that we have been getting from our customers that they want to have multiyear contracts with annual billings. It’s good for them in managing their cash flow just like it’s good for us. It removes the volatility that we see and as you can see from our guidance this quarter, the volatility that we see with those multiyear upfront contracts. In terms of what drove the behavior that we saw this past quarter, well, the end of the multiyear discount is coming at the start of next year. And so we were anticipating more demand for multiyear upfront contracts. And in the end, we are seeing slightly less demand than we expected. In the current macroeconomic environment, that’s not surprising. The trade-off of the discount versus the cash upfront, it’s not as enticing for some customers right now. We have assumed that the behavior that we saw with respect to the multi-years in Q3 persists through Q4. And that’s what’s built into our guidance. It’s consistent with our overall guidance philosophy. And we really think that it reinforces our strategy to move to annual billings. We are hopeful that it’s a positive sign for the transition next year. And then finally, in terms of what we can do in order to drive the pace, well, a lot of that’s going to come down to our internal capabilities being available. I have mentioned before, that we are investing in systems to set us up to manage all these contracts at scale, and we are on pace. With those system changes, ultimately, it’s going to come down to what’s on our price list and how we work through these programmatic details with our partners. And these are all decisions that are very much under discussion right now, and that you will hear more from us over the next couple of months.
Michael Funk: Okay. Great. Thank you for the question.
Operator: Thank you. One moment please. Our next question comes from the line of Gal Munda of Wolfe Research. Your line is open.
Gal Munda: Thanks for taking my questions. The first one is just around Fusion 360 and what you guys are seeing there. I know that when we visited Autodesk University with us, really, really good feedback. At the same time, the macro environment in manufacturing is kind of going a little bit slow. Is there anything particularly that makes you potentially see any sort of slowdown in that, or do you think your Fusion 360 throughout the cycle is going to perform better than what you have seen in the past in your manufacturing portfolio? Thank you.
Andrew Anagnost: Yes. So, first off, Gal, manufacturing grew 13%, 14% on constant currency, that’s still best-in-class for our space. So, we continue to believe that we are taking share in that respect. Look, you can’t have a slowdown in Europe, where we are very strong, without seeing some slowdown in new Innovyze [ph] acquisition with regards to Fusion. However, we still continue to acquire more new users than any of our competitors in the space. So, even in the face of some headwinds where we see some slowing, we are outpacing our competitors, which is kind of the important metric here in terms of the appetite and desire for Fusion. It continues to be the disruptive player, the disruptive price point, the disruptive capabilities. And our customers continue to embrace the solution even in the environment of headwinds. So, we are not concerned because customers really need the efficiency of an end-to-end connected solution, and they really want what they get at the kind of price points that we deliver with Fusion. So, we continue to be the preferred solution. I continue that – I expect that to continue, and I expect our relative performance to remain strong.
Gal Munda: That’s perfect. Thank you. And then just as a follow-up, thinking about the opportunity. I know when COVID happened and we talked about the non-compliant user opportunity, you kind of posed a little bit everything, and you said we are going to come back when the environment, especially macro, is a little bit stronger. You have done that over the last year. If I am thinking about heading into another macro weakness, how much of an opportunity is coming from the non-compliant users, or how much more lenient you might be maybe for a year or 2 years until that plays out? Thank you.
Andrew Anagnost: Yes. I think we have got a good rhythm in our compliance business right now. I mean I think COVID was a very unique situation where there was a sudden and precipitous impact on our customers. I think we are heading into kind of a different environment in many respect. Of course, manufacturers are seeing increased costs in terms of energy and material costs and things associated with that. So, the pressures are real. But I think the rate and pace that we are on right now with regards to license compliance makes sense. Like I have always said, this isn’t something that we are going to slam the accelerator on and try to move faster. But right now, I don’t see us actually changing our pace or slowing down in any kind of way. I think we are at a nice clip right now, and I think that we will be able to maintain it through any kind of bumpiness that we might see as we head into the winter.
Gal Munda: Thanks Andrew. Appreciate that.
Operator: Thank you. One moment please. Our next question comes from the line of Matt Hedberg of RBC. Your line is open.
Matt Hedberg: Great. Thanks for taking my question guys. Debbie, I wanted to come back to the cash flow breadcrumbs that you gave. Sort of – you keep talking about the range of $1.2 billion to $1.7 billion and wanting to progress as fast as possible. I mean does that effectively imply that, that low end of FactSet consensus is at play? Just sort of curious on why phrase it as a range like that?
Debbie Clifford: Thanks Matt. So, we are not guiding on the call today. We are trying to provide some insight into how to think about it. And that range is in the realm of possibility, and there are a couple of factors that we want to continue to emphasize that are going to impact that. And that is the rate at which our customers transition to annual billings and the overall macroeconomic environment. But as I have said, we will provide specifics on the next earnings call.
Matt Hedberg: Got it. Thanks. And then maybe just one on the expense side, I appreciate the currency headwinds next year and sort of the reiteration of kind of the long-term margin framework. Are there things that you guys are doing right now from a spend perspective, whether it’s hiring or just sort of like general cost consciousness as we get into more economic uncertainty?
Debbie Clifford: Thanks. So, first, I want to say that we have been focused on ensuring that we don’t spend ahead of top line growth. We have delivered considerable operating margin expansion over the last couple of years. We have exhibited a spend discipline that we now benefit from as the market conditions continue to evolve. If we focus on the near-term, we have delivered on our margin goals for the year-to-date. We are on track to do so through the end of the year. You can see that from no change in our operating margin guidance. Our hiring plans at the beginning of the year reflected really what is a solid balance between proactive investment and the discipline required to achieve our margin targets. As we look ahead to next year, we are in the planning process right now, but we are focused on ensuring that we continue this pattern of disciplined spend. We are looking to ensure that we can invest in the right areas to drive the strategy. So, things like purposeful and strategic rather than broad-based investing in areas like our industry clouds and shared services, but all against a backdrop of delivering a healthy margin. And I also want to say that we want to ensure that we are not too short-term in our thinking. We have a strong balance sheet. We want to make sure that we strike that right balance as we navigate these macro waters. We want to capitalize on the downturn to continue to invest, but all while keeping that watchful eye on operating margin. And as we said before, we are committed to achieving a margin target in the 38% to 40% range in that fiscal ‘23 to ‘26 window.
Matt Hedberg: Alright. Thanks.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Tyler Radke of Citi. Your line is open.
Tyler Radke: Thanks for taking my question. Andrew, so at AU, you obviously announced the product announcements on Forma and Flow. I am curious how, if you could talk a little bit about the plans to accelerate the engineering velocity, specifically, is this is going to require more hiring, or is it just kind of re-prioritization of your engineers? And then just kind of comparing it to the timeline that you saw Fusion play out in that monetization cycle, just help us understand how you are expecting kind of the product to roll out and the monetization trend over time? Thanks.
Andrew Anagnost: Yes. So, first off, one of the things we did to just start Forma, as you might recall at the beginning of the pandemic, we acquired a Norwegian company called Spacemaker. And we have continued to invest in that team, and we will continue to expand that team either by repurposing existing resources to work with that team or by adding additional resources to that team to make sure that we are on track. But one of the foundational investments that supports all of the things we are trying to do with our investment in data. And that’s an ongoing investment in trying to break up Revit files and make them more accessible in the cloud as granular data. Forma and – by nature is built net native on the cloud and it has granular data at its core. So, that’s one of the kind of core vectors that we will be doing. But we will be incrementally investing to ensure that we are heading on the right path with this solution. But we have done some of that already. And we have kind of absorbed some of those investments today. Now, I think the question about timeline is a really good one because these kind of transformations – what we are doing with Forma is different, right. What we are doing with Revit to improve its performance and improve its capabilities based on what our customers are asking us to do is making their current tools better. But what Forma is doing, especially with its connection – its native connections to downstream process is different. It takes time for different to penetrate the industry, just like different took time with Fusion. It was – we have been working on Fusion for over a decade, alright, roughly speaking a decade. So, you can expect that it’s going to take 5 years for Forma to mature and even longer for it to totally replace what our customers are doing. However, our goal is to incrementally add value to the process as time goes on, just like we did with Fusion. Fusion, we added incremental value with the connection to downstream manufacturing. In Forma, we are going to add incremental value with regards to the data platforms and the connection to the downstream construction processes. So, that’s all connected, but it is going to take time similar to what we saw with Fusion.
Tyler Radke: That’s helpful. And Debbie, maybe a question for you. So, just on current RPO, it looked like that did pick up a bit quarter-over-quarter if you back out the currency. Can you just help us understand I guess first, do you kind of view that as the best leading indicator given the headwinds in billings? And just remind us how you are thinking about the puts and takes on that just as you do – renew these large EBA customers in the coming quarters. Just anything we should be mindful of there? Thank you.
Debbie Clifford: Yes. Sure. So yes, I mean current RPO is a very important metric in monitoring our business performance. And you are right, particularly when you normalize for the currency impacts that growth was in a healthy zone. So, I want to just continue to stress that FX has been really volatile, and that’s going to continue to impact the growth rate. So, definitely look at the constant currency growth rates over time. Also, the timing and volume of our EBAs impacts the growth rate period-to-period. And so sometimes what you see is that when we have large cohorts of our EBAs coming up for renewal, it tends to be back-end loaded in our fiscal years and most often in our Q4, we start to see growth impacts as the year progresses, in many cases, deceleration Q1 to Q3 that would tick back up as those cohorts for EBAs come back up for renewal. So, growth rate should tick back up over time, given consistent historical – given patterns consistent with our historical patterns. But again, remember the constant currency has just been a zinger that’s going to impact growth rates for quite a while here. So – but it is an important metric for us, and we monitor it closely.
Tyler Radke: Thank you.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Jason Celino of Key. Your line is open.
Jason Celino: Hi. Thanks for taking me in. Just two quick ones. So, when we look at the fourth quarter guidance, it looks like you will exit the year at 8% growth at the midpoint, pretty big decel from third quarter. I guess what is the FX headwind built into here? And are there any other factors that we should think about for Q4?
Debbie Clifford: Yes. So, Jason, the biggest impact is currency. We have seen a growing currency headwind during the year, and that’s gradually showing up in the growth rates as the year progresses. It’s about a 3-point headwind in Q4. It was a 1-point headwind in Q3 and was neutral in the tailwind at the beginning of the year. So, you can see that it’s gradually having a significant impact on our growth rate. That’s the biggest driver of the implied growth rate that you are talking about. Also, to a lesser extent – but Andrew did mention that we saw a modest deceleration in our new business, particularly in Europe during Q3, that does have a slight follow-on impact to revenue in Q4.
Jason Celino: Okay. Great. Thank you. And then the last multiyear appetite, it sounds like, to some extent, some of this is macro related. I guess where do you see that dynamic most prevalent? Was it with your larger customers, your smaller customers, international versus domestic? Just trying to understand kind of the puts and takes. Thanks.
Debbie Clifford: Yes. It tends to be larger deal sizes, not surprisingly. I think that when our customers start to exhibit cash conservation behavior, that behavior does tend to be more prevalent with some of the larger deal sizes. And remember, they are still signing multiyear contracts, they are just signing multiyear contracts and asking for annual billings, which for those larger deals, we are willing to accommodate while we continue to invest in the back-office infrastructure to be able to handle the totality of the multiyear base with annual billings at scale.
Jason Celino: Okay, perfect. Thank you.
Operator: Thank you. [Operator Instructions] Our next question comes from the line of Keith Weiss of Morgan Stanley. Your line is open.
Keith Weiss: Hi, thank you so much. The comments on the stable renewal rates, and I’d just like to dig into the expansion motion and it’s not like never tension stayed within the historical range, but curious if you are seeing any changes on just the expansion behavior with the shift in macro and should we expect a similar range into 2024? Is there any risk that we could fall outside of those ranges just given the broader macro headwinds? Thank you.
Andrew Anagnost: So with regards to retention rates, look, retention rates continue to be strong and maintain steadiness. I think we are going to continue to see that steadiness into next year. The one area where we expect to see softness with macro headwinds is at the low end of our market. So the low end of the market is low ASPs, but high volume. So, the retention rates can move around on a volume basis when there is headwinds like this. But generally speaking, broadly across our business, we see retention rates holding up. Our products are mission-critical to what our customers do. They need them. But at the low end of our business, we will probably see some headwinds there, but they won’t be material to the larger business.
Debbie Clifford: I would just add that our net revenue retention rate was comfortably within the target range of 100% to 110% and in the short-term, our expectation is that it will stay in that range.
Keith Weiss: Great. And then just following up on kind of the comments about the strong balance sheet and willing to invest, wanted to see if you are seeing any change in behavior in the competitive landscape, especially from some companies that may not have as strong a balance sheet? So any changes you are seeing in the behavior overall? Thank you.
Andrew Anagnost: So with regards to – I just want to give a clarification on that question. With regards to the competitive environment in what way in terms of how that – how does it – just give me a clarification on your question a little bit there. I didn’t quite understand.
Keith Weiss: Yes, sure. So you guys have a strong balance sheet kind of willing to invest in the current environment, just even though there maybe some macro headwinds. But you likely have some peers out there that may not be as well funded or has strong balance sheets. So curious if you are just seeing any sort of changes in behavior across the competitive landscape?
Andrew Anagnost: Yes, okay. Okay, good. I just wanted to make sure that I was in it. So look, we are in better shape than some of our competitors that are not profitable. In certain situations, people are going to be chasing, I think long-term things that kind of boost revenue or pull revenue forward. They will be doing customer unfriendly things to try to pull things forward. We are not in that position right now, especially in certain types of sectors. We are maintaining customer-friendly practices. We are focusing on the long-term. We’re investing in the long-term. And that will actually provide competitive advantage as we move out of the slowdown. And it’s always great to be in a position to invest during a slowdown and to not have to pull short-term levers to try to achieve profitability, maintain profitability or get in the way of things. We will probably have more dry powder for inorganic activity than some of our competitors as we head through this. So yes, strong balance sheet actually helps us invest ahead of the curve while we go through these things. So I am pretty confident that we are ahead of the game in a lot of places.
Operator: Thank you. That is all the time that we do have for question. So I’d like to turn the call back over to Simon Mays-Smith for any closing remarks.
Simon Mays-Smith: Thanks everyone for joining us. I hope the call was useful. For those of you that celebrated happy Thanksgiving and happy holidays and we’ll look forward to catching up with you again at conferences and in the New Year at our fourth quarter earnings. Thanks very much.
Operator: Thank you. Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating. You may now disconnect. Have a great day. | [
{
"speaker": "Operator",
"text": "Thank you for standing by and welcome to the Autodesk Q3 Fiscal ‘23 Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now turn the conference over to your host Mr. Simon Mays-Smith, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the third quarter results of our fiscal ‘23. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings including our most recent Form 10-Q and the Form 8-K filed with today’s press release for important risk factors and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numerical growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or XL Financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon and welcome everyone to the call. We again reported record third quarter revenue, non-GAAP operating margin and free cash flow. Encouragingly, the business is performing as we’d expect given secular growth tailwinds and macroeconomic, geopolitical policy and COVID-19-related headwinds. Subscription renewal rates remain resilient. Our competitive performance remains strong. Outside of Russia and China, new business growth slightly decelerated in the quarter, most notably in Europe, but overall growth remains good. And we see less demand for multiyear upfront and more demand for annual contracts than we expected. We are hopeful this is a positive signal for our transition next year to annual billings for multiyear contracts. Overall, our leading indicators are consistent with these trends. Channel partners remain optimistic, but with hints of caution. Usage rates continue to grow modestly in the U.S. and APAC, excluding China, but are flat in Europe, excluding Russia. And bid activity on BuildingConnected remains robust as the industry continues to work through its backlog. We are reinforcing the secular tailwinds to our business by accelerating the convergence of workflows within and between the industries we serve, creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. Our strategy is underpinned by disciplined and focused investments through the economic cycle, which enables Autodesk to remain well invested to realize the significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments later. In September, we hosted more than 10,000 customers and partners at Autodesk University. There was incredible energy, excitement and optimism for being together in person for the first time in 3 years. There was also palpable momentum behind the digital transformation of the industries we serve. At AU, we announced Fusion, Forma and Flow, our three industry clouds, which will connect data, teams and workflows in the cloud on our trusted platform. By increasing our engineering velocity, moving data from files to the cloud and expanding our third-party ecosystem, they will enable Autodesk to further increase customer value by delivering even greater efficiency and sustainability. I will now turn the call over to Debbie to take you through our third quarter financial performance and guidance for the fourth quarter and full fiscal year. I’ll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. In a more challenging macroeconomic environment, Autodesk performed in line with our expectations in the third quarter, excluding the impact of in-quarter currency movements on revenue. Resilient subscription renewal rates, healthy new business growth and a strong competitive performance were partly offset by geopolitical, macroeconomic, policy and COVID-19-related headwinds, foreign exchange movements and less demand for multiyear upfront and more demand for annual contracts than we expected. Total revenue grew 14% and 15% at constant exchange rates. By product, AutoCAD and AutoCAD LT revenue grew 10%. AEC and manufacturing revenue both grew 13% and M&E revenue grew 24%, partly driven by upfront revenue growth. By region, revenue grew 17% in the Americas, 10% in EMEA and 14% in APAC. At constant exchange rates, EMEA and APAC grew 12% and 18%, respectively. By channel, direct revenue increased 14%, representing 35% of total revenue, while indirect revenue grew 13%. Our product subscription renewal rates remain strong, and our net revenue retention rate was comfortably within our 100% to 110% target range. Billings increased 16% to $1.4 billion, reflecting continued solid underlying demand, partly offset by foreign exchange movements and a shift in mix from multiyear upfront to annual contracts versus expectations. Total deferred revenue grew 13% to $3.8 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 11% and 9%, respectively. At constant exchange rates, RPO and current RPO grew approximately 15% and 13%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 93%, while non-GAAP operating margin increased by 4 percentage points to approximately 36%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margin increased by 3 percentage points to approximately 20%. We delivered robust third quarter free cash flow of $460 million, up 79% year-over-year reflecting strong revenue growth, margin improvement and a larger multiyear upfront billing cohort. Turning to capital allocation, we continue to actively manage capital within our framework. As Andrew said, our organic and inorganic investments will remain disciplined and focused through the economic cycle. We will continue to offset dilution from our stock-based compensation program and to accelerate repurchases opportunistically when it makes sense to do so. Year-to-date, we purchased 4.4 million shares for $873 million at an average price of approximately $200 per share, which compared to last year contributed to a reduction in our diluted weighted average shares outstanding by approximately 5 million to 217 million shares. We also announced today that the Board has authorized a further $5 billion for share repurchases. And in December, we plan to retire a $350 million bond when it comes due. Recall that we effectively refinanced this bond last October at historically low rates when we issued our first sustainability bond. And related to that new sustainability bond, we published our first sustainability bond impact report about a month ago, which updates our progress. You can find the report on our Investor Relations website. Now let me finish with guidance. Andrew gave you a readout on the business and our markets at the beginning of the call. Our renewal business continues to be a highlight, reflecting the ongoing importance of our software in helping our customers achieve their goals. New business growth continues to be relatively stronger in North America with growth in EMEA and APAC outside of Russia and China, slightly decelerating, but overall growth remains good. And we’ve seen less demand for multiyear upfront and more demand for annual contracts than we expected. As we look ahead and as we’ve done in the past, our Q4 and fiscal ‘23 guidance assumes that market conditions remain consistent with what we saw as we exited Q3. The strengthening of the U.S. dollar during the quarter generated slight incremental FX headwinds, reducing full year billings and revenue by approximately $10 million and $5 million, respectively, for the remainder of fiscal ‘23. Bringing these factors together, the overall headline is that our fiscal ‘23 revenue, margin and earnings per share guidance remained close to the previous midpoint at constant exchange rates and comfortably within our previous guidance ranges. Our lower fiscal ‘23 billings and free cash flow guidance primarily reflects less demand for multiyear upfront and more demand for annual contracts than we expected. We’re narrowing the fiscal ‘23 revenue range to be between $4.99 billion and $5.005 billion. We continue to expect non-GAAP operating margin to be approximately 36%. And we expect free cash flow to be between $1.9 billion and $1.98 billion. The slide deck and updated Excel financials on our website have more details on modeling assumptions for the full year of fiscal ‘23. The challenges our customers face continue to evolve that reinforce the need for digital transformation, which gives us confidence in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our long-term revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. Fusion, Forma and Flow connect data, teams and workflows in the cloud on our trusted platform, making Autodesk rapidly scalable and extensible into adjacent verticals from architectural and engineering to construction and operations, from product engineering to product data management and product manufacturing. Our platform is also scalable and extensible between verticals with industrialized construction and into new workflows like XR. By accelerating the convergence of workflows within and between the industries we serve, we are also creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. In AEC, our customers continue to digitally transform their workflows to win new business and become more efficient and sustainable. For example, to support the city of Changwon smart city ambitions, the Changwon Architectural Design Institute, which operates across architecture, municipal engineering and city planning is standardizing on AEC collections and developing features to Revit APIs, which automate modeling, drawings and specification inspection. These will leverage the design institute’s expertise in BIM and enable faster and higher quality design, reduce error and waste during construction and build the digital twins for post-construction operation and maintenance. In a challenging market environment, the design institute has been able to win new business and capture new market through digital transformation. In construction, we are seeking to eliminate waste at the source rather than simply automating the process around it. By seamlessly connecting construction data and workflows both upstream with preconstruction and design and downstream to hand over, operations and maintenance bases to our digital twin, we are enabling a more connected and sustainable way of building. For example, after a leading mechanical contractor in the United States purchased a competitor’s construction management product a few years ago, communication and workflows between the design and field teams were disconnected, resulting in data fragmentation, less insight, more complicated reporting and ultimately low adoption of the process. To resolve these issues, it chose to consolidate all of its design to build workload on the integrated Autodesk platform, turning to Autodesk Build to streamline handoffs between detailing, the fab shop and the field. Our momentum in construction continues to grow. Across construction, we added almost 1,000 new logos with Autodesk Build’s monthly active users growing more than 60% quarter-over-quarter and becoming Autodesk’s largest construction products. In infrastructure, we see greater appetite from owners to accelerate their digital transformation to connect workflows from designed to make on the Autodesk platform. For example, to transform the speed, efficiency and sustainability of its network, one of the leading electricity network operators in Europe is accelerating its transformation from 2D to BIM and digital twins. In the third quarter, it signed its first EBA with Autodesk, adding Revit and Docs to enable it to upgrade the capacity of its substations and incorporate renewable power generation rapidly and safely. To accelerate maintenance workflows and reduce costs, the customer is in-sourcing the production of maintenance parts and using Fusion 360 as a platform for 3D printing. Turning to manufacturing, we have sustained good momentum in our manufacturing portfolio this quarter as we connected more workflows from design through to the shop floor, developed more on-ramps to our manufacturing platform and delivered new powerful tools and functionality to Fusion 360 extension. We continue to drive efficiency and sustainability for our customers and provide further resilience and competitiveness in uncertain times. For example, De Nora is an Italian multinational company specializing in electrochemistry and is a leader in sustainable technologies in the industrial green hydrogen production chain. It has been a longtime user of AutoCAD and Revit. Over the last few years, it accelerated its cloud strategy by replacing a competitor’s on-premise PLM solution with an integrated Vault and Fusion 360-managed solutions and improve the security of its data, enables seamless collaboration between product design and manufacturing and more easily onboard and integrate acquisitions. In Q3, it took another step in its digital transformation by firstly transitioning to named users and adding premium for better usage reporting, insights and single sign on security and secondly, by adding Flex to optimize consumption for its occasional users. Heineken is on a mission to become the best connected brewer as part of its evergreen strategy and is undergoing a digital transformation to ensure is prepared for the unforeseen challenges in an ever-changing world. To help, Autodesk has been supporting Heineken’s 3D printing initiative with an expanded adoption of Fusion 360 across a number of breweries. By designing and manufacturing their own equipment parts in-house, Heineken has been able to see a reduction in the replacement times of a number of parts from over 6 weeks to just 4 hours, significantly reducing downtime and lessening the carbon impact of shipping new parts when necessary. Scanship AS, a Vow Group company is a great example of how our customers are using our Fusion platform to generate sustainable outcomes efficiently and transparently for customers. It has developed technology that processes waste and purified wastewater providing valuable, sustainable and circular resources and clean energy to a wide range of customers. By consolidating on Fusion 360 managed with Upchain, Scanship AS will be able to connect data and workflows in the cloud to manage processes and collaborate more easily and efficiently, while also gaining greater transparency on its supply chain to deliver decarbonized products to its customers. Fusion 360’s commercial subscribers grew steadily, ending the quarter with 211,000 subscribers, with demand for extensions continuing to grow at an exceptional pace. Outside of commercial use, a rapidly growing ecosystem of students and hobbyists learning next-generation technology and workflows will take those skills with them into the workforce. We would like to congratulate students from over 57 countries who recently competed in the finals of the WorldSkills competition, aptly referred to as the Olympics for vocational skills. Students used the latest workflows and technologies from Fusion 360 and Autodesk Construction Cloud to compete in vocational disciplines such as mechanical engineering, additive manufacturing and digital construction. Sit Shun Le from Singapore, who won the gold medal for additive manufacturing, used Fusion 360 to find the optimum structure and then minimize the amount of materials used through additive manufacturing. All participants were able to hone their skills using next-generation technology. I am inspired by their ingenuity and optimistic about the innovation they will bring to the workforce of the future. And finally, we continue to work with customers to provide access to the most current and secure software through our license compliance initiatives. For example, we worked collaboratively with a large multinational manufacturing company seeking to adhere to the same software standards and ensure access to the latest and safest software for all its employees across the globe. We helped customers conduct a self-audit that identifies gaps in its operations in China and then crafted and optimized a bespoked subscription plan. As a result, we agreed to an approximately 5 million contracts in Q3, our largest ever license compliance agreement. During the quarter, we closed eight deals of $500,000 and four deals over $1 million. To close, subscription renewal rates and net revenue retention continue to compound. New business growth remains good, and our competitive performance remains strong. The business is performing as we’d expect given secular growth tailwinds and macroeconomic, geopolitical, policy and COVID-19 headwind. Our capital allocation will remain disciplined and focused through the cycle with organic investment and acquisitions accelerating our growth potential and competitive intensity and share buyback offsetting dilution. The breadth and depth of the market opportunity ahead of us is substantial, and our platform investments will expand that opportunity and realization of it. Operator, we would now like to open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Saket Kalia of Barclays. Your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hey, Andrew. Hey, Debbie. Thanks for taking my questions here. Debbie, maybe we will start to start with you. I don’t want to put you on the spot here. But I guess just given the evolving macro and some of the other factors that we spoke about, is there anything that you want us to know high level on kind of how you’re thinking about fiscal ‘24 as we maybe fine-tune our models looking out?"
},
{
"speaker": "Debbie Clifford",
"text": "Hi, Saket. Hope you are doing great. So we will give formal guidance for fiscal ‘24 in February when we report on next quarter’s results. But here are some things to think about. First, on revenue. At this point, we expect some exogenous headwinds out of the gate. We will have about a 5-point-or-so incremental FX headwind. That’s because of the continued strengthening of the U.S. dollar and then another point of incremental headwind from exiting Russia. That’s going to make it tough for us to grow revenue beyond double digits. On margin, the revenue headwind creates margin growth headwinds, which likely means limited progress on reported margins in fiscal ‘24. Put another way, margins will look better at constant exchange rates. And then on free cash flow, FactSet consensus right now is a range of $1.2 billion to $1.7 billion. There is a couple of important things to consider. The first is the rate at which our customers transition to annual billings. And the second is the overall macroeconomic environment. We continue to be focused on executing on that transition as fast as possible because while the change is good for us, and it’s good for our customers, from a financial standpoint, we really want the noise behind us. So remember, the faster that we move the multiyear based annual billings, the greater the free cash flow headwind we will see in fiscal ‘24. On macro, we will, as usual, give our fiscal ‘24 guidance based on the macro conditions that we see as we exit fiscal ‘23."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Got it. That makes a lot of sense. Andrew, maybe for my follow-up for you, a lot of helpful commentary just on retention rates and sort of the pace of new business, I was wondering if you could just go one level deeper. And maybe we could just talk about how demand fared through the quarter? Most of the business, as I think we all know, is pretty high velocity. But I’m curious if you saw changing trends in pipeline or close rates or duration preferences towards the end of the quarter versus earlier? Any commentary there would be helpful."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Saket, good to hear from you. Alright. Look, Q3 was very much like Q2 and that the quarter was fairly consistent, right? What was different between Q3 and Q2 was the slowing down in Europe taking Russia out. And that was definitely something that was different about the quarters. But that was consistent across the entire quarter. There was no acceleration or change of that as you proceeded across the quarter. Europe was weak throughout the quarter. As were – some of the preferences with regards to multiyear billings, there was no kind of trend of more and more reluctance as you headed further and further down the quarter. So it’s a fairly consistent quarter with regards to all of those things and fairly consistent performance of the business across the quarter. So nothing that fundamentally changed in the quarter. Look, one of the things – another thing that was different about Q3 over Q2 is that we had some currency fluctuations towards the end. And that really is probably the only thing that was different, and those currency fluctuations were responsible for the majority of the small revenue miss."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very helpful, guys. Thanks a lot for taking my questions here."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Phil Winslow of Credit Suisse. [Operator Instructions] Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your line is open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, for you, first, to follow-up on some comments you made regarding your strategy at AU and then allow a follow-up for Debbie. So at AU, you made some comments with regard to the various clouds that you’ve introduced, and you made an important distinction between the AEC cloud and the manufacturing cloud, namely that manufacturing cloud is more mature. It’s been out in the market perhaps longer. So what is your expectation for the maturity or development of the AEC cloud to get it to where you think it needs to be so it’ll be comparably mature or capable, the way the manufacturing cloud is, the way you described it at AU? And then for Debbie as a follow-up since the door was open to an FY ‘24 discussion, apart from everything else you’re doing programmatically, could you talk about some of the things that you’re going to be doing with regard to channel compensation in terms of margin structure, comping on annual versus multiyear and all those various things that you’re planning to implement and if those are going to have any effect on your margins and your cash flow?"
},
{
"speaker": "Andrew Anagnost",
"text": "Alright, Jay. So I’ll start with regards to the Forma evolution. It’s going to be kind of similar to what happened with Fusion, all right? And I’ll kind of tell it this way. When we started Fusion, we actually anchored Fusion on two things. We started Fusion upfront in the design process. You probably don’t remember the early days of Fusions, Fusion was actually a conceptual design application. It was highly focused on consumer products design and upfront design processes. And we started to bolting onto it the downstream processes close to the [indiscernible] manufacturing, and we started building cloud-based connections between those two and basically filling off the middle between those two bookends of manufacturing and conceptual design. Think of the evolution of Forma is very similar to that, right? The cloud – the Forma cloud is going to start off focusing on the upfront conceptual phases of design, helping architects, planners, developers, all types of people that have to deal with early conceptual decisions about utilization, space utilization, aligning and distributing various aspects of development or an individual building and helping them make some better decisions far upfront in the design. But it’s also going to work to integrate downstream to what we’re doing in Construction Cloud. So Construction Cloud will start getting very close to some of the early bits of what Forma does. And over time, what’s going to happen is Forma and Construction Cloud, Construction Cloud representing the downstream example of manufacturing, all the bits in between are going to be filled out on the same platform, similar to the evolution that we walked through with Fusion. And that will basically bring the entire process to the cloud over time, but continuously adding value to what our customers are doing today throughout the entire development and evolution of that cloud."
},
{
"speaker": "Debbie Clifford",
"text": "And Jay, to your second question, channel compensation, the details, they are still in the works. But ultimately, how we think about engaging with our channel partners, engaging with our customers, how we think about the compensation programs, everything is about delivering value to our customers, driving adoption, driving customer satisfaction. So, examples of some of the things that you’ve seen us do historically are things like moving more front-end incentives to back-end incentives that mandate some kind of adoption metrics, things like that, again, all in service of trying to deliver value. And in terms of the impact on margins, well, we haven’t guided to margins next year, we haven’t guided specifically to anything next year other than some of the breadcrumbs that I just left you guys. But I would say that as we’ve said before, we’re committed to achieving our margin target in that 38% to 40% range in the fiscal ‘23 to ‘26 window."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Phil Winslow of Credit Suisse. Your line is open."
},
{
"speaker": "Phil Winslow",
"text": "Hi, thanks for taking my question. I should have one earlier. But Andrew, a question for you, then a follow-up for Debbie. One of the questions I think is about the cyclicality of the AEC industry. And as you mentioned, the industry entered this year with a backlog from 2020 and frankly, even 2019. But as you pointed out, the macroeconomic environment has obviously deteriorated. So my question is what are you seeing and hearing from this vertical, especially about sort of the go-forward pipeline, as you think about the software that Autodesk sells in the various spaces here, the design, plan, build and maintain? And then I’ll just wait to ask the question to Debbie. Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, one thing continues to pressure the industry more than the demand, and it is the labor shortages and the capacity to execute. Construction companies still have a backlog of business. They are still struggling to execute through the business that they have. I’m sure you saw that some of the leading indicators of architectural buildings have gone or entered into a shrinking territory, which means that architects are going to see some decline in some of their buildings moving forward, but they also still have a backlog of business. So we’re still seeing customers saying, look, you know what, I have a pretty big pipeline of business that I haven’t executed on a queue of projects, and I still have capacity problems of getting through it. They are labor-related, they are material related, they are execution related. So we still have an overhang of backlog that’s going to continue into next year for a lot of our customers, and that’s what we’re hearing from our customers. That’s not to say they are not seeing pressure, and that’s not to say that they are not seeing some pressure in various segments. But they are still seeing a pretty good book of business for the next 12 to 18 months. Now as things continue, they’ll start to see kind of downward pressure in some of that backlog. But right now, they are all much more concerned about their ability to execute than they are about the book of business that they are accumulating."
},
{
"speaker": "Phil Winslow",
"text": "Awesome. Thanks for that color. And then Debbie, just a follow-up on billings, at the beginning of the year, you talked about long-term deferred revenue, I think, being in the high 20s as a percentage of toll as you exit this year. I wonder if you could give us an update on that. And then in terms of next fiscal year, as you move towards 1-year billings, help us maybe quantify sort of the drawdown of long-term deferred revenue and the impact of that? Because obviously, you flagged the sell-side range right now of $1.2 billion to $1.7 billion, but obviously, that’s pretty broad. So maybe some color on the impact of long-term deferred next year would be helpful, too. Thanks."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So overall, our messaging in these two areas hasn’t changed. So we were talking about long-term deferred as a percent of total deferred in that 20s range, and it’s going to continue to be there. The impact of our guidance adjustment for billings, a little over $100 million on a $5 billion number is not significant. And so we’re not anticipating that they will have a major impact on the metrics that you described. As we think about next year, I don’t have anything additional to share on how to think about the decline or what have you, other than to reiterate what I said before, and that is to think about the FactSet consensus that’s out there right now, that range of $1.2 billion to $1.7 billion. And then to reiterate that it’s really our goal to move as fast as possible because we really like to get this financial noise behind us."
},
{
"speaker": "Phil Winslow",
"text": "Great. Thanks a lot."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Adam Borg of Stifel. Your line is open."
},
{
"speaker": "Adam Borg",
"text": "Hey, guys. Thanks for taking the questions. First, for Andrew, and then a follow-up for Debbie. So just given the macro, are you seeing any trends of customers either – not necessarily upgrading to collections that otherwise or doing so earlier in the year? Or conversely, any trade downs from collections to point solutions or even LT? And then I have a follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. Great. Adam. No, actually, there is no change in those demand preferences with regards to collections and what people are buying. The mix of state essentially is same, the renewal rate of the states pretty steady. If anything, what we’re seeing is softness in the low end of our business, which is what you would expect in a climate like this. LT growth has lowed, LT renewal rates have seen some pressure. That’s where we’re seeing things. The collections percentages, the collections renewal rates, these have remained steady throughout the year and throughout the quarter."
},
{
"speaker": "Adam Borg",
"text": "Awesome. And maybe just for Debbie. So – and I don’t know if this is a harder question to answer, but if the multiyear mix came in line with your original expectations, how we think about the billings guide or even the billings results in the year, right? If it was the original mix that going into the quarter. Thanks again."
},
{
"speaker": "Debbie Clifford",
"text": "If I understand your question correctly, if the proportion of our business that had been multiyear was in line with our expectations then we would have hit our original guide. And the fact that we’re seeing some in that cohort choose to move to annual billings or annual contracts, that’s making it so that we’re reducing the billings and free cash flow guide. But maybe – did I understand your question correctly?"
},
{
"speaker": "Adam Borg",
"text": "Super clear. Thanks again."
},
{
"speaker": "Debbie Clifford",
"text": "Okay."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Stephen Tusa of JPMorgan. Your line is open."
},
{
"speaker": "Stephen Tusa",
"text": "Hi, good evening, guys. How are you?"
},
{
"speaker": "Andrew Anagnost",
"text": "Good."
},
{
"speaker": "Stephen Tusa",
"text": "Thanks. So I’m just – maybe I’m an idiot, but just like reading between the lines, the faster you guys move in the transition, all else equal, the lower the free cash flow next year will be, correct? Or are there other things moving around?"
},
{
"speaker": "Debbie Clifford",
"text": "The faster the transition, well, first, I want to continue to characterize that the impact of the numbers is relatively small, and it would have a minor follow-on implications to next year. But ultimately, what was built into our guidance was an expectation of a certain proportion of the business that was going to be multiyear upfront. A small portion of those customers have elected to be annual. So rather than it being a negative impact to next year, it would be a very slight positive impact to next year because we would have annual billings next year that weren’t in the form of a multiyear upfront transaction this year. But I want to continue to reiterate that the impact is relatively small. The impact to our billings guidance this year is relatively small. And if you think about the scale of the free cash flow number next year, I want to go back to that range that I was talking about that FactSet consensus range of $1.2 billion to $1.7 billion. And our goal really is to move the totality of the multiyear base to annual billings as fast as possible. And the faster we go, the greater that headwind is going to be to free cash flow next year."
},
{
"speaker": "Stephen Tusa",
"text": "Yes, I was – yes, exactly. I was asking about ‘24. Basically, you’re kind of telling us $1.2 billion to $1.7 billion and then you’re reiterating that you’re going to try and move as fast as possible. So it was just much more of a ‘24 question, which you just, I think, answered."
},
{
"speaker": "Debbie Clifford",
"text": "Okay. Great."
},
{
"speaker": "Stephen Tusa",
"text": "Right. The faster you move, the more impact you have next year?"
},
{
"speaker": "Debbie Clifford",
"text": "Correct. Yes."
},
{
"speaker": "Stephen Tusa",
"text": "Yes. Okay. That’s super helpful. And any color on kind of the I guess, the drop-through on bookings – or sorry, billings when I look at free cash flow it’s like 85% to free cash flow, That’s, I guess – just it drops through with your gross margin. I would assume you don’t really manage that on a quarterly basis. So it makes some sense. I am I looking at that the right way? Or is there something on the cost line that moves around and mitigates that decline in billings?"
},
{
"speaker": "Debbie Clifford",
"text": "No. I think you are thinking about it in a directionally accurate way. The billings reduction then has a follow-on implication to the free cash flow reduction. There is nothing else going on there."
},
{
"speaker": "Stephen Tusa",
"text": "Yes, okay. Great. Thanks a lot for the color. Really appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Michael Funk of Bank of America. Your line is open."
},
{
"speaker": "Michael Funk",
"text": "Yes. Thank you for the questions. So you mentioned a few times trying to incentivize the shift from multiyear to annual. So first, what are you doing to incentivize that? I guess second, what drove the different customer behavior this quarter than expected with the shift? And I guess third part, same question, is how quickly do you believe that you can transition your base over to annual as we think about trying to model out the free cash flow impact?"
},
{
"speaker": "Debbie Clifford",
"text": "Okay. So let’s – taking detailed note. So in terms of the incentives, the incentives for both our channel partners – well, for our channel partners are still in place. So that’s part of the programmatic details that we are working through right now as we engage with our partners and we execute on the transition. Remember, a substantial majority of that transition is going to be next year in our fiscal ‘24, and that’s why those details are still in flight. On the customer side, what they have historically had a discount of anywhere from 10% to 5% to have a multiyear contract that’s invoiced and collected upfront and that discount goes away. So the incentive is not there necessarily in the future for those customers to be trying to pay for upfront. And we think based on the feedback that we have been getting from our customers that they want to have multiyear contracts with annual billings. It’s good for them in managing their cash flow just like it’s good for us. It removes the volatility that we see and as you can see from our guidance this quarter, the volatility that we see with those multiyear upfront contracts. In terms of what drove the behavior that we saw this past quarter, well, the end of the multiyear discount is coming at the start of next year. And so we were anticipating more demand for multiyear upfront contracts. And in the end, we are seeing slightly less demand than we expected. In the current macroeconomic environment, that’s not surprising. The trade-off of the discount versus the cash upfront, it’s not as enticing for some customers right now. We have assumed that the behavior that we saw with respect to the multi-years in Q3 persists through Q4. And that’s what’s built into our guidance. It’s consistent with our overall guidance philosophy. And we really think that it reinforces our strategy to move to annual billings. We are hopeful that it’s a positive sign for the transition next year. And then finally, in terms of what we can do in order to drive the pace, well, a lot of that’s going to come down to our internal capabilities being available. I have mentioned before, that we are investing in systems to set us up to manage all these contracts at scale, and we are on pace. With those system changes, ultimately, it’s going to come down to what’s on our price list and how we work through these programmatic details with our partners. And these are all decisions that are very much under discussion right now, and that you will hear more from us over the next couple of months."
},
{
"speaker": "Michael Funk",
"text": "Okay. Great. Thank you for the question."
},
{
"speaker": "Operator",
"text": "Thank you. One moment please. Our next question comes from the line of Gal Munda of Wolfe Research. Your line is open."
},
{
"speaker": "Gal Munda",
"text": "Thanks for taking my questions. The first one is just around Fusion 360 and what you guys are seeing there. I know that when we visited Autodesk University with us, really, really good feedback. At the same time, the macro environment in manufacturing is kind of going a little bit slow. Is there anything particularly that makes you potentially see any sort of slowdown in that, or do you think your Fusion 360 throughout the cycle is going to perform better than what you have seen in the past in your manufacturing portfolio? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, first off, Gal, manufacturing grew 13%, 14% on constant currency, that’s still best-in-class for our space. So, we continue to believe that we are taking share in that respect. Look, you can’t have a slowdown in Europe, where we are very strong, without seeing some slowdown in new Innovyze [ph] acquisition with regards to Fusion. However, we still continue to acquire more new users than any of our competitors in the space. So, even in the face of some headwinds where we see some slowing, we are outpacing our competitors, which is kind of the important metric here in terms of the appetite and desire for Fusion. It continues to be the disruptive player, the disruptive price point, the disruptive capabilities. And our customers continue to embrace the solution even in the environment of headwinds. So, we are not concerned because customers really need the efficiency of an end-to-end connected solution, and they really want what they get at the kind of price points that we deliver with Fusion. So, we continue to be the preferred solution. I continue that – I expect that to continue, and I expect our relative performance to remain strong."
},
{
"speaker": "Gal Munda",
"text": "That’s perfect. Thank you. And then just as a follow-up, thinking about the opportunity. I know when COVID happened and we talked about the non-compliant user opportunity, you kind of posed a little bit everything, and you said we are going to come back when the environment, especially macro, is a little bit stronger. You have done that over the last year. If I am thinking about heading into another macro weakness, how much of an opportunity is coming from the non-compliant users, or how much more lenient you might be maybe for a year or 2 years until that plays out? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. I think we have got a good rhythm in our compliance business right now. I mean I think COVID was a very unique situation where there was a sudden and precipitous impact on our customers. I think we are heading into kind of a different environment in many respect. Of course, manufacturers are seeing increased costs in terms of energy and material costs and things associated with that. So, the pressures are real. But I think the rate and pace that we are on right now with regards to license compliance makes sense. Like I have always said, this isn’t something that we are going to slam the accelerator on and try to move faster. But right now, I don’t see us actually changing our pace or slowing down in any kind of way. I think we are at a nice clip right now, and I think that we will be able to maintain it through any kind of bumpiness that we might see as we head into the winter."
},
{
"speaker": "Gal Munda",
"text": "Thanks Andrew. Appreciate that."
},
{
"speaker": "Operator",
"text": "Thank you. One moment please. Our next question comes from the line of Matt Hedberg of RBC. Your line is open."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks for taking my question guys. Debbie, I wanted to come back to the cash flow breadcrumbs that you gave. Sort of – you keep talking about the range of $1.2 billion to $1.7 billion and wanting to progress as fast as possible. I mean does that effectively imply that, that low end of FactSet consensus is at play? Just sort of curious on why phrase it as a range like that?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks Matt. So, we are not guiding on the call today. We are trying to provide some insight into how to think about it. And that range is in the realm of possibility, and there are a couple of factors that we want to continue to emphasize that are going to impact that. And that is the rate at which our customers transition to annual billings and the overall macroeconomic environment. But as I have said, we will provide specifics on the next earnings call."
},
{
"speaker": "Matt Hedberg",
"text": "Got it. Thanks. And then maybe just one on the expense side, I appreciate the currency headwinds next year and sort of the reiteration of kind of the long-term margin framework. Are there things that you guys are doing right now from a spend perspective, whether it’s hiring or just sort of like general cost consciousness as we get into more economic uncertainty?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks. So, first, I want to say that we have been focused on ensuring that we don’t spend ahead of top line growth. We have delivered considerable operating margin expansion over the last couple of years. We have exhibited a spend discipline that we now benefit from as the market conditions continue to evolve. If we focus on the near-term, we have delivered on our margin goals for the year-to-date. We are on track to do so through the end of the year. You can see that from no change in our operating margin guidance. Our hiring plans at the beginning of the year reflected really what is a solid balance between proactive investment and the discipline required to achieve our margin targets. As we look ahead to next year, we are in the planning process right now, but we are focused on ensuring that we continue this pattern of disciplined spend. We are looking to ensure that we can invest in the right areas to drive the strategy. So, things like purposeful and strategic rather than broad-based investing in areas like our industry clouds and shared services, but all against a backdrop of delivering a healthy margin. And I also want to say that we want to ensure that we are not too short-term in our thinking. We have a strong balance sheet. We want to make sure that we strike that right balance as we navigate these macro waters. We want to capitalize on the downturn to continue to invest, but all while keeping that watchful eye on operating margin. And as we said before, we are committed to achieving a margin target in the 38% to 40% range in that fiscal ‘23 to ‘26 window."
},
{
"speaker": "Matt Hedberg",
"text": "Alright. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Tyler Radke of Citi. Your line is open."
},
{
"speaker": "Tyler Radke",
"text": "Thanks for taking my question. Andrew, so at AU, you obviously announced the product announcements on Forma and Flow. I am curious how, if you could talk a little bit about the plans to accelerate the engineering velocity, specifically, is this is going to require more hiring, or is it just kind of re-prioritization of your engineers? And then just kind of comparing it to the timeline that you saw Fusion play out in that monetization cycle, just help us understand how you are expecting kind of the product to roll out and the monetization trend over time? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, first off, one of the things we did to just start Forma, as you might recall at the beginning of the pandemic, we acquired a Norwegian company called Spacemaker. And we have continued to invest in that team, and we will continue to expand that team either by repurposing existing resources to work with that team or by adding additional resources to that team to make sure that we are on track. But one of the foundational investments that supports all of the things we are trying to do with our investment in data. And that’s an ongoing investment in trying to break up Revit files and make them more accessible in the cloud as granular data. Forma and – by nature is built net native on the cloud and it has granular data at its core. So, that’s one of the kind of core vectors that we will be doing. But we will be incrementally investing to ensure that we are heading on the right path with this solution. But we have done some of that already. And we have kind of absorbed some of those investments today. Now, I think the question about timeline is a really good one because these kind of transformations – what we are doing with Forma is different, right. What we are doing with Revit to improve its performance and improve its capabilities based on what our customers are asking us to do is making their current tools better. But what Forma is doing, especially with its connection – its native connections to downstream process is different. It takes time for different to penetrate the industry, just like different took time with Fusion. It was – we have been working on Fusion for over a decade, alright, roughly speaking a decade. So, you can expect that it’s going to take 5 years for Forma to mature and even longer for it to totally replace what our customers are doing. However, our goal is to incrementally add value to the process as time goes on, just like we did with Fusion. Fusion, we added incremental value with the connection to downstream manufacturing. In Forma, we are going to add incremental value with regards to the data platforms and the connection to the downstream construction processes. So, that’s all connected, but it is going to take time similar to what we saw with Fusion."
},
{
"speaker": "Tyler Radke",
"text": "That’s helpful. And Debbie, maybe a question for you. So, just on current RPO, it looked like that did pick up a bit quarter-over-quarter if you back out the currency. Can you just help us understand I guess first, do you kind of view that as the best leading indicator given the headwinds in billings? And just remind us how you are thinking about the puts and takes on that just as you do – renew these large EBA customers in the coming quarters. Just anything we should be mindful of there? Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. Sure. So yes, I mean current RPO is a very important metric in monitoring our business performance. And you are right, particularly when you normalize for the currency impacts that growth was in a healthy zone. So, I want to just continue to stress that FX has been really volatile, and that’s going to continue to impact the growth rate. So, definitely look at the constant currency growth rates over time. Also, the timing and volume of our EBAs impacts the growth rate period-to-period. And so sometimes what you see is that when we have large cohorts of our EBAs coming up for renewal, it tends to be back-end loaded in our fiscal years and most often in our Q4, we start to see growth impacts as the year progresses, in many cases, deceleration Q1 to Q3 that would tick back up as those cohorts for EBAs come back up for renewal. So, growth rate should tick back up over time, given consistent historical – given patterns consistent with our historical patterns. But again, remember the constant currency has just been a zinger that’s going to impact growth rates for quite a while here. So – but it is an important metric for us, and we monitor it closely."
},
{
"speaker": "Tyler Radke",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Jason Celino of Key. Your line is open."
},
{
"speaker": "Jason Celino",
"text": "Hi. Thanks for taking me in. Just two quick ones. So, when we look at the fourth quarter guidance, it looks like you will exit the year at 8% growth at the midpoint, pretty big decel from third quarter. I guess what is the FX headwind built into here? And are there any other factors that we should think about for Q4?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So, Jason, the biggest impact is currency. We have seen a growing currency headwind during the year, and that’s gradually showing up in the growth rates as the year progresses. It’s about a 3-point headwind in Q4. It was a 1-point headwind in Q3 and was neutral in the tailwind at the beginning of the year. So, you can see that it’s gradually having a significant impact on our growth rate. That’s the biggest driver of the implied growth rate that you are talking about. Also, to a lesser extent – but Andrew did mention that we saw a modest deceleration in our new business, particularly in Europe during Q3, that does have a slight follow-on impact to revenue in Q4."
},
{
"speaker": "Jason Celino",
"text": "Okay. Great. Thank you. And then the last multiyear appetite, it sounds like, to some extent, some of this is macro related. I guess where do you see that dynamic most prevalent? Was it with your larger customers, your smaller customers, international versus domestic? Just trying to understand kind of the puts and takes. Thanks."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. It tends to be larger deal sizes, not surprisingly. I think that when our customers start to exhibit cash conservation behavior, that behavior does tend to be more prevalent with some of the larger deal sizes. And remember, they are still signing multiyear contracts, they are just signing multiyear contracts and asking for annual billings, which for those larger deals, we are willing to accommodate while we continue to invest in the back-office infrastructure to be able to handle the totality of the multiyear base with annual billings at scale."
},
{
"speaker": "Jason Celino",
"text": "Okay, perfect. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from the line of Keith Weiss of Morgan Stanley. Your line is open."
},
{
"speaker": "Keith Weiss",
"text": "Hi, thank you so much. The comments on the stable renewal rates, and I’d just like to dig into the expansion motion and it’s not like never tension stayed within the historical range, but curious if you are seeing any changes on just the expansion behavior with the shift in macro and should we expect a similar range into 2024? Is there any risk that we could fall outside of those ranges just given the broader macro headwinds? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "So with regards to retention rates, look, retention rates continue to be strong and maintain steadiness. I think we are going to continue to see that steadiness into next year. The one area where we expect to see softness with macro headwinds is at the low end of our market. So the low end of the market is low ASPs, but high volume. So, the retention rates can move around on a volume basis when there is headwinds like this. But generally speaking, broadly across our business, we see retention rates holding up. Our products are mission-critical to what our customers do. They need them. But at the low end of our business, we will probably see some headwinds there, but they won’t be material to the larger business."
},
{
"speaker": "Debbie Clifford",
"text": "I would just add that our net revenue retention rate was comfortably within the target range of 100% to 110% and in the short-term, our expectation is that it will stay in that range."
},
{
"speaker": "Keith Weiss",
"text": "Great. And then just following up on kind of the comments about the strong balance sheet and willing to invest, wanted to see if you are seeing any change in behavior in the competitive landscape, especially from some companies that may not have as strong a balance sheet? So any changes you are seeing in the behavior overall? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "So with regards to – I just want to give a clarification on that question. With regards to the competitive environment in what way in terms of how that – how does it – just give me a clarification on your question a little bit there. I didn’t quite understand."
},
{
"speaker": "Keith Weiss",
"text": "Yes, sure. So you guys have a strong balance sheet kind of willing to invest in the current environment, just even though there maybe some macro headwinds. But you likely have some peers out there that may not be as well funded or has strong balance sheets. So curious if you are just seeing any sort of changes in behavior across the competitive landscape?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, okay. Okay, good. I just wanted to make sure that I was in it. So look, we are in better shape than some of our competitors that are not profitable. In certain situations, people are going to be chasing, I think long-term things that kind of boost revenue or pull revenue forward. They will be doing customer unfriendly things to try to pull things forward. We are not in that position right now, especially in certain types of sectors. We are maintaining customer-friendly practices. We are focusing on the long-term. We’re investing in the long-term. And that will actually provide competitive advantage as we move out of the slowdown. And it’s always great to be in a position to invest during a slowdown and to not have to pull short-term levers to try to achieve profitability, maintain profitability or get in the way of things. We will probably have more dry powder for inorganic activity than some of our competitors as we head through this. So yes, strong balance sheet actually helps us invest ahead of the curve while we go through these things. So I am pretty confident that we are ahead of the game in a lot of places."
},
{
"speaker": "Operator",
"text": "Thank you. That is all the time that we do have for question. So I’d like to turn the call back over to Simon Mays-Smith for any closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks everyone for joining us. I hope the call was useful. For those of you that celebrated happy Thanksgiving and happy holidays and we’ll look forward to catching up with you again at conferences and in the New Year at our fourth quarter earnings. Thanks very much."
},
{
"speaker": "Operator",
"text": "Thank you. Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating. You may now disconnect. Have a great day."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 2 | 2,023 | 2022-08-24 17:00:00 | Operator: Thank you for standing by, and welcome to Autodesk's Second Quarter Fiscal 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the second quarter results of our fiscal 2023. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome, everyone, to the call. Today, we reported record second quarter revenue, non-GAAP operating margin and free cash flow. End market demand remained strong during the quarter, resulting in robust new business activity. Renewal rates were again excellent. All of this and our strong competitive performance more than offset the direct and indirect impact of geopolitical, macroeconomic, policy and COVID-19 related factors. Growing commercial usage outside China, Russia and Ukraine, record bid activity on BuildingConnected and continued channel partner optimism leave us well-placed to achieve our FY 2023 goals. As I said last quarter, the structural growth drivers for our business that were critical to our performance during the pandemic, such as flexibility and agility, continue to support and propel us during this period of elevated uncertainty. These growth drivers further cement the important role we play in our customers' digital transformations and increase our confidence in our strategy. Our steady strategy, industry-leading products, platform and business model innovation, sustained and focused investment and strong execution are creating additional opportunities for Autodesk. By accelerating the convergence of workflows within and between the industries we serve, we create broader and deeper partnerships with existing customers and bring new customers into our ecosystem. In pursuit of these goals, we announced at Autodesk University last year that we were moving from products to platforms and capabilities and bringing these capabilities to any device anywhere through the cloud. Over the coming weeks, months and years, you will hear a lot more from us about our plans and progress to build a world-class customer experience, catalyze our customers' digital transformation and establish industry-leading platforms for design and make. As evidence of the progress we have made already, Fusion 360 flew past 200,000 subscribers during the second quarter and signed its first million-dollar contract, both important milestones and indications of the opportunities ahead. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. Q2 was a strong quarter across products and channels. Our end markets were broadly consistent with last quarter, with our strongest growth in North America and growth in Europe and APAC impacted by the war in Ukraine and COVID lockdowns in China. Total revenue grew 17%, both as reported and at constant currency. By product, AutoCAD and AutoCAD LT revenue grew 13%, AEC revenue grew 18%, manufacturing revenue grew 16% and M&E revenue grew 20%. By region, revenue grew 22% in the Americas, 15% in EMEA and 10% in APAC or 13% at constant currency. By channel, direct revenue increased 18%, representing 34% of total revenue while indirect revenue grew 16%. Our product subscription renewal rates remain strong, and our net revenue retention rate was comfortably within our 100% to 110% target range. Billings increased 17% to $1.2 billion, reflecting robust underlying demand. Total deferred revenue grew 12% to $3.7 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 13% and 10%, respectively, reflecting strong billings growth and, as we've highlighted in the last two quarters, the timing and volume of multiyear contracts, which are typically on a three-year cycle. Multiyear contract volume remained strong during the quarter, as expected and as you can see from the uptick in long-term deferred as a percent of total deferred. Turning to the P&L. Non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin increased by 5 percentage points to approximately 36%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margins increased by six percentage points to approximately 20%. We delivered record second quarter free cash flow of $246 million, up 32% year-over-year, reflecting strong billings growth in both Q1 and Q2. We continued our accelerated share repurchasing during the quarter. We purchased 1.4 million shares for $257 million at an average price of approximately $182 per share, which, when compared to last year, contributed to a reduction in our weighted average shares outstanding by approximately three million to 270 million shares. While our capital allocation strategy remains unchanged, you can expect that we will continue to invest organically and inorganically to drive growth. We've proactively used our strong liquidity to repurchase 3.5 million shares in the first half of this year, front-loading the offset of next year's dilution. Now let me finish with guidance. The underlying business conditions we've been seeing are broadly unchanged. As I mentioned earlier, we're seeing strength in North America and continued healthy growth in Europe and Asia, outside of Russia and China, due to the geopolitical situation in both regions, as well as the COVID lockdowns in China. Our renewals business continues to be a highlight, reflecting the ongoing importance of our software and helping our customers achieve their goals. As we look ahead and as with previous quarters, our fiscal 2023 guidance assumes that market conditions remain consistent for the remainder of fiscal 2023. The strengthening of the US dollar during the quarter generated slight incremental FX headwinds, which reduced full year billings, revenue and free cash flow by approximately $20 million, $5 million and $5 million, respectively. Bringing these factors together, the overall headline for guidance is that it is unchanged at the midpoint across all metrics, with the underlying momentum of the business offsetting those incremental FX headwinds. We are narrowing the fiscal 2023 revenue range to be between $4.99 billion and $5.04 billion. We continue to expect non-GAAP operating margin to be approximately 36% and free cash flow to be between $2 billion and $2.08 billion. The slide deck and updated Excel financials on our website have more details on modeling assumptions for Q3 and full year fiscal 2023. While the challenges our customers face are changing, the growth drivers underpinning our strategy have only been reinforced, which gives us confidence in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud based solutions that drive efficiency and sustainability for our customers. Our business is scalable and extensible into adjacent vertical, from architecture and engineering to construction and operations, from product engineering to product data management and product manufacturing. It is also scalable and extensible between verticals, with industrialized construction and into new workflows like XR. By accelerating the convergence of workflows within and between the industries we serve, we are also creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. For example, Kimley-Horn, one of the nation's premier planning and design consultants, expanded its EBA in Q2, broadening and deepening its long-standing partnership with Autodesk. In addition to increasing its utilization of Civil 3D and Revit and driving further operational efficiency gains through BIM and cloud collaboration, it also chose to expand use of Innovyze in its rapidly growing water practice to help drive more growth opportunities and productivity gains. As we highlighted last quarter, digital workflows are being adopted across the infrastructure life cycle from asset owners, architects and engineers to construction to drive improved efficiency and sustainability. The Indiana Department of Transportation, which was looking for an efficient solution to simplify its document management and field collaboration, is another good Q2 example. By adopting Autodesk Build and ACC Connect, it will improve communication and coordination throughout the construction process and streamline the documentation of citizen issues, resulting in less waste and more return per taxpayer dollar. Across construction, the industry continues to look to connect workflows from planning and design to preconstruction, construction and ultimately, operations and maintenance. And we are enabling our customers to connect those workflows on a single platform. For example, a commercial real estate and property management company focused on owners, investors and occupants was tired of having multiple platforms across the project life cycle, resulting in inconsistencies, rework and poor handoffs. In Q2, it adopted the full Autodesk Construction Cloud to connect preconstruction with project management. It added quantification estimating to building connected and BIM Collaborate Pro in preconstruction and Autodesk Build for project management to give themselves a competitive advantage and increase profitability to improved collaboration and data management. Across the globe, our customers seek to connect and streamline their construction workflows, and we are enabling and accelerating that through our partner network, launching Autodesk Build in new markets like Japan, enabling more data formats on more devices and delivering more value to our customers through account-based pricing. We're also giving our customers control of their data through Bridge, leveraging the power of machine learning to anticipate project risk and seamlessly connecting workflows like takeoff, estimating and budgeting to delight our customers and improve their productivity. With monthly active users growing more than 45% quarter-over-quarter, Autodesk Build is being rapidly adopted by existing and new customers to connect and streamline their construction workflows. Turning to manufacturing. We sustained strong momentum in our manufacturing portfolio this quarter as we connected more workflows beyond the design studio, developed more on-ramps to our manufacturing platform and delivered new powerful tools and functionality through Fusion 360 extensions. Customers continue to expand their adoption of the Fusion platform beyond design and engineering. This quarter, a US supplier of metal cutting tools chose to create a state-of-the-art collaboration tool on Fusion to enable its sales organization to demonstrate its digital manufacturing technology to customers. By enabling customer customization to be immediately reflected in factory manufacturing instructions, the tool will be a competitive advantage during the selling process. For Autodesk, it adds a significant new persona group to Fusion's addressable market opportunity. In automotive, we continue to grow our footprint beyond the design studio into manufacturing as automotive OEMs seek to break down the work silos and shorten the handoff and design cycles. For example, a top-tier commercial vehicle manufacturer renewed and increased its partnership with Autodesk as part of its strategic focus on building a sustainable product and service portfolio, which leverages new technologies and digital innovation to accelerate electrical vehicle solutions. In addition to Alias, which it already uses for surfacing work of all its vehicles, it is utilizing VR technology from the wild in combination with VRED and Navisworks to drive innovation and visualization from design and engineering through factory design. Our Fusion 360 platform approach enables customers to seamlessly connect workflows and push the boundaries of innovation through the advanced design and manufacturing technologies and extensions. For example, a global leader in seat manufacturing, which works with many major automakers worldwide, engaged Autodesk Consulting to develop a blended workflow across design, product engineering and manufacturing. The result was a seat that proves passenger comfort and safety while reducing the weight and number of parts. Using Autodesk design tools like Alias Conceptual Design and Fusion 360 thinner design, it was able to redefine the seat design with thinner seat sections and improved comfort and safety. Fusion 360's commercial subscribers grew steadily, ending the quarter with 205,000 subscribers and demand for our new extensions, including machining, generative design and nesting and fabrication continuing to grow at an exceptional pace. In education, engineering students are using Fusion 360 to learn the skills of the future in institutions like Grwp Llandrillo Menai, the largest further education college group in Wales. Students there are applying their studies to benefit local industry partners and businesses. For example, students recently used Fusion 360's cloud based data management and advanced 3D machining to help a local RV manufacturer improve its output by about 50%. The college is now planning to integrate Fusion 360 across its 11 campuses due to its ease of use, modern user interface, accessibility across devices and ability to collaborate on team projects and share data. And finally, we continue to bring more users into our ecosystem through business model innovation and license compliance initiatives. When one of our EMEA customers realized that some usage from its international offices was noncompliant, it needed time and data to better understand its users before purchasing subscriptions. By purchasing our first-ever 100,000-pack of Flex tokens, the customer gained instant access to Autodesk's portfolio of products and usage data to make informed decisions on its future subscription purchases while also opening up new competitive opportunities for Autodesk. During the quarter, we closed seven deals over $500,000 with our license compliance initiatives, three of which were over $1 million. Flex and Premium are also helping customers transition from multi-user to named user contracts. A leading supplier of concrete form work and scaffolding systems in Europe has been unifying internally around BIM to accelerate its digital transformation. It added Premium plan to its transitions and named trade-ins to centralize software management, enable user-based analytics and license optimization and benefit from single sign-on security. It can also purchase Flex token to cover its occasional user needs. Let me finish where I started. Strong demand and robust competitive performance delivered excellent Q2 results. Our subscription business continues to demonstrate its growth potential and resilience. By accelerating the convergence of workflows within and between the industries we serve, we are accelerating the digital transformation of our customers and creating broader and deeper partnerships with them. And by moving from products to platforms and capabilities and bringing those capabilities to any device anywhere through the cloud, we are expanding our opportunity horizon. Look for us to talk more about that over the coming weeks, months and years. We look forward to seeing many of you at Autodesk University in a few weeks. Operator, we would now like to open the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Saket Kalia, your line is open.
Saket Kalia: Okay, great. Hey, Andrew, hey, Debbie. Thanks for taking my questions here.
Andrew Anagnost: How are you, Saket
Saket Kalia: Excellent, same here. Andrew, maybe first for you. Maybe we'll start to shift [Technical Difficulty] I wondered if you could expand a little bit on the comment around moving from products to platforms that we can all talk about [indiscernible] as the platform has evolved. But maybe you can just walk us through what that looks like in the future in terms of a platform from your perspective?
Andrew Anagnost: Yes. I want to be careful not to give away all the AU tidbits in some of those discussions. But it's an important question. Saket, I -- to put it in perspective, right now, we sell literally hundreds of products. And the challenges for our customers is trying to find out which one of these products solve which problems for them and also the fact that a lot of these products don't talk to each other very easily. So when you're selling hundreds of products, it's really difficult to connect data flows across all those capabilities. It's also really difficult to uniformly deliver multi-platform support, multi-device support, cloud computing and AI automation, which is really challenging. So what we're doing is we're moving away from this kind of disconnected portfolio of products to really a set of platforms to target each one of our industries with some underlying core technologies that support all of it. That will enable us to actually deploy capabilities to our customers as they need them for particular types of process, right, advanced manufacturing capabilities on a time-bound basis or a consumption basis, accumulation capabilities on a time-bound basis or a consumption basis. So they get access to what they need, when they need it, and it's all unified from a data flow point of view. This is kind of going to be revolutionary for a lot of our customers in terms of the evolution and where we're taking them. So it's really valuable for our customers in terms of connecting how they work and the value they get from each one of our products. And it's really important to us in terms of delivering more layers of automation and power to them to the cloud. So it is a journey. It's not going to happen overnight, but Fusion is an excellent example of where we're going and how we could deploy some of these things to our customers, especially when you look at the way extensions work, consumption works on top of the Fusion platform. It's a good model for where we're taking industry platforms for each one of our industries.
Saket Kalia: Got it, got it. That's really helpful. And it sounds like it will be exciting at AU. [Technical Difficulty] a follow-up for you. Can you just talk a little bit about the multiyear [Technical Difficulty] business? How are those renewals? I know they're starting to trickle in from three years ago in a bigger way. How are those renewals kind of coming in versus your expectations? And maybe looking forward, how do you plan on phasing that option out, I think, [Technical Difficulty]?
Debbie Clifford: Sure. So we continue to track the multiyear cohort closely. Our proportional volume for multiyear has been in line with our expectations for the first half of fiscal 2023, so that gives us confidence in our fiscal 2023 outlook. We also saw long-term deferred revenue as a percent of total deferred revenue tick up. That, too, was in line with our expectations. As we look ahead to the transition from upfront to annual billings, well, it hasn't started yet. We anticipate that the transition's going to start in early fiscal 2024, and we continue to work through the programmatic and operational details to get there, things like a partner transition plan, back-office system upgrades. But I'll say again, it's our bias to go as quickly as possible. In the meantime, obviously, we're focused on closing out this year, making sure that those multi-years come in consistent with historical patterns. And the fact that they are is giving us that confidence as we look to achieve our goals for this year.
Saket Kalia: Got it. Very clear. Thanks guys.
Operator: Thank you. Our next question comes from the line of Phil Winslow of Credit Suisse. Phil Winslow, your line is open.
Phil Winslow: Thanks for taking my question, and congrats on another quarter, reinforcing how Autodesk grows is simply not as cyclical anymore.
Andrew Anagnost: Thanks Phil.
Phil Winslow: Andrew, I just wanted to focus on the AEC side, because this is the area that I get the most questions on in terms of cyclicality, with two questions of my own for you. Firstly, what are you hearing from design customers in this segment about what continues to drive your incremental spending on Autodesk despite the cloudier macro? And then secondly, the 45% quarter-to-quarter growth in Autodesk Build MAUs in the slide deck and your commentary on just the BuildingConnected volumes also really stood out to us. Similarly, what are you hearing from these construction customers about why they also continue to lean in on digitizing their workloads in spite of the macro, or is this becoming because of the macro volatility that they're digitizing? Thanks.
Andrew Anagnost: Okay. That was a multi-part question. I will address it. So first off, let's talk about what we're hearing from design customers. The number one thing we're hearing from the design segment is the backlog of business, right? They have more business right now than they're able to effectively execute on. And the requirements of that business are increasing in terms of what kind of tools they need to use, how they need to approach the problems, owners, municipalities, all sorts of customers they deal with are putting more requirements on how they have to work. So they're all looking to up their game in digital tools. The biggest challenge we hear from these customers is hiring, frankly. We were hearing last year a lot of conversations about, oh boy, fixed bid contracts and inflationary pressures and all these things. As I've said previously, they bake these things now into their business bids and they're able to capture those costs in their contracts. But what they're struggling with is hiring. We're still growing even if they struggle to hire because they're getting people in but they have more demand for manpower and person power than they actually are able to capture at this point, okay? So that's something we're hearing really robustly. Now let's go to the growth in construction. First off, I want to give you my quarterly disclaimer. When you look at the construction business, the make number does not capture the full story in the construction business. The EBA growth is hidden in the design bucket. So when you count how we're doing with our enterprise business agreements and the overall territory business, that we grew close to 30% in that business. So that's really quite nice growth. And what we're hearing, and I'm glad you picked up on the 45% growth on monthly active users, we're hearing a couple of things. One, first off, we've lit up our territory business, our partners in the territory. This is driving a lot of really nice growth in the US and in Europe, and it's going to continue to drive that growth. And that's bringing us closer to certain customers lower down in the market, the mid-market and below, which I think is a really important point in our journey, okay. The other thing I want to talk about is when customers are starting to realize is they need a lot more than just a project management or a construction site management tool. They really are looking to their future, where they're trying to connect the design and the build all the way together continuously. And one of the big linchpins in all of that is preconstruction planning. The vast majority of the cost and complexity of a construction project is built in during the preconstruction planning phase. You get that wrong, you bid wrong, you come in with lower margins, you have more churn and complexity in your project. So this connection between design, preconstruction all the way to build is increasingly really important to their customers. So customers are taking a lot more time to evaluate what they're trying to invest in. And I think you also probably noticed, at least a little bit in the introductory commentary, that infrastructure is a big play for us here. So Department of Transportation, and you saw Indiana, the Indiana Department of Transportation lean into our portfolio for looking at their future needs. We're hearing more and more from Departments of Transportation that are really looking to upgrade and modify their stack to be much more designed to build on a much more modern cloud infrastructure. So there's a lot going on in construction, Phil, and it's coming at us from multiple directions, and right now, it's all positive.
Phil Winslow: Awesome. Appreciate all the details. Thank you, and keep up the great work.
Andrew Anagnost: Thanks, Phil.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Jay Vleeschhouwer, your line is open.
Jay Vleeschhouwer: Good evening, Andrew, Debbie and Simon. Andrew, you have, by our calculation, the largest R&D budget in your peer group, but you don't necessarily have the largest headcount in R&D. And so the question is, particularly given your earlier comment about the large number of products that you're currently developing and having to manage, how you see or how are you working on improving your R&D productivity or effectivity, if you will, in terms of your core platform, your applications technology and ultimately, product usability to drive MAUs and further enlarging the installed base? And then for Debbie, you commented earlier with respect to your back-office as part of your initiatives over the next number of years. On that point, could you comment on where you are in terms of your operational capacity for the new licensing model and deliverables that you're going to have as you have an increasingly complex offering to customers in terms of Flex and everything else you're doing, the platform Andrew mentioned? Are you, in fact, going to have the requisite back office to handle all of that?
Andrew Anagnost: All right. So Jay, let me start with your questions. Yes, you are correct. We have the largest R&D budget but we don't necessarily have the largest headcount on R&D. Part of that is because of where we concentrate on R&D and what kind of talent we're pursuing. We're pursuing a lot of cloud talent, a lot of cloud-native talent, full staff development talent that allows us to build out the core cloud capabilities and continue to expand them. That talent resides in certain places, and it has certain costs associated with it and we think that's the right strategy. We don't hire a lot of R& D content headcount that's associated specifically with customer-specific development in, say, other parts of the world. So we do hire in specific areas because of what we're trying to do. And when it comes to developer productivity, you hit on a really important aspect of why do we have platform services? Why are we extending the depth and breadth of the things that we build in the platform services? One of the reasons we're doing that is to lift the burden away from some of these development teams on things like data flow, on things like visualization and capabilities that should be uniform across every platform or product that we -- or capability that we deploy. So more and more, as you see these -- the portfolio of platform capabilities not only mature but expand, it's going to increase the productivity of the teams that are looking at features that are facing particular industries and capabilities that are facing particular industries. It's a big part of why we have these services, and we're already starting to see some of those benefits, especially with regards to data flow, which is an initiative driven primarily by the platform organization within Autodesk. And it's being aligned across the various industries to make sure that we get the right kind of synergies and lift from our data APIs and our data connectivity. So yes, you will see increasing productivity associated with this. We're definitely spending on quality over quantity, and I think that's the right strategy for where we're at right now.
Debbie Clifford: And then Jay, to answer your question about operational capacity for things like new business model, I would say that we are well on our way on this journey but we still have some ground to cover in order to be where we need to be. And I think that, that's an appropriate place to be at this stage of the journey. Now of course, we don't launch new business models without the ability to support them, which is why, as one example, we are delaying the shift to annual billings until next year, so that we can spend the time that we need to be able to invest in our back-office systems to make sure that we have a good customer experience and that we have the right controls and automated capabilities in the back office. I mean, ultimately, this is something that we focus on not only to make sure that we have the capacity to support new business models but also so we can scale. If we want to achieve our long-term growth aspirations, we need to continue to invest in our back-office infrastructure in order to be able to scale efficiently, effectively and in an automated way to do it.
Jay Vleeschhouwer: Okay. Thank you very much.
Andrew Anagnost: Thank you Jay.
Operator: Thank you. Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Your question please, Matt Hedberg.
Matt Hedberg: Hey, thanks guys. Andrew, for you, the growth in Fusion 360 was really fantastic to hear. Can you talk about where those subs are coming from? Are these greenfield? Are they replacements? And maybe just a little bit more on with a lot of alternatives, why Fusion 360?
Andrew Anagnost: Yeah. So first half is a bit of a mix, all right? A lot of these are greenfield investors acquiring design software connected to connected to manufacturing software for the first time. But there's a lot of rip and replace going on. I think you've probably heard me talk many times about how we're going into accounts where people might have a seat of SOLIDWORKS and a seat of Mastercam or some kind of other CAM software and they're saying, well, Fusion is all I need. And we're -- we've been consistently creating and growing subscribers from that type of business. But what we're seeing more and more, and I think this is one of the things that is important about the user growth you're seeing, is that where we've gone in and we've started some department or part of a particular company, we're starting to grow the installed base within those companies. So we're still bringing in new customers, primarily along this design to make vector, but we're starting to grow within the accounts we've captured. This is the kind of flywheel you'd like to see as you start to mature a business, and we're starting to see some of that. The reason people buy is there is there's three kind of vectors here that people pay attention to: one, of course, is the price. The pricing model for Fusion is disruptive. It's native subscription-based. It's not a reimagining of an existing perpetual business. It's a native subscription-based business. It has extensions and things and consumptive models that allow people to pay for what they use and manage how much it costs from the use of software. They love that. Two, they love the design to make integration, the end-to-end integration from the design process all the way to actually programming and driving the machine on the shop floor. This kind of merger and convergence of design and make something that's really valuable to a lot of people. And the third thing might surprise you a little bit. It's our YouTube community. It's the amount of content that's out there on YouTube, which by the way, exceeds even much more mature products that are out there in the market, where people cannot only learn how to do something in Fusion, they can learn how to do it exceptionally in Fusion. It's a very passionate, very engaged and really very knowledgeable community that's publishing all this content. And people really buy for those reasons. They buy for the disruptive business model, they buy for the design make integration and they buy for the fact that they can find just a tutorial about just about anything you can think of to get really expert level in the product.
Matt Hedberg: That's super, super helpful. And then Debbie, the consistency is obviously really good to see. The macro environment, this is not easy, clearly, but the consistency was great. I'm wondering if you could talk a little bit about the linearity in the quarter. And maybe what are you seeing thus far in August?
Debbie Clifford: So the linearity that we saw during the quarter is consistent with what we've seen in previous periods. I would say nothing newsworthy to report there. And obviously, at this point, we're not commenting on what we're seeing in August.
Matt Hedberg: Thank you.
Operator: Thank you. Our next question comes from Adam Borg of Stifel. Your line is open, Adam Borg
Adam Borg: Guys, and thanks so much for taking the question. Maybe just first for Andrew on the Infrastructure Bill. I know that's something we talked about in the past and the positive tailwinds that could have for Autodesk. So maybe just a quick update here. And then as I think about the recently passed Inflation Reduction Act, there's a lot of language in there about clean energy and sustainability. I'd love to hear how you think about that impacting Autodesk over time as well.
Andrew Anagnost: Yes. And so first, let's talk about the Infrastructure Bill. As with any of these goals and like I've said in the past, the money is slowly trickling out, all right? And what you're seeing is people are actually starting to begin the process of planning around particular types of projects. But more importantly, what's happening is a lot of the recipients of some of these funds, particularly Departments of Transportation, are starting to rethink how they're approaching their design processes. And by the way, energy efficiency and sustainability play into how they think about some of these things. So remember, there was a seed money in that bill to enable Departments of Transportation to explore and expand digital transformation in their processes. This is bringing about a lot of introspection and thought within these departments. And they're starting to look at their next 10-year portfolio of tools. And they're looking to buy ahead of their ability to plan and execute some of these infrastructure projects. We are absolutely seeing that early activity with regards to our relationship with large firms like AECOM that engage in the infrastructure and how they're going to engage over the next 10 years and Departments of Transportation that have similar challenges and similar needs over the next 10-year period, okay? So that's something we're seeing live. Now with regards to the Inflation Reduction Act, the jury is out on that, all right? Anything that drives energy efficiency and sustainability is ultimately going to trickle down into what the requirements are for some of our customers, especially when electrification is becoming so important. So you're going to see a lot more electrification and efficiency spec for our customers. But unclear where that will fall with regards to impact on our business.
Adam Borg: That's great. And maybe just a quick follow-up, even on Matt's question on Fusion 360. Just on manufacturing more broadly, we'd love to hear more about Upchain and how that fits in the broader strategy you've been talking about here with Fusion 360 today? Thank you guys.
Andrew Anagnost: Yeah. So Upchain is the data management layer that's cloud-native that allows us to actually not only manage the flow of Fusion information environment but any other heterogeneous data that might exist in the environment. All of our customers live in a heterogeneous world. We will never have a customer that is uniformly using just an Autodesk product or just Autodesk's portfolio. So not only does Upchain bring us cloud-native data management, but it also brings us heterogeneous management of this data and the ability to manage this flow and reconcile things in the cloud, which has huge power for how people use data management in the future. If you look at the evolution of Upchain, it's going to more and more just merge with some of the Fusion life cycle and Fusion managed capabilities we already have and will become the native cloud data management platform for Fusion. So that's where Upchain plays. It's basically a deep and wide native data management platform in the cloud for us.
Adam Borg: Excellent. Thanks again.
Andrew Anagnost: You're very welcome.
Operator: Thank you. Our next question comes from Joe Vruwink of Baird. Your question please, Joe Vruwink.
Joe Vruwink: Great. Thank you. I guess, I'll stick on manufacturing because I think to get 16% growth there; the desktop products have to be contributing at a pretty high level. What's been the driver of success there? And then you shared an interesting anecdote just in automotive and seeing broader usage. How much can that same playbook be used in process or some of your other discrete sectors where you have exposure?
Andrew Anagnost: Yes. So you picked up on something, we're growing faster than any of our competitors, so we continue to take share in manufacturing. And yes, you're right, it's our whole portfolio that's continuing to grow the share in manufacturing. And why is that? So there's a couple of reasons. One, we keep introducing new technologies, all right? And we bring these new technologies to our customers in a way that if you buy the present, you get the future, right? So if you're buying and better, you get Fusion. And that allows you to not only feel good about the product you're using today but know that you're hooked up to where the company is going over the next five to 10 years. And I think that's a real competitive advantage for us in terms of how we bring technology to market. But you're also seeing us blend new types of technologies into the workflows that our customers are trying to do in automotive and other places. I think one of the things that was interesting about what I said in my opening commentary was the blending of both The Wild and VRED, which is -- The Wild was a very early acquisition and then we have VRED, which is an existing mature technology. People are exploring the intersections of various technologies that we have. And you've probably picked up on the fact that our strength in manufacturing has extended more into facilities management with large manufacturers and looking to manage their actual factory assets. So there's overlap associated with those things and there's some overlap with our AEC business with regard to that. But those are the things that are driving our growth in manufacturing. You're right, it's the whole portfolio. The whole portfolio is moving forward and you're also seeing obviously tremendous growth with Fusion, right? We have to maintain that. We like what we see, but customers like what we're doing.
Joe Vruwink: Okay, that's great. And then just trying to put the pieces together with guidance. So you're raising the organic forecast by a bit. This still sounds like it assumes the same underlying macro assumptions. So ultimately, it's Autodesk's execution that's driving the organic raise. I guess what is the driver of better-than-expected performance there?
Debbie Clifford: Ultimately, it is about execution but it's the momentum in the business that we saw, particularly as we exited Q2. So here's how we're thinking about guidance. We had that slight lead in Q2. But of course, we kept our full year guidance flat now at the currency headwinds. The guidance does reflect the demand environment that we saw as we exited Q2. That's consistent with what we've done with previous quarters. The business continues to perform strongly. We have that resilient subscription business model, which is durable during a potential economic downturn and we exited Q2, as I said, with strong momentum. So these are all the factors that are baked into our guidance. I also want to point out that we did retain a range of $50 million on revenue. That gives us some flexibility, especially with that subscription business model, which is more predictable and a significant portion of our future revenue is already on the balance sheet.
Joe Vruwink: Great. Thank you.
Operator: Thank you. Our next question comes from Jason Celino of KeyBanc Capital Markets. Jason Celino, your line is open.
Jason Celino: Great, thanks. It's good to hear the strong bidding activity through BuildingConnected. With customer backlogs still lengthened and these hiring challenges that you keep hearing about, is there any change to the lead time on the projects being bid on? I guess what I'm asking is, is the strong activity you're seeing for next year, following year, how does that kind of pan out?
Andrew Anagnost: You know what, that is an excellent question. I'm not sure I can answer it in a satisfying way. But here's what I will say. Current bidding activity is a predictor of future build activity, right? Bidding with contractors and other things is an early process in actually executing a project. So when you see an increase in bid activity on BuildingConnected, what you're actually seeing is an increase in the book of business of projects that will actually get executed downstream, right? So this is a good predictor of ongoing activity as you close a bid, you actually then move into execution with that particular subcontractor and some of the things associated with that. So it does give us a forward indication of how much site activity is going to be happening and how much actual real building is going to be going on. And that's one of the reasons why we highlighted one of the reasons we value that connection to the bid activity so much. Not exactly what you asked but that's the depth that I can answer at this point.
Jason Celino: Okay, perfect. And then on Innovyze, I think you mentioned it kind of in one deal in your prepared remarks, but how is it performing? Any change to win rates since you've acquired it? And then I think at some point, there was going to be some sort of subscription effort transition for the existing base. Any worthwhile update there?
Andrew Anagnost: Yes. So Innovyze continues to perform well. It's doing particularly well in terms of our EBA businesses. A lot of our enterprise business agreement customers are looking to incorporate Innovyze into their contracts with us, which is exactly one of the big synergies we expected when we acquired Innovyze. They have begun their business model transformation. They're in the throes of that right now. It's going quite well. We expect to finish that in a reasonable amount of time. So that's going quite well. But the business is doing well, and we continue to get a lot of interest not only in water in general from our customers, but also in the owner side of Innovyze where they're building solutions that actually manage the operation of the water facilities.
Jason Celino: Perfect. Thanks Andrew.
Andrew Anagnost: Thank you, Jason.
Operator: Thank you. Our next question comes from Michael Funk of Bank of America. Michael Funk, your line is open.
Michael Funk: Yeah. Thank you for the question this evening. A couple if I could. Just back to the comments of the uniformity of products as you move to a platform or saying you don't want to tip your hand here. But how heavy of a lift is this? And what is the timing involved? And then in addition to the increased attractiveness for customers, are there efficiencies that will accrue to Autodesk as well by adding more uniformity across the platforms?
Andrew Anagnost: Yeah. So first off, let's be super clear. This isn't something that we're just suddenly starting out of the blue, right? It's been going on for quite some time in various forms. It is the most mature in its journey in the manufacturing space with what we're doing with Fusion 360. And that gives you a lot of visibility to what happens and how the portfolio is consolidated over time. A lot of capabilities that exist as separate products have shown up as extensions and native capabilities in the Fusion environment. And that absolutely gives us long-term synergies where we're building on one environment versus trying to support the multiple products and their multiple needs. So you actually do get a lot of synergies. Right now, of course, we're double spending on a lot of things and we will double spend for some time. But the journey is not new to us. Fusion is quite mature. AEC is beginning its journey, seated with some of the cloud-native acquisitions we did particularly around what we did with Spacemaker, a team that has been very much focused on the future of how people do building information model on a cloud platform, building information modeling on a cloud platform. And we have other things that we'll be showing up in the media and entertainment space, again not wanting to tip my hand for some of the discussions we'll have later. But yes, there are long-term synergies here. We are absolutely and will continue to double spend for a period of five to 10 years on some of these. Products overlap for a long time. We've been through several transformations of products, AutoCAD and Revit, Mechanical Desktop and Adventure in the past for those of you who are familiar with some of those names. And yes, the overlap takes a while, but eventually what happens is most of the engineering effort and capability goes to the new platform and we evolve away in that direction.
Michael Funk: Understood, yeah. Long-term complex project. And then the earlier comments on the delay and shift to annual billing. Just want to make sure I completely understood. Was the comment that you wanted to make sure that the processes were better than they are now and the back office is better than it is right now? And if that's correct, I guess what were the issues that you were seeing that you wanted to streamline just to make that a more enjoyable process for the customers?
Debbie Clifford: Yeah. So first, let's level set on our intention to move from a multiyear upfront annual billings was always intended to start at the beginning of next year. So that's not any change that we've made on our side. And the reason why we did that was two-fold; one, we needed to invest in our back-office systems infrastructure to make sure that we could execute on this transition at scale in an automated way, such that our customers would have a good customer experience, and we would have the controls and automated processes in place that we need in our back office. So that's point number one. Maybe more importantly is point number two. Our partners are a really important part of our ecosystem. And so it was important to us to give them advanced notice, getting back to our last Investor Day, that we intended to embark on this journey so that we could work together with them to build the program, the policies and all the things that we needed to do to make sure that they were along with us on the journey and that the entire ecosystem benefits from the shift to annual billings because just like it will be predictable for us to have an annual billing cycle, so too will it be for our customers and our partners. But our partners needed time to plan. And so we wanted to make sure that we were collaborating with them in a healthy way as we move towards this transition.
Michael Funk: Yes, that’s pretty helpful color. Thank you.
Operator: Thank you. Our next question comes from Bhavin Shah of Deutsche Bank. Bhavin Shah, your line is open.
Bhavin Shah: Andrew, we continue to hear very good things about BIM Collaborate Pro within the architecture and engineering customer base. Can you maybe better help us understand where we are in terms of adoption of Collaborate Pro within like the Revit customer base? And how we should think about the adoption curve going forward?
Andrew Anagnost: Yes. It's an excellent question. Look, it's still actually really early. I mean, BIM Collaborate Pro continues to grow robustly. As you recall, when we were -- during the pandemic, we saw quite a surge in the adoption of that product, and the adoption of it has continued post the pandemic period as more and more people become aware of the capabilities of BIM Collaborate Pro. In terms of total penetration into the Revit base, it's still really early days in terms of penetrating the vast majority of the Revit base. In fact, interestingly enough, one of the biggest requests we get is to make BIM Collaborate Pro work as robustly with Civil 3D as it does with Revit. And that's something that we're addressing, which is another vector where Collaborate Pro is going to be able to penetrate the infrastructure space as well. Still really early days though in total penetration of the Revit base. Continues to grow. It's an on-ramp to digital preconstruction and Autodesk Construction Cloud in many ways. And we're really happy with the way customers are adopting that. It was one of the unexpected silver linings of the turmoil and tragedy of the pandemic that customers finally realize that, that is a utility that is valuable to them now and in the future.
Bhavin Shah: Makes a ton of sense. And I guess along those lines and you kind of intimated at this a little bit, like in terms of adoption here, have you seen that accelerate customers' journeys towards some of your other cloud-based solutions that you guys offer?
Andrew Anagnost: Yes. It absolutely does. It's a -- I hesitate to call it an on-ramp to our full portfolio of cloud solutions. But what it does is it gives customers a lot of confidence in how the cloud actually changes their processes. They actually start to understand that, wow, this isn't just better. It's actually different and better. And it allows them and empowers them and encourages them to explore some of the other capabilities. Oh, maybe I should be doing a preconstruction planning in the cloud. Oh, if I'm doing preconstruction planning in the cloud, I should be doing online site management in the cloud as well. So it absolutely demystifies the cloud for them and shows some of the core benefits. It really does educate a lot of our customer base on why the cloud matters and why it's so important to their distributed and highly collaborative future.
Operator: We'll go to our next question, which comes from the line of Gal Munda of Wolfe Research. Gal Munda, your line is open.
Gal Munda: Thank you for taking my question. And maybe, Andrew, just for you to start. You are calling out the noncompliant users again, and it seems like you're running roughly at a run rate that you were pre-pandemic again. How much of that is just having a Flex model as well being able to go more effectively towards your accounts that already pay you but maybe not pay enough and now you have a tool in order to monetize that? And maybe just how big Flex could be in the future as you embark on that opportunity?
Andrew Anagnost: Yeah. So actually, Gal, you're picking up on something that was implied in the opening commentary that Flex is a highly valuable tool when you go and you reach the noncompliant users. In a lot of cases, what you're finding in a noncompliant usage situation is it's a multi-user situation gone bad, all right, where they've over-installed software or they've tried to use software in unlicensed ways. And what they're really trying to do is distribute usage, enable occasional usage and some of the things associated with that. Flex is an excellent way to walk into some of those accounts, and in a collaborative manner get them exploring other ways of engaging with Autodesk. And it absolutely will have some positive impacts on how we do license compliance business. Now as we look broadly at Flex, again, it's still really early days with Flex. We continue to see growth and we continue to see a lot of new users coming in with Flex. One of the growth vectors for Flex that I'm particularly excited about is in the long tail of our business. Because what Flex allows you to do, if you're in a smaller company, say you're in a five-person company and you want to occasionally use Revit for some of the projects you bid on, but the vast majority of your projects are AutoCAD or you want to engage in structural simulation for a particular product, the Flex model lets people dabble. It lets people engage with advanced functionality and advanced capabilities on a pay-per-use basis. And they don't have to commit to an annual subscription or a multiyear subscription to get some of these capabilities. So I think there's a lot of long-term growth capabilities built into the long tail of our business that Flex will likely unlock. The jury is still out. We're early on the journey so we'll see where that heads. That's one of the areas that I think is very interesting for Flex.
Operator: And as that is all the time we have for questions, I'd like to turn the call back over to Simon Mays-Smith for any closing remarks.
Simon Mays-Smith: Thanks, everyone, for joining us. We'll look forward to seeing, we hope, many of you at AU, Autodesk University, in a few weeks' time in New Orleans. I'm sure, I’m pronouncing the name correctly. Thanks, everyone. Thank you, Latif.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
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"speaker": "Operator",
"text": "Thank you for standing by, and welcome to Autodesk's Second Quarter Fiscal 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead."
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"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the second quarter results of our fiscal 2023. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew."
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"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome, everyone, to the call. Today, we reported record second quarter revenue, non-GAAP operating margin and free cash flow. End market demand remained strong during the quarter, resulting in robust new business activity. Renewal rates were again excellent. All of this and our strong competitive performance more than offset the direct and indirect impact of geopolitical, macroeconomic, policy and COVID-19 related factors. Growing commercial usage outside China, Russia and Ukraine, record bid activity on BuildingConnected and continued channel partner optimism leave us well-placed to achieve our FY 2023 goals. As I said last quarter, the structural growth drivers for our business that were critical to our performance during the pandemic, such as flexibility and agility, continue to support and propel us during this period of elevated uncertainty. These growth drivers further cement the important role we play in our customers' digital transformations and increase our confidence in our strategy. Our steady strategy, industry-leading products, platform and business model innovation, sustained and focused investment and strong execution are creating additional opportunities for Autodesk. By accelerating the convergence of workflows within and between the industries we serve, we create broader and deeper partnerships with existing customers and bring new customers into our ecosystem. In pursuit of these goals, we announced at Autodesk University last year that we were moving from products to platforms and capabilities and bringing these capabilities to any device anywhere through the cloud. Over the coming weeks, months and years, you will hear a lot more from us about our plans and progress to build a world-class customer experience, catalyze our customers' digital transformation and establish industry-leading platforms for design and make. As evidence of the progress we have made already, Fusion 360 flew past 200,000 subscribers during the second quarter and signed its first million-dollar contract, both important milestones and indications of the opportunities ahead. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives."
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"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. Q2 was a strong quarter across products and channels. Our end markets were broadly consistent with last quarter, with our strongest growth in North America and growth in Europe and APAC impacted by the war in Ukraine and COVID lockdowns in China. Total revenue grew 17%, both as reported and at constant currency. By product, AutoCAD and AutoCAD LT revenue grew 13%, AEC revenue grew 18%, manufacturing revenue grew 16% and M&E revenue grew 20%. By region, revenue grew 22% in the Americas, 15% in EMEA and 10% in APAC or 13% at constant currency. By channel, direct revenue increased 18%, representing 34% of total revenue while indirect revenue grew 16%. Our product subscription renewal rates remain strong, and our net revenue retention rate was comfortably within our 100% to 110% target range. Billings increased 17% to $1.2 billion, reflecting robust underlying demand. Total deferred revenue grew 12% to $3.7 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 13% and 10%, respectively, reflecting strong billings growth and, as we've highlighted in the last two quarters, the timing and volume of multiyear contracts, which are typically on a three-year cycle. Multiyear contract volume remained strong during the quarter, as expected and as you can see from the uptick in long-term deferred as a percent of total deferred. Turning to the P&L. Non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin increased by 5 percentage points to approximately 36%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margins increased by six percentage points to approximately 20%. We delivered record second quarter free cash flow of $246 million, up 32% year-over-year, reflecting strong billings growth in both Q1 and Q2. We continued our accelerated share repurchasing during the quarter. We purchased 1.4 million shares for $257 million at an average price of approximately $182 per share, which, when compared to last year, contributed to a reduction in our weighted average shares outstanding by approximately three million to 270 million shares. While our capital allocation strategy remains unchanged, you can expect that we will continue to invest organically and inorganically to drive growth. We've proactively used our strong liquidity to repurchase 3.5 million shares in the first half of this year, front-loading the offset of next year's dilution. Now let me finish with guidance. The underlying business conditions we've been seeing are broadly unchanged. As I mentioned earlier, we're seeing strength in North America and continued healthy growth in Europe and Asia, outside of Russia and China, due to the geopolitical situation in both regions, as well as the COVID lockdowns in China. Our renewals business continues to be a highlight, reflecting the ongoing importance of our software and helping our customers achieve their goals. As we look ahead and as with previous quarters, our fiscal 2023 guidance assumes that market conditions remain consistent for the remainder of fiscal 2023. The strengthening of the US dollar during the quarter generated slight incremental FX headwinds, which reduced full year billings, revenue and free cash flow by approximately $20 million, $5 million and $5 million, respectively. Bringing these factors together, the overall headline for guidance is that it is unchanged at the midpoint across all metrics, with the underlying momentum of the business offsetting those incremental FX headwinds. We are narrowing the fiscal 2023 revenue range to be between $4.99 billion and $5.04 billion. We continue to expect non-GAAP operating margin to be approximately 36% and free cash flow to be between $2 billion and $2.08 billion. The slide deck and updated Excel financials on our website have more details on modeling assumptions for Q3 and full year fiscal 2023. While the challenges our customers face are changing, the growth drivers underpinning our strategy have only been reinforced, which gives us confidence in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you."
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{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud based solutions that drive efficiency and sustainability for our customers. Our business is scalable and extensible into adjacent vertical, from architecture and engineering to construction and operations, from product engineering to product data management and product manufacturing. It is also scalable and extensible between verticals, with industrialized construction and into new workflows like XR. By accelerating the convergence of workflows within and between the industries we serve, we are also creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. For example, Kimley-Horn, one of the nation's premier planning and design consultants, expanded its EBA in Q2, broadening and deepening its long-standing partnership with Autodesk. In addition to increasing its utilization of Civil 3D and Revit and driving further operational efficiency gains through BIM and cloud collaboration, it also chose to expand use of Innovyze in its rapidly growing water practice to help drive more growth opportunities and productivity gains. As we highlighted last quarter, digital workflows are being adopted across the infrastructure life cycle from asset owners, architects and engineers to construction to drive improved efficiency and sustainability. The Indiana Department of Transportation, which was looking for an efficient solution to simplify its document management and field collaboration, is another good Q2 example. By adopting Autodesk Build and ACC Connect, it will improve communication and coordination throughout the construction process and streamline the documentation of citizen issues, resulting in less waste and more return per taxpayer dollar. Across construction, the industry continues to look to connect workflows from planning and design to preconstruction, construction and ultimately, operations and maintenance. And we are enabling our customers to connect those workflows on a single platform. For example, a commercial real estate and property management company focused on owners, investors and occupants was tired of having multiple platforms across the project life cycle, resulting in inconsistencies, rework and poor handoffs. In Q2, it adopted the full Autodesk Construction Cloud to connect preconstruction with project management. It added quantification estimating to building connected and BIM Collaborate Pro in preconstruction and Autodesk Build for project management to give themselves a competitive advantage and increase profitability to improved collaboration and data management. Across the globe, our customers seek to connect and streamline their construction workflows, and we are enabling and accelerating that through our partner network, launching Autodesk Build in new markets like Japan, enabling more data formats on more devices and delivering more value to our customers through account-based pricing. We're also giving our customers control of their data through Bridge, leveraging the power of machine learning to anticipate project risk and seamlessly connecting workflows like takeoff, estimating and budgeting to delight our customers and improve their productivity. With monthly active users growing more than 45% quarter-over-quarter, Autodesk Build is being rapidly adopted by existing and new customers to connect and streamline their construction workflows. Turning to manufacturing. We sustained strong momentum in our manufacturing portfolio this quarter as we connected more workflows beyond the design studio, developed more on-ramps to our manufacturing platform and delivered new powerful tools and functionality through Fusion 360 extensions. Customers continue to expand their adoption of the Fusion platform beyond design and engineering. This quarter, a US supplier of metal cutting tools chose to create a state-of-the-art collaboration tool on Fusion to enable its sales organization to demonstrate its digital manufacturing technology to customers. By enabling customer customization to be immediately reflected in factory manufacturing instructions, the tool will be a competitive advantage during the selling process. For Autodesk, it adds a significant new persona group to Fusion's addressable market opportunity. In automotive, we continue to grow our footprint beyond the design studio into manufacturing as automotive OEMs seek to break down the work silos and shorten the handoff and design cycles. For example, a top-tier commercial vehicle manufacturer renewed and increased its partnership with Autodesk as part of its strategic focus on building a sustainable product and service portfolio, which leverages new technologies and digital innovation to accelerate electrical vehicle solutions. In addition to Alias, which it already uses for surfacing work of all its vehicles, it is utilizing VR technology from the wild in combination with VRED and Navisworks to drive innovation and visualization from design and engineering through factory design. Our Fusion 360 platform approach enables customers to seamlessly connect workflows and push the boundaries of innovation through the advanced design and manufacturing technologies and extensions. For example, a global leader in seat manufacturing, which works with many major automakers worldwide, engaged Autodesk Consulting to develop a blended workflow across design, product engineering and manufacturing. The result was a seat that proves passenger comfort and safety while reducing the weight and number of parts. Using Autodesk design tools like Alias Conceptual Design and Fusion 360 thinner design, it was able to redefine the seat design with thinner seat sections and improved comfort and safety. Fusion 360's commercial subscribers grew steadily, ending the quarter with 205,000 subscribers and demand for our new extensions, including machining, generative design and nesting and fabrication continuing to grow at an exceptional pace. In education, engineering students are using Fusion 360 to learn the skills of the future in institutions like Grwp Llandrillo Menai, the largest further education college group in Wales. Students there are applying their studies to benefit local industry partners and businesses. For example, students recently used Fusion 360's cloud based data management and advanced 3D machining to help a local RV manufacturer improve its output by about 50%. The college is now planning to integrate Fusion 360 across its 11 campuses due to its ease of use, modern user interface, accessibility across devices and ability to collaborate on team projects and share data. And finally, we continue to bring more users into our ecosystem through business model innovation and license compliance initiatives. When one of our EMEA customers realized that some usage from its international offices was noncompliant, it needed time and data to better understand its users before purchasing subscriptions. By purchasing our first-ever 100,000-pack of Flex tokens, the customer gained instant access to Autodesk's portfolio of products and usage data to make informed decisions on its future subscription purchases while also opening up new competitive opportunities for Autodesk. During the quarter, we closed seven deals over $500,000 with our license compliance initiatives, three of which were over $1 million. Flex and Premium are also helping customers transition from multi-user to named user contracts. A leading supplier of concrete form work and scaffolding systems in Europe has been unifying internally around BIM to accelerate its digital transformation. It added Premium plan to its transitions and named trade-ins to centralize software management, enable user-based analytics and license optimization and benefit from single sign-on security. It can also purchase Flex token to cover its occasional user needs. Let me finish where I started. Strong demand and robust competitive performance delivered excellent Q2 results. Our subscription business continues to demonstrate its growth potential and resilience. By accelerating the convergence of workflows within and between the industries we serve, we are accelerating the digital transformation of our customers and creating broader and deeper partnerships with them. And by moving from products to platforms and capabilities and bringing those capabilities to any device anywhere through the cloud, we are expanding our opportunity horizon. Look for us to talk more about that over the coming weeks, months and years. We look forward to seeing many of you at Autodesk University in a few weeks. Operator, we would now like to open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Saket Kalia, your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hey, Andrew, hey, Debbie. Thanks for taking my questions here."
},
{
"speaker": "Andrew Anagnost",
"text": "How are you, Saket"
},
{
"speaker": "Saket Kalia",
"text": "Excellent, same here. Andrew, maybe first for you. Maybe we'll start to shift [Technical Difficulty] I wondered if you could expand a little bit on the comment around moving from products to platforms that we can all talk about [indiscernible] as the platform has evolved. But maybe you can just walk us through what that looks like in the future in terms of a platform from your perspective?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. I want to be careful not to give away all the AU tidbits in some of those discussions. But it's an important question. Saket, I -- to put it in perspective, right now, we sell literally hundreds of products. And the challenges for our customers is trying to find out which one of these products solve which problems for them and also the fact that a lot of these products don't talk to each other very easily. So when you're selling hundreds of products, it's really difficult to connect data flows across all those capabilities. It's also really difficult to uniformly deliver multi-platform support, multi-device support, cloud computing and AI automation, which is really challenging. So what we're doing is we're moving away from this kind of disconnected portfolio of products to really a set of platforms to target each one of our industries with some underlying core technologies that support all of it. That will enable us to actually deploy capabilities to our customers as they need them for particular types of process, right, advanced manufacturing capabilities on a time-bound basis or a consumption basis, accumulation capabilities on a time-bound basis or a consumption basis. So they get access to what they need, when they need it, and it's all unified from a data flow point of view. This is kind of going to be revolutionary for a lot of our customers in terms of the evolution and where we're taking them. So it's really valuable for our customers in terms of connecting how they work and the value they get from each one of our products. And it's really important to us in terms of delivering more layers of automation and power to them to the cloud. So it is a journey. It's not going to happen overnight, but Fusion is an excellent example of where we're going and how we could deploy some of these things to our customers, especially when you look at the way extensions work, consumption works on top of the Fusion platform. It's a good model for where we're taking industry platforms for each one of our industries."
},
{
"speaker": "Saket Kalia",
"text": "Got it, got it. That's really helpful. And it sounds like it will be exciting at AU. [Technical Difficulty] a follow-up for you. Can you just talk a little bit about the multiyear [Technical Difficulty] business? How are those renewals? I know they're starting to trickle in from three years ago in a bigger way. How are those renewals kind of coming in versus your expectations? And maybe looking forward, how do you plan on phasing that option out, I think, [Technical Difficulty]?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So we continue to track the multiyear cohort closely. Our proportional volume for multiyear has been in line with our expectations for the first half of fiscal 2023, so that gives us confidence in our fiscal 2023 outlook. We also saw long-term deferred revenue as a percent of total deferred revenue tick up. That, too, was in line with our expectations. As we look ahead to the transition from upfront to annual billings, well, it hasn't started yet. We anticipate that the transition's going to start in early fiscal 2024, and we continue to work through the programmatic and operational details to get there, things like a partner transition plan, back-office system upgrades. But I'll say again, it's our bias to go as quickly as possible. In the meantime, obviously, we're focused on closing out this year, making sure that those multi-years come in consistent with historical patterns. And the fact that they are is giving us that confidence as we look to achieve our goals for this year."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very clear. Thanks guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Phil Winslow of Credit Suisse. Phil Winslow, your line is open."
},
{
"speaker": "Phil Winslow",
"text": "Thanks for taking my question, and congrats on another quarter, reinforcing how Autodesk grows is simply not as cyclical anymore."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks Phil."
},
{
"speaker": "Phil Winslow",
"text": "Andrew, I just wanted to focus on the AEC side, because this is the area that I get the most questions on in terms of cyclicality, with two questions of my own for you. Firstly, what are you hearing from design customers in this segment about what continues to drive your incremental spending on Autodesk despite the cloudier macro? And then secondly, the 45% quarter-to-quarter growth in Autodesk Build MAUs in the slide deck and your commentary on just the BuildingConnected volumes also really stood out to us. Similarly, what are you hearing from these construction customers about why they also continue to lean in on digitizing their workloads in spite of the macro, or is this becoming because of the macro volatility that they're digitizing? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. That was a multi-part question. I will address it. So first off, let's talk about what we're hearing from design customers. The number one thing we're hearing from the design segment is the backlog of business, right? They have more business right now than they're able to effectively execute on. And the requirements of that business are increasing in terms of what kind of tools they need to use, how they need to approach the problems, owners, municipalities, all sorts of customers they deal with are putting more requirements on how they have to work. So they're all looking to up their game in digital tools. The biggest challenge we hear from these customers is hiring, frankly. We were hearing last year a lot of conversations about, oh boy, fixed bid contracts and inflationary pressures and all these things. As I've said previously, they bake these things now into their business bids and they're able to capture those costs in their contracts. But what they're struggling with is hiring. We're still growing even if they struggle to hire because they're getting people in but they have more demand for manpower and person power than they actually are able to capture at this point, okay? So that's something we're hearing really robustly. Now let's go to the growth in construction. First off, I want to give you my quarterly disclaimer. When you look at the construction business, the make number does not capture the full story in the construction business. The EBA growth is hidden in the design bucket. So when you count how we're doing with our enterprise business agreements and the overall territory business, that we grew close to 30% in that business. So that's really quite nice growth. And what we're hearing, and I'm glad you picked up on the 45% growth on monthly active users, we're hearing a couple of things. One, first off, we've lit up our territory business, our partners in the territory. This is driving a lot of really nice growth in the US and in Europe, and it's going to continue to drive that growth. And that's bringing us closer to certain customers lower down in the market, the mid-market and below, which I think is a really important point in our journey, okay. The other thing I want to talk about is when customers are starting to realize is they need a lot more than just a project management or a construction site management tool. They really are looking to their future, where they're trying to connect the design and the build all the way together continuously. And one of the big linchpins in all of that is preconstruction planning. The vast majority of the cost and complexity of a construction project is built in during the preconstruction planning phase. You get that wrong, you bid wrong, you come in with lower margins, you have more churn and complexity in your project. So this connection between design, preconstruction all the way to build is increasingly really important to their customers. So customers are taking a lot more time to evaluate what they're trying to invest in. And I think you also probably noticed, at least a little bit in the introductory commentary, that infrastructure is a big play for us here. So Department of Transportation, and you saw Indiana, the Indiana Department of Transportation lean into our portfolio for looking at their future needs. We're hearing more and more from Departments of Transportation that are really looking to upgrade and modify their stack to be much more designed to build on a much more modern cloud infrastructure. So there's a lot going on in construction, Phil, and it's coming at us from multiple directions, and right now, it's all positive."
},
{
"speaker": "Phil Winslow",
"text": "Awesome. Appreciate all the details. Thank you, and keep up the great work."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Phil."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Jay Vleeschhouwer, your line is open."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Good evening, Andrew, Debbie and Simon. Andrew, you have, by our calculation, the largest R&D budget in your peer group, but you don't necessarily have the largest headcount in R&D. And so the question is, particularly given your earlier comment about the large number of products that you're currently developing and having to manage, how you see or how are you working on improving your R&D productivity or effectivity, if you will, in terms of your core platform, your applications technology and ultimately, product usability to drive MAUs and further enlarging the installed base? And then for Debbie, you commented earlier with respect to your back-office as part of your initiatives over the next number of years. On that point, could you comment on where you are in terms of your operational capacity for the new licensing model and deliverables that you're going to have as you have an increasingly complex offering to customers in terms of Flex and everything else you're doing, the platform Andrew mentioned? Are you, in fact, going to have the requisite back office to handle all of that?"
},
{
"speaker": "Andrew Anagnost",
"text": "All right. So Jay, let me start with your questions. Yes, you are correct. We have the largest R&D budget but we don't necessarily have the largest headcount on R&D. Part of that is because of where we concentrate on R&D and what kind of talent we're pursuing. We're pursuing a lot of cloud talent, a lot of cloud-native talent, full staff development talent that allows us to build out the core cloud capabilities and continue to expand them. That talent resides in certain places, and it has certain costs associated with it and we think that's the right strategy. We don't hire a lot of R& D content headcount that's associated specifically with customer-specific development in, say, other parts of the world. So we do hire in specific areas because of what we're trying to do. And when it comes to developer productivity, you hit on a really important aspect of why do we have platform services? Why are we extending the depth and breadth of the things that we build in the platform services? One of the reasons we're doing that is to lift the burden away from some of these development teams on things like data flow, on things like visualization and capabilities that should be uniform across every platform or product that we -- or capability that we deploy. So more and more, as you see these -- the portfolio of platform capabilities not only mature but expand, it's going to increase the productivity of the teams that are looking at features that are facing particular industries and capabilities that are facing particular industries. It's a big part of why we have these services, and we're already starting to see some of those benefits, especially with regards to data flow, which is an initiative driven primarily by the platform organization within Autodesk. And it's being aligned across the various industries to make sure that we get the right kind of synergies and lift from our data APIs and our data connectivity. So yes, you will see increasing productivity associated with this. We're definitely spending on quality over quantity, and I think that's the right strategy for where we're at right now."
},
{
"speaker": "Debbie Clifford",
"text": "And then Jay, to answer your question about operational capacity for things like new business model, I would say that we are well on our way on this journey but we still have some ground to cover in order to be where we need to be. And I think that, that's an appropriate place to be at this stage of the journey. Now of course, we don't launch new business models without the ability to support them, which is why, as one example, we are delaying the shift to annual billings until next year, so that we can spend the time that we need to be able to invest in our back-office systems to make sure that we have a good customer experience and that we have the right controls and automated capabilities in the back office. I mean, ultimately, this is something that we focus on not only to make sure that we have the capacity to support new business models but also so we can scale. If we want to achieve our long-term growth aspirations, we need to continue to invest in our back-office infrastructure in order to be able to scale efficiently, effectively and in an automated way to do it."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thank you very much."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you Jay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Your question please, Matt Hedberg."
},
{
"speaker": "Matt Hedberg",
"text": "Hey, thanks guys. Andrew, for you, the growth in Fusion 360 was really fantastic to hear. Can you talk about where those subs are coming from? Are these greenfield? Are they replacements? And maybe just a little bit more on with a lot of alternatives, why Fusion 360?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So first half is a bit of a mix, all right? A lot of these are greenfield investors acquiring design software connected to connected to manufacturing software for the first time. But there's a lot of rip and replace going on. I think you've probably heard me talk many times about how we're going into accounts where people might have a seat of SOLIDWORKS and a seat of Mastercam or some kind of other CAM software and they're saying, well, Fusion is all I need. And we're -- we've been consistently creating and growing subscribers from that type of business. But what we're seeing more and more, and I think this is one of the things that is important about the user growth you're seeing, is that where we've gone in and we've started some department or part of a particular company, we're starting to grow the installed base within those companies. So we're still bringing in new customers, primarily along this design to make vector, but we're starting to grow within the accounts we've captured. This is the kind of flywheel you'd like to see as you start to mature a business, and we're starting to see some of that. The reason people buy is there is there's three kind of vectors here that people pay attention to: one, of course, is the price. The pricing model for Fusion is disruptive. It's native subscription-based. It's not a reimagining of an existing perpetual business. It's a native subscription-based business. It has extensions and things and consumptive models that allow people to pay for what they use and manage how much it costs from the use of software. They love that. Two, they love the design to make integration, the end-to-end integration from the design process all the way to actually programming and driving the machine on the shop floor. This kind of merger and convergence of design and make something that's really valuable to a lot of people. And the third thing might surprise you a little bit. It's our YouTube community. It's the amount of content that's out there on YouTube, which by the way, exceeds even much more mature products that are out there in the market, where people cannot only learn how to do something in Fusion, they can learn how to do it exceptionally in Fusion. It's a very passionate, very engaged and really very knowledgeable community that's publishing all this content. And people really buy for those reasons. They buy for the disruptive business model, they buy for the design make integration and they buy for the fact that they can find just a tutorial about just about anything you can think of to get really expert level in the product."
},
{
"speaker": "Matt Hedberg",
"text": "That's super, super helpful. And then Debbie, the consistency is obviously really good to see. The macro environment, this is not easy, clearly, but the consistency was great. I'm wondering if you could talk a little bit about the linearity in the quarter. And maybe what are you seeing thus far in August?"
},
{
"speaker": "Debbie Clifford",
"text": "So the linearity that we saw during the quarter is consistent with what we've seen in previous periods. I would say nothing newsworthy to report there. And obviously, at this point, we're not commenting on what we're seeing in August."
},
{
"speaker": "Matt Hedberg",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Borg of Stifel. Your line is open, Adam Borg"
},
{
"speaker": "Adam Borg",
"text": "Guys, and thanks so much for taking the question. Maybe just first for Andrew on the Infrastructure Bill. I know that's something we talked about in the past and the positive tailwinds that could have for Autodesk. So maybe just a quick update here. And then as I think about the recently passed Inflation Reduction Act, there's a lot of language in there about clean energy and sustainability. I'd love to hear how you think about that impacting Autodesk over time as well."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. And so first, let's talk about the Infrastructure Bill. As with any of these goals and like I've said in the past, the money is slowly trickling out, all right? And what you're seeing is people are actually starting to begin the process of planning around particular types of projects. But more importantly, what's happening is a lot of the recipients of some of these funds, particularly Departments of Transportation, are starting to rethink how they're approaching their design processes. And by the way, energy efficiency and sustainability play into how they think about some of these things. So remember, there was a seed money in that bill to enable Departments of Transportation to explore and expand digital transformation in their processes. This is bringing about a lot of introspection and thought within these departments. And they're starting to look at their next 10-year portfolio of tools. And they're looking to buy ahead of their ability to plan and execute some of these infrastructure projects. We are absolutely seeing that early activity with regards to our relationship with large firms like AECOM that engage in the infrastructure and how they're going to engage over the next 10 years and Departments of Transportation that have similar challenges and similar needs over the next 10-year period, okay? So that's something we're seeing live. Now with regards to the Inflation Reduction Act, the jury is out on that, all right? Anything that drives energy efficiency and sustainability is ultimately going to trickle down into what the requirements are for some of our customers, especially when electrification is becoming so important. So you're going to see a lot more electrification and efficiency spec for our customers. But unclear where that will fall with regards to impact on our business."
},
{
"speaker": "Adam Borg",
"text": "That's great. And maybe just a quick follow-up, even on Matt's question on Fusion 360. Just on manufacturing more broadly, we'd love to hear more about Upchain and how that fits in the broader strategy you've been talking about here with Fusion 360 today? Thank you guys."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So Upchain is the data management layer that's cloud-native that allows us to actually not only manage the flow of Fusion information environment but any other heterogeneous data that might exist in the environment. All of our customers live in a heterogeneous world. We will never have a customer that is uniformly using just an Autodesk product or just Autodesk's portfolio. So not only does Upchain bring us cloud-native data management, but it also brings us heterogeneous management of this data and the ability to manage this flow and reconcile things in the cloud, which has huge power for how people use data management in the future. If you look at the evolution of Upchain, it's going to more and more just merge with some of the Fusion life cycle and Fusion managed capabilities we already have and will become the native cloud data management platform for Fusion. So that's where Upchain plays. It's basically a deep and wide native data management platform in the cloud for us."
},
{
"speaker": "Adam Borg",
"text": "Excellent. Thanks again."
},
{
"speaker": "Andrew Anagnost",
"text": "You're very welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Joe Vruwink of Baird. Your question please, Joe Vruwink."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Thank you. I guess, I'll stick on manufacturing because I think to get 16% growth there; the desktop products have to be contributing at a pretty high level. What's been the driver of success there? And then you shared an interesting anecdote just in automotive and seeing broader usage. How much can that same playbook be used in process or some of your other discrete sectors where you have exposure?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So you picked up on something, we're growing faster than any of our competitors, so we continue to take share in manufacturing. And yes, you're right, it's our whole portfolio that's continuing to grow the share in manufacturing. And why is that? So there's a couple of reasons. One, we keep introducing new technologies, all right? And we bring these new technologies to our customers in a way that if you buy the present, you get the future, right? So if you're buying and better, you get Fusion. And that allows you to not only feel good about the product you're using today but know that you're hooked up to where the company is going over the next five to 10 years. And I think that's a real competitive advantage for us in terms of how we bring technology to market. But you're also seeing us blend new types of technologies into the workflows that our customers are trying to do in automotive and other places. I think one of the things that was interesting about what I said in my opening commentary was the blending of both The Wild and VRED, which is -- The Wild was a very early acquisition and then we have VRED, which is an existing mature technology. People are exploring the intersections of various technologies that we have. And you've probably picked up on the fact that our strength in manufacturing has extended more into facilities management with large manufacturers and looking to manage their actual factory assets. So there's overlap associated with those things and there's some overlap with our AEC business with regard to that. But those are the things that are driving our growth in manufacturing. You're right, it's the whole portfolio. The whole portfolio is moving forward and you're also seeing obviously tremendous growth with Fusion, right? We have to maintain that. We like what we see, but customers like what we're doing."
},
{
"speaker": "Joe Vruwink",
"text": "Okay, that's great. And then just trying to put the pieces together with guidance. So you're raising the organic forecast by a bit. This still sounds like it assumes the same underlying macro assumptions. So ultimately, it's Autodesk's execution that's driving the organic raise. I guess what is the driver of better-than-expected performance there?"
},
{
"speaker": "Debbie Clifford",
"text": "Ultimately, it is about execution but it's the momentum in the business that we saw, particularly as we exited Q2. So here's how we're thinking about guidance. We had that slight lead in Q2. But of course, we kept our full year guidance flat now at the currency headwinds. The guidance does reflect the demand environment that we saw as we exited Q2. That's consistent with what we've done with previous quarters. The business continues to perform strongly. We have that resilient subscription business model, which is durable during a potential economic downturn and we exited Q2, as I said, with strong momentum. So these are all the factors that are baked into our guidance. I also want to point out that we did retain a range of $50 million on revenue. That gives us some flexibility, especially with that subscription business model, which is more predictable and a significant portion of our future revenue is already on the balance sheet."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Celino of KeyBanc Capital Markets. Jason Celino, your line is open."
},
{
"speaker": "Jason Celino",
"text": "Great, thanks. It's good to hear the strong bidding activity through BuildingConnected. With customer backlogs still lengthened and these hiring challenges that you keep hearing about, is there any change to the lead time on the projects being bid on? I guess what I'm asking is, is the strong activity you're seeing for next year, following year, how does that kind of pan out?"
},
{
"speaker": "Andrew Anagnost",
"text": "You know what, that is an excellent question. I'm not sure I can answer it in a satisfying way. But here's what I will say. Current bidding activity is a predictor of future build activity, right? Bidding with contractors and other things is an early process in actually executing a project. So when you see an increase in bid activity on BuildingConnected, what you're actually seeing is an increase in the book of business of projects that will actually get executed downstream, right? So this is a good predictor of ongoing activity as you close a bid, you actually then move into execution with that particular subcontractor and some of the things associated with that. So it does give us a forward indication of how much site activity is going to be happening and how much actual real building is going to be going on. And that's one of the reasons why we highlighted one of the reasons we value that connection to the bid activity so much. Not exactly what you asked but that's the depth that I can answer at this point."
},
{
"speaker": "Jason Celino",
"text": "Okay, perfect. And then on Innovyze, I think you mentioned it kind of in one deal in your prepared remarks, but how is it performing? Any change to win rates since you've acquired it? And then I think at some point, there was going to be some sort of subscription effort transition for the existing base. Any worthwhile update there?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Innovyze continues to perform well. It's doing particularly well in terms of our EBA businesses. A lot of our enterprise business agreement customers are looking to incorporate Innovyze into their contracts with us, which is exactly one of the big synergies we expected when we acquired Innovyze. They have begun their business model transformation. They're in the throes of that right now. It's going quite well. We expect to finish that in a reasonable amount of time. So that's going quite well. But the business is doing well, and we continue to get a lot of interest not only in water in general from our customers, but also in the owner side of Innovyze where they're building solutions that actually manage the operation of the water facilities."
},
{
"speaker": "Jason Celino",
"text": "Perfect. Thanks Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Jason."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Michael Funk of Bank of America. Michael Funk, your line is open."
},
{
"speaker": "Michael Funk",
"text": "Yeah. Thank you for the question this evening. A couple if I could. Just back to the comments of the uniformity of products as you move to a platform or saying you don't want to tip your hand here. But how heavy of a lift is this? And what is the timing involved? And then in addition to the increased attractiveness for customers, are there efficiencies that will accrue to Autodesk as well by adding more uniformity across the platforms?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So first off, let's be super clear. This isn't something that we're just suddenly starting out of the blue, right? It's been going on for quite some time in various forms. It is the most mature in its journey in the manufacturing space with what we're doing with Fusion 360. And that gives you a lot of visibility to what happens and how the portfolio is consolidated over time. A lot of capabilities that exist as separate products have shown up as extensions and native capabilities in the Fusion environment. And that absolutely gives us long-term synergies where we're building on one environment versus trying to support the multiple products and their multiple needs. So you actually do get a lot of synergies. Right now, of course, we're double spending on a lot of things and we will double spend for some time. But the journey is not new to us. Fusion is quite mature. AEC is beginning its journey, seated with some of the cloud-native acquisitions we did particularly around what we did with Spacemaker, a team that has been very much focused on the future of how people do building information model on a cloud platform, building information modeling on a cloud platform. And we have other things that we'll be showing up in the media and entertainment space, again not wanting to tip my hand for some of the discussions we'll have later. But yes, there are long-term synergies here. We are absolutely and will continue to double spend for a period of five to 10 years on some of these. Products overlap for a long time. We've been through several transformations of products, AutoCAD and Revit, Mechanical Desktop and Adventure in the past for those of you who are familiar with some of those names. And yes, the overlap takes a while, but eventually what happens is most of the engineering effort and capability goes to the new platform and we evolve away in that direction."
},
{
"speaker": "Michael Funk",
"text": "Understood, yeah. Long-term complex project. And then the earlier comments on the delay and shift to annual billing. Just want to make sure I completely understood. Was the comment that you wanted to make sure that the processes were better than they are now and the back office is better than it is right now? And if that's correct, I guess what were the issues that you were seeing that you wanted to streamline just to make that a more enjoyable process for the customers?"
},
{
"speaker": "Debbie Clifford",
"text": "Yeah. So first, let's level set on our intention to move from a multiyear upfront annual billings was always intended to start at the beginning of next year. So that's not any change that we've made on our side. And the reason why we did that was two-fold; one, we needed to invest in our back-office systems infrastructure to make sure that we could execute on this transition at scale in an automated way, such that our customers would have a good customer experience, and we would have the controls and automated processes in place that we need in our back office. So that's point number one. Maybe more importantly is point number two. Our partners are a really important part of our ecosystem. And so it was important to us to give them advanced notice, getting back to our last Investor Day, that we intended to embark on this journey so that we could work together with them to build the program, the policies and all the things that we needed to do to make sure that they were along with us on the journey and that the entire ecosystem benefits from the shift to annual billings because just like it will be predictable for us to have an annual billing cycle, so too will it be for our customers and our partners. But our partners needed time to plan. And so we wanted to make sure that we were collaborating with them in a healthy way as we move towards this transition."
},
{
"speaker": "Michael Funk",
"text": "Yes, that’s pretty helpful color. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bhavin Shah of Deutsche Bank. Bhavin Shah, your line is open."
},
{
"speaker": "Bhavin Shah",
"text": "Andrew, we continue to hear very good things about BIM Collaborate Pro within the architecture and engineering customer base. Can you maybe better help us understand where we are in terms of adoption of Collaborate Pro within like the Revit customer base? And how we should think about the adoption curve going forward?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. It's an excellent question. Look, it's still actually really early. I mean, BIM Collaborate Pro continues to grow robustly. As you recall, when we were -- during the pandemic, we saw quite a surge in the adoption of that product, and the adoption of it has continued post the pandemic period as more and more people become aware of the capabilities of BIM Collaborate Pro. In terms of total penetration into the Revit base, it's still really early days in terms of penetrating the vast majority of the Revit base. In fact, interestingly enough, one of the biggest requests we get is to make BIM Collaborate Pro work as robustly with Civil 3D as it does with Revit. And that's something that we're addressing, which is another vector where Collaborate Pro is going to be able to penetrate the infrastructure space as well. Still really early days though in total penetration of the Revit base. Continues to grow. It's an on-ramp to digital preconstruction and Autodesk Construction Cloud in many ways. And we're really happy with the way customers are adopting that. It was one of the unexpected silver linings of the turmoil and tragedy of the pandemic that customers finally realize that, that is a utility that is valuable to them now and in the future."
},
{
"speaker": "Bhavin Shah",
"text": "Makes a ton of sense. And I guess along those lines and you kind of intimated at this a little bit, like in terms of adoption here, have you seen that accelerate customers' journeys towards some of your other cloud-based solutions that you guys offer?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. It absolutely does. It's a -- I hesitate to call it an on-ramp to our full portfolio of cloud solutions. But what it does is it gives customers a lot of confidence in how the cloud actually changes their processes. They actually start to understand that, wow, this isn't just better. It's actually different and better. And it allows them and empowers them and encourages them to explore some of the other capabilities. Oh, maybe I should be doing a preconstruction planning in the cloud. Oh, if I'm doing preconstruction planning in the cloud, I should be doing online site management in the cloud as well. So it absolutely demystifies the cloud for them and shows some of the core benefits. It really does educate a lot of our customer base on why the cloud matters and why it's so important to their distributed and highly collaborative future."
},
{
"speaker": "Operator",
"text": "We'll go to our next question, which comes from the line of Gal Munda of Wolfe Research. Gal Munda, your line is open."
},
{
"speaker": "Gal Munda",
"text": "Thank you for taking my question. And maybe, Andrew, just for you to start. You are calling out the noncompliant users again, and it seems like you're running roughly at a run rate that you were pre-pandemic again. How much of that is just having a Flex model as well being able to go more effectively towards your accounts that already pay you but maybe not pay enough and now you have a tool in order to monetize that? And maybe just how big Flex could be in the future as you embark on that opportunity?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So actually, Gal, you're picking up on something that was implied in the opening commentary that Flex is a highly valuable tool when you go and you reach the noncompliant users. In a lot of cases, what you're finding in a noncompliant usage situation is it's a multi-user situation gone bad, all right, where they've over-installed software or they've tried to use software in unlicensed ways. And what they're really trying to do is distribute usage, enable occasional usage and some of the things associated with that. Flex is an excellent way to walk into some of those accounts, and in a collaborative manner get them exploring other ways of engaging with Autodesk. And it absolutely will have some positive impacts on how we do license compliance business. Now as we look broadly at Flex, again, it's still really early days with Flex. We continue to see growth and we continue to see a lot of new users coming in with Flex. One of the growth vectors for Flex that I'm particularly excited about is in the long tail of our business. Because what Flex allows you to do, if you're in a smaller company, say you're in a five-person company and you want to occasionally use Revit for some of the projects you bid on, but the vast majority of your projects are AutoCAD or you want to engage in structural simulation for a particular product, the Flex model lets people dabble. It lets people engage with advanced functionality and advanced capabilities on a pay-per-use basis. And they don't have to commit to an annual subscription or a multiyear subscription to get some of these capabilities. So I think there's a lot of long-term growth capabilities built into the long tail of our business that Flex will likely unlock. The jury is still out. We're early on the journey so we'll see where that heads. That's one of the areas that I think is very interesting for Flex."
},
{
"speaker": "Operator",
"text": "And as that is all the time we have for questions, I'd like to turn the call back over to Simon Mays-Smith for any closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, everyone, for joining us. We'll look forward to seeing, we hope, many of you at AU, Autodesk University, in a few weeks' time in New Orleans. I'm sure, I’m pronouncing the name correctly. Thanks, everyone. Thank you, Latif."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 1 | 2,023 | 2022-05-26 17:20:00 | Operator: Thank you for standing by and welcome to Autodesk First Quarter Fiscal 2023 Earnings Call. [Operator Instructions] I would now like to hand the call over to your host, VP, Investor Relations, Simon Mays-Smith. Please go ahead.
Simon Mays-Smith: Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the first quarter results of our fiscal ‘23. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You will find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today’s press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon and welcome, everyone to the call. Today, we reported record first quarter revenue, non-GAAP operating margin and free cash flow fueled by strong demand and a robust competitive performance. The structural growth drivers for our business that were critical to our performance during the pandemic such as flexibility and agility continue to support and propel us during elevated macroeconomic, geopolitical, and policy uncertainty. These growth drivers further cement the important role we play in our customers’ digital transformation and increase our confidence in our strategy. Our steady strategy, industry-leading products, platform and business model innovation, sustained and focused investment, and strong execution are creating additional opportunities for Autodesk. By accelerating the convergence of workflows within and between the industries we serve, we create broader and deeper partnerships with existing customers and bring new customers into our ecosystem. A prime example of this is infrastructure. The combination of Revit, Civil 3D, Navisworks, Autodesk BIM Collaborate Pro, InfraWorks, and more recently Autodesk Construction Cloud and Innovyze delivers industry-leading end-to-end capabilities in transportation and water from planning and design to construction and operations. And our customers can extend those capabilities through our partnerships with Aurigo in capital planning and ESRI in geospatial mapping. This is important because governments and asset owners across the globe are investing growing amounts in next-generation infrastructure to meet the societal and environmental needs of the next century and are retooling now to do it. That equals opportunity for Autodesk. For example, in the first quarter, we signed our second largest EBA ever with a large global infrastructure company in a deal that included Innovyze and Autodesk Build for the first time. Across Autodesk, we are focused on unifying more common data and fluidly connecting more workflows in the cloud in ways that delight our customers and lead them to new, more efficient and more sustainable ways of working. And by doing that, we will move beyond carbon neutrality for ourselves to transform our customers’ carbon footprint. Together, we can design and make a better world for all that advances equitable access to the in-demand skills of the future. Before I turn the call over to Debbie to take you through the details of our financial performance and outlook, I want to update you on important decisions we made about our business in Russia. You will recall that the invasion of Ukraine occurred hours before our last earnings call. In light of the conflict, we halted all of our new and renewal business in Russia on March 3. We strongly believe this decision was the right thing to do and that it is in our long-term interest, even though it comes at a cost, which Debbie will detail in a moment. Of course, our immediate focus remains on the safety and well-being of our employees in the region, and we continue to monitor the situation closely. Beyond the immediate impact in Russia, other leading indicators trend positive. For example, usage remained steady in Europe during the quarter and grew in America and Asia-Pacific region; building connected bid activity again hit record levels; and our partner channel remains optimistic. The strong momentum sets us up well for the remainder of the year. Debbie, now over to you to take everyone through the details of our quarterly financial performance and guidance for the year. I will come back afterwards to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks Andrew. Q1 was a strong quarter driven by broad-based strength across products and regions. If we compare the revenue result versus guidance, the outperformance was due to that strength as well as the upfront revenue in a large EBA, which we had forecasted would close later in the year. Total revenue grew 18% and 17% in constant currency. By product, AutoCAD and AutoCAD LT revenue grew 21%; AEC revenue grew 17%; Manufacturing revenue grew 14%; and M&E revenue grew 24%. By region, revenue grew 24% in the Americas, 17% in EMEA, and 10% in APAC. Direct revenue increased 22% and represented 34% of total revenue, up 1 percentage point from last year due to strength in both enterprise and e-commerce. Our product subscription renewal rates remained at record highs and our net revenue retention rate was comfortably within our 100% to 110% target range. Billings increased 16% to $1.1 billion, reflecting robust underlying demand. Total deferred revenue grew 12% to $3.7 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 11% and 10% respectively, reflecting strong billings growth, and as I flagged last quarter the timing and volume of multiyear contracts, which are typically on a 3-year cycle. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin increased by 6 percentage points to approximately 34%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margins increased by 4 percentage points to approximately 18%. As Andrew mentioned, we delivered record first quarter free cash flow of $422 million, up 34% year-over-year, reflecting strong billings growth in both Q4 and Q1. With the broad equity market pullback in Q1 and our strong cash position, we again accelerated our share repurchasing during the quarter. We purchased 2.1 million shares for $436 million at an average price of approximately $212 per share, which contributed to a reduction in our weighted average shares outstanding of approximately $2 million. While our capital allocation strategy remains unchanged, you can expect that we will continue to invest organically and inorganically to drive growth. Over the last two quarters, we have proactively used our strong liquidity to accelerate repurchasing and will continue to be opportunistic in doing so when market conditions allow for it. Now, let me finish with guidance. The overall headline is that the underlying business conditions that we’ve been seeing are unchanged save for Russia and the continued strengthening of the U.S. dollar. Our business continues to perform well and to post top line growth ahead of our peers. As you can imagine, we are keeping a close eye on the geopolitical, macroeconomic, and policy environments. But against that backdrop in Q1, renewal rates remain strong; multiyear billings were in line with our expectations; and we exited the quarter with strong momentum. As we look ahead and as with previous quarters, we are assuming that market conditions in fiscal ‘23 are consistent with recent quarters. The decision to halt our new and renewal business in Russia had a direct impact on our outlook. Billings decreased by approximately $115 million, revenue by $40 million and free cash flow by $80 million. Of course, we are not satisfied with that outcome, and we will work hard to mitigate the impact by accelerating our channel evolution, customer retention and digital growth initiatives and by doubling down on early successes from recent acquisitions like Innovyze. Beyond Russia, the U.S. dollar continued to strengthen during Q1. While we benefit from a robust hedging program, the pace of FX volatility has been incredibly rapid, and it’s having an impact on our fiscal ‘23 outlook, reducing billings, revenue and free cash flow by approximately $80 million, $20 million and $50 million, respectively. Bringing these factors together, we expect fiscal ‘23 revenue to be between $4.96 billion and $5.06 billion. We expect non-GAAP operating margin to increase 400 basis points year-over-year to approximately 36%, reflecting 1 point of impact from removing Russia from our forecast. We expect free cash flow to be between $2.0 billion and $2.08 billion. The slide deck on our website has more details on modeling assumptions for Q2 and full year fiscal ‘23. The volatile global environment has reinforced the structural growth drivers underpinning our strategy give us confidence in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range, and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. Our business is scalable and extensible into adjacent verticals: from architecture and engineering, through construction and owners; from product engineering to product data management and product manufacturing. It is also scalable and extensible between verticals with industrialized construction and into new workflows like XR. By accelerating the convergence of workloads within and between the industries we serve, we are also creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. For example, in AEC, AECOM is the world’s most trusted infrastructure consulting firm that delivers professional services throughout the project lifecycle from planning, design and engineering, to program and construction management. With growing investment in infrastructure, customers are increasingly seeking both efficiency and sustainability to meet ESG goals such as net zero carbon, resiliency, quality of life, social impact and safety. This aligns AECOM and its customers closely with Autodesk’s values and capabilities. In Q1, AECOM renewed and increased its EBA with Autodesk. The renewal promotes further platform standardization and now extends from design further into build with the addition of Autodesk Construction Cloud and from bridges and tunnels to water with the addition of Innovyze. Across the globe, our customers are seeking to connect and streamline their workflows. As we enable our partner network to distribute Autodesk Construction Cloud, we serve more of that growing demand. For example, Bravida, which is based in Sweden, is a leading provider of technical end-to-end consulting design, installation and service solutions across the Nordic region, focusing on efficiency and sustainability. It is responsible for the installation of fire sprinklers, ventilation, electrics and safety systems in the tunnels of The Stockholm Bypass Project, the largest infrastructure project in Sweden’s history. Having adopted Autodesk’s AEC collection and realizing 50% cost savings and a significant reduction in carbon dioxide using Revit in the design phase of the project, Bravida was looking for a complementary system to seamlessly connect the build phase. Adopting Autodesk Build enable it to connect office and field data and workflows in the cloud, standardize and track projects accurately and manage procurement and logistics, health and safety and cost more effectively and efficiently. With the launch of Autodesk Build, the introduction of an account-based pricing business model, distribution through our channel partners and giving subcontractors the ability to have their own instance of their data, we are connecting more workflows, both within construction and between adjacent workflows in design, preconstruction and operations and maintenance. After evaluating various project management solutions for more than a year, Donohoe Construction Company, a top mid-market GC in Washington, D.C., chose Autodesk Build to seamlessly connect project, site and cost management workflows. Autodesk’s industry-leading cost management system, which is integrated into and included with Autodesk Build, is anticipated to enable Donohoe to control change order management and reporting much more seamlessly with its project and site management workflows. We are excited to partner with Donohoe to build a sustainable future together. We are investing in Autodesk Construction Cloud to do even more. For example, we launched Bridge to enable subcontractors to have their own instance of their data, a critical factor in improving their business processes. We are also rapidly integrating ProEst so that estimates can be pushed to the cost module in Autodesk Build, enabling it to automatically create a budget. With strong growth from Autodesk Build and the benefit of recently launched ACC bundles for preconstruction and construction operations, Autodesk Construction Cloud reported its best ever new business growth quarter, with an increasing proportion of that growth coming from EMEA and APAC and growing contract size and renewal rates. Turning to manufacturing, we sustained strong momentum in our manufacturing portfolio this quarter as we connected more workflows beyond the design studio, developed more on-ramps to our manufacturing platform, and delivered new powerful tools and functionality through Fusion 360 Extensions. As we connect and develop new workflows in the cloud and provide more ways for customers to use our products, we have the opportunity to renew engagement with some of our legacy customers. For example, a high-tech manufacturer in Germany, which has been using Autodesk software since 1991, was using Inventor software purchased in 2018. By updating from a perpetual license to a product design and manufacturing collection subscription in Q1, the team will benefit from significant process and performance improvements, which alleviate mechanical engineering bottlenecks and better serve its high demand periods. Because of its familiarity with Autodesk, the customer enabled these improvements immediately and leveraged its existing IP without migration. We are happy to have them back on our latest and most secure software. In automotive, we continue to grow our footprint beyond the design studio into manufacturing as automotive OEMs seek to break down work silos and shorten handoff and design cycles. Enovate Motors, an electric vehicle manufacturer in China, added product design and manufacturing collections on top of its Alias and VRED subscriptions to achieve a seamless digital workflow across design and manufacturing. Enovate will be able to build higher quality cars more efficiently by connecting workloads in the cloud that enable more collaboration and better data integrity. Our Fusion 360 platform approach enables customers to seamlessly connect workflows while also delivering powerful tools and functionality to those that needed through extensions. For example, an educational toy manufacturer based in the U.S. started using Fusion 360 about a year ago and quickly recognized the impact working on the cloud would have on its ability to collaborate across sites between product design and product engineering. Q1 was able to seamlessly activate manage, nesting and product design extensions within the Fusion 360 user interface, giving access to even more powerful tools and functionality to those that needed it. For example, the Fusion 360 Manage Extension unlocks additional data management functionality to manage design changes at any stage of production with the click of a button using pre-built workflows. Fusion 360’s commercial subscribers grew steadily, ending the quarter with 198,000 subscribers with demand for our new extensions, including machining, generative design and nesting and fabrication, continuing to grow at an exceptional pace. Outside of commercial use, our education partnerships are helping students learn the in-demand skills of the future. For example, Government Tool Room & Training Center, or GTTC, is a premier vocational institution in India, with 6,000 students across 28 campuses. Q1 GTTC adopted Fusion 360 and its tool and die making courses, because it was easy for students to learn, spanned the entire course from conceptual design through simulation to fabrication, and gave students hands-on experience with next generation workflows such as generative design, 3D printing for additive manufacturing and digital simulation and generation of G-code outputs. And finally, we continue to bring more users into our ecosystem through business model innovation and license compliance initiatives. BESIX is a multidisciplinary firm whose contracts in construction, infrastructure and machine works often have a high level of complexity. To support its standardization effort across all projects of regions, the BESIX group uses BIM Collaborate Pro and Docs to collaborate on Revit projects in a secure common data environment. For additional security and efficiency, it now leverages our premium plan in Flex. By better understanding its usage through the enhanced reporting functions within our premium plant, it can provide access to occasional users through Flex while realizing the additional security benefits of single sign-on across its global employee base. We continue to work with our customers to maximize their access to current and secure versions of our software. For example, an international research institution in Europe, which is both students and employees, was mistakenly using education subscriptions for commercial use cases. By partnering with their leadership, we ensured the relevant departments had access to the necessary tools by combining subscriptions to our industry collections with Flex tokens. The collaborative approach resulted in a compliance deal of over €1 million. During the quarter, we closed eight deals over $500,000 of our license compliances, two of which were over $1 million. Let me finish with the story. I recently visited the FUTURES exhibition at Smithsonian Institution in Washington. I highly recommend visiting if you are in the area this summer before it closes in mid-July. It is the Smithsonian’s first building-wide exploration of the future. Autodesk partnered with Smithsonian to create an interactive experience called Future Communities that brings visitors together to build a sustainable community block using analytics and goal-driven design with Autodesk generative design technology. Guests collaborate both with each other and AI, adjusting the input they deem most important. Each guest takes on a different persona with specific goals and input factors, which include social, ecological and economic considerations, ranging from availability of green space and low-carbon transportation to the reach of public services and employment opportunities. The evolving community block is displayed in real-time, and the technology showcases the types of trade-offs necessary to achieve various outcomes. The exhibit structure was generally designed to be strong and lightweight, using sustainable materials and modular space frame components that can be easily assembled and disassembled for minimum construction waste. The exhibit not only represents Autodesk vision of the future, that of collaborative and connected workflows and data in the cloud that designs and makes a better world for all, that meets the challenges posed by carbon, water and waste, and that advances equity and access to the in-demand skills of the future. But in addition, the exhibit represents a very diverse set of visions for how the future may unfold. The one thing they share is an unwavering sense of optimism about what we can all accomplish together. Every day, our goal is to empower innovators with design and make technology that turns their vision into reality, helping them to achieve the new possible. I share this story because it gives me great confidence in the future of Autodesk and our vision of a better world, design and made for all. Operator, we would now like to open the call for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from the line of Phil Winslow of Credit Suisse. Your line is open.
Phil Winslow: Thanks for taking my question, and congrats on a great strong start to the year. Now Construction Cloud delivered its best new business growth quarter ever. You signed your second largest EBA ever with an infrastructure company. And I loved obviously the example of a manufacturing vendor getting current moving to subscription from a lapsed perpetual license. But when you think about this, investors have been concerned about Autodesk’s exposure, specifically to these cyclical end markets and the potential impact to your business. However, the numbers you just report, the large deals you highlighted clearly don’t show this. So my questions are, what are you hearing from customers about why Autodesk is seeing sustained demand and what gives you confidence in the durability of these drivers?
Andrew Anagnost: Yes. So Phil, I think somebody wrote a report about us not being a cyclical business anymore. I can’t remember who it was.
Phil Winslow: [indiscernible] analyst, probably, yes.
Andrew Anagnost: Probably an incredibly bright analyst. So look, a couple of things happened in the quarter, and we’re projecting those forward through the year just consistently. And I think it’s important to kind of just talk about this notion of diversification not only of geographical spread of our business but disciplined spread and also business model spread, and I’ll talk about that on a couple of vectors . So first off, let’s just talk about what kind of highlighted in resiliency around our business. Throughout the quarter, the monthly active usage that we track regularly continued to strengthen throughout the entire quarter. It continued to strengthen right up to the end. Yes, we absolutely saw a pullback during the early part of the invasion of Ukraine in Europe, but that rebounded as the quarter progressed. So one, we have a strong demand environment, and we’re selling into that demand environment from multiple vectors, construction, infrastructure, and general building design as well as manufacturing. So we’re working across these things. And what was happening at the same time, and I think this is an important point about the underlying kind of health and resilience in our business, is even when we saw dips in our new business growth in Europe during – just as the invasion in the Ukraine started, which, by the way, recovered as the quarter progressed, renewal rates strengthened broadly. So we saw a broad strengthening in renewal rates. So that broad strengthening in renewal rate actually was able to offset some of the slowness in the new businesses. All of these things are things that we expect to see continue throughout the year and provide durability and stability for our business. Now, the U.S. was strong during the year as well. We did see some softness early on in APAC because it was most sensitive to the currency effects, but if you take out some of the COVID-effective regions like Japan and China, or just Japan specifically, we saw much higher growth rates in APAC than are indicated by the overall results. All of this is a balance between new business and offsetting impacts from renewal businesses. So between the diversity of – our geographic diversity where we’re kind of distributed across multiple spaces, the vectors of diversity we have around selling into infrastructure, construction, core design, manufacturing and the offsetting of really strong renewal rates – increasing renewal rates even in areas of weaker or at least some weakness in new business, that gives us confidence in terms of the durability for the rest of the year.
Phil Winslow: Awesome, thanks. Keep up the great work.
Andrew Anagnost: Thank you, Phil.
Operator: Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your question please.
Jay Vleeschhouwer: Good evening. Looking ahead into next year, first fiscal ‘24 cash flow, a question as to how you’re going to work with the channel to get through that? 5 or 6 years ago when you went through your first multiphase transition in the model, you were very conscientious about making sure you’ve got the channel through all the changes in terms of upfront, upgrades, maintenance, and so forth. And so, when you look into next year and beyond, how are you thinking about preserving or managing channel margins, their cash flow, their recurring revenue streams as you go through that valley of your own cash flow next year and then look through a rebound in fiscal ‘25? That’s the first question.
Andrew Anagnost: Yes. Alright. Okay. So let’s start with that, Jay. So first off, let’s just back up and talk about the high-level principle that we’re working towards here, right? We’re trying to move away from these upfront multiyear deals to annualized billings. None of us want this. We don’t like the way it creates a lumpiness in our cash flow. Frankly, our partners don’t like the way it creates the lumpiness in their cash flow as well, and they don’t like discounting to get multiyear upfront deals closed. So you look at this, we’re trying to create a more stable, reliable, and predictable cash flow build-out beyond – FY ‘24 and beyond. Okay. So yes, FY ‘24 will be the trough. But after that, we’re going to grow much more consistently double digits out and predictably moving forward, which is what we want, what you want. We can’t get there fast enough. And frankly, our partners can’t get there fast enough. So we do integrate programs to help them get there. One of the core programs here right now is we’re encouraging them to work with us on conserving some of that upfront cash they are going to be collecting because that’s cash flow directly into the partner’s pockets, alright? And then we do adjust for early on some of their back-end incentives to ensure that they can transition smoothly from a cash flow basis and continue to do – to work and support our business the way they have. So it’s not that different from what we’ve done previously. But you’re right, we have to support them through this dip. But once we’re all through this dip, it’s this nice predictable cash flow buildup that we all want and is going to create a stronger and more reliable business and more durable business. They like it. We like it. And we’re helping them through it.
Jay Vleeschhouwer: Okay. Thank you for that. Shorter-term question, you mentioned a couple of times so far on the call usage rate, which is always useful to hear about. Could you speak about that, Andrew, in terms of vertical or end markets? You spoke about it by geo and generally, but could you speak about it in terms of AEC including, in particular, ACC manufacturing and perhaps even what are you seeing in terms of standalone apps versus collection usage?
Andrew Anagnost: Yes. Here is what’s interesting, alright? And this is another one of these things that’s just really great about our portfolio is the increase in monthly active usage was broad-based. There wasn’t any particular place that was stronger or weaker than the other, all right? So we saw increases in monthly active usage of AutoCAD, Revit, Inventor, Fusion. And in fact, in Construction Cloud, we saw a 30% year-over-year increase in monthly active usage, which is a really nice surge on the Construction Cloud side. So there wasn’t any particular standout or holdout in those monthly active usage numbers. They really were broad across the spectrum. Now when you talk about collection usage, we don’t really look at it that way. I mean we just look at adoption with – adoption of the individual products. We don’t necessarily flag it according to a collection. But one thing we have consistently saw is multi-product usage continues to be robust in the collection environment. And actually, we’ve been slicing that data differently over time. So we got a better sense for how multi-product usage was moving forward. And it looks pretty solid. So the people who buy collections really are engaged in multi-product usage, but no hot spots or cold spots in terms of this monthly active usage growth geographic or industry-wise. I remember there was a slowdown when Russia invaded Ukraine, but it came back as the quarter progressed.
Jay Vleeschhouwer: Understood. Thank you, Andrew.
Andrew Anagnost: Thank you, Jay.
Operator: Thank you. Our next question comes from Saket Kalia of Barclays. Your line is open.
Saket Kalia: Okay, great. Hi, guys. Thanks for taking my questions here. Debbie, maybe I’ll start with you. Autodesk did 34% operating margin this quarter, great to see. The guide is for 36% for the year. I know we’re taking a point out of that for Russia. So it’s not a huge ramp through the year, but it’s a question that we get nonetheless. So I’m just wondering for everyone’s benefit, you could just go one level deeper into some of the moving parts around the margin expansion this year, particularly in this inflationary environment.
Debbie Clifford: Sure. Thanks, Saket. So before I say anything, I want to let all of you guys know that I have a terrible cold. I say this now because I know my voice sounds gravelly. So I just figured I’d be upfront about it, so there weren’t any questions. I also – I don’t want you to interpret my unusual sounding voice as a lack of enthusiasm. Unfortunately, it’s just a garden variety cold, not COVID that I’m struggling with. So anyway, just wanted to be upfront about it.
Saket Kalia: I appreciate that.
Debbie Clifford: On to your question, at the end of the day, the biggest driver of margin improvement over time is going to be revenue growth. And it’s that revenue growth combined with our continued discipline with spend that’s going to deliver that leverage. For this year’s guide, the ramp to 36% is a little less peak because of the impact to the top line that we saw from Russia, and we had that impact flow through to the margin. We think it’s important to continue to invest to further our strategy. We don’t want to be doing any kind of knee-jerk reaction on spend because of Russia. Yes, the inflationary pressures that you mentioned are there. We’re monitoring them closely. But right now, we feel it’s all manageable. I’d also point out that the margin target at 36% represents a 4 percentage point improvement year-over-year. So we’re delivering considerable operating margin leverage at our scale. As we progress through fiscal ‘23, we’re assuming a gradual improvement in margin as the revenue grows and as we continue to tightly manage our spend. That’s a similar pattern to what we saw in fiscal ‘22.
Saket Kalia: Got it. Very helpful. Andrew, maybe for you for my follow-up. Thanks for the macro commentary. Great to see the consistent renewal rates and the increase in monthly active users. I was wondering if you could just look at it from a different lens and wondering if you could just talk about your new business, sort of how that trended in Q1 qualitatively, of course? And how you’re thinking about that as part of the full year guide?
Andrew Anagnost: Yes. So the new business trended pretty consistently in the U.S. throughout the quarter. It trended fairly consistently in APAC throughout the quarter. There was a slowdown during the Ukrainian invasion at the beginning that recovered as the quarter progressed. And what we’re doing right now is we’re looking at those new business trends, and we’re essentially carrying them forward into the year, expecting it to continue at kind of similar levels as we go through the year. Obviously, we saw a complete evaporation of new business in Russia and some impact in Belarus. But like I said, Europe recovered after – shortly after the invasion progressed. So that’s the way we’re viewing these. That’s the way they played out throughout the quarter, and we’re assuming similar performance throughout the year.
Saket Kalia: Got it. Very helpful, guys. Thank you.
Andrew Anagnost: Thank you, Saket. Have a good one.
Operator: Thank you. Our next question comes from Adam Borg of Stifel. Your line is open.
Adam Borg: Great. Thanks so much for taking the question. Maybe just for Andrew, you spent a good – as a matter of time in your prepared remarks talking about infrastructure, including the largest EBA deal and just the breadth of your portfolio. So I’d love to just get an update on your conversations with the industry, how you’re thinking about the upfront or the existing infrastructure bill, latest thoughts on the impact to the industry and ultimately the impact of Autodesk, any such timing there?
Andrew Anagnost: Yes. So you probably read recently that no, not a lot of money has made it out yet. This is what we told you when the bill originally passed. It takes time for these things to make their way into the system. Most of our customers are in proposal mode right now. Departments of Transportation and other places are in proposal mode. Some grants have been awarded, and the money will start flowing soon. So we expect to see projects related to some of the infrastructure build spending to show up. We are particularly interested in the $100 million that’s being targeted to help departments and transportation drive digital technologies into their processes. And we’ve been talking to the Department of Transportation – the U.S. Department of Transportation on how best to kind of drive that into the DOT so that they can actually utilize that money to change their processes. But we haven’t seen a lot yet. But what we are seeing is customers like, for instance, what we saw with AECOM when their EBA renewals coming on, they are layering in construction cloud and infrastructure capability, specifically Innovyze in the AECOM deal to get ahead of some of this. Water is going to be a big deal in the infrastructure spending, and it’s showing up to be a big deal in a lot of places. I expect we’re going to see that trend continue as we head into some of the contracts actually getting awarded and the money actually flowing out of Washington, that people will buy, for instance, Innovyze on some of their renewals and some of their kind of deal discussions with us to get ahead of some of the things that they are probably going to be bidding on.
Adam Borg: That’s really helpful. And maybe just a real quick follow-up on the macro, obviously, you guys are very clear about the diversity of the strength that you’ve seen. And maybe I’ll just ask the diversity question slightly differently. In the past, you talked about a small end of the market, the mid-end and the larger end by different customer sizes, by employees or seats. I’m just curious, any differentiation you saw across the installed base, looking that way in terms of macro, both the installed base and new business there? Thanks again.
Andrew Anagnost: Yes. No significant differentiation, actually. The low end of the business held up quite well, actually. And we have a standard clip of new customer acquisition that we see just about every quarter to manage our business. It didn’t change. It held steady and the new customer acquisition, generally speaking, the customers that have never been in our database before, generally come from the low end of our business. So the low end held up well. You saw the high end held up well. There was some pressure with regards to people kind of growing their installs, net revenue retention rate. So new inside of existing accounts saw some pressure, but not a lot. And actually, that improved as well. So, no discernible strong difference worth noting between the various segments.
Adam Borg: Excellent. Thanks again for the time.
Operator: Thank you. Our next question comes from Matt Hedberg of RBC Capital Markets. Please go ahead.
Matt Hedberg: Great. Thanks, guys. Hey, Andrew, maybe for you first. Obviously, I think we all understand at least that this business is not as cyclical as Autodesk of old. And I think that’s clear through the subscription transition here. Now if the global economy works is slow, I just wanted to double-click on really the value of your subscriptions and why these renewal rates could be better than a lot of investors perceive even if there is a slowing.
Andrew Anagnost: Well, first off and foremost, they need these subscriptions to do their jobs, right. They have to – they need the software to build their – to do their book of business, right. And if you look at our customers and you talk to our customers, and I am sure you looked at some of the indicators and some of the things that are out there. Our customers have a fairly robust book of business. In fact, most of our customers are building up a backlog. And if you have a conversation with them, their biggest challenge right now is I can’t hire, I am having trouble hiring, materials aren’t showing up on time. Like I told you last year, they were likely to price inflationary pressure into their bids. So, it’s not so much that they are dealing with cost compression between bid price and cost price. It has a lot more to do with labor and access to the materials for delivery. None of them are talking about pulling back anytime soon because of the backlog they are seeing in their business. So, they need the software. They need it. They need it now. So, they are going to continue to renew this software in order to keep using it. And they are looking to hire more people. They just can’t find them right now.
Matt Hedberg: That’s super helpful. Thank you for that. And then, Debbie, we will see if your voice can hold up here. Obviously, a big year for multiyear renewals that ramps throughout the year, but I am wondering, was there anything that surprised you about billings duration in 1Q? And maybe how might that progress as the year unfolds?
Debbie Clifford: Hi. Thanks Matt. Nothing surprising, we continue, of course, to track the multiyear cohort closely. And the proportional volume that we have been seeing for multiyear was in line with our expectations for all of fiscal ‘22 and also in through Q1 of fiscal ‘23. So, that gives us confidence in our fiscal ‘23 outlook.
Matt Hedberg: Got it. Well done guys.
Operator: Our next question comes from Joe Vruwink of Baird. Your line is open.
Joe Vruwink: Great. Hi everyone. One thing that stood out this quarter was the accelerating growth from the partner channel. How much would you credit some of the recent initiatives like opening up Construction Cloud or being able to get in front of customers with some of the new commercial formats as opposed to just kind of the general trends in the business that you have been talking about?
Andrew Anagnost: Yes. That’s an excellent question. I can’t give you a particularly deep answer there. However, we did see significant growth in the partner channel with Construction Cloud, and we are starting to light up Construction Cloud in the channel, which is really important for us in terms of our mid-market expansion of that business. So, it probably had an effect on certain key partners. But to give you the exact detail about how much of that was related to new business within the channel versus their – the traditional business they are turning over, I can’t really give you an exact breakdown on that. Debbie, do we have any fidelity on that at all with regards to the channel business?
Debbie Clifford: Not at this point, I would say. I mean we saw broad-based strengths through the channel – through our channel partners during the quarter outside, of course, of Russia. And then that immediate slowdown that we talked about in Europe that then picked back up as we exited Q1. And we did see that momentum as we exited Q1. But I wouldn’t highlight anything specific. Certainly the success that we are seeing in Construction is helping. But remember, Construction, while it’s an explosive growth area for us, on the whole, it’s still a smaller part of our business. So, that strength is contributing to overall partner strength, but we are also seeing just broad-based strength through the core of our business as well.
Joe Vruwink: Okay. Great. And then I will ask another macro question. But can you maybe contrast the business environment we have been in late February onward? It sounds like, ultimately, trends have been good and stable. Contrast that with last fall. Obviously, inflationary pressures still around. They haven’t abated. We are layering on some incremental macro things, but it’s stability now as opposed to some moderation last fall, maybe differences or what you see is contributing to the stability more recently.
Andrew Anagnost: Yes. Well, if you remember back in the fall, I talked a lot about some of our customers being caught off-guard by the rapid inflation and supply chain difficulties. So some of our customers were on fixed bid contracts. And fixed bid contracts, when your cost of goods are going up, are really a serious issue for their businesses. So, their businesses were feeling a lot of pinch. Manufacturers were able to pass the cost through to their customers directly, AEC customers less so. So, manufacturers suffered more from some of the supply chain things. What you are seeing now is customers – they are not surprised by this. They know how to bid the contract. So, there is a general kind of bidding parity out there, and people are building in inflationary impacts into their bids and into their projects. So, that creates a much more stable environment for them with regards to having a book of projects that are – having their margins deteriorate rapidly and some that you want to get to that have better margins. So, what they are seeing right now is just a better spectrum of margins across the projects. That’s one key thing that contributes to the stability. Does that make sense?
Joe Vruwink: It does. Yes. Thank you.
Andrew Anagnost: And we fully expected them to do that.
Operator: Thank you. Our next question comes from Keith Weiss of Morgan Stanley. Your line is open.
Keith Weiss: Hi. Congrats and thanks for taking the question. Very nice quarter. Maybe following on that last question, really a two-parter. One, Debbie, when you are talking to us about the full year guidance, it seems like we are adjusting for currency. That’s just about it. It doesn’t sound like we are adjusting the forecast down for anticipation of any macro weakness or any further weakening of demand trends. So, one, I just wanted to clarify that side of the equation. And then two, if demand does weaken and you do see the macro impacts kind of catching up with all – in software land, what’s the reaction on sort of the spending side of the equation? Is the philosophy that we are looking to protect free cash flows, or is it the market opportunity is too big and we really need to keep investing for growth, and we are going to look to sustain and take advantage of your balance sheet to be able to sustain that investment and get ahead of your competitors? I am trying to understand kind of your philosophy on how you view potential demand slowdown. Thank you.
Debbie Clifford: Thanks. Keith, lots to unpack there. So, if I got lost a little bit as I go, please keep me on it. Let’s start with the guidance. The impact to the guidance that we are talking about today relates to FX and Russia. You said FX, but it also includes Russia. There is no change to the underlying business assumptions for the rest of our business, and that’s because we haven’t seen a change in the demand environment for the rest of our business. As a matter of fact, although we saw a bit of a slowdown focused mostly on Europe at the onset of the invasion of Ukraine, we saw a bounce back, and we really exited Q1 with momentum. And so that gives us confidence as we look to the rest of this year. And we have built into our guidance assumptions that reflect the demand that we saw as we exited Q1. And then when we think about margin, remember that with the subscription business model, we have a very resilient business model. Even with the adjustment to revenue for Russia, it was only about a point of our total revenue, we let that flow through to operating margins because we want to make sure that we are not doing any kind of knee-jerk reaction on spend. We think it’s important to continue to invest to make sure that we can further our strategy. I don’t think – I don’t see a scenario at this point where if the world – or the economy were to deteriorate even further that we would see substantial further pressure on operating margins because of that resilient business model. But of course, we are going to manage our business in the best way possible.
Andrew Anagnost: And this is absolutely the right time to invest in the business. When you are a business of our size with our resilience and our footprint, and you are up against smaller, less resilient, more challenged competitors, you invest. You invest. You pull ahead of the competition. You keep focused on the things you are trying to do. You expand your category leadership. You solidify category leadership in other places. We have got category leadership in 3D for BIM, which is a very important growth segment in AEC. We have got category leadership for design through Construction, in the Construction space, deals like deals like Bravida, AECOM, BESIX. These are all people trying to buy into this connected AI-driven cloud-based design through construction environment. That’s the category we are in, and we are kind of already the king. So, this is the perfect time to continue to invest. It helps you lap the competition. The competition will be able to invest to the same degree. I think this is not the time you pull back, right, especially given the underlying strength of our business. It’s solid. You can see it. We have got the multiple vectors of resiliency here and the kind of nice portfolio of options that we can leverage. I am definitely in a mindset that investment is good for us.
Keith Weiss: Got it. That’s super clear and long-term I think that makes sense.
Operator: Thank you. Our next question comes from Steve Koenig of SMBC Nikko. Your line is open.
Steve Koenig: Hey Andrew. Hey Debbie. Thanks for taking my question. Debbie, I have a cold, too, and it’s not COVID. So, we are in the same boat. So, hope you get better soon here. I wanted to – I may have missed it and apologize if I did. But can you give us a little more specifics on when you saw business start to bounce back in EMEA, was it right at the end of the quarter? Was it a week after? Was it a little before? And yes – and then I have got one more for you, Debbie.
Andrew Anagnost: Yes. Actually, it was fairly short-term after the initial invasion. It was within weeks, alright. It wasn’t like it was a long thing. It fell off. It slowed down a bit as the invasion started. And then within a few weeks, it was rising back up again and back up to where it had started. So, it didn’t take that long. It surprised us, honestly.
Steve Koenig: And was it – I was trying to parse your earlier statements. Was it kind of balanced between new business and renewals, or was it kind of more one or the other?
Andrew Anagnost: Renewal stayed strength – strong throughout the entire cycle, alright. So, renewals kept building as the quarter progressed. There was never a slowdown in renewal momentum. A matter of fact, if anything, it just kept strengthening and strengthening, alright. It was only in the new business part that we saw a slowdown post invasion that recovered. So, no, renewals just kept building.
Steve Koenig: Yes. Got it. Okay. Great. And then for my follow-up, and actually either of you are welcome to answer this as you see fit. So, you raised prices at the end of March, and I am sure that’s all embedded in your guidance. And it allows you to invest appropriately and get to the margins you want. How do you think about in this inflationary environment your internal compensation trajectory and also what you are doing with partners? And how does inflation affect your plans there? What do you have to tweak or finesse to – you have very high employee retention, you have very good rates. So, how do you maintain that? Thanks and I appreciate taking my questions.
Andrew Anagnost: Yes. So let me – because there is two questions there. First, let me comment on the price increases so that we are all on the same page here. The price increases were highly targeted to certain parts of the world where we had artificially suppressed the price below our long-term goal of having standard euro, U.S. and yen-denominated pricing. So, what you are seeing is, in certain places, we are raising prices to equalize so that we can get to this kind of standard-based pricing that simplifies some of our go-to-market practices. So, we had some artificially suppressed prices in regions, and that’s what was going on there, okay. It’s – there is no change in our standard pricing policy. In fact, places like Europe did not see a price increase, alright. So, I just want to be clear, we are all on the same page with regards to pricing and the things associated with that. Now, with regards to inflationary pressures and uncertainty in employment area [ph], but we are no different, alright. We see pressure in terms of employee compensation and trying to help our employees navigate an increasingly inflationary environment. We increased our raised pool. We increased our bonus this year. And equally important, we are increasing our stock-based compensation, and you will probably see us continue to increase our stock-based compensation for our employee base. So, these moves were made and baked into the year well ahead of the start of the year to ensure that we were able to meet our employees or at least try to meet our employees where they were at. But we will certainly continue to look at our pay position. We will probably continue to see some pressure there in terms of staying competitive. We are retaining employees at high rates. We will also continue to use stock-based compensation more robustly and more broadly within the organization, which we think is good for the company, good for investors and good for employees.
Steve Koenig: It sounds good. Thanks very much Andrew.
Operator: Thank you. Our next question comes from Bhavin Shah of Deutsche Bank. Your line is open.
Bhavin Shah: Great. Thanks for taking my questions and I will focus my question to Andrew and say Debbie both of course. Andrew, just hoping to get to the call, you noted the robust competitive performance during the quarter. Can you maybe just elaborate on this? What verticals or products are seeing better success or even improved win rates? And what’s driving some of this?
Andrew Anagnost: Yes. Well, it’s basically every sector. I mean every one of our industries, we are growing faster than our competitors, alright. So, we are taking share as we are selling more seats in some highly competitive industries. So, you are seeing us doing well in AEC. You are seeing us doing well in manufacturing, both on seat counts and revenue counts, which I think is really important because you want to watch both of those performances. We even did quite nicely in media entertainment year-over-year. So, we are absolutely seeing broad-based competitive performance. I mean obviously, one of the places that we all watch is Construction, too. In Construction, if you look at the kind of the raw make numbers, we grew 24% year-over-year. But you got to remember, some of that construction that make opportunity is actually in the EBAs, which are counted a design. So, when you look at our total make performance and taking that – those EBA impacts where we kind of put – make components into the EBAs, we grew into the mid-30s. And Construction Cloud monthly active usage grew slightly north of 30%. This is all great, solid competitive performance. AEC – Construction Cloud of its best new business growth quarter. International growth for Construction Cloud was significantly higher than its regular growth. We are lighting up the channel in the mid-market. We are kind of solidifying our category leader position in this design through construction position. Essentially, anybody else in this player – this space is kind of outside that category, they are very niche or there is being waiting for the industry to move on and move past them. So, I think we are in a very strong competitive position right now. I think it’s our job to continue to maintain that. But it was across all the industries we serve.
Bhavin Shah: Super helpful. And thanks for that color. And just one quick follow-up. It was really interesting to see that large EBA deal include Innovyze, and these are good things here as well. Where are you on your integration plans just with this solution? And where are you in terms of evolving the product set here? And how do we just think about the pipeline of customers who are looking to leverage some of your water-based products?
Andrew Anagnost: Yes. Look, we have made really great progress integrating Innovyze in. The company was fairly similar to us when we bought them. So, there is a lot of things that are rapidly getting integrated. Of course, there are some product integration pieces and some back-office systems that are still kind of working through some of the integrations. But in terms of integration, that’s not a barrier right now to where we are at with Innovyze. One of the things that’s exciting about what Innovyze does is it’s already kind of fulfill the end-to-end vision for water that we have for construction and manufacturing. It goes everywhere from design all the way to operate. And it has some fairly sophisticated cloud-based tools for water infrastructure operators, sewage treatment operators, other water infrastructure operators that allow them to actually manage the facilities once they have been put into operations. So, it’s a very robust solution. It covers a very broad piece of it, and it fits incredibly nicely into our portfolio, both story-wise, strategy-wise, and frankly, sales motion-wise.
Operator: And ladies and gentlemen, that is all the time we have for Q&A today. This concludes today’s conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by and welcome to Autodesk First Quarter Fiscal 2023 Earnings Call. [Operator Instructions] I would now like to hand the call over to your host, VP, Investor Relations, Simon Mays-Smith. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the first quarter results of our fiscal ‘23. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You will find the earnings press release, slide presentation and transcript of today’s opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today’s press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon and welcome, everyone to the call. Today, we reported record first quarter revenue, non-GAAP operating margin and free cash flow fueled by strong demand and a robust competitive performance. The structural growth drivers for our business that were critical to our performance during the pandemic such as flexibility and agility continue to support and propel us during elevated macroeconomic, geopolitical, and policy uncertainty. These growth drivers further cement the important role we play in our customers’ digital transformation and increase our confidence in our strategy. Our steady strategy, industry-leading products, platform and business model innovation, sustained and focused investment, and strong execution are creating additional opportunities for Autodesk. By accelerating the convergence of workflows within and between the industries we serve, we create broader and deeper partnerships with existing customers and bring new customers into our ecosystem. A prime example of this is infrastructure. The combination of Revit, Civil 3D, Navisworks, Autodesk BIM Collaborate Pro, InfraWorks, and more recently Autodesk Construction Cloud and Innovyze delivers industry-leading end-to-end capabilities in transportation and water from planning and design to construction and operations. And our customers can extend those capabilities through our partnerships with Aurigo in capital planning and ESRI in geospatial mapping. This is important because governments and asset owners across the globe are investing growing amounts in next-generation infrastructure to meet the societal and environmental needs of the next century and are retooling now to do it. That equals opportunity for Autodesk. For example, in the first quarter, we signed our second largest EBA ever with a large global infrastructure company in a deal that included Innovyze and Autodesk Build for the first time. Across Autodesk, we are focused on unifying more common data and fluidly connecting more workflows in the cloud in ways that delight our customers and lead them to new, more efficient and more sustainable ways of working. And by doing that, we will move beyond carbon neutrality for ourselves to transform our customers’ carbon footprint. Together, we can design and make a better world for all that advances equitable access to the in-demand skills of the future. Before I turn the call over to Debbie to take you through the details of our financial performance and outlook, I want to update you on important decisions we made about our business in Russia. You will recall that the invasion of Ukraine occurred hours before our last earnings call. In light of the conflict, we halted all of our new and renewal business in Russia on March 3. We strongly believe this decision was the right thing to do and that it is in our long-term interest, even though it comes at a cost, which Debbie will detail in a moment. Of course, our immediate focus remains on the safety and well-being of our employees in the region, and we continue to monitor the situation closely. Beyond the immediate impact in Russia, other leading indicators trend positive. For example, usage remained steady in Europe during the quarter and grew in America and Asia-Pacific region; building connected bid activity again hit record levels; and our partner channel remains optimistic. The strong momentum sets us up well for the remainder of the year. Debbie, now over to you to take everyone through the details of our quarterly financial performance and guidance for the year. I will come back afterwards to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks Andrew. Q1 was a strong quarter driven by broad-based strength across products and regions. If we compare the revenue result versus guidance, the outperformance was due to that strength as well as the upfront revenue in a large EBA, which we had forecasted would close later in the year. Total revenue grew 18% and 17% in constant currency. By product, AutoCAD and AutoCAD LT revenue grew 21%; AEC revenue grew 17%; Manufacturing revenue grew 14%; and M&E revenue grew 24%. By region, revenue grew 24% in the Americas, 17% in EMEA, and 10% in APAC. Direct revenue increased 22% and represented 34% of total revenue, up 1 percentage point from last year due to strength in both enterprise and e-commerce. Our product subscription renewal rates remained at record highs and our net revenue retention rate was comfortably within our 100% to 110% target range. Billings increased 16% to $1.1 billion, reflecting robust underlying demand. Total deferred revenue grew 12% to $3.7 billion. Total RPO of $4.7 billion and current RPO of $3.1 billion grew 11% and 10% respectively, reflecting strong billings growth, and as I flagged last quarter the timing and volume of multiyear contracts, which are typically on a 3-year cycle. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin increased by 6 percentage points to approximately 34%, reflecting strong revenue growth and ongoing cost discipline. GAAP operating margins increased by 4 percentage points to approximately 18%. As Andrew mentioned, we delivered record first quarter free cash flow of $422 million, up 34% year-over-year, reflecting strong billings growth in both Q4 and Q1. With the broad equity market pullback in Q1 and our strong cash position, we again accelerated our share repurchasing during the quarter. We purchased 2.1 million shares for $436 million at an average price of approximately $212 per share, which contributed to a reduction in our weighted average shares outstanding of approximately $2 million. While our capital allocation strategy remains unchanged, you can expect that we will continue to invest organically and inorganically to drive growth. Over the last two quarters, we have proactively used our strong liquidity to accelerate repurchasing and will continue to be opportunistic in doing so when market conditions allow for it. Now, let me finish with guidance. The overall headline is that the underlying business conditions that we’ve been seeing are unchanged save for Russia and the continued strengthening of the U.S. dollar. Our business continues to perform well and to post top line growth ahead of our peers. As you can imagine, we are keeping a close eye on the geopolitical, macroeconomic, and policy environments. But against that backdrop in Q1, renewal rates remain strong; multiyear billings were in line with our expectations; and we exited the quarter with strong momentum. As we look ahead and as with previous quarters, we are assuming that market conditions in fiscal ‘23 are consistent with recent quarters. The decision to halt our new and renewal business in Russia had a direct impact on our outlook. Billings decreased by approximately $115 million, revenue by $40 million and free cash flow by $80 million. Of course, we are not satisfied with that outcome, and we will work hard to mitigate the impact by accelerating our channel evolution, customer retention and digital growth initiatives and by doubling down on early successes from recent acquisitions like Innovyze. Beyond Russia, the U.S. dollar continued to strengthen during Q1. While we benefit from a robust hedging program, the pace of FX volatility has been incredibly rapid, and it’s having an impact on our fiscal ‘23 outlook, reducing billings, revenue and free cash flow by approximately $80 million, $20 million and $50 million, respectively. Bringing these factors together, we expect fiscal ‘23 revenue to be between $4.96 billion and $5.06 billion. We expect non-GAAP operating margin to increase 400 basis points year-over-year to approximately 36%, reflecting 1 point of impact from removing Russia from our forecast. We expect free cash flow to be between $2.0 billion and $2.08 billion. The slide deck on our website has more details on modeling assumptions for Q2 and full year fiscal ‘23. The volatile global environment has reinforced the structural growth drivers underpinning our strategy give us confidence in our long-term growth potential. We continue to target double-digit revenue growth, non-GAAP operating margins in the 38% to 40% range, and double-digit free cash flow growth on a compound annual basis. These metrics are intended to provide a floor to our revenue growth ambitions and a ceiling to our spend growth expectations. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. Our business is scalable and extensible into adjacent verticals: from architecture and engineering, through construction and owners; from product engineering to product data management and product manufacturing. It is also scalable and extensible between verticals with industrialized construction and into new workflows like XR. By accelerating the convergence of workloads within and between the industries we serve, we are also creating broader and deeper partnerships with existing customers and bringing new customers into our ecosystem. For example, in AEC, AECOM is the world’s most trusted infrastructure consulting firm that delivers professional services throughout the project lifecycle from planning, design and engineering, to program and construction management. With growing investment in infrastructure, customers are increasingly seeking both efficiency and sustainability to meet ESG goals such as net zero carbon, resiliency, quality of life, social impact and safety. This aligns AECOM and its customers closely with Autodesk’s values and capabilities. In Q1, AECOM renewed and increased its EBA with Autodesk. The renewal promotes further platform standardization and now extends from design further into build with the addition of Autodesk Construction Cloud and from bridges and tunnels to water with the addition of Innovyze. Across the globe, our customers are seeking to connect and streamline their workflows. As we enable our partner network to distribute Autodesk Construction Cloud, we serve more of that growing demand. For example, Bravida, which is based in Sweden, is a leading provider of technical end-to-end consulting design, installation and service solutions across the Nordic region, focusing on efficiency and sustainability. It is responsible for the installation of fire sprinklers, ventilation, electrics and safety systems in the tunnels of The Stockholm Bypass Project, the largest infrastructure project in Sweden’s history. Having adopted Autodesk’s AEC collection and realizing 50% cost savings and a significant reduction in carbon dioxide using Revit in the design phase of the project, Bravida was looking for a complementary system to seamlessly connect the build phase. Adopting Autodesk Build enable it to connect office and field data and workflows in the cloud, standardize and track projects accurately and manage procurement and logistics, health and safety and cost more effectively and efficiently. With the launch of Autodesk Build, the introduction of an account-based pricing business model, distribution through our channel partners and giving subcontractors the ability to have their own instance of their data, we are connecting more workflows, both within construction and between adjacent workflows in design, preconstruction and operations and maintenance. After evaluating various project management solutions for more than a year, Donohoe Construction Company, a top mid-market GC in Washington, D.C., chose Autodesk Build to seamlessly connect project, site and cost management workflows. Autodesk’s industry-leading cost management system, which is integrated into and included with Autodesk Build, is anticipated to enable Donohoe to control change order management and reporting much more seamlessly with its project and site management workflows. We are excited to partner with Donohoe to build a sustainable future together. We are investing in Autodesk Construction Cloud to do even more. For example, we launched Bridge to enable subcontractors to have their own instance of their data, a critical factor in improving their business processes. We are also rapidly integrating ProEst so that estimates can be pushed to the cost module in Autodesk Build, enabling it to automatically create a budget. With strong growth from Autodesk Build and the benefit of recently launched ACC bundles for preconstruction and construction operations, Autodesk Construction Cloud reported its best ever new business growth quarter, with an increasing proportion of that growth coming from EMEA and APAC and growing contract size and renewal rates. Turning to manufacturing, we sustained strong momentum in our manufacturing portfolio this quarter as we connected more workflows beyond the design studio, developed more on-ramps to our manufacturing platform, and delivered new powerful tools and functionality through Fusion 360 Extensions. As we connect and develop new workflows in the cloud and provide more ways for customers to use our products, we have the opportunity to renew engagement with some of our legacy customers. For example, a high-tech manufacturer in Germany, which has been using Autodesk software since 1991, was using Inventor software purchased in 2018. By updating from a perpetual license to a product design and manufacturing collection subscription in Q1, the team will benefit from significant process and performance improvements, which alleviate mechanical engineering bottlenecks and better serve its high demand periods. Because of its familiarity with Autodesk, the customer enabled these improvements immediately and leveraged its existing IP without migration. We are happy to have them back on our latest and most secure software. In automotive, we continue to grow our footprint beyond the design studio into manufacturing as automotive OEMs seek to break down work silos and shorten handoff and design cycles. Enovate Motors, an electric vehicle manufacturer in China, added product design and manufacturing collections on top of its Alias and VRED subscriptions to achieve a seamless digital workflow across design and manufacturing. Enovate will be able to build higher quality cars more efficiently by connecting workloads in the cloud that enable more collaboration and better data integrity. Our Fusion 360 platform approach enables customers to seamlessly connect workflows while also delivering powerful tools and functionality to those that needed through extensions. For example, an educational toy manufacturer based in the U.S. started using Fusion 360 about a year ago and quickly recognized the impact working on the cloud would have on its ability to collaborate across sites between product design and product engineering. Q1 was able to seamlessly activate manage, nesting and product design extensions within the Fusion 360 user interface, giving access to even more powerful tools and functionality to those that needed it. For example, the Fusion 360 Manage Extension unlocks additional data management functionality to manage design changes at any stage of production with the click of a button using pre-built workflows. Fusion 360’s commercial subscribers grew steadily, ending the quarter with 198,000 subscribers with demand for our new extensions, including machining, generative design and nesting and fabrication, continuing to grow at an exceptional pace. Outside of commercial use, our education partnerships are helping students learn the in-demand skills of the future. For example, Government Tool Room & Training Center, or GTTC, is a premier vocational institution in India, with 6,000 students across 28 campuses. Q1 GTTC adopted Fusion 360 and its tool and die making courses, because it was easy for students to learn, spanned the entire course from conceptual design through simulation to fabrication, and gave students hands-on experience with next generation workflows such as generative design, 3D printing for additive manufacturing and digital simulation and generation of G-code outputs. And finally, we continue to bring more users into our ecosystem through business model innovation and license compliance initiatives. BESIX is a multidisciplinary firm whose contracts in construction, infrastructure and machine works often have a high level of complexity. To support its standardization effort across all projects of regions, the BESIX group uses BIM Collaborate Pro and Docs to collaborate on Revit projects in a secure common data environment. For additional security and efficiency, it now leverages our premium plan in Flex. By better understanding its usage through the enhanced reporting functions within our premium plant, it can provide access to occasional users through Flex while realizing the additional security benefits of single sign-on across its global employee base. We continue to work with our customers to maximize their access to current and secure versions of our software. For example, an international research institution in Europe, which is both students and employees, was mistakenly using education subscriptions for commercial use cases. By partnering with their leadership, we ensured the relevant departments had access to the necessary tools by combining subscriptions to our industry collections with Flex tokens. The collaborative approach resulted in a compliance deal of over €1 million. During the quarter, we closed eight deals over $500,000 of our license compliances, two of which were over $1 million. Let me finish with the story. I recently visited the FUTURES exhibition at Smithsonian Institution in Washington. I highly recommend visiting if you are in the area this summer before it closes in mid-July. It is the Smithsonian’s first building-wide exploration of the future. Autodesk partnered with Smithsonian to create an interactive experience called Future Communities that brings visitors together to build a sustainable community block using analytics and goal-driven design with Autodesk generative design technology. Guests collaborate both with each other and AI, adjusting the input they deem most important. Each guest takes on a different persona with specific goals and input factors, which include social, ecological and economic considerations, ranging from availability of green space and low-carbon transportation to the reach of public services and employment opportunities. The evolving community block is displayed in real-time, and the technology showcases the types of trade-offs necessary to achieve various outcomes. The exhibit structure was generally designed to be strong and lightweight, using sustainable materials and modular space frame components that can be easily assembled and disassembled for minimum construction waste. The exhibit not only represents Autodesk vision of the future, that of collaborative and connected workflows and data in the cloud that designs and makes a better world for all, that meets the challenges posed by carbon, water and waste, and that advances equity and access to the in-demand skills of the future. But in addition, the exhibit represents a very diverse set of visions for how the future may unfold. The one thing they share is an unwavering sense of optimism about what we can all accomplish together. Every day, our goal is to empower innovators with design and make technology that turns their vision into reality, helping them to achieve the new possible. I share this story because it gives me great confidence in the future of Autodesk and our vision of a better world, design and made for all. Operator, we would now like to open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from the line of Phil Winslow of Credit Suisse. Your line is open."
},
{
"speaker": "Phil Winslow",
"text": "Thanks for taking my question, and congrats on a great strong start to the year. Now Construction Cloud delivered its best new business growth quarter ever. You signed your second largest EBA ever with an infrastructure company. And I loved obviously the example of a manufacturing vendor getting current moving to subscription from a lapsed perpetual license. But when you think about this, investors have been concerned about Autodesk’s exposure, specifically to these cyclical end markets and the potential impact to your business. However, the numbers you just report, the large deals you highlighted clearly don’t show this. So my questions are, what are you hearing from customers about why Autodesk is seeing sustained demand and what gives you confidence in the durability of these drivers?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Phil, I think somebody wrote a report about us not being a cyclical business anymore. I can’t remember who it was."
},
{
"speaker": "Phil Winslow",
"text": "[indiscernible] analyst, probably, yes."
},
{
"speaker": "Andrew Anagnost",
"text": "Probably an incredibly bright analyst. So look, a couple of things happened in the quarter, and we’re projecting those forward through the year just consistently. And I think it’s important to kind of just talk about this notion of diversification not only of geographical spread of our business but disciplined spread and also business model spread, and I’ll talk about that on a couple of vectors . So first off, let’s just talk about what kind of highlighted in resiliency around our business. Throughout the quarter, the monthly active usage that we track regularly continued to strengthen throughout the entire quarter. It continued to strengthen right up to the end. Yes, we absolutely saw a pullback during the early part of the invasion of Ukraine in Europe, but that rebounded as the quarter progressed. So one, we have a strong demand environment, and we’re selling into that demand environment from multiple vectors, construction, infrastructure, and general building design as well as manufacturing. So we’re working across these things. And what was happening at the same time, and I think this is an important point about the underlying kind of health and resilience in our business, is even when we saw dips in our new business growth in Europe during – just as the invasion in the Ukraine started, which, by the way, recovered as the quarter progressed, renewal rates strengthened broadly. So we saw a broad strengthening in renewal rates. So that broad strengthening in renewal rate actually was able to offset some of the slowness in the new businesses. All of these things are things that we expect to see continue throughout the year and provide durability and stability for our business. Now, the U.S. was strong during the year as well. We did see some softness early on in APAC because it was most sensitive to the currency effects, but if you take out some of the COVID-effective regions like Japan and China, or just Japan specifically, we saw much higher growth rates in APAC than are indicated by the overall results. All of this is a balance between new business and offsetting impacts from renewal businesses. So between the diversity of – our geographic diversity where we’re kind of distributed across multiple spaces, the vectors of diversity we have around selling into infrastructure, construction, core design, manufacturing and the offsetting of really strong renewal rates – increasing renewal rates even in areas of weaker or at least some weakness in new business, that gives us confidence in terms of the durability for the rest of the year."
},
{
"speaker": "Phil Winslow",
"text": "Awesome, thanks. Keep up the great work."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Phil."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your question please."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Good evening. Looking ahead into next year, first fiscal ‘24 cash flow, a question as to how you’re going to work with the channel to get through that? 5 or 6 years ago when you went through your first multiphase transition in the model, you were very conscientious about making sure you’ve got the channel through all the changes in terms of upfront, upgrades, maintenance, and so forth. And so, when you look into next year and beyond, how are you thinking about preserving or managing channel margins, their cash flow, their recurring revenue streams as you go through that valley of your own cash flow next year and then look through a rebound in fiscal ‘25? That’s the first question."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Alright. Okay. So let’s start with that, Jay. So first off, let’s just back up and talk about the high-level principle that we’re working towards here, right? We’re trying to move away from these upfront multiyear deals to annualized billings. None of us want this. We don’t like the way it creates a lumpiness in our cash flow. Frankly, our partners don’t like the way it creates the lumpiness in their cash flow as well, and they don’t like discounting to get multiyear upfront deals closed. So you look at this, we’re trying to create a more stable, reliable, and predictable cash flow build-out beyond – FY ‘24 and beyond. Okay. So yes, FY ‘24 will be the trough. But after that, we’re going to grow much more consistently double digits out and predictably moving forward, which is what we want, what you want. We can’t get there fast enough. And frankly, our partners can’t get there fast enough. So we do integrate programs to help them get there. One of the core programs here right now is we’re encouraging them to work with us on conserving some of that upfront cash they are going to be collecting because that’s cash flow directly into the partner’s pockets, alright? And then we do adjust for early on some of their back-end incentives to ensure that they can transition smoothly from a cash flow basis and continue to do – to work and support our business the way they have. So it’s not that different from what we’ve done previously. But you’re right, we have to support them through this dip. But once we’re all through this dip, it’s this nice predictable cash flow buildup that we all want and is going to create a stronger and more reliable business and more durable business. They like it. We like it. And we’re helping them through it."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thank you for that. Shorter-term question, you mentioned a couple of times so far on the call usage rate, which is always useful to hear about. Could you speak about that, Andrew, in terms of vertical or end markets? You spoke about it by geo and generally, but could you speak about it in terms of AEC including, in particular, ACC manufacturing and perhaps even what are you seeing in terms of standalone apps versus collection usage?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Here is what’s interesting, alright? And this is another one of these things that’s just really great about our portfolio is the increase in monthly active usage was broad-based. There wasn’t any particular place that was stronger or weaker than the other, all right? So we saw increases in monthly active usage of AutoCAD, Revit, Inventor, Fusion. And in fact, in Construction Cloud, we saw a 30% year-over-year increase in monthly active usage, which is a really nice surge on the Construction Cloud side. So there wasn’t any particular standout or holdout in those monthly active usage numbers. They really were broad across the spectrum. Now when you talk about collection usage, we don’t really look at it that way. I mean we just look at adoption with – adoption of the individual products. We don’t necessarily flag it according to a collection. But one thing we have consistently saw is multi-product usage continues to be robust in the collection environment. And actually, we’ve been slicing that data differently over time. So we got a better sense for how multi-product usage was moving forward. And it looks pretty solid. So the people who buy collections really are engaged in multi-product usage, but no hot spots or cold spots in terms of this monthly active usage growth geographic or industry-wise. I remember there was a slowdown when Russia invaded Ukraine, but it came back as the quarter progressed."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Understood. Thank you, Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Jay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Saket Kalia of Barclays. Your line is open."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hi, guys. Thanks for taking my questions here. Debbie, maybe I’ll start with you. Autodesk did 34% operating margin this quarter, great to see. The guide is for 36% for the year. I know we’re taking a point out of that for Russia. So it’s not a huge ramp through the year, but it’s a question that we get nonetheless. So I’m just wondering for everyone’s benefit, you could just go one level deeper into some of the moving parts around the margin expansion this year, particularly in this inflationary environment."
},
{
"speaker": "Debbie Clifford",
"text": "Sure. Thanks, Saket. So before I say anything, I want to let all of you guys know that I have a terrible cold. I say this now because I know my voice sounds gravelly. So I just figured I’d be upfront about it, so there weren’t any questions. I also – I don’t want you to interpret my unusual sounding voice as a lack of enthusiasm. Unfortunately, it’s just a garden variety cold, not COVID that I’m struggling with. So anyway, just wanted to be upfront about it."
},
{
"speaker": "Saket Kalia",
"text": "I appreciate that."
},
{
"speaker": "Debbie Clifford",
"text": "On to your question, at the end of the day, the biggest driver of margin improvement over time is going to be revenue growth. And it’s that revenue growth combined with our continued discipline with spend that’s going to deliver that leverage. For this year’s guide, the ramp to 36% is a little less peak because of the impact to the top line that we saw from Russia, and we had that impact flow through to the margin. We think it’s important to continue to invest to further our strategy. We don’t want to be doing any kind of knee-jerk reaction on spend because of Russia. Yes, the inflationary pressures that you mentioned are there. We’re monitoring them closely. But right now, we feel it’s all manageable. I’d also point out that the margin target at 36% represents a 4 percentage point improvement year-over-year. So we’re delivering considerable operating margin leverage at our scale. As we progress through fiscal ‘23, we’re assuming a gradual improvement in margin as the revenue grows and as we continue to tightly manage our spend. That’s a similar pattern to what we saw in fiscal ‘22."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very helpful. Andrew, maybe for you for my follow-up. Thanks for the macro commentary. Great to see the consistent renewal rates and the increase in monthly active users. I was wondering if you could just look at it from a different lens and wondering if you could just talk about your new business, sort of how that trended in Q1 qualitatively, of course? And how you’re thinking about that as part of the full year guide?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So the new business trended pretty consistently in the U.S. throughout the quarter. It trended fairly consistently in APAC throughout the quarter. There was a slowdown during the Ukrainian invasion at the beginning that recovered as the quarter progressed. And what we’re doing right now is we’re looking at those new business trends, and we’re essentially carrying them forward into the year, expecting it to continue at kind of similar levels as we go through the year. Obviously, we saw a complete evaporation of new business in Russia and some impact in Belarus. But like I said, Europe recovered after – shortly after the invasion progressed. So that’s the way we’re viewing these. That’s the way they played out throughout the quarter, and we’re assuming similar performance throughout the year."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very helpful, guys. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Saket. Have a good one."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Borg of Stifel. Your line is open."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks so much for taking the question. Maybe just for Andrew, you spent a good – as a matter of time in your prepared remarks talking about infrastructure, including the largest EBA deal and just the breadth of your portfolio. So I’d love to just get an update on your conversations with the industry, how you’re thinking about the upfront or the existing infrastructure bill, latest thoughts on the impact to the industry and ultimately the impact of Autodesk, any such timing there?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So you probably read recently that no, not a lot of money has made it out yet. This is what we told you when the bill originally passed. It takes time for these things to make their way into the system. Most of our customers are in proposal mode right now. Departments of Transportation and other places are in proposal mode. Some grants have been awarded, and the money will start flowing soon. So we expect to see projects related to some of the infrastructure build spending to show up. We are particularly interested in the $100 million that’s being targeted to help departments and transportation drive digital technologies into their processes. And we’ve been talking to the Department of Transportation – the U.S. Department of Transportation on how best to kind of drive that into the DOT so that they can actually utilize that money to change their processes. But we haven’t seen a lot yet. But what we are seeing is customers like, for instance, what we saw with AECOM when their EBA renewals coming on, they are layering in construction cloud and infrastructure capability, specifically Innovyze in the AECOM deal to get ahead of some of this. Water is going to be a big deal in the infrastructure spending, and it’s showing up to be a big deal in a lot of places. I expect we’re going to see that trend continue as we head into some of the contracts actually getting awarded and the money actually flowing out of Washington, that people will buy, for instance, Innovyze on some of their renewals and some of their kind of deal discussions with us to get ahead of some of the things that they are probably going to be bidding on."
},
{
"speaker": "Adam Borg",
"text": "That’s really helpful. And maybe just a real quick follow-up on the macro, obviously, you guys are very clear about the diversity of the strength that you’ve seen. And maybe I’ll just ask the diversity question slightly differently. In the past, you talked about a small end of the market, the mid-end and the larger end by different customer sizes, by employees or seats. I’m just curious, any differentiation you saw across the installed base, looking that way in terms of macro, both the installed base and new business there? Thanks again."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. No significant differentiation, actually. The low end of the business held up quite well, actually. And we have a standard clip of new customer acquisition that we see just about every quarter to manage our business. It didn’t change. It held steady and the new customer acquisition, generally speaking, the customers that have never been in our database before, generally come from the low end of our business. So the low end held up well. You saw the high end held up well. There was some pressure with regards to people kind of growing their installs, net revenue retention rate. So new inside of existing accounts saw some pressure, but not a lot. And actually, that improved as well. So, no discernible strong difference worth noting between the various segments."
},
{
"speaker": "Adam Borg",
"text": "Excellent. Thanks again for the time."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Matt Hedberg of RBC Capital Markets. Please go ahead."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks, guys. Hey, Andrew, maybe for you first. Obviously, I think we all understand at least that this business is not as cyclical as Autodesk of old. And I think that’s clear through the subscription transition here. Now if the global economy works is slow, I just wanted to double-click on really the value of your subscriptions and why these renewal rates could be better than a lot of investors perceive even if there is a slowing."
},
{
"speaker": "Andrew Anagnost",
"text": "Well, first off and foremost, they need these subscriptions to do their jobs, right. They have to – they need the software to build their – to do their book of business, right. And if you look at our customers and you talk to our customers, and I am sure you looked at some of the indicators and some of the things that are out there. Our customers have a fairly robust book of business. In fact, most of our customers are building up a backlog. And if you have a conversation with them, their biggest challenge right now is I can’t hire, I am having trouble hiring, materials aren’t showing up on time. Like I told you last year, they were likely to price inflationary pressure into their bids. So, it’s not so much that they are dealing with cost compression between bid price and cost price. It has a lot more to do with labor and access to the materials for delivery. None of them are talking about pulling back anytime soon because of the backlog they are seeing in their business. So, they need the software. They need it. They need it now. So, they are going to continue to renew this software in order to keep using it. And they are looking to hire more people. They just can’t find them right now."
},
{
"speaker": "Matt Hedberg",
"text": "That’s super helpful. Thank you for that. And then, Debbie, we will see if your voice can hold up here. Obviously, a big year for multiyear renewals that ramps throughout the year, but I am wondering, was there anything that surprised you about billings duration in 1Q? And maybe how might that progress as the year unfolds?"
},
{
"speaker": "Debbie Clifford",
"text": "Hi. Thanks Matt. Nothing surprising, we continue, of course, to track the multiyear cohort closely. And the proportional volume that we have been seeing for multiyear was in line with our expectations for all of fiscal ‘22 and also in through Q1 of fiscal ‘23. So, that gives us confidence in our fiscal ‘23 outlook."
},
{
"speaker": "Matt Hedberg",
"text": "Got it. Well done guys."
},
{
"speaker": "Operator",
"text": "Our next question comes from Joe Vruwink of Baird. Your line is open."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi everyone. One thing that stood out this quarter was the accelerating growth from the partner channel. How much would you credit some of the recent initiatives like opening up Construction Cloud or being able to get in front of customers with some of the new commercial formats as opposed to just kind of the general trends in the business that you have been talking about?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. That’s an excellent question. I can’t give you a particularly deep answer there. However, we did see significant growth in the partner channel with Construction Cloud, and we are starting to light up Construction Cloud in the channel, which is really important for us in terms of our mid-market expansion of that business. So, it probably had an effect on certain key partners. But to give you the exact detail about how much of that was related to new business within the channel versus their – the traditional business they are turning over, I can’t really give you an exact breakdown on that. Debbie, do we have any fidelity on that at all with regards to the channel business?"
},
{
"speaker": "Debbie Clifford",
"text": "Not at this point, I would say. I mean we saw broad-based strengths through the channel – through our channel partners during the quarter outside, of course, of Russia. And then that immediate slowdown that we talked about in Europe that then picked back up as we exited Q1. And we did see that momentum as we exited Q1. But I wouldn’t highlight anything specific. Certainly the success that we are seeing in Construction is helping. But remember, Construction, while it’s an explosive growth area for us, on the whole, it’s still a smaller part of our business. So, that strength is contributing to overall partner strength, but we are also seeing just broad-based strength through the core of our business as well."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Great. And then I will ask another macro question. But can you maybe contrast the business environment we have been in late February onward? It sounds like, ultimately, trends have been good and stable. Contrast that with last fall. Obviously, inflationary pressures still around. They haven’t abated. We are layering on some incremental macro things, but it’s stability now as opposed to some moderation last fall, maybe differences or what you see is contributing to the stability more recently."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Well, if you remember back in the fall, I talked a lot about some of our customers being caught off-guard by the rapid inflation and supply chain difficulties. So some of our customers were on fixed bid contracts. And fixed bid contracts, when your cost of goods are going up, are really a serious issue for their businesses. So, their businesses were feeling a lot of pinch. Manufacturers were able to pass the cost through to their customers directly, AEC customers less so. So, manufacturers suffered more from some of the supply chain things. What you are seeing now is customers – they are not surprised by this. They know how to bid the contract. So, there is a general kind of bidding parity out there, and people are building in inflationary impacts into their bids and into their projects. So, that creates a much more stable environment for them with regards to having a book of projects that are – having their margins deteriorate rapidly and some that you want to get to that have better margins. So, what they are seeing right now is just a better spectrum of margins across the projects. That’s one key thing that contributes to the stability. Does that make sense?"
},
{
"speaker": "Joe Vruwink",
"text": "It does. Yes. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "And we fully expected them to do that."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Keith Weiss of Morgan Stanley. Your line is open."
},
{
"speaker": "Keith Weiss",
"text": "Hi. Congrats and thanks for taking the question. Very nice quarter. Maybe following on that last question, really a two-parter. One, Debbie, when you are talking to us about the full year guidance, it seems like we are adjusting for currency. That’s just about it. It doesn’t sound like we are adjusting the forecast down for anticipation of any macro weakness or any further weakening of demand trends. So, one, I just wanted to clarify that side of the equation. And then two, if demand does weaken and you do see the macro impacts kind of catching up with all – in software land, what’s the reaction on sort of the spending side of the equation? Is the philosophy that we are looking to protect free cash flows, or is it the market opportunity is too big and we really need to keep investing for growth, and we are going to look to sustain and take advantage of your balance sheet to be able to sustain that investment and get ahead of your competitors? I am trying to understand kind of your philosophy on how you view potential demand slowdown. Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks. Keith, lots to unpack there. So, if I got lost a little bit as I go, please keep me on it. Let’s start with the guidance. The impact to the guidance that we are talking about today relates to FX and Russia. You said FX, but it also includes Russia. There is no change to the underlying business assumptions for the rest of our business, and that’s because we haven’t seen a change in the demand environment for the rest of our business. As a matter of fact, although we saw a bit of a slowdown focused mostly on Europe at the onset of the invasion of Ukraine, we saw a bounce back, and we really exited Q1 with momentum. And so that gives us confidence as we look to the rest of this year. And we have built into our guidance assumptions that reflect the demand that we saw as we exited Q1. And then when we think about margin, remember that with the subscription business model, we have a very resilient business model. Even with the adjustment to revenue for Russia, it was only about a point of our total revenue, we let that flow through to operating margins because we want to make sure that we are not doing any kind of knee-jerk reaction on spend. We think it’s important to continue to invest to make sure that we can further our strategy. I don’t think – I don’t see a scenario at this point where if the world – or the economy were to deteriorate even further that we would see substantial further pressure on operating margins because of that resilient business model. But of course, we are going to manage our business in the best way possible."
},
{
"speaker": "Andrew Anagnost",
"text": "And this is absolutely the right time to invest in the business. When you are a business of our size with our resilience and our footprint, and you are up against smaller, less resilient, more challenged competitors, you invest. You invest. You pull ahead of the competition. You keep focused on the things you are trying to do. You expand your category leadership. You solidify category leadership in other places. We have got category leadership in 3D for BIM, which is a very important growth segment in AEC. We have got category leadership for design through Construction, in the Construction space, deals like deals like Bravida, AECOM, BESIX. These are all people trying to buy into this connected AI-driven cloud-based design through construction environment. That’s the category we are in, and we are kind of already the king. So, this is the perfect time to continue to invest. It helps you lap the competition. The competition will be able to invest to the same degree. I think this is not the time you pull back, right, especially given the underlying strength of our business. It’s solid. You can see it. We have got the multiple vectors of resiliency here and the kind of nice portfolio of options that we can leverage. I am definitely in a mindset that investment is good for us."
},
{
"speaker": "Keith Weiss",
"text": "Got it. That’s super clear and long-term I think that makes sense."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steve Koenig of SMBC Nikko. Your line is open."
},
{
"speaker": "Steve Koenig",
"text": "Hey Andrew. Hey Debbie. Thanks for taking my question. Debbie, I have a cold, too, and it’s not COVID. So, we are in the same boat. So, hope you get better soon here. I wanted to – I may have missed it and apologize if I did. But can you give us a little more specifics on when you saw business start to bounce back in EMEA, was it right at the end of the quarter? Was it a week after? Was it a little before? And yes – and then I have got one more for you, Debbie."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Actually, it was fairly short-term after the initial invasion. It was within weeks, alright. It wasn’t like it was a long thing. It fell off. It slowed down a bit as the invasion started. And then within a few weeks, it was rising back up again and back up to where it had started. So, it didn’t take that long. It surprised us, honestly."
},
{
"speaker": "Steve Koenig",
"text": "And was it – I was trying to parse your earlier statements. Was it kind of balanced between new business and renewals, or was it kind of more one or the other?"
},
{
"speaker": "Andrew Anagnost",
"text": "Renewal stayed strength – strong throughout the entire cycle, alright. So, renewals kept building as the quarter progressed. There was never a slowdown in renewal momentum. A matter of fact, if anything, it just kept strengthening and strengthening, alright. It was only in the new business part that we saw a slowdown post invasion that recovered. So, no, renewals just kept building."
},
{
"speaker": "Steve Koenig",
"text": "Yes. Got it. Okay. Great. And then for my follow-up, and actually either of you are welcome to answer this as you see fit. So, you raised prices at the end of March, and I am sure that’s all embedded in your guidance. And it allows you to invest appropriately and get to the margins you want. How do you think about in this inflationary environment your internal compensation trajectory and also what you are doing with partners? And how does inflation affect your plans there? What do you have to tweak or finesse to – you have very high employee retention, you have very good rates. So, how do you maintain that? Thanks and I appreciate taking my questions."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So let me – because there is two questions there. First, let me comment on the price increases so that we are all on the same page here. The price increases were highly targeted to certain parts of the world where we had artificially suppressed the price below our long-term goal of having standard euro, U.S. and yen-denominated pricing. So, what you are seeing is, in certain places, we are raising prices to equalize so that we can get to this kind of standard-based pricing that simplifies some of our go-to-market practices. So, we had some artificially suppressed prices in regions, and that’s what was going on there, okay. It’s – there is no change in our standard pricing policy. In fact, places like Europe did not see a price increase, alright. So, I just want to be clear, we are all on the same page with regards to pricing and the things associated with that. Now, with regards to inflationary pressures and uncertainty in employment area [ph], but we are no different, alright. We see pressure in terms of employee compensation and trying to help our employees navigate an increasingly inflationary environment. We increased our raised pool. We increased our bonus this year. And equally important, we are increasing our stock-based compensation, and you will probably see us continue to increase our stock-based compensation for our employee base. So, these moves were made and baked into the year well ahead of the start of the year to ensure that we were able to meet our employees or at least try to meet our employees where they were at. But we will certainly continue to look at our pay position. We will probably continue to see some pressure there in terms of staying competitive. We are retaining employees at high rates. We will also continue to use stock-based compensation more robustly and more broadly within the organization, which we think is good for the company, good for investors and good for employees."
},
{
"speaker": "Steve Koenig",
"text": "It sounds good. Thanks very much Andrew."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Bhavin Shah of Deutsche Bank. Your line is open."
},
{
"speaker": "Bhavin Shah",
"text": "Great. Thanks for taking my questions and I will focus my question to Andrew and say Debbie both of course. Andrew, just hoping to get to the call, you noted the robust competitive performance during the quarter. Can you maybe just elaborate on this? What verticals or products are seeing better success or even improved win rates? And what’s driving some of this?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Well, it’s basically every sector. I mean every one of our industries, we are growing faster than our competitors, alright. So, we are taking share as we are selling more seats in some highly competitive industries. So, you are seeing us doing well in AEC. You are seeing us doing well in manufacturing, both on seat counts and revenue counts, which I think is really important because you want to watch both of those performances. We even did quite nicely in media entertainment year-over-year. So, we are absolutely seeing broad-based competitive performance. I mean obviously, one of the places that we all watch is Construction, too. In Construction, if you look at the kind of the raw make numbers, we grew 24% year-over-year. But you got to remember, some of that construction that make opportunity is actually in the EBAs, which are counted a design. So, when you look at our total make performance and taking that – those EBA impacts where we kind of put – make components into the EBAs, we grew into the mid-30s. And Construction Cloud monthly active usage grew slightly north of 30%. This is all great, solid competitive performance. AEC – Construction Cloud of its best new business growth quarter. International growth for Construction Cloud was significantly higher than its regular growth. We are lighting up the channel in the mid-market. We are kind of solidifying our category leader position in this design through construction position. Essentially, anybody else in this player – this space is kind of outside that category, they are very niche or there is being waiting for the industry to move on and move past them. So, I think we are in a very strong competitive position right now. I think it’s our job to continue to maintain that. But it was across all the industries we serve."
},
{
"speaker": "Bhavin Shah",
"text": "Super helpful. And thanks for that color. And just one quick follow-up. It was really interesting to see that large EBA deal include Innovyze, and these are good things here as well. Where are you on your integration plans just with this solution? And where are you in terms of evolving the product set here? And how do we just think about the pipeline of customers who are looking to leverage some of your water-based products?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Look, we have made really great progress integrating Innovyze in. The company was fairly similar to us when we bought them. So, there is a lot of things that are rapidly getting integrated. Of course, there are some product integration pieces and some back-office systems that are still kind of working through some of the integrations. But in terms of integration, that’s not a barrier right now to where we are at with Innovyze. One of the things that’s exciting about what Innovyze does is it’s already kind of fulfill the end-to-end vision for water that we have for construction and manufacturing. It goes everywhere from design all the way to operate. And it has some fairly sophisticated cloud-based tools for water infrastructure operators, sewage treatment operators, other water infrastructure operators that allow them to actually manage the facilities once they have been put into operations. So, it’s a very robust solution. It covers a very broad piece of it, and it fits incredibly nicely into our portfolio, both story-wise, strategy-wise, and frankly, sales motion-wise."
},
{
"speaker": "Operator",
"text": "And ladies and gentlemen, that is all the time we have for Q&A today. This concludes today’s conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 4 | 2,024 | 2024-02-29 17:00:00 | Operator: Thank you for standing by. And welcome to Autodesk's Fourth Quarter and Full Year Fiscal 2024 Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator. And good afternoon. Thanks for joining our conference call to discuss the fourth quarter and full year fiscal 2024 results. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. During this call, we will make forward-looking statements including outlook and related assumptions, products and strategy. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon. And welcome, everyone, to the call. We finished the year strongly, delivering 40% constant currency revenue growth in the fourth quarter of fiscal 2024. Resilience, discipline and opportunity again underpinned our robust financial and competitive performance. Autodesk's resiliency comes from its subscription business model and its product and customer diversification, which balances growth across different regions and industries. Renewal rates remained strong. And new business growth and leading indicators were consistent with recent quarters. Despite ongoing macroeconomic policy and geopolitical headwinds, we saw growing usage, record big activity on BuildingConnected and cautious optimism from channel partners. Disciplined and focused execution and strategic capital deployment through the economic cycle enables Autodesk to realize the significant benefits of its strategy, while mitigating the risks of having to make expensive catch-up investments later on. With the new transaction model, we are approaching the final phase of modernizing our go-to-market motion, which has involved updating our infrastructure, retiring old system to end business models, and building more durable and direct relationships with our customers and ecosystem. At the same time, we are advancing a multi-year process to develop lifecycle solutions within and between our industry clouds, powered by shared platform services and with Autodesk's data model at its core. Together, these will enable Autodesk, its customers, and partners to create more valuable, data-driven and connected products and services. Having led the industry in general design, we are leading again in 3D generative AI. Autodesk is getting closer to a transformational leap where Autodesk AI is to [three] (ph) design and make where ChatGPT is to language. Our new multimodal foundation models will enable design and make customers to automate low-value and repetitive tasks and generate more high-value complex designs more rapidly and with much greater consistency. We can already generate 3D representations from images 10 times faster and with faster higher-quality and currently available through the AI. We're bolstering our homegrown capabilities and data with partnerships and acquisitions in existing and adjacent verticals. Our recent bidirectional integration of fusion with cadence and the acquisition of payouts are good examples. Discipline and focus on executing our strategy and deploying capital also underpin our opportunity. Our go-to-market and platform initiatives will drive even greater operational velocity and efficiency within Autodesk, which will free up further resources to invest in our industry clouds and capabilities, including AI and sustained margin improvement. And with a modernized go-to-market motion, lifecycle solutions and platform services, Autodesk will fulfill its potential to break down the silos within and between manufacturing, AEC and media entertainment, enabling our customers to unleash their data and design a better world built for all. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for fiscal 2025, I'll then come back to update you on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. Our financial performance in the fourth quarter and for the fiscal year was strong, particularly in our enterprise business. Early renewals and strong upfront revenue from enterprise business agreements or EBAs and federal governments drove some of the outperformance relative to our expectations in both Q4 billings and revenue. Overall market conditions and the underlying momentum of the business were consistent with the last few quarters. Total revenue grew 11% and 14% in constant-currency with upfront revenue driving 2 percentage points of that growth. By products in constant currency, AutoCAD and AutoCAD LT revenue grew 7%, AEC revenue grew 18%, manufacturing revenue grew 16% and M&E revenue was up 8%. AEC and manufacturing benefited from EBA true-up and upfront revenue. By region in constant currency, revenue grew 19% in the Americas, 11% in EMEA and 8% in APAC. Direct revenue increased 19% and represented 39% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the Autodesk's store. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. Billings declined 19% in the quarter, resulting from the transition from upfront to annual billings for multiyear contracts as expected. So, slightly offset by some early renewals in North America. As part of our implementation sequencing for the new transaction model, we shifted our North American price increase from the end of March to the beginning of February. This resulted in some renewals moving from Q1 fiscal 2025 to Q4 fiscal 2024 which modestly boosted billings in January. Total deferred revenue decreased 7% to $4.3 billion and expected result of the transition from upfront to annual billings for multiyear contracts. Total RPO of $6.1 billion and current RPO of $4 billion grew 9% and 13% respectively. Early renewals drove about 1 percentage point of current RPO growth. Total RPO growth decelerated in Q4 when compared to Q3 when we closed our largest-ever EBA. The year-over-year deceleration was due to the lower mix of multiyear contracts in fiscal 2024 when compared to fiscal 2023, which I mentioned last quarter. In line with recent quarters and our expectations, we again saw some evidence of multiyear customers switching to annual contracts during the quarter. Turning to the P&L, GAAP and non-GAAP gross margin were broadly level, while operating margin was modestly lower in the fourth quarter, primarily due to the timing of Autodesk University costs shifting from Q3 to Q4, which we flagged last quarter. As expected, full-year non-GAAP operating margin was level year-over-year but up about one 1 percentage point at constant exchange rates. Fourth-quarter GAAP operating margin was up 40 basis points year-over-year and about 1 percentage point at constant exchange rates, partly due to a reduction in stock-based compensation as a percent of revenue. At current course and speed, the ratio of stock-based compensation as a percent of revenue peaks in fiscal 2024. We expect it to fall to 10% or lower over time. Free cash flow for the quarter and full year was $427 million and $1.28 billion respectively with early renewals, providing a modest tailwind in the fourth quarter. The most significant free-cash-flow headwinds from our transition from upfront to annual billings for multiyear contracts are now behind us, which means our free-cash-flow through during fiscal 2024 and will mechanically rebuild over the next few years. Turning to capital allocation. We continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long-term shareholder value. As you heard from Andrew, we continue to invest organically and through complementary acquisitions to enhance our capabilities and the industry clouds and platform that underpin them. During the quarter, we purchased approximately 300,000 shares for $63 million at an average price of approximately $217 per share. We have now offset estimated dilution from our stock-based compensation program well into fiscal 2026. We will continue to repurchase shares opportunistically to offset dilution from stock-based compensation when it makes sense to do so. Now let me finish with guidance. Overall, end-market demand has remained pretty consistent over the last few quarters. Macroeconomic and one-off factors like the Hollywood writer strike dragged on the new business growth rate during fiscal 2024 and will modestly drag on revenue growth in fiscal 2025, but Autodesk's resilience and robust underlying demand for its products and services reinforce its long-term growth potential. Turning to revenue. I want to highlight four key puts and takes impacting growth in fiscal 2025. First, let me talk about the new transaction model. We've added some slides to the earnings deck to help illustrate how to think about this shift, which I'll briefly summarize. The new transaction model enables Autodesk to build closer, more direct relationships with its customers and partners and to better understand and serve them with more data, more self-service and greater predictability. It will be a cornerstone of the data services that Andrew talked about earlier. As you can see from Slide 11, the transition mechanically drives higher revenue and costs is broadly neutral to operating profit and free-cash-flow dollars and is a headwind to operating margin percent. About $600 million of payments made the resellers and developed markets in fiscal 2024 were accounted for as contra-revenue. As this business moves to the new transaction model, these payments will shift to marketing and sales expense over the next few years, all else equal, with the timing of cost recognition not materially different than before. The change affects a substantial majority of our business, but note that emerging markets and our federal government business will remain on the buy-sell model for the foreseeable future. The pace of the shift will primarily be determined by the mechanical build from ratable subscription revenue accounting and the rate of regional rollout of the new transaction model. While the former is relatively easy to predict given the ratable revenue recognition of our subscription business model, which fills over time, the latter will in part be determined by what we learn as we roll out the model further. We gained useful insights from the successful rollout in Australia, and we're expecting to learn more as we roll out with much higher volumes in North America this year. We will be able to apply those learnings when we launch in EMEA. Our fiscal 2025 guidance assumes the new transaction model is deployed in North America in Q2 of fiscal 2025 and provides about a 1 percentage point tailwind to Autodesk's revenue growth and a 3 points to 4 point tailwind to billings growth. Second, the acquisition of payouts, which closed on February 20th, is expected to contribute about 0.5 point of revenue growth in fiscal 2025. Third, token consumption for the fiscal 12021 EBA cohort exceeded consumption predictions made during the pandemic which resulted in true-up payments in fiscal 2024. Token consumption and the smaller post-pandemic fiscal 2022 EBA cohort is tracking more in line with predictions, which means we expect fewer true-up payments in fiscal 2025. This pandemic echo effect is about a point of headwind to fiscal 2025 revenue growth. And fourth, our rolling four-quarter foreign-exchange hedges means that FX is expected to be about a 1 percentage point headwind to reported revenue growth in fiscal 2025. Bringing this altogether, we expect revenue of between $5.99 billion and $6.09 billion in fiscal 2025, which translates into a revenue growth of about 9% to 11% compared to fiscal 2024. Adjusting the midpoint of our guidance to exclude noise from the new transaction model, acquisitions, the absence of EBA true-up revenue and FX, we expect underlying revenue to grow more than 10% in fiscal 2025. Moving on to margins. We're going to manage our non-GAAP operating margins between a range of 35% and 36% in fiscal 2025, with the goal of keeping them roughly level with fiscal 2024. This means we expect a roughly one-point underlying margin improvement will be broadly offset by the margin headwind from the new transaction model. As we transition to the new transaction model, we'll see operating margin headwinds from the accounting change of moving reseller costs from contra-revenue to sales and marketing expense. We'll also have incremental investment in people, processes and automation. But over the long-term, we expect that this transition to the new transaction model will enable us to further optimize our business, which we anticipate will provide a tailwind to revenue, operating income and free-cash-flow dollars, even after the incremental costs we expect to incur. Moving on to free cash flow, we expect to generate between $1.43 billion and $1.5 billion of free cash flow in fiscal 2025. In Australia, some channel partners accelerated renewals ahead of the transition to the new transaction model to derisk month one of the transition. Because the new transaction model will be rolled out in Q2 in North America, it may be that the behavior we saw in Australia occurs also in North America, which may accelerate billings and free cash flow to earlier quarters, but should not materially change the outlook for the year. Excluding $200 million from fiscal 2024 free cash flow from multiyear upfront billings, which are now billed annually, in fiscal 2025, we expect free cash flow growth of about 35% at the midpoint of our guidance. We expect faster free-cash-flow growth in fiscal 2026 because of the return of our largest multi-year renewal cohort, the mechanical stacking of multiyear contracts billed annually and a larger EBA cohort. As we navigate the new transaction model transition, the pace of the rollout will create noise in the P&L. So we think free cash flow is the best measure of our performance. At current course and speed, our free cash flow estimate for fiscal 2026 at the midpoint is approximately $2.05 billion, which is in line with consensus estimates. In the context of significant macroeconomic, geopolitical, policy, health and climate uncertainty, the mechanical rebuilding of our free cash flow as we transition to annual billings for multiyear contracts gives Autodesk an enviable source of visibility and certainty. We continue to manage our business using a Rule-of-40 framework with a goal of reaching 45% or more over time. We are taking significant steps toward our goal this year and next. We think this balance between compounding growth and strong free-cash-flow margins, captured in the Rule-of-40 framework is the hallmark of the most valuable companies in the world and we intend to remain one of them. The slide deck on our website has more details on modeling assumptions for Q1 and full-year fiscal 2025. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Let me finish by updating you on our strong progress in the fourth quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction fueled by customers consolidating onto our solutions to connect and optimize previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions, encompassing design, preconstruction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the mid-market. As a sign of that growing momentum, we closed a record number of deals over 100,000 and $1 million in construction accounts in the United States and worldwide during this quarter. Let me give you a few examples. First, Vinci, a world leader in concessions, energy and construction has been leveraging Autodesk solutions to streamline its operations and drive international expansion. With a platform approach, Revit customization and BIM as a standard practice, Vinci has achieved significant time savings annually and captured more business abroad. In Q4, Vinci renewed its fourth enterprise business agreement with Autodesk, expanding the deployment of Autodesk Construction Cloud on major projects to further integrate its data and workflows, and ensure a seamless transition from design through construction. Second, after a competitive RFP process early in the year, Fortis Construction, an ENR 400 firm based in Oregon ran a thorough peer assessment and selected Autodesk Construction Cloud for a six-month pilot. With the confidence gained during the pilot and close alignment between the construction technology vision and Autodesk roadmap to a connected design-build-operate platform, Fortis committed in Q4 to a multi-year agreement across preconstruction and construction. And third, the Pennsylvania Department of Transportation recently chose Autodesk Construction Cloud as the primary tool powering its project delivery collaboration center, which will manage the project delivery of infrastructure projects in the state, in large part due to our software-inclusive open ecosystem. Again, these stories have a common theme, managing people, processes and data across the project lifecycle to increase efficiency and sustainability, while decreasing risk. Overtime, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. With the acquisition of Payapps, Autodesk will embed payment and compliance management into the project lifecycle. It can take an average of 83 days for subcontractors to get paid after putting work in place. And because of the risk, many will not bid on a project if a general contractor or an owner has a reputation for slow payments. Our goal is to leverage technology that eases the burden of construction payment management in a simpler, faster and more efficient process for all construction project stakeholders. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate our design and make platform to grow their business and make it more resilient. In automotive, we continue to grow our footprint beyond the design studio into manufacturing and connected factories as automotive OEMs connect data and shorten hand-off to the design cycle. In the US, a leading manufacturer of leveraged AEC Solutions Fusion and Autodesk platform services to develop a connected factory, it delivered a much greater ROI to significantly faster design durations, product prototyping and data federation. Due to expanded EBA signed in Q4, it is exploring using VR studio tools in customization and increasing its adoption of Autodesk Construction Cloud to bring its new factories to life. We continue to serve some of the largest manufacturers in the world with a full breadth of our portfolio, as they design and make both products and factories. One of the largest private manufacturers in the US leverages our advanced manufacturing portfolio including Fusion, PowerMill and Moldflow, which has helped reduce rework in plastic designed by 20%. To build clean-energy solutions, it utilizes our AEC collection, including BIM metadata, assembly breakout and installation instructions for its building products. In Q4, the customer increased its EBA with Autodesk, and plans to expand our partnership beyond Revit and Autodesk Construction Cloud to support the digitalization of its factories. Fusion remains one of the fastest-growing products in the manufacturing industry and ended the quarter with 255,000 subscribers, driven by the growing number of customers who recognize the value of cloud-based workflows, enhancing efficiency, sustainability and resilience within their organization. As the breadth and depth of Fusion features and capabilities expand, we're beginning to drive adoption by larger companies and sort of higher-value segments of the professional market through expansion. As we do this, commercial subscriptions will become less complete indicators of Fusion's performance relative to the value we can realize in our reporting or change to reflect that. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. In the fall, the University of Delaware selected Fusion for more than 600 students to use in its introduction to engineering class, replacing a competitor's solution. Fusion was chosen because it facilitated better team collaboration, was easily adopted thing to available teaching resources and provided a single integrated platform to learn CAD, stimulation and CAM. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. In Q4, an American pharmaceutical company looked to understand its own usage better and ensure remains compliant in the transition to our named user model. In collaboration with our license compliance team, a preventative audit was conducted to identify risk areas and construct the combination of subscriptions and Flex tokens for continued access. It is also taking the opportunity Flex enables us to trial new products from our portfolio, resulting in an annual spend increase of more than 30%. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. Time and again, our success in executing strategic transformation and added new growth vectors, built a more diverse and resilient business, forged broader, trusted and more durable partnerships with more customers and given Autodesk a longer runway of growth and free-cash-flow generation. We are building the future with focus, purpose and optimism. Operator, we would like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question, please Saket.
Saket Kalia: Okay. Great. Hey Andrew, hey Debbie. Thanks for taking my questions here and nicely done.
Debbie Clifford: Thanks, Sakit.
Andrew Anagnost: Thanks, Sakit.
Saket Kalia: Hey, guys. Andrew, maybe just to start with you, you talked a little bit more about generative AI on this call, which was great to hear. Maybe just to make sure the question is asked, can you just talk about what your sort of core engineering customers are saying about generative AI? And I'm sure it's a very long discussion, but how do you think about the value that Autodesk can provide sort of on that journey?
Andrew Anagnost: Yeah. So first off, Saket, let me make it clear that, it’s our intent to be the market leader in generative AI, just like we were in generative design over 10 years ago. So we intend to lean into this pretty heavily. Our AI lab has been in existence since 2018, it's been where some of the core research that's contributing to some of the things I talked about in the opening commentary came from. But also, we've been delivering AI in our products for several years now -- we just released drawing automation into Fusion, which allows people to automate manufacturing drawing stacks, which is a very labor intensive effort, and it's a high productivity driver for our customers. So, in terms of what our customers are saying to us. One, they're looking for the productivity increases. They're asking what are they going to look like, what kind of productivity increases are you going to deliver to this, and how are you going to use our data to deliver those productivity increases. Now, in terms of how we're going to do this is, there's two avenues that we're going to be approaching here. One is going to be more disruptive to how our customers work and the other one is going to be basically automating the capabilities and workflows they have today. We have to do both. Both have different value levers, both will have different adoption curves. Some of the things I talked about in the opening commentary about some of our new tools for generating 3D models from photographs or for incomplete 3D models, those are disruptive approaches that set up initial model ideas for our customers and allow them to do things initially with a blank slate kind of concept, where they create a model from specifications and requirements. We haven't released any of that yet, we will at some point release that to a private beta. But right now it's just something we're really proud of and we think is really important. That's an important disruptive technology. The other technologies are also going to look a lot like what we did with Fusion drawing automation. There are going to be tools that take the complexity of delivering and creating a 3D model and all of its outputs to a process and take it from months to weeks or sometimes even days and that's going to make customers who are currently using these tools maybe slower in the adoption of more disruptive tools, incredibly more productive. Both avenues are valid, both are important, and both are areas that we're focusing on.
Saket Kalia: Got it. That makes a lot of sense. Debbie, maybe for my follow up for you, Autodesk obviously provides a lot of value to its customers, which you're also able to capture as well. Maybe the question is, can you just talk a little about some of the recent pricing actions that have been out there? And what sort of customer behavior that might drive as a result? I think there was a little bit of difference in pricing, sort of between one year and multi-year subscriptions. How do you think about that impacting the model, if at all, going forward?
Debbie Clifford: Sure. So let's start first with what we did. So there's a couple of things that are going on. We did about a 3 point increase for market factors and then we did a 5% increase for renewals. With market factors this was something that we've been talking about for a while. Our goal is to streamline pricing around the world. And then for the renewals price change before the increase, we had a 10 point price differential between new and renewal and with this move to agency or the move to the new transaction model, we don't see as much of a need for that delta. In Q4 what we did was, we moved up the timing of the price increase so that we could better sequence things with the new transaction model coming and that led to some early renewals down the stretch. That's part of what gave an extra point of growth to current RPO. But the price increase overall was most helpful to billings, but it wasn't material to revenue and free cash flow.
Saket Kalia: Got it. Very helpful. Thanks, guys.
Operator: Thank you. Our next question comes from the line of Adam Borg of Stifel. Your question please, Adam.
Adam Borg: Great. And thanks much for taking the question. Maybe on the transactional model and thanks guys for all of the disclosures around it. Maybe talk a little bit more about the learnings you have from the early customer and partner feedback in Australia and even now that you have the early days of this direct relationship, anything interesting there that you're learning from your more direct relationship with customers, be it usage or adoption or expansion that you clearly didn't have before with the prior model? Thanks.
Andrew Anagnost: Yes. Thanks, Adam, for that question. First off, let me just reinforce something here, because I want to make sure that we're all on the same page here about why we're doing this, right? This is a critical part of a relentless, ongoing modernization of Autodesk business, getting us ready for the long term success we expect in a world of AI driven, cloud-based solutions for design to make lifecycles, right? It's a necessary step in this. It's the last big one in our journey of all the ones we've done at this point, and it really has some big benefits for our customers, long term. One, it's going to allow us to understand them a lot better in ways that we can't currently understand them because don't have the full account record of what the customer is doing. Two, it's going to allow us to deliver a lot more self service capability to these customers. And three, it's going to turn our partner channel into design made collaborators and consultants for our customers with their own unique IP and their own services and away from transaction partners. So it's critical that we kind of get on the same page of that. With regards to Australia, we actually did learn a lot, right? Mostly about the transactions at this point because it was only for a quarter and a little bit. It didn't necessarily have direct impacts on customer behavior. But what we did learn we've now put into the process. In fact, we actually delayed our US rollout by 30 days based on some of the learnings during the Australian process. We changed our roadmap for some of the capabilities, updated and upgraded some of the capabilities in the transaction systems to kind of correspond with some things we saw in Australia. And we also kind of delivered some new enablement materials for partners and frankly for customers as well, so they understand how this transaction model impacts their relationship with Autodesk. So we definitely took the learnings to the bank to make sure that we were better prepared and we even gave ourselves a little bit more time, based on what we learned to finish up a few things that we think are going to be impactful.
Adam Borg: That's great. And maybe just as a quick follow up, you talked about some success with state DoT, as you think about kind of the infrastructure bill and the stimulus that continues to be deployed. Maybe just give a quick update on Innovyze and just a quick State of the Union there and the opportunity as part of the broader infrastructure push. Thanks so much.
Andrew Anagnost: Yea, so you'll probably hear us use the word -- name Innovyze a lot less and talk a little bit more about Autodesk Construction or water solutions moving forward, all right. So I just want to be clear about that. Water is and has been a big part of our EBA successes. Larger customers are adding water solutions. I think there's an obvious reason for that. Water is just as important as it was before, if not more so. I think you're probably aware that in California, we just had yet another kind of flood where people didn't expect to have floods in San Diego and that's all because water management infrastructure is moving water in the wrong places. So people need to build and rebuild water infrastructure of all types, water scarcity, water purity, all of these things. Water is going to be a big business moving into the future and it's continued to enhance some of our EBAs with that respect. Since you mentioned infrastructure in general, I just want to kind of point a little bit to something that you heard in the opening commentary about PennDOT, all right. I think that's a really important story about what's going on there. Why is PennDOT choosing our solutions? What's going on? Because of the infrastructure bill and some of the money that was put in the infrastructure bill to help some of these Departments of Transportation understand how to invest in the future, PennDOT looked at its portfolio of tools, they looked at the future, they looked at what they need going out 10 years, 20 years in the future, what kind of modern stacks they want to work on, and they chose to move to our solutions and incorporate more of our solutions in their environment. That's an important first step in what we're trying to do. We want to be part of modernizing these Departments of Transportation with the kind of modern staff that we've created in the end-to-end design to make solutions. That's another vector here to pay attention to as the infrastructure boom kind of continues to roll out into the United States.
Adam Borg: Great. Thanks for all the details.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin securities. Your question please, Jay.
Jay Vleeschhouwer: Thank you. Good afternoon. Andrew, first question concerns the transaction model and what I'd like to ask about is relating the operational and transactional and accounting systems and compensation systems that you've put in place relative to the scale of your volume. You added well over 700,000 subscriptions in fiscal 2024, more than you added in fiscal 2023. You've spoken of certain growth expectations for volume over time. So, maybe help us understand the capacity that you have in place now to support the long term volume growth expectations that you have, because undoubtedly you're looking to do substantially more subscription additions than you did in fiscal 2024.
Andrew Anagnost: Yes. So Jay, obviously the modernization of Autodesk and its back office infrastructures isn't just about rolling out the new transaction model and the kind of the nuts and bolts of that. It's actually about increasing our internal capacity to do these things at scale, which is exactly what we were trying to test in Australia, in the various environments and that we've been testing since then. So, we are very confident that we've not only built a transaction environment, but a cascading set of capabilities that allow us to scale significantly as we move forward. Because you're right, we intend to get deeper and deeper into people's design and make processes and that's going to increase the amount of subscriptions that are being used downstream in other types of make processes and we have to be able to operate at scale. So this is not just a new transactional model modernization effort. It's a full scale modernization effort inside of Autodesk that captures all aspects of this. And the good thing about the cascading rollout, the way we're doing it this year with the US first, is again we're going to get yet another test on the volume and capacity of the systems that allows us to understand where we're at before we go live with the next level of rollout and volume capture. But just know that this is more than just a transaction model. It is a full scale modernization of what's going on under the hood at Autodesk.
Jay Vleeschhouwer: Yes. Understood. Second question concerns products and technology. When we think back to the various product sessions and roadmap sessions that you talked about at AU a few months ago, what do you think are the critical executables -- product deliverables that you're aiming for, for this year either in terms of improving upon or expanding the existing products, such as Revit or other new tools?
Andrew Anagnost: Yes, so I'll just hit a few here okay. First off, in manufacturing, the critical thing that really needs to happen this year for Fusion, for example, is we have to improve our capability to help move Fusion from small teams in the design and make part of the business, all the way up to supporting full scale engineering team. So basically scaling the size of installations inside of our customer base with Fusion. That's going to be through a combination of things we do with our cloud based data management solutions as well as some of our AI-based solutions which basically attract people to the product because of the productivity enhancement. But that is definitely an important effort. There's a second ancillary effort with regards to the Fusion around ensuring that our partnerships with companies like Cadence and the internal EDA capabilities we built in the Fusion set us up for a boom in smart products. We want to be the solution that people choose for smart products. We built enough capability into Fusion that people can get a certain way end-to-end with Fusion and we're partnering to make sure that when things get more sophisticated, we're able to move up into the more sophisticated processes associated with these smart products. Now, when it comes to Forma, Forma and Fusion kind of dance together here and one of the things that -- it's really important to do as we move into this year is make sure that Forma and Revit play together as our customers try to move forward as they adopt Fusion and also as they use Revit more collaborative in the cloud, that these two products work together in some way, that they exchange data and interoperate in ways that nobody else can achieve. Because the truth of the matter is, the work that people are doing with Revit isn't going away. It's a huge amount of what they do and we need to make sure that, that work is more efficient in a formal world. So, look for us to not only increase the capabilities of Forma, but increase its relationship with Revit as well, which I think is really important. The last thing I'll say, just around media and entertainment is, we have to continue to take what we're doing with regards to moving beyond post production special effects into full production management, script-to-screen capabilities for our customers in the filmmaking industry and make some of that real with the flow platform and that's really the big goal for the media entertainment team, is to make flow real this year and help our customers really see possibilities of integrating new types of complex solutions on top of a single production management environment.
Jay Vleeschhouwer: Very good. Thank you Andrew. Thank you Debbie.
Andrew Anagnost: You're very welcome.
Operator: Thank you. Our next question comes from the line of Joe Vruwink of Baird. Please go ahead Joe.
Joe Vruwink: Great. Hi everyone. Thanks for taking my questions. I wanted to ask -- so Autodesk has framed growth rates over the long arc of time in that 10% to 15% range. 2025 guidance is obviously holding to the 10%. When you think about 10% conceptually, is that ultimately, as you would expect, just given the nature of your businesses being exposed to certain end markets that are perhaps now closer to their bottoming or troughing point in a given cycle? And if that maybe is the case and this is the bottoming point, what indications are you watching over coming quarters to maybe set the stage for a recovery scenario, which, of course, your markets typically do after they reach that bottoming point?
Debbie Clifford: Thanks. So, we continue to target that 10% to 15% revenue growth algorithm and you're right, the midpoint for fiscal 2025 was right at that 10% coming off a year where we did 13% growth in constant currency. And really what we've said is that where we end up in that 10% to 15% range is going to be contingent upon the macroeconomic backdrop that we operate in, as well as our ability to harvest the opportunities that we have before us across AEC, manufacturing and so on. And so, the things that we're watching as we proceed through this year with that 10% midpoint are some of the things that we've been talking about for a while now. So, new business growth is really important indicator of future revenue performance for the company and we said in this last quarter that new business growth grew, but it was relatively soft, consistent with what we had seen over the previous several quarters. So, definitely being impacted by macro and that's one of the factors that's driving the 10% revenue growth midpoint in fiscal 2025, so we'll continue to watch that closely. We also watch product usage, we watch bidding activity on our BuildingConnected platform, and we stay close to our channel partners, try and understand what they're seeing in terms of their demand. So those are the things that we're going to be watching to see how this year progresses and beyond.
Joe Vruwink: Okay thanks. That's helpful. And then I wanted to follow-up on the free cash flow. I think I heard $2.05 billion for fiscal 2026. At one point there was a comment that the progression between FY 2024 and 2026, that was going to be linear, of course, if you normalize for that $200 million effect benefit last year and then comes out this year. I guess as I look at that and the $2.05 billion, it's not quite linear. It would seem like FY 2026 is actually maybe a bit stronger. Did something change in kind of the modeling out of the progression? Just any color there?
Debbie Clifford: Nothing's changed Joe. So we said that we anticipate that cash flow would grow greater in fiscal 2026 than what we saw in fiscal 2025. And when you think about modeling the growth rate, just remember that you have to remove the $200 million in fiscal 2024 before we stopped selling multi-year contracts upfront.
Joe Vruwink: Okay, I'll leave it there. Thank you very much.
Operator: Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets. Your line is open, Jason.
Jason Celino: Great. Thanks for taking my question. Maybe first for Andrew, just on the acquisition of Payapps and they were a great partner of yours. Just curious on what drove the decision to acquire them outright versus just extending the partnership? Thanks.
Andrew Anagnost: Yes. All right, so since you opened up the door there, let's talk a little bit about construction in general, because I think it's important to kind of highlight what's been going on there. We had a great EBA quarter for construction. Construction saw strong growth in our largest accounts, which is really important for the long term health of construction. And at a really high level we also saw an increase in $100,000 deals and $1 million deals both in the US and internationally and that's really important. And this is where -- one of the things where Payapps comes in, right? Remember, we're going end-to-end with our solutions here from design all the way to make. And we want to make sure that we get into the preconstruction planning and other types of our customers processes. It takes 83 days for our customers to process payments in their environment that's just too long. Now, we're not getting into the transaction business. What we're doing is, we're getting into the business of helping them automate and track those payments across their entire life cycle so that they can get, quicker return, reduce that 83 days to be faster, and increase their cash flows. This has to be something we tightly integrate into our solution. So, we intend to tightly integrate this in just like we rebuilt some of the other solutions we acquired previously into what is today Autodesk Build, which is a new modern platform for doing some of these things. So we thought it was very important to own this so that we can integrate it. And then we went out there and we bought a premium asset. It's a leader. It's a global leader in payment processors. It's not a small company, it's not what we could afford, it's what we needed. And I think that's really important. So, when we look forward at construction right now, we see tools like this being critical as well as our pre-construction tools and we actually see the deal cycles maybe getting a little longer, but we're competing head-to-head a lot more. And I want to again highlight that Fortis deal out of Oregon, which was a head-to-head competitive deal with a pilot period that ended up going fully to Autodesk. So what we see right now in our business is building momentum driven by the end-to-end solution and kind of acquisitions, like Payapps as well. So, when we look forward into next year, we don't see deceleration of the business, we see acceleration.
Jason Celino: Okay. No, that's very helpful. And then my quick follow up for Debbie. Sorry if I missed it, but the 13% constant currency growth we did this year, did you mention how much was from the strong renewal cohort and then maybe any upfront revenues? I'm just trying to understand the several points of decel embedded in the 2025 guide? Thanks.
Debbie Clifford: Yes. So the early renewal cohort didn't have any impact to revenue really, that had more of an impact on billings than it would have on revenue. And then the strength that we saw in enterprise represented about 1 point of growth.
Jason Celino: Okay, great. Thank you.
Operator: Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead Tyler.
Tyler Radke: Yes. Thanks for taking the question. Along the similar lines of Jason's question on construction Andrew. I'm just wondering if you could provide us an update on the go-to-market changes that you made, I believe last year and how you're expecting that business and you talked about acceleration, obviously make revenue is growing in the teens. Is this a business you think can be 20% over the medium term? Just help us frame what you're seeing both from the go-to-market and pipeline perspective? Thank you.
Andrew Anagnost: Yes. So, as you know, last year was the full year of integrating the sales force back into the mainline sales force. We went through some of the integration efforts to do that. There were obviously some slowdowns in the business related to integration of those things. Those things are past us now, the business is fully integrated. It's starting the year off, not only fully integrated from the get-go, but with all of the processes, plans and capabilities all lined up according to how we want to grow the business heading into the year. And one of the things I wanted you to notice in my previous commentary is that, we're seeing deal activity going up. So, the pipeline is actually firming up really well and we're in more deals and some of these deals are more competitive, but we embrace that because when we're in a competitive deals, that means we're showing up in places we weren't showing up before because people are calling us in. That's a really important part of this whole entire process. People are starting to ask themselves what solution do they need for the next 10 years, 15 years versus what's available out there today. And the end-to-end capabilities we're delivering, especially leaning more heavily into our preconstruction capabilities, which lock in a lot of the cost and complexity and risk of a construction project, this is where we're leaning into this year and this is where we're going to be driving the growth. So I think we're past integration issues moving forward into pure execution at scale inside the mainline salesforce. The EBA success is a great example of that.
Tyler Radke: That's helpful. And maybe a follow up for Debbie and apologies I've been jumping around calls, but can you just frame how you're thinking about the relative drivers of the top line growth outlook for FY 2025 between subs growth and pricing and the usual factors that build up to that? Thank you.
Debbie Clifford: Sure. So, we typically are trying to target roughly 50-50 split of growth coming from volume and it's either price mix or margin basically, partner margin is how we think about it. So, across volume and price, again, our target is to do roughly 50-50 in fiscal 2025 that would continue to be our goal. Now there's certainly years where it's going to vacillate between one or the other and we've talked about how this past year our new business was growing slower than we would anticipate in a more normal macroeconomic environment. As we look ahead, we're hoping to get that growth coming from roughly equally across those two, volume and price. So that's how we're thinking about it.
Tyler Radke: Thanks, Debbie.
Operator: Thank you. Our next question comes from the line of Michael Funk of Bank of America. Your question, please, Michael?
Michael Funk: Yes. Thank you for the questions. So first, one of your competitors mentioned pressure on projected seat growth due to the declining ranks of engineers. Are you seeing a similar impact or is that not impacting your customers?
Andrew Anagnost: We are not seeing a decline in our growth rates because of any pressure out there associated with engineers. As a matter of fact, one of the things that's really important because we're moving into design and make processes, we have a pretty broad swath of people that we're able to touch. Also, we continue to displace competitive products, especially with Fusion in the manufacturing space. So, we're not seeing that kind of effect declining bases. We do see customers at times optimizing their installations with Autodesk to try to right size things, but not because they're downsizing their employment base.
Michael Funk: Thank you for that. Then one for you Debbie, and thank you for the clarity and moving pieces in 2025. In the press release, you mentioned that the guidance for growth in 2025, you said adjusting for FX, EBA acquisitions, transaction model you gave additional data points on the call, is the right way to think about it that guidance, constant currency ex-EBA transaction model and acquisitions is basically 9.5% to 11.5% growth rate in 2025, is that the right very basic math?
Debbie Clifford: So what we talked about was a point of headwind from FX, a point of headwind from the absence of EBA true-ups, half a point of tailwind from acquisitions, and a point of tailwind from the new transaction model. So the net effect of that is half a point. So, yes.
Michael Funk: Great. Thank you very much.
Operator: Thank you. Our next question comes from the line of Stephen Tusa of JP Morgan. Your question please, Stephen.
Stephen Tusa: Hey, guys. Congrats on a good quarter. What would do you think is in the kind of crystal ball to drive you to the low end of the range? Like what are you concerned about that you can see today? I assume that's part of the macro, but what within the macro would get you to the low end of the range?
Debbie Clifford: We'll continue to watch that new business grow. That's something that we're laser focused on and if macroeconomic conditions were to shift, then that would be probably one of the first things that we'd be impacted and that can take us to the lower end of the range. We're watching end market demand pretty closely so that's why we talk about bid activity on BuildingConnected and it continues to be at record highs. But of course, if that were to take a turn, that can have an impact on us. And then we monitor these sentiment that we're hearing from our channel partners to understand how they're seeing end market demand and what the impacts might be for our business. So, those are the types of things that could inform whether or not we would be at the lower end of the range.
Stephen Tusa: Okay and just to be clear, I thought it was when you went through some of the other moving parts on guidance that it netted out to kind of a point of tailwind. I guess you're throwing in the EBA true ups, or at least adjusting those out to get to an underlying rate. Is that part of the calc there?
Debbie Clifford: Yes. And sorry to go back to the last question, because there's a lot of moving parts here, and it has been confusing. So for revenue in the guide, it's 1 point of headwind from FX, 1 point of headwind from the absence of EBA true-ups, 0.5 point of tailwind from the acquisitions, and 1 point of tailwind from the new transaction model, which is a net negative. So net 0.5 negative headwind as we look into the guide for fiscal 2025.
Stephen Tusa: Okay. And then just one last quick one on the subs. I guess they're up 12 for the year, if I have that number right. Your constant currency was 13 can you maybe explain what you mean by half coming from volume and half coming from price? It seems like that's a lot from -- much more from volume there maybe there's some mix or something like that?
Debbie Clifford: Yeah, there's definitely mix effects. And like I said, our target is to have it be roughly 50-50 between volume and price. But in any given year, we're going to have some puts and takes between that. But when we think about our guidance for fiscal 2025, we're targeting that 50-50 mix again.
Stephen Tusa: Okay, great. Thanks a lot.
Operator: Thank you. Our next question comes from the line of Nay Soe Naing of Berenberg. Your question, please Nay.
Nay Soe Naing: Hi, everyone. Thank you for taking my questions. I've got two, if I may. Starting with you mentioned a lot of positive developments in the products like ACC BuildingConnect and the Fusion 360. I was wondering how we should think about that when it comes to your make revenue. And if we look at the growth rates in make segment, it's been consistent around 17% on constant currency for the past three quarters. Is there a possibility with all the positive developments that the make revenue will go back to growth rates in the 20s going forward? That was my first question. And the second question is on the new transaction model, please. I think Debbie, you mentioned that you're expecting 1 percentage point of growth tailwind from the new transaction, FY 2025, which will equate about $55 million and then the slide deck you mentioned there's about $600 million of reseller commission in total. So the remaining $450 million or so -- sorry, apologies, $550 million or so, will that all come through in FY 2026, or will it take longer for all the contra revenue to flush through in your P&L? Thank you.
Debbie Clifford: So a couple of things. So first sorry, you were a little bit garbled and coming through, so we didn't quite get the first question and we'll go ahead and try and take those in the callbacks. But when we think about the new transaction model and the $600 million, I think the most important things to take away are the $600 million is a good number to model with. As you think about how to model the business during the transition and the pace at which you'll see the new transaction model cost, that $600 million bleed into revenue and expense over time is really going to be dictated by the pace of the rollout. And so, think of it as something that's going to be bleeding into revenue and expense over the next couple of years.
Nay Soe Naing: Right. I think at the previous quarter you mentioned it would take about two years to implement this new transaction model. So, presumably this total $600 million bleeding into revenue and cost will take longer than two years to complete in totality?
Debbie Clifford: So the act of transitioning, the invoicing will take approximately two years to complete. But remember that we recognize revenue over approximately one year. So it's going to be a little past that when the invoices at the higher amount bleed into revenue.
Nay Soe Naing: Right. Okay, understood. Thank you. My first question is around the make revenue. The growth rates has been consistent around 17% past three quarters. Should we expect that to go back to the 20% plus that we had in the past given the positive developments around the products like BuildingConnect or ACC or Fusion 360?
Debbie Clifford: Our goal would be to drive greater growth from the make revenue line. That's going to be an important aspect of our ability to achieve our target 10% to 15% growth algorithm over time and it's an area where we've been making incremental investments. So, we anticipate that, that revenue growth rate is going to be higher than the core business.
Operator: Ladies and gentlemen, as that is all the time we have for Q&A today, I would now like to turn the call back to Simon Mays-Smith for close remarks. Sir?
Simon Mays-Smith: Thank you everyone for joining us. We look forward to seeing many of you on the road over the coming weeks and at our Q1 conference call later in the year. Thanks very much.
Operator: This concludes today’s conference call. Thank you for participating and you may now disconnect. | [
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{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator. And good afternoon. Thanks for joining our conference call to discuss the fourth quarter and full year fiscal 2024 results. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. During this call, we will make forward-looking statements including outlook and related assumptions, products and strategy. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon. And welcome, everyone, to the call. We finished the year strongly, delivering 40% constant currency revenue growth in the fourth quarter of fiscal 2024. Resilience, discipline and opportunity again underpinned our robust financial and competitive performance. Autodesk's resiliency comes from its subscription business model and its product and customer diversification, which balances growth across different regions and industries. Renewal rates remained strong. And new business growth and leading indicators were consistent with recent quarters. Despite ongoing macroeconomic policy and geopolitical headwinds, we saw growing usage, record big activity on BuildingConnected and cautious optimism from channel partners. Disciplined and focused execution and strategic capital deployment through the economic cycle enables Autodesk to realize the significant benefits of its strategy, while mitigating the risks of having to make expensive catch-up investments later on. With the new transaction model, we are approaching the final phase of modernizing our go-to-market motion, which has involved updating our infrastructure, retiring old system to end business models, and building more durable and direct relationships with our customers and ecosystem. At the same time, we are advancing a multi-year process to develop lifecycle solutions within and between our industry clouds, powered by shared platform services and with Autodesk's data model at its core. Together, these will enable Autodesk, its customers, and partners to create more valuable, data-driven and connected products and services. Having led the industry in general design, we are leading again in 3D generative AI. Autodesk is getting closer to a transformational leap where Autodesk AI is to [three] (ph) design and make where ChatGPT is to language. Our new multimodal foundation models will enable design and make customers to automate low-value and repetitive tasks and generate more high-value complex designs more rapidly and with much greater consistency. We can already generate 3D representations from images 10 times faster and with faster higher-quality and currently available through the AI. We're bolstering our homegrown capabilities and data with partnerships and acquisitions in existing and adjacent verticals. Our recent bidirectional integration of fusion with cadence and the acquisition of payouts are good examples. Discipline and focus on executing our strategy and deploying capital also underpin our opportunity. Our go-to-market and platform initiatives will drive even greater operational velocity and efficiency within Autodesk, which will free up further resources to invest in our industry clouds and capabilities, including AI and sustained margin improvement. And with a modernized go-to-market motion, lifecycle solutions and platform services, Autodesk will fulfill its potential to break down the silos within and between manufacturing, AEC and media entertainment, enabling our customers to unleash their data and design a better world built for all. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for fiscal 2025, I'll then come back to update you on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. Our financial performance in the fourth quarter and for the fiscal year was strong, particularly in our enterprise business. Early renewals and strong upfront revenue from enterprise business agreements or EBAs and federal governments drove some of the outperformance relative to our expectations in both Q4 billings and revenue. Overall market conditions and the underlying momentum of the business were consistent with the last few quarters. Total revenue grew 11% and 14% in constant-currency with upfront revenue driving 2 percentage points of that growth. By products in constant currency, AutoCAD and AutoCAD LT revenue grew 7%, AEC revenue grew 18%, manufacturing revenue grew 16% and M&E revenue was up 8%. AEC and manufacturing benefited from EBA true-up and upfront revenue. By region in constant currency, revenue grew 19% in the Americas, 11% in EMEA and 8% in APAC. Direct revenue increased 19% and represented 39% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the Autodesk's store. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. Billings declined 19% in the quarter, resulting from the transition from upfront to annual billings for multiyear contracts as expected. So, slightly offset by some early renewals in North America. As part of our implementation sequencing for the new transaction model, we shifted our North American price increase from the end of March to the beginning of February. This resulted in some renewals moving from Q1 fiscal 2025 to Q4 fiscal 2024 which modestly boosted billings in January. Total deferred revenue decreased 7% to $4.3 billion and expected result of the transition from upfront to annual billings for multiyear contracts. Total RPO of $6.1 billion and current RPO of $4 billion grew 9% and 13% respectively. Early renewals drove about 1 percentage point of current RPO growth. Total RPO growth decelerated in Q4 when compared to Q3 when we closed our largest-ever EBA. The year-over-year deceleration was due to the lower mix of multiyear contracts in fiscal 2024 when compared to fiscal 2023, which I mentioned last quarter. In line with recent quarters and our expectations, we again saw some evidence of multiyear customers switching to annual contracts during the quarter. Turning to the P&L, GAAP and non-GAAP gross margin were broadly level, while operating margin was modestly lower in the fourth quarter, primarily due to the timing of Autodesk University costs shifting from Q3 to Q4, which we flagged last quarter. As expected, full-year non-GAAP operating margin was level year-over-year but up about one 1 percentage point at constant exchange rates. Fourth-quarter GAAP operating margin was up 40 basis points year-over-year and about 1 percentage point at constant exchange rates, partly due to a reduction in stock-based compensation as a percent of revenue. At current course and speed, the ratio of stock-based compensation as a percent of revenue peaks in fiscal 2024. We expect it to fall to 10% or lower over time. Free cash flow for the quarter and full year was $427 million and $1.28 billion respectively with early renewals, providing a modest tailwind in the fourth quarter. The most significant free-cash-flow headwinds from our transition from upfront to annual billings for multiyear contracts are now behind us, which means our free-cash-flow through during fiscal 2024 and will mechanically rebuild over the next few years. Turning to capital allocation. We continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long-term shareholder value. As you heard from Andrew, we continue to invest organically and through complementary acquisitions to enhance our capabilities and the industry clouds and platform that underpin them. During the quarter, we purchased approximately 300,000 shares for $63 million at an average price of approximately $217 per share. We have now offset estimated dilution from our stock-based compensation program well into fiscal 2026. We will continue to repurchase shares opportunistically to offset dilution from stock-based compensation when it makes sense to do so. Now let me finish with guidance. Overall, end-market demand has remained pretty consistent over the last few quarters. Macroeconomic and one-off factors like the Hollywood writer strike dragged on the new business growth rate during fiscal 2024 and will modestly drag on revenue growth in fiscal 2025, but Autodesk's resilience and robust underlying demand for its products and services reinforce its long-term growth potential. Turning to revenue. I want to highlight four key puts and takes impacting growth in fiscal 2025. First, let me talk about the new transaction model. We've added some slides to the earnings deck to help illustrate how to think about this shift, which I'll briefly summarize. The new transaction model enables Autodesk to build closer, more direct relationships with its customers and partners and to better understand and serve them with more data, more self-service and greater predictability. It will be a cornerstone of the data services that Andrew talked about earlier. As you can see from Slide 11, the transition mechanically drives higher revenue and costs is broadly neutral to operating profit and free-cash-flow dollars and is a headwind to operating margin percent. About $600 million of payments made the resellers and developed markets in fiscal 2024 were accounted for as contra-revenue. As this business moves to the new transaction model, these payments will shift to marketing and sales expense over the next few years, all else equal, with the timing of cost recognition not materially different than before. The change affects a substantial majority of our business, but note that emerging markets and our federal government business will remain on the buy-sell model for the foreseeable future. The pace of the shift will primarily be determined by the mechanical build from ratable subscription revenue accounting and the rate of regional rollout of the new transaction model. While the former is relatively easy to predict given the ratable revenue recognition of our subscription business model, which fills over time, the latter will in part be determined by what we learn as we roll out the model further. We gained useful insights from the successful rollout in Australia, and we're expecting to learn more as we roll out with much higher volumes in North America this year. We will be able to apply those learnings when we launch in EMEA. Our fiscal 2025 guidance assumes the new transaction model is deployed in North America in Q2 of fiscal 2025 and provides about a 1 percentage point tailwind to Autodesk's revenue growth and a 3 points to 4 point tailwind to billings growth. Second, the acquisition of payouts, which closed on February 20th, is expected to contribute about 0.5 point of revenue growth in fiscal 2025. Third, token consumption for the fiscal 12021 EBA cohort exceeded consumption predictions made during the pandemic which resulted in true-up payments in fiscal 2024. Token consumption and the smaller post-pandemic fiscal 2022 EBA cohort is tracking more in line with predictions, which means we expect fewer true-up payments in fiscal 2025. This pandemic echo effect is about a point of headwind to fiscal 2025 revenue growth. And fourth, our rolling four-quarter foreign-exchange hedges means that FX is expected to be about a 1 percentage point headwind to reported revenue growth in fiscal 2025. Bringing this altogether, we expect revenue of between $5.99 billion and $6.09 billion in fiscal 2025, which translates into a revenue growth of about 9% to 11% compared to fiscal 2024. Adjusting the midpoint of our guidance to exclude noise from the new transaction model, acquisitions, the absence of EBA true-up revenue and FX, we expect underlying revenue to grow more than 10% in fiscal 2025. Moving on to margins. We're going to manage our non-GAAP operating margins between a range of 35% and 36% in fiscal 2025, with the goal of keeping them roughly level with fiscal 2024. This means we expect a roughly one-point underlying margin improvement will be broadly offset by the margin headwind from the new transaction model. As we transition to the new transaction model, we'll see operating margin headwinds from the accounting change of moving reseller costs from contra-revenue to sales and marketing expense. We'll also have incremental investment in people, processes and automation. But over the long-term, we expect that this transition to the new transaction model will enable us to further optimize our business, which we anticipate will provide a tailwind to revenue, operating income and free-cash-flow dollars, even after the incremental costs we expect to incur. Moving on to free cash flow, we expect to generate between $1.43 billion and $1.5 billion of free cash flow in fiscal 2025. In Australia, some channel partners accelerated renewals ahead of the transition to the new transaction model to derisk month one of the transition. Because the new transaction model will be rolled out in Q2 in North America, it may be that the behavior we saw in Australia occurs also in North America, which may accelerate billings and free cash flow to earlier quarters, but should not materially change the outlook for the year. Excluding $200 million from fiscal 2024 free cash flow from multiyear upfront billings, which are now billed annually, in fiscal 2025, we expect free cash flow growth of about 35% at the midpoint of our guidance. We expect faster free-cash-flow growth in fiscal 2026 because of the return of our largest multi-year renewal cohort, the mechanical stacking of multiyear contracts billed annually and a larger EBA cohort. As we navigate the new transaction model transition, the pace of the rollout will create noise in the P&L. So we think free cash flow is the best measure of our performance. At current course and speed, our free cash flow estimate for fiscal 2026 at the midpoint is approximately $2.05 billion, which is in line with consensus estimates. In the context of significant macroeconomic, geopolitical, policy, health and climate uncertainty, the mechanical rebuilding of our free cash flow as we transition to annual billings for multiyear contracts gives Autodesk an enviable source of visibility and certainty. We continue to manage our business using a Rule-of-40 framework with a goal of reaching 45% or more over time. We are taking significant steps toward our goal this year and next. We think this balance between compounding growth and strong free-cash-flow margins, captured in the Rule-of-40 framework is the hallmark of the most valuable companies in the world and we intend to remain one of them. The slide deck on our website has more details on modeling assumptions for Q1 and full-year fiscal 2025. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Let me finish by updating you on our strong progress in the fourth quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction fueled by customers consolidating onto our solutions to connect and optimize previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions, encompassing design, preconstruction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the mid-market. As a sign of that growing momentum, we closed a record number of deals over 100,000 and $1 million in construction accounts in the United States and worldwide during this quarter. Let me give you a few examples. First, Vinci, a world leader in concessions, energy and construction has been leveraging Autodesk solutions to streamline its operations and drive international expansion. With a platform approach, Revit customization and BIM as a standard practice, Vinci has achieved significant time savings annually and captured more business abroad. In Q4, Vinci renewed its fourth enterprise business agreement with Autodesk, expanding the deployment of Autodesk Construction Cloud on major projects to further integrate its data and workflows, and ensure a seamless transition from design through construction. Second, after a competitive RFP process early in the year, Fortis Construction, an ENR 400 firm based in Oregon ran a thorough peer assessment and selected Autodesk Construction Cloud for a six-month pilot. With the confidence gained during the pilot and close alignment between the construction technology vision and Autodesk roadmap to a connected design-build-operate platform, Fortis committed in Q4 to a multi-year agreement across preconstruction and construction. And third, the Pennsylvania Department of Transportation recently chose Autodesk Construction Cloud as the primary tool powering its project delivery collaboration center, which will manage the project delivery of infrastructure projects in the state, in large part due to our software-inclusive open ecosystem. Again, these stories have a common theme, managing people, processes and data across the project lifecycle to increase efficiency and sustainability, while decreasing risk. Overtime, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. With the acquisition of Payapps, Autodesk will embed payment and compliance management into the project lifecycle. It can take an average of 83 days for subcontractors to get paid after putting work in place. And because of the risk, many will not bid on a project if a general contractor or an owner has a reputation for slow payments. Our goal is to leverage technology that eases the burden of construction payment management in a simpler, faster and more efficient process for all construction project stakeholders. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate our design and make platform to grow their business and make it more resilient. In automotive, we continue to grow our footprint beyond the design studio into manufacturing and connected factories as automotive OEMs connect data and shorten hand-off to the design cycle. In the US, a leading manufacturer of leveraged AEC Solutions Fusion and Autodesk platform services to develop a connected factory, it delivered a much greater ROI to significantly faster design durations, product prototyping and data federation. Due to expanded EBA signed in Q4, it is exploring using VR studio tools in customization and increasing its adoption of Autodesk Construction Cloud to bring its new factories to life. We continue to serve some of the largest manufacturers in the world with a full breadth of our portfolio, as they design and make both products and factories. One of the largest private manufacturers in the US leverages our advanced manufacturing portfolio including Fusion, PowerMill and Moldflow, which has helped reduce rework in plastic designed by 20%. To build clean-energy solutions, it utilizes our AEC collection, including BIM metadata, assembly breakout and installation instructions for its building products. In Q4, the customer increased its EBA with Autodesk, and plans to expand our partnership beyond Revit and Autodesk Construction Cloud to support the digitalization of its factories. Fusion remains one of the fastest-growing products in the manufacturing industry and ended the quarter with 255,000 subscribers, driven by the growing number of customers who recognize the value of cloud-based workflows, enhancing efficiency, sustainability and resilience within their organization. As the breadth and depth of Fusion features and capabilities expand, we're beginning to drive adoption by larger companies and sort of higher-value segments of the professional market through expansion. As we do this, commercial subscriptions will become less complete indicators of Fusion's performance relative to the value we can realize in our reporting or change to reflect that. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. In the fall, the University of Delaware selected Fusion for more than 600 students to use in its introduction to engineering class, replacing a competitor's solution. Fusion was chosen because it facilitated better team collaboration, was easily adopted thing to available teaching resources and provided a single integrated platform to learn CAD, stimulation and CAM. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. In Q4, an American pharmaceutical company looked to understand its own usage better and ensure remains compliant in the transition to our named user model. In collaboration with our license compliance team, a preventative audit was conducted to identify risk areas and construct the combination of subscriptions and Flex tokens for continued access. It is also taking the opportunity Flex enables us to trial new products from our portfolio, resulting in an annual spend increase of more than 30%. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. Time and again, our success in executing strategic transformation and added new growth vectors, built a more diverse and resilient business, forged broader, trusted and more durable partnerships with more customers and given Autodesk a longer runway of growth and free-cash-flow generation. We are building the future with focus, purpose and optimism. Operator, we would like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question, please Saket."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hey Andrew, hey Debbie. Thanks for taking my questions here and nicely done."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Sakit."
},
{
"speaker": "Andrew Anagnost",
"text": "Thanks, Sakit."
},
{
"speaker": "Saket Kalia",
"text": "Hey, guys. Andrew, maybe just to start with you, you talked a little bit more about generative AI on this call, which was great to hear. Maybe just to make sure the question is asked, can you just talk about what your sort of core engineering customers are saying about generative AI? And I'm sure it's a very long discussion, but how do you think about the value that Autodesk can provide sort of on that journey?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So first off, Saket, let me make it clear that, it’s our intent to be the market leader in generative AI, just like we were in generative design over 10 years ago. So we intend to lean into this pretty heavily. Our AI lab has been in existence since 2018, it's been where some of the core research that's contributing to some of the things I talked about in the opening commentary came from. But also, we've been delivering AI in our products for several years now -- we just released drawing automation into Fusion, which allows people to automate manufacturing drawing stacks, which is a very labor intensive effort, and it's a high productivity driver for our customers. So, in terms of what our customers are saying to us. One, they're looking for the productivity increases. They're asking what are they going to look like, what kind of productivity increases are you going to deliver to this, and how are you going to use our data to deliver those productivity increases. Now, in terms of how we're going to do this is, there's two avenues that we're going to be approaching here. One is going to be more disruptive to how our customers work and the other one is going to be basically automating the capabilities and workflows they have today. We have to do both. Both have different value levers, both will have different adoption curves. Some of the things I talked about in the opening commentary about some of our new tools for generating 3D models from photographs or for incomplete 3D models, those are disruptive approaches that set up initial model ideas for our customers and allow them to do things initially with a blank slate kind of concept, where they create a model from specifications and requirements. We haven't released any of that yet, we will at some point release that to a private beta. But right now it's just something we're really proud of and we think is really important. That's an important disruptive technology. The other technologies are also going to look a lot like what we did with Fusion drawing automation. There are going to be tools that take the complexity of delivering and creating a 3D model and all of its outputs to a process and take it from months to weeks or sometimes even days and that's going to make customers who are currently using these tools maybe slower in the adoption of more disruptive tools, incredibly more productive. Both avenues are valid, both are important, and both are areas that we're focusing on."
},
{
"speaker": "Saket Kalia",
"text": "Got it. That makes a lot of sense. Debbie, maybe for my follow up for you, Autodesk obviously provides a lot of value to its customers, which you're also able to capture as well. Maybe the question is, can you just talk a little about some of the recent pricing actions that have been out there? And what sort of customer behavior that might drive as a result? I think there was a little bit of difference in pricing, sort of between one year and multi-year subscriptions. How do you think about that impacting the model, if at all, going forward?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So let's start first with what we did. So there's a couple of things that are going on. We did about a 3 point increase for market factors and then we did a 5% increase for renewals. With market factors this was something that we've been talking about for a while. Our goal is to streamline pricing around the world. And then for the renewals price change before the increase, we had a 10 point price differential between new and renewal and with this move to agency or the move to the new transaction model, we don't see as much of a need for that delta. In Q4 what we did was, we moved up the timing of the price increase so that we could better sequence things with the new transaction model coming and that led to some early renewals down the stretch. That's part of what gave an extra point of growth to current RPO. But the price increase overall was most helpful to billings, but it wasn't material to revenue and free cash flow."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very helpful. Thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Adam Borg of Stifel. Your question please, Adam."
},
{
"speaker": "Adam Borg",
"text": "Great. And thanks much for taking the question. Maybe on the transactional model and thanks guys for all of the disclosures around it. Maybe talk a little bit more about the learnings you have from the early customer and partner feedback in Australia and even now that you have the early days of this direct relationship, anything interesting there that you're learning from your more direct relationship with customers, be it usage or adoption or expansion that you clearly didn't have before with the prior model? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Thanks, Adam, for that question. First off, let me just reinforce something here, because I want to make sure that we're all on the same page here about why we're doing this, right? This is a critical part of a relentless, ongoing modernization of Autodesk business, getting us ready for the long term success we expect in a world of AI driven, cloud-based solutions for design to make lifecycles, right? It's a necessary step in this. It's the last big one in our journey of all the ones we've done at this point, and it really has some big benefits for our customers, long term. One, it's going to allow us to understand them a lot better in ways that we can't currently understand them because don't have the full account record of what the customer is doing. Two, it's going to allow us to deliver a lot more self service capability to these customers. And three, it's going to turn our partner channel into design made collaborators and consultants for our customers with their own unique IP and their own services and away from transaction partners. So it's critical that we kind of get on the same page of that. With regards to Australia, we actually did learn a lot, right? Mostly about the transactions at this point because it was only for a quarter and a little bit. It didn't necessarily have direct impacts on customer behavior. But what we did learn we've now put into the process. In fact, we actually delayed our US rollout by 30 days based on some of the learnings during the Australian process. We changed our roadmap for some of the capabilities, updated and upgraded some of the capabilities in the transaction systems to kind of correspond with some things we saw in Australia. And we also kind of delivered some new enablement materials for partners and frankly for customers as well, so they understand how this transaction model impacts their relationship with Autodesk. So we definitely took the learnings to the bank to make sure that we were better prepared and we even gave ourselves a little bit more time, based on what we learned to finish up a few things that we think are going to be impactful."
},
{
"speaker": "Adam Borg",
"text": "That's great. And maybe just as a quick follow up, you talked about some success with state DoT, as you think about kind of the infrastructure bill and the stimulus that continues to be deployed. Maybe just give a quick update on Innovyze and just a quick State of the Union there and the opportunity as part of the broader infrastructure push. Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yea, so you'll probably hear us use the word -- name Innovyze a lot less and talk a little bit more about Autodesk Construction or water solutions moving forward, all right. So I just want to be clear about that. Water is and has been a big part of our EBA successes. Larger customers are adding water solutions. I think there's an obvious reason for that. Water is just as important as it was before, if not more so. I think you're probably aware that in California, we just had yet another kind of flood where people didn't expect to have floods in San Diego and that's all because water management infrastructure is moving water in the wrong places. So people need to build and rebuild water infrastructure of all types, water scarcity, water purity, all of these things. Water is going to be a big business moving into the future and it's continued to enhance some of our EBAs with that respect. Since you mentioned infrastructure in general, I just want to kind of point a little bit to something that you heard in the opening commentary about PennDOT, all right. I think that's a really important story about what's going on there. Why is PennDOT choosing our solutions? What's going on? Because of the infrastructure bill and some of the money that was put in the infrastructure bill to help some of these Departments of Transportation understand how to invest in the future, PennDOT looked at its portfolio of tools, they looked at the future, they looked at what they need going out 10 years, 20 years in the future, what kind of modern stacks they want to work on, and they chose to move to our solutions and incorporate more of our solutions in their environment. That's an important first step in what we're trying to do. We want to be part of modernizing these Departments of Transportation with the kind of modern staff that we've created in the end-to-end design to make solutions. That's another vector here to pay attention to as the infrastructure boom kind of continues to roll out into the United States."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks for all the details."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin securities. Your question please, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good afternoon. Andrew, first question concerns the transaction model and what I'd like to ask about is relating the operational and transactional and accounting systems and compensation systems that you've put in place relative to the scale of your volume. You added well over 700,000 subscriptions in fiscal 2024, more than you added in fiscal 2023. You've spoken of certain growth expectations for volume over time. So, maybe help us understand the capacity that you have in place now to support the long term volume growth expectations that you have, because undoubtedly you're looking to do substantially more subscription additions than you did in fiscal 2024."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Jay, obviously the modernization of Autodesk and its back office infrastructures isn't just about rolling out the new transaction model and the kind of the nuts and bolts of that. It's actually about increasing our internal capacity to do these things at scale, which is exactly what we were trying to test in Australia, in the various environments and that we've been testing since then. So, we are very confident that we've not only built a transaction environment, but a cascading set of capabilities that allow us to scale significantly as we move forward. Because you're right, we intend to get deeper and deeper into people's design and make processes and that's going to increase the amount of subscriptions that are being used downstream in other types of make processes and we have to be able to operate at scale. So this is not just a new transactional model modernization effort. It's a full scale modernization effort inside of Autodesk that captures all aspects of this. And the good thing about the cascading rollout, the way we're doing it this year with the US first, is again we're going to get yet another test on the volume and capacity of the systems that allows us to understand where we're at before we go live with the next level of rollout and volume capture. But just know that this is more than just a transaction model. It is a full scale modernization of what's going on under the hood at Autodesk."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Yes. Understood. Second question concerns products and technology. When we think back to the various product sessions and roadmap sessions that you talked about at AU a few months ago, what do you think are the critical executables -- product deliverables that you're aiming for, for this year either in terms of improving upon or expanding the existing products, such as Revit or other new tools?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, so I'll just hit a few here okay. First off, in manufacturing, the critical thing that really needs to happen this year for Fusion, for example, is we have to improve our capability to help move Fusion from small teams in the design and make part of the business, all the way up to supporting full scale engineering team. So basically scaling the size of installations inside of our customer base with Fusion. That's going to be through a combination of things we do with our cloud based data management solutions as well as some of our AI-based solutions which basically attract people to the product because of the productivity enhancement. But that is definitely an important effort. There's a second ancillary effort with regards to the Fusion around ensuring that our partnerships with companies like Cadence and the internal EDA capabilities we built in the Fusion set us up for a boom in smart products. We want to be the solution that people choose for smart products. We built enough capability into Fusion that people can get a certain way end-to-end with Fusion and we're partnering to make sure that when things get more sophisticated, we're able to move up into the more sophisticated processes associated with these smart products. Now, when it comes to Forma, Forma and Fusion kind of dance together here and one of the things that -- it's really important to do as we move into this year is make sure that Forma and Revit play together as our customers try to move forward as they adopt Fusion and also as they use Revit more collaborative in the cloud, that these two products work together in some way, that they exchange data and interoperate in ways that nobody else can achieve. Because the truth of the matter is, the work that people are doing with Revit isn't going away. It's a huge amount of what they do and we need to make sure that, that work is more efficient in a formal world. So, look for us to not only increase the capabilities of Forma, but increase its relationship with Revit as well, which I think is really important. The last thing I'll say, just around media and entertainment is, we have to continue to take what we're doing with regards to moving beyond post production special effects into full production management, script-to-screen capabilities for our customers in the filmmaking industry and make some of that real with the flow platform and that's really the big goal for the media entertainment team, is to make flow real this year and help our customers really see possibilities of integrating new types of complex solutions on top of a single production management environment."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Very good. Thank you Andrew. Thank you Debbie."
},
{
"speaker": "Andrew Anagnost",
"text": "You're very welcome."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Joe Vruwink of Baird. Please go ahead Joe."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi everyone. Thanks for taking my questions. I wanted to ask -- so Autodesk has framed growth rates over the long arc of time in that 10% to 15% range. 2025 guidance is obviously holding to the 10%. When you think about 10% conceptually, is that ultimately, as you would expect, just given the nature of your businesses being exposed to certain end markets that are perhaps now closer to their bottoming or troughing point in a given cycle? And if that maybe is the case and this is the bottoming point, what indications are you watching over coming quarters to maybe set the stage for a recovery scenario, which, of course, your markets typically do after they reach that bottoming point?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks. So, we continue to target that 10% to 15% revenue growth algorithm and you're right, the midpoint for fiscal 2025 was right at that 10% coming off a year where we did 13% growth in constant currency. And really what we've said is that where we end up in that 10% to 15% range is going to be contingent upon the macroeconomic backdrop that we operate in, as well as our ability to harvest the opportunities that we have before us across AEC, manufacturing and so on. And so, the things that we're watching as we proceed through this year with that 10% midpoint are some of the things that we've been talking about for a while now. So, new business growth is really important indicator of future revenue performance for the company and we said in this last quarter that new business growth grew, but it was relatively soft, consistent with what we had seen over the previous several quarters. So, definitely being impacted by macro and that's one of the factors that's driving the 10% revenue growth midpoint in fiscal 2025, so we'll continue to watch that closely. We also watch product usage, we watch bidding activity on our BuildingConnected platform, and we stay close to our channel partners, try and understand what they're seeing in terms of their demand. So those are the things that we're going to be watching to see how this year progresses and beyond."
},
{
"speaker": "Joe Vruwink",
"text": "Okay thanks. That's helpful. And then I wanted to follow-up on the free cash flow. I think I heard $2.05 billion for fiscal 2026. At one point there was a comment that the progression between FY 2024 and 2026, that was going to be linear, of course, if you normalize for that $200 million effect benefit last year and then comes out this year. I guess as I look at that and the $2.05 billion, it's not quite linear. It would seem like FY 2026 is actually maybe a bit stronger. Did something change in kind of the modeling out of the progression? Just any color there?"
},
{
"speaker": "Debbie Clifford",
"text": "Nothing's changed Joe. So we said that we anticipate that cash flow would grow greater in fiscal 2026 than what we saw in fiscal 2025. And when you think about modeling the growth rate, just remember that you have to remove the $200 million in fiscal 2024 before we stopped selling multi-year contracts upfront."
},
{
"speaker": "Joe Vruwink",
"text": "Okay, I'll leave it there. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets. Your line is open, Jason."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks for taking my question. Maybe first for Andrew, just on the acquisition of Payapps and they were a great partner of yours. Just curious on what drove the decision to acquire them outright versus just extending the partnership? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. All right, so since you opened up the door there, let's talk a little bit about construction in general, because I think it's important to kind of highlight what's been going on there. We had a great EBA quarter for construction. Construction saw strong growth in our largest accounts, which is really important for the long term health of construction. And at a really high level we also saw an increase in $100,000 deals and $1 million deals both in the US and internationally and that's really important. And this is where -- one of the things where Payapps comes in, right? Remember, we're going end-to-end with our solutions here from design all the way to make. And we want to make sure that we get into the preconstruction planning and other types of our customers processes. It takes 83 days for our customers to process payments in their environment that's just too long. Now, we're not getting into the transaction business. What we're doing is, we're getting into the business of helping them automate and track those payments across their entire life cycle so that they can get, quicker return, reduce that 83 days to be faster, and increase their cash flows. This has to be something we tightly integrate into our solution. So, we intend to tightly integrate this in just like we rebuilt some of the other solutions we acquired previously into what is today Autodesk Build, which is a new modern platform for doing some of these things. So we thought it was very important to own this so that we can integrate it. And then we went out there and we bought a premium asset. It's a leader. It's a global leader in payment processors. It's not a small company, it's not what we could afford, it's what we needed. And I think that's really important. So, when we look forward at construction right now, we see tools like this being critical as well as our pre-construction tools and we actually see the deal cycles maybe getting a little longer, but we're competing head-to-head a lot more. And I want to again highlight that Fortis deal out of Oregon, which was a head-to-head competitive deal with a pilot period that ended up going fully to Autodesk. So what we see right now in our business is building momentum driven by the end-to-end solution and kind of acquisitions, like Payapps as well. So, when we look forward into next year, we don't see deceleration of the business, we see acceleration."
},
{
"speaker": "Jason Celino",
"text": "Okay. No, that's very helpful. And then my quick follow up for Debbie. Sorry if I missed it, but the 13% constant currency growth we did this year, did you mention how much was from the strong renewal cohort and then maybe any upfront revenues? I'm just trying to understand the several points of decel embedded in the 2025 guide? Thanks."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So the early renewal cohort didn't have any impact to revenue really, that had more of an impact on billings than it would have on revenue. And then the strength that we saw in enterprise represented about 1 point of growth."
},
{
"speaker": "Jason Celino",
"text": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead Tyler."
},
{
"speaker": "Tyler Radke",
"text": "Yes. Thanks for taking the question. Along the similar lines of Jason's question on construction Andrew. I'm just wondering if you could provide us an update on the go-to-market changes that you made, I believe last year and how you're expecting that business and you talked about acceleration, obviously make revenue is growing in the teens. Is this a business you think can be 20% over the medium term? Just help us frame what you're seeing both from the go-to-market and pipeline perspective? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, as you know, last year was the full year of integrating the sales force back into the mainline sales force. We went through some of the integration efforts to do that. There were obviously some slowdowns in the business related to integration of those things. Those things are past us now, the business is fully integrated. It's starting the year off, not only fully integrated from the get-go, but with all of the processes, plans and capabilities all lined up according to how we want to grow the business heading into the year. And one of the things I wanted you to notice in my previous commentary is that, we're seeing deal activity going up. So, the pipeline is actually firming up really well and we're in more deals and some of these deals are more competitive, but we embrace that because when we're in a competitive deals, that means we're showing up in places we weren't showing up before because people are calling us in. That's a really important part of this whole entire process. People are starting to ask themselves what solution do they need for the next 10 years, 15 years versus what's available out there today. And the end-to-end capabilities we're delivering, especially leaning more heavily into our preconstruction capabilities, which lock in a lot of the cost and complexity and risk of a construction project, this is where we're leaning into this year and this is where we're going to be driving the growth. So I think we're past integration issues moving forward into pure execution at scale inside the mainline salesforce. The EBA success is a great example of that."
},
{
"speaker": "Tyler Radke",
"text": "That's helpful. And maybe a follow up for Debbie and apologies I've been jumping around calls, but can you just frame how you're thinking about the relative drivers of the top line growth outlook for FY 2025 between subs growth and pricing and the usual factors that build up to that? Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So, we typically are trying to target roughly 50-50 split of growth coming from volume and it's either price mix or margin basically, partner margin is how we think about it. So, across volume and price, again, our target is to do roughly 50-50 in fiscal 2025 that would continue to be our goal. Now there's certainly years where it's going to vacillate between one or the other and we've talked about how this past year our new business was growing slower than we would anticipate in a more normal macroeconomic environment. As we look ahead, we're hoping to get that growth coming from roughly equally across those two, volume and price. So that's how we're thinking about it."
},
{
"speaker": "Tyler Radke",
"text": "Thanks, Debbie."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Michael Funk of Bank of America. Your question, please, Michael?"
},
{
"speaker": "Michael Funk",
"text": "Yes. Thank you for the questions. So first, one of your competitors mentioned pressure on projected seat growth due to the declining ranks of engineers. Are you seeing a similar impact or is that not impacting your customers?"
},
{
"speaker": "Andrew Anagnost",
"text": "We are not seeing a decline in our growth rates because of any pressure out there associated with engineers. As a matter of fact, one of the things that's really important because we're moving into design and make processes, we have a pretty broad swath of people that we're able to touch. Also, we continue to displace competitive products, especially with Fusion in the manufacturing space. So, we're not seeing that kind of effect declining bases. We do see customers at times optimizing their installations with Autodesk to try to right size things, but not because they're downsizing their employment base."
},
{
"speaker": "Michael Funk",
"text": "Thank you for that. Then one for you Debbie, and thank you for the clarity and moving pieces in 2025. In the press release, you mentioned that the guidance for growth in 2025, you said adjusting for FX, EBA acquisitions, transaction model you gave additional data points on the call, is the right way to think about it that guidance, constant currency ex-EBA transaction model and acquisitions is basically 9.5% to 11.5% growth rate in 2025, is that the right very basic math?"
},
{
"speaker": "Debbie Clifford",
"text": "So what we talked about was a point of headwind from FX, a point of headwind from the absence of EBA true-ups, half a point of tailwind from acquisitions, and a point of tailwind from the new transaction model. So the net effect of that is half a point. So, yes."
},
{
"speaker": "Michael Funk",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Stephen Tusa of JP Morgan. Your question please, Stephen."
},
{
"speaker": "Stephen Tusa",
"text": "Hey, guys. Congrats on a good quarter. What would do you think is in the kind of crystal ball to drive you to the low end of the range? Like what are you concerned about that you can see today? I assume that's part of the macro, but what within the macro would get you to the low end of the range?"
},
{
"speaker": "Debbie Clifford",
"text": "We'll continue to watch that new business grow. That's something that we're laser focused on and if macroeconomic conditions were to shift, then that would be probably one of the first things that we'd be impacted and that can take us to the lower end of the range. We're watching end market demand pretty closely so that's why we talk about bid activity on BuildingConnected and it continues to be at record highs. But of course, if that were to take a turn, that can have an impact on us. And then we monitor these sentiment that we're hearing from our channel partners to understand how they're seeing end market demand and what the impacts might be for our business. So, those are the types of things that could inform whether or not we would be at the lower end of the range."
},
{
"speaker": "Stephen Tusa",
"text": "Okay and just to be clear, I thought it was when you went through some of the other moving parts on guidance that it netted out to kind of a point of tailwind. I guess you're throwing in the EBA true ups, or at least adjusting those out to get to an underlying rate. Is that part of the calc there?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. And sorry to go back to the last question, because there's a lot of moving parts here, and it has been confusing. So for revenue in the guide, it's 1 point of headwind from FX, 1 point of headwind from the absence of EBA true-ups, 0.5 point of tailwind from the acquisitions, and 1 point of tailwind from the new transaction model, which is a net negative. So net 0.5 negative headwind as we look into the guide for fiscal 2025."
},
{
"speaker": "Stephen Tusa",
"text": "Okay. And then just one last quick one on the subs. I guess they're up 12 for the year, if I have that number right. Your constant currency was 13 can you maybe explain what you mean by half coming from volume and half coming from price? It seems like that's a lot from -- much more from volume there maybe there's some mix or something like that?"
},
{
"speaker": "Debbie Clifford",
"text": "Yeah, there's definitely mix effects. And like I said, our target is to have it be roughly 50-50 between volume and price. But in any given year, we're going to have some puts and takes between that. But when we think about our guidance for fiscal 2025, we're targeting that 50-50 mix again."
},
{
"speaker": "Stephen Tusa",
"text": "Okay, great. Thanks a lot."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Nay Soe Naing of Berenberg. Your question, please Nay."
},
{
"speaker": "Nay Soe Naing",
"text": "Hi, everyone. Thank you for taking my questions. I've got two, if I may. Starting with you mentioned a lot of positive developments in the products like ACC BuildingConnect and the Fusion 360. I was wondering how we should think about that when it comes to your make revenue. And if we look at the growth rates in make segment, it's been consistent around 17% on constant currency for the past three quarters. Is there a possibility with all the positive developments that the make revenue will go back to growth rates in the 20s going forward? That was my first question. And the second question is on the new transaction model, please. I think Debbie, you mentioned that you're expecting 1 percentage point of growth tailwind from the new transaction, FY 2025, which will equate about $55 million and then the slide deck you mentioned there's about $600 million of reseller commission in total. So the remaining $450 million or so -- sorry, apologies, $550 million or so, will that all come through in FY 2026, or will it take longer for all the contra revenue to flush through in your P&L? Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "So a couple of things. So first sorry, you were a little bit garbled and coming through, so we didn't quite get the first question and we'll go ahead and try and take those in the callbacks. But when we think about the new transaction model and the $600 million, I think the most important things to take away are the $600 million is a good number to model with. As you think about how to model the business during the transition and the pace at which you'll see the new transaction model cost, that $600 million bleed into revenue and expense over time is really going to be dictated by the pace of the rollout. And so, think of it as something that's going to be bleeding into revenue and expense over the next couple of years."
},
{
"speaker": "Nay Soe Naing",
"text": "Right. I think at the previous quarter you mentioned it would take about two years to implement this new transaction model. So, presumably this total $600 million bleeding into revenue and cost will take longer than two years to complete in totality?"
},
{
"speaker": "Debbie Clifford",
"text": "So the act of transitioning, the invoicing will take approximately two years to complete. But remember that we recognize revenue over approximately one year. So it's going to be a little past that when the invoices at the higher amount bleed into revenue."
},
{
"speaker": "Nay Soe Naing",
"text": "Right. Okay, understood. Thank you. My first question is around the make revenue. The growth rates has been consistent around 17% past three quarters. Should we expect that to go back to the 20% plus that we had in the past given the positive developments around the products like BuildingConnect or ACC or Fusion 360?"
},
{
"speaker": "Debbie Clifford",
"text": "Our goal would be to drive greater growth from the make revenue line. That's going to be an important aspect of our ability to achieve our target 10% to 15% growth algorithm over time and it's an area where we've been making incremental investments. So, we anticipate that, that revenue growth rate is going to be higher than the core business."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, as that is all the time we have for Q&A today, I would now like to turn the call back to Simon Mays-Smith for close remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you everyone for joining us. We look forward to seeing many of you on the road over the coming weeks and at our Q1 conference call later in the year. Thanks very much."
},
{
"speaker": "Operator",
"text": "This concludes today’s conference call. Thank you for participating and you may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 3 | 2,024 | 2023-11-21 17:00:00 | Operator: Thank you for standing by, and welcome to Autodesk's Third Quarter Fiscal Year 2024 Earnings Conference Call. [Operator Instructions] I would now like to hand the call over to VP of Investor Relations, Simon Mays-Smith. Please go ahead.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the third quarter results of Autodesk's fiscal 2024. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. Following this call, you can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, products and product capabilities, business models and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials are available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome, everyone, to the call. Resilience, discipline and opportunity again underpinned Autodesk strong financial and competitive performance despite continued macroeconomic policy and geopolitical headwinds. Renewal rates have remained strong and new business trends have been largely consistent for many quarters. Our subscription business model and our product and customer diversification enable that. It means that accelerating growth in Canada has balanced decelerating growth in the United Kingdom. The growing momentum in construction has balanced deteriorating momentum in media and entertainment. And that strength from our enterprise and smaller customers has balanced softness from medium-sized customers. Our leading indicators remain consistent with last quarter with growing usage, record bid activity on building connected and cautious optimism from channel partners. Disciplined and focused execution and strategic deployment of capital through the economic cycle, enables Autodesk to realize the significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments later. As Steve said at Investor Day, we introduced a new transaction model for Flex, which gives Autodesk a more direct relationship with its customers and more closely integrates with its channel partners. We began testing the new transaction model across our product suite in Australia a couple of weeks ago. Assuming the launch proceeds is expected in fiscal '25 and '26, we intend to transition our indirect business to the new transaction model in all our major markets globally. In the new transaction model, partners provide a quote to customers, but the actual transaction happens directly between Autodesk and the customer. The new transaction model is an important step on our path to integrate more closely with our customers' workflows enabled by, among other things, Autodesk platform services and our industry cloud's fusion, forma and flow. Autodesk, its customers and partners will be able to build more valuable, data-driven and connected products and services in our industry cloud and on our platform. The new transaction model is consequential. Many of you will have seen other companies adopting agency models and will already understand the math. In the near term, the new transaction model results in a shift from contra revenue to operating costs that provide a tailwind to revenue growth, while being broadly neutral to operating profit and free cash flow dollars and mechanically result in percent operating margins taking a step or two backwards. Over the long term, optimization enabled by this transition will provide a tailwind to revenue, operating income and free cash flow dollars even after the cost of setting up our building platform. Finally, there is opportunity from developing next-generation technologies and services that deliver end-to-end digital transformation of our design and make customers and enable a better world designed and made for all. I was at Autodesk University last week, alongside more than 10,000 attendees, where we announced Autodesk AI, technology we've been working on and investing in for years. We showed how our design to make platform will automate noncreative work, help customers analyze their data and surface insights and augment their work to make them more agile and creative, but there is no AI without actionable data. And that's why we're also investing in Autodesk platform services, which are accessible, extensible and open via our APIs. Autodesk Platform Services offers several critical capabilities, but data services are the most impactful. These provide the tools that make data actionable. And at the core of our data services is the Autodesk data model. Think of the Autodesk data model is the knowledge graph that gives customers access to the design, make and project data in granular bite-sized chunks. The data chunks are the building blocks of new automation, analysis and augmentation that will enable our customers and partners to build more valuable, data-driven and connected products and services. Autodesk remains relentlessly curious propensity and desire to evolve and innovate. Time and again, well-executed transformation from desktop to cloud from perpetual license and maintenance to subscription has added new growth factors, built a more diverse and resilient business, forged broader trusted and more durable partnerships with more customers and given Autodesk a longer run rate of growth and free cash flow generation. With our transformation from file to data and outcomes from upfront to annual billings and from indirect to direct go-to-market motion, we are building an even brighter future with focus, purpose and optimism. Our customers are also committed to transformation and Autodesk is deploying automation to increase their success in an environment with ongoing headwinds from material scarcity, labor shortages and supply chain disruption. That commitment was reflected in Autodesk's largest-ever EBA signed during the quarter and record contributions from our construction and water verticals to our overall EBA performance. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I'll then come back to update you on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. Overall, market conditions and the underlying momentum of the business remained similar to the last few quarters. Our financial performance in the third quarter was strong, particularly from our EBA cohorts, where incremental true-up and upfront revenue from a handful of large customers drove upside. As expected, the co-termed deal we called out in our Q1 results renewed in the third quarter with a significant uplift in deal size. Total revenue grew 10% and 13% in constant currency. By product in constant currency, AutoCAD and AutoCAD LT revenue grew 7%, AEC revenue grew 20%, manufacturing revenue grew 9% and in double-digits, excluding variances and upfront revenue, and M&E revenue was down 4% and up high single-digits percent, excluding variances in upfront revenue. By region in constant currency, revenue grew 19% in the Americas, 11% in EMEA and 3% in APAC, which still reflects the impact of last year's COVID lockdown in China. Direct revenue increased 19% and represented 38% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the eStore. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. The transition from upfront to annual billings for multiyear contracts is proceeding broadly as expected. We had the second full quarter impact in our third fiscal quarter, which resulted in billings declining 11%. Total deferred revenue increased 6% to $4 billion. Total RPO of $5.2 billion and current RPO of $3.5 billion both grew 12%. Excluding the tailwind from our largest ever EBA, total RPO growth decelerated modestly in Q3 as expected when compared to Q2, mostly due to the lower mix of multiyear contracts in fiscal 2024 when compared to fiscal 2023. Turning to the P&L. Non-GAAP gross margin remained broadly level at 93%. GAAP and non-GAAP operating margin increased driven by revenue growth and continued cost discipline. I'd also note that costs associated with Autodesk University have shifted from the third quarter last year to the fourth quarter this year due to the timing of the event. Free cash flow was $13 million in the third quarter, primarily limited by the transition from upfront to annual billings for multiyear contracts and the payment of federal taxes we discussed earlier this year. Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We remain vigilant during this period of macroeconomic uncertainty. As you heard from Andrew, we continue to invest organically and through acquisitions in our capabilities and services and the cloud and platform services that underpin them. We purchased approximately 500,000 shares for $112 million, at an average price of approximately $206 per share. We will continue to offset dilution from our stock-based compensation program to opportunistically accelerate repurchases when it makes sense to do so. Now, let me finish with guidance. The overall headline is that our end markets and competitive performance are at the better end of the range of possible outcomes we modeled at the beginning of the year. This means the business is generally trending towards the higher end of our expectations. Incrementally, FX and co-terming have been slightly more of a headwind to billings than we expected. EBA expansions have been slightly more of a tailwind to revenue and interest income has been slightly more of a tailwind to earnings per share and free cash flow. Against this backdrop, we are keeping our billings guidance constant, while raising our revenue, earnings per share, and free cash flow guidance. I'd like to summarize the key factors we've highlighted so far this year. The comments I've made in previous quarters regarding the fiscal 2024 EBA cohort, foreign exchange movements, and the impact of the switch from upfront annual billings for most multiyear customers are still applicable. We again saw some evidence of multiyear customers switching to annual contracts during the third quarter, as you'd expect, given the removal of the upfront discount. We're keeping an eye on it as we enter our significant fourth quarter. All else equal, if customers switch to annual contracts, it would proportionately reduce the unbilled portion of our total remaining performance obligations and negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged. Annual renewals create more opportunities for us to drive adoption and upsell and are without the price lock embedded in multiyear contracts. Putting that all together, we now expect fiscal 2024 revenue to be between $5.45 billion and $5.47 billion. We expect non-GAAP operating margins to be similar to fiscal 2023 levels with constant currency margin improvement, offset by FX headwinds. We expect free cash flow to be between $1.2 billion and $1.26 billion to reflect higher revenue guidance we're increasing the guidance range for non-GAAP earnings per share to be between $7.43 and $7.49. Our billings guidance remains unchanged, given incremental foreign exchange headwinds and the potential for further EBA co-terming in the fourth quarter. The slide deck on our website has more details on modeling assumptions for Q4 and full year fiscal 2024. We continue to manage our business using a Rule of 40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins captured in the Rule of 40 framework is the hallmark of the most valuable companies in the world, and we intend to remain one of them. As we've been saying all year, the path to 45% will not be linear. We've talked about all of the factors behind that over the last three quarters, and I think it's useful to put them all in one place here, particularly as we look into fiscal 2025 and 2026. First, the macroeconomic drag on new subscriber growth, a smaller EBA renewal cohort with less upfront revenue mix, and the absence of EBA true-up payments are headwinds to revenue growth in fiscal 2025. Slightly offsetting that, we expect our new transaction model, which Andrew discussed earlier, to be a tailwind to revenue growth in fiscal 2025 and beyond. Assuming no material change in the macroeconomic, geopolitical or policy environment, we'd expect fiscal 2025 revenue growth to be about 9% or more. In other words, at least around the same or more growth as we are now expecting in fiscal 2024. And second, the transition to annual billings means that about $200 million of free cash flow in Q1 fiscal 2024 that came from multiyear contracts built upfront will not recur in fiscal 2025. This will reduce reported free cash flow growth in fiscal 2025. And make underlying comparisons between the two years harder. If you adjust fiscal 2024 free cash flow down by $200 million to make it more comparable with fiscal 2025 and fiscal 2026 on an underlying basis, the stacking of multiyear contracts build annually will mechanically generate significant free cash flow growth in fiscal 2025 and fiscal 2026. The progression from the adjusted fiscal 2024 free cash flow base, will be a bit more linear, although fiscal 2026 free cash flow growth is expected to be faster than fiscal 2025 as our largest renewal cohort converts to annual billings in that year. As you build your fiscal 2025 quarterly and full year estimates, please pay attention to what we've said each quarter during fiscal 2024. As Andrew said, our new transaction model will likely provide a tailwind to revenue growth be broadly neutral to operating profit and free cash flow dollars and be a headwind to operating margin percent. The magnitude of each will be dependent on the speed of deployment. Excluding any impact from the new transaction model, we are planning for operating margin improvement in fiscal 2025. Overall, we expect first half, second half free cash flow linearity in fiscal 2025 to be more normal than in fiscal 2024. And we still anticipate fiscal 2024 will be the free cash flow trough during our transition from upfront to annual billings for multiyear contracts. Per usual, we'll give fiscal 2025 guidance when we report fiscal 2024 results, so I don't intend to parse these comments before them. As I said at our Investor Day last March, the new normal is that there is no normal. Macroeconomic uncertainty is being compounded by geopolitical, policy, health and climate uncertainty. I'm thinking here of generational movements in monetary policy, fiscal policy, inflation, exchange rates, politics, geopolitical tension, supply chains, extreme weather events and, of course, the pandemic. These increased the number of factors outside of our control and the range of possible outcomes, which makes the operating environment harder to navigate both for Autodesk and its customers. In this context, the mechanical rebuilding of our free cash flow as we transition to annual billings for multiyear contracts, gives Autodesk an enviable source of visibility and certainty. I hope this gives you a better understanding of why we've consistently said that the path to 45% will not be linear. But let me also reiterate this. We're managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal, regardless of the macroeconomic backdrop. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie Let me finish by updating you on our progress in the third quarter. We continue to see good momentum in AEC, particularly in transportation, water infrastructure and construction. Fueled by customers consolidating on our solutions to connect and optimize previously siloed workflows to the cloud. Market conditions remain similar to previous quarters. In Q3, WSP, one of the world's leading professional services firms closed its sixth EBA with Autodesk, a testament to our strong and enduring partnership. Leveraging the breadth of our portfolio, WSP has delivered the comprehensive range of services demanded by its clients, generate millions of dollars in pipeline across the AEC and manufacturing industries, secured bridge and groundwork contracts through automation capabilities, reduce costs through increased efficiency and most importantly, delivered impactful results for its customers. TCE, a global engineering and consulting firm, which supports all types of infrastructure is harnessing Autodesk solutions to bolster its sustainable development goals around clean water and sanitation. Industry innovation, infrastructure and responsible consumption and production, utilizing Autodesk's BIM Collaborate Pro, TCE plans to improve team collaboration through easier data exchange, fewer classes and more effective designer years. Autodesk solutions are empowering TCE to manage, coordinate and execute projects more efficiently, thus contributing to a better quality of life through improved infrastructure. We are seeing growing customer interest in our complete end-to-end construction solutions, which encompass design, preconstruction and field execution through handover and into operations. Encouragingly, Autodesk Construction Cloud MAUs were again up well over 100% in the quarter. In Q3, LFD, Inc., an ENR top 200 general contractor based in Ohio, selected Autodesk Construction Cloud over directly competitive offerings as its end-to-end construction platform. With our preconstruction and cost capabilities of standout differentiator, it ultimately chose Autodesk based on our level of partnership, our aligned vision and commitment to serve the evolving needs of the construction industry and the momentum our solution has demonstrated in the marketplace. Again, these stories have a common theme: managing people, processes and data across the project lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way, and we remain focused on enabling that transition through our industry clouds. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and to consolidate on our design and make platform to grow their business and make it more resilient. For example, a global industrial company based in the U.S. is partnering with Autodesk to innovate more rapidly in its business. The customer had already standardized on Autodesk's up chain to streamline its data and process manager within their molding technology solutions and modernize its CAM process by adopting Fusion to significantly reduce programming time and eliminate risks from legacy software. During Q3, it renewed its EBA with Autodesk and plans to broaden its use of up chain, vault infusion. It is exploring Fusion's ability to enhance process management and its digital threat initiatives, which focus on product life cycle management, closed-loop quality, sustainability design, service life cycle management and supplier insight. Fusion continues to provide an easy on-ramp into our cloud ecosystem for existing and new customers. For example, a leading manufacturer for the agriculture industry is migrating from network licenses to named users and complementing those subscriptions with Flex tokens to maximize value and access for occasional users. As it digitizes its factories and create digital twins for its global facilities, it will use Flex to explore Autodesk's most advanced technology for Fusion, for CAM tool path automation and generative design. Flex provides the customer with the flexibility to scale its usage based on its needs, making sure its users have access to the right products at the right time. Fusion continues to grow strongly, ending the quarter with 241,000 subscribers as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. In automotive, we continue to grow our footprint beyond the design studio into manufacturing and connected factories. In Q3, a leading automotive manufacturer renewed and expanded its EBA by more than 50%. In addition to its existing usage of alias for concept design modeling and design evaluation, the customer is replacing an internal tool with Red for lighting simulation. In the future, it will implement flow production tracking to improve and accelerate project communication and collaboration across departments and expand its use of Autodesk's integrated factory modeling to optimize factory layouts and enhance operational performance. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. For example, our partnership with PanState is making a positive impact in design classes and car CMC activities across the PanState, Barron's, Burks, Terresburg and University Park campuses. PSU Harrisburg has recently adopted Fusion in its core design class and plans to integrate it into its mechanical engineering curriculum. Fusion's accessible platform allows students to seamlessly transition from car to CAE and CAM enabling them to make a different outside the classroom and in industrial applications. They have already collaborated with NASA on a generative design project for spaceflight applications, inspiring numerous projects at NASA. And finally, we continue with our customers to ensure they are using the latest and most secure versions of our software. A publicly traded construction company in Japan thought to streamline software management processes and minimize compliance risks by leveraging single sign-on FFO and directly sync features available in our premium plan. Through a collaborative analysis of the client software usage logs, we identify instances of noncompliant usage and recommended an appropriate number of subscriptions based on usage frequency and actual requirements. This proactive approach ensures that the client has the necessary access to meet their needs while maintaining compliance. We've been laying the foundation to build enterprise-level AI for years with connected data, teams and workflows in industry cloud, real-time and immersive experiences, shared extensible and trusted platform services and innovative business models and trusted partnerships. Autodesk remains relentlessly curious with the propensity and desire to evolve and innovate. We are building the future with focus, purpose and optimism. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays.
Saket Kalia: Okay. Great. Hi guys, thanks for taking my questions here. How are you?
Andrew Anagnost: Great, Saket.
Saket Kalia: Andrew, maybe for you. Lots of talk about here, right, particularly with the new transaction model. Maybe the right first question here would be. Why is this new model, I guess, as consequential as you said in your prepared remarks. Any color there you can add?
Andrew Anagnost: Yes, absolutely. Let me start Saket by saying First, the business is super resilient where we're built through resilience, and this is really showing up in these results this round as well. And that's going to continue into the future. When we talk about this new transaction model, I think it's important to back up and talking about what we're trying to do with our customers and the journey we've been on. We are trying to do no less than move all of our customers to cloud-based life cycle solutions powered by AI that connect their design and make processes in a way that they've never had connected before. Now to do that, you absolutely cannot use 40-year-old systems and business models. So we've been on this relentless journey to modernize the company. We started moving from developing cloud-based products to subscription models, to annualized billings. I mean you've seen journey after journey here to modernize the company. This is the next step and one of the most important steps in modernizing the company so that we have the kind of relationship with our customers that actually matches the kind of technology we're delivering to them. So through this, we're not only going to have direct engagement with our customers through the products they use in the cloud, we're going to have direct engagements with them as a customer as an account. We're going to understand them at the account level and as an entity, not just as a collection of transactions passed through several tiers. And that's really important. Because that will not only give us more information about our customers, it will help us give more information to our partners about our customers and understand them significantly better. And it will wrap up the whole solution and business model and capabilities in one package. The other really consequential thing here is our partner network has to move transaction-focused partners to solution-focused partners. They are going to be incredibly important on the front lines in helping our customers deploy and integrate new design to make solutions in the cloud. And this is going to be part of that transition for them. So yes, it is very consequential. And it's part and parcel of a long stream of modernizations we've been working on for a while, and I do think it's very significant.
Saket Kalia: Got it. No, absolutely. It sounds very strategic. Debbie, maybe for my follow-up for you. I know you said you wouldn't parse out your comments on fiscal 2025. But -- could we maybe parse out those comments for fiscal '25 just a bit kind of given some of the moving parts sort to ask, but...
Debbie Clifford: There are indeed a lot of moving parts, Saket. So thanks for the question. I know that's the question that everyone wants to ask. I'm not going to parse all the details, but I'll just highlight some of the things that we called out in the opening commentary. Those things are the non-recurrence of EBA upfront and true-up revenue, FX and the macro drag on new subscriber growth, these are all things that are headwinds to revenue growth next year. We also talked about the impact depending on the timing of this move to a new transaction model. That's going to be a tailwind to revenue. It will be margin and cash flow dollar neutral and is a headwind to margin percent. We'll give you all the details on this in February for the usual. But remember, what we're really trying to do is set ourselves up for success over the long term.
Saket Kalia: Makes a lot of sense. Thanks, guys. I’ll get back in queue.
Operator: Thank you. Please standby for our next question. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities.
Jay Vleeschhouwer: Thank you. Good evening. So on fiscal 2025, following up on Saket's question, at the analyst meeting earlier this year, Debbie, you showed a chart depicting sustainable double-digit growth for Autodesk of 10% to 15%. And based on a combination of various price and volume components, are you still adhering to that plethora of price and volume sources of growth? Or have you changed your thinking in terms of the magnitude or mix of those sources of growth over time?
Debbie Clifford: We are still targeting those sources of growth, Jay, as well as targeting the growth parameters of 10 to 15 points of revenue growth. Really, what we're dealing with is this uncertain environment. And based on what we know today and assuming that market conditions are similar to what we've seen over the last several quarters, we do see revenue growth next year of about 9% or more. And what's driving that is really all those puts and takes that I talked about in the opening commentary. It's really important to remember that what we're trying to do is set ourselves up for success over the long-term.
Jay Vleeschhouwer: Okay. Andrew, for you, following up on AU last week. There were a number of quite interesting and useful sessions on our roadmaps and product plans, particularly on AUC and more broadly with regard to the data model. So, let me ask you an unavoidably complex question about that. So, when you -- so when you think about the role of what you call granular data, does that ultimately affect as you implement that the packaging or composition or consumption of the software? And you also gave quite detailed description of where you're going with ACC and Bill and AC generally. But there's no timeline in any of those presentations. So, how are you thinking about the GA of much of what you talked about last week at AU in terms of making commercial a very large set of new technology features, particularly for AC?
Andrew Anagnost: Yes. Okay. So, let me tackle that with the first thing around the granular data. So, ultimately, as you journey down this path, what does happen is the way the product operates all the products Forma in particular in terms of how it interacts with Revit and ultimately how those two blend together, they do become an environment that looks very much like the fusion environment. And that environment is very different, as you know, than what it currently exists in most of the wide -- the mainstream usage of our AC products. So, yes, granular data ultimately leads to a different way that people consume and use the products in a different paradigm for which they actually engage with the product every day. So. that's clear, okay? Timeline, I don't know exactly which presentation you're in. I suspect given your questions, you are in the more longer term timeline presentation. So, a lot of stuff you saw there was over a two to five-year time frame, but a lot of that is going to show up in the two to three-year timeframe associated with some of the things you heard. Now, I think it's kind of obvious to tell which ones we're towards the earlier part of that spectrum rather to the later part of that spectrum. Turning some of these solutions over into infrastructure solutions and combining them with some of our infrastructure stuff. Probably towards the later end, getting the data more granular, uniting detailed design and conceptual design in Forma, probably much more closer. That kind of expectation you can have with those road maps.
Jay Vleeschhouwer: Great, great. Thank you both.
Operator: Thank you. Our next question comes from the line of Adam Borg of Stifel.
Adam Borg: Awesome. Thanks so much for taking the question. Maybe for Debbie, just on the multiyear to annual billings transition. Maybe just if you could just remind us kind of where we are overall in the process relative to expectations. And I do know that there are still some smaller cohorts that have yet to transition and just curious kind of where we are for those and if that's going to take place next year? Or is that still kind of in process?
Debbie Clifford: Sure. Thanks. The rollout is going well. We're a couple of quarters in the systems are working. Customers and partners are behaving pretty much as we expected. So overall, the performance is in line with our expectations. I think the key thing is, remember, we're kind of at the beginning of this journey. This is going to be a three-year journey. So we're going to have a mechanical rebuild of free cash flow as we get into next year, fiscal 2025 and also in fiscal 2026. So some of the comments that I made on the call are important, and that is helping you think about how to normalize our fiscal 2024 cash flow headed into fiscal 2025. So we're moving that $200 million at the beginning of fiscal 2024 as we head into fiscal 2025. And then broadly, the fact that we'll have bigger cohorts coming up for renewal in fiscal 2026, which drives faster growth in free cash flow in that period. So overall, things are going well, and we're at this interesting point where we expect to see mechanical rebuilding of free cash flow from here.
Adam Borg: Got it. And maybe just a quick question. Interesting AI announcements with Autodesk AI, back at AU last week. Any commentary on how to think about any price uplift from those solutions? Thanks again.
Andrew Anagnost: Yes. So I'll take that one, Adam. Look, some of these features are already and will be delivered through our existing products. However, there are new models will be exploring with some of these capabilities. Obviously, it's a little too early to talk about actual monetization. But I do think some of the things you're seeing with Microsoft right now are quite interesting where highly evolved large models, which we have not yet deployed out in the market are offered up to individual customers as a here's your model. Now you train it, you custom train it and extend it with your data. Those kind of models are going to be very interesting in the future and really look like possibilities that we'll probably explore and look at. As we move forward. But for now, a lot of this functionality is going to end up integrated with the existing products as it has been for the last several years.
Adam Borg: Great. Thanks again.
Operator: Thank you. Our next question comes from the line of Joe Vruwink of Baird.
Joe Vruwink: Great. Hi, everyone. Maybe just a follow-up on that last question. Andrew, like you said, AI and automation is not new at Autodesk. But I did think the messaging was maybe a little more exact and pointed just as it pertains to the cloud data strategy and how that really is the gateway to future AI capabilities that Autodesk how customers need to be thinking about this. So my question is just curious to hear any feedback from customers on this approach. And maybe levels of resistance or buy in, you've started to hear just pertaining the customers kind of pooling their data and Autodesk ends up being the aggregator of industry information?
Andrew Anagnost: Yes. So look, we have a very strong point of view on ethical and high trust use of data, and we intend to continue to pursue that with our customers and take a broad and strong stance around look, it's your data. We're going to work with you to use it appropriately for things that make the whole ecosystem better. We're going to do it in a way that's trusted. And we're also going to work with you in a way that allows you to preserve the IP that you think is important to you that does not become part of the entire ecosystem. So this is a conversation I have with many, many customers most obviously recognize the trade-off between massive amounts of productivity in terms of automating model creation and some of the benefits there. So they want to participate in ways that actually make sense for them and that maintain the trust and integrity that we're looking to do. So look for us to handle this in exactly that matter as we move forward.
Joe Vruwink: Okay. Great. And then I'm going to take my best shot at FY 2025 question as well. But I think maybe 2 points of clarification or additional information. So Debbie, just on kind of the known headwind to free cash flow next year because of the long-term deferreds that happened to hit in this year. Can you reconcile that with the normal seasonality comment. Should we be removing that and then thinking about modeling normal seasonality, part A? Part B, you've talked about currency a lot is having impacts on some of these numbers. And I would imagine just given what's on the balance sheet, you probably have a good sense of what currency will be next year. How does currency factor into that 9% plus revenue growth rate you provided?
Debbie Clifford: Sure. Thanks, Joe. So on the first question, I think you're thinking about it in a reasonable way. So take out the $200 million and then it should have a more reasonable that will give you more reasonable modeling expectations as you think about modeling fiscal 2025 and beyond. And then on currency, is it's really been all over the place. I think everybody has been seeing that. What we see right now is that it would be a headwind for us as we head into next year. But given the volatility, I think it really could go either way. But based on what we're seeing right now, it is a headwind to revenue growth next year.
Joe Vruwink: Okay. Thank you very much.
Operator: Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler.
Tyler Radke: Okay. Great. Thanks for taking the question here. Andrew, you talked about some record contribution from the construction side of the business, I think, broadly, but also within the EBAs. Could you elaborate within Autodesk Construction Cloud. What are the strongest areas you're seeing customers about?
Andrew Anagnost: Yes. No. What's interesting is. We're not seeing the softness in construction that others may have highlighted. In fact, we have incredibly strong performance at the top end of our business. We saw strong growth internationally. And we're seeing growth in the U.S. And a lot of things are going on in the construction business right now. And whereas you see some sectors slowing down retail warehouse office things like that. You're seeing other things offsetting it. Again, the dynamicism of Autodesk business, manufacturing, industrial, lots of factory construction going on data centers, health care, , infrastructure, all of these things are picking up. So we've got a lot of dynamics that are playing well with regards to our construction business right now. When we look at the business, we look at the indicators that we have, bid board activity was at record highs again. So we saw a good strong bid activity there. While construction backlog may have declined a bit, it's still high, all right? And the number one thing that I heard from general contractors at Autodesk University was still can't hire enough. So they're still going to be working through that backlog at a relatively slow pace. Also, what's really interesting is we're seeing ourselves in more deals down market now more competitive deals, and frankly, we're winning some of them. And I think that's interesting. I think that probably results in slowing down deals for some of our competitors in various markets. But we're actually seeing a lot more interesting deal activity.
Tyler Radke: That's helpful. And a follow-up for Debbie. I appreciate you getting a lot of questions on FY 2025. And I'm not going to ask you to dissect it further. But if I think about just trying to bridge the 9%, which seems like it does have some tailwinds from the transactional changes relative to that 10% to 15% framework that you gave, it doesn't seem like macro has worsened relative to a few quarters ago or a year ago when you gave that out based on your commentary. Just help us understand that bridge. Is it mostly conservatism or maybe currency or some of the other headwinds are larger than we're thinking about? Thank you.
Debbie Clifford: Yes. Sure. So remember, you got to be thinking about the non-recurrence of the EBA upfront and true-up revenue that we've been talking about all year. FX, as I just mentioned, could be a factor right now, we're assuming that it is a headwind to revenue growth. And then finally, we have been talking about the macro drag on new subscriber growth all year. And remember, given the ratable revenue recognition model that we have, what we're seeing with new subscriber growth this year has more of an implication for revenue growth next year than for revenue today. So those three factors are the biggest factors driving our estimate of 9% or more as we head into next year.
Tyler Radke: Okay. Thank you.
Operator: Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets.
Jason Celino: Great. Thanks for taking my question. Maybe one on the EBAs. So in Q3, did you see any of these renewals maybe happen earlier than expected? Overall, it sounds like you're still seeing some timing true-ups, but also some pretty big expansions. Is the overarching takeaway that the cohort is expanding maybe better than what you had anticipated?
Debbie Clifford: Thanks, Jason. So the EBA cohort has been performing really well all year, which has been great. Remember, this is a cohort that last renewed in late 2020. That was at the height of the pandemic. And back then, they made more conservative assumptions about usage because of the uncertain environment at that time. Fast forward to today, these customers are continuing to manage through a high demand for projects. That's led to higher overall usage on their contracts. And as we've mentioned before, we do monitor the usage. So we've had insight into the potential EBA upside as the year has progressed. We've continued to update our outlook, which is each quarter of the renewals and the true-ups. And as we look at Q4. We've got our eye on the remainder of this large EBA cohort and the signs continue to be strong. We factored all of this into our latest estimates, and that's what drove the top line upgrade that we communicated today.
Jason Celino: Okay. Great. And then I asked this question last quarter, but it sounds like a few of your competitors might be starting to see some of the water infrastructure funding start to flow plan intended this time. Are you seeing this, too? And then is this the strength that you're already seeing? Or could this be an additional opportunity for maybe next year?
Andrew Anagnost: Yes. Jason, one of the things that you may have heard is that some of that money from the infrastructure bill that was targeting modernization of departments of transportation was really, it's about $34 million that's significant in that not only it starts these DOTs on their process of modernization and evaluating the modernization, but it also was directed at several DOTs that we have relationships with and where we've actually displaced competitors and engaged with the infrastructure. So that's pretty exciting stuff. That shows money starting to flow to the projects. As I've always said, it takes time to release this money from the flood gates of Washington into the places floodgate of Washington, that's kind of an oxymoronic comment. But it takes time to get there. And that -- these -- this money is going to kind of again, build up momentum for the rest of the projects and help us move forward. So I would say it continues to be an emerging opportunity. Projects are getting started, but there's more hope in the future for even more projects.
Jason Celino: Okay, Great. Thank you.
Operator: Thank you. Our next question comes from the line of Michael Funk of Bank of America.
Michael Funk: Yes. Thanks for the questions. Two, if I could. So first for you, Andrew. A number of changes with partner relationships from last year, you mentioned the new transaction model I think earlier you also changed the commission structure to more back end versus front-end loaded. So curious what kind of reaction you're hearing from your partners and how you expect these changes to impact that relationship?
Andrew Anagnost: Yes. So obviously, we invest a lot in bringing our partners along on this. It doesn't mean all partners are going to be happy with these changes. Okay? It's just that is not an outcome that we're looking for or is likely. But many partners are going to be happy with these changes because we've been very clear about what the path is to growth for them. Beyond that, we've taken a really kind of incremental approach to these things with our partners. We kind of led them along, showed them the way. You might recall, we started the new transaction model with Flex, close to about 1.5 years ago in Australia, then we rolled it out to the broad-based partner network and everybody got experience with it. Now we're testing in Australia. Again, we take our partners along on these journeys in very deliberate ways. And frankly, the credibility we have with our partners in terms of making their businesses more consequential and significant and, frankly, larger over time has really created an environment where there's a lot of trust. And there's a lot of discussion about what's the best way to do this. What this means for them and where it's going to take their business. And this will make the partners ultimately more consequential in some of the business discussions with their partners with their customers by bringing them closer to the design and make infrastructure work that needs to happen in the services and support that.
Michael Funk: Thank you for that, Andrew. And one for you, Debbie, will see a check on the accounting of the math. You mentioned EBA revenue, non-recurrence in fiscal 2025 a few times. So, two pieces. First, accounting. I thought that the true-ups with upsizing in EBA, I thought that was recognized ratably over the term of the contract. Just trying to think how that might carry over an impact 2025, I'm correcting that accounting? And then second, if you can just remind us on the actual benefit to fiscal year 2024 from those items so we can pull that out of the fiscal year 2025 number?
Debbie Clifford: Sure. So, from an accounting standpoint, the true-ups we recognize upfront. So, think of it as an enterprise customer signs up for X number of tokens. And when they exceed X number of tokens, we build them for the differential and we recognize that revenue upfront and it doesn't recur in future periods, unless over the next three-year contract term, they utilized more than the tokens allotted in their contract again. So, that's why it's something that is sort of a one-off -- a good one off, but a one-off nonetheless, that could only recur three years from now for these contracts if we found ourselves in the same situation. And then in terms of sizing the benefit to fiscal 2024, we haven't gotten into exact numbers, but you can think about the overall guidance upgrade that we talked about today is largely being driven by the strength that we're seeing from the enterprise business this year.
Michael Funk: Great. Thank you both.
Operator: Thank you. Our next question comes from the line of Matt Hedberg of RBC.
Matt Hedberg: Great. Thanks for taking my questions. I guess for either of you, maybe thinking longer term, I'm curious if you could help us with maybe the -- this move from contra revenue. What is the impact to sort of like pro forma revenue growth once the business has migrated more so to the Flex model?
Debbie Clifford: Matt, it's going to be -- revenue growth will accelerate. And the pace at which it accelerates is going to be determined based on how we go about the rollout. But as we mentioned, we're working on that now. We launched Flex last year. We just launched Australia. We're learning from Australia -- as we -- right now. And then as we look ahead to next year, we intend to go global with this, but we need to make sure that we are set up for success, which is why we're watching Australia closely. But when we execute finally, on all aspects of this transition, it will be an accelerator to revenue growth.
Matt Hedberg: Got it. Thank you. And then I know last quarter, you saw some pretty good non-compliant conversions I don't think you mentioned the other side - recall you're talking about that. Was there any this quarter that you called out?
Debbie Clifford: We continue to perform well with our non-compliant conversions. So, I think you've heard us talk about a couple of things. I think historically, we have talked about some of the larger deals that we've closed, and those types of deals are still happening. But as I recall, on last quarter's earnings call, Andrew was talking about some of the stuff that we've been doing in product that's driving more conversion. That's on a smaller scale in terms of deal sizes, but is driving significant volume for Autodesk. So, over time, you're going to see us continue to flex different means of driving more compliance from non-compliant users, and it continues to be a steady drumbeat contributor to our revenue growth over time.
Matt Hedberg: Got it. Thanks.
Operator: Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank. Please go ahead, Bhavin
Bhavin Shah: Great. Thanks for taking my question. Just kind of following up on that last one on the new transaction model. Like what kind of learnings are you looking to see from Australia before kind of rolling the app more broadly and kind of any disruption kind of that we should think about from a pointer perspective?
Andrew Anagnost: Well, one of the things that we're trying to make sure that we see is how do the partners line up their deals so that they're able to enter them into the system and make sure they get their pipeline lined up with the new way of doing things because they're going after directly enter them into the system. Some of these services used to be taken over by distributors for some of our partners. We're going to make sure that -- we want to make sure that large volumes work well with the systems. We're pretty confident at this point because of the Flex experience, but we know we want to stress test these things. We want to make sure that it works for all the product offerings that there's no issues or hiccups with particular things that when people try to true up renewal dates or line them up, there's not issues with those things. It's all the things that go into the mechanics of a partner entering the deal, all right, and having those things actually function. We just want to make sure it all works. Again, we have a lot of confidence because of the Flex work, but those are the things we're going to be testing for in the Australia pilot.
Bhavin Shah: That's helpful there. And just kind of following up on Fusion 360. I know you guys are making some pricing adjustments going into next year, kind of raising the list price on Fusion 360, but kind of rationalizing and lowering the price on the extensions. What's the kind of the rationale behind this? Is this to drive kind of further extension adoption down the road? And kind of how does this inform your views on as you think about rolling this out to the form and the like?
Andrew Anagnost: Yes. So Bob, what we're doing there is the price increase in Fusion is directly connected to the value we're delivering Fusion we're making sure some of the customers who have been with us for a long time are treated appropriately and fairly. So we're paying attention to all those things to customer dynamics. But what we saw is that the value in base Fusion has just increased to high level that we should be looking at the price more carefully. The value is going to continue to increase. And what we saw is that some of the extensions would probably see better adoption in some of the base -- the value was shifted to the base offering and the price of the extensions were contracted a little bit. So it's all this kind of balancing the overall cost of ownership for particular types of customers. And it's an appropriate time to do it.
Bhavin Shah: Very helpful. Thanks for taking the question.
Operator: Thank you. Our next question comes from the line of Steve Tusa of JPMorgan. Your question please, Steve,
Steve Tusa: Hi, guys. Thanks for taking my question. Just on the subscriber growth, are we talking like -- you mentioned the macro impact several times. What are we kind of talking about what kind of rate this year? Is that like in the low to mid-single-digit range? And then what would it take for that to go flat? What type of macro do you think it would take to go flat? And then secondarily, just on the free cash flow side, I think at the Investor Day, you had put a chart in there that insinuated that cash would still grow from 2023 through the number in 2026. Are we still on track for that kind of longer-term view just to level set us on the longer-term cash outlook?
Andrew Anagnost: Yes. So Steve, let me take the first question a little bit. I won't answer the specific question. What I want to say is our business is incredibly resilient. You have to really pay attention to that, we're built for resilience. And I want to highlight some of the differences in puts and takes here. For instance, you probably noticed that AEC grew 20% in the quarter. And that offset some of the headwinds from media and entertainment due to wider strikes and after strikes. Regionally, India and Canada offset the U.S. and the U.K. Market segment-wise, EBAs and small businesses offset the mid-market. You have to think of the business through this built for resilient framework. And so I want to shift your lens a little bit, and then I'll let Debbie comment on the second part of your question.
Debbie Clifford: Yes, I would say, look, outside of the new transaction model, nothing has changed, and we're on track to achieving our goals. But this is a pretty big decision for us to transform our go-to-market. But I think is really beneficial to the company. It's going to drive greater free cash flow and greater revenue growth over the long term. I'm not going to parse comments about fiscal 2026 in addition to fiscal 2025 on this call. What we're really trying to do is set ourselves up for success over the long term and make smart decisions for the business and for our shareholders.
Steve Tusa: Okay. Great. Thanks a lot.
Operator: Thank you. That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks.
Simon Mays-Smith: Thanks, everyone, for joining us. Wishing those who celebrate a happy Thanksgiving and looking forward to catching up with you on the road over the coming weeks and at next quarter's earnings. Thanks so much, Latif. Handing back to you.
Operator: Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by, and welcome to Autodesk's Third Quarter Fiscal Year 2024 Earnings Conference Call. [Operator Instructions] I would now like to hand the call over to VP of Investor Relations, Simon Mays-Smith. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the third quarter results of Autodesk's fiscal 2024. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. Following this call, you can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, products and product capabilities, business models and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials are available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome, everyone, to the call. Resilience, discipline and opportunity again underpinned Autodesk strong financial and competitive performance despite continued macroeconomic policy and geopolitical headwinds. Renewal rates have remained strong and new business trends have been largely consistent for many quarters. Our subscription business model and our product and customer diversification enable that. It means that accelerating growth in Canada has balanced decelerating growth in the United Kingdom. The growing momentum in construction has balanced deteriorating momentum in media and entertainment. And that strength from our enterprise and smaller customers has balanced softness from medium-sized customers. Our leading indicators remain consistent with last quarter with growing usage, record bid activity on building connected and cautious optimism from channel partners. Disciplined and focused execution and strategic deployment of capital through the economic cycle, enables Autodesk to realize the significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments later. As Steve said at Investor Day, we introduced a new transaction model for Flex, which gives Autodesk a more direct relationship with its customers and more closely integrates with its channel partners. We began testing the new transaction model across our product suite in Australia a couple of weeks ago. Assuming the launch proceeds is expected in fiscal '25 and '26, we intend to transition our indirect business to the new transaction model in all our major markets globally. In the new transaction model, partners provide a quote to customers, but the actual transaction happens directly between Autodesk and the customer. The new transaction model is an important step on our path to integrate more closely with our customers' workflows enabled by, among other things, Autodesk platform services and our industry cloud's fusion, forma and flow. Autodesk, its customers and partners will be able to build more valuable, data-driven and connected products and services in our industry cloud and on our platform. The new transaction model is consequential. Many of you will have seen other companies adopting agency models and will already understand the math. In the near term, the new transaction model results in a shift from contra revenue to operating costs that provide a tailwind to revenue growth, while being broadly neutral to operating profit and free cash flow dollars and mechanically result in percent operating margins taking a step or two backwards. Over the long term, optimization enabled by this transition will provide a tailwind to revenue, operating income and free cash flow dollars even after the cost of setting up our building platform. Finally, there is opportunity from developing next-generation technologies and services that deliver end-to-end digital transformation of our design and make customers and enable a better world designed and made for all. I was at Autodesk University last week, alongside more than 10,000 attendees, where we announced Autodesk AI, technology we've been working on and investing in for years. We showed how our design to make platform will automate noncreative work, help customers analyze their data and surface insights and augment their work to make them more agile and creative, but there is no AI without actionable data. And that's why we're also investing in Autodesk platform services, which are accessible, extensible and open via our APIs. Autodesk Platform Services offers several critical capabilities, but data services are the most impactful. These provide the tools that make data actionable. And at the core of our data services is the Autodesk data model. Think of the Autodesk data model is the knowledge graph that gives customers access to the design, make and project data in granular bite-sized chunks. The data chunks are the building blocks of new automation, analysis and augmentation that will enable our customers and partners to build more valuable, data-driven and connected products and services. Autodesk remains relentlessly curious propensity and desire to evolve and innovate. Time and again, well-executed transformation from desktop to cloud from perpetual license and maintenance to subscription has added new growth factors, built a more diverse and resilient business, forged broader trusted and more durable partnerships with more customers and given Autodesk a longer run rate of growth and free cash flow generation. With our transformation from file to data and outcomes from upfront to annual billings and from indirect to direct go-to-market motion, we are building an even brighter future with focus, purpose and optimism. Our customers are also committed to transformation and Autodesk is deploying automation to increase their success in an environment with ongoing headwinds from material scarcity, labor shortages and supply chain disruption. That commitment was reflected in Autodesk's largest-ever EBA signed during the quarter and record contributions from our construction and water verticals to our overall EBA performance. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I'll then come back to update you on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. Overall, market conditions and the underlying momentum of the business remained similar to the last few quarters. Our financial performance in the third quarter was strong, particularly from our EBA cohorts, where incremental true-up and upfront revenue from a handful of large customers drove upside. As expected, the co-termed deal we called out in our Q1 results renewed in the third quarter with a significant uplift in deal size. Total revenue grew 10% and 13% in constant currency. By product in constant currency, AutoCAD and AutoCAD LT revenue grew 7%, AEC revenue grew 20%, manufacturing revenue grew 9% and in double-digits, excluding variances and upfront revenue, and M&E revenue was down 4% and up high single-digits percent, excluding variances in upfront revenue. By region in constant currency, revenue grew 19% in the Americas, 11% in EMEA and 3% in APAC, which still reflects the impact of last year's COVID lockdown in China. Direct revenue increased 19% and represented 38% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the eStore. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. The transition from upfront to annual billings for multiyear contracts is proceeding broadly as expected. We had the second full quarter impact in our third fiscal quarter, which resulted in billings declining 11%. Total deferred revenue increased 6% to $4 billion. Total RPO of $5.2 billion and current RPO of $3.5 billion both grew 12%. Excluding the tailwind from our largest ever EBA, total RPO growth decelerated modestly in Q3 as expected when compared to Q2, mostly due to the lower mix of multiyear contracts in fiscal 2024 when compared to fiscal 2023. Turning to the P&L. Non-GAAP gross margin remained broadly level at 93%. GAAP and non-GAAP operating margin increased driven by revenue growth and continued cost discipline. I'd also note that costs associated with Autodesk University have shifted from the third quarter last year to the fourth quarter this year due to the timing of the event. Free cash flow was $13 million in the third quarter, primarily limited by the transition from upfront to annual billings for multiyear contracts and the payment of federal taxes we discussed earlier this year. Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We remain vigilant during this period of macroeconomic uncertainty. As you heard from Andrew, we continue to invest organically and through acquisitions in our capabilities and services and the cloud and platform services that underpin them. We purchased approximately 500,000 shares for $112 million, at an average price of approximately $206 per share. We will continue to offset dilution from our stock-based compensation program to opportunistically accelerate repurchases when it makes sense to do so. Now, let me finish with guidance. The overall headline is that our end markets and competitive performance are at the better end of the range of possible outcomes we modeled at the beginning of the year. This means the business is generally trending towards the higher end of our expectations. Incrementally, FX and co-terming have been slightly more of a headwind to billings than we expected. EBA expansions have been slightly more of a tailwind to revenue and interest income has been slightly more of a tailwind to earnings per share and free cash flow. Against this backdrop, we are keeping our billings guidance constant, while raising our revenue, earnings per share, and free cash flow guidance. I'd like to summarize the key factors we've highlighted so far this year. The comments I've made in previous quarters regarding the fiscal 2024 EBA cohort, foreign exchange movements, and the impact of the switch from upfront annual billings for most multiyear customers are still applicable. We again saw some evidence of multiyear customers switching to annual contracts during the third quarter, as you'd expect, given the removal of the upfront discount. We're keeping an eye on it as we enter our significant fourth quarter. All else equal, if customers switch to annual contracts, it would proportionately reduce the unbilled portion of our total remaining performance obligations and negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged. Annual renewals create more opportunities for us to drive adoption and upsell and are without the price lock embedded in multiyear contracts. Putting that all together, we now expect fiscal 2024 revenue to be between $5.45 billion and $5.47 billion. We expect non-GAAP operating margins to be similar to fiscal 2023 levels with constant currency margin improvement, offset by FX headwinds. We expect free cash flow to be between $1.2 billion and $1.26 billion to reflect higher revenue guidance we're increasing the guidance range for non-GAAP earnings per share to be between $7.43 and $7.49. Our billings guidance remains unchanged, given incremental foreign exchange headwinds and the potential for further EBA co-terming in the fourth quarter. The slide deck on our website has more details on modeling assumptions for Q4 and full year fiscal 2024. We continue to manage our business using a Rule of 40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins captured in the Rule of 40 framework is the hallmark of the most valuable companies in the world, and we intend to remain one of them. As we've been saying all year, the path to 45% will not be linear. We've talked about all of the factors behind that over the last three quarters, and I think it's useful to put them all in one place here, particularly as we look into fiscal 2025 and 2026. First, the macroeconomic drag on new subscriber growth, a smaller EBA renewal cohort with less upfront revenue mix, and the absence of EBA true-up payments are headwinds to revenue growth in fiscal 2025. Slightly offsetting that, we expect our new transaction model, which Andrew discussed earlier, to be a tailwind to revenue growth in fiscal 2025 and beyond. Assuming no material change in the macroeconomic, geopolitical or policy environment, we'd expect fiscal 2025 revenue growth to be about 9% or more. In other words, at least around the same or more growth as we are now expecting in fiscal 2024. And second, the transition to annual billings means that about $200 million of free cash flow in Q1 fiscal 2024 that came from multiyear contracts built upfront will not recur in fiscal 2025. This will reduce reported free cash flow growth in fiscal 2025. And make underlying comparisons between the two years harder. If you adjust fiscal 2024 free cash flow down by $200 million to make it more comparable with fiscal 2025 and fiscal 2026 on an underlying basis, the stacking of multiyear contracts build annually will mechanically generate significant free cash flow growth in fiscal 2025 and fiscal 2026. The progression from the adjusted fiscal 2024 free cash flow base, will be a bit more linear, although fiscal 2026 free cash flow growth is expected to be faster than fiscal 2025 as our largest renewal cohort converts to annual billings in that year. As you build your fiscal 2025 quarterly and full year estimates, please pay attention to what we've said each quarter during fiscal 2024. As Andrew said, our new transaction model will likely provide a tailwind to revenue growth be broadly neutral to operating profit and free cash flow dollars and be a headwind to operating margin percent. The magnitude of each will be dependent on the speed of deployment. Excluding any impact from the new transaction model, we are planning for operating margin improvement in fiscal 2025. Overall, we expect first half, second half free cash flow linearity in fiscal 2025 to be more normal than in fiscal 2024. And we still anticipate fiscal 2024 will be the free cash flow trough during our transition from upfront to annual billings for multiyear contracts. Per usual, we'll give fiscal 2025 guidance when we report fiscal 2024 results, so I don't intend to parse these comments before them. As I said at our Investor Day last March, the new normal is that there is no normal. Macroeconomic uncertainty is being compounded by geopolitical, policy, health and climate uncertainty. I'm thinking here of generational movements in monetary policy, fiscal policy, inflation, exchange rates, politics, geopolitical tension, supply chains, extreme weather events and, of course, the pandemic. These increased the number of factors outside of our control and the range of possible outcomes, which makes the operating environment harder to navigate both for Autodesk and its customers. In this context, the mechanical rebuilding of our free cash flow as we transition to annual billings for multiyear contracts, gives Autodesk an enviable source of visibility and certainty. I hope this gives you a better understanding of why we've consistently said that the path to 45% will not be linear. But let me also reiterate this. We're managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal, regardless of the macroeconomic backdrop. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie Let me finish by updating you on our progress in the third quarter. We continue to see good momentum in AEC, particularly in transportation, water infrastructure and construction. Fueled by customers consolidating on our solutions to connect and optimize previously siloed workflows to the cloud. Market conditions remain similar to previous quarters. In Q3, WSP, one of the world's leading professional services firms closed its sixth EBA with Autodesk, a testament to our strong and enduring partnership. Leveraging the breadth of our portfolio, WSP has delivered the comprehensive range of services demanded by its clients, generate millions of dollars in pipeline across the AEC and manufacturing industries, secured bridge and groundwork contracts through automation capabilities, reduce costs through increased efficiency and most importantly, delivered impactful results for its customers. TCE, a global engineering and consulting firm, which supports all types of infrastructure is harnessing Autodesk solutions to bolster its sustainable development goals around clean water and sanitation. Industry innovation, infrastructure and responsible consumption and production, utilizing Autodesk's BIM Collaborate Pro, TCE plans to improve team collaboration through easier data exchange, fewer classes and more effective designer years. Autodesk solutions are empowering TCE to manage, coordinate and execute projects more efficiently, thus contributing to a better quality of life through improved infrastructure. We are seeing growing customer interest in our complete end-to-end construction solutions, which encompass design, preconstruction and field execution through handover and into operations. Encouragingly, Autodesk Construction Cloud MAUs were again up well over 100% in the quarter. In Q3, LFD, Inc., an ENR top 200 general contractor based in Ohio, selected Autodesk Construction Cloud over directly competitive offerings as its end-to-end construction platform. With our preconstruction and cost capabilities of standout differentiator, it ultimately chose Autodesk based on our level of partnership, our aligned vision and commitment to serve the evolving needs of the construction industry and the momentum our solution has demonstrated in the marketplace. Again, these stories have a common theme: managing people, processes and data across the project lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way, and we remain focused on enabling that transition through our industry clouds. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and to consolidate on our design and make platform to grow their business and make it more resilient. For example, a global industrial company based in the U.S. is partnering with Autodesk to innovate more rapidly in its business. The customer had already standardized on Autodesk's up chain to streamline its data and process manager within their molding technology solutions and modernize its CAM process by adopting Fusion to significantly reduce programming time and eliminate risks from legacy software. During Q3, it renewed its EBA with Autodesk and plans to broaden its use of up chain, vault infusion. It is exploring Fusion's ability to enhance process management and its digital threat initiatives, which focus on product life cycle management, closed-loop quality, sustainability design, service life cycle management and supplier insight. Fusion continues to provide an easy on-ramp into our cloud ecosystem for existing and new customers. For example, a leading manufacturer for the agriculture industry is migrating from network licenses to named users and complementing those subscriptions with Flex tokens to maximize value and access for occasional users. As it digitizes its factories and create digital twins for its global facilities, it will use Flex to explore Autodesk's most advanced technology for Fusion, for CAM tool path automation and generative design. Flex provides the customer with the flexibility to scale its usage based on its needs, making sure its users have access to the right products at the right time. Fusion continues to grow strongly, ending the quarter with 241,000 subscribers as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. In automotive, we continue to grow our footprint beyond the design studio into manufacturing and connected factories. In Q3, a leading automotive manufacturer renewed and expanded its EBA by more than 50%. In addition to its existing usage of alias for concept design modeling and design evaluation, the customer is replacing an internal tool with Red for lighting simulation. In the future, it will implement flow production tracking to improve and accelerate project communication and collaboration across departments and expand its use of Autodesk's integrated factory modeling to optimize factory layouts and enhance operational performance. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. For example, our partnership with PanState is making a positive impact in design classes and car CMC activities across the PanState, Barron's, Burks, Terresburg and University Park campuses. PSU Harrisburg has recently adopted Fusion in its core design class and plans to integrate it into its mechanical engineering curriculum. Fusion's accessible platform allows students to seamlessly transition from car to CAE and CAM enabling them to make a different outside the classroom and in industrial applications. They have already collaborated with NASA on a generative design project for spaceflight applications, inspiring numerous projects at NASA. And finally, we continue with our customers to ensure they are using the latest and most secure versions of our software. A publicly traded construction company in Japan thought to streamline software management processes and minimize compliance risks by leveraging single sign-on FFO and directly sync features available in our premium plan. Through a collaborative analysis of the client software usage logs, we identify instances of noncompliant usage and recommended an appropriate number of subscriptions based on usage frequency and actual requirements. This proactive approach ensures that the client has the necessary access to meet their needs while maintaining compliance. We've been laying the foundation to build enterprise-level AI for years with connected data, teams and workflows in industry cloud, real-time and immersive experiences, shared extensible and trusted platform services and innovative business models and trusted partnerships. Autodesk remains relentlessly curious with the propensity and desire to evolve and innovate. We are building the future with focus, purpose and optimism. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hi guys, thanks for taking my questions here. How are you?"
},
{
"speaker": "Andrew Anagnost",
"text": "Great, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Andrew, maybe for you. Lots of talk about here, right, particularly with the new transaction model. Maybe the right first question here would be. Why is this new model, I guess, as consequential as you said in your prepared remarks. Any color there you can add?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, absolutely. Let me start Saket by saying First, the business is super resilient where we're built through resilience, and this is really showing up in these results this round as well. And that's going to continue into the future. When we talk about this new transaction model, I think it's important to back up and talking about what we're trying to do with our customers and the journey we've been on. We are trying to do no less than move all of our customers to cloud-based life cycle solutions powered by AI that connect their design and make processes in a way that they've never had connected before. Now to do that, you absolutely cannot use 40-year-old systems and business models. So we've been on this relentless journey to modernize the company. We started moving from developing cloud-based products to subscription models, to annualized billings. I mean you've seen journey after journey here to modernize the company. This is the next step and one of the most important steps in modernizing the company so that we have the kind of relationship with our customers that actually matches the kind of technology we're delivering to them. So through this, we're not only going to have direct engagement with our customers through the products they use in the cloud, we're going to have direct engagements with them as a customer as an account. We're going to understand them at the account level and as an entity, not just as a collection of transactions passed through several tiers. And that's really important. Because that will not only give us more information about our customers, it will help us give more information to our partners about our customers and understand them significantly better. And it will wrap up the whole solution and business model and capabilities in one package. The other really consequential thing here is our partner network has to move transaction-focused partners to solution-focused partners. They are going to be incredibly important on the front lines in helping our customers deploy and integrate new design to make solutions in the cloud. And this is going to be part of that transition for them. So yes, it is very consequential. And it's part and parcel of a long stream of modernizations we've been working on for a while, and I do think it's very significant."
},
{
"speaker": "Saket Kalia",
"text": "Got it. No, absolutely. It sounds very strategic. Debbie, maybe for my follow-up for you. I know you said you wouldn't parse out your comments on fiscal 2025. But -- could we maybe parse out those comments for fiscal '25 just a bit kind of given some of the moving parts sort to ask, but..."
},
{
"speaker": "Debbie Clifford",
"text": "There are indeed a lot of moving parts, Saket. So thanks for the question. I know that's the question that everyone wants to ask. I'm not going to parse all the details, but I'll just highlight some of the things that we called out in the opening commentary. Those things are the non-recurrence of EBA upfront and true-up revenue, FX and the macro drag on new subscriber growth, these are all things that are headwinds to revenue growth next year. We also talked about the impact depending on the timing of this move to a new transaction model. That's going to be a tailwind to revenue. It will be margin and cash flow dollar neutral and is a headwind to margin percent. We'll give you all the details on this in February for the usual. But remember, what we're really trying to do is set ourselves up for success over the long term."
},
{
"speaker": "Saket Kalia",
"text": "Makes a lot of sense. Thanks, guys. I’ll get back in queue."
},
{
"speaker": "Operator",
"text": "Thank you. Please standby for our next question. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. So on fiscal 2025, following up on Saket's question, at the analyst meeting earlier this year, Debbie, you showed a chart depicting sustainable double-digit growth for Autodesk of 10% to 15%. And based on a combination of various price and volume components, are you still adhering to that plethora of price and volume sources of growth? Or have you changed your thinking in terms of the magnitude or mix of those sources of growth over time?"
},
{
"speaker": "Debbie Clifford",
"text": "We are still targeting those sources of growth, Jay, as well as targeting the growth parameters of 10 to 15 points of revenue growth. Really, what we're dealing with is this uncertain environment. And based on what we know today and assuming that market conditions are similar to what we've seen over the last several quarters, we do see revenue growth next year of about 9% or more. And what's driving that is really all those puts and takes that I talked about in the opening commentary. It's really important to remember that what we're trying to do is set ourselves up for success over the long-term."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Andrew, for you, following up on AU last week. There were a number of quite interesting and useful sessions on our roadmaps and product plans, particularly on AUC and more broadly with regard to the data model. So, let me ask you an unavoidably complex question about that. So, when you -- so when you think about the role of what you call granular data, does that ultimately affect as you implement that the packaging or composition or consumption of the software? And you also gave quite detailed description of where you're going with ACC and Bill and AC generally. But there's no timeline in any of those presentations. So, how are you thinking about the GA of much of what you talked about last week at AU in terms of making commercial a very large set of new technology features, particularly for AC?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay. So, let me tackle that with the first thing around the granular data. So, ultimately, as you journey down this path, what does happen is the way the product operates all the products Forma in particular in terms of how it interacts with Revit and ultimately how those two blend together, they do become an environment that looks very much like the fusion environment. And that environment is very different, as you know, than what it currently exists in most of the wide -- the mainstream usage of our AC products. So, yes, granular data ultimately leads to a different way that people consume and use the products in a different paradigm for which they actually engage with the product every day. So. that's clear, okay? Timeline, I don't know exactly which presentation you're in. I suspect given your questions, you are in the more longer term timeline presentation. So, a lot of stuff you saw there was over a two to five-year time frame, but a lot of that is going to show up in the two to three-year timeframe associated with some of the things you heard. Now, I think it's kind of obvious to tell which ones we're towards the earlier part of that spectrum rather to the later part of that spectrum. Turning some of these solutions over into infrastructure solutions and combining them with some of our infrastructure stuff. Probably towards the later end, getting the data more granular, uniting detailed design and conceptual design in Forma, probably much more closer. That kind of expectation you can have with those road maps."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Great, great. Thank you both."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Adam Borg of Stifel."
},
{
"speaker": "Adam Borg",
"text": "Awesome. Thanks so much for taking the question. Maybe for Debbie, just on the multiyear to annual billings transition. Maybe just if you could just remind us kind of where we are overall in the process relative to expectations. And I do know that there are still some smaller cohorts that have yet to transition and just curious kind of where we are for those and if that's going to take place next year? Or is that still kind of in process?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. Thanks. The rollout is going well. We're a couple of quarters in the systems are working. Customers and partners are behaving pretty much as we expected. So overall, the performance is in line with our expectations. I think the key thing is, remember, we're kind of at the beginning of this journey. This is going to be a three-year journey. So we're going to have a mechanical rebuild of free cash flow as we get into next year, fiscal 2025 and also in fiscal 2026. So some of the comments that I made on the call are important, and that is helping you think about how to normalize our fiscal 2024 cash flow headed into fiscal 2025. So we're moving that $200 million at the beginning of fiscal 2024 as we head into fiscal 2025. And then broadly, the fact that we'll have bigger cohorts coming up for renewal in fiscal 2026, which drives faster growth in free cash flow in that period. So overall, things are going well, and we're at this interesting point where we expect to see mechanical rebuilding of free cash flow from here."
},
{
"speaker": "Adam Borg",
"text": "Got it. And maybe just a quick question. Interesting AI announcements with Autodesk AI, back at AU last week. Any commentary on how to think about any price uplift from those solutions? Thanks again."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So I'll take that one, Adam. Look, some of these features are already and will be delivered through our existing products. However, there are new models will be exploring with some of these capabilities. Obviously, it's a little too early to talk about actual monetization. But I do think some of the things you're seeing with Microsoft right now are quite interesting where highly evolved large models, which we have not yet deployed out in the market are offered up to individual customers as a here's your model. Now you train it, you custom train it and extend it with your data. Those kind of models are going to be very interesting in the future and really look like possibilities that we'll probably explore and look at. As we move forward. But for now, a lot of this functionality is going to end up integrated with the existing products as it has been for the last several years."
},
{
"speaker": "Adam Borg",
"text": "Great. Thanks again."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Joe Vruwink of Baird."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi, everyone. Maybe just a follow-up on that last question. Andrew, like you said, AI and automation is not new at Autodesk. But I did think the messaging was maybe a little more exact and pointed just as it pertains to the cloud data strategy and how that really is the gateway to future AI capabilities that Autodesk how customers need to be thinking about this. So my question is just curious to hear any feedback from customers on this approach. And maybe levels of resistance or buy in, you've started to hear just pertaining the customers kind of pooling their data and Autodesk ends up being the aggregator of industry information?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So look, we have a very strong point of view on ethical and high trust use of data, and we intend to continue to pursue that with our customers and take a broad and strong stance around look, it's your data. We're going to work with you to use it appropriately for things that make the whole ecosystem better. We're going to do it in a way that's trusted. And we're also going to work with you in a way that allows you to preserve the IP that you think is important to you that does not become part of the entire ecosystem. So this is a conversation I have with many, many customers most obviously recognize the trade-off between massive amounts of productivity in terms of automating model creation and some of the benefits there. So they want to participate in ways that actually make sense for them and that maintain the trust and integrity that we're looking to do. So look for us to handle this in exactly that matter as we move forward."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Great. And then I'm going to take my best shot at FY 2025 question as well. But I think maybe 2 points of clarification or additional information. So Debbie, just on kind of the known headwind to free cash flow next year because of the long-term deferreds that happened to hit in this year. Can you reconcile that with the normal seasonality comment. Should we be removing that and then thinking about modeling normal seasonality, part A? Part B, you've talked about currency a lot is having impacts on some of these numbers. And I would imagine just given what's on the balance sheet, you probably have a good sense of what currency will be next year. How does currency factor into that 9% plus revenue growth rate you provided?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. Thanks, Joe. So on the first question, I think you're thinking about it in a reasonable way. So take out the $200 million and then it should have a more reasonable that will give you more reasonable modeling expectations as you think about modeling fiscal 2025 and beyond. And then on currency, is it's really been all over the place. I think everybody has been seeing that. What we see right now is that it would be a headwind for us as we head into next year. But given the volatility, I think it really could go either way. But based on what we're seeing right now, it is a headwind to revenue growth next year."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler."
},
{
"speaker": "Tyler Radke",
"text": "Okay. Great. Thanks for taking the question here. Andrew, you talked about some record contribution from the construction side of the business, I think, broadly, but also within the EBAs. Could you elaborate within Autodesk Construction Cloud. What are the strongest areas you're seeing customers about?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. No. What's interesting is. We're not seeing the softness in construction that others may have highlighted. In fact, we have incredibly strong performance at the top end of our business. We saw strong growth internationally. And we're seeing growth in the U.S. And a lot of things are going on in the construction business right now. And whereas you see some sectors slowing down retail warehouse office things like that. You're seeing other things offsetting it. Again, the dynamicism of Autodesk business, manufacturing, industrial, lots of factory construction going on data centers, health care, , infrastructure, all of these things are picking up. So we've got a lot of dynamics that are playing well with regards to our construction business right now. When we look at the business, we look at the indicators that we have, bid board activity was at record highs again. So we saw a good strong bid activity there. While construction backlog may have declined a bit, it's still high, all right? And the number one thing that I heard from general contractors at Autodesk University was still can't hire enough. So they're still going to be working through that backlog at a relatively slow pace. Also, what's really interesting is we're seeing ourselves in more deals down market now more competitive deals, and frankly, we're winning some of them. And I think that's interesting. I think that probably results in slowing down deals for some of our competitors in various markets. But we're actually seeing a lot more interesting deal activity."
},
{
"speaker": "Tyler Radke",
"text": "That's helpful. And a follow-up for Debbie. I appreciate you getting a lot of questions on FY 2025. And I'm not going to ask you to dissect it further. But if I think about just trying to bridge the 9%, which seems like it does have some tailwinds from the transactional changes relative to that 10% to 15% framework that you gave, it doesn't seem like macro has worsened relative to a few quarters ago or a year ago when you gave that out based on your commentary. Just help us understand that bridge. Is it mostly conservatism or maybe currency or some of the other headwinds are larger than we're thinking about? Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. Sure. So remember, you got to be thinking about the non-recurrence of the EBA upfront and true-up revenue that we've been talking about all year. FX, as I just mentioned, could be a factor right now, we're assuming that it is a headwind to revenue growth. And then finally, we have been talking about the macro drag on new subscriber growth all year. And remember, given the ratable revenue recognition model that we have, what we're seeing with new subscriber growth this year has more of an implication for revenue growth next year than for revenue today. So those three factors are the biggest factors driving our estimate of 9% or more as we head into next year."
},
{
"speaker": "Tyler Radke",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks for taking my question. Maybe one on the EBAs. So in Q3, did you see any of these renewals maybe happen earlier than expected? Overall, it sounds like you're still seeing some timing true-ups, but also some pretty big expansions. Is the overarching takeaway that the cohort is expanding maybe better than what you had anticipated?"
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Jason. So the EBA cohort has been performing really well all year, which has been great. Remember, this is a cohort that last renewed in late 2020. That was at the height of the pandemic. And back then, they made more conservative assumptions about usage because of the uncertain environment at that time. Fast forward to today, these customers are continuing to manage through a high demand for projects. That's led to higher overall usage on their contracts. And as we've mentioned before, we do monitor the usage. So we've had insight into the potential EBA upside as the year has progressed. We've continued to update our outlook, which is each quarter of the renewals and the true-ups. And as we look at Q4. We've got our eye on the remainder of this large EBA cohort and the signs continue to be strong. We factored all of this into our latest estimates, and that's what drove the top line upgrade that we communicated today."
},
{
"speaker": "Jason Celino",
"text": "Okay. Great. And then I asked this question last quarter, but it sounds like a few of your competitors might be starting to see some of the water infrastructure funding start to flow plan intended this time. Are you seeing this, too? And then is this the strength that you're already seeing? Or could this be an additional opportunity for maybe next year?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Jason, one of the things that you may have heard is that some of that money from the infrastructure bill that was targeting modernization of departments of transportation was really, it's about $34 million that's significant in that not only it starts these DOTs on their process of modernization and evaluating the modernization, but it also was directed at several DOTs that we have relationships with and where we've actually displaced competitors and engaged with the infrastructure. So that's pretty exciting stuff. That shows money starting to flow to the projects. As I've always said, it takes time to release this money from the flood gates of Washington into the places floodgate of Washington, that's kind of an oxymoronic comment. But it takes time to get there. And that -- these -- this money is going to kind of again, build up momentum for the rest of the projects and help us move forward. So I would say it continues to be an emerging opportunity. Projects are getting started, but there's more hope in the future for even more projects."
},
{
"speaker": "Jason Celino",
"text": "Okay, Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Michael Funk of Bank of America."
},
{
"speaker": "Michael Funk",
"text": "Yes. Thanks for the questions. Two, if I could. So first for you, Andrew. A number of changes with partner relationships from last year, you mentioned the new transaction model I think earlier you also changed the commission structure to more back end versus front-end loaded. So curious what kind of reaction you're hearing from your partners and how you expect these changes to impact that relationship?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So obviously, we invest a lot in bringing our partners along on this. It doesn't mean all partners are going to be happy with these changes. Okay? It's just that is not an outcome that we're looking for or is likely. But many partners are going to be happy with these changes because we've been very clear about what the path is to growth for them. Beyond that, we've taken a really kind of incremental approach to these things with our partners. We kind of led them along, showed them the way. You might recall, we started the new transaction model with Flex, close to about 1.5 years ago in Australia, then we rolled it out to the broad-based partner network and everybody got experience with it. Now we're testing in Australia. Again, we take our partners along on these journeys in very deliberate ways. And frankly, the credibility we have with our partners in terms of making their businesses more consequential and significant and, frankly, larger over time has really created an environment where there's a lot of trust. And there's a lot of discussion about what's the best way to do this. What this means for them and where it's going to take their business. And this will make the partners ultimately more consequential in some of the business discussions with their partners with their customers by bringing them closer to the design and make infrastructure work that needs to happen in the services and support that."
},
{
"speaker": "Michael Funk",
"text": "Thank you for that, Andrew. And one for you, Debbie, will see a check on the accounting of the math. You mentioned EBA revenue, non-recurrence in fiscal 2025 a few times. So, two pieces. First, accounting. I thought that the true-ups with upsizing in EBA, I thought that was recognized ratably over the term of the contract. Just trying to think how that might carry over an impact 2025, I'm correcting that accounting? And then second, if you can just remind us on the actual benefit to fiscal year 2024 from those items so we can pull that out of the fiscal year 2025 number?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So, from an accounting standpoint, the true-ups we recognize upfront. So, think of it as an enterprise customer signs up for X number of tokens. And when they exceed X number of tokens, we build them for the differential and we recognize that revenue upfront and it doesn't recur in future periods, unless over the next three-year contract term, they utilized more than the tokens allotted in their contract again. So, that's why it's something that is sort of a one-off -- a good one off, but a one-off nonetheless, that could only recur three years from now for these contracts if we found ourselves in the same situation. And then in terms of sizing the benefit to fiscal 2024, we haven't gotten into exact numbers, but you can think about the overall guidance upgrade that we talked about today is largely being driven by the strength that we're seeing from the enterprise business this year."
},
{
"speaker": "Michael Funk",
"text": "Great. Thank you both."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Matt Hedberg of RBC."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks for taking my questions. I guess for either of you, maybe thinking longer term, I'm curious if you could help us with maybe the -- this move from contra revenue. What is the impact to sort of like pro forma revenue growth once the business has migrated more so to the Flex model?"
},
{
"speaker": "Debbie Clifford",
"text": "Matt, it's going to be -- revenue growth will accelerate. And the pace at which it accelerates is going to be determined based on how we go about the rollout. But as we mentioned, we're working on that now. We launched Flex last year. We just launched Australia. We're learning from Australia -- as we -- right now. And then as we look ahead to next year, we intend to go global with this, but we need to make sure that we are set up for success, which is why we're watching Australia closely. But when we execute finally, on all aspects of this transition, it will be an accelerator to revenue growth."
},
{
"speaker": "Matt Hedberg",
"text": "Got it. Thank you. And then I know last quarter, you saw some pretty good non-compliant conversions I don't think you mentioned the other side - recall you're talking about that. Was there any this quarter that you called out?"
},
{
"speaker": "Debbie Clifford",
"text": "We continue to perform well with our non-compliant conversions. So, I think you've heard us talk about a couple of things. I think historically, we have talked about some of the larger deals that we've closed, and those types of deals are still happening. But as I recall, on last quarter's earnings call, Andrew was talking about some of the stuff that we've been doing in product that's driving more conversion. That's on a smaller scale in terms of deal sizes, but is driving significant volume for Autodesk. So, over time, you're going to see us continue to flex different means of driving more compliance from non-compliant users, and it continues to be a steady drumbeat contributor to our revenue growth over time."
},
{
"speaker": "Matt Hedberg",
"text": "Got it. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank. Please go ahead, Bhavin"
},
{
"speaker": "Bhavin Shah",
"text": "Great. Thanks for taking my question. Just kind of following up on that last one on the new transaction model. Like what kind of learnings are you looking to see from Australia before kind of rolling the app more broadly and kind of any disruption kind of that we should think about from a pointer perspective?"
},
{
"speaker": "Andrew Anagnost",
"text": "Well, one of the things that we're trying to make sure that we see is how do the partners line up their deals so that they're able to enter them into the system and make sure they get their pipeline lined up with the new way of doing things because they're going after directly enter them into the system. Some of these services used to be taken over by distributors for some of our partners. We're going to make sure that -- we want to make sure that large volumes work well with the systems. We're pretty confident at this point because of the Flex experience, but we know we want to stress test these things. We want to make sure that it works for all the product offerings that there's no issues or hiccups with particular things that when people try to true up renewal dates or line them up, there's not issues with those things. It's all the things that go into the mechanics of a partner entering the deal, all right, and having those things actually function. We just want to make sure it all works. Again, we have a lot of confidence because of the Flex work, but those are the things we're going to be testing for in the Australia pilot."
},
{
"speaker": "Bhavin Shah",
"text": "That's helpful there. And just kind of following up on Fusion 360. I know you guys are making some pricing adjustments going into next year, kind of raising the list price on Fusion 360, but kind of rationalizing and lowering the price on the extensions. What's the kind of the rationale behind this? Is this to drive kind of further extension adoption down the road? And kind of how does this inform your views on as you think about rolling this out to the form and the like?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Bob, what we're doing there is the price increase in Fusion is directly connected to the value we're delivering Fusion we're making sure some of the customers who have been with us for a long time are treated appropriately and fairly. So we're paying attention to all those things to customer dynamics. But what we saw is that the value in base Fusion has just increased to high level that we should be looking at the price more carefully. The value is going to continue to increase. And what we saw is that some of the extensions would probably see better adoption in some of the base -- the value was shifted to the base offering and the price of the extensions were contracted a little bit. So it's all this kind of balancing the overall cost of ownership for particular types of customers. And it's an appropriate time to do it."
},
{
"speaker": "Bhavin Shah",
"text": "Very helpful. Thanks for taking the question."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Steve Tusa of JPMorgan. Your question please, Steve,"
},
{
"speaker": "Steve Tusa",
"text": "Hi, guys. Thanks for taking my question. Just on the subscriber growth, are we talking like -- you mentioned the macro impact several times. What are we kind of talking about what kind of rate this year? Is that like in the low to mid-single-digit range? And then what would it take for that to go flat? What type of macro do you think it would take to go flat? And then secondarily, just on the free cash flow side, I think at the Investor Day, you had put a chart in there that insinuated that cash would still grow from 2023 through the number in 2026. Are we still on track for that kind of longer-term view just to level set us on the longer-term cash outlook?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Steve, let me take the first question a little bit. I won't answer the specific question. What I want to say is our business is incredibly resilient. You have to really pay attention to that, we're built for resilience. And I want to highlight some of the differences in puts and takes here. For instance, you probably noticed that AEC grew 20% in the quarter. And that offset some of the headwinds from media and entertainment due to wider strikes and after strikes. Regionally, India and Canada offset the U.S. and the U.K. Market segment-wise, EBAs and small businesses offset the mid-market. You have to think of the business through this built for resilient framework. And so I want to shift your lens a little bit, and then I'll let Debbie comment on the second part of your question."
},
{
"speaker": "Debbie Clifford",
"text": "Yes, I would say, look, outside of the new transaction model, nothing has changed, and we're on track to achieving our goals. But this is a pretty big decision for us to transform our go-to-market. But I think is really beneficial to the company. It's going to drive greater free cash flow and greater revenue growth over the long term. I'm not going to parse comments about fiscal 2026 in addition to fiscal 2025 on this call. What we're really trying to do is set ourselves up for success over the long term and make smart decisions for the business and for our shareholders."
},
{
"speaker": "Steve Tusa",
"text": "Okay. Great. Thanks a lot."
},
{
"speaker": "Operator",
"text": "Thank you. That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, everyone, for joining us. Wishing those who celebrate a happy Thanksgiving and looking forward to catching up with you on the road over the coming weeks and at next quarter's earnings. Thanks so much, Latif. Handing back to you."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 2 | 2,024 | 2023-08-23 17:00:00 | Operator: Thank you for standing by, and welcome to Autodesk's Second Quarter 2024 Earnings Call. [Operator Instruction] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the second quarter results of Autodesk's fiscal '24. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, products and product capabilities, business models and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release, or Excel financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome, everyone, to the call. Resilience, discipline and opportunity again underpinned Autodesk's strong financial and competitive performance despite continued macroeconomic policy and geopolitical headwinds. Resilience provided by our subscription business model and our product and customer diversification discipline and focus in executing our strategy and deploying capital through the economic cycle and opportunity from developing next-generation technology and services which deliver end-to-end digital transformation of our Design and Make customers and enable a better world designed and built for all. Our leading indicators remained consistent with last quarter with growing usage and record bid activity on BuildingConnected and cautious optimism from channel partners. Customers remain committed to transformation and to Autodesk leveraging automation more where they are seeing headwinds from the economy, labor shortages and supply chains. That commitment was reflected in our Q2 performance, growing adoption and token consumption within Enterprise Business Agreement and strong renewal rates. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. We were delighted that Autodesk was recently highlighted as a Best Workplace for Innovators by Fast Company. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. Overall market conditions and the underlying momentum of the business remained similar to the last few quarters. Despite a tough macroeconomic backdrop that continues to drag on the overall rate of new subscriber acquisition and the forward momentum of the business and may continue to do so. Our financial performance in the second quarter was strong. We said last quarter that we had a strong cohort of EBAs renewing in the second half of the year that last renewed three years ago at the start of the pandemic and that subsequent adoption and usage has been strong. Some of that strength came through in the second quarter, which was earlier than we were expecting and which boosted billings, free cash flow and subscription revenue. Total revenue grew 9% and 12% in constant currency. By products in constant currency, AutoCAD and AutoCAD LT revenue grew 9%, AEC revenue grew 14%, Manufacturing revenue grew 9% and in double digits, excluding a headwind from variances in upfront revenue, and M&E revenue grew 10%. By region in constant currency, revenue grew 15% in the Americas, 11% in EMEA and 6% in APAC. Direct revenue increased 18% and represented 37% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the eStore. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. The transition from upfront to annual billings for multiyear contracts is proceeding broadly as expected. We had a full quarter impact in the second quarter, which resulted in billings declining 8%. Total deferred revenue increased 14% to $4.2 billion. Total RPO of $5.2 billion and current RPO of $3.5 billion grew 11% and 12%, respectively. Turning to the P&L. Non-GAAP gross margin remained broadly level at 92%. GAAP and non-GAAP operating margin remained broadly level with revenue growth and cost discipline, offsetting the impact of exchange rate movements. Free cash flow was $128 million in the second quarter, which was a bit better than we've been expecting, primarily due to the timing of EBAs, but also due to some favorable in-quarter linearity. Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We are being vigilant during this period of macroeconomic uncertainty. During Q2, we purchased approximately 400,000 shares for $87 million at an average price of approximately $200 per share. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense to do so. Now let me finish with guidance. The headline is that overall, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year. Our sustained momentum in the second quarter and early expansion of some EBAs expected to renew later in the year, reduce the likelihood of our more cautious forecast scenarios given that, we're raising the lower end of our guidance ranges. Let me summarize some key factors we highlighted earlier in the year. First, we have a strong cohort of EBAs renewing in the second half of the year, although, as I mentioned earlier, some of that benefit was billed in the second quarter. Second, foreign exchange movements will be a headwind to revenue growth and margins in fiscal '24. The revenue headwind will moderate a bit in the second half of the year. Third, Switching from upfront to annual billings for most multiyear customers creates a significant headwind to free cash flow in fiscal '24 and a smaller headwind in fiscal '25. Our expectations for the billings transition are unchanged. Fourth, as we thought might happen, we saw some evidence of multiyear customers switching to annual contracts during the second quarter. It wasn't big enough to be called a trend, but we're keeping an eye on it. It's still early days, and we'll keep you updated as the year progresses. All else equal, if customers switch to annual contracts, it would proportionately reduce the unbilled portion of our total remaining performance obligations and negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins and free cash flow would remain broadly unchanged. Annual renewals create more opportunities for us to drive adoption and upsell and are without the price lock embedded in multiyear contracts. And fifth, we expect our cash tax rate will return to a more normalized level of approximately 31% of GAAP profit before tax in fiscal '24, up from 25% in fiscal '23. We the federal tax payment extension after the winter storms in California means cash tax payments shift from the first half of the year to the third quarter, reducing third quarter free cash flow. Second half free cash flow generation will, therefore, be significantly weighted to the fourth quarter. We still anticipate fiscal '24 will be the cash flow trough during our transition from upfront to annual billings for multiyear contracts. Putting that all together, we now expect fiscal '24 revenue to be between $5.41 billion and $5.46 billion. We expect non-GAAP operating margins to be similar to fiscal '23 levels with constant currency margin improvement, offset by FX headwinds. We expect free cash flow to be between $1.17 billion and $1.25 billion. We're increasing the guidance range for non-GAAP earnings per share to be between $7.30 and $7.49 to reflect higher interest income on our cash balances in addition to the reduced likelihood of our more cautious forecast scenarios. The slide deck on our website has more details on modeling assumptions for Q3 and full year fiscal '24. We continue to manage our business using a rule of 40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins captured in the rule of 40 framework is the hallmark of the most valuable companies in the world, and we intend to remain one of them. As we said back in February, the path to 45% will not be linear, given the macroeconomic drag on revenue growth from the rate of new subscriptions growth and the drag to free cash flow as we transition away from multiyear contracts paid upfront. But let me be clear, we're managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal regardless of the macroeconomic backdrop. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Let me finish by updating you on our progress in the second quarter. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. We continue to see good growth in AEC, fueled by customers consolidating on our solutions to connect and optimize previously siloed workflows through the cloud. And as we talked about in February, digital momentum is also building among asset owners in infrastructure and other areas. This momentum is expected to accelerate with infrastructure investment programs like the U.S. Advanced Digital Construction Management System program, which launched during our second quarter. Cannon Design is a global design practice encompassing strategy, experience, architecture, engineering and social impact. It is driving forward its digital transformation and embracing the cloud to increase operational efficiency, enhance security, establish a single point of truth and enable more seamless end-to-end collaboration. During the quarter, it expanded its investment with Autodesk by leveraging Autodesk Docs as a common data environment adopting Forma and is exploring opportunities to integrate Autodesk's XR and asset management capabilities to its design portfolio. Outside the U.S. our construction platform is benefiting from our strong international presence and established channel partner network. During the quarter, a property developer and transit network operator based in Asia needed to simplify operations across its many infrastructure projects with a wide range of contractors and subcontractors. To manage this complexity, it needed a single source of truth for its project data and way to streamline workflows on a single platform. In Q2, it leveraged support from our local channel partner and standardize on one platform by adding Autodesk Construction Cloud to its existing portfolio of Autodesk AEC design tools to gain visibility into contractors and subcontractors workflow and the potential to unlock breakthrough productivity gains. Shook Construction, an ENR 400 general contractor based in Ohio made the decision to standardized on Autodesk Construction Cloud to better streamline their operational workflows. After evaluating many competitive options, Shook Construction chose Autodesk Construction Cloud as the best fit for driving consistent workflows, creating high-impact collaboration with their construction partners and eliminating cumbersome manual workflows. We continue to benefit from our complete end-to-end solutions, which encompass design, preconstruction and field execution through handover and into operations. Again, these stories have a common theme: managing people, process and data across the lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way, and we remain focused on enabling that transition through digital transformation. We talked last quarter about the short-term disruption from integrating our construction and worldwide sales teams. I'm pleased to report that things began to settle in the second quarter. We believe that combining the two teams will allow us to expand the scale and reach of our construction business, particularly in our design customer base and our ability to serve our customers across the complete project life cycle. Encouragingly, Autodesk Construction Cloud MAUs were up over 100% in the quarter. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make platform to grow their business and make it more resilient. For example, a multinational manufacturer which serves the construction industry on both a building product manufacturer and through tools and construction processes has been leveraging the Autodesk portfolio to connect workflows across the AEC and manufacturing industries. It's expanded its commitment to BIM using Revit, Navisworks and Construction Cloud, which has enabled the customer to adopt a collaborative and data-driven approach across design, construction and maintenance services. which minimizes clashes and rework and culminates in more efficient and successful building projects. In the second quarter, the customer grew its EBA with Autodesk ahead of its Q4 renewal date to accelerate the adoption of BIM and facilitate the design of its products and materials directly within MEP models. Fusion continues to provide an easy on rate into our cloud ecosystem for existing and new customers. In Europe, an appliance manufacturer who was already an existing user of our manufacturing collection and AutoCAD mechanical, purchased additional seats of Fusion for PCB design. It's heating systems division will leverage Fusion's electronic design automation capabilities to quickly and seamlessly connect more of its design to manufacturing workflow to drive greater efficiency. Fusion continues to grow strongly, ending the quarter with 236,000 subscribers as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. At Investor Day, I talked about leveraging our key growth enablers, including business model evolution, customer experience evolution and convergence between industries to provide more and better choices for our customers. Our Flex consumption model is a good example of this. Flex's consumption pricing means existing and new customers can try new products with less friction and enables Autodesk to better serve infrequent users. Not surprisingly, the lion's share of the business has come from new or existing customers expanding their relationship with Autodesk. During the quarter, we signed 3 more million dollar Flex deals. As Steve said at our Investor Day, we've also introduced a new transaction model for Flex, which will give Autodesk a more direct relationship with our customers and more closely integrate with our channel partners over time. We will begin testing our new transaction model more broadly in Australia later this year. And finally, we continue to work with noncompliant users to ensure that they are using the latest and most secure versions of our software. For example, after identifying and alerting a Chinese-based automobile designer about noncompliant usage and despite working to ongoing challenges from the pandemic, the customer eventually committed to three year VRED and Alias subscriptions. As expected, our initiatives to tighten concurrent usage of named user subscription and expand the precision and reach of our in-product messaging drove incremental growth during the quarter. Now let me finish with the story. According to the National Oceanic Service, Coral reefs are some of the most diverse and valuable ecosystems on earth. While they take up less than 1% of the ocean floor, their extraordinary biodiversity supports about 25% of all marine life. Healthy coral reefs support fisheries as well as jobs and businesses through tourism and recreation. It also buffer shorelines against 97% of the energy from waves, storms and floods, helping to prevent loss of life, property damage and erosion. It can take 10,000 to tens of millions of years for our coral reefs to form, and just weeks for it to die. Rising ocean temperatures can cause coral to bleach and die. Half of living coral reefs have died since the 1950s. Without intervention, we're on track to lose 70% to 90% of the remainder by 2050. That is, unless we find a faster way to bring coral reefs back from the brink. With support from Autodesk and the Autodesk Foundation, a company called Coral Maker is using our digital tools, artificial intelligence, and robotics to deliver core restoration at scale with cloud collaboration to keep the global team connected across oceans and time zones. As Dr. Karen Foster, coral makers founder says, the partnership with Autodesk has empowered us to develop new technology to restore reef at a rate unimaginable a few years ago. Current restoration projects can deploy about hectare of portal per year. With coral makers technology, it's possible to deploy 100 sectors per year. From the oceans to the earth and Sky augmented design, powered by Autodesk will enable our customers to go further and faster to design and make a better world for all. We've been laying the foundation to build enterprise level AI for years with connected data, teams and workflows in industry cloud. real time and immersive experiences, shared extensible and trusted platform services, innovative business models and trusted partnerships. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. We are building the future with focus, purpose and optimism. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Please go ahead, Saket.
Saket Kalia: Okay. Great. Hi Andrew. Hi, Debbie. How are you guys doing? Thanks for taking my questions here.
Debbie Clifford: We're doing great. How are you Saket?
Saket Kalia: Doing great, doing great. Debbie, maybe for you, just a quick housekeeping question here. Great to see the revised range on a lot of metrics, particularly revenue. And so, when I think about the midpoint of the revenue guide going up by about $25 million, first of all, great to see the impact of FX to start to lighten. But could you just maybe walk us through a broad brush how much of this year's raise on revenue is from FX versus maybe some underlying fundamentals in the business?
Debbie Clifford: Yes. So, we had a small increase in the midpoint of the guide. The dollar change was immaterial it's tough really to come up with a mix of assumptions that get us to the low end of our previous guidance range. So, the midpoint increase reflects a mix of both organic and FX assumptions. Overall, the business is tracking generally in line with our expectations.
Saket Kalia: Okay. Got it. Got it. Andrew, maybe for you, of an open-ended question. But I guess now as you've completed the first quarter of this transition to a new billing model. Is there anything that's surprising you about maybe how customers or how partners are behaving, again, open ended?
Andrew Anagnost: Yes. No real big surprises. Saket I mean - Debbie flagged last quarter that we might see some customers reverting back to annual contracts as a result of the change. We did see that. Nothing really out of bound zone, nothing really surprising. Debbie, do you want to add anything to the details or...
Debbie Clifford: Yes. I would say the initial rollout of the new billings model is going well. The systems are working, customer and partner behavior is pretty much as we expected. As Andrew mentioned, we are seeing a small proportion of our customers choose annual contracts versus multiyear contracts billed annually, but generally, we expected a bit of that, and the performance has been in line with our expectations. And remember, if customers choose annual contracts, it doesn't impact the P&L. It only impacts unbilled and total RPO. It's still early days. We're monitoring it closely. And I think it just continues to be a good example of how we're working to optimize the business. It's about reducing the volatility of our cash flow while simultaneously giving our customers, the purchasing pattern that they want. And then finally, I'd say that there's no change in how we expect the transition to impact our cash flow outlook.
Saket Kalia: Got it. All very clear. Thanks guys.
Operator: Thank you. Please stand by for our next question which comes from the line of Jay Vleeschhouwer of Griffin Securities.
Jay Vleeschhouwer: Got it. Thank you. Good evening. Andrew, for you first, you made some constructive comments about what you're seeing in the AEC business. But more broadly, and as you're well aware, there's quite a bit of ferment going on in that market right now in terms of references to what's come to be called BIM 2.0 as you know, just a couple of months ago at an AUC conference, a customer group launched a new customer-developed design specification for software. You yourselves are working on a dual track of enhancing revenue, but focusing on format. So lots going on in terms of various currents in that industry or part of the industry. Help us understand how you're thinking about managing for all those different dynamics that are going on in the AEC industry. And then a follow-up.
Andrew Anagnost: Yes. So Jay thanks. Jay, there's three threats to this, right? One is kind of the core platform threat around data and data flow. At the root of all of this, we need to make sure as much of the data that we have locked inside Revit files and lots of other types of files that our customers have gets turned into APIs wherever possible, right? This is a lubricant to the workflows that people are worried about. And I think a part of really what underpins the whole concept of BIM 2.0. That's one of the things. The second piece is you've got to make sure that their ability to do detailed in-depth complicated, sophisticated BIM models gets more performant, more productive and faster. That's core to kind of building up, and improving Revit in some significant ways, which we're absolutely looking at. But the third point, which I think is more important is you really need to reimagine how BIM is being done. The paradigm needs to shift, and it needs to shift to the world of not only being cloud-enabled but also being what we really like to call augmented design-enabled or outcome-based in whatever language we use, so that you can actually change the way people do BIM. And that's one of the big things that we're focusing on with Forma. And that's very different than - we have certain types of competitors. It's in line with what the spec is from the customers. But when you talk about data revenue improvements, and the move to what we call augmented design or outcome-based design. Those are the big thrust in terms of what we're trying to do to bring the industry to a better way of doing BIM?
Jay Vleeschhouwer: Okay. Second question refers to the comments you made about a new transactional model and a pilot you're going to be undertaking in Australia. So maybe you could elaborate on that. When I hear that, it sounds to me like there's potentially going to be some further change to channel economics. You've just completed the move to back-end-only margins. Are you thinking about perhaps taking the flex commission model more broadly across the rest of the business? Or what exactly you're looking to accomplish with that?
Andrew Anagnost: So let's talk about the Flex experiment and the things you were doing with - I think with Flex last. First off, Flex because it's like a consumption-based model, and it involves usage of various different products - it really - it's really incredibly helpful for the customer for us to be able to have a much more direct relationship with the customer with regards to that offering. Because that way we're able to offer a lot more visibility to how they're using the offering, what they're using, when they're using it, how much they're consuming, and actually help them get the most out of the offer. So, what we've done over the last year is we've proved out a new transaction model working with our partners, and rolling out across various regions that is supporting Flex, and that is a much more direct transaction model. Through that process, we've learned a lot. We've gained a lot of knowledge. We've addressed a lot of issues both systems-wise and process-wise. And we are now in a position with Flex to start growing, and expanding that model at greater and greater volume. And that's exactly what's happening with Flex. The volume of Flex is increasing, increasing, and we're doing it reliably, repeatedly and in a pretty positive way. Where we go from here depends solely on how we watch these things evolve and what the benefits of this transaction model for us. And all options are open to us in the future, but that's where we are right now. We've perfected what we've done on the Flex.
Jay Vleeschhouwer: Okay. Thank you.
Operator: Thank you. Our next question comes from the line of Adam Borg of Stifel.
Adam Borg: Awesome. And thanks so much for taking the questions. Maybe just for Andrew on the infrastructure opportunity. I know you've been calling out increasing traction with State Department of Transportation, and you even referenced some grants in the quarter in the script. So maybe just talk a little bit more about how you think about the infrastructure opportunity overall? And really what separates all of that from competitors in going after it?
Andrew Anagnost: Yes. So look, at a high level, one of the things I'm really excited about the thing with a really long name. The advanced digital construction management system program that the U.S. government rolled out, that is the program related to the money that's designed to help department of transportation look at their infrastructure, look at their processes, and start modernizing their digital processes around design and construction of infrastructure. That's an important step in getting a lot of these Department of Transportations to really start thinking about how they get ready to spend more money on infrastructure, and do it better and address the serious capacity challenges we have around materials, manpower, and dollars with regards to what we have to do. So pretty excited about, that because that's an open door to having new conversations with these departments about how they do things. Our focus has not changed. We are very much focused on water and road and rail, and we continue to innovate and drive improvements in those areas. I think our biggest differentiator is what we bring to market as a modern architecture. We bring to market more cloud-based solutions, more owner-based solutions for managing the infrastructure once you have it, and really just more technology that sits together in different ways. So, we're looking forward to having that discussion with the Department of Transportation over the next months and coming years. And I think you're going to start to see real change in some of those organizations.
Adam Borg: That's really helpful. And maybe just as my follow-up, just on the earlier-than-expected EBA renewal pool in the quarter. So maybe just talk about - just given the softer macro obviously, that our checks have been suggesting, and you talked about no real change sequentially. But just what's leading to customers to choose to renew early and - maybe just as a quick follow-up to that, as we think about the guidance for the year, any way to quantify the type of expansion opportunity embedded from the EBA? Thanks so much.
Debbie Clifford: I think, Adam, you were coming - in and out a little bit, but I think I got the bulk of what you were saying. So just stop me if I'm missing something. But in terms of the EBA behavior. Really, what we saw was driven by them. Our customers were managing their own budgets and cash flow. And so, their desire to get early billings for frankly, higher usage of their tokens was driven by their own - behavior, which we see as a real positive sign for us in engaging with those enterprise customers. They're seeing strong usage of our portfolio, and they're continuing to invest in their relationship with us. And those billings boosted our total billings, revenue, and free cash flow during the quarter. So overall, I think it's a win-win. There was a second part, I think, to your question.
Adam Borg: Yes. Just curious. And so thanks. I was just curious, any way to quantify kind of the type of expansion opportunity from the EBA renewal pool in the back half of the year as you think about full year guidance?
Debbie Clifford: Not something we can quantify for you, Adam, but I would just reiterate the fact that we do see it as a real positive that for the first two quarters of the year-to-date that we're seeing strong usage, and that's already leading to early billings. So a positive from our standpoint overall.
Adam Borg: Awesome. Thanks so much.
Operator: Thank you. Our next question comes from the line of Joe Vruwink of Baird.
Joe Vruwink: Great. Hi, everyone. Maybe I wanted to revisit your AEC exposure. I know you've discussed this in the past and just as there's offsets, so commercial market see pressure, institutional or infrastructure far better. So you have diversification there. I guess when you think about the current business composition, and how the different subsectors are faring, do you think the nature of Autodesk and AEC is any better or worse than would have been the case in past cycles? And I'm asking less about Autodesk just as a subscription model now versus a license model in the past. And more about Autodesk and things like Revit adoption or reliance on the cloud which might create a different dynamic for the business this down cycle versus past down cycles.
Andrew Anagnost: I think one of the things that you said, and I want to reinforce it, is that - we are diversified across all sectors of making things. Everything that gets made, we're involved in. It's not just AUC, it's buildings, it's bridges, it's car, it's electronics. And of course, it's film and game. So just remember, we're diversified across all of those segments. What's different now, and I think it's important to recognize this. Is that the AEC industry as a whole is chasing productivity and digitization gains, the entire industry, from construction, all the way through to any design in every part of the process in between, engineering and all the things associated with that. So that fundamental change is creating long-term pull for what we're doing. And what we're doing is we're connecting the design, and make processes across that industry together in the cloud in unique and highly integrated way. So that people can do things faster, more sustainably and with greater - with lower risk and better outcomes. That fundamental shift is very different than what we've seen before. And that's going to - we're going to be riding that fundamental shift for quite a few years.
Joe Vruwink: Okay. Great. Andrew, that's helpful. And then second question, wondering if you can comment on how you see the writers and actors, strike potentially impacting business in media and entertainment, particularly if this goes on for a while and your customers are finishing what's in post-production with, I suppose, a lack of new things coming in, what that might mean towards the end of the year?
Andrew Anagnost: Yes. So you've hit one thing right there, right? People are still in post-production right now for the existing book that post production overhang will continue for a little while. If the strike continues for months on end, we will likely see an increased impact on our media and entertainment business. It's still growing now. It definitely slowed down in Q2, but it's still growing. So as we look forward, your guess is as good as mine about how long this strike will go on. But I do remind you our exposure to media entertainment is relatively small compared to the other parts of our business. But there's no doubt that an extended strike could have an impact on that business.
Joe Vruwink: Okay. Thank you very much.
Operator: Thank you. Our next question comes from the line of Tyler Radke of Citi.
Tyler Radke: Yes. Thanks for taking the question. So I wanted to just go back to the commentary on kind of the puts and takes in the quarter. So you talked about seeing some early expansions on some of the multiyear EBAs. And I just wanted to clarify, was that also stronger expansion? Or was it more of a timing factor? And then Debbie, this might be a bit of a nitpicky question. But just as I look at the constant currency revenue guidance, I think the high end of the guide says 12% plus versus 13% last quarter. I just wasn't sure if there was a change there. If you could just kind of comment on the puts and takes on that, too? Thank you.
Debbie Clifford: Sure. Thanks, Tyler. So the EBA usage was strong, and we've been tracking it for the year-to-date. It wasn't necessarily stronger than our expectations, however. So to clarify, it's really more than anything it's a timing difference. We were expecting that the revenue would hit in Q4 and it hit in Q2. But the fact that our customers are using more than they had anticipated the onset of the contracts is a good thing. It's just that we've been tracking it. We've known about it for the year-to-date, and we just saw the invoices in Q2 versus Q4. In terms of the constant currency guide, the range, it was impacted really by rounding. The dollar change was immaterial. And overall, the business is tracking generally in line with our expectations.
Tyler Radke: Okay. Great. And follow-up for Andrew. You talked about some encouraging signs on the Autodesk construction side, given the reorg, you talked about it kind of settling in. How - maybe just remind us kind of what were the big changes? What are you hoping to accomplish? And should we start to see the make revenue begin to accelerate throughout the rest of the year? Thank you.
Andrew Anagnost: Yes, Tyler. Happy to clarify that. So look, what we did in Q1 is we merged the Autodesk Construction Solutions sales force with the mainline sales force. This was with the objective of long-term accelerating business growth in that area, particularly in our design-centric accounts. So we wanted to keep the contractor and subcontractor power of the ACS team and combine it with the teams that are focused on some of our design accounts as well. We expected some bumps in doing that because you have to realign account assignments, you have to realign players and who's in charge of what. We've seen a lot of those bumps get smoothed out into Q2. So we're seeing a return to expected patents. We've lost no business during the process. As I told you - as I told you earlier in the opening commentary, when we talked about - when I talked about things like Shook, the general contractor in Ohio. We're winning - we're continuing to win these contractors. Primarily, one of the things we hear a lot is the pricing predictability associated with our offering and the ability to show them a path not only to a stable pricing model, which customers really like and increasingly see a viable and strong alternative to project management and what ACS offers, but also in terms of the integration between design and banking. I expect the consolidation of the sales force is to continue to further accelerate the construction business moving forward as we continue to work this through. So progress in the right direction, and we can expect to see more progress.
Tyler Radke: Great to hear. Thank you.
Operator: Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets.
Jason Celino: Great. Thanks for taking my question. This is a spin on Saket's very first question, but it relates to the quarter and not necessarily the guide. But when we look at the outperformance in the quarter, it's the biggest beat on a percentage and an absolute basis we've seen in many quarters. Can you just help us unpack maybe what the magnitude of the EBA strength was or the FX kind of benefits, if there were any?
Debbie Clifford: The biggest driver of the beat came from the EBAs.
Jason Celino: Okay. Perfect. And then, Andrew, curious on updates on Innovyze. At the beginning of the year, I think there was this view that funding for sewer projects and water projects hadn't quite started to flow, no pun unintended yet, but that maybe we would see things start to open up in the second half or next year. Is that still the case? I guess what are you seeing?
Andrew Anagnost: Yes. I mean, look, look at the news, right, all you get is increasing evidence that most regions and municipalities need to reevaluate their water management, both at a sewage level and a treatment level infrastructure. So that has fundamentally not changed. And we haven't yet seen the increase in project actually starting projects in that area. But what we are seeing is people buying ahead of demand. So we actually saw a lot of strength with Innovyze in our EBAs in our large accounts, which is an important precursor to some of the larger efforts that might go on moving forward. But no floodgates have opened up yet, no pun intended from my side. But we still see the exact same pattern we've talked about.
Jason Celino: Okay. Great. Appreciate it. and I like the puns.
Operator: Thank you. Our next question comes from the line of Michael Funk of Bank of America.
Michael Funk: Yes. Thank you all for the questions tonight. A couple if I could. So on the EBA renewal comments that you made earlier, can you give us a sense of the like-for-like change there, whether or not customers on balance or upsizing, increasing the duration of the contract, what that looked like.
Debbie Clifford: So to clarify, these contracts, they were not contracts that were renewed. We're expecting that these contracts will be renewed in Q4 per our normal cycles. What happened is that these customers have been using ahead of the usage that was built into their original contracts. And so what we saw in Q2 was billings for the overuse versus the original contracts. But we still expect the renewals will occur in Q4.
Michael Funk: Understood. I must have miss heard you earlier. So for the overview then, do you expect that trend to continue for the remainder of the year? And what do you think is driving that over use?
Debbie Clifford: We're certainly hopeful that, that trend continues. We see it as a very positive sign that our customers are asking for early billings because they're using our products more than they anticipated, and they're using the broad breadth of the portfolio. The other thing I would say is that the usage that was built into these contracts when they were originally signed. Remember, this was three years ago, at the onset of the pandemic. And so the usage in those contracts might have been a bit lower just given the environment in which those contracts were renewed. And so as we start to come out of the pandemic, we're seeing more and more usage. We've talked about usage being broadly speaking for Autodesk, but also for our EBAs being a good leading indicator, and that usage continues to increase. I don't have a crystal ball, Michael. I wish I did. I could tell you for sure that the usage would continue to go up in the back half of the year, but we're certainly hopeful and all signs are leading in that direction.
Michael Funk: Okay. So, in terms of trends so far this quarter to date are consistent with 2Q?
Debbie Clifford: Sorry, I didn't hear.
Michael Funk: Your last comment about trends continuing is the interpretation there that the trend has continued in - from 2Q into this quarter of increased usage.
Debbie Clifford: We're not commenting on Q3 at this point. Overall, the performance that we saw from our EBAs in Q2 is really strong, and we're hopeful that it will continue.
Michael Funk: Great. Thank you, Debbie.
Operator: Thank you. Our next question comes from the line of Matt Hedberg of RBC Capital Markets.
Matt Hedberg: Great. Thanks for taking my questions. Congrats on the stability here. Really, really good to see. Maybe, Debbie, for you, maybe I missed it, but cash flow was - free cash flow was significantly better than we thought this quarter. I know you don't guide quarterly. So maybe just - again, maybe I missed it, but a little bit more on sort of why free cash flow is so strong this quarter? And as we think about Q3, Q4 kind of the linearity there, you took the low end of the full year up a little bit. How should we kind of think about that split sort of between 3Q and 4Q?
Debbie Clifford: Yes. So Q2 was strong, primarily because of the timing of the EBA billings that I've been talking about as well as some favorable in-quarter linearity. So the linearity that we saw was better than we had expected. And then when we look at the back half of the year, second half free cash flow will be significantly weighted to the fourth quarter. I've called out the federal tax payment extension that positively impacted the first half free cash flow, and it will negatively impact Q3. Overall, we still anticipate that fiscal '24 is going to be the free cash flow trough during this transition from upfront annual billings.
Matt Hedberg: Great. Thanks. And then, Andrew, for you, following up on earlier questions kind of on the split of your business, obviously, an extremely diversified model. But I guess regarding commercial real estate exposure, I know it's difficult to give an exact percentage of your exposure there. But just broadly speaking, we get asked all the time, what's Autodesk's exposure to the category. How should we think about kind of Autodesk in the CRE market?
Andrew Anagnost: To be honest, you shouldn't, okay? This is some of the conversations we had during the housing crisis, like, how should we think about Autodesk relative to the housing. And the question is, you shouldn't, all right? The amount of things that need to be built and rebuilt in our customer base is ginormous, all right? They don't have current capacity, either people-wise, dollar-wise or capability-wise, to actually work through all the things that are going on. So the momentum of the industry pivots to other areas. Now even if you look at commercial real estate, people are still reconfiguring commercial real estate within the segment in order either to make it more attractive to a shrinking pool of renters or to repurpose that space to other uses. But in terms of exposure to Autodesk, you got to be careful about overblowing that because the money always goes somewhere else. There's always a lot of work to be done in other sectors. That just means that people that were traditionally bidding on commercial real estate projects are now bidding and engaging on other types of projects.
Matt Hedberg: Super helpful. Thank you for that.
Operator: Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank.
Bhavin Shah: Great. Thanks for taking my question. Andrew, we continue to hear good things from your customers and partners regarding your ability to innovate and enhance many of your acquired assets, whether it's Innovyze, PlanGrid, et cetera. Can you just remind us of your views on go-forward M&A and your M&A philosophy. And maybe kind of what are some of the lessons we learned from prior deals?
Andrew Anagnost: Yes. So we are an acquisitive company. We will continue to be an acquisitive company. We always like when the environment gets more attractive for acquisitions, but we are always looking to make sure that a potential acquisition is strategically aligned with our priorities. That means that it's either accelerating an effort that we're currently working on or bringing us into an adjacency that we weren't working on but that we see as an attractive place. Timing matters as well in terms of what timing is right for us to do these things that we keep the business reasonably focused on the things that are important and don't try to juggle 18 balls at once, right? But we will continue to be acquisitive, and we have the cash flow and balance sheet ability here to do whatever we need to do in terms of strategic fit and expansion that we're interested in moving forward. So don't expect any change. In terms of learning, look, you always learn, you can integrate some of the back office faster, all right? There's a [indiscernible] and all these things is integrate sales and back office infrastructure quicker and you go faster.
Bhavin Shah: Super helpful there. Just on another topic, can you just talk about what you're seeing with A&E customers as it relates to hiring. I know many of these customers have got talent shortages over the past few years. Are you seeing any easing here or any kind of other general commentary in terms of hiring within A&E customers. Thanks so much for taking my question.
Andrew Anagnost: Yes. It depends on the sector. But honestly, in construction and manufacturing, you're seeing - they're still seeing challenges with hiring, right? It's one of the big things we hear from them is their ability to not only find but retain talent, especially qualified talent. So hiring continues to be an issue on the execution side of our customers, primarily towards the mix side.
Operator: Thank you. Our next question comes from the line of Ken Wong of Oppenheimer & Company.
Ken Wong: Great. Thank you for taking my question. Just a quick one for me. As we think about - I think Debbie, you mentioned new customer softness is kind of consistent with what you guys are seeing. But just wanted to make sure, relative to last quarter, I think you guys had called out a bit of an air pocket that normalized. How should we think about the way that played out this quarter in terms of adding new subs?
Debbie Clifford: The overall market conditions, new subs, momentum in the business was similar to last quarter. We talked about leading indicators being consistent with last quarter, growing usage, record bid activity on BuildingConnected ,cautious optimism from our channel partners. Beyond that, I would just add that our regional performance was broadly similar to what we've seen for several quarters. direct business, including enterprise and eStore as well as India actually were bright spots for us, but they were offset by some tougher patches like China as well as the softer performance that we talked about in M&A.
Ken Wong: Got it. And then I realize maybe it's a very small nuance. But I think last quarter, you guys saw a little bit of a dip, and then it recovered in terms of new sub ads. I guess when you're saying it's consistent with last quarter, would it be more consistent with that exit or kind of full quarter dynamic where averaged out maybe a little lighter than anticipated.
Debbie Clifford: So remember what we said last quarter was that we saw a slight dip after we stopped selling the multiyear contracts upfronts, but then it recovered as we exited the quarter and as we got into early Q2, and we saw that consistently throughout Q2.
Ken Wong: Okay. Perfect. Thank you, Debbie.
Operator: Thank you. Please standby. Our next question comes from the line of Nay Soe Naing, Berenberg.
Nay Soe Naing: Hi. Thank you for squeezing me in. Just got a quick question from me. Coming back to the early was better than expected or earlier than expected EBA renewals I was wondering if we were to exclude that impact in the quarter, the performance in AEC, would we have seen an inflection in terms of the growth levels because what we've seen in the past couple of quarters is the gradual decline in growth rates. So I was wondering if we didn't have this early renewals and EPAs would be an easy segment would have seen a further deceleration in growth rates? Or would we see a bit of an uptick compared to Q1? Thank you.
Debbie Clifford: So the early billings that we talked about for EBAs are what drove the revenue beat versus our guide. But when you think about that beat on a dollar basis in comparison to the totality of our AEC business, the AEC business is vastly larger. So it's not a big driver of the overall trend that we're seeing in AEC, but it was the driver of EBA.
Nay Soe Naing: Thank you.
Operator: Thank you. Our next question comes from the line of Patrick Baumann of JPMorgan. Please go ahead, Patrick.
Patrick Baumann: Thank you. This is Pat on for Steve. So just a couple probably for Debbie. You touched on sales in terms of the moving parts of the guide raise there. I guess in terms of the free cash flow midpoint, what was - I know it was only - it was a small number, but what was the driver of the raise there? And then on the EPS, the adjusted EPS guidance rate - raise, there's like $25 million of other income. Is that simply the benefit from the interest on cash that you mentioned in the preamble?
Debbie Clifford: Yes. So starting with cash, it's due to the performance that we saw in Q2. So I talked a little bit earlier in this Q&A session about the EBA billings that we saw in Q2 as well as the favorable in core linearity. So those were drivers of the difference that you saw in our cash flow guidance. And then in terms of EPS, the other income is due to higher interest income from our cash balances.
Patrick Baumann: Good. Does that flow through the cash flow?
Debbie Clifford: In part, well, yes, yes.
Patrick Baumann: Okay. And then sorry, one more on cash flow for my second question. Is the - do you think is the third quarter going to be negative or positive on free cash flow. You said I think, significantly weighted to the fourth quarter in the second half, which I think is similar to your prior commentary from last quarter. But I think you also thought at that time that maybe second quarter and third quarter could be negative. Is your view that free cash flow will be negative in the third quarter given the impact of this cash item that was pushed from the first half to the third quarter?
Debbie Clifford: We're not going to guide on a quarterly basis for free cash flow, but I'll try to be helpful. I just want to reiterate some of the comments. So remember that second half free cash flow is going to be significantly weighted into the fourth quarter. And the biggest driver of that is the extension of our federal tax payments that had a positive impact on the first half but are going to negatively impact Q3. So think about that as you put your model together.
Patrick Baumann: Okay. Thanks so much. Best of luck.
Operator: Thank you. That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?
Simon Mays-Smith: Thanks, and thank you, everyone, for joining today. We look forward to updating you on our progress in November on our Q3 earnings call. I look forward to speaking to you then. Thank you so much.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by, and welcome to Autodesk's Second Quarter 2024 Earnings Call. [Operator Instruction] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the second quarter results of Autodesk's fiscal '24. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, products and product capabilities, business models and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release, or Excel financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome, everyone, to the call. Resilience, discipline and opportunity again underpinned Autodesk's strong financial and competitive performance despite continued macroeconomic policy and geopolitical headwinds. Resilience provided by our subscription business model and our product and customer diversification discipline and focus in executing our strategy and deploying capital through the economic cycle and opportunity from developing next-generation technology and services which deliver end-to-end digital transformation of our Design and Make customers and enable a better world designed and built for all. Our leading indicators remained consistent with last quarter with growing usage and record bid activity on BuildingConnected and cautious optimism from channel partners. Customers remain committed to transformation and to Autodesk leveraging automation more where they are seeing headwinds from the economy, labor shortages and supply chains. That commitment was reflected in our Q2 performance, growing adoption and token consumption within Enterprise Business Agreement and strong renewal rates. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. We were delighted that Autodesk was recently highlighted as a Best Workplace for Innovators by Fast Company. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. Overall market conditions and the underlying momentum of the business remained similar to the last few quarters. Despite a tough macroeconomic backdrop that continues to drag on the overall rate of new subscriber acquisition and the forward momentum of the business and may continue to do so. Our financial performance in the second quarter was strong. We said last quarter that we had a strong cohort of EBAs renewing in the second half of the year that last renewed three years ago at the start of the pandemic and that subsequent adoption and usage has been strong. Some of that strength came through in the second quarter, which was earlier than we were expecting and which boosted billings, free cash flow and subscription revenue. Total revenue grew 9% and 12% in constant currency. By products in constant currency, AutoCAD and AutoCAD LT revenue grew 9%, AEC revenue grew 14%, Manufacturing revenue grew 9% and in double digits, excluding a headwind from variances in upfront revenue, and M&E revenue grew 10%. By region in constant currency, revenue grew 15% in the Americas, 11% in EMEA and 6% in APAC. Direct revenue increased 18% and represented 37% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the eStore. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. The transition from upfront to annual billings for multiyear contracts is proceeding broadly as expected. We had a full quarter impact in the second quarter, which resulted in billings declining 8%. Total deferred revenue increased 14% to $4.2 billion. Total RPO of $5.2 billion and current RPO of $3.5 billion grew 11% and 12%, respectively. Turning to the P&L. Non-GAAP gross margin remained broadly level at 92%. GAAP and non-GAAP operating margin remained broadly level with revenue growth and cost discipline, offsetting the impact of exchange rate movements. Free cash flow was $128 million in the second quarter, which was a bit better than we've been expecting, primarily due to the timing of EBAs, but also due to some favorable in-quarter linearity. Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We are being vigilant during this period of macroeconomic uncertainty. During Q2, we purchased approximately 400,000 shares for $87 million at an average price of approximately $200 per share. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense to do so. Now let me finish with guidance. The headline is that overall, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year. Our sustained momentum in the second quarter and early expansion of some EBAs expected to renew later in the year, reduce the likelihood of our more cautious forecast scenarios given that, we're raising the lower end of our guidance ranges. Let me summarize some key factors we highlighted earlier in the year. First, we have a strong cohort of EBAs renewing in the second half of the year, although, as I mentioned earlier, some of that benefit was billed in the second quarter. Second, foreign exchange movements will be a headwind to revenue growth and margins in fiscal '24. The revenue headwind will moderate a bit in the second half of the year. Third, Switching from upfront to annual billings for most multiyear customers creates a significant headwind to free cash flow in fiscal '24 and a smaller headwind in fiscal '25. Our expectations for the billings transition are unchanged. Fourth, as we thought might happen, we saw some evidence of multiyear customers switching to annual contracts during the second quarter. It wasn't big enough to be called a trend, but we're keeping an eye on it. It's still early days, and we'll keep you updated as the year progresses. All else equal, if customers switch to annual contracts, it would proportionately reduce the unbilled portion of our total remaining performance obligations and negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins and free cash flow would remain broadly unchanged. Annual renewals create more opportunities for us to drive adoption and upsell and are without the price lock embedded in multiyear contracts. And fifth, we expect our cash tax rate will return to a more normalized level of approximately 31% of GAAP profit before tax in fiscal '24, up from 25% in fiscal '23. We the federal tax payment extension after the winter storms in California means cash tax payments shift from the first half of the year to the third quarter, reducing third quarter free cash flow. Second half free cash flow generation will, therefore, be significantly weighted to the fourth quarter. We still anticipate fiscal '24 will be the cash flow trough during our transition from upfront to annual billings for multiyear contracts. Putting that all together, we now expect fiscal '24 revenue to be between $5.41 billion and $5.46 billion. We expect non-GAAP operating margins to be similar to fiscal '23 levels with constant currency margin improvement, offset by FX headwinds. We expect free cash flow to be between $1.17 billion and $1.25 billion. We're increasing the guidance range for non-GAAP earnings per share to be between $7.30 and $7.49 to reflect higher interest income on our cash balances in addition to the reduced likelihood of our more cautious forecast scenarios. The slide deck on our website has more details on modeling assumptions for Q3 and full year fiscal '24. We continue to manage our business using a rule of 40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins captured in the rule of 40 framework is the hallmark of the most valuable companies in the world, and we intend to remain one of them. As we said back in February, the path to 45% will not be linear, given the macroeconomic drag on revenue growth from the rate of new subscriptions growth and the drag to free cash flow as we transition away from multiyear contracts paid upfront. But let me be clear, we're managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal regardless of the macroeconomic backdrop. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Let me finish by updating you on our progress in the second quarter. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. We continue to see good growth in AEC, fueled by customers consolidating on our solutions to connect and optimize previously siloed workflows through the cloud. And as we talked about in February, digital momentum is also building among asset owners in infrastructure and other areas. This momentum is expected to accelerate with infrastructure investment programs like the U.S. Advanced Digital Construction Management System program, which launched during our second quarter. Cannon Design is a global design practice encompassing strategy, experience, architecture, engineering and social impact. It is driving forward its digital transformation and embracing the cloud to increase operational efficiency, enhance security, establish a single point of truth and enable more seamless end-to-end collaboration. During the quarter, it expanded its investment with Autodesk by leveraging Autodesk Docs as a common data environment adopting Forma and is exploring opportunities to integrate Autodesk's XR and asset management capabilities to its design portfolio. Outside the U.S. our construction platform is benefiting from our strong international presence and established channel partner network. During the quarter, a property developer and transit network operator based in Asia needed to simplify operations across its many infrastructure projects with a wide range of contractors and subcontractors. To manage this complexity, it needed a single source of truth for its project data and way to streamline workflows on a single platform. In Q2, it leveraged support from our local channel partner and standardize on one platform by adding Autodesk Construction Cloud to its existing portfolio of Autodesk AEC design tools to gain visibility into contractors and subcontractors workflow and the potential to unlock breakthrough productivity gains. Shook Construction, an ENR 400 general contractor based in Ohio made the decision to standardized on Autodesk Construction Cloud to better streamline their operational workflows. After evaluating many competitive options, Shook Construction chose Autodesk Construction Cloud as the best fit for driving consistent workflows, creating high-impact collaboration with their construction partners and eliminating cumbersome manual workflows. We continue to benefit from our complete end-to-end solutions, which encompass design, preconstruction and field execution through handover and into operations. Again, these stories have a common theme: managing people, process and data across the lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way, and we remain focused on enabling that transition through digital transformation. We talked last quarter about the short-term disruption from integrating our construction and worldwide sales teams. I'm pleased to report that things began to settle in the second quarter. We believe that combining the two teams will allow us to expand the scale and reach of our construction business, particularly in our design customer base and our ability to serve our customers across the complete project life cycle. Encouragingly, Autodesk Construction Cloud MAUs were up over 100% in the quarter. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make platform to grow their business and make it more resilient. For example, a multinational manufacturer which serves the construction industry on both a building product manufacturer and through tools and construction processes has been leveraging the Autodesk portfolio to connect workflows across the AEC and manufacturing industries. It's expanded its commitment to BIM using Revit, Navisworks and Construction Cloud, which has enabled the customer to adopt a collaborative and data-driven approach across design, construction and maintenance services. which minimizes clashes and rework and culminates in more efficient and successful building projects. In the second quarter, the customer grew its EBA with Autodesk ahead of its Q4 renewal date to accelerate the adoption of BIM and facilitate the design of its products and materials directly within MEP models. Fusion continues to provide an easy on rate into our cloud ecosystem for existing and new customers. In Europe, an appliance manufacturer who was already an existing user of our manufacturing collection and AutoCAD mechanical, purchased additional seats of Fusion for PCB design. It's heating systems division will leverage Fusion's electronic design automation capabilities to quickly and seamlessly connect more of its design to manufacturing workflow to drive greater efficiency. Fusion continues to grow strongly, ending the quarter with 236,000 subscribers as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. At Investor Day, I talked about leveraging our key growth enablers, including business model evolution, customer experience evolution and convergence between industries to provide more and better choices for our customers. Our Flex consumption model is a good example of this. Flex's consumption pricing means existing and new customers can try new products with less friction and enables Autodesk to better serve infrequent users. Not surprisingly, the lion's share of the business has come from new or existing customers expanding their relationship with Autodesk. During the quarter, we signed 3 more million dollar Flex deals. As Steve said at our Investor Day, we've also introduced a new transaction model for Flex, which will give Autodesk a more direct relationship with our customers and more closely integrate with our channel partners over time. We will begin testing our new transaction model more broadly in Australia later this year. And finally, we continue to work with noncompliant users to ensure that they are using the latest and most secure versions of our software. For example, after identifying and alerting a Chinese-based automobile designer about noncompliant usage and despite working to ongoing challenges from the pandemic, the customer eventually committed to three year VRED and Alias subscriptions. As expected, our initiatives to tighten concurrent usage of named user subscription and expand the precision and reach of our in-product messaging drove incremental growth during the quarter. Now let me finish with the story. According to the National Oceanic Service, Coral reefs are some of the most diverse and valuable ecosystems on earth. While they take up less than 1% of the ocean floor, their extraordinary biodiversity supports about 25% of all marine life. Healthy coral reefs support fisheries as well as jobs and businesses through tourism and recreation. It also buffer shorelines against 97% of the energy from waves, storms and floods, helping to prevent loss of life, property damage and erosion. It can take 10,000 to tens of millions of years for our coral reefs to form, and just weeks for it to die. Rising ocean temperatures can cause coral to bleach and die. Half of living coral reefs have died since the 1950s. Without intervention, we're on track to lose 70% to 90% of the remainder by 2050. That is, unless we find a faster way to bring coral reefs back from the brink. With support from Autodesk and the Autodesk Foundation, a company called Coral Maker is using our digital tools, artificial intelligence, and robotics to deliver core restoration at scale with cloud collaboration to keep the global team connected across oceans and time zones. As Dr. Karen Foster, coral makers founder says, the partnership with Autodesk has empowered us to develop new technology to restore reef at a rate unimaginable a few years ago. Current restoration projects can deploy about hectare of portal per year. With coral makers technology, it's possible to deploy 100 sectors per year. From the oceans to the earth and Sky augmented design, powered by Autodesk will enable our customers to go further and faster to design and make a better world for all. We've been laying the foundation to build enterprise level AI for years with connected data, teams and workflows in industry cloud. real time and immersive experiences, shared extensible and trusted platform services, innovative business models and trusted partnerships. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. We are building the future with focus, purpose and optimism. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Please go ahead, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hi Andrew. Hi, Debbie. How are you guys doing? Thanks for taking my questions here."
},
{
"speaker": "Debbie Clifford",
"text": "We're doing great. How are you Saket?"
},
{
"speaker": "Saket Kalia",
"text": "Doing great, doing great. Debbie, maybe for you, just a quick housekeeping question here. Great to see the revised range on a lot of metrics, particularly revenue. And so, when I think about the midpoint of the revenue guide going up by about $25 million, first of all, great to see the impact of FX to start to lighten. But could you just maybe walk us through a broad brush how much of this year's raise on revenue is from FX versus maybe some underlying fundamentals in the business?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So, we had a small increase in the midpoint of the guide. The dollar change was immaterial it's tough really to come up with a mix of assumptions that get us to the low end of our previous guidance range. So, the midpoint increase reflects a mix of both organic and FX assumptions. Overall, the business is tracking generally in line with our expectations."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Got it. Got it. Andrew, maybe for you, of an open-ended question. But I guess now as you've completed the first quarter of this transition to a new billing model. Is there anything that's surprising you about maybe how customers or how partners are behaving, again, open ended?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. No real big surprises. Saket I mean - Debbie flagged last quarter that we might see some customers reverting back to annual contracts as a result of the change. We did see that. Nothing really out of bound zone, nothing really surprising. Debbie, do you want to add anything to the details or..."
},
{
"speaker": "Debbie Clifford",
"text": "Yes. I would say the initial rollout of the new billings model is going well. The systems are working, customer and partner behavior is pretty much as we expected. As Andrew mentioned, we are seeing a small proportion of our customers choose annual contracts versus multiyear contracts billed annually, but generally, we expected a bit of that, and the performance has been in line with our expectations. And remember, if customers choose annual contracts, it doesn't impact the P&L. It only impacts unbilled and total RPO. It's still early days. We're monitoring it closely. And I think it just continues to be a good example of how we're working to optimize the business. It's about reducing the volatility of our cash flow while simultaneously giving our customers, the purchasing pattern that they want. And then finally, I'd say that there's no change in how we expect the transition to impact our cash flow outlook."
},
{
"speaker": "Saket Kalia",
"text": "Got it. All very clear. Thanks guys."
},
{
"speaker": "Operator",
"text": "Thank you. Please stand by for our next question which comes from the line of Jay Vleeschhouwer of Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Got it. Thank you. Good evening. Andrew, for you first, you made some constructive comments about what you're seeing in the AEC business. But more broadly, and as you're well aware, there's quite a bit of ferment going on in that market right now in terms of references to what's come to be called BIM 2.0 as you know, just a couple of months ago at an AUC conference, a customer group launched a new customer-developed design specification for software. You yourselves are working on a dual track of enhancing revenue, but focusing on format. So lots going on in terms of various currents in that industry or part of the industry. Help us understand how you're thinking about managing for all those different dynamics that are going on in the AEC industry. And then a follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So Jay thanks. Jay, there's three threats to this, right? One is kind of the core platform threat around data and data flow. At the root of all of this, we need to make sure as much of the data that we have locked inside Revit files and lots of other types of files that our customers have gets turned into APIs wherever possible, right? This is a lubricant to the workflows that people are worried about. And I think a part of really what underpins the whole concept of BIM 2.0. That's one of the things. The second piece is you've got to make sure that their ability to do detailed in-depth complicated, sophisticated BIM models gets more performant, more productive and faster. That's core to kind of building up, and improving Revit in some significant ways, which we're absolutely looking at. But the third point, which I think is more important is you really need to reimagine how BIM is being done. The paradigm needs to shift, and it needs to shift to the world of not only being cloud-enabled but also being what we really like to call augmented design-enabled or outcome-based in whatever language we use, so that you can actually change the way people do BIM. And that's one of the big things that we're focusing on with Forma. And that's very different than - we have certain types of competitors. It's in line with what the spec is from the customers. But when you talk about data revenue improvements, and the move to what we call augmented design or outcome-based design. Those are the big thrust in terms of what we're trying to do to bring the industry to a better way of doing BIM?"
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Second question refers to the comments you made about a new transactional model and a pilot you're going to be undertaking in Australia. So maybe you could elaborate on that. When I hear that, it sounds to me like there's potentially going to be some further change to channel economics. You've just completed the move to back-end-only margins. Are you thinking about perhaps taking the flex commission model more broadly across the rest of the business? Or what exactly you're looking to accomplish with that?"
},
{
"speaker": "Andrew Anagnost",
"text": "So let's talk about the Flex experiment and the things you were doing with - I think with Flex last. First off, Flex because it's like a consumption-based model, and it involves usage of various different products - it really - it's really incredibly helpful for the customer for us to be able to have a much more direct relationship with the customer with regards to that offering. Because that way we're able to offer a lot more visibility to how they're using the offering, what they're using, when they're using it, how much they're consuming, and actually help them get the most out of the offer. So, what we've done over the last year is we've proved out a new transaction model working with our partners, and rolling out across various regions that is supporting Flex, and that is a much more direct transaction model. Through that process, we've learned a lot. We've gained a lot of knowledge. We've addressed a lot of issues both systems-wise and process-wise. And we are now in a position with Flex to start growing, and expanding that model at greater and greater volume. And that's exactly what's happening with Flex. The volume of Flex is increasing, increasing, and we're doing it reliably, repeatedly and in a pretty positive way. Where we go from here depends solely on how we watch these things evolve and what the benefits of this transaction model for us. And all options are open to us in the future, but that's where we are right now. We've perfected what we've done on the Flex."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Adam Borg of Stifel."
},
{
"speaker": "Adam Borg",
"text": "Awesome. And thanks so much for taking the questions. Maybe just for Andrew on the infrastructure opportunity. I know you've been calling out increasing traction with State Department of Transportation, and you even referenced some grants in the quarter in the script. So maybe just talk a little bit more about how you think about the infrastructure opportunity overall? And really what separates all of that from competitors in going after it?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So look, at a high level, one of the things I'm really excited about the thing with a really long name. The advanced digital construction management system program that the U.S. government rolled out, that is the program related to the money that's designed to help department of transportation look at their infrastructure, look at their processes, and start modernizing their digital processes around design and construction of infrastructure. That's an important step in getting a lot of these Department of Transportations to really start thinking about how they get ready to spend more money on infrastructure, and do it better and address the serious capacity challenges we have around materials, manpower, and dollars with regards to what we have to do. So pretty excited about, that because that's an open door to having new conversations with these departments about how they do things. Our focus has not changed. We are very much focused on water and road and rail, and we continue to innovate and drive improvements in those areas. I think our biggest differentiator is what we bring to market as a modern architecture. We bring to market more cloud-based solutions, more owner-based solutions for managing the infrastructure once you have it, and really just more technology that sits together in different ways. So, we're looking forward to having that discussion with the Department of Transportation over the next months and coming years. And I think you're going to start to see real change in some of those organizations."
},
{
"speaker": "Adam Borg",
"text": "That's really helpful. And maybe just as my follow-up, just on the earlier-than-expected EBA renewal pool in the quarter. So maybe just talk about - just given the softer macro obviously, that our checks have been suggesting, and you talked about no real change sequentially. But just what's leading to customers to choose to renew early and - maybe just as a quick follow-up to that, as we think about the guidance for the year, any way to quantify the type of expansion opportunity embedded from the EBA? Thanks so much."
},
{
"speaker": "Debbie Clifford",
"text": "I think, Adam, you were coming - in and out a little bit, but I think I got the bulk of what you were saying. So just stop me if I'm missing something. But in terms of the EBA behavior. Really, what we saw was driven by them. Our customers were managing their own budgets and cash flow. And so, their desire to get early billings for frankly, higher usage of their tokens was driven by their own - behavior, which we see as a real positive sign for us in engaging with those enterprise customers. They're seeing strong usage of our portfolio, and they're continuing to invest in their relationship with us. And those billings boosted our total billings, revenue, and free cash flow during the quarter. So overall, I think it's a win-win. There was a second part, I think, to your question."
},
{
"speaker": "Adam Borg",
"text": "Yes. Just curious. And so thanks. I was just curious, any way to quantify kind of the type of expansion opportunity from the EBA renewal pool in the back half of the year as you think about full year guidance?"
},
{
"speaker": "Debbie Clifford",
"text": "Not something we can quantify for you, Adam, but I would just reiterate the fact that we do see it as a real positive that for the first two quarters of the year-to-date that we're seeing strong usage, and that's already leading to early billings. So a positive from our standpoint overall."
},
{
"speaker": "Adam Borg",
"text": "Awesome. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Joe Vruwink of Baird."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi, everyone. Maybe I wanted to revisit your AEC exposure. I know you've discussed this in the past and just as there's offsets, so commercial market see pressure, institutional or infrastructure far better. So you have diversification there. I guess when you think about the current business composition, and how the different subsectors are faring, do you think the nature of Autodesk and AEC is any better or worse than would have been the case in past cycles? And I'm asking less about Autodesk just as a subscription model now versus a license model in the past. And more about Autodesk and things like Revit adoption or reliance on the cloud which might create a different dynamic for the business this down cycle versus past down cycles."
},
{
"speaker": "Andrew Anagnost",
"text": "I think one of the things that you said, and I want to reinforce it, is that - we are diversified across all sectors of making things. Everything that gets made, we're involved in. It's not just AUC, it's buildings, it's bridges, it's car, it's electronics. And of course, it's film and game. So just remember, we're diversified across all of those segments. What's different now, and I think it's important to recognize this. Is that the AEC industry as a whole is chasing productivity and digitization gains, the entire industry, from construction, all the way through to any design in every part of the process in between, engineering and all the things associated with that. So that fundamental change is creating long-term pull for what we're doing. And what we're doing is we're connecting the design, and make processes across that industry together in the cloud in unique and highly integrated way. So that people can do things faster, more sustainably and with greater - with lower risk and better outcomes. That fundamental shift is very different than what we've seen before. And that's going to - we're going to be riding that fundamental shift for quite a few years."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Great. Andrew, that's helpful. And then second question, wondering if you can comment on how you see the writers and actors, strike potentially impacting business in media and entertainment, particularly if this goes on for a while and your customers are finishing what's in post-production with, I suppose, a lack of new things coming in, what that might mean towards the end of the year?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So you've hit one thing right there, right? People are still in post-production right now for the existing book that post production overhang will continue for a little while. If the strike continues for months on end, we will likely see an increased impact on our media and entertainment business. It's still growing now. It definitely slowed down in Q2, but it's still growing. So as we look forward, your guess is as good as mine about how long this strike will go on. But I do remind you our exposure to media entertainment is relatively small compared to the other parts of our business. But there's no doubt that an extended strike could have an impact on that business."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Tyler Radke of Citi."
},
{
"speaker": "Tyler Radke",
"text": "Yes. Thanks for taking the question. So I wanted to just go back to the commentary on kind of the puts and takes in the quarter. So you talked about seeing some early expansions on some of the multiyear EBAs. And I just wanted to clarify, was that also stronger expansion? Or was it more of a timing factor? And then Debbie, this might be a bit of a nitpicky question. But just as I look at the constant currency revenue guidance, I think the high end of the guide says 12% plus versus 13% last quarter. I just wasn't sure if there was a change there. If you could just kind of comment on the puts and takes on that, too? Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "Sure. Thanks, Tyler. So the EBA usage was strong, and we've been tracking it for the year-to-date. It wasn't necessarily stronger than our expectations, however. So to clarify, it's really more than anything it's a timing difference. We were expecting that the revenue would hit in Q4 and it hit in Q2. But the fact that our customers are using more than they had anticipated the onset of the contracts is a good thing. It's just that we've been tracking it. We've known about it for the year-to-date, and we just saw the invoices in Q2 versus Q4. In terms of the constant currency guide, the range, it was impacted really by rounding. The dollar change was immaterial. And overall, the business is tracking generally in line with our expectations."
},
{
"speaker": "Tyler Radke",
"text": "Okay. Great. And follow-up for Andrew. You talked about some encouraging signs on the Autodesk construction side, given the reorg, you talked about it kind of settling in. How - maybe just remind us kind of what were the big changes? What are you hoping to accomplish? And should we start to see the make revenue begin to accelerate throughout the rest of the year? Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, Tyler. Happy to clarify that. So look, what we did in Q1 is we merged the Autodesk Construction Solutions sales force with the mainline sales force. This was with the objective of long-term accelerating business growth in that area, particularly in our design-centric accounts. So we wanted to keep the contractor and subcontractor power of the ACS team and combine it with the teams that are focused on some of our design accounts as well. We expected some bumps in doing that because you have to realign account assignments, you have to realign players and who's in charge of what. We've seen a lot of those bumps get smoothed out into Q2. So we're seeing a return to expected patents. We've lost no business during the process. As I told you - as I told you earlier in the opening commentary, when we talked about - when I talked about things like Shook, the general contractor in Ohio. We're winning - we're continuing to win these contractors. Primarily, one of the things we hear a lot is the pricing predictability associated with our offering and the ability to show them a path not only to a stable pricing model, which customers really like and increasingly see a viable and strong alternative to project management and what ACS offers, but also in terms of the integration between design and banking. I expect the consolidation of the sales force is to continue to further accelerate the construction business moving forward as we continue to work this through. So progress in the right direction, and we can expect to see more progress."
},
{
"speaker": "Tyler Radke",
"text": "Great to hear. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks for taking my question. This is a spin on Saket's very first question, but it relates to the quarter and not necessarily the guide. But when we look at the outperformance in the quarter, it's the biggest beat on a percentage and an absolute basis we've seen in many quarters. Can you just help us unpack maybe what the magnitude of the EBA strength was or the FX kind of benefits, if there were any?"
},
{
"speaker": "Debbie Clifford",
"text": "The biggest driver of the beat came from the EBAs."
},
{
"speaker": "Jason Celino",
"text": "Okay. Perfect. And then, Andrew, curious on updates on Innovyze. At the beginning of the year, I think there was this view that funding for sewer projects and water projects hadn't quite started to flow, no pun unintended yet, but that maybe we would see things start to open up in the second half or next year. Is that still the case? I guess what are you seeing?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. I mean, look, look at the news, right, all you get is increasing evidence that most regions and municipalities need to reevaluate their water management, both at a sewage level and a treatment level infrastructure. So that has fundamentally not changed. And we haven't yet seen the increase in project actually starting projects in that area. But what we are seeing is people buying ahead of demand. So we actually saw a lot of strength with Innovyze in our EBAs in our large accounts, which is an important precursor to some of the larger efforts that might go on moving forward. But no floodgates have opened up yet, no pun intended from my side. But we still see the exact same pattern we've talked about."
},
{
"speaker": "Jason Celino",
"text": "Okay. Great. Appreciate it. and I like the puns."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Michael Funk of Bank of America."
},
{
"speaker": "Michael Funk",
"text": "Yes. Thank you all for the questions tonight. A couple if I could. So on the EBA renewal comments that you made earlier, can you give us a sense of the like-for-like change there, whether or not customers on balance or upsizing, increasing the duration of the contract, what that looked like."
},
{
"speaker": "Debbie Clifford",
"text": "So to clarify, these contracts, they were not contracts that were renewed. We're expecting that these contracts will be renewed in Q4 per our normal cycles. What happened is that these customers have been using ahead of the usage that was built into their original contracts. And so what we saw in Q2 was billings for the overuse versus the original contracts. But we still expect the renewals will occur in Q4."
},
{
"speaker": "Michael Funk",
"text": "Understood. I must have miss heard you earlier. So for the overview then, do you expect that trend to continue for the remainder of the year? And what do you think is driving that over use?"
},
{
"speaker": "Debbie Clifford",
"text": "We're certainly hopeful that, that trend continues. We see it as a very positive sign that our customers are asking for early billings because they're using our products more than they anticipated, and they're using the broad breadth of the portfolio. The other thing I would say is that the usage that was built into these contracts when they were originally signed. Remember, this was three years ago, at the onset of the pandemic. And so the usage in those contracts might have been a bit lower just given the environment in which those contracts were renewed. And so as we start to come out of the pandemic, we're seeing more and more usage. We've talked about usage being broadly speaking for Autodesk, but also for our EBAs being a good leading indicator, and that usage continues to increase. I don't have a crystal ball, Michael. I wish I did. I could tell you for sure that the usage would continue to go up in the back half of the year, but we're certainly hopeful and all signs are leading in that direction."
},
{
"speaker": "Michael Funk",
"text": "Okay. So, in terms of trends so far this quarter to date are consistent with 2Q?"
},
{
"speaker": "Debbie Clifford",
"text": "Sorry, I didn't hear."
},
{
"speaker": "Michael Funk",
"text": "Your last comment about trends continuing is the interpretation there that the trend has continued in - from 2Q into this quarter of increased usage."
},
{
"speaker": "Debbie Clifford",
"text": "We're not commenting on Q3 at this point. Overall, the performance that we saw from our EBAs in Q2 is really strong, and we're hopeful that it will continue."
},
{
"speaker": "Michael Funk",
"text": "Great. Thank you, Debbie."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Matt Hedberg of RBC Capital Markets."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks for taking my questions. Congrats on the stability here. Really, really good to see. Maybe, Debbie, for you, maybe I missed it, but cash flow was - free cash flow was significantly better than we thought this quarter. I know you don't guide quarterly. So maybe just - again, maybe I missed it, but a little bit more on sort of why free cash flow is so strong this quarter? And as we think about Q3, Q4 kind of the linearity there, you took the low end of the full year up a little bit. How should we kind of think about that split sort of between 3Q and 4Q?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So Q2 was strong, primarily because of the timing of the EBA billings that I've been talking about as well as some favorable in-quarter linearity. So the linearity that we saw was better than we had expected. And then when we look at the back half of the year, second half free cash flow will be significantly weighted to the fourth quarter. I've called out the federal tax payment extension that positively impacted the first half free cash flow, and it will negatively impact Q3. Overall, we still anticipate that fiscal '24 is going to be the free cash flow trough during this transition from upfront annual billings."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks. And then, Andrew, for you, following up on earlier questions kind of on the split of your business, obviously, an extremely diversified model. But I guess regarding commercial real estate exposure, I know it's difficult to give an exact percentage of your exposure there. But just broadly speaking, we get asked all the time, what's Autodesk's exposure to the category. How should we think about kind of Autodesk in the CRE market?"
},
{
"speaker": "Andrew Anagnost",
"text": "To be honest, you shouldn't, okay? This is some of the conversations we had during the housing crisis, like, how should we think about Autodesk relative to the housing. And the question is, you shouldn't, all right? The amount of things that need to be built and rebuilt in our customer base is ginormous, all right? They don't have current capacity, either people-wise, dollar-wise or capability-wise, to actually work through all the things that are going on. So the momentum of the industry pivots to other areas. Now even if you look at commercial real estate, people are still reconfiguring commercial real estate within the segment in order either to make it more attractive to a shrinking pool of renters or to repurpose that space to other uses. But in terms of exposure to Autodesk, you got to be careful about overblowing that because the money always goes somewhere else. There's always a lot of work to be done in other sectors. That just means that people that were traditionally bidding on commercial real estate projects are now bidding and engaging on other types of projects."
},
{
"speaker": "Matt Hedberg",
"text": "Super helpful. Thank you for that."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank."
},
{
"speaker": "Bhavin Shah",
"text": "Great. Thanks for taking my question. Andrew, we continue to hear good things from your customers and partners regarding your ability to innovate and enhance many of your acquired assets, whether it's Innovyze, PlanGrid, et cetera. Can you just remind us of your views on go-forward M&A and your M&A philosophy. And maybe kind of what are some of the lessons we learned from prior deals?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we are an acquisitive company. We will continue to be an acquisitive company. We always like when the environment gets more attractive for acquisitions, but we are always looking to make sure that a potential acquisition is strategically aligned with our priorities. That means that it's either accelerating an effort that we're currently working on or bringing us into an adjacency that we weren't working on but that we see as an attractive place. Timing matters as well in terms of what timing is right for us to do these things that we keep the business reasonably focused on the things that are important and don't try to juggle 18 balls at once, right? But we will continue to be acquisitive, and we have the cash flow and balance sheet ability here to do whatever we need to do in terms of strategic fit and expansion that we're interested in moving forward. So don't expect any change. In terms of learning, look, you always learn, you can integrate some of the back office faster, all right? There's a [indiscernible] and all these things is integrate sales and back office infrastructure quicker and you go faster."
},
{
"speaker": "Bhavin Shah",
"text": "Super helpful there. Just on another topic, can you just talk about what you're seeing with A&E customers as it relates to hiring. I know many of these customers have got talent shortages over the past few years. Are you seeing any easing here or any kind of other general commentary in terms of hiring within A&E customers. Thanks so much for taking my question."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. It depends on the sector. But honestly, in construction and manufacturing, you're seeing - they're still seeing challenges with hiring, right? It's one of the big things we hear from them is their ability to not only find but retain talent, especially qualified talent. So hiring continues to be an issue on the execution side of our customers, primarily towards the mix side."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Ken Wong of Oppenheimer & Company."
},
{
"speaker": "Ken Wong",
"text": "Great. Thank you for taking my question. Just a quick one for me. As we think about - I think Debbie, you mentioned new customer softness is kind of consistent with what you guys are seeing. But just wanted to make sure, relative to last quarter, I think you guys had called out a bit of an air pocket that normalized. How should we think about the way that played out this quarter in terms of adding new subs?"
},
{
"speaker": "Debbie Clifford",
"text": "The overall market conditions, new subs, momentum in the business was similar to last quarter. We talked about leading indicators being consistent with last quarter, growing usage, record bid activity on BuildingConnected ,cautious optimism from our channel partners. Beyond that, I would just add that our regional performance was broadly similar to what we've seen for several quarters. direct business, including enterprise and eStore as well as India actually were bright spots for us, but they were offset by some tougher patches like China as well as the softer performance that we talked about in M&A."
},
{
"speaker": "Ken Wong",
"text": "Got it. And then I realize maybe it's a very small nuance. But I think last quarter, you guys saw a little bit of a dip, and then it recovered in terms of new sub ads. I guess when you're saying it's consistent with last quarter, would it be more consistent with that exit or kind of full quarter dynamic where averaged out maybe a little lighter than anticipated."
},
{
"speaker": "Debbie Clifford",
"text": "So remember what we said last quarter was that we saw a slight dip after we stopped selling the multiyear contracts upfronts, but then it recovered as we exited the quarter and as we got into early Q2, and we saw that consistently throughout Q2."
},
{
"speaker": "Ken Wong",
"text": "Okay. Perfect. Thank you, Debbie."
},
{
"speaker": "Operator",
"text": "Thank you. Please standby. Our next question comes from the line of Nay Soe Naing, Berenberg."
},
{
"speaker": "Nay Soe Naing",
"text": "Hi. Thank you for squeezing me in. Just got a quick question from me. Coming back to the early was better than expected or earlier than expected EBA renewals I was wondering if we were to exclude that impact in the quarter, the performance in AEC, would we have seen an inflection in terms of the growth levels because what we've seen in the past couple of quarters is the gradual decline in growth rates. So I was wondering if we didn't have this early renewals and EPAs would be an easy segment would have seen a further deceleration in growth rates? Or would we see a bit of an uptick compared to Q1? Thank you."
},
{
"speaker": "Debbie Clifford",
"text": "So the early billings that we talked about for EBAs are what drove the revenue beat versus our guide. But when you think about that beat on a dollar basis in comparison to the totality of our AEC business, the AEC business is vastly larger. So it's not a big driver of the overall trend that we're seeing in AEC, but it was the driver of EBA."
},
{
"speaker": "Nay Soe Naing",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Patrick Baumann of JPMorgan. Please go ahead, Patrick."
},
{
"speaker": "Patrick Baumann",
"text": "Thank you. This is Pat on for Steve. So just a couple probably for Debbie. You touched on sales in terms of the moving parts of the guide raise there. I guess in terms of the free cash flow midpoint, what was - I know it was only - it was a small number, but what was the driver of the raise there? And then on the EPS, the adjusted EPS guidance rate - raise, there's like $25 million of other income. Is that simply the benefit from the interest on cash that you mentioned in the preamble?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So starting with cash, it's due to the performance that we saw in Q2. So I talked a little bit earlier in this Q&A session about the EBA billings that we saw in Q2 as well as the favorable in core linearity. So those were drivers of the difference that you saw in our cash flow guidance. And then in terms of EPS, the other income is due to higher interest income from our cash balances."
},
{
"speaker": "Patrick Baumann",
"text": "Good. Does that flow through the cash flow?"
},
{
"speaker": "Debbie Clifford",
"text": "In part, well, yes, yes."
},
{
"speaker": "Patrick Baumann",
"text": "Okay. And then sorry, one more on cash flow for my second question. Is the - do you think is the third quarter going to be negative or positive on free cash flow. You said I think, significantly weighted to the fourth quarter in the second half, which I think is similar to your prior commentary from last quarter. But I think you also thought at that time that maybe second quarter and third quarter could be negative. Is your view that free cash flow will be negative in the third quarter given the impact of this cash item that was pushed from the first half to the third quarter?"
},
{
"speaker": "Debbie Clifford",
"text": "We're not going to guide on a quarterly basis for free cash flow, but I'll try to be helpful. I just want to reiterate some of the comments. So remember that second half free cash flow is going to be significantly weighted into the fourth quarter. And the biggest driver of that is the extension of our federal tax payments that had a positive impact on the first half but are going to negatively impact Q3. So think about that as you put your model together."
},
{
"speaker": "Patrick Baumann",
"text": "Okay. Thanks so much. Best of luck."
},
{
"speaker": "Operator",
"text": "Thank you. That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, and thank you, everyone, for joining today. We look forward to updating you on our progress in November on our Q3 earnings call. I look forward to speaking to you then. Thank you so much."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 1 | 2,024 | 2023-05-25 17:00:00 | Operator: Thank you for standing by, and welcome to Autodesk First Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, VP, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the first quarter results of Autodesk's fiscal '24. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today's press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our investor relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. Autodesk's strong financial and competitive performance in the first quarter of fiscal 2024 is again a testament to three enduring strengths: resilience, discipline, and opportunity. In a more challenging macroeconomic, policy and geopolitical environment, our resilient business model, and geographic, product and customer diversification, enabled us to deliver 12% revenue growth in constant currency, healthy margins, and record first quarter free cash flow. Leading indicators remained consistent with last quarter with product usage growing modestly, bid activity on BuildingConnected again at record levels, and continued cautious optimism from channel partners. Consistent with year-over-year economic momentum, we saw new subscription growth decelerate in North America and accelerate in EMEA. But our customers remain committed to transformation and to Autodesk, leveraging automation more as they see headwinds from the economy and supply chains. That commitment is reflected in larger, broader and more strategic partnerships, improving renewal rates, consistent net revenue retention, and growing adoption and usage of our products within EBAs; all of which helped drive 12% growth in current RPO and 15% growth in total RPO. While macroeconomics are unpredictable in the short-term, we are executing our strategy through the economic cycle with disciplined and focused capital deployment, underpinned by one of the best growth, margin, and balance sheet profiles in the industry. This enables Autodesk to remain well invested to realize the significant benefits of its strategy, while mitigating the risk of having to make expensive catch-up investments later. Discipline and focus also mean making sure we are investing in the right places. This is a constant process of optimization and improvement with increased vigilance during periods of macroeconomic uncertainty to prioritize investment and recruitment. As you heard at our recent Investor Day, we are deploying next-generation technology and services and end-to-end digital transformation within and between the industries we serve and, in so doing, shifting Autodesk from products to capabilities. Our AEC industry cloud, Forma, launched on May 8, is a great example of our vision. During pre-release trials, customers like CUBE 3 clearly saw how Autodesk Forma's intuitive user interface enabled rapid adoption by existing and new users; how bi-directional data flows enhanced the value of other Autodesk products like Revit; and how a single, integrated environment in the cloud, enhanced by AI, accelerated modeling and response times while significantly enhancing the value delivered to its customers. While using Forma during its trial, CUBE 3 delivered more creative and valuable designs to its customers while reducing the concept design phase by 50% or more. At Investor Day, I also talked about leveraging our key growth enablers, including business model evolution, customer experience evolution, and convergence between industries, to provide more and better choices for our customers. Our Flex consumption model is a good example of this. Flex's consumption pricing means existing and new customers can try new products with less friction, and also enables Autodesk to better serve infrequent users. Not surprisingly, the lion's share of the business has come from new customers or existing customers expanding their relationship with Autodesk. As Steve said at our Investor Day, we've also introduced a new transaction model for Flex, which will give Autodesk a more direct relationship with our customers and more closely integrate with our channel partners over time. During the quarter, Flex moved up into the top 10 products on our e-store, and we signed our first million-dollar Flex deal. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. Our transformation from products to capabilities will enable us to forge broader, trusted and more durable partnerships with more customers; gives Autodesk a longer runway of growth and free cash flow generation; and enables a better world designed and built for all. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to update you on our strategic growth initiatives.
Debbie Clifford: Thanks, Andrew. Amidst a more challenging macroeconomic environment and ongoing headwinds from currency and Russia, Q1 was strong. The overall momentum of the business was similar to last quarter with new subscriber growth decelerating a bit and renewal rates improving a bit quarter-over-quarter such that current remaining performance obligation growth was the same as last quarter. Strong renewal rates demonstrate existing customers are committed to, and investing in, their long-term strategic partnerships with Autodesk. Some customers are also elevating their relationships with Autodesk from subsidiaries to companywide. When this happens, it can sometimes cause quarterly timing differences for the renewal as multiple contracts are co-termed to a single renewal date. We saw an instance of that in Q1 and, as a result, some of the up-front revenue we expected to hit in Q1, we now expect later in the year. Q1 revenue would have been toward the top end of our guidance range if adjusted for this up-front revenue. Total revenue grew 8%, and 12% in constant currency. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 10%, AEC revenue grew 11%, manufacturing revenue grew 13%, and M&E revenue grew 9%. By region in constant currency: revenue grew 14% in the Americas, 11% in EMEA, and 8% in APAC. Direct revenue increased 15% in constant currency and represented 35% of total revenue, up 1 percentage point from last year, due to strength in both enterprise and ecommerce. Net revenue retention rate remained the same as last quarter and within 100% to 110% at constant exchange rates. As we flagged in our annual guidance given last quarter, our transition from up-front to annual billings for multi-year contracts impacts our billings growth this year. That transition started on March 28, so we had about one month of headwind in the first quarter. Billings increased 4% to $1.2 billion, primarily reflecting growing renewal rates and early renewals, partly offset by about one month of annual billings for most multi-year contracts. Total deferred revenue increased 20% to $4.5 billion. Total RPO of $5.4 billion and current RPO of $3.5 billion grew 15% and 12%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin decreased by 2 percentage points to approximately 32%. This reflects ongoing cost discipline, including the expected Q1 cost of repurposing approximately 250 roles to invest in our strategic priorities, as well as the impact of exchange rate movements. GAAP operating margin decreased by 1 percentage point to approximately 17% for the same reasons. Free cash flow was $714 million in the first quarter, up 69% year-over-year. In addition to the underlying momentum of the business, there were three factors that provided a tailwind in the first quarter: first, cash collections from the last month of billings in fiscal '23 were strong; second, we saw favorable linearity and early renewals in the first quarter, driven by the end of our multi-year billed up-front program; and third, after the winter storms in California, we received a federal tax payment extension to the third quarter. Turning to capital allocation, we continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. As Andrew said, we are being vigilant during this period of macroeconomic uncertainty, paying close attention to attrition and recruitment rates, and the increased upward pressure on costs from a weakening dollar. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense to do so. During Q1, we purchased 2.7 million shares for $534 million, at an average price of approximately $199 per share, reducing total shares outstanding by about 3 million shares. Now, let me finish with guidance. The overall headlines are: the expectations embedded in our guidance range for the full year remain consistent with the underlying momentum in the business; and, we expect a tailwind in the second half of the year from a strong cohort of Enterprise Business Agreements. These EBAs last renewed three years ago at the start of the pandemic, and subsequent adoption and usage has been strong. Let me summarize some key factors we highlighted last quarter. First, foreign exchange movements will be a headwind to revenue growth and margins in fiscal '24. Revenue headwinds from Russia and FX peak in the first half of the year. Margin headwinds from FX will persist throughout the year. Second, switching from up-front to annual billings for most multi-year customers creates a significant headwind for free cash flow in fiscal '24 and a smaller headwind in fiscal '25. Given this transition started on March 28, this will become more apparent from the second quarter onward. Our expectations for the billings transition are unchanged. And third, it's possible that during the transition to multi-year contracts billed annually, some customers may choose annual contracts instead. We haven't seen much evidence of this in the limited time since the annual billings program started on March 28, but it's early days and we'll keep you updated as the year progresses. All else equal, if this were to occur, it would proportionately reduce the unbilled portion of our total remaining performance obligations and would negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged in this scenario. Annual renewals create more opportunities for us to drive adoption and upsell, but are without the price lock embedded in multi-year contracts. We still expect our cash tax rate will return to a more normalized level of approximately 31% of GAAP profit before tax in fiscal '24, up from 25% in fiscal '23 for the reasons we outlined last quarter. As I mentioned earlier, a federal tax payment extension after the winter storms in California means cash tax payments will shift from the first half of the year to the third quarter, reducing third quarter free cash flow. The tax payment extension will change the first half/second half free cash flow linearity a little bit. But we still think we'll generate roughly half of our free cash flow in the second half of the year, with second half free cash flow generation significantly weighted to the fourth quarter. We still anticipate fiscal '24 to be the free cash flow trough during our transition from up-front to annual billings for multi-year contracts. Putting that all together, we still expect fiscal '24 revenue to be between $5.36 billion and $5.46 billion, up about 8% at the mid-point, or about 13% at constant exchange rates and excluding the impact from Russia. Normal seasonality, peak second quarter currency and Russia headwinds and, as I mentioned earlier, a strong second half pipeline of enterprise agreements last renewed three years ago in the immediate aftermath of the onset of the pandemic, mean we expect reported revenue growth to accelerate in the second half of the year. We expect non-GAAP operating margins to be similar to fiscal '23 levels with constant currency margin improvement offset by FX headwinds. As I said earlier, in a more challenging macroeconomic environment, we are being vigilant and proactive to sustain our margins. We expect free cash flow to be between $1.15 billion and $1.25 billion. The mid-point of that range, $1.2 billion, implies a 41% reduction in free cash flow compared to fiscal '23, primarily due to the shift to annual billings, a smaller multi-year cohort, FX, and our cash tax rate. The slide deck on our website has more details on modeling assumptions for Q2 and full year fiscal '24. We continue to manage our business using a rule-of-40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins, captured in the rule-of-40 framework, is the hallmark of the most valuable companies in the world. And we intend to remain one of them. As we said last quarter, the rate of improvement will obviously be somewhat determined by the macroeconomic backdrop. But, let me be clear, we're managing the business to this metric and feel it strikes the right balance between driving top-line growth and delivering on disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal, regardless of the macroeconomic backdrop. Andrew, back to you.
Andrew Anagnost: Thank you, Debbie. Let me finish by updating you on our progress in the first quarter. Our strategy is to transform the industries we serve with end-to-end, cloud-based solutions that drive efficiency and sustainability for our customers. We continue to see good growth in AEC, fueled by customers consolidating on our solutions to connect previously siloed workflows in the cloud. HNTB, an employee-owned infrastructure solutions firm that serves public and private owners and contractors, expanded its EBA with Autodesk to help achieve its goals around design modernization, digital transformation and digital infrastructure solutions. The ability provided by our EBA means that HNTB can easily consolidate more workflows to Autodesk. For example, in addition to adopting and integrating Autodesk Build and Innovyze, HNTB has been prototyping Autodesk's immersive collaboration platform. By leveraging VR collaboration, it has been able to help transportation agencies like Florida's Turnpike Enterprise use digital twins to train facility management and first responder teams on real-life scenarios from the safety of their offices instead of on busy interstate highways. HNTB sees the potential of further applications in its work on complex bridges and tunnels, as well as its work with airports and state departments of transportation across the country. In construction, we continue to benefit from our complete end-to-end solutions which encompass design, preconstruction and field execution, through handover and into operations. DPR is among the top 10 largest general contractors and construction management firms in the U.S. and specializes in technically complex and sustainable projects. In the first quarter, DPR expanded and extended its partnership with Autodesk and unified on Autodesk Construction Cloud, our construction platform that connects stakeholders throughout the project lifecycle. In moving away from point solutions and onto Autodesk's common data environment and cloud, DPR aims to connect all workflows, centralize communications, and improve project management and operations across the office and job site. We continue to see significant opportunities to grow our construction platform outside the U.S., benefiting from our strong international presence and reputation. In Singapore, Autodesk Build was selected over three competitive offerings as the construction management platform for what will be Singapore's tallest skyscraper. When awarding the contract to our partner, China Harbour, the project owners chose Autodesk Build because it connected the design and make processes in the cloud, centralized project schedules, and generated automated clash reports to reduce risk during construction. Of course, these stories have a common theme: managing across the project lifecycle to increase efficiency and sustainability, while decreasing risk. And this means our customers are renewing and expanding their relationships with us. Over time, we expect the majority of all projects to be managed this way and we're getting ready today to scale to serve that demand. Jim talked at our Investor Day about how product innovation, go-to-market expansion, and customer success are helping us get ready. In the first quarter, we took another important step by integrating our construction sales force into our worldwide sales team. While integrations of this scale inevitably cause some short-term disruption, combining the two teams will allow us to expand the scale and reach of our construction business, particularly in our design customer base, and our ability to serve our customers across the project lifecycle. Moving on to manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make Platform to grow their business and make it more resilient. For example, Rittal is a leading manufacturer of electrical enclosure systems. It uses Inventor, Vault and Moldflow to optimize and manage its product manufacturing to produce thousands of customized and configured switch cabinets daily. Rittal is focused on maximizing internal automation to accelerate its speed to market and respond more nimbly to changes in demand. In Q1, it increased its EBA with Autodesk to include Fusion to serve as its central data management system, build a more resilient supply chain, and drive competitive advantage through quicker turnaround times. Using Fusion, Rittal will be able to automatically route online customer orders through to its engineers and integrated production line and make deliveries in as little as one or two days. In the U.K., a precision engineering firm was looking to update its CAM workflow to increase engineering efficiency and optimize costs. After a competitive evaluation, the customer migrated from its existing provider to Fusion with the Machining Extension because of Fusion's intuitive UI, cloud capabilities, and simple integrations with its existing software and machines. Realizing the opportunities to drive breakthrough efficiency by consolidating all workflows on a single Design and Make Platform, the customer is now also evaluating the migration of its CAD workflows from a competitor to Fusion. Fusion continues to grow strongly, ending the quarter with 231,000 subscribers, as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. In partnership with higher education providers across the globe, we continue to invest in the workforce of the future. We recently partnered with the Tamil Nadu Skill Development Corporation and Anna University in India to integrate Fusion into its 20 mandatory product engineering courses and launched the Fusion Design Challenge to showcase the skills of 20,000 students. Fusion's intuitive UI and cloud-based data management make it easy for students to learn and collaborate on class projects. Autodesk is also investing in a new Technology Engagement Center at California State University, Northridge, that will promote interdisciplinary collaboration in engineering and computer academic programs and house the Global Hispanic Serving Institution Equity Innovation Hub, which aims to build a more diverse and inclusive engineering workforce. And finally, we continue to work with non-compliant users to ensure they are using the latest and most secure versions of our software. In the first quarter, we made substantial progress on two initiatives we outlined at Investor Day: further hardening our systems by significantly tightening concurrent usage of named user subscriptions, and significantly expanding the precision and reach of our in-project -- product messaging. We expect both initiatives to drive further conversion and growth in the second half of the year and beyond. Let me finish where I started. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. With our AI infused industry clouds, Fusion, Forma, and Flow, scaled on Autodesk Platform Services, our customers will be able to leverage their large, domain specific, inter- and intra-industry data sets to deliver further breakthrough productivity, operations, and sustainability gains. And with intuitive UIs and the application of multi-modal AI models that move beyond language models to capture sketches and reality directly into accurate 3D models, we will be able to accelerate the transition from products to capabilities that I talked about at our recent Investor Day. Our transformation from products to capabilities will enable us to forge broader, trusted and more durable partnerships with more customers; give Autodesk a longer runway of growth and free cash flow generation; and enable a better world designed and built for all. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question please, Saket.
Saket Kalia: Okay. Great. Hey, Andrew. Hey, Debbie. How you doing? Thanks for taking my questions here. Andrew, maybe just for you. Appreciate the macro commentary, very helpful. I think we all try to speak to at least a subset of your partners through the quarter. And frankly, through the quarter, some of those checks, albeit limited, were mixed or soft, right, of course, reflecting the macro. Maybe the question that I have for you is, I was wondering if you saw that as well. And if you did, whether some of those trends have maybe continued here through the second quarter?
Andrew Anagnost: Yes, Saket. Good to see you by the way. Good to talk to you. So, yes, let me tell you what we saw and consistent with what people heard from the partners. So, whenever we have a large event like ending multi-year, what happens is partners and teams tend to pack up deals into that event, they even pull pipeline forward to try to get it into the event, so that they can kind of close their deal, get things trued up around the event. This happens every time consistently when we have event like this. It's one of the reasons why we try to align these events with quarter-end, so we don't have conversations like this. So, if that was the case, what you would have expected is that business would rebound to kind of expected levels post the end of the quarter, which is exactly what happened. It's exactly what we're seeing at the beginning of the quarter [indiscernible] and we're back to what we would expect to be [indiscernible]. Debbie, you want to add anything about the macro environment that we haven't said already or anything -- any commentary that might help understand how the quarter progressed?
Debbie Clifford: Sure. So, overall, our leading indicators remain broadly the same as what we saw last quarter. We saw usage grow modestly. We saw record bid activity on BuildingConnected. We continue to see cautious optimism from our channel partners. New subscriber growth decelerated a bit quarter-over-quarter, but renewal rates improved. Also like last quarter, Europe was a bit better, the U.S. was a bit worse, Asia was about the same. So, net-net, the overall momentum of the business was somewhat similar to what we saw last quarter with some puts and takes. It's all in line with the guidance expectations for the year and it's consistent with macro trends. Current RPO growth is a good forward indicator for you. It was the same as last quarter at 12% growth. And as we've said before, the business is going to grow faster in better environments and slower in more uncertain environments, but our goal continues to be to set ourselves up for success in fiscal '24 and beyond.
Saket Kalia: Got it. That's really helpful, Debbie. Debbie, maybe for my follow-up for you. Great to see the cash flow strength this quarter, well ahead of what we were expecting. I was just wondering if you could just zoom into what drove that. And maybe just looking forward, how you're sort of thinking about the shape of cash flow this year, particularly where we trough here in fiscal '24? Does that make sense?
Debbie Clifford: Yes. So, Q1 free cash flow was strong for a couple of reasons. First, cash collections from the last month of billings in fiscal '23 were strong. Second, we also saw favorable linearity and early renewals in Q1 that were driven by the end of multi-year build upfront. And then, third, as I mentioned on the call, after the winter storms in California, we received a federal tax payment extension for the third quarter. Our overall expectations for free cash flow on the year, including linearity, are unchanged. We still expect that we're going to generate about half of our free cash flow in the second half of the year, with heavier weighting to Q4. Some of the factors to think about across Q2, Q3 and Q4, we have the full quarter impact from the switch to annual billings. In Q2, remember that we had some early renewal billings that were pulled into Q1. And then with that tax payment extension to Q3, that has a positive impact to free cash flow in Q1 and Q2, but a negative offset in Q3. But overall, I just would reiterate that our expectations are unchanged and that we expect to generate about half of that free cash flow in the second half of the year.
Saket Kalia: Got it. Very helpful, guys. Thank you.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your question please, Jay.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, you referenced the effect on channel behavior in the quarter as a result of the billing change. But more broadly, there are some other evolutions that your sales model is going through affecting not just the VARs but also the VADs. And I'm wondering how you're thinking about the operational or execution risks associated with that evolution which certainly goes beyond Q1 in terms of perhaps either demand generation, fulfillment of which you'll be doing more of on your own, perhaps the elements of channel comp as they change with the back end change. So maybe just let's talk about some of those ongoing executables that you need to get right vis-à-vis the sales model. Then, I'll ask my follow-up.
Andrew Anagnost: Yes, Jay, that's a great question. So, one of the things that I'll say like first upfront is why are we exploring some of these things. And it's a great example of what we're doing with Flex in particular. We're doing these things because our customers get a much more instant on self-service like experience kind of more like an e-store experience from all their transactions. But they also get the added bonus of support that local and connected to them through their VARs. They get service and other types of supports from their VARs locally. It also allows us to really get a lot of visibility about what their usage patterns are, how they're using the product, and then also share that visibility with our partners and other people so that we can understand these customers better. So, there's lots of great things about it. But more importantly, rolling out kind of changes like that and exploring these kinds of new models and something like Flex, which is a lower volume offering right now, those doing quite well, gives us a lot of opportunity to learn a lot of things and work through a lot of things. Debbie, why don't you talk specifically about some of the things that we've been learning from Flex as we've been working through all of these new transaction models.
Debbie Clifford: Sure. Yes. So, as Andrew mentioned, we launched this Flex agency model in Q1. We have learned a lot. Some of the things that we've been learning are things like the importance of driving a seamless vendor setup process. These are situations where customers will have to set up Autodesk as a vendor as opposed to a partner. We're getting insights and learnings around -- by having access to more data, and we're able to better forecast with having that access to better data. So, like Andrew mentioned, as with anything in this area, we're focused on testing and learning as we go. We want to make sure that we have scalable processes for all stakeholders and the ecosystem, and we'll continue to keep doing that.
Jay Vleeschhouwer: Okay. As follow-up, Debbie, at the meeting two months ago in your slide with regard to double-digit growth or what you called sustainable double-digit growth, you had eight different line items referring to volume as component of your growth. When you look out over the balance of the year, what do you think might be of those perhaps the two or three most important volume drivers to the business?
Debbie Clifford: That's an excellent question, Jay. I mean, the view that I talked about from Investor Day hasn't changed much, granted our Investor Day wasn't very long ago, so that's a good thing. But we're going to be looking to continue to drive volume from all the different areas or growth vectors that we have. So, things like our investments in AEC, the proliferation of BIM, expansion and infrastructure, driving more growth from construction. I think what was interesting for us this quarter was really seeing continued strengthening of our renewal rate, because, ultimately, with higher renewal rates, that becomes a net volume driver for us. And that really goes down to the investments that we've been making in our customer success teams, who are really doing an excellent job of driving those renewal rates up, driving success with our customers, because that's a really important part of keeping the volume engine going at Autodesk. So, those are some initial thoughts, Jay.
Jay Vleeschhouwer: Okay. Great. Thank you, both.
Andrew Anagnost: Thank you, Jay.
Operator: Thank you. Our next question comes from the line of Adam Borg of Stifel. Your line is open, Adam.
Adam Borg: Great, and thanks so much for taking the questions. Maybe for you, Andrew, I know at Analyst Day, you talked a lot about the broadening opportunity around serving the owner market and not just in conceptual design, but during operations. So, I know it's still early in this journey. Maybe you could share with us how that message is resonating and as you look to expand into AEC and obviously [indiscernible]?
Andrew Anagnost: Yes. So the way -- the vector that we have into that space right now is through Tandem. And the best way to talk about that is the increase in people using more modeling assets in Tandem and the monthly active usage rates that are going associated with that, we're starting to see very nice pickup with that. We're engaging with a series of owner-level customers on direct collaborations in terms of how Tandem serves some of their needs, where it has development requirements to serve some additional needs. So, we've got a lot of really good customer engagement, which is definitely where you'd expect to be at this point in the process. So, we're really happy with the progress here and we're happy with the level of engaging with Tandem. Tandem is getting a lot of visibility, a lot of interest and a lot of focus with owners, but also with people that serve owners that want digital twins and things associated with digital twins from, say, other types of vendors.
Adam Borg: That's really helpful. Thanks for that. And maybe, Debbie, as a quick follow-up. I think you've mentioned in the script about repurposing 250 roles in the quarter. Maybe you can provide a little bit more detail there? Thanks, again.
Debbie Clifford: Sure. So, uncertainty really just is the new normal. I think we're all living this. Since we last reported earnings, we've seen a bunch of stuff happen. There was a major regional bank crisis. We're seeing deadlock discussions about the debt ceiling in Congress. The Fed, just a few weeks ago, acknowledged that those things could have an impact on the economy, but so they didn't know how. We're in the same boat. But it's very important to us to deliver on our margin goal. So, it's against that backdrop that we're taking a prudent approach to how we manage the business, that means tightening the belt a bit. So, in Q1, we did some repurposing of roles to allow us to reinvest. And in Q2 and onward, we proactively taken steps to slow the pace of our hiring to ensure that we don't get ahead of ourselves on spend in light of this continued macro uncertainty. And we think that slowing spending earlier in the year provides more investment flexibility versus trying to slow spending later in the year. Again, our goal continues to be to set ourselves up for success since fiscal '24 and the long term.
Adam Borg: Excellent. Thanks again.
Operator: Thank you. Our next question comes from the line of Joe Vruwink of Baird. Your question please, Joe.
Joe Vruwink: Great. Hi, everyone. Maybe just a bit of clarification on near-term performance and reconciling, just the comment. I think, leading indicators around product usage, that's fairly consistent. But then, the new sub growth decelerating in the Americas. I guess, normally, I think the leading indicators kind of predict that. So was this something around new subs that just kind of popped up in the quarter?
Andrew Anagnost: No, it was consistent with what we were seeing in our monthly active user trends. That's how the monthly active user trends are so good at predictive behavior. We kind of expected a slight decrease in velocity in the Americas and more of an increase in Europe. So, it's consistent with the indicators we see and it's consistent with the indicators moving forward as well.
Joe Vruwink: Okay. Great. Thanks for that. And then, just, I guess, I get the AI question. Just in terms of capabilities that already exist on the platform, thinking about things like Space Maker or the Generative Extension on Fusion, have you started to see kind of an uplift in interest just as more industries are studying adoption around AI? And is there anything you've seen to this point maybe specifically around video, media content where you start thinking about maybe changing product road maps, or all just based on kind of the pace of innovation that's coming out?
Andrew Anagnost: So, yes, first let's be very clear. We've been talking about AI for a long time, all right? And we've been building machine learning models into our application for a while now. So, there's already significant velocity inside of Autodesk conversations. What's changed is ChatGPT created a version of AI that everybody understood. So, we're all now having a common conversation about what AI can and cannot do and how it functions as a [indiscernible] or an assistant or a co-creator in these processes. So, make no bones about it, we've been working on these things for a while. This isn't a course and speed change for us. And I want to be super clear about that. Now, like I said, we've been in Construction IQ. Space Maker is no longer a product anymore, it's Forma now, which we rolled out, which even has more enhanced underpinnings or associated with machine learning. You probably -- if you follow what we do in our AI Lab, we published a lot of work on kind of fairly advanced things around large models and things that you can do with creating 3D models and representations using machine learning. So, we've been out there with this for a while. What it does allow us to do, it had a very meaningful customers about -- conversation with our customers about "Look, we've been telling you that this was going to be a cocreation technology. Take a look at what you're seeing out there with the large language models and the things that you're getting from OpenAI and see how this kind of can be evolved to creating 3D building information models, more complex models, complex design, sustainability decisions, optionality, all the things associated in some of the things you're seeing inside of Forma." So, the customers now get it. They kind of get the connection between what we're doing and what we said it was going to do in the future, because there's an example here that everybody understands. And I think that's super powerful. So, it's current course and speed for us. We're going to be probably speeding up a little bit on some of our work with more larger and complex models, but this is something we've been doing for a while.
Joe Vruwink: Okay. Thank you, Andrew.
Operator: Thank you. Our next question comes from the line of Michael Funk of Bank of America. Your line is open, Michael.
Michael Funk: Yes, thank you for the questions. So, Debbie, you mentioned you highlighted the slowing sub growth and usage has been strong. Can you help me understand the relationship if any between those two? And is the sub growth simply a factor of customers tightening their belts more due to the uncertain macro that you highlighted a few times, or is there some other -- something else behind that?
Debbie Clifford: Yes, thanks. So, the biggest factor driving the sub growth that we saw in Q1 was actually the end of sale of the multi-year upfront contracts. So, Andrew mentioned it at the top of this Q&A session, but remember that the demand pattern that we saw during the quarter was impacted by that end of sale. Before the launch, we saw higher volume. And then, post launch, demand was lighter. That's typical of what we see when we launch programs like this to the market. But what it meant was that, on a net basis, the new piece of our business decelerated as we headed out of the quarter. So, Andrew also mentioned that over the last several weeks in May, we've seen that demand bounce back a bit. And it's generally in line with our expectations at this point.
Michael Funk: Okay. Great. And then one more. Debbie, you also mentioned tailwind in second half, one being the EBA renewal pattern, adoption and usage has been strong there, I think you noted. Can you give us some more detail just on the moving pieces around the EBA renewals? Is it contract changes, pricing changes, what will be driving that tailwind in the second half of the year around the renewals?
Debbie Clifford: Sure. So, maybe I'll just take a step back and talk about revenue linearity overall and then double click a bit into EBAs. So, to recap, we're expecting revenue growth deceleration in Q2, followed by growth acceleration in the back half of the year that's consistent with historical seasonal patterns for Autodesk. And it was built into our annual guidance from the start. When we look at things by quarter, in Q2, we have the peak of FX and Russia and their drag on revenue growth. In the second half, the negative impact from exiting Russia goes away, and that drag from FX reduces as the year progresses. And then, we have that big cohort of EBAs, particularly in Q4, those are deals that renewed three years ago, at the beginning of the pandemic, where subsequent adoption and usage have been strong. And it's that deal flow that drives that seasonal growth acceleration primarily in Q4. We thought -- you can go back and look at our opening commentary back in fiscal '21 for Q4 where we talked a bit about those deals they tended to be in the auto space. And so, we're anticipating that those deals will come through and we think the fact that they've had good adoption and usage is a good indicator that we're going to see that behavior happen in Q4 as expected. So, overall, I mean, our business, the momentum is pretty consistent with what we've seen for a while here now and the assumptions that we have embedded in our guidance reflect, but we've been seeing for a while and we remain on track to achieve our full year financial goals. And I can't reiterate enough that we continue to try and set ourselves up for success in fiscal '24 and beyond.
Michael Funk: Great. Thank you for the questions.
Operator: Thank you. Our next question comes from the line of Matt Hedberg of RBC. Your line is open, Matt.
Matt Hedberg: Great. Thanks for taking my questions, guys. Andrew, in your prepared remarks, you talked a lot about AEC and obviously construction. This is an area obviously as we all know that's been sort of laggard to adopt SaaS and cloud. Can you talk about sort of where we're at in this evolution? The pandemic is behind us now, I think. But like, are you starting to see some of these field workers, some of the folks that are sort of like behind the scenes on construction starting to sort of embrace the technology more so? Is it a generational thing? Just any sort of like incremental sort of catalyst for further construction cloud adoption?
Andrew Anagnost: Yes, it's a good question the way you phrased that around incremental catalysts. I think actually the rising adoption is becoming its own catalysts in many respect. I mean, obviously, we're continuing to see good growth in construction. We're seeing solid adoption. We're seeing really significant adoption in our EBA account. And adoption tends to lead to more adoption, because the people who adopt these technologies and start using these technologies on a regular basis tend to have higher bid precision, higher bid accuracy, tend to be able to execute more effectively during the projects, manage cost better and all things associated with that. And that's a flywheel effect, because if you're better able to manage the cost of the project, you're better able to estimate the next project, bid on that project and win an envelope that preserves your margins. So that is kind of the biggest thing that's going on right now out there in the industry is the flywheel effect. There's no kind of generational catalyst that's yet coming in here. But I will tell you there's one other thing that's persistently out there that's driving people to look towards technology, and it's they can't hire people, all right? More and more, they are not able to fully staff their sites and their jobs to the level that they were in the past. So, they need these productivity gains from technology. And it's between that and the flywheel of competition, there's kind of a momentum here that I don't see slowing down.
Matt Hedberg: Super insightful. No, that's great. Thanks again for the time tonight, guys.
Operator: Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler.
Tyler Radke: Yes, thanks for taking the question. So, just a couple of questions on the indicators that you saw in the quarter. Andrew, you talked about bid activity at record levels in BuildingConnected. I guess, should we be thinking about that as a sign of health in the end markets or more of a function of buildings connected, strong competitive position and digitization tailwinds? And then, just curious if you could talk about the slowdown in new subscriptions or deceleration that you saw. Was that more on the AEC side or any end market or where -- the segment where you saw that?
Andrew Anagnost: Okay. So, let me address the next part of the question. Kind of the answer to your BuildingConnected question kind of both, all right? BuildingConnected certainly active. There's lots of activity going on there. But remember, it's the trend that matters. So, if the trends continue to indicate a large degree of bid activity, that means there's a large degree of bid activity out in the ecosystem. And what also is important to recognize is, our customers and especially in the AEC land, they're still working through backlogs. I mean, every customer I talk to has the same issue or same opportunity, however you want to look at it, that they still have to work through their backlog, they're still having trouble getting enough people to get the projects moving at the right kind of pace and so on and so forth. So there's still a backlog out there. But the trend on bid activity is real and it absolutely represents what's going on in the U.S. market in particular. Now with regards to deceleration and rebound in Q2 around volume, there was no hotspot, right? It was kind of uniformly the same across the board, right? So, it was more kind of dynamics of the business rather than any kind of particular hotspot.
Tyler Radke: Great. And then, just on the EBA renewals for the second half, are you expecting those to renew at kind of the typical net expansion rate that you see for the broader company? Or are you expecting anything different just given the environment?
Andrew Anagnost: Well, I mean, I'll let Debbie follow-up on this. But one of the things that she highlighted was that a lot of these EBAs that are coming due were ones that were renewed during the pandemic at a time where there was downward pressure on their activity and their usage and [indiscernible], things have obviously changed significantly since then. So, Debbie, do you want to comment on kind of the average relative difference within -- with these cohort versus [direct to] (ph) company?
Debbie Clifford: Yes, I mean, I would say that in terms of what we're baking into our guidance, we're assuming that these customers renew at reasonable levels. I'm not going to get into more specifics beyond that. What's key is that they renew and we feel good about that happening given the fact that there has been high adoption and usage across these EBAs. It's a big cohort for us. We saw that performance back in fiscal '21. It was also an equally unusual economic time at that point. And so, I don't see this situation as any different. I think we've set the guidance at a reasonable point.
Tyler Radke: All right. Thank you very much.
Operator: Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank. Your question please, Bhavin.
Bhavin Shah: Great. Thanks for taking my question. Andrew, just given what's going on with the debt ceiling, any sort of impact that we should think about regarding federal deals and the pace of that business? And then, kind of related point, can you give us an update on where we are into the FedRAMP Moderate for Docs and BIM 360, Collaborate Pro?
Andrew Anagnost: Yes. So let me talk a little bit about [FedRAMP] (ph) here. So we've submitted all our paperwork. Our systems are ready. Autodesk systems are already for FedRAMP. We're just waiting for the government to come back and give us the approval and move forward. So, that's all proceeding ahead for us. We're waiting for the government to respond now at this point. With regards to the debt ceiling, I'm not really going to speculate on the debt ceiling. I would say that I think the things that impact us are bipartisan priorities. These are things that both parties want. Infrastructure and the things associated with that, they all want this. So, I would suspect the things that matter a lot to Autodesk and to Autodesk business are probably not going to be impacted by all the activity going on in D.C. right now.
Bhavin Shah: Helpful there. And then just maybe a quick pivot to Construction Cloud. I know you talked a little bit about combining sales [within organization] (ph). Can you just maybe elaborate on some of the assumptions in terms of what you're expecting in terms of disruption, for how long? And then maybe when should that [be merged] (ph) and drive better performance in productivity?
Andrew Anagnost: Yes. So, first, let me kind of clarify exactly what we did. So, we merged the independent construction team with the mainline sales team inside the company. And we had kind of a few goals in mind there. One, we wanted to get a little bit more emphasis on the territory business that covers all of our business. And we wanted to make sure that we were focused not only on pure construction accounts, but design and construction accounts where we actually have pretty significant competitive advantage and there's a lot of opportunity. So this just kind of sharpened the pencil on kind of pursuing those opportunities in kind of a concerted way and kind of getting all the energy behind one effort. And we're pretty confident that, that's exactly what we're going to get. But of course, when you do that, sales reps get new accounts, people get moved from accounts, so they'll get new responsibilities. So it creates a little bit of short-term disruption. We absolutely expect that to work its way out over the next quarter or two. And we expect it to kind of compound benefits from doing us moving forward.
Bhavin Shah: Makes a great sense. Thanks for taking my questions.
Operator: Thank you. Our next question comes from the line of Steve Tusa of JPMorgan. Your question please, Steve.
Steve Tusa: Hey, guys. Good evening. The -- just if we were to see a continued decline in the things like the ABI or kind of an isolated decline in new office markets, if you will, can you just remind us of, is that even a big enough exposure to matter for you guys? Or just kind of remind us what part of your business is exposed to those trends just on the macro. And then secondly, if I just do the simple math on half-over-half free cash flow, that implies negative free cash flow for the second quarter to get it back to the half of the year. Is that kind of the right construct? Thanks.
Andrew Anagnost: I'll let Debbie answer the second half of that, but let me talk more broadly about what's going on in the AEC sector. With everything in these sectors, there's always puts and takes, right? And what you see is one sector sees some kind of decline in activity, nobody is building new office buildings or whatever. And in other cases, some people are seeing increases in activity. And that's exactly what we're seeing. I'll give you a classic example of what goes on in this environment. So, people are pulling back from office space right now, pretty significantly downsizing their offices. And as a result, what's happening is that there's more competition for getting people to sign leases for new office space. So what that's leading to is a kind of modernization of office space to accommodate new ways of working or to attract the best renters. And people are spending money on that, which is offsetting money being spent in other places. And we've taken all of this into account as we look forward into our business throughout the year. So that kind of gives you a sense for how billings shift around and how money moves around and what our relative sensitivity as to some of these things. A lot of these indicators you talked about, they kind of tell you what's already happened, not what's going to happen necessarily. That's why we like to pay attention to kind of our leading indicators around monthly active usage of the products. Now, I'll turn it over to Debbie to discuss the other part of your question.
Debbie Clifford: Yes, in terms of free cash flow, I'm not going to get into specific guidance by quarter, but I would say directionally, I think you're thinking about it in a reasonable way. And just to recap some of the things, remember, with the tax payment extension to Q3, we'll have a negative also in Q3. And some of the things that I outlined in terms of the linearity of free cash flow on the year are the things that you should be thinking about. So, I recommend going back and listening to some of those points because that will help you model free cash flow by quarter.
Steve Tusa: Yes, great. Thanks for the details. Thank you.
Operator: Thank you. Our next question comes from the line of Sterling Auty of MoffettNathanson. Your question please, Sterling.
Sterling Auty: Yes, thanks. Hi, guys. So, just wondering, given the comments about the second half acceleration, does that mean that you're expecting the peak of the macro impact to really hit next quarter? Or is some of that acceleration more just due to improvement in Autodesk execution based on some of the changes that you had mentioned during the prepared remarks?
Debbie Clifford: So, Sterling, what I would say is we're not assuming any peak or trough in macro. We have a range for our guidance in our 7% to 9% range for revenue. We have the ability to address whatever macroeconomic situation that we see. And what we saw in Q1 was consistent with our general expectations on the year, and we've continued those expectations as we think about our outlook for the rest of the year. And you can see that our outlook is in line. What's really driving the change in linearity in our revenue growth is some of the things that I talked about, so seasonality, the acceleration that we expect from EBAs in the back half of the year, the impact from FX, and not having the drag from the exit of Russia anymore. So it's more about those things than it is about any fundamental underlying changes in our assumptions related to macro.
Sterling Auty: That makes sense. And then Andrew, one for you. When you think about the long-term opportunity for generative AI, LLMs, conversational interfaces, et cetera. Do you view this as something that's going to ultimately raise the ARPU and/or prices for Autodesk solutions, given the additional value add? Or is it going to be more differentiation at the current price levels just so you can drive more market share?
Andrew Anagnost: I think it's going to be a little bit of both, all right? In some cases, we're going to be delivering significantly more value to certain types of customers and we expect to charge for that value. In other cases, it's going to be a massive productivity enhancement for customers, and those customers are going to use that productivity to get more business, increase their book of business and it will be a competitive advantage for Autodesk. So it's a little bit of a mix of both, all right? But either way, we're going to be helping customers be a lot more efficient in one area and be much more creative in other areas in terms of designing what they need to do and how they need to design things.
Sterling Auty: Got it. Thank you.
Operator: Thank you. And that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?
Simon Mays-Smith: Thank you, Latif, and thanks, everyone, for joining us on the call. We look forward to catching up with you next quarter. If you have any questions, please just e-mail us on simon@autodesk.com. Latif, back to you.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by, and welcome to Autodesk First Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, VP, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the first quarter results of Autodesk's fiscal '24. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today's press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our investor relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. Autodesk's strong financial and competitive performance in the first quarter of fiscal 2024 is again a testament to three enduring strengths: resilience, discipline, and opportunity. In a more challenging macroeconomic, policy and geopolitical environment, our resilient business model, and geographic, product and customer diversification, enabled us to deliver 12% revenue growth in constant currency, healthy margins, and record first quarter free cash flow. Leading indicators remained consistent with last quarter with product usage growing modestly, bid activity on BuildingConnected again at record levels, and continued cautious optimism from channel partners. Consistent with year-over-year economic momentum, we saw new subscription growth decelerate in North America and accelerate in EMEA. But our customers remain committed to transformation and to Autodesk, leveraging automation more as they see headwinds from the economy and supply chains. That commitment is reflected in larger, broader and more strategic partnerships, improving renewal rates, consistent net revenue retention, and growing adoption and usage of our products within EBAs; all of which helped drive 12% growth in current RPO and 15% growth in total RPO. While macroeconomics are unpredictable in the short-term, we are executing our strategy through the economic cycle with disciplined and focused capital deployment, underpinned by one of the best growth, margin, and balance sheet profiles in the industry. This enables Autodesk to remain well invested to realize the significant benefits of its strategy, while mitigating the risk of having to make expensive catch-up investments later. Discipline and focus also mean making sure we are investing in the right places. This is a constant process of optimization and improvement with increased vigilance during periods of macroeconomic uncertainty to prioritize investment and recruitment. As you heard at our recent Investor Day, we are deploying next-generation technology and services and end-to-end digital transformation within and between the industries we serve and, in so doing, shifting Autodesk from products to capabilities. Our AEC industry cloud, Forma, launched on May 8, is a great example of our vision. During pre-release trials, customers like CUBE 3 clearly saw how Autodesk Forma's intuitive user interface enabled rapid adoption by existing and new users; how bi-directional data flows enhanced the value of other Autodesk products like Revit; and how a single, integrated environment in the cloud, enhanced by AI, accelerated modeling and response times while significantly enhancing the value delivered to its customers. While using Forma during its trial, CUBE 3 delivered more creative and valuable designs to its customers while reducing the concept design phase by 50% or more. At Investor Day, I also talked about leveraging our key growth enablers, including business model evolution, customer experience evolution, and convergence between industries, to provide more and better choices for our customers. Our Flex consumption model is a good example of this. Flex's consumption pricing means existing and new customers can try new products with less friction, and also enables Autodesk to better serve infrequent users. Not surprisingly, the lion's share of the business has come from new customers or existing customers expanding their relationship with Autodesk. As Steve said at our Investor Day, we've also introduced a new transaction model for Flex, which will give Autodesk a more direct relationship with our customers and more closely integrate with our channel partners over time. During the quarter, Flex moved up into the top 10 products on our e-store, and we signed our first million-dollar Flex deal. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. Our transformation from products to capabilities will enable us to forge broader, trusted and more durable partnerships with more customers; gives Autodesk a longer runway of growth and free cash flow generation; and enables a better world designed and built for all. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to update you on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"text": "Thanks, Andrew. Amidst a more challenging macroeconomic environment and ongoing headwinds from currency and Russia, Q1 was strong. The overall momentum of the business was similar to last quarter with new subscriber growth decelerating a bit and renewal rates improving a bit quarter-over-quarter such that current remaining performance obligation growth was the same as last quarter. Strong renewal rates demonstrate existing customers are committed to, and investing in, their long-term strategic partnerships with Autodesk. Some customers are also elevating their relationships with Autodesk from subsidiaries to companywide. When this happens, it can sometimes cause quarterly timing differences for the renewal as multiple contracts are co-termed to a single renewal date. We saw an instance of that in Q1 and, as a result, some of the up-front revenue we expected to hit in Q1, we now expect later in the year. Q1 revenue would have been toward the top end of our guidance range if adjusted for this up-front revenue. Total revenue grew 8%, and 12% in constant currency. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 10%, AEC revenue grew 11%, manufacturing revenue grew 13%, and M&E revenue grew 9%. By region in constant currency: revenue grew 14% in the Americas, 11% in EMEA, and 8% in APAC. Direct revenue increased 15% in constant currency and represented 35% of total revenue, up 1 percentage point from last year, due to strength in both enterprise and ecommerce. Net revenue retention rate remained the same as last quarter and within 100% to 110% at constant exchange rates. As we flagged in our annual guidance given last quarter, our transition from up-front to annual billings for multi-year contracts impacts our billings growth this year. That transition started on March 28, so we had about one month of headwind in the first quarter. Billings increased 4% to $1.2 billion, primarily reflecting growing renewal rates and early renewals, partly offset by about one month of annual billings for most multi-year contracts. Total deferred revenue increased 20% to $4.5 billion. Total RPO of $5.4 billion and current RPO of $3.5 billion grew 15% and 12%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin decreased by 2 percentage points to approximately 32%. This reflects ongoing cost discipline, including the expected Q1 cost of repurposing approximately 250 roles to invest in our strategic priorities, as well as the impact of exchange rate movements. GAAP operating margin decreased by 1 percentage point to approximately 17% for the same reasons. Free cash flow was $714 million in the first quarter, up 69% year-over-year. In addition to the underlying momentum of the business, there were three factors that provided a tailwind in the first quarter: first, cash collections from the last month of billings in fiscal '23 were strong; second, we saw favorable linearity and early renewals in the first quarter, driven by the end of our multi-year billed up-front program; and third, after the winter storms in California, we received a federal tax payment extension to the third quarter. Turning to capital allocation, we continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. As Andrew said, we are being vigilant during this period of macroeconomic uncertainty, paying close attention to attrition and recruitment rates, and the increased upward pressure on costs from a weakening dollar. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense to do so. During Q1, we purchased 2.7 million shares for $534 million, at an average price of approximately $199 per share, reducing total shares outstanding by about 3 million shares. Now, let me finish with guidance. The overall headlines are: the expectations embedded in our guidance range for the full year remain consistent with the underlying momentum in the business; and, we expect a tailwind in the second half of the year from a strong cohort of Enterprise Business Agreements. These EBAs last renewed three years ago at the start of the pandemic, and subsequent adoption and usage has been strong. Let me summarize some key factors we highlighted last quarter. First, foreign exchange movements will be a headwind to revenue growth and margins in fiscal '24. Revenue headwinds from Russia and FX peak in the first half of the year. Margin headwinds from FX will persist throughout the year. Second, switching from up-front to annual billings for most multi-year customers creates a significant headwind for free cash flow in fiscal '24 and a smaller headwind in fiscal '25. Given this transition started on March 28, this will become more apparent from the second quarter onward. Our expectations for the billings transition are unchanged. And third, it's possible that during the transition to multi-year contracts billed annually, some customers may choose annual contracts instead. We haven't seen much evidence of this in the limited time since the annual billings program started on March 28, but it's early days and we'll keep you updated as the year progresses. All else equal, if this were to occur, it would proportionately reduce the unbilled portion of our total remaining performance obligations and would negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged in this scenario. Annual renewals create more opportunities for us to drive adoption and upsell, but are without the price lock embedded in multi-year contracts. We still expect our cash tax rate will return to a more normalized level of approximately 31% of GAAP profit before tax in fiscal '24, up from 25% in fiscal '23 for the reasons we outlined last quarter. As I mentioned earlier, a federal tax payment extension after the winter storms in California means cash tax payments will shift from the first half of the year to the third quarter, reducing third quarter free cash flow. The tax payment extension will change the first half/second half free cash flow linearity a little bit. But we still think we'll generate roughly half of our free cash flow in the second half of the year, with second half free cash flow generation significantly weighted to the fourth quarter. We still anticipate fiscal '24 to be the free cash flow trough during our transition from up-front to annual billings for multi-year contracts. Putting that all together, we still expect fiscal '24 revenue to be between $5.36 billion and $5.46 billion, up about 8% at the mid-point, or about 13% at constant exchange rates and excluding the impact from Russia. Normal seasonality, peak second quarter currency and Russia headwinds and, as I mentioned earlier, a strong second half pipeline of enterprise agreements last renewed three years ago in the immediate aftermath of the onset of the pandemic, mean we expect reported revenue growth to accelerate in the second half of the year. We expect non-GAAP operating margins to be similar to fiscal '23 levels with constant currency margin improvement offset by FX headwinds. As I said earlier, in a more challenging macroeconomic environment, we are being vigilant and proactive to sustain our margins. We expect free cash flow to be between $1.15 billion and $1.25 billion. The mid-point of that range, $1.2 billion, implies a 41% reduction in free cash flow compared to fiscal '23, primarily due to the shift to annual billings, a smaller multi-year cohort, FX, and our cash tax rate. The slide deck on our website has more details on modeling assumptions for Q2 and full year fiscal '24. We continue to manage our business using a rule-of-40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins, captured in the rule-of-40 framework, is the hallmark of the most valuable companies in the world. And we intend to remain one of them. As we said last quarter, the rate of improvement will obviously be somewhat determined by the macroeconomic backdrop. But, let me be clear, we're managing the business to this metric and feel it strikes the right balance between driving top-line growth and delivering on disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal, regardless of the macroeconomic backdrop. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Debbie. Let me finish by updating you on our progress in the first quarter. Our strategy is to transform the industries we serve with end-to-end, cloud-based solutions that drive efficiency and sustainability for our customers. We continue to see good growth in AEC, fueled by customers consolidating on our solutions to connect previously siloed workflows in the cloud. HNTB, an employee-owned infrastructure solutions firm that serves public and private owners and contractors, expanded its EBA with Autodesk to help achieve its goals around design modernization, digital transformation and digital infrastructure solutions. The ability provided by our EBA means that HNTB can easily consolidate more workflows to Autodesk. For example, in addition to adopting and integrating Autodesk Build and Innovyze, HNTB has been prototyping Autodesk's immersive collaboration platform. By leveraging VR collaboration, it has been able to help transportation agencies like Florida's Turnpike Enterprise use digital twins to train facility management and first responder teams on real-life scenarios from the safety of their offices instead of on busy interstate highways. HNTB sees the potential of further applications in its work on complex bridges and tunnels, as well as its work with airports and state departments of transportation across the country. In construction, we continue to benefit from our complete end-to-end solutions which encompass design, preconstruction and field execution, through handover and into operations. DPR is among the top 10 largest general contractors and construction management firms in the U.S. and specializes in technically complex and sustainable projects. In the first quarter, DPR expanded and extended its partnership with Autodesk and unified on Autodesk Construction Cloud, our construction platform that connects stakeholders throughout the project lifecycle. In moving away from point solutions and onto Autodesk's common data environment and cloud, DPR aims to connect all workflows, centralize communications, and improve project management and operations across the office and job site. We continue to see significant opportunities to grow our construction platform outside the U.S., benefiting from our strong international presence and reputation. In Singapore, Autodesk Build was selected over three competitive offerings as the construction management platform for what will be Singapore's tallest skyscraper. When awarding the contract to our partner, China Harbour, the project owners chose Autodesk Build because it connected the design and make processes in the cloud, centralized project schedules, and generated automated clash reports to reduce risk during construction. Of course, these stories have a common theme: managing across the project lifecycle to increase efficiency and sustainability, while decreasing risk. And this means our customers are renewing and expanding their relationships with us. Over time, we expect the majority of all projects to be managed this way and we're getting ready today to scale to serve that demand. Jim talked at our Investor Day about how product innovation, go-to-market expansion, and customer success are helping us get ready. In the first quarter, we took another important step by integrating our construction sales force into our worldwide sales team. While integrations of this scale inevitably cause some short-term disruption, combining the two teams will allow us to expand the scale and reach of our construction business, particularly in our design customer base, and our ability to serve our customers across the project lifecycle. Moving on to manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make Platform to grow their business and make it more resilient. For example, Rittal is a leading manufacturer of electrical enclosure systems. It uses Inventor, Vault and Moldflow to optimize and manage its product manufacturing to produce thousands of customized and configured switch cabinets daily. Rittal is focused on maximizing internal automation to accelerate its speed to market and respond more nimbly to changes in demand. In Q1, it increased its EBA with Autodesk to include Fusion to serve as its central data management system, build a more resilient supply chain, and drive competitive advantage through quicker turnaround times. Using Fusion, Rittal will be able to automatically route online customer orders through to its engineers and integrated production line and make deliveries in as little as one or two days. In the U.K., a precision engineering firm was looking to update its CAM workflow to increase engineering efficiency and optimize costs. After a competitive evaluation, the customer migrated from its existing provider to Fusion with the Machining Extension because of Fusion's intuitive UI, cloud capabilities, and simple integrations with its existing software and machines. Realizing the opportunities to drive breakthrough efficiency by consolidating all workflows on a single Design and Make Platform, the customer is now also evaluating the migration of its CAD workflows from a competitor to Fusion. Fusion continues to grow strongly, ending the quarter with 231,000 subscribers, as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. In partnership with higher education providers across the globe, we continue to invest in the workforce of the future. We recently partnered with the Tamil Nadu Skill Development Corporation and Anna University in India to integrate Fusion into its 20 mandatory product engineering courses and launched the Fusion Design Challenge to showcase the skills of 20,000 students. Fusion's intuitive UI and cloud-based data management make it easy for students to learn and collaborate on class projects. Autodesk is also investing in a new Technology Engagement Center at California State University, Northridge, that will promote interdisciplinary collaboration in engineering and computer academic programs and house the Global Hispanic Serving Institution Equity Innovation Hub, which aims to build a more diverse and inclusive engineering workforce. And finally, we continue to work with non-compliant users to ensure they are using the latest and most secure versions of our software. In the first quarter, we made substantial progress on two initiatives we outlined at Investor Day: further hardening our systems by significantly tightening concurrent usage of named user subscriptions, and significantly expanding the precision and reach of our in-project -- product messaging. We expect both initiatives to drive further conversion and growth in the second half of the year and beyond. Let me finish where I started. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. With our AI infused industry clouds, Fusion, Forma, and Flow, scaled on Autodesk Platform Services, our customers will be able to leverage their large, domain specific, inter- and intra-industry data sets to deliver further breakthrough productivity, operations, and sustainability gains. And with intuitive UIs and the application of multi-modal AI models that move beyond language models to capture sketches and reality directly into accurate 3D models, we will be able to accelerate the transition from products to capabilities that I talked about at our recent Investor Day. Our transformation from products to capabilities will enable us to forge broader, trusted and more durable partnerships with more customers; give Autodesk a longer runway of growth and free cash flow generation; and enable a better world designed and built for all. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question please, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Okay. Great. Hey, Andrew. Hey, Debbie. How you doing? Thanks for taking my questions here. Andrew, maybe just for you. Appreciate the macro commentary, very helpful. I think we all try to speak to at least a subset of your partners through the quarter. And frankly, through the quarter, some of those checks, albeit limited, were mixed or soft, right, of course, reflecting the macro. Maybe the question that I have for you is, I was wondering if you saw that as well. And if you did, whether some of those trends have maybe continued here through the second quarter?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, Saket. Good to see you by the way. Good to talk to you. So, yes, let me tell you what we saw and consistent with what people heard from the partners. So, whenever we have a large event like ending multi-year, what happens is partners and teams tend to pack up deals into that event, they even pull pipeline forward to try to get it into the event, so that they can kind of close their deal, get things trued up around the event. This happens every time consistently when we have event like this. It's one of the reasons why we try to align these events with quarter-end, so we don't have conversations like this. So, if that was the case, what you would have expected is that business would rebound to kind of expected levels post the end of the quarter, which is exactly what happened. It's exactly what we're seeing at the beginning of the quarter [indiscernible] and we're back to what we would expect to be [indiscernible]. Debbie, you want to add anything about the macro environment that we haven't said already or anything -- any commentary that might help understand how the quarter progressed?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So, overall, our leading indicators remain broadly the same as what we saw last quarter. We saw usage grow modestly. We saw record bid activity on BuildingConnected. We continue to see cautious optimism from our channel partners. New subscriber growth decelerated a bit quarter-over-quarter, but renewal rates improved. Also like last quarter, Europe was a bit better, the U.S. was a bit worse, Asia was about the same. So, net-net, the overall momentum of the business was somewhat similar to what we saw last quarter with some puts and takes. It's all in line with the guidance expectations for the year and it's consistent with macro trends. Current RPO growth is a good forward indicator for you. It was the same as last quarter at 12% growth. And as we've said before, the business is going to grow faster in better environments and slower in more uncertain environments, but our goal continues to be to set ourselves up for success in fiscal '24 and beyond."
},
{
"speaker": "Saket Kalia",
"text": "Got it. That's really helpful, Debbie. Debbie, maybe for my follow-up for you. Great to see the cash flow strength this quarter, well ahead of what we were expecting. I was just wondering if you could just zoom into what drove that. And maybe just looking forward, how you're sort of thinking about the shape of cash flow this year, particularly where we trough here in fiscal '24? Does that make sense?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes. So, Q1 free cash flow was strong for a couple of reasons. First, cash collections from the last month of billings in fiscal '23 were strong. Second, we also saw favorable linearity and early renewals in Q1 that were driven by the end of multi-year build upfront. And then, third, as I mentioned on the call, after the winter storms in California, we received a federal tax payment extension for the third quarter. Our overall expectations for free cash flow on the year, including linearity, are unchanged. We still expect that we're going to generate about half of our free cash flow in the second half of the year, with heavier weighting to Q4. Some of the factors to think about across Q2, Q3 and Q4, we have the full quarter impact from the switch to annual billings. In Q2, remember that we had some early renewal billings that were pulled into Q1. And then with that tax payment extension to Q3, that has a positive impact to free cash flow in Q1 and Q2, but a negative offset in Q3. But overall, I just would reiterate that our expectations are unchanged and that we expect to generate about half of that free cash flow in the second half of the year."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Very helpful, guys. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your question please, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, you referenced the effect on channel behavior in the quarter as a result of the billing change. But more broadly, there are some other evolutions that your sales model is going through affecting not just the VARs but also the VADs. And I'm wondering how you're thinking about the operational or execution risks associated with that evolution which certainly goes beyond Q1 in terms of perhaps either demand generation, fulfillment of which you'll be doing more of on your own, perhaps the elements of channel comp as they change with the back end change. So maybe just let's talk about some of those ongoing executables that you need to get right vis-à-vis the sales model. Then, I'll ask my follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, Jay, that's a great question. So, one of the things that I'll say like first upfront is why are we exploring some of these things. And it's a great example of what we're doing with Flex in particular. We're doing these things because our customers get a much more instant on self-service like experience kind of more like an e-store experience from all their transactions. But they also get the added bonus of support that local and connected to them through their VARs. They get service and other types of supports from their VARs locally. It also allows us to really get a lot of visibility about what their usage patterns are, how they're using the product, and then also share that visibility with our partners and other people so that we can understand these customers better. So, there's lots of great things about it. But more importantly, rolling out kind of changes like that and exploring these kinds of new models and something like Flex, which is a lower volume offering right now, those doing quite well, gives us a lot of opportunity to learn a lot of things and work through a lot of things. Debbie, why don't you talk specifically about some of the things that we've been learning from Flex as we've been working through all of these new transaction models."
},
{
"speaker": "Debbie Clifford",
"text": "Sure. Yes. So, as Andrew mentioned, we launched this Flex agency model in Q1. We have learned a lot. Some of the things that we've been learning are things like the importance of driving a seamless vendor setup process. These are situations where customers will have to set up Autodesk as a vendor as opposed to a partner. We're getting insights and learnings around -- by having access to more data, and we're able to better forecast with having that access to better data. So, like Andrew mentioned, as with anything in this area, we're focused on testing and learning as we go. We want to make sure that we have scalable processes for all stakeholders and the ecosystem, and we'll continue to keep doing that."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. As follow-up, Debbie, at the meeting two months ago in your slide with regard to double-digit growth or what you called sustainable double-digit growth, you had eight different line items referring to volume as component of your growth. When you look out over the balance of the year, what do you think might be of those perhaps the two or three most important volume drivers to the business?"
},
{
"speaker": "Debbie Clifford",
"text": "That's an excellent question, Jay. I mean, the view that I talked about from Investor Day hasn't changed much, granted our Investor Day wasn't very long ago, so that's a good thing. But we're going to be looking to continue to drive volume from all the different areas or growth vectors that we have. So, things like our investments in AEC, the proliferation of BIM, expansion and infrastructure, driving more growth from construction. I think what was interesting for us this quarter was really seeing continued strengthening of our renewal rate, because, ultimately, with higher renewal rates, that becomes a net volume driver for us. And that really goes down to the investments that we've been making in our customer success teams, who are really doing an excellent job of driving those renewal rates up, driving success with our customers, because that's a really important part of keeping the volume engine going at Autodesk. So, those are some initial thoughts, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Great. Thank you, both."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Jay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Adam Borg of Stifel. Your line is open, Adam."
},
{
"speaker": "Adam Borg",
"text": "Great, and thanks so much for taking the questions. Maybe for you, Andrew, I know at Analyst Day, you talked a lot about the broadening opportunity around serving the owner market and not just in conceptual design, but during operations. So, I know it's still early in this journey. Maybe you could share with us how that message is resonating and as you look to expand into AEC and obviously [indiscernible]?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So the way -- the vector that we have into that space right now is through Tandem. And the best way to talk about that is the increase in people using more modeling assets in Tandem and the monthly active usage rates that are going associated with that, we're starting to see very nice pickup with that. We're engaging with a series of owner-level customers on direct collaborations in terms of how Tandem serves some of their needs, where it has development requirements to serve some additional needs. So, we've got a lot of really good customer engagement, which is definitely where you'd expect to be at this point in the process. So, we're really happy with the progress here and we're happy with the level of engaging with Tandem. Tandem is getting a lot of visibility, a lot of interest and a lot of focus with owners, but also with people that serve owners that want digital twins and things associated with digital twins from, say, other types of vendors."
},
{
"speaker": "Adam Borg",
"text": "That's really helpful. Thanks for that. And maybe, Debbie, as a quick follow-up. I think you've mentioned in the script about repurposing 250 roles in the quarter. Maybe you can provide a little bit more detail there? Thanks, again."
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So, uncertainty really just is the new normal. I think we're all living this. Since we last reported earnings, we've seen a bunch of stuff happen. There was a major regional bank crisis. We're seeing deadlock discussions about the debt ceiling in Congress. The Fed, just a few weeks ago, acknowledged that those things could have an impact on the economy, but so they didn't know how. We're in the same boat. But it's very important to us to deliver on our margin goal. So, it's against that backdrop that we're taking a prudent approach to how we manage the business, that means tightening the belt a bit. So, in Q1, we did some repurposing of roles to allow us to reinvest. And in Q2 and onward, we proactively taken steps to slow the pace of our hiring to ensure that we don't get ahead of ourselves on spend in light of this continued macro uncertainty. And we think that slowing spending earlier in the year provides more investment flexibility versus trying to slow spending later in the year. Again, our goal continues to be to set ourselves up for success since fiscal '24 and the long term."
},
{
"speaker": "Adam Borg",
"text": "Excellent. Thanks again."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Joe Vruwink of Baird. Your question please, Joe."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Hi, everyone. Maybe just a bit of clarification on near-term performance and reconciling, just the comment. I think, leading indicators around product usage, that's fairly consistent. But then, the new sub growth decelerating in the Americas. I guess, normally, I think the leading indicators kind of predict that. So was this something around new subs that just kind of popped up in the quarter?"
},
{
"speaker": "Andrew Anagnost",
"text": "No, it was consistent with what we were seeing in our monthly active user trends. That's how the monthly active user trends are so good at predictive behavior. We kind of expected a slight decrease in velocity in the Americas and more of an increase in Europe. So, it's consistent with the indicators we see and it's consistent with the indicators moving forward as well."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Great. Thanks for that. And then, just, I guess, I get the AI question. Just in terms of capabilities that already exist on the platform, thinking about things like Space Maker or the Generative Extension on Fusion, have you started to see kind of an uplift in interest just as more industries are studying adoption around AI? And is there anything you've seen to this point maybe specifically around video, media content where you start thinking about maybe changing product road maps, or all just based on kind of the pace of innovation that's coming out?"
},
{
"speaker": "Andrew Anagnost",
"text": "So, yes, first let's be very clear. We've been talking about AI for a long time, all right? And we've been building machine learning models into our application for a while now. So, there's already significant velocity inside of Autodesk conversations. What's changed is ChatGPT created a version of AI that everybody understood. So, we're all now having a common conversation about what AI can and cannot do and how it functions as a [indiscernible] or an assistant or a co-creator in these processes. So, make no bones about it, we've been working on these things for a while. This isn't a course and speed change for us. And I want to be super clear about that. Now, like I said, we've been in Construction IQ. Space Maker is no longer a product anymore, it's Forma now, which we rolled out, which even has more enhanced underpinnings or associated with machine learning. You probably -- if you follow what we do in our AI Lab, we published a lot of work on kind of fairly advanced things around large models and things that you can do with creating 3D models and representations using machine learning. So, we've been out there with this for a while. What it does allow us to do, it had a very meaningful customers about -- conversation with our customers about \"Look, we've been telling you that this was going to be a cocreation technology. Take a look at what you're seeing out there with the large language models and the things that you're getting from OpenAI and see how this kind of can be evolved to creating 3D building information models, more complex models, complex design, sustainability decisions, optionality, all the things associated in some of the things you're seeing inside of Forma.\" So, the customers now get it. They kind of get the connection between what we're doing and what we said it was going to do in the future, because there's an example here that everybody understands. And I think that's super powerful. So, it's current course and speed for us. We're going to be probably speeding up a little bit on some of our work with more larger and complex models, but this is something we've been doing for a while."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Thank you, Andrew."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Michael Funk of Bank of America. Your line is open, Michael."
},
{
"speaker": "Michael Funk",
"text": "Yes, thank you for the questions. So, Debbie, you mentioned you highlighted the slowing sub growth and usage has been strong. Can you help me understand the relationship if any between those two? And is the sub growth simply a factor of customers tightening their belts more due to the uncertain macro that you highlighted a few times, or is there some other -- something else behind that?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes, thanks. So, the biggest factor driving the sub growth that we saw in Q1 was actually the end of sale of the multi-year upfront contracts. So, Andrew mentioned it at the top of this Q&A session, but remember that the demand pattern that we saw during the quarter was impacted by that end of sale. Before the launch, we saw higher volume. And then, post launch, demand was lighter. That's typical of what we see when we launch programs like this to the market. But what it meant was that, on a net basis, the new piece of our business decelerated as we headed out of the quarter. So, Andrew also mentioned that over the last several weeks in May, we've seen that demand bounce back a bit. And it's generally in line with our expectations at this point."
},
{
"speaker": "Michael Funk",
"text": "Okay. Great. And then one more. Debbie, you also mentioned tailwind in second half, one being the EBA renewal pattern, adoption and usage has been strong there, I think you noted. Can you give us some more detail just on the moving pieces around the EBA renewals? Is it contract changes, pricing changes, what will be driving that tailwind in the second half of the year around the renewals?"
},
{
"speaker": "Debbie Clifford",
"text": "Sure. So, maybe I'll just take a step back and talk about revenue linearity overall and then double click a bit into EBAs. So, to recap, we're expecting revenue growth deceleration in Q2, followed by growth acceleration in the back half of the year that's consistent with historical seasonal patterns for Autodesk. And it was built into our annual guidance from the start. When we look at things by quarter, in Q2, we have the peak of FX and Russia and their drag on revenue growth. In the second half, the negative impact from exiting Russia goes away, and that drag from FX reduces as the year progresses. And then, we have that big cohort of EBAs, particularly in Q4, those are deals that renewed three years ago, at the beginning of the pandemic, where subsequent adoption and usage have been strong. And it's that deal flow that drives that seasonal growth acceleration primarily in Q4. We thought -- you can go back and look at our opening commentary back in fiscal '21 for Q4 where we talked a bit about those deals they tended to be in the auto space. And so, we're anticipating that those deals will come through and we think the fact that they've had good adoption and usage is a good indicator that we're going to see that behavior happen in Q4 as expected. So, overall, I mean, our business, the momentum is pretty consistent with what we've seen for a while here now and the assumptions that we have embedded in our guidance reflect, but we've been seeing for a while and we remain on track to achieve our full year financial goals. And I can't reiterate enough that we continue to try and set ourselves up for success in fiscal '24 and beyond."
},
{
"speaker": "Michael Funk",
"text": "Great. Thank you for the questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Matt Hedberg of RBC. Your line is open, Matt."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks for taking my questions, guys. Andrew, in your prepared remarks, you talked a lot about AEC and obviously construction. This is an area obviously as we all know that's been sort of laggard to adopt SaaS and cloud. Can you talk about sort of where we're at in this evolution? The pandemic is behind us now, I think. But like, are you starting to see some of these field workers, some of the folks that are sort of like behind the scenes on construction starting to sort of embrace the technology more so? Is it a generational thing? Just any sort of like incremental sort of catalyst for further construction cloud adoption?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, it's a good question the way you phrased that around incremental catalysts. I think actually the rising adoption is becoming its own catalysts in many respect. I mean, obviously, we're continuing to see good growth in construction. We're seeing solid adoption. We're seeing really significant adoption in our EBA account. And adoption tends to lead to more adoption, because the people who adopt these technologies and start using these technologies on a regular basis tend to have higher bid precision, higher bid accuracy, tend to be able to execute more effectively during the projects, manage cost better and all things associated with that. And that's a flywheel effect, because if you're better able to manage the cost of the project, you're better able to estimate the next project, bid on that project and win an envelope that preserves your margins. So that is kind of the biggest thing that's going on right now out there in the industry is the flywheel effect. There's no kind of generational catalyst that's yet coming in here. But I will tell you there's one other thing that's persistently out there that's driving people to look towards technology, and it's they can't hire people, all right? More and more, they are not able to fully staff their sites and their jobs to the level that they were in the past. So, they need these productivity gains from technology. And it's between that and the flywheel of competition, there's kind of a momentum here that I don't see slowing down."
},
{
"speaker": "Matt Hedberg",
"text": "Super insightful. No, that's great. Thanks again for the time tonight, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler."
},
{
"speaker": "Tyler Radke",
"text": "Yes, thanks for taking the question. So, just a couple of questions on the indicators that you saw in the quarter. Andrew, you talked about bid activity at record levels in BuildingConnected. I guess, should we be thinking about that as a sign of health in the end markets or more of a function of buildings connected, strong competitive position and digitization tailwinds? And then, just curious if you could talk about the slowdown in new subscriptions or deceleration that you saw. Was that more on the AEC side or any end market or where -- the segment where you saw that?"
},
{
"speaker": "Andrew Anagnost",
"text": "Okay. So, let me address the next part of the question. Kind of the answer to your BuildingConnected question kind of both, all right? BuildingConnected certainly active. There's lots of activity going on there. But remember, it's the trend that matters. So, if the trends continue to indicate a large degree of bid activity, that means there's a large degree of bid activity out in the ecosystem. And what also is important to recognize is, our customers and especially in the AEC land, they're still working through backlogs. I mean, every customer I talk to has the same issue or same opportunity, however you want to look at it, that they still have to work through their backlog, they're still having trouble getting enough people to get the projects moving at the right kind of pace and so on and so forth. So there's still a backlog out there. But the trend on bid activity is real and it absolutely represents what's going on in the U.S. market in particular. Now with regards to deceleration and rebound in Q2 around volume, there was no hotspot, right? It was kind of uniformly the same across the board, right? So, it was more kind of dynamics of the business rather than any kind of particular hotspot."
},
{
"speaker": "Tyler Radke",
"text": "Great. And then, just on the EBA renewals for the second half, are you expecting those to renew at kind of the typical net expansion rate that you see for the broader company? Or are you expecting anything different just given the environment?"
},
{
"speaker": "Andrew Anagnost",
"text": "Well, I mean, I'll let Debbie follow-up on this. But one of the things that she highlighted was that a lot of these EBAs that are coming due were ones that were renewed during the pandemic at a time where there was downward pressure on their activity and their usage and [indiscernible], things have obviously changed significantly since then. So, Debbie, do you want to comment on kind of the average relative difference within -- with these cohort versus [direct to] (ph) company?"
},
{
"speaker": "Debbie Clifford",
"text": "Yes, I mean, I would say that in terms of what we're baking into our guidance, we're assuming that these customers renew at reasonable levels. I'm not going to get into more specifics beyond that. What's key is that they renew and we feel good about that happening given the fact that there has been high adoption and usage across these EBAs. It's a big cohort for us. We saw that performance back in fiscal '21. It was also an equally unusual economic time at that point. And so, I don't see this situation as any different. I think we've set the guidance at a reasonable point."
},
{
"speaker": "Tyler Radke",
"text": "All right. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank. Your question please, Bhavin."
},
{
"speaker": "Bhavin Shah",
"text": "Great. Thanks for taking my question. Andrew, just given what's going on with the debt ceiling, any sort of impact that we should think about regarding federal deals and the pace of that business? And then, kind of related point, can you give us an update on where we are into the FedRAMP Moderate for Docs and BIM 360, Collaborate Pro?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So let me talk a little bit about [FedRAMP] (ph) here. So we've submitted all our paperwork. Our systems are ready. Autodesk systems are already for FedRAMP. We're just waiting for the government to come back and give us the approval and move forward. So, that's all proceeding ahead for us. We're waiting for the government to respond now at this point. With regards to the debt ceiling, I'm not really going to speculate on the debt ceiling. I would say that I think the things that impact us are bipartisan priorities. These are things that both parties want. Infrastructure and the things associated with that, they all want this. So, I would suspect the things that matter a lot to Autodesk and to Autodesk business are probably not going to be impacted by all the activity going on in D.C. right now."
},
{
"speaker": "Bhavin Shah",
"text": "Helpful there. And then just maybe a quick pivot to Construction Cloud. I know you talked a little bit about combining sales [within organization] (ph). Can you just maybe elaborate on some of the assumptions in terms of what you're expecting in terms of disruption, for how long? And then maybe when should that [be merged] (ph) and drive better performance in productivity?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So, first, let me kind of clarify exactly what we did. So, we merged the independent construction team with the mainline sales team inside the company. And we had kind of a few goals in mind there. One, we wanted to get a little bit more emphasis on the territory business that covers all of our business. And we wanted to make sure that we were focused not only on pure construction accounts, but design and construction accounts where we actually have pretty significant competitive advantage and there's a lot of opportunity. So this just kind of sharpened the pencil on kind of pursuing those opportunities in kind of a concerted way and kind of getting all the energy behind one effort. And we're pretty confident that, that's exactly what we're going to get. But of course, when you do that, sales reps get new accounts, people get moved from accounts, so they'll get new responsibilities. So it creates a little bit of short-term disruption. We absolutely expect that to work its way out over the next quarter or two. And we expect it to kind of compound benefits from doing us moving forward."
},
{
"speaker": "Bhavin Shah",
"text": "Makes a great sense. Thanks for taking my questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Steve Tusa of JPMorgan. Your question please, Steve."
},
{
"speaker": "Steve Tusa",
"text": "Hey, guys. Good evening. The -- just if we were to see a continued decline in the things like the ABI or kind of an isolated decline in new office markets, if you will, can you just remind us of, is that even a big enough exposure to matter for you guys? Or just kind of remind us what part of your business is exposed to those trends just on the macro. And then secondly, if I just do the simple math on half-over-half free cash flow, that implies negative free cash flow for the second quarter to get it back to the half of the year. Is that kind of the right construct? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "I'll let Debbie answer the second half of that, but let me talk more broadly about what's going on in the AEC sector. With everything in these sectors, there's always puts and takes, right? And what you see is one sector sees some kind of decline in activity, nobody is building new office buildings or whatever. And in other cases, some people are seeing increases in activity. And that's exactly what we're seeing. I'll give you a classic example of what goes on in this environment. So, people are pulling back from office space right now, pretty significantly downsizing their offices. And as a result, what's happening is that there's more competition for getting people to sign leases for new office space. So what that's leading to is a kind of modernization of office space to accommodate new ways of working or to attract the best renters. And people are spending money on that, which is offsetting money being spent in other places. And we've taken all of this into account as we look forward into our business throughout the year. So that kind of gives you a sense for how billings shift around and how money moves around and what our relative sensitivity as to some of these things. A lot of these indicators you talked about, they kind of tell you what's already happened, not what's going to happen necessarily. That's why we like to pay attention to kind of our leading indicators around monthly active usage of the products. Now, I'll turn it over to Debbie to discuss the other part of your question."
},
{
"speaker": "Debbie Clifford",
"text": "Yes, in terms of free cash flow, I'm not going to get into specific guidance by quarter, but I would say directionally, I think you're thinking about it in a reasonable way. And just to recap some of the things, remember, with the tax payment extension to Q3, we'll have a negative also in Q3. And some of the things that I outlined in terms of the linearity of free cash flow on the year are the things that you should be thinking about. So, I recommend going back and listening to some of those points because that will help you model free cash flow by quarter."
},
{
"speaker": "Steve Tusa",
"text": "Yes, great. Thanks for the details. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Sterling Auty of MoffettNathanson. Your question please, Sterling."
},
{
"speaker": "Sterling Auty",
"text": "Yes, thanks. Hi, guys. So, just wondering, given the comments about the second half acceleration, does that mean that you're expecting the peak of the macro impact to really hit next quarter? Or is some of that acceleration more just due to improvement in Autodesk execution based on some of the changes that you had mentioned during the prepared remarks?"
},
{
"speaker": "Debbie Clifford",
"text": "So, Sterling, what I would say is we're not assuming any peak or trough in macro. We have a range for our guidance in our 7% to 9% range for revenue. We have the ability to address whatever macroeconomic situation that we see. And what we saw in Q1 was consistent with our general expectations on the year, and we've continued those expectations as we think about our outlook for the rest of the year. And you can see that our outlook is in line. What's really driving the change in linearity in our revenue growth is some of the things that I talked about, so seasonality, the acceleration that we expect from EBAs in the back half of the year, the impact from FX, and not having the drag from the exit of Russia anymore. So it's more about those things than it is about any fundamental underlying changes in our assumptions related to macro."
},
{
"speaker": "Sterling Auty",
"text": "That makes sense. And then Andrew, one for you. When you think about the long-term opportunity for generative AI, LLMs, conversational interfaces, et cetera. Do you view this as something that's going to ultimately raise the ARPU and/or prices for Autodesk solutions, given the additional value add? Or is it going to be more differentiation at the current price levels just so you can drive more market share?"
},
{
"speaker": "Andrew Anagnost",
"text": "I think it's going to be a little bit of both, all right? In some cases, we're going to be delivering significantly more value to certain types of customers and we expect to charge for that value. In other cases, it's going to be a massive productivity enhancement for customers, and those customers are going to use that productivity to get more business, increase their book of business and it will be a competitive advantage for Autodesk. So it's a little bit of a mix of both, all right? But either way, we're going to be helping customers be a lot more efficient in one area and be much more creative in other areas in terms of designing what they need to do and how they need to design things."
},
{
"speaker": "Sterling Auty",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. And that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you, Latif, and thanks, everyone, for joining us on the call. We look forward to catching up with you next quarter. If you have any questions, please just e-mail us on simon@autodesk.com. Latif, back to you."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 4 | 2,025 | 2025-02-27 17:00:00 | Operator: Thank you for standing by and welcome to Autodesk Fourth Quarter and Full Year Fiscal 2025 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, Vice President Investor Relations. Please go ahead.
Simon Mays-Smith : Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss Autodesk’s fiscal 2025 fourth quarter and full year results. Andrew Anagnost, our CEO, and Janesh Moorjani, our CFO, are on the line with me. During this call, we will make forward-looking statements, including outlook and related assumptions, and on products, go-to-market and strategies. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today’s press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost : Thank you, Simon, and welcome everyone to the call. Autodesk delivered strong fourth quarter and full year results. Billings and revenue topped the higher end of our expected range, despite new foreign exchange headwinds, while margins and free cash flow exceeded our expectations. You will all have seen our restructuring announcement this afternoon, which has two parts: first, we have initiated the optimization phase of our sales and marketing plan, and second, we are reallocating internal resources to accelerate our strategic priorities and strengthen our resilience. Let me talk about them in turn. Our go-to-market; GTM model, has evolved significantly and purposefully, from the transition to subscription and multi-year contracts billed annually, through self-service enablement, the adoption of direct billing, and more. We are now beginning the optimization phase, which positions Autodesk to better meet the evolving needs of its customers and channel partners. This comes from faster and less complex processes and more digital self-service and automation that enable tighter channel partnerships and less duplication of effort. Autodesk will continue to evolve its GTM to increase customer satisfaction and Autodesk’s productivity. Our current focus is on marketing, customer success, and operations with an emphasis on consolidating teams into centers of excellence and investing in systems and processes that increase sales and marketing, S&M efficiency at scale. Our future focus will be on tighter channel partner integration, which will drive sales productivity and a greater emphasis on value creation for customers, and the broad deployment of self-service capabilities to further increase sales and marketing efficiency. Through this on-going optimization, we expect operating profit dollars and pre-new transaction model non-GAAP margin improvement in both fiscal 2026 and fiscal 2027 and, once the optimization phase is complete, we expect to deliver GAAP margins among the best in the industry. Turning to where we are reallocating internal resources to focus on the long-term. Autodesk is focused on the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. Our investments in cloud, platform, and AI are ahead of our peers and will drive growth by providing our customers with increasingly valuable and connected solutions and supporting a much broader customer and developer ecosystem. To maintain and extend this leadership, we’re shifting resources across the company to accelerate investments in these high-potential strategic priorities. We are also building the capabilities we will need to enable future optimization and ensuring that we distribute critical expertise globally to remain competitive, resilient, and flexible. As I said last quarter, we are generating strong and sustained momentum in absolute terms and relative to peers. There are three main reasons; attractive long-term secular growth markets, a focused strategy delivering ever more valuable and connected solutions to our customers, and a resilient business. Disciplined execution is driving greater operational velocity and efficiency. We are deploying capital to grow the business, further reduce our share count, and enhance value creation over time. We believe these factors will deliver sustainable shareholder value over many years. Janesh is with me here at our annual sales conference today. We’re excited to have him at Autodesk and he’s already making an impact. I'd like to welcome him and turn the call over to him, so he can take you through our results and guidance for the year ahead. I’ll then come back to provide an update on our strategic growth initiatives.
Janesh Moorjani : Thanks, Andrew. I'm delighted to be here with all of you. Before I get into our results, I’ll touch on two areas of potential that I saw that attracted me to Autodesk. First, we are well-positioned to deliver growth at scale, as we drive the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. And second we have significant potential to drive expanded profitability, as we further optimize the level and effectiveness of investments in the business. Having spent the last few months gaining a deeper understanding of our business, I am confident in our ability to do both. Let’s turn to the results. The fourth quarter and full-year fiscal 2025 results were strong. Overall, the broader economic environment and the underlying momentum of the business in the fourth quarter were consistent with the last few quarters with continuing strong renewal rates and headwinds to new business growth. Total revenue in the fourth quarter grew 12% as reported and in constant currency. We generated broad-based growth across products and regions. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 9%; AECO revenue grew 15%; manufacturing revenue grew 10%, and in the low teens excluding up-front revenue; and M&E revenue grew 10%. Our Make products continue to enhance growth, driven by ongoing strength in Construction and Fusion. By region in constant currency, revenue grew 11% in the Americas, 13% in EMEA, and 11% in APAC. The contribution from the new transaction model to revenue was $46 million in the fourth quarter and $71 million for the year. Direct revenue increased 35% in constant currency, and represented 47% of total revenue, up 8 percentage points from last year, benefiting from strong growth in the Autodesk Store, and also from the tailwind to revenue from the new transaction model. Billings increased 24% in the quarter at constant currency, reflecting the shift to annual billings for most multi-year contracts and the transition to the new transaction model. The contribution from the new transaction model to billings was $155 million in the fourth quarter and $262 million for the full year. RPO of $6.9 billion and current RPO of $4.5 billion grew 14% and 12%, respectively. As expected, current RPO growth was affected by tailwinds from the new transaction model, and headwinds from the declining contribution of billed and unbilled deferred revenue from larger multi-year and EBA cohorts ahead of renewal in fiscal 2026. Turning to margins. Fourth-quarter GAAP and non-GAAP operating margins were 22% and 37%, respectively, reflecting year-over-year increases of 90 basis points and 160 basis points. We were pleased that we exceeded our non-GAAP margin expectations, demonstrating strong fiscal discipline. For fiscal 2025, GAAP and non-GAAP margins increased approximately 220 and 140 basis points year-over-year, respectively, excluding the impact of the new transaction model and currency movements. Free cash flow for fiscal 2025 was $1.57 billion, which was ahead of the high end of our guidance. In the fourth quarter, we purchased approximately 1.4 million shares for $414 million, at an average price of approximately $299 per share. For the full year, we purchased approximately 3.1 million shares for $858 million, at an average price of approximately $279 per share. Turning to guidance. To give you a clearer view on the underlying dynamics of the business, I will speak to the numbers excluding the impacts of the new transaction model and in constant currency. You’ll also see in today's earnings deck that we’ve split out the impact of the new transaction model and currency movements for our fiscal 2026 guidance. For a thorough review of how the new transaction model works, please see the opening commentary and earnings deck from our Q2 fiscal 2025 earnings call. Let me start by framing how we are thinking about fiscal 2026. Our starting position is strong. We hold leadership positions in many of our markets and have a loyal customer base with a high degree of recurring revenue. We are leading in cloud, platform and AI as we help our customers realize the benefits of converged workflows and data in the cloud. In building our guidance, we have not assumed fundamental changes in the broader geopolitical and macroeconomic environment or in the momentum of our markets. Our business model is resilient, and we are seeing strong momentum in our growth businesses like Construction and Fusion. Our focus through fiscal 2026 will be on driving growth from new and existing customers while maintaining strong renewal rates. Our approach to building the guidance for fiscal 2026 was similar to that for fiscal 2025. Our guidance is based on the range of possible outcomes in our bottom-up sales forecast which is grounded in the momentum of the business. Given our restructuring plans and CRO transition, we believe some disruption is possible. While we have mitigation plans and actions in place for these changes, we believe it is prudent to consider these in our outlook, and our guidance reflects this. This frames how we are thinking about fiscal 2026. There are more financial details in our earnings press release and earnings deck, but let me give you some color. We expect constant currency billings growth of 17% to 19%, excluding the impact of the new transaction model. Billings growth remains elevated this year due to our transition to annual billing for most multi-year contracts. We expect constant currency revenue growth of between 8% and 9%, excluding the impact of the new transaction model. This range reflects the assumptions that I mentioned earlier. We expect GAAP operating margin to be in the range of 21% to 22%. Excluding the impact of the new transaction model and currency movements, we expect non-GAAP operating margin to be in the range of 39% to 40%, which is at the higher end of the guidance range we gave three years ago. We expect to generate between $2.075 billion and $2.175 billion of free cash flow in fiscal 2026. This is after absorbing approximately $110 million to $120 million of cash outflows related to the actions we announced earlier today, and includes an anticipated discrete cash benefit of $130 million to $150 million from the utilization of US deferred tax assets. We've provided more information on this in the slide deck. We expect to buy back between approximately $1.1 billion and $1.2 billion of shares in fiscal 2026, which is a 30% to 40% increase compared to fiscal 2025, and the timing of which will depend on market conditions and other factors like debt refinancing. The slide deck on our website has more details on modeling assumptions for the first quarter and full year fiscal 2026. Finally, I’ll share how we are currently thinking about our longer-term future. Since joining Autodesk last December, my conviction in our market opportunity, our ability to meaningfully expand our operating margin, and our capacity to deliver sustainable shareholder value over many years, has been reaffirmed. That said, our underlying growth has been hovering around the bottom end of the 10% to 15% revenue growth framework we previously provided, as you've seen over the past couple of years and in our fiscal 2026 guidance. While we believe our resilient base, the successful execution of our product strategy, and the benefits of the new transaction model will catalyze sustainable growth in the future, our 10% to 15% growth framework is no longer appropriate given the consistent momentum of the business today. On the other hand, it’s clear to me that margins can be higher. We’ve announced today the first phase of our go-to-market optimization which is primarily in marketing, customer success and operations, and reflects the continued execution of our overall go-to-market evolution of the past few years. We are focused on executing this plan while minimizing potential disruption. Through this phase, we intend to deliver underlying operating margin expansion in fiscal 2026, as reflected in our guidance, while also building capabilities we need for future optimization beyond fiscal 2026. These capabilities include tighter channel partnerships with less duplication of effort; and more digital self-service and automation, which increases customer satisfaction and workforce productivity. Once our overall go-to-market optimization is complete, we expect Autodesk will be able to better serve its customers and deliver GAAP margins among the best in the industry. We will share more on our path to further margin expansion at an investor day in the third quarter of this year. It’s been invigorating getting to work, finalizing our fiscal 2026 plans, and preparing for execution. I can already see there is tremendous potential ahead. I look forward to meeting our investors and analysts over the coming weeks. Andrew, back to you.
Andrew Anagnost: Thank you, Janesh. Autodesk is focused on the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. Autodesk is at the forefront of convergence because we’ve been evolving and investing in the business models, products and platforms, and go-to-market that capitalize on it. With convergence, simulation done in the conceptual design phase can significantly reduce rework and cost during construction. With convergence, the components of a building can be manufactured offsite and assembled on site at lower cost and higher safety. With convergence, universal AI models can make better, and more valuable, inference that power a better world designed for all. Let me give you a few examples from the quarter. Mott MacDonald, a global engineering, development and management consultancy, known for its work on major projects such as Heathrow Airport Terminal 5 and the Bay Area Rapid Transit, BART Silicon Valley Phase II extension, renewed its 6th EBA in the quarter. This renewal expands our long-standing partnership to drive better outcomes through digital delivery. In addition to expanding usage of Revit, Civil 3D, Autodesk Build, and Autodesk Water, Mott MacDonald plans to leverage additional capabilities to increase project productivity and workflows for optimized design. Power Design, the #28 ENR 600 specialty contractor, selected Autodesk Build, as an essential link in their construction technology. This strategic choice enhances coordination between design and construction, ensuring seamless collaboration across teams and systems. By unifying project data from concept to completion, Autodesk helps Power Design protect design integrity, optimize workflows, and drive efficiency at scale. Cleveland Construction, a national commercial GC, is replacing a competitive solution with Autodesk Construction Cloud to support the next phase of its growth and leveraging our end-to-end solution from preconstruction to cost management and payments with GCPay. I talked earlier about closer integrations with our channel-partners and this deal demonstrates that potential. Using its proprietary technology for migrating project data from displaced solutions, an Autodesk platinum partner produced a comprehensive implementation plan that gave Cleveland Construction the confidence to make this transition. These stories have a common theme: converging people, processes and data across the project lifecycle to increase efficiency and sustainability, while decreasing risk. Our comprehensive end-to-end industry clouds and platform drive convergence and extend our footprint further into larger growth segments like infrastructure and construction. As a sign of our progress, construction revenue growth accelerated in the fourth quarter and we added almost 400 net new logos. Moving on to manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make platform to drive growth and increase resilience. For example, a global leader in toys is expanding its usage of Autodesk to all three of our industry clouds; Fusion, Forma, and Flow, to meet its profitability goals in Manufacturing, while launching new revenue models into Digital Entertainment. Autodesk’s unique industry expertise across AECO, manufacturing and media bridges data across physical and digital product development and between design and make. Buhler a family-owned Swiss multinational plant equipment manufacturer, renewed and expanded its EBA in the quarter. Autodesk will be one of Buhler’s key strategic partners in the development and execution of their digital strategy, as it moves to optimize for outcomes by connecting data and workflows, from Product and Plant design to project delivery including Installation. MSC Industrial Supply, one of the largest industrial distributors in North America with the leading position across metalworking product categories, will begin leveraging Autodesk Fusion’s connected supply chain capabilities, and unique, all-in-one cloud CAD, CAM, CAE, and PCB platform, to enhance its industry-leading Application Optimization AP-OP program. Through this strategic relationship, MSC’s team of metalworking specialists will be able to optimize toolpaths and validate cutting parameters more efficiently through enhanced virtual testing capabilities that further strengthen their best-in-class tooling recommendations for manufacturing customers. By combining MSC’s suite of solutions and services with Autodesk Fusion’s advanced capabilities this partnership creates an unmatched value proposition for manufacturers in North America, resulting in approximately $500 million in savings for MSC's customers in fiscal year 2024. Converged data opens up new opportunities for Autodesk, in this case with a sales team. As customers seek to drive efficient innovation, Fusion extension attach rates are increasing and driving average sales prices [up] (ph). And we’re delivering meaningful productivity gains to customers where we deploy AI. For example, our recently launched AutoConstrain tool in Fusion, which leverages AI to simplify the process of defining sketch geometry, has a roughly 50% acceptance rate on suggested geometry, saving significant time for higher value work. In education, universities continue to modernize their courses and curriculum to attract and prepare future engineers. For example, in Q4, Autodesk signed a Memorandum of Understanding with the Indian Institute of Technology Bombay to integrate our industry leading solutions into IIT Bombay's innovative education and research programs, to equip the next generation of engineers and designers with industry ready skills. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. For example, while working with an administrator of European railway infrastructure in the process of adopting BIM to optimize its infrastructure development and sustainability practices, we identified gaps in compliance. Working together, we addressed compliance while supporting their digital transformation. Attractive long-term secular growth markets, a focused strategy delivering ever-more valuable and connected solutions to our customers, and a resilient business, are generating strong and sustained momentum in absolute terms and relative to peers. Disciplined execution is driving greater operational velocity and efficiency. We are deploying capital to grow the business, further reduce our share count, and enhance value creation over time. In combination, we believe these factors will deliver sustainable shareholder value over many years. Throughout Autodesk’s history, we have taken decisive actions to drive our business forward – even when they are difficult. This commitment has been paramount to our success over the last 40 years and remains true today. To our team members who depart as a result of our restructuring, I extend my sincere appreciation for your contributions to Autodesk. You will always be a part of Autodesk’s story, and I am grateful for everything you have done. Operator, we would now like to open the call up for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Please go ahead, Saket.
Saket Kalia : Okay, great. Hi guys thanks for taking my question here. And welcome, Janesh.
Janesh Moorjani : Thanks, Saket.
Saket Kalia : Absolutely. Andrew, maybe to start with you. I want to zoom into the 10% to 15% medium growth rate a little bit. And if I'm understanding your comments correctly, the rate of new business growth is the key reason why that medium-term growth rate maybe is no longer appropriate. And you've been talking about slow new business for a while now. Maybe the question is, what drives that new business growth higher over time?
Andrew Anagnost : Yes. Good evening Saket, good to talk to you. Thanks for this question. Look, first off, I think you've got the thinking right up-front. Let me just comment a little bit on what's happened in the past and then I'll answer the substance of your question. So first off, if we look back in the past, there's a couple of things that were really impacting new business growth as we were moving to the last couple of years. One is all the things that Autodesk was changing. So we changed a lot of things that has a measurable impact on partner productivity with regards to balancing renewals and new business. The other thing was economic uncertainty, all the things associated with the macro environment. These things impaired some of our customers' willingness to invest in their business. So those things happen lately in the past. Moving forward, there's some things that we have control of and that we don't have control of that are going to drive us back on to our growth path. The first thing, if we look at the things we don't have control, we don't have control of the macro uncertainty. That is going to continue, and that will definitely impact some of our customers' thinking. But what we do have control of is in two key areas, one related to new product subs and one related to our new businesses that primarily show up in the Make category, the emerging and high-growth businesses. With regard to the former, we are on a journey of go-to-market optimization right now. And that is going to enhance the productivity of our channel. We've been impacting their productivity with all the change. We're on a cycle now where over a period of time, we'll be increasing their productivity. That's going to allow them to focus more on new business growth that's in our control. The other thing that's in our control is during this current rib cycle, we actually invested in driving the growth of our emerging and high-growth business on the mix side. And that includes investing in the industry cloud, the core cloud platform and in AI. So these things are going to not only continue the current momentum, but our goal is to enhance the current momentum. And these are high-growth businesses having long-term impacts on our business. So those are the things that are in our control that get us back to a place where we can feel confident in reinforcing the floor of our long-term business growth.
Saket Kalia : Got it. Got it. And maybe that's a natural segue for you, Janesh, I mean, as you know, margin potential has been one of the key investor debates on Autodesk. And so I mean, I think maybe to start, it is important to flag that margins here for '25 were ahead and the guide for '26 is higher than expected as well. But maybe you could just give us a little bit more color on the margin potential here. And how today's restructuring announcement, to Andrew's point, maybe fits into that debate?
Janesh Moorjani : Thanks, Saket. I appreciate this is one of the foremost issues on investors' minds. As I step back and look at fiscal '25 first, we are actually really pleased that we delivered strong outperformance here, thanks to our strong fiscal discipline in the fourth quarter. And I want to thank Betsy for setting us up for a strong Q4 on that front. Today's announcement does reflect the continuation of our multiyear journey as Andrew was talking about to evolve our go-to-market, and it fits in very nicely with our overall margin expansion goals. It's something that the team had been planning for thoughtfully since the introduction of the new transaction model. It's also allowing us to expand our underlying non-GAAP operating margin quite meaningfully this year when you hold aside the effects of the new transaction model. So when I look at it serving customers better through tighter integration and more cell service eventually expands our market opportunity and also ultimately lowers the unit cost of serving those customers, which will help driving even more efficient go-to-market motion in the future. So we have conviction in our potential to drive higher margins over time as we execute this plan and as we focus on future opportunities that I touched on in the opening commentary.
Saket Kalia: Very helpful guys. Thank you.
Janesh Moorjani : Thank you.
Operator: Thank you. Our next question comes from Adam Borg of Stifel. Please go ahead Adam.
Adam Borg: Awesome. Thanks so much for taking the question. I'd like to extend the welcome to Janesh as well. Maybe for Andrew, just piggyback on a comment you just made to Saket's question around just macro uncertainty and obviously, things that are outside of your control. I'd love to hear a little bit more about kind of what you're hearing with your customer conversations around overall sentiment, how that's playing out overall? And then maybe talk a little bit about the new administration and some potential puts and takes there either shortening regulation being a tailwind or some questions around tariffs, immigration policy and how that ultimately impacts customers and their decision-making over the next six to 12 months? Thanks so much.
Andrew Anagnost : Yes. Okay, Adam. Thanks for that question. So first off, our business is resilient enough. It's diversified enough that it can absorb and react to any kind of policy changes in a sustainable way. The thing I'm hearing from our customers is they want certainty. It's uncertainty that's kind of fueling customer angst. It's not what the output is, what the answer is. It's just the uncertainty. And that's the thing that we want to move fast -- past. We want to move to certainty, policy. Once policy's in place, I have faith in Autodesk's business to navigate whatever the policy is. But uncertainty is not something that our customers want to work through.
Adam Borg: Great. Thank you so much.
Operator: Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Please go ahead, Jay.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, with respect to the 10% to 15% growth range you've previously spoken of, the company at its last analyst meeting gave us multiple elements of that. In other words, a variety of price and volume components for that, most of which have to do with your core business, as you call it, renewal and expansion within the core business, less so with new or adjacent businesses. So maybe break down that thinking about the growth range in those terms, perhaps with regard to how you're thinking about pricing leverage from here and the multiple elements of queue or volume that you had previously spoken of. Then I have a product question.
Andrew Anagnost : Yes. Jay, I'm going to go back to what I said previously and focus on these two key elements. Enhancing channel productivity as we move through all these changes, that is a critical thing for us. It is part of our ongoing optimization cycle. It's going to be something that delivers over multiple years. That will create a tailwind within our channel business for some of these core subs issues. And I think that's the more important thing to focus on. And the emerging businesses have always been a part of our plan. And I think you see very clearly that the make businesses are growing robustly and we are investing to make sure that those continue to grow at that rate or accelerate beyond that rate. So that's where you want to focus right now in terms of getting the business back to where we want it to be over time.
Jay Vleeschhouwer: Okay. Outside of the various go-to-market changes and optimization and so forth, what would you say for this year and beyond are the critical product or technology executables that you are reallocating to or investing in? Maybe talk about how you're thinking about the business impact of platform services, the new data models and so on and so forth, things that we've talked about consistently most recently at AU.
Andrew Anagnost : Yes. So what we're doing is we're accelerating some of the road maps associated with our industry cloud. So you're going to see more activity associated with the Construction side and the Forma side of the AEC industry cloud. And you are going to see more energy and activity associated with the Fusion Cloud and some of the things associated to driving that. So there's investments made in that. Within the core platform, it is all about expanding the granular data that's available to our customers, expanding the footprint of APIs that are available to our customers and investing in that so that we can accelerate not only what our customers are accessing but the common services that the industry clouds are accessing. So that is part of the investment. And of course, we're going to continue to turn the crank on some of the [ARP] (ph) features. As you know, Jay, we just introduced our first commercial AI, a generative-AI feature into Fusion. It's the auto constraint feature. It's out there, getting used by our users. It's got approximately a 50% acceptance rate, which is a really high rate for a generative technology and it just gets smarter as it goes. That's a real productivity tool for our customers that really makes a difference. There is going to be more of those, right? And that's where the investment is going.
Jay Vleeschhouwer : Thank you Andrew.
Operator: Thank you. Our next question comes from Jason Celino of KeyBanc Capital Markets. Your question please Jason.
Jason Celino : Great. Thanks for taking my question. One question on the guide and then the reduction in force. Now I'm cognizant that you've got some business momentum, and I understand why you're making the changes. But does the revenue guide assume any extra conservatism just on potential of disruption. It's just the change is quite a large reduction. So I guess what have you built into the guide relative to that?
Janesh Moorjani : Hi, this is Janesh. Maybe I'll take that. So as I mentioned in the opening commentary, our approach to building the guidance for fiscal '26 did consider a range of possible outcomes from our overall bottoms-up sales forecast. And then we did factor in some level of risk potential associated with the restructuring plans and the CRO transition. We've put in place good mitigation plans and actions that we have to manage those. But we thought it's prudent to consider these in our outlook. So our guidance does reflect that.
Jason Celino : Okay. I appreciate that. And then on prior calls, there were some mentions of a bigger EBA cohort, multiyear customers coming up for renewals, that wasn't really brought up on this call. Is that still an opportunity for you for this year? And any details on how big of a cohort this might be or what's built in? Thank you.
Janesh Moorjani : It's still an opportunity. We didn't reference it discretely because we have mentioned it before. Nothing has really changed on that front. We've got both the EBA cohort, as well as the product subscription multi-year cohorts that will come up for renewal later this year.
Jason Celino : Okay. Thank you Janesh.
Operator: Thank you. Our next question comes from Taylor McGinnis of UBS. Please go ahead, Taylor.
Taylor McGinnis: Yeah, hi. Thanks so much for talking my question. Just on the margin guide. So the underlying 300 basis points of margin improvement is really strong. But can you just break down and quantify the drivers of that expansion. So how much is from cost savings, like scaling back on some of the duplicative costs and streamlining the sales force? How much might be from cost savings associated with the risk? And then maybe just secondly, when we think about the margin potential beyond 2026, I guess, any initial thoughts you can provide there? Thanks.
Janesh Moorjani : Yes, I'm happy to take that. So as we think about the overall impact in fiscal '26 and the underlying operating margin increase that we're guiding to, that demonstrates our overall commitment to expanding profitability this year, obviously, but it's part of our longer-term plans. The reinvestment and our organic hiring plans, all of that is an integrated plan. You mentioned the actions that we've taken in the field organization and the [RIF] (ph), and that's all part of the same plan. We also had our organic hiring plans that we had for fiscal '26. So it's hard to break all of that apart. But that said, to just give you a sense of how we are thinking about it. If you look at our fiscal '25 total spending, that grew 7% year-over-year, excluding the new transaction model. And our fiscal '26 total spending, that implies growth of only 4% year-over-year on a similar basis in constant currency. So that gives you a sense of the extent of both the optimization and the spend discipline that we are driving in the business overall. And then as I think a little bit ahead on fiscal '27, we are committed to further margin expansion beyond fiscal '26 on an underlying basis, as we've talked about. And that will continue. And ultimately, when that overall go-to-market optimization is complete, we expect that we have GAAP margins among the best in the industry, and we'll share a little bit more details in terms of what that means when we get to our Investor Day in the third quarter.
Taylor McGinnis: Great. Thank you so much.
Operator: Thank you. Next question comes from Bhavin Shah of Deutsche Bank. Please go ahead, Bhavin.
Bhavin Shah: Great. Thanks for taking my question. Janesh, just kind of following up on that, what's the timeline you guys are thinking about in terms of kind of seeing some of the benefits from a lot of the adjustments you're making to sales and marketing? And when do you kind of see that sales and marketing efficiency show up from a revenue perspective.
Janesh Moorjani : Yes. Bhavin, clearly, we are seeing a significant benefit here in fiscal '26 itself. As I mentioned, that's a big part of the underlying margin expansion that we are delivering. With respect to what that translates to for fiscal '27 and beyond as I mentioned, we've got more work to do in terms of the next set of activities that we need to plan for as we think about what it means to drive tighter channel partner integrations and build the capabilities that we need for self-service. We're investing this year to build those capabilities so that we can be set up to lower our overall cost to serve our customers in future years. And again, we will spell some of the details out around that in the Investor Day in the third quarter.
Bhavin Shah: That's super helpful. And just one quick follow-up. It sounds like you guys are going to be pretty aggressive from a shareholder return perspective in fiscal '26 and kind of given some of the changes you're talking about from the top line perspective and focus on efficiencies. How are you now thinking about M&A and do these actions change your view at all?
Andrew Anagnost : Yes, Bhavin, our view on M&A doesn't change. We've always been an acquisitive company. We're always looking for anything that can accelerate our strategy or take us into adjacencies that we think are relevant to the company. But that's consistent with previous stances on this. If we see something like that, we will act on it.
Operator: Thank you. Our next question comes from Joe Vruwink of Baird. Joe Vruwink, your line is open. Please go ahead.
Joe Vruwink: Great. Sorry, I was on mute. I'll get those right one of these times. I wanted to go back a few questions just on the year-over-year margin assumptions. It looks like if I'm reading Slide 10 correctly, you are assuming the agency change is about a 6-point impact on growth in the upcoming year. So I think that means a 6 point headwind on margins. You're kind of guiding to margins flat to slightly up. So can you bridge the 6 points you're able to layer back on to get to where you are guiding the year.
Janesh Moorjani : Joe, I am happy to take that. A 6 point revenue headwind is the right way to think about the top line, but that doesn't translate to a 6 point margin headwind. You'll see on that same slide that we've actually just fell out for you exactly what the margin headwind is as well it's 3 percentage points. So on an as-reported basis are -- we would expect to ultimately have 36% to 37%, and that's the same in constant currency. But once you adjust to the new transaction model as well as currency, that rises to 39% to 40%.
Joe Vruwink: Okay. And that's the underlying you're talking about. Okay. And --.
Janesh Moorjani : Keep in mind, you've got partner commissions that we pay as well in that model.
Joe Vruwink: Yes. Okay. Understood. And then going to—just it makes sense that as you see a slower new subscriber addition that builds over time and kind of compresses the revenue growth rate I guess the one thing that's a bit surprising is the growth rates in the AEC product segments are still really good, and I think this quarter was 14%. And that seems just as difficult an environment as what manufacturing customers and a lot of way are going through. Do you think you're kind of outperforming there in that segment and maybe those challenges elsewhere because it would seem like the AEC performance is ultimately standing out in this environment?
Andrew Anagnost : Yes. So what you are seeing in AEC is you're seeing our construction performance, all right? Construction is doing quite well. You saw that we added 400 new logos. We've got a building momentum there. We've got a great product. Looking forward, we are very bullish about where we're taking the construction business. The payment business is doing well. We are seeing wonderful growth associated with that. Customers like the product. They have plans to implement it. They're really attracted to the broad end-to-end solution. That's what people are buying for, their future, not for their present needs. They are trying to get front of where they need to be. That's what you're seeing in AEC. I also want to make sure that I just address something you said. Remember, with regards to manufacturing growth, you just have to take into account that we had some upfront revenue comparison last year. Those upfront revenue blips kind of have a disproportionate impact on how the manufacturing looks when you account for that, that growth is actually in low double digits. So we are actually performing well there as well relative to peers, especially on a full year basis. So what you're seeing in AEC, that's why you want to see us drive those Make businesses even more because they're really having an impact. Rev is doing great. There’s no doubt, but Construction is doing fantastic.
Joe Vruwink : Okay, thank you very much.
Operator: Thank you. Our next question comes from Elizabeth Porter of Morgan Stanley. Please go ahead, Eizabeth.
Elizabeth Porter : Great. Thank you very much for the question. Self-service sounds like a pretty big opportunity to drive the underlying efficiency. And just given Autodesk, can be a complex piece of software that does require some higher touch from sales or partners. Just how should we think about the base of business that could be applicable to self-service. Any sort of comments to help us understand kind of where it is today and where it could go over time would be very helpful. Thank you.
Andrew Anagnost : Yes. Self-service can touch just about every aspect of our business from a transactional point of view. So for us -- as a matter of fact, in -- some of our reinvest, we are going into improving some of these self-service capabilities right out of the gate. So on a transaction basis, the easier you make it for customers to see what they own, manage what they own, add new seats and all the things and be aware of what their users are using and where they might need more capacity, that drives up-sell and cross-sell immediately. The other aspects of self-service on the support level, look, there's a bunch of things that our customers come in and do that are very low-value transactions that we're getting significantly better at building systems that can automatically address those needs with the customer so that we can focus our human resources on the high-value returns. So every aspect of the business can benefit from an improved and enhanced self-service and there is lots of low-hanging fruit as we move forward in terms of making the self-service capabilities easier to access, easier to use and more complete in terms of how they work with our customers.
Elizabeth Porter : Great. And then just given we are just now entering this optimization phase for sales and marketing, and it is going to be a multiyear journey, it sounds like. At a high level, could you just help us understand a bit more what are some of the near-term versus longer-term key milestones we should look towards as we're going through this optimization phase?
Andrew Anagnost : Yes. So first off, let me just remind everybody, this optimization phase is a deliberately planned activity connected to the last two years of changes. When we began the move to the new transaction model is when we began the planning of this optimization phase. So this is a purposeful, deliberate planned-out effort. The high-level main focuses for this are on optimizing certain processes, enhancing self-service like I talked about earlier, also improving efficiency and tightening the relationships with our partners, so that we just generally reduce duplication and get more efficiency from the whole system overall. The initial phases were focused primarily on some of our marketing efficiency some of the marketing-related go-to-market aspects of our efficiency. As we move forward, you're going to see us drill a little bit more into making sure that we're creating tighter relationships with our partners and ensuring that there's more optimization in terms of productivity associated with partner relationships, and you're going to see self-service have a bigger impact on the business moving forward. So considering a continuum from -- starting with the marketing optimization, moving through a continuum to enhancing partner engagement and getting more efficient there all the way through maximizing returns on self-service. All of that is going to deliver long-term margin improvement for the operating income improvement for the company.
Elizabeth Porter: Thank you. Thank you very much.
Operator: Thank you. Our next question comes from Matt Hedberg of RBC. Matt, your line is open.
Matt Hedberg : Great. Thanks for taking my questions. And congrats again, Janesh. Really look forward to working with you again here at Autodesk. And starting out the year with a really strong free cash flow guide is really great to see as well. Maybe, Andrew, you talked a little bit earlier about Fusion, Gen AI, the product launch there. I guess I'm just wondering more philosophically, could you talk about sort of how we should think about additional generative AI rollouts across the product portfolio, how we should think about pricing? And just kind of the sensitivity around some of these data models given, obviously, a lot of it is customer specific.
Andrew Anagnost : Yes. Look, we are very much focused on enhancing customer productivity with these tools. as the tools get more and more productive, obviously, there is opportunity to charge additional money for really high productivity AI features. So that we capture some of the productivity we bring to the customers. We share some of the productivity with them, and we capture some of the value back to us. What you're seeing with some of these early features is essentially things that help the customer build 3D models more quickly, more rapidly with a lot less labor. So that's really hitting them right in their productivity and it also makes our products much more competitive in situations, especially in Fusionland, we're dealing with a very large ecosystem of products that we compete with and this essentially sets up Fusion to be much more competitive as we move forward. If you look forward at some of the things we're doing in AEC, Forma is really dedicated to servicing AI capabilities that allow people to be much more productive creating building information models in a completely different way. We've already rolled out early conceptual features around analysis, around tools that help people make initial sizing a set of kind of doors and windows and initial frameworks. This has a huge possibility to bring them to the masses, meaning bring building information modeling down to smaller and smaller companies that have found Revit out of reach for both their capabilities and their budgets. Forma has an opportunity to really expand the footprint of who can do building information modeling. And that's one of the things we're targeting at those long term. So look for AI to provide not only new productivity, better competitive value and long-term potentially higher monetization for some of these highly productive features, but also look for it to expand our market footprint.
Matt Hedberg : Got it. That's super helpful. And then Janesh, one for you, it sounds like we are going to get maybe a bit more color on kind of a midterm model perhaps on the Q3 Analyst Day. And so maybe just as a follow-up question to kind of thinking about the lower end of that 10% to 15% guidance range. I guess, how should we think about like maybe a floor of growth? We're getting that from a couple of investors today. Is there kind of a way to think about like -- is it kind of like high single digits? Is it 10%? Just any way to kind of think about how you think about kind of the lower end of kind of a growth outcome.
Janesh Moorjani : Matt, great to be reconnected and looking forward to working with you, actually. So in terms of that growth range of the bottom-end of that framework of around 10%, if you look back over the last couple of years, that's where we fundamentally have been. And in fiscal '26, we are guiding to the 8% to 9% in constant currency, excluding the new transaction model effect. And actually, that's consistent with the underlying growth that we delivered in fiscal '25. So overall, we think that the business is resilient, and we've had consistent performance over a period of time, and our focus fundamentally is actually on driving sustainable growth as we continue to focus on new business growth and driving our Make business, especially through construction and manufacturing and the overall platform strategy like Andrew was saying.
Matt Hedberg : Thanks, guys. Congrats.
Janesh Moorjani : Thank you.
Operator: Our next question comes from Joshua Tilton of Wolfe Research. Please go ahead, Joshua.
Joshua Tilton : Hi, guys, can you hear me?
Janesh Moorjani : Yes, we can.
Joshua Tilton : Great. Thanks for sneaking me in, I have two quick ones. The first question is, is there any sense you can give -- you can just help us understand maybe where the NRR finished for the year relative to what you're guiding to for revenue for next year. So for example, you're guiding to about 8.5% core growth ex-transition for next year. Like where relative to that are existing customers growing finishing this year? And then my second question is just a little more simple. How much of the recent like restructuring -- RIF announcement benefit is factored into the current operating margin guidance for this year?
Janesh Moorjani : Yes. Maybe I'll just address both of those. So in terms of the net retention rate, you'll see that we have, in the modeling guidelines, we've provided a view on how we are thinking about fiscal '26, which is basically the same as it was in fiscal '25. It's a range of 100% to 110%. And I realize that is a wide range, and we are essentially guiding to 8% to 9% growth on the underlying. But the way I think about that is the net retention rate essentially is hovers around the middle of the range. It can bounce around by a few points in any particular quarter. That's why we put a reasonably wide range to it. And so that is how we are thinking about that piece. And I'm sorry, would you mind repeating the second question, please?
Joshua Tilton : Yes. Just how much of the recent risk announcement or layoff announcement benefit is baked into the current operating margin guidance for this year?
Janesh Moorjani : Yes. So as we built the operating margin guidance for the year, obviously, any savings from the action are baked into the guidance already. But as I talked about earlier, the reinvestment and our organic hiring plan that we had built for fiscal '26 is really an integrated plan. And so if I think about the overall spending growth that we've baked into the model, which might be a different way to look at it. That spending growth overall for fiscal '26, again holding aside the effect of the new transaction model is slowing from 7% last year to [4%] (ph) this year in constant currency.
Joshua Tilton: Thank you, very helpful.
Operator: Thank you. Our next question comes from Michael Turrin of Wells Fargo Securities. Your question please Michael.
Michael Turrin : Hey great. Thanks appreciate you taken the question. I know there have been a few different angles on this. But Janesh, just on the commentary around the long-term target, just any perspective you can add given it is early in your tenure, so decision process that went into this? And maybe help us parse how much is using a different set of assumptions there or just any more context you can add because that is where we're getting the most questions initially.
Janesh Moorjani : Yes, I'm happy to talk about that. And look, fundamentally, my view on the business is very similar to what we've experienced in the past. And coming into the business, recognizing that for the past couple of years, we've been hovering around the low-end of that range. And fiscal '26 on an apples-to-apples basis is very similar. The reality is we've just not been in the middle to high-end of that range and that's -- as I looked at the ranges, it felt inappropriate to have a range out there if we have not delivered against that in the last couple of years, at least being towards the middle or high end of that. And that was really the core principle behind this. But fundamentally, when I look at the business, as I said we delivered consistently, and it is a resilient business. You've seen us deliver over the last couple of years when there is been a lot of external factors that have been outside of our control. You've seen us do that through the business model transition we've been driving. We've got a strong and loyal customer base. Our products are in market-leading positions. We feel very good about our position overall.
Michael Turrin : Yes, that's helpful color. And then, Andrew, just on the headcount reduction. I know these are tough decisions. Maybe just speak to how you ensure you're making the right level of change there, balancing efficiency with preserving the continuity and business momentum you're seeing? Thanks.
Andrew Anagnost : Yes. So we look at these things definitely over a long timeframe, and we are definitely trying to balance the risk short-term with the reward long-term in terms of what we did. And we feel like we've taken a really balanced approach here. You can see we've reinvested some of the money into future systems and capabilities that will allow us to do additional optimizations in the future. So we're trying to make sure that we cut the right kind of balance here so that we keep the business moving in the right direction, and we factored a lot of that risk into the way we're guiding. So I think we've done it right. And I think the ongoing optimizations are going to continue to deliver increasing profits as we move forward into next year.
Michael Turrin: Thanks very much.
Operator: Thank you. Our next question comes from Ken Wong of Oppenheimer & Company. Please go ahead, Ken.
Ken Wong : Great. Maybe the last one on just that 10% to 15% range. I realize inappropriate to kind of keep that out there given the conditions and the performance. But with all the improvements that you guys are putting through with the go-to-market changes, the work with the channel, I mean, should we think about the other side of this when macro is fine, when you guys have delivered on the go-to-market changes that 10% to 15% is back in play? Is it arguably maybe even a better number? Like help us think through what the end goal with some of these changes would be in respect to what were the prior 10% to 15% goals.
Andrew Anagnost : So Ken, where we're at right now, just to a [tax] (ph) the acknowledgment of where the business is right now. What you're not hearing is a reduction in face of the long-term growth potential for the company, all right? The areas we're talking about are the areas that really need to improve to drive the kind of behavior we want long term. It's all about getting the channel more productive. That's going to be a result of some of the changes that we're doing right now in some of the optimizations. The more productive the channel is, the more energy it has to spend on new business, the more the new business starts to build up over time and actually show up as revenue growth over time. The other thing is we are really excited about moving the design and make solution in a lot of our customers. So watch that make bucket because that's a clear sign that we are being successful penetrating the end-to-end solution. That's real long-term new growth for Autodesk. And by investing in that, we are essentially front-loading the capability to keep building up that book of business, which then shows up in the top-line over time. So that's the way to look at it. It's not a retreat from confidence in the long-term growth structure of the business, quite the contrary, but it is an acknowledgment of where we are at today.
Ken Wong : Got it. Okay. Perfect. And then just a quick follow-up on, like, look, you guys have rolled out across all three regions now as far as the agency transition. Any update on how kind of those three areas are tracking. Obviously, we have the Americas, which were kind of a little further along, but you just rolled out APAC, would just love a sense of kind of how those are mapping relative to internal plans.
Andrew Anagnost : Yes. So for the most part, things are going as we planned. There's an initial kind of pull forward of the business, and there is some production in new business as people go through getting their systems set up and renewing. We did see a few more productivity problems as we were hitting the end of all these rollouts than was originally expected, but we are now working through all of that. But for the most part, this is perceived as we expected, with a little bit more kind of, okay, we have some work to do to help the partners manage these systems effectively moving forward.
Ken Wong: All right. Perfect. Thank you so much Andrew.
Andrew Anagnost : You’re very welcome.
Operator: Thank you. And ladies and gentlemen, that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks.
Simon Mays-Smith: Thank you, everyone, for joining us today. We'll look forward to seeing many of you over the coming weeks. If you have any questions, please just e-mail me [simon@autodesk.com] (ph), and we'll look forward to catching up on our Q1 earnings call. Thanks so much [Latif] (ph) the team, and goodbye, everyone.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by and welcome to Autodesk Fourth Quarter and Full Year Fiscal 2025 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, Vice President Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss Autodesk’s fiscal 2025 fourth quarter and full year results. Andrew Anagnost, our CEO, and Janesh Moorjani, our CFO, are on the line with me. During this call, we will make forward-looking statements, including outlook and related assumptions, and on products, go-to-market and strategies. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today’s press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today’s call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. Autodesk delivered strong fourth quarter and full year results. Billings and revenue topped the higher end of our expected range, despite new foreign exchange headwinds, while margins and free cash flow exceeded our expectations. You will all have seen our restructuring announcement this afternoon, which has two parts: first, we have initiated the optimization phase of our sales and marketing plan, and second, we are reallocating internal resources to accelerate our strategic priorities and strengthen our resilience. Let me talk about them in turn. Our go-to-market; GTM model, has evolved significantly and purposefully, from the transition to subscription and multi-year contracts billed annually, through self-service enablement, the adoption of direct billing, and more. We are now beginning the optimization phase, which positions Autodesk to better meet the evolving needs of its customers and channel partners. This comes from faster and less complex processes and more digital self-service and automation that enable tighter channel partnerships and less duplication of effort. Autodesk will continue to evolve its GTM to increase customer satisfaction and Autodesk’s productivity. Our current focus is on marketing, customer success, and operations with an emphasis on consolidating teams into centers of excellence and investing in systems and processes that increase sales and marketing, S&M efficiency at scale. Our future focus will be on tighter channel partner integration, which will drive sales productivity and a greater emphasis on value creation for customers, and the broad deployment of self-service capabilities to further increase sales and marketing efficiency. Through this on-going optimization, we expect operating profit dollars and pre-new transaction model non-GAAP margin improvement in both fiscal 2026 and fiscal 2027 and, once the optimization phase is complete, we expect to deliver GAAP margins among the best in the industry. Turning to where we are reallocating internal resources to focus on the long-term. Autodesk is focused on the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. Our investments in cloud, platform, and AI are ahead of our peers and will drive growth by providing our customers with increasingly valuable and connected solutions and supporting a much broader customer and developer ecosystem. To maintain and extend this leadership, we’re shifting resources across the company to accelerate investments in these high-potential strategic priorities. We are also building the capabilities we will need to enable future optimization and ensuring that we distribute critical expertise globally to remain competitive, resilient, and flexible. As I said last quarter, we are generating strong and sustained momentum in absolute terms and relative to peers. There are three main reasons; attractive long-term secular growth markets, a focused strategy delivering ever more valuable and connected solutions to our customers, and a resilient business. Disciplined execution is driving greater operational velocity and efficiency. We are deploying capital to grow the business, further reduce our share count, and enhance value creation over time. We believe these factors will deliver sustainable shareholder value over many years. Janesh is with me here at our annual sales conference today. We’re excited to have him at Autodesk and he’s already making an impact. I'd like to welcome him and turn the call over to him, so he can take you through our results and guidance for the year ahead. I’ll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Janesh Moorjani",
"text": "Thanks, Andrew. I'm delighted to be here with all of you. Before I get into our results, I’ll touch on two areas of potential that I saw that attracted me to Autodesk. First, we are well-positioned to deliver growth at scale, as we drive the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. And second we have significant potential to drive expanded profitability, as we further optimize the level and effectiveness of investments in the business. Having spent the last few months gaining a deeper understanding of our business, I am confident in our ability to do both. Let’s turn to the results. The fourth quarter and full-year fiscal 2025 results were strong. Overall, the broader economic environment and the underlying momentum of the business in the fourth quarter were consistent with the last few quarters with continuing strong renewal rates and headwinds to new business growth. Total revenue in the fourth quarter grew 12% as reported and in constant currency. We generated broad-based growth across products and regions. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 9%; AECO revenue grew 15%; manufacturing revenue grew 10%, and in the low teens excluding up-front revenue; and M&E revenue grew 10%. Our Make products continue to enhance growth, driven by ongoing strength in Construction and Fusion. By region in constant currency, revenue grew 11% in the Americas, 13% in EMEA, and 11% in APAC. The contribution from the new transaction model to revenue was $46 million in the fourth quarter and $71 million for the year. Direct revenue increased 35% in constant currency, and represented 47% of total revenue, up 8 percentage points from last year, benefiting from strong growth in the Autodesk Store, and also from the tailwind to revenue from the new transaction model. Billings increased 24% in the quarter at constant currency, reflecting the shift to annual billings for most multi-year contracts and the transition to the new transaction model. The contribution from the new transaction model to billings was $155 million in the fourth quarter and $262 million for the full year. RPO of $6.9 billion and current RPO of $4.5 billion grew 14% and 12%, respectively. As expected, current RPO growth was affected by tailwinds from the new transaction model, and headwinds from the declining contribution of billed and unbilled deferred revenue from larger multi-year and EBA cohorts ahead of renewal in fiscal 2026. Turning to margins. Fourth-quarter GAAP and non-GAAP operating margins were 22% and 37%, respectively, reflecting year-over-year increases of 90 basis points and 160 basis points. We were pleased that we exceeded our non-GAAP margin expectations, demonstrating strong fiscal discipline. For fiscal 2025, GAAP and non-GAAP margins increased approximately 220 and 140 basis points year-over-year, respectively, excluding the impact of the new transaction model and currency movements. Free cash flow for fiscal 2025 was $1.57 billion, which was ahead of the high end of our guidance. In the fourth quarter, we purchased approximately 1.4 million shares for $414 million, at an average price of approximately $299 per share. For the full year, we purchased approximately 3.1 million shares for $858 million, at an average price of approximately $279 per share. Turning to guidance. To give you a clearer view on the underlying dynamics of the business, I will speak to the numbers excluding the impacts of the new transaction model and in constant currency. You’ll also see in today's earnings deck that we’ve split out the impact of the new transaction model and currency movements for our fiscal 2026 guidance. For a thorough review of how the new transaction model works, please see the opening commentary and earnings deck from our Q2 fiscal 2025 earnings call. Let me start by framing how we are thinking about fiscal 2026. Our starting position is strong. We hold leadership positions in many of our markets and have a loyal customer base with a high degree of recurring revenue. We are leading in cloud, platform and AI as we help our customers realize the benefits of converged workflows and data in the cloud. In building our guidance, we have not assumed fundamental changes in the broader geopolitical and macroeconomic environment or in the momentum of our markets. Our business model is resilient, and we are seeing strong momentum in our growth businesses like Construction and Fusion. Our focus through fiscal 2026 will be on driving growth from new and existing customers while maintaining strong renewal rates. Our approach to building the guidance for fiscal 2026 was similar to that for fiscal 2025. Our guidance is based on the range of possible outcomes in our bottom-up sales forecast which is grounded in the momentum of the business. Given our restructuring plans and CRO transition, we believe some disruption is possible. While we have mitigation plans and actions in place for these changes, we believe it is prudent to consider these in our outlook, and our guidance reflects this. This frames how we are thinking about fiscal 2026. There are more financial details in our earnings press release and earnings deck, but let me give you some color. We expect constant currency billings growth of 17% to 19%, excluding the impact of the new transaction model. Billings growth remains elevated this year due to our transition to annual billing for most multi-year contracts. We expect constant currency revenue growth of between 8% and 9%, excluding the impact of the new transaction model. This range reflects the assumptions that I mentioned earlier. We expect GAAP operating margin to be in the range of 21% to 22%. Excluding the impact of the new transaction model and currency movements, we expect non-GAAP operating margin to be in the range of 39% to 40%, which is at the higher end of the guidance range we gave three years ago. We expect to generate between $2.075 billion and $2.175 billion of free cash flow in fiscal 2026. This is after absorbing approximately $110 million to $120 million of cash outflows related to the actions we announced earlier today, and includes an anticipated discrete cash benefit of $130 million to $150 million from the utilization of US deferred tax assets. We've provided more information on this in the slide deck. We expect to buy back between approximately $1.1 billion and $1.2 billion of shares in fiscal 2026, which is a 30% to 40% increase compared to fiscal 2025, and the timing of which will depend on market conditions and other factors like debt refinancing. The slide deck on our website has more details on modeling assumptions for the first quarter and full year fiscal 2026. Finally, I’ll share how we are currently thinking about our longer-term future. Since joining Autodesk last December, my conviction in our market opportunity, our ability to meaningfully expand our operating margin, and our capacity to deliver sustainable shareholder value over many years, has been reaffirmed. That said, our underlying growth has been hovering around the bottom end of the 10% to 15% revenue growth framework we previously provided, as you've seen over the past couple of years and in our fiscal 2026 guidance. While we believe our resilient base, the successful execution of our product strategy, and the benefits of the new transaction model will catalyze sustainable growth in the future, our 10% to 15% growth framework is no longer appropriate given the consistent momentum of the business today. On the other hand, it’s clear to me that margins can be higher. We’ve announced today the first phase of our go-to-market optimization which is primarily in marketing, customer success and operations, and reflects the continued execution of our overall go-to-market evolution of the past few years. We are focused on executing this plan while minimizing potential disruption. Through this phase, we intend to deliver underlying operating margin expansion in fiscal 2026, as reflected in our guidance, while also building capabilities we need for future optimization beyond fiscal 2026. These capabilities include tighter channel partnerships with less duplication of effort; and more digital self-service and automation, which increases customer satisfaction and workforce productivity. Once our overall go-to-market optimization is complete, we expect Autodesk will be able to better serve its customers and deliver GAAP margins among the best in the industry. We will share more on our path to further margin expansion at an investor day in the third quarter of this year. It’s been invigorating getting to work, finalizing our fiscal 2026 plans, and preparing for execution. I can already see there is tremendous potential ahead. I look forward to meeting our investors and analysts over the coming weeks. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Janesh. Autodesk is focused on the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. Autodesk is at the forefront of convergence because we’ve been evolving and investing in the business models, products and platforms, and go-to-market that capitalize on it. With convergence, simulation done in the conceptual design phase can significantly reduce rework and cost during construction. With convergence, the components of a building can be manufactured offsite and assembled on site at lower cost and higher safety. With convergence, universal AI models can make better, and more valuable, inference that power a better world designed for all. Let me give you a few examples from the quarter. Mott MacDonald, a global engineering, development and management consultancy, known for its work on major projects such as Heathrow Airport Terminal 5 and the Bay Area Rapid Transit, BART Silicon Valley Phase II extension, renewed its 6th EBA in the quarter. This renewal expands our long-standing partnership to drive better outcomes through digital delivery. In addition to expanding usage of Revit, Civil 3D, Autodesk Build, and Autodesk Water, Mott MacDonald plans to leverage additional capabilities to increase project productivity and workflows for optimized design. Power Design, the #28 ENR 600 specialty contractor, selected Autodesk Build, as an essential link in their construction technology. This strategic choice enhances coordination between design and construction, ensuring seamless collaboration across teams and systems. By unifying project data from concept to completion, Autodesk helps Power Design protect design integrity, optimize workflows, and drive efficiency at scale. Cleveland Construction, a national commercial GC, is replacing a competitive solution with Autodesk Construction Cloud to support the next phase of its growth and leveraging our end-to-end solution from preconstruction to cost management and payments with GCPay. I talked earlier about closer integrations with our channel-partners and this deal demonstrates that potential. Using its proprietary technology for migrating project data from displaced solutions, an Autodesk platinum partner produced a comprehensive implementation plan that gave Cleveland Construction the confidence to make this transition. These stories have a common theme: converging people, processes and data across the project lifecycle to increase efficiency and sustainability, while decreasing risk. Our comprehensive end-to-end industry clouds and platform drive convergence and extend our footprint further into larger growth segments like infrastructure and construction. As a sign of our progress, construction revenue growth accelerated in the fourth quarter and we added almost 400 net new logos. Moving on to manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make platform to drive growth and increase resilience. For example, a global leader in toys is expanding its usage of Autodesk to all three of our industry clouds; Fusion, Forma, and Flow, to meet its profitability goals in Manufacturing, while launching new revenue models into Digital Entertainment. Autodesk’s unique industry expertise across AECO, manufacturing and media bridges data across physical and digital product development and between design and make. Buhler a family-owned Swiss multinational plant equipment manufacturer, renewed and expanded its EBA in the quarter. Autodesk will be one of Buhler’s key strategic partners in the development and execution of their digital strategy, as it moves to optimize for outcomes by connecting data and workflows, from Product and Plant design to project delivery including Installation. MSC Industrial Supply, one of the largest industrial distributors in North America with the leading position across metalworking product categories, will begin leveraging Autodesk Fusion’s connected supply chain capabilities, and unique, all-in-one cloud CAD, CAM, CAE, and PCB platform, to enhance its industry-leading Application Optimization AP-OP program. Through this strategic relationship, MSC’s team of metalworking specialists will be able to optimize toolpaths and validate cutting parameters more efficiently through enhanced virtual testing capabilities that further strengthen their best-in-class tooling recommendations for manufacturing customers. By combining MSC’s suite of solutions and services with Autodesk Fusion’s advanced capabilities this partnership creates an unmatched value proposition for manufacturers in North America, resulting in approximately $500 million in savings for MSC's customers in fiscal year 2024. Converged data opens up new opportunities for Autodesk, in this case with a sales team. As customers seek to drive efficient innovation, Fusion extension attach rates are increasing and driving average sales prices [up] (ph). And we’re delivering meaningful productivity gains to customers where we deploy AI. For example, our recently launched AutoConstrain tool in Fusion, which leverages AI to simplify the process of defining sketch geometry, has a roughly 50% acceptance rate on suggested geometry, saving significant time for higher value work. In education, universities continue to modernize their courses and curriculum to attract and prepare future engineers. For example, in Q4, Autodesk signed a Memorandum of Understanding with the Indian Institute of Technology Bombay to integrate our industry leading solutions into IIT Bombay's innovative education and research programs, to equip the next generation of engineers and designers with industry ready skills. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. For example, while working with an administrator of European railway infrastructure in the process of adopting BIM to optimize its infrastructure development and sustainability practices, we identified gaps in compliance. Working together, we addressed compliance while supporting their digital transformation. Attractive long-term secular growth markets, a focused strategy delivering ever-more valuable and connected solutions to our customers, and a resilient business, are generating strong and sustained momentum in absolute terms and relative to peers. Disciplined execution is driving greater operational velocity and efficiency. We are deploying capital to grow the business, further reduce our share count, and enhance value creation over time. In combination, we believe these factors will deliver sustainable shareholder value over many years. Throughout Autodesk’s history, we have taken decisive actions to drive our business forward – even when they are difficult. This commitment has been paramount to our success over the last 40 years and remains true today. To our team members who depart as a result of our restructuring, I extend my sincere appreciation for your contributions to Autodesk. You will always be a part of Autodesk’s story, and I am grateful for everything you have done. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Please go ahead, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hi guys thanks for taking my question here. And welcome, Janesh."
},
{
"speaker": "Janesh Moorjani",
"text": "Thanks, Saket."
},
{
"speaker": "Saket Kalia",
"text": "Absolutely. Andrew, maybe to start with you. I want to zoom into the 10% to 15% medium growth rate a little bit. And if I'm understanding your comments correctly, the rate of new business growth is the key reason why that medium-term growth rate maybe is no longer appropriate. And you've been talking about slow new business for a while now. Maybe the question is, what drives that new business growth higher over time?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Good evening Saket, good to talk to you. Thanks for this question. Look, first off, I think you've got the thinking right up-front. Let me just comment a little bit on what's happened in the past and then I'll answer the substance of your question. So first off, if we look back in the past, there's a couple of things that were really impacting new business growth as we were moving to the last couple of years. One is all the things that Autodesk was changing. So we changed a lot of things that has a measurable impact on partner productivity with regards to balancing renewals and new business. The other thing was economic uncertainty, all the things associated with the macro environment. These things impaired some of our customers' willingness to invest in their business. So those things happen lately in the past. Moving forward, there's some things that we have control of and that we don't have control of that are going to drive us back on to our growth path. The first thing, if we look at the things we don't have control, we don't have control of the macro uncertainty. That is going to continue, and that will definitely impact some of our customers' thinking. But what we do have control of is in two key areas, one related to new product subs and one related to our new businesses that primarily show up in the Make category, the emerging and high-growth businesses. With regard to the former, we are on a journey of go-to-market optimization right now. And that is going to enhance the productivity of our channel. We've been impacting their productivity with all the change. We're on a cycle now where over a period of time, we'll be increasing their productivity. That's going to allow them to focus more on new business growth that's in our control. The other thing that's in our control is during this current rib cycle, we actually invested in driving the growth of our emerging and high-growth business on the mix side. And that includes investing in the industry cloud, the core cloud platform and in AI. So these things are going to not only continue the current momentum, but our goal is to enhance the current momentum. And these are high-growth businesses having long-term impacts on our business. So those are the things that are in our control that get us back to a place where we can feel confident in reinforcing the floor of our long-term business growth."
},
{
"speaker": "Saket Kalia",
"text": "Got it. Got it. And maybe that's a natural segue for you, Janesh, I mean, as you know, margin potential has been one of the key investor debates on Autodesk. And so I mean, I think maybe to start, it is important to flag that margins here for '25 were ahead and the guide for '26 is higher than expected as well. But maybe you could just give us a little bit more color on the margin potential here. And how today's restructuring announcement, to Andrew's point, maybe fits into that debate?"
},
{
"speaker": "Janesh Moorjani",
"text": "Thanks, Saket. I appreciate this is one of the foremost issues on investors' minds. As I step back and look at fiscal '25 first, we are actually really pleased that we delivered strong outperformance here, thanks to our strong fiscal discipline in the fourth quarter. And I want to thank Betsy for setting us up for a strong Q4 on that front. Today's announcement does reflect the continuation of our multiyear journey as Andrew was talking about to evolve our go-to-market, and it fits in very nicely with our overall margin expansion goals. It's something that the team had been planning for thoughtfully since the introduction of the new transaction model. It's also allowing us to expand our underlying non-GAAP operating margin quite meaningfully this year when you hold aside the effects of the new transaction model. So when I look at it serving customers better through tighter integration and more cell service eventually expands our market opportunity and also ultimately lowers the unit cost of serving those customers, which will help driving even more efficient go-to-market motion in the future. So we have conviction in our potential to drive higher margins over time as we execute this plan and as we focus on future opportunities that I touched on in the opening commentary."
},
{
"speaker": "Saket Kalia",
"text": "Very helpful guys. Thank you."
},
{
"speaker": "Janesh Moorjani",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Borg of Stifel. Please go ahead Adam."
},
{
"speaker": "Adam Borg",
"text": "Awesome. Thanks so much for taking the question. I'd like to extend the welcome to Janesh as well. Maybe for Andrew, just piggyback on a comment you just made to Saket's question around just macro uncertainty and obviously, things that are outside of your control. I'd love to hear a little bit more about kind of what you're hearing with your customer conversations around overall sentiment, how that's playing out overall? And then maybe talk a little bit about the new administration and some potential puts and takes there either shortening regulation being a tailwind or some questions around tariffs, immigration policy and how that ultimately impacts customers and their decision-making over the next six to 12 months? Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Okay, Adam. Thanks for that question. So first off, our business is resilient enough. It's diversified enough that it can absorb and react to any kind of policy changes in a sustainable way. The thing I'm hearing from our customers is they want certainty. It's uncertainty that's kind of fueling customer angst. It's not what the output is, what the answer is. It's just the uncertainty. And that's the thing that we want to move fast -- past. We want to move to certainty, policy. Once policy's in place, I have faith in Autodesk's business to navigate whatever the policy is. But uncertainty is not something that our customers want to work through."
},
{
"speaker": "Adam Borg",
"text": "Great. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Please go ahead, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, with respect to the 10% to 15% growth range you've previously spoken of, the company at its last analyst meeting gave us multiple elements of that. In other words, a variety of price and volume components for that, most of which have to do with your core business, as you call it, renewal and expansion within the core business, less so with new or adjacent businesses. So maybe break down that thinking about the growth range in those terms, perhaps with regard to how you're thinking about pricing leverage from here and the multiple elements of queue or volume that you had previously spoken of. Then I have a product question."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Jay, I'm going to go back to what I said previously and focus on these two key elements. Enhancing channel productivity as we move through all these changes, that is a critical thing for us. It is part of our ongoing optimization cycle. It's going to be something that delivers over multiple years. That will create a tailwind within our channel business for some of these core subs issues. And I think that's the more important thing to focus on. And the emerging businesses have always been a part of our plan. And I think you see very clearly that the make businesses are growing robustly and we are investing to make sure that those continue to grow at that rate or accelerate beyond that rate. So that's where you want to focus right now in terms of getting the business back to where we want it to be over time."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Outside of the various go-to-market changes and optimization and so forth, what would you say for this year and beyond are the critical product or technology executables that you are reallocating to or investing in? Maybe talk about how you're thinking about the business impact of platform services, the new data models and so on and so forth, things that we've talked about consistently most recently at AU."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So what we're doing is we're accelerating some of the road maps associated with our industry cloud. So you're going to see more activity associated with the Construction side and the Forma side of the AEC industry cloud. And you are going to see more energy and activity associated with the Fusion Cloud and some of the things associated to driving that. So there's investments made in that. Within the core platform, it is all about expanding the granular data that's available to our customers, expanding the footprint of APIs that are available to our customers and investing in that so that we can accelerate not only what our customers are accessing but the common services that the industry clouds are accessing. So that is part of the investment. And of course, we're going to continue to turn the crank on some of the [ARP] (ph) features. As you know, Jay, we just introduced our first commercial AI, a generative-AI feature into Fusion. It's the auto constraint feature. It's out there, getting used by our users. It's got approximately a 50% acceptance rate, which is a really high rate for a generative technology and it just gets smarter as it goes. That's a real productivity tool for our customers that really makes a difference. There is going to be more of those, right? And that's where the investment is going."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you Andrew."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Celino of KeyBanc Capital Markets. Your question please Jason."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks for taking my question. One question on the guide and then the reduction in force. Now I'm cognizant that you've got some business momentum, and I understand why you're making the changes. But does the revenue guide assume any extra conservatism just on potential of disruption. It's just the change is quite a large reduction. So I guess what have you built into the guide relative to that?"
},
{
"speaker": "Janesh Moorjani",
"text": "Hi, this is Janesh. Maybe I'll take that. So as I mentioned in the opening commentary, our approach to building the guidance for fiscal '26 did consider a range of possible outcomes from our overall bottoms-up sales forecast. And then we did factor in some level of risk potential associated with the restructuring plans and the CRO transition. We've put in place good mitigation plans and actions that we have to manage those. But we thought it's prudent to consider these in our outlook. So our guidance does reflect that."
},
{
"speaker": "Jason Celino",
"text": "Okay. I appreciate that. And then on prior calls, there were some mentions of a bigger EBA cohort, multiyear customers coming up for renewals, that wasn't really brought up on this call. Is that still an opportunity for you for this year? And any details on how big of a cohort this might be or what's built in? Thank you."
},
{
"speaker": "Janesh Moorjani",
"text": "It's still an opportunity. We didn't reference it discretely because we have mentioned it before. Nothing has really changed on that front. We've got both the EBA cohort, as well as the product subscription multi-year cohorts that will come up for renewal later this year."
},
{
"speaker": "Jason Celino",
"text": "Okay. Thank you Janesh."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Taylor McGinnis of UBS. Please go ahead, Taylor."
},
{
"speaker": "Taylor McGinnis",
"text": "Yeah, hi. Thanks so much for talking my question. Just on the margin guide. So the underlying 300 basis points of margin improvement is really strong. But can you just break down and quantify the drivers of that expansion. So how much is from cost savings, like scaling back on some of the duplicative costs and streamlining the sales force? How much might be from cost savings associated with the risk? And then maybe just secondly, when we think about the margin potential beyond 2026, I guess, any initial thoughts you can provide there? Thanks."
},
{
"speaker": "Janesh Moorjani",
"text": "Yes, I'm happy to take that. So as we think about the overall impact in fiscal '26 and the underlying operating margin increase that we're guiding to, that demonstrates our overall commitment to expanding profitability this year, obviously, but it's part of our longer-term plans. The reinvestment and our organic hiring plans, all of that is an integrated plan. You mentioned the actions that we've taken in the field organization and the [RIF] (ph), and that's all part of the same plan. We also had our organic hiring plans that we had for fiscal '26. So it's hard to break all of that apart. But that said, to just give you a sense of how we are thinking about it. If you look at our fiscal '25 total spending, that grew 7% year-over-year, excluding the new transaction model. And our fiscal '26 total spending, that implies growth of only 4% year-over-year on a similar basis in constant currency. So that gives you a sense of the extent of both the optimization and the spend discipline that we are driving in the business overall. And then as I think a little bit ahead on fiscal '27, we are committed to further margin expansion beyond fiscal '26 on an underlying basis, as we've talked about. And that will continue. And ultimately, when that overall go-to-market optimization is complete, we expect that we have GAAP margins among the best in the industry, and we'll share a little bit more details in terms of what that means when we get to our Investor Day in the third quarter."
},
{
"speaker": "Taylor McGinnis",
"text": "Great. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Next question comes from Bhavin Shah of Deutsche Bank. Please go ahead, Bhavin."
},
{
"speaker": "Bhavin Shah",
"text": "Great. Thanks for taking my question. Janesh, just kind of following up on that, what's the timeline you guys are thinking about in terms of kind of seeing some of the benefits from a lot of the adjustments you're making to sales and marketing? And when do you kind of see that sales and marketing efficiency show up from a revenue perspective."
},
{
"speaker": "Janesh Moorjani",
"text": "Yes. Bhavin, clearly, we are seeing a significant benefit here in fiscal '26 itself. As I mentioned, that's a big part of the underlying margin expansion that we are delivering. With respect to what that translates to for fiscal '27 and beyond as I mentioned, we've got more work to do in terms of the next set of activities that we need to plan for as we think about what it means to drive tighter channel partner integrations and build the capabilities that we need for self-service. We're investing this year to build those capabilities so that we can be set up to lower our overall cost to serve our customers in future years. And again, we will spell some of the details out around that in the Investor Day in the third quarter."
},
{
"speaker": "Bhavin Shah",
"text": "That's super helpful. And just one quick follow-up. It sounds like you guys are going to be pretty aggressive from a shareholder return perspective in fiscal '26 and kind of given some of the changes you're talking about from the top line perspective and focus on efficiencies. How are you now thinking about M&A and do these actions change your view at all?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes, Bhavin, our view on M&A doesn't change. We've always been an acquisitive company. We're always looking for anything that can accelerate our strategy or take us into adjacencies that we think are relevant to the company. But that's consistent with previous stances on this. If we see something like that, we will act on it."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Joe Vruwink of Baird. Joe Vruwink, your line is open. Please go ahead."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Sorry, I was on mute. I'll get those right one of these times. I wanted to go back a few questions just on the year-over-year margin assumptions. It looks like if I'm reading Slide 10 correctly, you are assuming the agency change is about a 6-point impact on growth in the upcoming year. So I think that means a 6 point headwind on margins. You're kind of guiding to margins flat to slightly up. So can you bridge the 6 points you're able to layer back on to get to where you are guiding the year."
},
{
"speaker": "Janesh Moorjani",
"text": "Joe, I am happy to take that. A 6 point revenue headwind is the right way to think about the top line, but that doesn't translate to a 6 point margin headwind. You'll see on that same slide that we've actually just fell out for you exactly what the margin headwind is as well it's 3 percentage points. So on an as-reported basis are -- we would expect to ultimately have 36% to 37%, and that's the same in constant currency. But once you adjust to the new transaction model as well as currency, that rises to 39% to 40%."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. And that's the underlying you're talking about. Okay. And --."
},
{
"speaker": "Janesh Moorjani",
"text": "Keep in mind, you've got partner commissions that we pay as well in that model."
},
{
"speaker": "Joe Vruwink",
"text": "Yes. Okay. Understood. And then going to—just it makes sense that as you see a slower new subscriber addition that builds over time and kind of compresses the revenue growth rate I guess the one thing that's a bit surprising is the growth rates in the AEC product segments are still really good, and I think this quarter was 14%. And that seems just as difficult an environment as what manufacturing customers and a lot of way are going through. Do you think you're kind of outperforming there in that segment and maybe those challenges elsewhere because it would seem like the AEC performance is ultimately standing out in this environment?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So what you are seeing in AEC is you're seeing our construction performance, all right? Construction is doing quite well. You saw that we added 400 new logos. We've got a building momentum there. We've got a great product. Looking forward, we are very bullish about where we're taking the construction business. The payment business is doing well. We are seeing wonderful growth associated with that. Customers like the product. They have plans to implement it. They're really attracted to the broad end-to-end solution. That's what people are buying for, their future, not for their present needs. They are trying to get front of where they need to be. That's what you're seeing in AEC. I also want to make sure that I just address something you said. Remember, with regards to manufacturing growth, you just have to take into account that we had some upfront revenue comparison last year. Those upfront revenue blips kind of have a disproportionate impact on how the manufacturing looks when you account for that, that growth is actually in low double digits. So we are actually performing well there as well relative to peers, especially on a full year basis. So what you're seeing in AEC, that's why you want to see us drive those Make businesses even more because they're really having an impact. Rev is doing great. There’s no doubt, but Construction is doing fantastic."
},
{
"speaker": "Joe Vruwink",
"text": "Okay, thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Elizabeth Porter of Morgan Stanley. Please go ahead, Eizabeth."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. Thank you very much for the question. Self-service sounds like a pretty big opportunity to drive the underlying efficiency. And just given Autodesk, can be a complex piece of software that does require some higher touch from sales or partners. Just how should we think about the base of business that could be applicable to self-service. Any sort of comments to help us understand kind of where it is today and where it could go over time would be very helpful. Thank you."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Self-service can touch just about every aspect of our business from a transactional point of view. So for us -- as a matter of fact, in -- some of our reinvest, we are going into improving some of these self-service capabilities right out of the gate. So on a transaction basis, the easier you make it for customers to see what they own, manage what they own, add new seats and all the things and be aware of what their users are using and where they might need more capacity, that drives up-sell and cross-sell immediately. The other aspects of self-service on the support level, look, there's a bunch of things that our customers come in and do that are very low-value transactions that we're getting significantly better at building systems that can automatically address those needs with the customer so that we can focus our human resources on the high-value returns. So every aspect of the business can benefit from an improved and enhanced self-service and there is lots of low-hanging fruit as we move forward in terms of making the self-service capabilities easier to access, easier to use and more complete in terms of how they work with our customers."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. And then just given we are just now entering this optimization phase for sales and marketing, and it is going to be a multiyear journey, it sounds like. At a high level, could you just help us understand a bit more what are some of the near-term versus longer-term key milestones we should look towards as we're going through this optimization phase?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, let me just remind everybody, this optimization phase is a deliberately planned activity connected to the last two years of changes. When we began the move to the new transaction model is when we began the planning of this optimization phase. So this is a purposeful, deliberate planned-out effort. The high-level main focuses for this are on optimizing certain processes, enhancing self-service like I talked about earlier, also improving efficiency and tightening the relationships with our partners, so that we just generally reduce duplication and get more efficiency from the whole system overall. The initial phases were focused primarily on some of our marketing efficiency some of the marketing-related go-to-market aspects of our efficiency. As we move forward, you're going to see us drill a little bit more into making sure that we're creating tighter relationships with our partners and ensuring that there's more optimization in terms of productivity associated with partner relationships, and you're going to see self-service have a bigger impact on the business moving forward. So considering a continuum from -- starting with the marketing optimization, moving through a continuum to enhancing partner engagement and getting more efficient there all the way through maximizing returns on self-service. All of that is going to deliver long-term margin improvement for the operating income improvement for the company."
},
{
"speaker": "Elizabeth Porter",
"text": "Thank you. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Matt Hedberg of RBC. Matt, your line is open."
},
{
"speaker": "Matt Hedberg",
"text": "Great. Thanks for taking my questions. And congrats again, Janesh. Really look forward to working with you again here at Autodesk. And starting out the year with a really strong free cash flow guide is really great to see as well. Maybe, Andrew, you talked a little bit earlier about Fusion, Gen AI, the product launch there. I guess I'm just wondering more philosophically, could you talk about sort of how we should think about additional generative AI rollouts across the product portfolio, how we should think about pricing? And just kind of the sensitivity around some of these data models given, obviously, a lot of it is customer specific."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. Look, we are very much focused on enhancing customer productivity with these tools. as the tools get more and more productive, obviously, there is opportunity to charge additional money for really high productivity AI features. So that we capture some of the productivity we bring to the customers. We share some of the productivity with them, and we capture some of the value back to us. What you're seeing with some of these early features is essentially things that help the customer build 3D models more quickly, more rapidly with a lot less labor. So that's really hitting them right in their productivity and it also makes our products much more competitive in situations, especially in Fusionland, we're dealing with a very large ecosystem of products that we compete with and this essentially sets up Fusion to be much more competitive as we move forward. If you look forward at some of the things we're doing in AEC, Forma is really dedicated to servicing AI capabilities that allow people to be much more productive creating building information models in a completely different way. We've already rolled out early conceptual features around analysis, around tools that help people make initial sizing a set of kind of doors and windows and initial frameworks. This has a huge possibility to bring them to the masses, meaning bring building information modeling down to smaller and smaller companies that have found Revit out of reach for both their capabilities and their budgets. Forma has an opportunity to really expand the footprint of who can do building information modeling. And that's one of the things we're targeting at those long term. So look for AI to provide not only new productivity, better competitive value and long-term potentially higher monetization for some of these highly productive features, but also look for it to expand our market footprint."
},
{
"speaker": "Matt Hedberg",
"text": "Got it. That's super helpful. And then Janesh, one for you, it sounds like we are going to get maybe a bit more color on kind of a midterm model perhaps on the Q3 Analyst Day. And so maybe just as a follow-up question to kind of thinking about the lower end of that 10% to 15% guidance range. I guess, how should we think about like maybe a floor of growth? We're getting that from a couple of investors today. Is there kind of a way to think about like -- is it kind of like high single digits? Is it 10%? Just any way to kind of think about how you think about kind of the lower end of kind of a growth outcome."
},
{
"speaker": "Janesh Moorjani",
"text": "Matt, great to be reconnected and looking forward to working with you, actually. So in terms of that growth range of the bottom-end of that framework of around 10%, if you look back over the last couple of years, that's where we fundamentally have been. And in fiscal '26, we are guiding to the 8% to 9% in constant currency, excluding the new transaction model effect. And actually, that's consistent with the underlying growth that we delivered in fiscal '25. So overall, we think that the business is resilient, and we've had consistent performance over a period of time, and our focus fundamentally is actually on driving sustainable growth as we continue to focus on new business growth and driving our Make business, especially through construction and manufacturing and the overall platform strategy like Andrew was saying."
},
{
"speaker": "Matt Hedberg",
"text": "Thanks, guys. Congrats."
},
{
"speaker": "Janesh Moorjani",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Joshua Tilton of Wolfe Research. Please go ahead, Joshua."
},
{
"speaker": "Joshua Tilton",
"text": "Hi, guys, can you hear me?"
},
{
"speaker": "Janesh Moorjani",
"text": "Yes, we can."
},
{
"speaker": "Joshua Tilton",
"text": "Great. Thanks for sneaking me in, I have two quick ones. The first question is, is there any sense you can give -- you can just help us understand maybe where the NRR finished for the year relative to what you're guiding to for revenue for next year. So for example, you're guiding to about 8.5% core growth ex-transition for next year. Like where relative to that are existing customers growing finishing this year? And then my second question is just a little more simple. How much of the recent like restructuring -- RIF announcement benefit is factored into the current operating margin guidance for this year?"
},
{
"speaker": "Janesh Moorjani",
"text": "Yes. Maybe I'll just address both of those. So in terms of the net retention rate, you'll see that we have, in the modeling guidelines, we've provided a view on how we are thinking about fiscal '26, which is basically the same as it was in fiscal '25. It's a range of 100% to 110%. And I realize that is a wide range, and we are essentially guiding to 8% to 9% growth on the underlying. But the way I think about that is the net retention rate essentially is hovers around the middle of the range. It can bounce around by a few points in any particular quarter. That's why we put a reasonably wide range to it. And so that is how we are thinking about that piece. And I'm sorry, would you mind repeating the second question, please?"
},
{
"speaker": "Joshua Tilton",
"text": "Yes. Just how much of the recent risk announcement or layoff announcement benefit is baked into the current operating margin guidance for this year?"
},
{
"speaker": "Janesh Moorjani",
"text": "Yes. So as we built the operating margin guidance for the year, obviously, any savings from the action are baked into the guidance already. But as I talked about earlier, the reinvestment and our organic hiring plan that we had built for fiscal '26 is really an integrated plan. And so if I think about the overall spending growth that we've baked into the model, which might be a different way to look at it. That spending growth overall for fiscal '26, again holding aside the effect of the new transaction model is slowing from 7% last year to [4%] (ph) this year in constant currency."
},
{
"speaker": "Joshua Tilton",
"text": "Thank you, very helpful."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Michael Turrin of Wells Fargo Securities. Your question please Michael."
},
{
"speaker": "Michael Turrin",
"text": "Hey great. Thanks appreciate you taken the question. I know there have been a few different angles on this. But Janesh, just on the commentary around the long-term target, just any perspective you can add given it is early in your tenure, so decision process that went into this? And maybe help us parse how much is using a different set of assumptions there or just any more context you can add because that is where we're getting the most questions initially."
},
{
"speaker": "Janesh Moorjani",
"text": "Yes, I'm happy to talk about that. And look, fundamentally, my view on the business is very similar to what we've experienced in the past. And coming into the business, recognizing that for the past couple of years, we've been hovering around the low-end of that range. And fiscal '26 on an apples-to-apples basis is very similar. The reality is we've just not been in the middle to high-end of that range and that's -- as I looked at the ranges, it felt inappropriate to have a range out there if we have not delivered against that in the last couple of years, at least being towards the middle or high end of that. And that was really the core principle behind this. But fundamentally, when I look at the business, as I said we delivered consistently, and it is a resilient business. You've seen us deliver over the last couple of years when there is been a lot of external factors that have been outside of our control. You've seen us do that through the business model transition we've been driving. We've got a strong and loyal customer base. Our products are in market-leading positions. We feel very good about our position overall."
},
{
"speaker": "Michael Turrin",
"text": "Yes, that's helpful color. And then, Andrew, just on the headcount reduction. I know these are tough decisions. Maybe just speak to how you ensure you're making the right level of change there, balancing efficiency with preserving the continuity and business momentum you're seeing? Thanks."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So we look at these things definitely over a long timeframe, and we are definitely trying to balance the risk short-term with the reward long-term in terms of what we did. And we feel like we've taken a really balanced approach here. You can see we've reinvested some of the money into future systems and capabilities that will allow us to do additional optimizations in the future. So we're trying to make sure that we cut the right kind of balance here so that we keep the business moving in the right direction, and we factored a lot of that risk into the way we're guiding. So I think we've done it right. And I think the ongoing optimizations are going to continue to deliver increasing profits as we move forward into next year."
},
{
"speaker": "Michael Turrin",
"text": "Thanks very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ken Wong of Oppenheimer & Company. Please go ahead, Ken."
},
{
"speaker": "Ken Wong",
"text": "Great. Maybe the last one on just that 10% to 15% range. I realize inappropriate to kind of keep that out there given the conditions and the performance. But with all the improvements that you guys are putting through with the go-to-market changes, the work with the channel, I mean, should we think about the other side of this when macro is fine, when you guys have delivered on the go-to-market changes that 10% to 15% is back in play? Is it arguably maybe even a better number? Like help us think through what the end goal with some of these changes would be in respect to what were the prior 10% to 15% goals."
},
{
"speaker": "Andrew Anagnost",
"text": "So Ken, where we're at right now, just to a [tax] (ph) the acknowledgment of where the business is right now. What you're not hearing is a reduction in face of the long-term growth potential for the company, all right? The areas we're talking about are the areas that really need to improve to drive the kind of behavior we want long term. It's all about getting the channel more productive. That's going to be a result of some of the changes that we're doing right now in some of the optimizations. The more productive the channel is, the more energy it has to spend on new business, the more the new business starts to build up over time and actually show up as revenue growth over time. The other thing is we are really excited about moving the design and make solution in a lot of our customers. So watch that make bucket because that's a clear sign that we are being successful penetrating the end-to-end solution. That's real long-term new growth for Autodesk. And by investing in that, we are essentially front-loading the capability to keep building up that book of business, which then shows up in the top-line over time. So that's the way to look at it. It's not a retreat from confidence in the long-term growth structure of the business, quite the contrary, but it is an acknowledgment of where we are at today."
},
{
"speaker": "Ken Wong",
"text": "Got it. Okay. Perfect. And then just a quick follow-up on, like, look, you guys have rolled out across all three regions now as far as the agency transition. Any update on how kind of those three areas are tracking. Obviously, we have the Americas, which were kind of a little further along, but you just rolled out APAC, would just love a sense of kind of how those are mapping relative to internal plans."
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So for the most part, things are going as we planned. There's an initial kind of pull forward of the business, and there is some production in new business as people go through getting their systems set up and renewing. We did see a few more productivity problems as we were hitting the end of all these rollouts than was originally expected, but we are now working through all of that. But for the most part, this is perceived as we expected, with a little bit more kind of, okay, we have some work to do to help the partners manage these systems effectively moving forward."
},
{
"speaker": "Ken Wong",
"text": "All right. Perfect. Thank you so much Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "You’re very welcome."
},
{
"speaker": "Operator",
"text": "Thank you. And ladies and gentlemen, that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thank you, everyone, for joining us today. We'll look forward to seeing many of you over the coming weeks. If you have any questions, please just e-mail me [simon@autodesk.com] (ph), and we'll look forward to catching up on our Q1 earnings call. Thanks so much [Latif] (ph) the team, and goodbye, everyone."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 3 | 2,025 | 2024-11-26 17:00:00 | Operator: Thank you for standing by, and welcome to Autodesk Third Quarter and Fiscal Year 2025 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, VP, Investor Relations. Please go ahead.
Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the third quarter results of Autodesk’s fiscal ‘25. On the line with me is Andrew Anagnost, our CEO and Betsy Rafael, our Interim CFO. During this call, we will make forward-looking statements, including outlook and related assumptions, and on products and strategies. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today’s press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year on year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. We finished the third quarter Q3 of the year strongly delivering 12% revenue growth in constant currency and have again raised full year guidance. This reflects the sustained momentum of the business and successful execution of our strategy, including a smooth implementation of the new transaction model in Western Europe. Once again, opportunity, resilience and discipline underpinned our performance. Last month at Autodesk University in San Diego, we hosted 12,000 registered attendees and another 30,000 online. We showed how granular data in the cloud, organized the data models and connected to everything through APIs can deliver even more valuable and connected solutions for customers and partners and support a much broader ecosystem and marketplace. Customers and channel partners that I spoke with at AU remained cautiously optimistic, a sentiment consistent with the underlying momentum of our business, our growing product usage and building connected bid activity trends over recent quarters. I left AU with a tremendous sense of purpose and optimism in the ingenuity and persistence of our customers and for the future. On our earnings call last quarter, I set out our secular growth opportunities and our strategy to capitalize on them. I concluded that Autodesk's investment in cloud, platform and AI in pursuit of those opportunities were ahead of its peers. AU was a good demonstration of that. But we're also leading the industry in modernizing our go to market motion, starting a few years ago with the subscription transition through consumption and self-service enablement and more recently to direct billing. These initiatives enable Autodesk to build larger and more durable direct relationships with its customers and to serve them more efficiently. We have already seen significant benefits from initiatives like these and there's more to come in the next optimization phase. Taking out the effects on margins from FX and the new transaction model, we still expect to be towards the midpoint of our fiscal ‘26 non-GAAP operating margin target of 38% to 40% in fiscal ‘25, a year ahead of schedule. We are confident we will make further improvement in fiscal ‘26 on the same basis. The new transaction model will enable tighter channel partnerships with less duplication of effort and more digital self-service and automation, which increases customer satisfaction and workforce productivity. It will also create new opportunities for partners and Autodesk to earn more with less emphasis on transaction revenue sharing and a greater emphasis on value creation for customers. Once complete, we expect the new transaction model and subsequent go to market optimization to increase sales and marketing efficiency and deliver GAAP margins among the best in the industry. Attractive long-term secular growth markets, a focused strategy delivering ever more valuable and connected solutions to our customers, and a resilient business are generating strong and sustained momentum both in absolute terms and relative to peers. Disciplined execution and capital deployment is driven even greater operational velocity and efficiency within Autodesk and will underpin the mechanical build of revenue and free cash flow over the next few years and GAAP margins among the best in the industry. We will continue to deploy capital to offset and buy forward dilution as our free cash flow grows from the fiscal ‘24 trough. This practice has reduced our share count over the last three years. We have significantly increased our share repurchase authorization to extend this momentum flexibility over the medium term with the precise trajectory remaining dependent on our debt repayment schedule and the ebb and flow of M&A. In combination, we believe these factors will deliver sustainable shareholder value over many years. Before I conclude, I'd like to formally welcome Janesh to Autodesk. We're excited to welcome Janesh who brings a wealth of experience and will be instrumental in sustaining Autodesk's growth and enhanced profitability momentum. Of equal importance, I'd like to thank Betsy for stepping in as interim CFO at an important time in the company's journey and I'm looking forward to continuing to work closely with her as an Autodesk Board member. I will now turn the call over to Betsy to discuss our quarterly financial performance and guidance for the year. I'll then return to provide an update on our strategic growth initiatives.
Betsy Rafael : Thanks, Andrew. Q3 was another strong quarter. We generated broad-based underlying growth across products and regions. In addition, we saw revenue increases from the new transaction model and M&A, which were offset by the absence of enterprise business agreement true ups from Q3 last year and FX. Our make products continued to enhance growth driven by our ongoing strength in construction and fusion. Overall, macroeconomic, policy and geopolitical challenges and the underlying momentum of the business were consistent with the last few quarters with continued strong renewal rates and headwinds to our new business growth. Total revenue grew 11% and 12% in constant currency. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 8%. AEC revenue, which was most impacted by the absence of true-up revenues, grew 12%; manufacturing revenue grew 16% and still comfortably in double digits excluding upfront revenue. And M&E revenue grew 15%, boosted by the Pix acquisition and associated integration adjustments. By region in constant currency, revenue grew 11% in the Americas, which was most impacted by the absence of true revenues, 13% in EMEA and 14% in APAC. The mechanical contribution from the new transaction model to revenue was $17 million in the third quarter and $25 million on a year to date basis. Direct revenue increased 23% and represented 42% of total revenue, up 4 percentage points from last year, benefiting from strong growth in both EBAs and the Autodesk store and also the natural tailwind to revenue from the new transaction model. Net revenue retention rate remained within the 100% to 110% range at constant exchange rate. Billings increased 28% in the quarter, reflecting a tailwind from the prior year shift to annual billings for most multiyear contracts, early renewals and the natural tailwind from the transition to the new transaction model. Similar to last quarter and as expected, co-turning negatively impacted billings ahead of the launch of the new transaction model in Western Europe. The natural contribution from the new transaction model to billings was $72 million in the third quarter and $108 million on a year to date basis. Total deferred revenue decreased 9% to $3.7 billion and was again impacted by the transition from upfront to annual billings for multi-year contracts. Total RPO of $6.1 million and current RPO of $4 million grew 17% and 14%, respectively, which reflects a tailwind from early renewals and the new transaction model and a headwind from the declining contribution of billed and unbilled deferred revenue from large multi-year and EBA cohorts ahead of renewals in fiscal 2026. Excluding these, current RPO growth was broadly consistent with Q2. We do expect the new transaction model and the larger FY’26 renewal cohorts to have a greater impact on both RPO and current RPO growth in Q4 of fiscal ‘25. Turning to margins, GAAP and non-GAAP gross margins were broadly level. With Autodesk University shifting back to Q3 this year from Q4 last year, GAAP and non-GAAP operating margins decreased by 2 and 3 percentage points respectively. The timing effect from AU obviously washes out over the full year. At current course and speed, the ratio of stock based compensation as a percentage of revenue peaked in fiscal ‘24 will fall by more than a percentage point in fiscal ‘25 and will be below 10% over time. Free cash flow for the quarter was $199 million. This benefited from some channel partners in Western Europe booking business earlier in the quarter ahead of the transition to the new transaction model really to de-risk month 1 after the transition. This accelerated free cash flow to the third quarter, which was partially offset by the expected negative impact of co-terming in Western Europe. Turning now to capital allocation. We continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long term shareholder value. As expected, the pace of buybacks picked up in the third quarter. We purchased approximately 1.2 million shares or $319 million at an average price of approximately $269 per share. We will continue to deploy capital to offset and buy forward dilution as our free cash flow grows from the fiscal ’24 trough. This practice has reduced our share count by about 5 million shares over the last three years with an average percentage reduction of about 70 basis points per year. We increased the amount authorized under our share repurchase program by $5 billion for a total of approximately $9 billion This extends our flexibility over the medium term with the precise trajectory remaining dependent on our debt repayment schedule as well as the ebbs and flow of M&A. Now let me finish with guidance. As we said in February, the pace of the rollout of the new transaction model will create noise in billings and the P&L. So we think free cash flow is the best measure of our performance. Taking out that noise, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year with continued strong renewal rates and headwinds to new business growth. Our sustained momentum in the third quarter and smooth launch of the new transaction model in Western Europe reduced the likelihood of our more cautious forecast scenario. Given that, we're raising the midpoint of our billing, revenue, margin, earnings per share and free cash flow guidance ranges. So let me give you a little bit more detail. The underlying momentum of billings is in line with our expectations. Compared to our modeling at the start of the year, the launch of the new transaction model in Western Europe in Q3 and early renewals have been a tailwind to billing, whereas more co-terming, more business done under the old buy sell model before the launch of the new transaction model and in recent weeks FX movements have been headwind stability. We now estimate that the new transaction model will provide between a 5 and 5.5 percentage point tailwind to billings growth in fiscal ‘25. We've raised the midpoint of our fiscal ‘25 billings guidance by $10 million to a range of $5.90 billion to $5.98 billion. The underlying momentum of revenue is also in line with our expectations. We estimate the new transaction model will provide around 1 to 1.5 percentage point tailwind to revenue growth in fiscal ‘25. Upfront revenue contributed 2 percentage points to revenue growth in Q4 of fiscal ‘24 and therefore this is a headwind in Q4 of fiscal ‘25. While not large enough to call out at the start of the year, it was already factored into our Q4 and our full year model. We've raised the midpoint of our fiscal ‘25 revenue guidance range by $18 million to a range of $6.12 billion to $6.13 billion. We're increasing our GAAP and non-GAAP margin guidance midpoint by 25 basis points by raising the bottom end of the ranges by 50 basis points. The GAAP margin guidance range is now 21.5% to 22%. The non-GAAP margin guidance range is now 35.5% to 36%, which includes a 1 to 1.5 percentage point underlying margin improvement broadly offset by the margin headwinds from the new transaction model and the related incremental investments in people, processes and automation. The underlying momentum of free cash flow is also in line with our expectations. The headwind to billings from co-terming and FX rate that I mentioned earlier is being offset by early renewals, faster collection and improved underlying margins. We raised the midpoint of our fiscal ‘25 free cash flow guidance by $10 million and tightened the range to $1.47 billion to $1.5 billion. We expect strong free cash flow growth in fiscal ‘26 because of the return of our largest multiyear renewal cohort, the natural mechanical stacking of multiyear contracts billed annually and a larger EBA cohort. With our current trajectory, we still estimate free cash flow in fiscal ‘26 to be around $2.05 billion at the midpoint. The slide deck on our website has more details on modeling assumptions for Q3 and for the full fiscal year ‘25. And while this may be my last earnings call for Autodesk, I will stick around for a bit to ensure a smooth transition for Janesh. Thank you, Andrew, and everyone at Autodesk for your support while I was here and to the many investors and the analysts with whom I've had lively discussions over the last few quarters. While the transition to annual billings for multiyear contracts and deployment of the new transaction model has created noise in billings in the P&L, they do provide a natural near term tailwind to revenue and free cash flow growth. Combined with a resilient business model, sustained competitive momentum, Autodesk has enviable sources of visibility and certainty in a very uncertain world. For all these reasons, I step down from my role as Interim CFO with tremendous optimism for the future. Andrew, back to you.
Andrew Anagnost: Thank you, Betsy. Let me finish by updating you on our strong progress in the third quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction, fueled by customers consolidating on to our solutions to connect and optimize previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions encompassing design, pre-construction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the midmarket. As a sign of our growing momentum as the benefits of our end to end solution become more apparent, our construction business continue to perform robustly with net new customers doubling year over year and existing customers renewal and expansion rates remaining strong. Let me give you a few examples. Power Construction is number 79 on the engineering news record ENR top 400 U.S. Contractor list. It is a Chicago-based general contractor serving residential and non-residential end markets. After completing a competitive RFP to replace its legacy project management tool, Power selected Autodesk for its unified construction platform across preconstruction, construction and VDC. By standardizing on Autodesk Construction Cloud, Power will have a single source of truth for project data, enhanced collaboration capabilities and streamlined workflows on a single platform. Power Construction was one of two ENR 400 top 100 U.S. Contractors that standardized enterprise wide on Autodesk build during the quarter. In Europe, Bouygues, a top 10 ENR 250 International contractor based in France and leader in sustainable building and infrastructure projects renewed and expanded its EBA in the quarter. Bouygues is continuing to consolidate on Autodesk Solutions across the enterprise, including broader adoption of Autodesk Forma, Carbon Insight and Informed Design to digitize, decarbonize and industrialize projects. It also significantly increases commitment to Autodesk Construction Cloud to drive efficiency gains and faster bid response times through better collaboration between design and project teams. Surbana Jurong is number 23 on ENRs top 225 International Design Firms. Based in Singapore, it is an urban infrastructure and integrated solutions consulting firm. In Q3, it renewed its third EBA which included increased investment in Autodesk Construction Cloud and Autodesk Water Infrastructure Solutions. ACC is helping to scale its operations through increased automation, integrated design workflows and enhanced collaboration across time zones. Our Water Infrastructure Solutions will be a core technology supporting its growth ambitions in planning, designing, engineering and managing water projects for customers worldwide. Again, these stories have a common theme, managing people, processes and data across the project lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformation and consolidate on our Design and Make platform. Fusion remains one of the fastest growing products in the manufacturing industry. As customers seek to drive innovation and growth at lower cost, Fusion extension attach rates are increasing which is helping to drive the average sales price higher. For example, in the quarter, a global manufacturer supplying the semiconductor industry selected Fusion Manage and Vault PLM over competitive solutions to foster greater collaboration across manufacturing sites and improve operating efficiency. Once fully scaled and operational, this customer expects to save 105,000 hours per year by connecting people and data resulting in reduced product development cost and faster time to market. In the UK, Playdale Playground has been designing, manufacturing and installing outdoor playground equipment for over 40 years. This quarter, Playdale added Fusion to its existing portfolio of audio solutions including Inventor, AutoCAD and Vault to streamline and digitize workflows, optimize production to reduce lead times, reduce non-conformities and replace inefficient excel driven operations on the shop floor. A long-time Autodesk customer and global leader in precision engineering solutions renewed and expanded it’s EBA in the quarter. In addition to Inventor, Vault and AutoCAD, it is adopting Fusion's general design capabilities for material waste reduction and fluid flow optimization and mold flow to reduce manufacturing costs and defects while increasing mold yields. In education, universities continue to modernize their courses and curriculum to attract and prepare future engineers. For example, from this winter, students at the University of Stuttgart’s Institute for Medical Device Technology will use Fusion across 6 courses. Fusion was selected to replace a competitive solution for its modern platform, ease of use, cloud collaboration capabilities and unique combination of PCB and Additive manufacturing workflows in a single team environment. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. For example, after a period of rapid scaling and diversification, a large multinational manufacturing company in APAC was looking to align compliance rates across its global employee base. Working collaboratively, we addressed compliance issues while cementing a long term partnership and completing one of our largest ever license compliance agreements which included expanded adoption of Alias and VRED for the design studio and PDMC for mechanical engineering and rail design. Attractive long term secular growth markets, a focused strategy delivering ever more valuable and connected solutions to our customers and a resilient business are generating strong and sustained momentum both in absolute terms and relative to peers. Disciplined execution and capital deployment is driving even greater operational velocity and efficiency within Autodesk. And we continue to deploy capital to deliver sustainable shareholder value over many years. I retain a tremendous sense of purpose and optimism in the ingenuity and persistence of our customers and for the future. Operator, we would now like to open the call up for questions.
Operator: [Operator Instructions] Our first question comes from the line of Jason Celino of KeyBanc Capital Markets.
Jason Celino: Hey, thanks for taking my questions. Just two for me. The first one, Andrew, some of us are unfamiliar with Janesh. Can you just tell us a little bit more about him and what he brings to Autodesk?
Andrew Anagnost : I certainly can. Before I do that, let me make sure that I thank Betsy for everything she brought to Autodesk during this interim period. I really appreciate it, the company appreciates it. Thank you, Betsy. Now, we're really excited about Janesh. Let me tell you why we're excited about Janesh. As you remember, one of the things I was telling you that I was looking for was someone that was going to be able to dispassionately drive optimization and scale inside Autodesk. And what that really means is someone that's going to be really inwardly focused looking at every dollar that we invest and make sure that we're getting the most returns for the business, that investors are getting the best returns from their business. The next kind of criteria we were looking for, which is a nice to have was time in the seat as a sitting CFO, which was important for us as well. But it was kind of the next nice to have after the optimization of scale. Janesh brings a great balance of both of those things, all right. He's been in the seat seven years at Elastic, both CFO and COO, driving some fairly turbulent changes inside of Elastic. So he's got battle scars from pushing inside the company to get changes done inside and we like that. We like that a lot. He's also got very good early experience at companies that we feel have always added value to Autodesk. So, he was at VMware in a senior position, he was at Cisco in a senior position. We've had good success bringing people from those kind of companies. He worked at those companies driving optimization at scale, which is the number one criteria I was looking for when we're driving this work. He also has another nice to have. He's got knowledge of our industry. He spent two years at PTC in his career. He was actually recently on the PTC Board. So, he understands our industry and he'll be able to get up to speed pretty quickly. The number one goal here, drive optimization and scale over the next few years, make sure that we're getting everything we need from every dollar we invest, which is a very important theme for Autodesk. And with that, I'm really excited and I'm looking forward to him joining in December.
Jason Celino: Okay, great. Interesting. And then for my second question, now that you do have a CFO, do you have any thoughts on when you might hold the next Investor Day? I think in the past you usually did it in March. Is that a good timeframe or is that too soon?
Andrew Anagnost : Yeah. Well, Janesh is joining in December. I think we need to give him time to get his few legs on, give him time to kind of drive the end of the year and actually get us set up for next fiscal year in good speed. So, I would say, it's unlikely we will be doing anything in the spring, but we will get back to you on that as soon as Janesh is ready to talk about those things.
Operator: Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities.
Jay Vleeschhouwer: Thank you. Andrew, as of the third quarter, your three year CAGR for current RPO is about 12%. How are you thinking about the sustainability or perhaps improvement upon that CAGR for CRPO over the next number of years? When we think about the ingredients of that, it looks like over the last several years, the CAGR for your unit volume for all brands is roughly 6% to 7% in the aggregate. So on top of that, you've had price and other ingredients, but perhaps talk about how you think you might be able to improve upon the most recent trajectory for current RPO? Then my follow-up.
Betsy Rafael : Yeah. Hi, Jay. This is Betsy. Let me just give you a couple of things. There's a number of things that are going on, on the headline of the CRPO number. If you first take away the headwinds and the tailwinds, CRPO was broadly consistent with the second quarter. And as I mentioned in my opening commentary, early renewals and growth with and the new transaction model are providing a tailwind. And then there's also a headwind to CRPO growth from the declining contribution of billed and unbilled deferred revenue, ripped from the large multiyear and EBA cohort coming up for renewal in fiscal '26. And just as a reminder, these are the same larger cohorts we are calling out as tailwinds to free cash flow for next year. And if you look back to fiscal ‘22, we saw the same dynamic ahead of the fiscal 2023 renewals as well.
Jay Vleeschhouwer: Okay. Since new management is part of the news this evening, could you talk about how you're thinking about the Chief Revenue Officer position? Would it make sense perhaps to continue to have separate CRO or do you think it might make more sense perhaps to combine CRO and COO?
Andrew Anagnost : Yeah. So, we're going to continue to have a separate CRO because we have various functions that work together there under the COO organization including our IT organization, our infrastructure and all things associated with. What we're looking for in our CRO is someone that understands how to continue to drive a business when you have direct engagement with the customer. So that means someone that really understands what it takes to analyze self-service patterns, actually understand the data that comes in from the customers to help drive cross sell and up sell, while also transforming a channel from a transactionally focused extension of Autodesk to kind of a solutions partner that's driving lifecycle solutions for our customers. So, that's the kind of role we're looking for here. And yes, it's going to continue to be a standalone CRO role within the COO organization.
Operator: The next question comes from the line of Adam Borg of Stifel.
Adam Borg: Awesome. Thanks so much for taking the questions and congrats to Betsy and Janesh. Maybe on the new transaction model, I know it's still early. I was just curious, are there any learnings from those customers that are on the new model that you're seeing in terms of the adoption of Autodesk technology and the ability to find white space to better upsell and cross-sell different solutions now that you have a more direct relationship?
Andrew Anagnost : Yeah, Adam, it's really early on to be able to make any kind of conclusions about that. What I can tell you is that we definitely see some shift to some of the direct channels at Autodesk for customers that were probably just served on a very kind of arm's length kind of transactional level. But in terms of driving cross sell and upsell, early days, early days. But if you want to get a sense for how that might evolve, we've got experience with our EBAs and our enterprise business agreements. And we've learned over the years that having that kind of relationship with the customer, where we really understand their usage patterns, who they are and what they're doing, we are much more effective at driving cross sell and up sell, even when partnering with our channel partners. So I think those kind of stand as a testament of what's possible as we move forward with the completion of the new transaction model.
Adam Borg: Great. And maybe just as a quick follow-up, just as we think about the new administration coming in, you talked about the macro being broadly consistent. Any change in tone in your conversations with the end markets in terms of optimism or their ability or willingness to expand new projects ahead of the administration, any pause or just full steam ahead? I'm just curious, any commentary you have there from a macro perspective would be really, really helpful.
Andrew Anagnost : What I'll say is the things that matter to our customers are bipartisan things, all right? Our customers care about infrastructure build outs. Both parties care about infrastructure build outs. Our customers care about domestic manufacturing, be it in Europe, be it in the United States. Both parties agree that domestic manufacturing build-outs are important. It's supply chain independent, supply chain stability. All of these things are bipartisan issues that really affect our customers. So regardless of the administration, I suspect the things that are important to our customers are continuing to be a focus.
Operator: Our next question comes from the line of Joe Vruwink of Baird.
Joe Vruwink: Great. Thank you. On the outlook for next year, $2.05 billion in free cash has I think been the expectation for the past year now. Within the last year, you've also seen more co term of contracts and I think that leads to better billings in FY '26. So my question is, does that actually create the potential that things are better and that's why you're qualifying now the $2.05 billion as the midpoint of possibilities?
Betsy Rafael: There is no change to how we've talked about the free cash flow guide for fiscal ‘26. It continues to be $2.05 billion at the midpoint.
Joe Vruwink: Okay. Fair enough. And then just on the M&A environment over recent history, Autodesk has been more in a mode of, I would say, strategic tuck ins. I think there was actually an asset in the CFE simulation space that was announced during AU in the quarter. Is that the right approach for Autodesk just given this point in time all the work you've done to build out the cloud platform, the data models and so these tuck-ins make the most sense? And if that's true, how would you maybe compare and contrast some of the larger scale M&A that's happening with your peers in the space?
Andrew Anagnost : Yeah. So, look, consolidation in our space is inevitable. I'm not going to comment on any specific deals, but here is what I will say. Autodesk has always been an acquisitive company and we will be a acquisitive company when that makes both strategic and financial sense for the company.
Operator: Our next question comes from the line of Elizabeth Porter of Morgan Stanley.
Elizabeth Porter: Great. Thanks so much for the question. As partners are getting customers just up and running on the new transaction model, we picked up that they're spending a little bit more time than usual of time and resources with those existing customers. So I was curious if that had any impact on new business demand kind of more recently. And then just more broadly, any change in new business trends that you think you should call out from versus last quarter?
Betsy Rafael : Yes. Elizabeth, it's Betsey. And so just broadly speaking, we continue to see growth but at a slower pace due to a number of factors over the really over the last several years, macro COVID, exiting Russia, elections. And while a drag on the forward momentum of the business, all of that's really factored into our guidance. So I kind of just will leave it at that.
Elizabeth Porter: Great. And then a follow-up just on billings. Understanding there's a lot of volatility around the change from multiyear and the transaction model. But it looks like guidance implies a bigger step down in growth in Q4 just despite an easier year ago compare. So it's helpful that you could help us unpack the balance of those headwinds and tailwinds that would drive kind of a greater downtick in growth in Q4.
Betsy Rafael : Well, again, let me start out with just from a fiscal '25 perspective. Your billing tailwinds are going to be from the final shift to annual billing, new transaction model and early renewals. And you're going to get headwinds from co-terming and business booked ahead of the new transaction model launch and in recent weeks, some FX. So again, I think that we've continued to perform well as we've executed through Q3. And so, I think we feel very strongly about our expectations for Q4.
Operator: Our next question comes from the line of Bhavin Shah of Deutsche Bank.
Bhavin Shah: Great. Thanks for taking my question. Andrew, at University, there appeared to be a noticeable uptick in attendance and sessions geared towards owners and operators. What's been driving the recent interest from this segment? How much of it is enhancing you guys have made versus really more focusing and emphasizing from a go to market perspective? And how long before this segment of buyers kind of becomes more meaningful to the financials?
Andrew Anagnost : Yeah, Bhavin, that's an excellent question, all right. We're very interested in tackling the whole entire lifecycle from design through make, construction, manufacturing all the way into operations. You're probably aware we have a product called Tandem. And a lot of those sessions were driven by increasing interest and increasing adoption of Tandem, which is a digital twin solution tightly coupled to our solutions that also has a toolkit that allows people to easily connect sensor data through the digital twin solution. So you're seeing that uptick because we're directly releasing products and capabilities that are of interest to the owner space. You can expect to see that trend continue over time and you can expect to see us continue to talk about the owner space, continue to deliver solutions for the owner space and even APIs for the owner space. It's an area of great interest, especially when it comes not only to vertical buildings, but factories and other things that are related to that as well as infrastructure like what we were doing with some of our water owner solutions. So, yes, owners matter. We're building software for them and you're going to see more of that.
Bhavin Shah: Super helpful there. And then Betsy, one for you. Just in terms of the underlying improvement that we've been seeing in the margins and I know you've called out FX and the transaction model. I know it's very early, but as we think about next year, how do we think about the impact of FX and the transaction model to kind of the headline operating margins?
Betsy Rafael : Well, I wish I could give you that answer, but I think that the new CFO would probably have a little bit of a problem with that. So we'll wait till the end of February to give you more specifics on that.
Operator: Our next question comes from the line of Tyler Radke of Citi.
Tyler Radke: Yes, good afternoon. Thanks for taking the questions. I was going to ask you about a placeholder for next year's guidance, Betsy, but I don't want to waste a question on that, but feel free to answer. But Andrew, I wanted to kind of ask you about some of your comments you made around efficiency, especially as it relates to hiring Janesh, who you pointed out has a lot of experience at larger companies, VMware, Cisco, et cetera. Now that you're a few quarters into this transaction model rollout, you have kind of visibility better on some of the channel, prior channel relationships, having that direct billing with the customer. What are some of the areas that you've identified as having that efficiency potential? And then as we think about that efficiency unlock, should we think about that as incremental to the free cash flow number you have out for next year or is that embedded in that already?
Andrew Anagnost: So many layers in that question. So first, let me kind of answer the question in a curious serious stage, it's going to dodge other ones, okay. So first off, optimization is kind of a mindset at Autodesk. It's not something that suddenly happens. I want to reemphasize that because if you look right now this year, for example, when you look at the apples to apples comparison, which will be in the slide deck or in our disclosed materials. You can see that our non-GAAP margins are already hitting the targets we set for next year, this year, okay. So optimization is a mentality. You've also heard me say over and over again as the new transaction model starts to roll out, optimization of our go-to-market efforts is going to be a critical step for us and part of the optimization journey that we're on. That's going to deliver margin growth for the company for couple of years to come, okay. And I think that's important. It's a long-term driver. Now, we're getting into the specifics, okay. I think the specifics are probably for another time, but let me just kind of give you a sense for some of the things that are important, all right. One is the drive to self-service, all right. Self-service is a huge impact on how our customers will engage with us and where those customers come from. And that is a value accretive to Autodesk, both on an efficiency side from renewals and other things, but also on a revenue growth side through capturing the customers directly. The other thing I talked about is understanding the customer better, so the upsell and cross sell. So we're going to be able to do a lot more automation and understanding about what where the opportunities are and that's going to drive some efficiencies. And we're moving the channel partners away from this model of being the transactional players to being the solution providers and the IP providers to our customers. That's going to have all sorts of opportunities to eliminate duplication of effort and drive real cost efficiencies for the company moving forward. So there's both top-line efficiencies here and revenue growth, but there's bottom line efficiencies as well through removing the redundancies and steps that just aren't necessary for the customer. You'll get a lot more clarity on that as you see us continue to move forward with this go to market optimization in next year and beyond that.
Tyler Radke: Great. Thanks for the detail. And then my follow-up question, Andrew, you talked about some really strong net new customer additions within the construction cloud, I think doubling year over year. We also saw the make revenue accelerate to 28% constant currency. Can you just help us understand, do you think that reacceleration is durable? And how are you sort of thinking about just your position there? What's been driving that strength in the new customer additions?
Andrew Anagnost : First, let me comment on the make revenue, then I'm going to go into construction. So, the make revenue also includes some revenue from PIX and things associated with that. However, let's talk about the facts around our construction business, because I think this is important, right? Number one factor is that we continue to drive consistent high growth in our construction solutions. You're seeing it, it's built into the make numbers and it's the lion share of those make numbers. You're really seeing some consistent growth there. That's organically. Inorganically, we're actually executing incredibly well on things like Payapps and that's driving acceleration of our growth. So we are not decelerating as a business, okay. We are actually performing solidly or inorganically we're accelerating, all right. And I just want to be really clear about that. And yes, we said year over year we drove a 2x increase in our new customers. And I'll talk about where some of that's coming from in just a minute. But I also want to highlight the other thing that's going on. We are strengthening an already strong position in the ENR 400. So you heard about the story about power construction, which was a great example of someone taking out a competitive RFP and say, look, I need a forward looking cloud based solution on new technology that goes end to end from design to construction all the way to operations. And they chose us. And that was just one example that we gave in the opening commentary. So already a strengthening position in the ENR 400. Now, the other qualitative things that are driving some of that new customer growth is we already have our distribution channel operating at scale. In the U.S, this is helping us go down market more effectively, which is allowing us to capture more customers more effectively, be places where we weren't before and where others aren't, which is part of driving that. But also, we're already at scale operating internationally with our distribution channel. So that's driving international growth for us. And that's a really important driver as well as some of those net new accounts that you're seeing there. And the last thing I'll add and then I'm done with construction is that look, I heard this over and over again at AU. I'm hearing it over and over again from customers in lots of different places. They want the end-to-end solution. They want the life in the cloud. They're placing bets for the next 10 years. They want to go from design to construction to operations. And that's just making our solution more attractive to the market.
Operator: Our next question comes from the line of Michael Turrin of Wells Fargo.
Michael Turrin: Hey, thanks very much. Appreciate you taking the questions. The commentary on the call sounded consistent, but wondering if there are any added details you can provide for us on, just the overall macro spend environment and how that's maybe progressing across either key product segments or geos, whatever split you think is more useful. I think what we're trying to get a sense for is if there are any shades of improvement anywhere or if you'd characterize as mainly just consistent over the past couple of quarters?
Andrew Anagnost : Michael, I think the core answer here is consistency, okay? We're seeing consistent trends that we've seen with all in all the other quarters. There's always puts and takes in a large business like ours, especially one that's diverse as ours. But the general tone is, it's consistent with prior quarters.
Betsy Rafael: And I would just add that there's also been a lot of noise this year from the new transaction model and then obviously the elections leading up to that. And so it's hard to sparse out, kind of that particular behavior. So I think as Andrew said, we call it consistent.
Michael Turrin: Yes, tough first, two. That's why we keep asking. Betsy, congrats on the transition back given you're also on the Board. I think it'd be useful to hear you chime in on the hiring of Janesh and maybe just also comment on how you ensure you're able to hand over the reins and keep progress going on the key transitions the company is working through?
Betsy Rafael : First, I was involved in the process, which was quite extensive in the company, the recruiting of Janesh. And so we're certainly very excited to have him on board. What I would also say, is obviously with my experience of being on the board for 11 years as well as my deep dive into the business over the last six months, One of the reasons I'm staying around until the end of the fiscal year is I think I can be really helpful in that transition for Janesh. And so I'm very much looking forward. And I think that we have a great finance team, and I think that he's going to be -- he's going to fit very well, and I'm looking forward to making that happen as fast as we can.
Operator: Our next question comes from the line of Matthew Hedberg of RBC Capital Markets.
Mike Richards: Hey, guys. This is, Mike Richards on for Matt. Thanks for taking the question. I was wondering if you could provide an update on Project Bernini and maybe how customer reception has been and where we are in developing other foundational models or just the monetization opportunity there.
Andrew Anagnost : Yeah. So first off, before I comment on bringing you, AI is you might have heard from AU. AI is embedded in everything we're doing from a bottom up and a top down perspective. And you also heard us talk at AU about new types of foundation models we're building that understand how certain things are done in our applications. You heard about a foundation model that's driving automated drawing creation. You heard about a foundation model that's driving automated sketch generation and sketch constraints. That kind of stuff is bottom up innovation. Bernini is more of a top down type innovation where you're actually specifying things and trying to generate a preliminary outcome from those specifications. And what we've been doing with Bernini is we've been trying to engage with certain targeted customers to get them to participate with us in making Bernini smarter and more intelligent. It's not available commercially right now, but it's getting more intelligent. We've actually been successful in getting some customers to stand up and say, look, yeah, I'd like to work with you to make this more intelligent because we need something that actually understands 3D geometry as geometry, not just as a picture of something, okay? So that's what's going on with Bernini right now. And you should continue to see refinements and extensions of that moving forward. Now with regard to monetization, monetization, nobody knows exactly how all this is going to be monetized. But is a few vectors here that come into play. One, we are ahead of our competitors in this space. We intend to be ahead. We're investing to stay ahead. That increases one's competitive position in the marketplace and that's really important. Also, you get to be able to charge for some of these incremental features in the future. When you're delivering value or a high quality outcome as a result, you're going to charge for that outcome. How we charge for those things? Let's let this play out, okay? It's still early days. But you also there's also monetization opportunity through licensing certain technologies for specific mature maturation for a specific customer's needs, all right. And that will be another avenue. So how these avenues play out, which one weighs more, let's just play out. But what you need to know about Autodesk is we're ahead, we've been ahead for a while, we were the first out there with an AI research lab that's been out there for over six years, published 70 papers. We're right on the cutting edge of 3D design technology and AI, and we intend to stay there.
Operator: Our next question comes from the line of Steve Tusa of JPMorgan.
Steve Tusa: Hey, good evening or afternoon. Lots of good questions asked. Just a detailed one, what's the change in the billings contribution from the transaction model change, the 5% to 6% to 5% to 5.5%.
Andrew Anagnost : Yeah. So it's basically because we did more buy sell business ahead of the European launch. So remember we said 5% to 6% when we launched Europe and it was the if we did more buy sell business, which means there's less tailwind from the new transaction model. The flip side means that means that the underlying increase in our billings guidance is greater than it looks on a headline basis.
Operator: Our next question comes from the line of Joshua Tilton of Wolfe Research.
Joshua Tilton: Great. I have a kind of a high level one on the incoming CFO. If I if I heard correctly, we didn't exactly get, like, an initial outlook for, revenue growth for next year. And I'm just trying to understand in the context of the new CFO coming in, is there anything that could change the calculus of how you guys think about that 10% to 15% growth for the underlying business outside of the agency transition that's ongoing today?
Andrew Anagnost : Well, first, let's talk about that framework a little bit and then I'll comment a little bit on the increase in CFO. So, look, the 10% to 50% growth, right now we're pretty much right at the bottom end of that range. And if we look back over the last two years, there's been a series of things that created headwinds to new business. It started off with things like the pandemic, the inflation, the exiting of the Russian business, the writer's strike, the whole trade wars within particular geographies, all of these things were accumulated headwinds that built slowly into the business and have pushed us down to the low end of the range. It takes time in a subscription model for those things to build out of the business, okay? So it's going to take time for us to build out of that. That's to be expected with a subscription model. The revenue goes down slowly, it goes back up slowly as headwinds turn into tailwinds. So expect us to be near the bottom of that range in the short term just as a general kind of guideline for the core business to be at the bottom of the range, okay? As a long term framework, the 10% to 15% still makes sense as a long term guide for the company. But of course, as new eyes come in, we'll look at these things and we'll evaluate them. But right now, this all still makes sense.
Operator: Our next question comes from the line of Siti Panigrahi of Mizuho.
Siti Panigrahi: Thanks for taking my question. I understand the new business model have some kind of noise on your expense and margin side. But if you exclude that, where do you see some of the operating leverages that you can drive in next year or so?
Betsy Rafael : Well, I think we've actually provided kind of historically what we've done over the last three years pretty clearly. And I think we said that we're continuing to be focused on expansion, but nothing further to add as far as next year.
Betsy Rafael : We did provide data on that. So you can see what the underlying thing is and we expect to see continued improvement in that same vector.
Simon Mays-Smith : On the same basis.
Andrew Anagnost : On the same basis, on the same apples-to-apples basis.
Operator: Our next question comes from the line of Michael Funk of Bank of America.
Michael Funk: Hey, guys. Thank you for the questions tonight. Two if I could. You've mentioned a few times in the last calls about the largest multiyear cohort renewing next year and then also a large EBA cohort. Just wondering if you can give us kind of the range of potential outcomes among the renewals there, whether potential to upsell, risk of down sell and what that variance might look like around those renewals?
Betsy Rafael : No, I mean, I think what we have said is that it's the largest cohort that and we saw that performance in ‘23. And so we expect a strong renewal year, but we're not giving any specific guidance on what that looks like for ‘26 at this point and we'll wait until we report earnings in February.
Michael Funk: Okay, great. And then Betsy, one more. You've mentioned a few times off the investment in new transaction model, people, processes and automation, presumably more fixed cost versus variable like commission. Can you quantify that for us to help us with modeling as we try to forecast margin? I know you've not giving guidance, but better understanding of what that cost might actually be on an absolute basis would help us to think about our modeling?
Simon Mays-Smith : Mike, we've got a slide in the earnings deck to help you think about modeling and I'll just point you to that.
Operator: Thank you. And ladies and gentlemen, that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?
Simon Mays-Smith: Great. Thanks, and thank you everyone for joining us today. Looking forward to seeing many of you on the road over the next few weeks. If you have any questions in the meantime, please email me or call me. And in the meantime, all those of you in North America, wishing you a very happy Thanksgiving. Thank you.
Operator: Thank you, Simon. This concludes today's conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by, and welcome to Autodesk Third Quarter and Fiscal Year 2025 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, VP, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the third quarter results of Autodesk’s fiscal ‘25. On the line with me is Andrew Anagnost, our CEO and Betsy Rafael, our Interim CFO. During this call, we will make forward-looking statements, including outlook and related assumptions, and on products and strategies. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today’s press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year on year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon, and welcome everyone to the call. We finished the third quarter Q3 of the year strongly delivering 12% revenue growth in constant currency and have again raised full year guidance. This reflects the sustained momentum of the business and successful execution of our strategy, including a smooth implementation of the new transaction model in Western Europe. Once again, opportunity, resilience and discipline underpinned our performance. Last month at Autodesk University in San Diego, we hosted 12,000 registered attendees and another 30,000 online. We showed how granular data in the cloud, organized the data models and connected to everything through APIs can deliver even more valuable and connected solutions for customers and partners and support a much broader ecosystem and marketplace. Customers and channel partners that I spoke with at AU remained cautiously optimistic, a sentiment consistent with the underlying momentum of our business, our growing product usage and building connected bid activity trends over recent quarters. I left AU with a tremendous sense of purpose and optimism in the ingenuity and persistence of our customers and for the future. On our earnings call last quarter, I set out our secular growth opportunities and our strategy to capitalize on them. I concluded that Autodesk's investment in cloud, platform and AI in pursuit of those opportunities were ahead of its peers. AU was a good demonstration of that. But we're also leading the industry in modernizing our go to market motion, starting a few years ago with the subscription transition through consumption and self-service enablement and more recently to direct billing. These initiatives enable Autodesk to build larger and more durable direct relationships with its customers and to serve them more efficiently. We have already seen significant benefits from initiatives like these and there's more to come in the next optimization phase. Taking out the effects on margins from FX and the new transaction model, we still expect to be towards the midpoint of our fiscal ‘26 non-GAAP operating margin target of 38% to 40% in fiscal ‘25, a year ahead of schedule. We are confident we will make further improvement in fiscal ‘26 on the same basis. The new transaction model will enable tighter channel partnerships with less duplication of effort and more digital self-service and automation, which increases customer satisfaction and workforce productivity. It will also create new opportunities for partners and Autodesk to earn more with less emphasis on transaction revenue sharing and a greater emphasis on value creation for customers. Once complete, we expect the new transaction model and subsequent go to market optimization to increase sales and marketing efficiency and deliver GAAP margins among the best in the industry. Attractive long-term secular growth markets, a focused strategy delivering ever more valuable and connected solutions to our customers, and a resilient business are generating strong and sustained momentum both in absolute terms and relative to peers. Disciplined execution and capital deployment is driven even greater operational velocity and efficiency within Autodesk and will underpin the mechanical build of revenue and free cash flow over the next few years and GAAP margins among the best in the industry. We will continue to deploy capital to offset and buy forward dilution as our free cash flow grows from the fiscal ‘24 trough. This practice has reduced our share count over the last three years. We have significantly increased our share repurchase authorization to extend this momentum flexibility over the medium term with the precise trajectory remaining dependent on our debt repayment schedule and the ebb and flow of M&A. In combination, we believe these factors will deliver sustainable shareholder value over many years. Before I conclude, I'd like to formally welcome Janesh to Autodesk. We're excited to welcome Janesh who brings a wealth of experience and will be instrumental in sustaining Autodesk's growth and enhanced profitability momentum. Of equal importance, I'd like to thank Betsy for stepping in as interim CFO at an important time in the company's journey and I'm looking forward to continuing to work closely with her as an Autodesk Board member. I will now turn the call over to Betsy to discuss our quarterly financial performance and guidance for the year. I'll then return to provide an update on our strategic growth initiatives."
},
{
"speaker": "Betsy Rafael",
"text": "Thanks, Andrew. Q3 was another strong quarter. We generated broad-based underlying growth across products and regions. In addition, we saw revenue increases from the new transaction model and M&A, which were offset by the absence of enterprise business agreement true ups from Q3 last year and FX. Our make products continued to enhance growth driven by our ongoing strength in construction and fusion. Overall, macroeconomic, policy and geopolitical challenges and the underlying momentum of the business were consistent with the last few quarters with continued strong renewal rates and headwinds to our new business growth. Total revenue grew 11% and 12% in constant currency. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 8%. AEC revenue, which was most impacted by the absence of true-up revenues, grew 12%; manufacturing revenue grew 16% and still comfortably in double digits excluding upfront revenue. And M&E revenue grew 15%, boosted by the Pix acquisition and associated integration adjustments. By region in constant currency, revenue grew 11% in the Americas, which was most impacted by the absence of true revenues, 13% in EMEA and 14% in APAC. The mechanical contribution from the new transaction model to revenue was $17 million in the third quarter and $25 million on a year to date basis. Direct revenue increased 23% and represented 42% of total revenue, up 4 percentage points from last year, benefiting from strong growth in both EBAs and the Autodesk store and also the natural tailwind to revenue from the new transaction model. Net revenue retention rate remained within the 100% to 110% range at constant exchange rate. Billings increased 28% in the quarter, reflecting a tailwind from the prior year shift to annual billings for most multiyear contracts, early renewals and the natural tailwind from the transition to the new transaction model. Similar to last quarter and as expected, co-turning negatively impacted billings ahead of the launch of the new transaction model in Western Europe. The natural contribution from the new transaction model to billings was $72 million in the third quarter and $108 million on a year to date basis. Total deferred revenue decreased 9% to $3.7 billion and was again impacted by the transition from upfront to annual billings for multi-year contracts. Total RPO of $6.1 million and current RPO of $4 million grew 17% and 14%, respectively, which reflects a tailwind from early renewals and the new transaction model and a headwind from the declining contribution of billed and unbilled deferred revenue from large multi-year and EBA cohorts ahead of renewals in fiscal 2026. Excluding these, current RPO growth was broadly consistent with Q2. We do expect the new transaction model and the larger FY’26 renewal cohorts to have a greater impact on both RPO and current RPO growth in Q4 of fiscal ‘25. Turning to margins, GAAP and non-GAAP gross margins were broadly level. With Autodesk University shifting back to Q3 this year from Q4 last year, GAAP and non-GAAP operating margins decreased by 2 and 3 percentage points respectively. The timing effect from AU obviously washes out over the full year. At current course and speed, the ratio of stock based compensation as a percentage of revenue peaked in fiscal ‘24 will fall by more than a percentage point in fiscal ‘25 and will be below 10% over time. Free cash flow for the quarter was $199 million. This benefited from some channel partners in Western Europe booking business earlier in the quarter ahead of the transition to the new transaction model really to de-risk month 1 after the transition. This accelerated free cash flow to the third quarter, which was partially offset by the expected negative impact of co-terming in Western Europe. Turning now to capital allocation. We continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long term shareholder value. As expected, the pace of buybacks picked up in the third quarter. We purchased approximately 1.2 million shares or $319 million at an average price of approximately $269 per share. We will continue to deploy capital to offset and buy forward dilution as our free cash flow grows from the fiscal ’24 trough. This practice has reduced our share count by about 5 million shares over the last three years with an average percentage reduction of about 70 basis points per year. We increased the amount authorized under our share repurchase program by $5 billion for a total of approximately $9 billion This extends our flexibility over the medium term with the precise trajectory remaining dependent on our debt repayment schedule as well as the ebbs and flow of M&A. Now let me finish with guidance. As we said in February, the pace of the rollout of the new transaction model will create noise in billings and the P&L. So we think free cash flow is the best measure of our performance. Taking out that noise, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year with continued strong renewal rates and headwinds to new business growth. Our sustained momentum in the third quarter and smooth launch of the new transaction model in Western Europe reduced the likelihood of our more cautious forecast scenario. Given that, we're raising the midpoint of our billing, revenue, margin, earnings per share and free cash flow guidance ranges. So let me give you a little bit more detail. The underlying momentum of billings is in line with our expectations. Compared to our modeling at the start of the year, the launch of the new transaction model in Western Europe in Q3 and early renewals have been a tailwind to billing, whereas more co-terming, more business done under the old buy sell model before the launch of the new transaction model and in recent weeks FX movements have been headwind stability. We now estimate that the new transaction model will provide between a 5 and 5.5 percentage point tailwind to billings growth in fiscal ‘25. We've raised the midpoint of our fiscal ‘25 billings guidance by $10 million to a range of $5.90 billion to $5.98 billion. The underlying momentum of revenue is also in line with our expectations. We estimate the new transaction model will provide around 1 to 1.5 percentage point tailwind to revenue growth in fiscal ‘25. Upfront revenue contributed 2 percentage points to revenue growth in Q4 of fiscal ‘24 and therefore this is a headwind in Q4 of fiscal ‘25. While not large enough to call out at the start of the year, it was already factored into our Q4 and our full year model. We've raised the midpoint of our fiscal ‘25 revenue guidance range by $18 million to a range of $6.12 billion to $6.13 billion. We're increasing our GAAP and non-GAAP margin guidance midpoint by 25 basis points by raising the bottom end of the ranges by 50 basis points. The GAAP margin guidance range is now 21.5% to 22%. The non-GAAP margin guidance range is now 35.5% to 36%, which includes a 1 to 1.5 percentage point underlying margin improvement broadly offset by the margin headwinds from the new transaction model and the related incremental investments in people, processes and automation. The underlying momentum of free cash flow is also in line with our expectations. The headwind to billings from co-terming and FX rate that I mentioned earlier is being offset by early renewals, faster collection and improved underlying margins. We raised the midpoint of our fiscal ‘25 free cash flow guidance by $10 million and tightened the range to $1.47 billion to $1.5 billion. We expect strong free cash flow growth in fiscal ‘26 because of the return of our largest multiyear renewal cohort, the natural mechanical stacking of multiyear contracts billed annually and a larger EBA cohort. With our current trajectory, we still estimate free cash flow in fiscal ‘26 to be around $2.05 billion at the midpoint. The slide deck on our website has more details on modeling assumptions for Q3 and for the full fiscal year ‘25. And while this may be my last earnings call for Autodesk, I will stick around for a bit to ensure a smooth transition for Janesh. Thank you, Andrew, and everyone at Autodesk for your support while I was here and to the many investors and the analysts with whom I've had lively discussions over the last few quarters. While the transition to annual billings for multiyear contracts and deployment of the new transaction model has created noise in billings in the P&L, they do provide a natural near term tailwind to revenue and free cash flow growth. Combined with a resilient business model, sustained competitive momentum, Autodesk has enviable sources of visibility and certainty in a very uncertain world. For all these reasons, I step down from my role as Interim CFO with tremendous optimism for the future. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Betsy. Let me finish by updating you on our strong progress in the third quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction, fueled by customers consolidating on to our solutions to connect and optimize previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions encompassing design, pre-construction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the midmarket. As a sign of our growing momentum as the benefits of our end to end solution become more apparent, our construction business continue to perform robustly with net new customers doubling year over year and existing customers renewal and expansion rates remaining strong. Let me give you a few examples. Power Construction is number 79 on the engineering news record ENR top 400 U.S. Contractor list. It is a Chicago-based general contractor serving residential and non-residential end markets. After completing a competitive RFP to replace its legacy project management tool, Power selected Autodesk for its unified construction platform across preconstruction, construction and VDC. By standardizing on Autodesk Construction Cloud, Power will have a single source of truth for project data, enhanced collaboration capabilities and streamlined workflows on a single platform. Power Construction was one of two ENR 400 top 100 U.S. Contractors that standardized enterprise wide on Autodesk build during the quarter. In Europe, Bouygues, a top 10 ENR 250 International contractor based in France and leader in sustainable building and infrastructure projects renewed and expanded its EBA in the quarter. Bouygues is continuing to consolidate on Autodesk Solutions across the enterprise, including broader adoption of Autodesk Forma, Carbon Insight and Informed Design to digitize, decarbonize and industrialize projects. It also significantly increases commitment to Autodesk Construction Cloud to drive efficiency gains and faster bid response times through better collaboration between design and project teams. Surbana Jurong is number 23 on ENRs top 225 International Design Firms. Based in Singapore, it is an urban infrastructure and integrated solutions consulting firm. In Q3, it renewed its third EBA which included increased investment in Autodesk Construction Cloud and Autodesk Water Infrastructure Solutions. ACC is helping to scale its operations through increased automation, integrated design workflows and enhanced collaboration across time zones. Our Water Infrastructure Solutions will be a core technology supporting its growth ambitions in planning, designing, engineering and managing water projects for customers worldwide. Again, these stories have a common theme, managing people, processes and data across the project lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformation and consolidate on our Design and Make platform. Fusion remains one of the fastest growing products in the manufacturing industry. As customers seek to drive innovation and growth at lower cost, Fusion extension attach rates are increasing which is helping to drive the average sales price higher. For example, in the quarter, a global manufacturer supplying the semiconductor industry selected Fusion Manage and Vault PLM over competitive solutions to foster greater collaboration across manufacturing sites and improve operating efficiency. Once fully scaled and operational, this customer expects to save 105,000 hours per year by connecting people and data resulting in reduced product development cost and faster time to market. In the UK, Playdale Playground has been designing, manufacturing and installing outdoor playground equipment for over 40 years. This quarter, Playdale added Fusion to its existing portfolio of audio solutions including Inventor, AutoCAD and Vault to streamline and digitize workflows, optimize production to reduce lead times, reduce non-conformities and replace inefficient excel driven operations on the shop floor. A long-time Autodesk customer and global leader in precision engineering solutions renewed and expanded it’s EBA in the quarter. In addition to Inventor, Vault and AutoCAD, it is adopting Fusion's general design capabilities for material waste reduction and fluid flow optimization and mold flow to reduce manufacturing costs and defects while increasing mold yields. In education, universities continue to modernize their courses and curriculum to attract and prepare future engineers. For example, from this winter, students at the University of Stuttgart’s Institute for Medical Device Technology will use Fusion across 6 courses. Fusion was selected to replace a competitive solution for its modern platform, ease of use, cloud collaboration capabilities and unique combination of PCB and Additive manufacturing workflows in a single team environment. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. For example, after a period of rapid scaling and diversification, a large multinational manufacturing company in APAC was looking to align compliance rates across its global employee base. Working collaboratively, we addressed compliance issues while cementing a long term partnership and completing one of our largest ever license compliance agreements which included expanded adoption of Alias and VRED for the design studio and PDMC for mechanical engineering and rail design. Attractive long term secular growth markets, a focused strategy delivering ever more valuable and connected solutions to our customers and a resilient business are generating strong and sustained momentum both in absolute terms and relative to peers. Disciplined execution and capital deployment is driving even greater operational velocity and efficiency within Autodesk. And we continue to deploy capital to deliver sustainable shareholder value over many years. I retain a tremendous sense of purpose and optimism in the ingenuity and persistence of our customers and for the future. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Jason Celino of KeyBanc Capital Markets."
},
{
"speaker": "Jason Celino",
"text": "Hey, thanks for taking my questions. Just two for me. The first one, Andrew, some of us are unfamiliar with Janesh. Can you just tell us a little bit more about him and what he brings to Autodesk?"
},
{
"speaker": "Andrew Anagnost",
"text": "I certainly can. Before I do that, let me make sure that I thank Betsy for everything she brought to Autodesk during this interim period. I really appreciate it, the company appreciates it. Thank you, Betsy. Now, we're really excited about Janesh. Let me tell you why we're excited about Janesh. As you remember, one of the things I was telling you that I was looking for was someone that was going to be able to dispassionately drive optimization and scale inside Autodesk. And what that really means is someone that's going to be really inwardly focused looking at every dollar that we invest and make sure that we're getting the most returns for the business, that investors are getting the best returns from their business. The next kind of criteria we were looking for, which is a nice to have was time in the seat as a sitting CFO, which was important for us as well. But it was kind of the next nice to have after the optimization of scale. Janesh brings a great balance of both of those things, all right. He's been in the seat seven years at Elastic, both CFO and COO, driving some fairly turbulent changes inside of Elastic. So he's got battle scars from pushing inside the company to get changes done inside and we like that. We like that a lot. He's also got very good early experience at companies that we feel have always added value to Autodesk. So, he was at VMware in a senior position, he was at Cisco in a senior position. We've had good success bringing people from those kind of companies. He worked at those companies driving optimization at scale, which is the number one criteria I was looking for when we're driving this work. He also has another nice to have. He's got knowledge of our industry. He spent two years at PTC in his career. He was actually recently on the PTC Board. So, he understands our industry and he'll be able to get up to speed pretty quickly. The number one goal here, drive optimization and scale over the next few years, make sure that we're getting everything we need from every dollar we invest, which is a very important theme for Autodesk. And with that, I'm really excited and I'm looking forward to him joining in December."
},
{
"speaker": "Jason Celino",
"text": "Okay, great. Interesting. And then for my second question, now that you do have a CFO, do you have any thoughts on when you might hold the next Investor Day? I think in the past you usually did it in March. Is that a good timeframe or is that too soon?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. Well, Janesh is joining in December. I think we need to give him time to get his few legs on, give him time to kind of drive the end of the year and actually get us set up for next fiscal year in good speed. So, I would say, it's unlikely we will be doing anything in the spring, but we will get back to you on that as soon as Janesh is ready to talk about those things."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Andrew, as of the third quarter, your three year CAGR for current RPO is about 12%. How are you thinking about the sustainability or perhaps improvement upon that CAGR for CRPO over the next number of years? When we think about the ingredients of that, it looks like over the last several years, the CAGR for your unit volume for all brands is roughly 6% to 7% in the aggregate. So on top of that, you've had price and other ingredients, but perhaps talk about how you think you might be able to improve upon the most recent trajectory for current RPO? Then my follow-up."
},
{
"speaker": "Betsy Rafael",
"text": "Yeah. Hi, Jay. This is Betsy. Let me just give you a couple of things. There's a number of things that are going on, on the headline of the CRPO number. If you first take away the headwinds and the tailwinds, CRPO was broadly consistent with the second quarter. And as I mentioned in my opening commentary, early renewals and growth with and the new transaction model are providing a tailwind. And then there's also a headwind to CRPO growth from the declining contribution of billed and unbilled deferred revenue, ripped from the large multiyear and EBA cohort coming up for renewal in fiscal '26. And just as a reminder, these are the same larger cohorts we are calling out as tailwinds to free cash flow for next year. And if you look back to fiscal ‘22, we saw the same dynamic ahead of the fiscal 2023 renewals as well."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Since new management is part of the news this evening, could you talk about how you're thinking about the Chief Revenue Officer position? Would it make sense perhaps to continue to have separate CRO or do you think it might make more sense perhaps to combine CRO and COO?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So, we're going to continue to have a separate CRO because we have various functions that work together there under the COO organization including our IT organization, our infrastructure and all things associated with. What we're looking for in our CRO is someone that understands how to continue to drive a business when you have direct engagement with the customer. So that means someone that really understands what it takes to analyze self-service patterns, actually understand the data that comes in from the customers to help drive cross sell and up sell, while also transforming a channel from a transactionally focused extension of Autodesk to kind of a solutions partner that's driving lifecycle solutions for our customers. So, that's the kind of role we're looking for here. And yes, it's going to continue to be a standalone CRO role within the COO organization."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Adam Borg of Stifel."
},
{
"speaker": "Adam Borg",
"text": "Awesome. Thanks so much for taking the questions and congrats to Betsy and Janesh. Maybe on the new transaction model, I know it's still early. I was just curious, are there any learnings from those customers that are on the new model that you're seeing in terms of the adoption of Autodesk technology and the ability to find white space to better upsell and cross-sell different solutions now that you have a more direct relationship?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah, Adam, it's really early on to be able to make any kind of conclusions about that. What I can tell you is that we definitely see some shift to some of the direct channels at Autodesk for customers that were probably just served on a very kind of arm's length kind of transactional level. But in terms of driving cross sell and upsell, early days, early days. But if you want to get a sense for how that might evolve, we've got experience with our EBAs and our enterprise business agreements. And we've learned over the years that having that kind of relationship with the customer, where we really understand their usage patterns, who they are and what they're doing, we are much more effective at driving cross sell and up sell, even when partnering with our channel partners. So I think those kind of stand as a testament of what's possible as we move forward with the completion of the new transaction model."
},
{
"speaker": "Adam Borg",
"text": "Great. And maybe just as a quick follow-up, just as we think about the new administration coming in, you talked about the macro being broadly consistent. Any change in tone in your conversations with the end markets in terms of optimism or their ability or willingness to expand new projects ahead of the administration, any pause or just full steam ahead? I'm just curious, any commentary you have there from a macro perspective would be really, really helpful."
},
{
"speaker": "Andrew Anagnost",
"text": "What I'll say is the things that matter to our customers are bipartisan things, all right? Our customers care about infrastructure build outs. Both parties care about infrastructure build outs. Our customers care about domestic manufacturing, be it in Europe, be it in the United States. Both parties agree that domestic manufacturing build-outs are important. It's supply chain independent, supply chain stability. All of these things are bipartisan issues that really affect our customers. So regardless of the administration, I suspect the things that are important to our customers are continuing to be a focus."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Joe Vruwink of Baird."
},
{
"speaker": "Joe Vruwink",
"text": "Great. Thank you. On the outlook for next year, $2.05 billion in free cash has I think been the expectation for the past year now. Within the last year, you've also seen more co term of contracts and I think that leads to better billings in FY '26. So my question is, does that actually create the potential that things are better and that's why you're qualifying now the $2.05 billion as the midpoint of possibilities?"
},
{
"speaker": "Betsy Rafael",
"text": "There is no change to how we've talked about the free cash flow guide for fiscal ‘26. It continues to be $2.05 billion at the midpoint."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Fair enough. And then just on the M&A environment over recent history, Autodesk has been more in a mode of, I would say, strategic tuck ins. I think there was actually an asset in the CFE simulation space that was announced during AU in the quarter. Is that the right approach for Autodesk just given this point in time all the work you've done to build out the cloud platform, the data models and so these tuck-ins make the most sense? And if that's true, how would you maybe compare and contrast some of the larger scale M&A that's happening with your peers in the space?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So, look, consolidation in our space is inevitable. I'm not going to comment on any specific deals, but here is what I will say. Autodesk has always been an acquisitive company and we will be a acquisitive company when that makes both strategic and financial sense for the company."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Elizabeth Porter of Morgan Stanley."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. Thanks so much for the question. As partners are getting customers just up and running on the new transaction model, we picked up that they're spending a little bit more time than usual of time and resources with those existing customers. So I was curious if that had any impact on new business demand kind of more recently. And then just more broadly, any change in new business trends that you think you should call out from versus last quarter?"
},
{
"speaker": "Betsy Rafael",
"text": "Yes. Elizabeth, it's Betsey. And so just broadly speaking, we continue to see growth but at a slower pace due to a number of factors over the really over the last several years, macro COVID, exiting Russia, elections. And while a drag on the forward momentum of the business, all of that's really factored into our guidance. So I kind of just will leave it at that."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. And then a follow-up just on billings. Understanding there's a lot of volatility around the change from multiyear and the transaction model. But it looks like guidance implies a bigger step down in growth in Q4 just despite an easier year ago compare. So it's helpful that you could help us unpack the balance of those headwinds and tailwinds that would drive kind of a greater downtick in growth in Q4."
},
{
"speaker": "Betsy Rafael",
"text": "Well, again, let me start out with just from a fiscal '25 perspective. Your billing tailwinds are going to be from the final shift to annual billing, new transaction model and early renewals. And you're going to get headwinds from co-terming and business booked ahead of the new transaction model launch and in recent weeks, some FX. So again, I think that we've continued to perform well as we've executed through Q3. And so, I think we feel very strongly about our expectations for Q4."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Bhavin Shah of Deutsche Bank."
},
{
"speaker": "Bhavin Shah",
"text": "Great. Thanks for taking my question. Andrew, at University, there appeared to be a noticeable uptick in attendance and sessions geared towards owners and operators. What's been driving the recent interest from this segment? How much of it is enhancing you guys have made versus really more focusing and emphasizing from a go to market perspective? And how long before this segment of buyers kind of becomes more meaningful to the financials?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah, Bhavin, that's an excellent question, all right. We're very interested in tackling the whole entire lifecycle from design through make, construction, manufacturing all the way into operations. You're probably aware we have a product called Tandem. And a lot of those sessions were driven by increasing interest and increasing adoption of Tandem, which is a digital twin solution tightly coupled to our solutions that also has a toolkit that allows people to easily connect sensor data through the digital twin solution. So you're seeing that uptick because we're directly releasing products and capabilities that are of interest to the owner space. You can expect to see that trend continue over time and you can expect to see us continue to talk about the owner space, continue to deliver solutions for the owner space and even APIs for the owner space. It's an area of great interest, especially when it comes not only to vertical buildings, but factories and other things that are related to that as well as infrastructure like what we were doing with some of our water owner solutions. So, yes, owners matter. We're building software for them and you're going to see more of that."
},
{
"speaker": "Bhavin Shah",
"text": "Super helpful there. And then Betsy, one for you. Just in terms of the underlying improvement that we've been seeing in the margins and I know you've called out FX and the transaction model. I know it's very early, but as we think about next year, how do we think about the impact of FX and the transaction model to kind of the headline operating margins?"
},
{
"speaker": "Betsy Rafael",
"text": "Well, I wish I could give you that answer, but I think that the new CFO would probably have a little bit of a problem with that. So we'll wait till the end of February to give you more specifics on that."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Tyler Radke of Citi."
},
{
"speaker": "Tyler Radke",
"text": "Yes, good afternoon. Thanks for taking the questions. I was going to ask you about a placeholder for next year's guidance, Betsy, but I don't want to waste a question on that, but feel free to answer. But Andrew, I wanted to kind of ask you about some of your comments you made around efficiency, especially as it relates to hiring Janesh, who you pointed out has a lot of experience at larger companies, VMware, Cisco, et cetera. Now that you're a few quarters into this transaction model rollout, you have kind of visibility better on some of the channel, prior channel relationships, having that direct billing with the customer. What are some of the areas that you've identified as having that efficiency potential? And then as we think about that efficiency unlock, should we think about that as incremental to the free cash flow number you have out for next year or is that embedded in that already?"
},
{
"speaker": "Andrew Anagnost",
"text": "So many layers in that question. So first, let me kind of answer the question in a curious serious stage, it's going to dodge other ones, okay. So first off, optimization is kind of a mindset at Autodesk. It's not something that suddenly happens. I want to reemphasize that because if you look right now this year, for example, when you look at the apples to apples comparison, which will be in the slide deck or in our disclosed materials. You can see that our non-GAAP margins are already hitting the targets we set for next year, this year, okay. So optimization is a mentality. You've also heard me say over and over again as the new transaction model starts to roll out, optimization of our go-to-market efforts is going to be a critical step for us and part of the optimization journey that we're on. That's going to deliver margin growth for the company for couple of years to come, okay. And I think that's important. It's a long-term driver. Now, we're getting into the specifics, okay. I think the specifics are probably for another time, but let me just kind of give you a sense for some of the things that are important, all right. One is the drive to self-service, all right. Self-service is a huge impact on how our customers will engage with us and where those customers come from. And that is a value accretive to Autodesk, both on an efficiency side from renewals and other things, but also on a revenue growth side through capturing the customers directly. The other thing I talked about is understanding the customer better, so the upsell and cross sell. So we're going to be able to do a lot more automation and understanding about what where the opportunities are and that's going to drive some efficiencies. And we're moving the channel partners away from this model of being the transactional players to being the solution providers and the IP providers to our customers. That's going to have all sorts of opportunities to eliminate duplication of effort and drive real cost efficiencies for the company moving forward. So there's both top-line efficiencies here and revenue growth, but there's bottom line efficiencies as well through removing the redundancies and steps that just aren't necessary for the customer. You'll get a lot more clarity on that as you see us continue to move forward with this go to market optimization in next year and beyond that."
},
{
"speaker": "Tyler Radke",
"text": "Great. Thanks for the detail. And then my follow-up question, Andrew, you talked about some really strong net new customer additions within the construction cloud, I think doubling year over year. We also saw the make revenue accelerate to 28% constant currency. Can you just help us understand, do you think that reacceleration is durable? And how are you sort of thinking about just your position there? What's been driving that strength in the new customer additions?"
},
{
"speaker": "Andrew Anagnost",
"text": "First, let me comment on the make revenue, then I'm going to go into construction. So, the make revenue also includes some revenue from PIX and things associated with that. However, let's talk about the facts around our construction business, because I think this is important, right? Number one factor is that we continue to drive consistent high growth in our construction solutions. You're seeing it, it's built into the make numbers and it's the lion share of those make numbers. You're really seeing some consistent growth there. That's organically. Inorganically, we're actually executing incredibly well on things like Payapps and that's driving acceleration of our growth. So we are not decelerating as a business, okay. We are actually performing solidly or inorganically we're accelerating, all right. And I just want to be really clear about that. And yes, we said year over year we drove a 2x increase in our new customers. And I'll talk about where some of that's coming from in just a minute. But I also want to highlight the other thing that's going on. We are strengthening an already strong position in the ENR 400. So you heard about the story about power construction, which was a great example of someone taking out a competitive RFP and say, look, I need a forward looking cloud based solution on new technology that goes end to end from design to construction all the way to operations. And they chose us. And that was just one example that we gave in the opening commentary. So already a strengthening position in the ENR 400. Now, the other qualitative things that are driving some of that new customer growth is we already have our distribution channel operating at scale. In the U.S, this is helping us go down market more effectively, which is allowing us to capture more customers more effectively, be places where we weren't before and where others aren't, which is part of driving that. But also, we're already at scale operating internationally with our distribution channel. So that's driving international growth for us. And that's a really important driver as well as some of those net new accounts that you're seeing there. And the last thing I'll add and then I'm done with construction is that look, I heard this over and over again at AU. I'm hearing it over and over again from customers in lots of different places. They want the end-to-end solution. They want the life in the cloud. They're placing bets for the next 10 years. They want to go from design to construction to operations. And that's just making our solution more attractive to the market."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Michael Turrin of Wells Fargo."
},
{
"speaker": "Michael Turrin",
"text": "Hey, thanks very much. Appreciate you taking the questions. The commentary on the call sounded consistent, but wondering if there are any added details you can provide for us on, just the overall macro spend environment and how that's maybe progressing across either key product segments or geos, whatever split you think is more useful. I think what we're trying to get a sense for is if there are any shades of improvement anywhere or if you'd characterize as mainly just consistent over the past couple of quarters?"
},
{
"speaker": "Andrew Anagnost",
"text": "Michael, I think the core answer here is consistency, okay? We're seeing consistent trends that we've seen with all in all the other quarters. There's always puts and takes in a large business like ours, especially one that's diverse as ours. But the general tone is, it's consistent with prior quarters."
},
{
"speaker": "Betsy Rafael",
"text": "And I would just add that there's also been a lot of noise this year from the new transaction model and then obviously the elections leading up to that. And so it's hard to sparse out, kind of that particular behavior. So I think as Andrew said, we call it consistent."
},
{
"speaker": "Michael Turrin",
"text": "Yes, tough first, two. That's why we keep asking. Betsy, congrats on the transition back given you're also on the Board. I think it'd be useful to hear you chime in on the hiring of Janesh and maybe just also comment on how you ensure you're able to hand over the reins and keep progress going on the key transitions the company is working through?"
},
{
"speaker": "Betsy Rafael",
"text": "First, I was involved in the process, which was quite extensive in the company, the recruiting of Janesh. And so we're certainly very excited to have him on board. What I would also say, is obviously with my experience of being on the board for 11 years as well as my deep dive into the business over the last six months, One of the reasons I'm staying around until the end of the fiscal year is I think I can be really helpful in that transition for Janesh. And so I'm very much looking forward. And I think that we have a great finance team, and I think that he's going to be -- he's going to fit very well, and I'm looking forward to making that happen as fast as we can."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Matthew Hedberg of RBC Capital Markets."
},
{
"speaker": "Mike Richards",
"text": "Hey, guys. This is, Mike Richards on for Matt. Thanks for taking the question. I was wondering if you could provide an update on Project Bernini and maybe how customer reception has been and where we are in developing other foundational models or just the monetization opportunity there."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So first off, before I comment on bringing you, AI is you might have heard from AU. AI is embedded in everything we're doing from a bottom up and a top down perspective. And you also heard us talk at AU about new types of foundation models we're building that understand how certain things are done in our applications. You heard about a foundation model that's driving automated drawing creation. You heard about a foundation model that's driving automated sketch generation and sketch constraints. That kind of stuff is bottom up innovation. Bernini is more of a top down type innovation where you're actually specifying things and trying to generate a preliminary outcome from those specifications. And what we've been doing with Bernini is we've been trying to engage with certain targeted customers to get them to participate with us in making Bernini smarter and more intelligent. It's not available commercially right now, but it's getting more intelligent. We've actually been successful in getting some customers to stand up and say, look, yeah, I'd like to work with you to make this more intelligent because we need something that actually understands 3D geometry as geometry, not just as a picture of something, okay? So that's what's going on with Bernini right now. And you should continue to see refinements and extensions of that moving forward. Now with regard to monetization, monetization, nobody knows exactly how all this is going to be monetized. But is a few vectors here that come into play. One, we are ahead of our competitors in this space. We intend to be ahead. We're investing to stay ahead. That increases one's competitive position in the marketplace and that's really important. Also, you get to be able to charge for some of these incremental features in the future. When you're delivering value or a high quality outcome as a result, you're going to charge for that outcome. How we charge for those things? Let's let this play out, okay? It's still early days. But you also there's also monetization opportunity through licensing certain technologies for specific mature maturation for a specific customer's needs, all right. And that will be another avenue. So how these avenues play out, which one weighs more, let's just play out. But what you need to know about Autodesk is we're ahead, we've been ahead for a while, we were the first out there with an AI research lab that's been out there for over six years, published 70 papers. We're right on the cutting edge of 3D design technology and AI, and we intend to stay there."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steve Tusa of JPMorgan."
},
{
"speaker": "Steve Tusa",
"text": "Hey, good evening or afternoon. Lots of good questions asked. Just a detailed one, what's the change in the billings contribution from the transaction model change, the 5% to 6% to 5% to 5.5%."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So it's basically because we did more buy sell business ahead of the European launch. So remember we said 5% to 6% when we launched Europe and it was the if we did more buy sell business, which means there's less tailwind from the new transaction model. The flip side means that means that the underlying increase in our billings guidance is greater than it looks on a headline basis."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Joshua Tilton of Wolfe Research."
},
{
"speaker": "Joshua Tilton",
"text": "Great. I have a kind of a high level one on the incoming CFO. If I if I heard correctly, we didn't exactly get, like, an initial outlook for, revenue growth for next year. And I'm just trying to understand in the context of the new CFO coming in, is there anything that could change the calculus of how you guys think about that 10% to 15% growth for the underlying business outside of the agency transition that's ongoing today?"
},
{
"speaker": "Andrew Anagnost",
"text": "Well, first, let's talk about that framework a little bit and then I'll comment a little bit on the increase in CFO. So, look, the 10% to 50% growth, right now we're pretty much right at the bottom end of that range. And if we look back over the last two years, there's been a series of things that created headwinds to new business. It started off with things like the pandemic, the inflation, the exiting of the Russian business, the writer's strike, the whole trade wars within particular geographies, all of these things were accumulated headwinds that built slowly into the business and have pushed us down to the low end of the range. It takes time in a subscription model for those things to build out of the business, okay? So it's going to take time for us to build out of that. That's to be expected with a subscription model. The revenue goes down slowly, it goes back up slowly as headwinds turn into tailwinds. So expect us to be near the bottom of that range in the short term just as a general kind of guideline for the core business to be at the bottom of the range, okay? As a long term framework, the 10% to 15% still makes sense as a long term guide for the company. But of course, as new eyes come in, we'll look at these things and we'll evaluate them. But right now, this all still makes sense."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Siti Panigrahi of Mizuho."
},
{
"speaker": "Siti Panigrahi",
"text": "Thanks for taking my question. I understand the new business model have some kind of noise on your expense and margin side. But if you exclude that, where do you see some of the operating leverages that you can drive in next year or so?"
},
{
"speaker": "Betsy Rafael",
"text": "Well, I think we've actually provided kind of historically what we've done over the last three years pretty clearly. And I think we said that we're continuing to be focused on expansion, but nothing further to add as far as next year."
},
{
"speaker": "Betsy Rafael",
"text": "We did provide data on that. So you can see what the underlying thing is and we expect to see continued improvement in that same vector."
},
{
"speaker": "Simon Mays-Smith",
"text": "On the same basis."
},
{
"speaker": "Andrew Anagnost",
"text": "On the same basis, on the same apples-to-apples basis."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Michael Funk of Bank of America."
},
{
"speaker": "Michael Funk",
"text": "Hey, guys. Thank you for the questions tonight. Two if I could. You've mentioned a few times in the last calls about the largest multiyear cohort renewing next year and then also a large EBA cohort. Just wondering if you can give us kind of the range of potential outcomes among the renewals there, whether potential to upsell, risk of down sell and what that variance might look like around those renewals?"
},
{
"speaker": "Betsy Rafael",
"text": "No, I mean, I think what we have said is that it's the largest cohort that and we saw that performance in ‘23. And so we expect a strong renewal year, but we're not giving any specific guidance on what that looks like for ‘26 at this point and we'll wait until we report earnings in February."
},
{
"speaker": "Michael Funk",
"text": "Okay, great. And then Betsy, one more. You've mentioned a few times off the investment in new transaction model, people, processes and automation, presumably more fixed cost versus variable like commission. Can you quantify that for us to help us with modeling as we try to forecast margin? I know you've not giving guidance, but better understanding of what that cost might actually be on an absolute basis would help us to think about our modeling?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Mike, we've got a slide in the earnings deck to help you think about modeling and I'll just point you to that."
},
{
"speaker": "Operator",
"text": "Thank you. And ladies and gentlemen, that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"text": "Great. Thanks, and thank you everyone for joining us today. Looking forward to seeing many of you on the road over the next few weeks. If you have any questions in the meantime, please email me or call me. And in the meantime, all those of you in North America, wishing you a very happy Thanksgiving. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you, Simon. This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
ADSK | 2 | 2,025 | 2024-08-29 17:00:00 | Operator: Good day, and thank you for standing by. Welcome to the Q2 Fiscal '25 Autodesk Earnings Conference Call. At this time all participants are in a listen-only mode. Please be advised that today's conference is being recorded. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I’d now like to hand the conference over to your speaker today, Simon Mays-Smith, Vice President, Investor Relations.
Simon Mays-Smith: Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the second quarter results of Autodesk's fiscal '25. On the line with me is Andrew Anagnost, our CEO; and Betsy Rafael, our Interim CFO. During this call, we will make forward-looking statements, including outlook and related assumptions, products and strategies. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call, as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials, available on our Investor Relations website. And now, I will turn the call over to Andrew.
Andrew Anagnost: Thank you, Simon and welcome everyone to the call. We finished the second quarter and first half of the year strongly, delivering 13% revenue growth in constant currency in both periods and have raised guidance for the full year, reflecting the sustained momentum of the business and the smooth launch of the new transaction model in North America in June and expected launch in Western Europe in September. Once again, opportunity, resilience and discipline underpinned our performance. In March last year, we laid out the secular growth trends in our markets from accelerating digital transformation in Architecture, Engineering and Construction or AEC, to the transition to the cloud in manufacturing and media and entertainment. These secular trends are driving customers to break down siloed workflows and seamlessly connect data end-to-end. Real-world experiences from remote collaboration to supply chain disruption and AI are reinforcing these trends. We’re aggressively pursuing our strategy to benefit from these secular trends, including the development of next-generation technology and services, end-to-end digital transformation and unique growth enablers such as business model evolution, customer experience evolution and convergence between industries. Our investments in cloud, platform and AI in pursuit of these growth opportunities and ahead of our peers enable Autodesk to provide its customers with ever more valuable and connected solutions and to support a much broader customer and developer ecosystem and marketplace. While macroeconomic policy, geopolitical and one-off factors like the Hollywood strikes have impacted industry growth, Autodesk subscription model and diversified product and customer portfolio have proven resilient. The underlying momentum of the business and key performance indicators remain consistent with previous quarters, as evidenced by increased product usage, record bid activity on building connected and cautious optimism from our channel partners. We realized the significant benefits of this strategy for shareholders through our disciplined and focused execution and capital deployment throughout the economic cycle. These investments mitigate the risk of expensive catch up investments in the future and support sustained revenue, margin and free cash flow growth. To support our growth initiatives and margin improvement, we have been modernizing our go-to-market approach to create more durable and direct relationships with our customers and to serve them more efficiently. And we are transforming our platform to enable greater engineering velocity and efficiency to support a broader customer and developer ecosystem and marketplace. We’ve already seen significant benefits from initiatives like these and there is more to come. Stripping out the effects of margins from FX and the new transaction model, we expect to be towards the midpoint of our fiscal '26 non-GAAP operating margin target of 38% to 40% in fiscal '25, a year ahead of schedule and representing about 300 basis points of improvement since fiscal '23. We are confident we will make further improvements in fiscal '26 on the same basis. Once complete, we expect the new transaction model and subsequent go-to-market optimization to increase sales and marketing efficiency and deliver GAAP margins among the best in the industry. Non-GAAP operating profit, including stock-based compensation costs, will become a key metric to track as we make this transition. Attractive long-term secular growth market, a focused-strategy delivering ever more valuable and connected solutions to our customers and a resilient business model are generating strong and sustained momentum both in absolute terms and relative to peers. Disciplined execution and capital deployment is driving even further operational velocity and efficiency within Autodesk and will underpin the mechanical build of revenue and free cash flow over the next few years and GAAP margins among the best in the industry. We expect the pace of buybacks to buy forward dilution will pick up into fiscal '26, as our free cash flow builds from the fiscal '24 trough. We expect this to result in a further reduction in shares outstanding over time, continuing the capital return trend of the last few years. In combination we believe these factors will deliver sustainable shareholder value over many years. I would like to welcome Betsy, and thank her for stepping in as Interim CFO and will now turn the call over to her to take you through the details of our quarterly financial performance and guidance for the year. I will then come back to provide an update on our strategic growth initiatives.
Betsy Rafael: Thanks, Andrew. Q2 was a strong quarter. We generated broad-based growth across products and regions in AEC and manufacturing which was partly offset by softness in media and entertainment, primarily due to the lingering effect of the Hollywood strike. Our make business continues to enhance growth, driven by ongoing strength in construction and fusion. Overall, macroeconomic, policy and geopolitical challenges and the underlying momentum of the business were consistent with the last few quarters and included strong renewal rates, but softer business -- new business in China and Korea. The new transaction model did not make a material contribution to our second quarter results. In his opening remarks, Andrew discussed the benefits we expect to derive from our go-to-market initiatives, which support our growth and ongoing margin improvement. Before I discuss revenue, billings, deferred revenue, RPO and free cash flow, let me remind you of how these metrics naturally and mechanically evolve during the shift to annual billings for most multi-year contracts, as well as the new transaction model. The shift to annual billings for most multi-year contracts moves billed deferred revenue into unbilled deferred revenue in our financial reporting. Unbilled deferred revenue would then not be included in deferred revenue on our balance sheet, but would be included in our remaining performance obligations disclosure. Initially this reduces billing, deferred revenue and free cash flow as you saw in fiscal 2024, but is gradually becoming a tailwind to billings and free cash flow, as our annually billed multi-year cohorts rebuild. Metrics that include unbilled deferred revenue like RPO give a better view of performance during our transition to annual billings for most multi-year contracts. And as we have said before, we will continue to offer multi-year contracts build upfront in certain circumstances, such as in emerging countries, where there is increased credit risk if not received upfront. On the Autodesk Store, until we enable system changes to offer annual billing and of course, on an exception basis, when it is driven by customer preference such as for our non-cloud enabled offerings. Just to give you some context on scale, multi-year contracts build upfront incrementally contributed less than 5% of total billings in the second quarter. The new transaction model also has mechanical and timing impacts on billings, deferred revenue, revenue and operating costs. The amount of impact is determined by the pace of the model rollout. In addition, channel partner and customer behavior can also impact the results. The mechanical impact is due to the way channel partner payments are recognized and accounted for in the P&L. Under the old or the buy-sell model, channel-partner payments are deducted from gross billings and revenue. We then report net billings and net revenue Conversely, in the new transaction model, we record channel partner payments in sales and marketing expense. So as we shift from the old model to the new, there is an increase in billings, deferred revenue, revenue and sales and marketing expense. That increase in revenue and operating costs resulting from the change in the way that channel-partner payments are recognized and accounting for flows ratably through revenue and cost in the P&L over time. And the overall pace of that transition is determined by when we launch the new transaction model into each geography. In the short-term, moving the P&L geography at channel partner payments from contra revenue to sales and marketing expense, creates a headwind to the operating margin percentage, but it is really broadly neutral to operating profit and free cash flow dollars. But over the long-term, we expect that this transition to the new transaction model will enable us to further optimize our business, which we anticipate will provide a tailwind to revenue and deliver GAAP margins among the best in the industry on mechanically higher revenue and despite mechanically higher costs. Channel partner and customer behavior during the rollout of the new transaction model are much harder to predict and model. For example, with channel partners better prepared ahead of launch, more customers in North America and Australia co-termed their contract expirations to align the timing of renewals across their business. This had a negative impact on the timing of billings and deferred revenue. And as we've seen many times before, co-termed contracts actually create an opportunity for larger contracts on renewal, as we elevate our relationship with customers from subsidiaries to company-wide. Along with more self-service functionality, it also enabled us to reduce administrative costs and serve our customers more efficiently. While activity in the second quarter was probably more tactical in nature, co-terming is one of the expected benefits of the new transaction model and will be one of the drivers of our margin momentum over the coming years. As I'll discuss, this creates timing headwinds, but is not a change in the underlying momentum of the business. We will give you much more details about the impact of the new transaction model on fiscal '25 results and the expected impact on fiscal '26, when we report our full year results next February. So now let's move on to the results. Total revenue grew 12% and 13% in constant currency. By product in constant currency, AutoCAD and AutoCAD LT revenue grew 8%, AEC revenue grew 15%, manufacturing revenue grew 17% and in the low-teens, excluding upfront revenue. M&E grew 5%. Revenue grew 13% in all regions on a constant currency basis. Direct revenue increased 21%, and represented 40% of total revenue, up 3 percentage points from last year benefiting from strong growth in both EBAs and the Autodesk Stores. Net revenue retention rate remained within the 100% to 110% range at constant exchange rate. Billings increased 13% in the quarter, reflecting a modest tailwind from the prior year shift to annual billings for most multi-year contracts and a mechanical tailwind of approximately 2% from the transition to the new transaction models. Billings were also negatively impacted by more co-termed. Total deferred revenue decreased 13% to $3.7 billion, and was again impacted by the transition from upfront to annual billings for multi-year contracts. Total RPO of $5.9 billion and current RPO of $3.9 billion grew 12% and 11% respectively. Turning to margins, GAAP and non-GAAP gross margins were broadly level, while GAAP and non-GAAP operating margins increased by 4 percentage points and 1 percentage points, respectively. At current course and speed, the ratio of stock-based compensation as a percentage of revenue peaked in fiscal '24, will fall by more than 1 percentage point in fiscal '25 and will be below 10% over time. Free cash flow for the quarter was $203 million. As we said might happen back in February, some channel partners in North America booked business earlier in the quarter ahead of the transition to the new transaction model to de-risk month one after the transition. This accelerated free cash flow to the second quarter, which was partially offset by the negative impact of [no] (ph) more co-terming. Turning to capital allocation, we continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long-term shareholder value. During the second quarter, we purchased approximately 471,000 shares for $115 million, which is an average price of approximately $245 per share. We do expect the pace of buybacks to pick up during the second half of the year, as we had very minimal purchases in the first half. We will also continue to deploy capital to offset dilution into fiscal 2026, as our free cash flow grows from the fiscal 2024 trough generated by the transition from upfront to annual billings, again, from most multi-year contracts. We will continue to buy forward dilution, which we expect to result in a further reduction in shares outstanding over time, continuing the capital return trends of the last few years. We have reduced our share count by about 5 million shares over the last three years with an average percentage reduction of about 70 basis points per year. Now let me finish with guidance. As we said in February, the pace of the rollout of the new transaction will create noise in billings and the P&L. So, we think free cash flow is the best measure of our performance. Taking out that noise, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year. Our sustained momentum in the second quarter and the smooth launch of the new transaction model in North America reduced the likelihood of our more cautious forecast scenarios. Given that, we are raising the midpoint of our billings, revenue, earnings per share and free cash flow guidance ranges. Let me give you a little bit more detail. The underlying momentum of billings is in-line with our expectations, but two of our modeling assumptions have changed. First, the new transaction model is expected to launch in Western Europe in September rather than in early fiscal '26, which was our modeling assumption at the start of fiscal '25. This is a tailwind to our reported billings. Second more customers have co-termed contracts in North America than we model and we've assumed the same thing will happen in Western Europe. This timing effect is a headwind to reported billings in fiscal 2025. The net effect of these is a 5 percentage point to 6 percentage point tailwind to billings from the new transaction model in fiscal 2025, which includes a 3 percentage point to 4 percentage point tailwind from North America specifically. We have raised our fiscal '25 billings guidance to a range between $5.88 billion and $5.98 billion. The underlying momentum of revenue is also in-line with our expectations. The $40 million increase to the top-end of revenue guidance reflects the expected launch of the new transaction model in Western Europe in September, as well as acquisitions and think about those in roughly equal measures. The $90 million increase to the bottom-end of the guidance range includes that $40 million with the remainder, an underlying increase due to the reduced likelihood of our more cautious forecast scenarios. At the midpoint, we are increasing revenue guidance by $65 million or $25 million excluding the impact of [new] (ph) acquisition and the new transaction model. Our fiscal '25 guidance range is now between $6.08 billion and $6.13 billion, translating into revenue growth of around 11% at the midpoint when compared to fiscal ['24] (ph) and includes 1 percentage point to 1.5 percentage point from the new transaction model. Underlying margins are slightly better than our previous guidance and that enables us to offer -- offset higher expected cost from the earlier launch of the new transaction model in Western Europe. While we still expect non-GAAP operating margins between the range of 35% and 36% in fiscal '25, that now includes a 1 point to 1.5 point underlying margin improvement that is broadly offset by the margin headwinds from the new transaction model and the incremental investment in people, processes and automation. The underlying momentum of free cash flow is in-line with our expectations as well. The headwind to billings from co-terming that I mentioned earlier is largely being offset by faster collections and improved underlying margins. We've raised the lower end of our fiscal '25 free cash flow guidance, resulting in a range between $1.45 billion and $1.5 billion. We expect strong free cash flow growth in fiscal '26, because of the return of our largest multi-year renewal cohort, the natural mechanical stacking of multi-year contracts billed annually and a larger overall EBA cohort. With our current trajectory, we still estimate free cash flow in fiscal 2026 to be around $2.05 billion at the midpoint. While the transition to annual billing for multi-year contracts and the deployment of the new transaction model, creates noise and billings in the P&L, they do provide a natural tailwind to revenue and free cash flow over the next few years. Combined with a resilient business model and sustained competitive momentum, Autodesk has enviable sources of visibility and certainty, given the context of significant macroeconomic, geopolitical, policy, health and climate uncertainty. We continue to manage our business using a Rule of 40 framework with a goal of reaching 45% or more over time. We are taking significant steps toward our goal this year and next. We think this balance between compounding revenue growth and strong free cash flow margins captured in the Rule of 40 framework, is the hallmark of the most valuable companies in the world and we intend to remain one of them. The slide deck on our website has more details on modeling assumptions for both Q3 and full fiscal year '25. Andrew, back to you.
Andrew Anagnost: Thank you Betsy. Let me finish by updating you on our strong progress in the second quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction, fueled by customers consolidating onto our solutions to connect and optimize, previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions encompassing design, pre-construction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the mid-market. As a sign of that growing momentum, our construction business had another strong net new customer quarter as the benefits of our end-to-end solution became more apparent. Let me give you a few examples. Thornton Tomasetti is an internationally recognized engineering design and analysis firm, which uses Revit and other advanced technologies to enable us to deliver projects at all scales and levels of complexity. We have been a proud partner as it has transformed its business to excellence and interoperability in BIM. The transition from BIM 360 to Autodesk Construction Cloud has optimized project workflows and cloud collaboration. Autodesk's virtual reality tools have reimagined its visualization workflows and Dynamo and generative design have enabled its team to focus on high value creative work. During the quarter, Thornton Tomasetti renewed its EBA with Autodesk and expanded it by more than 50%. To address challenges of a fragmented ecosystem and siloed working environments, a European consortium of nine public water operators serving millions of residents across numerous municipalities decided to expand its relationship with Autodesk by adding BIM Collaborate and BIM Collaborate Pro and an upgraded premium plan to its existing AutoCAD, Docs, AEC collections and InfoWorks subscriptions. With these expanded capabilities, it will continue its digital transformation, accelerating its transition from 2D to 3D and its ability to manage all assets in a common data environment across all consortium members. In the quarter, a leading single source specialty subcontractor based in the Midwest of the United States, began looking to replace point solutions that no longer supported custom workflow. With the help of a channel partner after a 45-day evaluation, the subcontractor chose to adopt Autodesk Build, which complements its virtual construction and design capabilities, streamlines communication between design and construction teams and importantly gives us control over and ownership of its own data. Again, these stories have a common theme, managing people, processes and data across the project life cycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. Moving onto manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate our design and make platform. In automotive, we continue to strengthen and expand our partnerships, both within and beyond the design studio. In the second quarter, a leading European manufacturer renewed and expanded its EBA to accelerate its time to market and help drive its business transformation initiatives. In addition to Alias for concept design, it will leverage VRED for virtual prototypes and flow production tracking for project management. These solutions democratize visualization across the organization, reducing the resilience -- reliance on physical prototypes, improving design collaboration and speeding up the product development process. Additionally, as the manufacturer moves to build new battery factories, it is exploring the adoption of integrated factory modeling to reduce costs and increase collaboration across suppliers and contractors throughout the project lifecycle. Meissner, a global leader in complex tool and plant construction, is leveraging Autodesk solutions to adapt more quickly to a fast-moving automotive industry. It is driving business growth through improved production cycle times, while meeting high-quality reliability standards at reduced costs. To achieve this, Meissner has adopted power mill for complex simultaneous five axis milling, PowerInspect for programming 3D measurement inspection routines and machine parts and PowerShape to produce blow-molded plastic hollow parts, while leveraging Fusion for its collaboration capabilities. Fusion remains one of the fastest-growing products in the manufacturing industry. As customers seek to drive innovation and growth at lower costs, Fusion extension attach rates are increasing, which is helping to drive the average sales price higher. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. Three years ago, Bochum University, a public research university in Germany, evaluated Fusion for its mechanical engineering department, but determined the solution didn't fulfill existing requirements. In the second quarter, impressed with Fusion's significantly expanded capabilities in electronics and PCB design, configuration, drawing automation and collaboration, Bochum decided to replace a high-end competitive solution with Fusion for all mechanical engineering courses. With the Fusion platform, Bochum students can now acquire end-to-end workflow skills from simulation in the cloud to data management with just one installation, enabling better collaborative learning and employability for students, while saving time and administration costs for the university. And finally, we continue to leverage unique growth enablers such as business model evolution, customer experience evolution and convergence between industries to grow our market opportunity. For example, Mercury Engineering is a European leader in construction solutions. The company builds and manages complex engineering and construction projects for the world's leading corporations across a range of sectors, including data centers, semiconductor and life sciences to support its digital edge initiatives and the ability to deliver large scale projects wherever its clients operate, Mercury increased its investment in Flex, during the quarter. Using Flex to access solutions such as Navisworks, Revit, ReCap, AutoCAD and Plant 3D, coupled with Account-Based Autodesk Construction Cloud, Mercury enjoys frictionless consumption, limitless cloud access, the ability to rapidly scale up new projects with the right tools and the ability to collaborate across its ecosystem. I know many of you pay close attention to the American Institute of Architects' data, and we do too, but maybe not always to the same data. In 2022, the AIA said that almost half of architecture firms' total billings came from reconstruction and renovation projects, up from about a third 20 years ago, with the rest coming from new builds. In commercial and industrial and institutional subsectors, reconstruction and renovation accounted for more than 60% of billings. From infrastructure exceeding its design life to regulations mandating greater efficiency, and with climate change making action more urgent, renovation and reconstruction are growing trends both in the United States and worldwide. For buildings and infrastructure, Autodesk is a leader in BIM and digital technologies across the project lifecycle that underpin these reconstruction and renovation efforts. That's why we're delighted to be named as the Official Design and Make platform of the LA28 Olympic and Paralympic Games to support LA28's, no new permanent venues plan and commitment to build LA28's footprint by adapting existing or building temporary infrastructure. Autodesk will support LA28's more than $1 billion temporary overlay and construction plan, including retrofitting more than 40 venues across the Los Angeles metro area. Over the next four years, LA28 will use Autodesk software and Building Information Modeling BIM, tools to bring to life an ambitious venue plan, consultative support to help LA28 meet its delivery and sustainability plan and Autodesk Construction Cloud, as a central tool to facilitate better collaboration with thousands of critical stakeholders on the design, development and ultimate delivery of the venues. Autodesk's technology is used every day to design and make a better world, and we are thrilled to be LA28's official design and make platform. Before I open the call for questions, I would like to quickly update you on our CFO search. We have some excellent candidates and are making good progress. Once our new CFO is up to speed and we've launched a new transaction model in all developed markets, we will set out our plans in more detail. We'll update you when we have more to say. Operator, we would now like to open the call up for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Saket Kalia with Barclays. You may proceed.
Saket Kalia: Okay, great. Hey, Andrew. Hey, Betsy. Thanks for taking my questions here. Andrew, since you last reported Starboard Value has issued a couple of letters and a slide deck. Just maybe for the benefit of the Group, I was wondering if you had any high level thoughts that you wanted to share with us.
Andrew Anagnost: Right to it, Saket. All right. Look, first-off we listen to all of our investors and we listen carefully. We've met with Starboard several times. They came and presented to our Board. And I'll tell you one thing we are very much aligned with them on is there is a lot more shareholder value to be created from Autodesk for our investors, okay? And I think it is important to kind of talk about, okay, what should we be excited about. Today's results, we delivered in a pretty tough environment. We've seen macro impacts. We have had one-off impacts from Russia, from China, from writers and actors strikes and still you're seeing the kind of results that we delivered this quarter. Revenues up, free cash flows up, the guide's up 1% at the midpoint. Those things come from work and discipline. And how did we get here? There is a couple of things I want to make sure we remember and highlight, okay? About two years ago, we began this journey to move away from multi-year contracts billed upfront to multi-year contracts billed annually. I know that created some clouds for all of you on the outlook of Autodesk for 18 months. But look -- look at the results, okay. Two years ago the number of multi-year contracts billed upfront was measured in the billions. Today, you heard from Betsy, it's immaterial, right? Now the great thing about that is that billions from the past comes back to you, but it comes back to you in a nice smooth build up over time. It is math. I love math. More than that, it's simple math and we all love simple math. That money is coming and it is building up. So one, that's something to be excited about ongoing value from Autodesk. Another thing I want to talk about that which was really important. Last year, we started this journey on the new transaction model. And when we told you about the new transaction model, what did we tell you we were doing it for? We were doing it to get more control and visibility over our sales and marketing costs. And that is the mission going forward here. We see line of sight to increasing productivity and effectiveness in our sales and marketing motion and driving some of those costs down on a per [deal] (ph) basis which is great because that's how we see line of sight to margin growth. Now why should you believe me? Why should you believe us? All right. Let's look at what happened -- what's going to happen this year. This year, we are going to achieve the non-GAAP targets on an apples-to-apples basis that we set out two years ago, a year ahead of target. So I think you can trust that we're focused on this and that we're going to deliver. So, we agree with Starboard that there is a lot more value creation coming out of Autodesk. And I'm really excited about it going forward and the results that we've delivered this quarter are just the first step in that journey.
Saket Kalia: Yeah, absolutely. That was super helpful, Andrew. Maybe for my follow-up for you as well, maybe just moving to the business. You gave some nice examples of construction wins in the quarter. Could we just go one level deeper into Autodesk Construction Cloud? Maybe talk about sort of the overall construction backdrop that you are seeing and how you feel about ACC competitively?
Andrew Anagnost: Yeah. That's a great question, right? And look, first-off, the thing I'm really excited about with our construction business is that we are maintaining momentum in a really tough competitive environment where others are having challenges maintaining momentum, but we are maintaining momentum. And there is a couple of key reasons why we are maintaining momentum. One, there is still a large backlog in construction. Backlog matters, all right and that backlog is still there and kind of construction professionals are still interested in digitization. That in addition to our value proposition becoming more resonant with customers. One, the portfolio of Construction Cloud is competitive, people like it. They like our value proposition of going from design to construction. They like the flexibility of the business models we bring to them. They are looking to either move to Construction Cloud net new or they are looking to move from older solutions, competitive solutions to our solutions. The other thing is in the mid-market, in the US, we see our competition more and we win more and that's because of the strengthening of this value proposition. And the last bit I think is worth talking about is the international growth for Autodesk. This is a place where Autodesk has a superpower and we are going to continue to grow internationally. We saw strong growth internationally. We are going to continue to see strong growth internationally. And long term, that is going to continue to kind of be accretive to our construction business. So a lot going on there, but I do want people to remember there is a backlog and we are definitely maintaining momentum.
Saket Kalia: Very helpful, guys. Thank you.
Operator: Thank you. Our next question comes from Jay Vleeschhouwer with Griffin Securities. You may proceed.
Jay Vleeschhouwer: Thank you. Good evening. Andrew, with regard to the new engagement or transactional model, the new channel compensation arithmetic is very readily understandable, but I would like to ask more about the division of labor under the new model, which is to say your inside sales, your customer success investments and the like versus the channel. So how do you see the role of your inside and other direct sales capacities versus that of the channel, particularly when it comes to renewals and/or upselling, how do you see the role of the e-Store versus the channel under the new model? Then my follow-up.
Andrew Anagnost: Jay, you are asking some very specific questions. Let me kind of answer it in a very general way. Look, with this new transaction model, with the ability to drive clear divisions of labor, there are opportunities to drive efficiencies and productivity moving forward in sales and marketing, right? So absolutely, you are highlighting some things with regards to our partners and with regards to us that we are going to continue to perfect over time. And that is where some of this margin growth is going to come from -- most of this margin growth is going to come from over the next couple of years. So you are definitely talking around some of the areas that are important to discuss.
Jay Vleeschhouwer: Okay. Second question with regard to the billings co-terming effects, the model effects and the like, perhaps we can parse that to get at the organic effects of the business, which is to say, how are you thinking about your license volume and mix expectations? In other words, how are you thinking near-term and long-term with regard to the volume assumptions that you've previously spoken about in your overall P times Q framework?
Andrew Anagnost: So look, let me just start here for -- if Betsy, you want to add anything. I think the important thing to get about the co-terming is that what it does is it takes some billings out of the current renewal cycle and moves them forward. And more importantly, it creates efficiency in our renewal process. All right. So, we are going to get much more efficiency in our renewal process. A co-term contract is much more easy to wrangle at renewal time than another contract. It's also much more easy to do cross-sell, up-sell and expansion at renewal time. So, you are going to get some efficiencies from this. So co-terming is good, even though it has some puts and takes on where the billings show up. So I think that's kind of the important piece to take away from that. The rest of that detail is a little harder to address directly.
Betsy Rafael: The only thing I would add is with fewer contracts to manage, you also drive efficiency from the inside the company.
Saket Kalia: All right. Thank you.
Operator: Thank you. Our next question comes from Adam Borg with Stifel. You may proceed.
Adam Borg: Awesome, and thanks so much for taking the questions. Just maybe for Andrew, just going back to the new transactional model, it is great to hear that things are going smoothly so far in North America. I was hoping you could maybe go a step deeper on what that exactly means. And importantly, what's given the confidence to rollout accelerate the rollout into Europe and Japan ahead of expectations, especially given the additional complexities you've talked about pulling out internationally.
Andrew Anagnost: Yeah. It's a good question. So remember – let us just recount the incremental journey we've taken here, right? We started with Australia, really stressed and tested the system in that environment. We always like to stress and test things in smaller markets, on smaller -- on smaller pools. And we have essentially completed the entire rollout in the US. And during that time, we've had no major issues, no major issues came up with regards to disruption to the business as we did this. Now, of course, there is all sorts of quality of life issues. There has been a backlog of issues that people want more functionality, they want more capability to do X, Y and Z. And what we are doing is we are working that backlog and we gave ourselves a little bit of extra time to clear that backlog. Some of that backlog is specific to test runs that we've done in Europe as well. So given what we learned in Australia, given how the US went even smoother than Australia and we had a much shorter recovery time as we rolled out in Australia, given that we are probably going to see the same kind of pull forward in Europe that we saw in the US, which buffers things as we move forward, we are very confident about the cascade here and how this is going to roll out.
Betsy Rafael: The only thing that's different in Western Europe from North America is really that it is different currencies and there is different legal regulatory laws in place. But I think that we've learned from each step along the way and so are very, very comfortable with the plan for the full fiscal year.
Adam Borg: That's super helpful. And maybe just as a quick follow-up, Andrew, obviously, US elections coming up in a few months. I hope you could talk a little bit more about what you are seeing in the end-market demand environment. Are the AEC or manufacturing industry is making any changes in their decision making process, either accelerating or slowing down decision making ahead of the election in a few months? Thanks again.
Andrew Anagnost: Yeah. The good thing here is that the issues that affect our customers are bipartisan issues, all right? Infrastructure, manufacturing, Go-USA, everything across the world, they are bipartisan issues. So, I think whoever wins, there may be all sorts of other puts and takes. But with regards to the things that affect our customers' end-markets, I see little impact and we are not hearing a lot of trepidation from our customers on that.
Adam Borg: Incredibly helpful. Thanks, again.
Operator: Thank you. Our next question comes from Jason Celino with KeyBanc Capital Markets. You may proceed.
Jason Celino: Great. Thanks for taking my questions. I kind of wanted to kind of dig into just the performance of the quarter. Obviously, you beat nicely, you beat margins nicely. You are keeping kind of the margin framework the same for the year, even though you are absorbing some of these incremental headwinds from the transition. So internally, did you do anything to drive leverage or sources of leverage with that?
Andrew Anagnost: No, we did nothing unusual to do this, all right? This is all the rate and pace of the business. Betsy, do you want to comment a little bit more?
Betsy Rafael: I think that we did see underlying improvement in the margin and that was intentional knowing that we were going to get some headwinds from some of these transitions.
Jason Celino: Okay. Great. And then maybe just a little more pointed on the free cash flow side. So it is a $10 million raise, nice to see. Obviously, the transition timelines have no impact to free cash flow. So, I know you said some customers signed earlier in 2Q. So is the raise on free cash flow just a function of timing or more a function like the core business? Thank you.
Betsy Rafael: No, I think a lot of it is a timing issue because we originally estimated that -- we didn't anticipate the significance of people buying ahead of the launch in North America. And so our original assumption for free cash flow for FY’25, was that roughly two-thirds of it would take place in the back half of the year. Our current modeling assumption is one half of that will take place in the back half of the year.
Jason Celino: Excellent. Thank you.
Operator: Thank you. Our next question comes from Elizabeth Porter with Morgan Stanley. You may proceed.
Elizabeth Porter: Great. Thank you so much for the question. I wanted to ask a bit on the pricing environment. I believe one of the things we picked up was the move to the transactional model should allow you to have some more control on discounting behavior and help narrow some of the price differentials you've seen. So I wanted to ask, is this a lever you expect to use? And is it something you are doing today or a future opportunity and how we could think about that going forward?
Andrew Anagnost: Yeah. So the place where that has the biggest impact is with our partners, quite frankly. What our best partners really like about the new transaction model is it prevents a less competent, less value-added partner coming in and undermining them on price on a big deal where they are trying to really add value. So for our partners, this is definitely going to allow them to sell to the value they are delivering. For us, moving forward, it is all about the efficiencies of the process. So for us, it is not so much about the price. The partners are definitely going to benefit from that. What we are going to benefit is the ability to get the efficiencies and the costs out of the environment as we move forward. And I think that is where you want to look at for us. So the partners, definitely a price advantage for our best partners. For us, a cost advantage as we drive productivity.
Betsy Rafael: And enhance the strategic relationships directly with customers.
Elizabeth Porter: Great. And then just as a follow-up, I appreciate the comments on the overall demand environment. I was hoping you could unpack a little bit more around the new business trends. I understand the macro remains challenging. Anything you are picking up from a new business standpoint in the quarter or how that outlook is changing?
Andrew Anagnost: Yeah. So let me talk about that a little bit. Generally broadly, okay, we are seeing the same kind of trends that we've seen in previous quarters. There are absolutely some headwinds in new business, but there is different puts and takes here as we look at this quarter now. Our moving forward metrics like monthly active usage and build -- bids on building connected, those show the same kind of positive forward momentum that we've seen in the past. But if you look at the market, obviously AEC continued to do well. This has a lot to do with construction growth helping in there, as well as other things driving Revit, and the backlog associated with that. Manufacturing did well. It beat a lot of our competitors in the market. The drag was media and entertainment, still coming out of the effects of those strikes, okay, and that will continue to take time. Geographically, a few puts and takes here, okay? Most of the world was strong, but China and Korea were drags on our business geographically, right? And that gives you kind of a lay for -- lay of the land for what we see. But one of the things that you got to take away from this is -- Autodesk is an incredibly resilient business. There is puts and takes in one part of the business. There -- you might be off on certain types of projects, but you are up on other types of projects, one geography is down and other geography is up. This is the magic of Autodesk and our very distributed and resilient business, and that's what you are seeing as a result here.
Elizabeth Porter: Great. Thank you very much.
Operator: Thank you. Our next question comes from Joe Vruwink with Baird. You may proceed.
Joe Vruwink: Hi. Great. Hi, everyone. Going back, Andrew to your manufacturing comments, so growth in the upper teens there or low teens for just the ratable business. Those numbers definitely stand out relative to what we've been hearing throughout the summer, I think particularly at the high-end where there is been some commentary about more deal lumpiness at enterprise. I mean, you have exposure to mid-market and enterprise. You gave anecdotes about both segments. I'm wondering if you are ultimately seeing maybe more share movement and that's ultimately explaining the strength there.
Andrew Anagnost: We are definitely seeing share movement. But look, we feel like we're out in front on a lot of things. Fusion did well in the quarter. Its e-comm growth was consistent with previous quarters. More importantly, we continue to drive ASPs up for Fusion with attach rates of extensions and other options in the Fusion base. So you are absolutely seeing a share shift.
Joe Vruwink: Okay. And then on the slide showing underlying margin improvement that's taken place since FY ‘23, how much latent investment is still being absorbed in that normalized 39%? So you talked about making investment in cloud platform AI. Those investments are -- so you're ahead of peers and not needing to make up some future catch-up investment. I mean, another way to say is you are spending some amount and you haven't matched it against revenues yet. So just wondering if it is possible to quantify what that is because that would seem to be an area of future improvement in addition to what you are doing with the transaction model?
Andrew Anagnost: No, there is always a delay in R&D investment and return on R&D investment, okay? So there is always a shift. We are definitely in a time of great technological advancements here. We're definitely in an environment where share shift is starting to happen. So, there's always a shift in those areas, okay? And I think, we should expect that there is this delay between the actual value creation and the investment. That's very natural in technology like this. That's why I want you to understand that we are very focused on net sales and marketing productivity moving forward because that's how we are going to drive the margin growth over the next couple of years as the investments in these new and emerging technologies start to really pick up.
Joe Vruwink: Okay. Thank you.
Operator: Thank you. Our next question comes from Ken Wong with Oppenheimer & Co. You may proceed.
Ken Wong: Fantastic. I wanted to maybe dig into the margins a little bit. You mentioned being ahead of schedule on the margin profile, also confident you can make further improvements in fiscal 2026. I guess, how should we think about where that could go? We are at a point where you haven't even optimized for sales and marketing. What's the right way to think about that trajectory?
Andrew Anagnost: So, it is a little early for me to say, I'm not going to be giving the guide for next year. So there is a couple of things that are gating here, okay? One, we want to complete the rollout of the new transaction model. We want to hire a new CFO and get their fingers on this. And then what we'll do is we will start giving you more color on the specifics for next year. But suffice it to say, what I'm trying to do is give you confidence that, one, we're not only paying attention to this, but we've got line of sight, just like we did in the move to annualized billings, look at the results that we are delivering now as a result of that, okay? That was two years ago, look at the results we're delivering. Now I'm telling you we have line of sight on other productivity improvements associated with sales and marketing in the new transaction model. So, I want you to know, we see it and you need to believe in it.
Betsy Rafael: And as we've said before, the P&L is going to be noisy, as we continue to transition to the new transaction model. And that's why we anchored you on the FY’26 free cash flow target to give you a sense of what to expect. And with our current trajectory, we still estimate that the free cash flow in fiscal '26 to be around $2.05 billion at the midpoint. And as I said earlier, we have our largest multi-year cohort renewing. We have a large EBA cohort and we have kind of the natural transition to annual billings from upfront billings.
Ken Wong: Okay. Perfect. We will await anxiously for these details. Maybe second, just thinking about the -- we've talked a lot about the potential economics and kind of the partner activity on the transaction model. Like what are you guys hearing from customers and do they even care, do they even notice like is there some sort of a benefit on their side that they might be seeing that we're maybe on the analyst world not quite as cognizant of?
Andrew Anagnost: Yeah. So look, for most customers, it is a non-event, all right, because they're just finding themselves buying differently. Some are happier, some would prefer to go through a third-party. Notice that some are taking the opportunity to true up contracts, all right? That -- what they're doing right there is a thing, oh, I have a chance to clean up my relationship with Autodesk, that's going to give me more power come the renewal cycle. So they actually see advantages with cleaning up their relationship with us and making sure that they have visibility in their company. So that's good for them. But for the most part, it's not a big customer issue, both positive or negative.
Ken Wong: Okay, perfect. Thank you for the insights, guys.
Operator: Thank you. Our next question comes from Tyler Radke with Citi. You may proceed.
Tyler Radke: Yes. Thank you for taking the question. I guess just to start off on the free cash flow number for next year, I guess that's one piece of guidance or at least a target that you've given. Can you just talk about the confidence behind that? And as you think about being ahead of plan in terms of some of these margin optimizations, like how much margin and cost optimizations is built into that number?
Betsy Rafael: Well, again, we are obviously not going to be giving you detailed guidance for fiscal 2026 at this point. But what we will do at the end of the fiscal year is we'll give you a lot more details about the impact of the new transaction model, both on fiscal '25, as well as what we expected -- how we expect it to impact fiscal '26. And right now, we are focused on the rollout in North America, as well as Western Europe in September. What I can say is the tailwind to revenue growth will be greater in fiscal '26 than in '25. And all else being equal, the greater the tailwind to revenue in '26, the greater the headwind to margins. And again -- but we’re very focused on managing that. Again, based upon this change in the geography on the balance sheet and the P&L, we are still largely focused on being able to manage to margins that are better than they are today. And again, going back to the free cash flow number of the $2.05 billion at the midpoint, obviously that's up significantly from where it is this year. And I mentioned earlier, the largest multi-year cohort is renewing next year. We have a large EBA cohort. And again this natural transition from annual billing -- from the upfront to the annual billings will also help us from a cash flow perspective.
Tyler Radke: Great. And for Andrew the make revenue in the quarter was particularly strong, I think the strongest sequential growth in a number of years despite sort of having the leap year last quarter. Was there any one-time factors there, or is that sort of a function of share gains and some of the re-org that you've done in that organization to sort of accelerate growth?
Andrew Anagnost: Yes. So first off, the core underlying momentum of the make businesses have been tact. There was one one-time factor, the acquisition of Payapps is in there as well, all right, which is an important piece of it. But the underlying momentum in the Construction and Fusion business, that is solid and consistent with previous quarters with a little kick from the Payapps business, okay? Makes sense?
Tyler Radke: Yeah. Yeah, any way to quantify the Payapps in the quarter?
Andrew Anagnost: No.
Tyler Radke: Okay. Thank you. Thought I'd try.
Andrew Anagnost: No. Always we’re trying, always ask.
Operator: Thank you. That is all the time we have for Q&A today. I would now like to turn the call back over to Simon Mays-Smith for any closing remarks.
Simon Mays-Smith: Thanks everyone for attending. We look forward to seeing many of you on the road over the coming weeks and towards AU at the end of October. Please just ping me if you have any questions in the meantime. Otherwise, we'll catch up on next quarter's call towards the end of November. Thanks so much.
Operator: Thank you. This concludes the conference. Thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and thank you for standing by. Welcome to the Q2 Fiscal '25 Autodesk Earnings Conference Call. At this time all participants are in a listen-only mode. Please be advised that today's conference is being recorded. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I’d now like to hand the conference over to your speaker today, Simon Mays-Smith, Vice President, Investor Relations."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the second quarter results of Autodesk's fiscal '25. On the line with me is Andrew Anagnost, our CEO; and Betsy Rafael, our Interim CFO. During this call, we will make forward-looking statements, including outlook and related assumptions, products and strategies. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call, as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials, available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you, Simon and welcome everyone to the call. We finished the second quarter and first half of the year strongly, delivering 13% revenue growth in constant currency in both periods and have raised guidance for the full year, reflecting the sustained momentum of the business and the smooth launch of the new transaction model in North America in June and expected launch in Western Europe in September. Once again, opportunity, resilience and discipline underpinned our performance. In March last year, we laid out the secular growth trends in our markets from accelerating digital transformation in Architecture, Engineering and Construction or AEC, to the transition to the cloud in manufacturing and media and entertainment. These secular trends are driving customers to break down siloed workflows and seamlessly connect data end-to-end. Real-world experiences from remote collaboration to supply chain disruption and AI are reinforcing these trends. We’re aggressively pursuing our strategy to benefit from these secular trends, including the development of next-generation technology and services, end-to-end digital transformation and unique growth enablers such as business model evolution, customer experience evolution and convergence between industries. Our investments in cloud, platform and AI in pursuit of these growth opportunities and ahead of our peers enable Autodesk to provide its customers with ever more valuable and connected solutions and to support a much broader customer and developer ecosystem and marketplace. While macroeconomic policy, geopolitical and one-off factors like the Hollywood strikes have impacted industry growth, Autodesk subscription model and diversified product and customer portfolio have proven resilient. The underlying momentum of the business and key performance indicators remain consistent with previous quarters, as evidenced by increased product usage, record bid activity on building connected and cautious optimism from our channel partners. We realized the significant benefits of this strategy for shareholders through our disciplined and focused execution and capital deployment throughout the economic cycle. These investments mitigate the risk of expensive catch up investments in the future and support sustained revenue, margin and free cash flow growth. To support our growth initiatives and margin improvement, we have been modernizing our go-to-market approach to create more durable and direct relationships with our customers and to serve them more efficiently. And we are transforming our platform to enable greater engineering velocity and efficiency to support a broader customer and developer ecosystem and marketplace. We’ve already seen significant benefits from initiatives like these and there is more to come. Stripping out the effects of margins from FX and the new transaction model, we expect to be towards the midpoint of our fiscal '26 non-GAAP operating margin target of 38% to 40% in fiscal '25, a year ahead of schedule and representing about 300 basis points of improvement since fiscal '23. We are confident we will make further improvements in fiscal '26 on the same basis. Once complete, we expect the new transaction model and subsequent go-to-market optimization to increase sales and marketing efficiency and deliver GAAP margins among the best in the industry. Non-GAAP operating profit, including stock-based compensation costs, will become a key metric to track as we make this transition. Attractive long-term secular growth market, a focused-strategy delivering ever more valuable and connected solutions to our customers and a resilient business model are generating strong and sustained momentum both in absolute terms and relative to peers. Disciplined execution and capital deployment is driving even further operational velocity and efficiency within Autodesk and will underpin the mechanical build of revenue and free cash flow over the next few years and GAAP margins among the best in the industry. We expect the pace of buybacks to buy forward dilution will pick up into fiscal '26, as our free cash flow builds from the fiscal '24 trough. We expect this to result in a further reduction in shares outstanding over time, continuing the capital return trend of the last few years. In combination we believe these factors will deliver sustainable shareholder value over many years. I would like to welcome Betsy, and thank her for stepping in as Interim CFO and will now turn the call over to her to take you through the details of our quarterly financial performance and guidance for the year. I will then come back to provide an update on our strategic growth initiatives."
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"speaker": "Betsy Rafael",
"text": "Thanks, Andrew. Q2 was a strong quarter. We generated broad-based growth across products and regions in AEC and manufacturing which was partly offset by softness in media and entertainment, primarily due to the lingering effect of the Hollywood strike. Our make business continues to enhance growth, driven by ongoing strength in construction and fusion. Overall, macroeconomic, policy and geopolitical challenges and the underlying momentum of the business were consistent with the last few quarters and included strong renewal rates, but softer business -- new business in China and Korea. The new transaction model did not make a material contribution to our second quarter results. In his opening remarks, Andrew discussed the benefits we expect to derive from our go-to-market initiatives, which support our growth and ongoing margin improvement. Before I discuss revenue, billings, deferred revenue, RPO and free cash flow, let me remind you of how these metrics naturally and mechanically evolve during the shift to annual billings for most multi-year contracts, as well as the new transaction model. The shift to annual billings for most multi-year contracts moves billed deferred revenue into unbilled deferred revenue in our financial reporting. Unbilled deferred revenue would then not be included in deferred revenue on our balance sheet, but would be included in our remaining performance obligations disclosure. Initially this reduces billing, deferred revenue and free cash flow as you saw in fiscal 2024, but is gradually becoming a tailwind to billings and free cash flow, as our annually billed multi-year cohorts rebuild. Metrics that include unbilled deferred revenue like RPO give a better view of performance during our transition to annual billings for most multi-year contracts. And as we have said before, we will continue to offer multi-year contracts build upfront in certain circumstances, such as in emerging countries, where there is increased credit risk if not received upfront. On the Autodesk Store, until we enable system changes to offer annual billing and of course, on an exception basis, when it is driven by customer preference such as for our non-cloud enabled offerings. Just to give you some context on scale, multi-year contracts build upfront incrementally contributed less than 5% of total billings in the second quarter. The new transaction model also has mechanical and timing impacts on billings, deferred revenue, revenue and operating costs. The amount of impact is determined by the pace of the model rollout. In addition, channel partner and customer behavior can also impact the results. The mechanical impact is due to the way channel partner payments are recognized and accounted for in the P&L. Under the old or the buy-sell model, channel-partner payments are deducted from gross billings and revenue. We then report net billings and net revenue Conversely, in the new transaction model, we record channel partner payments in sales and marketing expense. So as we shift from the old model to the new, there is an increase in billings, deferred revenue, revenue and sales and marketing expense. That increase in revenue and operating costs resulting from the change in the way that channel-partner payments are recognized and accounting for flows ratably through revenue and cost in the P&L over time. And the overall pace of that transition is determined by when we launch the new transaction model into each geography. In the short-term, moving the P&L geography at channel partner payments from contra revenue to sales and marketing expense, creates a headwind to the operating margin percentage, but it is really broadly neutral to operating profit and free cash flow dollars. But over the long-term, we expect that this transition to the new transaction model will enable us to further optimize our business, which we anticipate will provide a tailwind to revenue and deliver GAAP margins among the best in the industry on mechanically higher revenue and despite mechanically higher costs. Channel partner and customer behavior during the rollout of the new transaction model are much harder to predict and model. For example, with channel partners better prepared ahead of launch, more customers in North America and Australia co-termed their contract expirations to align the timing of renewals across their business. This had a negative impact on the timing of billings and deferred revenue. And as we've seen many times before, co-termed contracts actually create an opportunity for larger contracts on renewal, as we elevate our relationship with customers from subsidiaries to company-wide. Along with more self-service functionality, it also enabled us to reduce administrative costs and serve our customers more efficiently. While activity in the second quarter was probably more tactical in nature, co-terming is one of the expected benefits of the new transaction model and will be one of the drivers of our margin momentum over the coming years. As I'll discuss, this creates timing headwinds, but is not a change in the underlying momentum of the business. We will give you much more details about the impact of the new transaction model on fiscal '25 results and the expected impact on fiscal '26, when we report our full year results next February. So now let's move on to the results. Total revenue grew 12% and 13% in constant currency. By product in constant currency, AutoCAD and AutoCAD LT revenue grew 8%, AEC revenue grew 15%, manufacturing revenue grew 17% and in the low-teens, excluding upfront revenue. M&E grew 5%. Revenue grew 13% in all regions on a constant currency basis. Direct revenue increased 21%, and represented 40% of total revenue, up 3 percentage points from last year benefiting from strong growth in both EBAs and the Autodesk Stores. Net revenue retention rate remained within the 100% to 110% range at constant exchange rate. Billings increased 13% in the quarter, reflecting a modest tailwind from the prior year shift to annual billings for most multi-year contracts and a mechanical tailwind of approximately 2% from the transition to the new transaction models. Billings were also negatively impacted by more co-termed. Total deferred revenue decreased 13% to $3.7 billion, and was again impacted by the transition from upfront to annual billings for multi-year contracts. Total RPO of $5.9 billion and current RPO of $3.9 billion grew 12% and 11% respectively. Turning to margins, GAAP and non-GAAP gross margins were broadly level, while GAAP and non-GAAP operating margins increased by 4 percentage points and 1 percentage points, respectively. At current course and speed, the ratio of stock-based compensation as a percentage of revenue peaked in fiscal '24, will fall by more than 1 percentage point in fiscal '25 and will be below 10% over time. Free cash flow for the quarter was $203 million. As we said might happen back in February, some channel partners in North America booked business earlier in the quarter ahead of the transition to the new transaction model to de-risk month one after the transition. This accelerated free cash flow to the second quarter, which was partially offset by the negative impact of [no] (ph) more co-terming. Turning to capital allocation, we continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long-term shareholder value. During the second quarter, we purchased approximately 471,000 shares for $115 million, which is an average price of approximately $245 per share. We do expect the pace of buybacks to pick up during the second half of the year, as we had very minimal purchases in the first half. We will also continue to deploy capital to offset dilution into fiscal 2026, as our free cash flow grows from the fiscal 2024 trough generated by the transition from upfront to annual billings, again, from most multi-year contracts. We will continue to buy forward dilution, which we expect to result in a further reduction in shares outstanding over time, continuing the capital return trends of the last few years. We have reduced our share count by about 5 million shares over the last three years with an average percentage reduction of about 70 basis points per year. Now let me finish with guidance. As we said in February, the pace of the rollout of the new transaction will create noise in billings and the P&L. So, we think free cash flow is the best measure of our performance. Taking out that noise, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year. Our sustained momentum in the second quarter and the smooth launch of the new transaction model in North America reduced the likelihood of our more cautious forecast scenarios. Given that, we are raising the midpoint of our billings, revenue, earnings per share and free cash flow guidance ranges. Let me give you a little bit more detail. The underlying momentum of billings is in-line with our expectations, but two of our modeling assumptions have changed. First, the new transaction model is expected to launch in Western Europe in September rather than in early fiscal '26, which was our modeling assumption at the start of fiscal '25. This is a tailwind to our reported billings. Second more customers have co-termed contracts in North America than we model and we've assumed the same thing will happen in Western Europe. This timing effect is a headwind to reported billings in fiscal 2025. The net effect of these is a 5 percentage point to 6 percentage point tailwind to billings from the new transaction model in fiscal 2025, which includes a 3 percentage point to 4 percentage point tailwind from North America specifically. We have raised our fiscal '25 billings guidance to a range between $5.88 billion and $5.98 billion. The underlying momentum of revenue is also in-line with our expectations. The $40 million increase to the top-end of revenue guidance reflects the expected launch of the new transaction model in Western Europe in September, as well as acquisitions and think about those in roughly equal measures. The $90 million increase to the bottom-end of the guidance range includes that $40 million with the remainder, an underlying increase due to the reduced likelihood of our more cautious forecast scenarios. At the midpoint, we are increasing revenue guidance by $65 million or $25 million excluding the impact of [new] (ph) acquisition and the new transaction model. Our fiscal '25 guidance range is now between $6.08 billion and $6.13 billion, translating into revenue growth of around 11% at the midpoint when compared to fiscal ['24] (ph) and includes 1 percentage point to 1.5 percentage point from the new transaction model. Underlying margins are slightly better than our previous guidance and that enables us to offer -- offset higher expected cost from the earlier launch of the new transaction model in Western Europe. While we still expect non-GAAP operating margins between the range of 35% and 36% in fiscal '25, that now includes a 1 point to 1.5 point underlying margin improvement that is broadly offset by the margin headwinds from the new transaction model and the incremental investment in people, processes and automation. The underlying momentum of free cash flow is in-line with our expectations as well. The headwind to billings from co-terming that I mentioned earlier is largely being offset by faster collections and improved underlying margins. We've raised the lower end of our fiscal '25 free cash flow guidance, resulting in a range between $1.45 billion and $1.5 billion. We expect strong free cash flow growth in fiscal '26, because of the return of our largest multi-year renewal cohort, the natural mechanical stacking of multi-year contracts billed annually and a larger overall EBA cohort. With our current trajectory, we still estimate free cash flow in fiscal 2026 to be around $2.05 billion at the midpoint. While the transition to annual billing for multi-year contracts and the deployment of the new transaction model, creates noise and billings in the P&L, they do provide a natural tailwind to revenue and free cash flow over the next few years. Combined with a resilient business model and sustained competitive momentum, Autodesk has enviable sources of visibility and certainty, given the context of significant macroeconomic, geopolitical, policy, health and climate uncertainty. We continue to manage our business using a Rule of 40 framework with a goal of reaching 45% or more over time. We are taking significant steps toward our goal this year and next. We think this balance between compounding revenue growth and strong free cash flow margins captured in the Rule of 40 framework, is the hallmark of the most valuable companies in the world and we intend to remain one of them. The slide deck on our website has more details on modeling assumptions for both Q3 and full fiscal year '25. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"text": "Thank you Betsy. Let me finish by updating you on our strong progress in the second quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction, fueled by customers consolidating onto our solutions to connect and optimize, previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions encompassing design, pre-construction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the mid-market. As a sign of that growing momentum, our construction business had another strong net new customer quarter as the benefits of our end-to-end solution became more apparent. Let me give you a few examples. Thornton Tomasetti is an internationally recognized engineering design and analysis firm, which uses Revit and other advanced technologies to enable us to deliver projects at all scales and levels of complexity. We have been a proud partner as it has transformed its business to excellence and interoperability in BIM. The transition from BIM 360 to Autodesk Construction Cloud has optimized project workflows and cloud collaboration. Autodesk's virtual reality tools have reimagined its visualization workflows and Dynamo and generative design have enabled its team to focus on high value creative work. During the quarter, Thornton Tomasetti renewed its EBA with Autodesk and expanded it by more than 50%. To address challenges of a fragmented ecosystem and siloed working environments, a European consortium of nine public water operators serving millions of residents across numerous municipalities decided to expand its relationship with Autodesk by adding BIM Collaborate and BIM Collaborate Pro and an upgraded premium plan to its existing AutoCAD, Docs, AEC collections and InfoWorks subscriptions. With these expanded capabilities, it will continue its digital transformation, accelerating its transition from 2D to 3D and its ability to manage all assets in a common data environment across all consortium members. In the quarter, a leading single source specialty subcontractor based in the Midwest of the United States, began looking to replace point solutions that no longer supported custom workflow. With the help of a channel partner after a 45-day evaluation, the subcontractor chose to adopt Autodesk Build, which complements its virtual construction and design capabilities, streamlines communication between design and construction teams and importantly gives us control over and ownership of its own data. Again, these stories have a common theme, managing people, processes and data across the project life cycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. Moving onto manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate our design and make platform. In automotive, we continue to strengthen and expand our partnerships, both within and beyond the design studio. In the second quarter, a leading European manufacturer renewed and expanded its EBA to accelerate its time to market and help drive its business transformation initiatives. In addition to Alias for concept design, it will leverage VRED for virtual prototypes and flow production tracking for project management. These solutions democratize visualization across the organization, reducing the resilience -- reliance on physical prototypes, improving design collaboration and speeding up the product development process. Additionally, as the manufacturer moves to build new battery factories, it is exploring the adoption of integrated factory modeling to reduce costs and increase collaboration across suppliers and contractors throughout the project lifecycle. Meissner, a global leader in complex tool and plant construction, is leveraging Autodesk solutions to adapt more quickly to a fast-moving automotive industry. It is driving business growth through improved production cycle times, while meeting high-quality reliability standards at reduced costs. To achieve this, Meissner has adopted power mill for complex simultaneous five axis milling, PowerInspect for programming 3D measurement inspection routines and machine parts and PowerShape to produce blow-molded plastic hollow parts, while leveraging Fusion for its collaboration capabilities. Fusion remains one of the fastest-growing products in the manufacturing industry. As customers seek to drive innovation and growth at lower costs, Fusion extension attach rates are increasing, which is helping to drive the average sales price higher. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. Three years ago, Bochum University, a public research university in Germany, evaluated Fusion for its mechanical engineering department, but determined the solution didn't fulfill existing requirements. In the second quarter, impressed with Fusion's significantly expanded capabilities in electronics and PCB design, configuration, drawing automation and collaboration, Bochum decided to replace a high-end competitive solution with Fusion for all mechanical engineering courses. With the Fusion platform, Bochum students can now acquire end-to-end workflow skills from simulation in the cloud to data management with just one installation, enabling better collaborative learning and employability for students, while saving time and administration costs for the university. And finally, we continue to leverage unique growth enablers such as business model evolution, customer experience evolution and convergence between industries to grow our market opportunity. For example, Mercury Engineering is a European leader in construction solutions. The company builds and manages complex engineering and construction projects for the world's leading corporations across a range of sectors, including data centers, semiconductor and life sciences to support its digital edge initiatives and the ability to deliver large scale projects wherever its clients operate, Mercury increased its investment in Flex, during the quarter. Using Flex to access solutions such as Navisworks, Revit, ReCap, AutoCAD and Plant 3D, coupled with Account-Based Autodesk Construction Cloud, Mercury enjoys frictionless consumption, limitless cloud access, the ability to rapidly scale up new projects with the right tools and the ability to collaborate across its ecosystem. I know many of you pay close attention to the American Institute of Architects' data, and we do too, but maybe not always to the same data. In 2022, the AIA said that almost half of architecture firms' total billings came from reconstruction and renovation projects, up from about a third 20 years ago, with the rest coming from new builds. In commercial and industrial and institutional subsectors, reconstruction and renovation accounted for more than 60% of billings. From infrastructure exceeding its design life to regulations mandating greater efficiency, and with climate change making action more urgent, renovation and reconstruction are growing trends both in the United States and worldwide. For buildings and infrastructure, Autodesk is a leader in BIM and digital technologies across the project lifecycle that underpin these reconstruction and renovation efforts. That's why we're delighted to be named as the Official Design and Make platform of the LA28 Olympic and Paralympic Games to support LA28's, no new permanent venues plan and commitment to build LA28's footprint by adapting existing or building temporary infrastructure. Autodesk will support LA28's more than $1 billion temporary overlay and construction plan, including retrofitting more than 40 venues across the Los Angeles metro area. Over the next four years, LA28 will use Autodesk software and Building Information Modeling BIM, tools to bring to life an ambitious venue plan, consultative support to help LA28 meet its delivery and sustainability plan and Autodesk Construction Cloud, as a central tool to facilitate better collaboration with thousands of critical stakeholders on the design, development and ultimate delivery of the venues. Autodesk's technology is used every day to design and make a better world, and we are thrilled to be LA28's official design and make platform. Before I open the call for questions, I would like to quickly update you on our CFO search. We have some excellent candidates and are making good progress. Once our new CFO is up to speed and we've launched a new transaction model in all developed markets, we will set out our plans in more detail. We'll update you when we have more to say. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Saket Kalia with Barclays. You may proceed."
},
{
"speaker": "Saket Kalia",
"text": "Okay, great. Hey, Andrew. Hey, Betsy. Thanks for taking my questions here. Andrew, since you last reported Starboard Value has issued a couple of letters and a slide deck. Just maybe for the benefit of the Group, I was wondering if you had any high level thoughts that you wanted to share with us."
},
{
"speaker": "Andrew Anagnost",
"text": "Right to it, Saket. All right. Look, first-off we listen to all of our investors and we listen carefully. We've met with Starboard several times. They came and presented to our Board. And I'll tell you one thing we are very much aligned with them on is there is a lot more shareholder value to be created from Autodesk for our investors, okay? And I think it is important to kind of talk about, okay, what should we be excited about. Today's results, we delivered in a pretty tough environment. We've seen macro impacts. We have had one-off impacts from Russia, from China, from writers and actors strikes and still you're seeing the kind of results that we delivered this quarter. Revenues up, free cash flows up, the guide's up 1% at the midpoint. Those things come from work and discipline. And how did we get here? There is a couple of things I want to make sure we remember and highlight, okay? About two years ago, we began this journey to move away from multi-year contracts billed upfront to multi-year contracts billed annually. I know that created some clouds for all of you on the outlook of Autodesk for 18 months. But look -- look at the results, okay. Two years ago the number of multi-year contracts billed upfront was measured in the billions. Today, you heard from Betsy, it's immaterial, right? Now the great thing about that is that billions from the past comes back to you, but it comes back to you in a nice smooth build up over time. It is math. I love math. More than that, it's simple math and we all love simple math. That money is coming and it is building up. So one, that's something to be excited about ongoing value from Autodesk. Another thing I want to talk about that which was really important. Last year, we started this journey on the new transaction model. And when we told you about the new transaction model, what did we tell you we were doing it for? We were doing it to get more control and visibility over our sales and marketing costs. And that is the mission going forward here. We see line of sight to increasing productivity and effectiveness in our sales and marketing motion and driving some of those costs down on a per [deal] (ph) basis which is great because that's how we see line of sight to margin growth. Now why should you believe me? Why should you believe us? All right. Let's look at what happened -- what's going to happen this year. This year, we are going to achieve the non-GAAP targets on an apples-to-apples basis that we set out two years ago, a year ahead of target. So I think you can trust that we're focused on this and that we're going to deliver. So, we agree with Starboard that there is a lot more value creation coming out of Autodesk. And I'm really excited about it going forward and the results that we've delivered this quarter are just the first step in that journey."
},
{
"speaker": "Saket Kalia",
"text": "Yeah, absolutely. That was super helpful, Andrew. Maybe for my follow-up for you as well, maybe just moving to the business. You gave some nice examples of construction wins in the quarter. Could we just go one level deeper into Autodesk Construction Cloud? Maybe talk about sort of the overall construction backdrop that you are seeing and how you feel about ACC competitively?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. That's a great question, right? And look, first-off, the thing I'm really excited about with our construction business is that we are maintaining momentum in a really tough competitive environment where others are having challenges maintaining momentum, but we are maintaining momentum. And there is a couple of key reasons why we are maintaining momentum. One, there is still a large backlog in construction. Backlog matters, all right and that backlog is still there and kind of construction professionals are still interested in digitization. That in addition to our value proposition becoming more resonant with customers. One, the portfolio of Construction Cloud is competitive, people like it. They like our value proposition of going from design to construction. They like the flexibility of the business models we bring to them. They are looking to either move to Construction Cloud net new or they are looking to move from older solutions, competitive solutions to our solutions. The other thing is in the mid-market, in the US, we see our competition more and we win more and that's because of the strengthening of this value proposition. And the last bit I think is worth talking about is the international growth for Autodesk. This is a place where Autodesk has a superpower and we are going to continue to grow internationally. We saw strong growth internationally. We are going to continue to see strong growth internationally. And long term, that is going to continue to kind of be accretive to our construction business. So a lot going on there, but I do want people to remember there is a backlog and we are definitely maintaining momentum."
},
{
"speaker": "Saket Kalia",
"text": "Very helpful, guys. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jay Vleeschhouwer with Griffin Securities. You may proceed."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Thank you. Good evening. Andrew, with regard to the new engagement or transactional model, the new channel compensation arithmetic is very readily understandable, but I would like to ask more about the division of labor under the new model, which is to say your inside sales, your customer success investments and the like versus the channel. So how do you see the role of your inside and other direct sales capacities versus that of the channel, particularly when it comes to renewals and/or upselling, how do you see the role of the e-Store versus the channel under the new model? Then my follow-up."
},
{
"speaker": "Andrew Anagnost",
"text": "Jay, you are asking some very specific questions. Let me kind of answer it in a very general way. Look, with this new transaction model, with the ability to drive clear divisions of labor, there are opportunities to drive efficiencies and productivity moving forward in sales and marketing, right? So absolutely, you are highlighting some things with regards to our partners and with regards to us that we are going to continue to perfect over time. And that is where some of this margin growth is going to come from -- most of this margin growth is going to come from over the next couple of years. So you are definitely talking around some of the areas that are important to discuss."
},
{
"speaker": "Jay Vleeschhouwer",
"text": "Okay. Second question with regard to the billings co-terming effects, the model effects and the like, perhaps we can parse that to get at the organic effects of the business, which is to say, how are you thinking about your license volume and mix expectations? In other words, how are you thinking near-term and long-term with regard to the volume assumptions that you've previously spoken about in your overall P times Q framework?"
},
{
"speaker": "Andrew Anagnost",
"text": "So look, let me just start here for -- if Betsy, you want to add anything. I think the important thing to get about the co-terming is that what it does is it takes some billings out of the current renewal cycle and moves them forward. And more importantly, it creates efficiency in our renewal process. All right. So, we are going to get much more efficiency in our renewal process. A co-term contract is much more easy to wrangle at renewal time than another contract. It's also much more easy to do cross-sell, up-sell and expansion at renewal time. So, you are going to get some efficiencies from this. So co-terming is good, even though it has some puts and takes on where the billings show up. So I think that's kind of the important piece to take away from that. The rest of that detail is a little harder to address directly."
},
{
"speaker": "Betsy Rafael",
"text": "The only thing I would add is with fewer contracts to manage, you also drive efficiency from the inside the company."
},
{
"speaker": "Saket Kalia",
"text": "All right. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Adam Borg with Stifel. You may proceed."
},
{
"speaker": "Adam Borg",
"text": "Awesome, and thanks so much for taking the questions. Just maybe for Andrew, just going back to the new transactional model, it is great to hear that things are going smoothly so far in North America. I was hoping you could maybe go a step deeper on what that exactly means. And importantly, what's given the confidence to rollout accelerate the rollout into Europe and Japan ahead of expectations, especially given the additional complexities you've talked about pulling out internationally."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. It's a good question. So remember – let us just recount the incremental journey we've taken here, right? We started with Australia, really stressed and tested the system in that environment. We always like to stress and test things in smaller markets, on smaller -- on smaller pools. And we have essentially completed the entire rollout in the US. And during that time, we've had no major issues, no major issues came up with regards to disruption to the business as we did this. Now, of course, there is all sorts of quality of life issues. There has been a backlog of issues that people want more functionality, they want more capability to do X, Y and Z. And what we are doing is we are working that backlog and we gave ourselves a little bit of extra time to clear that backlog. Some of that backlog is specific to test runs that we've done in Europe as well. So given what we learned in Australia, given how the US went even smoother than Australia and we had a much shorter recovery time as we rolled out in Australia, given that we are probably going to see the same kind of pull forward in Europe that we saw in the US, which buffers things as we move forward, we are very confident about the cascade here and how this is going to roll out."
},
{
"speaker": "Betsy Rafael",
"text": "The only thing that's different in Western Europe from North America is really that it is different currencies and there is different legal regulatory laws in place. But I think that we've learned from each step along the way and so are very, very comfortable with the plan for the full fiscal year."
},
{
"speaker": "Adam Borg",
"text": "That's super helpful. And maybe just as a quick follow-up, Andrew, obviously, US elections coming up in a few months. I hope you could talk a little bit more about what you are seeing in the end-market demand environment. Are the AEC or manufacturing industry is making any changes in their decision making process, either accelerating or slowing down decision making ahead of the election in a few months? Thanks again."
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. The good thing here is that the issues that affect our customers are bipartisan issues, all right? Infrastructure, manufacturing, Go-USA, everything across the world, they are bipartisan issues. So, I think whoever wins, there may be all sorts of other puts and takes. But with regards to the things that affect our customers' end-markets, I see little impact and we are not hearing a lot of trepidation from our customers on that."
},
{
"speaker": "Adam Borg",
"text": "Incredibly helpful. Thanks, again."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jason Celino with KeyBanc Capital Markets. You may proceed."
},
{
"speaker": "Jason Celino",
"text": "Great. Thanks for taking my questions. I kind of wanted to kind of dig into just the performance of the quarter. Obviously, you beat nicely, you beat margins nicely. You are keeping kind of the margin framework the same for the year, even though you are absorbing some of these incremental headwinds from the transition. So internally, did you do anything to drive leverage or sources of leverage with that?"
},
{
"speaker": "Andrew Anagnost",
"text": "No, we did nothing unusual to do this, all right? This is all the rate and pace of the business. Betsy, do you want to comment a little bit more?"
},
{
"speaker": "Betsy Rafael",
"text": "I think that we did see underlying improvement in the margin and that was intentional knowing that we were going to get some headwinds from some of these transitions."
},
{
"speaker": "Jason Celino",
"text": "Okay. Great. And then maybe just a little more pointed on the free cash flow side. So it is a $10 million raise, nice to see. Obviously, the transition timelines have no impact to free cash flow. So, I know you said some customers signed earlier in 2Q. So is the raise on free cash flow just a function of timing or more a function like the core business? Thank you."
},
{
"speaker": "Betsy Rafael",
"text": "No, I think a lot of it is a timing issue because we originally estimated that -- we didn't anticipate the significance of people buying ahead of the launch in North America. And so our original assumption for free cash flow for FY’25, was that roughly two-thirds of it would take place in the back half of the year. Our current modeling assumption is one half of that will take place in the back half of the year."
},
{
"speaker": "Jason Celino",
"text": "Excellent. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Elizabeth Porter with Morgan Stanley. You may proceed."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. Thank you so much for the question. I wanted to ask a bit on the pricing environment. I believe one of the things we picked up was the move to the transactional model should allow you to have some more control on discounting behavior and help narrow some of the price differentials you've seen. So I wanted to ask, is this a lever you expect to use? And is it something you are doing today or a future opportunity and how we could think about that going forward?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So the place where that has the biggest impact is with our partners, quite frankly. What our best partners really like about the new transaction model is it prevents a less competent, less value-added partner coming in and undermining them on price on a big deal where they are trying to really add value. So for our partners, this is definitely going to allow them to sell to the value they are delivering. For us, moving forward, it is all about the efficiencies of the process. So for us, it is not so much about the price. The partners are definitely going to benefit from that. What we are going to benefit is the ability to get the efficiencies and the costs out of the environment as we move forward. And I think that is where you want to look at for us. So the partners, definitely a price advantage for our best partners. For us, a cost advantage as we drive productivity."
},
{
"speaker": "Betsy Rafael",
"text": "And enhance the strategic relationships directly with customers."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. And then just as a follow-up, I appreciate the comments on the overall demand environment. I was hoping you could unpack a little bit more around the new business trends. I understand the macro remains challenging. Anything you are picking up from a new business standpoint in the quarter or how that outlook is changing?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So let me talk about that a little bit. Generally broadly, okay, we are seeing the same kind of trends that we've seen in previous quarters. There are absolutely some headwinds in new business, but there is different puts and takes here as we look at this quarter now. Our moving forward metrics like monthly active usage and build -- bids on building connected, those show the same kind of positive forward momentum that we've seen in the past. But if you look at the market, obviously AEC continued to do well. This has a lot to do with construction growth helping in there, as well as other things driving Revit, and the backlog associated with that. Manufacturing did well. It beat a lot of our competitors in the market. The drag was media and entertainment, still coming out of the effects of those strikes, okay, and that will continue to take time. Geographically, a few puts and takes here, okay? Most of the world was strong, but China and Korea were drags on our business geographically, right? And that gives you kind of a lay for -- lay of the land for what we see. But one of the things that you got to take away from this is -- Autodesk is an incredibly resilient business. There is puts and takes in one part of the business. There -- you might be off on certain types of projects, but you are up on other types of projects, one geography is down and other geography is up. This is the magic of Autodesk and our very distributed and resilient business, and that's what you are seeing as a result here."
},
{
"speaker": "Elizabeth Porter",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Joe Vruwink with Baird. You may proceed."
},
{
"speaker": "Joe Vruwink",
"text": "Hi. Great. Hi, everyone. Going back, Andrew to your manufacturing comments, so growth in the upper teens there or low teens for just the ratable business. Those numbers definitely stand out relative to what we've been hearing throughout the summer, I think particularly at the high-end where there is been some commentary about more deal lumpiness at enterprise. I mean, you have exposure to mid-market and enterprise. You gave anecdotes about both segments. I'm wondering if you are ultimately seeing maybe more share movement and that's ultimately explaining the strength there."
},
{
"speaker": "Andrew Anagnost",
"text": "We are definitely seeing share movement. But look, we feel like we're out in front on a lot of things. Fusion did well in the quarter. Its e-comm growth was consistent with previous quarters. More importantly, we continue to drive ASPs up for Fusion with attach rates of extensions and other options in the Fusion base. So you are absolutely seeing a share shift."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. And then on the slide showing underlying margin improvement that's taken place since FY ‘23, how much latent investment is still being absorbed in that normalized 39%? So you talked about making investment in cloud platform AI. Those investments are -- so you're ahead of peers and not needing to make up some future catch-up investment. I mean, another way to say is you are spending some amount and you haven't matched it against revenues yet. So just wondering if it is possible to quantify what that is because that would seem to be an area of future improvement in addition to what you are doing with the transaction model?"
},
{
"speaker": "Andrew Anagnost",
"text": "No, there is always a delay in R&D investment and return on R&D investment, okay? So there is always a shift. We are definitely in a time of great technological advancements here. We're definitely in an environment where share shift is starting to happen. So, there's always a shift in those areas, okay? And I think, we should expect that there is this delay between the actual value creation and the investment. That's very natural in technology like this. That's why I want you to understand that we are very focused on net sales and marketing productivity moving forward because that's how we are going to drive the margin growth over the next couple of years as the investments in these new and emerging technologies start to really pick up."
},
{
"speaker": "Joe Vruwink",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ken Wong with Oppenheimer & Co. You may proceed."
},
{
"speaker": "Ken Wong",
"text": "Fantastic. I wanted to maybe dig into the margins a little bit. You mentioned being ahead of schedule on the margin profile, also confident you can make further improvements in fiscal 2026. I guess, how should we think about where that could go? We are at a point where you haven't even optimized for sales and marketing. What's the right way to think about that trajectory?"
},
{
"speaker": "Andrew Anagnost",
"text": "So, it is a little early for me to say, I'm not going to be giving the guide for next year. So there is a couple of things that are gating here, okay? One, we want to complete the rollout of the new transaction model. We want to hire a new CFO and get their fingers on this. And then what we'll do is we will start giving you more color on the specifics for next year. But suffice it to say, what I'm trying to do is give you confidence that, one, we're not only paying attention to this, but we've got line of sight, just like we did in the move to annualized billings, look at the results that we are delivering now as a result of that, okay? That was two years ago, look at the results we're delivering. Now I'm telling you we have line of sight on other productivity improvements associated with sales and marketing in the new transaction model. So, I want you to know, we see it and you need to believe in it."
},
{
"speaker": "Betsy Rafael",
"text": "And as we've said before, the P&L is going to be noisy, as we continue to transition to the new transaction model. And that's why we anchored you on the FY’26 free cash flow target to give you a sense of what to expect. And with our current trajectory, we still estimate that the free cash flow in fiscal '26 to be around $2.05 billion at the midpoint. And as I said earlier, we have our largest multi-year cohort renewing. We have a large EBA cohort and we have kind of the natural transition to annual billings from upfront billings."
},
{
"speaker": "Ken Wong",
"text": "Okay. Perfect. We will await anxiously for these details. Maybe second, just thinking about the -- we've talked a lot about the potential economics and kind of the partner activity on the transaction model. Like what are you guys hearing from customers and do they even care, do they even notice like is there some sort of a benefit on their side that they might be seeing that we're maybe on the analyst world not quite as cognizant of?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yeah. So look, for most customers, it is a non-event, all right, because they're just finding themselves buying differently. Some are happier, some would prefer to go through a third-party. Notice that some are taking the opportunity to true up contracts, all right? That -- what they're doing right there is a thing, oh, I have a chance to clean up my relationship with Autodesk, that's going to give me more power come the renewal cycle. So they actually see advantages with cleaning up their relationship with us and making sure that they have visibility in their company. So that's good for them. But for the most part, it's not a big customer issue, both positive or negative."
},
{
"speaker": "Ken Wong",
"text": "Okay, perfect. Thank you for the insights, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Tyler Radke with Citi. You may proceed."
},
{
"speaker": "Tyler Radke",
"text": "Yes. Thank you for taking the question. I guess just to start off on the free cash flow number for next year, I guess that's one piece of guidance or at least a target that you've given. Can you just talk about the confidence behind that? And as you think about being ahead of plan in terms of some of these margin optimizations, like how much margin and cost optimizations is built into that number?"
},
{
"speaker": "Betsy Rafael",
"text": "Well, again, we are obviously not going to be giving you detailed guidance for fiscal 2026 at this point. But what we will do at the end of the fiscal year is we'll give you a lot more details about the impact of the new transaction model, both on fiscal '25, as well as what we expected -- how we expect it to impact fiscal '26. And right now, we are focused on the rollout in North America, as well as Western Europe in September. What I can say is the tailwind to revenue growth will be greater in fiscal '26 than in '25. And all else being equal, the greater the tailwind to revenue in '26, the greater the headwind to margins. And again -- but we’re very focused on managing that. Again, based upon this change in the geography on the balance sheet and the P&L, we are still largely focused on being able to manage to margins that are better than they are today. And again, going back to the free cash flow number of the $2.05 billion at the midpoint, obviously that's up significantly from where it is this year. And I mentioned earlier, the largest multi-year cohort is renewing next year. We have a large EBA cohort. And again this natural transition from annual billing -- from the upfront to the annual billings will also help us from a cash flow perspective."
},
{
"speaker": "Tyler Radke",
"text": "Great. And for Andrew the make revenue in the quarter was particularly strong, I think the strongest sequential growth in a number of years despite sort of having the leap year last quarter. Was there any one-time factors there, or is that sort of a function of share gains and some of the re-org that you've done in that organization to sort of accelerate growth?"
},
{
"speaker": "Andrew Anagnost",
"text": "Yes. So first off, the core underlying momentum of the make businesses have been tact. There was one one-time factor, the acquisition of Payapps is in there as well, all right, which is an important piece of it. But the underlying momentum in the Construction and Fusion business, that is solid and consistent with previous quarters with a little kick from the Payapps business, okay? Makes sense?"
},
{
"speaker": "Tyler Radke",
"text": "Yeah. Yeah, any way to quantify the Payapps in the quarter?"
},
{
"speaker": "Andrew Anagnost",
"text": "No."
},
{
"speaker": "Tyler Radke",
"text": "Okay. Thank you. Thought I'd try."
},
{
"speaker": "Andrew Anagnost",
"text": "No. Always we’re trying, always ask."
},
{
"speaker": "Operator",
"text": "Thank you. That is all the time we have for Q&A today. I would now like to turn the call back over to Simon Mays-Smith for any closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"text": "Thanks everyone for attending. We look forward to seeing many of you on the road over the coming weeks and towards AU at the end of October. Please just ping me if you have any questions in the meantime. Otherwise, we'll catch up on next quarter's call towards the end of November. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes the conference. Thank you for your participation. You may now disconnect."
}
] | Autodesk, Inc. | 119,902 |
AEE | 4 | 2,020 | 2021-02-19 10:00:00 | Operator: Greetings, and welcome to the Ameren Corporation's Fourth Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Mr. Andrew Kirk, Director of Investor Relations. Thank you. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that's accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and Risk Factors section in our filings with the SEC. Lastly, all per-share earnings amounts discussed during today's presentation, including earnings guidance are presented on a diluted basis, unless otherwise noted. Now here's Warner.
Warner Baxter: Thanks Andrew. Good morning, everyone and thank you for joining us. Before I begin our discussion of year end results and other key business matters, I'll start with few comments on COVID-19 as well as the steps we've taken to deliver safe, reliable electric and natural gas service to our customers during the recent period of extremely cold weather in our region. To begin, help you, your families and colleagues are safe and healthy. While COVID-19 has driven a great deal of change, I can assure you that one thing that remains constant in Ameren is our strong commitment to the safety of our co-workers, customers and communities. So too is a strong focus on delivering safe, reliable, cleaner, and affordable electric and natural gas service during this unprecedented time. We recognize that millions of customers in Missouri and Illinois are dependent on us. I can't express enough appreciation to my co-workers who have shown great agility, innovation, determination and a keen focus on safety while delivering on our mission to power the quality of life. And while we're focused on addressing the challenges associated with the pandemic, and achieving our mission each day, we never lose sight of our vision, leading the way to a sustainable energy future. Despite the significant challenges presented by COVID-19, I look to the future with optimism. Not just because vaccines are now being distributed to millions around the world, but also because of how our co-workers stepped up and addressed a multitude of challenges and capitalize on opportunities in 2020 that will clearly help us achieve our vision. Speaking of stepping up to challenges to ensure that we continue to deliver on our mission and vision, our team has been tirelessly working over the last week to ensure that we continue to deliver safe, reliable electric and natural gas services to millions of people in our service territory, despite the extremely cold weather that we are experiencing in our region. As the extremely cold weather has created significant challenges to maintain the safety and reliability of the energy grid in several areas of the country. Understandably, the cold weather has driven a significant increase in customer demand for electric and natural gas service. At the same time, the extreme weather has resulted in natural gas supply disruptions and limitations, operational issues of power plants and transmission constraints, combined these extraordinary circumstances that several regional transmission organizations to implement Emergency Operations protocols, which include controlled interruptions of service to customers in several states, most notably in Texas. Not surprisingly, the same set of conditions resulting in significant increases in power and natural gas prices in the energy markets. Today, we have not experienced any significant reliability issues in Missouri or Illinois businesses as past investments in energy infrastructure that paid off. In addition to strong operation of our gas storage fields in Illinois, and coal fired energy centers in Missouri, as well as our robust interconnections with gas pipeline suppliers, and the power markets have played a major role as well. Rest assured, we will continue to actively manage this challenging situation for our customers. Turning to page 4. Before I jump into the details of our accomplishments and strategic areas of focus, I want to reiterate the strategy that has been delivering significant long-term value to all of our stakeholders. Specifically, our strategies to invest in a robust pipeline of great regulated energy infrastructure, continuously improve operating performance, and advocate for responsible energy and economic policies to deliver superior value to our customers and shareholders. As always, our customers continue to be at the center of our strategy. I am pleased to say that our actions and performance in 2020 as well as our strategic areas of focus for the future, are strongly aligned with our customers and shareholders expectations to lead the way to a sustainable energy future, which brings me to a discussion about 2020 performance. As I said earlier, we delivered strong financial and operational performance in 2020. Yesterday, we announced 2020 earnings $3.50 per share, compared to earnings of $3.35 per share earned in 2019. Excluding the impact from weather 2020 normalized earnings increase to $3.54 per share, or approximately 6.6% from 2019, weather normalized earnings of $3.32 per share. With our customers and shareholders expectations in mind, we made significant investments in energy infrastructure in 2020 that resulted in a more reliable, resilient, secure and cleaner energy grid, as well as contributed to strong rate base growth in all of our business segments. Consistent with these objectives, and despite COVID-19 challenges, we successfully executed on a robust pipeline of investments across all of our businesses. In 2020, as outlined on this page, we also achieve constructive outcomes in several regulatory proceedings that will help drive additional infrastructure investments that will benefit customers and shareholders while keeping our customers rates affordable. The bottom line is that we successfully execute our strategy in 2020, which will drive significant long-term value for all of our stakeholders. Turning to page 5, here we highlight the significant progress we made in an area that has and will continue to be a significant area of focus, sustainability. Last September, we announced the transformation of clean energy transition plan that effectively balances environmental stewardship, with reliability, and affordability. In particular, we establish the Clean Energy goal of net zero carbon emissions by 2050 across all of our operations in Missouri, in Illinois, we also established strong interim carbon reduction goals of 50% by 2030, and 85% by 2040, based on 2005 levels. In addition, our plan includes robust investments in new wind and solar generations have been mindful of reliability. Notably, we are targeting adding 5,400 megawatts new renewable wind and solar generation resources to our generation portfolio by 2014. Our plan also includes advancing the retirement of two coal fired energy centers, extending the life of our carbon free Callaway nuclear energy center to eight years and partnering with the electric power Research Institute in assessing advanced clean energy technologies for the future. We have already executed key elements of this plan. In particular, a significant milestone toward accomplishing our net zero carbon emissions goal was reached with the acquisition of the 400 megawatt high Prairie Renewable Energy Center in December. This was our first wind generation addition, and is the largest wind facility in the state of Missouri. Earlier this year, we also acquired our second wind generation investment, the Atchison Renewable Energy Center, which when completed, is expected to be a 300 megawatt facility. We also have a strong, long-term commitment to our customers and communities to be socially responsible, and economically impactful. There has never been a more important time than now to be a leader in this area, and we are leaning forward. In terms of COVID-19 relief, we've been continuously working to help our customers in need, including implementing disconnection moratoriums, providing a special bill payment plans, providing over $23 million of critical funds for energy assistance, and other basic needs. We have a virtual diversity Equity and Inclusion Leadership Summit in June 2020 that included over 600 community leaders and co-workers. During that summit, and we made a commitment of $10 million over the next five years to nonprofit organizations focused on DNI and we spent over $800 million with diverse suppliers in 2020, a 24% increase over 2019. From a governance perspective, our Board of Directors oversight of sustainability risks was enhanced. In addition, we named our first Chief Renewable Development Officer to lead our continued efforts to transition to a cleaner and more diverse generation portfolio. Further, the Board of Directors strengthened our executive compensation program by adding a 10% long-term incentive based on implementing our clean energy transition plans. And just last week, the Board approved the addition of workforce and supplier diversity metrics to our short-term incentive plan for 2021. All of these efforts are consistent with our vision, leading the way to a sustainable energy future in our mission to power the quality of life. Turning to page 6, as you can see on this page, our laser focus on executing our strategy for the last several years has delivered strong results. From a customer standpoint, our investments in infrastructure have driven our reliability to top quartile performance, while at the same time our disciplined cost management has kept our electric rates among the lowest in the country. The combination of these factors itself drive significantly higher customer satisfaction scores. It also delivered superior value to our shareholders as you can see on page 7. Our weather normalized core earnings per share has risen 70% or and an approximately 8% compound annual growth rate since we exited our unregulated generation business in 2013. Our dividend rate has increased 25% over the same time period. This has resulted in a significant reduction in our weather normalized dividend payout ratio from over 77% in 2013 to 56% in 2020. Near the bottom of our 55% to 70%, targeted dividend payout range, position us well for continued strong infrastructure investments and rate based growth, as well as future dividend growth. Speaking of dividend growth, I am pleased to report that last week; Ameren's Board of Directors approved a quarterly dividend increase of approximately 7%, resulting in an annualized dividend rate of $2.20 per share. This increase, coupled with a dividend increase of 4% in October 2020 reflects confidence by Ameren's board of directors in the outlook for our businesses, and management's ability to execute a strategy for the long-term benefit of our customers and shareholders. While I'm very pleased with our past performance, we are not sitting back and taking a deep breath. We remained focused on accelerating and enhancing our performance in 2021 in the years ahead, so we can continue to deliver superior value to our customers, communities and shareholders, which brings me to page 8. Yesterday afternoon, we also announced that we expect our 2020 earnings to be in the range of $3.65 to $3.85 per share. Michael will provide you with more details on our 2021 gains a bit later. Building on the strong execution of our strategy and our robust earnings growth over the past several years, we continue to expect to deliver long-term earnings growth that is among the best in the industry. We expect to deliver 6% to 8% compound annual earnings per share growth from 2021 to 2025 using the midpoint of our 2021 guidance $3.75 per share, as the base. Our long term earnings growth will be driven by continued execution of our strategy, including investing in infrastructure for the benefit of our customers, while keeping rates affordable. Another important element of our strong total shareholder return story is our dividend. Looking ahead Ameren expects future dividend growth to be in line with its long-term earnings per share growth expectations within a payout ratio range of 55% to 70%. In addition to earnings growth considerations, future dividend decisions will be driven by cash flow, investment requirements, and other business conditions. Turning the page 9, the first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. The strong long term earnings growth I just discussed is primarily driven by a rate based growth plan. Today, we are rolling forward our five year investment plan and as you can see, we expect to grow our rate base in an approximately 8% compound annual rates for the 2020 through 2025 period. This growth is driven by our robust capital plan for approximately $17 billion over the next five years that will deliver significant value to our customers and the communities we serve. Our plan includes strategically allocating capital to all four of our business segments. Importantly, our five year earnings and rate based growth projections do not include 1,200 megawatts of incremental renewable investment opportunities, from Ameren Missouri's integrated resource plan. Our team continues to assess several renewable generation proposals from developers. We expect to file for certificates and convenience and necessity for some renewable generation projects in 2021 with the Missouri PSC. We expect to add these investments to our multi year rate base outlook, as we finalize pending negotiations with noble energy developers and move further along in the regulatory approval process in Missouri. Finally, we remain focused on discipline cost management, earn as close to our allowed returns as possible, and all of our businesses. Speaking of a disciplined cost management, let's now turn to page 10. Over the last several years, we've worked hard to enhance the regulatory frameworks in both Missouri and Illinois to help drive additional infrastructure investments that will benefit customers and shareholders. At the same time, we've been very focused on discipline cost management to keep rates affordable. Our efforts are paying off. As outlined on this page, residential rates have decreased since opting into these enhanced regulatory frameworks for all of our Missouri electric and Illinois electric and natural gas distribution businesses. So to be clear, since these constructive frameworks have been put in place, significant investments have been made, reliability has improved, rates have gone down, and 1000s of jobs have been created. While this is a great win for our customers and communities; we are not done. Turning to page 11. As you can see from this chart, our operating expenses have decreased 14% since 2015. We will remain relentlessly focused on disciplined cost management, as we look forward to the next five years and beyond. This will not only include the robust cost management initiatives undertaken to manage COVID-19, but also several other customer affordability initiatives. These initiatives include the automation and optimization of our processes, including leveraging the benefits from significant past, and future investments in digital technologies, and grid modernization. In addition, as part of the Ameren Missouri integrated resource plan, we will work to responsibly retire our coal fired energy centers over time, which includes thoughtfully managing workforce changes through attrition, transfers to other facilities, and retraining for other positions in the company. Turning now to page 12; next, I want to cover the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. An enhanced version of the Downstate Clean Energy Affordability Act legislation was filed in the past week, which in past would apply to both the Ameren Illinois electric and natural gas distribution businesses. This legislation would allow an Illinois to make significant investments in solar energy, battery storage and gas infrastructure to improve safety and reliability, as well as in transportation electrification, in order to benefit customers in the academy across central and southern Illinois. This important piece of legislation also required diverse suppliers spend reporting for all electric renewable energy providers. Another key component of the Downstate Clean Energy Affordability Act that it would allow for performance based ratemaking for an Illinois Natural Gas and Electric distribution businesses through 2032. Proposed performance metric would ensure investments are aligned with and are contributing to reliability of the energy grid, as well as to transition to the Clean Energy vision of the state. Further, this legislation would modify the amount of return on equity methodology in each business to align with returns being earned other gas and electric utilities across the nation. This legislation builds on Ameren Illinois efforts to invest in critical energy infrastructure under a transparent and stable regulatory framework that has supported significant investments, improve safety and reliability, as well as creating over 1,400 jobs, all while keeping electric rates well below the Midwest, and national averages. This bill would also move the state of Illinois closer to reaching its goal of 100% clean energy by 2050. By providing for performance base rate making in both electric and gas distribution businesses, we believe that proposed legislation would further align the energy goal of Ameren Illinois and the state of Illinois, for the benefit of our customers, the communities we serve and the environment. All these benefits in mind, we are focused on working with key stakeholders to get this important legislation passed this year. Moving now to page 13 for an update on our $1.1 billion wind generation investment plan to achieve compliance with Missouri's renewable energy standard through the acquisition of 700 megawatts new wind generation at two sites in Missouri. As I mentioned earlier, Ameren Missouri closed on the acquisition of our first Wind Energy Center, a 400 megawatt project in northeast Missouri in December. Last month, we acquired our second wind generation project, the 300 megawatt Atchison Renewable Energy Center, located in Northwest Missouri; approximately 120 megawatts are already in service. We expect a total of 150 megawatts to be in service by the end of the first quarter, with remain expected later in 2021 upon the replacement of certain turbine blades. We finance these projects through a combination of green first mortgage bonds, and common stock issued in our forward equity sale agreement. We do not expect the construction delay on Atchison and wind facility to have a significant economic consequence or reduce the production tax credits for this project. Because the rule change made by the US Department of Treasury last year to extend the end service criteria by one year to December 31, 2021. Turning now to page 14, and an update on our Callaway Energy Center. During its return to full power as part of its 24th refueling and maintenance outage in late December 2020 Ameren Missouri's Callaway Energy Center experienced a non nuclear operating issue related to its generator. A thorough investigation this matter was conducted and the decision was made to replace certain key components of the generator in order to safely and sustainably returned to energy center the service. Work is already underway on this capital project, which we expect will cost approximately $65 million. We're also pursuing the recovery of costs through applicable warranties and insurance. Due to the long lead time for the manufacturing, repair and installation of these components, the Energy Center is expected to return to service from May June or early July. And as announced previously, we do not expect this amount to have a significant impact on Ameren's financial results. Turning now to page 15. As we look to the future, the successful execution of our five year plan is not only focused on delivering strong results for 2025, but it's also designed to position Ameren for success over the next decade and beyond. We believe that a safe, reliable, resilient, secure and cleaner energy grid will be increasingly important and bring even greater value to our customers, our communities and shareholders. With this long term view in mind, we will make an investment that will position Ameren to meet our customers' future energy needs, and rising expectations; support our transition to a cleaner energy future and provide safe, reliable natural gas services. Right side of this page shows that our allocation of capital is expected to grow our electric and natural gas energy delivery investments to be 82% of our rate base by the end of 2025. As a result of Ameren Missouri's investment in 700 megawatts of wind generation, combined with the scheduled retirement of the Meramec coal-fired Energy Center in 2022. We expect coal fired generation to decline to just 7% of rate base and our renewable generation to increase to 6% of rate base by year in 2025. As noted previously, our current five year plan does not include 1,200 megawatts, an incremental renewable generation included in Ameren Missouri's integrated resource plan by 2025. These actions were just further examples of the steps we are taking to address our customers and shareholders focus on ESG matters and achieve our net zero carbon emissions goal by 2050. The bottom line is that we're taking steps today across the board to presume Ameren for success in 2021 and beyond. Moving to page 16. Looking ahead to the end of this decade, we have a robust pipeline of investment opportunities of over $40 billion that will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter, and cleaner. Importantly, these investment opportunities exclude any new reasonably beneficial transmission projects that would increase the reliability and resiliency of the energy grid, as well as enable additional renewable generation projects. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customer's needs and exceed their expectations. But they will also create 1000s of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's future energy needs and delivering on our customers expectations. Moving to page 17; as we have outlined in our presentation today, we are focused on delivering a sustainable energy future for our customers' communities and our country. Consistent with that focus, yesterday, we issued our updated ESG investor presentation called leading the way to a sustainable energy future. This presentation demonstrates how we have been effectively integrating our focus on environmental, social, governance and sustainability managed into our corporate strategy. This slide summarizes our strong sustainability value proposition for environmental, social and governance matters. Throughout the course of my discussion this morning, I've already covered many of these topics. Few other notable points include the fact that we were honored to again be recognized by Diversity Inc, as one of the top utilities in the country for diversity, equity and inclusion, as well as be rated in the Top 25 of all companies for ESG in their inaugural list. Finally, our strong corporate governance is led by a very talented and diverse Board of Directors focused on strong oversight of ESG matters. I encourage you to take some time to read more about our sustainability value proposition. You can find this presentation at ameren.investors.com. Moving to page 18, to sum of our value proposition; we remain firmly convinced that the execution of our strategy in 2021 and beyond will deliver superior value to our customers, shareholders in the environment. We believe our expectation of a 6% to 8% compound annual earnings growth from 2021 to 2025 driven by strong rate based growth compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all form of business segments, as we have an experienced and dedicated team to get it done. That fact, coupled with our sustained past execution of our strategy on many fronts, has positioned us well for future success. Further, our shares continue to offer investors a solid dividend. Our strong earnings growth expectations outlined today, position us well for future dividend growth. Simply put, we believe our strong earnings and dividend growth outlooks results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today. And I'll now turn the call over to Michael.
Michael Moehn: Thanks, Warner and good morning, everyone. Turning now to page 20 of our presentation. Yesterday we reported 2020 earnings of $3.50 per share compared to earnings of $3.35 per share in 2019. Ameren Transmission earnings were up $0.13 per share, which reflected an increase in infrastructure investment and the impact of the first quarter on the MISO allowed base return equity. Earnings from Ameren Illinois Natural Gas were up $0.06 per share, which reflected increased infrastructure investments and lower other operations and main expenses due to discipline cost management. Earnings in Ameren Missouri, our largest segment increased $0.03 per share from $1.74 per share in 2019 to $1.77 per share in 2020. The comparison reflected new electric service rates effective April 1, which increase earnings by $0.23 per share compared to 2019. Earnings also benefited from lower operations and maintenance expenses, which increased earnings to $0.16 per share. This was due in part to the deferral of expenses related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage compared to recognizing all the expenses for the spring 2019 outage at that time. The change in time and expense recognition was approved by the Missouri PSC in early 2020 and better aligns revenue with expenses. In addition, the decline in other O&M expenses were driven by discipline cost management exercised throughout the year. These favorable factors are mostly offset by lower electric retail sales driven by the impacts of COVID-19 and weather, which together reduce earnings by approximately $0.18 per share. In 2020, we experienced milder than normal summer and winter temperatures compared to near normal summer and winter temperatures in 2019. In addition, lower MEEIA performance incentives reduced earnings by $0.09 per share compared to 2019 and higher interest expense due to higher long term debt outstanding reduced earnings by $0.04 per share. And finally, under terms of the Missouri rate review settlement order, we recognized a one time charitable contribution which reduced earnings by $0.02 per share. During the Ameren Illinois electric distribution earnings decrease $0.01 per share, which reflected a lower allowed return on equity underperformance base rate making mostly offset by increased infrastructure and energy efficiency investments. The allowed return equity under formulaic reckoning was 7.4% in 2020, compared to 8.4% in 2019, and was applied to year end rate base. The 2020 allowed ROE was based on the 2020 average 30 year Treasury yield of approximately 1.6%, down from the 2019 average of 2.6%. And finally, Ameren Parent and other results were lower compared to 2019 due to increase interest expense, resulting from higher, long term debt outstanding, as well as reduced tax benefits primarily associated with share based compensation. Turning to page 21, outline this page our all electric sales trends for Illinois Missouri, and Illinois electric distribution for 2020 compared to 2019. Overall, the year end results for Ameren are largely consistent with our expectations, outlined in our call in May in terms of impact on total sales and earnings per share for 2020 due to COVID-19. Recall that changes in electric sales in Illinois, no matter the cause do not affect earnings, since we have full revenue decoupling. And moving to page 22 of the presentation. Here we provide an overview of our $17.1 billion of strategically allocated capital plan expenditures for the 2021 through 2025 period. By business segments that analyze the approximately 8% projected rate base growth Warner discussed earlier. This plan includes an incremental $1.1 billion compared to the $16 billion five year plan for 2020 through 2024 that we laid out last February. Turning to page 23, we outline here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth and cash from operations as the investments are reflected in customer rates. We also expect to generate significant tax deferrals. Those tax deferrals are driven primarily by timing differences between financial statements depreciation, reflected in customer rates and accelerated depreciation for tax purposes. In addition to the benefits of accelerated tax depreciation, as a result of a $1.1 billion investment in 700 megawatts of wind generation, we will generate production tax credits over this period. From a financing perspective, while we have no long term debt maturities in 2021, we do expect to continue issuing long-term debt at the Ameren Parent, Ameren Missouri and Ameren Illinois to fund a portion of our cash requirements. We also plan to continue to use newly issued shares from our dividend reinvestment employee benefit plans over the five year guidance period. We expect this to provide equity funding of approximately $100 million annually. Last week, we physically settled the remaining shares under a forward equity sale agreement to generate approximately $115 million. In order for us to maintain a strong balance sheet while we fund a robust infrastructure plan, we expect incremental equity issuance of approximately $150 million in 2021 and $300 million each year starting in 2022 through 2025. All of these actions are expected to enable us to maintain a consolidated capitalization target of approximately 45% equity. Moving to page 24 of our presentation, I would now like to discuss key drivers impacting our 2021 earnings guidance. As Warner stated we expect 2020 to 2021 diluted earnings per share to be in the range of $3.65 to $3.85 per share. On this page, and next we have listed key earnings drivers and assumptions behind our 2021 earnings guidance broken down by segment as compared to our 2020 results. Beginning with Ameren Missouri, earnings are expected to rise in 2021. As previously noted, a majority of the 700 megawatts of wind generation investment was placed in service at the end of 2020 in early 2021. As a result, we expect to see significant contributions to earnings from these investments in 2021. The 2021 earnings comparison is also expected to be favorably impacted by the first quarter -- in the first quarter by increased Missouri electric service rates that took effect April 1, 2020. We also expect higher weather normalized electric sales and other margins in 2021 compared to 2020, as outlined by customer class on the slide reflecting the continuing improvement in economic activity since the COVID-19 lockdowns that began in the second quarter of last year. While 2021 sales expectations are much improved over 2020 we do not expect total sales to return to pre COVID-19 levels this year. Further, we expect to return to normal weather in 2021 will increase Ameren Missouri earnings by approximately $0.04 compared to 2020 results. We expect the amortization expenses associated with the fall 2020 Callaway schedule refueling and maintenance outage to reduce earnings by approximately $0.08 per share in 2021. The fall 2020 average cost of approximately $0.12 per share was deferred pursuant to the Missouri PSC order and is expected to be amortized over approximately 17 months starting January 2021. We also expect higher operations and maintenance expenses to reduce earnings. Moving on earnings from our FERC regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois, and ATXI projects made under forward looking for another rate making. This benefit will be partially offset by the absence of the impact of the 2020 FERC quarter on the MISO base allowed return on equity. Turning to page 25; for Ameren Illinois electric distribution earnings are expected to benefit in 2021 compared to 2020 from additional infrastructure investments made under Illinois performance based rate making. Our guidance incorporates a rate base -- formula based allowed ROE of 7.75% using your forecast at 1.9% 2020 average yield for the 30 year Treasury bond, which is higher than the allowed ROE of 7.4% in 2020. The allowed ROE is applied to year end rate base. For Ameren Illinois Natural Gas earnings will benefit from higher delivery service rates based on a 2021 feature test year, which were affected late last month as well as from infrastructure investments, qualifying for the rider investment treatment. Moving now to Ameren variance drivers and assumption, we expect the increase common shares outstanding as a result of the issuance under the forward equity sale agreement, our dividend reinvestment employee benefit plans and additional equity issuance of approximately $115 million to unfairly impact earnings per share by $0.12 cents. Of course, in 2021, we will seek to manage all of our businesses during as close to our allowed returns as possible while being mindful of operating and other business needs. I'd also like to take a moment to discuss our electric retail sales outlook. We expect weather normalized Missouri kilowatt hour sales to be in the range of flat to up approximately 0.5% compounded annually over our five year plan, excluding the effects of our MEEIA energy efficiency plans, using 2021 as the base year. Again, we exclude MEEIA effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales resulting from our energy efficiency efforts. Turning to Illinois; we expect our weather normalized kilowatt hour sales, including energy efficiency to be relatively flat over the five year plan. Turning to page 26, Ameren Missouri regulatory matters; last October, we follow requests with the Missouri PSC to track and defer in a regulatory asset certain COVID-19 related costs incurred net of any COVID-19 realized cost savings. Through December 31, 2020, we've accumulated approximately $6 million in net costs, and we requested additional true ups. If our requests are approved by the Missouri PSC the ability to recover and the time to recover these costs would be determined as part of the next electric and gas rate reviews. We continue to work towards a settlement with key stakeholders. I would also note that the PSE is under no deadline to issue orders. Speaking of future rate reviews, we continue to expect to file the next Ameren Missouri electric and gas rate reviews by the end of March 2021. Turning to page 27 in Illinois, Ameren Illinois electric regulatory matters; in December, the ITC approved a $49 million base electric distribution rate decrease and Illinois rate update proceeding with new rates effective at the beginning of the year. This marks the third consecutive overall reduction in rates in the seventh overall rate decrease in its performance base rate making began in 2011. In Ameren Illinois natural gas regulatory matters last month the ICC approved a $76 million annual increase in gas distribution rates using a 2021 future test year, a 9.67% of return on equity, and a 52% equity ratio. The $76 million included $44 million of annual revenues that would otherwise be recovered in 2021 under Ameren Illinois qualifying infrastructure plant and other riders. New rates were affected in late January. Finally turning to page 28. We have a strong team and are well positioned to continue to execute our plan. We delivered strong earnings growth in 2020. And we expect to deliver strong earnings growth in 2021 as we continue to successfully execute our strategy. As we look ahead, we expect 6% to 8% compound earnings per share growth from 2021 to 2025, driven by robust rate base growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. And Ameren shares continued to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions] Our first question comes from Julien Smith with Bank of America.
JulienSmith: Good morning to you and congratulations. Quite well, thank you, little frigid here in Texas. I suppose if you can elaborate a little bit. I know you provided some comments in your remarks here on Callaway. Can you elaborate a little bit more about how you've been able to reduce your fuel and purchase power costs care through the period as well as elaborate a little bit more just exactly what's transpired and what repairs are alongside. It seems like you're going to seek the bulk of the recovery through insurance and warranties here but if you can elaborate there, too.
WarnerBaxter: Yes, and thanks, Julien, lots of stuff to unpack there. I'm going to first ask Marty to talk a little bit about sort of what happened in the event and some of the actions that we're taking to make sure we get timely recovery. And then I'll talk a little bit about how we're balancing the fuel purchase power costs. So Marty why don't you to talk a little bit about the event in Callaway and how we're managing through that place.
MartinLyons: Yes, sure. Warner and good morning, Julien. Yes, we talked about in our prepared remarks, during the return to full power after our last refueling and maintenance outage, we experienced an issue with the electric generator, so non nuclear part of the plant non nuclear operation issue. So, subsequently, we did open up generator for inspection and identified issues with both the router as well as the status. So we decided that significant components did need to be replaced, those are long lead time materials that need to be manufactured, installed, tested, et cetera. So that we can ultimately make sure that we bring the plant back safely and sustainably. And we do estimate that that'll take as we said, late June, early July. So during this period of time the plant does remain down, but as we suggested, we're going to be doing everything we can to reduce the ultimate costs, including pursuing recovery of costs through warranties as well as we've made insurance claims, and to have insurance both on the property side as well as for accidental outage impacts as it relates to last generation.
WarnerBaxter: So I think that summarizes generally the event and what we're doing from a warranty and insurance perspective. I think, Julien, what we're doing from an operational perspective is what we do, when Callaway has this normal outages, we adjust the efforts and the outages or move those around for our coal fired energy centers. Now, I got to tell you, I'm pleased to say during this very cold period, our coal fired energy centers operated extremely well. And we do the same thing with the rest of our generating use, because all those go to mitigate the impact that Callaway is out. And so those are things that our team has already checked and adjusted for during this period of time. And we're very focused on just doing that the work that Marty described extremely well, getting Callaway back in service for the benefit of our customers.
JulienSmith: Excellent. If I can sneak in this one on legislation. I mean, there's been some consternation out in the market about this 30 year Treasury gyration and some of the proposals out there. I know a lot of bills floating out there. There's been some pickup in attention on that nuance. How would you characterize that? It seems like perhaps part of the back and forth and negotiation in the early part of the session here?
WarnerBaxter: Well, you're right. There are a lot of bills being discussed and actually filed in the state of Illinois. And I tell you, we're excited about the Downstate Clean Energy Affordability Act. And really the enhancements those were made through the act that we just filed last year, and do several things. One, Julien, it addresses the issue that you talked about, it really is no longer that Downstate Clean Energy Affordability Act that was filed isn't based on a 30 year Treasury, it is doing what legislators really wanted to have done back in 2012, when the modernization action plan was put in place. That was simply to try and have the return on equity really become very close to the national average. And that's exactly what's reflected in there. And so we -- that's why we like that, though, and of course, we'd like to build that was filed, because it not only applies to our electric business, but our gas business, because we're firmly convinced that performance based rate making has been terrific things for the state of Illinois in terms of reliability, in terms of affordability and jobs. And we think we can duplicate that in natural gas business. We think that's the best way forward. I'm sorry, Julian, you dropped out little bit there. I'm sorry.
JulienSmith: I am sorry, the gap as well as electric seems like a priority.
WarnerBaxter: Exactly, right. So look just to sum it up, there are a lot of bills out there. Obviously very early innings of the session. Yes, there's some that are trying to take different approaches to it. The only thing you can rest assured is that Richard Mark and his team, they're at the table. We're talking with key stakeholders and we are strongly supporting the Downstate Clean Energy Affordability Act.
Operator: Our next question comes from Insoo Kim with Goldman Sachs.
InsooKim: Good morning and thank you for the time. I guess my first question going back to the Callaway outages a little bit and your work to mitigate any cost increases from purchase power fuel is expectation currently that during this time period, whether it's with the Callaway now or in the next few months, with the outage ongoing, that the fact it will still happen through bills? Or is there contemplation that maybe there'll be some type of deployment payment setup?
MichaelMoehn: Good morning, this is Michael. Yes, you see, you are right. I mean, we have a fuel adjustment clause in place Insoo that fully expect to those costs would flow through that there's a 95, five, sharing on that mechanism, as Marty said, I mean, there is this, look, do everything we can to possibly mitigate the overall impact on customers. And so there is insurance that both on the property side as well as the replacement power side not upon on whether or not we're going to get recovered there, but to the extent that we do, and obviously would go to mitigate a big part of that impact.
InsooKim: Got it. And then on your funding equity plans through 2025, correct me if I'm wrong, but I think the last time you were contemplating was the $150 million run rate for the year through 2024 and now it seems like a stepped up COVID turning 2022 is that contemplating just that base CapEx frankly 2025? Or somewhat inclusive of potential upside from renewable projects or other items.
MichaelMoehn: No, you're looking at the right way. I mean it's up about $150 million per year, starting in 2022, from where we were before, and it really is driven by we got about $1.1 billion additional capital here. $16 billion where we were last February to where we are today at $17.1 billion. And it really is just to continue to conservatively finance this balance sheet. We like our ratings, where they are, being heavily wanted Moody's BBB plus at S&P, and maintain that capital structure right at about 45%. So that's really what it's being driven to do at the end of the day, Insoo.
InsooKim: Got it. And just if I make what range of [Indiscernible] debt, should we be considering with this plan?
MichaelMoehn: Yes, we haven't specifically given that in the past, I mean, it Moody's, we have a threshold, a third target, S&P we have a threshold of 13%. We have 17% threshold at Moody's. I would tell you historically we've been 19% 20%. It's been coming down a little bit over time as we've invested more in capital, but we've had some good margins there.
Operator: Our next question comes from Durgesh Chopra with Evercore ISI.
DurgeshChopra: Good morning, guys. Thanks for taking my question. Going back to just the ROE, can you -- see pretty clear on what you're zooming for 2021? But maybe just how you're thinking about 30 year in the context of your five year plan?
WarnerBaxter: Yes, good. Appreciate the question. We historically, you're right. I mean, we're assuming 1.95 here for this year. And as you think, Durgesh, about our overall range the 6% to 8% off of this 375, it provides you a quite a bit of range, you go out in time, obviously about 40%, up $0.40 in total. And we really haven't historically said what we are assuming it. It obviously accommodates a number of things within that in terms of those ROEs, in terms of CapEx, in terms of regulatory outcomes, et cetera. But we haven't specifically said that we're targeting from a 30 year Treasury.
DurgeshChopra: Got it. Is it -- can we assume that like with the most of the forecasts here that you're assuming that yields creep up higher? Is that a fair assumption? Or are you kind of modeling surely a flat and that would be upside?
WarnerBaxter: It is a wide range and lots of different things can accommodate it in there. I mean, obviously, the 30 years moved quite a bit here in the last few months or so, but difficult to speculate exactly where it's going.
DurgeshChopra: Understood. Okay. I understand that. Maybe just one quick one, the 1.2 gigawatt of the investment that you highlight in the Missouri IRB what's the cadence of timing and cadence of including that in the current five year plan? Or you think that falls out of the current five years and it's more like 2025 and beyond?
WarnerBaxter: So yes, this is Warner. Look, we've said before, we're focused on getting some of these renewable energy projects done consistent with our integrated resource plan. And so Marty and his team are working very hard, looking at several proposals, and as we said in our prepared remarks, that we plan on filing some CCN, still in 2021, to start addressing that. And so we don't have a specific number in terms of what we'll pursue. But we're looking to execute that plan. Simply put once we, when we do that we get further along the regulatory process, we finish our negotiations with developers, we think about the interconnection agreements to the extent needed. All those things will really dictate when we ultimately put them in our CapEx plan. But I would not suggest that 1,200 megawatts are outside of that -- all of that will be outside of the 2025.
Operator: Our next question comes from Steve Fleishman with Wolfe Research
SteveFleishman: Hey, great, thanks. Hey, Warner. So just a question on the dividend increase you did, which obviously, very happy about but you did, do it kind of off cycle. So you kind of did it in increase higher increase and you've been doing five months after you did your last one. So kind of curious, like, why didn't you do that in October? Or why don't you wait till next October? Is there any other kind of sense on what like, why now? And is this kind of the timing when you're going to do dividend increases going forward?
WarnerBaxter: Yes. That's a great question. Look, we've discussed with you and investors in the past look, Ameren's dividend, and this dividend policy are really important matters to our Board of Directors. And so clearly the Board took careful consideration in terms of thinking first and foremost about the dividend policy. And as you know, we announced that dividend policy change that talked about the future dividend growth is really going to be in line with our long term earnings per share growth and within our payout ratio of 55% to 70%, which is what we talked about in the past. And so when they did that, we all collectively did that we also carefully considered the practice that we've been using over the last several years of raising the dividend in the fall or in October. And at the end of the day, the Board of Directors came to conclusion that it was really just appropriate to align the dividend increase we announced last week with the simultaneous updating of the dividend policy, which I just described. And then also to align it with our discussion about long term earnings guidance, which as you know we typically do right now at the beginning of the year. And so I can never tell you exactly what the Board would do in the future. And I would expect the practice that we employ this year to continue in the future. So of course all future dividend decisions, as we've said before, are driven by all kinds of things earnings, growth, cash flow, investments, business conditions, those types of things, but I expect to practice that we've employed this year to be consistent in the future.
Operator: Our next question comes from Paul Patterson with Glenrock Associates.
PaulPatterson: Great. So a really -- with easy with respect to the legislation and just sort of follow up on Julien's question. It seems like the sort of your -- you've got a downstate approach. And as you know there and as you mentioned, the other bills and stuff going on. I'm just wondering, sort of the strategy there and the thoughts about having sort of a one approach for downstate versus upstate. And could just elaborate a little bit one strategy there and just sort of a general what your thoughts are about what might be going on?
WarnerBaxter: Sure. Look, really our message around this Paul hasn't really changed. We talked last year and we'll continue to talk about that. As we see it as our legislators see it the downstate needs are different. And keep in mind when we think about downstate, I mean we are the major energy supplier downstate not just on the electric side, but on the gas side as well. So that downstate legislators looked at it and they clearly recognize there's some broad policy issues in the state of Illinois clearly in the northern portion. The state of around the nuclear plants, these are important issues and so we get that. And of course, we're engaged in those conversations, because we want to make sure that policy decisions made for the nuclear plants and others don't have negative implications for our customers' downstate. So we're engaged there. But similarly, we know the importance of investing in energy infrastructure on the electric and gas businesses, and we don't want to lose sight of that. And so we have proposed legislation, like we did last year that really is affecting the downstate, which is very consistent with what the state of Illinois wants to move towards a cleaner energy future. In this Downstate Affordability Act isn't just about grid modernization, let's just be clear, it is in part, and certainly around the gas business, that also is driving towards greater electrification, greater solar and battery storage, and its own standard policies that support these critical investments. So, now look if at the end of the day, we are -- we believe this is an appropriate approach. Of course, we're still early in the session, as Julien and I discussed a little while ago, and so we will engage with key stakeholders, other utilities on this important management. This is the direction that we think is appropriate, and certainly the sponsors of the legislation do as well.
PaulPatterson: Okay, great. And then appreciate the data on the cost reductions and build data. But just in general, as you've updated your forecast everything here. What's your expectation for the potential bill impact or just roughly speaking, with this growth trajectory that you guys have?
MichaelMoehn: Yes, I might comment just specifically for on O&M, and I'm not going to really comment on the overall bill impact itself. I think we've done a very good job, obviously, over time and managing that in terms of impact the customer, but if you think about the O&M piece of that as Warner pointed out, we've had some good success in managing those costs really on a flat basis over the last five years. And as we think about the future, we're obviously mindful of the capital that we're investing, and we're really focused on keeping that on O&M flattish over this five year forecasts as well.
Operator: Our last question comes from the line of Jeremy Tonet with JPMorgan.
JeremyTonet: Good morning. Thanks for taking the questions, looking at your prior rate based disclosures in today's update; the growth into 2025 is closer to 9%. If I'm doing the math there, right. Can you speak of the CapEx status here that is the typical industry profile that is more end loaded on the CapEx and the other thoughts on -- [Tech Difficulty] back and forth on ultimate pay Jeremy, I'm sorry, you are you are breaking up. It was hard to hear the first par
WarnerBaxter: Hey, Jeremy, I am sorry. You are breaking it up. It is hard to hear the first part of your question. So and then our rate base growth. Look, if you could start again, I apologize. It just wasn't coming across clearly, please.
JeremyTonet: Sure. Can you hear me now? Is this better?
WarnerBaxter: Yes, it's much better. Thank you.
JeremyTonet: Sorry about that. So looking at your prior rate based disclosures in today's update, it looks like growth into 2025 is closer to 9%. Can you speak to the CapEx reference here versus typical industry profile, which is more kind of front end loaded on the CapEx? And then just also kind of thinking about Missouri renewables ownership and transmission investments as well. Do you see this is additive to this growth, extending the growth one way or for having any other impacts here?
WarnerBaxter: Yes. So let me -- I'll answer the second part. And then Michael, maybe you can get a little bit into to the math in the first part. Couple of things; with regard to the renewables and the transmission, we do see these as meaningful opportunities to continue a rate base growth. Now, as we've said in the past, we're not out here, given our five year plan and whether it will be 100% additive in all respects. And that be premature for me to say that, but to be clear we see the real needs clearly in our integrated resource plan for renewables. And we are taking steps as we discussed earlier to begin executing that plan. In fact, we have already started that, as you know with regard to the 700 megawatts, but we believe it's absolutely a prudent and appropriate to do more as we transition to a cleaner energy future. That clean energy future really is not going to be coming forth if we don't have greater levels of investment in transmission. And so as we pointed out in our slides and before that these large regional transmission projects, which have really put our country in the position where it is today in terms of growth and renewables, we're going to need to do more of that. And so we see those as greater opportunities when they come in is a little early to say we had been actively working with MISO and other key stakeholders to try and put the process in place for those transmission investments to get going on those. As I've said before, those take time, and not going to be done here in a year or two, if anything, we might see some towards the back end of our 2021 to 2025 plan. But we certainly see greater levels of investment in transmission in the next decade to enable where this transition to a clean energy future. So stay tuned in terms of how it ultimately gets additive. But we see that as clearly potential upside opportunities. And, Michael, I'll let you address for specific rate base question.
MichaelMoehn: Yes, Jeremy. And I'm not sure I completely followed your question. But let me try again, I can, you can do a little follow up, if it doesn't hit what you're looking for. I mean the overall rate base growth obviously has come down a little bit from where we were in February; it's just a function of obviously a higher jump off point here and in 2020, but still very robust rate base growth of 8% as noted on the slide. As we think about beyond 2025, and obviously, there's a large pipeline of opportunity there 40 plus billion dollars that we've indicated. And look, we'll have to just continue to assess over time, how we continue to phase this into the capital plan, we're mindful to the previous question about customer affordability, and just managing overall rate impact. So that's got to be factored into all this just overall financing those types of things. So I think there's lots of opportunity there in terms of the overall runway, and we'll just continue to update as we move through time.
JeremyTonet: Got it, that's helpful. Maybe just to clarify, if I look at kind of the platform like some score was 25 yesterday at the rate base, I think it looks like a 9% step up there. And so we could take that discussion offline. Maybe it just kind of building off the some of the other comments you've had here given this week's extreme weather, how is your system performed overall, I guess, in light of everything, but more importantly do you expect any local policy impacts as a result of this week? Whether it's capacity, resiliency, generation transition, or anything from these events?
WarnerBaxter: Yes, so Jeremy, this is Warner again. Look, couple of things. One, our system perform really quite well. Do we have our share of challenges because of the overall impact to the energy grid broadly in different areas of the country? Yes, we're impacted by that because of the interconnectivity, but our system performed well, and as I said before, certainly the fact that we had our coal fired energy centers running well, our gas storage operations doing very well. And those investments that we've been making over the last 5-10 years, it really paid off during this period of time. So no, we as I said, we did not have any significant reliability issues. And we're pleased to say that. Now, when you step back and say what is going to happen as a result of all this, I believe there will be greater levels of oversight or perhaps hearings. And as we all collectively try to understand how we can continue to improve the grid. I'm not going to speculate where it'll be it, whether there'll be, I think, likely state or federal matters but we're just -- we've been very focused on, as an industry is making sure that we're taking care of our customers collectively. But there's going to be more to be head on this to be sure. And we look forward to engaging with stakeholders should we be asked to, but I can be pleased to tell you and others, that's just a held up well, and we delivered customers safe, reliable electric and natural gas during this period of time.
JeremyTonet: Got it. That's very helpful. Just one last one if I could on Callaway here in outage. And just want to come back to how much ultimate cost recovery do you expect to seek from warranties and insurance. And insurance are there any early investigations findings that inform your kind of confidence here on the ultimate liability and [Indiscernible]?
WarnerBaxter: And Jeremy, honestly we're, it'd be premature for us to comment on that. We're dealing with the appropriate parties from a warranty perspective, from an insurance perspective, that work continues so if we -- when we have material updates on that we will provide it. But it's just too early for us to really comment any further at this stage.
Operator: We have reached the end of the question-and-answer session. I'd like to turn the call back over to Andrew Kirk for closing comment.
Andrew Kirk: Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial Analysts inquiries should be directed to me, Andrew Kirk, media should call Tony Paraino. Again, thank you for your interest in Ameren and have a great day.
Operator: This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to the Ameren Corporation's Fourth Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Mr. Andrew Kirk, Director of Investor Relations. Thank you. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that's accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and Risk Factors section in our filings with the SEC. Lastly, all per-share earnings amounts discussed during today's presentation, including earnings guidance are presented on a diluted basis, unless otherwise noted. Now here's Warner."
},
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"speaker": "Warner Baxter",
"text": "Thanks Andrew. Good morning, everyone and thank you for joining us. Before I begin our discussion of year end results and other key business matters, I'll start with few comments on COVID-19 as well as the steps we've taken to deliver safe, reliable electric and natural gas service to our customers during the recent period of extremely cold weather in our region. To begin, help you, your families and colleagues are safe and healthy. While COVID-19 has driven a great deal of change, I can assure you that one thing that remains constant in Ameren is our strong commitment to the safety of our co-workers, customers and communities. So too is a strong focus on delivering safe, reliable, cleaner, and affordable electric and natural gas service during this unprecedented time. We recognize that millions of customers in Missouri and Illinois are dependent on us. I can't express enough appreciation to my co-workers who have shown great agility, innovation, determination and a keen focus on safety while delivering on our mission to power the quality of life. And while we're focused on addressing the challenges associated with the pandemic, and achieving our mission each day, we never lose sight of our vision, leading the way to a sustainable energy future. Despite the significant challenges presented by COVID-19, I look to the future with optimism. Not just because vaccines are now being distributed to millions around the world, but also because of how our co-workers stepped up and addressed a multitude of challenges and capitalize on opportunities in 2020 that will clearly help us achieve our vision. Speaking of stepping up to challenges to ensure that we continue to deliver on our mission and vision, our team has been tirelessly working over the last week to ensure that we continue to deliver safe, reliable electric and natural gas services to millions of people in our service territory, despite the extremely cold weather that we are experiencing in our region. As the extremely cold weather has created significant challenges to maintain the safety and reliability of the energy grid in several areas of the country. Understandably, the cold weather has driven a significant increase in customer demand for electric and natural gas service. At the same time, the extreme weather has resulted in natural gas supply disruptions and limitations, operational issues of power plants and transmission constraints, combined these extraordinary circumstances that several regional transmission organizations to implement Emergency Operations protocols, which include controlled interruptions of service to customers in several states, most notably in Texas. Not surprisingly, the same set of conditions resulting in significant increases in power and natural gas prices in the energy markets. Today, we have not experienced any significant reliability issues in Missouri or Illinois businesses as past investments in energy infrastructure that paid off. In addition to strong operation of our gas storage fields in Illinois, and coal fired energy centers in Missouri, as well as our robust interconnections with gas pipeline suppliers, and the power markets have played a major role as well. Rest assured, we will continue to actively manage this challenging situation for our customers. Turning to page 4. Before I jump into the details of our accomplishments and strategic areas of focus, I want to reiterate the strategy that has been delivering significant long-term value to all of our stakeholders. Specifically, our strategies to invest in a robust pipeline of great regulated energy infrastructure, continuously improve operating performance, and advocate for responsible energy and economic policies to deliver superior value to our customers and shareholders. As always, our customers continue to be at the center of our strategy. I am pleased to say that our actions and performance in 2020 as well as our strategic areas of focus for the future, are strongly aligned with our customers and shareholders expectations to lead the way to a sustainable energy future, which brings me to a discussion about 2020 performance. As I said earlier, we delivered strong financial and operational performance in 2020. Yesterday, we announced 2020 earnings $3.50 per share, compared to earnings of $3.35 per share earned in 2019. Excluding the impact from weather 2020 normalized earnings increase to $3.54 per share, or approximately 6.6% from 2019, weather normalized earnings of $3.32 per share. With our customers and shareholders expectations in mind, we made significant investments in energy infrastructure in 2020 that resulted in a more reliable, resilient, secure and cleaner energy grid, as well as contributed to strong rate base growth in all of our business segments. Consistent with these objectives, and despite COVID-19 challenges, we successfully executed on a robust pipeline of investments across all of our businesses. In 2020, as outlined on this page, we also achieve constructive outcomes in several regulatory proceedings that will help drive additional infrastructure investments that will benefit customers and shareholders while keeping our customers rates affordable. The bottom line is that we successfully execute our strategy in 2020, which will drive significant long-term value for all of our stakeholders. Turning to page 5, here we highlight the significant progress we made in an area that has and will continue to be a significant area of focus, sustainability. Last September, we announced the transformation of clean energy transition plan that effectively balances environmental stewardship, with reliability, and affordability. In particular, we establish the Clean Energy goal of net zero carbon emissions by 2050 across all of our operations in Missouri, in Illinois, we also established strong interim carbon reduction goals of 50% by 2030, and 85% by 2040, based on 2005 levels. In addition, our plan includes robust investments in new wind and solar generations have been mindful of reliability. Notably, we are targeting adding 5,400 megawatts new renewable wind and solar generation resources to our generation portfolio by 2014. Our plan also includes advancing the retirement of two coal fired energy centers, extending the life of our carbon free Callaway nuclear energy center to eight years and partnering with the electric power Research Institute in assessing advanced clean energy technologies for the future. We have already executed key elements of this plan. In particular, a significant milestone toward accomplishing our net zero carbon emissions goal was reached with the acquisition of the 400 megawatt high Prairie Renewable Energy Center in December. This was our first wind generation addition, and is the largest wind facility in the state of Missouri. Earlier this year, we also acquired our second wind generation investment, the Atchison Renewable Energy Center, which when completed, is expected to be a 300 megawatt facility. We also have a strong, long-term commitment to our customers and communities to be socially responsible, and economically impactful. There has never been a more important time than now to be a leader in this area, and we are leaning forward. In terms of COVID-19 relief, we've been continuously working to help our customers in need, including implementing disconnection moratoriums, providing a special bill payment plans, providing over $23 million of critical funds for energy assistance, and other basic needs. We have a virtual diversity Equity and Inclusion Leadership Summit in June 2020 that included over 600 community leaders and co-workers. During that summit, and we made a commitment of $10 million over the next five years to nonprofit organizations focused on DNI and we spent over $800 million with diverse suppliers in 2020, a 24% increase over 2019. From a governance perspective, our Board of Directors oversight of sustainability risks was enhanced. In addition, we named our first Chief Renewable Development Officer to lead our continued efforts to transition to a cleaner and more diverse generation portfolio. Further, the Board of Directors strengthened our executive compensation program by adding a 10% long-term incentive based on implementing our clean energy transition plans. And just last week, the Board approved the addition of workforce and supplier diversity metrics to our short-term incentive plan for 2021. All of these efforts are consistent with our vision, leading the way to a sustainable energy future in our mission to power the quality of life. Turning to page 6, as you can see on this page, our laser focus on executing our strategy for the last several years has delivered strong results. From a customer standpoint, our investments in infrastructure have driven our reliability to top quartile performance, while at the same time our disciplined cost management has kept our electric rates among the lowest in the country. The combination of these factors itself drive significantly higher customer satisfaction scores. It also delivered superior value to our shareholders as you can see on page 7. Our weather normalized core earnings per share has risen 70% or and an approximately 8% compound annual growth rate since we exited our unregulated generation business in 2013. Our dividend rate has increased 25% over the same time period. This has resulted in a significant reduction in our weather normalized dividend payout ratio from over 77% in 2013 to 56% in 2020. Near the bottom of our 55% to 70%, targeted dividend payout range, position us well for continued strong infrastructure investments and rate based growth, as well as future dividend growth. Speaking of dividend growth, I am pleased to report that last week; Ameren's Board of Directors approved a quarterly dividend increase of approximately 7%, resulting in an annualized dividend rate of $2.20 per share. This increase, coupled with a dividend increase of 4% in October 2020 reflects confidence by Ameren's board of directors in the outlook for our businesses, and management's ability to execute a strategy for the long-term benefit of our customers and shareholders. While I'm very pleased with our past performance, we are not sitting back and taking a deep breath. We remained focused on accelerating and enhancing our performance in 2021 in the years ahead, so we can continue to deliver superior value to our customers, communities and shareholders, which brings me to page 8. Yesterday afternoon, we also announced that we expect our 2020 earnings to be in the range of $3.65 to $3.85 per share. Michael will provide you with more details on our 2021 gains a bit later. Building on the strong execution of our strategy and our robust earnings growth over the past several years, we continue to expect to deliver long-term earnings growth that is among the best in the industry. We expect to deliver 6% to 8% compound annual earnings per share growth from 2021 to 2025 using the midpoint of our 2021 guidance $3.75 per share, as the base. Our long term earnings growth will be driven by continued execution of our strategy, including investing in infrastructure for the benefit of our customers, while keeping rates affordable. Another important element of our strong total shareholder return story is our dividend. Looking ahead Ameren expects future dividend growth to be in line with its long-term earnings per share growth expectations within a payout ratio range of 55% to 70%. In addition to earnings growth considerations, future dividend decisions will be driven by cash flow, investment requirements, and other business conditions. Turning the page 9, the first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. The strong long term earnings growth I just discussed is primarily driven by a rate based growth plan. Today, we are rolling forward our five year investment plan and as you can see, we expect to grow our rate base in an approximately 8% compound annual rates for the 2020 through 2025 period. This growth is driven by our robust capital plan for approximately $17 billion over the next five years that will deliver significant value to our customers and the communities we serve. Our plan includes strategically allocating capital to all four of our business segments. Importantly, our five year earnings and rate based growth projections do not include 1,200 megawatts of incremental renewable investment opportunities, from Ameren Missouri's integrated resource plan. Our team continues to assess several renewable generation proposals from developers. We expect to file for certificates and convenience and necessity for some renewable generation projects in 2021 with the Missouri PSC. We expect to add these investments to our multi year rate base outlook, as we finalize pending negotiations with noble energy developers and move further along in the regulatory approval process in Missouri. Finally, we remain focused on discipline cost management, earn as close to our allowed returns as possible, and all of our businesses. Speaking of a disciplined cost management, let's now turn to page 10. Over the last several years, we've worked hard to enhance the regulatory frameworks in both Missouri and Illinois to help drive additional infrastructure investments that will benefit customers and shareholders. At the same time, we've been very focused on discipline cost management to keep rates affordable. Our efforts are paying off. As outlined on this page, residential rates have decreased since opting into these enhanced regulatory frameworks for all of our Missouri electric and Illinois electric and natural gas distribution businesses. So to be clear, since these constructive frameworks have been put in place, significant investments have been made, reliability has improved, rates have gone down, and 1000s of jobs have been created. While this is a great win for our customers and communities; we are not done. Turning to page 11. As you can see from this chart, our operating expenses have decreased 14% since 2015. We will remain relentlessly focused on disciplined cost management, as we look forward to the next five years and beyond. This will not only include the robust cost management initiatives undertaken to manage COVID-19, but also several other customer affordability initiatives. These initiatives include the automation and optimization of our processes, including leveraging the benefits from significant past, and future investments in digital technologies, and grid modernization. In addition, as part of the Ameren Missouri integrated resource plan, we will work to responsibly retire our coal fired energy centers over time, which includes thoughtfully managing workforce changes through attrition, transfers to other facilities, and retraining for other positions in the company. Turning now to page 12; next, I want to cover the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. An enhanced version of the Downstate Clean Energy Affordability Act legislation was filed in the past week, which in past would apply to both the Ameren Illinois electric and natural gas distribution businesses. This legislation would allow an Illinois to make significant investments in solar energy, battery storage and gas infrastructure to improve safety and reliability, as well as in transportation electrification, in order to benefit customers in the academy across central and southern Illinois. This important piece of legislation also required diverse suppliers spend reporting for all electric renewable energy providers. Another key component of the Downstate Clean Energy Affordability Act that it would allow for performance based ratemaking for an Illinois Natural Gas and Electric distribution businesses through 2032. Proposed performance metric would ensure investments are aligned with and are contributing to reliability of the energy grid, as well as to transition to the Clean Energy vision of the state. Further, this legislation would modify the amount of return on equity methodology in each business to align with returns being earned other gas and electric utilities across the nation. This legislation builds on Ameren Illinois efforts to invest in critical energy infrastructure under a transparent and stable regulatory framework that has supported significant investments, improve safety and reliability, as well as creating over 1,400 jobs, all while keeping electric rates well below the Midwest, and national averages. This bill would also move the state of Illinois closer to reaching its goal of 100% clean energy by 2050. By providing for performance base rate making in both electric and gas distribution businesses, we believe that proposed legislation would further align the energy goal of Ameren Illinois and the state of Illinois, for the benefit of our customers, the communities we serve and the environment. All these benefits in mind, we are focused on working with key stakeholders to get this important legislation passed this year. Moving now to page 13 for an update on our $1.1 billion wind generation investment plan to achieve compliance with Missouri's renewable energy standard through the acquisition of 700 megawatts new wind generation at two sites in Missouri. As I mentioned earlier, Ameren Missouri closed on the acquisition of our first Wind Energy Center, a 400 megawatt project in northeast Missouri in December. Last month, we acquired our second wind generation project, the 300 megawatt Atchison Renewable Energy Center, located in Northwest Missouri; approximately 120 megawatts are already in service. We expect a total of 150 megawatts to be in service by the end of the first quarter, with remain expected later in 2021 upon the replacement of certain turbine blades. We finance these projects through a combination of green first mortgage bonds, and common stock issued in our forward equity sale agreement. We do not expect the construction delay on Atchison and wind facility to have a significant economic consequence or reduce the production tax credits for this project. Because the rule change made by the US Department of Treasury last year to extend the end service criteria by one year to December 31, 2021. Turning now to page 14, and an update on our Callaway Energy Center. During its return to full power as part of its 24th refueling and maintenance outage in late December 2020 Ameren Missouri's Callaway Energy Center experienced a non nuclear operating issue related to its generator. A thorough investigation this matter was conducted and the decision was made to replace certain key components of the generator in order to safely and sustainably returned to energy center the service. Work is already underway on this capital project, which we expect will cost approximately $65 million. We're also pursuing the recovery of costs through applicable warranties and insurance. Due to the long lead time for the manufacturing, repair and installation of these components, the Energy Center is expected to return to service from May June or early July. And as announced previously, we do not expect this amount to have a significant impact on Ameren's financial results. Turning now to page 15. As we look to the future, the successful execution of our five year plan is not only focused on delivering strong results for 2025, but it's also designed to position Ameren for success over the next decade and beyond. We believe that a safe, reliable, resilient, secure and cleaner energy grid will be increasingly important and bring even greater value to our customers, our communities and shareholders. With this long term view in mind, we will make an investment that will position Ameren to meet our customers' future energy needs, and rising expectations; support our transition to a cleaner energy future and provide safe, reliable natural gas services. Right side of this page shows that our allocation of capital is expected to grow our electric and natural gas energy delivery investments to be 82% of our rate base by the end of 2025. As a result of Ameren Missouri's investment in 700 megawatts of wind generation, combined with the scheduled retirement of the Meramec coal-fired Energy Center in 2022. We expect coal fired generation to decline to just 7% of rate base and our renewable generation to increase to 6% of rate base by year in 2025. As noted previously, our current five year plan does not include 1,200 megawatts, an incremental renewable generation included in Ameren Missouri's integrated resource plan by 2025. These actions were just further examples of the steps we are taking to address our customers and shareholders focus on ESG matters and achieve our net zero carbon emissions goal by 2050. The bottom line is that we're taking steps today across the board to presume Ameren for success in 2021 and beyond. Moving to page 16. Looking ahead to the end of this decade, we have a robust pipeline of investment opportunities of over $40 billion that will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter, and cleaner. Importantly, these investment opportunities exclude any new reasonably beneficial transmission projects that would increase the reliability and resiliency of the energy grid, as well as enable additional renewable generation projects. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customer's needs and exceed their expectations. But they will also create 1000s of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's future energy needs and delivering on our customers expectations. Moving to page 17; as we have outlined in our presentation today, we are focused on delivering a sustainable energy future for our customers' communities and our country. Consistent with that focus, yesterday, we issued our updated ESG investor presentation called leading the way to a sustainable energy future. This presentation demonstrates how we have been effectively integrating our focus on environmental, social, governance and sustainability managed into our corporate strategy. This slide summarizes our strong sustainability value proposition for environmental, social and governance matters. Throughout the course of my discussion this morning, I've already covered many of these topics. Few other notable points include the fact that we were honored to again be recognized by Diversity Inc, as one of the top utilities in the country for diversity, equity and inclusion, as well as be rated in the Top 25 of all companies for ESG in their inaugural list. Finally, our strong corporate governance is led by a very talented and diverse Board of Directors focused on strong oversight of ESG matters. I encourage you to take some time to read more about our sustainability value proposition. You can find this presentation at ameren.investors.com. Moving to page 18, to sum of our value proposition; we remain firmly convinced that the execution of our strategy in 2021 and beyond will deliver superior value to our customers, shareholders in the environment. We believe our expectation of a 6% to 8% compound annual earnings growth from 2021 to 2025 driven by strong rate based growth compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all form of business segments, as we have an experienced and dedicated team to get it done. That fact, coupled with our sustained past execution of our strategy on many fronts, has positioned us well for future success. Further, our shares continue to offer investors a solid dividend. Our strong earnings growth expectations outlined today, position us well for future dividend growth. Simply put, we believe our strong earnings and dividend growth outlooks results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today. And I'll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Warner and good morning, everyone. Turning now to page 20 of our presentation. Yesterday we reported 2020 earnings of $3.50 per share compared to earnings of $3.35 per share in 2019. Ameren Transmission earnings were up $0.13 per share, which reflected an increase in infrastructure investment and the impact of the first quarter on the MISO allowed base return equity. Earnings from Ameren Illinois Natural Gas were up $0.06 per share, which reflected increased infrastructure investments and lower other operations and main expenses due to discipline cost management. Earnings in Ameren Missouri, our largest segment increased $0.03 per share from $1.74 per share in 2019 to $1.77 per share in 2020. The comparison reflected new electric service rates effective April 1, which increase earnings by $0.23 per share compared to 2019. Earnings also benefited from lower operations and maintenance expenses, which increased earnings to $0.16 per share. This was due in part to the deferral of expenses related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage compared to recognizing all the expenses for the spring 2019 outage at that time. The change in time and expense recognition was approved by the Missouri PSC in early 2020 and better aligns revenue with expenses. In addition, the decline in other O&M expenses were driven by discipline cost management exercised throughout the year. These favorable factors are mostly offset by lower electric retail sales driven by the impacts of COVID-19 and weather, which together reduce earnings by approximately $0.18 per share. In 2020, we experienced milder than normal summer and winter temperatures compared to near normal summer and winter temperatures in 2019. In addition, lower MEEIA performance incentives reduced earnings by $0.09 per share compared to 2019 and higher interest expense due to higher long term debt outstanding reduced earnings by $0.04 per share. And finally, under terms of the Missouri rate review settlement order, we recognized a one time charitable contribution which reduced earnings by $0.02 per share. During the Ameren Illinois electric distribution earnings decrease $0.01 per share, which reflected a lower allowed return on equity underperformance base rate making mostly offset by increased infrastructure and energy efficiency investments. The allowed return equity under formulaic reckoning was 7.4% in 2020, compared to 8.4% in 2019, and was applied to year end rate base. The 2020 allowed ROE was based on the 2020 average 30 year Treasury yield of approximately 1.6%, down from the 2019 average of 2.6%. And finally, Ameren Parent and other results were lower compared to 2019 due to increase interest expense, resulting from higher, long term debt outstanding, as well as reduced tax benefits primarily associated with share based compensation. Turning to page 21, outline this page our all electric sales trends for Illinois Missouri, and Illinois electric distribution for 2020 compared to 2019. Overall, the year end results for Ameren are largely consistent with our expectations, outlined in our call in May in terms of impact on total sales and earnings per share for 2020 due to COVID-19. Recall that changes in electric sales in Illinois, no matter the cause do not affect earnings, since we have full revenue decoupling. And moving to page 22 of the presentation. Here we provide an overview of our $17.1 billion of strategically allocated capital plan expenditures for the 2021 through 2025 period. By business segments that analyze the approximately 8% projected rate base growth Warner discussed earlier. This plan includes an incremental $1.1 billion compared to the $16 billion five year plan for 2020 through 2024 that we laid out last February. Turning to page 23, we outline here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth and cash from operations as the investments are reflected in customer rates. We also expect to generate significant tax deferrals. Those tax deferrals are driven primarily by timing differences between financial statements depreciation, reflected in customer rates and accelerated depreciation for tax purposes. In addition to the benefits of accelerated tax depreciation, as a result of a $1.1 billion investment in 700 megawatts of wind generation, we will generate production tax credits over this period. From a financing perspective, while we have no long term debt maturities in 2021, we do expect to continue issuing long-term debt at the Ameren Parent, Ameren Missouri and Ameren Illinois to fund a portion of our cash requirements. We also plan to continue to use newly issued shares from our dividend reinvestment employee benefit plans over the five year guidance period. We expect this to provide equity funding of approximately $100 million annually. Last week, we physically settled the remaining shares under a forward equity sale agreement to generate approximately $115 million. In order for us to maintain a strong balance sheet while we fund a robust infrastructure plan, we expect incremental equity issuance of approximately $150 million in 2021 and $300 million each year starting in 2022 through 2025. All of these actions are expected to enable us to maintain a consolidated capitalization target of approximately 45% equity. Moving to page 24 of our presentation, I would now like to discuss key drivers impacting our 2021 earnings guidance. As Warner stated we expect 2020 to 2021 diluted earnings per share to be in the range of $3.65 to $3.85 per share. On this page, and next we have listed key earnings drivers and assumptions behind our 2021 earnings guidance broken down by segment as compared to our 2020 results. Beginning with Ameren Missouri, earnings are expected to rise in 2021. As previously noted, a majority of the 700 megawatts of wind generation investment was placed in service at the end of 2020 in early 2021. As a result, we expect to see significant contributions to earnings from these investments in 2021. The 2021 earnings comparison is also expected to be favorably impacted by the first quarter -- in the first quarter by increased Missouri electric service rates that took effect April 1, 2020. We also expect higher weather normalized electric sales and other margins in 2021 compared to 2020, as outlined by customer class on the slide reflecting the continuing improvement in economic activity since the COVID-19 lockdowns that began in the second quarter of last year. While 2021 sales expectations are much improved over 2020 we do not expect total sales to return to pre COVID-19 levels this year. Further, we expect to return to normal weather in 2021 will increase Ameren Missouri earnings by approximately $0.04 compared to 2020 results. We expect the amortization expenses associated with the fall 2020 Callaway schedule refueling and maintenance outage to reduce earnings by approximately $0.08 per share in 2021. The fall 2020 average cost of approximately $0.12 per share was deferred pursuant to the Missouri PSC order and is expected to be amortized over approximately 17 months starting January 2021. We also expect higher operations and maintenance expenses to reduce earnings. Moving on earnings from our FERC regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois, and ATXI projects made under forward looking for another rate making. This benefit will be partially offset by the absence of the impact of the 2020 FERC quarter on the MISO base allowed return on equity. Turning to page 25; for Ameren Illinois electric distribution earnings are expected to benefit in 2021 compared to 2020 from additional infrastructure investments made under Illinois performance based rate making. Our guidance incorporates a rate base -- formula based allowed ROE of 7.75% using your forecast at 1.9% 2020 average yield for the 30 year Treasury bond, which is higher than the allowed ROE of 7.4% in 2020. The allowed ROE is applied to year end rate base. For Ameren Illinois Natural Gas earnings will benefit from higher delivery service rates based on a 2021 feature test year, which were affected late last month as well as from infrastructure investments, qualifying for the rider investment treatment. Moving now to Ameren variance drivers and assumption, we expect the increase common shares outstanding as a result of the issuance under the forward equity sale agreement, our dividend reinvestment employee benefit plans and additional equity issuance of approximately $115 million to unfairly impact earnings per share by $0.12 cents. Of course, in 2021, we will seek to manage all of our businesses during as close to our allowed returns as possible while being mindful of operating and other business needs. I'd also like to take a moment to discuss our electric retail sales outlook. We expect weather normalized Missouri kilowatt hour sales to be in the range of flat to up approximately 0.5% compounded annually over our five year plan, excluding the effects of our MEEIA energy efficiency plans, using 2021 as the base year. Again, we exclude MEEIA effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales resulting from our energy efficiency efforts. Turning to Illinois; we expect our weather normalized kilowatt hour sales, including energy efficiency to be relatively flat over the five year plan. Turning to page 26, Ameren Missouri regulatory matters; last October, we follow requests with the Missouri PSC to track and defer in a regulatory asset certain COVID-19 related costs incurred net of any COVID-19 realized cost savings. Through December 31, 2020, we've accumulated approximately $6 million in net costs, and we requested additional true ups. If our requests are approved by the Missouri PSC the ability to recover and the time to recover these costs would be determined as part of the next electric and gas rate reviews. We continue to work towards a settlement with key stakeholders. I would also note that the PSE is under no deadline to issue orders. Speaking of future rate reviews, we continue to expect to file the next Ameren Missouri electric and gas rate reviews by the end of March 2021. Turning to page 27 in Illinois, Ameren Illinois electric regulatory matters; in December, the ITC approved a $49 million base electric distribution rate decrease and Illinois rate update proceeding with new rates effective at the beginning of the year. This marks the third consecutive overall reduction in rates in the seventh overall rate decrease in its performance base rate making began in 2011. In Ameren Illinois natural gas regulatory matters last month the ICC approved a $76 million annual increase in gas distribution rates using a 2021 future test year, a 9.67% of return on equity, and a 52% equity ratio. The $76 million included $44 million of annual revenues that would otherwise be recovered in 2021 under Ameren Illinois qualifying infrastructure plant and other riders. New rates were affected in late January. Finally turning to page 28. We have a strong team and are well positioned to continue to execute our plan. We delivered strong earnings growth in 2020. And we expect to deliver strong earnings growth in 2021 as we continue to successfully execute our strategy. As we look ahead, we expect 6% to 8% compound earnings per share growth from 2021 to 2025, driven by robust rate base growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. And Ameren shares continued to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Julien Smith with Bank of America."
},
{
"speaker": "JulienSmith",
"text": "Good morning to you and congratulations. Quite well, thank you, little frigid here in Texas. I suppose if you can elaborate a little bit. I know you provided some comments in your remarks here on Callaway. Can you elaborate a little bit more about how you've been able to reduce your fuel and purchase power costs care through the period as well as elaborate a little bit more just exactly what's transpired and what repairs are alongside. It seems like you're going to seek the bulk of the recovery through insurance and warranties here but if you can elaborate there, too."
},
{
"speaker": "WarnerBaxter",
"text": "Yes, and thanks, Julien, lots of stuff to unpack there. I'm going to first ask Marty to talk a little bit about sort of what happened in the event and some of the actions that we're taking to make sure we get timely recovery. And then I'll talk a little bit about how we're balancing the fuel purchase power costs. So Marty why don't you to talk a little bit about the event in Callaway and how we're managing through that place."
},
{
"speaker": "MartinLyons",
"text": "Yes, sure. Warner and good morning, Julien. Yes, we talked about in our prepared remarks, during the return to full power after our last refueling and maintenance outage, we experienced an issue with the electric generator, so non nuclear part of the plant non nuclear operation issue. So, subsequently, we did open up generator for inspection and identified issues with both the router as well as the status. So we decided that significant components did need to be replaced, those are long lead time materials that need to be manufactured, installed, tested, et cetera. So that we can ultimately make sure that we bring the plant back safely and sustainably. And we do estimate that that'll take as we said, late June, early July. So during this period of time the plant does remain down, but as we suggested, we're going to be doing everything we can to reduce the ultimate costs, including pursuing recovery of costs through warranties as well as we've made insurance claims, and to have insurance both on the property side as well as for accidental outage impacts as it relates to last generation."
},
{
"speaker": "WarnerBaxter",
"text": "So I think that summarizes generally the event and what we're doing from a warranty and insurance perspective. I think, Julien, what we're doing from an operational perspective is what we do, when Callaway has this normal outages, we adjust the efforts and the outages or move those around for our coal fired energy centers. Now, I got to tell you, I'm pleased to say during this very cold period, our coal fired energy centers operated extremely well. And we do the same thing with the rest of our generating use, because all those go to mitigate the impact that Callaway is out. And so those are things that our team has already checked and adjusted for during this period of time. And we're very focused on just doing that the work that Marty described extremely well, getting Callaway back in service for the benefit of our customers."
},
{
"speaker": "JulienSmith",
"text": "Excellent. If I can sneak in this one on legislation. I mean, there's been some consternation out in the market about this 30 year Treasury gyration and some of the proposals out there. I know a lot of bills floating out there. There's been some pickup in attention on that nuance. How would you characterize that? It seems like perhaps part of the back and forth and negotiation in the early part of the session here?"
},
{
"speaker": "WarnerBaxter",
"text": "Well, you're right. There are a lot of bills being discussed and actually filed in the state of Illinois. And I tell you, we're excited about the Downstate Clean Energy Affordability Act. And really the enhancements those were made through the act that we just filed last year, and do several things. One, Julien, it addresses the issue that you talked about, it really is no longer that Downstate Clean Energy Affordability Act that was filed isn't based on a 30 year Treasury, it is doing what legislators really wanted to have done back in 2012, when the modernization action plan was put in place. That was simply to try and have the return on equity really become very close to the national average. And that's exactly what's reflected in there. And so we -- that's why we like that, though, and of course, we'd like to build that was filed, because it not only applies to our electric business, but our gas business, because we're firmly convinced that performance based rate making has been terrific things for the state of Illinois in terms of reliability, in terms of affordability and jobs. And we think we can duplicate that in natural gas business. We think that's the best way forward. I'm sorry, Julian, you dropped out little bit there. I'm sorry."
},
{
"speaker": "JulienSmith",
"text": "I am sorry, the gap as well as electric seems like a priority."
},
{
"speaker": "WarnerBaxter",
"text": "Exactly, right. So look just to sum it up, there are a lot of bills out there. Obviously very early innings of the session. Yes, there's some that are trying to take different approaches to it. The only thing you can rest assured is that Richard Mark and his team, they're at the table. We're talking with key stakeholders and we are strongly supporting the Downstate Clean Energy Affordability Act."
},
{
"speaker": "Operator",
"text": "Our next question comes from Insoo Kim with Goldman Sachs."
},
{
"speaker": "InsooKim",
"text": "Good morning and thank you for the time. I guess my first question going back to the Callaway outages a little bit and your work to mitigate any cost increases from purchase power fuel is expectation currently that during this time period, whether it's with the Callaway now or in the next few months, with the outage ongoing, that the fact it will still happen through bills? Or is there contemplation that maybe there'll be some type of deployment payment setup?"
},
{
"speaker": "MichaelMoehn",
"text": "Good morning, this is Michael. Yes, you see, you are right. I mean, we have a fuel adjustment clause in place Insoo that fully expect to those costs would flow through that there's a 95, five, sharing on that mechanism, as Marty said, I mean, there is this, look, do everything we can to possibly mitigate the overall impact on customers. And so there is insurance that both on the property side as well as the replacement power side not upon on whether or not we're going to get recovered there, but to the extent that we do, and obviously would go to mitigate a big part of that impact."
},
{
"speaker": "InsooKim",
"text": "Got it. And then on your funding equity plans through 2025, correct me if I'm wrong, but I think the last time you were contemplating was the $150 million run rate for the year through 2024 and now it seems like a stepped up COVID turning 2022 is that contemplating just that base CapEx frankly 2025? Or somewhat inclusive of potential upside from renewable projects or other items."
},
{
"speaker": "MichaelMoehn",
"text": "No, you're looking at the right way. I mean it's up about $150 million per year, starting in 2022, from where we were before, and it really is driven by we got about $1.1 billion additional capital here. $16 billion where we were last February to where we are today at $17.1 billion. And it really is just to continue to conservatively finance this balance sheet. We like our ratings, where they are, being heavily wanted Moody's BBB plus at S&P, and maintain that capital structure right at about 45%. So that's really what it's being driven to do at the end of the day, Insoo."
},
{
"speaker": "InsooKim",
"text": "Got it. And just if I make what range of [Indiscernible] debt, should we be considering with this plan?"
},
{
"speaker": "MichaelMoehn",
"text": "Yes, we haven't specifically given that in the past, I mean, it Moody's, we have a threshold, a third target, S&P we have a threshold of 13%. We have 17% threshold at Moody's. I would tell you historically we've been 19% 20%. It's been coming down a little bit over time as we've invested more in capital, but we've had some good margins there."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore ISI."
},
{
"speaker": "DurgeshChopra",
"text": "Good morning, guys. Thanks for taking my question. Going back to just the ROE, can you -- see pretty clear on what you're zooming for 2021? But maybe just how you're thinking about 30 year in the context of your five year plan?"
},
{
"speaker": "WarnerBaxter",
"text": "Yes, good. Appreciate the question. We historically, you're right. I mean, we're assuming 1.95 here for this year. And as you think, Durgesh, about our overall range the 6% to 8% off of this 375, it provides you a quite a bit of range, you go out in time, obviously about 40%, up $0.40 in total. And we really haven't historically said what we are assuming it. It obviously accommodates a number of things within that in terms of those ROEs, in terms of CapEx, in terms of regulatory outcomes, et cetera. But we haven't specifically said that we're targeting from a 30 year Treasury."
},
{
"speaker": "DurgeshChopra",
"text": "Got it. Is it -- can we assume that like with the most of the forecasts here that you're assuming that yields creep up higher? Is that a fair assumption? Or are you kind of modeling surely a flat and that would be upside?"
},
{
"speaker": "WarnerBaxter",
"text": "It is a wide range and lots of different things can accommodate it in there. I mean, obviously, the 30 years moved quite a bit here in the last few months or so, but difficult to speculate exactly where it's going."
},
{
"speaker": "DurgeshChopra",
"text": "Understood. Okay. I understand that. Maybe just one quick one, the 1.2 gigawatt of the investment that you highlight in the Missouri IRB what's the cadence of timing and cadence of including that in the current five year plan? Or you think that falls out of the current five years and it's more like 2025 and beyond?"
},
{
"speaker": "WarnerBaxter",
"text": "So yes, this is Warner. Look, we've said before, we're focused on getting some of these renewable energy projects done consistent with our integrated resource plan. And so Marty and his team are working very hard, looking at several proposals, and as we said in our prepared remarks, that we plan on filing some CCN, still in 2021, to start addressing that. And so we don't have a specific number in terms of what we'll pursue. But we're looking to execute that plan. Simply put once we, when we do that we get further along the regulatory process, we finish our negotiations with developers, we think about the interconnection agreements to the extent needed. All those things will really dictate when we ultimately put them in our CapEx plan. But I would not suggest that 1,200 megawatts are outside of that -- all of that will be outside of the 2025."
},
{
"speaker": "Operator",
"text": "Our next question comes from Steve Fleishman with Wolfe Research"
},
{
"speaker": "SteveFleishman",
"text": "Hey, great, thanks. Hey, Warner. So just a question on the dividend increase you did, which obviously, very happy about but you did, do it kind of off cycle. So you kind of did it in increase higher increase and you've been doing five months after you did your last one. So kind of curious, like, why didn't you do that in October? Or why don't you wait till next October? Is there any other kind of sense on what like, why now? And is this kind of the timing when you're going to do dividend increases going forward?"
},
{
"speaker": "WarnerBaxter",
"text": "Yes. That's a great question. Look, we've discussed with you and investors in the past look, Ameren's dividend, and this dividend policy are really important matters to our Board of Directors. And so clearly the Board took careful consideration in terms of thinking first and foremost about the dividend policy. And as you know, we announced that dividend policy change that talked about the future dividend growth is really going to be in line with our long term earnings per share growth and within our payout ratio of 55% to 70%, which is what we talked about in the past. And so when they did that, we all collectively did that we also carefully considered the practice that we've been using over the last several years of raising the dividend in the fall or in October. And at the end of the day, the Board of Directors came to conclusion that it was really just appropriate to align the dividend increase we announced last week with the simultaneous updating of the dividend policy, which I just described. And then also to align it with our discussion about long term earnings guidance, which as you know we typically do right now at the beginning of the year. And so I can never tell you exactly what the Board would do in the future. And I would expect the practice that we employ this year to continue in the future. So of course all future dividend decisions, as we've said before, are driven by all kinds of things earnings, growth, cash flow, investments, business conditions, those types of things, but I expect to practice that we've employed this year to be consistent in the future."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Patterson with Glenrock Associates."
},
{
"speaker": "PaulPatterson",
"text": "Great. So a really -- with easy with respect to the legislation and just sort of follow up on Julien's question. It seems like the sort of your -- you've got a downstate approach. And as you know there and as you mentioned, the other bills and stuff going on. I'm just wondering, sort of the strategy there and the thoughts about having sort of a one approach for downstate versus upstate. And could just elaborate a little bit one strategy there and just sort of a general what your thoughts are about what might be going on?"
},
{
"speaker": "WarnerBaxter",
"text": "Sure. Look, really our message around this Paul hasn't really changed. We talked last year and we'll continue to talk about that. As we see it as our legislators see it the downstate needs are different. And keep in mind when we think about downstate, I mean we are the major energy supplier downstate not just on the electric side, but on the gas side as well. So that downstate legislators looked at it and they clearly recognize there's some broad policy issues in the state of Illinois clearly in the northern portion. The state of around the nuclear plants, these are important issues and so we get that. And of course, we're engaged in those conversations, because we want to make sure that policy decisions made for the nuclear plants and others don't have negative implications for our customers' downstate. So we're engaged there. But similarly, we know the importance of investing in energy infrastructure on the electric and gas businesses, and we don't want to lose sight of that. And so we have proposed legislation, like we did last year that really is affecting the downstate, which is very consistent with what the state of Illinois wants to move towards a cleaner energy future. In this Downstate Affordability Act isn't just about grid modernization, let's just be clear, it is in part, and certainly around the gas business, that also is driving towards greater electrification, greater solar and battery storage, and its own standard policies that support these critical investments. So, now look if at the end of the day, we are -- we believe this is an appropriate approach. Of course, we're still early in the session, as Julien and I discussed a little while ago, and so we will engage with key stakeholders, other utilities on this important management. This is the direction that we think is appropriate, and certainly the sponsors of the legislation do as well."
},
{
"speaker": "PaulPatterson",
"text": "Okay, great. And then appreciate the data on the cost reductions and build data. But just in general, as you've updated your forecast everything here. What's your expectation for the potential bill impact or just roughly speaking, with this growth trajectory that you guys have?"
},
{
"speaker": "MichaelMoehn",
"text": "Yes, I might comment just specifically for on O&M, and I'm not going to really comment on the overall bill impact itself. I think we've done a very good job, obviously, over time and managing that in terms of impact the customer, but if you think about the O&M piece of that as Warner pointed out, we've had some good success in managing those costs really on a flat basis over the last five years. And as we think about the future, we're obviously mindful of the capital that we're investing, and we're really focused on keeping that on O&M flattish over this five year forecasts as well."
},
{
"speaker": "Operator",
"text": "Our last question comes from the line of Jeremy Tonet with JPMorgan."
},
{
"speaker": "JeremyTonet",
"text": "Good morning. Thanks for taking the questions, looking at your prior rate based disclosures in today's update; the growth into 2025 is closer to 9%. If I'm doing the math there, right. Can you speak of the CapEx status here that is the typical industry profile that is more end loaded on the CapEx and the other thoughts on -- [Tech Difficulty] back and forth on ultimate pay Jeremy, I'm sorry, you are you are breaking up. It was hard to hear the first par"
},
{
"speaker": "WarnerBaxter",
"text": "Hey, Jeremy, I am sorry. You are breaking it up. It is hard to hear the first part of your question. So and then our rate base growth. Look, if you could start again, I apologize. It just wasn't coming across clearly, please."
},
{
"speaker": "JeremyTonet",
"text": "Sure. Can you hear me now? Is this better?"
},
{
"speaker": "WarnerBaxter",
"text": "Yes, it's much better. Thank you."
},
{
"speaker": "JeremyTonet",
"text": "Sorry about that. So looking at your prior rate based disclosures in today's update, it looks like growth into 2025 is closer to 9%. Can you speak to the CapEx reference here versus typical industry profile, which is more kind of front end loaded on the CapEx? And then just also kind of thinking about Missouri renewables ownership and transmission investments as well. Do you see this is additive to this growth, extending the growth one way or for having any other impacts here?"
},
{
"speaker": "WarnerBaxter",
"text": "Yes. So let me -- I'll answer the second part. And then Michael, maybe you can get a little bit into to the math in the first part. Couple of things; with regard to the renewables and the transmission, we do see these as meaningful opportunities to continue a rate base growth. Now, as we've said in the past, we're not out here, given our five year plan and whether it will be 100% additive in all respects. And that be premature for me to say that, but to be clear we see the real needs clearly in our integrated resource plan for renewables. And we are taking steps as we discussed earlier to begin executing that plan. In fact, we have already started that, as you know with regard to the 700 megawatts, but we believe it's absolutely a prudent and appropriate to do more as we transition to a cleaner energy future. That clean energy future really is not going to be coming forth if we don't have greater levels of investment in transmission. And so as we pointed out in our slides and before that these large regional transmission projects, which have really put our country in the position where it is today in terms of growth and renewables, we're going to need to do more of that. And so we see those as greater opportunities when they come in is a little early to say we had been actively working with MISO and other key stakeholders to try and put the process in place for those transmission investments to get going on those. As I've said before, those take time, and not going to be done here in a year or two, if anything, we might see some towards the back end of our 2021 to 2025 plan. But we certainly see greater levels of investment in transmission in the next decade to enable where this transition to a clean energy future. So stay tuned in terms of how it ultimately gets additive. But we see that as clearly potential upside opportunities. And, Michael, I'll let you address for specific rate base question."
},
{
"speaker": "MichaelMoehn",
"text": "Yes, Jeremy. And I'm not sure I completely followed your question. But let me try again, I can, you can do a little follow up, if it doesn't hit what you're looking for. I mean the overall rate base growth obviously has come down a little bit from where we were in February; it's just a function of obviously a higher jump off point here and in 2020, but still very robust rate base growth of 8% as noted on the slide. As we think about beyond 2025, and obviously, there's a large pipeline of opportunity there 40 plus billion dollars that we've indicated. And look, we'll have to just continue to assess over time, how we continue to phase this into the capital plan, we're mindful to the previous question about customer affordability, and just managing overall rate impact. So that's got to be factored into all this just overall financing those types of things. So I think there's lots of opportunity there in terms of the overall runway, and we'll just continue to update as we move through time."
},
{
"speaker": "JeremyTonet",
"text": "Got it, that's helpful. Maybe just to clarify, if I look at kind of the platform like some score was 25 yesterday at the rate base, I think it looks like a 9% step up there. And so we could take that discussion offline. Maybe it just kind of building off the some of the other comments you've had here given this week's extreme weather, how is your system performed overall, I guess, in light of everything, but more importantly do you expect any local policy impacts as a result of this week? Whether it's capacity, resiliency, generation transition, or anything from these events?"
},
{
"speaker": "WarnerBaxter",
"text": "Yes, so Jeremy, this is Warner again. Look, couple of things. One, our system perform really quite well. Do we have our share of challenges because of the overall impact to the energy grid broadly in different areas of the country? Yes, we're impacted by that because of the interconnectivity, but our system performed well, and as I said before, certainly the fact that we had our coal fired energy centers running well, our gas storage operations doing very well. And those investments that we've been making over the last 5-10 years, it really paid off during this period of time. So no, we as I said, we did not have any significant reliability issues. And we're pleased to say that. Now, when you step back and say what is going to happen as a result of all this, I believe there will be greater levels of oversight or perhaps hearings. And as we all collectively try to understand how we can continue to improve the grid. I'm not going to speculate where it'll be it, whether there'll be, I think, likely state or federal matters but we're just -- we've been very focused on, as an industry is making sure that we're taking care of our customers collectively. But there's going to be more to be head on this to be sure. And we look forward to engaging with stakeholders should we be asked to, but I can be pleased to tell you and others, that's just a held up well, and we delivered customers safe, reliable electric and natural gas during this period of time."
},
{
"speaker": "JeremyTonet",
"text": "Got it. That's very helpful. Just one last one if I could on Callaway here in outage. And just want to come back to how much ultimate cost recovery do you expect to seek from warranties and insurance. And insurance are there any early investigations findings that inform your kind of confidence here on the ultimate liability and [Indiscernible]?"
},
{
"speaker": "WarnerBaxter",
"text": "And Jeremy, honestly we're, it'd be premature for us to comment on that. We're dealing with the appropriate parties from a warranty perspective, from an insurance perspective, that work continues so if we -- when we have material updates on that we will provide it. But it's just too early for us to really comment any further at this stage."
},
{
"speaker": "Operator",
"text": "We have reached the end of the question-and-answer session. I'd like to turn the call back over to Andrew Kirk for closing comment."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial Analysts inquiries should be directed to me, Andrew Kirk, media should call Tony Paraino. Again, thank you for your interest in Ameren and have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 3 | 2,020 | 2020-11-06 10:00:00 | Executives: Andrew Kirk - Ameren Corp. Warner L. Baxter - Ameren Corp. Michael L. Moehn - Ameren Corp. Marty Lyons - Ameren Corp.
Analysts: Jeremy Tonet - JPMorgan Securities LLC Durgesh Chopra - Evercore Group LLC Paul Patterson - Glenrock Associates LLC Sangita Jain - KeyBanc Capital Markets, Inc. Andrew Stuart Levi - HITE Hedge Asset Management LLC Insoo Kim - Goldman Sachs & Co. LLC David Paz - Wolfe Research LLC
Operator: Greetings and welcome to the Ameren Corporation's Third Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. Mr. Kirk, you may begin.
Andrew Kirk - Ameren Corp.: Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President, and Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then, we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that's accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the AmerenInvestors.com homepage that will be referenced by our speakers. As noted on page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions, and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday, and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance are presented on a diluted basis unless otherwise noted. Now, here's Warner.
Warner L. Baxter - Ameren Corp.: Thanks, Andrew. Good morning, everyone, and thank you for joining us. Before I jump into our discussion of third quarter results, another key business manners, I'll start with a few comments on COVID-19. So, again, I hope you, your families, and colleagues are safe and healthy during this challenging time. While COVID-19 has driven a great deal of change, I can assure you that one thing that remains constant in Ameren is our strong commitment to the safety of our co-workers, customers, and communities. So, too, is our strong focus on delivering safe, reliable, cleaner, and affordable electric and natural gas service during this unprecedented time. We recognize that millions of customers in Missouri and Illinois are depending on us. I can't express enough appreciation to my co-workers who have shown great agility, innovation, determination and a keen focus on safety while delivering on our mission to power the quality of life. We continue to carefully monitor the impact of COVID-19 on our electric sales, liquidity, and supply chain. To date, these impacts have been manageable and are largely in line with our expectations. In addition, our team continues to successfully execute our strategy across the entire business. Looking ahead, we'll remain focus on executing our strategy including employing our strong safety practices as well as continued exercise financial discipline to mitigate the impacts of COVID-19. At the same time, we will look to capitalize on key opportunities that we have identified during the last several months including benefits we are realizing from our digital investments and other efficiencies in our operations. Turning now to page 4 for an update on third quarter results and 2020 earnings guidance. Yesterday, we announced third quarter 2020 earnings of $1.47 per share compared to $1.47 per share earned in 2019. A summary of the key drivers is provided on this page, which Michael will discuss in more detail in a moment. I am pleased to report that we remain on track to deliver solid earnings growth in 2020 over 2019. Yesterday, we also announced that we narrowed our 2020 earnings guidance range to $3.40 per share to $3.55 per share. That compares to our initial guidance range of $3.40 per share to $3.60 per share. Moving to page 5, here, we reiterate our strategic plan, which we have been executing very well throughout the year. We expect our plan will continue delivering significant value for our customers and a strong long-term earnings growth for our shareholders. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers in all four of our jurisdictions. As I have said many times in the past, our customers are at the center of our strategy. Our customers have been clear. They want safe, reliable, and clean energy, all at an affordable price. Our goal is to meet our customers' energy needs and exceed their expectations. As you can see on the right side of this page, during the first nine months of this year, we invested a significant capital in each of our business segments to achieve our goal for our customers, and we are delivering results. Our energy grid is becoming more reliable, resilient, and secure. We are implementing and enabling clean energy through our renewable energy and transmission investments, and our customers' electric rates remain among the lowest in the country at approximately 20% below the national average. Of course, we're not done. We will continue to make critical investments across our businesses to modernize the energy grid. In addition, we will continue to transition our generation portfolio to a cleaner and more diverse portfolio in a responsible fashion. That transition will include significant investments in renewable energy, which I will cover in more detail in a moment. And we will continue to invest in innovative technologies including digital technologies to meet and exceed our customers' rising expectations. Consistent with the Ameren Missouri Smart Energy Plan, we're putting meaningful dollars to work to modernize the energy grid and to serve our customers better. I am pleased to report that in July, Ameren Missouri began installing the first of 1.2 million electric smart meters for customers. The installation of these smart meters over the next several years will enhance reliability and provide more visibility and choices for our customers to control their energy usage. Our Ameren Illinois electric and gas distribution customers already seeing these benefits as we completed the installation of over 1.2 million electric smart meters and over 830,000 gas modules in 2019. We have also been working hard in the regulatory arena to earn fair returns on our investments. As we discussed on our first and second quarter earnings calls, new electric rates went into effect on April 1 of this year as a result of the constructor settlement in Ameren Missouri's electric rate review. In addition, as Michael will cover in more detail later, we will continue to progress through our electric and natural gas regulatory proceedings in Illinois. We expect a final decision in the electric proceeding by December of this year and a final decision in a gas proceeding by January of next year. From an operational perspective, the Callaway Energy Center began its scheduled refueling and maintenance outage in early October. The outage is progressing safely and on schedule. Finally, another important element of the first pillar of our strategy has been and remains our relentless focus on continuous improvement and disciplined cost management to keep rates affordable. Moving to page 6 and the second pillar of our strategy, which includes enhancing regulatory frameworks for the benefit of all stakeholders. In Illinois, we continue to support the proposed Downstate Clean Energy Affordability Act. This important legislation would allow Ameren Illinois to make significant investments in solar energy and battery storage to improve reliability, as well as to make investments in transportation electrification in order to benefit customers and the economy across Central and Southern Illinois. In addition, it would help address energy policy challenges facing the state, including the need for additional renewable sources and better electric vehicle charging infrastructure. This bill would help address these challenges and move the state of Illinois closer to reaching its goal of 100% clean energy by 2050. This legislation will also continue to support important investments in the energy grid to meet our customers' expectations for a more reliable and resilient energy grid. In addition, this legislation would modify the allowable return on equity formula and would also extend the electric performance-based ratemaking framework through 2032. We have been actively participating in energy policy discussions, including the governors and Senate working group meetings. As noted on this slide, a veto session is currently scheduled for certain days in November and December. Consistent with the views that we expressed during our second quarter call, we do not expect comprehensive energy legislation to be addressed during the veto session in 2020. Looking ahead, we will continue to engage with the key stakeholders in an open and transparent fashion to better understand their views and advocate for constructive energy policies that support investment and critical infrastructure. Moving to Ameren Missouri regulatory matters, on October 16, we have filed requests with the Missouri Public Service Commission to track and defer in a regulatory asset certain COVID-19 related costs incurred, net of any COVID-19 realized cost savings. Through September 30, 2020, we have accumulated approximately $9 million of net costs, and we've requested additional true-ups next year. If our requests are approved by the Missouri PSC, the recovery and the timing of recovery of these costs would be determined as part of the next electric and gas rate reviews. The PSC is under no deadline to issue orders, and we cannot predict the ultimate outcome of this matter. Speaking of future rate reviews and as we discussed during our second quarter conference call, we continue to expect to file the next Ameren Missouri electric rate review in the first half of 2021. In addition, we also expect to file an Ameren Missouri natural gas rate review during the first half of 2021 as well. Turning now to page 7 and Missouri's Integrated Resource Plan. In late September, we announced a transformative preferred plan that will accelerate our transition to a cleaner and more diverse generation portfolio while carefully balancing two important needs for our customers: reliability and affordability. Our plan is clearly transformational as it significantly accelerates our carbon emission reduction goals from those that we established in 2017. In particular, the plan targets a 50% reduction in carbon emissions below 2005 levels by 2030 and an 85% reduction by 2040. And by 2050, our goal is to achieve net-zero carbon emissions across all of Ameren. We plan to achieve these goals by making significant investments in renewable generation. Under our preferred plan, we would add 3,100 megawatts of wind and solar to our portfolio, representing approximately $4.5 billion of investment by 2030. By 2040, in total, 5,400 megawatts of wind and solar would be added for a total investment of approximately $8 billion. These renewable generation additions include our wind generation investment of $1.2 billion for 700 megawatts that we expect will be substantially complete this year. The plan also advances the retirement of two of our coal-fired energy centers, with all of our coal-fired energy centers retired by 2042. It is important to note that our plan does not include the addition of any combined cycle natural gas plants. Further, we expect to seek an extension of the operating license of our carbon-free Callaway Nuclear Energy Center beyond the current expiration date of 2044. And we will continue to implement robust energy efficiency and demand response programs. Importantly, our plan represents a responsible transition of our portfolio that takes into consideration environmental stewardship, system reliability, and customer affordability. Our plan leverages the very low-cost generation that our customers enjoy today and used it as a bridge to enable us to add greater levels of intermittent resources in the future while ensuring system reliability. Our plan also intends to leverage important research and development investments by the public and private sectors and incorporate advances in clean energy technologies over time to achieve our net-zero carbon emissions goal. We are very excited about this transformational plan and are already taking steps to implement it. In September, we issued a request for proposal that will enable us to assess and take the appropriate next steps on solar and wind projects that will deliver the best value to our customers, consistent with our IRP. Responses to our request have been robust and we are in the process of assessing those proposals as we speak. We will provide an update on our assessment as well as our five-year capital plan for 2021 to 2025 during our year-end conference call in February. Consistent with our approach in the past, we will consider a variety of factors before we include such major projects into our plan. Having said that, one thing is clear. Our IRP includes significant incremental investment opportunities including approximately $3 billion by 2030. As I said before, we are very excited about our transformational plan as well as how Ameren and our industry are leading the country and the world in executing responsible and achievable plans to significantly reduce carbon emissions and in so doing creating a cleaner and sustainable energy future. Speaking of creating a cleaner and sustainable energy future, let's move now to page 8 for an update on our $1.2 billion wind generation investment plan to achieve compliance with Missouri's Renewable Energy Standard through the acquisition of 700 megawatts of new wind generation at two sites in Missouri. Good progress continues to be made at both facilities. All of the construction and related installation of key components for the 400 megawatt facility have been completed and testing of the units will be completed over the next several weeks. As a result, we expect a 400 megawatt facility to be in service by the end of 2020. For the 300 megawatt facility, we are working closely with the developer to monitor the shipment and installation of remaining facility components. As we discussed on prior earnings calls this year, we have experienced some delays in the project due to several factors including those related to challenges in the global supply chain due to COVID-19, as well as in the transportation of certain components. As a result, we expect a portion of the project, or approximately $200 million of investment, to be placed in service in the first quarter of 2021. We do not expect this to have a significant economic consequences or reduce the production tax credits for this project because of the recent rule changes made by the U.S. Department of the Treasury to extend the in-service criteria by one year to December 31, 2021. Moving to page 9, looking ahead through the end of this decade, we have a robust pipeline of investment opportunities of over $39 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter, and cleaner. This robust pipeline now includes the new renewable generation proposed in the preferred plan of the Missouri Integrated Resource Plan, which added approximately $3 billion of incremental investment opportunities in 2020 to 2029. Importantly, these investment opportunities exclude any new regionally beneficial transmission projects that would increase the reliability and resiliency of the energy grid, as well as enable additional renewable generation projects. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our country's future energy needs and delivering on our customers' expectations. Moving to page 10; a few moments ago, I mentioned that we are focused on delivering a sustainable energy future for our customers, communities, and our country. Consistent with that focus, we recently published a stakeholder presentation called Leading the Way to a Sustainable Energy Future, which is Ameren's vision statement. This presentation demonstrates how we have been effectively integrating our focus on environmental, social, governance and sustainability matters into our corporate strategy. This slide summarizes our sustainability value proposition for environmental, social, and governance matters. We have a strong environmental focus which is, in part, demonstrated by the Missouri Integrated Resource Plan I discussed earlier. Importantly, the preferred plan discussed earlier is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. Emissions from our coal-fired energy centers are well below state and federal limits, and our natural gas pipeline system has no cast or wrought iron pipes. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. There has never been a more important time than now to be a leader in this area. In terms of COVID-19 relief, we have been tirelessly working to help our customers in need, including implementing disconnection moratoriums, providing special bill payment plans, and providing over $15 million of critical funds for energy assistance and other basic needs. And we have set up and spoken out against racial injustice and discrimination and have taken actions to enable our company and community to further embrace diversity, equity, and inclusion. And we were honored to again be recognized by DiversityInc as one of the top utilities in the country for diversity, equity and inclusion. Finally, our strong corporate governance is led by a diverse Board of Directors, focused on strong oversight that's aligned with ESG matters. And our executive compensation practices include performance metrics that are tied to sustainable long-term performance and progress towards a cleaner, sustainable energy future. I encourage you to take some time to read more about our sustainability value proposition. You can find this presentation at amereninvestors.com. Moving to page 11; to sum up our value proposition, the consistent execution of our strategy over many years and on many fronts has positioned us well for future success. We remain firmly convinced that the execution of this strategy in 2020 and beyond will deliver superior value to our customers, shareholders, and the environment. In May, we affirmed our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings per share growth for the 2020 through 2024 period. This earnings growth is primarily driven by our approximate 9% compound annual rate base growth from 2019 through 2024, and compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. In addition, we will continue to advocate for constructive regulatory frameworks and energy policies to support these important investments for the future. Further, our shares continue to offer investors a solid dividend. Last month, Ameren's board of directors expressed its confidence in our long-term growth plan by increasing the dividend by 4%, the 7th consecutive year with a dividend increase. Given the midpoint of our 2020 earnings guidance range that I discussed earlier, our dividend payout ratio is approximate 59%, which stores the (00:21:13) lower end of our company's targeted dividend payout ratio range of 55% to 70%. This factor, combined with strong earnings growth expectations, (00:21:24) well for future dividend growth. Of course, future dividend decisions will be driven by earnings growth, in addition to cash flows and other business conditions. Together, we believe our strong earnings growth outlook, combined with our solid dividend, results in an attractive total return opportunity for shareholders. Again, thank you all for joining us today, and I'll now turn the call over to Michael.
Michael L. Moehn - Ameren Corp.: Thanks, Warner, and good morning, everyone. Turning now to page 13 of our presentation. Yesterday we reported third quarter 2020 earnings of $1.47 per share compared to earnings of $1.47 per share for the year-ago quarter. The key factors by segment that drove the year-over-year results are highlighted on this page. Ameren Transmission and Ameren Illinois Natural Gas earnings were up $0.03 and $0.02 per share, respectively, reflecting increased infrastructure investments. In Ameren Illinois Electric Distribution earnings increased $0.01 per share, reflecting increased infrastructure and energy efficiency investments, partially offset by a lower expected allowed of return on equity under (00:22:28) performance-based ratemaking. Ameren Missouri, our largest segment, reported earnings that declined $0.02 per share compared to the prior year. The comparison was primarily driven by a lower electric sales of $0.08 per share due to both milder than normal temperatures in the third quarter compared to warmer than normal temperatures in the previous year, as well as lower weather-normalized sales, primarily due to impacts of COVID-19. Ameren Missouri's earnings also reflected lower MEEIA performance incentives of $0.03 per share compared to the year-ago period. These unfavorable factors were partially offset by new electric service rates effective April 1, which increased earnings by $0.08 per share compared to the year-ago period, as well as lower operations and maintenance expenses reflecting a disciplined cost management, which increased earnings by $0.04 per share. And finally, Ameren Parent and Other results decreased $0.04 per share, primarily due to the timing of income tax expense, which is not expected to impact full year earnings and increased interest expense resulting from higher long-term debt outstanding. Moving now to page 14 of our presentation, I'd like to briefly touch on key drivers impacting our 2020 earnings guidance. As Warner stated, we narrowed our 2020 earnings guidance to a range of $3.40 to $3.55 per share from $3.40 to $3.60 per share. This guidance range assumes normal weather in the remaining three months of the year, as well as reflect sales update since our second quarter earnings call in August primarily related to COVID-19. For the year, we expect total weather normalized sales in Ameren Missouri to be down approximately 2%. Broken down by customer class, we now expect 2020 commercial sales to decline approximately 6.5%, industrial sales to decline approximately 3% and residential sales to increase approximately 3.5%. Overall, our update today is largely consistent with our expectations outlined in our call in May in terms of both total sales and EPS impacts for 2020 due to COVID-19. Before moving on, let me briefly cover electric sales trends for Ameren Illinois Electric Distribution for the first nine months of this year compared to the first nine months of last year. Weather-normalized kilowatt-hour sales to Illinois residential customers increased a little over 2.5%. And weather-normalized kilowatt-hour sales to Illinois commercial and industrial customers decreased 6.5% and nearly 8%, respectively. Recall that changes in electric sales in Illinois no matter the cause do not affect our earnings since we have full revenue decoupling. Moving on to other guidance considerations; select earnings considerations for the balance of the year are listed on this page. As Warner mentioned earlier, we remain very focused on maintaining disciplined cost management for the remainder of the year. Our focus in these areas enabled us to effectively address the headwinds we have faced from COVID-19 to-date. Moving now to page 15 for an update on Ameren Illinois regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance-based ratemaking, we are required to file annual rate updates to systematically adjust cash flows over time for changes in costs of service and to true up any prior period over and under recovery (00:25:53) of such costs. In late September, the ICC staff recommended a $49 million base rate decrease compared to our rate – compared to our request of a $45 million base rate decrease. A decision is expected by December with new rates expected to be effective in January 2021. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois natural gas distribution rates using a 2021 future test year and has since updated our request to in September (00:26:29). We're requesting a rate increase of $97 million, while the ICC staff has recommended an increase of $60 million. A decision is expected by January 2021 with new rates expected to be effective in February 2021. Turning now to page 16 for an update on financing activities. I'd like to highlight an important milestone recently reached for our wind generation investments. On October 9, Ameren Missouri issued $550 million of 2.625% green first mortgage bonds due in 2051. This issuance marked the first green bond offering for the company as the lowest coupon that Ameren Missouri or any Ameren issuer has secured on 30-year debt. At the time of issuance, it was also the fifth lowest 30-year coupon ever in the power and utility industry. Proceeds from the issuance will be used to fund a portion of the 700 megawatts of wind generation investment. We also expect to settle a portion of the equity forward sale agreement before the end of this year with proceeds also used to fund a portion of the wind generation investment. We expect to settle the remainder of the equity forward sale agreement when the 300-megawatt wind project is completed in the first quarter of 2021. Finally, on October 15, Ameren Corporation redeemed $350 million or 2.7% senior unsecured debt at par that to mature on November 15. A portion of the proceeds from the $800 million issuance by Ameren Corporation in early April was used to fund the repayment. Before moving on, I'd also like to mention that we expect Ameren Illinois to issue long-term debt this year to repay short-term debt. Moving now to page 17, we plan to provide 2021 earnings guidance when we release fourth quarter results in February next year. Using our 2020 year-to-date results and guidance as a reference point, we have listed on this page select items to consider as you think about the earnings outlook for next year. Beginning with Missouri, as previously noted, the 700 megawatts of wind generation are expected to be substantially in-service by the end of 2020 with a portion of the 300-megawatt facility expected to be in service in the first quarter of 2021. As a result, we expect to see contributions earnings from these investments beginning in 2021. The 2021 earnings comparison is also expected to be favorably impacted (00:28:54) in the first quarter next year by the increase in Missouri electric service rates that took effect April 1, 2020. We also expect higher weather-normalized electric sales in 2021 compared to 2020, reflecting the continuing improvement in economic activities since the COVID-19 lockdowns in the second quarter of this year. Further, we expect the return to normal weather in 2021 will increase Ameren Missouri earnings by approximately $0.04 compared to 2020 results through the third quarter, assuming normal weather in the last quarter this year. As a result in Missouri PSC approval of our requested change in the way we account for Callaway's scheduled refueling and maintenance expenses, we expect the amortization expenses associated with the fall 2020 outage to be approximately $0.07 per share higher in 2021 than the amortization expense expected to be realized in 2020. The fall 2020 outage is expected to cost approximately $0.11 per share and will be amortized over approximately 18 months starting in December of this year. Moving on, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois and ATXI projects made under our forward-looking formula ratemaking. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2021 compared to 2020 from an additional infrastructure investments made under the Illinois performance-based ratemaking. The allowed ROE under the formula would be at the average of the 2021 30-year treasury yield plus 5.8%, which applied to year-end rate base. For Ameren Illinois Natural Gas, earnings are expected to benefit from higher delivery service rates based on a 2021 future test year and from infrastructure investments qualifying for rider treatment. Finally, the issuance of common shares under the forward sale agreement to fund a portion of our wind generation investments and under our dividend reinvestment and employee benefit plans as well as additional equity of approximately $150 million (00:30:58) in 2021 are expected to unfavorably impact earnings per share. Of course, in 2021, we will seek to manage all of our businesses to earn as close to our allowed return as possible, while being mindful of operating in other business needs (00:31:11). Finally, turning to page 18, I will summarize. We have a strong team and are well-positioned to continue executing our plan. We continue to expect to deliver solid earnings growth in 2020 as we successfully execute our strategy and navigate the impacts of COVID-19. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. Further, we believe the growth compares very favorably with the growth of our utility peers, and Ameren shares continue to offer investors a solid dividend. In total, we have attractive total shareholder return story that converts very favorably to our peers. This concludes my prepared remarks. With that, now, we'll invite your questions.
Operator: Thank you. We will now be conducting a question-and-answer session. We ask that you please limit your time to one question and one follow-up as necessary. Our first question comes from line of Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet - JPMorgan Securities LLC: Hi. Good morning.
Warner L. Baxter - Ameren Corp.: Good morning, Jeremy. Good morning. How are you doing?
Jeremy Tonet - JPMorgan Securities LLC: Great. Thank you.
Warner L. Baxter - Ameren Corp.: Terrific.
Jeremy Tonet - JPMorgan Securities LLC: Just want to dig in on 2021 a little bit more if I could and would you be able to provide any additional color on the sales outlook across different sectors; residential, commercial, industrial in your 2021 earnings considerations? And what local trends are you seeing and how do you expect these trends to change over 2021 with COVID recovery? And then lastly, are there any additional considerations for your gas versus electric operations under continued COVID impact?
Warner L. Baxter - Ameren Corp.: Yeah. So, Jeremy, so, lot to unpack there. Clearly, Michael laid out some of the trends that we have seen in 2020, and now obviously, we've talked a little bit about 2021 in the past. So, Michael, why don't you maybe touch on some of those trends? And then we can sort of look at the gas business and sort of the second part of that question.
Michael L. Moehn - Ameren Corp.: Yeah. Good morning. Appreciate the question. Yeah, look, we did lay out quite a bit of detail, obviously, onto2020, and we continue to, I think, track pretty well with where we expected things to come out as we talked about the beginning of the year. I think for the most part, it's coming in about where we expected. The mix is a little bit different. As you think about 2021, I mean, we're doing a lot of different scenarios, Jeremy, and we're thinking about how this recovery is going to continue. And we are obviously modeling a recovery to continue into 2021, and we're looking hard within each of those sectors. And obviously, you've seen the strong piece on the residential side, industrial, it's come back for the most part. Commercial is the area we're spending a lot of time on just really trying to understand what that impact will be for retail, et cetera. So, we haven't, obviously, provided what we're going to exactly see for 2021 because we want to really see where 2020 continues to finish out here. Being really thoughtful about it, I mean, I – to be honest, I'm not seeing a lot of scenarios where we would gain all of that back; I mean, I'll be honest about that. But we clearly do continue to see the recovery continue in place. Now, all of that is premised on the fact that we wouldn't go back to any sort of shelter-in-place orders. And for the most part, where we're impacted by earnings here in Missouri, we're pretty well opened up. I mean, you do have certain sectors operating at some limited capacity, restaurants or retail, those kind of things. And so, we're assuming that some of that continues to come back. But again, all that's premised on the fact that we wouldn't have any significant sort of shelter in place at the moment.
Warner L. Baxter - Ameren Corp.: Yeah. Michael, I think that's a great summary. So, I think Michael summed it up well. We continue to see really pretty much what we expected at the outset. We expected a modest recovery over time, and that's what we're seeing. And we'll get more guidance, of course, when we come out in our February conference call with regard to 2021 and beyond, so we'll be able to give you some more perspectives. You asked about the gas business. And so, keep in mind, the – our big gas business. We have a small gas business in Missouri, but the big gas business is in Illinois, and that's decoupled. And so, when you think in terms of COVID-19, the implications there are really nonexistent in terms of the overall impacts on sales and margins and the like.
Michael L. Moehn - Ameren Corp.: Yeah. That's exactly right, Warner. I mean, we are decoupled for the residential and small noncommercial customer in Illinois, which is probably about 90% of the margin over there, Jeremy. So that's probably the – really the way to think about that for 2021.
Jeremy Tonet - JPMorgan Securities LLC: Got it. That's very helpful. Thank you. And maybe just pivoting a bit over to the Missouri rate cases and what are the primary drivers of the timing of the Missouri rate cases here? And do you expect to incorporate any IRP elements in the electric filing around the plant retirements, and are there any notable test year differences under a first half 2021 filing versus filing now?
Warner L. Baxter - Ameren Corp.: Yeah, Jeremy. So, this is Warner. Look, I think that we'll be able to provide a lot more detail when we ultimately file the rate case. But as we've said before when we think about filing this next rate review, we're going to be mindful of the fact that we have some big wind generation projects, right, renewable wind generation projects that we expect to be substantially in-service by the end of the year. And so, that's clearly a driver, always an opportunity to true up for costs and sales. Those will, obviously, be drivers as well. But to say there'll be any significant variations at this point in time, it'd be premature. Marty and his team are diligently putting together that rate review. And as we said, we'll put together in the first half of next year. And so, I really think the best thing to say is that, obviously, the wind generation is a big portion of it, as well as the Smart Energy Plan, right? I keep and (00:37:16) not lose focus on the fact that we're making significant investments in Missouri. So, those will be some key drivers to be looking towards, and we'll be able to give you a better update when we file that plan sometime in the first half of next year.
Jeremy Tonet - JPMorgan Securities LLC: Got it. That's helpful. I appreciate it. Thank you.
Warner L. Baxter - Ameren Corp.: Thanks, Jeremy. Have a good day.
Operator: Thank you. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Please proceed with your question.
Warner L. Baxter - Ameren Corp.: Good morning.
Michael L. Moehn - Ameren Corp.: Good morning.
Durgesh Chopra - Evercore Group LLC: Hey. Good morning, guys. Thank you for taking my question. I'm sorry I didn't realize I was in mute. Maybe – you guys talked about sort of you're going to be cautious and disciplined including some of those incremental CapEx on the Q4 call. Perhaps what are – between now and Q4 sort of what goes into that consideration of including that CapEx (00:38:11)? Is there something incremental on the IRP that you're going to hear (00:38:14)? Just any thoughts or color around that would be appreciated.
Warner L. Baxter - Ameren Corp.: Sure. Sure. So, this is Warner, again. Look, as we've said in the past, we'll be thoughtful in terms of when we include new renewable generation projects, things from the Integrated Resource Plan into our long-term CapEx and look at (00:38:34) a variety of factors. And certainly, one important matter that we'll be mindful of is that Marty and his team, they've issued an RFP for the wind and solar projects. And so, that's already out there. So, well, not only we filed (00:38:46) the IRP, but we're taking steps to execute elements of that plan. And of course, an RFP and our ability to assess those projects from that RFP will be one important consideration that we'll look at. And, of course, there are regulatory factors. It's always – we want to be thoughtful in terms of when we do these things, looking at the nature of the projects, the regulatory approvals that would be required, all those things go into our determination of when we actually put it in there. But as I said at the outset, one thing is clear, is that the opportunities from our Integrated Resource Plan are significant, and there are $3 billion through 2030. And so, Michael, any other thing that you would add to that?
Michael L. Moehn - Ameren Corp.: (00:39:25), that's a great summary, I think, of the IRP itself. I mean, I think of just the normal kind of budgeting and stuff, the updates that we'll do in the February timeframe, we go through that process obviously throughout the year. We continue to look at capital allocation issues. And so, it'll be the normal updates just in the course of the business that we run through. And so, you certainly should expect to see that. And that's typically when we do that in that February call as well.
Warner L. Baxter - Ameren Corp.: Absolutely. Absolutely.
Durgesh Chopra - Evercore Group LLC: That's great. And maybe just a quick follow-up. Could you comment on sort of how much room do you have (00:39:58)? I mean, that's sort of something that you've routinely talked with investors about, and how does the IRP plan fit in to that?
Michael L. Moehn - Ameren Corp.: Yeah. Perfect, appreciate that question. Really what we've said in the past, I think you were referring to the 2.85% cap that was built in the Senate Bill 564. Really, there's only two things that have occurred. And again, that's a CAGR over that 2017 through 2023 time period. Two things have happened since that legislation was passed. We had the – obviously, the federal tax reduction that occurred in 2019 (00:40:30). We're able to keep half of that for purposes of that calculation. And then we just obviously concluded this last rate review, which was another 1% decrease. So we haven't specifically said exactly how much headroom, but to give you a sense that both of those things have been rate decreases. You've got the 2.85% CAGR, so it gives you hopefully an idea of what kind of headroom we have today.
Durgesh Chopra - Evercore Group LLC: Great. Thanks, guys. Appreciate the time.
Warner L. Baxter - Ameren Corp.: Sure.
Operator: Thank you. Our next question comes from the line of Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Michael L. Moehn - Ameren Corp.: Julien, how are you doing?
Unknown Speaker: Hey, good morning. It's actually Darius Lazney (00:41:11) on for Julien. How are you?
Warner L. Baxter - Ameren Corp.: I'm doing terrific. How are you doing?
Unknown Speaker: Doing well. Thanks. I just wanted to quickly touch on your 2020 guidance. As I've looked at your drivers relative to the Q2 update, it looks like you're expecting an incrementally higher ROE in Illinois and it looks like your Q4 COVID impact, once you back out the Q3 impact, looks like that's gotten a little bit better by about a penny. So, can you maybe just help us understand a little bit better what drove the reduction by a nickel at the high end?
Michael L. Moehn - Ameren Corp.: Yeah. I mean, really, I think if you think about the reduction of the nickel, I mean, so, if you go to – through 9.30% (00:41:56), we're down about $0.04, obviously, on weather. We've had a number of COVID impacts there. You can see about $0.17 or so along with that. And as we thought about it, we've offset a lot of those COVID impacts, obviously, with some disciplined cost management on the O&M side. And really, it's about adjusting that down by a couple of cents on the weather piece of that, really, is what drove that decision.
Unknown Speaker: Okay, great. Thank you. And if I could just touch on the dividend briefly. You mentioned in your remarks earlier, you guys – it sounds like you have a little bit of latitude relative to your 55% to 70% range. So, I know future decisions are obviously subject to board approval, but how should we think about future increases in the payout relative to the payout range and also to your 6% to 8% EPS CAGR?
Warner L. Baxter - Ameren Corp.: Yeah. And I appreciate – this is Warner again. Clearly, the dividend is an important area of focus for our board of directors. And we've been clear all along that we target our dividend payout ratio of 55% to 70%. And so, as you know, over the last several years that we've allocated a great deal of our capital to rate-based growth, which has obviously driven strong earnings per share growth, which that couple with our solid dividend has really delivered really strong total shareholder returns. So at the same time, I think, as you pointed out, we've seen that dividend payout ratio now come lower down our overall range. And so, that factor coupled with our strong earnings per share growth expectations of 6% to 8% really positions us well for future dividend growth. Now, I can't ultimately predict that, but the point is that we try to execute our strategy and position ourselves for a solid dividend growth and perhaps even a greater dividend growth in the future. And so you saw our board of directors just increased it to 4% just recently. I think that's evidence of their belief on our overall strategic plan and their confidence in it. And so, we'll continue to visit that going forward, but that does just give us an opportunity certainly when you look at those metrics to continue to grow that dividend.
Unknown Speaker: Okay. Thank you very much.
Warner L. Baxter - Ameren Corp.: Sure.
Operator: Thank you. Our next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question.
Warner L. Baxter - Ameren Corp.: Hello, Paul. How are you?
Paul Patterson - Glenrock Associates LLC: Thank you (44:25). All right. I'm managing. A busy day today. So, in terms of Illinois, legislatively speaking, do you expect anything to happen in this abbreviated session here? Would you switch to clean energy or the formula rate stuff that you put forward and what have you? I mean, do you see anything legislatively significantly happening?
Warner L. Baxter - Ameren Corp.: Yeah.
Paul Patterson - Glenrock Associates LLC: (44:52)?
Warner L. Baxter - Ameren Corp.: Yeah. So, Paul, this is Warner. So, yeah, and I said in the talking points, we do not expect comprehensive energy legislation to be addressed in the veto session which is coming up. They obviously have two sessions scheduled in November and December for certain days. So, we do not see that at this point. Of course, we can't certainly predict that. But as we sit here now, we do not see comprehensive legislation on really any of those fronts being addressed in the veto session at this time.
Paul Patterson - Glenrock Associates LLC: Okay. And then just to clarify, it looks to me that you're – although you're lowering the top end of the guidance for this year, your growth rate is still off of the midpoint of your original guidance of 2020, correct?
Warner L. Baxter - Ameren Corp.: Yeah.
Michael L. Moehn - Ameren Corp.: That's the way to think about it. Absolutely. This is Michael.
Paul Patterson - Glenrock Associates LLC: Awesome. Thanks, guys.
Warner L. Baxter - Ameren Corp.: Sure, Paul. Thank you.
Operator: Thank you. Our next question comes from the line of Sophie Karp with KeyBanc Capital Markets. Please proceed with your question.
Sangita Jain - KeyBanc Capital Markets, Inc.: Hi. Good morning.
Warner L. Baxter - Ameren Corp.: Good morning.
Sangita Jain - KeyBanc Capital Markets, Inc.: This is – good morning. This is Sangita for Sophie. Thanks for taking my question.
Warner L. Baxter - Ameren Corp.: Absolutely.
Sangita Jain - KeyBanc Capital Markets, Inc.: Just to follow-up on the Illinois legislature question. Can you tell us when they do come back full time and if you have a sense of when they may decide to pick up this piece of legislation?
Warner L. Baxter - Ameren Corp.: Well, so, we laid out on the talking points the specific dates for the veto session. And...
Sangita Jain - KeyBanc Capital Markets, Inc.: Yeah.
Warner L. Baxter - Ameren Corp.: ...and there's a thing called a lame duck session. There's been no specific dates for them to set that. That would be sometime in January. So, whether they have that remains to be seen. That's ultimately up to the Speaker and the President and the Senate. So, no specific dates. But one of the things getting to the second part of your question is when might they take it up. I've learned long ago not to handicap, not just legislative proposals or when legislation ultimately be taken up. I would just say this, that there – stakeholders are absolutely engaged on energy legislation in a lot of various forms including the Downstate Clean Energy Affordability Act, right? That is continuing to be a topic of conversation, as well as comprehensive energy legislation to address items and issues that are being addressed up in the northern part of the state. And, obviously, we're very focused on things that are new in the southern part of the state. So because of that, I do expect energy legislation to be a topic of discussion in the next session, but I certainly can't predict when and what form it'll take at this time. All I can say is that Richard Mark and his team are advocating for the Downstate Clean Energy Affordability Act for all of the right reasons because we believe it will deliver a significant value for our customers, certainly for the state of Illinois. And we believe, too, it'll continue to deliver long-term value for not just customers, but also for shareholders. So, stay tuned.
Sangita Jain - KeyBanc Capital Markets, Inc.: Oh, thanks for that. And then, if I can follow up with just one more. Can you tell us what the timeline looks like for the Missouri IRP approval since that'll give us some kind of an indication on CapEx (48:11)?
Warner L. Baxter - Ameren Corp.: Sure. A couple of things around that. I know Marty Lyons is on the line, he can jump into some of the specifics. But there is no set time period with regard to the Integrated Resource Plan. History has shown that it's usually all addressed within sort of one year of the filing. And, I think, last time, it was around nine months when it was all said and done. And so, remember, too, the Commission, when they go through this, they really approve the overall process and what we go through in terms of putting together the Integrated Resource Plan. They don't necessarily go through and approve specific elements or projects contained within that plan. And so, the process has been started. Filings have been made. And then, Marty, I'll let you come on in if there's any other specific details around that. But, again, the Commission doesn't have a set time period, but history has shown it's usually done within 9 to 12 months. Marty, do you have anything to add from that?
Marty Lyons - Ameren Corp.: Warner, that's all accurate. I would say that once we file the IRP, there's opportunities for others, other stakeholders to comment on their perspectives and any deficiencies they see. The Commission at its option can have a hearing to discuss those matters that others bring up and ultimately will provide some perspective on the IRP. But typically, what the Commission does is just identifies whether there were any deficiencies or not. It's not necessarily an approval of the IRP itself or an endorsement of the IRP. So, with all that said, the other thing I would simply mention is in our prepared remarks, we mentioned that we have already issued a request for proposal relating to projects that we would plan to do in accordance with our preferred plan. And we're not precluded from moving forward with negotiating or announcing or filing for certificate of convenience and need with the Commission. There's nothing that precludes us from taking any of those steps before the Commission actually rules on the Integrated Resource Plan in the way that I mentioned.
Sangita Jain - KeyBanc Capital Markets, Inc.: Great. Thanks. Thank you so much and that was very helpful.
Warner L. Baxter - Ameren Corp.: Great. Thank you.
Operator: Thank you. Our next question comes from the line of Andrew Levi with HITE Hedge. Please proceed with your question.
Andrew Stuart Levi - HITE Hedge Asset Management LLC: Hey, guys. How are you doing?
Michael L. Moehn - Ameren Corp.: Good morning. How are you (50:56)?
Warner L. Baxter - Ameren Corp.: Terrific. How are you doing?
Andrew Stuart Levi - HITE Hedge Asset Management LLC: I'm doing well.
Warner L. Baxter - Ameren Corp.: That's terrific.
Andrew Stuart Levi - HITE Hedge Asset Management LLC: Actually, I think I'm all set. I think Paul already asked my questions. But just to clarify, so the 5% delta from your guidance, we shouldn't carry that into 2021. There's really no effect from that as far as the midpoint or what was going to be your base or anything like that. It's all kind of weather related and kind of one time, I wouldn't say (51:31) one-time stuff, but you don't extend (51:32) stuff that you can – that will come back in 2021.
Michael L. Moehn - Ameren Corp.: You got it, Andy. I think you said 5%, but $0.05, yeah, is – yeah.
Andrew Stuart Levi - HITE Hedge Asset Management LLC: I said $0.05. Yeah.
Michael L. Moehn - Ameren Corp.: Yeah. So, anyway, so...
Warner L. Baxter - Ameren Corp.: Andy, you made my knees buckle when you said 5% Let's be clear, (51:52), it's $0.05.
Andrew Stuart Levi - HITE Hedge Asset Management LLC: Did I say that? I apologize (51:55).
Michael L. Moehn - Ameren Corp.: No. no. No worries. But you're thinking about the right way in terms of the jump-off point, so.
Andrew Stuart Levi - HITE Hedge Asset Management LLC: Okay. Great. Thank you very much.
Warner L. Baxter - Ameren Corp.: Sure. Thank you, Andy.
Operator: Thank you. Our next question comes from line of Insoo Kim with Goldman Sachs. Please proceed with your question.
Warner L. Baxter - Ameren Corp.: Good morning, Insoo. How are you?
Insoo Kim - Goldman Sachs & Co. LLC: Thank you (52:16). Good. Good morning. Just one question from me. Can you just give us the latest update on the appeals process for the, I think, the judge's ruling last year on the Labadie and Rush Island plants and whether we expect any updates before the end of the year?
Warner L. Baxter - Ameren Corp.: Sure. Insoo, this is Warner again. We have filed our briefs with the appellate courts, obviously, putting forth what we believe are very strong arguments. And so, really, where things are at today is that we're waiting for the court to schedule oral arguments. And we're still hopeful to have those scheduled by the end of the year. So, that's – it's going through the normal process. Of course, there are no specific timeframe that the court has to act or to take specific action. But – so, we'll wait to hear the schedule, and it's still possible to have them still by the end of the year.
Insoo Kim - Goldman Sachs & Co. LLC: Got it. And if the decision – the appeals process is going against you, then what are procedurally the next steps that you're considering? And given these plants in your IRP, at least, I know you've outlined some of the retirement dates and this could potentially require you to take other actions, like what are some of the thought processes there?
Warner L. Baxter - Ameren Corp.: So, I think, Insoo – and I'm just making sure it's a little bit garbled here. In terms of – is your specific question, as a result of the court's decision how much time might that change? Is that what your question was in terms of our IRP?
Insoo Kim - Goldman Sachs & Co. LLC: Not necessarily IRP. But if the appeals process doesn't go your way, what are the next steps and just thought processes around given the remaining rate base of the plants, what your thought process around the plants will be?
Warner L. Baxter - Ameren Corp.: Sure. Look, if – as I said, we strongly believe we have a great case. But having said that, if things go against what we think is the appropriate answer, then we'll do what we always do. We'll step back. We'll take a look at what we believe our next steps are. It depends on the specific actions and things that the court says, of course. And then, we'll take a look and determine what we think, is the – in the best long-term interest of our customers and certainly our shareholders. So, it'd be premature to speculate just exactly where that might head.
Insoo Kim - Goldman Sachs & Co. LLC: Understood. Thank you very much.
Warner L. Baxter - Ameren Corp.: Thanks, Insoo.
Michael L. Moehn - Ameren Corp.: Take care.
Operator: Thank you. Our next question comes from Line of David Paz with Wolfe Research. Please proceed with your question.
Warner L. Baxter - Ameren Corp.: Good morning, David. How are you?
David Paz - Wolfe Research LLC: Yeah. Good morning, Warner. How are you doing?
Warner L. Baxter - Ameren Corp.: I'm terrific. Thank you.
David Paz - Wolfe Research LLC: Great. Just one follow-up question maybe. Assuming you were to own the 1.2 gigawatts of renewables under your preferred option in the IRP, and I think those are projected to be online by year-end 2025...
Warner L. Baxter - Ameren Corp.: Correct.
David Paz - Wolfe Research LLC: ...do you anticipate that to be – have an upward bias on your EPS growth target or will that CapEx – renewables CapEx push out or displace other nonrenewables CapEx in that 2024, 2025 period? Thanks.
Michael L. Moehn - Ameren Corp.: Yeah. Hey, David. This is Michael. Probably won't be a terribly satisfactory answer. But I mean, I think – look, we're probably a bit premature to speculate on that. I mean, it's something that we will be very thoughtful about and we'll take a number of things under consideration when you look at it just in terms of what the overall rate impact is, the timing of it. I mean, hopefully, we'll be able to give us some additional color on that in February as Warner talked about. I mean, we don't want to get ahead of just the regulatory process there. But we'll be very thoughtful about it, but it's probably a bit premature to answer that.
David Paz - Wolfe Research LLC: Okay. Understand. Thank you.
Warner L. Baxter - Ameren Corp.: Thanks, David.
Operator: Thank you. Ladies and gentlemen, that concludes our time allowed for questions. I'll turn the floor back to Mr. Kirk for any final comments.
Andrew Kirk - Ameren Corp.: Yeah. Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial inquiries should be directed to me, Andrew Kirk. Media should call Brad Brown. Again, thank you for your interest in Ameren. We look forward to visiting with you at our EEI meetings next week. Until then, have a great day.
Operator: Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. | [
{
"speaker": "Executives",
"text": "Andrew Kirk - Ameren Corp. Warner L. Baxter - Ameren Corp. Michael L. Moehn - Ameren Corp. Marty Lyons - Ameren Corp."
},
{
"speaker": "Analysts",
"text": "Jeremy Tonet - JPMorgan Securities LLC Durgesh Chopra - Evercore Group LLC Paul Patterson - Glenrock Associates LLC Sangita Jain - KeyBanc Capital Markets, Inc. Andrew Stuart Levi - HITE Hedge Asset Management LLC Insoo Kim - Goldman Sachs & Co. LLC David Paz - Wolfe Research LLC"
},
{
"speaker": "Operator",
"text": "Greetings and welcome to the Ameren Corporation's Third Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. Mr. Kirk, you may begin."
},
{
"speaker": "Andrew Kirk - Ameren Corp.",
"text": "Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President, and Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then, we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that's accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the AmerenInvestors.com homepage that will be referenced by our speakers. As noted on page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions, and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday, and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance are presented on a diluted basis unless otherwise noted. Now, here's Warner."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. Before I jump into our discussion of third quarter results, another key business manners, I'll start with a few comments on COVID-19. So, again, I hope you, your families, and colleagues are safe and healthy during this challenging time. While COVID-19 has driven a great deal of change, I can assure you that one thing that remains constant in Ameren is our strong commitment to the safety of our co-workers, customers, and communities. So, too, is our strong focus on delivering safe, reliable, cleaner, and affordable electric and natural gas service during this unprecedented time. We recognize that millions of customers in Missouri and Illinois are depending on us. I can't express enough appreciation to my co-workers who have shown great agility, innovation, determination and a keen focus on safety while delivering on our mission to power the quality of life. We continue to carefully monitor the impact of COVID-19 on our electric sales, liquidity, and supply chain. To date, these impacts have been manageable and are largely in line with our expectations. In addition, our team continues to successfully execute our strategy across the entire business. Looking ahead, we'll remain focus on executing our strategy including employing our strong safety practices as well as continued exercise financial discipline to mitigate the impacts of COVID-19. At the same time, we will look to capitalize on key opportunities that we have identified during the last several months including benefits we are realizing from our digital investments and other efficiencies in our operations. Turning now to page 4 for an update on third quarter results and 2020 earnings guidance. Yesterday, we announced third quarter 2020 earnings of $1.47 per share compared to $1.47 per share earned in 2019. A summary of the key drivers is provided on this page, which Michael will discuss in more detail in a moment. I am pleased to report that we remain on track to deliver solid earnings growth in 2020 over 2019. Yesterday, we also announced that we narrowed our 2020 earnings guidance range to $3.40 per share to $3.55 per share. That compares to our initial guidance range of $3.40 per share to $3.60 per share. Moving to page 5, here, we reiterate our strategic plan, which we have been executing very well throughout the year. We expect our plan will continue delivering significant value for our customers and a strong long-term earnings growth for our shareholders. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers in all four of our jurisdictions. As I have said many times in the past, our customers are at the center of our strategy. Our customers have been clear. They want safe, reliable, and clean energy, all at an affordable price. Our goal is to meet our customers' energy needs and exceed their expectations. As you can see on the right side of this page, during the first nine months of this year, we invested a significant capital in each of our business segments to achieve our goal for our customers, and we are delivering results. Our energy grid is becoming more reliable, resilient, and secure. We are implementing and enabling clean energy through our renewable energy and transmission investments, and our customers' electric rates remain among the lowest in the country at approximately 20% below the national average. Of course, we're not done. We will continue to make critical investments across our businesses to modernize the energy grid. In addition, we will continue to transition our generation portfolio to a cleaner and more diverse portfolio in a responsible fashion. That transition will include significant investments in renewable energy, which I will cover in more detail in a moment. And we will continue to invest in innovative technologies including digital technologies to meet and exceed our customers' rising expectations. Consistent with the Ameren Missouri Smart Energy Plan, we're putting meaningful dollars to work to modernize the energy grid and to serve our customers better. I am pleased to report that in July, Ameren Missouri began installing the first of 1.2 million electric smart meters for customers. The installation of these smart meters over the next several years will enhance reliability and provide more visibility and choices for our customers to control their energy usage. Our Ameren Illinois electric and gas distribution customers already seeing these benefits as we completed the installation of over 1.2 million electric smart meters and over 830,000 gas modules in 2019. We have also been working hard in the regulatory arena to earn fair returns on our investments. As we discussed on our first and second quarter earnings calls, new electric rates went into effect on April 1 of this year as a result of the constructor settlement in Ameren Missouri's electric rate review. In addition, as Michael will cover in more detail later, we will continue to progress through our electric and natural gas regulatory proceedings in Illinois. We expect a final decision in the electric proceeding by December of this year and a final decision in a gas proceeding by January of next year. From an operational perspective, the Callaway Energy Center began its scheduled refueling and maintenance outage in early October. The outage is progressing safely and on schedule. Finally, another important element of the first pillar of our strategy has been and remains our relentless focus on continuous improvement and disciplined cost management to keep rates affordable. Moving to page 6 and the second pillar of our strategy, which includes enhancing regulatory frameworks for the benefit of all stakeholders. In Illinois, we continue to support the proposed Downstate Clean Energy Affordability Act. This important legislation would allow Ameren Illinois to make significant investments in solar energy and battery storage to improve reliability, as well as to make investments in transportation electrification in order to benefit customers and the economy across Central and Southern Illinois. In addition, it would help address energy policy challenges facing the state, including the need for additional renewable sources and better electric vehicle charging infrastructure. This bill would help address these challenges and move the state of Illinois closer to reaching its goal of 100% clean energy by 2050. This legislation will also continue to support important investments in the energy grid to meet our customers' expectations for a more reliable and resilient energy grid. In addition, this legislation would modify the allowable return on equity formula and would also extend the electric performance-based ratemaking framework through 2032. We have been actively participating in energy policy discussions, including the governors and Senate working group meetings. As noted on this slide, a veto session is currently scheduled for certain days in November and December. Consistent with the views that we expressed during our second quarter call, we do not expect comprehensive energy legislation to be addressed during the veto session in 2020. Looking ahead, we will continue to engage with the key stakeholders in an open and transparent fashion to better understand their views and advocate for constructive energy policies that support investment and critical infrastructure. Moving to Ameren Missouri regulatory matters, on October 16, we have filed requests with the Missouri Public Service Commission to track and defer in a regulatory asset certain COVID-19 related costs incurred, net of any COVID-19 realized cost savings. Through September 30, 2020, we have accumulated approximately $9 million of net costs, and we've requested additional true-ups next year. If our requests are approved by the Missouri PSC, the recovery and the timing of recovery of these costs would be determined as part of the next electric and gas rate reviews. The PSC is under no deadline to issue orders, and we cannot predict the ultimate outcome of this matter. Speaking of future rate reviews and as we discussed during our second quarter conference call, we continue to expect to file the next Ameren Missouri electric rate review in the first half of 2021. In addition, we also expect to file an Ameren Missouri natural gas rate review during the first half of 2021 as well. Turning now to page 7 and Missouri's Integrated Resource Plan. In late September, we announced a transformative preferred plan that will accelerate our transition to a cleaner and more diverse generation portfolio while carefully balancing two important needs for our customers: reliability and affordability. Our plan is clearly transformational as it significantly accelerates our carbon emission reduction goals from those that we established in 2017. In particular, the plan targets a 50% reduction in carbon emissions below 2005 levels by 2030 and an 85% reduction by 2040. And by 2050, our goal is to achieve net-zero carbon emissions across all of Ameren. We plan to achieve these goals by making significant investments in renewable generation. Under our preferred plan, we would add 3,100 megawatts of wind and solar to our portfolio, representing approximately $4.5 billion of investment by 2030. By 2040, in total, 5,400 megawatts of wind and solar would be added for a total investment of approximately $8 billion. These renewable generation additions include our wind generation investment of $1.2 billion for 700 megawatts that we expect will be substantially complete this year. The plan also advances the retirement of two of our coal-fired energy centers, with all of our coal-fired energy centers retired by 2042. It is important to note that our plan does not include the addition of any combined cycle natural gas plants. Further, we expect to seek an extension of the operating license of our carbon-free Callaway Nuclear Energy Center beyond the current expiration date of 2044. And we will continue to implement robust energy efficiency and demand response programs. Importantly, our plan represents a responsible transition of our portfolio that takes into consideration environmental stewardship, system reliability, and customer affordability. Our plan leverages the very low-cost generation that our customers enjoy today and used it as a bridge to enable us to add greater levels of intermittent resources in the future while ensuring system reliability. Our plan also intends to leverage important research and development investments by the public and private sectors and incorporate advances in clean energy technologies over time to achieve our net-zero carbon emissions goal. We are very excited about this transformational plan and are already taking steps to implement it. In September, we issued a request for proposal that will enable us to assess and take the appropriate next steps on solar and wind projects that will deliver the best value to our customers, consistent with our IRP. Responses to our request have been robust and we are in the process of assessing those proposals as we speak. We will provide an update on our assessment as well as our five-year capital plan for 2021 to 2025 during our year-end conference call in February. Consistent with our approach in the past, we will consider a variety of factors before we include such major projects into our plan. Having said that, one thing is clear. Our IRP includes significant incremental investment opportunities including approximately $3 billion by 2030. As I said before, we are very excited about our transformational plan as well as how Ameren and our industry are leading the country and the world in executing responsible and achievable plans to significantly reduce carbon emissions and in so doing creating a cleaner and sustainable energy future. Speaking of creating a cleaner and sustainable energy future, let's move now to page 8 for an update on our $1.2 billion wind generation investment plan to achieve compliance with Missouri's Renewable Energy Standard through the acquisition of 700 megawatts of new wind generation at two sites in Missouri. Good progress continues to be made at both facilities. All of the construction and related installation of key components for the 400 megawatt facility have been completed and testing of the units will be completed over the next several weeks. As a result, we expect a 400 megawatt facility to be in service by the end of 2020. For the 300 megawatt facility, we are working closely with the developer to monitor the shipment and installation of remaining facility components. As we discussed on prior earnings calls this year, we have experienced some delays in the project due to several factors including those related to challenges in the global supply chain due to COVID-19, as well as in the transportation of certain components. As a result, we expect a portion of the project, or approximately $200 million of investment, to be placed in service in the first quarter of 2021. We do not expect this to have a significant economic consequences or reduce the production tax credits for this project because of the recent rule changes made by the U.S. Department of the Treasury to extend the in-service criteria by one year to December 31, 2021. Moving to page 9, looking ahead through the end of this decade, we have a robust pipeline of investment opportunities of over $39 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter, and cleaner. This robust pipeline now includes the new renewable generation proposed in the preferred plan of the Missouri Integrated Resource Plan, which added approximately $3 billion of incremental investment opportunities in 2020 to 2029. Importantly, these investment opportunities exclude any new regionally beneficial transmission projects that would increase the reliability and resiliency of the energy grid, as well as enable additional renewable generation projects. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our country's future energy needs and delivering on our customers' expectations. Moving to page 10; a few moments ago, I mentioned that we are focused on delivering a sustainable energy future for our customers, communities, and our country. Consistent with that focus, we recently published a stakeholder presentation called Leading the Way to a Sustainable Energy Future, which is Ameren's vision statement. This presentation demonstrates how we have been effectively integrating our focus on environmental, social, governance and sustainability matters into our corporate strategy. This slide summarizes our sustainability value proposition for environmental, social, and governance matters. We have a strong environmental focus which is, in part, demonstrated by the Missouri Integrated Resource Plan I discussed earlier. Importantly, the preferred plan discussed earlier is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. Emissions from our coal-fired energy centers are well below state and federal limits, and our natural gas pipeline system has no cast or wrought iron pipes. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. There has never been a more important time than now to be a leader in this area. In terms of COVID-19 relief, we have been tirelessly working to help our customers in need, including implementing disconnection moratoriums, providing special bill payment plans, and providing over $15 million of critical funds for energy assistance and other basic needs. And we have set up and spoken out against racial injustice and discrimination and have taken actions to enable our company and community to further embrace diversity, equity, and inclusion. And we were honored to again be recognized by DiversityInc as one of the top utilities in the country for diversity, equity and inclusion. Finally, our strong corporate governance is led by a diverse Board of Directors, focused on strong oversight that's aligned with ESG matters. And our executive compensation practices include performance metrics that are tied to sustainable long-term performance and progress towards a cleaner, sustainable energy future. I encourage you to take some time to read more about our sustainability value proposition. You can find this presentation at amereninvestors.com. Moving to page 11; to sum up our value proposition, the consistent execution of our strategy over many years and on many fronts has positioned us well for future success. We remain firmly convinced that the execution of this strategy in 2020 and beyond will deliver superior value to our customers, shareholders, and the environment. In May, we affirmed our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings per share growth for the 2020 through 2024 period. This earnings growth is primarily driven by our approximate 9% compound annual rate base growth from 2019 through 2024, and compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. In addition, we will continue to advocate for constructive regulatory frameworks and energy policies to support these important investments for the future. Further, our shares continue to offer investors a solid dividend. Last month, Ameren's board of directors expressed its confidence in our long-term growth plan by increasing the dividend by 4%, the 7th consecutive year with a dividend increase. Given the midpoint of our 2020 earnings guidance range that I discussed earlier, our dividend payout ratio is approximate 59%, which stores the (00:21:13) lower end of our company's targeted dividend payout ratio range of 55% to 70%. This factor, combined with strong earnings growth expectations, (00:21:24) well for future dividend growth. Of course, future dividend decisions will be driven by earnings growth, in addition to cash flows and other business conditions. Together, we believe our strong earnings growth outlook, combined with our solid dividend, results in an attractive total return opportunity for shareholders. Again, thank you all for joining us today, and I'll now turn the call over to Michael."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Thanks, Warner, and good morning, everyone. Turning now to page 13 of our presentation. Yesterday we reported third quarter 2020 earnings of $1.47 per share compared to earnings of $1.47 per share for the year-ago quarter. The key factors by segment that drove the year-over-year results are highlighted on this page. Ameren Transmission and Ameren Illinois Natural Gas earnings were up $0.03 and $0.02 per share, respectively, reflecting increased infrastructure investments. In Ameren Illinois Electric Distribution earnings increased $0.01 per share, reflecting increased infrastructure and energy efficiency investments, partially offset by a lower expected allowed of return on equity under (00:22:28) performance-based ratemaking. Ameren Missouri, our largest segment, reported earnings that declined $0.02 per share compared to the prior year. The comparison was primarily driven by a lower electric sales of $0.08 per share due to both milder than normal temperatures in the third quarter compared to warmer than normal temperatures in the previous year, as well as lower weather-normalized sales, primarily due to impacts of COVID-19. Ameren Missouri's earnings also reflected lower MEEIA performance incentives of $0.03 per share compared to the year-ago period. These unfavorable factors were partially offset by new electric service rates effective April 1, which increased earnings by $0.08 per share compared to the year-ago period, as well as lower operations and maintenance expenses reflecting a disciplined cost management, which increased earnings by $0.04 per share. And finally, Ameren Parent and Other results decreased $0.04 per share, primarily due to the timing of income tax expense, which is not expected to impact full year earnings and increased interest expense resulting from higher long-term debt outstanding. Moving now to page 14 of our presentation, I'd like to briefly touch on key drivers impacting our 2020 earnings guidance. As Warner stated, we narrowed our 2020 earnings guidance to a range of $3.40 to $3.55 per share from $3.40 to $3.60 per share. This guidance range assumes normal weather in the remaining three months of the year, as well as reflect sales update since our second quarter earnings call in August primarily related to COVID-19. For the year, we expect total weather normalized sales in Ameren Missouri to be down approximately 2%. Broken down by customer class, we now expect 2020 commercial sales to decline approximately 6.5%, industrial sales to decline approximately 3% and residential sales to increase approximately 3.5%. Overall, our update today is largely consistent with our expectations outlined in our call in May in terms of both total sales and EPS impacts for 2020 due to COVID-19. Before moving on, let me briefly cover electric sales trends for Ameren Illinois Electric Distribution for the first nine months of this year compared to the first nine months of last year. Weather-normalized kilowatt-hour sales to Illinois residential customers increased a little over 2.5%. And weather-normalized kilowatt-hour sales to Illinois commercial and industrial customers decreased 6.5% and nearly 8%, respectively. Recall that changes in electric sales in Illinois no matter the cause do not affect our earnings since we have full revenue decoupling. Moving on to other guidance considerations; select earnings considerations for the balance of the year are listed on this page. As Warner mentioned earlier, we remain very focused on maintaining disciplined cost management for the remainder of the year. Our focus in these areas enabled us to effectively address the headwinds we have faced from COVID-19 to-date. Moving now to page 15 for an update on Ameren Illinois regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance-based ratemaking, we are required to file annual rate updates to systematically adjust cash flows over time for changes in costs of service and to true up any prior period over and under recovery (00:25:53) of such costs. In late September, the ICC staff recommended a $49 million base rate decrease compared to our rate – compared to our request of a $45 million base rate decrease. A decision is expected by December with new rates expected to be effective in January 2021. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois natural gas distribution rates using a 2021 future test year and has since updated our request to in September (00:26:29). We're requesting a rate increase of $97 million, while the ICC staff has recommended an increase of $60 million. A decision is expected by January 2021 with new rates expected to be effective in February 2021. Turning now to page 16 for an update on financing activities. I'd like to highlight an important milestone recently reached for our wind generation investments. On October 9, Ameren Missouri issued $550 million of 2.625% green first mortgage bonds due in 2051. This issuance marked the first green bond offering for the company as the lowest coupon that Ameren Missouri or any Ameren issuer has secured on 30-year debt. At the time of issuance, it was also the fifth lowest 30-year coupon ever in the power and utility industry. Proceeds from the issuance will be used to fund a portion of the 700 megawatts of wind generation investment. We also expect to settle a portion of the equity forward sale agreement before the end of this year with proceeds also used to fund a portion of the wind generation investment. We expect to settle the remainder of the equity forward sale agreement when the 300-megawatt wind project is completed in the first quarter of 2021. Finally, on October 15, Ameren Corporation redeemed $350 million or 2.7% senior unsecured debt at par that to mature on November 15. A portion of the proceeds from the $800 million issuance by Ameren Corporation in early April was used to fund the repayment. Before moving on, I'd also like to mention that we expect Ameren Illinois to issue long-term debt this year to repay short-term debt. Moving now to page 17, we plan to provide 2021 earnings guidance when we release fourth quarter results in February next year. Using our 2020 year-to-date results and guidance as a reference point, we have listed on this page select items to consider as you think about the earnings outlook for next year. Beginning with Missouri, as previously noted, the 700 megawatts of wind generation are expected to be substantially in-service by the end of 2020 with a portion of the 300-megawatt facility expected to be in service in the first quarter of 2021. As a result, we expect to see contributions earnings from these investments beginning in 2021. The 2021 earnings comparison is also expected to be favorably impacted (00:28:54) in the first quarter next year by the increase in Missouri electric service rates that took effect April 1, 2020. We also expect higher weather-normalized electric sales in 2021 compared to 2020, reflecting the continuing improvement in economic activities since the COVID-19 lockdowns in the second quarter of this year. Further, we expect the return to normal weather in 2021 will increase Ameren Missouri earnings by approximately $0.04 compared to 2020 results through the third quarter, assuming normal weather in the last quarter this year. As a result in Missouri PSC approval of our requested change in the way we account for Callaway's scheduled refueling and maintenance expenses, we expect the amortization expenses associated with the fall 2020 outage to be approximately $0.07 per share higher in 2021 than the amortization expense expected to be realized in 2020. The fall 2020 outage is expected to cost approximately $0.11 per share and will be amortized over approximately 18 months starting in December of this year. Moving on, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois and ATXI projects made under our forward-looking formula ratemaking. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2021 compared to 2020 from an additional infrastructure investments made under the Illinois performance-based ratemaking. The allowed ROE under the formula would be at the average of the 2021 30-year treasury yield plus 5.8%, which applied to year-end rate base. For Ameren Illinois Natural Gas, earnings are expected to benefit from higher delivery service rates based on a 2021 future test year and from infrastructure investments qualifying for rider treatment. Finally, the issuance of common shares under the forward sale agreement to fund a portion of our wind generation investments and under our dividend reinvestment and employee benefit plans as well as additional equity of approximately $150 million (00:30:58) in 2021 are expected to unfavorably impact earnings per share. Of course, in 2021, we will seek to manage all of our businesses to earn as close to our allowed return as possible, while being mindful of operating in other business needs (00:31:11). Finally, turning to page 18, I will summarize. We have a strong team and are well-positioned to continue executing our plan. We continue to expect to deliver solid earnings growth in 2020 as we successfully execute our strategy and navigate the impacts of COVID-19. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. Further, we believe the growth compares very favorably with the growth of our utility peers, and Ameren shares continue to offer investors a solid dividend. In total, we have attractive total shareholder return story that converts very favorably to our peers. This concludes my prepared remarks. With that, now, we'll invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now be conducting a question-and-answer session. We ask that you please limit your time to one question and one follow-up as necessary. Our first question comes from line of Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet - JPMorgan Securities LLC",
"text": "Hi. Good morning."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Good morning, Jeremy. Good morning. How are you doing?"
},
{
"speaker": "Jeremy Tonet - JPMorgan Securities LLC",
"text": "Great. Thank you."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Terrific."
},
{
"speaker": "Jeremy Tonet - JPMorgan Securities LLC",
"text": "Just want to dig in on 2021 a little bit more if I could and would you be able to provide any additional color on the sales outlook across different sectors; residential, commercial, industrial in your 2021 earnings considerations? And what local trends are you seeing and how do you expect these trends to change over 2021 with COVID recovery? And then lastly, are there any additional considerations for your gas versus electric operations under continued COVID impact?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah. So, Jeremy, so, lot to unpack there. Clearly, Michael laid out some of the trends that we have seen in 2020, and now obviously, we've talked a little bit about 2021 in the past. So, Michael, why don't you maybe touch on some of those trends? And then we can sort of look at the gas business and sort of the second part of that question."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Yeah. Good morning. Appreciate the question. Yeah, look, we did lay out quite a bit of detail, obviously, onto2020, and we continue to, I think, track pretty well with where we expected things to come out as we talked about the beginning of the year. I think for the most part, it's coming in about where we expected. The mix is a little bit different. As you think about 2021, I mean, we're doing a lot of different scenarios, Jeremy, and we're thinking about how this recovery is going to continue. And we are obviously modeling a recovery to continue into 2021, and we're looking hard within each of those sectors. And obviously, you've seen the strong piece on the residential side, industrial, it's come back for the most part. Commercial is the area we're spending a lot of time on just really trying to understand what that impact will be for retail, et cetera. So, we haven't, obviously, provided what we're going to exactly see for 2021 because we want to really see where 2020 continues to finish out here. Being really thoughtful about it, I mean, I – to be honest, I'm not seeing a lot of scenarios where we would gain all of that back; I mean, I'll be honest about that. But we clearly do continue to see the recovery continue in place. Now, all of that is premised on the fact that we wouldn't go back to any sort of shelter-in-place orders. And for the most part, where we're impacted by earnings here in Missouri, we're pretty well opened up. I mean, you do have certain sectors operating at some limited capacity, restaurants or retail, those kind of things. And so, we're assuming that some of that continues to come back. But again, all that's premised on the fact that we wouldn't have any significant sort of shelter in place at the moment."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah. Michael, I think that's a great summary. So, I think Michael summed it up well. We continue to see really pretty much what we expected at the outset. We expected a modest recovery over time, and that's what we're seeing. And we'll get more guidance, of course, when we come out in our February conference call with regard to 2021 and beyond, so we'll be able to give you some more perspectives. You asked about the gas business. And so, keep in mind, the – our big gas business. We have a small gas business in Missouri, but the big gas business is in Illinois, and that's decoupled. And so, when you think in terms of COVID-19, the implications there are really nonexistent in terms of the overall impacts on sales and margins and the like."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Yeah. That's exactly right, Warner. I mean, we are decoupled for the residential and small noncommercial customer in Illinois, which is probably about 90% of the margin over there, Jeremy. So that's probably the – really the way to think about that for 2021."
},
{
"speaker": "Jeremy Tonet - JPMorgan Securities LLC",
"text": "Got it. That's very helpful. Thank you. And maybe just pivoting a bit over to the Missouri rate cases and what are the primary drivers of the timing of the Missouri rate cases here? And do you expect to incorporate any IRP elements in the electric filing around the plant retirements, and are there any notable test year differences under a first half 2021 filing versus filing now?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah, Jeremy. So, this is Warner. Look, I think that we'll be able to provide a lot more detail when we ultimately file the rate case. But as we've said before when we think about filing this next rate review, we're going to be mindful of the fact that we have some big wind generation projects, right, renewable wind generation projects that we expect to be substantially in-service by the end of the year. And so, that's clearly a driver, always an opportunity to true up for costs and sales. Those will, obviously, be drivers as well. But to say there'll be any significant variations at this point in time, it'd be premature. Marty and his team are diligently putting together that rate review. And as we said, we'll put together in the first half of next year. And so, I really think the best thing to say is that, obviously, the wind generation is a big portion of it, as well as the Smart Energy Plan, right? I keep and (00:37:16) not lose focus on the fact that we're making significant investments in Missouri. So, those will be some key drivers to be looking towards, and we'll be able to give you a better update when we file that plan sometime in the first half of next year."
},
{
"speaker": "Jeremy Tonet - JPMorgan Securities LLC",
"text": "Got it. That's helpful. I appreciate it. Thank you."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Thanks, Jeremy. Have a good day."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Please proceed with your question."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Good morning."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Good morning."
},
{
"speaker": "Durgesh Chopra - Evercore Group LLC",
"text": "Hey. Good morning, guys. Thank you for taking my question. I'm sorry I didn't realize I was in mute. Maybe – you guys talked about sort of you're going to be cautious and disciplined including some of those incremental CapEx on the Q4 call. Perhaps what are – between now and Q4 sort of what goes into that consideration of including that CapEx (00:38:11)? Is there something incremental on the IRP that you're going to hear (00:38:14)? Just any thoughts or color around that would be appreciated."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure. Sure. So, this is Warner, again. Look, as we've said in the past, we'll be thoughtful in terms of when we include new renewable generation projects, things from the Integrated Resource Plan into our long-term CapEx and look at (00:38:34) a variety of factors. And certainly, one important matter that we'll be mindful of is that Marty and his team, they've issued an RFP for the wind and solar projects. And so, that's already out there. So, well, not only we filed (00:38:46) the IRP, but we're taking steps to execute elements of that plan. And of course, an RFP and our ability to assess those projects from that RFP will be one important consideration that we'll look at. And, of course, there are regulatory factors. It's always – we want to be thoughtful in terms of when we do these things, looking at the nature of the projects, the regulatory approvals that would be required, all those things go into our determination of when we actually put it in there. But as I said at the outset, one thing is clear, is that the opportunities from our Integrated Resource Plan are significant, and there are $3 billion through 2030. And so, Michael, any other thing that you would add to that?"
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "(00:39:25), that's a great summary, I think, of the IRP itself. I mean, I think of just the normal kind of budgeting and stuff, the updates that we'll do in the February timeframe, we go through that process obviously throughout the year. We continue to look at capital allocation issues. And so, it'll be the normal updates just in the course of the business that we run through. And so, you certainly should expect to see that. And that's typically when we do that in that February call as well."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Absolutely. Absolutely."
},
{
"speaker": "Durgesh Chopra - Evercore Group LLC",
"text": "That's great. And maybe just a quick follow-up. Could you comment on sort of how much room do you have (00:39:58)? I mean, that's sort of something that you've routinely talked with investors about, and how does the IRP plan fit in to that?"
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Yeah. Perfect, appreciate that question. Really what we've said in the past, I think you were referring to the 2.85% cap that was built in the Senate Bill 564. Really, there's only two things that have occurred. And again, that's a CAGR over that 2017 through 2023 time period. Two things have happened since that legislation was passed. We had the – obviously, the federal tax reduction that occurred in 2019 (00:40:30). We're able to keep half of that for purposes of that calculation. And then we just obviously concluded this last rate review, which was another 1% decrease. So we haven't specifically said exactly how much headroom, but to give you a sense that both of those things have been rate decreases. You've got the 2.85% CAGR, so it gives you hopefully an idea of what kind of headroom we have today."
},
{
"speaker": "Durgesh Chopra - Evercore Group LLC",
"text": "Great. Thanks, guys. Appreciate the time."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Julien, how are you doing?"
},
{
"speaker": "Unknown Speaker",
"text": "Hey, good morning. It's actually Darius Lazney (00:41:11) on for Julien. How are you?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "I'm doing terrific. How are you doing?"
},
{
"speaker": "Unknown Speaker",
"text": "Doing well. Thanks. I just wanted to quickly touch on your 2020 guidance. As I've looked at your drivers relative to the Q2 update, it looks like you're expecting an incrementally higher ROE in Illinois and it looks like your Q4 COVID impact, once you back out the Q3 impact, looks like that's gotten a little bit better by about a penny. So, can you maybe just help us understand a little bit better what drove the reduction by a nickel at the high end?"
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Yeah. I mean, really, I think if you think about the reduction of the nickel, I mean, so, if you go to – through 9.30% (00:41:56), we're down about $0.04, obviously, on weather. We've had a number of COVID impacts there. You can see about $0.17 or so along with that. And as we thought about it, we've offset a lot of those COVID impacts, obviously, with some disciplined cost management on the O&M side. And really, it's about adjusting that down by a couple of cents on the weather piece of that, really, is what drove that decision."
},
{
"speaker": "Unknown Speaker",
"text": "Okay, great. Thank you. And if I could just touch on the dividend briefly. You mentioned in your remarks earlier, you guys – it sounds like you have a little bit of latitude relative to your 55% to 70% range. So, I know future decisions are obviously subject to board approval, but how should we think about future increases in the payout relative to the payout range and also to your 6% to 8% EPS CAGR?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah. And I appreciate – this is Warner again. Clearly, the dividend is an important area of focus for our board of directors. And we've been clear all along that we target our dividend payout ratio of 55% to 70%. And so, as you know, over the last several years that we've allocated a great deal of our capital to rate-based growth, which has obviously driven strong earnings per share growth, which that couple with our solid dividend has really delivered really strong total shareholder returns. So at the same time, I think, as you pointed out, we've seen that dividend payout ratio now come lower down our overall range. And so, that factor coupled with our strong earnings per share growth expectations of 6% to 8% really positions us well for future dividend growth. Now, I can't ultimately predict that, but the point is that we try to execute our strategy and position ourselves for a solid dividend growth and perhaps even a greater dividend growth in the future. And so you saw our board of directors just increased it to 4% just recently. I think that's evidence of their belief on our overall strategic plan and their confidence in it. And so, we'll continue to visit that going forward, but that does just give us an opportunity certainly when you look at those metrics to continue to grow that dividend."
},
{
"speaker": "Unknown Speaker",
"text": "Okay. Thank you very much."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Hello, Paul. How are you?"
},
{
"speaker": "Paul Patterson - Glenrock Associates LLC",
"text": "Thank you (44:25). All right. I'm managing. A busy day today. So, in terms of Illinois, legislatively speaking, do you expect anything to happen in this abbreviated session here? Would you switch to clean energy or the formula rate stuff that you put forward and what have you? I mean, do you see anything legislatively significantly happening?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah."
},
{
"speaker": "Paul Patterson - Glenrock Associates LLC",
"text": "(44:52)?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah. So, Paul, this is Warner. So, yeah, and I said in the talking points, we do not expect comprehensive energy legislation to be addressed in the veto session which is coming up. They obviously have two sessions scheduled in November and December for certain days. So, we do not see that at this point. Of course, we can't certainly predict that. But as we sit here now, we do not see comprehensive legislation on really any of those fronts being addressed in the veto session at this time."
},
{
"speaker": "Paul Patterson - Glenrock Associates LLC",
"text": "Okay. And then just to clarify, it looks to me that you're – although you're lowering the top end of the guidance for this year, your growth rate is still off of the midpoint of your original guidance of 2020, correct?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Yeah."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "That's the way to think about it. Absolutely. This is Michael."
},
{
"speaker": "Paul Patterson - Glenrock Associates LLC",
"text": "Awesome. Thanks, guys."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure, Paul. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Sophie Karp with KeyBanc Capital Markets. Please proceed with your question."
},
{
"speaker": "Sangita Jain - KeyBanc Capital Markets, Inc.",
"text": "Hi. Good morning."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Good morning."
},
{
"speaker": "Sangita Jain - KeyBanc Capital Markets, Inc.",
"text": "This is – good morning. This is Sangita for Sophie. Thanks for taking my question."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Absolutely."
},
{
"speaker": "Sangita Jain - KeyBanc Capital Markets, Inc.",
"text": "Just to follow-up on the Illinois legislature question. Can you tell us when they do come back full time and if you have a sense of when they may decide to pick up this piece of legislation?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Well, so, we laid out on the talking points the specific dates for the veto session. And..."
},
{
"speaker": "Sangita Jain - KeyBanc Capital Markets, Inc.",
"text": "Yeah."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "...and there's a thing called a lame duck session. There's been no specific dates for them to set that. That would be sometime in January. So, whether they have that remains to be seen. That's ultimately up to the Speaker and the President and the Senate. So, no specific dates. But one of the things getting to the second part of your question is when might they take it up. I've learned long ago not to handicap, not just legislative proposals or when legislation ultimately be taken up. I would just say this, that there – stakeholders are absolutely engaged on energy legislation in a lot of various forms including the Downstate Clean Energy Affordability Act, right? That is continuing to be a topic of conversation, as well as comprehensive energy legislation to address items and issues that are being addressed up in the northern part of the state. And, obviously, we're very focused on things that are new in the southern part of the state. So because of that, I do expect energy legislation to be a topic of discussion in the next session, but I certainly can't predict when and what form it'll take at this time. All I can say is that Richard Mark and his team are advocating for the Downstate Clean Energy Affordability Act for all of the right reasons because we believe it will deliver a significant value for our customers, certainly for the state of Illinois. And we believe, too, it'll continue to deliver long-term value for not just customers, but also for shareholders. So, stay tuned."
},
{
"speaker": "Sangita Jain - KeyBanc Capital Markets, Inc.",
"text": "Oh, thanks for that. And then, if I can follow up with just one more. Can you tell us what the timeline looks like for the Missouri IRP approval since that'll give us some kind of an indication on CapEx (48:11)?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure. A couple of things around that. I know Marty Lyons is on the line, he can jump into some of the specifics. But there is no set time period with regard to the Integrated Resource Plan. History has shown that it's usually all addressed within sort of one year of the filing. And, I think, last time, it was around nine months when it was all said and done. And so, remember, too, the Commission, when they go through this, they really approve the overall process and what we go through in terms of putting together the Integrated Resource Plan. They don't necessarily go through and approve specific elements or projects contained within that plan. And so, the process has been started. Filings have been made. And then, Marty, I'll let you come on in if there's any other specific details around that. But, again, the Commission doesn't have a set time period, but history has shown it's usually done within 9 to 12 months. Marty, do you have anything to add from that?"
},
{
"speaker": "Marty Lyons - Ameren Corp.",
"text": "Warner, that's all accurate. I would say that once we file the IRP, there's opportunities for others, other stakeholders to comment on their perspectives and any deficiencies they see. The Commission at its option can have a hearing to discuss those matters that others bring up and ultimately will provide some perspective on the IRP. But typically, what the Commission does is just identifies whether there were any deficiencies or not. It's not necessarily an approval of the IRP itself or an endorsement of the IRP. So, with all that said, the other thing I would simply mention is in our prepared remarks, we mentioned that we have already issued a request for proposal relating to projects that we would plan to do in accordance with our preferred plan. And we're not precluded from moving forward with negotiating or announcing or filing for certificate of convenience and need with the Commission. There's nothing that precludes us from taking any of those steps before the Commission actually rules on the Integrated Resource Plan in the way that I mentioned."
},
{
"speaker": "Sangita Jain - KeyBanc Capital Markets, Inc.",
"text": "Great. Thanks. Thank you so much and that was very helpful."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Andrew Levi with HITE Hedge. Please proceed with your question."
},
{
"speaker": "Andrew Stuart Levi - HITE Hedge Asset Management LLC",
"text": "Hey, guys. How are you doing?"
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Good morning. How are you (50:56)?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Terrific. How are you doing?"
},
{
"speaker": "Andrew Stuart Levi - HITE Hedge Asset Management LLC",
"text": "I'm doing well."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "That's terrific."
},
{
"speaker": "Andrew Stuart Levi - HITE Hedge Asset Management LLC",
"text": "Actually, I think I'm all set. I think Paul already asked my questions. But just to clarify, so the 5% delta from your guidance, we shouldn't carry that into 2021. There's really no effect from that as far as the midpoint or what was going to be your base or anything like that. It's all kind of weather related and kind of one time, I wouldn't say (51:31) one-time stuff, but you don't extend (51:32) stuff that you can – that will come back in 2021."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "You got it, Andy. I think you said 5%, but $0.05, yeah, is – yeah."
},
{
"speaker": "Andrew Stuart Levi - HITE Hedge Asset Management LLC",
"text": "I said $0.05. Yeah."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Yeah. So, anyway, so..."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Andy, you made my knees buckle when you said 5% Let's be clear, (51:52), it's $0.05."
},
{
"speaker": "Andrew Stuart Levi - HITE Hedge Asset Management LLC",
"text": "Did I say that? I apologize (51:55)."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "No. no. No worries. But you're thinking about the right way in terms of the jump-off point, so."
},
{
"speaker": "Andrew Stuart Levi - HITE Hedge Asset Management LLC",
"text": "Okay. Great. Thank you very much."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure. Thank you, Andy."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from line of Insoo Kim with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Good morning, Insoo. How are you?"
},
{
"speaker": "Insoo Kim - Goldman Sachs & Co. LLC",
"text": "Thank you (52:16). Good. Good morning. Just one question from me. Can you just give us the latest update on the appeals process for the, I think, the judge's ruling last year on the Labadie and Rush Island plants and whether we expect any updates before the end of the year?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure. Insoo, this is Warner again. We have filed our briefs with the appellate courts, obviously, putting forth what we believe are very strong arguments. And so, really, where things are at today is that we're waiting for the court to schedule oral arguments. And we're still hopeful to have those scheduled by the end of the year. So, that's – it's going through the normal process. Of course, there are no specific timeframe that the court has to act or to take specific action. But – so, we'll wait to hear the schedule, and it's still possible to have them still by the end of the year."
},
{
"speaker": "Insoo Kim - Goldman Sachs & Co. LLC",
"text": "Got it. And if the decision – the appeals process is going against you, then what are procedurally the next steps that you're considering? And given these plants in your IRP, at least, I know you've outlined some of the retirement dates and this could potentially require you to take other actions, like what are some of the thought processes there?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "So, I think, Insoo – and I'm just making sure it's a little bit garbled here. In terms of – is your specific question, as a result of the court's decision how much time might that change? Is that what your question was in terms of our IRP?"
},
{
"speaker": "Insoo Kim - Goldman Sachs & Co. LLC",
"text": "Not necessarily IRP. But if the appeals process doesn't go your way, what are the next steps and just thought processes around given the remaining rate base of the plants, what your thought process around the plants will be?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Sure. Look, if – as I said, we strongly believe we have a great case. But having said that, if things go against what we think is the appropriate answer, then we'll do what we always do. We'll step back. We'll take a look at what we believe our next steps are. It depends on the specific actions and things that the court says, of course. And then, we'll take a look and determine what we think, is the – in the best long-term interest of our customers and certainly our shareholders. So, it'd be premature to speculate just exactly where that might head."
},
{
"speaker": "Insoo Kim - Goldman Sachs & Co. LLC",
"text": "Understood. Thank you very much."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Thanks, Insoo."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Take care."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Line of David Paz with Wolfe Research. Please proceed with your question."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Good morning, David. How are you?"
},
{
"speaker": "David Paz - Wolfe Research LLC",
"text": "Yeah. Good morning, Warner. How are you doing?"
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "I'm terrific. Thank you."
},
{
"speaker": "David Paz - Wolfe Research LLC",
"text": "Great. Just one follow-up question maybe. Assuming you were to own the 1.2 gigawatts of renewables under your preferred option in the IRP, and I think those are projected to be online by year-end 2025..."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Correct."
},
{
"speaker": "David Paz - Wolfe Research LLC",
"text": "...do you anticipate that to be – have an upward bias on your EPS growth target or will that CapEx – renewables CapEx push out or displace other nonrenewables CapEx in that 2024, 2025 period? Thanks."
},
{
"speaker": "Michael L. Moehn - Ameren Corp.",
"text": "Yeah. Hey, David. This is Michael. Probably won't be a terribly satisfactory answer. But I mean, I think – look, we're probably a bit premature to speculate on that. I mean, it's something that we will be very thoughtful about and we'll take a number of things under consideration when you look at it just in terms of what the overall rate impact is, the timing of it. I mean, hopefully, we'll be able to give us some additional color on that in February as Warner talked about. I mean, we don't want to get ahead of just the regulatory process there. But we'll be very thoughtful about it, but it's probably a bit premature to answer that."
},
{
"speaker": "David Paz - Wolfe Research LLC",
"text": "Okay. Understand. Thank you."
},
{
"speaker": "Warner L. Baxter - Ameren Corp.",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Thank you. Ladies and gentlemen, that concludes our time allowed for questions. I'll turn the floor back to Mr. Kirk for any final comments."
},
{
"speaker": "Andrew Kirk - Ameren Corp.",
"text": "Yeah. Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial inquiries should be directed to me, Andrew Kirk. Media should call Brad Brown. Again, thank you for your interest in Ameren. We look forward to visiting with you at our EEI meetings next week. Until then, have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 2 | 2,020 | 2020-08-07 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation’s Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer and Michael Moehn, our Executive Vice President and Chief Financial Officer, as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance, as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis unless otherwise noted. Now here's Warner who will start on Page 4 of the presentation.
Warner Baxter: Thanks, Andrew. Good morning, everyone, and thank you for joining us. Before I jump into our presentation, I'll start by saying that I hope you, your families and colleagues are safe and healthy during this challenging time. This morning I will begin our presentation by providing a COVID-19 update and in particular highlight the actions we have taken to support our customers, communities and coworkers. I'll then touch on our second quarter results and 2020 earnings guidance and finish with a discussion of several key elements of our strategy that we continue to execute very well, which will position us to continue delivering strong long-term value for our customers and shareholders. Turning now to Slide 4 and COVID-19. Our strong commitment to the safety of our coworkers, customers and communities remains constant, so to is our strong focus on delivering safe, reliable and affordable electric and natural gas service during this unprecedented time. We recognize that major customers in Missouri and Illinois are depending on us. I can't express enough appreciation to my coworkers who have shown great agility, innovation, determination, and a keen focus on safety and delivering on our mission to power the quality of life. While we are focused on delivering a safe, reliable and affordable service, we also recognize that our mission goes beyond this during this challenging time. We recognize that our customers and communities have significant needs. That is why we are working directly with our customers and special payment plans for the utility bills. We're also working closely with many dedicated community partners, and have contributed approximately $15 million for energy assistance and COVID-19 support to our customers in Missouri and Illinois. And I'm very pleased to tell you that our coworkers and Board of Directors are directly engaged in this effort to our AmerenCares Power of Giving program for COVID-19. Together, these programs are helping our residential, small business and not for profit customers meet their needs. In addition, we are tirelessly working with our customers to help them gain access to a host of federal support programs, including low income Energy Assistance funds. Our customers are at the center of our strategy and we will continue to take steps to help them during this unprecedented time. Throughout this challenging period, I'm also pleased to say that we have been effectively executing our strategy across all of our businesses. The key element of our strategy is to invest in energy infrastructure to benefit our customers, and in so doing provide important jobs to support the local economy, as well as local suppliers at a time when they are needed most. Looking ahead, we recognize that we will need to be managing the impacts of COVID-19 for some time, with safety and delivering on our mission and strategy at the top of our minds. We plan to continue managing our business under our current COVID-19 protocols, which includes having a significant portion of our workforce working remotely for at least the end of this year. We also continue to carefully monitor the impact of COVID-19 on our electric sales, liquidity and supply chain. To-date, these impacts have been manageable and in line with our expectations. At the same time, we remain focused on exercising financial discipline to mitigate the potential impacts of COVID-19, while capitalizing on some key opportunities that we have identified during this crisis, including benefits we are realizing from our digital transformation investments and streamline operating practices. Turning now to Page 5 for an update on second quarter results and 2020 earnings guidance. Yesterday, we announced second quarter 2020 earnings of $0.98 per share compared to $0.72 per share earned in 2019. The summary of the key drivers of the year-over-year increase of $0.26 per share is provided on this page, which Mike will discuss in more detail in a moment. The strong execution of our strategic plan drove strong quarterly earnings results, and enabled us to affirm our 2020 earnings guidance range of $3.40 per share to $3.60 per share. Moving to Page 6, here we reiterate our strategic plan, which as I just mentioned, we've been executing very well throughout the year. We expect our plan to continue delivering significant value for our customers and strong long-term earnings growth for our shareholders. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers and all of our jurisdictions. As you can see on the right side of this page, during the first half of this year, we invested significant capital in each of our business segments to better serve our customers, most notably Ameren Transmission, where we effectively managed a nearly 25% increase in infrastructure investment compared to the first half of 2019. These investments are delivering value to our customers and community. Our energy grid is becoming more reliable, resilient and secure, and our digital investments are enhancing our customer's experience. Of course, we're not done. Looking ahead, we continue to see the need for robust energy infrastructure investments to meet our customer's energy needs and exceed their expectations of keeping rates affordable. Our electric rates in both Missouri and Illinois continue to be well below the Midwest and national averages. As we discussed in our first quarter earnings call, new electric rates went into effect on April 1st of this year as a result of a constructive settlement in Ameren Missouri's electric rate review. The settlement included a $32 million annual revenue decrease, which marks the second consecutive decrease since 2018. Since Ameren Missouri's last electric rate review in 2017 if customer rates have decreased by 7%, while at the same time, we've continued to make significant investments in energy infrastructure to benefit our customers. As Michael will cover in more detail later, we have also been very busy managing our electric and natural gas regulatory proceedings in Illinois. We expect the final decision in the electric proceedings by December of this year, and a final decision in the gas proceeding by January of next year. Finally, another important element of the first pillar of our strategy has been and remains our relentless focus on continuous improvements and disciplined cost management to keep rates affordable. Moving to the second pillar of our strategy, which includes enhancing regulatory frameworks for the benefit of all stakeholders. As you know, we continue to support the proposed Downstate Clean Energy Affordability Act in Illinois. This important legislation would allow Ameren Illinois to make significant investments in solar energy and battery storage to improve reliability, as well as to make investments in transportation and electrification, in order to benefit customers and the economy across Central and Southern Illinois. In addition, it would help address the pressing energy policy challenges facing the state, including the need for additional renewable sources and better electric vehicle charging infrastructure. This bill will help address these challenges and move the State of Illinois closer to reaching the score of 100% clean energy by 2050. In addition, this legislation would modify the allowed return on equity formula to increase the basis point adder to the average 30-year treasury rate from 580 to 680 and would also extend the electric performance based rate making framework through 2032. Importantly, this legislation builds on Ameren Illinois’ efforts to modernize the energy grid into a transparent and stable regulatory framework that it support a significant investment to modernize the energy grid, while improving reliability and creating approximately 1,400 jobs, all while keeping rates well below the Midwest and national averages. In fact, all in residential rates in 2020 are down 1% compared to 2012, the first year of performance based rates. Simply put, the performance based grid modernization legislation that was passed in 2011 and extended twice by the Illinois legislature under different administrations has been an overwhelming success for Illinois. With all these benefits in mind, we remain focused on working with key stakeholders to get this important legislation passed. Turning now to Page 7, I’ll provide an update on for regulatory matters. In May, the FERC issued an order on the rehearing request related to its November 2019 order addressing two complaint cases that reduced MISO’s base return on equity. The order establish a new base return on equity methodology using three models, the risk premium model, capital asset pricing model and the discounted cash flow model. To revise order sets of base return on equity of 10.02% for transmission projects for the first complaint case period and effective as of September 28, 2016. This results in return on equity of 10.52% for Ameren Transmission, including the 50 basis point adder being a part of MISO. The FERC also dismissed the second complaint case. We're pleased with the order and believe it is to be constructive as the new three model methodology expands the range of reasonableness used to assess whether current returns on equity are just unreasonable. The FERC also issued a notice of proposed rule making in March. Overall, we believe that the policies outlined in the proposed rule making are constructive. As a result, we along with the other MISO transmission owners, filed comments in June in support of the proposed increase to the RTO adder, reliability and benefit based incentives and the ROE cap. We are unable to predict the ultimate timing or impact of these matters as the FERC is under no timeline to issue decision. Moving now to Page 8 for an update on the third pillar of our strategy, creating and capitalizing on options for investment for the benefit of our customers, shareholders and the environment. Here we provide an update on our $1.2 billion wind generation investment plan to achieve compliance with Missouri's renewable energy standard through the acquisition of 700 megawatts of new wind generation at two sites in Missouri. In short, there's been no significant change to the project schedules from what we discussed on our first quarter call in May. Construction is well underway at both facilities. We are working closely with the developers for both projects to monitor the timing of manufacturing, shipment and installation of facility components. We continue to expect the 400 megawatt facility to be in service by the end of 2020. Regarding the 300 megawatt facility, we expect it to be substantially in service by the end of 2020. However, as a result of certain delays we discussed on our first quarter earnings call in May, we expect the portion of the project, representing approximately $100 million of investment to be placed in service in the first quarter of 2021. We expect no reduction in production tax credits, because of the recent rule changes made by the U.S. Department of the Treasury to extend the in-service criteria by one year to December 31, 2021. Furthermore, we will continue to explore additional renewable energy investment opportunities that will drive long term value for our customers and shareholders. Right now, Ameren Missouri is in the process of finalizing its next integrated resource plan. For several months, we've been working closely with key stakeholders and developing our plan. We are carefully looking at several approaches to best meet our customers’ future energy needs and effectively transition our generation to a cleaner, more diverse portfolio in a responsible fashion. We'll be finalizing our plan for the next 45 days and plan to file our IRP with the Missouri PSC by September 30th. We are excited about the benefits that our current wind generation project will deliver to all stakeholders, as well as the prospects for additional renewable generation resources to meet our customers’ energy needs in the future. Moving to Page 9. Looking ahead through the end of this decade, we have a robust pipeline of investment opportunities of over $36 billion that will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter and cleaner. These investment opportunities exclude any potential new renewable generation from Missouri integrated resource plan, as well as any potential new multivalue transmission projects that would increase the reliability and resiliency of the energy grid, as well as enable additional renewable generation projects. Of course, our investment opportunities not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for local economies. Maintaining constructive energy policies that support robust investment and energy infrastructure will be critical to meeting our country's future energy needs and delivering on our customers' expectations. Moving to Page 10. to sum up our value proposition, the consistent execution of our strategy over many years and on many fronts does position as well for future success. We remain firmly convinced that the execution of this strategy in 2020 and beyond will deliver superior value to our customers, shareholders and the environment. In May, we affirmed our five year growth plan, which included our expectation of 6% to 8% compound annual earnings per share growth for the 2020 through 2024 period using the 2020 EPS guidance range midpoint as the base. This earnings growth is primarily driven by our approximate 9% compound annual rate base growth from 2019 through 2024 and compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Further, our shares continue to offer investors a solid dividend. Our strong earnings growth expectations position us well for future dividend growth. Of course, future dividend decisions will be driven by earnings growth in addition to cash flows and other business conditions. Together, we believe our strong earnings growth outlook, combined with our solid dividend, results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today. And I'll now turn the call over to Michael. Michael?
Michael Moehn: Thanks, Warner and good morning, everyone. Turning now to page 12 of our presentation. Yesterday, we reported second quarter 2020 earnings of $0.98 per share compared to earnings of $0.72 per share for the year ago quarter. The key factors by segment that drove the overall $0.26 per share increase are highlighted on the page. Ameren Missouri, our largest segment reported increased earnings of $0.18 per share. The increase in earnings is driven by lower operations and maintenance expenses, including the absence of a scheduled Callaway Energy Center refueling and maintenance outage, as well as disciplined cost management and favorable market returns and company owned life insurance investments, which together increased earnings by $0.15 per share. The year-over-year improvement also reflected new electric service rates effective April 1st, driven in part by increased infrastructure investments. The year-over-year impact from electric sales was flat at the $0.05 per share benefit from near normal temperatures in the second quarter compared to milder than normal temperatures in the previous year were offset by $0.05 per share reduction from lower weather normalized sales, primarily due to the impacts of COVID-19. Moving now to Ameren Transmission, earnings per share were up $0.07. This increase reflected the impact of the FERC order on the MISO base allowed return on equity, which increased earnings $0.04 per share, as well as increased infrastructure investments. Earnings for Ameren Illinois Natural Gas were up $0.03 per share due to increased infrastructure investments and lower operations and maintenance expenses. Ameren Illinois Electric Distribution earnings were down $0.01 per share, reflecting a lower expected allowed return on equity under performance based rate making, partially offset by increased infrastructure investments. And finally, Ameren Parent and other results also decreased $0.01 per share, primarily due to increased interest expense resulting from the long-term debt issuance in early April. Moving now to Page 13 of our presentation, I'd like to briefly touch on key drivers impacting our 2020 earnings guidance. As Warner stated, we continue to expect 2020 diluted earnings to be in the range of $3.40 to $3.60 per share. This guidance range assumes normal weather and the remaining six months of the year, as well as reflect sales updates from our first quarter earnings call in May primarily related to COVID-19. On our call in May, we estimated COVID-19 related sales impact to the Ameren Missouri would reduce our 2020 earnings per share expectations by approximately $0.10 per share, and we believe this will be a solid estimate. For the year, we still expect total weather normalized sales to be down approximately 2.5%. Broken down by customer class, we expect 2020 commercial sales to decline approximately 7.5%, industrial sales decline approximately 4.5% and residential sales to increase approximately 4%. While we've seen a slight change in the relative mix of sales. Overall, our update today is largely consistent with our expectations outlined in our call in May in terms of both total sales and EPS impacts for 2020 due to COVID-19. Before moving on, I would note that Ameren Missouri customer sales for June, excluding the impact of warmer than normal weather, were down approximately 0.2% compared to the prior year, reflecting the impact of COVID-19. Broken down by customer class and compared to the prior year, Ameren Missouri June weather normalized commercial and industrial sales declined approximately 9.5% and 3% respectively, which were largely offset by an increased weather normalized sales to residential customers of approximately 11%. These statistics are notable given they represent the first full month of sales after the stay at home orders were lifted. Before moving on, let me briefly cover electric sales transfer at Ameren Illinois Electric Distribution for the first six months of this year compared to the first six months of last year. Weather normalized kilowatt hour sales to Illinois residential customers increased about 4% and weather normalized kilowatt hour sales to Illinois commercial and industrial customers decreased approximately 7% and 8% respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect earnings since we have full revenue decoupling. Moving on to other guidance considerations, select earnings considerations by quarter for the balance of the year are listed on this page. Our 2020 earnings guidance range also incorporates an estimated 2020 allowed ROE for Ameren Illinois Electric Distribution of 7.2%, which reflects a 30-year treasury yield yield of approximately 4%. Finally, we also remain very focused on maintaining disciplined cost management for the remainder of the year. Moving now to Page 14 for the regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance based rate making, our utilities are required to file annual updates to systematically adjust cash flows overtime for changes in cost of service and to drip any prior period over or under recoveries of such cost. In late June, the ICC staff recommended a $53 million base rate decrease compared to our request of $45 million base rate decrease. A decision is expected in December with new rates expected to be effective in January 2021. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois Natural Gas distribution rates using a 2021 future test year, and has since updated our request in our July rebuttal testimony. In June, the ICC staff and other interveners, including the Citizens Utility Board and Illinois Industrial and Energy Consumers filed a rebuttal testimony in a rate review. Our original request as well as our July rebuttal testimony incorporated a 10.5% return on equity, while staff and other interveners have recommended a 9.32% and 9.2% return on equity respectively. We continue to seek 54% equity ratio compared to the ICC staffs and other interveners’ recommendation of 50.43% and 50% respectively. A decision is expected by January 2021 with new rates expected to be effective in February of 2021. Finally, turning to Page 15 and I will summarize. We have a strong team and are well positioned to continue executing on our plan. We continue to expect to deliver strong earnings growth in 2020 and we’re successfully executing our strategy and navigate the impacts of COVID-19. As we look to the longer term, we continue to expect strong earnings per share growth, driven by robust rate based growth and disciplined cost management. Further, we believe this growth compares very favorably to the growth of our utility peers. And Ameren shares continue to offer investors an attractive dividends. In total, we have an attractive total shareholder return story that compares very favorably to our peers. And now, I'll turn it back over to Warner.
Warner Baxter: Great. Thanks, Michael. While we spend a great deal of time this morning talking about how we're effectively addressing issues associated with COVID-19 and delivering strong results for our customers and shareholders, I think it's important to note that another matter is at top of our minds, that matter is that level of profound racial prejudice, injustice and intolerance that we still have in this country and in our own community, especially against black people. We've recently seen too many sizzle tests of African Americans. And to be clear, there’s absolutely no place for racism, injustice or hatred of any kind at Ameren, in our community, in our country or anywhere in the world. We must challenge such behavior when we witness it and take steps to drive positive changes to eliminate it. And that is exactly what we're doing in Ameren. In Ameren, diversity, equity and inclusion is a core value. While we've been recognized by DiversityInc is one of the top facilities in the country for our diversity, equity and inclusion practices, we are not standing still. In fact, we recently conducted a virtual diversity, equity and inclusion summit in St. Louis. The theme of this summit was the courage to love your values. Ameren leaders, community leaders and national leaders came together to begin listening to each other more thoughtfully and to begin taking even more steps to address this critical issue. We have made the entire program available on our Web site. I encourage you to take time and listen to the amazing stories of courage and passion for diversity, equity and inclusion. We're now ready to take your questions.
Operator: Thank you. We will now be conducting a question answer session [Operator Instructions]. Our first question comes from line of Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Just want to start off with the IRP here and just want to see how the outreach is progressing and any early thoughts that you can share with us at this point or feedback with the filing coming soon here?
Warner Baxter: Well, as you know noticed, this is an extensive process with stakeholders has been going on for several months. Marty Lyons and his team have been did just a terrific job of just outlining some of our perspectives and getting insights which is really important. So I would say, as you know, we're getting to the tail end of that process. And it would be really inappropriate to say just exactly what the feedback is then because we're putting together all that and we'll ultimately issue our integrated resource plan here at the end of September. But I can tell you the conversations have been constructive, the insight is great and we look forward to submitting that that integrated resource plan. And as you heard in my talking points, we've looked at a lot of things in this integrated resource plan. We certainly look at the technology, which is out there and we’ve certainly seen renewable energy technology and their related costs continue to come down. Take a careful look at our coal-fired energy centers and the useful lives of those plants and we really think about what's really going to deliver value to our customers in the State of Missouri. And so we look forward to submitting that plan at the end of September.
Jeremy Tonet: Just pivoting to the O&M savings side, with what you guys realize so far year to date this quarter. What portion do you think you might be able to retain on an ongoing basis? And do you have any kind of updated thoughts on cost savings into 2021 at this point?
Warner Baxter: Maybe Michael, I want you to hit a little bit on the quarter and then I can maybe address some of the ongoing. So, I'll let you take the first shot at it…
Michael Moehn: Jeremy, we said on that first quarter call and I think even if you think back to sort of the beginning of the year, we said that O&M was going to be up. We didn't say how much for the overall year and then we came forward to the first quarter call and we said O&M was going to be down. And you can see that obviously, we are doing a good job of managing, the teams working hard on managing cost down where we can, being very careful about headcount. Obviously, where we have opportunities on because of reduced load, there's reduced maintenance costs. Obviously, from a travel, entertainment perspective, being very thoughtful there. And so, I think the team has done a nice job continuing to help offset some of these things going into 2020. In terms of sort of what we retain and what is reoccurring. I mean, Warner can certainly touch on 2021. But I mean at the moment, we're just going to continue to watch this closely, it's helping us offset some of these sales headwinds that we have. And it's across the board. I know we focus a lot on the Missouri side, because that's where it hits the bottom line, but it is across Illinois distribution, Illinois natural gas as well.
Warner Baxter: Yes, well said, Michael. Jeremy, the reality is that, obviously, we're very focused on 2020. But we're looking ahead too. We do see several of these savings that we're realizing today that we can really carry over into next year. Things like, what was different perspective on how we think about travel, what was a different perspective in terms of the consultants that we have to bring in to work with us and how they can work remotely. And our digital investments have really been a step change, not just for our current workforce but how we engage and work with others. You think about real estate too and facilities costs. We've had to explore because of our digital team and the investments that we're making, and we're exploring other facilities to lease in the future, because we're simply outgrowing what we currently have. We see opportunities there and that's just not going to be necessary prospectively, because reality is we can work very effectively remotely. And so now that coupled with some really, I said in my talking points, how the team has really done some innovative things and been agile out in the field in terms of our work practices. Not only are they safer than they are. I mean, they're going to give us the ability to work more effectively and productively. And that coupled with our digital investments, I think these are the types of things that we are already going to put in our playbook, not just for this year but for many years ahead. So stay tuned. More to come when we talk more about the future in our O&M.
Operator: Our next question comes from Julien Dumoulin-Smith with Bank of America Merrill Lynch. Please proceed with your question.
Julien Dumoulin-Smith: If I can follow up on the last question here on the IRT and I understand that with this thing fairly imminent, you can't comment too much. But can you give us a little bit of perspective on how that might eventually flow into your formal CapEx projections, especially to the extent to which we're talking about incremental renewables and how [Multiple Speakers] your future recovery?
Warner Baxter: Julien, it would be just premature to really say how that would play out. I mean, number one, we have to roll out the IRP plan. We'll talk about what additional investment opportunities might be there, of course, associated with renewable energy. And then we'll take a look at that in terms of our five year plans and to what extent that has an impact. So as opposed to doing a piecemeal we’ll be better served for everybody when we roll out the plan to be able to really talk about it in a comprehensive fashion. And so we'll be in a good position to do that certainly during our third quarter conference call. And as we move into EEI, that will be a great topic of conversation just as it was in 2017 when we announced our 700 megawatts of wind generation and 100 megawatts of solar. We anticipate having a very comprehensive discussion at that time as well.
Julien Dumoulin-Smith: And then if I can also follow up on the last question around cost management and to you off of the sustainable cost savings that you talk about, you've identified and you anticipate holding on to. When you think about the pressures created from these lower 30 year treasury. Is it potentially an offset as you think about it? You could take that anywhere you want. but I'm curious on how you would frame the five year view given those longer data pressures here?
Michael Moehn: Just putting in context of not necessarily a number. But absolutely, I mean O&M customer affordability has always been a lever that we've used. I mean, it's not something that’s sort of we've discovered here during 2020 as a result of this pandemic. But obviously, there's been more accelerated focus on it. But absolutely, I mean, it is something that helps us work through these headwinds that we've had. And as you know that 30-year treasury has been a headwind for a while and we've continued to offset that with it.
Warner Baxter: And Julien as we -- we're mindful of the low 30-year treasuries. And certainly O&M is one of those levers for all the reasons that Michael said. But look we also have levers in terms of robust capital plan as we talked about on the call that we have infrastructure that we can move forward, especially at this lower cost of capital it might make sense for customers and for us to do that. And so we'll look at that and of course, we always take a look at capital allocation and many other levers. So this is how we operate the business in terms of looking not just at one lever but multiple levers to make sure we're delivering on our promises.
Operator: Our next question comes from line of Shahriar Pourreza with Guggenheim. Please proceed with your question.
Shahriar Pourreza: So first, just on the timing of the next rate case in Missouri. Just wondering if you have any updated thoughts here. In the past, you’ve pointed to potentially filing the summer for new rates at the beginning of next year. But obviously, of course, wind has the potential to move into the first quarter of next year. How are you thinking about this now given all the moving pieces and the buyer [Technical Difficulty] Illinois, just wondering why have you been hearing from the legislature in terms of continued interest. Has it still been on the mind of lawmakers, is there having kind of taken a backseat as other pressing issues related to the virus have come to the forefront? And then just [Multiple Speakers] consideration…
Warner Baxter: No, please finish your question…
Shahriar Pourreza: Just wondering if something could get done in the veto session in November, is it more likely to get pushed into next year?
Warner Baxter: Let me try and take that in several pieces, and Rich and Mark and his team have continued to work very hard to have conversations, virtually of course, with the key stakeholders, and not just legislators or stakeholders. So couple things to think about there. In terms of energy policy, I think energy policy broadly in the State of Illinois is still at the top of a lot of folks’ minds and rightfully so, because energy policy is important. That's why as we said as part of our talking points and as well as what you've heard us say before, that’s why we support so strongly the downstate clean energy affordability act, because it really addresses many of the key issues that the State of Illinois is focused on, more renewable energy resources, more investments in electrification, as well as grid modernization. These are things that have been really important for the State of Illinois, and will continue to be. And so we continue to have conversations with key stakeholders around that particular piece of legislation that we still support. Having said that, as you know, there's been a lot of dialog and some concerns raised as a result of the Commonwealth Edison federal investigation, so we understand that. And so consequently, as we think ahead what we're going to do is continue to double down on our efforts to work with stakeholders collaboratively, listen to their concerns, but make sure that we point out the value of the current regulatory framework and our proposal. And at the end of the day, our focus is going to continue to be to try and find a solution that gives us the ability collectively in the State of Illinois to invest in critical infrastructure, and give us the ability to earn a fair return and deliver values to our customers in the State of Illinois. Now in terms of timing, I’ve learned a long time ago that I don't predict when things will be addressed by any legislature or when things will ultimately get done. And obviously, things are a little bit more complicated as we approach this upcoming veto session. In light of a lot of the activities, my best perspective and Rich and I’ve talked a lot about this, whether something gets done in the veto session around the Downstate Clean Energy Affordability Act, I would tell you it’s, from my perspective, a challenge or as I like to use force analogies, I call it a long pot to get done in the veto session. So that's our best perspective on it in terms of what we think may still happen this year but importantly, where we're going to continue to focus our efforts on.
Operator: Our next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question.
Paul Patterson: Some of my questions before have been answered here. But just to sort of follow-up on the Illinois thing, there does seem to be this lease with a vocal group, sort of this unhappiness with the formula rate plan, which you outlined the benefits of and in fact the low cost of capital associated with it and what have you. And I’m just wondering if you could elaborate a little bit more as to what’s sort of driving that? The same people seem to be sort of interested in the issues you also discussed, which are FX and diversity and economic justice that sort of thing. And so I'm just wondering, is there some room here to sort of address their concerns, or is there something more fundamentally that's happening here that’s just not clear to me with respect to this concern about formulate rate plans? And I realized that you guys are just one part of it, there's this big northern part of the state that has its own issues. I was just wondering if you could talk about that?
Warner Baxter: I guess, a couple of comments. Yes, clearly, we've seen the governor and other groups come out and say they oppose the existing framework that's out there. And look the thing that we think is important, recognizing that a lot of that may be and so I'm speculating a bit, just simply surrounding the issues with Commonwealth Edison and the investigations and how it was linked to when performance based rate making was put in place many years ago. Our job and Rich and his team, they do a terrific job at this. And we're just going to sit down and just make sure we meet with stakeholders in a collaborative way and just sit there and explain what this framework has really done. And that's really what we should do, it’s been some open and transparent framework that essentially every year the Illinois Commerce Commission takes to look at what we're doing. And you've heard me say and espouse the benefits of this particular framework. And the real winner has been the State of Illinois and our customers. It's been an overwhelming success in so many ways. And so it's just important that we make sure that we level set everybody. At the same time, we're going to be at the table listening to their concerns and if they have legitimate concerns, we'll see what ways we can try to bridge whatever gaps there maybe. And so, that's just how we will continue to do business. And as I said a moment ago, really the key from our perspective is sitting at the table and really to put in place constructive energy policies. They're going to support investment and infrastructure, energy infrastructure in particular, gives us the ability to earn a fair return on those investments but also to deliver significant value to our customers in the State of Illinois and create thousands of jobs. So we think there's opportunities and there will be opportunities to sit down and talk with these stakeholders and make sure we have a good understanding of what's been done and what we think can be done prospectively. And so there's a lot of noise. Look, we recognize and that creates challenges, I get it. But at the same time, just because there's noise does it mean that we're not going to sit down and have a collaborative approach with these key stakeholders.
Operator: [Operator Instructions] Our next question comes from line of Insoo Kim with Goldman Sachs. Please proceed with your question.
Insoo Kim: My only remaining question is, I guess partially relate to the IRP. But could you just give us the latest on the U.S. district disorder from last fall to install scrubbers on couple of your coal plants, including Rush Island and how are you incorporating or thinking about this when you're developing your IRP process?
Warner Baxter: So Insoo, I want to make sure. Are you talking about the new scores reviews? Is that what you're referring to? Or something different?
Insoo Kim: It is just the, I think a violation of the clean air…
Warner Baxter: Yes, that’s right. And so just a quick update on that one. So as you know, this has been a matter of litigation related to our Rush Island energy center back to 2011. And we've been through the courts. And so at the state of play right now is that we've appealed the decision to the court of appeals and made it all the appropriate briefings and filings with the courts. And my sense is that there is no specific time frame but it'll be this fall before you probably see any kind of activity associated with this. But again, there's no specific time frame but all the briefs have been filed here in the first half in May. And so, I would just say stay tuned. No real developments other than going through the standard process.
Insoo Kim: And I guess in terms of the thought on the generation free transformation and the upcoming IRP. Your assumption will be that you haven't violated the act, so you'll plan accordingly based on that assumption?
Warner Baxter: Yes, rest assured we clearly believe we have not violated the act. And so, yes, that would be a fair statement and assumption that we’ll have going into the integrated resource plan.
Operator: Thank you. We have no further questions at this time. Mr. Kirk, I would now like to turn the floor back over to you for closing comments.
Andrew Kirk: Thank you for participating in this call. A replay of this call will be available for one year on our Web site. If you have questions, you may call the contacts listed on earnings release. Financial analyst inquiries should be directed to me, Andrew Kirk. Media should call Erin Davis. Again, thank you for your interest in Ameren, and have a great day.
Operator: Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at the time. Thank you for your participation and have a wonderful day. | [
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{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer and Michael Moehn, our Executive Vice President and Chief Financial Officer, as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance, as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis unless otherwise noted. Now here's Warner who will start on Page 4 of the presentation."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. Before I jump into our presentation, I'll start by saying that I hope you, your families and colleagues are safe and healthy during this challenging time. This morning I will begin our presentation by providing a COVID-19 update and in particular highlight the actions we have taken to support our customers, communities and coworkers. I'll then touch on our second quarter results and 2020 earnings guidance and finish with a discussion of several key elements of our strategy that we continue to execute very well, which will position us to continue delivering strong long-term value for our customers and shareholders. Turning now to Slide 4 and COVID-19. Our strong commitment to the safety of our coworkers, customers and communities remains constant, so to is our strong focus on delivering safe, reliable and affordable electric and natural gas service during this unprecedented time. We recognize that major customers in Missouri and Illinois are depending on us. I can't express enough appreciation to my coworkers who have shown great agility, innovation, determination, and a keen focus on safety and delivering on our mission to power the quality of life. While we are focused on delivering a safe, reliable and affordable service, we also recognize that our mission goes beyond this during this challenging time. We recognize that our customers and communities have significant needs. That is why we are working directly with our customers and special payment plans for the utility bills. We're also working closely with many dedicated community partners, and have contributed approximately $15 million for energy assistance and COVID-19 support to our customers in Missouri and Illinois. And I'm very pleased to tell you that our coworkers and Board of Directors are directly engaged in this effort to our AmerenCares Power of Giving program for COVID-19. Together, these programs are helping our residential, small business and not for profit customers meet their needs. In addition, we are tirelessly working with our customers to help them gain access to a host of federal support programs, including low income Energy Assistance funds. Our customers are at the center of our strategy and we will continue to take steps to help them during this unprecedented time. Throughout this challenging period, I'm also pleased to say that we have been effectively executing our strategy across all of our businesses. The key element of our strategy is to invest in energy infrastructure to benefit our customers, and in so doing provide important jobs to support the local economy, as well as local suppliers at a time when they are needed most. Looking ahead, we recognize that we will need to be managing the impacts of COVID-19 for some time, with safety and delivering on our mission and strategy at the top of our minds. We plan to continue managing our business under our current COVID-19 protocols, which includes having a significant portion of our workforce working remotely for at least the end of this year. We also continue to carefully monitor the impact of COVID-19 on our electric sales, liquidity and supply chain. To-date, these impacts have been manageable and in line with our expectations. At the same time, we remain focused on exercising financial discipline to mitigate the potential impacts of COVID-19, while capitalizing on some key opportunities that we have identified during this crisis, including benefits we are realizing from our digital transformation investments and streamline operating practices. Turning now to Page 5 for an update on second quarter results and 2020 earnings guidance. Yesterday, we announced second quarter 2020 earnings of $0.98 per share compared to $0.72 per share earned in 2019. The summary of the key drivers of the year-over-year increase of $0.26 per share is provided on this page, which Mike will discuss in more detail in a moment. The strong execution of our strategic plan drove strong quarterly earnings results, and enabled us to affirm our 2020 earnings guidance range of $3.40 per share to $3.60 per share. Moving to Page 6, here we reiterate our strategic plan, which as I just mentioned, we've been executing very well throughout the year. We expect our plan to continue delivering significant value for our customers and strong long-term earnings growth for our shareholders. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers and all of our jurisdictions. As you can see on the right side of this page, during the first half of this year, we invested significant capital in each of our business segments to better serve our customers, most notably Ameren Transmission, where we effectively managed a nearly 25% increase in infrastructure investment compared to the first half of 2019. These investments are delivering value to our customers and community. Our energy grid is becoming more reliable, resilient and secure, and our digital investments are enhancing our customer's experience. Of course, we're not done. Looking ahead, we continue to see the need for robust energy infrastructure investments to meet our customer's energy needs and exceed their expectations of keeping rates affordable. Our electric rates in both Missouri and Illinois continue to be well below the Midwest and national averages. As we discussed in our first quarter earnings call, new electric rates went into effect on April 1st of this year as a result of a constructive settlement in Ameren Missouri's electric rate review. The settlement included a $32 million annual revenue decrease, which marks the second consecutive decrease since 2018. Since Ameren Missouri's last electric rate review in 2017 if customer rates have decreased by 7%, while at the same time, we've continued to make significant investments in energy infrastructure to benefit our customers. As Michael will cover in more detail later, we have also been very busy managing our electric and natural gas regulatory proceedings in Illinois. We expect the final decision in the electric proceedings by December of this year, and a final decision in the gas proceeding by January of next year. Finally, another important element of the first pillar of our strategy has been and remains our relentless focus on continuous improvements and disciplined cost management to keep rates affordable. Moving to the second pillar of our strategy, which includes enhancing regulatory frameworks for the benefit of all stakeholders. As you know, we continue to support the proposed Downstate Clean Energy Affordability Act in Illinois. This important legislation would allow Ameren Illinois to make significant investments in solar energy and battery storage to improve reliability, as well as to make investments in transportation and electrification, in order to benefit customers and the economy across Central and Southern Illinois. In addition, it would help address the pressing energy policy challenges facing the state, including the need for additional renewable sources and better electric vehicle charging infrastructure. This bill will help address these challenges and move the State of Illinois closer to reaching the score of 100% clean energy by 2050. In addition, this legislation would modify the allowed return on equity formula to increase the basis point adder to the average 30-year treasury rate from 580 to 680 and would also extend the electric performance based rate making framework through 2032. Importantly, this legislation builds on Ameren Illinois’ efforts to modernize the energy grid into a transparent and stable regulatory framework that it support a significant investment to modernize the energy grid, while improving reliability and creating approximately 1,400 jobs, all while keeping rates well below the Midwest and national averages. In fact, all in residential rates in 2020 are down 1% compared to 2012, the first year of performance based rates. Simply put, the performance based grid modernization legislation that was passed in 2011 and extended twice by the Illinois legislature under different administrations has been an overwhelming success for Illinois. With all these benefits in mind, we remain focused on working with key stakeholders to get this important legislation passed. Turning now to Page 7, I’ll provide an update on for regulatory matters. In May, the FERC issued an order on the rehearing request related to its November 2019 order addressing two complaint cases that reduced MISO’s base return on equity. The order establish a new base return on equity methodology using three models, the risk premium model, capital asset pricing model and the discounted cash flow model. To revise order sets of base return on equity of 10.02% for transmission projects for the first complaint case period and effective as of September 28, 2016. This results in return on equity of 10.52% for Ameren Transmission, including the 50 basis point adder being a part of MISO. The FERC also dismissed the second complaint case. We're pleased with the order and believe it is to be constructive as the new three model methodology expands the range of reasonableness used to assess whether current returns on equity are just unreasonable. The FERC also issued a notice of proposed rule making in March. Overall, we believe that the policies outlined in the proposed rule making are constructive. As a result, we along with the other MISO transmission owners, filed comments in June in support of the proposed increase to the RTO adder, reliability and benefit based incentives and the ROE cap. We are unable to predict the ultimate timing or impact of these matters as the FERC is under no timeline to issue decision. Moving now to Page 8 for an update on the third pillar of our strategy, creating and capitalizing on options for investment for the benefit of our customers, shareholders and the environment. Here we provide an update on our $1.2 billion wind generation investment plan to achieve compliance with Missouri's renewable energy standard through the acquisition of 700 megawatts of new wind generation at two sites in Missouri. In short, there's been no significant change to the project schedules from what we discussed on our first quarter call in May. Construction is well underway at both facilities. We are working closely with the developers for both projects to monitor the timing of manufacturing, shipment and installation of facility components. We continue to expect the 400 megawatt facility to be in service by the end of 2020. Regarding the 300 megawatt facility, we expect it to be substantially in service by the end of 2020. However, as a result of certain delays we discussed on our first quarter earnings call in May, we expect the portion of the project, representing approximately $100 million of investment to be placed in service in the first quarter of 2021. We expect no reduction in production tax credits, because of the recent rule changes made by the U.S. Department of the Treasury to extend the in-service criteria by one year to December 31, 2021. Furthermore, we will continue to explore additional renewable energy investment opportunities that will drive long term value for our customers and shareholders. Right now, Ameren Missouri is in the process of finalizing its next integrated resource plan. For several months, we've been working closely with key stakeholders and developing our plan. We are carefully looking at several approaches to best meet our customers’ future energy needs and effectively transition our generation to a cleaner, more diverse portfolio in a responsible fashion. We'll be finalizing our plan for the next 45 days and plan to file our IRP with the Missouri PSC by September 30th. We are excited about the benefits that our current wind generation project will deliver to all stakeholders, as well as the prospects for additional renewable generation resources to meet our customers’ energy needs in the future. Moving to Page 9. Looking ahead through the end of this decade, we have a robust pipeline of investment opportunities of over $36 billion that will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter and cleaner. These investment opportunities exclude any potential new renewable generation from Missouri integrated resource plan, as well as any potential new multivalue transmission projects that would increase the reliability and resiliency of the energy grid, as well as enable additional renewable generation projects. Of course, our investment opportunities not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for local economies. Maintaining constructive energy policies that support robust investment and energy infrastructure will be critical to meeting our country's future energy needs and delivering on our customers' expectations. Moving to Page 10. to sum up our value proposition, the consistent execution of our strategy over many years and on many fronts does position as well for future success. We remain firmly convinced that the execution of this strategy in 2020 and beyond will deliver superior value to our customers, shareholders and the environment. In May, we affirmed our five year growth plan, which included our expectation of 6% to 8% compound annual earnings per share growth for the 2020 through 2024 period using the 2020 EPS guidance range midpoint as the base. This earnings growth is primarily driven by our approximate 9% compound annual rate base growth from 2019 through 2024 and compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Further, our shares continue to offer investors a solid dividend. Our strong earnings growth expectations position us well for future dividend growth. Of course, future dividend decisions will be driven by earnings growth in addition to cash flows and other business conditions. Together, we believe our strong earnings growth outlook, combined with our solid dividend, results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today. And I'll now turn the call over to Michael. Michael?"
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Warner and good morning, everyone. Turning now to page 12 of our presentation. Yesterday, we reported second quarter 2020 earnings of $0.98 per share compared to earnings of $0.72 per share for the year ago quarter. The key factors by segment that drove the overall $0.26 per share increase are highlighted on the page. Ameren Missouri, our largest segment reported increased earnings of $0.18 per share. The increase in earnings is driven by lower operations and maintenance expenses, including the absence of a scheduled Callaway Energy Center refueling and maintenance outage, as well as disciplined cost management and favorable market returns and company owned life insurance investments, which together increased earnings by $0.15 per share. The year-over-year improvement also reflected new electric service rates effective April 1st, driven in part by increased infrastructure investments. The year-over-year impact from electric sales was flat at the $0.05 per share benefit from near normal temperatures in the second quarter compared to milder than normal temperatures in the previous year were offset by $0.05 per share reduction from lower weather normalized sales, primarily due to the impacts of COVID-19. Moving now to Ameren Transmission, earnings per share were up $0.07. This increase reflected the impact of the FERC order on the MISO base allowed return on equity, which increased earnings $0.04 per share, as well as increased infrastructure investments. Earnings for Ameren Illinois Natural Gas were up $0.03 per share due to increased infrastructure investments and lower operations and maintenance expenses. Ameren Illinois Electric Distribution earnings were down $0.01 per share, reflecting a lower expected allowed return on equity under performance based rate making, partially offset by increased infrastructure investments. And finally, Ameren Parent and other results also decreased $0.01 per share, primarily due to increased interest expense resulting from the long-term debt issuance in early April. Moving now to Page 13 of our presentation, I'd like to briefly touch on key drivers impacting our 2020 earnings guidance. As Warner stated, we continue to expect 2020 diluted earnings to be in the range of $3.40 to $3.60 per share. This guidance range assumes normal weather and the remaining six months of the year, as well as reflect sales updates from our first quarter earnings call in May primarily related to COVID-19. On our call in May, we estimated COVID-19 related sales impact to the Ameren Missouri would reduce our 2020 earnings per share expectations by approximately $0.10 per share, and we believe this will be a solid estimate. For the year, we still expect total weather normalized sales to be down approximately 2.5%. Broken down by customer class, we expect 2020 commercial sales to decline approximately 7.5%, industrial sales decline approximately 4.5% and residential sales to increase approximately 4%. While we've seen a slight change in the relative mix of sales. Overall, our update today is largely consistent with our expectations outlined in our call in May in terms of both total sales and EPS impacts for 2020 due to COVID-19. Before moving on, I would note that Ameren Missouri customer sales for June, excluding the impact of warmer than normal weather, were down approximately 0.2% compared to the prior year, reflecting the impact of COVID-19. Broken down by customer class and compared to the prior year, Ameren Missouri June weather normalized commercial and industrial sales declined approximately 9.5% and 3% respectively, which were largely offset by an increased weather normalized sales to residential customers of approximately 11%. These statistics are notable given they represent the first full month of sales after the stay at home orders were lifted. Before moving on, let me briefly cover electric sales transfer at Ameren Illinois Electric Distribution for the first six months of this year compared to the first six months of last year. Weather normalized kilowatt hour sales to Illinois residential customers increased about 4% and weather normalized kilowatt hour sales to Illinois commercial and industrial customers decreased approximately 7% and 8% respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect earnings since we have full revenue decoupling. Moving on to other guidance considerations, select earnings considerations by quarter for the balance of the year are listed on this page. Our 2020 earnings guidance range also incorporates an estimated 2020 allowed ROE for Ameren Illinois Electric Distribution of 7.2%, which reflects a 30-year treasury yield yield of approximately 4%. Finally, we also remain very focused on maintaining disciplined cost management for the remainder of the year. Moving now to Page 14 for the regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance based rate making, our utilities are required to file annual updates to systematically adjust cash flows overtime for changes in cost of service and to drip any prior period over or under recoveries of such cost. In late June, the ICC staff recommended a $53 million base rate decrease compared to our request of $45 million base rate decrease. A decision is expected in December with new rates expected to be effective in January 2021. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois Natural Gas distribution rates using a 2021 future test year, and has since updated our request in our July rebuttal testimony. In June, the ICC staff and other interveners, including the Citizens Utility Board and Illinois Industrial and Energy Consumers filed a rebuttal testimony in a rate review. Our original request as well as our July rebuttal testimony incorporated a 10.5% return on equity, while staff and other interveners have recommended a 9.32% and 9.2% return on equity respectively. We continue to seek 54% equity ratio compared to the ICC staffs and other interveners’ recommendation of 50.43% and 50% respectively. A decision is expected by January 2021 with new rates expected to be effective in February of 2021. Finally, turning to Page 15 and I will summarize. We have a strong team and are well positioned to continue executing on our plan. We continue to expect to deliver strong earnings growth in 2020 and we’re successfully executing our strategy and navigate the impacts of COVID-19. As we look to the longer term, we continue to expect strong earnings per share growth, driven by robust rate based growth and disciplined cost management. Further, we believe this growth compares very favorably to the growth of our utility peers. And Ameren shares continue to offer investors an attractive dividends. In total, we have an attractive total shareholder return story that compares very favorably to our peers. And now, I'll turn it back over to Warner."
},
{
"speaker": "Warner Baxter",
"text": "Great. Thanks, Michael. While we spend a great deal of time this morning talking about how we're effectively addressing issues associated with COVID-19 and delivering strong results for our customers and shareholders, I think it's important to note that another matter is at top of our minds, that matter is that level of profound racial prejudice, injustice and intolerance that we still have in this country and in our own community, especially against black people. We've recently seen too many sizzle tests of African Americans. And to be clear, there’s absolutely no place for racism, injustice or hatred of any kind at Ameren, in our community, in our country or anywhere in the world. We must challenge such behavior when we witness it and take steps to drive positive changes to eliminate it. And that is exactly what we're doing in Ameren. In Ameren, diversity, equity and inclusion is a core value. While we've been recognized by DiversityInc is one of the top facilities in the country for our diversity, equity and inclusion practices, we are not standing still. In fact, we recently conducted a virtual diversity, equity and inclusion summit in St. Louis. The theme of this summit was the courage to love your values. Ameren leaders, community leaders and national leaders came together to begin listening to each other more thoughtfully and to begin taking even more steps to address this critical issue. We have made the entire program available on our Web site. I encourage you to take time and listen to the amazing stories of courage and passion for diversity, equity and inclusion. We're now ready to take your questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now be conducting a question answer session [Operator Instructions]. Our first question comes from line of Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Just want to start off with the IRP here and just want to see how the outreach is progressing and any early thoughts that you can share with us at this point or feedback with the filing coming soon here?"
},
{
"speaker": "Warner Baxter",
"text": "Well, as you know noticed, this is an extensive process with stakeholders has been going on for several months. Marty Lyons and his team have been did just a terrific job of just outlining some of our perspectives and getting insights which is really important. So I would say, as you know, we're getting to the tail end of that process. And it would be really inappropriate to say just exactly what the feedback is then because we're putting together all that and we'll ultimately issue our integrated resource plan here at the end of September. But I can tell you the conversations have been constructive, the insight is great and we look forward to submitting that that integrated resource plan. And as you heard in my talking points, we've looked at a lot of things in this integrated resource plan. We certainly look at the technology, which is out there and we’ve certainly seen renewable energy technology and their related costs continue to come down. Take a careful look at our coal-fired energy centers and the useful lives of those plants and we really think about what's really going to deliver value to our customers in the State of Missouri. And so we look forward to submitting that plan at the end of September."
},
{
"speaker": "Jeremy Tonet",
"text": "Just pivoting to the O&M savings side, with what you guys realize so far year to date this quarter. What portion do you think you might be able to retain on an ongoing basis? And do you have any kind of updated thoughts on cost savings into 2021 at this point?"
},
{
"speaker": "Warner Baxter",
"text": "Maybe Michael, I want you to hit a little bit on the quarter and then I can maybe address some of the ongoing. So, I'll let you take the first shot at it…"
},
{
"speaker": "Michael Moehn",
"text": "Jeremy, we said on that first quarter call and I think even if you think back to sort of the beginning of the year, we said that O&M was going to be up. We didn't say how much for the overall year and then we came forward to the first quarter call and we said O&M was going to be down. And you can see that obviously, we are doing a good job of managing, the teams working hard on managing cost down where we can, being very careful about headcount. Obviously, where we have opportunities on because of reduced load, there's reduced maintenance costs. Obviously, from a travel, entertainment perspective, being very thoughtful there. And so, I think the team has done a nice job continuing to help offset some of these things going into 2020. In terms of sort of what we retain and what is reoccurring. I mean, Warner can certainly touch on 2021. But I mean at the moment, we're just going to continue to watch this closely, it's helping us offset some of these sales headwinds that we have. And it's across the board. I know we focus a lot on the Missouri side, because that's where it hits the bottom line, but it is across Illinois distribution, Illinois natural gas as well."
},
{
"speaker": "Warner Baxter",
"text": "Yes, well said, Michael. Jeremy, the reality is that, obviously, we're very focused on 2020. But we're looking ahead too. We do see several of these savings that we're realizing today that we can really carry over into next year. Things like, what was different perspective on how we think about travel, what was a different perspective in terms of the consultants that we have to bring in to work with us and how they can work remotely. And our digital investments have really been a step change, not just for our current workforce but how we engage and work with others. You think about real estate too and facilities costs. We've had to explore because of our digital team and the investments that we're making, and we're exploring other facilities to lease in the future, because we're simply outgrowing what we currently have. We see opportunities there and that's just not going to be necessary prospectively, because reality is we can work very effectively remotely. And so now that coupled with some really, I said in my talking points, how the team has really done some innovative things and been agile out in the field in terms of our work practices. Not only are they safer than they are. I mean, they're going to give us the ability to work more effectively and productively. And that coupled with our digital investments, I think these are the types of things that we are already going to put in our playbook, not just for this year but for many years ahead. So stay tuned. More to come when we talk more about the future in our O&M."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Bank of America Merrill Lynch. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "If I can follow up on the last question here on the IRT and I understand that with this thing fairly imminent, you can't comment too much. But can you give us a little bit of perspective on how that might eventually flow into your formal CapEx projections, especially to the extent to which we're talking about incremental renewables and how [Multiple Speakers] your future recovery?"
},
{
"speaker": "Warner Baxter",
"text": "Julien, it would be just premature to really say how that would play out. I mean, number one, we have to roll out the IRP plan. We'll talk about what additional investment opportunities might be there, of course, associated with renewable energy. And then we'll take a look at that in terms of our five year plans and to what extent that has an impact. So as opposed to doing a piecemeal we’ll be better served for everybody when we roll out the plan to be able to really talk about it in a comprehensive fashion. And so we'll be in a good position to do that certainly during our third quarter conference call. And as we move into EEI, that will be a great topic of conversation just as it was in 2017 when we announced our 700 megawatts of wind generation and 100 megawatts of solar. We anticipate having a very comprehensive discussion at that time as well."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "And then if I can also follow up on the last question around cost management and to you off of the sustainable cost savings that you talk about, you've identified and you anticipate holding on to. When you think about the pressures created from these lower 30 year treasury. Is it potentially an offset as you think about it? You could take that anywhere you want. but I'm curious on how you would frame the five year view given those longer data pressures here?"
},
{
"speaker": "Michael Moehn",
"text": "Just putting in context of not necessarily a number. But absolutely, I mean O&M customer affordability has always been a lever that we've used. I mean, it's not something that’s sort of we've discovered here during 2020 as a result of this pandemic. But obviously, there's been more accelerated focus on it. But absolutely, I mean, it is something that helps us work through these headwinds that we've had. And as you know that 30-year treasury has been a headwind for a while and we've continued to offset that with it."
},
{
"speaker": "Warner Baxter",
"text": "And Julien as we -- we're mindful of the low 30-year treasuries. And certainly O&M is one of those levers for all the reasons that Michael said. But look we also have levers in terms of robust capital plan as we talked about on the call that we have infrastructure that we can move forward, especially at this lower cost of capital it might make sense for customers and for us to do that. And so we'll look at that and of course, we always take a look at capital allocation and many other levers. So this is how we operate the business in terms of looking not just at one lever but multiple levers to make sure we're delivering on our promises."
},
{
"speaker": "Operator",
"text": "Our next question comes from line of Shahriar Pourreza with Guggenheim. Please proceed with your question."
},
{
"speaker": "Shahriar Pourreza",
"text": "So first, just on the timing of the next rate case in Missouri. Just wondering if you have any updated thoughts here. In the past, you’ve pointed to potentially filing the summer for new rates at the beginning of next year. But obviously, of course, wind has the potential to move into the first quarter of next year. How are you thinking about this now given all the moving pieces and the buyer [Technical Difficulty] Illinois, just wondering why have you been hearing from the legislature in terms of continued interest. Has it still been on the mind of lawmakers, is there having kind of taken a backseat as other pressing issues related to the virus have come to the forefront? And then just [Multiple Speakers] consideration…"
},
{
"speaker": "Warner Baxter",
"text": "No, please finish your question…"
},
{
"speaker": "Shahriar Pourreza",
"text": "Just wondering if something could get done in the veto session in November, is it more likely to get pushed into next year?"
},
{
"speaker": "Warner Baxter",
"text": "Let me try and take that in several pieces, and Rich and Mark and his team have continued to work very hard to have conversations, virtually of course, with the key stakeholders, and not just legislators or stakeholders. So couple things to think about there. In terms of energy policy, I think energy policy broadly in the State of Illinois is still at the top of a lot of folks’ minds and rightfully so, because energy policy is important. That's why as we said as part of our talking points and as well as what you've heard us say before, that’s why we support so strongly the downstate clean energy affordability act, because it really addresses many of the key issues that the State of Illinois is focused on, more renewable energy resources, more investments in electrification, as well as grid modernization. These are things that have been really important for the State of Illinois, and will continue to be. And so we continue to have conversations with key stakeholders around that particular piece of legislation that we still support. Having said that, as you know, there's been a lot of dialog and some concerns raised as a result of the Commonwealth Edison federal investigation, so we understand that. And so consequently, as we think ahead what we're going to do is continue to double down on our efforts to work with stakeholders collaboratively, listen to their concerns, but make sure that we point out the value of the current regulatory framework and our proposal. And at the end of the day, our focus is going to continue to be to try and find a solution that gives us the ability collectively in the State of Illinois to invest in critical infrastructure, and give us the ability to earn a fair return and deliver values to our customers in the State of Illinois. Now in terms of timing, I’ve learned a long time ago that I don't predict when things will be addressed by any legislature or when things will ultimately get done. And obviously, things are a little bit more complicated as we approach this upcoming veto session. In light of a lot of the activities, my best perspective and Rich and I’ve talked a lot about this, whether something gets done in the veto session around the Downstate Clean Energy Affordability Act, I would tell you it’s, from my perspective, a challenge or as I like to use force analogies, I call it a long pot to get done in the veto session. So that's our best perspective on it in terms of what we think may still happen this year but importantly, where we're going to continue to focus our efforts on."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Paul Patterson",
"text": "Some of my questions before have been answered here. But just to sort of follow-up on the Illinois thing, there does seem to be this lease with a vocal group, sort of this unhappiness with the formula rate plan, which you outlined the benefits of and in fact the low cost of capital associated with it and what have you. And I’m just wondering if you could elaborate a little bit more as to what’s sort of driving that? The same people seem to be sort of interested in the issues you also discussed, which are FX and diversity and economic justice that sort of thing. And so I'm just wondering, is there some room here to sort of address their concerns, or is there something more fundamentally that's happening here that’s just not clear to me with respect to this concern about formulate rate plans? And I realized that you guys are just one part of it, there's this big northern part of the state that has its own issues. I was just wondering if you could talk about that?"
},
{
"speaker": "Warner Baxter",
"text": "I guess, a couple of comments. Yes, clearly, we've seen the governor and other groups come out and say they oppose the existing framework that's out there. And look the thing that we think is important, recognizing that a lot of that may be and so I'm speculating a bit, just simply surrounding the issues with Commonwealth Edison and the investigations and how it was linked to when performance based rate making was put in place many years ago. Our job and Rich and his team, they do a terrific job at this. And we're just going to sit down and just make sure we meet with stakeholders in a collaborative way and just sit there and explain what this framework has really done. And that's really what we should do, it’s been some open and transparent framework that essentially every year the Illinois Commerce Commission takes to look at what we're doing. And you've heard me say and espouse the benefits of this particular framework. And the real winner has been the State of Illinois and our customers. It's been an overwhelming success in so many ways. And so it's just important that we make sure that we level set everybody. At the same time, we're going to be at the table listening to their concerns and if they have legitimate concerns, we'll see what ways we can try to bridge whatever gaps there maybe. And so, that's just how we will continue to do business. And as I said a moment ago, really the key from our perspective is sitting at the table and really to put in place constructive energy policies. They're going to support investment and infrastructure, energy infrastructure in particular, gives us the ability to earn a fair return on those investments but also to deliver significant value to our customers in the State of Illinois and create thousands of jobs. So we think there's opportunities and there will be opportunities to sit down and talk with these stakeholders and make sure we have a good understanding of what's been done and what we think can be done prospectively. And so there's a lot of noise. Look, we recognize and that creates challenges, I get it. But at the same time, just because there's noise does it mean that we're not going to sit down and have a collaborative approach with these key stakeholders."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from line of Insoo Kim with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Insoo Kim",
"text": "My only remaining question is, I guess partially relate to the IRP. But could you just give us the latest on the U.S. district disorder from last fall to install scrubbers on couple of your coal plants, including Rush Island and how are you incorporating or thinking about this when you're developing your IRP process?"
},
{
"speaker": "Warner Baxter",
"text": "So Insoo, I want to make sure. Are you talking about the new scores reviews? Is that what you're referring to? Or something different?"
},
{
"speaker": "Insoo Kim",
"text": "It is just the, I think a violation of the clean air…"
},
{
"speaker": "Warner Baxter",
"text": "Yes, that’s right. And so just a quick update on that one. So as you know, this has been a matter of litigation related to our Rush Island energy center back to 2011. And we've been through the courts. And so at the state of play right now is that we've appealed the decision to the court of appeals and made it all the appropriate briefings and filings with the courts. And my sense is that there is no specific time frame but it'll be this fall before you probably see any kind of activity associated with this. But again, there's no specific time frame but all the briefs have been filed here in the first half in May. And so, I would just say stay tuned. No real developments other than going through the standard process."
},
{
"speaker": "Insoo Kim",
"text": "And I guess in terms of the thought on the generation free transformation and the upcoming IRP. Your assumption will be that you haven't violated the act, so you'll plan accordingly based on that assumption?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, rest assured we clearly believe we have not violated the act. And so, yes, that would be a fair statement and assumption that we’ll have going into the integrated resource plan."
},
{
"speaker": "Operator",
"text": "Thank you. We have no further questions at this time. Mr. Kirk, I would now like to turn the floor back over to you for closing comments."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you for participating in this call. A replay of this call will be available for one year on our Web site. If you have questions, you may call the contacts listed on earnings release. Financial analyst inquiries should be directed to me, Andrew Kirk. Media should call Erin Davis. Again, thank you for your interest in Ameren, and have a great day."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at the time. Thank you for your participation and have a wonderful day."
}
] | Ameren Corporation | 373,264 |
AEE | 1 | 2,020 | 2020-05-12 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation First Quarter 2020 Earnings Call. [Operator Instructions]. I would now like to turn the conference over to your host, Mr. Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the Forward-looking Statements section in the news release we issued today and the Forward-looking Statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now here's Warner, who will start on Page 4 of the presentation.
Warner Baxter: Thanks, Andrew. Good morning, everyone, and thank you for joining us. This morning, I'm going to begin our presentation by providing a COVID-19 update and, in particular, highlighting some of the key efforts we are taking for the safety and security of our coworkers and customers during this difficult time, while providing the central electric and natural gas service. I will then touch on our first quarter results and 2020 earnings guidance. Finally, I will discuss our long-term growth prospects while highlighting some important strategic matters that will position Ameren for future success. Before I jump into the details, I hope that you, your families and colleagues are safe and healthy during this unprecedented time. As our world works to address COVID-19, many things are uncertain. But the Ameren's commitment to safety of our coworkers, our customers and our communities remains constant. At Ameren, we never compromise on safety, it is one of our core values. I want to express my profound appreciation for those who are on the front lines battling this virus. To the health care workers, first responders, grocery store workers, local leaders, community workers and, of course, all utility workers across our nation, thank you. In particular, I want to express my sincere appreciation to my Ameren coworkers, who remain focused every day on delivering safe, reliable power and natural gas to millions of people in Missouri and Illinois. To ensure that we could continue to deliver safe and reliable service, we took swift action in January and assembled a cross-functional crisis management response team following reports about threats related to COVID-19. Since January, our team has been planning and implementing a pandemic response, consistent with established guidelines and industry best practices as well as in consultation with world-class health experts and state and local government leaders. We quickly restricted domestic and international travel and implemented from -- work-from-home policies for anyone that could to limit exposure of our coworkers. Of course, our coworkers are crucial to the execution of our mission and many continue to be out in our communities and in our energy centers every day, keeping the lights on and the natural gas flowing for millions of customers in Missouri and Illinois. Our actions to continue safe operations also included securing and supplying personal protective equipment, separating work crews, adjusting more schedules, performing robust health screenings at home and on-site and of course, practicing social distancing with coworkers and customers. Our transition to our new work practices went very well. Not only were we able to quickly take significant actions to protect the safety of our coworkers and customers, we have been able to continue executing our projects and strategic plan across our entire business. We also recognize this is a difficult time for many of our customers, who are struggling financially due to lost wages and other circumstances related to COVID-19. That's why we currently have voluntarily suspended all electric and gas disconnects for nonpayment and waived all late payment fees for customers unable to pay their energy bill on time. In addition, we have contributed $1 million in energy assistance and nearly $1 million to fund other COVID-19 relief efforts to help families and businesses in our Illinois and Missouri communities, and we're not done helping our customers and our communities. As part of our Ameren Missouri rate review settlement, we are working with Missouri Office of the Public Counsel to provide another $3.5 million in energy assistance funds for Missouri residential customers in need. Our proposal is pending approval from Missouri Public Service Commission. In addition, we live and work in our communities. And we want to go beyond keeping the lights on and natural gas flowing for our millions of customers. As a result, we recently launched an Ameren Cares initiative, whereby our leadership team, Board of Directors and all Ameren coworkers can contribute to COVID-19 relief efforts, including energy assistance for our customers. Operationally, we are exercising financial discipline and taking several actions to mitigate the expected financial impacts of COVID-19 on our business. Those actions include, among other things, stringent hiring restrictions, managing spending on outside of consultants, significantly restricting travel and modifying the scope of our energies and our maintenance outages, in large part, to enhance the safety of our coworkers. In addition, we have taken several actions to strengthen our already solid liquidity position. Those steps included proactively accessing the capital markets earlier this year. Michael will share some of those details with you a bit later. Looking ahead, we are putting the final touches on the first phase of our return to facilities transition plan for our coworkers that are working remotely. Safety will remain at the top of our mind, and this transition will be done in a very measured and thoughtful way. We will also continue to work with state and local leaders as well as with the health care community to support reopening of regional economy in a safe, measured and timely fashion. Stay-at-home orders in Missouri were lifted on May 4. On the St. Louis area, those orders will be lifting on May 18. In Illinois, the stay-at-home motor remains in place through May 30. Of course, we expect restrictions on economic and social activity will continue in all of our communities for some time. Since we are an essential business, these orders should not limit our operations or the execution of our strategic plan beyond the safety measures we have implemented for the protection of our coworkers and customers. I am very proud of our work that our coworkers have done over the last several months. Having said that, we are not letting our guard down. We will continue to be relentlessly focused on safety and delivering on our mission to power the quality of life for our customers and communities and managing through this unprecedented period of time. With that, let's now turn to Page 5 for an update on first quarter results and 2020 earnings guidance. Yesterday, we announced first quarter 2020 earnings of $0.59 per share compared to $0.78 per share earned in 2019. This slide outlines some of the key drivers that impacted earnings in the first quarter. While we had some items that drove earnings down compared to last year, I am pleased to tell you that we continue to effectively execute all elements of our strategic plan. In addition, due to the actions we have taken to mitigate the expected financial impacts of COVID-19, which I described earlier, combined with the constructive outcome in our Missouri rate review, which benefited all stakeholders, we remain on track to deliver within our 2020 earnings guidance range or $3.40 per share to $3.60 per share. In affirming our 2020 guidance, we have assessed several economic scenarios and taken into consideration expectations associated with lower Missouri total electric sales, the potential for higher bad debt expenses and lower returns in our Illinois electric distribution business due to lower interest rates, among other things. Michael will discuss our first quarter earnings, 2020 earnings guidance and other related items in more detail later. Turning now to Page 6. Yesterday, we also affirmed our expectation to deliver 6% to 8% compound annual earnings per share growth from 2020 to 2024, driven by robust compound annual rate base growth of approximately 9%. Simply put, we continue to believe our strategy to deliver strong, long-term earnings growth remains intact. This outlook accommodates several factors, including the range of treasury rates, sales growth, spending levels, regulatory developments and impacts of COVID-19. And of course, earnings growth in any individual year will be impacted by the timing of capital expenditures, regulatory rate reviews and sales volumes, including those driven by weather, impacts from COVID-19 and other factors. Moving to Page 7. Here, we reiterate our strategic plan. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers. As a result, and as you can see on the right side of this page, during the first 3 months of this year, we invested significant capital in each of our business segments, and the pipeline remains robust. In addition, we remain on track to achieve our capital expenditure target for 2020. Regarding regulatory matters, I am pleased to report that in March the Missouri Public Service Commission approved a constructive settlement in Ameren Missouri's electric rate review that included a $32 million annual revenue decrease. It incorporates lower fuel and transportation costs, taxes and regulatory asset amortization expenses, while providing for recovery of significant infrastructure investments as well as an opportunity to earn within the implicit range of 9.4% to 9.8% return on equity on a growing Missouri rate base. This decrease marks the second consecutive decrease since 2018 when customers received a 6% rate cut as a result of the federal corporate income tax reduction and our Smart Energy Plan. In Illinois last month, we made our required annual electric distribution formula rate update filing, requesting a $45 million base rate decrease. If we're approved as requested, all-in 2021 residential electric rates for customers taking delivery and energy supply from Ameren Illinois would be down approximately 1% since formula ratemaking began in 2012. As you can see with these rate decreases, we are clearly focused on keeping our customers cost competitive and affordable through continuous improvement and disciplined cost management, while we make significant investments in energy infrastructure to deliver long-term value. Michael will provide more detail about the electric and natural gas rate reviews in a moment. Turning now to Page 8 and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies, beginning with Ameren Illinois Electric Distribution. The Downstate Clean Energy Affordability Act legislation was filed in February. This important legislation would allow Ameren Illinois to make significant investments in solar energy and battery storage to improve reliability as well as to make investments in transportation electrification in order to benefit customers and the economy across Central and Southern Illinois. In addition, this legislation would modify the allowed return on equity formula to increase the basis point adder to the average 30-year treasury rate from 580 basis points to 680 basis points and would also extend electric formula ratemaking to 2032. The Downstate Clean energy Affordability Act will move the state of Illinois closer to reaching its goal of 100% clean energy by 2050, and builds on Ameren Illinois' efforts to modernize the energy grid under a transparent and stable regulatory framework that has supported significant investment to modernize the energy grid, while improving reliability and creating jobs, all while keeping rates well below the Midwest and national averages. With all these benefits in mind, we are focused on working with key stakeholders to get this important legislation passed. Prior to adjournment of the Illinois General Assembly in mid-March due to COVID-19, the House Bill had advanced to the Public Utilities Committee and a Senate Bill still awaited assignment to the Energy and Public Utilities Committee. In light of the challenges that exist with COVID-19, it's unclear whether these bills will advance in the spring session, which is currently set to end May 31, that's extended by the leadership in the Illinois House and Senate. If not past the spring, these bills could also be addressed in a veto session or potentially other special sessions later this year. Turning to Page 9 for an update on FERC regulatory matters. In terms of the FERC's November 2019 order and its subsequent order to extend time to reconsider hearing requests, I do not have any significant updates. However, the FERC did recently take some constructive actions that could further support investment in transmission. In particular, in March, the FERC issued a Notice of Proposed Rulemaking on electric transmission ROE incentives. In the notice, the FERC proposed several changes to ROE incentives, including an increase in the regional transmission organization, or RTO, participation adder from 50 basis points to 100 basis points. For perspective, every 50 basis point change in our FERC ROE impacts annual earnings per share by approximately $0.04. The notice also proposes incentives on new projects by considering the benefits rather than the risks of a project. We are pleased with the direction the FERC has taken with this notice. It suggests that the FERC understands the importance of incentivizing transmission investment to both upgrade and replace the aging infrastructure and to also enable the transition to more renewable generation across the country. We expect to file comments by the July 1st deadline. Of course, we are unable to predict the ultimate timing or impact of these FERC matters as the FERC is under no time line to issue a decision. Moving now to Page 10 for an update on the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. Here, we provide an update on our wind generation investment plans to achieve compliance with Missouri's renewable energy standard and continue to transition our generation portfolio. We've received all regulatory approvals to acquire 700 megawatts of new wind generation at 2 sites in Missouri. Construction is well underway and continues at both wind generation facilities. We continue to work closely with the developers for both projects to monitor the timely manufacturing, shipment and installation of facility components, which are coming from various parts of the world. We continue to expect the 400-megawatt facility to be in service by the end of 2020. However, the 300-megawatt facility is facing greater challenges, given that this project was originally scheduled to be completed later in the year. The developer continues to work towards completing the entire project in 2020. However, manufacturing, shipping and other supply chain issues have negatively impacted the schedule on this project. While we have not received formal notice from the developer that any portion of this project will be delayed beyond December 31, 2020, at this time, our discussions with the developer indicate that completion of a portion of the project representing approximately $100 million of investment may go in service in the first quarter of 2021. While we would be disappointed that this entire project is not completed in 2020, it is important to keep some key factors in mind. First, if only this portion of this project is not completed in 2020, we would still be closing on approximately $1.1 billion or 92% of our planned 2020 wind generation investment of $1.2 billion. In addition, for any portion of the project completed in 2021, we have contractual protections to pay a reduced amount to account for the potential loss of production tax credits, subject to an obligation to later pay the original contracted amount should Ameren be entitled to receive those credits. Finally, late last week, U.S. Department of the Treasury indicated plans to modify the wind production tax credit rules, which is expected to result in a 1-year extension of in-service criteria. The bottom line is, we expect to deliver on the vast majority of our wind generation investment in 2020. We believe these investments will deliver clear, long-term benefits to our customers, the communities we serve and the environment. Finally, consistent with our goal to meet our customers' long-term energy needs in a responsible manner, we will assess additional renewable generation opportunities in the context of our next integrated resource plan, which will be filed in September of this year. This comprehensive stakeholder process is well underway to evaluate our future customer demand as well as generation resources needed over the next 20 years and beyond. We continue to work with key stakeholders in this process and are committed to transitioning Ameren Missouri's generation to a cleaner, more diverse portfolio in a responsible fashion for our customers, our shareholders and the environment. Moving to Page 11. Looking ahead through the end of this decade, we have a robust pipeline of investments of over $36 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. These investment opportunities exclude any potential new renewable generation from the next Missouri integrated resource plan, which, as I just noted, will be filed in September as well as any potential new multi-value transmission projects. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for local economies. Needless to say, this is very important for our country and the communities we serve at this time. Maintaining constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our customers -- country's future energy needs and delivering on our customers' expectations. Moving to Page 12. To sum up our value proposition, while the current environment is challenging, we are optimistic about the future. The consistent execution of our strategy over many years and on many fronts has positioned us well for future success. We remain firmly convinced that the execution of this same strategy in 2020 and over the next decade will deliver superior value to our customers, shareholders and the environment. We believe the expectation of a 6% to 8% earnings per share compound annual growth rate from 2020 through 2024 driven by strong rate base growth compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all 4 of our business segments as we have an experienced and dedicated team to get it done. Further, our shares continue to offer investors a solid dividend. Our strong earnings growth expectations outlined today position us well for future dividend growth. Of course, future dividend decisions will be driven by earnings growth in addition to cash flows and other business conditions. Together, we believe our strong earnings growth outlook, combined with our solid dividend, results in a very attractive total return opportunity for shareholders. Before I turn the call over to Michael, I'd like to mention an important report that we recently issued. Just last week, we published the Annual Ameren Sustainability Report. This report outlines how we are effectively managing a wide range of environmental, social and governance matters for the benefit of all stakeholders. I encourage you to read it at amereninvestors.com. Again, thank you all for joining us today. I'll now turn the call over to Michael.
Michael Moehn: Thanks, Warner, and good morning, everyone. Turning now to Page 14 of our presentation. Today, we reported first quarter 2020 earnings of $0.59 per share compared to earnings of $0.78 per share for the year ago quarter. The key factors that drove the overall $0.19 per share decrease are highlighted by segment on this page. Earnings from Missouri, our largest segment, were down $0.20 per share. The results reflected lower electric retail sales, primarily driven by mild winter temperatures in 2020 compared to colder-than-normal temperatures in the year ago period as well as the absence of energy efficiency performance incentives in the first quarter of 2020, which, combined, reduced earnings by $0.11 per share. In addition, earnings were impacted by higher operations and maintenance expenses, which reduced earnings by $0.08 per share. This increase in operation and maintenance expense was primarily driven by changes in the cash surrender value of our company-owned life insurance. Finally, under terms of the Missouri rate review settlement in order, we recognized a onetime charitable contributions in the first quarter, which reduced earnings by $0.02 per share. Earnings for Ameren Illinois natural gas were slightly lower due to higher operation and maintenance expenses, also due to change in the cash surrender value of COLI, mostly offset by increased investments in infrastructure. Ameren Illinois electric distribution earnings were flat, reflecting increased investments in infrastructure, offset by a lower allowed return on equity. Ameren transmission earnings were $0.01 per share higher due to an increased investments in infrastructure, partially offset by a lower allowed return on equity. Finally, Ameren parent and Other results also increased $0.01 per share, driven primarily by the timing of income tax expense, which is not expected to impact full year earnings, offset by reduced tax benefits associated with share-based compensation. Before moving on, let me briefly cover electric sales trends for our Missouri and Ameren Illinois electric distribution for the first 3 months of this year compared to the first 3 months of last year. While we did see an impact on electric margins for Ameren Missouri and Ameren Illinois electric distribution due to COVID-19, the impact was not material in the first quarter due in part to the timing of the stay-at-home orders in Illinois that began March 21 and the stay-at-home orders in the city -- St. Louis City and St. Louis County that began March 23. In addition, March is a solar month. As a result, we tend to have less earnings exposure to large percentage changes in sales than we would otherwise have in the winter or summer months. Weather-normalized kilowatt hour sales to Missouri residential customers increased 2.5%, excluding the effects of our Missouri Energy Efficiency Plan under MEEIA. Weather-normalized kilowatt hour sales to Missouri commercial and industrial customers decreased 1.5% and 2%, respectively, after excluding the effects of our energy efficiency plan. We exclude MEEIA effects because the plan provides rate recovery to ensure that earnings are not affected by the reduced electric sales resulting from our energy efficiency efforts. Weather-normalized kilowatt hour sales to Illinois residential customers increased about 1% and weather-normalized kilowatt hour sales to Illinois commercial and industrial customers decreased 1.5% and 2%, respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. I'll touch a bit more on sales expectations for the second quarter and the balance of the year in a moment. Turning to Page 15. As you think about the financial uncertainties for the remainder of the year due to COVID-19, this page lays out the regulatory mechanisms available in our business segments to mitigate certain COVID-19 uncertainties, including lower sales revenues, higher bad debt and pension expense. As you can see on this slide, we have constructive regulatory mechanisms to address these uncertainties for business segments that accounted for approximately 50% of our 2019 earnings. We have limited exposure to changes in sales in Illinois as we are fully decoupled in our electric distribution business as well as for residential and small nonresidential natural gas sales. In addition, any variance in bad debt expense in Illinois are recovered through the electric and gas uncollectible adjustment riders. Also, formula rates in our Ameren transmission business provide for a recovery of any variance in revenues, bad debt expense or pension expense. In Missouri, we currently do not have any -- have a regulatory mechanism to mitigate the financial impacts of changes in sales volume or bad debt expense. For perspective, approximately 50% of our annual Missouri electric margins are residential, 40% are commercial and 10% are industrial. The earnings impact of a 1% change in annual sales in 2020 by class is approximately $0.03 for residential, $0.02 for commercial and $0.005 for industrial. It should be noted that we have seasonal electric rates in Missouri. Because of seasonal rates, approximately 50% of our electric margins are typically realized from June through September, assuming normal weather. We are mining the financial impacts of COVID-19 and have the ability to seek an accounting authority order from the Missouri PSC to track such impacts for recovery in a future rate review. Finally, any variance in pension expense from Missouri is recovered through a pension tracker. With that in mind, turning to Page 16, I'd like to briefly touch on key drivers impacting our 2020 earnings guidance. As Warner stated, we continue to expect 2020 diluted earnings to be in the range of $3.40 to $3.60 per share. This guidance range assumes normal weather in the remaining 9 months of the year as well as reflects several other updates from our February call, primarily related to COVID-19. While it's still very difficult to predict the ultimate impacts of COVID-19 on our business, our team viewed several COVID-19 scenarios incorporated what we believe are prudent and reasonable assumptions into our earnings guidance. Our guidance contemplates the stay-at-home orders currently in effect. As Warner mentioned, the Governor of Missouri lifted the statewide stay-at-home order on May 4, although St. Louis City and County will begin lifting in their orders on May 18. While these restrictions are being lifted in May, our guidance assumes limited business activity during the entire second quarter, which will significantly impact commercial and industrial sales, while favorably impacting residential sales. As the year goes on, we expect to see commercial and industrial sales improve in the third and fourth quarters, but never fully recovering by year-end. We also expect residential sales to taper off as the year goes on, especially in the fall when schools reopen. As a result, our guidance assumes a gradual recovery. As we sit here today, we expect lower sales in Missouri due to COVID-19 to reduce earnings approximately $0.10 per share compared to 2019 weather-normalized sales. For the year, we expect total weather-normalized sales to be down approximately 2.5%. Broken down by class, we expect 2020 commercial sales to decline approximately 7%, industrial to decline approximately 4% and residential to increase approximately 2.5%. Before moving on, I would note that Ameren Missouri customer sales for April, excluding the impact of colder-than-normal weather, were down approximately 7%, reflecting the negative impact from COVID-19 compared to the prior year. Broken down by class and compared to the prior year, preliminary Ameren Missouri April weather-normalized commercial and industrial sales declined approximately 15% and 10%, respectively, which more than offset the margins on increased weather-normalized sales to residential customers of approximately 6%. Similar to March, April and May are mild weather months. As a result, our annual earnings have less exposure to large percentage changes in residential and commercial sales than in those months. Moving on to other guidance considerations. Despite the extensive federal actions being taken to provide COVID-19 relief to individual and businesses across the country as well as the energy assistance funding that Ameren is providing, we understand that some customers will still face challenges in paying their bills, and we incorporated an increase in bad debt expense into our guidance for the balance of the year. Today's guidance also incorporates an estimated 2020 allowed ROE for Ameren Illinois electric distribution of 7.3%, which reflects a 30-year treasury yield of approximately 1.5% as well as an increase in parent interest expense associated with the accelerated $800 million note issuance at Ameren Corp., which I'll touch on more in a moment. On the positive side, we've incorporated the final terms of the Ameren Missouri Electric rate review settlement, which we'll discuss later as well. In addition, as Warner mentioned, we've already taken certain actions, put in place other actions to reduce cost to help mitigate the expected negative financial impacts of COVID-19. Rest assured, we will remain very disciplined in managing our costs for the remainder of the year. Finally, select earnings considerations by quarter for the balance of the year are listed on this page. Moving now to Page 17 for a discussion of Ameren Missouri regulatory matters. In March, the PSC approved a stipulation and agreement that resolved the Ameren Missouri rate review. As many of you know, the agreement was a black box settlement, and therefore, the final order does not provide certain specific details. Effective April 1, base electric revenues were decreased by $32 million annually or a decrease of approximately 1%, 80% of which we expect to realize this year. Concurrently, net base energy costs, which will be the basis used for prospective changes to the fuel adjustment clause rider, decreased by approximately $115 million annually. In addition, net regulatory asset and liability amortization expenses and the base level of expenses for regulatory tracking mechanisms reduced by approximately $50 million annually. The agreement did not specify an allowed ROE at rate base level or a common equity ratio. However, the PSC determined that an implicit ROE in the range of 9.4% to 9.8% is reasonable. In the absence of a stated ROE, our goal continues to be earn as close to 9.6%, the midpoint of the ROE range as possible. The agreement also called for a continued use of a 9.53% ROE to calculate allowance for funds used during construction. Finally, the approved agreement provided for a continuation of key trackers and riders, including the fuel adjustment clause, where the sharing percentage of 95%-5% was affirmed by the commission in April. Looking ahead, we will continue to assess the timing of our next Missouri rate review. In making this determination, we will take into account consideration of the constructive rate settlement of this recent rate review; the ongoing impacts of COVID-19 on our customers and our business; our capital expenditures, including the planned wind acquisitions coupled with the flexibility provided by Senate Bill 564 Plan and Service Accounting and other cost of service considerations. Turning to Page 18 for a financing and liquidity update. We feel very good about our liquidity and financial position today, in particular, after taking a number of steps in March and early April to access the capital markets. On March 20, Ameren Missouri issued $465 million of 2.95% first mortgage bond due in 2030. This tied for the lowest rate for a 10-year bond issuance in Ameren Missouri's history, which helps keep customers rates low as proceeds were used to repay short-term debt, including short-term debt incurred to repay a maturity in a $85 million of 5% senior unsecured notes that matured on February 1. Additionally, on April 3, Ameren Corp. issued $800 million of 3.5% senior unsecured notes due in 2031. These proceeds were used for general corporate purposes, including to repay short-term debt and to fund the repayment of Ameren Corp.'s 2.7% senior notes due November 15, which is the only maturity remaining in 2020. We decided to accelerate the holding company debt offering to secure our liquidity position during an uncertain time in the credit markets. We continue to expect to issue long-term debt at Ameren Missouri later this year to fund a portion of the wind generation investments expected to be in-service by the end of 2020. And I would note there are no long-term debt maturities in 2021. In December, we also increased the capacity of our credit facilities by $200 million and extended the maturity dates out to December 2024. Ameren's available liquidity on April 30 was approximately $2.5 billion. This includes the $2.3 billion of combined credit facilities available and approximately $150 million of cash on hand at the end of the month. There are no outstanding credit facility or commercial paper borrowings as of April 30. In addition, we also expect to receive between $540 million and $550 million upon the physical settlement of the August 2019 forward sale agreement on or before March 31, 2021, which is expected to be used to fund a portion of the Ameren Missouri's wind generation investments. Finally, I'm pleased to report that last month, both Moody's and S&P affirmed their credit rating outlooks of stable. Moving now to Page 19 for an update on Ameren Illinois regulatory matters. Last month, we made a required annual electric distribution formula rate update filing requesting a $45 million base rate decrease. Under Illinois formula ratemaking, Ameren Illinois is required to make an annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true-up any prior period over or under recoveries of such costs. If approved, as requested, all-in 2021 residential electric rates for customers taking delivery and energy supply from Ameren Illinois would be down by approximately 1% since formula ratemaking began in 2012. The ICC will review the matter in the months ahead with a decision expected in December of this year and new rates effective in January of next year. This along with our natural gas rate review remain on track. Finally, turning to Page 20, I'll summarize. We have a strong team and are well positioned to continue executing on our plan during these unprecedented times. We continue to expect to deliver strong earnings growth in 2020 as we successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. Further, we believe this growth compares very favorably with the growth of our regulated utility peers. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. This concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions]. Our first question comes from the line of Julien Dumoulin-Smith with Bank of America.
Julien Dumoulin-Smith: Hope you all are doing well.
Warner Baxter: Hope you are doing well as well. Good to hear your voice.
Julien Dumoulin-Smith: Likewise. I wanted to follow-up on Missouri. And I mean, this is mostly in context of 1Q, you had a number of, call it, higher expenses. You've listed them out fairly in some detail. How do you think about those cascading through the course of the year and into '21? I imagine much of it like weather and onetime contributions are pretty limited to 1Q '20. But separately from focusing on higher expense, how do you think about the totality of O&M opportunities to offset the details that you provided on the lower 2.5% sales altogether?
Michael Moehn: Perfect. Julien, this is Michael. So I'll take a stab at this and then certainly Warner can add anything as well. But I mean, if I heard you right, you broke up a little bit there, but in terms of the higher costs that we saw in the first quarter, clearly, we're impacted by this company-owned life insurance, which we indicated in there, so that obviously provided a headwind. As you think back in terms of where we were at the beginning of the year, we talked about O&M costs being higher in general. We didn't guide to a specific number, we just said that we were going to be higher. Obviously, you have these headwinds that are occurring in the first quarter. As we think about all these COVID-related issues that we outlined in terms of what's going on with sales and bad debt, we are clearly focused on guiding to a lower O&M number today. And so hopefully, it gives you some context, not giving you the specifics of it. But clearly, we were higher O&M going into the year, got these headwinds. We've taken a number of actions, as Warner said, in terms of just managing headcount, obviously travel, conferences, watching overtime where we can, all those kind of things to make sure that we can keep a firm grasp on this.
Warner Baxter: Yes. I think, Michael, you hit it right. So look, we're guiding down now from O&M expenses from where they were last year. And look, in looking at some of those things, Julien, clearly, we're mindful of several things. Of course, we're mindful of the expected impacts of COVID-19, which Michael did a nice job of outlining before. But of course, we're also mindful that we need to make sure we're delivering safe and reliable service to our customers. But clearly, we never lose our focus to earn as close to allowed return as possible. So when we think about all those things and providing that guidance, that's how we think about the O&M actions that we've taken.
Julien Dumoulin-Smith: Got it. Okay. But no specific pinpoint number here for the total -- totality of the year. And then a follow-up...
Warner Baxter: Yes, not at this point. I think we're going to continue to monitor it. And as you can appreciate here, we're here in the first quarter. And so we'll continue to monitor operations for the rest of the year, so yes. But that gives you, I think, a good sense of the direction that we're headed.
Julien Dumoulin-Smith: Absolutely. And then related to this, if I can, what about the Missouri's rate case strategy? I know you put a bullet in your slides about that, but can you elaborate on your thinking today? And again, also being cognizant that, yes, we're still in the first quarter here in terms of results, but how are you at least conceptually thinking about approaching it?
Warner Baxter: Yes. So Julien, just a couple of thoughts there. And then Marty, who's joining us remotely, all of our leaders, just so you know, our presidents are joining us remotely today as we continue to make sure we do the proper social distancing. So look, I think, at the end of the day, really no decision has been made at this time. But clearly, when you think about your next rate case filing, there are several things you have to think about. And certainly, the wind projects, right, which we've talked about on the call, but we also have to be mindful of the implications and impacts of COVID-19. And so those coupled with the fact that we just completed our last rate review, and those are some of the things that you would put on the list in terms of making a final determination there. And Marty, I know that you're on, anything that you would add to some of the things that you and your team are kicking around?
Martin Lyons: Well, Warren, you hit on a couple of the key ones. I think, Julien, when you look back at our last rate review filing, it was really to set up the timing for this next one, given the wind projects that we have going into service later this year, so those projects will still be top of mind in terms of getting those completed and making sure we think about how to time a rate case around those. Of course, Senate Bill 564, the Plan and Service Accounting, has really provided us some better flexibility on capital expenditures and the ability to be able to defer depreciation, return and get full recovery, so that's a consideration. But as Warner said, we feel good about the constructive rate settlement that we just had in this past rate review. I think that puts us in a good position to really think about the timing going forward. COVID-19, obviously, having impacts on our customers and our business, as Warner mentioned. And so all of those will be considerations as well as other cost of service considerations that will go into it. So I think all of that considered just means that we'll be thinking about really the best timing for this next rate review.
Operator: Our next question comes from the line of Jeremy Tonet with JPMorgan.
Rich Sunderland: It's Rich Sunderland, on for Jeremy. So just starting off with the wind project, appreciate the update there. Could you speak to any regulatory obligations with regards to the in-service dates? And maybe just a little bit more color with the line of sight to the potential end of year versus a slight push into Q1 for the 300 megawatts?
Warner Baxter: Yes. So this is Warner. So in terms of regulatory obligations, really none by the end of this year. Of course, we're very focused on getting those done in a timely fashion, as we outlined during the call. But if some of the projects -- and we talked about, at this time, we think there's a possibility for $100 million of that second project to get pushed into 2021. That doesn't cause any particular regulatory challenges for us. So that's how I see that.
Michael Moehn: Yes. I mean, you got the renewable standard here in the state of Missouri. You got 15% by 2021, but we'll be in compliance with that. That's what Warner is saying that no issues with that.
Rich Sunderland: Great. And then on bad debt expense, could you speak to a little bit about trends from maybe '08, '09 and what you're baking into guidance for 2020?
Warner Baxter: Yes, Michael, why don't you take that one, please?
Michael Moehn: Yes, you bet. So look, we're looking and mindful of everything that's happening to the customers. They're looking at in terms of LIHEAP is providing, obviously, an unprecedented amount of dollars here. I think Warren mentioned as well that we have dollars that are being allocated, obviously, to energy assistance as well. But as we step back and look at and going back to '08, '09, you're right, I think that's a great place for us to spend some time. I mean, we've done a nice job of driving down bad debt expense over time. We're probably at about $8 million today in bad debt expense. If you think about '08, '09 time frame, you're probably closer to $14 million, $15 million. So that's probably a good proxy to think about in terms of a couple of cents, about $6 million in terms of headwind potentially associated with bad debt expense.
Operator: Our next question comes from the line of Paul Patterson with Glenrock.
Paul Patterson: Just on your comments, you mentioned that the long-term growth had certain expectations with respect to the 30-year treasury. And I know you guys have legislation pending in Illinois, which you mentioned and went over. But how should we think about what the long-term growth rate is if we do have this 30-year treasury where it is at? And also just your rate base growth seems to be unchanged and what have you. How should we think about what your expectation is, absent any legislation changing what the treasury -- the 30-year treasury would be?
Warner Baxter: So Michael, why don't you address sort of the overall 30-year treasury, and then maybe I can jump in and talk about the potential allocation of capital and -- okay?
Michael Moehn: Got it. I appreciate the question. I think as you think about the long-term guidance, and if you think about the 350 as the midpoint for 2020 and you take the 6% to 8% off of that, Paul, I mean, you get to about a $0.35 range out there in 2024, so a decent size range. And I think that range accommodates a number of things, which I think Warner maybe even referred to earlier. I mean, it refers potential treasury outcomes, certainly rate case outcomes, the timing of CapEx, other things. I mean, there are a number of levers that can be pulled over time. I would remind you a couple of, I think, key data points just to keep in mind. I mean, for every 50 basis points move in that distribution business, it's worth about -- it's an impact of about $0.035. And the other thing to keep in mind, too, is, I mean, as you think about how we're allocating capital today and where rate base growth is going over time, I mean, you get out to 2024, that Illinois distribution business is only about 18% of the overall rate base. So those are things just to keep in the back of your mind as you think about different impacts associated with that $0.35 range. I don't know if Warner...
Warner Baxter: I think that's a good point. So maybe I'll add then a little bit more color because you had a specific question around how we might think about our investments in Illinois. So look, we're mindful of the fact that our return on equity in Illinois is below industry averages. And I mean, that's why we're supporting legislation that's going to add 100 basis points to the current 580 basis points to the 30-year treasury. And so at the same time, too, we recognized that we're currently in an, frankly, unprecedented period in our country's history that's obviously driving historically low interest rates. And so what I would say is that, look, we're not going to have a knee-jerk reaction to our investment strategy because the investments that we've been making in Illinois have been delivering value to both our customers and shareholders. But look, we're also going to continue to monitor the situation. And at the same time, Rich and his team, they're going to be relentless and trying to make sure we pass what we think is really good legislation for our customers, the state of Illinois and certainly for our shareholders. And in so doing, we're going to continue to advocate for fair returns on those infrastructure investments. And then so doing, too, we think if we continue to make them, they're going to deliver a lot of value to our customers. So that's the color, that's in terms of how we think about it right now.
Paul Patterson: Okay. I mean -- and I appreciate the color. I'm just sort of wondering, though, if we don't get legislation and if the rate is so low, would you -- I mean, I would assume that there would probably be some change in how you would allocate capital. I mean, it is a pretty robust rate base growth that you have in those slides and stuff where...
Warner Baxter: Sure. Like I said before, we're going to be mindful of our returns in our businesses. We always are mindful about how we allocate capital. We obviously are very thoughtful and strategic and so doing. But at the same time, as I sit here today, we're not going to be making any predictions or knee-jerk reactions.
Paul Patterson: Okay. Fair enough. And these are some technically...
Warner Baxter: Thanks, Paul. Please -- if you have another comment, please.
Paul Patterson: Okay. I'm sorry. Just on the COLI, you broke it out for Missouri. And I just was sort of -- just trying to understand why the Illinois distribution isn't affected apparently by it? And could you just give us a little bit more color about how that COLI is distributed and -- I mean, not anything huge, if it's very complicated, don't bother your time, but just want to get more on that.
Michael Moehn: No worries. Good question. Certainly, it's not complicated. I mean, it really -- Illinois -- it doesn't impact the Illinois distribution business because of the formula rate nature of it. So where you do have a little bit of impact is on the Illinois natural gas side. And so really focused in on the primary piece of Missouri because that's where the biggest impact is just because of the nature of that regulatory regime.
Operator: [Operator Instructions]. Our next question comes from the line of James Thalacker with BMO Capital Markets.
James Thalacker: Just following up real quickly on Paul's question. As you kind of look out at the reaffirmation of the 6% to 8% in the past, I know you guys have used kind of the forward curve for treasuries. Is that kind of what we should assume as embedded in the growth rate from here?
Michael Moehn: Yes. No, Paul -- no, Jim. Historically, I think we maybe did guide to that several years ago. I think we kind of moved away from that a bit ago. And so again, just we have various internal assumptions in there. And again, as Warner stated, when we have a lot of different levers that we can pull, I know there's some sensitivity about just given, obviously, where that 30-year treasury sits today. But again, it's a $0.35 range, talked about the size of that overall distribution out there in 2024. I talked about the sensitivity to those rates. And so I think there are things that we continue to do to manage around that.
Warner Baxter: Yes. I think, too, Michael, just to add. I mean, so don't lose sight of the slide that we show up there about the robust pipeline of investment that we have across all of our enterprises that goes not just beyond this first 5 years, but the $36 billion in total over 10 years. So that's certainly a lever that we have. And of course, all along, we're mindful of customer affordability and those types of things. So look, we don't -- we never say anything is a lay up, right? But at the same time, we're going to be very thoughtful in terms of how we manage the business that drives value for our customers and value for our shareholders.
James Thalacker: Got it. Okay. And I guess, just as a real quick follow-up. As you look at the range, I know that you affirmed it today, but are you guys comfortable at this point in kind of talking about with your cost containment, and what you see for your sort of sales progression through the year through the various scenarios of kind of where you see yourself within that range? Would it be sort of at the midpoint, upper half, sort of lower half? Like how are you thinking about that?
Warner Baxter: Yes, Jim. So this is Warner again. So I assume you're talking about our 2020 EPS guidance. And so look, consistent with our past practice, we just don't disclose where we're at within our guidance range, frankly, at any given time. And so the only thing I would say is that this team is focused and has a strong record of not just being focused but delivering within our guidance, and that's where we're going to continue to be focused in 2020.
James Thalacker: Hope everyone is safe and well.
Operator: Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Kirk for any final comments.
Andrew Kirk: Thank you for participating in this call. A replay of this call will be available for 1 year on our website. If you have questions, you can -- may call the contacts listed on our earnings release. Financial analysts' inquiries should be directed to me, Andrew Kirk. Media should call Erin Davis. Again, thank you for your interest in Ameren, and have a great day.
Operator: Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. | [
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"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation First Quarter 2020 Earnings Call. [Operator Instructions]. I would now like to turn the conference over to your host, Mr. Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the Forward-looking Statements section in the news release we issued today and the Forward-looking Statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now here's Warner, who will start on Page 4 of the presentation."
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"speaker": "Warner Baxter",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. This morning, I'm going to begin our presentation by providing a COVID-19 update and, in particular, highlighting some of the key efforts we are taking for the safety and security of our coworkers and customers during this difficult time, while providing the central electric and natural gas service. I will then touch on our first quarter results and 2020 earnings guidance. Finally, I will discuss our long-term growth prospects while highlighting some important strategic matters that will position Ameren for future success. Before I jump into the details, I hope that you, your families and colleagues are safe and healthy during this unprecedented time. As our world works to address COVID-19, many things are uncertain. But the Ameren's commitment to safety of our coworkers, our customers and our communities remains constant. At Ameren, we never compromise on safety, it is one of our core values. I want to express my profound appreciation for those who are on the front lines battling this virus. To the health care workers, first responders, grocery store workers, local leaders, community workers and, of course, all utility workers across our nation, thank you. In particular, I want to express my sincere appreciation to my Ameren coworkers, who remain focused every day on delivering safe, reliable power and natural gas to millions of people in Missouri and Illinois. To ensure that we could continue to deliver safe and reliable service, we took swift action in January and assembled a cross-functional crisis management response team following reports about threats related to COVID-19. Since January, our team has been planning and implementing a pandemic response, consistent with established guidelines and industry best practices as well as in consultation with world-class health experts and state and local government leaders. We quickly restricted domestic and international travel and implemented from -- work-from-home policies for anyone that could to limit exposure of our coworkers. Of course, our coworkers are crucial to the execution of our mission and many continue to be out in our communities and in our energy centers every day, keeping the lights on and the natural gas flowing for millions of customers in Missouri and Illinois. Our actions to continue safe operations also included securing and supplying personal protective equipment, separating work crews, adjusting more schedules, performing robust health screenings at home and on-site and of course, practicing social distancing with coworkers and customers. Our transition to our new work practices went very well. Not only were we able to quickly take significant actions to protect the safety of our coworkers and customers, we have been able to continue executing our projects and strategic plan across our entire business. We also recognize this is a difficult time for many of our customers, who are struggling financially due to lost wages and other circumstances related to COVID-19. That's why we currently have voluntarily suspended all electric and gas disconnects for nonpayment and waived all late payment fees for customers unable to pay their energy bill on time. In addition, we have contributed $1 million in energy assistance and nearly $1 million to fund other COVID-19 relief efforts to help families and businesses in our Illinois and Missouri communities, and we're not done helping our customers and our communities. As part of our Ameren Missouri rate review settlement, we are working with Missouri Office of the Public Counsel to provide another $3.5 million in energy assistance funds for Missouri residential customers in need. Our proposal is pending approval from Missouri Public Service Commission. In addition, we live and work in our communities. And we want to go beyond keeping the lights on and natural gas flowing for our millions of customers. As a result, we recently launched an Ameren Cares initiative, whereby our leadership team, Board of Directors and all Ameren coworkers can contribute to COVID-19 relief efforts, including energy assistance for our customers. Operationally, we are exercising financial discipline and taking several actions to mitigate the expected financial impacts of COVID-19 on our business. Those actions include, among other things, stringent hiring restrictions, managing spending on outside of consultants, significantly restricting travel and modifying the scope of our energies and our maintenance outages, in large part, to enhance the safety of our coworkers. In addition, we have taken several actions to strengthen our already solid liquidity position. Those steps included proactively accessing the capital markets earlier this year. Michael will share some of those details with you a bit later. Looking ahead, we are putting the final touches on the first phase of our return to facilities transition plan for our coworkers that are working remotely. Safety will remain at the top of our mind, and this transition will be done in a very measured and thoughtful way. We will also continue to work with state and local leaders as well as with the health care community to support reopening of regional economy in a safe, measured and timely fashion. Stay-at-home orders in Missouri were lifted on May 4. On the St. Louis area, those orders will be lifting on May 18. In Illinois, the stay-at-home motor remains in place through May 30. Of course, we expect restrictions on economic and social activity will continue in all of our communities for some time. Since we are an essential business, these orders should not limit our operations or the execution of our strategic plan beyond the safety measures we have implemented for the protection of our coworkers and customers. I am very proud of our work that our coworkers have done over the last several months. Having said that, we are not letting our guard down. We will continue to be relentlessly focused on safety and delivering on our mission to power the quality of life for our customers and communities and managing through this unprecedented period of time. With that, let's now turn to Page 5 for an update on first quarter results and 2020 earnings guidance. Yesterday, we announced first quarter 2020 earnings of $0.59 per share compared to $0.78 per share earned in 2019. This slide outlines some of the key drivers that impacted earnings in the first quarter. While we had some items that drove earnings down compared to last year, I am pleased to tell you that we continue to effectively execute all elements of our strategic plan. In addition, due to the actions we have taken to mitigate the expected financial impacts of COVID-19, which I described earlier, combined with the constructive outcome in our Missouri rate review, which benefited all stakeholders, we remain on track to deliver within our 2020 earnings guidance range or $3.40 per share to $3.60 per share. In affirming our 2020 guidance, we have assessed several economic scenarios and taken into consideration expectations associated with lower Missouri total electric sales, the potential for higher bad debt expenses and lower returns in our Illinois electric distribution business due to lower interest rates, among other things. Michael will discuss our first quarter earnings, 2020 earnings guidance and other related items in more detail later. Turning now to Page 6. Yesterday, we also affirmed our expectation to deliver 6% to 8% compound annual earnings per share growth from 2020 to 2024, driven by robust compound annual rate base growth of approximately 9%. Simply put, we continue to believe our strategy to deliver strong, long-term earnings growth remains intact. This outlook accommodates several factors, including the range of treasury rates, sales growth, spending levels, regulatory developments and impacts of COVID-19. And of course, earnings growth in any individual year will be impacted by the timing of capital expenditures, regulatory rate reviews and sales volumes, including those driven by weather, impacts from COVID-19 and other factors. Moving to Page 7. Here, we reiterate our strategic plan. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers. As a result, and as you can see on the right side of this page, during the first 3 months of this year, we invested significant capital in each of our business segments, and the pipeline remains robust. In addition, we remain on track to achieve our capital expenditure target for 2020. Regarding regulatory matters, I am pleased to report that in March the Missouri Public Service Commission approved a constructive settlement in Ameren Missouri's electric rate review that included a $32 million annual revenue decrease. It incorporates lower fuel and transportation costs, taxes and regulatory asset amortization expenses, while providing for recovery of significant infrastructure investments as well as an opportunity to earn within the implicit range of 9.4% to 9.8% return on equity on a growing Missouri rate base. This decrease marks the second consecutive decrease since 2018 when customers received a 6% rate cut as a result of the federal corporate income tax reduction and our Smart Energy Plan. In Illinois last month, we made our required annual electric distribution formula rate update filing, requesting a $45 million base rate decrease. If we're approved as requested, all-in 2021 residential electric rates for customers taking delivery and energy supply from Ameren Illinois would be down approximately 1% since formula ratemaking began in 2012. As you can see with these rate decreases, we are clearly focused on keeping our customers cost competitive and affordable through continuous improvement and disciplined cost management, while we make significant investments in energy infrastructure to deliver long-term value. Michael will provide more detail about the electric and natural gas rate reviews in a moment. Turning now to Page 8 and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies, beginning with Ameren Illinois Electric Distribution. The Downstate Clean Energy Affordability Act legislation was filed in February. This important legislation would allow Ameren Illinois to make significant investments in solar energy and battery storage to improve reliability as well as to make investments in transportation electrification in order to benefit customers and the economy across Central and Southern Illinois. In addition, this legislation would modify the allowed return on equity formula to increase the basis point adder to the average 30-year treasury rate from 580 basis points to 680 basis points and would also extend electric formula ratemaking to 2032. The Downstate Clean energy Affordability Act will move the state of Illinois closer to reaching its goal of 100% clean energy by 2050, and builds on Ameren Illinois' efforts to modernize the energy grid under a transparent and stable regulatory framework that has supported significant investment to modernize the energy grid, while improving reliability and creating jobs, all while keeping rates well below the Midwest and national averages. With all these benefits in mind, we are focused on working with key stakeholders to get this important legislation passed. Prior to adjournment of the Illinois General Assembly in mid-March due to COVID-19, the House Bill had advanced to the Public Utilities Committee and a Senate Bill still awaited assignment to the Energy and Public Utilities Committee. In light of the challenges that exist with COVID-19, it's unclear whether these bills will advance in the spring session, which is currently set to end May 31, that's extended by the leadership in the Illinois House and Senate. If not past the spring, these bills could also be addressed in a veto session or potentially other special sessions later this year. Turning to Page 9 for an update on FERC regulatory matters. In terms of the FERC's November 2019 order and its subsequent order to extend time to reconsider hearing requests, I do not have any significant updates. However, the FERC did recently take some constructive actions that could further support investment in transmission. In particular, in March, the FERC issued a Notice of Proposed Rulemaking on electric transmission ROE incentives. In the notice, the FERC proposed several changes to ROE incentives, including an increase in the regional transmission organization, or RTO, participation adder from 50 basis points to 100 basis points. For perspective, every 50 basis point change in our FERC ROE impacts annual earnings per share by approximately $0.04. The notice also proposes incentives on new projects by considering the benefits rather than the risks of a project. We are pleased with the direction the FERC has taken with this notice. It suggests that the FERC understands the importance of incentivizing transmission investment to both upgrade and replace the aging infrastructure and to also enable the transition to more renewable generation across the country. We expect to file comments by the July 1st deadline. Of course, we are unable to predict the ultimate timing or impact of these FERC matters as the FERC is under no time line to issue a decision. Moving now to Page 10 for an update on the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. Here, we provide an update on our wind generation investment plans to achieve compliance with Missouri's renewable energy standard and continue to transition our generation portfolio. We've received all regulatory approvals to acquire 700 megawatts of new wind generation at 2 sites in Missouri. Construction is well underway and continues at both wind generation facilities. We continue to work closely with the developers for both projects to monitor the timely manufacturing, shipment and installation of facility components, which are coming from various parts of the world. We continue to expect the 400-megawatt facility to be in service by the end of 2020. However, the 300-megawatt facility is facing greater challenges, given that this project was originally scheduled to be completed later in the year. The developer continues to work towards completing the entire project in 2020. However, manufacturing, shipping and other supply chain issues have negatively impacted the schedule on this project. While we have not received formal notice from the developer that any portion of this project will be delayed beyond December 31, 2020, at this time, our discussions with the developer indicate that completion of a portion of the project representing approximately $100 million of investment may go in service in the first quarter of 2021. While we would be disappointed that this entire project is not completed in 2020, it is important to keep some key factors in mind. First, if only this portion of this project is not completed in 2020, we would still be closing on approximately $1.1 billion or 92% of our planned 2020 wind generation investment of $1.2 billion. In addition, for any portion of the project completed in 2021, we have contractual protections to pay a reduced amount to account for the potential loss of production tax credits, subject to an obligation to later pay the original contracted amount should Ameren be entitled to receive those credits. Finally, late last week, U.S. Department of the Treasury indicated plans to modify the wind production tax credit rules, which is expected to result in a 1-year extension of in-service criteria. The bottom line is, we expect to deliver on the vast majority of our wind generation investment in 2020. We believe these investments will deliver clear, long-term benefits to our customers, the communities we serve and the environment. Finally, consistent with our goal to meet our customers' long-term energy needs in a responsible manner, we will assess additional renewable generation opportunities in the context of our next integrated resource plan, which will be filed in September of this year. This comprehensive stakeholder process is well underway to evaluate our future customer demand as well as generation resources needed over the next 20 years and beyond. We continue to work with key stakeholders in this process and are committed to transitioning Ameren Missouri's generation to a cleaner, more diverse portfolio in a responsible fashion for our customers, our shareholders and the environment. Moving to Page 11. Looking ahead through the end of this decade, we have a robust pipeline of investments of over $36 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. These investment opportunities exclude any potential new renewable generation from the next Missouri integrated resource plan, which, as I just noted, will be filed in September as well as any potential new multi-value transmission projects. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for local economies. Needless to say, this is very important for our country and the communities we serve at this time. Maintaining constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our customers -- country's future energy needs and delivering on our customers' expectations. Moving to Page 12. To sum up our value proposition, while the current environment is challenging, we are optimistic about the future. The consistent execution of our strategy over many years and on many fronts has positioned us well for future success. We remain firmly convinced that the execution of this same strategy in 2020 and over the next decade will deliver superior value to our customers, shareholders and the environment. We believe the expectation of a 6% to 8% earnings per share compound annual growth rate from 2020 through 2024 driven by strong rate base growth compares very favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all 4 of our business segments as we have an experienced and dedicated team to get it done. Further, our shares continue to offer investors a solid dividend. Our strong earnings growth expectations outlined today position us well for future dividend growth. Of course, future dividend decisions will be driven by earnings growth in addition to cash flows and other business conditions. Together, we believe our strong earnings growth outlook, combined with our solid dividend, results in a very attractive total return opportunity for shareholders. Before I turn the call over to Michael, I'd like to mention an important report that we recently issued. Just last week, we published the Annual Ameren Sustainability Report. This report outlines how we are effectively managing a wide range of environmental, social and governance matters for the benefit of all stakeholders. I encourage you to read it at amereninvestors.com. Again, thank you all for joining us today. I'll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Warner, and good morning, everyone. Turning now to Page 14 of our presentation. Today, we reported first quarter 2020 earnings of $0.59 per share compared to earnings of $0.78 per share for the year ago quarter. The key factors that drove the overall $0.19 per share decrease are highlighted by segment on this page. Earnings from Missouri, our largest segment, were down $0.20 per share. The results reflected lower electric retail sales, primarily driven by mild winter temperatures in 2020 compared to colder-than-normal temperatures in the year ago period as well as the absence of energy efficiency performance incentives in the first quarter of 2020, which, combined, reduced earnings by $0.11 per share. In addition, earnings were impacted by higher operations and maintenance expenses, which reduced earnings by $0.08 per share. This increase in operation and maintenance expense was primarily driven by changes in the cash surrender value of our company-owned life insurance. Finally, under terms of the Missouri rate review settlement in order, we recognized a onetime charitable contributions in the first quarter, which reduced earnings by $0.02 per share. Earnings for Ameren Illinois natural gas were slightly lower due to higher operation and maintenance expenses, also due to change in the cash surrender value of COLI, mostly offset by increased investments in infrastructure. Ameren Illinois electric distribution earnings were flat, reflecting increased investments in infrastructure, offset by a lower allowed return on equity. Ameren transmission earnings were $0.01 per share higher due to an increased investments in infrastructure, partially offset by a lower allowed return on equity. Finally, Ameren parent and Other results also increased $0.01 per share, driven primarily by the timing of income tax expense, which is not expected to impact full year earnings, offset by reduced tax benefits associated with share-based compensation. Before moving on, let me briefly cover electric sales trends for our Missouri and Ameren Illinois electric distribution for the first 3 months of this year compared to the first 3 months of last year. While we did see an impact on electric margins for Ameren Missouri and Ameren Illinois electric distribution due to COVID-19, the impact was not material in the first quarter due in part to the timing of the stay-at-home orders in Illinois that began March 21 and the stay-at-home orders in the city -- St. Louis City and St. Louis County that began March 23. In addition, March is a solar month. As a result, we tend to have less earnings exposure to large percentage changes in sales than we would otherwise have in the winter or summer months. Weather-normalized kilowatt hour sales to Missouri residential customers increased 2.5%, excluding the effects of our Missouri Energy Efficiency Plan under MEEIA. Weather-normalized kilowatt hour sales to Missouri commercial and industrial customers decreased 1.5% and 2%, respectively, after excluding the effects of our energy efficiency plan. We exclude MEEIA effects because the plan provides rate recovery to ensure that earnings are not affected by the reduced electric sales resulting from our energy efficiency efforts. Weather-normalized kilowatt hour sales to Illinois residential customers increased about 1% and weather-normalized kilowatt hour sales to Illinois commercial and industrial customers decreased 1.5% and 2%, respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. I'll touch a bit more on sales expectations for the second quarter and the balance of the year in a moment. Turning to Page 15. As you think about the financial uncertainties for the remainder of the year due to COVID-19, this page lays out the regulatory mechanisms available in our business segments to mitigate certain COVID-19 uncertainties, including lower sales revenues, higher bad debt and pension expense. As you can see on this slide, we have constructive regulatory mechanisms to address these uncertainties for business segments that accounted for approximately 50% of our 2019 earnings. We have limited exposure to changes in sales in Illinois as we are fully decoupled in our electric distribution business as well as for residential and small nonresidential natural gas sales. In addition, any variance in bad debt expense in Illinois are recovered through the electric and gas uncollectible adjustment riders. Also, formula rates in our Ameren transmission business provide for a recovery of any variance in revenues, bad debt expense or pension expense. In Missouri, we currently do not have any -- have a regulatory mechanism to mitigate the financial impacts of changes in sales volume or bad debt expense. For perspective, approximately 50% of our annual Missouri electric margins are residential, 40% are commercial and 10% are industrial. The earnings impact of a 1% change in annual sales in 2020 by class is approximately $0.03 for residential, $0.02 for commercial and $0.005 for industrial. It should be noted that we have seasonal electric rates in Missouri. Because of seasonal rates, approximately 50% of our electric margins are typically realized from June through September, assuming normal weather. We are mining the financial impacts of COVID-19 and have the ability to seek an accounting authority order from the Missouri PSC to track such impacts for recovery in a future rate review. Finally, any variance in pension expense from Missouri is recovered through a pension tracker. With that in mind, turning to Page 16, I'd like to briefly touch on key drivers impacting our 2020 earnings guidance. As Warner stated, we continue to expect 2020 diluted earnings to be in the range of $3.40 to $3.60 per share. This guidance range assumes normal weather in the remaining 9 months of the year as well as reflects several other updates from our February call, primarily related to COVID-19. While it's still very difficult to predict the ultimate impacts of COVID-19 on our business, our team viewed several COVID-19 scenarios incorporated what we believe are prudent and reasonable assumptions into our earnings guidance. Our guidance contemplates the stay-at-home orders currently in effect. As Warner mentioned, the Governor of Missouri lifted the statewide stay-at-home order on May 4, although St. Louis City and County will begin lifting in their orders on May 18. While these restrictions are being lifted in May, our guidance assumes limited business activity during the entire second quarter, which will significantly impact commercial and industrial sales, while favorably impacting residential sales. As the year goes on, we expect to see commercial and industrial sales improve in the third and fourth quarters, but never fully recovering by year-end. We also expect residential sales to taper off as the year goes on, especially in the fall when schools reopen. As a result, our guidance assumes a gradual recovery. As we sit here today, we expect lower sales in Missouri due to COVID-19 to reduce earnings approximately $0.10 per share compared to 2019 weather-normalized sales. For the year, we expect total weather-normalized sales to be down approximately 2.5%. Broken down by class, we expect 2020 commercial sales to decline approximately 7%, industrial to decline approximately 4% and residential to increase approximately 2.5%. Before moving on, I would note that Ameren Missouri customer sales for April, excluding the impact of colder-than-normal weather, were down approximately 7%, reflecting the negative impact from COVID-19 compared to the prior year. Broken down by class and compared to the prior year, preliminary Ameren Missouri April weather-normalized commercial and industrial sales declined approximately 15% and 10%, respectively, which more than offset the margins on increased weather-normalized sales to residential customers of approximately 6%. Similar to March, April and May are mild weather months. As a result, our annual earnings have less exposure to large percentage changes in residential and commercial sales than in those months. Moving on to other guidance considerations. Despite the extensive federal actions being taken to provide COVID-19 relief to individual and businesses across the country as well as the energy assistance funding that Ameren is providing, we understand that some customers will still face challenges in paying their bills, and we incorporated an increase in bad debt expense into our guidance for the balance of the year. Today's guidance also incorporates an estimated 2020 allowed ROE for Ameren Illinois electric distribution of 7.3%, which reflects a 30-year treasury yield of approximately 1.5% as well as an increase in parent interest expense associated with the accelerated $800 million note issuance at Ameren Corp., which I'll touch on more in a moment. On the positive side, we've incorporated the final terms of the Ameren Missouri Electric rate review settlement, which we'll discuss later as well. In addition, as Warner mentioned, we've already taken certain actions, put in place other actions to reduce cost to help mitigate the expected negative financial impacts of COVID-19. Rest assured, we will remain very disciplined in managing our costs for the remainder of the year. Finally, select earnings considerations by quarter for the balance of the year are listed on this page. Moving now to Page 17 for a discussion of Ameren Missouri regulatory matters. In March, the PSC approved a stipulation and agreement that resolved the Ameren Missouri rate review. As many of you know, the agreement was a black box settlement, and therefore, the final order does not provide certain specific details. Effective April 1, base electric revenues were decreased by $32 million annually or a decrease of approximately 1%, 80% of which we expect to realize this year. Concurrently, net base energy costs, which will be the basis used for prospective changes to the fuel adjustment clause rider, decreased by approximately $115 million annually. In addition, net regulatory asset and liability amortization expenses and the base level of expenses for regulatory tracking mechanisms reduced by approximately $50 million annually. The agreement did not specify an allowed ROE at rate base level or a common equity ratio. However, the PSC determined that an implicit ROE in the range of 9.4% to 9.8% is reasonable. In the absence of a stated ROE, our goal continues to be earn as close to 9.6%, the midpoint of the ROE range as possible. The agreement also called for a continued use of a 9.53% ROE to calculate allowance for funds used during construction. Finally, the approved agreement provided for a continuation of key trackers and riders, including the fuel adjustment clause, where the sharing percentage of 95%-5% was affirmed by the commission in April. Looking ahead, we will continue to assess the timing of our next Missouri rate review. In making this determination, we will take into account consideration of the constructive rate settlement of this recent rate review; the ongoing impacts of COVID-19 on our customers and our business; our capital expenditures, including the planned wind acquisitions coupled with the flexibility provided by Senate Bill 564 Plan and Service Accounting and other cost of service considerations. Turning to Page 18 for a financing and liquidity update. We feel very good about our liquidity and financial position today, in particular, after taking a number of steps in March and early April to access the capital markets. On March 20, Ameren Missouri issued $465 million of 2.95% first mortgage bond due in 2030. This tied for the lowest rate for a 10-year bond issuance in Ameren Missouri's history, which helps keep customers rates low as proceeds were used to repay short-term debt, including short-term debt incurred to repay a maturity in a $85 million of 5% senior unsecured notes that matured on February 1. Additionally, on April 3, Ameren Corp. issued $800 million of 3.5% senior unsecured notes due in 2031. These proceeds were used for general corporate purposes, including to repay short-term debt and to fund the repayment of Ameren Corp.'s 2.7% senior notes due November 15, which is the only maturity remaining in 2020. We decided to accelerate the holding company debt offering to secure our liquidity position during an uncertain time in the credit markets. We continue to expect to issue long-term debt at Ameren Missouri later this year to fund a portion of the wind generation investments expected to be in-service by the end of 2020. And I would note there are no long-term debt maturities in 2021. In December, we also increased the capacity of our credit facilities by $200 million and extended the maturity dates out to December 2024. Ameren's available liquidity on April 30 was approximately $2.5 billion. This includes the $2.3 billion of combined credit facilities available and approximately $150 million of cash on hand at the end of the month. There are no outstanding credit facility or commercial paper borrowings as of April 30. In addition, we also expect to receive between $540 million and $550 million upon the physical settlement of the August 2019 forward sale agreement on or before March 31, 2021, which is expected to be used to fund a portion of the Ameren Missouri's wind generation investments. Finally, I'm pleased to report that last month, both Moody's and S&P affirmed their credit rating outlooks of stable. Moving now to Page 19 for an update on Ameren Illinois regulatory matters. Last month, we made a required annual electric distribution formula rate update filing requesting a $45 million base rate decrease. Under Illinois formula ratemaking, Ameren Illinois is required to make an annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true-up any prior period over or under recoveries of such costs. If approved, as requested, all-in 2021 residential electric rates for customers taking delivery and energy supply from Ameren Illinois would be down by approximately 1% since formula ratemaking began in 2012. The ICC will review the matter in the months ahead with a decision expected in December of this year and new rates effective in January of next year. This along with our natural gas rate review remain on track. Finally, turning to Page 20, I'll summarize. We have a strong team and are well positioned to continue executing on our plan during these unprecedented times. We continue to expect to deliver strong earnings growth in 2020 as we successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. Further, we believe this growth compares very favorably with the growth of our regulated utility peers. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. This concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question comes from the line of Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hope you all are doing well."
},
{
"speaker": "Warner Baxter",
"text": "Hope you are doing well as well. Good to hear your voice."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Likewise. I wanted to follow-up on Missouri. And I mean, this is mostly in context of 1Q, you had a number of, call it, higher expenses. You've listed them out fairly in some detail. How do you think about those cascading through the course of the year and into '21? I imagine much of it like weather and onetime contributions are pretty limited to 1Q '20. But separately from focusing on higher expense, how do you think about the totality of O&M opportunities to offset the details that you provided on the lower 2.5% sales altogether?"
},
{
"speaker": "Michael Moehn",
"text": "Perfect. Julien, this is Michael. So I'll take a stab at this and then certainly Warner can add anything as well. But I mean, if I heard you right, you broke up a little bit there, but in terms of the higher costs that we saw in the first quarter, clearly, we're impacted by this company-owned life insurance, which we indicated in there, so that obviously provided a headwind. As you think back in terms of where we were at the beginning of the year, we talked about O&M costs being higher in general. We didn't guide to a specific number, we just said that we were going to be higher. Obviously, you have these headwinds that are occurring in the first quarter. As we think about all these COVID-related issues that we outlined in terms of what's going on with sales and bad debt, we are clearly focused on guiding to a lower O&M number today. And so hopefully, it gives you some context, not giving you the specifics of it. But clearly, we were higher O&M going into the year, got these headwinds. We've taken a number of actions, as Warner said, in terms of just managing headcount, obviously travel, conferences, watching overtime where we can, all those kind of things to make sure that we can keep a firm grasp on this."
},
{
"speaker": "Warner Baxter",
"text": "Yes. I think, Michael, you hit it right. So look, we're guiding down now from O&M expenses from where they were last year. And look, in looking at some of those things, Julien, clearly, we're mindful of several things. Of course, we're mindful of the expected impacts of COVID-19, which Michael did a nice job of outlining before. But of course, we're also mindful that we need to make sure we're delivering safe and reliable service to our customers. But clearly, we never lose our focus to earn as close to allowed return as possible. So when we think about all those things and providing that guidance, that's how we think about the O&M actions that we've taken."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Okay. But no specific pinpoint number here for the total -- totality of the year. And then a follow-up..."
},
{
"speaker": "Warner Baxter",
"text": "Yes, not at this point. I think we're going to continue to monitor it. And as you can appreciate here, we're here in the first quarter. And so we'll continue to monitor operations for the rest of the year, so yes. But that gives you, I think, a good sense of the direction that we're headed."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Absolutely. And then related to this, if I can, what about the Missouri's rate case strategy? I know you put a bullet in your slides about that, but can you elaborate on your thinking today? And again, also being cognizant that, yes, we're still in the first quarter here in terms of results, but how are you at least conceptually thinking about approaching it?"
},
{
"speaker": "Warner Baxter",
"text": "Yes. So Julien, just a couple of thoughts there. And then Marty, who's joining us remotely, all of our leaders, just so you know, our presidents are joining us remotely today as we continue to make sure we do the proper social distancing. So look, I think, at the end of the day, really no decision has been made at this time. But clearly, when you think about your next rate case filing, there are several things you have to think about. And certainly, the wind projects, right, which we've talked about on the call, but we also have to be mindful of the implications and impacts of COVID-19. And so those coupled with the fact that we just completed our last rate review, and those are some of the things that you would put on the list in terms of making a final determination there. And Marty, I know that you're on, anything that you would add to some of the things that you and your team are kicking around?"
},
{
"speaker": "Martin Lyons",
"text": "Well, Warren, you hit on a couple of the key ones. I think, Julien, when you look back at our last rate review filing, it was really to set up the timing for this next one, given the wind projects that we have going into service later this year, so those projects will still be top of mind in terms of getting those completed and making sure we think about how to time a rate case around those. Of course, Senate Bill 564, the Plan and Service Accounting, has really provided us some better flexibility on capital expenditures and the ability to be able to defer depreciation, return and get full recovery, so that's a consideration. But as Warner said, we feel good about the constructive rate settlement that we just had in this past rate review. I think that puts us in a good position to really think about the timing going forward. COVID-19, obviously, having impacts on our customers and our business, as Warner mentioned. And so all of those will be considerations as well as other cost of service considerations that will go into it. So I think all of that considered just means that we'll be thinking about really the best timing for this next rate review."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jeremy Tonet with JPMorgan."
},
{
"speaker": "Rich Sunderland",
"text": "It's Rich Sunderland, on for Jeremy. So just starting off with the wind project, appreciate the update there. Could you speak to any regulatory obligations with regards to the in-service dates? And maybe just a little bit more color with the line of sight to the potential end of year versus a slight push into Q1 for the 300 megawatts?"
},
{
"speaker": "Warner Baxter",
"text": "Yes. So this is Warner. So in terms of regulatory obligations, really none by the end of this year. Of course, we're very focused on getting those done in a timely fashion, as we outlined during the call. But if some of the projects -- and we talked about, at this time, we think there's a possibility for $100 million of that second project to get pushed into 2021. That doesn't cause any particular regulatory challenges for us. So that's how I see that."
},
{
"speaker": "Michael Moehn",
"text": "Yes. I mean, you got the renewable standard here in the state of Missouri. You got 15% by 2021, but we'll be in compliance with that. That's what Warner is saying that no issues with that."
},
{
"speaker": "Rich Sunderland",
"text": "Great. And then on bad debt expense, could you speak to a little bit about trends from maybe '08, '09 and what you're baking into guidance for 2020?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, Michael, why don't you take that one, please?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, you bet. So look, we're looking and mindful of everything that's happening to the customers. They're looking at in terms of LIHEAP is providing, obviously, an unprecedented amount of dollars here. I think Warren mentioned as well that we have dollars that are being allocated, obviously, to energy assistance as well. But as we step back and look at and going back to '08, '09, you're right, I think that's a great place for us to spend some time. I mean, we've done a nice job of driving down bad debt expense over time. We're probably at about $8 million today in bad debt expense. If you think about '08, '09 time frame, you're probably closer to $14 million, $15 million. So that's probably a good proxy to think about in terms of a couple of cents, about $6 million in terms of headwind potentially associated with bad debt expense."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Paul Patterson with Glenrock."
},
{
"speaker": "Paul Patterson",
"text": "Just on your comments, you mentioned that the long-term growth had certain expectations with respect to the 30-year treasury. And I know you guys have legislation pending in Illinois, which you mentioned and went over. But how should we think about what the long-term growth rate is if we do have this 30-year treasury where it is at? And also just your rate base growth seems to be unchanged and what have you. How should we think about what your expectation is, absent any legislation changing what the treasury -- the 30-year treasury would be?"
},
{
"speaker": "Warner Baxter",
"text": "So Michael, why don't you address sort of the overall 30-year treasury, and then maybe I can jump in and talk about the potential allocation of capital and -- okay?"
},
{
"speaker": "Michael Moehn",
"text": "Got it. I appreciate the question. I think as you think about the long-term guidance, and if you think about the 350 as the midpoint for 2020 and you take the 6% to 8% off of that, Paul, I mean, you get to about a $0.35 range out there in 2024, so a decent size range. And I think that range accommodates a number of things, which I think Warner maybe even referred to earlier. I mean, it refers potential treasury outcomes, certainly rate case outcomes, the timing of CapEx, other things. I mean, there are a number of levers that can be pulled over time. I would remind you a couple of, I think, key data points just to keep in mind. I mean, for every 50 basis points move in that distribution business, it's worth about -- it's an impact of about $0.035. And the other thing to keep in mind, too, is, I mean, as you think about how we're allocating capital today and where rate base growth is going over time, I mean, you get out to 2024, that Illinois distribution business is only about 18% of the overall rate base. So those are things just to keep in the back of your mind as you think about different impacts associated with that $0.35 range. I don't know if Warner..."
},
{
"speaker": "Warner Baxter",
"text": "I think that's a good point. So maybe I'll add then a little bit more color because you had a specific question around how we might think about our investments in Illinois. So look, we're mindful of the fact that our return on equity in Illinois is below industry averages. And I mean, that's why we're supporting legislation that's going to add 100 basis points to the current 580 basis points to the 30-year treasury. And so at the same time, too, we recognized that we're currently in an, frankly, unprecedented period in our country's history that's obviously driving historically low interest rates. And so what I would say is that, look, we're not going to have a knee-jerk reaction to our investment strategy because the investments that we've been making in Illinois have been delivering value to both our customers and shareholders. But look, we're also going to continue to monitor the situation. And at the same time, Rich and his team, they're going to be relentless and trying to make sure we pass what we think is really good legislation for our customers, the state of Illinois and certainly for our shareholders. And in so doing, we're going to continue to advocate for fair returns on those infrastructure investments. And then so doing, too, we think if we continue to make them, they're going to deliver a lot of value to our customers. So that's the color, that's in terms of how we think about it right now."
},
{
"speaker": "Paul Patterson",
"text": "Okay. I mean -- and I appreciate the color. I'm just sort of wondering, though, if we don't get legislation and if the rate is so low, would you -- I mean, I would assume that there would probably be some change in how you would allocate capital. I mean, it is a pretty robust rate base growth that you have in those slides and stuff where..."
},
{
"speaker": "Warner Baxter",
"text": "Sure. Like I said before, we're going to be mindful of our returns in our businesses. We always are mindful about how we allocate capital. We obviously are very thoughtful and strategic and so doing. But at the same time, as I sit here today, we're not going to be making any predictions or knee-jerk reactions."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Fair enough. And these are some technically..."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Paul. Please -- if you have another comment, please."
},
{
"speaker": "Paul Patterson",
"text": "Okay. I'm sorry. Just on the COLI, you broke it out for Missouri. And I just was sort of -- just trying to understand why the Illinois distribution isn't affected apparently by it? And could you just give us a little bit more color about how that COLI is distributed and -- I mean, not anything huge, if it's very complicated, don't bother your time, but just want to get more on that."
},
{
"speaker": "Michael Moehn",
"text": "No worries. Good question. Certainly, it's not complicated. I mean, it really -- Illinois -- it doesn't impact the Illinois distribution business because of the formula rate nature of it. So where you do have a little bit of impact is on the Illinois natural gas side. And so really focused in on the primary piece of Missouri because that's where the biggest impact is just because of the nature of that regulatory regime."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our next question comes from the line of James Thalacker with BMO Capital Markets."
},
{
"speaker": "James Thalacker",
"text": "Just following up real quickly on Paul's question. As you kind of look out at the reaffirmation of the 6% to 8% in the past, I know you guys have used kind of the forward curve for treasuries. Is that kind of what we should assume as embedded in the growth rate from here?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. No, Paul -- no, Jim. Historically, I think we maybe did guide to that several years ago. I think we kind of moved away from that a bit ago. And so again, just we have various internal assumptions in there. And again, as Warner stated, when we have a lot of different levers that we can pull, I know there's some sensitivity about just given, obviously, where that 30-year treasury sits today. But again, it's a $0.35 range, talked about the size of that overall distribution out there in 2024. I talked about the sensitivity to those rates. And so I think there are things that we continue to do to manage around that."
},
{
"speaker": "Warner Baxter",
"text": "Yes. I think, too, Michael, just to add. I mean, so don't lose sight of the slide that we show up there about the robust pipeline of investment that we have across all of our enterprises that goes not just beyond this first 5 years, but the $36 billion in total over 10 years. So that's certainly a lever that we have. And of course, all along, we're mindful of customer affordability and those types of things. So look, we don't -- we never say anything is a lay up, right? But at the same time, we're going to be very thoughtful in terms of how we manage the business that drives value for our customers and value for our shareholders."
},
{
"speaker": "James Thalacker",
"text": "Got it. Okay. And I guess, just as a real quick follow-up. As you look at the range, I know that you affirmed it today, but are you guys comfortable at this point in kind of talking about with your cost containment, and what you see for your sort of sales progression through the year through the various scenarios of kind of where you see yourself within that range? Would it be sort of at the midpoint, upper half, sort of lower half? Like how are you thinking about that?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, Jim. So this is Warner again. So I assume you're talking about our 2020 EPS guidance. And so look, consistent with our past practice, we just don't disclose where we're at within our guidance range, frankly, at any given time. And so the only thing I would say is that this team is focused and has a strong record of not just being focused but delivering within our guidance, and that's where we're going to continue to be focused in 2020."
},
{
"speaker": "James Thalacker",
"text": "Hope everyone is safe and well."
},
{
"speaker": "Operator",
"text": "Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Kirk for any final comments."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you for participating in this call. A replay of this call will be available for 1 year on our website. If you have questions, you can -- may call the contacts listed on our earnings release. Financial analysts' inquiries should be directed to me, Andrew Kirk. Media should call Erin Davis. Again, thank you for your interest in Ameren, and have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 4 | 2,021 | 2022-02-18 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. Mr. Kirk, you may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Warner Baxter, our Executive Chairman; Marty Lyons, our President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining us remotely. Warner will begin with a business overview. He will be followed by Marty, who will provide a strategic and business update for 2022 and beyond. And Michael will wrap up our prepared remarks with a discussion of key financial matters, including our earnings guidance. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now here's Warner, who will start on Page 4.
Warner Baxter: Thanks, Andrew. Good morning, everyone, and thank you for joining us. To begin, I'd like to remind everyone that effective January 1 of this year, I became Executive Chairman of Ameren, Marty Lyons became President and CEO. Our transition to this new forward-thinking leadership structure is going very well. In light of the significant activities taking place in our industry, this new structure is enabling me to focus on key energy and economic policy matters and working with Marty on key strategic initiatives. At the same time, Marty has hit the ground running, leading the Ameren team in overall strategy development and execution, as well as managing the significant day-to-day operational and other responsibilities of the CEO. Our industry is transforming and millions of customers in Missouri and Illinois are depending on us to achieve our vision, leading the way to a sustainable energy future and our mission to power the quality of life. Each year provides a new set of opportunities and challenges, but one thing that remains constant in Ameren is our strong commitment to safely deliver reliable, cleaner and affordable electric and natural gas service. Our team continues to effectively execute our strategic plan across all of our businesses. including safely and successfully completing billions of dollars of value-adding projects for our customers; advocating for constructive federal and state energy policies and regulatory outcomes; leaning further forward on our digital transformation; and pursuing a wide range of sustainability goals. Simply put, continued strong execution of our strategic plan is delivering significant value to our customers, communities, shareholders and the environment, which brings me to a discussion of our 2021 performance. Yesterday, we announced 2021 earnings of $3.84 per share compared to earnings of $3.50 per share in 2020 or an increase of nearly 10%. Excluding the impact from weather, 2021 normalized earnings were $3.82 per share or an increase of approximately 8% from 2020's weather-normalized earnings of $3.54 per share. We made significant investments in energy infrastructure in 2021 and that resulted in a more reliable, resilient, secure and cleaner energy grid as well as contributed to strong rate base growth at all of our business segments. As outlined on this page, we also achieved several constructive regulatory and legislative outcomes that will facilitate additional infrastructure investments while keeping our customers' rates affordable. This strong execution of our strategy in 2021 will continue to drive significant long-term value for all of our stakeholders. Turning to Page 5. As you can see on this page, our laser focus on keeping our customers at the center of our strategy has delivered strong results for our customers. Our investments in infrastructure have resulted in top quartile reliability, affordability and customer satisfaction. The frequency of outages on our system continues to trend downward, resulting from our infrastructure investments, coupled with a focus on innovation and continuous improvement. Our disciplined cost management has helped drive our electric rates approximately 25% below Midwest and national averages. And I'm extremely proud to say that J.D. Power recently ranked Ameren Illinois #1 in residential customer satisfaction in the Midwest, among large electric utility providers, with Ameren Missouri ranking third. Further, we have continued to deliver superior value to our shareholders, as you can see on Page 6. Our weather-normalized core earnings per share have risen 84% and an approximate 8% compound annual growth rate since we exited our unregulated generation business in 2013, while our dividends paid per share have increased approximately 38% over the same time period. This has driven a strong total return of nearly 220% for our shareholders from 2013 to 2021, which was significantly above our utility peer average. I'm very pleased with our past performance. You can rest assured that our team will remain focused on enhancing performance in 2022 and in the years ahead so that we can continue to deliver superior value to our customers, communities and shareholders. Turning to Page 7. This page summarizes our strong sustainability value proposition and focus on environmental, social, governance and sustainable growth goals. Beginning with environmental stewardship, in September 2020, Ameren announced its transformational plan to achieve net zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes interim carbon emission reduction targets of 50% and 85% below 2005 levels by 2030 and 2040, respectively, which is consistent with the objectives of the Paris Agreement in limiting global temperature rise to 1.5 degrees Celsius. We plan to file an update to the 2020 Integrated Resource Plan in the first half of this year, which Marty will discuss a bit later. In 2021, we acquired the 300-megawatt Atchison Renewable Energy Center located in Northwest Missouri, our second wind generation investment. This acquisition is a significant step forward, along the path to meeting our clean energy goals. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. This slide highlights a few of the many things we are doing for our customers and communities, including being an industry leader in diversity, equity and inclusion. We were honored to be recognized again by DiversityInc as one of the top utilities in 2021, in addition to a top company for ESG. And we continue to help drive inclusive economic growth by spending approximately $900 million with diverse suppliers in 2021, an 11% increase over 2020. Further, our strong corporate governance is led by a diverse Board of Directors focused on strong oversight that's aligned with ESG matters. And our executive compensation practices include performance metrics that are tied to diversity, equity and inclusion and progress towards a cleaner energy future. Finally, this slide summarizes our very strong sustainable growth proposition, which remains among the best in the industry. Today, we published our updated ESG investor presentation called Leading the Way to a Sustainable Energy Future, available at amereninvestors.com. This presentation demonstrates how we have been effectively integrating our focus on environmental, social, governance and sustainability matters into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. As noted previously, as part of my new role of Executive Chairman, I will focus on key energy and economic policy matters, including through my leadership roles at the Edison Electric Institute and the Electric Power Research Institute as well as engaging with key stakeholders. Speaking of key energy and economic policy matters, we continue to strongly support and advocate for a robust federal clean energy tax package. In particular, we support clean energy transition tax incentives, including wind, solar and nuclear production tax credits, electric vehicle tax credits, transmission and storage investment tax credits as well as direct pay and normalization opt-out provisions. We strongly believe these forward-thinking policies to address climate change will advance the clean energy transition in a safe, reliable and affordable fashion and will deliver significant long-term benefits for our customers, communities and country. We will continue to work with key stakeholders, along with our industry colleagues to advance constructive federal energy and economic policies. In closing, our team has accomplished a great deal over the last several years. Their relentless commitment to our vision, mission and strategy has delivered strong value to our customers, communities and shareholders. Looking ahead, I'm even more excited about our future because I believe these efforts have positioned Ameren very well to deliver superior value over many years to come. Now here is Marty to tell you how our team will keep delivering under this strategy in the future.
Martin Lyons: Thanks, Warner. Before I jump into the details, I would like to extend my appreciation to all of my coworkers for their dedication in 2021. Our accomplishments during the year are a result of their hard work and focus on executing our strategy, which has been delivering significant long-term value for all of our stakeholders. Going forward, our strategy remains the same, which is to invest in and operate our utilities in a manner consistent with existing regulatory frameworks, enhance regulatory frameworks, advocate for responsible energy and economic policies, and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. As Chief Executive Officer, my focus is to drive continuous improvement as we execute our strategy and take Ameren to higher heights. Moving now to Page 9. Yesterday afternoon, we announced that we expect our 2022 earnings to be in a range of $3.95 to $4.15 per share. Based on the midpoint of the range, this represents 8% earnings per share growth compared to the midpoint of our initial 2021 guidance range. Michael will provide you with more details on our 2022 guidance a bit later. Building on the strong execution of our strategy and our robust earnings growth over the past several years, we continue to expect to deliver long-term earnings growth that is among the best in the industry. We expect to deliver 6% to 8% compound annual earnings per share growth from 2022 through 2026 using the midpoint of our 2022 guidance, $4.05 per share as the base. Our long-term earnings growth will be driven by continued execution of our strategy, including investing in infrastructure for the benefit of our customers while keeping rates affordable. Our dividend is another important element of our strong total shareholder return. I am pleased to report that last week, Ameren's Board of Directors approved a quarterly dividend increase of 7.3%, resulting in an annualized dividend rate of $2.36 per share. This increase reflects confidence by Ameren's Board of Directors in the outlook for our businesses and management's ability to execute its strategy for the long-term benefit of our customers and shareholders. Looking ahead, we expect Ameren's future dividend growth to be in line with our long-term earnings per share growth expectations and within a payout ratio range of 55% to 70%. And while I'm very pleased with our past performance, we are not sitting back and taking a breath. Turning to Page 10. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. The strong long-term earnings growth I just discussed is primarily driven by our rate base growth plan. Today, we are rolling forward our 5-year investment plan. And as you can see, we expect to grow our rate base at an approximate 7% compound annual rate for the 2021 through 2026 period. This growth is driven by our robust capital plan of approximately $17 billion over the next 5 years that will deliver significant value to our customers and the communities we serve. Our plan includes strategically allocating capital to all 4 of our business segments. Importantly, renewable generation and regionally beneficial transmission represent additional investment opportunities. We expect to file an update to our 2020 Missouri Integrated Resource Plan in the first half of this year, in light of the accelerated retirement of our Rush Island Energy Center. This filing will include a comprehensive set of updated assumptions, taking into account MISO's long-range transmission planning process and potential legislative and regulatory developments at the federal level among other things. This updated planning process is underway, and we fully expect it to underscore the need for expansion of our renewable generation portfolio and transmission investment. We continue to work in earnest with developers to acquire renewable generation projects to be completed in 2024 through 2026, as evidenced by the announcement earlier this week of an agreement to acquire a 150-megawatt solar energy project. We expect to announce further agreements over the course of this year and to file certificates of convenience and necessity, or CCNs, with the Missouri PSC after the updates to the 2020 IRP have been filed. Finally, we remain focused on disciplined cost management to keep rates affordable and improve earned returns in all of our businesses. Moving to Page 11. As we look to the future, our 5-year plan is not only focused on delivering strong results through 2026, but it is also designed to position Ameren for success over the next decade and beyond. We believe that a safe, reliable, resilient, secure and cleaner energy grid will be increasingly important and bring even greater value to our customers, our communities and shareholders. With this long-term view in mind, we are making investments that will position Ameren to provide safe and reliable electric and natural gas service but also to meet our customers' future energy needs and rising expectations and support our transition to a cleaner energy future. The right side of this page shows that our allocation of capital is expected to grow our electric and natural gas energy delivery investments to be 84% of our rate base and coal-fired generation to decline to just 6% of rate base by the end of 2026. Only 4% of the capital expenditures in our 5-year plan are expected to be spent on coal-related projects. Importantly, our 5-year plan does not reflect the expected early retirement of the Rush Island Energy Center or investment opportunities associated with renewable generation and regionally beneficial transmission projects. The bottom line is that we are taking steps today across the board to position Ameren for success in 2022 and beyond. Turning now to Page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of over $45 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will not only create a stronger, smarter and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs in the future and delivering on our customers' expectations. Moving now to Page 13. As we have discussed with you in the past, MISO completed a study outlining the potential road map of transmission projects through 2039. Taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation, based on announced utility integrated resource plans, state mandates and goals for clean energy or carbon emission reductions, among other things. Under MISO's Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon emissions reduction below 2005 levels by 2039, MISO estimates approximately $30 billion of future transmission investment would be necessary in the MISO footprint. Under its Future 3 scenario, which resulted in an 80% reduction in carbon emissions below 2005 levels by 2039, MISO estimates approximately $100 billion of transmission investment in the MISO footprint would be needed. It is clear that investment in transmission is going to play a critical role in the energy transition. And we are well positioned to plan and execute potential projects in the future for the benefit of our customers and country. I am pleased to report that in January, MISO transmission owners and MISO reached an agreement on a revision to the cost allocation for certain of these important regional transmission projects. The cost allocation tariff revisions were submitted to FERC for approval on February 4. The revisions allow for allocation of project costs within the subregion where the benefits are recognized. Previous regional benefit project costs have been spread broadly across the MISO region, which was prior to the addition of the MISO South subregion. Comments are due by March 7. MISO and MISO transmission owners have requested an effective date of May 19, 2022. We continue to work with MISO and other key stakeholders and believe certain projects outlined in Future 1 are likely to be included in this year's MISO transmission planning process, which is expected to be completed in mid-2022. Turning now to Page 14 and an update on our Rush Island Energy Center. As you may recall, in 2011, the Department of Justice, on behalf of the EPA, filed a complaint against Ameren Missouri, alleging that in performing certain projects at the Rush Island Energy Center, it violated the New Source Review provisions of the Clean Air Act. In 2017, the District Court issued a liability ruling and in September 2019, ordered the installation of pollution control equipment at the Rush Island Energy Center. In November, the U.S. Court of Appeals denied Ameren Missouri's request for reconsideration of its decision affirming the District Court's order that requires installation of a scrubber at Rush Island Energy Center in order to continue operations. Subsequently, Ameren Missouri announced its intention to retire the energy center in lieu of installing a scrubber and requested a modification from the District Court of its previous order to allow for plant closure, along with time to address any reliability issues. Ameren Missouri expects to make an Attachment Y filing soon, formally notifying MISO of its intention to retire the Rush Island Energy Center. MISO will then conduct a reliability assessment. A preliminary study completed by MISO in January of 2022, indicated that in advance of retirement, transmission upgrades and additional voltage support are needed on the transmission system to ensure reliability. The preliminary MISO reliability study was filed with the District Court, which is under no deadline to issue an order regarding our request to modify the September 2019 remedy order. As stated earlier, in light of these developments, Ameren Missouri expects to file an update to the Integrated Resource Plan with the Missouri PSC in the first half of 2022, which will reflect the expected accelerated retirement date of the Rush Island Energy Center. Such filing will also reflect the expected use of securitization in order to recover the remaining investment in Rush Island. Lastly, this week at the Missouri PSC staff's request, the commission directed them to review various matters associated with our plans to retire Rush Island. Overall, we understand the desire of the commission and staff to develop a deeper understanding of our decision to accelerate closure of Rush Island and related system reliability considerations. We welcome the review and believe it will be good for the commission and staff as well as all stakeholders to have a deeper understanding of this matter. From our standpoint, it should also help to inform future rate review, IRP and securitization proceedings. Before leaving this slide, I would also like to provide some insight on recent findings proposed by the EPA related to our Sioux and Meramec Energy Center impoundments. Last month, Ameren Missouri received notice of an interim decision by the EPA that has rejected Ameren Missouri's request to extend the time line for operating certain impoundments located at the Sioux and Meramec energy centers until a replacement pond could be built at Sioux and in the case of Meramec, the energy center retires, which is expected later this year. We are pursuing options to address the EPA decision and at this time, do not expect any significant impacts on operations. Meramec will close as planned by the end of 2022. Moving to Page 15 to the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Over the years, we have been successful in executing this element of our strategy by focusing on delivering value to our customers through investments in energy infrastructure and extensive collaboration with key stakeholders in all of our regulatory jurisdictions. I am very pleased to report progress continued last year when the Illinois energy transition legislation was enacted. This is a constructive law that addresses the key objectives, and we felt were important for our customers and the communities we serve. The law established a new forward-thinking regulatory framework that will enable us to continue to make important infrastructure investments to enhance the reliability and resiliency of the energy grid as well as enable us to invest in 2 solar or solar plus battery storage pilot projects. It will also give us the ability to earn fair returns on these investments. The Illinois energy law allows for an electric utility to opt in to a multiyear rate plan effective for 4 years beginning in 2024. We are currently working with key stakeholders through various workshops, which will continue over the course of 2022 to establish specific procedures, including performance metrics to implement this legislation. We expect performance metrics to be approved by the ICC by late September. Subject to finalizing key aspects of this rate-making framework, we anticipate filing a multiyear rate plan by January 20, 2023. Moving to Missouri legislative matters, a key piece of legislation was filed for consideration in this year's session. Bills have been introduced in both the House and the Senate to enhance the Smart Energy Plan legislation enacted in 2018. As part of Missouri's Smart Energy Plan, a multiyear effort to strengthen the grid, our customers are benefiting from stronger poles, more resilient power lines, smart equipment and upgraded circuits to better withstand severe weather events and restore power more quickly. The proposed legislation would enhance and extend the existing regulatory framework. It would modify the rate cap from the current 2.85% compound annual all-in cap on growth in customer rates, to a 2.5% average annual cap on rates on rate impacts of PISA deferrals. In addition, the proposed legislation would expand and extend economic development incentives as well as remove the sunset date. With all of this in mind, we are focused on working with key stakeholders to get this important legislation passed this year. Moving to Page 16. Over the last several years, we have worked hard to enhance the regulatory frameworks in both Missouri and Illinois to help drive additional infrastructure investments that will benefit customers and shareholders. At the same time, we have been very focused on disciplined cost management to keep rates affordable. Since opting into constructive regulatory frameworks, significant investments have been made, reliability has improved, rates have remained relatively flat, customer satisfaction has increased and thousands of jobs have been created. While these are great wins for our customers and communities, we are not done. Turning to Page 17. As you can see from this chart, our total fuel and purchase power and operations and maintenance expenses have decreased 3% compared to 2016 levels. And we will remain relentlessly focused on continuous improvement and disciplined cost management as we look forward to the next 5 years. This will not only include continuing the robust cost management initiatives implemented over the past 2 years due to COVID-19, but also several other customer affordability initiatives. These initiatives include the automation and optimization of our processes, including leveraging the benefits from significant past and future investments in digital technologies and grid modernization. Moving to Page 18. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will continue to deliver superior value to our customers, shareholders and the environment. We believe our expectation of 6% to 8% compound annual earnings growth from 2022 through 2026, driven by strong rate base growth, compares very favorably with our regulated utility peers. I am confident in our ability to execute our customer-focused strategy and investment plans across all 4 of our business segments as we have an experienced and dedicated team with a track record of execution that has positioned us well for future success. Further, our shares continue to offer investors an attractive dividend. And the strong earnings growth expectations we outlined today position us well for future dividend growth. Simply put, we believe our strong earnings and dividend growth outlook result in a very attractive total return opportunity for shareholders. Finally, turning to Page 19. I would like to take the opportunity to introduce to you Ameren Missouri's new Chairman and President, Mark Birk. Over the last 2 years, I was fortunate to have the opportunity to lead the Ameren Missouri organization and work closely with Mark. Mark has been an invaluable part of the Ameren team over the last 35 years. Prior to his new role, Mark served as Ameren Missouri's Senior Vice President of Customer and Power Operations. And over the course of his career, he has held numerous corporate and operations roles, including oversight of strategy and planning, business risk management, safety, nuclear operations as well as a host of electric and natural gas operational areas. I look forward to working with Mark in the future in our new roles. Again, thank you all for joining us today. And I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to Page 21 of our presentation. Yesterday, we reported 2021 earnings of $3.84 per share compared to earnings of $3.50 per share in 2020, an increase of 9.7%. Earnings in Ameren Missouri, our largest segment, increased $0.25 per share from $1.77 per share in 2020 to $2.02 per share in 2021. Increased investments in infrastructure and wind generation, eligible for plant and service accounting and the Renewable Energy Standard Rate Adjustment Mechanism, or RESRAM, positively impacted earnings by $0.21 per share. Higher electric retail sales also increased earnings by approximately $0.16 per share, largely due to continued economic recovery in 2021 compared to unfavorable impacts of COVID-19 in the year ago period. We've included on this page the year-over-year weather-normalized sales variances. Total weather-normalized sales in 2021 were largely consistent with our expectations outlined on our call last February. New electric service rates effective April 1, 2020, also increased earnings during 2021 by approximately $0.10 per share compared to the year ago period. Finally, these favorable factors were partially offset by higher operations and maintenance expenses, which decreased earnings $0.12 per share, primarily due to the amortization of deferred expenses related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage. Moving to Ameren Illinois Electric Distribution, earnings increased $0.06 per share, which reflected increased infrastructure and energy efficiency investments and a higher allowed return on equity under performance-based ratemaking. The formula base return on equity was 7.85% in 2021 compared to 7.4% in 2020 as it was applied to -- and was applied to a year-end rate base. The 2021 ROE was based on the 2021 average 30-year treasury yield of 2.05%, up from the 2020 average of approximately 1.6%. Ameren Transmission earnings were up $0.02 per share, which reflected increased infrastructure investments that were mostly offset by the absence of the benefit from the May 2020 FERC order addressing the MISO allowed base return on equity and the impact of the March 2021 FERC quarter addressing the historical recovery of materials and supplies inventories. Earnings for Ameren Illinois Natural Gas were up $0.02 per share, which reflected new delivery service rates effective in late January 2021 and increased infrastructure investments, partially offset by higher other operations and maintenance expenses. Ameren Parent and other results were down $0.01 per share, which reflected increased interest expense, primarily from higher long-term debt balances. And finally, earnings per share and earnings per share drivers on this page are computed using 2020 weighted average shares outstanding. The higher shares outstanding in 2021 reduced overall earnings by $0.15 per share. Before moving on, I'll touch on 2021 sales trends for Ameren Illinois Electric Distribution. Weather-normalized kilowatt hour sales to Illinois residential customers were flat year-over-year and weather-normalized kilowatt hour sales to Illinois commercial and industrial customers increased 3% and 3.5%, respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Moving to Page 22 of the presentation. Here, we provide an overview of the $17.3 billion of strategically allocated planned expenditures for the 2022 through 2026 period by business segment that underlies the approximately 7% projected rate base growth Marty discussed earlier. This plan includes an incremental $200 million compared to the $17.1 billion 5-year plan for 2021 through 2025 that was laid out last February, which included the $500 million wind investment completed in 2021. As you can see on the right side of this page, we are allocating capital consistent with the allowed return on equity under each regulatory framework. Importantly, as Marty mentioned earlier, renewable generation and regionally beneficial transmission represent additional investment opportunities. Turning to Page 23. We outlined here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. We also expect to generate significant tax deferrals. These tax deferrals are driven primarily by the timing differences between financial statement depreciation reflected in customer rates and accelerated depreciation for tax purposes. From a financing perspective, we expect to continue to issue long-term debt in Ameren Missouri and Ameren Illinois to fund a portion of our cash requirements. Pursuant to a November 2021 note purchase agreement, we will issue $95 million of ATXI debt in August 2022. We also plan to continue to use newly-issued shares for our dividend reinvestment and employee benefit plans over the 5-year guidance period. We expect this to provide equity funding of approximately $100 million annually. In order for us to maintain a strong balance sheet while we fund our robust infrastructure plan, we expect incremental equity issuances of approximately $300 million each year starting in 2022 through 2026. Approximately $95 million of equity outlined for 2022 was sold on a forward basis under our at-the-market equity distribution program, leaving approximately $200 million to be sold for the remainder of 2022. Together, issuance of our 401(k), DRPlus and ATM equity programs are expected to support our equity needs through 2023. All of these actions are expected to enable us to support a consolidated capitalization target of approximately 45% equity over the 5-year plan. Moving to Page 24 of our presentation. I would now like to discuss key drivers impacting our 2022 earnings guidance. As Marty stated, we expect 2022 diluted earnings per share to be in the range of $3.95 to $4.15 per share. On this page and the next, we have listed key earnings drivers and assumptions behind our 2022 earnings guidance, broken down by segment as compared to the 2021 results. Beginning with Ameren Missouri, earnings are expected to rise in 2022. New electric service rates will be effective February 28, the 2022 earnings comparison is also expected to be favorably impacted by higher investments in infrastructure and wind generation that's eligible for PISA and RESRAM, which benefits earnings in January and February until rates are reset. We also expect to recognize earnings related to energy efficiency performance incentives from both 2021 and 2022 planned years in 2022. As a result, we expect energy efficiency performance incentives to be approximately $0.04 per share higher than 2021. These favorable factors are expected to be partially offset by higher operations and maintenance and interest expenses. Further, we expect the return to normal weather in 2022 will be decreasing Ameren Missouri earnings by approximately $0.02 compared to 2021 results. We also expect higher total weather-normalized electric sales of approximately 1% in 2022 compared to 2021, as residential sales decline and commercial sales continue to increase. We expect total weather-normalized sales to return to 2019 levels by mid-2022, with this year's growth expected to be primarily over the second half of the year. Moving on, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois and ATXI projects made under forward-looking formula ratemaking. The absence of the March 2021 FERC order on historical recovery of materials and supplies is also expected to increase earnings $0.03 per share. Turning to Page 25. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2022 compared to 2021 from additional infrastructure investments made under Illinois performance-based rate making. Our guidance incorporates a performance-based ROE of 8.05% using a forecasted 2.25% 2022 average yield for the 30-year treasury bond, which is higher than the allowed ROE of 7.85% in 2021. The allowed ROE is applied to year-end rate base. For Ameren Illinois Natural Gas, earnings will benefit from higher delivery service rates that were effective late January 2021 as well as from infrastructure investments qualifying for rider treatment. These favorable factors are expected to be partially offset by higher operations and maintenance and depreciation and amortization expenses. Moving now to Ameren-wide drivers and assumptions. We expect the increased common shares outstanding to unfavorably impact earnings per share by $0.04 and higher interest expense, primarily from higher long-term debt balances. Of course, in 2022, we will seek to manage all of our businesses to earn as close to our allowed returns as possible while being mindful of operating and other business needs. I'd also like to take a moment to discuss our retail electric sales outlook. We expect the weather-normalized Missouri kilowatt-hour sales to be in the range of flat to up approximately 0.5% compounded annually over the 5-year plan, excluding the effects of our MEEIA energy efficiency plan using 2022 as the base year. We exclude MEEIA effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales resulting from our energy efficiency efforts. Turning to Illinois. We expect our weather-normalized kilowatt-hour sales, including energy efficiency, to be relatively flat over the 5-year plan. Turning to Page 26 and regulatory matters. In December, the PSC approved a nonunanimous stipulation agreement that resolved both the electric and natural gas rate reuse for Ameren Missouri. The agreements were black box settlements, which did not provide for certain specific details of the final orders. In both rate reviews, an allowed ROE was not specified but did provide for approximately 52% equity ratio for use in calculating PISA and RESRAM. The electric revenue requirement increased by $220 million annually, reflecting a rate base of $10.2 billion. The approved agreement also provided for the continuation of key trackers and riders, including the fuel adjustment clause. The natural gas revenue requirement was increased by $5 million annually, reflecting a $313 million rate base. Both electric and natural gas rate changes are effective at the end of this month. Looking ahead, we will continue to assess the timing of our next rate review. In making this decision, we will take into account several considerations, including our capital expenditures and other cost of service considerations as well as updates to the Integrated Resource Plan expected to be filed in the first half of this year, reflecting the accelerated retirement of the Rush Island Energy Center and timing of our expected securitization filing. Regarding Ameren Illinois regulatory matters, in December, the ICC approved a $58 million base electric distribution rate increase in the annual rate update proceeding with new rates that were effective at the beginning of this year. Finally, turning to Page 27. We have a strong team and are well positioned to continue executing our plan. We delivered strong earnings growth in 2021, and we expect to deliver strong earnings growth in 2022 as we continue to successfully execute our strategy. And as we look ahead, we expect 6% to 8% compound earnings per share growth from 2022 to 2026, driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions]. Our first question comes from Shar Pourreza with Guggenheim Partners.
Shahriar Pourreza: Just a couple of quick questions here. First, just on supply chain. Are you seeing any impacts on the renewable side, especially as we think about the 2.4 gigs? I mean we've seen a few of your peers shift megawatts out either from panel shortages or other sort of supply chain disruptions. Any thoughts here? Any materials locked in or procured? And if this isn't transitory, since you guys are essentially swapping megawatts for megawatts as we think about renewables versus coal, could any project delays cause an impact to sort of the coal retirement time lines, especially as we're thinking about Sioux?
Martin Lyons: Shar, yes, this is Marty. Let me take that one on supply chain as it relates renewables and then perhaps Michael can comment on supply chain or issues more broadly. First of all, I'd say that as we went through last year, we had hoped by the end of the year to have announced some renewable projects. As you saw, we just announced one this week, which we're excited about. I would say it's a start in terms of the renewal projects that we hope to get announced and delivered in the '24 to 2026 time frame. But to your point, some of the negotiations last fall and into the winter were, I would just say, slowed by supply chain issues, tariff issues, some of the inflationary pressure seen in the renewable space, which simply meant that it was taking a little longer to work through some of the contractual negotiations. But we're able to get that first project announced. We are still expecting this year to announce other projects. And we'll see whether these things are transitory or not. But again, some of the bigger bulk of the projects we're trying to get done are out there in that '24 to 2026 time frame. So certainly, time for some of those issues to settle down. Ultimately, whether that has any impact on longer term, our scheduled coal retirement at Sioux will remain to be seen. As you know, especially in light of the accelerated closure of Rush Island, we plan to update our Integrated Resource Plan in the first half of this year. And so as we do that, we'll be taking into consideration some of the observations -- more recent observations we have on the renewable market, the timing of expected projects there as well as just the other -- the broader dynamics associated with reliability of our system long term and providing updates in there. So it would really be premature to say whether there's any impact on the retirement date of Sioux. But again, we're continuing to work with developers on these renewable projects and do expect to have further announcements this year. As I did indicate in the prepared remarks, to the extent that we have additional projects to be approved by the commission, we anticipate filing those CCNs after we file the update to the Integrated Resource Plan because that Integrated Resource Plan provides a good backdrop for the commission to consider the approval of those CCNs. Michael, any other comments broadly on supply chain?
Michael Moehn: Marty, no, that was pretty comprehensive. Nothing material to add to that answer. Shar, do you have something else?
Shahriar Pourreza: Yes, terrific. And then just one last one. I know this is maybe a little bit of a perennial topic at this point, but any thoughts on sort of the potential end of QIP in Illinois? I mean it seems like efforts to eliminate it are getting a little bit noisy again, but it's also scheduled to expire in '23. Could we see it extended? Would it change one way or another have any impact on your updated plan to invest about $1.8 billion between now and '26?
Martin Lyons: Yes, Shar. A terrific question. You know that the QIP in the gas business in Illinois has been really, I think, a terrific rider for the benefit of customers. It's really allowed us to do a lot of projects in Illinois, as much as 50% of our capital expenditures, replacing underground pipes, et cetera, to improve the safety and reliability of our gas system. So it's been a good rider. Certainly can't predict whether any legislative effort to end it prematurely will be successful or not. As you said, it's already scheduled to expire at the end of 2023. So look, it's been a good rider. We'd love to see it extended. We'd love to see perhaps some other mechanism go in its place that would be similarly beneficial. But ultimately, we do have in the gas business in Illinois, a favorable foundation for ratemaking, which is a forward test year with other good features like decoupling. So look, as we move forward, we'll continue to see whether there's either an extension of that QIP or perhaps something else that goes in its place. But ultimately, we can reassess both, not only the projects that we've got but also the timing of rate reviews and the like. At the end of the day, we feel like the projects that we're doing there, the projects we have planned there are great for our customers, great for the communities, and we'll look for a path forward to making those investments.
Operator: Our next question comes from the line of Durgesh Chopra with Evercore.
Durgesh Chopra: On the 6% to 8% growth rate target, I mean, obviously, it looks like there's a ton of upside CapEx potential, whether it's the Rush Island-related CapEx, the MISO transmission CapEx, there may be an ROE bump in future years from the SB2408 in Illinois. What are you assuming in that 6% to 8% growth rate target in terms of these upside opportunities?
Martin Lyons: Well, again, I think that you've summarized it well. At the end of the day, we've got $17.3 billion of planned capital expenditures over 4 quality jurisdictions. We expect that to drive 7% compound annual rate base growth. And really, that is the foundational driver of our 6% to 8% planned EPS CAGR over this period of time. But you also pointed out some additional opportunities we have, and those are specifically in the areas of renewable generation as well as some of these regionally beneficial transmission projects. And those represent potential additions to the capital expenditure plans and the rate base growth. So those are -- the things that you highlight are the things that give us confidence, not only in our ability to execute the $17.3 billion and the 7% rate base growth, but certainly conviction around that 6% to 8% EPS growth target.
Michael Moehn: Yes, the only thing I would add to that, Marty's really comprehensive answer, is with respect to Illinois, we kind of moved through this new process there in terms of opting into the multiyear plan. I think we'll continue to step back and assess the opportunities there. There obviously is a tremendous amount of projects that are needed to get done on the benefit of customers. We've made some great progress there, but there's just a lot of aging infrastructure. So as you know, we've been pulling that CapEx down a little bit over time just because of some of those returns. And so we'll assess that too as an opportunity, but Marty certainly highlighted the big ones.
Martin Lyons: Thanks, Michael.
Durgesh Chopra: Got it. And then maybe can I just follow up on the whole -- the staff and commission review of the Rush Island retirement and generation needs to fill that hole, what are sort of the key milestones for us to watch there in terms of like the next steps that we should be watching for? Is that -- and then what is the end outcome you think of that review process?
Martin Lyons: Yes, sure. So I think as it relates to Rush Island, we'll be continuing to work with the District Court in terms of the plans forward for the ultimate retirement date of Rush Island. As we shared in our prepared remarks, there was a preliminary assessment done by MISO related to the closure of Rush Island, which really determined that there were upgrades and additional investments needed too for voltage support and long-range -- longer-term reliability of the system in light of that planned closure. And so now we'll be moving forward with filing an Attachment Y soon, which will be more of a -- I just call it a formal assessment. The preliminary assessment's done and that formal assessment will be done. And then once we've done that, we have to determine what the right investments are to be made on the system and get those planned and approved and executed over time. So some of the milestones to watch there, the MISO Y filing as well as decisions coming from the District Court around the retirement of that plant. So those are some things in that regard. Now specifically, in terms of the staff review, like I said, what they're looking to do here, I think, is really get a deeper understanding of the decision to close Rush Island as well as these reliability impacts that I've been talking about. Rush Island, as you know, is a 1,200-megawatt plant. It's been highly reliable. It's been low cost and provided great value to our customers over time. So in terms of their review, they'll be conducting that, there's going to be -- the commission has asked them to file a preliminary report around April 15, but there's really no deadline on any kind of a final report from the commission staff. And then we also, at the commission's request, we'll be providing monthly status updates in terms of the progress towards closure of Rush Island and I think importantly to what we're doing from a reliability standpoint associated with that. So those are some of the milestones to look for.
Durgesh Chopra: Congrats on a solid quarter.
Operator: Our next question comes from the line of Jeremy Tonet with JPMorgan.
Jeremy Tonet: I just want to build off some of those questions there. Just wondering if you could frame, with regards to the Missouri IRP, MTEP process, Rush Island, just when could this be pulled into the plan? When do you think this could materialize? And how do we think about, I guess, potential incremental equity needs should this come in? Just trying to get the size of CapEx timing and incremental equity, how that might balance out.
Martin Lyons: Yes, Jeremy, this is Marty. I'll start, and I'm sure Mike will add on to this as well. But a couple of things. As we laid out again, in the IRP, we really expect that, that will get filed in the first half of this year. And importantly, there, we'll be considering, like I said, the early retirement of Rush Island, any updates to our renewable expansion plans, investments needed in the transmission system as well and doing a comprehensive update of that Integrated Resource Plan. So through that, certainly, you'll get an idea of some of the updated thoughts in terms of additional investments that may be required. Also, as you mentioned and we mentioned in our prepared remarks, we do expect that the MISO will end up approving some of the projects that will move us towards that Future 1 plan that they've got out there, and we expect that, that, again, too, is going to occur by mid this year. Premature to say the size of the portfolio projects that MISO approved in this Tranche 1 that we expect to get approved midyear or the size of the allocation of projects to us. But that's going to be another key milestone as we look ahead to this year in terms of identifying additional potential investments that we'll have longer term. So with that, those -- midyear, we should get some greater visibility, I suspect, in terms of some of those potential projects. And then I think as a team, we'll have to step back and assess those projects and decide ultimately which of those becomes additive to our plan and in what years and how we move forward with execution. Michael, you want to tackle some of those other questions?
Michael Moehn: Yes. Perfect, Marty. Yes. I think that's well said. I mean, just in terms of -- Jeremy, we said this before. We just don't want to get in front of the regulatory process on that, and we'll just continue to assess these over time. And as we make that determination and figure out sort of what is incremental to the plan, that's when we would step back and look at what our financing needs would be with respect to that. As we've said in the past, we like our ratings where they are today. We're very focused on our metrics. We're targeting this capitalization ratio of about 45% equity over the balance of the plan. That's really what's driven the $300 million that we have in there today. And again, it would kind of be just on a case-specific basis. I wouldn't see us deviating much from that honestly, so I mean if that gives you any indication of how we would think about financing this going forward. But we would assess it at that point in time. So hopefully, that helps.
Jeremy Tonet: That's very helpful, not much on the equity side, but great to hear. And then just from a transmission perspective, can you give any sense of the size and scope of the reliability needs around Rush Island's closure? Just wondering any thoughts you could provide there?
Martin Lyons: Yes. Really hard to at this point. We're in those early stages, like I said, through the preliminary assessment that MISO did clear. The transmission upgrades are going to be needed both for voltage support as well as to ensure long-term reliability of the system. So clearly, some transmission investment needs there. But it's premature to say exactly what those will be. Efforts along those lines, given the preliminary assessment are already underway to determine some of those things. But ultimately, it will be a process working with MISO in particular, to determine what those needs will be and how much of an investment will be required there.
Operator: Our next question is from Paul Patterson with Glenrock Associates.
Paul Patterson: Congratulations. So just on the Missouri legislation that you have there. Just wondering sort of what the practical impact from a shareholder perspective might be if you guys have that? And also, what's the reason from going from a 2.85% cap to a 2.5% cap? Is that just part of the give and take of legislation? Or is there something that's specifically happening that's causing people to want that?
Martin Lyons: Yes, Paul, good questions. Look, as it relates to this legislation, first of all, this plant and service accounting, we call it, Missouri Smart Energy Plan, has been working really well for customers. It's really allowed us to make significant additional investment in our system. We talked early on in the call about how that's just driving higher reliability. It's allowed us to deploy clean energy. It's really doing good things for the economy. We've created a lot of jobs and at the same time, been able to keep rates very low for customers. So it's really been working extremely well. And what this legislation really is all about is just making sure that we have a sustainable long-term framework to support continuation of those efforts. So it's really all about longevity of what the legislature put in place several years ago. And so that's what it's all about. You see some of the features we laid out in the slides: removes the sunset from the plan, which would be good, improves longevity to begin with; improves the economic development incentives, which have been really great for attracting businesses and helping businesses expand in our state. So it's improvement there. What the cap specifically is all about is today, as you see, there's a cap on the overall growth in rates, total rates. What we're saying here is that it would be better to have a cap, which is a good consumer protection, a cap, but it would be on the impact of these deferrals, the piece of deferrals that were really directed by that legislation. And so that, too, I think, improves longevity of the ability to utilize and -- this great regulatory framework long term.
Paul Patterson: So when do we need to -- I mean, you've got it there now, but when is the sunset again on the current one?
Martin Lyons: Sunset on the current one is the end of 2023. Now when we say sunset, it doesn't necessarily go away. It just means that we would need to go to the commission and re-up or ask them to re-up for another 5 years. So we would need to make a filing and the commission would need to approve that for another 5 years.
Paul Patterson: So it's not a real sunset? I mean -- so I mean, I guess you would be at the discretion of the commission as opposed to having it sort of legislatively in place. Is that the way to think of it?
Michael Moehn: Correct.
Martin Lyons: Yes, it's the right way to think about it. That's right. That's why I wanted to clarify my thoughts. You'd use the word sunset and I'd responded, but it's not a hard stop. Just a check-in point, if you will, to go back to the commission and re-up for another 5 years. But you're absolutely right in the way you've characterized the legislation, which would be more of a steady state going forward.
Michael Moehn: And Paul, this is Michael. I mean, if we were to do that opt-in and then everything that sort of exists today from a cap, sort of all of that would continue to apply going forward, right? So the commission has the ability to extend it but not modify it in any way, just to be clear.
Paul Patterson: And then on the coal ash, any thought about what the -- and I apologize if I missed this, what the total number in terms of the EPA impact might be? And also, is that -- how would that be treated regulatory speaking? Is that something that could be securitized? Or just how should we think about any potential coal ash cleanup expense?
Martin Lyons: No. Paul, there's really no -- we weren't really talking about coal ash cleanup expenses. It's really modifications to the impoundments that we have at these power plants in order to be able to continue to dispose of either ash or residuals coming out of our scrubbing. So again, what we said on the call there is, really don't expect to have any material impact from the EPA's decision. Part of it related to Meramec, which we have plans to close at the end of 2022. And then the other potential impact was at our Sioux Energy Center, and we are working through options, which we believe will ultimately mean that there's no significant impact in terms of the EPA's recent ruling.
Michael Moehn: Yes, that's right. And then Paul, it would just be in...
Paul Patterson: Okay. So in other words, the impoundment improvements really aren't going to be all that costly. Is that right?
Martin Lyons: Correct. It would just be a typical capital project that we would recover in the normal course of our rate review. And yes, correct. It is not going to be an overly material number as we sit here today.
Paul Patterson: Well, that's very good news. Okay. Awesome. Congratulations again.
Operator: Our next question is from Julien Dumoulin-Smith with Bank of America.
Julien Dumoulin-Smith: Listen, just with respect to the comments on Jeremy's question earlier, I want to go back, if I can, just to understand the cadence of some of these updates. If I hear you guys right, though, with respect to Rush Island and some of the MISO agreements in principle that you have, you could be in a position to at least update some of the transmission spending earlier than perhaps, say, some of the incremental renewables here. Can you talk about the time line here? I mean you've got Attachment Y coming pretty soon, it would seem. If this agreement translates in, as you say, Stage 1 in mid-'22, could you be in a position to look at kind of a more holistic view on transmission by, say, the November EEI time frame? Just curious if you can elaborate a little bit more on how that comes together, to what extent? It seems like there is an overlap in what you would be doing from a transmission perspective and what ultimately transpires around Rush Island. Or do you need to really wait for the full IRP process to play itself out prior to knowing what that transmission spend looks like?
Martin Lyons: Yes, Julien, obviously, you had a lot of topics in that question, and there are a bunch of moving parts. I think, number one, like you said on Rush Island, we'll let this MISO Y play out. But even if they come back pretty quickly on the MISO Y and again confirm that transmission investments are needed for both voltage support and long-term reliability, still then there'll be a process to determine what exactly those investments are and over what time period they'll be made. I can't give you an exact time line in terms of when we'll have clarity on all of that. But that's item number one. Item number two is the MISO actually approving projects as part of their Midwest region Tranche 1 approval process. And like I said, we do expect that, that will occur around midyear. And so there, we should get some clarity in terms of what projects of that portfolio would be ours to do, and we can begin assessing how we'll go about executing those and when those would be added to our plan. So we'll get some clarity there as well. And then with respect to the IRP, again, time line there is, again, around middle of the year. We said first half of this year. There is a little bit of dependency there. We'd certainly like to have clarity in terms of when transmission investments could be made, when Rush Island will actually be closing. And so we expect that over the course of this next 6 months, we should be able to have -- working with the District Court, MISO, et cetera, get some clarity on that. So all of those, I think, things will come to fruition likely in the first half of this year. We should get a lot of information, which we'll certainly be able to discuss. I think on our second quarter call, we'll have a lot of information there. Whether we update or not at EEI, hard to say. What traditionally we've done, and we discussed this earlier, step back, look at all these additional projects, look at the prioritization within our overall plan. Consider which of those projects we can get done, which of those are going to be additive, et cetera, how we're going to finance it. Typically, we'd lay that out on our fourth quarter call. But again, we should be able to provide, I think, a pretty comprehensive update on where things stand at the end of the second quarter and going into EEI. Michael, any additional thoughts there?
Michael Moehn: No. Marty, that's good.
Julien Dumoulin-Smith: Awesome. And just a quick clarification from Paul's question. Just with respect to the QIP, obviously, you've laid out your CapEx expectations through the full period here, including the -- I'm going to use the word sunset, I get that's not entirely appropriate. How do you think about whether or not that's extended and how that impacts your CapEx budget? I understand it impacts the recovery mechanisms and timing they're in. But it presumably does not impact your CapEx, one way or another?
Michael Moehn: That's right. I mean, look, the CapEx is an important CapEx that needs to be done on behalf of customers. We'll have to step back, I think as Marty said in his answer, and look at if that was not in place, how we file rate reviews and those types of things. But this is needed CapEx that's driving reliability improvements for customers, safety improvement for customers, et cetera.
Julien Dumoulin-Smith: Got it. All right. Actually, guys, I'll leave it there. Sorry, you're going to say something?
Martin Lyons: No, I was going to say thanks, Julien. I appreciate the questions.
Operator: We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Marty Lyons for closing comments.
Martin Lyons: Great. Well, I just wanted to say thank you to all of you for joining us today. As you can see, we had a really strong 2021. And we remain very, very focused on delivering again in 2022 and beyond for our customers, our communities and for all of you, our shareholders. So with that, please be safe, and we look forward to seeing many of you in person over the coming months.
Operator: This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. Mr. Kirk, you may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Warner Baxter, our Executive Chairman; Marty Lyons, our President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining us remotely. Warner will begin with a business overview. He will be followed by Marty, who will provide a strategic and business update for 2022 and beyond. And Michael will wrap up our prepared remarks with a discussion of key financial matters, including our earnings guidance. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now here's Warner, who will start on Page 4."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. To begin, I'd like to remind everyone that effective January 1 of this year, I became Executive Chairman of Ameren, Marty Lyons became President and CEO. Our transition to this new forward-thinking leadership structure is going very well. In light of the significant activities taking place in our industry, this new structure is enabling me to focus on key energy and economic policy matters and working with Marty on key strategic initiatives. At the same time, Marty has hit the ground running, leading the Ameren team in overall strategy development and execution, as well as managing the significant day-to-day operational and other responsibilities of the CEO. Our industry is transforming and millions of customers in Missouri and Illinois are depending on us to achieve our vision, leading the way to a sustainable energy future and our mission to power the quality of life. Each year provides a new set of opportunities and challenges, but one thing that remains constant in Ameren is our strong commitment to safely deliver reliable, cleaner and affordable electric and natural gas service. Our team continues to effectively execute our strategic plan across all of our businesses. including safely and successfully completing billions of dollars of value-adding projects for our customers; advocating for constructive federal and state energy policies and regulatory outcomes; leaning further forward on our digital transformation; and pursuing a wide range of sustainability goals. Simply put, continued strong execution of our strategic plan is delivering significant value to our customers, communities, shareholders and the environment, which brings me to a discussion of our 2021 performance. Yesterday, we announced 2021 earnings of $3.84 per share compared to earnings of $3.50 per share in 2020 or an increase of nearly 10%. Excluding the impact from weather, 2021 normalized earnings were $3.82 per share or an increase of approximately 8% from 2020's weather-normalized earnings of $3.54 per share. We made significant investments in energy infrastructure in 2021 and that resulted in a more reliable, resilient, secure and cleaner energy grid as well as contributed to strong rate base growth at all of our business segments. As outlined on this page, we also achieved several constructive regulatory and legislative outcomes that will facilitate additional infrastructure investments while keeping our customers' rates affordable. This strong execution of our strategy in 2021 will continue to drive significant long-term value for all of our stakeholders. Turning to Page 5. As you can see on this page, our laser focus on keeping our customers at the center of our strategy has delivered strong results for our customers. Our investments in infrastructure have resulted in top quartile reliability, affordability and customer satisfaction. The frequency of outages on our system continues to trend downward, resulting from our infrastructure investments, coupled with a focus on innovation and continuous improvement. Our disciplined cost management has helped drive our electric rates approximately 25% below Midwest and national averages. And I'm extremely proud to say that J.D. Power recently ranked Ameren Illinois #1 in residential customer satisfaction in the Midwest, among large electric utility providers, with Ameren Missouri ranking third. Further, we have continued to deliver superior value to our shareholders, as you can see on Page 6. Our weather-normalized core earnings per share have risen 84% and an approximate 8% compound annual growth rate since we exited our unregulated generation business in 2013, while our dividends paid per share have increased approximately 38% over the same time period. This has driven a strong total return of nearly 220% for our shareholders from 2013 to 2021, which was significantly above our utility peer average. I'm very pleased with our past performance. You can rest assured that our team will remain focused on enhancing performance in 2022 and in the years ahead so that we can continue to deliver superior value to our customers, communities and shareholders. Turning to Page 7. This page summarizes our strong sustainability value proposition and focus on environmental, social, governance and sustainable growth goals. Beginning with environmental stewardship, in September 2020, Ameren announced its transformational plan to achieve net zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes interim carbon emission reduction targets of 50% and 85% below 2005 levels by 2030 and 2040, respectively, which is consistent with the objectives of the Paris Agreement in limiting global temperature rise to 1.5 degrees Celsius. We plan to file an update to the 2020 Integrated Resource Plan in the first half of this year, which Marty will discuss a bit later. In 2021, we acquired the 300-megawatt Atchison Renewable Energy Center located in Northwest Missouri, our second wind generation investment. This acquisition is a significant step forward, along the path to meeting our clean energy goals. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. This slide highlights a few of the many things we are doing for our customers and communities, including being an industry leader in diversity, equity and inclusion. We were honored to be recognized again by DiversityInc as one of the top utilities in 2021, in addition to a top company for ESG. And we continue to help drive inclusive economic growth by spending approximately $900 million with diverse suppliers in 2021, an 11% increase over 2020. Further, our strong corporate governance is led by a diverse Board of Directors focused on strong oversight that's aligned with ESG matters. And our executive compensation practices include performance metrics that are tied to diversity, equity and inclusion and progress towards a cleaner energy future. Finally, this slide summarizes our very strong sustainable growth proposition, which remains among the best in the industry. Today, we published our updated ESG investor presentation called Leading the Way to a Sustainable Energy Future, available at amereninvestors.com. This presentation demonstrates how we have been effectively integrating our focus on environmental, social, governance and sustainability matters into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. As noted previously, as part of my new role of Executive Chairman, I will focus on key energy and economic policy matters, including through my leadership roles at the Edison Electric Institute and the Electric Power Research Institute as well as engaging with key stakeholders. Speaking of key energy and economic policy matters, we continue to strongly support and advocate for a robust federal clean energy tax package. In particular, we support clean energy transition tax incentives, including wind, solar and nuclear production tax credits, electric vehicle tax credits, transmission and storage investment tax credits as well as direct pay and normalization opt-out provisions. We strongly believe these forward-thinking policies to address climate change will advance the clean energy transition in a safe, reliable and affordable fashion and will deliver significant long-term benefits for our customers, communities and country. We will continue to work with key stakeholders, along with our industry colleagues to advance constructive federal energy and economic policies. In closing, our team has accomplished a great deal over the last several years. Their relentless commitment to our vision, mission and strategy has delivered strong value to our customers, communities and shareholders. Looking ahead, I'm even more excited about our future because I believe these efforts have positioned Ameren very well to deliver superior value over many years to come. Now here is Marty to tell you how our team will keep delivering under this strategy in the future."
},
{
"speaker": "Martin Lyons",
"text": "Thanks, Warner. Before I jump into the details, I would like to extend my appreciation to all of my coworkers for their dedication in 2021. Our accomplishments during the year are a result of their hard work and focus on executing our strategy, which has been delivering significant long-term value for all of our stakeholders. Going forward, our strategy remains the same, which is to invest in and operate our utilities in a manner consistent with existing regulatory frameworks, enhance regulatory frameworks, advocate for responsible energy and economic policies, and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. As Chief Executive Officer, my focus is to drive continuous improvement as we execute our strategy and take Ameren to higher heights. Moving now to Page 9. Yesterday afternoon, we announced that we expect our 2022 earnings to be in a range of $3.95 to $4.15 per share. Based on the midpoint of the range, this represents 8% earnings per share growth compared to the midpoint of our initial 2021 guidance range. Michael will provide you with more details on our 2022 guidance a bit later. Building on the strong execution of our strategy and our robust earnings growth over the past several years, we continue to expect to deliver long-term earnings growth that is among the best in the industry. We expect to deliver 6% to 8% compound annual earnings per share growth from 2022 through 2026 using the midpoint of our 2022 guidance, $4.05 per share as the base. Our long-term earnings growth will be driven by continued execution of our strategy, including investing in infrastructure for the benefit of our customers while keeping rates affordable. Our dividend is another important element of our strong total shareholder return. I am pleased to report that last week, Ameren's Board of Directors approved a quarterly dividend increase of 7.3%, resulting in an annualized dividend rate of $2.36 per share. This increase reflects confidence by Ameren's Board of Directors in the outlook for our businesses and management's ability to execute its strategy for the long-term benefit of our customers and shareholders. Looking ahead, we expect Ameren's future dividend growth to be in line with our long-term earnings per share growth expectations and within a payout ratio range of 55% to 70%. And while I'm very pleased with our past performance, we are not sitting back and taking a breath. Turning to Page 10. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. The strong long-term earnings growth I just discussed is primarily driven by our rate base growth plan. Today, we are rolling forward our 5-year investment plan. And as you can see, we expect to grow our rate base at an approximate 7% compound annual rate for the 2021 through 2026 period. This growth is driven by our robust capital plan of approximately $17 billion over the next 5 years that will deliver significant value to our customers and the communities we serve. Our plan includes strategically allocating capital to all 4 of our business segments. Importantly, renewable generation and regionally beneficial transmission represent additional investment opportunities. We expect to file an update to our 2020 Missouri Integrated Resource Plan in the first half of this year, in light of the accelerated retirement of our Rush Island Energy Center. This filing will include a comprehensive set of updated assumptions, taking into account MISO's long-range transmission planning process and potential legislative and regulatory developments at the federal level among other things. This updated planning process is underway, and we fully expect it to underscore the need for expansion of our renewable generation portfolio and transmission investment. We continue to work in earnest with developers to acquire renewable generation projects to be completed in 2024 through 2026, as evidenced by the announcement earlier this week of an agreement to acquire a 150-megawatt solar energy project. We expect to announce further agreements over the course of this year and to file certificates of convenience and necessity, or CCNs, with the Missouri PSC after the updates to the 2020 IRP have been filed. Finally, we remain focused on disciplined cost management to keep rates affordable and improve earned returns in all of our businesses. Moving to Page 11. As we look to the future, our 5-year plan is not only focused on delivering strong results through 2026, but it is also designed to position Ameren for success over the next decade and beyond. We believe that a safe, reliable, resilient, secure and cleaner energy grid will be increasingly important and bring even greater value to our customers, our communities and shareholders. With this long-term view in mind, we are making investments that will position Ameren to provide safe and reliable electric and natural gas service but also to meet our customers' future energy needs and rising expectations and support our transition to a cleaner energy future. The right side of this page shows that our allocation of capital is expected to grow our electric and natural gas energy delivery investments to be 84% of our rate base and coal-fired generation to decline to just 6% of rate base by the end of 2026. Only 4% of the capital expenditures in our 5-year plan are expected to be spent on coal-related projects. Importantly, our 5-year plan does not reflect the expected early retirement of the Rush Island Energy Center or investment opportunities associated with renewable generation and regionally beneficial transmission projects. The bottom line is that we are taking steps today across the board to position Ameren for success in 2022 and beyond. Turning now to Page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of over $45 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will not only create a stronger, smarter and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs in the future and delivering on our customers' expectations. Moving now to Page 13. As we have discussed with you in the past, MISO completed a study outlining the potential road map of transmission projects through 2039. Taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation, based on announced utility integrated resource plans, state mandates and goals for clean energy or carbon emission reductions, among other things. Under MISO's Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon emissions reduction below 2005 levels by 2039, MISO estimates approximately $30 billion of future transmission investment would be necessary in the MISO footprint. Under its Future 3 scenario, which resulted in an 80% reduction in carbon emissions below 2005 levels by 2039, MISO estimates approximately $100 billion of transmission investment in the MISO footprint would be needed. It is clear that investment in transmission is going to play a critical role in the energy transition. And we are well positioned to plan and execute potential projects in the future for the benefit of our customers and country. I am pleased to report that in January, MISO transmission owners and MISO reached an agreement on a revision to the cost allocation for certain of these important regional transmission projects. The cost allocation tariff revisions were submitted to FERC for approval on February 4. The revisions allow for allocation of project costs within the subregion where the benefits are recognized. Previous regional benefit project costs have been spread broadly across the MISO region, which was prior to the addition of the MISO South subregion. Comments are due by March 7. MISO and MISO transmission owners have requested an effective date of May 19, 2022. We continue to work with MISO and other key stakeholders and believe certain projects outlined in Future 1 are likely to be included in this year's MISO transmission planning process, which is expected to be completed in mid-2022. Turning now to Page 14 and an update on our Rush Island Energy Center. As you may recall, in 2011, the Department of Justice, on behalf of the EPA, filed a complaint against Ameren Missouri, alleging that in performing certain projects at the Rush Island Energy Center, it violated the New Source Review provisions of the Clean Air Act. In 2017, the District Court issued a liability ruling and in September 2019, ordered the installation of pollution control equipment at the Rush Island Energy Center. In November, the U.S. Court of Appeals denied Ameren Missouri's request for reconsideration of its decision affirming the District Court's order that requires installation of a scrubber at Rush Island Energy Center in order to continue operations. Subsequently, Ameren Missouri announced its intention to retire the energy center in lieu of installing a scrubber and requested a modification from the District Court of its previous order to allow for plant closure, along with time to address any reliability issues. Ameren Missouri expects to make an Attachment Y filing soon, formally notifying MISO of its intention to retire the Rush Island Energy Center. MISO will then conduct a reliability assessment. A preliminary study completed by MISO in January of 2022, indicated that in advance of retirement, transmission upgrades and additional voltage support are needed on the transmission system to ensure reliability. The preliminary MISO reliability study was filed with the District Court, which is under no deadline to issue an order regarding our request to modify the September 2019 remedy order. As stated earlier, in light of these developments, Ameren Missouri expects to file an update to the Integrated Resource Plan with the Missouri PSC in the first half of 2022, which will reflect the expected accelerated retirement date of the Rush Island Energy Center. Such filing will also reflect the expected use of securitization in order to recover the remaining investment in Rush Island. Lastly, this week at the Missouri PSC staff's request, the commission directed them to review various matters associated with our plans to retire Rush Island. Overall, we understand the desire of the commission and staff to develop a deeper understanding of our decision to accelerate closure of Rush Island and related system reliability considerations. We welcome the review and believe it will be good for the commission and staff as well as all stakeholders to have a deeper understanding of this matter. From our standpoint, it should also help to inform future rate review, IRP and securitization proceedings. Before leaving this slide, I would also like to provide some insight on recent findings proposed by the EPA related to our Sioux and Meramec Energy Center impoundments. Last month, Ameren Missouri received notice of an interim decision by the EPA that has rejected Ameren Missouri's request to extend the time line for operating certain impoundments located at the Sioux and Meramec energy centers until a replacement pond could be built at Sioux and in the case of Meramec, the energy center retires, which is expected later this year. We are pursuing options to address the EPA decision and at this time, do not expect any significant impacts on operations. Meramec will close as planned by the end of 2022. Moving to Page 15 to the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Over the years, we have been successful in executing this element of our strategy by focusing on delivering value to our customers through investments in energy infrastructure and extensive collaboration with key stakeholders in all of our regulatory jurisdictions. I am very pleased to report progress continued last year when the Illinois energy transition legislation was enacted. This is a constructive law that addresses the key objectives, and we felt were important for our customers and the communities we serve. The law established a new forward-thinking regulatory framework that will enable us to continue to make important infrastructure investments to enhance the reliability and resiliency of the energy grid as well as enable us to invest in 2 solar or solar plus battery storage pilot projects. It will also give us the ability to earn fair returns on these investments. The Illinois energy law allows for an electric utility to opt in to a multiyear rate plan effective for 4 years beginning in 2024. We are currently working with key stakeholders through various workshops, which will continue over the course of 2022 to establish specific procedures, including performance metrics to implement this legislation. We expect performance metrics to be approved by the ICC by late September. Subject to finalizing key aspects of this rate-making framework, we anticipate filing a multiyear rate plan by January 20, 2023. Moving to Missouri legislative matters, a key piece of legislation was filed for consideration in this year's session. Bills have been introduced in both the House and the Senate to enhance the Smart Energy Plan legislation enacted in 2018. As part of Missouri's Smart Energy Plan, a multiyear effort to strengthen the grid, our customers are benefiting from stronger poles, more resilient power lines, smart equipment and upgraded circuits to better withstand severe weather events and restore power more quickly. The proposed legislation would enhance and extend the existing regulatory framework. It would modify the rate cap from the current 2.85% compound annual all-in cap on growth in customer rates, to a 2.5% average annual cap on rates on rate impacts of PISA deferrals. In addition, the proposed legislation would expand and extend economic development incentives as well as remove the sunset date. With all of this in mind, we are focused on working with key stakeholders to get this important legislation passed this year. Moving to Page 16. Over the last several years, we have worked hard to enhance the regulatory frameworks in both Missouri and Illinois to help drive additional infrastructure investments that will benefit customers and shareholders. At the same time, we have been very focused on disciplined cost management to keep rates affordable. Since opting into constructive regulatory frameworks, significant investments have been made, reliability has improved, rates have remained relatively flat, customer satisfaction has increased and thousands of jobs have been created. While these are great wins for our customers and communities, we are not done. Turning to Page 17. As you can see from this chart, our total fuel and purchase power and operations and maintenance expenses have decreased 3% compared to 2016 levels. And we will remain relentlessly focused on continuous improvement and disciplined cost management as we look forward to the next 5 years. This will not only include continuing the robust cost management initiatives implemented over the past 2 years due to COVID-19, but also several other customer affordability initiatives. These initiatives include the automation and optimization of our processes, including leveraging the benefits from significant past and future investments in digital technologies and grid modernization. Moving to Page 18. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will continue to deliver superior value to our customers, shareholders and the environment. We believe our expectation of 6% to 8% compound annual earnings growth from 2022 through 2026, driven by strong rate base growth, compares very favorably with our regulated utility peers. I am confident in our ability to execute our customer-focused strategy and investment plans across all 4 of our business segments as we have an experienced and dedicated team with a track record of execution that has positioned us well for future success. Further, our shares continue to offer investors an attractive dividend. And the strong earnings growth expectations we outlined today position us well for future dividend growth. Simply put, we believe our strong earnings and dividend growth outlook result in a very attractive total return opportunity for shareholders. Finally, turning to Page 19. I would like to take the opportunity to introduce to you Ameren Missouri's new Chairman and President, Mark Birk. Over the last 2 years, I was fortunate to have the opportunity to lead the Ameren Missouri organization and work closely with Mark. Mark has been an invaluable part of the Ameren team over the last 35 years. Prior to his new role, Mark served as Ameren Missouri's Senior Vice President of Customer and Power Operations. And over the course of his career, he has held numerous corporate and operations roles, including oversight of strategy and planning, business risk management, safety, nuclear operations as well as a host of electric and natural gas operational areas. I look forward to working with Mark in the future in our new roles. Again, thank you all for joining us today. And I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to Page 21 of our presentation. Yesterday, we reported 2021 earnings of $3.84 per share compared to earnings of $3.50 per share in 2020, an increase of 9.7%. Earnings in Ameren Missouri, our largest segment, increased $0.25 per share from $1.77 per share in 2020 to $2.02 per share in 2021. Increased investments in infrastructure and wind generation, eligible for plant and service accounting and the Renewable Energy Standard Rate Adjustment Mechanism, or RESRAM, positively impacted earnings by $0.21 per share. Higher electric retail sales also increased earnings by approximately $0.16 per share, largely due to continued economic recovery in 2021 compared to unfavorable impacts of COVID-19 in the year ago period. We've included on this page the year-over-year weather-normalized sales variances. Total weather-normalized sales in 2021 were largely consistent with our expectations outlined on our call last February. New electric service rates effective April 1, 2020, also increased earnings during 2021 by approximately $0.10 per share compared to the year ago period. Finally, these favorable factors were partially offset by higher operations and maintenance expenses, which decreased earnings $0.12 per share, primarily due to the amortization of deferred expenses related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage. Moving to Ameren Illinois Electric Distribution, earnings increased $0.06 per share, which reflected increased infrastructure and energy efficiency investments and a higher allowed return on equity under performance-based ratemaking. The formula base return on equity was 7.85% in 2021 compared to 7.4% in 2020 as it was applied to -- and was applied to a year-end rate base. The 2021 ROE was based on the 2021 average 30-year treasury yield of 2.05%, up from the 2020 average of approximately 1.6%. Ameren Transmission earnings were up $0.02 per share, which reflected increased infrastructure investments that were mostly offset by the absence of the benefit from the May 2020 FERC order addressing the MISO allowed base return on equity and the impact of the March 2021 FERC quarter addressing the historical recovery of materials and supplies inventories. Earnings for Ameren Illinois Natural Gas were up $0.02 per share, which reflected new delivery service rates effective in late January 2021 and increased infrastructure investments, partially offset by higher other operations and maintenance expenses. Ameren Parent and other results were down $0.01 per share, which reflected increased interest expense, primarily from higher long-term debt balances. And finally, earnings per share and earnings per share drivers on this page are computed using 2020 weighted average shares outstanding. The higher shares outstanding in 2021 reduced overall earnings by $0.15 per share. Before moving on, I'll touch on 2021 sales trends for Ameren Illinois Electric Distribution. Weather-normalized kilowatt hour sales to Illinois residential customers were flat year-over-year and weather-normalized kilowatt hour sales to Illinois commercial and industrial customers increased 3% and 3.5%, respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Moving to Page 22 of the presentation. Here, we provide an overview of the $17.3 billion of strategically allocated planned expenditures for the 2022 through 2026 period by business segment that underlies the approximately 7% projected rate base growth Marty discussed earlier. This plan includes an incremental $200 million compared to the $17.1 billion 5-year plan for 2021 through 2025 that was laid out last February, which included the $500 million wind investment completed in 2021. As you can see on the right side of this page, we are allocating capital consistent with the allowed return on equity under each regulatory framework. Importantly, as Marty mentioned earlier, renewable generation and regionally beneficial transmission represent additional investment opportunities. Turning to Page 23. We outlined here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. We also expect to generate significant tax deferrals. These tax deferrals are driven primarily by the timing differences between financial statement depreciation reflected in customer rates and accelerated depreciation for tax purposes. From a financing perspective, we expect to continue to issue long-term debt in Ameren Missouri and Ameren Illinois to fund a portion of our cash requirements. Pursuant to a November 2021 note purchase agreement, we will issue $95 million of ATXI debt in August 2022. We also plan to continue to use newly-issued shares for our dividend reinvestment and employee benefit plans over the 5-year guidance period. We expect this to provide equity funding of approximately $100 million annually. In order for us to maintain a strong balance sheet while we fund our robust infrastructure plan, we expect incremental equity issuances of approximately $300 million each year starting in 2022 through 2026. Approximately $95 million of equity outlined for 2022 was sold on a forward basis under our at-the-market equity distribution program, leaving approximately $200 million to be sold for the remainder of 2022. Together, issuance of our 401(k), DRPlus and ATM equity programs are expected to support our equity needs through 2023. All of these actions are expected to enable us to support a consolidated capitalization target of approximately 45% equity over the 5-year plan. Moving to Page 24 of our presentation. I would now like to discuss key drivers impacting our 2022 earnings guidance. As Marty stated, we expect 2022 diluted earnings per share to be in the range of $3.95 to $4.15 per share. On this page and the next, we have listed key earnings drivers and assumptions behind our 2022 earnings guidance, broken down by segment as compared to the 2021 results. Beginning with Ameren Missouri, earnings are expected to rise in 2022. New electric service rates will be effective February 28, the 2022 earnings comparison is also expected to be favorably impacted by higher investments in infrastructure and wind generation that's eligible for PISA and RESRAM, which benefits earnings in January and February until rates are reset. We also expect to recognize earnings related to energy efficiency performance incentives from both 2021 and 2022 planned years in 2022. As a result, we expect energy efficiency performance incentives to be approximately $0.04 per share higher than 2021. These favorable factors are expected to be partially offset by higher operations and maintenance and interest expenses. Further, we expect the return to normal weather in 2022 will be decreasing Ameren Missouri earnings by approximately $0.02 compared to 2021 results. We also expect higher total weather-normalized electric sales of approximately 1% in 2022 compared to 2021, as residential sales decline and commercial sales continue to increase. We expect total weather-normalized sales to return to 2019 levels by mid-2022, with this year's growth expected to be primarily over the second half of the year. Moving on, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois and ATXI projects made under forward-looking formula ratemaking. The absence of the March 2021 FERC order on historical recovery of materials and supplies is also expected to increase earnings $0.03 per share. Turning to Page 25. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2022 compared to 2021 from additional infrastructure investments made under Illinois performance-based rate making. Our guidance incorporates a performance-based ROE of 8.05% using a forecasted 2.25% 2022 average yield for the 30-year treasury bond, which is higher than the allowed ROE of 7.85% in 2021. The allowed ROE is applied to year-end rate base. For Ameren Illinois Natural Gas, earnings will benefit from higher delivery service rates that were effective late January 2021 as well as from infrastructure investments qualifying for rider treatment. These favorable factors are expected to be partially offset by higher operations and maintenance and depreciation and amortization expenses. Moving now to Ameren-wide drivers and assumptions. We expect the increased common shares outstanding to unfavorably impact earnings per share by $0.04 and higher interest expense, primarily from higher long-term debt balances. Of course, in 2022, we will seek to manage all of our businesses to earn as close to our allowed returns as possible while being mindful of operating and other business needs. I'd also like to take a moment to discuss our retail electric sales outlook. We expect the weather-normalized Missouri kilowatt-hour sales to be in the range of flat to up approximately 0.5% compounded annually over the 5-year plan, excluding the effects of our MEEIA energy efficiency plan using 2022 as the base year. We exclude MEEIA effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales resulting from our energy efficiency efforts. Turning to Illinois. We expect our weather-normalized kilowatt-hour sales, including energy efficiency, to be relatively flat over the 5-year plan. Turning to Page 26 and regulatory matters. In December, the PSC approved a nonunanimous stipulation agreement that resolved both the electric and natural gas rate reuse for Ameren Missouri. The agreements were black box settlements, which did not provide for certain specific details of the final orders. In both rate reviews, an allowed ROE was not specified but did provide for approximately 52% equity ratio for use in calculating PISA and RESRAM. The electric revenue requirement increased by $220 million annually, reflecting a rate base of $10.2 billion. The approved agreement also provided for the continuation of key trackers and riders, including the fuel adjustment clause. The natural gas revenue requirement was increased by $5 million annually, reflecting a $313 million rate base. Both electric and natural gas rate changes are effective at the end of this month. Looking ahead, we will continue to assess the timing of our next rate review. In making this decision, we will take into account several considerations, including our capital expenditures and other cost of service considerations as well as updates to the Integrated Resource Plan expected to be filed in the first half of this year, reflecting the accelerated retirement of the Rush Island Energy Center and timing of our expected securitization filing. Regarding Ameren Illinois regulatory matters, in December, the ICC approved a $58 million base electric distribution rate increase in the annual rate update proceeding with new rates that were effective at the beginning of this year. Finally, turning to Page 27. We have a strong team and are well positioned to continue executing our plan. We delivered strong earnings growth in 2021, and we expect to deliver strong earnings growth in 2022 as we continue to successfully execute our strategy. And as we look ahead, we expect 6% to 8% compound earnings per share growth from 2022 to 2026, driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question comes from Shar Pourreza with Guggenheim Partners."
},
{
"speaker": "Shahriar Pourreza",
"text": "Just a couple of quick questions here. First, just on supply chain. Are you seeing any impacts on the renewable side, especially as we think about the 2.4 gigs? I mean we've seen a few of your peers shift megawatts out either from panel shortages or other sort of supply chain disruptions. Any thoughts here? Any materials locked in or procured? And if this isn't transitory, since you guys are essentially swapping megawatts for megawatts as we think about renewables versus coal, could any project delays cause an impact to sort of the coal retirement time lines, especially as we're thinking about Sioux?"
},
{
"speaker": "Martin Lyons",
"text": "Shar, yes, this is Marty. Let me take that one on supply chain as it relates renewables and then perhaps Michael can comment on supply chain or issues more broadly. First of all, I'd say that as we went through last year, we had hoped by the end of the year to have announced some renewable projects. As you saw, we just announced one this week, which we're excited about. I would say it's a start in terms of the renewal projects that we hope to get announced and delivered in the '24 to 2026 time frame. But to your point, some of the negotiations last fall and into the winter were, I would just say, slowed by supply chain issues, tariff issues, some of the inflationary pressure seen in the renewable space, which simply meant that it was taking a little longer to work through some of the contractual negotiations. But we're able to get that first project announced. We are still expecting this year to announce other projects. And we'll see whether these things are transitory or not. But again, some of the bigger bulk of the projects we're trying to get done are out there in that '24 to 2026 time frame. So certainly, time for some of those issues to settle down. Ultimately, whether that has any impact on longer term, our scheduled coal retirement at Sioux will remain to be seen. As you know, especially in light of the accelerated closure of Rush Island, we plan to update our Integrated Resource Plan in the first half of this year. And so as we do that, we'll be taking into consideration some of the observations -- more recent observations we have on the renewable market, the timing of expected projects there as well as just the other -- the broader dynamics associated with reliability of our system long term and providing updates in there. So it would really be premature to say whether there's any impact on the retirement date of Sioux. But again, we're continuing to work with developers on these renewable projects and do expect to have further announcements this year. As I did indicate in the prepared remarks, to the extent that we have additional projects to be approved by the commission, we anticipate filing those CCNs after we file the update to the Integrated Resource Plan because that Integrated Resource Plan provides a good backdrop for the commission to consider the approval of those CCNs. Michael, any other comments broadly on supply chain?"
},
{
"speaker": "Michael Moehn",
"text": "Marty, no, that was pretty comprehensive. Nothing material to add to that answer. Shar, do you have something else?"
},
{
"speaker": "Shahriar Pourreza",
"text": "Yes, terrific. And then just one last one. I know this is maybe a little bit of a perennial topic at this point, but any thoughts on sort of the potential end of QIP in Illinois? I mean it seems like efforts to eliminate it are getting a little bit noisy again, but it's also scheduled to expire in '23. Could we see it extended? Would it change one way or another have any impact on your updated plan to invest about $1.8 billion between now and '26?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, Shar. A terrific question. You know that the QIP in the gas business in Illinois has been really, I think, a terrific rider for the benefit of customers. It's really allowed us to do a lot of projects in Illinois, as much as 50% of our capital expenditures, replacing underground pipes, et cetera, to improve the safety and reliability of our gas system. So it's been a good rider. Certainly can't predict whether any legislative effort to end it prematurely will be successful or not. As you said, it's already scheduled to expire at the end of 2023. So look, it's been a good rider. We'd love to see it extended. We'd love to see perhaps some other mechanism go in its place that would be similarly beneficial. But ultimately, we do have in the gas business in Illinois, a favorable foundation for ratemaking, which is a forward test year with other good features like decoupling. So look, as we move forward, we'll continue to see whether there's either an extension of that QIP or perhaps something else that goes in its place. But ultimately, we can reassess both, not only the projects that we've got but also the timing of rate reviews and the like. At the end of the day, we feel like the projects that we're doing there, the projects we have planned there are great for our customers, great for the communities, and we'll look for a path forward to making those investments."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Durgesh Chopra with Evercore."
},
{
"speaker": "Durgesh Chopra",
"text": "On the 6% to 8% growth rate target, I mean, obviously, it looks like there's a ton of upside CapEx potential, whether it's the Rush Island-related CapEx, the MISO transmission CapEx, there may be an ROE bump in future years from the SB2408 in Illinois. What are you assuming in that 6% to 8% growth rate target in terms of these upside opportunities?"
},
{
"speaker": "Martin Lyons",
"text": "Well, again, I think that you've summarized it well. At the end of the day, we've got $17.3 billion of planned capital expenditures over 4 quality jurisdictions. We expect that to drive 7% compound annual rate base growth. And really, that is the foundational driver of our 6% to 8% planned EPS CAGR over this period of time. But you also pointed out some additional opportunities we have, and those are specifically in the areas of renewable generation as well as some of these regionally beneficial transmission projects. And those represent potential additions to the capital expenditure plans and the rate base growth. So those are -- the things that you highlight are the things that give us confidence, not only in our ability to execute the $17.3 billion and the 7% rate base growth, but certainly conviction around that 6% to 8% EPS growth target."
},
{
"speaker": "Michael Moehn",
"text": "Yes, the only thing I would add to that, Marty's really comprehensive answer, is with respect to Illinois, we kind of moved through this new process there in terms of opting into the multiyear plan. I think we'll continue to step back and assess the opportunities there. There obviously is a tremendous amount of projects that are needed to get done on the benefit of customers. We've made some great progress there, but there's just a lot of aging infrastructure. So as you know, we've been pulling that CapEx down a little bit over time just because of some of those returns. And so we'll assess that too as an opportunity, but Marty certainly highlighted the big ones."
},
{
"speaker": "Martin Lyons",
"text": "Thanks, Michael."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. And then maybe can I just follow up on the whole -- the staff and commission review of the Rush Island retirement and generation needs to fill that hole, what are sort of the key milestones for us to watch there in terms of like the next steps that we should be watching for? Is that -- and then what is the end outcome you think of that review process?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, sure. So I think as it relates to Rush Island, we'll be continuing to work with the District Court in terms of the plans forward for the ultimate retirement date of Rush Island. As we shared in our prepared remarks, there was a preliminary assessment done by MISO related to the closure of Rush Island, which really determined that there were upgrades and additional investments needed too for voltage support and long-range -- longer-term reliability of the system in light of that planned closure. And so now we'll be moving forward with filing an Attachment Y soon, which will be more of a -- I just call it a formal assessment. The preliminary assessment's done and that formal assessment will be done. And then once we've done that, we have to determine what the right investments are to be made on the system and get those planned and approved and executed over time. So some of the milestones to watch there, the MISO Y filing as well as decisions coming from the District Court around the retirement of that plant. So those are some things in that regard. Now specifically, in terms of the staff review, like I said, what they're looking to do here, I think, is really get a deeper understanding of the decision to close Rush Island as well as these reliability impacts that I've been talking about. Rush Island, as you know, is a 1,200-megawatt plant. It's been highly reliable. It's been low cost and provided great value to our customers over time. So in terms of their review, they'll be conducting that, there's going to be -- the commission has asked them to file a preliminary report around April 15, but there's really no deadline on any kind of a final report from the commission staff. And then we also, at the commission's request, we'll be providing monthly status updates in terms of the progress towards closure of Rush Island and I think importantly to what we're doing from a reliability standpoint associated with that. So those are some of the milestones to look for."
},
{
"speaker": "Durgesh Chopra",
"text": "Congrats on a solid quarter."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "I just want to build off some of those questions there. Just wondering if you could frame, with regards to the Missouri IRP, MTEP process, Rush Island, just when could this be pulled into the plan? When do you think this could materialize? And how do we think about, I guess, potential incremental equity needs should this come in? Just trying to get the size of CapEx timing and incremental equity, how that might balance out."
},
{
"speaker": "Martin Lyons",
"text": "Yes, Jeremy, this is Marty. I'll start, and I'm sure Mike will add on to this as well. But a couple of things. As we laid out again, in the IRP, we really expect that, that will get filed in the first half of this year. And importantly, there, we'll be considering, like I said, the early retirement of Rush Island, any updates to our renewable expansion plans, investments needed in the transmission system as well and doing a comprehensive update of that Integrated Resource Plan. So through that, certainly, you'll get an idea of some of the updated thoughts in terms of additional investments that may be required. Also, as you mentioned and we mentioned in our prepared remarks, we do expect that the MISO will end up approving some of the projects that will move us towards that Future 1 plan that they've got out there, and we expect that, that, again, too, is going to occur by mid this year. Premature to say the size of the portfolio projects that MISO approved in this Tranche 1 that we expect to get approved midyear or the size of the allocation of projects to us. But that's going to be another key milestone as we look ahead to this year in terms of identifying additional potential investments that we'll have longer term. So with that, those -- midyear, we should get some greater visibility, I suspect, in terms of some of those potential projects. And then I think as a team, we'll have to step back and assess those projects and decide ultimately which of those becomes additive to our plan and in what years and how we move forward with execution. Michael, you want to tackle some of those other questions?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Perfect, Marty. Yes. I think that's well said. I mean, just in terms of -- Jeremy, we said this before. We just don't want to get in front of the regulatory process on that, and we'll just continue to assess these over time. And as we make that determination and figure out sort of what is incremental to the plan, that's when we would step back and look at what our financing needs would be with respect to that. As we've said in the past, we like our ratings where they are today. We're very focused on our metrics. We're targeting this capitalization ratio of about 45% equity over the balance of the plan. That's really what's driven the $300 million that we have in there today. And again, it would kind of be just on a case-specific basis. I wouldn't see us deviating much from that honestly, so I mean if that gives you any indication of how we would think about financing this going forward. But we would assess it at that point in time. So hopefully, that helps."
},
{
"speaker": "Jeremy Tonet",
"text": "That's very helpful, not much on the equity side, but great to hear. And then just from a transmission perspective, can you give any sense of the size and scope of the reliability needs around Rush Island's closure? Just wondering any thoughts you could provide there?"
},
{
"speaker": "Martin Lyons",
"text": "Yes. Really hard to at this point. We're in those early stages, like I said, through the preliminary assessment that MISO did clear. The transmission upgrades are going to be needed both for voltage support as well as to ensure long-term reliability of the system. So clearly, some transmission investment needs there. But it's premature to say exactly what those will be. Efforts along those lines, given the preliminary assessment are already underway to determine some of those things. But ultimately, it will be a process working with MISO in particular, to determine what those needs will be and how much of an investment will be required there."
},
{
"speaker": "Operator",
"text": "Our next question is from Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"text": "Congratulations. So just on the Missouri legislation that you have there. Just wondering sort of what the practical impact from a shareholder perspective might be if you guys have that? And also, what's the reason from going from a 2.85% cap to a 2.5% cap? Is that just part of the give and take of legislation? Or is there something that's specifically happening that's causing people to want that?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, Paul, good questions. Look, as it relates to this legislation, first of all, this plant and service accounting, we call it, Missouri Smart Energy Plan, has been working really well for customers. It's really allowed us to make significant additional investment in our system. We talked early on in the call about how that's just driving higher reliability. It's allowed us to deploy clean energy. It's really doing good things for the economy. We've created a lot of jobs and at the same time, been able to keep rates very low for customers. So it's really been working extremely well. And what this legislation really is all about is just making sure that we have a sustainable long-term framework to support continuation of those efforts. So it's really all about longevity of what the legislature put in place several years ago. And so that's what it's all about. You see some of the features we laid out in the slides: removes the sunset from the plan, which would be good, improves longevity to begin with; improves the economic development incentives, which have been really great for attracting businesses and helping businesses expand in our state. So it's improvement there. What the cap specifically is all about is today, as you see, there's a cap on the overall growth in rates, total rates. What we're saying here is that it would be better to have a cap, which is a good consumer protection, a cap, but it would be on the impact of these deferrals, the piece of deferrals that were really directed by that legislation. And so that, too, I think, improves longevity of the ability to utilize and -- this great regulatory framework long term."
},
{
"speaker": "Paul Patterson",
"text": "So when do we need to -- I mean, you've got it there now, but when is the sunset again on the current one?"
},
{
"speaker": "Martin Lyons",
"text": "Sunset on the current one is the end of 2023. Now when we say sunset, it doesn't necessarily go away. It just means that we would need to go to the commission and re-up or ask them to re-up for another 5 years. So we would need to make a filing and the commission would need to approve that for another 5 years."
},
{
"speaker": "Paul Patterson",
"text": "So it's not a real sunset? I mean -- so I mean, I guess you would be at the discretion of the commission as opposed to having it sort of legislatively in place. Is that the way to think of it?"
},
{
"speaker": "Michael Moehn",
"text": "Correct."
},
{
"speaker": "Martin Lyons",
"text": "Yes, it's the right way to think about it. That's right. That's why I wanted to clarify my thoughts. You'd use the word sunset and I'd responded, but it's not a hard stop. Just a check-in point, if you will, to go back to the commission and re-up for another 5 years. But you're absolutely right in the way you've characterized the legislation, which would be more of a steady state going forward."
},
{
"speaker": "Michael Moehn",
"text": "And Paul, this is Michael. I mean, if we were to do that opt-in and then everything that sort of exists today from a cap, sort of all of that would continue to apply going forward, right? So the commission has the ability to extend it but not modify it in any way, just to be clear."
},
{
"speaker": "Paul Patterson",
"text": "And then on the coal ash, any thought about what the -- and I apologize if I missed this, what the total number in terms of the EPA impact might be? And also, is that -- how would that be treated regulatory speaking? Is that something that could be securitized? Or just how should we think about any potential coal ash cleanup expense?"
},
{
"speaker": "Martin Lyons",
"text": "No. Paul, there's really no -- we weren't really talking about coal ash cleanup expenses. It's really modifications to the impoundments that we have at these power plants in order to be able to continue to dispose of either ash or residuals coming out of our scrubbing. So again, what we said on the call there is, really don't expect to have any material impact from the EPA's decision. Part of it related to Meramec, which we have plans to close at the end of 2022. And then the other potential impact was at our Sioux Energy Center, and we are working through options, which we believe will ultimately mean that there's no significant impact in terms of the EPA's recent ruling."
},
{
"speaker": "Michael Moehn",
"text": "Yes, that's right. And then Paul, it would just be in..."
},
{
"speaker": "Paul Patterson",
"text": "Okay. So in other words, the impoundment improvements really aren't going to be all that costly. Is that right?"
},
{
"speaker": "Martin Lyons",
"text": "Correct. It would just be a typical capital project that we would recover in the normal course of our rate review. And yes, correct. It is not going to be an overly material number as we sit here today."
},
{
"speaker": "Paul Patterson",
"text": "Well, that's very good news. Okay. Awesome. Congratulations again."
},
{
"speaker": "Operator",
"text": "Our next question is from Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Listen, just with respect to the comments on Jeremy's question earlier, I want to go back, if I can, just to understand the cadence of some of these updates. If I hear you guys right, though, with respect to Rush Island and some of the MISO agreements in principle that you have, you could be in a position to at least update some of the transmission spending earlier than perhaps, say, some of the incremental renewables here. Can you talk about the time line here? I mean you've got Attachment Y coming pretty soon, it would seem. If this agreement translates in, as you say, Stage 1 in mid-'22, could you be in a position to look at kind of a more holistic view on transmission by, say, the November EEI time frame? Just curious if you can elaborate a little bit more on how that comes together, to what extent? It seems like there is an overlap in what you would be doing from a transmission perspective and what ultimately transpires around Rush Island. Or do you need to really wait for the full IRP process to play itself out prior to knowing what that transmission spend looks like?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, Julien, obviously, you had a lot of topics in that question, and there are a bunch of moving parts. I think, number one, like you said on Rush Island, we'll let this MISO Y play out. But even if they come back pretty quickly on the MISO Y and again confirm that transmission investments are needed for both voltage support and long-term reliability, still then there'll be a process to determine what exactly those investments are and over what time period they'll be made. I can't give you an exact time line in terms of when we'll have clarity on all of that. But that's item number one. Item number two is the MISO actually approving projects as part of their Midwest region Tranche 1 approval process. And like I said, we do expect that, that will occur around midyear. And so there, we should get some clarity in terms of what projects of that portfolio would be ours to do, and we can begin assessing how we'll go about executing those and when those would be added to our plan. So we'll get some clarity there as well. And then with respect to the IRP, again, time line there is, again, around middle of the year. We said first half of this year. There is a little bit of dependency there. We'd certainly like to have clarity in terms of when transmission investments could be made, when Rush Island will actually be closing. And so we expect that over the course of this next 6 months, we should be able to have -- working with the District Court, MISO, et cetera, get some clarity on that. So all of those, I think, things will come to fruition likely in the first half of this year. We should get a lot of information, which we'll certainly be able to discuss. I think on our second quarter call, we'll have a lot of information there. Whether we update or not at EEI, hard to say. What traditionally we've done, and we discussed this earlier, step back, look at all these additional projects, look at the prioritization within our overall plan. Consider which of those projects we can get done, which of those are going to be additive, et cetera, how we're going to finance it. Typically, we'd lay that out on our fourth quarter call. But again, we should be able to provide, I think, a pretty comprehensive update on where things stand at the end of the second quarter and going into EEI. Michael, any additional thoughts there?"
},
{
"speaker": "Michael Moehn",
"text": "No. Marty, that's good."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Awesome. And just a quick clarification from Paul's question. Just with respect to the QIP, obviously, you've laid out your CapEx expectations through the full period here, including the -- I'm going to use the word sunset, I get that's not entirely appropriate. How do you think about whether or not that's extended and how that impacts your CapEx budget? I understand it impacts the recovery mechanisms and timing they're in. But it presumably does not impact your CapEx, one way or another?"
},
{
"speaker": "Michael Moehn",
"text": "That's right. I mean, look, the CapEx is an important CapEx that needs to be done on behalf of customers. We'll have to step back, I think as Marty said in his answer, and look at if that was not in place, how we file rate reviews and those types of things. But this is needed CapEx that's driving reliability improvements for customers, safety improvement for customers, et cetera."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. All right. Actually, guys, I'll leave it there. Sorry, you're going to say something?"
},
{
"speaker": "Martin Lyons",
"text": "No, I was going to say thanks, Julien. I appreciate the questions."
},
{
"speaker": "Operator",
"text": "We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Marty Lyons for closing comments."
},
{
"speaker": "Martin Lyons",
"text": "Great. Well, I just wanted to say thank you to all of you for joining us today. As you can see, we had a really strong 2021. And we remain very, very focused on delivering again in 2022 and beyond for our customers, our communities and for all of you, our shareholders. So with that, please be safe, and we look forward to seeing many of you in person over the coming months."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 3 | 2,021 | 2021-11-04 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation’s Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded. It is now my pleasure to introduce our host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer; Michael Moehn, our Executive Vice President and Chief Financial Officer; and Marty Lyons, President of Ameren Missouri, as well as other members of the Ameren management team joining us remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in our News Release we issued yesterday and the forward-looking statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today’s presentation, including earnings guidance, are presented on a diluted basis unless otherwise noted. Now here’s Warner, who will start on Page 4 of our presentation.
Warner Baxter: Thanks, Andrew. Good morning, everyone, and thank you for joining us. To begin, I am pleased to report that our team continues to effectively execute our strategic plan across all of our businesses, which includes making significant investments in our energy infrastructure to enhance the reliability and resiliency with the energy grid as well as transition to a cleaner energy future in a responsible fashion. These investments, coupled with our continued focus on disciplined cost management and delivering significant value to our customers, communities and shareholders. We’ll now do our third quarter earnings results. Yesterday, we announced third quarter 2021 earnings of $1.65 per share. Our earnings were up $0.18 per share from the same time period in 2020. This slide highlights the key drivers of our strong performance. Michael will discuss the key drivers of our third quarter earnings results a bit later. Due to the continued strong execution of our strategy, I am also pleased to report that we raised our 2021 earnings guidance. Our 2021 earnings guidance range is now $3.75 per share to $3.95 per share compared to our original guidance range of $3.65 per share to $3.85 per share. Turning now to Page 5, where we reiterate our strategic plan. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of our customers. As a result, and as you can see on the right side of this page, during the first nine months of this year, we invested significant capital in each of our business segments. These investments are delivering value to our customers. As I said before, our energy grade is stronger, more resilient and more secure because of the investments we are making in all four business segments. As we head into the winter months, I’d like to highlight some of the value these investments have created in Ameren Illinois and Ameren Missouri natural gas businesses. Our natural gas transmission and distribution investments are focused on upgrading and modernizing gas main and equipment infrastructure, all the strength in safety and reliability of our system for our customers. Being mindful of the gas distribution issues experienced in the industry in the past, I will note that our Ameren Illinois and Ameren Missouri natural gas distribution systems are comprised almost entirely a plastic and protected coated steel pipelines. There is no cast iron pipe in our systems, and we expect to eliminate all unprotected steel pipe by the end of this year. These investments are just another example of how we are putting our customers at the center of our strategy. Moving now to regulatory matters. In late March, Ameren Missouri filed a request for a $299 million increase and annual electric service revenues and a $9 million increase in annual natural gas service revenues with the Missouri Public Service Commission. In our Illinois Electric business, we have requested a $59 million base rate increase our required annual electric distribution rate filing. These proceedings are moving along on schedule. Michael will provide more information on these proceedings a bit later. Finally, we remain relentlessly focused on continuous improvement and disciplined cost management, including maintaining many of the cost savings that we realized in 2020 due to the actions we took to mitigate the impacts of COVID-19. Moving to Page 6 and the second pillar of our strategy: enhancing regulatory frameworks and advocating for responsible energy and economic policies. Over the years, we have been successful in executing this element of our strategy by delivering value to our customers for our investments in energy infrastructure and through extensive collaboration with key stakeholders in all of our regulatory jurisdictions. I am very pleased to report that these efforts paid off again in the third quarter when the Illinois legislature passed the Climate and Equitable Jobs Act, or CEJA, which is later signed by Governor Pritzker. CEJA is a constructive piece of legislation that addresses the key objectives that we felt were important for our customers and the communities we serve. It will enable us to continue to make important infrastructure investments to enhance the reliability and resiliency of the energy grid for a new forward-thinking regulatory framework. It will also give us the ability to earn fair returns on those investments as well as enable us to invest in two solar and/or battery storage pilot projects. CEJA allows for an electric utility to opt in to a multi-year rate plan effective for four years beginning in 2024. We are currently working with key stockholders and will continue to over the course of 2022, to establish specific procedures, including performance metrics to implement this legislation, subject to finalizing key aspects of this rate-making framework, we anticipate filing a multi-year rate plan by mid-January 2023. Michael will discuss this constructive piece of legislation in more in a moment. Shifting now to the federal level, where important energy legislation continues to be discussed. Needless to say, the situation around federal legislation remains fluid and ever changing. One thing that remains constant is our strong support for clean energy transition tax incentives including wind and solar production tax credits, transmission and storage investment tax credits as well as direct pay and normalization opt-out provisions. We also continue to strongly support significant funding for research, design and development for new clean energy technologies, electrification of the transportation sector and grid resiliency. We support these important legislative initiatives, because we strongly believe they will deliver significant long-term benefits to our customers, communities and country. We will continue to work with key stakeholders, along with our industry colleagues to advance constructive federal energy and economic policies that will help us transition to a cleaner energy future in a responsible fashion. Speaking of our transition to our cleaner energy future, please turn to Page 7 in the discussion of future transmission investment needs. As we have discussed with you in the past, MISO completed a study outlining the potential road map of transmission projects through 2039. Taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates and goals for clean energy or carbon emission reductions, among other things. On MISO’s Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon emissions reduction below 2005 levels by 2039. MISO estimates approximately $30 billion, the future transmission investment would be necessary in the MISO footprint. Under its future tree scenario, which resulted in an 80% reduction in carbon emissions below 2005 levels by 2039. MISO estimates approximately $100 billion of transmission investment and the MISO footprint would be needed. It is clear that investment in transmission is going to play a critical role in the clean energy transition, and we are well-positioned to plan and execute the potential projects in the future for the benefit of our customers and country. We continue to work with MISO and other key stakeholders and believe certain projects outlined in Future 1 are likely going to be included in this year’s MISO transmission planning process, which is expected to be completed in early 2022. Moving now to Page 8 and an update on litigation regarding Ameren Missouri’s past compliance with the new source review provisions of the Clean Air Act. As you may recall, this litigation dates back to 2011 and the Department of Justice on behalf of the EPA bought a complaint against Ameren Missouri, alleging that and performing certain projects at the Rush Island Energy Center, we have violated the new source review provisions of the Clean Air Act. In 2017, the District Court issued a liability ruling and in September 2019, or the installation of push control equipment at the Rush Island Energy Center as well as at the Labadie Energy Center. September of this year, U.S. Court of Appeals preferred the District Court’s 2019 order requires us to install a scrubber at our Rush Island Energy Center, but denied the order to install additional pollution control equipment at Labadie. Last month, we thought a request for rehearing with U.S. Court of Appeals. While we wait for a final decision from the courts, we continue to assess several alternatives to effectively address the Court of Appeals decision, including legal, operational and regulatory measures. In reviewing these options, we are also carefully assessing the impact on customer costs as well as generation or transmission investments needed to maintain system reliability. And we are certainly mindful of the policies that are being considered at the federal level to help address climate change. Should our decision results in a material change to our integrated resource plan, we will file an updated plan with the Missouri PSC. Turning to Page 9. We remain focused on delivering a sustainable energy future for our customers, communities and our country. This page summarizes our strong sustainability value proposition for environmental, social and governance matters and is consistent with our vision, leading the way to a sustainable energy future. Beginning with environmental stewardship, last September, Ameren announced its transformation plan to achieve net zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes interim carbon emission reduction targets of 50% and 85% below 2005 levels in 2030 and 2040, respectively, and is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. This slide highlights the many things we are doing for our customers and communities including being an industry leader in diversity, equity and inclusion. Further, our strong corporate governance is led by a diverse Board of Directors focused on strong oversight that’s aligned with ESG matters and our executive compensation practices include performance metrics that are tied to sustainable long-term performance, diversity equity inclusion and progress towards a cleaner sustained energy future. Finally, this slide highlights our very strong sustainable growth proposition, which is among the best in the industry. Turning to Page 10, you will go down further on this key element. Our strong sustainable growth proposition is driven by a robust pipeline of investment opportunities over $40 billion over the next decade that will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter and cleaner. Importantly, these investment opportunities exclude any new reasonably beneficial transmission projects, including the potential road map of MISO transmission projects I discussed earlier, all of which would increase the reliability and resiliency of the energy grid as well as help to enable our country’s transition to a cleaner energy future. In addition, we expect to see greater focus on infrastructure investments to support the electrification of the transportation sector in the future. Our outlook through 2030 does not include significant infrastructure investments for electrification at this time. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner energy future and a safe, reliable and affordable fashion will be critical to meeting our country’s future energy needs and delivering on our customers’ expectations. Moving to Page 11. Another key element of our sustainable growth proposition is the five-year earnings per share growth guidance we issued in February, which included a 6% to 8% compound annual earnings per share growth rate from 2021 to 2025. This earnings growth is primarily driven by strong rate base growth and compares very favorably with our regulated utility peers. Importantly, our five-year earnings and rate base growth projections do not include 1,200 megawatts of incremental renewable investment opportunities outlined in Ameren Missouri’s Integrated Resource Plan. Our team continues to assess several global generation proposals from developers. We expect to file with the Missouri PSC for approval of a portion of these planned renewable investments this year. I am confident in our ability to execute our investment plans and strategies across all four of our business segments. That fact, coupled with our sustained past execution of our strategy on many fronts, has positioned us well for future success. Further, our shares continue to offer investors a strong dividend, which we expect to grow in line with our long-term earnings per share growth guidance. Simply put, we believe our strong earnings and dividend growth outlook results in a very attractive total return opportunity for shareholders. Finally, turning to Page 12. I will wrap up with a few comments about the organizational changes we announced a few weeks ago. Over the past eight years, I have had the great privilege to serve as Chairman, President and Chief Executive Officer of Ameren. During this time, I’ve been very fortunate to lead the team that has done an excellent job in executing our strategy and delivering strong value to our customers, communities and shareholders. Last month, I was humbled and honored that the Board of Directors elected me to serve as Executive Chairman effective January 1, 2022. At the same time, and consistent with our robust succession planning process, I was very pleased that the Board of Directors also elected Marty Lyons to serve as President and Chief Executive Officer as well as to join the Board of Directors on January 1. Marty is an outstanding leader and is exceptionally qualified to lead our company as CEO during this transformation and time in our industry. Of course, many of you know Marty very well as he spent a decade as the company’s Chief Financial Officer. And during the past 20 years, Marty has demonstrated strong operational, financial, regulatory and strategic acumen. I must say that I’m very excited about our new forward-thinking leadership structure. Working closely with Marty and our strong leadership team, I will remain actively engaged in overseeing important strategic matters impacting the company, including our transition to a cleaner energy future and will also remain focused on key energy and economic policy matters, especially in my leadership roles at the Edison Electric Institute and the Electric Power Research Institute as well as engaging with key stakeholders. Marty will take on significant duties of the CEO, which includes leading all aspects of Ameren strategy development and execution as well as the day-to-day operational, financial, regulatory, legal and workforce matters impacting the company. I, along with our Board of Directors, are very confident that Marty is clearly ready to lead Ameren as its new CEO. With that, I’ll congratulate Marty once again for his promotion to CEO and turn it over to him to say a few words.
Marty Lyons: Thank you, Warner. I’m truly grateful for and humbled by the opportunity to lead Ameren during these exciting times for our company and for our industry. I’m also honored to follow on your footsteps Warner. You’ve led our team to execute on a strategy that has delivered significant value to our customers and shareholders. Working with his outstanding leadership team and my dedicated coworkers at Ameren, we will remain focused on successfully executing this strategy in the future. I look forward to engaging with all of you joining us on the call today and in the weeks and months ahead. With that, I’ll turn it back over to you, Warner.
Warner Baxter: Thank you, Marty. I look forward to continuing to work closely with you in your new role. Together, we remain firmly convinced that the continued execution of our strategy in the future will deliver superior value to our customers, communities, shareholders and the environment. Thank you all for joining us today. I’ll now turn the call over to Michael.
Michael Moehn: Thanks, Warner, and good morning, everyone. Turning now to Page 14 of our presentation. Yesterday, we reported third quarter 2021 earnings of $1.65 per share compared to $1.47 per share for the year ago quarter. Earnings in Ameren Missouri, our largest segment increased $0.27 per share, driven primarily by a change in seasonal electric rate design, resulting from the March 2020 rate order, which provided for lower winter rates in May and higher summer rates in September rather than the blended rates used in both months in 2020. Higher electric retail sales also increased earnings by approximately $0.10 per share, largely due to continued economic recovery in this year’s third quarter compared to the unfavorable impacts of COVID-19 in the year ago period. As well as higher electric retail sales driven by warmer-than-normal summer temperatures in the period compared to near-normal summer temperatures in the year-ago period. We’ve included on this page, the year-over-year weather-normalized sales variances for the quarter. Total weather normalized sales year-to-date, shown on Page 27 of the presentation are largely consistent with our expectations outlined on our call in February, as we still expect total sales to be up approximately 2% in 2021 compared to 2020. That said, we’ve seen a net benefit in margins due to residential and commercial sales coming in higher than expected and industrial sales slightly lower than expected. Increased investments in infrastructure and wind generation eligible for plant and service accounting and the renewable energy standard rate adjustment mechanism or RESRAM, positively impacted earnings by $0.07 per share. The timing of tax expense, which is not expected to materially impact full year results increased earnings by $0.03 per share. Higher operations and maintenance expense decreased earnings by $0.04 per share in 2021 compared to the third quarter of 2020, which was affected by COVID-19 and remained flat year-to-date driven by disciplined cost management. Finally, the amortization of deferred income taxes related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage also decreased earnings $0.02 per share. Moving to other segments. Ameren Transmission earnings increased $0.03 per share year-over-year, reflecting increased infrastructure investment. Ameren Illinois Electric Distribution earnings per share were comparable, which reflected increased infrastructure and energy efficiency investments and a higher allowed ROE under performance-based ratemaking, partially offset by dilution. Earnings for Illinois and natural gas decreased $0.04 per share. Increased delivery service rates that became effective in late January 2021 were more than offset by a change in rate design during the quarter, which is not expected to impact full year results. Ameren parent and other results decreased $0.08 per share compared to the third quarter of 2020, primarily due to the timing of income tax expense, which is not expected to materially impact full year results. Finally, 2021 earnings per share reflected higher weighted average shares outstanding. Before moving on, I’ll touch on year-to-date sales trends for Ameren Illinois Electric Distribution. Weather normalized kilowatt hour sales to Illinois residential customers decreased 0.5%. And weather normalized kilowatt hour sales to Illinois commercial and industrial customers increased 2.5% and 1.5%, respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Turning to Page 15. Now we’d like to briefly touch on key drivers impacting our 2021 earnings guidance. We have remained very focused on maintaining disciplined cost management and we’ll continue that focus. As Warner noted, due to the solid execution of our strategy, we now expect 2021 diluted earnings to be in the range of $3.75 per share to $3.95 per share, an increase from our original guidance range of $3.65 per share to $3.85 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed on our earnings call in February. Moving to Page 16 for an update on regulatory matters. On March 31, we filed for a $299 million electric revenue increase within Missouri Public Service Commission. The request includes a 9.9% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $10 billion. In October, Missouri Public Service Commission staff and other interveners filed a bottle testimony. Missouri PSC staff recommended a $188 million revenue increase, including a return on equity range of 9.25% to 9.75% and an equity ratio of 50% based on Ameren Missouri’s capital structure at June 30, 2021, which will be updated to use the capital structure as of September 30, 2021. The October staff recognition was lower primarily due to lower recommended depreciation expense, which would not be expected to impact earnings. Turning to Page 17. In addition to the electric filing on March 31, we filed for a $9 million natural gas revenue increase within Missouri PSC. The request includes a 9.8% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $310 million. Missouri PSC staff recommended a $4 million revenue increase, including a return on equity range of 9.25% to 9.75% and an equity ratio of 50.32% based on Ameren Missouri’s capital structure at June 30, 2021, which will be updated to use of the capital structure as of September 30, 2021. Other parties, including the Missouri Office of Public Counsel have also made recommended adjustments to our Missouri electric and gas rate request. Evidentiary hearings are scheduled to begin in late November, and the Missouri PSC decisions from both rate reviews are expected by early February with new rates expected to be effective by late February. Moving to Page 18, Ameren Illinois regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance-based rate making these annual rate updates systematically adjust cash flows over time for changes in cost of service and true up any prior period over or under recovery of such costs. In August, the ICC staff recommended a $58 million base rate increase compared to our request of $59 million base rate increase. An ICC decision is expected in December with new rates expected to be effective in January 2022. Turning now to Page 19. As Warner mentioned, in September, constructive energy legislation was enacted in the State of Illinois. This allows Ameren Illinois the option to file a four-year rate plan in January 2023 for rates effective beginning in 2024. The return on equity, which will be determined by the Illinois Commerce Commission, may impacted by plus or minus 20 to 60 basis points based on the utility’s ability to meet certain performance metrics related to items such as reliability, customer service and supplier diversity. The plan also allows for the use of year-end rate base and an equity ratio up to 50% within higher equity ratio subject to approval by the ICC. In addition, it calls revenue decoupling and an annual reconciliation of cost and revenues for each annual period approved in the multiyear rate plan. There’s a cap on the true-up, which may not exceed 105% of the revenue requirement and excludes variation from certain forecasted costs. The exclusions include cross associated with major storms, changing in timing of expenditure and investment that moved the expenditure investment into or out of the applicable calendar year and changes in income taxes, among other things. The true-up cap also excludes cost recovered through riders such as purchase power, transmission and bad debts. Rate impact to customers may also be mitigated through the ability to phase in rates. The legislation also allows for two utility-owned solar and/or battery storage pilot projects to be located near Peoria and East St. Louis at a cost not to exceed $20 million each. It also provides for programs that encourage transportation electrification in the state. We believe this framework will improve our ability to make significant investments in the State of Illinois and earn a fair return on equity. Looking ahead, we have the ability to opt into the multiyear rate plan or use the future test year traditional rate-making framework, both of which include a return on equity determined by the ICC and revenue decoupling. Should we choose to opt into the new multiyear rate plan, our four-year plan must be filed by January 20, 2023. We anticipate continuing to use the performance-based ratemaking until we proceed with a multiyear rate plan filing or choose to move ahead with using the traditional framework. Moving to Page 20 for a financing update. We continue to feel very good about our financial position. We’re able to successfully actually on several debt issuances earlier this year, which we have outlined on this page. In order for us to maintain our credit ratings and a strong balance sheet, while we fund our robust infrastructure plan and consistent with prior guidance as of August 15, we have completed the issuance of approximately $150 million of common equity through our at-the-market or ATM program that was established in May. Further, approximately $30 million of equity outlined for 2022 have been sold year-to-date under the programs forward sales agreement. Together with the issuance under our 401(k) and DRPlus program, our $750 million ATM equity program is expected to support equity needs through 2023. Moving now to Page 21. I’d like to briefly touch on the recent increase in natural gas prices around the country and the potential impact it may have on customer bills this coming winter. Beginning with our natural gas business, heading into the winter season, Ameren Illinois is approximately 75% hedged and Ameren Missouri is approximately 85% hedged based on normal seasonal sales. Approximately 60% of Ameren Illinois winter supply of natural gas was bought this summer at lower prices and is being stored in the company’s 12 underground storage fields. Both companies are 100% volumetrically hedged based on maximum seasonal sales. Regarding the electric business in Missouri, we are currently long generation and any margin made through offices sales flow back to customers as a benefit on their bills through the fuel adjustment clause. Given our low cost of generation, rising natural gas and power prices have the potential to benefit our electric customers in Missouri. Turning to Page 22. We plan to provide 2022 earnings guidance when we release fourth quarter results in February next year. Using our 2021 guidance of the reference point, we have listed on this page select items to consider as you earnings outlook for next year. Next, I would note, we expect to recognize earnings related to energy efficiency performance from both 2021 and 2022 plan years and 2022. As a result, we expect energy efficiency performance incentives to be approximately $0.04 per share higher than 2021. Further, our return to normal weather in 2022 would decrease Ameren Missouri earnings by approximately $0.04 compared to 2021 results to date, assuming warm weather in the last quarter of the year. Beginning with Missouri, we expect the new electric service rates to be effective in 2022 as a result of our attending rate review. These rates are expected to reflect recovery of and return on new infrastructure and wind generation investments, which are expected to increase earnings when compared to 2021. Prior to new electric service rates taking effect in late February, we expect increase investments in infrastructure and wind generation eligible for plant-in-service accounting and the RESRAM to positively impact earnings. Next, we expect to recognize earnings related to energy efficiency performance incentives from both 2021 and 2022 plan years and 2022. As a result, we expect the energy efficiency performance incentives to be approximately $0.04 per share higher than 2021. Further, I returned to normal weather in 2022, decrease Ameren Missouri earnings by approximately $0.04 compared to 2021 results to-date, assuming normal weather in the last quarter of the year. Next, earnings from our FERC-related electric transition entities are expected to benefit from additional investments in the Ameren Illinois projects made under forward-looking formula ratemaking. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2022 compared to 2021 from additional infrastructure investments made under Illinois formula ratemaking. The allowed ROE under the will be the average 2022 30-year treasury yield plus 5.8%. For Ameren Illinois Natural Gas, earnings are expected to benefit from new delivery service rates effective late January 2021 as well as an increase in infrastructure investments qualifying for rider treatment that were in the current allowed ROE of 9.67%. Lastly, turning to Page 23, we’re well positioned to continue executing our plan, continue to expect to deliver strong earnings growth in 2021, as we successfully execute our strategy. And as we look to the longer term, we expect strong earnings per share growth, driven by robust rate-based growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulator utility peers. Ameren Missouri is continue to offer investors and attractive dividend. In summary, we have a total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: Thank you. And ladies and gentlemen, at this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan. Please state your question
Warner Baxter: Good morning, Jeremy.
Jeremy Tonet: Hi, good morning.
Warner Baxter: Good morning.
Jeremy Tonet: Good morning, thanks. Thanks for all the detail there and just want to pick up on the MISO MTAP side. I was just wondering if you might be able provide any more color for your expectations there in the process. And what could this specifically mean for Ameren over time? Realize might begin a little bit ahead of ourselves here, but just want to know if there’s any way you could frame, I guess what you think could be possible for Ameren CapEx, yes?
Warner Baxter: Yes. Thanks, Jeremy, for the question. Number one, let me just start with this. We’re very excited about the opportunity that we have for the transmission investment. Number one, we’re absolutely convinced that transmission is going to play an integral role. And that’s a fair company, for our country and really executing this clean energy transition. And we’re right in the middle of it. We have been before, and we are going to continue to be. And so look, it’s premature to put I would say, a specific number. As you heard us in our prepared remarks, MISO has identified $30 billion to $100 billion of investment opportunities of potential projects. And I will tell you, where the country is going is closer to that scenario 3, which is closer to the $100 billion number. So what we’re doing – what MISO is doing, what stakeholders are doing. Look, we’re working together to try and make sure that we put together a good set of projects coming out of this first MTAP that will start us on this path toward just clean energy transition. And as we look at it, if you look at that scenario 1 that’s highlighted out there, we really think the focus will be on more no regrets types of projects as we start putting our toes in the water, if you will, maybe getting up to our knees. And then from there, I think we’ll see it continue to get progressively bigger over time. We think there’ll be some no regrets projects. And in terms of timing, look, I think the group – our group and many stakeholders are working collaboratively to try and figure out the best projects as well as cost allocation things. These things are all things that you typically go through in this process. And so at the end of the day, we think that MISO will propose early in 2022, these projects to their Board of Directors, it will be well informed. And then what we believe will be hopefully will be an approval process that will get them in early 2022. So when you look at them in our overall plans, as we’ve said before, you might see some of these projects in our current five-year plan start coming into play towards the back end of our five-year plan. But certainly, in the second half of this decade, I think you’re going to see a significant emphasis and need for transmission projects. So that’s really what I can tell you today. But as I’ll finish the way I started there, we’re excited about the opportunity because we think it’s significant and important.
Jeremy Tonet: Got it. That’s helpful. We eagerly await there.
Warner Baxter: We view as well.
Jeremy Tonet: Maybe just pivoting over to the Missouri IRP here. Just wondering if you could share with us thoughts on next steps and I guess, how Rush Island plays into it, what we should be thinking about there?
Warner Baxter: Yes. Thanks, Jeremy. Marty Lyons has been in the middle of all those things. I’m going to turn it over to him to respond to your questions. Marty, go ahead.
Marty Lyons: Thanks, Jeremy. Hey, how are you today? Appreciate the question. As it relates to the integrated resource plan, obviously, we filed last fall and as Warner said earlier in the prepared remarks, we continue to work with multiple developers with respect to several projects that would fit within that 1,200 megawatts of clean energy that we plan to deliver over the next several years consistent with that integrated resource plan. So we’re continuing to work on those, and we still expect to file with the commission still this year for approval of a portion of those project. So that work is going on. And then you mentioned the Rush Island Energy Center. And so as you saw in our slides today, in August, the court of appeals affirmed the District Court’s September 19 order. As we said in our slides and prepared remarks, we did file for a rehearing of that decision on October 18. So we do expect to hear back from the court and quite likely by the end of this year, we expect in terms of that rehearing. So it’s really premature to say what action we will take with respect to Rush Island at this point. We’ll wait to see whether there’s a rehearing. But that rehearing is denied and ultimately, we’re faced with that decision. Obviously, it may entail scrubbers in Rush Island or the accelerated retirement of that plant, which might also include the utilization of the securitization legislation was passed earlier this year. So those are some of the things we’re looking at. Considerations as we think about those alternatives or things like customer rate impacts, replacement generation needs and importantly, reliability and investments that may be required in terms of transmission to the extent that Rush Island were to be prematurely retired. So those are some of the considerations. I’ll tell you this, if ultimately a decision is made to retire Rush Island prematurely versus the day we had in our prior integrated resource plan that will require them that we file an updated integrated resource plan with the Missouri Public Service Commission. So stay tuned on that. Like I said, it’s premature to say how all of that will turn out, but that gives you a little bit of color on the potential path forward.
Jeremy Tonet: Got it. That’s helpful. And just 1 last quick one, if I could. Just wondering if you might be able to comment on your generation position? And do you see any potential customer benefits under current market conditions right now?
Michael Moehn: Hey, Jeremy, it’s Michael. Yes, I think we indicated in the prepared remarks in the slide that we historically have been long in the Missouri side. And so obviously, to the extent, that we’re able to take advantage of that in the marketplace is also some sales that flow back to customers through the fuel adjustment clause. So certainly, given where natural gas prices are, which is what the impact it’s having on power prices, it’s definitely a bit of a tailwind from a customer affordability standpoint.
Jeremy Tonet: Got it. I’ll leave it there. Thank you.
Warner Baxter: Thanks, Jeremy. See you next week.
Operator: Our next question comes from Julien Dumoulin-Smith with Bank of America.
Warner Baxter: Good morning, Julien. How are you doing?
Dariusz Lozny: Hey, good morning. This is Dariusz on for Julien actually. Thank you for taking my question. Can you just clarify, it was a little unclear from the opening remarks. Do you intend – or are you still evaluating whether or not you’ll file under a multiyear rate plan in Illinois in or before January 23?
Warner Baxter: Yes. So this is Warner. So let me just summarize what we’ve said. Clearly, as I said and as Michael said, we think this is a forward-thinking, constructive regulatory structure. And not only is it constructive that enables us to make investments that we think are important for customers, but also gives us the opportunity to earn a fair return on those investments. Now what we said too, is that the structure is out there, but there’s still some work to be done, meaning that there are jobs that have to be taken care of next year, as you might have with any specific and comprehensive piece of legislation and we’re going to work through those workshops. Now we believe those workshops were at the table, and we expect them to be constructive outcomes. And so as a result, as we said, too, we anticipate filing for a multiyear rate plan in 2023. But there’s still some work to be done. And so we’re not trying to hedge or be cute. We just sort of telling it like it is. At the same time, as I said, we think it’s a constructive piece of legislation that we think will bring benefits to our customers state of Illinois and certainly to our shareholders. Michael, do you have anything you want to add?
Michael Moehn: Look, you said it all correctly. I mean these workshops will continue on through 2022. And I think we’ll have a conclusion of the by the fall. So we’ll have even better clarity. But as Warner said, the benefits clearly seem to be pretty significant here in terms of just the overall framework itself.
Warner Baxter: Yes. And just to give you a perspective, these workshops as you know, we talk about performance metrics. There’s a performance-based ratemaking perspective and concept incorporated in this legislation. So the performance metrics have to be determined, how you work through some of the details of the multiyear rate plan. These are things that stakeholders have to come to the table. And we look forward to working collaboratively with all of them next year.
Dariusz Lozny: Okay, thank you. That’s very helpful color. And if I could pivot maybe to federal legislation, if I can. Have you quantified at all or thought about the potential upside impact on your credit metrics from direct pay, if that were included in final legislation?
Warner Baxter: Yes, thanks. Needless to say, that is a very fluid situation just in the bigger picture. And so to say that we’ve quantified in particular, the specific impacts that would be premature. I will say, there are elements of the clean energy tax incentives, which I think are very good for customers and could be good for cash flows, especially when you look at the direct pay portions around, certainly, the ITCs and the PTCs that wind and solar are small up tax incentives. So Michael, I know that you and your team have been looking at it, but we haven’t put a specific finger on it, but do you want to add a little more color than that?
Michael Moehn: Yes. I mean at a high level, that’s correct, Warner. I mean we are – they get into it. I think there are some positive aspects. There are also some things we got to just get our hands around, head around with respect to like this minimum tax liability, which seems to run counter to some those credits as well. So those are just some different aspects that we’re really trying to balance at the end of the day. But hopefully, over the course of the next quarter or so, we’ll have a much better feel for where this is going.
Warner Baxter: One thing you can miss assured is that me and my industry colleagues, we’re at the table to try and make sure that we get a constructive piece of federal legislation down across the board that will enable us to continue to move forward thoughtfully and effectively with the clean energy transition.
Dariusz Lozny: Great. Thank you very much. I’ll hop back on from here.
Warner Baxter: You bet. Thank you.
Operator: Our next question comes from Insoo Kim with Goldman Sachs. Please state your question.
Warner Baxter: Good morning, Insoo. How are you doing?
Insoo Kim: Good morning, Warner. How are you? My first question is on – the question on the Rush Island and the long-term generation plan. If the appeal process is unsuccessful. First of all, is it by the end of 2023 that you need to either put the scrubbers on or retire? Or is it 24? And then my – the related question to that is, as you think about potential changes to the plan if this had to shut early, given that long generation position? How do we think about some of the opportunities on the replacement side of things?
Warner Baxter: Marty, why don’t you jump on and then address that one, please?
Marty Lyons: Yes. Thanks, Insoo. Good to talk to you again. With respect to moving forward with scrubber, I think there, the expectation is that we would – if we went that route, as expeditiously as possible to put the scrubbers in place at Rush Island. So I’m not sure that there’s an exact time line. Obviously, the acquisition design, construction would take some time to get that put in place. And then with respect to the other route that you described, the retirement route, I think there, we’d be looking at how long Rush Island would continue to operate, obviously, given the things I talked about before, replacement generation needs, importantly, reliability issues around the system in the event of premature retirement, which again may necessitate some transmission investments in order to maintain reliability. So all of those things would be taken into consideration. And ultimately, to the extent that incremental generation was required or some acceleration of the clean energy transition that we’ve got laid out in our IRP, that would all be laid out in that updated integrated resource plan. So again, if we don’t move forward with the scrubber, if we do decide that the Rush Island needs to be shut down earlier than the day in our IRP, which was 2039, then we would move forward with an update to the Integrated Resource Plan. And again, and so that would assess all of the potential adjustments to generation need and timing that were laid out in that prior September Integrated Resource Plan filing.
Insoo Kim: Got it. Thanks for the color, Marty. The second question is on the grid 2021 guidance raising that by $0.10 as we think about the 2022, I know some of the weather benefit helped this year as well. But how do we think about some of the moving pieces that help 2021 that could potentially carry into 2022? And in that consideration slide, I didn’t see a specific mention to year-over-year low growth just curious on your base assumption there.
Warner Baxter: Yes. Look, there’s a lot in that question there. Let me give you a couple of pieces, just in terms of the growth itself. I mean, year-to-date, we’ve put in there from a residential standpoint, we’re up 1.5%, commercial 3.5% and industrial 1%. So about 2%, and that’s really what we guided to at the beginning of the year in February. Now the mix is a little bit different. So we’re seeing some improvement in margin there, which is a driver of that increase in the midpoint that you talked about in addition to weather. So we – the plan remains on track with respect to that sales piece, that 2%, we see that sort of guiding in at the same point towards the end of the year. As we talked about at the beginning of the year, that will get us close to being back to 2019, but not quite. So I think the recovery continues, and we’re optimistic about we continue to see things open up here in both of our service territories in Missouri and Illinois. With respect to the guidance itself, I just remind you again, we really – in February last year, that 6% to 8% guidance was off of that midpoint. Obviously, at $375 million, that original midpoint of $375 million. We certainly have given you some select items to think about here in 2022. And then obviously, in February, we’ll roll all this forward to give you another look at capital as well as give you just more specifics about obviously, where our range will be in our earnings guidance for 2022 at that point in time. So hopefully, that give you a little bit of color you’re looking for.
Insoo Kim: Got it. Thank you, and congrats, Marty and Warner both of you, and see you soon.
Marty Lyons: Thanks, Insoo.
Warner Baxter: Thanks, Insoo. See you next week.
Operator: Our next question comes from Durgesh Chopra with Evercore ISI. Please state your question.
Warner Baxter: Good morning, Durgesh.
Durgesh Chopra: Hey, good morning, Warner. Congratulations and to you as well, Marty.
Warner Baxter: Thank you.
Durgesh Chopra: I look forward to working with you.
Marty Lyons: You bet.
Durgesh Chopra: Maybe just can you talk about the 1.2 gigawatts in Missouri IRP. Just kind of what of that – what – how many – what portion of that capacity are you going to file for with the commission or get approvals for this year or early next year? Just as you’re thinking about your CapEx plan being extended another year, I’m thinking about how much of that 1.2 gigawatt might be layered in?
Warner Baxter: Sure. You bet, Marty, why don’t you come on in and address that from an operational perspective, and maybe Michael, you can talk about how we think about guidance in terms of capital expenditures and those types of things.
Marty Lyons: Yes, that sounds great, Warner. Durgesh, I appreciate the question. The – and I think Michael will get into this and expand on it, none of that 1,200 megawatts is really included today in the rate base growth or earnings guidance we have. As I said earlier, we continue to work with multiple developers with respect to multiple projects that would go towards filling out that 1,200 megawatts. At this point, as we negotiate through those, I mean it’s important to understand that those negotiations take time. There’s diligence involved. There’s again, multiple developers we’re working with really to get the best deals we can for our customers ultimately, and there are multiple contracts that need to be negotiated with each one of the developers. So we continue to work, again, with multiple of them on multiple projects. And at this point, I’d say again, I’d say we’re expecting to file for approval for a portion of that 1,200 megawatts. I expect that, that will happen this year still, but also then even further into next year. So stay tuned. I think it’s premature to say exactly which project or projects we’ll announce this year or early next, but we’re working actively on several. So that’s where we stand today.
Michael Moehn: Thanks, Marty. Just a couple of other small points on that $17 billion plan that we have out there, as Marty pointed out, there’s very, very little in there with respect to any of these renewable projects. Now we did indicate in that 10-year plan, that $40 billion plus, there is $3 billion of potential projects, which what Marty is referring to. So as we get more clarity on that timing, obviously, typically, what we do in February as we roll forward that capital plan, to be able to give you a bit more transparency about what the timing of that to the extent that we feel better about it and know it. So that’s just a little bit more color on exactly what’s there from a capital standpoint.
Durgesh Chopra: I appreciate that detail. Then just shifting gears to Illinois, Obviously, now the – under the new framework, the ROE goes back to the ICC and they kind of come back with an ROE number. Just any early thoughts on how might they be calculating that? I mean we and investors have talked about sort of your gas assets there and the ROEs they’re getting in 9%-plus range. Just any – from your seat, just any early color into what ROE might look like or how might that be calculated? I appreciate that. Thank you.
Warner Baxter: Sure. This is Warner. Look, it’s certainly be premature to predict where the ROEs would be. I mean the filing is going to be sometime in 2023, and it’s a multi-year filing. But what we can point to is, obviously, the 580 basis points, put a 30-year treasury, what that yields today. What we can point to is that in our gas business that we did at the beginning of this year, put in place a – the rate review results, that was a 9.67% return on equity for our gas business. It’s not the electric business, but it’s the gas business. It is just a data point. But how that will ultimately look and what the request will be for a multi-year rate plan, a lot of facts and circumstances will go into that. But we do see an opportunity for improvement, clearly, from our existing return on equity going forward.
Marty Lyons: Yes. I mean – and just think about that 9.67 is kind of traditional cost of capital kind of calculations. There’s nothing that’s sort of unique about it from a regulatory perspective. So it’s obviously different than moving away from this formulaic piece that we have.
Warner Baxter: Exactly. And we would expect the overall process and looking at that return on equity in terms of sort of a traditional look would be very similar. But obviously, with the multi-year rate plan, there may be some other factors that have come into us. So stay tuned.
Durgesh Chopra: All right. I’ll leave it there. Thanks, guys.
Warner Baxter: You bet. Thank you.
Operator: Our next question comes from Paul Patterson with Glenrock Associates. Please state your question.
Warner Baxter: Good morning, Paul.
Paul Patterson: Good morning. How are you doing?
Warner Baxter: I’m good. How are you?
Paul Patterson: Okay. So what I wanted to – first of all, I want to congratulate you guys. Is this your last call, Warner?
Warner Baxter: Number one, thank you. I’m truly excited about the new leadership structure and certainly the new roles that Marty and I are taking. And in terms of the last call, gosh, we’re taking one step at a time. We’re not saying this is my last call or anything like that. We’ll take that one step at a time. But you can kind of maybe in the EEI next week. That’s for sure.
Paul Patterson: Okay. Well, congratulations both of you.
Warner Baxter: Thank you.
Paul Patterson: And so just some – most of my questions have been answered, but a couple of quick ones for you. And I apologize for not knowing this, but what are no regrets projects I just don’t feel that grew blank. What does that mean?
Warner Baxter: It’s probably a Warner term, right. So really, when you look at all these projects, I mean, some you can sit there and say, gosh, when we had to get we’re having these congestion areas when we had to get from point A to point B, we have these projects that are in the queue, there are certain of these regional projects, which really satisfy a lot of those transmission – or excuse me, renewable energy projects that are in the queue. And you do the analysis and you sit there and say, gosh, no one could be no one. I shouldn’t say that. It would be hard for people to argue that this isn’t a project that isn’t going to be significantly beneficial to the MISO footprint, frankly, to our country. So I can’t put those as no regrets, low risk, let’s call them that way. Lower-risk projects relatively speaking, compared to some that may have more complications. And so when you look at that scenario one, we think from our perspective, right, beauty’s in the – holder, but from our perspective, and we think there are several of those in there that need to be – they need to move forward. So that’s what I mean. We haven’t outlined which of those that we believe are there, and this is part of the collaborative process that we go through with MISO and other key stakeholders. But that’s how we think. Really lower risk is probably a better term to characterize those projects as.
Paul Patterson: Okay. Fair enough. And then sort of a technical question. There was this discovery dispute in the Missouri rate case on the Smart Energy Plan. And if you look to me like basically, they did to address in their testimony or rebottle or what have you. And I just wanted to make sure, has that really been resolved? I just wasn’t clear to me from what they were saying, they didn’t really seem to address it and the revenue requirement everything didn’t seem to penalize you or anything for the recommendation. So my question is, has that issue been taken care of?
Marty Lyons: Paul, it’s Marty. I can’t say whether it’s been fully taken care of everybody’s satisfaction. I will tell you this, we do look to work constructively with all the parties in these rate reviews to get everybody the information they need in a timely basis to make decisions. And to your point, do not believe it’s an active issue in terms of a quantified difference between our position and the positions of others in the case. So hopefully, we have resolved that issue fully. But like you said, it’s not manifesting itself today in any kind of difference between the parties.
Paul Patterson: Okay. Great. And then finally, back to the 2024 question. I realize it’s very early, but it does seem like a big opportunity with – to the Illinois legislation. And I’m just wondering when you guys might incorporate it the potential outlook with it into your long-term guidance. I mean it doesn’t sound like it will be anything immediate, but I was just wondering, could it be a year from now or so that you guys would feel more comfortable talking about its potential benefit impact to the long-term growth outlook? Or would you be basically waiting until I guess, whenever the 2023 decision was made kind of, so to speak?
Marty Lyons: Sure. Yes, Paul, this is Marty. It’s a fair question. We’ll provide a lot more guidance, right, on that specific question and others when we come with our longer-term guidance in February. We’ll give you our view, right, on how we think about the guidance that we set in and how we think about regulatory frameworks and all those types of things. So sit here today, obviously, nothing to change, nothing to talk about other than as we’ve said, we think it’s a constructive piece of legislation that we anticipate assuming that things go well in the workshops, so we would file for a multi-year rate plan. How we embed that into our long-term guidance in early 2022, stay tuned. We’ll be able to provide more detail on that.
Paul Patterson: Okay. Awesome. Well, thanks so much, and congratulations again and have a great one.
Marty Lyons: Thanks, Paul. You do the same.
Operator: Thanks. And our next question comes from David Paz with Wolfe. Please state your question.
Warner Baxter: Hello David, how are you doing?
David Paz: Hey Warner, how are you doing? Congratulations on both of you and Marty.
Warner Baxter: Thank you.
Marty Lyons: Thanks, David. Thank you.
David Paz: I just want to follow-up on a couple of quick questions. Just the following-up on the 1,200 megawatt maybe lots of Missouri question. I understand the spend is not in your stated outlook, financial outlook, but is any of the equity for that investment in your financing plan?
Michael Moehn: Yes. Hey David, this is Michael. I mean that $17 billion plan again out there. The equity that we talked about back in third are really supports that $17 billion plan. It’s again sort of there by default that win is not in there, there’s no equity in there for.
David Paz: Got it. And then in an earlier question, Michael, did you say that you would be going forward your growth rate off of 2022 guidance or 2021 actuals when you were talking about the February update?
Michael Moehn: Yes. I was just referring to last February, David, when we gave the 6% to 8% earnings per share growth guidance, it was off of that midpoint of 3.75%. And so that’s where people should continue to stay focused. We obviously gave you some 2022 select items here to think about in the third quarter, and then we’ll obviously roll forward stuff and give you a specific guidance in February of 2022.
David Paz: I see. Okay. Great. And maybe just a last question. I think Marty, can you provide an update maybe on just how settlement talks are going in the rate case or whether they’re still going?
Marty Lyons: Yes. Thanks, David. The settlement talks really get going here over the next couple of weeks. We actually have, as we laid out in the slide, server battle testimony that’s actually do Friday. So I think all the parties are focused on that. And then soon after that, the parties will be pulling together reconciliations of the differences between our case and the updated positions of the staff, in particular, but also other parties. And then settlement discussions will get underway. As you know, again, is our – right now, the evidence you’re hearing are really scheduled to begin right after Thanksgiving on November 29. So my expectation is that starting next week and all the way through that time period, there’ll be settlement discussions, hopefully, to narrow the issues and if possible, to resolve the entire case. Obviously, we have been successful in settling a number of cases that we’ve had over the past several years, including the last rate review. So we certainly expect to work towards that goal. And like I said, those discussions will really be happening between now and likely the beginning of those evidentiary hearings.
David Paz: Great. Thank you so much.
Warner Baxter: Thanks, David. See you next week.
Operator: Thank you. And we have reached the end of the question-and-answer session. So I’ll now turn the call back over to Andrew Kirk for closing remarks.
Andrew Kirk: Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial inquiries should be directed to me, Andrew Kirk. Media should call Tony Paraino, Again, thank you for your interest in Ameren, and looking forward to seeing many of you next week at EEI. Thanks.
Operator: Thank you. This concludes today’s conference. All parties may disconnect. Have a good day. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation’s Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded. It is now my pleasure to introduce our host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer; Michael Moehn, our Executive Vice President and Chief Financial Officer; and Marty Lyons, President of Ameren Missouri, as well as other members of the Ameren management team joining us remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in our News Release we issued yesterday and the forward-looking statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today’s presentation, including earnings guidance, are presented on a diluted basis unless otherwise noted. Now here’s Warner, who will start on Page 4 of our presentation."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. To begin, I am pleased to report that our team continues to effectively execute our strategic plan across all of our businesses, which includes making significant investments in our energy infrastructure to enhance the reliability and resiliency with the energy grid as well as transition to a cleaner energy future in a responsible fashion. These investments, coupled with our continued focus on disciplined cost management and delivering significant value to our customers, communities and shareholders. We’ll now do our third quarter earnings results. Yesterday, we announced third quarter 2021 earnings of $1.65 per share. Our earnings were up $0.18 per share from the same time period in 2020. This slide highlights the key drivers of our strong performance. Michael will discuss the key drivers of our third quarter earnings results a bit later. Due to the continued strong execution of our strategy, I am also pleased to report that we raised our 2021 earnings guidance. Our 2021 earnings guidance range is now $3.75 per share to $3.95 per share compared to our original guidance range of $3.65 per share to $3.85 per share. Turning now to Page 5, where we reiterate our strategic plan. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of our customers. As a result, and as you can see on the right side of this page, during the first nine months of this year, we invested significant capital in each of our business segments. These investments are delivering value to our customers. As I said before, our energy grade is stronger, more resilient and more secure because of the investments we are making in all four business segments. As we head into the winter months, I’d like to highlight some of the value these investments have created in Ameren Illinois and Ameren Missouri natural gas businesses. Our natural gas transmission and distribution investments are focused on upgrading and modernizing gas main and equipment infrastructure, all the strength in safety and reliability of our system for our customers. Being mindful of the gas distribution issues experienced in the industry in the past, I will note that our Ameren Illinois and Ameren Missouri natural gas distribution systems are comprised almost entirely a plastic and protected coated steel pipelines. There is no cast iron pipe in our systems, and we expect to eliminate all unprotected steel pipe by the end of this year. These investments are just another example of how we are putting our customers at the center of our strategy. Moving now to regulatory matters. In late March, Ameren Missouri filed a request for a $299 million increase and annual electric service revenues and a $9 million increase in annual natural gas service revenues with the Missouri Public Service Commission. In our Illinois Electric business, we have requested a $59 million base rate increase our required annual electric distribution rate filing. These proceedings are moving along on schedule. Michael will provide more information on these proceedings a bit later. Finally, we remain relentlessly focused on continuous improvement and disciplined cost management, including maintaining many of the cost savings that we realized in 2020 due to the actions we took to mitigate the impacts of COVID-19. Moving to Page 6 and the second pillar of our strategy: enhancing regulatory frameworks and advocating for responsible energy and economic policies. Over the years, we have been successful in executing this element of our strategy by delivering value to our customers for our investments in energy infrastructure and through extensive collaboration with key stakeholders in all of our regulatory jurisdictions. I am very pleased to report that these efforts paid off again in the third quarter when the Illinois legislature passed the Climate and Equitable Jobs Act, or CEJA, which is later signed by Governor Pritzker. CEJA is a constructive piece of legislation that addresses the key objectives that we felt were important for our customers and the communities we serve. It will enable us to continue to make important infrastructure investments to enhance the reliability and resiliency of the energy grid for a new forward-thinking regulatory framework. It will also give us the ability to earn fair returns on those investments as well as enable us to invest in two solar and/or battery storage pilot projects. CEJA allows for an electric utility to opt in to a multi-year rate plan effective for four years beginning in 2024. We are currently working with key stockholders and will continue to over the course of 2022, to establish specific procedures, including performance metrics to implement this legislation, subject to finalizing key aspects of this rate-making framework, we anticipate filing a multi-year rate plan by mid-January 2023. Michael will discuss this constructive piece of legislation in more in a moment. Shifting now to the federal level, where important energy legislation continues to be discussed. Needless to say, the situation around federal legislation remains fluid and ever changing. One thing that remains constant is our strong support for clean energy transition tax incentives including wind and solar production tax credits, transmission and storage investment tax credits as well as direct pay and normalization opt-out provisions. We also continue to strongly support significant funding for research, design and development for new clean energy technologies, electrification of the transportation sector and grid resiliency. We support these important legislative initiatives, because we strongly believe they will deliver significant long-term benefits to our customers, communities and country. We will continue to work with key stakeholders, along with our industry colleagues to advance constructive federal energy and economic policies that will help us transition to a cleaner energy future in a responsible fashion. Speaking of our transition to our cleaner energy future, please turn to Page 7 in the discussion of future transmission investment needs. As we have discussed with you in the past, MISO completed a study outlining the potential road map of transmission projects through 2039. Taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates and goals for clean energy or carbon emission reductions, among other things. On MISO’s Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon emissions reduction below 2005 levels by 2039. MISO estimates approximately $30 billion, the future transmission investment would be necessary in the MISO footprint. Under its future tree scenario, which resulted in an 80% reduction in carbon emissions below 2005 levels by 2039. MISO estimates approximately $100 billion of transmission investment and the MISO footprint would be needed. It is clear that investment in transmission is going to play a critical role in the clean energy transition, and we are well-positioned to plan and execute the potential projects in the future for the benefit of our customers and country. We continue to work with MISO and other key stakeholders and believe certain projects outlined in Future 1 are likely going to be included in this year’s MISO transmission planning process, which is expected to be completed in early 2022. Moving now to Page 8 and an update on litigation regarding Ameren Missouri’s past compliance with the new source review provisions of the Clean Air Act. As you may recall, this litigation dates back to 2011 and the Department of Justice on behalf of the EPA bought a complaint against Ameren Missouri, alleging that and performing certain projects at the Rush Island Energy Center, we have violated the new source review provisions of the Clean Air Act. In 2017, the District Court issued a liability ruling and in September 2019, or the installation of push control equipment at the Rush Island Energy Center as well as at the Labadie Energy Center. September of this year, U.S. Court of Appeals preferred the District Court’s 2019 order requires us to install a scrubber at our Rush Island Energy Center, but denied the order to install additional pollution control equipment at Labadie. Last month, we thought a request for rehearing with U.S. Court of Appeals. While we wait for a final decision from the courts, we continue to assess several alternatives to effectively address the Court of Appeals decision, including legal, operational and regulatory measures. In reviewing these options, we are also carefully assessing the impact on customer costs as well as generation or transmission investments needed to maintain system reliability. And we are certainly mindful of the policies that are being considered at the federal level to help address climate change. Should our decision results in a material change to our integrated resource plan, we will file an updated plan with the Missouri PSC. Turning to Page 9. We remain focused on delivering a sustainable energy future for our customers, communities and our country. This page summarizes our strong sustainability value proposition for environmental, social and governance matters and is consistent with our vision, leading the way to a sustainable energy future. Beginning with environmental stewardship, last September, Ameren announced its transformation plan to achieve net zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes interim carbon emission reduction targets of 50% and 85% below 2005 levels in 2030 and 2040, respectively, and is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. This slide highlights the many things we are doing for our customers and communities including being an industry leader in diversity, equity and inclusion. Further, our strong corporate governance is led by a diverse Board of Directors focused on strong oversight that’s aligned with ESG matters and our executive compensation practices include performance metrics that are tied to sustainable long-term performance, diversity equity inclusion and progress towards a cleaner sustained energy future. Finally, this slide highlights our very strong sustainable growth proposition, which is among the best in the industry. Turning to Page 10, you will go down further on this key element. Our strong sustainable growth proposition is driven by a robust pipeline of investment opportunities over $40 billion over the next decade that will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter and cleaner. Importantly, these investment opportunities exclude any new reasonably beneficial transmission projects, including the potential road map of MISO transmission projects I discussed earlier, all of which would increase the reliability and resiliency of the energy grid as well as help to enable our country’s transition to a cleaner energy future. In addition, we expect to see greater focus on infrastructure investments to support the electrification of the transportation sector in the future. Our outlook through 2030 does not include significant infrastructure investments for electrification at this time. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner energy future and a safe, reliable and affordable fashion will be critical to meeting our country’s future energy needs and delivering on our customers’ expectations. Moving to Page 11. Another key element of our sustainable growth proposition is the five-year earnings per share growth guidance we issued in February, which included a 6% to 8% compound annual earnings per share growth rate from 2021 to 2025. This earnings growth is primarily driven by strong rate base growth and compares very favorably with our regulated utility peers. Importantly, our five-year earnings and rate base growth projections do not include 1,200 megawatts of incremental renewable investment opportunities outlined in Ameren Missouri’s Integrated Resource Plan. Our team continues to assess several global generation proposals from developers. We expect to file with the Missouri PSC for approval of a portion of these planned renewable investments this year. I am confident in our ability to execute our investment plans and strategies across all four of our business segments. That fact, coupled with our sustained past execution of our strategy on many fronts, has positioned us well for future success. Further, our shares continue to offer investors a strong dividend, which we expect to grow in line with our long-term earnings per share growth guidance. Simply put, we believe our strong earnings and dividend growth outlook results in a very attractive total return opportunity for shareholders. Finally, turning to Page 12. I will wrap up with a few comments about the organizational changes we announced a few weeks ago. Over the past eight years, I have had the great privilege to serve as Chairman, President and Chief Executive Officer of Ameren. During this time, I’ve been very fortunate to lead the team that has done an excellent job in executing our strategy and delivering strong value to our customers, communities and shareholders. Last month, I was humbled and honored that the Board of Directors elected me to serve as Executive Chairman effective January 1, 2022. At the same time, and consistent with our robust succession planning process, I was very pleased that the Board of Directors also elected Marty Lyons to serve as President and Chief Executive Officer as well as to join the Board of Directors on January 1. Marty is an outstanding leader and is exceptionally qualified to lead our company as CEO during this transformation and time in our industry. Of course, many of you know Marty very well as he spent a decade as the company’s Chief Financial Officer. And during the past 20 years, Marty has demonstrated strong operational, financial, regulatory and strategic acumen. I must say that I’m very excited about our new forward-thinking leadership structure. Working closely with Marty and our strong leadership team, I will remain actively engaged in overseeing important strategic matters impacting the company, including our transition to a cleaner energy future and will also remain focused on key energy and economic policy matters, especially in my leadership roles at the Edison Electric Institute and the Electric Power Research Institute as well as engaging with key stakeholders. Marty will take on significant duties of the CEO, which includes leading all aspects of Ameren strategy development and execution as well as the day-to-day operational, financial, regulatory, legal and workforce matters impacting the company. I, along with our Board of Directors, are very confident that Marty is clearly ready to lead Ameren as its new CEO. With that, I’ll congratulate Marty once again for his promotion to CEO and turn it over to him to say a few words."
},
{
"speaker": "Marty Lyons",
"text": "Thank you, Warner. I’m truly grateful for and humbled by the opportunity to lead Ameren during these exciting times for our company and for our industry. I’m also honored to follow on your footsteps Warner. You’ve led our team to execute on a strategy that has delivered significant value to our customers and shareholders. Working with his outstanding leadership team and my dedicated coworkers at Ameren, we will remain focused on successfully executing this strategy in the future. I look forward to engaging with all of you joining us on the call today and in the weeks and months ahead. With that, I’ll turn it back over to you, Warner."
},
{
"speaker": "Warner Baxter",
"text": "Thank you, Marty. I look forward to continuing to work closely with you in your new role. Together, we remain firmly convinced that the continued execution of our strategy in the future will deliver superior value to our customers, communities, shareholders and the environment. Thank you all for joining us today. I’ll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Warner, and good morning, everyone. Turning now to Page 14 of our presentation. Yesterday, we reported third quarter 2021 earnings of $1.65 per share compared to $1.47 per share for the year ago quarter. Earnings in Ameren Missouri, our largest segment increased $0.27 per share, driven primarily by a change in seasonal electric rate design, resulting from the March 2020 rate order, which provided for lower winter rates in May and higher summer rates in September rather than the blended rates used in both months in 2020. Higher electric retail sales also increased earnings by approximately $0.10 per share, largely due to continued economic recovery in this year’s third quarter compared to the unfavorable impacts of COVID-19 in the year ago period. As well as higher electric retail sales driven by warmer-than-normal summer temperatures in the period compared to near-normal summer temperatures in the year-ago period. We’ve included on this page, the year-over-year weather-normalized sales variances for the quarter. Total weather normalized sales year-to-date, shown on Page 27 of the presentation are largely consistent with our expectations outlined on our call in February, as we still expect total sales to be up approximately 2% in 2021 compared to 2020. That said, we’ve seen a net benefit in margins due to residential and commercial sales coming in higher than expected and industrial sales slightly lower than expected. Increased investments in infrastructure and wind generation eligible for plant and service accounting and the renewable energy standard rate adjustment mechanism or RESRAM, positively impacted earnings by $0.07 per share. The timing of tax expense, which is not expected to materially impact full year results increased earnings by $0.03 per share. Higher operations and maintenance expense decreased earnings by $0.04 per share in 2021 compared to the third quarter of 2020, which was affected by COVID-19 and remained flat year-to-date driven by disciplined cost management. Finally, the amortization of deferred income taxes related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage also decreased earnings $0.02 per share. Moving to other segments. Ameren Transmission earnings increased $0.03 per share year-over-year, reflecting increased infrastructure investment. Ameren Illinois Electric Distribution earnings per share were comparable, which reflected increased infrastructure and energy efficiency investments and a higher allowed ROE under performance-based ratemaking, partially offset by dilution. Earnings for Illinois and natural gas decreased $0.04 per share. Increased delivery service rates that became effective in late January 2021 were more than offset by a change in rate design during the quarter, which is not expected to impact full year results. Ameren parent and other results decreased $0.08 per share compared to the third quarter of 2020, primarily due to the timing of income tax expense, which is not expected to materially impact full year results. Finally, 2021 earnings per share reflected higher weighted average shares outstanding. Before moving on, I’ll touch on year-to-date sales trends for Ameren Illinois Electric Distribution. Weather normalized kilowatt hour sales to Illinois residential customers decreased 0.5%. And weather normalized kilowatt hour sales to Illinois commercial and industrial customers increased 2.5% and 1.5%, respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Turning to Page 15. Now we’d like to briefly touch on key drivers impacting our 2021 earnings guidance. We have remained very focused on maintaining disciplined cost management and we’ll continue that focus. As Warner noted, due to the solid execution of our strategy, we now expect 2021 diluted earnings to be in the range of $3.75 per share to $3.95 per share, an increase from our original guidance range of $3.65 per share to $3.85 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed on our earnings call in February. Moving to Page 16 for an update on regulatory matters. On March 31, we filed for a $299 million electric revenue increase within Missouri Public Service Commission. The request includes a 9.9% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $10 billion. In October, Missouri Public Service Commission staff and other interveners filed a bottle testimony. Missouri PSC staff recommended a $188 million revenue increase, including a return on equity range of 9.25% to 9.75% and an equity ratio of 50% based on Ameren Missouri’s capital structure at June 30, 2021, which will be updated to use the capital structure as of September 30, 2021. The October staff recognition was lower primarily due to lower recommended depreciation expense, which would not be expected to impact earnings. Turning to Page 17. In addition to the electric filing on March 31, we filed for a $9 million natural gas revenue increase within Missouri PSC. The request includes a 9.8% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $310 million. Missouri PSC staff recommended a $4 million revenue increase, including a return on equity range of 9.25% to 9.75% and an equity ratio of 50.32% based on Ameren Missouri’s capital structure at June 30, 2021, which will be updated to use of the capital structure as of September 30, 2021. Other parties, including the Missouri Office of Public Counsel have also made recommended adjustments to our Missouri electric and gas rate request. Evidentiary hearings are scheduled to begin in late November, and the Missouri PSC decisions from both rate reviews are expected by early February with new rates expected to be effective by late February. Moving to Page 18, Ameren Illinois regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance-based rate making these annual rate updates systematically adjust cash flows over time for changes in cost of service and true up any prior period over or under recovery of such costs. In August, the ICC staff recommended a $58 million base rate increase compared to our request of $59 million base rate increase. An ICC decision is expected in December with new rates expected to be effective in January 2022. Turning now to Page 19. As Warner mentioned, in September, constructive energy legislation was enacted in the State of Illinois. This allows Ameren Illinois the option to file a four-year rate plan in January 2023 for rates effective beginning in 2024. The return on equity, which will be determined by the Illinois Commerce Commission, may impacted by plus or minus 20 to 60 basis points based on the utility’s ability to meet certain performance metrics related to items such as reliability, customer service and supplier diversity. The plan also allows for the use of year-end rate base and an equity ratio up to 50% within higher equity ratio subject to approval by the ICC. In addition, it calls revenue decoupling and an annual reconciliation of cost and revenues for each annual period approved in the multiyear rate plan. There’s a cap on the true-up, which may not exceed 105% of the revenue requirement and excludes variation from certain forecasted costs. The exclusions include cross associated with major storms, changing in timing of expenditure and investment that moved the expenditure investment into or out of the applicable calendar year and changes in income taxes, among other things. The true-up cap also excludes cost recovered through riders such as purchase power, transmission and bad debts. Rate impact to customers may also be mitigated through the ability to phase in rates. The legislation also allows for two utility-owned solar and/or battery storage pilot projects to be located near Peoria and East St. Louis at a cost not to exceed $20 million each. It also provides for programs that encourage transportation electrification in the state. We believe this framework will improve our ability to make significant investments in the State of Illinois and earn a fair return on equity. Looking ahead, we have the ability to opt into the multiyear rate plan or use the future test year traditional rate-making framework, both of which include a return on equity determined by the ICC and revenue decoupling. Should we choose to opt into the new multiyear rate plan, our four-year plan must be filed by January 20, 2023. We anticipate continuing to use the performance-based ratemaking until we proceed with a multiyear rate plan filing or choose to move ahead with using the traditional framework. Moving to Page 20 for a financing update. We continue to feel very good about our financial position. We’re able to successfully actually on several debt issuances earlier this year, which we have outlined on this page. In order for us to maintain our credit ratings and a strong balance sheet, while we fund our robust infrastructure plan and consistent with prior guidance as of August 15, we have completed the issuance of approximately $150 million of common equity through our at-the-market or ATM program that was established in May. Further, approximately $30 million of equity outlined for 2022 have been sold year-to-date under the programs forward sales agreement. Together with the issuance under our 401(k) and DRPlus program, our $750 million ATM equity program is expected to support equity needs through 2023. Moving now to Page 21. I’d like to briefly touch on the recent increase in natural gas prices around the country and the potential impact it may have on customer bills this coming winter. Beginning with our natural gas business, heading into the winter season, Ameren Illinois is approximately 75% hedged and Ameren Missouri is approximately 85% hedged based on normal seasonal sales. Approximately 60% of Ameren Illinois winter supply of natural gas was bought this summer at lower prices and is being stored in the company’s 12 underground storage fields. Both companies are 100% volumetrically hedged based on maximum seasonal sales. Regarding the electric business in Missouri, we are currently long generation and any margin made through offices sales flow back to customers as a benefit on their bills through the fuel adjustment clause. Given our low cost of generation, rising natural gas and power prices have the potential to benefit our electric customers in Missouri. Turning to Page 22. We plan to provide 2022 earnings guidance when we release fourth quarter results in February next year. Using our 2021 guidance of the reference point, we have listed on this page select items to consider as you earnings outlook for next year. Next, I would note, we expect to recognize earnings related to energy efficiency performance from both 2021 and 2022 plan years and 2022. As a result, we expect energy efficiency performance incentives to be approximately $0.04 per share higher than 2021. Further, our return to normal weather in 2022 would decrease Ameren Missouri earnings by approximately $0.04 compared to 2021 results to date, assuming warm weather in the last quarter of the year. Beginning with Missouri, we expect the new electric service rates to be effective in 2022 as a result of our attending rate review. These rates are expected to reflect recovery of and return on new infrastructure and wind generation investments, which are expected to increase earnings when compared to 2021. Prior to new electric service rates taking effect in late February, we expect increase investments in infrastructure and wind generation eligible for plant-in-service accounting and the RESRAM to positively impact earnings. Next, we expect to recognize earnings related to energy efficiency performance incentives from both 2021 and 2022 plan years and 2022. As a result, we expect the energy efficiency performance incentives to be approximately $0.04 per share higher than 2021. Further, I returned to normal weather in 2022, decrease Ameren Missouri earnings by approximately $0.04 compared to 2021 results to-date, assuming normal weather in the last quarter of the year. Next, earnings from our FERC-related electric transition entities are expected to benefit from additional investments in the Ameren Illinois projects made under forward-looking formula ratemaking. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2022 compared to 2021 from additional infrastructure investments made under Illinois formula ratemaking. The allowed ROE under the will be the average 2022 30-year treasury yield plus 5.8%. For Ameren Illinois Natural Gas, earnings are expected to benefit from new delivery service rates effective late January 2021 as well as an increase in infrastructure investments qualifying for rider treatment that were in the current allowed ROE of 9.67%. Lastly, turning to Page 23, we’re well positioned to continue executing our plan, continue to expect to deliver strong earnings growth in 2021, as we successfully execute our strategy. And as we look to the longer term, we expect strong earnings per share growth, driven by robust rate-based growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulator utility peers. Ameren Missouri is continue to offer investors and attractive dividend. In summary, we have a total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. And ladies and gentlemen, at this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan. Please state your question"
},
{
"speaker": "Warner Baxter",
"text": "Good morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Warner Baxter",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "Good morning, thanks. Thanks for all the detail there and just want to pick up on the MISO MTAP side. I was just wondering if you might be able provide any more color for your expectations there in the process. And what could this specifically mean for Ameren over time? Realize might begin a little bit ahead of ourselves here, but just want to know if there’s any way you could frame, I guess what you think could be possible for Ameren CapEx, yes?"
},
{
"speaker": "Warner Baxter",
"text": "Yes. Thanks, Jeremy, for the question. Number one, let me just start with this. We’re very excited about the opportunity that we have for the transmission investment. Number one, we’re absolutely convinced that transmission is going to play an integral role. And that’s a fair company, for our country and really executing this clean energy transition. And we’re right in the middle of it. We have been before, and we are going to continue to be. And so look, it’s premature to put I would say, a specific number. As you heard us in our prepared remarks, MISO has identified $30 billion to $100 billion of investment opportunities of potential projects. And I will tell you, where the country is going is closer to that scenario 3, which is closer to the $100 billion number. So what we’re doing – what MISO is doing, what stakeholders are doing. Look, we’re working together to try and make sure that we put together a good set of projects coming out of this first MTAP that will start us on this path toward just clean energy transition. And as we look at it, if you look at that scenario 1 that’s highlighted out there, we really think the focus will be on more no regrets types of projects as we start putting our toes in the water, if you will, maybe getting up to our knees. And then from there, I think we’ll see it continue to get progressively bigger over time. We think there’ll be some no regrets projects. And in terms of timing, look, I think the group – our group and many stakeholders are working collaboratively to try and figure out the best projects as well as cost allocation things. These things are all things that you typically go through in this process. And so at the end of the day, we think that MISO will propose early in 2022, these projects to their Board of Directors, it will be well informed. And then what we believe will be hopefully will be an approval process that will get them in early 2022. So when you look at them in our overall plans, as we’ve said before, you might see some of these projects in our current five-year plan start coming into play towards the back end of our five-year plan. But certainly, in the second half of this decade, I think you’re going to see a significant emphasis and need for transmission projects. So that’s really what I can tell you today. But as I’ll finish the way I started there, we’re excited about the opportunity because we think it’s significant and important."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s helpful. We eagerly await there."
},
{
"speaker": "Warner Baxter",
"text": "We view as well."
},
{
"speaker": "Jeremy Tonet",
"text": "Maybe just pivoting over to the Missouri IRP here. Just wondering if you could share with us thoughts on next steps and I guess, how Rush Island plays into it, what we should be thinking about there?"
},
{
"speaker": "Warner Baxter",
"text": "Yes. Thanks, Jeremy. Marty Lyons has been in the middle of all those things. I’m going to turn it over to him to respond to your questions. Marty, go ahead."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Jeremy. Hey, how are you today? Appreciate the question. As it relates to the integrated resource plan, obviously, we filed last fall and as Warner said earlier in the prepared remarks, we continue to work with multiple developers with respect to several projects that would fit within that 1,200 megawatts of clean energy that we plan to deliver over the next several years consistent with that integrated resource plan. So we’re continuing to work on those, and we still expect to file with the commission still this year for approval of a portion of those project. So that work is going on. And then you mentioned the Rush Island Energy Center. And so as you saw in our slides today, in August, the court of appeals affirmed the District Court’s September 19 order. As we said in our slides and prepared remarks, we did file for a rehearing of that decision on October 18. So we do expect to hear back from the court and quite likely by the end of this year, we expect in terms of that rehearing. So it’s really premature to say what action we will take with respect to Rush Island at this point. We’ll wait to see whether there’s a rehearing. But that rehearing is denied and ultimately, we’re faced with that decision. Obviously, it may entail scrubbers in Rush Island or the accelerated retirement of that plant, which might also include the utilization of the securitization legislation was passed earlier this year. So those are some of the things we’re looking at. Considerations as we think about those alternatives or things like customer rate impacts, replacement generation needs and importantly, reliability and investments that may be required in terms of transmission to the extent that Rush Island were to be prematurely retired. So those are some of the considerations. I’ll tell you this, if ultimately a decision is made to retire Rush Island prematurely versus the day we had in our prior integrated resource plan that will require them that we file an updated integrated resource plan with the Missouri Public Service Commission. So stay tuned on that. Like I said, it’s premature to say how all of that will turn out, but that gives you a little bit of color on the potential path forward."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s helpful. And just 1 last quick one, if I could. Just wondering if you might be able to comment on your generation position? And do you see any potential customer benefits under current market conditions right now?"
},
{
"speaker": "Michael Moehn",
"text": "Hey, Jeremy, it’s Michael. Yes, I think we indicated in the prepared remarks in the slide that we historically have been long in the Missouri side. And so obviously, to the extent, that we’re able to take advantage of that in the marketplace is also some sales that flow back to customers through the fuel adjustment clause. So certainly, given where natural gas prices are, which is what the impact it’s having on power prices, it’s definitely a bit of a tailwind from a customer affordability standpoint."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. I’ll leave it there. Thank you."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Jeremy. See you next week."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Warner Baxter",
"text": "Good morning, Julien. How are you doing?"
},
{
"speaker": "Dariusz Lozny",
"text": "Hey, good morning. This is Dariusz on for Julien actually. Thank you for taking my question. Can you just clarify, it was a little unclear from the opening remarks. Do you intend – or are you still evaluating whether or not you’ll file under a multiyear rate plan in Illinois in or before January 23?"
},
{
"speaker": "Warner Baxter",
"text": "Yes. So this is Warner. So let me just summarize what we’ve said. Clearly, as I said and as Michael said, we think this is a forward-thinking, constructive regulatory structure. And not only is it constructive that enables us to make investments that we think are important for customers, but also gives us the opportunity to earn a fair return on those investments. Now what we said too, is that the structure is out there, but there’s still some work to be done, meaning that there are jobs that have to be taken care of next year, as you might have with any specific and comprehensive piece of legislation and we’re going to work through those workshops. Now we believe those workshops were at the table, and we expect them to be constructive outcomes. And so as a result, as we said, too, we anticipate filing for a multiyear rate plan in 2023. But there’s still some work to be done. And so we’re not trying to hedge or be cute. We just sort of telling it like it is. At the same time, as I said, we think it’s a constructive piece of legislation that we think will bring benefits to our customers state of Illinois and certainly to our shareholders. Michael, do you have anything you want to add?"
},
{
"speaker": "Michael Moehn",
"text": "Look, you said it all correctly. I mean these workshops will continue on through 2022. And I think we’ll have a conclusion of the by the fall. So we’ll have even better clarity. But as Warner said, the benefits clearly seem to be pretty significant here in terms of just the overall framework itself."
},
{
"speaker": "Warner Baxter",
"text": "Yes. And just to give you a perspective, these workshops as you know, we talk about performance metrics. There’s a performance-based ratemaking perspective and concept incorporated in this legislation. So the performance metrics have to be determined, how you work through some of the details of the multiyear rate plan. These are things that stakeholders have to come to the table. And we look forward to working collaboratively with all of them next year."
},
{
"speaker": "Dariusz Lozny",
"text": "Okay, thank you. That’s very helpful color. And if I could pivot maybe to federal legislation, if I can. Have you quantified at all or thought about the potential upside impact on your credit metrics from direct pay, if that were included in final legislation?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, thanks. Needless to say, that is a very fluid situation just in the bigger picture. And so to say that we’ve quantified in particular, the specific impacts that would be premature. I will say, there are elements of the clean energy tax incentives, which I think are very good for customers and could be good for cash flows, especially when you look at the direct pay portions around, certainly, the ITCs and the PTCs that wind and solar are small up tax incentives. So Michael, I know that you and your team have been looking at it, but we haven’t put a specific finger on it, but do you want to add a little more color than that?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. I mean at a high level, that’s correct, Warner. I mean we are – they get into it. I think there are some positive aspects. There are also some things we got to just get our hands around, head around with respect to like this minimum tax liability, which seems to run counter to some those credits as well. So those are just some different aspects that we’re really trying to balance at the end of the day. But hopefully, over the course of the next quarter or so, we’ll have a much better feel for where this is going."
},
{
"speaker": "Warner Baxter",
"text": "One thing you can miss assured is that me and my industry colleagues, we’re at the table to try and make sure that we get a constructive piece of federal legislation down across the board that will enable us to continue to move forward thoughtfully and effectively with the clean energy transition."
},
{
"speaker": "Dariusz Lozny",
"text": "Great. Thank you very much. I’ll hop back on from here."
},
{
"speaker": "Warner Baxter",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Insoo Kim with Goldman Sachs. Please state your question."
},
{
"speaker": "Warner Baxter",
"text": "Good morning, Insoo. How are you doing?"
},
{
"speaker": "Insoo Kim",
"text": "Good morning, Warner. How are you? My first question is on – the question on the Rush Island and the long-term generation plan. If the appeal process is unsuccessful. First of all, is it by the end of 2023 that you need to either put the scrubbers on or retire? Or is it 24? And then my – the related question to that is, as you think about potential changes to the plan if this had to shut early, given that long generation position? How do we think about some of the opportunities on the replacement side of things?"
},
{
"speaker": "Warner Baxter",
"text": "Marty, why don’t you jump on and then address that one, please?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Thanks, Insoo. Good to talk to you again. With respect to moving forward with scrubber, I think there, the expectation is that we would – if we went that route, as expeditiously as possible to put the scrubbers in place at Rush Island. So I’m not sure that there’s an exact time line. Obviously, the acquisition design, construction would take some time to get that put in place. And then with respect to the other route that you described, the retirement route, I think there, we’d be looking at how long Rush Island would continue to operate, obviously, given the things I talked about before, replacement generation needs, importantly, reliability issues around the system in the event of premature retirement, which again may necessitate some transmission investments in order to maintain reliability. So all of those things would be taken into consideration. And ultimately, to the extent that incremental generation was required or some acceleration of the clean energy transition that we’ve got laid out in our IRP, that would all be laid out in that updated integrated resource plan. So again, if we don’t move forward with the scrubber, if we do decide that the Rush Island needs to be shut down earlier than the day in our IRP, which was 2039, then we would move forward with an update to the Integrated Resource Plan. And again, and so that would assess all of the potential adjustments to generation need and timing that were laid out in that prior September Integrated Resource Plan filing."
},
{
"speaker": "Insoo Kim",
"text": "Got it. Thanks for the color, Marty. The second question is on the grid 2021 guidance raising that by $0.10 as we think about the 2022, I know some of the weather benefit helped this year as well. But how do we think about some of the moving pieces that help 2021 that could potentially carry into 2022? And in that consideration slide, I didn’t see a specific mention to year-over-year low growth just curious on your base assumption there."
},
{
"speaker": "Warner Baxter",
"text": "Yes. Look, there’s a lot in that question there. Let me give you a couple of pieces, just in terms of the growth itself. I mean, year-to-date, we’ve put in there from a residential standpoint, we’re up 1.5%, commercial 3.5% and industrial 1%. So about 2%, and that’s really what we guided to at the beginning of the year in February. Now the mix is a little bit different. So we’re seeing some improvement in margin there, which is a driver of that increase in the midpoint that you talked about in addition to weather. So we – the plan remains on track with respect to that sales piece, that 2%, we see that sort of guiding in at the same point towards the end of the year. As we talked about at the beginning of the year, that will get us close to being back to 2019, but not quite. So I think the recovery continues, and we’re optimistic about we continue to see things open up here in both of our service territories in Missouri and Illinois. With respect to the guidance itself, I just remind you again, we really – in February last year, that 6% to 8% guidance was off of that midpoint. Obviously, at $375 million, that original midpoint of $375 million. We certainly have given you some select items to think about here in 2022. And then obviously, in February, we’ll roll all this forward to give you another look at capital as well as give you just more specifics about obviously, where our range will be in our earnings guidance for 2022 at that point in time. So hopefully, that give you a little bit of color you’re looking for."
},
{
"speaker": "Insoo Kim",
"text": "Got it. Thank you, and congrats, Marty and Warner both of you, and see you soon."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Insoo."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Insoo. See you next week."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore ISI. Please state your question."
},
{
"speaker": "Warner Baxter",
"text": "Good morning, Durgesh."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning, Warner. Congratulations and to you as well, Marty."
},
{
"speaker": "Warner Baxter",
"text": "Thank you."
},
{
"speaker": "Durgesh Chopra",
"text": "I look forward to working with you."
},
{
"speaker": "Marty Lyons",
"text": "You bet."
},
{
"speaker": "Durgesh Chopra",
"text": "Maybe just can you talk about the 1.2 gigawatts in Missouri IRP. Just kind of what of that – what – how many – what portion of that capacity are you going to file for with the commission or get approvals for this year or early next year? Just as you’re thinking about your CapEx plan being extended another year, I’m thinking about how much of that 1.2 gigawatt might be layered in?"
},
{
"speaker": "Warner Baxter",
"text": "Sure. You bet, Marty, why don’t you come on in and address that from an operational perspective, and maybe Michael, you can talk about how we think about guidance in terms of capital expenditures and those types of things."
},
{
"speaker": "Marty Lyons",
"text": "Yes, that sounds great, Warner. Durgesh, I appreciate the question. The – and I think Michael will get into this and expand on it, none of that 1,200 megawatts is really included today in the rate base growth or earnings guidance we have. As I said earlier, we continue to work with multiple developers with respect to multiple projects that would go towards filling out that 1,200 megawatts. At this point, as we negotiate through those, I mean it’s important to understand that those negotiations take time. There’s diligence involved. There’s again, multiple developers we’re working with really to get the best deals we can for our customers ultimately, and there are multiple contracts that need to be negotiated with each one of the developers. So we continue to work, again, with multiple of them on multiple projects. And at this point, I’d say again, I’d say we’re expecting to file for approval for a portion of that 1,200 megawatts. I expect that, that will happen this year still, but also then even further into next year. So stay tuned. I think it’s premature to say exactly which project or projects we’ll announce this year or early next, but we’re working actively on several. So that’s where we stand today."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty. Just a couple of other small points on that $17 billion plan that we have out there, as Marty pointed out, there’s very, very little in there with respect to any of these renewable projects. Now we did indicate in that 10-year plan, that $40 billion plus, there is $3 billion of potential projects, which what Marty is referring to. So as we get more clarity on that timing, obviously, typically, what we do in February as we roll forward that capital plan, to be able to give you a bit more transparency about what the timing of that to the extent that we feel better about it and know it. So that’s just a little bit more color on exactly what’s there from a capital standpoint."
},
{
"speaker": "Durgesh Chopra",
"text": "I appreciate that detail. Then just shifting gears to Illinois, Obviously, now the – under the new framework, the ROE goes back to the ICC and they kind of come back with an ROE number. Just any early thoughts on how might they be calculating that? I mean we and investors have talked about sort of your gas assets there and the ROEs they’re getting in 9%-plus range. Just any – from your seat, just any early color into what ROE might look like or how might that be calculated? I appreciate that. Thank you."
},
{
"speaker": "Warner Baxter",
"text": "Sure. This is Warner. Look, it’s certainly be premature to predict where the ROEs would be. I mean the filing is going to be sometime in 2023, and it’s a multi-year filing. But what we can point to is, obviously, the 580 basis points, put a 30-year treasury, what that yields today. What we can point to is that in our gas business that we did at the beginning of this year, put in place a – the rate review results, that was a 9.67% return on equity for our gas business. It’s not the electric business, but it’s the gas business. It is just a data point. But how that will ultimately look and what the request will be for a multi-year rate plan, a lot of facts and circumstances will go into that. But we do see an opportunity for improvement, clearly, from our existing return on equity going forward."
},
{
"speaker": "Marty Lyons",
"text": "Yes. I mean – and just think about that 9.67 is kind of traditional cost of capital kind of calculations. There’s nothing that’s sort of unique about it from a regulatory perspective. So it’s obviously different than moving away from this formulaic piece that we have."
},
{
"speaker": "Warner Baxter",
"text": "Exactly. And we would expect the overall process and looking at that return on equity in terms of sort of a traditional look would be very similar. But obviously, with the multi-year rate plan, there may be some other factors that have come into us. So stay tuned."
},
{
"speaker": "Durgesh Chopra",
"text": "All right. I’ll leave it there. Thanks, guys."
},
{
"speaker": "Warner Baxter",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Patterson with Glenrock Associates. Please state your question."
},
{
"speaker": "Warner Baxter",
"text": "Good morning, Paul."
},
{
"speaker": "Paul Patterson",
"text": "Good morning. How are you doing?"
},
{
"speaker": "Warner Baxter",
"text": "I’m good. How are you?"
},
{
"speaker": "Paul Patterson",
"text": "Okay. So what I wanted to – first of all, I want to congratulate you guys. Is this your last call, Warner?"
},
{
"speaker": "Warner Baxter",
"text": "Number one, thank you. I’m truly excited about the new leadership structure and certainly the new roles that Marty and I are taking. And in terms of the last call, gosh, we’re taking one step at a time. We’re not saying this is my last call or anything like that. We’ll take that one step at a time. But you can kind of maybe in the EEI next week. That’s for sure."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Well, congratulations both of you."
},
{
"speaker": "Warner Baxter",
"text": "Thank you."
},
{
"speaker": "Paul Patterson",
"text": "And so just some – most of my questions have been answered, but a couple of quick ones for you. And I apologize for not knowing this, but what are no regrets projects I just don’t feel that grew blank. What does that mean?"
},
{
"speaker": "Warner Baxter",
"text": "It’s probably a Warner term, right. So really, when you look at all these projects, I mean, some you can sit there and say, gosh, when we had to get we’re having these congestion areas when we had to get from point A to point B, we have these projects that are in the queue, there are certain of these regional projects, which really satisfy a lot of those transmission – or excuse me, renewable energy projects that are in the queue. And you do the analysis and you sit there and say, gosh, no one could be no one. I shouldn’t say that. It would be hard for people to argue that this isn’t a project that isn’t going to be significantly beneficial to the MISO footprint, frankly, to our country. So I can’t put those as no regrets, low risk, let’s call them that way. Lower-risk projects relatively speaking, compared to some that may have more complications. And so when you look at that scenario one, we think from our perspective, right, beauty’s in the – holder, but from our perspective, and we think there are several of those in there that need to be – they need to move forward. So that’s what I mean. We haven’t outlined which of those that we believe are there, and this is part of the collaborative process that we go through with MISO and other key stakeholders. But that’s how we think. Really lower risk is probably a better term to characterize those projects as."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Fair enough. And then sort of a technical question. There was this discovery dispute in the Missouri rate case on the Smart Energy Plan. And if you look to me like basically, they did to address in their testimony or rebottle or what have you. And I just wanted to make sure, has that really been resolved? I just wasn’t clear to me from what they were saying, they didn’t really seem to address it and the revenue requirement everything didn’t seem to penalize you or anything for the recommendation. So my question is, has that issue been taken care of?"
},
{
"speaker": "Marty Lyons",
"text": "Paul, it’s Marty. I can’t say whether it’s been fully taken care of everybody’s satisfaction. I will tell you this, we do look to work constructively with all the parties in these rate reviews to get everybody the information they need in a timely basis to make decisions. And to your point, do not believe it’s an active issue in terms of a quantified difference between our position and the positions of others in the case. So hopefully, we have resolved that issue fully. But like you said, it’s not manifesting itself today in any kind of difference between the parties."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Great. And then finally, back to the 2024 question. I realize it’s very early, but it does seem like a big opportunity with – to the Illinois legislation. And I’m just wondering when you guys might incorporate it the potential outlook with it into your long-term guidance. I mean it doesn’t sound like it will be anything immediate, but I was just wondering, could it be a year from now or so that you guys would feel more comfortable talking about its potential benefit impact to the long-term growth outlook? Or would you be basically waiting until I guess, whenever the 2023 decision was made kind of, so to speak?"
},
{
"speaker": "Marty Lyons",
"text": "Sure. Yes, Paul, this is Marty. It’s a fair question. We’ll provide a lot more guidance, right, on that specific question and others when we come with our longer-term guidance in February. We’ll give you our view, right, on how we think about the guidance that we set in and how we think about regulatory frameworks and all those types of things. So sit here today, obviously, nothing to change, nothing to talk about other than as we’ve said, we think it’s a constructive piece of legislation that we anticipate assuming that things go well in the workshops, so we would file for a multi-year rate plan. How we embed that into our long-term guidance in early 2022, stay tuned. We’ll be able to provide more detail on that."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Awesome. Well, thanks so much, and congratulations again and have a great one."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Paul. You do the same."
},
{
"speaker": "Operator",
"text": "Thanks. And our next question comes from David Paz with Wolfe. Please state your question."
},
{
"speaker": "Warner Baxter",
"text": "Hello David, how are you doing?"
},
{
"speaker": "David Paz",
"text": "Hey Warner, how are you doing? Congratulations on both of you and Marty."
},
{
"speaker": "Warner Baxter",
"text": "Thank you."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, David. Thank you."
},
{
"speaker": "David Paz",
"text": "I just want to follow-up on a couple of quick questions. Just the following-up on the 1,200 megawatt maybe lots of Missouri question. I understand the spend is not in your stated outlook, financial outlook, but is any of the equity for that investment in your financing plan?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Hey David, this is Michael. I mean that $17 billion plan again out there. The equity that we talked about back in third are really supports that $17 billion plan. It’s again sort of there by default that win is not in there, there’s no equity in there for."
},
{
"speaker": "David Paz",
"text": "Got it. And then in an earlier question, Michael, did you say that you would be going forward your growth rate off of 2022 guidance or 2021 actuals when you were talking about the February update?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. I was just referring to last February, David, when we gave the 6% to 8% earnings per share growth guidance, it was off of that midpoint of 3.75%. And so that’s where people should continue to stay focused. We obviously gave you some 2022 select items here to think about in the third quarter, and then we’ll obviously roll forward stuff and give you a specific guidance in February of 2022."
},
{
"speaker": "David Paz",
"text": "I see. Okay. Great. And maybe just a last question. I think Marty, can you provide an update maybe on just how settlement talks are going in the rate case or whether they’re still going?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Thanks, David. The settlement talks really get going here over the next couple of weeks. We actually have, as we laid out in the slide, server battle testimony that’s actually do Friday. So I think all the parties are focused on that. And then soon after that, the parties will be pulling together reconciliations of the differences between our case and the updated positions of the staff, in particular, but also other parties. And then settlement discussions will get underway. As you know, again, is our – right now, the evidence you’re hearing are really scheduled to begin right after Thanksgiving on November 29. So my expectation is that starting next week and all the way through that time period, there’ll be settlement discussions, hopefully, to narrow the issues and if possible, to resolve the entire case. Obviously, we have been successful in settling a number of cases that we’ve had over the past several years, including the last rate review. So we certainly expect to work towards that goal. And like I said, those discussions will really be happening between now and likely the beginning of those evidentiary hearings."
},
{
"speaker": "David Paz",
"text": "Great. Thank you so much."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, David. See you next week."
},
{
"speaker": "Operator",
"text": "Thank you. And we have reached the end of the question-and-answer session. So I’ll now turn the call back over to Andrew Kirk for closing remarks."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial inquiries should be directed to me, Andrew Kirk. Media should call Tony Paraino, Again, thank you for your interest in Ameren, and looking forward to seeing many of you next week at EEI. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today’s conference. All parties may disconnect. Have a good day."
}
] | Ameren Corporation | 373,264 |
AEE | 2 | 2,021 | 2021-08-06 10:00:00 | Operator: Greetings. Welcome to Ameren Corporation’s Second Quarter 2021 Earnings Call. [Operator Instructions] Please note this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer and Michael Moehn, our Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team joining us remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate-only as of the date of today’s live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today’s presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now, here is Warner, who will start on Page 4 of our presentation.
Warner Baxter: Thanks, Andrew. Good morning, everyone and thank you for joining us. This morning, I will begin with the statement that I have been making for quite some time now. Simply put, our team continues to effectively execute our strategic plan across all of our businesses, which includes making significant investments in our energy infrastructure to enhance the reliability and resiliency of the energy grid as well as transition to a cleaner energy future in a responsible fashion. These investments, coupled with our continued focus on disciplined cost management delivering significant value to our customers, communities and shareholders. Moving now to our second quarter earnings results, yesterday, we announced second quarter 2021 earnings of $0.80 per share. Our earnings were down $0.18 per share from the same time period in 2020, primarily due to a change in the seasonal electric rate design at Ameren Missouri that reduced earnings $0.19 per share. The impact of this change in rate design will reverse in the third quarter of 2021 and is not expected to impact full year results. Michael will discuss the other key drivers of our strong quarter earnings results a bit later. Due to the continued strong execution of our strategy, I am pleased to report that we remain on track to deliver within our 2021 earnings guidance range of $3.65 per share to $3.85 per share. Speaking of the execution of our strategy, let’s move to Page 5, where we reiterate our strategic plan. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure with a long-term benefit of our customers. As a result and as you can see on the right side of this page, during the first 6 months of this year, we invested significant capital in each of our business segments, including wind generation at Ameren Missouri, which I will discuss later. These investments are delivering value to our customers. As I said before, our energy grid is stronger, more resilient and more secure, because of the investments we are making in all four business segments. Consistent with the Missouri Smart Energy Plan, we have made significant investments to harden energy grid, which has reduced outages and installed nearly 300,000 electric smart meters for customers. These smart meters will help customers better manage their usage and control their overall energy costs. In Illinois, we continue to execute on our electric distribution and gas modernization action plans. The plans include investments to strengthen electric power poles. We placed gas transmission pipelines and compression coupled steel mains as well as to implement new efficiency measures, including mobile enhanced communications and assessment capabilities for our careers. These improvements, along with our investments in outage detection technology, were resulting in improvements in system reliability and millions of dollars in savings for customers. Moving now to regulatory matters, in late March, Ameren Missouri filed a request for a $299 million increase in annual electric service revenues and a $9 million increase in annual natural gas revenues with the Missouri Public Service Commission. In our Illinois Electric business, we requested a $60 million base rate increase in our required annual electric distribution rate filing. These proceedings are all moving along on schedule. We will be able to provide you information on these proceedings as they develop later this summer and into the fall. Finally, we have remained relentlessly focused on continuous improvement and disciplined cost management, including retaining the cost savings that we realized in 2020 due to the actions we took to mitigate the impacts of COVID-19. Moving to Page 6 and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Starting in Missouri, in May, the Missouri legislator passed the bill, allowing for securitization in the state. This constructive legislation which is trying by governance parsing in July give us another important regulatory tool to facilitate our transition to a cleaner energy future and a cost effective manner for our customers. However, as we have stated in the past, a robust integrated resource plan does not rely on securitization to be successful. Our flexible and responsible plan, which includes approximately $8 billion of investments in renewable energy through 2040, the retirement of all of our coal-fired energy centers and extending the life of our carbon-free Callaway nuclear energy center focuses on getting the energy we provide to our customers as clean as we can, as fast as we can without compromising from reliability, customer affordability and the evolution of new clean energy technologies. And as I will touch on later, I am pleased to say that we are already taking steps to implement this important plan for our customers, the State of Missouri and our country. Moving now to Illinois, last month, the Illinois Commerce Commission approved Ameren Illinois electric vehicle charging program. Under this program, we are able to support the development of a network of charging infrastructure in Central and Southern Illinois as well as implement special time-based delivery service rates and other incentives to help encourage the use of electric vehicles. We are excited about this new program, because it will drive greater electrification of the transportation sector as well as help the state of Illinois move towards its clean energy goals. Moving to legislative efforts, as many of you know, we have been working to enhance the regulatory framework for our Illinois Electric business. The performance-based regulatory framework in place today has delivered strong value for customers and shareholders over the years. However, the framework is scheduled to sunset in 2022. As a result, we have been working with key stakeholders to develop constructive long-term regulatory policies that support important investments in energy infrastructure, while enabling us to earn fair returns on those investments. As you know, throughout the regulator legislative session, which ended late May, we advocated for the Downstate Clean Energy Affordability Act which was largely extended the existing framework until 2032, while putting in place provisions that would set the Ameren Illinois electric distribution ROE at the national average. At the same time, many other energy-related legislative proposals from other stakeholders were proposed during the legislative session, including proposals from Governor Pritzker, labor and environmental groups, to address the closure of nuclear plants in the states, Illinois clean energy transition and the electric distribution framework going forward. For months, stakeholders have been in discussion seeking to find an appropriate compromise to all these proposals. While progress is made in these issues, the regular legislative session ended on May 31 with no energy legislation being put before the Senate or House of Representatives for a vote. A special session was called in mid-June to further discuss draft energy legislation, but no bill was filed nor action taken. Needless to say, we will continue to work with key stakeholders to find a constructive solution to this important matter. Turning to Page 7 for an update on FERC regulatory matters, in April, FERC issued a supplemental notice of proposed rulemaking, or NOPR, on electric transmission return on equity incentive adder for participation in the regional transmission organization, or RTO. As you may recall, under the NOPR, the RTO incentive adder would be removed from utilities that have been members of an RTO for 3 years or more, like the Ameren Illinois and ATXI. We have been very clear that we disagreed with FERC proposed recommendation in this matter for a number of reasons and recently filed comments strongly posing the removal of the adder. Of course, we are unable to predict the ultimate outcome or timing of this matter as the FERC is under no timeline to issue a decision. In addition, in June, the FERC issued an order establishing a joint federal state task force and electric transmission. This order establishes a first of its kind task force to respond with state commission’s transmission-related issues including how to plan and pay for transmission facilities, recognizing that federal and state regulators share authority over different aspects of these transmission-related issues. The task force will be comprised of the FERC commissioners and representatives nominated by the National Association of Regulatory Utility Commissioners from 10 state commissions. The first public meeting is expected to be held this fall. Also last month, the FERC issued an advanced notice of proposed rulemaking related to regional transmission planning and cost allocation processes, including critical long-term planning for anticipated future generation needs. We continue to asses the managed rates in the advanced NOPR and expect to file comments with the FERC this fall. Again, we are unable to predict the ultimate timing or outcome of this matter as FERC is under no timeline to issue a decision. Speaking to plan for future transmissions, please turn to Page 8. As I discussed on the call in May, MISO completed a study outlining a potential roadmap of transmission projects through 2039, taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates and goals for clean imaging or carbon emission reductions, among other things. Under MISO’s Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon-emission reduction below 2005 levels by 2039 MISO estimates approximately $30 billion of future transmission investment in the MISO footprint. Further, MISO’s Future 3 scenario resulted in an 80% reduction in carbon emissions below 2005 levels by 2039. Under this scenario, MISO estimates approximately $100 billion of transmission investment in the MISO footprint will be needed. It is clear that investment in transmission is going to play a critical role in the clean energy transition and we are well-positioned to plan and execute potential projects in the future for the benefit of our customers and country. We continue to work with MISO and other key stakeholders and believe certain projects outlined in Future 1 are likely to be included in this year’s MISO’s transmission planning process, which is currently scheduled to be completed in the fourth quarter of 2021. However, it is possible the process could go into the first quarter of 2022. Moving now to Page 9 for an update on our $1.1 billion wind generation investment related to the acquisition of 700 megawatts of new wind generation at 2 sites in Missouri. Ameren Missouri closed on the acquisition of its first wind energy center, a 400 megawatt project in Northeast Missouri in December. In January, Ameren Missouri acquired a second wind generation project, the 300 megawatt Atchison Renewable Energy Center located in Northwest Missouri. I am pleased to report that as of the end of the second quarter, the Atchison Renewable Energy Center is now in service. With both facilities now operating, it marks a key milestone as we continue to transition our energy portfolio towards a cleaner energy future. Turning now to Page 10 and an update on Missouri’s Callaway energy center. As we have previously discussed, during its return to full power, as part of its 24th refueling and maintenance outage in late December 2020, Callaway experienced a non-nuclear operating issue related to its generator. A thorough investigation of this matter was conducted and a decision was made to rewind the generator stator and rotor in order to safely and sustainably return to energy center to service. I am pleased to report that the generator project was executed very well and that the energy center returned to service on August 4. The completion of this project positions Callaway for a sustainable long-term future. The cost of the capital project was approximately $60 million. As we have said previously, the insurance claims for the capital project and replacement power have been accepted by our insurance carrier, which will mitigate the impacts of this outage for our customers. In addition, we do not expect this matter to have a significant impact on Ameren’s financial results. Turning to Page 11, we remain focused on delivering a sustainable energy future for our customers, communities and our country. This page summarizes our strong sustainability value proposition for environmental, social and governance matters and is consistent with our vision, leading the way to a sustainable energy future. Beginning with environmental stewardship, last September, Ameren announced its transformational plan to achieve net-zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes interim carbon-emission reduction targets of 50% and 85% below 2005 levels in 2030 and 2040 respectively and is consistent with the objectives of the Paris agreement and limiting global temperature rise to 1.5 degrees Celsius. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. Finally, our strong corporate covenants is led by a diverse Board of Directors focused on strong oversight that’s aligned with ESG matters. And our executive compensation practices include performance metrics that are tied to sustainable long-term performance, diversity, equity and inclusion and progress towards a cleaner, sustainable energy future. I encourage you to take some time to read more about our strong sustainability value proposition. You can find all of our ESG-related reports at amereninvestors.com. Turning now to Page 12, looking ahead, we have a strong sustainable growth proposition, which will be driven by a robust pipeline of investment opportunities of over $40 billion over the next decade that will deliver significant value to all our stakeholders in making the energy grid stronger, smarter and cleaner. Importantly, these investment opportunities exclude any new vehemently better special transmission projects, including the potential road map of MISO transmission projects I discussed earlier, all of which would increase the reliability and resiliency of the energy grid as well as enable our country’s transition to a cleaner energy future. In addition, we expect to see greater focus from a policy perspective and infrastructure investments to support the electrification of the transportation sector. Our outlook through 2030 does not include significant event structure investments for electrification at this time. Of course, our investment opportunities will not only create stronger and cleaner energy grid to meet our customers’ needs and exceed their expectations, but they would also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner energy future and is safe, reliable and affordable fashion will be critical to meeting our country’s future energy needs and delivering on our customers’ expectations. Moving to Page 13, to sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2021 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our 5-year growth outlook, which included a 6% to 8% compound annual earnings growth rate from 2021 to 2025. This earnings growth is primarily driven by strong rate base growth and compares very favorably with our regulated utility peers. Importantly, our 5-year earnings and rate base growth projections do not include 1,200 megawatts of incremental renewable investment opportunities outlined in Ameren Missouri’s and greater resource plan. Our team continues to assess several renewable generation proposals from developers. We expect to file this year with the Missouri PSC for certificates of convenience and necessity for a portion of these planned renewable investments. I am confident in our ability to execute our investment plans and strategies across all four of our business segments, which we have an experienced and dedicated team to get it done. That fact, coupled with our sustained past execution and our strategy on many fronts has positioned us well for future success. Further, our shares continue to offer the investors a solid dividend, which we expect to grow in line with our long-term earnings per share growth guidance. Simply put, we believe our strong earnings and dividend growth outlook results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today. I will now turn to Michael.
Michael Moehn: Thanks, Warner and good morning everyone. Turning now to Page 15 of our presentation, yesterday, we reported second quarter 2021 earnings of $0.80 per share compared to $0.98 per share for the year-ago quarter. Earnings in Ameren Missouri, our largest segment, decreased $0.18 per share, driven primarily by a change in seasonal electric rate design, resulting from the March 2020 rate order, which provided for winter rates in May and summer rates in September rather than the blended rates used in both months in 2020. The rate design change decrease earnings $0.19 per share and is not expected to impact full year results. Earnings were also impacted by the timing of income tax expense, which decreased earnings $0.03 per share and is not expected to impact full year results. As Warner mentioned, during the quarter, we remain relentlessly focused on continuous improvement and discipline cost management and have been able to largely maintained the level of operations and maintenance savings this quarter that we experienced during the year-ago period, which was significantly affected COVID-19. The increase in other operations and maintenance expenses, which decreased earnings $0.02 per share, was primarily due to more favorable market returns on the cash surrender value of company-owned life insurance in the year-ago period. As you can see, we have worked hard this year to control costs where we can. The amortization of deferred expenses related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage and higher interest expense primarily due to higher long-term debt balances outstanding also decreased earnings $0.02 per share. These factors were partially offset by an increase in earnings of $0.05 per share due to increased investments in infrastructure and wind generation, eligible for plant and service accounting and the Renewable Energy Standard Rate Adjustment Mechanism, or RESRAM. Higher electric retail sales also increased earnings by approximately $0.04 per share, largely due to continued economic recovery in this year’s second quarter compared to the unfavorable impacts of COVID-19 in the year-ago period. We’ve included on this page the year-over-year weather-normalized sales variances for the quarter. Overall weather-normalized sales are largely consistent with our expectations outlined in our call in February as we still expect total sales to be up approximately 2% in 2021 compared to 2020. Moving to other segments, Ameren Transmission earnings declined $0.03 per share over year, which reflected the absence of the prior year benefit from the May 2020 FERC order addressing the allowed base return on equity, which more than offset earnings on increased infrastructure investment. Earnings for Ameren oil natural gas decreased $0.01 per share. Increased delivery service rates that became effective in late January 2021 were offset by a change in rate design, which is not expected to impact full year results. Ameren Illinois electric distribution earnings increased $0.02 per share, which reflected increased infrastructure investments and a higher allowed ROE under performance-based rate making. Ameren parent and other results were also up $0.02 per share compared to the second quarter of 2020 primarily due to the timing of income tax expense, which is not expected to impact full year results. And finally, 2021 earnings per share reflected higher weighted average shares outstanding. Before moving on, I will touch on year-to-date sales trends for Illinois Electric distribution. Weather normalized kilowatt hour sales to Illinois residential customers decreased 1%. And weather normalized kilowatt hour sales to Illinois commercial and industrial customers increased 2.5% and 2% respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Turning to Page 16, now I’d like to briefly touch on key drivers impacting our 2021 earnings guidance. We’re off to a strong first half in 2021. And as Warner stated, we continue to expect 2021 diluted earnings to be in the range of $3.65 to $3.85 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed on our earnings call in February. I will note that our third quarter earnings comparison will be positively impacted by approximately $0.19 per share due to the seasonal electric rate design change effective in 2021 at Ameren Missouri that we discussed earlier. Moving now to Page 17 for an update on our regulatory matters. Starting with Ameren Missouri, as you recall, on March 31, we filed for a $299 million electric revenue increase with the Missouri Public Service Commission. The request includes a 9.9% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $10 billion. [indiscernible] will be filed in early September with the bottle testing by October 15. Evidence hearings are scheduled to begin in late November. In addition, on March 31, we filed for a $9 million natural gas revenue increase with the Missouri PSC. The request includes a 9.8% return on equity, a 51.9% equity ratio and a September 30, 2021, estimated rate base of $310 million. A Missouri PSC decision in both rate reviews is expected by early February, with new rates expected to be effective by late February. Moving down renewal – Illinois regulatory matters, in April, we made our required annual electric distribution rate update filing. Under Illinois performance-based ratemaking, these annual rate updates systematically adjust cash flows over time for changes in cost of service and true up any prior period over or under recovery of such costs. In late June, the ICC staff recommended a $54 million base rate increase compared to our request of a $60 million base rate increase. An ICC decision is expected in December with new rates expected to be effective in January 2022. Moving to Page 18. In early June, Ameren published a sustainability financing framework, becoming one of the first utilities in the nation to do so. Under this framework, Ameren and its issuing subsidiaries may elect to finance or refinance new and existing projects that have an environmental or social benefit through green bonds, social bonds, sustainability bonds, green loans or other financial instruments. Given the amount of investment activity at Ameren and the utility subsidiaries are pursuing, that have environmental or social benefits, we expect to be a relatively frequent issuer under our sustainability financing framework. In June, both Ameren Missouri and Ameren Illinois issued green bonds consistent with this new financing framework. More information about this framework is available at amereninvestors.com. Turning to Page 19 for a financing and liquidity update, we continue to feel very good about our liquidity and financial position. As I just mentioned in June, Ameren Missouri and Ameren Illinois issued green bonds with the net proceeds to be allocated to sustainable projects, meeting certain eligibility requirements under the sustainability financing framework. Additional debt issuances are outlined on this page. Further, earlier this year, we physically settled the remaining shares under our forward equity sale agree for proceeds of approximately $115 million. In order for us to maintain our credit ratings and a strong balance sheet while we found our robust infrastructure plan, we expected to issue a total of approximately $150 million of common equity in 2021 under the at-the-market or ATM program established in May. This is consistent with prior guidance provided in February and May. And to date, approximately $122 million of equity has been issued through this program. Our $750 million ATM equity program is expected to support our equity needs through 2023. Finally, Ameren’s available liquidity as of July 30 was approximately $1.8 billion. Lastly, turning to Page 20, we are well positioned to continue to execute on our plan. We continue to expect to deliver strong earnings growth in 2021 as we successfully execute our strategy. And as we look to the longer term, we expect strong earnings per share growth driven by a robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulated peers. Ameren shares continue to offer investors an attractive dividend. In total, we have a strong total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions] Our first question is from Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Good morning.
Warner Baxter: Good morning. How are you doing, sir?
Jeremy Tonet: Good. Good. Thank you. Just want to see how you think about the Missouri securitization legislation as a tool for transitioning the fleet. Just wondering if you – any thoughts you have there? Are there any particular reasons that could be more or less attractive for you to use versus kind of other considerations we should be thinking about?
Warner Baxter: Excuse me. Thanks, Jeremy. Yes, look, as we’ve said before, we’ve said securitization is a great regulatory tool and one that we don’t see is necessary to execute our integrated resource plan, but certainly a great regulatory tool. So in the big picture, as we go down the path, if we see changes in policies, change in economic conditions or really the overall economics for renewables, perhaps we will look at securitization as a tool to use. But right now, we are very comfortable and like our integrated resource plan and complement Marty Lyons and his team really did a nice job working with stakeholders to get that across the finish line. And so Marty, why don’t you come on in and see if you have any additional comments on the securitization tool that we have available to us.
Marty Lyons: Yes, Warner. Well, you described it very well. And Jeremy, thanks for the question. We outlined on Slide 25, our transition over time. It’s the integrated resource plan that we filed last fall. And as Warner mentioned, that plan and the execution of that plan were not dependent upon utilization of securitization. Really, what you see there is our plan as it stands today as to use our low-cost, reliable coal fleet as a foundation to bring in more renewables over time and provide reliable power to our customers. But as Warner said, to the extent situations change and require adjustments to this plan, it could be that securitization would be a very good tool to have in our toolbox to perhaps make this transition more swiftly and do it in a way that provides affordable rates to our customers. So, I think a really good tool to have in the toolbox, but again, not needed today as we look at this integrated resource plan.
Jeremy Tonet: Great. That’s really helpful color there. Maybe just kind of shifting gears here. Have you seen any developments in MISO as work progresses towards year-end project updates there? Just wondering if you might be able to expand a bit more, I guess, your thoughts there and what that could mean for Ameren?
Warner Baxter: Sure. Thanks, Jeremy. And look, as we discussed really on our last quarter call and as we talked about in our prepared remarks. We really see transmission investment as being critical for our country’s transition to a clean energy future. And certainly, MISO being right in the middle of the country is going to play an integral role. And obviously, we have a big footprint in MISO. And so as we have looked at it, MISO has really done a fine job from our perspective. And we are really looking out to see what some of those long-range transmission projects might be. No, they are not definitive yet, but they laid out a real nice plan for us to really think about and work with key stakeholders. And that’s exactly what we have been doing working without the key stakeholders and say, okay, what are these projects that we need to move forward with. I would say MISO is still in the middle of that process with us and so many others. And as you know, they will take that long-range plan that we outlined in our slides. And they are going to put that and include aspects of that thinking in MISO’s transmission expansion plan, which is a process that we will, hopefully, see moving forward by the end of this year. So, beyond that, I would say the conversations and analysis continues. The only thing I will say is that we believe we are well positioned to execute many of those projects. And we believe if you look at that Future 1, that some of those projects are going to likely be in this intent that comes out here at the end of this year or perhaps some maybe into early next year, because those are some no regrets projects that are in there that we need to move forward on, not just in the Midwest but for our country. So, we can move forward on this clean energy transition. So, nothing specific yet, but needless to say, there is a lot of work going around with the teams to try and move forward on this important aspect of the clean energy transition. So, stay tuned, more to come.
Jeremy Tonet: Got it. That’s very helpful. Thanks for that. I will leave it there.
Warner Baxter: Thanks. Thanks, Jeremy. Have a good weekend.
Jeremy Tonet: You too.
Operator: And our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question.
Warner Baxter: How are you? Good morning Paul.
Paul Patterson: Good morning. How are you?
Warner Baxter: Well, good here.
Paul Patterson: Good to hear. So, just to sort of follow-up on Jeremy’s question there on the MTAP process and the transmission opportunities, which sound pretty exciting. One of the questions, I guess, that sort of comes up here is as you are aware, that in Missouri, there is this clean energy line. I forgot the exact name, but you are familiar with it. It’s the one that’s been held up by challenges to it. It seems like forever. It’s not your line. It’s more like a merchant line. But in general, how should we think about once MISO is sort of identified, etcetera, the – bringing those – assuming that you guys get a good line of sight on opportunities for yourselves, how should we think about siding or permitting, etcetera, with respect to some of these projects in the context of that example that I have mentioned versus some of the add-ons and stuff that don’t seem to have as much in the way of hurdles, do you follow what I am saying?
Warner Baxter: Paul, a bit complicated. So, let me tell you, its Grain Belt is the name of the line that you are referring to.
Paul Patterson: Sorry. That slipped my mind.
Warner Baxter: Yes. And so I will make a couple of comments. And then Marty, you can talk about how the Grain Belt project has been incorporated, in some respects, at least commented upon in our integrated resource plan. But just big picture, whether it’s the Grain Belt or any transmission, obviously, permitting and siding is an important aspect of transmission. I think this is why you are seeing FERC and others, state commissions and others and legislators, take a very careful look at this because we have recognized that that’s an important aspect of getting any of these major transmission projects done. And some significant transmission projects are going to have to be done to – for us to affect the clean energy transition. And so one of the things I will tell you, we work very hard as a company at this, and that is being very thoughtful and reaching out with stakeholders in the communities early and often to talk about the needs for the transmission line, but also how we can work with those stakeholders in those communities, so we can get the permitting and signing done in a timely fashion. Shawn Schukar and his team have done that for years and years now. And this is why you have seen the success that we had in the last multi-valued projects that MISO did almost a decade ago. Now those projects were so successful is because a lot of work was done on the front end, so we could execute on the back end. As we look forward to any future transmission project, that’s exactly what we will continue to do. Now Grain Belt, obviously, as you rightfully said, that is not our project. But certainly it’s something that has received a lot of attention in Missouri and otherwise. And so Marty, I want you to comment a little bit about some of the things that we have been looking at in terms of Grain Belt as part of our integrated resource planning process.
Marty Lyons: Yes, sure, Warner, and I am happy to comment. So, I mentioned our integrated resource plan we filed last fall. And again, back on that Slide 25, where we depict our plan, that’s really our preferred plan out from the Integrated Resource Plan as we move forward. But as we develop that plan, we looked at a number of scenarios in terms of the path forward to get to what we believe to be the most reliable and affordable path forward. And in these scenarios, certainly, we evaluated utilization of Grain Belt as well as many other kinds of scenarios. And where we stand right now in terms of our integrated resource plan, as you all know, we did put out a request for proposals last year on various resources that might be available to fulfill our needs. Obviously, our ambition is to acquire, 1,200 megawatts of renewables, wind, solar, through 2025. And we do still expect to file later this year with the PSC for certificates of convenience and necessity for a portion of those planned projects. But as we go through broadly, looking at just the next 5 years, but even beyond, certainly, we will continue to consider all options, including utilization of Grain Belt as we think about fulfilling those needs. In terms of your question, Paul, I think you were asking about large-scale transmission, smaller-scale transmission. As we go about looking at the various resources that might fulfill our needs, certainly, we work closely with Shawn and his team and think very much about the transmission investments that will be required to facilitate investment in any of those projects, whether wind or solar. And it’s an important part of our consideration as we think about the resources that will be most affordable for our customers.
Paul Patterson: Okay. Great. And then just finally on Illinois, I mean you mentioned in your remarks, and I am just sort of – do you have any sense as to whether or not something happens in the next, I guess, couple of months here or I mean you guys are obviously a lot closer to it than I am. I am just sort of wondering if you had any odds on something in Illinois what those odds might be for something getting done.
Warner Baxter: Sure. Thanks, Paul. I have learned long ago not to make predictions about legislation. And especially in this particular case, it’s a complex piece of legislation. The only thing I can say is what I have said before and I will say again, Richard, Mark and his team, they have been working tirelessly for many months now with key stakeholders to try and forge a path forward. That is a constructive solution that’s going to enable us to make the investments we need to make in the energy grid and earn fair returns in the State of Illinois. And in so doing enhance reliability, create jobs and help really the State of Illinois and our country move towards a clean energy future. So, all of those things are all true. They remain true today, and we continue to be at the table with key stakeholders. But now I am not going to make any prediction in terms of time, weather or any timing, but rest assured, we are working hard at it, and we are at the table with the key stakeholders to try and get the constructive solution done.
Paul Patterson: Okay, great. Thanks a lot.
Operator: [Operator Instructions] Our next question is from Julien Dumoulin-Smith from Bank of America. Please proceed with your question.
Warner Baxter: Good morning Julien.
Julien Dumoulin-Smith: Hi. Good morning team. Thank you for this time and the opportunity. I appreciate it.
Warner Baxter: Absolutely.
Julien Dumoulin-Smith: So perhaps just let’s kick it off with our favorite subject here. And I want to hear your thoughts and perspectives around this June task force, right? You mentioned FERC and joining forces here. That seems like a fairly potent combination to drive real change, right? So I would be curious, what do you – what is the focus here? And specifically, what key issues are you asking them to address, right? When it comes to utilities, not HVDC lines with their own challenges and prospects, but from your perspective, tangibly, how can they step in and help you all?
Warner Baxter: You bet. Thanks, Julien. Look, we are encouraged that the Federal regulators and State regulators are not only talking, but they are trying to find a path forward. Because as I have said now several times on this call, the transmission is going to be a critical component of getting these major transmission projects done for our country. And so as we all know, the Federal regulators, FERC and the State regulators, their jurisdictions or lose the issues can sometimes overlap. And so things that are really important all the time is how we can sort through permitting and sighting. And clearly, another issue around transmission projects, especially these regional projects, which we are talking about in large part with these MISO projects, how you allocate the costs fairly and appropriately. And so what I think, Julian, what will happen with some of these conversations and what we hope to have happened is that there is a better understanding of the issues, perhaps a bit of a meeting of the minds, and so we can start moving forward in a more timely fashion than we might have otherwise had. And of course, when we are making the types of investments that we are making that we want to have, let’s say, greater levels of regulatory certainty. And so these things, I think, will be helpful. I am not suggesting that this task force will solve it all. But I think what it will do will provide a great forum for stakeholders, not just regulators, companies like ours and others to come to the table and say, “Okay, here are things that really matter, and here is how we can lean further forward in the transmission space,” which we, needless to say, strongly support the need to lean forward, further, faster in the transmission space.
Julien Dumoulin-Smith: Got it. Alright. Fair enough. And then if I can, I mean, let’s move it back to your own portfolio there. How are you thinking about transmission interconnect delays, costs, etcetera, just as you think about your own efforts? And then what are you observing regionally? Again, clearly, the need for transmission is principally evidenced by the elevated cost of interconnection costs and that translating to a relatively stagnant trajectory of processing this queue. Are you seeing issues with your own projects? And then more broadly, are you seeing these elevated costs with other developers in and around insurance sectors? If you can elaborate on it.
Warner Baxter: Yes, lots to unpack in there, and so let me make a few comments. So number one, Marty a moment ago was talking about how we proceed to the integrated resource planning process. And he also said, a key element of the projects that we look at and select really look very hard at transmission, interconnections, where developers may be in the queue, to try and move things forward. And that’s frankly how we were successful in moving in a very thoughtful and timely fashion with our 700 megawatts of wind generation. So, what we are seeing there, this is all part of our due diligence. Are you seeing sort of a backup, yes. Are you seeing now that organizations like MISO are looking beyond just today, looking to the future with this long-term resource planning effort, the answer to that is yes, and that’s why we support it. It will, we believe, help alleviate, in the future, if you look sort of a decade out, which is really when you think about transmission projects, look just for tomorrow, you look, say, a decade out, what are the things that we need to be doing today to position ourselves for success in the future. So, we are encouraged by that. Are we seeing the increases in prices or challenges, well, it’s premature to say that. We are still going through the process, still talking to developers, working with MISO and others. But the only thing I do know is that we have, I would say, unique expertise to provide the analysis, but also unique expertise to execute these important transmission projects, not just for our projects, but frankly, the projects that I will have regional and frankly, countrywide, positive implications to move forward to clean energy transition. So, I don’t know if, Julien, that answered your specific question. This is certainly an important aspect of what we are seeing, but this is not new to us. And I will finish with this, too. The other encouraging thing that we are seeing is that, in particular, in this instance, MISO is working with the other regional transmission organizations, in this particular instance, SPP, to try and coordinate even better some of these transmission projects and needs. So, you don’t have surprises, right, when it comes time to try and move forward with a particular renewal energy project. That, too, is encouraging. And we look forward to the results of that collaborative effort from those two organizations. And I am sure PJM and MISO will be having similar conversations sometime done ago.
Julien Dumoulin-Smith: Alright. Excellent. Sorry to squeeze in one more. But just obviously, you have identified there are certain renewable opportunities that are excluded from your 5-year outlook. And I know to certainly say that 5-year outlook is also going to be rolled forward here in the next few – in six months. Can you talk about the next data points that we should be watching in terms of more formally, including some of those projects into your plan just time line to have from that?
Warner Baxter: You bet. You stated it correctly, Julien, that none of these large regional projects that we outlined in our slides are reflected not only in our 5-year plan, but as you know, we look out 10 years, that $40 billion, we say $40 billion plus, while that big plus to that item is the potential for these large regional transmission projects. So, we are excited about that opportunity to be able to execute some of those. So, what’s the next thing to look at, look, I think that the MTAP, the MISO transmission expansion planning process, that will be really sort of your next visible sign. You will probably see – there may be some information out there towards the end of the third quarter into the fourth quarter. But the process itself, which ultimately goes before the Board of Directors of MISO, will be really in the fourth quarter at the earliest, as I said in my prepared remarks. That could go into the first quarter of next year. But that would be probably, I would say, part of the next data point, if you will, but not – but to be clear, as I said before, a lot of work is going on today to try and make sure that, that is gone as smoothly as possible. But that’s what I would be looking for a little bit later. Michael, you have a point there.
Michael Moehn: Yes, Julien, I think the only other thing with respect to the renewable projects, the data point there, I think Warner maybe even said this in his opening remarks, is it really that regulatory process. So, look for those CCN filings in the back half of this year, that’s really going to get those kick start from the approval standpoint. That’s, again, those are really speaking to the RFP process itself. Warner was really talking about the transmission.
Warner Baxter: Yes. Well said. Thank you, Michael. That’s exactly right. We said we expect to be filing for sub-CCH still here by the end of this year. So, that would be another important data point to be looking for incremental capital expenditure opportunities.
Julien Dumoulin-Smith: Got it. We will watch to look at. Excellent. Thank you all very much.
Warner Baxter: Thanks Julien. Have a good weekend.
Operator: And we have reached the end of the question-and-answer session. And I’ll now turn the call over to Andrew Kirk for closing remarks.
Andrew Kirk: Thank you for participating in this call. A replay of this call will be available for 1 year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial analyst inquiries should be directed to me, Andrew Kirk. Media should call Tony Paraino. Again, thank you for your interest in Ameren, and have a great day.
Operator: This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings. Welcome to Ameren Corporation’s Second Quarter 2021 Earnings Call. [Operator Instructions] Please note this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you and good morning. On the call with me today are Warner Baxter, our Chairman, President and Chief Executive Officer and Michael Moehn, our Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team joining us remotely. Warner and Michael will discuss our earnings results and guidance as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate-only as of the date of today’s live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today’s presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now, here is Warner, who will start on Page 4 of our presentation."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Andrew. Good morning, everyone and thank you for joining us. This morning, I will begin with the statement that I have been making for quite some time now. Simply put, our team continues to effectively execute our strategic plan across all of our businesses, which includes making significant investments in our energy infrastructure to enhance the reliability and resiliency of the energy grid as well as transition to a cleaner energy future in a responsible fashion. These investments, coupled with our continued focus on disciplined cost management delivering significant value to our customers, communities and shareholders. Moving now to our second quarter earnings results, yesterday, we announced second quarter 2021 earnings of $0.80 per share. Our earnings were down $0.18 per share from the same time period in 2020, primarily due to a change in the seasonal electric rate design at Ameren Missouri that reduced earnings $0.19 per share. The impact of this change in rate design will reverse in the third quarter of 2021 and is not expected to impact full year results. Michael will discuss the other key drivers of our strong quarter earnings results a bit later. Due to the continued strong execution of our strategy, I am pleased to report that we remain on track to deliver within our 2021 earnings guidance range of $3.65 per share to $3.85 per share. Speaking of the execution of our strategy, let’s move to Page 5, where we reiterate our strategic plan. The first pillar of our strategy stresses investing in and operating our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure with a long-term benefit of our customers. As a result and as you can see on the right side of this page, during the first 6 months of this year, we invested significant capital in each of our business segments, including wind generation at Ameren Missouri, which I will discuss later. These investments are delivering value to our customers. As I said before, our energy grid is stronger, more resilient and more secure, because of the investments we are making in all four business segments. Consistent with the Missouri Smart Energy Plan, we have made significant investments to harden energy grid, which has reduced outages and installed nearly 300,000 electric smart meters for customers. These smart meters will help customers better manage their usage and control their overall energy costs. In Illinois, we continue to execute on our electric distribution and gas modernization action plans. The plans include investments to strengthen electric power poles. We placed gas transmission pipelines and compression coupled steel mains as well as to implement new efficiency measures, including mobile enhanced communications and assessment capabilities for our careers. These improvements, along with our investments in outage detection technology, were resulting in improvements in system reliability and millions of dollars in savings for customers. Moving now to regulatory matters, in late March, Ameren Missouri filed a request for a $299 million increase in annual electric service revenues and a $9 million increase in annual natural gas revenues with the Missouri Public Service Commission. In our Illinois Electric business, we requested a $60 million base rate increase in our required annual electric distribution rate filing. These proceedings are all moving along on schedule. We will be able to provide you information on these proceedings as they develop later this summer and into the fall. Finally, we have remained relentlessly focused on continuous improvement and disciplined cost management, including retaining the cost savings that we realized in 2020 due to the actions we took to mitigate the impacts of COVID-19. Moving to Page 6 and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Starting in Missouri, in May, the Missouri legislator passed the bill, allowing for securitization in the state. This constructive legislation which is trying by governance parsing in July give us another important regulatory tool to facilitate our transition to a cleaner energy future and a cost effective manner for our customers. However, as we have stated in the past, a robust integrated resource plan does not rely on securitization to be successful. Our flexible and responsible plan, which includes approximately $8 billion of investments in renewable energy through 2040, the retirement of all of our coal-fired energy centers and extending the life of our carbon-free Callaway nuclear energy center focuses on getting the energy we provide to our customers as clean as we can, as fast as we can without compromising from reliability, customer affordability and the evolution of new clean energy technologies. And as I will touch on later, I am pleased to say that we are already taking steps to implement this important plan for our customers, the State of Missouri and our country. Moving now to Illinois, last month, the Illinois Commerce Commission approved Ameren Illinois electric vehicle charging program. Under this program, we are able to support the development of a network of charging infrastructure in Central and Southern Illinois as well as implement special time-based delivery service rates and other incentives to help encourage the use of electric vehicles. We are excited about this new program, because it will drive greater electrification of the transportation sector as well as help the state of Illinois move towards its clean energy goals. Moving to legislative efforts, as many of you know, we have been working to enhance the regulatory framework for our Illinois Electric business. The performance-based regulatory framework in place today has delivered strong value for customers and shareholders over the years. However, the framework is scheduled to sunset in 2022. As a result, we have been working with key stakeholders to develop constructive long-term regulatory policies that support important investments in energy infrastructure, while enabling us to earn fair returns on those investments. As you know, throughout the regulator legislative session, which ended late May, we advocated for the Downstate Clean Energy Affordability Act which was largely extended the existing framework until 2032, while putting in place provisions that would set the Ameren Illinois electric distribution ROE at the national average. At the same time, many other energy-related legislative proposals from other stakeholders were proposed during the legislative session, including proposals from Governor Pritzker, labor and environmental groups, to address the closure of nuclear plants in the states, Illinois clean energy transition and the electric distribution framework going forward. For months, stakeholders have been in discussion seeking to find an appropriate compromise to all these proposals. While progress is made in these issues, the regular legislative session ended on May 31 with no energy legislation being put before the Senate or House of Representatives for a vote. A special session was called in mid-June to further discuss draft energy legislation, but no bill was filed nor action taken. Needless to say, we will continue to work with key stakeholders to find a constructive solution to this important matter. Turning to Page 7 for an update on FERC regulatory matters, in April, FERC issued a supplemental notice of proposed rulemaking, or NOPR, on electric transmission return on equity incentive adder for participation in the regional transmission organization, or RTO. As you may recall, under the NOPR, the RTO incentive adder would be removed from utilities that have been members of an RTO for 3 years or more, like the Ameren Illinois and ATXI. We have been very clear that we disagreed with FERC proposed recommendation in this matter for a number of reasons and recently filed comments strongly posing the removal of the adder. Of course, we are unable to predict the ultimate outcome or timing of this matter as the FERC is under no timeline to issue a decision. In addition, in June, the FERC issued an order establishing a joint federal state task force and electric transmission. This order establishes a first of its kind task force to respond with state commission’s transmission-related issues including how to plan and pay for transmission facilities, recognizing that federal and state regulators share authority over different aspects of these transmission-related issues. The task force will be comprised of the FERC commissioners and representatives nominated by the National Association of Regulatory Utility Commissioners from 10 state commissions. The first public meeting is expected to be held this fall. Also last month, the FERC issued an advanced notice of proposed rulemaking related to regional transmission planning and cost allocation processes, including critical long-term planning for anticipated future generation needs. We continue to asses the managed rates in the advanced NOPR and expect to file comments with the FERC this fall. Again, we are unable to predict the ultimate timing or outcome of this matter as FERC is under no timeline to issue a decision. Speaking to plan for future transmissions, please turn to Page 8. As I discussed on the call in May, MISO completed a study outlining a potential roadmap of transmission projects through 2039, taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates and goals for clean imaging or carbon emission reductions, among other things. Under MISO’s Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon-emission reduction below 2005 levels by 2039 MISO estimates approximately $30 billion of future transmission investment in the MISO footprint. Further, MISO’s Future 3 scenario resulted in an 80% reduction in carbon emissions below 2005 levels by 2039. Under this scenario, MISO estimates approximately $100 billion of transmission investment in the MISO footprint will be needed. It is clear that investment in transmission is going to play a critical role in the clean energy transition and we are well-positioned to plan and execute potential projects in the future for the benefit of our customers and country. We continue to work with MISO and other key stakeholders and believe certain projects outlined in Future 1 are likely to be included in this year’s MISO’s transmission planning process, which is currently scheduled to be completed in the fourth quarter of 2021. However, it is possible the process could go into the first quarter of 2022. Moving now to Page 9 for an update on our $1.1 billion wind generation investment related to the acquisition of 700 megawatts of new wind generation at 2 sites in Missouri. Ameren Missouri closed on the acquisition of its first wind energy center, a 400 megawatt project in Northeast Missouri in December. In January, Ameren Missouri acquired a second wind generation project, the 300 megawatt Atchison Renewable Energy Center located in Northwest Missouri. I am pleased to report that as of the end of the second quarter, the Atchison Renewable Energy Center is now in service. With both facilities now operating, it marks a key milestone as we continue to transition our energy portfolio towards a cleaner energy future. Turning now to Page 10 and an update on Missouri’s Callaway energy center. As we have previously discussed, during its return to full power, as part of its 24th refueling and maintenance outage in late December 2020, Callaway experienced a non-nuclear operating issue related to its generator. A thorough investigation of this matter was conducted and a decision was made to rewind the generator stator and rotor in order to safely and sustainably return to energy center to service. I am pleased to report that the generator project was executed very well and that the energy center returned to service on August 4. The completion of this project positions Callaway for a sustainable long-term future. The cost of the capital project was approximately $60 million. As we have said previously, the insurance claims for the capital project and replacement power have been accepted by our insurance carrier, which will mitigate the impacts of this outage for our customers. In addition, we do not expect this matter to have a significant impact on Ameren’s financial results. Turning to Page 11, we remain focused on delivering a sustainable energy future for our customers, communities and our country. This page summarizes our strong sustainability value proposition for environmental, social and governance matters and is consistent with our vision, leading the way to a sustainable energy future. Beginning with environmental stewardship, last September, Ameren announced its transformational plan to achieve net-zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes interim carbon-emission reduction targets of 50% and 85% below 2005 levels in 2030 and 2040 respectively and is consistent with the objectives of the Paris agreement and limiting global temperature rise to 1.5 degrees Celsius. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. Finally, our strong corporate covenants is led by a diverse Board of Directors focused on strong oversight that’s aligned with ESG matters. And our executive compensation practices include performance metrics that are tied to sustainable long-term performance, diversity, equity and inclusion and progress towards a cleaner, sustainable energy future. I encourage you to take some time to read more about our strong sustainability value proposition. You can find all of our ESG-related reports at amereninvestors.com. Turning now to Page 12, looking ahead, we have a strong sustainable growth proposition, which will be driven by a robust pipeline of investment opportunities of over $40 billion over the next decade that will deliver significant value to all our stakeholders in making the energy grid stronger, smarter and cleaner. Importantly, these investment opportunities exclude any new vehemently better special transmission projects, including the potential road map of MISO transmission projects I discussed earlier, all of which would increase the reliability and resiliency of the energy grid as well as enable our country’s transition to a cleaner energy future. In addition, we expect to see greater focus from a policy perspective and infrastructure investments to support the electrification of the transportation sector. Our outlook through 2030 does not include significant event structure investments for electrification at this time. Of course, our investment opportunities will not only create stronger and cleaner energy grid to meet our customers’ needs and exceed their expectations, but they would also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner energy future and is safe, reliable and affordable fashion will be critical to meeting our country’s future energy needs and delivering on our customers’ expectations. Moving to Page 13, to sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2021 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our 5-year growth outlook, which included a 6% to 8% compound annual earnings growth rate from 2021 to 2025. This earnings growth is primarily driven by strong rate base growth and compares very favorably with our regulated utility peers. Importantly, our 5-year earnings and rate base growth projections do not include 1,200 megawatts of incremental renewable investment opportunities outlined in Ameren Missouri’s and greater resource plan. Our team continues to assess several renewable generation proposals from developers. We expect to file this year with the Missouri PSC for certificates of convenience and necessity for a portion of these planned renewable investments. I am confident in our ability to execute our investment plans and strategies across all four of our business segments, which we have an experienced and dedicated team to get it done. That fact, coupled with our sustained past execution and our strategy on many fronts has positioned us well for future success. Further, our shares continue to offer the investors a solid dividend, which we expect to grow in line with our long-term earnings per share growth guidance. Simply put, we believe our strong earnings and dividend growth outlook results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today. I will now turn to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Warner and good morning everyone. Turning now to Page 15 of our presentation, yesterday, we reported second quarter 2021 earnings of $0.80 per share compared to $0.98 per share for the year-ago quarter. Earnings in Ameren Missouri, our largest segment, decreased $0.18 per share, driven primarily by a change in seasonal electric rate design, resulting from the March 2020 rate order, which provided for winter rates in May and summer rates in September rather than the blended rates used in both months in 2020. The rate design change decrease earnings $0.19 per share and is not expected to impact full year results. Earnings were also impacted by the timing of income tax expense, which decreased earnings $0.03 per share and is not expected to impact full year results. As Warner mentioned, during the quarter, we remain relentlessly focused on continuous improvement and discipline cost management and have been able to largely maintained the level of operations and maintenance savings this quarter that we experienced during the year-ago period, which was significantly affected COVID-19. The increase in other operations and maintenance expenses, which decreased earnings $0.02 per share, was primarily due to more favorable market returns on the cash surrender value of company-owned life insurance in the year-ago period. As you can see, we have worked hard this year to control costs where we can. The amortization of deferred expenses related to the fall 2020 Callaway Energy Center scheduled refueling and maintenance outage and higher interest expense primarily due to higher long-term debt balances outstanding also decreased earnings $0.02 per share. These factors were partially offset by an increase in earnings of $0.05 per share due to increased investments in infrastructure and wind generation, eligible for plant and service accounting and the Renewable Energy Standard Rate Adjustment Mechanism, or RESRAM. Higher electric retail sales also increased earnings by approximately $0.04 per share, largely due to continued economic recovery in this year’s second quarter compared to the unfavorable impacts of COVID-19 in the year-ago period. We’ve included on this page the year-over-year weather-normalized sales variances for the quarter. Overall weather-normalized sales are largely consistent with our expectations outlined in our call in February as we still expect total sales to be up approximately 2% in 2021 compared to 2020. Moving to other segments, Ameren Transmission earnings declined $0.03 per share over year, which reflected the absence of the prior year benefit from the May 2020 FERC order addressing the allowed base return on equity, which more than offset earnings on increased infrastructure investment. Earnings for Ameren oil natural gas decreased $0.01 per share. Increased delivery service rates that became effective in late January 2021 were offset by a change in rate design, which is not expected to impact full year results. Ameren Illinois electric distribution earnings increased $0.02 per share, which reflected increased infrastructure investments and a higher allowed ROE under performance-based rate making. Ameren parent and other results were also up $0.02 per share compared to the second quarter of 2020 primarily due to the timing of income tax expense, which is not expected to impact full year results. And finally, 2021 earnings per share reflected higher weighted average shares outstanding. Before moving on, I will touch on year-to-date sales trends for Illinois Electric distribution. Weather normalized kilowatt hour sales to Illinois residential customers decreased 1%. And weather normalized kilowatt hour sales to Illinois commercial and industrial customers increased 2.5% and 2% respectively. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Turning to Page 16, now I’d like to briefly touch on key drivers impacting our 2021 earnings guidance. We’re off to a strong first half in 2021. And as Warner stated, we continue to expect 2021 diluted earnings to be in the range of $3.65 to $3.85 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed on our earnings call in February. I will note that our third quarter earnings comparison will be positively impacted by approximately $0.19 per share due to the seasonal electric rate design change effective in 2021 at Ameren Missouri that we discussed earlier. Moving now to Page 17 for an update on our regulatory matters. Starting with Ameren Missouri, as you recall, on March 31, we filed for a $299 million electric revenue increase with the Missouri Public Service Commission. The request includes a 9.9% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $10 billion. [indiscernible] will be filed in early September with the bottle testing by October 15. Evidence hearings are scheduled to begin in late November. In addition, on March 31, we filed for a $9 million natural gas revenue increase with the Missouri PSC. The request includes a 9.8% return on equity, a 51.9% equity ratio and a September 30, 2021, estimated rate base of $310 million. A Missouri PSC decision in both rate reviews is expected by early February, with new rates expected to be effective by late February. Moving down renewal – Illinois regulatory matters, in April, we made our required annual electric distribution rate update filing. Under Illinois performance-based ratemaking, these annual rate updates systematically adjust cash flows over time for changes in cost of service and true up any prior period over or under recovery of such costs. In late June, the ICC staff recommended a $54 million base rate increase compared to our request of a $60 million base rate increase. An ICC decision is expected in December with new rates expected to be effective in January 2022. Moving to Page 18. In early June, Ameren published a sustainability financing framework, becoming one of the first utilities in the nation to do so. Under this framework, Ameren and its issuing subsidiaries may elect to finance or refinance new and existing projects that have an environmental or social benefit through green bonds, social bonds, sustainability bonds, green loans or other financial instruments. Given the amount of investment activity at Ameren and the utility subsidiaries are pursuing, that have environmental or social benefits, we expect to be a relatively frequent issuer under our sustainability financing framework. In June, both Ameren Missouri and Ameren Illinois issued green bonds consistent with this new financing framework. More information about this framework is available at amereninvestors.com. Turning to Page 19 for a financing and liquidity update, we continue to feel very good about our liquidity and financial position. As I just mentioned in June, Ameren Missouri and Ameren Illinois issued green bonds with the net proceeds to be allocated to sustainable projects, meeting certain eligibility requirements under the sustainability financing framework. Additional debt issuances are outlined on this page. Further, earlier this year, we physically settled the remaining shares under our forward equity sale agree for proceeds of approximately $115 million. In order for us to maintain our credit ratings and a strong balance sheet while we found our robust infrastructure plan, we expected to issue a total of approximately $150 million of common equity in 2021 under the at-the-market or ATM program established in May. This is consistent with prior guidance provided in February and May. And to date, approximately $122 million of equity has been issued through this program. Our $750 million ATM equity program is expected to support our equity needs through 2023. Finally, Ameren’s available liquidity as of July 30 was approximately $1.8 billion. Lastly, turning to Page 20, we are well positioned to continue to execute on our plan. We continue to expect to deliver strong earnings growth in 2021 as we successfully execute our strategy. And as we look to the longer term, we expect strong earnings per share growth driven by a robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulated peers. Ameren shares continue to offer investors an attractive dividend. In total, we have a strong total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question is from Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Good morning."
},
{
"speaker": "Warner Baxter",
"text": "Good morning. How are you doing, sir?"
},
{
"speaker": "Jeremy Tonet",
"text": "Good. Good. Thank you. Just want to see how you think about the Missouri securitization legislation as a tool for transitioning the fleet. Just wondering if you – any thoughts you have there? Are there any particular reasons that could be more or less attractive for you to use versus kind of other considerations we should be thinking about?"
},
{
"speaker": "Warner Baxter",
"text": "Excuse me. Thanks, Jeremy. Yes, look, as we’ve said before, we’ve said securitization is a great regulatory tool and one that we don’t see is necessary to execute our integrated resource plan, but certainly a great regulatory tool. So in the big picture, as we go down the path, if we see changes in policies, change in economic conditions or really the overall economics for renewables, perhaps we will look at securitization as a tool to use. But right now, we are very comfortable and like our integrated resource plan and complement Marty Lyons and his team really did a nice job working with stakeholders to get that across the finish line. And so Marty, why don’t you come on in and see if you have any additional comments on the securitization tool that we have available to us."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Warner. Well, you described it very well. And Jeremy, thanks for the question. We outlined on Slide 25, our transition over time. It’s the integrated resource plan that we filed last fall. And as Warner mentioned, that plan and the execution of that plan were not dependent upon utilization of securitization. Really, what you see there is our plan as it stands today as to use our low-cost, reliable coal fleet as a foundation to bring in more renewables over time and provide reliable power to our customers. But as Warner said, to the extent situations change and require adjustments to this plan, it could be that securitization would be a very good tool to have in our toolbox to perhaps make this transition more swiftly and do it in a way that provides affordable rates to our customers. So, I think a really good tool to have in the toolbox, but again, not needed today as we look at this integrated resource plan."
},
{
"speaker": "Jeremy Tonet",
"text": "Great. That’s really helpful color there. Maybe just kind of shifting gears here. Have you seen any developments in MISO as work progresses towards year-end project updates there? Just wondering if you might be able to expand a bit more, I guess, your thoughts there and what that could mean for Ameren?"
},
{
"speaker": "Warner Baxter",
"text": "Sure. Thanks, Jeremy. And look, as we discussed really on our last quarter call and as we talked about in our prepared remarks. We really see transmission investment as being critical for our country’s transition to a clean energy future. And certainly, MISO being right in the middle of the country is going to play an integral role. And obviously, we have a big footprint in MISO. And so as we have looked at it, MISO has really done a fine job from our perspective. And we are really looking out to see what some of those long-range transmission projects might be. No, they are not definitive yet, but they laid out a real nice plan for us to really think about and work with key stakeholders. And that’s exactly what we have been doing working without the key stakeholders and say, okay, what are these projects that we need to move forward with. I would say MISO is still in the middle of that process with us and so many others. And as you know, they will take that long-range plan that we outlined in our slides. And they are going to put that and include aspects of that thinking in MISO’s transmission expansion plan, which is a process that we will, hopefully, see moving forward by the end of this year. So, beyond that, I would say the conversations and analysis continues. The only thing I will say is that we believe we are well positioned to execute many of those projects. And we believe if you look at that Future 1, that some of those projects are going to likely be in this intent that comes out here at the end of this year or perhaps some maybe into early next year, because those are some no regrets projects that are in there that we need to move forward on, not just in the Midwest but for our country. So, we can move forward on this clean energy transition. So, nothing specific yet, but needless to say, there is a lot of work going around with the teams to try and move forward on this important aspect of the clean energy transition. So, stay tuned, more to come."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s very helpful. Thanks for that. I will leave it there."
},
{
"speaker": "Warner Baxter",
"text": "Thanks. Thanks, Jeremy. Have a good weekend."
},
{
"speaker": "Jeremy Tonet",
"text": "You too."
},
{
"speaker": "Operator",
"text": "And our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Warner Baxter",
"text": "How are you? Good morning Paul."
},
{
"speaker": "Paul Patterson",
"text": "Good morning. How are you?"
},
{
"speaker": "Warner Baxter",
"text": "Well, good here."
},
{
"speaker": "Paul Patterson",
"text": "Good to hear. So, just to sort of follow-up on Jeremy’s question there on the MTAP process and the transmission opportunities, which sound pretty exciting. One of the questions, I guess, that sort of comes up here is as you are aware, that in Missouri, there is this clean energy line. I forgot the exact name, but you are familiar with it. It’s the one that’s been held up by challenges to it. It seems like forever. It’s not your line. It’s more like a merchant line. But in general, how should we think about once MISO is sort of identified, etcetera, the – bringing those – assuming that you guys get a good line of sight on opportunities for yourselves, how should we think about siding or permitting, etcetera, with respect to some of these projects in the context of that example that I have mentioned versus some of the add-ons and stuff that don’t seem to have as much in the way of hurdles, do you follow what I am saying?"
},
{
"speaker": "Warner Baxter",
"text": "Paul, a bit complicated. So, let me tell you, its Grain Belt is the name of the line that you are referring to."
},
{
"speaker": "Paul Patterson",
"text": "Sorry. That slipped my mind."
},
{
"speaker": "Warner Baxter",
"text": "Yes. And so I will make a couple of comments. And then Marty, you can talk about how the Grain Belt project has been incorporated, in some respects, at least commented upon in our integrated resource plan. But just big picture, whether it’s the Grain Belt or any transmission, obviously, permitting and siding is an important aspect of transmission. I think this is why you are seeing FERC and others, state commissions and others and legislators, take a very careful look at this because we have recognized that that’s an important aspect of getting any of these major transmission projects done. And some significant transmission projects are going to have to be done to – for us to affect the clean energy transition. And so one of the things I will tell you, we work very hard as a company at this, and that is being very thoughtful and reaching out with stakeholders in the communities early and often to talk about the needs for the transmission line, but also how we can work with those stakeholders in those communities, so we can get the permitting and signing done in a timely fashion. Shawn Schukar and his team have done that for years and years now. And this is why you have seen the success that we had in the last multi-valued projects that MISO did almost a decade ago. Now those projects were so successful is because a lot of work was done on the front end, so we could execute on the back end. As we look forward to any future transmission project, that’s exactly what we will continue to do. Now Grain Belt, obviously, as you rightfully said, that is not our project. But certainly it’s something that has received a lot of attention in Missouri and otherwise. And so Marty, I want you to comment a little bit about some of the things that we have been looking at in terms of Grain Belt as part of our integrated resource planning process."
},
{
"speaker": "Marty Lyons",
"text": "Yes, sure, Warner, and I am happy to comment. So, I mentioned our integrated resource plan we filed last fall. And again, back on that Slide 25, where we depict our plan, that’s really our preferred plan out from the Integrated Resource Plan as we move forward. But as we develop that plan, we looked at a number of scenarios in terms of the path forward to get to what we believe to be the most reliable and affordable path forward. And in these scenarios, certainly, we evaluated utilization of Grain Belt as well as many other kinds of scenarios. And where we stand right now in terms of our integrated resource plan, as you all know, we did put out a request for proposals last year on various resources that might be available to fulfill our needs. Obviously, our ambition is to acquire, 1,200 megawatts of renewables, wind, solar, through 2025. And we do still expect to file later this year with the PSC for certificates of convenience and necessity for a portion of those planned projects. But as we go through broadly, looking at just the next 5 years, but even beyond, certainly, we will continue to consider all options, including utilization of Grain Belt as we think about fulfilling those needs. In terms of your question, Paul, I think you were asking about large-scale transmission, smaller-scale transmission. As we go about looking at the various resources that might fulfill our needs, certainly, we work closely with Shawn and his team and think very much about the transmission investments that will be required to facilitate investment in any of those projects, whether wind or solar. And it’s an important part of our consideration as we think about the resources that will be most affordable for our customers."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Great. And then just finally on Illinois, I mean you mentioned in your remarks, and I am just sort of – do you have any sense as to whether or not something happens in the next, I guess, couple of months here or I mean you guys are obviously a lot closer to it than I am. I am just sort of wondering if you had any odds on something in Illinois what those odds might be for something getting done."
},
{
"speaker": "Warner Baxter",
"text": "Sure. Thanks, Paul. I have learned long ago not to make predictions about legislation. And especially in this particular case, it’s a complex piece of legislation. The only thing I can say is what I have said before and I will say again, Richard, Mark and his team, they have been working tirelessly for many months now with key stakeholders to try and forge a path forward. That is a constructive solution that’s going to enable us to make the investments we need to make in the energy grid and earn fair returns in the State of Illinois. And in so doing enhance reliability, create jobs and help really the State of Illinois and our country move towards a clean energy future. So, all of those things are all true. They remain true today, and we continue to be at the table with key stakeholders. But now I am not going to make any prediction in terms of time, weather or any timing, but rest assured, we are working hard at it, and we are at the table with the key stakeholders to try and get the constructive solution done."
},
{
"speaker": "Paul Patterson",
"text": "Okay, great. Thanks a lot."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question is from Julien Dumoulin-Smith from Bank of America. Please proceed with your question."
},
{
"speaker": "Warner Baxter",
"text": "Good morning Julien."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hi. Good morning team. Thank you for this time and the opportunity. I appreciate it."
},
{
"speaker": "Warner Baxter",
"text": "Absolutely."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "So perhaps just let’s kick it off with our favorite subject here. And I want to hear your thoughts and perspectives around this June task force, right? You mentioned FERC and joining forces here. That seems like a fairly potent combination to drive real change, right? So I would be curious, what do you – what is the focus here? And specifically, what key issues are you asking them to address, right? When it comes to utilities, not HVDC lines with their own challenges and prospects, but from your perspective, tangibly, how can they step in and help you all?"
},
{
"speaker": "Warner Baxter",
"text": "You bet. Thanks, Julien. Look, we are encouraged that the Federal regulators and State regulators are not only talking, but they are trying to find a path forward. Because as I have said now several times on this call, the transmission is going to be a critical component of getting these major transmission projects done for our country. And so as we all know, the Federal regulators, FERC and the State regulators, their jurisdictions or lose the issues can sometimes overlap. And so things that are really important all the time is how we can sort through permitting and sighting. And clearly, another issue around transmission projects, especially these regional projects, which we are talking about in large part with these MISO projects, how you allocate the costs fairly and appropriately. And so what I think, Julian, what will happen with some of these conversations and what we hope to have happened is that there is a better understanding of the issues, perhaps a bit of a meeting of the minds, and so we can start moving forward in a more timely fashion than we might have otherwise had. And of course, when we are making the types of investments that we are making that we want to have, let’s say, greater levels of regulatory certainty. And so these things, I think, will be helpful. I am not suggesting that this task force will solve it all. But I think what it will do will provide a great forum for stakeholders, not just regulators, companies like ours and others to come to the table and say, “Okay, here are things that really matter, and here is how we can lean further forward in the transmission space,” which we, needless to say, strongly support the need to lean forward, further, faster in the transmission space."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Alright. Fair enough. And then if I can, I mean, let’s move it back to your own portfolio there. How are you thinking about transmission interconnect delays, costs, etcetera, just as you think about your own efforts? And then what are you observing regionally? Again, clearly, the need for transmission is principally evidenced by the elevated cost of interconnection costs and that translating to a relatively stagnant trajectory of processing this queue. Are you seeing issues with your own projects? And then more broadly, are you seeing these elevated costs with other developers in and around insurance sectors? If you can elaborate on it."
},
{
"speaker": "Warner Baxter",
"text": "Yes, lots to unpack in there, and so let me make a few comments. So number one, Marty a moment ago was talking about how we proceed to the integrated resource planning process. And he also said, a key element of the projects that we look at and select really look very hard at transmission, interconnections, where developers may be in the queue, to try and move things forward. And that’s frankly how we were successful in moving in a very thoughtful and timely fashion with our 700 megawatts of wind generation. So, what we are seeing there, this is all part of our due diligence. Are you seeing sort of a backup, yes. Are you seeing now that organizations like MISO are looking beyond just today, looking to the future with this long-term resource planning effort, the answer to that is yes, and that’s why we support it. It will, we believe, help alleviate, in the future, if you look sort of a decade out, which is really when you think about transmission projects, look just for tomorrow, you look, say, a decade out, what are the things that we need to be doing today to position ourselves for success in the future. So, we are encouraged by that. Are we seeing the increases in prices or challenges, well, it’s premature to say that. We are still going through the process, still talking to developers, working with MISO and others. But the only thing I do know is that we have, I would say, unique expertise to provide the analysis, but also unique expertise to execute these important transmission projects, not just for our projects, but frankly, the projects that I will have regional and frankly, countrywide, positive implications to move forward to clean energy transition. So, I don’t know if, Julien, that answered your specific question. This is certainly an important aspect of what we are seeing, but this is not new to us. And I will finish with this, too. The other encouraging thing that we are seeing is that, in particular, in this instance, MISO is working with the other regional transmission organizations, in this particular instance, SPP, to try and coordinate even better some of these transmission projects and needs. So, you don’t have surprises, right, when it comes time to try and move forward with a particular renewal energy project. That, too, is encouraging. And we look forward to the results of that collaborative effort from those two organizations. And I am sure PJM and MISO will be having similar conversations sometime done ago."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Alright. Excellent. Sorry to squeeze in one more. But just obviously, you have identified there are certain renewable opportunities that are excluded from your 5-year outlook. And I know to certainly say that 5-year outlook is also going to be rolled forward here in the next few – in six months. Can you talk about the next data points that we should be watching in terms of more formally, including some of those projects into your plan just time line to have from that?"
},
{
"speaker": "Warner Baxter",
"text": "You bet. You stated it correctly, Julien, that none of these large regional projects that we outlined in our slides are reflected not only in our 5-year plan, but as you know, we look out 10 years, that $40 billion, we say $40 billion plus, while that big plus to that item is the potential for these large regional transmission projects. So, we are excited about that opportunity to be able to execute some of those. So, what’s the next thing to look at, look, I think that the MTAP, the MISO transmission expansion planning process, that will be really sort of your next visible sign. You will probably see – there may be some information out there towards the end of the third quarter into the fourth quarter. But the process itself, which ultimately goes before the Board of Directors of MISO, will be really in the fourth quarter at the earliest, as I said in my prepared remarks. That could go into the first quarter of next year. But that would be probably, I would say, part of the next data point, if you will, but not – but to be clear, as I said before, a lot of work is going on today to try and make sure that, that is gone as smoothly as possible. But that’s what I would be looking for a little bit later. Michael, you have a point there."
},
{
"speaker": "Michael Moehn",
"text": "Yes, Julien, I think the only other thing with respect to the renewable projects, the data point there, I think Warner maybe even said this in his opening remarks, is it really that regulatory process. So, look for those CCN filings in the back half of this year, that’s really going to get those kick start from the approval standpoint. That’s, again, those are really speaking to the RFP process itself. Warner was really talking about the transmission."
},
{
"speaker": "Warner Baxter",
"text": "Yes. Well said. Thank you, Michael. That’s exactly right. We said we expect to be filing for sub-CCH still here by the end of this year. So, that would be another important data point to be looking for incremental capital expenditure opportunities."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. We will watch to look at. Excellent. Thank you all very much."
},
{
"speaker": "Warner Baxter",
"text": "Thanks Julien. Have a good weekend."
},
{
"speaker": "Operator",
"text": "And we have reached the end of the question-and-answer session. And I’ll now turn the call over to Andrew Kirk for closing remarks."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you for participating in this call. A replay of this call will be available for 1 year on our website. If you have questions, you may call the contacts listed on our earnings release. Financial analyst inquiries should be directed to me, Andrew Kirk. Media should call Tony Paraino. Again, thank you for your interest in Ameren, and have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 1 | 2,021 | 2021-05-11 10:00:00 | Operator: Greetings and welcome to Ameren Corporation's First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to turn the conference over to your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you and good morning. On the call with me today are Warner Baxter, our Chairman, President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer, as well as other members of the Ameren management team joining us remotely. Warner and Michael will discuss our earnings results and guidance, as well as provide a business update, then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of this presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions, and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued today and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation included earnings guidance are presented on a diluted basis unless otherwise noted. And here’s Warner.
Warner Baxter: Thanks, Andrew. Good morning, everyone, and thank you for joining us. I hope you, your families and colleagues are safe and healthy. Before I begin my discussion about first quarter results and related business matters, I want to begin with a few COVID-19. It is hard to believe that we have now been addressing the challenges associated with this pandemic for over a year now. Needless to say, much has changed. However, one thing that has not changed is our relentless focus on delivering safe, reliable, cleaner and affordable electric and natural gas service for the millions of people in Missouri and Illinois that are depending on us. As I said during our year-end conference call in February, despite the significant challenges presented by COVID-19, I look to the future with optimism. In part, this was due to the aggressive distribution of vaccines throughout our country. I'm pleased to say that we are beginning to see the fruits of the incredible efforts by so many in the health care, government, public and private sectors. COVID-19 cases are down significantly from earlier in the year and restrictions have lessened. As a result, we are clearly seeing signs that the economy is improving on our service territory and across the country. Optimism was also driven by how our co-workers have consistently stepped up and addressed a multitude of challenges and capitalized on opportunities and the strong execution of our strategy that is delivering value to our customers, communities and shareholders. Together, these factors contributed to our ability to get off to a strong start in 2021, which brings me to a discussion of our first quarter results starting on Page 4. Yesterday, we announced first quarter 2021 earnings of $0.91 per share compared to earnings of $0.59 per share in the first quarter of 2020. Year-over-year increase of $0.32 per share reflected increased infrastructure investments across all of our business segments that will drive significant long-term benefits for our customers. The key drivers of first quarter results are outlined on this slide. I'm also pleased to report that we continue to effectively execute our strategic plan and remain on track to deliver within our 2021 earnings guidance range of $3.65 per share to $3.85 per share. Michael will discuss our first quarter earnings, 2021 earnings guidance and other related items in more detail later. Moving to Page 5, here we reiterate a strategic plan. The first pillar of our strategy stresses investing in and operating on our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers. As a result, and as you can see on the right side of this page, during the first three months of this year we invested significant capital in each of our business segments including our investment in wind generation. Regarding regulatory matters in late March Ameren Missouri filed a request for a $299 million increase in annual electric service revenue with the Missouri Public Service Commission. In addition, Ameren Missouri filed a request for a $9 million increase in annual natural gas revenue with the PSC. While Michael will discuss the details of the request at a moment, I'd like to briefly touch on some of the key benefits, our electric and natural gas customers in Missouri are seeing as a result of the investments reflected in these rate requests. We are now in the third year of the Ameren Missouri’s Smart Energy Plan, which is focused on strengthening the grid, infrastructure upgrades, adding more renewable generation and creating programs to stimulate economic growth for communities across the state. Our grid modernization investments incorporates smart technology including outage detection and restoration switches as well as smart meters, which allow customers to take advantage of new rate options. These investments are delivering results to improve reliability and resiliency. For example on circuits with new smart technology upgrades, we have seen up to a 40% improvement in reliability. Of course, we also remain committed to a clean energy transition for our customers and state. This is demonstrated through our recent acquisitions of two wind generation facilities located in Northern Missouri totaling 700 megawatts. In addition, our investments are stimulating economic growth for communities across the state. I’m pleased to say that 57% of Ameren Missouri suppliers in 2020 were Missouri-based and 32% of its sourcebook capital spend was with the first suppliers. And we're doing all of these things while keeping our customers electric rates approximately 20% below the average and other Midwest states and across the country. At the same time, we remained very disciplined in managing our costs. As a result, if approved, the new electric rate requests represent a 5.4% total increased over an almost five year period, yearly average of approximately 1%. We will remain disciplined in managing our costs while we build a stronger, smarter and cleaner energy system for our customers now and in the future. Moving now to Ameren Illinois regulatory matters. In January, we received the constructive rate order from the ICC that resulted in a $76 million annual increase in gas distribution mix. New rates went into effect in late January. In our Illinois Electric Business, we made our required annual electric distribution make filing requesting a $64 million base rate increase. This filing is only the second requested increase in delivery service rates in six years. While Michael will touch on the details of our filing a bit later, I think it is important to note that for years, our Illinois customers have realized the benefits of our significant investments in energy infrastructure. This performance-based rate making began in 2012. Reliability has improved by 20% and over 1,400 jobs have been created. At the same time, electric rates are among the lowest in the country and Midwest approximately 3% below 2012 levels. This performance-based framework has been a win-win for our customers and the state of Illinois. That is why we continue to strongly advocate for performance-based regulatory framework in the Illinois legislature, which brings me to our discussion of the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies on page six. As I discussed in our conference call in February, an enhanced version of the Downstate Clean Energy Affordability Act legislation was filed earlier this year which if passed would apply to both the Ameren Illinois Electric and Natural Gas Distribution businesses. This legislation would allow Ameren Illinois to make significant investments in solar energy, battery storage, and electric and gas infrastructure to continue to enhance safety and reliability as well as in the transportation electrification in order to benefit customers in the economy across Central and Southern Illinois. This important piece of legislation would also require a diverse supplier spend reporting for all electric renewable energy providers. Another key component of the Downstate Clean Energy Affordability Act is that it would allow for performance-based rate making for Ameren Illinois’ natural gas and electric distribution businesses to 2032. The proposed performance metrics will ensure investments are aligned with and are contributing to the safety and reliability of the energy grid and natural gas systems, as well as the state's vision for the transition to clean energy. Further, this legislation would modify the allowed return on equity methodology in each business to align with the average returns being earned by other gas and electric utilities across the nation. And as I noted a moment ago, this legislation builds on Ameren Illinois' efforts to invest in critical energy infrastructure under a transparent and stable regulatory framework that has supported significant investment, improved safety and reliability, and created significant new jobs, all while keeping electric rates well below the Midwest and national averages. This bill would also move the State of Illinois closer to reaching its goal of 100% clean energy by 2050. With all of these benefits in mind, we are focused on working with key stakeholders to get this important legislation passed. To-date, the Downstate Clean Energy Affordability Act has received strong bipartisan support from members of the Senate and House. Currently, House Bill 1734 has 49 sponsors, and Senate Bill 311 has 21 sponsors. As I'm sure you know, there are also several other energy-related bills being considered by the legislature. We will continue to be actively engaged with key stakeholders throughout the legislative session on these important energy policy matters. The spring session is currently set in May 31. Turning to Page 7 for an update on FERC regulatory matters, In April, FERC issued a supplemental notice of proposed rulemaking on the electric transmission return on equity incentive adder for participation in a Regional Transmission Organization or RTO. In the supplemental notice, the firm proposes to limit the duration of the 50 basis point ROE incentive adder for companies that join an RTO to three years. FERC also proposes to eliminate the adder for utilities that have been part of an RTO for three years or more, which would include Ameren Illinois and ATXI. Without this incentive adder Ameren Illinois and ATXI would earn the current allowed base ROE of 10.02%. For perspective, every 50 basis point change in our FERC ROE affects annual earnings per share for approximately $0.04. Needless to say, we are disappointed with the direction the FERC has taken in the supplemental notice and strongly oppose the removal of the adder. From our perspective, our job participation adder is needed to compensate companies for assuming risk associated with turning over operational control of assets to the RTO. The proposals also inconsistent with the first stated policy goals and the intent of existing amount to encourage our RTO participation. We will continue to advocate for the RTO incentive adder and other project incentive adders proposed in the March 2020 NOPR. We will file comments on the supplemental NOPR by the May 26 deadline. Of course we are unable to predict the ultimate outcome or timing of this matter as the focus under no timeline to issue a decision. Moving now to Page 8, policy matters are important because transmission investment is going to play a critical role in a country's clean energy transition. As we have discussed before, myself and other key stakeholders including Ameren have been carefully assessing the transmission needs in the MISO footprint to ensure the overall reliability and resiliency of the energy grid is maintained. Our companies execute their clean energy transition plans. Recently, MISO published several reports that outline some of the preliminary thoughts on MISO’s transmission needs in the future. This page summarizes a recent study that outlines a potential road map of transmission projects to 2039, taking into consideration the rapidly evolving generation mix that includes significant levels of renewable generation based on announced utility integrated resource plans, state mandates, and goals for clean energy indoor carbon emission reductions, among other things. I would also note that MISO in the Southwest Power Pool are also working together to develop a similar evaluation of transmission needed to support the transition across both regions. The bottom line is that significant regional and local transmission investments will be needed for the clean energy transition over the next 10 to 20 years. For example, under MISO’s future one scenario which is a scenario that resulted in an approximate 60% carbon emission reduction below 2005 levels by 2039, MISO estimates future transmission investment could amount to an estimated $30 billion in the MISO footprint. Further, future three resulted in an approximate 80% reduction in carbon emission levels below 2005 levels by 2039. MISO has estimated future three could result in an estimated $100 billion of transmission investment in the MISO footprint. We provide some context to this. During MISO’s last regional transmission planning process, approximately $6.5 billion of multivariate project investments were made over the last 10 years or so. In light of the continued focus on the clean energy transition in our country, we are actively working with MISO and other key stakeholders to move the assessment and project approval process along, with an appropriate sense of urgency to ensure we maintain a safe, reliable, and resilient energy grid and do so in an affordable fashion. Given our past success in executing large regional transmission projects, we believe we are well positioned to plan and execute potential projects in the future for the benefit of our customers and country. We believe certain projects outlined in Future 1 will be included in this year's MISO transmission planning process, which is scheduled to be completed in the fourth quarter of 2021. We look forward to working with MISO and key stakeholders on this important planning process. Speaking of clean energy transitions, let's move now to Page 9 for an update on our $1.1 billion wind generation investment planned to achieve compliance with Missouri's renewable energy standard through the acquisition of 700 megawatts new wind generation at two sites in Missouri. Ameren Missouri closed on the acquisition of its first wind energy center, a 400-megawatt project in Northeast Missouri in December. In January, Ameren Missouri acquired its second wind generation project, the 300-megawatt Atchison Renewable Energy Center located in Northwest Missouri. Approximately half the megawatts of the Atchison Renewable Energy Center are in service. We expect the remaining megawatts to be placed in service by September 30. Turning now to Page 10 and an update on Ameren Missouri's Callaway Energy Center. During its return to full power as part of its 24th refueling and maintenance outage in late December 2020, Callaway experience a non-nuclear operating issue related to its generator. At their own, investigation of this matter was conducted, and the decision was made to rewind the generator stutter and router in order to safely and sustainably return the energy sector to service. The project is going well and we continue to expect the capital project to cost approximately $65 million. I am also pleased to report that the insurance claims within the capital project and replacement power have been accepted by insurance carrier, which will mitigate the impacts of this outage for our customers. We expect the Callaway Energy Center to return to service in July. As we have said previously, would you not expect this man to have a significant impact on Ameren financial results. Turning the Page 11, we are focused on delivering a sustainable energy future for our customers, communities, and our country. This page summarizes a strong sustainability value proposition for environmental social and governance matters and is consistent with our vision, leading the way to a sustainable energy future. I have discussed several elements of our strong sustainability value proposition with you in the past. So, in the interest of time, I will not go through all of these points again this morning. Having said that and moving to Page 12, you should know that we have already made significant progress in our sustainability efforts in 2021. Here, we highlight several key achievements to date this year. Beginning with environmental stewardship last September, Ameren announced his transformational plan to achieve net zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes strong interim carbon emission reduction targets at 50% and 85% below 2005 levels in 2013 and 2014 respectively. This plan is also at the heart of our updated climate risk report, which is based on the recommendations of the task force on climate-related financial disclosures which were issued last week. I am pleased to report our plan is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. In terms of social impact, I am very excited to say that our efforts in this area continue to be recognized by leading organizations. Last week, Diversity, Inc. announced Ameren is once again named number one on the top utilities list with diversity and inclusion, which we have been proudly a part of since 2009. Diversity, Inc. also ranked Ameren second on the top 10 regional companies and as a top company for ESG among all industries. In addition, for the fifth year overall, we've been certified by a great place to work. And finally, we are recognized as the best place to work for LGTBQ but in Human Rights Campaign. Moving to governance, our board and management have established governance structures that enable a focus on the ESG matters that drive Ameren strategy, mission, and vision, including the addition of ESG metrics to drive executive compensation programs. In particular, our board of directors refined our executive compensation program by adding workforce and supplier diversity metrics to our short-term incentive plan for 2021. In addition, we recently issued several social impact policies. Since our call in February, we've also issued several reports reflecting our sustainability efforts and advances. Just last week we posted our 2021 Sustainability Report, which expands a mini ESG and sustainability topics and posted the 2020 ESG sustainability template. And for the first time, we publish information using the Sustainability Accounting Standards Board reporting framework and mapped our business activities to the United Nations Sustainable Development Goals. I encourage you to take some time to read more about our strong sustainability value proposition. You can find all of our ESG related reports at amereninvestors.com. Turning now to Page 13. Environmental stewardship, social impact and governance are three pillars of our strong sustainability value proposition. Our final pillar is sustainable growth. Looking ahead, we have a strong sustainable growth proposition which will be driven by a robust pipeline of investment opportunities of over $40 billion. Over the next decade it will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter and cleaner. Importantly, these investment opportunities exclude any new regionally beneficial transmission projects that I described earlier, all of which would increase the reliability and resiliency of the energy grid as well as enable additional renewable generation projects. In addition, we expect to see greater focus from a policy perspective on infrastructure investments to support the electrification of the transportation sector. Our outlook to 2030 does not include significant infrastructure investments for electrification at this time either. Of course our investment opportunities do not only create a stronger and cleaner energy grid to meet our customers’ needs and exceed their expectations but they will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future and a safe, reliable and affordable fashion will be critical to meeting our country's future energy needs and delivering on our customers’ expectations. Moving to Page 14. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2021 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our five year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2021 to 2025. This earnings growth is primarily driven by strong weight based growth and compares very favorably with our regulated utility peers. Importantly, our five year earnings and rate base growth projections do not include 1,200 megawatts of incremental renewable investment opportunities outlined in Ameren Missouri's integrated resource plan. Our team continues to assess several renewable generation proposals from developers. We expect to file this year with the Missouri PSC for certificates of convenience and necessity for a portion of these planned renewable investments. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experience and dedicated team to get it done. That fact, coupled with our sustained past execution of our strategy on many fronts, this position as well for future success. Further, our shares continue to offer investors a solid dividend, which we expect to grow in line with our long term earnings per share growth guidance. Simply put, we believe our strong earnings and dividend growth outlook results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today now we’ll now turn the call over to Michael.
Michael Moehn: Thanks, Warner and good morning, everyone. Turning now to Page 16 of our presentation. Yesterday, we reported first quarter 2021 earnings of $0.91 per share compared to $0.59 per share for the year ago quarter. Earnings at Ameren Missouri, our largest segment increased $0.22 per share due to several favorable factors. The earnings comparison reflected new electric service rates effective April 1, 2020 which increased earnings by $0.10 per share. In addition, earnings benefited from lower operations and maintenance expenses which increased earnings $0.07 per share. This was primarily driven by the absence of an unfavorable market returns that occurred in 2020 on the cash surrender value of our company-owned life insurance as well as disciplined cost management. Earnings also benefited by approximately $0.04 per share from higher electric retail sales driven by near-normal winter temperatures compared to milder-than-normal winter temperatures in the year-ago period. We have included on this page the year-over-year weather normalized sales variances for the quarter that showed total sales to be comparable with Q1 2020, which was largely unaffected by COVID-19. We continue to see improvements in sales as schools and businesses reopen and begin to increase their levels of operation. Earnings were positively impacted by the timing of income tax expense, which we do not expect to impact full-year results, as well as the absence of charitable donations that were made pursuant to the Missouri rate review settlement in March 2020. And finally, these favorable factors were partially offset by the amortization of deferred expenses related to the fall 2020 Callaway Energy Center’s scheduled refueling and maintenance outage. Moving to other segments, earnings for Ameren Illinois natural gas were up $0.08 reflecting higher delivery service rates that were affected January 25, 2021, incorporating a change in rate design as well as the increased infrastructure investments and a lower allowed ROE. The first quarter of 2021 benefit from the change in rate design is not expected to impact full-year results. Ameren Illinois electric distribution earnings increased $0.03 per share which reflected increased infrastructure investments and a higher allowed ROE on a performance base rate-making of approximately 8.15% compared to 7.45% for the year ago quarter. Ameren Transmission earnings were comparable year-over-year which reflected increased infrastructure investments that were offset by unfavorable $0.03 impact of a March 2021 FERC order. This order related to an intervenor challenge regarding the historical recoveries of material and supplies inventories and rates and will have no impact on the current formula rate calculation prospectively. And finally, Ameren Parent and Other results were down $0.0 per share compared to the first quarter of 2020 due to increased interest expense resulting from higher long term debt outstanding offset by the timing of income tax expense, which is not expected to impact full year results. Finally, 2021 earnings per share reflected higher weighted average shares outstanding. Before moving on, I'll touch on sales trends in Illinois electric distribution in the quarter. Weather normalized kilowatt hour sales to Illinois residential customers increased 1.5%. And weather normalized kilowatt hour sales to Illinois commercial and industrial customers decreased 1.5% and 2.5%, respectively. Recall that changes in electric sales in Illinois no matter the cause do not affect our earnings since we have full revenue decoupling. Turning to Page 17, I would now like to briefly touch on key drivers impacting our 2021 earnings guidance. We're off to a strong start in 2021 as Warner stated, we continue to expect 2021 diluted earnings to be in the range of $3.65 to $3.85 per share. Select earnings considerations for the balance of the year are listed on this page and a supplemental to the key drivers and assumptions discussed in our earnings call in February. I'll note that our second quarter earnings comparison will be negatively impacted due to a seasonal rate design change effective for 2021 in Ameren Missouri as part of the March 2020 electric rate order. This order called for winter rates in May and summer rates in September rather than the blended rates used in both months in 2020. The second quarter results were also being negatively impacted by the absence of the impact of the 2024 FERC order approving the MyCelx-allowed base are we at Ameren Transmission. Together, these two items are expected to reduce second quarter earnings by approximately $0.25 year-over-year. I encourage you to take this into consideration as you develop your expectations for our second quarter earnings results. Turning now to Page 18, here, we outline in more detail our recently filed Missouri electric rate review that Warner mentioned earlier. This reflects many benefits including major upgrades, the electric system reliability and resiliency for customers as well as investments to support the transition to a cleaner energy for the benefit of customers and local communities. Now, let me take a moment to go through the details of this filing. The request includes a 9.9% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $10 billion. This includes a test year into December 31, 2020 with certain pro-forma adjustments through September 30, 2021. The requests include a continuation of the existing FAC and other regulatory mechanisms along with a request to recover certain costs associated with the Merrimack Energy Center which is expected to retire in 2022 over a five-year period from the date of the new rates become effective. As outlined in this page, the key drivers of our $299 million annual rate increase include increased infrastructure investments made under Ameren Missouri smart energy plan, impact of the transition to a cleaner generation portfolio, decrease weather normalized customer sales volumes and a higher pension, OPEB, and tax harmonization expenses, partially offset by lower operation and maintenance expenses. Moving to Page 19 for an update on other Ameren Missouri regulatory matters. In March 2021, we also filed a natural gas rate review. The details for the $9 million annual revenue increase request are outline on this page. We expect the Missouri PSC decision in both our electric and natural gas rate reviews by February 2022 with new rates expected to be effective by March. Further, last October, we filed a request with the Missouri PSC to track and defer in a regulatory asset certain COVID-related costs incurred net of any COVID-related costs savings. In March 2021, the Missouri PSC approved this request. $9 million of net costs were incurred through March 31, 2021. We recognized $5 million in the first quarter of this year and expect the remaining portion relating to late fees to be recognized when realized and rates beginning in early 2022. The timing to recover these costs will be determined as part of our pending electric and gas rate reviews. Moving now to Page 20 for an update on Ameren Illinois regulatory matters. Last month, we made our required annual electric distribution performance-based rate update file and requesting a $64 million base rate increase. Under Illinois performance-based rate making, Ameren Illinois is required to make annual rate updates to systematically adjust cash flows over time for changes and costs of service and a true of any prior period over or under recovery of such cost. Since this constructive framework began, Ameren Illinois has made prudent investments to strengthen the grid and reduce outages and continues to do so. Major investments including the request or the installation of outage avoidance and detection technology. Major investments, including the request, are the installation of outage avoidance and detection technology; integration of storm-hardening equipment; adoption of clean energy technologies; and the implementation of new energy efficiency measures, including mobile-enhanced communications and assessment capabilities for electric field workers. The ICC will review our request in the months ahead, with a decision expected in December of this year and new rates effective in January of next year. Turning to Page 21 for a financing and liquidity update, we continue to feel very good about our liquidity and financial position. In February, Ameren Corporation issued $450 million of 1.75% senior unsecured notes due in 2028. The proceeds were used for general corporate purposes, including to repay short-term debt. We also expect both Ameren Missouri and Ameren Illinois to issue long-term debt in 2021. In addition, as we mentioned on the call in February, during the quarter, we physically settled the remaining shares under our forward equity sales agreement to generate approximately $150 million - $115 million. In order for us to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $150 million of additional common equity during the balance of 2021 which is consistent with the guidance we provided in February. To that end, in May, we expect to establish an at-the-market or ATM equity program to support our equity needs through 2023. This future equity issuance will enable us to maintain a consolidated capital structure consisting of approximately 45% equity over time. The incremental natural gas and power purchases incurred due to the extreme cold in mid-February this year did not have a significant impact on our liquidity or ability to fund our future operations and investment. Ameren’s available equity as of April 30 was approximately $1.3 billion, which includes $2.3 billion of combined credit facility capacity net of approximately $1 billion of commercial paper borrowings at the end of the month. Finally, turning to Page 22, we're well positioned to continue executing our plan. We're off to a solid start and we expect to deliver strong earnings growth in 2021 as we continue to successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate based growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Thanks for all the colors today, very helpful. Maybe just starting off with regards to the Illinois legislative session here, do you have any sense for the relative priority of utility issues within the overall clean energy legislation discussions? And do you see any potential for kind of a grand bargain here to be reached on energy?
Warner Baxter: Yes, thanks, Jeremy a couple of things there. One, I do think clean energy legislation is a focus for the legislature. I think just by the fact that you see so many bills that are being discussed out there and rightfully so right. The clean energy transition is obviously very important not just for Illinois, but across the country. Certainly as I said in my prepared remarks, there's no doubt that there are several bills that are being considered whether there's a grand bargain, if you will or whether these bills are put together look, it's just too early to say. The only thing I can say is this, is that we are at the table with key stakeholders trying to find a solution and to advocate for the downstate Clean Energy Affordability Act. Because as you heard me say many times, that Act that - those provisions are performance-based rate making approach has really delivered significant benefits for our customers and the entire state of Illinois. So, we have until the end of the month to try and get something across the finish line. Richard Mark and his team have been working tirelessly at that. Now to say their tireless work and the work that we've been doing for many years has already elicited strong bipartisan support. So, we're hopeful to get the proper provisions and a final piece of legislation.
Jeremy Tonet: Got it that's very helpful. Thanks.
Warner Baxter: Sure.
Jeremy Tonet: Maybe pivoting over to transmission, it seems like an exciting time for transmission, if you will. And do you have any sense of the magnitude of specific projects that could be identified by MISO before year-end or in the not too distant future? And what do you see separately as the potential for large scale HVDC transmission opportunities outside or beyond the MISO process. And then finally, I guess with transmission trying to scale the opportunity set here? So I'm wondering if you could help us think through roughly how much CapEx did Ameren deploy over the years where MISO brought renewable penetration from very little to the high levels that is today. Is there any rules - any kind of measures we can think of like $10 billion to accommodate 10%. Just trying to scale the opportunity set here?
Warner Baxter: Jeremy, lots to unpack there. Let me see if - I'll try to respond to those things, and Michael and Andrew will help me if I haven’t hit a point, but certainly come back on. Let me answer your first question - your last question perhaps first. As I said in my prepared remarks, there's about $6.5 billion of regional transmission projects that really were deployed across the MISO footprint over the last decade, if you will. We did about $2 billion of that. Now that doesn't mean - there is a different time, different place. But obviously we did 25%, 30%, almost of those, and it's because of our location in the MISO footprint. And so that's just number one. Two, what you said at the outset, I agree with. It is a very exciting time to be in the transmission business and especially one in the MISO footprint. When you're sitting in the center of the country, what MISO does with its transmission is integral to the clean energy transition for our country. And so, what you're seeing today is obviously - is a preliminary list of projects that were informed certainly by stakeholder conversations, as well as integrated resource plans and state energy policies, among many other things. It's hard to say just exactly what will ultimately come out of, let's just call it, the transmission plan that will be filed later this year. But the way we look at it and we look at that Future 1 which we showed on that slide, we think that there are a lot of projects contained in that that we think are really kind of no regrets types of projects. It's premature to put a number on it and which projects will go. Because what MISO does now is now they've put out this road map, they are basically looking for input from stakeholders. And so, you can expect throughout 2021 stakeholders will be providing input into that road map. And with that input, MISO will ultimately prepare their long-range plan, their MTEP is what they call it. And we expect that to be filed in the fourth quarter. Ultimately, a process from there Jeremy has been some more input. But ultimately, the MTEP is put before the MISO Board of Directors for vote and hopefully approval by the end of the year. So, it's not too far away but that future one is, I would say, the first step. But then as you look beyond that, as we said in future three, obviously those investments continue to grow over time. And as we said, they range from $30 billion to $100 billion. Those are MISO’s preliminary estimates that will continue to be refined. So hopefully that gives you some of the sense. I'm not sure if I missed, if I addressed all of your questions in there. But I think I got them all there.
Jeremy Tonet: I think that’s very helpful. But maybe just to follow-up, anything on that HVDC front where Ameren might have a bit more leverage.
Warner Baxter: It's a little premature to say that. These are things we look at. Obviously there is some opportunities that we're looking at even in connection with the Missouri Integrated Resource Plan. So a little early to be making those kind of judgment calls, but stay tuned.
Jeremy Tonet: And if I could just do one quick last one, as far as what's coming out of the Biden infrastructure plan, early stages here, but is there anything that you are focused on? Do you see investment upside or benefits from lower ratepayer cost or anything else that could really kind of get things moving with the transmission kind of permitting, paying, planning process here?
Warner Baxter: Sure, well I will say one thing that we are encouraged by in terms of what the Biden administration has done. It’s number one. They're very focused on providing significant funding for new clean energy technologies which we think is going to be so important for our industry, for our country to get to a net zero carbon future by 2050 which is certainly our goal. I think the other thing that you're seeing is you understand. Why you put out a bill that really has some - I think some very good incentives to invest in clean energy technologies and those incentives range from tax credits. They range from tax normalization policies to give opt out provisions. They include tax credits also for transmission. And so, we look at the provisions that build on that. I won't go through all the details here. That bill will really have a direct impact on the overall cost to our customers. And so, we're obviously very encouraged and enthused about that so, a lot going on in Washington DC. We're at the table working with the stakeholders. And we are hopeful that we will continue to see progress and incentives for clean energy technologies here in the next several months.
Operator: Our next question is from Shar Pourreza with Guggenheim Partners. Please proceed with your question.
Shar Pourreza: Just a - good excellent so, just a quick follow-up on Illinois, if something doesn't pass in the next couple of weeks, Warner, do you sort of intend to push over the summer. What are your thoughts on getting something done during the veto session? I know there's obviously a lot of competing interests, there's a lot of bills? You highlighted that. Some of them are outside of energy, there’s new legislators and politicians. So, there's also a question mark with many of energy is even a priority right now. So, just trying to get a bit of a sense if something doesn't get done in two weeks, how do we sort of price this in the veto session?
Warner Baxter: Sure, Shar, one of the things as you talk about veto session in Illinois. And Illinois is a bit unique, perhaps, compared to other states whereby the veto session isn't really just there to address bills that have been vetoed but also can address bills that have been presented during the regular session. So to be clear, I'll say this first, we are very focused on trying to get something across the finish line for the benefit of our customers in the State of Illinois on energy policy here by May 31. But your question is what, what if it doesn't happen here in the next several weeks? Well then it could be brought up in the veto session. And our approach would be very much of what we've been doing. We will continue to strongly advocate for the Downstate Clean Energy Affordability Act. And the reason why we will continue to strongly advocate for it is because it has strong bipartisan support. We have House bills and Senate bills with strong bipartisan support as well as supporters from north and the south part of the state. And so, we're going to continue to push for that because we - strongly believe it's the best policy going forward for the state of Illinois. It isn't just because we believe it, it’s because it been delivering results for almost a decade now. And that's why we're going to continue to advocate for. So, I do think people say whether it's a priority, I will tell you there are conversations going on in the state of Illinois around energy policy. So, I know they have other priorities that they have to balance but I do believe energy policy is one of them.
Shar Pourreza: And just lastly shifting maybe south, obviously it's not a major priority for you guys are essential to current growth plan that obviously you're re-highlighting today. But any thoughts on securitization, legislation as it makes its way through the chambers. Any sort of expectations you can provide as we get to the homestretch?
Warner Baxter: Well, we are - we're in the homestretch in the state of Missouri at the end of this week. And Marty Lyons and his team have been working hard on that. And we provided some perspectives but Marty you have been in the middle of that. I'm just going to turn over you. Maybe give us the latest update if you don't mind.
Martin Lyons: Sure, Warner. Yeah, you're absolutely right. Securitization isn't something that we see is required to isn't something that we see as required to be able to carry out our integrated resource plan. But we do think it would be a good tool to have in the toolbox of the commission especially as crafted in Missouri. So you're right. There have been aversions going through the House and the Senate. They're very, very similar at this point. Last night, actually, the Senate passed the House securitization bill which is HB734 and they did make some slight modifications to that. So, now, that goes back to the house to the fiscal review committee and we'll see whether that can be then voted on in the House. We may see actually some action as early as today. But in any event what has to happen over the remainder of the week is that the language needs to get conformed between the two, the Senate bill, the House bill. Like I said, they're very, very similar at this point and ultimately needs to be passed by the end of the week. As Warner indicated, the legislative session ends on May 14th this Friday - this Friday afternoon. So, in any event, we're very close. Can't predict whether it'll actually get done, but it's really positioned pretty well for success. So we'll keep our fingers crossed for the remainder of this week.
Shar Pourreza: And just - Marty, just assuming you get securitization, obviously, this is the messages you don't need it for the IRP but curious if you get securitization, is there an acceleration of the plan under the IRP or any opportunities to potentially accelerate the plan?
Martin Lyons: No, there's really no change to the integrated resource plan. When we filed that last September, we filed it believing that it was the most affordable process and most reliable process for transitioning our fleet over time. And so we stand by the integrated resource plan that we filed. Of course, we've been getting comments on that. We expect that ultimately the Getting comments on that. We expect that ultimately the commission will rule on whether that process that we went through was appropriate. We certainly believe it was. And it would only be through consideration of changes that might occur over time that would cause us to modify the IRP. We still believe the preferred plan that we filed as the appropriate pass. Securitization passes, there would not be any immediate impact on the integrated resource plan. But like I said, conditions change through times. And we do believe having securitization in the toolkit of the commission would be a good thing to have.
Operator: Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Julien Dumoulin-Smith: You guys have a lot on your plate and congrats on continued success in de-risking?
Warner Baxter: You bet.
Julien Dumoulin-Smith: I would say, I would say - I mean Warner you made some interesting comments on transmission earlier. I would ask obviously the future one, two and three have big numbers long timelines and you've already tried the pieces part but how would you characterize this current MTF as best you see it coming together against some of those bigger projects? How much should we be expecting here, right? If you want to just sort of start to set expectations initially considering that obviously you think long queue is?
Warner Baxter: Yes. Julien so, a couple comments there. It is really premature to really say exactly which of those projects will ultimately show up in the MTEP. I think myself did a fine job of putting together this long range plan which gives us collectively an opportunity to weigh in on it and to try and keep really our finger on the pulse of all the things that are going on around the country, not just in the states but around the country. So it just is too premature. But I will say this, that we, as well as MISO and other stakeholders, there is a sense of urgency to address this, these matters because we see the clean energy transition coming, and we know that transmission is critical to its success. And so, consequently, there's a significant amount of interest, a significant amount of work being done. And so we're not too far away from really hearing what that's going to be. The fourth quarter is really, for all practical purposes, right around the corner. And as you know, some of these projects, as you said, they take time to plan, get approval, and ultimately to execute. So, again, as we see this, and I've said this in the past, it's really just - the study really is consistent with what we've been talking about really for the last several years. We see significant transmission opportunities, and should they come in the form of this MTEP or otherwise, we think they're probably, if there are any, would come towards the back-end of our five-year current capital expenditure plan, but especially in the second half of this decade, you see some of these transmission projects really come to fruition. And as I’ve said before, we're well positioned, well positioned to execute on many of those projects. So we're looking forward to it.
Julien Dumoulin-Smith: Got it. Excellent. Sorry to follow up on legislation very narrowly here. How do you see the potential of moving into June versus the end of May? I know there's some latitude issue there. And then also, more importantly, the contrast of a grand bargain would be potentially carving out this issue in the sunset, the question on the utility front separately from anything bigger. Is that conceivable in your mind, or does this need to be a bigger deal as far as you're concerned?
Michael Moehn: Julien, Michael here. I’m not sure we caught your whole question. You're talking about moving from outside of the May 31 ending the session into June, so like of our special session?
Julien Dumoulin-Smith: Yes, exactly. It was my specific question.
Michael Moehn: Okay. Illinois legislature?
Warner Baxter: Illinois legislature.
Michael Moehn: I’m sorry. It was a little faint. Look, like everything else. We certainly can't predict whether there would be a special session of sorts in the Illinois legislature. As I said before, we're focused on the spring session in May 31 and should that not bear fruit within, we'll see where the next steps are. And then we talked a little bit earlier about the veto session. So premature to speculate whether a special session would be called.
Julien Dumoulin-Smith: Fair enough. But you don't need to necessarily get this grand deal to get this sunset - the sunset address.
Michael Moehn: No. I'm sorry. Thank you. No, at the end of the day, so just to be clear - this expires in 2022, right. So this is not a piece of legislation has to be done this year. It expires in 2022. And let's not forget that the overall regulatory framework that we have which we’d go to now has some things in there that are solid as a forward test year as decoupling bad debt writers and those other things and return on equity that will be done in the normal course of return on equity setting and by the Illinois Commerce Commission. And so, bottom line is this. Now we strongly believe that the Downstate Clean Energy Affordability Act and all the provisions in there are clearly - are in the best interest of our customers in the state of Illinois. We're going to continue to advocate for that. But it doesn't have to be done here in the next week or the veto session. But having said that, we think having that certainty and sustainability is the right way to go. That's why we're pushing for it.
Operator: Our next question comes from Durgesh Chopra with Evercore ISI. Please proceed with your question.
Durgesh Chopra: Just Michael, quick clarification on the equity, in Q4 you said, you guys said $300 million a year to 2025, the ATM goes through 2023. Is still $300 million per year, a good sort of number to model till 2025?
Warner Baxter: Yes, I appreciate the question, yes. So, if you go back to February, yes the same, the same metrics that we gave, we're doing $150 million here in 2021 and then $300 million 2022, through 2025. All of those assumptions still stand today. And this ATM is going to allow us to execute against that.
Durgesh Chopra: Understood. Thank you. And then maybe just - I want to get into a little bit of detail on the, on the Missouri securitization. Warren I’m just clearly, you assume it doesn't impact your IRP, could sort of your assets be at risk? I'm thinking about early retirement of coal plants, the capacity factors of your generation assets and whether sort of the legislation now sort of accelerates the recovery of coal plants and impacts the rate base growth profile. Just any color there would be great. Thank you, Warren.
Michael Moehn: Yes. Thank, Durgesh and I’ll have Marty weigh in at the moment. Look as we've said before, we're very fortunate. We have a strong baseload coal fleet that runs, that runs a lot. And it's because of you know some of the actions and things we've done really over the past several years, decades frankly. And so, we laid out our integrated resource plan and you see that systematically, we are retiring our coal fired energy centers over time. And it's because number one, we think it's in the best interest of our customers from a reliability and affordability perspective. And so, as Marty said, we don't see that changing. But conditions could change, right, whether it's at the state level or federal level. And so securitization is not going to drive us to do anything different other than absent changes that may happen, as I said, from a policy perspective or otherwise. But it is a good tool to have in our toolbox, should those changes occur. So we - our coal plants are valuable assets to us today. Over time, we will retire them. But we don't see any near-term changes to how we plan on operating or certainly risks to those assets. Marty, would you have anything to add to that?
Martin Lyons: Well, first, I firmly agree with everything that you conveyed. And when you look at the integrated resource plan that we filed, we've got four coal-fired energy centers. As Warner said, we've got very efficient coal plants. They operate very well. But with that said, in our integrated resource plan, we did lay out that we're retiring our Meramec facility here in 2022. We expect that that will be fully recovered at that point in time. We did propose the accelerated closure of both the Sioux and the Rush Island plants, Sioux by about five years and Rush Island by about six years. So Sioux would close in 2028, Rush Island in 2039, and then Labadie, which is our largest plant and most efficient plant, would close in two stages in 2036 and 2042. So, again, we've accelerated the expected closure of two of our plants, and those accelerations and the recovery of those are actually reflected in the rate review filing that we made here in March. So we're looking to accelerate the recovery of those plants. And then of course the rates are also positively impacted by the expectation of Meramec closing. So, those things are reflected there. That's historically the way we've handled things in Missouri. And again as Warner said, when we filed the IRP we made a host of assumptions. Conditions can change and vary from the assumptions that we made through time for a variety of reasons. And as I said before, securitization is not going to change the integrated resource plan, preferred plan that we have today. But if conditions change versus the assumptions we've made through time, again securitization will be a good tool to have in the tool box.
Durgesh Chopra: Understood. Appreciate the color. It sounds like it's more of an opportunity than a risk for you guys. Thanks for taking my question.
Warner Baxter: You bet. Thank you.
Operator: Next question comes from Stephen Byrd with Morgan Stanley. Please proceed with your question.
Stephen Byrd: Lot's been covered in Q&A. I guess I was stepping back and thinking about kind of key areas of growth upside for you all over - I mean you have a very impressive growth plan as it is, but thinking especially about incremental renewables, elements of your IRP but just other dynamics. And just wanted to step way back and think about those kind of key categories of additional growth upside and wonder if you could just comment on that?
Warner Baxter: You bet. You bet. Well, I think there are a couple of them one, we've - probably more than a couple frankly there are several. And one, we talked quite a bit about already today and that's transmission. So as you know we present investment opportunities for 2030 of $40 billion plus of investment opportunities. And one of the reasons we put that plus there is because transmission. So that $40 billion number that we have of investment opportunities does not include any of the regional transmission projects that we've spent quite a bit of time talking about already. So, Stephen, that would be certainly one meaningful upside to our investment profile that we have prospectively. A second one and another one that we've talked about - and again, I mentioned this a little bit earlier. Is electrification and the infrastructure that has to go for the greater electrification especially for the transportation sector in our country. Now, our long-term plan has really no meaningful investments associated with the electrification of the, transportation sector and as you listen to the policymakers discuss the need for a cleaner energy transition in this country and lower carbon emissions. Well, the transportation sector is the greatest carbon emitter in our country today. And so, you've heard certainly the automakers and others continue to lean further in. Well, we're going to lean further in, too, and we have been. And so, I think that, too, is a significant opportunity. But I'll tell you, just to be clear you know what I’ve done with all of our investments in grid modernization. We need to continue to make investments in the grid both in Missouri and Illinois to make sure that the grid continues to be reliable and resilient. So, as we look at those investment opportunities which could also then include renewable - greater levels of renewable energy over time, we have quite a bit in there. But times as we said could change if policies change those two could be investment opportunities. I didn't put a specific number on those. But they're sizable. They're sizable. And so, we see our robust infrastructure plan that we have already today continuing for some time.
Stephen Byrd: Really helpful. And then maybe just one additional question on transmission, a lot of questions already on this, but thinking about sort of FERC and FERC has their objective to eliminate barriers to executing on transmission. How do you see that factoring into the existing RTO processes? Is that more of just a long-term objective of FERC or could that yield particular impacts to the outlook for transmission growth?
Warner Baxter: Yes, thanks Steve. And yes, I would say it's a bit too early to say. To what extent, FERC will get more engage in the RTO processes, which have obviously been very well defined over the years. And whether FERC will engage in that, it's just premature to say. What I will say is that certainly the clean energy transition and the importance of policies to support that clean energy transition are important issues for we certainly as transition owners, but also for FERC. And I think Chairman Glick and the commissioners there recognize that. I think you're going to continue to see greater levels of attention and focus at FERC on things that they can do to accelerate safe, reliable, and affordable transmission build around the country.
Operator: Our next question comes from Paul Patterson with Glenrock Associates. Please proceed with your questions.
Paul Patterson: I’m well, I’m well. So a quick technical question for Marty, the Missouri securitization bill. It sounded to me that you - and I've been following it that the House version that's been amended - the House bill has been amended in the Senate and now is in the Housing Committee? If it passes out of the House without any changes, does it go straight to the governor or does it - it was a little confusing to me or does it have to be - will there have to be some changes - does it have to go back to the Senate - assuming there’s no changes made in the House?
Martin Lyons: Yes, if there are no changes made in the House, then it will go to the governor. So if they make - the Senate voted it out last night. And if the House makes no changes and votes it out then it will be done and off to the governor.
Paul Patterson: Okay, that would be nice. And then with respect to the Illinois legislation and I know this doesn't pertain specifically to you guys, but it's sort of an element I think potentially is the PGM auction. Do you think that's going to play any role in the timing here because as you know that's coming up a little bit sooner than the - at least it's beginning a little sooner than the end of the month?
Warner Baxter: This is Warner, I simply can't predict that. I really don't know. Obviously you're right. It's not something that's directly correlated to us. But obviously we keep an eye on all things that could have an impact. But let’s hope it wouldn't be appropriate for me to comment on that.
Paul Patterson: Okay. I'll leave that one alone. So the crystal ball question. So - well just moving on to very quickly on the MISO issue and the ROE ensure to being part of an RTO. If this - if FERC takes action that could be - that you perceived to be negative with respect to the transmission ROE and being part of an RTO. Is there anything we should think as being potentially an outcome from that that you guys might take - or? How should we - I mean I just noticed you guys bringing that up in the slide presentation. I just wanted to - I was wondering are you guys - is there any - how should we think about it, if they do reverse this 50 basis points or do other action that might lower the ROE?
Warner Baxter: Sure, well Paul, I mean the reason we bring it up certainly in our prepared remarks is because we believe that the potential direction that FERC is taking is inconsistent with FERC policy its inconsistent with the intention of the law. And we think right now is the time where FERC should be doing everything it can to incent companies, to join and remain in RTOs. And so we bring that up simply because of that. And certainly, we think the 50-basis-point adders, is absolutely positively appropriate for us to have because we've given up control of our system. So I think that's in the first instance. We're not trying to be any more specific than that. And that we are going to work very hard here between now and the end of the month and put together our comments like others in the industry to state our position very clearly to FERC.
Operator: Our next question comes from Insoo Kim with Goldman Sachs. Please proceed with your question.
Insoo Kim: Just one question from me and I just wanted your update on the latest on the clean air litigation regarding your Rush Island plan, I think Labadie is involved. I think you're expecting kind of a ruling from the appeals court sometime this year. Is that still on your expectation? And I guess depending on what comes out of that, if there is a - if it goes against you on the appeal side, how do you think about the next step as it relates to the timing of potential CapEx or just the state of B plans?
Warner Baxter: Sure, sure a couple things, just to refresh everyone's memory. So our argument was held in December of last year. And so, that case, and this was review case is simply before the appellate court now. We said we expected a decision this year, but I'll tell you that the appellate court has no timeline in terms of when they must issue a decision. But we would think in the normal course, we would expect to see something this year. So we simply don't know. Look - the question is whether we get an unfavorable ruling. I'll start with this. We believe we presented a very strong case to the courts in this matter in December. And then should they ultimately rule against this. We'll step back and assess what actions we need to take at that time. And so, it’s would be really premature to speculate on what actions we would take and what impact it might have on our overall plan. So, if and when we come to that we'll address that in due course. So, stay tuned is probably the best message here.
Insoo Kim: Got it? I guess in terms in relation to this current securitization bill perhaps, do you think that could provide one avenue that could help you navigate through this matter?
Warner Baxter: Certainly, as Marty stated before, securitization is a tool for several things whether it would be something that would apply here. We'll just have to wait and see. But first things first, we're focused on winning that case before the appellate court and then continue to execute the plan that we laid out before the Missouri Public Service Commission and our integrated resource plan.
Operator: We have reached the end of the question-and-answer session. At this time I'd like to turn the call back over to Andrew Kirk for closing comments.
Andrew Kirk: Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have any questions, you may call the contacts list on our earnings release. Financial analyst inquiries should be directed to me Andrew Kirk. Media should call Tony Paraino. Again, thank you for your interest in Ameren. Have a great day.
Operator: This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings and welcome to Ameren Corporation's First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to turn the conference over to your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you and good morning. On the call with me today are Warner Baxter, our Chairman, President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer, as well as other members of the Ameren management team joining us remotely. Warner and Michael will discuss our earnings results and guidance, as well as provide a business update, then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of this presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions, and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued today and the forward-looking statements and risk factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation included earnings guidance are presented on a diluted basis unless otherwise noted. And here’s Warner."
},
{
"speaker": "Warner Baxter",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. I hope you, your families and colleagues are safe and healthy. Before I begin my discussion about first quarter results and related business matters, I want to begin with a few COVID-19. It is hard to believe that we have now been addressing the challenges associated with this pandemic for over a year now. Needless to say, much has changed. However, one thing that has not changed is our relentless focus on delivering safe, reliable, cleaner and affordable electric and natural gas service for the millions of people in Missouri and Illinois that are depending on us. As I said during our year-end conference call in February, despite the significant challenges presented by COVID-19, I look to the future with optimism. In part, this was due to the aggressive distribution of vaccines throughout our country. I'm pleased to say that we are beginning to see the fruits of the incredible efforts by so many in the health care, government, public and private sectors. COVID-19 cases are down significantly from earlier in the year and restrictions have lessened. As a result, we are clearly seeing signs that the economy is improving on our service territory and across the country. Optimism was also driven by how our co-workers have consistently stepped up and addressed a multitude of challenges and capitalized on opportunities and the strong execution of our strategy that is delivering value to our customers, communities and shareholders. Together, these factors contributed to our ability to get off to a strong start in 2021, which brings me to a discussion of our first quarter results starting on Page 4. Yesterday, we announced first quarter 2021 earnings of $0.91 per share compared to earnings of $0.59 per share in the first quarter of 2020. Year-over-year increase of $0.32 per share reflected increased infrastructure investments across all of our business segments that will drive significant long-term benefits for our customers. The key drivers of first quarter results are outlined on this slide. I'm also pleased to report that we continue to effectively execute our strategic plan and remain on track to deliver within our 2021 earnings guidance range of $3.65 per share to $3.85 per share. Michael will discuss our first quarter earnings, 2021 earnings guidance and other related items in more detail later. Moving to Page 5, here we reiterate a strategic plan. The first pillar of our strategy stresses investing in and operating on our utilities in a manner consistent with existing regulatory frameworks. This has driven our multiyear focus on investing in energy infrastructure for the long-term benefit of customers. As a result, and as you can see on the right side of this page, during the first three months of this year we invested significant capital in each of our business segments including our investment in wind generation. Regarding regulatory matters in late March Ameren Missouri filed a request for a $299 million increase in annual electric service revenue with the Missouri Public Service Commission. In addition, Ameren Missouri filed a request for a $9 million increase in annual natural gas revenue with the PSC. While Michael will discuss the details of the request at a moment, I'd like to briefly touch on some of the key benefits, our electric and natural gas customers in Missouri are seeing as a result of the investments reflected in these rate requests. We are now in the third year of the Ameren Missouri’s Smart Energy Plan, which is focused on strengthening the grid, infrastructure upgrades, adding more renewable generation and creating programs to stimulate economic growth for communities across the state. Our grid modernization investments incorporates smart technology including outage detection and restoration switches as well as smart meters, which allow customers to take advantage of new rate options. These investments are delivering results to improve reliability and resiliency. For example on circuits with new smart technology upgrades, we have seen up to a 40% improvement in reliability. Of course, we also remain committed to a clean energy transition for our customers and state. This is demonstrated through our recent acquisitions of two wind generation facilities located in Northern Missouri totaling 700 megawatts. In addition, our investments are stimulating economic growth for communities across the state. I’m pleased to say that 57% of Ameren Missouri suppliers in 2020 were Missouri-based and 32% of its sourcebook capital spend was with the first suppliers. And we're doing all of these things while keeping our customers electric rates approximately 20% below the average and other Midwest states and across the country. At the same time, we remained very disciplined in managing our costs. As a result, if approved, the new electric rate requests represent a 5.4% total increased over an almost five year period, yearly average of approximately 1%. We will remain disciplined in managing our costs while we build a stronger, smarter and cleaner energy system for our customers now and in the future. Moving now to Ameren Illinois regulatory matters. In January, we received the constructive rate order from the ICC that resulted in a $76 million annual increase in gas distribution mix. New rates went into effect in late January. In our Illinois Electric Business, we made our required annual electric distribution make filing requesting a $64 million base rate increase. This filing is only the second requested increase in delivery service rates in six years. While Michael will touch on the details of our filing a bit later, I think it is important to note that for years, our Illinois customers have realized the benefits of our significant investments in energy infrastructure. This performance-based rate making began in 2012. Reliability has improved by 20% and over 1,400 jobs have been created. At the same time, electric rates are among the lowest in the country and Midwest approximately 3% below 2012 levels. This performance-based framework has been a win-win for our customers and the state of Illinois. That is why we continue to strongly advocate for performance-based regulatory framework in the Illinois legislature, which brings me to our discussion of the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies on page six. As I discussed in our conference call in February, an enhanced version of the Downstate Clean Energy Affordability Act legislation was filed earlier this year which if passed would apply to both the Ameren Illinois Electric and Natural Gas Distribution businesses. This legislation would allow Ameren Illinois to make significant investments in solar energy, battery storage, and electric and gas infrastructure to continue to enhance safety and reliability as well as in the transportation electrification in order to benefit customers in the economy across Central and Southern Illinois. This important piece of legislation would also require a diverse supplier spend reporting for all electric renewable energy providers. Another key component of the Downstate Clean Energy Affordability Act is that it would allow for performance-based rate making for Ameren Illinois’ natural gas and electric distribution businesses to 2032. The proposed performance metrics will ensure investments are aligned with and are contributing to the safety and reliability of the energy grid and natural gas systems, as well as the state's vision for the transition to clean energy. Further, this legislation would modify the allowed return on equity methodology in each business to align with the average returns being earned by other gas and electric utilities across the nation. And as I noted a moment ago, this legislation builds on Ameren Illinois' efforts to invest in critical energy infrastructure under a transparent and stable regulatory framework that has supported significant investment, improved safety and reliability, and created significant new jobs, all while keeping electric rates well below the Midwest and national averages. This bill would also move the State of Illinois closer to reaching its goal of 100% clean energy by 2050. With all of these benefits in mind, we are focused on working with key stakeholders to get this important legislation passed. To-date, the Downstate Clean Energy Affordability Act has received strong bipartisan support from members of the Senate and House. Currently, House Bill 1734 has 49 sponsors, and Senate Bill 311 has 21 sponsors. As I'm sure you know, there are also several other energy-related bills being considered by the legislature. We will continue to be actively engaged with key stakeholders throughout the legislative session on these important energy policy matters. The spring session is currently set in May 31. Turning to Page 7 for an update on FERC regulatory matters, In April, FERC issued a supplemental notice of proposed rulemaking on the electric transmission return on equity incentive adder for participation in a Regional Transmission Organization or RTO. In the supplemental notice, the firm proposes to limit the duration of the 50 basis point ROE incentive adder for companies that join an RTO to three years. FERC also proposes to eliminate the adder for utilities that have been part of an RTO for three years or more, which would include Ameren Illinois and ATXI. Without this incentive adder Ameren Illinois and ATXI would earn the current allowed base ROE of 10.02%. For perspective, every 50 basis point change in our FERC ROE affects annual earnings per share for approximately $0.04. Needless to say, we are disappointed with the direction the FERC has taken in the supplemental notice and strongly oppose the removal of the adder. From our perspective, our job participation adder is needed to compensate companies for assuming risk associated with turning over operational control of assets to the RTO. The proposals also inconsistent with the first stated policy goals and the intent of existing amount to encourage our RTO participation. We will continue to advocate for the RTO incentive adder and other project incentive adders proposed in the March 2020 NOPR. We will file comments on the supplemental NOPR by the May 26 deadline. Of course we are unable to predict the ultimate outcome or timing of this matter as the focus under no timeline to issue a decision. Moving now to Page 8, policy matters are important because transmission investment is going to play a critical role in a country's clean energy transition. As we have discussed before, myself and other key stakeholders including Ameren have been carefully assessing the transmission needs in the MISO footprint to ensure the overall reliability and resiliency of the energy grid is maintained. Our companies execute their clean energy transition plans. Recently, MISO published several reports that outline some of the preliminary thoughts on MISO’s transmission needs in the future. This page summarizes a recent study that outlines a potential road map of transmission projects to 2039, taking into consideration the rapidly evolving generation mix that includes significant levels of renewable generation based on announced utility integrated resource plans, state mandates, and goals for clean energy indoor carbon emission reductions, among other things. I would also note that MISO in the Southwest Power Pool are also working together to develop a similar evaluation of transmission needed to support the transition across both regions. The bottom line is that significant regional and local transmission investments will be needed for the clean energy transition over the next 10 to 20 years. For example, under MISO’s future one scenario which is a scenario that resulted in an approximate 60% carbon emission reduction below 2005 levels by 2039, MISO estimates future transmission investment could amount to an estimated $30 billion in the MISO footprint. Further, future three resulted in an approximate 80% reduction in carbon emission levels below 2005 levels by 2039. MISO has estimated future three could result in an estimated $100 billion of transmission investment in the MISO footprint. We provide some context to this. During MISO’s last regional transmission planning process, approximately $6.5 billion of multivariate project investments were made over the last 10 years or so. In light of the continued focus on the clean energy transition in our country, we are actively working with MISO and other key stakeholders to move the assessment and project approval process along, with an appropriate sense of urgency to ensure we maintain a safe, reliable, and resilient energy grid and do so in an affordable fashion. Given our past success in executing large regional transmission projects, we believe we are well positioned to plan and execute potential projects in the future for the benefit of our customers and country. We believe certain projects outlined in Future 1 will be included in this year's MISO transmission planning process, which is scheduled to be completed in the fourth quarter of 2021. We look forward to working with MISO and key stakeholders on this important planning process. Speaking of clean energy transitions, let's move now to Page 9 for an update on our $1.1 billion wind generation investment planned to achieve compliance with Missouri's renewable energy standard through the acquisition of 700 megawatts new wind generation at two sites in Missouri. Ameren Missouri closed on the acquisition of its first wind energy center, a 400-megawatt project in Northeast Missouri in December. In January, Ameren Missouri acquired its second wind generation project, the 300-megawatt Atchison Renewable Energy Center located in Northwest Missouri. Approximately half the megawatts of the Atchison Renewable Energy Center are in service. We expect the remaining megawatts to be placed in service by September 30. Turning now to Page 10 and an update on Ameren Missouri's Callaway Energy Center. During its return to full power as part of its 24th refueling and maintenance outage in late December 2020, Callaway experience a non-nuclear operating issue related to its generator. At their own, investigation of this matter was conducted, and the decision was made to rewind the generator stutter and router in order to safely and sustainably return the energy sector to service. The project is going well and we continue to expect the capital project to cost approximately $65 million. I am also pleased to report that the insurance claims within the capital project and replacement power have been accepted by insurance carrier, which will mitigate the impacts of this outage for our customers. We expect the Callaway Energy Center to return to service in July. As we have said previously, would you not expect this man to have a significant impact on Ameren financial results. Turning the Page 11, we are focused on delivering a sustainable energy future for our customers, communities, and our country. This page summarizes a strong sustainability value proposition for environmental social and governance matters and is consistent with our vision, leading the way to a sustainable energy future. I have discussed several elements of our strong sustainability value proposition with you in the past. So, in the interest of time, I will not go through all of these points again this morning. Having said that and moving to Page 12, you should know that we have already made significant progress in our sustainability efforts in 2021. Here, we highlight several key achievements to date this year. Beginning with environmental stewardship last September, Ameren announced his transformational plan to achieve net zero carbon emissions by 2050 across all of our operations in Missouri and Illinois. This plan includes strong interim carbon emission reduction targets at 50% and 85% below 2005 levels in 2013 and 2014 respectively. This plan is also at the heart of our updated climate risk report, which is based on the recommendations of the task force on climate-related financial disclosures which were issued last week. I am pleased to report our plan is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. In terms of social impact, I am very excited to say that our efforts in this area continue to be recognized by leading organizations. Last week, Diversity, Inc. announced Ameren is once again named number one on the top utilities list with diversity and inclusion, which we have been proudly a part of since 2009. Diversity, Inc. also ranked Ameren second on the top 10 regional companies and as a top company for ESG among all industries. In addition, for the fifth year overall, we've been certified by a great place to work. And finally, we are recognized as the best place to work for LGTBQ but in Human Rights Campaign. Moving to governance, our board and management have established governance structures that enable a focus on the ESG matters that drive Ameren strategy, mission, and vision, including the addition of ESG metrics to drive executive compensation programs. In particular, our board of directors refined our executive compensation program by adding workforce and supplier diversity metrics to our short-term incentive plan for 2021. In addition, we recently issued several social impact policies. Since our call in February, we've also issued several reports reflecting our sustainability efforts and advances. Just last week we posted our 2021 Sustainability Report, which expands a mini ESG and sustainability topics and posted the 2020 ESG sustainability template. And for the first time, we publish information using the Sustainability Accounting Standards Board reporting framework and mapped our business activities to the United Nations Sustainable Development Goals. I encourage you to take some time to read more about our strong sustainability value proposition. You can find all of our ESG related reports at amereninvestors.com. Turning now to Page 13. Environmental stewardship, social impact and governance are three pillars of our strong sustainability value proposition. Our final pillar is sustainable growth. Looking ahead, we have a strong sustainable growth proposition which will be driven by a robust pipeline of investment opportunities of over $40 billion. Over the next decade it will deliver significant value to all of our stakeholders and making our energy grid stronger, smarter and cleaner. Importantly, these investment opportunities exclude any new regionally beneficial transmission projects that I described earlier, all of which would increase the reliability and resiliency of the energy grid as well as enable additional renewable generation projects. In addition, we expect to see greater focus from a policy perspective on infrastructure investments to support the electrification of the transportation sector. Our outlook to 2030 does not include significant infrastructure investments for electrification at this time either. Of course our investment opportunities do not only create a stronger and cleaner energy grid to meet our customers’ needs and exceed their expectations but they will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future and a safe, reliable and affordable fashion will be critical to meeting our country's future energy needs and delivering on our customers’ expectations. Moving to Page 14. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2021 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our five year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2021 to 2025. This earnings growth is primarily driven by strong weight based growth and compares very favorably with our regulated utility peers. Importantly, our five year earnings and rate base growth projections do not include 1,200 megawatts of incremental renewable investment opportunities outlined in Ameren Missouri's integrated resource plan. Our team continues to assess several renewable generation proposals from developers. We expect to file this year with the Missouri PSC for certificates of convenience and necessity for a portion of these planned renewable investments. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experience and dedicated team to get it done. That fact, coupled with our sustained past execution of our strategy on many fronts, this position as well for future success. Further, our shares continue to offer investors a solid dividend, which we expect to grow in line with our long term earnings per share growth guidance. Simply put, we believe our strong earnings and dividend growth outlook results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today now we’ll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Warner and good morning, everyone. Turning now to Page 16 of our presentation. Yesterday, we reported first quarter 2021 earnings of $0.91 per share compared to $0.59 per share for the year ago quarter. Earnings at Ameren Missouri, our largest segment increased $0.22 per share due to several favorable factors. The earnings comparison reflected new electric service rates effective April 1, 2020 which increased earnings by $0.10 per share. In addition, earnings benefited from lower operations and maintenance expenses which increased earnings $0.07 per share. This was primarily driven by the absence of an unfavorable market returns that occurred in 2020 on the cash surrender value of our company-owned life insurance as well as disciplined cost management. Earnings also benefited by approximately $0.04 per share from higher electric retail sales driven by near-normal winter temperatures compared to milder-than-normal winter temperatures in the year-ago period. We have included on this page the year-over-year weather normalized sales variances for the quarter that showed total sales to be comparable with Q1 2020, which was largely unaffected by COVID-19. We continue to see improvements in sales as schools and businesses reopen and begin to increase their levels of operation. Earnings were positively impacted by the timing of income tax expense, which we do not expect to impact full-year results, as well as the absence of charitable donations that were made pursuant to the Missouri rate review settlement in March 2020. And finally, these favorable factors were partially offset by the amortization of deferred expenses related to the fall 2020 Callaway Energy Center’s scheduled refueling and maintenance outage. Moving to other segments, earnings for Ameren Illinois natural gas were up $0.08 reflecting higher delivery service rates that were affected January 25, 2021, incorporating a change in rate design as well as the increased infrastructure investments and a lower allowed ROE. The first quarter of 2021 benefit from the change in rate design is not expected to impact full-year results. Ameren Illinois electric distribution earnings increased $0.03 per share which reflected increased infrastructure investments and a higher allowed ROE on a performance base rate-making of approximately 8.15% compared to 7.45% for the year ago quarter. Ameren Transmission earnings were comparable year-over-year which reflected increased infrastructure investments that were offset by unfavorable $0.03 impact of a March 2021 FERC order. This order related to an intervenor challenge regarding the historical recoveries of material and supplies inventories and rates and will have no impact on the current formula rate calculation prospectively. And finally, Ameren Parent and Other results were down $0.0 per share compared to the first quarter of 2020 due to increased interest expense resulting from higher long term debt outstanding offset by the timing of income tax expense, which is not expected to impact full year results. Finally, 2021 earnings per share reflected higher weighted average shares outstanding. Before moving on, I'll touch on sales trends in Illinois electric distribution in the quarter. Weather normalized kilowatt hour sales to Illinois residential customers increased 1.5%. And weather normalized kilowatt hour sales to Illinois commercial and industrial customers decreased 1.5% and 2.5%, respectively. Recall that changes in electric sales in Illinois no matter the cause do not affect our earnings since we have full revenue decoupling. Turning to Page 17, I would now like to briefly touch on key drivers impacting our 2021 earnings guidance. We're off to a strong start in 2021 as Warner stated, we continue to expect 2021 diluted earnings to be in the range of $3.65 to $3.85 per share. Select earnings considerations for the balance of the year are listed on this page and a supplemental to the key drivers and assumptions discussed in our earnings call in February. I'll note that our second quarter earnings comparison will be negatively impacted due to a seasonal rate design change effective for 2021 in Ameren Missouri as part of the March 2020 electric rate order. This order called for winter rates in May and summer rates in September rather than the blended rates used in both months in 2020. The second quarter results were also being negatively impacted by the absence of the impact of the 2024 FERC order approving the MyCelx-allowed base are we at Ameren Transmission. Together, these two items are expected to reduce second quarter earnings by approximately $0.25 year-over-year. I encourage you to take this into consideration as you develop your expectations for our second quarter earnings results. Turning now to Page 18, here, we outline in more detail our recently filed Missouri electric rate review that Warner mentioned earlier. This reflects many benefits including major upgrades, the electric system reliability and resiliency for customers as well as investments to support the transition to a cleaner energy for the benefit of customers and local communities. Now, let me take a moment to go through the details of this filing. The request includes a 9.9% return on equity, a 51.9% equity ratio and a September 30, 2021 estimated rate base of $10 billion. This includes a test year into December 31, 2020 with certain pro-forma adjustments through September 30, 2021. The requests include a continuation of the existing FAC and other regulatory mechanisms along with a request to recover certain costs associated with the Merrimack Energy Center which is expected to retire in 2022 over a five-year period from the date of the new rates become effective. As outlined in this page, the key drivers of our $299 million annual rate increase include increased infrastructure investments made under Ameren Missouri smart energy plan, impact of the transition to a cleaner generation portfolio, decrease weather normalized customer sales volumes and a higher pension, OPEB, and tax harmonization expenses, partially offset by lower operation and maintenance expenses. Moving to Page 19 for an update on other Ameren Missouri regulatory matters. In March 2021, we also filed a natural gas rate review. The details for the $9 million annual revenue increase request are outline on this page. We expect the Missouri PSC decision in both our electric and natural gas rate reviews by February 2022 with new rates expected to be effective by March. Further, last October, we filed a request with the Missouri PSC to track and defer in a regulatory asset certain COVID-related costs incurred net of any COVID-related costs savings. In March 2021, the Missouri PSC approved this request. $9 million of net costs were incurred through March 31, 2021. We recognized $5 million in the first quarter of this year and expect the remaining portion relating to late fees to be recognized when realized and rates beginning in early 2022. The timing to recover these costs will be determined as part of our pending electric and gas rate reviews. Moving now to Page 20 for an update on Ameren Illinois regulatory matters. Last month, we made our required annual electric distribution performance-based rate update file and requesting a $64 million base rate increase. Under Illinois performance-based rate making, Ameren Illinois is required to make annual rate updates to systematically adjust cash flows over time for changes and costs of service and a true of any prior period over or under recovery of such cost. Since this constructive framework began, Ameren Illinois has made prudent investments to strengthen the grid and reduce outages and continues to do so. Major investments including the request or the installation of outage avoidance and detection technology. Major investments, including the request, are the installation of outage avoidance and detection technology; integration of storm-hardening equipment; adoption of clean energy technologies; and the implementation of new energy efficiency measures, including mobile-enhanced communications and assessment capabilities for electric field workers. The ICC will review our request in the months ahead, with a decision expected in December of this year and new rates effective in January of next year. Turning to Page 21 for a financing and liquidity update, we continue to feel very good about our liquidity and financial position. In February, Ameren Corporation issued $450 million of 1.75% senior unsecured notes due in 2028. The proceeds were used for general corporate purposes, including to repay short-term debt. We also expect both Ameren Missouri and Ameren Illinois to issue long-term debt in 2021. In addition, as we mentioned on the call in February, during the quarter, we physically settled the remaining shares under our forward equity sales agreement to generate approximately $150 million - $115 million. In order for us to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $150 million of additional common equity during the balance of 2021 which is consistent with the guidance we provided in February. To that end, in May, we expect to establish an at-the-market or ATM equity program to support our equity needs through 2023. This future equity issuance will enable us to maintain a consolidated capital structure consisting of approximately 45% equity over time. The incremental natural gas and power purchases incurred due to the extreme cold in mid-February this year did not have a significant impact on our liquidity or ability to fund our future operations and investment. Ameren’s available equity as of April 30 was approximately $1.3 billion, which includes $2.3 billion of combined credit facility capacity net of approximately $1 billion of commercial paper borrowings at the end of the month. Finally, turning to Page 22, we're well positioned to continue executing our plan. We're off to a solid start and we expect to deliver strong earnings growth in 2021 as we continue to successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate based growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Thanks for all the colors today, very helpful. Maybe just starting off with regards to the Illinois legislative session here, do you have any sense for the relative priority of utility issues within the overall clean energy legislation discussions? And do you see any potential for kind of a grand bargain here to be reached on energy?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, thanks, Jeremy a couple of things there. One, I do think clean energy legislation is a focus for the legislature. I think just by the fact that you see so many bills that are being discussed out there and rightfully so right. The clean energy transition is obviously very important not just for Illinois, but across the country. Certainly as I said in my prepared remarks, there's no doubt that there are several bills that are being considered whether there's a grand bargain, if you will or whether these bills are put together look, it's just too early to say. The only thing I can say is this, is that we are at the table with key stakeholders trying to find a solution and to advocate for the downstate Clean Energy Affordability Act. Because as you heard me say many times, that Act that - those provisions are performance-based rate making approach has really delivered significant benefits for our customers and the entire state of Illinois. So, we have until the end of the month to try and get something across the finish line. Richard Mark and his team have been working tirelessly at that. Now to say their tireless work and the work that we've been doing for many years has already elicited strong bipartisan support. So, we're hopeful to get the proper provisions and a final piece of legislation."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it that's very helpful. Thanks."
},
{
"speaker": "Warner Baxter",
"text": "Sure."
},
{
"speaker": "Jeremy Tonet",
"text": "Maybe pivoting over to transmission, it seems like an exciting time for transmission, if you will. And do you have any sense of the magnitude of specific projects that could be identified by MISO before year-end or in the not too distant future? And what do you see separately as the potential for large scale HVDC transmission opportunities outside or beyond the MISO process. And then finally, I guess with transmission trying to scale the opportunity set here? So I'm wondering if you could help us think through roughly how much CapEx did Ameren deploy over the years where MISO brought renewable penetration from very little to the high levels that is today. Is there any rules - any kind of measures we can think of like $10 billion to accommodate 10%. Just trying to scale the opportunity set here?"
},
{
"speaker": "Warner Baxter",
"text": "Jeremy, lots to unpack there. Let me see if - I'll try to respond to those things, and Michael and Andrew will help me if I haven’t hit a point, but certainly come back on. Let me answer your first question - your last question perhaps first. As I said in my prepared remarks, there's about $6.5 billion of regional transmission projects that really were deployed across the MISO footprint over the last decade, if you will. We did about $2 billion of that. Now that doesn't mean - there is a different time, different place. But obviously we did 25%, 30%, almost of those, and it's because of our location in the MISO footprint. And so that's just number one. Two, what you said at the outset, I agree with. It is a very exciting time to be in the transmission business and especially one in the MISO footprint. When you're sitting in the center of the country, what MISO does with its transmission is integral to the clean energy transition for our country. And so, what you're seeing today is obviously - is a preliminary list of projects that were informed certainly by stakeholder conversations, as well as integrated resource plans and state energy policies, among many other things. It's hard to say just exactly what will ultimately come out of, let's just call it, the transmission plan that will be filed later this year. But the way we look at it and we look at that Future 1 which we showed on that slide, we think that there are a lot of projects contained in that that we think are really kind of no regrets types of projects. It's premature to put a number on it and which projects will go. Because what MISO does now is now they've put out this road map, they are basically looking for input from stakeholders. And so, you can expect throughout 2021 stakeholders will be providing input into that road map. And with that input, MISO will ultimately prepare their long-range plan, their MTEP is what they call it. And we expect that to be filed in the fourth quarter. Ultimately, a process from there Jeremy has been some more input. But ultimately, the MTEP is put before the MISO Board of Directors for vote and hopefully approval by the end of the year. So, it's not too far away but that future one is, I would say, the first step. But then as you look beyond that, as we said in future three, obviously those investments continue to grow over time. And as we said, they range from $30 billion to $100 billion. Those are MISO’s preliminary estimates that will continue to be refined. So hopefully that gives you some of the sense. I'm not sure if I missed, if I addressed all of your questions in there. But I think I got them all there."
},
{
"speaker": "Jeremy Tonet",
"text": "I think that’s very helpful. But maybe just to follow-up, anything on that HVDC front where Ameren might have a bit more leverage."
},
{
"speaker": "Warner Baxter",
"text": "It's a little premature to say that. These are things we look at. Obviously there is some opportunities that we're looking at even in connection with the Missouri Integrated Resource Plan. So a little early to be making those kind of judgment calls, but stay tuned."
},
{
"speaker": "Jeremy Tonet",
"text": "And if I could just do one quick last one, as far as what's coming out of the Biden infrastructure plan, early stages here, but is there anything that you are focused on? Do you see investment upside or benefits from lower ratepayer cost or anything else that could really kind of get things moving with the transmission kind of permitting, paying, planning process here?"
},
{
"speaker": "Warner Baxter",
"text": "Sure, well I will say one thing that we are encouraged by in terms of what the Biden administration has done. It’s number one. They're very focused on providing significant funding for new clean energy technologies which we think is going to be so important for our industry, for our country to get to a net zero carbon future by 2050 which is certainly our goal. I think the other thing that you're seeing is you understand. Why you put out a bill that really has some - I think some very good incentives to invest in clean energy technologies and those incentives range from tax credits. They range from tax normalization policies to give opt out provisions. They include tax credits also for transmission. And so, we look at the provisions that build on that. I won't go through all the details here. That bill will really have a direct impact on the overall cost to our customers. And so, we're obviously very encouraged and enthused about that so, a lot going on in Washington DC. We're at the table working with the stakeholders. And we are hopeful that we will continue to see progress and incentives for clean energy technologies here in the next several months."
},
{
"speaker": "Operator",
"text": "Our next question is from Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shar Pourreza",
"text": "Just a - good excellent so, just a quick follow-up on Illinois, if something doesn't pass in the next couple of weeks, Warner, do you sort of intend to push over the summer. What are your thoughts on getting something done during the veto session? I know there's obviously a lot of competing interests, there's a lot of bills? You highlighted that. Some of them are outside of energy, there’s new legislators and politicians. So, there's also a question mark with many of energy is even a priority right now. So, just trying to get a bit of a sense if something doesn't get done in two weeks, how do we sort of price this in the veto session?"
},
{
"speaker": "Warner Baxter",
"text": "Sure, Shar, one of the things as you talk about veto session in Illinois. And Illinois is a bit unique, perhaps, compared to other states whereby the veto session isn't really just there to address bills that have been vetoed but also can address bills that have been presented during the regular session. So to be clear, I'll say this first, we are very focused on trying to get something across the finish line for the benefit of our customers in the State of Illinois on energy policy here by May 31. But your question is what, what if it doesn't happen here in the next several weeks? Well then it could be brought up in the veto session. And our approach would be very much of what we've been doing. We will continue to strongly advocate for the Downstate Clean Energy Affordability Act. And the reason why we will continue to strongly advocate for it is because it has strong bipartisan support. We have House bills and Senate bills with strong bipartisan support as well as supporters from north and the south part of the state. And so, we're going to continue to push for that because we - strongly believe it's the best policy going forward for the state of Illinois. It isn't just because we believe it, it’s because it been delivering results for almost a decade now. And that's why we're going to continue to advocate for. So, I do think people say whether it's a priority, I will tell you there are conversations going on in the state of Illinois around energy policy. So, I know they have other priorities that they have to balance but I do believe energy policy is one of them."
},
{
"speaker": "Shar Pourreza",
"text": "And just lastly shifting maybe south, obviously it's not a major priority for you guys are essential to current growth plan that obviously you're re-highlighting today. But any thoughts on securitization, legislation as it makes its way through the chambers. Any sort of expectations you can provide as we get to the homestretch?"
},
{
"speaker": "Warner Baxter",
"text": "Well, we are - we're in the homestretch in the state of Missouri at the end of this week. And Marty Lyons and his team have been working hard on that. And we provided some perspectives but Marty you have been in the middle of that. I'm just going to turn over you. Maybe give us the latest update if you don't mind."
},
{
"speaker": "Martin Lyons",
"text": "Sure, Warner. Yeah, you're absolutely right. Securitization isn't something that we see is required to isn't something that we see as required to be able to carry out our integrated resource plan. But we do think it would be a good tool to have in the toolbox of the commission especially as crafted in Missouri. So you're right. There have been aversions going through the House and the Senate. They're very, very similar at this point. Last night, actually, the Senate passed the House securitization bill which is HB734 and they did make some slight modifications to that. So, now, that goes back to the house to the fiscal review committee and we'll see whether that can be then voted on in the House. We may see actually some action as early as today. But in any event what has to happen over the remainder of the week is that the language needs to get conformed between the two, the Senate bill, the House bill. Like I said, they're very, very similar at this point and ultimately needs to be passed by the end of the week. As Warner indicated, the legislative session ends on May 14th this Friday - this Friday afternoon. So, in any event, we're very close. Can't predict whether it'll actually get done, but it's really positioned pretty well for success. So we'll keep our fingers crossed for the remainder of this week."
},
{
"speaker": "Shar Pourreza",
"text": "And just - Marty, just assuming you get securitization, obviously, this is the messages you don't need it for the IRP but curious if you get securitization, is there an acceleration of the plan under the IRP or any opportunities to potentially accelerate the plan?"
},
{
"speaker": "Martin Lyons",
"text": "No, there's really no change to the integrated resource plan. When we filed that last September, we filed it believing that it was the most affordable process and most reliable process for transitioning our fleet over time. And so we stand by the integrated resource plan that we filed. Of course, we've been getting comments on that. We expect that ultimately the Getting comments on that. We expect that ultimately the commission will rule on whether that process that we went through was appropriate. We certainly believe it was. And it would only be through consideration of changes that might occur over time that would cause us to modify the IRP. We still believe the preferred plan that we filed as the appropriate pass. Securitization passes, there would not be any immediate impact on the integrated resource plan. But like I said, conditions change through times. And we do believe having securitization in the toolkit of the commission would be a good thing to have."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "You guys have a lot on your plate and congrats on continued success in de-risking?"
},
{
"speaker": "Warner Baxter",
"text": "You bet."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "I would say, I would say - I mean Warner you made some interesting comments on transmission earlier. I would ask obviously the future one, two and three have big numbers long timelines and you've already tried the pieces part but how would you characterize this current MTF as best you see it coming together against some of those bigger projects? How much should we be expecting here, right? If you want to just sort of start to set expectations initially considering that obviously you think long queue is?"
},
{
"speaker": "Warner Baxter",
"text": "Yes. Julien so, a couple comments there. It is really premature to really say exactly which of those projects will ultimately show up in the MTEP. I think myself did a fine job of putting together this long range plan which gives us collectively an opportunity to weigh in on it and to try and keep really our finger on the pulse of all the things that are going on around the country, not just in the states but around the country. So it just is too premature. But I will say this, that we, as well as MISO and other stakeholders, there is a sense of urgency to address this, these matters because we see the clean energy transition coming, and we know that transmission is critical to its success. And so, consequently, there's a significant amount of interest, a significant amount of work being done. And so we're not too far away from really hearing what that's going to be. The fourth quarter is really, for all practical purposes, right around the corner. And as you know, some of these projects, as you said, they take time to plan, get approval, and ultimately to execute. So, again, as we see this, and I've said this in the past, it's really just - the study really is consistent with what we've been talking about really for the last several years. We see significant transmission opportunities, and should they come in the form of this MTEP or otherwise, we think they're probably, if there are any, would come towards the back-end of our five-year current capital expenditure plan, but especially in the second half of this decade, you see some of these transmission projects really come to fruition. And as I’ve said before, we're well positioned, well positioned to execute on many of those projects. So we're looking forward to it."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Excellent. Sorry to follow up on legislation very narrowly here. How do you see the potential of moving into June versus the end of May? I know there's some latitude issue there. And then also, more importantly, the contrast of a grand bargain would be potentially carving out this issue in the sunset, the question on the utility front separately from anything bigger. Is that conceivable in your mind, or does this need to be a bigger deal as far as you're concerned?"
},
{
"speaker": "Michael Moehn",
"text": "Julien, Michael here. I’m not sure we caught your whole question. You're talking about moving from outside of the May 31 ending the session into June, so like of our special session?"
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes, exactly. It was my specific question."
},
{
"speaker": "Michael Moehn",
"text": "Okay. Illinois legislature?"
},
{
"speaker": "Warner Baxter",
"text": "Illinois legislature."
},
{
"speaker": "Michael Moehn",
"text": "I’m sorry. It was a little faint. Look, like everything else. We certainly can't predict whether there would be a special session of sorts in the Illinois legislature. As I said before, we're focused on the spring session in May 31 and should that not bear fruit within, we'll see where the next steps are. And then we talked a little bit earlier about the veto session. So premature to speculate whether a special session would be called."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Fair enough. But you don't need to necessarily get this grand deal to get this sunset - the sunset address."
},
{
"speaker": "Michael Moehn",
"text": "No. I'm sorry. Thank you. No, at the end of the day, so just to be clear - this expires in 2022, right. So this is not a piece of legislation has to be done this year. It expires in 2022. And let's not forget that the overall regulatory framework that we have which we’d go to now has some things in there that are solid as a forward test year as decoupling bad debt writers and those other things and return on equity that will be done in the normal course of return on equity setting and by the Illinois Commerce Commission. And so, bottom line is this. Now we strongly believe that the Downstate Clean Energy Affordability Act and all the provisions in there are clearly - are in the best interest of our customers in the state of Illinois. We're going to continue to advocate for that. But it doesn't have to be done here in the next week or the veto session. But having said that, we think having that certainty and sustainability is the right way to go. That's why we're pushing for it."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore ISI. Please proceed with your question."
},
{
"speaker": "Durgesh Chopra",
"text": "Just Michael, quick clarification on the equity, in Q4 you said, you guys said $300 million a year to 2025, the ATM goes through 2023. Is still $300 million per year, a good sort of number to model till 2025?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, I appreciate the question, yes. So, if you go back to February, yes the same, the same metrics that we gave, we're doing $150 million here in 2021 and then $300 million 2022, through 2025. All of those assumptions still stand today. And this ATM is going to allow us to execute against that."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Thank you. And then maybe just - I want to get into a little bit of detail on the, on the Missouri securitization. Warren I’m just clearly, you assume it doesn't impact your IRP, could sort of your assets be at risk? I'm thinking about early retirement of coal plants, the capacity factors of your generation assets and whether sort of the legislation now sort of accelerates the recovery of coal plants and impacts the rate base growth profile. Just any color there would be great. Thank you, Warren."
},
{
"speaker": "Michael Moehn",
"text": "Yes. Thank, Durgesh and I’ll have Marty weigh in at the moment. Look as we've said before, we're very fortunate. We have a strong baseload coal fleet that runs, that runs a lot. And it's because of you know some of the actions and things we've done really over the past several years, decades frankly. And so, we laid out our integrated resource plan and you see that systematically, we are retiring our coal fired energy centers over time. And it's because number one, we think it's in the best interest of our customers from a reliability and affordability perspective. And so, as Marty said, we don't see that changing. But conditions could change, right, whether it's at the state level or federal level. And so securitization is not going to drive us to do anything different other than absent changes that may happen, as I said, from a policy perspective or otherwise. But it is a good tool to have in our toolbox, should those changes occur. So we - our coal plants are valuable assets to us today. Over time, we will retire them. But we don't see any near-term changes to how we plan on operating or certainly risks to those assets. Marty, would you have anything to add to that?"
},
{
"speaker": "Martin Lyons",
"text": "Well, first, I firmly agree with everything that you conveyed. And when you look at the integrated resource plan that we filed, we've got four coal-fired energy centers. As Warner said, we've got very efficient coal plants. They operate very well. But with that said, in our integrated resource plan, we did lay out that we're retiring our Meramec facility here in 2022. We expect that that will be fully recovered at that point in time. We did propose the accelerated closure of both the Sioux and the Rush Island plants, Sioux by about five years and Rush Island by about six years. So Sioux would close in 2028, Rush Island in 2039, and then Labadie, which is our largest plant and most efficient plant, would close in two stages in 2036 and 2042. So, again, we've accelerated the expected closure of two of our plants, and those accelerations and the recovery of those are actually reflected in the rate review filing that we made here in March. So we're looking to accelerate the recovery of those plants. And then of course the rates are also positively impacted by the expectation of Meramec closing. So, those things are reflected there. That's historically the way we've handled things in Missouri. And again as Warner said, when we filed the IRP we made a host of assumptions. Conditions can change and vary from the assumptions that we made through time for a variety of reasons. And as I said before, securitization is not going to change the integrated resource plan, preferred plan that we have today. But if conditions change versus the assumptions we've made through time, again securitization will be a good tool to have in the tool box."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Appreciate the color. It sounds like it's more of an opportunity than a risk for you guys. Thanks for taking my question."
},
{
"speaker": "Warner Baxter",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "Next question comes from Stephen Byrd with Morgan Stanley. Please proceed with your question."
},
{
"speaker": "Stephen Byrd",
"text": "Lot's been covered in Q&A. I guess I was stepping back and thinking about kind of key areas of growth upside for you all over - I mean you have a very impressive growth plan as it is, but thinking especially about incremental renewables, elements of your IRP but just other dynamics. And just wanted to step way back and think about those kind of key categories of additional growth upside and wonder if you could just comment on that?"
},
{
"speaker": "Warner Baxter",
"text": "You bet. You bet. Well, I think there are a couple of them one, we've - probably more than a couple frankly there are several. And one, we talked quite a bit about already today and that's transmission. So as you know we present investment opportunities for 2030 of $40 billion plus of investment opportunities. And one of the reasons we put that plus there is because transmission. So that $40 billion number that we have of investment opportunities does not include any of the regional transmission projects that we've spent quite a bit of time talking about already. So, Stephen, that would be certainly one meaningful upside to our investment profile that we have prospectively. A second one and another one that we've talked about - and again, I mentioned this a little bit earlier. Is electrification and the infrastructure that has to go for the greater electrification especially for the transportation sector in our country. Now, our long-term plan has really no meaningful investments associated with the electrification of the, transportation sector and as you listen to the policymakers discuss the need for a cleaner energy transition in this country and lower carbon emissions. Well, the transportation sector is the greatest carbon emitter in our country today. And so, you've heard certainly the automakers and others continue to lean further in. Well, we're going to lean further in, too, and we have been. And so, I think that, too, is a significant opportunity. But I'll tell you, just to be clear you know what I’ve done with all of our investments in grid modernization. We need to continue to make investments in the grid both in Missouri and Illinois to make sure that the grid continues to be reliable and resilient. So, as we look at those investment opportunities which could also then include renewable - greater levels of renewable energy over time, we have quite a bit in there. But times as we said could change if policies change those two could be investment opportunities. I didn't put a specific number on those. But they're sizable. They're sizable. And so, we see our robust infrastructure plan that we have already today continuing for some time."
},
{
"speaker": "Stephen Byrd",
"text": "Really helpful. And then maybe just one additional question on transmission, a lot of questions already on this, but thinking about sort of FERC and FERC has their objective to eliminate barriers to executing on transmission. How do you see that factoring into the existing RTO processes? Is that more of just a long-term objective of FERC or could that yield particular impacts to the outlook for transmission growth?"
},
{
"speaker": "Warner Baxter",
"text": "Yes, thanks Steve. And yes, I would say it's a bit too early to say. To what extent, FERC will get more engage in the RTO processes, which have obviously been very well defined over the years. And whether FERC will engage in that, it's just premature to say. What I will say is that certainly the clean energy transition and the importance of policies to support that clean energy transition are important issues for we certainly as transition owners, but also for FERC. And I think Chairman Glick and the commissioners there recognize that. I think you're going to continue to see greater levels of attention and focus at FERC on things that they can do to accelerate safe, reliable, and affordable transmission build around the country."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Patterson with Glenrock Associates. Please proceed with your questions."
},
{
"speaker": "Paul Patterson",
"text": "I’m well, I’m well. So a quick technical question for Marty, the Missouri securitization bill. It sounded to me that you - and I've been following it that the House version that's been amended - the House bill has been amended in the Senate and now is in the Housing Committee? If it passes out of the House without any changes, does it go straight to the governor or does it - it was a little confusing to me or does it have to be - will there have to be some changes - does it have to go back to the Senate - assuming there’s no changes made in the House?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, if there are no changes made in the House, then it will go to the governor. So if they make - the Senate voted it out last night. And if the House makes no changes and votes it out then it will be done and off to the governor."
},
{
"speaker": "Paul Patterson",
"text": "Okay, that would be nice. And then with respect to the Illinois legislation and I know this doesn't pertain specifically to you guys, but it's sort of an element I think potentially is the PGM auction. Do you think that's going to play any role in the timing here because as you know that's coming up a little bit sooner than the - at least it's beginning a little sooner than the end of the month?"
},
{
"speaker": "Warner Baxter",
"text": "This is Warner, I simply can't predict that. I really don't know. Obviously you're right. It's not something that's directly correlated to us. But obviously we keep an eye on all things that could have an impact. But let’s hope it wouldn't be appropriate for me to comment on that."
},
{
"speaker": "Paul Patterson",
"text": "Okay. I'll leave that one alone. So the crystal ball question. So - well just moving on to very quickly on the MISO issue and the ROE ensure to being part of an RTO. If this - if FERC takes action that could be - that you perceived to be negative with respect to the transmission ROE and being part of an RTO. Is there anything we should think as being potentially an outcome from that that you guys might take - or? How should we - I mean I just noticed you guys bringing that up in the slide presentation. I just wanted to - I was wondering are you guys - is there any - how should we think about it, if they do reverse this 50 basis points or do other action that might lower the ROE?"
},
{
"speaker": "Warner Baxter",
"text": "Sure, well Paul, I mean the reason we bring it up certainly in our prepared remarks is because we believe that the potential direction that FERC is taking is inconsistent with FERC policy its inconsistent with the intention of the law. And we think right now is the time where FERC should be doing everything it can to incent companies, to join and remain in RTOs. And so we bring that up simply because of that. And certainly, we think the 50-basis-point adders, is absolutely positively appropriate for us to have because we've given up control of our system. So I think that's in the first instance. We're not trying to be any more specific than that. And that we are going to work very hard here between now and the end of the month and put together our comments like others in the industry to state our position very clearly to FERC."
},
{
"speaker": "Operator",
"text": "Our next question comes from Insoo Kim with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Insoo Kim",
"text": "Just one question from me and I just wanted your update on the latest on the clean air litigation regarding your Rush Island plan, I think Labadie is involved. I think you're expecting kind of a ruling from the appeals court sometime this year. Is that still on your expectation? And I guess depending on what comes out of that, if there is a - if it goes against you on the appeal side, how do you think about the next step as it relates to the timing of potential CapEx or just the state of B plans?"
},
{
"speaker": "Warner Baxter",
"text": "Sure, sure a couple things, just to refresh everyone's memory. So our argument was held in December of last year. And so, that case, and this was review case is simply before the appellate court now. We said we expected a decision this year, but I'll tell you that the appellate court has no timeline in terms of when they must issue a decision. But we would think in the normal course, we would expect to see something this year. So we simply don't know. Look - the question is whether we get an unfavorable ruling. I'll start with this. We believe we presented a very strong case to the courts in this matter in December. And then should they ultimately rule against this. We'll step back and assess what actions we need to take at that time. And so, it’s would be really premature to speculate on what actions we would take and what impact it might have on our overall plan. So, if and when we come to that we'll address that in due course. So, stay tuned is probably the best message here."
},
{
"speaker": "Insoo Kim",
"text": "Got it? I guess in terms in relation to this current securitization bill perhaps, do you think that could provide one avenue that could help you navigate through this matter?"
},
{
"speaker": "Warner Baxter",
"text": "Certainly, as Marty stated before, securitization is a tool for several things whether it would be something that would apply here. We'll just have to wait and see. But first things first, we're focused on winning that case before the appellate court and then continue to execute the plan that we laid out before the Missouri Public Service Commission and our integrated resource plan."
},
{
"speaker": "Operator",
"text": "We have reached the end of the question-and-answer session. At this time I'd like to turn the call back over to Andrew Kirk for closing comments."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you for participating in this call. A replay of this call will be available for one year on our website. If you have any questions, you may call the contacts list on our earnings release. Financial analyst inquiries should be directed to me Andrew Kirk. Media should call Tony Paraino. Again, thank you for your interest in Ameren. Have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 4 | 2,022 | 2023-02-16 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host for today's call, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings. For more information about various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4.
Marty Lyons: Thanks, Andrew, and welcome back. We're thrilled that you're healthy again and here with us for this call and ready to fully engage with our investors and the analysts. Good morning, everyone, and thank you for joining us today as we reflect on our 2022 performance and look ahead to 2023 and beyond. I'd like to start by expressing appreciation for the Ameren team's dedication and hard work over the last year. In 2022, we continued to successfully execute our long-term strategy, as shown on Page 4, which is delivering strong results today while laying a strong foundation for the future. Shown on Page 5 are some exciting strategic achievements from the past year for Ameren, our customers, shareholders, the environment and the industry as a whole. Let me touch on a few key accomplishments. We made $3.4 billion of infrastructure investments in 2022 that resulted in a more reliable, resilient, secure and cleaner energy grid, as well as contributed to strong growth at all of our business segments. For example, as part of our Ameren Missouri Smart Energy Plan, over 400 smart switches were installed to reduce outages from hours to minutes and even seconds, and 34 substations were upgraded or built new to better serve communities. In addition, over 300,000 smart meters were installed for our Missouri customers, enabling better visibility into their energy usage. In Illinois, our customers are benefiting from the replacement of more than 3,000 electric poles, 64 miles of coupled steel distribution pipelines and 24 miles of gas transmission pipelines. Further, our transmission business placed in service 19 new or upgraded transmission substations and approximately 200 miles of new or upgraded transmission lines. These are just a few of the many projects completed in 2022. As a result of these and similar investments, I'm proud to say that Ameren's most recent system average interruption frequency reliability scores have ranked in the top quartile of our industry. We also had several achievements on the regulatory and legislative front. In February, new Ameren Missouri Electric Service rates took effect as a result of our 2021 rate review, which was constructively settled. In June, we filed a change to our integrated resource plan, accelerating our planned clean energy investments, carbon emission reduction goals and our plan to achieve net-zero by 2045 while thoughtfully considering customer affordability and energy grid reliability. In July, our pipeline of investments was significantly enhanced when the Mid-Continent Independent System Operator, or MISO, approved a portfolio of long-range transmission projects, including significant projects in our operating footprint. And in August, Senate Bill 745 was enacted in Missouri, extending the constructive smart energy plan legislation that became law in 2018 out through 2028, with possible extension to 2033. I’m pleased to say that a result – as a result of these developments, in 2022, we were able to increase our 10-year investment opportunity pipeline from $40 billion to $48 billion. Further, in our Ameren Illinois Electric Distribution business, in September, the Illinois Commerce Commission, or ICC, approved constructive performance metrics, which paved the way for our multiyear rate plan filing this January. And finally, at the federal level, passage of the inflation Reduction Act will support the clean energy transition, reducing the cost of related infrastructure investments for both our customers in both Missouri and Illinois. I would like to express appreciation for all the hard work of the entire Ameren team to advance these important achievements. At the same time, across Ameren, we are all working to keep customer bills as low as possible while investing to ensure we provide safe, reliable and cleaner energy for our customers. We remain laser-focused on disciplined cost management, practicing continuous improvement and optimizing our operating performance as we transform our business. In 2022, we continued our transition to a cleaner energy generation portfolio, and as planned in December, we retired our oldest and least-efficient coal-fired plant, the Meramec Energy Center. Thank you to all of our coworkers who have worked at Meramec providing reliable energy over the past several decades. We recognize that our customers depend on us every day to supply the energy that supports their daily lives, and as such, we have kept them at the center of our strategy. We are honored that in 2022 and for the third consecutive year, our residential customers have recognized Ameren with a top-quartile overall customer satisfaction ranking among large electric utility providers in the Midwest. In addition, Ameren Missouri ranked number one in business customer satisfaction. And finally, for our shareholders. Yesterday, we announced 2022 earnings of $4.14 per share compared to earnings of $3.84 per share in 2021. This result was at the high end of our earnings per share guidance range. The strong execution of our strategy in 2022 reflects strategic alignment across all of our business segments. We are staying focused on optimizing our operations and safely completing billions of dollars of value-adding projects to deliver significant value to our customers, communities, shareholders and the environment. Turning now to Page 6. Here, you can see we have delivered consistent superior value to our shareholders for nearly a decade. Since 2013, our weather-normalized core earnings per share have risen 92% at an approximate 7.5% compound annual growth rate, while our annual dividends paid per share have increased approximately 48% over the same time period. This drove a strong total return of nearly 226% for our shareholders from 2013 to 2022, which was significantly above our utility peer average. While I am very pleased with our track record of strong and consistent performance, rest assured that we are not letting up. Our team will remain focused on enhancing performance in 2023 and in the years ahead so that we can continue to deliver superior value to our customers, communities and shareholders. Turning to Page 7. This page summarizes our strong sustainability value proposition and focus on environmental, social, governance and sustainable growth goals and reflects the way we integrate our sustainability values into our normal course of business. Beginning with environmental stewardship. Last June, we announced an acceleration of our transformational generation resource plan, now aiming to achieve net-zero Scope 1 and 2 carbon emissions by 2045 and across all of our operations in Missouri and Illinois, which is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. This plan also advances our interim greenhouse gas emission reduction targets to 60% and 85% below 2005 levels by 2030 and 2040, respectively. As mentioned, in 2022, we were assigned certain projects as part of the Tranche 1 project portfolio to prospectively build and operate significant transmission investments in MISO territory. These as well as other transmission investments will provide our region access to a diverse mix of energy resources and are an important step forward to support a smooth clean energy transition. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. One example is our effort to drive inclusive economic growth at Ameren and in our communities. In 2022, we spent approximately $1.1 billion with diverse suppliers, including minority, women and veteran-owned businesses, a 22% increase over 2021. Because of actions like this, in May, we were honored to be recognized again by Diversity Inc. as number one on the nation's top utilities list for diversity, equity and inclusion. This is the 14th consecutive year we have been named to this distinguished list. I am also very pleased to say that Ameren was named a top company for ESG for the third consecutive year. In addition, we continue to support many nonprofit organizations in the communities we serve, including programs focused on DE&I, to which, we have made a $10 million contribution commitment by 2025. Moving to governance. Our strong corporate governance is led by a diverse Board of Directors focused on strong oversight of our sustainability efforts. In 2022, we named our first combined Chief Sustainability, Diversity and Philanthropy Officer to further optimize our initiatives. And our executive compensation practices include performance metrics that are tied to diversity, equity, inclusion and progress toward a clean energy future for all. Finally, this slide summarizes our very strong sustainable growth proposition, which we believe remains among the best in the industry. Today, we published our updated sustainability investor presentation called Leading the Way to a Sustainable Energy Future, which is available at amereninvestors.com. It demonstrates how we have been effectively integrating our sustainability values and practices into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. Moving to Page 8, we turn our focus to the current year. We expect 2023 to be another busy year, and we are excited about a number of strategic objectives. Notably, we will maintain our focus on significant infrastructure investment for the benefit of our customers. We expect to invest approximately $3.5 billion in electric, natural gas and transmission infrastructure to bolster safety, security, reliability, resiliency and further the clean energy transition in a responsible fashion. And as the nation's clean energy transition continues, we plan to help develop the needed transmission investment by submitting bids for the MISO Tranche 1 competitive long-range transmission projects as well as support analysis of potential Tranche 2 projects. We have an active regulatory calendar this year. We look to constructively conclude our Ameren Missouri electric rate review Ameren Illinois Electric multiyear rate plan and Ameren Illinois natural gas rate review. We will also work to successfully advocate for certificates of convenience and necessity for future renewable generation at Ameren Missouri. And our next Ameren Missouri integrated resource plan will be filed in September, which will include a comprehensive update of assumptions, including changes driven by the inflation Reduction Act enacted last year. Finally, we are focused on maintaining disciplined cost management with the expectation of holding operations and maintenance expenses flat in 2023 relative to 2022. Moving now to Page 9. I Yesterday afternoon, we announced that we expect our 2023 earnings to be in a range of $4.25 to $4.45 per share. Based on the midpoint of the range, this represents 7% earnings per share growth compared to the midpoint of our original 2022 guidance range of $4.05 per share. Michael will provide you with more details on our 2023 guidance a bit later. Building on the strong execution of our strategy and our robust earnings growth over the past several years, we expect to deliver 6% to 8% compound annual earnings per share growth from 2023 through 2027 using the midpoint of our 2023 guidance, $4.35 per share, as the base. Our dividend is another important element of our strong total shareholder return proposition. Last week, Ameren's Board of Directors approved a quarterly dividend increase of approximately 7%, resulting in an annualized dividend rate of $2.52 per share. This represents our third consecutive year of approximately 7% dividend growth, and the increase reflects confidence by Ameren's Board of Directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect Ameren's future dividend growth to be in line with our long-term earnings per share growth expectations and within a payout ratio range of 55% to 70%. We expect our weather-normalized dividend payout ratio in 2023 to be approximately 58%. I have full confidence in our team as we look ahead. Turning to Page 10. The strong long-term earnings growth I just discussed is primarily the result of rate base growth driven by investment in energy infrastructure under constructive regulatory frameworks. Today, we are rolling forward our five-year investment plan. And as you can see, we expect to grow our rate base at an approximate 8% compound annual rate for the 2022 through 2027 period. Our robust capital plan of approximately $19.7 billion over the next 5 years will deliver significant value to our customers and the communities we serve. Our plan includes strategically allocating capital to all four of our business segments, and importantly, includes investment in a signed MISO long-range transmission planning projects of approximately $800 million and renewable energy projects of approximately $2.5 billion through 2027. Finally, we remain focused on disciplined cost management to keep customer bills as low as possible and improved earned returns in all of our businesses. Moving to Page 11. As we look to the future, our 5-year plan is not only focused on delivering strong results through 2027, but is also designed to position Ameren for success over the next decade and beyond. The right side of this page shows that our allocation of capital is expected to grow our electric and natural gas energy delivery investments to be 81% of our rate base by the end of 2027. Incorporating renewable investment opportunities from our latest IRP, we expect our rate base from renewable generation to grow to 11%, and for coal-fired generation to decline to just 3% of rate base by the end of 2027. In light of the Rush Island and Sue Energy Centers approaching retirement by 2025 and 2030, respectively, only approximately 3.5% of the capital expenditures in our 5-year plan are expected to be spent on coal-related projects, focusing on investments needed for safety, reliability and environmental compliance. The bottom line is that we are taking steps today across the board to position Ameren to provide safe, reliable, affordable and cleaner energy for the long term. Turning now to Page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of $48 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country’s energy needs in the future and delivering on our customers’ expectations. Moving now to Page 13. Our investment plans released today incorporate our intentions to invest in significant renewable resources as we execute the clean energy transition laid out in our Ameren Missouri Integrated Resource Plan. Our IRP lays out the most prudent approach to systematically invest in renewable energy generation to complement existing and planned dispatchable resources, building a diverse, reliable, resilient and affordable system for our customers. We continue to work in earnest with developers to acquire renewable generation projects and expect to announce further agreements over the course of this year. We are pleased to say that last week, the Missouri PSC approved our Certificate of Convenience and Necessity for the 200-megawatt Huck Finn solar project. Construction of this facility is expected to create approximately 250 jobs, and once in operation, produce enough energy to power approximately 40,000 homes. We expect the Missouri PSC decision on a remaining pending Certificate of Convenience and Necessity for the 150-megawatt Boomtown solar project by April, though the commission is under no deadline to issue a decision. We look forward to continuing to engage with stakeholders regarding our future generation needs and clean energy transition. Moving to Slide 14. As we’ve discussed in the past, MISO completed a study outlining a potential road map of transmission projects through 2039. In July, MISO approved the first set of projects, which includes $1.8 billion assigned to Ameren. Detailed design work and project planning for the assigned Tranche 1 projects are underway. MISO requests for proposal on the remaining competitive projects have begun to be issued, and we expect the proposal and evaluation process to take place over the course of 2023 and 2024. Looking ahead to Tranche 2, analysis of potential projects is underway and will continue for the remainder of the year. MISO anticipates the Tranche 2 portfolio of projects will be approved in the first half of 2024. Moving to Page 15. As noted earlier, we remain relentlessly focused on continuous improvement and disciplined cost management. Ongoing initiatives include the automation and optimization of numerous processes leveraging the benefits from significant past and future investments in digital technologies and grid modernization. Additionally, in 2022, we extended most of our collective bargaining unit labor agreements out through mid to late 2026 for nearly all Ameren union represented employees, which will provide predictability in our labor costs in the coming years. In 2023, we expect our operations and maintenance expenses to be flat with 2022, and we are targeting flat operations and maintenance expenses through 2027. Moving to Page 16. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2023 and beyond will continue to deliver superior value to our customers, shareholders and the environment. We believe our expectation of 6% to 8% compound annual earnings growth from 2023 through 2027 driven by strong rate base growth compares very favorably with our regulated utility peers. I am confident in our ability to execute our strategy and investment plans across all four of our business segments as we have an experienced and dedicated team with a track record of execution that has positioned us well for future success. Further, our shares continue to offer investors an attractive dividend and the strong earnings growth expectations we outlined today position us well for future dividend growth. Simply put, we believe this results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today, and I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to Page 18 of our presentation. Yesterday, we reported 2022 earnings of $4.14 per share compared to earnings of $3.84 per share in 2021, an increase of approximately 8%. This page summarizes key drivers impacting earnings at each segment. I would note in the fourth quarter, we benefited from colder than normal weather as well as an improved market conditions related to the cash surrender value of our company-owned life insurance investments, which contributed to 2022 earnings results at the top end of the earnings per share guidance range that we outlined on our third quarter call. We’ve also included on this page the year-over-year weather-normalized sales trends for Ameren Missouri. Weather-normalized kilowatt hour sales to Illinois residential and industrial customers were down approximately 1.5% and 1% year-over-year, respectively. And weather-normalized kilowatt hour sales to Illinois commercial customers increased by approximately 0.5%. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Moving to Page 19 of the presentation. Here, we provide an overview of our $19.7 billion of planned capital expenditures for the 2023 through 2027 period by business segment that supports the approximately 8% projected compound annual rate base growth. We’ve incorporated an incremental $2.4 billion compared to the $17.3 billion five-year plan for 2022 through 2026 that we laid out last February. The plan includes investments related to assigned MISO long-range transmission projects as well as renewable energy generation investments aligned with our 2022 Missouri Integrated Resource Plan. As you can see on the right side of this page, we are allocating capital consistent with the allowed return on equity under each regulatory framework. Turning to Page 20. We outlined here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth in cash from operations as investments were reflected in customer rates. We also expect to generate significant tax deferrals. The tax deferrals are driven primarily by the timing differences between financial statement depreciation reflected in customer rates and accelerated depreciation for tax purposes. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. We also plan to continue to use newly issued shares from our dividend reinvestment and employee benefit plans over the five-year guidance period. We expect this to provide equity funding of approximately $100 million annually. In order for us to maintain a strong balance sheet while we fund our robust infrastructure plan, we expect incremental equity issuances of approximately $300 million in 2023 and $500 million each year from 2024 through 2027. The $300 million of equity needs outlined for 2023 have been fulfilled through forward sales agreements under our at-the-market equity distribution program which we expect to settle by the end of this year. All of these actions are expected to enable us to support a consolidated capitalization target of approximately 45% equity. And lastly, the bottom of Page 20 shows our pension and OPEB obligations were well funded at the end of 2022. Constructive regulatory mechanisms are in place for a recovery of associated costs, including a tracker at Ameren Missouri and formulaic rates in the Ameren Illinois Electric Distribution and Ameren Transmission. Moving to Page 21 of our presentation. I would now like to discuss key drivers impacting our 2023 earnings guidance. We expect 2023 diluted earnings per share to be in the range of $4.25 per share to $4.45 per share. On this page and next, we have listed key earnings drivers and assumptions behind our 2023 earnings guidance broken down by segment as compared to the 2022 results. I would note, consistent with past practice, our 2023 earnings guidance does not include any expectation of COLI gains or losses. Beginning with Ameren Missouri. Earnings are expected to rise in 2023. New electric service rates effective July 1, 2023, are expected to increase earnings. The earnings comparison is also expected to be favorably impacted by higher investments in infrastructure that are eligible for PISA primarily during the first half of 2023 before rates are reset. We expect a return to normal weather in 2023 will decrease Ameren Missouri earnings by approximately $0.14 compared to 2022 results. Further, we expect higher interest expense largely driven by higher long-term debt outstanding. And we expect to recognize earnings related to energy efficiency performance incentives from a single plan year in 2023. Moving on, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois and ATXI projects made under forward-looking formula ratemaking. Turning to Page 22. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2023 compared to 2022 from additional infrastructure investments made under Illinois performance-based ratemaking. We also expect higher earnings in Ameren Illinois Electric Distribution from a higher allowed return on equity due to the expected higher 30-year treasury rates. Our guidance incorporates an ROE of 9.55% using a forecasted 3.75% 2023 average yield for the 30-year treasury bond, which is higher than the allowed ROE of 8.9% in 2022. The allowed ROE is applied to year-end rate base. For Ameren Illinois Natural Gas, earnings will benefit from infrastructure investments qualifying for rider treatment which are expected to be partially offset by higher depreciation expense. Moving now to Ameren-wide drivers and assumptions. We expect increased common shares outstanding to unfavorably impact earnings per share by $0.08. And we expect higher interest expense in the Ameren Parent. Of course, in 2023, we will seek to manage all of our businesses to earn as close to our allowed returns as possible while being mindful of operating and other business needs. I’d also like to take a moment to discuss our retail electric sales outlook. We expect weather-normalized Missouri kilowatt-hour sales to be in the range of flat to up approximately 0.5% compounded annually over a five-year plan, excluding the effects of MIA energy efficiency plans using 2022 as the base year. We exclude MIA effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales resulting from our energy efficiency efforts. Turning to Illinois. We expect our weather-normalized kilowatt-hour sales, including energy efficiency, to be relatively flat over our five-year plan. Turning to Page 23, of Missouri regulatory matters. In August, we filed for a $316 million electric revenue increase with the Missouri Public Service Commission. The request includes a 10.2% return on equity, a 51.9% equity ratio and a December 31, 2022, estimated rate base of $11.6 billion. In January, the Missouri Public Service Commission staff and other interviewers filed rebuttal testimony. Missouri PSC staff recommended a $199 million revenue increase including a return on equity range of 9.34% to 9.84% and an equity ratio of 51.84% based on the Ameren Missouri capital structure at September 30, 2022. The equity ratio will be updated to use the capital structure as of December 31, 2022. The difference between our request and the Missouri PSC staff’s recommendation is primarily driven by return on equity and treatment of the High Prairie and Rush Island energy centers. Both of our request and staff’s recommendation will be trued up through December 31, 2022. As always, we will seek to work through these and other differences with interveners as we work through the proceedings. Evidentiary hearings are scheduled to begin in April, and the decision from the Missouri PSC is expected by June 2023 with rates effective by July 1, 2023. Turning to Page 24 for details on Illinois Electric matters. In January, Ameren Illinois Electric Distribution filed its first multiyear rate plan, or MYRP, with the ICC. The MYRP includes a great plan that lays out our electric distribution investment plans for Illinois and supports our annual revenue increase request for the next four years. Our request for $175 million revenue increase in 2024 is based on an average rate base of $4.3 billion, a return on equity of 10.5% and an equity ratio of just under 54%. You can find additional key components of our MYRP on this slide. The base return on equity will be adjusted up or down annually based on seven performance metrics focused heavily on reliability and peak load reduction. Importantly, our capital expenditure plans for the coming years are expected to drive improvements in many of the areas of focus for these performance metrics. An annual revenue requirement true-up will take place each year with 105% cap on actual costs compared to the revenue requirement approved in the MYRP. However, many variable items, such as changes in purchase power costs, interest rates, changes in taxes and large storm restoration costs, are excluded from this cap. We expect the ICC decision on the MYRP by December 2023 with new rates effective in January 2024. Additionally, as part of the Illinois Energy Transition legislation, in June, Ameren Illinois filed a transportation beneficial electrification plan. The plan proposes to spend $27 million to provide incentives, rates and programs to encourage electric vehicle utilization and infrastructure development across Ameren Illinois service territory through 2025. This is being done in support of the Governor’s goal of 1 million electric vehicles on the road by 2030. We expect an ICC order on the transportation electrification filing by the end of March 2023. Moving to Page 25. We recently concluded our formula rate review of Ameren Illinois Electric Distribution. In December, the ICC approved a $61 million rate increase as part of its annual performance-based rate update. New rates became effective in January. Major investments included in this request were the installation of outage avoidance and detection technology, integration of storm-hardening equipment and the implementation of new technology to improve communication with our customers. Since implementing the performance-based ratemaking in 2012, reliability has increased by approximately 20%, and the equivalent of over 1,700 jobs have been created. We look forward to the new performance-based rate making under the MYRP, which will also allow us the opportunity to improve our returns in exchange for meaningful improvements for the benefit of our customers. Finally, in January, Ameren Illinois Natural Gas requested a $160 million revenue increase from the ICC based on a 10.7% return on equity and an approximately 54% equity ratio and a $2.9 billion rate base using our future 2024 test year. This requested increase includes approximately $77 million that would otherwise be recovered in 2024 under QIP and other riders. An ICC decision is required by late November 2023, with rates expected to be effective in early December 2023. You can see we have an active regulatory calendar ahead of us. We’ve developed strong relationships with our stakeholders and have a long track record of constructive results that show our investments are truly making a difference in the lives of our customers. On Page 26, we provide an update regarding the Inflation Reduction Act. As we sit here today, we do not expect the corporate minimum tax, or CMT, to apply in 2023 or 2024. We continue to model the CMT, and it’s possible it could impact 2025 and beyond. We await additional guidance from Treasury, which we expect to provide further clarity. Again, these potential incremental annual cash tax payments are not expected to be material. These estimates are of course subject to the amount and timing of capital expenditures being placed in service or retired, timing of rate reviews and additional guidance that may be issued by the IRS or Department of Treasury, among other items. Finally, moving to Page 27. I’ll emphasize again that we have a strong team and are well positioned to continue executing our plan. We delivered strong earnings growth in 2022, and we expect to deliver strong earnings growth in 2023 as we continue to successfully execute our strategy. And as we look ahead, we expect 6% to 8% compound earnings per share growth from 2023 to 2027, driven by robust rate base growth and disciplined cost management. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continued to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions] Our first question comes from the line of Nicholas Campanella with Credit Suisse. Please proceed with your question.
Nicholas Campanella: Hey, everyone. Thanks for all the info today and Andrew, welcome back. Really happy to hear your voice.
Andrew Kirk: Thanks, Nick. Appreciate it.
Nicholas Campanella: Absolutely. Yes. So I guess just on the Missouri rate case, you did have some differences here in rate base for staff, but just wanted to get a sense of your overall appetite to settle this case if that’s still a possibility – just thinking back to how prior cases have gone. Thank you.
Marty Lyons: Yes, Nick, this is Marty Lyons. Good morning. Thanks for the question. Yes. Look, as we go into each case, we certainly are hopeful of being able to reach a constructive settlement. And as we talked about many times, we have a good history of working with stakeholders in Missouri and reaching constructive settlements. We outlined where we are in the case today in our prepared materials, you saw in the slide deck, and we outlined some of the issues that divide us today, mainly in some of the traditional areas like ROE, but also on a couple of issues like High Prairie and Rush Island energy centers, where there’s some differences between us and the staff in particular. Importantly, all of us will be updating our cases based on year-end rate base as well as other true-up items that go through December 31. So you mentioned some of the differences in rate base. Really, those are just timing differences between the staff’s rate base, which was as of June 30 and the company’s filed position, which projected through December 31. But all of those things are going to be trued up here in the coming days up through December 31. So importantly, some dates that we highlighted, a final reconciliation of the parties’ positions will be due March 30, and that comes after server bottle testimony, which is on March 13. And then evidentiary hearings of those are needed would start on April 3. So traditionally, the best time to be able to reach a constructive settlement given where this rate case is, this rate review would be end of March, early April in terms of when you might be able to really reach a constructive settlement with the parties.
Nicholas Campanella: That’s helpful. Appreciate that. And then just on the equity financing, recognizing that you did raise CapEx in this new five-year plan. You do have some sizable needs here in the out years and I know you recently last quarter also said that you were increasing the ATM to $1 billion for 2024 and beyond. But can you just help us understand, with the equity in the plan, just your preferred source of funding that or sourcing it, rather.
Michael Moehn: Yes. Yes, you bet, Nick. Good morning. This is Michael, A couple of things, then I’ll get specifically on that question. I mean, again, I think as we’ve talked over time, I mean, we do believe our balance sheet really provides us a position of strength here. We’ve worked hard to continue to conservatively manage it. I think we like our ratings where they are, Baa1, BBB+. We obviously have more margin at S&P than we do at Moody’s. We talked about that from time to time. We continue to target this capitalization ratio of close to 45%, which I think, again, it served us well in these various regulatory proceedings and making sure we’re maintaining these balance sheets appropriately at the subsidiaries. In terms of what we need here, you’re right. I mean, the $2.4 billion of incremental capital, I think what we continue to message along the year, as we thought about any increases in capital associated with these opportunities around LRTP or the renewables that we should continue to think about our balance sheet in a similar fashion. And I think that’s what we’re doing here, we’re laying out this incremental really $800 million of equity. There’s some obviously retained earnings in there as well, kind of gets you back to that same sort of capitalization ratio. The ATM has served us well up to this point. I mean, we’ve taken care of all of our needs for 2023, Nick. We’ve sold forward in 2023. So we’re really finished with that $300 million. We started to sell forward into 2024. You’re right that we did increase the capacity of the ATM. We’ll have to continue to evaluate that over time as we would run into any limits there. But again, it’s a really efficient way for us to issue capital. We think it’s a manageable amount if you look at it relative to our total market capitalization. So we feel comfortable with it. And again, I think that it provides us quite a bit of strength there as we just think about the overall funding that we need over the course of the next five years.
Nicholas Campanella: Appreciate the color. I’ll get back in the queue. Thank you.
Operator: Our next question comes from Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Hi. Good morning.
Marty Lyons: Good morning, Jeremy.
Jeremy Tonet: I just wanted to start off with, I guess, a rate base CAGR, the 8% as you laid out there in the $2.5 billion figure. Just wondering, what are the IRP assumptions in your CapEx plan update that – underpin the $2.5 billion there. And what does this imply for company ownership of resources versus PPA? And how do you view the overall line of sight here? And when do you expect to kind of get final commission decisions on all resources?
Marty Lyons: Yes. Good morning, Jeremy, this is Marty. There’s a few questions, I think, embedded in that question. So I’ll start and perhaps Michael would want to add on. First of all, the capital expenditures that we’ve put into the plan in Missouri for the IRP really tie to the plan that we laid out in the IRP. So if you go back and you look at that overall time line, we plan to add 800 megawatts through 2025 and then another 2,000 megawatts of renewables between 2026 and 2030. And if you just do some simple math there, it’s about 400 megawatts per year. So you end up with about 1,600 megawatts overall over a five-year period. And again, we’ve put in about $2.5 billion as an estimate for that. So that’s how it lines up. We were pleased to have the commission, Missouri Public Service Commission approved the Huck Finn project, which was a 200-megawatt solar project we’d proposed, they approved that one recently at CCN. And of course, we’ve got the Boomtown project, which is a 150-megawatt solar project before them now and awaiting the decision. And we continue to work with developers on additional renewable projects to really fill out that plan that we have under the IRP, which we think is absolutely the most prudent way to move forward to provide our customers the reliable, affordable and cleaner energy that they’re seeking. Now back to the overall CapEx plan. What you’ll notice is we’ve got a $19.7 billion overall capital expenditure plan for 2023 to 2027. That compares to the one we had previously, which was 2022 to 2026, we had $17.3 billion. So we’ve added about $2.4 billion overall as we move from our prior plan to this one. And in Missouri in particular, I’d point out that we previously had $8.9 billion of planned expenditures moving now to $10.4 million, which is about a $1.5 billion overall addition. So we’ve embedded the expectation of those renewable projects getting done in the overall $10.4 million. But I would say we’ve taken a measured approach to upping our overall capital expenditure plan, which gives us great confidence in our ability to achieve it. Again, we’ve already had one renewable project approved. We’ve got a strong pipeline of capital expenditure opportunity over the next 10 years, as we’ve talked about, $48 billion and have a lot of confidence in our ability to execute, not only the $10.4 billion plan for Missouri, but the overall $19.7 billion plan we’ve laid out today.
Michael Moehn: Yes. The only thing, Jeremy, I might add to that, Marty just gave a really comprehensive answer, is just specifically with the pipeline to renewables itself. And look, the team continues to do a lot of really hard work here. There’s some active RFPs they continue to have open. They continue to have a lot of conversations with developers about these projects. I think you had something embedded there about how do we think about maybe PPAs versus ownership. Again, we believe that ownership is in the best interest of our customers for the long term, and that’s really where our focus has been. It’s certainly evidenced by what we did with the wind projects. Certainly, we’re closing with the two renewable solar projects that Marty spoke about. So I’d say an active pipeline, and I think, obviously, the supply chain issues have been well publicized. I think we continue to work through those and feel good about the projects we have out there, and it’s going to continue to be a lot of focus and effort over the coming years.
Jeremy Tonet: Got it. That's very helpful there. And then moving, I guess, to MISO here, what are your current thoughts on potential MISO long-range transmission planning, given MISO seems to be modeling more aggressive assumptions in light of IRA. So wondering your thoughts on the outlook there.
Michael Moehn: Yes. I would say with respect to Tranche 2, we're certainly actively engaged with other stakeholders with MISO and modeling out the benefits of potential projects that would come out of tranche our overall expectation as we sit here today is that the overall portfolio of projects that MISO would approve as part of tranche to will be larger than the overall size of the projects that were approved as part of Tranche 1. But I think it'd be premature to comment on specifically which projects might land in our service territory or be assigned specifically to us. But rest assured, we'll be working with other stakeholders to model the transmission projects that we think would be best for customers and the reliability of the system overall and to obviously effectuate the clean energy transition. And we do expect that, as we said in our prepared remarks, MISO, to make some final determination early next year.
Jeremy Tonet: Got it. That's very helpful. And then just kind of tying this together, you've raised CapEx. You've raised rate base growth a little bit here. I'm just wondering what you think this could mean for EPS. You don't have the 30-year, I guess, bringing fluctuations in the way that it was in the past. So as you currently look at your EPS CAGR outlook, do you see any bias within the range towards the higher parts, given this step up in CapEx and rate base here, rate base growth?
Marty Lyons: Yes, Jeremy, I mean, I think as you know, I mean, our past practice really has not been to sort of speculate where we'll be within that range. I think I'll point to where we have achieved results, obviously. Historically, we've been to 7.5% CAGR since about 2013. So I'll let that sort of speak to itself. Obviously, we did raise the rate base growth from 7% to 8%. And I mean again, as you think about that range, over time, it drives about a $0.45 range, that 6% to 8% over that kind of five-year period. And obviously, there are some drivers, as you pointed out, in terms of just outcomes in the multiyear rate plan, earned versus allowed ROEs, financing assumptions, et cetera. But again, let sort of the past speak for itself at the moment.
Michael Moehn: Yes. And Jeremy, I'd just reiterate what I said. We feel very confident in our ability to be able to execute that $19.7 billion CapEx plan, which gives us confidence in our ability to execute that 8% rate base growth plan. And that underscores our confidence in the 6% to 8% EPS CAGR that we've outlined today.
Jeremy Tonet: Got it. That's helpful. I'll leave it there. And Andrew, really great to hear you on the call.
Andrew Kirk: Thanks, Jeremy. Appreciate it. Glad to hear you, too.
Operator: [Operator Instructions] Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Julien Dumoulin-Smith: Hey, good morning, team. Thanks for the time, appreciate the comments thus far. Maybe to follow up on Nick's question earlier, just with respect to Illinois and prospects for settling here. Any further elaborations around the new compact there? Just as you step into this, I just want to understand. Does this need to be sort of fully litigated and fully fleshed out to establish more of a record, given the context of some shift in the compact here? And again, that's a question specifically directed at both the electric and the gas.
Marty Lyons: Yes. Julien, this is Marty. Yes, I think your intuition is probably right there, especially as it relates to the multiyear rate plan. I think it's hard to speculate. I mean, if ever we have the opportunity to really enter into a constructive settlement with stakeholders, we're certainly going to be interested in having that dialogue with stakeholders. I think it's just very early in this multiyear rate plan filing. Obviously, we haven't seen any staff or intervenor direct testimony. We won't see that until May. And really premature to know whether it's something that could be constructively settled or not. I will note that in Illinois, there hasn't been that history of overall global settlements that we've had in Missouri. But we'll certainly be looking after we get testimony to work with stakeholders to resolve differences, narrow the issues. And if we can, settle and that would hold true for the gas case as well.
Julien Dumoulin-Smith: Right. It holds through as and you probably want to work through a fully litigated case here.
Marty Lyons: No. I guess what I was saying there is we're always going to be wanting to work with stakeholders. Once we see the differences to narrow those differences, certainly correct any errors and really to narrow the issues. And if we can reach a global settlement and put that before the commission, we'll seek to do that. I was just saying with respect to the electric distribution part of the business, given the newness of this framework and the fact that we haven't seen any testimony really premature to say whether that's something that has a high degree of probability.
Julien Dumoulin-Smith: Yes. All right. And actually, as it pertains to QIP here, just – I know that there's a new framework on the electric side, and that's largely established at this point pending implementation. But QIP and its subsequent forms or iterations remains a little bit outstanding. Can you elaborate what your thoughts are, and perhaps going back whether legislatively or otherwise at this point, to get something new? Again, I'll leave it open ended on what that might look like. I know we've talked about this in the past at times, but is there a window today to revisit that conversation perhaps in the slate you did before?
Michael Moehn: Julian, this is Marty again. Look, we haven't given up some sort of replacement for QIP and really because the QIP was in our die really great rider for our customers, really allowed us to make some investments that bolster the safety and reliability of the gas system. I'd say our focus right now is really though on the gas case that you and I just discussed. And really looking to get a constructive resolution of that case. As you know, the overall gas regulatory environment, even without QIP is solid with forward test years, revenue decoupling, bad debt riders, et cetera. So we believe that going forward, without the QIP, we'd need to be thoughtful about the timing of rate reviews, but they do use forward test years, which I think is very important to think about. And we'll be thoughtful about the timing of capital expenditures to replace aging equipment, et cetera. So we do think the regulatory environment without QIP is something we can manage around, we can still invest, we can earn good returns. But we will look for windows of opportunity to look for something to replace the QIP. I'll leave the door open like you did in terms of what form that may take. But right now, our focus is on that gas case.
Julien Dumoulin-Smith: Yes. Excellent. And then sorry, quick clarification from earlier. Boomtown, just is there anything different about this? Say, relative to Huck Finn or something like that, that might stand out in terms of that approval process? Obviously, the timing here being a little different in terms of the duration for the CCF.
Marty Lyons: Yes. I think one of the differences, Julian, is the Huck Finn project was proposed to be compliance with the renewable energy standard that we have in Missouri, and it was approved as such. The Boomtown project is really being proposed twofold. One, for customers, especially large industrial commercial customers that are looking for renewable energy as part of a consumer program for them, and as well as part of our transition under the IRP. But it's not being proposed for specific compliance with the renewable energy standard. And so that's a distinguishing fact between the two.
Julien Dumoulin-Smith: Andrew, I echo the sentiment.
Andrew Kirk: Thanks, Julien. Appreciate it.
Operator: We have reached the end of the question-and-answer session. I would now like to turn the call back to Marty Lyons for closing comments.
Marty Lyons: Well, thank you all for joining us today. As you heard, we had a very strong 2022, and we really remain focused on delivering again in 2023 and beyond, for our customers, for our communities and for our shareholders. So with that, be safe, and we look forward to seeing many of you over the coming months.
Operator: This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host for today's call, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings. For more information about various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Andrew, and welcome back. We're thrilled that you're healthy again and here with us for this call and ready to fully engage with our investors and the analysts. Good morning, everyone, and thank you for joining us today as we reflect on our 2022 performance and look ahead to 2023 and beyond. I'd like to start by expressing appreciation for the Ameren team's dedication and hard work over the last year. In 2022, we continued to successfully execute our long-term strategy, as shown on Page 4, which is delivering strong results today while laying a strong foundation for the future. Shown on Page 5 are some exciting strategic achievements from the past year for Ameren, our customers, shareholders, the environment and the industry as a whole. Let me touch on a few key accomplishments. We made $3.4 billion of infrastructure investments in 2022 that resulted in a more reliable, resilient, secure and cleaner energy grid, as well as contributed to strong growth at all of our business segments. For example, as part of our Ameren Missouri Smart Energy Plan, over 400 smart switches were installed to reduce outages from hours to minutes and even seconds, and 34 substations were upgraded or built new to better serve communities. In addition, over 300,000 smart meters were installed for our Missouri customers, enabling better visibility into their energy usage. In Illinois, our customers are benefiting from the replacement of more than 3,000 electric poles, 64 miles of coupled steel distribution pipelines and 24 miles of gas transmission pipelines. Further, our transmission business placed in service 19 new or upgraded transmission substations and approximately 200 miles of new or upgraded transmission lines. These are just a few of the many projects completed in 2022. As a result of these and similar investments, I'm proud to say that Ameren's most recent system average interruption frequency reliability scores have ranked in the top quartile of our industry. We also had several achievements on the regulatory and legislative front. In February, new Ameren Missouri Electric Service rates took effect as a result of our 2021 rate review, which was constructively settled. In June, we filed a change to our integrated resource plan, accelerating our planned clean energy investments, carbon emission reduction goals and our plan to achieve net-zero by 2045 while thoughtfully considering customer affordability and energy grid reliability. In July, our pipeline of investments was significantly enhanced when the Mid-Continent Independent System Operator, or MISO, approved a portfolio of long-range transmission projects, including significant projects in our operating footprint. And in August, Senate Bill 745 was enacted in Missouri, extending the constructive smart energy plan legislation that became law in 2018 out through 2028, with possible extension to 2033. I’m pleased to say that a result – as a result of these developments, in 2022, we were able to increase our 10-year investment opportunity pipeline from $40 billion to $48 billion. Further, in our Ameren Illinois Electric Distribution business, in September, the Illinois Commerce Commission, or ICC, approved constructive performance metrics, which paved the way for our multiyear rate plan filing this January. And finally, at the federal level, passage of the inflation Reduction Act will support the clean energy transition, reducing the cost of related infrastructure investments for both our customers in both Missouri and Illinois. I would like to express appreciation for all the hard work of the entire Ameren team to advance these important achievements. At the same time, across Ameren, we are all working to keep customer bills as low as possible while investing to ensure we provide safe, reliable and cleaner energy for our customers. We remain laser-focused on disciplined cost management, practicing continuous improvement and optimizing our operating performance as we transform our business. In 2022, we continued our transition to a cleaner energy generation portfolio, and as planned in December, we retired our oldest and least-efficient coal-fired plant, the Meramec Energy Center. Thank you to all of our coworkers who have worked at Meramec providing reliable energy over the past several decades. We recognize that our customers depend on us every day to supply the energy that supports their daily lives, and as such, we have kept them at the center of our strategy. We are honored that in 2022 and for the third consecutive year, our residential customers have recognized Ameren with a top-quartile overall customer satisfaction ranking among large electric utility providers in the Midwest. In addition, Ameren Missouri ranked number one in business customer satisfaction. And finally, for our shareholders. Yesterday, we announced 2022 earnings of $4.14 per share compared to earnings of $3.84 per share in 2021. This result was at the high end of our earnings per share guidance range. The strong execution of our strategy in 2022 reflects strategic alignment across all of our business segments. We are staying focused on optimizing our operations and safely completing billions of dollars of value-adding projects to deliver significant value to our customers, communities, shareholders and the environment. Turning now to Page 6. Here, you can see we have delivered consistent superior value to our shareholders for nearly a decade. Since 2013, our weather-normalized core earnings per share have risen 92% at an approximate 7.5% compound annual growth rate, while our annual dividends paid per share have increased approximately 48% over the same time period. This drove a strong total return of nearly 226% for our shareholders from 2013 to 2022, which was significantly above our utility peer average. While I am very pleased with our track record of strong and consistent performance, rest assured that we are not letting up. Our team will remain focused on enhancing performance in 2023 and in the years ahead so that we can continue to deliver superior value to our customers, communities and shareholders. Turning to Page 7. This page summarizes our strong sustainability value proposition and focus on environmental, social, governance and sustainable growth goals and reflects the way we integrate our sustainability values into our normal course of business. Beginning with environmental stewardship. Last June, we announced an acceleration of our transformational generation resource plan, now aiming to achieve net-zero Scope 1 and 2 carbon emissions by 2045 and across all of our operations in Missouri and Illinois, which is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. This plan also advances our interim greenhouse gas emission reduction targets to 60% and 85% below 2005 levels by 2030 and 2040, respectively. As mentioned, in 2022, we were assigned certain projects as part of the Tranche 1 project portfolio to prospectively build and operate significant transmission investments in MISO territory. These as well as other transmission investments will provide our region access to a diverse mix of energy resources and are an important step forward to support a smooth clean energy transition. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. One example is our effort to drive inclusive economic growth at Ameren and in our communities. In 2022, we spent approximately $1.1 billion with diverse suppliers, including minority, women and veteran-owned businesses, a 22% increase over 2021. Because of actions like this, in May, we were honored to be recognized again by Diversity Inc. as number one on the nation's top utilities list for diversity, equity and inclusion. This is the 14th consecutive year we have been named to this distinguished list. I am also very pleased to say that Ameren was named a top company for ESG for the third consecutive year. In addition, we continue to support many nonprofit organizations in the communities we serve, including programs focused on DE&I, to which, we have made a $10 million contribution commitment by 2025. Moving to governance. Our strong corporate governance is led by a diverse Board of Directors focused on strong oversight of our sustainability efforts. In 2022, we named our first combined Chief Sustainability, Diversity and Philanthropy Officer to further optimize our initiatives. And our executive compensation practices include performance metrics that are tied to diversity, equity, inclusion and progress toward a clean energy future for all. Finally, this slide summarizes our very strong sustainable growth proposition, which we believe remains among the best in the industry. Today, we published our updated sustainability investor presentation called Leading the Way to a Sustainable Energy Future, which is available at amereninvestors.com. It demonstrates how we have been effectively integrating our sustainability values and practices into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. Moving to Page 8, we turn our focus to the current year. We expect 2023 to be another busy year, and we are excited about a number of strategic objectives. Notably, we will maintain our focus on significant infrastructure investment for the benefit of our customers. We expect to invest approximately $3.5 billion in electric, natural gas and transmission infrastructure to bolster safety, security, reliability, resiliency and further the clean energy transition in a responsible fashion. And as the nation's clean energy transition continues, we plan to help develop the needed transmission investment by submitting bids for the MISO Tranche 1 competitive long-range transmission projects as well as support analysis of potential Tranche 2 projects. We have an active regulatory calendar this year. We look to constructively conclude our Ameren Missouri electric rate review Ameren Illinois Electric multiyear rate plan and Ameren Illinois natural gas rate review. We will also work to successfully advocate for certificates of convenience and necessity for future renewable generation at Ameren Missouri. And our next Ameren Missouri integrated resource plan will be filed in September, which will include a comprehensive update of assumptions, including changes driven by the inflation Reduction Act enacted last year. Finally, we are focused on maintaining disciplined cost management with the expectation of holding operations and maintenance expenses flat in 2023 relative to 2022. Moving now to Page 9. I Yesterday afternoon, we announced that we expect our 2023 earnings to be in a range of $4.25 to $4.45 per share. Based on the midpoint of the range, this represents 7% earnings per share growth compared to the midpoint of our original 2022 guidance range of $4.05 per share. Michael will provide you with more details on our 2023 guidance a bit later. Building on the strong execution of our strategy and our robust earnings growth over the past several years, we expect to deliver 6% to 8% compound annual earnings per share growth from 2023 through 2027 using the midpoint of our 2023 guidance, $4.35 per share, as the base. Our dividend is another important element of our strong total shareholder return proposition. Last week, Ameren's Board of Directors approved a quarterly dividend increase of approximately 7%, resulting in an annualized dividend rate of $2.52 per share. This represents our third consecutive year of approximately 7% dividend growth, and the increase reflects confidence by Ameren's Board of Directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect Ameren's future dividend growth to be in line with our long-term earnings per share growth expectations and within a payout ratio range of 55% to 70%. We expect our weather-normalized dividend payout ratio in 2023 to be approximately 58%. I have full confidence in our team as we look ahead. Turning to Page 10. The strong long-term earnings growth I just discussed is primarily the result of rate base growth driven by investment in energy infrastructure under constructive regulatory frameworks. Today, we are rolling forward our five-year investment plan. And as you can see, we expect to grow our rate base at an approximate 8% compound annual rate for the 2022 through 2027 period. Our robust capital plan of approximately $19.7 billion over the next 5 years will deliver significant value to our customers and the communities we serve. Our plan includes strategically allocating capital to all four of our business segments, and importantly, includes investment in a signed MISO long-range transmission planning projects of approximately $800 million and renewable energy projects of approximately $2.5 billion through 2027. Finally, we remain focused on disciplined cost management to keep customer bills as low as possible and improved earned returns in all of our businesses. Moving to Page 11. As we look to the future, our 5-year plan is not only focused on delivering strong results through 2027, but is also designed to position Ameren for success over the next decade and beyond. The right side of this page shows that our allocation of capital is expected to grow our electric and natural gas energy delivery investments to be 81% of our rate base by the end of 2027. Incorporating renewable investment opportunities from our latest IRP, we expect our rate base from renewable generation to grow to 11%, and for coal-fired generation to decline to just 3% of rate base by the end of 2027. In light of the Rush Island and Sue Energy Centers approaching retirement by 2025 and 2030, respectively, only approximately 3.5% of the capital expenditures in our 5-year plan are expected to be spent on coal-related projects, focusing on investments needed for safety, reliability and environmental compliance. The bottom line is that we are taking steps today across the board to position Ameren to provide safe, reliable, affordable and cleaner energy for the long term. Turning now to Page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of $48 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country’s energy needs in the future and delivering on our customers’ expectations. Moving now to Page 13. Our investment plans released today incorporate our intentions to invest in significant renewable resources as we execute the clean energy transition laid out in our Ameren Missouri Integrated Resource Plan. Our IRP lays out the most prudent approach to systematically invest in renewable energy generation to complement existing and planned dispatchable resources, building a diverse, reliable, resilient and affordable system for our customers. We continue to work in earnest with developers to acquire renewable generation projects and expect to announce further agreements over the course of this year. We are pleased to say that last week, the Missouri PSC approved our Certificate of Convenience and Necessity for the 200-megawatt Huck Finn solar project. Construction of this facility is expected to create approximately 250 jobs, and once in operation, produce enough energy to power approximately 40,000 homes. We expect the Missouri PSC decision on a remaining pending Certificate of Convenience and Necessity for the 150-megawatt Boomtown solar project by April, though the commission is under no deadline to issue a decision. We look forward to continuing to engage with stakeholders regarding our future generation needs and clean energy transition. Moving to Slide 14. As we’ve discussed in the past, MISO completed a study outlining a potential road map of transmission projects through 2039. In July, MISO approved the first set of projects, which includes $1.8 billion assigned to Ameren. Detailed design work and project planning for the assigned Tranche 1 projects are underway. MISO requests for proposal on the remaining competitive projects have begun to be issued, and we expect the proposal and evaluation process to take place over the course of 2023 and 2024. Looking ahead to Tranche 2, analysis of potential projects is underway and will continue for the remainder of the year. MISO anticipates the Tranche 2 portfolio of projects will be approved in the first half of 2024. Moving to Page 15. As noted earlier, we remain relentlessly focused on continuous improvement and disciplined cost management. Ongoing initiatives include the automation and optimization of numerous processes leveraging the benefits from significant past and future investments in digital technologies and grid modernization. Additionally, in 2022, we extended most of our collective bargaining unit labor agreements out through mid to late 2026 for nearly all Ameren union represented employees, which will provide predictability in our labor costs in the coming years. In 2023, we expect our operations and maintenance expenses to be flat with 2022, and we are targeting flat operations and maintenance expenses through 2027. Moving to Page 16. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2023 and beyond will continue to deliver superior value to our customers, shareholders and the environment. We believe our expectation of 6% to 8% compound annual earnings growth from 2023 through 2027 driven by strong rate base growth compares very favorably with our regulated utility peers. I am confident in our ability to execute our strategy and investment plans across all four of our business segments as we have an experienced and dedicated team with a track record of execution that has positioned us well for future success. Further, our shares continue to offer investors an attractive dividend and the strong earnings growth expectations we outlined today position us well for future dividend growth. Simply put, we believe this results in a very attractive total return opportunity for shareholders. Again, thank you all for joining us today, and I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to Page 18 of our presentation. Yesterday, we reported 2022 earnings of $4.14 per share compared to earnings of $3.84 per share in 2021, an increase of approximately 8%. This page summarizes key drivers impacting earnings at each segment. I would note in the fourth quarter, we benefited from colder than normal weather as well as an improved market conditions related to the cash surrender value of our company-owned life insurance investments, which contributed to 2022 earnings results at the top end of the earnings per share guidance range that we outlined on our third quarter call. We’ve also included on this page the year-over-year weather-normalized sales trends for Ameren Missouri. Weather-normalized kilowatt hour sales to Illinois residential and industrial customers were down approximately 1.5% and 1% year-over-year, respectively. And weather-normalized kilowatt hour sales to Illinois commercial customers increased by approximately 0.5%. Recall that changes in electric sales in Illinois, no matter the cause, do not affect our earnings since we have full revenue decoupling. Moving to Page 19 of the presentation. Here, we provide an overview of our $19.7 billion of planned capital expenditures for the 2023 through 2027 period by business segment that supports the approximately 8% projected compound annual rate base growth. We’ve incorporated an incremental $2.4 billion compared to the $17.3 billion five-year plan for 2022 through 2026 that we laid out last February. The plan includes investments related to assigned MISO long-range transmission projects as well as renewable energy generation investments aligned with our 2022 Missouri Integrated Resource Plan. As you can see on the right side of this page, we are allocating capital consistent with the allowed return on equity under each regulatory framework. Turning to Page 20. We outlined here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth in cash from operations as investments were reflected in customer rates. We also expect to generate significant tax deferrals. The tax deferrals are driven primarily by the timing differences between financial statement depreciation reflected in customer rates and accelerated depreciation for tax purposes. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. We also plan to continue to use newly issued shares from our dividend reinvestment and employee benefit plans over the five-year guidance period. We expect this to provide equity funding of approximately $100 million annually. In order for us to maintain a strong balance sheet while we fund our robust infrastructure plan, we expect incremental equity issuances of approximately $300 million in 2023 and $500 million each year from 2024 through 2027. The $300 million of equity needs outlined for 2023 have been fulfilled through forward sales agreements under our at-the-market equity distribution program which we expect to settle by the end of this year. All of these actions are expected to enable us to support a consolidated capitalization target of approximately 45% equity. And lastly, the bottom of Page 20 shows our pension and OPEB obligations were well funded at the end of 2022. Constructive regulatory mechanisms are in place for a recovery of associated costs, including a tracker at Ameren Missouri and formulaic rates in the Ameren Illinois Electric Distribution and Ameren Transmission. Moving to Page 21 of our presentation. I would now like to discuss key drivers impacting our 2023 earnings guidance. We expect 2023 diluted earnings per share to be in the range of $4.25 per share to $4.45 per share. On this page and next, we have listed key earnings drivers and assumptions behind our 2023 earnings guidance broken down by segment as compared to the 2022 results. I would note, consistent with past practice, our 2023 earnings guidance does not include any expectation of COLI gains or losses. Beginning with Ameren Missouri. Earnings are expected to rise in 2023. New electric service rates effective July 1, 2023, are expected to increase earnings. The earnings comparison is also expected to be favorably impacted by higher investments in infrastructure that are eligible for PISA primarily during the first half of 2023 before rates are reset. We expect a return to normal weather in 2023 will decrease Ameren Missouri earnings by approximately $0.14 compared to 2022 results. Further, we expect higher interest expense largely driven by higher long-term debt outstanding. And we expect to recognize earnings related to energy efficiency performance incentives from a single plan year in 2023. Moving on, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois and ATXI projects made under forward-looking formula ratemaking. Turning to Page 22. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2023 compared to 2022 from additional infrastructure investments made under Illinois performance-based ratemaking. We also expect higher earnings in Ameren Illinois Electric Distribution from a higher allowed return on equity due to the expected higher 30-year treasury rates. Our guidance incorporates an ROE of 9.55% using a forecasted 3.75% 2023 average yield for the 30-year treasury bond, which is higher than the allowed ROE of 8.9% in 2022. The allowed ROE is applied to year-end rate base. For Ameren Illinois Natural Gas, earnings will benefit from infrastructure investments qualifying for rider treatment which are expected to be partially offset by higher depreciation expense. Moving now to Ameren-wide drivers and assumptions. We expect increased common shares outstanding to unfavorably impact earnings per share by $0.08. And we expect higher interest expense in the Ameren Parent. Of course, in 2023, we will seek to manage all of our businesses to earn as close to our allowed returns as possible while being mindful of operating and other business needs. I’d also like to take a moment to discuss our retail electric sales outlook. We expect weather-normalized Missouri kilowatt-hour sales to be in the range of flat to up approximately 0.5% compounded annually over a five-year plan, excluding the effects of MIA energy efficiency plans using 2022 as the base year. We exclude MIA effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales resulting from our energy efficiency efforts. Turning to Illinois. We expect our weather-normalized kilowatt-hour sales, including energy efficiency, to be relatively flat over our five-year plan. Turning to Page 23, of Missouri regulatory matters. In August, we filed for a $316 million electric revenue increase with the Missouri Public Service Commission. The request includes a 10.2% return on equity, a 51.9% equity ratio and a December 31, 2022, estimated rate base of $11.6 billion. In January, the Missouri Public Service Commission staff and other interviewers filed rebuttal testimony. Missouri PSC staff recommended a $199 million revenue increase including a return on equity range of 9.34% to 9.84% and an equity ratio of 51.84% based on the Ameren Missouri capital structure at September 30, 2022. The equity ratio will be updated to use the capital structure as of December 31, 2022. The difference between our request and the Missouri PSC staff’s recommendation is primarily driven by return on equity and treatment of the High Prairie and Rush Island energy centers. Both of our request and staff’s recommendation will be trued up through December 31, 2022. As always, we will seek to work through these and other differences with interveners as we work through the proceedings. Evidentiary hearings are scheduled to begin in April, and the decision from the Missouri PSC is expected by June 2023 with rates effective by July 1, 2023. Turning to Page 24 for details on Illinois Electric matters. In January, Ameren Illinois Electric Distribution filed its first multiyear rate plan, or MYRP, with the ICC. The MYRP includes a great plan that lays out our electric distribution investment plans for Illinois and supports our annual revenue increase request for the next four years. Our request for $175 million revenue increase in 2024 is based on an average rate base of $4.3 billion, a return on equity of 10.5% and an equity ratio of just under 54%. You can find additional key components of our MYRP on this slide. The base return on equity will be adjusted up or down annually based on seven performance metrics focused heavily on reliability and peak load reduction. Importantly, our capital expenditure plans for the coming years are expected to drive improvements in many of the areas of focus for these performance metrics. An annual revenue requirement true-up will take place each year with 105% cap on actual costs compared to the revenue requirement approved in the MYRP. However, many variable items, such as changes in purchase power costs, interest rates, changes in taxes and large storm restoration costs, are excluded from this cap. We expect the ICC decision on the MYRP by December 2023 with new rates effective in January 2024. Additionally, as part of the Illinois Energy Transition legislation, in June, Ameren Illinois filed a transportation beneficial electrification plan. The plan proposes to spend $27 million to provide incentives, rates and programs to encourage electric vehicle utilization and infrastructure development across Ameren Illinois service territory through 2025. This is being done in support of the Governor’s goal of 1 million electric vehicles on the road by 2030. We expect an ICC order on the transportation electrification filing by the end of March 2023. Moving to Page 25. We recently concluded our formula rate review of Ameren Illinois Electric Distribution. In December, the ICC approved a $61 million rate increase as part of its annual performance-based rate update. New rates became effective in January. Major investments included in this request were the installation of outage avoidance and detection technology, integration of storm-hardening equipment and the implementation of new technology to improve communication with our customers. Since implementing the performance-based ratemaking in 2012, reliability has increased by approximately 20%, and the equivalent of over 1,700 jobs have been created. We look forward to the new performance-based rate making under the MYRP, which will also allow us the opportunity to improve our returns in exchange for meaningful improvements for the benefit of our customers. Finally, in January, Ameren Illinois Natural Gas requested a $160 million revenue increase from the ICC based on a 10.7% return on equity and an approximately 54% equity ratio and a $2.9 billion rate base using our future 2024 test year. This requested increase includes approximately $77 million that would otherwise be recovered in 2024 under QIP and other riders. An ICC decision is required by late November 2023, with rates expected to be effective in early December 2023. You can see we have an active regulatory calendar ahead of us. We’ve developed strong relationships with our stakeholders and have a long track record of constructive results that show our investments are truly making a difference in the lives of our customers. On Page 26, we provide an update regarding the Inflation Reduction Act. As we sit here today, we do not expect the corporate minimum tax, or CMT, to apply in 2023 or 2024. We continue to model the CMT, and it’s possible it could impact 2025 and beyond. We await additional guidance from Treasury, which we expect to provide further clarity. Again, these potential incremental annual cash tax payments are not expected to be material. These estimates are of course subject to the amount and timing of capital expenditures being placed in service or retired, timing of rate reviews and additional guidance that may be issued by the IRS or Department of Treasury, among other items. Finally, moving to Page 27. I’ll emphasize again that we have a strong team and are well positioned to continue executing our plan. We delivered strong earnings growth in 2022, and we expect to deliver strong earnings growth in 2023 as we continue to successfully execute our strategy. And as we look ahead, we expect 6% to 8% compound earnings per share growth from 2023 to 2027, driven by robust rate base growth and disciplined cost management. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continued to offer investors an attractive dividend. In total, we have an attractive total shareholder return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Nicholas Campanella with Credit Suisse. Please proceed with your question."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey, everyone. Thanks for all the info today and Andrew, welcome back. Really happy to hear your voice."
},
{
"speaker": "Andrew Kirk",
"text": "Thanks, Nick. Appreciate it."
},
{
"speaker": "Nicholas Campanella",
"text": "Absolutely. Yes. So I guess just on the Missouri rate case, you did have some differences here in rate base for staff, but just wanted to get a sense of your overall appetite to settle this case if that’s still a possibility – just thinking back to how prior cases have gone. Thank you."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Nick, this is Marty Lyons. Good morning. Thanks for the question. Yes. Look, as we go into each case, we certainly are hopeful of being able to reach a constructive settlement. And as we talked about many times, we have a good history of working with stakeholders in Missouri and reaching constructive settlements. We outlined where we are in the case today in our prepared materials, you saw in the slide deck, and we outlined some of the issues that divide us today, mainly in some of the traditional areas like ROE, but also on a couple of issues like High Prairie and Rush Island energy centers, where there’s some differences between us and the staff in particular. Importantly, all of us will be updating our cases based on year-end rate base as well as other true-up items that go through December 31. So you mentioned some of the differences in rate base. Really, those are just timing differences between the staff’s rate base, which was as of June 30 and the company’s filed position, which projected through December 31. But all of those things are going to be trued up here in the coming days up through December 31. So importantly, some dates that we highlighted, a final reconciliation of the parties’ positions will be due March 30, and that comes after server bottle testimony, which is on March 13. And then evidentiary hearings of those are needed would start on April 3. So traditionally, the best time to be able to reach a constructive settlement given where this rate case is, this rate review would be end of March, early April in terms of when you might be able to really reach a constructive settlement with the parties."
},
{
"speaker": "Nicholas Campanella",
"text": "That’s helpful. Appreciate that. And then just on the equity financing, recognizing that you did raise CapEx in this new five-year plan. You do have some sizable needs here in the out years and I know you recently last quarter also said that you were increasing the ATM to $1 billion for 2024 and beyond. But can you just help us understand, with the equity in the plan, just your preferred source of funding that or sourcing it, rather."
},
{
"speaker": "Michael Moehn",
"text": "Yes. Yes, you bet, Nick. Good morning. This is Michael, A couple of things, then I’ll get specifically on that question. I mean, again, I think as we’ve talked over time, I mean, we do believe our balance sheet really provides us a position of strength here. We’ve worked hard to continue to conservatively manage it. I think we like our ratings where they are, Baa1, BBB+. We obviously have more margin at S&P than we do at Moody’s. We talked about that from time to time. We continue to target this capitalization ratio of close to 45%, which I think, again, it served us well in these various regulatory proceedings and making sure we’re maintaining these balance sheets appropriately at the subsidiaries. In terms of what we need here, you’re right. I mean, the $2.4 billion of incremental capital, I think what we continue to message along the year, as we thought about any increases in capital associated with these opportunities around LRTP or the renewables that we should continue to think about our balance sheet in a similar fashion. And I think that’s what we’re doing here, we’re laying out this incremental really $800 million of equity. There’s some obviously retained earnings in there as well, kind of gets you back to that same sort of capitalization ratio. The ATM has served us well up to this point. I mean, we’ve taken care of all of our needs for 2023, Nick. We’ve sold forward in 2023. So we’re really finished with that $300 million. We started to sell forward into 2024. You’re right that we did increase the capacity of the ATM. We’ll have to continue to evaluate that over time as we would run into any limits there. But again, it’s a really efficient way for us to issue capital. We think it’s a manageable amount if you look at it relative to our total market capitalization. So we feel comfortable with it. And again, I think that it provides us quite a bit of strength there as we just think about the overall funding that we need over the course of the next five years."
},
{
"speaker": "Nicholas Campanella",
"text": "Appreciate the color. I’ll get back in the queue. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi. Good morning."
},
{
"speaker": "Marty Lyons",
"text": "Good morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "I just wanted to start off with, I guess, a rate base CAGR, the 8% as you laid out there in the $2.5 billion figure. Just wondering, what are the IRP assumptions in your CapEx plan update that – underpin the $2.5 billion there. And what does this imply for company ownership of resources versus PPA? And how do you view the overall line of sight here? And when do you expect to kind of get final commission decisions on all resources?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Good morning, Jeremy, this is Marty. There’s a few questions, I think, embedded in that question. So I’ll start and perhaps Michael would want to add on. First of all, the capital expenditures that we’ve put into the plan in Missouri for the IRP really tie to the plan that we laid out in the IRP. So if you go back and you look at that overall time line, we plan to add 800 megawatts through 2025 and then another 2,000 megawatts of renewables between 2026 and 2030. And if you just do some simple math there, it’s about 400 megawatts per year. So you end up with about 1,600 megawatts overall over a five-year period. And again, we’ve put in about $2.5 billion as an estimate for that. So that’s how it lines up. We were pleased to have the commission, Missouri Public Service Commission approved the Huck Finn project, which was a 200-megawatt solar project we’d proposed, they approved that one recently at CCN. And of course, we’ve got the Boomtown project, which is a 150-megawatt solar project before them now and awaiting the decision. And we continue to work with developers on additional renewable projects to really fill out that plan that we have under the IRP, which we think is absolutely the most prudent way to move forward to provide our customers the reliable, affordable and cleaner energy that they’re seeking. Now back to the overall CapEx plan. What you’ll notice is we’ve got a $19.7 billion overall capital expenditure plan for 2023 to 2027. That compares to the one we had previously, which was 2022 to 2026, we had $17.3 billion. So we’ve added about $2.4 billion overall as we move from our prior plan to this one. And in Missouri in particular, I’d point out that we previously had $8.9 billion of planned expenditures moving now to $10.4 million, which is about a $1.5 billion overall addition. So we’ve embedded the expectation of those renewable projects getting done in the overall $10.4 million. But I would say we’ve taken a measured approach to upping our overall capital expenditure plan, which gives us great confidence in our ability to achieve it. Again, we’ve already had one renewable project approved. We’ve got a strong pipeline of capital expenditure opportunity over the next 10 years, as we’ve talked about, $48 billion and have a lot of confidence in our ability to execute, not only the $10.4 billion plan for Missouri, but the overall $19.7 billion plan we’ve laid out today."
},
{
"speaker": "Michael Moehn",
"text": "Yes. The only thing, Jeremy, I might add to that, Marty just gave a really comprehensive answer, is just specifically with the pipeline to renewables itself. And look, the team continues to do a lot of really hard work here. There’s some active RFPs they continue to have open. They continue to have a lot of conversations with developers about these projects. I think you had something embedded there about how do we think about maybe PPAs versus ownership. Again, we believe that ownership is in the best interest of our customers for the long term, and that’s really where our focus has been. It’s certainly evidenced by what we did with the wind projects. Certainly, we’re closing with the two renewable solar projects that Marty spoke about. So I’d say an active pipeline, and I think, obviously, the supply chain issues have been well publicized. I think we continue to work through those and feel good about the projects we have out there, and it’s going to continue to be a lot of focus and effort over the coming years."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful there. And then moving, I guess, to MISO here, what are your current thoughts on potential MISO long-range transmission planning, given MISO seems to be modeling more aggressive assumptions in light of IRA. So wondering your thoughts on the outlook there."
},
{
"speaker": "Michael Moehn",
"text": "Yes. I would say with respect to Tranche 2, we're certainly actively engaged with other stakeholders with MISO and modeling out the benefits of potential projects that would come out of tranche our overall expectation as we sit here today is that the overall portfolio of projects that MISO would approve as part of tranche to will be larger than the overall size of the projects that were approved as part of Tranche 1. But I think it'd be premature to comment on specifically which projects might land in our service territory or be assigned specifically to us. But rest assured, we'll be working with other stakeholders to model the transmission projects that we think would be best for customers and the reliability of the system overall and to obviously effectuate the clean energy transition. And we do expect that, as we said in our prepared remarks, MISO, to make some final determination early next year."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful. And then just kind of tying this together, you've raised CapEx. You've raised rate base growth a little bit here. I'm just wondering what you think this could mean for EPS. You don't have the 30-year, I guess, bringing fluctuations in the way that it was in the past. So as you currently look at your EPS CAGR outlook, do you see any bias within the range towards the higher parts, given this step up in CapEx and rate base here, rate base growth?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, Jeremy, I mean, I think as you know, I mean, our past practice really has not been to sort of speculate where we'll be within that range. I think I'll point to where we have achieved results, obviously. Historically, we've been to 7.5% CAGR since about 2013. So I'll let that sort of speak to itself. Obviously, we did raise the rate base growth from 7% to 8%. And I mean again, as you think about that range, over time, it drives about a $0.45 range, that 6% to 8% over that kind of five-year period. And obviously, there are some drivers, as you pointed out, in terms of just outcomes in the multiyear rate plan, earned versus allowed ROEs, financing assumptions, et cetera. But again, let sort of the past speak for itself at the moment."
},
{
"speaker": "Michael Moehn",
"text": "Yes. And Jeremy, I'd just reiterate what I said. We feel very confident in our ability to be able to execute that $19.7 billion CapEx plan, which gives us confidence in our ability to execute that 8% rate base growth plan. And that underscores our confidence in the 6% to 8% EPS CAGR that we've outlined today."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. I'll leave it there. And Andrew, really great to hear you on the call."
},
{
"speaker": "Andrew Kirk",
"text": "Thanks, Jeremy. Appreciate it. Glad to hear you, too."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning, team. Thanks for the time, appreciate the comments thus far. Maybe to follow up on Nick's question earlier, just with respect to Illinois and prospects for settling here. Any further elaborations around the new compact there? Just as you step into this, I just want to understand. Does this need to be sort of fully litigated and fully fleshed out to establish more of a record, given the context of some shift in the compact here? And again, that's a question specifically directed at both the electric and the gas."
},
{
"speaker": "Marty Lyons",
"text": "Yes. Julien, this is Marty. Yes, I think your intuition is probably right there, especially as it relates to the multiyear rate plan. I think it's hard to speculate. I mean, if ever we have the opportunity to really enter into a constructive settlement with stakeholders, we're certainly going to be interested in having that dialogue with stakeholders. I think it's just very early in this multiyear rate plan filing. Obviously, we haven't seen any staff or intervenor direct testimony. We won't see that until May. And really premature to know whether it's something that could be constructively settled or not. I will note that in Illinois, there hasn't been that history of overall global settlements that we've had in Missouri. But we'll certainly be looking after we get testimony to work with stakeholders to resolve differences, narrow the issues. And if we can, settle and that would hold true for the gas case as well."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Right. It holds through as and you probably want to work through a fully litigated case here."
},
{
"speaker": "Marty Lyons",
"text": "No. I guess what I was saying there is we're always going to be wanting to work with stakeholders. Once we see the differences to narrow those differences, certainly correct any errors and really to narrow the issues. And if we can reach a global settlement and put that before the commission, we'll seek to do that. I was just saying with respect to the electric distribution part of the business, given the newness of this framework and the fact that we haven't seen any testimony really premature to say whether that's something that has a high degree of probability."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes. All right. And actually, as it pertains to QIP here, just – I know that there's a new framework on the electric side, and that's largely established at this point pending implementation. But QIP and its subsequent forms or iterations remains a little bit outstanding. Can you elaborate what your thoughts are, and perhaps going back whether legislatively or otherwise at this point, to get something new? Again, I'll leave it open ended on what that might look like. I know we've talked about this in the past at times, but is there a window today to revisit that conversation perhaps in the slate you did before?"
},
{
"speaker": "Michael Moehn",
"text": "Julian, this is Marty again. Look, we haven't given up some sort of replacement for QIP and really because the QIP was in our die really great rider for our customers, really allowed us to make some investments that bolster the safety and reliability of the gas system. I'd say our focus right now is really though on the gas case that you and I just discussed. And really looking to get a constructive resolution of that case. As you know, the overall gas regulatory environment, even without QIP is solid with forward test years, revenue decoupling, bad debt riders, et cetera. So we believe that going forward, without the QIP, we'd need to be thoughtful about the timing of rate reviews, but they do use forward test years, which I think is very important to think about. And we'll be thoughtful about the timing of capital expenditures to replace aging equipment, et cetera. So we do think the regulatory environment without QIP is something we can manage around, we can still invest, we can earn good returns. But we will look for windows of opportunity to look for something to replace the QIP. I'll leave the door open like you did in terms of what form that may take. But right now, our focus is on that gas case."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes. Excellent. And then sorry, quick clarification from earlier. Boomtown, just is there anything different about this? Say, relative to Huck Finn or something like that, that might stand out in terms of that approval process? Obviously, the timing here being a little different in terms of the duration for the CCF."
},
{
"speaker": "Marty Lyons",
"text": "Yes. I think one of the differences, Julian, is the Huck Finn project was proposed to be compliance with the renewable energy standard that we have in Missouri, and it was approved as such. The Boomtown project is really being proposed twofold. One, for customers, especially large industrial commercial customers that are looking for renewable energy as part of a consumer program for them, and as well as part of our transition under the IRP. But it's not being proposed for specific compliance with the renewable energy standard. And so that's a distinguishing fact between the two."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Andrew, I echo the sentiment."
},
{
"speaker": "Andrew Kirk",
"text": "Thanks, Julien. Appreciate it."
},
{
"speaker": "Operator",
"text": "We have reached the end of the question-and-answer session. I would now like to turn the call back to Marty Lyons for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Well, thank you all for joining us today. As you heard, we had a very strong 2022, and we really remain focused on delivering again in 2023 and beyond, for our customers, for our communities and for our shareholders. So with that, be safe, and we look forward to seeing many of you over the coming months."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 3 | 2,022 | 2022-11-04 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Megan McPhail, Manager of Investor for Ameren Corporation. Thank you. Mrs. McPhail, you may begin.
Megan McPhail: Thank you, and good morning. On the call with me today are Marty Lyons, our President, Chief Executive Officer; Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. Marty and Michael will discuss our earnings results and guidance, as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward -looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section on our news release we issued yesterday and the forward-looking statements and risk factors section in our filings with SEC. Lastly, all per share earnings amounts discussed during today’s presentation including earnings guidance are presented on a diluted basis unless otherwise noted. Now here's Marty, who will start on page 4.
Marty Lyons: Thanks, Megan. Good morning, everyone. And thank you for joining us. I'm pleased to report that we continue to execute on our strategic plan across each of our business segments, delivering significant value to our customers and shareholders while remaining focused on safety. At the start of the year, we laid out some key initiatives we were focused on. As I sit here today, I can confidently say that we have been able to deliver on these through strong execution of our plan. Starting with Ameren Missouri in February, our new Ameren Missouri Electric service rates took effect as a result of our recent rate review, which was constructively settled at the end of last year. In June, we filed a change to our Integrated Resource Plan, accelerating our planned clean energy investments, carbon emission reduction goals and our plan to achieve net zero by 2045. The Midcontinent Independent System Operator or MISO approved a portfolio of long-range transmission projects, including significant projects in our operating footprint. And in August, Senate Bill 745 was enacted in Missouri, extending the constructive Smart Energy Plan legislation that became law in 2018 out through 2028, with possible extension to 2033. I am pleased to say as a result of these developments in 2022, we were able to increase our 10-year investment opportunity pipeline from $40 billion to $48 billion. Further in our Ameren Illinois Electric Distribution business, in September, the Illinois Commerce Commission or ICC, approved constructive performance metrics, which keep us on track to file a multi-year rate plan next January. And finally at the federal level passage of the Inflation Reduction Act will support the clean energy transition, reducing the cost of related infrastructure investments for our customers in both Missouri and Illinois. I would like to express appreciation for all the hard work of the entire Ameren team to advance these important achievements. Additionally, I'd like to recognize our team's strong commitment to the communities we serve. This year we named our first Chief Sustainability Diversity and Philanthropy Officer to further optimize Our ESG impact. In October, she convened more than 1,000 Ameren team members and community leaders in person and virtually for a diversity and inclusion summit, featuring many nationally recognized leaders and speakers. Because of actions like this, in May, Ameren was recognized for the third time as DiversityInc’s top rated utility, and made the overall top utilities list for the 14th consecutive year. Another example of our team's commitment to our communities is our recently concluded 2022 companywide United Way Campaign, which raised approximately $1.7 million, funds which will go a long way towards supporting approximately 50 United Way organizations in our service territory. This is an addition to the nearly $2.6 million United Way contribution made by Ameren. Again, thank you for all you do. Moving now to quarterly results. Yesterday, we announced third quarter 2022 earnings of $1.74 per share, compared to earnings of $1.65 per share in the third quarter of 2021. The year-over-year improvement reflected increased infrastructure investments across all of our business segments that will drive significant long-term benefits for our customers. This page highlights the key drivers of our strong performance. Due to strong execution of our strategy, we have narrowed our 2022 earnings guidance to a range of $4 to $4.15 per share. This compares to our initial guidance range of $3.95 per share to $4.15 per share. Michael will discuss our third quarter earnings, 2022 earnings guidance and other related items in more detail. Moving to page 5, you will find our strategic plan reiterated. We continue to invest in and operate our utilities in a manner consistent with existing regulatory frameworks, enhance regulatory frameworks and advocate for responsible energy and economic policies and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. Turning now to page 6, which highlights our commitment to the first pillar of our strategy investing in and operating our utilities in a manner consistent with existing regulatory frameworks. Our strong long-term earnings growth guidance is primarily driven by our infrastructure investment and rate base growth plans, which are supported by constructive regulatory frameworks. As you can see on the right side of this page, consistent with our plans for 2022, we are strategically investing significant capital in each of our business segments in order to maintain safe and reliable operations as we transition to a cleaner energy grid. These investments are the key drivers of our ongoing Ameren Missouri and Ameren Illinois rate reviews. Our energy grid is smarter, stronger, more resilient, safer and more secure. Because of the investments we've been able to make in all four of our business segments. At Ameren Missouri, as a result of significant investments we have been making under the Smart Energy Plan. We estimate over 6.5 million minutes of customer outages have been avoided in 2022. As always, while we invest to build a smarter, stronger, safer and cleaner energy grid for our customers, we continue to work diligently to manage our costs, leverage our investments and optimize our performance. Moving now to page7, and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. As I mentioned, the Inflation Reduction Act or IRA was enacted in August, which among other things is designed to help reduce the costs of the clean energy transition. We are very pleased with results as it provides tax credits for wind, solar and nuclear energy centers, energy storage, carbon capture utilization and storage and hydrogen developments. The incentives in the IRA align well with our Missouri integrated resource plan and our Ameren wide goal of reaching net zero carbon emissions by 2045. Overall, the IRA will enhance affordability of the clean energy transition for our customers in Missouri and Illinois. Michael will discuss the expected impacts of the IRA in more detail in a moment. Before moving on, I would also like to briefly touch on the Infrastructure Investment and Jobs Act or IIJA that was enacted earlier this year. We are actively collaborating with stakeholders in Missouri and Illinois toward accessing benefits of the federal funding provided through this act for our customers. In July when announced our collaboration with local businesses and community groups, academic institutions and various companies to form the Greater St. Louis and Illinois Regional Clean Hydrogen Hub Industrial Cluster. This group is collaborating on infrastructure development and innovative technology deployment needed to drive decarbonization goals and collectively achieve greenhouse gas emission reductions for the region by 2035. The IIJA established an $8 billion competitive program, with the intent to fund six to eight regional hydrogen hubs across the country, and provides for an additional $8.5 billion program for development of carbon capture and storage technologies. By next spring, our regional hydrogen cluster expects to apply for funding through the program to take part in advancing this potential renewable energy source for our region. Turning to page 8. At the state level, our customers are benefiting as a result of Ameren Missouri Smart Energy Plan, a multiyear effort to strengthen and modernize the energy grid. As I just mentioned, Missouri Senate Bill 745, passed earlier this year and became effective in August, enhancing and extending the sunset date on the current Smart Energy Plan legislation through December 31, 2028 with an extension through December 31, 2033 if the utility requests and PSC approves. We believe extending Missouri Smart Energy Plan will continue to benefit our customers and communities as we transform the energy grid of today to build a brighter energy future for generations to come, while creating significant economic development and jobs in the state. Moving now to page 9 and an update on the Illinois Energy Legislation enacted in 2021. By January 20 of 2023, we plan to file a multiyear rate plan with the ICC for electric delivery service rates effective at the beginning of 2024. In late September, the ICC approved seven performance metrics, which will result in up to 24 symmetrical basis points of potential adjustments to the allowed return on equity under the multiyear rate plan. These performance metrics have been designed to incentivize improvement in areas such as reliability, supplier diversity, affordability, and customer service, as we continue to make significant investments in the state of Illinois for the benefit of our customers and communities. Turning to page 10, and the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. Here we provide an update on the MISO long range transmission planning process. As we have discussed with you in the past, MISO completed a study outlining a potential roadmap of transmission investments through 2039 taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates and goals for clean energy or carbon emission reductions, among other things. In July, MISO approved Tranche 1, a set of projects located in MISO north, which had estimates to cost approximately $10 billion. Approximately $1.8 billion of these projects are in our service territory and have been assigned to Ameren. Preliminary design work and project planning are already underway. Construction is expected to begin in 2025, with completion dates expected near the end of this decade. In addition to the assigned projects, MISO approved approximately $700 million of competitive projects that cross through our Missouri service territory, which provide additional potential investment opportunities. Request for proposals for the two competitive projects in our service territory are expected to be released in December 2022 and March 2023. Once released, we expect a proposal and evaluation process to take approximately 12 months. We are well positioned to compete for and successfully execute these projects, given their location and our expertise constructing, operating and maintaining large regional transmission projects. MISO continues its work on future tranches, and it's indicated that an initial set of Tranche 2 projects also located in MISO north, is expected to be approved in the second half of 2023. Projects include in Tranche 3 are expected to be located in MISO south, with approval scheduled by the end of 2024. While projects identified in Tranche 4, are expected to improve transfer capability between MISO north and MISO south, and will be studied upon approval of Tranche 3. Turning to page 11. Looking ahead over the next decade, we have a robust pipeline of investment opportunities that will deliver significant value to all of our stakeholders by making our energy grid smarter, stronger and cleaner. As a result of the Long-Range transmission projects just discussed, as well as the additional renewables and combined cycle generation included in the change to the IRP filed in June, we increased our pipeline of investment opportunities to $48 billion over the next decade. We expect to update and roll forward our five-year capital plan on our year-end call-in February. And as always, we will evaluate all of our opportunities across all business segments to ensure we maximize value for our customers and shareholders. When determining the timing of our projects, we remain mindful of portfolio diversification in both technology and geography, workforce and supply chain capacity and the impacts to grid reliability, while aggressively managing costs. Maintaining constructive energy policies that support robust investment in energy infrastructure, and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs in the future, and delivering on our customers’ expectations. Moving now to page 12, we are focused on delivering a sustainable energy future for our customers, communities and our country. This page summarizes our strong sustainability value proposition and focus on environmental, social governance and sustainable growth goals. The change to the Ameren Missouri IRP filed in June supports a 60% reduction in carbon emissions by 2030 and an 85% reduction by 2040 compared to 2005 levels. And our goal of net zero carbon emissions by 2045 is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. Importantly, our energy policy advocacy and investment plans align with these goals. In terms of governance in October, the CPA-Zicklin Index once again named Ameren, one of the top three companies in the utility industry for corporate political disclosures and accountability. We also remain focused on supporting our communities, including utilizing our very robust supplier diversity program to help ensure we execute on an equitable clean energy transition. And we remain committed to helping our customers keep their bills as low as possible, through robust energy efficiency programs, and energy assistance for those in need. Lastly, our strong, sustainable growth proposition remains among the best in the industry. We have a robust pipeline of future investments that will continue to modernize the grid and enable the transition to a cleaner energy future. I encourage you to take some time to read more about our strong sustainability value proposition, you can find our ESG related reports at amereninvestors.com. Turning to page 13. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our current five-year growth plan, which included our expectation of a 6% to 8% compound annual growth rate earnings growth rate from 2022 through 2026. This earnings growth is primarily driven by strong rate base growth supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. We expect average future dividend growth to be in line with our long-term earnings per share growth expectations and a payout ratio range of 55% to 70%. In February 2022, Ameren’s Board of Directors last increased the quarterly dividend by $0.04 or $0.59, to $0.59 per share or approximately 7%. We plan to deliver strong, long-term earnings and dividend growth which results in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plan and strategy across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. And I will now turn the call over to Michael.
Michael Moehn : Thanks, Marty. And good morning, everyone. Yesterday we reported third quarter 2022 earnings of $1.74 per share, compared to $1.65 per share for the year ago quarter. Page 15 summarizes key drivers impacting earnings at each segment, I'd like to take a moment to highlight a few key variances for the quarter. Earnings in Ameren Missouri, our largest segment benefited from higher electric service rates, which became effective on February 28, 2022. The increase and reserve were partially offset by higher O&M driven in part by unfavorable market returns in 2022 on company owned life insurance investments. Earnings at our remaining three business segments were higher primarily driven by increased investments in infrastructure, in addition to a higher allowed return equated to Ameren Illinois Electric Distribution. Before moving on, I'll touch on year-to-date sales transfer for Ameren Missouri and Ameren Illinois Electric Distribution. Weather normalized kilowatt hours sales to Missouri residential customers were comparable versus the prior year, and sales to commercial customers increased about 1%. Weather normalized kilowatt hour sales to Missouri industrial customers decreased about 1%. Weather normalized kilowatt hour sales to Illinois residential customers decreased about 1%, and sales to commercial and industrial customers increased about 0.005% and 1% respectively. Recall that changes in electric sales in Illinois no matter the cause, do not affect earnings since we have full revenue decoupling. Turning to page 16. I would now like to briefly touch on our 2022 earnings guidance. We have delivered strong earnings in the first nine months of 2022 and are well positioned to finish the year strong. As Marty stated, we have narrowed our 2022 diluted earnings guidance to be in the range of $4 to $4.15 per share. This is a comparison to our original guidance range of $3.95 to $4.15 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed in our earnings call in February. As we reflect on our full year results, the benefits we have seen from weather year-to-date, and from higher than expected 30-year Treasury rates are mostly offset by company owned life insurance investments performance, as well as higher than expected short term and long-term borrowing rates. Turning now to page 17 for an update on regulatory matters, starting with Ameren Missouri, in August, we filed for a $360 million electric revenue increase with the Missouri Public Service Commission. The request which was driven by the by increased infrastructure investments under the Smart Energy Plan includes a 10.2% return on equity, a 51.9% equity ratio, ending December 31, 2022 estimated rate base of $11.6 billion. In October, we supplement our filing to request a tracker for the benefits and costs resulting from the Inflation Reduction Act. Missouri PSC staff and other intervenors are expected to file direct testimony in January 2023 with hearing scheduled for early April 2023. We expect to have a Missouri PSC decision by June 2023 and new rates to be affected by July 1, 2023. We look forward to our continue to work with all key stakeholders on this request. Moving to page 18 to Illinois Regulatory Matters. Earlier this year, we made our required annual electric distribution rate update filing. Under Illinois performance base rate making these annual rate update systematically adjust cash flows over time for changes in cost of service and trued up any prior period over or under recovery of such cost. In August, the ICC staff updated a recommendation to reflect a $61 million base rate increase compared to our updated request of an $84 million base rate increase. The $23 million variance is primarily driven by a difference in the capital structure common equity ratio, as we have proposed 54% compared to the ICC staff recommended 50%. For perspective, the order received from the ICC last December included a common equity ratio of 51%. And ICC decision is expected in December with new rates to be effective in January 2023. Finally, we expect to file a new rate review with the ICC for our Ameren Illinois Natural Gas business in early 2023 using a forward test year ending December 31, 2024. Turning now to page 19. As Marty mentioned, we're pleased with the Inflation Reduction Act, which enhances affordability of the clean energy transition for our customers in both Missouri and Illinois. We currently estimate based on the clean energy investments outlined in the preferred plan included in the change to Ameren Missouri's IRP that the production tax credits provided for in the legislation will yield more than $1 billion in net benefits by 2030, saving our Ameren Missouri customers an average of more than 4% per year over that period of time as compared to what they would have paid. We expect our Illinois customers to receive the benefits from the legislation over time to reduce power purchase cost. Further, as we sit here today, we do not expect the corporate minimum tax of 15% on adjusted financial statement income to apply in 2023. Incremental annual cash payments due to the corporate minimum tax beyond 2023 are not expected to be material. And finally, we're assessing our ability to utilize the 10% production or investment tax per data for presiding projects at existing energy communities, including retired coal fired energy centers. Moving to page 20, we provide a financing update, we continue to feel very good about our financial position. We were able to successfully execute on several debt issuances earlier this year, which are outlined on this page. In order to maintain a strong balance sheet while we fund our robust infrastructure plan, consistent with the guidance in February, we expect to issue approximately $300 million in common equity in both 2022 and 2023. We're very pleased to say that through our, at the market equity program, we have now fulfilled these equity needs executed through the forward sales agreements with an average initial forward sales price of approximately $90. And we expect to issue approximately 3.4 million and 3.2 million common shares upon settlement by yearend 2022 and 2023, respectively. Having substantially utilized the $750 million of capacity under our existing ATM program, we expect to increase the existing program by approximately $1 billion to address equity needs in 2024 and beyond. Moving to page 21. In light of the recent rising interest rate environment, we have provided our long-term debt maturities remaining through 2026. We have just $47 million of long-term debt maturing later this in Ameren Missouri and $100 million with long term debt in Ameren Illinois, maturing in 2023. All of our long-term debt is at fixed rates and variable rate debt is limited to commercial paper borrowings. It's also important to note that a portion of the interest cost is also capitalized in the normal course is related debt supports construction work in progress. I'd also like to know we receive recovery of any changes in interest expense in our Illinois, Ameren Illinois Electric Distribution and Ameren Transmission businesses through the reconciliation process. Further, we have some favorable exposure at the Ameren Illinois Electric Distribution return on equity as it's tied to the 30-year Treasury rate through 2023. Changes in long term and short-term debt costs today in Ameren Missouri and Ameren Illinois Natural Gas will be incorporated into rate reviews for recovery over time, which includes a trued-up to the cost of capital as of December 31, 2022, and the current Ameren Missouri Electric rate review. We're mindful the changes in interest rates and remain focused on managing costs for our customers. Turning to page 22, I'd like to briefly touch on our natural gas business as we head into the winter months. We recognize the inflationary environment customers are facing we're working to keep bills as low as possible and write energy savings programs for our customers. We're actively working with customers in both Missouri and Illinois to help them gain access to funds available through low income, Home Energy Assistance Grants and other energy assistance funds in addition to our energy efficiency programs. Details on these customers assistance programs and the energy efficiency programs can be found on our website@amerenn.com. Both Ameren Illinois and Ameren Illinois and Ameren Missouri Natural Gas combined prices are approximately 85% hedge based on normal seasonal sales and 100% of the Ameren Illinois Natural Gas is volumetrically hedge based on maximum seasonal sales. From a customer bill perspective, residential natural gas customers in Illinois and Missouri are expected to see bill increases of approximately 4% and 14% respectively, compared to the 2021, 2022 winter season. Turning to page 23, we plan to provide 2023 earnings guidance when we release fourth quarter results in February next year. Using our 2022 guidance as a reference point we have listed on this page select items to consider as you think about our earnings outlook for next year. Beginning with Missouri, earnings are expected to be higher in 2023 when compared to 2022 due to new electric service rates effective in late February 2022. And the new electric service rates expected to be affected by July 2023 as a result of the pending rate review. We also expect increased investments in infrastructure eligible for plan and service accounting to positively impact earnings. Further, we expect energy efficiency performance incentives to be approximately $0.03 per share lower in 2023 compared to 2022. A return to normal weather in 2023 would decrease Ameren Missouri earnings by approximately $0.11 compared to 2022 results to date assuming normal weather in the last quarter of the year. Next earnings from our FERC related electric transmission activities are expected to benefit from additional investments in Ameren Illinois projects made under forward looking formula ratemaking. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2023 compared to 2022 from additional infrastructure investments made of Illinois performance base rate making. The allowed ROE under the formula would be the average 2023, 30-year Treasury yield plus 5.8% Ameren Illinois Natural Gas earnings are expected benefit from an increase in infrastructure investments qualifying for rider treatment that will earn the current allowed ROE of 9.67%. And finally, have a note consistent with past practices our 2023 earnings guidance will include no expectation of COLI gains or losses. Turning to page 24 to summarize, we continue to expect to deliver strong earnings growth in 2022 as if we successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. The bottom line is that we are well positioned to continue executing our plan and Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder returns through the comparison very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions] Our first question is from Julien Smith with Bank of America.
Darius Lozny: Hey, guys, good morning. This is Darius on for Julian, thank you for taking the question. Wanted to start off at Illinois gas. Acknowledging that you guys have a filing -- a plan filing later in ‘23. Just curious with the pending sunset of that QIP rider, how you're thinking about potential forward looking cadence of filings or potentially, is there any appetite that you perceive for some kind of legislative solution, maybe akin to the multi-year rate plans that are now available on the electric side of things? Just curious how you're thinking about that at a high level?
Michael Moehn: Yes, perfect. Good morning, this is my Michael. Yes, I'll start and Marty can certainly supplement it. Look, we haven't really said exactly what our future cadence will be, you're correct as a QIP, is set to sunset at the end of ‘23. And so, we're indicating that we're going to file a case here, and it'll be effective under this QIP for the balance of 2023. I mean I think the thing to keep in mind is you step back, and you look at the Illinois gas regulations. I mean, it's still very constructive, even absent the QIP and all, I'll come back to that. But I mean, there is forward test year, rates are decoupled, bad debt tracker, et cetera. I mean, there's some real positives with respect to what goes on there. But as the team gets to look at the opportunities there. I mean, we may have to have a different cadence if it were ultimately expired. But there could be an appetite to extend something at some point. We just really haven't engaged in those conversations at the moment. But we feel like absent even getting an extended, there are certainly ways to continue to manage that business very constructively going forward. Anything to add, Marty?
Marty Lyons: Michael, that was well said. I would just say that as we look ahead to our gas business, we certainly see the opportunity and, frankly, need for continued investment in our infrastructure to ensure that safe and reliable for our customers. I think that the QIP that we've had over time, that infrastructure mechanism has really provided some good benefits for customers as we think about what it's enabled in terms of a timely investment in the system. So as Michael said, we'll certainly utilize the forward test year capabilities that we have under Illinois law today and continue to consider along with other stakeholders, whether a replacement for QIP is something that we can introduce in the future or not, we'll see. Thank you.
Darius Lozny: Great. Thank you for that. Appreciate the color. One more, if I can, and this is on the 2023 earnings considerations. I realize it's not a formal guidance or fully exhausted. But I noticed O&M is not included as one of the drivers. Are you planning to -- or are you managing to flat year-over-year? And maybe that's why it's not included on that list because it won't move the needle one way or the other on as an EPS driver? Or just how are you thinking about that cadence.
Michael Moehn: Yes. I appreciate the question there, too. Historically, we really haven't given O&M guidance, especially as you think about some of these ongoing rate reviews, which makes it a little bit complicated at the end of the day. I would tell you that we continue to stay very focused on O&M itself. And if you look at kind of our year-to-date results, and I think Missouri is a good example. And you back out obviously some of the noise with COLI and some of the refined coal that got caught up in the rate review. We really have managed that to about 1.5%, 1.7% sort of increase. So I think the team has done a great job from a core perspective. We have made comments before that we continue to aspire to being flat over the time horizon we look out over the five-year plan. If you look at historically where we've been, I think we've shared a couple of these slides in the past, I think maybe the '16 through '21 period was the last time we were actually down over that period of time. So I always look to make it really a nondriver at the end of the day. I think we can give you a little more color as we get to February. But again, it is just a little more complicated because of some of the ongoing rate reviews as well. So hopefully, that helps.
Operator: Our next question is from the line of Paul Patterson with Glenrock Associates.
Paul Patterson: Hey, how are you guys doing? Good morning. So back to that slide 23, I was also -- and I apologize if I missed it, it just lots of earnings today. Just on the impact of interest rates. I mean, I was just wondering if you could -- you did mention different maturities and everything going on. But I was just wondering if you have a rule of thumb of how we should maybe be thinking about things you've done to -- just what the impact of higher interest rates might be, I guess, is something to think about? Just if you could give us any flavor on that.
Michael Moehn: Yes, I appreciate the question. I mean we really did try to provide some of that detail on '21 to give you a sense of sort of what's happening from a redemption standpoint. Obviously, we're going to have some just normal financings in the normal course. We didn't provide anything in there just because of what's going on with respect to rates. What I tried to also do, Paul, as you look at the recovery of interest rates in terms of how we think about it, transmission business. Obviously, formula rates got a little bit of a positive -- obviously, a positive hedge on the 30-year treasury offsetting in addition to you have a formula on the interest rate within the electric distribution business. And then Missouri itself, we're obviously in the middle of a rate review. So you'll be updating some of the capital structure and the cost of capital as we go through that rate review through the end of this year. So I tried to give that perspective just to give you a sense for what the impact would be in 2023.
Paul Patterson: Yes, No, I appreciate the slide 21. I noticed, I guess, I was just wondering if you had a sheet on and Mike of course, there is short term you have and what have you. I was just wondering I guess we've got some sophisticated math you want us to do, which is fine. Okay. That's basically my only question. Thanks so much and have a great weekend.
Operator: Our next question is from the line of David Paz with Wolfe Research.
David Paz: Hey, good morning. On the February call, as you plan to update -- are you planning to update your EPS growth target through 2027? And if so, will you roll in the expectations of the incremental Missouri renewables investments and the initial spending on the MISO projects?
Marty Lyons: Yes, David, this is Marty. Yes, in our February call, we will plan to update you on our thoughts in terms of EPS CAGR from 2023 to 2027 at that point in time. We'll also, at that time, expect to update our capital expenditure plan which right now really runs through '26, we'll take that out through 2027. And we'll also update you on our expectations in terms of our rate base CAGR out through 2027. So those are all things that we plan to do on the February call. In terms of the overall investment pipeline, as we've discussed this morning, this year as a result of the Missouri Integrated Resource Plan, as a result of the MISO approving Tranche 1 projects, we bumped our overall 10-year pipeline from $40 billion to $48 billion. And as we mentioned in some of the specifics, some of those capital expenditures, we would expect to start to fall in the latter half of that five-year update. So those are things that we'll consider how best to fold-in to both our five-year CapEx guidance as well as that rate base CAGR.
David Paz: Got it. And do you think those -- would you make an assumption on the competitive projects for MISO spending? Or would that be just mostly on the assigned projects?
Marty Lyons: Yes. David, I think at this point, haven't made a firm determination as to whether what will fold-in or not. I would say with respect to some of those competitive projects, while it's a little bit of a different thing than we faced in the past, I would say, traditionally, we've been a bit conservative about rolling those things in until we have better line of sight to those being projects that we would be able to firmly execute. So I would expect with respect to those projects, we take a bit of a conservative posture.
David Paz: Makes sense. And then just on equity, remind me your equity needs for 2024 to 2026 that we said when you last updated them. And along with that, just your targeted consolidated equity ratio?
Michael Moehn: Yes. David, this is Michael. Yes, so when we roll forward our plan in February ‘22, so we had $300 million basically of external equity through the balance of that plan, plus $100 million of DRIP as indicated, very pleased with where we are today. I mean we've gotten the '22 and '23 offer there. So you should continue to assume that $300 million ‘24 through the balance, we continue to target a capitalization ratio close to 45% over that five-year plan. So we'll stay focused on that. And then as Marty just talked about, as we roll forward into February and roll forward the new capital plan, obviously, we'll step back and address any financing needs as part of what happens with that capital plan itself, but you should continue to think about that $300 million at the moment.
Operator: Mr. Lyons, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.
Marty Lyons: Okay. Well, thank you all for joining us today. As you heard on the call, we've had a strong 2022 year-to-date. We remain focused on continuing to deliver strong value through the end of this year for our customers, communities and our shareholders. So Again, thanks for joining us. We look forward to seeing many of you, I think, at the EEI conference, which is just a couple of weeks away. Thanks all and be safe.
Operator: Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Megan McPhail, Manager of Investor for Ameren Corporation. Thank you. Mrs. McPhail, you may begin."
},
{
"speaker": "Megan McPhail",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our President, Chief Executive Officer; Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. Marty and Michael will discuss our earnings results and guidance, as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward -looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section on our news release we issued yesterday and the forward-looking statements and risk factors section in our filings with SEC. Lastly, all per share earnings amounts discussed during today’s presentation including earnings guidance are presented on a diluted basis unless otherwise noted. Now here's Marty, who will start on page 4."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Megan. Good morning, everyone. And thank you for joining us. I'm pleased to report that we continue to execute on our strategic plan across each of our business segments, delivering significant value to our customers and shareholders while remaining focused on safety. At the start of the year, we laid out some key initiatives we were focused on. As I sit here today, I can confidently say that we have been able to deliver on these through strong execution of our plan. Starting with Ameren Missouri in February, our new Ameren Missouri Electric service rates took effect as a result of our recent rate review, which was constructively settled at the end of last year. In June, we filed a change to our Integrated Resource Plan, accelerating our planned clean energy investments, carbon emission reduction goals and our plan to achieve net zero by 2045. The Midcontinent Independent System Operator or MISO approved a portfolio of long-range transmission projects, including significant projects in our operating footprint. And in August, Senate Bill 745 was enacted in Missouri, extending the constructive Smart Energy Plan legislation that became law in 2018 out through 2028, with possible extension to 2033. I am pleased to say as a result of these developments in 2022, we were able to increase our 10-year investment opportunity pipeline from $40 billion to $48 billion. Further in our Ameren Illinois Electric Distribution business, in September, the Illinois Commerce Commission or ICC, approved constructive performance metrics, which keep us on track to file a multi-year rate plan next January. And finally at the federal level passage of the Inflation Reduction Act will support the clean energy transition, reducing the cost of related infrastructure investments for our customers in both Missouri and Illinois. I would like to express appreciation for all the hard work of the entire Ameren team to advance these important achievements. Additionally, I'd like to recognize our team's strong commitment to the communities we serve. This year we named our first Chief Sustainability Diversity and Philanthropy Officer to further optimize Our ESG impact. In October, she convened more than 1,000 Ameren team members and community leaders in person and virtually for a diversity and inclusion summit, featuring many nationally recognized leaders and speakers. Because of actions like this, in May, Ameren was recognized for the third time as DiversityInc’s top rated utility, and made the overall top utilities list for the 14th consecutive year. Another example of our team's commitment to our communities is our recently concluded 2022 companywide United Way Campaign, which raised approximately $1.7 million, funds which will go a long way towards supporting approximately 50 United Way organizations in our service territory. This is an addition to the nearly $2.6 million United Way contribution made by Ameren. Again, thank you for all you do. Moving now to quarterly results. Yesterday, we announced third quarter 2022 earnings of $1.74 per share, compared to earnings of $1.65 per share in the third quarter of 2021. The year-over-year improvement reflected increased infrastructure investments across all of our business segments that will drive significant long-term benefits for our customers. This page highlights the key drivers of our strong performance. Due to strong execution of our strategy, we have narrowed our 2022 earnings guidance to a range of $4 to $4.15 per share. This compares to our initial guidance range of $3.95 per share to $4.15 per share. Michael will discuss our third quarter earnings, 2022 earnings guidance and other related items in more detail. Moving to page 5, you will find our strategic plan reiterated. We continue to invest in and operate our utilities in a manner consistent with existing regulatory frameworks, enhance regulatory frameworks and advocate for responsible energy and economic policies and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. Turning now to page 6, which highlights our commitment to the first pillar of our strategy investing in and operating our utilities in a manner consistent with existing regulatory frameworks. Our strong long-term earnings growth guidance is primarily driven by our infrastructure investment and rate base growth plans, which are supported by constructive regulatory frameworks. As you can see on the right side of this page, consistent with our plans for 2022, we are strategically investing significant capital in each of our business segments in order to maintain safe and reliable operations as we transition to a cleaner energy grid. These investments are the key drivers of our ongoing Ameren Missouri and Ameren Illinois rate reviews. Our energy grid is smarter, stronger, more resilient, safer and more secure. Because of the investments we've been able to make in all four of our business segments. At Ameren Missouri, as a result of significant investments we have been making under the Smart Energy Plan. We estimate over 6.5 million minutes of customer outages have been avoided in 2022. As always, while we invest to build a smarter, stronger, safer and cleaner energy grid for our customers, we continue to work diligently to manage our costs, leverage our investments and optimize our performance. Moving now to page7, and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. As I mentioned, the Inflation Reduction Act or IRA was enacted in August, which among other things is designed to help reduce the costs of the clean energy transition. We are very pleased with results as it provides tax credits for wind, solar and nuclear energy centers, energy storage, carbon capture utilization and storage and hydrogen developments. The incentives in the IRA align well with our Missouri integrated resource plan and our Ameren wide goal of reaching net zero carbon emissions by 2045. Overall, the IRA will enhance affordability of the clean energy transition for our customers in Missouri and Illinois. Michael will discuss the expected impacts of the IRA in more detail in a moment. Before moving on, I would also like to briefly touch on the Infrastructure Investment and Jobs Act or IIJA that was enacted earlier this year. We are actively collaborating with stakeholders in Missouri and Illinois toward accessing benefits of the federal funding provided through this act for our customers. In July when announced our collaboration with local businesses and community groups, academic institutions and various companies to form the Greater St. Louis and Illinois Regional Clean Hydrogen Hub Industrial Cluster. This group is collaborating on infrastructure development and innovative technology deployment needed to drive decarbonization goals and collectively achieve greenhouse gas emission reductions for the region by 2035. The IIJA established an $8 billion competitive program, with the intent to fund six to eight regional hydrogen hubs across the country, and provides for an additional $8.5 billion program for development of carbon capture and storage technologies. By next spring, our regional hydrogen cluster expects to apply for funding through the program to take part in advancing this potential renewable energy source for our region. Turning to page 8. At the state level, our customers are benefiting as a result of Ameren Missouri Smart Energy Plan, a multiyear effort to strengthen and modernize the energy grid. As I just mentioned, Missouri Senate Bill 745, passed earlier this year and became effective in August, enhancing and extending the sunset date on the current Smart Energy Plan legislation through December 31, 2028 with an extension through December 31, 2033 if the utility requests and PSC approves. We believe extending Missouri Smart Energy Plan will continue to benefit our customers and communities as we transform the energy grid of today to build a brighter energy future for generations to come, while creating significant economic development and jobs in the state. Moving now to page 9 and an update on the Illinois Energy Legislation enacted in 2021. By January 20 of 2023, we plan to file a multiyear rate plan with the ICC for electric delivery service rates effective at the beginning of 2024. In late September, the ICC approved seven performance metrics, which will result in up to 24 symmetrical basis points of potential adjustments to the allowed return on equity under the multiyear rate plan. These performance metrics have been designed to incentivize improvement in areas such as reliability, supplier diversity, affordability, and customer service, as we continue to make significant investments in the state of Illinois for the benefit of our customers and communities. Turning to page 10, and the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. Here we provide an update on the MISO long range transmission planning process. As we have discussed with you in the past, MISO completed a study outlining a potential roadmap of transmission investments through 2039 taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates and goals for clean energy or carbon emission reductions, among other things. In July, MISO approved Tranche 1, a set of projects located in MISO north, which had estimates to cost approximately $10 billion. Approximately $1.8 billion of these projects are in our service territory and have been assigned to Ameren. Preliminary design work and project planning are already underway. Construction is expected to begin in 2025, with completion dates expected near the end of this decade. In addition to the assigned projects, MISO approved approximately $700 million of competitive projects that cross through our Missouri service territory, which provide additional potential investment opportunities. Request for proposals for the two competitive projects in our service territory are expected to be released in December 2022 and March 2023. Once released, we expect a proposal and evaluation process to take approximately 12 months. We are well positioned to compete for and successfully execute these projects, given their location and our expertise constructing, operating and maintaining large regional transmission projects. MISO continues its work on future tranches, and it's indicated that an initial set of Tranche 2 projects also located in MISO north, is expected to be approved in the second half of 2023. Projects include in Tranche 3 are expected to be located in MISO south, with approval scheduled by the end of 2024. While projects identified in Tranche 4, are expected to improve transfer capability between MISO north and MISO south, and will be studied upon approval of Tranche 3. Turning to page 11. Looking ahead over the next decade, we have a robust pipeline of investment opportunities that will deliver significant value to all of our stakeholders by making our energy grid smarter, stronger and cleaner. As a result of the Long-Range transmission projects just discussed, as well as the additional renewables and combined cycle generation included in the change to the IRP filed in June, we increased our pipeline of investment opportunities to $48 billion over the next decade. We expect to update and roll forward our five-year capital plan on our year-end call-in February. And as always, we will evaluate all of our opportunities across all business segments to ensure we maximize value for our customers and shareholders. When determining the timing of our projects, we remain mindful of portfolio diversification in both technology and geography, workforce and supply chain capacity and the impacts to grid reliability, while aggressively managing costs. Maintaining constructive energy policies that support robust investment in energy infrastructure, and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs in the future, and delivering on our customers’ expectations. Moving now to page 12, we are focused on delivering a sustainable energy future for our customers, communities and our country. This page summarizes our strong sustainability value proposition and focus on environmental, social governance and sustainable growth goals. The change to the Ameren Missouri IRP filed in June supports a 60% reduction in carbon emissions by 2030 and an 85% reduction by 2040 compared to 2005 levels. And our goal of net zero carbon emissions by 2045 is consistent with the objectives of the Paris Agreement and limiting global temperature rise to 1.5 degrees Celsius. Importantly, our energy policy advocacy and investment plans align with these goals. In terms of governance in October, the CPA-Zicklin Index once again named Ameren, one of the top three companies in the utility industry for corporate political disclosures and accountability. We also remain focused on supporting our communities, including utilizing our very robust supplier diversity program to help ensure we execute on an equitable clean energy transition. And we remain committed to helping our customers keep their bills as low as possible, through robust energy efficiency programs, and energy assistance for those in need. Lastly, our strong, sustainable growth proposition remains among the best in the industry. We have a robust pipeline of future investments that will continue to modernize the grid and enable the transition to a cleaner energy future. I encourage you to take some time to read more about our strong sustainability value proposition, you can find our ESG related reports at amereninvestors.com. Turning to page 13. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our current five-year growth plan, which included our expectation of a 6% to 8% compound annual growth rate earnings growth rate from 2022 through 2026. This earnings growth is primarily driven by strong rate base growth supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. We expect average future dividend growth to be in line with our long-term earnings per share growth expectations and a payout ratio range of 55% to 70%. In February 2022, Ameren’s Board of Directors last increased the quarterly dividend by $0.04 or $0.59, to $0.59 per share or approximately 7%. We plan to deliver strong, long-term earnings and dividend growth which results in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plan and strategy across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. And I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty. And good morning, everyone. Yesterday we reported third quarter 2022 earnings of $1.74 per share, compared to $1.65 per share for the year ago quarter. Page 15 summarizes key drivers impacting earnings at each segment, I'd like to take a moment to highlight a few key variances for the quarter. Earnings in Ameren Missouri, our largest segment benefited from higher electric service rates, which became effective on February 28, 2022. The increase and reserve were partially offset by higher O&M driven in part by unfavorable market returns in 2022 on company owned life insurance investments. Earnings at our remaining three business segments were higher primarily driven by increased investments in infrastructure, in addition to a higher allowed return equated to Ameren Illinois Electric Distribution. Before moving on, I'll touch on year-to-date sales transfer for Ameren Missouri and Ameren Illinois Electric Distribution. Weather normalized kilowatt hours sales to Missouri residential customers were comparable versus the prior year, and sales to commercial customers increased about 1%. Weather normalized kilowatt hour sales to Missouri industrial customers decreased about 1%. Weather normalized kilowatt hour sales to Illinois residential customers decreased about 1%, and sales to commercial and industrial customers increased about 0.005% and 1% respectively. Recall that changes in electric sales in Illinois no matter the cause, do not affect earnings since we have full revenue decoupling. Turning to page 16. I would now like to briefly touch on our 2022 earnings guidance. We have delivered strong earnings in the first nine months of 2022 and are well positioned to finish the year strong. As Marty stated, we have narrowed our 2022 diluted earnings guidance to be in the range of $4 to $4.15 per share. This is a comparison to our original guidance range of $3.95 to $4.15 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed in our earnings call in February. As we reflect on our full year results, the benefits we have seen from weather year-to-date, and from higher than expected 30-year Treasury rates are mostly offset by company owned life insurance investments performance, as well as higher than expected short term and long-term borrowing rates. Turning now to page 17 for an update on regulatory matters, starting with Ameren Missouri, in August, we filed for a $360 million electric revenue increase with the Missouri Public Service Commission. The request which was driven by the by increased infrastructure investments under the Smart Energy Plan includes a 10.2% return on equity, a 51.9% equity ratio, ending December 31, 2022 estimated rate base of $11.6 billion. In October, we supplement our filing to request a tracker for the benefits and costs resulting from the Inflation Reduction Act. Missouri PSC staff and other intervenors are expected to file direct testimony in January 2023 with hearing scheduled for early April 2023. We expect to have a Missouri PSC decision by June 2023 and new rates to be affected by July 1, 2023. We look forward to our continue to work with all key stakeholders on this request. Moving to page 18 to Illinois Regulatory Matters. Earlier this year, we made our required annual electric distribution rate update filing. Under Illinois performance base rate making these annual rate update systematically adjust cash flows over time for changes in cost of service and trued up any prior period over or under recovery of such cost. In August, the ICC staff updated a recommendation to reflect a $61 million base rate increase compared to our updated request of an $84 million base rate increase. The $23 million variance is primarily driven by a difference in the capital structure common equity ratio, as we have proposed 54% compared to the ICC staff recommended 50%. For perspective, the order received from the ICC last December included a common equity ratio of 51%. And ICC decision is expected in December with new rates to be effective in January 2023. Finally, we expect to file a new rate review with the ICC for our Ameren Illinois Natural Gas business in early 2023 using a forward test year ending December 31, 2024. Turning now to page 19. As Marty mentioned, we're pleased with the Inflation Reduction Act, which enhances affordability of the clean energy transition for our customers in both Missouri and Illinois. We currently estimate based on the clean energy investments outlined in the preferred plan included in the change to Ameren Missouri's IRP that the production tax credits provided for in the legislation will yield more than $1 billion in net benefits by 2030, saving our Ameren Missouri customers an average of more than 4% per year over that period of time as compared to what they would have paid. We expect our Illinois customers to receive the benefits from the legislation over time to reduce power purchase cost. Further, as we sit here today, we do not expect the corporate minimum tax of 15% on adjusted financial statement income to apply in 2023. Incremental annual cash payments due to the corporate minimum tax beyond 2023 are not expected to be material. And finally, we're assessing our ability to utilize the 10% production or investment tax per data for presiding projects at existing energy communities, including retired coal fired energy centers. Moving to page 20, we provide a financing update, we continue to feel very good about our financial position. We were able to successfully execute on several debt issuances earlier this year, which are outlined on this page. In order to maintain a strong balance sheet while we fund our robust infrastructure plan, consistent with the guidance in February, we expect to issue approximately $300 million in common equity in both 2022 and 2023. We're very pleased to say that through our, at the market equity program, we have now fulfilled these equity needs executed through the forward sales agreements with an average initial forward sales price of approximately $90. And we expect to issue approximately 3.4 million and 3.2 million common shares upon settlement by yearend 2022 and 2023, respectively. Having substantially utilized the $750 million of capacity under our existing ATM program, we expect to increase the existing program by approximately $1 billion to address equity needs in 2024 and beyond. Moving to page 21. In light of the recent rising interest rate environment, we have provided our long-term debt maturities remaining through 2026. We have just $47 million of long-term debt maturing later this in Ameren Missouri and $100 million with long term debt in Ameren Illinois, maturing in 2023. All of our long-term debt is at fixed rates and variable rate debt is limited to commercial paper borrowings. It's also important to note that a portion of the interest cost is also capitalized in the normal course is related debt supports construction work in progress. I'd also like to know we receive recovery of any changes in interest expense in our Illinois, Ameren Illinois Electric Distribution and Ameren Transmission businesses through the reconciliation process. Further, we have some favorable exposure at the Ameren Illinois Electric Distribution return on equity as it's tied to the 30-year Treasury rate through 2023. Changes in long term and short-term debt costs today in Ameren Missouri and Ameren Illinois Natural Gas will be incorporated into rate reviews for recovery over time, which includes a trued-up to the cost of capital as of December 31, 2022, and the current Ameren Missouri Electric rate review. We're mindful the changes in interest rates and remain focused on managing costs for our customers. Turning to page 22, I'd like to briefly touch on our natural gas business as we head into the winter months. We recognize the inflationary environment customers are facing we're working to keep bills as low as possible and write energy savings programs for our customers. We're actively working with customers in both Missouri and Illinois to help them gain access to funds available through low income, Home Energy Assistance Grants and other energy assistance funds in addition to our energy efficiency programs. Details on these customers assistance programs and the energy efficiency programs can be found on our website@amerenn.com. Both Ameren Illinois and Ameren Illinois and Ameren Missouri Natural Gas combined prices are approximately 85% hedge based on normal seasonal sales and 100% of the Ameren Illinois Natural Gas is volumetrically hedge based on maximum seasonal sales. From a customer bill perspective, residential natural gas customers in Illinois and Missouri are expected to see bill increases of approximately 4% and 14% respectively, compared to the 2021, 2022 winter season. Turning to page 23, we plan to provide 2023 earnings guidance when we release fourth quarter results in February next year. Using our 2022 guidance as a reference point we have listed on this page select items to consider as you think about our earnings outlook for next year. Beginning with Missouri, earnings are expected to be higher in 2023 when compared to 2022 due to new electric service rates effective in late February 2022. And the new electric service rates expected to be affected by July 2023 as a result of the pending rate review. We also expect increased investments in infrastructure eligible for plan and service accounting to positively impact earnings. Further, we expect energy efficiency performance incentives to be approximately $0.03 per share lower in 2023 compared to 2022. A return to normal weather in 2023 would decrease Ameren Missouri earnings by approximately $0.11 compared to 2022 results to date assuming normal weather in the last quarter of the year. Next earnings from our FERC related electric transmission activities are expected to benefit from additional investments in Ameren Illinois projects made under forward looking formula ratemaking. For Ameren Illinois Electric Distribution, earnings are expected to benefit in 2023 compared to 2022 from additional infrastructure investments made of Illinois performance base rate making. The allowed ROE under the formula would be the average 2023, 30-year Treasury yield plus 5.8% Ameren Illinois Natural Gas earnings are expected benefit from an increase in infrastructure investments qualifying for rider treatment that will earn the current allowed ROE of 9.67%. And finally, have a note consistent with past practices our 2023 earnings guidance will include no expectation of COLI gains or losses. Turning to page 24 to summarize, we continue to expect to deliver strong earnings growth in 2022 as if we successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. The bottom line is that we are well positioned to continue executing our plan and Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder returns through the comparison very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question is from Julien Smith with Bank of America."
},
{
"speaker": "Darius Lozny",
"text": "Hey, guys, good morning. This is Darius on for Julian, thank you for taking the question. Wanted to start off at Illinois gas. Acknowledging that you guys have a filing -- a plan filing later in ‘23. Just curious with the pending sunset of that QIP rider, how you're thinking about potential forward looking cadence of filings or potentially, is there any appetite that you perceive for some kind of legislative solution, maybe akin to the multi-year rate plans that are now available on the electric side of things? Just curious how you're thinking about that at a high level?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, perfect. Good morning, this is my Michael. Yes, I'll start and Marty can certainly supplement it. Look, we haven't really said exactly what our future cadence will be, you're correct as a QIP, is set to sunset at the end of ‘23. And so, we're indicating that we're going to file a case here, and it'll be effective under this QIP for the balance of 2023. I mean I think the thing to keep in mind is you step back, and you look at the Illinois gas regulations. I mean, it's still very constructive, even absent the QIP and all, I'll come back to that. But I mean, there is forward test year, rates are decoupled, bad debt tracker, et cetera. I mean, there's some real positives with respect to what goes on there. But as the team gets to look at the opportunities there. I mean, we may have to have a different cadence if it were ultimately expired. But there could be an appetite to extend something at some point. We just really haven't engaged in those conversations at the moment. But we feel like absent even getting an extended, there are certainly ways to continue to manage that business very constructively going forward. Anything to add, Marty?"
},
{
"speaker": "Marty Lyons",
"text": "Michael, that was well said. I would just say that as we look ahead to our gas business, we certainly see the opportunity and, frankly, need for continued investment in our infrastructure to ensure that safe and reliable for our customers. I think that the QIP that we've had over time, that infrastructure mechanism has really provided some good benefits for customers as we think about what it's enabled in terms of a timely investment in the system. So as Michael said, we'll certainly utilize the forward test year capabilities that we have under Illinois law today and continue to consider along with other stakeholders, whether a replacement for QIP is something that we can introduce in the future or not, we'll see. Thank you."
},
{
"speaker": "Darius Lozny",
"text": "Great. Thank you for that. Appreciate the color. One more, if I can, and this is on the 2023 earnings considerations. I realize it's not a formal guidance or fully exhausted. But I noticed O&M is not included as one of the drivers. Are you planning to -- or are you managing to flat year-over-year? And maybe that's why it's not included on that list because it won't move the needle one way or the other on as an EPS driver? Or just how are you thinking about that cadence."
},
{
"speaker": "Michael Moehn",
"text": "Yes. I appreciate the question there, too. Historically, we really haven't given O&M guidance, especially as you think about some of these ongoing rate reviews, which makes it a little bit complicated at the end of the day. I would tell you that we continue to stay very focused on O&M itself. And if you look at kind of our year-to-date results, and I think Missouri is a good example. And you back out obviously some of the noise with COLI and some of the refined coal that got caught up in the rate review. We really have managed that to about 1.5%, 1.7% sort of increase. So I think the team has done a great job from a core perspective. We have made comments before that we continue to aspire to being flat over the time horizon we look out over the five-year plan. If you look at historically where we've been, I think we've shared a couple of these slides in the past, I think maybe the '16 through '21 period was the last time we were actually down over that period of time. So I always look to make it really a nondriver at the end of the day. I think we can give you a little more color as we get to February. But again, it is just a little more complicated because of some of the ongoing rate reviews as well. So hopefully, that helps."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"text": "Hey, how are you guys doing? Good morning. So back to that slide 23, I was also -- and I apologize if I missed it, it just lots of earnings today. Just on the impact of interest rates. I mean, I was just wondering if you could -- you did mention different maturities and everything going on. But I was just wondering if you have a rule of thumb of how we should maybe be thinking about things you've done to -- just what the impact of higher interest rates might be, I guess, is something to think about? Just if you could give us any flavor on that."
},
{
"speaker": "Michael Moehn",
"text": "Yes, I appreciate the question. I mean we really did try to provide some of that detail on '21 to give you a sense of sort of what's happening from a redemption standpoint. Obviously, we're going to have some just normal financings in the normal course. We didn't provide anything in there just because of what's going on with respect to rates. What I tried to also do, Paul, as you look at the recovery of interest rates in terms of how we think about it, transmission business. Obviously, formula rates got a little bit of a positive -- obviously, a positive hedge on the 30-year treasury offsetting in addition to you have a formula on the interest rate within the electric distribution business. And then Missouri itself, we're obviously in the middle of a rate review. So you'll be updating some of the capital structure and the cost of capital as we go through that rate review through the end of this year. So I tried to give that perspective just to give you a sense for what the impact would be in 2023."
},
{
"speaker": "Paul Patterson",
"text": "Yes, No, I appreciate the slide 21. I noticed, I guess, I was just wondering if you had a sheet on and Mike of course, there is short term you have and what have you. I was just wondering I guess we've got some sophisticated math you want us to do, which is fine. Okay. That's basically my only question. Thanks so much and have a great weekend."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of David Paz with Wolfe Research."
},
{
"speaker": "David Paz",
"text": "Hey, good morning. On the February call, as you plan to update -- are you planning to update your EPS growth target through 2027? And if so, will you roll in the expectations of the incremental Missouri renewables investments and the initial spending on the MISO projects?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, David, this is Marty. Yes, in our February call, we will plan to update you on our thoughts in terms of EPS CAGR from 2023 to 2027 at that point in time. We'll also, at that time, expect to update our capital expenditure plan which right now really runs through '26, we'll take that out through 2027. And we'll also update you on our expectations in terms of our rate base CAGR out through 2027. So those are all things that we plan to do on the February call. In terms of the overall investment pipeline, as we've discussed this morning, this year as a result of the Missouri Integrated Resource Plan, as a result of the MISO approving Tranche 1 projects, we bumped our overall 10-year pipeline from $40 billion to $48 billion. And as we mentioned in some of the specifics, some of those capital expenditures, we would expect to start to fall in the latter half of that five-year update. So those are things that we'll consider how best to fold-in to both our five-year CapEx guidance as well as that rate base CAGR."
},
{
"speaker": "David Paz",
"text": "Got it. And do you think those -- would you make an assumption on the competitive projects for MISO spending? Or would that be just mostly on the assigned projects?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. David, I think at this point, haven't made a firm determination as to whether what will fold-in or not. I would say with respect to some of those competitive projects, while it's a little bit of a different thing than we faced in the past, I would say, traditionally, we've been a bit conservative about rolling those things in until we have better line of sight to those being projects that we would be able to firmly execute. So I would expect with respect to those projects, we take a bit of a conservative posture."
},
{
"speaker": "David Paz",
"text": "Makes sense. And then just on equity, remind me your equity needs for 2024 to 2026 that we said when you last updated them. And along with that, just your targeted consolidated equity ratio?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. David, this is Michael. Yes, so when we roll forward our plan in February ‘22, so we had $300 million basically of external equity through the balance of that plan, plus $100 million of DRIP as indicated, very pleased with where we are today. I mean we've gotten the '22 and '23 offer there. So you should continue to assume that $300 million ‘24 through the balance, we continue to target a capitalization ratio close to 45% over that five-year plan. So we'll stay focused on that. And then as Marty just talked about, as we roll forward into February and roll forward the new capital plan, obviously, we'll step back and address any financing needs as part of what happens with that capital plan itself, but you should continue to think about that $300 million at the moment."
},
{
"speaker": "Operator",
"text": "Mr. Lyons, there are no further questions at this time. I would like to turn the floor back over to you for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Okay. Well, thank you all for joining us today. As you heard on the call, we've had a strong 2022 year-to-date. We remain focused on continuing to deliver strong value through the end of this year for our customers, communities and our shareholders. So Again, thanks for joining us. We look forward to seeing many of you, I think, at the EEI conference, which is just a couple of weeks away. Thanks all and be safe."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 2 | 2,022 | 2022-08-05 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host, Megan McPhail, Manager of Investor. Thank you. You may begin.
Megan McPhail: Thank you, and good morning. On the call with me today are Marty Lyons, our President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining us remotely. Marty and Michael will discuss our earnings results and guidance, as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward –looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions in financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section on our news release we issued yesterday and the forward-looking statements and risk factors section in our filings with SEC. Lastly, all per share earnings amounts discussed during today’s presentation including earnings guidance are presented on a diluted basis unless otherwise noted. Now here is Marty who will start on page 4.
Marty Lyons: Thanks, Megan. Good morning, everyone. And thank you for joining us. We had a solid quarter and we're excited to share an update today on a number of recent developments. As always, our team continues to work hard to execute our strategic plan across all of our business segments, allowing us to deliver significant value to our customers and shareholders. Yesterday, we announced second quarter 2022 earnings of $0.80 per share, compared to earnings of $0.80 per share in the second quarter of 2021. The year-over-year results reflected increased infrastructure investments across all our business segments that will drive significant long-term benefits for our customers. The key drivers of our second quarter results are outlined on this slide. I am pleased to report that we remain on track to deliver solid earnings growth in 2022 and are reaffirming our 2022 earnings guidance range of $3.95 per share to $4.15 per share. Michael will discuss our second quarter earnings, 2022 earnings guidance and other related items in more detail later. Moving to slide 5, you will find our strategic plan reiterated. We continue to invest in and operate our utilities in a manner consistent with existing regulatory frameworks, enhance regulatory frameworks and advocate for responsible energy and economic policies and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. Turning now to page 6, which highlights our commitment to the first pillar of our strategy, investing in and operating our utilities in a manner consistent with existing regulatory frameworks. Our strong long-term earnings growth guidance is primarily driven by our infrastructure investment and rate base growth plans, which are supported by constructive regulatory frameworks. You can see on the right side of this page, we continue to strategically invest significant capital in each of our business segments in order to maintain safe and reliable operations as we transition to a cleaner energy grid. Regarding regulatory matters earlier this week, Ameren Missouri filed an electric rate review with the Missouri Public Service Commission requesting a $316 million annual revenue increase. This request reflects significant modernization upgrades to the electric grid for system reliability, resiliency and safety, as well as investments to support the transition to cleaner energy for the benefit of our customers and local communities. In our Illinois Electric business, we recently requested an $84 million revenue increase in our required annual electric distribution rate filing. Again, key drivers for this rate increase includes significant investments to enhance the grid for our customers and communities, which will deliver long-term benefits. Michael will cover these in more detail a bit later. And we will provide updates on these proceedings as they develop later this year. As we invest to build a safer, stronger, smarter and cleaner energy grid for our customers, we also continue to work diligently to manage our costs, leverage our investments and optimize our performance. Moving now to page 7, and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Without question energy policy at the federal and state levels and constructed regulatory frameworks that incentivize meaningful and needed infrastructure investments have never been more important as we look too reliably and securely transition to a cleaner energy future as affordably as possible. As late last week, it was announced that Senators Schumer and Manchin reached agreement on proposed legislation that would, among other things, extend significant incentives for clean energy development and deployment. Given the Clean Energy Transition underway in Illinois and Missouri, as highlighted by our recent change to the Ameren Missouri Integrated Resource Plan, filed with the Missouri PSC in June and our goal of reaching net zero carbon emissions by 2045. We are very excited about the potential benefits of this legislation. Specifically, the credits proposed for wind, solar storage, nuclear, Carbon Capture Utilization and Storage or CCUS and hydrogen will align very well with the significant investments proposed in the Missouri IRP. Importantly, the benefits of these tax incentives will ultimately lower the cost of the clean energy transition for our customers in Missouri, and Illinois over time. These potential tax credits when coupled with the significant clean energy funding made available through the infrastructure investment in JOBS Act passed earlier this year will drive significant long-term benefits for our customers, communities and the country. I will also note that the proposed legislation includes a minimum corporate income tax for public companies with pretax book earnings above $1 billion. At the state level, as part of Ameren Missouri Smart Energy Plan, a multiyear effort to strengthen the grid, our customers are benefiting from stronger poles, more resilient power lines, smart equipment, including modern substations, and upgraded circuits to better withstand severe weather events and restore power more quickly. As we mentioned on our first quarter earnings call, Missouri Senate Bill 745, which enhances and extends the smart energy plan passed earlier this year with strong majority support in the General Assembly. The bill was later signed by Governor Parson. We believe extending Missouri's Smart Energy Plan will continue to benefit our customers and communities as we transform the energy grid of today to build a brighter energy future for generations to come. And while creating significant economic development and jobs in the state. Moving to page 8 for Illinois legislative matters, we continue to make progress working towards the implementation of the Illinois energy Transition Legislation enacted last year, including the performance metrics required by the legislation. Ameren Illinois has proposed eight performance metrics each worth three basis points of incentives for a total of 24 basis points of symmetric, equity return upside or downside potential. The ICC staff is mostly aligned with Ameren Illinois on the performance metrics and is proposed the range of 20 to 24 total basis points of increased or decreased return opportunities. We expect a final order from the ICC by late September in the performance metrics docket. We look forward to the ICCs order and filing our first multiyear rate plan next year, as we believe this legislation will support important energy grid investments and deliver value to customers. Turning to page 9, for an update on our plan to accelerate the retirement of the Rush Island Energy Center. Last month in response to our notification to MISO of our intention to retire the energy center, MISO issued its final Attachment Y report, designating the generating units at the Rush Island Energy Center as systems support resources. MISO also concluded that certain mitigation measures including transmission upgrades should occur to ensure reliability before the energy center is retired. Those transmission upgrade projects have been approved by the MISO and we have started the design and procurement process associated with the upgrades, which we expect to complete by late 2025. In the interim, until Rush Island can be retired, Ameren Missouri has proposed limiting operations at the Energy Center. The District Court is under no obligation or deadline to issue a rule modifying its remedy order to reflect the MISO SSR designation or proposed interim operating parameters. The original March 31, 2024 compliance date remains in effect unless extended by the court. We expected decision in the near term. Turning now to page 10 for an update on changes to our 2020 Ameren Missouri Integrated Resource Plan, which we filed in June. Our IRP is a 20 year energy plan created to ensure reliability for our customers for years to come. I'm excited to share with you that these changes to the plan accelerate our clean energy additions, reduce carbon emissions even further in the short term, and accelerate the company's net zero carbon emissions goal by five years. Specifically, the plan targets a 60% reduction in carbon emissions below 2005 levels by 2030 and an 85% reduction by 2040 and by 2045, our goal is to achieve net zero carbon emissions across all of Ameren. The new goals include both Scope 1 and Scope 2 emissions, including other greenhouse gas emissions of methane, nitrous oxide, and sulfur hexafluoride. We plan to achieve these goals by making significant investments in renewable energy, including 2,800 megawatts of renewable energy by 2030, representing an investment opportunity of $4.3 billion. This is an increase of $1 billion from our 2022 -- excuse me our 2020 IRP. By 2040 in total, in total, the plan includes 4,700 megawatts of renewable generation for a total investment opportunity of $7.5 billion. The plan also includes 1,200 megawatts of gas combined cycle generation by 2031, an investment opportunity of $1.7 billion, which will allow us to safely and reliably advance the net retirement timeline of our fossil generation, including the accelerated retirement of the Rush Island Energy Center. Further, the plan includes 800 megawatts of battery storage by 2040, representing an investment opportunity of $650 million, we expect to add 1,200 megawatts of clean dispatchable resource by 2042. And to also seek an extension of the operating license of our carbon free Callaway Nuclear Energy Center beyond the current expiration date of 2044. These changes to the 2020 IRP will drive our ability to meet customers rising needs and expectations for reliable, affordable and clean energy sources. Achieving these goals is dependent upon a variety of factors including cost effective advancements in innovative clean energy technologies, and constructed federal and state energy and economic policies. We have issued a request for proposal to solicit solar and wind projects that will allow us to take the next steps and deliver the best value for our customers. One thing is clear. Our IRP includes significant incremental investment opportunities, and we're very excited as we continue to execute our clean energy transition plan. Turning now to page 11. Speaking of executing our Clean Energy Transition Plan, in July, we filed Certificates of Convenience and Necessity or CCN with the Missouri Public Service Commission for two solar project acquisitions, Boomtown, a 150 megawatt solar energy center located in southern Illinois, is expected to be in service by the fourth quarter of 2020. Huck Finn, a 200 megawatt solar energy center located in Eastern Missouri, would be Ameren’s largest solar project to date, generating more than 25 times the amount of energy of Missouri's largest existing solar facility. This solar project is also expected to be in service by the fourth quarter of 2024. While the Missouri PSC is under no deadline to issue an order on the CCN filings, we expect decisions by March and April 2023 for the 200 megawatt and the 150 megawatt facilities respectively. Looking ahead, we expect to announce further agreements for the acquisition of renewables between now and the first half of 2023. Turning to page 12, in the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. This page provides an update on the MISO long range transmission planning process. As we have discussed with you in the past, MISO completed a study outlining a potential roadmap of transmission investments through 2039 taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates, and goals for clean energy or carbon emission reductions, as well as electrification of the transportation sector, among other things. In July, MISO approved tranche one, a set of projects located at MISO north, which had estimated to cost more than $10 billion. Of these projects approximately $1.8 billion represent projects in our service territory that have been assigned to Ameren. We expect to refine the scope, cost estimates and timelines for these projects over the remainder of this year. In addition to the assigned projects, MISO approved approximately $700 million of competitive projects that cross through our Missouri service territory, which provide additional potential investment opportunities. We are well positioned to compete for and successfully execute on these projects, given the location of the projects and our expertise constructing large regional transmission projects. Later this month, MISO is expected to post a schedule outlining the RFP process for competitive bidding, with the first RFP expected to be issued by late September. The competitive bidding process is expected to take 12 to 24 months. For the projects assigned to Ameren, we expect the capital expenditures to begin in 2025 with the completion dates expected near the end of this decade. MISO has also begun work on three additional tranches, and is indicated that an initial set of tranche two projects also located in MISO north is expected to be approved in the second half of 2023. Projects including tranche 3 are expected to be located in MISO south, with approval scheduled by the end of 2024 while projects identified in tranche 4 are expected to improve transfer capability between MISO north and MISO south, and will be studied upon approval of tranche 3. Turning then to page 13. Looking ahead over the next decade, we have a robust pipeline of investment opportunities that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. We have updated the investment opportunities to reflect the additional renewable and combined cycle generation included in the change to the IRP filed in June. We now expect over $48 billion of investment opportunities over the next decade, maintaining constructive energy policies that support robust investment in energy infrastructure, and a transition to a cleaner future in responsible fashion will be critical to meeting our country's energy needs in the future, and delivering on our customers’ expectations. Moving now to page 14, we're focused on delivering a sustainable energy futures for our customers, communities and our country. This slide summarizes our strong sustainability value proposition and focus on environmental, social, governance, and sustainable growth goals. The change to the Ameren Missouri IRP filed in June supports our goal of net zero carbon emissions by 2045. And is also consistent with the objectives of the Paris Agreement in limiting global temperature rise to 1.5 degrees Celsius. We also remain focused on supporting our communities, including our very robust supplier diversity program. Our strong sustainable growth proposition remains among the best in the industry. We have a robust pipeline of future investments that will continue to modernize the grid and enable the transition to a cleaner energy future. I encourage you to take some time to read more about our strong sustainability value proposition, you can find all of our ESG related reports at amereninvestors.com. Turning to page 15. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our five year growth plan which included our expectation of a 6% to 8% compound annual earnings growth rate from 2022 through 2026. This earnings growth is primarily driven by strong rate base growth supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. We expect Ameren’s future dividend growth to be in line with our long-term earnings per share growth expectations, and within a payout ratio range of 55% to 70%. We expect to deliver strong long-term earnings and dividend growth which results in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all four of our business segments, as we have an experienced and dedicated team to get it done. Finally, turning to page 16, I would like to take the opportunity to congratulate Richard Mark on his retirement and extend my gratitude for his many contributions made to Ameren and our communities. Richard served in several leadership positions during his 20 year career at Ameren and was influential in the advancement of the electric and natural gas distribution grids throughout southern and central Illinois, including installing advanced technologies, improving reliability, and creating 1000s of jobs in addition to his strong community engagement. Thank you, Richard, and I wish you well in your retirement. I would also like to introduce to you Ameren Illinois’s new President Lenny Singh. Lenny brings more than 30 years of utility experience serving in both electric and natural gas operations, most recently as Senior Vice President of Consolidated Edison Company of New York. Over the course of his career, Lenny is focused on operational excellence and value creation, prioritizing safety, customer satisfaction, continuous improvement, action and accountability. I look forward to working with Lenny as he builds on Ameren Illinois success as we work to safely, reliably and securely drive the clean energy transition in the state of Illinois. Again, thank you all for joining us today. And I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty. And good morning everyone. Yesterday, we reported second quarter 2022 earnings of $0.80 per share, compared to $0.80 per share for the year ago quarter. Slide 18 summarizes key drivers impacting earnings at each segment. I'd like to take a moment to highlight a few key variances for the quarter. Earnings in Ameren Missouri, our largest segment benefited from higher electric retail sales driven by warmer early summer temperatures during the quarter compared to near normal temperatures in the year ago period, and higher electric grid. A positive factors impacting earnings Ameren Missouri were more than offset by, among other things, higher operations and maintenance expenses. Higher O&M reflected unfavorable market returns in 2022 on company on life insurance investments compared to payroll market returns in the year ago period. In addition, the higher O&M expenses were driven by the absence of refined coal credits in 2022, which had been a benefit to our coal fired energy centers in 2021, and prior year and increased transmission and distribution expenses including storm cost. The reduction in refined coal credits was anticipated and reflected in the new electric service rates effective earlier this year. In fact, year-to-date, O&M costs excluding COLI are largely in line with what we expected when we provide guidance in February. We remain focused on discipline cost management for the second half of the year. Before moving on, I'll touch on sales trends for Ameren Missouri and Ameren Illinois electric distribution year-to-date, weather normalized kilowatt hour sales to Missouri residential and commercial customers increased about 0.5% and 1.5% respectively. Our weather normalized kilowatt hour sales to Missouri industrial customers decrease about 0.5%. Weather normalized kilowatt hour sales to Illinois residential and commercial customers increased about 1.5% each year-to-date and weather normalized kilowatt hour sales to Illinois industrial customers increased about 0.5%. Recall that changes in electric sales in Illinois no matter the cause do not affect our earnings. Since we have full revenue to coupling. Turning to page 19. I would now like to briefly touch on key drivers impacting our 2022 earnings guidance. We've delivered solid earnings in the first half of 2022 and are well positioned to finish the year strong. As Marty stated, we continue to expect 2022 diluted earnings to be in the range of $3.95 to $4.15 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed in our call -- earnings call in February. As we reflect on our earnings for the full year results, the benefits we've seen from weather during the first half of the year and from the higher expected 30 year Treasury rates are offset in part by unfavorable market returns and company on life insurance, as well as higher than expected short term and long-term borrowing rates. I encourage you to take these into consideration as you develop your expectations for the third quarter and full year earnings results. Turning now to page 20 for an update on regulatory matters, starting with Ameren Missouri. Earlier this week, we filed for a $316 million electric revenue increase with the Missouri Public Service Commission. The request includes a 10.2% return on equity, a 51.9% equity ratio, and a December 31, 2022 estimated rate base of $11.6 billion. Drivers are the requested increase on investments on the Smart Energy Plan, including increased cost of capital and depreciation expense, as well as increased net fuel expense due to reduced off system sales driven by expected reduced operations at Rush Island. As Marty noted earlier, customers are benefiting from investments made in to the smart energy plan to strengthen the grid, including infrastructure upgrades, bolstering reliability and resiliency, installation of smart meters and improving our reliability of up to 40% on [Inaudible] with new smart technology upgrades. We expect the Missouri PSC decision by June 2023 and new rates to be affected by July 1, 2023. We look forward to working with all key stakeholders on this request. Moving to page 21, an Ameren Illinois regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance base rate making, these annual rate updates systematically adjust cash flows over time for changes in cost of service and true-up of any prior period over or under recovery of such cost. In late June, the ICC staff recommended a $60 million base rate increase compared to our updated request of an $84 million base rate increase. The $24 million variance is primarily driven by a difference in the common equity ratio, as we propose 54% compared to the ICC staffs recommended 50%. For perspective, the order received from the ICC last December included a common equity ratio of 51% and ICC decision is expected in December with new rates expected to be effective in January 2023. On page 22, we provide a financing update, we continue to feel very good about our financial position. On April 1, Ameren Missouri issues $525 million or 3.9% green first mortgage bonds due 2052. Proceeds of the offering are used to fund capital expenditures and refinance short-term debt. In order to maintain a strong balance sheet while we fund our robust infrastructure plan consistent with the guidance in February. This year, we expect to issue approximately $300 million of common equity under our aftermarket equity program. We have fulfilled all of our 22 equity needs through the forward sales agreement entered into as April 1, and we expect to issue 3.4 million common shares by the end of this year upon settlement. Further, as of July 12, approximately $225 million of the $300 million of equity outlined 2023 has been sold forward under that program. Finally, turning to page 23, we have had a solid first half and we expect to deliver strong earnings growth in 2022 as we continue to successfully execute our strategy. Today, we've outlined significant and exciting investment opportunities over the back half of our current capital plan and beyond that are not reflected in our 2022 to 2026 capital plan. Consistent with our approach in the past, we will step back and take a comprehensive look at our investment opportunities and provide our five year capital plan for 2023 through 2027, during our year end conference call in February. As we look at the longer term, we continue to expect strong earnings per share growth driven by robust rate based growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. The bottom line is that we are well positioned to continue executing our current plan. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder returns to where that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator Instructions] Our first question comes from Shahriar Pourreza with Guggenheim Partners.
Shahriar Pourreza: Hey, good morning, Marty. Not too bad. It's very good day. Marty, Let me ask just thank you for the visibility. Obviously, we're on the tranche 1 opportunities, but just a two part question here. What's your, I guess, confidence level on the competitive slice? Or how should we be thinking about maybe your ability to capture that? Is there a technical or cost of capital facet to your advantage? And then does this -- how does this sort of interact with your prior CaPex and sort of rate base guide? I mean, some of the projects do break ground in ‘25. So could these be an accretive to your 6% to 8%? Thanks.
Marty Lyons: Yes, you bet Shahriar, good questions. And, here I hope you have a Good Friday and a good weekend. But back to your questions, in terms of the competitive projects coming out of tranche 1, as we highlighted a little over $700 million of those. And as we mentioned in our prepared remarks that we do believe we're well positioned to compete for and successfully execute those, I think the bottom line is that we believe we're really well positioned to efficiently build, operate and maintain those assets over time. The projects that are competitive are within our footprint. They're places where we have strong relationships with local communities, regulators, suppliers, contractors, et cetera. And we've been operating in this area for many years. So we know the land, we know the environmental conditions and issues. And I tell you too that we've been working for several years now, as we've developed billions of dollars’ worth of transmission projects, and we've been working overtime with suppliers and contractors to really bring down the costs of construction. And because these projects, these competitive projects are contiguous with other assets that we own and operate, we think we're really well positioned to operate and maintain these assets at a low cost over time. So those are some of the reasons that we believe at the end of the day, we're well positioned to compete and execute on those projects. So we look forward to participating in that competitive process over time. And then your second question really got to some of the incremental capital into our plan. I'll let Michael comment on that. But you're right, in terms of the $1.8 billion worth of projects that were assigned to us, we do again, expect to begin those in 2025. And those cash flows and capital expenditures to be incurred over between 2025 and the end of the decade. Michael, any comments in terms of the added CaPex?
Michael Moehn: Yes. Good morning, Shahriar. Marty said as well in terms of the capital plan itself, Shahriar, and we've talked about this, I mean, I think that it's great to start getting some clarity here around these different projects. And as Marty said I think some of this could even benefit the five year plan, as we have indicated we're going to step back. And what we typically do with our cadences, will update all this in the February timeframe. And my sense is this has got the ability to be accretive to our five year capital plan, as well as just additive to the overall runway, as we talk about the growth story. I think as we, if you kind of remember, if you reflect back on the $48 billion that we have there now that number used to be $40 billion, we captured about $5 billion associated with transmission projects, it was broadly to try to look at these LRTP projects over the next 10 years. So, I think we got it in there. And now, it's a matter of where it just ends up by year, if that makes sense.
Shahriar Pourreza: It does. Yes. I am sure it does.
Marty Lyons: Shahriar, this is Marty. And I think Michael touched on a good thing as we started the year we looked ahead to Q2, and we noted that there were going to be some important updates in Q2, and I think that's exactly what came through in terms of the Integrated Resource Plan in Missouri that indicated about $2.7 billion of incremental spend between now and 2031. And then, as Michael said, the LRTP, adding another $1.8 billion of expenditures that we have signed to us, as well as this potential for $700 million of additional competitive projects. So as Michael said all those things gave us confidence to add that $8 billion to that long-term capital expenditure outlook.
Shahriar Pourreza: Perfect. And then just I know, you just probably touched on it a little bit on just the Inflation Reduction Act. I mean, obviously, [Inaudible] proposed some changes, I think we go to a vote on Saturday. Can you just touch a little bit on the tax side? I mean, some of the utilities have talked about a technical fix with the 50% AMT? Are you in sort of EI lobbying against it? Could you get a carved out? And then if there isn't enactment of that AMT how do we sort of think about the cash flows and rate base growth impact and the recovery timing? Thanks.
Marty Lyons: Shahriar, there's a lot there. And as you noted even based on the reports this morning there seems to be some moving pieces as it relates to the corporate minimum tax. Let me just say this overall, about the legislation, we're excited about the potential tax credits in the legislation, especially the wind and the solar, given the 4,700 megawatts of renewables that we looked at, in Missouri by 2040, based on our Integrated Resource Plan, so that's all pretty exciting, and even net of CMT impact. We think the legislation is good for Ameren, for our customers in both Missouri and Illinois, because it really should lower the cost of the clean energy transition in both states. And that's not even mention in some of the other positives in there, whether it's the credits for nuclear storage, CCUS, hydrogen things we talked about on the call, all of which align with our long-term resource plan. So that's all really good, other things you're aware of things like the PTC for solar is a positive versus the prior ITC and transferability provisions, which are things that we really think could help us to pass the value associated with some of these tax credits to our customers more swiftly. So, like I said, net, we think that the legislation overall is good and will help facilitate a lower cost transition to this clean energy. As it relates to the CMT, it is applicable to us, given that we have pretax book income of greater than $1 billion, but probably premature to speculate on exactly what that impact would be given, as you mentioned, some of the moving pieces that aren't even really clear to us at this particular time. But at the end of the day, we do think based on what we have seen we do believe that the cash flow impacts would be manageable. And as would and Michael can comment on this better, but also the impacts on credit metrics and credit rating. So that's, I guess, where we stand on things. Shahriar, hopefully, I answered all of your questions. Michael, do you have anything to add?
Michael Moehn: Yes, I think Marty, I think at a high level you gave it good justice there. I mean, I think overall, we do see it as being manual. There are a lot of moving pieces here. So I think that's why we're really trying to stay away from the specifics, but as we look at it and model it out we do think as Marty said both from a cash flow as well as any sort of impact, Shahriar, our FFO to debt metrics, that it definitely is something that's manageable. And I think the important thing to remember is just that the net benefit to customers just from an overall credit standpoint, certainly on the Missouri side, as you think about this clean energy transition that we're about to go through.
Operator: Our next question comes from Jeremy Tonet with JP Morgan.
Jeremy Tonet: Hi, good morning. Just wanted to round out the MISO tranche 1 conversation a little bit more. Would Ameren entertain the notion of pursuing competitive processes beyond the $700 million identified or is that the extent of what you would consider? And also we've heard about there being kind of some incremental upside to these projects, maybe 10% to 15% of CapEx, additionally for kind of ancillary components to these projects. And just wondering if you had any thoughts along those lines?
Marty Lyons: Yes, Jeremy, good questions. You've certainly will look to compete for the $700 million if there are other projects that are competitive, certainly we'll take a look at those as well. We're not limited to these. But of course, as you know, in many of the surrounding states you have entities with rights of first refusal. So, look, we feel good about the ones that have been assigned to us. I can't emphasize that enough. That's $1.8 billion we feel great about, and we'll go after the $700 million if we see other opportunities, we'll certainly look to compete in those as well. I wouldn't speculate right now, Jeremy, on in terms of any incremental investment beyond these, these are the estimates that really came from MISO. And as we indicated in our call, prepared remarks we'll certainly be looking to next steps is really work on more refined design, procurement, the regulatory approvals, et cetera. And give updates on what we think the overall value of these projects are, perhaps when we get around to February and update our overall plans, but for now, we think these are the best estimates to be able to provide.
Jeremy Tonet: Got it. That's helpful. Thanks. And then just as it relates to Rush Island here, if you could provide any incremental thoughts with regards to transmission upgrade opportunity here. Any – could you provide any estimates on what these upgrades could look like? I know it's bigger than a breadbox. We're trying to kind of scope out what that might look like.
Marty Lyons: Yes, good question. Look, we, we gave pretty good update in our prepared remarks on Rush Island. We did indicate that design and procurements underway with respect to the upgrade projects that MISO had approved. I mean I think our best estimate today, and this was a bit of a broad range, probably in the $100 million to $150 million range. And but like I said, we'll be able to refine that further as we go through the design and procurement activities.
Operator: Our next question is from Julien Dumoulin-Smith with Bank of America.
Julien Smith: Hey, good morning, team. Thanks for the time, the opportunity. Hope you guys are well. Thank you. Thank you, sir. So maybe I want to come back to the Rush Island situation. I know, you mentioned ’25 for instance, on retirement here, but I want to talk about these other CSAP regulations. And just try to understand how that lines up. I know that there's some proposals out there for 2026. And obviously, you've got a couple other plans Labadie and Sioux. How do you see this playing out? Because obviously that there's EPA regs and sort of hypothetical ether, and then there's sort of reality of them lining up against your portfolio in a pretty meaningful way. I just want to understand sort of the specifics as to, I mean, obviously, it's subject to litigation, but how do you see this playing out more specifically for your portfolio? And as you see to try to balance things?
Marty Lyons: Yes so as it relates to the CSAPR rules, look, it's something we're not only monitoring but engaging with EPA in terms of providing comment. Of course, Merrimack is retiring this year, Rush Island is, as you mentioned, looks like it's going to retire in the 2024 to 2025 timeframe. Again, we don't expect the transmission investments to be fully completed until 2025. As we noted, we have proposed some limited operations between now and then between now and when the plant would ultimately retire all subject to the court's ruling in terms of operating parameters as well as the ultimate closure date. But certainly going to significantly reduce NOx emissions as we ramped down towards closure of that facility. So I think the focus really becomes, Julien, that on NOx controls, at Labadie and Sioux, and I would remind you there that we've made significant investments over time in terms of NOx controls, and we're more than complying with all the current standards that are out there. So with respect to the proposed additional rules I think we'll wait to comment on specifically what the impacts will be at Labadie and Sioux over time, until we get the final rules, which we expect to come out next March. But I will tell you that what we'll be doing and we are, we're analyzing strategies for compliance, and making sure that we get the full benefit of the controls that we do have in place today at Labadie and Sue.
Julien Smith: Yes. Excellent. Thank you. And then if I can, just jumping in on the inflation conversation, obviously, you filed here, though, your latest iteration of a rate case. But how are you seeing sort of cost inflation manifests itself across your portfolio? And how do you think about balancing that given the test here, embedded in the current rate case? And then the other levers you might have.
Michael Moehn: Yes, thanks, Julien. This is Michael. Look, inflation, it certainly we're in a little different environment today. But I mean, I think we've talked historically, and we've showed you a couple of times, even have a slide, I think that went through 16 through 21. And our overall operating costs were down about 3%. And so, look, we remain focused on it, you referenced this Missouri rate review that we just filed here. I would tell you that that's really predicated on a lot of capital investment within the Smart Energy Plan, we outlined, and I think the benefits that customers are getting associated with those investments. And obviously, it's also being impacted by what we just talked about with respect to Rush Island, and the net fuel costs and operating in that plant in a more limited fashion as well. So when you really cut through what's going on in case, it's not, it's really not about O&M costs, which I think is a testament to what this team has been doing in terms of just looking for ways to continue to hold down costs wherever possible. So in the present environment, I think we're managing well through it. As we noted, on the call, we had some O&M was up, but it was really driven by some one time things between the COLI performance towards some storm costs. And when you cut through it, it certainly lines up with what our expectations were on the February timeframe, we released guidance.
Julien Smith: Got it. And just prospectively, here, just if I can push a little bit further, obviously, you've done a good job, sort of to date, if you will, if you look prospectively whether that's related to the cadence of labor relation negotiations, et cetera. When do you -- what kind of trajectory, what inflation are you seeing sort of in real time more prospectively here? If you can comment a little bit more?
Michael Moehn: Yes, sure. Look, I do. Yes, absolutely, I keep my comments consistent with already been in the past. And that's Marty and I and the rest of the team is very focused on these costs, and doing all that we can to control what we can control. And look, we aspire to keep these O&M costs. I think we said this for the really flat over the five year horizon, if at all possible, it's obviously, and it’s a bit more challenging in this environment. But again, as we look to our capital plan, we look to the investments that we're making in automation and digital and smart meters. I mean, we're using all of those things to increase productivity, lower costs where we can and we're going to stay focused on it and just do absolutely all that we can because we know again what it means to our customers, we understand we talked about this from a capital perspective for every dollar of O&M we reduce we can spend the equivalent $7 of capital and so, it is certainly top of mind, and continuous everyday focus here.
Operator: Our next question is from Paul Patterson with Glenrock Associates.
Paul Patterson: Hey, good morning. So, just on Rush Island, just sort of technically speaking. If you don't get, I mean if the courts don' completely go your way, the plan to shut down, what would actually happen, or do we have an idea about what would happen?
Marty Lyons: Yes, I guess I don't want to speculate that on, Paul, I think that it's obviously a process that we're still we're working through with court and the court proceedings and so we laid out for you on slide 9 the facts as they stand today and certainly wouldn't speculate if we get to that that crossroads, I would point you on slide 9, we said that with respect to the court, the March 31, 2024 compliance day remains in effect, unless extended by the courts. So the courts got that ability and certainly don't want to speculate as to what the court will or won't do. And we'll let these proceedings play out.
Paul Patterson: Okay. Fair enough. I don't want to push that. I guess it's all hypothetical, I guess, to certain degree. So with respect to wind curtailments that we've been seeing in the area, I was wondering if you could tell us what you've been seeing, not just in Ameren but the greater Ameren neighborhood so to speak, as well as how tranche 1 and other sort of activity occurring, like I guess, Green Belt is talking about a 25%, I think, increase among other things, as there's just a lot of moving pieces, I guess to put it right, so I'm just sort of wondering what if you could just sort of comment about what you're seeing there in terms of additions of generation plants, traditional plants, shutting down and transmission, what you see sort of the current situation with wind curtailments is generically speaking in your general region and what tranche 1 and other things might do with respect to the issue.
Marty Lyons: Yes Paul, I guess I don't have a specific comment on wind curtailments and something we can follow up on you, follow up with you on. That said what I have seen recently is a map of these tranche 1 projects overlaid against where we're seeing congestion across MISO. And I will tell you, there's tremendous alignment there meeting these plan projects and tranche 1 really align well with where we're seeing congestion across the footprint really promised to alleviate some of that congestion. And I think that's why if you go back a year or so ago, [Worter] made a comment about these being, I forget the word he use, but kind of no brainer projects or something like that, and no regrets projects. And I think what he really meant by those is that whether we proceed towards future one, two, or three in MISO these projects are very foundational, no matter where you go, and they're needed today to address some of the congestion that we're already seeing within the MISO footprint. And the look ahead to tranche 2, 3 and 4 especially based on what we're seeing coming out of this IRA legislation I think is really going to push us beyond that future one to more of like a closer to a future two kind of outlook. And my sense is that some of that'll end up getting baked into the extent of the projects that are approved in future tranches, including tranche 2, which is still expected to be approved by late next year. So again, don't have a specific comment on your question about what we're seeing currently. But to your question about these transmission projects and the need to alleviate congestion issues we're seeing absolutely they aligned very well.
Operator: [Operator Instructions] Our next question comes from Anthony Crowdell with Mizuho.
Anthony Crowdell: Hey, good morning, Mike. Good morning, Marty. Thanks for taking my questions. I guess first on the Missouri rate filing, just as I think about you filed in ‘21, you're filing again, in ‘22. We had a piece of legislation passed, just what's now, that you maybe have more clarity on the forward looking CaPex plan? What kind of frequency of rate filing you expecting in Missouri for the next two or three years?
Michael Moehn: Andy, we haven't actually said, I mean, you're right, we've been on kind of a two year cycle here at this point. And look, I mean, we obviously we want to continue to stretch these out as much as we possibly can. But just given the pace that we've been on from a capital standpoint two years has been sort of what the required paces be, needed to be. I think the only other thing to just keep in mind is that we are required to file every four years just because of the fuel adjustment clause, but otherwise we do want to try to stretch them out as long as we can.
Anthony Crowdell: Grea.t And then I guess, last, it is may be hard or may not be a great question. If I think about the futures one projects that the company will bid on, did the incumbent utilities, you guys operate in that jurisdiction, it's seems that maybe you're -- the incumbent utilities are more likely to submit a proposal for a more robust, like infrastructure, because it's in your jurisdiction, you're looking at [Inaudible] at asset list, be active for 50 years, 60 years or something like that, where's the competitor coming in there, they just meet the bare minimum of a design spec, and it makes it more affordable, and wins the competitive process? Is that possible? Or it's the design specs are the same for everyone?
Marty Lyons: I really think MISO is going to do their best to make sure that there are very clear scope and design and construction expectations and attributes such that you can really get apples-to-apples comparisons in these bids. And I gave a fairly extensive answer to a question earlier, at the end of the day, I just want to reinforce, I mean we really do believe that we're well positioned to efficiently build, operate and maintain these assets over time. But it is our expectation that there'll be every effort made to ensure there's apples-to-apples comparisons.
Operator: Our next question is from Neil Kalton with Wells Fargo Securities.
Neil Kalton: Hi, guys, how are you? Yes. So I know, it's not your project Greenbelts Express, though, there's been some recent developments, the capacity, as Paul mentioned, is going up on the project. And I would imagine IRA probably has some positive implications for the economics and prospects. I would love your latest thoughts on that project, if you will.
Marty Lyons: Hey, Neil, it’s Marty. Absolutely, we laid out in this updated Integrated Resource Plan some pretty significant ambitions in terms of addition of renewables. We’re talking about 2,800 megawatts through 2030. 4,300 megawatts by 2035. And we've filed a couple of CCN is related to that, as you know the Boomtown project, Huck Finn project, a couple of projects we outlined on this call, but there's a long way to go in terms of the addition of renewables. So we have issued a request for proposal, and we're evaluating the best options for our customers. As we've discussed with you and others over time Greenbelt remains a project that is of interest, primarily because of the opportunity to bring wind energy from the West, the Kansas region, for example, into Missouri for the benefit of our Missouri customers, and, in fact, in our integrated resource plan had highlighted the potential to utilize that line to bring in as much as 1,000 megawatts of wind energy. So it is something that we continue to evaluate, and we'll evaluate as we look at the opportunities for renewables that come out of this RFP, ultimately, as you know, we want to make sure we pick the right projects for our customers from the standpoint of affordability, and good mix of assets to meet their needs over time.
Neil Kalton: Great, thanks. And then one other question. I think in your prepared remarks, you mentioned, hydrogen as being, you sort of mentioned as part of the IRA, can you elaborate a bit more on sort of how you're thinking about hydrogen? Is this sort of nearer term opportunity, or any thoughts on that as well, please?
Marty Lyons: Yes, Neil. So in our updated integrated resource plan that we filed in June, we actually added a 1,200 megawatt combined cycle plant by 2031. And the idea there is to get to our net zero emissions by 2045. The idea would be to construct that with an eye towards transitioning to hydrogen or hydrogen blend with carbon capture retrofit by as early as the 2040 timeframe. So it's with regard to that project is specifically that we think about that.
Operator: We have reached the end of the question and answer session. I'd now like to turn the call back over to Marty Lyons for closing comments.
Marty Lyons: Great. Hey, thank you all for joining us today. I hope what you heard is we have a very strong start to 2022. We're looking to finish strong for the remainder of this year and we remain focused on continuing to deliver significant long-term value to our customers. The communities that we serve and to our shareholders. And so anyway, we look forward to seeing many of you at conferences over the next couple of months and we again, appreciate you joining us. Have a great day.
Operator: This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host, Megan McPhail, Manager of Investor. Thank you. You may begin."
},
{
"speaker": "Megan McPhail",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining us remotely. Marty and Michael will discuss our earnings results and guidance, as well as provide a business update. Then we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward –looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions in financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section on our news release we issued yesterday and the forward-looking statements and risk factors section in our filings with SEC. Lastly, all per share earnings amounts discussed during today’s presentation including earnings guidance are presented on a diluted basis unless otherwise noted. Now here is Marty who will start on page 4."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Megan. Good morning, everyone. And thank you for joining us. We had a solid quarter and we're excited to share an update today on a number of recent developments. As always, our team continues to work hard to execute our strategic plan across all of our business segments, allowing us to deliver significant value to our customers and shareholders. Yesterday, we announced second quarter 2022 earnings of $0.80 per share, compared to earnings of $0.80 per share in the second quarter of 2021. The year-over-year results reflected increased infrastructure investments across all our business segments that will drive significant long-term benefits for our customers. The key drivers of our second quarter results are outlined on this slide. I am pleased to report that we remain on track to deliver solid earnings growth in 2022 and are reaffirming our 2022 earnings guidance range of $3.95 per share to $4.15 per share. Michael will discuss our second quarter earnings, 2022 earnings guidance and other related items in more detail later. Moving to slide 5, you will find our strategic plan reiterated. We continue to invest in and operate our utilities in a manner consistent with existing regulatory frameworks, enhance regulatory frameworks and advocate for responsible energy and economic policies and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. Turning now to page 6, which highlights our commitment to the first pillar of our strategy, investing in and operating our utilities in a manner consistent with existing regulatory frameworks. Our strong long-term earnings growth guidance is primarily driven by our infrastructure investment and rate base growth plans, which are supported by constructive regulatory frameworks. You can see on the right side of this page, we continue to strategically invest significant capital in each of our business segments in order to maintain safe and reliable operations as we transition to a cleaner energy grid. Regarding regulatory matters earlier this week, Ameren Missouri filed an electric rate review with the Missouri Public Service Commission requesting a $316 million annual revenue increase. This request reflects significant modernization upgrades to the electric grid for system reliability, resiliency and safety, as well as investments to support the transition to cleaner energy for the benefit of our customers and local communities. In our Illinois Electric business, we recently requested an $84 million revenue increase in our required annual electric distribution rate filing. Again, key drivers for this rate increase includes significant investments to enhance the grid for our customers and communities, which will deliver long-term benefits. Michael will cover these in more detail a bit later. And we will provide updates on these proceedings as they develop later this year. As we invest to build a safer, stronger, smarter and cleaner energy grid for our customers, we also continue to work diligently to manage our costs, leverage our investments and optimize our performance. Moving now to page 7, and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Without question energy policy at the federal and state levels and constructed regulatory frameworks that incentivize meaningful and needed infrastructure investments have never been more important as we look too reliably and securely transition to a cleaner energy future as affordably as possible. As late last week, it was announced that Senators Schumer and Manchin reached agreement on proposed legislation that would, among other things, extend significant incentives for clean energy development and deployment. Given the Clean Energy Transition underway in Illinois and Missouri, as highlighted by our recent change to the Ameren Missouri Integrated Resource Plan, filed with the Missouri PSC in June and our goal of reaching net zero carbon emissions by 2045. We are very excited about the potential benefits of this legislation. Specifically, the credits proposed for wind, solar storage, nuclear, Carbon Capture Utilization and Storage or CCUS and hydrogen will align very well with the significant investments proposed in the Missouri IRP. Importantly, the benefits of these tax incentives will ultimately lower the cost of the clean energy transition for our customers in Missouri, and Illinois over time. These potential tax credits when coupled with the significant clean energy funding made available through the infrastructure investment in JOBS Act passed earlier this year will drive significant long-term benefits for our customers, communities and the country. I will also note that the proposed legislation includes a minimum corporate income tax for public companies with pretax book earnings above $1 billion. At the state level, as part of Ameren Missouri Smart Energy Plan, a multiyear effort to strengthen the grid, our customers are benefiting from stronger poles, more resilient power lines, smart equipment, including modern substations, and upgraded circuits to better withstand severe weather events and restore power more quickly. As we mentioned on our first quarter earnings call, Missouri Senate Bill 745, which enhances and extends the smart energy plan passed earlier this year with strong majority support in the General Assembly. The bill was later signed by Governor Parson. We believe extending Missouri's Smart Energy Plan will continue to benefit our customers and communities as we transform the energy grid of today to build a brighter energy future for generations to come. And while creating significant economic development and jobs in the state. Moving to page 8 for Illinois legislative matters, we continue to make progress working towards the implementation of the Illinois energy Transition Legislation enacted last year, including the performance metrics required by the legislation. Ameren Illinois has proposed eight performance metrics each worth three basis points of incentives for a total of 24 basis points of symmetric, equity return upside or downside potential. The ICC staff is mostly aligned with Ameren Illinois on the performance metrics and is proposed the range of 20 to 24 total basis points of increased or decreased return opportunities. We expect a final order from the ICC by late September in the performance metrics docket. We look forward to the ICCs order and filing our first multiyear rate plan next year, as we believe this legislation will support important energy grid investments and deliver value to customers. Turning to page 9, for an update on our plan to accelerate the retirement of the Rush Island Energy Center. Last month in response to our notification to MISO of our intention to retire the energy center, MISO issued its final Attachment Y report, designating the generating units at the Rush Island Energy Center as systems support resources. MISO also concluded that certain mitigation measures including transmission upgrades should occur to ensure reliability before the energy center is retired. Those transmission upgrade projects have been approved by the MISO and we have started the design and procurement process associated with the upgrades, which we expect to complete by late 2025. In the interim, until Rush Island can be retired, Ameren Missouri has proposed limiting operations at the Energy Center. The District Court is under no obligation or deadline to issue a rule modifying its remedy order to reflect the MISO SSR designation or proposed interim operating parameters. The original March 31, 2024 compliance date remains in effect unless extended by the court. We expected decision in the near term. Turning now to page 10 for an update on changes to our 2020 Ameren Missouri Integrated Resource Plan, which we filed in June. Our IRP is a 20 year energy plan created to ensure reliability for our customers for years to come. I'm excited to share with you that these changes to the plan accelerate our clean energy additions, reduce carbon emissions even further in the short term, and accelerate the company's net zero carbon emissions goal by five years. Specifically, the plan targets a 60% reduction in carbon emissions below 2005 levels by 2030 and an 85% reduction by 2040 and by 2045, our goal is to achieve net zero carbon emissions across all of Ameren. The new goals include both Scope 1 and Scope 2 emissions, including other greenhouse gas emissions of methane, nitrous oxide, and sulfur hexafluoride. We plan to achieve these goals by making significant investments in renewable energy, including 2,800 megawatts of renewable energy by 2030, representing an investment opportunity of $4.3 billion. This is an increase of $1 billion from our 2022 -- excuse me our 2020 IRP. By 2040 in total, in total, the plan includes 4,700 megawatts of renewable generation for a total investment opportunity of $7.5 billion. The plan also includes 1,200 megawatts of gas combined cycle generation by 2031, an investment opportunity of $1.7 billion, which will allow us to safely and reliably advance the net retirement timeline of our fossil generation, including the accelerated retirement of the Rush Island Energy Center. Further, the plan includes 800 megawatts of battery storage by 2040, representing an investment opportunity of $650 million, we expect to add 1,200 megawatts of clean dispatchable resource by 2042. And to also seek an extension of the operating license of our carbon free Callaway Nuclear Energy Center beyond the current expiration date of 2044. These changes to the 2020 IRP will drive our ability to meet customers rising needs and expectations for reliable, affordable and clean energy sources. Achieving these goals is dependent upon a variety of factors including cost effective advancements in innovative clean energy technologies, and constructed federal and state energy and economic policies. We have issued a request for proposal to solicit solar and wind projects that will allow us to take the next steps and deliver the best value for our customers. One thing is clear. Our IRP includes significant incremental investment opportunities, and we're very excited as we continue to execute our clean energy transition plan. Turning now to page 11. Speaking of executing our Clean Energy Transition Plan, in July, we filed Certificates of Convenience and Necessity or CCN with the Missouri Public Service Commission for two solar project acquisitions, Boomtown, a 150 megawatt solar energy center located in southern Illinois, is expected to be in service by the fourth quarter of 2020. Huck Finn, a 200 megawatt solar energy center located in Eastern Missouri, would be Ameren’s largest solar project to date, generating more than 25 times the amount of energy of Missouri's largest existing solar facility. This solar project is also expected to be in service by the fourth quarter of 2024. While the Missouri PSC is under no deadline to issue an order on the CCN filings, we expect decisions by March and April 2023 for the 200 megawatt and the 150 megawatt facilities respectively. Looking ahead, we expect to announce further agreements for the acquisition of renewables between now and the first half of 2023. Turning to page 12, in the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. This page provides an update on the MISO long range transmission planning process. As we have discussed with you in the past, MISO completed a study outlining a potential roadmap of transmission investments through 2039 taking into consideration the rapidly evolving generation mix that includes significant additions of renewable generation based on announced utility integrated resource plans, state mandates, and goals for clean energy or carbon emission reductions, as well as electrification of the transportation sector, among other things. In July, MISO approved tranche one, a set of projects located at MISO north, which had estimated to cost more than $10 billion. Of these projects approximately $1.8 billion represent projects in our service territory that have been assigned to Ameren. We expect to refine the scope, cost estimates and timelines for these projects over the remainder of this year. In addition to the assigned projects, MISO approved approximately $700 million of competitive projects that cross through our Missouri service territory, which provide additional potential investment opportunities. We are well positioned to compete for and successfully execute on these projects, given the location of the projects and our expertise constructing large regional transmission projects. Later this month, MISO is expected to post a schedule outlining the RFP process for competitive bidding, with the first RFP expected to be issued by late September. The competitive bidding process is expected to take 12 to 24 months. For the projects assigned to Ameren, we expect the capital expenditures to begin in 2025 with the completion dates expected near the end of this decade. MISO has also begun work on three additional tranches, and is indicated that an initial set of tranche two projects also located in MISO north is expected to be approved in the second half of 2023. Projects including tranche 3 are expected to be located in MISO south, with approval scheduled by the end of 2024 while projects identified in tranche 4 are expected to improve transfer capability between MISO north and MISO south, and will be studied upon approval of tranche 3. Turning then to page 13. Looking ahead over the next decade, we have a robust pipeline of investment opportunities that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. We have updated the investment opportunities to reflect the additional renewable and combined cycle generation included in the change to the IRP filed in June. We now expect over $48 billion of investment opportunities over the next decade, maintaining constructive energy policies that support robust investment in energy infrastructure, and a transition to a cleaner future in responsible fashion will be critical to meeting our country's energy needs in the future, and delivering on our customers’ expectations. Moving now to page 14, we're focused on delivering a sustainable energy futures for our customers, communities and our country. This slide summarizes our strong sustainability value proposition and focus on environmental, social, governance, and sustainable growth goals. The change to the Ameren Missouri IRP filed in June supports our goal of net zero carbon emissions by 2045. And is also consistent with the objectives of the Paris Agreement in limiting global temperature rise to 1.5 degrees Celsius. We also remain focused on supporting our communities, including our very robust supplier diversity program. Our strong sustainable growth proposition remains among the best in the industry. We have a robust pipeline of future investments that will continue to modernize the grid and enable the transition to a cleaner energy future. I encourage you to take some time to read more about our strong sustainability value proposition, you can find all of our ESG related reports at amereninvestors.com. Turning to page 15. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our five year growth plan which included our expectation of a 6% to 8% compound annual earnings growth rate from 2022 through 2026. This earnings growth is primarily driven by strong rate base growth supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. We expect Ameren’s future dividend growth to be in line with our long-term earnings per share growth expectations, and within a payout ratio range of 55% to 70%. We expect to deliver strong long-term earnings and dividend growth which results in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all four of our business segments, as we have an experienced and dedicated team to get it done. Finally, turning to page 16, I would like to take the opportunity to congratulate Richard Mark on his retirement and extend my gratitude for his many contributions made to Ameren and our communities. Richard served in several leadership positions during his 20 year career at Ameren and was influential in the advancement of the electric and natural gas distribution grids throughout southern and central Illinois, including installing advanced technologies, improving reliability, and creating 1000s of jobs in addition to his strong community engagement. Thank you, Richard, and I wish you well in your retirement. I would also like to introduce to you Ameren Illinois’s new President Lenny Singh. Lenny brings more than 30 years of utility experience serving in both electric and natural gas operations, most recently as Senior Vice President of Consolidated Edison Company of New York. Over the course of his career, Lenny is focused on operational excellence and value creation, prioritizing safety, customer satisfaction, continuous improvement, action and accountability. I look forward to working with Lenny as he builds on Ameren Illinois success as we work to safely, reliably and securely drive the clean energy transition in the state of Illinois. Again, thank you all for joining us today. And I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty. And good morning everyone. Yesterday, we reported second quarter 2022 earnings of $0.80 per share, compared to $0.80 per share for the year ago quarter. Slide 18 summarizes key drivers impacting earnings at each segment. I'd like to take a moment to highlight a few key variances for the quarter. Earnings in Ameren Missouri, our largest segment benefited from higher electric retail sales driven by warmer early summer temperatures during the quarter compared to near normal temperatures in the year ago period, and higher electric grid. A positive factors impacting earnings Ameren Missouri were more than offset by, among other things, higher operations and maintenance expenses. Higher O&M reflected unfavorable market returns in 2022 on company on life insurance investments compared to payroll market returns in the year ago period. In addition, the higher O&M expenses were driven by the absence of refined coal credits in 2022, which had been a benefit to our coal fired energy centers in 2021, and prior year and increased transmission and distribution expenses including storm cost. The reduction in refined coal credits was anticipated and reflected in the new electric service rates effective earlier this year. In fact, year-to-date, O&M costs excluding COLI are largely in line with what we expected when we provide guidance in February. We remain focused on discipline cost management for the second half of the year. Before moving on, I'll touch on sales trends for Ameren Missouri and Ameren Illinois electric distribution year-to-date, weather normalized kilowatt hour sales to Missouri residential and commercial customers increased about 0.5% and 1.5% respectively. Our weather normalized kilowatt hour sales to Missouri industrial customers decrease about 0.5%. Weather normalized kilowatt hour sales to Illinois residential and commercial customers increased about 1.5% each year-to-date and weather normalized kilowatt hour sales to Illinois industrial customers increased about 0.5%. Recall that changes in electric sales in Illinois no matter the cause do not affect our earnings. Since we have full revenue to coupling. Turning to page 19. I would now like to briefly touch on key drivers impacting our 2022 earnings guidance. We've delivered solid earnings in the first half of 2022 and are well positioned to finish the year strong. As Marty stated, we continue to expect 2022 diluted earnings to be in the range of $3.95 to $4.15 per share. Select earnings considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discussed in our call -- earnings call in February. As we reflect on our earnings for the full year results, the benefits we've seen from weather during the first half of the year and from the higher expected 30 year Treasury rates are offset in part by unfavorable market returns and company on life insurance, as well as higher than expected short term and long-term borrowing rates. I encourage you to take these into consideration as you develop your expectations for the third quarter and full year earnings results. Turning now to page 20 for an update on regulatory matters, starting with Ameren Missouri. Earlier this week, we filed for a $316 million electric revenue increase with the Missouri Public Service Commission. The request includes a 10.2% return on equity, a 51.9% equity ratio, and a December 31, 2022 estimated rate base of $11.6 billion. Drivers are the requested increase on investments on the Smart Energy Plan, including increased cost of capital and depreciation expense, as well as increased net fuel expense due to reduced off system sales driven by expected reduced operations at Rush Island. As Marty noted earlier, customers are benefiting from investments made in to the smart energy plan to strengthen the grid, including infrastructure upgrades, bolstering reliability and resiliency, installation of smart meters and improving our reliability of up to 40% on [Inaudible] with new smart technology upgrades. We expect the Missouri PSC decision by June 2023 and new rates to be affected by July 1, 2023. We look forward to working with all key stakeholders on this request. Moving to page 21, an Ameren Illinois regulatory matters. In April, we made our required annual electric distribution rate update filing. Under Illinois performance base rate making, these annual rate updates systematically adjust cash flows over time for changes in cost of service and true-up of any prior period over or under recovery of such cost. In late June, the ICC staff recommended a $60 million base rate increase compared to our updated request of an $84 million base rate increase. The $24 million variance is primarily driven by a difference in the common equity ratio, as we propose 54% compared to the ICC staffs recommended 50%. For perspective, the order received from the ICC last December included a common equity ratio of 51% and ICC decision is expected in December with new rates expected to be effective in January 2023. On page 22, we provide a financing update, we continue to feel very good about our financial position. On April 1, Ameren Missouri issues $525 million or 3.9% green first mortgage bonds due 2052. Proceeds of the offering are used to fund capital expenditures and refinance short-term debt. In order to maintain a strong balance sheet while we fund our robust infrastructure plan consistent with the guidance in February. This year, we expect to issue approximately $300 million of common equity under our aftermarket equity program. We have fulfilled all of our 22 equity needs through the forward sales agreement entered into as April 1, and we expect to issue 3.4 million common shares by the end of this year upon settlement. Further, as of July 12, approximately $225 million of the $300 million of equity outlined 2023 has been sold forward under that program. Finally, turning to page 23, we have had a solid first half and we expect to deliver strong earnings growth in 2022 as we continue to successfully execute our strategy. Today, we've outlined significant and exciting investment opportunities over the back half of our current capital plan and beyond that are not reflected in our 2022 to 2026 capital plan. Consistent with our approach in the past, we will step back and take a comprehensive look at our investment opportunities and provide our five year capital plan for 2023 through 2027, during our year end conference call in February. As we look at the longer term, we continue to expect strong earnings per share growth driven by robust rate based growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers. The bottom line is that we are well positioned to continue executing our current plan. And Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder returns to where that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Shahriar Pourreza with Guggenheim Partners."
},
{
"speaker": "Shahriar Pourreza",
"text": "Hey, good morning, Marty. Not too bad. It's very good day. Marty, Let me ask just thank you for the visibility. Obviously, we're on the tranche 1 opportunities, but just a two part question here. What's your, I guess, confidence level on the competitive slice? Or how should we be thinking about maybe your ability to capture that? Is there a technical or cost of capital facet to your advantage? And then does this -- how does this sort of interact with your prior CaPex and sort of rate base guide? I mean, some of the projects do break ground in ‘25. So could these be an accretive to your 6% to 8%? Thanks."
},
{
"speaker": "Marty Lyons",
"text": "Yes, you bet Shahriar, good questions. And, here I hope you have a Good Friday and a good weekend. But back to your questions, in terms of the competitive projects coming out of tranche 1, as we highlighted a little over $700 million of those. And as we mentioned in our prepared remarks that we do believe we're well positioned to compete for and successfully execute those, I think the bottom line is that we believe we're really well positioned to efficiently build, operate and maintain those assets over time. The projects that are competitive are within our footprint. They're places where we have strong relationships with local communities, regulators, suppliers, contractors, et cetera. And we've been operating in this area for many years. So we know the land, we know the environmental conditions and issues. And I tell you too that we've been working for several years now, as we've developed billions of dollars’ worth of transmission projects, and we've been working overtime with suppliers and contractors to really bring down the costs of construction. And because these projects, these competitive projects are contiguous with other assets that we own and operate, we think we're really well positioned to operate and maintain these assets at a low cost over time. So those are some of the reasons that we believe at the end of the day, we're well positioned to compete and execute on those projects. So we look forward to participating in that competitive process over time. And then your second question really got to some of the incremental capital into our plan. I'll let Michael comment on that. But you're right, in terms of the $1.8 billion worth of projects that were assigned to us, we do again, expect to begin those in 2025. And those cash flows and capital expenditures to be incurred over between 2025 and the end of the decade. Michael, any comments in terms of the added CaPex?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Good morning, Shahriar. Marty said as well in terms of the capital plan itself, Shahriar, and we've talked about this, I mean, I think that it's great to start getting some clarity here around these different projects. And as Marty said I think some of this could even benefit the five year plan, as we have indicated we're going to step back. And what we typically do with our cadences, will update all this in the February timeframe. And my sense is this has got the ability to be accretive to our five year capital plan, as well as just additive to the overall runway, as we talk about the growth story. I think as we, if you kind of remember, if you reflect back on the $48 billion that we have there now that number used to be $40 billion, we captured about $5 billion associated with transmission projects, it was broadly to try to look at these LRTP projects over the next 10 years. So, I think we got it in there. And now, it's a matter of where it just ends up by year, if that makes sense."
},
{
"speaker": "Shahriar Pourreza",
"text": "It does. Yes. I am sure it does."
},
{
"speaker": "Marty Lyons",
"text": "Shahriar, this is Marty. And I think Michael touched on a good thing as we started the year we looked ahead to Q2, and we noted that there were going to be some important updates in Q2, and I think that's exactly what came through in terms of the Integrated Resource Plan in Missouri that indicated about $2.7 billion of incremental spend between now and 2031. And then, as Michael said, the LRTP, adding another $1.8 billion of expenditures that we have signed to us, as well as this potential for $700 million of additional competitive projects. So as Michael said all those things gave us confidence to add that $8 billion to that long-term capital expenditure outlook."
},
{
"speaker": "Shahriar Pourreza",
"text": "Perfect. And then just I know, you just probably touched on it a little bit on just the Inflation Reduction Act. I mean, obviously, [Inaudible] proposed some changes, I think we go to a vote on Saturday. Can you just touch a little bit on the tax side? I mean, some of the utilities have talked about a technical fix with the 50% AMT? Are you in sort of EI lobbying against it? Could you get a carved out? And then if there isn't enactment of that AMT how do we sort of think about the cash flows and rate base growth impact and the recovery timing? Thanks."
},
{
"speaker": "Marty Lyons",
"text": "Shahriar, there's a lot there. And as you noted even based on the reports this morning there seems to be some moving pieces as it relates to the corporate minimum tax. Let me just say this overall, about the legislation, we're excited about the potential tax credits in the legislation, especially the wind and the solar, given the 4,700 megawatts of renewables that we looked at, in Missouri by 2040, based on our Integrated Resource Plan, so that's all pretty exciting, and even net of CMT impact. We think the legislation is good for Ameren, for our customers in both Missouri and Illinois, because it really should lower the cost of the clean energy transition in both states. And that's not even mention in some of the other positives in there, whether it's the credits for nuclear storage, CCUS, hydrogen things we talked about on the call, all of which align with our long-term resource plan. So that's all really good, other things you're aware of things like the PTC for solar is a positive versus the prior ITC and transferability provisions, which are things that we really think could help us to pass the value associated with some of these tax credits to our customers more swiftly. So, like I said, net, we think that the legislation overall is good and will help facilitate a lower cost transition to this clean energy. As it relates to the CMT, it is applicable to us, given that we have pretax book income of greater than $1 billion, but probably premature to speculate on exactly what that impact would be given, as you mentioned, some of the moving pieces that aren't even really clear to us at this particular time. But at the end of the day, we do think based on what we have seen we do believe that the cash flow impacts would be manageable. And as would and Michael can comment on this better, but also the impacts on credit metrics and credit rating. So that's, I guess, where we stand on things. Shahriar, hopefully, I answered all of your questions. Michael, do you have anything to add?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, I think Marty, I think at a high level you gave it good justice there. I mean, I think overall, we do see it as being manual. There are a lot of moving pieces here. So I think that's why we're really trying to stay away from the specifics, but as we look at it and model it out we do think as Marty said both from a cash flow as well as any sort of impact, Shahriar, our FFO to debt metrics, that it definitely is something that's manageable. And I think the important thing to remember is just that the net benefit to customers just from an overall credit standpoint, certainly on the Missouri side, as you think about this clean energy transition that we're about to go through."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jeremy Tonet with JP Morgan."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning. Just wanted to round out the MISO tranche 1 conversation a little bit more. Would Ameren entertain the notion of pursuing competitive processes beyond the $700 million identified or is that the extent of what you would consider? And also we've heard about there being kind of some incremental upside to these projects, maybe 10% to 15% of CapEx, additionally for kind of ancillary components to these projects. And just wondering if you had any thoughts along those lines?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, Jeremy, good questions. You've certainly will look to compete for the $700 million if there are other projects that are competitive, certainly we'll take a look at those as well. We're not limited to these. But of course, as you know, in many of the surrounding states you have entities with rights of first refusal. So, look, we feel good about the ones that have been assigned to us. I can't emphasize that enough. That's $1.8 billion we feel great about, and we'll go after the $700 million if we see other opportunities, we'll certainly look to compete in those as well. I wouldn't speculate right now, Jeremy, on in terms of any incremental investment beyond these, these are the estimates that really came from MISO. And as we indicated in our call, prepared remarks we'll certainly be looking to next steps is really work on more refined design, procurement, the regulatory approvals, et cetera. And give updates on what we think the overall value of these projects are, perhaps when we get around to February and update our overall plans, but for now, we think these are the best estimates to be able to provide."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. Thanks. And then just as it relates to Rush Island here, if you could provide any incremental thoughts with regards to transmission upgrade opportunity here. Any – could you provide any estimates on what these upgrades could look like? I know it's bigger than a breadbox. We're trying to kind of scope out what that might look like."
},
{
"speaker": "Marty Lyons",
"text": "Yes, good question. Look, we, we gave pretty good update in our prepared remarks on Rush Island. We did indicate that design and procurements underway with respect to the upgrade projects that MISO had approved. I mean I think our best estimate today, and this was a bit of a broad range, probably in the $100 million to $150 million range. And but like I said, we'll be able to refine that further as we go through the design and procurement activities."
},
{
"speaker": "Operator",
"text": "Our next question is from Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Julien Smith",
"text": "Hey, good morning, team. Thanks for the time, the opportunity. Hope you guys are well. Thank you. Thank you, sir. So maybe I want to come back to the Rush Island situation. I know, you mentioned ’25 for instance, on retirement here, but I want to talk about these other CSAP regulations. And just try to understand how that lines up. I know that there's some proposals out there for 2026. And obviously, you've got a couple other plans Labadie and Sioux. How do you see this playing out? Because obviously that there's EPA regs and sort of hypothetical ether, and then there's sort of reality of them lining up against your portfolio in a pretty meaningful way. I just want to understand sort of the specifics as to, I mean, obviously, it's subject to litigation, but how do you see this playing out more specifically for your portfolio? And as you see to try to balance things?"
},
{
"speaker": "Marty Lyons",
"text": "Yes so as it relates to the CSAPR rules, look, it's something we're not only monitoring but engaging with EPA in terms of providing comment. Of course, Merrimack is retiring this year, Rush Island is, as you mentioned, looks like it's going to retire in the 2024 to 2025 timeframe. Again, we don't expect the transmission investments to be fully completed until 2025. As we noted, we have proposed some limited operations between now and then between now and when the plant would ultimately retire all subject to the court's ruling in terms of operating parameters as well as the ultimate closure date. But certainly going to significantly reduce NOx emissions as we ramped down towards closure of that facility. So I think the focus really becomes, Julien, that on NOx controls, at Labadie and Sioux, and I would remind you there that we've made significant investments over time in terms of NOx controls, and we're more than complying with all the current standards that are out there. So with respect to the proposed additional rules I think we'll wait to comment on specifically what the impacts will be at Labadie and Sioux over time, until we get the final rules, which we expect to come out next March. But I will tell you that what we'll be doing and we are, we're analyzing strategies for compliance, and making sure that we get the full benefit of the controls that we do have in place today at Labadie and Sue."
},
{
"speaker": "Julien Smith",
"text": "Yes. Excellent. Thank you. And then if I can, just jumping in on the inflation conversation, obviously, you filed here, though, your latest iteration of a rate case. But how are you seeing sort of cost inflation manifests itself across your portfolio? And how do you think about balancing that given the test here, embedded in the current rate case? And then the other levers you might have."
},
{
"speaker": "Michael Moehn",
"text": "Yes, thanks, Julien. This is Michael. Look, inflation, it certainly we're in a little different environment today. But I mean, I think we've talked historically, and we've showed you a couple of times, even have a slide, I think that went through 16 through 21. And our overall operating costs were down about 3%. And so, look, we remain focused on it, you referenced this Missouri rate review that we just filed here. I would tell you that that's really predicated on a lot of capital investment within the Smart Energy Plan, we outlined, and I think the benefits that customers are getting associated with those investments. And obviously, it's also being impacted by what we just talked about with respect to Rush Island, and the net fuel costs and operating in that plant in a more limited fashion as well. So when you really cut through what's going on in case, it's not, it's really not about O&M costs, which I think is a testament to what this team has been doing in terms of just looking for ways to continue to hold down costs wherever possible. So in the present environment, I think we're managing well through it. As we noted, on the call, we had some O&M was up, but it was really driven by some one time things between the COLI performance towards some storm costs. And when you cut through it, it certainly lines up with what our expectations were on the February timeframe, we released guidance."
},
{
"speaker": "Julien Smith",
"text": "Got it. And just prospectively, here, just if I can push a little bit further, obviously, you've done a good job, sort of to date, if you will, if you look prospectively whether that's related to the cadence of labor relation negotiations, et cetera. When do you -- what kind of trajectory, what inflation are you seeing sort of in real time more prospectively here? If you can comment a little bit more?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, sure. Look, I do. Yes, absolutely, I keep my comments consistent with already been in the past. And that's Marty and I and the rest of the team is very focused on these costs, and doing all that we can to control what we can control. And look, we aspire to keep these O&M costs. I think we said this for the really flat over the five year horizon, if at all possible, it's obviously, and it’s a bit more challenging in this environment. But again, as we look to our capital plan, we look to the investments that we're making in automation and digital and smart meters. I mean, we're using all of those things to increase productivity, lower costs where we can and we're going to stay focused on it and just do absolutely all that we can because we know again what it means to our customers, we understand we talked about this from a capital perspective for every dollar of O&M we reduce we can spend the equivalent $7 of capital and so, it is certainly top of mind, and continuous everyday focus here."
},
{
"speaker": "Operator",
"text": "Our next question is from Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"text": "Hey, good morning. So, just on Rush Island, just sort of technically speaking. If you don't get, I mean if the courts don' completely go your way, the plan to shut down, what would actually happen, or do we have an idea about what would happen?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, I guess I don't want to speculate that on, Paul, I think that it's obviously a process that we're still we're working through with court and the court proceedings and so we laid out for you on slide 9 the facts as they stand today and certainly wouldn't speculate if we get to that that crossroads, I would point you on slide 9, we said that with respect to the court, the March 31, 2024 compliance day remains in effect, unless extended by the courts. So the courts got that ability and certainly don't want to speculate as to what the court will or won't do. And we'll let these proceedings play out."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Fair enough. I don't want to push that. I guess it's all hypothetical, I guess, to certain degree. So with respect to wind curtailments that we've been seeing in the area, I was wondering if you could tell us what you've been seeing, not just in Ameren but the greater Ameren neighborhood so to speak, as well as how tranche 1 and other sort of activity occurring, like I guess, Green Belt is talking about a 25%, I think, increase among other things, as there's just a lot of moving pieces, I guess to put it right, so I'm just sort of wondering what if you could just sort of comment about what you're seeing there in terms of additions of generation plants, traditional plants, shutting down and transmission, what you see sort of the current situation with wind curtailments is generically speaking in your general region and what tranche 1 and other things might do with respect to the issue."
},
{
"speaker": "Marty Lyons",
"text": "Yes Paul, I guess I don't have a specific comment on wind curtailments and something we can follow up on you, follow up with you on. That said what I have seen recently is a map of these tranche 1 projects overlaid against where we're seeing congestion across MISO. And I will tell you, there's tremendous alignment there meeting these plan projects and tranche 1 really align well with where we're seeing congestion across the footprint really promised to alleviate some of that congestion. And I think that's why if you go back a year or so ago, [Worter] made a comment about these being, I forget the word he use, but kind of no brainer projects or something like that, and no regrets projects. And I think what he really meant by those is that whether we proceed towards future one, two, or three in MISO these projects are very foundational, no matter where you go, and they're needed today to address some of the congestion that we're already seeing within the MISO footprint. And the look ahead to tranche 2, 3 and 4 especially based on what we're seeing coming out of this IRA legislation I think is really going to push us beyond that future one to more of like a closer to a future two kind of outlook. And my sense is that some of that'll end up getting baked into the extent of the projects that are approved in future tranches, including tranche 2, which is still expected to be approved by late next year. So again, don't have a specific comment on your question about what we're seeing currently. But to your question about these transmission projects and the need to alleviate congestion issues we're seeing absolutely they aligned very well."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Anthony Crowdell with Mizuho."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning, Mike. Good morning, Marty. Thanks for taking my questions. I guess first on the Missouri rate filing, just as I think about you filed in ‘21, you're filing again, in ‘22. We had a piece of legislation passed, just what's now, that you maybe have more clarity on the forward looking CaPex plan? What kind of frequency of rate filing you expecting in Missouri for the next two or three years?"
},
{
"speaker": "Michael Moehn",
"text": "Andy, we haven't actually said, I mean, you're right, we've been on kind of a two year cycle here at this point. And look, I mean, we obviously we want to continue to stretch these out as much as we possibly can. But just given the pace that we've been on from a capital standpoint two years has been sort of what the required paces be, needed to be. I think the only other thing to just keep in mind is that we are required to file every four years just because of the fuel adjustment clause, but otherwise we do want to try to stretch them out as long as we can."
},
{
"speaker": "Anthony Crowdell",
"text": "Grea.t And then I guess, last, it is may be hard or may not be a great question. If I think about the futures one projects that the company will bid on, did the incumbent utilities, you guys operate in that jurisdiction, it's seems that maybe you're -- the incumbent utilities are more likely to submit a proposal for a more robust, like infrastructure, because it's in your jurisdiction, you're looking at [Inaudible] at asset list, be active for 50 years, 60 years or something like that, where's the competitor coming in there, they just meet the bare minimum of a design spec, and it makes it more affordable, and wins the competitive process? Is that possible? Or it's the design specs are the same for everyone?"
},
{
"speaker": "Marty Lyons",
"text": "I really think MISO is going to do their best to make sure that there are very clear scope and design and construction expectations and attributes such that you can really get apples-to-apples comparisons in these bids. And I gave a fairly extensive answer to a question earlier, at the end of the day, I just want to reinforce, I mean we really do believe that we're well positioned to efficiently build, operate and maintain these assets over time. But it is our expectation that there'll be every effort made to ensure there's apples-to-apples comparisons."
},
{
"speaker": "Operator",
"text": "Our next question is from Neil Kalton with Wells Fargo Securities."
},
{
"speaker": "Neil Kalton",
"text": "Hi, guys, how are you? Yes. So I know, it's not your project Greenbelts Express, though, there's been some recent developments, the capacity, as Paul mentioned, is going up on the project. And I would imagine IRA probably has some positive implications for the economics and prospects. I would love your latest thoughts on that project, if you will."
},
{
"speaker": "Marty Lyons",
"text": "Hey, Neil, it’s Marty. Absolutely, we laid out in this updated Integrated Resource Plan some pretty significant ambitions in terms of addition of renewables. We’re talking about 2,800 megawatts through 2030. 4,300 megawatts by 2035. And we've filed a couple of CCN is related to that, as you know the Boomtown project, Huck Finn project, a couple of projects we outlined on this call, but there's a long way to go in terms of the addition of renewables. So we have issued a request for proposal, and we're evaluating the best options for our customers. As we've discussed with you and others over time Greenbelt remains a project that is of interest, primarily because of the opportunity to bring wind energy from the West, the Kansas region, for example, into Missouri for the benefit of our Missouri customers, and, in fact, in our integrated resource plan had highlighted the potential to utilize that line to bring in as much as 1,000 megawatts of wind energy. So it is something that we continue to evaluate, and we'll evaluate as we look at the opportunities for renewables that come out of this RFP, ultimately, as you know, we want to make sure we pick the right projects for our customers from the standpoint of affordability, and good mix of assets to meet their needs over time."
},
{
"speaker": "Neil Kalton",
"text": "Great, thanks. And then one other question. I think in your prepared remarks, you mentioned, hydrogen as being, you sort of mentioned as part of the IRA, can you elaborate a bit more on sort of how you're thinking about hydrogen? Is this sort of nearer term opportunity, or any thoughts on that as well, please?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, Neil. So in our updated integrated resource plan that we filed in June, we actually added a 1,200 megawatt combined cycle plant by 2031. And the idea there is to get to our net zero emissions by 2045. The idea would be to construct that with an eye towards transitioning to hydrogen or hydrogen blend with carbon capture retrofit by as early as the 2040 timeframe. So it's with regard to that project is specifically that we think about that."
},
{
"speaker": "Operator",
"text": "We have reached the end of the question and answer session. I'd now like to turn the call back over to Marty Lyons for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Great. Hey, thank you all for joining us today. I hope what you heard is we have a very strong start to 2022. We're looking to finish strong for the remainder of this year and we remain focused on continuing to deliver significant long-term value to our customers. The communities that we serve and to our shareholders. And so anyway, we look forward to seeing many of you at conferences over the next couple of months and we again, appreciate you joining us. Have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 1 | 2,022 | 2022-05-06 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you. Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining us remotely. Marty and Michael will discuss our earnings results and guidance, as well as provide a business update. And we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now here's Marty, who will start on page four.
Martin Lyons: Thanks Andrew. Good morning everyone, and thank you for joining us. We've had a solid start to the year and our team continues to effectively execute our strategic plan across all of our business segments, allowing us to deliver consistently strong results for our customers and shareholders. Yesterday, we announced first quarter 2022 earnings of $0.97 per share compared to earnings of $0.91 per share in the first quarter of 2021. The year-over-year increase of $0.06 per share reflected increased infrastructure investments across all of our business segments that will drive significant long-term benefits for our customers. The key drivers of our first quarter results are outlined on this slide. I am pleased to report that we remain on track to deliver within our 2022 earnings guidance range of $3.95 per share to $4.15 per share. Michael will discuss our first quarter earnings, 2022 earnings guidance and other related items in more detail later. Moving to slide five. You will find our strategic plan reiterated. We continue to invest in and operate our utilities in a manner consistent with existing regulatory frameworks. Enhance regulatory frameworks and advocate for responsible energy and economic policies and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. Turning out to page six, which highlights our commitment to the first pillar of our strategy, investing in and operating our utilities in a manner consistent with existing regulatory frameworks. Our strong long-term earnings growth guidance is primarily driven by our infrastructure investment and rate-based growth plans, which are supported by constructive regulatory frameworks. Our plan includes strategically allocating capital to all four of our business segments. You can see on the right side of this page, we have invested significant capital in each of our business segments during the first three months of this year, in order to maintain safe and more reliable operations all while facilitating and driving a clean energy transition. Regarding regulatory matters in late February, new Ameren Missouri electric and natural gas service rates went into effect, reflecting significant investment in grid modernization, reliability, resiliency, security, and renewable energy generation. In addition, in April Ameren Illinois filed its required annual electric distribution rate update, reflecting similar infrastructure investments and service improvements in that jurisdiction and requesting an $83 million increase. Ongoing investment across all four business segments is building a safer, stronger, smarter, and cleaner energy grid for our customers now and in the future. At the same time, we are maintaining discipline with regard to costs, leveraging our investments and focusing on continuous improvement to optimize our performance and drive greater value for our customers. Moving to page seven and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Over the last several years, we have worked hard to enhance the regulatory frameworks in both Missouri and Illinois, to enable meaningful and needed infrastructure investments to support reliability, resiliency, and safety. In order to consistently deliver strong value for our customers, communities, and shareholders, while practicing responsible environmental stewardship, we continue to work towards enhancing regulatory frameworks and advocating for responsible energy and economic policies. Workshops related to the implementation of the Illinois energy transition legislation enacted last year are ongoing and performance metrics related to the multi-year rate plan are expected to be approved by the ICC by late September. We believe this legislation will support important energy grid investments and will deliver value to customers, such as the utility owned solar in optional battery storage pilot projects in two communities, Peoria and East St. Louis. We're excited to announce that we began construction of an approximate $10 million, 2.5 megawatt solar energy facility in East St. Louis in early March. This energy center will strengthen the energy grid, while building a cleaner energy future for this Illinois community. Before moving on, I'd like to briefly discuss recent energy and capacity purchases made by the Illinois power agency on behalf of our Ameren Illinois customers for the upcoming June, 2022, through May, 2023 planning year. As you know, global events have been impacting the cost of energy commodities, and power prices in the Midwest have been elevated. Further, a combination of factors, including higher energy usage, a reduction of dispatchable generation and the construct of MISO's capacity market are all being cited as causes of a spike in regional capacity prices. Unfortunately, as a result of these factors, some of our Illinois customers will be seen a meaningful increase to the energy supply component of their bills beginning in June. It is important to note that energy and capacity costs are passed on to our Ameren Illinois customers through a rider with no markup. While factors leading to these increases and potential perspective mitigation will undoubtedly be discussed amongst stakeholders, our approach remains the same. We will continue to focus on supporting our customers and communities by connecting them with bill assistance where needed and continuing to invest strategically to support a responsible clean energy transition in Illinois. Moving now to page eight and Missouri legislative matters. As part of Ameren Missouri smart energy plan, a multi-year effort to strengthen the grid, our customers are benefiting from stronger poles, more resilient power lines, smart equipment, including modern substations and upgraded circuits to better withstand severe weather events and restore power more quickly. I am pleased to report that yesterday afternoon, Senate Bill 745 passed by strong majority support in the general assembly. This bill enhances the smart energy plan legislation enacted in 2018. More specifically, the bill extends the sunset date on the current smart energy plan legislation through December 31st, 2028 with an extension through December 31st, 2033, if the utility requests and the PSE approves. The bill also modifies the rate cap beginning in 2024 from the current 2.85% compound annual all in cap on growth in customer rates to a 2.5% average annual cap on rate impacts of piece of deferrals. In addition, the bill expands and extends economic development incentives and provides for a property tax tracker. The bill will now be sent to the governor for signature. We believe extending Missouri smart energy plan will continue to benefit our customers and communities, as we transform the energy grid of today to build a brighter energy future for generations to come, all while creating significant economic development and jobs in the state. Turning to page nine. We will now provide an update on developments related to our plan to accelerate the retirement of the Rush Island Energy Center. As discussed on our year-end earnings call in late February, Ameren Missouri filed an attachment Y with MISO notifying it of our intention to close the energy center. As a result of that filing MISO is now studying the grid reliability implications of Rush Island's planned closure in order to determine any investments and interim operating parameters required prior to closure in order to mitigate system reliability risks. I would note MISO's preliminary study completed in January, 2022 recommended transmission upgrades and indicated additional voltage support will be needed on the transmission system to ensure reliability. While MISO is under no deadline to issue a final report, we expect a draft report will be issued this month. The District Court, which is awaiting MISO's analysis, is also under no deadline to issue a final order regarding the accelerated retirement date. Ameren Missouri expects to file an update to its 2020 integrated resource plan with the Missouri PSE in June, which will reflect the expected accelerated retirement date of the Rush Island Energy Center. Such filing will also include discussion of the expected use of securitization in order to recover the remaining investment in Rush Island. We continue to work with all parties involved to move forward with the accelerated retirement in the most responsible fashion. On page 10, we turn our focus to the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. This page provides an update on the MISO long range transmission planning process. As we have discussed with you in the past, MISO completed a study outlining the potential roadmap of transmission investments through 2039, taking into consideration the rapidly evolving generation mix, that includes significant editions of renewable generation based on announced utility integrated resource plans, state mandates, and goals for clean energy or carbon emission reductions, as well as electrification of the transportation sector among other things. Under MISO's Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon emission reduction below 2005 levels by 2039, MISO estimates approximately $30 billion, a future transmission investment would be necessary in the MISO footprint. Under its Future 3 scenario, which resulted in an approximate 80% reduction in carbon emissions below 2005 levels by 2039, MISO estimates approximately $100 billion of transmission investment into MISO footprint would be needed. As part of Tranche 1, MISO working with key stakeholders, including transmission owners has identified projects located in MISO North estimated to total more than $10 billion. The projects crossing through our Missouri and Illinois service territories provide significant investment opportunities. We believe we are well-positioned to execute on these projects, given the location of the projects and our expertise constructing large regional transmission projects. MISO approval of Tranche 1 is expected in late July. Work on three additional Tranches has begun and MISO has indicated that an initial set of Tranche 2 projects also located MISO North is scheduled to be approved in the first quarter of 2023. Projects included in Tranche 3 three are expected to be located in MISO South, with approval scheduled in the fourth quarter of 2024, while projects identified in Tranche 4 are expected to improve transfer capability between MISO North and MISO South with approval scheduled in the fourth quarter of 2025. Moving now to page 11. We are focused on delivering sustainable energy future for our customers, communities and our country. This slide summarizes our strong sustainability value proposition and focus on environmental, social, governance and sustainable growth goals. Our preferred plan included in Ameren Missouri's 2020 IRP supports our goal of net-zero carbon emission by 2050, as well as interim carbon emission reduction targets of 50% and 85% below 2005 levels by 2030 and 2040, respectively, which is consistent with the objectives of the Paris agreement and limiting global temperature rise to 1.5 degrees Celsius. As previously noted the IRP will be updated in June to reflect among other things, MISO's long-range transmission planning, legislative and regulatory developments, and the early retirement of Rush Island. We continue to work diligently to optimize our sustainability value proposition, including our clean energy transition. In just last month, we announced completion of our newest clean energy resource, a six megawatt solar facility. The Montgomery County solar center is part of our Missouri community solar program, which began in 2018, offering customers the opportunity to invest in solar energy generation in their community through a shared system. The energy center is now up and running, supporting more than 2,000 customers who want to take part in clean energy generation without having to pay high upfront cost to install solar equipment on their own roofs or property. The program is fully subscribed, and we are evaluating expansion opportunities at additional sites. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. I'm excited to say that this week DiversityInc announced once again, that they have named Ameren Number One on their top utilities list for diversity and inclusion, a list we have proudly been part of since 2009. DiversityInc also recognized Ameren as a top company for veterans, black executives, as well as a top company for ESG among all industries. This slide highlights a few of the many things we are doing for our customers and communities, including being an industry leader in diversity, equity and inclusion. Further, our strong corporate governance is led by a diverse Board of Directors focused on strong oversight that's aligned with ESG matters. We recently named our first Chief Sustainability and Diversity Officer to further optimize our ESG impact by aligning these interconnected areas. Finally, this slide summarizes our very strong sustainable growth proposition, which remains among the best in the industry. As mentioned on our call in February, we have a robust pipeline of future investments that will continue to modernize the grid and enable the transition to a cleaner energy future. This pipeline includes over $45 billion of investment opportunities over the next decade, that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create stronger economies and thousands of jobs for the communities we serve. I encourage you to take some time to read more about our strong sustainability value proposition. You can find all of our ESG related reports at amereninvestors.com. Turning to page 12. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2022 through 2026. This earnings growth is primarily driven by strong rate-based growth, supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. I will note renewable generation and regionally beneficial transmission projects represent additional investment opportunities. We expect to announce further agreements for the acquisition of renewables over the course of this year and to file certificates of convenience and necessity, or CCNs with the Missouri PSC after the updates to the 2020 IRP have been filed in June. We expect to deliver strong long-term earnings and dividend growth, which results in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all four of our business segments, as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. And I will now turn the call over to Michael.
Michael Moehn: Thanks Marty and good morning, everyone. Turning now to page 14 of our presentation. Yesterday, we reported first quarter 2022 earnings of $0.97 per share compared to $0.91 per share for the year ago quarter. Earnings in Ameren Missouri, our largest segment increased $0.01 per share due to several factors. Earnings increased by approximately $0.03 per share from higher electric retail sales driven by colder than normal winter temperatures in the first quarter of 2022 compared to near normal winter temperatures in the year ago period. We've included on this page the year-over-year weather normalized sales variances for the quarter that showed that total sales to be of one half percent compared to the first quarter of 2021. The earnings comparison also reflected investments in infrastructure and wind generation eligible for PISA and RESRAM which benefited earnings in January and February by $0.03 until rates were set. These favorable factors were partially offset by higher operations and maintenance expenses, which decreased earnings $0.05 per share. This was driven in part by the unfavorable market returns in 2022 that occurred during the first quarter on the cash surrender value of our company owned life insurance. Moving to other segments. Ameren Transmission earnings increased $0.03 year-over-year, which reflected the absence of the March, 2021 FERC order addressing materials and supplies inventories, and increased infrastructure investments. Earnings for Ameren Illinois Natural Gas were up $0.01 reflecting increased infrastructure investments and higher delivery service rates were effective in late January, 2021, partially offset by higher operations and maintenance expenses. Ameren Illinois Electric Distribution earnings also increased $0.01 year-over-year, which reflected increased infrastructure investments and a higher allowed ROE and the performance based rate making of approximately 8.5% compared to approximately 8.2% for the year ago quarter. And finally Ameren Parent and other results were comparable to the first quarter of 2021. Before moving on, I'll touch on the sales trends for Ameren Illinois Electric Distribution in the quarter. Weather normalized kilowatt hour sales to Illinois residential customers decreased about one half percent. And Weather normalized kilowatt hour sales to Illinois commercial and industrial customers increased about one half of percent and 1.5%, respectively. Recall that changes on electric sales in Illinois no matter the cause do not affect our earnings since we have full revenue decoupling. Turning to page 15. I would now like to briefly touch on key drivers impacting our 2022 earnings guidance. We're off to a strong start in 2022. And as Marty stated, we continue to expect 2022 diluted earnings to be in the range of $3.95 to $4.15 per share. Select earning considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discuss on our earnings call in February. I encourage you to take these into consideration as you develop your expectations for our second quarter earnings results. Turning now to page 16 for details regarding the Ameren Illinois Electric Distribution rate increase request. In April, Ameren Illinois submitted a request for an $83 million revenue increase to the ICC in its annual performance based rate update. Our Illinois customers are continuing to realize the benefits or significant investments in energy infrastructure. Since performance based rate making began in 2012, reliability has improved over 20% and over 1,400 jobs have been created. J.D. Power rank Ameren Illinois number one in residential customer satisfaction in the Midwest among large electric utility providers for 2021. Major investments include in this request are the installation of outage avoidance and detection technology, integration of storm, harding equipment and implementation of new technology to optimize interaction with customers. We expect the ICC's decision by December, 2022 with rates effective in January, 2023. On page 17, we provide a financing update. We continue to feel very good about our financial position. On April 1st, Ameren Missouri issued $525 million of 3.9% green first mortgage bonds due 2052. We intend to use these proceeds as the offering to fund capital expenditures and refinance short-term debt. Subsequently, we plan to allocate an amount equal to the proceeds to sustainable projects, meaning certain eligibility criteria, including investments in transmission and distribution infrastructure, designed to make the system more resilient, and improve customer reliability investments in energy efficiency. Additionally, in order for us to maintain our credit rating and a strong balance sheet, while we fund our robust infrastructure plan consistent with the guidance in February, this year we expect to issue approximately $300 million of common equity under our after market equity program. We're well-positioned to fulfill our 2022 equity needs through forward sales agreements entered in as of April 1st and expect to issue 3.4 million common shares by the end of this year upon settlement. Together with the issuance under our 401(k) and DRPlus programs, our $750 million ATM equity program is expected to support our equity needs through 2023. On page 18, we summarize our green bond issuance over the last few years. Our sustainability financing framework, one of the first of its kind for utility in the nation, supports Ameren sustainability goals and the current target of net-zero carbon emissions by 2050, as well as other social initiatives. The financing proceeds from the issuance of the framework will be allocated eligible environmental and social projects, including renewable generation, climate change adaptation, clean transportation, socioeconomic advancement, and the employment creation, doing just a few. Finally turning to page 19. We're well-positioned to continue to executing our plan. We're off to a solid start and expect to deliver strong earnings growth in 2022, as we continue to successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth, driven by robust rate-based growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers and Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total share of return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions.
Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. First question today will be coming from the line of Jeremy Tonet with JP Morgan. Please proceed with your question.
Jeremy Tonet: Hi, good morning.
Martin Lyons: Morning, Jeremy.
Jeremy Tonet: Thanks for having me. Just want to start off with MISO long range transmission planning here Tranche 1. Just wondering if there's any way that you could quantify what the opportunity set might be specific to Ameren here? Trying to get a sense for how big that could be in your mind.
Martin Lyons: Yeah. Jeremy, I appreciate the question. Look, as we said in the prepared remarks, we certainly believe we're well-positioned for projects that MISO has outlined that cross through our Missouri and Illinois footprints. But as we sit here today, we don't want to get ahead of the MISO in terms of their overall approval of their projects or the designation of which ones are brownfield or greenfield projects. So, we do expect that when they approve these projects in July, we expect that they will designate which ones are brownfield. They'll indicate which transmission owner has been assigned those projects. So -- and I would just say stay tuned. As I said, in the February call we'll, we expect to have more to discuss on our Q2 earnings call.
Jeremy Tonet: Got it. We'll, eagerly await that. And just wanted to see that there's some new development in Missouri as well as it relates to PISA. And just wondering if that comes through, what your thoughts would be there as far as PISA flexibility and how that impacts Ameren's planning.
Martin Lyons: Yeah. Thanks Jeremy. Yeah. We were actually very pleased that yesterday the legislature did pass Senate Bill 745, which was great. That's a bill that really extends the longevity of the smart energy plan, that we have in Missouri. And so, we're very appreciative of the strong support of the legislature with regard to that legislation. And I think it's a recognition that the investments that we've been making in Missouri, have really been producing good benefits for our customers in terms of safety and reliability of the service that we provide. And the fact that, we're really scratching the surface in terms of the investments that we need to replace aging infrastructure and modernize our equipment throughout our Missouri footprint. I think it's also a recognition of the economic development benefits associated with that legislation. We're having a positive impact as we invest on our economies, through the creation of jobs. We concentrate on using Missouri vendors substantially for the things that we procure and the things that we invest in. And there's some great economic development, incentive rates associated with this legislation that help Missouri businesses grow, as well as attract Missouri businesses to the state. So, we're really excited about the legislature passing Senate Bill 745. It now heads to the governor's desk for signature, and we're excited to be able to extend the benefits of the smart energy plan prospectively.
Jeremy Tonet: Got it. That's helpful. And just one last one, if I could. On a similar note, recent eminent, domain legislation Missouri, could you comment on the implications for Greenbelt, MISO or anything else as far as investment that could be related to Ameren in the state going forward there?
Martin Lyons: Yeah. I think -- I don't think with respect to that legislation, that there are any immediate impacts other than making sure that as we move forward in time to the extent that, there are greenfield transmission projects that -- owners of agricultural properties are compensated fairly for their property. I think that's the primary impact going forward.
Jeremy Tonet: Got it. I'll leave it there. Thank you.
Operator: Thank you. Our next question is in the line of Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Dariusz Lozny: Hey, good morning. This is Dariusz for Julien. Thanks for the time. Maybe just on the proposed multi-year rate plans for Illinois Electric. Can you talk a little bit about -- I know it's somewhat early in the process still, but can you maybe discuss a little bit about what type of performance metrics are being considered as you go through that workshop process?
Michael Moehn: Yeah. You bet. Good morning. This is Michael Moehn. I would say things are moving along, just fine there. I think a lot of constructive conversations, workshops, et cetera. There's a number of different paths that are occurring. There's one associated with the performance metrics. I'll give you a few details. There's one around a multi-year grade plan, et cetera. And so, I think they're all moving along, as we sort of anticipated last year and so nothing that we see that's concerning. With respect to the performance metrics themselves, it really is kind of the standard stuff that you would think about from like a reliability standpoint. So, system average, days of disruption, you're looking at customer metrics in terms of customer response time on calls, et cetera. So, kind of standard stuff. Right now, we are advocating for about 24 basis points. So, there's about eight different metrics and ascribing three basis points to each one of those metrics. Everything still should -- it's be on track to conclude here by September of this year, and at that point in time, we'd make the decision. And as we've said before, we see ourselves opting into that and then the multi-year rate plan we need to be filed in January of 2023. Does that help?
Dariusz Lozny: That does help. That's very helpful. Appreciate it. And maybe just one other one on the equity financing, can you -- just want to confirm that the forward agreement that you guys executed for your funding in 2022, that takes off requirements for the full year, other than the drip. And then also the amount under the forward agreement, does -- that's part of the $750 million included under the ATM program? Is that accurate?
Michael Moehn: Yeah. You got both of those correct. So that $300 million that we've sold for, that does take care of the requirements here that we outline in February for 2022. And then that is part of that $750 million. That $750 million should get us through the end of 2023.
Dariusz Lozny: Okay. Great. Thank you for clarifying that. I'll leave it here.
Michael Moehn: You bet.
Operator: Our next question is coming from the line of Shar Pourreza with Guggenheim Partners. Please proceed with your question.
Shahriar Pourreza: Hey, good morning guys.
Martin Lyons: Good morning, Shar.
Shahriar Pourreza: Good morning. If you could -- I'd like to maybe touch on Illinois. The bill and kind of the reliability backdrop seems to be a little bit noisy amid sort of the year-over-year jump in PRA costs, planned retirements under [indiscernible] 33:15. And just the general concerns that obviously is coming from some of the C&I customers. I guess, how do you sort of see this kind of resolving in the next couple of years, especially as you're looking to go through multi-year rate plans in the interim?
Martin Lyons: Yeah. Sure. There's certainly a lot there. I think, first of all, the backdrop to your question is that recently, we've been seeing higher power prices here in the Midwest. And then, recently as a result of the MISO capacity auction, we also saw capacity prices clear at high prices really at cost of new entry. And those higher costs of power prices as well as the capacity prices then will be borne by our Illinois customers, because we know it's a retail choice state. Typically, what we've seen is that various retail electric suppliers have supplied about 60% to 65% of our customers and then around 30% to 35% have procured their power through us. But when they do, of course, it's really the Illinois power agency that does the procurement of the power and the capacity. And as they've reported, those prices were elevated. And therefore, some of our customers are going to see meaningful increases in their bills starting here in June. So, I think, first of all, concern for our customers. We're trying to make sure that we provide education about the impacts of these higher prices, so that people know what to expect and they can take actions accordingly. And we're also in offering bill assistance where needed as well as, of course, reinforcing the opportunities under our energy efficiency programs, which are robust in the state. And then, some customers obviously will be still taking power through local muni aggregation programs, things of that nature that may actually not see bill increases immediately. But we are certainly concerned about those customers. I think, then, more broadly, I think you say, how does this resolve itself? I think that, first of all, as we go into the summer, there are concerns about just reliability. I would say when you see prices clear at [indiscernible], it's a sign that the resources to supply the load with cushion are tight. So, we expect that MISO will be tight this summer. We expect that the MISO itself that is ultimately responsible for ensuring grid reliability is certainly going to be doing everything they can, working with stakeholders as we head into warm weather situations to ensure that every possible resource available to supply customers. And certainly, we'll be doing all we can as a company, especially when we look at our Missouri energy resources to make sure that they're available and ready to go in the hot weather months. And so, again, I think that's some of the efforts in the short0term. In the long-term, we'll see how this plays out. I mean, with capacity prices, clearing account, it's a clear signal to the market that more is needed in terms of dispatchable energy resources to meet our load. And we'll have to see how all of that plays out. And we'll be working with stakeholders as appropriate throughout all of that to help mitigate that situation in the long-term. As a result -- as it relates to our multi-year rate plan, as Michael said, we're sort of marching towards a filing here in January related to that multi-year rate plan. That then, the Illinois Commerce Commission would rule on towards the end of 2022 with implementation -- or excuse me -- end of 2023 with implementation in 2024. As I said on the prepared remarks, we still have significant aging infrastructure in Illinois. The investments that we're making are producing improved reliability for our customers, ensuring we provide safe and reliable service. And I think, even what we're seeing in terms of the tight market situation in Illinois, an appropriate backdrop for continued investment in infrastructure, both transmission, as well as distribution infrastructure. So, we still see the need for the investments that we're making in Illinois and don't see any impact right now on the multi-year rate plan filing itself and moving forward with that from the backdrop that we discussed.
Shahriar Pourreza: Got it. That's perfect. And then, lastly for me. Obviously, you have the opportunity to earn on some of your generation length in MISO and flow that back to Missouri customers. Are you seeing that today? And any sort of quantification of the potential benefit to customers there?
Martin Lyons: No real quantification of the benefits. You're right. In Missouri, right now, have length in terms of our generation profile. And to the extent that power prices are elevated provides an opportunity for us to enhanced margins and all of those margins -- 95% of them flow back to our customers in the form of reduced rates. So, no quantification of that right now, but you're right in terms of your thoughts on how that works.
Shahriar Pourreza: Okay. Terrific. Thanks guys. I stop there. Appreciate it.
Martin Lyons: Thank you.
Operator: The next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question.
Paul Patterson: Hey. Good morning.
Martin Lyons: Good morning, Paul.
Paul Patterson: So, congratulations on the -- on getting the piece of stuff over the goal line. And just a follow-up on Shar's question on Illinois. You say that it doesn't have an impact on what your -- the company's outlook on the needs for your plans. But I'm wondering does the concerns -- at least I've been seeing by the Illinois legislators and I assume perhaps others in Illinois, does it lead to perhaps a better -- a more receptive attitude perhaps to -- or more of a buy-in what you've been proposing on the part of policymakers perhaps in Illinois? Or do you think it's pretty much the same situation we're just sort of seeing. I don't know, sort of legislative drama, if you follow what I'm saying?
Martin Lyons: Yeah. Paul, it's hard to say at this point. I would say it's premature to conclude one way or another. I think what we're seeing right now is folks really digesting the news in terms of the power -- higher power and capacity prices. And what that means in terms of its implications for policy going forward, we will -- we'll see -- I think it's premature.
Paul Patterson: Okay. And then, with respect to just the Greenbelt legislation, it sounds like this is probably going to enable Greenbelt to get built. And I'm wondering if Greenbelt -- how -- a transmission project like that or others might impact your plans for infrastructure development, if you have a big line like coming into crossing your area -- what have you?
Martin Lyons: Well, with respect to Greenbelt, obviously, that's a project that's been underway for quite some time and has been progressing, and we had certainly anticipated that. One of the things that we've talked about in the past is last year -- or I should say in the fall 2020 when we filed our integrated resource plan, one of the things we did is assess the potential to utilize some of that capacity and wind in Kansas to meet some of our renewable goals and as part of our integrated resource plan. So, I think the biggest thing for us, Paul, is we think about that project -- when we think about the update to our integrated resource plan that we'll be filing in June, it's just the continuing optionality associated with that resource -- or those resources in potentially fulfilling the needs of our integrated resource plan. So, that's something that we will continue to assess as we move forward.
Paul Patterson: Okay. Thanks so much. And have a good weekend.
Martin Lyons: Thanks.
Operator: [Operator Instructions] Our next question comes from the line of Anthony Crowdell with Mizuho. Please proceed with your question.
Anthony Crowdell: Hey, good morning, Marty. Good morning, Mike.
Martin Lyons: Good morning.
Anthony Crowdell: Hey, like the Blues, I don't think they tie it up here. So, I'm rooting for them until they meet the Rangers. But just hopefully, two quick questions, I guess. One, if I think about Missouri and Illinois, both right first refusal states. And if the transmission lines are greenfield, does that mean they are competitively bid? Or maybe just wondering what's the distinction you're making between brownfield and greenfield?
Martin Lyons: Well, I think you've generally got it. Missouri and Illinois though are not right of first refusal states, which is why that distinction between brownfield and greenfield is important. So, if it's a brownfield, which generally you should think of as new transmission on existing right of way, that -- we would then expect to be assigned to us as a transmission owner. And then, the question will be, are there segments of projects that are greenfield, which might be subject to competitive bidding. And that's what we'll wait to see as it comes out of the MISO's July approval of these projects.
Anthony Crowdell: Great. And then, just another follow-up here. Moving to Illinois -- and I guess, maybe 30-year treasury. I think, right now, it's about 90 basis points above expectation, I think, for the year where you guys had thought was going to be. I calculate that as kind of like a $0.07 tailwind. I guess, are there any headwinds I think about that maybe could potentially offset that benefit when I'm thinking about the year? Or is maybe my number's wrong on from where the expectation was of the 30-year versus where it's at now?
Michael Moehn: Yeah. And no -- look, you got the estimate right. I mean, we -- in February, we estimated 2.25. Now you got to remember, it's an average over the course of the year. So, I think it averaged about 2.25 over the first quarter. So, just keep that in mind. But look, it's in a good spot. I think what we indicated in our guidance for the remainder of the year, we're assuming it averages about 2.7. So, if you average that with the first quarter that would be around 2.9 or so. So, you're right, it's certainly elevated relative to that, if you think about it. In terms of things that could offset it. Obviously, along with that comes some increased financing costs that we've been incurring a little bit on some of the short-term debt other things. But look, it's a good tailwind to have at this point. There's still a lot of the year left. We got a lot of execution to do. We're going to stay focused on it. We don't want to get ahead of ourselves.
Anthony Crowdell: Great. Thanks for taking my questions and congrats on a good quarter.
Michael Moehn: Thank you.
Martin Lyons: Thank you.
Operator: Thank you. At this time, we have reached the end of our question-and-answer session. And I'll turn the floor back to Mr. Lyons for closing comments.
Martin Lyons: Yeah. Thank you all for joining us today. We're really pleased. We had a strong start to 2022. And we certainly, as Michael said, remain focused on continuing to deliver throughout the year for our customers, our communities and our shareholders. I'd like to invite all of you to attend our Annual Shareholder Meeting, which is being held on May 12th, and we look forward to seeing many of you at the AGA Financial Forum in the next couple of weeks. So, with that, thank you all, and have a great day.
Operator: This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation. | [
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{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our President, Chief Executive Officer; and Michael Moehn, our Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team joining us remotely. Marty and Michael will discuss our earnings results and guidance, as well as provide a business update. And we will open the call for questions. Before we begin, let me cover a few administrative details. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. To assist with our call this morning, we have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements that are commonly referred to as forward-looking statements. Such statements include those about future expectations, beliefs, plans, projections, strategies, targets, estimates, objectives, events, conditions and financial performance. We caution you that various factors could cause actual results to differ materially from those anticipated. For additional information concerning these factors, please read the forward-looking statements section in the news release we issued yesterday and the forward-looking statements and Risk Factors sections in our filings with the SEC. Lastly, all per share earnings amounts discussed during today's presentation, including earnings guidance, are presented on a diluted basis, unless otherwise noted. Now here's Marty, who will start on page four."
},
{
"speaker": "Martin Lyons",
"text": "Thanks Andrew. Good morning everyone, and thank you for joining us. We've had a solid start to the year and our team continues to effectively execute our strategic plan across all of our business segments, allowing us to deliver consistently strong results for our customers and shareholders. Yesterday, we announced first quarter 2022 earnings of $0.97 per share compared to earnings of $0.91 per share in the first quarter of 2021. The year-over-year increase of $0.06 per share reflected increased infrastructure investments across all of our business segments that will drive significant long-term benefits for our customers. The key drivers of our first quarter results are outlined on this slide. I am pleased to report that we remain on track to deliver within our 2022 earnings guidance range of $3.95 per share to $4.15 per share. Michael will discuss our first quarter earnings, 2022 earnings guidance and other related items in more detail later. Moving to slide five. You will find our strategic plan reiterated. We continue to invest in and operate our utilities in a manner consistent with existing regulatory frameworks. Enhance regulatory frameworks and advocate for responsible energy and economic policies and create and capitalize on opportunities for investment for the benefit of our customers, shareholders and the environment. Turning out to page six, which highlights our commitment to the first pillar of our strategy, investing in and operating our utilities in a manner consistent with existing regulatory frameworks. Our strong long-term earnings growth guidance is primarily driven by our infrastructure investment and rate-based growth plans, which are supported by constructive regulatory frameworks. Our plan includes strategically allocating capital to all four of our business segments. You can see on the right side of this page, we have invested significant capital in each of our business segments during the first three months of this year, in order to maintain safe and more reliable operations all while facilitating and driving a clean energy transition. Regarding regulatory matters in late February, new Ameren Missouri electric and natural gas service rates went into effect, reflecting significant investment in grid modernization, reliability, resiliency, security, and renewable energy generation. In addition, in April Ameren Illinois filed its required annual electric distribution rate update, reflecting similar infrastructure investments and service improvements in that jurisdiction and requesting an $83 million increase. Ongoing investment across all four business segments is building a safer, stronger, smarter, and cleaner energy grid for our customers now and in the future. At the same time, we are maintaining discipline with regard to costs, leveraging our investments and focusing on continuous improvement to optimize our performance and drive greater value for our customers. Moving to page seven and the second pillar of our strategy, enhancing regulatory frameworks and advocating for responsible energy and economic policies. Over the last several years, we have worked hard to enhance the regulatory frameworks in both Missouri and Illinois, to enable meaningful and needed infrastructure investments to support reliability, resiliency, and safety. In order to consistently deliver strong value for our customers, communities, and shareholders, while practicing responsible environmental stewardship, we continue to work towards enhancing regulatory frameworks and advocating for responsible energy and economic policies. Workshops related to the implementation of the Illinois energy transition legislation enacted last year are ongoing and performance metrics related to the multi-year rate plan are expected to be approved by the ICC by late September. We believe this legislation will support important energy grid investments and will deliver value to customers, such as the utility owned solar in optional battery storage pilot projects in two communities, Peoria and East St. Louis. We're excited to announce that we began construction of an approximate $10 million, 2.5 megawatt solar energy facility in East St. Louis in early March. This energy center will strengthen the energy grid, while building a cleaner energy future for this Illinois community. Before moving on, I'd like to briefly discuss recent energy and capacity purchases made by the Illinois power agency on behalf of our Ameren Illinois customers for the upcoming June, 2022, through May, 2023 planning year. As you know, global events have been impacting the cost of energy commodities, and power prices in the Midwest have been elevated. Further, a combination of factors, including higher energy usage, a reduction of dispatchable generation and the construct of MISO's capacity market are all being cited as causes of a spike in regional capacity prices. Unfortunately, as a result of these factors, some of our Illinois customers will be seen a meaningful increase to the energy supply component of their bills beginning in June. It is important to note that energy and capacity costs are passed on to our Ameren Illinois customers through a rider with no markup. While factors leading to these increases and potential perspective mitigation will undoubtedly be discussed amongst stakeholders, our approach remains the same. We will continue to focus on supporting our customers and communities by connecting them with bill assistance where needed and continuing to invest strategically to support a responsible clean energy transition in Illinois. Moving now to page eight and Missouri legislative matters. As part of Ameren Missouri smart energy plan, a multi-year effort to strengthen the grid, our customers are benefiting from stronger poles, more resilient power lines, smart equipment, including modern substations and upgraded circuits to better withstand severe weather events and restore power more quickly. I am pleased to report that yesterday afternoon, Senate Bill 745 passed by strong majority support in the general assembly. This bill enhances the smart energy plan legislation enacted in 2018. More specifically, the bill extends the sunset date on the current smart energy plan legislation through December 31st, 2028 with an extension through December 31st, 2033, if the utility requests and the PSE approves. The bill also modifies the rate cap beginning in 2024 from the current 2.85% compound annual all in cap on growth in customer rates to a 2.5% average annual cap on rate impacts of piece of deferrals. In addition, the bill expands and extends economic development incentives and provides for a property tax tracker. The bill will now be sent to the governor for signature. We believe extending Missouri smart energy plan will continue to benefit our customers and communities, as we transform the energy grid of today to build a brighter energy future for generations to come, all while creating significant economic development and jobs in the state. Turning to page nine. We will now provide an update on developments related to our plan to accelerate the retirement of the Rush Island Energy Center. As discussed on our year-end earnings call in late February, Ameren Missouri filed an attachment Y with MISO notifying it of our intention to close the energy center. As a result of that filing MISO is now studying the grid reliability implications of Rush Island's planned closure in order to determine any investments and interim operating parameters required prior to closure in order to mitigate system reliability risks. I would note MISO's preliminary study completed in January, 2022 recommended transmission upgrades and indicated additional voltage support will be needed on the transmission system to ensure reliability. While MISO is under no deadline to issue a final report, we expect a draft report will be issued this month. The District Court, which is awaiting MISO's analysis, is also under no deadline to issue a final order regarding the accelerated retirement date. Ameren Missouri expects to file an update to its 2020 integrated resource plan with the Missouri PSE in June, which will reflect the expected accelerated retirement date of the Rush Island Energy Center. Such filing will also include discussion of the expected use of securitization in order to recover the remaining investment in Rush Island. We continue to work with all parties involved to move forward with the accelerated retirement in the most responsible fashion. On page 10, we turn our focus to the third pillar of our strategy, creating and capitalizing on opportunities for investment for the benefit of our customers, shareholders and the environment. This page provides an update on the MISO long range transmission planning process. As we have discussed with you in the past, MISO completed a study outlining the potential roadmap of transmission investments through 2039, taking into consideration the rapidly evolving generation mix, that includes significant editions of renewable generation based on announced utility integrated resource plans, state mandates, and goals for clean energy or carbon emission reductions, as well as electrification of the transportation sector among other things. Under MISO's Future 1 scenario, which is the scenario that resulted in an approximate 60% carbon emission reduction below 2005 levels by 2039, MISO estimates approximately $30 billion, a future transmission investment would be necessary in the MISO footprint. Under its Future 3 scenario, which resulted in an approximate 80% reduction in carbon emissions below 2005 levels by 2039, MISO estimates approximately $100 billion of transmission investment into MISO footprint would be needed. As part of Tranche 1, MISO working with key stakeholders, including transmission owners has identified projects located in MISO North estimated to total more than $10 billion. The projects crossing through our Missouri and Illinois service territories provide significant investment opportunities. We believe we are well-positioned to execute on these projects, given the location of the projects and our expertise constructing large regional transmission projects. MISO approval of Tranche 1 is expected in late July. Work on three additional Tranches has begun and MISO has indicated that an initial set of Tranche 2 projects also located MISO North is scheduled to be approved in the first quarter of 2023. Projects included in Tranche 3 three are expected to be located in MISO South, with approval scheduled in the fourth quarter of 2024, while projects identified in Tranche 4 are expected to improve transfer capability between MISO North and MISO South with approval scheduled in the fourth quarter of 2025. Moving now to page 11. We are focused on delivering sustainable energy future for our customers, communities and our country. This slide summarizes our strong sustainability value proposition and focus on environmental, social, governance and sustainable growth goals. Our preferred plan included in Ameren Missouri's 2020 IRP supports our goal of net-zero carbon emission by 2050, as well as interim carbon emission reduction targets of 50% and 85% below 2005 levels by 2030 and 2040, respectively, which is consistent with the objectives of the Paris agreement and limiting global temperature rise to 1.5 degrees Celsius. As previously noted the IRP will be updated in June to reflect among other things, MISO's long-range transmission planning, legislative and regulatory developments, and the early retirement of Rush Island. We continue to work diligently to optimize our sustainability value proposition, including our clean energy transition. In just last month, we announced completion of our newest clean energy resource, a six megawatt solar facility. The Montgomery County solar center is part of our Missouri community solar program, which began in 2018, offering customers the opportunity to invest in solar energy generation in their community through a shared system. The energy center is now up and running, supporting more than 2,000 customers who want to take part in clean energy generation without having to pay high upfront cost to install solar equipment on their own roofs or property. The program is fully subscribed, and we are evaluating expansion opportunities at additional sites. We also have a strong long-term commitment to our customers and communities to be socially responsible and economically impactful. I'm excited to say that this week DiversityInc announced once again, that they have named Ameren Number One on their top utilities list for diversity and inclusion, a list we have proudly been part of since 2009. DiversityInc also recognized Ameren as a top company for veterans, black executives, as well as a top company for ESG among all industries. This slide highlights a few of the many things we are doing for our customers and communities, including being an industry leader in diversity, equity and inclusion. Further, our strong corporate governance is led by a diverse Board of Directors focused on strong oversight that's aligned with ESG matters. We recently named our first Chief Sustainability and Diversity Officer to further optimize our ESG impact by aligning these interconnected areas. Finally, this slide summarizes our very strong sustainable growth proposition, which remains among the best in the industry. As mentioned on our call in February, we have a robust pipeline of future investments that will continue to modernize the grid and enable the transition to a cleaner energy future. This pipeline includes over $45 billion of investment opportunities over the next decade, that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will not only create a stronger and cleaner energy grid to meet our customers' needs and exceed their expectations, but they will also create stronger economies and thousands of jobs for the communities we serve. I encourage you to take some time to read more about our strong sustainability value proposition. You can find all of our ESG related reports at amereninvestors.com. Turning to page 12. To sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2022 and beyond will deliver superior value to our customers, shareholders and the environment. In February, we issued our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2022 through 2026. This earnings growth is primarily driven by strong rate-based growth, supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. I will note renewable generation and regionally beneficial transmission projects represent additional investment opportunities. We expect to announce further agreements for the acquisition of renewables over the course of this year and to file certificates of convenience and necessity, or CCNs with the Missouri PSC after the updates to the 2020 IRP have been filed in June. We expect to deliver strong long-term earnings and dividend growth, which results in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all four of our business segments, as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. And I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks Marty and good morning, everyone. Turning now to page 14 of our presentation. Yesterday, we reported first quarter 2022 earnings of $0.97 per share compared to $0.91 per share for the year ago quarter. Earnings in Ameren Missouri, our largest segment increased $0.01 per share due to several factors. Earnings increased by approximately $0.03 per share from higher electric retail sales driven by colder than normal winter temperatures in the first quarter of 2022 compared to near normal winter temperatures in the year ago period. We've included on this page the year-over-year weather normalized sales variances for the quarter that showed that total sales to be of one half percent compared to the first quarter of 2021. The earnings comparison also reflected investments in infrastructure and wind generation eligible for PISA and RESRAM which benefited earnings in January and February by $0.03 until rates were set. These favorable factors were partially offset by higher operations and maintenance expenses, which decreased earnings $0.05 per share. This was driven in part by the unfavorable market returns in 2022 that occurred during the first quarter on the cash surrender value of our company owned life insurance. Moving to other segments. Ameren Transmission earnings increased $0.03 year-over-year, which reflected the absence of the March, 2021 FERC order addressing materials and supplies inventories, and increased infrastructure investments. Earnings for Ameren Illinois Natural Gas were up $0.01 reflecting increased infrastructure investments and higher delivery service rates were effective in late January, 2021, partially offset by higher operations and maintenance expenses. Ameren Illinois Electric Distribution earnings also increased $0.01 year-over-year, which reflected increased infrastructure investments and a higher allowed ROE and the performance based rate making of approximately 8.5% compared to approximately 8.2% for the year ago quarter. And finally Ameren Parent and other results were comparable to the first quarter of 2021. Before moving on, I'll touch on the sales trends for Ameren Illinois Electric Distribution in the quarter. Weather normalized kilowatt hour sales to Illinois residential customers decreased about one half percent. And Weather normalized kilowatt hour sales to Illinois commercial and industrial customers increased about one half of percent and 1.5%, respectively. Recall that changes on electric sales in Illinois no matter the cause do not affect our earnings since we have full revenue decoupling. Turning to page 15. I would now like to briefly touch on key drivers impacting our 2022 earnings guidance. We're off to a strong start in 2022. And as Marty stated, we continue to expect 2022 diluted earnings to be in the range of $3.95 to $4.15 per share. Select earning considerations for the balance of the year are listed on this page and are supplemental to the key drivers and assumptions discuss on our earnings call in February. I encourage you to take these into consideration as you develop your expectations for our second quarter earnings results. Turning now to page 16 for details regarding the Ameren Illinois Electric Distribution rate increase request. In April, Ameren Illinois submitted a request for an $83 million revenue increase to the ICC in its annual performance based rate update. Our Illinois customers are continuing to realize the benefits or significant investments in energy infrastructure. Since performance based rate making began in 2012, reliability has improved over 20% and over 1,400 jobs have been created. J.D. Power rank Ameren Illinois number one in residential customer satisfaction in the Midwest among large electric utility providers for 2021. Major investments include in this request are the installation of outage avoidance and detection technology, integration of storm, harding equipment and implementation of new technology to optimize interaction with customers. We expect the ICC's decision by December, 2022 with rates effective in January, 2023. On page 17, we provide a financing update. We continue to feel very good about our financial position. On April 1st, Ameren Missouri issued $525 million of 3.9% green first mortgage bonds due 2052. We intend to use these proceeds as the offering to fund capital expenditures and refinance short-term debt. Subsequently, we plan to allocate an amount equal to the proceeds to sustainable projects, meaning certain eligibility criteria, including investments in transmission and distribution infrastructure, designed to make the system more resilient, and improve customer reliability investments in energy efficiency. Additionally, in order for us to maintain our credit rating and a strong balance sheet, while we fund our robust infrastructure plan consistent with the guidance in February, this year we expect to issue approximately $300 million of common equity under our after market equity program. We're well-positioned to fulfill our 2022 equity needs through forward sales agreements entered in as of April 1st and expect to issue 3.4 million common shares by the end of this year upon settlement. Together with the issuance under our 401(k) and DRPlus programs, our $750 million ATM equity program is expected to support our equity needs through 2023. On page 18, we summarize our green bond issuance over the last few years. Our sustainability financing framework, one of the first of its kind for utility in the nation, supports Ameren sustainability goals and the current target of net-zero carbon emissions by 2050, as well as other social initiatives. The financing proceeds from the issuance of the framework will be allocated eligible environmental and social projects, including renewable generation, climate change adaptation, clean transportation, socioeconomic advancement, and the employment creation, doing just a few. Finally turning to page 19. We're well-positioned to continue to executing our plan. We're off to a solid start and expect to deliver strong earnings growth in 2022, as we continue to successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth, driven by robust rate-based growth and discipline cost management. Further, we believe this growth will compare favorably with the growth of our regulated utility peers and Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total share of return story that compares very favorably to our peers. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. First question today will be coming from the line of Jeremy Tonet with JP Morgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Martin Lyons",
"text": "Morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Thanks for having me. Just want to start off with MISO long range transmission planning here Tranche 1. Just wondering if there's any way that you could quantify what the opportunity set might be specific to Ameren here? Trying to get a sense for how big that could be in your mind."
},
{
"speaker": "Martin Lyons",
"text": "Yeah. Jeremy, I appreciate the question. Look, as we said in the prepared remarks, we certainly believe we're well-positioned for projects that MISO has outlined that cross through our Missouri and Illinois footprints. But as we sit here today, we don't want to get ahead of the MISO in terms of their overall approval of their projects or the designation of which ones are brownfield or greenfield projects. So, we do expect that when they approve these projects in July, we expect that they will designate which ones are brownfield. They'll indicate which transmission owner has been assigned those projects. So -- and I would just say stay tuned. As I said, in the February call we'll, we expect to have more to discuss on our Q2 earnings call."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. We'll, eagerly await that. And just wanted to see that there's some new development in Missouri as well as it relates to PISA. And just wondering if that comes through, what your thoughts would be there as far as PISA flexibility and how that impacts Ameren's planning."
},
{
"speaker": "Martin Lyons",
"text": "Yeah. Thanks Jeremy. Yeah. We were actually very pleased that yesterday the legislature did pass Senate Bill 745, which was great. That's a bill that really extends the longevity of the smart energy plan, that we have in Missouri. And so, we're very appreciative of the strong support of the legislature with regard to that legislation. And I think it's a recognition that the investments that we've been making in Missouri, have really been producing good benefits for our customers in terms of safety and reliability of the service that we provide. And the fact that, we're really scratching the surface in terms of the investments that we need to replace aging infrastructure and modernize our equipment throughout our Missouri footprint. I think it's also a recognition of the economic development benefits associated with that legislation. We're having a positive impact as we invest on our economies, through the creation of jobs. We concentrate on using Missouri vendors substantially for the things that we procure and the things that we invest in. And there's some great economic development, incentive rates associated with this legislation that help Missouri businesses grow, as well as attract Missouri businesses to the state. So, we're really excited about the legislature passing Senate Bill 745. It now heads to the governor's desk for signature, and we're excited to be able to extend the benefits of the smart energy plan prospectively."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. And just one last one, if I could. On a similar note, recent eminent, domain legislation Missouri, could you comment on the implications for Greenbelt, MISO or anything else as far as investment that could be related to Ameren in the state going forward there?"
},
{
"speaker": "Martin Lyons",
"text": "Yeah. I think -- I don't think with respect to that legislation, that there are any immediate impacts other than making sure that as we move forward in time to the extent that, there are greenfield transmission projects that -- owners of agricultural properties are compensated fairly for their property. I think that's the primary impact going forward."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. I'll leave it there. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is in the line of Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Dariusz Lozny",
"text": "Hey, good morning. This is Dariusz for Julien. Thanks for the time. Maybe just on the proposed multi-year rate plans for Illinois Electric. Can you talk a little bit about -- I know it's somewhat early in the process still, but can you maybe discuss a little bit about what type of performance metrics are being considered as you go through that workshop process?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah. You bet. Good morning. This is Michael Moehn. I would say things are moving along, just fine there. I think a lot of constructive conversations, workshops, et cetera. There's a number of different paths that are occurring. There's one associated with the performance metrics. I'll give you a few details. There's one around a multi-year grade plan, et cetera. And so, I think they're all moving along, as we sort of anticipated last year and so nothing that we see that's concerning. With respect to the performance metrics themselves, it really is kind of the standard stuff that you would think about from like a reliability standpoint. So, system average, days of disruption, you're looking at customer metrics in terms of customer response time on calls, et cetera. So, kind of standard stuff. Right now, we are advocating for about 24 basis points. So, there's about eight different metrics and ascribing three basis points to each one of those metrics. Everything still should -- it's be on track to conclude here by September of this year, and at that point in time, we'd make the decision. And as we've said before, we see ourselves opting into that and then the multi-year rate plan we need to be filed in January of 2023. Does that help?"
},
{
"speaker": "Dariusz Lozny",
"text": "That does help. That's very helpful. Appreciate it. And maybe just one other one on the equity financing, can you -- just want to confirm that the forward agreement that you guys executed for your funding in 2022, that takes off requirements for the full year, other than the drip. And then also the amount under the forward agreement, does -- that's part of the $750 million included under the ATM program? Is that accurate?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah. You got both of those correct. So that $300 million that we've sold for, that does take care of the requirements here that we outline in February for 2022. And then that is part of that $750 million. That $750 million should get us through the end of 2023."
},
{
"speaker": "Dariusz Lozny",
"text": "Okay. Great. Thank you for clarifying that. I'll leave it here."
},
{
"speaker": "Michael Moehn",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question is coming from the line of Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shahriar Pourreza",
"text": "Hey, good morning guys."
},
{
"speaker": "Martin Lyons",
"text": "Good morning, Shar."
},
{
"speaker": "Shahriar Pourreza",
"text": "Good morning. If you could -- I'd like to maybe touch on Illinois. The bill and kind of the reliability backdrop seems to be a little bit noisy amid sort of the year-over-year jump in PRA costs, planned retirements under [indiscernible] 33:15. And just the general concerns that obviously is coming from some of the C&I customers. I guess, how do you sort of see this kind of resolving in the next couple of years, especially as you're looking to go through multi-year rate plans in the interim?"
},
{
"speaker": "Martin Lyons",
"text": "Yeah. Sure. There's certainly a lot there. I think, first of all, the backdrop to your question is that recently, we've been seeing higher power prices here in the Midwest. And then, recently as a result of the MISO capacity auction, we also saw capacity prices clear at high prices really at cost of new entry. And those higher costs of power prices as well as the capacity prices then will be borne by our Illinois customers, because we know it's a retail choice state. Typically, what we've seen is that various retail electric suppliers have supplied about 60% to 65% of our customers and then around 30% to 35% have procured their power through us. But when they do, of course, it's really the Illinois power agency that does the procurement of the power and the capacity. And as they've reported, those prices were elevated. And therefore, some of our customers are going to see meaningful increases in their bills starting here in June. So, I think, first of all, concern for our customers. We're trying to make sure that we provide education about the impacts of these higher prices, so that people know what to expect and they can take actions accordingly. And we're also in offering bill assistance where needed as well as, of course, reinforcing the opportunities under our energy efficiency programs, which are robust in the state. And then, some customers obviously will be still taking power through local muni aggregation programs, things of that nature that may actually not see bill increases immediately. But we are certainly concerned about those customers. I think, then, more broadly, I think you say, how does this resolve itself? I think that, first of all, as we go into the summer, there are concerns about just reliability. I would say when you see prices clear at [indiscernible], it's a sign that the resources to supply the load with cushion are tight. So, we expect that MISO will be tight this summer. We expect that the MISO itself that is ultimately responsible for ensuring grid reliability is certainly going to be doing everything they can, working with stakeholders as we head into warm weather situations to ensure that every possible resource available to supply customers. And certainly, we'll be doing all we can as a company, especially when we look at our Missouri energy resources to make sure that they're available and ready to go in the hot weather months. And so, again, I think that's some of the efforts in the short0term. In the long-term, we'll see how this plays out. I mean, with capacity prices, clearing account, it's a clear signal to the market that more is needed in terms of dispatchable energy resources to meet our load. And we'll have to see how all of that plays out. And we'll be working with stakeholders as appropriate throughout all of that to help mitigate that situation in the long-term. As a result -- as it relates to our multi-year rate plan, as Michael said, we're sort of marching towards a filing here in January related to that multi-year rate plan. That then, the Illinois Commerce Commission would rule on towards the end of 2022 with implementation -- or excuse me -- end of 2023 with implementation in 2024. As I said on the prepared remarks, we still have significant aging infrastructure in Illinois. The investments that we're making are producing improved reliability for our customers, ensuring we provide safe and reliable service. And I think, even what we're seeing in terms of the tight market situation in Illinois, an appropriate backdrop for continued investment in infrastructure, both transmission, as well as distribution infrastructure. So, we still see the need for the investments that we're making in Illinois and don't see any impact right now on the multi-year rate plan filing itself and moving forward with that from the backdrop that we discussed."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. That's perfect. And then, lastly for me. Obviously, you have the opportunity to earn on some of your generation length in MISO and flow that back to Missouri customers. Are you seeing that today? And any sort of quantification of the potential benefit to customers there?"
},
{
"speaker": "Martin Lyons",
"text": "No real quantification of the benefits. You're right. In Missouri, right now, have length in terms of our generation profile. And to the extent that power prices are elevated provides an opportunity for us to enhanced margins and all of those margins -- 95% of them flow back to our customers in the form of reduced rates. So, no quantification of that right now, but you're right in terms of your thoughts on how that works."
},
{
"speaker": "Shahriar Pourreza",
"text": "Okay. Terrific. Thanks guys. I stop there. Appreciate it."
},
{
"speaker": "Martin Lyons",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Paul Patterson",
"text": "Hey. Good morning."
},
{
"speaker": "Martin Lyons",
"text": "Good morning, Paul."
},
{
"speaker": "Paul Patterson",
"text": "So, congratulations on the -- on getting the piece of stuff over the goal line. And just a follow-up on Shar's question on Illinois. You say that it doesn't have an impact on what your -- the company's outlook on the needs for your plans. But I'm wondering does the concerns -- at least I've been seeing by the Illinois legislators and I assume perhaps others in Illinois, does it lead to perhaps a better -- a more receptive attitude perhaps to -- or more of a buy-in what you've been proposing on the part of policymakers perhaps in Illinois? Or do you think it's pretty much the same situation we're just sort of seeing. I don't know, sort of legislative drama, if you follow what I'm saying?"
},
{
"speaker": "Martin Lyons",
"text": "Yeah. Paul, it's hard to say at this point. I would say it's premature to conclude one way or another. I think what we're seeing right now is folks really digesting the news in terms of the power -- higher power and capacity prices. And what that means in terms of its implications for policy going forward, we will -- we'll see -- I think it's premature."
},
{
"speaker": "Paul Patterson",
"text": "Okay. And then, with respect to just the Greenbelt legislation, it sounds like this is probably going to enable Greenbelt to get built. And I'm wondering if Greenbelt -- how -- a transmission project like that or others might impact your plans for infrastructure development, if you have a big line like coming into crossing your area -- what have you?"
},
{
"speaker": "Martin Lyons",
"text": "Well, with respect to Greenbelt, obviously, that's a project that's been underway for quite some time and has been progressing, and we had certainly anticipated that. One of the things that we've talked about in the past is last year -- or I should say in the fall 2020 when we filed our integrated resource plan, one of the things we did is assess the potential to utilize some of that capacity and wind in Kansas to meet some of our renewable goals and as part of our integrated resource plan. So, I think the biggest thing for us, Paul, is we think about that project -- when we think about the update to our integrated resource plan that we'll be filing in June, it's just the continuing optionality associated with that resource -- or those resources in potentially fulfilling the needs of our integrated resource plan. So, that's something that we will continue to assess as we move forward."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Thanks so much. And have a good weekend."
},
{
"speaker": "Martin Lyons",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from the line of Anthony Crowdell with Mizuho. Please proceed with your question."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning, Marty. Good morning, Mike."
},
{
"speaker": "Martin Lyons",
"text": "Good morning."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, like the Blues, I don't think they tie it up here. So, I'm rooting for them until they meet the Rangers. But just hopefully, two quick questions, I guess. One, if I think about Missouri and Illinois, both right first refusal states. And if the transmission lines are greenfield, does that mean they are competitively bid? Or maybe just wondering what's the distinction you're making between brownfield and greenfield?"
},
{
"speaker": "Martin Lyons",
"text": "Well, I think you've generally got it. Missouri and Illinois though are not right of first refusal states, which is why that distinction between brownfield and greenfield is important. So, if it's a brownfield, which generally you should think of as new transmission on existing right of way, that -- we would then expect to be assigned to us as a transmission owner. And then, the question will be, are there segments of projects that are greenfield, which might be subject to competitive bidding. And that's what we'll wait to see as it comes out of the MISO's July approval of these projects."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. And then, just another follow-up here. Moving to Illinois -- and I guess, maybe 30-year treasury. I think, right now, it's about 90 basis points above expectation, I think, for the year where you guys had thought was going to be. I calculate that as kind of like a $0.07 tailwind. I guess, are there any headwinds I think about that maybe could potentially offset that benefit when I'm thinking about the year? Or is maybe my number's wrong on from where the expectation was of the 30-year versus where it's at now?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah. And no -- look, you got the estimate right. I mean, we -- in February, we estimated 2.25. Now you got to remember, it's an average over the course of the year. So, I think it averaged about 2.25 over the first quarter. So, just keep that in mind. But look, it's in a good spot. I think what we indicated in our guidance for the remainder of the year, we're assuming it averages about 2.7. So, if you average that with the first quarter that would be around 2.9 or so. So, you're right, it's certainly elevated relative to that, if you think about it. In terms of things that could offset it. Obviously, along with that comes some increased financing costs that we've been incurring a little bit on some of the short-term debt other things. But look, it's a good tailwind to have at this point. There's still a lot of the year left. We got a lot of execution to do. We're going to stay focused on it. We don't want to get ahead of ourselves."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. Thanks for taking my questions and congrats on a good quarter."
},
{
"speaker": "Michael Moehn",
"text": "Thank you."
},
{
"speaker": "Martin Lyons",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, we have reached the end of our question-and-answer session. And I'll turn the floor back to Mr. Lyons for closing comments."
},
{
"speaker": "Martin Lyons",
"text": "Yeah. Thank you all for joining us today. We're really pleased. We had a strong start to 2022. And we certainly, as Michael said, remain focused on continuing to deliver throughout the year for our customers, our communities and our shareholders. I'd like to invite all of you to attend our Annual Shareholder Meeting, which is being held on May 12th, and we look forward to seeing many of you at the AGA Financial Forum in the next couple of weeks. So, with that, thank you all, and have a great day."
},
{
"speaker": "Operator",
"text": "This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 4 | 2,023 | 2024-02-23 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modelling for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4.
Marty Lyons: Thanks, Andrew. Good morning, everyone, and thank you for joining us today. Beginning on Page four, our strategic plan highlights our steadfast commitment to providing safe and reliable energy in a sustainable manner. We do this by investing in rate-regulated infrastructure, enhancing regulatory frameworks and advocating for responsible energy policies, while optimizing operating performance through ongoing continuous improvement in order to keep rates affordable. Our strong 2023 operating and financial results, which we will cover today, reflect execution on our key business objectives for the year, which will continue to create value for our customers, communities, shareholders and the environment in the years ahead. I'd like to express appreciation for my Ameren coworkers' unwavering commitment to our strategy. Turning to Page five, this page summarizes our strong sustainability value proposition. Our operations and investments in 2023 made the energy grid safer, smarter, cleaner, more reliable and resilient, supporting thousands of jobs in our local communities in Missouri and Illinois, and driving a positive impact on the economies of each state. In the process, we helped hundreds of local, small and diverse businesses grow, and we gave back to numerous charitable organizations to help our neighbors in need. For example, last year, almost 60% of our total sourceable spend was with suppliers in our Missouri and Illinois communities, while 26% was with local small and diverse suppliers, creating jobs and economic growth and contributing to thriving communities in the areas where we operate. The positive impact of our investments was reinforced by our top quartile reliability performance in 2023, as measured by the frequency of outages. At the same time, our Ameren supplied residential customer rates, on average, were below the Midwest average. Today, we published our updated sustainability investor presentation called, Leading the Way to a Sustainable Energy Future, available at amereninvestors.com. I encourage you to take some time to read more about our strong sustainability value proposition. Turning to Page six. When I reflect on the business objectives we laid out at the start of 2023, I am pleased to say that we made some great strides in each of our three strategic pillars. That said, we did not achieve the results expected in our Illinois gas and electric regulatory proceedings. On Page seven, we lay out our key strategic accomplishments for 2023 in more detail. This past year, we invested $3.6 billion in infrastructure, spread strategically across our business segments, in order to improve service for our customers. These investments are needed to reduce the frequency and duration of outages in the face of volatile weather events, such as this past summer, when we experienced the most impactful storms in the last 10 years. Ameren, Illinois' work in restoring power to nearly 200,000 customers in the wake of the June 29, 2023 derecho was recognized with an Emergency Response Award by the Edison Electric Institute at its recent Winter Membership Meeting and there's plenty more work to be done to address aging infrastructure and make the grid stronger and smarter, while supporting the clean energy transition, making it truly an exciting time to be in the utility industry. Of course, every utility's ability to invest must be supported by constructive regulation, which brings me back to our regulatory developments in the fourth quarter. The State of Illinois has ambitious energy transition goals, goals which we continue to work collaboratively with stakeholders to support. Of course, achieving these goals will require significant sustained investment in the state's energy infrastructure in the coming decades. In 2023, Ameren, Illinois filed plans with the Illinois Commerce Commission, or ICC, to incorporate proposed investments in critical electric and natural gas infrastructure into prospective rates. Unfortunately, the ICC decisions in both the electric and natural gas rate reviews late last year were disappointing, reducing cash flows available for investment and delaying needed investments in energy infrastructure. We will continue working with stakeholders on a path forward to approval of an electric grid investment plan, revised revenue requirements incorporating ongoing and prospective investments, and an improved overall regulatory environment. We must work to build a stronger understanding that consistent, constructive regulatory environments are required to attract investment, support energy infrastructure development, economic expansion and jobs. Michael will cover the electric multiyear rate plan and the natural gas orders in more detail in a moment. Moving to Ameren, Missouri; in November, Ameren, Missouri filed a petition with the Missouri PSC, seeking approval to securitize the unrecovered investment in and costs associated with the planned fall 2024 retirement of our Rush Island Energy Center. The securitization is expected to result in significant savings for our customers when compared with cost recovery under traditional rate making. We, of course, recognize the importance of keeping our customers' bills as low as possible, while investing to improve service, which leads me to the third pillar of our strategy, optimizing operating performance. In 2023, our operations and maintenance expenses declined by 4% year-over-year. We automated and streamlined many of our finance, supply chain and customer service and workforce processes and we continue to drive new efficiencies in our field work through deployment of smart meters, work management systems and distribution automation. Notably, our Missouri customer rates have only increased 1.8% compounded annually since the smart energy plan legislation took effect in April 2017, with our Missouri residential customer rates consistently remaining 25% or more below the Midwest average. For our shareholders, yesterday we announced 2023 earnings of $4.38 per share compared to earnings of $4.14 per share in 2022. The result was above the midpoint of our original earnings per share guidance range of $4.35 per share. On a weather normalized basis, 2023 earnings results represent a 10% increase year-over-year. Turning to Page eight; here, you can see we have delivered consistent superior value to our shareholders for the past decade. Since 2013, our weather normalized core earnings per share have risen at an approximate 7.8% compound annual growth rate, while our annual dividends paid per share have increased approximately 58% over the same time period. This drove a strong total return of 173% for our shareholders from 2013 to 2023, which was significantly above our utility peer average. This track record of strong and consistent performance gives me conviction regarding our business strategy and rest assured, we are not looking back. We are focused on the objectives ahead. Moving to Page nine; we turn our focus to the current year. We expect 2024 to be another busy year and it hit the ground running. Notably, we will maintain our focus on strategic infrastructure investment for the benefit of our customers, while working hard to reduce operating costs and improve the regulatory environments in which we operate. We expect to invest approximately $4.4 billion in electric, natural gas and transmission infrastructure to bolster safety, security, reliability, resiliency and further the clean energy transition in a responsible fashion. This represents an increase of 22% from the prior year. Our plan includes approximately $1 billion of investment in new generation this year with new solar facilities expected to be in service by year end. The investment plans are aligned with our regulatory outcomes and expectations associated with each of our business segments. We also have several opportunities to enhance our regulatory and legislative environments in the year ahead. Next week, Ameren, Illinois will file a hearing testimony requesting to update 2024 through 2027 rates for 2023 yearend rate base and a base level of grid reliability investments. Then in March, Ameren, Illinois will file its revised multi-year grid plan with the ICC to address the commission's findings stated in their December order. An updated rate plan will also be filed to incorporate revised investment plans. Concurrently, we are evaluating all appropriate options to better align prospective regulatory outcomes with the goal of making progress on a reliable clean energy transition in an affordable fashion. We will work with all impacted stakeholders to advocate for constructive regulatory frameworks across our Illinois businesses, which will better support the state's energy transition goals. At Ameren, Missouri, we'd look to obtain approval to securitize the Russia Island energy center and advocate for Certificates of Convenience and Necessity or CCNs for future renewable and dispatchable generation, consistent with the integrated resource plan filed in September. The plan calls for investment in new dispatchable energy resources, including an on-demand 800 megawatt gas simple cycle energy center by 2027, which could be turned on as needed in a matter of minutes to ensure reliability of the energy grid during periods of peak energy demand. In January, we filed a request for the air permit for this simple cycle plant, Castle Bluff Energy Center to be located on the site of our retired Merrimack Energy Center. Utilizing this site, will keep construction costs down, bring back jobs and provide additional tax revenue for the surrounding region. We expect to file for CCN approval with the Missouri PSE later this year. We will also continue to support the analysis and approval of potential MISO tranche 2 transmission projects that will serve the needs of the Midwest region, improving the grid's ability to integrate renewable resources efficiently and effectively. Given the importance of dispatchable generation to reliability, we are advocating for improved Missouri regulatory treatment for generation investments, akin to the treatment afforded other investments in electric infrastructure in the state. Further on the legislative front in both Missouri and Illinois, we are advocating for Right of First Refusal -- Right of First Refusal Legislation to support the timely construction of transmission resources needed for system reliability and efficiency and to maximize customer benefits. Shifting our focus to operations, as we identify ways to continuously improve our business, we're focused on maintaining disciplined cost management to hold operations and maintenance expenses flat in 2024 to 2023 levels. Moving now to Page 10; yesterday afternoon, we announced that we expect our 2024 earnings to be in a range of $4.52 to $4.72 per share. Based on the midpoint of this range, this represents 6.2% earnings per share growth compared to the midpoint of our original 2023 guidance range of $4.35 per share. Michael will provide you with more details on our 2024 guidance a bit later. We expect to deliver 6% to 8% compound annual earnings per share growth from 2024 through 2028, using the midpoint of our 2024 guidance of $4.62 per share as the base. At this time, we expect earnings growth to trend below the midpoint of our range until the outlook in Illinois improves or the impacts of other growth opportunities are realized. That being said, we continue to have an outstanding portfolio of investment opportunities across our business segments, totalling more than $55 billion over the next 10 years and a strong balance sheet, which provide us potential earnings growth levers that warrant maintaining a guidance range with up to 8% growth. Our dividend is another important element of our strong total shareholder return proposition. Earlier this month, Ameren's board of directors approved a quarterly dividend increase of 6.3%, resulting in an annual dividend rate of $2.68 per share. This represents the 11th consecutive year that we have raised the dividend and reflects confidence by Ameren's board of directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect Ameren's future dividend growth to be in line with our long-term earnings per share growth expectations and within a payout ratio range of 55% to 65%. We expect our weather normalized dividend payout ratio in 2024 to be approximately 58%. Over the last decade, we have gradually lowered our payout ratio, which provides financial flexibility, while executing our robust energy infrastructure investment plans. Turning to Page 11; the strong long-term earnings growth I just discussed is primarily the result of rate-based growth driven by investment in energy infrastructure, made strategically under constructive regulatory frameworks. Today, we are rolling forward our five-year investment plan and as you can see, we expect to grow our rate base in an 8.2% compound annual rate for 2023 through 2028. This plan represents an increase of $2.2 billion compared to the $19.7 billion five-year plan for 2023 through 2027 that we laid out last February. The plan includes investment in renewables and simple cycle gas generation consistent with Ameren Missouri's integrated resource plan and because of the ICC's orders late last year, our capital plan for Ameren Illinois investments has been reduced by approximately $400 million from 2024 through 2027 compared to our prior five-year plan. We expect that this level of investment, which we expect will provide safe and adequate service as well as meet compliance requirements under the Climate and Equitable Jobs Act will ultimately be approved by the ICC. That said, we continue to believe that a higher level of investment supported by a more constructive return on capital investment would be in the best interest of our customers and communities and we will continue our advocacy. Finally, we remain focused on keeping customer bills as low as possible and improving earned returns in all of our businesses. Moving to Page 12; as we look to the future, our five-year plan is not only focused on delivering strong results through 2028, but it's also designed to position Ameren for success over the next decade and beyond. The right side of this page shows how our allocation of capital is expected to change over the next five years. Incorporating generation investment opportunities from our latest IRP, we expect our 2028 rate base to reflect our diversified approach for maintaining reliability with renewable generation and dispatchable generation representing 12% and 11% of rate base, respectively. Notably, our coal-fired generation is expected to be just 3% of rate base by the end of 2028. The bottom line is that we are taking steps today across the board to position Ameren to provide safe, reliable, affordable and cleaner energy for the long-term. Moving now to Page 13; our investment plan released today incorporated our intentions to invest over time in significant renewable and dispatchable resources as laid out in our Ameren, Missouri IRP. In 2023, we were pleased that Missouri PSC approved CCNs for the Huck Finn and Boomtown solar projects, and in doing so, indicated support for our responsible gradual transition and I'm happy to announce that we reached a stipulation and agreement regarding our next four solar projects, totalling 550 megawatts. These projects will support our lease cost plan for meeting customers' energy needs as we systematically invest to create a diverse mix of generation resources that preserves reliability as we retire our existing coal fleet over the next 20 years. While the Missouri PSC is under no deadline to issue an order on these four project CCNs, we expect a decision in March with these projects expected to go in service between 2024 and 2026. We expect to file additional CCNs consistent with the IRP later this year. Moving to Slide 14; as we've discussed in the past, MISO completed a study outlining a proposed roadmap of transmission projects through 2039. Detailed project planning, design work and procurement for the Tranche 1 projects assigned or awarded to Ameren is underway, and we expect construction to begin in 2026. During 2023, Ameren was awarded the first two competitive Tranche 1 projects, totalling approximately $100 million. Ameren submitted the third and final Tranche 1 competitive bid in October and expects the project to be awarded by June 2024. When awarding the competitive projects to Ameren, MISO noted our sound route design, engineering and cost containment plan, and innovative approach working with stakeholders as key factors in the winning bids. This is indicative of how we plan and develop all transmission projects. We believe our collaborative, customer-centric and community-respectful approach to building and maintaining low-cost projects is why we should be directly assigned these projects in the future in both Missouri and Illinois. MISO expects to approve a set of Tranche 2 long-range transmission projects in the first half of 2024, which will again address Midwest region needs. Turning now to Page 15; looking ahead over the next decade, we have a robust pipeline of investment opportunities of over $55 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Moving to Page 16; discipline cost management and a focus on customer affordability is nothing new to us here at Ameren and we expect 2024 to be another year of disciplined cost control and value realization from continuous improvement initiatives, which Michael will provide more details on in a few minutes. Through innovation and new efficiencies, we continue to target flat operations and maintenance expenses through 2028. Moving to Page 17; to sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2024 and beyond will continue to deliver superior value to our customers, shareholders and the environment. We believe our expectation of 6% to 8% compound annual earnings growth from 2024 through 2028, is driven by strong rate-based growth and supported by a strong balance sheet, compares favourably with our regulated utility peers. I'm confident in our ability to execute our strategy and investment plans across all four of our business segments, as we have an experienced and dedicated team with a track record of execution. Further, our shares continue to offer investors an attractive dividend, and we are positioned well for future dividend growth. Simply put, we believe this results in an attractive, total return opportunity for shareholders. Again, thank you all for joining us today, and I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to Page 19 of our presentation; yesterday, we reported 2023 earnings of $4.38 per share, compared to earnings of $4.14 per share in 2022, an increase of approximately 6%. This page summarizes key drivers impacting earnings in each segment, which are largely consistent with what we reported throughout 2023. As Marty noted, when normalized for temperature variations over the past two years, we estimate that our earnings grew 10%. Moving to Page 20, I'll cover our few key developments from the fourth quarter. In November, Ameren Missouri filed for securitization of costs associated with the Rush Island Energy Center as we approach the plan retirement date of October 15, 2024. If approved as requested, Ameren Missouri would be able to refinance and recover approximately $519 million, reflecting the remaining value of the plant and decommissioning costs. Missouri PSC orders are expected in June, 2024. To mitigate the impact of the lost rate base associated with the Rush Island retirement, we expect our Huck Finn and Boomtown solar facilities with an estimated total investment of approximately $650 million to be placed in service near the end of this year. Turning to Page 21, as Marty mentioned, late in 2023, the ICC issued orders under Ameren Illinois Natural Gas and Electric Rate Reviews. In November, the ICC approved $112 million annual base rate increase for natural gas delivery service, which included $77 million that would have otherwise been recovered under letters. The order reflects a 2024 future test year, a 9.44% allowed return on equity, a 50% common equity layer, and a rate base of $2.85 billion. New rates were effective in late November. We filed for a rehearing of this order with the ICC and were denied. So on January 03, Ameren Illinois appealed the ICC decision to the Illinois Fifth District Appellate Court, seeking that the ICC modify the return on equity and certain plant disallowances, among other things. The court is under no deadline to address this appeal. Turning to Page 22, in December, the ICC issued an order in our Ameren Illinois Electric Multi-Year Rate and Grid Plan filings. In its order, the ICC established an alternative revenue requirement based on our 2022 rate base, and is requiring us to refile and provide additional justification for our grid plan. We're in the process of revising our grid plan and we'll file it by the March 13 deadline. We will also revise our multi-year rate plan to incorporate these grid plan revisions. In the meantime, the December order reflects a cumulative increase from 2024 through 2027 of $142 million in revenues. The order approved an allowed return on equity of approximately 8.72% and a 50% equity layer. In January, Ameren Illinois filed for a rehearing of the December order with the ICC. On January 31, the ICC ordered a partial rehearing regarding certain operations and maintenance expenses, use of the 2022 rate base for establishing the revenue requirement for 2024 through 2027, and a base level of grid reliability investments. We expect a decision on these items subject to rehearing by the end of June with new interim rates expected to be effective at the discretion of the commission. Following the ICC's response to our rehearing request, Ameren Illinois also filed an appeal to the Illinois Fifth District Appellate Court on January 31, to address the remaining items which were denied for rehearing, including the return on equity. The court is under no deadline to address this appeal. We remain focused on providing safe and adequate service for our Illinois customers. Moving to Page 23; our overall outlook remains bright as we have a robust pipeline of investment opportunities. Our Ameren Transmission Missouri business lenders continue to benefit from meaningful ongoing investments to work by reliable, constructive regulation. Here we provide an overview of our $21.9 billion of planned capital expenditures for 2024 through 2028 by business segment that supports our consolidated 8.2% compound annual rate-based growth expectations. As you can see on the right side of this page, we're allocating capital consistent with the allowed return on equity under each regulatory framework. Our Ameren Missouri Smart Energy Plan filed today with the Missouri PSC provides more detail on how we strategically invest to replace aging infrastructure with more resilient, reliable equipment to serve our customers. After five years of Smart Energy Plan investments, we are a full year ahead of our initially planned smart meter installation in the state. That said, at our current investment levels, we still have decades of investment needed to address aging distribution substations and overhead and underground lines. You can find additional details on the Smart Energy Plan allocation of our 2024 planned capital investments on Page 32 and Page 33 in the appendix of this presentation. Turning to Page 24, we have outlined here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. We also expect to generate significant tax deferrals driven primarily by the timing difference between financial statement, depreciation reflected in customer rates and the accelerated depreciation for tax purposes. As we sit here today, we do not expect a transferability of solar and wind tax credits materially impact capital funding, nor do we expect the corporate minimum tax to apply during our five-year plan. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. For us to maintain a strong balance sheet while we fund a robust infrastructure investment plan, we have entered into forward sales agreements for $230 million of common stock issuances under our at-the-market equity distribution program to address most of our 2024 equity needs. We expect to sell these by the end of the year. The only additional equity we expect to issue in 2024 will be approximately $70 million for our dividend reinvestment and employee benefit plans. Incremental equity issues of approximately $600 million each year are planned for 2025 through 2028, a portion of which we expect to be issued through our DRIP and employee benefit plans. The $600 million per year is unchanged from our previous plan outline last February. All of these actions are expected to sustain our strong balance sheet and credit ratings. Moving to Page 25 of our presentation, I would now like to discuss key drivers impacting our 2024 earnings guidance. We expect 2024 diluted earnings per share in the range of $4.52 per share to $4.72 per share. This accommodates a range of outcomes on our ongoing Illinois regular proceedings, along with our typical business risk and opportunities. Detailed by segment as compared to the 2023 results can be found on this page and the next. Beginning with Ameren Missouri, earnings are expected to rise in 2024. Earnings are expected to be favourably impacted by the higher investments in infrastructure that are eligible for PISA and AFDC treatment, as well as new electric service rates effective July 2023. Earnings are also expected to benefit from higher weather normalized kilowatt hour sales to Missouri residential and commercial customers, which are expected to increase by 1% year-over-year in 2024, while sales to industrial customers are expected to increase by 4% year-over-year. These projected increases are driven primarily by customer count growth and General Motors resuming full production levels after a work stoppage in the third quarter of 2023. We also expect to benefit from lower operations and maintenance expenses. And we expect a return to normal weather in 2024 will increase Ameren Missouri earnings by approximately $0.03 compared to 2023 results. These favourable factors are expected to be partially offset by higher interest expense, primarily due to higher long-term debt balances. Moving on, earnings from our FERC regulated electric transmission activities are expected to benefit from additional investments in Ameren, Illinois and ATXI projects made under forward-looking formula rate making. Turning to Page 26; for Ameren Illinois electric distribution, the year-over-year earnings comparison will be impacted by the lower allowed ROE approved by the ICC in the multi-year rate plan versus the 2023 allowed ROE, which was driven by the 30-year treasury rates plus 580 basis points. The allowed ROE is applied to yearend rate base, which includes 2023 rate base and 2024 plan capital additions. For Ameren, Illinois natural gas, earnings will benefit from higher delivery service rates effective November, 2023, incorporating additional infrastructure investments, partially offset by a lower allowed ROE and common equity ratio. Earnings will also benefit from lower operations and maintenance expenses. Moving now to Ameren wide drivers and assumptions; we expect increased weighted average common shares outstanding to unfavorably impact earnings per share. We expect higher interest rate expense in Ameren parent due to increased debt balances. At the end of 2023, we turned out all then outstanding commercial paper balances at Ameren parent through two debt offerings. The first issued in November was $600 million and 5.7% senior unsecured notes due in 2026 and the second in December was $700 million of 5% senior unsecured notes due in 2029. Of course, in 2024, we'll seek to manage all of our businesses to earn as close to our allowed returns as possible. With that in mind, and support our expectation for lower operations and maintenance expenses in our Ameren Missouri and Illinois natural gas businesses, we've instituted several cost saving initiatives in 2024, including a hiring freeze, reducing our contractor and consultant workforce and deferring or eliminating discretionary spend. We'll be strategic about workforce management and continued investment in digital efficiency to allow us to sustain these cost reductions. Before moving on, I'd like to touch on the expected sales growth for our service territory. While we're conservative on our model and we are optimistic about the opportunity for strong economic development in the years ahead. in the last three years, our economic development teams have helped to bring 65 new projects to our communities in Missouri and over 125 projects in Illinois, bringing with an estimated total of over 14,000 jobs. These projects are generally expected to be completed in the next couple of years. With that in mind, we expect weather normalized kilowatt hour sales to be in the range of flat to up approximately 0.5%, compounded annually over a five-year plan, excluding the effects of our new energy efficiency plans, using 2023 as the base year. We exclude the effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales, resulting from our energy efficiency efforts. Turning to Illinois, we expect our weather normalized kilowatt hour sales to be relatively flat to down 0.5% over our five-year plan, driven primarily by increases in energy efficiency and solar adoption. Recall that changes in Illinois electric sales, no matter the cause, do not affect earnings since we have full revenue decoupling. Finally, moving to Page 27, I'll emphasize again that we have a strong team and a long track record of execution. We delivered strong earnings growth in 2023 and expect to continue to deliver 6% to 8% compound earnings per share growth over the next five years, driven by robust rate-based growth and disciplined cost management. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continued to offer investors an attractive dividend. In total, we have an attractive total share of return story. That concludes our prepared remarks. We now invite your questions.
Operator: [Operator instructions] Our first question comes from a line of Shahriar Pourreza with Guggenheim. Please proceed with your question.
Shahriar Pourreza: Marty, obviously you've throttled back Illinois electric spend here pretty significantly versus the prior plan, which I think is completely expected just coming off those ICC orders. Can you just speak a little bit more to what you've actually embedded in that 2.3% five-year CAGR as it relates to the grid plan? I guess put differently, could we see that tick higher later this year once the plan is approved? Or is the embedded base case there still subject to some upside and downside scenarios? Thanks.
Marty Lyons: Yeah, I'll let Michael comment on that further, but I would say, Shahriar, you're right. What we've done here is we've baked in what we believe to be a prudent level of capital expenditures, given the overall outcomes that we had in Illinois. As we said in our prepared remarks, we do believe that this is an appropriate amount to continue to provide safe and adequate service to our customers and meet the requirements of CEJA And that's what's been baked in. I just repeat what I said earlier, which is that we do believe a higher amount of investment over time is originally proposed last year is prudent and appropriate for our customers to provide the kind of service that they expect to really further the state's energy goals and policy goals. But again, what we've modelled in here is what we do believe would be a level that would be expected to be approved by the commission over time through the rehearing process, as well as through our upcoming grid plan filing and rate plan. So again, we do expect that this level of investment is something that will ultimately be reflected in those outcomes, but with that, in terms of further clarity on the CapEx, Michael, any comment?
Michael Moehn: Yeah, maybe just a couple of finer points. Good morning, Shahriar. I think Marty said it well. As we think about the capital plan that we've allocated there, again, Marty's correct. We're absolutely focused on providing safe and reliable service. I think we're being conservative in how we think about this. There's this 105% revenue requirement cap that we need to stay underneath and as you know, and I think there was some discussion about this, the commission's order pointed to '22 rate base. I think it was really more of a function of, because that was really the only year and rate base to point to. We definitely have the ability to, I think we'll recover our '23 expenditures, it's really under another formula rate. As they do that and they update and we're seeking some of those clarification, that obviously would give you more headroom under that 105% revenue cap. I think we took a conservative approach saying, let's make sure whatever we spend in '24, we stay under pointing back to the '22. So my point is you have a lot more flexibility going forward. I think to Marty's point, we'll have to step back and then decide, given the 8.72%, how do you feel about allocating more capital there? But as we continue to see improvement here, there's obviously would be those opportunities.
Shahriar Pourreza: Got it. Perfect and Marty, just, thanks Michael. Marty, just on Tranche 1, is it versus Tranche 2, is it still your expectation Tranche 2 will exceed Tranche 1? And then just on Tranche 2 estimates, are they embedded in that $55 billion pipeline number? Could any of the awards fall within this kind of five-year cycle you've got out there? Thanks guys.
Marty Lyons: Yeah, good questions, Shahriar. So with respect to Tranche 2, we do expect it, continue to expect it, to be considerably larger than the Tranche 1 investments and, MISO, as we said in our prepared remarks, is still saying that they expect to have those approved by the middle of this year. We'll see how that comes to fruition, but we do expect that in the first half, we'll at minimum start to get some clarity on, what some of those projects might look like. But again, Shahriar, to your point, significantly larger. Now, with respect to our plans that we've laid out, within the five-year plan, nothing is baked in for Tranche 2 investments. However, in the $55 billion, we do have, some amount in there for potential Tranche 2 investments. So, within the $55 billion, yes, certainly we do have some.
Operator: Our next question comes from the line of Nicholas Campanella with Barclays. Please proceed with your question.
Nicholas Campanella: Appreciate the guidance update and just the comment that you're kind of below the midpoint of the 6% to 8% range. Can you just kind of expand on, what we should be watching for that kind of gets you back to that midpoint and I'm taking into account the comments around, it seems that some of this transmission spending has been reflected in the plan, correct me if I'm wrong and then you're also just kind of assuming, CapEx for the Illinois distribution segment as proposed is approved as well. Just what should we be looking for to get you back into that midpoint? Thanks.
Marty Lyons: Yeah, Nick, maybe we'll take that in two part. I'll actually turn it over to Michael first to maybe provide a little bit more clarity on our thinking around the growth and then I'll provide some color on some of the upsides in our plan.
Michael Moehn: Yeah, good morning, Nick. Just to put a little finer point on the midpoint, I think as Marty said in his comments, expect to be a little below that midpoint and if you think about historically where we have been, just sort of the highest level, you go back to, February of last year, we had 8.4% rate-based growth and over that period of time, we were issuing roughly about 2% worth of dilution, say over the five-year plan. So it got you down to call it, 6.4%, 6.5% something like that. And then we've done a nice job of continuing to close the allowed versus earned gaps, continuous improvement. There's been a number of opportunities being really thoughtful about allocating capital to the places that are giving us the highest return and you can see it, obviously, historically we were trending above that 7% midpoint and we kind of think about where we are today, we got this 8.2% rate-based growth, really kind of the same dilution math. So with all things, we need to kind of put you at that 6.2% and then there's obviously still improvement opportunities as we continue to look forward and I think as we think about a midpoint, it's someplace between that 6.5% to 7% today. So let's call it 6.7%, just to put a little finer point on. So 6.7% versus sort of 7%, where I think we kind of pointed people historically and again, we've had opportunities to do better than that and Marty will talk about where I think, the future still lies for us. You'd think about the $55 billion, the capital projects that we have there. There's opportunities to continue to be thoughtful about the transmission that we just talked about a second ago and so those are the things that will provide us those opportunities. So hopefully that gives you a little more clarity on the math and I'll let Marty talk a little larger picture.
Marty Lyons: Yeah, I think, Michael started to touch on it a little bit. In terms of, the upsides, as I said in the prepared remarks, we certainly see good justification for keeping that 6% up to 8% growth and really what it reflects is that strong pipeline of investments that we have. We start there, $55 billion of potential investments over the next 10 years. We have baked into the five-year plan, the Tranche 1 investments that we've been assigned to us or that we've won, but we also have competitive proposal out there right now for another Tranche 1 project, which hasn't been baked in and that provides us some upside. We've talked about just a second ago, some of the Tranche 2 projects. We've got further investments to be made with respect to Missouri as it relates to the IRP. We've got some of those, certainly baked in today. As I mentioned, we had a very strong balance sheet and opportunities, as Michael just said, to continue to close the gap between our allowed and earned returns, which provides upside. And then of course, as we look ahead in Illinois, a couple of things, first, you know, the current multi-year grid plan or rate plan ends in 2027. And so as we look out even to 2028, there's opportunities to think about that differently and what our approach will be in 2028 and then I go back to maybe the most important thing, which is in the interim to really work to improve the Illinois situation and perhaps provide an opportunity for greater investment in Illinois. So, there, as we said in the call, we're gonna continue and engage in a dialogue with all stakeholders about the benefits of investment, risks of disinvestment, and our goal of really aligning our investments with the policy goals of the state around reliability, affordability, the clean energy transition and of course, we all know that our investments drive, not only improvements in critical energy infrastructure, but jobs and economics expansion. So, look, we've got to just continue to show financial discipline in the short term, but in the longer term, make sure we create this dialogue that having consistent constructive regulation, having strong investment in infrastructure in the state is going to benefit, our customers, their communities, the economy, the state and continue to work to make Illinois a place that attracts greater investment.
Nicholas Campanella: All right, thank you very much for that. And then I guess just on the O&M, I think in your prepared remarks, or even on slides here, 4% first last year, and then you're doing more O&M, just looking through the EPS slides, you have positives for Missouri and Illinois. So just, is 4% of the magnitude of decrease that we should expect to continue through '24? Can you maybe give us any type of way to frame that? And then how are you kind of thinking about just recapture of that, or timing of the next rate cases in Missouri, if you can maybe expand?
Michael Moehn: Good morning again, Nicholas. This is Michael, let me take this, and Marty can certainly add in, and we've talked about this, obviously, over time. Customer affordability is not something that is new to us. I think we've been really focused as a company on it for a number of years, and really up and down the P&L and we've talked about this, we, I think, do a great job of kind of going in and continuing to benchmark ourselves, all of the different areas of our business. And some are really good, some have opportunities, and we continue to close the gap in those opportunities and I think, Marty pointed to the 4%. It was, obviously people are very focused on it. We've talked about flat O&M over the five-year period is a good way to think about it, but the bottom line is there are a number of levers that we're able to pull here. I think as we think about '24 specifically, I mentioned in my opening remarks, I think we're taking just another view here. We're looking at headcount, I talked about headcount, hiring freeze at the moment, being very thoughtful about just contingent workforce, consultant dollars, any sort of discretionary spend. I think all the right things to do just in this elevated rate environment anyway for customers, and so that's really the focus there. But we're also being very thoughtful and strategic about, as you mentioned, just rate reviews, etcetera and being thoughtful about investments on the digital side too, just to make sure we make these costs sustainable. That's really what we want to do. I think we've talked about, we've had an increased investment in the digital platform over the last several years after we got PISA passed, and it's allowed us to replace our work management systems, our back office accounting systems. We continue to put a great deal of distribution automation, etcetera, on the system and all of these things are productivity improvements over time, which just give us a lot of confidence. This is a lever that we can continue to pull. So, Marty, anything to add there?
Marty Lyons: No, nothing to add there. Thanks for the question.
Nicholas Campanella: And I'm sorry, just to follow up on that, are you planning to file a Missouri rate case in the next year, or is that more than a year out?
Michael Moehn: Yeah, that's not something we've decided yet and look, if you look back over time, it's been every 18 months to 24 months we've filed a case, but haven't stated when we're going to plan to file the next one. So we'll be thoughtful about that. Look, we always try to go as long as we can between rate cases, and we'll continue to take that approach, but be thoughtful about when major capital additions go in and the like to think about the timing of our cases.
Nicholas Campanella: All right, thanks for taking my questions. Have a good day.
Operator: Our next question comes from the line of Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Thanks for all the detail today, and just wanted to kind of follow up on some of the points that you've talked about before and just regarding your capital reallocation, how should we be thinking about Missouri bill impact over time from the higher CapEx, just any thoughts there. And then also as we think about deploying that capital, the timing for receiving approvals and permits with additional transmission investments, broadly speaking on that side, if you could provide some more color there would be helpful.
Marty Lyons: Yeah, a lot there, Jeremy. I think number one, in terms of bill impacts, we're going to work through time as we have to keep the bill impacts as manageable as possible. I think, we had a pretty good track record in Missouri since we got a more constructive regulation, legislation back in 2018, and it really kept the growth in bills really below the level of inflation and so we're going to look to continue to, as Michael stated a minute ago, pretty comprehensively, take a lot of actions across the board to really manage our operating costs. And really, to the extent that we have rate increase requests, really make those about the capital additions that are going in that are producing greater reliability, for our customers, etcetera, where they're seeing the benefits. So, we're going to continue to work to keep our belt tight and as I said, overall, look to keep our operating costs flat over the next several years and as Michael said, create as many productivity improvements as we can. So that's our goal. Now, with respect to these projects, I would say when you look at our capital expenditure plans over the next five years for Missouri, I would say a need, they really relate on the left side of the graph on Page 23 to things that were included in our integrated resource plan. So, there the integrated resource plan had called for 2,800 megawatts of renewables by 2030. This is a piece of that as we move ahead with renewables, over half of what we've got there in that capital spend of $3.3 billion is related to two CCNs that have already been approved and then there's four CCNs that are pending right now and we expect to be able to file a stipulated settlement on those in the near term and so those are proceeding well. And then, with respect to the dispatchable generation, part of this is the simple cycle gas plant that we plan to put in service over the next five years and then part of this is continuing to invest in the dispatchable energy resources that we have in the state, but we will, as we said on our call, we've begun to do work around this 800 megawatt simple cycle gas plant and we will consider when to file a CCN for that. So, those are some timelines in terms of some of the investments we've got. Michael, any color to add?
Michael Moehn: Yeah, Marty did a great job there, Jeremy. I think the only thing that I'd probably add there is if you think about the $13 billion that we're allocating to Missouri, about 25% of its renewables and obviously an important factor is just the PTC, ITC that's being, given off with respect to those projects. So you think about the impact for customers, ultimately, there is a really big benefit there and so it's just something to keep in mind. I agree with everything else Marty said. We continue to be focused to all the comments I made before. It's not something new that we're doing here. Sometimes you can get a little lumpy impact in Missouri just because of the timing and the rate reviews, but the team really is focused on trying to keep these bills as low as possible.
Jeremy Tonet: And maybe just shifting towards Illinois and from where you sit, just wondering your perspective and what you see happening with regards to potential legislative or legal responses to the Illinois orders there in the state house. How have your conversations with stakeholders been trending here? Just any color you could share would be helpful.
Michael Moehn: Yeah, I think, look, the first order of business as we look at is, as I said before, to really try to work constructively with stakeholders and right now I'd say our primary focus is a couple of things. It's number one, making the rehearing filing, which is we plan to make next Thursday. So there, the opportunity to have rehearing around incorporation of 2023 rate base, as well as baseline capital investments that we plan to make over the next five years and have those included in a rehearing. And then as we've said before, we follow that up with our grid plan update and filing in mid-March. There again, we get feedback from the commission, obviously on deficiencies that they saw within the initial filing. We're looking to address those. We're looking to work constructively with stakeholders, whether it's the staff or other parties to make our filing as strong as we can to address the commission's identified deficiencies and position ourselves for success in getting, again, both a good outcome in the rehearing, as well as getting that grid plan approved and ultimately incorporated into a revised rate plan. So, I think those are where really our focuses are in the short term. Like I said, in the longer term, we'd like to see a more constructive environment for investment, and that's going to take really engagement with all stakeholders and I think, what we found is a receptivity among stakeholders to have the conversation, to listen, and we'll figure out over time what the best path forward is to achieving the result we want, which is a more constructive environment for investment, which again, we believe is ultimately in the best interest of customers, communities and in the achievement of the state's policy goals.
Operator: Our next question comes from the line of David Arcaro with Morgan Stanley. Please proceed with your question.
David Arcaro: I wanted to, in terms of whether normal load growth, just wondering how conservative...
Michael Moehn: Hey, David, we're having a really hard time hearing you. Could you speak up a little, David?
David Arcaro: Just in terms of whether normal load growth, was wondering how conservative the outlook is that you're presenting here. Is there any possibility for acceleration either from any manufacturing activity or data center activity that you're seeing or otherwise?
Michael Moehn: Yeah, let me start off, and then certainly Marty can add as well. I think, yeah, I tried to provide a little of this color in the opening remarks. Look, I think we do a good conservative job of kind of thinking about the load growth, but there are some really positive things happening in our service territory. Just economically, it's very strong. GDP growth is strong here and I'm really talking about kind of the greater Missouri area. Unemployments, running below the national average. We've had, if you think about even just '24 more specifically, we got the GM coming back on. They've added some additional load. There's a couple of data imaging companies that are using just a tremendous amount of energy, about 20 megawatts. These things really begin to add up and there's just a number of longer term, I think, opportunities as we think about data centers and other things from an information technology standpoint that could provide some economic growth. I think we do a good job of not really baking that in at this point. We talked about toward flat up a half percent, but I'm optimistic that, hopefully that is ends up turning out differently. So, Marty.
Marty Lyons: Yeah, I would just say that, look, we have a broad service territory and we're deeply involved in throughout Illinois and Missouri in economic development activities and our teams support economic development expansion across both service territories. I would say this though, in the greater St. Louis region, both in the Illinois side and the Missouri side, I'm more excited than I've been in years with respect to, I would say, the collaborative approach to really going after economic development efforts and really thinking about, how we drive inclusive economic growth, economic development and compete for projects. And I've never seen the community as unified and speaking with one voice and going after these things. We're seeing some wins, some wins that'll produce, I think, economic expansion two and three years out, some positive announcements, as Michael said. But, and I hope we are being conservative with respect to our growth projections. That said, as we see growth, we often see also, continued efforts on energy efficiency, both the energy efficiency we promote, but also just kind of energy efficiency in general and so try to be realistic about our growth expectations of those efforts.
David Arcaro: And then was just curious, what level of FFO to debt you're seeing over the plan? Wondering to the extent you realize some of the CapEx upside opportunities, how that could impact the equity needs going forward?
Michael Moehn: Yeah, perfect. So, again, we haven't really given targets in the past. I think what we've talked about is, look, we like our ratings where they are, BAA1, BBB+, that downgrade threshold S&P is 13. 17 at Moody's. We've trended obviously closer to that 17%. Again, as I outlined in my opening remarks, we feel good about our balance sheet. I think we come into this from a position of strength as I look out over the five years, the equity needs that I outlined certainly support, I believe actually maintaining that BAA1 and so maintaining something over that 17%, over that five year period. And so, and again, I try to be clear on what we did from an equity standpoint, for 2024, we're assuming $300 million of equity. We've done about $230 million under our ATM program today. Really the remaining balance that we need to do is related to our DRIP 401k. And then for all the other years, it's really consistent with where we had been before. So basically $600 million and again, I think supports those credit ratings that I just spoke about.
Operator: Our next question comes from line of Durgesh Chopra with Evercore. Please receive your question.
Durgesh Chopra: Hey guys, thanks for giving me time. I know it's close to the hour. Just Michael, on the point about equity, maybe you could just expand on this. So the CapEx plan is up, the five year CapEx plan is up close to 10%, a little over 10%, but the equity is kind of the same. Are you kind of modelling now lesser question versus the downgrade thresholds or are there other cash flow improvements that you might be missing?
Michael Moehn: Yeah, I don't know if there's other cash flow improvements. Again, I think we're always been conservative as we think about the balance sheet and so, again, I feel good about what I just said, David, in terms of how we're thinking about the FFO to debt over time and being above that downgrade threshold at 17%. We continue to obviously work with the rating agencies. We'll be in talking to them again in the spring and so, I guess I don't have any reason to feel concerned about it at this point and again, I think it's the right thing to do. We added the capital and still feel good about the levels that we're at given the equity that we're issuing.
Durgesh Chopra: Got it. And then maybe just a couple of clarifying questions and this will be quick, hopefully, but in the current five year CapEx plan, the four solar projects that you have settlement for in Missouri, those are included in the plan. Confirm that for us and then the upside would be the Missouri IRP results and then any transmission project awards from the MISO planning. Am I thinking about it correctly?
Marty Lyons: Well, I think, first of all, yes. The projects that we've already had CCNs for, as well as the subject to the stipulation are included in the five-year CapEx that's shown on Slide 23 and in fact, some additional CapEx as well for renewable projects that we anticipate to come into service by the end of 2028. And then the second part of your question was?
Durgesh Chopra: It was just the traffic upside.
Marty Lyons: No, I would think there, what we're saying is with respect to transmission, we've got the Tranche 1 projects that have been assigned to us or awarded or included in there, but what we have not included in there is any upside for a potential additional win of a transmission project that we've proposed on.
Durgesh Chopra: Got it. Thank you so much. I appreciate the time.
Operator: Thank you. Our final question comes from the line of Julien Dumoulin Smith with Bank of America. Please proceed with your question.
Julien Dumoulin Smith: Hey, good morning team. Thank you guys very much for the time. I appreciate it, or squeezing me in here. Look, maybe just to kick off quickly here, just on the balance sheet, obviously you're bringing down equity slightly over the comparable period from last plan. I'm taking CapEx fairly meaningfully here. I just wanted to clarify, just where are you relative to the required metrics? Can you elaborate a little bit through the cadence of the plan, how you're thinking about the FFO to debt? Or just where are you starting and ending, if you will and then I got to follow up real quickly.
Michael Moehn: Yeah, good morning, Julian. It's Michael. As I said, we have -- the downgrade threshold of Moody's is 17% and we historically haven't talked about exactly what we're targeting. But again, over this five-year plan, there is cushion over that 17%. Again, I feel good about it. We have been, I think, done a great job of sort of telegraphing what our equity needs, being very disciplined about going out and issuing that equity. I think we come into this kind of super CapEx environment with a very, very healthy balance sheet. As you know, we're not trying to get up to some level, right, where we've been at these levels and I see us staying at that level over the five-year plan.
Julien Dumoulin Smith: Got it, so every year kind of over that 17% threshold, give or take. And the rating is…
Michael Moehn: Over the five-year plan, yeah. Over 17%.
Marty Lyons: And again, look, as we have frequent conversations, then we'll go in again and have another conversation with them, so.
Julien Dumoulin Smith: Wonderful. And just to clarify this on the Missouri CapEx, obviously that's a nice uptick there and obviously you haven't necessarily decided when you're finally cased, but how do you think about just the clarity that you have on that spend, right? When you think about having visibility tied to specific projects that are likely to be approved or what have you, I just want to understand the level of confidence that there is in this CapEx in Missouri. Obviously you're putting a lot more in there. Just wanna understand what are the key parameters, what are the key inputs that you're thinking about in saying, look, we've got confidence in the totality of this, right? What pieces aren't necessarily approved perhaps?
Michael Moehn: Well, look, I think one of the things you could look at, Julien, is every year at this time, we make a filing in Missouri where we're very transparent and lay out what our planned capital expenditures are, how we're justifying those, thinking about those, where they plan to go and so you'll see that actually today coming from Ameren, Missouri. It happens every year at the same time and then it's subject to public discussion about the plans and where they're going. I would say this, as you look at Missouri, it's really, as I said earlier, it's really to align our investment with the things that were in our IRP last fall. So, we do plan to invest in an 800 megawatt simple cycle plant. We do plan to continue to invest in our dispatchable resources, which is both our coal-fired energy centers to get them through to their retirement, making sure that they're reliable and efficient, making sure that we continue to invest in our nuclear facilities. So we've got a lot of dispatchable resources there. And then as it related to the IRP, also we had planned investments in renewables in some over this five-year period and in battery storage as well and so those are included in the plan. As I mentioned earlier, with respect to renewables, we got a positive order out of the commission on a couple of CCNs last year. We've got four that are pending right now that we believe will be filing a stipulated settlement here in the short term. And we would look to commission approval, but those would be subject to commission approval. And then we've got other planned investments in renewables, again, in accordance with that IRP. And then with respect to the remainder of the spend, it really has to do with continued investment in our distribution infrastructure. I think our customers are seeing a lot of benefits today, as I mentioned in our prepared remarks, especially when we have severe weather events. We're seeing the infrastructure investments that we are making, which are stronger, thicker, taller poles, smart automation, distribution automation, our system, new substations. We're really seeing the benefit of that in terms of reduced frequency of outage. I mentioned earlier, the hit top quartile in terms of safety measures or frequency of outages here. So seeing a lot of benefits from that, but, we've only really been at that since 2018, and there's a tremendous amount of investment still to be made, really decades of investment still to be made in terms of not only replacing aging infrastructure, but really modernizing that infrastructure to make sure that the kind of benefits that we're seeing in terms of reduced frequency and duration of outages across our service territory in Missouri. So again, all of that is subject to further planning and etcetera, but I think, again, I'd point you to today's filing in Missouri, which really lays out all the specifics in terms of the plans we had to invest and the justification. With that, I'll stop.
Operator: Thank you. Mr. Lyons, I would now like to turn the floor back over to you for closing comments.
Marty Lyons: Yeah, well, thank you. And I wanna thank everybody for their participation today, their questions. We thank you for your investment, your confidence in our Ameren team. We're going to work to build on the best we have of delivering reliable, safe and affordable energy for our customers and communities across both Missouri and Illinois. So look, everybody, be safe and we look forward to seeing many of you at conferences over the next few weeks.
Operator: Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day. | [
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"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modelling for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
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"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4."
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"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us today. Beginning on Page four, our strategic plan highlights our steadfast commitment to providing safe and reliable energy in a sustainable manner. We do this by investing in rate-regulated infrastructure, enhancing regulatory frameworks and advocating for responsible energy policies, while optimizing operating performance through ongoing continuous improvement in order to keep rates affordable. Our strong 2023 operating and financial results, which we will cover today, reflect execution on our key business objectives for the year, which will continue to create value for our customers, communities, shareholders and the environment in the years ahead. I'd like to express appreciation for my Ameren coworkers' unwavering commitment to our strategy. Turning to Page five, this page summarizes our strong sustainability value proposition. Our operations and investments in 2023 made the energy grid safer, smarter, cleaner, more reliable and resilient, supporting thousands of jobs in our local communities in Missouri and Illinois, and driving a positive impact on the economies of each state. In the process, we helped hundreds of local, small and diverse businesses grow, and we gave back to numerous charitable organizations to help our neighbors in need. For example, last year, almost 60% of our total sourceable spend was with suppliers in our Missouri and Illinois communities, while 26% was with local small and diverse suppliers, creating jobs and economic growth and contributing to thriving communities in the areas where we operate. The positive impact of our investments was reinforced by our top quartile reliability performance in 2023, as measured by the frequency of outages. At the same time, our Ameren supplied residential customer rates, on average, were below the Midwest average. Today, we published our updated sustainability investor presentation called, Leading the Way to a Sustainable Energy Future, available at amereninvestors.com. I encourage you to take some time to read more about our strong sustainability value proposition. Turning to Page six. When I reflect on the business objectives we laid out at the start of 2023, I am pleased to say that we made some great strides in each of our three strategic pillars. That said, we did not achieve the results expected in our Illinois gas and electric regulatory proceedings. On Page seven, we lay out our key strategic accomplishments for 2023 in more detail. This past year, we invested $3.6 billion in infrastructure, spread strategically across our business segments, in order to improve service for our customers. These investments are needed to reduce the frequency and duration of outages in the face of volatile weather events, such as this past summer, when we experienced the most impactful storms in the last 10 years. Ameren, Illinois' work in restoring power to nearly 200,000 customers in the wake of the June 29, 2023 derecho was recognized with an Emergency Response Award by the Edison Electric Institute at its recent Winter Membership Meeting and there's plenty more work to be done to address aging infrastructure and make the grid stronger and smarter, while supporting the clean energy transition, making it truly an exciting time to be in the utility industry. Of course, every utility's ability to invest must be supported by constructive regulation, which brings me back to our regulatory developments in the fourth quarter. The State of Illinois has ambitious energy transition goals, goals which we continue to work collaboratively with stakeholders to support. Of course, achieving these goals will require significant sustained investment in the state's energy infrastructure in the coming decades. In 2023, Ameren, Illinois filed plans with the Illinois Commerce Commission, or ICC, to incorporate proposed investments in critical electric and natural gas infrastructure into prospective rates. Unfortunately, the ICC decisions in both the electric and natural gas rate reviews late last year were disappointing, reducing cash flows available for investment and delaying needed investments in energy infrastructure. We will continue working with stakeholders on a path forward to approval of an electric grid investment plan, revised revenue requirements incorporating ongoing and prospective investments, and an improved overall regulatory environment. We must work to build a stronger understanding that consistent, constructive regulatory environments are required to attract investment, support energy infrastructure development, economic expansion and jobs. Michael will cover the electric multiyear rate plan and the natural gas orders in more detail in a moment. Moving to Ameren, Missouri; in November, Ameren, Missouri filed a petition with the Missouri PSC, seeking approval to securitize the unrecovered investment in and costs associated with the planned fall 2024 retirement of our Rush Island Energy Center. The securitization is expected to result in significant savings for our customers when compared with cost recovery under traditional rate making. We, of course, recognize the importance of keeping our customers' bills as low as possible, while investing to improve service, which leads me to the third pillar of our strategy, optimizing operating performance. In 2023, our operations and maintenance expenses declined by 4% year-over-year. We automated and streamlined many of our finance, supply chain and customer service and workforce processes and we continue to drive new efficiencies in our field work through deployment of smart meters, work management systems and distribution automation. Notably, our Missouri customer rates have only increased 1.8% compounded annually since the smart energy plan legislation took effect in April 2017, with our Missouri residential customer rates consistently remaining 25% or more below the Midwest average. For our shareholders, yesterday we announced 2023 earnings of $4.38 per share compared to earnings of $4.14 per share in 2022. The result was above the midpoint of our original earnings per share guidance range of $4.35 per share. On a weather normalized basis, 2023 earnings results represent a 10% increase year-over-year. Turning to Page eight; here, you can see we have delivered consistent superior value to our shareholders for the past decade. Since 2013, our weather normalized core earnings per share have risen at an approximate 7.8% compound annual growth rate, while our annual dividends paid per share have increased approximately 58% over the same time period. This drove a strong total return of 173% for our shareholders from 2013 to 2023, which was significantly above our utility peer average. This track record of strong and consistent performance gives me conviction regarding our business strategy and rest assured, we are not looking back. We are focused on the objectives ahead. Moving to Page nine; we turn our focus to the current year. We expect 2024 to be another busy year and it hit the ground running. Notably, we will maintain our focus on strategic infrastructure investment for the benefit of our customers, while working hard to reduce operating costs and improve the regulatory environments in which we operate. We expect to invest approximately $4.4 billion in electric, natural gas and transmission infrastructure to bolster safety, security, reliability, resiliency and further the clean energy transition in a responsible fashion. This represents an increase of 22% from the prior year. Our plan includes approximately $1 billion of investment in new generation this year with new solar facilities expected to be in service by year end. The investment plans are aligned with our regulatory outcomes and expectations associated with each of our business segments. We also have several opportunities to enhance our regulatory and legislative environments in the year ahead. Next week, Ameren, Illinois will file a hearing testimony requesting to update 2024 through 2027 rates for 2023 yearend rate base and a base level of grid reliability investments. Then in March, Ameren, Illinois will file its revised multi-year grid plan with the ICC to address the commission's findings stated in their December order. An updated rate plan will also be filed to incorporate revised investment plans. Concurrently, we are evaluating all appropriate options to better align prospective regulatory outcomes with the goal of making progress on a reliable clean energy transition in an affordable fashion. We will work with all impacted stakeholders to advocate for constructive regulatory frameworks across our Illinois businesses, which will better support the state's energy transition goals. At Ameren, Missouri, we'd look to obtain approval to securitize the Russia Island energy center and advocate for Certificates of Convenience and Necessity or CCNs for future renewable and dispatchable generation, consistent with the integrated resource plan filed in September. The plan calls for investment in new dispatchable energy resources, including an on-demand 800 megawatt gas simple cycle energy center by 2027, which could be turned on as needed in a matter of minutes to ensure reliability of the energy grid during periods of peak energy demand. In January, we filed a request for the air permit for this simple cycle plant, Castle Bluff Energy Center to be located on the site of our retired Merrimack Energy Center. Utilizing this site, will keep construction costs down, bring back jobs and provide additional tax revenue for the surrounding region. We expect to file for CCN approval with the Missouri PSE later this year. We will also continue to support the analysis and approval of potential MISO tranche 2 transmission projects that will serve the needs of the Midwest region, improving the grid's ability to integrate renewable resources efficiently and effectively. Given the importance of dispatchable generation to reliability, we are advocating for improved Missouri regulatory treatment for generation investments, akin to the treatment afforded other investments in electric infrastructure in the state. Further on the legislative front in both Missouri and Illinois, we are advocating for Right of First Refusal -- Right of First Refusal Legislation to support the timely construction of transmission resources needed for system reliability and efficiency and to maximize customer benefits. Shifting our focus to operations, as we identify ways to continuously improve our business, we're focused on maintaining disciplined cost management to hold operations and maintenance expenses flat in 2024 to 2023 levels. Moving now to Page 10; yesterday afternoon, we announced that we expect our 2024 earnings to be in a range of $4.52 to $4.72 per share. Based on the midpoint of this range, this represents 6.2% earnings per share growth compared to the midpoint of our original 2023 guidance range of $4.35 per share. Michael will provide you with more details on our 2024 guidance a bit later. We expect to deliver 6% to 8% compound annual earnings per share growth from 2024 through 2028, using the midpoint of our 2024 guidance of $4.62 per share as the base. At this time, we expect earnings growth to trend below the midpoint of our range until the outlook in Illinois improves or the impacts of other growth opportunities are realized. That being said, we continue to have an outstanding portfolio of investment opportunities across our business segments, totalling more than $55 billion over the next 10 years and a strong balance sheet, which provide us potential earnings growth levers that warrant maintaining a guidance range with up to 8% growth. Our dividend is another important element of our strong total shareholder return proposition. Earlier this month, Ameren's board of directors approved a quarterly dividend increase of 6.3%, resulting in an annual dividend rate of $2.68 per share. This represents the 11th consecutive year that we have raised the dividend and reflects confidence by Ameren's board of directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect Ameren's future dividend growth to be in line with our long-term earnings per share growth expectations and within a payout ratio range of 55% to 65%. We expect our weather normalized dividend payout ratio in 2024 to be approximately 58%. Over the last decade, we have gradually lowered our payout ratio, which provides financial flexibility, while executing our robust energy infrastructure investment plans. Turning to Page 11; the strong long-term earnings growth I just discussed is primarily the result of rate-based growth driven by investment in energy infrastructure, made strategically under constructive regulatory frameworks. Today, we are rolling forward our five-year investment plan and as you can see, we expect to grow our rate base in an 8.2% compound annual rate for 2023 through 2028. This plan represents an increase of $2.2 billion compared to the $19.7 billion five-year plan for 2023 through 2027 that we laid out last February. The plan includes investment in renewables and simple cycle gas generation consistent with Ameren Missouri's integrated resource plan and because of the ICC's orders late last year, our capital plan for Ameren Illinois investments has been reduced by approximately $400 million from 2024 through 2027 compared to our prior five-year plan. We expect that this level of investment, which we expect will provide safe and adequate service as well as meet compliance requirements under the Climate and Equitable Jobs Act will ultimately be approved by the ICC. That said, we continue to believe that a higher level of investment supported by a more constructive return on capital investment would be in the best interest of our customers and communities and we will continue our advocacy. Finally, we remain focused on keeping customer bills as low as possible and improving earned returns in all of our businesses. Moving to Page 12; as we look to the future, our five-year plan is not only focused on delivering strong results through 2028, but it's also designed to position Ameren for success over the next decade and beyond. The right side of this page shows how our allocation of capital is expected to change over the next five years. Incorporating generation investment opportunities from our latest IRP, we expect our 2028 rate base to reflect our diversified approach for maintaining reliability with renewable generation and dispatchable generation representing 12% and 11% of rate base, respectively. Notably, our coal-fired generation is expected to be just 3% of rate base by the end of 2028. The bottom line is that we are taking steps today across the board to position Ameren to provide safe, reliable, affordable and cleaner energy for the long-term. Moving now to Page 13; our investment plan released today incorporated our intentions to invest over time in significant renewable and dispatchable resources as laid out in our Ameren, Missouri IRP. In 2023, we were pleased that Missouri PSC approved CCNs for the Huck Finn and Boomtown solar projects, and in doing so, indicated support for our responsible gradual transition and I'm happy to announce that we reached a stipulation and agreement regarding our next four solar projects, totalling 550 megawatts. These projects will support our lease cost plan for meeting customers' energy needs as we systematically invest to create a diverse mix of generation resources that preserves reliability as we retire our existing coal fleet over the next 20 years. While the Missouri PSC is under no deadline to issue an order on these four project CCNs, we expect a decision in March with these projects expected to go in service between 2024 and 2026. We expect to file additional CCNs consistent with the IRP later this year. Moving to Slide 14; as we've discussed in the past, MISO completed a study outlining a proposed roadmap of transmission projects through 2039. Detailed project planning, design work and procurement for the Tranche 1 projects assigned or awarded to Ameren is underway, and we expect construction to begin in 2026. During 2023, Ameren was awarded the first two competitive Tranche 1 projects, totalling approximately $100 million. Ameren submitted the third and final Tranche 1 competitive bid in October and expects the project to be awarded by June 2024. When awarding the competitive projects to Ameren, MISO noted our sound route design, engineering and cost containment plan, and innovative approach working with stakeholders as key factors in the winning bids. This is indicative of how we plan and develop all transmission projects. We believe our collaborative, customer-centric and community-respectful approach to building and maintaining low-cost projects is why we should be directly assigned these projects in the future in both Missouri and Illinois. MISO expects to approve a set of Tranche 2 long-range transmission projects in the first half of 2024, which will again address Midwest region needs. Turning now to Page 15; looking ahead over the next decade, we have a robust pipeline of investment opportunities of over $55 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investment opportunities will also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Moving to Page 16; discipline cost management and a focus on customer affordability is nothing new to us here at Ameren and we expect 2024 to be another year of disciplined cost control and value realization from continuous improvement initiatives, which Michael will provide more details on in a few minutes. Through innovation and new efficiencies, we continue to target flat operations and maintenance expenses through 2028. Moving to Page 17; to sum up our value proposition, we remain firmly convinced that the execution of our strategy in 2024 and beyond will continue to deliver superior value to our customers, shareholders and the environment. We believe our expectation of 6% to 8% compound annual earnings growth from 2024 through 2028, is driven by strong rate-based growth and supported by a strong balance sheet, compares favourably with our regulated utility peers. I'm confident in our ability to execute our strategy and investment plans across all four of our business segments, as we have an experienced and dedicated team with a track record of execution. Further, our shares continue to offer investors an attractive dividend, and we are positioned well for future dividend growth. Simply put, we believe this results in an attractive, total return opportunity for shareholders. Again, thank you all for joining us today, and I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to Page 19 of our presentation; yesterday, we reported 2023 earnings of $4.38 per share, compared to earnings of $4.14 per share in 2022, an increase of approximately 6%. This page summarizes key drivers impacting earnings in each segment, which are largely consistent with what we reported throughout 2023. As Marty noted, when normalized for temperature variations over the past two years, we estimate that our earnings grew 10%. Moving to Page 20, I'll cover our few key developments from the fourth quarter. In November, Ameren Missouri filed for securitization of costs associated with the Rush Island Energy Center as we approach the plan retirement date of October 15, 2024. If approved as requested, Ameren Missouri would be able to refinance and recover approximately $519 million, reflecting the remaining value of the plant and decommissioning costs. Missouri PSC orders are expected in June, 2024. To mitigate the impact of the lost rate base associated with the Rush Island retirement, we expect our Huck Finn and Boomtown solar facilities with an estimated total investment of approximately $650 million to be placed in service near the end of this year. Turning to Page 21, as Marty mentioned, late in 2023, the ICC issued orders under Ameren Illinois Natural Gas and Electric Rate Reviews. In November, the ICC approved $112 million annual base rate increase for natural gas delivery service, which included $77 million that would have otherwise been recovered under letters. The order reflects a 2024 future test year, a 9.44% allowed return on equity, a 50% common equity layer, and a rate base of $2.85 billion. New rates were effective in late November. We filed for a rehearing of this order with the ICC and were denied. So on January 03, Ameren Illinois appealed the ICC decision to the Illinois Fifth District Appellate Court, seeking that the ICC modify the return on equity and certain plant disallowances, among other things. The court is under no deadline to address this appeal. Turning to Page 22, in December, the ICC issued an order in our Ameren Illinois Electric Multi-Year Rate and Grid Plan filings. In its order, the ICC established an alternative revenue requirement based on our 2022 rate base, and is requiring us to refile and provide additional justification for our grid plan. We're in the process of revising our grid plan and we'll file it by the March 13 deadline. We will also revise our multi-year rate plan to incorporate these grid plan revisions. In the meantime, the December order reflects a cumulative increase from 2024 through 2027 of $142 million in revenues. The order approved an allowed return on equity of approximately 8.72% and a 50% equity layer. In January, Ameren Illinois filed for a rehearing of the December order with the ICC. On January 31, the ICC ordered a partial rehearing regarding certain operations and maintenance expenses, use of the 2022 rate base for establishing the revenue requirement for 2024 through 2027, and a base level of grid reliability investments. We expect a decision on these items subject to rehearing by the end of June with new interim rates expected to be effective at the discretion of the commission. Following the ICC's response to our rehearing request, Ameren Illinois also filed an appeal to the Illinois Fifth District Appellate Court on January 31, to address the remaining items which were denied for rehearing, including the return on equity. The court is under no deadline to address this appeal. We remain focused on providing safe and adequate service for our Illinois customers. Moving to Page 23; our overall outlook remains bright as we have a robust pipeline of investment opportunities. Our Ameren Transmission Missouri business lenders continue to benefit from meaningful ongoing investments to work by reliable, constructive regulation. Here we provide an overview of our $21.9 billion of planned capital expenditures for 2024 through 2028 by business segment that supports our consolidated 8.2% compound annual rate-based growth expectations. As you can see on the right side of this page, we're allocating capital consistent with the allowed return on equity under each regulatory framework. Our Ameren Missouri Smart Energy Plan filed today with the Missouri PSC provides more detail on how we strategically invest to replace aging infrastructure with more resilient, reliable equipment to serve our customers. After five years of Smart Energy Plan investments, we are a full year ahead of our initially planned smart meter installation in the state. That said, at our current investment levels, we still have decades of investment needed to address aging distribution substations and overhead and underground lines. You can find additional details on the Smart Energy Plan allocation of our 2024 planned capital investments on Page 32 and Page 33 in the appendix of this presentation. Turning to Page 24, we have outlined here the expected funding sources for the infrastructure investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. We also expect to generate significant tax deferrals driven primarily by the timing difference between financial statement, depreciation reflected in customer rates and the accelerated depreciation for tax purposes. As we sit here today, we do not expect a transferability of solar and wind tax credits materially impact capital funding, nor do we expect the corporate minimum tax to apply during our five-year plan. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. For us to maintain a strong balance sheet while we fund a robust infrastructure investment plan, we have entered into forward sales agreements for $230 million of common stock issuances under our at-the-market equity distribution program to address most of our 2024 equity needs. We expect to sell these by the end of the year. The only additional equity we expect to issue in 2024 will be approximately $70 million for our dividend reinvestment and employee benefit plans. Incremental equity issues of approximately $600 million each year are planned for 2025 through 2028, a portion of which we expect to be issued through our DRIP and employee benefit plans. The $600 million per year is unchanged from our previous plan outline last February. All of these actions are expected to sustain our strong balance sheet and credit ratings. Moving to Page 25 of our presentation, I would now like to discuss key drivers impacting our 2024 earnings guidance. We expect 2024 diluted earnings per share in the range of $4.52 per share to $4.72 per share. This accommodates a range of outcomes on our ongoing Illinois regular proceedings, along with our typical business risk and opportunities. Detailed by segment as compared to the 2023 results can be found on this page and the next. Beginning with Ameren Missouri, earnings are expected to rise in 2024. Earnings are expected to be favourably impacted by the higher investments in infrastructure that are eligible for PISA and AFDC treatment, as well as new electric service rates effective July 2023. Earnings are also expected to benefit from higher weather normalized kilowatt hour sales to Missouri residential and commercial customers, which are expected to increase by 1% year-over-year in 2024, while sales to industrial customers are expected to increase by 4% year-over-year. These projected increases are driven primarily by customer count growth and General Motors resuming full production levels after a work stoppage in the third quarter of 2023. We also expect to benefit from lower operations and maintenance expenses. And we expect a return to normal weather in 2024 will increase Ameren Missouri earnings by approximately $0.03 compared to 2023 results. These favourable factors are expected to be partially offset by higher interest expense, primarily due to higher long-term debt balances. Moving on, earnings from our FERC regulated electric transmission activities are expected to benefit from additional investments in Ameren, Illinois and ATXI projects made under forward-looking formula rate making. Turning to Page 26; for Ameren Illinois electric distribution, the year-over-year earnings comparison will be impacted by the lower allowed ROE approved by the ICC in the multi-year rate plan versus the 2023 allowed ROE, which was driven by the 30-year treasury rates plus 580 basis points. The allowed ROE is applied to yearend rate base, which includes 2023 rate base and 2024 plan capital additions. For Ameren, Illinois natural gas, earnings will benefit from higher delivery service rates effective November, 2023, incorporating additional infrastructure investments, partially offset by a lower allowed ROE and common equity ratio. Earnings will also benefit from lower operations and maintenance expenses. Moving now to Ameren wide drivers and assumptions; we expect increased weighted average common shares outstanding to unfavorably impact earnings per share. We expect higher interest rate expense in Ameren parent due to increased debt balances. At the end of 2023, we turned out all then outstanding commercial paper balances at Ameren parent through two debt offerings. The first issued in November was $600 million and 5.7% senior unsecured notes due in 2026 and the second in December was $700 million of 5% senior unsecured notes due in 2029. Of course, in 2024, we'll seek to manage all of our businesses to earn as close to our allowed returns as possible. With that in mind, and support our expectation for lower operations and maintenance expenses in our Ameren Missouri and Illinois natural gas businesses, we've instituted several cost saving initiatives in 2024, including a hiring freeze, reducing our contractor and consultant workforce and deferring or eliminating discretionary spend. We'll be strategic about workforce management and continued investment in digital efficiency to allow us to sustain these cost reductions. Before moving on, I'd like to touch on the expected sales growth for our service territory. While we're conservative on our model and we are optimistic about the opportunity for strong economic development in the years ahead. in the last three years, our economic development teams have helped to bring 65 new projects to our communities in Missouri and over 125 projects in Illinois, bringing with an estimated total of over 14,000 jobs. These projects are generally expected to be completed in the next couple of years. With that in mind, we expect weather normalized kilowatt hour sales to be in the range of flat to up approximately 0.5%, compounded annually over a five-year plan, excluding the effects of our new energy efficiency plans, using 2023 as the base year. We exclude the effects because the plan provides rate recovery to ensure that earnings are not affected by reduced electric sales, resulting from our energy efficiency efforts. Turning to Illinois, we expect our weather normalized kilowatt hour sales to be relatively flat to down 0.5% over our five-year plan, driven primarily by increases in energy efficiency and solar adoption. Recall that changes in Illinois electric sales, no matter the cause, do not affect earnings since we have full revenue decoupling. Finally, moving to Page 27, I'll emphasize again that we have a strong team and a long track record of execution. We delivered strong earnings growth in 2023 and expect to continue to deliver 6% to 8% compound earnings per share growth over the next five years, driven by robust rate-based growth and disciplined cost management. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continued to offer investors an attractive dividend. In total, we have an attractive total share of return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "[Operator instructions] Our first question comes from a line of Shahriar Pourreza with Guggenheim. Please proceed with your question."
},
{
"speaker": "Shahriar Pourreza",
"text": "Marty, obviously you've throttled back Illinois electric spend here pretty significantly versus the prior plan, which I think is completely expected just coming off those ICC orders. Can you just speak a little bit more to what you've actually embedded in that 2.3% five-year CAGR as it relates to the grid plan? I guess put differently, could we see that tick higher later this year once the plan is approved? Or is the embedded base case there still subject to some upside and downside scenarios? Thanks."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, I'll let Michael comment on that further, but I would say, Shahriar, you're right. What we've done here is we've baked in what we believe to be a prudent level of capital expenditures, given the overall outcomes that we had in Illinois. As we said in our prepared remarks, we do believe that this is an appropriate amount to continue to provide safe and adequate service to our customers and meet the requirements of CEJA And that's what's been baked in. I just repeat what I said earlier, which is that we do believe a higher amount of investment over time is originally proposed last year is prudent and appropriate for our customers to provide the kind of service that they expect to really further the state's energy goals and policy goals. But again, what we've modelled in here is what we do believe would be a level that would be expected to be approved by the commission over time through the rehearing process, as well as through our upcoming grid plan filing and rate plan. So again, we do expect that this level of investment is something that will ultimately be reflected in those outcomes, but with that, in terms of further clarity on the CapEx, Michael, any comment?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah, maybe just a couple of finer points. Good morning, Shahriar. I think Marty said it well. As we think about the capital plan that we've allocated there, again, Marty's correct. We're absolutely focused on providing safe and reliable service. I think we're being conservative in how we think about this. There's this 105% revenue requirement cap that we need to stay underneath and as you know, and I think there was some discussion about this, the commission's order pointed to '22 rate base. I think it was really more of a function of, because that was really the only year and rate base to point to. We definitely have the ability to, I think we'll recover our '23 expenditures, it's really under another formula rate. As they do that and they update and we're seeking some of those clarification, that obviously would give you more headroom under that 105% revenue cap. I think we took a conservative approach saying, let's make sure whatever we spend in '24, we stay under pointing back to the '22. So my point is you have a lot more flexibility going forward. I think to Marty's point, we'll have to step back and then decide, given the 8.72%, how do you feel about allocating more capital there? But as we continue to see improvement here, there's obviously would be those opportunities."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. Perfect and Marty, just, thanks Michael. Marty, just on Tranche 1, is it versus Tranche 2, is it still your expectation Tranche 2 will exceed Tranche 1? And then just on Tranche 2 estimates, are they embedded in that $55 billion pipeline number? Could any of the awards fall within this kind of five-year cycle you've got out there? Thanks guys."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, good questions, Shahriar. So with respect to Tranche 2, we do expect it, continue to expect it, to be considerably larger than the Tranche 1 investments and, MISO, as we said in our prepared remarks, is still saying that they expect to have those approved by the middle of this year. We'll see how that comes to fruition, but we do expect that in the first half, we'll at minimum start to get some clarity on, what some of those projects might look like. But again, Shahriar, to your point, significantly larger. Now, with respect to our plans that we've laid out, within the five-year plan, nothing is baked in for Tranche 2 investments. However, in the $55 billion, we do have, some amount in there for potential Tranche 2 investments. So, within the $55 billion, yes, certainly we do have some."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Nicholas Campanella with Barclays. Please proceed with your question."
},
{
"speaker": "Nicholas Campanella",
"text": "Appreciate the guidance update and just the comment that you're kind of below the midpoint of the 6% to 8% range. Can you just kind of expand on, what we should be watching for that kind of gets you back to that midpoint and I'm taking into account the comments around, it seems that some of this transmission spending has been reflected in the plan, correct me if I'm wrong and then you're also just kind of assuming, CapEx for the Illinois distribution segment as proposed is approved as well. Just what should we be looking for to get you back into that midpoint? Thanks."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, Nick, maybe we'll take that in two part. I'll actually turn it over to Michael first to maybe provide a little bit more clarity on our thinking around the growth and then I'll provide some color on some of the upsides in our plan."
},
{
"speaker": "Michael Moehn",
"text": "Yeah, good morning, Nick. Just to put a little finer point on the midpoint, I think as Marty said in his comments, expect to be a little below that midpoint and if you think about historically where we have been, just sort of the highest level, you go back to, February of last year, we had 8.4% rate-based growth and over that period of time, we were issuing roughly about 2% worth of dilution, say over the five-year plan. So it got you down to call it, 6.4%, 6.5% something like that. And then we've done a nice job of continuing to close the allowed versus earned gaps, continuous improvement. There's been a number of opportunities being really thoughtful about allocating capital to the places that are giving us the highest return and you can see it, obviously, historically we were trending above that 7% midpoint and we kind of think about where we are today, we got this 8.2% rate-based growth, really kind of the same dilution math. So with all things, we need to kind of put you at that 6.2% and then there's obviously still improvement opportunities as we continue to look forward and I think as we think about a midpoint, it's someplace between that 6.5% to 7% today. So let's call it 6.7%, just to put a little finer point on. So 6.7% versus sort of 7%, where I think we kind of pointed people historically and again, we've had opportunities to do better than that and Marty will talk about where I think, the future still lies for us. You'd think about the $55 billion, the capital projects that we have there. There's opportunities to continue to be thoughtful about the transmission that we just talked about a second ago and so those are the things that will provide us those opportunities. So hopefully that gives you a little more clarity on the math and I'll let Marty talk a little larger picture."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, I think, Michael started to touch on it a little bit. In terms of, the upsides, as I said in the prepared remarks, we certainly see good justification for keeping that 6% up to 8% growth and really what it reflects is that strong pipeline of investments that we have. We start there, $55 billion of potential investments over the next 10 years. We have baked into the five-year plan, the Tranche 1 investments that we've been assigned to us or that we've won, but we also have competitive proposal out there right now for another Tranche 1 project, which hasn't been baked in and that provides us some upside. We've talked about just a second ago, some of the Tranche 2 projects. We've got further investments to be made with respect to Missouri as it relates to the IRP. We've got some of those, certainly baked in today. As I mentioned, we had a very strong balance sheet and opportunities, as Michael just said, to continue to close the gap between our allowed and earned returns, which provides upside. And then of course, as we look ahead in Illinois, a couple of things, first, you know, the current multi-year grid plan or rate plan ends in 2027. And so as we look out even to 2028, there's opportunities to think about that differently and what our approach will be in 2028 and then I go back to maybe the most important thing, which is in the interim to really work to improve the Illinois situation and perhaps provide an opportunity for greater investment in Illinois. So, there, as we said in the call, we're gonna continue and engage in a dialogue with all stakeholders about the benefits of investment, risks of disinvestment, and our goal of really aligning our investments with the policy goals of the state around reliability, affordability, the clean energy transition and of course, we all know that our investments drive, not only improvements in critical energy infrastructure, but jobs and economics expansion. So, look, we've got to just continue to show financial discipline in the short term, but in the longer term, make sure we create this dialogue that having consistent constructive regulation, having strong investment in infrastructure in the state is going to benefit, our customers, their communities, the economy, the state and continue to work to make Illinois a place that attracts greater investment."
},
{
"speaker": "Nicholas Campanella",
"text": "All right, thank you very much for that. And then I guess just on the O&M, I think in your prepared remarks, or even on slides here, 4% first last year, and then you're doing more O&M, just looking through the EPS slides, you have positives for Missouri and Illinois. So just, is 4% of the magnitude of decrease that we should expect to continue through '24? Can you maybe give us any type of way to frame that? And then how are you kind of thinking about just recapture of that, or timing of the next rate cases in Missouri, if you can maybe expand?"
},
{
"speaker": "Michael Moehn",
"text": "Good morning again, Nicholas. This is Michael, let me take this, and Marty can certainly add in, and we've talked about this, obviously, over time. Customer affordability is not something that is new to us. I think we've been really focused as a company on it for a number of years, and really up and down the P&L and we've talked about this, we, I think, do a great job of kind of going in and continuing to benchmark ourselves, all of the different areas of our business. And some are really good, some have opportunities, and we continue to close the gap in those opportunities and I think, Marty pointed to the 4%. It was, obviously people are very focused on it. We've talked about flat O&M over the five-year period is a good way to think about it, but the bottom line is there are a number of levers that we're able to pull here. I think as we think about '24 specifically, I mentioned in my opening remarks, I think we're taking just another view here. We're looking at headcount, I talked about headcount, hiring freeze at the moment, being very thoughtful about just contingent workforce, consultant dollars, any sort of discretionary spend. I think all the right things to do just in this elevated rate environment anyway for customers, and so that's really the focus there. But we're also being very thoughtful and strategic about, as you mentioned, just rate reviews, etcetera and being thoughtful about investments on the digital side too, just to make sure we make these costs sustainable. That's really what we want to do. I think we've talked about, we've had an increased investment in the digital platform over the last several years after we got PISA passed, and it's allowed us to replace our work management systems, our back office accounting systems. We continue to put a great deal of distribution automation, etcetera, on the system and all of these things are productivity improvements over time, which just give us a lot of confidence. This is a lever that we can continue to pull. So, Marty, anything to add there?"
},
{
"speaker": "Marty Lyons",
"text": "No, nothing to add there. Thanks for the question."
},
{
"speaker": "Nicholas Campanella",
"text": "And I'm sorry, just to follow up on that, are you planning to file a Missouri rate case in the next year, or is that more than a year out?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah, that's not something we've decided yet and look, if you look back over time, it's been every 18 months to 24 months we've filed a case, but haven't stated when we're going to plan to file the next one. So we'll be thoughtful about that. Look, we always try to go as long as we can between rate cases, and we'll continue to take that approach, but be thoughtful about when major capital additions go in and the like to think about the timing of our cases."
},
{
"speaker": "Nicholas Campanella",
"text": "All right, thanks for taking my questions. Have a good day."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Thanks for all the detail today, and just wanted to kind of follow up on some of the points that you've talked about before and just regarding your capital reallocation, how should we be thinking about Missouri bill impact over time from the higher CapEx, just any thoughts there. And then also as we think about deploying that capital, the timing for receiving approvals and permits with additional transmission investments, broadly speaking on that side, if you could provide some more color there would be helpful."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, a lot there, Jeremy. I think number one, in terms of bill impacts, we're going to work through time as we have to keep the bill impacts as manageable as possible. I think, we had a pretty good track record in Missouri since we got a more constructive regulation, legislation back in 2018, and it really kept the growth in bills really below the level of inflation and so we're going to look to continue to, as Michael stated a minute ago, pretty comprehensively, take a lot of actions across the board to really manage our operating costs. And really, to the extent that we have rate increase requests, really make those about the capital additions that are going in that are producing greater reliability, for our customers, etcetera, where they're seeing the benefits. So, we're going to continue to work to keep our belt tight and as I said, overall, look to keep our operating costs flat over the next several years and as Michael said, create as many productivity improvements as we can. So that's our goal. Now, with respect to these projects, I would say when you look at our capital expenditure plans over the next five years for Missouri, I would say a need, they really relate on the left side of the graph on Page 23 to things that were included in our integrated resource plan. So, there the integrated resource plan had called for 2,800 megawatts of renewables by 2030. This is a piece of that as we move ahead with renewables, over half of what we've got there in that capital spend of $3.3 billion is related to two CCNs that have already been approved and then there's four CCNs that are pending right now and we expect to be able to file a stipulated settlement on those in the near term and so those are proceeding well. And then, with respect to the dispatchable generation, part of this is the simple cycle gas plant that we plan to put in service over the next five years and then part of this is continuing to invest in the dispatchable energy resources that we have in the state, but we will, as we said on our call, we've begun to do work around this 800 megawatt simple cycle gas plant and we will consider when to file a CCN for that. So, those are some timelines in terms of some of the investments we've got. Michael, any color to add?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah, Marty did a great job there, Jeremy. I think the only thing that I'd probably add there is if you think about the $13 billion that we're allocating to Missouri, about 25% of its renewables and obviously an important factor is just the PTC, ITC that's being, given off with respect to those projects. So you think about the impact for customers, ultimately, there is a really big benefit there and so it's just something to keep in mind. I agree with everything else Marty said. We continue to be focused to all the comments I made before. It's not something new that we're doing here. Sometimes you can get a little lumpy impact in Missouri just because of the timing and the rate reviews, but the team really is focused on trying to keep these bills as low as possible."
},
{
"speaker": "Jeremy Tonet",
"text": "And maybe just shifting towards Illinois and from where you sit, just wondering your perspective and what you see happening with regards to potential legislative or legal responses to the Illinois orders there in the state house. How have your conversations with stakeholders been trending here? Just any color you could share would be helpful."
},
{
"speaker": "Michael Moehn",
"text": "Yeah, I think, look, the first order of business as we look at is, as I said before, to really try to work constructively with stakeholders and right now I'd say our primary focus is a couple of things. It's number one, making the rehearing filing, which is we plan to make next Thursday. So there, the opportunity to have rehearing around incorporation of 2023 rate base, as well as baseline capital investments that we plan to make over the next five years and have those included in a rehearing. And then as we've said before, we follow that up with our grid plan update and filing in mid-March. There again, we get feedback from the commission, obviously on deficiencies that they saw within the initial filing. We're looking to address those. We're looking to work constructively with stakeholders, whether it's the staff or other parties to make our filing as strong as we can to address the commission's identified deficiencies and position ourselves for success in getting, again, both a good outcome in the rehearing, as well as getting that grid plan approved and ultimately incorporated into a revised rate plan. So, I think those are where really our focuses are in the short term. Like I said, in the longer term, we'd like to see a more constructive environment for investment, and that's going to take really engagement with all stakeholders and I think, what we found is a receptivity among stakeholders to have the conversation, to listen, and we'll figure out over time what the best path forward is to achieving the result we want, which is a more constructive environment for investment, which again, we believe is ultimately in the best interest of customers, communities and in the achievement of the state's policy goals."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Arcaro with Morgan Stanley. Please proceed with your question."
},
{
"speaker": "David Arcaro",
"text": "I wanted to, in terms of whether normal load growth, just wondering how conservative..."
},
{
"speaker": "Michael Moehn",
"text": "Hey, David, we're having a really hard time hearing you. Could you speak up a little, David?"
},
{
"speaker": "David Arcaro",
"text": "Just in terms of whether normal load growth, was wondering how conservative the outlook is that you're presenting here. Is there any possibility for acceleration either from any manufacturing activity or data center activity that you're seeing or otherwise?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah, let me start off, and then certainly Marty can add as well. I think, yeah, I tried to provide a little of this color in the opening remarks. Look, I think we do a good conservative job of kind of thinking about the load growth, but there are some really positive things happening in our service territory. Just economically, it's very strong. GDP growth is strong here and I'm really talking about kind of the greater Missouri area. Unemployments, running below the national average. We've had, if you think about even just '24 more specifically, we got the GM coming back on. They've added some additional load. There's a couple of data imaging companies that are using just a tremendous amount of energy, about 20 megawatts. These things really begin to add up and there's just a number of longer term, I think, opportunities as we think about data centers and other things from an information technology standpoint that could provide some economic growth. I think we do a good job of not really baking that in at this point. We talked about toward flat up a half percent, but I'm optimistic that, hopefully that is ends up turning out differently. So, Marty."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, I would just say that, look, we have a broad service territory and we're deeply involved in throughout Illinois and Missouri in economic development activities and our teams support economic development expansion across both service territories. I would say this though, in the greater St. Louis region, both in the Illinois side and the Missouri side, I'm more excited than I've been in years with respect to, I would say, the collaborative approach to really going after economic development efforts and really thinking about, how we drive inclusive economic growth, economic development and compete for projects. And I've never seen the community as unified and speaking with one voice and going after these things. We're seeing some wins, some wins that'll produce, I think, economic expansion two and three years out, some positive announcements, as Michael said. But, and I hope we are being conservative with respect to our growth projections. That said, as we see growth, we often see also, continued efforts on energy efficiency, both the energy efficiency we promote, but also just kind of energy efficiency in general and so try to be realistic about our growth expectations of those efforts."
},
{
"speaker": "David Arcaro",
"text": "And then was just curious, what level of FFO to debt you're seeing over the plan? Wondering to the extent you realize some of the CapEx upside opportunities, how that could impact the equity needs going forward?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah, perfect. So, again, we haven't really given targets in the past. I think what we've talked about is, look, we like our ratings where they are, BAA1, BBB+, that downgrade threshold S&P is 13. 17 at Moody's. We've trended obviously closer to that 17%. Again, as I outlined in my opening remarks, we feel good about our balance sheet. I think we come into this from a position of strength as I look out over the five years, the equity needs that I outlined certainly support, I believe actually maintaining that BAA1 and so maintaining something over that 17%, over that five year period. And so, and again, I try to be clear on what we did from an equity standpoint, for 2024, we're assuming $300 million of equity. We've done about $230 million under our ATM program today. Really the remaining balance that we need to do is related to our DRIP 401k. And then for all the other years, it's really consistent with where we had been before. So basically $600 million and again, I think supports those credit ratings that I just spoke about."
},
{
"speaker": "Operator",
"text": "Our next question comes from line of Durgesh Chopra with Evercore. Please receive your question."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey guys, thanks for giving me time. I know it's close to the hour. Just Michael, on the point about equity, maybe you could just expand on this. So the CapEx plan is up, the five year CapEx plan is up close to 10%, a little over 10%, but the equity is kind of the same. Are you kind of modelling now lesser question versus the downgrade thresholds or are there other cash flow improvements that you might be missing?"
},
{
"speaker": "Michael Moehn",
"text": "Yeah, I don't know if there's other cash flow improvements. Again, I think we're always been conservative as we think about the balance sheet and so, again, I feel good about what I just said, David, in terms of how we're thinking about the FFO to debt over time and being above that downgrade threshold at 17%. We continue to obviously work with the rating agencies. We'll be in talking to them again in the spring and so, I guess I don't have any reason to feel concerned about it at this point and again, I think it's the right thing to do. We added the capital and still feel good about the levels that we're at given the equity that we're issuing."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. And then maybe just a couple of clarifying questions and this will be quick, hopefully, but in the current five year CapEx plan, the four solar projects that you have settlement for in Missouri, those are included in the plan. Confirm that for us and then the upside would be the Missouri IRP results and then any transmission project awards from the MISO planning. Am I thinking about it correctly?"
},
{
"speaker": "Marty Lyons",
"text": "Well, I think, first of all, yes. The projects that we've already had CCNs for, as well as the subject to the stipulation are included in the five-year CapEx that's shown on Slide 23 and in fact, some additional CapEx as well for renewable projects that we anticipate to come into service by the end of 2028. And then the second part of your question was?"
},
{
"speaker": "Durgesh Chopra",
"text": "It was just the traffic upside."
},
{
"speaker": "Marty Lyons",
"text": "No, I would think there, what we're saying is with respect to transmission, we've got the Tranche 1 projects that have been assigned to us or awarded or included in there, but what we have not included in there is any upside for a potential additional win of a transmission project that we've proposed on."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Thank you so much. I appreciate the time."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question comes from the line of Julien Dumoulin Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Hey, good morning team. Thank you guys very much for the time. I appreciate it, or squeezing me in here. Look, maybe just to kick off quickly here, just on the balance sheet, obviously you're bringing down equity slightly over the comparable period from last plan. I'm taking CapEx fairly meaningfully here. I just wanted to clarify, just where are you relative to the required metrics? Can you elaborate a little bit through the cadence of the plan, how you're thinking about the FFO to debt? Or just where are you starting and ending, if you will and then I got to follow up real quickly."
},
{
"speaker": "Michael Moehn",
"text": "Yeah, good morning, Julian. It's Michael. As I said, we have -- the downgrade threshold of Moody's is 17% and we historically haven't talked about exactly what we're targeting. But again, over this five-year plan, there is cushion over that 17%. Again, I feel good about it. We have been, I think, done a great job of sort of telegraphing what our equity needs, being very disciplined about going out and issuing that equity. I think we come into this kind of super CapEx environment with a very, very healthy balance sheet. As you know, we're not trying to get up to some level, right, where we've been at these levels and I see us staying at that level over the five-year plan."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Got it, so every year kind of over that 17% threshold, give or take. And the rating is…"
},
{
"speaker": "Michael Moehn",
"text": "Over the five-year plan, yeah. Over 17%."
},
{
"speaker": "Marty Lyons",
"text": "And again, look, as we have frequent conversations, then we'll go in again and have another conversation with them, so."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Wonderful. And just to clarify this on the Missouri CapEx, obviously that's a nice uptick there and obviously you haven't necessarily decided when you're finally cased, but how do you think about just the clarity that you have on that spend, right? When you think about having visibility tied to specific projects that are likely to be approved or what have you, I just want to understand the level of confidence that there is in this CapEx in Missouri. Obviously you're putting a lot more in there. Just wanna understand what are the key parameters, what are the key inputs that you're thinking about in saying, look, we've got confidence in the totality of this, right? What pieces aren't necessarily approved perhaps?"
},
{
"speaker": "Michael Moehn",
"text": "Well, look, I think one of the things you could look at, Julien, is every year at this time, we make a filing in Missouri where we're very transparent and lay out what our planned capital expenditures are, how we're justifying those, thinking about those, where they plan to go and so you'll see that actually today coming from Ameren, Missouri. It happens every year at the same time and then it's subject to public discussion about the plans and where they're going. I would say this, as you look at Missouri, it's really, as I said earlier, it's really to align our investment with the things that were in our IRP last fall. So, we do plan to invest in an 800 megawatt simple cycle plant. We do plan to continue to invest in our dispatchable resources, which is both our coal-fired energy centers to get them through to their retirement, making sure that they're reliable and efficient, making sure that we continue to invest in our nuclear facilities. So we've got a lot of dispatchable resources there. And then as it related to the IRP, also we had planned investments in renewables in some over this five-year period and in battery storage as well and so those are included in the plan. As I mentioned earlier, with respect to renewables, we got a positive order out of the commission on a couple of CCNs last year. We've got four that are pending right now that we believe will be filing a stipulated settlement here in the short term. And we would look to commission approval, but those would be subject to commission approval. And then we've got other planned investments in renewables, again, in accordance with that IRP. And then with respect to the remainder of the spend, it really has to do with continued investment in our distribution infrastructure. I think our customers are seeing a lot of benefits today, as I mentioned in our prepared remarks, especially when we have severe weather events. We're seeing the infrastructure investments that we are making, which are stronger, thicker, taller poles, smart automation, distribution automation, our system, new substations. We're really seeing the benefit of that in terms of reduced frequency of outage. I mentioned earlier, the hit top quartile in terms of safety measures or frequency of outages here. So seeing a lot of benefits from that, but, we've only really been at that since 2018, and there's a tremendous amount of investment still to be made, really decades of investment still to be made in terms of not only replacing aging infrastructure, but really modernizing that infrastructure to make sure that the kind of benefits that we're seeing in terms of reduced frequency and duration of outages across our service territory in Missouri. So again, all of that is subject to further planning and etcetera, but I think, again, I'd point you to today's filing in Missouri, which really lays out all the specifics in terms of the plans we had to invest and the justification. With that, I'll stop."
},
{
"speaker": "Operator",
"text": "Thank you. Mr. Lyons, I would now like to turn the floor back over to you for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Yeah, well, thank you. And I wanna thank everybody for their participation today, their questions. We thank you for your investment, your confidence in our Ameren team. We're going to work to build on the best we have of delivering reliable, safe and affordable energy for our customers and communities across both Missouri and Illinois. So look, everybody, be safe and we look forward to seeing many of you at conferences over the next few weeks."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day."
}
] | Ameren Corporation | 373,264 |
AEE | 3 | 2,023 | 2023-11-09 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4.
Marty Lyons: Thanks, Andrew. Good morning, everyone, and thank you for joining us today. We had a strong quarter, and we're excited to share an update with you on recent developments. But before I begin our quarterly update, I would like to take the opportunity to congratulate Warner Baxter, who retired as Executive Chairman on November 2. Over his 28-year career with the company, Warner has had a significant positive impact on our industry, company and community. And frankly, each of us here this morning. Under Warner's leadership, Ameren has successfully executed a strategy focused on robust energy infrastructure investments supported by constructive energy policies driving strong value for Ameren's customers, communities and shareholders. And consistent with his focus on sustainability, he leaves behind a strong team dedicated to maintaining that focus and continuously improving. Congratulations Warner, and I wish you well in your retirement. Moving now to Page 5 and our quarterly update. Our dedicated team continues to execute our strategic plan across all of our business segments, which entails investing in energy infrastructure to deliver safe, reliable, clean and affordable electric and natural gas services to our customers. Turning to Page 6. Our strategic plan integrates our strong sustainability value proposition balancing the four pillars of environmental stewardship, positive social impact, strong governance and sustainable growth. Here, we summarized some of the many things we are doing for our customers, communities, coworkers and shareholders. And today, we published our updated sustainability investor presentation called leading the way to a sustainable energy future available at amereninvestors.com. which more fully details how we have been effectively integrating our sustainability value proposition, balancing the four pillars of environmental stewardship, positive social impact, strong governance and sustainable growth. Here, we summarize some of the many things we are doing for our customers, communities, co-workers and shareholders. And today, we published our updated sustainability investor presentation called leading the way to a sustainable energy future, available at amereninvestors.com which more fully details how we have been effectively integrating our sustainability value transmission lines. Such legislation would support the timely and cost-effective construction of the MISO long-range transmission planning projects and other need to transmission investments. Unfortunately, the legislation was vetoed by the governor in August, it was not ultimately brought to a vote during the detail session. We will continue to work with key stakeholders to support this important piece of legislation in the spring legislative session. On Page 14, we look ahead to the next decade. We have a robust pipeline of investment opportunities totaling more than $48 billion that will deliver significant value to all our stakeholders by making our energy grid stronger, smarter and cleaner. The $48 billion does not reflect the incremental investment opportunities included in the recently filed Integrated Resource Plan. We will provide an updated number on our call next February, along with the new five-year capital plan. Of course, our investments create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and to transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Turning now to Page 15. In February, we updated our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings growth rate from 2023 through 2027. This earnings growth is primarily driven by strong compound annual rate base growth of 8.4%, supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all 4 of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. And I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to Page 17 of our presentation. Yesterday, we reported third quarter 2023 earnings of $1.87 per share, compared to $1.74 per share for the year ago quarter. This page summarizes key drivers impacting earnings at each segment. Under our constructive regulatory frameworks, we experienced earnings growth driven by increased investments in infrastructure in all of our business segments. As you can see, the key quarterly drivers are largely consistent with the guidance considerations laid out in February and the supplemental considerations provided on the first and second quarter earnings calls. We were able to deliver strong earnings performance during the quarter as a result of our diverse business mix and disciplined cost management. Before moving on, I'll touch on sales trends for Ameren Missouri and Ameren Illinois Electric Distribution. Year-to-date, weather-normalized kilowatt-hour sales to Missouri residential, commercial and industrial customers decreased 2%, 0.5% and 2.5%, respectively, compared to last year. The year-to-date decrease in residential sales reflects an anticipated transition back to the office for many people. In addition, energy demand was lower as a result of the impacts from severe weather experienced in our service territory this quarter. That said, our residential sales remain a little over 3% higher than pre-COVID 2019 levels. For Industrial, we expect the year-to-date decline to moderate over the remaining course of the year as the UAW strike ends, coupled with increased demand, including from a General Motors plant expansion and a new graphics processing company. Year-to-date, weather-normalized kilo hour sales to Illinois customers have declined about 3% on average compared to last year. Recall that changes in electric -- Illinois Electric sales, no matter the cause, do not affect our earnings since we have full revenue to cope in. Moving to Page 18. I would now like to briefly touch on our 2023 earnings guidance. We delivered strong earnings in the first nine months of 2023 and are well positioned to finish the year strong. As Marty stated, we have narrowed our 2023 earnings guidance to be in the range of $4.30 to $4.45 per share. This is in comparison to our original guidance range of $4.25 and to $4.45 per share. On this page, we've highlighted slight considerations impacting our 2023 earnings guidance for the remainder of the year. These are supplemental to the key drivers and assumptions discussed on our earnings call in February. I encourage you to take these into consideration as you develop your expectations for the fourth quarter earnings results. Turning now to Page 19. In January, Ameren Illinois Electric Distribution followed its first multiyear rate plan or MYRP with the ICC, our MYRP is designed around 3 key elements: providing safe and reliable energy to our customers deploying capital in a way that achieves the climate and equitable job to act objectives as included in our performance metrics and fulfilling the clean energy transition by preparing our system to accept more renewables and electric vehicles over time. The MYRP details a grid modernization plan that includes our planned electric distribution investments and supports our annual revenue increase request for the next four years. In September, the ICC staff followed a brief recommending a cumulative increase of $322 million in revenue for 2024 through 2027. This includes a return on equity of 8.9%, reflecting the 2022 average 30-year treasury rate plus 580 basis points. It also includes a 50% equity ratio. Also in September, Ameren Illinois updated its request to reflect a cumulative increase of $444 million in revenues, which reflect a return on equity of 10.5% and an equity ratio of 54%. In October, the administrative law judges recommended a cumulative increase of $338 million in revenues, incorporating a 9.24% return on equity and a 50% equity ratio. Our brief on exceptions filed last Thursday, calls for a return on it of 9.85% and an equity ratio of 52%. We expect an ICC decision by mid-December with new rates affected by January 2024. Turning to Page 20. In April, we saw that our electric distribution annual rate reconciliation to reconcile the 2022 revenue requirements to actual cost. In August, the ICC staff updated a recommended reconciliation adjustment to $110 million base rate increase compared to our updated request of $117 million base rate increase. The $7 million variance is driven by a difference in the common equity ratio as we have proposed a 52% compared to the ICC staff's recommended 52%. An ICC decision is required by December 2023, and the full amount would be collected from customers in 2024. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois Natural Gas distribution rates using a 2024 future test year. In October, we filed an updated request for a $140 million increase based on a 10.22% ROE and a 52% common equity ratio and a $2.9 billion rate base. In October, the ICC staff recommended a $127 million increase based on the 9.89% return on equity and a 50% common equity ratio, which is consistent with the ALJ proposed order issued in September. We expect an ICC decision by mid-November with rates expected to be effective in early December this year. On Page 21, we provide a financing update. We continue to feel very good about our financial position. We were able to successfully execute two debt issuances earlier this year, which you've outlined on this page. Further, in order to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity, consisting of 3.2 million shares by the end of this year. These shares were previously sold forward under an ATM program with an average initial forward sales price of approximately $93 per share. Additionally, on September 30, we've entered into forward sales agreements under an ATM program for approximately $92 million to support our 2024 equity needs with an average initial forward sales price of approximately $86 per share. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. We continue to be strategic and thoughtful about our financing and our robust capital plan. Turning to Page 22. I'd like to briefly touch on our natural gas business as we head into the wearer months. Both Ameren Illinois and Ameren Missouri natural gas commodity prices are approximately 91% price edged based on normal seasonal sales and 100% volumetrically hedged based on maximum seasonal sales. I'm pleased to say, in light of the drop in natural gas prices, residential natural gas customers in Illinois and Missouri are expected to see total bill decreases of approximately 13% and 23%, respectively, compared to the 2022, 2023 winter season. Turning to Page 23. We plan to provide 2024 earnings guidance when we release fourth quarter results in February next year. Using our 2023 guidance as a reference point, we've listed on this page select items to consider when you think about our earnings outlook for next year. Beginning with Missouri, earnings are expected to be higher in 2024 when compared to 2023 due to new electric service rates effective in July 2023. We also expect increased investments in infrastructure eligible for plant and service accounting, but positively impact earnings. Our return to weather in 2024 would increase Ameren's earnings by approximately $0.02 compared to 2023 results to date, assuming normal weather in the last quarter of the year. Next, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois projects made under forward-looking formula ratemaking. Ameren Illinois Electric Distribution, earnings are expected to benefit in 2024 compared to 2023 from additional infrastructure investments. The allowed ROE under the new multiyear rate plan effective at the beginning of 2024, will be determined by the ITC as part of the pending rate review compared to the average 2023 30-year treasury yield plus 5.8% -- review compared to the average 2023, 30-year treasury yield plus 5.8%, which is currently in place. Ameren Illinois Natural Gas earnings are expected to benefit from higher delivery service rates based on a 2024 future test year. Moving now to Ameren wide considerations. We expect increased common shares outstanding and higher interest expense at Ameren to unfavorably impact earnings in 2024 compared to 2023. Finally, I would now consistent with past practice, our 2024 earnings guidance will include no expectation of COLI gains or losses. And turning to Page 24. We're well positioned to continue executing our plan. We expect to deliver strong earnings growth in 2023 and over the long-term, driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend and total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from Nicholas Campanella with Barclays. Please proceed with your question.
Unidentified Analyst: Hey everybody, it's Nathan Richardson [ph] on for Nick.
Marty Lyons: Hey, good morning, Nathan. This is Marty Lyons. Before you get to your question, I just you may not have experienced this, but I think many of our participants that were participating on the webcast missed a portion of our prepared remarks because of systems issue, but I just want to reassure everybody, we will post our replay of the entire conference call as soon as possible following the end of the Q&A session. So with that, please carry on with your question.
Unidentified Analyst: Got you. And I just want to talk about equity needs first. I'm sorry if I missed this, but in the September slide, you talked about $500 million of equity needs per year from $24 million to $27 million. And would this still be the case? And would you mind maybe talking about how you're thinking about ATM versus block needs and what you would be open to?
Michael Moehn: Yes. Perfect. Good morning. This is Michael. Yes, our equity needs are really unchanged from where they were at the beginning of the year, we issued our five-year guidance. We talked about $300 million of equity that we needed to do in '23 and then $500 million per year, beginning in '24 through the balance of '27, happy to report, I think we've said this before, we've taken care of those equity needs for '23. Those have been done under an ATM forward sales, so we'll bring those down here at the end of the year. We've sold forward about $100 million of the $500 million need for 25 through some forward sales. As we sit here today, we continue to find the ATM to be very effective, efficient. We'll continue to evaluate our needs. Our capital comes in pretty ratably. So the ATM works well from that perspective. And so -- but we're always open to, if there are better mechanisms to continue to take advantage of.
Unidentified Analyst: Got you. Thank you. And then one last one. So sticking with financing. You have a robust IRP with a lot of renewables. Can you help me think about your position on transferability cash flow and whether that is something you would utilize and maybe a timeline for that?
Michael Moehn: Yes, you bet. I mean, it looks like the transferability market continues to evolve here nicely and continue to see some deals get -- starting to get done there, which is great. Yes. I mean as we kind of step back and think about it, it's certainly something we could avail ourselves of over time just because we don't have necessarily the tax appetite to use all those when we need to. And so as we think about from a financing perspective, I mean, there could be -- it could be a slight positive, right, just over time? I mean ultimately, you're going to end up providing those back to customers, which is great because it ends up lowering the cost of those renewables, which is what we all want. But there could be some positive temporary regulatory lag that we may experience from time-to-time. But not a huge, I think replacement any sort of financing needs going forward, if that makes sense.
Unidentified Analyst: Got it, makes sense. Thank you very much.
Michael Moehn: You bet, thank you.
Operator: Our next question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question.
Shahriar Pourreza: Hey guys, good morning.
Michael Moehn: Hey Shar, good morning.
Shahriar Pourreza: Good morning. Let me just starting with Illinois. I mean, can you just maybe talk a little bit about the outlook for the balance of the process here on the multiyear. I mean, obviously, your neighbor in Chicago was very dissatisfied with the ALJ. You have briefs out there. I guess what's your expectation for the ICC to depart from the ALJ at this point? And what's the next step, right? So would you consider filing for a rehearing of the ALJ stands as is? Would you look to defer redeploy CapEx? I'm just kind of curious what the next step could be if you get an adverse decision.
Marty Lyons: Yes. Look, Shar, I think great questions overall. First of all, as you referred to, we filed our reply brief in September. And we believe that what we filed there really best supports achievement of the State of Illinois goals is captured in the Clean Energy and Jobs Act. And so if you look at that, that's where we really believe that the state would be best served and the customers of the state. So look, I would say, as I think about the process to date, we've been pleased both the staff and frankly, now that in the ALJ as well, they've supported nearly 95% of our planned capital investments over the next four years. So I think that's a positive that's occurred through this process. We -- as we stated in our prepared remarks are disappointed with the recommended return on equity and capital structure that came from the ALJ as well as the treatment of the OPEB asset. But the case isn't over. Like I said, last week, we filed our brief on exceptions. We articulated our concerns and the reasons for seeking a better outcome from the commission. And I'd say that's really where you get to the next steps, reply briefs on exceptions or due on November 14, and then we'll expect a commission decision by mid-December. As we said in our -- again, in our prepared remarks, we continue to support our initial asks of a 10.5% ROE and 54% equity in the cap structure. But we did in our reply brief suggests an alternative that the commission could arrive at 9.85% ROE or an alternative equity structure of 52% equity. And in coming up with those, we looked at alternative data and the record looked at the averages of comparable utilities as it related to cap structure. So again, I'd refer you to our filing for further details on those. But we remain hopeful at this point that the commission will meet -- is going to reach a more constructive and fair outcome that came from the ALJ. And then at this point, I wouldn't comment on what action we may take post the commission ruling. Michael, you want to make it count?
Michael Moehn: Might agree with all those comments. And just Shar, remind you, I think you know this, I mean, it's about 18% of our rate base today. And again, as we sort of step back and just look at our overall capital plan, we got the $19.7 billion out there over the next five years and $48 billion over the next 10. I think we have really constructive jurisdictions to continue to allocate that. We'll continue to be thoughtful about that. As Marty said, I think where we are from a rate base and capital addition standpoint and that rate review process is a positive at 95% or so. But we have some flexibility to pivot if needed.
Shahriar Pourreza: And then just to confirm, just the equity ratio going into it, no block equity. So just I guess how do we think about juicing of that?
Michael Moehn: Yes. I mean again, as I think as we sit here today, really just kind of stand by the comment I just made about the ATM itself. I think it provides us a great deal of flexibility. It's cost-effective. It's not to say that we wouldn't entertain something if we needed to. But again, just the way that capital is being laid in over time. It's been a pretty effective way to do it.
Marty Lyons: Yes. And Shar, just to build on sort of the answers that I gave and Michael gave. I think as it relates to our overall plan, and Michael mentioned this, I mean, we obviously have robust portfolio of capital expenditures that we can make across all of our segments. And we really feel very confident as we sit here today and our continued ability to grow at 6% to 8% in terms of our EPS CAGR. As we've laid out before, we've got $48 plus billion of infrastructure pipeline out through 2032. And we remain very confident in our overall ability to execute as a company.
Shahriar Pourreza: Perfect, thanks very much guys and big congrats to owner but I have a sense that he is going to be as busy as ever anyway even in Phase 2. Appreciate it guys.
Marty Lyons: You're probably right. Thanks.
Operator: Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Unidentified Analyst: Hey guys, good morning. This is Darius on for Julien. Appreciate you taking the question. Maybe just to start with, you alluded to this, and I appreciate that you don't have formal '24 guidance out there. But with the drivers and the visibility that you have now and the known of the ALJ rex in both the Illinois cases, can you comment on maybe just how you see that 6% to 8% shaping up on a year-over-year basis? Does the ALJ sort of give you a basis to still hit that range in '24?
Michael Moehn: Hey Darius, Michael here, thanks again for the question. Look, again, as we sit here today and we updated and provided guidance in February, that's we feel good about that 6% to 8%, thinking about that midpoint of 435. We gave you some select drivers here, right, in terms of what we see sort of impacting us kind of year-over-year. But again, feel good about the situation that we again feel good about the 8.4% rate base growth that we have. We've had obviously the updated IRP that we released in September. We talked about an incremental $1.5 billion of capital that could come into the plan over time there. So again, as we sit here today, feel very good about that 6% to 8% earnings per share growth.
Unidentified Analyst: Okay. Excellent. Thank you for the detail. And maybe if I can ask one on the competitive transmission projects. Just looking at your updated slide, it looks like the -- and I appreciate these are MISO's estimates, but it looks like the overall competitive opportunity is unchanged at a little bit under $1 billion, but there was -- maybe within that, the content, including Orient, any Fairport was slightly lower than in our previous -- or in the previous estimates. So just curious if you guys can comment on maybe the other projects within that set of competitive opportunities, do you see anything moving up or down as the estimates get for the refined.
Marty Lyons: Yes, happy to answer that question. This is Marty again. So again, with respect to the projects that were signed to us in Tranche 1, the $1.8 billion, as we're getting underway with those, which is fantastic. And then there were about $700 million of competitive projects. And the first one that we bid on was the Orient to Denny Fairport project. And we're very pleased that we were selected as the winning bidder on that project. As you mentioned, the ultimate price that we bid was lower than the MISO's original planning estimate. And I think our bid is indicative of the kind of work we do to partner with others, whether those be co-ops and munis in the area or vendors to really deliver a low-cost project. And as I mentioned, MISO's numbers are planning estimates and don't necessarily have the rigor that goes into the formal bids that we provide. But I wouldn't read too much into where that project came out relative to MISO's estimates. Each project is going to be different. Each project has its own routing issues, land acquisition requirements, partnering opportunities, et cetera. So you really can't extrapolate that outcome to the entirety. But again, I think we're very pleased with where we are. We are very pleased that we were selected as the winning bidder on that project. And we submitted another bid on another project, the Denny to Zachary Thomas Hill Maywood project. And we've got one more that we plan to bid on as well the Skunk River.
Unidentified Analyst: Great, thank you very much for the color. Appreciate it.
Operator: Our next question is from Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Hi, good morning.
Marty Lyons: Good morning.
Jeremy Tonet: Just want to come back to Illinois Electric, if I could, realized questions have been asked, but maybe just to put a finer point on some of the questions here. Why do you think the ALJ's ROEs came out so different than your proposal? Or are there any specifics in the ALJ filing that you see that justifies this difference or why they view the electric ROEs less than the gas ROEs as you see kind of justifying this delta?
Marty Lyons: This is Marty again. I really can't comment on why, if you will, they got to that. They used some discounted cash flow and capital asset pricing model kind of calculations that used some data that was in the record. But again, in our reply briefs, we note certain data that alternatively should be used in our view, in those calculations if they were used. And of course, staff use similar calculations and came up with a little over 10%. So again, I can't say why, but we again feel like inappropriate data points were used in those calculations, which again, in our reply briefs we addressed, and I'd refer you there in terms of our thoughts in terms of those calculations.
Jeremy Tonet: Got it. Understood. Maybe pivoting towards Missouri here and the IRP, what has been the reaction to the proposed Missouri IRP here? How have conversations with stakeholders been trending over time?
Marty Lyons: Yes, I think the conversation that's been had within the state is very much a balanced one. I think that some of the things that we put into this IRP as opposed to our prior one was the addition of 800 megawatts of gas simple cycle in 2027. And we made a couple of adjustments to, first of all, the timing of one coal-fired energy center to push that out for a couple of years and with it push out a 1,200-megawatt planned combined cycle plant. And then I can say we also move forward some of the battery storage technology we had planned by about five years. And I think the conversation has been balanced because in doing this, what we're really doing is putting -- stressing the fact that our integrated resource plan really represents what we believe to be the lowest cost approach to transitioning our portfolio of energy centers over time and maintain importantly, the reliability that our customers expect and as we do that, making sure that we're being good environmental stores. We're able to add those resources to bolster reliability, while still hitting carbon emission reduction targets that we've discussed previously of 60% by 2030, 85% by 2040, and ultimately, that net zero. So again, I believe the conversation has been really balanced because of that, our focus on affordability, our focus on reliability, while still hitting our targets in terms of environmental stewardship.
Jeremy Tonet: Got it. Make sense. Very helpful. I'll leave it there. Thank you.
Marty Lyons: Thank you.
Michael Moehn: Thanks, Jeremy.
Operator: Our next question comes from David Arcaro with Morgan Stanley. Please proceed with your question.
David Arcaro: Hey, good morning. Thanks so much for taking my question. Wondering if you could just speak a little bit to -- related to the CCNs and renewables in Missouri, how competitive are renewables currently? And just what's your latest in terms of how you're positioned to compete for company-owned generation versus contracting?
Marty Lyons: Yes. With respect to the Missouri renewables, earlier this year, the Missouri Public Service Commission approved to solar projects that we had proposed, both the Huck Finn and the Boomtown solar projects together, there are about 350 megawatts of investment. And those are projects that we will be constructed and that we will be own, and we expect closing date on those to be Q4 of 2024. So a good step forward in terms of commission approval of projects consistent with our IRP and our ownership. We also filed for CCNs this year for an additional 550 megawatts of solar projects, four projects in total. And that's going to be proceeding. We expect a commission decision on that early next year. And again, we do believe it's in the best interest of our customers and communities long term for these projects to be constructed for our ownership. In our Integrated Resource Plan, we didn't change the amount of our anticipated and planned overall renewables versus our prior IRP, we did include an expectation that the costs associated with those renewables would increase. However, those costs are being offset by the impact of the higher production tax credits and investment tax credits that are available under the Inflation Reduction Act. So when we go to -- when you look at the IRP, which we laid out the timeline on Slide 10 that we provided. What you see there is a really good balance of the growth in renewable projects, but also investments in assets that will preserve reliability, as I mentioned a second ago, both the gas simple cycle, the gas combined cycle, some of the battery storage technology that's really going to ensure that we continue to have a reliable system. But the important thing is that this combination of resources, along with the continued investment, ensuring the reliability of our existing dispatchable assets, both our Callaway nuclear plant as well as our coal assets through retirement. We really believe that this represents a least cost plan for providing energy to our customers in Missouri and preserving again, the reliability that they expect. So again, the CCNs that we're proposing for the renewables really fit with execution of this IRP. And then with respect to your last question. While you can't rule out the possibility of PPAs. What we've really demonstrated over time, if you look at some of the renewable projects that we've put into our portfolio and have had approved by the commission, is that we really do believe in the long term that our ownership and operation of these assets provides the long-term lowest cost for our customers.
David Arcaro: Great. Thanks for all that color. Very helpful. And I was wondering if you could also touch on your expectations here for load growth going forward. We've seen weather normal loads still trending down through most of the year. I'm wondering if you could give your perspective on when that might settle down and outlook for industrial sales to within that?
Michael Moehn: Yes, you bet. Good morning, David, this is Michael. Yes, this year has obviously been a little interesting. You see some of the decreases in residential. I think we attribute that to a couple of things. We had some significant storms number of them over the summer that certainly contributed a bit to that. And then also, we still just working through, I think, the going back from working at home into the office. And so you're certainly seeing that transition as well. And it continues to throw the number around a bit. We've -- obviously, we've had some extreme weather here and there, which always factors into kind of how you think about this on a normalized basis, but you try to get it as close as possible. I do think it is beginning to level out as we kind of look forward. And I mean, again, I think I pointed out, if you look at our residential side of things, I mean, you're seeing about 3% growth relative to where we were kind of pre-pandemic. And the other positive is we actually have customer growth year-to-date, too. So ultimately, you believe that's going to continue to transition into some sales growth. I think on the commercial side, we continue to see some positives. I mean the industrial line noted that obviously we are impacted by the strike at GM that was going on for some period of time that obviously seems to be concluding. There's actually an expansion that has occurred there and so we should see that be a positive element going into the remainder of the fourth quarter. And then I think there's some positive developments that we're seeing just broadly on the industrial side as well that are adding some little growth. So I mean as we look out in the future, I think we still stick by this about 0.5% kind of load growth over time. I think that has the ability, hopefully, to move up as some of this industrial continues to evolve, but that's where we are today, David.
David Arcaro: Okay, great. Thanks so much. See you soon.
Michael Moehn: You bet.
Operator: Our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question.
Paul Patterson: Hey, good morning guys.
Marty Lyons: Good morning, Paul.
Paul Patterson: Just wanted to -- I apologize if I missed this, because I did have some tech problems. But the -- Darius, was asking about the competitive bid, and I was wondering, do you guys have any data that you guys provided or can provide on kinds of what kind of returns you're seeing in the competitive transmission versus just in general?
Marty Lyons: Yes. Paul, first of all, I do apologize again for the technical difficulty you and others experienced apologize for that and the inconvenience. I don't think we have anything that we could point to in terms of return. I would say this. I mean, when we bid on these projects, we're very cognizant of what we think our cost of capital is and what appropriate return expectations are for these projects. So that's certainly taken into consideration when making any bid. So I think the assumption should be that is a winning bidder of this project that we expect to earn a fair return on the project.
Paul Patterson: Sure. Okay. But I guess maybe it's competitive to tell us what that might be? Is that right? Or can you?
Marty Lyons: Yes, I think so. I mean, we'll give some consideration post the call to whether there's anything we can point to. But yes, I think that probably not something that I think we could point to today.
Paul Patterson:
, :
Marty Lyons: Well, I think, Paul, as it relates to the court cases as we watch court case around the country, both in Texas as well as a couple of other states. We've seen them run into problems in Texas. We've seen the ROFRs upheld in other states. So we're going to continue to watch the developments across all of these cases. And then make sure that whatever we bring forward, which we do plan to bring forward next year, these rights of first refusal, both in Illinois and Missouri. That we make appropriate adjustments to the proposed legislation to ensure that they're able to withstand legal challenges and hold up. If for some reason through the process of these things going through the courts, we don't believe that they'd be lawful. Obviously, that would affect whether we move forward with seeking these rights of first refusal or not. But as we sit here today, we do believe both in Missouri and Illinois that these rights of first refusal really are very beneficial to our customers and communities. I think we just talked about this [indiscernible] that we won, which was this Orient-Denny-Fairport project. And I think it just goes to show that we are a low-cost constructor. We are a low-cost operator. And we do believe that these projects have very good value for customers. And when MISO puts these forward Tranche 1, I mean what's to come in Tranche 2, these projects have very good benefit to cost ratios. And by not assigning those to the incumbent transmission operator by putting them out for bid, you're delaying those benefits to customers by two years or so. And again, we've certainly demonstrated we're a low-cost provider. So we do think that these rights of first refusal are in the best interest of our customers. The citizens of both the states of Illinois and Missouri. And we look forward to working with stakeholders as we move towards the next legislative session to really build a stronger coalition and make sure people really understand the value, and we'll work with all stakeholders to put forward legislation that we think not only can pass, it should pass, but can withstand any core challenges. So back to your question, Paul, we'll continue to monitor these cases as we have and adjust as needed.
Paul Patterson: Okay. And absolutely, I hear you on your ability to demonstrate your competitiveness and stuff. But just I guess what I'm saying -- I guess what I'm asking about is the Supreme Court, I guess, what I'm wondering is would that invalidate ROFRs? Do you follow what I'm saying -- I mean across the country? Or do you see this as being specific to -- I mean I guess what I'm saying -- I don't know stands an industry question, if you follow me to sort of -- I'm trying to figure out for my own edification or like what happens if it is in [indiscernible] I guess that would mean the Fifth Circuit would stand. And if that is the case, what -- how do we think about the ROFR people where I'm coming from?
Marty Lyons: Well, I do. And I guess we'd have to see how the Supreme Court rules, what they say. But when -- we talked about this a little bit on the last call. When we looked at Texas, we thought it was really more applicable to the situation in Texas whereas when we looked at crafting the rights of first refusal we've been putting forward more aligned with states where the ROFRs have been upheld in the courts. So I think we'd ultimately have to look at the ultimate -- the Supreme Court decision and its applicability. But I guess I can't really comment further at this time, Paul.
Paul Patterson: I got you. I appreciate. Thanks so much and thanks.
Marty Lyons: You bet. Thank you. See you soon.
Operator: Our final question comes from Anthony Crowdell with Mizuho. Please proceed with your question.
Anthony Crowdell: Hey, good morning. Thanks for squeezing me in. Just hopefully an easy one. You talked a lot about the financing plan. It seems like it's intact. A lot of capital opportunities, rate base opportunities. I'm just wondering what do you think is the most challenging part of the play that you have?
Michael Moehn: Yes. Hey, Anthony, it's Michael. Look, I think it's just about continued execution around all these projects, right? I mean I think we got some robust rate base growth, 8.4%, as you just noted, $20 billion of capital plans. We got to continue to execute these wells, get them into service, make sure we realize all the benefits associated with them. Obviously, we're in a different financing environment today than we were a couple of years ago. So that creates some headwinds you've got to continue to work through. But I mean ultimately, I think we talked about this in the past, we've got a number of mechanisms to recover those financing costs pretty rapidly through both on the Illinois side. We can always accelerate some rate reviews that we needed to on the Missouri side. But at the end of the day, I think it's really -- this comes back down to just an affordability opportunities just making sure that we keep cost as low as we possibly can for customers as we work through this incredibly important clean energy transition. Marty, anything to add to that?
Marty Lyons: No, I think that's well covered. Anthony, any other questions?
Anthony Crowdell: No, I'm good. Thank you so much. I'll catch you guys up in Phoenix.
Marty Lyons: Look forward to seeing you.
Michael Moehn: See you next week.
Operator: Mr. Lyons, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments.
Marty Lyons: Well, thank you all for joining us today. Once again, I apologize for the technical difficulties, some of your experiences -- you experienced, and as I mentioned, we'll make sure that we opposed a replay of this call as quickly as possible. I think what you heard today is we have really had a strong start to 2023. We've gotten through these important summer months. And just with just a couple of months left, remain very confident in our ability to achieve our earnings per share growth goals for this year and earnings per share range that we've outlined today. We make sure that we're focused on continuing to deliver strong value, both for our customers, our communities as well as for our shareholders. As we underscore today, we continue to expect 6% to 8% earnings per share growth for '23 to '27. It's supported by strong investment in rate-regulated infrastructure and rate base growth of 80.4% compound annually from 2022 to 2027. So we feel very good about our execution of our plan, and I thank you all for joining us, and we look forward to seeing you all soon. Have a great day.
Operator: This concludes today's teleconference. You may disconnect your lines at this time, and we thank you for your participation. | [
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"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
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"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4."
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{
"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us today. We had a strong quarter, and we're excited to share an update with you on recent developments. But before I begin our quarterly update, I would like to take the opportunity to congratulate Warner Baxter, who retired as Executive Chairman on November 2. Over his 28-year career with the company, Warner has had a significant positive impact on our industry, company and community. And frankly, each of us here this morning. Under Warner's leadership, Ameren has successfully executed a strategy focused on robust energy infrastructure investments supported by constructive energy policies driving strong value for Ameren's customers, communities and shareholders. And consistent with his focus on sustainability, he leaves behind a strong team dedicated to maintaining that focus and continuously improving. Congratulations Warner, and I wish you well in your retirement. Moving now to Page 5 and our quarterly update. Our dedicated team continues to execute our strategic plan across all of our business segments, which entails investing in energy infrastructure to deliver safe, reliable, clean and affordable electric and natural gas services to our customers. Turning to Page 6. Our strategic plan integrates our strong sustainability value proposition balancing the four pillars of environmental stewardship, positive social impact, strong governance and sustainable growth. Here, we summarized some of the many things we are doing for our customers, communities, coworkers and shareholders. And today, we published our updated sustainability investor presentation called leading the way to a sustainable energy future available at amereninvestors.com. which more fully details how we have been effectively integrating our sustainability value proposition, balancing the four pillars of environmental stewardship, positive social impact, strong governance and sustainable growth. Here, we summarize some of the many things we are doing for our customers, communities, co-workers and shareholders. And today, we published our updated sustainability investor presentation called leading the way to a sustainable energy future, available at amereninvestors.com which more fully details how we have been effectively integrating our sustainability value transmission lines. Such legislation would support the timely and cost-effective construction of the MISO long-range transmission planning projects and other need to transmission investments. Unfortunately, the legislation was vetoed by the governor in August, it was not ultimately brought to a vote during the detail session. We will continue to work with key stakeholders to support this important piece of legislation in the spring legislative session. On Page 14, we look ahead to the next decade. We have a robust pipeline of investment opportunities totaling more than $48 billion that will deliver significant value to all our stakeholders by making our energy grid stronger, smarter and cleaner. The $48 billion does not reflect the incremental investment opportunities included in the recently filed Integrated Resource Plan. We will provide an updated number on our call next February, along with the new five-year capital plan. Of course, our investments create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and to transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Turning now to Page 15. In February, we updated our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings growth rate from 2023 through 2027. This earnings growth is primarily driven by strong compound annual rate base growth of 8.4%, supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all 4 of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. And I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to Page 17 of our presentation. Yesterday, we reported third quarter 2023 earnings of $1.87 per share, compared to $1.74 per share for the year ago quarter. This page summarizes key drivers impacting earnings at each segment. Under our constructive regulatory frameworks, we experienced earnings growth driven by increased investments in infrastructure in all of our business segments. As you can see, the key quarterly drivers are largely consistent with the guidance considerations laid out in February and the supplemental considerations provided on the first and second quarter earnings calls. We were able to deliver strong earnings performance during the quarter as a result of our diverse business mix and disciplined cost management. Before moving on, I'll touch on sales trends for Ameren Missouri and Ameren Illinois Electric Distribution. Year-to-date, weather-normalized kilowatt-hour sales to Missouri residential, commercial and industrial customers decreased 2%, 0.5% and 2.5%, respectively, compared to last year. The year-to-date decrease in residential sales reflects an anticipated transition back to the office for many people. In addition, energy demand was lower as a result of the impacts from severe weather experienced in our service territory this quarter. That said, our residential sales remain a little over 3% higher than pre-COVID 2019 levels. For Industrial, we expect the year-to-date decline to moderate over the remaining course of the year as the UAW strike ends, coupled with increased demand, including from a General Motors plant expansion and a new graphics processing company. Year-to-date, weather-normalized kilo hour sales to Illinois customers have declined about 3% on average compared to last year. Recall that changes in electric -- Illinois Electric sales, no matter the cause, do not affect our earnings since we have full revenue to cope in. Moving to Page 18. I would now like to briefly touch on our 2023 earnings guidance. We delivered strong earnings in the first nine months of 2023 and are well positioned to finish the year strong. As Marty stated, we have narrowed our 2023 earnings guidance to be in the range of $4.30 to $4.45 per share. This is in comparison to our original guidance range of $4.25 and to $4.45 per share. On this page, we've highlighted slight considerations impacting our 2023 earnings guidance for the remainder of the year. These are supplemental to the key drivers and assumptions discussed on our earnings call in February. I encourage you to take these into consideration as you develop your expectations for the fourth quarter earnings results. Turning now to Page 19. In January, Ameren Illinois Electric Distribution followed its first multiyear rate plan or MYRP with the ICC, our MYRP is designed around 3 key elements: providing safe and reliable energy to our customers deploying capital in a way that achieves the climate and equitable job to act objectives as included in our performance metrics and fulfilling the clean energy transition by preparing our system to accept more renewables and electric vehicles over time. The MYRP details a grid modernization plan that includes our planned electric distribution investments and supports our annual revenue increase request for the next four years. In September, the ICC staff followed a brief recommending a cumulative increase of $322 million in revenue for 2024 through 2027. This includes a return on equity of 8.9%, reflecting the 2022 average 30-year treasury rate plus 580 basis points. It also includes a 50% equity ratio. Also in September, Ameren Illinois updated its request to reflect a cumulative increase of $444 million in revenues, which reflect a return on equity of 10.5% and an equity ratio of 54%. In October, the administrative law judges recommended a cumulative increase of $338 million in revenues, incorporating a 9.24% return on equity and a 50% equity ratio. Our brief on exceptions filed last Thursday, calls for a return on it of 9.85% and an equity ratio of 52%. We expect an ICC decision by mid-December with new rates affected by January 2024. Turning to Page 20. In April, we saw that our electric distribution annual rate reconciliation to reconcile the 2022 revenue requirements to actual cost. In August, the ICC staff updated a recommended reconciliation adjustment to $110 million base rate increase compared to our updated request of $117 million base rate increase. The $7 million variance is driven by a difference in the common equity ratio as we have proposed a 52% compared to the ICC staff's recommended 52%. An ICC decision is required by December 2023, and the full amount would be collected from customers in 2024. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois Natural Gas distribution rates using a 2024 future test year. In October, we filed an updated request for a $140 million increase based on a 10.22% ROE and a 52% common equity ratio and a $2.9 billion rate base. In October, the ICC staff recommended a $127 million increase based on the 9.89% return on equity and a 50% common equity ratio, which is consistent with the ALJ proposed order issued in September. We expect an ICC decision by mid-November with rates expected to be effective in early December this year. On Page 21, we provide a financing update. We continue to feel very good about our financial position. We were able to successfully execute two debt issuances earlier this year, which you've outlined on this page. Further, in order to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity, consisting of 3.2 million shares by the end of this year. These shares were previously sold forward under an ATM program with an average initial forward sales price of approximately $93 per share. Additionally, on September 30, we've entered into forward sales agreements under an ATM program for approximately $92 million to support our 2024 equity needs with an average initial forward sales price of approximately $86 per share. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. We continue to be strategic and thoughtful about our financing and our robust capital plan. Turning to Page 22. I'd like to briefly touch on our natural gas business as we head into the wearer months. Both Ameren Illinois and Ameren Missouri natural gas commodity prices are approximately 91% price edged based on normal seasonal sales and 100% volumetrically hedged based on maximum seasonal sales. I'm pleased to say, in light of the drop in natural gas prices, residential natural gas customers in Illinois and Missouri are expected to see total bill decreases of approximately 13% and 23%, respectively, compared to the 2022, 2023 winter season. Turning to Page 23. We plan to provide 2024 earnings guidance when we release fourth quarter results in February next year. Using our 2023 guidance as a reference point, we've listed on this page select items to consider when you think about our earnings outlook for next year. Beginning with Missouri, earnings are expected to be higher in 2024 when compared to 2023 due to new electric service rates effective in July 2023. We also expect increased investments in infrastructure eligible for plant and service accounting, but positively impact earnings. Our return to weather in 2024 would increase Ameren's earnings by approximately $0.02 compared to 2023 results to date, assuming normal weather in the last quarter of the year. Next, earnings from our FERC-regulated electric transmission activities are expected to benefit from additional investments in Ameren Illinois projects made under forward-looking formula ratemaking. Ameren Illinois Electric Distribution, earnings are expected to benefit in 2024 compared to 2023 from additional infrastructure investments. The allowed ROE under the new multiyear rate plan effective at the beginning of 2024, will be determined by the ITC as part of the pending rate review compared to the average 2023 30-year treasury yield plus 5.8% -- review compared to the average 2023, 30-year treasury yield plus 5.8%, which is currently in place. Ameren Illinois Natural Gas earnings are expected to benefit from higher delivery service rates based on a 2024 future test year. Moving now to Ameren wide considerations. We expect increased common shares outstanding and higher interest expense at Ameren to unfavorably impact earnings in 2024 compared to 2023. Finally, I would now consistent with past practice, our 2024 earnings guidance will include no expectation of COLI gains or losses. And turning to Page 24. We're well positioned to continue executing our plan. We expect to deliver strong earnings growth in 2023 and over the long-term, driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend and total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from Nicholas Campanella with Barclays. Please proceed with your question."
},
{
"speaker": "Unidentified Analyst",
"text": "Hey everybody, it's Nathan Richardson [ph] on for Nick."
},
{
"speaker": "Marty Lyons",
"text": "Hey, good morning, Nathan. This is Marty Lyons. Before you get to your question, I just you may not have experienced this, but I think many of our participants that were participating on the webcast missed a portion of our prepared remarks because of systems issue, but I just want to reassure everybody, we will post our replay of the entire conference call as soon as possible following the end of the Q&A session. So with that, please carry on with your question."
},
{
"speaker": "Unidentified Analyst",
"text": "Got you. And I just want to talk about equity needs first. I'm sorry if I missed this, but in the September slide, you talked about $500 million of equity needs per year from $24 million to $27 million. And would this still be the case? And would you mind maybe talking about how you're thinking about ATM versus block needs and what you would be open to?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Perfect. Good morning. This is Michael. Yes, our equity needs are really unchanged from where they were at the beginning of the year, we issued our five-year guidance. We talked about $300 million of equity that we needed to do in '23 and then $500 million per year, beginning in '24 through the balance of '27, happy to report, I think we've said this before, we've taken care of those equity needs for '23. Those have been done under an ATM forward sales, so we'll bring those down here at the end of the year. We've sold forward about $100 million of the $500 million need for 25 through some forward sales. As we sit here today, we continue to find the ATM to be very effective, efficient. We'll continue to evaluate our needs. Our capital comes in pretty ratably. So the ATM works well from that perspective. And so -- but we're always open to, if there are better mechanisms to continue to take advantage of."
},
{
"speaker": "Unidentified Analyst",
"text": "Got you. Thank you. And then one last one. So sticking with financing. You have a robust IRP with a lot of renewables. Can you help me think about your position on transferability cash flow and whether that is something you would utilize and maybe a timeline for that?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, you bet. I mean, it looks like the transferability market continues to evolve here nicely and continue to see some deals get -- starting to get done there, which is great. Yes. I mean as we kind of step back and think about it, it's certainly something we could avail ourselves of over time just because we don't have necessarily the tax appetite to use all those when we need to. And so as we think about from a financing perspective, I mean, there could be -- it could be a slight positive, right, just over time? I mean ultimately, you're going to end up providing those back to customers, which is great because it ends up lowering the cost of those renewables, which is what we all want. But there could be some positive temporary regulatory lag that we may experience from time-to-time. But not a huge, I think replacement any sort of financing needs going forward, if that makes sense."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it, makes sense. Thank you very much."
},
{
"speaker": "Michael Moehn",
"text": "You bet, thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shahriar Pourreza",
"text": "Hey guys, good morning."
},
{
"speaker": "Michael Moehn",
"text": "Hey Shar, good morning."
},
{
"speaker": "Shahriar Pourreza",
"text": "Good morning. Let me just starting with Illinois. I mean, can you just maybe talk a little bit about the outlook for the balance of the process here on the multiyear. I mean, obviously, your neighbor in Chicago was very dissatisfied with the ALJ. You have briefs out there. I guess what's your expectation for the ICC to depart from the ALJ at this point? And what's the next step, right? So would you consider filing for a rehearing of the ALJ stands as is? Would you look to defer redeploy CapEx? I'm just kind of curious what the next step could be if you get an adverse decision."
},
{
"speaker": "Marty Lyons",
"text": "Yes. Look, Shar, I think great questions overall. First of all, as you referred to, we filed our reply brief in September. And we believe that what we filed there really best supports achievement of the State of Illinois goals is captured in the Clean Energy and Jobs Act. And so if you look at that, that's where we really believe that the state would be best served and the customers of the state. So look, I would say, as I think about the process to date, we've been pleased both the staff and frankly, now that in the ALJ as well, they've supported nearly 95% of our planned capital investments over the next four years. So I think that's a positive that's occurred through this process. We -- as we stated in our prepared remarks are disappointed with the recommended return on equity and capital structure that came from the ALJ as well as the treatment of the OPEB asset. But the case isn't over. Like I said, last week, we filed our brief on exceptions. We articulated our concerns and the reasons for seeking a better outcome from the commission. And I'd say that's really where you get to the next steps, reply briefs on exceptions or due on November 14, and then we'll expect a commission decision by mid-December. As we said in our -- again, in our prepared remarks, we continue to support our initial asks of a 10.5% ROE and 54% equity in the cap structure. But we did in our reply brief suggests an alternative that the commission could arrive at 9.85% ROE or an alternative equity structure of 52% equity. And in coming up with those, we looked at alternative data and the record looked at the averages of comparable utilities as it related to cap structure. So again, I'd refer you to our filing for further details on those. But we remain hopeful at this point that the commission will meet -- is going to reach a more constructive and fair outcome that came from the ALJ. And then at this point, I wouldn't comment on what action we may take post the commission ruling. Michael, you want to make it count?"
},
{
"speaker": "Michael Moehn",
"text": "Might agree with all those comments. And just Shar, remind you, I think you know this, I mean, it's about 18% of our rate base today. And again, as we sort of step back and just look at our overall capital plan, we got the $19.7 billion out there over the next five years and $48 billion over the next 10. I think we have really constructive jurisdictions to continue to allocate that. We'll continue to be thoughtful about that. As Marty said, I think where we are from a rate base and capital addition standpoint and that rate review process is a positive at 95% or so. But we have some flexibility to pivot if needed."
},
{
"speaker": "Shahriar Pourreza",
"text": "And then just to confirm, just the equity ratio going into it, no block equity. So just I guess how do we think about juicing of that?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. I mean again, as I think as we sit here today, really just kind of stand by the comment I just made about the ATM itself. I think it provides us a great deal of flexibility. It's cost-effective. It's not to say that we wouldn't entertain something if we needed to. But again, just the way that capital is being laid in over time. It's been a pretty effective way to do it."
},
{
"speaker": "Marty Lyons",
"text": "Yes. And Shar, just to build on sort of the answers that I gave and Michael gave. I think as it relates to our overall plan, and Michael mentioned this, I mean, we obviously have robust portfolio of capital expenditures that we can make across all of our segments. And we really feel very confident as we sit here today and our continued ability to grow at 6% to 8% in terms of our EPS CAGR. As we've laid out before, we've got $48 plus billion of infrastructure pipeline out through 2032. And we remain very confident in our overall ability to execute as a company."
},
{
"speaker": "Shahriar Pourreza",
"text": "Perfect, thanks very much guys and big congrats to owner but I have a sense that he is going to be as busy as ever anyway even in Phase 2. Appreciate it guys."
},
{
"speaker": "Marty Lyons",
"text": "You're probably right. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Unidentified Analyst",
"text": "Hey guys, good morning. This is Darius on for Julien. Appreciate you taking the question. Maybe just to start with, you alluded to this, and I appreciate that you don't have formal '24 guidance out there. But with the drivers and the visibility that you have now and the known of the ALJ rex in both the Illinois cases, can you comment on maybe just how you see that 6% to 8% shaping up on a year-over-year basis? Does the ALJ sort of give you a basis to still hit that range in '24?"
},
{
"speaker": "Michael Moehn",
"text": "Hey Darius, Michael here, thanks again for the question. Look, again, as we sit here today and we updated and provided guidance in February, that's we feel good about that 6% to 8%, thinking about that midpoint of 435. We gave you some select drivers here, right, in terms of what we see sort of impacting us kind of year-over-year. But again, feel good about the situation that we again feel good about the 8.4% rate base growth that we have. We've had obviously the updated IRP that we released in September. We talked about an incremental $1.5 billion of capital that could come into the plan over time there. So again, as we sit here today, feel very good about that 6% to 8% earnings per share growth."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. Excellent. Thank you for the detail. And maybe if I can ask one on the competitive transmission projects. Just looking at your updated slide, it looks like the -- and I appreciate these are MISO's estimates, but it looks like the overall competitive opportunity is unchanged at a little bit under $1 billion, but there was -- maybe within that, the content, including Orient, any Fairport was slightly lower than in our previous -- or in the previous estimates. So just curious if you guys can comment on maybe the other projects within that set of competitive opportunities, do you see anything moving up or down as the estimates get for the refined."
},
{
"speaker": "Marty Lyons",
"text": "Yes, happy to answer that question. This is Marty again. So again, with respect to the projects that were signed to us in Tranche 1, the $1.8 billion, as we're getting underway with those, which is fantastic. And then there were about $700 million of competitive projects. And the first one that we bid on was the Orient to Denny Fairport project. And we're very pleased that we were selected as the winning bidder on that project. As you mentioned, the ultimate price that we bid was lower than the MISO's original planning estimate. And I think our bid is indicative of the kind of work we do to partner with others, whether those be co-ops and munis in the area or vendors to really deliver a low-cost project. And as I mentioned, MISO's numbers are planning estimates and don't necessarily have the rigor that goes into the formal bids that we provide. But I wouldn't read too much into where that project came out relative to MISO's estimates. Each project is going to be different. Each project has its own routing issues, land acquisition requirements, partnering opportunities, et cetera. So you really can't extrapolate that outcome to the entirety. But again, I think we're very pleased with where we are. We are very pleased that we were selected as the winning bidder on that project. And we submitted another bid on another project, the Denny to Zachary Thomas Hill Maywood project. And we've got one more that we plan to bid on as well the Skunk River."
},
{
"speaker": "Unidentified Analyst",
"text": "Great, thank you very much for the color. Appreciate it."
},
{
"speaker": "Operator",
"text": "Our next question is from Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Marty Lyons",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "Just want to come back to Illinois Electric, if I could, realized questions have been asked, but maybe just to put a finer point on some of the questions here. Why do you think the ALJ's ROEs came out so different than your proposal? Or are there any specifics in the ALJ filing that you see that justifies this difference or why they view the electric ROEs less than the gas ROEs as you see kind of justifying this delta?"
},
{
"speaker": "Marty Lyons",
"text": "This is Marty again. I really can't comment on why, if you will, they got to that. They used some discounted cash flow and capital asset pricing model kind of calculations that used some data that was in the record. But again, in our reply briefs, we note certain data that alternatively should be used in our view, in those calculations if they were used. And of course, staff use similar calculations and came up with a little over 10%. So again, I can't say why, but we again feel like inappropriate data points were used in those calculations, which again, in our reply briefs we addressed, and I'd refer you there in terms of our thoughts in terms of those calculations."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Understood. Maybe pivoting towards Missouri here and the IRP, what has been the reaction to the proposed Missouri IRP here? How have conversations with stakeholders been trending over time?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, I think the conversation that's been had within the state is very much a balanced one. I think that some of the things that we put into this IRP as opposed to our prior one was the addition of 800 megawatts of gas simple cycle in 2027. And we made a couple of adjustments to, first of all, the timing of one coal-fired energy center to push that out for a couple of years and with it push out a 1,200-megawatt planned combined cycle plant. And then I can say we also move forward some of the battery storage technology we had planned by about five years. And I think the conversation has been balanced because in doing this, what we're really doing is putting -- stressing the fact that our integrated resource plan really represents what we believe to be the lowest cost approach to transitioning our portfolio of energy centers over time and maintain importantly, the reliability that our customers expect and as we do that, making sure that we're being good environmental stores. We're able to add those resources to bolster reliability, while still hitting carbon emission reduction targets that we've discussed previously of 60% by 2030, 85% by 2040, and ultimately, that net zero. So again, I believe the conversation has been really balanced because of that, our focus on affordability, our focus on reliability, while still hitting our targets in terms of environmental stewardship."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Make sense. Very helpful. I'll leave it there. Thank you."
},
{
"speaker": "Marty Lyons",
"text": "Thank you."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Jeremy."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Arcaro with Morgan Stanley. Please proceed with your question."
},
{
"speaker": "David Arcaro",
"text": "Hey, good morning. Thanks so much for taking my question. Wondering if you could just speak a little bit to -- related to the CCNs and renewables in Missouri, how competitive are renewables currently? And just what's your latest in terms of how you're positioned to compete for company-owned generation versus contracting?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. With respect to the Missouri renewables, earlier this year, the Missouri Public Service Commission approved to solar projects that we had proposed, both the Huck Finn and the Boomtown solar projects together, there are about 350 megawatts of investment. And those are projects that we will be constructed and that we will be own, and we expect closing date on those to be Q4 of 2024. So a good step forward in terms of commission approval of projects consistent with our IRP and our ownership. We also filed for CCNs this year for an additional 550 megawatts of solar projects, four projects in total. And that's going to be proceeding. We expect a commission decision on that early next year. And again, we do believe it's in the best interest of our customers and communities long term for these projects to be constructed for our ownership. In our Integrated Resource Plan, we didn't change the amount of our anticipated and planned overall renewables versus our prior IRP, we did include an expectation that the costs associated with those renewables would increase. However, those costs are being offset by the impact of the higher production tax credits and investment tax credits that are available under the Inflation Reduction Act. So when we go to -- when you look at the IRP, which we laid out the timeline on Slide 10 that we provided. What you see there is a really good balance of the growth in renewable projects, but also investments in assets that will preserve reliability, as I mentioned a second ago, both the gas simple cycle, the gas combined cycle, some of the battery storage technology that's really going to ensure that we continue to have a reliable system. But the important thing is that this combination of resources, along with the continued investment, ensuring the reliability of our existing dispatchable assets, both our Callaway nuclear plant as well as our coal assets through retirement. We really believe that this represents a least cost plan for providing energy to our customers in Missouri and preserving again, the reliability that they expect. So again, the CCNs that we're proposing for the renewables really fit with execution of this IRP. And then with respect to your last question. While you can't rule out the possibility of PPAs. What we've really demonstrated over time, if you look at some of the renewable projects that we've put into our portfolio and have had approved by the commission, is that we really do believe in the long term that our ownership and operation of these assets provides the long-term lowest cost for our customers."
},
{
"speaker": "David Arcaro",
"text": "Great. Thanks for all that color. Very helpful. And I was wondering if you could also touch on your expectations here for load growth going forward. We've seen weather normal loads still trending down through most of the year. I'm wondering if you could give your perspective on when that might settle down and outlook for industrial sales to within that?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, you bet. Good morning, David, this is Michael. Yes, this year has obviously been a little interesting. You see some of the decreases in residential. I think we attribute that to a couple of things. We had some significant storms number of them over the summer that certainly contributed a bit to that. And then also, we still just working through, I think, the going back from working at home into the office. And so you're certainly seeing that transition as well. And it continues to throw the number around a bit. We've -- obviously, we've had some extreme weather here and there, which always factors into kind of how you think about this on a normalized basis, but you try to get it as close as possible. I do think it is beginning to level out as we kind of look forward. And I mean, again, I think I pointed out, if you look at our residential side of things, I mean, you're seeing about 3% growth relative to where we were kind of pre-pandemic. And the other positive is we actually have customer growth year-to-date, too. So ultimately, you believe that's going to continue to transition into some sales growth. I think on the commercial side, we continue to see some positives. I mean the industrial line noted that obviously we are impacted by the strike at GM that was going on for some period of time that obviously seems to be concluding. There's actually an expansion that has occurred there and so we should see that be a positive element going into the remainder of the fourth quarter. And then I think there's some positive developments that we're seeing just broadly on the industrial side as well that are adding some little growth. So I mean as we look out in the future, I think we still stick by this about 0.5% kind of load growth over time. I think that has the ability, hopefully, to move up as some of this industrial continues to evolve, but that's where we are today, David."
},
{
"speaker": "David Arcaro",
"text": "Okay, great. Thanks so much. See you soon."
},
{
"speaker": "Michael Moehn",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Paul Patterson",
"text": "Hey, good morning guys."
},
{
"speaker": "Marty Lyons",
"text": "Good morning, Paul."
},
{
"speaker": "Paul Patterson",
"text": "Just wanted to -- I apologize if I missed this, because I did have some tech problems. But the -- Darius, was asking about the competitive bid, and I was wondering, do you guys have any data that you guys provided or can provide on kinds of what kind of returns you're seeing in the competitive transmission versus just in general?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Paul, first of all, I do apologize again for the technical difficulty you and others experienced apologize for that and the inconvenience. I don't think we have anything that we could point to in terms of return. I would say this. I mean, when we bid on these projects, we're very cognizant of what we think our cost of capital is and what appropriate return expectations are for these projects. So that's certainly taken into consideration when making any bid. So I think the assumption should be that is a winning bidder of this project that we expect to earn a fair return on the project."
},
{
"speaker": "Paul Patterson",
"text": "Sure. Okay. But I guess maybe it's competitive to tell us what that might be? Is that right? Or can you?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, I think so. I mean, we'll give some consideration post the call to whether there's anything we can point to. But yes, I think that probably not something that I think we could point to today."
},
{
"speaker": "Paul Patterson",
"text": ""
},
{
"speaker": ",",
"text": ""
},
{
"speaker": "Marty Lyons",
"text": "Well, I think, Paul, as it relates to the court cases as we watch court case around the country, both in Texas as well as a couple of other states. We've seen them run into problems in Texas. We've seen the ROFRs upheld in other states. So we're going to continue to watch the developments across all of these cases. And then make sure that whatever we bring forward, which we do plan to bring forward next year, these rights of first refusal, both in Illinois and Missouri. That we make appropriate adjustments to the proposed legislation to ensure that they're able to withstand legal challenges and hold up. If for some reason through the process of these things going through the courts, we don't believe that they'd be lawful. Obviously, that would affect whether we move forward with seeking these rights of first refusal or not. But as we sit here today, we do believe both in Missouri and Illinois that these rights of first refusal really are very beneficial to our customers and communities. I think we just talked about this [indiscernible] that we won, which was this Orient-Denny-Fairport project. And I think it just goes to show that we are a low-cost constructor. We are a low-cost operator. And we do believe that these projects have very good value for customers. And when MISO puts these forward Tranche 1, I mean what's to come in Tranche 2, these projects have very good benefit to cost ratios. And by not assigning those to the incumbent transmission operator by putting them out for bid, you're delaying those benefits to customers by two years or so. And again, we've certainly demonstrated we're a low-cost provider. So we do think that these rights of first refusal are in the best interest of our customers. The citizens of both the states of Illinois and Missouri. And we look forward to working with stakeholders as we move towards the next legislative session to really build a stronger coalition and make sure people really understand the value, and we'll work with all stakeholders to put forward legislation that we think not only can pass, it should pass, but can withstand any core challenges. So back to your question, Paul, we'll continue to monitor these cases as we have and adjust as needed."
},
{
"speaker": "Paul Patterson",
"text": "Okay. And absolutely, I hear you on your ability to demonstrate your competitiveness and stuff. But just I guess what I'm saying -- I guess what I'm asking about is the Supreme Court, I guess, what I'm wondering is would that invalidate ROFRs? Do you follow what I'm saying -- I mean across the country? Or do you see this as being specific to -- I mean I guess what I'm saying -- I don't know stands an industry question, if you follow me to sort of -- I'm trying to figure out for my own edification or like what happens if it is in [indiscernible] I guess that would mean the Fifth Circuit would stand. And if that is the case, what -- how do we think about the ROFR people where I'm coming from?"
},
{
"speaker": "Marty Lyons",
"text": "Well, I do. And I guess we'd have to see how the Supreme Court rules, what they say. But when -- we talked about this a little bit on the last call. When we looked at Texas, we thought it was really more applicable to the situation in Texas whereas when we looked at crafting the rights of first refusal we've been putting forward more aligned with states where the ROFRs have been upheld in the courts. So I think we'd ultimately have to look at the ultimate -- the Supreme Court decision and its applicability. But I guess I can't really comment further at this time, Paul."
},
{
"speaker": "Paul Patterson",
"text": "I got you. I appreciate. Thanks so much and thanks."
},
{
"speaker": "Marty Lyons",
"text": "You bet. Thank you. See you soon."
},
{
"speaker": "Operator",
"text": "Our final question comes from Anthony Crowdell with Mizuho. Please proceed with your question."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning. Thanks for squeezing me in. Just hopefully an easy one. You talked a lot about the financing plan. It seems like it's intact. A lot of capital opportunities, rate base opportunities. I'm just wondering what do you think is the most challenging part of the play that you have?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Hey, Anthony, it's Michael. Look, I think it's just about continued execution around all these projects, right? I mean I think we got some robust rate base growth, 8.4%, as you just noted, $20 billion of capital plans. We got to continue to execute these wells, get them into service, make sure we realize all the benefits associated with them. Obviously, we're in a different financing environment today than we were a couple of years ago. So that creates some headwinds you've got to continue to work through. But I mean ultimately, I think we talked about this in the past, we've got a number of mechanisms to recover those financing costs pretty rapidly through both on the Illinois side. We can always accelerate some rate reviews that we needed to on the Missouri side. But at the end of the day, I think it's really -- this comes back down to just an affordability opportunities just making sure that we keep cost as low as we possibly can for customers as we work through this incredibly important clean energy transition. Marty, anything to add to that?"
},
{
"speaker": "Marty Lyons",
"text": "No, I think that's well covered. Anthony, any other questions?"
},
{
"speaker": "Anthony Crowdell",
"text": "No, I'm good. Thank you so much. I'll catch you guys up in Phoenix."
},
{
"speaker": "Marty Lyons",
"text": "Look forward to seeing you."
},
{
"speaker": "Michael Moehn",
"text": "See you next week."
},
{
"speaker": "Operator",
"text": "Mr. Lyons, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Well, thank you all for joining us today. Once again, I apologize for the technical difficulties, some of your experiences -- you experienced, and as I mentioned, we'll make sure that we opposed a replay of this call as quickly as possible. I think what you heard today is we have really had a strong start to 2023. We've gotten through these important summer months. And just with just a couple of months left, remain very confident in our ability to achieve our earnings per share growth goals for this year and earnings per share range that we've outlined today. We make sure that we're focused on continuing to deliver strong value, both for our customers, our communities as well as for our shareholders. As we underscore today, we continue to expect 6% to 8% earnings per share growth for '23 to '27. It's supported by strong investment in rate-regulated infrastructure and rate base growth of 80.4% compound annually from 2022 to 2027. So we feel very good about our execution of our plan, and I thank you all for joining us, and we look forward to seeing you all soon. Have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's teleconference. You may disconnect your lines at this time, and we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 2 | 2,023 | 2023-08-03 10:00:00 | Operator: Greetings and welcome to Ameren Corporation's Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you and good morning. On the call with me today are Marty Lyons, our President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer, as well as the other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage. That will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance, and similar matters which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here's Marty, who will start on page four.
Marty Lyons: Thanks, Andrew. Good morning, everyone, and thank you for joining us today. Before we cover our second quarter earnings results, I would like to discuss a series of major storm events which occurred in late June and July and disrupted power to a significant number of our electric customers across Illinois and Missouri. Collectively, this was the worst month for storm events Ameren has experienced in approximately 15-years. I would like to thank our customers for their patience as we work to restore their power. I'm also grateful for and proud of the Ameren team. Importantly, our team worked hundreds of thousands of man hours in challenging conditions with no significant employee injuries. These outages emphasize why we believe continued investment in grid reliability and resiliency remains as important and necessary as ever for our customers, which brings me to page four. Our dedicated team will continue to execute our strategic plan across all of our business segments, which entails proactively investing in energy infrastructure to deliver safe, reliable, clean, and affordable electric and natural gas services to our customers. And moving to page five. Our strategic plan, integrates our strong sustainability value proposition, balancing the four pillars of environmental stewardship, positive social impact, strong governance, and sustainable growth. Here we summarize some of the many things we are doing for our customers, communities, co-workers, and shareholders. And today, we published our updated sustainability investor presentation called Leading the Way to a Sustainable Energy Future, available at amereninvestors.com, which more fully details how we have been effectively integrating our sustainability values and practices into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. Turning to page six. Yesterday, we announced second quarter 2023 earnings of $0.90 per share, compared to earnings of $0.80 per share in the second quarter of 2022. The key drivers of our second quarter results are outlined on this slide. As a result of our strong execution in the first-half of the year, I'm pleased to report that we remain on track to deliver within our 2023 earnings guidance range of $4.25 per share to $4.45 per share. Moving to page seven. On our call in February, I highlighted some of our key strategic business objectives for 2023. We continue to make great progress as a result of our team's dedication. Outlined on page eight, are a few key accomplishments this quarter. As you can see on the right side of this page, we've invested significant capital in each of our business segments during the first-half of this year, increasing spending nearly 20%, compared to the year ago period. These investments will continue to improve the reliability, resiliency, safety, and efficiency of our system as we make a clean energy transition for the benefit of our customers. During these first six months of the year, Ameren Missouri installed over 175,000 smart meters, 147 smart switches, and 32 underground cable miles and energized eight upgraded substations. Over 75% of our Ameren Missouri electric customers now have smart meters, allowing for better understanding of energy usage and choice amongst several time-of-use rates offered. In Illinois, our customers are benefiting from over 3,700 new or reinforced electric poles and 91 new smart switches on electric distribution circuits year-to-date, and we continue to focus on replacing mechanically-coupled gas service pipes. Further, our transmission business completed a total of 117 projects in the first-half of the year, including line rebuilds, new transmission circuits, transformer replacements, generator interconnections, and other upgrades to aging infrastructure, supporting the economic delivery of renewable energy resources for our customers, as well as the overall resiliency of the transmission system. This includes the transmission portion of our Intelligrid program which was completed this spring. Ameren's Intelligrid network is a safe and secure private telecommunications network, which enables the full functionality of smart grid technologies, giving Ameren greater awareness of system conditions, potentially reducing outage frequencies, and durations to milliseconds instead of minutes or hours. As a result, it will reduce costs and wait times for customers. I'd like to express my appreciation for the Ameren team's dedication, hard work, and collaboration so far this year to deliver value for our customers. Moving on to regulatory matters. In June, the Missouri Public Service Commission approved constructive settlement terms of the Ameren Missouri electric rate review, which called for a $140 million annual revenue increase. New customer rates were effective July 9, representing an increase of approximately 2% compounded annually since April 1, 2017 prior to Ameren Missouri adopting plant-in-service accounting, or PISA. PISA, which is effective through at least 2028, allows Ameren Missouri to make meaningful and timely infrastructure investments, providing significant benefits to our customers. We also continue to make progress on the clean energy transition through the addition of solar to our generation portfolio. Moving to Ameren Illinois. Our team has been working diligently with key stakeholders in our ongoing electric distribution multi-year rate plan, or MYRP, and natural gas rate reviews. We filed rebuttal -- answer rebuttal testimony in June and July, respectively, and are encouraged by the constructive progress made to date. Michael will discuss these in more detail in a moment. In June, the Ameren Illinois beneficial electrification plan approved by the commission in March was updated to include $65 million through 2025 for programs, incentives, and rates encouraging electric vehicle adoption and infrastructure development. In legislative matters, we were supportive of the transmission efficiency and cooperation law, or House Bill 3445, which was passed by the Illinois General Assembly in May. This bill would support timely and cost-effective construction of transmission projects, which I will touch on more on the next slide. Moving onto operational matters. We remain focused on keeping customer bills as low as possible through disciplined cost management, continuous improvement, and optimizing our operating performance as we transform our business through investment to ensure we sustainably provide safe, reliable, and cleaner energy for our customers. Finally, in early May, the Callaway Energy Center was brought back online following a brief planned maintenance outage, which was completed safely and on schedule. The next scheduled Callaway refueling and maintenance outage is planned for this fall. Turning to page nine. As I just mentioned, in May, the Illinois General Assembly passed House Bill 3445 or the transmission efficiency and cooperation law which, if enacted, would provide incumbent utilities, including Ameren, the right of first refusal to build MISO long-range transmission planning projects approved by year end 2024. If enacted, HB 3445 will support the clean energy transition, benefiting our Illinois customers and communities and the broader MISO region. As the local utility, we believe we are well-positioned to efficiently build, operate, and maintain these transmission assets over time. The right of first refusal allows for the construction process to begin sooner and the resulting customer benefits to be realized much quicker. Importantly, we competitively bid each component of our projects and utilized local suppliers and contractors who support the local economy. In addition, we have long-term relationships with key stakeholders in the region and work closely with landowners and communities when citing transmission lines. The bill supports the timely and cost-effective construction of the MISO long-range transmission projects, including one Tranche 1 project approved in July 2022 and Tranche 2 projects expected to be approved in the first-half of 2024. The legislation was sent to the Governor for signature on June 22, who has until August 21 to sign, veto, or abstain from acting on the bill. Should the Governor abstain, the bill will automatically become law. Turning to page 10. As we've discussed in the past, MISO completed a study outlining a potential road map of transmission projects through 2039. Detailed project planning, design work, and procurement for the Tranche 1 projects assigned to Ameren is underway, and we expect construction to begin in 2026. MISO requests for a proposal for its estimated $700 million of Tranche 1 competitive projects have been issued. We submitted our first bid related to the Orient-Denny-Fairport in May. The remaining two bids are due in October and November of this year. The proposal and evaluation process for the competitive projects is expected to take place over the course of 2023 and into mid-2024. Looking ahead to Tranche 2, MISO's analysis of potential projects is well underway and will continue for the remainder of the year and into next year. MISO anticipates the Tranche 2 portfolio of projects will be approved in the first-half of 2024. Continued investment in transmission is needed to facilitate the transfer capability of energy across the region as more dispatchable generation retires and renewables come online. On another matter related to MISO, an independent review was completed in July at the request of the ICC, which evaluated the benefits of Ameren Illinois' continued participation in MISO, compared to the PJM Interconnection regional transmission organization. The study considered reliability, resource adequacy, resiliency, affordability, equity, environmental impact, and general health, safety and welfare of Illinois residents. In conclusion, the independent consultant determine that Ameren Illinois remaining in MISO avoids significant economic costs for the customers of Ameren Illinois and Illinois residents more broadly. Before moving on, I'm happy to say that the Illinois Power Agency's procurement events this past May, which set energy and capacity prices from June 1, 2023 through May 31, 2024, resulted in significantly lower prices compared to last year. In fact, we expect a decline of over 25% in Ameren Illinois' Basic Generation Service rate. For customers taking power from Ameren Illinois, assuming normal weather, this could result in double-digit percentage decreases on their overall electric bill providing welcome relief for customers. Moving now to page 11. As laid out in our June 2022 Missouri Integrated Resource Plan, or IRP, we're taking a thoughtful and measured approach to investing in new generation as our older energy centers near retirement. In support of this transition, we were pleased with the Missouri PSC approvals of certificates of convenience and necessity, or CCNs, for the Huck Finn Solar Project in February and the Boomtown Solar Project in April. Construction of Boomtown began in July and construction of Huck Finn is expected to begin in October. In June, we filed with the Missouri PSC for four additional CCNs totaling 550 megawatts of new solar generation across our service territory. These projects support our ongoing generation transformation, which calls for adding 2,800 megawatts of renewable generation by 2030, while maintaining the reliability and affordability our customers expect. These projects will bring over 900 new construction jobs and additional tax revenues and other payments to the area. Subject to approval, these solar projects are expected to go in service between 2024 and 2026. While the Missouri PSC is under no deadline to issue an order on these CCN filings, we expect decisions in the first quarter of 2024. Ameren Missouri is in the process of finalizing its next IRP, and we look forward to filing it with the Missouri PSC by the end of September. We believe the plan filed in 2022 includes a balanced and measured approach to adding renewables over time. As we continue the transition to a cleaner and more diverse generation portfolio, we are focused on reliability of the system, in particular in the hot summer and cold winter months. As a result, we are evaluating the need for more dispatchable energy prior to 2030, which is also consistent with MISO's view of future generation capacity needs in our region. On page 12, we look ahead to the next decade. We have a robust pipeline of investment opportunities, totaling more than $48 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter, and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Turning to page 13. In February, we updated our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2023 through 2027. This earnings growth is primarily driven by our strong compound annual rate base growth of 8.4%, supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you, all, for joining us today, and I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to page 15 of our presentation. Yesterday, we reported second quarter 2023 earnings of $0.90 per share, compared to $0.80 per share for the year-ago quarter. This page summarizes key drivers impacting earnings at each segment. As you can see under our constructive regulatory frameworks, we experienced earnings growth driven by increased investments in infrastructure in all of our business segments. Ameren Missouri earnings were negatively impacted by normal temperatures in the quarter, compared to warmer-than-normal temperatures in the year-ago period. We were still able to deliver a strong earnings performance during the quarter as a result of our diverse business mix and disciplined cost management. Before moving on, I'll touch on sales trends for Ameren Missouri and Ameren Illinois electric distribution. Year-to-date weather-normalized kilowatt-hour sales to Missouri residential and industrial customers decreased about 1% and 2.5%, respectively. Year-to-date weather normalized kilowatt hour sales to Missouri commercial customers increased about 0.5%. The modest decline in residential sales year-over-year were expected as more people return to the office, yet there has been nearly a 4% increase in residential sales as compared to pre-pandemic levels. Year-to-date weather normalized kilowatt hour sales to Illinois customers have declined about 3.5%, compared to last year. Recall that changes in Illinois electric sales, no matter the cause, do not affect our earnings, since we have full revenue decoupling. On the economic development front, there have been several announcements to build or expand within our territory. In Missouri, Boeing plans for nearly $2 billion expansion of its aerospace program and would create 500 new jobs. In addition, ICL Group plans to expand their lithium battery material manufacturing plant in St. Louis, which will support the production of EV batteries and will be the first large-scale plant of its type in the country, creating an additional 165 jobs. I'm pleased to say that we continue to see a strong labor market in Missouri, with an unemployment rate of 2.6%, well below the national average. And in Illinois, Manner Polymers and the Prysmian Group announced plans to build facilities manufacturing electric vehicle components and renewable energy cable, which collectively would create nearly a 150 jobs in the state. Moving to page 16. Yesterday, we reaffirmed our 2023 earnings guidance range of $4.25 to $4.45 per share. On this page, we've highlighted select considerations impacting our 2023 earnings guidance for the remainder of the year. These are supplemental to the key drivers and assumptions discussed on our earnings call in February. I encourage you to take these into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Turning now to page 17, I'll provide an update on our regulatory rate proceedings. In June, the Missouri PSC approved a stipulation and agreement in our Ameren Missouri electric rate review for $140 million annual revenue increase. The agreement was a black box settlement and did not specify certain details including return on equity, capital structure, or rate base. The agreement did provide for the continuation of key trackers and riders, including the fuel adjustment clause. New electric service rates were effective July 9th. In other Missouri regulatory matters, in preparation for the planned retirement of our Rush Island Energy Center, last week Ameren has already filed a 60-day notice with the Missouri PSC for the securitization on costs associated with the Rush Island Energy Center. We will seek to finance the costs associated with the retirement, including our remaining net book value of the Rush Island Energy Center through the securitization. As of June 30, 2023, the net book value was approximately $550 million. We expect to file our petition seeking commission approval of the securitization as early as the fourth quarter of this year. Once filed, the regulatory proceedings are expected to take up to seven months to complete. Moving to Page 18, in January, Ameren Illinois electric distribution filed its first multi-year rate plan, or MYRP, with the ICC. Our MYRP is designed around three key elements: Providing safe and reliable energy to our customers, deploying capital in a way that achieves the Climate and Equitable Jobs Act objectives as included in our performance metrics, and fulfilling the clean energy transition by preparing our system to accept more renewables and electric vehicles over time. The MYRP details a grid modernization plan that includes our planned electric distribution investments and supports our annual revenue increase request for the next four years. On July 13, the ICC staff filed a rebuttal testimony recommending a cumulative increase of $317 million in revenue for 2024 through 2027. This includes a return on equity of 8.9%, reflecting the 2022 average 30-year treasury rate, plus 580 basis points. If adopted, staff suggested the return on equity would be updated annually. It also includes a 50% equity ratio. On July 27, Ameren Illinois updated its request for a cumulative increase of $448 million in revenues. This increase includes a return on equity of 10.5% and an equity ratio of 54%. The variance in the Ameren Illinois’ cumulative request and the staff's recommended accumulative increase is driven primarily by the return on equity and the common equity ratio, which makes up $81 million of the $131 million variance. An ICC decision is required by December 2023 with new rates effective by January 2024. Turning to page 19. In April, we filed our electric distribution annual rate reconciliation following to reconcile the 2022 revenue requirement to actual cost. In late June, the ICC staff recommended a $109 million base rate increase, compared to our updated request of $125 million base rate increase. The $16 million variance is primarily driven by a difference in the common equity ratio as we have proposed 54%, compared to the ICC staff's recommended 50%. An ICC decision is required by December 2023 and the full amount will be collected from customers in 2024. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois natural gas distribution rates using a 2024 future test year. In July, we filed a third rebuttal testimony requesting $148 million increase based on a 10.3% ROE, a 54% equity ratio, and a $2.9 billion rate base. Staff has recommended a $128 million increase reflecting a 9.9% return on equity and a 50% equity ratio. Other interveners have recommended an increase of $98 million to a $106 million, reflecting a 9.5% return on equity and a 52% equity ratio. An ICC decision is required by late November 2023 with rates expected to be effective in early December of this year. On page 20, we provide a financing update. We continue to feel very good about our financial position. On May 31, Ameren Illinois issued $500 million of 4.95% first mortgage bonds due in 2033. Proceeds of this offering were used to repay a portion of a short-term debt and to repay a $100 million, or 0.375% first mortgage bonds that matured June 15. Further, in order for us to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity, consisting of approximately $3.2 million shares by the end of this year. These shares were previously sold forward under our ATM equity program. Additionally, we have begun to enter into forward sales agreements to support our 2024 equity needs. As of June 30, approximately $92 million of the $500 million of equity outlined for 2024 has been sold forward under the program. Together with the issuance under our 401(k) and DRPlus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. And turning to page 21. We're off to a strong start and well-positioned to continue executing our plan. We expect to deliver strong earnings growth in 2023 and over the long term, driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend and total shareholder return story. This concludes our prepared remarks. We now invite your questions.
Operator: Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Julien Dumoulin-Smith: Hey, good morning, team. Thanks so much for the time. Appreciate it. Thanks for all the comments. Maybe just kicking this thing up on the Rush Island side of the equation. Just with the book value, it seems like that $550 million. Can you comment a little bit on the size of the securitization and maybe the offset to that, if you will, when you think about the additional transmission rate base opportunities in otherwise you articulated? Just thinking about the timing and the net puts and takes here, if you will.
Michael Moehn: Yes. Hey, good morning, Julien. I appreciate the question. This is Michael. Yes, from an overall amount, I mean, again, we provide that book value of $550 million, again, this will be probably a year from now. But you should think roughly in those lines. I mean, around $500 million would be some depreciation, etc., that will occur. There's couple of items that get incorporate into that like inventory, etc. But around $500 million. And I think as we've talked about in the past and then we have a lot of flexibility here in terms of what we do with that, in terms of additional investments. It's really not restricted. It just really needs to go back into infrastructure. We obviously can use it to buyback, debt, and other things as well. But I mean given our capital plan, there's lots to do there. I think from a timing perspective, that's what -- we're being very thoughtful about trying to determine the actual retirement date itself, get this well in advance of that to give us plenty of time to make sure that we continue to replace that rate base over time and avoid any sort of earnings hit there. Hopefully, that helps.
Julien Dumoulin-Smith: No, absolutely. Thanks, again. And then just when you think about the offsets here, just to push a little bit further on that, right, Rush Island, okay, securitization, one year out. Obviously, you alluded to a few different things there. Transmission probably being the single most notable element of what you talked about a moment ago. Can you maybe elaborate a little bit what HB 3445, if I got the number right, does? And then separately, just on the timing for Trance 2, I mean, what opportunity you see there as well, right, I mean -- and/or competitive pieces from Tranche 1? Just trying to think about, like, again, that emphasis on the puts and especially here the opportunities.
Marty Lyons: Hey, Julien. This is Marty. Hey, thanks, again, for your questions. Just to first tack on to what Michael said and then answer some of your specific questions, but when we planned out our capital expenditures for this five years and we looked at the timing and amount on a year-by-year basis, we were thoughtful about the potential timing of this Rush Island closure and securitization filing. And so, within that, we had already timed some of our capital expenditures in a thoughtful manner to, as Michael said, ensure that as Rush Island comes out of rate base, that we don't have any kink, if you will, in the trajectory of our rate base growth and our earnings growth. So, some of that's already baked into our plan, Julien, I guess, first and foremost. Now you did ask about some of the transmission investment, and specifically about, the legislation coming through Illinois, the transmission efficiency and cooperation law, which was HB 3445 that you referenced. There, as we explained in our prepared remarks, the General Assembly passed that legislation in May of this year. And now it's really on the Governor's desk for his potential signature. So, it got to the Governor on -- in late June, June 22, and he has 60-days, which means the decision deadline for the Governor is August 21. And if you were to sign that, that would mean that the one Tranche 1 project in Illinois would come to us, and then any Tranche 2 projects that were approved in the first-half of '24, that's our expectation, but anytime in 2024 would also come to us as the incumbent transmission owner. Now, the Governor has expressed some concerns about that legislation. So, it's unsure what actions he will take. I'll tell you that supporters of the bill, including ourselves, continue to share the benefits of the legislation and hopefully address his concerns. If he signs the law, obviously, the bill obviously becomes law. And as we mentioned in our prepared remarks, if he takes no action, that bill becomes law as well. So, we'll see what action he ultimately takes. But we continue to believe that, that right of first refusal is really in the best interests of our customers and the residents of the State of Illinois. Then you just mentioned on overall what MISO is doing in terms of these projects. Again, as you know, MISO is evaluating what projects might come out of Tranche 2. I will say there that we continue to believe that the work that they're doing point to an overall portfolio that would be larger than what they approved in part of Tranche 1. And that's really because, as they've gone through this analysis, one of the things, obviously, that's come to fruition is the IRA legislation in D.C., which means that we expect more renewables than had previously been expected. And so, MISO is planning towards something that's between sort of a Future 2 and Future 3. And again, we expect that they'll continue to work through that. It's premature to say exactly how large that portfolio will be or exactly what transmission projects may fall into our service territories in Illinois or Missouri. But MISO continues to believe that they'll approve those projects in the first half of next year.
Julien Dumoulin-Smith: Got it. Excellent, thank you for the thoughtful response, guys. Really appreciate it. Take care [Multiple Speakers]
Marty Lyons: Thanks, Julien.
Michael Moehn: Thanks, Julien.
Operator: Our next question comes from Paul Patterson with Glenrock Associates. Please proceed with your question.
Paul Patterson: Hey, good morning, guys.
Marty Lyons: Good morning, Paul.
Paul Patterson: So, just to follow up on Julien's questions about the ROFR, I know that you guys are involved in -- I apologize, but what I was wondering is that the Supreme Court and this Fifth Circuit decision regarding the ROFR in Texas, do you think that could have any wider implications in the country if it's allowed to stand?
Marty Lyons: Julien -- or, sorry, Paul, I apologize. Paul, it's a -- yes, it's okay. I apologize, again. But look, it's -- some of the actions that have been taken in various states seem to be particular to the way that legislation was passed or -- and so, look, we're going to continue to pursue it. We think that if the Governor were to sign this into law, it would be applicable and applicable too, as we've said before, both to MISO Tranche 1 projects, as well as Tranche 2 projects that are approved in 2024. So, look, I guess, time will tell, but I think that as we sit here today, we think this would stand.
Paul Patterson: You think it would stand. So, I got you. So, in other words, if the Fifth Circuit, which is a Texas situation, you don't think would apply to Illinois because of the individual walls that were -- because of the differences -- if I understand you correctly, tell me if I'm wrong, because of the differences between the Texas law and what passed in Illinois assuming that it's signed. Is that right?
Marty Lyons: I do believe that.
Paul Patterson: Okay. That's great. Thanks so much.
Marty Lyons: Thanks, Paul.
Operator: Our next question comes from Jeremy Tonet, J.P. Morgan. Please proceed with your question.
Jeremy Tonet: Hi, good morning.
Marty Lyons: Hey, good morning, Jeremy.
Michael Moehn: Hey, Jeremy.
Jeremy Tonet: Hey. Just wanted to dial into Illinois a little bit more if we could, and I know that you touched on your commentary. But just wondering if it's possible to provide any more color on updates in the Illinois electric rate case. And just maybe how the tone of conversations with regulators and stakeholders have been trending recently.
Marty Lyons: Yes. I think that maybe I'll start and perhaps Michael would want to tack on here as well. This is Marty. I think what you heard in our prepared remarks, again, is that we really feel like we're working constructively with stakeholders as we work through this process. Of course, this is the first multi-year grid and multi-year rate filing. And so, as to be expected, you're going have to work through some of the mechanics. But ultimately, I still believe that we're going to get to a constructive outcome, something that accomplishes the policy goals that [CEJA] (ph) had for the state. And you'll notice that when we started this -- down this path and direct testimony, the ICC staff's recommendation was about 56% of our overall ask. And through the rounds of testimony and additional support that we've been able to provide with the staff, we've been able to work constructively with them to were there suggested revenue increase now is about 70% of our request. So, we've made positive progress there. In our slides, we detailed that there's still a difference between our recommended -- or, requested cumulative increase in that recommended by the staff. And that difference is about $131 million over that four-year period. And we broke down some of the components for you. So, look, we're going to continue to work constructively with stakeholders. And like I said, I think we'll be able to get to a constructive outcome. And importantly, that accomplishes the policy goals of CEJA. So, I don't know if you have any more specific questions, or Michael, you want to add something?
Michael Moehn: Yes. Just a couple of comments, Marty, a good overview. And I -- look, I do think the team has collectively, between us and staff and others, continue to work very collaboratively, trying to really work through these issues. I think we all want the best answer, obviously, for customers, making sure that we're delivering on all of the policy objectives that Marty talked about, that CEJA is really wanting to achieve as well. And I think as Marty talked about, that difference today of about $131 million, about 62% of that is really tied up in ROE and cap structure. And so, there is this sort of fundamental difference on ROE today. They're still recommending the old formula that was approved under EMIA, which was basically 580 basis points plus the 30-year treasury versus we really think the law says, look, it's a cost of equity determined by the commission under -- their authority under the laws of the state that govern these rate reviews. But I mean, even putting that aside, I think the important thing to remember too, if you took a current mark on that ROE today at 580 basis points, I mean, it's something approaching 10. And I think the only other point I would make too, is I think -- and under kind of traditional cost of capital, under like a CAPN or DCF, the staff did also point out, I think they would have been at about 10.02 but then revert it back to this formula. So anyway, I gave you those details because I think it does kind of narrow a lot of the issues in terms of where the difference is, Jeremy.
Jeremy Tonet: Got it. That's very helpful. And maybe a follow-up to peel back a little bit more, if I can, if there is anything left that can be said here. Just specifically with regards to your rebuttal strategy on the notably lower-than-expected ROE, the $700 million capital discrepancy, $100 million medical OPEB overfunded balance. Just wondering if you could speak to any changes in receptivity overall given Ameren's rebuttal?
Michael Moehn: Yes, Hey Jeremy, this is Michael again. Yes, I mean, just again to be clear, I think that receptivity has shown in the fact that I think we've closed that gap. So you continue -- you referred to the $700 million gap. I'd say that gap is about $350 million today. So I mean, there's been some good work that's been done on both sides to agree that, look, here's some additional support and go ahead and accept those. That really ultimately -- Marty mentioned going from 56% to 70% of the ask, that was really a large part of it. The other items that you noted are still out there, the post-retirement issue that we'll continue to argue for, we do think that it should be included. Customers are benefiting from this. It's an overfunded plan. It's throwing off gains that are actually reducing rates for customers, et cetera. We're going to continue to make those arguments, and we'll see ultimately where it goes through the process over the next couple of months.
Jeremy Tonet: Got it. That's very helpful. One just quick last one, if I could. With the decrease in energy prices, as we've seen, has bid pressure kind of faded from the conversations with the public and policymakers? Or is it still front of mind in discussions?
Michael Moehn: No, look, I mean, I think the overall backdrop is much better today I mean, given what's happened with commodity prices both on the natural gas side. And so you've actually already seen some of those benefits start rolling through on the PGAs, et cetera. I think we've talked about that. And then certainly, some of these capacity auctions and the corresponding energy auctions are certainly providing relief to customers. That's always a good thing to see, right, in terms of just making sure that we're trying to get the lowest possible bill for customers. So I'd say it's less of a conversation today and it's a good tailwind as we think about the future.
Jeremy Tonet: Got it. That makes sense. That’s helpful. I’ll leave it there. Thanks.
Michael Moehn: Okay. Thanks, Jeremy.
Operator: Our next question comes from Sophie Karp with KeyBanc Capital Markets. Please proceed with your question.
Sophie Karp: Hi, good morning and thank you for taking my question. [Multiple Speakers] too in this Illinois situation little more? The -- and you provided a lot of color already, but I'm just curious if you think there's a legitimate legal argument as to why the old formula should be used in the new framework, why the staff is taken to that gold formula here.
Marty Lyons: Yes. Sophie, this is Marty. One of the things CEJA called for in the legislation was that the cost of equity be determined consistent with commission practice and law. And we believe that means the use of traditional methods like capital asset pricing model, discounted cash flow analysis, IEIMA which was the prior legislation, had some very explicit language that required the use of formulaic. So we've certainly argued that the intent of CEJA was for the commission to use its traditional methodology. And I would note there that the staff and their testimony as part of the multiyear rate plan, instead of that traditional CAPM and DCF kind of analysis was used that they would get an ROE of about 10.02 as a recommendation. And of course, in our gas rate case that's pending, the staff there recommending a 9.89. So at the end of the day, that's what we're hanging our head on is that we believe that CEJA called for the use of that kind of methodology.
Sophie Karp: Got it, got it. Thank you. And then -- maybe if I can ask a solar question. I'm just curious on your Missouri solar projects, particularly the ones that yourself building or participate in building them, how are you thinking about your procurement strategy with respect to potentially getting adders for domestic content and things like that. Does that influence your decision as to what equipment you're going to procure for these?
Marty Lyons: Yes. Sophie, it certainly does. So as you saw in our slides in terms of our build-out, we do plan to have projects that are build transfer agreements that are built by developers, projects that are developed to a certain point and then we procure them and finalize the construction ourselves and then some self-build. And certainly, we're taking a host of considerations into account when we look at where these projects are being built and what they're being built with. And so if we can take advantage of a site that provides us with incremental tax credit opportunities, we'll do that. If we can take advantage of procurement strategies that -- resources that allow us to maximize the value of credits, we're going to do that. So at the end of the day, our goal with this is to build a portfolio of projects that really provides a good diversity, low cost for our customers, reliability for our customers. And we'll look to maximize those tax credits to the extent possible to again deliver the lowest present value of revenue requirements for our customers.
Sophie Karp: Great. Thank you. And do you expect to self-consume those tax credits? Or would you be looking to monetize them to the third party?
Michael Moehn: Ultimately, I think it's a combination of both, Sophie. I mean, we're not sitting on a lot of credit today. But I mean, as we build into these, certainly again we'll be very thoughtful about. We've been very involved in these issues on transferability and get a clarification working through some of these rating agency issues, et cetera. But I absolutely think that it could be a combination of both as we move forward.
Sophie Karp: Thank you so much. That’s all from me.
Michael Moehn: You bet. Thanks.
Operator: [Operator Instructions] Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question.
Julien Dumoulin-Smith: Hey, guys. I was worried it was going to end earlier. I wanted to squeeze in a couple here. Look, I wanted to come back to what was being discussed on Illinois real quickly. Do you have any thoughts about Illinois gas here? I know that's very preliminary, but it seems like there could be some conversations going into '24 on perhaps reform that might look akin to Colorado or something like that, But you -- or Minnesota at that. But you guys tell me, what are you guys hearing or seeing on any front there.
Marty Lyons: Yes, Julien, in terms of legislation for next year, I can't say that there's anything percolating right now that we're aware of or involved in. I think that right now, our focus obviously is on this Illinois multiyear rate plan on the electric side. And also getting a constructive resolution of our pending Illinois gas case. And so that's our focus right now. I know in the past, there was some discussion around QIP, but of course, that's expiring at the end of this year. And right now, we think we're positioned well as we utilize the forward rate cases in Illinois for our gas business. So really nothing to share with you on that front right now, Julien.
Julien Dumoulin-Smith: All right. Fair enough. And obviously, you've got these new CCNs going on the Missouri side. Just any lessons learned from Boomtown, Huck, et cetera?
Marty Lyons: I don't think there are any specific lessons learned. We were certainly pleased to receive the commission's authorization to move forward with Huck and Boomtown and pleased with the orders received and the resolution of those. So I wouldn't say there's any specific lesson learned. We think all four of the projects that we have proposed are excellent projects for the benefit of our customers and move us along the path towards the investments that were laid out in our 2022 IRP. And we've got another IRP that we plan to file this September. And certainly, we think those projects are consistent with the path that we'll lay out as part of that IRP as well.
Julien Dumoulin-Smith: Awesome. Alright, guys. Super quick. Thank you.
Marty Lyons: Thank you, Julien.
Operator: It appears that there are no further questions at this time. I would now like to turn the floor back over to Marty Lyons for closing remarks.
Marty Lyons: Yes. Terrific. Well, thank you all for joining us today. We had a strong first half of 2023, and we remain absolutely focused on strong execution for the remainder of this year. So we look forward to seeing many of you at conferences in the coming months, and thanks again, have great day.
Operator: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings and welcome to Ameren Corporation's Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you and good morning. On the call with me today are Marty Lyons, our President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer, as well as the other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage. That will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance, and similar matters which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here's Marty, who will start on page four."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us today. Before we cover our second quarter earnings results, I would like to discuss a series of major storm events which occurred in late June and July and disrupted power to a significant number of our electric customers across Illinois and Missouri. Collectively, this was the worst month for storm events Ameren has experienced in approximately 15-years. I would like to thank our customers for their patience as we work to restore their power. I'm also grateful for and proud of the Ameren team. Importantly, our team worked hundreds of thousands of man hours in challenging conditions with no significant employee injuries. These outages emphasize why we believe continued investment in grid reliability and resiliency remains as important and necessary as ever for our customers, which brings me to page four. Our dedicated team will continue to execute our strategic plan across all of our business segments, which entails proactively investing in energy infrastructure to deliver safe, reliable, clean, and affordable electric and natural gas services to our customers. And moving to page five. Our strategic plan, integrates our strong sustainability value proposition, balancing the four pillars of environmental stewardship, positive social impact, strong governance, and sustainable growth. Here we summarize some of the many things we are doing for our customers, communities, co-workers, and shareholders. And today, we published our updated sustainability investor presentation called Leading the Way to a Sustainable Energy Future, available at amereninvestors.com, which more fully details how we have been effectively integrating our sustainability values and practices into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. Turning to page six. Yesterday, we announced second quarter 2023 earnings of $0.90 per share, compared to earnings of $0.80 per share in the second quarter of 2022. The key drivers of our second quarter results are outlined on this slide. As a result of our strong execution in the first-half of the year, I'm pleased to report that we remain on track to deliver within our 2023 earnings guidance range of $4.25 per share to $4.45 per share. Moving to page seven. On our call in February, I highlighted some of our key strategic business objectives for 2023. We continue to make great progress as a result of our team's dedication. Outlined on page eight, are a few key accomplishments this quarter. As you can see on the right side of this page, we've invested significant capital in each of our business segments during the first-half of this year, increasing spending nearly 20%, compared to the year ago period. These investments will continue to improve the reliability, resiliency, safety, and efficiency of our system as we make a clean energy transition for the benefit of our customers. During these first six months of the year, Ameren Missouri installed over 175,000 smart meters, 147 smart switches, and 32 underground cable miles and energized eight upgraded substations. Over 75% of our Ameren Missouri electric customers now have smart meters, allowing for better understanding of energy usage and choice amongst several time-of-use rates offered. In Illinois, our customers are benefiting from over 3,700 new or reinforced electric poles and 91 new smart switches on electric distribution circuits year-to-date, and we continue to focus on replacing mechanically-coupled gas service pipes. Further, our transmission business completed a total of 117 projects in the first-half of the year, including line rebuilds, new transmission circuits, transformer replacements, generator interconnections, and other upgrades to aging infrastructure, supporting the economic delivery of renewable energy resources for our customers, as well as the overall resiliency of the transmission system. This includes the transmission portion of our Intelligrid program which was completed this spring. Ameren's Intelligrid network is a safe and secure private telecommunications network, which enables the full functionality of smart grid technologies, giving Ameren greater awareness of system conditions, potentially reducing outage frequencies, and durations to milliseconds instead of minutes or hours. As a result, it will reduce costs and wait times for customers. I'd like to express my appreciation for the Ameren team's dedication, hard work, and collaboration so far this year to deliver value for our customers. Moving on to regulatory matters. In June, the Missouri Public Service Commission approved constructive settlement terms of the Ameren Missouri electric rate review, which called for a $140 million annual revenue increase. New customer rates were effective July 9, representing an increase of approximately 2% compounded annually since April 1, 2017 prior to Ameren Missouri adopting plant-in-service accounting, or PISA. PISA, which is effective through at least 2028, allows Ameren Missouri to make meaningful and timely infrastructure investments, providing significant benefits to our customers. We also continue to make progress on the clean energy transition through the addition of solar to our generation portfolio. Moving to Ameren Illinois. Our team has been working diligently with key stakeholders in our ongoing electric distribution multi-year rate plan, or MYRP, and natural gas rate reviews. We filed rebuttal -- answer rebuttal testimony in June and July, respectively, and are encouraged by the constructive progress made to date. Michael will discuss these in more detail in a moment. In June, the Ameren Illinois beneficial electrification plan approved by the commission in March was updated to include $65 million through 2025 for programs, incentives, and rates encouraging electric vehicle adoption and infrastructure development. In legislative matters, we were supportive of the transmission efficiency and cooperation law, or House Bill 3445, which was passed by the Illinois General Assembly in May. This bill would support timely and cost-effective construction of transmission projects, which I will touch on more on the next slide. Moving onto operational matters. We remain focused on keeping customer bills as low as possible through disciplined cost management, continuous improvement, and optimizing our operating performance as we transform our business through investment to ensure we sustainably provide safe, reliable, and cleaner energy for our customers. Finally, in early May, the Callaway Energy Center was brought back online following a brief planned maintenance outage, which was completed safely and on schedule. The next scheduled Callaway refueling and maintenance outage is planned for this fall. Turning to page nine. As I just mentioned, in May, the Illinois General Assembly passed House Bill 3445 or the transmission efficiency and cooperation law which, if enacted, would provide incumbent utilities, including Ameren, the right of first refusal to build MISO long-range transmission planning projects approved by year end 2024. If enacted, HB 3445 will support the clean energy transition, benefiting our Illinois customers and communities and the broader MISO region. As the local utility, we believe we are well-positioned to efficiently build, operate, and maintain these transmission assets over time. The right of first refusal allows for the construction process to begin sooner and the resulting customer benefits to be realized much quicker. Importantly, we competitively bid each component of our projects and utilized local suppliers and contractors who support the local economy. In addition, we have long-term relationships with key stakeholders in the region and work closely with landowners and communities when citing transmission lines. The bill supports the timely and cost-effective construction of the MISO long-range transmission projects, including one Tranche 1 project approved in July 2022 and Tranche 2 projects expected to be approved in the first-half of 2024. The legislation was sent to the Governor for signature on June 22, who has until August 21 to sign, veto, or abstain from acting on the bill. Should the Governor abstain, the bill will automatically become law. Turning to page 10. As we've discussed in the past, MISO completed a study outlining a potential road map of transmission projects through 2039. Detailed project planning, design work, and procurement for the Tranche 1 projects assigned to Ameren is underway, and we expect construction to begin in 2026. MISO requests for a proposal for its estimated $700 million of Tranche 1 competitive projects have been issued. We submitted our first bid related to the Orient-Denny-Fairport in May. The remaining two bids are due in October and November of this year. The proposal and evaluation process for the competitive projects is expected to take place over the course of 2023 and into mid-2024. Looking ahead to Tranche 2, MISO's analysis of potential projects is well underway and will continue for the remainder of the year and into next year. MISO anticipates the Tranche 2 portfolio of projects will be approved in the first-half of 2024. Continued investment in transmission is needed to facilitate the transfer capability of energy across the region as more dispatchable generation retires and renewables come online. On another matter related to MISO, an independent review was completed in July at the request of the ICC, which evaluated the benefits of Ameren Illinois' continued participation in MISO, compared to the PJM Interconnection regional transmission organization. The study considered reliability, resource adequacy, resiliency, affordability, equity, environmental impact, and general health, safety and welfare of Illinois residents. In conclusion, the independent consultant determine that Ameren Illinois remaining in MISO avoids significant economic costs for the customers of Ameren Illinois and Illinois residents more broadly. Before moving on, I'm happy to say that the Illinois Power Agency's procurement events this past May, which set energy and capacity prices from June 1, 2023 through May 31, 2024, resulted in significantly lower prices compared to last year. In fact, we expect a decline of over 25% in Ameren Illinois' Basic Generation Service rate. For customers taking power from Ameren Illinois, assuming normal weather, this could result in double-digit percentage decreases on their overall electric bill providing welcome relief for customers. Moving now to page 11. As laid out in our June 2022 Missouri Integrated Resource Plan, or IRP, we're taking a thoughtful and measured approach to investing in new generation as our older energy centers near retirement. In support of this transition, we were pleased with the Missouri PSC approvals of certificates of convenience and necessity, or CCNs, for the Huck Finn Solar Project in February and the Boomtown Solar Project in April. Construction of Boomtown began in July and construction of Huck Finn is expected to begin in October. In June, we filed with the Missouri PSC for four additional CCNs totaling 550 megawatts of new solar generation across our service territory. These projects support our ongoing generation transformation, which calls for adding 2,800 megawatts of renewable generation by 2030, while maintaining the reliability and affordability our customers expect. These projects will bring over 900 new construction jobs and additional tax revenues and other payments to the area. Subject to approval, these solar projects are expected to go in service between 2024 and 2026. While the Missouri PSC is under no deadline to issue an order on these CCN filings, we expect decisions in the first quarter of 2024. Ameren Missouri is in the process of finalizing its next IRP, and we look forward to filing it with the Missouri PSC by the end of September. We believe the plan filed in 2022 includes a balanced and measured approach to adding renewables over time. As we continue the transition to a cleaner and more diverse generation portfolio, we are focused on reliability of the system, in particular in the hot summer and cold winter months. As a result, we are evaluating the need for more dispatchable energy prior to 2030, which is also consistent with MISO's view of future generation capacity needs in our region. On page 12, we look ahead to the next decade. We have a robust pipeline of investment opportunities, totaling more than $48 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter, and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Turning to page 13. In February, we updated our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2023 through 2027. This earnings growth is primarily driven by our strong compound annual rate base growth of 8.4%, supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return that compares favorably with our regulated utility peers. I'm confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you, all, for joining us today, and I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to page 15 of our presentation. Yesterday, we reported second quarter 2023 earnings of $0.90 per share, compared to $0.80 per share for the year-ago quarter. This page summarizes key drivers impacting earnings at each segment. As you can see under our constructive regulatory frameworks, we experienced earnings growth driven by increased investments in infrastructure in all of our business segments. Ameren Missouri earnings were negatively impacted by normal temperatures in the quarter, compared to warmer-than-normal temperatures in the year-ago period. We were still able to deliver a strong earnings performance during the quarter as a result of our diverse business mix and disciplined cost management. Before moving on, I'll touch on sales trends for Ameren Missouri and Ameren Illinois electric distribution. Year-to-date weather-normalized kilowatt-hour sales to Missouri residential and industrial customers decreased about 1% and 2.5%, respectively. Year-to-date weather normalized kilowatt hour sales to Missouri commercial customers increased about 0.5%. The modest decline in residential sales year-over-year were expected as more people return to the office, yet there has been nearly a 4% increase in residential sales as compared to pre-pandemic levels. Year-to-date weather normalized kilowatt hour sales to Illinois customers have declined about 3.5%, compared to last year. Recall that changes in Illinois electric sales, no matter the cause, do not affect our earnings, since we have full revenue decoupling. On the economic development front, there have been several announcements to build or expand within our territory. In Missouri, Boeing plans for nearly $2 billion expansion of its aerospace program and would create 500 new jobs. In addition, ICL Group plans to expand their lithium battery material manufacturing plant in St. Louis, which will support the production of EV batteries and will be the first large-scale plant of its type in the country, creating an additional 165 jobs. I'm pleased to say that we continue to see a strong labor market in Missouri, with an unemployment rate of 2.6%, well below the national average. And in Illinois, Manner Polymers and the Prysmian Group announced plans to build facilities manufacturing electric vehicle components and renewable energy cable, which collectively would create nearly a 150 jobs in the state. Moving to page 16. Yesterday, we reaffirmed our 2023 earnings guidance range of $4.25 to $4.45 per share. On this page, we've highlighted select considerations impacting our 2023 earnings guidance for the remainder of the year. These are supplemental to the key drivers and assumptions discussed on our earnings call in February. I encourage you to take these into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Turning now to page 17, I'll provide an update on our regulatory rate proceedings. In June, the Missouri PSC approved a stipulation and agreement in our Ameren Missouri electric rate review for $140 million annual revenue increase. The agreement was a black box settlement and did not specify certain details including return on equity, capital structure, or rate base. The agreement did provide for the continuation of key trackers and riders, including the fuel adjustment clause. New electric service rates were effective July 9th. In other Missouri regulatory matters, in preparation for the planned retirement of our Rush Island Energy Center, last week Ameren has already filed a 60-day notice with the Missouri PSC for the securitization on costs associated with the Rush Island Energy Center. We will seek to finance the costs associated with the retirement, including our remaining net book value of the Rush Island Energy Center through the securitization. As of June 30, 2023, the net book value was approximately $550 million. We expect to file our petition seeking commission approval of the securitization as early as the fourth quarter of this year. Once filed, the regulatory proceedings are expected to take up to seven months to complete. Moving to Page 18, in January, Ameren Illinois electric distribution filed its first multi-year rate plan, or MYRP, with the ICC. Our MYRP is designed around three key elements: Providing safe and reliable energy to our customers, deploying capital in a way that achieves the Climate and Equitable Jobs Act objectives as included in our performance metrics, and fulfilling the clean energy transition by preparing our system to accept more renewables and electric vehicles over time. The MYRP details a grid modernization plan that includes our planned electric distribution investments and supports our annual revenue increase request for the next four years. On July 13, the ICC staff filed a rebuttal testimony recommending a cumulative increase of $317 million in revenue for 2024 through 2027. This includes a return on equity of 8.9%, reflecting the 2022 average 30-year treasury rate, plus 580 basis points. If adopted, staff suggested the return on equity would be updated annually. It also includes a 50% equity ratio. On July 27, Ameren Illinois updated its request for a cumulative increase of $448 million in revenues. This increase includes a return on equity of 10.5% and an equity ratio of 54%. The variance in the Ameren Illinois’ cumulative request and the staff's recommended accumulative increase is driven primarily by the return on equity and the common equity ratio, which makes up $81 million of the $131 million variance. An ICC decision is required by December 2023 with new rates effective by January 2024. Turning to page 19. In April, we filed our electric distribution annual rate reconciliation following to reconcile the 2022 revenue requirement to actual cost. In late June, the ICC staff recommended a $109 million base rate increase, compared to our updated request of $125 million base rate increase. The $16 million variance is primarily driven by a difference in the common equity ratio as we have proposed 54%, compared to the ICC staff's recommended 50%. An ICC decision is required by December 2023 and the full amount will be collected from customers in 2024. Earlier this year, we also filed with the ICC for an annual increase in Ameren Illinois natural gas distribution rates using a 2024 future test year. In July, we filed a third rebuttal testimony requesting $148 million increase based on a 10.3% ROE, a 54% equity ratio, and a $2.9 billion rate base. Staff has recommended a $128 million increase reflecting a 9.9% return on equity and a 50% equity ratio. Other interveners have recommended an increase of $98 million to a $106 million, reflecting a 9.5% return on equity and a 52% equity ratio. An ICC decision is required by late November 2023 with rates expected to be effective in early December of this year. On page 20, we provide a financing update. We continue to feel very good about our financial position. On May 31, Ameren Illinois issued $500 million of 4.95% first mortgage bonds due in 2033. Proceeds of this offering were used to repay a portion of a short-term debt and to repay a $100 million, or 0.375% first mortgage bonds that matured June 15. Further, in order for us to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity, consisting of approximately $3.2 million shares by the end of this year. These shares were previously sold forward under our ATM equity program. Additionally, we have begun to enter into forward sales agreements to support our 2024 equity needs. As of June 30, approximately $92 million of the $500 million of equity outlined for 2024 has been sold forward under the program. Together with the issuance under our 401(k) and DRPlus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. And turning to page 21. We're off to a strong start and well-positioned to continue executing our plan. We expect to deliver strong earnings growth in 2023 and over the long term, driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend and total shareholder return story. This concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning, team. Thanks so much for the time. Appreciate it. Thanks for all the comments. Maybe just kicking this thing up on the Rush Island side of the equation. Just with the book value, it seems like that $550 million. Can you comment a little bit on the size of the securitization and maybe the offset to that, if you will, when you think about the additional transmission rate base opportunities in otherwise you articulated? Just thinking about the timing and the net puts and takes here, if you will."
},
{
"speaker": "Michael Moehn",
"text": "Yes. Hey, good morning, Julien. I appreciate the question. This is Michael. Yes, from an overall amount, I mean, again, we provide that book value of $550 million, again, this will be probably a year from now. But you should think roughly in those lines. I mean, around $500 million would be some depreciation, etc., that will occur. There's couple of items that get incorporate into that like inventory, etc. But around $500 million. And I think as we've talked about in the past and then we have a lot of flexibility here in terms of what we do with that, in terms of additional investments. It's really not restricted. It just really needs to go back into infrastructure. We obviously can use it to buyback, debt, and other things as well. But I mean given our capital plan, there's lots to do there. I think from a timing perspective, that's what -- we're being very thoughtful about trying to determine the actual retirement date itself, get this well in advance of that to give us plenty of time to make sure that we continue to replace that rate base over time and avoid any sort of earnings hit there. Hopefully, that helps."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "No, absolutely. Thanks, again. And then just when you think about the offsets here, just to push a little bit further on that, right, Rush Island, okay, securitization, one year out. Obviously, you alluded to a few different things there. Transmission probably being the single most notable element of what you talked about a moment ago. Can you maybe elaborate a little bit what HB 3445, if I got the number right, does? And then separately, just on the timing for Trance 2, I mean, what opportunity you see there as well, right, I mean -- and/or competitive pieces from Tranche 1? Just trying to think about, like, again, that emphasis on the puts and especially here the opportunities."
},
{
"speaker": "Marty Lyons",
"text": "Hey, Julien. This is Marty. Hey, thanks, again, for your questions. Just to first tack on to what Michael said and then answer some of your specific questions, but when we planned out our capital expenditures for this five years and we looked at the timing and amount on a year-by-year basis, we were thoughtful about the potential timing of this Rush Island closure and securitization filing. And so, within that, we had already timed some of our capital expenditures in a thoughtful manner to, as Michael said, ensure that as Rush Island comes out of rate base, that we don't have any kink, if you will, in the trajectory of our rate base growth and our earnings growth. So, some of that's already baked into our plan, Julien, I guess, first and foremost. Now you did ask about some of the transmission investment, and specifically about, the legislation coming through Illinois, the transmission efficiency and cooperation law, which was HB 3445 that you referenced. There, as we explained in our prepared remarks, the General Assembly passed that legislation in May of this year. And now it's really on the Governor's desk for his potential signature. So, it got to the Governor on -- in late June, June 22, and he has 60-days, which means the decision deadline for the Governor is August 21. And if you were to sign that, that would mean that the one Tranche 1 project in Illinois would come to us, and then any Tranche 2 projects that were approved in the first-half of '24, that's our expectation, but anytime in 2024 would also come to us as the incumbent transmission owner. Now, the Governor has expressed some concerns about that legislation. So, it's unsure what actions he will take. I'll tell you that supporters of the bill, including ourselves, continue to share the benefits of the legislation and hopefully address his concerns. If he signs the law, obviously, the bill obviously becomes law. And as we mentioned in our prepared remarks, if he takes no action, that bill becomes law as well. So, we'll see what action he ultimately takes. But we continue to believe that, that right of first refusal is really in the best interests of our customers and the residents of the State of Illinois. Then you just mentioned on overall what MISO is doing in terms of these projects. Again, as you know, MISO is evaluating what projects might come out of Tranche 2. I will say there that we continue to believe that the work that they're doing point to an overall portfolio that would be larger than what they approved in part of Tranche 1. And that's really because, as they've gone through this analysis, one of the things, obviously, that's come to fruition is the IRA legislation in D.C., which means that we expect more renewables than had previously been expected. And so, MISO is planning towards something that's between sort of a Future 2 and Future 3. And again, we expect that they'll continue to work through that. It's premature to say exactly how large that portfolio will be or exactly what transmission projects may fall into our service territories in Illinois or Missouri. But MISO continues to believe that they'll approve those projects in the first half of next year."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Excellent, thank you for the thoughtful response, guys. Really appreciate it. Take care [Multiple Speakers]"
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Julien."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Julien."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Paul Patterson",
"text": "Hey, good morning, guys."
},
{
"speaker": "Marty Lyons",
"text": "Good morning, Paul."
},
{
"speaker": "Paul Patterson",
"text": "So, just to follow up on Julien's questions about the ROFR, I know that you guys are involved in -- I apologize, but what I was wondering is that the Supreme Court and this Fifth Circuit decision regarding the ROFR in Texas, do you think that could have any wider implications in the country if it's allowed to stand?"
},
{
"speaker": "Marty Lyons",
"text": "Julien -- or, sorry, Paul, I apologize. Paul, it's a -- yes, it's okay. I apologize, again. But look, it's -- some of the actions that have been taken in various states seem to be particular to the way that legislation was passed or -- and so, look, we're going to continue to pursue it. We think that if the Governor were to sign this into law, it would be applicable and applicable too, as we've said before, both to MISO Tranche 1 projects, as well as Tranche 2 projects that are approved in 2024. So, look, I guess, time will tell, but I think that as we sit here today, we think this would stand."
},
{
"speaker": "Paul Patterson",
"text": "You think it would stand. So, I got you. So, in other words, if the Fifth Circuit, which is a Texas situation, you don't think would apply to Illinois because of the individual walls that were -- because of the differences -- if I understand you correctly, tell me if I'm wrong, because of the differences between the Texas law and what passed in Illinois assuming that it's signed. Is that right?"
},
{
"speaker": "Marty Lyons",
"text": "I do believe that."
},
{
"speaker": "Paul Patterson",
"text": "Okay. That's great. Thanks so much."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Paul."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jeremy Tonet, J.P. Morgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Marty Lyons",
"text": "Hey, good morning, Jeremy."
},
{
"speaker": "Michael Moehn",
"text": "Hey, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Hey. Just wanted to dial into Illinois a little bit more if we could, and I know that you touched on your commentary. But just wondering if it's possible to provide any more color on updates in the Illinois electric rate case. And just maybe how the tone of conversations with regulators and stakeholders have been trending recently."
},
{
"speaker": "Marty Lyons",
"text": "Yes. I think that maybe I'll start and perhaps Michael would want to tack on here as well. This is Marty. I think what you heard in our prepared remarks, again, is that we really feel like we're working constructively with stakeholders as we work through this process. Of course, this is the first multi-year grid and multi-year rate filing. And so, as to be expected, you're going have to work through some of the mechanics. But ultimately, I still believe that we're going to get to a constructive outcome, something that accomplishes the policy goals that [CEJA] (ph) had for the state. And you'll notice that when we started this -- down this path and direct testimony, the ICC staff's recommendation was about 56% of our overall ask. And through the rounds of testimony and additional support that we've been able to provide with the staff, we've been able to work constructively with them to were there suggested revenue increase now is about 70% of our request. So, we've made positive progress there. In our slides, we detailed that there's still a difference between our recommended -- or, requested cumulative increase in that recommended by the staff. And that difference is about $131 million over that four-year period. And we broke down some of the components for you. So, look, we're going to continue to work constructively with stakeholders. And like I said, I think we'll be able to get to a constructive outcome. And importantly, that accomplishes the policy goals of CEJA. So, I don't know if you have any more specific questions, or Michael, you want to add something?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Just a couple of comments, Marty, a good overview. And I -- look, I do think the team has collectively, between us and staff and others, continue to work very collaboratively, trying to really work through these issues. I think we all want the best answer, obviously, for customers, making sure that we're delivering on all of the policy objectives that Marty talked about, that CEJA is really wanting to achieve as well. And I think as Marty talked about, that difference today of about $131 million, about 62% of that is really tied up in ROE and cap structure. And so, there is this sort of fundamental difference on ROE today. They're still recommending the old formula that was approved under EMIA, which was basically 580 basis points plus the 30-year treasury versus we really think the law says, look, it's a cost of equity determined by the commission under -- their authority under the laws of the state that govern these rate reviews. But I mean, even putting that aside, I think the important thing to remember too, if you took a current mark on that ROE today at 580 basis points, I mean, it's something approaching 10. And I think the only other point I would make too, is I think -- and under kind of traditional cost of capital, under like a CAPN or DCF, the staff did also point out, I think they would have been at about 10.02 but then revert it back to this formula. So anyway, I gave you those details because I think it does kind of narrow a lot of the issues in terms of where the difference is, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful. And maybe a follow-up to peel back a little bit more, if I can, if there is anything left that can be said here. Just specifically with regards to your rebuttal strategy on the notably lower-than-expected ROE, the $700 million capital discrepancy, $100 million medical OPEB overfunded balance. Just wondering if you could speak to any changes in receptivity overall given Ameren's rebuttal?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, Hey Jeremy, this is Michael again. Yes, I mean, just again to be clear, I think that receptivity has shown in the fact that I think we've closed that gap. So you continue -- you referred to the $700 million gap. I'd say that gap is about $350 million today. So I mean, there's been some good work that's been done on both sides to agree that, look, here's some additional support and go ahead and accept those. That really ultimately -- Marty mentioned going from 56% to 70% of the ask, that was really a large part of it. The other items that you noted are still out there, the post-retirement issue that we'll continue to argue for, we do think that it should be included. Customers are benefiting from this. It's an overfunded plan. It's throwing off gains that are actually reducing rates for customers, et cetera. We're going to continue to make those arguments, and we'll see ultimately where it goes through the process over the next couple of months."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful. One just quick last one, if I could. With the decrease in energy prices, as we've seen, has bid pressure kind of faded from the conversations with the public and policymakers? Or is it still front of mind in discussions?"
},
{
"speaker": "Michael Moehn",
"text": "No, look, I mean, I think the overall backdrop is much better today I mean, given what's happened with commodity prices both on the natural gas side. And so you've actually already seen some of those benefits start rolling through on the PGAs, et cetera. I think we've talked about that. And then certainly, some of these capacity auctions and the corresponding energy auctions are certainly providing relief to customers. That's always a good thing to see, right, in terms of just making sure that we're trying to get the lowest possible bill for customers. So I'd say it's less of a conversation today and it's a good tailwind as we think about the future."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That makes sense. That’s helpful. I’ll leave it there. Thanks."
},
{
"speaker": "Michael Moehn",
"text": "Okay. Thanks, Jeremy."
},
{
"speaker": "Operator",
"text": "Our next question comes from Sophie Karp with KeyBanc Capital Markets. Please proceed with your question."
},
{
"speaker": "Sophie Karp",
"text": "Hi, good morning and thank you for taking my question. [Multiple Speakers] too in this Illinois situation little more? The -- and you provided a lot of color already, but I'm just curious if you think there's a legitimate legal argument as to why the old formula should be used in the new framework, why the staff is taken to that gold formula here."
},
{
"speaker": "Marty Lyons",
"text": "Yes. Sophie, this is Marty. One of the things CEJA called for in the legislation was that the cost of equity be determined consistent with commission practice and law. And we believe that means the use of traditional methods like capital asset pricing model, discounted cash flow analysis, IEIMA which was the prior legislation, had some very explicit language that required the use of formulaic. So we've certainly argued that the intent of CEJA was for the commission to use its traditional methodology. And I would note there that the staff and their testimony as part of the multiyear rate plan, instead of that traditional CAPM and DCF kind of analysis was used that they would get an ROE of about 10.02 as a recommendation. And of course, in our gas rate case that's pending, the staff there recommending a 9.89. So at the end of the day, that's what we're hanging our head on is that we believe that CEJA called for the use of that kind of methodology."
},
{
"speaker": "Sophie Karp",
"text": "Got it, got it. Thank you. And then -- maybe if I can ask a solar question. I'm just curious on your Missouri solar projects, particularly the ones that yourself building or participate in building them, how are you thinking about your procurement strategy with respect to potentially getting adders for domestic content and things like that. Does that influence your decision as to what equipment you're going to procure for these?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Sophie, it certainly does. So as you saw in our slides in terms of our build-out, we do plan to have projects that are build transfer agreements that are built by developers, projects that are developed to a certain point and then we procure them and finalize the construction ourselves and then some self-build. And certainly, we're taking a host of considerations into account when we look at where these projects are being built and what they're being built with. And so if we can take advantage of a site that provides us with incremental tax credit opportunities, we'll do that. If we can take advantage of procurement strategies that -- resources that allow us to maximize the value of credits, we're going to do that. So at the end of the day, our goal with this is to build a portfolio of projects that really provides a good diversity, low cost for our customers, reliability for our customers. And we'll look to maximize those tax credits to the extent possible to again deliver the lowest present value of revenue requirements for our customers."
},
{
"speaker": "Sophie Karp",
"text": "Great. Thank you. And do you expect to self-consume those tax credits? Or would you be looking to monetize them to the third party?"
},
{
"speaker": "Michael Moehn",
"text": "Ultimately, I think it's a combination of both, Sophie. I mean, we're not sitting on a lot of credit today. But I mean, as we build into these, certainly again we'll be very thoughtful about. We've been very involved in these issues on transferability and get a clarification working through some of these rating agency issues, et cetera. But I absolutely think that it could be a combination of both as we move forward."
},
{
"speaker": "Sophie Karp",
"text": "Thank you so much. That’s all from me."
},
{
"speaker": "Michael Moehn",
"text": "You bet. Thanks."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Julien Dumoulin-Smith with Bank of America. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, guys. I was worried it was going to end earlier. I wanted to squeeze in a couple here. Look, I wanted to come back to what was being discussed on Illinois real quickly. Do you have any thoughts about Illinois gas here? I know that's very preliminary, but it seems like there could be some conversations going into '24 on perhaps reform that might look akin to Colorado or something like that, But you -- or Minnesota at that. But you guys tell me, what are you guys hearing or seeing on any front there."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Julien, in terms of legislation for next year, I can't say that there's anything percolating right now that we're aware of or involved in. I think that right now, our focus obviously is on this Illinois multiyear rate plan on the electric side. And also getting a constructive resolution of our pending Illinois gas case. And so that's our focus right now. I know in the past, there was some discussion around QIP, but of course, that's expiring at the end of this year. And right now, we think we're positioned well as we utilize the forward rate cases in Illinois for our gas business. So really nothing to share with you on that front right now, Julien."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "All right. Fair enough. And obviously, you've got these new CCNs going on the Missouri side. Just any lessons learned from Boomtown, Huck, et cetera?"
},
{
"speaker": "Marty Lyons",
"text": "I don't think there are any specific lessons learned. We were certainly pleased to receive the commission's authorization to move forward with Huck and Boomtown and pleased with the orders received and the resolution of those. So I wouldn't say there's any specific lesson learned. We think all four of the projects that we have proposed are excellent projects for the benefit of our customers and move us along the path towards the investments that were laid out in our 2022 IRP. And we've got another IRP that we plan to file this September. And certainly, we think those projects are consistent with the path that we'll lay out as part of that IRP as well."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Awesome. Alright, guys. Super quick. Thank you."
},
{
"speaker": "Marty Lyons",
"text": "Thank you, Julien."
},
{
"speaker": "Operator",
"text": "It appears that there are no further questions at this time. I would now like to turn the floor back over to Marty Lyons for closing remarks."
},
{
"speaker": "Marty Lyons",
"text": "Yes. Terrific. Well, thank you all for joining us today. We had a strong first half of 2023, and we remain absolutely focused on strong execution for the remainder of this year. So we look forward to seeing many of you at conferences in the coming months, and thanks again, have great day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 1 | 2,023 | 2023-05-05 11:00:00 | Operator: Greetings, and welcome to Ameren Corporation's First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4.
Marty Lyons: Thanks, Andrew. Good morning, everyone, and thank you for joining us today as we discuss our first quarter 2023 earnings results. Our dedicated team continues to successfully execute on our strategic plan across all of our business segments allowing us to consistently deliver for our customers, shareholders and the environment while laying a strong foundation for the future. And as shown on Page 5, our strategic plan integrates our strong sustainability value proposition balancing the four pillars of environmental stewardship, social impact, governance and sustainable growth. These areas of focus incorporate our carbon reduction goals which are consistent with the objective of the Paris Agreement to limit global temperature rise to 1.5 degrees Celsius. Here we also highlight a few of the many items we are doing for our customers and communities including being an industry leader in diversity equity and inclusion. We are honored that earlier this week DiversityInc named Ameren to its Hall of Fame, the first utility and only 11th company to be added. DiversityInc also recognized Ameren as a top company among all industries for ESG supplier diversity, philanthropy and employee resource groups or ERGs. For more than two decades, our team has made an explicit commitment to fostering diversity equity and inclusion within our company and in the communities we serve. It is a value that we believe is foundational to our mission to power the quality of life. We look forward to sharing best practices with other companies as we all work together to create vibrant cultures and communities. Further, our strong corporate governance is led by a diverse Board of Directors focused on overseeing the execution of our strategic plan in a sustainable manner. Finally, this page summarizes our sustainable growth proposition which remains among the best in the industry. As mentioned on our call in February, we have a robust pipeline of over $48 billion of investment opportunities to continue to modernize the grid and enable the transition to a cleaner energy future. Today, we published our updated sustainability investor presentation called Leading The Way to a Sustainable Energy Future. It's available at amereninvestors.com which demonstrates how we have been effectively integrating our sustainability values and practices into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. Turning now to Page 6. Yesterday, we announced first quarter 2023 earnings of $1 per share compared to earnings of $0.97 per share in the first quarter of 2022. The key drivers of our first quarter results are outlined on this slide. As a result of our strong execution in the first quarter, I'm pleased to report that we remain on track to deliver within our 2023 earnings guidance range of $4.25 per share to $4.45 per share. Moving to Page 7. On our call in February, I highlighted some of the key strategic business objectives for 2023. We have been laser-focused on achieving these objectives. On Page 8, we outlined several of our key accomplishments to date. As you can see on the right side of this page, we have invested significant capital in each of our business segments during the first three months of this year. These investments will continue to improve reliability, resiliency, safety and efficiency of service to our customers. During the quarter, Ameren Missouri installed over 74,000 smart meters, 84 smart switches and 19 underground cable miles and energized one upgraded substation. In Illinois, our customers are benefiting from almost 1,600 new or reinforced electric poles and 36 new smart switches on electric distribution circuits as we continue to focus on replacing mechanically coupled gas service pipes. Further, our transmission business is expected to complete 40 new or upgraded transmission substations and 120 miles of new or upgraded transmission lines in the first half of the year. I'd like to express my appreciation for the Ameren team's dedication and hard work to start the year. It is worth noting that all of these system improvements were accomplished despite several major and minor storm events including tornadoes, which our teams responded to safely and rapidly to restore service to impacted customers. I am pleased to say that 97% of customers that lost power as a result of these storms saw service restored within 24 hours. Thank you again for your dedication to our customers and communities. Moving on to regulatory matters. We are pleased with the constructive settlement of the Ameren Missouri Electric rate review in April. The stipulation and agreement calls for $140 million annual revenue increase and is subject to Missouri Public Service Commission approval. If approved, residential customer rates will have increased approximately 2% compounded annually since April 1, 2017 prior to Ameren Missouri opting into plant and service accounting. This constructive regulatory framework which is effective through at least 2028 continues to allow Ameren Missouri to make meaningful infrastructure investments providing significant benefits to customers. These investments have contributed to a 12% improvement in reliability for Ameren Missouri customers since 2017. We've achieved additional constructive regulatory outcomes this year in Missouri and Illinois related to our clean energy transition, which I'll touch on more in a moment. Moving on to operational matters. To ensure strong operational performance over the coming summer months, last week we initiated a planned maintenance outage on the generator at the Callaway Energy Center. We expect the energy center to be back online next week. Finally, we remain focused on keeping customer bills as low as possible through disciplined cost management, continuous improvement and optimizing our operating performance as we transform our business through investment to ensure we sustainably provide safe, reliable, resilient and cleaner energy for our customers. Moving to page 9. As we've discussed in the past, MISO completed a study outlining a potential road map of transmission projects through 2039. Detail project planning, design work and procurement for the $1.8 billion of Tranche 1 projects assigned to Ameren is underway. MISO's request for proposal on the remaining $700 million of competitive projects in Missouri and Illinois have begun to be issued and we are in the process of preparing our proposals. We expect to submit our first bid relating to the Orient - Denny - Fairport line later this month. The proposal and evaluation process for the three competitive projects is expected to take place over the course of 2023 and into mid-2024. Looking ahead to Tranche 2, MISO's analysis of potential projects is well underway and will continue for the remainder of the year and into early next year. MISO anticipates the Tranche 2 portfolios of projects will be approved in the first half of 2024. Moving now to page 10. In February and April, the Missouri PSC approved certificates of convenience and necessity or CCNs for two Ameren Missouri's solar projects, the Huck Finn Solar Project located in Missouri and the Boomtown Solar Project in Illinois. The Huck Finn project which will support compliance with the Missouri Renewable Energy Standard will be our largest solar project to date. Construction of this facility is expected to create approximately 250 jobs. And once in operation, it will produce enough energy to power approximately 40,000 homes. In addition in April, the Missouri PSC approved Ameren Missouri's Renewable Solutions Program, which will be supported by the 150-megawatt Boomtown project. This subscription-based program is available to midsized and large commercial and industrial customers and municipalities across Missouri. Participating organizations can enroll for up to 100% of their future energy needs to meet their own renewable goals. 10 organizations are the initial participants in this innovative program, which is fully subscribed. Further I'm excited to say Ameren Missouri has entered into an engineering, supply and construction agreement to construct the 50-megawatt Vandalia Solar Project located in Central Missouri. This project represents the first larger-scale renewable energy center that will be fully developed and built by Ameren Missouri. We expect to file for a CCN for this project with the Missouri PSC midyear. We expect to announce additional solar energy projects in the next few months. These renewable projects are consistent with Ameren Missouri's Integrated Resource Plan, which includes a thoughtful and measured approach to transition our generation portfolio. Turning to page 11. I will cover progress being made in both Illinois and Missouri to provide incentive supporting investment infrastructure that will enable advancement of electric vehicles or EVs across our service territory and in our region. We continue to see electric vehicle adoption advanced in our region and expect further growth as a result of our EV programs in both states in addition to increased state and federal funding. In March, the ICC approved Ameren Illinois' beneficial electrification program, which expands on its existing electric vehicle charging program and provides at least $27 million through 2025 for programs, incentives and rates encouraging EV adoption and infrastructure development with a focus on equity and low-income customers. Through this plan, we will also support the governor's goal of having one million electric vehicles on the road in Illinois by 2030. In Missouri, the PSC approved our Charge Ahead Program in 2020 and extended it in 2022. This $11 million program aims to eliminate barriers and incentivize electric vehicle adoption. This includes the addition of approximately 1,800 public workplaces and multi-dwelling charging ports by 2024. Along the Missouri highway corridors, 14 fast-charging stations are already in operation as part of this program. In addition, we are participating in and supporting the Edison Electric Institute's National Corridor Charging initiative. We believe strong adoption of electric vehicles will provide benefits for our customers including lower rates due to load growth and importantly advance the clean energy transition. Moving to page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of $48 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Turning to page 13. In February, we updated our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2023 through 2027. This earnings growth is primarily driven by strong compound annual rate base growth of 8.4% supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. Combined, we expect to deliver strong, long-term earnings and dividend growth, resulting in an attractive total return that compares favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again thank you all for joining us today. I will now turn the call over to Michael.
Michael Moehn: Thanks Marty, and good morning, everyone. Turning now to page 15 of our presentation. Yesterday we reported first quarter 2023 earnings of $1 per share, compared to $0.97 per share for the year ago quarter. This page summarizes key drivers impacting earnings at each segment. As you can see under our constructive regulatory frameworks, we experienced earnings growth in Ameren Transmission, Illinois Electric Distribution and Illinois Natural Gas driven by increased infrastructure investment. While Ameren Missouri's earnings declined driven by the warmest combined January and February in 50 years, we were able to deliver strong earnings performance during the quarter as a result of our diverse business mix and disciplined cost management. Moving to page 16. Despite experiencing one of the warmest winters in 50 years, we're off to a strong start. We continue to expect 2023 earnings to be in the range of $4.25 to $4.45 per share. The $0.05 earnings per share impact due to mild first quarter temperatures, is expected to be offset through disciplined cost management. On this page, we've highlighted select considerations impacting our 2023 earnings guidance for the remainder of the year. These are supplemental to the key drivers and assumptions discussed in our earnings call in February. I encourage you to take these into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Turning now to page 17 for details on the Ameren Missouri electric rate review. In April, a non-unanimous stipulation agreement was reached in our Ameren Missouri electric rate review for $140 million annual revenue increase. The stipulation agreement was a black box settlement and did not specify certain details, including return on equity, capital structure or rate base. The agreement did provide for the continuation of key trackers and riders including the fuel adjustment clause. Pending Missouri PSC approval new Ameren Missouri electric service rates are expected to be effective by July 1. Moving to Page 18. In January, Ameren Illinois Electric Distribution filed its first multi-year rate plan or MYRP with the ICC. The MYRP includes a grid monetization plan that lays out our electric distribution investment and supports our annual revenue increase request for the next four years. Our request for $171 million rate increase in 2024 is based on an average rate base of $4.3 billion, a return on equity of 10.5% and an equity ratio of 54%. Our filing includes the phase-in provision and proposal for 50% of the requested 2024 rate increase to be collected from customers in 2026. We expect staff and intervening testimony next Thursday, May 11 and an ICC decision by December with rates effective January 2024. You can find additional key components of our MYRP following on this slide. Turning to Page 19 and other Illinois regulatory matters. In April, we filed our electric distribution annual rate reconciliation, requesting an additional $127 million to reconcile the 2022 revenue requirements to the actual cost. An ICC decision is required by December and the full amount would be collected from customers in 2024. In January, we filed our Ameren Illinois Natural Gas rate review requesting a $160 million increase, based on a 10.7% ROE, a 54% equity ratio and a $2.9 billion rate base. We expect staff and intervenor testimony today and an ICC decision by late November with rates effective in early December. On Page 20 we provide a financing update. We continue to feel very good about our financial position. On March 13, Ameren Missouri issued $500 million of 5.45% first mortgage bonds due 2053. Proceeds of the offering were used to fund capital expenditures and refinance short-term debt. Further, in order for us to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity, consisting of approximately 3.2 million shares by the end of this year. These shares were previously sold forward under our ATM equity program. Additionally, we have begun to enter into forward sales agreements in support of our 2024 equity needs, together with the issuance of our 401(k) and our DRPlus programs. Our ATM equity program is expected to support our equity needs in 2024 and beyond. Finally, turning to Page 21. We're well-positioned to continue executing our plan. We're off to a strong start and we expect to deliver strong earnings growth in 2023 as we continue to successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Jeremy Tonet with JPMorgan. Please proceed with your question.
Robin Shillock: Hi. This is Robin Shillock on for Jeremy. With one week left in the Missouri legislative session, any updates on the right of first refusal legislation that you've been supporting? And additionally, has this or any other recent Missouri legislative developments influenced your outlook for MISO or transmission opportunities in the state?
Marty Lyons: Yes. Look, you're right we've got just a little bit of time left, the legislative session. This is Marty Lyons by the way ends on May 12 at 6:00 p.m. And we have been supportive of right of first refusal legislation that's been moving along in the legislature. And so, you've probably been following House Bill 992 and Senate Bill 568 and we certainly support the legislative efforts there. Both bills have been heard in committees and we'll see whether there's any action on those bills as we approach the end of the session. So, we again, continue to believe that right of first refusal legislation is a positive. It certainly would allow transmission infrastructure to be built more rapidly in our state and at a cost competitive level. So, we're very supportive of that. We'll see whether it gets through. It's hard to predict any piece of legislation, whether it will go through, given the various priorities the legislature has. But in terms of the latter part of your question, whether that's influencing our thoughts on any of our path forward, I would say, no. As we look ahead, we continue to invest in a reliable clean energy transition, meaning, both reliable energy delivery infrastructure, renewable energy, as well as transmission. So, we'll continue to pursue those things. We do think things like right of first refusal are important to make sure that that infrastructure build-out can happen efficiently and effectively and maintain a good reliable system. But we'll keep forging forward, so thanks for your question.
Robin Shillock: Great. Thank you.
Operator: [Operator Instructions] Mr. Lyons, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments.
Marty Lyons: Okay. Well, thank you all for joining us today. As you heard in our prepared remarks, we've had a strong start to 2023 and we remain focused on continuing to deliver for the remainder of the year. So, we invite you to join our annual shareholder meeting which is coming up here on May 11 and we look forward to seeing many of you at the AGA Financial Forum in a couple of weeks. With that, thank you, and everybody have a great day.
Operator: This concludes today's teleconference. You may disconnect your lines at this time, and we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Andrew Kirk, Director of Investor Relations for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us today as we discuss our first quarter 2023 earnings results. Our dedicated team continues to successfully execute on our strategic plan across all of our business segments allowing us to consistently deliver for our customers, shareholders and the environment while laying a strong foundation for the future. And as shown on Page 5, our strategic plan integrates our strong sustainability value proposition balancing the four pillars of environmental stewardship, social impact, governance and sustainable growth. These areas of focus incorporate our carbon reduction goals which are consistent with the objective of the Paris Agreement to limit global temperature rise to 1.5 degrees Celsius. Here we also highlight a few of the many items we are doing for our customers and communities including being an industry leader in diversity equity and inclusion. We are honored that earlier this week DiversityInc named Ameren to its Hall of Fame, the first utility and only 11th company to be added. DiversityInc also recognized Ameren as a top company among all industries for ESG supplier diversity, philanthropy and employee resource groups or ERGs. For more than two decades, our team has made an explicit commitment to fostering diversity equity and inclusion within our company and in the communities we serve. It is a value that we believe is foundational to our mission to power the quality of life. We look forward to sharing best practices with other companies as we all work together to create vibrant cultures and communities. Further, our strong corporate governance is led by a diverse Board of Directors focused on overseeing the execution of our strategic plan in a sustainable manner. Finally, this page summarizes our sustainable growth proposition which remains among the best in the industry. As mentioned on our call in February, we have a robust pipeline of over $48 billion of investment opportunities to continue to modernize the grid and enable the transition to a cleaner energy future. Today, we published our updated sustainability investor presentation called Leading The Way to a Sustainable Energy Future. It's available at amereninvestors.com which demonstrates how we have been effectively integrating our sustainability values and practices into our corporate strategy. I encourage you to take some time to read more about our strong sustainability value proposition. Turning now to Page 6. Yesterday, we announced first quarter 2023 earnings of $1 per share compared to earnings of $0.97 per share in the first quarter of 2022. The key drivers of our first quarter results are outlined on this slide. As a result of our strong execution in the first quarter, I'm pleased to report that we remain on track to deliver within our 2023 earnings guidance range of $4.25 per share to $4.45 per share. Moving to Page 7. On our call in February, I highlighted some of the key strategic business objectives for 2023. We have been laser-focused on achieving these objectives. On Page 8, we outlined several of our key accomplishments to date. As you can see on the right side of this page, we have invested significant capital in each of our business segments during the first three months of this year. These investments will continue to improve reliability, resiliency, safety and efficiency of service to our customers. During the quarter, Ameren Missouri installed over 74,000 smart meters, 84 smart switches and 19 underground cable miles and energized one upgraded substation. In Illinois, our customers are benefiting from almost 1,600 new or reinforced electric poles and 36 new smart switches on electric distribution circuits as we continue to focus on replacing mechanically coupled gas service pipes. Further, our transmission business is expected to complete 40 new or upgraded transmission substations and 120 miles of new or upgraded transmission lines in the first half of the year. I'd like to express my appreciation for the Ameren team's dedication and hard work to start the year. It is worth noting that all of these system improvements were accomplished despite several major and minor storm events including tornadoes, which our teams responded to safely and rapidly to restore service to impacted customers. I am pleased to say that 97% of customers that lost power as a result of these storms saw service restored within 24 hours. Thank you again for your dedication to our customers and communities. Moving on to regulatory matters. We are pleased with the constructive settlement of the Ameren Missouri Electric rate review in April. The stipulation and agreement calls for $140 million annual revenue increase and is subject to Missouri Public Service Commission approval. If approved, residential customer rates will have increased approximately 2% compounded annually since April 1, 2017 prior to Ameren Missouri opting into plant and service accounting. This constructive regulatory framework which is effective through at least 2028 continues to allow Ameren Missouri to make meaningful infrastructure investments providing significant benefits to customers. These investments have contributed to a 12% improvement in reliability for Ameren Missouri customers since 2017. We've achieved additional constructive regulatory outcomes this year in Missouri and Illinois related to our clean energy transition, which I'll touch on more in a moment. Moving on to operational matters. To ensure strong operational performance over the coming summer months, last week we initiated a planned maintenance outage on the generator at the Callaway Energy Center. We expect the energy center to be back online next week. Finally, we remain focused on keeping customer bills as low as possible through disciplined cost management, continuous improvement and optimizing our operating performance as we transform our business through investment to ensure we sustainably provide safe, reliable, resilient and cleaner energy for our customers. Moving to page 9. As we've discussed in the past, MISO completed a study outlining a potential road map of transmission projects through 2039. Detail project planning, design work and procurement for the $1.8 billion of Tranche 1 projects assigned to Ameren is underway. MISO's request for proposal on the remaining $700 million of competitive projects in Missouri and Illinois have begun to be issued and we are in the process of preparing our proposals. We expect to submit our first bid relating to the Orient - Denny - Fairport line later this month. The proposal and evaluation process for the three competitive projects is expected to take place over the course of 2023 and into mid-2024. Looking ahead to Tranche 2, MISO's analysis of potential projects is well underway and will continue for the remainder of the year and into early next year. MISO anticipates the Tranche 2 portfolios of projects will be approved in the first half of 2024. Moving now to page 10. In February and April, the Missouri PSC approved certificates of convenience and necessity or CCNs for two Ameren Missouri's solar projects, the Huck Finn Solar Project located in Missouri and the Boomtown Solar Project in Illinois. The Huck Finn project which will support compliance with the Missouri Renewable Energy Standard will be our largest solar project to date. Construction of this facility is expected to create approximately 250 jobs. And once in operation, it will produce enough energy to power approximately 40,000 homes. In addition in April, the Missouri PSC approved Ameren Missouri's Renewable Solutions Program, which will be supported by the 150-megawatt Boomtown project. This subscription-based program is available to midsized and large commercial and industrial customers and municipalities across Missouri. Participating organizations can enroll for up to 100% of their future energy needs to meet their own renewable goals. 10 organizations are the initial participants in this innovative program, which is fully subscribed. Further I'm excited to say Ameren Missouri has entered into an engineering, supply and construction agreement to construct the 50-megawatt Vandalia Solar Project located in Central Missouri. This project represents the first larger-scale renewable energy center that will be fully developed and built by Ameren Missouri. We expect to file for a CCN for this project with the Missouri PSC midyear. We expect to announce additional solar energy projects in the next few months. These renewable projects are consistent with Ameren Missouri's Integrated Resource Plan, which includes a thoughtful and measured approach to transition our generation portfolio. Turning to page 11. I will cover progress being made in both Illinois and Missouri to provide incentive supporting investment infrastructure that will enable advancement of electric vehicles or EVs across our service territory and in our region. We continue to see electric vehicle adoption advanced in our region and expect further growth as a result of our EV programs in both states in addition to increased state and federal funding. In March, the ICC approved Ameren Illinois' beneficial electrification program, which expands on its existing electric vehicle charging program and provides at least $27 million through 2025 for programs, incentives and rates encouraging EV adoption and infrastructure development with a focus on equity and low-income customers. Through this plan, we will also support the governor's goal of having one million electric vehicles on the road in Illinois by 2030. In Missouri, the PSC approved our Charge Ahead Program in 2020 and extended it in 2022. This $11 million program aims to eliminate barriers and incentivize electric vehicle adoption. This includes the addition of approximately 1,800 public workplaces and multi-dwelling charging ports by 2024. Along the Missouri highway corridors, 14 fast-charging stations are already in operation as part of this program. In addition, we are participating in and supporting the Edison Electric Institute's National Corridor Charging initiative. We believe strong adoption of electric vehicles will provide benefits for our customers including lower rates due to load growth and importantly advance the clean energy transition. Moving to page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of $48 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country's energy needs and delivering on our customers' expectations. Turning to page 13. In February, we updated our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2023 through 2027. This earnings growth is primarily driven by strong compound annual rate base growth of 8.4% supported by strategic allocation of infrastructure investment to each of our operating segments based on their constructive regulatory frameworks. Combined, we expect to deliver strong, long-term earnings and dividend growth, resulting in an attractive total return that compares favorably with our regulated utility peers. I am confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again thank you all for joining us today. I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks Marty, and good morning, everyone. Turning now to page 15 of our presentation. Yesterday we reported first quarter 2023 earnings of $1 per share, compared to $0.97 per share for the year ago quarter. This page summarizes key drivers impacting earnings at each segment. As you can see under our constructive regulatory frameworks, we experienced earnings growth in Ameren Transmission, Illinois Electric Distribution and Illinois Natural Gas driven by increased infrastructure investment. While Ameren Missouri's earnings declined driven by the warmest combined January and February in 50 years, we were able to deliver strong earnings performance during the quarter as a result of our diverse business mix and disciplined cost management. Moving to page 16. Despite experiencing one of the warmest winters in 50 years, we're off to a strong start. We continue to expect 2023 earnings to be in the range of $4.25 to $4.45 per share. The $0.05 earnings per share impact due to mild first quarter temperatures, is expected to be offset through disciplined cost management. On this page, we've highlighted select considerations impacting our 2023 earnings guidance for the remainder of the year. These are supplemental to the key drivers and assumptions discussed in our earnings call in February. I encourage you to take these into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Turning now to page 17 for details on the Ameren Missouri electric rate review. In April, a non-unanimous stipulation agreement was reached in our Ameren Missouri electric rate review for $140 million annual revenue increase. The stipulation agreement was a black box settlement and did not specify certain details, including return on equity, capital structure or rate base. The agreement did provide for the continuation of key trackers and riders including the fuel adjustment clause. Pending Missouri PSC approval new Ameren Missouri electric service rates are expected to be effective by July 1. Moving to Page 18. In January, Ameren Illinois Electric Distribution filed its first multi-year rate plan or MYRP with the ICC. The MYRP includes a grid monetization plan that lays out our electric distribution investment and supports our annual revenue increase request for the next four years. Our request for $171 million rate increase in 2024 is based on an average rate base of $4.3 billion, a return on equity of 10.5% and an equity ratio of 54%. Our filing includes the phase-in provision and proposal for 50% of the requested 2024 rate increase to be collected from customers in 2026. We expect staff and intervening testimony next Thursday, May 11 and an ICC decision by December with rates effective January 2024. You can find additional key components of our MYRP following on this slide. Turning to Page 19 and other Illinois regulatory matters. In April, we filed our electric distribution annual rate reconciliation, requesting an additional $127 million to reconcile the 2022 revenue requirements to the actual cost. An ICC decision is required by December and the full amount would be collected from customers in 2024. In January, we filed our Ameren Illinois Natural Gas rate review requesting a $160 million increase, based on a 10.7% ROE, a 54% equity ratio and a $2.9 billion rate base. We expect staff and intervenor testimony today and an ICC decision by late November with rates effective in early December. On Page 20 we provide a financing update. We continue to feel very good about our financial position. On March 13, Ameren Missouri issued $500 million of 5.45% first mortgage bonds due 2053. Proceeds of the offering were used to fund capital expenditures and refinance short-term debt. Further, in order for us to maintain our credit ratings and a strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity, consisting of approximately 3.2 million shares by the end of this year. These shares were previously sold forward under our ATM equity program. Additionally, we have begun to enter into forward sales agreements in support of our 2024 equity needs, together with the issuance of our 401(k) and our DRPlus programs. Our ATM equity program is expected to support our equity needs in 2024 and beyond. Finally, turning to Page 21. We're well-positioned to continue executing our plan. We're off to a strong start and we expect to deliver strong earnings growth in 2023 as we continue to successfully execute our strategy. As we look to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. Further, we believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Robin Shillock",
"text": "Hi. This is Robin Shillock on for Jeremy. With one week left in the Missouri legislative session, any updates on the right of first refusal legislation that you've been supporting? And additionally, has this or any other recent Missouri legislative developments influenced your outlook for MISO or transmission opportunities in the state?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Look, you're right we've got just a little bit of time left, the legislative session. This is Marty Lyons by the way ends on May 12 at 6:00 p.m. And we have been supportive of right of first refusal legislation that's been moving along in the legislature. And so, you've probably been following House Bill 992 and Senate Bill 568 and we certainly support the legislative efforts there. Both bills have been heard in committees and we'll see whether there's any action on those bills as we approach the end of the session. So, we again, continue to believe that right of first refusal legislation is a positive. It certainly would allow transmission infrastructure to be built more rapidly in our state and at a cost competitive level. So, we're very supportive of that. We'll see whether it gets through. It's hard to predict any piece of legislation, whether it will go through, given the various priorities the legislature has. But in terms of the latter part of your question, whether that's influencing our thoughts on any of our path forward, I would say, no. As we look ahead, we continue to invest in a reliable clean energy transition, meaning, both reliable energy delivery infrastructure, renewable energy, as well as transmission. So, we'll continue to pursue those things. We do think things like right of first refusal are important to make sure that that infrastructure build-out can happen efficiently and effectively and maintain a good reliable system. But we'll keep forging forward, so thanks for your question."
},
{
"speaker": "Robin Shillock",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Mr. Lyons, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Okay. Well, thank you all for joining us today. As you heard in our prepared remarks, we've had a strong start to 2023 and we remain focused on continuing to deliver for the remainder of the year. So, we invite you to join our annual shareholder meeting which is coming up here on May 11 and we look forward to seeing many of you at the AGA Financial Forum in a couple of weeks. With that, thank you, and everybody have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's teleconference. You may disconnect your lines at this time, and we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 4 | 2,024 | 2025-02-14 10:00:00 | Operator: Greetings and welcome to Ameren Corporation Fourth Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Senior Director, Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk, you may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty.
Martin Lyons: Thanks, Andrew. Good morning, everyone, and thank you for joining us. This morning, we will discuss 2024 financial results, recap events and accomplishments and look ahead to 2025 and beyond. What you'll hear is that the Ameren team's collective efforts produced strong results operationally and financially in 2024. And just as important, the team accomplished strategic goals that position our company to provide higher levels of satisfaction for our customers and strong returns for our shareholders in the years ahead. In 2025, we are again set up to deliver strong results, but also to take meaningful steps towards enabling our communities to benefit from significant economic development opportunities. Those opportunities offer direct investment in our states, bringing jobs and incremental tax revenue. And for Ameren, as we discuss our plans today, it means sales growth and the need to accelerate capital investments to meet the energy needs driven by that industrial demand. Starting on Page 4. We continue to be guided by our Three Pillar strategy. To invest in rate-regulated infrastructure, to enhance regulatory frameworks and advocate for responsible energy policy and optimize our operating performance. This strategy has served us well for the last decade and we will remain focused on solid execution year in and year out to maximize value for our customers, communities and shareholders. With that, let me summarize our 2024 performance on Page 5. I'm pleased to say that we accomplished all our key business objectives outlined at this time last year and on this page. Importantly, we strategically invested approximately $4.3 billion in energy infrastructure, secured timely regulatory approvals for future investment and prudently managed our operating costs while delivering reliable energy service. And yesterday, we announced 2024 adjusted earnings of $4.63 per share compared to earnings of $4.38 per share in 2023. This result was above our 2024 adjusted earnings guidance midpoint. Turning to Page 6, which highlights the benefits of the investments we are making for our customers. The successful execution of our strategy continues to drive improved reliability and strong customer service while keeping customer rates low in comparison to the national and Midwest averages. Further, our ongoing infrastructure investments improved grid resilience as demonstrated by the performance of our system during severe winter storms in early January of this year. Despite challenging conditions, our grid improvements prevented over 3.5 million minutes of potential outage time across our service territories in Missouri and Illinois. Importantly, we had no issues on the more than 250 miles of power lines that have already been updated through Ameren Missouri's Smart Energy Plan. On Page 7, we summarize our strong performance for shareholders over time. Our goal, like we said in the past, is to deliver at the midpoint or higher within our earnings guidance range. Our weather-normalized adjusted earnings per share have risen at an approximate 7.6% compound annual growth rate since 2013, while our annual dividends paid per share have increased approximately 68%. This has driven a strong total return of nearly 250% for our shareholders over the same period, which was significantly above utility index averages. Moving to Page 8. As we look to the opportunities ahead, in 2025, our focus will be on continuing to provide safe, reliable service to our customers at competitive rates while bringing additional growth opportunities to our states. We'll do this, first and foremost, by investing approximately $4.2 billion in electric, natural gas and transmission infrastructure to bolster the safety, security, reliability and responsiveness of the energy grid. Further, we're focused on enhancing our generation plans to meet customers' needs, achieving constructive regulatory outcomes and advocating for policies that enhance reliability and resource adequacy as well as attracting new businesses to our communities. As always, while we work to accomplish these objectives, we will remain focused on operating as efficiently and effectively as possible. Moving to Page 9 for an update on our long-term growth outlook. We continue to extract 2025 earnings to be in a range of $4.85 per share to $5.05 per share. The midpoint of this range represents approximately 7% earnings per share growth compared to our adjusted 2024 earnings results. Building on the execution of our strategy and track record of strong earnings growth, we expect to deliver 6% to 8% compound annual earnings per share growth from 2025 through 2029, using the midpoint of our 2025 guidance of $4.95 per share as the base. We're excited about the robust sales growth and energy infrastructure investment opportunities in front of us, which strengthen our confidence in our ability to deliver strong long-term earnings growth. I'll speak more about those things in a moment. In addition to growing earnings per share, last week, Ameren's Board of Directors approved a quarterly dividend increase of approximately 6%, resulting in an annualized dividend rate of $2.84 per share. This represents our 12th consecutive year of increasing our dividend, which reflects continued confidence by Ameren's Board of Directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect to grow our dividend in line with our long-term earnings per share growth expectations and for our dividend payout ratio to range from 55% to 65% of earnings per share. Combined, these elements support our strong total shareholder return proposition. Turning to Page 10 for more on the foundation of our earnings outlook. Our strong long-term earnings growth expectation is driven by robust rate base growth, reflecting investment in energy infrastructure, included in Ameren Missouri's Smart Energy Plan, which incorporates its Preferred Resource Plan, Ameren Illinois's Multi-Year Rate Plan and projects awarded to Ameren in MISO's long-range transmission planning. Today, we are rolling forward our five-year investment plan. And as you can see, we expect to grow our rate base at a 9.2% compound annual rate from 2024 through 2029. This robust rate base growth is driven by a 20% increase in our five-year capital plan compared to the previous capital plan laid out last February, primarily reflecting accelerated generation needed to serve our updated sales growth expectations. Now turning to Page 11 for more detail on the growth opportunities in Missouri driving the significant increase in our capital plan. We expect tremendous opportunities for economic growth over the next five to seven years. Our region's economy spans multiple sectors from aviation, biotechnology, chemicals, financial services, beverage and food manufacturing, life and plant sciences to health care and logistics and a variety of other manufacturing concerns. And increasingly, it is an attractive location for data centers. Based on our robust economic development pipeline, we are now expecting our weather-normalized retail sales to increase approximately 5.5% compounded annually from 2025 through 2029, compared to our prior plan expectations of flat to up 0.5%. This sales growth expectation is consistent with the notice we filed with the Missouri Public Service Commission of our intention to update our Preferred Resource Plan. That plan assumes approximately 500 megawatts of load growth by the end of 2027, a total of 1 gigawatt by the end of 2029 and 1.5 gigawatts by the end of 2032. Since our third quarter earnings call, we have signed additional construction agreements with data center developers for 1.5 gigawatts of new load to be interconnected to our transmission system, bringing our total to approximately 1.8 gigawatts. These construction agreements are subject to acceptance of a modified industrial tariff under which new customers would receive energy service. Earlier this week, we submitted the necessary transmission load request related to these agreements to MISO for expedited project review and expect approval in April. Further, we are actively working to propose a modified tariff for large industrial customers, including data center customers, and we expect to file for approval of the tariff with the Missouri Public Service Commission by the second quarter. While there's no deadline for commission approval, we are optimistic we'd receive a decision and that the tariff would be in effect before the end of the year. We remain aligned with key stakeholders across the state in our efforts to attract new businesses to the region. Our economic development pipeline beyond our current construction agreements remains robust and we will continue to pursue each opportunity vigorously to maximize value for our customers and communities. As the green shading on our slide indicates, a range of sales growth outcomes could ultimately occur. But based on our planned generation resource build out, we expect to have the capacity to serve 2 gigawatts of new demand by 2032 and even more thereafter. Moving then to Page 12 for an update on Missouri's generation plans. Considering the significant sales growth potential, the lead time needed to construct new generation and other key considerations, Ameren Missouri notified the Missouri PSC that we are changing the Preferred Resource Plan in our September 2023 IRP, which lays out generation, our generation plan for the next 20 years. As mentioned, our new preferred plan is designed to serve 1.5 gigawatts of additional demand by 2032. And as I mentioned, it provides for a range of outcomes. The key objectives of our resource planning remain the same. A balanced mix of resources to provide reliable, lowest cost and cleaner energy for our customers. Our preferred plan calls for acceleration and expansion of natural gas generation and battery storage, acceleration of solar generation investment, potential extension of the life of our Sioux Energy Center by up to three years and investment in additional nuclear generation by 2040. In total, the change in preferred plan represents the addition of 2.3 gigawatts of generation capacity by 2035 and when factoring in updated costs for all planned resources, represents approximately $7 billion of increased investment by 2035 compared to the 2023 IRP. Our execution of this investment plan will lay the foundation for reliable economic expansion in Missouri. For further details on the differences between the Preferred Resource Plan from the 2023 IRP and new 2025 Preferred Resource Plan, see Page 31 of this presentation. Turning to Page 13 for an update on the new generation recently placed in service or under development. This past year was just a start to the robust generation portfolio additions. Three new solar facilities totaling 500 megawatts and representing approximately $1 billion of investment were placed in service during the fourth quarter of 2024 as planned. Combined, the three facilities are expected to generate energy sufficient to power 92,000 homes annually and we continue to execute our IRP. We have another 1,200 megawatts of approved generation currently under construction. And we expect to file a request with the Missouri PSC for approval of additional generation and battery energy storage in the coming months. Moving now to Page 14 for a transmission update. In December, MISO approved a nearly $22 billion Tranche 2.1 portfolio, which is expected to provide significant reliability and capacity benefits for the region. MISO has already selected Ameren to lead $1.3 billion worth of these critical grid infrastructure projects in Missouri and Illinois. The portfolio also includes $6.5 billion of projects, which will be open for competitive bid, of which approximately $1.8 billion are in Illinois. We believe we are well positioned to compete for all these opportunities as we have a strong track record of developing and operating cost effective and high-quality transmission infrastructure. MISO and its transmission owners will continue to assess the current long-range transmission future scenarios to support our region's energy needs in the years ahead. This analysis is expected to be followed by development of the Tranche 2.2 project portfolio. Moving to Page 15 for a legislative update. In January, the Missouri legislative session began. Several bills are currently under consideration, including the Power Predictability and Reliability Act, the Missouri First Transmission Act, proposed modifications to integrated resource planning and the opportunity for future test year regulatory frameworks for natural gas and water utilities. While these bills are at various stages in the legislative process, they collectively demonstrate Missouri's commitment to enabling a reliable and efficient energy future and supporting economic growth and job creation within our communities. Ameren will remain actively engaged with policymakers and key stakeholders in the months ahead to advocate for constructive energy policy. Turning to Page 16 for an update on our 10-year investment pipeline. Looking ahead, we have a robust pipeline of investment opportunities of over $63 billion that will deliver significant value to all of our stakeholders by making our energy grid more reliable, stronger and smarter. In addition, these investments will support many thousands of jobs within our local economies. Of course, constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our region's energy needs and delivering on our customers' expectations. Turning now to Page 17, to sum up our value proposition. We remain convinced that the execution of our strategy in 2025 and beyond will continue to deliver superior value to our customers and shareholders. Our earnings growth expectations are driven by strong compound annual rate base growth of 9.2% and strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high-quality utility growth story. Combined, our strong long-term 6% to 8% earnings growth plan and an attractive and growing dividend result in a compelling total return story. Further, we have a strong track record of execution and an experienced management team. I'm confident in Ameren's team's ability to execute our investment plans and other elements of our strategy across all four of our business segments. Again, thank you all for joining us today and I'll now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. I'll begin on Page 19 of our presentation with our 2024 earnings results. Yesterday, we reported 2024 adjusted earnings of $4.63 per share, compared to earnings of $4.38 per share in 2023. Our 2024 earnings exclude two charges totaling $0.21 per share. The first is related to the NSR settlement approved by the US District Court for the Eastern District of Missouri for the Rush Island Energy Center. The second is related to the Federal Energy Regulatory Commission's order on base return on equity. On Page 20, we summarize key drivers impacting adjusted earnings at each segment. Our strong 2024 adjusted earnings results were largely driven by our strategic infrastructure investments. In addition, weather-normalized retail sales grew approximately 2% across Ameren Missouri with 2%, 1.5% and 3% growth in our residential, commercial and industrial classes respectively. Notably, industrial sales continue to remain robust, driven largely by growth from customers in the manufacturing and technology sectors. This year's sales growth reflects the strong economy across our service territory, which will serve as a solid foundation for future potential growth. Our focus remains on balancing necessary investments with prudent cost management to support both system reliability and customer affordability. At the beginning of last year, we set an ambitious goal to hold O&M expenses flat given the importance of cost control and managing customer rate impacts. I'm proud to report that we've made significant strides in this area. Importantly, at Ameren Missouri, when excluding the onetime NSR charge, all-in O&M expenses were down $12 million year-over-year. As we navigate the current economic landscape, we expect our proactive cost management and strategic investments will continue to drive operational efficiencies and keep our customer rates below the national and the Midwest averages. Moving to Page 21 to cover regulatory progress made in the fourth quarter. In December, the Missouri PSC staff recommended a $398 million annual revenue increase in our 2024 Ameren Missouri electric rate review. The difference between our request of $446 million and staff's recommendation is primarily driven by staff's proposed return on equity of 9.74% versus our request of 10.25%, and treatment of High Prairie Energy Center, partially offset by estimated off-system sales and fuel costs, which will be subject to true-up in regulatory recovery mechanisms. The equity ratio will be updated to use the capital structure as of December 31st, 2024. Surrebuttal and True-up Direct Testimony will be available later today. As we have in the past, we will seek to work through these and other differences with interveners over the coming weeks. Evidentiary hearings are scheduled to begin in mid-March and the decision for the Missouri PSC is expected by May, with new rates effective by June 1st. Turning to Page 22 for an update on our regulatory proceedings in Illinois. In December, the Illinois Commerce Commission, or ICC, issued orders in two of our pending Illinois rate reviews. The ICC approved our revised grid plan and the corresponding Multi-Year Rate Plan or MYRP for 2024 through 2027 for a cumulative revenue increase of $309 million versus our request for an increase of $332 million. These annual revenues reflect our recoverable costs, average rate base of $4.8 billion by 2027, and as anticipated, no change in the 8.72% return on equity. Investments in the energy grid under this multiyear plan is expected to preserve safety, reliability and the day-to-day operations of our system while also making progress towards the clean energy transition. We're pleased to have an ICC-approved grid plan through 2027, which provides clarity on the work ahead. In addition, the ICC approved our request for $158 million reconciliation adjustment in the final electric distribution reconciliation of 2023's revenue requirement. The full amount will be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that was collected during 2024. New rates from the 2023 reconciliation in 2024 through 2027 MYRP were affected at the end of last year. Moving now to Page 23 for an update on the Illinois gas regulatory matters. In January, Ameren Illinois Natural Gas Distribution requested $140 million annual base rate increase based on a 10.7% return on equity, a 52% equity ratio and a $3.3 billion average rate base during our future 2026 test year. An ICC decision is required by early December, with rates expected to be effective in December 2025. Turning to Page 24. We look ahead to our company-wide capital plan for the next five years. Here, we provide an overview of our $26.3 billion of planned capital expenditures for 2025 through 2029, by business segment, which support our consolidated 9.2% compound annual rate base growth expectations. As Marty highlighted, we have a robust capital investment opportunities ahead of us. The five-year infrastructure investment plan we are releasing today represents a 20% increase over our investment plan issued last year. This increase includes additional generation reflected in the Ameren Missouri Smart Energy Plan including the new Preferred Resource Plan and the Ameren Illinois MYRP order. As you can see on the right side of this page, we are continuing to allocate capital consistent with the allowed return on equity under each regulatory framework. Page 32 in the appendix of this presentation provides a summary of the Ameren Missouri Smart Energy Plan, now filed with the Missouri PSC, which outlines CapEx by year over the next five years. Turning to Page 25. Here, we outlined the expected funding sources for the investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. From a tax perspective, we expect to generate significant tax deferrals, driven primarily by the timing differences between financial statement's depreciation reflected in customer rates and accelerated depreciation for tax purposes. We will continue to advocate, along with others in our industry, to retain clean energy tax credits for the benefit of our customers. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. To maintain a strong balance sheet while we fund our robust investment plan, we expect to issue approximately $600 million of equity each year from 2025 through 2029, a portion of which we expect to be issued through our dividend reinvestment and employee benefit plans. These actions are expected to maintain our strong balance sheet and credit ratings. Turning to Page 26 for further details on our 2025 financing plan. To fund a portion of the $4.2 billion of investment in 2025, we expect debt issuances totaling $500 million, $650 million and $750 million in Ameren Missouri, Ameren Illinois and Ameren Parent, respectively. In addition, as of today, we've entered into forward sales agreements for $265 million of common stock issuances under our at-the-market equity distribution program to address a portion of our 2025 equity needs. We expect to settle these by the end of the year. Moving to Page 27 of our presentation for our 2025 earnings guidance. Today, we are affirming our 2025 diluted earnings per share guidance range of $4.85 per share to $5.05 per share, the midpoint of which represents approximately 7% growth compared to our 2024 adjusted earnings results. These earnings drivers are summarized on this page and remain largely consistent with those discussed on our third quarter earnings call. We expect our disciplined cost management to hold operations and maintenance expenses to around a 1% compound annual growth rate over the five-year plan. Finally, turning to Page 28. We remain confident and excited in our long-term strategy, which we expect will continue to drive consistent superior value for all of our stakeholders. We have strong investment opportunities that benefit our customers and attract and support new business. We expect strong earnings per share growth driven by robust rate base growth, disciplined cost management and a strong customer growth pipeline. As we said before, we have the right strategy, the right team and the right culture to capitalize on opportunities, to create value for our customers and shareholders. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question.
Shahriar Pourreza: Hey, guys. Good morning.
Martin Lyons: Good morning, Shar.
Shahriar Pourreza: Good morning, Marty. Maybe just, Marty, if you can dig into the growth profile a little more. So you're now just over 9% rate base CAGR. You've got this new sales number with 1 gig by '29, equity is largely the same. Can you speak to how close you are to the top end of 6% to 8% at this point? Are we another '29 hyperscaler deal away from piercing 8%? Thanks.
Martin Lyons: Yes, Shar, thanks. You've got some of the building blocks that we laid out for you today. I'm pretty excited about the sales growth that we outlined on Slide 11. Very much excited about the capital plan that we laid out on Slide 24 and it's backed up by the new IRP changes that we've put forward that are on Slide 12. So lot of good building blocks. And like you said, we've provided the financing assumptions as well. So hopefully, I've given you and everybody else, some good building blocks to build out your models. I guess I'd say with respect to the EPS growth, we've said before that our goal is to deliver at or above the midpoint. And we really mean that year in and year out as we look ahead over the next five years. As we pointed out earlier, we certainly do have a history of doing that as well, really delivering within the upper end of that guidance range. As we look out over the next five years, and you kind of talked about this a little bit, we see that sales growth sort of occurring over time, really starting in late 2026 and into 2027. You see on that chart on Slide 11, 500 megawatts expected by the end of 2027. And as you point out, 1 gig of additional demand by the end of 2029. So it's sort of ramps up in the mid to late parts of this period. Similarly, with rate base growth, we certainly don't give that to you year-by-year. But as you look at that Slide 12, that I referenced with the updated IRP, you can see where some of the investments are going to come into service in order to serve that load. And again it's mid to back-end loaded over this five-year period. So look I think those are some of the building blocks and there's certainly a number of steps that need to take place to bring all these sales growth expectations to fruition and get this generation built. But based on the plans we've laid out today, we would expect to deliver near the upper end of the range in the mid to latter part of the plan.
Michael Moehn: Hey, Shar. That was well said. The only thing I might add to that too is I think it's sort of implied what Marty's saying, if you look at that long-term capital plan too, we were at $55 plus billion out there over the next 10 years. Obviously, we updated that with this Preferred Resource Plan that was just filed this morning and updated that to $63 plus billion. So again, I think it just speaks to the longevity of the pipeline and the plan.
Shahriar Pourreza: No, that's very well stated. And then on just the resource plan update, can you just help us sensitize a little more on the scenarios? The preferred plan is 1.5 gigs by 2032, so that's our baseline. But how much of capacity headroom is there in the resource mix if you wind up going beyond that? Are we looking at more generation capital? Would it be backfilled with retirement extensions, repowerings, et cetera? Thanks guys.
Martin Lyons: Yes. As you look at the IRP update that we filed today, in a lot of ways, that reflects what in the short-term, in the next five years, we think, can realistically get done. And what you see there is mostly acceleration of things that we had in our prior plan. And we've talked about this before, the acceleration of renewable investments, battery storage, investment in gas-fired generation. And again, when we look at that opportunity that we have to build that generation out, we believe that we could serve that 2 gigawatts that we have outlined on Slide 11 by 2032 and even more thereafter. So we're really excited today to have the almost 1.8 gigawatts of construction agreements in place today. Last quarter, we provided sort of a sales funnel, if you will, that talked about tens of thousands of megawatts of potential new demand across Missouri and Illinois. That's all still true today. We're excited about that. As we outlined in our plans today that, again, in the IRP, we believe we can serve the load that's been signed up with the construction agreements. We're also continuing to engage with potential developers of data centers in Missouri and Illinois. And we're going to continue to court that interest. Like I said, having the opportunity to serve more even with these plans that we've laid out today. So I think it's all good. On Illinois, I just mentioned that while it's not stated in the slides here, we have several projects in the engineering review stage in Illinois. There are some attractive development sites there, just like there are in Missouri and some good state incentives. So we're doing all we can in each state to help businesses connect to the grid and grow, and grow the communities, the economies that we serve.
Shahriar Pourreza: Perfect. Lots of tailwinds. Congrats, guys. Appreciate it. Fantastic.
Martin Lyons: Thanks.
Operator: Our next question comes from Durgesh Chopra with Evercore. Please proceed with your question.
Durgesh Chopra: Hey, team. Good morning. Happy Valentine's Day.
Martin Lyons: All right. Same to you, Durgesh. Good to hear from you.
Durgesh Chopra: Good. Thank you. Well, a quick shout out to your IR team. The IRP reconciliation is crisp as always and makes my job a lot easier. Listen, two questions. First, on the balance sheet, just like -- the capital line is about 20% higher. The equity is the same. Maybe just where are you tracking on FFO to debt? And are you positioned strongly enough with this capital plan to be at Baa1 or are we thinking about Baa2? Just thoughts there.
Michael Moehn: Good morning. You're making Andrew smile over here, by the way, Durgesh. Nice shout out to him. So he's happy to hear that. Look, as we've talked in the past, we feel good about our balance sheet. We've been very proactive over time issuing equity. I think we've continued to protect and support the balance sheet in a really conservative way. As I sit here today and looking out over the five-year plan, we absolutely feel that this equity here will support the Baa1, BBB+. I mean we're at or above that 17% threshold that Moody's has us at. And that's really obviously the downgrade threshold that we have for us. Just to remind you, at S&P, we're at 13%. So we're probably closer to the upgrade threshold than we are the downgrade threshold given where we maintain the metrics. But again, as we sit here today and what we have from a funding perspective, we feel very, very good about it.
Durgesh Chopra: Got it. Okay. Excellent. And then maybe just a lot of upside investment opportunities on the MISO side, on the IRP. Maybe can you just help reconcile what is in the five-year plan? And then what are the quantum of opportunities if there's a way to size the capital amount, which is truly upside and not yet in the capital plan, if you know where I'm going with this?
Michael Moehn: Yes. Let me start with the transmission piece and Marty can certainly chime in here as well. I mean I think probably the easiest way, Durgesh, to think about it is we had about $5 billion in the overall 10-year pipeline associated with LRTP. And so about $2 billion of that was in the first five years, which has been allocated to us as part of those that first Tranche 1 plus those competitive projects that we won. So that's that first piece. And then you got a remaining $3 billion that you're filling out and that has been $1.3 billion awarded to us here in Tranche 2. And so then we obviously have these competitive projects that we indicate about $6.5 billion worth of projects that we're going to bid on to fill out that piece. So I think the way to think about it, there is clearly upside with respect to some of those competitive projects today and how we think about that $5 billion that's in there. So Marty, anything to add on the transmission side?
Martin Lyons: On the transmission side, I would just say, overall, as we think about the capital plan, we feel like it's conservative and achievable. As you look at the other elements of the capital plan on Slide 24, in Missouri, what we've done is look to align the generation spending there with the updated IRP we filed today, the Illinois Electric Distribution is aligned with the outcome of the Multi-Year Grid and Rate Plans that we had last year. The Illinois gas spending is aligned with our 2023 gas rate review as well as the pending gas rate review and Michael just discussed transmission. So we've aligned all those things. I would note that Ameren Missouri non-generation spending is down a little bit from what we had in our last five-year plan. And I would say that overall, despite the increase in spending that you're seeing and investments you're seeing in Missouri, there's conservatism baked into those numbers as we think about the five-year plan. So I think it's conservative. It's achievable, but it is aligned with those things Michael and I talked about.
Durgesh Chopra: Excellent. Appreciate the discussion there. Thank you.
Martin Lyons: Take care.
Operator: Our next question comes from Nicholas Campanella with Barclays. Please proceed with your question.
Nicholas Campanella: Hey, good morning. Thanks for all the updates and taking my questions today.
Martin Lyons: You bet.
Nicholas Campanella: Hey so I just -- when I look across the portfolio, there's just a lot of tailwinds, whether it's Missouri rate review seems like it's going off to a solid start. And I know that there's legislation this year, you're kind of laying the framework for potentially more data centers to come into your territories. And if you were to have success here, let's just say you kind of move into the high scenario load growth range or you do have to kind of accelerate capital in the plan, is there a point in which you would kind of like reevaluate the growth rate or do these opportunities kind of extend that premium 6% to 8% offering at the?
Martin Lyons: Yes. Well, thanks for the question. And you're right, there are a number of tailwinds that we've got today. I mean we're very excited for our communities and for our customers as we think about some of the economic development opportunities that we're seeing in Missouri and Illinois. And as you mentioned for us, it certainly means opportunities to invest to support those businesses, to help grow those businesses and impact our sales. And we are pleased that in Missouri, in particular, there's good alignment, I believe, with stakeholders to really go after some of these economic development opportunities and provide some of the regulatory tools and mechanisms and outcomes to be able to support the continued investment and growth in our communities. So I think that's all good. As you think about our growth rate over time, certainly, our objective is going to be to maximize that growth rate as we think about the investments that are needed through time. We're not going to constrain it, is another way to put it. In answer, I think, to the first question we got, though, as we think about the next five years, still feel like this 6% to 8% growth guidance is the right guidance. Again, as I said earlier, in the short-term, we'll be at or above that midpoint. But as we see that load growth occurring later in the five-year period, as we see the rate base growing later in that five-year period, as I said before, we do expect to deliver near the upper end of the range in the mid to latter part of the plan. As we go through time, if some of these tailwinds continue and should the growth even accelerate further, we'll certainly reevaluate the overall earnings per share growth range. As I said, we certainly don't want to constrain it in any way.
Nicholas Campanella: That's super helpful. I appreciate that. And I'm sorry to make you repeat yourself a little bit on what's in the plan versus not, but just you mentioned that you have capacity to serve 2 gigawatts of demand or you're working towards capacity to serve 2 gigawatts of demand by 2032. It does seem you have like 1.8 under construction. So I just is what you're doing freeing up additional capacity to attract an additional 2 gigs. So if you were to have an additional demand, you'd have to do more CapEx for that or does this kind of -- does this plan and this CapEx plan create that capacity for you? I just wanted to understand that.
Martin Lyons: Yes. Thanks for the question. I'll try to clarify. As we look at some of this load, it ramps up over time. And so even when you think about that 1.8 gig, it's going to ramp up over some period of time based upon the customers' needs. And so the plan that we laid out today, the resource plan that we laid out, as I said, we think that would support the ability to serve a full 2 gigawatts by 2032 but even more after that. And so as that load grows, we can not only serve that 2 gigs by 2032, but even more so after that. And look, if there's more demand, we'll continue to explore ways to serve even beyond that. So again, we're not constraining ourselves. But as we look at this next five years, with the investments we've outlined are the things that, we do believe we can realistically achieve and support that load growth that I just talked about.
Nicholas Campanella: All right. Thank you very much.
Operator: [Operator Instructions] Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question.
Carly Davenport: Hey, good morning. Thanks so much for taking the questions. Maybe just two quick ones for me. First, on the sales growth outlook. Can you just help us put that 5.5% CAGR into the context of sort of the total pipeline that you're seeing in Missouri or maybe said another way, can you just talk about how you sort of risked the pipeline to come out to this 5.5% level over the course of the new five-year plan?
Martin Lyons: Yes, I'll see what color I can provide on that. When you look back on the Q3 call, in that funnel, we talked about tens of thousands of megawatts of potential demand, 75% of that from data centers and about 65% of that Missouri. So significant demand. But what's happened through time is we worked with different developers in terms of transmission access. And as I said earlier, about 1.5 gigs of new construction agreements have been signed on top of the ones that we had when we talked last in Q4. So we've really been trying to take those in terms of in a fair and equitable way in terms of the orders that they came in and have asked for interconnection. And that's where we are today. Now to put it all in sort of scale terms. I mean 2 gigs, if we're serving 2 gigs by the end of 2032 that represents about a 45% increase in Missouri sales. So pretty significant. But as I said earlier, Carly, this is what we've got today, given the construction agreements that we've got signed, given the tariff discussions we have going on with end users and we look at the, again, the generation that we can accelerate and deliver within this time period. We think 1.5 gig is a good point estimate. But again it could be greater as we think about the sales by 2032.
Michael Moehn: And Carly it's Michael. Just a little finer point. I mean I think the comments that we have made previously about this first 250 megawatts, I think, still stands. We talked about that being online by the end of 2026. And then as Marty said, it kind of ramps in over time, 500 by the end of '27 and then you get to 1 gig by the end of 2029. And the only thing I might add in addition to this, I mean, I think we're coming off of a good foundation as well, right? As I indicated in my talking points, we ended the year at just a little bit right at about 2% growth. And it was across all classes, 2% on the residential side, 1.5% on the commercial and then a really robust 3% on the industrial side. And we're forecasting additional growth in '25 relative to '24 as well. So I mean, I think, again, it gives us good backdrop just what we're talking about here in terms of the foundation.
Carly Davenport: Great. I appreciate all that color. That's really helpful. And then maybe just on the updated IRP in Missouri. I know you mentioned this in your opening remarks, but you did have some new nuclear longer dated, of course, by 2040 reflected in that new filing. Obviously, it's a big focus of the market. So could you just talk a little bit about kind of how you envision that new capacity? Is that more focused on opportunities around SMRs or something more like an AP1000?
Martin Lyons: Yes. Thanks, Carly. And you're right, it's long-dated. When we look out to 2040 time frame, looking at adding new nuclear and we talked about that balanced energy portfolio we see in the future. And when you look out to, say, 2045, what we see is about 70% dispatchable resources with nearly 40% nuclear, a little over 30% gas and then about 30% of our energy coming from renewables. So that's what we're sort of looking towards when we look very long-term. And of course, we've got experience with nuclear. Our Callaway plant here in Missouri has served our customers well for the past 40 years and we expect it to continue for the next 40 years. That said, I'd say as we sit here today, we really haven't put a stake in the ground in terms of what technology would make the most sense for us in terms of a nuclear technology. Certainly, when you look at the megawatts that we have in there for new nuclear, about 1,500, you got a full range of options, as you mentioned, in terms of technology. But what we're really looking to do over the next three to five years is to devote resources internally to monitor and studying these technologies closely and exploring perhaps what activities might be prudent to take that would say be technology agnostic, which might include things like construction permitting and the like. I don't see in the next few years, any material financial commitment as it relates to new nuclear, as you say, it's sort of long-dated. But we do think that's part of our energy future as we look out to a balanced portfolio in Missouri.
Carly Davenport: Great. Thanks so much for the answers. Appreciate the time.
Martin Lyons: You bet.
Operator: Our next question comes from Julien Dumoulin-Smith with Jefferies. Please proceed with your question.
Julien Dumoulin-Smith: Hey, good morning, team. How are you guys doing?
Martin Lyons: Great, Julian. How about you?
Julien Dumoulin-Smith: Hey, great. Happy Friday. With that said, you guys, I mean just a remarkable update here across the board, whether it's the minimal limited incremental equity, great roll forward of the rate base here. I mean really what's left to address on the call here is, as you think about regulatory lag in front of you in this investment cycle, can you speak to that a little bit here and what you're facing, if that, there's any kind of timing issues? Obviously, you're emphasizing being at the upper end of the plan in the back half of the year. Can you speak to maybe any kind of earned ROE expectations and maybe marry that up against expectations and how to frame and sensitize any potential legislative outcomes here? Obviously, you spoke to some of them in brief earlier, but maybe just kind of square that up, if you will, and set any expectations on the cadence of earnings through the five-year period, too?
Michael Moehn: Let me start on the regulatory lag and then Marty can come in and talk about the legislative process. I mean, Julien, as you know, I mean we've always managed these businesses prudently try to earn as close to our allowed as possible. I mean if you kind of look at where we are on a historical basis versus some place in excess of 10% kind of across the overall portfolio of different returns. And as you said, I mean, we got to continue to be thoughtful about this. Obviously, you have rate reviews and other things you got to be thoughtful about from a timing perspective. And so that goes into how we think about projects. And Mark Birk and his team do a really good job just thinking about when those are going to need to be in place from a cutoff date, et cetera, just again to make sure that we're maximizing the returns and minimizing any regulatory lag. And then the other thing that we've obviously done in addition to all of this, which I think is just a good practice in general is we've managed our overall O&M cost really, really well. We talked about this at the beginning of the year. I mean, we went through another process of kind of looking at spans and layers, doing a lot of benchmarking, looking up and down the P&L. We've made significant investments in technology over the past five, six years. We're continuing to start to see some of that benefit from a productivity standpoint today, both back office and in the field, which I think is helpful being very thoughtful about as we turn -- have turnover and the replacements we put back into the business et cetera. So I think all of that has served us well and it obviously manifests itself in having O&M be down $12 million, which I indicated in the talking points, year-over-year, which I think is good in this environment because we want to be doing everything we possibly can to try to minimize the impact of this transition. So that's what I would say about that from a regulatory lag perspective, Marty can certainly add in and talk about the legislative piece too.
Martin Lyons: Yes, I thought that was good, Michael. I think, Julien, as you go through time, we'll have to adjust and think through the timing of our rate reviews, as Michael mentioned, for a variety of factors. And again, some of it is going to be really getting better visibility in terms of how some of the sales growth is going to occur through time and refined timing on some of the, I'll call it, chunkier in-service dates on some of the elements of our integrated resource plan. And those things will help to refine our regulatory timing as well as thoughts on regulatory lag. But you did mention legislation in Missouri. There are a number of legislative initiatives that are progressing. As you know, the legislative session just recently kicked off and goes through, I think, May 16th of this year. So quite a bit of time. But we outlined on Slide 15, a number of various pieces of legislation that are sort of percolating. And some of them are familiar to you, things we've talked about in the past like really extension of PISA. As you think about some of these generation investments we want to make, getting that sunset pushed out in time is really helpful to us, gives us greater visibility in terms of regulatory framework and certainty through time, extending that to include natural gas generation. Again, we've got that built into our plan. These things are important in terms of supporting this economic development, this investment in generation. You see other things like the Missouri First Transmission Act, really making sure that we can get transmission built quickly have good import-export capability in our region, again, supports the economic growth. And then you see some of the other things that are percolating, you have changes to the integrated resource planning, allowing QIP in rate base for new natural gas generation or other energy centers, you see forward test years for natural gas and water. So I think some good constructive things that would be, again, incrementally supportive of investment in the state and incrementally supportive of broader economic growth and development in the state. And so the active consideration on these, there's a long way to go, but as we have recently seen some Senate action on that, in particular, so a consolidation of a number of these bills into one bill with Senate Bill 4. So I'd encourage you to continue to monitor these. We'll certainly continue as well as others to actively engage. But I think it's just good constructive discussion that about things that would be supportive of investment and economic growth in our state. So thanks.
Julien Dumoulin-Smith: Excellent, guys. Best of luck. It's a real pleasure to see us come together. All right. You guys take care.
Martin Lyons: You too, Julien. See you soon.
Operator: Our next question comes from Anthony Crowdell with Mizuho. Please proceed with your question.
Anthony Crowdell: Hey, good morning, guys. Thanks for the update. Hopefully, just two quick questions. One is, I think, on Slide 31, where you, kudos to Andrew again. You do a great job of breaking it out. Just wondering 2030 you have 1,600 megawatts of gas, 800 more than your original plan. We hear or seen in the papers, the challenges of procuring new gas fired generation. Just anything you could add on the ability to add that generation? I have one follow-up.
Michael Moehn: Yes. No, Anthony, this is Michael. Look, we feel good about that addition. I mean, we've taken steps along the way in Missouri to make sure that we could procure what we needed to, to get this online, given the importance of it, given the significance of what we're seeing from a supply chain perspective. So I think we've mentioned this before, but I think those steps have served us well, and we should be in good shape to bring this online. Still a lot of work to do. But from a critical component standpoint we're set.
Anthony Crowdell: Great. And then on the S&P rating just if you could just give me the numbers. I missed it to the earlier question. I think you said you're closer to the upgrade threshold. Would you mind just those numbers again?
Michael Moehn: Yes, our downgrade threshold at S&P is 13%, Anthony. And so we've been certainly north of 17% or above there on that calculation. And so I don't know exactly what the upgrade threshold is, but it's -- we're much closer to that than we are the downgrade threshold. That's the point I guess I was trying to make.
Anthony Crowdell: Great. Thanks so much for taking the question and congrats on a great update.
Michael Moehn: Thanks, Anthony.
Operator: Our next question comes from Bill Appicelli with UBS. Please proceed with your question.
William Appicelli: Hi. Good morning.
Martin Lyons: Hey, Bill. Good morning.
William Appicelli: A question on the large load tariff that you're going to be filing. Can you just share some details around that? Is that going to have minimum load commitments for a set period of time? Is there an expectation that this is new load that's going to be -- have a neutral impact or potentially a beneficial impact to existing customers? Any color you can share on that filing?
Martin Lyons: Yes, Bill, I'd say it's premature to say exactly how it's going to be structured. But you're hitting on the right points. We're actively working with some of the prospective customers to finalize the tariff. I'd say discussions are going well. But you're right. I mean typical contract items, things like revenues to cover cost, the cost to serve, tenor of contract, minimum takes, exit provisions, credit provisions. I mean these are the things that we're focused on.
William Appicelli: Okay. But I mean but the point would be that existing customers would be held -- would be neutral to the large load coming on?
Martin Lyons: At a minimum, yes.
William Appicelli: Yes. Okay. And then just on the Missouri rate case, I think, there's a settlement window coming up next week. I know you've got hearings set for middle of March. But any update on how you're feeling around maybe the possibility of settling the rate case in this upcoming window?
Michael Moehn: Bill, it's Michael. Again, I think as I indicated on the call itself, I mean, I think we sit in a good spot at this point in terms of the differences between us versus staff. I think we indicated, in the last update, we were at $446 million versus $398 million from staff and so most of that is being driven by ROE, they're at 9.74%, and we're at 10.25%. And then there's an issue associated with this High Prairie wind place. So I think, ultimately, we always look to try to find a constructive way to get these settled. You can never guarantee that. But I think we sit in a good spot to continue to have some constructive conversations here over the coming weeks and we'll see what time brings us.
William Appicelli: Okay. All right. Great. Thanks very much.
Operator: Our next question comes from Jeremy Tonet with JPMorgan Chase. Please proceed with your question.
Jeremy Tonet: Hi. Good morning and a very Happy Valentine's Day to all.
Martin Lyons: Same to you. Michael's got his pink shirt on today. He's ready to go.
Jeremy Tonet: Great to see. Great to see. I was just wondering if I go to the financing plan a little bit, the $4.4 billion of increase in CapEx, yet only $300 million of incremental equity, I haven't seen that from all your peers out there. Just wondering if you could talk a bit more about the specific drivers here that allow you to minimize additional equity issuance here? Is there any shaping of CapEx over the five-year plan and how that impacts financing considerations?
Michael Moehn: No, Jeremy, I mean, look, I think it's more of a product just how we've managed this over time, right? We came into this kind of super cycle of CapEx in a really strong position. We've always protected the balance sheet. Again we've liked our ratings where they have been historically. And so I think that's really probably the difference here as we just, as we worked into it, that we had some continued room. If you went back and looked over time, we were certainly in excess of even those downgrade thresholds where we are today. But as we look over the next five years, as I mentioned earlier, I feel good that we're going to be at or above that 17%, which is really the threshold metric for us on the Moody's side.
Jeremy Tonet: Got it. Great to see what being conservative on the balance sheet can do to you, make sense. And maybe just one last one, if I could. Circling back to legislation, do these items represent upside to your plan? Any way to size the magnitude of earnings and cash flow benefits from possible legislation here?
Martin Lyons: I think these are really things that can create a win-win for customers and shareholders as we think about executing the capital plans that we've got. And I think in large respect, go a long way simply to helping us turn closer to our allowed return as we deploy the capital.
Jeremy Tonet: Got it. Great. Thank you for that. See you next month in Denver.
Martin Lyons: You bet.
Operator: Our next question comes from David Paz with Wolfe Research. Please proceed with your question.
Martin Lyons: Good morning, David.
David Paz: Good morning. Sorry I think my question has mostly been answered, but maybe just a little more precise question here. I know you said that you expect to be within the 6% to 8% EPS growth target each year and then the upper end in the latter half of the planning period. But do you see any specific headwinds that puts you below the midpoint, say, next year in 2026 before that sales growth kicks in? And if so what are those?
Martin Lyons: No, David, I wouldn't say there are any specific headwinds with respect to being at the midpoint or higher as we look at next year. But again I think the point I was trying to make is, when you look at some of that sales growth again and Michael, I think, underscored this, we really see that ramping up late '26, into 2027 and then beyond. And you can look at also to some of the rate base growth, which occurs sort of again mid to latter part. But no I wasn't trying to suggest that next year we would be expecting to sort of miss that mark.
David Paz: Got it. Okay. Thank you.
Martin Lyons: All right, David. Hey, I think, we're going to have to wrap it up for today. We've got some other business we have to attend to this morning. I really appreciate all the interest we had on the call this morning. Lots of great questions and dialogue. I think you can tell that we're very energized by the opportunities ahead, the power growth for our communities and for our shareholders. And so with that, please be safe, and we look forward to seeing many of you at upcoming conferences.
Operator: This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation. | [
{
"speaker": "Operator",
"text": "Greetings and welcome to Ameren Corporation Fourth Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Senior Director, Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk, you may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty."
},
{
"speaker": "Martin Lyons",
"text": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. This morning, we will discuss 2024 financial results, recap events and accomplishments and look ahead to 2025 and beyond. What you'll hear is that the Ameren team's collective efforts produced strong results operationally and financially in 2024. And just as important, the team accomplished strategic goals that position our company to provide higher levels of satisfaction for our customers and strong returns for our shareholders in the years ahead. In 2025, we are again set up to deliver strong results, but also to take meaningful steps towards enabling our communities to benefit from significant economic development opportunities. Those opportunities offer direct investment in our states, bringing jobs and incremental tax revenue. And for Ameren, as we discuss our plans today, it means sales growth and the need to accelerate capital investments to meet the energy needs driven by that industrial demand. Starting on Page 4. We continue to be guided by our Three Pillar strategy. To invest in rate-regulated infrastructure, to enhance regulatory frameworks and advocate for responsible energy policy and optimize our operating performance. This strategy has served us well for the last decade and we will remain focused on solid execution year in and year out to maximize value for our customers, communities and shareholders. With that, let me summarize our 2024 performance on Page 5. I'm pleased to say that we accomplished all our key business objectives outlined at this time last year and on this page. Importantly, we strategically invested approximately $4.3 billion in energy infrastructure, secured timely regulatory approvals for future investment and prudently managed our operating costs while delivering reliable energy service. And yesterday, we announced 2024 adjusted earnings of $4.63 per share compared to earnings of $4.38 per share in 2023. This result was above our 2024 adjusted earnings guidance midpoint. Turning to Page 6, which highlights the benefits of the investments we are making for our customers. The successful execution of our strategy continues to drive improved reliability and strong customer service while keeping customer rates low in comparison to the national and Midwest averages. Further, our ongoing infrastructure investments improved grid resilience as demonstrated by the performance of our system during severe winter storms in early January of this year. Despite challenging conditions, our grid improvements prevented over 3.5 million minutes of potential outage time across our service territories in Missouri and Illinois. Importantly, we had no issues on the more than 250 miles of power lines that have already been updated through Ameren Missouri's Smart Energy Plan. On Page 7, we summarize our strong performance for shareholders over time. Our goal, like we said in the past, is to deliver at the midpoint or higher within our earnings guidance range. Our weather-normalized adjusted earnings per share have risen at an approximate 7.6% compound annual growth rate since 2013, while our annual dividends paid per share have increased approximately 68%. This has driven a strong total return of nearly 250% for our shareholders over the same period, which was significantly above utility index averages. Moving to Page 8. As we look to the opportunities ahead, in 2025, our focus will be on continuing to provide safe, reliable service to our customers at competitive rates while bringing additional growth opportunities to our states. We'll do this, first and foremost, by investing approximately $4.2 billion in electric, natural gas and transmission infrastructure to bolster the safety, security, reliability and responsiveness of the energy grid. Further, we're focused on enhancing our generation plans to meet customers' needs, achieving constructive regulatory outcomes and advocating for policies that enhance reliability and resource adequacy as well as attracting new businesses to our communities. As always, while we work to accomplish these objectives, we will remain focused on operating as efficiently and effectively as possible. Moving to Page 9 for an update on our long-term growth outlook. We continue to extract 2025 earnings to be in a range of $4.85 per share to $5.05 per share. The midpoint of this range represents approximately 7% earnings per share growth compared to our adjusted 2024 earnings results. Building on the execution of our strategy and track record of strong earnings growth, we expect to deliver 6% to 8% compound annual earnings per share growth from 2025 through 2029, using the midpoint of our 2025 guidance of $4.95 per share as the base. We're excited about the robust sales growth and energy infrastructure investment opportunities in front of us, which strengthen our confidence in our ability to deliver strong long-term earnings growth. I'll speak more about those things in a moment. In addition to growing earnings per share, last week, Ameren's Board of Directors approved a quarterly dividend increase of approximately 6%, resulting in an annualized dividend rate of $2.84 per share. This represents our 12th consecutive year of increasing our dividend, which reflects continued confidence by Ameren's Board of Directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect to grow our dividend in line with our long-term earnings per share growth expectations and for our dividend payout ratio to range from 55% to 65% of earnings per share. Combined, these elements support our strong total shareholder return proposition. Turning to Page 10 for more on the foundation of our earnings outlook. Our strong long-term earnings growth expectation is driven by robust rate base growth, reflecting investment in energy infrastructure, included in Ameren Missouri's Smart Energy Plan, which incorporates its Preferred Resource Plan, Ameren Illinois's Multi-Year Rate Plan and projects awarded to Ameren in MISO's long-range transmission planning. Today, we are rolling forward our five-year investment plan. And as you can see, we expect to grow our rate base at a 9.2% compound annual rate from 2024 through 2029. This robust rate base growth is driven by a 20% increase in our five-year capital plan compared to the previous capital plan laid out last February, primarily reflecting accelerated generation needed to serve our updated sales growth expectations. Now turning to Page 11 for more detail on the growth opportunities in Missouri driving the significant increase in our capital plan. We expect tremendous opportunities for economic growth over the next five to seven years. Our region's economy spans multiple sectors from aviation, biotechnology, chemicals, financial services, beverage and food manufacturing, life and plant sciences to health care and logistics and a variety of other manufacturing concerns. And increasingly, it is an attractive location for data centers. Based on our robust economic development pipeline, we are now expecting our weather-normalized retail sales to increase approximately 5.5% compounded annually from 2025 through 2029, compared to our prior plan expectations of flat to up 0.5%. This sales growth expectation is consistent with the notice we filed with the Missouri Public Service Commission of our intention to update our Preferred Resource Plan. That plan assumes approximately 500 megawatts of load growth by the end of 2027, a total of 1 gigawatt by the end of 2029 and 1.5 gigawatts by the end of 2032. Since our third quarter earnings call, we have signed additional construction agreements with data center developers for 1.5 gigawatts of new load to be interconnected to our transmission system, bringing our total to approximately 1.8 gigawatts. These construction agreements are subject to acceptance of a modified industrial tariff under which new customers would receive energy service. Earlier this week, we submitted the necessary transmission load request related to these agreements to MISO for expedited project review and expect approval in April. Further, we are actively working to propose a modified tariff for large industrial customers, including data center customers, and we expect to file for approval of the tariff with the Missouri Public Service Commission by the second quarter. While there's no deadline for commission approval, we are optimistic we'd receive a decision and that the tariff would be in effect before the end of the year. We remain aligned with key stakeholders across the state in our efforts to attract new businesses to the region. Our economic development pipeline beyond our current construction agreements remains robust and we will continue to pursue each opportunity vigorously to maximize value for our customers and communities. As the green shading on our slide indicates, a range of sales growth outcomes could ultimately occur. But based on our planned generation resource build out, we expect to have the capacity to serve 2 gigawatts of new demand by 2032 and even more thereafter. Moving then to Page 12 for an update on Missouri's generation plans. Considering the significant sales growth potential, the lead time needed to construct new generation and other key considerations, Ameren Missouri notified the Missouri PSC that we are changing the Preferred Resource Plan in our September 2023 IRP, which lays out generation, our generation plan for the next 20 years. As mentioned, our new preferred plan is designed to serve 1.5 gigawatts of additional demand by 2032. And as I mentioned, it provides for a range of outcomes. The key objectives of our resource planning remain the same. A balanced mix of resources to provide reliable, lowest cost and cleaner energy for our customers. Our preferred plan calls for acceleration and expansion of natural gas generation and battery storage, acceleration of solar generation investment, potential extension of the life of our Sioux Energy Center by up to three years and investment in additional nuclear generation by 2040. In total, the change in preferred plan represents the addition of 2.3 gigawatts of generation capacity by 2035 and when factoring in updated costs for all planned resources, represents approximately $7 billion of increased investment by 2035 compared to the 2023 IRP. Our execution of this investment plan will lay the foundation for reliable economic expansion in Missouri. For further details on the differences between the Preferred Resource Plan from the 2023 IRP and new 2025 Preferred Resource Plan, see Page 31 of this presentation. Turning to Page 13 for an update on the new generation recently placed in service or under development. This past year was just a start to the robust generation portfolio additions. Three new solar facilities totaling 500 megawatts and representing approximately $1 billion of investment were placed in service during the fourth quarter of 2024 as planned. Combined, the three facilities are expected to generate energy sufficient to power 92,000 homes annually and we continue to execute our IRP. We have another 1,200 megawatts of approved generation currently under construction. And we expect to file a request with the Missouri PSC for approval of additional generation and battery energy storage in the coming months. Moving now to Page 14 for a transmission update. In December, MISO approved a nearly $22 billion Tranche 2.1 portfolio, which is expected to provide significant reliability and capacity benefits for the region. MISO has already selected Ameren to lead $1.3 billion worth of these critical grid infrastructure projects in Missouri and Illinois. The portfolio also includes $6.5 billion of projects, which will be open for competitive bid, of which approximately $1.8 billion are in Illinois. We believe we are well positioned to compete for all these opportunities as we have a strong track record of developing and operating cost effective and high-quality transmission infrastructure. MISO and its transmission owners will continue to assess the current long-range transmission future scenarios to support our region's energy needs in the years ahead. This analysis is expected to be followed by development of the Tranche 2.2 project portfolio. Moving to Page 15 for a legislative update. In January, the Missouri legislative session began. Several bills are currently under consideration, including the Power Predictability and Reliability Act, the Missouri First Transmission Act, proposed modifications to integrated resource planning and the opportunity for future test year regulatory frameworks for natural gas and water utilities. While these bills are at various stages in the legislative process, they collectively demonstrate Missouri's commitment to enabling a reliable and efficient energy future and supporting economic growth and job creation within our communities. Ameren will remain actively engaged with policymakers and key stakeholders in the months ahead to advocate for constructive energy policy. Turning to Page 16 for an update on our 10-year investment pipeline. Looking ahead, we have a robust pipeline of investment opportunities of over $63 billion that will deliver significant value to all of our stakeholders by making our energy grid more reliable, stronger and smarter. In addition, these investments will support many thousands of jobs within our local economies. Of course, constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our region's energy needs and delivering on our customers' expectations. Turning now to Page 17, to sum up our value proposition. We remain convinced that the execution of our strategy in 2025 and beyond will continue to deliver superior value to our customers and shareholders. Our earnings growth expectations are driven by strong compound annual rate base growth of 9.2% and strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high-quality utility growth story. Combined, our strong long-term 6% to 8% earnings growth plan and an attractive and growing dividend result in a compelling total return story. Further, we have a strong track record of execution and an experienced management team. I'm confident in Ameren's team's ability to execute our investment plans and other elements of our strategy across all four of our business segments. Again, thank you all for joining us today and I'll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. I'll begin on Page 19 of our presentation with our 2024 earnings results. Yesterday, we reported 2024 adjusted earnings of $4.63 per share, compared to earnings of $4.38 per share in 2023. Our 2024 earnings exclude two charges totaling $0.21 per share. The first is related to the NSR settlement approved by the US District Court for the Eastern District of Missouri for the Rush Island Energy Center. The second is related to the Federal Energy Regulatory Commission's order on base return on equity. On Page 20, we summarize key drivers impacting adjusted earnings at each segment. Our strong 2024 adjusted earnings results were largely driven by our strategic infrastructure investments. In addition, weather-normalized retail sales grew approximately 2% across Ameren Missouri with 2%, 1.5% and 3% growth in our residential, commercial and industrial classes respectively. Notably, industrial sales continue to remain robust, driven largely by growth from customers in the manufacturing and technology sectors. This year's sales growth reflects the strong economy across our service territory, which will serve as a solid foundation for future potential growth. Our focus remains on balancing necessary investments with prudent cost management to support both system reliability and customer affordability. At the beginning of last year, we set an ambitious goal to hold O&M expenses flat given the importance of cost control and managing customer rate impacts. I'm proud to report that we've made significant strides in this area. Importantly, at Ameren Missouri, when excluding the onetime NSR charge, all-in O&M expenses were down $12 million year-over-year. As we navigate the current economic landscape, we expect our proactive cost management and strategic investments will continue to drive operational efficiencies and keep our customer rates below the national and the Midwest averages. Moving to Page 21 to cover regulatory progress made in the fourth quarter. In December, the Missouri PSC staff recommended a $398 million annual revenue increase in our 2024 Ameren Missouri electric rate review. The difference between our request of $446 million and staff's recommendation is primarily driven by staff's proposed return on equity of 9.74% versus our request of 10.25%, and treatment of High Prairie Energy Center, partially offset by estimated off-system sales and fuel costs, which will be subject to true-up in regulatory recovery mechanisms. The equity ratio will be updated to use the capital structure as of December 31st, 2024. Surrebuttal and True-up Direct Testimony will be available later today. As we have in the past, we will seek to work through these and other differences with interveners over the coming weeks. Evidentiary hearings are scheduled to begin in mid-March and the decision for the Missouri PSC is expected by May, with new rates effective by June 1st. Turning to Page 22 for an update on our regulatory proceedings in Illinois. In December, the Illinois Commerce Commission, or ICC, issued orders in two of our pending Illinois rate reviews. The ICC approved our revised grid plan and the corresponding Multi-Year Rate Plan or MYRP for 2024 through 2027 for a cumulative revenue increase of $309 million versus our request for an increase of $332 million. These annual revenues reflect our recoverable costs, average rate base of $4.8 billion by 2027, and as anticipated, no change in the 8.72% return on equity. Investments in the energy grid under this multiyear plan is expected to preserve safety, reliability and the day-to-day operations of our system while also making progress towards the clean energy transition. We're pleased to have an ICC-approved grid plan through 2027, which provides clarity on the work ahead. In addition, the ICC approved our request for $158 million reconciliation adjustment in the final electric distribution reconciliation of 2023's revenue requirement. The full amount will be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that was collected during 2024. New rates from the 2023 reconciliation in 2024 through 2027 MYRP were affected at the end of last year. Moving now to Page 23 for an update on the Illinois gas regulatory matters. In January, Ameren Illinois Natural Gas Distribution requested $140 million annual base rate increase based on a 10.7% return on equity, a 52% equity ratio and a $3.3 billion average rate base during our future 2026 test year. An ICC decision is required by early December, with rates expected to be effective in December 2025. Turning to Page 24. We look ahead to our company-wide capital plan for the next five years. Here, we provide an overview of our $26.3 billion of planned capital expenditures for 2025 through 2029, by business segment, which support our consolidated 9.2% compound annual rate base growth expectations. As Marty highlighted, we have a robust capital investment opportunities ahead of us. The five-year infrastructure investment plan we are releasing today represents a 20% increase over our investment plan issued last year. This increase includes additional generation reflected in the Ameren Missouri Smart Energy Plan including the new Preferred Resource Plan and the Ameren Illinois MYRP order. As you can see on the right side of this page, we are continuing to allocate capital consistent with the allowed return on equity under each regulatory framework. Page 32 in the appendix of this presentation provides a summary of the Ameren Missouri Smart Energy Plan, now filed with the Missouri PSC, which outlines CapEx by year over the next five years. Turning to Page 25. Here, we outlined the expected funding sources for the investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. From a tax perspective, we expect to generate significant tax deferrals, driven primarily by the timing differences between financial statement's depreciation reflected in customer rates and accelerated depreciation for tax purposes. We will continue to advocate, along with others in our industry, to retain clean energy tax credits for the benefit of our customers. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. To maintain a strong balance sheet while we fund our robust investment plan, we expect to issue approximately $600 million of equity each year from 2025 through 2029, a portion of which we expect to be issued through our dividend reinvestment and employee benefit plans. These actions are expected to maintain our strong balance sheet and credit ratings. Turning to Page 26 for further details on our 2025 financing plan. To fund a portion of the $4.2 billion of investment in 2025, we expect debt issuances totaling $500 million, $650 million and $750 million in Ameren Missouri, Ameren Illinois and Ameren Parent, respectively. In addition, as of today, we've entered into forward sales agreements for $265 million of common stock issuances under our at-the-market equity distribution program to address a portion of our 2025 equity needs. We expect to settle these by the end of the year. Moving to Page 27 of our presentation for our 2025 earnings guidance. Today, we are affirming our 2025 diluted earnings per share guidance range of $4.85 per share to $5.05 per share, the midpoint of which represents approximately 7% growth compared to our 2024 adjusted earnings results. These earnings drivers are summarized on this page and remain largely consistent with those discussed on our third quarter earnings call. We expect our disciplined cost management to hold operations and maintenance expenses to around a 1% compound annual growth rate over the five-year plan. Finally, turning to Page 28. We remain confident and excited in our long-term strategy, which we expect will continue to drive consistent superior value for all of our stakeholders. We have strong investment opportunities that benefit our customers and attract and support new business. We expect strong earnings per share growth driven by robust rate base growth, disciplined cost management and a strong customer growth pipeline. As we said before, we have the right strategy, the right team and the right culture to capitalize on opportunities, to create value for our customers and shareholders. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shahriar Pourreza",
"text": "Hey, guys. Good morning."
},
{
"speaker": "Martin Lyons",
"text": "Good morning, Shar."
},
{
"speaker": "Shahriar Pourreza",
"text": "Good morning, Marty. Maybe just, Marty, if you can dig into the growth profile a little more. So you're now just over 9% rate base CAGR. You've got this new sales number with 1 gig by '29, equity is largely the same. Can you speak to how close you are to the top end of 6% to 8% at this point? Are we another '29 hyperscaler deal away from piercing 8%? Thanks."
},
{
"speaker": "Martin Lyons",
"text": "Yes, Shar, thanks. You've got some of the building blocks that we laid out for you today. I'm pretty excited about the sales growth that we outlined on Slide 11. Very much excited about the capital plan that we laid out on Slide 24 and it's backed up by the new IRP changes that we've put forward that are on Slide 12. So lot of good building blocks. And like you said, we've provided the financing assumptions as well. So hopefully, I've given you and everybody else, some good building blocks to build out your models. I guess I'd say with respect to the EPS growth, we've said before that our goal is to deliver at or above the midpoint. And we really mean that year in and year out as we look ahead over the next five years. As we pointed out earlier, we certainly do have a history of doing that as well, really delivering within the upper end of that guidance range. As we look out over the next five years, and you kind of talked about this a little bit, we see that sales growth sort of occurring over time, really starting in late 2026 and into 2027. You see on that chart on Slide 11, 500 megawatts expected by the end of 2027. And as you point out, 1 gig of additional demand by the end of 2029. So it's sort of ramps up in the mid to late parts of this period. Similarly, with rate base growth, we certainly don't give that to you year-by-year. But as you look at that Slide 12, that I referenced with the updated IRP, you can see where some of the investments are going to come into service in order to serve that load. And again it's mid to back-end loaded over this five-year period. So look I think those are some of the building blocks and there's certainly a number of steps that need to take place to bring all these sales growth expectations to fruition and get this generation built. But based on the plans we've laid out today, we would expect to deliver near the upper end of the range in the mid to latter part of the plan."
},
{
"speaker": "Michael Moehn",
"text": "Hey, Shar. That was well said. The only thing I might add to that too is I think it's sort of implied what Marty's saying, if you look at that long-term capital plan too, we were at $55 plus billion out there over the next 10 years. Obviously, we updated that with this Preferred Resource Plan that was just filed this morning and updated that to $63 plus billion. So again, I think it just speaks to the longevity of the pipeline and the plan."
},
{
"speaker": "Shahriar Pourreza",
"text": "No, that's very well stated. And then on just the resource plan update, can you just help us sensitize a little more on the scenarios? The preferred plan is 1.5 gigs by 2032, so that's our baseline. But how much of capacity headroom is there in the resource mix if you wind up going beyond that? Are we looking at more generation capital? Would it be backfilled with retirement extensions, repowerings, et cetera? Thanks guys."
},
{
"speaker": "Martin Lyons",
"text": "Yes. As you look at the IRP update that we filed today, in a lot of ways, that reflects what in the short-term, in the next five years, we think, can realistically get done. And what you see there is mostly acceleration of things that we had in our prior plan. And we've talked about this before, the acceleration of renewable investments, battery storage, investment in gas-fired generation. And again, when we look at that opportunity that we have to build that generation out, we believe that we could serve that 2 gigawatts that we have outlined on Slide 11 by 2032 and even more thereafter. So we're really excited today to have the almost 1.8 gigawatts of construction agreements in place today. Last quarter, we provided sort of a sales funnel, if you will, that talked about tens of thousands of megawatts of potential new demand across Missouri and Illinois. That's all still true today. We're excited about that. As we outlined in our plans today that, again, in the IRP, we believe we can serve the load that's been signed up with the construction agreements. We're also continuing to engage with potential developers of data centers in Missouri and Illinois. And we're going to continue to court that interest. Like I said, having the opportunity to serve more even with these plans that we've laid out today. So I think it's all good. On Illinois, I just mentioned that while it's not stated in the slides here, we have several projects in the engineering review stage in Illinois. There are some attractive development sites there, just like there are in Missouri and some good state incentives. So we're doing all we can in each state to help businesses connect to the grid and grow, and grow the communities, the economies that we serve."
},
{
"speaker": "Shahriar Pourreza",
"text": "Perfect. Lots of tailwinds. Congrats, guys. Appreciate it. Fantastic."
},
{
"speaker": "Martin Lyons",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore. Please proceed with your question."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, team. Good morning. Happy Valentine's Day."
},
{
"speaker": "Martin Lyons",
"text": "All right. Same to you, Durgesh. Good to hear from you."
},
{
"speaker": "Durgesh Chopra",
"text": "Good. Thank you. Well, a quick shout out to your IR team. The IRP reconciliation is crisp as always and makes my job a lot easier. Listen, two questions. First, on the balance sheet, just like -- the capital line is about 20% higher. The equity is the same. Maybe just where are you tracking on FFO to debt? And are you positioned strongly enough with this capital plan to be at Baa1 or are we thinking about Baa2? Just thoughts there."
},
{
"speaker": "Michael Moehn",
"text": "Good morning. You're making Andrew smile over here, by the way, Durgesh. Nice shout out to him. So he's happy to hear that. Look, as we've talked in the past, we feel good about our balance sheet. We've been very proactive over time issuing equity. I think we've continued to protect and support the balance sheet in a really conservative way. As I sit here today and looking out over the five-year plan, we absolutely feel that this equity here will support the Baa1, BBB+. I mean we're at or above that 17% threshold that Moody's has us at. And that's really obviously the downgrade threshold that we have for us. Just to remind you, at S&P, we're at 13%. So we're probably closer to the upgrade threshold than we are the downgrade threshold given where we maintain the metrics. But again, as we sit here today and what we have from a funding perspective, we feel very, very good about it."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Okay. Excellent. And then maybe just a lot of upside investment opportunities on the MISO side, on the IRP. Maybe can you just help reconcile what is in the five-year plan? And then what are the quantum of opportunities if there's a way to size the capital amount, which is truly upside and not yet in the capital plan, if you know where I'm going with this?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Let me start with the transmission piece and Marty can certainly chime in here as well. I mean I think probably the easiest way, Durgesh, to think about it is we had about $5 billion in the overall 10-year pipeline associated with LRTP. And so about $2 billion of that was in the first five years, which has been allocated to us as part of those that first Tranche 1 plus those competitive projects that we won. So that's that first piece. And then you got a remaining $3 billion that you're filling out and that has been $1.3 billion awarded to us here in Tranche 2. And so then we obviously have these competitive projects that we indicate about $6.5 billion worth of projects that we're going to bid on to fill out that piece. So I think the way to think about it, there is clearly upside with respect to some of those competitive projects today and how we think about that $5 billion that's in there. So Marty, anything to add on the transmission side?"
},
{
"speaker": "Martin Lyons",
"text": "On the transmission side, I would just say, overall, as we think about the capital plan, we feel like it's conservative and achievable. As you look at the other elements of the capital plan on Slide 24, in Missouri, what we've done is look to align the generation spending there with the updated IRP we filed today, the Illinois Electric Distribution is aligned with the outcome of the Multi-Year Grid and Rate Plans that we had last year. The Illinois gas spending is aligned with our 2023 gas rate review as well as the pending gas rate review and Michael just discussed transmission. So we've aligned all those things. I would note that Ameren Missouri non-generation spending is down a little bit from what we had in our last five-year plan. And I would say that overall, despite the increase in spending that you're seeing and investments you're seeing in Missouri, there's conservatism baked into those numbers as we think about the five-year plan. So I think it's conservative. It's achievable, but it is aligned with those things Michael and I talked about."
},
{
"speaker": "Durgesh Chopra",
"text": "Excellent. Appreciate the discussion there. Thank you."
},
{
"speaker": "Martin Lyons",
"text": "Take care."
},
{
"speaker": "Operator",
"text": "Our next question comes from Nicholas Campanella with Barclays. Please proceed with your question."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey, good morning. Thanks for all the updates and taking my questions today."
},
{
"speaker": "Martin Lyons",
"text": "You bet."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey so I just -- when I look across the portfolio, there's just a lot of tailwinds, whether it's Missouri rate review seems like it's going off to a solid start. And I know that there's legislation this year, you're kind of laying the framework for potentially more data centers to come into your territories. And if you were to have success here, let's just say you kind of move into the high scenario load growth range or you do have to kind of accelerate capital in the plan, is there a point in which you would kind of like reevaluate the growth rate or do these opportunities kind of extend that premium 6% to 8% offering at the?"
},
{
"speaker": "Martin Lyons",
"text": "Yes. Well, thanks for the question. And you're right, there are a number of tailwinds that we've got today. I mean we're very excited for our communities and for our customers as we think about some of the economic development opportunities that we're seeing in Missouri and Illinois. And as you mentioned for us, it certainly means opportunities to invest to support those businesses, to help grow those businesses and impact our sales. And we are pleased that in Missouri, in particular, there's good alignment, I believe, with stakeholders to really go after some of these economic development opportunities and provide some of the regulatory tools and mechanisms and outcomes to be able to support the continued investment and growth in our communities. So I think that's all good. As you think about our growth rate over time, certainly, our objective is going to be to maximize that growth rate as we think about the investments that are needed through time. We're not going to constrain it, is another way to put it. In answer, I think, to the first question we got, though, as we think about the next five years, still feel like this 6% to 8% growth guidance is the right guidance. Again, as I said earlier, in the short-term, we'll be at or above that midpoint. But as we see that load growth occurring later in the five-year period, as we see the rate base growing later in that five-year period, as I said before, we do expect to deliver near the upper end of the range in the mid to latter part of the plan. As we go through time, if some of these tailwinds continue and should the growth even accelerate further, we'll certainly reevaluate the overall earnings per share growth range. As I said, we certainly don't want to constrain it in any way."
},
{
"speaker": "Nicholas Campanella",
"text": "That's super helpful. I appreciate that. And I'm sorry to make you repeat yourself a little bit on what's in the plan versus not, but just you mentioned that you have capacity to serve 2 gigawatts of demand or you're working towards capacity to serve 2 gigawatts of demand by 2032. It does seem you have like 1.8 under construction. So I just is what you're doing freeing up additional capacity to attract an additional 2 gigs. So if you were to have an additional demand, you'd have to do more CapEx for that or does this kind of -- does this plan and this CapEx plan create that capacity for you? I just wanted to understand that."
},
{
"speaker": "Martin Lyons",
"text": "Yes. Thanks for the question. I'll try to clarify. As we look at some of this load, it ramps up over time. And so even when you think about that 1.8 gig, it's going to ramp up over some period of time based upon the customers' needs. And so the plan that we laid out today, the resource plan that we laid out, as I said, we think that would support the ability to serve a full 2 gigawatts by 2032 but even more after that. And so as that load grows, we can not only serve that 2 gigs by 2032, but even more so after that. And look, if there's more demand, we'll continue to explore ways to serve even beyond that. So again, we're not constraining ourselves. But as we look at this next five years, with the investments we've outlined are the things that, we do believe we can realistically achieve and support that load growth that I just talked about."
},
{
"speaker": "Nicholas Campanella",
"text": "All right. Thank you very much."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thanks so much for taking the questions. Maybe just two quick ones for me. First, on the sales growth outlook. Can you just help us put that 5.5% CAGR into the context of sort of the total pipeline that you're seeing in Missouri or maybe said another way, can you just talk about how you sort of risked the pipeline to come out to this 5.5% level over the course of the new five-year plan?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, I'll see what color I can provide on that. When you look back on the Q3 call, in that funnel, we talked about tens of thousands of megawatts of potential demand, 75% of that from data centers and about 65% of that Missouri. So significant demand. But what's happened through time is we worked with different developers in terms of transmission access. And as I said earlier, about 1.5 gigs of new construction agreements have been signed on top of the ones that we had when we talked last in Q4. So we've really been trying to take those in terms of in a fair and equitable way in terms of the orders that they came in and have asked for interconnection. And that's where we are today. Now to put it all in sort of scale terms. I mean 2 gigs, if we're serving 2 gigs by the end of 2032 that represents about a 45% increase in Missouri sales. So pretty significant. But as I said earlier, Carly, this is what we've got today, given the construction agreements that we've got signed, given the tariff discussions we have going on with end users and we look at the, again, the generation that we can accelerate and deliver within this time period. We think 1.5 gig is a good point estimate. But again it could be greater as we think about the sales by 2032."
},
{
"speaker": "Michael Moehn",
"text": "And Carly it's Michael. Just a little finer point. I mean I think the comments that we have made previously about this first 250 megawatts, I think, still stands. We talked about that being online by the end of 2026. And then as Marty said, it kind of ramps in over time, 500 by the end of '27 and then you get to 1 gig by the end of 2029. And the only thing I might add in addition to this, I mean, I think we're coming off of a good foundation as well, right? As I indicated in my talking points, we ended the year at just a little bit right at about 2% growth. And it was across all classes, 2% on the residential side, 1.5% on the commercial and then a really robust 3% on the industrial side. And we're forecasting additional growth in '25 relative to '24 as well. So I mean, I think, again, it gives us good backdrop just what we're talking about here in terms of the foundation."
},
{
"speaker": "Carly Davenport",
"text": "Great. I appreciate all that color. That's really helpful. And then maybe just on the updated IRP in Missouri. I know you mentioned this in your opening remarks, but you did have some new nuclear longer dated, of course, by 2040 reflected in that new filing. Obviously, it's a big focus of the market. So could you just talk a little bit about kind of how you envision that new capacity? Is that more focused on opportunities around SMRs or something more like an AP1000?"
},
{
"speaker": "Martin Lyons",
"text": "Yes. Thanks, Carly. And you're right, it's long-dated. When we look out to 2040 time frame, looking at adding new nuclear and we talked about that balanced energy portfolio we see in the future. And when you look out to, say, 2045, what we see is about 70% dispatchable resources with nearly 40% nuclear, a little over 30% gas and then about 30% of our energy coming from renewables. So that's what we're sort of looking towards when we look very long-term. And of course, we've got experience with nuclear. Our Callaway plant here in Missouri has served our customers well for the past 40 years and we expect it to continue for the next 40 years. That said, I'd say as we sit here today, we really haven't put a stake in the ground in terms of what technology would make the most sense for us in terms of a nuclear technology. Certainly, when you look at the megawatts that we have in there for new nuclear, about 1,500, you got a full range of options, as you mentioned, in terms of technology. But what we're really looking to do over the next three to five years is to devote resources internally to monitor and studying these technologies closely and exploring perhaps what activities might be prudent to take that would say be technology agnostic, which might include things like construction permitting and the like. I don't see in the next few years, any material financial commitment as it relates to new nuclear, as you say, it's sort of long-dated. But we do think that's part of our energy future as we look out to a balanced portfolio in Missouri."
},
{
"speaker": "Carly Davenport",
"text": "Great. Thanks so much for the answers. Appreciate the time."
},
{
"speaker": "Martin Lyons",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Jefferies. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning, team. How are you guys doing?"
},
{
"speaker": "Martin Lyons",
"text": "Great, Julian. How about you?"
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, great. Happy Friday. With that said, you guys, I mean just a remarkable update here across the board, whether it's the minimal limited incremental equity, great roll forward of the rate base here. I mean really what's left to address on the call here is, as you think about regulatory lag in front of you in this investment cycle, can you speak to that a little bit here and what you're facing, if that, there's any kind of timing issues? Obviously, you're emphasizing being at the upper end of the plan in the back half of the year. Can you speak to maybe any kind of earned ROE expectations and maybe marry that up against expectations and how to frame and sensitize any potential legislative outcomes here? Obviously, you spoke to some of them in brief earlier, but maybe just kind of square that up, if you will, and set any expectations on the cadence of earnings through the five-year period, too?"
},
{
"speaker": "Michael Moehn",
"text": "Let me start on the regulatory lag and then Marty can come in and talk about the legislative process. I mean, Julien, as you know, I mean we've always managed these businesses prudently try to earn as close to our allowed as possible. I mean if you kind of look at where we are on a historical basis versus some place in excess of 10% kind of across the overall portfolio of different returns. And as you said, I mean, we got to continue to be thoughtful about this. Obviously, you have rate reviews and other things you got to be thoughtful about from a timing perspective. And so that goes into how we think about projects. And Mark Birk and his team do a really good job just thinking about when those are going to need to be in place from a cutoff date, et cetera, just again to make sure that we're maximizing the returns and minimizing any regulatory lag. And then the other thing that we've obviously done in addition to all of this, which I think is just a good practice in general is we've managed our overall O&M cost really, really well. We talked about this at the beginning of the year. I mean, we went through another process of kind of looking at spans and layers, doing a lot of benchmarking, looking up and down the P&L. We've made significant investments in technology over the past five, six years. We're continuing to start to see some of that benefit from a productivity standpoint today, both back office and in the field, which I think is helpful being very thoughtful about as we turn -- have turnover and the replacements we put back into the business et cetera. So I think all of that has served us well and it obviously manifests itself in having O&M be down $12 million, which I indicated in the talking points, year-over-year, which I think is good in this environment because we want to be doing everything we possibly can to try to minimize the impact of this transition. So that's what I would say about that from a regulatory lag perspective, Marty can certainly add in and talk about the legislative piece too."
},
{
"speaker": "Martin Lyons",
"text": "Yes, I thought that was good, Michael. I think, Julien, as you go through time, we'll have to adjust and think through the timing of our rate reviews, as Michael mentioned, for a variety of factors. And again, some of it is going to be really getting better visibility in terms of how some of the sales growth is going to occur through time and refined timing on some of the, I'll call it, chunkier in-service dates on some of the elements of our integrated resource plan. And those things will help to refine our regulatory timing as well as thoughts on regulatory lag. But you did mention legislation in Missouri. There are a number of legislative initiatives that are progressing. As you know, the legislative session just recently kicked off and goes through, I think, May 16th of this year. So quite a bit of time. But we outlined on Slide 15, a number of various pieces of legislation that are sort of percolating. And some of them are familiar to you, things we've talked about in the past like really extension of PISA. As you think about some of these generation investments we want to make, getting that sunset pushed out in time is really helpful to us, gives us greater visibility in terms of regulatory framework and certainty through time, extending that to include natural gas generation. Again, we've got that built into our plan. These things are important in terms of supporting this economic development, this investment in generation. You see other things like the Missouri First Transmission Act, really making sure that we can get transmission built quickly have good import-export capability in our region, again, supports the economic growth. And then you see some of the other things that are percolating, you have changes to the integrated resource planning, allowing QIP in rate base for new natural gas generation or other energy centers, you see forward test years for natural gas and water. So I think some good constructive things that would be, again, incrementally supportive of investment in the state and incrementally supportive of broader economic growth and development in the state. And so the active consideration on these, there's a long way to go, but as we have recently seen some Senate action on that, in particular, so a consolidation of a number of these bills into one bill with Senate Bill 4. So I'd encourage you to continue to monitor these. We'll certainly continue as well as others to actively engage. But I think it's just good constructive discussion that about things that would be supportive of investment and economic growth in our state. So thanks."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent, guys. Best of luck. It's a real pleasure to see us come together. All right. You guys take care."
},
{
"speaker": "Martin Lyons",
"text": "You too, Julien. See you soon."
},
{
"speaker": "Operator",
"text": "Our next question comes from Anthony Crowdell with Mizuho. Please proceed with your question."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning, guys. Thanks for the update. Hopefully, just two quick questions. One is, I think, on Slide 31, where you, kudos to Andrew again. You do a great job of breaking it out. Just wondering 2030 you have 1,600 megawatts of gas, 800 more than your original plan. We hear or seen in the papers, the challenges of procuring new gas fired generation. Just anything you could add on the ability to add that generation? I have one follow-up."
},
{
"speaker": "Michael Moehn",
"text": "Yes. No, Anthony, this is Michael. Look, we feel good about that addition. I mean, we've taken steps along the way in Missouri to make sure that we could procure what we needed to, to get this online, given the importance of it, given the significance of what we're seeing from a supply chain perspective. So I think we've mentioned this before, but I think those steps have served us well, and we should be in good shape to bring this online. Still a lot of work to do. But from a critical component standpoint we're set."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. And then on the S&P rating just if you could just give me the numbers. I missed it to the earlier question. I think you said you're closer to the upgrade threshold. Would you mind just those numbers again?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, our downgrade threshold at S&P is 13%, Anthony. And so we've been certainly north of 17% or above there on that calculation. And so I don't know exactly what the upgrade threshold is, but it's -- we're much closer to that than we are the downgrade threshold. That's the point I guess I was trying to make."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. Thanks so much for taking the question and congrats on a great update."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Anthony."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bill Appicelli with UBS. Please proceed with your question."
},
{
"speaker": "William Appicelli",
"text": "Hi. Good morning."
},
{
"speaker": "Martin Lyons",
"text": "Hey, Bill. Good morning."
},
{
"speaker": "William Appicelli",
"text": "A question on the large load tariff that you're going to be filing. Can you just share some details around that? Is that going to have minimum load commitments for a set period of time? Is there an expectation that this is new load that's going to be -- have a neutral impact or potentially a beneficial impact to existing customers? Any color you can share on that filing?"
},
{
"speaker": "Martin Lyons",
"text": "Yes, Bill, I'd say it's premature to say exactly how it's going to be structured. But you're hitting on the right points. We're actively working with some of the prospective customers to finalize the tariff. I'd say discussions are going well. But you're right. I mean typical contract items, things like revenues to cover cost, the cost to serve, tenor of contract, minimum takes, exit provisions, credit provisions. I mean these are the things that we're focused on."
},
{
"speaker": "William Appicelli",
"text": "Okay. But I mean but the point would be that existing customers would be held -- would be neutral to the large load coming on?"
},
{
"speaker": "Martin Lyons",
"text": "At a minimum, yes."
},
{
"speaker": "William Appicelli",
"text": "Yes. Okay. And then just on the Missouri rate case, I think, there's a settlement window coming up next week. I know you've got hearings set for middle of March. But any update on how you're feeling around maybe the possibility of settling the rate case in this upcoming window?"
},
{
"speaker": "Michael Moehn",
"text": "Bill, it's Michael. Again, I think as I indicated on the call itself, I mean, I think we sit in a good spot at this point in terms of the differences between us versus staff. I think we indicated, in the last update, we were at $446 million versus $398 million from staff and so most of that is being driven by ROE, they're at 9.74%, and we're at 10.25%. And then there's an issue associated with this High Prairie wind place. So I think, ultimately, we always look to try to find a constructive way to get these settled. You can never guarantee that. But I think we sit in a good spot to continue to have some constructive conversations here over the coming weeks and we'll see what time brings us."
},
{
"speaker": "William Appicelli",
"text": "Okay. All right. Great. Thanks very much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jeremy Tonet with JPMorgan Chase. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi. Good morning and a very Happy Valentine's Day to all."
},
{
"speaker": "Martin Lyons",
"text": "Same to you. Michael's got his pink shirt on today. He's ready to go."
},
{
"speaker": "Jeremy Tonet",
"text": "Great to see. Great to see. I was just wondering if I go to the financing plan a little bit, the $4.4 billion of increase in CapEx, yet only $300 million of incremental equity, I haven't seen that from all your peers out there. Just wondering if you could talk a bit more about the specific drivers here that allow you to minimize additional equity issuance here? Is there any shaping of CapEx over the five-year plan and how that impacts financing considerations?"
},
{
"speaker": "Michael Moehn",
"text": "No, Jeremy, I mean, look, I think it's more of a product just how we've managed this over time, right? We came into this kind of super cycle of CapEx in a really strong position. We've always protected the balance sheet. Again we've liked our ratings where they have been historically. And so I think that's really probably the difference here as we just, as we worked into it, that we had some continued room. If you went back and looked over time, we were certainly in excess of even those downgrade thresholds where we are today. But as we look over the next five years, as I mentioned earlier, I feel good that we're going to be at or above that 17%, which is really the threshold metric for us on the Moody's side."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Great to see what being conservative on the balance sheet can do to you, make sense. And maybe just one last one, if I could. Circling back to legislation, do these items represent upside to your plan? Any way to size the magnitude of earnings and cash flow benefits from possible legislation here?"
},
{
"speaker": "Martin Lyons",
"text": "I think these are really things that can create a win-win for customers and shareholders as we think about executing the capital plans that we've got. And I think in large respect, go a long way simply to helping us turn closer to our allowed return as we deploy the capital."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Great. Thank you for that. See you next month in Denver."
},
{
"speaker": "Martin Lyons",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Paz with Wolfe Research. Please proceed with your question."
},
{
"speaker": "Martin Lyons",
"text": "Good morning, David."
},
{
"speaker": "David Paz",
"text": "Good morning. Sorry I think my question has mostly been answered, but maybe just a little more precise question here. I know you said that you expect to be within the 6% to 8% EPS growth target each year and then the upper end in the latter half of the planning period. But do you see any specific headwinds that puts you below the midpoint, say, next year in 2026 before that sales growth kicks in? And if so what are those?"
},
{
"speaker": "Martin Lyons",
"text": "No, David, I wouldn't say there are any specific headwinds with respect to being at the midpoint or higher as we look at next year. But again I think the point I was trying to make is, when you look at some of that sales growth again and Michael, I think, underscored this, we really see that ramping up late '26, into 2027 and then beyond. And you can look at also to some of the rate base growth, which occurs sort of again mid to latter part. But no I wasn't trying to suggest that next year we would be expecting to sort of miss that mark."
},
{
"speaker": "David Paz",
"text": "Got it. Okay. Thank you."
},
{
"speaker": "Martin Lyons",
"text": "All right, David. Hey, I think, we're going to have to wrap it up for today. We've got some other business we have to attend to this morning. I really appreciate all the interest we had on the call this morning. Lots of great questions and dialogue. I think you can tell that we're very energized by the opportunities ahead, the power growth for our communities and for our shareholders. And so with that, please be safe, and we look forward to seeing many of you at upcoming conferences."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 3 | 2,024 | 2024-11-07 10:00:00 | Operator: Greetings and welcome to the Ameren Corporation Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Andrew Kirk, Director of Investor Relations, Corporate Modeling for Ameren Corporation. Mr. Kirk, please proceed.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, and Chief Executive Officer, and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer, along with other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance, and similar matters, which are commonly referred to as forward-looking statements. Please refer to our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here is Marty, who will start on page four.
Marty Lyons: Thanks, Andrew. Good morning, everyone. Thank you for joining us today as we cover our third quarter 2024 earnings results. I will begin today on page four. We are focused on delivering strong long-term value for our customers, communities, shareholders, and the environment. By investing in rate-regulated infrastructure, enhancing regulatory frameworks, and advocating for responsible energy policies, we are positioning ourselves to take advantage of future opportunities to benefit all of our stakeholders. Through a disciplined approach to optimizing our operating performance, we have been able to keep our customer rates low in comparison to the national average as we transform the energy grid, enhance reliability, and provide cleaner energy to our communities. We remain excited for the future, and we see strong growth opportunities unfolding over the next decade. Turning to page five. Yesterday, we announced third quarter 2024 adjusted earnings of $1.87 per share, compared to earnings of $1.87 per share in the third quarter of 2023. These comparable adjusted earnings results were in line with our expectations. The third quarter and year-to-date 2024 adjusted results exclude two charges related to separate proceedings that have been ongoing for over a decade. The first related to an agreement in principle to settle the Rush Island Energy Center New Source Review and Clean Air Act proceeding, and the second, for customer refunds required by the Federal Energy Regulatory Commission's (FERC) October 2024 order, which established a new base return on equity within the Midcontinent Independent System Operator (MISO), that was applied retroactively to certain periods extending back to 2013. Key earnings drivers are highlighted on this page. Mike will discuss the factors driving the quarterly results in more detail in a moment. Our strong investment pipeline continues to drive earnings growth, and I am excited about the significant economic growth opportunities in the communities we serve. The Greater St. Louis region is experiencing some of the highest employment growth we have seen in the better part of three decades. In August, the region was ranked fourth among large metro areas in the country for employment growth, and we are seeing this strength in our region reflected in strong weather-normalized retail sales growth year-to-date across all customer classes in Missouri. Turning now to page six. Thanks to our team's execution of our strategy over the course of this year, we have a strong foundation as we head into the final months of 2024. We expect to deliver 2024 earnings within our adjusted guidance range of $4.55 per share to $4.69 per share. We expect our 2025 earnings per share to be in the range of $4.85 and $5.05, with the midpoint representing a 7.1% increase over the midpoint of our 2024 adjusted guidance range. While our historical practice has been to provide initial earnings guidance on our fourth quarter earnings call in February, we are issuing this 2025 guidance now to reinforce our confidence in our ability to deliver on our 6% to 8% earnings per share growth guidance expectations. We expect to provide our long-term earnings growth guidance and capital and financing plans on our year-end call in February. On page seven, we highlight the latest advancements across Ameren as we execute our strategic objectives for the year. Our infrastructure investment plan is designed to improve the reliability, resiliency, safety, and efficiency of our system. As we remain focused on a reliable clean energy transition, year-to-date, we have invested $3 billion to replace aging infrastructure and also build the new infrastructure needed to meet our customers' growing demand for a diverse mix of energy resources. Just last week, we announced that we have now closed on three solar energy centers this year, totaling 500 megawatts of new generation, which are undergoing final testing and are expected to be in service by the end of the year. On the regulatory front, MISO's long-range transmission planning process is progressing toward approval of the tranche 2.1 portfolio by the end of the year. In September, MISO released additional tranche 2.1 project details, which included approximately $3.6 billion of transmission investment needed in our Missouri and Illinois service territories to support reliability for the region. At Ameren Missouri, we are working to bring more dispatchable generation onto the grid. In October, the Missouri Public Service Commission (Missouri PSC) approved a certificate of convenience and necessity (CCN) and post-construction cost deferral for the 800-megawatt simple cycle natural gas energy center, Castle Bluff. This $900 million investment in dispatchable generation will support energy reliability in our region and will also create hundreds of construction jobs, several new permanent jobs, and additional tax revenue for the region. In addition, in November, we reached an agreement in principle with the US Department of Justice to settle the Rush Island Energy Center New Source Review and Clean Air Act proceeding. I will cover the details of the agreement in a moment. Finally, at Ameren Illinois, in October, the administrative law judge (ALJ) issued a proposed order regarding our revised 2024 through 2027 electric distribution multiyear rate plan. Importantly, the ALJ proposed order supports 99% of our requested rate base when excluding the impacts of other post-employment benefits (OPEB). Following our team's extensive engagement with key stakeholders, all interveners support the Illinois Commerce Commission's (ICC) approval of a revised grid plan with limited adjustments. We look forward to an ICC decision by the end of this year, which we expect to be consistent with the multiyear capital plans we issued in February. Last, operational performance across our company remains strong, with a focus on delivering safer, more reliable, and affordable energy through grid hardening, enhanced automation, optimization, and standardization. Turning to page eight for an update on Ameren Missouri's new generation project. We continue to execute our Ameren Missouri Integrated Resource Plan (IRP), which focuses on maintaining and building a diverse, cleaner generation portfolio to ensure our reliable and low-cost mix of energy resources to serve our customers' needs. As I mentioned, we have three solar projects in the later stages of commissioning and testing that are expected to be in service. We are also working toward the successful construction of another 400 megawatts of solar generation across three additional projects, which we expect will be ready to serve customers in late 2025 and 2026. Further, as I mentioned, in October, Missouri PSC approved the CCN for the dispatchable 800-megawatt simple cycle natural gas energy center Castle Bluff, following a constructive settlement with the commission staff and other interveners. The order also includes post-construction cost deferral to reduce unrecovered costs by allowing us to defer and recover the depreciation expense from the Castle Bluff Energy Center and an adjusted weighted average cost of capital return on the investment from the time it is placed in service to when it is incorporated into base rates. As solar energy predictably rises and then falls every day, it is vital to have Castle Bluff Energy Center to bolster grid reliability for our customers. Prep work has begun on Castle Bluff, which will be located on the site of our retired Meramec Energy Center, allowing us to cost-effectively expedite the construction by leveraging an existing site with infrastructure in place. The energy center is expected to be in service for our customers by the end of 2027. We look forward to continuing to work with key stakeholders to bring additional generation online as quickly as possible to meet the needs of all customers, including businesses looking to relocate or expand in Missouri. Moving now to page nine for an update on the MISO long-range transmission projects. In September, MISO provided additional detail and individual project cost estimates underlying the almost $22 billion tranche 2.1 portfolio, which is expected to drive significant reliability and capacity benefits for the region. The portfolio includes three projects in our Missouri and Illinois service territories that collectively represent an investment opportunity of approximately $3.6 billion. We await MISO's determination of which projects will be directly assigned and which will go through a competitive bidding process. MISO expects to approve the tranche 2.1 projects by the end of this year. Once approved, MISO plans to commence work in 2025 on the tranche 2.2 portfolio to address further transmission needs in the North and Midwest regions. As we continue to see substantial load growth across the country, MISO and its transmission owners will continue to assess whether the current long-range transmission future scenarios will be sufficient to support our region's energy needs in the years ahead. Moving now to page ten for an update on our expanding customer growth opportunities. Our service territories have a broad-based, diverse economy, which continues to expand across a variety of manufacturing sectors, including aerospace, agriculture, and food processing, to name a few. So far this year, we have received expansion commitments or executed new contracts for approximately 350 megawatts of new load from data centers, manufacturing, and other industries, 90% of which is located in Missouri. These projects are expected to create more than 2,200 jobs. We expect these new and expanding customers to be fully ramped up by 2028. We are excited about these opportunities and see tremendous additional opportunities for growth over the next five to seven years, which will bring jobs and additional tax base to benefit our state and local communities. Through ongoing collaboration with a variety of state and local stakeholders, we continue to attract new business and data center interest. Over the last few months, our economic development pipeline of potential additional demand has doubled in size, and we are making meaningful progress with several potential customers. These customers, representing several gigawatts of interest, have completed transmission engineering studies, and over the coming months, each will further evaluate the site locations and determine whether they will move forward with agreements. We are pleased to offer reliable service and competitive rates, as well as the people, resources, expertise, and partnerships needed to deliver for these customers. The ultimate net financial impact of any incremental load will be dependent upon a variety of factors, including customer ramp-up time, additional generation or grid investments needed, timing of rate reviews, and tariff structures. To that end, we are in the process of carefully evaluating potential load growth opportunities and our associated generation portfolio needs and would expect to update our IRP by February of 2025. This is an exciting time in our industry, and we look forward to finding solutions for these significant potential new customers. Turning then to page eleven. After almost fifty years of providing cost-effective energy to our customers, our Rush Island Energy Center was safely retired on October fifteenth. We are grateful to our coworkers who made this plant a reliable and low-cost energy source for our customers for many decades. Careful planning over several years enabled us to ensure that every employee impacted by the retirement of Rush Island had an opportunity with the company as we continue to thoughtfully transition our generation resources while retaining our talented workforce. The Missouri PSC has authorized recovery of approximately $470 million of cost related to the retirement of Rush Island through the issuance of securitized utility tariff. We are working through the next steps to execute that issuance. In addition, in November, Ameren Missouri and the US Department of Justice reached a settlement agreement in principle requiring Ameren Missouri to fund two mitigation relief programs in addition to retiring the energy center. The cost of these programs, which will provide for the electrification of school buses over a three-year period and air purifiers for eligible Ameren Missouri residential customers over twelve months, totaled $64 million. The charges recorded this year related to this agreement are excluded from our adjusted earnings results. The agreement between the DOJ and Ameren Missouri is subject to approval by the US District Court for the Eastern District of Missouri, which is expected by the end of the year. Moving to page twelve. Looking ahead over the coming decade, we have a robust pipeline of investment opportunities of more than $55 billion that will continue to deliver significant value to our stakeholders, create thousands of jobs, generate tax revenue for our local economies, and support economic growth in our region. Importantly, our ten-year investment pipeline does not reflect possible additional generation as we evaluate our needs to serve potential additional load growth. Any such changes to our ten-year investment pipeline will be reflected in our February earnings call update. Moving to page thirteen, our five-year growth plan released last February included our expectation of a 6% to 8% compound annual earnings growth rate from 2024 through 2028. This earnings growth is driven by strong compound annual rate base growth of 8.2% and strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high-quality utility growth story. Combined, our strong long-term 6% to 8% earnings growth and an attractive and growing dividend, which today yields 3.1%, result in a compelling total return story. We have a strong track record of execution, a strong balance sheet, and an experienced management team. I am confident in our ability to execute our investment plans and other elements of our strategy across all four of our business segments. Again, thank you all for joining us today, and I will now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. I will begin on page fifteen of our presentation with an earnings reconciliation for two earnings adjustments that Marty mentioned earlier. Yesterday, we reported third quarter 2024 GAAP earnings of $1.70 per share, which included a charge for additional mitigation relief related to the Rush Island Energy Center and a charge for the October 2024 FERC order on MISO's allowed base ROE. Both of these charges related to matters outstanding for the last decade. Excluding these two charges, Ameren reported third quarter adjusted earnings of $1.87 per share, compared to earnings of $1.87 per share for the year-ago quarter. The total after-tax charge of $0.17 per share in 2024 related to our Rush Island Energy Center reflects the estimated cost of the mitigation relief program agreed to with the US Department of Justice. This includes the $0.04 per share charge recorded in the first quarter of 2024. Subject to approval by the district court, we expect a settlement agreement to resolve the proceeding related to the new source review provisions of the Clean Air Act. Turning to the charge for the FERC order, recall, since November 2013, the allowed base ROE for FERC-regulated transmission rate base within the MISO has been subject to review. In FERC's October 2024 order, it established a new base ROE of 9.98% for the periods of November 2013 through February 2015, and September 2016 forward, which decreased the allowed base ROE from 10.02% and will require refunds with interest for these periods, totaling an after-tax impact of $0.04 per share. The return on equity from MISO projects is now 10.48%, including the 50 basis point adder, and we do not expect a four basis point decrease in ROE to have a material impact on earnings expectations going forward. Turning to page sixteen for detailed earnings results for the third quarter. Our adjusted earnings performance during the quarter was driven primarily by strategic investments and disciplined cost management, offset by changes in return equity for Ameren Illinois Electric Distribution and rate design at Ameren Illinois Natural Gas. Additional factors that contributed to the year-over-year earnings per share results are highlighted on this page. Year-to-date results are outlined on page twenty-six of today's presentation. Before moving on, I will touch on sales trends for Ameren Missouri and Ameren Illinois Electric Distribution. While miles were lower this quarter compared to the year-ago period, creating some earnings drag, our third quarter weather-normalized retail sales remained strong at an overall increase of approximately 1.5% compared to the year-ago period. Year-to-date, weather-normalized kilowatt-hour sales to Missouri residential, commercial, and industrial customers increased approximately 2%, 1%, and 3%, respectively, compared to last year. The year-to-date increase in industrial sales reflects production growth driven by new industrial plant additions and additional shift work in our service territory. Year-to-date, weather-normalized kilowatt-hour sales to Illinois customers were flat compared to last year. Recall that changes in electric sales, no matter the cost, do not affect the earnings since we have full revenue decoupling. On page seventeen, we summarize select earnings considerations for the balance of the year. We expect our 2024 adjusted earnings to be in the range of $4.55 to $4.69 per share. Notably, we expect a positive year-over-year earnings impact in the fourth quarter driven primarily by strategic infrastructure investments, strong cost management programs, and lower charitable trust contributions compared to the year-ago period. I encourage you to take the settlement-arranged drivers noted on this slide into consideration as you develop your earnings expectations for the remainder of the year. Turning to page eighteen, where we provide detail on our expectations for 2025. As we head into 2025, we feel confident that strong execution of our strategic plan this year will position us to deliver on our expected long-term earnings growth. With that in mind, we expect 2025 earnings per share to be in the range of $4.85 and $5.05. The midpoint of this range represents a little above 7% earnings per share growth compared to the midpoint of our 2024 adjusted earnings guidance range. Expected 2025 earnings detailed by segment as compared to our 2024 expectations are highlighted on this page. Beginning with Ameren Missouri, earnings are expected to benefit from new electric service rates effective by June 2025 and higher investment eligible for plant and service accounting. Earnings are also expected to benefit from higher weather-normalized retail sales, primarily to Missouri's commercial and industrial customers, which are expected to increase by 1% and 2%, respectively, driven primarily by the expansion and growth from our existing customers. We expect to update our long-term sales forecast in February. Further, we expect higher interest expense in Ameren Missouri and Ameren Parent, Transmission, and Ameren Illinois Electric Distribution, driven by higher infrastructure investment. Earnings in Ameren Illinois Natural Gas are expected to be lower due to cost recovery impacts between rate reviews. Ameren-wide, we expect increased weighted average common shares outstanding to unfavorably impact earnings per share. Robust infrastructure investment and economic growth opportunities, coupled with identified business process optimization opportunities and continued strong strategic focus, give us confidence in our ability to grow in 2025 and the years ahead. Turning to page nineteen for a brief update on Missouri regulatory matters. In August, the Missouri PSC set the procedural schedule for our ongoing Ameren Missouri electric rate review. Intervenor testimony is due in early December, and we expect a decision by the commission by May 2025, with new rates effective by June. Recall that approximately 90% of this request is driven by investments under Ameren Missouri's Smart Energy Plan, including major upgrades to the electric system and investments in generation. If approved as requested, new electric service rates would remain well below the national and Midwest averages. Turning to Ameren Illinois regulatory matters on page twenty. Under Illinois formula rate-making, which expired at the end of 2023, Ameren Illinois was required to file annual rate updates to systematically adjust cash flows over time for changes in the cost of service and to true up any prior period over or under recovery of such costs. For the final electric distribution reconciliation of 2023's revenue requirement, in August, the ICC staff recommended approval of our proposed $158 million reconciliation adjustment. The full amount would be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that is being collected during 2024. This will result in a net increase in cash flow of $48 million, or approximately a 1.5% increase in the total average residential customer bill. An ICC decision is expected by December, with new rates effective in 2025. Turning to page twenty-one for an update on the multiyear rate plan covering 2024 through 2027. In October, the ALJ recommended a cumulative revenue increase of $315 million based on an average rate base of $4.9 billion by 2027. Excluding the OPEB issue, the ALJ's proposed order supports 99% of the rate base that we requested in a revised multiyear rate plan. This would allow us to invest in the energy grid to maintain safety, reliability, and the day-to-day operations of our system, while also making progress towards an affordable, equitable, clean energy transition. Following constructive engagement with the interveners to narrow the remaining issues, their latest proposals reflect a multiyear grid plan that is largely consistent with our guidance laid out in February. We expect an ICC decision by December, with new rates effective January 1, 2025. Under the multiyear rate plan, any annual revenues will be based on actual recoverable costs, year-end rate base, and a return on equity, provided they do not exceed 105% of the approved revenue requirements after certain exclusions. Moving to page twenty-two to provide a financing update. We continue to feel very good about our financial position. Ameren's parent long-term issuer credit ratings of Baa1 and BBB+ at Moody's and S&P, respectively, compare favorably to the peer average, providing us with financial flexibility. To maintain our credit ratings and strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity in total in 2024. By the end of 2023, we sold approximately $230 million of the expected $300 million through the at-the-market (ATM) program, consisting of approximately 2.9 million shares, which we expect to settle by the end of this year. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to fulfill our 2024 equity needs. Additionally, as of September 30th, we have entered into forward sales agreements under our ATM program for approximately $155 million to support our 2025 equity needs, with an average initial forward sales price of approximately $82 per share. As always, we are thoughtful about strategically financing our robust capital plan. Turning to page twenty-three. We remain confident in our long-term strategy, which we expect to continue to drive consistent superior value for all of our stakeholders. As highlighted today, we have made significant progress towards our goals. We have strong infrastructure investment opportunities to benefit our customers and attract new businesses, and we continue to see signs of an attractive regional economy, including solid retail sales growth, strong employment growth in the St. Louis region, moderating interest rates and inflation, and a robust economic development pipeline that will deliver strong earnings growth in 2025. Looking beyond, we expect consistent strong earnings per share growth driven by robust rate base growth, disciplined cost management, and a robust customer growth pipeline. As we said before, we have the right strategy, team, and culture to capitalize on opportunities to create value for our customers and shareholders. We believe this growth will compare favorably with the growth of our peers, and shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: Ladies and gentlemen, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Jeremy Tonet with JPMorgan. Please proceed.
Robin (for Jeremy Tonet): Hey, this is Robin on for Jeremy. How are you? Oh, great. Good morning. So maybe just to follow-up, you mentioned providing 2025 guidance at 3Q to underscore your confidence in your earnings trajectory. Could you elaborate on that strategy given several ongoing regulatory proceedings? And specifically, how should we think about the 2025 range relative to potential regulatory outcomes?
Marty Lyons: Yeah, sure. Well, you know, first of all, as you look back on some of the comments we made at the second quarter, we have a long history of growing at 7% or above. Our goal as we go into each year, of course, is to deliver at the midpoint or even higher within our range. Some of the things that we pointed to last quarter that are just giving us more long-term conviction have to do with inflation cooling, strong local economy, demand improving, some of the things we have talked about even on this call with respect to customer growth opportunities and great investments that we have got across all of our segments, whether it is distribution, transmission, and generation, and, of course, a strong balance sheet. So we have strong conviction in our ability to grow long-term. As we looked at 2025, we certainly have confidence in our ability to deliver within the range that we pointed out today. As we look ahead over the next few months, typically, we have delivered this guidance in February. We are delivering it now because we do have strong confidence, and we believe that whatever unfolds in the months ahead, we will be able to adjust our plan and hit the mark in terms of the guidance that we delivered.
Robin: Great. Thanks. And then maybe just a follow-up on the mentioned economic development opportunities. You mentioned you have gotten some interest from an impressive several gigawatts of potential opportunities. Just any high-level thoughts on how you factor in potential double counting, like, say, if those customers are also submitting those inbounds to other utilities or service territories?
Marty Lyons: Yeah, sure. And look, I think you are absolutely right. We pointed out on our slide that we have tens of thousands of megawatts of potential new demand, so a significant amount. We certainly expect that, if we call it double counting, but a lot of these folks are looking at the same properties. You have got developers as well as hyperscalers. And so, yeah, there is certainly duplication in there. What we are doing is really working through with each of those counterparties in a methodical way. We mentioned that we have had progress with potential counterparties representing several gigawatts of demand. We are working through with them on evaluating the sites, the transmission access, the generation that might be needed to serve them. Eventually, we expect that to be narrowed down. It is one of the reasons why we have been cautious about not really announcing any of this load until we get a construction agreement because these conversations have to progress to the point where we have a construction agreement. The other thing to keep in mind is we have mentioned in our prepared remarks that we expect that over the coming months, we will get even greater visibility. We will have a better sense of what the demand might be over the coming years and be able to incorporate that into our plans for incremental generation. So expect to put a greater stake in the ground, if you will, in February, which is when we believe we will be in a position to update some of those sales forecasts and update our IRP.
Robin: Great. Thank you. Appreciate the color.
Operator: The next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed.
Paul Patterson: Hey. Good morning.
Marty Lyons: Hey, Paul. Good morning.
Paul Patterson: Just a few quick questions. On the refilled group plan, it looks like, I guess, they are going to have oral arguments, I guess, based on what the AG wanted. Any thoughts about that? I mean, at this late date that they are looking at doing that?
Marty Lyons: Yeah. Paul, I do not think I would read anything into that. Obviously, there are some differences, which I think because of the hard work of our teams along with the various stakeholders in these cases, we have really narrowed down the potential adjustments that folks have argued for. If you look on slide twenty-one in our materials, we laid out where the proposed rate base would be taking into consideration potential adjustments that have been advocated by various parties. You see where the staff is and where the ALJ came out. But I think it is normal that you would have oral arguments over the remaining differences. But again, I would point to the ALJ's proposed order, which certainly gives us confidence in terms of where this may land with the commission when they ultimately decide in December.
Michael Moehn: Hey, Paul. This is Michael. I was just going to add that these oral arguments have been scheduled for a long time, so that is fairly typical, and they are actually being held on November twentieth. So as Marty said, I think what we have today is a constructive data point from the ALJ. I think all the interveners are recommending approval of the grid plan at this point. We will just see where the arguments take us.
Paul Patterson: Okay. Great. And then on slide nine, you mentioned the transmission projects and the reliability and also the growing customer calls. I was wondering if you could elaborate a little bit more on the customer call side, like what this might mean to customers. Because we do not see them. Go ahead. I am sorry.
Marty Lyons: Yeah. No. It is okay, Paul. I mean, we are really referring to, and we added a bullet which we have not had in the past, about the customer benefits in a range of 1.3 to 5.6 times in terms of the portfolio cost. So that relates to the overall approximately $22 billion of projects. When MISO goes through these and they propose these various projects, one of the things they do is obviously estimate the cost of these projects, which we have listed, at least for the projects in our service territory down below. But they also do an assessment of what the benefits to the customers are going to be in relation to those costs. Each of these projects has the positive math behind it, if you will, that suggests that customers' costs over time will be lower as a result of these investments. So that is what we are really trying to convey.
Paul Patterson: Okay. But there is not going to be some dramatic cost, I guess, when these new lines show up and cheaper stuff comes in? Or is it sort of all mixed up together and it is going to take some time for it all to show up kind of thing?
Marty Lyons: Yeah. I think it will show up over time. I do not have any exact rate impact to point to.
Paul Patterson: I got it. Thanks. Okay. Then finally, on the new customers, you mentioned with one tranche of the new customers that there was 90% Missouri versus Illinois. I guess I was wondering when people are looking to, with all these robust discussions that you are having, is there more interest in one state versus another, or is there any flavor as to if there is, what might be driving that?
Marty Lyons: Yeah. Look. We have data center interest really in each of the states. So if you look over to the right, on that slide ten, we talked about tens of thousands of megawatts of potential new demand. You see various elements of that. I would say today in our pipeline, about 75% is data centers, 15% is manufacturing, and 10% is other, which is probably how that breaks down. Within that data center interest that we have got, about 65% of it is Missouri, and 35% of it is Illinois today in terms of what is in our pipeline. So there is clearly data center interest in each of the states. Each of the states is attractive for various reasons and in some cases, different reasons. But what we have announced today with respect to these construction agreements, which is more over on the left where we have 250 megawatts of data center demand, 100 megawatts of additional load from a variety of sources, it just so happens that 90% of that is actually in Missouri. About 10% of that is Illinois today in terms of those agreements that we have in place. Now, as we look ahead, certainly, the impact to us from an earnings perspective is going to be differentiated in the two states. In Illinois, obviously, if we have transmission or distribution investment that supports that load growth, we get the earnings impact of that. In Missouri, which is vertically integrated, we also have the impact of the opportunity to earn on any incremental generation.
Paul Patterson: Okay. But there is no specific reason for that? It just that is the way it fell out, I guess. Okay. I appreciate it. Thanks so much. Have a great one.
Operator: You bet. The next question comes from the line of Carly Davenport with Goldman Sachs. Please proceed.
Carly Davenport: Hey. Good morning. Thanks so much for taking my questions. Maybe just to follow-up on an earlier question on the earnings guidance range. As you think about 2025 growth at just over 7% relative to the midpoint of 2024, can you just give us your thoughts on looking forward where you see yourself in the range, just taking into consideration some of the incremental opportunities that you have highlighted and if there is any potential upside to that range going forward?
Marty Lyons: Yeah. Carly, look. In terms of our range, we have said 6% to 8% is our EPS CAGR that we are targeting for the period 2024 to 2028. As I mentioned earlier, when we look back, we have got a strong track record of delivering above the midpoint, above 7%, and our goals as we look ahead are to deliver at or above. As you said, we have some positive data points we are seeing today. Again, one of the things is the slow growth, which we just talked about. Some potential load growth. We are working hard to bring that to fruition for the benefit of our customers, our communities, and we are going to work hard to do that. At this point, I would say that is where we are at now. We will come out in February. We will provide our perspectives on load growth going forward, update our investment plans, and we will note any potential implications on guidance. But we feel good about the 6% to 8% and, again, our target of hitting at or above that midpoint. Michael, anything to add?
Michael Moehn: Hey, Carly. It is Michael. I think it is well said. The only other thing I might add is just again, the overall backlog of investment opportunities. Marty spoke about this earlier. We have got the $55 billion that we continue to point to. I think that pipeline remains robust. We talked about this opportunity just with the data centers. That could potentially drive some additional capital. So, I mean, your question specifically was what could take you to the upside of that? I think it is those additional investment opportunities over time. I think there is also opportunity, as Marty said, not only just from the data center, but the underlying economic data within, certainly in the Missouri territory, is very strong today. Just looking at the overall employment, the GDP rate, we are seeing customer growth, which we just alluded to. We are seeing customer account growth, population growth, and all of those things, I think, are a great backdrop. Then, yeah, we continue to think about just how do we optimize the financing in this going forward. So that is where I would probably leave it at this point.
Carly Davenport: Got it. Great. That is super helpful. And then maybe just another quick one. You have previously talked about some O&M reductions coming in the second half of the year. Looks like 3Q was still up year over year, but then you called out some efficiency in the earnings driver slides for 4Q. Are you able to give some color on what programs you are sort of pursuing there? And if what you have called out on the slides is all-inclusive of what you are looking at on O&M.
Michael Moehn: Yeah. You bet. And you are right. We have been pointing to this towards the beginning of the year. I said it was going to be in the back half. And I think you are certainly seeing that show up in Missouri. Specifically, you know, $0.05. You look at what we are pointing to in the fourth quarter, year over year expecting $0.03 and $0.01 in Missouri and Illinois Natural Gas, respectively. And, again, just consistent with some of the things I have talked about in the past. This is not something that is new to us. We have been after these programs for a long time. Beginning in the year, we talked specifically about some things that we were doing around just being thoughtful with respect to headcount, discretionary spend coming out of some of the Illinois decisions. I think we continued to lean into them. We continue to find more opportunities. Looking at spans and layers, looking at simplification. We just have an opportunity for us to be more consistent across our platform, which drives efficiencies, back-end reduction, overhead cost, etc. We do a lot of benchmarking in this. You see some of that public benchmarking, and we benchmark well, but in areas we have opportunities. So wherever we are benchmarking, constantly looking at how do we move up a quartile. I think the team is absolutely committed to this, and we have not exhausted all the opportunities at this point.
Carly Davenport: Got it. Great. Thanks so much.
Operator: The next question comes from the line of Julien Dumoulin Smith with Jefferies. Please proceed.
Brian (for Julien Dumoulin Smith): Yeah. Hi. Good morning. It is actually Brian. I am still on for Julien.
Marty Lyons: Brian?
Brian: Alright. Hey. Just to follow-up on Ameren Transmission. It looks like just the assumption in this 2025 versus 2024 looks like growth in rate base is pushing 9%, and it seems that the growth there is accelerating as we move through the five-year plan, approaching, I guess, the double-digit overall rate base growth CAGR. Is the near term in 2025 and 2026 really just the prior MISO tranche projects that have been approved and that you are developing? And then is there any possibility of these tranche two projects being pulled forward versus the early to mid-2030s target dates?
Marty Lyons: As it relates to the MISO projects, the tranche one projects, I tell you, the construction there is really going to take place between 2026 and 2030 is our projection today. Some of these MISO tranche 2.1 projects, those will probably go in service in the 2032 to 2034 time frame. We think most of the expenditures for those are outside of the current five-year period. Although, we will be certainly looking to accelerate those if possible. There is no reason that tranche two project work and tranche one project work cannot overlap. So we will be looking to bring this to fruition for the benefit of our customers and communities as soon as we can once they are approved and once they are assigned to us. Otherwise, we always have ongoing projects in the transmission space that are outside of those that are part of the tranche one or tranche two that are approved through annual MISO processes. Those continue to be foundational in our overall spending and growth in the transmission space.
Michael Moehn: The only thing I might add to that is, you think about those $55 billion pipeline. We have talked about this, about $5 billion is in there with respect to the LRTP projects. Brian, so you think about tranche one, we had the $1.8 billion assigned, the $700 million on the competitive projects. There will be some variation of those ultimately where they ended up settling out, but then you have tranche 2.1, which will again we will see what ultimately gets assigned or competitive, but there is $3.6 billion of eligible projects. Then you are going to obviously roll into this 2.2 tranche. I am just giving you the math if you kind of want to think about that $5 billion, and it is, yeah, you can see the pipeline associated with getting there pretty easily.
Brian: Okay. Great. And just as we look towards the 2025 Missouri legislative session, how active will Ameren be or involved in any proposed bills that I think might need to be proposed as early as this December, whether it is PISA for fossil fuel or gas-fired generation, any road for or, I guess, expanding expediting the generation review, which would tie into maybe your February 2025 IRP update.
Marty Lyons: Yeah. Look, those are all potential considerations. They are very logical. Last session, we were advocating for things along those lines, which was the expansion of PISA to be able to cover generation assets, extending the sunset date on the PISA, the generation assets that are included in our IRP. We did, and we will continue to advocate for the right of first refusal on transmission because, again, we think it is critical to get these transmission projects done sooner rather than later. Just talked about the great benefit-to-cost ratios they have got. Of course, I think their key as well is building incremental generation to making sure that we have got reliable power, low-cost power here in our region. Those are going to be key things that we focus on, and then my sense is that there will be a variety of other things that might be considered as we focus on, as a state, on economic development, job creation, and making sure that we have got a strong, reliable, affordable, balanced portfolio of energy resources to be able to meet the needs of prospective customers. Certainly, we will be considering all those things as we move towards that next legislative session.
Brian: Great. Thank you very much.
Operator: Thank you. The next question comes from the line of David Paz with Wolfe Research. Please proceed.
David Paz: Hi there. Good morning.
Marty Lyons: Morning.
David Paz: You may have just hit on this, but let me ask it a little differently. Could you maybe elaborate on how these potential agreements with large load customers may transpire? Could they entail potential new generation that the customer helps cover directly, and then just how are regulators and policymakers facilitating those types of discussions if they are?
Marty Lyons: Yeah. No. Good question. As we look at some of the potential load growth specifically in Missouri where we are vertically integrated, we own generation. We have got to be thoughtful about what incremental resources might be needed to serve some of the incremental load. We mentioned on our last call with respect to the 350 megawatts of additional load that has been announced with the construction agreements. We have the available resources to be able to serve them. But as these load forecasts grow, we are going to need to consider additional resources. That is under consideration now. That is going to be what we will be trying to work through as we think about updating our integrated resource plan early next year. I think that plan when we file it will deliver more clarity in terms of our thoughts there. With respect to the incremental cost, it is something we need to think through as we think about the incremental investments that we made to serve all of our customers, including these additional customers, just need to think through the appropriate portion of the costs so that all parties are treated fairly. That is ongoing consideration, ongoing dialogue with some of the entities that are looking to expand here. I think those conversations will continue over the coming months.
Michael Moehn: Hey, David. It is Michael. I am just pointing out the obvious. Historically, we were a bit long. Right? We began this transition, and we have some of these plants closing. Obviously, we have less length today. Adding Castle Bluff that Marty spoke about earlier, that is definitely in the right direction. That is exactly what the team is evaluating as part of this IRP evaluation and whether we are going to need to file again, trying to take some various scenarios under these load growth opportunities and match that really up against our generation to see if we need to add additional generation on top of that.
Marty Lyons: Great. I would just say this. When you look at our IRP, you can see the elements that we might bring forward. We had renewable resources in there. We will be evaluating. Can we pull those forward? Can we pull forward battery storage technology? As Michael said, we have got some simple cycle, combined cycle that we need to add some additional gas-fired generation. These are the elements we are looking at as we think about updating that IRP.
David Paz: Okay. That makes sense. Then just on 2025 quickly, do you anticipate your consistent EPS growth guidance from February to be based off of 2025?
Marty Lyons: Got it. I mean, that has sort of been our historical practice, David. We will update based on whatever that midpoint is for that 2025 we have got. In this case, it is that $4.95. So that would be the expectation.
David Paz: Okay. Great. Thank you.
Operator: Thank you. The next question comes from the line of Nick Campanella with Barclays. Please proceed.
Nick Campanella: Hey. Good morning. Thanks for taking my question. I got up a little late. I will try not to repeat. But clearly, you gave 2025 guidance earlier here, which is a sign of confidence going into next year. Capital is going up. How much capital is going up in the near term versus kind of the long term of your financial plan? Does that impact your equity needs? Do you still just kind of programmatically lean on the ATM, or would you contemplate other mechanisms around that? Thank you.
Michael Moehn: Hey, Nick. Michael here. From a capital perspective, I mean, I just continue to think in terms of the $21.9 billion that is out there. We have talked about a number of factors that we are updating for and just spent some time talking about this IRP. That is the process that we are going through, going through our typical capital planning process as we speak and putting the final touches on that. That is what we will come out with here in February. From a financing perspective, the plan that we put out there last February still stands today, focused on that $300 million. Got that largely done for 2024. Starting to lean into the 2025 piece. Got about $155 million of that done. In terms of ongoing financing assumptions, we have talked about this. We like our ratings where they are, the Baa1, BBB+. Downgrade threshold of 17 at S&P is, we have got quite a bit of margin there. The threshold metric for us is on S&P. It is 17. That is the one we will continue to watch. From a financing assumption standpoint, I would assume what we have sort of put out there at this point. So maintaining those and that consolidated equity ratio, around 40%, which is where it is today.
Nick Campanella: Thanks a lot. I appreciate that. Then maybe some considerations with the election that just happened. I believe that there are some EPA-driven investments in your plan today. Do you think any of that could change? How would you quantify your positioning around the new candidate? Can you also clarify if you have transferability cash flow in the plan? Thank you.
Marty Lyons: Yeah. There is a lot there. Obviously, the election just happened. When we think about the election, overall, one of the things to keep in mind is our strategy and our priorities of the company certainly do not change. Our focus is on making great infrastructure investments for the benefit of our customers and communities, advocating for energy policies to maximize that value, and, of course, as I mentioned before, seeking great economic development opportunities. We are going to be working with policymakers to make sure we maximize the benefit of those for our communities. While you did not ask about this, I think the most significant area of focus coming out of the federal elections probably could be around tax policy. As you know, as a fully regulated company, all the increases and decreases in taxes flow directly through to our customers' rates. Things like the corporate income tax rate, value of tax credits, those are things that have pretty meaningful effects on our customer rates. My sense is with Republican leadership, it is going to certainly be less likely that we see an increase in corporate taxes. I think that is positive for our customers from a bill perspective. I do expect there is going to be a conversation around some of these clean energy tax provisions in the IRA. I think we in our industry will all engage with policymakers on the considerations. My expectation is that Republicans will probably take a surgical approach to adjustments to the IRA given some of the direct customer benefits. For us, specifically, I would say the most meaningful benefits of the tax credits are around solar, battery storage, nuclear, and wind. Those are some of the things we will be thinking about. You mentioned transferability. Transferability of tax credits is important to us. We will make sure that policymakers are certainly aware of the importance of those too. Frankly, based on our IRP that we have on record, we filed, all of those things have a value of about a billion and a half positive value. Those tax credits do to our customers in Missouri alone. It is a significant benefit, and that is over about a ten-year period, the next ten-year period in our IRP. We will just make sure that as we engage with policymakers, whatever they decide, that at least they have those facts and they are aware of those benefits that we expect to have for our customers. At the end of the day, you should know that the investments in our system that we are going to make are whatever we think are appropriate from a reliability and affordability perspective and as we continue to adopt some of the new technologies that are out there. I think those are the biggest points with the election. You had mentioned EPA rules. I think that with respect to the EPA rules and the CapEx that we have in our plans today, I do not see those as changing. The EPA's greenhouse gas rules, on the other hand, that are working their way through the courts, I do expect that, ultimately, those rules would be stayed given some of the provisions that are in them with respect to carbon capture and storage and co-firing with natural gas. We will see what happens with respect to those proposed rules as we go through sort of a change in administration and change in legislature. But I think those rules, personally, in my mind, are flawed as they stand today. Those would be my comments. Any other questions from you?
Nick Campanella: I would say that you answered the four-part question very well. I appreciate it. Thanks.
Marty Lyons: Thank you.
Operator: Ladies and gentlemen, this concludes our question and answer session. I will turn the call back to Marty Lyons for closing remarks.
Marty Lyons: Terrific. Hey, thank you all for joining us today. As you can tell, we remain absolutely focused on closing out the year very strong, and we look forward to seeing many of you at the conference next week. Again, thank you very much, and everybody have a great day.
Operator: This concludes today's conference. You may disconnect your lines at this time. Enjoy the rest of your day. | [
{
"speaker": "Operator",
"text": "Greetings and welcome to the Ameren Corporation Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Andrew Kirk, Director of Investor Relations, Corporate Modeling for Ameren Corporation. Mr. Kirk, please proceed."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, and Chief Executive Officer, and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer, along with other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance, and similar matters, which are commonly referred to as forward-looking statements. Please refer to our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here is Marty, who will start on page four."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone. Thank you for joining us today as we cover our third quarter 2024 earnings results. I will begin today on page four. We are focused on delivering strong long-term value for our customers, communities, shareholders, and the environment. By investing in rate-regulated infrastructure, enhancing regulatory frameworks, and advocating for responsible energy policies, we are positioning ourselves to take advantage of future opportunities to benefit all of our stakeholders. Through a disciplined approach to optimizing our operating performance, we have been able to keep our customer rates low in comparison to the national average as we transform the energy grid, enhance reliability, and provide cleaner energy to our communities. We remain excited for the future, and we see strong growth opportunities unfolding over the next decade. Turning to page five. Yesterday, we announced third quarter 2024 adjusted earnings of $1.87 per share, compared to earnings of $1.87 per share in the third quarter of 2023. These comparable adjusted earnings results were in line with our expectations. The third quarter and year-to-date 2024 adjusted results exclude two charges related to separate proceedings that have been ongoing for over a decade. The first related to an agreement in principle to settle the Rush Island Energy Center New Source Review and Clean Air Act proceeding, and the second, for customer refunds required by the Federal Energy Regulatory Commission's (FERC) October 2024 order, which established a new base return on equity within the Midcontinent Independent System Operator (MISO), that was applied retroactively to certain periods extending back to 2013. Key earnings drivers are highlighted on this page. Mike will discuss the factors driving the quarterly results in more detail in a moment. Our strong investment pipeline continues to drive earnings growth, and I am excited about the significant economic growth opportunities in the communities we serve. The Greater St. Louis region is experiencing some of the highest employment growth we have seen in the better part of three decades. In August, the region was ranked fourth among large metro areas in the country for employment growth, and we are seeing this strength in our region reflected in strong weather-normalized retail sales growth year-to-date across all customer classes in Missouri. Turning now to page six. Thanks to our team's execution of our strategy over the course of this year, we have a strong foundation as we head into the final months of 2024. We expect to deliver 2024 earnings within our adjusted guidance range of $4.55 per share to $4.69 per share. We expect our 2025 earnings per share to be in the range of $4.85 and $5.05, with the midpoint representing a 7.1% increase over the midpoint of our 2024 adjusted guidance range. While our historical practice has been to provide initial earnings guidance on our fourth quarter earnings call in February, we are issuing this 2025 guidance now to reinforce our confidence in our ability to deliver on our 6% to 8% earnings per share growth guidance expectations. We expect to provide our long-term earnings growth guidance and capital and financing plans on our year-end call in February. On page seven, we highlight the latest advancements across Ameren as we execute our strategic objectives for the year. Our infrastructure investment plan is designed to improve the reliability, resiliency, safety, and efficiency of our system. As we remain focused on a reliable clean energy transition, year-to-date, we have invested $3 billion to replace aging infrastructure and also build the new infrastructure needed to meet our customers' growing demand for a diverse mix of energy resources. Just last week, we announced that we have now closed on three solar energy centers this year, totaling 500 megawatts of new generation, which are undergoing final testing and are expected to be in service by the end of the year. On the regulatory front, MISO's long-range transmission planning process is progressing toward approval of the tranche 2.1 portfolio by the end of the year. In September, MISO released additional tranche 2.1 project details, which included approximately $3.6 billion of transmission investment needed in our Missouri and Illinois service territories to support reliability for the region. At Ameren Missouri, we are working to bring more dispatchable generation onto the grid. In October, the Missouri Public Service Commission (Missouri PSC) approved a certificate of convenience and necessity (CCN) and post-construction cost deferral for the 800-megawatt simple cycle natural gas energy center, Castle Bluff. This $900 million investment in dispatchable generation will support energy reliability in our region and will also create hundreds of construction jobs, several new permanent jobs, and additional tax revenue for the region. In addition, in November, we reached an agreement in principle with the US Department of Justice to settle the Rush Island Energy Center New Source Review and Clean Air Act proceeding. I will cover the details of the agreement in a moment. Finally, at Ameren Illinois, in October, the administrative law judge (ALJ) issued a proposed order regarding our revised 2024 through 2027 electric distribution multiyear rate plan. Importantly, the ALJ proposed order supports 99% of our requested rate base when excluding the impacts of other post-employment benefits (OPEB). Following our team's extensive engagement with key stakeholders, all interveners support the Illinois Commerce Commission's (ICC) approval of a revised grid plan with limited adjustments. We look forward to an ICC decision by the end of this year, which we expect to be consistent with the multiyear capital plans we issued in February. Last, operational performance across our company remains strong, with a focus on delivering safer, more reliable, and affordable energy through grid hardening, enhanced automation, optimization, and standardization. Turning to page eight for an update on Ameren Missouri's new generation project. We continue to execute our Ameren Missouri Integrated Resource Plan (IRP), which focuses on maintaining and building a diverse, cleaner generation portfolio to ensure our reliable and low-cost mix of energy resources to serve our customers' needs. As I mentioned, we have three solar projects in the later stages of commissioning and testing that are expected to be in service. We are also working toward the successful construction of another 400 megawatts of solar generation across three additional projects, which we expect will be ready to serve customers in late 2025 and 2026. Further, as I mentioned, in October, Missouri PSC approved the CCN for the dispatchable 800-megawatt simple cycle natural gas energy center Castle Bluff, following a constructive settlement with the commission staff and other interveners. The order also includes post-construction cost deferral to reduce unrecovered costs by allowing us to defer and recover the depreciation expense from the Castle Bluff Energy Center and an adjusted weighted average cost of capital return on the investment from the time it is placed in service to when it is incorporated into base rates. As solar energy predictably rises and then falls every day, it is vital to have Castle Bluff Energy Center to bolster grid reliability for our customers. Prep work has begun on Castle Bluff, which will be located on the site of our retired Meramec Energy Center, allowing us to cost-effectively expedite the construction by leveraging an existing site with infrastructure in place. The energy center is expected to be in service for our customers by the end of 2027. We look forward to continuing to work with key stakeholders to bring additional generation online as quickly as possible to meet the needs of all customers, including businesses looking to relocate or expand in Missouri. Moving now to page nine for an update on the MISO long-range transmission projects. In September, MISO provided additional detail and individual project cost estimates underlying the almost $22 billion tranche 2.1 portfolio, which is expected to drive significant reliability and capacity benefits for the region. The portfolio includes three projects in our Missouri and Illinois service territories that collectively represent an investment opportunity of approximately $3.6 billion. We await MISO's determination of which projects will be directly assigned and which will go through a competitive bidding process. MISO expects to approve the tranche 2.1 projects by the end of this year. Once approved, MISO plans to commence work in 2025 on the tranche 2.2 portfolio to address further transmission needs in the North and Midwest regions. As we continue to see substantial load growth across the country, MISO and its transmission owners will continue to assess whether the current long-range transmission future scenarios will be sufficient to support our region's energy needs in the years ahead. Moving now to page ten for an update on our expanding customer growth opportunities. Our service territories have a broad-based, diverse economy, which continues to expand across a variety of manufacturing sectors, including aerospace, agriculture, and food processing, to name a few. So far this year, we have received expansion commitments or executed new contracts for approximately 350 megawatts of new load from data centers, manufacturing, and other industries, 90% of which is located in Missouri. These projects are expected to create more than 2,200 jobs. We expect these new and expanding customers to be fully ramped up by 2028. We are excited about these opportunities and see tremendous additional opportunities for growth over the next five to seven years, which will bring jobs and additional tax base to benefit our state and local communities. Through ongoing collaboration with a variety of state and local stakeholders, we continue to attract new business and data center interest. Over the last few months, our economic development pipeline of potential additional demand has doubled in size, and we are making meaningful progress with several potential customers. These customers, representing several gigawatts of interest, have completed transmission engineering studies, and over the coming months, each will further evaluate the site locations and determine whether they will move forward with agreements. We are pleased to offer reliable service and competitive rates, as well as the people, resources, expertise, and partnerships needed to deliver for these customers. The ultimate net financial impact of any incremental load will be dependent upon a variety of factors, including customer ramp-up time, additional generation or grid investments needed, timing of rate reviews, and tariff structures. To that end, we are in the process of carefully evaluating potential load growth opportunities and our associated generation portfolio needs and would expect to update our IRP by February of 2025. This is an exciting time in our industry, and we look forward to finding solutions for these significant potential new customers. Turning then to page eleven. After almost fifty years of providing cost-effective energy to our customers, our Rush Island Energy Center was safely retired on October fifteenth. We are grateful to our coworkers who made this plant a reliable and low-cost energy source for our customers for many decades. Careful planning over several years enabled us to ensure that every employee impacted by the retirement of Rush Island had an opportunity with the company as we continue to thoughtfully transition our generation resources while retaining our talented workforce. The Missouri PSC has authorized recovery of approximately $470 million of cost related to the retirement of Rush Island through the issuance of securitized utility tariff. We are working through the next steps to execute that issuance. In addition, in November, Ameren Missouri and the US Department of Justice reached a settlement agreement in principle requiring Ameren Missouri to fund two mitigation relief programs in addition to retiring the energy center. The cost of these programs, which will provide for the electrification of school buses over a three-year period and air purifiers for eligible Ameren Missouri residential customers over twelve months, totaled $64 million. The charges recorded this year related to this agreement are excluded from our adjusted earnings results. The agreement between the DOJ and Ameren Missouri is subject to approval by the US District Court for the Eastern District of Missouri, which is expected by the end of the year. Moving to page twelve. Looking ahead over the coming decade, we have a robust pipeline of investment opportunities of more than $55 billion that will continue to deliver significant value to our stakeholders, create thousands of jobs, generate tax revenue for our local economies, and support economic growth in our region. Importantly, our ten-year investment pipeline does not reflect possible additional generation as we evaluate our needs to serve potential additional load growth. Any such changes to our ten-year investment pipeline will be reflected in our February earnings call update. Moving to page thirteen, our five-year growth plan released last February included our expectation of a 6% to 8% compound annual earnings growth rate from 2024 through 2028. This earnings growth is driven by strong compound annual rate base growth of 8.2% and strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high-quality utility growth story. Combined, our strong long-term 6% to 8% earnings growth and an attractive and growing dividend, which today yields 3.1%, result in a compelling total return story. We have a strong track record of execution, a strong balance sheet, and an experienced management team. I am confident in our ability to execute our investment plans and other elements of our strategy across all four of our business segments. Again, thank you all for joining us today, and I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. I will begin on page fifteen of our presentation with an earnings reconciliation for two earnings adjustments that Marty mentioned earlier. Yesterday, we reported third quarter 2024 GAAP earnings of $1.70 per share, which included a charge for additional mitigation relief related to the Rush Island Energy Center and a charge for the October 2024 FERC order on MISO's allowed base ROE. Both of these charges related to matters outstanding for the last decade. Excluding these two charges, Ameren reported third quarter adjusted earnings of $1.87 per share, compared to earnings of $1.87 per share for the year-ago quarter. The total after-tax charge of $0.17 per share in 2024 related to our Rush Island Energy Center reflects the estimated cost of the mitigation relief program agreed to with the US Department of Justice. This includes the $0.04 per share charge recorded in the first quarter of 2024. Subject to approval by the district court, we expect a settlement agreement to resolve the proceeding related to the new source review provisions of the Clean Air Act. Turning to the charge for the FERC order, recall, since November 2013, the allowed base ROE for FERC-regulated transmission rate base within the MISO has been subject to review. In FERC's October 2024 order, it established a new base ROE of 9.98% for the periods of November 2013 through February 2015, and September 2016 forward, which decreased the allowed base ROE from 10.02% and will require refunds with interest for these periods, totaling an after-tax impact of $0.04 per share. The return on equity from MISO projects is now 10.48%, including the 50 basis point adder, and we do not expect a four basis point decrease in ROE to have a material impact on earnings expectations going forward. Turning to page sixteen for detailed earnings results for the third quarter. Our adjusted earnings performance during the quarter was driven primarily by strategic investments and disciplined cost management, offset by changes in return equity for Ameren Illinois Electric Distribution and rate design at Ameren Illinois Natural Gas. Additional factors that contributed to the year-over-year earnings per share results are highlighted on this page. Year-to-date results are outlined on page twenty-six of today's presentation. Before moving on, I will touch on sales trends for Ameren Missouri and Ameren Illinois Electric Distribution. While miles were lower this quarter compared to the year-ago period, creating some earnings drag, our third quarter weather-normalized retail sales remained strong at an overall increase of approximately 1.5% compared to the year-ago period. Year-to-date, weather-normalized kilowatt-hour sales to Missouri residential, commercial, and industrial customers increased approximately 2%, 1%, and 3%, respectively, compared to last year. The year-to-date increase in industrial sales reflects production growth driven by new industrial plant additions and additional shift work in our service territory. Year-to-date, weather-normalized kilowatt-hour sales to Illinois customers were flat compared to last year. Recall that changes in electric sales, no matter the cost, do not affect the earnings since we have full revenue decoupling. On page seventeen, we summarize select earnings considerations for the balance of the year. We expect our 2024 adjusted earnings to be in the range of $4.55 to $4.69 per share. Notably, we expect a positive year-over-year earnings impact in the fourth quarter driven primarily by strategic infrastructure investments, strong cost management programs, and lower charitable trust contributions compared to the year-ago period. I encourage you to take the settlement-arranged drivers noted on this slide into consideration as you develop your earnings expectations for the remainder of the year. Turning to page eighteen, where we provide detail on our expectations for 2025. As we head into 2025, we feel confident that strong execution of our strategic plan this year will position us to deliver on our expected long-term earnings growth. With that in mind, we expect 2025 earnings per share to be in the range of $4.85 and $5.05. The midpoint of this range represents a little above 7% earnings per share growth compared to the midpoint of our 2024 adjusted earnings guidance range. Expected 2025 earnings detailed by segment as compared to our 2024 expectations are highlighted on this page. Beginning with Ameren Missouri, earnings are expected to benefit from new electric service rates effective by June 2025 and higher investment eligible for plant and service accounting. Earnings are also expected to benefit from higher weather-normalized retail sales, primarily to Missouri's commercial and industrial customers, which are expected to increase by 1% and 2%, respectively, driven primarily by the expansion and growth from our existing customers. We expect to update our long-term sales forecast in February. Further, we expect higher interest expense in Ameren Missouri and Ameren Parent, Transmission, and Ameren Illinois Electric Distribution, driven by higher infrastructure investment. Earnings in Ameren Illinois Natural Gas are expected to be lower due to cost recovery impacts between rate reviews. Ameren-wide, we expect increased weighted average common shares outstanding to unfavorably impact earnings per share. Robust infrastructure investment and economic growth opportunities, coupled with identified business process optimization opportunities and continued strong strategic focus, give us confidence in our ability to grow in 2025 and the years ahead. Turning to page nineteen for a brief update on Missouri regulatory matters. In August, the Missouri PSC set the procedural schedule for our ongoing Ameren Missouri electric rate review. Intervenor testimony is due in early December, and we expect a decision by the commission by May 2025, with new rates effective by June. Recall that approximately 90% of this request is driven by investments under Ameren Missouri's Smart Energy Plan, including major upgrades to the electric system and investments in generation. If approved as requested, new electric service rates would remain well below the national and Midwest averages. Turning to Ameren Illinois regulatory matters on page twenty. Under Illinois formula rate-making, which expired at the end of 2023, Ameren Illinois was required to file annual rate updates to systematically adjust cash flows over time for changes in the cost of service and to true up any prior period over or under recovery of such costs. For the final electric distribution reconciliation of 2023's revenue requirement, in August, the ICC staff recommended approval of our proposed $158 million reconciliation adjustment. The full amount would be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that is being collected during 2024. This will result in a net increase in cash flow of $48 million, or approximately a 1.5% increase in the total average residential customer bill. An ICC decision is expected by December, with new rates effective in 2025. Turning to page twenty-one for an update on the multiyear rate plan covering 2024 through 2027. In October, the ALJ recommended a cumulative revenue increase of $315 million based on an average rate base of $4.9 billion by 2027. Excluding the OPEB issue, the ALJ's proposed order supports 99% of the rate base that we requested in a revised multiyear rate plan. This would allow us to invest in the energy grid to maintain safety, reliability, and the day-to-day operations of our system, while also making progress towards an affordable, equitable, clean energy transition. Following constructive engagement with the interveners to narrow the remaining issues, their latest proposals reflect a multiyear grid plan that is largely consistent with our guidance laid out in February. We expect an ICC decision by December, with new rates effective January 1, 2025. Under the multiyear rate plan, any annual revenues will be based on actual recoverable costs, year-end rate base, and a return on equity, provided they do not exceed 105% of the approved revenue requirements after certain exclusions. Moving to page twenty-two to provide a financing update. We continue to feel very good about our financial position. Ameren's parent long-term issuer credit ratings of Baa1 and BBB+ at Moody's and S&P, respectively, compare favorably to the peer average, providing us with financial flexibility. To maintain our credit ratings and strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity in total in 2024. By the end of 2023, we sold approximately $230 million of the expected $300 million through the at-the-market (ATM) program, consisting of approximately 2.9 million shares, which we expect to settle by the end of this year. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to fulfill our 2024 equity needs. Additionally, as of September 30th, we have entered into forward sales agreements under our ATM program for approximately $155 million to support our 2025 equity needs, with an average initial forward sales price of approximately $82 per share. As always, we are thoughtful about strategically financing our robust capital plan. Turning to page twenty-three. We remain confident in our long-term strategy, which we expect to continue to drive consistent superior value for all of our stakeholders. As highlighted today, we have made significant progress towards our goals. We have strong infrastructure investment opportunities to benefit our customers and attract new businesses, and we continue to see signs of an attractive regional economy, including solid retail sales growth, strong employment growth in the St. Louis region, moderating interest rates and inflation, and a robust economic development pipeline that will deliver strong earnings growth in 2025. Looking beyond, we expect consistent strong earnings per share growth driven by robust rate base growth, disciplined cost management, and a robust customer growth pipeline. As we said before, we have the right strategy, team, and culture to capitalize on opportunities to create value for our customers and shareholders. We believe this growth will compare favorably with the growth of our peers, and shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Jeremy Tonet with JPMorgan. Please proceed."
},
{
"speaker": "Robin (for Jeremy Tonet)",
"text": "Hey, this is Robin on for Jeremy. How are you? Oh, great. Good morning. So maybe just to follow-up, you mentioned providing 2025 guidance at 3Q to underscore your confidence in your earnings trajectory. Could you elaborate on that strategy given several ongoing regulatory proceedings? And specifically, how should we think about the 2025 range relative to potential regulatory outcomes?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah, sure. Well, you know, first of all, as you look back on some of the comments we made at the second quarter, we have a long history of growing at 7% or above. Our goal as we go into each year, of course, is to deliver at the midpoint or even higher within our range. Some of the things that we pointed to last quarter that are just giving us more long-term conviction have to do with inflation cooling, strong local economy, demand improving, some of the things we have talked about even on this call with respect to customer growth opportunities and great investments that we have got across all of our segments, whether it is distribution, transmission, and generation, and, of course, a strong balance sheet. So we have strong conviction in our ability to grow long-term. As we looked at 2025, we certainly have confidence in our ability to deliver within the range that we pointed out today. As we look ahead over the next few months, typically, we have delivered this guidance in February. We are delivering it now because we do have strong confidence, and we believe that whatever unfolds in the months ahead, we will be able to adjust our plan and hit the mark in terms of the guidance that we delivered."
},
{
"speaker": "Robin",
"text": "Great. Thanks. And then maybe just a follow-up on the mentioned economic development opportunities. You mentioned you have gotten some interest from an impressive several gigawatts of potential opportunities. Just any high-level thoughts on how you factor in potential double counting, like, say, if those customers are also submitting those inbounds to other utilities or service territories?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah, sure. And look, I think you are absolutely right. We pointed out on our slide that we have tens of thousands of megawatts of potential new demand, so a significant amount. We certainly expect that, if we call it double counting, but a lot of these folks are looking at the same properties. You have got developers as well as hyperscalers. And so, yeah, there is certainly duplication in there. What we are doing is really working through with each of those counterparties in a methodical way. We mentioned that we have had progress with potential counterparties representing several gigawatts of demand. We are working through with them on evaluating the sites, the transmission access, the generation that might be needed to serve them. Eventually, we expect that to be narrowed down. It is one of the reasons why we have been cautious about not really announcing any of this load until we get a construction agreement because these conversations have to progress to the point where we have a construction agreement. The other thing to keep in mind is we have mentioned in our prepared remarks that we expect that over the coming months, we will get even greater visibility. We will have a better sense of what the demand might be over the coming years and be able to incorporate that into our plans for incremental generation. So expect to put a greater stake in the ground, if you will, in February, which is when we believe we will be in a position to update some of those sales forecasts and update our IRP."
},
{
"speaker": "Robin",
"text": "Great. Thank you. Appreciate the color."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed."
},
{
"speaker": "Paul Patterson",
"text": "Hey. Good morning."
},
{
"speaker": "Marty Lyons",
"text": "Hey, Paul. Good morning."
},
{
"speaker": "Paul Patterson",
"text": "Just a few quick questions. On the refilled group plan, it looks like, I guess, they are going to have oral arguments, I guess, based on what the AG wanted. Any thoughts about that? I mean, at this late date that they are looking at doing that?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah. Paul, I do not think I would read anything into that. Obviously, there are some differences, which I think because of the hard work of our teams along with the various stakeholders in these cases, we have really narrowed down the potential adjustments that folks have argued for. If you look on slide twenty-one in our materials, we laid out where the proposed rate base would be taking into consideration potential adjustments that have been advocated by various parties. You see where the staff is and where the ALJ came out. But I think it is normal that you would have oral arguments over the remaining differences. But again, I would point to the ALJ's proposed order, which certainly gives us confidence in terms of where this may land with the commission when they ultimately decide in December."
},
{
"speaker": "Michael Moehn",
"text": "Hey, Paul. This is Michael. I was just going to add that these oral arguments have been scheduled for a long time, so that is fairly typical, and they are actually being held on November twentieth. So as Marty said, I think what we have today is a constructive data point from the ALJ. I think all the interveners are recommending approval of the grid plan at this point. We will just see where the arguments take us."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Great. And then on slide nine, you mentioned the transmission projects and the reliability and also the growing customer calls. I was wondering if you could elaborate a little bit more on the customer call side, like what this might mean to customers. Because we do not see them. Go ahead. I am sorry."
},
{
"speaker": "Marty Lyons",
"text": "Yeah. No. It is okay, Paul. I mean, we are really referring to, and we added a bullet which we have not had in the past, about the customer benefits in a range of 1.3 to 5.6 times in terms of the portfolio cost. So that relates to the overall approximately $22 billion of projects. When MISO goes through these and they propose these various projects, one of the things they do is obviously estimate the cost of these projects, which we have listed, at least for the projects in our service territory down below. But they also do an assessment of what the benefits to the customers are going to be in relation to those costs. Each of these projects has the positive math behind it, if you will, that suggests that customers' costs over time will be lower as a result of these investments. So that is what we are really trying to convey."
},
{
"speaker": "Paul Patterson",
"text": "Okay. But there is not going to be some dramatic cost, I guess, when these new lines show up and cheaper stuff comes in? Or is it sort of all mixed up together and it is going to take some time for it all to show up kind of thing?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah. I think it will show up over time. I do not have any exact rate impact to point to."
},
{
"speaker": "Paul Patterson",
"text": "I got it. Thanks. Okay. Then finally, on the new customers, you mentioned with one tranche of the new customers that there was 90% Missouri versus Illinois. I guess I was wondering when people are looking to, with all these robust discussions that you are having, is there more interest in one state versus another, or is there any flavor as to if there is, what might be driving that?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah. Look. We have data center interest really in each of the states. So if you look over to the right, on that slide ten, we talked about tens of thousands of megawatts of potential new demand. You see various elements of that. I would say today in our pipeline, about 75% is data centers, 15% is manufacturing, and 10% is other, which is probably how that breaks down. Within that data center interest that we have got, about 65% of it is Missouri, and 35% of it is Illinois today in terms of what is in our pipeline. So there is clearly data center interest in each of the states. Each of the states is attractive for various reasons and in some cases, different reasons. But what we have announced today with respect to these construction agreements, which is more over on the left where we have 250 megawatts of data center demand, 100 megawatts of additional load from a variety of sources, it just so happens that 90% of that is actually in Missouri. About 10% of that is Illinois today in terms of those agreements that we have in place. Now, as we look ahead, certainly, the impact to us from an earnings perspective is going to be differentiated in the two states. In Illinois, obviously, if we have transmission or distribution investment that supports that load growth, we get the earnings impact of that. In Missouri, which is vertically integrated, we also have the impact of the opportunity to earn on any incremental generation."
},
{
"speaker": "Paul Patterson",
"text": "Okay. But there is no specific reason for that? It just that is the way it fell out, I guess. Okay. I appreciate it. Thanks so much. Have a great one."
},
{
"speaker": "Operator",
"text": "You bet. The next question comes from the line of Carly Davenport with Goldman Sachs. Please proceed."
},
{
"speaker": "Carly Davenport",
"text": "Hey. Good morning. Thanks so much for taking my questions. Maybe just to follow-up on an earlier question on the earnings guidance range. As you think about 2025 growth at just over 7% relative to the midpoint of 2024, can you just give us your thoughts on looking forward where you see yourself in the range, just taking into consideration some of the incremental opportunities that you have highlighted and if there is any potential upside to that range going forward?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah. Carly, look. In terms of our range, we have said 6% to 8% is our EPS CAGR that we are targeting for the period 2024 to 2028. As I mentioned earlier, when we look back, we have got a strong track record of delivering above the midpoint, above 7%, and our goals as we look ahead are to deliver at or above. As you said, we have some positive data points we are seeing today. Again, one of the things is the slow growth, which we just talked about. Some potential load growth. We are working hard to bring that to fruition for the benefit of our customers, our communities, and we are going to work hard to do that. At this point, I would say that is where we are at now. We will come out in February. We will provide our perspectives on load growth going forward, update our investment plans, and we will note any potential implications on guidance. But we feel good about the 6% to 8% and, again, our target of hitting at or above that midpoint. Michael, anything to add?"
},
{
"speaker": "Michael Moehn",
"text": "Hey, Carly. It is Michael. I think it is well said. The only other thing I might add is just again, the overall backlog of investment opportunities. Marty spoke about this earlier. We have got the $55 billion that we continue to point to. I think that pipeline remains robust. We talked about this opportunity just with the data centers. That could potentially drive some additional capital. So, I mean, your question specifically was what could take you to the upside of that? I think it is those additional investment opportunities over time. I think there is also opportunity, as Marty said, not only just from the data center, but the underlying economic data within, certainly in the Missouri territory, is very strong today. Just looking at the overall employment, the GDP rate, we are seeing customer growth, which we just alluded to. We are seeing customer account growth, population growth, and all of those things, I think, are a great backdrop. Then, yeah, we continue to think about just how do we optimize the financing in this going forward. So that is where I would probably leave it at this point."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Great. That is super helpful. And then maybe just another quick one. You have previously talked about some O&M reductions coming in the second half of the year. Looks like 3Q was still up year over year, but then you called out some efficiency in the earnings driver slides for 4Q. Are you able to give some color on what programs you are sort of pursuing there? And if what you have called out on the slides is all-inclusive of what you are looking at on O&M."
},
{
"speaker": "Michael Moehn",
"text": "Yeah. You bet. And you are right. We have been pointing to this towards the beginning of the year. I said it was going to be in the back half. And I think you are certainly seeing that show up in Missouri. Specifically, you know, $0.05. You look at what we are pointing to in the fourth quarter, year over year expecting $0.03 and $0.01 in Missouri and Illinois Natural Gas, respectively. And, again, just consistent with some of the things I have talked about in the past. This is not something that is new to us. We have been after these programs for a long time. Beginning in the year, we talked specifically about some things that we were doing around just being thoughtful with respect to headcount, discretionary spend coming out of some of the Illinois decisions. I think we continued to lean into them. We continue to find more opportunities. Looking at spans and layers, looking at simplification. We just have an opportunity for us to be more consistent across our platform, which drives efficiencies, back-end reduction, overhead cost, etc. We do a lot of benchmarking in this. You see some of that public benchmarking, and we benchmark well, but in areas we have opportunities. So wherever we are benchmarking, constantly looking at how do we move up a quartile. I think the team is absolutely committed to this, and we have not exhausted all the opportunities at this point."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Great. Thanks so much."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Julien Dumoulin Smith with Jefferies. Please proceed."
},
{
"speaker": "Brian (for Julien Dumoulin Smith)",
"text": "Yeah. Hi. Good morning. It is actually Brian. I am still on for Julien."
},
{
"speaker": "Marty Lyons",
"text": "Brian?"
},
{
"speaker": "Brian",
"text": "Alright. Hey. Just to follow-up on Ameren Transmission. It looks like just the assumption in this 2025 versus 2024 looks like growth in rate base is pushing 9%, and it seems that the growth there is accelerating as we move through the five-year plan, approaching, I guess, the double-digit overall rate base growth CAGR. Is the near term in 2025 and 2026 really just the prior MISO tranche projects that have been approved and that you are developing? And then is there any possibility of these tranche two projects being pulled forward versus the early to mid-2030s target dates?"
},
{
"speaker": "Marty Lyons",
"text": "As it relates to the MISO projects, the tranche one projects, I tell you, the construction there is really going to take place between 2026 and 2030 is our projection today. Some of these MISO tranche 2.1 projects, those will probably go in service in the 2032 to 2034 time frame. We think most of the expenditures for those are outside of the current five-year period. Although, we will be certainly looking to accelerate those if possible. There is no reason that tranche two project work and tranche one project work cannot overlap. So we will be looking to bring this to fruition for the benefit of our customers and communities as soon as we can once they are approved and once they are assigned to us. Otherwise, we always have ongoing projects in the transmission space that are outside of those that are part of the tranche one or tranche two that are approved through annual MISO processes. Those continue to be foundational in our overall spending and growth in the transmission space."
},
{
"speaker": "Michael Moehn",
"text": "The only thing I might add to that is, you think about those $55 billion pipeline. We have talked about this, about $5 billion is in there with respect to the LRTP projects. Brian, so you think about tranche one, we had the $1.8 billion assigned, the $700 million on the competitive projects. There will be some variation of those ultimately where they ended up settling out, but then you have tranche 2.1, which will again we will see what ultimately gets assigned or competitive, but there is $3.6 billion of eligible projects. Then you are going to obviously roll into this 2.2 tranche. I am just giving you the math if you kind of want to think about that $5 billion, and it is, yeah, you can see the pipeline associated with getting there pretty easily."
},
{
"speaker": "Brian",
"text": "Okay. Great. And just as we look towards the 2025 Missouri legislative session, how active will Ameren be or involved in any proposed bills that I think might need to be proposed as early as this December, whether it is PISA for fossil fuel or gas-fired generation, any road for or, I guess, expanding expediting the generation review, which would tie into maybe your February 2025 IRP update."
},
{
"speaker": "Marty Lyons",
"text": "Yeah. Look, those are all potential considerations. They are very logical. Last session, we were advocating for things along those lines, which was the expansion of PISA to be able to cover generation assets, extending the sunset date on the PISA, the generation assets that are included in our IRP. We did, and we will continue to advocate for the right of first refusal on transmission because, again, we think it is critical to get these transmission projects done sooner rather than later. Just talked about the great benefit-to-cost ratios they have got. Of course, I think their key as well is building incremental generation to making sure that we have got reliable power, low-cost power here in our region. Those are going to be key things that we focus on, and then my sense is that there will be a variety of other things that might be considered as we focus on, as a state, on economic development, job creation, and making sure that we have got a strong, reliable, affordable, balanced portfolio of energy resources to be able to meet the needs of prospective customers. Certainly, we will be considering all those things as we move towards that next legislative session."
},
{
"speaker": "Brian",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you. The next question comes from the line of David Paz with Wolfe Research. Please proceed."
},
{
"speaker": "David Paz",
"text": "Hi there. Good morning."
},
{
"speaker": "Marty Lyons",
"text": "Morning."
},
{
"speaker": "David Paz",
"text": "You may have just hit on this, but let me ask it a little differently. Could you maybe elaborate on how these potential agreements with large load customers may transpire? Could they entail potential new generation that the customer helps cover directly, and then just how are regulators and policymakers facilitating those types of discussions if they are?"
},
{
"speaker": "Marty Lyons",
"text": "Yeah. No. Good question. As we look at some of the potential load growth specifically in Missouri where we are vertically integrated, we own generation. We have got to be thoughtful about what incremental resources might be needed to serve some of the incremental load. We mentioned on our last call with respect to the 350 megawatts of additional load that has been announced with the construction agreements. We have the available resources to be able to serve them. But as these load forecasts grow, we are going to need to consider additional resources. That is under consideration now. That is going to be what we will be trying to work through as we think about updating our integrated resource plan early next year. I think that plan when we file it will deliver more clarity in terms of our thoughts there. With respect to the incremental cost, it is something we need to think through as we think about the incremental investments that we made to serve all of our customers, including these additional customers, just need to think through the appropriate portion of the costs so that all parties are treated fairly. That is ongoing consideration, ongoing dialogue with some of the entities that are looking to expand here. I think those conversations will continue over the coming months."
},
{
"speaker": "Michael Moehn",
"text": "Hey, David. It is Michael. I am just pointing out the obvious. Historically, we were a bit long. Right? We began this transition, and we have some of these plants closing. Obviously, we have less length today. Adding Castle Bluff that Marty spoke about earlier, that is definitely in the right direction. That is exactly what the team is evaluating as part of this IRP evaluation and whether we are going to need to file again, trying to take some various scenarios under these load growth opportunities and match that really up against our generation to see if we need to add additional generation on top of that."
},
{
"speaker": "Marty Lyons",
"text": "Great. I would just say this. When you look at our IRP, you can see the elements that we might bring forward. We had renewable resources in there. We will be evaluating. Can we pull those forward? Can we pull forward battery storage technology? As Michael said, we have got some simple cycle, combined cycle that we need to add some additional gas-fired generation. These are the elements we are looking at as we think about updating that IRP."
},
{
"speaker": "David Paz",
"text": "Okay. That makes sense. Then just on 2025 quickly, do you anticipate your consistent EPS growth guidance from February to be based off of 2025?"
},
{
"speaker": "Marty Lyons",
"text": "Got it. I mean, that has sort of been our historical practice, David. We will update based on whatever that midpoint is for that 2025 we have got. In this case, it is that $4.95. So that would be the expectation."
},
{
"speaker": "David Paz",
"text": "Okay. Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. The next question comes from the line of Nick Campanella with Barclays. Please proceed."
},
{
"speaker": "Nick Campanella",
"text": "Hey. Good morning. Thanks for taking my question. I got up a little late. I will try not to repeat. But clearly, you gave 2025 guidance earlier here, which is a sign of confidence going into next year. Capital is going up. How much capital is going up in the near term versus kind of the long term of your financial plan? Does that impact your equity needs? Do you still just kind of programmatically lean on the ATM, or would you contemplate other mechanisms around that? Thank you."
},
{
"speaker": "Michael Moehn",
"text": "Hey, Nick. Michael here. From a capital perspective, I mean, I just continue to think in terms of the $21.9 billion that is out there. We have talked about a number of factors that we are updating for and just spent some time talking about this IRP. That is the process that we are going through, going through our typical capital planning process as we speak and putting the final touches on that. That is what we will come out with here in February. From a financing perspective, the plan that we put out there last February still stands today, focused on that $300 million. Got that largely done for 2024. Starting to lean into the 2025 piece. Got about $155 million of that done. In terms of ongoing financing assumptions, we have talked about this. We like our ratings where they are, the Baa1, BBB+. Downgrade threshold of 17 at S&P is, we have got quite a bit of margin there. The threshold metric for us is on S&P. It is 17. That is the one we will continue to watch. From a financing assumption standpoint, I would assume what we have sort of put out there at this point. So maintaining those and that consolidated equity ratio, around 40%, which is where it is today."
},
{
"speaker": "Nick Campanella",
"text": "Thanks a lot. I appreciate that. Then maybe some considerations with the election that just happened. I believe that there are some EPA-driven investments in your plan today. Do you think any of that could change? How would you quantify your positioning around the new candidate? Can you also clarify if you have transferability cash flow in the plan? Thank you."
},
{
"speaker": "Marty Lyons",
"text": "Yeah. There is a lot there. Obviously, the election just happened. When we think about the election, overall, one of the things to keep in mind is our strategy and our priorities of the company certainly do not change. Our focus is on making great infrastructure investments for the benefit of our customers and communities, advocating for energy policies to maximize that value, and, of course, as I mentioned before, seeking great economic development opportunities. We are going to be working with policymakers to make sure we maximize the benefit of those for our communities. While you did not ask about this, I think the most significant area of focus coming out of the federal elections probably could be around tax policy. As you know, as a fully regulated company, all the increases and decreases in taxes flow directly through to our customers' rates. Things like the corporate income tax rate, value of tax credits, those are things that have pretty meaningful effects on our customer rates. My sense is with Republican leadership, it is going to certainly be less likely that we see an increase in corporate taxes. I think that is positive for our customers from a bill perspective. I do expect there is going to be a conversation around some of these clean energy tax provisions in the IRA. I think we in our industry will all engage with policymakers on the considerations. My expectation is that Republicans will probably take a surgical approach to adjustments to the IRA given some of the direct customer benefits. For us, specifically, I would say the most meaningful benefits of the tax credits are around solar, battery storage, nuclear, and wind. Those are some of the things we will be thinking about. You mentioned transferability. Transferability of tax credits is important to us. We will make sure that policymakers are certainly aware of the importance of those too. Frankly, based on our IRP that we have on record, we filed, all of those things have a value of about a billion and a half positive value. Those tax credits do to our customers in Missouri alone. It is a significant benefit, and that is over about a ten-year period, the next ten-year period in our IRP. We will just make sure that as we engage with policymakers, whatever they decide, that at least they have those facts and they are aware of those benefits that we expect to have for our customers. At the end of the day, you should know that the investments in our system that we are going to make are whatever we think are appropriate from a reliability and affordability perspective and as we continue to adopt some of the new technologies that are out there. I think those are the biggest points with the election. You had mentioned EPA rules. I think that with respect to the EPA rules and the CapEx that we have in our plans today, I do not see those as changing. The EPA's greenhouse gas rules, on the other hand, that are working their way through the courts, I do expect that, ultimately, those rules would be stayed given some of the provisions that are in them with respect to carbon capture and storage and co-firing with natural gas. We will see what happens with respect to those proposed rules as we go through sort of a change in administration and change in legislature. But I think those rules, personally, in my mind, are flawed as they stand today. Those would be my comments. Any other questions from you?"
},
{
"speaker": "Nick Campanella",
"text": "I would say that you answered the four-part question very well. I appreciate it. Thanks."
},
{
"speaker": "Marty Lyons",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes our question and answer session. I will turn the call back to Marty Lyons for closing remarks."
},
{
"speaker": "Marty Lyons",
"text": "Terrific. Hey, thank you all for joining us today. As you can tell, we remain absolutely focused on closing out the year very strong, and we look forward to seeing many of you at the conference next week. Again, thank you very much, and everybody have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time. Enjoy the rest of your day."
}
] | Ameren Corporation | 373,264 |
AEE | 2 | 2,024 | 2024-08-02 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation's Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk. You may begin.
Andrew Kirk : Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team. This call contains time sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amerenvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday, as well as our SEC filings for more information about the various factors that cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4.
Marty Lyons : Thanks, Andrew. Good morning, everyone. We're pleased to have you joining us today as we cover our second quarter 2024 earnings results and recent developments across our business segments. Overall, it was a very productive and positive quarter. As always, our dedicated and experienced management team remained laser focused on executing our strategic plan, positioning us well to take advantage of future opportunities to drive significant value for our customers and shareholders. Speaking of opportunities, I'm tremendously excited about the investment opportunities ahead for us in this dynamic period for the utility industry. In my 20 plus years with the company, our economic development and sales growth pipeline is the most robust I have seen, which I'll touch on more in a moment. First, let me cover our earnings and operations results for the second quarter. Yesterday, we announced second quarter 2024 earnings of $0.97 per share compared to earnings of $0.90 per share in the second quarter of 2023. Key drivers of these strong results are highlighted on this page. And for the six months of the year, our results have been solid, driven by infrastructure investments made for the benefit of our customers, encouraging weather normalized retail sales and disciplined cost control. We remain on track to deliver earnings within our guidance range of $4.52 per share $4.72 per share. Turning to Page 5, our strategic plan is designed to deliver on our steadfast commitment to providing safe and reliable energy in a sustainable manner. We do this by investing in rate regulated infrastructure, enhancing regulatory frameworks, and advocating for responsible energy policies, while optimizing operating performance through ongoing continuous improvement in order to keep rates affordable. I'd like to express appreciation for my Ameren coworkers unwavering commitment to our strategy. On Page 6, we highlight our key accomplishments in the second quarter as we execute our strategy to deliver on our 2024 objectives. The strategic infrastructure investments we have made in the first six months of the year are designed to maintain the safety and reliability of the energy grid, to modernize the grid, and to harden against more frequent severe weather events. Over Memorial Day weekend, severe thunderstorms swept through Missouri and Illinois, bringing strong winds, flooding, and golf ball sized hail. As always, our teams quickly and safely assessed the damage, cleared trees, and worked long hours to make repairs to restore power as quickly as possible, allowing critical infrastructure to continue operations, businesses to remain open, and homes to stay cool and safe. But even better, during the first half of 2024, over 22,000 Missouri and 11,000 Illinois customer outages were prevented during storms due to rapid detection, rerouting and restoration of power by automated switches across our system and over 6.4 million minutes of customer outages across both states were avoided due to investments to modernize the grid. As we look ahead to future investment for the benefit of our customers, it's important to operate under constructive regulatory jurisdiction and legislative policies. This quarter, we've made significant regulatory advancements, which Michael and I will cover in more depth on the coming slides. At Ameren Missouri, our largest business segment, we continue to make regulatory progress with the Missouri Public Service Commission for new solar and natural gas generation, which supports our integrated resource plan. Our Cass County solar project was approved in June and is expected to be one of three solar projects placed in service this year, which collectively, along with Huck Finn and Boomtown, represent an investment of approximately $1 billion. The Commission also approved a constructive order for the securitization of costs associated with our Rush Island Energy Center in connection with its retirement in October of this year. And finally regarding generation updates, in June, we filed the CCN with the Missouri PSC for our dispatchable Castle Bluff Energy Center. Overall, we continue to make significant progress on our smart energy plan in Missouri, a combination of distribution, transmission and generation projects to bolster reliability and empower our customers. In late-June, Ameren Missouri filed its electric rate review request with the commission, which is substantially driven by infrastructure improvements made under this plan. If approved, Ameren Missouri customer rates would still remain well below national and Midwest averages. Turning to transmission, the Midcontinent Independent System Operator or MISO's long range transmission plan continues to evolve. In April, MISO concluded the bid evaluation process for the Tranche 1 competitive projects in our service territory, ultimately awarding all three competitive projects to Ameren. And they continue to develop the $23 billion to $27 billion Tranche 2.1 project portfolio, which promises meaningful brownfield and greenfield investment opportunities within our service territory. Finally, in Illinois, the Illinois Commerce Commission issued an order on the rehearing of Ameren Illinois' multi-year rate plan for 2024 through 2027. Importantly, the order supports our planned base level of grid reliability investment that is reflected in our 2024 earnings guidance. Further, the ICC order reflects 94% of the rate base in our ongoing multiyear rate plan proceeding. We look forward to an ICC decision on the multiyear grid investment and rate plans by the end of this year. In addition to these significant regulatory advancements, we have seen strong operational performance across the business with a focus on delivering safe, reliable, affordable energy service through enhanced automation, optimization, and standardization, which Michael will cover in more detail. Moving now to Page 7 for an update on our expanding customer growth opportunities. On the first quarter call, we touched on economic development opportunities in our service territory. Since then, collectively across Ameren Missouri and Illinois, we have seen a significant increase in the number of data center inquiries and formal engineering reviews underway, which combined would represent thousands of megawatts of additional demand. Our teams along with a variety of state and local stakeholders are working aggressively to attract these and manufacturing and other economic development opportunities to our service territories. Of course, Ameren has a strong track record of reliable infrastructure development and we have the people, resources, expertise and partnerships needed to go after these opportunities. Further, our Missouri and Illinois territories offer an attractive value proposition for commercial and industrial customers. This includes sites with transmission, fiber and water access coupled with competitive rates and tax incentives. In Missouri, we also have reliable generation with a growing portfolio of clean and dispatchable assets and the ability to expand in order to serve these economic development opportunities. So far this year, a construction agreement has been executed for a 250 megawatt data center, which would represent an approximate 40% and 5% annualized increase to Ameren Missouri's industrial megawatt hour sales and total megawatt hour sales respectively upon completion and full ramp up. Our construction to extend transmission and distribution services to support this data center is expected to be completed in December of 2025 with the customer ramping up operations from 2026 through 2028. In addition, we've received expansion commitments or executed new contracts for over 85 megawatts of additional load for manufacturing, smaller data centers and other industries across both states. We would expect these new and expanding customers to be fully ramped up by 2028 with sufficient generation to serve them, creating value for all customers over time. We're excited about these opportunities, which will bring jobs and additional tax base to benefit our state and local communities. Importantly, the new data center and other customer commitments were not reflected in the weather normalized sales expectations included in our five year earnings per share growth guidance issued in February. Of course, the ultimate net impact of any incremental load will be dependent upon a variety of factors, including customer ramp up time, additional generation investment needs, timing of rate reviews and tariff structures. To that end, we currently expect to update our Ameren Missouri Integrated Resource Plan or IRP by February 2025 following a careful evaluation of potential load growth and our planned generation portfolio. And we will work with all stakeholders to bring the economic benefits of these customer expansion opportunities to all customers, our communities, and shareholders. Turning to Page 8. We continue to execute our Missouri IRP, which focuses on maintaining and building a diverse generation portfolio to ensure a reliable, low cost and cleaner mix of energy resources to serve our customer needs. We had two key developments this quarter. First, in June, the Missouri PSC approved the CCN for the 150 megawatt Cass County solar facility, which is expected to begin serving customers in the fourth quarter of this year. This facility will serve business customers who subscribe through our Renewable Energy Solutions program to receive all or part of their energy needs from renewables. The Missouri PSC approval followed a successful auction held in May, where customers across Missouri signed up to take part in the Renewable Energy Solutions program expansion. Demand remains strong for programs that bring businesses readymade solutions to help them reach their sustainability goals. Second, in June, we also filed a CCN with the Missouri PSC for our Castle Bluff Energy Center, an on demand 800 megawatt natural gas simple cycle facility to serve as a reliable backup source of energy ready to operate on the most extreme winter nights and summer days. Castle Bluff, subject to commission approval, represents an approximately $900 million investment and is expected to be in service by the end of 2027. Moving now to Page 9 for an update on the MISO long range transmission projects. MISO and its transmission owners continue to engage in economic analysis of the Tranche 2 proposed set of projects. In June, an initial set of Tranche 2 projects now referred to as Tranche 2.1 were proposed with a cost estimate of $23 billion to $27 billion. The portfolio identifies a need for a mix of brownfield and greenfield transmission lines of varying voltage levels and new or improved substations in both our Missouri and Illinois service territories. Ultimately, we won 100% of the Tranche 1 projects in our service territories, reflecting our ability to deliver timely, cost effective, high value projects to our communities. We expect we'll be able to compete for Tranche 2 greenfield projects in a similarly competitive manner to better serve our customers. MISO expects to approve the Tranche 2.1 projects by the end of the year. Once approved, MISO plans to propose a second set of Tranche 2 projects or Tranche 2.2 in 2025 to address further transmission needs in the North and Midwest regions. Turning to Page 10, looking ahead over the next decade, we have a robust pipeline of investment opportunities of well over $55 billion that will deliver significant value to our stakeholders and create thousands of jobs for our local economies. In addition, we see several tailwinds forming across our business segments. Specifically, we are seeing significant sales growth potential, which I discussed a few moments ago, and this may require us to reassess our Ameren Missouri IRP and further expand our generation investment pipeline. We're seeing a growing focus amongst Missouri stakeholders on generation planning and reliability, and we see a strong need to embrace enhanced reliability focused policies in legislative sessions to come. Further, MISO's analysis of transmission needs in the Midwest region will likely identify additional opportunities to improve the ability to move electricity across the region. Maintaining constructive energy policies that support robust investment in energy infrastructure and to maintain reliability while transitioning to a cleaner energy future in a responsible fashion will be critical to meeting our country's growing energy needs and delivering on our customers' expectations. Moving to Page 11, in February, we updated our 5-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2024 through 2028. This earnings growth is primarily driven by strong compound annual rate base growth of 8.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high quality utility growth story. Combined, our strong long term 6% to 8% earnings growth plan and an attractive and growing dividend, which today yields 3.4% result in a compelling total return story. We have a strong track record of execution, a strong balance sheet, and an experienced management team. I'm confident in our ability execute our investment plans and strategies across all four of our business segments. Again, thank you all for joining us today and I'll now turn the call over to Michael.
Michael Moehn : Thanks, Marty, and good morning, everyone. I'll begin on Page 13 of our presentation. Yesterday, we reported second quarter 2024 earnings of $0.97 per share compared to $0.90 per share for the year ago quarter. We delivered strong earnings performance during the quarter, driven primarily by strategic infrastructure investments and disciplined cost management. While earnings saw a strong benefit from favorable weather, we also continue to see encouraging levels of customer growth and energy usage. Further, through disciplined cost controls, operations and maintenance expenses companywide were flat for the quarter when excluding the impacts from non-reoccurring items as part of the 2023 Ameren Missouri rate order. Additional factors that contribute to the overall $0.07 per share increase are highlighted on this page. Year-to-date results are outlined on Page 24 of today's presentation. Notably, year-to-date 2024, we've experienced strong weather normalized industrial sales growth of 3% as compared to the prior year period. This has been driven primarily by significant growth from our existing large primary service customers in the digital and data analytics industry. We expect to see continued growth as we bring on new customers and support existing customers' expansions in the coming years. Further, we continue to see strong weather normalized kilowatt hour sales growth across all rate classes in Missouri. Moving to Page 14, as we think about the remainder of the year, we remain confident in our 2024 earnings guidance range and continue to expect earnings to be in the range of $4.52 to $4.72 per share. The warmer spring and early summer temperatures experienced this quarter offset the mild first quarter as we are flat year-to-date for weather. In addition, as we outlined in our first quarter call, we expect to see meaningful year-over-year O&M reductions in the second half of the year, reflecting several cost savings initiatives implemented in 2024, the benefits of which continue to build throughout the year. I encourage you to take these and other supplemental earnings drivers noted on the slide into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Moving to Page 15, Ameren Missouri Regulatory Matters. In June, the Missouri PSC approved the securitization of approximately $470 million of costs associated with the scheduled retirement of our Rush Island Energy Center on October 15. We expect the difference between our original ask of $519 million and the final order to be reflected in future rate proceedings. Turning to Page 16. In late June, Ameren Missouri filed for a $446 million electric revenue increase with the Missouri PSC. 90% of this request is driven by increased capital investment under Ameren Missouri Smart Energy Plan to recover investments in major upgrades to the electrical system and investments in generation. The request includes a 10.25% return on equity, a 52% equity ratio and a December 31, 2024 estimated rate base of $14 billion. We expect a decision from the Missouri PSC by May 2025 with new rates affected by June of next year. Turning to Ameren Illinois on Page 17. Under Illinois formula rate making, which expired at the end of 2023, Ameren Illinois was required to file annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true up any prior period over or under recovery of such cost. For the final electric distribution reconciliation of 2023's revenue requirement, in July, the ICC staff recommended a $157 million base rate increase compared to our updated request of $158 million. The full amount would be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that is being collected during 2024. This will result in a net customer impact of $48 million or an approximately 1.5% increase in the total average residential customer bill. The ICC will review this matter in the months ahead with a decision expected by December of this year and new rates effective early next year. Turning to Page 18 for an update on the multiyear rate plan covering 2024 through 2027. We are pleased to receive a constructive decision from the ICC in the rehearing of our multiyear rate plan. Recall in January, the ICC upon approving our rehearing request had ordered that we identify a base level investment needed to adequately operate the grid safely. In June, after extensive stakeholder engagement and additional analysis provided by our team, the ICC approved a $285 million cumulative revenue increase from 2023, representing approximately 94% of our rehearing request and a 1% average residential bill increase for 2024. Excluding OPEB, the order represents approximately 99% of our rehearing rate base request and also 96% of the rate base included in the revised multiyear rate plan, which will be reviewed by the commission later this year. Interim rates for this order were effective in late June and will remain in effect until superseded by a revised MYRP order. The [real] was a positive first step in getting a base level grid investment approved. However, there is still much work to be done in the State of Illinois to achieve the objectives laid out in The Climate and Equitable Jobs Act passed in 2021. Approval of our revised multiyear grid plan and rate plan will allow us to appropriately invest more in the energy grid to preserve safety, reliability and day-to-day operations of our system. And make progress towards an affordable, equitable clean energy transition. In July, the ICC staff recommended a cumulative revenue increase of $302 million versus our July 2024 updated request of $334 million with the variance driven primarily by the renewal of OPEB and certain capital projects from rate base. Annual revenues will be based on actual recoverable costs year-end rate base and a return on equity adjusted for any performance incentives or penalties provided they do not exceed 105% of the approved revenue requirement. Lastly, with the narrowing of remaining issues, cross examination was weighed for hearings earlier this week, and we expect an ICC decision by December with rates effective January 1, 2025. Moving to Page 19. We provide a financing update. We continue to feel very good about our financial position. Our Ameren parent credit ratings of Baa1 and BBB+ at Moody's and S&P, respectively, compare favorably to the peer average, providing us with financial flexibility. To maintain our credit ratings and a strong balance sheet while we fund a robust infrastructure plan we expect to issue approximately $300 million of common equity in 2024. By the end of 2023, we had sold forward approximately $230 million of this $300 million through the at-the-market or ATM program consisting of approximately 2.9 million shares, which we expect to issue by the end of this year. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to support our equity needs in 2024. Turning to Page 20. Ameren continuously strives to find ways to work more efficiently to reduce costs for our customers. At the start of the year, we instituted several cost savings initiatives, including a detailed review of all hiring with a focus on spans and layers, reducing some of our contractor and consultant workforce. And deferring or eliminating discretionary spending while we identified further opportunities for sustainable cost reductions. Since then, we have enhanced our continuous improvement in disciplined cost management efforts through numerous customer affordability initiatives that will provide greater collaboration and coordination across our business. Through company-wide automation, standardization and optimization, we are streamlining processes, leveraging shared capabilities and eliminating redundant work to provide sustainable cost savings. Our leadership team is committed to prudently managing costs on behalf of our customers, while providing quality service and reliability. Turning to Page 21. We're off to a solid start in the first half of the year and expect to deliver strong earnings growth in 2024 as we continue to successfully execute our comprehensive business strategy. We continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. As Marty mentioned, we see several tailwinds forming in the months and years ahead. We have the right strategy, team and opportunities to create value for our customers and our shareholders. We believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: We'll now conduct a question-and-answer session. [Operator Instructions]. Our first question is from Shar Pourreza with Guggenheim Partners.
Shar Pourreza: So just real quick on Rush Island kind of the bid-ask saw you guys got a third-party media a few days ago. Any sort of read through from that to timing or where the process could land within that $100 million range?
Marty Lyons: Yes. Thanks, Shar. We posted a slide in the appendix, Slide 27. The just provides to be listening a little bit of background in the case. But we were pleased that the judge ordered mediation, which hopefully will lead to some constructive settlement negotiations between the parties. We expect the mediation to take place this summer in the event that mediation isn't successful in reaching a settlement between the party. We would expect that the judge would likely have evidence year hearings in September, and we'd still get a resolution of the case this year. So I don't think any read through on exactly where we'll end up between -- in that bid-ask spread, but nonetheless, we think, a positive step forward.
Shar Pourreza: Okay. Perfect. And then just on the transmission side, and obviously, it was a little topical as part of the on Tranche 2.0, 2.1. Any color at this point on how to think about the competitive allocation within that? Is it line by line, greenfield versus brownfield? And just remind us on potential timing of spend associated with these, what are in-service dates.
Marty Lyons: Yes, Shar. All good questions. So when you look at Tranche 2.1 and you look at the map that we provided on Page 9, you see a breakdown between the 765 kV lines and the 345 kV lines, and you see some of those in Missouri and Illinois. We're pretty excited about the way this is shaping up overall. With respect to the red lines, we see those as being more likely brownfield the green dotted lines more likely greenfield. And so you see a mix of those things there. At this point, no specific cost estimates for those lines that run in our service territory. The $23 billion to $27 billion numbers we give overall or MISOs estimates for the total portfolio, but I can't give you a breakdown right now on those that are in our footprint. And of course, if the brownfield, we would expect them to be allocated to us. If the greenfield, we would expect to compete for those. And we were very pleased with our ability to compete for the Tranche 1 projects. As we noted on our -- in our prepared remarks, really winning all three that were in our service territory. And Shar, at the end of the day, we think it speaks to our ability to deliver these projects in a timely way in a cost-effective way. Again, we feel like we are good at constructing these and great at operating them. And we've done a great job partnering with munis, co-ops, contractors and others to make sure we can deliver. Now with respect to the time line on the Tranche 1 projects, we really expect the construction of those to extend from 2026 to 2030. I think we have about $1.6 billion or so in our 5-year plan for those Tranche 1 projects. And then with respect to the Tranche 2.1 projects, I think largely that spend is probably outside of our 5-year plan. However, there's really no reason that these have to happen sequentially to the extent that any of these Tranche 2.1 projects can be started and overlap with some of the work on Tranche 1. No problem there. And again, excited about this Tranche 2.1, but also expect in Tranche 2.2 that we'll see even more projects in our Missouri and Illinois footprint. And so overall, again, just very pleased with the work MISO is doing here and the responsiveness to stakeholders in the process.
Operator: Our next question is from Nick Campanella with Barclays.
Nick Campanella: So I just wanted to ask on the data center construction slide. It just seems that you're really only kind of focusing on things where third is turning but you have -- looks like gigawatts of opportunity. The Missouri system seems to have capacity to supplement this 85-plus megawatts, if I'm right. But what do you think the tipping point is to really accelerate procurements in this next IRP? And I guess how many more megawatts do you think you'll have realistically kind of have clarity on by the time you get to that fine line?
Marty Lyons: Yes. Nick, those are all good observations and takeaways from the information we provided on Slide 7. When you look at that graph on the right, there, we talk about the economic development pipeline we have thousands of megawatts or gigawatts of opportunity. And in fact, that is true. So we've got just a number of parties that are doing engineering reviews and interconnection studies, and all of that's great. Those are initial processes. What we called out on the left, however, is -- you mentioned it turning. I would say when we have construction agreements, it means we have an executed agreement between ourselves and a data center, which confirms transmission capacity, cost to extend service and time lines, et cetera. And importantly, obligates the customer to pay for that extension of service with down payments for equipment. So you're right, things have begun to take shape. And so that's when we felt like we can move it into the category of really kind of talking about what we see in terms of the time line, how that would ramp up its overall size. And so pretty excited there to have a 250-megawatt data center that we see starting to use service in 2026 and ramping up through 2028. And of course, that's a nice tailwind as we think about that usage over that period of time. And then mentioned this other 85 megawatts. We're not just going after data centers from an economic development standpoint, really going after manufacturing and others. And that 85 megawatts that you mentioned is really a mix of manufacturing, smaller data centers, et cetera. So look, we're pretty excited. There's a -- certainly, I think you mentioned there's a concentration of interest in Missouri. And to the extent that this load grows, that very well may require that we would provide an update to our IRP. So again, we expect that over the coming 6 months or so that we'll see a firming of some of these other economic development opportunities. And as we further assess that load and what it means to our sales, and we give thought to what that means to our generation portfolio. That's where we expect that we would need to update our IRP with in mind right now, we're thinking February of next year.
Michael Moehn: Nick, this is Michael here. I might just add. That's a great update from Marty and just from an overall macro perspective, I mean, I think the backdrop in the St. Louis region is positive though, even putting aside this data center opportunity. I think we noted this in the slide, year-to-date sales residential up 2.5%, commercial 1.6%, industrial 3.1%. So a little bit over 2% year-to-date, which is a mark change where we've been in the past. And so there are some really positive things happening about 25,000 jobs created in the past year in the St. Louis region. One of the kind of hotter job markets here, unemployment rates running below the national average. So all of those things, I think, bode well with respect to all the things that Marty talked about as well.
Nick Campanella: And I guess just to count a few things that have changed in the fourth quarter when you kind of set this guidance of the 6% to 8%. The IRP is coming. You have this Tranche 2 visibility to MISO. I understand that, that's a little bit more longer dated. Obviously, we have more kind of clarity on Illinois with the rehearing process. But your stock is also up year-to-date, and that should also help your kind of financing accretion, if you're still doing that $600 million a year through the plan? And in the fourth quarter, you kind of talked about tracking towards the 6.2%. You said 6.2% when kind of discussing the 6% to 8%. Just how do you feel about your position within the 6% to 8% now? Has that improved a bit, with some of these tailwinds? How should we think about that?
Marty Lyons: Yes. Yes, Nick. I'd tell you that was a great question/statement. I think you got it right. If you look back at our track record over the past 10-plus years, we've been growing EPS at north of 7%. And that's our goal, which is to deliver at or above the midpoint of our earnings per share growth range. And as I sit here today versus where we were 6 months ago, I agree with you that there are a number of tailwinds that have been forming. Inflation has been interest rates have been moderating. Stock price has been improving. You're all right on all those things. Our demand outlook has been improving with data centers and other. Michael just talked about some of the job growth that we're seeing in the Greater St. Louis region. We're really excited about these transmission investment prospects we have with Tranche 1, Tranche 2.1, Tranche 2.2, all very exciting. We still have a tremendous amount of investment needed for grid modernization and the clean energy transition and we've got a really strong balance sheet to be able to get it done. So very excited about those prospects and again, when we look back just in terms of what our team was able to accomplish in the second quarter, I'm very proud of that overall. We continue to make great investments for the benefit of our customers. And on Page 6, we'll set out a half dozen things that we completed during the second quarter that really position us for success in the years ahead. And I have to say this was all accomplished by a team that is also, at the same time, really focused on customer affordability. We put a lot of cost savings initiatives in place this year and the team overcame that and delivered a really strong quarter from an operations and earnings standpoint. And again, I think you're right, we're set up very well for the future given some of the tailwinds we have.
Operator: Our next question is from Jeremy Tonet with JPMorgan.
Jeremy Tonet: Just wanted to pick up -- I guess, start with the Chevron doctrine here. In recent changes, does that impact your thought process going forward? Or any thoughts you could share there?
Marty Lyons: Yes. Nick, I don't know that it really changes our thought process going forward. Obviously, Chevron is going to probably have far-reaching implications for federal agencies and core proceedings going forward. Of course, it doesn't affect any prior cases. I mean I think when the Supreme Court ruled on Chevron, they basically said, "Hey, this doesn't call into question any prior cases”. But my sense is it will impact ongoing rule makings and court reviews as it relates to things coming out of FERC or things coming out of EPA, et cetera. So again, I think there'll be far-reaching impacts, but I'll leave it to the lawyers that are working through all those matters to assess how it may impact things.
Jeremy Tonet: Got it. This is Jeremy. But Nick a friend, so we're all good here. But maybe to follow up on the -- just as far as that -- it just seems like a vast opportunity set with the multiple gigs you're talking about and how you think about, I guess, conversion rate there. It still seems like a sizable opportunity. But just wondering, there talks about double counting out there. So just wondering how you, I guess, think about that whole process.
Marty Lyons: Yes, Jeremy. I don't think I called you Nick, but if I did, I apologize. But in any event, Jeremy, it's a good question. I think, again, when I did respond to Nick earlier, I think that, again, we're going to be conservative, I would say, in how we bring these things into our guidance. Obviously, when we gave our guidance at the beginning of the year, none of this was in our load growth projections. And so we're going to be thoughtful about it. As I said earlier, we thought it'd be good to share with you all the economic development pipeline that we have, and it's robust. But again, a large amount of this is still in the process of engineering reviews and interconnection studies, and so we're really excited about that. And as I said in the prepared remarks, our team as well as state local, stakeholders are working hard to bring these fruition. We think that our -- both of our states, Missouri and Illinois should be very competitive with respect to these opportunities. Again, access to transmission, fiber, workforce, water, all those things, both of our states have very good sales and use tax incentives. I think we're two of just 26 states that have these and our incentives are very competitive with those that do. So we feel like we're positioned very well to convert these and bring these to fruition. But to your point, Jeremy, it's hard to know with some of these folks. They're looking at our sites, they're looking potentially at sites in other states. And so we're going to be conservative about how we bring those into our guidance. Again, just repeating, we felt comfortable talking about this 250-megawatt data center because we have a construction agreement. We think that's a firmer position to be in. And then as we update our sales guidance again in February, we'll incorporate those opportunities that we believe are firmer like this one that has a construction agreement.
Jeremy Tonet: Got it. That's helpful there. Maybe just picking up real quick with stakeholders in the state, our conversations with stakeholders in Missouri seem to indicate a view of constructive commentary, I guess, coming out of the commission there, and we've seen some kind of changes over time with the composition. I'm just wondering, any updated thoughts you could share on Missouri. Any changes you see there?
Marty Lyons: Well, I would just say that I'd refer you back just to even this past quarter, Jeremy, and some of the things that we accomplished from a regulatory standpoint, which is back on Page 6. The approval of the Cast County project. We filed the CCN for the 800-megawatt Castle Bluff natural gas energy center, some of the commentary coming out of the commission suggests a desire for more dispatchable resources and understanding that we need that for reliability. So we're excited to make that filing. We got the approval of the securitization. So I think that what we're seeing is a continuation of constructive regulatory results in Missouri, the commission is going to have a forum to talk about reliability for the state looking forward, and we think that's a constructive thing. We're seeing these exciting economic development opportunities, and we need to make sure that Missouri has the resources to serve our existing customers and those additional economic development opportunities. So we think, again, that's a good constructive forum setting up for the future.
Operator: Our next question is from Carly Davenport with Goldman Sachs.
Carly Davenport: Maybe just to start to go quickly back to the IRP update that you guys expect to file early next year. Recognize you've got the low growth element that could have an impact there. But could you also talk a little bit about the expectations around resource mix as you sort of have some more time to work through the EPA regulations?
Marty Lyons: Yes. Carly, it's a good question. And look, it's -- something we file in February, a lot of work to be done, as I mentioned, really trying to assess the load growth, get our arms around, what of this will come to fruition, how do we want to serve it. I think when you look at the IRP that we filed back in September 2023, it was a good mix of resources, maintaining our existing dispatchable assets thinking about bringing in a mix of renewables, dispatchable resources like simple cycle gas combined cycle gas as well as battery storage technologies. And my sense is that if we see load growth that we're going to build into our plans going forward, it probably means in the short-term, an acceleration of some of the renewables, the batteries and very possibly additional simple cycle natural gas. When you look longer term, we will have to give some thought as we file that, and to your point about how we think about the EPA's proposed greenhouse gas rules. And that may be impacted by whether the Supreme Court issues the stay of those later this year. But again, I would just say the things we have to think about, as I mentioned on one of our prior calls is the implications of those rules for carbon capture at our planned combined cycle facility as well as co-firing with gas at our Labadie Energy Center. And so those are some of the things we'll be thinking about. And given the uncertainty of whether that greenhouse gas rule will ultimately come into effect, we'll have to think about how we do or don't reflect that in our plans going forward. So a lot to think about. So I appreciate you teeing it up. I don't have any firm answer for you today, but those are some of the considerations.
Michael Moehn: Yes. Carly, it's Michael. The only thing I might add to that is with respect to some of these environmental rules, there probably are some regrets moves that we'll continue to look at. Marty mentioned this co-firing issue, trying to make sure we have access to gas some of these facilities that we don't have today. So taking some steps there that we think probably are prudent just to give us some additional flexibility, not knowing exactly where these rules will ultimately end up.
Carly Davenport: Got it. Okay. That context is super helpful, and we'll stay tuned there. The follow-up is just on MISO Tranche 2. I know you guys addressed kind of Tranche 2.1 a bit earlier. But could you talk a little bit about 2.2 kind of how that split of the tranches came about. And ultimately, if you have any views on what that could look like from a sizing perspective relative to Tranche 2.1 and also Tranche 1.
Marty Lyons: Yes, I'll -- this is Marty again, Carly. I'll start. I think is MISO looked at these projects and heard from stakeholders, there was some logical order in terms of how you might want to build out some of the infrastructure that we believe is ultimately going to be required in the Midwest region, given all of the region's goals with respect to clean energy transition and what MISO sees in terms of potential relocation of generation facilities and load, et cetera. So I think it was more or less what's a logical order to build some of these things out and then to step back and use the expectation of these investments in the consideration and planning for the next set of projects. Now with that said, I'd mentioned, for example, we have this 345 line that they're planning in Missouri. It may or may not preclude the need for a 765 line, which was in the last presentation presented. We also don't see a whole lot of investment on the current map in the Southern part of Illinois and extending Indiana, so we may see some more investment there. But again, it's premature. Again, we'll get these finalized by MISO expecting this year. Talking to MISO, while they've been at it working on potential for 2.2, there's still a lot of more work to be done, which is why they really don't expect to get those approved until sometime into 2025. So look, I just think it's really premature to talk about what those might be and what the size of it's going to be. I don't think it will be insignificant in terms of the additional investment there probably premature to specifically speculate.
Operator: Our next question is from Paul Patterson with Glenrock Associates.
Paul Patterson: Just to follow-up on the weather and the sales growth and what have you. [Indiscernible] correct that absent you would be up 2%. And with EMEA, it's flat. Is that pretty much right? Or if you could just elaborate a little bit on that. I apologize for not being completely clear.
Michael Moehn: Paul, this is Michael. From a year-to-date standpoint, again, residential is up 2.5%, 1.6% on the commercial side and 3.1% on the industrial side. So about 2.2% overall. With EMEA impact, I mean, it is a little bit less than that. I don't have it right here in front of me. But overall, I mean, look, it's just -- it's been much stronger than it has historically been.
Paul Patterson: I apologize. I was just looking at Slide 24, and if I looked at it, it seems to say like versus normal, it was zero. So in terms of -- at least on the EPS impact. So I'm just sort of -- if I -- so if I'm looking at it, I just wanted to -- it sounds like you guys have -- it is really working in terms of its impact on keeping for efficiency. Am I right about that? Or --
Michael Moehn: Well, I mean, there certainly is some impact from an energy efficiency standpoint. Although I think it's less than that. I mean the one thing that you're not seeing in here a little bit is a bit of price variance. So as you're switching kind of from between summer and when at rates, you get some different price variances in the block sales. And so when you strip that out, that's masking a little bit of the growth there and that will -- should like it typically does will flip around as you kind of move through time. So -- but I mean, EE does have an impact.
Marty Lyons: Yes. I think, Paul, if you're looking at that zero versus normal, what that's really just meant to say is that the weather to date has been normal. In the first quarter -- Yes. In the first quarter, weather was weak, second quarter weather was strong. What we're saying here is year-to-date there's been no weather impact versus normal conditions.
Paul Patterson: Okay. Sorry about that. Okay. And then with respect to your low forecast and the IRP that's going to be refreshed. I was wondering can you give us maybe just a little bit of a sense as to it sounds obviously like you've got a lot of positive things happening here. What kind of maybe range we might be looking at in terms of when the IRP -- when it's refreshed like how much it might go up?
Michael Moehn: Yes Paul, Michael here again, a bit premature, I think, to get into that conversation. Again, I mean as we came out in February, and I probably recall this, I mean we've been seeing historically kind of flat to up maybe 0.5% in terms of growth. And then I think there's been some positive updates as we've kind of moved through the year here and I just went through the year-to-date statistic. I mean we will absolutely do that. I think we're just wanting to make sure we feel good about the confidence level around, as Marty mentioned, around a number of these data centers, et cetera. And as we, I think, kind of March through time, we're going through our typical update and planning processes we always do right now. And so we'll do that here into the fall and then I think be in a much better position as we refresh that IRP and refresh that sales forecast, to give you a sense. Again, just -- I think we've used a little bit of the statistic in the past. I mean, just from an industrial perspective, that 250-megawatt project that Marty referenced, I mean that would represent about a 40% increase in our industrial sales and about an overall 5% increase in Missouri's retail sales. Just to give you a sense of it.
Marty Lyons: Yes. And I think, Paul, following up on Michael's comment there, I mean, we have the ability to serve that data center today with our existing mix of resources and the planned additions that we've got. So as we set up that IRP update, it's really about thinking about those thousands of megawatts that are in the queue today, looking -- doing its engineering studies, interconnection studies and really working with them and giving more thought to what if that's going to come to fruition? And what changes to the IRP might need to be made in light of those?
Paul Patterson: Okay. And then just should we think of this as sort of a consumer that the existing resources can serve all this? Is this basically going to be something that would help customers or even near-term at least in terms of just more cost being spread over more megawatt hours or is there an economic development issue that's happening here that -- I guess what I'm trying to say is, with your -- how should we think about this impacting rates vis-a-vis earnings if you follow what I'm saying, at least in the near-term?
Marty Lyons: Yes. Well, the customers that are signing on today, the 250 megawatts as well as the 85-plus megawatts are really utilizing existing tariffs that we have in place today that obviously have been vetted by the commission and put in place. And the goal of any of these tariffs is to make sure that costs are allocated appropriately and spread appropriately amongst customer classes. I think sit here today, I think we're fine. As we move through time, if we have thousands of megawatts that come to fruition, and we start to think about the different resources we may need to put in place to serve them. We're going to have to be thoughtful about what the appropriate tariffs are for those customers to make sure that they pay a fair price and that value again, accrues to all of our customers and communities.
Operator: Our next question is from Anthony Crowdell with Mizuho.
Anthony Crowdell: Just one quick one, kind of like a follow-up and maybe challenging to answer. I mean if I think back to -- and I know you guys don't have the exposure to the PJM capacity auction, but if I think back 10, 15 years ago, where we started to see some real bullish prices on capacity, I think the utilities kind of in that part of the country really responded with higher CapEx and the regulators really supported it. If we fast forward maybe last December, Illinois really, I think, tend to message or maybe slow down the CapEx spend in the state. I know you're not exposed to PJM capacity prices, but do you think the Illinois regulators maybe change their view and maybe realize the value of the added infrastructure maybe to help our customer build as more way to get power to them?
Marty Lyons: Yes. Look, I think in both states, I mentioned this earlier and the commission having a forum on reliability and resource adequacy and the same concerns I know exists in Illinois. And so, we'll see how policies shift and change over time. But look, I think at the end of the day, all stakeholders in both states. And certainly us as a utility and other service providers were all concerned and mindful of resource adequacy, reliability, affordability and a clean energy transition. And so I think your intuition is right that as you see cost pressures grow because of things like capacity prices or you see the need to support economic development and growth logically, you're going to have to start to think about the policies that support those things and resource adequacy. So I think your intuition is correct.
Operator: Our next question is from David Paz with Wolfe Research.
David Paz: So I just -- one thing just popped up a listen your responses. Just have you provided what of just a simple rule of thumb from sensitivity on EPS for every 1% increase in industrial sales?
Michael Moehn: Yes. We have historically, David. For every 1% on the industrial side, it's about $0.05 here's a good way to think about it. Now that change will change over time as you kind of move through and you got to change the generation mix, et cetera. But I mean, I think it's probably a decent rule of thumb today.
David Paz: And just on the discussions, and I know there's been plenty of questions here on attracting large load and the efforts you're making. But just what have you to rate stakeholders and leaders that what you need from a ratemaking standpoint. And could we see efforts to add trackers or riders expect the amortization of the large load or maybe an expansion of piece? I guess what are you telling them that [indiscernible] -- sorry, in Missouri.
Marty Lyons: Yes. I think David, all things for consideration. As I mentioned a few moments ago, with respect to the data center that we show on Page 7, this 250-megawatt data center and the other 85 megawatts of load, again, they're able to use our current industrial tariffs, and we're able to serve them with our current generation and plan generation. So no need for any special tariff there. Over time, as I said, to the extent that these other opportunities come to fruition, we may need to think about special tariffs. One thing to point to is we just had that Cass County Solar project approved. And there, we did put a special sort of tariff arrangement into place to ensure that there was a -- an appropriate apportionment of cost between our customer base as well as those industrial customers that are going to take power from Cass County. So we do have some experience working with the commission to put special tariffs in place. And we'll be giving thought to that as we move forward with additional data centers that we may be able to serve. And then to your point on -- I think it was on PSA, Certainly, one of the things we pursued legislatively last spring that had very good support was the extension of PSA to dispatchable generation. Such as the simple cycle assets that we're planning and combined cycle asset that we're planning. And so again, we had very good support for that. Again, the legislative session ended with that not getting across the finish line, but certainly expect that strong support as we go into next year.
Operator: Our next question is from Julien Dumoulin-Smith with Jefferies.
Julien Dumoulin-Smith: Just following up on this, right? So just on the process behind the -- shall we say, shorter-term procurement potential here, right? You alluded to it earlier, obviously, you have enough resources to deal with the 250 here initially. Perhaps that's not it, as you alluded to -- how do you think about the process itself, right? You do typically these IRPs at relatively consistent periods interims as well as there's a construction cycle behind that. There's a PSC process behind that you mentioned kind of the shorter-term potential in the medium-term potential need. How do you think about expediting that? We've seen that potentially in some of your adjacent jurisdictions? How do you think about that, A; and then, B, going back to the point raised, would you expect some of these tariff dynamics just play out in the, like, should we say, a subsequent rate case process beyond the current instance?
Marty Lyons: Yes. All good questions, Julien. So first of all, as I mentioned, with respect to these opportunities, we're certainly not waiting. We and other stakeholders around the states are aggressively interacting with these folks that are doing these engineering reviews, interconnection studies and doing everything we can to be able to support them and locating these facilities either in Missouri or Illinois as is appropriate. And so we're aggressively doing that. When you look at some of opportunity. Think about this 250-megawatt one that we talked about specifically. They’re going to be in service in 2026, ramping up usage through 2028. And that's what we're hearing from any of these is really a desire to ramp up over time. And so the idea is that, that would sort of dovetail with an update to the IRP, where we would potentially accelerate some of the planned additions, perhaps add some additional resources that we would get in place in time to be able to serve this load as it grows. When you think about that, certainly, there are some limitations. But when you think about that 800-megawatt simple cycle that we're putting in our plans today, the Castle Bluff about 4 years to get that in service between turbines, transformers, construction time line, et cetera. So we feel like we'll be able to work with some of these data center opportunities, get the IRP updated and filed. And hopefully be able to sort of have all these things dovetail and brought together at the right pace and speed. And yes, in terms of the any kind of changes in tariffs. We think those can happen both inside the context of a rate review or outside of a rate review. So we think we have flexibility there.
Julien Dumoulin-Smith: Okay. Even outside of the rare review, nice. It sounds like you got something in mind already. All right. And then separately quickly, just coal ash new rigs here in the last few months. I'm just curious on AROs accumulating and just the thoughts about some of the twist here.
Michael Moehn: Hey, Julien, Michael here. It's really not a significant issue for us. I mean we did go through and a couple of AROs, but a really immaterial amount. If you think about our exposure from a coal ash standpoint, I mean, we really got in front of this issue, probably 7 or 8 years ago. All of our ponds are closed or in the process of being finalized here. And so just not a lot of additional exposure, just a little bit of stuff around the edges.
Operator: There are no further questions at this time. I'd like to hand the floor back over to Marty Lyons for any closing comments.
Marty Lyons: Yes. Thanks, everybody, for joining us today. Some great questions. Appreciate the dialogue. Look, overall, we are really pleased to share our updates with you today, and we remain absolutely focused on strong execution for the remainder of this year. And we look forward to seeing many of you in the coming months. So with that, thanks. Have a great day. Have a great weekend.
Operator: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. | [
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"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation's Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
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"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team. This call contains time sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amerenvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday, as well as our SEC filings for more information about the various factors that cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4."
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"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone. We're pleased to have you joining us today as we cover our second quarter 2024 earnings results and recent developments across our business segments. Overall, it was a very productive and positive quarter. As always, our dedicated and experienced management team remained laser focused on executing our strategic plan, positioning us well to take advantage of future opportunities to drive significant value for our customers and shareholders. Speaking of opportunities, I'm tremendously excited about the investment opportunities ahead for us in this dynamic period for the utility industry. In my 20 plus years with the company, our economic development and sales growth pipeline is the most robust I have seen, which I'll touch on more in a moment. First, let me cover our earnings and operations results for the second quarter. Yesterday, we announced second quarter 2024 earnings of $0.97 per share compared to earnings of $0.90 per share in the second quarter of 2023. Key drivers of these strong results are highlighted on this page. And for the six months of the year, our results have been solid, driven by infrastructure investments made for the benefit of our customers, encouraging weather normalized retail sales and disciplined cost control. We remain on track to deliver earnings within our guidance range of $4.52 per share $4.72 per share. Turning to Page 5, our strategic plan is designed to deliver on our steadfast commitment to providing safe and reliable energy in a sustainable manner. We do this by investing in rate regulated infrastructure, enhancing regulatory frameworks, and advocating for responsible energy policies, while optimizing operating performance through ongoing continuous improvement in order to keep rates affordable. I'd like to express appreciation for my Ameren coworkers unwavering commitment to our strategy. On Page 6, we highlight our key accomplishments in the second quarter as we execute our strategy to deliver on our 2024 objectives. The strategic infrastructure investments we have made in the first six months of the year are designed to maintain the safety and reliability of the energy grid, to modernize the grid, and to harden against more frequent severe weather events. Over Memorial Day weekend, severe thunderstorms swept through Missouri and Illinois, bringing strong winds, flooding, and golf ball sized hail. As always, our teams quickly and safely assessed the damage, cleared trees, and worked long hours to make repairs to restore power as quickly as possible, allowing critical infrastructure to continue operations, businesses to remain open, and homes to stay cool and safe. But even better, during the first half of 2024, over 22,000 Missouri and 11,000 Illinois customer outages were prevented during storms due to rapid detection, rerouting and restoration of power by automated switches across our system and over 6.4 million minutes of customer outages across both states were avoided due to investments to modernize the grid. As we look ahead to future investment for the benefit of our customers, it's important to operate under constructive regulatory jurisdiction and legislative policies. This quarter, we've made significant regulatory advancements, which Michael and I will cover in more depth on the coming slides. At Ameren Missouri, our largest business segment, we continue to make regulatory progress with the Missouri Public Service Commission for new solar and natural gas generation, which supports our integrated resource plan. Our Cass County solar project was approved in June and is expected to be one of three solar projects placed in service this year, which collectively, along with Huck Finn and Boomtown, represent an investment of approximately $1 billion. The Commission also approved a constructive order for the securitization of costs associated with our Rush Island Energy Center in connection with its retirement in October of this year. And finally regarding generation updates, in June, we filed the CCN with the Missouri PSC for our dispatchable Castle Bluff Energy Center. Overall, we continue to make significant progress on our smart energy plan in Missouri, a combination of distribution, transmission and generation projects to bolster reliability and empower our customers. In late-June, Ameren Missouri filed its electric rate review request with the commission, which is substantially driven by infrastructure improvements made under this plan. If approved, Ameren Missouri customer rates would still remain well below national and Midwest averages. Turning to transmission, the Midcontinent Independent System Operator or MISO's long range transmission plan continues to evolve. In April, MISO concluded the bid evaluation process for the Tranche 1 competitive projects in our service territory, ultimately awarding all three competitive projects to Ameren. And they continue to develop the $23 billion to $27 billion Tranche 2.1 project portfolio, which promises meaningful brownfield and greenfield investment opportunities within our service territory. Finally, in Illinois, the Illinois Commerce Commission issued an order on the rehearing of Ameren Illinois' multi-year rate plan for 2024 through 2027. Importantly, the order supports our planned base level of grid reliability investment that is reflected in our 2024 earnings guidance. Further, the ICC order reflects 94% of the rate base in our ongoing multiyear rate plan proceeding. We look forward to an ICC decision on the multiyear grid investment and rate plans by the end of this year. In addition to these significant regulatory advancements, we have seen strong operational performance across the business with a focus on delivering safe, reliable, affordable energy service through enhanced automation, optimization, and standardization, which Michael will cover in more detail. Moving now to Page 7 for an update on our expanding customer growth opportunities. On the first quarter call, we touched on economic development opportunities in our service territory. Since then, collectively across Ameren Missouri and Illinois, we have seen a significant increase in the number of data center inquiries and formal engineering reviews underway, which combined would represent thousands of megawatts of additional demand. Our teams along with a variety of state and local stakeholders are working aggressively to attract these and manufacturing and other economic development opportunities to our service territories. Of course, Ameren has a strong track record of reliable infrastructure development and we have the people, resources, expertise and partnerships needed to go after these opportunities. Further, our Missouri and Illinois territories offer an attractive value proposition for commercial and industrial customers. This includes sites with transmission, fiber and water access coupled with competitive rates and tax incentives. In Missouri, we also have reliable generation with a growing portfolio of clean and dispatchable assets and the ability to expand in order to serve these economic development opportunities. So far this year, a construction agreement has been executed for a 250 megawatt data center, which would represent an approximate 40% and 5% annualized increase to Ameren Missouri's industrial megawatt hour sales and total megawatt hour sales respectively upon completion and full ramp up. Our construction to extend transmission and distribution services to support this data center is expected to be completed in December of 2025 with the customer ramping up operations from 2026 through 2028. In addition, we've received expansion commitments or executed new contracts for over 85 megawatts of additional load for manufacturing, smaller data centers and other industries across both states. We would expect these new and expanding customers to be fully ramped up by 2028 with sufficient generation to serve them, creating value for all customers over time. We're excited about these opportunities, which will bring jobs and additional tax base to benefit our state and local communities. Importantly, the new data center and other customer commitments were not reflected in the weather normalized sales expectations included in our five year earnings per share growth guidance issued in February. Of course, the ultimate net impact of any incremental load will be dependent upon a variety of factors, including customer ramp up time, additional generation investment needs, timing of rate reviews and tariff structures. To that end, we currently expect to update our Ameren Missouri Integrated Resource Plan or IRP by February 2025 following a careful evaluation of potential load growth and our planned generation portfolio. And we will work with all stakeholders to bring the economic benefits of these customer expansion opportunities to all customers, our communities, and shareholders. Turning to Page 8. We continue to execute our Missouri IRP, which focuses on maintaining and building a diverse generation portfolio to ensure a reliable, low cost and cleaner mix of energy resources to serve our customer needs. We had two key developments this quarter. First, in June, the Missouri PSC approved the CCN for the 150 megawatt Cass County solar facility, which is expected to begin serving customers in the fourth quarter of this year. This facility will serve business customers who subscribe through our Renewable Energy Solutions program to receive all or part of their energy needs from renewables. The Missouri PSC approval followed a successful auction held in May, where customers across Missouri signed up to take part in the Renewable Energy Solutions program expansion. Demand remains strong for programs that bring businesses readymade solutions to help them reach their sustainability goals. Second, in June, we also filed a CCN with the Missouri PSC for our Castle Bluff Energy Center, an on demand 800 megawatt natural gas simple cycle facility to serve as a reliable backup source of energy ready to operate on the most extreme winter nights and summer days. Castle Bluff, subject to commission approval, represents an approximately $900 million investment and is expected to be in service by the end of 2027. Moving now to Page 9 for an update on the MISO long range transmission projects. MISO and its transmission owners continue to engage in economic analysis of the Tranche 2 proposed set of projects. In June, an initial set of Tranche 2 projects now referred to as Tranche 2.1 were proposed with a cost estimate of $23 billion to $27 billion. The portfolio identifies a need for a mix of brownfield and greenfield transmission lines of varying voltage levels and new or improved substations in both our Missouri and Illinois service territories. Ultimately, we won 100% of the Tranche 1 projects in our service territories, reflecting our ability to deliver timely, cost effective, high value projects to our communities. We expect we'll be able to compete for Tranche 2 greenfield projects in a similarly competitive manner to better serve our customers. MISO expects to approve the Tranche 2.1 projects by the end of the year. Once approved, MISO plans to propose a second set of Tranche 2 projects or Tranche 2.2 in 2025 to address further transmission needs in the North and Midwest regions. Turning to Page 10, looking ahead over the next decade, we have a robust pipeline of investment opportunities of well over $55 billion that will deliver significant value to our stakeholders and create thousands of jobs for our local economies. In addition, we see several tailwinds forming across our business segments. Specifically, we are seeing significant sales growth potential, which I discussed a few moments ago, and this may require us to reassess our Ameren Missouri IRP and further expand our generation investment pipeline. We're seeing a growing focus amongst Missouri stakeholders on generation planning and reliability, and we see a strong need to embrace enhanced reliability focused policies in legislative sessions to come. Further, MISO's analysis of transmission needs in the Midwest region will likely identify additional opportunities to improve the ability to move electricity across the region. Maintaining constructive energy policies that support robust investment in energy infrastructure and to maintain reliability while transitioning to a cleaner energy future in a responsible fashion will be critical to meeting our country's growing energy needs and delivering on our customers' expectations. Moving to Page 11, in February, we updated our 5-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2024 through 2028. This earnings growth is primarily driven by strong compound annual rate base growth of 8.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high quality utility growth story. Combined, our strong long term 6% to 8% earnings growth plan and an attractive and growing dividend, which today yields 3.4% result in a compelling total return story. We have a strong track record of execution, a strong balance sheet, and an experienced management team. I'm confident in our ability execute our investment plans and strategies across all four of our business segments. Again, thank you all for joining us today and I'll now turn the call over to Michael."
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{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. I'll begin on Page 13 of our presentation. Yesterday, we reported second quarter 2024 earnings of $0.97 per share compared to $0.90 per share for the year ago quarter. We delivered strong earnings performance during the quarter, driven primarily by strategic infrastructure investments and disciplined cost management. While earnings saw a strong benefit from favorable weather, we also continue to see encouraging levels of customer growth and energy usage. Further, through disciplined cost controls, operations and maintenance expenses companywide were flat for the quarter when excluding the impacts from non-reoccurring items as part of the 2023 Ameren Missouri rate order. Additional factors that contribute to the overall $0.07 per share increase are highlighted on this page. Year-to-date results are outlined on Page 24 of today's presentation. Notably, year-to-date 2024, we've experienced strong weather normalized industrial sales growth of 3% as compared to the prior year period. This has been driven primarily by significant growth from our existing large primary service customers in the digital and data analytics industry. We expect to see continued growth as we bring on new customers and support existing customers' expansions in the coming years. Further, we continue to see strong weather normalized kilowatt hour sales growth across all rate classes in Missouri. Moving to Page 14, as we think about the remainder of the year, we remain confident in our 2024 earnings guidance range and continue to expect earnings to be in the range of $4.52 to $4.72 per share. The warmer spring and early summer temperatures experienced this quarter offset the mild first quarter as we are flat year-to-date for weather. In addition, as we outlined in our first quarter call, we expect to see meaningful year-over-year O&M reductions in the second half of the year, reflecting several cost savings initiatives implemented in 2024, the benefits of which continue to build throughout the year. I encourage you to take these and other supplemental earnings drivers noted on the slide into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Moving to Page 15, Ameren Missouri Regulatory Matters. In June, the Missouri PSC approved the securitization of approximately $470 million of costs associated with the scheduled retirement of our Rush Island Energy Center on October 15. We expect the difference between our original ask of $519 million and the final order to be reflected in future rate proceedings. Turning to Page 16. In late June, Ameren Missouri filed for a $446 million electric revenue increase with the Missouri PSC. 90% of this request is driven by increased capital investment under Ameren Missouri Smart Energy Plan to recover investments in major upgrades to the electrical system and investments in generation. The request includes a 10.25% return on equity, a 52% equity ratio and a December 31, 2024 estimated rate base of $14 billion. We expect a decision from the Missouri PSC by May 2025 with new rates affected by June of next year. Turning to Ameren Illinois on Page 17. Under Illinois formula rate making, which expired at the end of 2023, Ameren Illinois was required to file annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true up any prior period over or under recovery of such cost. For the final electric distribution reconciliation of 2023's revenue requirement, in July, the ICC staff recommended a $157 million base rate increase compared to our updated request of $158 million. The full amount would be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that is being collected during 2024. This will result in a net customer impact of $48 million or an approximately 1.5% increase in the total average residential customer bill. The ICC will review this matter in the months ahead with a decision expected by December of this year and new rates effective early next year. Turning to Page 18 for an update on the multiyear rate plan covering 2024 through 2027. We are pleased to receive a constructive decision from the ICC in the rehearing of our multiyear rate plan. Recall in January, the ICC upon approving our rehearing request had ordered that we identify a base level investment needed to adequately operate the grid safely. In June, after extensive stakeholder engagement and additional analysis provided by our team, the ICC approved a $285 million cumulative revenue increase from 2023, representing approximately 94% of our rehearing request and a 1% average residential bill increase for 2024. Excluding OPEB, the order represents approximately 99% of our rehearing rate base request and also 96% of the rate base included in the revised multiyear rate plan, which will be reviewed by the commission later this year. Interim rates for this order were effective in late June and will remain in effect until superseded by a revised MYRP order. The [real] was a positive first step in getting a base level grid investment approved. However, there is still much work to be done in the State of Illinois to achieve the objectives laid out in The Climate and Equitable Jobs Act passed in 2021. Approval of our revised multiyear grid plan and rate plan will allow us to appropriately invest more in the energy grid to preserve safety, reliability and day-to-day operations of our system. And make progress towards an affordable, equitable clean energy transition. In July, the ICC staff recommended a cumulative revenue increase of $302 million versus our July 2024 updated request of $334 million with the variance driven primarily by the renewal of OPEB and certain capital projects from rate base. Annual revenues will be based on actual recoverable costs year-end rate base and a return on equity adjusted for any performance incentives or penalties provided they do not exceed 105% of the approved revenue requirement. Lastly, with the narrowing of remaining issues, cross examination was weighed for hearings earlier this week, and we expect an ICC decision by December with rates effective January 1, 2025. Moving to Page 19. We provide a financing update. We continue to feel very good about our financial position. Our Ameren parent credit ratings of Baa1 and BBB+ at Moody's and S&P, respectively, compare favorably to the peer average, providing us with financial flexibility. To maintain our credit ratings and a strong balance sheet while we fund a robust infrastructure plan we expect to issue approximately $300 million of common equity in 2024. By the end of 2023, we had sold forward approximately $230 million of this $300 million through the at-the-market or ATM program consisting of approximately 2.9 million shares, which we expect to issue by the end of this year. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to support our equity needs in 2024. Turning to Page 20. Ameren continuously strives to find ways to work more efficiently to reduce costs for our customers. At the start of the year, we instituted several cost savings initiatives, including a detailed review of all hiring with a focus on spans and layers, reducing some of our contractor and consultant workforce. And deferring or eliminating discretionary spending while we identified further opportunities for sustainable cost reductions. Since then, we have enhanced our continuous improvement in disciplined cost management efforts through numerous customer affordability initiatives that will provide greater collaboration and coordination across our business. Through company-wide automation, standardization and optimization, we are streamlining processes, leveraging shared capabilities and eliminating redundant work to provide sustainable cost savings. Our leadership team is committed to prudently managing costs on behalf of our customers, while providing quality service and reliability. Turning to Page 21. We're off to a solid start in the first half of the year and expect to deliver strong earnings growth in 2024 as we continue to successfully execute our comprehensive business strategy. We continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. As Marty mentioned, we see several tailwinds forming in the months and years ahead. We have the right strategy, team and opportunities to create value for our customers and our shareholders. We believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "We'll now conduct a question-and-answer session. [Operator Instructions]. Our first question is from Shar Pourreza with Guggenheim Partners."
},
{
"speaker": "Shar Pourreza",
"text": "So just real quick on Rush Island kind of the bid-ask saw you guys got a third-party media a few days ago. Any sort of read through from that to timing or where the process could land within that $100 million range?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Thanks, Shar. We posted a slide in the appendix, Slide 27. The just provides to be listening a little bit of background in the case. But we were pleased that the judge ordered mediation, which hopefully will lead to some constructive settlement negotiations between the parties. We expect the mediation to take place this summer in the event that mediation isn't successful in reaching a settlement between the party. We would expect that the judge would likely have evidence year hearings in September, and we'd still get a resolution of the case this year. So I don't think any read through on exactly where we'll end up between -- in that bid-ask spread, but nonetheless, we think, a positive step forward."
},
{
"speaker": "Shar Pourreza",
"text": "Okay. Perfect. And then just on the transmission side, and obviously, it was a little topical as part of the on Tranche 2.0, 2.1. Any color at this point on how to think about the competitive allocation within that? Is it line by line, greenfield versus brownfield? And just remind us on potential timing of spend associated with these, what are in-service dates."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Shar. All good questions. So when you look at Tranche 2.1 and you look at the map that we provided on Page 9, you see a breakdown between the 765 kV lines and the 345 kV lines, and you see some of those in Missouri and Illinois. We're pretty excited about the way this is shaping up overall. With respect to the red lines, we see those as being more likely brownfield the green dotted lines more likely greenfield. And so you see a mix of those things there. At this point, no specific cost estimates for those lines that run in our service territory. The $23 billion to $27 billion numbers we give overall or MISOs estimates for the total portfolio, but I can't give you a breakdown right now on those that are in our footprint. And of course, if the brownfield, we would expect them to be allocated to us. If the greenfield, we would expect to compete for those. And we were very pleased with our ability to compete for the Tranche 1 projects. As we noted on our -- in our prepared remarks, really winning all three that were in our service territory. And Shar, at the end of the day, we think it speaks to our ability to deliver these projects in a timely way in a cost-effective way. Again, we feel like we are good at constructing these and great at operating them. And we've done a great job partnering with munis, co-ops, contractors and others to make sure we can deliver. Now with respect to the time line on the Tranche 1 projects, we really expect the construction of those to extend from 2026 to 2030. I think we have about $1.6 billion or so in our 5-year plan for those Tranche 1 projects. And then with respect to the Tranche 2.1 projects, I think largely that spend is probably outside of our 5-year plan. However, there's really no reason that these have to happen sequentially to the extent that any of these Tranche 2.1 projects can be started and overlap with some of the work on Tranche 1. No problem there. And again, excited about this Tranche 2.1, but also expect in Tranche 2.2 that we'll see even more projects in our Missouri and Illinois footprint. And so overall, again, just very pleased with the work MISO is doing here and the responsiveness to stakeholders in the process."
},
{
"speaker": "Operator",
"text": "Our next question is from Nick Campanella with Barclays."
},
{
"speaker": "Nick Campanella",
"text": "So I just wanted to ask on the data center construction slide. It just seems that you're really only kind of focusing on things where third is turning but you have -- looks like gigawatts of opportunity. The Missouri system seems to have capacity to supplement this 85-plus megawatts, if I'm right. But what do you think the tipping point is to really accelerate procurements in this next IRP? And I guess how many more megawatts do you think you'll have realistically kind of have clarity on by the time you get to that fine line?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Nick, those are all good observations and takeaways from the information we provided on Slide 7. When you look at that graph on the right, there, we talk about the economic development pipeline we have thousands of megawatts or gigawatts of opportunity. And in fact, that is true. So we've got just a number of parties that are doing engineering reviews and interconnection studies, and all of that's great. Those are initial processes. What we called out on the left, however, is -- you mentioned it turning. I would say when we have construction agreements, it means we have an executed agreement between ourselves and a data center, which confirms transmission capacity, cost to extend service and time lines, et cetera. And importantly, obligates the customer to pay for that extension of service with down payments for equipment. So you're right, things have begun to take shape. And so that's when we felt like we can move it into the category of really kind of talking about what we see in terms of the time line, how that would ramp up its overall size. And so pretty excited there to have a 250-megawatt data center that we see starting to use service in 2026 and ramping up through 2028. And of course, that's a nice tailwind as we think about that usage over that period of time. And then mentioned this other 85 megawatts. We're not just going after data centers from an economic development standpoint, really going after manufacturing and others. And that 85 megawatts that you mentioned is really a mix of manufacturing, smaller data centers, et cetera. So look, we're pretty excited. There's a -- certainly, I think you mentioned there's a concentration of interest in Missouri. And to the extent that this load grows, that very well may require that we would provide an update to our IRP. So again, we expect that over the coming 6 months or so that we'll see a firming of some of these other economic development opportunities. And as we further assess that load and what it means to our sales, and we give thought to what that means to our generation portfolio. That's where we expect that we would need to update our IRP with in mind right now, we're thinking February of next year."
},
{
"speaker": "Michael Moehn",
"text": "Nick, this is Michael here. I might just add. That's a great update from Marty and just from an overall macro perspective, I mean, I think the backdrop in the St. Louis region is positive though, even putting aside this data center opportunity. I think we noted this in the slide, year-to-date sales residential up 2.5%, commercial 1.6%, industrial 3.1%. So a little bit over 2% year-to-date, which is a mark change where we've been in the past. And so there are some really positive things happening about 25,000 jobs created in the past year in the St. Louis region. One of the kind of hotter job markets here, unemployment rates running below the national average. So all of those things, I think, bode well with respect to all the things that Marty talked about as well."
},
{
"speaker": "Nick Campanella",
"text": "And I guess just to count a few things that have changed in the fourth quarter when you kind of set this guidance of the 6% to 8%. The IRP is coming. You have this Tranche 2 visibility to MISO. I understand that, that's a little bit more longer dated. Obviously, we have more kind of clarity on Illinois with the rehearing process. But your stock is also up year-to-date, and that should also help your kind of financing accretion, if you're still doing that $600 million a year through the plan? And in the fourth quarter, you kind of talked about tracking towards the 6.2%. You said 6.2% when kind of discussing the 6% to 8%. Just how do you feel about your position within the 6% to 8% now? Has that improved a bit, with some of these tailwinds? How should we think about that?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Yes, Nick. I'd tell you that was a great question/statement. I think you got it right. If you look back at our track record over the past 10-plus years, we've been growing EPS at north of 7%. And that's our goal, which is to deliver at or above the midpoint of our earnings per share growth range. And as I sit here today versus where we were 6 months ago, I agree with you that there are a number of tailwinds that have been forming. Inflation has been interest rates have been moderating. Stock price has been improving. You're all right on all those things. Our demand outlook has been improving with data centers and other. Michael just talked about some of the job growth that we're seeing in the Greater St. Louis region. We're really excited about these transmission investment prospects we have with Tranche 1, Tranche 2.1, Tranche 2.2, all very exciting. We still have a tremendous amount of investment needed for grid modernization and the clean energy transition and we've got a really strong balance sheet to be able to get it done. So very excited about those prospects and again, when we look back just in terms of what our team was able to accomplish in the second quarter, I'm very proud of that overall. We continue to make great investments for the benefit of our customers. And on Page 6, we'll set out a half dozen things that we completed during the second quarter that really position us for success in the years ahead. And I have to say this was all accomplished by a team that is also, at the same time, really focused on customer affordability. We put a lot of cost savings initiatives in place this year and the team overcame that and delivered a really strong quarter from an operations and earnings standpoint. And again, I think you're right, we're set up very well for the future given some of the tailwinds we have."
},
{
"speaker": "Operator",
"text": "Our next question is from Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to pick up -- I guess, start with the Chevron doctrine here. In recent changes, does that impact your thought process going forward? Or any thoughts you could share there?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Nick, I don't know that it really changes our thought process going forward. Obviously, Chevron is going to probably have far-reaching implications for federal agencies and core proceedings going forward. Of course, it doesn't affect any prior cases. I mean I think when the Supreme Court ruled on Chevron, they basically said, \"Hey, this doesn't call into question any prior cases”. But my sense is it will impact ongoing rule makings and court reviews as it relates to things coming out of FERC or things coming out of EPA, et cetera. So again, I think there'll be far-reaching impacts, but I'll leave it to the lawyers that are working through all those matters to assess how it may impact things."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. This is Jeremy. But Nick a friend, so we're all good here. But maybe to follow up on the -- just as far as that -- it just seems like a vast opportunity set with the multiple gigs you're talking about and how you think about, I guess, conversion rate there. It still seems like a sizable opportunity. But just wondering, there talks about double counting out there. So just wondering how you, I guess, think about that whole process."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Jeremy. I don't think I called you Nick, but if I did, I apologize. But in any event, Jeremy, it's a good question. I think, again, when I did respond to Nick earlier, I think that, again, we're going to be conservative, I would say, in how we bring these things into our guidance. Obviously, when we gave our guidance at the beginning of the year, none of this was in our load growth projections. And so we're going to be thoughtful about it. As I said earlier, we thought it'd be good to share with you all the economic development pipeline that we have, and it's robust. But again, a large amount of this is still in the process of engineering reviews and interconnection studies, and so we're really excited about that. And as I said in the prepared remarks, our team as well as state local, stakeholders are working hard to bring these fruition. We think that our -- both of our states, Missouri and Illinois should be very competitive with respect to these opportunities. Again, access to transmission, fiber, workforce, water, all those things, both of our states have very good sales and use tax incentives. I think we're two of just 26 states that have these and our incentives are very competitive with those that do. So we feel like we're positioned very well to convert these and bring these to fruition. But to your point, Jeremy, it's hard to know with some of these folks. They're looking at our sites, they're looking potentially at sites in other states. And so we're going to be conservative about how we bring those into our guidance. Again, just repeating, we felt comfortable talking about this 250-megawatt data center because we have a construction agreement. We think that's a firmer position to be in. And then as we update our sales guidance again in February, we'll incorporate those opportunities that we believe are firmer like this one that has a construction agreement."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful there. Maybe just picking up real quick with stakeholders in the state, our conversations with stakeholders in Missouri seem to indicate a view of constructive commentary, I guess, coming out of the commission there, and we've seen some kind of changes over time with the composition. I'm just wondering, any updated thoughts you could share on Missouri. Any changes you see there?"
},
{
"speaker": "Marty Lyons",
"text": "Well, I would just say that I'd refer you back just to even this past quarter, Jeremy, and some of the things that we accomplished from a regulatory standpoint, which is back on Page 6. The approval of the Cast County project. We filed the CCN for the 800-megawatt Castle Bluff natural gas energy center, some of the commentary coming out of the commission suggests a desire for more dispatchable resources and understanding that we need that for reliability. So we're excited to make that filing. We got the approval of the securitization. So I think that what we're seeing is a continuation of constructive regulatory results in Missouri, the commission is going to have a forum to talk about reliability for the state looking forward, and we think that's a constructive thing. We're seeing these exciting economic development opportunities, and we need to make sure that Missouri has the resources to serve our existing customers and those additional economic development opportunities. So we think, again, that's a good constructive forum setting up for the future."
},
{
"speaker": "Operator",
"text": "Our next question is from Carly Davenport with Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"text": "Maybe just to start to go quickly back to the IRP update that you guys expect to file early next year. Recognize you've got the low growth element that could have an impact there. But could you also talk a little bit about the expectations around resource mix as you sort of have some more time to work through the EPA regulations?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Carly, it's a good question. And look, it's -- something we file in February, a lot of work to be done, as I mentioned, really trying to assess the load growth, get our arms around, what of this will come to fruition, how do we want to serve it. I think when you look at the IRP that we filed back in September 2023, it was a good mix of resources, maintaining our existing dispatchable assets thinking about bringing in a mix of renewables, dispatchable resources like simple cycle gas combined cycle gas as well as battery storage technologies. And my sense is that if we see load growth that we're going to build into our plans going forward, it probably means in the short-term, an acceleration of some of the renewables, the batteries and very possibly additional simple cycle natural gas. When you look longer term, we will have to give some thought as we file that, and to your point about how we think about the EPA's proposed greenhouse gas rules. And that may be impacted by whether the Supreme Court issues the stay of those later this year. But again, I would just say the things we have to think about, as I mentioned on one of our prior calls is the implications of those rules for carbon capture at our planned combined cycle facility as well as co-firing with gas at our Labadie Energy Center. And so those are some of the things we'll be thinking about. And given the uncertainty of whether that greenhouse gas rule will ultimately come into effect, we'll have to think about how we do or don't reflect that in our plans going forward. So a lot to think about. So I appreciate you teeing it up. I don't have any firm answer for you today, but those are some of the considerations."
},
{
"speaker": "Michael Moehn",
"text": "Yes. Carly, it's Michael. The only thing I might add to that is with respect to some of these environmental rules, there probably are some regrets moves that we'll continue to look at. Marty mentioned this co-firing issue, trying to make sure we have access to gas some of these facilities that we don't have today. So taking some steps there that we think probably are prudent just to give us some additional flexibility, not knowing exactly where these rules will ultimately end up."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Okay. That context is super helpful, and we'll stay tuned there. The follow-up is just on MISO Tranche 2. I know you guys addressed kind of Tranche 2.1 a bit earlier. But could you talk a little bit about 2.2 kind of how that split of the tranches came about. And ultimately, if you have any views on what that could look like from a sizing perspective relative to Tranche 2.1 and also Tranche 1."
},
{
"speaker": "Marty Lyons",
"text": "Yes, I'll -- this is Marty again, Carly. I'll start. I think is MISO looked at these projects and heard from stakeholders, there was some logical order in terms of how you might want to build out some of the infrastructure that we believe is ultimately going to be required in the Midwest region, given all of the region's goals with respect to clean energy transition and what MISO sees in terms of potential relocation of generation facilities and load, et cetera. So I think it was more or less what's a logical order to build some of these things out and then to step back and use the expectation of these investments in the consideration and planning for the next set of projects. Now with that said, I'd mentioned, for example, we have this 345 line that they're planning in Missouri. It may or may not preclude the need for a 765 line, which was in the last presentation presented. We also don't see a whole lot of investment on the current map in the Southern part of Illinois and extending Indiana, so we may see some more investment there. But again, it's premature. Again, we'll get these finalized by MISO expecting this year. Talking to MISO, while they've been at it working on potential for 2.2, there's still a lot of more work to be done, which is why they really don't expect to get those approved until sometime into 2025. So look, I just think it's really premature to talk about what those might be and what the size of it's going to be. I don't think it will be insignificant in terms of the additional investment there probably premature to specifically speculate."
},
{
"speaker": "Operator",
"text": "Our next question is from Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"text": "Just to follow-up on the weather and the sales growth and what have you. [Indiscernible] correct that absent you would be up 2%. And with EMEA, it's flat. Is that pretty much right? Or if you could just elaborate a little bit on that. I apologize for not being completely clear."
},
{
"speaker": "Michael Moehn",
"text": "Paul, this is Michael. From a year-to-date standpoint, again, residential is up 2.5%, 1.6% on the commercial side and 3.1% on the industrial side. So about 2.2% overall. With EMEA impact, I mean, it is a little bit less than that. I don't have it right here in front of me. But overall, I mean, look, it's just -- it's been much stronger than it has historically been."
},
{
"speaker": "Paul Patterson",
"text": "I apologize. I was just looking at Slide 24, and if I looked at it, it seems to say like versus normal, it was zero. So in terms of -- at least on the EPS impact. So I'm just sort of -- if I -- so if I'm looking at it, I just wanted to -- it sounds like you guys have -- it is really working in terms of its impact on keeping for efficiency. Am I right about that? Or --"
},
{
"speaker": "Michael Moehn",
"text": "Well, I mean, there certainly is some impact from an energy efficiency standpoint. Although I think it's less than that. I mean the one thing that you're not seeing in here a little bit is a bit of price variance. So as you're switching kind of from between summer and when at rates, you get some different price variances in the block sales. And so when you strip that out, that's masking a little bit of the growth there and that will -- should like it typically does will flip around as you kind of move through time. So -- but I mean, EE does have an impact."
},
{
"speaker": "Marty Lyons",
"text": "Yes. I think, Paul, if you're looking at that zero versus normal, what that's really just meant to say is that the weather to date has been normal. In the first quarter -- Yes. In the first quarter, weather was weak, second quarter weather was strong. What we're saying here is year-to-date there's been no weather impact versus normal conditions."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Sorry about that. Okay. And then with respect to your low forecast and the IRP that's going to be refreshed. I was wondering can you give us maybe just a little bit of a sense as to it sounds obviously like you've got a lot of positive things happening here. What kind of maybe range we might be looking at in terms of when the IRP -- when it's refreshed like how much it might go up?"
},
{
"speaker": "Michael Moehn",
"text": "Yes Paul, Michael here again, a bit premature, I think, to get into that conversation. Again, I mean as we came out in February, and I probably recall this, I mean we've been seeing historically kind of flat to up maybe 0.5% in terms of growth. And then I think there's been some positive updates as we've kind of moved through the year here and I just went through the year-to-date statistic. I mean we will absolutely do that. I think we're just wanting to make sure we feel good about the confidence level around, as Marty mentioned, around a number of these data centers, et cetera. And as we, I think, kind of March through time, we're going through our typical update and planning processes we always do right now. And so we'll do that here into the fall and then I think be in a much better position as we refresh that IRP and refresh that sales forecast, to give you a sense. Again, just -- I think we've used a little bit of the statistic in the past. I mean, just from an industrial perspective, that 250-megawatt project that Marty referenced, I mean that would represent about a 40% increase in our industrial sales and about an overall 5% increase in Missouri's retail sales. Just to give you a sense of it."
},
{
"speaker": "Marty Lyons",
"text": "Yes. And I think, Paul, following up on Michael's comment there, I mean, we have the ability to serve that data center today with our existing mix of resources and the planned additions that we've got. So as we set up that IRP update, it's really about thinking about those thousands of megawatts that are in the queue today, looking -- doing its engineering studies, interconnection studies and really working with them and giving more thought to what if that's going to come to fruition? And what changes to the IRP might need to be made in light of those?"
},
{
"speaker": "Paul Patterson",
"text": "Okay. And then just should we think of this as sort of a consumer that the existing resources can serve all this? Is this basically going to be something that would help customers or even near-term at least in terms of just more cost being spread over more megawatt hours or is there an economic development issue that's happening here that -- I guess what I'm trying to say is, with your -- how should we think about this impacting rates vis-a-vis earnings if you follow what I'm saying, at least in the near-term?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Well, the customers that are signing on today, the 250 megawatts as well as the 85-plus megawatts are really utilizing existing tariffs that we have in place today that obviously have been vetted by the commission and put in place. And the goal of any of these tariffs is to make sure that costs are allocated appropriately and spread appropriately amongst customer classes. I think sit here today, I think we're fine. As we move through time, if we have thousands of megawatts that come to fruition, and we start to think about the different resources we may need to put in place to serve them. We're going to have to be thoughtful about what the appropriate tariffs are for those customers to make sure that they pay a fair price and that value again, accrues to all of our customers and communities."
},
{
"speaker": "Operator",
"text": "Our next question is from Anthony Crowdell with Mizuho."
},
{
"speaker": "Anthony Crowdell",
"text": "Just one quick one, kind of like a follow-up and maybe challenging to answer. I mean if I think back to -- and I know you guys don't have the exposure to the PJM capacity auction, but if I think back 10, 15 years ago, where we started to see some real bullish prices on capacity, I think the utilities kind of in that part of the country really responded with higher CapEx and the regulators really supported it. If we fast forward maybe last December, Illinois really, I think, tend to message or maybe slow down the CapEx spend in the state. I know you're not exposed to PJM capacity prices, but do you think the Illinois regulators maybe change their view and maybe realize the value of the added infrastructure maybe to help our customer build as more way to get power to them?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. Look, I think in both states, I mentioned this earlier and the commission having a forum on reliability and resource adequacy and the same concerns I know exists in Illinois. And so, we'll see how policies shift and change over time. But look, I think at the end of the day, all stakeholders in both states. And certainly us as a utility and other service providers were all concerned and mindful of resource adequacy, reliability, affordability and a clean energy transition. And so I think your intuition is right that as you see cost pressures grow because of things like capacity prices or you see the need to support economic development and growth logically, you're going to have to start to think about the policies that support those things and resource adequacy. So I think your intuition is correct."
},
{
"speaker": "Operator",
"text": "Our next question is from David Paz with Wolfe Research."
},
{
"speaker": "David Paz",
"text": "So I just -- one thing just popped up a listen your responses. Just have you provided what of just a simple rule of thumb from sensitivity on EPS for every 1% increase in industrial sales?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. We have historically, David. For every 1% on the industrial side, it's about $0.05 here's a good way to think about it. Now that change will change over time as you kind of move through and you got to change the generation mix, et cetera. But I mean, I think it's probably a decent rule of thumb today."
},
{
"speaker": "David Paz",
"text": "And just on the discussions, and I know there's been plenty of questions here on attracting large load and the efforts you're making. But just what have you to rate stakeholders and leaders that what you need from a ratemaking standpoint. And could we see efforts to add trackers or riders expect the amortization of the large load or maybe an expansion of piece? I guess what are you telling them that [indiscernible] -- sorry, in Missouri."
},
{
"speaker": "Marty Lyons",
"text": "Yes. I think David, all things for consideration. As I mentioned a few moments ago, with respect to the data center that we show on Page 7, this 250-megawatt data center and the other 85 megawatts of load, again, they're able to use our current industrial tariffs, and we're able to serve them with our current generation and plan generation. So no need for any special tariff there. Over time, as I said, to the extent that these other opportunities come to fruition, we may need to think about special tariffs. One thing to point to is we just had that Cass County Solar project approved. And there, we did put a special sort of tariff arrangement into place to ensure that there was a -- an appropriate apportionment of cost between our customer base as well as those industrial customers that are going to take power from Cass County. So we do have some experience working with the commission to put special tariffs in place. And we'll be giving thought to that as we move forward with additional data centers that we may be able to serve. And then to your point on -- I think it was on PSA, Certainly, one of the things we pursued legislatively last spring that had very good support was the extension of PSA to dispatchable generation. Such as the simple cycle assets that we're planning and combined cycle asset that we're planning. And so again, we had very good support for that. Again, the legislative session ended with that not getting across the finish line, but certainly expect that strong support as we go into next year."
},
{
"speaker": "Operator",
"text": "Our next question is from Julien Dumoulin-Smith with Jefferies."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Just following up on this, right? So just on the process behind the -- shall we say, shorter-term procurement potential here, right? You alluded to it earlier, obviously, you have enough resources to deal with the 250 here initially. Perhaps that's not it, as you alluded to -- how do you think about the process itself, right? You do typically these IRPs at relatively consistent periods interims as well as there's a construction cycle behind that. There's a PSC process behind that you mentioned kind of the shorter-term potential in the medium-term potential need. How do you think about expediting that? We've seen that potentially in some of your adjacent jurisdictions? How do you think about that, A; and then, B, going back to the point raised, would you expect some of these tariff dynamics just play out in the, like, should we say, a subsequent rate case process beyond the current instance?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. All good questions, Julien. So first of all, as I mentioned, with respect to these opportunities, we're certainly not waiting. We and other stakeholders around the states are aggressively interacting with these folks that are doing these engineering reviews, interconnection studies and doing everything we can to be able to support them and locating these facilities either in Missouri or Illinois as is appropriate. And so we're aggressively doing that. When you look at some of opportunity. Think about this 250-megawatt one that we talked about specifically. They’re going to be in service in 2026, ramping up usage through 2028. And that's what we're hearing from any of these is really a desire to ramp up over time. And so the idea is that, that would sort of dovetail with an update to the IRP, where we would potentially accelerate some of the planned additions, perhaps add some additional resources that we would get in place in time to be able to serve this load as it grows. When you think about that, certainly, there are some limitations. But when you think about that 800-megawatt simple cycle that we're putting in our plans today, the Castle Bluff about 4 years to get that in service between turbines, transformers, construction time line, et cetera. So we feel like we'll be able to work with some of these data center opportunities, get the IRP updated and filed. And hopefully be able to sort of have all these things dovetail and brought together at the right pace and speed. And yes, in terms of the any kind of changes in tariffs. We think those can happen both inside the context of a rate review or outside of a rate review. So we think we have flexibility there."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Okay. Even outside of the rare review, nice. It sounds like you got something in mind already. All right. And then separately quickly, just coal ash new rigs here in the last few months. I'm just curious on AROs accumulating and just the thoughts about some of the twist here."
},
{
"speaker": "Michael Moehn",
"text": "Hey, Julien, Michael here. It's really not a significant issue for us. I mean we did go through and a couple of AROs, but a really immaterial amount. If you think about our exposure from a coal ash standpoint, I mean, we really got in front of this issue, probably 7 or 8 years ago. All of our ponds are closed or in the process of being finalized here. And so just not a lot of additional exposure, just a little bit of stuff around the edges."
},
{
"speaker": "Operator",
"text": "There are no further questions at this time. I'd like to hand the floor back over to Marty Lyons for any closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Yes. Thanks, everybody, for joining us today. Some great questions. Appreciate the dialogue. Look, overall, we are really pleased to share our updates with you today, and we remain absolutely focused on strong execution for the remainder of this year. And we look forward to seeing many of you in the coming months. So with that, thanks. Have a great day. Have a great weekend."
},
{
"speaker": "Operator",
"text": "This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEE | 1 | 2,024 | 2024-05-03 10:00:00 | Operator: Greetings, and welcome to Ameren Corporation’s First Quarter 2024 Earnings Call. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk, you may begin.
Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here’s Marty, who will start on Page 4.
Marty Lyons: Thank you, Andrew. Good morning, everyone, and thank you for joining us today as we discuss our first quarter 2024 earnings results. Our team continues to successfully execute on our strategic plan across all of our business segments, allowing us to deliver for our customers, shareholders and the environment, while laying a strong foundation for the future. Turning now to Page 5. Yesterday, we announced first quarter 2024 earnings of $0.98 per share compared to earnings of $1 per share in the first quarter of 2023. The key drivers of our first quarter results are outlined on this slide. Overall, our operating performance was strong during the quarter. We had periods of extreme cold weather in January and our natural gas and electric systems and our operating teams performed well. On balance, however, weather was mild during the quarter, marked by unseasonably warm temperatures in February and March. Despite the mild temperatures, our retail sales grew driven by encouraging signs of customer growth and usage. While we experienced higher operations and maintenance expenses, that was driven largely by a charge for proposed additional mitigation relief related to the Rush Island Energy Center New Source Review litigation. Despite the year-to-date weather headwinds and the Rush Island charge, our team is taking steps to contain spend, and we remain on track to deliver within our 2024 earnings guidance range of $4.52 per share to $4.72 per share. I’ll provide an update on our Rush Island Energy Center proceedings, and Michael will cover the first quarter and balance of the year earnings results in a bit more detail later. Moving to Page 6. On our call in February, I highlighted some of our top priorities for 2024 as we invest strategically, enhance our operating jurisdictions and optimize our business processes. Our team’s unwavering commitment to these objectives has already begun to produce results, as you can see on Page 7. Our investments continue to improve the reliability, resiliency, safety and efficiency of our service to our customers. In the first three months of this year, we have invested significant capital for the benefit of our customers. During the quarter, Ameren Missouri installed over 55,000 smart meters, 60 smart switches, 15 miles of energized underground cable, 8 miles of hardened overhead lines and upgraded 5 substations. In Illinois, our first quarter investments included replacing 550 poles due to standard inspections and storm damage, replacing switchgear at a key substation and installing 30 miles of underground cable for relocations, new customers and aged cable replacement. Further, our transmission business is on track to complete over 15 new or upgraded transmission substations and 45 miles of new or upgraded transmission lines in the first half of the year. These critical investments support our commitment to delivering safe and reliable energy for the benefit of our customers and we are seeing the benefit in 2024 in terms of reduced outages and shorter outage durations as a result of spring storms. For example, during the recent April storm, over 7,500 Missouri customer outages were prevented due to rapid detection, rerouting and restoration of power by automated switches across our system in over 2.3 million minutes of customer outages were avoided due to these investments. Moving on to first quarter regulatory and legislative outcomes. In March, Ameren Missouri received Missouri PSC approval of our largest-ever solar investment, three projects representing a total of 400 megawatts capable of powering approximately 73,000 homes. The approval of certificates of convenience and necessity, or CCN, for these projects is another constructive step along the pathway to executing our Ameren Missouri Integrated Resource Plan, or IRP. On the legislative front, the Missouri General Assembly is addressing power quality and reliability by considering bills to enhance and extend the current plant-in-service accounting, or PISA, legislation that would support investment in dispatchable resources and reliability. PISA has supported much needed reliability investments in the state’s energy grid over the past five years. While these bills, House Bill 1746 and Senate Bills 740 and 1422, have strong bipartisan support, time is short in the current general assembly session ends Friday, May 17. While the legislature has many priorities, we will continue to work with key stakeholders towards passage. At Ameren Transmission, progress continues to be made on the long-range transmission regional and beneficial projects, which I will cover in more detail in a moment. Turning to Illinois Electric delivery. We continue to diligently work for approval from the Illinois Commerce Commission, or the ICC of an electric grid investment plan, revised revenue requirements incorporating ongoing and prospective investments and an overall improved regulatory environment. In January, the commission granted a partial rehearing of our multi-year rate plan to address the base level of investment needed to operate the grid reliably. Subsequently, in February, we filed an updated plan as part of the rehearing proceeding. Then in March, we filed our revised multi-year grid and rate plans to address the commission’s findings stated in their December order. The rehearing and revised multi-year grid and rate plan proceedings are operating in parallel and with update rates for 2024 through 2027. We expect a decision from the ICC on the rehearing in June, which would provide a 2024 interim rate adjustment by July. We expect an ICC decision on the revised multi-year grid and rate plans by the end of the year, which would revise rates beginning January 2025. We continue to work with all impacted stakeholders to advocate for constructive regulatory frameworks and outcomes that support the state’s energy transition goals. Our ability to invest and deliver reliable and affordable energy is essential for our customers and the communities we serve and will support continued growth in our region. Moving on to operational matters. We remain committed to maintaining disciplined cost management to hold operations and maintenance expenses flat in 2024 to 2023 levels. I’d like to express my sincere appreciation to our Ameren team members who are working efficiently, collaboratively and safely to serve our customers. Now moving to Page 8 for details on the Rush Island securitization case at Ameren Missouri. Our request with the Missouri PSC to securitize the remaining balance of the Rush Island Energy Center and other related costs continues to make progress. In March, the Missouri PSC staff recommended securitization of $497 million as compared to our request of $519 million. Refinancing these investments through the issuance of securitized bonds, versus financing and recovery through traditional ratemaking will save our customers millions of dollars. Hearings were completed in April, and we expect the PSC’s decision by June 21. Now turning to Page 9 for an update on the new source review proceeding for Rush Island. As previously reported in 2017, the U.S. District Court of Eastern Missouri issued an order requiring the installation of a flue gas desulfurization system or scrubbers on our Rush Island Energy Center for violating new source review provisions of the Clean Air Act and install a dry sorbent injection system at our Labadie Energy Center, as mitigation for excess emissions at Rush Island. Upon appeal, the A circuit upheld the district court’s ruling with respect to the installation of scrubbers at Rush Island, but overturn the decision with respect to Labadie. Subsequently, we made the decision to accelerate the planned retirement of our Rush Island Energy Center, which was more economic for our customers than installing scrubbers. The District Court approved Ameren’s retirement proposal and established a retirement date of no later than October 15, 2024 to allow for the completion of various transmission reliability projects. The U.S. Department of Justice is seeking additional mitigation relief beyond the retirement of the energy center. In March of this year, the District Court ordered both parties to file proposals outlining additional mitigation relief for the court to consider. On Wednesday, Ameren Missouri and the DOJ filed their respective mitigation proposals. Ameren’s mitigation proposal consists of four essential elements: retirement of Rush Island, which eliminates all emissions through its previously planned 2039 retirement date, a school bus electrification program, including buses and charging stations, an air filter program geared towards underserved residential customers and surrender of sulfur dioxide allowances. Collectively, these programs are estimated to cost approximately $20 million, which resulted in a first quarter charge to earnings. The Department of Justice mitigation proposal includes a significantly greater number of buses, charging stations and advanced filters. The DOJ estimates their aggregate program cost to be approximately $120 million. We expect an evidentiary hearing will be scheduled sometime this summer, and we expect the District Court will issue a final ruling during the second half of 2024 that could be subject to further appeals. Before moving on, I’d like to provide an update on the series of new rules issued by the Environmental Protection Agency last week. As you know, Ameren Missouri remain committed to investing in a clean energy transition in a responsible manner, balancing reliability and affordability. The new rules expect generators to rely heavily on carbon capture and storage technologies, which are not ready for full-scale economy-wide deployment. These new rules apply not only to existing coal-fired units, but new gas-fired units with greater than 40% capacity factors as well, which would include the gas combined cycle facility called for in our current IRP in the early 2030s to maintain system reliability. In addition, for coal units retiring between 2032 and 2039, the rules will require natural gas co-firing by 2030. And as we noted in our comments to the proposed rules, co-firing with natural gas presents challenges from a permitting and construction standpoint. These requirements would most directly impact our Labadie Energy Center, which has units scheduled to retire in 2036 and 2042. While we are still assessing the impact of the rules on our Integrated Resource Plan, these new rules are making it more challenging and costly to maintain existing dispatchable generation or build new dispatchable generation. These challenges come at a time when supply and demand is tight, and the industry has seen significant potential load growth, particularly from data centers, the manufacturing industry and through the electrification of transportation. We will continue to closely review the final regulations and as with many environmental regulations, litigation by various stakeholders is likely. These rules, if not modified, would require significant investments beyond what’s in our current 10-year pipeline to meet compliance obligations and maintain a reliable system. Moving to Page 10. We look ahead to our future renewable generation developments. As I mentioned in March, the Missouri PSC approved CCNs for three Ameren Missouri solar projects totaling 400 megawatts. Split Rail, Vandalia and Bowling Green, all located in Missouri. The Missouri PSC in its March order also set terms upon which a fourth solar facility, the 150-megawatt Cass County, Illinois project could be approved if it is fully subscribed under Ameren Missouri’s renewable solutions program. The renewable solutions program is a subscription-based program that allows eligible businesses and organizations to manage their carbon footprint by replacing up to 100% of their total energy use with renewable sources. The online auction for customers to subscribe to the Cass County Solar Project is expected to take place in mid-May with Missouri PSC approval of the Cass County CCN expected following full subscription. Initial non-binding notices of intent for the subscription auction will receive from interested businesses in early April and reflected strong interest. Investing in solar energy is part of Ameren Missouri’s plans to affordably meet the long-term energy and reliability needs of our customers. The IRP calls for new dispatchable energy resources, including an on-demand 800-megawatt gas simple-cycle energy center by 2027 which could be turned on as needed in a matter of minutes to ensure reliability of the energy grid during periods of peak energy demand. Later this month, we expect to file a request for a CCN for this simple cycle plant, Castle Bluff Energy Center, to be located on the site of our retired Meramec Energy Center. Moving to Page 11. The Midcontinent Independent System Operator, or MISO, continues to advance its long-range transmission planning and project approval processes. For Tranche 1, we were pleased to be selected in April to develop the third and final competitive project in our service territory, which again emphasizes our track record of being able to deliver cost-effective, high-value projects to our communities. Ultimately, Ameren was assigned or awarded approximately 25% of total Tranche 1 portfolio projects addressing the MISO Midwest region in 100% of the projects in our service territory. We expect Tranche 1 construction to substantially begin in 2026 with completion dates through 2030. Looking ahead to Tranche 2, in March, MISO announced a long-range transmission Tranche 2 proposed project portfolio estimated to cost $17 billion to $23 billion, which included significant investments within our Ameren Missouri and Ameren Illinois service territories. Since then, we, and other key stakeholders, have been working with MISO to evaluate and comment on the portfolio of projects to assist MISO in ultimately approving the most appropriate path forward. MISO expects to vote on Tranche 2 in the third quarter of 2024. Moving to Slide 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of more than $55 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country’s growing energy needs and delivering on our customers’ expectations. Turning to Page 13. In February, we updated our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings growth rate from 2024 through 2028. The earnings growth is primarily driven by strong compound annual rate base growth of 8.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return. I’m confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. I’ll now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to Page 15 of our presentation. Yesterday, we reported first quarter 2024 earnings of $0.98 per share compared to $1 per share for the year ago quarter. The key factors that drove the overall $0.02 per share decrease are highlighted by segment on this page. We delivered solid earnings performance during the quarter as we continue to execute our strategy, including making infrastructure investments for the benefit of our customers. The first quarter included new service rates in Ameren Illinois Natural Gas and Ameren Missouri. In addition, strong customer growth and usage contributed to 3% higher electric weather-normalized retail sales at Ameren Missouri across all customer classes which were partially offset by milder weather impact. In fact, the third one was first quarter in the past 50 years. Earnings were also reduced by an increase in O&M and Ameren Missouri, largely driven by a $0.04 charge for proposed additional mitigation relief related to the Rush Island Energy Center. Moving to Page 16. As we think about the remainder of the year, we remain confident in our 2024 guidance range, and we continue to expect earnings to be in the range of $4.52 to $4.72 per share. As we think about the first quarter results versus our expectations, we lost $0.07 compared to normal for weather and $0.04 for the charge related to Rush Island. But experienced $0.02 of favorable weather-normalized sales beyond our expectations. As we look ahead, we expect to see meaningful year-over-year O&M reductions in the second half of the year reflecting several cost savings initiatives instituted in 2024, which are expected to build throughout the year. This includes hiring restrictions, reducing our contractor and consultant workforce, and deferring or eliminating discretionary spend. As we’ve discussed before, we have been actively managing costs for years and continue to create opportunities for further cost reductions through process redesign and digital technology investment leading to increased productivity and better experiences for our customers. In addition, we expect to benefit from higher earnings in Ameren Transmission over the balance of the year due to timing of financing and project expenditures. I encourage you to take these supplemental earnings drivers into consideration as you develop your expectation for quarterly earnings results for the remainder of the year. Finally, late last week, MISO concluded its planning resource auction for the 2024 to 2025 planning year, which assesses seasonal resource adequacy in each zone. As a result of higher load requirements, changes to the accreted capacity of generation available and reduced import capability, Zone 5, Ameren Missouri’s territory showed a model capacity shortfall and prices went through the cost of new entry or CONE for the non-peak load fall and spring seasons. Clearing prices in all other zones within MISO remained relatively flat. Unlike what Ameren Illinois experienced a couple of years ago, we do not expect to see material customer bill impact at Ameren Missouri resulting from this auction because our generation resources available to serve customers, nor do we see any issues with providing reliable electric service throughout the year for our customers. The MISO auction results do reinforce a couple of things. First, there is a strong need for us to continue to execute the generation plans called for an IRP. And second, the integration of new large electric loads and carbon-free renewable generation to the grid will require significant transmission expansion with some projects needed locally to ensure reliable service. We stand ready to work with stakeholders in our region to address the capacity needs. Before moving on, I’d like to provide an update on economic development. Through mid-April, we have successfully supported 21 new projects that have selected locations in our service territories which are expected to increase electric demand by almost 45 megawatts and natural gas issues by 1.6 million tons within the next few years. These projects will add an estimated 950 jobs across our service territories. The majority of these projects are existing customer expansions in the manufacturing, aerospace, data center, food processing and mining industries. Ameren Missouri and Ameren Illinois are actively working with state, regional and local partners on more than 150 economic development projects that are considering on location in our service territories including large low data centers and manufacturers in the automotive, aerospace and agricultural industries, among others. We will continue to work on development opportunities to build thriving communities in our service territory. Moving to Page 17 on Ameren Illinois regulatory matters. We have several Ameren Illinois electric distribution regulatory updates to cover with you, including the 2023 annual reconciliation, the 2024 through 2027 multiyear rate plan rehearing as well as a revised grid and rate plan filings. Starting with the 2023 annual reconciliation. Under Illinois formula ratemaking, which expired at the end of 2023, Ameren Illinois is required to file annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true up any prior period over or under recovery of such costs. In April, we filed our electric distribution annual rate reconciliation requests for $160 million adjustment for the 2023 revenue requirement to reflect actual costs. The full amount would be collected from customers in 2025, replacing the prior period reconciliation adjustment of $110 million that is being collected during 2024. For a net customer impact of $50 million or an approximately 1.5% increase in the total average residential customer bill. The ICC will review the matter once ahead with a decision expected in December of this year and new rates effective in early next year. Turning to the multiyear rate plan for 2024 through 2027 on Page 18. In January, Ameren Illinois has granted a partial rehearing by the ICC to address a base level of grid reliability investment and 2023 rate base additions. We filed our revised request enable for a cumulative annual revenue increase from 2023 rates of $305 million by 2027. Our request, which includes investments and costs related to preventive and corrective maintenance inventory, metering, new business and customer relocations would allow us to appropriately maintain the energy grid to preserve safety, reliability and day-to-day operations of our system. The ICC staff recommends a cumulative increase of $283 million, with the variance driven primarily by the renewal of other post-employment benefits and certain 2023 projects from rate base, the latter of which the staff deemed to be outside the scope of this rehearing. We expect an ICC decision on the rehearing proceeding by June 20, which will allow new 2024 interim rates to be effective by July. Moving to Page 19. In March, Ameren Illinois filed its revised electric multiyear grid plan and revised multiyear rate plan. Our request for a $321 million cumulative annual revenue increase from 2023 rates with supersede revenues granted through rehearing. Request is based on a return on equity of 8.72% and an equity ratio of 50%. Annual revenues will based on actual recoverable costs, year-end rate base and a return on equity adjusted for any performance incentives or penalties, provided the actual revenue requirement does not exceed the reconciliation cap. Our plans as proposed support an affordable, equitable energy transition, which we’ll advocate for over the remainder of the year. We expect the ICC staff and intervenor testimony in May and we expect an ICC decision by December with rates effective January 1, 2025. In other regulatory matters, last week, Ameren Missouri filed a 60-day notice with the Missouri PSC for our next electric service rate review. Moving to Page 20 to provide a financing update. We continue to feel very good about our financial position. On January 9, Ameren Missouri issued $350 million of 5.25% first mortgage bonds due 2054. And on April 4, Ameren Missouri issued $500 million or 5.2% first mortgage bonds due 2034. Net proceeds from both issuances were used to fund capital expenditures and/or refinance shorten debt. Further, in order for us to maintain our credit ratings and strong balance sheet, while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity in 2024. We sold for approximately $230 million under our at-the-market or ATM program, consisting of approximately 2.9 million shares, which we expect to issue by the end of this year. Together with the issuance under our 401(k) and DRPlus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. Finally, turning to Page 21. We’re off to a solid start in 2024 and well positioned to continue executing our plan. We expect to deliver strong earnings growth in 2024 as we continue to successfully execute our comprehensive business strategy. Looking to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. We also believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question.
Shar Pourreza: Hey, guys. Good morning.
Marty Lyons: Good morning, Shar.
Shar Pourreza: Good morning, Marty. Marty, can you just maybe elaborate a bit more on the recent EPA regs. I mean you touched a bit on the fleet impact like Labadie, but maybe expand on potential shifts to timing and scale the spending opportunities versus last year’s IRP if it makes it through the courts. I mean, could we see some pull forward of generation spend? What do you see as kind of an updated pathway here should we be thinking of an IRP update like you did with the Rush Island – rush decision. Thanks.
Marty Lyons: Well, Shar, you’ve outlined a number of the considerations. I mean, first of all, we’re all just still absorbing the rules. And so our teams are studying the new rules thoroughly and will be over the coming weeks, really trying to assess what the potential impacts are on our IRP. And certainly, that could mean, as you know, a revision to the IRP. But of course, too, we’ll expect these rules to likely be litigated, and so we’ll have to take into account that litigation and the uncertainties that it creates. In my prepared remarks, I noted a couple of the more notable concerns that we have. The first being that the rules do really rely on carbon capture and sequestration, which I think we all recognize is it really ready for prime time today. And the things that would impact we have, as you know, in our IRP planned combined cycle facility, 1,200 megawatts plan for the 2032, 2033 time frame, which is really important from a reliability perspective as we expect to retire our Sioux power plant, our coal-fired power plant in that 2032 time frame. And certainly, new combined cycle that would operate with greater than a 40% capacity factor, which we would expect this one to – would be impacted by that carbon capture and sequestration. So that certainly has significant implications as it relates to that planned combined cycle facility. And we’ll have to reassess and thinking through that. The other one I mentioned is our Labadie Energy Center, that plant is scheduled to retire really in phases with about half of it in 2036 and the other half of it 2042. So the rule would have implications for the ultimate retirement date, pulling that forward a little bit. But in order to be able to maintain the life of that facility out through 2039. The rules require co-firing with natural gas in the 2030 time frame. And of course, trying to get things permitted and constructed in that amount of time, certainly proposes challenges as well. And so I highlighted those in my prepared remarks today. So at the end of the day, Shar, I think as we look at these rules, we do have concerns about the feasibility and ultimately the reliability of our system. Those were our primary concerns. But you’re absolutely right. As we think about these rules, it certainly could cause revisions to the IRP and on balance, suggest a greater level of investment that would be required to maintain reliability of our system over the next 10 years.
Shar Pourreza: Got it. And then just a bit nuanced, but what exactly was going on with PI auction in Zone 5. I mean, obviously, it’s quite a large breakout for you, net neutral from a customer impact perspective, which you just highlighted. But maybe just some color on the backdrop. Is this kind of structural should we should expect it again or really kind of an administrative or design error? Thanks.
Michael Moehn: Hey. Shar, it’s Michael. Good morning. A couple of things. I mean, as you noted, I mean, obviously, Zone 5, we’ve moved to this new seasonal construct, we did see quite a bit of variability. You had $30 in the summer and $0.75 in the winter and then CONE in the fall and the spring, at 719. So as you note, I mean, this is a capacity issue. It’s not an energy issue. And so I think it’s always important to start with that. We expect to have obviously enough energy available for customers we don’t foresee any issues with respect to providing reliable service, which I think is important. Also from a customer impact standpoint, we really don’t see any material, if any impact to customers as well. And it gets a little complicated. I mean the MISO model is a revenue neutral model and so it will be some shifting that goes on. We have Missouri owns generation in Zone 4, we’re able to point to those as hedges, and so it helps offset all that. But I think when you step back, I mean, it is right trying to send a price signal with respect to meeting additional dispatchable generation that you just spoke about. I mean, there were a couple of things I noted in my prepared remarks. I mean it was due to increased load. There were some accreditation issues with respect to some generation. They got dinged for some past performance. That should go away over the next couple of years. And then there was a reduction in import capabilities. And also, I think there’s probably some transmission opportunities there that would relieve that. So I think, again, it does speak to what we’re trying to do from a dispatchable perspective. And I think, Shar, there’s a way to work around this and see some relief over the next couple of years.
Shar Pourreza: Okay, perfect. I appreciate it, guys. Thank you so much.
Marty Lyons: Thanks for the question, Shar.
Operator: Our next question is from Jeremy Tonet with JP Morgan Chase. Please proceed with your question.
Jeremy Tonet: Hi, good morning.
Marty Lyons: Hey, Jeremy. How are you today?
Jeremy Tonet: Good. How are you?
Marty Lyons: Good.
Jeremy Tonet: Just wanted to go to Missouri and as far as legislative initiatives there, if you could provide us, I guess, thoughts on the environment there, what you’re looking for and specifically PISA legislation and I think the session is ending soon. And so any thoughts there would be helpful.
Marty Lyons: Yes, Jeremy, you got it. I think that as we sit here today, the legislation that is most likely to get across the finish line, is that a piece of legislation. And so as you know, and I’m sure you’ve been following House Bill 1746 and Senate Bills 740 and 1422. I would say, at this point in session, they’re probably as well positioned as you could be for Passage Senate Bill 1422 and Senate Bill 740. They’re on the Senate informal calendar that could be brought up at any time and House Bill 1746, which passed out of the house with a very strong supportive vote of 119-17 is also now passed through the Senate Commerce Committee. It’s listed as #1 on House Bills for third reading. So things are well positioned. The challenge that I highlighted in the prepared remarks, however, is the time is short. The legislative session ends in two weeks on 17, and the legislature does have some significant things to get done, including the budget. So that’s really the concern is just whether time will run short. But in the meantime, we’ll continue to work with key stakeholders towards passage if we have a window to get it done.
Jeremy Tonet: Got it. That’s helpful. And then maybe just pivoting towards Illinois. As far as the regulatory processes are concerned with the electronic hearing the grid plan refiling, any incremental thoughts you can share with progression versus expectations there? And really, I guess the question is more on the other side with the legislature. Do you see any potential there to maybe secure more constructive development?
Michael Moehn: Hey, Jeremy, it’s Michael. Good morning. Maybe I’ll handle the regulatory if Marty wants to come on the legislative one, you can certainly do that. I think – but things are continuing to move along there. I think we mentioned this in our prepared remarks, I mean, from a rehearing process, feel good about where we stand today. Again, just really proud of the work the team has done. [Indiscernible] has been working really hard going through a number of public hearings, a number of workshops, et cetera, just getting this prepared. And I think you’re seeing that producing results here as we kind of work through this rehearing process. And so we should have a decision here in early – sometime in June with a great effective in July, and this will be an interim adjustment. And then obviously, we’ll have the more comprehensive multiyear rate plan, grid plan piece in the back half of the year. It’s great to have a procedural schedule around that, have some finality around this in the December time frame with rates in January. With respect to the rehearing piece, the differences between us and staff are fairly minimal at this point. As we indicated, we were at 305, and it sits at 283 today. It really comes down to 2 issues there. The OpEx issue that we’ve spoken about in the past. We still are continuing to advocate for that. We think it’s the right thing. I think our range accommodates that if it goes in a different direction. And then there were some projects that were really deferred into the grid plan itself. And so we’ll have another opportunity to advocate for those. So again, we feel as good as you can feel at this point in time. And team is focused on it and getting some stability put back in that process.
Marty Lyons: Yes, really, Jeremy, to add at this point. I mean, in terms of legislative initiatives, nothing to point to, of course, this year, both in Missouri and Illinois. We have supported a right of first refusal legislation in both states. In either states do we see those as moving forward at this time but continue to advocate for the benefit of those for our customers and for the reliability of the grid broadly but nothing to tack on right now.
Jeremy Tonet: Got it. That’s helpful. I’ll leave there. Thanks.
Operator: Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question.
Carly Davenport: Hey, good morning. Thanks so much for taking the questions today. Maybe just to follow up really quickly on the Illinois rehearing process. First, can you just remind us, what of that 305 revenue increase requested there is embedded in the 2024 guidance and kind of flexibility there to the extent there’s some gap. And then is there any potential for that decision to come earlier than the late June time frame that you laid out?
Michael Moehn: Hey, good morning, Carly. This is Michael. With the second part first, no, I think at this point, the expectation is kind of a little on that time frame and should have a decision here in July. In terms of sort of what’s embedded, that 305 is obviously over that four-year period. And so there’s a component, you can see that we have broken out for 2024. Again, feel good about what we have embedded in there and just sort of where the positions are. To the extent that something ended up changing that would have to just step back and look at it from a rate base perspective to the extent that it’s capital again, I mean, you’re earning 8.72%. So I mean that obviously minimizes the impact and we just have to see what our options are. I mean we do have flexibility with some additional capital there. But really just looking to see the process move along and feel better about the framework first.
Carly Davenport: Got it. Thank you. That’s super helpful. And then maybe just on Rush Island, you talked a bit about the delta between Ameren’s proposal and the DOJ proposal there. Is that just a matter of sizing the program that you expect to be the piece of debate? Or is there anything else that sort of sticks out as a point of debate as you think about into hearing there this summer.
Marty Lyons: Yes, you’re talking about which one were you asking about? Were you asking about NSR case, Carly? Yes. I think, you were. Listen, as it relates to the NSR, as we outlined in our slide prepared remarks, we’ve proposed a program set up a value of about $20 million and the Department of Justice is outlined a series of programs that they’ve estimated at $120 million. And when you look at the components of the two programs that are very similar in terms of electric school buses, air filtration programs, charging infrastructure, so very similar. So it really is seemingly not a matter of the program mix. But sort of the extent of them and the cost of them. So we can’t predict what mitigation the court would ultimately order. We would generally expect though, that the positions I just talked about that the parties have and the proposed orders that sort of just book ends for the degree of mitigation relief that was either ultimately reached through a settlement between ourselves and the Department of Justice for a court order. But really can’t speculate further at this point.
Carly Davenport: Got it. Okay. Thank you so much for the color.
Operator: Our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question.
Paul Patterson: Hey, good morning.
Marty Lyons: Hey, Paul.
Paul Patterson: So I just wanted to follow-up on the EPA rule. It seems so challenging, I guess. I’m just wondering, assuming that it’s largely in place or something, when you mentioned different reliability things you might have to do for reliability and stuff. Could you just sort of give us a general sense of what would happen? I mean, because as you mentioned, I think that carbon capture and sequestration is – got so many challenges associated with it. Would you just start running the plants lower? Would there be more batteries? Would it be – what would be sort of the remedy that might be thought about? And also, would there be any change in depreciation schedules? Or I’m just sort of wondering, I mean, it just sounds like a very difficult thing to sort of talk about potentially changing the IRP with a plan that seems so radical kind of, if you know what I’m saying.
Marty Lyons: Well, Paul, it’s Marty. I think you hit on a number of the considerations. And I’ll go back to what I said before. It’s early days. We just got in the rules. We’re going to go through a thorough assessment of the rules and reassessment of the IRP. And again, you’ve got the likelihood of litigation, which will have to be factored in as well to our considerations. But I think when you look at the steps we’re taking between now and 2030 as we currently have outlined, I think the EPA rules underscore the importance of these. We’ve got 2,800 megawatts of renewables planned by 2030. We got 400 megawatts of battery storage planned between now and 2030. We’ve got 800 megawatts of simple-cycle generation plan between now and 2030. And I think given these rules, certainly, it underscores the importance of all of those things. I think the broader implications that are down the line. I think with respect to the retirement of the Sioux Energy Center that we have plan for 2032 generally in line with the rules. The Labadie Energy Center, I mentioned earlier, half of it retired in 2036, half of it 2042, again, if that need to be retired by 2039, maybe a little bit of a change in depreciation there recovery. But I think the bigger thing for Labadie then would be getting gas into Labadie and the ability to be able to co-fire with natural gas so that we’ve got that. And then I think when you think about that combined cycle facility and again, first of all, the feasibility of doing carbon capture much less of the cost of doing carbon capture, you really have to reassess that, that plan in light of these rules. But you’re right, what it might mean otherwise is more simple cycle gas fired generation, more battery, storage technology, more renewables. Because, again, anything if you’re going to operate a combined cycle over 40% capacity factor, it calls for carbon capture. So that – but those are – I think you’ve got your sort of finger on the things that you have to consider, which is what would be an alternative mix of renewables and dispatchable resources that can maintain reliability for the system.
Paul Patterson: Okay. So we’ll just, I guess, monitor this. Okay. That’s very helpful. And then with respect to transition, there’s been a lot of focus on the part of officials in Washington and other places on great enhancing technologies. And I was just wondering how you thought about those and the potential deployment at Ameren and just any thoughts you might have on that.
Marty Lyons: Maybe we’ll let Shawn Schukar who runs our transmission operations comment on that.
Shawn Schukar: Yes. Thanks for the question. So the grid-enhancing technology, generally allow us to flow more across the system. They don’t take care of some of the capacity needs. And we see those as complementary as we transition through the grid investments, which means that we’ll be making some enhancements like you see from the MISO, but we also look at those grid-enhancing technologies to support the system, and we’ll be utilizing a combination of both.
Paul Patterson: Okay. Thank you. Good talk to you guys.
Marty Lyons: Thanks, Paul.
Operator: [Operator Instructions] Our next question comes from Nick Campanella with Barclays. Please proceed with your question.
Nick Campanella: Hey, good morning. Happy Friday.
Marty Lyons: Hello, Nick, same to you.
Nick Campanella: Hey, so I just wanted to ask quickly on the mitigation proposal on Rush Island because I know that you booked this $20 million figure, which was an ongoing hit in your O&M line, but then you kind of mentioned the risk the DOJ is asking for $120 million. And obviously, we’ll see where this goes at the end of the year. But like if it does go against you, is that still an ongoing item in your view? Or is that kind of more one-time in nature?
Marty Lyons: Nick, it’s a great question. And I think, ultimately, wherever this settles, it really is a one-time item, it is non-recurring. Given the size of it today, we didn’t think it appropriate to sort of carve it out. And as we talked about on our call, we’d look to overcome the cost of that with respect to ongoing operations savings. However, again, as I outlined, the $20 million we proposed and the $120 million of the DOJ propose probably bookends as we think about settlement and an ultimate potential court order here. But like I would agree with you that ultimately, whatever this cost is non-recurring in one-time and won’t be something that affects ongoing operations or earnings.
Nick Campanella: Hey, I really appreciate that. And as it just relates to 2024, I know you’re highlighting that you kind of have this line of sight to O&M in the back half of the plan. So just any comments on how you feel like you’re trending versus your full 2024 number at this point? Are you at the mid-point? Or I guess any comments there?
Michael Moehn: Yes. Hey Nick, it’s Michael here. Good Friday to you. Yes, look, I mean, we obviously reiterated our range of $450 million to $472 million really focused on the mid-point of that range. The team is completely aligned on flexing what we need to flex here from an O&M perspective. We talked about a number of programs. I think the first part of the year that we put in place with respect to some hiring freezes looking at discretionary spending and looking at contractors, travel, all those kinds of things. And again, those programs are fully ramped up at this point and feeling good about it. We have a long history of this. You’ve heard us talk about this. I mean we’ve been doing a number of things really from an automation and technology investment perspective. We’ve now fully deployed AMI [ph] and we feel we have distribution automation. We’ve done a great deal of stuff from the back office perspective in terms of accounting systems, HR systems, all of those are driving productivity improvements and we’re taking full advantage of. And I was sort of reflecting on the situation and thinking about 2020, that terrible COVID year, we only lost 15% of sales within about a week, and the team came together and really looked for tens of millions of dollars worth of opportunities that will really flex and continue to end up hitting our guidance for that year. I don’t see this as any different. We’ll continue to look for these opportunities. And ultimately, we’re going to make the decisions right for the long-term at the end of the day, but we do have the ability to flex out as we not as needed.
Nick Campanella: That’s really helpful and definitely acknowledge the ability to flex here, especially based on past. One more thing. Just you’re very clear, your 2024 equity needs are basically done outside of internal programs and maybe some DRIP, but just for 2025 and beyond, is $600 million a year still the kind of right number to be thinking about? I think that’s what you guys talked about in the fourth quarter?
Michael Moehn: Yes, yes, that’s correct. That still stands we delivered back there in February.
Nick Campanella: All right. Have a great day. Thanks.
Michael Moehn: Okay. Thanks for the questions.
Operator: Our final question is from David Paz with Wolfe Research. Please proceed with your question.
David Paz: Good morning.
Marty Lyons: Good morning, David.
David Paz: Could you maybe expand on the data center opportunities? I know you mentioned them, mentioning centers along with some other large customers. But just what opportunity are you seeing there, particularly on the investment side, and maybe any sense of the size of the projects that potentially could come down the pipe and just how much would an incremental investment from Ameren for a typical size project? Thank you.
Michael Moehn: Yes. Hey, good morning, David. I’ll start here. And certainly, Marty, I’ll probably chime in as well. But I mean, I think we have a strong value proposition, right, when it comes to serving both data centers and manufacturers. I mean, we’ve talked about this. We start from a really strong position just in terms of where our rates are, both on the Midwest and national average went well below. We presented a number of sites in both states that can ramp up quickly, sewer water transmission capabilities, et cetera. I’ve never seen state local regional leaders work together as they are right now, really trying to come together on a combined effort, offer various incentives to again, this is beyond just data centers, but manufacturers in general in terms of things around state and local we use taxes, development grants for workforce development, et cetera. We have a number of incentives in place here that are available to customers based on location and size. As we sit here today, Dave, we’ve executed a construction agreement for one data center and it’s got an estimated 250-megawatt lows. That’s sizable for us. We haven’t seen this kind of load growth in a really, really long time. We should be serving that customer by 2026. And I would say, we’re actively working 1,000-plus megawatts beyond that. And so these are all in different stages at this point, they’ll come online differently. But again, I think as we think about the IRP and just adding the renewables and the dispatchable generation that we’ve been adding in the last few years, I mean, this is exactly what we need. And again, all of these projects probably won’t come to fruition, but some of them are really, really moving along nicely. And beyond data centers, there’s just a tremendous amount happening in the manufacturing side as well. I mean, Boeing is the largest manufacturer here in the state of Missouri, started a $1.8 billion expansion here in Jefferson City is also doing a very large expansion, Illinois Wieland rolled products of $500 million expansion. I mean there are a number of projects here that continue – should continue to add to some significant growth. In terms of what that means from a capital perspective, obviously, it’s a net positive. I think we’re going to continue to step back and assess that. But it’s certainly great to see from an investment standpoint and certainly a customer affordability perspective, right? Because it’s going to make it obviously more affordable for all customers at the end of the day.
David Paz: Great. Thank you for that color. Maybe just sneak a quick one. I think you sounded like your tranche, the Tranche 2 initial concept map suggests that there will be some opportunities in your service areas. Any sense how to compare that to what the initial concept at Tranche 1 looks for you guys? Is it roughly the same in terms of potential dollar either size or dollars?
Marty Lyons: Yes. David, this is Marty. I’ll tell you, well, first of all, the map is encouraging as we shared. And I think if you look at our Slide 11 that we provided, you’ll see substantial proposed additional lines, both in our service territory and in Central Illinois as well as in the Eastern half of Missouri. And so that’s certainly exciting to see. We’re excited that the overall project portfolio was about twice the size of Tranche 1. You – everybody else, I’m sure recalls Tranche show 1 was about a $10 billion portfolio. We ended up having about 25% of that, as we talked about on the call and we were happy to be awarded some directly. We’re very proud to have won all three of the competitive projects that were in our service territory. So we certainly feel good about the way Tranche 1 turned out. It’s too soon to really say what level of investments would be in our service territory from Tranche 2 for really a couple of reasons. One, I would say that the – while we’re excited about these projects that were in our service territory, as you well know, right now, the MISO is going through a process of getting input from stakeholders regarding these proposed projects. And we do expect that as MISO considers the input from various stakeholders that these project plans will be modified. So it’s premature there, number one. Number two, when MISO put out these Tranche 2, they really didn’t assign while they came up with an overall portfolio investment of $17 billion to $23 billion, it really didn’t put any particular quantification of investment value on any particular substations or lines, et cetera. So really premature to even say how much these investment opportunities would be that are shown on this map. So for a couple of reasons, I think it’s premature to say how much of this would be in our service territory. And ultimately, how much would be brownfield or greenfield. So – but I think we will start to see iterations of this through time, and we’re excited that MISO seems to be very much targeting an approval of the Tranche 2 portfolio by mid-September. And so – and it should be pretty exciting over the next few months as we see how this unfolds.
David Paz: Great. Thank you.
Marty Lyons: Thanks, David.
Operator: We’ve reached the end of the question-and-answer session. I’d now like to turn the call back over to Marty Lyons for closing comments.
Marty Lyons: Great. Well, hey, I want to thank everybody for joining us today. We invite you to attend our Annual Shareholder Meeting, which is next week on May 9. And then Michael and Andrew, look forward to seeing many of you at the AGA Financial Forum in a couple of weeks. With that, thanks, and have a great day and a great weekend. | [
{
"speaker": "Operator",
"text": "Greetings, and welcome to Ameren Corporation’s First Quarter 2024 Earnings Call. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk, you may begin."
},
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here’s Marty, who will start on Page 4."
},
{
"speaker": "Marty Lyons",
"text": "Thank you, Andrew. Good morning, everyone, and thank you for joining us today as we discuss our first quarter 2024 earnings results. Our team continues to successfully execute on our strategic plan across all of our business segments, allowing us to deliver for our customers, shareholders and the environment, while laying a strong foundation for the future. Turning now to Page 5. Yesterday, we announced first quarter 2024 earnings of $0.98 per share compared to earnings of $1 per share in the first quarter of 2023. The key drivers of our first quarter results are outlined on this slide. Overall, our operating performance was strong during the quarter. We had periods of extreme cold weather in January and our natural gas and electric systems and our operating teams performed well. On balance, however, weather was mild during the quarter, marked by unseasonably warm temperatures in February and March. Despite the mild temperatures, our retail sales grew driven by encouraging signs of customer growth and usage. While we experienced higher operations and maintenance expenses, that was driven largely by a charge for proposed additional mitigation relief related to the Rush Island Energy Center New Source Review litigation. Despite the year-to-date weather headwinds and the Rush Island charge, our team is taking steps to contain spend, and we remain on track to deliver within our 2024 earnings guidance range of $4.52 per share to $4.72 per share. I’ll provide an update on our Rush Island Energy Center proceedings, and Michael will cover the first quarter and balance of the year earnings results in a bit more detail later. Moving to Page 6. On our call in February, I highlighted some of our top priorities for 2024 as we invest strategically, enhance our operating jurisdictions and optimize our business processes. Our team’s unwavering commitment to these objectives has already begun to produce results, as you can see on Page 7. Our investments continue to improve the reliability, resiliency, safety and efficiency of our service to our customers. In the first three months of this year, we have invested significant capital for the benefit of our customers. During the quarter, Ameren Missouri installed over 55,000 smart meters, 60 smart switches, 15 miles of energized underground cable, 8 miles of hardened overhead lines and upgraded 5 substations. In Illinois, our first quarter investments included replacing 550 poles due to standard inspections and storm damage, replacing switchgear at a key substation and installing 30 miles of underground cable for relocations, new customers and aged cable replacement. Further, our transmission business is on track to complete over 15 new or upgraded transmission substations and 45 miles of new or upgraded transmission lines in the first half of the year. These critical investments support our commitment to delivering safe and reliable energy for the benefit of our customers and we are seeing the benefit in 2024 in terms of reduced outages and shorter outage durations as a result of spring storms. For example, during the recent April storm, over 7,500 Missouri customer outages were prevented due to rapid detection, rerouting and restoration of power by automated switches across our system in over 2.3 million minutes of customer outages were avoided due to these investments. Moving on to first quarter regulatory and legislative outcomes. In March, Ameren Missouri received Missouri PSC approval of our largest-ever solar investment, three projects representing a total of 400 megawatts capable of powering approximately 73,000 homes. The approval of certificates of convenience and necessity, or CCN, for these projects is another constructive step along the pathway to executing our Ameren Missouri Integrated Resource Plan, or IRP. On the legislative front, the Missouri General Assembly is addressing power quality and reliability by considering bills to enhance and extend the current plant-in-service accounting, or PISA, legislation that would support investment in dispatchable resources and reliability. PISA has supported much needed reliability investments in the state’s energy grid over the past five years. While these bills, House Bill 1746 and Senate Bills 740 and 1422, have strong bipartisan support, time is short in the current general assembly session ends Friday, May 17. While the legislature has many priorities, we will continue to work with key stakeholders towards passage. At Ameren Transmission, progress continues to be made on the long-range transmission regional and beneficial projects, which I will cover in more detail in a moment. Turning to Illinois Electric delivery. We continue to diligently work for approval from the Illinois Commerce Commission, or the ICC of an electric grid investment plan, revised revenue requirements incorporating ongoing and prospective investments and an overall improved regulatory environment. In January, the commission granted a partial rehearing of our multi-year rate plan to address the base level of investment needed to operate the grid reliably. Subsequently, in February, we filed an updated plan as part of the rehearing proceeding. Then in March, we filed our revised multi-year grid and rate plans to address the commission’s findings stated in their December order. The rehearing and revised multi-year grid and rate plan proceedings are operating in parallel and with update rates for 2024 through 2027. We expect a decision from the ICC on the rehearing in June, which would provide a 2024 interim rate adjustment by July. We expect an ICC decision on the revised multi-year grid and rate plans by the end of the year, which would revise rates beginning January 2025. We continue to work with all impacted stakeholders to advocate for constructive regulatory frameworks and outcomes that support the state’s energy transition goals. Our ability to invest and deliver reliable and affordable energy is essential for our customers and the communities we serve and will support continued growth in our region. Moving on to operational matters. We remain committed to maintaining disciplined cost management to hold operations and maintenance expenses flat in 2024 to 2023 levels. I’d like to express my sincere appreciation to our Ameren team members who are working efficiently, collaboratively and safely to serve our customers. Now moving to Page 8 for details on the Rush Island securitization case at Ameren Missouri. Our request with the Missouri PSC to securitize the remaining balance of the Rush Island Energy Center and other related costs continues to make progress. In March, the Missouri PSC staff recommended securitization of $497 million as compared to our request of $519 million. Refinancing these investments through the issuance of securitized bonds, versus financing and recovery through traditional ratemaking will save our customers millions of dollars. Hearings were completed in April, and we expect the PSC’s decision by June 21. Now turning to Page 9 for an update on the new source review proceeding for Rush Island. As previously reported in 2017, the U.S. District Court of Eastern Missouri issued an order requiring the installation of a flue gas desulfurization system or scrubbers on our Rush Island Energy Center for violating new source review provisions of the Clean Air Act and install a dry sorbent injection system at our Labadie Energy Center, as mitigation for excess emissions at Rush Island. Upon appeal, the A circuit upheld the district court’s ruling with respect to the installation of scrubbers at Rush Island, but overturn the decision with respect to Labadie. Subsequently, we made the decision to accelerate the planned retirement of our Rush Island Energy Center, which was more economic for our customers than installing scrubbers. The District Court approved Ameren’s retirement proposal and established a retirement date of no later than October 15, 2024 to allow for the completion of various transmission reliability projects. The U.S. Department of Justice is seeking additional mitigation relief beyond the retirement of the energy center. In March of this year, the District Court ordered both parties to file proposals outlining additional mitigation relief for the court to consider. On Wednesday, Ameren Missouri and the DOJ filed their respective mitigation proposals. Ameren’s mitigation proposal consists of four essential elements: retirement of Rush Island, which eliminates all emissions through its previously planned 2039 retirement date, a school bus electrification program, including buses and charging stations, an air filter program geared towards underserved residential customers and surrender of sulfur dioxide allowances. Collectively, these programs are estimated to cost approximately $20 million, which resulted in a first quarter charge to earnings. The Department of Justice mitigation proposal includes a significantly greater number of buses, charging stations and advanced filters. The DOJ estimates their aggregate program cost to be approximately $120 million. We expect an evidentiary hearing will be scheduled sometime this summer, and we expect the District Court will issue a final ruling during the second half of 2024 that could be subject to further appeals. Before moving on, I’d like to provide an update on the series of new rules issued by the Environmental Protection Agency last week. As you know, Ameren Missouri remain committed to investing in a clean energy transition in a responsible manner, balancing reliability and affordability. The new rules expect generators to rely heavily on carbon capture and storage technologies, which are not ready for full-scale economy-wide deployment. These new rules apply not only to existing coal-fired units, but new gas-fired units with greater than 40% capacity factors as well, which would include the gas combined cycle facility called for in our current IRP in the early 2030s to maintain system reliability. In addition, for coal units retiring between 2032 and 2039, the rules will require natural gas co-firing by 2030. And as we noted in our comments to the proposed rules, co-firing with natural gas presents challenges from a permitting and construction standpoint. These requirements would most directly impact our Labadie Energy Center, which has units scheduled to retire in 2036 and 2042. While we are still assessing the impact of the rules on our Integrated Resource Plan, these new rules are making it more challenging and costly to maintain existing dispatchable generation or build new dispatchable generation. These challenges come at a time when supply and demand is tight, and the industry has seen significant potential load growth, particularly from data centers, the manufacturing industry and through the electrification of transportation. We will continue to closely review the final regulations and as with many environmental regulations, litigation by various stakeholders is likely. These rules, if not modified, would require significant investments beyond what’s in our current 10-year pipeline to meet compliance obligations and maintain a reliable system. Moving to Page 10. We look ahead to our future renewable generation developments. As I mentioned in March, the Missouri PSC approved CCNs for three Ameren Missouri solar projects totaling 400 megawatts. Split Rail, Vandalia and Bowling Green, all located in Missouri. The Missouri PSC in its March order also set terms upon which a fourth solar facility, the 150-megawatt Cass County, Illinois project could be approved if it is fully subscribed under Ameren Missouri’s renewable solutions program. The renewable solutions program is a subscription-based program that allows eligible businesses and organizations to manage their carbon footprint by replacing up to 100% of their total energy use with renewable sources. The online auction for customers to subscribe to the Cass County Solar Project is expected to take place in mid-May with Missouri PSC approval of the Cass County CCN expected following full subscription. Initial non-binding notices of intent for the subscription auction will receive from interested businesses in early April and reflected strong interest. Investing in solar energy is part of Ameren Missouri’s plans to affordably meet the long-term energy and reliability needs of our customers. The IRP calls for new dispatchable energy resources, including an on-demand 800-megawatt gas simple-cycle energy center by 2027 which could be turned on as needed in a matter of minutes to ensure reliability of the energy grid during periods of peak energy demand. Later this month, we expect to file a request for a CCN for this simple cycle plant, Castle Bluff Energy Center, to be located on the site of our retired Meramec Energy Center. Moving to Page 11. The Midcontinent Independent System Operator, or MISO, continues to advance its long-range transmission planning and project approval processes. For Tranche 1, we were pleased to be selected in April to develop the third and final competitive project in our service territory, which again emphasizes our track record of being able to deliver cost-effective, high-value projects to our communities. Ultimately, Ameren was assigned or awarded approximately 25% of total Tranche 1 portfolio projects addressing the MISO Midwest region in 100% of the projects in our service territory. We expect Tranche 1 construction to substantially begin in 2026 with completion dates through 2030. Looking ahead to Tranche 2, in March, MISO announced a long-range transmission Tranche 2 proposed project portfolio estimated to cost $17 billion to $23 billion, which included significant investments within our Ameren Missouri and Ameren Illinois service territories. Since then, we, and other key stakeholders, have been working with MISO to evaluate and comment on the portfolio of projects to assist MISO in ultimately approving the most appropriate path forward. MISO expects to vote on Tranche 2 in the third quarter of 2024. Moving to Slide 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of more than $55 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country’s growing energy needs and delivering on our customers’ expectations. Turning to Page 13. In February, we updated our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings growth rate from 2024 through 2028. The earnings growth is primarily driven by strong compound annual rate base growth of 8.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return. I’m confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. I’ll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to Page 15 of our presentation. Yesterday, we reported first quarter 2024 earnings of $0.98 per share compared to $1 per share for the year ago quarter. The key factors that drove the overall $0.02 per share decrease are highlighted by segment on this page. We delivered solid earnings performance during the quarter as we continue to execute our strategy, including making infrastructure investments for the benefit of our customers. The first quarter included new service rates in Ameren Illinois Natural Gas and Ameren Missouri. In addition, strong customer growth and usage contributed to 3% higher electric weather-normalized retail sales at Ameren Missouri across all customer classes which were partially offset by milder weather impact. In fact, the third one was first quarter in the past 50 years. Earnings were also reduced by an increase in O&M and Ameren Missouri, largely driven by a $0.04 charge for proposed additional mitigation relief related to the Rush Island Energy Center. Moving to Page 16. As we think about the remainder of the year, we remain confident in our 2024 guidance range, and we continue to expect earnings to be in the range of $4.52 to $4.72 per share. As we think about the first quarter results versus our expectations, we lost $0.07 compared to normal for weather and $0.04 for the charge related to Rush Island. But experienced $0.02 of favorable weather-normalized sales beyond our expectations. As we look ahead, we expect to see meaningful year-over-year O&M reductions in the second half of the year reflecting several cost savings initiatives instituted in 2024, which are expected to build throughout the year. This includes hiring restrictions, reducing our contractor and consultant workforce, and deferring or eliminating discretionary spend. As we’ve discussed before, we have been actively managing costs for years and continue to create opportunities for further cost reductions through process redesign and digital technology investment leading to increased productivity and better experiences for our customers. In addition, we expect to benefit from higher earnings in Ameren Transmission over the balance of the year due to timing of financing and project expenditures. I encourage you to take these supplemental earnings drivers into consideration as you develop your expectation for quarterly earnings results for the remainder of the year. Finally, late last week, MISO concluded its planning resource auction for the 2024 to 2025 planning year, which assesses seasonal resource adequacy in each zone. As a result of higher load requirements, changes to the accreted capacity of generation available and reduced import capability, Zone 5, Ameren Missouri’s territory showed a model capacity shortfall and prices went through the cost of new entry or CONE for the non-peak load fall and spring seasons. Clearing prices in all other zones within MISO remained relatively flat. Unlike what Ameren Illinois experienced a couple of years ago, we do not expect to see material customer bill impact at Ameren Missouri resulting from this auction because our generation resources available to serve customers, nor do we see any issues with providing reliable electric service throughout the year for our customers. The MISO auction results do reinforce a couple of things. First, there is a strong need for us to continue to execute the generation plans called for an IRP. And second, the integration of new large electric loads and carbon-free renewable generation to the grid will require significant transmission expansion with some projects needed locally to ensure reliable service. We stand ready to work with stakeholders in our region to address the capacity needs. Before moving on, I’d like to provide an update on economic development. Through mid-April, we have successfully supported 21 new projects that have selected locations in our service territories which are expected to increase electric demand by almost 45 megawatts and natural gas issues by 1.6 million tons within the next few years. These projects will add an estimated 950 jobs across our service territories. The majority of these projects are existing customer expansions in the manufacturing, aerospace, data center, food processing and mining industries. Ameren Missouri and Ameren Illinois are actively working with state, regional and local partners on more than 150 economic development projects that are considering on location in our service territories including large low data centers and manufacturers in the automotive, aerospace and agricultural industries, among others. We will continue to work on development opportunities to build thriving communities in our service territory. Moving to Page 17 on Ameren Illinois regulatory matters. We have several Ameren Illinois electric distribution regulatory updates to cover with you, including the 2023 annual reconciliation, the 2024 through 2027 multiyear rate plan rehearing as well as a revised grid and rate plan filings. Starting with the 2023 annual reconciliation. Under Illinois formula ratemaking, which expired at the end of 2023, Ameren Illinois is required to file annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true up any prior period over or under recovery of such costs. In April, we filed our electric distribution annual rate reconciliation requests for $160 million adjustment for the 2023 revenue requirement to reflect actual costs. The full amount would be collected from customers in 2025, replacing the prior period reconciliation adjustment of $110 million that is being collected during 2024. For a net customer impact of $50 million or an approximately 1.5% increase in the total average residential customer bill. The ICC will review the matter once ahead with a decision expected in December of this year and new rates effective in early next year. Turning to the multiyear rate plan for 2024 through 2027 on Page 18. In January, Ameren Illinois has granted a partial rehearing by the ICC to address a base level of grid reliability investment and 2023 rate base additions. We filed our revised request enable for a cumulative annual revenue increase from 2023 rates of $305 million by 2027. Our request, which includes investments and costs related to preventive and corrective maintenance inventory, metering, new business and customer relocations would allow us to appropriately maintain the energy grid to preserve safety, reliability and day-to-day operations of our system. The ICC staff recommends a cumulative increase of $283 million, with the variance driven primarily by the renewal of other post-employment benefits and certain 2023 projects from rate base, the latter of which the staff deemed to be outside the scope of this rehearing. We expect an ICC decision on the rehearing proceeding by June 20, which will allow new 2024 interim rates to be effective by July. Moving to Page 19. In March, Ameren Illinois filed its revised electric multiyear grid plan and revised multiyear rate plan. Our request for a $321 million cumulative annual revenue increase from 2023 rates with supersede revenues granted through rehearing. Request is based on a return on equity of 8.72% and an equity ratio of 50%. Annual revenues will based on actual recoverable costs, year-end rate base and a return on equity adjusted for any performance incentives or penalties, provided the actual revenue requirement does not exceed the reconciliation cap. Our plans as proposed support an affordable, equitable energy transition, which we’ll advocate for over the remainder of the year. We expect the ICC staff and intervenor testimony in May and we expect an ICC decision by December with rates effective January 1, 2025. In other regulatory matters, last week, Ameren Missouri filed a 60-day notice with the Missouri PSC for our next electric service rate review. Moving to Page 20 to provide a financing update. We continue to feel very good about our financial position. On January 9, Ameren Missouri issued $350 million of 5.25% first mortgage bonds due 2054. And on April 4, Ameren Missouri issued $500 million or 5.2% first mortgage bonds due 2034. Net proceeds from both issuances were used to fund capital expenditures and/or refinance shorten debt. Further, in order for us to maintain our credit ratings and strong balance sheet, while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity in 2024. We sold for approximately $230 million under our at-the-market or ATM program, consisting of approximately 2.9 million shares, which we expect to issue by the end of this year. Together with the issuance under our 401(k) and DRPlus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. Finally, turning to Page 21. We’re off to a solid start in 2024 and well positioned to continue executing our plan. We expect to deliver strong earnings growth in 2024 as we continue to successfully execute our comprehensive business strategy. Looking to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. We also believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shar Pourreza",
"text": "Hey, guys. Good morning."
},
{
"speaker": "Marty Lyons",
"text": "Good morning, Shar."
},
{
"speaker": "Shar Pourreza",
"text": "Good morning, Marty. Marty, can you just maybe elaborate a bit more on the recent EPA regs. I mean you touched a bit on the fleet impact like Labadie, but maybe expand on potential shifts to timing and scale the spending opportunities versus last year’s IRP if it makes it through the courts. I mean, could we see some pull forward of generation spend? What do you see as kind of an updated pathway here should we be thinking of an IRP update like you did with the Rush Island – rush decision. Thanks."
},
{
"speaker": "Marty Lyons",
"text": "Well, Shar, you’ve outlined a number of the considerations. I mean, first of all, we’re all just still absorbing the rules. And so our teams are studying the new rules thoroughly and will be over the coming weeks, really trying to assess what the potential impacts are on our IRP. And certainly, that could mean, as you know, a revision to the IRP. But of course, too, we’ll expect these rules to likely be litigated, and so we’ll have to take into account that litigation and the uncertainties that it creates. In my prepared remarks, I noted a couple of the more notable concerns that we have. The first being that the rules do really rely on carbon capture and sequestration, which I think we all recognize is it really ready for prime time today. And the things that would impact we have, as you know, in our IRP planned combined cycle facility, 1,200 megawatts plan for the 2032, 2033 time frame, which is really important from a reliability perspective as we expect to retire our Sioux power plant, our coal-fired power plant in that 2032 time frame. And certainly, new combined cycle that would operate with greater than a 40% capacity factor, which we would expect this one to – would be impacted by that carbon capture and sequestration. So that certainly has significant implications as it relates to that planned combined cycle facility. And we’ll have to reassess and thinking through that. The other one I mentioned is our Labadie Energy Center, that plant is scheduled to retire really in phases with about half of it in 2036 and the other half of it 2042. So the rule would have implications for the ultimate retirement date, pulling that forward a little bit. But in order to be able to maintain the life of that facility out through 2039. The rules require co-firing with natural gas in the 2030 time frame. And of course, trying to get things permitted and constructed in that amount of time, certainly proposes challenges as well. And so I highlighted those in my prepared remarks today. So at the end of the day, Shar, I think as we look at these rules, we do have concerns about the feasibility and ultimately the reliability of our system. Those were our primary concerns. But you’re absolutely right. As we think about these rules, it certainly could cause revisions to the IRP and on balance, suggest a greater level of investment that would be required to maintain reliability of our system over the next 10 years."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. And then just a bit nuanced, but what exactly was going on with PI auction in Zone 5. I mean, obviously, it’s quite a large breakout for you, net neutral from a customer impact perspective, which you just highlighted. But maybe just some color on the backdrop. Is this kind of structural should we should expect it again or really kind of an administrative or design error? Thanks."
},
{
"speaker": "Michael Moehn",
"text": "Hey. Shar, it’s Michael. Good morning. A couple of things. I mean, as you noted, I mean, obviously, Zone 5, we’ve moved to this new seasonal construct, we did see quite a bit of variability. You had $30 in the summer and $0.75 in the winter and then CONE in the fall and the spring, at 719. So as you note, I mean, this is a capacity issue. It’s not an energy issue. And so I think it’s always important to start with that. We expect to have obviously enough energy available for customers we don’t foresee any issues with respect to providing reliable service, which I think is important. Also from a customer impact standpoint, we really don’t see any material, if any impact to customers as well. And it gets a little complicated. I mean the MISO model is a revenue neutral model and so it will be some shifting that goes on. We have Missouri owns generation in Zone 4, we’re able to point to those as hedges, and so it helps offset all that. But I think when you step back, I mean, it is right trying to send a price signal with respect to meeting additional dispatchable generation that you just spoke about. I mean, there were a couple of things I noted in my prepared remarks. I mean it was due to increased load. There were some accreditation issues with respect to some generation. They got dinged for some past performance. That should go away over the next couple of years. And then there was a reduction in import capabilities. And also, I think there’s probably some transmission opportunities there that would relieve that. So I think, again, it does speak to what we’re trying to do from a dispatchable perspective. And I think, Shar, there’s a way to work around this and see some relief over the next couple of years."
},
{
"speaker": "Shar Pourreza",
"text": "Okay, perfect. I appreciate it, guys. Thank you so much."
},
{
"speaker": "Marty Lyons",
"text": "Thanks for the question, Shar."
},
{
"speaker": "Operator",
"text": "Our next question is from Jeremy Tonet with JP Morgan Chase. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Marty Lyons",
"text": "Hey, Jeremy. How are you today?"
},
{
"speaker": "Jeremy Tonet",
"text": "Good. How are you?"
},
{
"speaker": "Marty Lyons",
"text": "Good."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to go to Missouri and as far as legislative initiatives there, if you could provide us, I guess, thoughts on the environment there, what you’re looking for and specifically PISA legislation and I think the session is ending soon. And so any thoughts there would be helpful."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Jeremy, you got it. I think that as we sit here today, the legislation that is most likely to get across the finish line, is that a piece of legislation. And so as you know, and I’m sure you’ve been following House Bill 1746 and Senate Bills 740 and 1422. I would say, at this point in session, they’re probably as well positioned as you could be for Passage Senate Bill 1422 and Senate Bill 740. They’re on the Senate informal calendar that could be brought up at any time and House Bill 1746, which passed out of the house with a very strong supportive vote of 119-17 is also now passed through the Senate Commerce Committee. It’s listed as #1 on House Bills for third reading. So things are well positioned. The challenge that I highlighted in the prepared remarks, however, is the time is short. The legislative session ends in two weeks on 17, and the legislature does have some significant things to get done, including the budget. So that’s really the concern is just whether time will run short. But in the meantime, we’ll continue to work with key stakeholders towards passage if we have a window to get it done."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s helpful. And then maybe just pivoting towards Illinois. As far as the regulatory processes are concerned with the electronic hearing the grid plan refiling, any incremental thoughts you can share with progression versus expectations there? And really, I guess the question is more on the other side with the legislature. Do you see any potential there to maybe secure more constructive development?"
},
{
"speaker": "Michael Moehn",
"text": "Hey, Jeremy, it’s Michael. Good morning. Maybe I’ll handle the regulatory if Marty wants to come on the legislative one, you can certainly do that. I think – but things are continuing to move along there. I think we mentioned this in our prepared remarks, I mean, from a rehearing process, feel good about where we stand today. Again, just really proud of the work the team has done. [Indiscernible] has been working really hard going through a number of public hearings, a number of workshops, et cetera, just getting this prepared. And I think you’re seeing that producing results here as we kind of work through this rehearing process. And so we should have a decision here in early – sometime in June with a great effective in July, and this will be an interim adjustment. And then obviously, we’ll have the more comprehensive multiyear rate plan, grid plan piece in the back half of the year. It’s great to have a procedural schedule around that, have some finality around this in the December time frame with rates in January. With respect to the rehearing piece, the differences between us and staff are fairly minimal at this point. As we indicated, we were at 305, and it sits at 283 today. It really comes down to 2 issues there. The OpEx issue that we’ve spoken about in the past. We still are continuing to advocate for that. We think it’s the right thing. I think our range accommodates that if it goes in a different direction. And then there were some projects that were really deferred into the grid plan itself. And so we’ll have another opportunity to advocate for those. So again, we feel as good as you can feel at this point in time. And team is focused on it and getting some stability put back in that process."
},
{
"speaker": "Marty Lyons",
"text": "Yes, really, Jeremy, to add at this point. I mean, in terms of legislative initiatives, nothing to point to, of course, this year, both in Missouri and Illinois. We have supported a right of first refusal legislation in both states. In either states do we see those as moving forward at this time but continue to advocate for the benefit of those for our customers and for the reliability of the grid broadly but nothing to tack on right now."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s helpful. I’ll leave there. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thanks so much for taking the questions today. Maybe just to follow up really quickly on the Illinois rehearing process. First, can you just remind us, what of that 305 revenue increase requested there is embedded in the 2024 guidance and kind of flexibility there to the extent there’s some gap. And then is there any potential for that decision to come earlier than the late June time frame that you laid out?"
},
{
"speaker": "Michael Moehn",
"text": "Hey, good morning, Carly. This is Michael. With the second part first, no, I think at this point, the expectation is kind of a little on that time frame and should have a decision here in July. In terms of sort of what’s embedded, that 305 is obviously over that four-year period. And so there’s a component, you can see that we have broken out for 2024. Again, feel good about what we have embedded in there and just sort of where the positions are. To the extent that something ended up changing that would have to just step back and look at it from a rate base perspective to the extent that it’s capital again, I mean, you’re earning 8.72%. So I mean that obviously minimizes the impact and we just have to see what our options are. I mean we do have flexibility with some additional capital there. But really just looking to see the process move along and feel better about the framework first."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Thank you. That’s super helpful. And then maybe just on Rush Island, you talked a bit about the delta between Ameren’s proposal and the DOJ proposal there. Is that just a matter of sizing the program that you expect to be the piece of debate? Or is there anything else that sort of sticks out as a point of debate as you think about into hearing there this summer."
},
{
"speaker": "Marty Lyons",
"text": "Yes, you’re talking about which one were you asking about? Were you asking about NSR case, Carly? Yes. I think, you were. Listen, as it relates to the NSR, as we outlined in our slide prepared remarks, we’ve proposed a program set up a value of about $20 million and the Department of Justice is outlined a series of programs that they’ve estimated at $120 million. And when you look at the components of the two programs that are very similar in terms of electric school buses, air filtration programs, charging infrastructure, so very similar. So it really is seemingly not a matter of the program mix. But sort of the extent of them and the cost of them. So we can’t predict what mitigation the court would ultimately order. We would generally expect though, that the positions I just talked about that the parties have and the proposed orders that sort of just book ends for the degree of mitigation relief that was either ultimately reached through a settlement between ourselves and the Department of Justice for a court order. But really can’t speculate further at this point."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Okay. Thank you so much for the color."
},
{
"speaker": "Operator",
"text": "Our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Paul Patterson",
"text": "Hey, good morning."
},
{
"speaker": "Marty Lyons",
"text": "Hey, Paul."
},
{
"speaker": "Paul Patterson",
"text": "So I just wanted to follow-up on the EPA rule. It seems so challenging, I guess. I’m just wondering, assuming that it’s largely in place or something, when you mentioned different reliability things you might have to do for reliability and stuff. Could you just sort of give us a general sense of what would happen? I mean, because as you mentioned, I think that carbon capture and sequestration is – got so many challenges associated with it. Would you just start running the plants lower? Would there be more batteries? Would it be – what would be sort of the remedy that might be thought about? And also, would there be any change in depreciation schedules? Or I’m just sort of wondering, I mean, it just sounds like a very difficult thing to sort of talk about potentially changing the IRP with a plan that seems so radical kind of, if you know what I’m saying."
},
{
"speaker": "Marty Lyons",
"text": "Well, Paul, it’s Marty. I think you hit on a number of the considerations. And I’ll go back to what I said before. It’s early days. We just got in the rules. We’re going to go through a thorough assessment of the rules and reassessment of the IRP. And again, you’ve got the likelihood of litigation, which will have to be factored in as well to our considerations. But I think when you look at the steps we’re taking between now and 2030 as we currently have outlined, I think the EPA rules underscore the importance of these. We’ve got 2,800 megawatts of renewables planned by 2030. We got 400 megawatts of battery storage planned between now and 2030. We’ve got 800 megawatts of simple-cycle generation plan between now and 2030. And I think given these rules, certainly, it underscores the importance of all of those things. I think the broader implications that are down the line. I think with respect to the retirement of the Sioux Energy Center that we have plan for 2032 generally in line with the rules. The Labadie Energy Center, I mentioned earlier, half of it retired in 2036, half of it 2042, again, if that need to be retired by 2039, maybe a little bit of a change in depreciation there recovery. But I think the bigger thing for Labadie then would be getting gas into Labadie and the ability to be able to co-fire with natural gas so that we’ve got that. And then I think when you think about that combined cycle facility and again, first of all, the feasibility of doing carbon capture much less of the cost of doing carbon capture, you really have to reassess that, that plan in light of these rules. But you’re right, what it might mean otherwise is more simple cycle gas fired generation, more battery, storage technology, more renewables. Because, again, anything if you’re going to operate a combined cycle over 40% capacity factor, it calls for carbon capture. So that – but those are – I think you’ve got your sort of finger on the things that you have to consider, which is what would be an alternative mix of renewables and dispatchable resources that can maintain reliability for the system."
},
{
"speaker": "Paul Patterson",
"text": "Okay. So we’ll just, I guess, monitor this. Okay. That’s very helpful. And then with respect to transition, there’s been a lot of focus on the part of officials in Washington and other places on great enhancing technologies. And I was just wondering how you thought about those and the potential deployment at Ameren and just any thoughts you might have on that."
},
{
"speaker": "Marty Lyons",
"text": "Maybe we’ll let Shawn Schukar who runs our transmission operations comment on that."
},
{
"speaker": "Shawn Schukar",
"text": "Yes. Thanks for the question. So the grid-enhancing technology, generally allow us to flow more across the system. They don’t take care of some of the capacity needs. And we see those as complementary as we transition through the grid investments, which means that we’ll be making some enhancements like you see from the MISO, but we also look at those grid-enhancing technologies to support the system, and we’ll be utilizing a combination of both."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Thank you. Good talk to you guys."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Paul."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Nick Campanella with Barclays. Please proceed with your question."
},
{
"speaker": "Nick Campanella",
"text": "Hey, good morning. Happy Friday."
},
{
"speaker": "Marty Lyons",
"text": "Hello, Nick, same to you."
},
{
"speaker": "Nick Campanella",
"text": "Hey, so I just wanted to ask quickly on the mitigation proposal on Rush Island because I know that you booked this $20 million figure, which was an ongoing hit in your O&M line, but then you kind of mentioned the risk the DOJ is asking for $120 million. And obviously, we’ll see where this goes at the end of the year. But like if it does go against you, is that still an ongoing item in your view? Or is that kind of more one-time in nature?"
},
{
"speaker": "Marty Lyons",
"text": "Nick, it’s a great question. And I think, ultimately, wherever this settles, it really is a one-time item, it is non-recurring. Given the size of it today, we didn’t think it appropriate to sort of carve it out. And as we talked about on our call, we’d look to overcome the cost of that with respect to ongoing operations savings. However, again, as I outlined, the $20 million we proposed and the $120 million of the DOJ propose probably bookends as we think about settlement and an ultimate potential court order here. But like I would agree with you that ultimately, whatever this cost is non-recurring in one-time and won’t be something that affects ongoing operations or earnings."
},
{
"speaker": "Nick Campanella",
"text": "Hey, I really appreciate that. And as it just relates to 2024, I know you’re highlighting that you kind of have this line of sight to O&M in the back half of the plan. So just any comments on how you feel like you’re trending versus your full 2024 number at this point? Are you at the mid-point? Or I guess any comments there?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. Hey Nick, it’s Michael here. Good Friday to you. Yes, look, I mean, we obviously reiterated our range of $450 million to $472 million really focused on the mid-point of that range. The team is completely aligned on flexing what we need to flex here from an O&M perspective. We talked about a number of programs. I think the first part of the year that we put in place with respect to some hiring freezes looking at discretionary spending and looking at contractors, travel, all those kinds of things. And again, those programs are fully ramped up at this point and feeling good about it. We have a long history of this. You’ve heard us talk about this. I mean we’ve been doing a number of things really from an automation and technology investment perspective. We’ve now fully deployed AMI [ph] and we feel we have distribution automation. We’ve done a great deal of stuff from the back office perspective in terms of accounting systems, HR systems, all of those are driving productivity improvements and we’re taking full advantage of. And I was sort of reflecting on the situation and thinking about 2020, that terrible COVID year, we only lost 15% of sales within about a week, and the team came together and really looked for tens of millions of dollars worth of opportunities that will really flex and continue to end up hitting our guidance for that year. I don’t see this as any different. We’ll continue to look for these opportunities. And ultimately, we’re going to make the decisions right for the long-term at the end of the day, but we do have the ability to flex out as we not as needed."
},
{
"speaker": "Nick Campanella",
"text": "That’s really helpful and definitely acknowledge the ability to flex here, especially based on past. One more thing. Just you’re very clear, your 2024 equity needs are basically done outside of internal programs and maybe some DRIP, but just for 2025 and beyond, is $600 million a year still the kind of right number to be thinking about? I think that’s what you guys talked about in the fourth quarter?"
},
{
"speaker": "Michael Moehn",
"text": "Yes, yes, that’s correct. That still stands we delivered back there in February."
},
{
"speaker": "Nick Campanella",
"text": "All right. Have a great day. Thanks."
},
{
"speaker": "Michael Moehn",
"text": "Okay. Thanks for the questions."
},
{
"speaker": "Operator",
"text": "Our final question is from David Paz with Wolfe Research. Please proceed with your question."
},
{
"speaker": "David Paz",
"text": "Good morning."
},
{
"speaker": "Marty Lyons",
"text": "Good morning, David."
},
{
"speaker": "David Paz",
"text": "Could you maybe expand on the data center opportunities? I know you mentioned them, mentioning centers along with some other large customers. But just what opportunity are you seeing there, particularly on the investment side, and maybe any sense of the size of the projects that potentially could come down the pipe and just how much would an incremental investment from Ameren for a typical size project? Thank you."
},
{
"speaker": "Michael Moehn",
"text": "Yes. Hey, good morning, David. I’ll start here. And certainly, Marty, I’ll probably chime in as well. But I mean, I think we have a strong value proposition, right, when it comes to serving both data centers and manufacturers. I mean, we’ve talked about this. We start from a really strong position just in terms of where our rates are, both on the Midwest and national average went well below. We presented a number of sites in both states that can ramp up quickly, sewer water transmission capabilities, et cetera. I’ve never seen state local regional leaders work together as they are right now, really trying to come together on a combined effort, offer various incentives to again, this is beyond just data centers, but manufacturers in general in terms of things around state and local we use taxes, development grants for workforce development, et cetera. We have a number of incentives in place here that are available to customers based on location and size. As we sit here today, Dave, we’ve executed a construction agreement for one data center and it’s got an estimated 250-megawatt lows. That’s sizable for us. We haven’t seen this kind of load growth in a really, really long time. We should be serving that customer by 2026. And I would say, we’re actively working 1,000-plus megawatts beyond that. And so these are all in different stages at this point, they’ll come online differently. But again, I think as we think about the IRP and just adding the renewables and the dispatchable generation that we’ve been adding in the last few years, I mean, this is exactly what we need. And again, all of these projects probably won’t come to fruition, but some of them are really, really moving along nicely. And beyond data centers, there’s just a tremendous amount happening in the manufacturing side as well. I mean, Boeing is the largest manufacturer here in the state of Missouri, started a $1.8 billion expansion here in Jefferson City is also doing a very large expansion, Illinois Wieland rolled products of $500 million expansion. I mean there are a number of projects here that continue – should continue to add to some significant growth. In terms of what that means from a capital perspective, obviously, it’s a net positive. I think we’re going to continue to step back and assess that. But it’s certainly great to see from an investment standpoint and certainly a customer affordability perspective, right? Because it’s going to make it obviously more affordable for all customers at the end of the day."
},
{
"speaker": "David Paz",
"text": "Great. Thank you for that color. Maybe just sneak a quick one. I think you sounded like your tranche, the Tranche 2 initial concept map suggests that there will be some opportunities in your service areas. Any sense how to compare that to what the initial concept at Tranche 1 looks for you guys? Is it roughly the same in terms of potential dollar either size or dollars?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. David, this is Marty. I’ll tell you, well, first of all, the map is encouraging as we shared. And I think if you look at our Slide 11 that we provided, you’ll see substantial proposed additional lines, both in our service territory and in Central Illinois as well as in the Eastern half of Missouri. And so that’s certainly exciting to see. We’re excited that the overall project portfolio was about twice the size of Tranche 1. You – everybody else, I’m sure recalls Tranche show 1 was about a $10 billion portfolio. We ended up having about 25% of that, as we talked about on the call and we were happy to be awarded some directly. We’re very proud to have won all three of the competitive projects that were in our service territory. So we certainly feel good about the way Tranche 1 turned out. It’s too soon to really say what level of investments would be in our service territory from Tranche 2 for really a couple of reasons. One, I would say that the – while we’re excited about these projects that were in our service territory, as you well know, right now, the MISO is going through a process of getting input from stakeholders regarding these proposed projects. And we do expect that as MISO considers the input from various stakeholders that these project plans will be modified. So it’s premature there, number one. Number two, when MISO put out these Tranche 2, they really didn’t assign while they came up with an overall portfolio investment of $17 billion to $23 billion, it really didn’t put any particular quantification of investment value on any particular substations or lines, et cetera. So really premature to even say how much these investment opportunities would be that are shown on this map. So for a couple of reasons, I think it’s premature to say how much of this would be in our service territory. And ultimately, how much would be brownfield or greenfield. So – but I think we will start to see iterations of this through time, and we’re excited that MISO seems to be very much targeting an approval of the Tranche 2 portfolio by mid-September. And so – and it should be pretty exciting over the next few months as we see how this unfolds."
},
{
"speaker": "David Paz",
"text": "Great. Thank you."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "We’ve reached the end of the question-and-answer session. I’d now like to turn the call back over to Marty Lyons for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Great. Well, hey, I want to thank everybody for joining us today. We invite you to attend our Annual Shareholder Meeting, which is next week on May 9. And then Michael and Andrew, look forward to seeing many of you at the AGA Financial Forum in a couple of weeks. With that, thanks, and have a great day and a great weekend."
}
] | Ameren Corporation | 373,264 |
AEE | 1 | 2,025 | 2025-05-02 10:00:00 | Andrew Kirk: Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here’s Marty, who will start on Page 4.
Marty Lyons: Thanks, Andrew. Good morning, everyone. I will begin on Page 4. At Ameren, we remain steadfastly committed to our strategic plan, which continues to drive value for our customers, communities and shareholders. Our focus is clear, deliver reliable, affordable energy while making prudent investments in energy infrastructure. In the first quarter of 2025, we made great strides. Key energy infrastructure investments are enhancing the reliability and resiliency of the system for our 2.5 million electric customers and more than 900,000 natural gas customers across our service territory, ensuring they have the energy they need when they need it and facilitating economic growth in the communities we serve. Today, we’ll provide an update on first quarter performance and how execution of our strategic objectives outlined on this slide are translating into tangible benefits for customers, communities and shareholders. Let’s get started with details on our financial progress this quarter, which I will cover on Page 5. Yesterday, we announced first quarter 2025 earnings of $1.07 per share compared to adjusted earnings of $1.02 per share in the first quarter of 2024. The key drivers of these results are outlined on this slide. We continue to expect 2025 diluted earnings per share to be in the range of $4.85 per share and $5.05 per share. Moving to Page 6. On our call in February, I highlighted some of our top priorities for 2025 as we invest strategically to benefit customers, enhance regulatory frameworks and optimize business processes. The Ameren team’s efforts during the first quarter have already begun to yield positive results, as you can see on Page 7. Starting off, ongoing investments continue to improve the reliability, resiliency, safety and efficiency of service for customers while facilitating and contributing to economic growth. And as we look ahead, more will be required. In February, we filed our analysis with the Missouri Public Service Commission, or MoPSC, supporting a change to Ameren Missouri’s preferred resource plan which calls for significant investments in dispatchable natural gas and renewable generation resources as well as battery storage to ensure reliable service for our customers over the next decade. Enabling such investments requires collaborative efforts among key stakeholders, and we believe regulatory and legislative results this year in Missouri demonstrate a commitment to fostering a constructive environment for investment, which will allow Ameren Missouri to continue to attract capital on favorable terms in order to facilitate economic growth in the state. In April, the Missouri Commission approved a constructive settlement in our electric rate review that supports necessary grid reliability investments, while also maintaining customer rates that are well below national and Midwest averages. And in April, the Missouri General Assembly and Governor enacted comprehensive energy legislation signaling that investment in the state’s utility infrastructure is valued and paving the way for significant economic development within our communities and further job creation. We’re excited about the prospects for growth in Missouri and remain committed to creating lasting value for our customers, communities and shareholders through our strategic investments. Before moving on, I’d like to express my sincere appreciation to our Ameren team members who work safely and efficiently to reliably serve our customers, especially in extreme weather conditions like the cold wintery conditions we experienced in January and the wet windy, and tornadic conditions we experienced in March. And it’s worth noting that the grid hardening investments we have made in recent years performed exceptionally well, considering the severity of the storms. So far in 2025, we have prevented more than 114,000 customer outages through smart switching during major storms, equivalent to more than 30 million outage minutes avoided. For context, this means that our investments in smart technology have prevented more customer outages this quarter alone than in any full year since we began tracking these statistics in 2021. We continue to focus on optimizing our operations to deliver safe, reliable, resilient and affordable energy to our customers. Now moving to Page 8, where we provide more in terms of the Missouri legislative update. In April, the Governor signed Senate Bill 4, a wide-ranging energy bill into law. This bill includes multiple provisions that will support our ability to continue to meet the needs of our customers and maintain the state as an affordable and attractive place to do business. Some of the key provisions of Senate Bill 4 include expansion and extension of plant-in-service accounting, or PISA, a modified integrated resource planning, or IRP process, which accelerates generation project review and requires the Missouri Public Service Commission decision, authority for the commission to grant construction work in progress for qualifying generation investments and authority for the commission to approve use of a forward test year for our Missouri natural gas business. By extending PISA for another seven years through 2035 and expanding PISA to include new natural gas generation, our regulatory framework will continue to support investment in reliable energy for years to come better positioning Ameren Missouri future needs of our customers and communities. Importantly, PISA’s extension and expansion and the modified IRP process are expected to help key stakeholders align more quickly on generation needs and provide more certainty around future investment plans, enhancing our speed to deploy new resources for customers and communities. Turning to Page 9 for an update on the economic development opportunities. Our team is focused on doing all we can from an energy perspective to facilitate growth in our communities. We serve a diverse regional economy that spans multiple sectors, including manufacturing, aviation and defense, food and beverage and biotechnology, among others. In the first quarter, we successfully supported nearly a dozen projects, which will bring over $700 million of capital investment from these businesses and over 1,000 jobs across both states. In Missouri, we continue to expect approximately 5.5% compound annual sales growth from 2025 through 2029, primarily driven by increasing data center demand. Further supporting our growth opportunities, we now have signed construction agreements with data center developers representing a total of approximately 2.3 gigawatts of future demand, up 500 megawatts from our earnings call in February. These developers have demonstrated their confidence and commitment by submitting nonrefundable payments totaling $26 million towards the cost of necessary transmission upgrades. Subject to agreement on rate structure, potential large load customers would sign separate electric service agreements which would specify expected ramp-up schedules among other terms. We continue to expect to file for approval of the proposed rate structure with the MoPSC in the second quarter. While there’s no deadline for commission approval, we are optimistic that we’ll receive a decision and have an effective rate structure before the end of the year. We’re committed to working closely with regulators, customers and stakeholders to ensure we meet the evolving needs in our service territory in a responsible and sustainable manner. Our balanced approach to generation laid out in our IRP ensures reliable service to our customers, while also providing energy to serve rising customer demand and to support economic growth in our communities. On Page 10, we provide a brief update on the 1,200 megawatts of new generation currently under development at Ameren Missouri. These projects remain on schedule and on budget. Notably, we’ve executed contracts to acquire all eight turbines and other long lead time materials needed for our next two simple cycle natural gas energy centers expected to be in service in 2027 and 2028. Further, for solar energy centers under construction, including Vandalia, Bowling Green and Split Rail, nearly all imported equipment needed to execute the projects was in the U.S. prior to the April 2 trade tariff announcements, thereby limiting possible exposure to higher costs associated with announced tariffs on materials imported. We continue to monitor the dynamic tariff situation and work diligently to deliver cost-effective energy resources for our customers. Finally, we expect to file additional certificate of convenience and necessity requests with the commission in the coming months with respect to planned investments in gas generation, solar generation and battery storage. Moving to Page 11 for an update on MISO’s long-range transmission planning portfolios. We’re focused on developing proposals for the Tranche 2.1 long-range transmission planning competitive projects. We will evaluate each bidding opportunity carefully and submit bids for projects where we believe we have a competitive advantage with project design, cost and execution to deliver value for customers in the MISO region. The bid process for the $6.5 billion of competitive projects in the portfolio will take place over this year and next. Further, MISO continues its future scenario redesign efforts, which consider growing demand for energy and the effects of changing resource planning across the region. We’re actively engaged in this analysis with MISO and other transmission owners and expect MISO to issue its final report on the future redesign by the end of the year. Given this time frame, we’d expect work on the identification of Tranche 2.2 projects, which will address further transmission needs in the MISO region to commence as early as December 2025. Moving to Page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of more than $63 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner and powering economic growth in our communities, bringing significant tax base and jobs. Moving to Page 13. In February, we updated our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2025 through 2029. This earnings growth is primarily driven by strong compound annual rate base growth of 9.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. We expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return. I’m confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today and for your continued interest in Ameren. I’ll now turn the call over to Michael.
Michael Moehn: Thanks, Marty, and good morning, everyone. Turning now to Page 15 of our presentation. Yesterday, we reported first quarter 2025 earnings of $1.07 per share compared to adjusted earnings of $1.02 per share for the first quarter of 2024. The key factors that drove the increase are highlighted by segment on this page. Our infrastructure investments to strengthen the energy grid and to provide more energy resources to serve our customers continue to be the primary driver of earnings growth across the company. Further, the economic outlook for our service territories remain strong. In fact, over the 12 trailing months ended in March, Ameren Missouri’s total weather-normalized retail sales have increased by approximately 3% compared to the year ago period. We’ve seen continued strategic wins that highlight the strength of our service territory. Notably, Boeing was recently awarded The Next Generation Air Dominance contract by the federal government valued at least $20 billion. Boeing’s ongoing St. Louis campus expansion to support this contract and other defense work is expected to create a significant number of new jobs and manufacturing work and reaffirms their commitment to the St. Louis community. In addition to aerospace, we’re seeing growth in other sectors of our regional economy such as health care, education services and mining. Turning to Page 16, I’ll provide an update on our 2024 Ameren Missouri’s rate review. In April, the Missouri PSC approved a constructive stipulation and agreement for $355 million annual revenue increase. As our fifth consecutive settlement of electric revenue requirements in the state, this agreement continues our strong track record of achieving win-win results for our customers, communities and shareholders. The agreement does not specify certain details, including return on equity, capital structure or rate base. The agreement provides for the continuation of key trackers and riders, including the fuel adjustment clause. New rates will be effective on June 1. Importantly, new electric rates are expected to remain well below national and Midwest averages. Moving to Page 17. As we think about the remainder of the year, we remain confident in our 2025 guidance range and continue to expect earnings to be in the range of $4.85 to $5.05 per share, and we remain focused on delivering at the midpoint or higher. Here, we have provided the expected quarterly earnings impacts from our 2024 Missouri rate review for the remainder of the year. I encourage you to take these supplemental earnings drivers into consideration as you develop your expectations for quarterly earnings results for the balance of the year. Before moving on, I want to take a moment to discuss the trade tariffs recently proposed by the current administration. As Marty discussed, we have a robust capital spending plans in 2025 and the years ahead to meet critical customer needs. Our sourcing practices are designed to ensure we have materials where we need them and when we need them at competitive prices. In light of uncertainties associated with the tariffs, we are closely examining potential impacts on our capital budget. However, as we said here today, we expect any impact to be very manageable. We will continue to navigate the developing environment to ensure we remain well positioned to execute on our projects on time and as affordably as possible for our customers. Turning to Page 18, we’ll provide a financing update. We continue to feel very good about our financial position and made excellent progress to date on our 2025 financing plan. In March, Ameren Illinois issued $350 million of 5.625% first mortgage bonds due 2055 and Ameren Parent issued $750 million of 5.375% senior unsecured notes due 2035. In April, Ameren Missouri issued $500 million of 5.25% first mortgage bonds due 2035. To date, we have completed over 80% of our debt financings for the year. Also, we continue to systematically layer in hedges to mitigate interest rate exposure with respect to planned future parent debt issuances. Further, in order for us to support our credit ratings and maintain a strong balance sheet while we fund a robust infrastructure plan, we expect to issue approximately $600 million of common equity in 2025. We have sold forward approximately $535 million of equity under our at-the-market or ATM program, consisting of approximately 5.8 million shares, which we expect to issue near the end of this year. And we expect the remainder of our equity needs for the year to be issued under our dividend reinvestment and employee benefit plans. Having utilized most of the capacity available under our existing equity sales distribution program, we expect to increase the program capacity in the coming months to enable additional sales to support equity needs in 2026 and beyond. We’ll continue to be thoughtful about our approach to executing our equity plan. On the balance sheet front, in April, S&P affirmed our BBB+ credit rating, and we expect Moody’s to issue its annual credit opinion update later this month. As we said before, we value our current ratings, and we continue to target credit metrics at or above agency published downgrade thresholds. On Page 19, we provide an update on Illinois Regulatory Matters. Earlier this week, Ameren Illinois requested a $61 million revenue adjustment as part of the annual performance-based rate reconciliation proceeding under the electric multiyear rate plan. This adjustment reflects 2024 actual cost, actual year-end rate base and return on equity and common equity ratios established in the multiyear rate plan. And the Illinois Commerce Commission, or ICC, decision is expected by mid-December and rates reflecting the approved reconciliation adjustment will be effective by January 2026. Before moving on, I’d like to briefly discuss the MISO planning resource auction that took place earlier this week for the upcoming June 2025 through May 2026 planning year. Importantly, there are adequate resources able to maintain reliability across all zones and seasons. That said, new capacity additions did not keep pace with reduced accreditation, suspensions and retirements of generation and slightly reduced imports, which resulted in a notable increase in capacity prices for June through August 2025 in all MISO zones. The results reinforce the need to invest in new regional generation capacity as demand is expected to continue to grow with new large load customer additions and as we expect continued retirement of existing generation. That said, annualized capacity pricing for Zone 5 located in Missouri moderated since the prior year’s auction, due in part to its strategic infrastructure investments in the energy grids, transmission capabilities and generation resources. Changes in energy and capacity prices do not materially affect our earnings for Ameren Missouri or Ameren Illinois as they’re passed on to customers with no markup. In Zone 4, some of our Ameren Illinois customers will see increases in the energy supply component of their bill for the summer months. That will ultimately depend on if they are taking supply services from Ameren Illinois or the terms of their contract with another supplier. Notably, we would expect prices to return to pre-auction levels in October. We remain actively engaged in discussions with key stakeholders to develop long-term solutions to benefit of our Illinois customers by ensuring system reliability, promoting regional generation development and maintaining affordability while supporting the transition to cleaner energy in the state. We will continue to support our customers and communities by connecting them with bill assistance programs and resources where needed. Turning to Page 20. Our Illinois natural gas rate review remains in progress with intervenor and direct testimony expected next week. An ICC decision is expected by early December, with new rates effective later that month. In summary, turning to Page 21, we’re off to a strong start in 2025, and we’re well positioned to continue executing our strategic plan, which will drive consistent superior value for all of our stakeholders. We continue to expect strong earnings per share growth driven by robust rate base growth, disciplined cost management and a strong customer growth pipeline. As we said before, we have the right strategy, the right team and the right culture to capitalize on these opportunities and to create value for our customers and our shareholders. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares [ph] continued to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan. Please proceed with your question.
Jeremy Tonet: Hi good morning.
Marty Lyons: Good morning, Jeremy. Just wanted to start off with the additions as you laid out there. It seems like a lot of activity percolating. And just wanted to see the $350 million [ph] that you referenced there, I just want to make sure that’s separate from the 2.3 gigawatt referenced? Or I just wanted to kind of clarify that point in the outlook there.
Michael Moehn: Hey Jeremy, good morning, it’s Michael. So again, I think the incremental change is 1.8 gigawatt to 2.3 gigawatt. So we signed an additional 500 megawatts under construction agreements related to data centers. And so when you think about that 1.8 gigawatts that we had in the fourth quarter of last year, I mean, that was inclusive of that 350 megawatts. So hopefully, that’s clear. So it’s an incremental 500 megawatts between where we were at the fourth quarter.
Jeremy Tonet: Okay. Got it. And then just wondering if you could expand a bit more, I guess, as these additions continue how that looks for the need for new generation here compounds, I guess, some of the factors that you laid out earlier, just – any other thoughts would be helpful.
Marty Lyons: Yes, Jeremy, this is Marty. Again, thanks for joining us. When we think about the 2.3 gigawatts of data center load growth and you think about it in terms of the sales growth that we’ve laid out, it just gives us greater confidence in some of the sales growth estimates that we’ve provided. And when you went back and you look at the slide that we provided, I think it was Slide 9. We show there is an expectation of 5.5% compound annual sales growth in Missouri, and that is foundational, of course, to the resource plan that we filed, but also that resource plan that we filed has the generation that’s capable of supplying up to that 2 gigawatts of low growth by 2030, that’s shown in the green shaded area on that slide. And we think about this 2.3 gigawatts of data center construction agreements, again, just gives us greater confidence with respect to that sales growth. Now what we’re going to be working on here as we mentioned in our prepared remarks is, we’re going to be filing with the commission a rate construct for these large load customers here in the second quarter. And then we’re going to be working to develop service agreements with the hyperscalers that would use and others that would use these data centers. We expect these customers would sign these separate agreements and amongst other things, those agreements would lay out the ramp-up schedule, minimum load obligations and things like that. With that, we’ll get greater clarity in terms of the ramp-up schedule for these data centers. But if you sign 2.3 gigawatts of construction agreements, for example, you could still have at or less than 2 gigawatts of sales by 2032 depending upon the ramp-up schedule. So we’ll get greater clarity over time. But I think the 2.3 gigawatts certainly gives us greater confidence with respect to the sales growth. And of course, our IRP is tied to our plans. Now, I will say that as the interest in data centers grow, as we continue to explore avenues to provide incremental – incremental generation if needed, but feel like the generation plans that we laid out in that IRP would be adequate to serve this 2.3 gigawatts of load as we see it today.
Jeremy Tonet: Got it. That’s very helpful there. Thanks. I just wanted to go back to the IRA, if you could, and, there’s a lot of uncertainty at this point. But in the market, there’s a lot of attention on transferability if there were any changes there if that was taken away, I guess, the impacts that might have on your plan or how you think about potential offsets there as needed?
Marty Lyons: Yes, Jeremy, we’ll kind of tag team that. It’s certainly a really timely question. As you’ve seen in the press, [indiscernible] is expected to start marking up legislation in the next week or so. And Congress as a whole, I know wants to have a bill on the President’s desk by July 4. So a lot of work to be done here in the near term. So we’re going to see in the coming weeks where compromise can be reached on the tax credits and of course, other important provisions that will be in that legislation for our customers. And really, that’s the key here. I think these tax credits are all about being able to build the generation resources our customers need in the near term at an affordable cost. For us, based on that IRP that I just referred to earlier, which as you know, sort of incorporates in all of the above portfolio of resources, calls for more gas, solar, wind, batteries and eventually, nuclear. And so those tech neutral tax credits, they’re estimated to deliver a little over $2 billion of customer bill savings to our customers over the next 10 years based on that IRP. And that value, of course, doesn’t accrue to shareholders. Those credits reduced customer rates. So maintaining the credits as long as we can, let’s say, into the early 2030s, with Safe Harbor provisions and transferability would be really great for our customers. And the transferability you mentioned is really key. We use that provision today to sell the credits as they’re earned and then pass that cash on to customers. And I see it as the credits and the transferability really go hand-in-hand and are really key to that affordability picture. And so that’s what our – that’s what we’ve been advocating for, when I’ve been in D.C., it’s what our industry is advocating for and what others in D.C. are advocating for. And so look, as we look out over the next few weeks, the sausage making may not be pretty. Congress has a lot to balance in terms of their priorities. But I still remain optimistic we’ll get to a reasonable resolution based on the fact that this is really about – all about energy reliability for our customers, energy dominance, if you will, and customer energy prices. And I think that’s really key at the end of the day. But I’ll let Michael chime in further in terms of our specific plans.
Michael Moehn: Yes. Thanks, Marty, that’s a great overview, and I share Marty’s optimism. This ends up ultimately in a good spot. I think, Jeremy, a couple of things just to keep in mind, I mean, we talked about this before. I mean, we come into this in a position of strength, right? I mean I think our balance sheet is probably one of the stronger in the industry. And so that’s given us a great deal of flexibility. I think as we laid out on our fourth quarter call, we’re averaging about $300 million per year over this five-year plan with respect to credits. And I think the thing that gets a bit nuanced is, I think even in some of the discussions that are going on in D.C., it’s – a lot of this is already associated with projects that are in service or have been safe harbor. And so gets even further nuance down from there. But I mean, you take, for example, 2025, I think we have about, I don’t know, a little less than $300 million worth of credits. So we’ve already realized more than half of that this year, and then we’ll probably realize the rest of that over the next couple of months. But if you kind of go through scenarios and try to parse some of that back, look, I feel good about this. I think it’s manageable at the end of the day, I mean even without those credits. I mean you’re going to end up with higher rate base, obviously. Unfortunately, you’re going to have higher prices for customers. But I do think the cash flow piece is manageable, I think over that kind of 2025 through 2027 time period, kind of where we’re focused on with the rating agencies. We’re at or above that downgrade threshold over that period of time. So we just completed our review with S&P over the last couple of weeks. They again reaffirmed our BBB+ just sit in a really strong position with respect to them. They’re downgrade threshold. Just as a reminder, is 13%. We’ve got quite a bit of cushion over that as well. So again, I feel like we’ve got a lot of flexibility. Again, I share Marty’s optimism. I think this thing lands hopefully in an okay spot. But I think either way, we’re able to work around this in a manageable way.
Jeremy Tonet: Got it. Thank you for the thoughts. No one likes the sausage making. Thanks.
Marty Lyons: All right.
Operator: Our next question comes from Julien Dumoulin-Smith with Jefferies. Please proceed with your question.
Unidentified Analyst: Yes, hi, good morning. It’s Brian Russo [ph] on for Julien. How are you?
Marty Lyons: Great, Brian, Good to have you.
Unidentified Analyst: Just to follow up on the transferability question, the $300 million per year of tax credit monetization manageable. How technically, would you offset that? I think you’ve got an FFO to debt target of 17% every year. Could that be done without additional equity to offset the $300 million? Is there another way for you to accomplish that?
Michael Moehn: Absolutely. I mean, look, again, as I sit here today, what I just said before, I do think this is really manageable. I think even without these credits. And again, it’s – I think you got to get into how much really go away, right? Because I think there is a piece associated with stuff that’s already in service, stuff it’s safe harbor. I really think those probably stay. And even ultimately, if some of that stuff would go away, which seems to be a really draconian way to look at it, I still think it’s manageable without issuing additional equity, again, I think over that three-year period, we’re averaging it right at that downgrade threshold. And look, we continue to advocate with Moody’s, in particular, that downgrade threshold probably should come down too as well. When we look at a couple of our peers, we made some arguments around that, that we think given all the progress that we’ve continued to make regulatorily, legislatively in Missouri, got things stabilized in Illinois that we’re being held to a higher standard, which I think also would give some flexibility. So – but we’ll see where they ultimately go on all of that at the end of the day. But even without that, again, we feel very good about the financing plan that we have in place.
Unidentified Analyst: Okay. Great. And then on the PRP with Smart Plan, I mean, how confident are you on the time line that’s proposed and then the total cost of the $16.2 billion, it’s a diversified mix of like you said, renewables, gas and battery tariffs and obviously, a lot of macro uncertainty, the tariffs and supply chain. Just wanted to get your thoughts on your materials or major equipment type of procurement ahead of the ramp-up in spend?
Michael Moehn: Yes. This is Michael, again, Brian. Yes. Look, we feel great about our plan. I think we’ve talked about this over the past year. So with respect to those two gas turbines that we have in our plan, I mean we took some early action to put contracts in place with respect to the long lead time material and just recognizing the tightness that was getting there in the market. We’ve made payments in excess of $100 million to that supplier to make sure those are secured, feel good about the progress that’s being made there, construction started really on both sides. I think the teams feel very good, not hearing anything from the vendor that causes us any concern at all with respect to those gas turbines. Now we’re turning really our focus to the combined cycle that’s out there in the kind of 2032 time frame. And I think we’ll probably be in a position by the end of this year to have some contracts in place there as well. So that will give us even further confidence. From a renewable standpoint, I think we had a slide in there that talked about 400 megawatts of different projects from a solar perspective. Team has been just super aggressive about getting material on site for all of those projects. I feel very good about avoiding tariffs, most of that – those cells, et cetera, are in the U.S., either on site or they’re in warehouses, et cetera. Construction is well underway. Again, feel very good about what we see over the next few years. We’ll have to continue to kind of work around all these tariff issues. But at the present moment, we feel very good about the construction schedule.
Unidentified Analyst: Great. And then just lastly on your Missouri regulatory strategy, a constructive rate case settlement and with accelerating load growth ramping up in 2026 and beyond. And now with SB 4 support, do you see the cadence of your rate case filings changing? And then a follow-on to that would just be kind of the earned returns that you expect in Missouri now. I think historically, it’s been more of a step-up in terms of lag relative to when you get new rates and just curious there.
Michael Moehn: Yes, you bet. Again, I think the overall settlement, as you just noted, it was constructive. I think I noted in my remarks. I think it’s the fifth one. And so again, I think it’s a win-win for both customers and shareholders. And I think it’s just a reflection of, I think, all the progress that we’ve continued to make both regulatorily and legislatively in Missouri. And then obviously, as Marty went through some of the aspects of Senate Bill 4, again, I think it’s something is incrementally positive to how we think about regulatory lag. Our focus has always been earning as close to that allowed as possible. Mark Birk and the team continue to do a great job there. They’re very mindful of cost, very mindful of the regulatory cycle and getting things in service at the right times. As you noted, I mean, we’ve been on, I’d say, about every kind of two-year cadence. We’re always looking to try to stretch that out as far as we can. But just given the overall kind of super cycle of capital that we’re in, it’s hard to do that even with PISA. You really have to go in and kind of freshen up rates over a couple of years. Look, I think we’ll continue to step back as we – as Marty went through some of the data center opportunities and growth – we’ll evaluate that. I mean it gives us some more flexibility obviously, we want to do that. A lot will depend sort of on the ramp schedules, et cetera, when this stuff comes into place. As long as you can ever stand in Missouri as four years because of the FAC. So at some place between that two- and four-year cycle, but that’s sort of what’s on our mind on how we kind of think about it today.
Unidentified Analyst: Okay, great. Thank you very much.
Michael Moehn: You bet.
Operator: Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question.
Carly Davenport: Hey, good morning. Thanks so much for taking the questions today. Maybe to start, just as we think about the macro environment and the higher degree of uncertainty, is there anything that you’re seeing or hearing from your customers, particularly on the commercial or industrial side giving any early indications of any potential pockets of slowdown or changes in plans for future load?
Michael Moehn: Hey, good morning, Carly. This is Michael. No, not at all. I mean I think even I tried to note this in the remarks, if you kind of step back and it’s difficult when you’re kind of looking on a quarter-by-quarter basis. But if you look at the last trailing 12 months, I mean, the overall growth has still been very, very strong. I noted 3%, it’s across all classes. Again, residential up 1%, commercial up a little bit less, and then industrial it’s a strong 2%. So seeing growth in all areas that’s coming off of a strong year, as we noted in 2024, we ended up 2% there as well. Again, I noted the Boeing opportunity, which I think is tremendous for the country, tremendous for St. Louis, State of Missouri in terms of that F-47 being built here. I think it’s got a lot of long-term benefits. Marty noted a number of other industries [indiscernible]. Folks seem to be kind of weathering the storm, if you will, Marty, and anything to add from your perspective?
Marty Lyons: No, that’s exactly right. I would just say when we look ahead at the sales growth opportunities we have, really, the big thing driving that is this potential data center load hyperscaler interest. And that interest is just continued evidence, obviously, by the 500 megawatts of additional [Technical Difficulty]
Carly Davenport: Hey sorry, the line cut out there for a second. Sorry, can you guys still hear me?
Marty Lyons: Yes. We can now, yes.
Michael Moehn: Hopefully, you can hear us.
Carly Davenport: Great. I missed the last maybe 10 to 15 seconds, Marty of your kind of...
Michael Moehn: It was really important.
Carly Davenport: I know you started out on the data center piece and then I lost you for the last bit there.
Marty Lyons: Yes. Sorry about that. Yes, I was just underscoring that with respect to – because I know there have been some questions out in the market about the hyperscaler interest in data centers. And I just want to underscore, we’re still having very positive, constructive conversations there and moving forward at a steady pace. It’s underscored by obviously the 500 megawatts of additional construction agreements we had signed. But I know your question was about the overall economy, but when we look at some of the sales growth ahead, obviously, foundational to that is this data center demand is hyperscaler interest. And that continues to be just sort of rock solid in terms of how we’re moving forward with those conversations.
Carly Davenport: Great. Thank you for running back through that. Appreciate it. And then maybe just a quick follow-up on the broader capital plan. I know you had some high-level comments in the prepared-on tariffs being manageable. Is there any quantification you can provide on the exposure of the overall capital plan to tariffs? And if there’s any particular vertical that maybe is driving that exposure?
Michael Moehn: You bet. Yes. I mean I think when you kind of step back and look at the overall plan. I mean, just think about it in terms of the $26 billion so Carly, from that, about 65% is labor related, right? So we’re not talking about any tariffs with respect to that at the moment. So 35% is sort of on the material side. And then from there, historically, about 85% or so of that is domestically sourced. I mean the team has really done a nice job over the years developing a kind of a robust, diverse supply chain. So, I feel very, very good about that as we kind of look through where we potentially have some exposure, I think on average, we think over that $26 billion, it could be about 2%. And that’s really before any mitigation and the team will continue to look at it. Most of that’s going to be honestly tied up through some of the battery projects where we haven’t made final decisions yet. The team is kind of working through some final RFP pieces this year. And I think there’s some ability to pivot if we need to, to have some more of that domestically sourced. But also, we may decide to leave it there at the end of the day, if it makes more sense from a reliability standpoint. The quality of the product, et cetera. So again, that 2%, I think, is a very manageable number, I mean, it’s on top of that $26 billion plan that’s over that five years. These are capital projects that we’re talking about. Again, I think we’ll look for ways to try to mitigate that. I don’t want to minimize. Every dollar matters here, right? We don’t want to pass on any more costs than we absolutely have to. So the team will continue to look for ways to pivot and try to bring that down wherever possible. But I think at the highest level, the number is fairly manageable. Hopefully, that gives you some context.
Carly Davenport: That’s really helpful. Thank you so much for the time.
Operator: [Operator Instructions] Our next question comes from Paul Fremont with Ladenburg Thalmann. Please proceed with your question.
Paul Fremont: Thank you very much. I guess is there a cost estimate just on the Castle Bluff 800-megawatt plant now that you procure the turbines?
Michael Moehn: Yes. I think $900 million is the number that I think we may be disclosed in the end of the fourth quarter. So I still feel good about that estimate even as we’ve kind of gone through and freshened up everything from a contract perspective.
Paul Fremont: Great. And then if you were to choose to build additional gas fire generation, do you have a sense of what the cost would be and how long it would take for you to line up the equipment?
Michael Moehn: Well, we do have that other 800-megawatt gas plant that’s in the plan there, the following year. And again, I’ve made some previous comments about this. And again, we have secured the turbines there, we feel good about it. I’d say the costs were a little bit higher, but generally in the range. And more importantly, just feel good about being able to get the project done in that time frame from a reliability standpoint. And then the next one out there is this combined cycle plant, and I alluded to this a couple of minutes ago. I mean the team is in active RFP process and the moment going through and looking at potential turbine vendors, et cetera. And so we’ll have that locked down, I would say, by the end of this year. And so look, obviously, you’re seeing some tightness in the market. We’ll see what that ultimately produces from a cost perspective. but very focused on getting this generation online and the time frame that we’ve laid out there because of all the things that Marty talked about from the data center economic development, just general reliability perspective.
Paul Fremont: Great. Thank you very much.
Michael Moehn: You bet.
Operator: Our next question comes from David Paz with Wolfe Research. Please proceed with your question.
David Paz: Hi, good morning. Thanks for the time.
Michael Moehn: Hey, David.
David Paz: Hey just, I guess, quickly, just as – and I appreciate the update thorough as always. But as you stand today, do you see your EPS growth in the second half of your planning period towards that upper end of 6% to 8%.
Marty Lyons: The answer is yes. David, it does. No change there. as we talked about on our year-end call, certainly, we’ve given guidance of 6% to 8% EPS CAGR for 2025 to 2029. In the short-term, we expect to be at or above the midpoint and meaning this year and next year. But as we see some of this load tick up, which we expect to see that load growth in late 2026 and into 2027, as we talked about in February, we have some of this big CapEx that’s in our IRP that Michael just talked about goes into service in 2027, 2028, it goes into rate base. In those periods, yes, we expect to deliver near the upper end of the range in that middle to latter part of that five-year plan. And so – and look, I’m pleased with the performance this quarter. We talked about the additional construction agreements for data centers, which is giving us added confidence with respect to some of that load growth that we’re seeing. I’ll be honest with you, David. I was just pleased overall with the company’s performance here in the first quarter. I think the Ameren team did a great job making progress on a lot of the strategic goals that we had set for ourselves in Q1 and additionally performed very well operationally despite some weather challenges. And obviously, we delivered solid earnings and growth over last year. So real pleased about all that. We covered a lot of that in prepared remarks, so I won’t tick through at all. But the key is that those things, like the IRP filing, like the constructive rate review settlement in Missouri, Senate Bill 4 in Missouri, the financings that our team completed in this quarter, both debt and equity financings the incremental data center construction agreements, all of the ongoing cost management across the company and the business process improvement efforts that we’ve got underway, all of these things give me greater optimism about the future and confidence that we’re going to be able to invest and grow our economies and deliver great value for our customers, communities and shareholders. So as I sit here today, I think we had a very strong quarter and feel very good about the guidance that we provided back in February.
David Paz: Great. That’s good to hear. Thank you, Marty. Have a good day.
Marty Lyons: You bet, David.
Operator: We have reached the end of the question-and-answer session. I’d now like to turn the call back over to Marty Lyons for closing comments.
Marty Lyons: Great. Well, thank you all for joining us today. We look forward to seeing many of you at the AGA Financial Forum, which is coming up in a few weeks. And with that, thank you. Have a great day and a great weekend.
Operator: This concludes today’s conference. You may disconnect your lines at this time, and we thank you for your participation. | [
{
"speaker": "Andrew Kirk",
"text": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here’s Marty, who will start on Page 4."
},
{
"speaker": "Marty Lyons",
"text": "Thanks, Andrew. Good morning, everyone. I will begin on Page 4. At Ameren, we remain steadfastly committed to our strategic plan, which continues to drive value for our customers, communities and shareholders. Our focus is clear, deliver reliable, affordable energy while making prudent investments in energy infrastructure. In the first quarter of 2025, we made great strides. Key energy infrastructure investments are enhancing the reliability and resiliency of the system for our 2.5 million electric customers and more than 900,000 natural gas customers across our service territory, ensuring they have the energy they need when they need it and facilitating economic growth in the communities we serve. Today, we’ll provide an update on first quarter performance and how execution of our strategic objectives outlined on this slide are translating into tangible benefits for customers, communities and shareholders. Let’s get started with details on our financial progress this quarter, which I will cover on Page 5. Yesterday, we announced first quarter 2025 earnings of $1.07 per share compared to adjusted earnings of $1.02 per share in the first quarter of 2024. The key drivers of these results are outlined on this slide. We continue to expect 2025 diluted earnings per share to be in the range of $4.85 per share and $5.05 per share. Moving to Page 6. On our call in February, I highlighted some of our top priorities for 2025 as we invest strategically to benefit customers, enhance regulatory frameworks and optimize business processes. The Ameren team’s efforts during the first quarter have already begun to yield positive results, as you can see on Page 7. Starting off, ongoing investments continue to improve the reliability, resiliency, safety and efficiency of service for customers while facilitating and contributing to economic growth. And as we look ahead, more will be required. In February, we filed our analysis with the Missouri Public Service Commission, or MoPSC, supporting a change to Ameren Missouri’s preferred resource plan which calls for significant investments in dispatchable natural gas and renewable generation resources as well as battery storage to ensure reliable service for our customers over the next decade. Enabling such investments requires collaborative efforts among key stakeholders, and we believe regulatory and legislative results this year in Missouri demonstrate a commitment to fostering a constructive environment for investment, which will allow Ameren Missouri to continue to attract capital on favorable terms in order to facilitate economic growth in the state. In April, the Missouri Commission approved a constructive settlement in our electric rate review that supports necessary grid reliability investments, while also maintaining customer rates that are well below national and Midwest averages. And in April, the Missouri General Assembly and Governor enacted comprehensive energy legislation signaling that investment in the state’s utility infrastructure is valued and paving the way for significant economic development within our communities and further job creation. We’re excited about the prospects for growth in Missouri and remain committed to creating lasting value for our customers, communities and shareholders through our strategic investments. Before moving on, I’d like to express my sincere appreciation to our Ameren team members who work safely and efficiently to reliably serve our customers, especially in extreme weather conditions like the cold wintery conditions we experienced in January and the wet windy, and tornadic conditions we experienced in March. And it’s worth noting that the grid hardening investments we have made in recent years performed exceptionally well, considering the severity of the storms. So far in 2025, we have prevented more than 114,000 customer outages through smart switching during major storms, equivalent to more than 30 million outage minutes avoided. For context, this means that our investments in smart technology have prevented more customer outages this quarter alone than in any full year since we began tracking these statistics in 2021. We continue to focus on optimizing our operations to deliver safe, reliable, resilient and affordable energy to our customers. Now moving to Page 8, where we provide more in terms of the Missouri legislative update. In April, the Governor signed Senate Bill 4, a wide-ranging energy bill into law. This bill includes multiple provisions that will support our ability to continue to meet the needs of our customers and maintain the state as an affordable and attractive place to do business. Some of the key provisions of Senate Bill 4 include expansion and extension of plant-in-service accounting, or PISA, a modified integrated resource planning, or IRP process, which accelerates generation project review and requires the Missouri Public Service Commission decision, authority for the commission to grant construction work in progress for qualifying generation investments and authority for the commission to approve use of a forward test year for our Missouri natural gas business. By extending PISA for another seven years through 2035 and expanding PISA to include new natural gas generation, our regulatory framework will continue to support investment in reliable energy for years to come better positioning Ameren Missouri future needs of our customers and communities. Importantly, PISA’s extension and expansion and the modified IRP process are expected to help key stakeholders align more quickly on generation needs and provide more certainty around future investment plans, enhancing our speed to deploy new resources for customers and communities. Turning to Page 9 for an update on the economic development opportunities. Our team is focused on doing all we can from an energy perspective to facilitate growth in our communities. We serve a diverse regional economy that spans multiple sectors, including manufacturing, aviation and defense, food and beverage and biotechnology, among others. In the first quarter, we successfully supported nearly a dozen projects, which will bring over $700 million of capital investment from these businesses and over 1,000 jobs across both states. In Missouri, we continue to expect approximately 5.5% compound annual sales growth from 2025 through 2029, primarily driven by increasing data center demand. Further supporting our growth opportunities, we now have signed construction agreements with data center developers representing a total of approximately 2.3 gigawatts of future demand, up 500 megawatts from our earnings call in February. These developers have demonstrated their confidence and commitment by submitting nonrefundable payments totaling $26 million towards the cost of necessary transmission upgrades. Subject to agreement on rate structure, potential large load customers would sign separate electric service agreements which would specify expected ramp-up schedules among other terms. We continue to expect to file for approval of the proposed rate structure with the MoPSC in the second quarter. While there’s no deadline for commission approval, we are optimistic that we’ll receive a decision and have an effective rate structure before the end of the year. We’re committed to working closely with regulators, customers and stakeholders to ensure we meet the evolving needs in our service territory in a responsible and sustainable manner. Our balanced approach to generation laid out in our IRP ensures reliable service to our customers, while also providing energy to serve rising customer demand and to support economic growth in our communities. On Page 10, we provide a brief update on the 1,200 megawatts of new generation currently under development at Ameren Missouri. These projects remain on schedule and on budget. Notably, we’ve executed contracts to acquire all eight turbines and other long lead time materials needed for our next two simple cycle natural gas energy centers expected to be in service in 2027 and 2028. Further, for solar energy centers under construction, including Vandalia, Bowling Green and Split Rail, nearly all imported equipment needed to execute the projects was in the U.S. prior to the April 2 trade tariff announcements, thereby limiting possible exposure to higher costs associated with announced tariffs on materials imported. We continue to monitor the dynamic tariff situation and work diligently to deliver cost-effective energy resources for our customers. Finally, we expect to file additional certificate of convenience and necessity requests with the commission in the coming months with respect to planned investments in gas generation, solar generation and battery storage. Moving to Page 11 for an update on MISO’s long-range transmission planning portfolios. We’re focused on developing proposals for the Tranche 2.1 long-range transmission planning competitive projects. We will evaluate each bidding opportunity carefully and submit bids for projects where we believe we have a competitive advantage with project design, cost and execution to deliver value for customers in the MISO region. The bid process for the $6.5 billion of competitive projects in the portfolio will take place over this year and next. Further, MISO continues its future scenario redesign efforts, which consider growing demand for energy and the effects of changing resource planning across the region. We’re actively engaged in this analysis with MISO and other transmission owners and expect MISO to issue its final report on the future redesign by the end of the year. Given this time frame, we’d expect work on the identification of Tranche 2.2 projects, which will address further transmission needs in the MISO region to commence as early as December 2025. Moving to Page 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of more than $63 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner and powering economic growth in our communities, bringing significant tax base and jobs. Moving to Page 13. In February, we updated our five-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2025 through 2029. This earnings growth is primarily driven by strong compound annual rate base growth of 9.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. We expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return. I’m confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today and for your continued interest in Ameren. I’ll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"text": "Thanks, Marty, and good morning, everyone. Turning now to Page 15 of our presentation. Yesterday, we reported first quarter 2025 earnings of $1.07 per share compared to adjusted earnings of $1.02 per share for the first quarter of 2024. The key factors that drove the increase are highlighted by segment on this page. Our infrastructure investments to strengthen the energy grid and to provide more energy resources to serve our customers continue to be the primary driver of earnings growth across the company. Further, the economic outlook for our service territories remain strong. In fact, over the 12 trailing months ended in March, Ameren Missouri’s total weather-normalized retail sales have increased by approximately 3% compared to the year ago period. We’ve seen continued strategic wins that highlight the strength of our service territory. Notably, Boeing was recently awarded The Next Generation Air Dominance contract by the federal government valued at least $20 billion. Boeing’s ongoing St. Louis campus expansion to support this contract and other defense work is expected to create a significant number of new jobs and manufacturing work and reaffirms their commitment to the St. Louis community. In addition to aerospace, we’re seeing growth in other sectors of our regional economy such as health care, education services and mining. Turning to Page 16, I’ll provide an update on our 2024 Ameren Missouri’s rate review. In April, the Missouri PSC approved a constructive stipulation and agreement for $355 million annual revenue increase. As our fifth consecutive settlement of electric revenue requirements in the state, this agreement continues our strong track record of achieving win-win results for our customers, communities and shareholders. The agreement does not specify certain details, including return on equity, capital structure or rate base. The agreement provides for the continuation of key trackers and riders, including the fuel adjustment clause. New rates will be effective on June 1. Importantly, new electric rates are expected to remain well below national and Midwest averages. Moving to Page 17. As we think about the remainder of the year, we remain confident in our 2025 guidance range and continue to expect earnings to be in the range of $4.85 to $5.05 per share, and we remain focused on delivering at the midpoint or higher. Here, we have provided the expected quarterly earnings impacts from our 2024 Missouri rate review for the remainder of the year. I encourage you to take these supplemental earnings drivers into consideration as you develop your expectations for quarterly earnings results for the balance of the year. Before moving on, I want to take a moment to discuss the trade tariffs recently proposed by the current administration. As Marty discussed, we have a robust capital spending plans in 2025 and the years ahead to meet critical customer needs. Our sourcing practices are designed to ensure we have materials where we need them and when we need them at competitive prices. In light of uncertainties associated with the tariffs, we are closely examining potential impacts on our capital budget. However, as we said here today, we expect any impact to be very manageable. We will continue to navigate the developing environment to ensure we remain well positioned to execute on our projects on time and as affordably as possible for our customers. Turning to Page 18, we’ll provide a financing update. We continue to feel very good about our financial position and made excellent progress to date on our 2025 financing plan. In March, Ameren Illinois issued $350 million of 5.625% first mortgage bonds due 2055 and Ameren Parent issued $750 million of 5.375% senior unsecured notes due 2035. In April, Ameren Missouri issued $500 million of 5.25% first mortgage bonds due 2035. To date, we have completed over 80% of our debt financings for the year. Also, we continue to systematically layer in hedges to mitigate interest rate exposure with respect to planned future parent debt issuances. Further, in order for us to support our credit ratings and maintain a strong balance sheet while we fund a robust infrastructure plan, we expect to issue approximately $600 million of common equity in 2025. We have sold forward approximately $535 million of equity under our at-the-market or ATM program, consisting of approximately 5.8 million shares, which we expect to issue near the end of this year. And we expect the remainder of our equity needs for the year to be issued under our dividend reinvestment and employee benefit plans. Having utilized most of the capacity available under our existing equity sales distribution program, we expect to increase the program capacity in the coming months to enable additional sales to support equity needs in 2026 and beyond. We’ll continue to be thoughtful about our approach to executing our equity plan. On the balance sheet front, in April, S&P affirmed our BBB+ credit rating, and we expect Moody’s to issue its annual credit opinion update later this month. As we said before, we value our current ratings, and we continue to target credit metrics at or above agency published downgrade thresholds. On Page 19, we provide an update on Illinois Regulatory Matters. Earlier this week, Ameren Illinois requested a $61 million revenue adjustment as part of the annual performance-based rate reconciliation proceeding under the electric multiyear rate plan. This adjustment reflects 2024 actual cost, actual year-end rate base and return on equity and common equity ratios established in the multiyear rate plan. And the Illinois Commerce Commission, or ICC, decision is expected by mid-December and rates reflecting the approved reconciliation adjustment will be effective by January 2026. Before moving on, I’d like to briefly discuss the MISO planning resource auction that took place earlier this week for the upcoming June 2025 through May 2026 planning year. Importantly, there are adequate resources able to maintain reliability across all zones and seasons. That said, new capacity additions did not keep pace with reduced accreditation, suspensions and retirements of generation and slightly reduced imports, which resulted in a notable increase in capacity prices for June through August 2025 in all MISO zones. The results reinforce the need to invest in new regional generation capacity as demand is expected to continue to grow with new large load customer additions and as we expect continued retirement of existing generation. That said, annualized capacity pricing for Zone 5 located in Missouri moderated since the prior year’s auction, due in part to its strategic infrastructure investments in the energy grids, transmission capabilities and generation resources. Changes in energy and capacity prices do not materially affect our earnings for Ameren Missouri or Ameren Illinois as they’re passed on to customers with no markup. In Zone 4, some of our Ameren Illinois customers will see increases in the energy supply component of their bill for the summer months. That will ultimately depend on if they are taking supply services from Ameren Illinois or the terms of their contract with another supplier. Notably, we would expect prices to return to pre-auction levels in October. We remain actively engaged in discussions with key stakeholders to develop long-term solutions to benefit of our Illinois customers by ensuring system reliability, promoting regional generation development and maintaining affordability while supporting the transition to cleaner energy in the state. We will continue to support our customers and communities by connecting them with bill assistance programs and resources where needed. Turning to Page 20. Our Illinois natural gas rate review remains in progress with intervenor and direct testimony expected next week. An ICC decision is expected by early December, with new rates effective later that month. In summary, turning to Page 21, we’re off to a strong start in 2025, and we’re well positioned to continue executing our strategic plan, which will drive consistent superior value for all of our stakeholders. We continue to expect strong earnings per share growth driven by robust rate base growth, disciplined cost management and a strong customer growth pipeline. As we said before, we have the right strategy, the right team and the right culture to capitalize on these opportunities and to create value for our customers and our shareholders. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares [ph] continued to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi good morning."
},
{
"speaker": "Marty Lyons",
"text": "Good morning, Jeremy. Just wanted to start off with the additions as you laid out there. It seems like a lot of activity percolating. And just wanted to see the $350 million [ph] that you referenced there, I just want to make sure that’s separate from the 2.3 gigawatt referenced? Or I just wanted to kind of clarify that point in the outlook there."
},
{
"speaker": "Michael Moehn",
"text": "Hey Jeremy, good morning, it’s Michael. So again, I think the incremental change is 1.8 gigawatt to 2.3 gigawatt. So we signed an additional 500 megawatts under construction agreements related to data centers. And so when you think about that 1.8 gigawatts that we had in the fourth quarter of last year, I mean, that was inclusive of that 350 megawatts. So hopefully, that’s clear. So it’s an incremental 500 megawatts between where we were at the fourth quarter."
},
{
"speaker": "Jeremy Tonet",
"text": "Okay. Got it. And then just wondering if you could expand a bit more, I guess, as these additions continue how that looks for the need for new generation here compounds, I guess, some of the factors that you laid out earlier, just – any other thoughts would be helpful."
},
{
"speaker": "Marty Lyons",
"text": "Yes, Jeremy, this is Marty. Again, thanks for joining us. When we think about the 2.3 gigawatts of data center load growth and you think about it in terms of the sales growth that we’ve laid out, it just gives us greater confidence in some of the sales growth estimates that we’ve provided. And when you went back and you look at the slide that we provided, I think it was Slide 9. We show there is an expectation of 5.5% compound annual sales growth in Missouri, and that is foundational, of course, to the resource plan that we filed, but also that resource plan that we filed has the generation that’s capable of supplying up to that 2 gigawatts of low growth by 2030, that’s shown in the green shaded area on that slide. And we think about this 2.3 gigawatts of data center construction agreements, again, just gives us greater confidence with respect to that sales growth. Now what we’re going to be working on here as we mentioned in our prepared remarks is, we’re going to be filing with the commission a rate construct for these large load customers here in the second quarter. And then we’re going to be working to develop service agreements with the hyperscalers that would use and others that would use these data centers. We expect these customers would sign these separate agreements and amongst other things, those agreements would lay out the ramp-up schedule, minimum load obligations and things like that. With that, we’ll get greater clarity in terms of the ramp-up schedule for these data centers. But if you sign 2.3 gigawatts of construction agreements, for example, you could still have at or less than 2 gigawatts of sales by 2032 depending upon the ramp-up schedule. So we’ll get greater clarity over time. But I think the 2.3 gigawatts certainly gives us greater confidence with respect to the sales growth. And of course, our IRP is tied to our plans. Now, I will say that as the interest in data centers grow, as we continue to explore avenues to provide incremental – incremental generation if needed, but feel like the generation plans that we laid out in that IRP would be adequate to serve this 2.3 gigawatts of load as we see it today."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s very helpful there. Thanks. I just wanted to go back to the IRA, if you could, and, there’s a lot of uncertainty at this point. But in the market, there’s a lot of attention on transferability if there were any changes there if that was taken away, I guess, the impacts that might have on your plan or how you think about potential offsets there as needed?"
},
{
"speaker": "Marty Lyons",
"text": "Yes, Jeremy, we’ll kind of tag team that. It’s certainly a really timely question. As you’ve seen in the press, [indiscernible] is expected to start marking up legislation in the next week or so. And Congress as a whole, I know wants to have a bill on the President’s desk by July 4. So a lot of work to be done here in the near term. So we’re going to see in the coming weeks where compromise can be reached on the tax credits and of course, other important provisions that will be in that legislation for our customers. And really, that’s the key here. I think these tax credits are all about being able to build the generation resources our customers need in the near term at an affordable cost. For us, based on that IRP that I just referred to earlier, which as you know, sort of incorporates in all of the above portfolio of resources, calls for more gas, solar, wind, batteries and eventually, nuclear. And so those tech neutral tax credits, they’re estimated to deliver a little over $2 billion of customer bill savings to our customers over the next 10 years based on that IRP. And that value, of course, doesn’t accrue to shareholders. Those credits reduced customer rates. So maintaining the credits as long as we can, let’s say, into the early 2030s, with Safe Harbor provisions and transferability would be really great for our customers. And the transferability you mentioned is really key. We use that provision today to sell the credits as they’re earned and then pass that cash on to customers. And I see it as the credits and the transferability really go hand-in-hand and are really key to that affordability picture. And so that’s what our – that’s what we’ve been advocating for, when I’ve been in D.C., it’s what our industry is advocating for and what others in D.C. are advocating for. And so look, as we look out over the next few weeks, the sausage making may not be pretty. Congress has a lot to balance in terms of their priorities. But I still remain optimistic we’ll get to a reasonable resolution based on the fact that this is really about – all about energy reliability for our customers, energy dominance, if you will, and customer energy prices. And I think that’s really key at the end of the day. But I’ll let Michael chime in further in terms of our specific plans."
},
{
"speaker": "Michael Moehn",
"text": "Yes. Thanks, Marty, that’s a great overview, and I share Marty’s optimism. This ends up ultimately in a good spot. I think, Jeremy, a couple of things just to keep in mind, I mean, we talked about this before. I mean, we come into this in a position of strength, right? I mean I think our balance sheet is probably one of the stronger in the industry. And so that’s given us a great deal of flexibility. I think as we laid out on our fourth quarter call, we’re averaging about $300 million per year over this five-year plan with respect to credits. And I think the thing that gets a bit nuanced is, I think even in some of the discussions that are going on in D.C., it’s – a lot of this is already associated with projects that are in service or have been safe harbor. And so gets even further nuance down from there. But I mean, you take, for example, 2025, I think we have about, I don’t know, a little less than $300 million worth of credits. So we’ve already realized more than half of that this year, and then we’ll probably realize the rest of that over the next couple of months. But if you kind of go through scenarios and try to parse some of that back, look, I feel good about this. I think it’s manageable at the end of the day, I mean even without those credits. I mean you’re going to end up with higher rate base, obviously. Unfortunately, you’re going to have higher prices for customers. But I do think the cash flow piece is manageable, I think over that kind of 2025 through 2027 time period, kind of where we’re focused on with the rating agencies. We’re at or above that downgrade threshold over that period of time. So we just completed our review with S&P over the last couple of weeks. They again reaffirmed our BBB+ just sit in a really strong position with respect to them. They’re downgrade threshold. Just as a reminder, is 13%. We’ve got quite a bit of cushion over that as well. So again, I feel like we’ve got a lot of flexibility. Again, I share Marty’s optimism. I think this thing lands hopefully in an okay spot. But I think either way, we’re able to work around this in a manageable way."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Thank you for the thoughts. No one likes the sausage making. Thanks."
},
{
"speaker": "Marty Lyons",
"text": "All right."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Jefferies. Please proceed with your question."
},
{
"speaker": "Unidentified Analyst",
"text": "Yes, hi, good morning. It’s Brian Russo [ph] on for Julien. How are you?"
},
{
"speaker": "Marty Lyons",
"text": "Great, Brian, Good to have you."
},
{
"speaker": "Unidentified Analyst",
"text": "Just to follow up on the transferability question, the $300 million per year of tax credit monetization manageable. How technically, would you offset that? I think you’ve got an FFO to debt target of 17% every year. Could that be done without additional equity to offset the $300 million? Is there another way for you to accomplish that?"
},
{
"speaker": "Michael Moehn",
"text": "Absolutely. I mean, look, again, as I sit here today, what I just said before, I do think this is really manageable. I think even without these credits. And again, it’s – I think you got to get into how much really go away, right? Because I think there is a piece associated with stuff that’s already in service, stuff it’s safe harbor. I really think those probably stay. And even ultimately, if some of that stuff would go away, which seems to be a really draconian way to look at it, I still think it’s manageable without issuing additional equity, again, I think over that three-year period, we’re averaging it right at that downgrade threshold. And look, we continue to advocate with Moody’s, in particular, that downgrade threshold probably should come down too as well. When we look at a couple of our peers, we made some arguments around that, that we think given all the progress that we’ve continued to make regulatorily, legislatively in Missouri, got things stabilized in Illinois that we’re being held to a higher standard, which I think also would give some flexibility. So – but we’ll see where they ultimately go on all of that at the end of the day. But even without that, again, we feel very good about the financing plan that we have in place."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. Great. And then on the PRP with Smart Plan, I mean, how confident are you on the time line that’s proposed and then the total cost of the $16.2 billion, it’s a diversified mix of like you said, renewables, gas and battery tariffs and obviously, a lot of macro uncertainty, the tariffs and supply chain. Just wanted to get your thoughts on your materials or major equipment type of procurement ahead of the ramp-up in spend?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. This is Michael, again, Brian. Yes. Look, we feel great about our plan. I think we’ve talked about this over the past year. So with respect to those two gas turbines that we have in our plan, I mean we took some early action to put contracts in place with respect to the long lead time material and just recognizing the tightness that was getting there in the market. We’ve made payments in excess of $100 million to that supplier to make sure those are secured, feel good about the progress that’s being made there, construction started really on both sides. I think the teams feel very good, not hearing anything from the vendor that causes us any concern at all with respect to those gas turbines. Now we’re turning really our focus to the combined cycle that’s out there in the kind of 2032 time frame. And I think we’ll probably be in a position by the end of this year to have some contracts in place there as well. So that will give us even further confidence. From a renewable standpoint, I think we had a slide in there that talked about 400 megawatts of different projects from a solar perspective. Team has been just super aggressive about getting material on site for all of those projects. I feel very good about avoiding tariffs, most of that – those cells, et cetera, are in the U.S., either on site or they’re in warehouses, et cetera. Construction is well underway. Again, feel very good about what we see over the next few years. We’ll have to continue to kind of work around all these tariff issues. But at the present moment, we feel very good about the construction schedule."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. And then just lastly on your Missouri regulatory strategy, a constructive rate case settlement and with accelerating load growth ramping up in 2026 and beyond. And now with SB 4 support, do you see the cadence of your rate case filings changing? And then a follow-on to that would just be kind of the earned returns that you expect in Missouri now. I think historically, it’s been more of a step-up in terms of lag relative to when you get new rates and just curious there."
},
{
"speaker": "Michael Moehn",
"text": "Yes, you bet. Again, I think the overall settlement, as you just noted, it was constructive. I think I noted in my remarks. I think it’s the fifth one. And so again, I think it’s a win-win for both customers and shareholders. And I think it’s just a reflection of, I think, all the progress that we’ve continued to make both regulatorily and legislatively in Missouri. And then obviously, as Marty went through some of the aspects of Senate Bill 4, again, I think it’s something is incrementally positive to how we think about regulatory lag. Our focus has always been earning as close to that allowed as possible. Mark Birk and the team continue to do a great job there. They’re very mindful of cost, very mindful of the regulatory cycle and getting things in service at the right times. As you noted, I mean, we’ve been on, I’d say, about every kind of two-year cadence. We’re always looking to try to stretch that out as far as we can. But just given the overall kind of super cycle of capital that we’re in, it’s hard to do that even with PISA. You really have to go in and kind of freshen up rates over a couple of years. Look, I think we’ll continue to step back as we – as Marty went through some of the data center opportunities and growth – we’ll evaluate that. I mean it gives us some more flexibility obviously, we want to do that. A lot will depend sort of on the ramp schedules, et cetera, when this stuff comes into place. As long as you can ever stand in Missouri as four years because of the FAC. So at some place between that two- and four-year cycle, but that’s sort of what’s on our mind on how we kind of think about it today."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay, great. Thank you very much."
},
{
"speaker": "Michael Moehn",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thanks so much for taking the questions today. Maybe to start, just as we think about the macro environment and the higher degree of uncertainty, is there anything that you’re seeing or hearing from your customers, particularly on the commercial or industrial side giving any early indications of any potential pockets of slowdown or changes in plans for future load?"
},
{
"speaker": "Michael Moehn",
"text": "Hey, good morning, Carly. This is Michael. No, not at all. I mean I think even I tried to note this in the remarks, if you kind of step back and it’s difficult when you’re kind of looking on a quarter-by-quarter basis. But if you look at the last trailing 12 months, I mean, the overall growth has still been very, very strong. I noted 3%, it’s across all classes. Again, residential up 1%, commercial up a little bit less, and then industrial it’s a strong 2%. So seeing growth in all areas that’s coming off of a strong year, as we noted in 2024, we ended up 2% there as well. Again, I noted the Boeing opportunity, which I think is tremendous for the country, tremendous for St. Louis, State of Missouri in terms of that F-47 being built here. I think it’s got a lot of long-term benefits. Marty noted a number of other industries [indiscernible]. Folks seem to be kind of weathering the storm, if you will, Marty, and anything to add from your perspective?"
},
{
"speaker": "Marty Lyons",
"text": "No, that’s exactly right. I would just say when we look ahead at the sales growth opportunities we have, really, the big thing driving that is this potential data center load hyperscaler interest. And that interest is just continued evidence, obviously, by the 500 megawatts of additional [Technical Difficulty]"
},
{
"speaker": "Carly Davenport",
"text": "Hey sorry, the line cut out there for a second. Sorry, can you guys still hear me?"
},
{
"speaker": "Marty Lyons",
"text": "Yes. We can now, yes."
},
{
"speaker": "Michael Moehn",
"text": "Hopefully, you can hear us."
},
{
"speaker": "Carly Davenport",
"text": "Great. I missed the last maybe 10 to 15 seconds, Marty of your kind of..."
},
{
"speaker": "Michael Moehn",
"text": "It was really important."
},
{
"speaker": "Carly Davenport",
"text": "I know you started out on the data center piece and then I lost you for the last bit there."
},
{
"speaker": "Marty Lyons",
"text": "Yes. Sorry about that. Yes, I was just underscoring that with respect to – because I know there have been some questions out in the market about the hyperscaler interest in data centers. And I just want to underscore, we’re still having very positive, constructive conversations there and moving forward at a steady pace. It’s underscored by obviously the 500 megawatts of additional construction agreements we had signed. But I know your question was about the overall economy, but when we look at some of the sales growth ahead, obviously, foundational to that is this data center demand is hyperscaler interest. And that continues to be just sort of rock solid in terms of how we’re moving forward with those conversations."
},
{
"speaker": "Carly Davenport",
"text": "Great. Thank you for running back through that. Appreciate it. And then maybe just a quick follow-up on the broader capital plan. I know you had some high-level comments in the prepared-on tariffs being manageable. Is there any quantification you can provide on the exposure of the overall capital plan to tariffs? And if there’s any particular vertical that maybe is driving that exposure?"
},
{
"speaker": "Michael Moehn",
"text": "You bet. Yes. I mean I think when you kind of step back and look at the overall plan. I mean, just think about it in terms of the $26 billion so Carly, from that, about 65% is labor related, right? So we’re not talking about any tariffs with respect to that at the moment. So 35% is sort of on the material side. And then from there, historically, about 85% or so of that is domestically sourced. I mean the team has really done a nice job over the years developing a kind of a robust, diverse supply chain. So, I feel very, very good about that as we kind of look through where we potentially have some exposure, I think on average, we think over that $26 billion, it could be about 2%. And that’s really before any mitigation and the team will continue to look at it. Most of that’s going to be honestly tied up through some of the battery projects where we haven’t made final decisions yet. The team is kind of working through some final RFP pieces this year. And I think there’s some ability to pivot if we need to, to have some more of that domestically sourced. But also, we may decide to leave it there at the end of the day, if it makes more sense from a reliability standpoint. The quality of the product, et cetera. So again, that 2%, I think, is a very manageable number, I mean, it’s on top of that $26 billion plan that’s over that five years. These are capital projects that we’re talking about. Again, I think we’ll look for ways to try to mitigate that. I don’t want to minimize. Every dollar matters here, right? We don’t want to pass on any more costs than we absolutely have to. So the team will continue to look for ways to pivot and try to bring that down wherever possible. But I think at the highest level, the number is fairly manageable. Hopefully, that gives you some context."
},
{
"speaker": "Carly Davenport",
"text": "That’s really helpful. Thank you so much for the time."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Paul Fremont with Ladenburg Thalmann. Please proceed with your question."
},
{
"speaker": "Paul Fremont",
"text": "Thank you very much. I guess is there a cost estimate just on the Castle Bluff 800-megawatt plant now that you procure the turbines?"
},
{
"speaker": "Michael Moehn",
"text": "Yes. I think $900 million is the number that I think we may be disclosed in the end of the fourth quarter. So I still feel good about that estimate even as we’ve kind of gone through and freshened up everything from a contract perspective."
},
{
"speaker": "Paul Fremont",
"text": "Great. And then if you were to choose to build additional gas fire generation, do you have a sense of what the cost would be and how long it would take for you to line up the equipment?"
},
{
"speaker": "Michael Moehn",
"text": "Well, we do have that other 800-megawatt gas plant that’s in the plan there, the following year. And again, I’ve made some previous comments about this. And again, we have secured the turbines there, we feel good about it. I’d say the costs were a little bit higher, but generally in the range. And more importantly, just feel good about being able to get the project done in that time frame from a reliability standpoint. And then the next one out there is this combined cycle plant, and I alluded to this a couple of minutes ago. I mean the team is in active RFP process and the moment going through and looking at potential turbine vendors, et cetera. And so we’ll have that locked down, I would say, by the end of this year. And so look, obviously, you’re seeing some tightness in the market. We’ll see what that ultimately produces from a cost perspective. but very focused on getting this generation online and the time frame that we’ve laid out there because of all the things that Marty talked about from the data center economic development, just general reliability perspective."
},
{
"speaker": "Paul Fremont",
"text": "Great. Thank you very much."
},
{
"speaker": "Michael Moehn",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Paz with Wolfe Research. Please proceed with your question."
},
{
"speaker": "David Paz",
"text": "Hi, good morning. Thanks for the time."
},
{
"speaker": "Michael Moehn",
"text": "Hey, David."
},
{
"speaker": "David Paz",
"text": "Hey just, I guess, quickly, just as – and I appreciate the update thorough as always. But as you stand today, do you see your EPS growth in the second half of your planning period towards that upper end of 6% to 8%."
},
{
"speaker": "Marty Lyons",
"text": "The answer is yes. David, it does. No change there. as we talked about on our year-end call, certainly, we’ve given guidance of 6% to 8% EPS CAGR for 2025 to 2029. In the short-term, we expect to be at or above the midpoint and meaning this year and next year. But as we see some of this load tick up, which we expect to see that load growth in late 2026 and into 2027, as we talked about in February, we have some of this big CapEx that’s in our IRP that Michael just talked about goes into service in 2027, 2028, it goes into rate base. In those periods, yes, we expect to deliver near the upper end of the range in that middle to latter part of that five-year plan. And so – and look, I’m pleased with the performance this quarter. We talked about the additional construction agreements for data centers, which is giving us added confidence with respect to some of that load growth that we’re seeing. I’ll be honest with you, David. I was just pleased overall with the company’s performance here in the first quarter. I think the Ameren team did a great job making progress on a lot of the strategic goals that we had set for ourselves in Q1 and additionally performed very well operationally despite some weather challenges. And obviously, we delivered solid earnings and growth over last year. So real pleased about all that. We covered a lot of that in prepared remarks, so I won’t tick through at all. But the key is that those things, like the IRP filing, like the constructive rate review settlement in Missouri, Senate Bill 4 in Missouri, the financings that our team completed in this quarter, both debt and equity financings the incremental data center construction agreements, all of the ongoing cost management across the company and the business process improvement efforts that we’ve got underway, all of these things give me greater optimism about the future and confidence that we’re going to be able to invest and grow our economies and deliver great value for our customers, communities and shareholders. So as I sit here today, I think we had a very strong quarter and feel very good about the guidance that we provided back in February."
},
{
"speaker": "David Paz",
"text": "Great. That’s good to hear. Thank you, Marty. Have a good day."
},
{
"speaker": "Marty Lyons",
"text": "You bet, David."
},
{
"speaker": "Operator",
"text": "We have reached the end of the question-and-answer session. I’d now like to turn the call back over to Marty Lyons for closing comments."
},
{
"speaker": "Marty Lyons",
"text": "Great. Well, thank you all for joining us today. We look forward to seeing many of you at the AGA Financial Forum, which is coming up in a few weeks. And with that, thank you. Have a great day and a great weekend."
},
{
"speaker": "Operator",
"text": "This concludes today’s conference. You may disconnect your lines at this time, and we thank you for your participation."
}
] | Ameren Corporation | 373,264 |
AEP | 4 | 2,020 | 2021-02-25 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by, and welcome to the American Electric Power Fourth Quarter 2020 Earnings Call. . And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Cynthia. Good morning, everyone, and welcome to the Fourth Quarter 2020 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors.
Nicholas Akins: Good. Thanks, Darcy. And Darcy says happy birthday Bette Jo, this one's for you. But welcome, everyone, to the American Electric Power's Fourth Quarter 2020 Earnings Call. 2020 was a year of tremendous challenges, the likes of which we have never seen. It appears that 2021 has thus far had its own set of challenges. Our hearts go out to everyone that has been and are impacted by the ongoing challenges of COVID, and all the customers impacted by the severe cold and ice conditions that precipitated significant outages from Texas to West Virginia and beyond. There will be plenty of opportunities to do a postmortem of the conditions that led to these outages and to address changes to help ensure these kinds of events do not occur again. But as of now, getting customers back and some return to normalcy is paramount in everyone's mind. I'll discuss these issues a little later, but I want to tell you, in the midst of significant challenges, comes tremendous accomplishments that make us even stronger for the future, and AEP has once again delivered. The fourth quarter further illustrate the resiliency of AEP and its employees to deliver and exceed expectations in ensuring the consistent quality of earnings and dividend growth that you would expect from our premium regulated utility. AEP's operating earnings for the quarter came in at $0.87 a share, ending the year at $4.44 per share, which is the top of the operating earnings range that we projected for 2020, an excellent outcome, buoyed by our employees' aggressive moves to control costs during the COVID downturn of the economy, the arbitrage of residential to industrial and commercial loads that we have discussed in previous earnings calls, and certain tax and investment related outcomes that went our way, along with positive regulatory outcomes in several of our cases that concluded in 2020. Given the progress that we have made on cost control with our Achieving Excellence Program and in updating our load forecast for 2021, AEP is now revising our operating earnings guidance range for 2021, upward from a midpoint of $4.61 per share to $4.65 per share, bringing our new guidance range to $4.55 to $4.75 per share. We're also rebasing our 5% to 7% operating earnings growth rate on the new 2021 guidance range and continue in our view that we would be disappointed not to be in the upper half of the guidance range. AEP is reaffirming our $37 billion 5-year capital plan and are committed to our credit ratings quality as we move forward.
Julia Sloat: Thank you, Nick. Thank you, Darcy, and happy birthday, Bette Jo. It's good to be with everyone this morning. I'm going to walk us through the fourth quarter results, spend a little more time on the full year financial results, share some thoughts on our service territory load and economy, review our balance sheet and liquidity and then we'll finish up with our revised outlook for 2021. So let's go to Slide 6, which shows the comparison of GAAP to operating earnings for the quarter and for the year-to-date periods. GAAP earnings for the fourth quarter were $0.88 per share compared to $0.31 per share in 2019. GAAP earnings for the year were $4.44 per share compared to $3.89 per share in 2019. There's a reconciliation of GAAP to operating earnings on Pages 15 and 16 of the presentation today. So let's walk through our fourth quarter operating earnings performance by segment, which is laid out on Slide 7. Operating earnings for the fourth quarter totaled $0.87 per share compared to $0.60 per share in 2019. The detail by segment is provided in the boxes on the chart. But to summarize, the change in our collective regulated businesses was driven by lower O&M and the return on incremental investment to serve our customers, which more than offset higher depreciation and unfavorable weather. On the generation and marketing side, earnings were up $0.05 from 2019. This was driven by land sales and favorable effects associated with the retirement of plant and the generation business as well as higher wholesale margins. Lower retail margins were offset by the expected timing of income taxes. Corporate and Other was up $0.10 from last year, primarily due to lower taxes relating to state tax adjustments and consolidating items and investment gain on a privately held investment, all of which was partially offset by higher O&M. So let's take a look at our full year results on Page #8. Annual operating earnings for 2020 were $4.44 per share or $2.2 billion compared to $4.24 per share or $2.1 billion in 2019. Looking at the drivers by segment. Operating earnings for Vertically Integrated Utilities were $2.21 per share, up $0.04 year-over-year. Favorable items in this segment included lower O&M, the impact of rate changes across multiple jurisdictions and higher transmission revenue, primarily due to true-ups. Weather was unfavorable due to warmer-than-normal temperatures in 2020 and a warmer summer in 2019. Other decreases included higher depreciation and tax expenses and lower revenue items in AFUDC. Transmission and Distribution Utilities segment earned $1.03 per share, up $0.03 from 2019. Favorable drivers in this segment included higher rate changes, the recovery of increased transmission investment in ERCOT and the impact of the Ohio transmission true-up, both on O&M and transmission revenue. Other O&M was favorable due to the concerted effort to decrease O&M expenditures through onetime and sustainable reductions. These items were partially offset by the 2019 reversal of a regulatory provision in Ohio and higher depreciation associated with the increased investment. Other smaller drivers include things like higher interest and tax expenses. The roll-off of legacy riders in Ohio, prior year Texas carrying charges, unfavorable weather and AFUDC. The transmission - the AEP Transmission Holdco segment contributed $1.03 per share, down $0.02 from 2019 due to the impacts of the annual true-up and prior year FERC settlements. Our fundamental return on investment growth continued as net plant increased by $1.3 billion or 13% since December of 2019. Generation & Marketing produced $0.36 per share, up $0.06 year-over-year. The Renewables business grew with asset acquisitions. Land sales and other onetime items more than offset the impact of weaker wholesale prices on the Generation business and lower retail margins. Finally, Corporate and Other was up $0.09 per share, driven by taxes from lower state taxes and adjustments as well as an investment gain, partially offsetting these items with higher interest expense. Overall, we're pleased with our 2020 financial results as we landed in the upper half of our operating earnings guidance range. So let's take a look at our normalized load for the quarter on Page 9. Starting in the lower right corner, our fourth quarter normalized load came in 0.2% above the fourth quarter of 2019. This was significant, not only because it was the first time we saw positive load growth since the pandemic began, but it was also the strongest quarter for load growth in over 2 years. For the year, AEP's 2020 normalized load finished down 2.2% compared to 2019. Normalized load has continued to improve since bottoming out in the second quarter of 2020 when COVID restrictions were at their highest levels. A strong finish for the year and our retail load is one of the drivers that enabled us to reach the upper end of our guidance range in 2020. I'll talk a little bit more about why this occurred when we get to Slide 11, where we can view some economic data specific to our service territory. But for 2021, we're projecting 0.2% growth in normalized load. While this will be an improvement from the 2.2% decline in 2020, it also shows that our service territory is gradually getting back to its normal growth trajectory. In the upper left quadrant, our normalized residential sales increased by 5.2% in the fourth quarter and ended the year, up 3.2%. For both the quarter and year-to-date comparisons, growth in residential sales was spread across every operating company. Residential loads spiked in the second quarter of 2020 when the COVID restrictions were at their highest and people were spending the majority of their time at home. Looking to this year, while we expect residential sales to decline by 1.1% in 2021 as vaccinations are rolled out and as we migrate to our post-pandemic lives, we are assuming a moderate sustained load benefit from this segment, given the stickiness from work-from-home relationships or arrangements for many office workers across our service territory for the foreseeable future. So let's slide over to commercial sales in the upper right quadrant. Normalized commercial sales decreased by 2.1% in the fourth quarter and finished the year down 4.2%. Even though commercial sales were down across all operating companies in the quarter, we're seeing steady improvement since the pandemic began. In fact, the same sectors that were hardest hit by the shutdowns in the second quarter of 2020 were the most improved sectors in the fourth quarter. Specifically these sectors included schools, churches, restaurants and hotels. As when you look forward to 2021, we expect commercial sales to experience a modest 0.5% decline as the service territory continues to recover, which is still a significant improvement from the record-setting 4.2% decline we saw in 2020. The improvement in commercial sales will likely track with vaccinations and as a service territory population acquires additional immunity, this class of customers should be positioned for a strong recovery. In the lower left chart, industrial sales increased - or decreased by 2% in the quarter, ending the year down 5.7%. Even though industrial sales were down for the quarter in aggregate, we did have a few operating companies, namely I&M, AEP Ohio and AEP Texas post growth in industrial sales compared to the fourth quarter of 2019. Our projection for 2021 assumes industrial sales will continue to recover and end the year, up 1.9%. On Slide 10, we have a little more color on the industrial recovery we saw in the fourth quarter. The blue bar show the growth in sales to our oil and gas customers, led by growth in the pipeline transportation sector. Our total oil and gas sector sales in the fourth quarter came in 1.3% above last year. In fact, the pipeline transportation sector has been the fastest-growing sector since 2018. The orange bars show the growth in industrial sales, excluding oil and gas. While it was still down 3.3% for the quarter, you can see how dramatic the sequential improvement has been since the second quarter. The industrial sectors that are experiencing the strongest growth for the quarter were pipeline transportation and plastics and rubber manufacturing. This is mostly offset by softer demand from oil and gas extraction, mining and primary metals. Overall, we're seeing evidence of faster recovery in the industrial sector, which supports our projected growth in industrial sales for 2021. We anticipate improvements across most sectors with the exception of the coal mining sector as the industry faces headwinds with the shift toward reduced carbon dioxide emissions. So if you join me on Slide 11, I can provide the update, I mentioned a few moments ago, on the latest economic conditions within the AEP footprint. Starting with the chart on the left, you'll notice that AEP service territory experienced a 2% decline in gross regional product compared to the fourth quarter of 2019. This was 40 basis points better than the U.S. The AEP service territory was less impacted by the virus and had fewer restrictions on businesses than other parts of the country, which allowed our territory economy to fare better than the U.S. throughout the pandemic. Looking forward, the AEP service territory is expected to grow by 4.8% in 2021, relatively consistent with the economic recovery in the U.S. Moving to employment on the right, you can see that the job market for the AEP service territory also performed better than the U.S. throughout the pandemic. For the quarter, employment was down 4.6%, which was 1.4% better than the U.S. This is largely the result of the mix of jobs within our local economy, which has a heavier relative concentration of manufacturing and government jobs and a smaller share of leisure and hospitality jobs. Going forward, we expect the job growth of 1.1% in our service territory in 2021. So let's turn over to Page 12 to check on the company's capitalization and liquidity position. Our debt-to-cap ratio increased 0.7% in the fourth quarter to 61.8%. FFO to debt increased by 0.2% during the quarter to 13% on a Moody's basis, primarily due to changes in regulatory assets and working capital. Our liquidity position remains strong at $2.5 billion, supported by our revolving credit facility. I'd like to touch base on a couple of things relating to our financing plan as we receive questions from time to time on this. So our current financing plan does not include an assumption of any asset rotation. I'd like to share that we do believe it is incumbent upon us to engage an analysis of any opportunity within our portfolio that can generate more value for another party than it can generate for us. So to the extent that we engage in such activity that would result in the sale of an asset or a business unit, the associated proceeds would likely supplant some of the planned equity and/or debt financing you see on Page 39 in the appendix of the presentation today. Nick talked about the severe winter weather in Texas, which impacted both SPP and ERCOT. I want to take a moment to provide some quantification exposure details, since that's top of mind for us and also for you. As you know, the winter storm increased the demand for natural gas and limited natural gas supply availability, resulting in unanticipated market prices for natural gas power plants to meet reliability needs for the SPP electric system. PSO's preliminary estimate of natural gas cost and purchases of electricity are approximately $825 million. SWEPCO's preliminary estimate of natural gas cost is $375 million. To provide some perspective, PSO's annual fuel and purchase power costs are roughly $550 million to $600 million. So you get the sense of how big that is. Importantly, PSO and SWEPCO have active fuel clauses that permit recovery of prudently incurred fuel and purchase power expenses. However, we would expect this recovery to likely occur over an extended period of time in an effort to mitigate the impact on customer bills, which is consistent with the filing we submitted yesterday, seeking a regulatory asset and mechanism to recover the costs, inclusive of PSO's weighted average cost of capital. So we're taking this into consideration as it relates to our financing plans since the payments to suppliers are due in March. On that note, we're contemplating the use of long-term debt and the possibility of making funding contributions to PSO and SWEPCO from the parent company. As far as ERCOT exposure goes, as Nick mentioned, this would be related to AEP Texas' receipt of funds from the reps, AEP Renewables' wind generation assets and the wholesale load served by AEP Energy Partners, this exposure should not be significant. Switching gears. Our qualified pension funding increased 5% during the quarter to 101.8%, and our OPEB funding increased 20.4% to 160.9%. Strong equity returns in both plans were the primary driver for the funded status increases during the fourth quarter. The OPEB-planned funded status also benefited from lower-than-expected per capita and Medicare advantage rates, which reduced the liability. So let's go to Slide 13 to do a quick recap of where we've been and where we're going. So we begin 2020 with a proven track record. Our earnings in 2020 - sorry, we began 2021 with a proven track record. Our earnings were strong in 2020, as we continue to invest capital in our businesses and earn a return on this investment in response to expect the decline in sales from the pandemic and early mild weather, we implemented O&M savings from both onetime and sustainable reductions and we also got some help from favorable sales mix shift. We received approval of our North Central Wind project in Oklahoma, and that will be a benefit to our PSO and SWEPCO customers. In addition, over time, we've been able to grow our dividend in line with earnings and expect to be able to do so going forward. Our dividend payout ratio is solidly within our stated target range of 60% to 70%. So as we look forward to 2020, we feel confident in raising our operating earnings guidance range to $4.55 per share to $4.75 per share. This is up from our previously stated 2021 operating earnings guidance range of $4.51 per share to $4.71 per share. There's an operating earnings waterfall on Page 31 of the appendix reflecting the midpoint of this updated guidance. The primary differences from what we shared at EEI relate to normalized load and weather reflecting 2020 actual results as well as continued focus on sustainable O&M savings from lessons learned during the pandemic. Not surprisingly, examples on the O&M front include things like reduced nonessential travel and training since we know now a great deal of this can be done very effectively in a virtual format, sustaining some of the reduction in material and supply expenses, minimizing over time and efficiency modifications in our field crew practices, et cetera, just to name a few. Specifically, we're originally forecasting our 2021 untracked O&M to be $2.7 billion. but now we are forecasting this to be $2.62 billion compared to the $2.68 billion actual for 2020. So as we proceed through 2021, we'll finalize our pending rate cases and move forward with additional opportunities in the renewable space, supporting our ESG focus, as we transition toward a clean energy future. We will continue our disciplined approach to allocating capital, and we're confident there is significant runway in our capital programs to reaffirm our 5% to 7% growth rate of the increased 2021 operating earnings guidance range. So thanks so much for joining us for the call today. With that, I'm going to turn it over to the operator for your questions.
Operator: . And we will go to the line of Shar Pourreza with Guggenheim Securities.
Shahriar Pourreza: Just a couple of questions - just a couple of quick questions here. Nick, just on the Ohio settlement, it seems like you've been kind of close to a resolution for some time now with sort of the procedural schedule being paused to make room for continued dialogue. Is there sort of any pushes and takes we should be sort of thinking about at this juncture? Is the noise in the state, at all, impacting the conversations?
Nicholas Akins: No. The noise - there's no impact there. We continue in discussions with the parties. And the typical issues of distribution riders and ROEs and that kind of thing. So nothing unusual. And like I said, I think some of the discussions are going positively, and the parties continue to engage with one another. And we all know we have March 4 and I think that could actually be 2 or 3 days different as well. But nevertheless, everyone is focused on getting that concluded.
Shahriar Pourreza: Excellent. And then just on the Racine hydro sale, obviously, had an immaterial impact to sort of the financing plan, but it does sort of show kind of your desire to focus on the core business. So how are you sort of thinking about further asset optimization that could potentially offset some of the equity needs related to North Central? Whether we're thinking about a full utility transaction with an underperforming asset, for instance? Or a partial sale transaction may be similar to the Duke-GIC deal? Any sort of updated thoughts here on incremental opportunities you're seeing in the near term?
Nicholas Akins: Yes. There's a lot of creative ways, obviously, and Duke showed one of those, but there's others as well. Yes, we'll continue to look at all of our assets, actually. And as I mentioned in the call, the time for half measures and talk is over. So we've got to get about the process of ensuring that we're making the way to move to that clean energy future. That means we're going to have to make sure that we're rotating capital effectively and dealing with assets from an optimization standpoint in an effective fashion going forward. So that is a prime motivation for us, particularly with maintaining our balance sheet structure the way it is. We want to make absolutely sure that we manage this process actively in all of those ways. So - and that's why Brian is over in the strategy area to focus on some of these activities as well. So we'll continue that approach, and you'll see more to come.
Shahriar Pourreza: Got it. That's helpful. And then lastly for me, just on Rockport 2 and Pirkey. Any sort of additional thoughts there on the replacement generation and potentially what the implications could be sort of this 5-year capital plan you presented this morning?
Nicholas Akins: Yes. The 3,300 megawatts is an incremental 2,400 megawatts of what we had before. And some of that is related to Pirkey obviously. When you talk about Rockport, that's still yet to come. So there's still plenty of analysis getting done of all of our operating jurisdictions. And that's what I've talked about before, where we'll come out with our plans, which will be reflected in our integrated resource plans, and that would accommodate Rockport in any of the other measures that we have in place to move to that clean energy future. So you'll see that, like I said, by the time we get to the first quarter earnings call or before.
Operator: Our next question comes from the line of Steven Fleishman of Wolfe Research.
Steven Fleishman: Just, I guess, first question in terms of the 2021 guidance increase. If you go back to the segment, back to EEI. I think a lot of it is in the Corporate and Other segment. Could you clarify better like what's driving that?
Nicholas Akins: Yes. So in 2020, the Corporate and Other investments, there were some tax-related issues around the tax provisions that were put in place relative to COVID. And then also, there was some investment returns that were actually around - we were an early investor in charge point. And certainly, we had some opportunities there to monetize by the end of the year. And there are warrants that we held. So we continue to invest in different technologies. And we have investments that have gone positively. We've had investments that have gone negatively. And this is - this happened to be a year where it was positive from an investment standpoint. So - but from an ongoing perspective, it really is not so much driven. There still is some investment related activity that bleeds over into '21. But I'd say the story of '21 is, when we had - we didn't know exactly where the load was going, didn't know where the economy was going. We're feeling much better about that and the progress in 2021. And also our Achieving Excellence Program. We continue to advance in a very positive way from that perspective. So we felt like - certainly, the confidence level was much more for us to raise guidance, but also continue to encourage that we'll be in the upper half of that guidance range.
Julia Sloat: And Steve, this is Julie. The items that we're calling out here, obviously, were much more pronounced in the fourth quarter of 2020. And specifically, as it relates to an investment gain and some income tax items, et cetera. And if you look at Page 31 in the slide presentation, you can look again at that full year view, 2020 actual versus 2021 projected or revised projection, and you'll see that we still have a little bit of an investment gain associated with charge point in that particular column around Corporate and Other. And then we'll have a little bit of pickup on the O&M front and offsetting this is going to be some increased interest expense, largely due to continuing to fund the investment program. So we have slightly higher long-term debt balances out there.
Steven Fleishman: Okay. Just to verify because I just want to...
Nicholas Akins: Go ahead. Go ahead, Steve.
Steven Fleishman: So yes, I was just looking at the guidance you gave at EEI for 2021 and then the guidance that you're giving now for 2021. And I think the Corporate and Other is $0.08 better. So it sounds like that's mainly due to a mix of interest savings and then the charge point gains or some other things continuing?
Julia Sloat: As well as some O&M pickup, yes, improvement, I should say.
Steven Fleishman: That shows up in the - okay. And that's in the Corporate segment?
Julia Sloat: Yes. Bingo. Yes.
Steven Fleishman: Got it.
Julia Sloat: Versus what we showed you at EEI. Yes.
Steven Fleishman: Okay. Super helpful. And then one other question just on the SWEPCO new renewable megawatts. Do you have a sense how much of those you are going to be able to own? Are those all owned? Are some of those maybe PPA? Or how do we know the mix...
Nicholas Akins: Yes. We would certainly like to own as much of that as possible because I think it's really important for - from a capital structure perspective and these companies to be well funded and have a firm foundation within the states we serve. We feel like that these generation resources, particularly the renewable resources need to be vested within the operating company. So we'll continue that approach. And that - those are the filings that we'll make. And obviously, some portion of it may wind up being PPAs, but I think we have to get the message across that it's important to the vitality of the operating companies and the operating utilities in these states that we continue to flourish from a capital standpoint. And so I think, obviously, too, the weather events in SPP demonstrate that - and I'm going to be probably testifying again on this pretty soon. But I really think it's important for the utility to have a view of what Generation looks like in these particular events, and the interaction and interoperability of these resources with the transmission and distribution system is incredibly important. I started my career in - as an electrical engineer and system operations, and I went through an ice storm, and actually, I'll tell my age now, it was 1984. But mills were tripping with coal, pipeline was freezing, valves were freezing, all these activities were occurring, and it was our ability to redispatch and utilize the ties and those kinds of things that were important for us to be able to manage through that crisis. And that's why I think it's important for there to be control features in place and from an ownership perspective, be able to focus on ensuring those benefits for our customers. You look at even some of the coal-fired generation that was in place that mitigated some of the impact from a fuel cost perspective going forward with natural gas prices going up so much. So there's a reason for each part the portfolio, and I think it's important for the utility to be the party that runs those particular facilities. So that's my view. And certainly, we'll go into these cases with a firm view toward that.
Operator: Our next question comes from the line of Jeremy Tonet with JPMorgan.
Jeremy Tonet: I just wanted to start off with - on O&M, if I could? Just wanted to see what you guys are seeing there? Because it seems like it's a nice little step down even versus what you guys had at EEI there. And just wondering, if you could provide a bit more color what you see now versus then? And really, the durability of those savings, as you think about 2022 plus, just sticking around all these cost savings that you're pulling out?
Julia Sloat: Yes. This is Julie. Thanks so much for the question. Yes, O&M was a nice benefit to us in 2020. And we're going to try to hang on to as much of that and maybe a little bit more for 2021, as you can see in our forecast. So the things that we're looking to, would be things that are not only onetime in nature, but then obviously sustainable and try to take the learnings that we were able to glean from the pandemic really and how we had to operate in different ways. So things that we're talking about include things like data analytics, automation, digital tools, drone usage, outsourcing, workforce planning and then other related items, essentially, those types of things that I mentioned in my kind of preamble at the beginning of the call here. So reducing nonessential travel and training. I mean we've been able to be very successful in a virtual format. So that actually brings a fair amount of cost savings into the pocket as well, reduce materials and supplies to the extent that we can continue to rein in on advertising, minimizing overtime, et cetera. So we're looking at this from more of a sustainability or sustainable perspective, and we'll see what else we can kind of pull out of the hat in terms of additional learnings as we go forward. So it's a little bit of everything. So I can't particularly point you at one thing. And in fact, it's a variety of the entire team pooling together to be able to make this stuff come to fruition. And the track records there, we've been able to do it. So we're going to continue to turn the crank.
Jeremy Tonet: That's very helpful. And maybe just pivoting over towards the renewables. I think you mentioned 10 gigawatts of wind and solar generation in regulated states by 2030, you're looking to add there. And just wondering, if you could provide a bit more color on where you think that could fall out jurisdiction wise? It seems like SWEPCO has a good focus here. Just wondering where else you might be seeing the potential over that time frame?
Nicholas Akins: Yes. That's a number that continues to be in play, obviously. We originally had - I think it was like 7,500, 8,000 megawatts of renewables last time we showed and then adding the 2,400 gets to 10,000 or so. And then as we further update this analysis, like I said, by our first quarter earnings you'll see more renewables being placed in as well. So I think it is a work in progress.
Jeremy Tonet: Got it. Okay. We'll stay tuned there. And just last one, if I could. Post the elections here, just wondering Biden's plan for 2035, if that impacts you directly? And also with the new FERC - ahead of FERC here, just wondering what that could mean on the transmission side if you see kind of more supportive actions there and what opportunities that could bring to AEP?
Nicholas Akins: Yes, I think we'll see - continue to see supportive actions by FERC-related transmission because obviously, the build-out necessary to support renewables and clean energy is something that the Biden administration is taking on. And I'd be highly surprised if there's any let up on that. As a matter of fact, they're probably more aggressive than what the industry feels like they can do at this point. But certainly, in order to do that and aggressively meet the kind of targets that are being placed out there, transmission will play a critical role and that means AEP.
Operator: Our next question comes from the line of Durgesh Chopra with Evercore ISI.
Durgesh Chopra: So just, Julie, real quick, I just want to make sure I have this right. The storm - the last week's storm-related costs, I think when you add those numbers up between PSO and SWEPCO, roughly north of $1 billion, $1.2 billion, call it, the financing plan, the interest-related charges. Are those incorporated into your 2021 guidance numbers?
Julia Sloat: Not yet. No. And so we have not yet updated our financing plan. We're actually holding tight just a bit here until we get a little more clarity on exactly how this stuff is going to roll out, and we have firming up of all those numbers. As I mentioned, we made an application at the commission in Oklahoma. So that's another piece of that as well, and we will update you as we continue to move forward and make those crystallized plans for you. But as I mentioned, what you can largely anticipate is taking on a little bit more debt. Obviously, you're picking up on that with the increased potential interest expense. And obviously looking to be able to be sensitive to the customer needs, as they try to absorb this cost, but then also managing the balance sheet and the metrics that we really need to have to stay at that Baa2 stable type rating and arrangement.
Durgesh Chopra: Got it. Okay. Understood. So I guess maybe just in terms of the interest charges and other things, looks like, at least, near term, you're going to borrow debt. Is there a sort of plan to offset that with O&M or other savings in the business?
Julia Sloat: Yes. Yes. As a matter of fact, there are a couple of things that I'd point out. Number one, we're always going to work to mitigate any potential unforeseen risk, right? So plan do check, adjust as we move through the dynamic year. And the other thing that you may recall, me making a statement about, specifically, in my opening comments here, that application that we made at - for PSO in Oklahoma, specifically called out the fact that we were looking for a regulatory asset with a mechanism that included a WACC. And so that's incredibly important to us as well. I know Nick made the comment several times through his opening comments regarding making sure that our balance sheet metrics are intact. Having a WACC helps us do that because we need to be able to preserve the financial integrity of the operating companies as well as the entire enterprise. So those are the things that we'll be looking at. It's early. Yes. It's early.
Durgesh Chopra: Understood. Understood. And then just 1 quick follow-up on the Ohio rate case - Ohio settlement discussions on the rate case there. The March 4, is that the drop-dead date or can that be extended?
Nicholas Akins: Yes. It can be extended. But obviously, everyone is sort of geared towards March 4, but it could be extended.
Operator: Our next question comes from the line of Julien Dumoulin-Smith from Bank of America.
Julien Dumoulin-Smith: So Nick, maybe to start here. You seem passionate about it, and I'm quite curious. I mean you guys have a footprint that stretches RTOs here. How do you think about what reforms and weatherization looks like here? And how that could impact your capital budget? I hear your comments about reserve margins, et cetera, I was just curious if you can elaborate a little bit further? What are your lessons learned from 2014 and 1984 here, as you see them being applied perhaps in Texas holistically? And especially as you see your specific dialogues kicking off whether in Texas, or frankly, the other adjacent states as well?
Nicholas Akins: Yes. So in 2014, I really testified over 3 issues. One was capacity markets and understanding the value of capacity and certainly 24/7 baseload generation. But also the second part of it was the - at that point in 2014, it was the dash to gas. And then was gas and renewables, if we're going to depend upon natural gas for substantial part supply in this country, then we really have to reinforce the ability for natural gas to perform during these types of events. And that means someone's going to have to be able to pay for it and markets will have to compensate generators for those kinds of investments. And then for the utility system itself, it really is around infrastructure to support resiliency and hardening of the system. And also, one of the other areas, I talked about in 2014, was how quickly we retire units and what the replacements of those are and how we're changing the nature of the generation mix and those have different factors associated with the planning and operation of the grid. So those are critical areas where I think for really, if I were to opine on Texas, it'd be more around market reform to support weatherization, market reform around communications that exist during crisis times because it's important for operators to know and even T&D operators to know where the generation is coming from to make adjustments from a transmission and distribution standpoint. And so when you think about some of these opportunities that exist for us, it seems projects, on the seams of the RTOs, is particularly important to have interchange capability. Now for Texas, it may be more DC ties, it could be - well, obviously, it could be more transmission in general, but Texas will have to decide that. But I think there's opportunities for more levels of interchange, more ability to put infrastructure in place to support weatherization and then market changes to support the ability for capacity to be valued the way it should be based upon its contribution to the total grid. So those are key points that continue, and really, we sort of see - let me - with California, you sort of see the same thing. I mean they're depending on heavy level of imports from out of state. If out of state has issues, then they have issues internal, within the state. So when you think about all those things, I think the planning and the optimization of what occurs is going to really carry the day in terms of our ability to better take care of these types of situations.
Julien Dumoulin-Smith: Got it. Excellent. And if I could just quickly could clarify your earlier comments here? To quote you, I think you used the expression, "no time for half measures and talk is over." Can you elaborate a little bit on the timing there, just as you think about it? And obviously, you're already moving, is probably a question for Brian more than Nick. But what's the timing of this, just to make sure we're on the same page here? Whatever it...
Nicholas Akins: Yes. I think you have to see those decisions start this year because when you think about - I think what's crystallized for us is really the path that we're taking. We're moving to a clean energy future. We need to be able to move from a regulatory standpoint to ensure that we're achieving the balance sheet capacity to do the things that need to be done for the transition and the optimization of the grid, and I think it's really important for us to be able to manage internally, not only from an OEM perspective, but also our assets, with generally what the assets are that contribute to not only an improved return for our investors, but also in terms of optimization of the business itself. So that will be part of the path because you have 2 - you really have 2 - maybe 3 forcing functions, but, one of those is the movement to a clean energy economy, the other is the capital structure and balance sheet of the company and then the third is really focused on those 2 objectives, but ensuring that we're moving forward with infrastructure development and grid development to support resiliency and reliability of the grid. Those things, together, along with electrification, I think, are really going to be tailwinds for this industry going forward, but in particular, AEP is the largest transmission provider, we have a large distribution footprint and we have a significant amount, as I said in the last earnings call, we were on the precipice of clean energy transformation. So a lot of opportunity for AEP. We just need to make sure we manage all those throttles to ensure that we're consistently driving forward.
Operator: Next, we will go to the line of James Thalacker with BMO Capital Markets.
James Thalacker: Julie addressed some of the asset rotation to mitigate your financing needs. But yes, Nick, it's been a while since you've kind of, I guess, updated how you're thinking about how you prioritize growth via the different channels that are in front of you. I mean, obviously, Chuck's working on the nonregulated side on renewables, and you've got plenty of opportunities of regulated growth on the renewable side transmission. Just wondering like how are you thinking about inorganic growth maybe on the regulated side? Or how are you prioritizing sort of all those different opportunities in front of you?
Nicholas Akins: Yes. So obviously, our priorities are around transmission, distribution infrastructure, certainly, on the regulated transformation of the resources that are ongoing. Chuck's business is really with AEP Energy and so forth. They've done a great job of managing risk around that business, but they've also done a great job in terms of their allocation of capital and being able to manage it, not only within their own part of the business, but also in total - the entire enterprise. So Chuck is more than willing to turn capital over, if it's a better use anywhere else in the corporation and vice versa. But we like for that business to be less than 10% of the overall business. So - and it continues to track that. And it gives us the ability to, not only further optimize that business, and you're seeing continued - really continued opportunities on that part of the business with AEP OnSite Partners on special relationships with customers around resources that really drive tremendous benefit for us because we can also approach that on the regulated side as well. So I think there's an opportunity there. But certainly, our focus is ensuring that we're able to move forward with this clean energy transformation and all the optimization around the grid and the grid resiliency and the issues there and do it in a very pragmatic way. That means we're going to have to make sure that whoever is progressing better from that perspective, that's where the equity is going to go, and we need to ensure that we're managing that portfolio in that fashion. So we can now look at this business like it's a fully regulated business, and we can make decisions based upon - there obviously are things that we look at, like, what's the quality of the service territory? What's the quality of the regulatory environment? What's the ongoing view of valuation of any particular entity for us, for someone else? And what that means in terms of rotation of capital in terms of optimization? So we are continuing that approach. And I would say that we said in the past that if we - for all of our utilities, if we see the ability to continue sustainable growth and quality growth in those jurisdictions, they make a lot of sense to us. And then, of course, we have to look at also those that are challenged and understand what those challenges are, can we erase those challenges? Are they systemic challenges? Those are the kinds of things we have to look at, and we'll continue to do that, and that's what Brian is doing.
James Thalacker: Okay. Great. And just I guess, just 1 last follow-up on that because I know we're running up on time here. But I mean, when you look at like all the opportunities like you just rolled out another 2,400 megawatts of renewables. Transmission has always been something you've had plenty of opportunities, too. Like do you still look at those opportunities like where you can put earning assets in that like 1x rate base as your best opportunities? Or do you see, as you look across the landscape, like inorganic, maybe M&A or regulated properties or something that makes sense? Or is it just better to kind of stick to your point in the jurisdictions where you see the growth, it's visible, and you've got a good regulatory sort of opportunity to achieve your goals?
Nicholas Akins: Yes. I think our primary focus is due to 1x. And with the organic growth that's occurred and that's really why the previous question about whether we want to own the renewable assets or not? The question is, if we own those renewable assets and that gives us more capacity to be able to invest and we can take full advantage of tax benefits and other things that enable us to continue to organically grow. And as I said earlier, we have a very high threshold for M&A because we do feel like that we have plenty of opportunities. We just have to manage the portfolio in a way that optimizes that going forward. And so that's the way we sort of think about it. And then from an M&A perspective, it has to be strategic, it has to be accretive for shareholders, it has to be something that really produces strategic benefit for us in some fashion of what we're trying to do. But again, that's a high threshold.
Operator: Our next question comes from the line of Andrew Weisel with Scotiabank.
Andrew Weisel: Thanks for all the good detail on renewables. I just want to dig into 1 or 2 relative to your CapEx outlook. You mentioned the incremental capacity at SWEPCO, and then you mentioned that you'll do an AEP-wide regulated renewable plan in the coming months. Would a lot of that be incremental to the $37 billion? I know a lot of the spending will probably come after 2025, but do you think of that as upside to the plan?
Nicholas Akins: Yes. We would - it's early to tell, but we would like it to be incremental. So we'll be working to help support that. And obviously, as you said, some of its 2025, some of its 2028. So as we progress, we want to make sure, okay, if cash flow increases, load continues to improve, optimization of capital deployed makes a lot of - has a lot of benefit associated with that, then there's a lot of parts in the puzzle, sort of like when we did North Central, we didn't know what the financing plan for that was and we continued to focus on that one. And then we'll also continue to focus on trying to make sure that they are seen as incremental. That's our focus. So whether we have to obviate some of that with the redeployment of capital or not remains to be seen, but the target is for it to be incremental.
Andrew Weisel: Okay. Great. And then on the RFP at SWEPCO, you mentioned that you'd prefer to own those assets. Do you plan to bid in from the contracted renewables business as well as from the regulated utility?
Nicholas Akins: Well, from the contracted renewables business - our contracted renewables business are maybe rules associated with that. But just like with North Central, we did sort of a turnkey-type thing that really allows us to time the recovery with the investment itself. That's always sort of a preferred opportunity for us because it really is handled well from a financial standpoint and also handled well from a risk standpoint relative to the construction and customers, the risk to customers as well. So I think we probably stick with something like that and whether our contracted business is on the back end or not is another question. I mean, obviously, we don't really care if it's our contracted business or someone else as long as at the end of the day, we wind up owning it.
Andrew Weisel: Yes. Got it. That makes sense. Then one last one, just to clarify. I think you said you still want that contracted renewables to be capped at about 10% of the company, did I hear you right? And given the overall growing demand for renewables across the country and support out of DC, does that mean that you'll be more selective in your projects or look for higher returns at lower risk? How do you think about that dynamic?
Nicholas Akins: Yes. No. Yes, that's exactly right. We've always managed that business around higher returns. We want to be commensurate on a levered basis with our regulated businesses. And we will continue - as a matter of fact, we turn away a lot more projects than what we actually move forward with. And as you probably have seen, I guess, it seems to get more aggressive all the time about what the return levels are. And it's really - the difference is really what people say at the end of a contract, what that terminal value is. And we really don't want to get into that kind of war. We really focus on those relationships with customers and developers that help us move forward with very positive projects, and that's the way we'll continue to look at that business. And then OnSite Partners and others with specific customer-related issues, like, for example, here in Columbus, we have several businesses that we have signed up for a joint renewables project that we continue to focus on, and we do aggregation of customers in Columbus, which was approved by a referendum vote that AEP Energy would be doing. So it's those kinds of things that we can mix and match with the - and tailor the relationship that the customer is looking for. I think that's what we are after.
Julia Sloat: Just to circle back real quickly, too, if I could, just an additional comment. As it relates to that threshold in terms of business mix, there are a couple of reasons why that 10% makes sense for us. Number one, to a credit profile risk management perspective, that's very important for us. So that's something we keep top of mind. And the other is really on tax shield associated with debt. So we've got a couple of things that we're sensitive to and just continue to high grade the earnings opportunities from our unregulated contracted renewables business. But that gives you probably a little bit more perspective if that wasn't already top of mind for you because it surely is for us.
Nicholas Akins: Yes.
Andrew Weisel: Okay. Very helpful. And I just want to echo the congrats to Julie and congrats to the team on another strong year.
Nicholas Akins: Thank you.
Julia Sloat: Thank you.
Operator: Our final question will come from the line of Paul Patterson with Glenrock Associates.
Paul Patterson: So just some quick follow-up, just on the Oklahoma filing, I haven't had a chance to look at it. The - how long do you guys expect to - my understanding, if I heard you correctly, that you're asking for a weighted average cost of capital. I was wondering how long do you expect to have the - how long will it take to amortize the asset, I guess, with your filings?
Julia Sloat: Yes. Well, actually, we haven't been prescriptive in our filings. So we've got a little flexibility there. And so that's another reason why I kind of mentioned, we're thinking about any potential financing in the interim and how that would map to any potential outcome there. I do know that one of our peer companies out in Oklahoma made a similar filing, and I believe that it was 10 years on theirs as well as a WACC to give you a kind of perspective, but we want to be sensitive to customer bills as well as I'm sure you can imagine.
Paul Patterson: Okay. Sure. And when do you think we'll get some sort of feedback from the commission?
Julia Sloat: Probably a couple of months. I don't have a time line yet.
Paul Patterson: Sure. It's all early.
Julia Sloat: Yes.
Paul Patterson: And then just on - a really quick one on APCo. As I recall, you guys were granted rehearing in the - yes, the case. And you guys are also currently filing an appeal, and I was just - if you could elaborate a little bit more on that? Because I thought there wasn't a decision on - okay.
Nicholas Akins: Yes. That's right. Yes, we did file for rehearing, and it was granted and the parties are filing briefs and it stands with the commission. But also, we filed in the Virginia Supreme Court. So - because we're not wasting any time.
Paul Patterson: Okay. Okay. So just to sort of understand it procedurally, do you expect to get sign from the Supreme Court before the commission or the commission, I would think, normally before the Supreme Court?
Nicholas Akins: Yes. It's normally the commission before the Supreme Court. But obviously, we feel like it's such an important issue and a focus on what we believe state law says as they - it's important for the Supreme Court to resolve that issue in case the commission doesn't.
Paul Patterson: Okay. And do you know when would the commission might come out? Or any - is there a schedule on that? Or is it just whenever they want to?
Nicholas Akins: Yes. I think it's whenever they want.
Operator: And speakers, do you have any closing comments?
Julia Sloat: We do. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Cynthia, would you please give the replay information?
Operator: Certainly. And ladies and gentlemen, today's conference call will be available for replay after 6:30 p.m. today until 5 a.m. March 4. You may access the AT&T teleconference replay system by dialing 866-207-1041 and entering the access code of 9187414. International participants may dial 402-970-0847. Those numbers, once again, 866-207-1041 or 402-970-0847 and enter the access code of 9187414. That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by, and welcome to the American Electric Power Fourth Quarter 2020 Earnings Call. . And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Cynthia. Good morning, everyone, and welcome to the Fourth Quarter 2020 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors."
},
{
"speaker": "Nicholas Akins",
"text": "Good. Thanks, Darcy. And Darcy says happy birthday Bette Jo, this one's for you. But welcome, everyone, to the American Electric Power's Fourth Quarter 2020 Earnings Call. 2020 was a year of tremendous challenges, the likes of which we have never seen. It appears that 2021 has thus far had its own set of challenges. Our hearts go out to everyone that has been and are impacted by the ongoing challenges of COVID, and all the customers impacted by the severe cold and ice conditions that precipitated significant outages from Texas to West Virginia and beyond. There will be plenty of opportunities to do a postmortem of the conditions that led to these outages and to address changes to help ensure these kinds of events do not occur again. But as of now, getting customers back and some return to normalcy is paramount in everyone's mind. I'll discuss these issues a little later, but I want to tell you, in the midst of significant challenges, comes tremendous accomplishments that make us even stronger for the future, and AEP has once again delivered. The fourth quarter further illustrate the resiliency of AEP and its employees to deliver and exceed expectations in ensuring the consistent quality of earnings and dividend growth that you would expect from our premium regulated utility. AEP's operating earnings for the quarter came in at $0.87 a share, ending the year at $4.44 per share, which is the top of the operating earnings range that we projected for 2020, an excellent outcome, buoyed by our employees' aggressive moves to control costs during the COVID downturn of the economy, the arbitrage of residential to industrial and commercial loads that we have discussed in previous earnings calls, and certain tax and investment related outcomes that went our way, along with positive regulatory outcomes in several of our cases that concluded in 2020. Given the progress that we have made on cost control with our Achieving Excellence Program and in updating our load forecast for 2021, AEP is now revising our operating earnings guidance range for 2021, upward from a midpoint of $4.61 per share to $4.65 per share, bringing our new guidance range to $4.55 to $4.75 per share. We're also rebasing our 5% to 7% operating earnings growth rate on the new 2021 guidance range and continue in our view that we would be disappointed not to be in the upper half of the guidance range. AEP is reaffirming our $37 billion 5-year capital plan and are committed to our credit ratings quality as we move forward."
},
{
"speaker": "Julia Sloat",
"text": "Thank you, Nick. Thank you, Darcy, and happy birthday, Bette Jo. It's good to be with everyone this morning. I'm going to walk us through the fourth quarter results, spend a little more time on the full year financial results, share some thoughts on our service territory load and economy, review our balance sheet and liquidity and then we'll finish up with our revised outlook for 2021. So let's go to Slide 6, which shows the comparison of GAAP to operating earnings for the quarter and for the year-to-date periods. GAAP earnings for the fourth quarter were $0.88 per share compared to $0.31 per share in 2019. GAAP earnings for the year were $4.44 per share compared to $3.89 per share in 2019. There's a reconciliation of GAAP to operating earnings on Pages 15 and 16 of the presentation today. So let's walk through our fourth quarter operating earnings performance by segment, which is laid out on Slide 7. Operating earnings for the fourth quarter totaled $0.87 per share compared to $0.60 per share in 2019. The detail by segment is provided in the boxes on the chart. But to summarize, the change in our collective regulated businesses was driven by lower O&M and the return on incremental investment to serve our customers, which more than offset higher depreciation and unfavorable weather. On the generation and marketing side, earnings were up $0.05 from 2019. This was driven by land sales and favorable effects associated with the retirement of plant and the generation business as well as higher wholesale margins. Lower retail margins were offset by the expected timing of income taxes. Corporate and Other was up $0.10 from last year, primarily due to lower taxes relating to state tax adjustments and consolidating items and investment gain on a privately held investment, all of which was partially offset by higher O&M. So let's take a look at our full year results on Page #8. Annual operating earnings for 2020 were $4.44 per share or $2.2 billion compared to $4.24 per share or $2.1 billion in 2019. Looking at the drivers by segment. Operating earnings for Vertically Integrated Utilities were $2.21 per share, up $0.04 year-over-year. Favorable items in this segment included lower O&M, the impact of rate changes across multiple jurisdictions and higher transmission revenue, primarily due to true-ups. Weather was unfavorable due to warmer-than-normal temperatures in 2020 and a warmer summer in 2019. Other decreases included higher depreciation and tax expenses and lower revenue items in AFUDC. Transmission and Distribution Utilities segment earned $1.03 per share, up $0.03 from 2019. Favorable drivers in this segment included higher rate changes, the recovery of increased transmission investment in ERCOT and the impact of the Ohio transmission true-up, both on O&M and transmission revenue. Other O&M was favorable due to the concerted effort to decrease O&M expenditures through onetime and sustainable reductions. These items were partially offset by the 2019 reversal of a regulatory provision in Ohio and higher depreciation associated with the increased investment. Other smaller drivers include things like higher interest and tax expenses. The roll-off of legacy riders in Ohio, prior year Texas carrying charges, unfavorable weather and AFUDC. The transmission - the AEP Transmission Holdco segment contributed $1.03 per share, down $0.02 from 2019 due to the impacts of the annual true-up and prior year FERC settlements. Our fundamental return on investment growth continued as net plant increased by $1.3 billion or 13% since December of 2019. Generation & Marketing produced $0.36 per share, up $0.06 year-over-year. The Renewables business grew with asset acquisitions. Land sales and other onetime items more than offset the impact of weaker wholesale prices on the Generation business and lower retail margins. Finally, Corporate and Other was up $0.09 per share, driven by taxes from lower state taxes and adjustments as well as an investment gain, partially offsetting these items with higher interest expense. Overall, we're pleased with our 2020 financial results as we landed in the upper half of our operating earnings guidance range. So let's take a look at our normalized load for the quarter on Page 9. Starting in the lower right corner, our fourth quarter normalized load came in 0.2% above the fourth quarter of 2019. This was significant, not only because it was the first time we saw positive load growth since the pandemic began, but it was also the strongest quarter for load growth in over 2 years. For the year, AEP's 2020 normalized load finished down 2.2% compared to 2019. Normalized load has continued to improve since bottoming out in the second quarter of 2020 when COVID restrictions were at their highest levels. A strong finish for the year and our retail load is one of the drivers that enabled us to reach the upper end of our guidance range in 2020. I'll talk a little bit more about why this occurred when we get to Slide 11, where we can view some economic data specific to our service territory. But for 2021, we're projecting 0.2% growth in normalized load. While this will be an improvement from the 2.2% decline in 2020, it also shows that our service territory is gradually getting back to its normal growth trajectory. In the upper left quadrant, our normalized residential sales increased by 5.2% in the fourth quarter and ended the year, up 3.2%. For both the quarter and year-to-date comparisons, growth in residential sales was spread across every operating company. Residential loads spiked in the second quarter of 2020 when the COVID restrictions were at their highest and people were spending the majority of their time at home. Looking to this year, while we expect residential sales to decline by 1.1% in 2021 as vaccinations are rolled out and as we migrate to our post-pandemic lives, we are assuming a moderate sustained load benefit from this segment, given the stickiness from work-from-home relationships or arrangements for many office workers across our service territory for the foreseeable future. So let's slide over to commercial sales in the upper right quadrant. Normalized commercial sales decreased by 2.1% in the fourth quarter and finished the year down 4.2%. Even though commercial sales were down across all operating companies in the quarter, we're seeing steady improvement since the pandemic began. In fact, the same sectors that were hardest hit by the shutdowns in the second quarter of 2020 were the most improved sectors in the fourth quarter. Specifically these sectors included schools, churches, restaurants and hotels. As when you look forward to 2021, we expect commercial sales to experience a modest 0.5% decline as the service territory continues to recover, which is still a significant improvement from the record-setting 4.2% decline we saw in 2020. The improvement in commercial sales will likely track with vaccinations and as a service territory population acquires additional immunity, this class of customers should be positioned for a strong recovery. In the lower left chart, industrial sales increased - or decreased by 2% in the quarter, ending the year down 5.7%. Even though industrial sales were down for the quarter in aggregate, we did have a few operating companies, namely I&M, AEP Ohio and AEP Texas post growth in industrial sales compared to the fourth quarter of 2019. Our projection for 2021 assumes industrial sales will continue to recover and end the year, up 1.9%. On Slide 10, we have a little more color on the industrial recovery we saw in the fourth quarter. The blue bar show the growth in sales to our oil and gas customers, led by growth in the pipeline transportation sector. Our total oil and gas sector sales in the fourth quarter came in 1.3% above last year. In fact, the pipeline transportation sector has been the fastest-growing sector since 2018. The orange bars show the growth in industrial sales, excluding oil and gas. While it was still down 3.3% for the quarter, you can see how dramatic the sequential improvement has been since the second quarter. The industrial sectors that are experiencing the strongest growth for the quarter were pipeline transportation and plastics and rubber manufacturing. This is mostly offset by softer demand from oil and gas extraction, mining and primary metals. Overall, we're seeing evidence of faster recovery in the industrial sector, which supports our projected growth in industrial sales for 2021. We anticipate improvements across most sectors with the exception of the coal mining sector as the industry faces headwinds with the shift toward reduced carbon dioxide emissions. So if you join me on Slide 11, I can provide the update, I mentioned a few moments ago, on the latest economic conditions within the AEP footprint. Starting with the chart on the left, you'll notice that AEP service territory experienced a 2% decline in gross regional product compared to the fourth quarter of 2019. This was 40 basis points better than the U.S. The AEP service territory was less impacted by the virus and had fewer restrictions on businesses than other parts of the country, which allowed our territory economy to fare better than the U.S. throughout the pandemic. Looking forward, the AEP service territory is expected to grow by 4.8% in 2021, relatively consistent with the economic recovery in the U.S. Moving to employment on the right, you can see that the job market for the AEP service territory also performed better than the U.S. throughout the pandemic. For the quarter, employment was down 4.6%, which was 1.4% better than the U.S. This is largely the result of the mix of jobs within our local economy, which has a heavier relative concentration of manufacturing and government jobs and a smaller share of leisure and hospitality jobs. Going forward, we expect the job growth of 1.1% in our service territory in 2021. So let's turn over to Page 12 to check on the company's capitalization and liquidity position. Our debt-to-cap ratio increased 0.7% in the fourth quarter to 61.8%. FFO to debt increased by 0.2% during the quarter to 13% on a Moody's basis, primarily due to changes in regulatory assets and working capital. Our liquidity position remains strong at $2.5 billion, supported by our revolving credit facility. I'd like to touch base on a couple of things relating to our financing plan as we receive questions from time to time on this. So our current financing plan does not include an assumption of any asset rotation. I'd like to share that we do believe it is incumbent upon us to engage an analysis of any opportunity within our portfolio that can generate more value for another party than it can generate for us. So to the extent that we engage in such activity that would result in the sale of an asset or a business unit, the associated proceeds would likely supplant some of the planned equity and/or debt financing you see on Page 39 in the appendix of the presentation today. Nick talked about the severe winter weather in Texas, which impacted both SPP and ERCOT. I want to take a moment to provide some quantification exposure details, since that's top of mind for us and also for you. As you know, the winter storm increased the demand for natural gas and limited natural gas supply availability, resulting in unanticipated market prices for natural gas power plants to meet reliability needs for the SPP electric system. PSO's preliminary estimate of natural gas cost and purchases of electricity are approximately $825 million. SWEPCO's preliminary estimate of natural gas cost is $375 million. To provide some perspective, PSO's annual fuel and purchase power costs are roughly $550 million to $600 million. So you get the sense of how big that is. Importantly, PSO and SWEPCO have active fuel clauses that permit recovery of prudently incurred fuel and purchase power expenses. However, we would expect this recovery to likely occur over an extended period of time in an effort to mitigate the impact on customer bills, which is consistent with the filing we submitted yesterday, seeking a regulatory asset and mechanism to recover the costs, inclusive of PSO's weighted average cost of capital. So we're taking this into consideration as it relates to our financing plans since the payments to suppliers are due in March. On that note, we're contemplating the use of long-term debt and the possibility of making funding contributions to PSO and SWEPCO from the parent company. As far as ERCOT exposure goes, as Nick mentioned, this would be related to AEP Texas' receipt of funds from the reps, AEP Renewables' wind generation assets and the wholesale load served by AEP Energy Partners, this exposure should not be significant. Switching gears. Our qualified pension funding increased 5% during the quarter to 101.8%, and our OPEB funding increased 20.4% to 160.9%. Strong equity returns in both plans were the primary driver for the funded status increases during the fourth quarter. The OPEB-planned funded status also benefited from lower-than-expected per capita and Medicare advantage rates, which reduced the liability. So let's go to Slide 13 to do a quick recap of where we've been and where we're going. So we begin 2020 with a proven track record. Our earnings in 2020 - sorry, we began 2021 with a proven track record. Our earnings were strong in 2020, as we continue to invest capital in our businesses and earn a return on this investment in response to expect the decline in sales from the pandemic and early mild weather, we implemented O&M savings from both onetime and sustainable reductions and we also got some help from favorable sales mix shift. We received approval of our North Central Wind project in Oklahoma, and that will be a benefit to our PSO and SWEPCO customers. In addition, over time, we've been able to grow our dividend in line with earnings and expect to be able to do so going forward. Our dividend payout ratio is solidly within our stated target range of 60% to 70%. So as we look forward to 2020, we feel confident in raising our operating earnings guidance range to $4.55 per share to $4.75 per share. This is up from our previously stated 2021 operating earnings guidance range of $4.51 per share to $4.71 per share. There's an operating earnings waterfall on Page 31 of the appendix reflecting the midpoint of this updated guidance. The primary differences from what we shared at EEI relate to normalized load and weather reflecting 2020 actual results as well as continued focus on sustainable O&M savings from lessons learned during the pandemic. Not surprisingly, examples on the O&M front include things like reduced nonessential travel and training since we know now a great deal of this can be done very effectively in a virtual format, sustaining some of the reduction in material and supply expenses, minimizing over time and efficiency modifications in our field crew practices, et cetera, just to name a few. Specifically, we're originally forecasting our 2021 untracked O&M to be $2.7 billion. but now we are forecasting this to be $2.62 billion compared to the $2.68 billion actual for 2020. So as we proceed through 2021, we'll finalize our pending rate cases and move forward with additional opportunities in the renewable space, supporting our ESG focus, as we transition toward a clean energy future. We will continue our disciplined approach to allocating capital, and we're confident there is significant runway in our capital programs to reaffirm our 5% to 7% growth rate of the increased 2021 operating earnings guidance range. So thanks so much for joining us for the call today. With that, I'm going to turn it over to the operator for your questions."
},
{
"speaker": "Operator",
"text": ". And we will go to the line of Shar Pourreza with Guggenheim Securities."
},
{
"speaker": "Shahriar Pourreza",
"text": "Just a couple of questions - just a couple of quick questions here. Nick, just on the Ohio settlement, it seems like you've been kind of close to a resolution for some time now with sort of the procedural schedule being paused to make room for continued dialogue. Is there sort of any pushes and takes we should be sort of thinking about at this juncture? Is the noise in the state, at all, impacting the conversations?"
},
{
"speaker": "Nicholas Akins",
"text": "No. The noise - there's no impact there. We continue in discussions with the parties. And the typical issues of distribution riders and ROEs and that kind of thing. So nothing unusual. And like I said, I think some of the discussions are going positively, and the parties continue to engage with one another. And we all know we have March 4 and I think that could actually be 2 or 3 days different as well. But nevertheless, everyone is focused on getting that concluded."
},
{
"speaker": "Shahriar Pourreza",
"text": "Excellent. And then just on the Racine hydro sale, obviously, had an immaterial impact to sort of the financing plan, but it does sort of show kind of your desire to focus on the core business. So how are you sort of thinking about further asset optimization that could potentially offset some of the equity needs related to North Central? Whether we're thinking about a full utility transaction with an underperforming asset, for instance? Or a partial sale transaction may be similar to the Duke-GIC deal? Any sort of updated thoughts here on incremental opportunities you're seeing in the near term?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. There's a lot of creative ways, obviously, and Duke showed one of those, but there's others as well. Yes, we'll continue to look at all of our assets, actually. And as I mentioned in the call, the time for half measures and talk is over. So we've got to get about the process of ensuring that we're making the way to move to that clean energy future. That means we're going to have to make sure that we're rotating capital effectively and dealing with assets from an optimization standpoint in an effective fashion going forward. So that is a prime motivation for us, particularly with maintaining our balance sheet structure the way it is. We want to make absolutely sure that we manage this process actively in all of those ways. So - and that's why Brian is over in the strategy area to focus on some of these activities as well. So we'll continue that approach, and you'll see more to come."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. That's helpful. And then lastly for me, just on Rockport 2 and Pirkey. Any sort of additional thoughts there on the replacement generation and potentially what the implications could be sort of this 5-year capital plan you presented this morning?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. The 3,300 megawatts is an incremental 2,400 megawatts of what we had before. And some of that is related to Pirkey obviously. When you talk about Rockport, that's still yet to come. So there's still plenty of analysis getting done of all of our operating jurisdictions. And that's what I've talked about before, where we'll come out with our plans, which will be reflected in our integrated resource plans, and that would accommodate Rockport in any of the other measures that we have in place to move to that clean energy future. So you'll see that, like I said, by the time we get to the first quarter earnings call or before."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steven Fleishman of Wolfe Research."
},
{
"speaker": "Steven Fleishman",
"text": "Just, I guess, first question in terms of the 2021 guidance increase. If you go back to the segment, back to EEI. I think a lot of it is in the Corporate and Other segment. Could you clarify better like what's driving that?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. So in 2020, the Corporate and Other investments, there were some tax-related issues around the tax provisions that were put in place relative to COVID. And then also, there was some investment returns that were actually around - we were an early investor in charge point. And certainly, we had some opportunities there to monetize by the end of the year. And there are warrants that we held. So we continue to invest in different technologies. And we have investments that have gone positively. We've had investments that have gone negatively. And this is - this happened to be a year where it was positive from an investment standpoint. So - but from an ongoing perspective, it really is not so much driven. There still is some investment related activity that bleeds over into '21. But I'd say the story of '21 is, when we had - we didn't know exactly where the load was going, didn't know where the economy was going. We're feeling much better about that and the progress in 2021. And also our Achieving Excellence Program. We continue to advance in a very positive way from that perspective. So we felt like - certainly, the confidence level was much more for us to raise guidance, but also continue to encourage that we'll be in the upper half of that guidance range."
},
{
"speaker": "Julia Sloat",
"text": "And Steve, this is Julie. The items that we're calling out here, obviously, were much more pronounced in the fourth quarter of 2020. And specifically, as it relates to an investment gain and some income tax items, et cetera. And if you look at Page 31 in the slide presentation, you can look again at that full year view, 2020 actual versus 2021 projected or revised projection, and you'll see that we still have a little bit of an investment gain associated with charge point in that particular column around Corporate and Other. And then we'll have a little bit of pickup on the O&M front and offsetting this is going to be some increased interest expense, largely due to continuing to fund the investment program. So we have slightly higher long-term debt balances out there."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. Just to verify because I just want to..."
},
{
"speaker": "Nicholas Akins",
"text": "Go ahead. Go ahead, Steve."
},
{
"speaker": "Steven Fleishman",
"text": "So yes, I was just looking at the guidance you gave at EEI for 2021 and then the guidance that you're giving now for 2021. And I think the Corporate and Other is $0.08 better. So it sounds like that's mainly due to a mix of interest savings and then the charge point gains or some other things continuing?"
},
{
"speaker": "Julia Sloat",
"text": "As well as some O&M pickup, yes, improvement, I should say."
},
{
"speaker": "Steven Fleishman",
"text": "That shows up in the - okay. And that's in the Corporate segment?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. Bingo. Yes."
},
{
"speaker": "Steven Fleishman",
"text": "Got it."
},
{
"speaker": "Julia Sloat",
"text": "Versus what we showed you at EEI. Yes."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. Super helpful. And then one other question just on the SWEPCO new renewable megawatts. Do you have a sense how much of those you are going to be able to own? Are those all owned? Are some of those maybe PPA? Or how do we know the mix..."
},
{
"speaker": "Nicholas Akins",
"text": "Yes. We would certainly like to own as much of that as possible because I think it's really important for - from a capital structure perspective and these companies to be well funded and have a firm foundation within the states we serve. We feel like that these generation resources, particularly the renewable resources need to be vested within the operating company. So we'll continue that approach. And that - those are the filings that we'll make. And obviously, some portion of it may wind up being PPAs, but I think we have to get the message across that it's important to the vitality of the operating companies and the operating utilities in these states that we continue to flourish from a capital standpoint. And so I think, obviously, too, the weather events in SPP demonstrate that - and I'm going to be probably testifying again on this pretty soon. But I really think it's important for the utility to have a view of what Generation looks like in these particular events, and the interaction and interoperability of these resources with the transmission and distribution system is incredibly important. I started my career in - as an electrical engineer and system operations, and I went through an ice storm, and actually, I'll tell my age now, it was 1984. But mills were tripping with coal, pipeline was freezing, valves were freezing, all these activities were occurring, and it was our ability to redispatch and utilize the ties and those kinds of things that were important for us to be able to manage through that crisis. And that's why I think it's important for there to be control features in place and from an ownership perspective, be able to focus on ensuring those benefits for our customers. You look at even some of the coal-fired generation that was in place that mitigated some of the impact from a fuel cost perspective going forward with natural gas prices going up so much. So there's a reason for each part the portfolio, and I think it's important for the utility to be the party that runs those particular facilities. So that's my view. And certainly, we'll go into these cases with a firm view toward that."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "I just wanted to start off with - on O&M, if I could? Just wanted to see what you guys are seeing there? Because it seems like it's a nice little step down even versus what you guys had at EEI there. And just wondering, if you could provide a bit more color what you see now versus then? And really, the durability of those savings, as you think about 2022 plus, just sticking around all these cost savings that you're pulling out?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. This is Julie. Thanks so much for the question. Yes, O&M was a nice benefit to us in 2020. And we're going to try to hang on to as much of that and maybe a little bit more for 2021, as you can see in our forecast. So the things that we're looking to, would be things that are not only onetime in nature, but then obviously sustainable and try to take the learnings that we were able to glean from the pandemic really and how we had to operate in different ways. So things that we're talking about include things like data analytics, automation, digital tools, drone usage, outsourcing, workforce planning and then other related items, essentially, those types of things that I mentioned in my kind of preamble at the beginning of the call here. So reducing nonessential travel and training. I mean we've been able to be very successful in a virtual format. So that actually brings a fair amount of cost savings into the pocket as well, reduce materials and supplies to the extent that we can continue to rein in on advertising, minimizing overtime, et cetera. So we're looking at this from more of a sustainability or sustainable perspective, and we'll see what else we can kind of pull out of the hat in terms of additional learnings as we go forward. So it's a little bit of everything. So I can't particularly point you at one thing. And in fact, it's a variety of the entire team pooling together to be able to make this stuff come to fruition. And the track records there, we've been able to do it. So we're going to continue to turn the crank."
},
{
"speaker": "Jeremy Tonet",
"text": "That's very helpful. And maybe just pivoting over towards the renewables. I think you mentioned 10 gigawatts of wind and solar generation in regulated states by 2030, you're looking to add there. And just wondering, if you could provide a bit more color on where you think that could fall out jurisdiction wise? It seems like SWEPCO has a good focus here. Just wondering where else you might be seeing the potential over that time frame?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. That's a number that continues to be in play, obviously. We originally had - I think it was like 7,500, 8,000 megawatts of renewables last time we showed and then adding the 2,400 gets to 10,000 or so. And then as we further update this analysis, like I said, by our first quarter earnings you'll see more renewables being placed in as well. So I think it is a work in progress."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Okay. We'll stay tuned there. And just last one, if I could. Post the elections here, just wondering Biden's plan for 2035, if that impacts you directly? And also with the new FERC - ahead of FERC here, just wondering what that could mean on the transmission side if you see kind of more supportive actions there and what opportunities that could bring to AEP?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes, I think we'll see - continue to see supportive actions by FERC-related transmission because obviously, the build-out necessary to support renewables and clean energy is something that the Biden administration is taking on. And I'd be highly surprised if there's any let up on that. As a matter of fact, they're probably more aggressive than what the industry feels like they can do at this point. But certainly, in order to do that and aggressively meet the kind of targets that are being placed out there, transmission will play a critical role and that means AEP."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Durgesh Chopra with Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"text": "So just, Julie, real quick, I just want to make sure I have this right. The storm - the last week's storm-related costs, I think when you add those numbers up between PSO and SWEPCO, roughly north of $1 billion, $1.2 billion, call it, the financing plan, the interest-related charges. Are those incorporated into your 2021 guidance numbers?"
},
{
"speaker": "Julia Sloat",
"text": "Not yet. No. And so we have not yet updated our financing plan. We're actually holding tight just a bit here until we get a little more clarity on exactly how this stuff is going to roll out, and we have firming up of all those numbers. As I mentioned, we made an application at the commission in Oklahoma. So that's another piece of that as well, and we will update you as we continue to move forward and make those crystallized plans for you. But as I mentioned, what you can largely anticipate is taking on a little bit more debt. Obviously, you're picking up on that with the increased potential interest expense. And obviously looking to be able to be sensitive to the customer needs, as they try to absorb this cost, but then also managing the balance sheet and the metrics that we really need to have to stay at that Baa2 stable type rating and arrangement."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Okay. Understood. So I guess maybe just in terms of the interest charges and other things, looks like, at least, near term, you're going to borrow debt. Is there a sort of plan to offset that with O&M or other savings in the business?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. Yes. As a matter of fact, there are a couple of things that I'd point out. Number one, we're always going to work to mitigate any potential unforeseen risk, right? So plan do check, adjust as we move through the dynamic year. And the other thing that you may recall, me making a statement about, specifically, in my opening comments here, that application that we made at - for PSO in Oklahoma, specifically called out the fact that we were looking for a regulatory asset with a mechanism that included a WACC. And so that's incredibly important to us as well. I know Nick made the comment several times through his opening comments regarding making sure that our balance sheet metrics are intact. Having a WACC helps us do that because we need to be able to preserve the financial integrity of the operating companies as well as the entire enterprise. So those are the things that we'll be looking at. It's early. Yes. It's early."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Understood. And then just 1 quick follow-up on the Ohio rate case - Ohio settlement discussions on the rate case there. The March 4, is that the drop-dead date or can that be extended?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. It can be extended. But obviously, everyone is sort of geared towards March 4, but it could be extended."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Julien Dumoulin-Smith from Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "So Nick, maybe to start here. You seem passionate about it, and I'm quite curious. I mean you guys have a footprint that stretches RTOs here. How do you think about what reforms and weatherization looks like here? And how that could impact your capital budget? I hear your comments about reserve margins, et cetera, I was just curious if you can elaborate a little bit further? What are your lessons learned from 2014 and 1984 here, as you see them being applied perhaps in Texas holistically? And especially as you see your specific dialogues kicking off whether in Texas, or frankly, the other adjacent states as well?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. So in 2014, I really testified over 3 issues. One was capacity markets and understanding the value of capacity and certainly 24/7 baseload generation. But also the second part of it was the - at that point in 2014, it was the dash to gas. And then was gas and renewables, if we're going to depend upon natural gas for substantial part supply in this country, then we really have to reinforce the ability for natural gas to perform during these types of events. And that means someone's going to have to be able to pay for it and markets will have to compensate generators for those kinds of investments. And then for the utility system itself, it really is around infrastructure to support resiliency and hardening of the system. And also, one of the other areas, I talked about in 2014, was how quickly we retire units and what the replacements of those are and how we're changing the nature of the generation mix and those have different factors associated with the planning and operation of the grid. So those are critical areas where I think for really, if I were to opine on Texas, it'd be more around market reform to support weatherization, market reform around communications that exist during crisis times because it's important for operators to know and even T&D operators to know where the generation is coming from to make adjustments from a transmission and distribution standpoint. And so when you think about some of these opportunities that exist for us, it seems projects, on the seams of the RTOs, is particularly important to have interchange capability. Now for Texas, it may be more DC ties, it could be - well, obviously, it could be more transmission in general, but Texas will have to decide that. But I think there's opportunities for more levels of interchange, more ability to put infrastructure in place to support weatherization and then market changes to support the ability for capacity to be valued the way it should be based upon its contribution to the total grid. So those are key points that continue, and really, we sort of see - let me - with California, you sort of see the same thing. I mean they're depending on heavy level of imports from out of state. If out of state has issues, then they have issues internal, within the state. So when you think about all those things, I think the planning and the optimization of what occurs is going to really carry the day in terms of our ability to better take care of these types of situations."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Excellent. And if I could just quickly could clarify your earlier comments here? To quote you, I think you used the expression, \"no time for half measures and talk is over.\" Can you elaborate a little bit on the timing there, just as you think about it? And obviously, you're already moving, is probably a question for Brian more than Nick. But what's the timing of this, just to make sure we're on the same page here? Whatever it..."
},
{
"speaker": "Nicholas Akins",
"text": "Yes. I think you have to see those decisions start this year because when you think about - I think what's crystallized for us is really the path that we're taking. We're moving to a clean energy future. We need to be able to move from a regulatory standpoint to ensure that we're achieving the balance sheet capacity to do the things that need to be done for the transition and the optimization of the grid, and I think it's really important for us to be able to manage internally, not only from an OEM perspective, but also our assets, with generally what the assets are that contribute to not only an improved return for our investors, but also in terms of optimization of the business itself. So that will be part of the path because you have 2 - you really have 2 - maybe 3 forcing functions, but, one of those is the movement to a clean energy economy, the other is the capital structure and balance sheet of the company and then the third is really focused on those 2 objectives, but ensuring that we're moving forward with infrastructure development and grid development to support resiliency and reliability of the grid. Those things, together, along with electrification, I think, are really going to be tailwinds for this industry going forward, but in particular, AEP is the largest transmission provider, we have a large distribution footprint and we have a significant amount, as I said in the last earnings call, we were on the precipice of clean energy transformation. So a lot of opportunity for AEP. We just need to make sure we manage all those throttles to ensure that we're consistently driving forward."
},
{
"speaker": "Operator",
"text": "Next, we will go to the line of James Thalacker with BMO Capital Markets."
},
{
"speaker": "James Thalacker",
"text": "Julie addressed some of the asset rotation to mitigate your financing needs. But yes, Nick, it's been a while since you've kind of, I guess, updated how you're thinking about how you prioritize growth via the different channels that are in front of you. I mean, obviously, Chuck's working on the nonregulated side on renewables, and you've got plenty of opportunities of regulated growth on the renewable side transmission. Just wondering like how are you thinking about inorganic growth maybe on the regulated side? Or how are you prioritizing sort of all those different opportunities in front of you?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. So obviously, our priorities are around transmission, distribution infrastructure, certainly, on the regulated transformation of the resources that are ongoing. Chuck's business is really with AEP Energy and so forth. They've done a great job of managing risk around that business, but they've also done a great job in terms of their allocation of capital and being able to manage it, not only within their own part of the business, but also in total - the entire enterprise. So Chuck is more than willing to turn capital over, if it's a better use anywhere else in the corporation and vice versa. But we like for that business to be less than 10% of the overall business. So - and it continues to track that. And it gives us the ability to, not only further optimize that business, and you're seeing continued - really continued opportunities on that part of the business with AEP OnSite Partners on special relationships with customers around resources that really drive tremendous benefit for us because we can also approach that on the regulated side as well. So I think there's an opportunity there. But certainly, our focus is ensuring that we're able to move forward with this clean energy transformation and all the optimization around the grid and the grid resiliency and the issues there and do it in a very pragmatic way. That means we're going to have to make sure that whoever is progressing better from that perspective, that's where the equity is going to go, and we need to ensure that we're managing that portfolio in that fashion. So we can now look at this business like it's a fully regulated business, and we can make decisions based upon - there obviously are things that we look at, like, what's the quality of the service territory? What's the quality of the regulatory environment? What's the ongoing view of valuation of any particular entity for us, for someone else? And what that means in terms of rotation of capital in terms of optimization? So we are continuing that approach. And I would say that we said in the past that if we - for all of our utilities, if we see the ability to continue sustainable growth and quality growth in those jurisdictions, they make a lot of sense to us. And then, of course, we have to look at also those that are challenged and understand what those challenges are, can we erase those challenges? Are they systemic challenges? Those are the kinds of things we have to look at, and we'll continue to do that, and that's what Brian is doing."
},
{
"speaker": "James Thalacker",
"text": "Okay. Great. And just I guess, just 1 last follow-up on that because I know we're running up on time here. But I mean, when you look at like all the opportunities like you just rolled out another 2,400 megawatts of renewables. Transmission has always been something you've had plenty of opportunities, too. Like do you still look at those opportunities like where you can put earning assets in that like 1x rate base as your best opportunities? Or do you see, as you look across the landscape, like inorganic, maybe M&A or regulated properties or something that makes sense? Or is it just better to kind of stick to your point in the jurisdictions where you see the growth, it's visible, and you've got a good regulatory sort of opportunity to achieve your goals?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. I think our primary focus is due to 1x. And with the organic growth that's occurred and that's really why the previous question about whether we want to own the renewable assets or not? The question is, if we own those renewable assets and that gives us more capacity to be able to invest and we can take full advantage of tax benefits and other things that enable us to continue to organically grow. And as I said earlier, we have a very high threshold for M&A because we do feel like that we have plenty of opportunities. We just have to manage the portfolio in a way that optimizes that going forward. And so that's the way we sort of think about it. And then from an M&A perspective, it has to be strategic, it has to be accretive for shareholders, it has to be something that really produces strategic benefit for us in some fashion of what we're trying to do. But again, that's a high threshold."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Andrew Weisel with Scotiabank."
},
{
"speaker": "Andrew Weisel",
"text": "Thanks for all the good detail on renewables. I just want to dig into 1 or 2 relative to your CapEx outlook. You mentioned the incremental capacity at SWEPCO, and then you mentioned that you'll do an AEP-wide regulated renewable plan in the coming months. Would a lot of that be incremental to the $37 billion? I know a lot of the spending will probably come after 2025, but do you think of that as upside to the plan?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. We would - it's early to tell, but we would like it to be incremental. So we'll be working to help support that. And obviously, as you said, some of its 2025, some of its 2028. So as we progress, we want to make sure, okay, if cash flow increases, load continues to improve, optimization of capital deployed makes a lot of - has a lot of benefit associated with that, then there's a lot of parts in the puzzle, sort of like when we did North Central, we didn't know what the financing plan for that was and we continued to focus on that one. And then we'll also continue to focus on trying to make sure that they are seen as incremental. That's our focus. So whether we have to obviate some of that with the redeployment of capital or not remains to be seen, but the target is for it to be incremental."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Great. And then on the RFP at SWEPCO, you mentioned that you'd prefer to own those assets. Do you plan to bid in from the contracted renewables business as well as from the regulated utility?"
},
{
"speaker": "Nicholas Akins",
"text": "Well, from the contracted renewables business - our contracted renewables business are maybe rules associated with that. But just like with North Central, we did sort of a turnkey-type thing that really allows us to time the recovery with the investment itself. That's always sort of a preferred opportunity for us because it really is handled well from a financial standpoint and also handled well from a risk standpoint relative to the construction and customers, the risk to customers as well. So I think we probably stick with something like that and whether our contracted business is on the back end or not is another question. I mean, obviously, we don't really care if it's our contracted business or someone else as long as at the end of the day, we wind up owning it."
},
{
"speaker": "Andrew Weisel",
"text": "Yes. Got it. That makes sense. Then one last one, just to clarify. I think you said you still want that contracted renewables to be capped at about 10% of the company, did I hear you right? And given the overall growing demand for renewables across the country and support out of DC, does that mean that you'll be more selective in your projects or look for higher returns at lower risk? How do you think about that dynamic?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. No. Yes, that's exactly right. We've always managed that business around higher returns. We want to be commensurate on a levered basis with our regulated businesses. And we will continue - as a matter of fact, we turn away a lot more projects than what we actually move forward with. And as you probably have seen, I guess, it seems to get more aggressive all the time about what the return levels are. And it's really - the difference is really what people say at the end of a contract, what that terminal value is. And we really don't want to get into that kind of war. We really focus on those relationships with customers and developers that help us move forward with very positive projects, and that's the way we'll continue to look at that business. And then OnSite Partners and others with specific customer-related issues, like, for example, here in Columbus, we have several businesses that we have signed up for a joint renewables project that we continue to focus on, and we do aggregation of customers in Columbus, which was approved by a referendum vote that AEP Energy would be doing. So it's those kinds of things that we can mix and match with the - and tailor the relationship that the customer is looking for. I think that's what we are after."
},
{
"speaker": "Julia Sloat",
"text": "Just to circle back real quickly, too, if I could, just an additional comment. As it relates to that threshold in terms of business mix, there are a couple of reasons why that 10% makes sense for us. Number one, to a credit profile risk management perspective, that's very important for us. So that's something we keep top of mind. And the other is really on tax shield associated with debt. So we've got a couple of things that we're sensitive to and just continue to high grade the earnings opportunities from our unregulated contracted renewables business. But that gives you probably a little bit more perspective if that wasn't already top of mind for you because it surely is for us."
},
{
"speaker": "Nicholas Akins",
"text": "Yes."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Very helpful. And I just want to echo the congrats to Julie and congrats to the team on another strong year."
},
{
"speaker": "Nicholas Akins",
"text": "Thank you."
},
{
"speaker": "Julia Sloat",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our final question will come from the line of Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"text": "So just some quick follow-up, just on the Oklahoma filing, I haven't had a chance to look at it. The - how long do you guys expect to - my understanding, if I heard you correctly, that you're asking for a weighted average cost of capital. I was wondering how long do you expect to have the - how long will it take to amortize the asset, I guess, with your filings?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. Well, actually, we haven't been prescriptive in our filings. So we've got a little flexibility there. And so that's another reason why I kind of mentioned, we're thinking about any potential financing in the interim and how that would map to any potential outcome there. I do know that one of our peer companies out in Oklahoma made a similar filing, and I believe that it was 10 years on theirs as well as a WACC to give you a kind of perspective, but we want to be sensitive to customer bills as well as I'm sure you can imagine."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Sure. And when do you think we'll get some sort of feedback from the commission?"
},
{
"speaker": "Julia Sloat",
"text": "Probably a couple of months. I don't have a time line yet."
},
{
"speaker": "Paul Patterson",
"text": "Sure. It's all early."
},
{
"speaker": "Julia Sloat",
"text": "Yes."
},
{
"speaker": "Paul Patterson",
"text": "And then just on - a really quick one on APCo. As I recall, you guys were granted rehearing in the - yes, the case. And you guys are also currently filing an appeal, and I was just - if you could elaborate a little bit more on that? Because I thought there wasn't a decision on - okay."
},
{
"speaker": "Nicholas Akins",
"text": "Yes. That's right. Yes, we did file for rehearing, and it was granted and the parties are filing briefs and it stands with the commission. But also, we filed in the Virginia Supreme Court. So - because we're not wasting any time."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Okay. So just to sort of understand it procedurally, do you expect to get sign from the Supreme Court before the commission or the commission, I would think, normally before the Supreme Court?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. It's normally the commission before the Supreme Court. But obviously, we feel like it's such an important issue and a focus on what we believe state law says as they - it's important for the Supreme Court to resolve that issue in case the commission doesn't."
},
{
"speaker": "Paul Patterson",
"text": "Okay. And do you know when would the commission might come out? Or any - is there a schedule on that? Or is it just whenever they want to?"
},
{
"speaker": "Nicholas Akins",
"text": "Yes. I think it's whenever they want."
},
{
"speaker": "Operator",
"text": "And speakers, do you have any closing comments?"
},
{
"speaker": "Julia Sloat",
"text": "We do. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Cynthia, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Certainly. And ladies and gentlemen, today's conference call will be available for replay after 6:30 p.m. today until 5 a.m. March 4. You may access the AT&T teleconference replay system by dialing 866-207-1041 and entering the access code of 9187414. International participants may dial 402-970-0847. Those numbers, once again, 866-207-1041 or 402-970-0847 and enter the access code of 9187414. That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 3 | 2,020 | 2020-10-22 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by, and welcome to the American Electric Power Third Quarter 2020 Earnings Release Conference Call. At this time, all the participant lines are in a listen-only mode. However there will be an opportunity for your questions [Operator Instructions]. As a reminder, today’s call is being recorded. I'll turn the call now over to the Managing Director of Investor Relations, Ms. Darcy Reese. Please go ahead.
Darcy Reese: Thank you, John. Good morning everyone, and welcome to the third quarter 2020 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay. Thanks, Darcy, and welcome, everyone to American Electric Power's third quarter 2020 earnings call. The third quarter has been another strong quarter for AEP. Despite the continued challenges of COVID-19 and its effects on the economy, we continue to be optimistic about our ability to execute and provide the consistent quality of earnings and dividend growth, our shareholders expect, and provide focus on our customers and communities we serve to get past the multiple challenges, we face as a result of the pandemic. I know many of us have had the feeling during 2020 with these multiple challenges that Lenny Kravitz sang about in a song Flyaway singing, Oh, I want to get away, I want to fly away, yeah, yeah, yeah, probably figuratively and literally. But there is light at the end of the tunnel. As we move through this memorable year, AEP continues to drive firmly within the guidance range with targeting the midpoint, as we move to the last quarter. We're accomplishing this by executing on cost control in response to the pandemic, keeping our employees safe through the crisis by taking all the extra precautions, and working with our customers to alleviate the economic pressures during this time. We are also learning a lot during this crisis, the value of efficient work from home environments, the focus on capital and OEM management, the acceleration of our achieving excellence program, and the focus on social issues that drive a cultural brand that brings everyone into the journey of being the premier regulated utility AEP strives to be. In fact, AEP just made the Forbes JUST Capital 100 list for 2021 being the highest ranked utility on the list. We have also been involved with two major storm events, Hurricanes Laura and Delta, and SWEPCO in Louisiana territory. I'm proud of how our employees stepped up during these major weather events in the midst of COVID-19 protocols, to effectively and efficiently return service to our customers in a safe manner, just as they do every day to keep the lights on. And now it's even the more important service during work from home and stay at home environments. Financially, our operating performance continues to be strong in the face of these challenges. AEPs operating earnings for the quarter came in at $1.47 per share versus dollar $1.46 per share last year, bringing us to a $3.56 per share for year-to-date 2020, versus $3.65 per share last year this time. We continue to be firmly within the stated 2020 guidance range of $4.25 to $4.45, and we continue to be optimistic regarding our progress going into 2021. We are reaffirming our current guidance range and our long-term 5% to 7% growth rate. And as I have said previously, I would be disappointed not to be in the upper half of that 5% to 7% range. Our board just approved the dividend increase of approximately 6% in line with our earnings, in the middle of our targeted payout ratio of 60% to 70%, and consistent with our long-term growth rate of 5% to 7%. An incredible accomplishment given the headwinds we expect we are facing in the first quarter and the second quarter of this year. Even with this success in turbulent times, we are not out of the woods yet, but we are seeing improvement in industrial and residential load. However, commercial loads such as churches, restaurants, hotels and schools, not surprisingly, are still challenged. Brian, will get into more detail on the economy later. We could not have achieved the outcome today AEP has achieved thus far during the year, without our employees attention and cutting our costs to compensate for losses from the COVID economy. Our achieving excellence program is going very well and not only has it helped us compensate for the revenue losses due to the pandemic, but it set an excellent catalyst for the future in terms of continued O&M cost control. More to come on this at November EEI. Most economists believe the 2021 economy will improve. And while we are seeing positive progress going in the fourth quarter, industrial and commercial progress has slowed, perhaps until after the election cycle or during the second wave of the COVID cases or during the dependency of upcoming therapeutics and vaccines. With all of that said, it has been a very productive quarter and we expect improvement to continue into 2021. We continue to adhere to COVID pandemic-related protocols of temperature testing, mask requirements, social distancing and hygiene-related activities. Our confirmed cases are increasing with the apparent second wave, and we are doubling down on messaging around practicing safeguards outside of the work environment as much as inside. Thankfully, we have not lost anyone due to the virus, but vigilance and fighting complacency is key here. We also have continued our outreach to employees and the communities we serve regarding racial injustice. As I mentioned last quarter, our Seize the Moment initiative is important to reach a deeper understanding of the racial divides that exist, and gain perspective from one another about actionable next steps. Before I get to the regulatory updates, I'll just head this off at the past questions about HB6 in Ohio. I'll just say flatly that we have nothing new to report from AEP's perspective. Any potential legislative change is not imminent, particularly given a noisy election cycle. So perhaps we'll hear more after the election. As we've said earlier, any change to the existing legislation is likely to be financially insignificant AEP, and we will still be pushing for forward looking legislation regarding clean energy options, energy efficiency and other technology enhancements at grid scale and with our customers. Regarding the legal issues surrounding HB6, also nothing new to report and my previous comment stand on this subject. Now for the regulatory update, if there's one observation that has become apparent through this pandemic, it is the acknowledgement of the criticality of the service that we provide to our customers and communities. This year, we have weathered through the effects of a pandemic and overcome significant storm activity, that have challenged our system and our workforce. As we work with our regulators to position the company to be able to continue to meet the expectations of our customers and communities, we are stressing the fundamentals of a strong balance sheet. Now more than ever, it is essential for our operating companies to be well-positioned to have the cash flows and returns needed to attract the capital necessary to meet the ongoing needs of our customers and communities. And as you all know, we have a number of regulatory proceedings pending before our state regulators this quarter, most of which are needed to conform with previous regulatory stipulations, stay out provisions or to address the timing needs of critical investments. Ohio followed its most recent base case June 1, is required into the terms of our prior ESP for settlement. We are seeking a $41 million rate increase with a 10.15% ROE, a procedural schedule has not been established yet on that case. APCo filed its base rate case in March as required by Virginia law. We have completed hearings and the case has been submitted to the commission for a decision. Our Virginia residential customers have not experienced the rate increase over the past 10 years. In this case, we have asked for $37.9 million net of depreciation with an ROE of 9.9%. We were disappointed with the position taken by both staff and the AG, which fails to recognize our need to have an opportunity to earn our authorized return over the next trien period. We remain confident that the Commission will see through these arguments, and recognize their obligation under the law to allow the company an opportunity to earn a fair return. A decision is expected in November. Kentucky was subject to a stay out provision until June of this year. We subsequently filed our base rate case on June 29, where we asked for a $65 million increase and an ROE of 10%. The company has also sought to use the remaining unprotected AFDIT [ph] funds in Kentucky to offset bills for customers who cannot afford to pay their bills. The commissioner elected to combine this request with a base rate case filing and we expect resolution by yearend. Last but not least, in our SWEPCO jurisdiction, we received approval from the commission to create a regulatory asset for the costs associated with Hurricane Laura. We will ask for similar treatments for the costs associated with Hurricane Delta, and we are hopeful that we can put this year's hurricane season safely behind us. In Texas, SWEPCO made its base rate case filing on October 13, where we are seeking a $90.2 million increase with an ROE of 10.35%. We're also seeking to increase the storm reserve and increase our vegetation management expenditures to minimize the risk of future outages to our Texas customers. We continue to make progress on our North Central Wind projects, which will benefit our customers in Louisiana, Arkansas and Oklahoma. Foundation work is commenced at the Sundance facility, which is expected to be in service by the end of first quarter 2021, Invenergy is currently completing final site preparation on both the Maverick and Traverse locations. We continue to expect to acquire the Maverick facility by December 21, and the Traverse facility into December the first quarter of 2022 timeframe. We have filed our settlement true up in Arkansas and are finalizing our settlement true up in Oklahoma. We're looking forward to the benefits that these projects will bring to our customers, by providing access to some of the nation's richest wind resources and helping SWEPCO and PSO advance a greener energy future. So now to the equalizer chart, I'll talk about that. I think it's on Page 5 of the presentation. So our current ROE is about 9%. And you know we just generally target these returns to be in the 9.5% to 10% range. The ROEs below are not where they normalized. And certainly, keep in mind that we're also thickening equity layers as well. So, I'll talk about AEP Ohio first, I just mentioned the rate case there. It's above authorized primarily due to favorable regulatory items, partially offset by the roll off of the legacy issues that we've been talking about for years, regarding the [indiscernible] and the RSR. But we also expect the yearend ROE to trend around the authorized levels of 10%. For APCo, which I'd mentioned earlier is slightly below authorized, due a lower normalized usage and higher depreciation from increased capital investments, partially offset by continued management of the O&M expenses. Effective January 2020, costs associated with the last 17.5% of Wheeling Power's interest in Mitchell plant became recoverable through APCo and Wheeling rates. And then I've already discussed Virginia's tri-annual review. Kentucky, I already discussed the rate case there, but they're below and as you can see well-below authorized due to loss of load from weak economic conditions and loss of major customers, along with higher expenses during the stay out period. So, we have a lot of work to do there. I&M, the ROE for I&M at the end of third quarter was 10.4%. Its ROE was above authorized due to continued management of O&M expenses, reduced interest expense and rate true ups, partially offset by lower commercial industrial sales. I&M's ROE is projected to trend slightly below 10% by yearend, consistent with authorized ROEs in Michigan and in Indiana. PSO, its ROE is 8%. At the end of third quarter, it was below its authorized level primarily due to lower normalized usage and unfavorable weather in 2020, partially offset by continued management of O&M expenses. PSOs 2019 base case as you recall, approved the transmission track or a partial distribution tracker, and ROE of 9.4% authorized, so we'll continue to make progress there. SWEPCO, the ROE for SWEPCO is about 7.4%, and as you recall, much of that is related to the Turk Plant not being in retail rates in Arkansas, and that impacts by about 110 basis points. SWEPCO received an order in its Arkansas base case settlement in December 2019, and effective 2020 approved a $24 million revenue increase in ROE of 9.45%. In October 2020, we also filed the rate case in Texas, as I mentioned earlier. In AEP Texas, its ROE is around 7.5%, it was below authorized due to lag associated with a tiny of annual cost recovery filings. We did not make those filings during the pendency of the previous rate case, and of course, onetime adjustments from our finalized base rate case itself. Favorable regulatory treatment allows AEP Texas to file annual DCRF and TCOS filings, and we've since filed many of those at this point. I think there's been three cases that have been filed. And while earnings should improve in 2020, with a base rate case finalized and annual filings now resumed continued levels of investment in Texas will impact the ROE. The expectation is for the ROE to trend towards an authorized ROE of 9.4% in the long-term, but be around probably 8% by the end of 2020. As far as the transmission company is concerned, AEP Transmission Holdco was 9.8%, and it was below authorized primarily driven by the annual revenue true up in the second quarter of 2020 to return the over collection of 2019 revenues. Transmission is forecasted an ROE of 9.8% to 10.1% range in 2020. It is also interesting to note, that when you look at the average equity in our operating jurisdictions, The Transmission Holdco is now the largest, which that's happened for the first quarter. This first quarter that has actually occurred. So, making a lot of progress. But at the same time, though the investment is being made relative to transmission is certainly improving the quality of service to our customers. So, very happy with the progress we're making around our T&E investments and its ability to improve customers’ experiences. As I close, I'd be remiss in not thanking our employees at the Oklaunion Power Station that was officially retired from service a couple of weeks ago, after several decades of providing generation resources, and meeting the needs of our customers electricity demands in Texas and Oklahoma. Oklaunion was under construction about the time I joined AEP out of college. And when you see people and assets retiring, it just further illustrates the resiliency of AEP over the last 114 years, but also the change occurs and we have to change with it. Thanks again to all the Oklaunion employees through the years. So, all-in-all, a solid quarter for AEP and I can't resist when thinking about AEPs future post-COVID, with the latent value of the need for resiliency and reliability of the grid to support work from home environments, moving forward with the transformation to clean energy resources, which we had AEP or in the beginning stages of, and the further electrification of the economy. We would say in the words of late Eddie Van Halen, it's about time, this time's our time, and right on, we'll let it shine. I am convinced in overcoming the challenges of 2020. This company will be even stronger as we move into 2021 and beyond. Brian?
Brian Tierney: Thank you, Nick and good morning, everyone. I will take us through the third quarter and year-to-date financial results, provide some insight on load in the economy, review our balance sheet and liquidity and finish with a preview of what we will present at the EEI conference. Let's start briefly on Slide 6, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the third quarter were $1.51 per share, compared to $1.49 per share in 2019. GAAP earnings through September were $3.56 per share, compared to $3.58 per share last year. There's a reconciliation of GAAP to operating earnings on Pages 15 to 16 of the presentation. Let's turn to Slide 7, and look at the drivers of quarterly operating earnings by segment. Operating earnings for the third quarter were $1.47 per share or $728 million, compared to $1.46 per share or $722 million in 2019. Operating earnings for vertically integrated utilities were $0.85 per share down $0.04. This was driven by unfavorable weather, primarily due to warmer than normal temperatures last year, particularly in September. Other drivers including lower wholesale load and other operating revenue, as well as higher depreciation and taxes, primarily due to timing that were averse in the fourth quarter. Favorable items included lower O&M, favorable rate changes and higher transmission revenue. The transmission and distribution utility segment earned $0.31 per share up $0.04 from last year. Favorable items included higher rate changes in transmission revenue, as well as lower O&M. These favorable items were partially offset by unfavorable weather, depreciation, taxes and interest expense. The AEP Transmission Holdco segment continue to grow, contributing $0.28 per share an improvement of $0.03. This reflected the return on investment growth as net plant increased by $1.5 billion or 16% since September of last year. Generation and marketing produced operating earnings of $0.13 per share, down $0.03 from last year. This was driven by timing around income taxes and lower wholesale margins. Finally, corporate and other was up a penny from last year, primarily driven by lower taxes related to consolidating items that will reverse by year-end. Let's turn to Slide 8, and review our year-to-date results. Operating earnings through September were $3.56 per share or $1.77 billion, compared to $3.65 per share or $1.8 billion in 2019. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $1.90 per share comparable to last year. Favorable items in this segment included lower O&M, the impact of rate changes across multiple jurisdictions and higher transmission revenue primarily due to true ups. Weather was unfavorable due to warmer than normal winter temperatures this year and a warmer summer in 2019. Other decreases included higher depreciation and tax expenses, primarily due to timing and lower revenue items and AFUDC. The transmission and distribution utility segment earned $0.84 per share down a penny from last year. The negative variance was primarily driven by the 2019 reversal of a regulatory provision in Ohio. Other smaller drivers included higher depreciation and interest expense, the roll off of legacy riders in Ohio, prior year Texas carrying charges, unfavorable weather and tax expenses. These items were mostly offset by higher rate changes, the recovery of increased transmission investment in OCA [ph] and the impact of the Ohio transmission true up on both O&M and transmission revenue. Other O&M was also favorable due to the concerted effort to decrease O&M expenditures through one time and sustainable reductions. The AEP Transmission Holdco segment contributed $0.75 per share, down $0.07 from last year due to the impact of the annual true up and prior year FERC settlements. Our fundamental return on investment growth continued. Generation and marketing produced $0.31 per share, up a penny from last year. The Renewables business grew with asset acquisitions more than offsetting lower wholesale and retail margins and timing around income taxes. O&M sales and other onetime items offset the impact of weaker wholesale prices on the generating business. Finally, Corporate & Other was down $0.02 per share due to higher interest in taxes related to consolidating items that were reversed by the yearend, and offset by a prior year income tax adjustment. Partially offsetting these items was lower O&M. Overall, we are pleased with our financial results and are confident in confirming our annual operating earnings guidance of $4.25 to $4.45 per share. Turning to Slide 9, let's review the assumptions we shared during the first quarter earnings call to reaffirm guidance. Starting with the topline, we recently updated our retail sales forecast. Third quarter sales came in higher than previously projected. We now expect 2020 normalized sales to come in 2.7% below last year, which is 0.7% better than the load forecast from the first quarter. While the outlook has improved, it is still below the pre-recession forecast used for our original guidance. The favorable sales mix in 2020 has helped to mitigate the impact on earnings. The second item was the impact of weather. While the first quarter weather produced a significant drag, the second quarter and third quarter weather impacts were slightly favorable. In the second quarter presentation we mentioned that, July's weather was quite favorable. However, August and September weather was mild. As a result, we have revised the weather impact on 2020 earnings and now expect a $0.08 drag to 2020 results. The next item was on track the O&M expense. We had originally planned to drive O&M cost down to $2.8 billion from $3.1 billion in 2019. In response to the expected sales decline, we identified an additional $100 million of savings for both onetime in sustainable reductions and are on track to hit this lower expense target. Finally, we identified approximately $500 million of capital expenditures in the first quarter that could be shifted out of 2020 and in the future years. We made this decision to support our cash position through the expected downturn during the pandemic. As we discussed at the second quarter earnings call, results have come in better than expected and we've reinstated approximately $100 million of the $500 million back into 2020. Given the progress we've made on these key assumptions, we were able to reaffirm our 2020 operating earnings guidance range. Now let’s turn to Slide 10, to provide an update on our normalize load. Starting in the lower right corner, our third quarter normalized load was down 2.6%, this was slightly better than the forecast we shared with you in the first quarter. Through September, our normalized sales were down 3% from last year. In the upper left quadrant, our normalized residential sales increased by 3.8% in the quarter. Year-to-date residential sales were up 2.6%. We saw significant increases in our residential load at the beginning of the pandemic. The growth in residential sales has moderated as people return to work over the summer. Weather normalized residential sales are up across all jurisdictions. Moving clockwise, our normalized commercial sales decreased by 4.6% in the third quarter, bringing the year-to-date decline to 4.9%. As expected, the biggest declines in this class came from schools, churches, restaurants and hotels. Finally in the lower left chart, industrial sales decreased by 7.8% in the quarter, bringing the year-to-date decline to 7%. A number of factors have changed the outlook for this class, but the biggest driver is overall economic activity. The industrial sectors that posted the biggest declines for the quarter were mining, oil and gas extraction and primary metals. By contrast, plastics and rubber manufacturing posted a strong quarter related to the recovery of the automotive industry. Overall, load growth across the service territory followed the pattern we anticipated earlier in the year. During the second quarter, residential sales peaked and commercial and industrial sales hit their lows. Since then, our service territory has been working its way back to a more normalized levels. Because some businesses will continue to work remotely, we expect our residential sales to continue at higher levels for some time. Let's take a deeper look into why we raised our outlook for normalized load on Slide 11. The solid bars represent weather normalized load growth by quarter end 2020. The green lines represent the updated load forecast we shared during the first quarter earnings call. At that time, there was still a lot of uncertainty regarding the depth and duration of the economic slowdown and how customers would respond. While that forecast accurately predicted the depth of the contraction in the second quarter, our third quarter results indicated a better recovery than forecasted. Our latest view, anticipates a continuation of this trend barring another shutdown of the economy. Now let's move on to Slide 12 and review the company's capitalization and liquidity. Our debt to capital ratio remain unchanged in the third quarter and stands at 61.1%. Our FFO to debt ratio decreased 1.3% during the quarter to 12.8% on a Moody's basis, primarily due to timing of fuel recovery, storm cost deferrals and a pension contribution. Importantly, we expect this metric to end the year in the low to mid-teens, consistent with the guidance we have provided. Our liquidity position remains strong at $3.8 billion, supported by a revolving credit facility. Before providing an update on pension funding, I would like to discuss the plan to finance the North Central Wind Project. As a reminder, we have stated that we intend to use equity to finance approximately two-thirds of this $2 billion project. We plan to issue equity in coordination with the completion of the three individual projects that comprise North Central Wind. For this reason, we will take a flexible approach which could include and at the market mechanism, asset rotation, as well as traditional secondary offerings. This approach avoids unnecessary dilution and helps us deliver on the 5% to 7% earnings growth rate. Turning to our pension, I am pleased to report that funding increased 3.6% during the quarter to 97%, and our OPEB Funding increased 5% to 141%. Strong equity returns was the primary driver for the increases. The pension plan also benefited from a company contribution in the amount of the plan's annual service cost of $111.5 million. Let's wrap this up on Slide 13, so we can get to your questions. We are reaffirming our existing 2020 operating earnings guidance of $4.25 to $4.45 per share. Our message at EEI will be that we are leading the way forward as a premium regulated utility with an ESG focus delivering 5% to 7% earnings growth with dividends growing in line with earnings. Our plan includes the $2 billion North Central Wind project in Oklahoma, benefiting our customers in PSO and SWEPCO as we transition to a cleaner energy future. We will provide detailed drivers for 2021 earnings guidance by segment and updates to our capital expenditure and financing plans. We look forward to talking with many of you at the virtual EEI conference in a couple of weeks. One final item, in 2021, we will release 2020 fourth quarter and full year earnings in late February, coincident with the filing of the 2020 10-K, like we did last year. With that, I will turn the call over to the operator for your questions.
Operator: Thank you. [Operator Instructions]. And we will go to Julien Dumoulin-Smith with Bank of America Merrill Lynch. Please go ahead.
Nick Akins: Good morning, Julien.
Julien Dumoulin-Smith: Hey, howdy. Thanks for the time, guys. Perhaps just to kick things off. You talked about rolling out and reaffirming or perhaps preemptively reaffirming in the EEI the 5% to 7%. Can you talk a little bit about what's backstopping that? Specifically, in the last few months, we've seen some pretty substantial changes from some of your peers in Virginia. How can that play into APCo? And perhaps also similarly in Indiana, many of your peers are talking about opportunities. You all have perhaps Rockport. Just curious if you can talk about or perhaps foreshadow some of the conversations here on that role forward, if you don't mind, at the outset.
Brian Tierney: Julien, I think a lot of the things that we're going to talk about are renewable opportunities in addition to North Central Wind, how we're transitioning from a carbon-based generating fleet much more to a lot of the renewables that the Virginia Clean Energy Act enables and legislation in Indiana enables as well. So we're going to provide a lot more detail on that at EEI and take you through what that looks like. You have the renewable requirement in Virginia. You mentioned APCo. We've got the requirement there. And also Indiana, Michigan, we continue to do renewables in various areas there. We're also doing renewables, we just did fourth sale in Oklahoma. And then we also have renewable applications here in Ohio that are brewing as well. So, we'll have plenty to talk about. And I think, we don't we don't spend and then maybe we should spend more talking about the opportunities we've got available to us from a renewable standpoint. But the way I see it is that, we're just on the precipice of a massive transformation to renewable resources. And AEP, if you look at the runway it's pretty substantial. And that will continue particularly as we do individual relationships with customers, but also in terms of the regulated side as well, through the Integrated Resource Planning process. So we'll certainly talk more about that at November EEI.
Julien Dumoulin-Smith: Got it. Thanks for entertaining me there. Perhaps, if I can get more detailed here, if you don't mind. I know you all provided a little bit more of you want 23 here, but in tandem, you gave an updated view on FFO to total debt under Moody's definition of low to mid-teens versus perhaps prior characterizations of mid-teens. Is that simply a factor of rolling forward here? Or how are you thinking about this at this point?
Brian Tierney: Julien, the low to mid-teens is completely consistent with our prior messaging on FFO to debt. And that outlook was incorporated in Moody's when they made their adjustments back in August. And remember that will continue to improve as some of this accumulative deferred income taxes that is being repaid to the regulatory jurisdictions are occurring much more quickly than we thought, maybe we originally thinking 10 years. And it turned out to be five years. And that's occurring more quickly. So that FFO to debt metric will pick up as that rolls off.
Julien Dumoulin-Smith: Got it. Excellent. Thank you.
Brian Tierney: Yes.
Operator: Our next question is from Durgesh Chopra with Evercore ISI. Please go ahead.
Durgesh Chopra: Hey, good morning. Thanks. Great. Hey, just digging in a little bit into 2021. I appreciate you'll share more color at EEI. But could you quantify for us what that 2%, 2.7% sales degradation was year-to-date, part one? And part two, should we assume some of that $51 million year-to-date O&M savings to be carried forward into the next year?
Brian Tierney: Yes. So let me start with the 2.7% load degradation. It's what you would expect. It's largely commercial and industrial sales. The decrease is being offset by residential. And so, what we've seen is it takes more than just looking at the raw numbers on residential, commercial and industrial, it's really the mix. You remember, we make more margin on residential sales than we do on commercial and industrial. And that mix has come in better than we had anticipated at the beginning of the pandemic. So, it's not been as dire as what we thought it might be because of what's happened with the sales mix, rather than just the overall decreases. So that's been positive. Looking forward on O&M, we have for a number of years been tightening our belt and been very, very tight around untracked O&M in that $2.8 billion to $3.1 billion range. And with what we're doing with achieving excellence, and everything else we're doing with sustainable and non-sustainable O&M cuts, I'd anticipate us being towards the lower end of that range going forward.
Durgesh Chopra: Understood.
Nick Akins: When we look at the load forecast, I mean if you assume 2021 is going to be better, which we believe it is. And you look at that mix, we don't see residential. I mean, obviously, it will moderate as the economy comes back on the industrial and commercial side, commercial in particular. But still, you're going to have a continued longstanding remnant of improved residential support just by virtue of what companies have learned from the work from home environment. So, I'm a little bit bullish on the load and then at least a financial picture associated with load. And then when you look at the O&M this achieving excellence program it has truly been a fundamental change for us and augmentation of all the lean activities and other things that we did before. And it really is focused on a regular part of our budget process to ensure that we're capturing savings and every step along the way. So, feeling pretty good about the continual progress year-on-year of achieving excellence.
Durgesh Chopra: That's great, guys. Thanks for that color. Maybe just initial thoughts and I appreciate that that was going to be in the details, but initial thoughts on elections, taxes, climate plan and implications for AEP?
Nick Akins: Yes, so I guess, well, first of all, it's the election, certainly as a noisy election cycle, and who knows what's going to happen here, we never know. But we've got 114 years history of managing between the goalposts here, so we'll continue to do that. And our focus is on move into that clean energy economy. So really, the only difference obviously, is maybe the pace at which the change will occur if there's a Biden administration versus Trump. But nevertheless, it doesn't change that much for us, because we're focused on moving that clean energy economy as quickly as we can, to ensure that we are making that transition into the future that we know it's going to happen. Now, who knows where technology will go, even for fossil fuels, but nevertheless, we'll continue that transition to renewables and certainly some natural gas to ensure that we are delivering for our customers in the future. So, from a client perspective, we have an excellent record and I think that's why we get seen from the ESG community where they know what we're doing, they know what our message is, we're making continual progress. And we'll continue to make that progress. And then when you think about, as I said, in my original write up, I used the word latent, because it is a somewhat of an undeveloped or emerging activity around electrification of the economy, certainly around O&M and what we find with digitization and automation. And then, of course, as we move forward with the transformation, the generation transformation that we see ahead of us. So that's, that's why I'm feeling pretty good about where this company is heading.
Brian Tierney: Just a quick update on taxes. If we were to have an increase in taxes, we anticipate that our commissions would handle it. Really, one of two ways and not dissimilar to how they handled tax reform three or four years ago. We anticipate that they would either allow the increase to be deferred until the next rate proceeding, or we anticipate that they'd have kind of a one issue, order come out where they would allow us to adjust rates just to reflect the new expected higher income tax rate. In any event, we wouldn't expect it to be a significant driver to earnings or cash for the company going forward.
Durgesh Chopra: Great. Thanks. But it could be a modest delve into cash flow, like given sort of a reset in AVIT [ph] and amongst other things.
Nick Akins: I think the [Indiscernible].
Brian Tierney: Yes. Again, we don't anticipate it to be significant one way or the other.
Durgesh Chopra: Understood. Thanks, Brian. Thank you, Nick.
Brian Tierney: Thank you.
Nick Akins: Yep.
Operator: Our next question is from James Thalacker with BMO Capital Markets. Please go ahead.
Nick Akins: Good morning, James. Hello?
James Thalacker: Hey, thanks, guys. I apologize about the [multiple speakers]. Good morning. Two real quick questions. Just first, I guess, Brian, just addressing, North Central wind, I noticed in the slides that Traverse look like potentially be in service could be pushed out maybe by a quarter or so. Could you talk a little bit about it? Is that just a supply chain issue related to COVID? Or there's something else that was kind of driving that extended outlook?
Brian Tierney: Yes, a lot of it has to do more so than actual physical things. It's our ability to get permitting and the like done. And so during the shutdown, it was hard to be able to get into the offices, do land acquisitions, title searches and things like that. And that just potentially pushed us back at big teams. We're not in anticipating anything material there. We still anticipate late this year to early next year which is one of the signal that due to some of those unanticipated issues largely associated with COVID that that project could have a range of when it would come online.
Nick Akins: Hey, James, we feel like it's still going to be the end of the summer, but obviously it could fall into that range in the first quarter, we're confident of that particular range. But remember, we're not making any progress payments, either. It's sort of we require it when it's done. So from a financial perspective it's fine.
James Thalacker: Okay, great. Thanks. And I guess, just following up on that same issue. Brian, you talked about, three sort of potential ways to finance the final acquisition of those and this has been beat to death. But as you guys look to give 2021 guidance, obviously, an ATM would be something because spread over the full year, but asset rotation or even block equity, really probably something I think, as you were saying, sort of coordinating it with the final close would be something maybe closer to the end of the year. How are you guys, I guess thinking about that from a modeling perspective, as you present 2021?
Brian Tierney: It kind of matches what Nick was saying is that the projects don't -- we don't get the projects until commercial completion is done, we then get the project. And given the discrete nature of them, we can really time the equity issuance very closely with when the project comes online. And James the reason, we need that flexibility, you look at Sundance, which we're anticipating in the first quarter of 2020, that's about a $300 million project. We'll be able to time the equity issuance, if that's what it is closely with when that project comes online. The next one, which we're anticipating at the end of 2021, is about a $400 million project, Maverick. And then the last one is Traverse, which is about $1.3 billion and we talked about that being late 2021, early 2022. We believe that whether it's an aftermarket program, a follow on issuance or asset rotation, we're going to be able to time those very, very closely with when those discrete projects come online. So from a modeling standpoint, the timing that we're talking about really is going to be insignificant to 2021. And I'd start repeating myself and shaping it in 2021.
Nick Akins: James, Brian mentioned the options we're looking at. And rest assured internally, we're also being at the death. So, we'll make sure that we're making the right decisions relative to the timing associated with those investments.
James Thalacker: No worries. I understand the in service space, and it gives you guys a lot of flexibility. The last question, I guess, I just had, and you kind of answered my initial question was going back to the trailing 12 months FFO kind of dip down. You guys were looking for that sort of trend back into kind of where you guys were thinking sort of low to mid-teens, I guess. Are you still targeting that in the sort of '21, '22, '23 timeframe? I know you updated your cash flow forecasts for that recently.
Nick Akins: Yes, we are. It's that timeframe, yes.
James Thalacker: Okay, perfect. Thank you so much for the time.
Brian Tierney: Thanks, James.
Operator: And next, we'll go to Michael Lapides with Goldman Sachs. Please go ahead.
Nick Akins: Good morning, Michael.
Michael Lapides: Good morning, Nick. Thank you guys for taking my question. And Nick, sorry about your LSU Tigers.
Nick Akins: Yes. Alabama is doing good though. I'm sure you're happy with that.
Michael Lapides: Yes, let's hope they keep coaching. Brian, I want to come back to tax a little bit and who the heck Uncle Sam’s is going to do in the next year or so regarding corporate tax rates. But if there's a change in administration, if there's a higher corporate tax rate, I think we’ve seen numbers floated around 27% or 28%. I get that it's probably not much of an impact on the earnings power one way or another for AEP. But if you're talking to state commissioners or staff at the PSCs, or PUCs or others, it is a rate increase on customers. And it's a double whammy, because the cost of service goes up due to the higher tax rate and that just kind of flows through rates. But also the flow back of assets kind of slows down or declines. And it just strikes me as if I must say utility commissioner for public policy maker and given state, you're asking for what could be pretty decent size rate increases on customers coming out of an economic downturn. How does that get offset? I think about it from the customer standpoint. What's the get [Indiscernible].
Nick Akins: Hey, I think there's no doubt that -- and again, I think there was a lot of advantage taken with it with the tax reductions that occurred. And you're right, there's no doubt that there will be headroom that is reduced, because it is certainly going to be an impact to put those back in. Now, the question is how to put back in or what time frame and that kind of thing. But also that's why it's so important for us to move forward as quickly as possible and accelerate achieving excellence, so that we can mitigate that impact as much as possible. But still, you're looking at it in the face of a definite need for rehabilitation and continued capitalization of the grid to ensure that we have reliability and resiliency of supply, particularly when you're dealing with hurricanes, wildfires, cyber, all those kinds of issues we have to respond to that. So there'll be rate increases associated with the implementation of new taxes. And I think it's unavoidable, but certainly it's incumbent on us to make sure we mitigate that as much as possible with our achieving excellence program and other measures. And we'll have discussions with the commissions, just like we had discussions when tax reform occurred. And, it's unfortunate we didn't do it over a longer period of time like we had suggested, because then it would mitigate even the return of taxes. And if we continue vacillating back and forth like this, that's going to be a continual issue for our industry that our regulators need to recognize. We do have to keep some reserve there to ensure that we're not moving customer rates around, as much as could be as if it becomes pretty volatile. So, your point is well recognized, but we'll do what we can to mitigate the effects and we'll have those conversations. But I think one thing that's also come into play here, though is, is the nature of the importance of the service that we provide, for everyone to be able to watch their Netflix or do all the things they need to do at home, work from home. All those sorts of activities will change the nature of how we look at residential supply. And there's no question that that's going to change going forward. And that's why I'm always troubled by the commission saying that AMR versus AMI, for example, the investments we want to make in AMI, it's not because AMI is you don't just look at the cost of the meters of AMI and the undepreciated balance associated with AMR. You've got to look at what you're leveraging into and that's the customers’ ability to adjust to their own energy picture and be able to drive energy efficiency and all those things and give the customer the opportunity to do that, as opposed to of the system just decide in that forum. So, I think there's just a lot of things we need to have discussions about with our regulators to really focus on what that future actually means. And with electrification of the economy, that's clearly going to be an issue that we need to deal with to make sure our customers are more resilient, more reliable and as economic as possible, but also give them the opportunity to make adjustments on their total bill as opposed to dealing on a headline on rate increases.
Michael Lapides: Got it. Thank you for that, Nick. And then one other question, totally unrelated. I'm thinking about states where you've not really talked about sizable rate base growth and investment. One of those that stands out a little bit is West Virginia. How do you think about going forward, the pace of generation transformation in a state like West Virginia?
Nick Akins: Yes, I think, we're looking at all of our states now and all our state jurisdictions, and it's really sort of our resource planning on steroids. And even the dogs like it. And I think there's no question that we're in the process of moving forward with that transformation as quickly as possible, making significant T&D investments, but all and you see that based on the changes in capital. But then when you look at states like West Virginia, we will be -- I think the first step is going to be how we run coal fired capacity, for example, where we have other forms of energy coming in and have lower capacity factors on coal units, but still they be available if those times where, you have severe cold weather, or really warm weather in the summer. So, it's a way we run these facilities during the interim, but then it's also that transition that we make going forward. I think that's true for all of the jurisdictions. And our jurisdictions have been fairly conservative in making that transition. I think that pace can quick and though, as a result of the even the bipartisan focus on continuing to lower emissions in our plant. So, I think there's the catalysts are there. And actually, post-election, who knows what'll happen, but I still see, you're already seeing some Republican and Democratic legislation that's being proposed that tries to answer that question. And if you have that from a national standpoint and the states are moving forward with their own resolutions, and then we can be particularly helpful in ensuring that occurs as quickly as possible.
Michael Lapides: Got it. Thank you, Nick. Sorry about the [Indiscernible], and I both appreciate it. Thanks guys.
Nick Akins: No, that's fine.
Operator: Our next question is from the line of Sophie Karp with KeyBanc. Please go ahead.
Sophie Karp: Hi, good morning. Thanks for taking my questions.
Nick Akins: Yes, sure thing. Good morning.
Sophie Karp: I'm curious, I want to go back to kind of the load composition and the rate case activity. So, as we roll forward and the load dislocation continues to be persist, where we have this unusual situation where residential, maybe it's higher, but C&I is suppressed. And that's not really a normalized picture. So, if you go through your rate cases now, and the future rate cases where this period becomes your test here, right? How do you address that? Did you attempt to normalize? Do you just go with what they actually look like? So, that's my first question, I guess.
Nick Akins: Yes. So, we have multiple utilities, right. So, we have the opportunity to move around capital investment to time it with relative rate case activity to ensure that we are spinning on the right things at the right time. Not to say that we're trying to load the budgets or anything, what we're saying is that, that when we go through the rate case, filings, it's important to not only have discussions with the Commissions about what we're spending on, but what the results of that spending will be. So, if the load is not increasing, obviously, it exaggerate. It certainly challenges the rate impacts, because the denominator is not growing. If the denominator is growing, obviously, that's helpful. But if it isn't, you're still having to make choices about what the priorities are for each regulatory jurisdiction based on discussions with the Commissions to help us determine, okay, number one, what are we willing to pay for, number two, what are those priorities that exist. And some of those are absolute priorities and some of them are things that yes, we'd like to do, but it may be that we have to work out for a longer period of time before bringing that in. So, there's all kinds of dialogues that occur, relative to what that prioritization should be. And we'll continue doing that with our Commissions. And we have done, whether it's gone, where the economy is going well, or whether the economy has been in a downturn. I think we're moving toward an upturn. So that's going to be helpful.
Brian Tierney: Sophie, we also have some jurisdictions that have forward looking test years, so we'll be able to incorporate a forward looking view. And then we have places like Ohio, where residential and small commercial are already decoupled. So, there are lots of mitigations to unusual load circumstances that we find ourselves in right now.
Nick Akins: And some of these things are known and reasonable adjustments too, so you have to look at the 2020 test year and say, we had to make these changes because of COVID. And COVID is going to be sort of a unique circumstance and then we had to react. And actually, the Commissions themselves, we had moratoriums on customer cut-offs. So, there is adjustments we all made in that process, and I think we'll make those adjustments coming out of that process as well.
Sophie Karp: Great. Thank you. And then, if I may a quick follow-up on the Central Wind. You mentioned assets rotation, I guess, as a part of the considerations for equity financing there. What might those be? Is this more of a like one-off situation with churn assets in your portfolio? Or could we be looking at something more strategic here? Thank you.
Nick Akins: Well, so when we talk about potential assets, we look at everything, and we look at sources and uses. And obviously, we want the use part of it right now is how do we finance North Central Wind, a major project. And the sources can be anything in our portfolio, and that's where portfolio management is going to be a key part of what we do in the future. So, I'm not going to say, specifically what we're looking at, or anything like that at this point. But what I will say is that it's incumbent on us to be looking at everything from a source perspective, and then focusing on how we deploy capital in the best way and transfer that into really projects like North Central, and be able to fund it in the best way to ensure our shareholder value. And we will continue to do that. So, I think you got what the sort of year play out.
Sophie Karp: Thank you.
Nick Akins: Yep.
Operator: And with no further questions, yes, I'll turn it back to you.
Darcy Reese: Great. Thank you for joining us on today's call. As always, the IR team will be available to answer any questions you have. John, please give the replay information.
Operator: Certainly. And Ladies and gentlemen, this conference is available for replay. It starts today October 22, at 11:30 AM Eastern Time, and will last until October 29, at midnight. You may access to the replay at any time by dialing 866-207-1041 or 402-970-0847. The access code is 8222465. Those numbers again 866-207-1041 or 402-970-0847, access code 8222465. That does conclude your conference for today. We thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by, and welcome to the American Electric Power Third Quarter 2020 Earnings Release Conference Call. At this time, all the participant lines are in a listen-only mode. However there will be an opportunity for your questions [Operator Instructions]. As a reminder, today’s call is being recorded. I'll turn the call now over to the Managing Director of Investor Relations, Ms. Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, John. Good morning everyone, and welcome to the third quarter 2020 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay. Thanks, Darcy, and welcome, everyone to American Electric Power's third quarter 2020 earnings call. The third quarter has been another strong quarter for AEP. Despite the continued challenges of COVID-19 and its effects on the economy, we continue to be optimistic about our ability to execute and provide the consistent quality of earnings and dividend growth, our shareholders expect, and provide focus on our customers and communities we serve to get past the multiple challenges, we face as a result of the pandemic. I know many of us have had the feeling during 2020 with these multiple challenges that Lenny Kravitz sang about in a song Flyaway singing, Oh, I want to get away, I want to fly away, yeah, yeah, yeah, probably figuratively and literally. But there is light at the end of the tunnel. As we move through this memorable year, AEP continues to drive firmly within the guidance range with targeting the midpoint, as we move to the last quarter. We're accomplishing this by executing on cost control in response to the pandemic, keeping our employees safe through the crisis by taking all the extra precautions, and working with our customers to alleviate the economic pressures during this time. We are also learning a lot during this crisis, the value of efficient work from home environments, the focus on capital and OEM management, the acceleration of our achieving excellence program, and the focus on social issues that drive a cultural brand that brings everyone into the journey of being the premier regulated utility AEP strives to be. In fact, AEP just made the Forbes JUST Capital 100 list for 2021 being the highest ranked utility on the list. We have also been involved with two major storm events, Hurricanes Laura and Delta, and SWEPCO in Louisiana territory. I'm proud of how our employees stepped up during these major weather events in the midst of COVID-19 protocols, to effectively and efficiently return service to our customers in a safe manner, just as they do every day to keep the lights on. And now it's even the more important service during work from home and stay at home environments. Financially, our operating performance continues to be strong in the face of these challenges. AEPs operating earnings for the quarter came in at $1.47 per share versus dollar $1.46 per share last year, bringing us to a $3.56 per share for year-to-date 2020, versus $3.65 per share last year this time. We continue to be firmly within the stated 2020 guidance range of $4.25 to $4.45, and we continue to be optimistic regarding our progress going into 2021. We are reaffirming our current guidance range and our long-term 5% to 7% growth rate. And as I have said previously, I would be disappointed not to be in the upper half of that 5% to 7% range. Our board just approved the dividend increase of approximately 6% in line with our earnings, in the middle of our targeted payout ratio of 60% to 70%, and consistent with our long-term growth rate of 5% to 7%. An incredible accomplishment given the headwinds we expect we are facing in the first quarter and the second quarter of this year. Even with this success in turbulent times, we are not out of the woods yet, but we are seeing improvement in industrial and residential load. However, commercial loads such as churches, restaurants, hotels and schools, not surprisingly, are still challenged. Brian, will get into more detail on the economy later. We could not have achieved the outcome today AEP has achieved thus far during the year, without our employees attention and cutting our costs to compensate for losses from the COVID economy. Our achieving excellence program is going very well and not only has it helped us compensate for the revenue losses due to the pandemic, but it set an excellent catalyst for the future in terms of continued O&M cost control. More to come on this at November EEI. Most economists believe the 2021 economy will improve. And while we are seeing positive progress going in the fourth quarter, industrial and commercial progress has slowed, perhaps until after the election cycle or during the second wave of the COVID cases or during the dependency of upcoming therapeutics and vaccines. With all of that said, it has been a very productive quarter and we expect improvement to continue into 2021. We continue to adhere to COVID pandemic-related protocols of temperature testing, mask requirements, social distancing and hygiene-related activities. Our confirmed cases are increasing with the apparent second wave, and we are doubling down on messaging around practicing safeguards outside of the work environment as much as inside. Thankfully, we have not lost anyone due to the virus, but vigilance and fighting complacency is key here. We also have continued our outreach to employees and the communities we serve regarding racial injustice. As I mentioned last quarter, our Seize the Moment initiative is important to reach a deeper understanding of the racial divides that exist, and gain perspective from one another about actionable next steps. Before I get to the regulatory updates, I'll just head this off at the past questions about HB6 in Ohio. I'll just say flatly that we have nothing new to report from AEP's perspective. Any potential legislative change is not imminent, particularly given a noisy election cycle. So perhaps we'll hear more after the election. As we've said earlier, any change to the existing legislation is likely to be financially insignificant AEP, and we will still be pushing for forward looking legislation regarding clean energy options, energy efficiency and other technology enhancements at grid scale and with our customers. Regarding the legal issues surrounding HB6, also nothing new to report and my previous comment stand on this subject. Now for the regulatory update, if there's one observation that has become apparent through this pandemic, it is the acknowledgement of the criticality of the service that we provide to our customers and communities. This year, we have weathered through the effects of a pandemic and overcome significant storm activity, that have challenged our system and our workforce. As we work with our regulators to position the company to be able to continue to meet the expectations of our customers and communities, we are stressing the fundamentals of a strong balance sheet. Now more than ever, it is essential for our operating companies to be well-positioned to have the cash flows and returns needed to attract the capital necessary to meet the ongoing needs of our customers and communities. And as you all know, we have a number of regulatory proceedings pending before our state regulators this quarter, most of which are needed to conform with previous regulatory stipulations, stay out provisions or to address the timing needs of critical investments. Ohio followed its most recent base case June 1, is required into the terms of our prior ESP for settlement. We are seeking a $41 million rate increase with a 10.15% ROE, a procedural schedule has not been established yet on that case. APCo filed its base rate case in March as required by Virginia law. We have completed hearings and the case has been submitted to the commission for a decision. Our Virginia residential customers have not experienced the rate increase over the past 10 years. In this case, we have asked for $37.9 million net of depreciation with an ROE of 9.9%. We were disappointed with the position taken by both staff and the AG, which fails to recognize our need to have an opportunity to earn our authorized return over the next trien period. We remain confident that the Commission will see through these arguments, and recognize their obligation under the law to allow the company an opportunity to earn a fair return. A decision is expected in November. Kentucky was subject to a stay out provision until June of this year. We subsequently filed our base rate case on June 29, where we asked for a $65 million increase and an ROE of 10%. The company has also sought to use the remaining unprotected AFDIT [ph] funds in Kentucky to offset bills for customers who cannot afford to pay their bills. The commissioner elected to combine this request with a base rate case filing and we expect resolution by yearend. Last but not least, in our SWEPCO jurisdiction, we received approval from the commission to create a regulatory asset for the costs associated with Hurricane Laura. We will ask for similar treatments for the costs associated with Hurricane Delta, and we are hopeful that we can put this year's hurricane season safely behind us. In Texas, SWEPCO made its base rate case filing on October 13, where we are seeking a $90.2 million increase with an ROE of 10.35%. We're also seeking to increase the storm reserve and increase our vegetation management expenditures to minimize the risk of future outages to our Texas customers. We continue to make progress on our North Central Wind projects, which will benefit our customers in Louisiana, Arkansas and Oklahoma. Foundation work is commenced at the Sundance facility, which is expected to be in service by the end of first quarter 2021, Invenergy is currently completing final site preparation on both the Maverick and Traverse locations. We continue to expect to acquire the Maverick facility by December 21, and the Traverse facility into December the first quarter of 2022 timeframe. We have filed our settlement true up in Arkansas and are finalizing our settlement true up in Oklahoma. We're looking forward to the benefits that these projects will bring to our customers, by providing access to some of the nation's richest wind resources and helping SWEPCO and PSO advance a greener energy future. So now to the equalizer chart, I'll talk about that. I think it's on Page 5 of the presentation. So our current ROE is about 9%. And you know we just generally target these returns to be in the 9.5% to 10% range. The ROEs below are not where they normalized. And certainly, keep in mind that we're also thickening equity layers as well. So, I'll talk about AEP Ohio first, I just mentioned the rate case there. It's above authorized primarily due to favorable regulatory items, partially offset by the roll off of the legacy issues that we've been talking about for years, regarding the [indiscernible] and the RSR. But we also expect the yearend ROE to trend around the authorized levels of 10%. For APCo, which I'd mentioned earlier is slightly below authorized, due a lower normalized usage and higher depreciation from increased capital investments, partially offset by continued management of the O&M expenses. Effective January 2020, costs associated with the last 17.5% of Wheeling Power's interest in Mitchell plant became recoverable through APCo and Wheeling rates. And then I've already discussed Virginia's tri-annual review. Kentucky, I already discussed the rate case there, but they're below and as you can see well-below authorized due to loss of load from weak economic conditions and loss of major customers, along with higher expenses during the stay out period. So, we have a lot of work to do there. I&M, the ROE for I&M at the end of third quarter was 10.4%. Its ROE was above authorized due to continued management of O&M expenses, reduced interest expense and rate true ups, partially offset by lower commercial industrial sales. I&M's ROE is projected to trend slightly below 10% by yearend, consistent with authorized ROEs in Michigan and in Indiana. PSO, its ROE is 8%. At the end of third quarter, it was below its authorized level primarily due to lower normalized usage and unfavorable weather in 2020, partially offset by continued management of O&M expenses. PSOs 2019 base case as you recall, approved the transmission track or a partial distribution tracker, and ROE of 9.4% authorized, so we'll continue to make progress there. SWEPCO, the ROE for SWEPCO is about 7.4%, and as you recall, much of that is related to the Turk Plant not being in retail rates in Arkansas, and that impacts by about 110 basis points. SWEPCO received an order in its Arkansas base case settlement in December 2019, and effective 2020 approved a $24 million revenue increase in ROE of 9.45%. In October 2020, we also filed the rate case in Texas, as I mentioned earlier. In AEP Texas, its ROE is around 7.5%, it was below authorized due to lag associated with a tiny of annual cost recovery filings. We did not make those filings during the pendency of the previous rate case, and of course, onetime adjustments from our finalized base rate case itself. Favorable regulatory treatment allows AEP Texas to file annual DCRF and TCOS filings, and we've since filed many of those at this point. I think there's been three cases that have been filed. And while earnings should improve in 2020, with a base rate case finalized and annual filings now resumed continued levels of investment in Texas will impact the ROE. The expectation is for the ROE to trend towards an authorized ROE of 9.4% in the long-term, but be around probably 8% by the end of 2020. As far as the transmission company is concerned, AEP Transmission Holdco was 9.8%, and it was below authorized primarily driven by the annual revenue true up in the second quarter of 2020 to return the over collection of 2019 revenues. Transmission is forecasted an ROE of 9.8% to 10.1% range in 2020. It is also interesting to note, that when you look at the average equity in our operating jurisdictions, The Transmission Holdco is now the largest, which that's happened for the first quarter. This first quarter that has actually occurred. So, making a lot of progress. But at the same time, though the investment is being made relative to transmission is certainly improving the quality of service to our customers. So, very happy with the progress we're making around our T&E investments and its ability to improve customers’ experiences. As I close, I'd be remiss in not thanking our employees at the Oklaunion Power Station that was officially retired from service a couple of weeks ago, after several decades of providing generation resources, and meeting the needs of our customers electricity demands in Texas and Oklahoma. Oklaunion was under construction about the time I joined AEP out of college. And when you see people and assets retiring, it just further illustrates the resiliency of AEP over the last 114 years, but also the change occurs and we have to change with it. Thanks again to all the Oklaunion employees through the years. So, all-in-all, a solid quarter for AEP and I can't resist when thinking about AEPs future post-COVID, with the latent value of the need for resiliency and reliability of the grid to support work from home environments, moving forward with the transformation to clean energy resources, which we had AEP or in the beginning stages of, and the further electrification of the economy. We would say in the words of late Eddie Van Halen, it's about time, this time's our time, and right on, we'll let it shine. I am convinced in overcoming the challenges of 2020. This company will be even stronger as we move into 2021 and beyond. Brian?"
},
{
"speaker": "Brian Tierney",
"text": "Thank you, Nick and good morning, everyone. I will take us through the third quarter and year-to-date financial results, provide some insight on load in the economy, review our balance sheet and liquidity and finish with a preview of what we will present at the EEI conference. Let's start briefly on Slide 6, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the third quarter were $1.51 per share, compared to $1.49 per share in 2019. GAAP earnings through September were $3.56 per share, compared to $3.58 per share last year. There's a reconciliation of GAAP to operating earnings on Pages 15 to 16 of the presentation. Let's turn to Slide 7, and look at the drivers of quarterly operating earnings by segment. Operating earnings for the third quarter were $1.47 per share or $728 million, compared to $1.46 per share or $722 million in 2019. Operating earnings for vertically integrated utilities were $0.85 per share down $0.04. This was driven by unfavorable weather, primarily due to warmer than normal temperatures last year, particularly in September. Other drivers including lower wholesale load and other operating revenue, as well as higher depreciation and taxes, primarily due to timing that were averse in the fourth quarter. Favorable items included lower O&M, favorable rate changes and higher transmission revenue. The transmission and distribution utility segment earned $0.31 per share up $0.04 from last year. Favorable items included higher rate changes in transmission revenue, as well as lower O&M. These favorable items were partially offset by unfavorable weather, depreciation, taxes and interest expense. The AEP Transmission Holdco segment continue to grow, contributing $0.28 per share an improvement of $0.03. This reflected the return on investment growth as net plant increased by $1.5 billion or 16% since September of last year. Generation and marketing produced operating earnings of $0.13 per share, down $0.03 from last year. This was driven by timing around income taxes and lower wholesale margins. Finally, corporate and other was up a penny from last year, primarily driven by lower taxes related to consolidating items that will reverse by year-end. Let's turn to Slide 8, and review our year-to-date results. Operating earnings through September were $3.56 per share or $1.77 billion, compared to $3.65 per share or $1.8 billion in 2019. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $1.90 per share comparable to last year. Favorable items in this segment included lower O&M, the impact of rate changes across multiple jurisdictions and higher transmission revenue primarily due to true ups. Weather was unfavorable due to warmer than normal winter temperatures this year and a warmer summer in 2019. Other decreases included higher depreciation and tax expenses, primarily due to timing and lower revenue items and AFUDC. The transmission and distribution utility segment earned $0.84 per share down a penny from last year. The negative variance was primarily driven by the 2019 reversal of a regulatory provision in Ohio. Other smaller drivers included higher depreciation and interest expense, the roll off of legacy riders in Ohio, prior year Texas carrying charges, unfavorable weather and tax expenses. These items were mostly offset by higher rate changes, the recovery of increased transmission investment in OCA [ph] and the impact of the Ohio transmission true up on both O&M and transmission revenue. Other O&M was also favorable due to the concerted effort to decrease O&M expenditures through one time and sustainable reductions. The AEP Transmission Holdco segment contributed $0.75 per share, down $0.07 from last year due to the impact of the annual true up and prior year FERC settlements. Our fundamental return on investment growth continued. Generation and marketing produced $0.31 per share, up a penny from last year. The Renewables business grew with asset acquisitions more than offsetting lower wholesale and retail margins and timing around income taxes. O&M sales and other onetime items offset the impact of weaker wholesale prices on the generating business. Finally, Corporate & Other was down $0.02 per share due to higher interest in taxes related to consolidating items that were reversed by the yearend, and offset by a prior year income tax adjustment. Partially offsetting these items was lower O&M. Overall, we are pleased with our financial results and are confident in confirming our annual operating earnings guidance of $4.25 to $4.45 per share. Turning to Slide 9, let's review the assumptions we shared during the first quarter earnings call to reaffirm guidance. Starting with the topline, we recently updated our retail sales forecast. Third quarter sales came in higher than previously projected. We now expect 2020 normalized sales to come in 2.7% below last year, which is 0.7% better than the load forecast from the first quarter. While the outlook has improved, it is still below the pre-recession forecast used for our original guidance. The favorable sales mix in 2020 has helped to mitigate the impact on earnings. The second item was the impact of weather. While the first quarter weather produced a significant drag, the second quarter and third quarter weather impacts were slightly favorable. In the second quarter presentation we mentioned that, July's weather was quite favorable. However, August and September weather was mild. As a result, we have revised the weather impact on 2020 earnings and now expect a $0.08 drag to 2020 results. The next item was on track the O&M expense. We had originally planned to drive O&M cost down to $2.8 billion from $3.1 billion in 2019. In response to the expected sales decline, we identified an additional $100 million of savings for both onetime in sustainable reductions and are on track to hit this lower expense target. Finally, we identified approximately $500 million of capital expenditures in the first quarter that could be shifted out of 2020 and in the future years. We made this decision to support our cash position through the expected downturn during the pandemic. As we discussed at the second quarter earnings call, results have come in better than expected and we've reinstated approximately $100 million of the $500 million back into 2020. Given the progress we've made on these key assumptions, we were able to reaffirm our 2020 operating earnings guidance range. Now let’s turn to Slide 10, to provide an update on our normalize load. Starting in the lower right corner, our third quarter normalized load was down 2.6%, this was slightly better than the forecast we shared with you in the first quarter. Through September, our normalized sales were down 3% from last year. In the upper left quadrant, our normalized residential sales increased by 3.8% in the quarter. Year-to-date residential sales were up 2.6%. We saw significant increases in our residential load at the beginning of the pandemic. The growth in residential sales has moderated as people return to work over the summer. Weather normalized residential sales are up across all jurisdictions. Moving clockwise, our normalized commercial sales decreased by 4.6% in the third quarter, bringing the year-to-date decline to 4.9%. As expected, the biggest declines in this class came from schools, churches, restaurants and hotels. Finally in the lower left chart, industrial sales decreased by 7.8% in the quarter, bringing the year-to-date decline to 7%. A number of factors have changed the outlook for this class, but the biggest driver is overall economic activity. The industrial sectors that posted the biggest declines for the quarter were mining, oil and gas extraction and primary metals. By contrast, plastics and rubber manufacturing posted a strong quarter related to the recovery of the automotive industry. Overall, load growth across the service territory followed the pattern we anticipated earlier in the year. During the second quarter, residential sales peaked and commercial and industrial sales hit their lows. Since then, our service territory has been working its way back to a more normalized levels. Because some businesses will continue to work remotely, we expect our residential sales to continue at higher levels for some time. Let's take a deeper look into why we raised our outlook for normalized load on Slide 11. The solid bars represent weather normalized load growth by quarter end 2020. The green lines represent the updated load forecast we shared during the first quarter earnings call. At that time, there was still a lot of uncertainty regarding the depth and duration of the economic slowdown and how customers would respond. While that forecast accurately predicted the depth of the contraction in the second quarter, our third quarter results indicated a better recovery than forecasted. Our latest view, anticipates a continuation of this trend barring another shutdown of the economy. Now let's move on to Slide 12 and review the company's capitalization and liquidity. Our debt to capital ratio remain unchanged in the third quarter and stands at 61.1%. Our FFO to debt ratio decreased 1.3% during the quarter to 12.8% on a Moody's basis, primarily due to timing of fuel recovery, storm cost deferrals and a pension contribution. Importantly, we expect this metric to end the year in the low to mid-teens, consistent with the guidance we have provided. Our liquidity position remains strong at $3.8 billion, supported by a revolving credit facility. Before providing an update on pension funding, I would like to discuss the plan to finance the North Central Wind Project. As a reminder, we have stated that we intend to use equity to finance approximately two-thirds of this $2 billion project. We plan to issue equity in coordination with the completion of the three individual projects that comprise North Central Wind. For this reason, we will take a flexible approach which could include and at the market mechanism, asset rotation, as well as traditional secondary offerings. This approach avoids unnecessary dilution and helps us deliver on the 5% to 7% earnings growth rate. Turning to our pension, I am pleased to report that funding increased 3.6% during the quarter to 97%, and our OPEB Funding increased 5% to 141%. Strong equity returns was the primary driver for the increases. The pension plan also benefited from a company contribution in the amount of the plan's annual service cost of $111.5 million. Let's wrap this up on Slide 13, so we can get to your questions. We are reaffirming our existing 2020 operating earnings guidance of $4.25 to $4.45 per share. Our message at EEI will be that we are leading the way forward as a premium regulated utility with an ESG focus delivering 5% to 7% earnings growth with dividends growing in line with earnings. Our plan includes the $2 billion North Central Wind project in Oklahoma, benefiting our customers in PSO and SWEPCO as we transition to a cleaner energy future. We will provide detailed drivers for 2021 earnings guidance by segment and updates to our capital expenditure and financing plans. We look forward to talking with many of you at the virtual EEI conference in a couple of weeks. One final item, in 2021, we will release 2020 fourth quarter and full year earnings in late February, coincident with the filing of the 2020 10-K, like we did last year. With that, I will turn the call over to the operator for your questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions]. And we will go to Julien Dumoulin-Smith with Bank of America Merrill Lynch. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Julien."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, howdy. Thanks for the time, guys. Perhaps just to kick things off. You talked about rolling out and reaffirming or perhaps preemptively reaffirming in the EEI the 5% to 7%. Can you talk a little bit about what's backstopping that? Specifically, in the last few months, we've seen some pretty substantial changes from some of your peers in Virginia. How can that play into APCo? And perhaps also similarly in Indiana, many of your peers are talking about opportunities. You all have perhaps Rockport. Just curious if you can talk about or perhaps foreshadow some of the conversations here on that role forward, if you don't mind, at the outset."
},
{
"speaker": "Brian Tierney",
"text": "Julien, I think a lot of the things that we're going to talk about are renewable opportunities in addition to North Central Wind, how we're transitioning from a carbon-based generating fleet much more to a lot of the renewables that the Virginia Clean Energy Act enables and legislation in Indiana enables as well. So we're going to provide a lot more detail on that at EEI and take you through what that looks like. You have the renewable requirement in Virginia. You mentioned APCo. We've got the requirement there. And also Indiana, Michigan, we continue to do renewables in various areas there. We're also doing renewables, we just did fourth sale in Oklahoma. And then we also have renewable applications here in Ohio that are brewing as well. So, we'll have plenty to talk about. And I think, we don't we don't spend and then maybe we should spend more talking about the opportunities we've got available to us from a renewable standpoint. But the way I see it is that, we're just on the precipice of a massive transformation to renewable resources. And AEP, if you look at the runway it's pretty substantial. And that will continue particularly as we do individual relationships with customers, but also in terms of the regulated side as well, through the Integrated Resource Planning process. So we'll certainly talk more about that at November EEI."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Thanks for entertaining me there. Perhaps, if I can get more detailed here, if you don't mind. I know you all provided a little bit more of you want 23 here, but in tandem, you gave an updated view on FFO to total debt under Moody's definition of low to mid-teens versus perhaps prior characterizations of mid-teens. Is that simply a factor of rolling forward here? Or how are you thinking about this at this point?"
},
{
"speaker": "Brian Tierney",
"text": "Julien, the low to mid-teens is completely consistent with our prior messaging on FFO to debt. And that outlook was incorporated in Moody's when they made their adjustments back in August. And remember that will continue to improve as some of this accumulative deferred income taxes that is being repaid to the regulatory jurisdictions are occurring much more quickly than we thought, maybe we originally thinking 10 years. And it turned out to be five years. And that's occurring more quickly. So that FFO to debt metric will pick up as that rolls off."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Excellent. Thank you."
},
{
"speaker": "Brian Tierney",
"text": "Yes."
},
{
"speaker": "Operator",
"text": "Our next question is from Durgesh Chopra with Evercore ISI. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning. Thanks. Great. Hey, just digging in a little bit into 2021. I appreciate you'll share more color at EEI. But could you quantify for us what that 2%, 2.7% sales degradation was year-to-date, part one? And part two, should we assume some of that $51 million year-to-date O&M savings to be carried forward into the next year?"
},
{
"speaker": "Brian Tierney",
"text": "Yes. So let me start with the 2.7% load degradation. It's what you would expect. It's largely commercial and industrial sales. The decrease is being offset by residential. And so, what we've seen is it takes more than just looking at the raw numbers on residential, commercial and industrial, it's really the mix. You remember, we make more margin on residential sales than we do on commercial and industrial. And that mix has come in better than we had anticipated at the beginning of the pandemic. So, it's not been as dire as what we thought it might be because of what's happened with the sales mix, rather than just the overall decreases. So that's been positive. Looking forward on O&M, we have for a number of years been tightening our belt and been very, very tight around untracked O&M in that $2.8 billion to $3.1 billion range. And with what we're doing with achieving excellence, and everything else we're doing with sustainable and non-sustainable O&M cuts, I'd anticipate us being towards the lower end of that range going forward."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood."
},
{
"speaker": "Nick Akins",
"text": "When we look at the load forecast, I mean if you assume 2021 is going to be better, which we believe it is. And you look at that mix, we don't see residential. I mean, obviously, it will moderate as the economy comes back on the industrial and commercial side, commercial in particular. But still, you're going to have a continued longstanding remnant of improved residential support just by virtue of what companies have learned from the work from home environment. So, I'm a little bit bullish on the load and then at least a financial picture associated with load. And then when you look at the O&M this achieving excellence program it has truly been a fundamental change for us and augmentation of all the lean activities and other things that we did before. And it really is focused on a regular part of our budget process to ensure that we're capturing savings and every step along the way. So, feeling pretty good about the continual progress year-on-year of achieving excellence."
},
{
"speaker": "Durgesh Chopra",
"text": "That's great, guys. Thanks for that color. Maybe just initial thoughts and I appreciate that that was going to be in the details, but initial thoughts on elections, taxes, climate plan and implications for AEP?"
},
{
"speaker": "Nick Akins",
"text": "Yes, so I guess, well, first of all, it's the election, certainly as a noisy election cycle, and who knows what's going to happen here, we never know. But we've got 114 years history of managing between the goalposts here, so we'll continue to do that. And our focus is on move into that clean energy economy. So really, the only difference obviously, is maybe the pace at which the change will occur if there's a Biden administration versus Trump. But nevertheless, it doesn't change that much for us, because we're focused on moving that clean energy economy as quickly as we can, to ensure that we are making that transition into the future that we know it's going to happen. Now, who knows where technology will go, even for fossil fuels, but nevertheless, we'll continue that transition to renewables and certainly some natural gas to ensure that we are delivering for our customers in the future. So, from a client perspective, we have an excellent record and I think that's why we get seen from the ESG community where they know what we're doing, they know what our message is, we're making continual progress. And we'll continue to make that progress. And then when you think about, as I said, in my original write up, I used the word latent, because it is a somewhat of an undeveloped or emerging activity around electrification of the economy, certainly around O&M and what we find with digitization and automation. And then, of course, as we move forward with the transformation, the generation transformation that we see ahead of us. So that's, that's why I'm feeling pretty good about where this company is heading."
},
{
"speaker": "Brian Tierney",
"text": "Just a quick update on taxes. If we were to have an increase in taxes, we anticipate that our commissions would handle it. Really, one of two ways and not dissimilar to how they handled tax reform three or four years ago. We anticipate that they would either allow the increase to be deferred until the next rate proceeding, or we anticipate that they'd have kind of a one issue, order come out where they would allow us to adjust rates just to reflect the new expected higher income tax rate. In any event, we wouldn't expect it to be a significant driver to earnings or cash for the company going forward."
},
{
"speaker": "Durgesh Chopra",
"text": "Great. Thanks. But it could be a modest delve into cash flow, like given sort of a reset in AVIT [ph] and amongst other things."
},
{
"speaker": "Nick Akins",
"text": "I think the [Indiscernible]."
},
{
"speaker": "Brian Tierney",
"text": "Yes. Again, we don't anticipate it to be significant one way or the other."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Thanks, Brian. Thank you, Nick."
},
{
"speaker": "Brian Tierney",
"text": "Thank you."
},
{
"speaker": "Nick Akins",
"text": "Yep."
},
{
"speaker": "Operator",
"text": "Our next question is from James Thalacker with BMO Capital Markets. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, James. Hello?"
},
{
"speaker": "James Thalacker",
"text": "Hey, thanks, guys. I apologize about the [multiple speakers]. Good morning. Two real quick questions. Just first, I guess, Brian, just addressing, North Central wind, I noticed in the slides that Traverse look like potentially be in service could be pushed out maybe by a quarter or so. Could you talk a little bit about it? Is that just a supply chain issue related to COVID? Or there's something else that was kind of driving that extended outlook?"
},
{
"speaker": "Brian Tierney",
"text": "Yes, a lot of it has to do more so than actual physical things. It's our ability to get permitting and the like done. And so during the shutdown, it was hard to be able to get into the offices, do land acquisitions, title searches and things like that. And that just potentially pushed us back at big teams. We're not in anticipating anything material there. We still anticipate late this year to early next year which is one of the signal that due to some of those unanticipated issues largely associated with COVID that that project could have a range of when it would come online."
},
{
"speaker": "Nick Akins",
"text": "Hey, James, we feel like it's still going to be the end of the summer, but obviously it could fall into that range in the first quarter, we're confident of that particular range. But remember, we're not making any progress payments, either. It's sort of we require it when it's done. So from a financial perspective it's fine."
},
{
"speaker": "James Thalacker",
"text": "Okay, great. Thanks. And I guess, just following up on that same issue. Brian, you talked about, three sort of potential ways to finance the final acquisition of those and this has been beat to death. But as you guys look to give 2021 guidance, obviously, an ATM would be something because spread over the full year, but asset rotation or even block equity, really probably something I think, as you were saying, sort of coordinating it with the final close would be something maybe closer to the end of the year. How are you guys, I guess thinking about that from a modeling perspective, as you present 2021?"
},
{
"speaker": "Brian Tierney",
"text": "It kind of matches what Nick was saying is that the projects don't -- we don't get the projects until commercial completion is done, we then get the project. And given the discrete nature of them, we can really time the equity issuance very closely with when the project comes online. And James the reason, we need that flexibility, you look at Sundance, which we're anticipating in the first quarter of 2020, that's about a $300 million project. We'll be able to time the equity issuance, if that's what it is closely with when that project comes online. The next one, which we're anticipating at the end of 2021, is about a $400 million project, Maverick. And then the last one is Traverse, which is about $1.3 billion and we talked about that being late 2021, early 2022. We believe that whether it's an aftermarket program, a follow on issuance or asset rotation, we're going to be able to time those very, very closely with when those discrete projects come online. So from a modeling standpoint, the timing that we're talking about really is going to be insignificant to 2021. And I'd start repeating myself and shaping it in 2021."
},
{
"speaker": "Nick Akins",
"text": "James, Brian mentioned the options we're looking at. And rest assured internally, we're also being at the death. So, we'll make sure that we're making the right decisions relative to the timing associated with those investments."
},
{
"speaker": "James Thalacker",
"text": "No worries. I understand the in service space, and it gives you guys a lot of flexibility. The last question, I guess, I just had, and you kind of answered my initial question was going back to the trailing 12 months FFO kind of dip down. You guys were looking for that sort of trend back into kind of where you guys were thinking sort of low to mid-teens, I guess. Are you still targeting that in the sort of '21, '22, '23 timeframe? I know you updated your cash flow forecasts for that recently."
},
{
"speaker": "Nick Akins",
"text": "Yes, we are. It's that timeframe, yes."
},
{
"speaker": "James Thalacker",
"text": "Okay, perfect. Thank you so much for the time."
},
{
"speaker": "Brian Tierney",
"text": "Thanks, James."
},
{
"speaker": "Operator",
"text": "And next, we'll go to Michael Lapides with Goldman Sachs. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Michael."
},
{
"speaker": "Michael Lapides",
"text": "Good morning, Nick. Thank you guys for taking my question. And Nick, sorry about your LSU Tigers."
},
{
"speaker": "Nick Akins",
"text": "Yes. Alabama is doing good though. I'm sure you're happy with that."
},
{
"speaker": "Michael Lapides",
"text": "Yes, let's hope they keep coaching. Brian, I want to come back to tax a little bit and who the heck Uncle Sam’s is going to do in the next year or so regarding corporate tax rates. But if there's a change in administration, if there's a higher corporate tax rate, I think we’ve seen numbers floated around 27% or 28%. I get that it's probably not much of an impact on the earnings power one way or another for AEP. But if you're talking to state commissioners or staff at the PSCs, or PUCs or others, it is a rate increase on customers. And it's a double whammy, because the cost of service goes up due to the higher tax rate and that just kind of flows through rates. But also the flow back of assets kind of slows down or declines. And it just strikes me as if I must say utility commissioner for public policy maker and given state, you're asking for what could be pretty decent size rate increases on customers coming out of an economic downturn. How does that get offset? I think about it from the customer standpoint. What's the get [Indiscernible]."
},
{
"speaker": "Nick Akins",
"text": "Hey, I think there's no doubt that -- and again, I think there was a lot of advantage taken with it with the tax reductions that occurred. And you're right, there's no doubt that there will be headroom that is reduced, because it is certainly going to be an impact to put those back in. Now, the question is how to put back in or what time frame and that kind of thing. But also that's why it's so important for us to move forward as quickly as possible and accelerate achieving excellence, so that we can mitigate that impact as much as possible. But still, you're looking at it in the face of a definite need for rehabilitation and continued capitalization of the grid to ensure that we have reliability and resiliency of supply, particularly when you're dealing with hurricanes, wildfires, cyber, all those kinds of issues we have to respond to that. So there'll be rate increases associated with the implementation of new taxes. And I think it's unavoidable, but certainly it's incumbent on us to make sure we mitigate that as much as possible with our achieving excellence program and other measures. And we'll have discussions with the commissions, just like we had discussions when tax reform occurred. And, it's unfortunate we didn't do it over a longer period of time like we had suggested, because then it would mitigate even the return of taxes. And if we continue vacillating back and forth like this, that's going to be a continual issue for our industry that our regulators need to recognize. We do have to keep some reserve there to ensure that we're not moving customer rates around, as much as could be as if it becomes pretty volatile. So, your point is well recognized, but we'll do what we can to mitigate the effects and we'll have those conversations. But I think one thing that's also come into play here, though is, is the nature of the importance of the service that we provide, for everyone to be able to watch their Netflix or do all the things they need to do at home, work from home. All those sorts of activities will change the nature of how we look at residential supply. And there's no question that that's going to change going forward. And that's why I'm always troubled by the commission saying that AMR versus AMI, for example, the investments we want to make in AMI, it's not because AMI is you don't just look at the cost of the meters of AMI and the undepreciated balance associated with AMR. You've got to look at what you're leveraging into and that's the customers’ ability to adjust to their own energy picture and be able to drive energy efficiency and all those things and give the customer the opportunity to do that, as opposed to of the system just decide in that forum. So, I think there's just a lot of things we need to have discussions about with our regulators to really focus on what that future actually means. And with electrification of the economy, that's clearly going to be an issue that we need to deal with to make sure our customers are more resilient, more reliable and as economic as possible, but also give them the opportunity to make adjustments on their total bill as opposed to dealing on a headline on rate increases."
},
{
"speaker": "Michael Lapides",
"text": "Got it. Thank you for that, Nick. And then one other question, totally unrelated. I'm thinking about states where you've not really talked about sizable rate base growth and investment. One of those that stands out a little bit is West Virginia. How do you think about going forward, the pace of generation transformation in a state like West Virginia?"
},
{
"speaker": "Nick Akins",
"text": "Yes, I think, we're looking at all of our states now and all our state jurisdictions, and it's really sort of our resource planning on steroids. And even the dogs like it. And I think there's no question that we're in the process of moving forward with that transformation as quickly as possible, making significant T&D investments, but all and you see that based on the changes in capital. But then when you look at states like West Virginia, we will be -- I think the first step is going to be how we run coal fired capacity, for example, where we have other forms of energy coming in and have lower capacity factors on coal units, but still they be available if those times where, you have severe cold weather, or really warm weather in the summer. So, it's a way we run these facilities during the interim, but then it's also that transition that we make going forward. I think that's true for all of the jurisdictions. And our jurisdictions have been fairly conservative in making that transition. I think that pace can quick and though, as a result of the even the bipartisan focus on continuing to lower emissions in our plant. So, I think there's the catalysts are there. And actually, post-election, who knows what'll happen, but I still see, you're already seeing some Republican and Democratic legislation that's being proposed that tries to answer that question. And if you have that from a national standpoint and the states are moving forward with their own resolutions, and then we can be particularly helpful in ensuring that occurs as quickly as possible."
},
{
"speaker": "Michael Lapides",
"text": "Got it. Thank you, Nick. Sorry about the [Indiscernible], and I both appreciate it. Thanks guys."
},
{
"speaker": "Nick Akins",
"text": "No, that's fine."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Sophie Karp with KeyBanc. Please go ahead."
},
{
"speaker": "Sophie Karp",
"text": "Hi, good morning. Thanks for taking my questions."
},
{
"speaker": "Nick Akins",
"text": "Yes, sure thing. Good morning."
},
{
"speaker": "Sophie Karp",
"text": "I'm curious, I want to go back to kind of the load composition and the rate case activity. So, as we roll forward and the load dislocation continues to be persist, where we have this unusual situation where residential, maybe it's higher, but C&I is suppressed. And that's not really a normalized picture. So, if you go through your rate cases now, and the future rate cases where this period becomes your test here, right? How do you address that? Did you attempt to normalize? Do you just go with what they actually look like? So, that's my first question, I guess."
},
{
"speaker": "Nick Akins",
"text": "Yes. So, we have multiple utilities, right. So, we have the opportunity to move around capital investment to time it with relative rate case activity to ensure that we are spinning on the right things at the right time. Not to say that we're trying to load the budgets or anything, what we're saying is that, that when we go through the rate case, filings, it's important to not only have discussions with the Commissions about what we're spending on, but what the results of that spending will be. So, if the load is not increasing, obviously, it exaggerate. It certainly challenges the rate impacts, because the denominator is not growing. If the denominator is growing, obviously, that's helpful. But if it isn't, you're still having to make choices about what the priorities are for each regulatory jurisdiction based on discussions with the Commissions to help us determine, okay, number one, what are we willing to pay for, number two, what are those priorities that exist. And some of those are absolute priorities and some of them are things that yes, we'd like to do, but it may be that we have to work out for a longer period of time before bringing that in. So, there's all kinds of dialogues that occur, relative to what that prioritization should be. And we'll continue doing that with our Commissions. And we have done, whether it's gone, where the economy is going well, or whether the economy has been in a downturn. I think we're moving toward an upturn. So that's going to be helpful."
},
{
"speaker": "Brian Tierney",
"text": "Sophie, we also have some jurisdictions that have forward looking test years, so we'll be able to incorporate a forward looking view. And then we have places like Ohio, where residential and small commercial are already decoupled. So, there are lots of mitigations to unusual load circumstances that we find ourselves in right now."
},
{
"speaker": "Nick Akins",
"text": "And some of these things are known and reasonable adjustments too, so you have to look at the 2020 test year and say, we had to make these changes because of COVID. And COVID is going to be sort of a unique circumstance and then we had to react. And actually, the Commissions themselves, we had moratoriums on customer cut-offs. So, there is adjustments we all made in that process, and I think we'll make those adjustments coming out of that process as well."
},
{
"speaker": "Sophie Karp",
"text": "Great. Thank you. And then, if I may a quick follow-up on the Central Wind. You mentioned assets rotation, I guess, as a part of the considerations for equity financing there. What might those be? Is this more of a like one-off situation with churn assets in your portfolio? Or could we be looking at something more strategic here? Thank you."
},
{
"speaker": "Nick Akins",
"text": "Well, so when we talk about potential assets, we look at everything, and we look at sources and uses. And obviously, we want the use part of it right now is how do we finance North Central Wind, a major project. And the sources can be anything in our portfolio, and that's where portfolio management is going to be a key part of what we do in the future. So, I'm not going to say, specifically what we're looking at, or anything like that at this point. But what I will say is that it's incumbent on us to be looking at everything from a source perspective, and then focusing on how we deploy capital in the best way and transfer that into really projects like North Central, and be able to fund it in the best way to ensure our shareholder value. And we will continue to do that. So, I think you got what the sort of year play out."
},
{
"speaker": "Sophie Karp",
"text": "Thank you."
},
{
"speaker": "Nick Akins",
"text": "Yep."
},
{
"speaker": "Operator",
"text": "And with no further questions, yes, I'll turn it back to you."
},
{
"speaker": "Darcy Reese",
"text": "Great. Thank you for joining us on today's call. As always, the IR team will be available to answer any questions you have. John, please give the replay information."
},
{
"speaker": "Operator",
"text": "Certainly. And Ladies and gentlemen, this conference is available for replay. It starts today October 22, at 11:30 AM Eastern Time, and will last until October 29, at midnight. You may access to the replay at any time by dialing 866-207-1041 or 402-970-0847. The access code is 8222465. Those numbers again 866-207-1041 or 402-970-0847, access code 8222465. That does conclude your conference for today. We thank you for your participation. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 2 | 2,020 | 2020-08-06 09:00:00 | Operator: Ladies and gentlemen, thank you very much for standing by, and welcome to the American Electric Power Second Quarter 2020 Earnings Call. At this time, all lines are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given to you at that time. [Operator Instructions] And as a reminder, today’s conference call is being recorded. I would now like to turn the conference over to Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Cynthia. Good morning everyone and welcome to the second quarter 2020 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay. Thanks Darcy. And welcome, everyone to American Electric Power's second quarter 2020 earnings call. While, we continue to see the effects of COVID-19 pandemic, AEP has responded well with not only ensuring the safety of our employees and redefining the business processes to accommodate the changed environment and reducing our costs in response to lower revenues, but we also are responding to hurricane and storm activity to ensure the safe and reliable service to our customers. Our team at AEP Texas with support from internal and external resources performed well through Hurricane Hanna to restore power to over 200,000 customers during that recent weather event. And we're now supporting recovery efforts in the Northeast as well. While COVID cases were escalated in some areas, we continue to engage our employees on safe practices to prevent the virus spread both at work and outside of work to set an example in our communities. On the financial front our operating earnings performance has been strong in the face of these challenges. AEP's operating earnings came in for the quarter at $1.08 per share, bringing our year-to-date operating earnings to $2.10 per share versus $1 share for second quarter 2019 and $2.19 per share year-to-date 2019. We are reaffirming our originally stated guidance range of $4.25 to $4.45 per share and our 5% to 7% long-term growth rate. AEP is also adjusting our capital upward during the five-year capital forecast period from $33 billion to $35 billion to accommodate the North Central wind project addition. Also as we stated in the last quarter earnings call, we have continued to evaluate the short-term deferral of $500 million in our 2020 capital program that we talked about last quarter and we are placing $100 million back into the 2020 plan at this point. So all-in-all a constructive quarter given the headwinds of the economy due to COVID. In fact we continue to make progress toward our target of achieving at least the midpoint of the guidance range. As far as load is concerned, we continue to see the arbitrage between residential load and negative industrial and commercial load during the quarter. As we continue to look for leading indicators as to the health of the state economies, we have been pleased to see the new customer connections remain stable and some jurisdictions increasing from 2019 levels. Looking forward, we expect to see a continued shift to a certain degree from residential load back to commercial and industrial, albeit these shifts will be dependent upon the nature of the pandemic recovery. During the COVID-19 crisis, we continue to take all appropriate measures to ensure the safety of our employees both in the field and for those who can work-from-home. Temperature, testing masking requirements, social distancing and hygiene have become the normal course of business in this environment. While our offices are open to employee meetings and certain other activities, we are still asking our employees who can work-from-home to remain home, most likely through the end of the year. This has not slowed the progress, however, toward redefining our business processes going forward. Our Achieving Excellence Program is now back in full swing with the added dimension of work-for-home learnings that will enable us to define even more efficiencies than previously considered. We also late last year, completed an initial analysis of what a 21st century technology framework would look like, and with the addition of Therace Risch former JCPenney EVP, Chief Information Officer to our team. She has by the way hit the ground running. I'm confident the nexus of her efforts around IT and other technologies married with achieving excellence, COVID learnings, and other strategic initiatives will enable us to further define operating efficiencies that will benefit our customers and shareholders. We are on track for the $100 million of cost reductions for this year as we adjust to expectations regarding revenues due to COVID-19 and the first quarter weather deficiencies that we had. And after reviewing our July weather, we have partially made up for the weather issue that we talked about during the first quarter. So we are making progress within the guidance range expectations and we are now targeting the midpoint of our guidance. As we move closer to 2021 and the addition of North Central wind, we will still be disappointed not to be in the upper half of our 5% to 7% long-term growth rate. I would like to spend a little time taking -- talking about steps we are taking to internally consider the effects of the recent and ongoing discussions about race in America. AEP is not only engaged externally with various local and national organizations, but we were also open to very frank and open dialogue internally. We call it our cease-the-moment action plan. This plan includes engagement with our leaders and employees in the organization through internal discussions, external speakers, webcasts including myself now to be posted internally and process changes that will continue to make AEP a strong committed company that enables all of our employees to contribute in an open and transparent fashion. We have a great culture at this company, but we can always do better by understanding the impacts of stereotypes different perspectives based upon life experiences, the burden placed on employees of color in our organization and what systemic racism versus individual racism act actually means. I believe the dialogue will enable a much deeper discussion that will benefit our diversity and inclusion efforts as well as enable AEP to be a better partner to our communities, as we effectuate lasting change. We can't talk about these cultural attributes without also realizing what our brand projects externally. And that brings me to the second issue that we at AEP certainly believe affects our brand. That would be the issue surrounding Ohio House Bill six legislation. Let me start by saying that we are not aware of any information suggesting that AEP's participation in the process was anything other than lawful and ethical. We have a robust code of ethics and regularly communicate our expectations to our employees that they conduct all business including advocacy on public policy issues with integrity, honesty and in compliance with the law. We consistently advocate for policy positions that benefit our customer's, communities and shareholders and our advocacy of HB6 was no different. We ultimately supported the legislation because we believe it maintained important fuel diversity for Ohio including support for investments in renewables, nuclear generation and two coal plants operated by OVEC. We were surprised and disappointed to learn of what federal investigators alleged was a scheme by the speaker of the Ohio House and others to enrich themselves. And we along with you have been trying to educate ourselves about the criminal complaint and the underlying conduct in it. There has been a lot of speculation and media reports about the identity of various unnamed companies described in the affidavit in support of the complaint. Based on the facts that we know, we do not believe that AEP is any of the companies specifically described in the affidavit. We have not been contacted by any authorities conducting the investigation. If at any point we are, we will cooperate fully. I would also like to discuss 501(c)(4) organizations more generally. AEP has contributed to a variety of 501(c)(4) social welfare organizations to promote economic development and educational programs across our service territories. One such organization is Empowering Ohio's Economy, which was organized to promote economic and business development in Ohio. Starting in 2015, AEP contributed a total of $8.7 million to Empowering Ohio's Economy for review of publicly available tax forms filed by Empowering Ohio's Economy shows that it made a number of grants over time to a wide variety of charitable organizations under 501(c)(3) and social welfare organizations under 501(c)(4). Our contributions to Empowering Ohio's Economy to support its mission were appropriate and lawful. Given the ongoing legal proceedings surrounding HB6 that we are still learning about and that we are unaware of any allegations of wrongdoing involving AEP, I'm going to let those proceedings play out rather than commenting further on this subject. We also understand the concerns that some have expressed regarding the lack of transparency surrounding 501(c)(4) organizations which are not required to disclose their donors and amounts donated to them. With that in mind, we will commit to include additional disclosures in our corporate accountability report with respect to contributions that we made to 501(c)(4) organizations in 2020 and going forward. We also are reviewing best practices and working to improve our policies and processes around political contributions and contributions to 501(c)(4) entities. Regarding any repeal and replacement of HB6, we are fully prepared as we have done previously to engage in whatever dialogue needs to occur to chart a path in Ohio toward a balanced energy portfolio that moves toward a clean energy future for Ohio. AEP has been very clear since the beginning of a nuclear debate that we were concerned about forging a path toward the adoption of renewables, such as solar and wind along with other technologies, such as storage to mobile technologies, the big data analytics to enable a smarter and more efficient grid. HB6 has some of that, but we were also following HB247 to move Ohio forward from a clean energy technology perspective. If HB6 is repealed in a way that appropriately reverses its effects, the financial impact is minimal to AEP. We already had several years of recovery for the OVEC units HB6 elongated that. We will continue to recover our energy efficiency contracts entered into before the legislation. AEP Ohio is already decoupled in many respects. And we will continue to pursue bilateral solar and wind projects with customers. As we have said since day one, if our customers are expected to help put the bill for nuclear, they should also have the opportunity to take full benefit of renewables and movement to a clean energy economy and be able to access technologies that will help them to lower their electric bills. Unrelated to HB6, but an item that should not be lost in the Ohio legislature is continued interest in promoting greater broadband access particularly in rural Ohio. This is an area that we are well positioned to help stimulate by providing middle-mile services to ISPs to advance the service for those communities. We are optimistic that the broadband legislation that passed the House with broad support continues forward as the pandemic has shown the digital divide is real and getting more pronounced and the need for broadband access for our customers particularly rural customers is desperately needed and we can leverage into our communication system to make broadband access a reality. We have already begun pilots in Virginia and West Virginia. And certainly with our large amounts of -- need for large amounts of data from the grid for monitoring and analysis purposes tangentially providing mid-mile broadband accessibility is clearly a benefit to our communities. On the regulatory front our base rate case in Ohio was filed earlier this year where we're seeking a net revenue increase of $41 million a 10.15% ROE and continuation of our DOE and Enhanced Service Reliability Rider. We expect a procedural schedule to be set next month. In Kentucky, we filed our base rate case in July which should conclude by year-end. We have sought $65 million with a 10% ROE as well as AMI deployment within the state. We sought to be creative in our use of ADFIT funds to help lessen the rate impacts to customers in the state. I am pleased to report that the Texas Commission approved the AEP Texas DCRF settlement agreement increasing revenue requirement by approximately $39 million which reflects the $440 million of distribution investment placed in service in 2019. Throughout our territory new customer interconnects continue to be strong in much of our service territory in several areas exceeding what we have seen in recent years. While the virus continues to challenge this nation this provides hope in American commitment and ingenuity will continue to help fuel our recovery. Lastly we are extremely pleased to have now received all necessary regulatory approvals to move the full North Central wind investment forward for the benefit of our customers. Although the disappointing PUCT denial of our application results in the project benefits not extending to our Texas customers, we received approvals from the Arkansas Public Service Commission and the Louisiana Public Service Commission in May for their portion and the flex-up option. Approval of flex-up option was designed to enable the full value of the project to go forward even if the state elected not to take advantage of the opportunity. We are pleased that the Arkansas Public Service Commission and the Louisiana Public Service Commission along with the Oklahoma Corporation Commission have recognized the value of these projects. And we look forward to delivering this value to Arkansas, Louisiana and Oklahoma customers. With regards to the project schedule due to the COVID-19 pandemic, we expect a minimal delay in the completion of the 199-megawatt Sundance Project and expect the project to be delivered in the first quarter of 2021 instead of December 2020. The other two projects are currently expected to be delivered by the developer by the end of '21 -- 2021. We are pleased to report in May the RAS provided an extra year to the 4-year continuity safe harbor related to production tax credit eligibility. So we have an additional year of flexibility should there be any delays to deliver these projects and achieve full value for our customers. Now looking at the equalizer graph on Page five of the presentation, our overall regulated operations ROE is currently 9.1%. We like to target a range overall of 9.5% to 10%. So I'll go into some other things around weather and the other things that have come into play. AEP Ohio, the ROE for AEP Ohio at the end of the second quarter was 11.1%. Their ROE was above authorized due to favorable regulatory items and a transmission true-up partially offset by the roll-off of legacy fuel and capacity carrying charge recoveries. We expect the year-end ROE to trend around authorized levels of 10% as we maintain concurrent capital recovery of distribution and transmission investment. In June 2020 as I said earlier, we filed a rate case in Ohio. As far as APCo is concerned the end of the second quarter was 9.3% ROE. That ROE was below authorized due to lower normalized usage and higher depreciation from increased capital investments. Virginia's first tri-annual review was filed in March 2020 and covers the 2017 to 2019 periods and that case is currently ongoing. At Kentucky Power the ROE is down to 5.7%. It was below authorized due to loss of load from weak economic conditions and loss of major customers along with higher expenses. Transmission revenues were also lowered due to the delay of some capital projects. In June 2020 Kentucky Power filed a new base rate case seeking a $65 million revenue increase and an ROE of 10%. I&M came in at 10.6% for the quarter. The ROE was above authorized due to continued management of O&M expenses reduced interest expense and rate true-ups partially offset by lower normalized usage. I&M's ROE is projected to trend towards 10% at year-end consistent with authorized ROEs. PSO came in at 9.4% for the quarter. Their ROE is right in line with the authorized level due to management of O&M expenses offset by lower normalization usage. PSO's 2019 base case approved a transmission tracker, a partial distribution tracker, and an ROE of 9.4%. So, everything is going well there. SWEPCO came in at 8.3%. And again it's below authorized due to loss of load and the continued impact of the Arkansas share of the Turk Plant which accounts for about 110 basis points. SWEPCO received an order in its Arkansas-based settlement in December 2019, that's effective in January 2020 approving a $24 million increase and an ROE of 9.45%. AEP Texas came in the quarter at 7.4%, their ROE was below authorized due to lag associated with the timing. We've discussed this earlier last quarter of the annual cost recovery filings and one-time adjustments from our recently finalized base rate case. Favorable regulatory treatment allows AEP Texas to file annual DCRF and biannual TCOS filings to recover costs on significant capital investments. So, while earnings should improve in 2020 with the base rate case finalized the annual filings now resumed continued levels of investment in Texas will continue to impact the ROE as well. AEP Transmission came in at 9.8%. It was below authorized primarily driven by the annual revenue true-up in the second quarter of 2020 and to return the over-collection of 2019 revenues. Transmission is forecasting an ROE of in the range of 9.9% to 10.3% for 2020. So, that should continue on as the year goes forward. As I've mentioned in the past, our organization has undertaken a comprehensive view of our O&M and capital spending efficiency under a program that we coined Achieving Excellence. I'm excited about this opportunity for our employees because it goes to the heart of how we do work, removing past barriers that may have existed, and looking at our processes through a different lens. We are now moving into the implementation phase of this initiative with opportunities for increased O&M savings and increased efficiencies in our capital spending being implemented over the next three years and beyond. This work will serve as the platform and help to integrate other initiatives around organizational design, digitization, end-to-end process efficiency, and work-from-home initiatives. The program will also be a precursor to our annual budgeting process in the future. We will share more information about these initiatives and the expected O&M savings later this year, but we have recently jump-started this initiative by offering an early retirement incentive program for a targeted set of our employees. The program has recently closed and I'm pleased to say that we have reached our goals of this initiative where about 200 of our employees have selected to take this incentive to retire. I'm thankful to those who will be leaving the company soon for many reasons. One, for their years of service and dedication to AEP and for providing the company an opportunity to take advantage of organizational design changes upon their exit. I'll be providing more detail when we wrap up all these initiatives later this fall. Before I turn this over to Brian, particularly, with the headwinds we all face today, I'd like to paraphrase some of the lyrics from the song Lost in the Echo by the rock group Linkin Park that I think represents AEP today. Now, it may take a little time for you to figure out what I'm saying here. But nevertheless the lyrics say; we don't hold back we hold our own, we can't be mapped we can't be cloned, we can't C-flat, it ain't our tone. What you get from AEP is our consistent focus on being a positive tone attitude and performance that will help our communities and customers get through this pandemic and the culture issues that's scarring our society. We will continue to be uniquely qualified to bring stakeholders together to move toward a clean energy future for our customers and again provide the quality dividends and earnings that our shareholders expect. Brian, I'll turn it over to you.
Brian Tierney: Thank you, Nick and good morning everyone. I will take us through the second quarter and year-to-date financial results, provide an update on how we were thinking about 2020, including a look at July load, and finish with the review of our balance sheet and liquidity. Let's stop briefly on slide six which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $1.05 per share compared to $0.93 per share in 2019. GAAP earnings through June were $2.05 per share compared to $2.10 per share in 2019. There is a reconciliation of GAAP to operating earnings on pages 15 and 16 of the appendix. Let's turn to slide seven and look at the drivers of quarterly operating earnings by segment. Operating earnings for the second quarter were $1.08 per share or $534 million compared to $1 per share or $494 million in 2019. Operating earnings for Vertically Integrated Utilities were $0.55 per share, up $0.17, driven by lower O&M and higher transmission revenue primarily due to true-ups. Normalized retail load was favorable due to higher-margin residential sales more than offsetting significant decreases in industrial and commercial sales. We will talk more -- in more detail about our expectations around normalized load for the year later in the presentation. Other favorable items included weather and rate changes. These positive items were partially offset by higher depreciation and other taxes and lower wholesale load AFUDC and off-system sales. The transmission and distribution utility segment earned $0.29 per share, up $0.02 from last year. Both O&M and transmission revenue were favorable due to the impact of the transmission true-up on this segment. Increased transmission investment in ERCOT was positive as well. Rate changes were also favorable and partially offset by prior-year Texas carrying charges, the roll-off of legacy riders in Ohio, depreciation, lower normalized retail load and higher interest expense. The Transmission Holdco segment contributed $0.19 per share, down $0.12 due to the impacts of the annual true-up and a prior year FERC settlement. Our fundamental return on investment growth continued as net plant increased by $1.5 billion, or 17% since June of last year. Generation & Marketing produced operating earnings of $0.11 per share, up $0.05 from last year. Again on the sale of Conesville and land sales contributed to the increase in generation business and the renewables business grew with the acquisition of multiple renewable assets. These increases along with the timing around income taxes more than offset lower retail margins. Finally, Corporate and Other was down $0.04 per share primarily driven by higher taxes related to consolidating items that were reversed by the year-end and partially offset by lower O&M. Let's turn to slide 8 and review our year-to-date results. Operating earnings through June were $2.10 per share or $1 billion, compared to $2.19 per share or $1.1 billion in 2019. Looking at the drivers by segment. Operating earnings for Vertically Integrated Utilities were $1.05 per share, up $0.04. Earnings in this segment increased due to lower O&M and higher transmission revenue similar to the quarter as well as the impact of rate changes across multiple jurisdictions. Weather was unfavorable, primarily due to warmer than normal winter temperatures. Other decreases included higher depreciation, tax expenses and lower expected wholesale load, AFUDC, normalized retail load and off-system sales. The Transmission & Distribution Utilities segment earned $0.53 per share, down $0.05 from last year, primarily driven by a reversal of a regulatory provision in Ohio. Other smaller drivers, included higher depreciation, the roll-off of legacy riders in Ohio, prior-year Texas carrying charges, higher interest expense and unfavorable weather. These items were partially offset by higher rate changes, the Ohio transmission true-up impact on both O&M and transmission revenue and recovery of increased transmission investment in ERCOT. The AEP Transmission Holdco segment contributed $0.47 per share, down $0.10 from last year for the same reasons identified in the quarterly comparison. Generation & Marketing produced $0.18 per share, up $0.04 from last year. The growth in the renewables business and gains on generation more than offset the lower retail margins and timing around income taxes. Finally, Corporate and Other was down $0.02 per share due to higher interest expense and taxes related to consolidating items that will reverse by the year-end and offset by a prior year income tax adjustment. Partially offsetting these items is lower O&M. Turning to slide 9. Let's review the assumptions we shared during the first quarter earnings call. To reaffirm our 2020 operating earnings guidance range of $4.25 per share to $4.45 per share. As shown on the top line, we revised our retail sales projection from 1.5% growth in 2020 to a 3.4% decline by the end of the year. For the second quarter, our sales growth in total was on target with the revised projections. The mix of sales growth is slightly different than projected, but the date load is closely tracking to the revised forecast. The second item was the impact of weather. While the first quarter weather produced a significant drag, the second quarter weather was slightly favorable. In addition, we experienced warmer than normal weather in July, especially in the East. As a result, we are now assuming less of a negative impact to our 2020 results from weather. The third item was managing our untracked O&M expense. We had originally planned to drive down O&M costs in 2020 to $2.8 billion from $3.1 billion in 2019. During the first quarter call, we shared that in response to the expected decline in sales we now plan to reduce spend by an additional $100 million by aggressively managing O&M. We are on track to hit our projections through both one-time and sustainable reductions. Finally, on the first quarter call, we identified approximately $500 million of capital expenditures that could be shifted out of 2020 and into future years. This was in anticipation of the potential impact of the economic downturn on cash receipts. Through the second quarter, our day's sales outstanding have only marginally increased. We have brought about $100 million of the $500 million back into 2020 and we'll maintain flexibility as we move through the balance of the year. Given the progress made on these key assumptions in the second quarter, we are able to reaffirm our 2020 operating earnings guidance range. There are main items that could positively or negatively impact our projections for the second half of the year, but we are confident in our ability to manage our way through various scenarios. Now let's turn to slide 10 to provide an update on our normalized load for the quarter. Starting in the lower right corner, our second quarter normalized load was down 5.9%. This was consistent with the expectations we shared with you in the first quarter. We anticipated a significant contraction in the second quarter followed by a gradual recovery over the second half of the year. Through June, our normalized sales were down 3.1%. In the upper left quadrant, our normalized residential sales increased by 6.2% in the second quarter. Year-to-date residential sales were up 1.9% compared to last year. We saw significant increases in our residential load during the stay-at-home provisions that were in effect during the quarter. Even after our states began their phased reopenings, we saw strong growth in weather-normalized residential sales across all jurisdictions. This would suggest many of our customers have continued to work from home. We expect the spike in residential growth to moderate as the commercial and industrial sectors improve during the second half of the year. Moving clockwise, our normalized commercial sales decreased by 10.1% in the second quarter bringing the year-to-date decline to 5%. Prior to COVID, we had experienced consistent improvement in our commercial sales over the past year. State and post stay-at-home provisions challenged many of our commercial customers. All of our leading sectors experienced a drop in normalized load in the quarter with the biggest declines coming in schools, churches, restaurants and hotels. Should our states manage without having to shut down businesses again, we expect commercial sales to gradually improve throughout the balance of the year. Finally in the lower left chart, industrial sales decreased by 12.4% in the quarter bringing the year-to-date decline to 6.6%. A number of factors have changed the outlook for this class but the biggest driver is the overall drop in economic activity. The industrial sales – the industrial sectors that posted the biggest decline for the quarter were transportation, equipment, manufacturing, mining and primary metals. The two sectors that have grown in 2020 were pipeline transportation and petroleum and coal products. Let's take a look at weather-normalized load history and forecast in more detail on Slide 11. The chart on the left shows that for the second quarter actual load very closely tracked our revised forecast. As you can see from the chart, our revised forecast assumed an economic trough in the second quarter that would gradually improve over the course of the year. So far we are on track and we'll keep you updated as we move throughout the year. We wanted the time this call in order to give you the most updated load information through July. The chart on the upper right shows monthly total weather-normalized sales for March through July. Sales for our system were lowest in May and have shown improvement in June and July. Total normalized load for May was down 8.6% versus June, which was down 4.8% versus July, which was down only 2.4%. The monthly macro data for both the business and household surveys show that unemployment rates peaked in April and have improved since. This is consistent with our assumption that the trough is behind us and the economy should continue its gradual improvement through the balance of the year. The bottom right chart shows that for the month of July, the trend that we forecast for the balance of the year is on track. Although there are some differences in load mix to what we have predicted, our overall load is tracking very closely to our revised forecast. Normalized residential sales for July while still very positive at 4.3% were less than for the second quarter. And both commercial and industrial sales show real improvement versus the second quarter as shown on the prior page. Now let's move to Slide 12 and review the company's capitalization and liquidity. Our debt to total capital – our debt-to-capitalization ratio improved 70 basis points in the second quarter to 61.1%. This was largely attributable to reducing our short-term debt levels in conjunction with fortifying our liquidity position, as we navigated the capital market turbulence in March. In fact, our liquidity position stood strong at $2.9 billion at quarter end. The short-term reduction actions also helped improve our FFO-to-debt ratio when compared to the first quarter moving to 14.1% from 12.5% on a Moody's basis. Our Qualified Pension Funding remained flat at 93% and our OPEB Funding increased approximately 5% to 135%. A falling discount rate increased both plans liabilities during the quarter but strong asset returns especially in equities were able to offset the growth in liabilities. Let's wrap this up on Slide 13 so we can get to your questions. We are reaffirming our existing 2000 operating earnings guidance of $4.25 to $4.45 per share. We are on track to reduce our O&M by the additional $100 million we announced last quarter in response to the economic downturn and revised load implications. Of the $500 million of CapEx that we shifted out of 2020 into later years, we have now returned $100 million into this year. We will maintain our flexibility on this issue as we manage through the balance of the year. We obtained regulatory approvals in Oklahoma, Louisiana, Arkansas and FERC and are moving forward with our $2 billion North Central wind project in Oklahoma, benefiting our customers in PSO and SWEPCO. We have updated our capital plan from 33 – our five-year capital plan from $33 billion to $35 billion as well as our cash flow and credit metrics which are provided on Page 40 of the appendix. Because of our ability to continue to invest in our own system organically we are reaffirming our stated long-term growth rate of 5% to 7%. With that I will turn the call over to the operator for your questions.
Operator: [Operator Instructions] And our first question will come from the line of Jeremy Tonet with JPMorgan. And your line is open.
Nick Akins: Good morning, Jeremy.
Jeremy Tonet: Hi. Good morning.
Nick Akins: Good morning.
Jeremy Tonet: Hi. Thanks for taking my questions here. I wanted to start-off a couple of, I guess, opposing items influencing AEP going forward here North Central wind getting that over the finish line, obviously, a big positive COVID headwind on the other side here. Just wondering, if you could talk a bit more about how these two factors influence I guess your 5% to 7% range with North Central wind? I think we're just looking to see if that could really help you here, or just want to see how everything is shaking out I guess going forward?
Nick Akins: Yes. So I mean we look at -- and as Brian mentioned on the COVID activity and the load activity, you're seeing residential load be pretty strong. And certainly as you look forward I think residential load is going to continue to look strong with the work-from-home environment and the business cases that are developed afterwards. And then if you have Commercial and Industrial pickup as well, it could be positive from a financial standpoint. The other regarding North Central and other wind projects and solar projects, we have a real opportunity to transition to that clean energy economy going forward in our service territory and that will really makes us – again, we would be disappointed not to be in the upper part -- upper half of the 5% to 7% range because you have to be bullish about not only where load is going, but also in terms of the transformation from a -- just a pure and simple energy policy perspective regardless of who's in the White House in the next election, we'll continue moving toward a clean energy economy. And then also I think, bolstered by the other opportunities we have whether it's mid-range broadband or other types of activities electric vehicles and so forth that we're going to see the further electrification of this society. So I'm really bullish about this company in particular, but as well the industry.
Jeremy Tonet: That makes sense. That's helpful. Thanks. And maybe just kind of building off that with my second question. I think AEP is guiding to $1.3 billion of equity issuance to fund North Central at this point. Just wondering, if you could update us there on your thoughts with regard to is this definitively the path, or is there the potential for portfolio optimization? Is that still an option? I guess, how do you think about...
Brian Tierney: It absolutely is still an option. And we're looking at all those options to see how to best finance it. We have plenty of time to make those things happen. Nick said that Sundance might be pushed out to the first quarter of 2021, but we're not going to see the rest of those projects coming in Traverse and Maverick until the end of 2021. So all those things are in play whether it's equity or rotation of capital. But for planning purposes we are guiding people to two-thirds equity for that project in aggregate.
Jeremy Tonet: Got you. That’s very helpful. Thank you.
Nick Akins: Thanks, Jeremy.
Operator: Thank you. Our next question comes from the line of Andrew Weisel with Scotiabank. And your line is open.
Nick Akins: Good morning, Andrew.
Andrew Weisel: Good morning. First a question on dividends. So at the end of the deck you showed dividends in 2022 at $1.5 billion versus $1.4 billion previously. I also see the footnote that dividend should grow with earnings. My question is, is that increase of $100 million a function of more shares outstanding after the North Central wind equity, or does it imply a step-up in dividend per share along with a step-up in EPS or perhaps both?
Nick Akins: I think it'd be some of both because obviously with North Central additional equity involved there, but also as you said I mean our dividend will move with our earnings capability. So I'd say both.
Andrew Weisel: Okay. Great.
Nick Akins: Brian, do you have any comments? Okay.
Andrew Weisel: Go ahead.
Nick Akins: No, I was just seeing if Brian wanted to just comment on that but he said I covered it.
Andrew Weisel: Okay. Great. On CapEx you mentioned that you're pulling back $100 million of the deferred CapEx. I just want to understand -- be sure I understand what drove that. Is that a function of specific projects being more necessary or more appealing, or is it more a function of the better-than-expected cash flows?
Nick Akins: Yes, I think that's a positive story. Some of that is related to new customer connections. And so it was clearly evident that we needed to move that forward. But also we have the capability financially to move it forward. We talked about this last time the deferral of the $500 million we weren't changing the five-year capital plan we were going to maintain that level. And the $500 million was merely being deferred so that we could understand what the COVID issues were going to be. And so we're continually looking at our process going forward in terms of putting that 500 back in in various stages. So what you saw this quarter was the first stage of that.
Andrew Weisel: Very good. If I could just have one more here to clarify the last question from Jeremy. The 5% to 7% range you're pointing to the upper end of that. Is that a function of North Central wind now being included, or is it more that you're pointing to the higher end with or without North Central wind as a one-timer?
Nick Akins: Well, certainly, we looked at North Central, but obviously, we continue to track and we believe that the upper half of that guidance range is certainly achievable and something that we again would be disappointed not to be able to get there. So that's clearly an opportunity for us based on the things that I talked about earlier.
Brian Tierney: It should – North Central wind should certainly solidify our position in the upper half.
Nick Akins: Yeah. And keep in mind too at the same time the Achieving Excellence Progam is continuing to grow. So we already have plans in place and you're seeing sort of a crescendo of savings associated with that plan. And the first year 2020 is – some of it's in there, but not much. And when you look at the future years that continues to grow substantially, and certainly, as I've mentioned earlier the addition of Therace and the focus on digitization automation in combination with the learnings from COVID, I think going to further accentuate the benefits from achieving excellence.
Andrew Weisel: That all sounds great. Thank you so much.
Operator: Thank you. Our next question comes from the line of James Thalacker with BMO Capital Markets. And your line is open.
Nick Akins: Good morning, James.
James Thalacker: Hey, good morning, guys. Can you hear me?
Nick Akins: Yep, I'm hearing you yes. Good morning.
James Thalacker: Okay. Great. Real quick question. I know you had outlined the bending the cost curve EEI down to kind of $2.8 billion. And as COVID took over we're now down at $2.7 billion. It seems like year-to-date if you just look at it on an after-tax basis you guys are already kind of running above that kind of $100 million sort of run rate. How should, we I guess think about the non-tracked O&M versus the additional O&M that you are actually pulling out in response to COVID? And as we think about 2021, is there any guidance, I guess you could give us on how much of that you think will be retainable as we move into next year?
Brian Tierney: Yeah. So we're at this point James not able to provide obviously specific guidance on 2021. But I'll say, the incremental $100 million that we're able to garner is a combination of sustainable and one-timers. And I think it's a matter of managing our way through the downturn in normalized load and just working as hard as we can to pull out all the stops to make sure that we meet our commitments to shareholders and really target the middle part of that range without impacting customers. And so far, we've been able to do that. There have been some unexpected things that we've seen maybe some things that aren't line items in O&M that have come out. And I think you have things like travel and expense conventions that people go to things like that meals just buildings expense that you have things that just don't happen when everyone's working from home that, I think are more like one-timers but if people go back to work we'll start to put those things back into place. But you've seen our track record over the last nine or 10 years now and it's been keeping a very, very tight range on untracked O&M and we're using those skills that we've learned over the last several years to make sure that we're able to manage our way through this circumstance.
Nick Akins: Yeah, I would say, and as Brian mentioned I mean, there's a lot of learnings from COVID-19 and the impacts and how we've operated, and the efficiency of which we've operated. And I think it sort of changes, the perspective and changes the threshold of even, what one-timers are and ongoing, because I think the learnings we have from here we're going to be much different in our approach related to many of these activities. And actually, you would be surprised and I'll certainly talk about this more at the end of the year of what achieving excellence is showing us of things that were buried in the organization that we obviously have an opportunity to take advantage of. And so there's no question that you should expect the continued efficiency around the savings of O&M. And that's in the non-tracked area.
Brian Tierney: You've seen – on page 34 of the presentation, you've seen the tight range we've been able to keep it in. In terms of bending the curve as we go down to $2.7 billion in non-track, we actually are bending that curve downward at this point.
Nick Akins: Yes. Bending to warping. So that's good.
James Thalacker: No, that's great. And I guess just as a follow-up, I mean, obviously the run rate has been very, very good. I mean, you did a heroic job, I guess in 2Q just the bulk of it from a year-to-date perspective that's kind of showed up. But as you move through the rest of the year do you feel like you have additional room whether it be onetime or again Nick like you're talking about through just kind of change in workflow to continue to sort of press that down, if you need to if we get sort of resurgence in COVID again?
Nick Akins: Yeah. I think number one really, I think about – the processes are in place and the focus of the organization is in place to be able to adjust. And I'm perfectly happy with the foundation that's been put in place for this organization on an ongoing basis. I mean, because if we look at our Achieving Excellence Program, it's not just a onetime program. It's a regular process we're going to go through in budgeting. And it's also a regular process, where they'll go throughout the year, for us to be able to adjust. So we will do what we have to do. And there's no question, that we have the foundation to be able to do it.
James Thalacker: Okay. Great.
Nick Akins: Yeah.
James Thalacker: Well, thank you for taking my question. And best of luck guys.
Nick Akins: Thank you.
Operator: Thank you. Next we will go to the line of Durgesh Chopra with Evercore ISI. And your line is open.
Durgesh Chopra: Good morning, Nick.
Nick Akins: Hey good morning.
Durgesh Chopra: Oh! That is down. Hello? Hey can you hear me?
Nick Akins: Yeah. Go ahead.
Durgesh Chopra: Okay. Great, just -- I wanted to follow-up on the O&M $100 million number. What of that $100 million was actually achieved in the quarter?
Brian Tierney: It will be the O&M CapEx or the O&M -- I'm sorry O&M caps. It's going to be achieved rateably throughout the balance of the year. So from second quarter, third and fourth, think about it being achieved rateably, as we work our way through that.
Durgesh Chopra: Understood and I apologize there's like an echo in my -- when I'm speaking. So -- and then, the potential labor initiatives that you outlined is that in addition to the $100 million?
Brian Tierney: It's all incorporated to get us to that $2.7 billion number.
Durgesh Chopra: Understood guys. Thank you so much.
Brian Tierney: Sure. Thanks.
Operator: Thank you. Our next question comes from the line of Sophie Karp with KeyBanc. And your line is open.
Brian Tierney: Good morning, Sophie.
Sophie Karp: Hi good morning guys. Good morning. Congrats on the quarter.
Nick Akins: Thanks.
Sophie Karp: And thanks for the time. I'm just curious about -- maybe I can ask you, more of a high-level question. Given the landscape or market landscape that we are seeing right now. Do you see an opportunity maybe an opening to do some rotation in your portfolio of assets maybe high-graded a little bit if you will and divest some? And is there an opportunity for M&A for a more wires focused or like just asset [Technical Difficulty] …
Nick Akins: Yeah, Sophie.
Sophie Karp: …your puts and thoughts on that.
Nick Akins: Yeah, sure, we've certainly been consistent in the discussion around any M&A activity or in terms of -- what we can do in terms of rotation. That's always an option that's available to us. And this company is moving toward, a portfolio management approach where obviously we have sources and uses and those sources include the assets we have. And certainly we'll continue to look at those, as opportunities in time with investments that we make. So we will continue to do that. Regarding M&A activity we have a high threshold because we certainly have the ability to invest we have the ability to -- we have the largest transmission system in the country. Certainly our investment in our distribution businesses is continuing to grow considerably. And so, if we can invest that out without a premium, that's a good thing for our shareholders. Now that being said, we look at strategic areas that make sense to us but certainly that threshold is high. And we'll continue to evaluate that. But make no mistake that this company is focused on its ability to continue to grow, but grow efficiently for our shareholders. And we'll continue to do that.
Sophie Karp: Thank you.
Nick Akins: Yeah. Thank you.
Operator: Thank you. Our next question will come from the line of Paul Patterson with Glenrock Associates. And your line is open.
Nick Akins: Good morning, Paul.
Paul Patterson: Hey how are you doing?
Nick Akins: All right, how are you?
Paul Patterson: I am managing. No laugh. So I can do like that. And so, I don't think of you guys, being a primary beneficiary or primarily impacted by HB6, but is there any ancillary or anything we should think about with the potential repeal of HB6 in Ohio, that could impact you guys?
Nick Akins: Well, certainly with the repeal, it's -- how it's replaced is the issue, and obviously how it's repealed. Because there are some things some interconnections that occurred between HB6 and the regulatory process, where we had regulatory recovery for areas that we need to make sure that's a clean transition that occurs. But on its face, the issues that were involved with that for us should be pretty well taken care of. So that's why we're saying it should be a minimal issue for us. I think it's more of an opportunity for us, because if we're able to -- and really if the state focuses on the clean energy economy going forward, that's going to provide us some opportunities to really do this the right way including nuclear for the -- for our customers going forward.
Paul Patterson: But if it's not replaced, just because we don't know what's going to happen legislatively and who knows, how should we think about the potential impact?
Nick Akins: Yeah. So, if it's not replaced, then it stays the way it is then we should be fine, because there are already...
Paul Patterson: I mean, it's repealed and they don't -- they repeal it and they don't replace it if you file...
Nick Akins: Okay, okay good. Brian?
Brian Tierney: So, we'll be fine in that circumstance, Paul. We already had decoupling in place for residential and small commercial customers. We were already getting recovery of OVEC through 2024 through the regulatory process rather than 2030, and it allowed us to enter into bilateral contracts with customers, but we haven't signed any bilaterals to date. So, we think will be absolutely fine, if it's repealed and not replaced. But as Nick said, I think there are opportunities to do it right and replace it with something that's more positive.
Nick Akins: Yes, we've done bilateral contracts just not with that structure. So…
Paul Patterson: Okay, great. And then just on the PJM 205, end-of-life transmission planning filing. I know you guys are protesting that with almost every other transmission company. Do you have any sense as to what the potential impact would be from a shareholder perspective on transmission CapEx or anything else, if that 205 filing is accepted by FERC?
Brian Tierney: Paul, we think it would be pretty minimal to us.
Nick Akins: Yeah.
Paul Patterson: Okay. Good. Awesome, thanks so much.
Brian Tierney: Thank you.
Operator: Thank you. And at this time, I'm showing no other questions in queue. Please go ahead with any closing remarks.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Cynthia, would you please give the replay information.
Operator: Certainly. Ladies and gentlemen, today's conference call will be available for replay after 5:30 p.m. today and going until August 14 at 3:55 p.m. You may access the AT&T teleconference replay system by dialing 866-207-1041 and entering the access code of 7269937. International participants may dial 402-970-0847. Those numbers once again 866-207-1041 or 402-970-0847 and entering the access code of 7269937. That does conclude your conference for today. Thank you very much for your participation and for using AT&T Executive Teleconference Service. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you very much for standing by, and welcome to the American Electric Power Second Quarter 2020 Earnings Call. At this time, all lines are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given to you at that time. [Operator Instructions] And as a reminder, today’s conference call is being recorded. I would now like to turn the conference over to Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Cynthia. Good morning everyone and welcome to the second quarter 2020 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay. Thanks Darcy. And welcome, everyone to American Electric Power's second quarter 2020 earnings call. While, we continue to see the effects of COVID-19 pandemic, AEP has responded well with not only ensuring the safety of our employees and redefining the business processes to accommodate the changed environment and reducing our costs in response to lower revenues, but we also are responding to hurricane and storm activity to ensure the safe and reliable service to our customers. Our team at AEP Texas with support from internal and external resources performed well through Hurricane Hanna to restore power to over 200,000 customers during that recent weather event. And we're now supporting recovery efforts in the Northeast as well. While COVID cases were escalated in some areas, we continue to engage our employees on safe practices to prevent the virus spread both at work and outside of work to set an example in our communities. On the financial front our operating earnings performance has been strong in the face of these challenges. AEP's operating earnings came in for the quarter at $1.08 per share, bringing our year-to-date operating earnings to $2.10 per share versus $1 share for second quarter 2019 and $2.19 per share year-to-date 2019. We are reaffirming our originally stated guidance range of $4.25 to $4.45 per share and our 5% to 7% long-term growth rate. AEP is also adjusting our capital upward during the five-year capital forecast period from $33 billion to $35 billion to accommodate the North Central wind project addition. Also as we stated in the last quarter earnings call, we have continued to evaluate the short-term deferral of $500 million in our 2020 capital program that we talked about last quarter and we are placing $100 million back into the 2020 plan at this point. So all-in-all a constructive quarter given the headwinds of the economy due to COVID. In fact we continue to make progress toward our target of achieving at least the midpoint of the guidance range. As far as load is concerned, we continue to see the arbitrage between residential load and negative industrial and commercial load during the quarter. As we continue to look for leading indicators as to the health of the state economies, we have been pleased to see the new customer connections remain stable and some jurisdictions increasing from 2019 levels. Looking forward, we expect to see a continued shift to a certain degree from residential load back to commercial and industrial, albeit these shifts will be dependent upon the nature of the pandemic recovery. During the COVID-19 crisis, we continue to take all appropriate measures to ensure the safety of our employees both in the field and for those who can work-from-home. Temperature, testing masking requirements, social distancing and hygiene have become the normal course of business in this environment. While our offices are open to employee meetings and certain other activities, we are still asking our employees who can work-from-home to remain home, most likely through the end of the year. This has not slowed the progress, however, toward redefining our business processes going forward. Our Achieving Excellence Program is now back in full swing with the added dimension of work-for-home learnings that will enable us to define even more efficiencies than previously considered. We also late last year, completed an initial analysis of what a 21st century technology framework would look like, and with the addition of Therace Risch former JCPenney EVP, Chief Information Officer to our team. She has by the way hit the ground running. I'm confident the nexus of her efforts around IT and other technologies married with achieving excellence, COVID learnings, and other strategic initiatives will enable us to further define operating efficiencies that will benefit our customers and shareholders. We are on track for the $100 million of cost reductions for this year as we adjust to expectations regarding revenues due to COVID-19 and the first quarter weather deficiencies that we had. And after reviewing our July weather, we have partially made up for the weather issue that we talked about during the first quarter. So we are making progress within the guidance range expectations and we are now targeting the midpoint of our guidance. As we move closer to 2021 and the addition of North Central wind, we will still be disappointed not to be in the upper half of our 5% to 7% long-term growth rate. I would like to spend a little time taking -- talking about steps we are taking to internally consider the effects of the recent and ongoing discussions about race in America. AEP is not only engaged externally with various local and national organizations, but we were also open to very frank and open dialogue internally. We call it our cease-the-moment action plan. This plan includes engagement with our leaders and employees in the organization through internal discussions, external speakers, webcasts including myself now to be posted internally and process changes that will continue to make AEP a strong committed company that enables all of our employees to contribute in an open and transparent fashion. We have a great culture at this company, but we can always do better by understanding the impacts of stereotypes different perspectives based upon life experiences, the burden placed on employees of color in our organization and what systemic racism versus individual racism act actually means. I believe the dialogue will enable a much deeper discussion that will benefit our diversity and inclusion efforts as well as enable AEP to be a better partner to our communities, as we effectuate lasting change. We can't talk about these cultural attributes without also realizing what our brand projects externally. And that brings me to the second issue that we at AEP certainly believe affects our brand. That would be the issue surrounding Ohio House Bill six legislation. Let me start by saying that we are not aware of any information suggesting that AEP's participation in the process was anything other than lawful and ethical. We have a robust code of ethics and regularly communicate our expectations to our employees that they conduct all business including advocacy on public policy issues with integrity, honesty and in compliance with the law. We consistently advocate for policy positions that benefit our customer's, communities and shareholders and our advocacy of HB6 was no different. We ultimately supported the legislation because we believe it maintained important fuel diversity for Ohio including support for investments in renewables, nuclear generation and two coal plants operated by OVEC. We were surprised and disappointed to learn of what federal investigators alleged was a scheme by the speaker of the Ohio House and others to enrich themselves. And we along with you have been trying to educate ourselves about the criminal complaint and the underlying conduct in it. There has been a lot of speculation and media reports about the identity of various unnamed companies described in the affidavit in support of the complaint. Based on the facts that we know, we do not believe that AEP is any of the companies specifically described in the affidavit. We have not been contacted by any authorities conducting the investigation. If at any point we are, we will cooperate fully. I would also like to discuss 501(c)(4) organizations more generally. AEP has contributed to a variety of 501(c)(4) social welfare organizations to promote economic development and educational programs across our service territories. One such organization is Empowering Ohio's Economy, which was organized to promote economic and business development in Ohio. Starting in 2015, AEP contributed a total of $8.7 million to Empowering Ohio's Economy for review of publicly available tax forms filed by Empowering Ohio's Economy shows that it made a number of grants over time to a wide variety of charitable organizations under 501(c)(3) and social welfare organizations under 501(c)(4). Our contributions to Empowering Ohio's Economy to support its mission were appropriate and lawful. Given the ongoing legal proceedings surrounding HB6 that we are still learning about and that we are unaware of any allegations of wrongdoing involving AEP, I'm going to let those proceedings play out rather than commenting further on this subject. We also understand the concerns that some have expressed regarding the lack of transparency surrounding 501(c)(4) organizations which are not required to disclose their donors and amounts donated to them. With that in mind, we will commit to include additional disclosures in our corporate accountability report with respect to contributions that we made to 501(c)(4) organizations in 2020 and going forward. We also are reviewing best practices and working to improve our policies and processes around political contributions and contributions to 501(c)(4) entities. Regarding any repeal and replacement of HB6, we are fully prepared as we have done previously to engage in whatever dialogue needs to occur to chart a path in Ohio toward a balanced energy portfolio that moves toward a clean energy future for Ohio. AEP has been very clear since the beginning of a nuclear debate that we were concerned about forging a path toward the adoption of renewables, such as solar and wind along with other technologies, such as storage to mobile technologies, the big data analytics to enable a smarter and more efficient grid. HB6 has some of that, but we were also following HB247 to move Ohio forward from a clean energy technology perspective. If HB6 is repealed in a way that appropriately reverses its effects, the financial impact is minimal to AEP. We already had several years of recovery for the OVEC units HB6 elongated that. We will continue to recover our energy efficiency contracts entered into before the legislation. AEP Ohio is already decoupled in many respects. And we will continue to pursue bilateral solar and wind projects with customers. As we have said since day one, if our customers are expected to help put the bill for nuclear, they should also have the opportunity to take full benefit of renewables and movement to a clean energy economy and be able to access technologies that will help them to lower their electric bills. Unrelated to HB6, but an item that should not be lost in the Ohio legislature is continued interest in promoting greater broadband access particularly in rural Ohio. This is an area that we are well positioned to help stimulate by providing middle-mile services to ISPs to advance the service for those communities. We are optimistic that the broadband legislation that passed the House with broad support continues forward as the pandemic has shown the digital divide is real and getting more pronounced and the need for broadband access for our customers particularly rural customers is desperately needed and we can leverage into our communication system to make broadband access a reality. We have already begun pilots in Virginia and West Virginia. And certainly with our large amounts of -- need for large amounts of data from the grid for monitoring and analysis purposes tangentially providing mid-mile broadband accessibility is clearly a benefit to our communities. On the regulatory front our base rate case in Ohio was filed earlier this year where we're seeking a net revenue increase of $41 million a 10.15% ROE and continuation of our DOE and Enhanced Service Reliability Rider. We expect a procedural schedule to be set next month. In Kentucky, we filed our base rate case in July which should conclude by year-end. We have sought $65 million with a 10% ROE as well as AMI deployment within the state. We sought to be creative in our use of ADFIT funds to help lessen the rate impacts to customers in the state. I am pleased to report that the Texas Commission approved the AEP Texas DCRF settlement agreement increasing revenue requirement by approximately $39 million which reflects the $440 million of distribution investment placed in service in 2019. Throughout our territory new customer interconnects continue to be strong in much of our service territory in several areas exceeding what we have seen in recent years. While the virus continues to challenge this nation this provides hope in American commitment and ingenuity will continue to help fuel our recovery. Lastly we are extremely pleased to have now received all necessary regulatory approvals to move the full North Central wind investment forward for the benefit of our customers. Although the disappointing PUCT denial of our application results in the project benefits not extending to our Texas customers, we received approvals from the Arkansas Public Service Commission and the Louisiana Public Service Commission in May for their portion and the flex-up option. Approval of flex-up option was designed to enable the full value of the project to go forward even if the state elected not to take advantage of the opportunity. We are pleased that the Arkansas Public Service Commission and the Louisiana Public Service Commission along with the Oklahoma Corporation Commission have recognized the value of these projects. And we look forward to delivering this value to Arkansas, Louisiana and Oklahoma customers. With regards to the project schedule due to the COVID-19 pandemic, we expect a minimal delay in the completion of the 199-megawatt Sundance Project and expect the project to be delivered in the first quarter of 2021 instead of December 2020. The other two projects are currently expected to be delivered by the developer by the end of '21 -- 2021. We are pleased to report in May the RAS provided an extra year to the 4-year continuity safe harbor related to production tax credit eligibility. So we have an additional year of flexibility should there be any delays to deliver these projects and achieve full value for our customers. Now looking at the equalizer graph on Page five of the presentation, our overall regulated operations ROE is currently 9.1%. We like to target a range overall of 9.5% to 10%. So I'll go into some other things around weather and the other things that have come into play. AEP Ohio, the ROE for AEP Ohio at the end of the second quarter was 11.1%. Their ROE was above authorized due to favorable regulatory items and a transmission true-up partially offset by the roll-off of legacy fuel and capacity carrying charge recoveries. We expect the year-end ROE to trend around authorized levels of 10% as we maintain concurrent capital recovery of distribution and transmission investment. In June 2020 as I said earlier, we filed a rate case in Ohio. As far as APCo is concerned the end of the second quarter was 9.3% ROE. That ROE was below authorized due to lower normalized usage and higher depreciation from increased capital investments. Virginia's first tri-annual review was filed in March 2020 and covers the 2017 to 2019 periods and that case is currently ongoing. At Kentucky Power the ROE is down to 5.7%. It was below authorized due to loss of load from weak economic conditions and loss of major customers along with higher expenses. Transmission revenues were also lowered due to the delay of some capital projects. In June 2020 Kentucky Power filed a new base rate case seeking a $65 million revenue increase and an ROE of 10%. I&M came in at 10.6% for the quarter. The ROE was above authorized due to continued management of O&M expenses reduced interest expense and rate true-ups partially offset by lower normalized usage. I&M's ROE is projected to trend towards 10% at year-end consistent with authorized ROEs. PSO came in at 9.4% for the quarter. Their ROE is right in line with the authorized level due to management of O&M expenses offset by lower normalization usage. PSO's 2019 base case approved a transmission tracker, a partial distribution tracker, and an ROE of 9.4%. So, everything is going well there. SWEPCO came in at 8.3%. And again it's below authorized due to loss of load and the continued impact of the Arkansas share of the Turk Plant which accounts for about 110 basis points. SWEPCO received an order in its Arkansas-based settlement in December 2019, that's effective in January 2020 approving a $24 million increase and an ROE of 9.45%. AEP Texas came in the quarter at 7.4%, their ROE was below authorized due to lag associated with the timing. We've discussed this earlier last quarter of the annual cost recovery filings and one-time adjustments from our recently finalized base rate case. Favorable regulatory treatment allows AEP Texas to file annual DCRF and biannual TCOS filings to recover costs on significant capital investments. So, while earnings should improve in 2020 with the base rate case finalized the annual filings now resumed continued levels of investment in Texas will continue to impact the ROE as well. AEP Transmission came in at 9.8%. It was below authorized primarily driven by the annual revenue true-up in the second quarter of 2020 and to return the over-collection of 2019 revenues. Transmission is forecasting an ROE of in the range of 9.9% to 10.3% for 2020. So, that should continue on as the year goes forward. As I've mentioned in the past, our organization has undertaken a comprehensive view of our O&M and capital spending efficiency under a program that we coined Achieving Excellence. I'm excited about this opportunity for our employees because it goes to the heart of how we do work, removing past barriers that may have existed, and looking at our processes through a different lens. We are now moving into the implementation phase of this initiative with opportunities for increased O&M savings and increased efficiencies in our capital spending being implemented over the next three years and beyond. This work will serve as the platform and help to integrate other initiatives around organizational design, digitization, end-to-end process efficiency, and work-from-home initiatives. The program will also be a precursor to our annual budgeting process in the future. We will share more information about these initiatives and the expected O&M savings later this year, but we have recently jump-started this initiative by offering an early retirement incentive program for a targeted set of our employees. The program has recently closed and I'm pleased to say that we have reached our goals of this initiative where about 200 of our employees have selected to take this incentive to retire. I'm thankful to those who will be leaving the company soon for many reasons. One, for their years of service and dedication to AEP and for providing the company an opportunity to take advantage of organizational design changes upon their exit. I'll be providing more detail when we wrap up all these initiatives later this fall. Before I turn this over to Brian, particularly, with the headwinds we all face today, I'd like to paraphrase some of the lyrics from the song Lost in the Echo by the rock group Linkin Park that I think represents AEP today. Now, it may take a little time for you to figure out what I'm saying here. But nevertheless the lyrics say; we don't hold back we hold our own, we can't be mapped we can't be cloned, we can't C-flat, it ain't our tone. What you get from AEP is our consistent focus on being a positive tone attitude and performance that will help our communities and customers get through this pandemic and the culture issues that's scarring our society. We will continue to be uniquely qualified to bring stakeholders together to move toward a clean energy future for our customers and again provide the quality dividends and earnings that our shareholders expect. Brian, I'll turn it over to you."
},
{
"speaker": "Brian Tierney",
"text": "Thank you, Nick and good morning everyone. I will take us through the second quarter and year-to-date financial results, provide an update on how we were thinking about 2020, including a look at July load, and finish with the review of our balance sheet and liquidity. Let's stop briefly on slide six which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $1.05 per share compared to $0.93 per share in 2019. GAAP earnings through June were $2.05 per share compared to $2.10 per share in 2019. There is a reconciliation of GAAP to operating earnings on pages 15 and 16 of the appendix. Let's turn to slide seven and look at the drivers of quarterly operating earnings by segment. Operating earnings for the second quarter were $1.08 per share or $534 million compared to $1 per share or $494 million in 2019. Operating earnings for Vertically Integrated Utilities were $0.55 per share, up $0.17, driven by lower O&M and higher transmission revenue primarily due to true-ups. Normalized retail load was favorable due to higher-margin residential sales more than offsetting significant decreases in industrial and commercial sales. We will talk more -- in more detail about our expectations around normalized load for the year later in the presentation. Other favorable items included weather and rate changes. These positive items were partially offset by higher depreciation and other taxes and lower wholesale load AFUDC and off-system sales. The transmission and distribution utility segment earned $0.29 per share, up $0.02 from last year. Both O&M and transmission revenue were favorable due to the impact of the transmission true-up on this segment. Increased transmission investment in ERCOT was positive as well. Rate changes were also favorable and partially offset by prior-year Texas carrying charges, the roll-off of legacy riders in Ohio, depreciation, lower normalized retail load and higher interest expense. The Transmission Holdco segment contributed $0.19 per share, down $0.12 due to the impacts of the annual true-up and a prior year FERC settlement. Our fundamental return on investment growth continued as net plant increased by $1.5 billion, or 17% since June of last year. Generation & Marketing produced operating earnings of $0.11 per share, up $0.05 from last year. Again on the sale of Conesville and land sales contributed to the increase in generation business and the renewables business grew with the acquisition of multiple renewable assets. These increases along with the timing around income taxes more than offset lower retail margins. Finally, Corporate and Other was down $0.04 per share primarily driven by higher taxes related to consolidating items that were reversed by the year-end and partially offset by lower O&M. Let's turn to slide 8 and review our year-to-date results. Operating earnings through June were $2.10 per share or $1 billion, compared to $2.19 per share or $1.1 billion in 2019. Looking at the drivers by segment. Operating earnings for Vertically Integrated Utilities were $1.05 per share, up $0.04. Earnings in this segment increased due to lower O&M and higher transmission revenue similar to the quarter as well as the impact of rate changes across multiple jurisdictions. Weather was unfavorable, primarily due to warmer than normal winter temperatures. Other decreases included higher depreciation, tax expenses and lower expected wholesale load, AFUDC, normalized retail load and off-system sales. The Transmission & Distribution Utilities segment earned $0.53 per share, down $0.05 from last year, primarily driven by a reversal of a regulatory provision in Ohio. Other smaller drivers, included higher depreciation, the roll-off of legacy riders in Ohio, prior-year Texas carrying charges, higher interest expense and unfavorable weather. These items were partially offset by higher rate changes, the Ohio transmission true-up impact on both O&M and transmission revenue and recovery of increased transmission investment in ERCOT. The AEP Transmission Holdco segment contributed $0.47 per share, down $0.10 from last year for the same reasons identified in the quarterly comparison. Generation & Marketing produced $0.18 per share, up $0.04 from last year. The growth in the renewables business and gains on generation more than offset the lower retail margins and timing around income taxes. Finally, Corporate and Other was down $0.02 per share due to higher interest expense and taxes related to consolidating items that will reverse by the year-end and offset by a prior year income tax adjustment. Partially offsetting these items is lower O&M. Turning to slide 9. Let's review the assumptions we shared during the first quarter earnings call. To reaffirm our 2020 operating earnings guidance range of $4.25 per share to $4.45 per share. As shown on the top line, we revised our retail sales projection from 1.5% growth in 2020 to a 3.4% decline by the end of the year. For the second quarter, our sales growth in total was on target with the revised projections. The mix of sales growth is slightly different than projected, but the date load is closely tracking to the revised forecast. The second item was the impact of weather. While the first quarter weather produced a significant drag, the second quarter weather was slightly favorable. In addition, we experienced warmer than normal weather in July, especially in the East. As a result, we are now assuming less of a negative impact to our 2020 results from weather. The third item was managing our untracked O&M expense. We had originally planned to drive down O&M costs in 2020 to $2.8 billion from $3.1 billion in 2019. During the first quarter call, we shared that in response to the expected decline in sales we now plan to reduce spend by an additional $100 million by aggressively managing O&M. We are on track to hit our projections through both one-time and sustainable reductions. Finally, on the first quarter call, we identified approximately $500 million of capital expenditures that could be shifted out of 2020 and into future years. This was in anticipation of the potential impact of the economic downturn on cash receipts. Through the second quarter, our day's sales outstanding have only marginally increased. We have brought about $100 million of the $500 million back into 2020 and we'll maintain flexibility as we move through the balance of the year. Given the progress made on these key assumptions in the second quarter, we are able to reaffirm our 2020 operating earnings guidance range. There are main items that could positively or negatively impact our projections for the second half of the year, but we are confident in our ability to manage our way through various scenarios. Now let's turn to slide 10 to provide an update on our normalized load for the quarter. Starting in the lower right corner, our second quarter normalized load was down 5.9%. This was consistent with the expectations we shared with you in the first quarter. We anticipated a significant contraction in the second quarter followed by a gradual recovery over the second half of the year. Through June, our normalized sales were down 3.1%. In the upper left quadrant, our normalized residential sales increased by 6.2% in the second quarter. Year-to-date residential sales were up 1.9% compared to last year. We saw significant increases in our residential load during the stay-at-home provisions that were in effect during the quarter. Even after our states began their phased reopenings, we saw strong growth in weather-normalized residential sales across all jurisdictions. This would suggest many of our customers have continued to work from home. We expect the spike in residential growth to moderate as the commercial and industrial sectors improve during the second half of the year. Moving clockwise, our normalized commercial sales decreased by 10.1% in the second quarter bringing the year-to-date decline to 5%. Prior to COVID, we had experienced consistent improvement in our commercial sales over the past year. State and post stay-at-home provisions challenged many of our commercial customers. All of our leading sectors experienced a drop in normalized load in the quarter with the biggest declines coming in schools, churches, restaurants and hotels. Should our states manage without having to shut down businesses again, we expect commercial sales to gradually improve throughout the balance of the year. Finally in the lower left chart, industrial sales decreased by 12.4% in the quarter bringing the year-to-date decline to 6.6%. A number of factors have changed the outlook for this class but the biggest driver is the overall drop in economic activity. The industrial sales – the industrial sectors that posted the biggest decline for the quarter were transportation, equipment, manufacturing, mining and primary metals. The two sectors that have grown in 2020 were pipeline transportation and petroleum and coal products. Let's take a look at weather-normalized load history and forecast in more detail on Slide 11. The chart on the left shows that for the second quarter actual load very closely tracked our revised forecast. As you can see from the chart, our revised forecast assumed an economic trough in the second quarter that would gradually improve over the course of the year. So far we are on track and we'll keep you updated as we move throughout the year. We wanted the time this call in order to give you the most updated load information through July. The chart on the upper right shows monthly total weather-normalized sales for March through July. Sales for our system were lowest in May and have shown improvement in June and July. Total normalized load for May was down 8.6% versus June, which was down 4.8% versus July, which was down only 2.4%. The monthly macro data for both the business and household surveys show that unemployment rates peaked in April and have improved since. This is consistent with our assumption that the trough is behind us and the economy should continue its gradual improvement through the balance of the year. The bottom right chart shows that for the month of July, the trend that we forecast for the balance of the year is on track. Although there are some differences in load mix to what we have predicted, our overall load is tracking very closely to our revised forecast. Normalized residential sales for July while still very positive at 4.3% were less than for the second quarter. And both commercial and industrial sales show real improvement versus the second quarter as shown on the prior page. Now let's move to Slide 12 and review the company's capitalization and liquidity. Our debt to total capital – our debt-to-capitalization ratio improved 70 basis points in the second quarter to 61.1%. This was largely attributable to reducing our short-term debt levels in conjunction with fortifying our liquidity position, as we navigated the capital market turbulence in March. In fact, our liquidity position stood strong at $2.9 billion at quarter end. The short-term reduction actions also helped improve our FFO-to-debt ratio when compared to the first quarter moving to 14.1% from 12.5% on a Moody's basis. Our Qualified Pension Funding remained flat at 93% and our OPEB Funding increased approximately 5% to 135%. A falling discount rate increased both plans liabilities during the quarter but strong asset returns especially in equities were able to offset the growth in liabilities. Let's wrap this up on Slide 13 so we can get to your questions. We are reaffirming our existing 2000 operating earnings guidance of $4.25 to $4.45 per share. We are on track to reduce our O&M by the additional $100 million we announced last quarter in response to the economic downturn and revised load implications. Of the $500 million of CapEx that we shifted out of 2020 into later years, we have now returned $100 million into this year. We will maintain our flexibility on this issue as we manage through the balance of the year. We obtained regulatory approvals in Oklahoma, Louisiana, Arkansas and FERC and are moving forward with our $2 billion North Central wind project in Oklahoma, benefiting our customers in PSO and SWEPCO. We have updated our capital plan from 33 – our five-year capital plan from $33 billion to $35 billion as well as our cash flow and credit metrics which are provided on Page 40 of the appendix. Because of our ability to continue to invest in our own system organically we are reaffirming our stated long-term growth rate of 5% to 7%. With that I will turn the call over to the operator for your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And our first question will come from the line of Jeremy Tonet with JPMorgan. And your line is open."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi. Good morning."
},
{
"speaker": "Nick Akins",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi. Thanks for taking my questions here. I wanted to start-off a couple of, I guess, opposing items influencing AEP going forward here North Central wind getting that over the finish line, obviously, a big positive COVID headwind on the other side here. Just wondering, if you could talk a bit more about how these two factors influence I guess your 5% to 7% range with North Central wind? I think we're just looking to see if that could really help you here, or just want to see how everything is shaking out I guess going forward?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So I mean we look at -- and as Brian mentioned on the COVID activity and the load activity, you're seeing residential load be pretty strong. And certainly as you look forward I think residential load is going to continue to look strong with the work-from-home environment and the business cases that are developed afterwards. And then if you have Commercial and Industrial pickup as well, it could be positive from a financial standpoint. The other regarding North Central and other wind projects and solar projects, we have a real opportunity to transition to that clean energy economy going forward in our service territory and that will really makes us – again, we would be disappointed not to be in the upper part -- upper half of the 5% to 7% range because you have to be bullish about not only where load is going, but also in terms of the transformation from a -- just a pure and simple energy policy perspective regardless of who's in the White House in the next election, we'll continue moving toward a clean energy economy. And then also I think, bolstered by the other opportunities we have whether it's mid-range broadband or other types of activities electric vehicles and so forth that we're going to see the further electrification of this society. So I'm really bullish about this company in particular, but as well the industry."
},
{
"speaker": "Jeremy Tonet",
"text": "That makes sense. That's helpful. Thanks. And maybe just kind of building off that with my second question. I think AEP is guiding to $1.3 billion of equity issuance to fund North Central at this point. Just wondering, if you could update us there on your thoughts with regard to is this definitively the path, or is there the potential for portfolio optimization? Is that still an option? I guess, how do you think about..."
},
{
"speaker": "Brian Tierney",
"text": "It absolutely is still an option. And we're looking at all those options to see how to best finance it. We have plenty of time to make those things happen. Nick said that Sundance might be pushed out to the first quarter of 2021, but we're not going to see the rest of those projects coming in Traverse and Maverick until the end of 2021. So all those things are in play whether it's equity or rotation of capital. But for planning purposes we are guiding people to two-thirds equity for that project in aggregate."
},
{
"speaker": "Jeremy Tonet",
"text": "Got you. That’s very helpful. Thank you."
},
{
"speaker": "Nick Akins",
"text": "Thanks, Jeremy."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Andrew Weisel with Scotiabank. And your line is open."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Andrew."
},
{
"speaker": "Andrew Weisel",
"text": "Good morning. First a question on dividends. So at the end of the deck you showed dividends in 2022 at $1.5 billion versus $1.4 billion previously. I also see the footnote that dividend should grow with earnings. My question is, is that increase of $100 million a function of more shares outstanding after the North Central wind equity, or does it imply a step-up in dividend per share along with a step-up in EPS or perhaps both?"
},
{
"speaker": "Nick Akins",
"text": "I think it'd be some of both because obviously with North Central additional equity involved there, but also as you said I mean our dividend will move with our earnings capability. So I'd say both."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Great."
},
{
"speaker": "Nick Akins",
"text": "Brian, do you have any comments? Okay."
},
{
"speaker": "Andrew Weisel",
"text": "Go ahead."
},
{
"speaker": "Nick Akins",
"text": "No, I was just seeing if Brian wanted to just comment on that but he said I covered it."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Great. On CapEx you mentioned that you're pulling back $100 million of the deferred CapEx. I just want to understand -- be sure I understand what drove that. Is that a function of specific projects being more necessary or more appealing, or is it more a function of the better-than-expected cash flows?"
},
{
"speaker": "Nick Akins",
"text": "Yes, I think that's a positive story. Some of that is related to new customer connections. And so it was clearly evident that we needed to move that forward. But also we have the capability financially to move it forward. We talked about this last time the deferral of the $500 million we weren't changing the five-year capital plan we were going to maintain that level. And the $500 million was merely being deferred so that we could understand what the COVID issues were going to be. And so we're continually looking at our process going forward in terms of putting that 500 back in in various stages. So what you saw this quarter was the first stage of that."
},
{
"speaker": "Andrew Weisel",
"text": "Very good. If I could just have one more here to clarify the last question from Jeremy. The 5% to 7% range you're pointing to the upper end of that. Is that a function of North Central wind now being included, or is it more that you're pointing to the higher end with or without North Central wind as a one-timer?"
},
{
"speaker": "Nick Akins",
"text": "Well, certainly, we looked at North Central, but obviously, we continue to track and we believe that the upper half of that guidance range is certainly achievable and something that we again would be disappointed not to be able to get there. So that's clearly an opportunity for us based on the things that I talked about earlier."
},
{
"speaker": "Brian Tierney",
"text": "It should – North Central wind should certainly solidify our position in the upper half."
},
{
"speaker": "Nick Akins",
"text": "Yeah. And keep in mind too at the same time the Achieving Excellence Progam is continuing to grow. So we already have plans in place and you're seeing sort of a crescendo of savings associated with that plan. And the first year 2020 is – some of it's in there, but not much. And when you look at the future years that continues to grow substantially, and certainly, as I've mentioned earlier the addition of Therace and the focus on digitization automation in combination with the learnings from COVID, I think going to further accentuate the benefits from achieving excellence."
},
{
"speaker": "Andrew Weisel",
"text": "That all sounds great. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of James Thalacker with BMO Capital Markets. And your line is open."
},
{
"speaker": "Nick Akins",
"text": "Good morning, James."
},
{
"speaker": "James Thalacker",
"text": "Hey, good morning, guys. Can you hear me?"
},
{
"speaker": "Nick Akins",
"text": "Yep, I'm hearing you yes. Good morning."
},
{
"speaker": "James Thalacker",
"text": "Okay. Great. Real quick question. I know you had outlined the bending the cost curve EEI down to kind of $2.8 billion. And as COVID took over we're now down at $2.7 billion. It seems like year-to-date if you just look at it on an after-tax basis you guys are already kind of running above that kind of $100 million sort of run rate. How should, we I guess think about the non-tracked O&M versus the additional O&M that you are actually pulling out in response to COVID? And as we think about 2021, is there any guidance, I guess you could give us on how much of that you think will be retainable as we move into next year?"
},
{
"speaker": "Brian Tierney",
"text": "Yeah. So we're at this point James not able to provide obviously specific guidance on 2021. But I'll say, the incremental $100 million that we're able to garner is a combination of sustainable and one-timers. And I think it's a matter of managing our way through the downturn in normalized load and just working as hard as we can to pull out all the stops to make sure that we meet our commitments to shareholders and really target the middle part of that range without impacting customers. And so far, we've been able to do that. There have been some unexpected things that we've seen maybe some things that aren't line items in O&M that have come out. And I think you have things like travel and expense conventions that people go to things like that meals just buildings expense that you have things that just don't happen when everyone's working from home that, I think are more like one-timers but if people go back to work we'll start to put those things back into place. But you've seen our track record over the last nine or 10 years now and it's been keeping a very, very tight range on untracked O&M and we're using those skills that we've learned over the last several years to make sure that we're able to manage our way through this circumstance."
},
{
"speaker": "Nick Akins",
"text": "Yeah, I would say, and as Brian mentioned I mean, there's a lot of learnings from COVID-19 and the impacts and how we've operated, and the efficiency of which we've operated. And I think it sort of changes, the perspective and changes the threshold of even, what one-timers are and ongoing, because I think the learnings we have from here we're going to be much different in our approach related to many of these activities. And actually, you would be surprised and I'll certainly talk about this more at the end of the year of what achieving excellence is showing us of things that were buried in the organization that we obviously have an opportunity to take advantage of. And so there's no question that you should expect the continued efficiency around the savings of O&M. And that's in the non-tracked area."
},
{
"speaker": "Brian Tierney",
"text": "You've seen – on page 34 of the presentation, you've seen the tight range we've been able to keep it in. In terms of bending the curve as we go down to $2.7 billion in non-track, we actually are bending that curve downward at this point."
},
{
"speaker": "Nick Akins",
"text": "Yes. Bending to warping. So that's good."
},
{
"speaker": "James Thalacker",
"text": "No, that's great. And I guess just as a follow-up, I mean, obviously the run rate has been very, very good. I mean, you did a heroic job, I guess in 2Q just the bulk of it from a year-to-date perspective that's kind of showed up. But as you move through the rest of the year do you feel like you have additional room whether it be onetime or again Nick like you're talking about through just kind of change in workflow to continue to sort of press that down, if you need to if we get sort of resurgence in COVID again?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. I think number one really, I think about – the processes are in place and the focus of the organization is in place to be able to adjust. And I'm perfectly happy with the foundation that's been put in place for this organization on an ongoing basis. I mean, because if we look at our Achieving Excellence Program, it's not just a onetime program. It's a regular process we're going to go through in budgeting. And it's also a regular process, where they'll go throughout the year, for us to be able to adjust. So we will do what we have to do. And there's no question, that we have the foundation to be able to do it."
},
{
"speaker": "James Thalacker",
"text": "Okay. Great."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "James Thalacker",
"text": "Well, thank you for taking my question. And best of luck guys."
},
{
"speaker": "Nick Akins",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Next we will go to the line of Durgesh Chopra with Evercore ISI. And your line is open."
},
{
"speaker": "Durgesh Chopra",
"text": "Good morning, Nick."
},
{
"speaker": "Nick Akins",
"text": "Hey good morning."
},
{
"speaker": "Durgesh Chopra",
"text": "Oh! That is down. Hello? Hey can you hear me?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. Great, just -- I wanted to follow-up on the O&M $100 million number. What of that $100 million was actually achieved in the quarter?"
},
{
"speaker": "Brian Tierney",
"text": "It will be the O&M CapEx or the O&M -- I'm sorry O&M caps. It's going to be achieved rateably throughout the balance of the year. So from second quarter, third and fourth, think about it being achieved rateably, as we work our way through that."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood and I apologize there's like an echo in my -- when I'm speaking. So -- and then, the potential labor initiatives that you outlined is that in addition to the $100 million?"
},
{
"speaker": "Brian Tierney",
"text": "It's all incorporated to get us to that $2.7 billion number."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood guys. Thank you so much."
},
{
"speaker": "Brian Tierney",
"text": "Sure. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Sophie Karp with KeyBanc. And your line is open."
},
{
"speaker": "Brian Tierney",
"text": "Good morning, Sophie."
},
{
"speaker": "Sophie Karp",
"text": "Hi good morning guys. Good morning. Congrats on the quarter."
},
{
"speaker": "Nick Akins",
"text": "Thanks."
},
{
"speaker": "Sophie Karp",
"text": "And thanks for the time. I'm just curious about -- maybe I can ask you, more of a high-level question. Given the landscape or market landscape that we are seeing right now. Do you see an opportunity maybe an opening to do some rotation in your portfolio of assets maybe high-graded a little bit if you will and divest some? And is there an opportunity for M&A for a more wires focused or like just asset [Technical Difficulty] …"
},
{
"speaker": "Nick Akins",
"text": "Yeah, Sophie."
},
{
"speaker": "Sophie Karp",
"text": "…your puts and thoughts on that."
},
{
"speaker": "Nick Akins",
"text": "Yeah, sure, we've certainly been consistent in the discussion around any M&A activity or in terms of -- what we can do in terms of rotation. That's always an option that's available to us. And this company is moving toward, a portfolio management approach where obviously we have sources and uses and those sources include the assets we have. And certainly we'll continue to look at those, as opportunities in time with investments that we make. So we will continue to do that. Regarding M&A activity we have a high threshold because we certainly have the ability to invest we have the ability to -- we have the largest transmission system in the country. Certainly our investment in our distribution businesses is continuing to grow considerably. And so, if we can invest that out without a premium, that's a good thing for our shareholders. Now that being said, we look at strategic areas that make sense to us but certainly that threshold is high. And we'll continue to evaluate that. But make no mistake that this company is focused on its ability to continue to grow, but grow efficiently for our shareholders. And we'll continue to do that."
},
{
"speaker": "Sophie Karp",
"text": "Thank you."
},
{
"speaker": "Nick Akins",
"text": "Yeah. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question will come from the line of Paul Patterson with Glenrock Associates. And your line is open."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Paul."
},
{
"speaker": "Paul Patterson",
"text": "Hey how are you doing?"
},
{
"speaker": "Nick Akins",
"text": "All right, how are you?"
},
{
"speaker": "Paul Patterson",
"text": "I am managing. No laugh. So I can do like that. And so, I don't think of you guys, being a primary beneficiary or primarily impacted by HB6, but is there any ancillary or anything we should think about with the potential repeal of HB6 in Ohio, that could impact you guys?"
},
{
"speaker": "Nick Akins",
"text": "Well, certainly with the repeal, it's -- how it's replaced is the issue, and obviously how it's repealed. Because there are some things some interconnections that occurred between HB6 and the regulatory process, where we had regulatory recovery for areas that we need to make sure that's a clean transition that occurs. But on its face, the issues that were involved with that for us should be pretty well taken care of. So that's why we're saying it should be a minimal issue for us. I think it's more of an opportunity for us, because if we're able to -- and really if the state focuses on the clean energy economy going forward, that's going to provide us some opportunities to really do this the right way including nuclear for the -- for our customers going forward."
},
{
"speaker": "Paul Patterson",
"text": "But if it's not replaced, just because we don't know what's going to happen legislatively and who knows, how should we think about the potential impact?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So, if it's not replaced, then it stays the way it is then we should be fine, because there are already..."
},
{
"speaker": "Paul Patterson",
"text": "I mean, it's repealed and they don't -- they repeal it and they don't replace it if you file..."
},
{
"speaker": "Nick Akins",
"text": "Okay, okay good. Brian?"
},
{
"speaker": "Brian Tierney",
"text": "So, we'll be fine in that circumstance, Paul. We already had decoupling in place for residential and small commercial customers. We were already getting recovery of OVEC through 2024 through the regulatory process rather than 2030, and it allowed us to enter into bilateral contracts with customers, but we haven't signed any bilaterals to date. So, we think will be absolutely fine, if it's repealed and not replaced. But as Nick said, I think there are opportunities to do it right and replace it with something that's more positive."
},
{
"speaker": "Nick Akins",
"text": "Yes, we've done bilateral contracts just not with that structure. So…"
},
{
"speaker": "Paul Patterson",
"text": "Okay, great. And then just on the PJM 205, end-of-life transmission planning filing. I know you guys are protesting that with almost every other transmission company. Do you have any sense as to what the potential impact would be from a shareholder perspective on transmission CapEx or anything else, if that 205 filing is accepted by FERC?"
},
{
"speaker": "Brian Tierney",
"text": "Paul, we think it would be pretty minimal to us."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Good. Awesome, thanks so much."
},
{
"speaker": "Brian Tierney",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. And at this time, I'm showing no other questions in queue. Please go ahead with any closing remarks."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Cynthia, would you please give the replay information."
},
{
"speaker": "Operator",
"text": "Certainly. Ladies and gentlemen, today's conference call will be available for replay after 5:30 p.m. today and going until August 14 at 3:55 p.m. You may access the AT&T teleconference replay system by dialing 866-207-1041 and entering the access code of 7269937. International participants may dial 402-970-0847. Those numbers once again 866-207-1041 or 402-970-0847 and entering the access code of 7269937. That does conclude your conference for today. Thank you very much for your participation and for using AT&T Executive Teleconference Service. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 1 | 2,020 | 2020-05-06 09:00:00 | Operator: Ladies and gentlemen, thank you very much for standing by, and welcome to the American Electric Power first quarter 2020 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given to you at that time. If you should require assistance during today’s call, please press star then zero and an operator will assist you offline. I would now like to turn the conference over your first speaker, Ms Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Perky. Good morning everyone and welcome to the first quarter 2020 earnings call for American Electric Power. Thank you for taking the time today to join us. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Our presentation also includes references to non-GAAP financial information. Please refer to the reconciliation of the applicable GAAP measures provided in the appendix of today’s presentation. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay, thank you Darcy. Welcome and thank you all for joining AEP’s first quarter 2020 earnings call. I want to take a moment to extend our sympathies to all those who have been personally impacted by the COVID-19 pandemic. At AEP, we understand that we are all in this together. The AEP Foundation has contributed to charities across our footprint to ensure that we are part of the solution for the customers and communities. In addition to providing our employees with the personal protective equipment they need to do their jobs, we have donated masks, gloves, and other essential items needed by hospitals across our service territory. To further assist those in need within our communities, our customer service representatives have provided assistance in fielding questions on how to secure small business loans. Throughout these challenging times, I continue to be extremely proud of our employees who have done an outstanding job demonstrating their capacity for being adaptable and exercising the agility needed to meet the challenges of a rapidly changing situation. As we continue to adapt to the ongoing challenges imposed by COVID-19, we remain committed to keeping our employees safe and keeping America powered through these unprecedented times. Certainly as we headed into March during the first quarter, the story for the quarter would have been one in which we have all heard before, mild weather impacted the first quarter, but as we’ve also heard before, a quarter does not a year to make [ph] and there is plenty of time to recover from a mild winter. We adjust to these types of issues all the time. But I’m sure you’re more interested in the last half of March and what April tells us about the future. I’ll get into all that in a minute, but first let’s just do the headlines, the financial headlines for the quarter. For the first quarter, we came in with operating earnings of $1.02 per share. We are reaffirming our 2020 operating earnings guidance range of $4.25 to $4.45 per share and our 5% to 7% long term growth rate. AEP is doing this because, regardless of whether we forecast a V-shaped, a U-shaped or W-shaped COVID-19 recovery, we see our service territory as an arbitrage between residential load and commercial industrial load that is defined really by a pendulum between the financial characteristics of working from home versus the restart of commercial and industrial businesses. With all of this considered along with capital, O&M, credit metrics and updated load forecasts and actions we have taken, we expect to be the lower half of our guidance range. We are shifting $500 million of capital spending, substantially contracted renewable business and corporate-related capital for the time being to maintain our commitments to solid credit ratings. We are reaffirming our $33 billion of capital over the five-year period, however. We believe this to be the smart play given our ability to adjust capital quickly to respond to market conditions. We give all of this guidance insight given an exhaustive review county by county of our service territory from a load perspective through April, weather impacts thus far in the year, and expense control measures already put in place to respond to present conditions. We will continue to refine these assumptions as data become available. Certainly weather, customer load mix, pace of economic recovery and continued O&M related actions will dictate further positive progress within the guidance range. Brian will get into more detail about these assumptions, but I want to reaffirm for you that our balance sheet is strong, credit metrics are good, and liquidity is secure as we move forward. Let’s move on to the specifics related to COVID-19 and its implications to our operations and our financials as we see the year progressing. As many have heard, there is famous boxing quote from Iron Mike Tyson that is truly appropriate here: “Everyone has a plan until they get punched in the mouth.” Well, that’s what we have faced in the end of this quarter and will face probably for the rest of the year, but I’m here to tell you, yes, we’ve been challenged a little bit but we are very much still in the match because of our quick responses and agility to be in the position to reaffirm our existing guidance range. I’ll start by discussing our employees’ commitments to our customers, communities, and our shareholders as we move through the crisis that I referred to at the beginning of my presentation. First, I want to recognize all the healthcare and first responders who have put themselves in the line of fire to help us all to be more safe and healthy. As a critical infrastructure service company, the frontline employees of our utility have also taken on risk by ensuring we are out in the field responding to substantial storm activity to ensure the resiliency and reliability of electric service so that our hospitals, critical businesses, and customers who are under stay-at-home provisions can continue to benefit at least from some degree of comfort in these challenging times. We have instituted protection measures for these employees that reflect CDC guidance regarding physical distancing, including smaller work teams, proper hygiene, and appropriate PPE and testing to minimize risk of contact with the virus. Approximately 12,000, over 70% of AEP’s employees have been working from home for several weeks now and will continue to work from home even after stay-at-home provisions are lifted to ensure further precautions are taken both at home and at the office for employees who must return for various reasons. We have instituted specific COVID-19 adjustments to our health plans and benefits for employees, and as a critical infrastructure business have continued to pay our employees as they work from home. For most field-level employees, we have also awarded additional days off with pay to enable more time with their families during this time. We have over 82% of our call center employees working from home, and as they not only answer customer questions, they are also helping our small businesses get back on their feet by helping them navigate through the SBA loan provisions of the Cares Act. Regarding our customers, we recognize the hardships that this pandemic has brought on and have temporarily suspended all service disconnects for non-payment, and our team of call center professionals have been working diligently to administer more flexible payment arrangements for our commercial and residential customers. Some states have mandated this, but we do so voluntarily and our state commissions have fully supported these actions through the establishment of deferred accounting and other measures, which I want to take the time to thank them for addressing these issues. Regarding our communities, the AEP Foundation has donated over $3 million to support basic human needs to help address hardships from food security, housing, clothing, and other issues during this time. We have donated over 9,000 N95 masks, 110,000 gloves and disposable surgical masks, and 1,200 face shields from our warehouse stocks and 3D printing facilities within our innovation labs. In my 37 years of being in this business, I have never seen the level of coordination and concern by multiple agencies to do the right thing for our customers, our employees, our businesses and communities. While much focus on this call is on the financials, it is important to remember the part we play in the broader social fabric as a critical infrastructure business. Our effectiveness is defined by the level of cooperation and support from all of the agencies that we deal with: our state commissions and governors’ offices, federal and state legislators, FERC, NERC, DoE, DHS, NRC and others. They all have answered the call, and we at AEP thank them. There is much work yet to do, but I believe all have embraced the capital-S for social from an ESG investor perspective. From the operational side, we have had no disruptions to plant or grid operations while storm activity has been exceptional, given the significant storm activity in several of our operating company territories and considering the additional COVID-19 related safety precautions. There has not been a delay in the north central wind facilities construction and the regulatory cases regarding this project have continued on schedule. As well, future rate cases are on track to be filed, including in Ohio and Kentucky. On the regulatory front, it has been a busy quarter. In fact, we have already received approvals for 96% of the budgeted regulatory recovery for 2020. In March, the Indiana Regulatory Commission authorized a $77 million revenue increased based on a 9.7% ROE. The Commission approved IN’s proposed distribution system investments and full tracking of FERC transmission costs. The company had also sought an adjustment to reflect the reallocation of capacity costs associated with termination of certain wholesale contracts which was denied by the Commission. We have filed for re-hearing on this matter. In January, the Michigan Commission approved the settlement of the base rate case resulting in an increase of $36 million based on a 9.86% ROE. In April, the PUCT - Public Utility Commission of Texas issued a final order approving the settlement agreement in the AEP Texas base rate case, allowing for a 9.4% ROE with a 42.5% equity layer on the company’s $5 billion asset base. Also in April, we filed a DCRF - distribution cost recovery factor to add approximately $440 million in assets to the rate base for distribution investments we made to benefit our customers in AEP Texas. A T-cost filing - transmission cost filing was also made to recover $800 million in transmission investments made over a similar time frame. The company also filed a required base rate case in Virginia as part of the state’s annual review. In that filing, the company asked for a 9.9% ROE on a 50/50 cap structure on a $2.5 billion base, resulting in an increase of $64.9 million. Rates would be effective at the end of January 2021. There is no question that these are unprecedented times. I think it goes without saying that we will need to ensure that utilities and commissions work together to devise creative solutions to the challenges we all face. Tony Clark, former Commissioners at the Federal Energy Regulatory Commission prepared and submitted a white paper to NERUC recognizing the unique challenges the energy industry is facing and the need for regulators to be creative to new solutions. In that article, he called for policymakers at both the federal and state level to be proactive in both the short and long term by targeting measures that support both customers and utilities. Collectively with our legislators and our commissions, we need to work together to recognize the importance of protecting customers and ensuring utilities are able to invest in their systems and maintain the level of service that our communities depend upon, whether through deferrals or preferably riders or forward-looking test years, because cash is king again for utilities to be able to adequately invest in critical infrastructure. Two examples within our service territory where the Commissions have taken a proactive view have been in Texas and Ohio. We believe both are steps in the right direction. In Texas, the Commission approved the COVID-19 Electricity Relief Program for residential consumers who are having difficulty paying their bills. A rider has been put in place to fund the ERP that enables AEP Texas to access cash to begin the program cost. In Ohio, Commission staff recommended approval of the regulatory asset deferral for future recovery and recovery of the demand ratchet program costs through the existing economic development rider. This will help lessen the impact to industrials who are key employers within the state and protect utilities. We believe both are examples of progressive moves by states to help mitigate the risk associated with COVID-19 to both customers and provide certainty for utilities. Moving on to the North Central project, we continue to make progress on this landmark project that provides significant benefits for our 1.1 million customers in our PSO and SWEPCO states. We received approval of the unanimous settlement in Oklahoma as well as FERC approval in the first quarter. We expected May to be an important month for the project for the remaining jurisdictions, and I’m pleased to report that yesterday the Arkansas Public Service Commission approved the 155 megawatts, or approximately 10% of the total project along with the flex-up option. As you recall, the flex-up option allows Arkansas to increase the megawatt allocation should another SWEPCO state reject the application. The Commission in that order determined that SWEPCO should use it’s formulative rate rider to recover its costs. In early March, we filed the unanimous settlement in Louisiana for 268 megawatts or approximately 18% of the total project, which also included the flex-up option. We expect a decision by the Louisiana Public Service Commission in the May or June time frame. Lastly, after concluding our hearings in February, we expect a proposal for commission decision for the Texas ALJs in late May. With approvals in Oklahoma, Arkansas and FERC under our belt, the project has what it needs to go forward at 846 megawatts of the 1,485 megawatt project. Of course, the project can move forward with even more savings for customers and the full $2 billion investment opportunity if either the LPSC approves with the flex-up option or the LPSC and the Public Utility Commission of Texas approves their portion of the full project. Now let’s talk to the equalizer chart. Most of these are weather related, but for AEP Ohio we’ve had the roll-off of some of the legacy fuel and capacity carrying charges. They rolled off, so we expect the trend for the ROE to be at the authorized levels of around 10%. Presently, it’s at 9.9% for quarter 2020. In APCO, the ROE for APCO at the end of first quarter is 8.7%, and that’s driven by lower normalized usage and higher depreciation from increased capital investments, and of course unfavorable weather. Virginia’s first triannual review was filed in March 2020, as I mentioned earlier, and it covers the 2017 to 2019 periods. An ROE of 9.42% would be used for the triannual review with 70 basis point bandwidth of 8.72% to 10.12% ROE. Kentucky Power, the ROE for Kentucky Power at the end of first quarter was 6.7%, and that’s primarily driven by loss of load from weak economic conditions, loss of major customers along with higher expenses and unfavorable weather. We also have been in a stay out provision associated with rate filings, but that goes away here soon and we expect to be filing in Kentucky in the July time frame. I&M, the ROE at I&M is at 10.5%, and we’ve been implementing new rates for Indianan which will take place in the second quarter, but we fully expect to be at the authorized areas of around 9.7% to 9.86%. Then for PSO, PSO is at 9.2% primarily driven by unfavorable weather. SWEPCO at the end of first quarter was 6.2%, and that was because of a loss of load, unfavorable weather, and continued impact of the Arkansas share of the Turk plant, which accounts for about 112 basis points. The Arkansas base case settlement went in place in December 2019 and is effective January 2020, approved a $24 million revenue increase there. In AEP Texas, it’s at 8% and that’s due to a lag associated with the timing of annual filings and one-time adjustments from our recently finalized base rate case. Favorable regulatory treatment has historically allowed us to file annual DCRF and biannual T-cost filings to recover our cost, and I mentioned those earlier, so there’s a lag associated with those but we should see a pick-up there and drive more toward a 9.4% ROE in the long term. Then the transmission holdco at the end of the first quarter was 11.5% and it was driven by higher revenues due to differences between actual and forecasted revenues, so we fully expect the transmission ROE to be in the mid-10% range in 2020. With that, when there is a pandemic like the one we’re experiencing today that has not occurred in 100 years, and this nation’s economy has been effectively shut down for months, there is no question that everyone is challenged and AEP is no exception. We are up to the challenge to recognize not only the role that this company has in the resiliency and restart of our economy as well as the provision of electric service no matter where our customers are working or living, but also the importance of the consistency and quality of earnings and dividends to our shareholders that makes our work possible. We will strike that balance, respond to challenges, and I’ll stick with a boxing analogy with a Sylvester Stallone movie, Rocky, where the music is playing, the theme from Rocky and he’s running up the steps that represent the adversity of reaching a goal. I believe at the end of the year, we all - AEP, the communities we serve, our customers and our shareholders - will be at the summit, raising our arms in victory. Brian?
Brian Tierney: Thank you Nick, and good morning everyone. I will take us through the financial results for the quarter, provide some insight in how we’re thinking about 2020, including an update on April load, and finish with a review of our balance sheet and liquidity. Let’s stop briefly on Slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings were $1.00 per share compared to $1.16 per share in 2019. There is a reconciliation of GAAP to operating earnings in the appendix. Let’s turn to Slide 8 and look at the drivers of quarterly operating earnings. Operating earnings for the first quarter were $1.02 per share or $504 million, compared to $1.19 per share of $585 million in 2019. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $0.50 per share, down $0.13. Earnings in this segment declined primarily due to warmer than normal winter weather and lower normalized retail load. Other small decreases included higher depreciation, higher tax expense and lower wholesale load, AFUDC, and off-system sales. Favorable drivers included rate changes and higher transmission revenue. The transmission and distribution utilities segment earned $0.24 per share, down $0.08 from last year primarily driven by the 2019 reversal of a regulatory provision in Ohio. Other smaller drivers included higher depreciation, the roll-off of legacy riders in Ohio, and unfavorable weather. These items were partially offset by higher rate changes, normalized retail load, and recovery of increased transmission investment in ERCOT, as well as lower O&M. The AEP transmission holdco segment continued to grow, contributing $0.28 per share, an improvement of $0.03 over last year. Net plant increased by $1.5 billion or 18% since March of last year. Generation and marketing produced earnings of $0.07 per share, down $0.02 from last year. The renewables business grew with the acquisition of multiple renewable assets. Increases in retail margins were more than offset by timing around income taxes and lower generation sales due to lower energy prices and plant retirements. Finally, corporate and other was up $0.03 per share primarily driven by lower taxes relating to a prior year income tax adjustment and other consolidating items that were reversed by year end, other variances related to higher interest expense, and lower O&M. Earlier in the call, Nick indicated that we are reaffirming our 2020 operating earnings guidance range of $4.25 per share to $4.45 per share and would likely be in the lower half of that range. Let me give you some of the detail that leads us to that outcome on Slide 9 and then I’ll provide more detail on each of the key assumptions in the following slides. Our economic forecasting group uses Moody’s analytics as a key input to our models. In April, Moody’s published a county-level forecast that included the projected impact of COVID-19 on our service territory. We used this new data along with updated assumptions from our customer service engineers to come up with revised retail sales projections for the year. We now expect residential sales to increase 3% over 2019 levels largely driven by all of the activity that has taken place in residences rather than in places of work or in the classroom. Conversely, we are anticipating commercial sales contractions of 5.6% and industrial sales declines of 8% over 2019 levels. Many businesses have shifted their operations to a mostly online platform while other employers have had to make the difficult decision to furlough or reduce employee headcount until market demand is restored. These retail forecasts lead us to expect an overall decline in sales of 3.4%. This updated load would impact our prior forecast negatively by $0.15 per share. We have already discussed our year to date negative impact from mild weather of $0.11 per share. In response to these circumstances, we have taken action to reduce untracked operations and maintenance expenses by an additional $100 million, resulting in a positive expectation of $0.17 per share for the year. The net result of load, weather and O&M reductions would have a negative $0.09 per share impact for the year, leaving us inside but in the lower half of the original operating earnings guidance range. We realize moratoriums on disconnects and the economic impact to our customers may have on our cash receipts. In response to this, we have initiated a shift of $500 million of capital expenditures out of 2020 to be placed into the future years of 2021 to 2024. As we made these deferrals, we were mindful of customer and reliability impacts. In fact, about $200 million of these investments were in our competitive renewables business and about $100 million were corporate investments. The shifts can be ramped up or down going forward in response to how events play out in real time. With this moderate level of capital shifting, we are able to reaffirm our 5% to 7% long term growth rate off of our original 2019 operating earnings guidance range. Regarding potential increases in bad debt across our jurisdictions, we have already received orders in Texas, Arkansas, Louisiana and Virginia to set up regulatory assets related to COVID-19 costs. Other states where we have filed for recovery of COVID-related deferrals include Ohio, Michigan, Tennessee, and Oklahoma. We have tried on this slide to provide some of the detail for how the coronavirus and oil and gas events will impact AEP’s operating earnings for 2020. Instead of taking you through the details of our scenario planning, let me highlight some of the items that could positively and negatively impact our view as we make our way through the year. On the positive side, a sharp V-shape recovery that is more dramatic than the gradual recovery from the second quarter low point that we have assumed would improve results. Additionally, mitigation of coronavirus infection rates leading the economy to open up sooner than we have assumed would improve results. A greater increase in residential sales and an improvement in commercial and industrial sales would further improve our outlook. We have experienced a mild winter. If that carried forward into a warmer than normal summer, that would have positive earnings implications. Another positive would be if we could garner incremental savings to what we have assumed at the $2.7 billion level of untracked O&M expenses. The items that would create negative impacts to our assumptions are largely the opposite of the positives. A prolonged U-shaped or a dramatic L-shaped recovery would be more negative than our assumptions. Increased coronavirus infection rates could lead to weaker economic conditions for longer periods than we have assumed, potential impairing our outlook for the year. In addition, continued mild weather and/or O&M expenses beyond our control, like for storms, could negatively impact the outlook for 2020. We have tried our best using data, experience and judgment to update and share our outlook with you for 2020. We have tried not to be unreasonably optimistic nor pessimistic. This outlook allows us to reaffirm our 2020 operating earnings guidance range with a view that we are likely to be in the lower half of the range. Now let’s turn to Slide 10 and provide an update on our system load, focusing on our outlook for the balance of the year. Our first quarter normalized load was down seven-tenths of a percent compared to last year. Our residential and industrial sales were both down for the quarter while commercial sales were essentially flat. Our original guidance for the year assumed half a percent normalized load growth. Clearly a lot has changed since that forecast was developed. Since then, we have taken a fresh look at our forecast and now expect our total load to end the year down 3.4% on a weather normalized basis, with meaningful changes in customer mix and related margins. For 2020, we anticipate a significant contraction in the second quarter followed by a gradual recovery over the balance of the year. In the upper left quadrant, we raised our residential outlook for 2020 to 3%. We are seeing significant increases in our residential load during the stay-at-home period. Even after our states begin to reopen their economies in the second quarter, it is our expectation that many employees will continue to work from home. Having said this, we expect the strongest residential growth in the second quarter with some tapering off during the second half of the year. Moving clockwise, our commercial sales outlook is now assuming a 5.6% decline from 2019 levels. Prior to the COVID outbreak, we experienced consistent improvement in our commercial sales class over the past year; however, once the stay-at-home provisions were in place, we experienced significant declines in our sales to traditional retail stores, hotels, restaurants, churches and schools. However, not all commercial load was negatively impacted by the outbreak. Sales to hospitals and government support offices were up substantially in the first quarter. When you consider the challenges many businesses will face trying to introduce social distancing protocols into their normal operations, we are projecting a difficult second quarter for commercial sales with modest improvement through the remainder of the year. Finally, in the lower left chart the outlook for industrial sales has changed significantly. We now expect 2020 industrial sales to come in 8% below 2019 levels. A number of factors have changed the outlook for this class, but the biggest driver is the overall drop in economic activity. Over the past several weeks, we have learned a number of large industrial customers that were either idling their production or reducing their output temporarily until market conditions improve. In addition, a number of expansions we had previously assumed to come online later this year have been delayed or postponed. These delays should be reversed as the economy gradually recovers. Since nearly 30% of our industrial sales come from the oil and gas sectors, let me explain recent sales trends in this sector. Surprisingly, sales to the oil and gas sectors in the first quarter increased by 9.7%, which was the strongest quarter we’ve experienced since 2016. Most of that growth came from the pipeline transportation sector which was up 28% for the first quarter. Going forward, we expect some reduction in oil and gas extraction that will be offset by growth in the midstream and downstream operations. We don’t normally report on monthly load numbers, but since we had the data, let’s take a look at April load on Slide 11. Total normalized retail load for April was down 4.3% with the relationship between the retail classes being similar to what we assumed for the balance of the year. Not surprising given the number of people relegated to their homes, normalized residential sales were up 6% for the month. Equally not surprising, normalized commercial sales were down 7.7% for the month, with the biggest declines being in schools, churches, restaurants and hotels. Industrial sales were down 10% for the month. The biggest decline was in sectors that support the automotive industry, while we experienced strong sales growth in pipeline transportation and food manufacturing sectors. Looking at April’s results, the relationship between the classes, also know as sales mix, as well as the levels of sales in each class are consistent with the assumptions we have made for the second quarter of our balance of year assumptions. Moving on to Slide 12, let’s discuss some load sensitivities and highlight some of our rate recovery mechanisms. The three pie charts show that by segment and in total, about half of our non-fuel revenues come from the residential class. Applying the 3% growth we are now projecting for residential sales in total to the sensitivities we provided at last year’s EEI financial conference, we would pick up $0.12 a share from higher residential sales. Repeating the same calculations for the projected load loss in the commercial and industrial classes would produce a drag of approximately $0.11 and $0.16 per share respectively. When you add these three impacts together, you get the $0.15 per share impact we identified on Slide 9. Finally, retail rate design has a couple of features that stabilize our revenues during an economic downturn. First, most of our large industrial tariffs include demand provisions designed to cover the fixed portion of utility costs. These provisions remain in place even when volumes are down. Second, in our residential customer class we have had some success over the years better aligning the fixed portion of customer rates with fixed costs. Together these rate considerations provide a stabilizing effect on our revenues even when sales volumes decline. Turning to Slide 13, another key assumption is the weather. As mentioned earlier, weather in the first quarter was extremely mild. The green bar in the first quarter shows that mild weather cost us $71 million compared to normal, which was $65 million worse than the first quarter of last year. While our outlook assumes normal weather for the remainder of the year, this chart shows that weather can change significantly, as evidenced by last year’s experience. If we were to have another warm summer like we did in 2019, it could offset the $0.11 drag for weather in the first quarter that we showed you on Slide 9. Our management team has a proven track record of adapting our plans to changing conditions as necessary. In years when the weather has provided a tailwind, we have accelerated spending to provide stability to our earnings in line with our 5% to 7% growth targets. In years where weather has been less accommodating, we have been able to shift our spending to future years to achieve the same goal. You can expect this management team will react similarly this year. Turning to Slide 14, you can see that for nine years now, we have maintained O&M discipline and kept spending net of offsets in a tight range of between $2.8 billion and $3.1 billion. We had originally planned to drive down O&M costs in 2020 to $2.8 billion. In response to the expected decline in sales, we now plan to reduce O&M spend by an additional $100 million. Plans like the Achieving Excellence program and additional one-time and extraordinary reductions will help us to achieve those reductions. Now let’s move on to Slide15 and review the company’s capitalization and liquidity. Our debt to total capital ratio increased during the quarter from 59.8% to 61.8%. The increase in the debt component is attributable to financings to support our ongoing investment program and to fortify our liquidity position to ensure smooth operational financing during this period of market volatility. As you would expect, the increase in debt combined with the ongoing pressure associated with the flow back of ADIT resulted in pressure on our FFO to debt metric, which at quarter end stood at 12.5% on a Moody’s basis. The decline in the metric is also temporarily influenced by the $1 billion 364-day term loan the company proactively obtained in late March. Despite the temporary decline in this metric, rating agencies view this enhanced liquidity as credit positive. Adjusting for this facility and associated cash balances, the metric would be 13%. Our liquidity at the end of the quarter remained strong at $2.8 billion. Since then, our commercial paper balances have dropped to $1.6 billion and our liquidity position has increased to $3.1 billion. Our qualified pension funding increased approximately 4% to 93%, and our OPEB funding decreased approximately 15% to 130%. Pension and OPEB equity returns were negative 23% and negative 22% respectively for the quarter and were the primary reasons pensions and OPEB funding decreased. Fixed income returns of approximately 7% and 6% in the pension and OPEB respectively served to offset some of the equity losses. We have worked hard over the years to focus on pension and OPEB funding and are pleased with how the asset portfolios have performed in spite of recent market volatility. Let’s wrap this up on Slide 16 so we can quickly get to your questions. In response to the economic downturn and related implications, AEP has responded to quickly reduce our O&M spending by an additional $100 million for 2020. This action combined with our updated load forecast allows us to reaffirm our existing operating earnings guidance of 2020 from $4.25 to $4.45 per share. In addition, in response to uncertainties about cash flows related to reduced customer demand and potential delays in customer receipts, we are shifting about $500 million in capital expenditures out of 2020 and into the period 2021 to 2024. We can adjust the timing and size of this shift in reaction to how events play out relative to our assumptions. Because of our ability to continue to invest in our own system organically, we are confident in our ability to grow the company at our stated long term growth rate of 5% to 7%. We continue to make progress on obtaining approvals for our $2 billion North Central wind project in Oklahoma and plan to proceed when approvals are obtained. With that, I will turn the call over to the operator for your questions.
Operator: [Operator instructions] Our first question comes from the line of Steve Byrd with Morgan Stanley. Please go ahead.
Steve Byrd: Hi, good morning. Hope you all are doing well.
Nick Akins: Morning Steve.
Steve Byrd: Thanks for the update on a lot of topics. Wanted to talk first just about two of your rate cases, Indiana and Michigan, where I believe the test year is going to be a 2020 test year. How do you think about that sort of test year in light of COVID - you know, load adjustments, COVID-related expenses as you think through that rate case, and sort of how to approach 2020 given it’s such an unusual year?
Nick Akins: In at least Indiana, we have forward test year views, and I think it’s probably going to be particularly important as we go in for these cases for there to be an understanding that we are dealing with a COVID-related year if it is a test year. Wherever you have forward test years, though, you can account for that going forward in the rate making, but we’d be tuned into the process whether you pro forma in or do other things. I think there’s probably at least opportunities for discussion about that because COVID--you know, 2020 is going to be an usual year and to be used for test years would be particularly challenging. You have to really go to some form of pro forma view that has the level of investments, the level of business activity that you would normally see. So, I would expect our commissions to be reasonable in that approach.
Brian Tierney: You know, in both those cases, Steve, we had forward-looking test years and we do have orders effective in both of those jurisdictions.
Steve Byrd: Okay, that’s helpful. Yes, it makes sense that you’d sort of try to work to the adjustments. It makes sense. On North Central wind, some great progress there. That’s really encouraging. I guess I had sort of two related questions on North Central. If you do get those additional approvals that you’re waiting for, such as in Louisiana, Texas, can you quickly flex the plan to go to the higher megawatt level? Then relatedly, you’ve obviously deferred some capex. Do you have that flexibility to deploy whatever capital you need to, to make this a bigger project, or does your capital position caution against significant ramp-up in capex this year? Just thinking through the growth at North Central.
Nick Akins: Yes, so originally North Central was not in our capital plan, and so when we get approval for that, that’d be dealing with a different financing model associated with that. As far as the megawatt level and the amount of investment, yes, if we get approval for Louisiana for example, and Louisiana also approves the up rate which is in a settlement arrangement, then we would have the full $2 billion investment opportunity there. We already know we’re going forward with the project - that was the importance of Arkansas approval, so the project is moving forward. The question is what size, and then when Louisiana approves that, and hopefully with a flex-up as well, then that’s the full $2 billion, or if Texas takes their portion, then all operating jurisdictions will be taking their particular portions as we go forward. Now, there is additional opportunity for renewables in those areas. The integrated resource plans have the capability for that, but we felt like, as we originally said about this project, there is sort of a break point between the opportunities that existed around the wind farm project and the pricing, and we wanted to make absolutely sure that the pricing was very effective and produced very positive savings for our customers. So, we can always go out for a bid again to fill the rest of that from a resource planning perspective.
Brian Tierney: Steve, we’ll be full speed ahead on the capex associated with North Central wind one way or the other. Nick mentioned that it’s not in the $33 billion that we had previously identified for the five years, 2020 to 2024, and we previously said that we anticipate an equity component of that investment to be between 50% and 66%.
Steve Byrd: That’s super helpful. I’ll let others ask questions. Thank you.
Nick Akins: Thank you.
Operator: Thank you. Our next question comes from the line of Durgesh Chopra with Evercore. Please go ahead.
Durgesh Chopra: Hey, good morning guys. Thanks for taking my question. I have two. The first one on 2020 guidance range here, the $0.15 EPS hit, what are you assuming in terms of decline trends for the rest of the year? I guess what I’m asking is are you--as you make some amount of recovery in Q3 or Q4, just curious as to what you’re assuming in terms of profiling for the rest of the year.
Brian Tierney: Sure, so we are assuming that the second quarter would be the lowest quarter for load, and that there would be a gradual recovery over the balance of 2020 and into the first quarter of 2021.
Durgesh Chopra: Got it, perfect. Then, can you comment on just your--you know, assuming that you hit your lower half of the EPS guidance range for this year, where would that put you in terms of credit metrics [indiscernible] debt versus your targeted metrics? Then any color that you can provide us with your recent conversations that you have had with Moody’s on some of the changes that you’ve made to your plan?
Brian Tierney: We’ve really been--we anticipate year end being FFO to debt in that 13% to 14% range. We’ve communicated that with S&P and Moody’s, had dialogues with them as late as yesterday. They understand where we are and what we’re doing. I think they were encouraged to see us flex a little bit our capex for the balance of the year in response to anticipated lower cash flows than what we had anticipated, and they’re supportive of that. They were--they viewed what Julie and her team did around the term loan facility as being credit positive, and they are fully aware and apprised of what we’re doing. You should ask them, but I think their answer would be supportive.
Durgesh Chopra: Great, that’s all I had, guys. Thank you very much.
Nick Akins: Thank you, Durgesh.
Operator: Thank you. Our next question comes from the line of Julien Dumoulin with Bank of America. Please go ahead.
Julien Dumoulin: Hey, good morning team. I hope you’re all well. Perhaps just to pick up where the last question left off to start here. On guidance and the 2020 lower half, how do you think about the reduction in capex? I just want to reconcile this. It seems as if you’re not really changing FFO to debt expectations as you are bringing down capex altogether, but why do that relative to no change in earnings? Can you walk through the thought process there? Then also, it seems as if it doesn’t necessarily have too much of an earnings impact given the corporate nature of some of the capex, so I just want to make sure we’re thinking about that correctly as well.
Brian Tierney: Sure Julien, thanks for the question. We are anticipating there to be some reduction in cash flow this year associated with two things: one, lower customer demand, and then two, we have eliminated disconnects currently, and so we think that customers will pay us slower than what they have in the past. We’re not seeing the impact of that in a significant way yet - it’s too early, but in anticipation of lower cash flows to maintain those FFO to debt metrics, we felt it was prudent to at least engage the motor on our ability to scale back capex. In regards to the no impact on future earnings, we tried to do it in places that have either lower regulatory lag or the increase in earnings isn’t as great. Nick mentioned that some of that reduction is in the competitive renewables space and some of that reduction is also at corporate capital, things like IT and things like that, that are much slower to flow into customer rates during rate cases. Things that we are careful not to cut were things like transmission, where we’re spending on customer resilience and reliability and we have those formula-based rates to update and get that capex into rates on a fairly efficient basis. We were really thoughtful about how we cut that or shifted that small amount of capex, and made sure that it wasn’t impacting earnings.
Nick Akins: Julien, I think you’re reading it right, though - we’re being as transparent as we possibly can be through this process using the latest information. Matter of fact, we got the load information, April load information yesterday, so we’re trying to be as transparent as possible, but also taking the right, smart, appropriate steps to ensure that we’re able to be agile enough to do what we need to do. I think you’re reading that right. We obviously would put that capital back in as quickly as possible and then, as Brian mentioned, we’re not only mitigating any impacts to the earnings capability but also thinking ahead in terms of where we deploy that capital in the future. Then we also have North Central coming about, so those things are occurring. We’re trying to manage through this year in a very positive fashion and really a defensive posture, and then set ourselves up for the future years, in ’21 and beyond. We’ll continue that approach, and obviously if we get a hot summer, for example, we’ll throw capital back in - there’s all kinds of things we can adjust, and then from a residential standpoint, you heard our residential load for April was 6%, and we’re saying 3%, so we don’t know exactly how this is going to play out, particularly with changing dynamics of business cases themselves changing. I mean, we had Nationwide recently come out and say that their people are going to be working from home, and we have 17,000 employees and 12,000 are working from home. We may be looking through our Achieving Excellence program, which we have already accelerated, to look at how you look at people working from home and maybe the whole business cases changes from that perspective and also reduces O&M further. So we’re in the process of doing all that, but we’re just trying to be as transparent as possible. But you’re reading the tea leaves right.
Julien Dumoulin: Got it, excellent. Let me just clarify this from the transcript - you all reaffirmed intentions to file rate cases in various geographies. This doesn’t shift timing necessarily, it sounds like, nor--at the same time, I don’t want to tie one to the other, does it shift any expectations with respect to asset sales, disposals, strategic reviews? Just want to make sure we’re on the same page there, and there could be some further capital needs.
Nick Akins: No, it doesn’t change. As a matter of fact, we’ll continue those cases. Obviously, as I mentioned, in Kentucky we have a stay out provision. We need to file a case, and we’ll do that when that stay out provision is lifted, and then that would be effective January 1 of 2021. Then for Ohio, obviously we’re due to file a case there as well. It’s a pretty moderate case, but nevertheless. As far as we can tell, everything is going exactly like we had planned. Now, you may see some procedural schedules change, but the end result and the end dates aren’t changing, so that’s where we’re at today.
Julien Dumoulin: Great, thank you.
Operator: Thank you. Our next question comes from the line of Michael Lapides with Goldman Sachs. Please go ahead.
Nick Akins: Morning Michael.
Michael Lapides: She did a better job pronouncing my last name than most people do.
Nick Akins: I have the same problem.
Michael Lapides: I had a handful of questions. One, I’m going to be a little more specific on capex, so $500 million cut, $200 million is at the non-regulated renewable--
Nick Akins: Michael, $500 million shifted.
Michael Lapides: Shifted - my bad.
Nick Akins: We’re sensitive about that!
Michael Lapides: Five hundred shifted, 200 is at the non-regulated renewable, 100 is at corporate. What’s the other 200?
Brian Tierney: There’s another $75 million to $100 million that is in our distribution at our opcos, and then the other $100 million is spread across our organizations but not in the transmission side of the business.
Michael Lapides: Got it, okay. That’s fine. The other question is, is there any scenario where you could delay, given all that’s going on in the world, all the uncertainty about demand, about the impact of disconnects, is there any regulatory scenario where you could actually postpone or push out the AEP Ohio rate case?
Nick Akins: No, we don’t see that happening because obviously we’re required to file a case, and actually it’s a pretty moderate case, so I think that there really isn’t any reason to delay it at this point.
Brian Tierney: Michael, I think Nick’s answer earlier was there could be a delay in the procedural schedule. We would still expect to get the result of the case when we originally had.
Nick Akins: Yes.
Michael Lapides: Got it. Then final question--
Nick Akins: And everybody knows about it as well, so it won’t be a surprise to anybody. There’s a pretty negligible impact on customers too in that case.
Michael Lapides: Yes, that makes a ton of sense. Then last question, you all have done a great job in managing down O&M for the last four years, and you’ve taken a lot of O&M out of the company. It saves the customers money, it’s good for shareholders. At what point do you think the long term rate of change in O&M management starts to flatten out, meaning the curve, the ability to keep taking out more or become more efficient just starts to flatten out, the pace of change slows.
Nick Akins: You know, we’ve had a lot of conversations about that, but every day you’re surprised by some new innovation or something that can change the trajectory of O&M expense. We spend $4 billion a year, I think $2.8 billion is not tracked, and when you look at some of the opportunities that are available, and actually I think if there is a silver lining in the coronavirus pandemic, it is that we can really re-evaluate what it means to get our business done, because we’ve been very effective at the people working from home and actually productivity has not suffered as a result. We still have obviously the field employees that are still out there working as well, but you see the innovations that are occurring. I think we have years ahead of us to continue to optimize O&M expense, and when you think it’s going to level out, something new comes about and I think that’s going to be a continual opportunity for us. We actually--and you probably we announced we have a new senior vice president over our--actually, the digital experience, our Chief Information and Technology Officer who is joining the company, we wanted to make sure that we put technology and the customer experience, and certainly our charge innovation hub and those kinds of things together to really focus the organization on what the future holds and what it can mean in terms of O&M in the future. I think we don’t know the answer to that, and really you don’t want to know, you want to just keep pressing forward, and we’ll do that.
Michael Lapides: Got it, thank you Nick. Much appreciated.
Operator: Thank you. Our next question comes from the line of Jeremy Hulme [ph] with JP Morgan. Please go ahead.
Jeremy Hulme: Hi, good morning. Thanks for having me here. I could be wrong, but I think in the past you might have provided a multi-year view of financing needs in the earnings deck. I think I might have missed that here, so didn’t know if there any changes to how you’re thinking about funding capex going forward here, and is there any interplay with where Moody’s is at right now as you think about this?
Brian Tierney: Jeremy, there’s really no change in how we’re funding capex. I think the big thing we did really with the last call was give some insight into how we were going to fund more Central wind and the idea that we’d be doing that between 50% and 60% equity. We’ve always been fairly conservative in our balance sheet management, and we’re going to continue that going forward.
Jeremy Hulme: Got it. That’s it for me. Thanks for taking my question.
Brian Tierney: Thank you.
Operator: Thank you. Our next question comes from the line of James Thalacker with BMO Capital Markets. Please go ahead.
James Thalacker: Hey, how are you guys? Thanks for taking my call.
Nick Akins: Sure.
James Thalacker: Just following up on Jeremy’s question, just wondering, Brian and Nick, as you guys are getting closer to North Central wind approvals, have you sharpened your idea on how you’re thinking about financing that, and especially have you looked a little bit more maybe some cycling some current assets, as opposed to accessing the capital markets specifically?
Brian Tierney: James, we do have a little bit of time for that, right? The smaller portion of North Central wind is going to come, about $300 million at the end of ’20, which would really make the financing of that a ’21 event. Then we have really until the end of ’21 to go forward with that, so how we come up with the equity portion of that, whether it’s capital rotation or whether it’s the equity capital markets, are still things that we have plenty of time to work through. I think the important assumption was the range of percentage of equity that we’d use for that project, and that’s where we talked about being in the 50% to 66% of the project.
Nick Akins: Yes, and really probably the main message is all the options that were available to us before are still on the table and still being considered. There hasn’t been any change from a timing perspective in our ability to get that done, so I’d say we’re still at the same place we were and we’re ready to execute. I think it’s just a matter of us getting the ducks all in a row to ensure that we’re at the right place at the right time.
James Thalacker: Sure. I just wasn’t sure if you guys were looking at the potential for augmenting some of the equity with the recycling of assets, if there became a regulatory proceeding or something like that, that would have to be taken into consideration ahead of time just because of--
Nick Akins: Yes, and we’ve said for really over a year now that with capital rotation, but also sale of assets is on the table as part of that process. We’re obligated to do that from a shareholder perspective, and we will certainly do that.
James Thalacker: Got it. Thank you very much. Appreciate the time.
Operator: Thank you. Our next question comes from the line of Sophia Karp with Keybanc.
Nick Akins: Morning Sophia.
Sophia Karp: Hi. Good morning, thank you for taking my question. A couple of questions here for me. Can you remind us if North Central wind was contemplating tax equity financing as part of the plan?
Brian Tierney: It is not.
Sophia Karp: Okay, so then maybe another one for me. I know you guys have a pretty decent chunk of your workforce that was on track to retire within the next, call it five, seven years maybe. Are you contemplating offering them, these folks some sort of voluntary early retirement, maybe in an effort to cut O&M? Is that something that we could see on the table?
Nick Akins: Well, I usually get that question from employees. As we look at the O&M and the issues that we’re dealing with to try to reduce O&M to the $2.7 billion level and beyond, we look at a lot of things; but one thing we have to be very careful about is certainly if you offer things like that, you usually lose people you don’t want to lose. In this day and age certainly in our frontline employee ranks, we need every individual that’s working, and there’s a lot of competition going on for the professionals in those industries. That’s something we have to be really careful about. Now obviously if it’s part of the--as part of our regular operations that if we evaluate groups and there’s efficiencies in terms of resources, whether it’s vacancies or retirements or even where severance is offered, we’ll continually manage our resource based upon the work that’s in front of us, and we typically do that on a surgical basis rather than some generalized approach. I suspect that we’ll continue that approach.
Sophia Karp: Got it, thank you. One more from me, if I may. On the volumes, first, to what do you attribute the jump in oil and gas volumes? What kind of dynamic on the ground is driving that, and should we expect a reversal of that? As the states begin to sort of reopen, if you call it that, which ones of your service territories would you expect to reopen and maybe be on a faster trajectory sooner than the others [indiscernible]?
Brian Tierney: What’s really driving our results for oil and gas has been midstream and downstream, so I attribute a lot of that--it’s pipeline transportation, really, was up 28% for the quarter. What you’re seeing there is sort of a lag effect associated with all the increases that we’ve seen in oil and gas extraction and then it’s been moving that product from the oil patch to refineries and places where it can be used. That lag effect is finally catching up with us as we’ve seen people putting in electric compression on pipelines and our having to service that, and so that trend has continued well into the first quarter and even into the month of April. We’ve continued to see increases in pipeline transportation and downstream as well. The downstream might fall off a little bit as we’re seeing some reductions in refining, and certainly oil and gas extraction itself will be down as people shut in wells and don’t take as much as they previously had. But it’s really been the midstream part of that that’s been driving the growth in oil and gas that we’ve seen.
Nick Akins: Just to go back on your earlier question too, just an example, I probably have the opportunity for a call-out, our Conesville plant is retiring, the plant is retiring this month after over 60 years of service, and that’s typically what we’ve done. As plants retire, as employees shift from one plant to another and optimize across plants, we’ve enabled that through severance programs and those types of things, so that’s just an example of what you were mentioning before.
Brian Tierney: Then to our service territories as they open, all 11 of our traditional footprint states anticipate opening in May, and they generally have staged reopenings as we go through the month, but all of ours anticipate opening during this month.
Sophia Karp: Awesome, let’s hope that happen. Thank you.
Brian Tierney: Yes, I think our service territory, and it’s really interesting to me because we serve midsized cities and smaller - Columbus, Tulsa are our largest cities, but they’re obviously not New York or Chicago or other areas like that, San Francisco. That has actually improved the resilience because people are more spread out, and so our states have been able to methodically go through the shut-down provisions and now are methodically going through the restart provisions, and it’s been, I would say, probably more helpful to the recovery process for our service territory.
Sophia Karp: Thank you.
Darcy Reese: Perky, I just want to let you know, we have time for one more question.
Operator: Thank you. Our final question is from the line of Shar Pourreza with Guggenheim and Partners. Please go ahead.
Shar Pourreza: Hey, good morning guys.
Nick Akins: Morning Shar.
Shar Pourreza: Just one or two questions, more just clarification. Nick, you obviously reiterated guidance, the long term growth rate, 5% to 7% off the original base. I know in prior remarks, you’ve highlighted that you’d be disappointed if you weren’t in the upper end. Is that still the case, or have the issues around COVID and some of the moving pieces walked you back down a little bit from that?
Nick Akins: Yes, I guess I would still be disappointed, but obviously you have to look at it realistically, and based on the information we have today, I think we’re well placed in terms of that, and we’ll continually update it. Obviously I’d like to think there’s more upside than downside because we have looked very conservatively and very pragmatically at what we face relative to the business and customer base that we serve, but as we get North Central, I’m still optimistic about those future years where that gets fully layered in, starting in ’21. So 2020 may be a tread year for the guidance range and then we get the engine back fully on the tracks and get moving again.
Shar Pourreza: Got it. Then just one last on North Central, if you take the $2 billion spending around that project and you look at your $33 billion of opportunities in your base plan, as you guys look to layer in North Central spend and you’re looking at different financing opportunities, is there any spending opportunities within the core $33 billion that could be maybe secondary in nature of offsetting with North Central coming online, or should we think about $2 billion from North Central additive to $33 billion? I’m just trying to figure if we’re modeling this, how we should think about that.
Brian Tierney: And that’s why we’ve kept it outside. It’s additive to the $33 billion.
Shar Pourreza: Got it. Terrific, guys. Thanks so much for everything.
Brian Tierney: Thank you Shar.
Darcy Reese: Thank you for joining us on today’s call. As always, the IR team will be available to answer any additional questions you may have. Perky, will you please give the replay information?
Operator: Certainly. Ladies and gentlemen, this conference is available for replay starting today. Please dial 1-866-207-1041 and enter the access code of 3291585. You may also dial 402-970-0847 and enter the access code of 3291585. Those numbers again, 866-207-1041 and 402-970-0847 and entering the access code of 3291585. The replay will be available until May 13, 2020 at midnight. Ladies and gentleman, that does conclude your conference for today. Thank you very much for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you very much for standing by, and welcome to the American Electric Power first quarter 2020 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given to you at that time. If you should require assistance during today’s call, please press star then zero and an operator will assist you offline. I would now like to turn the conference over your first speaker, Ms Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Perky. Good morning everyone and welcome to the first quarter 2020 earnings call for American Electric Power. Thank you for taking the time today to join us. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Our presentation also includes references to non-GAAP financial information. Please refer to the reconciliation of the applicable GAAP measures provided in the appendix of today’s presentation. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay, thank you Darcy. Welcome and thank you all for joining AEP’s first quarter 2020 earnings call. I want to take a moment to extend our sympathies to all those who have been personally impacted by the COVID-19 pandemic. At AEP, we understand that we are all in this together. The AEP Foundation has contributed to charities across our footprint to ensure that we are part of the solution for the customers and communities. In addition to providing our employees with the personal protective equipment they need to do their jobs, we have donated masks, gloves, and other essential items needed by hospitals across our service territory. To further assist those in need within our communities, our customer service representatives have provided assistance in fielding questions on how to secure small business loans. Throughout these challenging times, I continue to be extremely proud of our employees who have done an outstanding job demonstrating their capacity for being adaptable and exercising the agility needed to meet the challenges of a rapidly changing situation. As we continue to adapt to the ongoing challenges imposed by COVID-19, we remain committed to keeping our employees safe and keeping America powered through these unprecedented times. Certainly as we headed into March during the first quarter, the story for the quarter would have been one in which we have all heard before, mild weather impacted the first quarter, but as we’ve also heard before, a quarter does not a year to make [ph] and there is plenty of time to recover from a mild winter. We adjust to these types of issues all the time. But I’m sure you’re more interested in the last half of March and what April tells us about the future. I’ll get into all that in a minute, but first let’s just do the headlines, the financial headlines for the quarter. For the first quarter, we came in with operating earnings of $1.02 per share. We are reaffirming our 2020 operating earnings guidance range of $4.25 to $4.45 per share and our 5% to 7% long term growth rate. AEP is doing this because, regardless of whether we forecast a V-shaped, a U-shaped or W-shaped COVID-19 recovery, we see our service territory as an arbitrage between residential load and commercial industrial load that is defined really by a pendulum between the financial characteristics of working from home versus the restart of commercial and industrial businesses. With all of this considered along with capital, O&M, credit metrics and updated load forecasts and actions we have taken, we expect to be the lower half of our guidance range. We are shifting $500 million of capital spending, substantially contracted renewable business and corporate-related capital for the time being to maintain our commitments to solid credit ratings. We are reaffirming our $33 billion of capital over the five-year period, however. We believe this to be the smart play given our ability to adjust capital quickly to respond to market conditions. We give all of this guidance insight given an exhaustive review county by county of our service territory from a load perspective through April, weather impacts thus far in the year, and expense control measures already put in place to respond to present conditions. We will continue to refine these assumptions as data become available. Certainly weather, customer load mix, pace of economic recovery and continued O&M related actions will dictate further positive progress within the guidance range. Brian will get into more detail about these assumptions, but I want to reaffirm for you that our balance sheet is strong, credit metrics are good, and liquidity is secure as we move forward. Let’s move on to the specifics related to COVID-19 and its implications to our operations and our financials as we see the year progressing. As many have heard, there is famous boxing quote from Iron Mike Tyson that is truly appropriate here: “Everyone has a plan until they get punched in the mouth.” Well, that’s what we have faced in the end of this quarter and will face probably for the rest of the year, but I’m here to tell you, yes, we’ve been challenged a little bit but we are very much still in the match because of our quick responses and agility to be in the position to reaffirm our existing guidance range. I’ll start by discussing our employees’ commitments to our customers, communities, and our shareholders as we move through the crisis that I referred to at the beginning of my presentation. First, I want to recognize all the healthcare and first responders who have put themselves in the line of fire to help us all to be more safe and healthy. As a critical infrastructure service company, the frontline employees of our utility have also taken on risk by ensuring we are out in the field responding to substantial storm activity to ensure the resiliency and reliability of electric service so that our hospitals, critical businesses, and customers who are under stay-at-home provisions can continue to benefit at least from some degree of comfort in these challenging times. We have instituted protection measures for these employees that reflect CDC guidance regarding physical distancing, including smaller work teams, proper hygiene, and appropriate PPE and testing to minimize risk of contact with the virus. Approximately 12,000, over 70% of AEP’s employees have been working from home for several weeks now and will continue to work from home even after stay-at-home provisions are lifted to ensure further precautions are taken both at home and at the office for employees who must return for various reasons. We have instituted specific COVID-19 adjustments to our health plans and benefits for employees, and as a critical infrastructure business have continued to pay our employees as they work from home. For most field-level employees, we have also awarded additional days off with pay to enable more time with their families during this time. We have over 82% of our call center employees working from home, and as they not only answer customer questions, they are also helping our small businesses get back on their feet by helping them navigate through the SBA loan provisions of the Cares Act. Regarding our customers, we recognize the hardships that this pandemic has brought on and have temporarily suspended all service disconnects for non-payment, and our team of call center professionals have been working diligently to administer more flexible payment arrangements for our commercial and residential customers. Some states have mandated this, but we do so voluntarily and our state commissions have fully supported these actions through the establishment of deferred accounting and other measures, which I want to take the time to thank them for addressing these issues. Regarding our communities, the AEP Foundation has donated over $3 million to support basic human needs to help address hardships from food security, housing, clothing, and other issues during this time. We have donated over 9,000 N95 masks, 110,000 gloves and disposable surgical masks, and 1,200 face shields from our warehouse stocks and 3D printing facilities within our innovation labs. In my 37 years of being in this business, I have never seen the level of coordination and concern by multiple agencies to do the right thing for our customers, our employees, our businesses and communities. While much focus on this call is on the financials, it is important to remember the part we play in the broader social fabric as a critical infrastructure business. Our effectiveness is defined by the level of cooperation and support from all of the agencies that we deal with: our state commissions and governors’ offices, federal and state legislators, FERC, NERC, DoE, DHS, NRC and others. They all have answered the call, and we at AEP thank them. There is much work yet to do, but I believe all have embraced the capital-S for social from an ESG investor perspective. From the operational side, we have had no disruptions to plant or grid operations while storm activity has been exceptional, given the significant storm activity in several of our operating company territories and considering the additional COVID-19 related safety precautions. There has not been a delay in the north central wind facilities construction and the regulatory cases regarding this project have continued on schedule. As well, future rate cases are on track to be filed, including in Ohio and Kentucky. On the regulatory front, it has been a busy quarter. In fact, we have already received approvals for 96% of the budgeted regulatory recovery for 2020. In March, the Indiana Regulatory Commission authorized a $77 million revenue increased based on a 9.7% ROE. The Commission approved IN’s proposed distribution system investments and full tracking of FERC transmission costs. The company had also sought an adjustment to reflect the reallocation of capacity costs associated with termination of certain wholesale contracts which was denied by the Commission. We have filed for re-hearing on this matter. In January, the Michigan Commission approved the settlement of the base rate case resulting in an increase of $36 million based on a 9.86% ROE. In April, the PUCT - Public Utility Commission of Texas issued a final order approving the settlement agreement in the AEP Texas base rate case, allowing for a 9.4% ROE with a 42.5% equity layer on the company’s $5 billion asset base. Also in April, we filed a DCRF - distribution cost recovery factor to add approximately $440 million in assets to the rate base for distribution investments we made to benefit our customers in AEP Texas. A T-cost filing - transmission cost filing was also made to recover $800 million in transmission investments made over a similar time frame. The company also filed a required base rate case in Virginia as part of the state’s annual review. In that filing, the company asked for a 9.9% ROE on a 50/50 cap structure on a $2.5 billion base, resulting in an increase of $64.9 million. Rates would be effective at the end of January 2021. There is no question that these are unprecedented times. I think it goes without saying that we will need to ensure that utilities and commissions work together to devise creative solutions to the challenges we all face. Tony Clark, former Commissioners at the Federal Energy Regulatory Commission prepared and submitted a white paper to NERUC recognizing the unique challenges the energy industry is facing and the need for regulators to be creative to new solutions. In that article, he called for policymakers at both the federal and state level to be proactive in both the short and long term by targeting measures that support both customers and utilities. Collectively with our legislators and our commissions, we need to work together to recognize the importance of protecting customers and ensuring utilities are able to invest in their systems and maintain the level of service that our communities depend upon, whether through deferrals or preferably riders or forward-looking test years, because cash is king again for utilities to be able to adequately invest in critical infrastructure. Two examples within our service territory where the Commissions have taken a proactive view have been in Texas and Ohio. We believe both are steps in the right direction. In Texas, the Commission approved the COVID-19 Electricity Relief Program for residential consumers who are having difficulty paying their bills. A rider has been put in place to fund the ERP that enables AEP Texas to access cash to begin the program cost. In Ohio, Commission staff recommended approval of the regulatory asset deferral for future recovery and recovery of the demand ratchet program costs through the existing economic development rider. This will help lessen the impact to industrials who are key employers within the state and protect utilities. We believe both are examples of progressive moves by states to help mitigate the risk associated with COVID-19 to both customers and provide certainty for utilities. Moving on to the North Central project, we continue to make progress on this landmark project that provides significant benefits for our 1.1 million customers in our PSO and SWEPCO states. We received approval of the unanimous settlement in Oklahoma as well as FERC approval in the first quarter. We expected May to be an important month for the project for the remaining jurisdictions, and I’m pleased to report that yesterday the Arkansas Public Service Commission approved the 155 megawatts, or approximately 10% of the total project along with the flex-up option. As you recall, the flex-up option allows Arkansas to increase the megawatt allocation should another SWEPCO state reject the application. The Commission in that order determined that SWEPCO should use it’s formulative rate rider to recover its costs. In early March, we filed the unanimous settlement in Louisiana for 268 megawatts or approximately 18% of the total project, which also included the flex-up option. We expect a decision by the Louisiana Public Service Commission in the May or June time frame. Lastly, after concluding our hearings in February, we expect a proposal for commission decision for the Texas ALJs in late May. With approvals in Oklahoma, Arkansas and FERC under our belt, the project has what it needs to go forward at 846 megawatts of the 1,485 megawatt project. Of course, the project can move forward with even more savings for customers and the full $2 billion investment opportunity if either the LPSC approves with the flex-up option or the LPSC and the Public Utility Commission of Texas approves their portion of the full project. Now let’s talk to the equalizer chart. Most of these are weather related, but for AEP Ohio we’ve had the roll-off of some of the legacy fuel and capacity carrying charges. They rolled off, so we expect the trend for the ROE to be at the authorized levels of around 10%. Presently, it’s at 9.9% for quarter 2020. In APCO, the ROE for APCO at the end of first quarter is 8.7%, and that’s driven by lower normalized usage and higher depreciation from increased capital investments, and of course unfavorable weather. Virginia’s first triannual review was filed in March 2020, as I mentioned earlier, and it covers the 2017 to 2019 periods. An ROE of 9.42% would be used for the triannual review with 70 basis point bandwidth of 8.72% to 10.12% ROE. Kentucky Power, the ROE for Kentucky Power at the end of first quarter was 6.7%, and that’s primarily driven by loss of load from weak economic conditions, loss of major customers along with higher expenses and unfavorable weather. We also have been in a stay out provision associated with rate filings, but that goes away here soon and we expect to be filing in Kentucky in the July time frame. I&M, the ROE at I&M is at 10.5%, and we’ve been implementing new rates for Indianan which will take place in the second quarter, but we fully expect to be at the authorized areas of around 9.7% to 9.86%. Then for PSO, PSO is at 9.2% primarily driven by unfavorable weather. SWEPCO at the end of first quarter was 6.2%, and that was because of a loss of load, unfavorable weather, and continued impact of the Arkansas share of the Turk plant, which accounts for about 112 basis points. The Arkansas base case settlement went in place in December 2019 and is effective January 2020, approved a $24 million revenue increase there. In AEP Texas, it’s at 8% and that’s due to a lag associated with the timing of annual filings and one-time adjustments from our recently finalized base rate case. Favorable regulatory treatment has historically allowed us to file annual DCRF and biannual T-cost filings to recover our cost, and I mentioned those earlier, so there’s a lag associated with those but we should see a pick-up there and drive more toward a 9.4% ROE in the long term. Then the transmission holdco at the end of the first quarter was 11.5% and it was driven by higher revenues due to differences between actual and forecasted revenues, so we fully expect the transmission ROE to be in the mid-10% range in 2020. With that, when there is a pandemic like the one we’re experiencing today that has not occurred in 100 years, and this nation’s economy has been effectively shut down for months, there is no question that everyone is challenged and AEP is no exception. We are up to the challenge to recognize not only the role that this company has in the resiliency and restart of our economy as well as the provision of electric service no matter where our customers are working or living, but also the importance of the consistency and quality of earnings and dividends to our shareholders that makes our work possible. We will strike that balance, respond to challenges, and I’ll stick with a boxing analogy with a Sylvester Stallone movie, Rocky, where the music is playing, the theme from Rocky and he’s running up the steps that represent the adversity of reaching a goal. I believe at the end of the year, we all - AEP, the communities we serve, our customers and our shareholders - will be at the summit, raising our arms in victory. Brian?"
},
{
"speaker": "Brian Tierney",
"text": "Thank you Nick, and good morning everyone. I will take us through the financial results for the quarter, provide some insight in how we’re thinking about 2020, including an update on April load, and finish with a review of our balance sheet and liquidity. Let’s stop briefly on Slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings were $1.00 per share compared to $1.16 per share in 2019. There is a reconciliation of GAAP to operating earnings in the appendix. Let’s turn to Slide 8 and look at the drivers of quarterly operating earnings. Operating earnings for the first quarter were $1.02 per share or $504 million, compared to $1.19 per share of $585 million in 2019. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $0.50 per share, down $0.13. Earnings in this segment declined primarily due to warmer than normal winter weather and lower normalized retail load. Other small decreases included higher depreciation, higher tax expense and lower wholesale load, AFUDC, and off-system sales. Favorable drivers included rate changes and higher transmission revenue. The transmission and distribution utilities segment earned $0.24 per share, down $0.08 from last year primarily driven by the 2019 reversal of a regulatory provision in Ohio. Other smaller drivers included higher depreciation, the roll-off of legacy riders in Ohio, and unfavorable weather. These items were partially offset by higher rate changes, normalized retail load, and recovery of increased transmission investment in ERCOT, as well as lower O&M. The AEP transmission holdco segment continued to grow, contributing $0.28 per share, an improvement of $0.03 over last year. Net plant increased by $1.5 billion or 18% since March of last year. Generation and marketing produced earnings of $0.07 per share, down $0.02 from last year. The renewables business grew with the acquisition of multiple renewable assets. Increases in retail margins were more than offset by timing around income taxes and lower generation sales due to lower energy prices and plant retirements. Finally, corporate and other was up $0.03 per share primarily driven by lower taxes relating to a prior year income tax adjustment and other consolidating items that were reversed by year end, other variances related to higher interest expense, and lower O&M. Earlier in the call, Nick indicated that we are reaffirming our 2020 operating earnings guidance range of $4.25 per share to $4.45 per share and would likely be in the lower half of that range. Let me give you some of the detail that leads us to that outcome on Slide 9 and then I’ll provide more detail on each of the key assumptions in the following slides. Our economic forecasting group uses Moody’s analytics as a key input to our models. In April, Moody’s published a county-level forecast that included the projected impact of COVID-19 on our service territory. We used this new data along with updated assumptions from our customer service engineers to come up with revised retail sales projections for the year. We now expect residential sales to increase 3% over 2019 levels largely driven by all of the activity that has taken place in residences rather than in places of work or in the classroom. Conversely, we are anticipating commercial sales contractions of 5.6% and industrial sales declines of 8% over 2019 levels. Many businesses have shifted their operations to a mostly online platform while other employers have had to make the difficult decision to furlough or reduce employee headcount until market demand is restored. These retail forecasts lead us to expect an overall decline in sales of 3.4%. This updated load would impact our prior forecast negatively by $0.15 per share. We have already discussed our year to date negative impact from mild weather of $0.11 per share. In response to these circumstances, we have taken action to reduce untracked operations and maintenance expenses by an additional $100 million, resulting in a positive expectation of $0.17 per share for the year. The net result of load, weather and O&M reductions would have a negative $0.09 per share impact for the year, leaving us inside but in the lower half of the original operating earnings guidance range. We realize moratoriums on disconnects and the economic impact to our customers may have on our cash receipts. In response to this, we have initiated a shift of $500 million of capital expenditures out of 2020 to be placed into the future years of 2021 to 2024. As we made these deferrals, we were mindful of customer and reliability impacts. In fact, about $200 million of these investments were in our competitive renewables business and about $100 million were corporate investments. The shifts can be ramped up or down going forward in response to how events play out in real time. With this moderate level of capital shifting, we are able to reaffirm our 5% to 7% long term growth rate off of our original 2019 operating earnings guidance range. Regarding potential increases in bad debt across our jurisdictions, we have already received orders in Texas, Arkansas, Louisiana and Virginia to set up regulatory assets related to COVID-19 costs. Other states where we have filed for recovery of COVID-related deferrals include Ohio, Michigan, Tennessee, and Oklahoma. We have tried on this slide to provide some of the detail for how the coronavirus and oil and gas events will impact AEP’s operating earnings for 2020. Instead of taking you through the details of our scenario planning, let me highlight some of the items that could positively and negatively impact our view as we make our way through the year. On the positive side, a sharp V-shape recovery that is more dramatic than the gradual recovery from the second quarter low point that we have assumed would improve results. Additionally, mitigation of coronavirus infection rates leading the economy to open up sooner than we have assumed would improve results. A greater increase in residential sales and an improvement in commercial and industrial sales would further improve our outlook. We have experienced a mild winter. If that carried forward into a warmer than normal summer, that would have positive earnings implications. Another positive would be if we could garner incremental savings to what we have assumed at the $2.7 billion level of untracked O&M expenses. The items that would create negative impacts to our assumptions are largely the opposite of the positives. A prolonged U-shaped or a dramatic L-shaped recovery would be more negative than our assumptions. Increased coronavirus infection rates could lead to weaker economic conditions for longer periods than we have assumed, potential impairing our outlook for the year. In addition, continued mild weather and/or O&M expenses beyond our control, like for storms, could negatively impact the outlook for 2020. We have tried our best using data, experience and judgment to update and share our outlook with you for 2020. We have tried not to be unreasonably optimistic nor pessimistic. This outlook allows us to reaffirm our 2020 operating earnings guidance range with a view that we are likely to be in the lower half of the range. Now let’s turn to Slide 10 and provide an update on our system load, focusing on our outlook for the balance of the year. Our first quarter normalized load was down seven-tenths of a percent compared to last year. Our residential and industrial sales were both down for the quarter while commercial sales were essentially flat. Our original guidance for the year assumed half a percent normalized load growth. Clearly a lot has changed since that forecast was developed. Since then, we have taken a fresh look at our forecast and now expect our total load to end the year down 3.4% on a weather normalized basis, with meaningful changes in customer mix and related margins. For 2020, we anticipate a significant contraction in the second quarter followed by a gradual recovery over the balance of the year. In the upper left quadrant, we raised our residential outlook for 2020 to 3%. We are seeing significant increases in our residential load during the stay-at-home period. Even after our states begin to reopen their economies in the second quarter, it is our expectation that many employees will continue to work from home. Having said this, we expect the strongest residential growth in the second quarter with some tapering off during the second half of the year. Moving clockwise, our commercial sales outlook is now assuming a 5.6% decline from 2019 levels. Prior to the COVID outbreak, we experienced consistent improvement in our commercial sales class over the past year; however, once the stay-at-home provisions were in place, we experienced significant declines in our sales to traditional retail stores, hotels, restaurants, churches and schools. However, not all commercial load was negatively impacted by the outbreak. Sales to hospitals and government support offices were up substantially in the first quarter. When you consider the challenges many businesses will face trying to introduce social distancing protocols into their normal operations, we are projecting a difficult second quarter for commercial sales with modest improvement through the remainder of the year. Finally, in the lower left chart the outlook for industrial sales has changed significantly. We now expect 2020 industrial sales to come in 8% below 2019 levels. A number of factors have changed the outlook for this class, but the biggest driver is the overall drop in economic activity. Over the past several weeks, we have learned a number of large industrial customers that were either idling their production or reducing their output temporarily until market conditions improve. In addition, a number of expansions we had previously assumed to come online later this year have been delayed or postponed. These delays should be reversed as the economy gradually recovers. Since nearly 30% of our industrial sales come from the oil and gas sectors, let me explain recent sales trends in this sector. Surprisingly, sales to the oil and gas sectors in the first quarter increased by 9.7%, which was the strongest quarter we’ve experienced since 2016. Most of that growth came from the pipeline transportation sector which was up 28% for the first quarter. Going forward, we expect some reduction in oil and gas extraction that will be offset by growth in the midstream and downstream operations. We don’t normally report on monthly load numbers, but since we had the data, let’s take a look at April load on Slide 11. Total normalized retail load for April was down 4.3% with the relationship between the retail classes being similar to what we assumed for the balance of the year. Not surprising given the number of people relegated to their homes, normalized residential sales were up 6% for the month. Equally not surprising, normalized commercial sales were down 7.7% for the month, with the biggest declines being in schools, churches, restaurants and hotels. Industrial sales were down 10% for the month. The biggest decline was in sectors that support the automotive industry, while we experienced strong sales growth in pipeline transportation and food manufacturing sectors. Looking at April’s results, the relationship between the classes, also know as sales mix, as well as the levels of sales in each class are consistent with the assumptions we have made for the second quarter of our balance of year assumptions. Moving on to Slide 12, let’s discuss some load sensitivities and highlight some of our rate recovery mechanisms. The three pie charts show that by segment and in total, about half of our non-fuel revenues come from the residential class. Applying the 3% growth we are now projecting for residential sales in total to the sensitivities we provided at last year’s EEI financial conference, we would pick up $0.12 a share from higher residential sales. Repeating the same calculations for the projected load loss in the commercial and industrial classes would produce a drag of approximately $0.11 and $0.16 per share respectively. When you add these three impacts together, you get the $0.15 per share impact we identified on Slide 9. Finally, retail rate design has a couple of features that stabilize our revenues during an economic downturn. First, most of our large industrial tariffs include demand provisions designed to cover the fixed portion of utility costs. These provisions remain in place even when volumes are down. Second, in our residential customer class we have had some success over the years better aligning the fixed portion of customer rates with fixed costs. Together these rate considerations provide a stabilizing effect on our revenues even when sales volumes decline. Turning to Slide 13, another key assumption is the weather. As mentioned earlier, weather in the first quarter was extremely mild. The green bar in the first quarter shows that mild weather cost us $71 million compared to normal, which was $65 million worse than the first quarter of last year. While our outlook assumes normal weather for the remainder of the year, this chart shows that weather can change significantly, as evidenced by last year’s experience. If we were to have another warm summer like we did in 2019, it could offset the $0.11 drag for weather in the first quarter that we showed you on Slide 9. Our management team has a proven track record of adapting our plans to changing conditions as necessary. In years when the weather has provided a tailwind, we have accelerated spending to provide stability to our earnings in line with our 5% to 7% growth targets. In years where weather has been less accommodating, we have been able to shift our spending to future years to achieve the same goal. You can expect this management team will react similarly this year. Turning to Slide 14, you can see that for nine years now, we have maintained O&M discipline and kept spending net of offsets in a tight range of between $2.8 billion and $3.1 billion. We had originally planned to drive down O&M costs in 2020 to $2.8 billion. In response to the expected decline in sales, we now plan to reduce O&M spend by an additional $100 million. Plans like the Achieving Excellence program and additional one-time and extraordinary reductions will help us to achieve those reductions. Now let’s move on to Slide15 and review the company’s capitalization and liquidity. Our debt to total capital ratio increased during the quarter from 59.8% to 61.8%. The increase in the debt component is attributable to financings to support our ongoing investment program and to fortify our liquidity position to ensure smooth operational financing during this period of market volatility. As you would expect, the increase in debt combined with the ongoing pressure associated with the flow back of ADIT resulted in pressure on our FFO to debt metric, which at quarter end stood at 12.5% on a Moody’s basis. The decline in the metric is also temporarily influenced by the $1 billion 364-day term loan the company proactively obtained in late March. Despite the temporary decline in this metric, rating agencies view this enhanced liquidity as credit positive. Adjusting for this facility and associated cash balances, the metric would be 13%. Our liquidity at the end of the quarter remained strong at $2.8 billion. Since then, our commercial paper balances have dropped to $1.6 billion and our liquidity position has increased to $3.1 billion. Our qualified pension funding increased approximately 4% to 93%, and our OPEB funding decreased approximately 15% to 130%. Pension and OPEB equity returns were negative 23% and negative 22% respectively for the quarter and were the primary reasons pensions and OPEB funding decreased. Fixed income returns of approximately 7% and 6% in the pension and OPEB respectively served to offset some of the equity losses. We have worked hard over the years to focus on pension and OPEB funding and are pleased with how the asset portfolios have performed in spite of recent market volatility. Let’s wrap this up on Slide 16 so we can quickly get to your questions. In response to the economic downturn and related implications, AEP has responded to quickly reduce our O&M spending by an additional $100 million for 2020. This action combined with our updated load forecast allows us to reaffirm our existing operating earnings guidance of 2020 from $4.25 to $4.45 per share. In addition, in response to uncertainties about cash flows related to reduced customer demand and potential delays in customer receipts, we are shifting about $500 million in capital expenditures out of 2020 and into the period 2021 to 2024. We can adjust the timing and size of this shift in reaction to how events play out relative to our assumptions. Because of our ability to continue to invest in our own system organically, we are confident in our ability to grow the company at our stated long term growth rate of 5% to 7%. We continue to make progress on obtaining approvals for our $2 billion North Central wind project in Oklahoma and plan to proceed when approvals are obtained. With that, I will turn the call over to the operator for your questions."
},
{
"speaker": "Operator",
"text": "[Operator instructions] Our first question comes from the line of Steve Byrd with Morgan Stanley. Please go ahead."
},
{
"speaker": "Steve Byrd",
"text": "Hi, good morning. Hope you all are doing well."
},
{
"speaker": "Nick Akins",
"text": "Morning Steve."
},
{
"speaker": "Steve Byrd",
"text": "Thanks for the update on a lot of topics. Wanted to talk first just about two of your rate cases, Indiana and Michigan, where I believe the test year is going to be a 2020 test year. How do you think about that sort of test year in light of COVID - you know, load adjustments, COVID-related expenses as you think through that rate case, and sort of how to approach 2020 given it’s such an unusual year?"
},
{
"speaker": "Nick Akins",
"text": "In at least Indiana, we have forward test year views, and I think it’s probably going to be particularly important as we go in for these cases for there to be an understanding that we are dealing with a COVID-related year if it is a test year. Wherever you have forward test years, though, you can account for that going forward in the rate making, but we’d be tuned into the process whether you pro forma in or do other things. I think there’s probably at least opportunities for discussion about that because COVID--you know, 2020 is going to be an usual year and to be used for test years would be particularly challenging. You have to really go to some form of pro forma view that has the level of investments, the level of business activity that you would normally see. So, I would expect our commissions to be reasonable in that approach."
},
{
"speaker": "Brian Tierney",
"text": "You know, in both those cases, Steve, we had forward-looking test years and we do have orders effective in both of those jurisdictions."
},
{
"speaker": "Steve Byrd",
"text": "Okay, that’s helpful. Yes, it makes sense that you’d sort of try to work to the adjustments. It makes sense. On North Central wind, some great progress there. That’s really encouraging. I guess I had sort of two related questions on North Central. If you do get those additional approvals that you’re waiting for, such as in Louisiana, Texas, can you quickly flex the plan to go to the higher megawatt level? Then relatedly, you’ve obviously deferred some capex. Do you have that flexibility to deploy whatever capital you need to, to make this a bigger project, or does your capital position caution against significant ramp-up in capex this year? Just thinking through the growth at North Central."
},
{
"speaker": "Nick Akins",
"text": "Yes, so originally North Central was not in our capital plan, and so when we get approval for that, that’d be dealing with a different financing model associated with that. As far as the megawatt level and the amount of investment, yes, if we get approval for Louisiana for example, and Louisiana also approves the up rate which is in a settlement arrangement, then we would have the full $2 billion investment opportunity there. We already know we’re going forward with the project - that was the importance of Arkansas approval, so the project is moving forward. The question is what size, and then when Louisiana approves that, and hopefully with a flex-up as well, then that’s the full $2 billion, or if Texas takes their portion, then all operating jurisdictions will be taking their particular portions as we go forward. Now, there is additional opportunity for renewables in those areas. The integrated resource plans have the capability for that, but we felt like, as we originally said about this project, there is sort of a break point between the opportunities that existed around the wind farm project and the pricing, and we wanted to make absolutely sure that the pricing was very effective and produced very positive savings for our customers. So, we can always go out for a bid again to fill the rest of that from a resource planning perspective."
},
{
"speaker": "Brian Tierney",
"text": "Steve, we’ll be full speed ahead on the capex associated with North Central wind one way or the other. Nick mentioned that it’s not in the $33 billion that we had previously identified for the five years, 2020 to 2024, and we previously said that we anticipate an equity component of that investment to be between 50% and 66%."
},
{
"speaker": "Steve Byrd",
"text": "That’s super helpful. I’ll let others ask questions. Thank you."
},
{
"speaker": "Nick Akins",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Durgesh Chopra with Evercore. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning guys. Thanks for taking my question. I have two. The first one on 2020 guidance range here, the $0.15 EPS hit, what are you assuming in terms of decline trends for the rest of the year? I guess what I’m asking is are you--as you make some amount of recovery in Q3 or Q4, just curious as to what you’re assuming in terms of profiling for the rest of the year."
},
{
"speaker": "Brian Tierney",
"text": "Sure, so we are assuming that the second quarter would be the lowest quarter for load, and that there would be a gradual recovery over the balance of 2020 and into the first quarter of 2021."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it, perfect. Then, can you comment on just your--you know, assuming that you hit your lower half of the EPS guidance range for this year, where would that put you in terms of credit metrics [indiscernible] debt versus your targeted metrics? Then any color that you can provide us with your recent conversations that you have had with Moody’s on some of the changes that you’ve made to your plan?"
},
{
"speaker": "Brian Tierney",
"text": "We’ve really been--we anticipate year end being FFO to debt in that 13% to 14% range. We’ve communicated that with S&P and Moody’s, had dialogues with them as late as yesterday. They understand where we are and what we’re doing. I think they were encouraged to see us flex a little bit our capex for the balance of the year in response to anticipated lower cash flows than what we had anticipated, and they’re supportive of that. They were--they viewed what Julie and her team did around the term loan facility as being credit positive, and they are fully aware and apprised of what we’re doing. You should ask them, but I think their answer would be supportive."
},
{
"speaker": "Durgesh Chopra",
"text": "Great, that’s all I had, guys. Thank you very much."
},
{
"speaker": "Nick Akins",
"text": "Thank you, Durgesh."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Julien Dumoulin with Bank of America. Please go ahead."
},
{
"speaker": "Julien Dumoulin",
"text": "Hey, good morning team. I hope you’re all well. Perhaps just to pick up where the last question left off to start here. On guidance and the 2020 lower half, how do you think about the reduction in capex? I just want to reconcile this. It seems as if you’re not really changing FFO to debt expectations as you are bringing down capex altogether, but why do that relative to no change in earnings? Can you walk through the thought process there? Then also, it seems as if it doesn’t necessarily have too much of an earnings impact given the corporate nature of some of the capex, so I just want to make sure we’re thinking about that correctly as well."
},
{
"speaker": "Brian Tierney",
"text": "Sure Julien, thanks for the question. We are anticipating there to be some reduction in cash flow this year associated with two things: one, lower customer demand, and then two, we have eliminated disconnects currently, and so we think that customers will pay us slower than what they have in the past. We’re not seeing the impact of that in a significant way yet - it’s too early, but in anticipation of lower cash flows to maintain those FFO to debt metrics, we felt it was prudent to at least engage the motor on our ability to scale back capex. In regards to the no impact on future earnings, we tried to do it in places that have either lower regulatory lag or the increase in earnings isn’t as great. Nick mentioned that some of that reduction is in the competitive renewables space and some of that reduction is also at corporate capital, things like IT and things like that, that are much slower to flow into customer rates during rate cases. Things that we are careful not to cut were things like transmission, where we’re spending on customer resilience and reliability and we have those formula-based rates to update and get that capex into rates on a fairly efficient basis. We were really thoughtful about how we cut that or shifted that small amount of capex, and made sure that it wasn’t impacting earnings."
},
{
"speaker": "Nick Akins",
"text": "Julien, I think you’re reading it right, though - we’re being as transparent as we possibly can be through this process using the latest information. Matter of fact, we got the load information, April load information yesterday, so we’re trying to be as transparent as possible, but also taking the right, smart, appropriate steps to ensure that we’re able to be agile enough to do what we need to do. I think you’re reading that right. We obviously would put that capital back in as quickly as possible and then, as Brian mentioned, we’re not only mitigating any impacts to the earnings capability but also thinking ahead in terms of where we deploy that capital in the future. Then we also have North Central coming about, so those things are occurring. We’re trying to manage through this year in a very positive fashion and really a defensive posture, and then set ourselves up for the future years, in ’21 and beyond. We’ll continue that approach, and obviously if we get a hot summer, for example, we’ll throw capital back in - there’s all kinds of things we can adjust, and then from a residential standpoint, you heard our residential load for April was 6%, and we’re saying 3%, so we don’t know exactly how this is going to play out, particularly with changing dynamics of business cases themselves changing. I mean, we had Nationwide recently come out and say that their people are going to be working from home, and we have 17,000 employees and 12,000 are working from home. We may be looking through our Achieving Excellence program, which we have already accelerated, to look at how you look at people working from home and maybe the whole business cases changes from that perspective and also reduces O&M further. So we’re in the process of doing all that, but we’re just trying to be as transparent as possible. But you’re reading the tea leaves right."
},
{
"speaker": "Julien Dumoulin",
"text": "Got it, excellent. Let me just clarify this from the transcript - you all reaffirmed intentions to file rate cases in various geographies. This doesn’t shift timing necessarily, it sounds like, nor--at the same time, I don’t want to tie one to the other, does it shift any expectations with respect to asset sales, disposals, strategic reviews? Just want to make sure we’re on the same page there, and there could be some further capital needs."
},
{
"speaker": "Nick Akins",
"text": "No, it doesn’t change. As a matter of fact, we’ll continue those cases. Obviously, as I mentioned, in Kentucky we have a stay out provision. We need to file a case, and we’ll do that when that stay out provision is lifted, and then that would be effective January 1 of 2021. Then for Ohio, obviously we’re due to file a case there as well. It’s a pretty moderate case, but nevertheless. As far as we can tell, everything is going exactly like we had planned. Now, you may see some procedural schedules change, but the end result and the end dates aren’t changing, so that’s where we’re at today."
},
{
"speaker": "Julien Dumoulin",
"text": "Great, thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Michael Lapides with Goldman Sachs. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Morning Michael."
},
{
"speaker": "Michael Lapides",
"text": "She did a better job pronouncing my last name than most people do."
},
{
"speaker": "Nick Akins",
"text": "I have the same problem."
},
{
"speaker": "Michael Lapides",
"text": "I had a handful of questions. One, I’m going to be a little more specific on capex, so $500 million cut, $200 million is at the non-regulated renewable--"
},
{
"speaker": "Nick Akins",
"text": "Michael, $500 million shifted."
},
{
"speaker": "Michael Lapides",
"text": "Shifted - my bad."
},
{
"speaker": "Nick Akins",
"text": "We’re sensitive about that!"
},
{
"speaker": "Michael Lapides",
"text": "Five hundred shifted, 200 is at the non-regulated renewable, 100 is at corporate. What’s the other 200?"
},
{
"speaker": "Brian Tierney",
"text": "There’s another $75 million to $100 million that is in our distribution at our opcos, and then the other $100 million is spread across our organizations but not in the transmission side of the business."
},
{
"speaker": "Michael Lapides",
"text": "Got it, okay. That’s fine. The other question is, is there any scenario where you could delay, given all that’s going on in the world, all the uncertainty about demand, about the impact of disconnects, is there any regulatory scenario where you could actually postpone or push out the AEP Ohio rate case?"
},
{
"speaker": "Nick Akins",
"text": "No, we don’t see that happening because obviously we’re required to file a case, and actually it’s a pretty moderate case, so I think that there really isn’t any reason to delay it at this point."
},
{
"speaker": "Brian Tierney",
"text": "Michael, I think Nick’s answer earlier was there could be a delay in the procedural schedule. We would still expect to get the result of the case when we originally had."
},
{
"speaker": "Nick Akins",
"text": "Yes."
},
{
"speaker": "Michael Lapides",
"text": "Got it. Then final question--"
},
{
"speaker": "Nick Akins",
"text": "And everybody knows about it as well, so it won’t be a surprise to anybody. There’s a pretty negligible impact on customers too in that case."
},
{
"speaker": "Michael Lapides",
"text": "Yes, that makes a ton of sense. Then last question, you all have done a great job in managing down O&M for the last four years, and you’ve taken a lot of O&M out of the company. It saves the customers money, it’s good for shareholders. At what point do you think the long term rate of change in O&M management starts to flatten out, meaning the curve, the ability to keep taking out more or become more efficient just starts to flatten out, the pace of change slows."
},
{
"speaker": "Nick Akins",
"text": "You know, we’ve had a lot of conversations about that, but every day you’re surprised by some new innovation or something that can change the trajectory of O&M expense. We spend $4 billion a year, I think $2.8 billion is not tracked, and when you look at some of the opportunities that are available, and actually I think if there is a silver lining in the coronavirus pandemic, it is that we can really re-evaluate what it means to get our business done, because we’ve been very effective at the people working from home and actually productivity has not suffered as a result. We still have obviously the field employees that are still out there working as well, but you see the innovations that are occurring. I think we have years ahead of us to continue to optimize O&M expense, and when you think it’s going to level out, something new comes about and I think that’s going to be a continual opportunity for us. We actually--and you probably we announced we have a new senior vice president over our--actually, the digital experience, our Chief Information and Technology Officer who is joining the company, we wanted to make sure that we put technology and the customer experience, and certainly our charge innovation hub and those kinds of things together to really focus the organization on what the future holds and what it can mean in terms of O&M in the future. I think we don’t know the answer to that, and really you don’t want to know, you want to just keep pressing forward, and we’ll do that."
},
{
"speaker": "Michael Lapides",
"text": "Got it, thank you Nick. Much appreciated."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jeremy Hulme [ph] with JP Morgan. Please go ahead."
},
{
"speaker": "Jeremy Hulme",
"text": "Hi, good morning. Thanks for having me here. I could be wrong, but I think in the past you might have provided a multi-year view of financing needs in the earnings deck. I think I might have missed that here, so didn’t know if there any changes to how you’re thinking about funding capex going forward here, and is there any interplay with where Moody’s is at right now as you think about this?"
},
{
"speaker": "Brian Tierney",
"text": "Jeremy, there’s really no change in how we’re funding capex. I think the big thing we did really with the last call was give some insight into how we were going to fund more Central wind and the idea that we’d be doing that between 50% and 60% equity. We’ve always been fairly conservative in our balance sheet management, and we’re going to continue that going forward."
},
{
"speaker": "Jeremy Hulme",
"text": "Got it. That’s it for me. Thanks for taking my question."
},
{
"speaker": "Brian Tierney",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of James Thalacker with BMO Capital Markets. Please go ahead."
},
{
"speaker": "James Thalacker",
"text": "Hey, how are you guys? Thanks for taking my call."
},
{
"speaker": "Nick Akins",
"text": "Sure."
},
{
"speaker": "James Thalacker",
"text": "Just following up on Jeremy’s question, just wondering, Brian and Nick, as you guys are getting closer to North Central wind approvals, have you sharpened your idea on how you’re thinking about financing that, and especially have you looked a little bit more maybe some cycling some current assets, as opposed to accessing the capital markets specifically?"
},
{
"speaker": "Brian Tierney",
"text": "James, we do have a little bit of time for that, right? The smaller portion of North Central wind is going to come, about $300 million at the end of ’20, which would really make the financing of that a ’21 event. Then we have really until the end of ’21 to go forward with that, so how we come up with the equity portion of that, whether it’s capital rotation or whether it’s the equity capital markets, are still things that we have plenty of time to work through. I think the important assumption was the range of percentage of equity that we’d use for that project, and that’s where we talked about being in the 50% to 66% of the project."
},
{
"speaker": "Nick Akins",
"text": "Yes, and really probably the main message is all the options that were available to us before are still on the table and still being considered. There hasn’t been any change from a timing perspective in our ability to get that done, so I’d say we’re still at the same place we were and we’re ready to execute. I think it’s just a matter of us getting the ducks all in a row to ensure that we’re at the right place at the right time."
},
{
"speaker": "James Thalacker",
"text": "Sure. I just wasn’t sure if you guys were looking at the potential for augmenting some of the equity with the recycling of assets, if there became a regulatory proceeding or something like that, that would have to be taken into consideration ahead of time just because of--"
},
{
"speaker": "Nick Akins",
"text": "Yes, and we’ve said for really over a year now that with capital rotation, but also sale of assets is on the table as part of that process. We’re obligated to do that from a shareholder perspective, and we will certainly do that."
},
{
"speaker": "James Thalacker",
"text": "Got it. Thank you very much. Appreciate the time."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Sophia Karp with Keybanc."
},
{
"speaker": "Nick Akins",
"text": "Morning Sophia."
},
{
"speaker": "Sophia Karp",
"text": "Hi. Good morning, thank you for taking my question. A couple of questions here for me. Can you remind us if North Central wind was contemplating tax equity financing as part of the plan?"
},
{
"speaker": "Brian Tierney",
"text": "It is not."
},
{
"speaker": "Sophia Karp",
"text": "Okay, so then maybe another one for me. I know you guys have a pretty decent chunk of your workforce that was on track to retire within the next, call it five, seven years maybe. Are you contemplating offering them, these folks some sort of voluntary early retirement, maybe in an effort to cut O&M? Is that something that we could see on the table?"
},
{
"speaker": "Nick Akins",
"text": "Well, I usually get that question from employees. As we look at the O&M and the issues that we’re dealing with to try to reduce O&M to the $2.7 billion level and beyond, we look at a lot of things; but one thing we have to be very careful about is certainly if you offer things like that, you usually lose people you don’t want to lose. In this day and age certainly in our frontline employee ranks, we need every individual that’s working, and there’s a lot of competition going on for the professionals in those industries. That’s something we have to be really careful about. Now obviously if it’s part of the--as part of our regular operations that if we evaluate groups and there’s efficiencies in terms of resources, whether it’s vacancies or retirements or even where severance is offered, we’ll continually manage our resource based upon the work that’s in front of us, and we typically do that on a surgical basis rather than some generalized approach. I suspect that we’ll continue that approach."
},
{
"speaker": "Sophia Karp",
"text": "Got it, thank you. One more from me, if I may. On the volumes, first, to what do you attribute the jump in oil and gas volumes? What kind of dynamic on the ground is driving that, and should we expect a reversal of that? As the states begin to sort of reopen, if you call it that, which ones of your service territories would you expect to reopen and maybe be on a faster trajectory sooner than the others [indiscernible]?"
},
{
"speaker": "Brian Tierney",
"text": "What’s really driving our results for oil and gas has been midstream and downstream, so I attribute a lot of that--it’s pipeline transportation, really, was up 28% for the quarter. What you’re seeing there is sort of a lag effect associated with all the increases that we’ve seen in oil and gas extraction and then it’s been moving that product from the oil patch to refineries and places where it can be used. That lag effect is finally catching up with us as we’ve seen people putting in electric compression on pipelines and our having to service that, and so that trend has continued well into the first quarter and even into the month of April. We’ve continued to see increases in pipeline transportation and downstream as well. The downstream might fall off a little bit as we’re seeing some reductions in refining, and certainly oil and gas extraction itself will be down as people shut in wells and don’t take as much as they previously had. But it’s really been the midstream part of that that’s been driving the growth in oil and gas that we’ve seen."
},
{
"speaker": "Nick Akins",
"text": "Just to go back on your earlier question too, just an example, I probably have the opportunity for a call-out, our Conesville plant is retiring, the plant is retiring this month after over 60 years of service, and that’s typically what we’ve done. As plants retire, as employees shift from one plant to another and optimize across plants, we’ve enabled that through severance programs and those types of things, so that’s just an example of what you were mentioning before."
},
{
"speaker": "Brian Tierney",
"text": "Then to our service territories as they open, all 11 of our traditional footprint states anticipate opening in May, and they generally have staged reopenings as we go through the month, but all of ours anticipate opening during this month."
},
{
"speaker": "Sophia Karp",
"text": "Awesome, let’s hope that happen. Thank you."
},
{
"speaker": "Brian Tierney",
"text": "Yes, I think our service territory, and it’s really interesting to me because we serve midsized cities and smaller - Columbus, Tulsa are our largest cities, but they’re obviously not New York or Chicago or other areas like that, San Francisco. That has actually improved the resilience because people are more spread out, and so our states have been able to methodically go through the shut-down provisions and now are methodically going through the restart provisions, and it’s been, I would say, probably more helpful to the recovery process for our service territory."
},
{
"speaker": "Sophia Karp",
"text": "Thank you."
},
{
"speaker": "Darcy Reese",
"text": "Perky, I just want to let you know, we have time for one more question."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question is from the line of Shar Pourreza with Guggenheim and Partners. Please go ahead."
},
{
"speaker": "Shar Pourreza",
"text": "Hey, good morning guys."
},
{
"speaker": "Nick Akins",
"text": "Morning Shar."
},
{
"speaker": "Shar Pourreza",
"text": "Just one or two questions, more just clarification. Nick, you obviously reiterated guidance, the long term growth rate, 5% to 7% off the original base. I know in prior remarks, you’ve highlighted that you’d be disappointed if you weren’t in the upper end. Is that still the case, or have the issues around COVID and some of the moving pieces walked you back down a little bit from that?"
},
{
"speaker": "Nick Akins",
"text": "Yes, I guess I would still be disappointed, but obviously you have to look at it realistically, and based on the information we have today, I think we’re well placed in terms of that, and we’ll continually update it. Obviously I’d like to think there’s more upside than downside because we have looked very conservatively and very pragmatically at what we face relative to the business and customer base that we serve, but as we get North Central, I’m still optimistic about those future years where that gets fully layered in, starting in ’21. So 2020 may be a tread year for the guidance range and then we get the engine back fully on the tracks and get moving again."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. Then just one last on North Central, if you take the $2 billion spending around that project and you look at your $33 billion of opportunities in your base plan, as you guys look to layer in North Central spend and you’re looking at different financing opportunities, is there any spending opportunities within the core $33 billion that could be maybe secondary in nature of offsetting with North Central coming online, or should we think about $2 billion from North Central additive to $33 billion? I’m just trying to figure if we’re modeling this, how we should think about that."
},
{
"speaker": "Brian Tierney",
"text": "And that’s why we’ve kept it outside. It’s additive to the $33 billion."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. Terrific, guys. Thanks so much for everything."
},
{
"speaker": "Brian Tierney",
"text": "Thank you Shar."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today’s call. As always, the IR team will be available to answer any additional questions you may have. Perky, will you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Certainly. Ladies and gentlemen, this conference is available for replay starting today. Please dial 1-866-207-1041 and enter the access code of 3291585. You may also dial 402-970-0847 and enter the access code of 3291585. Those numbers again, 866-207-1041 and 402-970-0847 and entering the access code of 3291585. The replay will be available until May 13, 2020 at midnight. Ladies and gentleman, that does conclude your conference for today. Thank you very much for your participation. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 4 | 2,021 | 2022-02-24 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by. And welcome to the American Electric Power Fourth Quarter 2021 Earnings Call. At this time, all lines are in a listen-only mode. Later we will conduct a question-and-answer session. And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Cynthia. Good morning, everyone. And welcome to the fourth quarter 2021 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer; and Julie Sloat, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay. Thanks, Darcy. Welcome, everyone, to American Electric Power's fourth quarter 2021 earnings call. I'm sure you all had time to read the earnings release and have seen all that we were able to accomplish in 2021. As we saw the results of several regulatory-related cases, it actually came in after the financial last November. AEP has come into 2022 flying high. The lyrics of a song by Lionel Richie and the Commodores actually the first concert or actually catered backstage when I was younger. Flying High says, I knew we could make it from the beginning. AEP has now moved from 4% to 6% to 5% to 7% to 6% to 7% long-term growth rate because of our purposeful steps to enhance growth opportunities and derisk the AEP portfolio. This process will continue. We so have so much to look forward to in 2022. But for the purpose of today's call, I'm going to start by providing a brief recap of our financial performance and then I want to talk about the evolution and the next steps we are taking in the execution of our business strategy, as well as the impact on our financing targets as we hone in on both our regulated generation transformation and our energy delivery infrastructure investments. These are continued refinements that we believe will not only allow us to better serve our customers, but will generate enhanced value for our investors as well. Finally, I will provide an update on the various strategic and regulatory initiatives that are already underway. Starting with the recap of financial highlights, we reported strong results for the fourth quarter, navigating difficult macro headwinds while maintaining our balance sheet and increasing our quarterly dividend. In fact, this quarter was our strongest ever fourth quarter, coming in above consensus estimates with fourth quarter GAAP earnings of $1.07 per share and operating earnings of $0.98 per share bringing our GAAP and operating earnings to $4.97 per share and $4.74 per share year-to-date, respectively. Our strong financial performance in the quarter generated regulated ROE of 9.2% with improved equity layers and enabled us to increase the quarter's dividend from $0.74 to $0.78 per share as announced in October of '21. Our performance rests firmly on the regulatory foundations laid this past year with a series of rate case activity across our jurisdictions. Since EEI, we've received constructive base case orders in Ohio and Oklahoma and we reached a settlement in Indiana that the commission approved yesterday and we anticipate shortly finalizing our other base rate cases in SWEPCO and PSO. Our management team continues to make significant headway in our strategic growth plan and transformation. In 2021, the comprehensive strategic review of our Kentucky operations resulted in an agreement to sell Kentucky Power and AEP Kentucky Transco for more than $2.8 billion. After receiving the necessary regulatory approvals, we expect this sale to close in the second quarter of 2022, notwithstanding the recent withdrawal of our FERC-related - FERC filing related to the Mitchell operating agreement. The completion of this transaction is expected to net AEP approximately $1.45 billion in cash after taxes and transaction fees, proceeds we will use to invest in regulated renewables and transmission. AEP is building on a strong record of actively managing our portfolio to support our growth as we invest in a clean energy future while delivering increased returns to shareholders. An integral part of our long-term strategy is the prioritization of AEP's regulated investment opportunities and the optimization of our assets. To that end, today, we are announcing the elimination of growth capital allocated to the contracted renewables in our 2022 to 2026 forecast and our intent to ultimately sell all or a portion of our contracted renewables portfolio in our Generation & Marketing business segment to help fund our growing capital requirements in our regulated portfolio. In making this decision, our team carefully considered the renewable opportunities in the context of our competitive business, existing competition in the space, our ability to efficiently monetize the PTC's ITC tax credits as regulated opportunities come to fruition, the attention needed to manage the size of this business relative to our overall regulated business and the potential value this business represents to others who are committed to contracted renewable development and operations. We are fully confident that the sale of this portfolio will both simplify and derisk our business while allowing us to allocate proceeds and assign additional capital to our regulated business where we see a meaningful pipeline of investment opportunities to better serve our customers and participate in the energy transition. This shift in direction enables us to recalibrate our 2022 to 2026 capital plan shifting approximately $1.5 billion of investment capital to transmission and raising it to $14.4 billion of the $38 billion 5 year plan. The capital originally allocated to the unregulated generation in the marketing segment will drop from $1.7 billion of the $38 billion 5-year plan to $400 million. The remaining $400 million in the Generation & Marketing segment will be largely allocated to maintenance capital and distributed generation assets. Our investment opportunities remain dynamic. And AEP operating companies will continue to develop integrated resource plans and grid enhancement plans over the near and long term in collaboration with stakeholders. This process continues to make substantial progress as shown on slide 43 of the earnings deck. Overall, we are targeting wind additions of approximately 8.6 gigawatts of solar additions of approximately 6.6 gigawatts by 2030. For which we have allocated $8.2 billion in our current 5 year capital plan. This - the migration from contracted renewables to significant increases in regulated renewables will ensure that AEP maintains the talent and resources to execute this plan. The capital plan also includes $24.8 billion allocated to grid investments. With the changes discussed and the expected completion of the sale of Kentucky Power, we plan on an Analyst Day presentation soon after the sale is completed to further update on all of these important initiatives. Now shifting gears to our regulated renewables opportunity. AEP has a positive record of actively managing its portfolio to support the growth of the company as we invest in our regulated business and renewable generation to transform and build a cleaner, more modern energy system, and we made significant progress on our regulated renewables opportunity in 2021. Our plan is to reduce carbon emissions by 80% by 2030 and achieve net 0 by 2050 is well underway. The 998-megawatt Traverse project, the largest single wind farm built at one time in North America is in the final stages of commissioning, and we expect the facility to go on launch soon. The combined investment in the Traverse project along with Maverick and Sundance, which both became operational in 2021 represent investment in renewable energy of approximately $2 billion and will save PSO and SWEPCO customers in Arkansas, Louisiana and Oklahoma an estimated $3 billion in electricity costs over the next 30 years. These three projects add 1,484 megawatts of regulated renewable energy to our portfolio, and we recently issued RFPs for renewable resources for 1.1 gigawatts at APCo and 1.3 gigawatts at I&M. We expect to make regulatory filings and obtain the necessary approvals for projects selected from RFP processes at APCo, I&M, PSO and SWEPCO. We are truly transforming the energy grid to better integrate renewable resources, delivering the low-cost, reliable energy that our customers rely on while simultaneously empowering positive social, economic and environmental change in the communities we serve, and we believe we can successfully enhance shareholder returns in the process. Finally and significantly, I'd like to speak to a few developments that highlight the economic vitality and prospects of the communities we serve. Our economic development team has been focusing on working collaboratively with our states to drive expansion within our service territory. As you know, in January, Intel announced plans to build 2 new leading-edge chip manufacturing facilities in Ohio for an initial investment of more than $20 billion. Over in West Virginia, Nucor announced in January they will build its new $2.7 billion state of the art facility in Mason County, West Virginia. Further, TAT Technologies will be moving its thermal components activities from Israel to Tulsa bringing 900 jobs to the region. In total, our economic development team reported 1,900 megawatts of new load, supporting over 20,000 new jobs announced in 2021 and thus far in 2022. As evidenced by these wins, we are proud to play a vital part in the infrastructure that enables job-creating projects of this kind in our service territories. Moreover, in today's environment, especially in today's environment, as companies in our country focus on energy and supply chain security, our service territory is primed to benefit. We are committed to remaining a good steward for the communities in which we operate as we transition to a clean energy future. Through our just transition effort, we support affected communities through coal plants retirement, by providing job placement services for displaced workers, fact based replacement and funding sources to support diversification. This just transition program has been applied as a model for the country and enabling positive social and economic transitions for affected communities. As I said at the outset, we have a lot to look forward to in 2022. As we recast our capital allocation and derisk the business, we feel confident in lifting and tightening our earnings growth target range from 5% to 7% to 6% to 7%. It has always been my preference to be in the upper half of the 5% to 7% range. And since we have demonstrated a track record of being able to deliver on these projections year in and year out, we are electing to revise the range to 6% to 7%. Accordingly, we will be lifting our 2022 operating earnings guidance range by $0.02 to $4.87 to $5.07 per share, with a midpoint of $4.97 to reflect the increase in growth rate target range. Lastly, we are increasing our funds from operations to debt target to a range of 14% to 15% from 13.5% to 15%, which we mentioned at November EEI. Throughout this process and beyond, we will be committed to maintaining a strong balance sheet. We discussed this at November EEI and can confirm that our FFO to debt and credit metrics have improved markedly as we expected. Over the past decade, AEP has achieved impressive and sustained long-term growth, consistently meeting and exceeding earnings projections while continuing to raise guidance. Our highly qualified Board and management team are executing a strategic plan that leverages AEP's scale, financial strength, effective portfolio management and diversity of regulatory jurisdictions to deliver safe, clean and reliable services for our customers while creating significant value for all AEP shareholders. We are also committed to examining and looking beyond the traditional forms of equity to fund the growth going forward, and our track record since 2015 in asset sales have been active and produce accretive opportunities for our shareholders. Our transformation strategy is working, and the investments we are making will continue to support our solid earnings growth and results. AEP stands poised to make great headway in 2022. And continue to capitalize on this momentum. Our organic growth opportunities for the next decade and our consistent ability to execute against our plan, make it possible to set our sights high for this year and beyond. Before I hand things over to Julie, I just want to take a moment to acknowledge the unwavering commitment and dedication of our employees. In the midst of another storm-filled winter, our employees have continued to prioritize the safety and security of our customers across all of our jurisdictions with significant ice storms impacting most of our territory in the past few weeks. I have been truly humbled by their tireless efforts to deliver on our initiatives and provide for our communities. Ultimately, their passion for the work we do is what makes our business so extraordinary. With that, I'll turn things over to Julie, who is going to walk you through the financial results for the quarter. Julie?
Julie Sloat: Thanks, Nick. Thank you very much. Thanks, Darcy. It's good to be with everyone this morning. Thanks for everyone - thanks, everyone, for dialing in. I'm going to walk us through the fourth quarter and full year results and then share some updates on our service territory load and then finish with some commentary on our financing plans, credit metrics and liquidity as well, some thoughts on our revised guidance, financial targets and portfolio management. So let's go to slide 10, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $1.07 per share $0.88 per share in 2020. GAAP earnings for the year were $4.97 per share compared to $4.44 per share in 2020. There's a reconciliation of GAAP to operating earnings on Pages 17 and 18 of the presentation today. Let's walk through our quarterly operating earnings performance by segment, which is on Slide 11. Operating earnings for the fourth quarter totaled $0.98 per share or $496 million compared to $0.87 per share or $433 million in 2020. Operating earnings for the vertically integrated utilities were $0.39 per share, up $0.08. Favorable drivers included rate changes across multiple jurisdictions, increased transmission revenue and lower income tax. These items were somewhat offset by lower normalized growth and higher depreciation. I'll talk about load a little bit more here in a minute. The Transmission and Distribution Utilities segment earned $0.25 per share, up $0.06 compared to last year. Favorable drivers in this segment included rate changes, normalized load and transmission revenues. Offsetting these favorable items were unfavorable December weather and increased depreciation. The AEP Transmission Holdco segment continued to grow, contributing $0.33 per share, which was an improvement of $0.06 driven by the return on the investment growth. Generation and Marketing produced $0.06 per share, up $0.01 from last year, largely due to favorable income taxes, wholesale margins, offset by lower generation in land sales. Finally, Corporate and Other was down $0.10 per share, driven by lower investment gains and unfavorable income taxes. The lower investment gains are largely related to charge point gains that we had in the fourth quarter of last year. Let's have a look at our year-to-date results on Slide 12. Operating earnings for 2021 totaled $4.74 or $2.4 billion compared to $4.44 per share or $2.2 billion in 2020. Looking at the drivers by segment. Operating earnings for the vertically integrated utilities were $2.26 per share, up $0.05 due to rate changes across multiple or various operating companies, favorable weather and increased transmission revenue. Offsetting these favorable variances were higher O&M as we return to a more normal level of O&M, increased depreciation expense and lower normalized retail load primarily in the residential class. On the transmission and distribution utilities segment, they earned $1.10 per share, up $0.07 from last year. Earnings in this segment were up due to higher transmission revenue, rate changes and increased normalized retail load which is mainly in the residential and commercial classes. Offsetting these favorable variances were increases in O&M, depreciation and other taxes, essentially property taxes related to the increased investment levels. The AEP Transmission Holdco segment contributed $1.35 per share, up $0.32 from last year related to investment growth and a favorable year-over-year true-up. Generation and Marketing produced $0.26 per share, down $0.10 last - from last year, largely due to favorable onetime items in the prior year associated with the downward revision of the Oklaunion ARO liability in contemplation of the plant shut down and the sale of the Conesville plant. Additionally, while we had land sales in both years, the level of sales was lower in 2021 versus 2020. Finally, Corporate and Other was down $0.04 per share. You'll notice that we aren't talking about investment gains in the year-to-date as we had a lot of timing differences across the quarters between 2020 and 2021, but net-net, we're flat for the year. The year-over-year decline in this segment was primarily driven by slightly higher O&M, interest expense and income taxes. Let's go to slide 13 and I'll update you on our normalized load performance for the quarter. Let me begin by providing you with a couple of interesting stats that highlight the status of the recovery throughout the AEP service territory. The first is the fact that we ended the year within 0.2% of our pre-pandemic sales levels and fully expect to exceed those levels in 2022. AEP's normalized load growth in 2021 was the strongest we've experienced in over a decade driven by the historic economic recovery throughout the service territory. And to build on that, our current projection suggests that 2022 will be the second strongest year for load growth over the past decade following behind 2021. So let's start in the upper left corner. Normalized residential sales were down 1.9% compared to the fourth quarter of 2020, bringing the annual decrease in residential sales in 2021 to 1.1%. The decline was spread across every operating company. However, the decline in residential sales in 2021 was largely driven by the comparison basis of 2020 when COVID restrictions were at their highest levels even though residential sales were down compared to 2020, they were still 2% above their pre-pandemic levels in 2019. In addition, residential customer accounts increased by 0.7% in 2021, which was the second strongest year for customer growth in over a decade. Customer growth was nearly twice as strong in the West, up 0.9% when compared to the East territory, which was up 0.5%. The last item to point out on the residential chart is that you'll notice that we added the projected 2022 growth to the right of the chart. We're projecting a modest decrease in residential sales in 2022, recognizing that there will not be likely another fiscal stimulus to boost the economy in 2022, like we had in the past 2 years. So moving over to the right, weather normalized commercial sales increased by 4.3% for both the quarter and the annual comparison. This made 2021 the strongest year for commercial sales in AEP history. 2021 included a strong bounce back in the sectors most impacted by the pandemic, such as schools, churches and hotels. But the strongest growth in commercial sales came from the growth in data centers, especially in Central Ohio. Looking forward, we expect a modest decline in commercial sales growth in 2022, recognizing the challenging conditions businesses are managing with inflation, the labor shortages and higher interest rates expected in 2022. So if we move to the lower left corner, you'll see that the industrial sales also posted a very strong quarter. Industrial sales for the quarter increased by 2.4%, bringing the annual growth up to 3.7%. Industrial sales were up at most operating companies in the quarter and mainly - in many of the largest sectors. Looking forward, we're projecting 5.7% growth in the industrial sales in 2022. This is mostly the result of the number of new large customer expansions that will be coming online as a result of our continued focus on economic development. Finally, when you pull it all together in the lower right corner, you'll see that AEP's normalized retail sales increased by 1.4% for the quarter and ended the year up 2.1% above 2020 levels. By all indications, the recovery from the pandemic has locked a year and our service territory is positioned to benefit from the future economic growth. Let's have a quick look at the company's capitalization and liquidity position beginning on Page 14. On a GAAP basis, our debt-to-capital ratio increased 0.1% from the prior quarter to 62.1%. When adjusted for the Storm Uri event, the ratio is slightly lower than it was at year-end 2020 and now stands at 61.4%. Let's talk about our FFO to debt metric. The impact of Storm Uri continues to have a temporary and noticeable impact on this metric. Taking a look at the upper right quadrant of this page, you'll see our FFO to debt metric based on the traditional Moody's and GAAP calculated basis as well as on an adjusted Moody's and GAAP calculated basis. On an unadjusted Moody's basis, our FFO to debt ratio decreased by 0.3% during the quarter to 9.9%. As you know, the rating agencies continue to take the anticipated recovery into consideration as it relates to our credit rating. On an adjusted basis, the Moody's FFO to debt metric is 13.3%. As mentioned in prior calls, this 13.3% figure removes or adjusts the calculation to eliminate the impact of approximately $1.2 billion of cash outflows associated with covering the unplanned Uri-driven fuel and purchase power costs in the SPP region directly impacting PSO and SWEPCO in particular. The metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. This should give you a sense of where we are or where we would be from a business as usual perspective. As Nick mentioned, we're now targeting an FFO to debt metric in the 14% to 15% range, which is commensurate with the Baa2, BBB flat stable rating. We expect to see this metric to begin to trend toward this new range of 14% to 15% in the latter half of 2022 as we make progress on the regulatory matters that are underway, including the recovery of Uri costs. As you know, we're in frequent contact with the rating agencies to keep them apprised of all aspects of our business and in the presentation today on Page 48, you'll see our financing plan. And aside from some modifications around the capital allocation and refinements on cash flows, everything remains intact as well as the general gist of the financing plan, including equity. Let's quickly visit our liquidity summary on the lower right side of this slide. Between our bank revolver capacity and cash balance, our liquidity position remains strong at $4 billion. And in the lower left, you can see our qualified pension funding continues to be strong, increasing 1.2% during the quarter to 104.8%. So let's go to slide 15. The initiatives that we talked about today set a strong foundation for 2022 and beyond, all of which I would submit to you include a commitment to a boost in our earnings power, credit position and high grading of our asset portfolio while derisking and simplifying our business profile. So to quickly recap of particular interest to our investor community, our equity investor community, we are lifting and tightening our long-term earnings growth rate to 6% to 7%. Consequently, we're increasing our 2022 earnings guidance range to $4.87 to $5.07 per share, up $0.02 from the original guidance. Of particular interest to our fixed income lender and credit rating agency community in addition to our equity investors, we're lifting and tightening our FFO to debt target range to 14% to 15%, which is consistent with a Baa2 stable and BBB flat stable rating. And of interest to all of our financial stakeholders, we are committed to the active management, high-grading and simplification of our asset portfolio to support our growth and transition to a clean energy future as a regulated utility holding company. The sale of our Kentucky operations is on track to close in the second quarter of this year and is reflected in our earnings guidance assumptions for 2022. And as we announced today, we've eliminated the growth capital in the contracted renewables area, moved that capital transmission and announced the sale process of all or a portion of the unregulated contract renewable portfolio with the goal of maximizing value. We've already begun to reflect a portion of this asset rotation in our 5-year $38 billion CapEx guidance as evidenced by the $1.5 billion increase in transmission investment and the $1.3 billion reduction in the unregulated generation and marketing segment. While the reallocation of capital is now assumed in the guidance range we have updated for you, the utilization of sales proceeds is not yet reflected in the multiyear financing plan. And therefore, what you can anticipate hearing or seeing from us is that we will operate within the increased earnings growth and credit metric financial targets we provided to you today, working within those targets, funds from the sale activities will be directed to our regulated business as we continue our efforts to enhance the transmission infrastructure and to effectuate our generation transformation. Additionally, depending on the timing of the sale of our unregulated contract renewables portfolio or any future asset optimization activities, we will have a bias toward reducing and/or avoiding future equity needs. As you would expect, we'll update our guidance details once we have announcements so we can share with you. We're confident in our ability to deliver on our new and improved promises to you, given our focus on disciplined capital allocation, solid execution and positive regulatory outcomes. We really appreciate your time today. I'm going to hand it back to the operator now so we can get your questions.
Operator: Thank you. Our first question, we'll go to the line of Steve Fleishman with Wolfe Research. And your line is open.
Steve Fleishman: Hey, good morning. Can you hear me okay, Nick?
Nick Akins: Yes. I can hear you fine.
Steve Fleishman: Okay. Great, thanks. Just on the renewables assets that you're selling, could you give us maybe a little info if you have it, maybe for 2021 actuals, even just the earnings or the EBITDA, cash flow of those - that business, those assets?
Nick Akins: Yes. And it's around $0.15.
Julie Sloat: Yes, Steve, this is Julie. I'll jump in here with some financial details, and I know Nick will jump in with some additional color. Let me talk about how we're thinking about this for 2022 because, as you know, 2021 was a bit of an anomaly with Storm Uri. So that kind of led to some different earnings streams that probably are not indicative of the asset base. So for 2022, what we're thinking is - and there's a little bit of wiggle room in here, talk about mid-teens in terms of sense, in terms of contribution to 2022 earnings. So if you want to kind of put a band around it, I don't know, $0.13 to $0.17 associated with those assets in particular, that gives you a little order of magnitude there.
Steve Fleishman: That's helpful. And do you have a sense of kind of EBITDA?
Julie Sloat: I don't have something to share with you today. And as you know, the renewable portfolio in terms of contracted assets is comprised of about, what, 1,600 megawatts of capacity, and that obviously varies from project to project. And as we said in our opening comments, we would be looking to monetize a portion or all of that over a period of time. So obviously, that will vary by asset and in projects specifically. So that's the only reason I'm being a little opaque on the EBITDA statistics.
Nick Akins: And you'll see some sales occur probably in 2022 and then more in 2023.
Steve Fleishman: Okay. Okay. That's helpful. And then the - can you just - one last financial question on that. Can you just remind me what the -- if there's any debt directly on those assets or not?
Julie Sloat: Yes. Steve, again, this is Julie. There is a project specific debt, and there's a tax equity on obligation component to it as well. So as of 12/31/21, the debt component was around $252 million, tax equity about $123 million. So all in, you're talking about $375 million.
Steve Fleishman: That's super helpful. Thanks. And then one other question, I'll leave it to others, please. Just the - curious just on the renewables, there's been a lot of cost inflation pressure on renewables. Obviously, there's inflation pressure on conventional as well, maybe even more. But just how are you feeling about kind of managing that within your RFPs and still showing that economically, this makes sense for your key states?
Nick Akins: Yes. We actually feel good about it because with Traverse coming online, that's really the last major physical addition for this year. And then most of the renewables that are being applied for are in that '24 and '25 range. So you still have time for supply chain to pick up and certainly from a pricing perspective to be able to adjust. So we feel really good about our position because we're not in the middle of something where we're having to adjust. And then -- so that's - we're in a good position going forward.
Steve Fleishman: Great. That’s helpful. Congrats on the announcements.
Operator: Thank you. Our next question comes from the line of Shar Pourreza with Guggenheim Partners. And your line is open.
Shar Pourreza: Good morning, guys. Just one - Nick, you went kind of fast through the 1 point in the prepared remarks. But I guess, can you elaborate again, how you're thinking about additional asset optimization opportunities should the IRPs at the various states kind of work in your favor? I mean, I guess, strategics, privates infrastructure seem to continue to want to pay up for assets. which we're obviously again seeing this morning. Did I hear you right that the message is, is that as you're thinking about incremental capital opportunities to fund the renewables through the IRPs that issuing traditional equity as a last resort.
Nick Akins: Yes. And actually, and I've said this, we're - we have two pinnacles of growth. We've got the transmission side, which we have plenty of capability relative to project flow to be able to check and adjust along the way. It's huge. And then, of course, on the renewable side of things, we have approximately in there about 50% estimate for ownership, which is sort of a view going into it. But I can say that because of after Storm Uri, after many of the effects in terms of utility ownership, we believe that ownership level is going to be higher than that. Matter of fact, in the Virginia side, it looks like 75% of it is owned and the other filings we're making is primarily 100% owned. So - and that really says to us that you're seeing a continual progression of really the standard view of portfolio management going forward. I think you're in the age of that and asset optimization to ensure that we're putting our capital in the right places. And that says there's a prioritization scheme as we go forward. Now I can't say today what that prioritization scheme looks like. But certainly, Kentucky was an example of that. First, it was the unregulated generation. Before that, it was the - I guess it was the barge line facilities. And you're seeing that step toward clarification, simplification and making sure that we are optimizing the capital in the right places. And today, we have, as I said earlier, the transmission in particular, we will not give up our position as being the largest transmission provider in this country by far. We have the bandwidth. We have the ability to move projects forward. And then on the renewable side, we're at the leading front edge of a major transformation that's going to benefit our ability to not only help in terms of customer rates because the renewables being brought in, but also to be able to deploy the capital necessary to make that happen. So you're going to see a continual process of moving forward with those kinds of activities. And the fact of the matter is, our renewables are now focused on capacity replacements, and so that's a natural progression of what occurs within the regulated framework. And for us, it puts us in great shape to make sure that these projects are actually needed. They actually produce benefits for consumers, and we have the backup capacity to provide for the demand periods. We're in a great position for this transformation. That's why we want to take advantage of it. So for those jurisdictions that meet those areas where transmission, the ability to participate in the clean energy transformation, those will be the high priority assets that we look at going forward.
Shar Pourreza: Okay. Perfect. That's helpful. And then Nick, just lastly on the growth rate ticking up to 6 7%. On one hand, it's consistent with your past comments about being in the top half of the trajectory. But on the other hand, you are basically telling the market, you don't see any situations where you see growth at 5%, right, which is great. As we think about sort of your wind and solar opportunity set through '26, which hasn't really changed from prior disclosures. How do we think about these in the context of your updated growth trajectory? Could they be accretive or simply extend the runway? And then are you assuming any sort of win assumptions in that updated growth guidance? Thank you.
Nick Akins: Yes. The way it sits right now, we look for sustainability when we make these adjustments associated with the growth rate, particularly the long-term growth rate. We would not have made this long-term growth rate if we didn't see a solid progression of the sustainability of the 6% to 7%. And actually, the project flow that you're seeing the - certainly, the reallocation of capital and actually - this is sort of an aside, but certainly, when we go from contracted renewables to the migration to a full suite of regulated renewables, it's -- we want to keep the talent that we have too, to make that transition and really focus on that effort. So I would say that the fundamentals are in place for continued optimization, solidification of 6% to 7%, validation of a midpoint that's higher than our previous midpoint and confirms to investors that we feel really good about the position that we're in. And as we go along, we'll see what happens, but we always look at -- when we make guidance changes and long-term growth changes, we look at the sustainability of that for years to come because consistency and quality of earnings and dividend are paramount to us.
Shar Pourreza: Terrific. Congrats, guys. Thank you very much.
Nick Akins: Thanks.
Operator: Thank you. Our next question comes from the line of Jeremy Tonet JPMorgan. Your line is open.
Jeremy Tonet: Hi, good morning.
Nick Akins: Morning, Jeremy.
Jeremy Tonet: Just wanted to bring a finer point to the equity question, if I could. It seems like the asset sale timing could be kind of in pieces here. I'm just wondering, does this line up where really kind of completely removes equity from the plan at this point? Just trying to get a finer point on what equity needs could look like post a successful sale here?
Nick Akins: Yes. I think it would be great if we could map it exactly to what the equity needs are in the future. But I can say that certainly, this is a big part of our ability to manage the portfolio so that we obviate the need for new equity, but you still have ATMs, you still have the convertibles that are coming on during that period of time. But at this point, we sit really good. I don't know if you want to go...
Julie Sloat: Yes. So Jeremy, you're right on. In an ideal situation, we would like to pick the landing on every equity issuance and be able to kind of sidestep that and have a really strong balance sheet in conjunction with that. We'll see how ultimately the timing goes, as I mentioned in my opening comments, there will be a bias toward trying to alleviate that pressure that you might otherwise perceive around equity issuances. But as you know, if you look at our financing plan, there's not a lot out there, $100 million of DRIP in 2023. And as Nick mentioned, we've got the convertibles that convert this year and next year. So we're in good shape. But to the extent that we can maximize value of asset sales and time those, yes, that would be definitely something we'd be interested in doing. But again, the idea is to hit on all of those objectives. 6% to 7% earnings growth hit nicely and comfortably in the guidance range that we give to you for 2022. And make sure that we're right alongside with the solid balance sheet metrics of 14% to 15% for that FFO to debt statistic. So we'll thread the needle.
Jeremy Tonet: Got it. That's very helpful there. And I just want to come back to bending the curve if you could on O&M. And just updated thoughts there on, I guess, how you see that progressing in this kind of inflationary environment? Any incremental thoughts you could share there?
Nick Akins: Yes. So - and obviously, we're taking a good hard look at that. Our achieving excellence program has been in place for a couple 3 years now. And it's really showing the value of our organization completely going through. And actually, it should be known, one of the silver linings of COVID if there is a silver lining of COVID is that made us think about what was truly needed for the company going forward, particularly when you made all these adjustments to compensate for what we thought would be a really negative approach to the economy during that period. So we're going to take those learnings and continue to focus on bending the O&M curve. And of course, that becomes even more of a challenge given labor rates, given certainly if there is supply chain-related activities on the long term. But we feel really confident in our ability to continue to bend that curve or at least hold it flat, but we'll certainly continue to focus on that. And that's a huge part of what we're doing because all these pieces sort of fit together where every dollar of O&M we're able to put $7 of capital in place with the reduction. So we have the focus on reducing the O&M as much as possible, and it's advantageous to us because we have a huge pipeline of additional capital opportunities that we could take advantage of for the betterment of customer service and so forth. And it's all sort of ties together. The load forecast has clearly been positive recently, and it looks like it's going to continue to be positive. That's good for cash flow and good for our ability to invest. And then certainly, all those things sort of fit together, but we'll continue to focus in on all of those activities going forward.
Jeremy Tonet: Got it. That’s very helpful. Leave it there, thanks.
Nick Akins: Yeah.
Operator: Thank you. Our next question comes from the line of Julien Dumoulin-Smith with Bank of America. Your line is open.
Julien Dumoulin-Smith: Hey, good morning, team. Thanks for the time. If I could follow up a little bit on the last couple of questions here. Just to the extent which that you're successful in, shall we say, fully offsetting equity here, where does that put you again? I know you're taking the moment now to raise your guidance ranges. But how do you think about being within that range to the context that you removed this equity as well? It would seem like this is a likely fairly accretive move to divest renewables given where the transaction multiples have been.
Nick Akins: Yes. Obviously, we're going to have to get in that process and understand what the actual benefits are. And of course, you're dealing with PTCs, ITCs, the value of those, the timing of those kinds of activities as well. And so we're going to have to sort of fill our way through that part of it. But certainly, the stage is set. And -- there's some -- and we're looking at somewhat of a phased approach, which that not only matches the equity needs, but also matches the business valuation itself. And I think that that's going to be a clear issue for us to focus on as we go forward. But Julie, anything you want to add?
Julie Sloat: No, I think you're hitting on it. I mean the other thing that we'll make sure that we're sensitive to Julien is obviously, customer rate is always sensitive to that. But to Nick's point, this allows us to set the runway, again, gives us confidence in the boost to the growth rate of 6% to 7% for the obvious reasons. And then the objective is to, again, maintain the balance sheet, continue to derisk and simplify the business portfolio and make sure that we're hitting comfortably in the guidance range that we give to you as we give that to you sequentially. Every year, we come out with a new guidance range for the upcoming year, and we'll continue to fine-tune that.
Nick Akins: The ability that we have to accelerate and deaccelerate is of tremendous value. And certainly from the contracted renewables process that we go through, that's going to be a benefit. Our ability to accelerate and deaccelerate, whether it's transmission, whether it's renewables, those are clear options that we have available to us that we didn't have before. And when you think about the progress that we're going to make and the ability to focus on even continuing to advance the capital needs. That's something that all these things are going to have to come together, but I can tell you that the foundation and the clear optimism around that continues to benefit us. And it will be a process, and that's why I mentioned the Analyst Day. I think it's going to be important in the Analyst Day for us to not only obviously celebrate the sale of Kentucky, but also to focus in on what the transactions are going to look like, what the structure of these deals are going to look like, the timing and be able to also talk about what capital looks like in the future based on what we're seeing relative to load and everything else.
Julien Dumoulin-Smith: And if I can, just one more quick one. I mean, why now is maybe the question, right? I mean I appreciate the guidance rates altogether, but just curious on the timing. Obviously, you all make sort of an annual update of EEI, you talked about in Analyst Day, prospectively. Just curious on what gave you the confidence now. I mean appreciative of the asset sale.
Nick Akins: No, thanks for the question because at November EEI, there was a lot still outstanding. We had 10 cases going on out there. I know we got a lot of questions about, okay, why has it taken so long in Ohio? Is your relationship? What's it like in Ohio? And it was like 2 weeks after that, that we got both cases done and they were clean orders. And our relationship is great with the regulators in Ohio and with legislature. So it was -- and then you had all the other cases that were still outstanding that came through I&M on Rockport. Certainly, there was a PSO base case that was done right at the end of the year. So you had all these things going on. But the other thing too is Kentucky transaction is still ongoing. And the process -- and it's -- like I said, it started with unregulated generation and certainly everything we knew before and that we need to solidify the consistency of our earnings going forward. Well, Kentucky was the first of the primary business units that we really took a look at. And now that, that process is ongoing, okay, what's the next step in our evolution? And when you think about those 2 pinnacles of growth, everything that we're going to be doing supports that ability to move that forward. We know -- and it wasn't lost on us that during November EEI when we reduced the transmission investment, there was an unintended message that, that somehow the transmission pipeline was ending or there were challenges associated with projects, and that was not the case. I mean we said that then, and we continue to fortify that measure. I think it was important for us to come out at this earnings call and set the record straight on what the firmness of the foundation of this company and its ability to move forward in a very, very positive way. And I just -- I wasn't going to let November EEI stand.
Julie Sloat: I can jump in another statistic that might be helpful to Julien as well. So when we look back at 2021, the rate relief we had assumed in guidance was something like $230 million as we got and then closed in on the end of the year, we had already secured something like 112% of that. So we were over what we had anticipated. So that gave us some momentum. And looking at 2022, so there's an updated 2022 waterfall for guidance in the presentation today that's got the actualization for 2021 and then some refinements for 2022 in conjunction with the growth rate uplift. But we're assuming about $381 million of rate relief. And this is before the Indiana settlement that was approved yesterday. We had already secured 55% of that. So we're north of 55%. I need to go back and do the math to boost that number up to accommodate the order that we got for Indiana. But again, validating and giving us confidence that now is the time to do this obviously, came in with a strong year in 2021, giving us the momentum and assurance around those regulatory recoveries that we had anticipated and a little bit more. So that's to give you a little bit of statistics to match what Nick just shared with you.
Nick Akins: Yes. And as I said at the beginning of the call, this process is not over. I mean we are continuing the process of really fine-tuning the optimization around all of our assets. And certainly, from a resource perspective to be able to take the contracted renewables and the talent that's there and be able to migrate that over to a massive build-out associated with regulated renewables is a great opportunity for us and certainly everyone involved with it because this process is going to continue. And certainly, we want to register that we will and have been a participant in that process. But the why now question is important. I mean the why now question is that we're at the precipice and I sort of presage this, I guess it was third quarter last year, but we're at the precipice of substantial movement toward a clean energy economy. You can do it with the transformation of renewables, you can do it with -- certainly with other types of technologies that are developing, but it also requires transmission. And certainly, just the refurbishment of transmission and distribution, by the way, we have a huge pipeline relative to distribution, too, that's been identified. That's really -- all of those are opportunities for us to focus in on what's truly important to our customers, but also to our shareholders.
Operator: Our next question comes from the line of Durgesh Chopra with Evercore ISI. Your line is open.
Durgesh Chopra: Just Julie, quickly to follow-up on the economics of the potential renewable sale. Should we be expecting a tax leakage there? Or you have enough NOLs and other tax to offset that?
Julie Sloat: Yes. Yes. We would expect a little tax leakage there. But as you know, we're not entirely efficient with our tax credits. So we've got a little bit of wiggle room because we've got some tax credits sitting on the bench. So I wouldn't necessarily look to that being as a stumbling block or a material gating item for us. So we'll be able to manage through that.
Durgesh Chopra: Okay. And just one, all the other questions were asked and answered. Just one, Nick, what's the confidence level in getting sort of the Kentucky sale done in Q2? We sort of saw the headlines of you sort of kind of withdrawing the petition from on the plants. So maybe just talk to that, what drove that decision of withdrawing that petition and the confidence level of closing that transaction in Q2.
Nick Akins: Yes, sure thing. Well, obviously, the state of Kentucky was concerned about the FERC case and the timing of it and how it would impact their schedule. So certainly, we recognize that and wanted to accommodate the Kentucky Commission. So we pulled down the FERC filing, and we'll certainly refile the FERC filing after Kentucky does their review. And of course, with the state approvals at that particular time, we may get a quicker response from FERC. So -- and that's -- I think they have 60 days, but it could happen earlier than that. But still, that keeps us in the second quarter. It'd be May to June time frame, but still in the second quarter. So that's not an issue for us. And I know that -- there's certainly a lot of dialogue will occur. It already has relative to Mitchell and how it works and then also in terms of what interveners may think about the transaction, but that's a typical -- any time you get into a sale of in a transaction. That kind of thing will occur and there'll be discussions and we'll get it all resolved. So we're still very confident that we're going to get that done because actually, the new owner has made commitments of jobs and those types of activities within the state of Kentucky. And I think it's really important for anyone looking at this transaction to recognize that you're putting this utility in the hands of a reputable operator. They'll do a good job managing the investments, but also a good job in the communities, and they're very focused on that. So really, the -- this process should be a forward-looking process, not a past process -- past-looking process. So I really think that that's going to carry the day.
Operator: Our next question comes from the line of Andrew Weisel with Scotiabank. Your line is open.
Andrew Weisel: First question. Forgive me if I missed it, but the new 6% to 7% growth range, is that anchored off the midpoint of the new 2022 guidance? And am I right that 2022 guidance includes contributions from contracted renewables, but not from Kentucky?
Julie Sloat: That's -- you've got that exactly right on all fronts, right on.
Nick Akins: Yes. It is 2022, new rebases.
Andrew Weisel: Okay. Would there be a rebase assuming the contracted renewables business does get sold? In other words, would -- if I take 6.5% off the new 2022 midpoint, would I need to lower that after an asset sale?
Nick Akins: I think you should look at the contracted renewables is supporting the 6% to 7% with the base of '22.
Julie Sloat: To add a finer point to that as well. To get right to the heart of your question, we do not expect to rebase our earnings when we take action on selling these assets in particular. And as we mentioned, it will take a little bit of an accordion feature to it in the sense that over time, these transactions will occur so we've got some flexibility there. And then with the redeployment of the cash coming in the door back to regulated utilities, so whether it's transmission or a combination of transmission and regulated renewables we feel confident that we'll be able to maintain the guidance ranges and continue along the trajectory.
Andrew Weisel: Okay. Great. And that makes sense given you said it was about $0.15 of EPS versus $5 or so for the business overall. And then lastly, just to confirm, can you comment on dividends, given the change to the EPS growth outlook and the potential asset sales? How should we think about the dividend growth outlook from here?
Nick Akins: Yes. No change there. Dividends will be commensurate with the earnings growth.
Operator: Our next question will come from the line of Nick Campanella with Credit Suisse. Your line is open.
Nick Campanella: Just looking at the 14% to 15% of total debt on the funding slides. Just curious what the feedback then from the agencies and the potential to sell some of the nonregulated stuff and the fact that your business mix is increasing to more regulated earnings. Do you expect any change in your minimum thresholds here?
Julie Sloat: Actually, we are having conversations. And as I mentioned earlier, we keep them apprised of all aspects of our business. So from a credit risk profile perspective, this should be viewed as a favorable step, again, as a commitment and continued twist towards traditional regulated portfolio of assets. So I can't speak for them as it relates to what those thresholds would be, but 14% to 15% is most definitely within the wicket as it relates to a solid and strong balance sheet, I would submit to you again, BAA2 stable, BBB flat, stable. That's where we expect to be with that 14% to 15%. And please do reach out to the credit rating agencies to make sure that they're armed with everything we know so that they can take care of you all.
Nick Campanella: Absolutely, absolutely. Yes. And then just regarding the sales forecast and your comments regarding economic growth. For this year, it seems like industrial is really driving overall consolidated weather normalized growth higher. Can you just kind of speak to what's baked into the long-term forecast here? And if we remain in a higher commodity price environment into '23, '24, how could that change things for AEP?
Nick Akins: We -- any long-term forecast, we tend to temper. We're actually getting in the process of a new forecast. But right now, we've estimated about 1% increase. And I think you'll see that this -- what was overall 1.5 or something like that.
Julie Sloat: 1.6%.
Nick Akins: Yes, 1.6%. So we're going into the year, assuming 1%. And with the investments being made by these large customers, industrial is always a leading edge relative to commercial and residential. So -- and then also when you look at the numbers, 1 year over another, it isn't quite apples and apples because of COVID and the impacts there. So you'll see a reduction in the residential. But if you look at pre COVID, it's more, it's higher because the stay-at-home environment has continued, work-from-home environment has continued. So we get the benefits of a more robust residential and at the same time, industrial picking up. And in fact, when you look at our service territory in relation to what's going on internationally, we do have strong energy growth and energy-related activities in our territories and manufacturing activities. And with onshoring around security, the point I was making earlier, we're going to wind up working pretty well from a growth perspective from a load standpoint.
Julie Sloat: To give you a little more color if this is helpful. I'm on Page 13 of the slide presentation today, and I'm looking at the industrial quadrant in the lower left side of that slide. As you point out, we are looking at a 5% -- 5.7% uplift in that particular weather normalized load. And it's really driven by previous economic development activities. As Nick pointed out today, those economic development opportunities really set the foundation for the future. So we're reaping the benefits of stuff that we've done in the past as you look at that forecast and that covers many sectors, metals, chemicals, paper, oil and gas, but about 99% of the load expansion in 2022 comes from our T&D segment in Texas and Ohio. Just to give you a little bit more color. And then that obviously drives you over to the right side of the slide, looking at 2022 estimated across the entire Board a 1.6% lift is what we're assuming. And then as Nick mentioned, beyond to the extent that we can push it to 1% on an ongoing basis, that would be fantastic, and that would be our hope and expectation.
Operator: We will go to the line of Paul Patterson with Glenrock Associates. Your line is open.
Paul Patterson: Great -- great presentation. I'm sorry if I missed this, but is the -- I assume that there's probably going to be gains on the sale of renewables. Are those gains going to be part of the 6% to 7% growth?
Julie Sloat: I guess let me ask or answer it this way. So we will have gains on the sales. And typically, when we have gains on sales of assets, capture those and the reconciliation gap to operating earnings, so we would kind of offset those. But asked another way or another question we got earlier, Paul, I don't know if you asked or heard this, but we were asked, would we be in a taxable gain situation. So I'll answer that question too. The answer would be yes. But we do have tax credits sitting on the bench that we'd be able to utilize against that. So what we don't want folks to do is worry about that being a real material gating item, we'd be able to manage through that.
Paul Patterson: Yes, I heard that, I guess. So just to clarify, it's not going to be part of operating earnings or adjusted earnings going forward?
Julie Sloat: Correct. That's correct. Yes. That will get captured in the reconciliation. Yes. you got it, not in operating earnings.
Paul Patterson: Okay, great. And then just the -- and I apologize if I missed this, but the average length of the contracts that are on these assets? Are there different vintages and stuff? I'm just wondering where that sort of stands?
Julie Sloat: Yes. average PPA length is around 11 years.
Paul Patterson: Okay, right now. Okay. And then just finally, on the Kentucky Power, you guys talked about the Mitchell plant sale, but the Kentucky PSC, as you know, on Tuesday, filed a protest not at FERC, not on the transaction itself, but on the application for the transaction, saying they felt that they need more information. And I was just sort of -- I was wondering if you could provide a little clarity. I mean they have their own proceeding, as you guys know, and they have -- and there's obviously this proceeding. I'm talking about the M&A via the transaction proceeding at FERC. And I'm just sort of wondering why they are -- or if you can give any insight as to why -- as to this protest that they filed saying, hey, the application is deficient. We're concerned about rates and we want more information. And sort of what -- how that might unfold or how we should think about that in the context of the proceeding?
Nick Akins: Yes. Well, certainly, there's going to be all kinds of activity around getting the transaction through. And Kentucky, as I said earlier, I mean Kentucky is thoughtfully going through the areas that it wants to take a look at relative to the transaction. And certainly, that's something that we're going to make sure it happens in the process. And as I mentioned earlier on the FERC thing, we'll file FERC as soon as Kentucky gets through that. But at this point, though, there's nothing certainly, nothing that we can address. Do you have anything you want to add to that?
Julie Sloat: No. that was fine.
Paul Patterson: Well, I guess what I'm sort of asking is, is that I'm talking about specifically the Tuesday filing, not the Mitchell plant sales. So I mean, in other words, they were saying, hey, they want more information. It just seems to me that being a regulator that's going to be reviewing the actual transaction, it seems at least to me to be somewhat -- I was a little bit confused by the fact that they're saying to FERC hey, with respect to the transaction proceeding that docket, the EC dock is saying, hey, hold off, provide us more please. Please get them to give us more information when I would think that given that you guys filed this months ago, that information, they could be asking you within the context of the Kentucky review. Do you follow what I'm saying. I don't want to go into great, (inaudible) if you follow me, but that's what sort of seems to me to be a little bit strange about the FERC, the FERC request from Tuesday or we're not requesting the protest.
Nick Akins: Yes. So -- well, you had the intervenors that came in. And -- and they're really trying to adjudicate issues that were already resolved by the Kentucky Commission. And so we'll go through that process of discussions with them. As far as Kentucky is concerned, obviously, they're looking to try to hold customers harmless during the transaction and really, as we look at this transaction, they're in good shape going forward. So I think, obviously, we'll have those discussions as we go along.
Operator: And with that, I'd like to turn it back over to the speakers for any closing comments.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Cynthia, would you please give the replay information?
Operator: Certainly. And ladies and gentlemen, today's conference call will be available for replay after 10:30 a.m. today until midnight, March 3. You may access the AT&T teleconference replay system by dialing (866) 207-1041 and entering the access code of 2171165. International participants may dial (402) 970-0847. Those numbers once again (866) 207-1041 and or (402) 970-0847 and enter the access code of 217115. That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.+ | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. And welcome to the American Electric Power Fourth Quarter 2021 Earnings Call. At this time, all lines are in a listen-only mode. Later we will conduct a question-and-answer session. And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Cynthia. Good morning, everyone. And welcome to the fourth quarter 2021 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer; and Julie Sloat, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay. Thanks, Darcy. Welcome, everyone, to American Electric Power's fourth quarter 2021 earnings call. I'm sure you all had time to read the earnings release and have seen all that we were able to accomplish in 2021. As we saw the results of several regulatory-related cases, it actually came in after the financial last November. AEP has come into 2022 flying high. The lyrics of a song by Lionel Richie and the Commodores actually the first concert or actually catered backstage when I was younger. Flying High says, I knew we could make it from the beginning. AEP has now moved from 4% to 6% to 5% to 7% to 6% to 7% long-term growth rate because of our purposeful steps to enhance growth opportunities and derisk the AEP portfolio. This process will continue. We so have so much to look forward to in 2022. But for the purpose of today's call, I'm going to start by providing a brief recap of our financial performance and then I want to talk about the evolution and the next steps we are taking in the execution of our business strategy, as well as the impact on our financing targets as we hone in on both our regulated generation transformation and our energy delivery infrastructure investments. These are continued refinements that we believe will not only allow us to better serve our customers, but will generate enhanced value for our investors as well. Finally, I will provide an update on the various strategic and regulatory initiatives that are already underway. Starting with the recap of financial highlights, we reported strong results for the fourth quarter, navigating difficult macro headwinds while maintaining our balance sheet and increasing our quarterly dividend. In fact, this quarter was our strongest ever fourth quarter, coming in above consensus estimates with fourth quarter GAAP earnings of $1.07 per share and operating earnings of $0.98 per share bringing our GAAP and operating earnings to $4.97 per share and $4.74 per share year-to-date, respectively. Our strong financial performance in the quarter generated regulated ROE of 9.2% with improved equity layers and enabled us to increase the quarter's dividend from $0.74 to $0.78 per share as announced in October of '21. Our performance rests firmly on the regulatory foundations laid this past year with a series of rate case activity across our jurisdictions. Since EEI, we've received constructive base case orders in Ohio and Oklahoma and we reached a settlement in Indiana that the commission approved yesterday and we anticipate shortly finalizing our other base rate cases in SWEPCO and PSO. Our management team continues to make significant headway in our strategic growth plan and transformation. In 2021, the comprehensive strategic review of our Kentucky operations resulted in an agreement to sell Kentucky Power and AEP Kentucky Transco for more than $2.8 billion. After receiving the necessary regulatory approvals, we expect this sale to close in the second quarter of 2022, notwithstanding the recent withdrawal of our FERC-related - FERC filing related to the Mitchell operating agreement. The completion of this transaction is expected to net AEP approximately $1.45 billion in cash after taxes and transaction fees, proceeds we will use to invest in regulated renewables and transmission. AEP is building on a strong record of actively managing our portfolio to support our growth as we invest in a clean energy future while delivering increased returns to shareholders. An integral part of our long-term strategy is the prioritization of AEP's regulated investment opportunities and the optimization of our assets. To that end, today, we are announcing the elimination of growth capital allocated to the contracted renewables in our 2022 to 2026 forecast and our intent to ultimately sell all or a portion of our contracted renewables portfolio in our Generation & Marketing business segment to help fund our growing capital requirements in our regulated portfolio. In making this decision, our team carefully considered the renewable opportunities in the context of our competitive business, existing competition in the space, our ability to efficiently monetize the PTC's ITC tax credits as regulated opportunities come to fruition, the attention needed to manage the size of this business relative to our overall regulated business and the potential value this business represents to others who are committed to contracted renewable development and operations. We are fully confident that the sale of this portfolio will both simplify and derisk our business while allowing us to allocate proceeds and assign additional capital to our regulated business where we see a meaningful pipeline of investment opportunities to better serve our customers and participate in the energy transition. This shift in direction enables us to recalibrate our 2022 to 2026 capital plan shifting approximately $1.5 billion of investment capital to transmission and raising it to $14.4 billion of the $38 billion 5 year plan. The capital originally allocated to the unregulated generation in the marketing segment will drop from $1.7 billion of the $38 billion 5-year plan to $400 million. The remaining $400 million in the Generation & Marketing segment will be largely allocated to maintenance capital and distributed generation assets. Our investment opportunities remain dynamic. And AEP operating companies will continue to develop integrated resource plans and grid enhancement plans over the near and long term in collaboration with stakeholders. This process continues to make substantial progress as shown on slide 43 of the earnings deck. Overall, we are targeting wind additions of approximately 8.6 gigawatts of solar additions of approximately 6.6 gigawatts by 2030. For which we have allocated $8.2 billion in our current 5 year capital plan. This - the migration from contracted renewables to significant increases in regulated renewables will ensure that AEP maintains the talent and resources to execute this plan. The capital plan also includes $24.8 billion allocated to grid investments. With the changes discussed and the expected completion of the sale of Kentucky Power, we plan on an Analyst Day presentation soon after the sale is completed to further update on all of these important initiatives. Now shifting gears to our regulated renewables opportunity. AEP has a positive record of actively managing its portfolio to support the growth of the company as we invest in our regulated business and renewable generation to transform and build a cleaner, more modern energy system, and we made significant progress on our regulated renewables opportunity in 2021. Our plan is to reduce carbon emissions by 80% by 2030 and achieve net 0 by 2050 is well underway. The 998-megawatt Traverse project, the largest single wind farm built at one time in North America is in the final stages of commissioning, and we expect the facility to go on launch soon. The combined investment in the Traverse project along with Maverick and Sundance, which both became operational in 2021 represent investment in renewable energy of approximately $2 billion and will save PSO and SWEPCO customers in Arkansas, Louisiana and Oklahoma an estimated $3 billion in electricity costs over the next 30 years. These three projects add 1,484 megawatts of regulated renewable energy to our portfolio, and we recently issued RFPs for renewable resources for 1.1 gigawatts at APCo and 1.3 gigawatts at I&M. We expect to make regulatory filings and obtain the necessary approvals for projects selected from RFP processes at APCo, I&M, PSO and SWEPCO. We are truly transforming the energy grid to better integrate renewable resources, delivering the low-cost, reliable energy that our customers rely on while simultaneously empowering positive social, economic and environmental change in the communities we serve, and we believe we can successfully enhance shareholder returns in the process. Finally and significantly, I'd like to speak to a few developments that highlight the economic vitality and prospects of the communities we serve. Our economic development team has been focusing on working collaboratively with our states to drive expansion within our service territory. As you know, in January, Intel announced plans to build 2 new leading-edge chip manufacturing facilities in Ohio for an initial investment of more than $20 billion. Over in West Virginia, Nucor announced in January they will build its new $2.7 billion state of the art facility in Mason County, West Virginia. Further, TAT Technologies will be moving its thermal components activities from Israel to Tulsa bringing 900 jobs to the region. In total, our economic development team reported 1,900 megawatts of new load, supporting over 20,000 new jobs announced in 2021 and thus far in 2022. As evidenced by these wins, we are proud to play a vital part in the infrastructure that enables job-creating projects of this kind in our service territories. Moreover, in today's environment, especially in today's environment, as companies in our country focus on energy and supply chain security, our service territory is primed to benefit. We are committed to remaining a good steward for the communities in which we operate as we transition to a clean energy future. Through our just transition effort, we support affected communities through coal plants retirement, by providing job placement services for displaced workers, fact based replacement and funding sources to support diversification. This just transition program has been applied as a model for the country and enabling positive social and economic transitions for affected communities. As I said at the outset, we have a lot to look forward to in 2022. As we recast our capital allocation and derisk the business, we feel confident in lifting and tightening our earnings growth target range from 5% to 7% to 6% to 7%. It has always been my preference to be in the upper half of the 5% to 7% range. And since we have demonstrated a track record of being able to deliver on these projections year in and year out, we are electing to revise the range to 6% to 7%. Accordingly, we will be lifting our 2022 operating earnings guidance range by $0.02 to $4.87 to $5.07 per share, with a midpoint of $4.97 to reflect the increase in growth rate target range. Lastly, we are increasing our funds from operations to debt target to a range of 14% to 15% from 13.5% to 15%, which we mentioned at November EEI. Throughout this process and beyond, we will be committed to maintaining a strong balance sheet. We discussed this at November EEI and can confirm that our FFO to debt and credit metrics have improved markedly as we expected. Over the past decade, AEP has achieved impressive and sustained long-term growth, consistently meeting and exceeding earnings projections while continuing to raise guidance. Our highly qualified Board and management team are executing a strategic plan that leverages AEP's scale, financial strength, effective portfolio management and diversity of regulatory jurisdictions to deliver safe, clean and reliable services for our customers while creating significant value for all AEP shareholders. We are also committed to examining and looking beyond the traditional forms of equity to fund the growth going forward, and our track record since 2015 in asset sales have been active and produce accretive opportunities for our shareholders. Our transformation strategy is working, and the investments we are making will continue to support our solid earnings growth and results. AEP stands poised to make great headway in 2022. And continue to capitalize on this momentum. Our organic growth opportunities for the next decade and our consistent ability to execute against our plan, make it possible to set our sights high for this year and beyond. Before I hand things over to Julie, I just want to take a moment to acknowledge the unwavering commitment and dedication of our employees. In the midst of another storm-filled winter, our employees have continued to prioritize the safety and security of our customers across all of our jurisdictions with significant ice storms impacting most of our territory in the past few weeks. I have been truly humbled by their tireless efforts to deliver on our initiatives and provide for our communities. Ultimately, their passion for the work we do is what makes our business so extraordinary. With that, I'll turn things over to Julie, who is going to walk you through the financial results for the quarter. Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Thanks, Nick. Thank you very much. Thanks, Darcy. It's good to be with everyone this morning. Thanks for everyone - thanks, everyone, for dialing in. I'm going to walk us through the fourth quarter and full year results and then share some updates on our service territory load and then finish with some commentary on our financing plans, credit metrics and liquidity as well, some thoughts on our revised guidance, financial targets and portfolio management. So let's go to slide 10, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $1.07 per share $0.88 per share in 2020. GAAP earnings for the year were $4.97 per share compared to $4.44 per share in 2020. There's a reconciliation of GAAP to operating earnings on Pages 17 and 18 of the presentation today. Let's walk through our quarterly operating earnings performance by segment, which is on Slide 11. Operating earnings for the fourth quarter totaled $0.98 per share or $496 million compared to $0.87 per share or $433 million in 2020. Operating earnings for the vertically integrated utilities were $0.39 per share, up $0.08. Favorable drivers included rate changes across multiple jurisdictions, increased transmission revenue and lower income tax. These items were somewhat offset by lower normalized growth and higher depreciation. I'll talk about load a little bit more here in a minute. The Transmission and Distribution Utilities segment earned $0.25 per share, up $0.06 compared to last year. Favorable drivers in this segment included rate changes, normalized load and transmission revenues. Offsetting these favorable items were unfavorable December weather and increased depreciation. The AEP Transmission Holdco segment continued to grow, contributing $0.33 per share, which was an improvement of $0.06 driven by the return on the investment growth. Generation and Marketing produced $0.06 per share, up $0.01 from last year, largely due to favorable income taxes, wholesale margins, offset by lower generation in land sales. Finally, Corporate and Other was down $0.10 per share, driven by lower investment gains and unfavorable income taxes. The lower investment gains are largely related to charge point gains that we had in the fourth quarter of last year. Let's have a look at our year-to-date results on Slide 12. Operating earnings for 2021 totaled $4.74 or $2.4 billion compared to $4.44 per share or $2.2 billion in 2020. Looking at the drivers by segment. Operating earnings for the vertically integrated utilities were $2.26 per share, up $0.05 due to rate changes across multiple or various operating companies, favorable weather and increased transmission revenue. Offsetting these favorable variances were higher O&M as we return to a more normal level of O&M, increased depreciation expense and lower normalized retail load primarily in the residential class. On the transmission and distribution utilities segment, they earned $1.10 per share, up $0.07 from last year. Earnings in this segment were up due to higher transmission revenue, rate changes and increased normalized retail load which is mainly in the residential and commercial classes. Offsetting these favorable variances were increases in O&M, depreciation and other taxes, essentially property taxes related to the increased investment levels. The AEP Transmission Holdco segment contributed $1.35 per share, up $0.32 from last year related to investment growth and a favorable year-over-year true-up. Generation and Marketing produced $0.26 per share, down $0.10 last - from last year, largely due to favorable onetime items in the prior year associated with the downward revision of the Oklaunion ARO liability in contemplation of the plant shut down and the sale of the Conesville plant. Additionally, while we had land sales in both years, the level of sales was lower in 2021 versus 2020. Finally, Corporate and Other was down $0.04 per share. You'll notice that we aren't talking about investment gains in the year-to-date as we had a lot of timing differences across the quarters between 2020 and 2021, but net-net, we're flat for the year. The year-over-year decline in this segment was primarily driven by slightly higher O&M, interest expense and income taxes. Let's go to slide 13 and I'll update you on our normalized load performance for the quarter. Let me begin by providing you with a couple of interesting stats that highlight the status of the recovery throughout the AEP service territory. The first is the fact that we ended the year within 0.2% of our pre-pandemic sales levels and fully expect to exceed those levels in 2022. AEP's normalized load growth in 2021 was the strongest we've experienced in over a decade driven by the historic economic recovery throughout the service territory. And to build on that, our current projection suggests that 2022 will be the second strongest year for load growth over the past decade following behind 2021. So let's start in the upper left corner. Normalized residential sales were down 1.9% compared to the fourth quarter of 2020, bringing the annual decrease in residential sales in 2021 to 1.1%. The decline was spread across every operating company. However, the decline in residential sales in 2021 was largely driven by the comparison basis of 2020 when COVID restrictions were at their highest levels even though residential sales were down compared to 2020, they were still 2% above their pre-pandemic levels in 2019. In addition, residential customer accounts increased by 0.7% in 2021, which was the second strongest year for customer growth in over a decade. Customer growth was nearly twice as strong in the West, up 0.9% when compared to the East territory, which was up 0.5%. The last item to point out on the residential chart is that you'll notice that we added the projected 2022 growth to the right of the chart. We're projecting a modest decrease in residential sales in 2022, recognizing that there will not be likely another fiscal stimulus to boost the economy in 2022, like we had in the past 2 years. So moving over to the right, weather normalized commercial sales increased by 4.3% for both the quarter and the annual comparison. This made 2021 the strongest year for commercial sales in AEP history. 2021 included a strong bounce back in the sectors most impacted by the pandemic, such as schools, churches and hotels. But the strongest growth in commercial sales came from the growth in data centers, especially in Central Ohio. Looking forward, we expect a modest decline in commercial sales growth in 2022, recognizing the challenging conditions businesses are managing with inflation, the labor shortages and higher interest rates expected in 2022. So if we move to the lower left corner, you'll see that the industrial sales also posted a very strong quarter. Industrial sales for the quarter increased by 2.4%, bringing the annual growth up to 3.7%. Industrial sales were up at most operating companies in the quarter and mainly - in many of the largest sectors. Looking forward, we're projecting 5.7% growth in the industrial sales in 2022. This is mostly the result of the number of new large customer expansions that will be coming online as a result of our continued focus on economic development. Finally, when you pull it all together in the lower right corner, you'll see that AEP's normalized retail sales increased by 1.4% for the quarter and ended the year up 2.1% above 2020 levels. By all indications, the recovery from the pandemic has locked a year and our service territory is positioned to benefit from the future economic growth. Let's have a quick look at the company's capitalization and liquidity position beginning on Page 14. On a GAAP basis, our debt-to-capital ratio increased 0.1% from the prior quarter to 62.1%. When adjusted for the Storm Uri event, the ratio is slightly lower than it was at year-end 2020 and now stands at 61.4%. Let's talk about our FFO to debt metric. The impact of Storm Uri continues to have a temporary and noticeable impact on this metric. Taking a look at the upper right quadrant of this page, you'll see our FFO to debt metric based on the traditional Moody's and GAAP calculated basis as well as on an adjusted Moody's and GAAP calculated basis. On an unadjusted Moody's basis, our FFO to debt ratio decreased by 0.3% during the quarter to 9.9%. As you know, the rating agencies continue to take the anticipated recovery into consideration as it relates to our credit rating. On an adjusted basis, the Moody's FFO to debt metric is 13.3%. As mentioned in prior calls, this 13.3% figure removes or adjusts the calculation to eliminate the impact of approximately $1.2 billion of cash outflows associated with covering the unplanned Uri-driven fuel and purchase power costs in the SPP region directly impacting PSO and SWEPCO in particular. The metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. This should give you a sense of where we are or where we would be from a business as usual perspective. As Nick mentioned, we're now targeting an FFO to debt metric in the 14% to 15% range, which is commensurate with the Baa2, BBB flat stable rating. We expect to see this metric to begin to trend toward this new range of 14% to 15% in the latter half of 2022 as we make progress on the regulatory matters that are underway, including the recovery of Uri costs. As you know, we're in frequent contact with the rating agencies to keep them apprised of all aspects of our business and in the presentation today on Page 48, you'll see our financing plan. And aside from some modifications around the capital allocation and refinements on cash flows, everything remains intact as well as the general gist of the financing plan, including equity. Let's quickly visit our liquidity summary on the lower right side of this slide. Between our bank revolver capacity and cash balance, our liquidity position remains strong at $4 billion. And in the lower left, you can see our qualified pension funding continues to be strong, increasing 1.2% during the quarter to 104.8%. So let's go to slide 15. The initiatives that we talked about today set a strong foundation for 2022 and beyond, all of which I would submit to you include a commitment to a boost in our earnings power, credit position and high grading of our asset portfolio while derisking and simplifying our business profile. So to quickly recap of particular interest to our investor community, our equity investor community, we are lifting and tightening our long-term earnings growth rate to 6% to 7%. Consequently, we're increasing our 2022 earnings guidance range to $4.87 to $5.07 per share, up $0.02 from the original guidance. Of particular interest to our fixed income lender and credit rating agency community in addition to our equity investors, we're lifting and tightening our FFO to debt target range to 14% to 15%, which is consistent with a Baa2 stable and BBB flat stable rating. And of interest to all of our financial stakeholders, we are committed to the active management, high-grading and simplification of our asset portfolio to support our growth and transition to a clean energy future as a regulated utility holding company. The sale of our Kentucky operations is on track to close in the second quarter of this year and is reflected in our earnings guidance assumptions for 2022. And as we announced today, we've eliminated the growth capital in the contracted renewables area, moved that capital transmission and announced the sale process of all or a portion of the unregulated contract renewable portfolio with the goal of maximizing value. We've already begun to reflect a portion of this asset rotation in our 5-year $38 billion CapEx guidance as evidenced by the $1.5 billion increase in transmission investment and the $1.3 billion reduction in the unregulated generation and marketing segment. While the reallocation of capital is now assumed in the guidance range we have updated for you, the utilization of sales proceeds is not yet reflected in the multiyear financing plan. And therefore, what you can anticipate hearing or seeing from us is that we will operate within the increased earnings growth and credit metric financial targets we provided to you today, working within those targets, funds from the sale activities will be directed to our regulated business as we continue our efforts to enhance the transmission infrastructure and to effectuate our generation transformation. Additionally, depending on the timing of the sale of our unregulated contract renewables portfolio or any future asset optimization activities, we will have a bias toward reducing and/or avoiding future equity needs. As you would expect, we'll update our guidance details once we have announcements so we can share with you. We're confident in our ability to deliver on our new and improved promises to you, given our focus on disciplined capital allocation, solid execution and positive regulatory outcomes. We really appreciate your time today. I'm going to hand it back to the operator now so we can get your questions."
},
{
"speaker": "Operator",
"text": "Thank you. Our first question, we'll go to the line of Steve Fleishman with Wolfe Research. And your line is open."
},
{
"speaker": "Steve Fleishman",
"text": "Hey, good morning. Can you hear me okay, Nick?"
},
{
"speaker": "Nick Akins",
"text": "Yes. I can hear you fine."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. Great, thanks. Just on the renewables assets that you're selling, could you give us maybe a little info if you have it, maybe for 2021 actuals, even just the earnings or the EBITDA, cash flow of those - that business, those assets?"
},
{
"speaker": "Nick Akins",
"text": "Yes. And it's around $0.15."
},
{
"speaker": "Julie Sloat",
"text": "Yes, Steve, this is Julie. I'll jump in here with some financial details, and I know Nick will jump in with some additional color. Let me talk about how we're thinking about this for 2022 because, as you know, 2021 was a bit of an anomaly with Storm Uri. So that kind of led to some different earnings streams that probably are not indicative of the asset base. So for 2022, what we're thinking is - and there's a little bit of wiggle room in here, talk about mid-teens in terms of sense, in terms of contribution to 2022 earnings. So if you want to kind of put a band around it, I don't know, $0.13 to $0.17 associated with those assets in particular, that gives you a little order of magnitude there."
},
{
"speaker": "Steve Fleishman",
"text": "That's helpful. And do you have a sense of kind of EBITDA?"
},
{
"speaker": "Julie Sloat",
"text": "I don't have something to share with you today. And as you know, the renewable portfolio in terms of contracted assets is comprised of about, what, 1,600 megawatts of capacity, and that obviously varies from project to project. And as we said in our opening comments, we would be looking to monetize a portion or all of that over a period of time. So obviously, that will vary by asset and in projects specifically. So that's the only reason I'm being a little opaque on the EBITDA statistics."
},
{
"speaker": "Nick Akins",
"text": "And you'll see some sales occur probably in 2022 and then more in 2023."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. Okay. That's helpful. And then the - can you just - one last financial question on that. Can you just remind me what the -- if there's any debt directly on those assets or not?"
},
{
"speaker": "Julie Sloat",
"text": "Yes. Steve, again, this is Julie. There is a project specific debt, and there's a tax equity on obligation component to it as well. So as of 12/31/21, the debt component was around $252 million, tax equity about $123 million. So all in, you're talking about $375 million."
},
{
"speaker": "Steve Fleishman",
"text": "That's super helpful. Thanks. And then one other question, I'll leave it to others, please. Just the - curious just on the renewables, there's been a lot of cost inflation pressure on renewables. Obviously, there's inflation pressure on conventional as well, maybe even more. But just how are you feeling about kind of managing that within your RFPs and still showing that economically, this makes sense for your key states?"
},
{
"speaker": "Nick Akins",
"text": "Yes. We actually feel good about it because with Traverse coming online, that's really the last major physical addition for this year. And then most of the renewables that are being applied for are in that '24 and '25 range. So you still have time for supply chain to pick up and certainly from a pricing perspective to be able to adjust. So we feel really good about our position because we're not in the middle of something where we're having to adjust. And then -- so that's - we're in a good position going forward."
},
{
"speaker": "Steve Fleishman",
"text": "Great. That’s helpful. Congrats on the announcements."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Shar Pourreza with Guggenheim Partners. And your line is open."
},
{
"speaker": "Shar Pourreza",
"text": "Good morning, guys. Just one - Nick, you went kind of fast through the 1 point in the prepared remarks. But I guess, can you elaborate again, how you're thinking about additional asset optimization opportunities should the IRPs at the various states kind of work in your favor? I mean, I guess, strategics, privates infrastructure seem to continue to want to pay up for assets. which we're obviously again seeing this morning. Did I hear you right that the message is, is that as you're thinking about incremental capital opportunities to fund the renewables through the IRPs that issuing traditional equity as a last resort."
},
{
"speaker": "Nick Akins",
"text": "Yes. And actually, and I've said this, we're - we have two pinnacles of growth. We've got the transmission side, which we have plenty of capability relative to project flow to be able to check and adjust along the way. It's huge. And then, of course, on the renewable side of things, we have approximately in there about 50% estimate for ownership, which is sort of a view going into it. But I can say that because of after Storm Uri, after many of the effects in terms of utility ownership, we believe that ownership level is going to be higher than that. Matter of fact, in the Virginia side, it looks like 75% of it is owned and the other filings we're making is primarily 100% owned. So - and that really says to us that you're seeing a continual progression of really the standard view of portfolio management going forward. I think you're in the age of that and asset optimization to ensure that we're putting our capital in the right places. And that says there's a prioritization scheme as we go forward. Now I can't say today what that prioritization scheme looks like. But certainly, Kentucky was an example of that. First, it was the unregulated generation. Before that, it was the - I guess it was the barge line facilities. And you're seeing that step toward clarification, simplification and making sure that we are optimizing the capital in the right places. And today, we have, as I said earlier, the transmission in particular, we will not give up our position as being the largest transmission provider in this country by far. We have the bandwidth. We have the ability to move projects forward. And then on the renewable side, we're at the leading front edge of a major transformation that's going to benefit our ability to not only help in terms of customer rates because the renewables being brought in, but also to be able to deploy the capital necessary to make that happen. So you're going to see a continual process of moving forward with those kinds of activities. And the fact of the matter is, our renewables are now focused on capacity replacements, and so that's a natural progression of what occurs within the regulated framework. And for us, it puts us in great shape to make sure that these projects are actually needed. They actually produce benefits for consumers, and we have the backup capacity to provide for the demand periods. We're in a great position for this transformation. That's why we want to take advantage of it. So for those jurisdictions that meet those areas where transmission, the ability to participate in the clean energy transformation, those will be the high priority assets that we look at going forward."
},
{
"speaker": "Shar Pourreza",
"text": "Okay. Perfect. That's helpful. And then Nick, just lastly on the growth rate ticking up to 6 7%. On one hand, it's consistent with your past comments about being in the top half of the trajectory. But on the other hand, you are basically telling the market, you don't see any situations where you see growth at 5%, right, which is great. As we think about sort of your wind and solar opportunity set through '26, which hasn't really changed from prior disclosures. How do we think about these in the context of your updated growth trajectory? Could they be accretive or simply extend the runway? And then are you assuming any sort of win assumptions in that updated growth guidance? Thank you."
},
{
"speaker": "Nick Akins",
"text": "Yes. The way it sits right now, we look for sustainability when we make these adjustments associated with the growth rate, particularly the long-term growth rate. We would not have made this long-term growth rate if we didn't see a solid progression of the sustainability of the 6% to 7%. And actually, the project flow that you're seeing the - certainly, the reallocation of capital and actually - this is sort of an aside, but certainly, when we go from contracted renewables to the migration to a full suite of regulated renewables, it's -- we want to keep the talent that we have too, to make that transition and really focus on that effort. So I would say that the fundamentals are in place for continued optimization, solidification of 6% to 7%, validation of a midpoint that's higher than our previous midpoint and confirms to investors that we feel really good about the position that we're in. And as we go along, we'll see what happens, but we always look at -- when we make guidance changes and long-term growth changes, we look at the sustainability of that for years to come because consistency and quality of earnings and dividend are paramount to us."
},
{
"speaker": "Shar Pourreza",
"text": "Terrific. Congrats, guys. Thank you very much."
},
{
"speaker": "Nick Akins",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jeremy Tonet JPMorgan. Your line is open."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Nick Akins",
"text": "Morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to bring a finer point to the equity question, if I could. It seems like the asset sale timing could be kind of in pieces here. I'm just wondering, does this line up where really kind of completely removes equity from the plan at this point? Just trying to get a finer point on what equity needs could look like post a successful sale here?"
},
{
"speaker": "Nick Akins",
"text": "Yes. I think it would be great if we could map it exactly to what the equity needs are in the future. But I can say that certainly, this is a big part of our ability to manage the portfolio so that we obviate the need for new equity, but you still have ATMs, you still have the convertibles that are coming on during that period of time. But at this point, we sit really good. I don't know if you want to go..."
},
{
"speaker": "Julie Sloat",
"text": "Yes. So Jeremy, you're right on. In an ideal situation, we would like to pick the landing on every equity issuance and be able to kind of sidestep that and have a really strong balance sheet in conjunction with that. We'll see how ultimately the timing goes, as I mentioned in my opening comments, there will be a bias toward trying to alleviate that pressure that you might otherwise perceive around equity issuances. But as you know, if you look at our financing plan, there's not a lot out there, $100 million of DRIP in 2023. And as Nick mentioned, we've got the convertibles that convert this year and next year. So we're in good shape. But to the extent that we can maximize value of asset sales and time those, yes, that would be definitely something we'd be interested in doing. But again, the idea is to hit on all of those objectives. 6% to 7% earnings growth hit nicely and comfortably in the guidance range that we give to you for 2022. And make sure that we're right alongside with the solid balance sheet metrics of 14% to 15% for that FFO to debt statistic. So we'll thread the needle."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful there. And I just want to come back to bending the curve if you could on O&M. And just updated thoughts there on, I guess, how you see that progressing in this kind of inflationary environment? Any incremental thoughts you could share there?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So - and obviously, we're taking a good hard look at that. Our achieving excellence program has been in place for a couple 3 years now. And it's really showing the value of our organization completely going through. And actually, it should be known, one of the silver linings of COVID if there is a silver lining of COVID is that made us think about what was truly needed for the company going forward, particularly when you made all these adjustments to compensate for what we thought would be a really negative approach to the economy during that period. So we're going to take those learnings and continue to focus on bending the O&M curve. And of course, that becomes even more of a challenge given labor rates, given certainly if there is supply chain-related activities on the long term. But we feel really confident in our ability to continue to bend that curve or at least hold it flat, but we'll certainly continue to focus on that. And that's a huge part of what we're doing because all these pieces sort of fit together where every dollar of O&M we're able to put $7 of capital in place with the reduction. So we have the focus on reducing the O&M as much as possible, and it's advantageous to us because we have a huge pipeline of additional capital opportunities that we could take advantage of for the betterment of customer service and so forth. And it's all sort of ties together. The load forecast has clearly been positive recently, and it looks like it's going to continue to be positive. That's good for cash flow and good for our ability to invest. And then certainly, all those things sort of fit together, but we'll continue to focus in on all of those activities going forward."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s very helpful. Leave it there, thanks."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Julien Dumoulin-Smith with Bank of America. Your line is open."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning, team. Thanks for the time. If I could follow up a little bit on the last couple of questions here. Just to the extent which that you're successful in, shall we say, fully offsetting equity here, where does that put you again? I know you're taking the moment now to raise your guidance ranges. But how do you think about being within that range to the context that you removed this equity as well? It would seem like this is a likely fairly accretive move to divest renewables given where the transaction multiples have been."
},
{
"speaker": "Nick Akins",
"text": "Yes. Obviously, we're going to have to get in that process and understand what the actual benefits are. And of course, you're dealing with PTCs, ITCs, the value of those, the timing of those kinds of activities as well. And so we're going to have to sort of fill our way through that part of it. But certainly, the stage is set. And -- there's some -- and we're looking at somewhat of a phased approach, which that not only matches the equity needs, but also matches the business valuation itself. And I think that that's going to be a clear issue for us to focus on as we go forward. But Julie, anything you want to add?"
},
{
"speaker": "Julie Sloat",
"text": "No, I think you're hitting on it. I mean the other thing that we'll make sure that we're sensitive to Julien is obviously, customer rate is always sensitive to that. But to Nick's point, this allows us to set the runway, again, gives us confidence in the boost to the growth rate of 6% to 7% for the obvious reasons. And then the objective is to, again, maintain the balance sheet, continue to derisk and simplify the business portfolio and make sure that we're hitting comfortably in the guidance range that we give to you as we give that to you sequentially. Every year, we come out with a new guidance range for the upcoming year, and we'll continue to fine-tune that."
},
{
"speaker": "Nick Akins",
"text": "The ability that we have to accelerate and deaccelerate is of tremendous value. And certainly from the contracted renewables process that we go through, that's going to be a benefit. Our ability to accelerate and deaccelerate, whether it's transmission, whether it's renewables, those are clear options that we have available to us that we didn't have before. And when you think about the progress that we're going to make and the ability to focus on even continuing to advance the capital needs. That's something that all these things are going to have to come together, but I can tell you that the foundation and the clear optimism around that continues to benefit us. And it will be a process, and that's why I mentioned the Analyst Day. I think it's going to be important in the Analyst Day for us to not only obviously celebrate the sale of Kentucky, but also to focus in on what the transactions are going to look like, what the structure of these deals are going to look like, the timing and be able to also talk about what capital looks like in the future based on what we're seeing relative to load and everything else."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "And if I can, just one more quick one. I mean, why now is maybe the question, right? I mean I appreciate the guidance rates altogether, but just curious on the timing. Obviously, you all make sort of an annual update of EEI, you talked about in Analyst Day, prospectively. Just curious on what gave you the confidence now. I mean appreciative of the asset sale."
},
{
"speaker": "Nick Akins",
"text": "No, thanks for the question because at November EEI, there was a lot still outstanding. We had 10 cases going on out there. I know we got a lot of questions about, okay, why has it taken so long in Ohio? Is your relationship? What's it like in Ohio? And it was like 2 weeks after that, that we got both cases done and they were clean orders. And our relationship is great with the regulators in Ohio and with legislature. So it was -- and then you had all the other cases that were still outstanding that came through I&M on Rockport. Certainly, there was a PSO base case that was done right at the end of the year. So you had all these things going on. But the other thing too is Kentucky transaction is still ongoing. And the process -- and it's -- like I said, it started with unregulated generation and certainly everything we knew before and that we need to solidify the consistency of our earnings going forward. Well, Kentucky was the first of the primary business units that we really took a look at. And now that, that process is ongoing, okay, what's the next step in our evolution? And when you think about those 2 pinnacles of growth, everything that we're going to be doing supports that ability to move that forward. We know -- and it wasn't lost on us that during November EEI when we reduced the transmission investment, there was an unintended message that, that somehow the transmission pipeline was ending or there were challenges associated with projects, and that was not the case. I mean we said that then, and we continue to fortify that measure. I think it was important for us to come out at this earnings call and set the record straight on what the firmness of the foundation of this company and its ability to move forward in a very, very positive way. And I just -- I wasn't going to let November EEI stand."
},
{
"speaker": "Julie Sloat",
"text": "I can jump in another statistic that might be helpful to Julien as well. So when we look back at 2021, the rate relief we had assumed in guidance was something like $230 million as we got and then closed in on the end of the year, we had already secured something like 112% of that. So we were over what we had anticipated. So that gave us some momentum. And looking at 2022, so there's an updated 2022 waterfall for guidance in the presentation today that's got the actualization for 2021 and then some refinements for 2022 in conjunction with the growth rate uplift. But we're assuming about $381 million of rate relief. And this is before the Indiana settlement that was approved yesterday. We had already secured 55% of that. So we're north of 55%. I need to go back and do the math to boost that number up to accommodate the order that we got for Indiana. But again, validating and giving us confidence that now is the time to do this obviously, came in with a strong year in 2021, giving us the momentum and assurance around those regulatory recoveries that we had anticipated and a little bit more. So that's to give you a little bit of statistics to match what Nick just shared with you."
},
{
"speaker": "Nick Akins",
"text": "Yes. And as I said at the beginning of the call, this process is not over. I mean we are continuing the process of really fine-tuning the optimization around all of our assets. And certainly, from a resource perspective to be able to take the contracted renewables and the talent that's there and be able to migrate that over to a massive build-out associated with regulated renewables is a great opportunity for us and certainly everyone involved with it because this process is going to continue. And certainly, we want to register that we will and have been a participant in that process. But the why now question is important. I mean the why now question is that we're at the precipice and I sort of presage this, I guess it was third quarter last year, but we're at the precipice of substantial movement toward a clean energy economy. You can do it with the transformation of renewables, you can do it with -- certainly with other types of technologies that are developing, but it also requires transmission. And certainly, just the refurbishment of transmission and distribution, by the way, we have a huge pipeline relative to distribution, too, that's been identified. That's really -- all of those are opportunities for us to focus in on what's truly important to our customers, but also to our shareholders."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Durgesh Chopra with Evercore ISI. Your line is open."
},
{
"speaker": "Durgesh Chopra",
"text": "Just Julie, quickly to follow-up on the economics of the potential renewable sale. Should we be expecting a tax leakage there? Or you have enough NOLs and other tax to offset that?"
},
{
"speaker": "Julie Sloat",
"text": "Yes. Yes. We would expect a little tax leakage there. But as you know, we're not entirely efficient with our tax credits. So we've got a little bit of wiggle room because we've got some tax credits sitting on the bench. So I wouldn't necessarily look to that being as a stumbling block or a material gating item for us. So we'll be able to manage through that."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. And just one, all the other questions were asked and answered. Just one, Nick, what's the confidence level in getting sort of the Kentucky sale done in Q2? We sort of saw the headlines of you sort of kind of withdrawing the petition from on the plants. So maybe just talk to that, what drove that decision of withdrawing that petition and the confidence level of closing that transaction in Q2."
},
{
"speaker": "Nick Akins",
"text": "Yes, sure thing. Well, obviously, the state of Kentucky was concerned about the FERC case and the timing of it and how it would impact their schedule. So certainly, we recognize that and wanted to accommodate the Kentucky Commission. So we pulled down the FERC filing, and we'll certainly refile the FERC filing after Kentucky does their review. And of course, with the state approvals at that particular time, we may get a quicker response from FERC. So -- and that's -- I think they have 60 days, but it could happen earlier than that. But still, that keeps us in the second quarter. It'd be May to June time frame, but still in the second quarter. So that's not an issue for us. And I know that -- there's certainly a lot of dialogue will occur. It already has relative to Mitchell and how it works and then also in terms of what interveners may think about the transaction, but that's a typical -- any time you get into a sale of in a transaction. That kind of thing will occur and there'll be discussions and we'll get it all resolved. So we're still very confident that we're going to get that done because actually, the new owner has made commitments of jobs and those types of activities within the state of Kentucky. And I think it's really important for anyone looking at this transaction to recognize that you're putting this utility in the hands of a reputable operator. They'll do a good job managing the investments, but also a good job in the communities, and they're very focused on that. So really, the -- this process should be a forward-looking process, not a past process -- past-looking process. So I really think that that's going to carry the day."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Andrew Weisel with Scotiabank. Your line is open."
},
{
"speaker": "Andrew Weisel",
"text": "First question. Forgive me if I missed it, but the new 6% to 7% growth range, is that anchored off the midpoint of the new 2022 guidance? And am I right that 2022 guidance includes contributions from contracted renewables, but not from Kentucky?"
},
{
"speaker": "Julie Sloat",
"text": "That's -- you've got that exactly right on all fronts, right on."
},
{
"speaker": "Nick Akins",
"text": "Yes. It is 2022, new rebases."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Would there be a rebase assuming the contracted renewables business does get sold? In other words, would -- if I take 6.5% off the new 2022 midpoint, would I need to lower that after an asset sale?"
},
{
"speaker": "Nick Akins",
"text": "I think you should look at the contracted renewables is supporting the 6% to 7% with the base of '22."
},
{
"speaker": "Julie Sloat",
"text": "To add a finer point to that as well. To get right to the heart of your question, we do not expect to rebase our earnings when we take action on selling these assets in particular. And as we mentioned, it will take a little bit of an accordion feature to it in the sense that over time, these transactions will occur so we've got some flexibility there. And then with the redeployment of the cash coming in the door back to regulated utilities, so whether it's transmission or a combination of transmission and regulated renewables we feel confident that we'll be able to maintain the guidance ranges and continue along the trajectory."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Great. And that makes sense given you said it was about $0.15 of EPS versus $5 or so for the business overall. And then lastly, just to confirm, can you comment on dividends, given the change to the EPS growth outlook and the potential asset sales? How should we think about the dividend growth outlook from here?"
},
{
"speaker": "Nick Akins",
"text": "Yes. No change there. Dividends will be commensurate with the earnings growth."
},
{
"speaker": "Operator",
"text": "Our next question will come from the line of Nick Campanella with Credit Suisse. Your line is open."
},
{
"speaker": "Nick Campanella",
"text": "Just looking at the 14% to 15% of total debt on the funding slides. Just curious what the feedback then from the agencies and the potential to sell some of the nonregulated stuff and the fact that your business mix is increasing to more regulated earnings. Do you expect any change in your minimum thresholds here?"
},
{
"speaker": "Julie Sloat",
"text": "Actually, we are having conversations. And as I mentioned earlier, we keep them apprised of all aspects of our business. So from a credit risk profile perspective, this should be viewed as a favorable step, again, as a commitment and continued twist towards traditional regulated portfolio of assets. So I can't speak for them as it relates to what those thresholds would be, but 14% to 15% is most definitely within the wicket as it relates to a solid and strong balance sheet, I would submit to you again, BAA2 stable, BBB flat, stable. That's where we expect to be with that 14% to 15%. And please do reach out to the credit rating agencies to make sure that they're armed with everything we know so that they can take care of you all."
},
{
"speaker": "Nick Campanella",
"text": "Absolutely, absolutely. Yes. And then just regarding the sales forecast and your comments regarding economic growth. For this year, it seems like industrial is really driving overall consolidated weather normalized growth higher. Can you just kind of speak to what's baked into the long-term forecast here? And if we remain in a higher commodity price environment into '23, '24, how could that change things for AEP?"
},
{
"speaker": "Nick Akins",
"text": "We -- any long-term forecast, we tend to temper. We're actually getting in the process of a new forecast. But right now, we've estimated about 1% increase. And I think you'll see that this -- what was overall 1.5 or something like that."
},
{
"speaker": "Julie Sloat",
"text": "1.6%."
},
{
"speaker": "Nick Akins",
"text": "Yes, 1.6%. So we're going into the year, assuming 1%. And with the investments being made by these large customers, industrial is always a leading edge relative to commercial and residential. So -- and then also when you look at the numbers, 1 year over another, it isn't quite apples and apples because of COVID and the impacts there. So you'll see a reduction in the residential. But if you look at pre COVID, it's more, it's higher because the stay-at-home environment has continued, work-from-home environment has continued. So we get the benefits of a more robust residential and at the same time, industrial picking up. And in fact, when you look at our service territory in relation to what's going on internationally, we do have strong energy growth and energy-related activities in our territories and manufacturing activities. And with onshoring around security, the point I was making earlier, we're going to wind up working pretty well from a growth perspective from a load standpoint."
},
{
"speaker": "Julie Sloat",
"text": "To give you a little more color if this is helpful. I'm on Page 13 of the slide presentation today, and I'm looking at the industrial quadrant in the lower left side of that slide. As you point out, we are looking at a 5% -- 5.7% uplift in that particular weather normalized load. And it's really driven by previous economic development activities. As Nick pointed out today, those economic development opportunities really set the foundation for the future. So we're reaping the benefits of stuff that we've done in the past as you look at that forecast and that covers many sectors, metals, chemicals, paper, oil and gas, but about 99% of the load expansion in 2022 comes from our T&D segment in Texas and Ohio. Just to give you a little bit more color. And then that obviously drives you over to the right side of the slide, looking at 2022 estimated across the entire Board a 1.6% lift is what we're assuming. And then as Nick mentioned, beyond to the extent that we can push it to 1% on an ongoing basis, that would be fantastic, and that would be our hope and expectation."
},
{
"speaker": "Operator",
"text": "We will go to the line of Paul Patterson with Glenrock Associates. Your line is open."
},
{
"speaker": "Paul Patterson",
"text": "Great -- great presentation. I'm sorry if I missed this, but is the -- I assume that there's probably going to be gains on the sale of renewables. Are those gains going to be part of the 6% to 7% growth?"
},
{
"speaker": "Julie Sloat",
"text": "I guess let me ask or answer it this way. So we will have gains on the sales. And typically, when we have gains on sales of assets, capture those and the reconciliation gap to operating earnings, so we would kind of offset those. But asked another way or another question we got earlier, Paul, I don't know if you asked or heard this, but we were asked, would we be in a taxable gain situation. So I'll answer that question too. The answer would be yes. But we do have tax credits sitting on the bench that we'd be able to utilize against that. So what we don't want folks to do is worry about that being a real material gating item, we'd be able to manage through that."
},
{
"speaker": "Paul Patterson",
"text": "Yes, I heard that, I guess. So just to clarify, it's not going to be part of operating earnings or adjusted earnings going forward?"
},
{
"speaker": "Julie Sloat",
"text": "Correct. That's correct. Yes. That will get captured in the reconciliation. Yes. you got it, not in operating earnings."
},
{
"speaker": "Paul Patterson",
"text": "Okay, great. And then just the -- and I apologize if I missed this, but the average length of the contracts that are on these assets? Are there different vintages and stuff? I'm just wondering where that sort of stands?"
},
{
"speaker": "Julie Sloat",
"text": "Yes. average PPA length is around 11 years."
},
{
"speaker": "Paul Patterson",
"text": "Okay, right now. Okay. And then just finally, on the Kentucky Power, you guys talked about the Mitchell plant sale, but the Kentucky PSC, as you know, on Tuesday, filed a protest not at FERC, not on the transaction itself, but on the application for the transaction, saying they felt that they need more information. And I was just sort of -- I was wondering if you could provide a little clarity. I mean they have their own proceeding, as you guys know, and they have -- and there's obviously this proceeding. I'm talking about the M&A via the transaction proceeding at FERC. And I'm just sort of wondering why they are -- or if you can give any insight as to why -- as to this protest that they filed saying, hey, the application is deficient. We're concerned about rates and we want more information. And sort of what -- how that might unfold or how we should think about that in the context of the proceeding?"
},
{
"speaker": "Nick Akins",
"text": "Yes. Well, certainly, there's going to be all kinds of activity around getting the transaction through. And Kentucky, as I said earlier, I mean Kentucky is thoughtfully going through the areas that it wants to take a look at relative to the transaction. And certainly, that's something that we're going to make sure it happens in the process. And as I mentioned earlier on the FERC thing, we'll file FERC as soon as Kentucky gets through that. But at this point, though, there's nothing certainly, nothing that we can address. Do you have anything you want to add to that?"
},
{
"speaker": "Julie Sloat",
"text": "No. that was fine."
},
{
"speaker": "Paul Patterson",
"text": "Well, I guess what I'm sort of asking is, is that I'm talking about specifically the Tuesday filing, not the Mitchell plant sales. So I mean, in other words, they were saying, hey, they want more information. It just seems to me that being a regulator that's going to be reviewing the actual transaction, it seems at least to me to be somewhat -- I was a little bit confused by the fact that they're saying to FERC hey, with respect to the transaction proceeding that docket, the EC dock is saying, hey, hold off, provide us more please. Please get them to give us more information when I would think that given that you guys filed this months ago, that information, they could be asking you within the context of the Kentucky review. Do you follow what I'm saying. I don't want to go into great, (inaudible) if you follow me, but that's what sort of seems to me to be a little bit strange about the FERC, the FERC request from Tuesday or we're not requesting the protest."
},
{
"speaker": "Nick Akins",
"text": "Yes. So -- well, you had the intervenors that came in. And -- and they're really trying to adjudicate issues that were already resolved by the Kentucky Commission. And so we'll go through that process of discussions with them. As far as Kentucky is concerned, obviously, they're looking to try to hold customers harmless during the transaction and really, as we look at this transaction, they're in good shape going forward. So I think, obviously, we'll have those discussions as we go along."
},
{
"speaker": "Operator",
"text": "And with that, I'd like to turn it back over to the speakers for any closing comments."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Cynthia, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Certainly. And ladies and gentlemen, today's conference call will be available for replay after 10:30 a.m. today until midnight, March 3. You may access the AT&T teleconference replay system by dialing (866) 207-1041 and entering the access code of 2171165. International participants may dial (402) 970-0847. Those numbers once again (866) 207-1041 and or (402) 970-0847 and enter the access code of 217115. That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.+"
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 3 | 2,021 | 2021-10-28 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to the American Electric Power Third Quarter, 2021 Earnings Conference Call. At this time, your telephone lines are in a listen-only mode. Later there will be an opportunity for questions and answers. If you would like to ask a question during the call, You have an indication you've been placed into queue, and you will move yourself from the queue by repeating the one as we command. Now as a reminder, your conference call today is being recorded. I will now turn the conference call over to your host, Vice President of Investor Relations, Darcy Reese. Go ahead please.
Darcy Reese: Thank you, Allen. Good morning, everyone and welcome to the Third Quarter 2021 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides and related financial information are available on our website at www. aep.com. Today we will be making Forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President, and Chief Executive Officer and Julie Sloat our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay. Thanks, Darcy. Welcome again, everyone to American Electric Power's third quarter 2021 earnings call. Today we're pleased to report a strong third quarter operating earnings of a $1.43 per share for the third quarter, this brings our year-to-date operating earnings to 376 per share versus 356 per share last year, which gives us confidence in raising the midpoint of our guidance range for 2021. AEP service territory continues to prove us with resiliency and stability with continued economic recovery experienced in the third quarter. In fact, AEP posted the strongest sales quarter in over a decade, and the gross regional product for the AEP footprint of third quarter was the highest on record, as well as job growth being the strongest since 1984. The strength and diversity of our portfolio, the robustness of our organic growth opportunities, and our consistent ability to execute against our plan places AEP among what we believe should be one of the country's premium regulated utilities. Our strength -- our strong performance this quarter, coupled with the level of economic recovery experienced within our footprint, provides us, once again, the confidence needed to raise our midpoint to 470 per share and nearer, the 2021 guidance range to 465 to 475 while reaffirming our 5% to 7% long-term earnings growth rate. And as I've stated previously, I would still be disappointed if we were not in that upper half of our long-term growth rate. The driver of our strong performance is the talent and commitment of our employees. Our front line of central service work teams has continued to adapt to ensure the needs of our customers and communities are met day in day -- day in and day out throughout the pandemic. Like many industries, the face of work for AEP will never be the same. As employees return to the office, we have taken actions to ensure the safe return to the workplace environment. I remain appreciative of the dedication of our employees and have the utmost confidence in their continuing ability to successfully check and adjust as we adapt to the future. We believe that this new work environment will continue to enable more efficiency, flexibility, and creativity, that will contribute to the culture to excel in meeting our strategic objectives. This new future of work along with digitization and automation will continue to provide benefits for our Achieving Excellence program. Our growth opportunities over the next decade are significant driven by our future forward renewables plan, that over 16 gigawatts of new renewables resources by 2030, and the transmission distribution investments needed to support the needs of a clean energy economy for our customers and communities. Additionally, the completion of a strategic review of our Kentucky Companies and our decision to move forward with the sale delivered utilities enables us to focus our attention on executing that transaction and delivering on our gross strategy. So, let's cover the announced sale of Kentucky Power. Earlier this week, on Tuesday at market close, we announced the sale of Kentucky Power and Kentucky Transco to Liberty Utilities, the regulated utility operation of Algonquin Power. The sale was a result of the strategic review that we launched back in April. The sale was subject to regulatory approvals, including approvals from the Federal Energy Regulatory Commission which is within a 180 days, and the Kentucky Public Service Commission, within a 120 days. The transaction was also subject to federal clearance pursuant to Hart-Scott-Rodino, which typically is within 30 to 60 days, and the clearance from the Committee on Foreign Investment in the U.S., within 90 and a 120 days for that approval. We anticipate making these regulatory filings in late November and early December. Separately, we will file -- with both the Kentucky, West Virginia and full commissions with necessary changes to the metro plant operating agreement to accommodate the ELG investments recently approved by the West Virginia Commission. The following will include a plan to resolve the question of Mitchell ownership post 2028. Both state commissions are expecting these filings as both issued recent orders directing us to do so. These filings will be made in the mid to late November time frame. We're also very pleased with the outcome of the strategic review and know that the future owner of our Kentucky assets will be a great steward for all stakeholders in Kentucky, our value employees, customers, and certainly the communities. Lastly, I want to thank all the Kentucky employees and the corporate support employees for their patience, during this review and for their continued focus on safety and operational excellence during this period, and as the transaction is completed. Now, moving to several of the regulatory activities. In Ohio, we expect an order in the fourth quarter on the settlement reached and filed with the Commission earlier this year. As a reminder of the settlement has broad support from the settling parties, including the commission staff, Ohio consumers’ counsel, Industrial companies, commercial companies, and other entities like Ohio Hospital Association. Additionally, AEP Ohio's grid smart Phase III settlement was filed yesterday and paves the way to continue our deployment of advanced smart grid technologies, including completion of our AMR meter rollout, the remaining 475,000 rollout customers. The unopposed settlement with support from commission staff allows consumer's counsel and several of our largest customers demonstrates that AEP Ohio continues to maintain a great working relationship with our regulator and interested parties. Public Service Company of Oklahoma reached a settlement in the rate case with the Oklahoma staff and other parties. The settlement was presented to the commission on October 5th. The black-box settlement includes 50.7 million net increase in rates while adding another 102.7 million in base rates. In addition to continuing the practice of allowing some interim recovery of Capex riders, the rider collecting for Maverick and Sundance North-Central wind assets was also included, in orders expected by year-end with rates reflected in November bills. In Indiana, the unfollowed base rate case on the July 1st based on a future test year model seeking 97 million in net revenue increase with a 10% ROE. Major items included recognition of over 500 million in capital investment per year in Indiana continuation of the transmission tracker a federal tax rider in the event of a change in federal tax rates and the advancement of AMI to provide customers greater control insight into their usage. The hearing was set before the Indiana Utility Regulatory Commission on December 2nd, with an order expected by April of '22. In a Southwestern Electric Power Company's jurisdictions cases are pending in Louisiana, Texas, and Arkansas. The SWEPCO Texas Commission deliberations set for November 18th. Parties filed exceptions to the preliminary draft order issued by the hearing and replies. So those exceptions were filed yesterday. SWEPCO is seeking a net revenue increase of $73 million with an ROE of 10.35%. Our file includes investments made from February 2018, accelerated depreciation for plant, a strong reserve, increased vegetation management. We expect an order in the fourth quarter with rates being retroactive back to March of '21. In SWEPCO Louisiana testimony has been filed a hearing scheduled for January of '22. A case $6 million to $73 million net revenue increase and a 10.35% ROE in order to expect between the second third quarter of '22. And so, at Arkansas, we were seeking a $56 million net revenue increase with a 10.35 ROE. The following contains with formula rate plan for subsequent years and considers the pending retirement of previously announced call net assets. This fall, we used time to align with the North-Central in-service dates and the provided mechanism both for recovery of costs associated with the investment and flow through of the PTC in SWEPCO customers. The hearing is set for March of '22. Both SWEPCO and PSO continue to make progress to recognize the Storm Uri expenditures. As a reminder, we filed for recovery of a lack returned over 5 years in Louisiana, Arkansas, Oklahoma, and Texas. PSO is moving forward with the state on the securitization of costs as premiering under Oklahoma law. We are continuing our efforts to secure approvals and clear clarity regarding investments necessary to with the EPA, CCR, ELG requirements. We received to construct the CCR compliance plans in Virginia, West Virginia, and Kentucky. While West Virginia approved ELG investments, Virginia, and Kentucky did not. West Virginia has since determined it was in the public interest to move forward with EOG investments for all 3 plans and has issued an order regarding in support of West Virginia investing to preserve the option for these plants to run past 2028, approving both the investment inward cost recovery from West Virginia customers. We'll be working with our commissions to implement the West Virginia decision and making the necessary adjustments to respect each state's decision. The Virginia Commission ask us to come back with more information, so we'll do that. We plan to lay out all the options before them, on how to satisfy their capacity needs. The Virginia PSC were approved the first-year revenue requirement of 4.8 million for broadband, which means we now have recovery for our world broadband efforts in both Virginia, and West Virginia. We continue to engage legislators and commissions, and other states and stand ready, to invest in synergistic mid-model broadband, to support advanced group technologies, and rural broadband for our communities. We also understand, it's all about execution. On September 10th, AEP began commercial operation of the 287-megawatt Maverick Wind Energy Center in North Central Oklahoma. Maverick was one of three wind projects that composed the North Central energy facilities, which will provide 1485 megawatts of clean energy to customers of our PSO and SWEPCO subsidiaries. The Traverse project, the largest single site wind farm in North America is well under construction and will come online in the January to April 2022 time frame. Transforming the way energy is generated, delivered, and consumed is necessary to support the needs of a clean energy economy and AEP continues to drive that transformation for the benefit of our customers and communities. With the success of doors central setting the foundation of our future forward regulated renewables platform, we are diligently working on securing additional renewable opportunities for our customers. RFP filings are going -- are ongoing and planned in multiple states. So more to come on this as we file for approval, after resources, as a result of the RFP that were out in the market for which some of you probably have heard of, we will be able to provide greater detail on the progress being made. Further, if federal efforts through the various tax proposals to extend and expand PTCs, ITCs for Clean Energy Resources succeed, even more benefits will be enjoyed by our customers. So now, we move quickly to the equalizer char now at this point, and I'll go quickly through this. So far, the average with the overall regulated operations is currently 9%. We generally target in the 9.5% to 10% range. So obviously we continue to work on that. AP Ohio came in at 9.3% for the third quarter, as blow authorized primarily due to timely recovery of capital investments, partially offset by higher O&M expenses. We expect that ROE to trend around authorized levels, as we maintain concurrent capital recovery of distribution, transmission investments. We also, as I mentioned earlier, expect the commission order here in the fourth quarter of '21. After it came in at 7.3%, as below authorized due to higher amortization, primarily related to what's hard coal-fired-generating assets, and higher depreciation from increase Virginia depreciation rates and capital investment. And as you know, we are still at the Appeals Court appealing -- the Virginia Supreme Court, which is currently outstanding. We filed appeal with that Virginia Supreme Court, so we're still waiting on that. As far as Kentucky is concerned, 6.9% below authorized due to loss of load from weak economic conditions and loss of major customers. Transmission revenues were also lower due to the delay in some capital projects. I&M came in at 10.3%. It's rare that's authorized ROE primarily due to increase in sales, partially offset by increased OEM and depreciation expenses associated with items continued capital investment programs. As far as PSO is concerned, came in at 7.6%. It's below its authorized level primarily due to increased capital investment currently not in base rates and higher than anticipated equity due to the extreme February winter weather event. And of course, we expect the commission order here on the rate case in the fourth quarter of '21. SWEPCO came in at 8.2% as well authorized due to increased capital investment currently not in base rates and the continued impact of the Arkansas share of the Turk plant that is not in retail rates. The Turkish, you again, accounts for about 110 basis points that we're not recovering in Arkansas. Again, as I mentioned earlier, we expect various commission orders, and particularly in Texas, in the fourth quarter of 2021, it's retroactive back to March. API Texas came in at 8.2% as below authorized primarily due to the significant level of investment in Texas. And of course, we have favorable regulatory treatment there with that annual DCOS and bi-annual TCOS filings to recover rates. So significant levels of investment in Texas will continue to impact the ROE. But the expectation is for the ROE to trend towards an authorized 9.4% in the longer-term. AEP Transmission Holdco came in at 11.2%. It was above authorized primarily driven by differences between actual and forecasted expenses. The transfer will benefit from a forward-looking formula rate mechanism, which helps minimize regulatory lag, and that forecasted dollar rate is around 11% in 2021. So overall, continue to make progress. Cases, obviously, we're waiting to hear the results of several cases that should provide some additional benefits, but that work continues. So, in closing, we are executing all and continue to drive the results expected of a premium regulated utility. The AEP portfolio is one that has enabled our investments in the wire side of the business supporting our transmission investments, including the $0.33 per share this quarter, through our AEP trends -- transmission Holdco investments. Our plan to transition our generation fleet and reduce carbon emissions by 80% by 2030 and net 0 by 2050 is well underway with 2 of our 3 wind facilities of our 2 billion investment in North-Central land under our belt, providing a solid foundation for the next decade of growth. Throughout this transition, we remain engaged in a trusted voice on energy transformation efforts, helping to ensure responsible transition to clean energy economy. And we will continue to support Federal efforts in that regard and State efforts as well. Finally, our strong quarter performance gives us the confidence again, to set our midpoint at 470, or the range of 465 to 475. And we continue to have all 17,000 employees dedicated to our customers and communities to enable the strong performance. Our discipline and controlling cost, our progress to manage the portfolio, and the significance of our future organic growth opportunities provides us with a confidence needed, in raising the midpoint and nearing the guidance range. Two weeks ago, I was really struck by the half time performance of the Ohio State Buckeyes marching band. They set their goals in my opinion, really high. Never do I expect to see a marching band dedicate their halftime show to the music of Rash (ph), to hear Tom saw your yyz(ph), the limelight and others, was truly amazing when they are difficult to even play. even though they were also marching while designing guitar players, drones, and other choreography on the field. The creativity and the execution came through to deliver a truly remarkable show. It made me think of our team at AEP, on November 11th, I've been AEP CEO for 10-years, I'm fortunate to lead a great Company with great people who have an outstanding track record of delivering on the promises made to investors and customers consistently year in and year out. And we fully expect to continue our drive to take this Company to the next level toward the clean energy economy and a solid infrastructure foundation bucks-rating aggressive goals and delivering with creativity and solid execution. With that, I will turn it over to Julie.
Julie Sloat : Thanks so much, Nick. Thanks, Darcy. And Nick I love your Buckeye reference. Go Bucks.
Nick Akins: I love that.
Julie Sloat : Thank you very much. Big game this weekend. Anyway, it's good to be with everybody this morning. I'm going to walk us through the third quarter and year-to-date financial results. I'll share some updates on our service territory load, and finish with some commentary on financing plans, credit metrics, and liquidity. Let's go to slide six, which shows the comparison of GAAP top rating earnings for the quarter and year-to-date periods. GAAP earnings for the third quarter were $1.59 per share, compared to a $1.51 per share in 2020. GAAP earnings through September were $3.90 per share compared to $3.56 per share in 2020. There's a reconciliation of GAAP to operating earnings on Pages 14 and 15 of the presentation today. Let's go to Slide 7 where we can talk about our quarterly operating earnings performance by segment. Operating earnings for the third quarter totaled $1.43 per share or $717 million compared to $1.47 per share or $728 million in 2020. Operating earnings from the vertically integrated utilities were $0.87 per share, up $0.02. Favorable drivers included, rate changes across multiple jurisdictions, weather primarily in the West, transmission revenue and lower income tax. These items were offset somewhat by higher O&M expenses to in part to lower prior year O&M, which included actions we took to adjust to the pandemic and higher depreciation expense, as well as lower normalized margins and lower AFUDC. The Transmission and Distribution Utilities segment earned $0.31 per share flat to last year. Favorable drivers in this segment included rate changes, transmission revenue, and income taxes. Offsetting these favorable items were O&M expenses again, a function of lower prior year O&M associated with pandemic growing efforts, depreciation, and property taxes. The AEP Transmission Holdco segment continued to grow, contributing $0.33 per share, that was an improvement of $0.05, driven by the return-on-investment growth. Generation and Marketing produced $0.04 per share, down $0.09 from last year, includes by the prior-year land sales, lower retail volumes and margins, generation and income taxes. Finally, Corporate and other was down $0.02 per share driven by lower investment gains, and unfavorable net interest expense, which was partially offset by lower income taxes. The lower investment gains, are related to a pullback of some of the ChargePoint related gains, we've talked about on prior quarters. Let's have a look at our year-to-date results on slide number 8. Operating earnings through September totaled $3.76 per share, or $1.9 billion compared to $3.56 per share, or $1.8 billion in 2020. Looking at the drivers by segment, operating earnings for vertically integrated utilities, were $1.87 per share down $0.03, due to higher O&M and depreciation expenses. Other smaller decreases included lower normalized sales and wholesale load, higher other taxes, and a prior period fuel adjustment. Offsetting these unfavorable variances were weight changes across various operating companies and the impact of weather due to warmer than normal temps in the winter of 2020 and the summer 2021, which created a favorable year-over-year comp for us. Other favorable items in this segment included higher off-system sales, transmission revenue, net interest expense, and income taxes. The transmission and distribution utilities segments earned $0.85 per share, up a penny from last year. Earnings in this segment were up due to higher transmission revenue, rate changes, weather, normalized load, and income taxes. Partially offsetting these favorable items were increased depreciation, O&M, other taxes, and interest expenses. AEP Transmission Holdco segment contributed $1.02 per share up $0.27 from last year, related to investment growth and favorable year-over-year true-up. Generation and marketing produced $0.20 per share down $0.11 from last year due to favorable one-time items in the prior year relating to an Oklaunion ARO adjustment in the sale of Conesville and reduced land sales in 2021. Higher energy margins and low expenses in the generation business offset the unfavorable marketplaces on the wholesale business during storm yearly in February. We also saw an unfavorable result in retail due to lower power and gas margins. Income taxes were also unfavorable. Finally, Corporate matter was up $0.06 per share driven by investment gains and lower taxes and partially offset by higher O&M. Let me take a quick minute here to talk about the investment gain, which is predominantly a function of our direct and indirect Investment ChargePoint. As you'll see on the waterfall, was produced a $0.06 benefit year-to-date in 2021, as compared to the corresponding 2020 period. You may recall that in the fourth quarter at full-year 2020, this investment produced a $0.05 contribution, and we would expect the year-over-year bids to be more pronounced at this point in 2021, as we have no benefit during the same period in 2020. Turning to Page 9, I'll update you on our normalized low performance for the quarter. We, then, get into the specifics. Let me start by reminding everyone that everything you see on the slide is showing year-over-year growth. That means these numbers can be influenced by what was going on last year or what is happening now in 2021. Given all that occurred in the economy last year, it's obvious that these growth rates are at least partially being influenced by the comparison basis. This leads to the natural follow-up question like, how does today's low compare to pre -pandemic level? And I'll get to that question on the next slide. But before I do, let's take a look what a -- at what our normalized low growth was for the quarter. Starting in the upper left corner, normalized residential sales were down 1.6% compared to last year, bringing the year-to-date declined down to 9/10 of a percent. That means that last year, residential sales were up 3.8% in the third quarter when the economy was just starting to reopen. One year later, they're down only 1.6%, which suggests there has been a shift up in residential sales, as more businesses have embraced a remote workforce for jobs that can be performed at home. The last item to point out on the residential charges that you'll notice that we added a new bar to the right, showing our latest projection for 2021 based on the load forecast update. The original guidance assumed residential sales would decrease by 1.1% in 2021. The latest update showed an improvement as we now expect residential to end the year down 9/10 of a percent. Moving right, weather-normalized commercial sales increased by 5%, bringing the year-to-date growth up to 4.3%. Last year's third quarter commercial sales were down 4.6%. So again, we're seeing a net positive stories of commercial sales classes bouncing back faster than expected. And while we're seeing a strong bounce back and the sector's most impacted by the pandemic such as schools, churches, and hotels, we're actually seeing the strongest growth in commercial sales this year from growth in data centers, especially in the Central Ohio. To give you some perspective, last year, the sector was the 9th largest commercial sector across the AP system. Today, it's the 6th largest, and will likely move further up in the rankings as more data center loads are expected to come in online over the next several years. You will also notice that our latest load forecast update now suggests that commercial sales were end-year up 3.7% as opposed to the 0.5% decline assumed in the original guidance forecast. The economy has recovered much faster than we originally assumed, which is one of the reasons why we've updated the forecast and ensuring an improvement in that regard. In the lower left corner, you'll see that industrial sales also had a very strong quarter. Industrial sales for the quarter increased by 7%, bringing the year-to-date up to 4.2%. Industrial sales were up at every operating Company in nearly every sector. I point out, however, that the 7% growth in the third quarter this year did not quite offset the 7.8% decline experienced last year. Which means we still have a little more room to grow before the industrial class fully recovers from the pandemic recession. The good news is we have a lot of momentum to work with. The latest node update now projects industrial sales will end the year up 4.3%, which is 2.4% higher than assumed in the original guidance forecast. Finally, when you put it all together in the lower left corner, you'll see that normalized retail sales increased by 3% for the quarter and were up 2.3% for the first 9 months. But all indications that recovery from the pandemic and recession is happening faster than expected and our service territory is positioned to benefit from future economic growth. You'll recall that the original guidance forecast assumed normalized load growth of 2/10 of a percent in 2021. Based on our latest update, we're now expecting to end the year up 2.2%, which is a supporting factor in narrowing our earnings guidance range, and raising the midpoint for 2021. Turning to Slide 10, I want to answer the question from earlier, that asked how our current low performance compares to pre -pandemic levels. This bar chart is designed to answer that question. The blue bars are the same year-to-date bars that we shared on the prior page. As a reminder, these represent growth versus 2020, which was influenced by the restrictions implemented to manage the public health crisis. The orange bars here show how the year-to-date sales in 2021 compared to 2019, which was the most recent pre - pandemic year for comparison. These bars tell us how close we are to a full recovery from the pandemic. Starting at the left, you'll notice that a reported residential sales are down 9/10 of a percent compared to last year, but they're actually up 1.6% compared to our pre -pandemic levels. This is a gauge for how our customers behaviors have changed since the pandemic, with more people working from home. The next bar shows that while commercial sales are up 4.3% compared to last year. There are still 8/10 of the percent below the pre -pandemic levels. Given the recent growth we're seeing, especially in the data center nodes, we would expect commercial sales to fully recover nearly soon. Moving further, right, you can notice that while the industrial sales were up 4.2% compared to last year, they are still 3% lower than pre -pandemic levels. Given some of the headwinds for manufacturing today with supply chain disruptions, later shortages, et cetera, it may take a little longer before the industrial quest fully recovers from the pandemic recession. But we do expect to eclipse the pre -pandemic levels in 2022. In total, our normalized load is up 2.3% compared to last year and is now within 7/10 of a percent of being fully recovered from the pandemic, so it's safe to say that we're pleased with the strength and balance of this recovery in the AEP system. Let's check on the Company's capitalization and liquidity on Page 11. On a GAAP basis, our debt-to-capital ratio decreased 0.4% from the prior quarter to 62.2%. When adjusted for the storm during event, the ratio is slightly lower than it was at year-end 2022, sorry 2020, and now stands at 61.5%. Let's talk about our FFO to debt metric, as in the first and second quarter. Effective storm yearly continues to have a temporary and noticeable impact, on this 2021 metric. Taking a look at the upper right quadrant on this page, you'll see our FFO to debt metrics based on traditional Moody's and GAAP calculated basis. As well as an adjusted Moody's and GAAP calculated basis. On a traditional unadjusted basis, our FFO - to -debt ratio increased by 0.9% during the quarter to 10.2% on a Moody's basis. And just, again, reiterate, radio agencies continue to take the anticipated recovery into consideration as it relates to our credit ratings. So very important to note that. On an adjusted basis, the Moody's FFO-to-debt metric is 13.6%. This figure removes or adjusts the calculation to eliminate the impact of approximately 1.2 billion of cash outflows associated with covering the unplanned urine-driven fuel and purchase power in the SPP region, directly impacting PSO and SWEPCO in particular. The metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. This should give you a sense of where we would be from a business - as -usual perspective with that 13.6%. Importantly, as Nick mentioned, the recovery of the fuel and purchase power expense in the PSO and SWEPCO jurisdictions is well underway and we're making progress. As a result, inconsistent with what we have previously communicated, we still anticipate our cash flow metrics to return to below the mid-teens target range next year. Obviously, we are trying to push towards the mid-teens range, but that will take us a little while longer, but we're definitely on our way there. And as you know, we'll keep you posted on our progress. Before we leave the Balance Sheet topic, I do want to make note of the intended change to our 2022 financing plan, in light of our announced sale of Kentucky Power and Kentucky Transco. You may recall that we had planned to issue $1.4 billion of equity in 2022, that's inclusive of $100 million dividend reinvestment plan to fund our growth Capex program, where we will provide our typical 3-year forward annual review of our cash flows and financial metrics at the upcoming EEI Conference, where we can expect to see is that the 2022 forecast will be adjusted to eliminate the previously planned $1.4 billion of equity financing that I just mentioned with any residual proceeds being used to reduce a small portion of the 2022 debt financing that we had planned. These actions will have no impact on our previously stated credit metric targets or messaging in that regard. On the slide deck today, on page 39, you'll see our current cash flow forecast, with which you are already familiar, We've included a note on the side to reflect the fact that the numbers have not been updated for the announced Kentucky transaction, along with the red circle around the 2022 financing -- equity financing amount that will be changed and updated when we roll out the new view in a couple of weeks in conjunction with the EEI conference. So, while we're talking about the Kentucky transaction, I can also share that we expect that the sale will be $0.01 to $0.02 accretive in 2022, and we will reflect this in our 2022 earnings guidance that we provide to you at the EEI Conference. Okay. So back to our regularly-scheduled earnings call programming and commentary. Let's take a quick moment to visit our liquidity summary on the lower right slot -- side of Slide 11. Our 5-year $4 billion bank revolver and 2-year $1 billion revolving credit facility, along with proceeds from the quarter-end debt issuance, support our liquidity position, which means we were strong at $5.1 billion. If you look at the lower left side of the page, you will see that our qualified pension continues to be well funded at a 104%. Additionally, our OPEB is funded at a 173.9%. Let's go slide 12 and I'll do a quick wrap up and we can get to your questions. Our performance through the first 3 quarters of this year gives us confidence to narrow our operating guidance to the upper half of our current range, resulting in the new range of $4.65 per share to $4.75 per share with a midpoint of $4.70 per share. As we stated, we are committed to our long-term growth, rate target of 5% to 7%. Today's 2021 earnings guidance revision is yet another demonstration of our drive to deliver performance in the upper half of our guidance range. From a strategic perspective, we're making significant progress in addressing items that are top of mind for our current and perspective investors. We're mounting contract to sell Kentucky Power and Kentucky Transco, which we expect to complete in the second quarter of 2022. This transaction enables us to avoid the 1.4 billion equity issuance, that was part of our original forecast, would share with you for 2022. Therefore, alleviates the overhang, the equity overhang. Also allows us to deliver transaction that we estimate to be 1 to 2 in 2022. We will be more able to do this, while concurrently preserving our ability to get our FFO to debt metrics comfortably, into that mid to low teens range by 2022, which is commensurate with a Moody's BAAT stabilizing, as we continue to target that. The intention is to remain in this credit metric range. Again, with a preference to try to get closer to that midpoint, as we move along in time. All of this positions us to continue our generation transformation, which is underpinned by the renewable investment opportunity we have shared with you in complemented by our ongoing energy delivery investment. So here you can expect to see from us at the upcoming EEI Conference in early November. In addition to the updated 3-year forward cash flow and financing plan, we'll be introducing and sharing the details behind our 2022 Earnings Guidance and our longer-term capital plan, we typically got out 5 years, all of which will incorporate the effects of the announced Kentucky sales. So, with that, surely, we do appreciate your time and attention and I'm going to turn it over to the operator so we can get to your questions.
Operator: Thank you. Also please, take up your handset before pressing any buttons. We will go first to the line of Julien Dumoulin Smith. Your line is open. Go ahead, please. I'm sorry. I'm having some technical difficulty, one moment while we open your line. Your line is open. Go ahead, please.
Julien Dumoulin Smith : Thank you. Can you hear me now?
Nick Akins : Hey you doing and how you?
Julien Dumoulin Smith : Hey, quite well. Thank you. Congratulations on the transaction there. Nicely done.
Nick Akins : Yeah, I'm angst.
Julien Dumoulin Smith : Absolutely. So perhaps just to dive into that one a little bit more, can you talk about what happens with the Mitchell plant here, just as a function of the sale, will it get transferred to Wheeling, how are you thinking about that vis -a - vis liberty, and any kind of pricing there, and in terms of transfer, what have you?
Nick Akins : Yes. That's why the operating agreement is being followed. Wheeling would become the operator and it does get transferred to Wheeling in 2028. And so that's really -- we're continuing with Kentucky being half-owner of Mitchell until that period of time. So, the Wheeling will take over the operations of the plant, the employees will move over to wheeling as well. And then we'll continue working with the West Virginia and Kentucky commission to get resolved the operating agreement and related issues. And then, of course, at the end -- at 2028, it transfers over at fair market value . So that's the plan. And that will get followed here in November and December time frame and we'll go through that. And actually, both commissions have the incentive to get this resolved because we do have various views of the ELG piece of it. So regardless of whether we had this transaction or not, we would be needing to fall for the operating agreement change out just because the different directions of the commissions have gone. So, we'll get that resolved as part of process to the overall approvals.
Julien Dumoulin Smith : Excellent. Nicely said -- nicely done. Fair market value it is. And then just vis -a - vis, ongoing transactions in portfolio evaluation of really a review with the equity means here in the very near-term, how do you think about just continued evaluation a portfolio? I mean, clearly, it's not necessarily a near-term dynamic, but want to give you the opportunity to speak to that a little bit further.
Nick Akins : Yes, sure. I said over and over, I guess for a couple of years now but even beyond that. We do have to get to portfolio management to enable us to look at the sources and uses of the capital needs that we have. And to manage the balance sheet, as Julie has mentioned. We target the mid-teens, and we want to get there, and obviously, we're well on our way of getting there. So, we want to do that, but at the same time, be able to fund the capital growth. And when you think about it, we've sold the unregulated generation, we sold Rover Rob's, we sold some hydro-related facilities. With Kentucky, we're talking about 6 billion of assets that have been sold, but they fueled substantial growth. I mean, to the tune of 7 billion a year in capital. It's part of the process to determine what the portfolio, needs to be in the future and we will continue to do that. Certainly, we have Chuck, and Julie, and others will continue to review that portfolio, and we will manage it in a proper way. I'll say this, Kentucky Power, you think about the threshold -- at one point we talked about we always invested in coal units no matter what. And, obviously, we've changed that focus to make sure it's more deliveries of in terms of the decision points that are made. It's quite a move for AEP to get to a point where we're managing our portfolio in a way that, first of all, we became fully regulate, and then we start to look at that portfolio to determine what's the best approach to fuel 20 billion in potential renewables investment. So, when you think about that, we have to consider it. And I can tell you, the last time we sold a regulated utility was, I guess, the Scranton Pennsylvania System, and then the Pennsylvania -- in Pennsylvania and the New Jersey system back in the 1940s and 50s. So, it's a pretty substantial change. And when you think about Kentucky Power sales, it was one of the first acquisitions of American Gas and Electric in 1922. So, by the time we get through this, it's been 100 years. So, when you think about the threshold level of portfolio management that has occurred in this Company, it really should show a lot on terms of our seriousness of making sure that we're managing that portfolio in the proper way. That's probably longer answer than what you asked for, but I want ed to at least get all that out there.
Julien Dumoulin Smith : Very much appreciate it. I'll leave it there. Speak with you guys soon.
Nick Akins : Okay.
Operator: We'll next go to the line of Shahriar Pourreza with Guggenheim Partners. Go ahead, please.
Nick Akins : Good morning, Shahriar.
Shahriar Pourreza : Good morning, guys and congrats on Kentucky.
Nick Akins : Yes.
Shahriar Pourreza : Just a follow-up on Julien's question a little bit more. As we think about trigger points for another asset sale what's kind of a catalyst because the 10-gigawatts of solar wind that you're looking to build through '25. I mean, even if you assume a 50-50 on PPA structure could yield an incremental $3 billion rate of spending opportunities. And you obviously have a slope of IRP. So do you need to see affirmations with the various filings or actual approvals in GRC. So how should we think about how these could be funded, especially in light of where the stock trades. So, yes.
Nick Akins : When you think about the way we're approaching the renewables fees, that the process has been, that we term the need for equity associated with those particular investments, when they actually come online and we get regulated recovery. So, we get the cash flow to support, those investments at the time they come online. That means, obviously our FFO to debt doesn't suffer as a result of that. So, if we continue that approach, and keep in mind too, I've always said that, for us to take a look at a regulated entity or other parts of our portfolio, doesn't match the future needs in terms of, where we are and where we're going as a Company. Is there, if we have a chronically under-performing part of the portfolio, then it's important for us to take a look at. That may be temporary, it could be long term, but certainly we have to make sure that we're evaluating each one of these assets in a way that says, okay. It doesn't matter where it's located, as long as we're getting certainly the return expectation and also the forward view of the utility is positive as compared to with others. So, we have to compare in various parts of our service territories and that's where we make those decisions.
Shahriar Pourreza : Perfect. And then just Nick, appreciate we're going to head into EEI we'll get an update here. But do you see the current renewable additions at least through '25 the 10 gigawatts, right, between solar and wind swinging materially with some of these counteractive items like federal policy benefits versus the input cost pressures we're seeing in the space impacting some project timings. So, do you see any of this swinging at all?
Nick Akins : Yeah, I do. And in your -- when we'd actually go do the analysis and we've done analysis for all the jurisdictions, but conditions changed, low changes certainly PTCs, ITCs can change as a result, which changed the business cases were some may have been on the margins particularly in the east now become benefits to customers. So, I think those numbers will continue to change and I can tell you from what I've seen so far. Those numbers will change. And some will go out, some will go down. But overall, normally, it should be on path, what we've talked about. And we'll have more to report on that. Probably during first quarter '22, because we'll have the integrated resource plans. And when those integrated resource plans are filed, that's where I mentioned today is you will have a more definitive view of what those projects look like because there will be the results of RFPs and there will be the results of actual projects that are put in for regulated approval. So, more definition, but I would certainly say that normally they will be in that category we've previously discussed.
Julie Sloat : And sure. What you should anticipate is when we go to EEI, you'll see a refreshed 5-year forward Capex plan, so '22 through '26, and you'll start to begin to see a little bit more of this renewable opportunity dropped in. So, stay tuned for that, and we'll be able to talk more granularly with you here in a couple of weeks.
Nick Akins : Yeah. And I would say that when you see that, it certainly will reflect, I don't know if you call it a risk-adjusted approach or whatever, but it's a nominal view for us to make financing plans, and then just like with North Central, we make decisions on whether it goes up or down based upon our ownership.
Shahriar Pourreza : Got it. Cheers to you guys. Congrats on the results. See you soon.
Nick Akins : Thank you.
Operator: We will next go to the line of Steve Fleishman with Wolfe Research. Go ahead, please.
Steve Fleishman : Hey, good morning. Can you hear me, Nick?
Nick Akins : Yes. Yes. I hear you.
Steve Fleishman : Okay, great. Thanks. Okay. One question that might be a bit premature, but there's obviously a lot going on in DC with the reconciliation bill and the like, and one of the provisions that's gotten more focused on this few days is the minimum tax provision. And I just be curious, how you're thinking -- for larger companies like yourself, how you're thinking if that has any impact for largely regulated utility like you or does it not really have much of an impact?
Nick Akins : Well, I would say, and we've been vocal about this and the industry has been vocal about it, if you put a minimum 15% tax and a lot of us are, as you know, heavy on capital, and its growth capital, and it's also infrastructure-related capital. So, an increase with the minimum tax would certainly have an accruing effect on our ability to continue with not only development of infrastructure and having effect on that, not to mention customers’ bills ultimately because the taxes were passed through to our customers. But also, the administration has a focus on green energy and it will have an effect on renewables transformation that's existing as well. So, I think I think they'll put a pail over all the utilities’ ability to continue invest in capital in the way that we are. Now, if we do that, then obviously there's customer impact associated with it. And again, it's a hidden tax on our customers. So, we're not for that provision. I think actually, we've been very worthwhile about this and trying to be an honest broker when we're talking about CEBP and all the other things that -- it was important for us to be able to make this transformation from a clean energy standpoint. Certainly, the PTCs, ITCs with expansion of long-term storage, nuclear, and certainly in terms of wind and solar, are very important to continue those process, to move to clean energy economy, and we can go a long way there. This industry is very focused on doing that, and any kind of tax headwind that goes the other direction is not helpful. I think you probably hear that across-the-board.
Steve Fleishman : Okay. More to direct AP things. Just on the approval for the Kentucky sale, could you remind us what the standard for approval is in Kentucky? Is it just in the public interest or that benefits?
Nick Akins : Yes. But it's in the public interest, obviously. Because they have to look at the suitor and determine is that the right route approach. And as I've done in the proper way and actually there has been some discussions in Kentucky previously. I think it's probably gone past some of that now that -- I want to make sure we were operating Kentucky the way we should. And we've been operating it the way we always have. So, we've been investing, we've been doing the things that we need to do. Whether we owned it or not. And I think certainly the buyer has recognized that and during the transition, we will continue to support a smooth transition to ensure that the services provided and things that need to be done to make Kentucky Power successful, we'll be there to do it. And of course, we'll support Liberty Utilities in Algonquin in doing that.
Steve Fleishman : Great. And then one just quick question maybe for Julie. The proceeds from the Kentucky sale look like they're matching up one for one with reducing the equity need. But obviously when you sell an asset, you lose some cash flow, albeit Kentucky maybe wasn't having the best cash flow. So, are there offsets in other businesses that are making up for the lost cash flow from the asset sale?
Julie Sloat : Yes, thanks for the question, Steve. You're right. I mean, we do lose the funds from operations that relates to Kentucky and Kentucky Transco. Although, we got to keep in mind that we also eliminate about $1.3 billion of debt associated with those assets to because that goes away. And the marathon that we think through, just to take it a step further is if we avoid issuing equity, we avoid having to cover off additional dividends that were in our original plan. So, another to a sidestep that as well. And that comes with, maybe also having some additional dollars to reduce debt. As I mentioned in my opening comments, anything above and beyond that $1.4 billion which channeled toward debt reduction that was otherwise planned for 2022. And then also, keep in mind that Kentucky Power had barely strained FFO - to -debt to begin with. So, to eliminate that piece of, I guess, drag to the overall average FFO -to-debt for their organization is also a net positive for us. So, we are able to put these numbers together. And quite frankly, from an FFO - to -debt perspective, it is mildly beneficial and obviously a little bit of a cost on the debt-to-cap because we're not issuing additional equity. But the numbers all do hang together and coincidentally we'll be able to take literally that $1.4 billion of planned equity out of the plan, and again, you'll see that at EEI when we'll refresh the forecast.
Steve Fleishman : Great. Thanks so much.
Nick Akins : Thanks, Steve.
Operator: Well let's go to the line of Durgesh Chopra with Evercore ISI. Go ahead, please.
Nick Akins : Morning, Durgesh.
Durgesh Chopra : Hey, good morning, Nick. Maybe just along the FFO-to-debt lines, my first question is to Julie. In terms of 2024, I'm thinking about your equity needs in my model shift used to target for FFO to debt. Actually, is it mid-teens or is it low to your ? Because, obviously, that's going to dictate, right, how much equity you might need in 2024. So, any color you could share there?
Julie Sloat : Got you. You'll see 2024 when we rollout our EEI guidance, so 3 years forward. But, as we continue to say, we are talking about mid - to -low teens. And the reason I say that is, as I mentioned today, if you look at our FFO to debt on an adjusted basis, so backing out the yearly consequence, we have something like 13.6% on a Moody's basis. As you know, our target has been to be around that Baa2 stable rating. That's why we talk about mid - to -low teens or low - to -mid teens. Obviously, our preference and our expectation are to start to push more towards what I would characterize as mid. It'd be nice to have at least a 14 handle on that FFO to debt, and that is absolutely the plan, but we'll be able to share more with you as we get to EEI and build that forecast, but I wouldn't change how you're thinking about it. So, thinking about mid to low teens as it relates to Moody's BAAT, with a preference towards 14 plus percent.
Durgesh Chopra : Got it. So, some of that moment to low teens through 2024 yeah. A big picture question, we've talked in depth about natural gas prices. So maybe just talk about your gas generation portfolio, fuel costs, any hedges in impacting customer bills?
Julie Sloat : I will take this from a customer rate perspective as I could, because that's how we think about it. Because ultimately this impacts our customers. When we think about, for example, a decent sensitivity analyses around, let's say a 10% hike in natural gas prices as we all know, they've gone up substantially. The impact to customer rates varies significantly from 1 operating Company to the next, depending on the field mix. So, for example, if I looked at Appalachian Power Company, the average residential impact price in terms of the 10% hiking gas prices would equate to about a 0.9% increase in the customer's rate. Let's compare and contrast that to say PSO or SWEPCO, whether there's much more gas concentration. So PSO, we'd be talking about 1.6% increase in customer rates. SWEPCO, 1.5%. So, this is something we're very sensitive to, because as you know, overall, we're extremely sensitive to customer rate increases and the aggregate as we continue to execute on our general Capex program. I don't know if -- Nick, you had any additional comments.
Nick Akins : I'd say certainly, your question actually shows the reinforcement of our renewable’s transformation because it's a perfect edge to natural gas of North Central were in place during the time of storm Yuri. It would have saved customers $225 million. So, when you think about the process we're going through, it's great to have natural gas it's -- and certainly -- but at the times where you can layer in renewables to do that, it turns out to be a significant benefit to consumers. So, it reinforces that. And I think probably this winter will show it.
Durgesh Chopra : Understood. Thanks, guys. I appreciate the time.
Julie Sloat : Thank you.
Operator: We'll next go to the line of Andrew Weisel with Deutsche Bank. Go ahead, please.
Nick Akins : Good morning, Andrew.
Andrew Weisel : Hey, good morning. Thanks for a lot of good updates here. One remaining question I had was after a few rate case settlements and expectations for several other outstanding cases to be resolved in the coming months, can you share your expectations around which sub we might file new rate cases over the next 12 months or so?
Nick Akins : We are -- I'm trying to think of what else will you be filling because just down here with jurisdiction we got a case that we expect approval of and certainly a lot of cases they're still ongoing and just about all the jurisdictions. So, I'd say we're always reviewing that on a regular basis at this point. We are playing with active cases that we got to get across the finish line and then determine where we are at. The other part here is looking at what happens with denominator because Julie mentioned, low is changing significantly and it continues to do that as we emerge from hopefully a post-COVID world. And if that's the case, then that would be a determinant in terms of when we would file for any case. I think, of course, if we do have tax changes that occur, then that'll force a whole new view going forward to many of these cases. Just like it did when we got tax reform last time around, except this one, maybe, on the upside.
Andrew Weisel : Okay, great. So, would it be fair to say that '22 at least the other second half of '22 might be a quieter year as far as the regulatory calendar than what we currently have?
Nick Akins : Probably quieter in terms of filings, but probably noisy in terms of results.
Andrew Weisel : Alright. Thank you very much.
Operator: We will go on next, one, please. We'll go next to the line of Michael Lapides with Goldman Sachs. Go ahead, please.
Michael Lapides : My name I'm fine. Rough year for your -- by you being goals this year. A lot of change. Hey, got a couple of questions for you. What the Kentucky sale and you guys have -- your slide number five. I think it says, over the years has done a good job of detailing how hard it's been on authorized in Kentucky. Now that Kentucky will be offshore play, when you look at the other jurisdictions, what are the ones that we say, hey, we still struggle to own authorize here? What are the structural changes? Whether it's legislation and we've seen lots of utilities in places like North Carolina, Kansas, Missouri, go in and make structural changes via legislation. What are the structural changes you are going to seek, outside of just normal rate case filings, that could help improve authorized versus in those jurisdictions.
Nick Akins : You're seeing a fundamental shift and all the remaining operating companies. We made a lot of progress on Ryder's and we have a lot of focus on getting concurrent recovery in cash in the door and what you're seeing really in terms of a lot of these lags, is the amount of investment that we're placing in these companies. But as well as you make the transition from certainly from wires related activities with Ryder's and then the renewables conversion that occurs, the way we're doing the renewables is commensurate with the recovery. So, we should see the authorized -- our returns be closer to the authorized as time goes forward. We don't see any fundamental issues in any of the jurisdictions that are left that says that we have significant headwinds. I mean, the only thing you could probably point to is the Turk issue at SWEPCO, but other than that -- and actually, when you think about Arkansas, we keep saying we're not recovering the Arkansas portion of the Turk. That's not because of the commission. That is because of the Supreme Court of Arkansas. So, we've got very good relations with the commissions and all the jurisdictions, and we feel like the fundamentals are there for continued improvement relative to that regulatory lag that exists. And because we're spending on more areas and our generation is really renewables, and that's helping out, every time we put an investment in, and the timing of the investment improves the FFO-to-debt, improves the returns of the individual companies. And I think we'll continue to make progress in that regard. So, I would be -- I'm pretty optimistic that we'll continue to make progress in all of these jurisdictions.
Michael Lapides : Got it. And just a quick follow-up, and just maybe a Julie one. Just curious when we think about your multi-year -- your guidance growth rate and the language around wanting to be at the high end, outside of the transmission segment, the standalone segment, what does that embed as an earned ROE at the rest of the regulated businesses?
Julie Sloat : Michael, we always -- as Nick mentioned, we strive to be in the upper half of the guidance range, not necessary the upper end, although that 'd be very nice. So just a point of clarification there. And as it relates to returns, as you can see, we've kind of been hovering around the 9% ROE return level. I think that's a safe place for you to assume that we'll kind of hang out there for a while until we get a little more traction. And the other thing if I could, circling back to your original question, when we look at the equalizer chart, often times we get questions around AEP taxes and why the lower we relative to authorize there, and so back to your question around growth and how do you manage the business, AEP Texas, we continue to invest a significant amount of capital on an annualized basis. And while we have very progressive rate recovery mechanisms in place that we really enjoy, I can tell you this, while the ROE may look a touch depressed relative to authorize, that Company continues to produce earnings growth and to save the 8% to 10% range. So that certifies our ability, back to your original point, getting that upper 1/2 of the range. So again, ROE, our system-wide average, assume roughly around 9% - ish and trending upward over time. And then around AEP Texas, k keeps in mind, the capital is intentional there as we continue to try to take care of the customer and grow that business. And it's paying dividends in 8% to 10% EPS growth out of it.
Nick Akins : And another thing if we look at is, we haven't gone that pages is actually the increase in equity layers as well. So, you see improvement in the equity layers and then, we're still investing and still meeting the 5% to 7% and being the upper half and that kind of thing. And of course, we continue to manage the FFO to debt towards the mid-teens. So that -- all of the pieces are starting to fit together. And there's a lot of optimization that will occur for us to -- how to execute on to ensure that we're continuing to meet the earnings objectives. But at the same time investing in the right things and enable us to bridge that gap on the regulatory lag.
Michael Lapides : Got it. Thank you, guys. Much appreciated. Congrats to have Kentucky.
Nick Akins : Yeah. Sure thing.
Julie Sloat : Thanks.
Operator: All right. Speakers, we have no one else in queue at this time.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Allen, would you please give the replay information?
Operator: Absolutely. Ladies and gentlemen, this conference will be made available for replay beginning at 05:30 PM today, October 28th, 2021 and lasting until November 4th, 2021 at midnight.
Operator: That will conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. Welcome to the American Electric Power Third Quarter, 2021 Earnings Conference Call. At this time, your telephone lines are in a listen-only mode. Later there will be an opportunity for questions and answers. If you would like to ask a question during the call, You have an indication you've been placed into queue, and you will move yourself from the queue by repeating the one as we command. Now as a reminder, your conference call today is being recorded. I will now turn the conference call over to your host, Vice President of Investor Relations, Darcy Reese. Go ahead please."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Allen. Good morning, everyone and welcome to the Third Quarter 2021 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides and related financial information are available on our website at www. aep.com. Today we will be making Forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President, and Chief Executive Officer and Julie Sloat our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay. Thanks, Darcy. Welcome again, everyone to American Electric Power's third quarter 2021 earnings call. Today we're pleased to report a strong third quarter operating earnings of a $1.43 per share for the third quarter, this brings our year-to-date operating earnings to 376 per share versus 356 per share last year, which gives us confidence in raising the midpoint of our guidance range for 2021. AEP service territory continues to prove us with resiliency and stability with continued economic recovery experienced in the third quarter. In fact, AEP posted the strongest sales quarter in over a decade, and the gross regional product for the AEP footprint of third quarter was the highest on record, as well as job growth being the strongest since 1984. The strength and diversity of our portfolio, the robustness of our organic growth opportunities, and our consistent ability to execute against our plan places AEP among what we believe should be one of the country's premium regulated utilities. Our strength -- our strong performance this quarter, coupled with the level of economic recovery experienced within our footprint, provides us, once again, the confidence needed to raise our midpoint to 470 per share and nearer, the 2021 guidance range to 465 to 475 while reaffirming our 5% to 7% long-term earnings growth rate. And as I've stated previously, I would still be disappointed if we were not in that upper half of our long-term growth rate. The driver of our strong performance is the talent and commitment of our employees. Our front line of central service work teams has continued to adapt to ensure the needs of our customers and communities are met day in day -- day in and day out throughout the pandemic. Like many industries, the face of work for AEP will never be the same. As employees return to the office, we have taken actions to ensure the safe return to the workplace environment. I remain appreciative of the dedication of our employees and have the utmost confidence in their continuing ability to successfully check and adjust as we adapt to the future. We believe that this new work environment will continue to enable more efficiency, flexibility, and creativity, that will contribute to the culture to excel in meeting our strategic objectives. This new future of work along with digitization and automation will continue to provide benefits for our Achieving Excellence program. Our growth opportunities over the next decade are significant driven by our future forward renewables plan, that over 16 gigawatts of new renewables resources by 2030, and the transmission distribution investments needed to support the needs of a clean energy economy for our customers and communities. Additionally, the completion of a strategic review of our Kentucky Companies and our decision to move forward with the sale delivered utilities enables us to focus our attention on executing that transaction and delivering on our gross strategy. So, let's cover the announced sale of Kentucky Power. Earlier this week, on Tuesday at market close, we announced the sale of Kentucky Power and Kentucky Transco to Liberty Utilities, the regulated utility operation of Algonquin Power. The sale was a result of the strategic review that we launched back in April. The sale was subject to regulatory approvals, including approvals from the Federal Energy Regulatory Commission which is within a 180 days, and the Kentucky Public Service Commission, within a 120 days. The transaction was also subject to federal clearance pursuant to Hart-Scott-Rodino, which typically is within 30 to 60 days, and the clearance from the Committee on Foreign Investment in the U.S., within 90 and a 120 days for that approval. We anticipate making these regulatory filings in late November and early December. Separately, we will file -- with both the Kentucky, West Virginia and full commissions with necessary changes to the metro plant operating agreement to accommodate the ELG investments recently approved by the West Virginia Commission. The following will include a plan to resolve the question of Mitchell ownership post 2028. Both state commissions are expecting these filings as both issued recent orders directing us to do so. These filings will be made in the mid to late November time frame. We're also very pleased with the outcome of the strategic review and know that the future owner of our Kentucky assets will be a great steward for all stakeholders in Kentucky, our value employees, customers, and certainly the communities. Lastly, I want to thank all the Kentucky employees and the corporate support employees for their patience, during this review and for their continued focus on safety and operational excellence during this period, and as the transaction is completed. Now, moving to several of the regulatory activities. In Ohio, we expect an order in the fourth quarter on the settlement reached and filed with the Commission earlier this year. As a reminder of the settlement has broad support from the settling parties, including the commission staff, Ohio consumers’ counsel, Industrial companies, commercial companies, and other entities like Ohio Hospital Association. Additionally, AEP Ohio's grid smart Phase III settlement was filed yesterday and paves the way to continue our deployment of advanced smart grid technologies, including completion of our AMR meter rollout, the remaining 475,000 rollout customers. The unopposed settlement with support from commission staff allows consumer's counsel and several of our largest customers demonstrates that AEP Ohio continues to maintain a great working relationship with our regulator and interested parties. Public Service Company of Oklahoma reached a settlement in the rate case with the Oklahoma staff and other parties. The settlement was presented to the commission on October 5th. The black-box settlement includes 50.7 million net increase in rates while adding another 102.7 million in base rates. In addition to continuing the practice of allowing some interim recovery of Capex riders, the rider collecting for Maverick and Sundance North-Central wind assets was also included, in orders expected by year-end with rates reflected in November bills. In Indiana, the unfollowed base rate case on the July 1st based on a future test year model seeking 97 million in net revenue increase with a 10% ROE. Major items included recognition of over 500 million in capital investment per year in Indiana continuation of the transmission tracker a federal tax rider in the event of a change in federal tax rates and the advancement of AMI to provide customers greater control insight into their usage. The hearing was set before the Indiana Utility Regulatory Commission on December 2nd, with an order expected by April of '22. In a Southwestern Electric Power Company's jurisdictions cases are pending in Louisiana, Texas, and Arkansas. The SWEPCO Texas Commission deliberations set for November 18th. Parties filed exceptions to the preliminary draft order issued by the hearing and replies. So those exceptions were filed yesterday. SWEPCO is seeking a net revenue increase of $73 million with an ROE of 10.35%. Our file includes investments made from February 2018, accelerated depreciation for plant, a strong reserve, increased vegetation management. We expect an order in the fourth quarter with rates being retroactive back to March of '21. In SWEPCO Louisiana testimony has been filed a hearing scheduled for January of '22. A case $6 million to $73 million net revenue increase and a 10.35% ROE in order to expect between the second third quarter of '22. And so, at Arkansas, we were seeking a $56 million net revenue increase with a 10.35 ROE. The following contains with formula rate plan for subsequent years and considers the pending retirement of previously announced call net assets. This fall, we used time to align with the North-Central in-service dates and the provided mechanism both for recovery of costs associated with the investment and flow through of the PTC in SWEPCO customers. The hearing is set for March of '22. Both SWEPCO and PSO continue to make progress to recognize the Storm Uri expenditures. As a reminder, we filed for recovery of a lack returned over 5 years in Louisiana, Arkansas, Oklahoma, and Texas. PSO is moving forward with the state on the securitization of costs as premiering under Oklahoma law. We are continuing our efforts to secure approvals and clear clarity regarding investments necessary to with the EPA, CCR, ELG requirements. We received to construct the CCR compliance plans in Virginia, West Virginia, and Kentucky. While West Virginia approved ELG investments, Virginia, and Kentucky did not. West Virginia has since determined it was in the public interest to move forward with EOG investments for all 3 plans and has issued an order regarding in support of West Virginia investing to preserve the option for these plants to run past 2028, approving both the investment inward cost recovery from West Virginia customers. We'll be working with our commissions to implement the West Virginia decision and making the necessary adjustments to respect each state's decision. The Virginia Commission ask us to come back with more information, so we'll do that. We plan to lay out all the options before them, on how to satisfy their capacity needs. The Virginia PSC were approved the first-year revenue requirement of 4.8 million for broadband, which means we now have recovery for our world broadband efforts in both Virginia, and West Virginia. We continue to engage legislators and commissions, and other states and stand ready, to invest in synergistic mid-model broadband, to support advanced group technologies, and rural broadband for our communities. We also understand, it's all about execution. On September 10th, AEP began commercial operation of the 287-megawatt Maverick Wind Energy Center in North Central Oklahoma. Maverick was one of three wind projects that composed the North Central energy facilities, which will provide 1485 megawatts of clean energy to customers of our PSO and SWEPCO subsidiaries. The Traverse project, the largest single site wind farm in North America is well under construction and will come online in the January to April 2022 time frame. Transforming the way energy is generated, delivered, and consumed is necessary to support the needs of a clean energy economy and AEP continues to drive that transformation for the benefit of our customers and communities. With the success of doors central setting the foundation of our future forward regulated renewables platform, we are diligently working on securing additional renewable opportunities for our customers. RFP filings are going -- are ongoing and planned in multiple states. So more to come on this as we file for approval, after resources, as a result of the RFP that were out in the market for which some of you probably have heard of, we will be able to provide greater detail on the progress being made. Further, if federal efforts through the various tax proposals to extend and expand PTCs, ITCs for Clean Energy Resources succeed, even more benefits will be enjoyed by our customers. So now, we move quickly to the equalizer char now at this point, and I'll go quickly through this. So far, the average with the overall regulated operations is currently 9%. We generally target in the 9.5% to 10% range. So obviously we continue to work on that. AP Ohio came in at 9.3% for the third quarter, as blow authorized primarily due to timely recovery of capital investments, partially offset by higher O&M expenses. We expect that ROE to trend around authorized levels, as we maintain concurrent capital recovery of distribution, transmission investments. We also, as I mentioned earlier, expect the commission order here in the fourth quarter of '21. After it came in at 7.3%, as below authorized due to higher amortization, primarily related to what's hard coal-fired-generating assets, and higher depreciation from increase Virginia depreciation rates and capital investment. And as you know, we are still at the Appeals Court appealing -- the Virginia Supreme Court, which is currently outstanding. We filed appeal with that Virginia Supreme Court, so we're still waiting on that. As far as Kentucky is concerned, 6.9% below authorized due to loss of load from weak economic conditions and loss of major customers. Transmission revenues were also lower due to the delay in some capital projects. I&M came in at 10.3%. It's rare that's authorized ROE primarily due to increase in sales, partially offset by increased OEM and depreciation expenses associated with items continued capital investment programs. As far as PSO is concerned, came in at 7.6%. It's below its authorized level primarily due to increased capital investment currently not in base rates and higher than anticipated equity due to the extreme February winter weather event. And of course, we expect the commission order here on the rate case in the fourth quarter of '21. SWEPCO came in at 8.2% as well authorized due to increased capital investment currently not in base rates and the continued impact of the Arkansas share of the Turk plant that is not in retail rates. The Turkish, you again, accounts for about 110 basis points that we're not recovering in Arkansas. Again, as I mentioned earlier, we expect various commission orders, and particularly in Texas, in the fourth quarter of 2021, it's retroactive back to March. API Texas came in at 8.2% as below authorized primarily due to the significant level of investment in Texas. And of course, we have favorable regulatory treatment there with that annual DCOS and bi-annual TCOS filings to recover rates. So significant levels of investment in Texas will continue to impact the ROE. But the expectation is for the ROE to trend towards an authorized 9.4% in the longer-term. AEP Transmission Holdco came in at 11.2%. It was above authorized primarily driven by differences between actual and forecasted expenses. The transfer will benefit from a forward-looking formula rate mechanism, which helps minimize regulatory lag, and that forecasted dollar rate is around 11% in 2021. So overall, continue to make progress. Cases, obviously, we're waiting to hear the results of several cases that should provide some additional benefits, but that work continues. So, in closing, we are executing all and continue to drive the results expected of a premium regulated utility. The AEP portfolio is one that has enabled our investments in the wire side of the business supporting our transmission investments, including the $0.33 per share this quarter, through our AEP trends -- transmission Holdco investments. Our plan to transition our generation fleet and reduce carbon emissions by 80% by 2030 and net 0 by 2050 is well underway with 2 of our 3 wind facilities of our 2 billion investment in North-Central land under our belt, providing a solid foundation for the next decade of growth. Throughout this transition, we remain engaged in a trusted voice on energy transformation efforts, helping to ensure responsible transition to clean energy economy. And we will continue to support Federal efforts in that regard and State efforts as well. Finally, our strong quarter performance gives us the confidence again, to set our midpoint at 470, or the range of 465 to 475. And we continue to have all 17,000 employees dedicated to our customers and communities to enable the strong performance. Our discipline and controlling cost, our progress to manage the portfolio, and the significance of our future organic growth opportunities provides us with a confidence needed, in raising the midpoint and nearing the guidance range. Two weeks ago, I was really struck by the half time performance of the Ohio State Buckeyes marching band. They set their goals in my opinion, really high. Never do I expect to see a marching band dedicate their halftime show to the music of Rash (ph), to hear Tom saw your yyz(ph), the limelight and others, was truly amazing when they are difficult to even play. even though they were also marching while designing guitar players, drones, and other choreography on the field. The creativity and the execution came through to deliver a truly remarkable show. It made me think of our team at AEP, on November 11th, I've been AEP CEO for 10-years, I'm fortunate to lead a great Company with great people who have an outstanding track record of delivering on the promises made to investors and customers consistently year in and year out. And we fully expect to continue our drive to take this Company to the next level toward the clean energy economy and a solid infrastructure foundation bucks-rating aggressive goals and delivering with creativity and solid execution. With that, I will turn it over to Julie."
},
{
"speaker": "Julie Sloat",
"text": "Thanks so much, Nick. Thanks, Darcy. And Nick I love your Buckeye reference. Go Bucks."
},
{
"speaker": "Nick Akins",
"text": "I love that."
},
{
"speaker": "Julie Sloat",
"text": "Thank you very much. Big game this weekend. Anyway, it's good to be with everybody this morning. I'm going to walk us through the third quarter and year-to-date financial results. I'll share some updates on our service territory load, and finish with some commentary on financing plans, credit metrics, and liquidity. Let's go to slide six, which shows the comparison of GAAP top rating earnings for the quarter and year-to-date periods. GAAP earnings for the third quarter were $1.59 per share, compared to a $1.51 per share in 2020. GAAP earnings through September were $3.90 per share compared to $3.56 per share in 2020. There's a reconciliation of GAAP to operating earnings on Pages 14 and 15 of the presentation today. Let's go to Slide 7 where we can talk about our quarterly operating earnings performance by segment. Operating earnings for the third quarter totaled $1.43 per share or $717 million compared to $1.47 per share or $728 million in 2020. Operating earnings from the vertically integrated utilities were $0.87 per share, up $0.02. Favorable drivers included, rate changes across multiple jurisdictions, weather primarily in the West, transmission revenue and lower income tax. These items were offset somewhat by higher O&M expenses to in part to lower prior year O&M, which included actions we took to adjust to the pandemic and higher depreciation expense, as well as lower normalized margins and lower AFUDC. The Transmission and Distribution Utilities segment earned $0.31 per share flat to last year. Favorable drivers in this segment included rate changes, transmission revenue, and income taxes. Offsetting these favorable items were O&M expenses again, a function of lower prior year O&M associated with pandemic growing efforts, depreciation, and property taxes. The AEP Transmission Holdco segment continued to grow, contributing $0.33 per share, that was an improvement of $0.05, driven by the return-on-investment growth. Generation and Marketing produced $0.04 per share, down $0.09 from last year, includes by the prior-year land sales, lower retail volumes and margins, generation and income taxes. Finally, Corporate and other was down $0.02 per share driven by lower investment gains, and unfavorable net interest expense, which was partially offset by lower income taxes. The lower investment gains, are related to a pullback of some of the ChargePoint related gains, we've talked about on prior quarters. Let's have a look at our year-to-date results on slide number 8. Operating earnings through September totaled $3.76 per share, or $1.9 billion compared to $3.56 per share, or $1.8 billion in 2020. Looking at the drivers by segment, operating earnings for vertically integrated utilities, were $1.87 per share down $0.03, due to higher O&M and depreciation expenses. Other smaller decreases included lower normalized sales and wholesale load, higher other taxes, and a prior period fuel adjustment. Offsetting these unfavorable variances were weight changes across various operating companies and the impact of weather due to warmer than normal temps in the winter of 2020 and the summer 2021, which created a favorable year-over-year comp for us. Other favorable items in this segment included higher off-system sales, transmission revenue, net interest expense, and income taxes. The transmission and distribution utilities segments earned $0.85 per share, up a penny from last year. Earnings in this segment were up due to higher transmission revenue, rate changes, weather, normalized load, and income taxes. Partially offsetting these favorable items were increased depreciation, O&M, other taxes, and interest expenses. AEP Transmission Holdco segment contributed $1.02 per share up $0.27 from last year, related to investment growth and favorable year-over-year true-up. Generation and marketing produced $0.20 per share down $0.11 from last year due to favorable one-time items in the prior year relating to an Oklaunion ARO adjustment in the sale of Conesville and reduced land sales in 2021. Higher energy margins and low expenses in the generation business offset the unfavorable marketplaces on the wholesale business during storm yearly in February. We also saw an unfavorable result in retail due to lower power and gas margins. Income taxes were also unfavorable. Finally, Corporate matter was up $0.06 per share driven by investment gains and lower taxes and partially offset by higher O&M. Let me take a quick minute here to talk about the investment gain, which is predominantly a function of our direct and indirect Investment ChargePoint. As you'll see on the waterfall, was produced a $0.06 benefit year-to-date in 2021, as compared to the corresponding 2020 period. You may recall that in the fourth quarter at full-year 2020, this investment produced a $0.05 contribution, and we would expect the year-over-year bids to be more pronounced at this point in 2021, as we have no benefit during the same period in 2020. Turning to Page 9, I'll update you on our normalized low performance for the quarter. We, then, get into the specifics. Let me start by reminding everyone that everything you see on the slide is showing year-over-year growth. That means these numbers can be influenced by what was going on last year or what is happening now in 2021. Given all that occurred in the economy last year, it's obvious that these growth rates are at least partially being influenced by the comparison basis. This leads to the natural follow-up question like, how does today's low compare to pre -pandemic level? And I'll get to that question on the next slide. But before I do, let's take a look what a -- at what our normalized low growth was for the quarter. Starting in the upper left corner, normalized residential sales were down 1.6% compared to last year, bringing the year-to-date declined down to 9/10 of a percent. That means that last year, residential sales were up 3.8% in the third quarter when the economy was just starting to reopen. One year later, they're down only 1.6%, which suggests there has been a shift up in residential sales, as more businesses have embraced a remote workforce for jobs that can be performed at home. The last item to point out on the residential charges that you'll notice that we added a new bar to the right, showing our latest projection for 2021 based on the load forecast update. The original guidance assumed residential sales would decrease by 1.1% in 2021. The latest update showed an improvement as we now expect residential to end the year down 9/10 of a percent. Moving right, weather-normalized commercial sales increased by 5%, bringing the year-to-date growth up to 4.3%. Last year's third quarter commercial sales were down 4.6%. So again, we're seeing a net positive stories of commercial sales classes bouncing back faster than expected. And while we're seeing a strong bounce back and the sector's most impacted by the pandemic such as schools, churches, and hotels, we're actually seeing the strongest growth in commercial sales this year from growth in data centers, especially in the Central Ohio. To give you some perspective, last year, the sector was the 9th largest commercial sector across the AP system. Today, it's the 6th largest, and will likely move further up in the rankings as more data center loads are expected to come in online over the next several years. You will also notice that our latest load forecast update now suggests that commercial sales were end-year up 3.7% as opposed to the 0.5% decline assumed in the original guidance forecast. The economy has recovered much faster than we originally assumed, which is one of the reasons why we've updated the forecast and ensuring an improvement in that regard. In the lower left corner, you'll see that industrial sales also had a very strong quarter. Industrial sales for the quarter increased by 7%, bringing the year-to-date up to 4.2%. Industrial sales were up at every operating Company in nearly every sector. I point out, however, that the 7% growth in the third quarter this year did not quite offset the 7.8% decline experienced last year. Which means we still have a little more room to grow before the industrial class fully recovers from the pandemic recession. The good news is we have a lot of momentum to work with. The latest node update now projects industrial sales will end the year up 4.3%, which is 2.4% higher than assumed in the original guidance forecast. Finally, when you put it all together in the lower left corner, you'll see that normalized retail sales increased by 3% for the quarter and were up 2.3% for the first 9 months. But all indications that recovery from the pandemic and recession is happening faster than expected and our service territory is positioned to benefit from future economic growth. You'll recall that the original guidance forecast assumed normalized load growth of 2/10 of a percent in 2021. Based on our latest update, we're now expecting to end the year up 2.2%, which is a supporting factor in narrowing our earnings guidance range, and raising the midpoint for 2021. Turning to Slide 10, I want to answer the question from earlier, that asked how our current low performance compares to pre -pandemic levels. This bar chart is designed to answer that question. The blue bars are the same year-to-date bars that we shared on the prior page. As a reminder, these represent growth versus 2020, which was influenced by the restrictions implemented to manage the public health crisis. The orange bars here show how the year-to-date sales in 2021 compared to 2019, which was the most recent pre - pandemic year for comparison. These bars tell us how close we are to a full recovery from the pandemic. Starting at the left, you'll notice that a reported residential sales are down 9/10 of a percent compared to last year, but they're actually up 1.6% compared to our pre -pandemic levels. This is a gauge for how our customers behaviors have changed since the pandemic, with more people working from home. The next bar shows that while commercial sales are up 4.3% compared to last year. There are still 8/10 of the percent below the pre -pandemic levels. Given the recent growth we're seeing, especially in the data center nodes, we would expect commercial sales to fully recover nearly soon. Moving further, right, you can notice that while the industrial sales were up 4.2% compared to last year, they are still 3% lower than pre -pandemic levels. Given some of the headwinds for manufacturing today with supply chain disruptions, later shortages, et cetera, it may take a little longer before the industrial quest fully recovers from the pandemic recession. But we do expect to eclipse the pre -pandemic levels in 2022. In total, our normalized load is up 2.3% compared to last year and is now within 7/10 of a percent of being fully recovered from the pandemic, so it's safe to say that we're pleased with the strength and balance of this recovery in the AEP system. Let's check on the Company's capitalization and liquidity on Page 11. On a GAAP basis, our debt-to-capital ratio decreased 0.4% from the prior quarter to 62.2%. When adjusted for the storm during event, the ratio is slightly lower than it was at year-end 2022, sorry 2020, and now stands at 61.5%. Let's talk about our FFO to debt metric, as in the first and second quarter. Effective storm yearly continues to have a temporary and noticeable impact, on this 2021 metric. Taking a look at the upper right quadrant on this page, you'll see our FFO to debt metrics based on traditional Moody's and GAAP calculated basis. As well as an adjusted Moody's and GAAP calculated basis. On a traditional unadjusted basis, our FFO - to -debt ratio increased by 0.9% during the quarter to 10.2% on a Moody's basis. And just, again, reiterate, radio agencies continue to take the anticipated recovery into consideration as it relates to our credit ratings. So very important to note that. On an adjusted basis, the Moody's FFO-to-debt metric is 13.6%. This figure removes or adjusts the calculation to eliminate the impact of approximately 1.2 billion of cash outflows associated with covering the unplanned urine-driven fuel and purchase power in the SPP region, directly impacting PSO and SWEPCO in particular. The metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. This should give you a sense of where we would be from a business - as -usual perspective with that 13.6%. Importantly, as Nick mentioned, the recovery of the fuel and purchase power expense in the PSO and SWEPCO jurisdictions is well underway and we're making progress. As a result, inconsistent with what we have previously communicated, we still anticipate our cash flow metrics to return to below the mid-teens target range next year. Obviously, we are trying to push towards the mid-teens range, but that will take us a little while longer, but we're definitely on our way there. And as you know, we'll keep you posted on our progress. Before we leave the Balance Sheet topic, I do want to make note of the intended change to our 2022 financing plan, in light of our announced sale of Kentucky Power and Kentucky Transco. You may recall that we had planned to issue $1.4 billion of equity in 2022, that's inclusive of $100 million dividend reinvestment plan to fund our growth Capex program, where we will provide our typical 3-year forward annual review of our cash flows and financial metrics at the upcoming EEI Conference, where we can expect to see is that the 2022 forecast will be adjusted to eliminate the previously planned $1.4 billion of equity financing that I just mentioned with any residual proceeds being used to reduce a small portion of the 2022 debt financing that we had planned. These actions will have no impact on our previously stated credit metric targets or messaging in that regard. On the slide deck today, on page 39, you'll see our current cash flow forecast, with which you are already familiar, We've included a note on the side to reflect the fact that the numbers have not been updated for the announced Kentucky transaction, along with the red circle around the 2022 financing -- equity financing amount that will be changed and updated when we roll out the new view in a couple of weeks in conjunction with the EEI conference. So, while we're talking about the Kentucky transaction, I can also share that we expect that the sale will be $0.01 to $0.02 accretive in 2022, and we will reflect this in our 2022 earnings guidance that we provide to you at the EEI Conference. Okay. So back to our regularly-scheduled earnings call programming and commentary. Let's take a quick moment to visit our liquidity summary on the lower right slot -- side of Slide 11. Our 5-year $4 billion bank revolver and 2-year $1 billion revolving credit facility, along with proceeds from the quarter-end debt issuance, support our liquidity position, which means we were strong at $5.1 billion. If you look at the lower left side of the page, you will see that our qualified pension continues to be well funded at a 104%. Additionally, our OPEB is funded at a 173.9%. Let's go slide 12 and I'll do a quick wrap up and we can get to your questions. Our performance through the first 3 quarters of this year gives us confidence to narrow our operating guidance to the upper half of our current range, resulting in the new range of $4.65 per share to $4.75 per share with a midpoint of $4.70 per share. As we stated, we are committed to our long-term growth, rate target of 5% to 7%. Today's 2021 earnings guidance revision is yet another demonstration of our drive to deliver performance in the upper half of our guidance range. From a strategic perspective, we're making significant progress in addressing items that are top of mind for our current and perspective investors. We're mounting contract to sell Kentucky Power and Kentucky Transco, which we expect to complete in the second quarter of 2022. This transaction enables us to avoid the 1.4 billion equity issuance, that was part of our original forecast, would share with you for 2022. Therefore, alleviates the overhang, the equity overhang. Also allows us to deliver transaction that we estimate to be 1 to 2 in 2022. We will be more able to do this, while concurrently preserving our ability to get our FFO to debt metrics comfortably, into that mid to low teens range by 2022, which is commensurate with a Moody's BAAT stabilizing, as we continue to target that. The intention is to remain in this credit metric range. Again, with a preference to try to get closer to that midpoint, as we move along in time. All of this positions us to continue our generation transformation, which is underpinned by the renewable investment opportunity we have shared with you in complemented by our ongoing energy delivery investment. So here you can expect to see from us at the upcoming EEI Conference in early November. In addition to the updated 3-year forward cash flow and financing plan, we'll be introducing and sharing the details behind our 2022 Earnings Guidance and our longer-term capital plan, we typically got out 5 years, all of which will incorporate the effects of the announced Kentucky sales. So, with that, surely, we do appreciate your time and attention and I'm going to turn it over to the operator so we can get to your questions."
},
{
"speaker": "Operator",
"text": "Thank you. Also please, take up your handset before pressing any buttons. We will go first to the line of Julien Dumoulin Smith. Your line is open. Go ahead, please. I'm sorry. I'm having some technical difficulty, one moment while we open your line. Your line is open. Go ahead, please."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Thank you. Can you hear me now?"
},
{
"speaker": "Nick Akins",
"text": "Hey you doing and how you?"
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Hey, quite well. Thank you. Congratulations on the transaction there. Nicely done."
},
{
"speaker": "Nick Akins",
"text": "Yeah, I'm angst."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Absolutely. So perhaps just to dive into that one a little bit more, can you talk about what happens with the Mitchell plant here, just as a function of the sale, will it get transferred to Wheeling, how are you thinking about that vis -a - vis liberty, and any kind of pricing there, and in terms of transfer, what have you?"
},
{
"speaker": "Nick Akins",
"text": "Yes. That's why the operating agreement is being followed. Wheeling would become the operator and it does get transferred to Wheeling in 2028. And so that's really -- we're continuing with Kentucky being half-owner of Mitchell until that period of time. So, the Wheeling will take over the operations of the plant, the employees will move over to wheeling as well. And then we'll continue working with the West Virginia and Kentucky commission to get resolved the operating agreement and related issues. And then, of course, at the end -- at 2028, it transfers over at fair market value . So that's the plan. And that will get followed here in November and December time frame and we'll go through that. And actually, both commissions have the incentive to get this resolved because we do have various views of the ELG piece of it. So regardless of whether we had this transaction or not, we would be needing to fall for the operating agreement change out just because the different directions of the commissions have gone. So, we'll get that resolved as part of process to the overall approvals."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Excellent. Nicely said -- nicely done. Fair market value it is. And then just vis -a - vis, ongoing transactions in portfolio evaluation of really a review with the equity means here in the very near-term, how do you think about just continued evaluation a portfolio? I mean, clearly, it's not necessarily a near-term dynamic, but want to give you the opportunity to speak to that a little bit further."
},
{
"speaker": "Nick Akins",
"text": "Yes, sure. I said over and over, I guess for a couple of years now but even beyond that. We do have to get to portfolio management to enable us to look at the sources and uses of the capital needs that we have. And to manage the balance sheet, as Julie has mentioned. We target the mid-teens, and we want to get there, and obviously, we're well on our way of getting there. So, we want to do that, but at the same time, be able to fund the capital growth. And when you think about it, we've sold the unregulated generation, we sold Rover Rob's, we sold some hydro-related facilities. With Kentucky, we're talking about 6 billion of assets that have been sold, but they fueled substantial growth. I mean, to the tune of 7 billion a year in capital. It's part of the process to determine what the portfolio, needs to be in the future and we will continue to do that. Certainly, we have Chuck, and Julie, and others will continue to review that portfolio, and we will manage it in a proper way. I'll say this, Kentucky Power, you think about the threshold -- at one point we talked about we always invested in coal units no matter what. And, obviously, we've changed that focus to make sure it's more deliveries of in terms of the decision points that are made. It's quite a move for AEP to get to a point where we're managing our portfolio in a way that, first of all, we became fully regulate, and then we start to look at that portfolio to determine what's the best approach to fuel 20 billion in potential renewables investment. So, when you think about that, we have to consider it. And I can tell you, the last time we sold a regulated utility was, I guess, the Scranton Pennsylvania System, and then the Pennsylvania -- in Pennsylvania and the New Jersey system back in the 1940s and 50s. So, it's a pretty substantial change. And when you think about Kentucky Power sales, it was one of the first acquisitions of American Gas and Electric in 1922. So, by the time we get through this, it's been 100 years. So, when you think about the threshold level of portfolio management that has occurred in this Company, it really should show a lot on terms of our seriousness of making sure that we're managing that portfolio in the proper way. That's probably longer answer than what you asked for, but I want ed to at least get all that out there."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Very much appreciate it. I'll leave it there. Speak with you guys soon."
},
{
"speaker": "Nick Akins",
"text": "Okay."
},
{
"speaker": "Operator",
"text": "We'll next go to the line of Shahriar Pourreza with Guggenheim Partners. Go ahead, please."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Shahriar."
},
{
"speaker": "Shahriar Pourreza",
"text": "Good morning, guys and congrats on Kentucky."
},
{
"speaker": "Nick Akins",
"text": "Yes."
},
{
"speaker": "Shahriar Pourreza",
"text": "Just a follow-up on Julien's question a little bit more. As we think about trigger points for another asset sale what's kind of a catalyst because the 10-gigawatts of solar wind that you're looking to build through '25. I mean, even if you assume a 50-50 on PPA structure could yield an incremental $3 billion rate of spending opportunities. And you obviously have a slope of IRP. So do you need to see affirmations with the various filings or actual approvals in GRC. So how should we think about how these could be funded, especially in light of where the stock trades. So, yes."
},
{
"speaker": "Nick Akins",
"text": "When you think about the way we're approaching the renewables fees, that the process has been, that we term the need for equity associated with those particular investments, when they actually come online and we get regulated recovery. So, we get the cash flow to support, those investments at the time they come online. That means, obviously our FFO to debt doesn't suffer as a result of that. So, if we continue that approach, and keep in mind too, I've always said that, for us to take a look at a regulated entity or other parts of our portfolio, doesn't match the future needs in terms of, where we are and where we're going as a Company. Is there, if we have a chronically under-performing part of the portfolio, then it's important for us to take a look at. That may be temporary, it could be long term, but certainly we have to make sure that we're evaluating each one of these assets in a way that says, okay. It doesn't matter where it's located, as long as we're getting certainly the return expectation and also the forward view of the utility is positive as compared to with others. So, we have to compare in various parts of our service territories and that's where we make those decisions."
},
{
"speaker": "Shahriar Pourreza",
"text": "Perfect. And then just Nick, appreciate we're going to head into EEI we'll get an update here. But do you see the current renewable additions at least through '25 the 10 gigawatts, right, between solar and wind swinging materially with some of these counteractive items like federal policy benefits versus the input cost pressures we're seeing in the space impacting some project timings. So, do you see any of this swinging at all?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, I do. And in your -- when we'd actually go do the analysis and we've done analysis for all the jurisdictions, but conditions changed, low changes certainly PTCs, ITCs can change as a result, which changed the business cases were some may have been on the margins particularly in the east now become benefits to customers. So, I think those numbers will continue to change and I can tell you from what I've seen so far. Those numbers will change. And some will go out, some will go down. But overall, normally, it should be on path, what we've talked about. And we'll have more to report on that. Probably during first quarter '22, because we'll have the integrated resource plans. And when those integrated resource plans are filed, that's where I mentioned today is you will have a more definitive view of what those projects look like because there will be the results of RFPs and there will be the results of actual projects that are put in for regulated approval. So, more definition, but I would certainly say that normally they will be in that category we've previously discussed."
},
{
"speaker": "Julie Sloat",
"text": "And sure. What you should anticipate is when we go to EEI, you'll see a refreshed 5-year forward Capex plan, so '22 through '26, and you'll start to begin to see a little bit more of this renewable opportunity dropped in. So, stay tuned for that, and we'll be able to talk more granularly with you here in a couple of weeks."
},
{
"speaker": "Nick Akins",
"text": "Yeah. And I would say that when you see that, it certainly will reflect, I don't know if you call it a risk-adjusted approach or whatever, but it's a nominal view for us to make financing plans, and then just like with North Central, we make decisions on whether it goes up or down based upon our ownership."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. Cheers to you guys. Congrats on the results. See you soon."
},
{
"speaker": "Nick Akins",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "We will next go to the line of Steve Fleishman with Wolfe Research. Go ahead, please."
},
{
"speaker": "Steve Fleishman",
"text": "Hey, good morning. Can you hear me, Nick?"
},
{
"speaker": "Nick Akins",
"text": "Yes. Yes. I hear you."
},
{
"speaker": "Steve Fleishman",
"text": "Okay, great. Thanks. Okay. One question that might be a bit premature, but there's obviously a lot going on in DC with the reconciliation bill and the like, and one of the provisions that's gotten more focused on this few days is the minimum tax provision. And I just be curious, how you're thinking -- for larger companies like yourself, how you're thinking if that has any impact for largely regulated utility like you or does it not really have much of an impact?"
},
{
"speaker": "Nick Akins",
"text": "Well, I would say, and we've been vocal about this and the industry has been vocal about it, if you put a minimum 15% tax and a lot of us are, as you know, heavy on capital, and its growth capital, and it's also infrastructure-related capital. So, an increase with the minimum tax would certainly have an accruing effect on our ability to continue with not only development of infrastructure and having effect on that, not to mention customers’ bills ultimately because the taxes were passed through to our customers. But also, the administration has a focus on green energy and it will have an effect on renewables transformation that's existing as well. So, I think I think they'll put a pail over all the utilities’ ability to continue invest in capital in the way that we are. Now, if we do that, then obviously there's customer impact associated with it. And again, it's a hidden tax on our customers. So, we're not for that provision. I think actually, we've been very worthwhile about this and trying to be an honest broker when we're talking about CEBP and all the other things that -- it was important for us to be able to make this transformation from a clean energy standpoint. Certainly, the PTCs, ITCs with expansion of long-term storage, nuclear, and certainly in terms of wind and solar, are very important to continue those process, to move to clean energy economy, and we can go a long way there. This industry is very focused on doing that, and any kind of tax headwind that goes the other direction is not helpful. I think you probably hear that across-the-board."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. More to direct AP things. Just on the approval for the Kentucky sale, could you remind us what the standard for approval is in Kentucky? Is it just in the public interest or that benefits?"
},
{
"speaker": "Nick Akins",
"text": "Yes. But it's in the public interest, obviously. Because they have to look at the suitor and determine is that the right route approach. And as I've done in the proper way and actually there has been some discussions in Kentucky previously. I think it's probably gone past some of that now that -- I want to make sure we were operating Kentucky the way we should. And we've been operating it the way we always have. So, we've been investing, we've been doing the things that we need to do. Whether we owned it or not. And I think certainly the buyer has recognized that and during the transition, we will continue to support a smooth transition to ensure that the services provided and things that need to be done to make Kentucky Power successful, we'll be there to do it. And of course, we'll support Liberty Utilities in Algonquin in doing that."
},
{
"speaker": "Steve Fleishman",
"text": "Great. And then one just quick question maybe for Julie. The proceeds from the Kentucky sale look like they're matching up one for one with reducing the equity need. But obviously when you sell an asset, you lose some cash flow, albeit Kentucky maybe wasn't having the best cash flow. So, are there offsets in other businesses that are making up for the lost cash flow from the asset sale?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, thanks for the question, Steve. You're right. I mean, we do lose the funds from operations that relates to Kentucky and Kentucky Transco. Although, we got to keep in mind that we also eliminate about $1.3 billion of debt associated with those assets to because that goes away. And the marathon that we think through, just to take it a step further is if we avoid issuing equity, we avoid having to cover off additional dividends that were in our original plan. So, another to a sidestep that as well. And that comes with, maybe also having some additional dollars to reduce debt. As I mentioned in my opening comments, anything above and beyond that $1.4 billion which channeled toward debt reduction that was otherwise planned for 2022. And then also, keep in mind that Kentucky Power had barely strained FFO - to -debt to begin with. So, to eliminate that piece of, I guess, drag to the overall average FFO -to-debt for their organization is also a net positive for us. So, we are able to put these numbers together. And quite frankly, from an FFO - to -debt perspective, it is mildly beneficial and obviously a little bit of a cost on the debt-to-cap because we're not issuing additional equity. But the numbers all do hang together and coincidentally we'll be able to take literally that $1.4 billion of planned equity out of the plan, and again, you'll see that at EEI when we'll refresh the forecast."
},
{
"speaker": "Steve Fleishman",
"text": "Great. Thanks so much."
},
{
"speaker": "Nick Akins",
"text": "Thanks, Steve."
},
{
"speaker": "Operator",
"text": "Well let's go to the line of Durgesh Chopra with Evercore ISI. Go ahead, please."
},
{
"speaker": "Nick Akins",
"text": "Morning, Durgesh."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning, Nick. Maybe just along the FFO-to-debt lines, my first question is to Julie. In terms of 2024, I'm thinking about your equity needs in my model shift used to target for FFO to debt. Actually, is it mid-teens or is it low to your ? Because, obviously, that's going to dictate, right, how much equity you might need in 2024. So, any color you could share there?"
},
{
"speaker": "Julie Sloat",
"text": "Got you. You'll see 2024 when we rollout our EEI guidance, so 3 years forward. But, as we continue to say, we are talking about mid - to -low teens. And the reason I say that is, as I mentioned today, if you look at our FFO to debt on an adjusted basis, so backing out the yearly consequence, we have something like 13.6% on a Moody's basis. As you know, our target has been to be around that Baa2 stable rating. That's why we talk about mid - to -low teens or low - to -mid teens. Obviously, our preference and our expectation are to start to push more towards what I would characterize as mid. It'd be nice to have at least a 14 handle on that FFO to debt, and that is absolutely the plan, but we'll be able to share more with you as we get to EEI and build that forecast, but I wouldn't change how you're thinking about it. So, thinking about mid to low teens as it relates to Moody's BAAT, with a preference towards 14 plus percent."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. So, some of that moment to low teens through 2024 yeah. A big picture question, we've talked in depth about natural gas prices. So maybe just talk about your gas generation portfolio, fuel costs, any hedges in impacting customer bills?"
},
{
"speaker": "Julie Sloat",
"text": "I will take this from a customer rate perspective as I could, because that's how we think about it. Because ultimately this impacts our customers. When we think about, for example, a decent sensitivity analyses around, let's say a 10% hike in natural gas prices as we all know, they've gone up substantially. The impact to customer rates varies significantly from 1 operating Company to the next, depending on the field mix. So, for example, if I looked at Appalachian Power Company, the average residential impact price in terms of the 10% hiking gas prices would equate to about a 0.9% increase in the customer's rate. Let's compare and contrast that to say PSO or SWEPCO, whether there's much more gas concentration. So PSO, we'd be talking about 1.6% increase in customer rates. SWEPCO, 1.5%. So, this is something we're very sensitive to, because as you know, overall, we're extremely sensitive to customer rate increases and the aggregate as we continue to execute on our general Capex program. I don't know if -- Nick, you had any additional comments."
},
{
"speaker": "Nick Akins",
"text": "I'd say certainly, your question actually shows the reinforcement of our renewable’s transformation because it's a perfect edge to natural gas of North Central were in place during the time of storm Yuri. It would have saved customers $225 million. So, when you think about the process we're going through, it's great to have natural gas it's -- and certainly -- but at the times where you can layer in renewables to do that, it turns out to be a significant benefit to consumers. So, it reinforces that. And I think probably this winter will show it."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Thanks, guys. I appreciate the time."
},
{
"speaker": "Julie Sloat",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "We'll next go to the line of Andrew Weisel with Deutsche Bank. Go ahead, please."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Andrew."
},
{
"speaker": "Andrew Weisel",
"text": "Hey, good morning. Thanks for a lot of good updates here. One remaining question I had was after a few rate case settlements and expectations for several other outstanding cases to be resolved in the coming months, can you share your expectations around which sub we might file new rate cases over the next 12 months or so?"
},
{
"speaker": "Nick Akins",
"text": "We are -- I'm trying to think of what else will you be filling because just down here with jurisdiction we got a case that we expect approval of and certainly a lot of cases they're still ongoing and just about all the jurisdictions. So, I'd say we're always reviewing that on a regular basis at this point. We are playing with active cases that we got to get across the finish line and then determine where we are at. The other part here is looking at what happens with denominator because Julie mentioned, low is changing significantly and it continues to do that as we emerge from hopefully a post-COVID world. And if that's the case, then that would be a determinant in terms of when we would file for any case. I think, of course, if we do have tax changes that occur, then that'll force a whole new view going forward to many of these cases. Just like it did when we got tax reform last time around, except this one, maybe, on the upside."
},
{
"speaker": "Andrew Weisel",
"text": "Okay, great. So, would it be fair to say that '22 at least the other second half of '22 might be a quieter year as far as the regulatory calendar than what we currently have?"
},
{
"speaker": "Nick Akins",
"text": "Probably quieter in terms of filings, but probably noisy in terms of results."
},
{
"speaker": "Andrew Weisel",
"text": "Alright. Thank you very much."
},
{
"speaker": "Operator",
"text": "We will go on next, one, please. We'll go next to the line of Michael Lapides with Goldman Sachs. Go ahead, please."
},
{
"speaker": "Michael Lapides",
"text": "My name I'm fine. Rough year for your -- by you being goals this year. A lot of change. Hey, got a couple of questions for you. What the Kentucky sale and you guys have -- your slide number five. I think it says, over the years has done a good job of detailing how hard it's been on authorized in Kentucky. Now that Kentucky will be offshore play, when you look at the other jurisdictions, what are the ones that we say, hey, we still struggle to own authorize here? What are the structural changes? Whether it's legislation and we've seen lots of utilities in places like North Carolina, Kansas, Missouri, go in and make structural changes via legislation. What are the structural changes you are going to seek, outside of just normal rate case filings, that could help improve authorized versus in those jurisdictions."
},
{
"speaker": "Nick Akins",
"text": "You're seeing a fundamental shift and all the remaining operating companies. We made a lot of progress on Ryder's and we have a lot of focus on getting concurrent recovery in cash in the door and what you're seeing really in terms of a lot of these lags, is the amount of investment that we're placing in these companies. But as well as you make the transition from certainly from wires related activities with Ryder's and then the renewables conversion that occurs, the way we're doing the renewables is commensurate with the recovery. So, we should see the authorized -- our returns be closer to the authorized as time goes forward. We don't see any fundamental issues in any of the jurisdictions that are left that says that we have significant headwinds. I mean, the only thing you could probably point to is the Turk issue at SWEPCO, but other than that -- and actually, when you think about Arkansas, we keep saying we're not recovering the Arkansas portion of the Turk. That's not because of the commission. That is because of the Supreme Court of Arkansas. So, we've got very good relations with the commissions and all the jurisdictions, and we feel like the fundamentals are there for continued improvement relative to that regulatory lag that exists. And because we're spending on more areas and our generation is really renewables, and that's helping out, every time we put an investment in, and the timing of the investment improves the FFO-to-debt, improves the returns of the individual companies. And I think we'll continue to make progress in that regard. So, I would be -- I'm pretty optimistic that we'll continue to make progress in all of these jurisdictions."
},
{
"speaker": "Michael Lapides",
"text": "Got it. And just a quick follow-up, and just maybe a Julie one. Just curious when we think about your multi-year -- your guidance growth rate and the language around wanting to be at the high end, outside of the transmission segment, the standalone segment, what does that embed as an earned ROE at the rest of the regulated businesses?"
},
{
"speaker": "Julie Sloat",
"text": "Michael, we always -- as Nick mentioned, we strive to be in the upper half of the guidance range, not necessary the upper end, although that 'd be very nice. So just a point of clarification there. And as it relates to returns, as you can see, we've kind of been hovering around the 9% ROE return level. I think that's a safe place for you to assume that we'll kind of hang out there for a while until we get a little more traction. And the other thing if I could, circling back to your original question, when we look at the equalizer chart, often times we get questions around AEP taxes and why the lower we relative to authorize there, and so back to your question around growth and how do you manage the business, AEP Texas, we continue to invest a significant amount of capital on an annualized basis. And while we have very progressive rate recovery mechanisms in place that we really enjoy, I can tell you this, while the ROE may look a touch depressed relative to authorize, that Company continues to produce earnings growth and to save the 8% to 10% range. So that certifies our ability, back to your original point, getting that upper 1/2 of the range. So again, ROE, our system-wide average, assume roughly around 9% - ish and trending upward over time. And then around AEP Texas, k keeps in mind, the capital is intentional there as we continue to try to take care of the customer and grow that business. And it's paying dividends in 8% to 10% EPS growth out of it."
},
{
"speaker": "Nick Akins",
"text": "And another thing if we look at is, we haven't gone that pages is actually the increase in equity layers as well. So, you see improvement in the equity layers and then, we're still investing and still meeting the 5% to 7% and being the upper half and that kind of thing. And of course, we continue to manage the FFO to debt towards the mid-teens. So that -- all of the pieces are starting to fit together. And there's a lot of optimization that will occur for us to -- how to execute on to ensure that we're continuing to meet the earnings objectives. But at the same time investing in the right things and enable us to bridge that gap on the regulatory lag."
},
{
"speaker": "Michael Lapides",
"text": "Got it. Thank you, guys. Much appreciated. Congrats to have Kentucky."
},
{
"speaker": "Nick Akins",
"text": "Yeah. Sure thing."
},
{
"speaker": "Julie Sloat",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "All right. Speakers, we have no one else in queue at this time."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Allen, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Absolutely. Ladies and gentlemen, this conference will be made available for replay beginning at 05:30 PM today, October 28th, 2021 and lasting until November 4th, 2021 at midnight."
},
{
"speaker": "Operator",
"text": "That will conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 2 | 2,021 | 2021-07-22 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by. And welcome to the American Electric Power Second Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded. I would now like to turn the conference to our host, Vice President of Investor Relations, Ms. Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Toni. Good morning, everyone. And welcome to the second quarter 2021 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides and related financial information are available on our website at aep.com.
Nick Akins: Okay. Thanks, Darcy. And welcome again everyone to American Electric Power’s second quarter 2021 earnings call. Today we reported a strong second quarter operating earnings of a $1.18 per share versus a $1.08 for the same period of 2020. Our second quarter results reflect significant progress in terms of economic recovery throughout AEP service territory, with a continued focus on OEM as we navigate through what is hopefully an emergence from the COVID-19 pandemic. Gross regional product has already exceeded its pre-pandemic levels and important across AEP service territory is now 2% of its pre-pandemic levels after adding over a 163,000 jobs in the first six months of this year. Increased vaccinations combined with the additional fiscal stimulus from the American Rescue Plan are contributing to the strong demand for goods and services throughout the economy. AEP’s normalized retail sales in the second quarter of 2021 were the highest we have seen since the second quarter of 2018. Clearly, we are pleased with the improvements we have seen thus far and we will continue to monitor the recovery’s progress over the second half of the year. Accordingly, we are reaffirming our 2021 guidance range of $4.55 per share to $4.75 per share and a 5% to 7% long-term growth rate and would be again disappointed not to be in the upper half of our stated guidance range as we have previously stated. Julie will be discussing these issues in more detail in her report. Rate case activity across our jurisdictions continues to be active and substantial. In Ohio, we are awaiting an order by the commission on the settlement reach involved with the commission earlier this year. As a reminder, the settlement has broad support in the settling parties including the commission staff, the Ohio Consumers Council, industrial companies, commercial companies and other entities like the Ohio Hospital Association. We expect a decision in the third quarter of this year. Public Service Company of Oklahoma filed a rate case at the end of April. PSO is seeking $115.4 million net revenue increase and a 10% ROE. The following transitions North Central costs from the right established in the approval into base rates.
Julie Sloat: All right. Thanks, Nick. Thanks, Darcy. It’s good to be with everyone this morning. I am going to walk us through the second quarter and year-to-date financial results, share some thoughts on our service territory load and finish with a review of our credit metrics and liquidity. So let’s go to slide number six which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $1.16 per share, compared to $1.05 per share in 2020. GAAP earnings through June were $2.31 per share, compared to $2.05 per share in 2020. There’s a reconciliation of GAAP to operating earnings on pages 14 and 15 of the presentation today. So let’s walk through our quarterly operating earnings performance by segment that’s laid out on slide number seven. Operating earnings for the second quarter totaled $1.18 per share or $590 million, compared to $1.98 per share or $534 million in 2020. Operating earnings for the Vertically Integrated Utilities were $0.45 per share, down $0.10 driven by a year-over-year increase in the O&M due to lower prior year O&M, which included actions we took to adjust to the pandemic. Other pressures included lower wholesale load and higher depreciation and other taxes. These items were partially offset by the impact of rate changes across multiple jurisdictions, higher normalized retail load, transmission revenue and off system sales. The Transmission and Distribution Utilities segment earned $0.31 per share, up $0.02 from last year. Favorable drivers in this segment included higher normalized retail load, transmission revenue and rate changes, partially offsetting these favorable items were higher tax, depreciation and O&M expenses, as well as unfavorable weather and lower AFUDC. The AEP Transmission Holdco segment continued to grow contributing $0.34 per share, an improvement of $0.15, which got a boost because of the unfavorable annual true-up last year consistent with the 2021 earnings guidance assumptions we had provided to you. Our fundamental return on investment growth continued as net plant increased by $1.4 billion or 13% since June of last year. Generation and Marketing produced $0.09 per share, down $0.02 from last year, influenced by the prior year land sales and one-time items relating to an Oklaunion ARO adjustment in the sale of Conesville. We were mostly offset in the generation business by higher energy margins and lower expenses from the retirement of Oklaunion. Finally, Corporate and Other was up $0.05 per share, driven by investment gains, lower tax -- and lower taxes, which was partially offset by higher O&M and net interest expense. So bear with me a moment, I am going to talk a little bit more about that investment gain as we walk through the year-to-date view. So, if you flip to slide eight, we can look at year-to-date results. Operating earnings through June totaled $2.33 per share or $1.2 billion, compared to $2.10 per share or $1 billion in 2020. Looking at the drivers by segment, operating earnings for Vertically Integrated Utilities were $1 per share, down $0.05 due to higher O&M and depreciation expenses. Other smaller increases included lower normalized retail and wholesale load, other -- higher other taxes and a prior period fuel adjustment. The impact of weather was favorable due to the warmer than normal temps in the winter of 2020. Other favorable items in this segment included the impact of rate changes across multiple jurisdictions, higher off-system sales and transmission revenue. The Transmission and Distribution Utilities segment earned $0.54 per share, up $0.01 from last year. Earnings in this segment were up due to higher transmission revenue, rate changes, weather and normalized retail load, partially offsetting these favorable items were higher tax, depreciation, O&M and interest expenses, as well as lower AFUDC. The AEP Transmission Holdco segment contributed $0.68 per share, up $0.21 from last year, for the same reasons identified in the quarterly comparison. Generation and Marketing produced $0.16 per share, down $0.02 from last year, due to favorable one-time items in the prior year relating to an Oklaunion ARO adjustment in the sale of Conesville, higher energy margins and lower expenses in the generation business offset the unfavorable ERCOT market prices on the wholesale business during Storm Uri in February. The decrease in renewables business was driven by lower energy margins and higher expenses. Finally, Corporate and Other was up $0.08 per share, driven by investment gains and lower taxes and partially offset by higher O&M. So, let me take a quick moment to comment about the investment gain which is predominantly a function of our direct and indirect investment in charge point. As you will see on the waterfall, this produced a $0.09 benefit year-to-date in 2021 as compared to the corresponding 2020 period. You may recall that in the fourth quarter and full year 2020, this investment produced a $0.05 contribution and we would expect the year-over-year variance to be more pronounced at this point in 2021 as we had no benefit during the same period in 2020. So, turning to page nine, I will update you on our normalized load performance for the quarter. Before I talk about class level trends, I’d like to start with a couple of observations at a macro level. So, first of all, since all of these charts are showing a year-over-year growth, it is important to recall that the second quarter of 2020 was at the trough of the recession when restrictions on businesses to manage the public health crisis were at their greatest. So the magnitude of growth percentages is being influenced by the comparison basis. And the second observation is that there has been a steady path to recovery since bottoming out in the second quarter of last year. The momentum we are seeing is a positive sign for the economic recovery throughout the serviced territory. So, if you start in the upper left corner, you will see that normalized residential sales were down 3.1% compared to last year bringing year-to-date decline down to 0.5%. As mentioned earlier, the comparison basis is the key here. You will notice that residential sales were up 6.2% when the COVID restrictions were at their greatest. In fact, one year later, they are only down 3.1% which suggests some of the increase in residential is having some staying power as more businesses have embraced a remote workforce for jobs that can be easily performed at home. In fact, the second quarter normalized sales in 2021 were the second highest second quarter on record exceeding every second quarter before the pandemic began. So moving to the right, weather normalized commercial sales increased by 10% bringing the year-to-date growth up to 3.9%. If you compare this with the residential class, you will notice the commercial sales growth in the second quarter is more symmetrical with last year when sales were down just over 10%. The growth in commercial sales for the quarter is spread across all operating companies and most sectors. The only sector that was down slightly compared to last year was grocery stores, which were very busy at the onset of the pandemic trying to keep shelves stocked when panic purchasing was at its highest. So moving to the lower left corner, you will see that the industrial sales also bounced back in the second quarter. Industrial sales for the quarter increased by 12.8% bringing the year-to-date growth up to 2 -- up 2.8%. Similar to commercial class -- the commercial class, you will see a symmetrical recovery compared to the second quarter of 2020 when sales were down 12.4%. Also industrial sales were up at every operating company and nearly every sector. The only industrial sector in our top 10 that reported less sales this year compared to the second quarter of 2020 is a paper manufacturing sector, which ironically was also higher last year, partially due to panic purchasing of toilet paper. This is a phenomenon that none of us is likely to forget especially if you were one of the folks who didn’t get a jump on it. Finally, in the lower right corner, you can see that in total normalized retail sales increased by 6.3% for the quarter and were up 1.9% through the first half of the year. By all indications, recovery from the pandemic and recession are on a firm footing. So, let’s go to slide 10. There are two more charts here that help put the second quarter normalized sales performance into perspective. The bar chart shows the last five years of weather normalized retail sales in the second quarters for the AEP System. Retail load performance in the second quarter of 2021 has not only recovered from the recession, but this is also the highest second quarter since 2018. The line chart on the bottom of this page shows the seasonally adjusted retail sales by quarter which provides an illustration of the trend of the recovery, and again, confirms that our current level of sales is the highest since the second quarter of 2018. So, before we leave the load story, let me remind you of an important factor to consider when evaluating the impact of load growth. The mix matters. So, while we are seeing strong growth now in commercial and industrial sales, those are priced at much lower realizations than the decline we are seeing in residential sales. To further illustrate this point, the impact of the pandemic was most pronounced in our biggest metropolitan area, that’s Columbus Ohio. Since Columbus -- since AEP Ohio is in the T&D Utility segment where we only collect an unbundled rate, the strong recovery that we are seeing this year is coming in at much lower realizations in the system average. Finally, let me remind you that there are rate design mechanisms in place to limit the exposure when entering a downturn that can also limit the impact when you are coming out of recession. So while the industrial sales are up significantly this year versus last year, it does not mean that revenues will increase by the same percentage. So what does all this mean when we think about the remainder of 2020? Well, it means that our confidence in our earnings guidance range is fortified by what we are seeing. It suggests that the low trends we anticipated are coming to fruition as the chart on page nine illustrates. Our continued investment at Transco is fueling strong performance in this segment beyond the favorable true-up impact that we had anticipated. And while O&M is up, it’s enabling us to take care of our business and customer needs given the low growth we are seeing. Obviously, we have the second half of the year to navigate, but we are pleased with the direction and are keeping a watchful eye on economic activity in our service territory, while scanning for any impact associated with rise in COVID variant. So, let’s check in on the company’s capitalization and liquidity position on page 11. On a GAAP basis, our debt to capital ratio increase 0.1% from the prior year quarter to 62.6% when adjusted for the Storm Uri event, the ratio remains consistent with year-end 2020 at 61.8%. Let’s talk about our FFO to debt metric. As it did in the first quarter the effect of Storm Uri continues to have a temporary and noticeable impact in 2021 on this metric. Taking a look at the upper right quadrant on this page, you will see that our FFO to debt metric based on the traditional Moody’s and GAAP calculated basis, as well as on an adjusted Moody’s and GAAP calculated basis. On a traditional unadjusted basis, our FFO to debt ratio increased by 0.2% during the quarter to 9.3% on a Moody’s basis. On an adjusted basis, the Moody’s FFO to debt metric is 12.8%. To be very clear, this 12.8% figure removes or adjusts the calculation to eliminate the impact of approximately $1.2 billion of cash outflows associated with covering the unplanned Uri driven fuel and purchase power costs in the SPP region directly impacting PSO and SWEPCO in particular. This metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. It should give you a sense of where we would be from a business as usual perspective. As you know, we are in frequent contact with the rating agencies to keep them apprised of all aspects of our business. The rating agencies continue to take the anticipated regulatory recovery into consideration as it relates to our credit rating. And importantly, there continues to be no change in our equity financing plan and our multiyear cash flow forecast is laid out on page 39 does not assume any asset rotation proceeds. Given the regulatory recovery activity that currently in flight, we do expect our FFO to debt cash flow metric to return to the low to mid-teens target range next year. So here’s a quick refresh on where all this regulatory activity stands today for PSO and SWEPCO. In Oklahoma, we are working through the regulatory process and anticipate issuing securitization bonds in the first half of 2022. In both Arkansas and Louisiana, recovery is underway, while final details get worked out in the regulatory process and we will be filing for recovery in Texas in the third quarter of 2021. So let’s take a quick moment to visit our liquidity summary on slide 11. You will see here that our liquidity position remains strong at $3.3 billion, supported by our five-year $4 billion bank revolver and two-year $1 billion revolving credit facility that we entered into on March 31st of this year. If you look at the lower left side of the page, you will see there are qualified pension continues to be well funded and our OpEd is funded at 174.2%. So let’s go to slide 12, we will do a quick wrap up and we can get your questions. Our performance in the first half of the year gives us confidence to reaffirm our operating earnings guidance range of $4.55 per share to $4.75 per share. Because of our ability to continue to invest in our own system organically including both our energy delivery system and the transformation of our generation fleet, we are confident in our ability to grow the company at our stated long-term growth rate of 5% to 7%. So we surely do appreciate your time and attention today. So, with that, I am going to turn the call over to the Operator for your questions.
Operator: Thank you. And that will come from the line of Julien Dumoulin-Smith with Bank of America. Please go ahead.
Julien Dumoulin-Smith: Hey. Good…
Nick Akins: Hi, Julien.
Julien Dumoulin-Smith: Thank you for all the remarks. I’d say at the pace that you guys were just talking I would have mistaken you guys sitting in New York or something like this?
Nick Akins: Yeah. No.
Julien Dumoulin-Smith: So, I am going to try to catch up on everything that was just said. But maybe in summary on the logos, I hear you. I think the critical comment you made was mixed. Where are you trending against your guidance range here as you think, but obviously third quarter matters critically, obviously kept intact the total load growth here? Any comments to just resolve that against the full year numbers, I mean, I know we are still early-ish in the year?
Nick Akins: Yeah. I think, well, you just sort of answered the question. We are still early in the year because the third quarter is particularly meaningful and we typically look after third quarter to see where we actually stand. But again, as Julie mentioned, OEM goes up commensurate with all the customer expansion as well and we have pretty sizable customer expansion. Look at the industrial and commercial numbers. They are up considerably. So and I think obviously without outstripping our estimate going into the year of what overall load growth would be. But it remains to be seen. Because I think we are sort of in a very cyclical period of trying to figure out what the future holds in terms of whether this other variant of COVID is going to have an impact or what happens actually is there are just pent-up frustration then it starts to moderate. What’s promising is though that we are seeing -- we are still seeing residential load, although it’s negative to 2020, it’s still a positive overall. So our original thesis of more residential load going forward. And if we can tie that together with improved industrial and commercial load as well, it could be very positive. But we certainly have to feel our way through that and really understand that. So we pass the third quarter before we really have a good feeling of that. Julie?
Julie Sloat: Yeah. Just maybe add a little finer point too. If you are thinking sequentially for the remainder of the year, our load growth rates are expected to moderate in the second half of the year based on prior year comps. So when you think about it, restrictions were most severe in the second quarter and by the third quarter of last year, so by the third quarter of last year, the service territory had begun essentially a phased reopening. And so as a result, the 6.3% growth for the second quarter, probably not only the highest growth in the quarter. And actually it is the highest growth in AEP’s history. But it will also be the highest load growth stat during the recovery. So if you think about the second half of the year, I would expect it year-over-year to moderate a little bit and so we are just keeping a watchful eye on how the trend continues to click along. I know I saw in The Wall Street Journal this morning CFOs commenting on where they think the economy is going to go, doesn’t look like anybody is changing their estimates based on COVID trends. But we are keeping an eye on that.
Julien Dumoulin-Smith: Got it. Excellent. Thank you. And then, if I can pivot the text, obviously, you all have a pretty meaningful footprint there. We have seen various legislative efforts underway. I am curious, as best you can tell thus far, I know it’s early. Any kind of context you can put especially on the transmission side, the potential project here? We are hearing from some of your peers about potentially meaningful shifts?
Nick Akins: Well, certainly, obviously, it remains to be seen as far as transmission investment and really we think of T&D and what part of the business is associated with T&D. We have made some inroads in terms of in terms of backup generation, those kinds of things in terms of transmission. I really think there’s probably continued opportunity for development of storage capability, of other transmission related investments on the grid to ensure that we are able to adjust that. For us, we are doing a lot in terms of line of sight into the transmission grid itself. We are continuing to expand our scale abilities, continuing to focus on our ability to have even more transmission in place, because if you are looking for additional generation to be placed in various areas, well, transmission is a big part of that solution as well. So is that, I think, Texas is sort of a microcosm of the country when you start reevaluating the system based upon the needs from not only a natural gas perspective, but also from a renewable perspective, that brings in the whole planning effort and communication in real time associated with the operations of the transmission and it -- for that matter the distribution system as well. So I think they are making the right steps and I think there’s more steps to be made so and it’s going to be a sort of a multiyear top of effort, and of course, we are a big part of the transmission in Texas. So we will be certainly very focused on how the T&D business can be expanded to improve the resiliency of the T&D efforts. But that means Texas is really going to have to start thinking about resources and a broader view of resources like we are having to do for the rest of the system and transmission technologies, and for that matter, distribution technologies are going to have to be recognized in its ability to provide a more resilient grid. You can’t have these strict lines drawn between generation and transmission and distribution because that’s not the world we are in anymore. So, we will continue that focus. Every legislative session, every regulatory session will be centered on that effort.
Julien Dumoulin-Smith: Excellent. Just last, Kentucky, I know you can’t say much, but what’s the level of interest if you can give any kind of parameters?
Nick Akins: Yeah. So, yeah, obviously, I don’t want to get into too much detail there. I think, again, you answered it sort of right at the beginning. It is a confidential process. But I can say that we do have a credible interest and it is a competitive process.
Julien Dumoulin-Smith: Excellent. Thank you all. Take care.
Nick Akins: Okay.
Operator: Thank you. Our next question comes from Steve Fleishman with Wolfe Research. Please go ahead.
Nick Akins: Good morning, Steve.
Steve Fleishman: Hey. Good morning. Can you hear me, Nick?
Nick Akins: Good morning. Oh! Yeah. I can hear you fine.
Steve Fleishman: Okay. Great. Thanks. I might have missed this, but just where are you on this $600 million of equity plan for this year? How much have you issued so far?
Julie Sloat: Yeah. Thanks for the question, Steve. We have actually used the ATM to issue just under $200 million. I think there’s around $195 million that was associated with the financing of the Sundance North Central wind facility and we will be continuing on with the rest of that program. As you know, about $100 million of that $600 million is also associated with the drip. So that continues to play in the background. Does that help?
Steve Fleishman: Okay.
Julie Sloat: Yeah.
Steve Fleishman: And then just -- this might be a little bit hard to answer, but just in terms of thinking about the $1.4 billion for next year that’s in the plan. Obviously, if you were to sell Kentucky, some of that could maybe offset some of that. So just -- could you just give us latest thoughts on how to think about the Kentucky outcome relative to that $1.4 billion for next year?
Julie Sloat: Yeah. And then, I will -- Nick can add a finer point from a strategic perspective. But purely from a financing perspective, you are right on the money, Steve. So we got $1.4 billion embedded in our plan. And for those of you who following along at home, we are on page 39 of the cash flow if you want to take a look at 2022. About $100 million of that again is associated with the drip, about $800 million is associated with north central wind financing and then we have another $500 million just associated with general funding of growth CapEx. And so to your point, Steve, to the extent that we would find ourselves in a situation where we were able to transact and bring dollars in the door, we would absolutely be able to work off some of that, otherwise equity issuance and sidestep that. So I don’t -- I can’t give you a number. We don’t have a transaction. But that is absolutely the thinking and how we are modeling different scenarios inside the house. And I don’t know, Nick, if you have any comment, it would be great.
Nick Akins: Well, I think, you covered it well. As far as -- it’s great to have a financing plan assuming Kentucky a sale at Kentucky doesn’t happen. But also it’s great to have options available to further optimize what that financing plan looks like. So and it is -- and I will say again, the timing particularly with Traverse being the last one, it’s the largest one in first quarter 2022, that sums up pretty well with this process. So we will get this resolved and there will be finance one way or another, but at the end of the day, the timing of it and the process is continuing on plan.
Julie Sloat: And just if I could…
Steve Fleishman: Okay.
Julie Sloat: …to follow up…
Steve Fleishman: Yeah.
Julie Sloat: …Steve. Again just to reiterate. The plan as it stands today, as you know, assumes no asset rotation. And again, I want to reinforce that, the 5% to 7% is well intact even if we don’t have a transaction.
Steve Fleishman: Okay. And are you -- do you have a bias within that range at all or just the kind of that’s the range?
Nick Akins: That’s -- probably we can’t answer at this point, Steve.
Steve Fleishman: Okay. So you are being very unbiased?
Nick Akins: We are.
Steve Fleishman: Smart move. Okay. Thanks so much.
Nick Akins: Yeah. Sure. Thanks.
Operator: Thank you. Our next question comes from the line of Shahriar Pourreza with Guggenheim Partners. Please go ahead.
Nick Akins: Good morning, Shahriar.
Shahriar Pourreza: Hey. Good morning, guys. I wanted to start with a recent event and get your sense on the Mitchell order and Kentucky, sort of rejecting the rate increase you saw, and obviously, it’s not a surprise well on AG strong comments prior to the decision. Nick is this sort of a signal that the state and the PSC in general they are starting to commit to maybe a little bit more of a rational thinking around an economic approach to coal like the least cost approach is just starting to bend further towards renewable. So how do we think about the viability of the plant in the state and could we see some acceleration of that 1.4-gig of solar and when you bought into plan for the state on a prior call as a direct grid? And then, how do we sort of think about West Virginia’s rate request coming off the Kentucky order?
Nick Akins: Yeah. That’s right. It’s sort of interesting. I mean, it’s multi-jurisdictional, as you know, and Mitchell is wheeling in Kentucky Power. And I think we have to get resolved Kentucky, Virginia and West Virginia. West Virginia has yet to speak on this issue, but -- and it’s only the ALJ in Virginia. So we will hear more on from Virginia on that. But I think it’s really important for us to really hold on our cards for now, because we got to get through a state process. It’s good to have clarity. And I think Kentucky, obviously, is the first shoe to drop in this regard. But we have also made it clear that these are multi-jurisdiction unit. So we have to make sure that there’s some compatibility of the jurisdictions that are involved. We will go through the process. We will get the initial views of the commissions and then if they are on different tracks, we will have to further analyze and resolve that with the commissions and there’s a lot of resolutions that could occur. Some are shorter, some are longer. But we have to understand where all three commissions are before really doing anything. I think it’s good to get clarity though and I think it’s pretty important that whether it’s the ELG or the CCR, if they approve CCR investments, but don’t improve -- approve ELG investments, then that effectively brings the generation retirement dates back from 2014 to 2028. So that’s something we have to consider along with those commissions. But we will know more about this in the August time frame. But I’d be hesitant to say what Kentucky, it’s pretty interesting that they would be looking at the ELG part of it. And I think there is becoming more of an awareness of -- that there has to be a plan. Now what that plan is, we have got a fully resolved with all those commissions. So, more to come on that.
Shahriar Pourreza: Got it. And thanks for the visibility around sort of the Kentucky process. I know, Nick, you obviously mentioned that further optimization is always a possibility. Remind us just like that sugar point is the shaping of that for instance that 16.6 gigawatts of renewables you discussed in the prior call. Obviously, Kentucky will more than likely backfill some of your North Central equity needs. So as you are thinking about further optimization, should we be watching the outcomes at the IRPs, the PSC approval, how much you plan to own versus PPA, which I guess would stipulate your incremental equity needs and the resulting size of potentially further optimization measures?
Nick Akins: Yeah. Yeah. So -- and just like, we have gone through probably a couple of years now of discussions about how North Central is going to get financed and we are finally getting to a point where ultimately we will know how it’s being financed. The 16.6 gigawatts and -- is, certainly, we made a pretty credible case that we ought to own a significant part of that. I’d like to own all of it. But certainly, if -- but operationally, and from a contracting standpoint, and certainly, the ability for us to respond to a system related activities, it’s important for us to own and control those assets. And I think that, as we go forward, you are right, it will be the integrated resource planning filings that were made, there will start that dialogue, now we are in the process of doing RFPs to get more information obviously from the -- for the market in terms of what’s out there from a developmental perspective and that process is ongoing. So, that will certainly fortify any CCN filings we have to make or anything like that after the resource planning filings. But the resource planning filings will be your first real dialogue around how quickly this transformation will occur and in each one of the jurisdictions. And so, we are feeling pretty good about it, because it’s getting to a point where we have to decide from a capacity standpoint, how we support these utilities and it’s pretty clear to me that the movement is to that clean energy economy to move it is to toward as long as you have some element of baseload 24x7 capacity, that renewables will be the big part of that. So, a lot of that’s just becoming, I think, it’s becoming much more transparent and our jurisdictions, I think, their conditions both federally and from a state perspective, they are just a better realization of what the options are and the timing of those options. And that’s what will drive of course to that resource planning process.
Shahriar Pourreza: Got it. And lastly for me and I apologize if I am putting you on the spot, Nick. The news just broke out this morning. But is there any kind of refer to the First Energy deferred prosecution agreement that was announced this morning to the SEC investigation at AEP?
Nick Akins: No. Like I said before, we are on the outside looking in. We have no knowledge of any of that activity. And so if the report is true, I am glad to see that there is some element of putting all these in a rearview mirror, because naturally, and I said before, AEP has been hung up in the wake of that. And I am certainly hopeful that there’s some closure brought about from that. So, but, yeah, I have -- it was a surprise to me and we knew nothing about it, and certainly, there’s really nothing else that we have -- that AEP can say other than what we have put on our website and naturally there’s just nothing to report from our perspective.
Shahriar Pourreza: Terrific. Thank you, Nick and Julie. Congrats on today’s results.
Nick Akins: Yeah. Okay.
Operator: Thank you. Our next question comes from the line of Stephen Byrd with Morgan Stanley. Please go ahead.
Nick Akins: Good morning, Stephen.
Stephen Byrd: Hey. Good morning.
Nick Akins: How are you?
Stephen Byrd: Congrats on a constructive update and on weeping in, you mentioned of both, Carly Simon and a maybe a first.
Nick Akins: Yeah. Right.
Stephen Byrd: Okay. So a lot has been covered . Just wanted to discuss on Kentucky, if there are approaches that can help minimize tax leakage, how are you all thinking about sort of ability to bring proceeds back and sort of the impact of taxes?
Julie Sloat: Yeah. Thanks for the question, Stephen. As you know, we are a little tax efficient right now. So, given the tax basis in Kentucky and the different hurdles that we are considering, I wouldn’t see that one being a show stopper. And quite frankly, that might give us an opportunity to enhance or improve our tax efficiency without getting into a bunch of numbers. I wouldn’t let that trip you up in terms of what things could stop us moving forward.
Stephen Byrd: Yeah. That’s helpful. And then maybe just thinking through the upcoming RFPs, you mentioned the APCo and SWEPCO RFPs, could you just talk a little more detail in terms of color around the timetable there? And I am sorry if I missed that if you all did go through it. I don’t -- didn’t quite follow there, I am just thinking about sort of what that might mean for timing of incremental spending and sort of how we should think about those processes?
Nick Akins: Yeah. So, we have certainly gone through the basic requirements for the RFPs for all of these areas. But as we go through that process, there is -- at APCo, we issued an RFP there for 300 megawatts of solar and wind resources really for a completion date of 2023 or 2024. And then in May of 2021, APCo issued an RFP to obtain, I guess, it was 100 megawatts of solar and wind energy via PPA and RFP for the renewable energy certificates only, which is consistent with the Virginia and what their requirements are. And then, SWEPCO issued an RFP for own resources up to 3,000 megawatts of wind and up to 300 megawatts of solar resources with optional battery storage by the way that can achieve a completion by 2024 to 2025. And they are also seeking 200 megawatts of capacity into 2023 to 2024 range and another 250 into 2025 to 2027 range, so those bids are due in mid-August. And then at PSO, we -- in June, we notified the regulators that it intends -- we intend to issue an RFP seeking up to 2,600 megawatts of wind and up to 1,350 megawatts of solar, again with options for battery storage consideration and that’s meeting capacity needs by 2025. So and then PSO plans to issue the RFP in October of this year. So those are the ones that are on the Board right now, and have really some near-term related requirements and most are capacity related requirements. So, and again, they are being done pretty much the same way as the others with North Central that we will certainly do more of it of a turnkey type of thing where we take ownership at the time it is approved in rate. So, and then, of course, we will go through the process of approvals by the various commissions along the way. So, but that’s the plan right now. And then, we will continue to -- as a matter of fact, we are spending a lot of time with our Board focused on the strategies related to these types of filings and the plan long-term and it’s important for everyone to understand this is going to be a continual process. And you are just seeing the first part of these really driven by capacity requirements and not just sort of an energy convenience. So, I think, they are really good to go out with right now and that’s what we have at this point.
Stephen Byrd: That’s really helpful. That’s all I had. Thank you.
Operator: Thank you. Our next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead.
Jeremy Tonet: Hi. Good morning.
Nick Akins: Good morning. How are you doing?
Jeremy Tonet: Good. Good.
Nick Akins: Okay.
Jeremy Tonet: Just wanted to pick up on Kentucky a little bit more, if that’s possible and I just want to know if you might be able to comment in any degree to whether the strategic review process has received more interest from strategic or financial players? And then as well, kind of given strong prices achieved in recent industry transactions and the strong interest here in Kentucky, has this process made you thought about more asset rotation beyond Kentucky to increase balance sheet headroom overall?
Nick Akins: Yeah. So, for the first question, we started out this process saying that that we expected to get strategics and financials, and we have strategics and financials, so both are involved. And then as far as your second question is concerned, as I said earlier with the Foo Fighters dialogue, this is going to be a continual process for us. And if we are practically fully regulated so we have the opportunities to look at if we are building 16.6 gigawatts of renewables resources during the transition, then we got to think -- we have to have everything on the table in terms of sources and uses. So we are going to go through that process, and of course, Kentucky is sort of a first stop, but we will continue to evaluate our assets as sources. And if it makes sense, based upon what the other opportunities are, then that’s the kind of framework that we want to move this company toward.
Jeremy Tonet: Got it. That’s helpful. Thanks for that. And then there’s news coming out of FERC with regards to kind of the transmission planning process. I am just wondering if you might be able to provide some thoughts on -- your thoughts on what’s been said recently and what you see is kind of best practices here?
Nick Akins: Yeah. So, obviously, we would like to see a much better transmission related planning across regions and AEP does a pretty good job itself in terms of transmission planning, because we do have a large system to consider. But at the same, RTO to RTO type planning process to try to make them more consistent so you can have this large transmission being built across regions and across states. If you are going to get that going, particularly as you are trying to get renewable resources to load centers, we are going to have to resolve these issues around multi-jurisdictional, multi-RTO type of analyses and making sure that we are consistent. The other part too is we have got to have consistency in terms of rate making and this notion of reevaluating incentives, structures and those types of things is not good for making decisions relative to transmission or -- and this is not good relative to the RTO model itself. So, I think, FERC really needs to sort of step back and take a look at it. And I think it’s a real positive approach to be focusing on the planning aspects and addressing RTO to RTO boundaries, addressing areas where, what’s competitive, what’s not competitive, all those types of things, that’s fine. But we have to have a clear planning process. And first of all, you can’t have coming back later after a project, multi-millions have been spent on a project to, say, we are going to stop the project. That has to change. And the other part of it is, we have got to be able to make these investments with some sense of certainty and be able to move quickly to make that happen. So, I just -- I think, there’s only so much value -- there’s a lot of value of being in an RTO for customers. But there also has to be value for the companies involved from -- to make the investments that benefit customers in orders of magnitude greater than what the costs are related to, any incentives related to transmission. And if you want to send a bad message for anybody to join an RTO or anybody to stay in an RTO, it’s just not good to start messing around with what the assumptions are relative to the future recovery of transmission investment. And now, when you start questioning incentives, you are really questioning anybody that’s trying to put a multiyear model together to show the benefits of transmission has to take that into account that something may change. So, like trying to make an investment in a coal unit, with clean energy activities going on in Washington. So you really do have to really think this process through and think about what you are trying to achieve. Sorry, I went on that one though.
Jeremy Tonet: No. That’s helpful. Thank you for that. I will stop there. Thank you.
Nick Akins: Thank you.
Operator: Thank you. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Please go ahead.
Nick Akins: Hey, Durgesh. How are you?
Durgesh Chopra: Hey. Good morning, Nick. Thanks for taking my question.
Nick Akins: Good morning.
Durgesh Chopra: Hey. You addressed sort of a lot of transmission questions in the Q&A. Maybe just like the MISO transmission opportunity that the MISO has flagged perhaps just sort of unveiled towards the end of the year. I know a small sort of a set of assets for you in that location. But could you compete for some of those projects? Could that be an upside for you there?
Nick Akins: Oh! Yeah. We could. We could compete with our Transource entity, which we have been. But, yeah, we could. And actually a small impact for us as it stands. But certainly, we could certainly participate in any of that, yeah.
Durgesh Chopra: Understood. And then just anything you are hearing at your level and your peers and through the sort of the EI organization. I mean the infrastructure bill has a pretty sizable CapEx on the transmission side or investment on the transmission side. Just anything you are hearing from that on the federal front?
Nick Akins: Yeah. So, obviously, we have the, I guess, that’s $1.2 trillion, the infrastructure bill that -- it’s interesting we are talking in trillions as opposed to billions now. But in terms of the hard infrastructure side of things, yeah, it appears there’s some kind of convergence in Washington on that particular issue, although, more has to be done on the actual language and things like that. But as far as pursuing the advancement of, and certainly, transmission investment, but direct pay and those kinds of issues are clearly important along the way. We also have to, as far as, renewables and clean energy, PTCs, ITCs extensions of those, I think that makes sense, particularly RSI did the delays because of COVID and that kind of thing. So I think there’s opportunities for that and then as far as electric vehicles, certainly we would like to see electric vehicle infrastructure continue to be developed. So, I think all of those areas are positive. The issue is how you leverage into the private. The private companies like ours or that instead of the government funding and for transmission, for example, we think that mechanisms already exist for the development of transmission as long as you can keep all the incentives and all that kind of stuff. But -- so the federal and -- federal government funding of that now is, I think, you have to sort of think about what level of encouragement and what area. So, if they can make siding much better, if they can make, certainly, the focus on planning. Those issues enable transmission to get investments. We have no problem financing transmission investments. So I think the government probably ought to pick and choose between what they truly want to focus on that not already leveraged into the utilities, for example. They can certainly encourage development of electric vehicles with the focus on charging station infrastructure and those types of things that would be a benefit. And then, as far as the renewables transformation or the clean energy transformation, any kind of hard infrastructure around being able to move more quickly from a renewable standpoint, whether tax incentives and also uh other technologies like storage. And then also, we would like to see benefits related to either tax incentives for coal-fired generation to reduce the underappreciated plant balances, for example. If you want to have a national plan around moving to a clean energy economy, then the more quickly we can reduce underappreciated plant balances, the better we are able to make decisions and conditions, and states can make decisions about what future resource replacements would be. So I think there’s several ways to really focus on this. But we are all moving toward a clean energy economy. We just need to make sure that the government doesn’t try to do too much across the Board as opposed to very selected areas that enable investment to continue in the private sector. That would be my view.
Durgesh Chopra: Appreciate that color, Nick. Really quick just -- good to see First Energy with all the DOJ investigation or at least have an agreement this morning they highlighted. Just any update on the SEC subpoena you got? Any more color that you can share with us?
Nick Akins: No. Nothing new there. We are -- we have been communicating with the SEC and we are responsive to any requests they have from a documentation standpoint. And we are going to continue to work with them and be supportive and constructive in the process and but nothing new to report there.
Durgesh Chopra: Understood. Thank you for taking my questions.
Nick Akins: Yeah.
Operator: Thank you. And our final question comes from the line of Michael Lapides with Goldman Sachs. Please go ahead.
Michael Lapides: Nice try on that one.
Nick Akins: Michael who?
Michael Lapides: Yeah. Hey. Actually, Michael, the guy who’s excited about the changes in the Southeastern Conference they had. Hey, guys, real quick question or two. First of all, one on O&M this year, obviously, O&M at the VIU segment is up a lot. How do you think about what the second half of the year O&M trajectory looks like versus the first half? And how should we think about both for VIU and T&D kind of segments, the long-term kind of the 2022 and beyond trajectory for O&M?
Nick Akins: Yeah. I will just generally say, and Julie can certainly follow up on this, but as you have expansions in customer load, you are going to have higher O&M associated with that, but that’s a good expansion. The issue for us is, what we typically do is, we are evaluating the true impacts of our Achieving Excellence Program against what our forecast needs to be in terms of bending the O&M curve. So we continue to take account of the good O&M that supports the expansion from a customer load perspective, but also continue to not only optimize that, but also continue the overall optimization of the O&M budget itself. So, yeah, you may see it, and that’s why, obviously, we are watching what third quarter looks like and fourth quarter with the low it does. But we want to make absolutely sure that we are continuing to make progress consistent with that plan of consistent earnings and dividend improvements in that 5% to 7% growth trajectory. So that’s what we are doing. We are not just saying, oh, yeah, load’s going up, let’s spend more O&M. It really is a measured approach from our perspective. Julie?
Julie Sloat: Yeah. No. That’s spot on, Nick. And thanks for the question, Michael. As I am sitting here thinking about this and as we were preparing for the earnings call, one of the things I am looking at is the mix point. You look at where load is coming in. And as mentioned in a previous answer to a question, we do expect that load on a relative basis. When you compare it to last year, for the second half, it would not be as pronounced, although we do expect it to continue to improve. So that’s a good thing. And that allows us to be a little more comfortable with O&M costs where they are, because that does help the customer in the long run. So we keep that top of mind and continue to be very diligent about managing costs. But if you are trying to model for the rest of the year, let me start by saying this, we are not changing our guidance. But as you know, once we start the year and we give you that plan, so you see that waterfall that we give to you, how we get to the end of the year, obviously changes, right, because it’s a dynamic business. So I wouldn’t be surprised if relative to that plan, if you saw our O&M be running a little richer. But I would hope that load would be hanging in there too. And then, as you know, we are doing well on the Transmission Holdco segment already kind of clipping along where we thought we would be for the full year. So there may be some benefit there too. So do keep that in mind when you go back and compare and contrast to that guidance walk that we gave to you. I think it was on February 25th during our earnings call and then we are happy to help you with any modeling that you have offline.
Michael Lapides: No. That sounds great. Thanks, guys. Much appreciated.
Nick Akins: Sure. Thanks.
Darcy Reese: Thank you for joining us on today’s call. As always, the IR team will be available to answer any additional questions you may have. Toni, would you please give the replay information.
Operator: Ladies and gentlemen, this conference will be available for a replay after 11:30 a.m. Eastern today through July 29, 2021. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering access code 4754105. International participants may dial 402-970-0847. Those numbers again are 1-866-207-1041 and 402-970-0847 with access code 4754105. That does conclude our conference for today. We thank you for your participation and for using AT&T conferencing service. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. And welcome to the American Electric Power Second Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded. I would now like to turn the conference to our host, Vice President of Investor Relations, Ms. Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Toni. Good morning, everyone. And welcome to the second quarter 2021 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides and related financial information are available on our website at aep.com."
},
{
"speaker": "Nick Akins",
"text": "Okay. Thanks, Darcy. And welcome again everyone to American Electric Power’s second quarter 2021 earnings call. Today we reported a strong second quarter operating earnings of a $1.18 per share versus a $1.08 for the same period of 2020. Our second quarter results reflect significant progress in terms of economic recovery throughout AEP service territory, with a continued focus on OEM as we navigate through what is hopefully an emergence from the COVID-19 pandemic. Gross regional product has already exceeded its pre-pandemic levels and important across AEP service territory is now 2% of its pre-pandemic levels after adding over a 163,000 jobs in the first six months of this year. Increased vaccinations combined with the additional fiscal stimulus from the American Rescue Plan are contributing to the strong demand for goods and services throughout the economy. AEP’s normalized retail sales in the second quarter of 2021 were the highest we have seen since the second quarter of 2018. Clearly, we are pleased with the improvements we have seen thus far and we will continue to monitor the recovery’s progress over the second half of the year. Accordingly, we are reaffirming our 2021 guidance range of $4.55 per share to $4.75 per share and a 5% to 7% long-term growth rate and would be again disappointed not to be in the upper half of our stated guidance range as we have previously stated. Julie will be discussing these issues in more detail in her report. Rate case activity across our jurisdictions continues to be active and substantial. In Ohio, we are awaiting an order by the commission on the settlement reach involved with the commission earlier this year. As a reminder, the settlement has broad support in the settling parties including the commission staff, the Ohio Consumers Council, industrial companies, commercial companies and other entities like the Ohio Hospital Association. We expect a decision in the third quarter of this year. Public Service Company of Oklahoma filed a rate case at the end of April. PSO is seeking $115.4 million net revenue increase and a 10% ROE. The following transitions North Central costs from the right established in the approval into base rates."
},
{
"speaker": "Julie Sloat",
"text": "All right. Thanks, Nick. Thanks, Darcy. It’s good to be with everyone this morning. I am going to walk us through the second quarter and year-to-date financial results, share some thoughts on our service territory load and finish with a review of our credit metrics and liquidity. So let’s go to slide number six which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $1.16 per share, compared to $1.05 per share in 2020. GAAP earnings through June were $2.31 per share, compared to $2.05 per share in 2020. There’s a reconciliation of GAAP to operating earnings on pages 14 and 15 of the presentation today. So let’s walk through our quarterly operating earnings performance by segment that’s laid out on slide number seven. Operating earnings for the second quarter totaled $1.18 per share or $590 million, compared to $1.98 per share or $534 million in 2020. Operating earnings for the Vertically Integrated Utilities were $0.45 per share, down $0.10 driven by a year-over-year increase in the O&M due to lower prior year O&M, which included actions we took to adjust to the pandemic. Other pressures included lower wholesale load and higher depreciation and other taxes. These items were partially offset by the impact of rate changes across multiple jurisdictions, higher normalized retail load, transmission revenue and off system sales. The Transmission and Distribution Utilities segment earned $0.31 per share, up $0.02 from last year. Favorable drivers in this segment included higher normalized retail load, transmission revenue and rate changes, partially offsetting these favorable items were higher tax, depreciation and O&M expenses, as well as unfavorable weather and lower AFUDC. The AEP Transmission Holdco segment continued to grow contributing $0.34 per share, an improvement of $0.15, which got a boost because of the unfavorable annual true-up last year consistent with the 2021 earnings guidance assumptions we had provided to you. Our fundamental return on investment growth continued as net plant increased by $1.4 billion or 13% since June of last year. Generation and Marketing produced $0.09 per share, down $0.02 from last year, influenced by the prior year land sales and one-time items relating to an Oklaunion ARO adjustment in the sale of Conesville. We were mostly offset in the generation business by higher energy margins and lower expenses from the retirement of Oklaunion. Finally, Corporate and Other was up $0.05 per share, driven by investment gains, lower tax -- and lower taxes, which was partially offset by higher O&M and net interest expense. So bear with me a moment, I am going to talk a little bit more about that investment gain as we walk through the year-to-date view. So, if you flip to slide eight, we can look at year-to-date results. Operating earnings through June totaled $2.33 per share or $1.2 billion, compared to $2.10 per share or $1 billion in 2020. Looking at the drivers by segment, operating earnings for Vertically Integrated Utilities were $1 per share, down $0.05 due to higher O&M and depreciation expenses. Other smaller increases included lower normalized retail and wholesale load, other -- higher other taxes and a prior period fuel adjustment. The impact of weather was favorable due to the warmer than normal temps in the winter of 2020. Other favorable items in this segment included the impact of rate changes across multiple jurisdictions, higher off-system sales and transmission revenue. The Transmission and Distribution Utilities segment earned $0.54 per share, up $0.01 from last year. Earnings in this segment were up due to higher transmission revenue, rate changes, weather and normalized retail load, partially offsetting these favorable items were higher tax, depreciation, O&M and interest expenses, as well as lower AFUDC. The AEP Transmission Holdco segment contributed $0.68 per share, up $0.21 from last year, for the same reasons identified in the quarterly comparison. Generation and Marketing produced $0.16 per share, down $0.02 from last year, due to favorable one-time items in the prior year relating to an Oklaunion ARO adjustment in the sale of Conesville, higher energy margins and lower expenses in the generation business offset the unfavorable ERCOT market prices on the wholesale business during Storm Uri in February. The decrease in renewables business was driven by lower energy margins and higher expenses. Finally, Corporate and Other was up $0.08 per share, driven by investment gains and lower taxes and partially offset by higher O&M. So, let me take a quick moment to comment about the investment gain which is predominantly a function of our direct and indirect investment in charge point. As you will see on the waterfall, this produced a $0.09 benefit year-to-date in 2021 as compared to the corresponding 2020 period. You may recall that in the fourth quarter and full year 2020, this investment produced a $0.05 contribution and we would expect the year-over-year variance to be more pronounced at this point in 2021 as we had no benefit during the same period in 2020. So, turning to page nine, I will update you on our normalized load performance for the quarter. Before I talk about class level trends, I’d like to start with a couple of observations at a macro level. So, first of all, since all of these charts are showing a year-over-year growth, it is important to recall that the second quarter of 2020 was at the trough of the recession when restrictions on businesses to manage the public health crisis were at their greatest. So the magnitude of growth percentages is being influenced by the comparison basis. And the second observation is that there has been a steady path to recovery since bottoming out in the second quarter of last year. The momentum we are seeing is a positive sign for the economic recovery throughout the serviced territory. So, if you start in the upper left corner, you will see that normalized residential sales were down 3.1% compared to last year bringing year-to-date decline down to 0.5%. As mentioned earlier, the comparison basis is the key here. You will notice that residential sales were up 6.2% when the COVID restrictions were at their greatest. In fact, one year later, they are only down 3.1% which suggests some of the increase in residential is having some staying power as more businesses have embraced a remote workforce for jobs that can be easily performed at home. In fact, the second quarter normalized sales in 2021 were the second highest second quarter on record exceeding every second quarter before the pandemic began. So moving to the right, weather normalized commercial sales increased by 10% bringing the year-to-date growth up to 3.9%. If you compare this with the residential class, you will notice the commercial sales growth in the second quarter is more symmetrical with last year when sales were down just over 10%. The growth in commercial sales for the quarter is spread across all operating companies and most sectors. The only sector that was down slightly compared to last year was grocery stores, which were very busy at the onset of the pandemic trying to keep shelves stocked when panic purchasing was at its highest. So moving to the lower left corner, you will see that the industrial sales also bounced back in the second quarter. Industrial sales for the quarter increased by 12.8% bringing the year-to-date growth up to 2 -- up 2.8%. Similar to commercial class -- the commercial class, you will see a symmetrical recovery compared to the second quarter of 2020 when sales were down 12.4%. Also industrial sales were up at every operating company and nearly every sector. The only industrial sector in our top 10 that reported less sales this year compared to the second quarter of 2020 is a paper manufacturing sector, which ironically was also higher last year, partially due to panic purchasing of toilet paper. This is a phenomenon that none of us is likely to forget especially if you were one of the folks who didn’t get a jump on it. Finally, in the lower right corner, you can see that in total normalized retail sales increased by 6.3% for the quarter and were up 1.9% through the first half of the year. By all indications, recovery from the pandemic and recession are on a firm footing. So, let’s go to slide 10. There are two more charts here that help put the second quarter normalized sales performance into perspective. The bar chart shows the last five years of weather normalized retail sales in the second quarters for the AEP System. Retail load performance in the second quarter of 2021 has not only recovered from the recession, but this is also the highest second quarter since 2018. The line chart on the bottom of this page shows the seasonally adjusted retail sales by quarter which provides an illustration of the trend of the recovery, and again, confirms that our current level of sales is the highest since the second quarter of 2018. So, before we leave the load story, let me remind you of an important factor to consider when evaluating the impact of load growth. The mix matters. So, while we are seeing strong growth now in commercial and industrial sales, those are priced at much lower realizations than the decline we are seeing in residential sales. To further illustrate this point, the impact of the pandemic was most pronounced in our biggest metropolitan area, that’s Columbus Ohio. Since Columbus -- since AEP Ohio is in the T&D Utility segment where we only collect an unbundled rate, the strong recovery that we are seeing this year is coming in at much lower realizations in the system average. Finally, let me remind you that there are rate design mechanisms in place to limit the exposure when entering a downturn that can also limit the impact when you are coming out of recession. So while the industrial sales are up significantly this year versus last year, it does not mean that revenues will increase by the same percentage. So what does all this mean when we think about the remainder of 2020? Well, it means that our confidence in our earnings guidance range is fortified by what we are seeing. It suggests that the low trends we anticipated are coming to fruition as the chart on page nine illustrates. Our continued investment at Transco is fueling strong performance in this segment beyond the favorable true-up impact that we had anticipated. And while O&M is up, it’s enabling us to take care of our business and customer needs given the low growth we are seeing. Obviously, we have the second half of the year to navigate, but we are pleased with the direction and are keeping a watchful eye on economic activity in our service territory, while scanning for any impact associated with rise in COVID variant. So, let’s check in on the company’s capitalization and liquidity position on page 11. On a GAAP basis, our debt to capital ratio increase 0.1% from the prior year quarter to 62.6% when adjusted for the Storm Uri event, the ratio remains consistent with year-end 2020 at 61.8%. Let’s talk about our FFO to debt metric. As it did in the first quarter the effect of Storm Uri continues to have a temporary and noticeable impact in 2021 on this metric. Taking a look at the upper right quadrant on this page, you will see that our FFO to debt metric based on the traditional Moody’s and GAAP calculated basis, as well as on an adjusted Moody’s and GAAP calculated basis. On a traditional unadjusted basis, our FFO to debt ratio increased by 0.2% during the quarter to 9.3% on a Moody’s basis. On an adjusted basis, the Moody’s FFO to debt metric is 12.8%. To be very clear, this 12.8% figure removes or adjusts the calculation to eliminate the impact of approximately $1.2 billion of cash outflows associated with covering the unplanned Uri driven fuel and purchase power costs in the SPP region directly impacting PSO and SWEPCO in particular. This metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. It should give you a sense of where we would be from a business as usual perspective. As you know, we are in frequent contact with the rating agencies to keep them apprised of all aspects of our business. The rating agencies continue to take the anticipated regulatory recovery into consideration as it relates to our credit rating. And importantly, there continues to be no change in our equity financing plan and our multiyear cash flow forecast is laid out on page 39 does not assume any asset rotation proceeds. Given the regulatory recovery activity that currently in flight, we do expect our FFO to debt cash flow metric to return to the low to mid-teens target range next year. So here’s a quick refresh on where all this regulatory activity stands today for PSO and SWEPCO. In Oklahoma, we are working through the regulatory process and anticipate issuing securitization bonds in the first half of 2022. In both Arkansas and Louisiana, recovery is underway, while final details get worked out in the regulatory process and we will be filing for recovery in Texas in the third quarter of 2021. So let’s take a quick moment to visit our liquidity summary on slide 11. You will see here that our liquidity position remains strong at $3.3 billion, supported by our five-year $4 billion bank revolver and two-year $1 billion revolving credit facility that we entered into on March 31st of this year. If you look at the lower left side of the page, you will see there are qualified pension continues to be well funded and our OpEd is funded at 174.2%. So let’s go to slide 12, we will do a quick wrap up and we can get your questions. Our performance in the first half of the year gives us confidence to reaffirm our operating earnings guidance range of $4.55 per share to $4.75 per share. Because of our ability to continue to invest in our own system organically including both our energy delivery system and the transformation of our generation fleet, we are confident in our ability to grow the company at our stated long-term growth rate of 5% to 7%. So we surely do appreciate your time and attention today. So, with that, I am going to turn the call over to the Operator for your questions."
},
{
"speaker": "Operator",
"text": "Thank you. And that will come from the line of Julien Dumoulin-Smith with Bank of America. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey. Good…"
},
{
"speaker": "Nick Akins",
"text": "Hi, Julien."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Thank you for all the remarks. I’d say at the pace that you guys were just talking I would have mistaken you guys sitting in New York or something like this?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. No."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "So, I am going to try to catch up on everything that was just said. But maybe in summary on the logos, I hear you. I think the critical comment you made was mixed. Where are you trending against your guidance range here as you think, but obviously third quarter matters critically, obviously kept intact the total load growth here? Any comments to just resolve that against the full year numbers, I mean, I know we are still early-ish in the year?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. I think, well, you just sort of answered the question. We are still early in the year because the third quarter is particularly meaningful and we typically look after third quarter to see where we actually stand. But again, as Julie mentioned, OEM goes up commensurate with all the customer expansion as well and we have pretty sizable customer expansion. Look at the industrial and commercial numbers. They are up considerably. So and I think obviously without outstripping our estimate going into the year of what overall load growth would be. But it remains to be seen. Because I think we are sort of in a very cyclical period of trying to figure out what the future holds in terms of whether this other variant of COVID is going to have an impact or what happens actually is there are just pent-up frustration then it starts to moderate. What’s promising is though that we are seeing -- we are still seeing residential load, although it’s negative to 2020, it’s still a positive overall. So our original thesis of more residential load going forward. And if we can tie that together with improved industrial and commercial load as well, it could be very positive. But we certainly have to feel our way through that and really understand that. So we pass the third quarter before we really have a good feeling of that. Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah. Just maybe add a little finer point too. If you are thinking sequentially for the remainder of the year, our load growth rates are expected to moderate in the second half of the year based on prior year comps. So when you think about it, restrictions were most severe in the second quarter and by the third quarter of last year, so by the third quarter of last year, the service territory had begun essentially a phased reopening. And so as a result, the 6.3% growth for the second quarter, probably not only the highest growth in the quarter. And actually it is the highest growth in AEP’s history. But it will also be the highest load growth stat during the recovery. So if you think about the second half of the year, I would expect it year-over-year to moderate a little bit and so we are just keeping a watchful eye on how the trend continues to click along. I know I saw in The Wall Street Journal this morning CFOs commenting on where they think the economy is going to go, doesn’t look like anybody is changing their estimates based on COVID trends. But we are keeping an eye on that."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Excellent. Thank you. And then, if I can pivot the text, obviously, you all have a pretty meaningful footprint there. We have seen various legislative efforts underway. I am curious, as best you can tell thus far, I know it’s early. Any kind of context you can put especially on the transmission side, the potential project here? We are hearing from some of your peers about potentially meaningful shifts?"
},
{
"speaker": "Nick Akins",
"text": "Well, certainly, obviously, it remains to be seen as far as transmission investment and really we think of T&D and what part of the business is associated with T&D. We have made some inroads in terms of in terms of backup generation, those kinds of things in terms of transmission. I really think there’s probably continued opportunity for development of storage capability, of other transmission related investments on the grid to ensure that we are able to adjust that. For us, we are doing a lot in terms of line of sight into the transmission grid itself. We are continuing to expand our scale abilities, continuing to focus on our ability to have even more transmission in place, because if you are looking for additional generation to be placed in various areas, well, transmission is a big part of that solution as well. So is that, I think, Texas is sort of a microcosm of the country when you start reevaluating the system based upon the needs from not only a natural gas perspective, but also from a renewable perspective, that brings in the whole planning effort and communication in real time associated with the operations of the transmission and it -- for that matter the distribution system as well. So I think they are making the right steps and I think there’s more steps to be made so and it’s going to be a sort of a multiyear top of effort, and of course, we are a big part of the transmission in Texas. So we will be certainly very focused on how the T&D business can be expanded to improve the resiliency of the T&D efforts. But that means Texas is really going to have to start thinking about resources and a broader view of resources like we are having to do for the rest of the system and transmission technologies, and for that matter, distribution technologies are going to have to be recognized in its ability to provide a more resilient grid. You can’t have these strict lines drawn between generation and transmission and distribution because that’s not the world we are in anymore. So, we will continue that focus. Every legislative session, every regulatory session will be centered on that effort."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent. Just last, Kentucky, I know you can’t say much, but what’s the level of interest if you can give any kind of parameters?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So, yeah, obviously, I don’t want to get into too much detail there. I think, again, you answered it sort of right at the beginning. It is a confidential process. But I can say that we do have a credible interest and it is a competitive process."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent. Thank you all. Take care."
},
{
"speaker": "Nick Akins",
"text": "Okay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Steve Fleishman with Wolfe Research. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Steve."
},
{
"speaker": "Steve Fleishman",
"text": "Hey. Good morning. Can you hear me, Nick?"
},
{
"speaker": "Nick Akins",
"text": "Good morning. Oh! Yeah. I can hear you fine."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. Great. Thanks. I might have missed this, but just where are you on this $600 million of equity plan for this year? How much have you issued so far?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah. Thanks for the question, Steve. We have actually used the ATM to issue just under $200 million. I think there’s around $195 million that was associated with the financing of the Sundance North Central wind facility and we will be continuing on with the rest of that program. As you know, about $100 million of that $600 million is also associated with the drip. So that continues to play in the background. Does that help?"
},
{
"speaker": "Steve Fleishman",
"text": "Okay."
},
{
"speaker": "Julie Sloat",
"text": "Yeah."
},
{
"speaker": "Steve Fleishman",
"text": "And then just -- this might be a little bit hard to answer, but just in terms of thinking about the $1.4 billion for next year that’s in the plan. Obviously, if you were to sell Kentucky, some of that could maybe offset some of that. So just -- could you just give us latest thoughts on how to think about the Kentucky outcome relative to that $1.4 billion for next year?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah. And then, I will -- Nick can add a finer point from a strategic perspective. But purely from a financing perspective, you are right on the money, Steve. So we got $1.4 billion embedded in our plan. And for those of you who following along at home, we are on page 39 of the cash flow if you want to take a look at 2022. About $100 million of that again is associated with the drip, about $800 million is associated with north central wind financing and then we have another $500 million just associated with general funding of growth CapEx. And so to your point, Steve, to the extent that we would find ourselves in a situation where we were able to transact and bring dollars in the door, we would absolutely be able to work off some of that, otherwise equity issuance and sidestep that. So I don’t -- I can’t give you a number. We don’t have a transaction. But that is absolutely the thinking and how we are modeling different scenarios inside the house. And I don’t know, Nick, if you have any comment, it would be great."
},
{
"speaker": "Nick Akins",
"text": "Well, I think, you covered it well. As far as -- it’s great to have a financing plan assuming Kentucky a sale at Kentucky doesn’t happen. But also it’s great to have options available to further optimize what that financing plan looks like. So and it is -- and I will say again, the timing particularly with Traverse being the last one, it’s the largest one in first quarter 2022, that sums up pretty well with this process. So we will get this resolved and there will be finance one way or another, but at the end of the day, the timing of it and the process is continuing on plan."
},
{
"speaker": "Julie Sloat",
"text": "And just if I could…"
},
{
"speaker": "Steve Fleishman",
"text": "Okay."
},
{
"speaker": "Julie Sloat",
"text": "…to follow up…"
},
{
"speaker": "Steve Fleishman",
"text": "Yeah."
},
{
"speaker": "Julie Sloat",
"text": "…Steve. Again just to reiterate. The plan as it stands today, as you know, assumes no asset rotation. And again, I want to reinforce that, the 5% to 7% is well intact even if we don’t have a transaction."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. And are you -- do you have a bias within that range at all or just the kind of that’s the range?"
},
{
"speaker": "Nick Akins",
"text": "That’s -- probably we can’t answer at this point, Steve."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. So you are being very unbiased?"
},
{
"speaker": "Nick Akins",
"text": "We are."
},
{
"speaker": "Steve Fleishman",
"text": "Smart move. Okay. Thanks so much."
},
{
"speaker": "Nick Akins",
"text": "Yeah. Sure. Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Shahriar Pourreza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Shahriar."
},
{
"speaker": "Shahriar Pourreza",
"text": "Hey. Good morning, guys. I wanted to start with a recent event and get your sense on the Mitchell order and Kentucky, sort of rejecting the rate increase you saw, and obviously, it’s not a surprise well on AG strong comments prior to the decision. Nick is this sort of a signal that the state and the PSC in general they are starting to commit to maybe a little bit more of a rational thinking around an economic approach to coal like the least cost approach is just starting to bend further towards renewable. So how do we think about the viability of the plant in the state and could we see some acceleration of that 1.4-gig of solar and when you bought into plan for the state on a prior call as a direct grid? And then, how do we sort of think about West Virginia’s rate request coming off the Kentucky order?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. That’s right. It’s sort of interesting. I mean, it’s multi-jurisdictional, as you know, and Mitchell is wheeling in Kentucky Power. And I think we have to get resolved Kentucky, Virginia and West Virginia. West Virginia has yet to speak on this issue, but -- and it’s only the ALJ in Virginia. So we will hear more on from Virginia on that. But I think it’s really important for us to really hold on our cards for now, because we got to get through a state process. It’s good to have clarity. And I think Kentucky, obviously, is the first shoe to drop in this regard. But we have also made it clear that these are multi-jurisdiction unit. So we have to make sure that there’s some compatibility of the jurisdictions that are involved. We will go through the process. We will get the initial views of the commissions and then if they are on different tracks, we will have to further analyze and resolve that with the commissions and there’s a lot of resolutions that could occur. Some are shorter, some are longer. But we have to understand where all three commissions are before really doing anything. I think it’s good to get clarity though and I think it’s pretty important that whether it’s the ELG or the CCR, if they approve CCR investments, but don’t improve -- approve ELG investments, then that effectively brings the generation retirement dates back from 2014 to 2028. So that’s something we have to consider along with those commissions. But we will know more about this in the August time frame. But I’d be hesitant to say what Kentucky, it’s pretty interesting that they would be looking at the ELG part of it. And I think there is becoming more of an awareness of -- that there has to be a plan. Now what that plan is, we have got a fully resolved with all those commissions. So, more to come on that."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. And thanks for the visibility around sort of the Kentucky process. I know, Nick, you obviously mentioned that further optimization is always a possibility. Remind us just like that sugar point is the shaping of that for instance that 16.6 gigawatts of renewables you discussed in the prior call. Obviously, Kentucky will more than likely backfill some of your North Central equity needs. So as you are thinking about further optimization, should we be watching the outcomes at the IRPs, the PSC approval, how much you plan to own versus PPA, which I guess would stipulate your incremental equity needs and the resulting size of potentially further optimization measures?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Yeah. So -- and just like, we have gone through probably a couple of years now of discussions about how North Central is going to get financed and we are finally getting to a point where ultimately we will know how it’s being financed. The 16.6 gigawatts and -- is, certainly, we made a pretty credible case that we ought to own a significant part of that. I’d like to own all of it. But certainly, if -- but operationally, and from a contracting standpoint, and certainly, the ability for us to respond to a system related activities, it’s important for us to own and control those assets. And I think that, as we go forward, you are right, it will be the integrated resource planning filings that were made, there will start that dialogue, now we are in the process of doing RFPs to get more information obviously from the -- for the market in terms of what’s out there from a developmental perspective and that process is ongoing. So, that will certainly fortify any CCN filings we have to make or anything like that after the resource planning filings. But the resource planning filings will be your first real dialogue around how quickly this transformation will occur and in each one of the jurisdictions. And so, we are feeling pretty good about it, because it’s getting to a point where we have to decide from a capacity standpoint, how we support these utilities and it’s pretty clear to me that the movement is to that clean energy economy to move it is to toward as long as you have some element of baseload 24x7 capacity, that renewables will be the big part of that. So, a lot of that’s just becoming, I think, it’s becoming much more transparent and our jurisdictions, I think, their conditions both federally and from a state perspective, they are just a better realization of what the options are and the timing of those options. And that’s what will drive of course to that resource planning process."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. And lastly for me and I apologize if I am putting you on the spot, Nick. The news just broke out this morning. But is there any kind of refer to the First Energy deferred prosecution agreement that was announced this morning to the SEC investigation at AEP?"
},
{
"speaker": "Nick Akins",
"text": "No. Like I said before, we are on the outside looking in. We have no knowledge of any of that activity. And so if the report is true, I am glad to see that there is some element of putting all these in a rearview mirror, because naturally, and I said before, AEP has been hung up in the wake of that. And I am certainly hopeful that there’s some closure brought about from that. So, but, yeah, I have -- it was a surprise to me and we knew nothing about it, and certainly, there’s really nothing else that we have -- that AEP can say other than what we have put on our website and naturally there’s just nothing to report from our perspective."
},
{
"speaker": "Shahriar Pourreza",
"text": "Terrific. Thank you, Nick and Julie. Congrats on today’s results."
},
{
"speaker": "Nick Akins",
"text": "Yeah. Okay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Stephen Byrd with Morgan Stanley. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Stephen."
},
{
"speaker": "Stephen Byrd",
"text": "Hey. Good morning."
},
{
"speaker": "Nick Akins",
"text": "How are you?"
},
{
"speaker": "Stephen Byrd",
"text": "Congrats on a constructive update and on weeping in, you mentioned of both, Carly Simon and a maybe a first."
},
{
"speaker": "Nick Akins",
"text": "Yeah. Right."
},
{
"speaker": "Stephen Byrd",
"text": "Okay. So a lot has been covered . Just wanted to discuss on Kentucky, if there are approaches that can help minimize tax leakage, how are you all thinking about sort of ability to bring proceeds back and sort of the impact of taxes?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah. Thanks for the question, Stephen. As you know, we are a little tax efficient right now. So, given the tax basis in Kentucky and the different hurdles that we are considering, I wouldn’t see that one being a show stopper. And quite frankly, that might give us an opportunity to enhance or improve our tax efficiency without getting into a bunch of numbers. I wouldn’t let that trip you up in terms of what things could stop us moving forward."
},
{
"speaker": "Stephen Byrd",
"text": "Yeah. That’s helpful. And then maybe just thinking through the upcoming RFPs, you mentioned the APCo and SWEPCO RFPs, could you just talk a little more detail in terms of color around the timetable there? And I am sorry if I missed that if you all did go through it. I don’t -- didn’t quite follow there, I am just thinking about sort of what that might mean for timing of incremental spending and sort of how we should think about those processes?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So, we have certainly gone through the basic requirements for the RFPs for all of these areas. But as we go through that process, there is -- at APCo, we issued an RFP there for 300 megawatts of solar and wind resources really for a completion date of 2023 or 2024. And then in May of 2021, APCo issued an RFP to obtain, I guess, it was 100 megawatts of solar and wind energy via PPA and RFP for the renewable energy certificates only, which is consistent with the Virginia and what their requirements are. And then, SWEPCO issued an RFP for own resources up to 3,000 megawatts of wind and up to 300 megawatts of solar resources with optional battery storage by the way that can achieve a completion by 2024 to 2025. And they are also seeking 200 megawatts of capacity into 2023 to 2024 range and another 250 into 2025 to 2027 range, so those bids are due in mid-August. And then at PSO, we -- in June, we notified the regulators that it intends -- we intend to issue an RFP seeking up to 2,600 megawatts of wind and up to 1,350 megawatts of solar, again with options for battery storage consideration and that’s meeting capacity needs by 2025. So and then PSO plans to issue the RFP in October of this year. So those are the ones that are on the Board right now, and have really some near-term related requirements and most are capacity related requirements. So, and again, they are being done pretty much the same way as the others with North Central that we will certainly do more of it of a turnkey type of thing where we take ownership at the time it is approved in rate. So, and then, of course, we will go through the process of approvals by the various commissions along the way. So, but that’s the plan right now. And then, we will continue to -- as a matter of fact, we are spending a lot of time with our Board focused on the strategies related to these types of filings and the plan long-term and it’s important for everyone to understand this is going to be a continual process. And you are just seeing the first part of these really driven by capacity requirements and not just sort of an energy convenience. So, I think, they are really good to go out with right now and that’s what we have at this point."
},
{
"speaker": "Stephen Byrd",
"text": "That’s really helpful. That’s all I had. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi. Good morning."
},
{
"speaker": "Nick Akins",
"text": "Good morning. How are you doing?"
},
{
"speaker": "Jeremy Tonet",
"text": "Good. Good."
},
{
"speaker": "Nick Akins",
"text": "Okay."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to pick up on Kentucky a little bit more, if that’s possible and I just want to know if you might be able to comment in any degree to whether the strategic review process has received more interest from strategic or financial players? And then as well, kind of given strong prices achieved in recent industry transactions and the strong interest here in Kentucky, has this process made you thought about more asset rotation beyond Kentucky to increase balance sheet headroom overall?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So, for the first question, we started out this process saying that that we expected to get strategics and financials, and we have strategics and financials, so both are involved. And then as far as your second question is concerned, as I said earlier with the Foo Fighters dialogue, this is going to be a continual process for us. And if we are practically fully regulated so we have the opportunities to look at if we are building 16.6 gigawatts of renewables resources during the transition, then we got to think -- we have to have everything on the table in terms of sources and uses. So we are going to go through that process, and of course, Kentucky is sort of a first stop, but we will continue to evaluate our assets as sources. And if it makes sense, based upon what the other opportunities are, then that’s the kind of framework that we want to move this company toward."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That’s helpful. Thanks for that. And then there’s news coming out of FERC with regards to kind of the transmission planning process. I am just wondering if you might be able to provide some thoughts on -- your thoughts on what’s been said recently and what you see is kind of best practices here?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So, obviously, we would like to see a much better transmission related planning across regions and AEP does a pretty good job itself in terms of transmission planning, because we do have a large system to consider. But at the same, RTO to RTO type planning process to try to make them more consistent so you can have this large transmission being built across regions and across states. If you are going to get that going, particularly as you are trying to get renewable resources to load centers, we are going to have to resolve these issues around multi-jurisdictional, multi-RTO type of analyses and making sure that we are consistent. The other part too is we have got to have consistency in terms of rate making and this notion of reevaluating incentives, structures and those types of things is not good for making decisions relative to transmission or -- and this is not good relative to the RTO model itself. So, I think, FERC really needs to sort of step back and take a look at it. And I think it’s a real positive approach to be focusing on the planning aspects and addressing RTO to RTO boundaries, addressing areas where, what’s competitive, what’s not competitive, all those types of things, that’s fine. But we have to have a clear planning process. And first of all, you can’t have coming back later after a project, multi-millions have been spent on a project to, say, we are going to stop the project. That has to change. And the other part of it is, we have got to be able to make these investments with some sense of certainty and be able to move quickly to make that happen. So, I just -- I think, there’s only so much value -- there’s a lot of value of being in an RTO for customers. But there also has to be value for the companies involved from -- to make the investments that benefit customers in orders of magnitude greater than what the costs are related to, any incentives related to transmission. And if you want to send a bad message for anybody to join an RTO or anybody to stay in an RTO, it’s just not good to start messing around with what the assumptions are relative to the future recovery of transmission investment. And now, when you start questioning incentives, you are really questioning anybody that’s trying to put a multiyear model together to show the benefits of transmission has to take that into account that something may change. So, like trying to make an investment in a coal unit, with clean energy activities going on in Washington. So you really do have to really think this process through and think about what you are trying to achieve. Sorry, I went on that one though."
},
{
"speaker": "Jeremy Tonet",
"text": "No. That’s helpful. Thank you for that. I will stop there. Thank you."
},
{
"speaker": "Nick Akins",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Hey, Durgesh. How are you?"
},
{
"speaker": "Durgesh Chopra",
"text": "Hey. Good morning, Nick. Thanks for taking my question."
},
{
"speaker": "Nick Akins",
"text": "Good morning."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey. You addressed sort of a lot of transmission questions in the Q&A. Maybe just like the MISO transmission opportunity that the MISO has flagged perhaps just sort of unveiled towards the end of the year. I know a small sort of a set of assets for you in that location. But could you compete for some of those projects? Could that be an upside for you there?"
},
{
"speaker": "Nick Akins",
"text": "Oh! Yeah. We could. We could compete with our Transource entity, which we have been. But, yeah, we could. And actually a small impact for us as it stands. But certainly, we could certainly participate in any of that, yeah."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. And then just anything you are hearing at your level and your peers and through the sort of the EI organization. I mean the infrastructure bill has a pretty sizable CapEx on the transmission side or investment on the transmission side. Just anything you are hearing from that on the federal front?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So, obviously, we have the, I guess, that’s $1.2 trillion, the infrastructure bill that -- it’s interesting we are talking in trillions as opposed to billions now. But in terms of the hard infrastructure side of things, yeah, it appears there’s some kind of convergence in Washington on that particular issue, although, more has to be done on the actual language and things like that. But as far as pursuing the advancement of, and certainly, transmission investment, but direct pay and those kinds of issues are clearly important along the way. We also have to, as far as, renewables and clean energy, PTCs, ITCs extensions of those, I think that makes sense, particularly RSI did the delays because of COVID and that kind of thing. So I think there’s opportunities for that and then as far as electric vehicles, certainly we would like to see electric vehicle infrastructure continue to be developed. So, I think all of those areas are positive. The issue is how you leverage into the private. The private companies like ours or that instead of the government funding and for transmission, for example, we think that mechanisms already exist for the development of transmission as long as you can keep all the incentives and all that kind of stuff. But -- so the federal and -- federal government funding of that now is, I think, you have to sort of think about what level of encouragement and what area. So, if they can make siding much better, if they can make, certainly, the focus on planning. Those issues enable transmission to get investments. We have no problem financing transmission investments. So I think the government probably ought to pick and choose between what they truly want to focus on that not already leveraged into the utilities, for example. They can certainly encourage development of electric vehicles with the focus on charging station infrastructure and those types of things that would be a benefit. And then, as far as the renewables transformation or the clean energy transformation, any kind of hard infrastructure around being able to move more quickly from a renewable standpoint, whether tax incentives and also uh other technologies like storage. And then also, we would like to see benefits related to either tax incentives for coal-fired generation to reduce the underappreciated plant balances, for example. If you want to have a national plan around moving to a clean energy economy, then the more quickly we can reduce underappreciated plant balances, the better we are able to make decisions and conditions, and states can make decisions about what future resource replacements would be. So I think there’s several ways to really focus on this. But we are all moving toward a clean energy economy. We just need to make sure that the government doesn’t try to do too much across the Board as opposed to very selected areas that enable investment to continue in the private sector. That would be my view."
},
{
"speaker": "Durgesh Chopra",
"text": "Appreciate that color, Nick. Really quick just -- good to see First Energy with all the DOJ investigation or at least have an agreement this morning they highlighted. Just any update on the SEC subpoena you got? Any more color that you can share with us?"
},
{
"speaker": "Nick Akins",
"text": "No. Nothing new there. We are -- we have been communicating with the SEC and we are responsive to any requests they have from a documentation standpoint. And we are going to continue to work with them and be supportive and constructive in the process and but nothing new to report there."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Thank you for taking my questions."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Operator",
"text": "Thank you. And our final question comes from the line of Michael Lapides with Goldman Sachs. Please go ahead."
},
{
"speaker": "Michael Lapides",
"text": "Nice try on that one."
},
{
"speaker": "Nick Akins",
"text": "Michael who?"
},
{
"speaker": "Michael Lapides",
"text": "Yeah. Hey. Actually, Michael, the guy who’s excited about the changes in the Southeastern Conference they had. Hey, guys, real quick question or two. First of all, one on O&M this year, obviously, O&M at the VIU segment is up a lot. How do you think about what the second half of the year O&M trajectory looks like versus the first half? And how should we think about both for VIU and T&D kind of segments, the long-term kind of the 2022 and beyond trajectory for O&M?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. I will just generally say, and Julie can certainly follow up on this, but as you have expansions in customer load, you are going to have higher O&M associated with that, but that’s a good expansion. The issue for us is, what we typically do is, we are evaluating the true impacts of our Achieving Excellence Program against what our forecast needs to be in terms of bending the O&M curve. So we continue to take account of the good O&M that supports the expansion from a customer load perspective, but also continue to not only optimize that, but also continue the overall optimization of the O&M budget itself. So, yeah, you may see it, and that’s why, obviously, we are watching what third quarter looks like and fourth quarter with the low it does. But we want to make absolutely sure that we are continuing to make progress consistent with that plan of consistent earnings and dividend improvements in that 5% to 7% growth trajectory. So that’s what we are doing. We are not just saying, oh, yeah, load’s going up, let’s spend more O&M. It really is a measured approach from our perspective. Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah. No. That’s spot on, Nick. And thanks for the question, Michael. As I am sitting here thinking about this and as we were preparing for the earnings call, one of the things I am looking at is the mix point. You look at where load is coming in. And as mentioned in a previous answer to a question, we do expect that load on a relative basis. When you compare it to last year, for the second half, it would not be as pronounced, although we do expect it to continue to improve. So that’s a good thing. And that allows us to be a little more comfortable with O&M costs where they are, because that does help the customer in the long run. So we keep that top of mind and continue to be very diligent about managing costs. But if you are trying to model for the rest of the year, let me start by saying this, we are not changing our guidance. But as you know, once we start the year and we give you that plan, so you see that waterfall that we give to you, how we get to the end of the year, obviously changes, right, because it’s a dynamic business. So I wouldn’t be surprised if relative to that plan, if you saw our O&M be running a little richer. But I would hope that load would be hanging in there too. And then, as you know, we are doing well on the Transmission Holdco segment already kind of clipping along where we thought we would be for the full year. So there may be some benefit there too. So do keep that in mind when you go back and compare and contrast to that guidance walk that we gave to you. I think it was on February 25th during our earnings call and then we are happy to help you with any modeling that you have offline."
},
{
"speaker": "Michael Lapides",
"text": "No. That sounds great. Thanks, guys. Much appreciated."
},
{
"speaker": "Nick Akins",
"text": "Sure. Thanks."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today’s call. As always, the IR team will be available to answer any additional questions you may have. Toni, would you please give the replay information."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this conference will be available for a replay after 11:30 a.m. Eastern today through July 29, 2021. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering access code 4754105. International participants may dial 402-970-0847. Those numbers again are 1-866-207-1041 and 402-970-0847 with access code 4754105. That does conclude our conference for today. We thank you for your participation and for using AT&T conferencing service. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 1 | 2,021 | 2021-04-22 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by, and welcome to the American Electric Power First Quarter 2021 Earnings Conference Call. As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Ms. Darcy Reese, Vice President of Investor Relations. Please go ahead.
Darcy Reese: Thank you, Tony. Good morning, everyone, and welcome to the First Quarter 2021 Earnings Call for American Electric Power. We appreciate you taking time today to join us today. Our earnings release, presentation slides and related financial information are available on our website at aep.com.
Nick Akins: Thanks, Darcy, and welcome again everyone to American Electric Power's first quarter 2021 earnings call and happy Earth Day. Before I get started with our results for the quarter, I just have to say, I was struck with the public relations - public reactions to the Chauvin verdict. It has been a long wait, but justice and faith in our legal system does prevail. I bring this up because it happens, I had chosen a song, which I do every quarter as you know for a different reason, but now it serves two purposes. One, the most mesmerizing singer as I'd ever heard was the late Marvin Gaye. I thought of his song when actually thinking about our quarter and the multitude of activities that AEP continues to accomplish and was thinking of what's going on the Marvin Gaye hit from 1971 written during another tumultuous time in America. This song was a plea for peace, justice and understanding perspectives to move forward in a positive way together. As I said, this song was released in 1971, 50 years ago, but it could not be more appropriate today. We need our leaders, our communities and indeed, our companies to continue to come together and stop the divisiveness, which the new cycle tends to feed off of and recognized we have a lot more in common than are differences, that would be a great start to advancing this nation in a positive way. That being said, getting to my original purpose, as I said earlier, what's going on with AEP as the lyrics say, hey, man, what's happening, whoo, everything is everything. We're going to do a get down today, why I tell you. So here we go, the first quarter of 2021 came in with operating earnings of $1.15 per share versus $1.02 for first quarter '20, which met our expectations particularly given impact in Texas, Arkansas, Louisiana and Oklahoma, which we reported on in last quarter's earnings call. AEP continues to reaffirm our 2021 guidance range of $4.55 to $4.75 per share and our 5% to 7% long-term growth rate, and we would still be disappointed not to be in the upper half of the guidance range.
Julia Sloat: Thanks, Nick, and thanks, Darcy. It's good to be with everyone this morning. I'm going to walk us through the financial results for the quarter, share some thoughts on our service territory load and economy, and then finish with a review of our credit metrics and liquidity. So let's go to Slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings were $1.16 per share compared to $1 per share in 2020. There is a reconciliation of GAAP to operating earnings on Page 15 of the presentation today. Let's walk through our quarterly operating earnings performance by segment, this is laid out on Slide 8. Operating earnings for the first quarter totaled $1.15 per share or $571 million compared to $1.02 per share or $504 million in 2020. Looking at the drivers by segment, operating earnings for the Vertically Integrated Utilities were $0.54 per share, up $0.04, driven by the favorable impact of weather due to warmer than normal winter temps in 2020. Other favorable items in this segment included Off-system sales, higher transmission revenue and the impact of rate changes across multiple jurisdictions, partially offsetting these favorable items were higher depreciation, lower normalized retail load, higher O&M, a prior period fuel adjustment and higher other taxes. The Transmission and Distribution Utilities segment earned $0.23 per share, down $0.01 from last year. Earnings in this segment declined primarily due to lower normalized retail load attributable in part to storm Uri. Other smaller decreases included higher depreciation, tax and O&M expenses. Favorable drivers in this segment included transmission revenue, rate changes and weather. The AEP Transmission Holdco segment continued to grow, contributing $0.35 per share, an improvement of $0.07 per share from last year. Net plant increased by $1.3 billion or 13% since March of last year. Generation and Marketing produced $0.06 per share, down $0.01 from last year. The favorable impact of the retirement of OCA Union and land sales on the generation business offset the unfavorable ERCOT market prices on the wholesale business during storm Uri in February. The decrease in the renewables business was driven by lower energy margins and higher expenses. Finally, Corporate and Other was up $0.04 per share, driven by an investment gain and lower interest expense, partially offsetting these items was the higher impact of - impact of higher taxes. Overall, we experienced a solid quarter and we're confident in reaffirming our annual operating earnings guidance. So let's take a look at our normalized load for the quarter on Page 9. Starting on the lower right corner, our first quarter normalized load came in 1.9% below the first quarter of 2020. There are two important factors to consider when evaluating the year-over-year comparison for the quarter. The first factor is that last year included an extra leap year day assuming everything else equal, you would expect about a 1% decline in sales due to one lesser day in the quarter, and the second factor is that the pandemic started during the last two weeks of the 2021st quarter. In other words, the first quarter analysis is comparing a pre-pandemic view of our service territory load to have you after COVID began. Importantly, we still expect a stronger recovery in the second half of this year as vaccinations increased positioning more communities to relax restrictions on businesses without jeopardizing public health and as a benefit of the American Rescue Plan stimulus, it was signed in late March, works its way through the economy. I'll talk a little bit more about the latest economic projections when we get to Slide 11. So let's take a look at the upper left quadrant, our normalized residential sales increased by 1.5% in the first quarter compared to last year. The growth in the residential sales was spread across most operating companies. As the pandemic recovery progresses, growth in residential sales as begun to moderate. While we expect residential sales to decline by 1.1% in 2021, we're assuming a moderate sustained load benefit from this customer class given the stickiness of work-from-home arrangements for many office workers across our service territory for the foreseeable future. So if you go over to the right, normalized commercial sales decreased by 1.6% in the first quarter. Even though commercial sales were down across every operating company excluding Ohio, we are seeing steady sequential improvement since the pandemic began. In fact, AEP Ohio was the first operating company to post positive commercial sales growth. This correlates well with the fact that the AEP Ohio territory added the most jobs in the first quarter. We also continue to see significant improvement in the same sectors that were hardest hit by the shutdowns in the second quarter of 2020. These sectors include schools, churches, restaurants and hotels. So finally, if you look in the lower left chart, you'll see that industrial sales decreased by 6.1% in the quarter compared to 2020. Industrial sales were down across every operating company and most industrial sectors. Not surprisingly, the biggest declines were located in the western territory where storm Uri in February caused a significant yet temporary - significant yet temporary disruptions to many manufacturing facilities located in ERCOT and SPP. In addition to the numerous electric generators unable to run due to frozen natural gas supply lines, there are a number of other manufacturing processes that rely on natural gas supply to produce their product. Many of those businesses were unable to produce for up to a week while the pipelines were being out and in some cases, industrial loads were stalled as long as 42 days in Texas. So the key takeaway here is that the dip in industrial sales in the first quarter was largely due to the one-time winter storm, which does not impact our fundamental outlook. So here's an interesting data point that illustrates this, our industrial sales in the eastern part of our service territory were down 2.6% as compared to the significant 12.8% drop in the western part of our service territory, which was impacted by Uri. So obviously, that's a pretty dramatic difference. That being said, we're still very bullish about the second half of the year as the US acquires a significantly greater concentration of immunity from vaccinations and as the full impact of the additional fiscal stimulus is felt throughout the service territory economy. So let's go over to Slide 10 where I can provide a little color on the industrial sales performance in the first quarter. The blue bars show the change in sales to our oil and gas customers. In aggregate, the sales to oil and gas sectors were down 9.6% in the first quarter, led by the 21% reduction in oil and gas extraction. Most of the decline in this sector is in response to the challenging market signals from last year when the drop in global demand along with the temporary price war caused oil prices to fall below many producers' breakeven point. However, we do not expect the weakness in oil and gas to persist. In fact, natural gas prices in March were up about 60% from last year and domestic oil prices last month have more than doubled since March of 2020. We fully expect the higher prices today will provide the necessary signal that producers are looking for to increase their production within the service territory. And once we see the production increase in the upstream sectors, it's only a matter of time before we see the corresponding increase in the midstream and downstream operations. The orange bars in the chart show the change in industrial sales, excluding oil and gas. While it was still down 3.3% for the quarter, we expect to see stronger improvement in the second half of the year as the global economy recovers from the pandemic. Some of the weakness in manufacturing right now is related to supply chain disruptions. As efforts continue to strengthen the resiliency of the domestic supply chain for manufacturing, the AEP service territory is certainly positioned to benefit from any movement in that direction. So let's go over to Slide number 11 where I can provide an update that I mentioned a few moments ago on the latest economic conditions within the AEP footprint. Starting in the lower left chart or on the left chart, you'll see that AEP service territory experienced a 1.6% increase in gross regional product compared to the first quarter of 2020. This was much better than the US, which had a relatively flat first quarter in terms of year-over-year GDP growth. The AEP service territory was less impacted by the virus and had fewer restrictions on businesses than other parts of the country, which has allowed the regional economy to fare better than the US throughout the pandemic. Looking forward, the AEP service territory is expected to grow by 5.2% in 2021, lagging the economic recovery in the US as you might expect. Moving to employment on the right, you can see that the job market for the AEP service territory has also outperformed the US throughout the pandemic. For the quarter, employment growth was only down 1.6%, which was 4 points or 4% better than the US during the first quarter. This is largely the result of the mix of jobs in our local economy, which has a heavier relative concentration of manufacturing and government jobs and a smaller share of leisure and hospitality jobs. Going forward, we expect job growth of 1.7% in 2021. So let's go over to Page 12 checking on the Company's capitalization and liquidity position. On a GAAP basis, our debt to capital ratio is 62.5%. When adjusted for the Storm Uri event, the ratio remains consistent with our year-end 2020 ratio at 61.8%. Let's talk about our FFO to debt metric because as you would expect and as we've been signaling, the impact of Storm Uri has and will have a temporary and noticeable impact in 2021 on this metric. Taking a look at the upper right quadrant on this page, you see our FFO to debt metric based on the traditional Moody's and GAAP calculated basis as well as on an adjusted Moody's and GAAP calculated basis. On a traditional unadjusted basis, our FFO to debt ratio decreased by 3.9% during the quarter to 9.1% on a Moody's basis. Well, this is a pretty dramatic impact. The rating agencies are very much aware of this and have taken the metric data point as well as the anticipated recovery into consideration as it relates to our credit rating. On an adjusted basis, the Moody's FFO to debt metric is 12.9%. To be very clear, this 12.9% figure removes or adjusts the calculation to eliminate the impact of approximately $1.2 billion of cash outflows associated with covering the unplanned Uri-driven fuel and purchase power in the SPP region directly impacting PSO and SWEPCO in particular. The metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. This should give you a sense of where we would be from a business as usual prospectus of 12.9% business as usual. As you know, we're in frequent contact with the rating agencies to keep them apprised of all aspects of our business and importantly, there is no change in our equity financing plan. On the topic of anticipated recovery, there is no debate that Storm Uri was an extreme event and consequently, the various states would like to resolve recovery docket as expeditiously as practical. Assuming recovery begins this year, our cash flow metrics will quickly return to the low to mid-teens target range next year as expected. So this should be a one year phenomenon for us. As many of you know, we have initiated regulatory cases in our respective states to evaluate the costs and determine the recovery plan. Let me provide a quick update where we are in this process. On February 24th, PSO filed with the Commission for recovery of fuel costs through a - with a regulatory asset and weighted average cost of capital carrying charge and subsequently filed a motion seeking recovery of a $615 million regulatory asset with a five-year amortization. At this point, PSO has received approval to defer the storm-related costs, with recovery of the established regulatory asset over five years at an interim rate of PSO's short-term financing cost of like 75 basis points. This is intended to be an interim order and the actual carrying charge will determined in a future review and the regulatory asset amount is subject to finalization. Importantly, Oklahoma has also taken up a securitization bill to address the extraordinary fuel and purchase power costs felt by all utilities, PSO will evaluate as the securitization is appropriate for the recovery. And if so, we would expect it to occur as early as next year. In March, the Arkansas Public Service Commission issued an order authorizing recovery of the approximate $113 million Arkansas jurisdictional share of the retail customer fuel cost over five years, with the carrying charges to be determined at a later date and the actual amount to be recovered being subject to finalization. We requested a WACC rate, which was supported by the staff in accordance with the order, SWEPCO began recovery in this jurisdiction in April, that was at a customer deposit rate of something like 80 basis points. The recovery period and associated carrying charge will be further reviewed in a hearing that's already been set for July 8th of this year, so 2021. In March, the Louisiana Public Service Commission approved a special order granting a temporary modification to the fuel adjustment clause to allow utilities to spread recovery over a longer period of time. In April, SWEPCO begin recovery of the Louisiana jurisdictional share of these fuel costs is about $150 million based on a five-year recovery period in a fuel over under recovery mechanism. SWEPCO will be working with the Louisiana Commission to finalize the actual recovery period and determine the appropriate carrying charge. And in Texas, SWEPCO intends to file for recovery under fuel surcharge, most likely in the second quarter. Our current plan is to request recovery over five years with a WACC carrying charge. Obviously, we have a lot in process on the regulatory recovery front on this matter and we'll keep you apprised as we make progress, because as we all know this is extremely important. Let's take a quick moment to visit our liquidity summary on the lower right of Slide 12. In March - on March 31st, AEP renewed its $4 billion bank revolver for five years and also entered into a two-year $1 billion revolving credit facility to fortify our liquidity position as we go forward, just placed our net liquidity position as of March 31st at a strong $3.4 billion. Switching gears, our qualified pension funding increased 1.7% during the quarter to 103.5% and our OPEB funding increased 9.6% to 170.5%. Rising interest rates that decreased plan liabilities along with positive equity returns were the primary drivers for the funded status increases in both plans during the first quarter. So let's go to Slide 13, so we can wrap this thing up and get your questions, but I just want to call out a couple of quick things before we do that. So on top of mind for many folks I know this, we want to mention to you that we completed the planned $125 million equity funding portion of the North Central Wind Sundance project. We used our at the market mechanism, so that we could time the equity need with our purchase of the Sundance project, which occurred last week. As you know, we will continue to move forward with additional opportunities in the renewable space supporting our ESG focus as we transition toward a clean energy future. Our performance in the first quarter and stability of our regulated business model gives us the confidence to reaffirm our operating earnings guidance range of $4.55 per share to $4.75 per share. Because of our ability to continue to invest in our own system organically, we are confident in our ability to grow the Company at our stated long-term growth rate of 5% to 7%. So we surely do appreciate your time and attention today. And with that, I'm going to turn the call over to the operator for your questions.
Operator: Our first question comes from the line of Shar Pourreza with Guggenheim Partners. Please go ahead.
Nick Akins: Good morning, Shar.
Shar Pourreza: Good morning, guys. Good morning, Nick. Good morning, everyone.
Julia Sloat: Good morning.
Shar Pourreza: So the - couple of quick questions here. First on the incremental 8.6 gigs of renewable opportunities, which just added to plan. It's very sizable - maybe touch a little bit on how we should think about these new opportunities in light of the 5% to 7% growth that you gave, what sort of financing avenues were you kind of looking at the approval tariffs and what are you assuming in terms of owned versus PPA?
Nick Akins: Yeah, I think we have - the last part - last part of your question first. I think we have a pretty compelling argument now for owners of these facilities given even past the winter storm activity that we learned operationally, certainly what we learned from the - really this the provisions of the agreements that we put in place relative to the approvals really stands better in terms of our ability to manage the project, manage congestion, manage other factors that really provide benefits to our customers. So we're going to make a strong position that we should own those assets and actually when you think about the strength of the utilities, it's going to be important for the states to really focus on how do we keep our utilities strong and PPAs don't do it from a capital structure perspective. We need to make sure that ownership and their flexibility of operations is key in that regard. And regarding the other, 8600 megawatts, yeah, it is a sizable number, but obviously when you look at the evaluation of the retirements, when you look at the needs of the operating companies and also North Central certainly showed, you can deploy capital and reduce the overall bills to consumers. So when you think about the retirements of coal-fired generation, the imposition of additional transmission, having the benefits of the fuel cost aspects of it are tremendously important. So when you look at the analysis having some level of carbon pricing in there certainly increases the focus on the ability for renewables to come into play and that's certainly what we've been focusing on. So as you look at the finance ability of it, the finance ability pretty much work like we - like it did for North Central, although it is large number. So we'll have to be very aware of what our balance sheet strength looks like during the process, the timing of when the different tranches of these renewables come into play, the cash position that supported with these projects coming online and being able to improve as Julia mentioned. This FFO to debt thing where it is today is really a 2021 issue. In 2022, FFO to debt comes back up and certainly with the ability to put these projects in place, it will help in terms of our ability to continue to fund these projects. So it will probably - we've certainly would like for it all to be incremental, but in reality when you go through this process, it will probably be around capital allocation and prioritization associated with that within the existing plan, but also incremental. So it'd be a combination of both. Yet to be seen, obviously if load continues to grow, if the position relative to the regulatory framework getting concurrent recovery, making sure that we get off the tax ADIT issues, that's all going to be helpful in terms of our ability to finance. So it's still a work in progress.
Shar Pourreza: Got it. And then maybe just transitioning to corporate strategy and asset optimization, obviously, the strategic review for Kentucky is started, so Brian has been obviously very busy year, can we maybe just elaborate on the phase we are in with that process has - have bidders emerge or data rooms opened and assuming this would backfill most of your Wind Catcher equity need. So assuming we are looking at a Duke style Indiana GIC transaction for the entire OPCo. So we should obviously consider leakage share any NOLs as well that could be applicable in this case?
Nick Akins: Yes, Shar, you are always ahead in terms of questions. Yeah, and I really can't answer any of those at this point because we are in a process and certainly as soon as we have information on it, I think the real issue here is, we have made a deliberate decision to really start our portfolio management approach and evaluating jurisdictions, because we are fully regulated. We can look at these areas and determine what the best fit is in terms of future capital needs and what our focus is in terms of moving to a clean energy economy. So - and for us to come out and say that we are in a strategic process relative to Kentucky is an important statement in that regard. That's probably as far as we can go right now.
Shar Pourreza: Let me ask you something a little bit more of a theoretical question, would you consider asset rotations above your current equity needs, let's say, from North Central to fund the incremental CapEx or renewables or T&D, I mean, you're within your credit metric guidance but does it make sense for you to further improve your balance sheet and simplify your store even further. I mean, do you kind of like looking at the stock valuation and does it may be more sense to - do you think there's incremental value from a multiple standpoint to even have a stronger balance sheet and operating even less states here and I'm thinking maybe Texas?
Nick Akins: Well, certainly, like I said, this is at the beginning of this process, but multiple expansion is clearly on our minds and making sure that you can - you're investing in the right things at the right places at the right time is going to be incredibly important. And you saw that with North Central of timing the recovery with the actual investments with the turnkey approach that we took and it's all about the timing of it, it's all about the decisions made to ensure that we are doing proper capital allocation and rotation to manage this process forward. So - and like I said earlier, that's going to be a continuing part of our business.
Shar Pourreza: Terrific. Thank you, guys. I'll jump in the queue. I appreciate it.
Operator: Thank you. Next, we go to the line of Julien Dumoulin Smith with Bank of America. Please go ahead.
Nick Akins: Good morning, Julien.
Julien Dumoulin Smith: Hey, good morning, team. Congratulations on all these updates.
Nick Akins: Yeah.
Julien Dumoulin Smith: A lot to digest here today, I did. If I can, let's start with a higher level question here, right. So you're proposing a lot specifically in PSO, how do you think about the events that have transpired in Texas and Uri impacting that and specifically around some intermittent resources like solar in Oklahoma, right. We just haven't seen a lot of that historically and so this is a little bit of new territory for that geography more than the economics all around. Can you talk to that and have you kind of vetted some of the proposals here and the approval process?
Nick Akins: Yeah, so obviously, we're right out of the gate in terms of the announcement of what's included in each jurisdiction. So we'll have discussions with the commissions and that's part of the integrated resource planning processes and keep in mind too, when we do this evaluation during the RFP, I mean, during the process, as always solving for whatever the lease cost is in terms of what those resources are. So it shows up as win. And then solar, typically it's showing up as more wind early on and solar starts to pick up, but that's pretty fungible as you go forward. I mean, these plans will change as we go forward based upon where technologies go, certainly where the opportunities exist. Oklahoma may want more wind and less solar, but that won't matter, it'd be a part of the total renewables piece that's included there. The other part of it too is, we will be very mindful of how much renewables are placed into service in relation to 24/7 supply and there is some natural gas that's built into this plan as well that enables more renewables to be put in place, but the real focus going forward during this transitional period will be for units that provide 24/7 to be more of a reliability component, certainly more of a - sort of an insurance backstop for weather events or other events that may occur that impact the grid security and will have to be very, very mindful of how those studies actually go. And I'll tell you, in our climate report, we saw for 2050 with a $15 carbon price and then more aggressive $30 carbon price, the 2035 case didn't solve because of the timing of getting resources in place and system-related issues. So you have to really think about how that's done and we've looked at these plans and we certainly believe that was the level of 24/7 supply we still have out there and the additional opportunity associated with just the diversity of some of these projects. It's going to be of particular value to our customers going forward. And I guess, I'll just remind you that North Central, had it been operational during this time of the Texas and Oklahoma outages with the Uri would have saved customers $227 million. So you think about the savings associated with that and the other thing too, the previous question, someone was - Shar was asking, when the utilities do it, they focus on the long term and North Central already had the weather package is already in place where you don't find that in a large part of the market. So we think the long-term when we go about after these investments and that's why ownership is clearly important.
Julien Dumoulin Smith: Excellent. And just to clarify this a little bit further, I know that the equity numbers aren't moving around too much, we're at all, frankly, relative to CapEx, but how much capital could be shifted given the latest updates here in the three-year versus the five-year outlook here? Just want to understand, out of the total 10-year view that you guys are providing today, how much could be in that three-year and five-year window as you think about just the specific timing of each of these dockets that will come up for renewable resources?
Nick Akins: Well, yeah, as I mentioned, 10,000 of the megawatts of the 16,000 - over 16,000 is in the '21 to '25 timeframe, so it's going to be near-term. So when you think about these projects, they take a couple of years to put in place. You'll be looking more at that '23 to '25 for most of it, but some of it was - is already in play. There is already RFPs going out for suppliers of some of these renewables as we speak. Julia, anything do you want to add to that?
Julia Sloat: No, you've got that perfect, thank you.
Nick Akins: Thank you.
Operator: Thank you. Our next question comes from the line of Stephen Byrd with Morgan Stanley. Please go ahead.
Stephen Byrd: Hi, thanks guys for taking my question.
Nick Akins: Good morning, Stephen.
Stephen Byrd: Good morning. Congrats on a great update and a big movement in renewables, so happy to see that. I wanted - if you could just talk a little bit more about as you grow out renewables, whether there might be some additional transmission distribution requirements or stores there just other things that would sort of be additive as well, it's obviously just huge amount of megawatts, just curious about the other impacts?
Nick Akins: Yeah, there will be and many of these projects, obviously, we'll have to look at the placement of these projects as in the level of congestion, but also the level of transmission investment that's required. But keep in mind too with the Biden administrations doing relative to the movement to clean energy, which obviously is a big part of his plan, large scale transmission will also be incredibly important. So, I see with what's going on today and in excess of all these things coming together, our transmission which you've always said is, as far as I can see for a decade, well, it's probably even higher. We don't know what that number is at this point and I think we've got to get through the process and fully understand that, but when you do the net benefits associated with fuel and the capital cost of the renewables projects and transmission, it's still a benefit to consumers. So, we'll go through that process, but you're right to be bullish about transmission in relation to these investments, but also everyone else's investments because we are the largest transmission provider in the country and most of this has to come through us.
Stephen Byrd: That's really helpful. And then I wanted to drill into Texas for just a moment. There are some bills as you know that are floating around that would permit securitization of costs and those look to be, I guess to me, quite helpful from a financing point of view, just curious how you're thinking about that impact, how might that impact your thoughts on financing? I appreciate the point you raised earlier that essentially the credit metrics are sort of artificially low at the moment because of the storm, but with some of this - some of these bills be especially helpful to you?
Nick Akins: Well, certainly the ERCOT portion of Texas, we are essentially a large company there at T&D. So, and we have, based on our cost provisions in place for recovery of that, we - the only real exposure we've got from a standpoint is any, I guess some of the reps, they could potentially go bankrupt and - but that's where it's going to be important to understand where that goes and also as far as securitization is concerned, we view securitization in the past in Texas and you're seeing it develop for what's classified of storm caused, but it really is Uri-related investments we'd be fine with that. Julia, anything...
Julia Sloat: No, that would be great. Great question, Stephen. So, we're keeping an eye on what's going on in Oklahoma. There is an opportunity potentially to engage in some securitization activity there, would love to get cash in the door. So if that's something that's workable, we will absolutely take the cash and my understanding is, the way that is being at least they initially discussed it and potentially structured would be such - in such a way that that does not sit on our balance sheet, which makes it even better. So, yes, we'll take that cash and with no doubt on the balance sheet, we like that very much. So, we are definitely poised and ready and waiting.
Stephen Byrd: That's great. Maybe one last quick one, just as we think about this growth in renewables, any changes in terms of your thoughts on coal retirement dates?
Nick Akins: Well, obviously the move we made on the second Rockport Unit solidified at least at 2028 and it could occur earlier depend on what the conditions are and what the evaluations are with the commission and the replacements of capacity. And so, we are - and actually, we're looking for provisions like that even in legislation that's occurring, because you're seeing all kinds of incentives developed for extension of PTCs, ITCs, direct pay we like, so direct pay not only for renewables projects, but also for transmission. If you have an ITC, but I think also, we'd like to see incentives for the undepreciated plant balances of coal units to further accelerate the ability to retire and obviate the impact to our customers. But the current plan does assume any of these advancements so - and this happens all the time where we have plans that are out there that are public, but lot of things get worked on and we'll continue to work on these objectives, because our objective is to move as quickly as possible to derisk these investments, particularly with new environmental rules with CCR and other things. We're making decisions about these plants and you've seen the last two quarters, we've announced earlier retirements of coal and lignite plant operation. So I would fully expect to see that process to continue.
Stephen Byrd: Very good. Thank you very much.
Nick Akins: Yeah.
Operator: Thank you. Our next question comes from the line of Steve Fleishman with Wolfe Research. Please go ahead.
Steve Fleishman: Yeah, thanks. Good morning, Nick and team.
Nick Akins: Good morning, Steve. How are you doing?
Steve Fleishman: I'm doing well. I have a couple of questions on the Kentucky Power announcement.
Nick Akins: Yeah.
Steve Fleishman: So just I think, Nick, you said that you're doing a strategic review with a target for year-end. So, is that the target to basically have a sales done and proceeds by year-end or have a kind of like a sale or other plan announced by year-end?
Nick Akins: Steve, so, I didn't say year-end. I said we would get the evaluation done in 2021, that could be earlier in the year, it could be later in the year. Obviously, we need to get farther down the road in terms of this process. I can tell you that the process is established, it's ongoing and we're going to move as quickly as possible. So - and we've always talked about the timing of the resolution of anything related to the weather was Kentucky or anything else in relation to the needs around North Central. So, and we still believe that timing fits.
Steve Fleishman: Okay, that's helpful.
Nick Akins: So, I wasn't saying that would be the end of the year before we know anything, I just said during '21.
Steve Fleishman: Okay. And just, is there kind of - this may be, it seems silly, but just, is there a reason that this wasn't like part of your slide deck or release or just - it was just stated on the call, just - it's something just happened, the Board just decide something?
Nick Akins: No, I think it was out of respect to our employees, because obviously, you can't say something like this from an SEC perspective without some thought around that, but also there is the human aspects of it too and employee aspects. Matter of fact, our employees just found out about it. When I've said it, I have a webcast after this with all employees to talk about this to just alleviate their concerns through the process, but this is the way that occurs, there is multiple things you have to think about when you're making these kinds of announcements.
Steve Fleishman: Understood. And then just in terms of - that's helpful. So in terms of the - in terms of thinking about your financing, this would still be potentially directed at replacing the equity needs that you have currently for North Central as a potential replacement for some of that it will be?
Nick Akins: Yeah, I'll let Julia talk about that.
Julia Sloat: Steve, yeah, thank you for the question. Absolutely, to the extent that we get dollars in the door, that will be a wonderful place to put that to work in terms of being able to sidestep some of the equity need and we'll see if we can make that happen, absolutely.
Nick Akins: We have the that we've access, but obviously it would change the nature of that.
Steve Fleishman: One challenge with Kentucky Power has a lot of coal plants and exposure I guess, so to speak, just, do you feel like there is still despite that decent interest to be able to monetize at a reasonable price?
Nick Akins: Yeah, and obviously different parties look at in different ways and that's what we're going to find out and through the strategic process is what evaluation Kentucky's ownership of Mitchell in terms of valuation and its impact on overall price would be. It still has value, it's still has years to operate and certainly, if you look at the plan that we presented, you still have a potential renewables opportunity there, particularly with the potential retirement of Mitchell at some point. So, anyone who is looking at this, I would say, it's not - in terms of just the valuation of Mitchell, it's a evaluation of what you do with it during the transition. So there's a lot of things to look at from that perspective.
Steve Fleishman: And my last question just on this topic and my last question is just, the overall portfolio optimization kind of that you've been doing, is this a conclusion of that or is this something where we could get more?
Nick Akins: No, it's going to be an ongoing part of our process. So it's just the beginning.
Steve Fleishman: Great. That's helpful. Thank you very much.
Nick Akins: Yeah, okay.
Operator: Thank you. Our next question comes from the line of the Durgesh Chopra with Evercore ISI. Please go ahead.
Nick Akins: Good morning, Durgesh.
Durgesh Chopra: Hey, good morning, Nick. Thank you for taking my question. Just I have - I think you've covered the rest, just on storm costs, Julia, you're currently deferring those, right, the $1.2 billion on the balance sheet, can you just reminded us...
Julia Sloat: Yeah...
Durgesh Chopra: Thank you. Can you just remind us what is factored into your 2021 guidance, I'm just thinking about how the sort of the regulatory decisions here in the next few months impact your 2021 numbers?
Julia Sloat: Yeah, absolutely. You have it exactly right. We're deferring those storm costs, particularly as it relates to the fuel and purchase power costs, because that's the biggest chunk of the dollars that we had exposure to as it relates to storm in Uri in particular. And as it relates to what's embedded in our guidance, I would tell you, we actually updated our cash flow forecast. That's included in the slide deck that you have today to incorporate the impact of this particular circumstance as well as the fact that we did have some ice storms and more I'd characterize more kind of normal storm-related activities that occurred in the eastern portion of our jurisdictions here during the first quarter. So all of that is factored into those new cash flow forecast details, which you'll see impacting the cash flow from operations line in the slide included in the deck today. As you know, we did take on some additional debt to be able to accommodate the fuel and purchase power spike that was not anticipated and so that is now being absorbed into our 2021 operations and therefore into our earnings. Interestingly, if you look at Page number 8 of the slide deck that we have out there today, on the Corporate and Other segment, you'll actually see that interest expense was a benefit to us this time despite the fact that we have taken on a little additional debt in that capacity, because we took a $500 million term loan on at the parent company interest rates - in terms of interest cost I should say, was much lower in this particular quarter versus last year. We do have - still have lower debt outstanding from a short-term perspective versus last year. So all of those factors, interestingly, helped to have this impact to be one of benefit to us in this particular period. So, steady as she goes, no change in forecast, still feeling really good about where we are. Hopefully that helps you a little bit.
Durgesh Chopra: It does. It does a nutshell. It's captured in your EPS guidance, interest costs and the cash flow metrics already reflect the sort of the some of the treatment you might get in terms of recovery for these costs.
Julia Sloat: You've got it. We did that by design because we wanted to make sure we had a fair amount of integrity in that forecast with - particularly when you look at the cash flow metrics and give a shout out to our fixed income friends because I know that's extremely important.
Durgesh Chopra: Understood, thanks. Just one last one for me. Nick, you mentioned the disappointing first quarter, it's just what to look forward there in terms of next steps, is there going to be a rulemaking procedure and just next steps there, what should we be looking for there?
Nick Akins: Yeah, there it is open for right now. So, and obviously our comments will be very direct and very focused, and I'm sure there'll be others in the industry with that as well, but it just seems like a direct polar opposite to where the administration is trying to go with movement to a clean energy economy and really it is directly opposite to years of precedents of encouraging the development of transmission. So I'm certainly hopeful as we get through the dialog of what this all means and actually with RTO participation, when we originally joined the RTO years ago, we were making a lot of money off of through an outrates of transmission. We traded that in for generation benefits, because we were selling a lot of generation. We're not selling generation, so to any real extent and certainly when you look at the value proposition of an RTO, it is centered on the ability to optimize across a larger jurisdiction. But from an AEP perspective, you got the cost of the RTO and certainly, our customers need to be able to benefit from that. So if you disrupt that net cost benefit opportunity, you will have people making different decisions about RTO participation. So I think it's just sort of a policy move in the wrong direction, but certainly and hopeful that the commission comes together on that.
Durgesh Chopra: Understood. Is there a timeline as to when the common period ends and when they might make a final determination yet?
Nick Akins: I don't know that there is right now, they have to post the noper in the Federal Register first. So we're thinking probably a summer timeframe for the noper.
Durgesh Chopra: Understood. Thank you. Appreciate the color.
Nick Akins: Yeah.
Operator: Thank you. Our next question comes from the line of Andrew Weisel with Scotiabank. Please go ahead.
Nick Akins: Good morning, Andrew.
Andrew Weisel: Thanks. Good morning, everyone. I appreciate late in the call here. First, just to follow up on the transmission, are you able to provide an EPS sensitivity or potential impact if that RTO incentive adder would it be eliminated?
Nick Akins: Yeah, we had in our queue, actually, the number for our evaluation that we lost the entire 50 basis points, it would amount to $55 million to $70 million pre-tax. So - and that's the evaluation now and who knows what they're going to do because you went in the meeting thinking they may actually go up on the RTO incentive, but they remains to be seen what they decide to do, but that's the impact.
Andrew Weisel: Well, that was the next thing I was going to ask, do you see any potential of an increase or do you think that's, it's a highly improbable at this point?
Nick Akins: I think certainly with what transpired, we're just trying to make sure it stays the same, but if it increases, there's a lot of reasons for it to increase because RTO participation and the adders associated with transmission, like I said, the expenses of an RTO continue to go up and up. So I think there definitely needs to be an incentive there.
Andrew Weisel: Okay, great. Then just one last follow-up question on the renewables. Do you - you talked a bit about the cost savings from coal plant retirements and I know it's early and the cost would be continuously changing hopefully downward. But from what you see today, do you expect this update to the generation stack to lower customer bills in most cases, all else equal and you mentioned something about potential carbon policy, does your analysis assumes some sort of federal clean energy standard and how would it look from an affordability perspective without that?
Nick Akins: We've always had the carbon value in our analysis from a resource planning perspective and I think it's $15 a ton is what we've used. In our reports, our Climate Report, we used two cases, a $15 case and a $30 case that was more aggressive and certainly that brought more - that case more renewables in more quickly, but that's not reflected in the plan that we've shown here. So, yes, it's certainly something that we're - we will continue to look at and evaluate with the commission.
Julia Sloat: If I could...
Nick Akins: Yeah go ahead.
Julia Sloat: Just to throw additional finer point on that as well, if carbon pricing is excluded from the equation, the renewable opportunity could get a haircut buy about 2 gigawatts. So it's not that significant, but want to throw that out there.
Nick Akins: Yeah, we're looking at this thing as a $15 billion to $20 billion investment opportunity. So, it would be not much of an impact if you took out the carbon pricing, but you can't plan for anything without putting in a carbon pricing these days.
Andrew Weisel: Okay, great. And the affordability question, assuming the carbon is in the bulk part of what you're talking...
Nick Akins: Yeah, and we've demonstrated that with North Central. I mean, you can put these projects in place and keep in mind, we're thinking about the resiliency and reliability of the grid too. So there's limitations and we have to go through that process, but the ones we have in this plan, we can do and certainly, when you look at the benefits of North Central, for example, it was $3 billion of benefit to the customers and so when you have those kinds of economics in play, if you're able to run your 24/7 generation has more of a reliability and as an insurance policy essentially and layer in as much renewables you can, put in transmission to make sure of the system continues to operate the way it should and then it could be pretty powerful combination to benefit customers in the future.
Andrew Weisel: That's great. Thank you very much for the details.
Nick Akins: Yeah.
Operator: Thank you. Our next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead.
Nick Akins: Good morning, Jeremy.
Jeremy Tonet: Good morning. Thanks for squeezing me in here at the end. Just wanted to touch based on Rockport, if I could, in kind of the decision tree that led to this and just wanted to see what other kinds of options you were evaluating, just a bit more color would be helpful there, thanks.
Nick Akins: Yeah, so obviously we were looking at future requirements instead of environmental requirements on the units and if we kept them operating longer than 2028, that would be a challenge from an economic perspective. We didn't want to start making those kinds of investments not knowing how long the units would actually be operational, so that was a consideration. The other, as I mentioned, was litigation to clear all that out to make sure we took ownership and we took control. And then, of course the value of the short-term bridge that exists that gives us the flexibility to make decisions with the Indiana Commission to focus on what is the right path for that transition. So it gives us a lot of optionality, a lot of flexibility and the control and by the way, I mean there's two units there. So one we own, one we leased and it just made more sense for us to own both of them and make the decision of the plant as a whole and be able to adjust accordingly. So, it worked out well overall from that perspective and like I say, it gives us a lot of optionality and flexibility and actually at a pretty - at a price that I think it was $115 million. So it's an opportunity for us to really pay for that degree of optionality that has considerable value.
Jeremy Tonet: Great, that's helpful. I'll stop there. Thanks.
Nick Akins: Yeah, sort of thing.
Darcy Reese: This is Darcy. We have time for one more question.
Operator: Great, thank you. Our last question comes from Michael Lapides with Goldman Sachs. Please go ahead.
Nick Akins: Michael, you snuck in there.
Michael Lapides: I snuck in at the end that better late than never. Thank you for taking my question, team. Hey, Nick, you mentioned Kentucky today, you also outline the renewable growth platform and plan for the regulated businesses. And obviously, lots of renewable companies, pure plays trading at pretty good multiples even after the recent share price weakness, just curious how do you think about the renewable portfolio at the G&M segment and whether that piece of the business is truly core to AEP or whether the real growth is obviously in the regulated subsidiaries and maybe the non-reg contracted renewable business could potentially be a source of funds for the parent to fund regulated growth?
Nick Akins: Yeah, so that's been a continual part of our business, just gets allocated capital, the AEP Energy gets allocated capital and he is perfectly willing to throw it back over the fence, because we make evaluations based upon his threshold which is commensurate with the regulated part and also just his business is important because it keeps us in a part of, like for example, we're doing a lot of projects here in Ohio directly with customers and it enables us to with customers and corporations actually and enables us to be in that business, but at the same time, we're able to manage the capital such that you can throw it back over the fence if we see a better opportunity on the regulated side. So we have that working very well where we can make those trade-offs on a continual basis. So yes, it could be a source of capital to do some of these things, and again that lends itself to the portfolio management approach to ensure that we're putting the money in the right place at the right time. So - and like I said, he is doing an incredible job with that and that organization and the fact is they are still doing the renewable part of it, but they're also doing specific relationships with customers with microgrids and those types of applications. So, the value proposition of that business is so important to us seeing the leading edge of what we need to be doing and making cases in our regulated business to ensure that we can continue to grow from those perspectives as well. So, all in all, it's working fine. But, yeah, the answer is yes, we can utilize that as a source.
Michael Lapides: Got it. Thank you, Nick. Much appreciate it, guys.
Nick Akins: Okay.
Darcy Reese: Hey, Tani, I wanted to say thank you for joining us on today's call. As always, the IR team will be available to answer any questions you may have. If you could please give the replay information.
Operator: Thank you, ladies and gentlemen. This conference will be available for replay after 11:30 AM Eastern today through April 29th at midnight. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code 3802483. International participants may dial 402-970-0847. Those numbers, again, are 1-866-207-1041 and 402-970-0847 with access code 3802483. That does conclude our conference for today. We thank you for your participation and for using AT&T Event Conferencing Service. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by, and welcome to the American Electric Power First Quarter 2021 Earnings Conference Call. As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Ms. Darcy Reese, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Tony. Good morning, everyone, and welcome to the First Quarter 2021 Earnings Call for American Electric Power. We appreciate you taking time today to join us today. Our earnings release, presentation slides and related financial information are available on our website at aep.com."
},
{
"speaker": "Nick Akins",
"text": "Thanks, Darcy, and welcome again everyone to American Electric Power's first quarter 2021 earnings call and happy Earth Day. Before I get started with our results for the quarter, I just have to say, I was struck with the public relations - public reactions to the Chauvin verdict. It has been a long wait, but justice and faith in our legal system does prevail. I bring this up because it happens, I had chosen a song, which I do every quarter as you know for a different reason, but now it serves two purposes. One, the most mesmerizing singer as I'd ever heard was the late Marvin Gaye. I thought of his song when actually thinking about our quarter and the multitude of activities that AEP continues to accomplish and was thinking of what's going on the Marvin Gaye hit from 1971 written during another tumultuous time in America. This song was a plea for peace, justice and understanding perspectives to move forward in a positive way together. As I said, this song was released in 1971, 50 years ago, but it could not be more appropriate today. We need our leaders, our communities and indeed, our companies to continue to come together and stop the divisiveness, which the new cycle tends to feed off of and recognized we have a lot more in common than are differences, that would be a great start to advancing this nation in a positive way. That being said, getting to my original purpose, as I said earlier, what's going on with AEP as the lyrics say, hey, man, what's happening, whoo, everything is everything. We're going to do a get down today, why I tell you. So here we go, the first quarter of 2021 came in with operating earnings of $1.15 per share versus $1.02 for first quarter '20, which met our expectations particularly given impact in Texas, Arkansas, Louisiana and Oklahoma, which we reported on in last quarter's earnings call. AEP continues to reaffirm our 2021 guidance range of $4.55 to $4.75 per share and our 5% to 7% long-term growth rate, and we would still be disappointed not to be in the upper half of the guidance range."
},
{
"speaker": "Julia Sloat",
"text": "Thanks, Nick, and thanks, Darcy. It's good to be with everyone this morning. I'm going to walk us through the financial results for the quarter, share some thoughts on our service territory load and economy, and then finish with a review of our credit metrics and liquidity. So let's go to Slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings were $1.16 per share compared to $1 per share in 2020. There is a reconciliation of GAAP to operating earnings on Page 15 of the presentation today. Let's walk through our quarterly operating earnings performance by segment, this is laid out on Slide 8. Operating earnings for the first quarter totaled $1.15 per share or $571 million compared to $1.02 per share or $504 million in 2020. Looking at the drivers by segment, operating earnings for the Vertically Integrated Utilities were $0.54 per share, up $0.04, driven by the favorable impact of weather due to warmer than normal winter temps in 2020. Other favorable items in this segment included Off-system sales, higher transmission revenue and the impact of rate changes across multiple jurisdictions, partially offsetting these favorable items were higher depreciation, lower normalized retail load, higher O&M, a prior period fuel adjustment and higher other taxes. The Transmission and Distribution Utilities segment earned $0.23 per share, down $0.01 from last year. Earnings in this segment declined primarily due to lower normalized retail load attributable in part to storm Uri. Other smaller decreases included higher depreciation, tax and O&M expenses. Favorable drivers in this segment included transmission revenue, rate changes and weather. The AEP Transmission Holdco segment continued to grow, contributing $0.35 per share, an improvement of $0.07 per share from last year. Net plant increased by $1.3 billion or 13% since March of last year. Generation and Marketing produced $0.06 per share, down $0.01 from last year. The favorable impact of the retirement of OCA Union and land sales on the generation business offset the unfavorable ERCOT market prices on the wholesale business during storm Uri in February. The decrease in the renewables business was driven by lower energy margins and higher expenses. Finally, Corporate and Other was up $0.04 per share, driven by an investment gain and lower interest expense, partially offsetting these items was the higher impact of - impact of higher taxes. Overall, we experienced a solid quarter and we're confident in reaffirming our annual operating earnings guidance. So let's take a look at our normalized load for the quarter on Page 9. Starting on the lower right corner, our first quarter normalized load came in 1.9% below the first quarter of 2020. There are two important factors to consider when evaluating the year-over-year comparison for the quarter. The first factor is that last year included an extra leap year day assuming everything else equal, you would expect about a 1% decline in sales due to one lesser day in the quarter, and the second factor is that the pandemic started during the last two weeks of the 2021st quarter. In other words, the first quarter analysis is comparing a pre-pandemic view of our service territory load to have you after COVID began. Importantly, we still expect a stronger recovery in the second half of this year as vaccinations increased positioning more communities to relax restrictions on businesses without jeopardizing public health and as a benefit of the American Rescue Plan stimulus, it was signed in late March, works its way through the economy. I'll talk a little bit more about the latest economic projections when we get to Slide 11. So let's take a look at the upper left quadrant, our normalized residential sales increased by 1.5% in the first quarter compared to last year. The growth in the residential sales was spread across most operating companies. As the pandemic recovery progresses, growth in residential sales as begun to moderate. While we expect residential sales to decline by 1.1% in 2021, we're assuming a moderate sustained load benefit from this customer class given the stickiness of work-from-home arrangements for many office workers across our service territory for the foreseeable future. So if you go over to the right, normalized commercial sales decreased by 1.6% in the first quarter. Even though commercial sales were down across every operating company excluding Ohio, we are seeing steady sequential improvement since the pandemic began. In fact, AEP Ohio was the first operating company to post positive commercial sales growth. This correlates well with the fact that the AEP Ohio territory added the most jobs in the first quarter. We also continue to see significant improvement in the same sectors that were hardest hit by the shutdowns in the second quarter of 2020. These sectors include schools, churches, restaurants and hotels. So finally, if you look in the lower left chart, you'll see that industrial sales decreased by 6.1% in the quarter compared to 2020. Industrial sales were down across every operating company and most industrial sectors. Not surprisingly, the biggest declines were located in the western territory where storm Uri in February caused a significant yet temporary - significant yet temporary disruptions to many manufacturing facilities located in ERCOT and SPP. In addition to the numerous electric generators unable to run due to frozen natural gas supply lines, there are a number of other manufacturing processes that rely on natural gas supply to produce their product. Many of those businesses were unable to produce for up to a week while the pipelines were being out and in some cases, industrial loads were stalled as long as 42 days in Texas. So the key takeaway here is that the dip in industrial sales in the first quarter was largely due to the one-time winter storm, which does not impact our fundamental outlook. So here's an interesting data point that illustrates this, our industrial sales in the eastern part of our service territory were down 2.6% as compared to the significant 12.8% drop in the western part of our service territory, which was impacted by Uri. So obviously, that's a pretty dramatic difference. That being said, we're still very bullish about the second half of the year as the US acquires a significantly greater concentration of immunity from vaccinations and as the full impact of the additional fiscal stimulus is felt throughout the service territory economy. So let's go over to Slide 10 where I can provide a little color on the industrial sales performance in the first quarter. The blue bars show the change in sales to our oil and gas customers. In aggregate, the sales to oil and gas sectors were down 9.6% in the first quarter, led by the 21% reduction in oil and gas extraction. Most of the decline in this sector is in response to the challenging market signals from last year when the drop in global demand along with the temporary price war caused oil prices to fall below many producers' breakeven point. However, we do not expect the weakness in oil and gas to persist. In fact, natural gas prices in March were up about 60% from last year and domestic oil prices last month have more than doubled since March of 2020. We fully expect the higher prices today will provide the necessary signal that producers are looking for to increase their production within the service territory. And once we see the production increase in the upstream sectors, it's only a matter of time before we see the corresponding increase in the midstream and downstream operations. The orange bars in the chart show the change in industrial sales, excluding oil and gas. While it was still down 3.3% for the quarter, we expect to see stronger improvement in the second half of the year as the global economy recovers from the pandemic. Some of the weakness in manufacturing right now is related to supply chain disruptions. As efforts continue to strengthen the resiliency of the domestic supply chain for manufacturing, the AEP service territory is certainly positioned to benefit from any movement in that direction. So let's go over to Slide number 11 where I can provide an update that I mentioned a few moments ago on the latest economic conditions within the AEP footprint. Starting in the lower left chart or on the left chart, you'll see that AEP service territory experienced a 1.6% increase in gross regional product compared to the first quarter of 2020. This was much better than the US, which had a relatively flat first quarter in terms of year-over-year GDP growth. The AEP service territory was less impacted by the virus and had fewer restrictions on businesses than other parts of the country, which has allowed the regional economy to fare better than the US throughout the pandemic. Looking forward, the AEP service territory is expected to grow by 5.2% in 2021, lagging the economic recovery in the US as you might expect. Moving to employment on the right, you can see that the job market for the AEP service territory has also outperformed the US throughout the pandemic. For the quarter, employment growth was only down 1.6%, which was 4 points or 4% better than the US during the first quarter. This is largely the result of the mix of jobs in our local economy, which has a heavier relative concentration of manufacturing and government jobs and a smaller share of leisure and hospitality jobs. Going forward, we expect job growth of 1.7% in 2021. So let's go over to Page 12 checking on the Company's capitalization and liquidity position. On a GAAP basis, our debt to capital ratio is 62.5%. When adjusted for the Storm Uri event, the ratio remains consistent with our year-end 2020 ratio at 61.8%. Let's talk about our FFO to debt metric because as you would expect and as we've been signaling, the impact of Storm Uri has and will have a temporary and noticeable impact in 2021 on this metric. Taking a look at the upper right quadrant on this page, you see our FFO to debt metric based on the traditional Moody's and GAAP calculated basis as well as on an adjusted Moody's and GAAP calculated basis. On a traditional unadjusted basis, our FFO to debt ratio decreased by 3.9% during the quarter to 9.1% on a Moody's basis. Well, this is a pretty dramatic impact. The rating agencies are very much aware of this and have taken the metric data point as well as the anticipated recovery into consideration as it relates to our credit rating. On an adjusted basis, the Moody's FFO to debt metric is 12.9%. To be very clear, this 12.9% figure removes or adjusts the calculation to eliminate the impact of approximately $1.2 billion of cash outflows associated with covering the unplanned Uri-driven fuel and purchase power in the SPP region directly impacting PSO and SWEPCO in particular. The metric is also adjusted to remove the effect of the associated debt we used to fund the unplanned payments. This should give you a sense of where we would be from a business as usual prospectus of 12.9% business as usual. As you know, we're in frequent contact with the rating agencies to keep them apprised of all aspects of our business and importantly, there is no change in our equity financing plan. On the topic of anticipated recovery, there is no debate that Storm Uri was an extreme event and consequently, the various states would like to resolve recovery docket as expeditiously as practical. Assuming recovery begins this year, our cash flow metrics will quickly return to the low to mid-teens target range next year as expected. So this should be a one year phenomenon for us. As many of you know, we have initiated regulatory cases in our respective states to evaluate the costs and determine the recovery plan. Let me provide a quick update where we are in this process. On February 24th, PSO filed with the Commission for recovery of fuel costs through a - with a regulatory asset and weighted average cost of capital carrying charge and subsequently filed a motion seeking recovery of a $615 million regulatory asset with a five-year amortization. At this point, PSO has received approval to defer the storm-related costs, with recovery of the established regulatory asset over five years at an interim rate of PSO's short-term financing cost of like 75 basis points. This is intended to be an interim order and the actual carrying charge will determined in a future review and the regulatory asset amount is subject to finalization. Importantly, Oklahoma has also taken up a securitization bill to address the extraordinary fuel and purchase power costs felt by all utilities, PSO will evaluate as the securitization is appropriate for the recovery. And if so, we would expect it to occur as early as next year. In March, the Arkansas Public Service Commission issued an order authorizing recovery of the approximate $113 million Arkansas jurisdictional share of the retail customer fuel cost over five years, with the carrying charges to be determined at a later date and the actual amount to be recovered being subject to finalization. We requested a WACC rate, which was supported by the staff in accordance with the order, SWEPCO began recovery in this jurisdiction in April, that was at a customer deposit rate of something like 80 basis points. The recovery period and associated carrying charge will be further reviewed in a hearing that's already been set for July 8th of this year, so 2021. In March, the Louisiana Public Service Commission approved a special order granting a temporary modification to the fuel adjustment clause to allow utilities to spread recovery over a longer period of time. In April, SWEPCO begin recovery of the Louisiana jurisdictional share of these fuel costs is about $150 million based on a five-year recovery period in a fuel over under recovery mechanism. SWEPCO will be working with the Louisiana Commission to finalize the actual recovery period and determine the appropriate carrying charge. And in Texas, SWEPCO intends to file for recovery under fuel surcharge, most likely in the second quarter. Our current plan is to request recovery over five years with a WACC carrying charge. Obviously, we have a lot in process on the regulatory recovery front on this matter and we'll keep you apprised as we make progress, because as we all know this is extremely important. Let's take a quick moment to visit our liquidity summary on the lower right of Slide 12. In March - on March 31st, AEP renewed its $4 billion bank revolver for five years and also entered into a two-year $1 billion revolving credit facility to fortify our liquidity position as we go forward, just placed our net liquidity position as of March 31st at a strong $3.4 billion. Switching gears, our qualified pension funding increased 1.7% during the quarter to 103.5% and our OPEB funding increased 9.6% to 170.5%. Rising interest rates that decreased plan liabilities along with positive equity returns were the primary drivers for the funded status increases in both plans during the first quarter. So let's go to Slide 13, so we can wrap this thing up and get your questions, but I just want to call out a couple of quick things before we do that. So on top of mind for many folks I know this, we want to mention to you that we completed the planned $125 million equity funding portion of the North Central Wind Sundance project. We used our at the market mechanism, so that we could time the equity need with our purchase of the Sundance project, which occurred last week. As you know, we will continue to move forward with additional opportunities in the renewable space supporting our ESG focus as we transition toward a clean energy future. Our performance in the first quarter and stability of our regulated business model gives us the confidence to reaffirm our operating earnings guidance range of $4.55 per share to $4.75 per share. Because of our ability to continue to invest in our own system organically, we are confident in our ability to grow the Company at our stated long-term growth rate of 5% to 7%. So we surely do appreciate your time and attention today. And with that, I'm going to turn the call over to the operator for your questions."
},
{
"speaker": "Operator",
"text": "Our first question comes from the line of Shar Pourreza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Shar."
},
{
"speaker": "Shar Pourreza",
"text": "Good morning, guys. Good morning, Nick. Good morning, everyone."
},
{
"speaker": "Julia Sloat",
"text": "Good morning."
},
{
"speaker": "Shar Pourreza",
"text": "So the - couple of quick questions here. First on the incremental 8.6 gigs of renewable opportunities, which just added to plan. It's very sizable - maybe touch a little bit on how we should think about these new opportunities in light of the 5% to 7% growth that you gave, what sort of financing avenues were you kind of looking at the approval tariffs and what are you assuming in terms of owned versus PPA?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, I think we have - the last part - last part of your question first. I think we have a pretty compelling argument now for owners of these facilities given even past the winter storm activity that we learned operationally, certainly what we learned from the - really this the provisions of the agreements that we put in place relative to the approvals really stands better in terms of our ability to manage the project, manage congestion, manage other factors that really provide benefits to our customers. So we're going to make a strong position that we should own those assets and actually when you think about the strength of the utilities, it's going to be important for the states to really focus on how do we keep our utilities strong and PPAs don't do it from a capital structure perspective. We need to make sure that ownership and their flexibility of operations is key in that regard. And regarding the other, 8600 megawatts, yeah, it is a sizable number, but obviously when you look at the evaluation of the retirements, when you look at the needs of the operating companies and also North Central certainly showed, you can deploy capital and reduce the overall bills to consumers. So when you think about the retirements of coal-fired generation, the imposition of additional transmission, having the benefits of the fuel cost aspects of it are tremendously important. So when you look at the analysis having some level of carbon pricing in there certainly increases the focus on the ability for renewables to come into play and that's certainly what we've been focusing on. So as you look at the finance ability of it, the finance ability pretty much work like we - like it did for North Central, although it is large number. So we'll have to be very aware of what our balance sheet strength looks like during the process, the timing of when the different tranches of these renewables come into play, the cash position that supported with these projects coming online and being able to improve as Julia mentioned. This FFO to debt thing where it is today is really a 2021 issue. In 2022, FFO to debt comes back up and certainly with the ability to put these projects in place, it will help in terms of our ability to continue to fund these projects. So it will probably - we've certainly would like for it all to be incremental, but in reality when you go through this process, it will probably be around capital allocation and prioritization associated with that within the existing plan, but also incremental. So it'd be a combination of both. Yet to be seen, obviously if load continues to grow, if the position relative to the regulatory framework getting concurrent recovery, making sure that we get off the tax ADIT issues, that's all going to be helpful in terms of our ability to finance. So it's still a work in progress."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. And then maybe just transitioning to corporate strategy and asset optimization, obviously, the strategic review for Kentucky is started, so Brian has been obviously very busy year, can we maybe just elaborate on the phase we are in with that process has - have bidders emerge or data rooms opened and assuming this would backfill most of your Wind Catcher equity need. So assuming we are looking at a Duke style Indiana GIC transaction for the entire OPCo. So we should obviously consider leakage share any NOLs as well that could be applicable in this case?"
},
{
"speaker": "Nick Akins",
"text": "Yes, Shar, you are always ahead in terms of questions. Yeah, and I really can't answer any of those at this point because we are in a process and certainly as soon as we have information on it, I think the real issue here is, we have made a deliberate decision to really start our portfolio management approach and evaluating jurisdictions, because we are fully regulated. We can look at these areas and determine what the best fit is in terms of future capital needs and what our focus is in terms of moving to a clean energy economy. So - and for us to come out and say that we are in a strategic process relative to Kentucky is an important statement in that regard. That's probably as far as we can go right now."
},
{
"speaker": "Shar Pourreza",
"text": "Let me ask you something a little bit more of a theoretical question, would you consider asset rotations above your current equity needs, let's say, from North Central to fund the incremental CapEx or renewables or T&D, I mean, you're within your credit metric guidance but does it make sense for you to further improve your balance sheet and simplify your store even further. I mean, do you kind of like looking at the stock valuation and does it may be more sense to - do you think there's incremental value from a multiple standpoint to even have a stronger balance sheet and operating even less states here and I'm thinking maybe Texas?"
},
{
"speaker": "Nick Akins",
"text": "Well, certainly, like I said, this is at the beginning of this process, but multiple expansion is clearly on our minds and making sure that you can - you're investing in the right things at the right places at the right time is going to be incredibly important. And you saw that with North Central of timing the recovery with the actual investments with the turnkey approach that we took and it's all about the timing of it, it's all about the decisions made to ensure that we are doing proper capital allocation and rotation to manage this process forward. So - and like I said earlier, that's going to be a continuing part of our business."
},
{
"speaker": "Shar Pourreza",
"text": "Terrific. Thank you, guys. I'll jump in the queue. I appreciate it."
},
{
"speaker": "Operator",
"text": "Thank you. Next, we go to the line of Julien Dumoulin Smith with Bank of America. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Julien."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Hey, good morning, team. Congratulations on all these updates."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "A lot to digest here today, I did. If I can, let's start with a higher level question here, right. So you're proposing a lot specifically in PSO, how do you think about the events that have transpired in Texas and Uri impacting that and specifically around some intermittent resources like solar in Oklahoma, right. We just haven't seen a lot of that historically and so this is a little bit of new territory for that geography more than the economics all around. Can you talk to that and have you kind of vetted some of the proposals here and the approval process?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, so obviously, we're right out of the gate in terms of the announcement of what's included in each jurisdiction. So we'll have discussions with the commissions and that's part of the integrated resource planning processes and keep in mind too, when we do this evaluation during the RFP, I mean, during the process, as always solving for whatever the lease cost is in terms of what those resources are. So it shows up as win. And then solar, typically it's showing up as more wind early on and solar starts to pick up, but that's pretty fungible as you go forward. I mean, these plans will change as we go forward based upon where technologies go, certainly where the opportunities exist. Oklahoma may want more wind and less solar, but that won't matter, it'd be a part of the total renewables piece that's included there. The other part of it too is, we will be very mindful of how much renewables are placed into service in relation to 24/7 supply and there is some natural gas that's built into this plan as well that enables more renewables to be put in place, but the real focus going forward during this transitional period will be for units that provide 24/7 to be more of a reliability component, certainly more of a - sort of an insurance backstop for weather events or other events that may occur that impact the grid security and will have to be very, very mindful of how those studies actually go. And I'll tell you, in our climate report, we saw for 2050 with a $15 carbon price and then more aggressive $30 carbon price, the 2035 case didn't solve because of the timing of getting resources in place and system-related issues. So you have to really think about how that's done and we've looked at these plans and we certainly believe that was the level of 24/7 supply we still have out there and the additional opportunity associated with just the diversity of some of these projects. It's going to be of particular value to our customers going forward. And I guess, I'll just remind you that North Central, had it been operational during this time of the Texas and Oklahoma outages with the Uri would have saved customers $227 million. So you think about the savings associated with that and the other thing too, the previous question, someone was - Shar was asking, when the utilities do it, they focus on the long term and North Central already had the weather package is already in place where you don't find that in a large part of the market. So we think the long-term when we go about after these investments and that's why ownership is clearly important."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Excellent. And just to clarify this a little bit further, I know that the equity numbers aren't moving around too much, we're at all, frankly, relative to CapEx, but how much capital could be shifted given the latest updates here in the three-year versus the five-year outlook here? Just want to understand, out of the total 10-year view that you guys are providing today, how much could be in that three-year and five-year window as you think about just the specific timing of each of these dockets that will come up for renewable resources?"
},
{
"speaker": "Nick Akins",
"text": "Well, yeah, as I mentioned, 10,000 of the megawatts of the 16,000 - over 16,000 is in the '21 to '25 timeframe, so it's going to be near-term. So when you think about these projects, they take a couple of years to put in place. You'll be looking more at that '23 to '25 for most of it, but some of it was - is already in play. There is already RFPs going out for suppliers of some of these renewables as we speak. Julia, anything do you want to add to that?"
},
{
"speaker": "Julia Sloat",
"text": "No, you've got that perfect, thank you."
},
{
"speaker": "Nick Akins",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Stephen Byrd with Morgan Stanley. Please go ahead."
},
{
"speaker": "Stephen Byrd",
"text": "Hi, thanks guys for taking my question."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Stephen."
},
{
"speaker": "Stephen Byrd",
"text": "Good morning. Congrats on a great update and a big movement in renewables, so happy to see that. I wanted - if you could just talk a little bit more about as you grow out renewables, whether there might be some additional transmission distribution requirements or stores there just other things that would sort of be additive as well, it's obviously just huge amount of megawatts, just curious about the other impacts?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, there will be and many of these projects, obviously, we'll have to look at the placement of these projects as in the level of congestion, but also the level of transmission investment that's required. But keep in mind too with the Biden administrations doing relative to the movement to clean energy, which obviously is a big part of his plan, large scale transmission will also be incredibly important. So, I see with what's going on today and in excess of all these things coming together, our transmission which you've always said is, as far as I can see for a decade, well, it's probably even higher. We don't know what that number is at this point and I think we've got to get through the process and fully understand that, but when you do the net benefits associated with fuel and the capital cost of the renewables projects and transmission, it's still a benefit to consumers. So, we'll go through that process, but you're right to be bullish about transmission in relation to these investments, but also everyone else's investments because we are the largest transmission provider in the country and most of this has to come through us."
},
{
"speaker": "Stephen Byrd",
"text": "That's really helpful. And then I wanted to drill into Texas for just a moment. There are some bills as you know that are floating around that would permit securitization of costs and those look to be, I guess to me, quite helpful from a financing point of view, just curious how you're thinking about that impact, how might that impact your thoughts on financing? I appreciate the point you raised earlier that essentially the credit metrics are sort of artificially low at the moment because of the storm, but with some of this - some of these bills be especially helpful to you?"
},
{
"speaker": "Nick Akins",
"text": "Well, certainly the ERCOT portion of Texas, we are essentially a large company there at T&D. So, and we have, based on our cost provisions in place for recovery of that, we - the only real exposure we've got from a standpoint is any, I guess some of the reps, they could potentially go bankrupt and - but that's where it's going to be important to understand where that goes and also as far as securitization is concerned, we view securitization in the past in Texas and you're seeing it develop for what's classified of storm caused, but it really is Uri-related investments we'd be fine with that. Julia, anything..."
},
{
"speaker": "Julia Sloat",
"text": "No, that would be great. Great question, Stephen. So, we're keeping an eye on what's going on in Oklahoma. There is an opportunity potentially to engage in some securitization activity there, would love to get cash in the door. So if that's something that's workable, we will absolutely take the cash and my understanding is, the way that is being at least they initially discussed it and potentially structured would be such - in such a way that that does not sit on our balance sheet, which makes it even better. So, yes, we'll take that cash and with no doubt on the balance sheet, we like that very much. So, we are definitely poised and ready and waiting."
},
{
"speaker": "Stephen Byrd",
"text": "That's great. Maybe one last quick one, just as we think about this growth in renewables, any changes in terms of your thoughts on coal retirement dates?"
},
{
"speaker": "Nick Akins",
"text": "Well, obviously the move we made on the second Rockport Unit solidified at least at 2028 and it could occur earlier depend on what the conditions are and what the evaluations are with the commission and the replacements of capacity. And so, we are - and actually, we're looking for provisions like that even in legislation that's occurring, because you're seeing all kinds of incentives developed for extension of PTCs, ITCs, direct pay we like, so direct pay not only for renewables projects, but also for transmission. If you have an ITC, but I think also, we'd like to see incentives for the undepreciated plant balances of coal units to further accelerate the ability to retire and obviate the impact to our customers. But the current plan does assume any of these advancements so - and this happens all the time where we have plans that are out there that are public, but lot of things get worked on and we'll continue to work on these objectives, because our objective is to move as quickly as possible to derisk these investments, particularly with new environmental rules with CCR and other things. We're making decisions about these plants and you've seen the last two quarters, we've announced earlier retirements of coal and lignite plant operation. So I would fully expect to see that process to continue."
},
{
"speaker": "Stephen Byrd",
"text": "Very good. Thank you very much."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Steve Fleishman with Wolfe Research. Please go ahead."
},
{
"speaker": "Steve Fleishman",
"text": "Yeah, thanks. Good morning, Nick and team."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Steve. How are you doing?"
},
{
"speaker": "Steve Fleishman",
"text": "I'm doing well. I have a couple of questions on the Kentucky Power announcement."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Steve Fleishman",
"text": "So just I think, Nick, you said that you're doing a strategic review with a target for year-end. So, is that the target to basically have a sales done and proceeds by year-end or have a kind of like a sale or other plan announced by year-end?"
},
{
"speaker": "Nick Akins",
"text": "Steve, so, I didn't say year-end. I said we would get the evaluation done in 2021, that could be earlier in the year, it could be later in the year. Obviously, we need to get farther down the road in terms of this process. I can tell you that the process is established, it's ongoing and we're going to move as quickly as possible. So - and we've always talked about the timing of the resolution of anything related to the weather was Kentucky or anything else in relation to the needs around North Central. So, and we still believe that timing fits."
},
{
"speaker": "Steve Fleishman",
"text": "Okay, that's helpful."
},
{
"speaker": "Nick Akins",
"text": "So, I wasn't saying that would be the end of the year before we know anything, I just said during '21."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. And just, is there kind of - this may be, it seems silly, but just, is there a reason that this wasn't like part of your slide deck or release or just - it was just stated on the call, just - it's something just happened, the Board just decide something?"
},
{
"speaker": "Nick Akins",
"text": "No, I think it was out of respect to our employees, because obviously, you can't say something like this from an SEC perspective without some thought around that, but also there is the human aspects of it too and employee aspects. Matter of fact, our employees just found out about it. When I've said it, I have a webcast after this with all employees to talk about this to just alleviate their concerns through the process, but this is the way that occurs, there is multiple things you have to think about when you're making these kinds of announcements."
},
{
"speaker": "Steve Fleishman",
"text": "Understood. And then just in terms of - that's helpful. So in terms of the - in terms of thinking about your financing, this would still be potentially directed at replacing the equity needs that you have currently for North Central as a potential replacement for some of that it will be?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, I'll let Julia talk about that."
},
{
"speaker": "Julia Sloat",
"text": "Steve, yeah, thank you for the question. Absolutely, to the extent that we get dollars in the door, that will be a wonderful place to put that to work in terms of being able to sidestep some of the equity need and we'll see if we can make that happen, absolutely."
},
{
"speaker": "Nick Akins",
"text": "We have the that we've access, but obviously it would change the nature of that."
},
{
"speaker": "Steve Fleishman",
"text": "One challenge with Kentucky Power has a lot of coal plants and exposure I guess, so to speak, just, do you feel like there is still despite that decent interest to be able to monetize at a reasonable price?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, and obviously different parties look at in different ways and that's what we're going to find out and through the strategic process is what evaluation Kentucky's ownership of Mitchell in terms of valuation and its impact on overall price would be. It still has value, it's still has years to operate and certainly, if you look at the plan that we presented, you still have a potential renewables opportunity there, particularly with the potential retirement of Mitchell at some point. So, anyone who is looking at this, I would say, it's not - in terms of just the valuation of Mitchell, it's a evaluation of what you do with it during the transition. So there's a lot of things to look at from that perspective."
},
{
"speaker": "Steve Fleishman",
"text": "And my last question just on this topic and my last question is just, the overall portfolio optimization kind of that you've been doing, is this a conclusion of that or is this something where we could get more?"
},
{
"speaker": "Nick Akins",
"text": "No, it's going to be an ongoing part of our process. So it's just the beginning."
},
{
"speaker": "Steve Fleishman",
"text": "Great. That's helpful. Thank you very much."
},
{
"speaker": "Nick Akins",
"text": "Yeah, okay."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of the Durgesh Chopra with Evercore ISI. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Durgesh."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning, Nick. Thank you for taking my question. Just I have - I think you've covered the rest, just on storm costs, Julia, you're currently deferring those, right, the $1.2 billion on the balance sheet, can you just reminded us..."
},
{
"speaker": "Julia Sloat",
"text": "Yeah..."
},
{
"speaker": "Durgesh Chopra",
"text": "Thank you. Can you just remind us what is factored into your 2021 guidance, I'm just thinking about how the sort of the regulatory decisions here in the next few months impact your 2021 numbers?"
},
{
"speaker": "Julia Sloat",
"text": "Yeah, absolutely. You have it exactly right. We're deferring those storm costs, particularly as it relates to the fuel and purchase power costs, because that's the biggest chunk of the dollars that we had exposure to as it relates to storm in Uri in particular. And as it relates to what's embedded in our guidance, I would tell you, we actually updated our cash flow forecast. That's included in the slide deck that you have today to incorporate the impact of this particular circumstance as well as the fact that we did have some ice storms and more I'd characterize more kind of normal storm-related activities that occurred in the eastern portion of our jurisdictions here during the first quarter. So all of that is factored into those new cash flow forecast details, which you'll see impacting the cash flow from operations line in the slide included in the deck today. As you know, we did take on some additional debt to be able to accommodate the fuel and purchase power spike that was not anticipated and so that is now being absorbed into our 2021 operations and therefore into our earnings. Interestingly, if you look at Page number 8 of the slide deck that we have out there today, on the Corporate and Other segment, you'll actually see that interest expense was a benefit to us this time despite the fact that we have taken on a little additional debt in that capacity, because we took a $500 million term loan on at the parent company interest rates - in terms of interest cost I should say, was much lower in this particular quarter versus last year. We do have - still have lower debt outstanding from a short-term perspective versus last year. So all of those factors, interestingly, helped to have this impact to be one of benefit to us in this particular period. So, steady as she goes, no change in forecast, still feeling really good about where we are. Hopefully that helps you a little bit."
},
{
"speaker": "Durgesh Chopra",
"text": "It does. It does a nutshell. It's captured in your EPS guidance, interest costs and the cash flow metrics already reflect the sort of the some of the treatment you might get in terms of recovery for these costs."
},
{
"speaker": "Julia Sloat",
"text": "You've got it. We did that by design because we wanted to make sure we had a fair amount of integrity in that forecast with - particularly when you look at the cash flow metrics and give a shout out to our fixed income friends because I know that's extremely important."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood, thanks. Just one last one for me. Nick, you mentioned the disappointing first quarter, it's just what to look forward there in terms of next steps, is there going to be a rulemaking procedure and just next steps there, what should we be looking for there?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, there it is open for right now. So, and obviously our comments will be very direct and very focused, and I'm sure there'll be others in the industry with that as well, but it just seems like a direct polar opposite to where the administration is trying to go with movement to a clean energy economy and really it is directly opposite to years of precedents of encouraging the development of transmission. So I'm certainly hopeful as we get through the dialog of what this all means and actually with RTO participation, when we originally joined the RTO years ago, we were making a lot of money off of through an outrates of transmission. We traded that in for generation benefits, because we were selling a lot of generation. We're not selling generation, so to any real extent and certainly when you look at the value proposition of an RTO, it is centered on the ability to optimize across a larger jurisdiction. But from an AEP perspective, you got the cost of the RTO and certainly, our customers need to be able to benefit from that. So if you disrupt that net cost benefit opportunity, you will have people making different decisions about RTO participation. So I think it's just sort of a policy move in the wrong direction, but certainly and hopeful that the commission comes together on that."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Is there a timeline as to when the common period ends and when they might make a final determination yet?"
},
{
"speaker": "Nick Akins",
"text": "I don't know that there is right now, they have to post the noper in the Federal Register first. So we're thinking probably a summer timeframe for the noper."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Thank you. Appreciate the color."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Andrew Weisel with Scotiabank. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Andrew."
},
{
"speaker": "Andrew Weisel",
"text": "Thanks. Good morning, everyone. I appreciate late in the call here. First, just to follow up on the transmission, are you able to provide an EPS sensitivity or potential impact if that RTO incentive adder would it be eliminated?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, we had in our queue, actually, the number for our evaluation that we lost the entire 50 basis points, it would amount to $55 million to $70 million pre-tax. So - and that's the evaluation now and who knows what they're going to do because you went in the meeting thinking they may actually go up on the RTO incentive, but they remains to be seen what they decide to do, but that's the impact."
},
{
"speaker": "Andrew Weisel",
"text": "Well, that was the next thing I was going to ask, do you see any potential of an increase or do you think that's, it's a highly improbable at this point?"
},
{
"speaker": "Nick Akins",
"text": "I think certainly with what transpired, we're just trying to make sure it stays the same, but if it increases, there's a lot of reasons for it to increase because RTO participation and the adders associated with transmission, like I said, the expenses of an RTO continue to go up and up. So I think there definitely needs to be an incentive there."
},
{
"speaker": "Andrew Weisel",
"text": "Okay, great. Then just one last follow-up question on the renewables. Do you - you talked a bit about the cost savings from coal plant retirements and I know it's early and the cost would be continuously changing hopefully downward. But from what you see today, do you expect this update to the generation stack to lower customer bills in most cases, all else equal and you mentioned something about potential carbon policy, does your analysis assumes some sort of federal clean energy standard and how would it look from an affordability perspective without that?"
},
{
"speaker": "Nick Akins",
"text": "We've always had the carbon value in our analysis from a resource planning perspective and I think it's $15 a ton is what we've used. In our reports, our Climate Report, we used two cases, a $15 case and a $30 case that was more aggressive and certainly that brought more - that case more renewables in more quickly, but that's not reflected in the plan that we've shown here. So, yes, it's certainly something that we're - we will continue to look at and evaluate with the commission."
},
{
"speaker": "Julia Sloat",
"text": "If I could..."
},
{
"speaker": "Nick Akins",
"text": "Yeah go ahead."
},
{
"speaker": "Julia Sloat",
"text": "Just to throw additional finer point on that as well, if carbon pricing is excluded from the equation, the renewable opportunity could get a haircut buy about 2 gigawatts. So it's not that significant, but want to throw that out there."
},
{
"speaker": "Nick Akins",
"text": "Yeah, we're looking at this thing as a $15 billion to $20 billion investment opportunity. So, it would be not much of an impact if you took out the carbon pricing, but you can't plan for anything without putting in a carbon pricing these days."
},
{
"speaker": "Andrew Weisel",
"text": "Okay, great. And the affordability question, assuming the carbon is in the bulk part of what you're talking..."
},
{
"speaker": "Nick Akins",
"text": "Yeah, and we've demonstrated that with North Central. I mean, you can put these projects in place and keep in mind, we're thinking about the resiliency and reliability of the grid too. So there's limitations and we have to go through that process, but the ones we have in this plan, we can do and certainly, when you look at the benefits of North Central, for example, it was $3 billion of benefit to the customers and so when you have those kinds of economics in play, if you're able to run your 24/7 generation has more of a reliability and as an insurance policy essentially and layer in as much renewables you can, put in transmission to make sure of the system continues to operate the way it should and then it could be pretty powerful combination to benefit customers in the future."
},
{
"speaker": "Andrew Weisel",
"text": "That's great. Thank you very much for the details."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Good morning. Thanks for squeezing me in here at the end. Just wanted to touch based on Rockport, if I could, in kind of the decision tree that led to this and just wanted to see what other kinds of options you were evaluating, just a bit more color would be helpful there, thanks."
},
{
"speaker": "Nick Akins",
"text": "Yeah, so obviously we were looking at future requirements instead of environmental requirements on the units and if we kept them operating longer than 2028, that would be a challenge from an economic perspective. We didn't want to start making those kinds of investments not knowing how long the units would actually be operational, so that was a consideration. The other, as I mentioned, was litigation to clear all that out to make sure we took ownership and we took control. And then, of course the value of the short-term bridge that exists that gives us the flexibility to make decisions with the Indiana Commission to focus on what is the right path for that transition. So it gives us a lot of optionality, a lot of flexibility and the control and by the way, I mean there's two units there. So one we own, one we leased and it just made more sense for us to own both of them and make the decision of the plant as a whole and be able to adjust accordingly. So, it worked out well overall from that perspective and like I say, it gives us a lot of optionality and flexibility and actually at a pretty - at a price that I think it was $115 million. So it's an opportunity for us to really pay for that degree of optionality that has considerable value."
},
{
"speaker": "Jeremy Tonet",
"text": "Great, that's helpful. I'll stop there. Thanks."
},
{
"speaker": "Nick Akins",
"text": "Yeah, sort of thing."
},
{
"speaker": "Darcy Reese",
"text": "This is Darcy. We have time for one more question."
},
{
"speaker": "Operator",
"text": "Great, thank you. Our last question comes from Michael Lapides with Goldman Sachs. Please go ahead."
},
{
"speaker": "Nick Akins",
"text": "Michael, you snuck in there."
},
{
"speaker": "Michael Lapides",
"text": "I snuck in at the end that better late than never. Thank you for taking my question, team. Hey, Nick, you mentioned Kentucky today, you also outline the renewable growth platform and plan for the regulated businesses. And obviously, lots of renewable companies, pure plays trading at pretty good multiples even after the recent share price weakness, just curious how do you think about the renewable portfolio at the G&M segment and whether that piece of the business is truly core to AEP or whether the real growth is obviously in the regulated subsidiaries and maybe the non-reg contracted renewable business could potentially be a source of funds for the parent to fund regulated growth?"
},
{
"speaker": "Nick Akins",
"text": "Yeah, so that's been a continual part of our business, just gets allocated capital, the AEP Energy gets allocated capital and he is perfectly willing to throw it back over the fence, because we make evaluations based upon his threshold which is commensurate with the regulated part and also just his business is important because it keeps us in a part of, like for example, we're doing a lot of projects here in Ohio directly with customers and it enables us to with customers and corporations actually and enables us to be in that business, but at the same time, we're able to manage the capital such that you can throw it back over the fence if we see a better opportunity on the regulated side. So we have that working very well where we can make those trade-offs on a continual basis. So yes, it could be a source of capital to do some of these things, and again that lends itself to the portfolio management approach to ensure that we're putting the money in the right place at the right time. So - and like I said, he is doing an incredible job with that and that organization and the fact is they are still doing the renewable part of it, but they're also doing specific relationships with customers with microgrids and those types of applications. So, the value proposition of that business is so important to us seeing the leading edge of what we need to be doing and making cases in our regulated business to ensure that we can continue to grow from those perspectives as well. So, all in all, it's working fine. But, yeah, the answer is yes, we can utilize that as a source."
},
{
"speaker": "Michael Lapides",
"text": "Got it. Thank you, Nick. Much appreciate it, guys."
},
{
"speaker": "Nick Akins",
"text": "Okay."
},
{
"speaker": "Darcy Reese",
"text": "Hey, Tani, I wanted to say thank you for joining us on today's call. As always, the IR team will be available to answer any questions you may have. If you could please give the replay information."
},
{
"speaker": "Operator",
"text": "Thank you, ladies and gentlemen. This conference will be available for replay after 11:30 AM Eastern today through April 29th at midnight. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code 3802483. International participants may dial 402-970-0847. Those numbers, again, are 1-866-207-1041 and 402-970-0847 with access code 3802483. That does conclude our conference for today. We thank you for your participation and for using AT&T Event Conferencing Service. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 4 | 2,022 | 2023-02-23 09:00:00 | Operator: Welcome to the American Electric Power Fourth Quarter 2022 Earnings Call. [Operator Instructions]. I would now like to turn the call over to our host Ms. Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Brad. Good morning everyone and welcome to the Fourth Quarter 2022 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release presentation slides and related financial information are available on our website at aep.com Today we will be making forward looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discuss of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Anne Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie.
Julia Sloat: Thanks, Darcy. Welcome, everyone, to American Electric Power's Fourth Quarter 2022 Earnings Call. I'm happy to be here with all of you this morning, and I'm pleased to be joined by our recently appointed CFO, Ann Kelly, who joined our team in late November. So here we go. We're making great progress and have a lot to share with you today, starting with the financial performance of our fourth quarter and year. I'll provide update on our Kentucky operations sale, unregulated renewable sale and retail business strategic review. I'll also provide insight into the regulatory and legislative front, as we work to implement important new initiatives to ensure our customers and communities needs, which are met in turn, and drives our high-quality investment proposition. Finally, I'll include an update -- or I'll conclude with an update on our generation fleet transformation as we continue to invest in regulated renewables and our energy delivery infrastructure, a summary of 2022 highlights and our focus for 2023 can be found on Slides 6 and 7 of today's presentation. As you know, we have a long history of consistently delivering and exceeding our earnings guidance and 2022 is no exception. I'm very proud of the dedication and accomplishments of the entire AEP team over the past year. While we finished the year strong, I can promise you, we're just getting started. Our robust financial plan continues to yield results. We delivered strong fourth quarter 2022 operating earnings of $1.05 per share bringing our full year 2022 operating earnings to $5.09 per share. We're also -- we also increased our quarterly dividend from $0.78 to $0.83 per share, which we announced back in October. AEP's teamwork-driven performance in 2022 has established a strong foundation from which we can reaffirm our 2023 full year operating earnings guidance range of $5.19 to $5.39, all while mitigating inflationary cost pressures, supply chain pressures and higher interest rates as well as constructively navigating regulatory and legislative frameworks. Formula rates in several of our state jurisdictions and in our high-growth transmission business help us to manage increased interest expense and higher costs. Importantly, as we keep customer affordability top of mind, we are actively working with our states on the economic development front to drive expansion in our service territory, and we are incorporating efficiencies and expense containment into our rate recovery filings to continue to help offset the impact of increased cost pressures. As a matter of fact, the economic development efforts over the past several years are proving to be appreciably beneficial, and we'll talk about normalized load in a few minutes. But to illustrate my point, I can tell you that normalized industrial sales were up 4.5%, largely as a result of those efforts, not to mention the added benefit of attracting jobs, residents and other cascading upside to our communities, all of which helps to manage customer rates given the bigger denominator. We value our stakeholder relationships, and we made steady progress on the regulatory front over the past year, including achieving constructive base rate outcomes in Arkansas and SWEPCO Texas and a favorable Supreme Court appeal related to Virginia's last rate case and the securitization of Winter Storm Uri costs in Oklahoma. Our resulting earned regulated ROE as of December 31 was 9.1%, which suggests we still have work to do on this front, and I'll talk about our regulatory activity that we have underway to address this. So hang with me for a few minutes, and I'll get there. AEP is leading the transition to a clean energy economy as we engage in one of the largest generation fleet transformations in our industry, in 2022, our 1.5 gigawatt North Central wind portfolio became fully operational with the completion of the Traverse wind farm project, which marked the beginning of our clean energy fleet transition. We'll continue to execute on our fleet transformation strategy with the opportunity to add approximately 17 gigawatts of new generation resources between 2023 and 2032, while mitigating fuel cost volatility and creating a more diverse resource portfolio to benefit our customers. This will significantly contribute to AEP's reduced carbon emissions profile and put us on a path to achieve our upgraded net zero goal by 2045. Importantly, the recent passage of the Inflation Reduction Act provides support for our clean energy goals, and this will extend our investment runway as we continue to address the needs of our generation fleet. Since assuming the role of President and now CEO, I prioritize simplifying and derisking our business profile, which has become a core standard by which we evaluate our business activity. By actively managing our portfolio and demonstrating a clear commitment to the successful execution of initiatives and transactions, we continue to deliver significant benefits to our stakeholders. As you are very much aware, we are working diligently to complete the sale of our Kentucky operations to Liberty. You can find the related regulatory time line on Slide 8 in the presentation today. As an update, AEP and Liberty followed the blueprint provided by the FERC order and filed a new FERC 203 application on February 14 of this year, requesting a shortened comment period and expedited approval to meet the contractual April 26, 2023 transaction close date. Immediately after the filing was made, FERC issued a notice incorporating a shortened 45-day comment deadline related to the application. The shortened comment period is a good sign signaling the commission is open to considering our application on an accelerated basis. AEP and Algonquin are in regular communication discussing various aspects of the transaction, the path forward and our partnership. We're mindful of the April 26 date in the stock purchase agreement and are cognizant of the tight time frame given the March 31 comment period deadline. The objective of both AEP and Algonquin remains clear, and that's to close the transaction. And both parties are firmly committed to moving forward and bringing forth the benefits of this transaction to customers. Related to our unregulated contract renewables portfolio, after strong buyer interest, we're pleased with our announcement made yesterday for the sale of our 1,365 megawatt portfolio to IRG Acquisition Holdings, which is a partnership owned by Invenergy, CDPQ and funds managed by Blackstone infrastructure. A summary of the sale can be seen on Slide 9 of the presentation today. We're currently targeting a second quarter 2023 close. The utilization of the proceeds from the sale is now reflected in our updated multiyear financing plan on Slide 39, and the transaction proceeds will be directed to support our regulated businesses as we enhance the energy delivery infrastructure and transform our generation fleet. Our near-term focus remains closing on our 2 pending sale transactions Kentucky and our unregulated renewables. Once both of these transactions are complete, we plan to revisit the equity needs in our current multiyear financing plan. As we've been clear in the past we will use the asset sales to responsibly eliminate equity while maintaining a strong balance sheet, no change in messaging on this. And that's important that I reiterate that. No change in the messaging. Finally, in October 2022, we announced the strategic review of our retail business. We're looking at this business to determine how or if it fits with the current AP portfolio and we'll keep you updated on our progress. We're expecting to complete the strategic review in the first half of 2023. Let me touch on our regulatory and legislative initiatives that we have underway. We remain focused on reducing our authorized versus actual ROE gap. As I mentioned earlier, our 2022 earned regulated was ?ROE 9.1% and -- our 2023 earnings guidance range assumes a 9.4% earned ROE, and we are already making progress in that direction. In January, we reached the settlement and gain commission approval for our Louisiana base case, which allows us to reestablish a formula rate plan -- as we advance through the year, the team will be active in completing our current base case in Oklahoma and rider recovery of the 88 megawatts of the Turk plant, which is not currently in Arkansas rates. We also filed an electric security plan in Ohio, which will take us into 2024. Let me shift gears and provide you with an update on our deferred fuel recovery efforts that are currently underway. As we've previously shared with you over the past several months, we have made adjustments to our traditional cost recovery methods in a number of our states to allow for recovery while spreading the cost out for our customers to make them more affordable. In West Virginia, we continue to pursue approval of the pass-through of fuel costs under the fuel clause. We also intend to propose an alternative path to recovery of these costs under proposed legislation, if Approved, that would allow us to securitize these costs and minimize customer impact. The West Virginia Commission recently instructed its staff to finish its prudence review of the 2021 and 2022 fuel costs. The state legislature continues to move the securitization legislation forward with the Commission Chair recently testifying in support before the lawmakers. I'll conclude my remarks with an update on our regulated renewables strategy and execution. Our capacity needs continue to drive us forward on the regulated renewables front, and we continue to work with our regulators, policymakers and other key stakeholders to ensure a durable and sustainable transmission -- transition to a clean energy economy in our vertically integrated state. The recently enacted Inflation Reduction Act will help us advance our goals in this area and will provide additional value to our customers as we seek to acquire resources consistent with our plan. We've made considerable progress on SWEPCO's 999-megawatt renewables application, which represents a $2.2 billion investment for AEP. Parties filed a unanimous settlement in Arkansas on January 27 and for a portfolio of owned wind and solar resources. A hearing was held in Texas in January, and we continue to have constructive settlement dialogue with parties in Louisiana, and the hearing date has been formally extended to March 21 to accommodate this. We look forward to receiving the commission's orders, which are expected in the second quarter of 2023 on Louisiana and the third quarter of 2023 for Texas. In November of 2022, PSO made a regulatory filing in Oklahoma to own 995.5 megawatts of solar and wind projects representing a $2.5 billion investment. A procedural schedule was issued last month which includes a hearing date in April and an expected commission order in the third quarter of this year. Separately, we're also seeking to acquire the 154-megawatt [indiscernible] wind facility in Oklahoma from EDF. FERC approved this acquisition on February 16, and we're pursuing rate recovery of this investment through the ongoing PSO base rate case. The project is already in service and will provide immediate capacity for PSO's customers. Our regulated renewables goals are aligned and supported by our integrated resources plans. In accordance with those plans, we issued request for proposal in 2022 for wind, solar and other resources at APCo, INM and once again at SWEPCO. We anticipate making the related regulatory funds to acquire additional resources under these RFPs throughout 2023. We continue to see rapid changes in our industry and increasing need and demand from customers and communities across the United States. At the end of 2022, as I prepared to assume my new position at AEP, the team and I dedicated a considerable amount of time and energy to determining how AEP would continue to deliver safe, clean, affordable and reliable energy and how we could deliver this energy faster and more efficiently to our customers while generating enhanced value to our stakeholders. Our long-term earnings growth rate of 6% to 7% is underpinned by a robust $40 billion capital investment plan for 2023 through 2027, which includes $15 billion in transmission and $9 billion in regulated renewables investments. As evidenced by our fourth quarter and full year 2022 performance AEP has had a long-standing track record of consistently delivering on our strategic objectives, our transformation strategy is working and the investments we're making continue to support our positive earnings growth and results. Now please join me in welcoming Ann to her first AEP earnings call. I'll leave you in her very capable hands as she provides insight and perspective into our performance drivers for 2022 and the details supporting our financial targets. Ann?
Ann Kelly: Thank you, Julia and Darcy. It's great to be with you all this morning and thanks for dialing in. I'll walk us through our fourth quarter and full year results, share some updates on our service territory load and our outlook for 2023 and finish with commentary on credit metrics and liquidity as well as some thoughts on our guidance, financial targets and portfolio management. So let's go to Slide 10, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. As Julie mentioned, we had a strong operating results in both the fourth quarter and for the full year. GAAP earnings for the fourth quarter were $0.75 per share compared to $1.07 per share in 2021. GAAP earnings for the year were $4.51 per share compared to $4.97 per share in 2021. For the quarter, I'll mention that we have reflected additional charges related to the expected sale of Kentucky Power and Kentucky Transco as nonoperating costs. This is largely a result of the delay in the closing from the need to file a new 203 application with the FERC. There are detailed reconciliations of GAAP to operating earnings on Pages 18 and 19 of the presentation today. Today, I'm going to focus more on our full year results, but I did want to provide a few highlights on the fourth quarter as we show on Slide 11. Operating earnings for the fourth quarter totaled $1.05 per share compared to $0.98 per share in 2021. This is a $0.07 or 7% increase year-over-year. While we had a lot of puts and takes, our vertically integrated and T&D utility segments continued to perform well, resulting from rate changes, transmission revenue and some favorable weather. We did see a $0.03 decline in our normalized retail margin, but that was due to a change in sales mix as low as favorable for the quarter. I'll discuss load in more detail in a couple of minutes. We were also able to support an increase in our O&M expenses as a result of the strong earnings that we were seeing. Transmission Holdco was favorable by $0.03, even after factoring in the loss the Ohio RTO adder as we continue to see the benefits of our investments. Generation and Marketing produced $0.16 per share, up $0.10 from last year, driven by increased retail energy margins and favorable generation performance, primarily driven by fewer average days year-over-year. And finally, Corporate and Other was down $0.05 per share driven by increased interest expense and investment losses, partially offset by favorable income taxes. Now let's have a look at our year-to-date results on Slide 12. Operating earnings for 2022 totaled $1.09 per share compared to $4.74 per share in 2021. This was an increase of $0.35 per share or 7%. Looking at the drivers by segment. Operating earnings for vertically integrated utilities were $2.56 per share, up $0.30. Due to rate changes across various operating companies, favorable weather, increased transmission revenue and also increase normalized load. Offsetting these favorable variances were higher O&M, increased depreciation expense and increased interest expense. Once again, the change in accounting around the Rockport Unit 2 lease results in $0.23 of favorable O&M offset by $0.23 of unfavorable depreciation. In the Transmission & Distribution Utilities segment, earned $1.16 per share, up $0.06 from last year. Favorable drivers in this segment included rate changes in Texas and Ohio, favorable weather and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. With the favorable weather and other items that we experienced in 2022, we were able to responsibly deploy additional O&M in both utility segments to spend on items like increased vegetation management to improve system reliability. The AEP Transmission Holdco segment contributed $1.32 per share, down $0.03 from last year. Favorable investment growth of $0.12 was more than offset by an unaffared true-up of $0.04, the loss of the RTO adder in Ohio and increased income taxes. Remember, our 2022 guidance had this segment down by $0.08 year-over-year as a result of the investment growth being more than offset by the annual true-up to some unfavorable comparisons for taxes and interest. Generation and Marketing produced $0.50 per share, up $0.24 from last year. The positive variance here is primarily due to the sale of renewable development sites, improved generation performance in land sales in the generation business, improved retail margins and increased wholesale margins stemming from favorable market conditions. And finally, Corporate and Other was down $0.22 per share, driven by investment losses unfavorable interest in increased O&M, partly offset by lower income taxes. The investment losses continue to be impacted by the year-over-year comparisons for our ChargePoint investment that we exited in the third quarter. As we mentioned earlier, we are reaffirming our guidance range for 2023. For convenience, we've included an updated waterfall on our actual 2022 results to the midpoint of our guidance for 2023 on Slide 36. While the variances changed due to the 2022 actual results, there is no change to our 2023 segment or overall guidance. We are confident that our regulatory actions to provide timely returns on our distribution and renewable investments, continued investment in transmission assets, the impact of economic development efforts and prudent O&M management will offset headwinds such as rising interest rates and inflationary pressures. Now turning to Slide 13, I'll provide an update on our normalized load performance. Overall, 2022 was a remarkable year for normalized load growth across the AEP service territory. Despite the Federal Reserve's intentional actions to slow down the economy, AEP experienced its strongest weather-normalized load growth in over 15 years with 2.8% annual growth. The most impressive part is that this is experience on top of a recovery year. As a reminder, 2021 was the strongest year for AEP's normalized growth in over a decade until 2022. The growth in 2022 was spread across nearly every operating company in every major retail class. Starting in the lower right corner of the slide, normalized retail sales increased by 1.9% in the fourth quarter and ended the year up 2.8% compared to last year. For the quarter, the growth in commercial and industrial sales will more than offset the modest decline in residential sales. Looking forward, you will see that we are expecting growth of 7% to 10% in 2023. The story is changing somewhat to further remove away from the pandemic. In 2022, the boost from fiscal policy overwhelmed the Federal Reserve's efforts to constrain the economy through monetary policy. In 2023, we expect the fiscal boost to date given the congressional changes after the election, while the Fed's efforts to tame inflation remain in place. We expect this to result in a slight moderation of economic growth for the balance of this year. Moving to the upper left corner, Normalized residential sales decreased by 0.8% in the fourth quarter but finished the year slightly above 2021. For the quarter, residential customer counts increased by 0.4%, but this was offset by a 1.2% decline in weather normalized usage. This is not surprising when you consider the impact that higher inflation, energy costs and interest rates on customers' disposable income to end the year. You will notice that we now expect residential sales to decrease by 0.5% in 2023 for the same reason. Moving right, weather-normalized commercial increased by 5.4% for the quarter and ended the year up 4.2% compared to 2021. The growth in commercial sales was spread across nearly every operating company. fastest-growing commercial sectors, professional scientific and tech services that includes data centers, which -- where load was up nearly 30% compared to last year for both the quarter and the year-to-date comparisons. The outlook for 2023 is showing a modest 0.6% growth. While we do see momentum in this class driven by economic development, the sustained impact of the labor shortage inflation high interest rates and energy costs will act as a headwind in 2023. Finally, focusing on the lower left corner, you see the industrial sales growth moderated in the fourth quarter, up 1.5% and while the year ended 4.5% above 2021. Industrial sales increased at most operating companies in many of our largest sectors. We continue to experience robust growth in the oil and gas sectors, which were up 6% compared to the fourth quarter of 2021. Outside of oil and gas, which tends to run countercyclical to the rest of the economy, we did notice softer industrial sales growth consistent with many of the economic indicators. As you know, the ISM manufacturing index fell below 50 in the fourth quarter, which is a sign of an industrial contraction. The combination of sustained inflation, supply chain disruptions, increasing borrowing costs, strong dollar and elevated energy costs have formed significant challenges for domestic manufacturing. Fortunately, AEP's past economic development activities are providing an offset and are keeping AEP's industrial sales growth in positive territory. You see that the outlook is showing industrial sales growth of 2.1% in 2023, which is largely attributable to the consistent economic development activities from the past. I'll provide additional detail on the impact of these efforts in the next slide. To summarize, the AP service territory experienced a remarkable year for load growth in 2022 despite the inflationary pressures on wages and energy and a federal reserve that was intentionally trying to slow down the economy. We are finally seeing evidence that these measures are starting to have an impact, which will result in slower growth in 2023. Fortunately, AEP's disciplined commitment to economic development should keep our load growth in the black moving forward. For example, absent economic development, our loan growth would have been essentially flat in the fourth quarter and up 1.1% for the year. Turning to Slide 14, I want to highlight how our commitment to economic development is helping to sustain load growth even in the face of challenging economic conditions. The chart on this slide illustrates why the strategy is so important to us. The blue bars on this chart show the growth of gross regional product for the AEP service territory over the past year. You can see that it has been slowing over the period. And in fact, for the fourth quarter, growth in AEP's GRP was slightly negative compared to the fourth quarter of 2021. However, the green bars here show our industrial sales growth over the same period. You'll notice they have been resilient throughout 2022 without any help from GRP. A lot of the growth in industrial load that we are seeing today is a consequence of economic development projects from previous years. And our focus on economic development is not just about the additional load that we report to you on a quarterly basis. We are also focused on attracting employers to the service territory. We know that adding new loading customers are a key strategy to providing value to all customers. This allows us to continue to prioritize investments that will improve the customer experience while mitigating the rate impacts on our customer base. By making this a key component of our strategy, AEP is helping to mitigate the impact of the economic downturn on our customers, communities and shareholders. And AEP's economic development team has a proven track record of helping to bring these new customers to our service territory with an emphasis on jobs and load. In fact, the AEP service territories added over 141,000 jobs in 2022. Let's move on to Slide 15 to discuss the company's capitalization and liquidity position. Taking a look at the upper left quadrant on this page, you see our FFO-to-debt metric stands at 13.2%, which is a decrease of 1.3% from the prior quarter. The primary reason for this decrease is the impact on both FFO and short-term debt from a decrease in our mark-to-market collateral positions associated with the decline in natural gas and power prices. as well as a continued increase in our deferred fuel balances. We remain committed to our targeted FFO-to-debt range of 14% to 15%, and we plan to trend back into that range near the end of 2023 as we continue to work through the regulatory recovery process of our deferred fuel balances, which can drive some volatility in the metrics. You can see our liquidity summary on the lower left quadrant side. Our 5-year $4 billion bank revolver and 2-year $1 billion revolving credit facility support our liquidity position, which remains strong at $2.6 billion. The $1.1 billion change from last quarter is mainly due to an increase in commercial paper outstanding for the reasons I mentioned earlier. On a GAAP basis, our debt-to-capital ratio increased from the prior quarter by 1.5% to 62.9%. On the qualified pension front, our funding status remained strong, ending the quarter at 102.4%. While assets performed as expected during the quarter, the primary driver for the funded status decreased was due to an increase in the liability caused by changes in actuarial assumptions influenced by the rising interest rate environment in 2022. Now turning to Slide 16. I'll give a quick recap of today's message. First, we are focused on execution. The Kentucky transaction is back in front of the FERC and Liberty and AEP are committed to moving forward with this transaction. We just announced the agreement to sell our unregulated contract renewables portfolio and are working through the strategic review of the retail business. Each of these actions will help us to simplify and derisk our business. Even as we worked on these initiatives, we didn't take our eye off the ball of managing the business. We finished 2022 with solid earnings and made significant investments to support our customers even with the backdrop of supply chain challenges and inflationary pressures. We continue to be committed to our long-term growth rate of 6% to 7% and continued dividend growth and a strong balance sheet while derisking the company, focusing on the customer and actively managing the portfolio. We really appreciate your time and attention today. I'm going to ask Brad to open up the call so that we can answer any questions that you may have.
Operator: [Operator Instructions]. And we'll first go to Shahriar Pourreza with Guggenheim Partners.
Shahriar Pourreza: So a couple of quick ones here. Looking at just the West Virginia fuel cost recovery, hearings were obviously held in 4Q, and there was a discussion about moving to quarterly time periods as well as securitization. I guess, can you give us maybe an update on how you're looking at the situation where we might be headed from here? There's a lot of moving pieces I guess. So how is the dialogue going? And sort of any sense of bill impact ranges, especially with the recent gas price collapse?
Julia Sloat: Yes. I still appreciate the question because shares, I'm sure you can imagine, it is absolutely top of mind for us. And as Ann mentioned in her comments, top of mind from a CFO perspective, most definitely. As you know, we did get an order. The staff is going through its paces as we had to work through the prudency review. And in the background, what's playing is a legislation that could potentially accommodate securitization of the dollars we have outstanding, our fuel balance in West Virginia $520 million -- so it's not insignificant and it's extremely important to be able to digest this in a way that can accommodate customer rates. So we're hoping that we'll be able to be in a position we'll be able to utilize the securitization legislation, if approved, to be able to smooth this out and take care of customer needs in terms of the bill in path. And I don't know, Ann, do you have any other thoughts on that, how we might do that?
Ann Kelly: Yes. No, it's absolutely right. I mean utilizing the securitization allows us to spread it out over time and minimize and actually keep our customer rates relatively flat, which is really the intention. Now this will take some time. It will be effective in June, and we need to commission the order. So we would expect the securitization to take place in the first half of 2024.
Shahriar Pourreza: Got it. Okay. Perfect. And then just lastly, on the financing needs. Obviously, we've noticed that you now include both the $1.2 billion expected cash proceeds from Kentucky as well as I think for the first time, the expected $1.2 billion from the contracted renewable sale. I guess looking at the sources and uses, why wait to update your funding needs on the equity side, especially if you're including the proceeds already. Is there anything we should be thinking about here?
Julia Sloat: No hidden message there at all, Shahriar. We want to make sure that we get both of these transactions in the bag, get them taken care of and then we'll recalibrate. And as you know, our objective is twofold. We want to make sure we have a strong balance sheet because we don't want anybody worried about any dilutive otherwise actions that we would have to take. So that's first and foremost. So top of mind for us is making sure that balance sheet is in check. And as you know, we put out a target goal for FFO to debt of 14% to 15%. That being said, to the extent that we will then be able to eliminate future equity needs, we don't have a significant amount of equity financing when you look out over the horizon. But if we're able to kind of pull that back a little bit and still hit the objective on the strong balance sheet, we'll absolutely do that. So no hidden message. Obviously, both of these are moving along, contractor renewables new for us. We know that, that will close in the second quarter. We believe that's the plan to close in the second quarter. And as you know, Kentucky is pending with its 203 application. So stay tuned. We just want to make sure that we got this completely right for you all and that you're not concerned.
Operator: And next, we'll go to Jeremy Tonet with JPMorgan. .
Jeremy Tonet: I just want to pivot towards the retail business a little bit. And if you could just peel back, I guess, a little bit how that process stands at this point. Just wondering, any thoughts that are be considered here of why that would remain in the portfolio, what might prevent you from selling it? I'm just wondering if you might be able to provide a little bit more color of what's in that business, EBITDA earnings or anything else to wrap our heads around there?
Julia Sloat: Yes, absolutely. And I love the question because that's exactly what we're doing in our house right now is going through the paces to determine exactly does it fit -- if there's anything that does fit, what does that look like? Stay tuned. That will be a first half story for AEP. So expect us to be coming to you probably in the second quarter with a little more granular detail because we're literally going through that analysis now and working with the troops to make sure we have that finally, too, so we can get back out to you. As far as quantifying how big is this business and what does it mean currently to AEP, the net asset position or, I guess, equity position, if you strip out the liabilities, we're talking about $193 million -- the vast majority of that is working capital to the tune of about $150 million of the $193 million, and the rest is largely IT software, and then we have a little smidge of goodwill in there of about $1 million to give you some parameters. And then another thing that I would think about is what does that mean from an EPS perspective, in 2022, this retail business contributed $0.05 of EPS. And in 2023, we have $0.04 embedded in our guidance to give you that goalpost to. Hopefully, that helps.
Jeremy Tonet: That's very helpful. And just going back to the renewables sale here. Was there an EBITDA number that you might be able to share with us or have shared on that?
Julia Sloat: We haven't disclosed an EBITDA number. I can tell you that in our guidance for 2023, we're looking at $0.01 that renewable business contributed, I think it was $0.08. Does that sound right, Ann? $0.08, yes?
Ann Kelly: $0.08, yes.
Julia Sloat: $0.08 in 2022 to give you those parameters.
Jeremy Tonet: Got it. That's helpful. And just one last one, if I could. Touching on what Shahriar was talking about with the fuel business what have you. And I guess if moving pieces here, getting back to what the agencies are looking at, how should we think about the cadence of fuel balance normalizing any other items as we get to the 14% to 15% FFO debt target range by year-end '23, I think?
Julia Sloat: That's right. We expect to get our -- up to the -- get the ball between the uprates in the last part of the year. We do expect to have a little bit of pressure on the front end as we continue to work through some of the fuel balances. As I mentioned, when you look at West Virginia stand-alone, it's about $520 million. Does that sound right, Ann?
Ann Kelly: Yes, $520 million. And as I mentioned, the securitization of that will take some time. So likely won't be done by the end of this year. But -- in terms of our other fuel balances in other jurisdictions, we have positive mechanisms to recover that. And also natural gas rates and power prices are declining, so that will help somewhat as well.
Operator: And next, we'll go to Steve Fleishman with Wolfe Research.
Steven Fleishman: Yes. So just kind of similar -- similar question on the deferred fuel. If you just looked at the year-end number on FFO to debt, how much do you think deferred fuel represents in terms of impact that's lowering that number? Looking at FFO to debt?
Julia Sloat: So we're at 13.2% as of year-end. And so if we get above that 14%-ish range by year-end 2023, I don't know that looks about -- I don't say entirely 100 basis points, but it's pretty significant.
Ann Kelly: Yes. I think it actually might be a little bit less than 100 basis when you think about it because we have $1.7 billion of deferred fuel at the end of the year.
Steven Fleishman: Okay. That's very helpful. And then just on the ROE improvement to the 9.4 in this year's guidance. Is it -- is there any states that are really driving a lot of that? Are there any states that they're still kind of the most room to go after '23?
Julia Sloat: Yes. So here's where I'll draw your attention to. And I know we have the little equalizer chart here in the slide deck somewhere. I think it's on Page 41. And so you can get a sense of kind of where we are hanging out on each of the respective operating company entities. But what we do have in play right now is that at PSO, so Oklahoma, we have a base case underway. So that should help us to begin to heal the ROE, the earned ROE at PSO. So stay tuned for that. So base case in play there. And then as I mentioned in my opening remarks, we recently were able to finalize our Louisiana base case and then reactivate this formula rate plan. So that will get underway to, again, to help move SWEPCO's ROE back up closer to its authorized levels. Kentucky, obviously, you know what we're doing with Kentucky. And APCo, I think APCo, that's why the legislation in Virginia becomes so important to us. because we're in an under-earning position right now. We got the outcome of the Virginia triennial case, which should be beneficial to us in 2023, but I would still expect APCo's ROE to be under pressure until we get, hopefully, some resolution around Virginia legislation that to the extent that we're able to modify the regulatory recovery methods that are being employed in that particular state, we'll begin to see some healing on that particular ROE, too. So our triennial versus say a biennial, AEP is going to lead more toward a biennial or an annual type look versus necessarily that triennial because unfortunately kind of tracks us in an under-earning position, so stay tuned. We'll see how the Virginia legislation process moved along. Our team is absolutely at the table with all the other stakeholders. So that sounds constructive. So we're hopeful and we'll see this developing situation through and then we would expect something to be in the improvement territory for APCo.
Steven Fleishman: Just for clarity on that last point in Virginia, why does -- what are things that would help you in the Virginia law, it go into the biannual so you don't have to go so far between cases or something else?
Julia Sloat: Anything shorter, Steve, is going to be better for us -- so that will move us in a more productive situation or direction for APCo in particular. I mean an annual rate trout would be fine, too. But again, you can see the direction. So that will be important for us as we work through the different solutions that are being contemplated now because I know we have, I think, 3 bills that are being evaluated or at least shopped in Virginia. But as I mentioned, AEP is absolutely at the table, and we'll see how this ultimately shakes out. Obviously, the benefit needs to go to the customers, but then also our investors as we work to improve the ROE.
Operator: Next, we can go to Nick Campanella with Credit Suisse.
Nicholas Campanella: I guess just very clear from the filings that have been made so far on the Kentucky transaction that the parties are committed here and you're working towards closing and what is somewhat of a tight deadline. Can you just kind of give us a sense how that changes, if your funding strategy changes at all if this deal weren't to go through and how that would overall kind of change your strategy if it went there.
Julia Sloat: Yes. Nick, I still appreciate the question, and I'll let Ann jump in here in a second on what our thoughts are on funding. But I have before I do that, I have to say, we're committed to the transaction. I know you point that out. And I know we do have a tight time line. That's precisely why I threw that out there in my opening comments. The objective is to, I'll say, push for the tape because I know we've got that April 26 date. But importantly, I need you guys to have this takeaway both the AEP and the Algonquin team members continue to have a regular dialogue and work closely together. So we're all in and we'll continue to push to try to do this as expeditiously as possible. But I think we're also in a good position from a financing perspective. Ann, you want to talk a little bit...
Ann Kelly: Yes, absolutely. So I mean should Kentucky not close, we would expect to keep our equity needs the same. So no new equity if that happens. We'll just be managing our FFO to debt as tightly as possible and don't expect any changes.
Nicholas Campanella: Okay. That's helpful. I appreciate that. And then I guess just I know we talked a lot about deferred fuel, but we noticed that the CFO is slightly depressed in '23 versus kind of what you outlined at the Analyst Day. And I think you're making up for that in the back part of the plan. But is that purely just deferred fuel impacts? Or is there something else fundamental there? That would helpful.
Ann Kelly: Yes, there's really 2 main drivers. Deferred fuel is the biggest piece, but the other piece is we've had some return of collateral from a mark-to-market due to the reduction in natural gas and power prices that has impacted that as well.
Operator: Next, we can go to Bill Appicelli with UBS.
Unidentified Analyst: Just going back to the Kentucky sale. I know you said that FERC provided for a 45-day comment period so that was look like it was going to be supportive of maybe an expedited ruling. But will we get further indications from FERC, if they will rule an expedited manner? Or do we just have to wait and see?
Julia Sloat: Yes. So the next gating item for us is March 31. That ends the commentary period, and we'll just proceed from there. We know the other backdrop for us or backstop for us, as I mentioned in my comments, is the April 26 date. So that's top of mind for us as well. But here's where I continue to go in my mind. None of the benefits yet to the customer until we close the transaction. They don't start in advance. So that's incredibly important. And I think we've got everyone's attention. And Bill, the other thing that we were particularly sensitive to, and I know Darcy has probably shared this with you, if you've called in, in the interim here, but we really made an effort to take the FERC blueprint to make sure that we were accommodating or addressing the concerns that FERC voiced as it relates to taking care of customers and making sure there's no harm. And as a matter of fact, if you at the application. I think we go in pre through the new 203 application in pretty granular form. I think it's Pages 4, 5 and 6. Clearly, I've read this a few times. Take a look at that if you want to get a better sense of what the parties have come up with to be able to take care of the customers in the state of Kentucky and specifically Kentucky Power's footprint. So I think everybody is going to be working on an expedited basis and schedule. And clearly, we very much appreciated the shortened comment period because I do think it's indicative. So we'll continue to work through it and rest assured that both the AEP and Algonquin team members will continue to be in regular contact with one another because at this point, we're partners in all of this.
Unidentified Analyst: Okay. No, that's very helpful. And then I guess, what happens if we get to the April 26 date, and we don't have a decision from FERC. Can that be extended or...
Julia Sloat: Excellent question, excellent question. And here's how we can answer that for you. I mentioned that the teams are in constant contact and regular contact. I would expect that if we get closer to that date, that the teams will be talking specifically about this. So stay tuned.
Operator: And next, we'll go to Durgesh Chopra with Evercore. .
Durgesh Chopra: Just first, a quick clarification. The -- I think you mentioned $0.08 for the renewables business EPS. That's just half year, right? So that's what's embedded in the guidance and the full year earnings are double that to $0.16, right?
Ann Kelly: No, $0.08 is last year. So the 2022 EPS from renewables, as we mentioned, for 2023, we expect that to be $0.01.
Durgesh Chopra: Got it. So that's the full year contribution for 2022?
Julia Sloat: That's correct. Yes, $0.08 for 2022, $0.01 for 2023. And so the way I would characterize it, and I think this is how we had the press release neutral to maybe slightly dilutive to the tune of $0.01. So from my chair, I'm not worried about it.
Durgesh Chopra: Got it. Okay. And then just, again, I want to go back to the sort of the financing slide. Can you just updated thoughts on use of proceeds here. Clearly, the renewable sale is on track and get $1.2 billion in cash. So how should we think about use of proceeds? Should that at least eliminate equity for 2024?
Julia Sloat: Yes. So do you want to take that?
Ann Kelly: No. Right now, we are not going to reduce any equity in the outer years. But as Julie mentioned, once we close the Kentucky transaction, the renewables transaction, we're going to we reevaluate and see whether or not we can responsibly take out equity in the future while keeping in mind and having a strong balance sheet.
Operator: And next, we can go to Paul Fremont with Ladenburg.
Unidentified Analyst: Great. So I guess the first question, right now, the sales proceeds from the 2 transactions actually are in excess of the equity that you had identified last year. So we should assume though that the sales proceeds don't eliminate your equity need, they just reduce it. Is that a fair characterization?
Julia Sloat: I think that's a fair characterization. And just as a reminder because Ann wasn't here when we made these announcements last year. But Paul, you may remember, we took out of the 2022 plan -- the 2022 plan, $1.4 billion of equity because we assume that the Kentucky transaction would have closed. We never put that equity back in. And so right now, we're just kind of waiting to have that particular transaction close. And then we introduced the contracted renewables transaction on top of that. So what you see today is versus what we originally had planned, we had already stripped out $1.4 billion of equity. So that's already assumed in this plan versus what we originally had when we announced Kentucky. And so as Ann mentioned, what you should anticipate is we've already assumed all the process both of these transactions are assumed in the multiyear forecast you have on Page 39. And that once we close on both of them, we like cash. We like cash coming in the door. So once we close on those, we'll be able to recalibrate to make sure we're doing -- hitting 2 objectives: number one, make sure that we're getting to that 15% -- 14% to 15% FFO-to-debt and then being able to tweak, meaning otherwise translation reduce any of those equity needs in those future periods. So don't anticipate us just piping all of that out because we've already assumed the Kentucky utilization was in there, but we may have some wiggle room here to take some additional dollars out in terms of equity once we close on the transaction. And so no hidden message there. We're just wait until we have the dollars, and we'll be right back to you to be able to take some of those equity needs out assuming we can get the metrics that we need to hit from an FFO-to-debt perspective, and I think we can do it.
Unidentified Analyst: Great. And then moving to Virginia. You guys -- or there's a bill, I think that's under duration SB 1075, would you expect that to survive, come out of conference and ultimately be adopted? Or I guess, what's your thought process on what will happen in Virginia?
Julia Sloat: Yes. So here's what I have. I have that SB 1075 was amended in the house and then we -- it was transitioned to a biennial. And then we're continuing to work with our legislators and the governors to reach some consensus on the language. And if this does pass, what you should anticipate is that AEP or APCo would file its last triennial in 2023, and that would cover the period through 2022. So we'll see if we can get this across the goal line. I know we've got some other competing bills or legislation that is being proposed as well, also looks like a biennial situation.
Unidentified Analyst: Great. And can you break out for 2022, just the contribution from generation?
Julia Sloat: From all of our generating assets or the generation market...
Unidentified Analyst: In the G&M section, so the merchant -- in other words, the merchant generation contribution in 2022.
Julia Sloat: Yes. I can give you the renewable part, that was $0.08. I have that off the top of my head. I can give you the -- so I'm going to work it a little bit backwards. I give you the retail piece of the business, and that's not the generation component. So that was $0.05. So then you've got, what, $0.13 there of the total earned. We can circle back with you, Paul, and get you that number, though. That would be no problem.
Unidentified Analyst: That would be great. And maybe the last question for me. the income tax changes and other and corporate and other, can you maybe give a little flavor as to what drove those?
Julia Sloat: Hang on one second here. We're kind of running through my notes because I don't have that in front of me.
Ann Kelly: Yes. So the income tax, there's a little bit of geography here with respect to the parent company loss that's driving that impact. And then -- the other is just a lot of very small items that are loan together.
Operator: And with no further questions in queue, I'll hand the call back over to Darcy Reese.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Brad, would you please give the replay information.
Operator: Certainly. Thank you. Ladies and gentlemen, this conference will be available for replay after 11:30 Eastern today and running through March 3 at midnight. You can access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code 3625886. International parties may dial 402-970-0847 with the access code 3625886. That does conclude our call for today. Thanks for your participation and for using the AT&T teleconference. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Welcome to the American Electric Power Fourth Quarter 2022 Earnings Call. [Operator Instructions]. I would now like to turn the call over to our host Ms. Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Brad. Good morning everyone and welcome to the Fourth Quarter 2022 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release presentation slides and related financial information are available on our website at aep.com Today we will be making forward looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discuss of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Anne Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie."
},
{
"speaker": "Julia Sloat",
"text": "Thanks, Darcy. Welcome, everyone, to American Electric Power's Fourth Quarter 2022 Earnings Call. I'm happy to be here with all of you this morning, and I'm pleased to be joined by our recently appointed CFO, Ann Kelly, who joined our team in late November. So here we go. We're making great progress and have a lot to share with you today, starting with the financial performance of our fourth quarter and year. I'll provide update on our Kentucky operations sale, unregulated renewable sale and retail business strategic review. I'll also provide insight into the regulatory and legislative front, as we work to implement important new initiatives to ensure our customers and communities needs, which are met in turn, and drives our high-quality investment proposition. Finally, I'll include an update -- or I'll conclude with an update on our generation fleet transformation as we continue to invest in regulated renewables and our energy delivery infrastructure, a summary of 2022 highlights and our focus for 2023 can be found on Slides 6 and 7 of today's presentation. As you know, we have a long history of consistently delivering and exceeding our earnings guidance and 2022 is no exception. I'm very proud of the dedication and accomplishments of the entire AEP team over the past year. While we finished the year strong, I can promise you, we're just getting started. Our robust financial plan continues to yield results. We delivered strong fourth quarter 2022 operating earnings of $1.05 per share bringing our full year 2022 operating earnings to $5.09 per share. We're also -- we also increased our quarterly dividend from $0.78 to $0.83 per share, which we announced back in October. AEP's teamwork-driven performance in 2022 has established a strong foundation from which we can reaffirm our 2023 full year operating earnings guidance range of $5.19 to $5.39, all while mitigating inflationary cost pressures, supply chain pressures and higher interest rates as well as constructively navigating regulatory and legislative frameworks. Formula rates in several of our state jurisdictions and in our high-growth transmission business help us to manage increased interest expense and higher costs. Importantly, as we keep customer affordability top of mind, we are actively working with our states on the economic development front to drive expansion in our service territory, and we are incorporating efficiencies and expense containment into our rate recovery filings to continue to help offset the impact of increased cost pressures. As a matter of fact, the economic development efforts over the past several years are proving to be appreciably beneficial, and we'll talk about normalized load in a few minutes. But to illustrate my point, I can tell you that normalized industrial sales were up 4.5%, largely as a result of those efforts, not to mention the added benefit of attracting jobs, residents and other cascading upside to our communities, all of which helps to manage customer rates given the bigger denominator. We value our stakeholder relationships, and we made steady progress on the regulatory front over the past year, including achieving constructive base rate outcomes in Arkansas and SWEPCO Texas and a favorable Supreme Court appeal related to Virginia's last rate case and the securitization of Winter Storm Uri costs in Oklahoma. Our resulting earned regulated ROE as of December 31 was 9.1%, which suggests we still have work to do on this front, and I'll talk about our regulatory activity that we have underway to address this. So hang with me for a few minutes, and I'll get there. AEP is leading the transition to a clean energy economy as we engage in one of the largest generation fleet transformations in our industry, in 2022, our 1.5 gigawatt North Central wind portfolio became fully operational with the completion of the Traverse wind farm project, which marked the beginning of our clean energy fleet transition. We'll continue to execute on our fleet transformation strategy with the opportunity to add approximately 17 gigawatts of new generation resources between 2023 and 2032, while mitigating fuel cost volatility and creating a more diverse resource portfolio to benefit our customers. This will significantly contribute to AEP's reduced carbon emissions profile and put us on a path to achieve our upgraded net zero goal by 2045. Importantly, the recent passage of the Inflation Reduction Act provides support for our clean energy goals, and this will extend our investment runway as we continue to address the needs of our generation fleet. Since assuming the role of President and now CEO, I prioritize simplifying and derisking our business profile, which has become a core standard by which we evaluate our business activity. By actively managing our portfolio and demonstrating a clear commitment to the successful execution of initiatives and transactions, we continue to deliver significant benefits to our stakeholders. As you are very much aware, we are working diligently to complete the sale of our Kentucky operations to Liberty. You can find the related regulatory time line on Slide 8 in the presentation today. As an update, AEP and Liberty followed the blueprint provided by the FERC order and filed a new FERC 203 application on February 14 of this year, requesting a shortened comment period and expedited approval to meet the contractual April 26, 2023 transaction close date. Immediately after the filing was made, FERC issued a notice incorporating a shortened 45-day comment deadline related to the application. The shortened comment period is a good sign signaling the commission is open to considering our application on an accelerated basis. AEP and Algonquin are in regular communication discussing various aspects of the transaction, the path forward and our partnership. We're mindful of the April 26 date in the stock purchase agreement and are cognizant of the tight time frame given the March 31 comment period deadline. The objective of both AEP and Algonquin remains clear, and that's to close the transaction. And both parties are firmly committed to moving forward and bringing forth the benefits of this transaction to customers. Related to our unregulated contract renewables portfolio, after strong buyer interest, we're pleased with our announcement made yesterday for the sale of our 1,365 megawatt portfolio to IRG Acquisition Holdings, which is a partnership owned by Invenergy, CDPQ and funds managed by Blackstone infrastructure. A summary of the sale can be seen on Slide 9 of the presentation today. We're currently targeting a second quarter 2023 close. The utilization of the proceeds from the sale is now reflected in our updated multiyear financing plan on Slide 39, and the transaction proceeds will be directed to support our regulated businesses as we enhance the energy delivery infrastructure and transform our generation fleet. Our near-term focus remains closing on our 2 pending sale transactions Kentucky and our unregulated renewables. Once both of these transactions are complete, we plan to revisit the equity needs in our current multiyear financing plan. As we've been clear in the past we will use the asset sales to responsibly eliminate equity while maintaining a strong balance sheet, no change in messaging on this. And that's important that I reiterate that. No change in the messaging. Finally, in October 2022, we announced the strategic review of our retail business. We're looking at this business to determine how or if it fits with the current AP portfolio and we'll keep you updated on our progress. We're expecting to complete the strategic review in the first half of 2023. Let me touch on our regulatory and legislative initiatives that we have underway. We remain focused on reducing our authorized versus actual ROE gap. As I mentioned earlier, our 2022 earned regulated was ?ROE 9.1% and -- our 2023 earnings guidance range assumes a 9.4% earned ROE, and we are already making progress in that direction. In January, we reached the settlement and gain commission approval for our Louisiana base case, which allows us to reestablish a formula rate plan -- as we advance through the year, the team will be active in completing our current base case in Oklahoma and rider recovery of the 88 megawatts of the Turk plant, which is not currently in Arkansas rates. We also filed an electric security plan in Ohio, which will take us into 2024. Let me shift gears and provide you with an update on our deferred fuel recovery efforts that are currently underway. As we've previously shared with you over the past several months, we have made adjustments to our traditional cost recovery methods in a number of our states to allow for recovery while spreading the cost out for our customers to make them more affordable. In West Virginia, we continue to pursue approval of the pass-through of fuel costs under the fuel clause. We also intend to propose an alternative path to recovery of these costs under proposed legislation, if Approved, that would allow us to securitize these costs and minimize customer impact. The West Virginia Commission recently instructed its staff to finish its prudence review of the 2021 and 2022 fuel costs. The state legislature continues to move the securitization legislation forward with the Commission Chair recently testifying in support before the lawmakers. I'll conclude my remarks with an update on our regulated renewables strategy and execution. Our capacity needs continue to drive us forward on the regulated renewables front, and we continue to work with our regulators, policymakers and other key stakeholders to ensure a durable and sustainable transmission -- transition to a clean energy economy in our vertically integrated state. The recently enacted Inflation Reduction Act will help us advance our goals in this area and will provide additional value to our customers as we seek to acquire resources consistent with our plan. We've made considerable progress on SWEPCO's 999-megawatt renewables application, which represents a $2.2 billion investment for AEP. Parties filed a unanimous settlement in Arkansas on January 27 and for a portfolio of owned wind and solar resources. A hearing was held in Texas in January, and we continue to have constructive settlement dialogue with parties in Louisiana, and the hearing date has been formally extended to March 21 to accommodate this. We look forward to receiving the commission's orders, which are expected in the second quarter of 2023 on Louisiana and the third quarter of 2023 for Texas. In November of 2022, PSO made a regulatory filing in Oklahoma to own 995.5 megawatts of solar and wind projects representing a $2.5 billion investment. A procedural schedule was issued last month which includes a hearing date in April and an expected commission order in the third quarter of this year. Separately, we're also seeking to acquire the 154-megawatt [indiscernible] wind facility in Oklahoma from EDF. FERC approved this acquisition on February 16, and we're pursuing rate recovery of this investment through the ongoing PSO base rate case. The project is already in service and will provide immediate capacity for PSO's customers. Our regulated renewables goals are aligned and supported by our integrated resources plans. In accordance with those plans, we issued request for proposal in 2022 for wind, solar and other resources at APCo, INM and once again at SWEPCO. We anticipate making the related regulatory funds to acquire additional resources under these RFPs throughout 2023. We continue to see rapid changes in our industry and increasing need and demand from customers and communities across the United States. At the end of 2022, as I prepared to assume my new position at AEP, the team and I dedicated a considerable amount of time and energy to determining how AEP would continue to deliver safe, clean, affordable and reliable energy and how we could deliver this energy faster and more efficiently to our customers while generating enhanced value to our stakeholders. Our long-term earnings growth rate of 6% to 7% is underpinned by a robust $40 billion capital investment plan for 2023 through 2027, which includes $15 billion in transmission and $9 billion in regulated renewables investments. As evidenced by our fourth quarter and full year 2022 performance AEP has had a long-standing track record of consistently delivering on our strategic objectives, our transformation strategy is working and the investments we're making continue to support our positive earnings growth and results. Now please join me in welcoming Ann to her first AEP earnings call. I'll leave you in her very capable hands as she provides insight and perspective into our performance drivers for 2022 and the details supporting our financial targets. Ann?"
},
{
"speaker": "Ann Kelly",
"text": "Thank you, Julia and Darcy. It's great to be with you all this morning and thanks for dialing in. I'll walk us through our fourth quarter and full year results, share some updates on our service territory load and our outlook for 2023 and finish with commentary on credit metrics and liquidity as well as some thoughts on our guidance, financial targets and portfolio management. So let's go to Slide 10, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. As Julie mentioned, we had a strong operating results in both the fourth quarter and for the full year. GAAP earnings for the fourth quarter were $0.75 per share compared to $1.07 per share in 2021. GAAP earnings for the year were $4.51 per share compared to $4.97 per share in 2021. For the quarter, I'll mention that we have reflected additional charges related to the expected sale of Kentucky Power and Kentucky Transco as nonoperating costs. This is largely a result of the delay in the closing from the need to file a new 203 application with the FERC. There are detailed reconciliations of GAAP to operating earnings on Pages 18 and 19 of the presentation today. Today, I'm going to focus more on our full year results, but I did want to provide a few highlights on the fourth quarter as we show on Slide 11. Operating earnings for the fourth quarter totaled $1.05 per share compared to $0.98 per share in 2021. This is a $0.07 or 7% increase year-over-year. While we had a lot of puts and takes, our vertically integrated and T&D utility segments continued to perform well, resulting from rate changes, transmission revenue and some favorable weather. We did see a $0.03 decline in our normalized retail margin, but that was due to a change in sales mix as low as favorable for the quarter. I'll discuss load in more detail in a couple of minutes. We were also able to support an increase in our O&M expenses as a result of the strong earnings that we were seeing. Transmission Holdco was favorable by $0.03, even after factoring in the loss the Ohio RTO adder as we continue to see the benefits of our investments. Generation and Marketing produced $0.16 per share, up $0.10 from last year, driven by increased retail energy margins and favorable generation performance, primarily driven by fewer average days year-over-year. And finally, Corporate and Other was down $0.05 per share driven by increased interest expense and investment losses, partially offset by favorable income taxes. Now let's have a look at our year-to-date results on Slide 12. Operating earnings for 2022 totaled $1.09 per share compared to $4.74 per share in 2021. This was an increase of $0.35 per share or 7%. Looking at the drivers by segment. Operating earnings for vertically integrated utilities were $2.56 per share, up $0.30. Due to rate changes across various operating companies, favorable weather, increased transmission revenue and also increase normalized load. Offsetting these favorable variances were higher O&M, increased depreciation expense and increased interest expense. Once again, the change in accounting around the Rockport Unit 2 lease results in $0.23 of favorable O&M offset by $0.23 of unfavorable depreciation. In the Transmission & Distribution Utilities segment, earned $1.16 per share, up $0.06 from last year. Favorable drivers in this segment included rate changes in Texas and Ohio, favorable weather and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. With the favorable weather and other items that we experienced in 2022, we were able to responsibly deploy additional O&M in both utility segments to spend on items like increased vegetation management to improve system reliability. The AEP Transmission Holdco segment contributed $1.32 per share, down $0.03 from last year. Favorable investment growth of $0.12 was more than offset by an unaffared true-up of $0.04, the loss of the RTO adder in Ohio and increased income taxes. Remember, our 2022 guidance had this segment down by $0.08 year-over-year as a result of the investment growth being more than offset by the annual true-up to some unfavorable comparisons for taxes and interest. Generation and Marketing produced $0.50 per share, up $0.24 from last year. The positive variance here is primarily due to the sale of renewable development sites, improved generation performance in land sales in the generation business, improved retail margins and increased wholesale margins stemming from favorable market conditions. And finally, Corporate and Other was down $0.22 per share, driven by investment losses unfavorable interest in increased O&M, partly offset by lower income taxes. The investment losses continue to be impacted by the year-over-year comparisons for our ChargePoint investment that we exited in the third quarter. As we mentioned earlier, we are reaffirming our guidance range for 2023. For convenience, we've included an updated waterfall on our actual 2022 results to the midpoint of our guidance for 2023 on Slide 36. While the variances changed due to the 2022 actual results, there is no change to our 2023 segment or overall guidance. We are confident that our regulatory actions to provide timely returns on our distribution and renewable investments, continued investment in transmission assets, the impact of economic development efforts and prudent O&M management will offset headwinds such as rising interest rates and inflationary pressures. Now turning to Slide 13, I'll provide an update on our normalized load performance. Overall, 2022 was a remarkable year for normalized load growth across the AEP service territory. Despite the Federal Reserve's intentional actions to slow down the economy, AEP experienced its strongest weather-normalized load growth in over 15 years with 2.8% annual growth. The most impressive part is that this is experience on top of a recovery year. As a reminder, 2021 was the strongest year for AEP's normalized growth in over a decade until 2022. The growth in 2022 was spread across nearly every operating company in every major retail class. Starting in the lower right corner of the slide, normalized retail sales increased by 1.9% in the fourth quarter and ended the year up 2.8% compared to last year. For the quarter, the growth in commercial and industrial sales will more than offset the modest decline in residential sales. Looking forward, you will see that we are expecting growth of 7% to 10% in 2023. The story is changing somewhat to further remove away from the pandemic. In 2022, the boost from fiscal policy overwhelmed the Federal Reserve's efforts to constrain the economy through monetary policy. In 2023, we expect the fiscal boost to date given the congressional changes after the election, while the Fed's efforts to tame inflation remain in place. We expect this to result in a slight moderation of economic growth for the balance of this year. Moving to the upper left corner, Normalized residential sales decreased by 0.8% in the fourth quarter but finished the year slightly above 2021. For the quarter, residential customer counts increased by 0.4%, but this was offset by a 1.2% decline in weather normalized usage. This is not surprising when you consider the impact that higher inflation, energy costs and interest rates on customers' disposable income to end the year. You will notice that we now expect residential sales to decrease by 0.5% in 2023 for the same reason. Moving right, weather-normalized commercial increased by 5.4% for the quarter and ended the year up 4.2% compared to 2021. The growth in commercial sales was spread across nearly every operating company. fastest-growing commercial sectors, professional scientific and tech services that includes data centers, which -- where load was up nearly 30% compared to last year for both the quarter and the year-to-date comparisons. The outlook for 2023 is showing a modest 0.6% growth. While we do see momentum in this class driven by economic development, the sustained impact of the labor shortage inflation high interest rates and energy costs will act as a headwind in 2023. Finally, focusing on the lower left corner, you see the industrial sales growth moderated in the fourth quarter, up 1.5% and while the year ended 4.5% above 2021. Industrial sales increased at most operating companies in many of our largest sectors. We continue to experience robust growth in the oil and gas sectors, which were up 6% compared to the fourth quarter of 2021. Outside of oil and gas, which tends to run countercyclical to the rest of the economy, we did notice softer industrial sales growth consistent with many of the economic indicators. As you know, the ISM manufacturing index fell below 50 in the fourth quarter, which is a sign of an industrial contraction. The combination of sustained inflation, supply chain disruptions, increasing borrowing costs, strong dollar and elevated energy costs have formed significant challenges for domestic manufacturing. Fortunately, AEP's past economic development activities are providing an offset and are keeping AEP's industrial sales growth in positive territory. You see that the outlook is showing industrial sales growth of 2.1% in 2023, which is largely attributable to the consistent economic development activities from the past. I'll provide additional detail on the impact of these efforts in the next slide. To summarize, the AP service territory experienced a remarkable year for load growth in 2022 despite the inflationary pressures on wages and energy and a federal reserve that was intentionally trying to slow down the economy. We are finally seeing evidence that these measures are starting to have an impact, which will result in slower growth in 2023. Fortunately, AEP's disciplined commitment to economic development should keep our load growth in the black moving forward. For example, absent economic development, our loan growth would have been essentially flat in the fourth quarter and up 1.1% for the year. Turning to Slide 14, I want to highlight how our commitment to economic development is helping to sustain load growth even in the face of challenging economic conditions. The chart on this slide illustrates why the strategy is so important to us. The blue bars on this chart show the growth of gross regional product for the AEP service territory over the past year. You can see that it has been slowing over the period. And in fact, for the fourth quarter, growth in AEP's GRP was slightly negative compared to the fourth quarter of 2021. However, the green bars here show our industrial sales growth over the same period. You'll notice they have been resilient throughout 2022 without any help from GRP. A lot of the growth in industrial load that we are seeing today is a consequence of economic development projects from previous years. And our focus on economic development is not just about the additional load that we report to you on a quarterly basis. We are also focused on attracting employers to the service territory. We know that adding new loading customers are a key strategy to providing value to all customers. This allows us to continue to prioritize investments that will improve the customer experience while mitigating the rate impacts on our customer base. By making this a key component of our strategy, AEP is helping to mitigate the impact of the economic downturn on our customers, communities and shareholders. And AEP's economic development team has a proven track record of helping to bring these new customers to our service territory with an emphasis on jobs and load. In fact, the AEP service territories added over 141,000 jobs in 2022. Let's move on to Slide 15 to discuss the company's capitalization and liquidity position. Taking a look at the upper left quadrant on this page, you see our FFO-to-debt metric stands at 13.2%, which is a decrease of 1.3% from the prior quarter. The primary reason for this decrease is the impact on both FFO and short-term debt from a decrease in our mark-to-market collateral positions associated with the decline in natural gas and power prices. as well as a continued increase in our deferred fuel balances. We remain committed to our targeted FFO-to-debt range of 14% to 15%, and we plan to trend back into that range near the end of 2023 as we continue to work through the regulatory recovery process of our deferred fuel balances, which can drive some volatility in the metrics. You can see our liquidity summary on the lower left quadrant side. Our 5-year $4 billion bank revolver and 2-year $1 billion revolving credit facility support our liquidity position, which remains strong at $2.6 billion. The $1.1 billion change from last quarter is mainly due to an increase in commercial paper outstanding for the reasons I mentioned earlier. On a GAAP basis, our debt-to-capital ratio increased from the prior quarter by 1.5% to 62.9%. On the qualified pension front, our funding status remained strong, ending the quarter at 102.4%. While assets performed as expected during the quarter, the primary driver for the funded status decreased was due to an increase in the liability caused by changes in actuarial assumptions influenced by the rising interest rate environment in 2022. Now turning to Slide 16. I'll give a quick recap of today's message. First, we are focused on execution. The Kentucky transaction is back in front of the FERC and Liberty and AEP are committed to moving forward with this transaction. We just announced the agreement to sell our unregulated contract renewables portfolio and are working through the strategic review of the retail business. Each of these actions will help us to simplify and derisk our business. Even as we worked on these initiatives, we didn't take our eye off the ball of managing the business. We finished 2022 with solid earnings and made significant investments to support our customers even with the backdrop of supply chain challenges and inflationary pressures. We continue to be committed to our long-term growth rate of 6% to 7% and continued dividend growth and a strong balance sheet while derisking the company, focusing on the customer and actively managing the portfolio. We really appreciate your time and attention today. I'm going to ask Brad to open up the call so that we can answer any questions that you may have."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. And we'll first go to Shahriar Pourreza with Guggenheim Partners."
},
{
"speaker": "Shahriar Pourreza",
"text": "So a couple of quick ones here. Looking at just the West Virginia fuel cost recovery, hearings were obviously held in 4Q, and there was a discussion about moving to quarterly time periods as well as securitization. I guess, can you give us maybe an update on how you're looking at the situation where we might be headed from here? There's a lot of moving pieces I guess. So how is the dialogue going? And sort of any sense of bill impact ranges, especially with the recent gas price collapse?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. I still appreciate the question because shares, I'm sure you can imagine, it is absolutely top of mind for us. And as Ann mentioned in her comments, top of mind from a CFO perspective, most definitely. As you know, we did get an order. The staff is going through its paces as we had to work through the prudency review. And in the background, what's playing is a legislation that could potentially accommodate securitization of the dollars we have outstanding, our fuel balance in West Virginia $520 million -- so it's not insignificant and it's extremely important to be able to digest this in a way that can accommodate customer rates. So we're hoping that we'll be able to be in a position we'll be able to utilize the securitization legislation, if approved, to be able to smooth this out and take care of customer needs in terms of the bill in path. And I don't know, Ann, do you have any other thoughts on that, how we might do that?"
},
{
"speaker": "Ann Kelly",
"text": "Yes. No, it's absolutely right. I mean utilizing the securitization allows us to spread it out over time and minimize and actually keep our customer rates relatively flat, which is really the intention. Now this will take some time. It will be effective in June, and we need to commission the order. So we would expect the securitization to take place in the first half of 2024."
},
{
"speaker": "Shahriar Pourreza",
"text": "Got it. Okay. Perfect. And then just lastly, on the financing needs. Obviously, we've noticed that you now include both the $1.2 billion expected cash proceeds from Kentucky as well as I think for the first time, the expected $1.2 billion from the contracted renewable sale. I guess looking at the sources and uses, why wait to update your funding needs on the equity side, especially if you're including the proceeds already. Is there anything we should be thinking about here?"
},
{
"speaker": "Julia Sloat",
"text": "No hidden message there at all, Shahriar. We want to make sure that we get both of these transactions in the bag, get them taken care of and then we'll recalibrate. And as you know, our objective is twofold. We want to make sure we have a strong balance sheet because we don't want anybody worried about any dilutive otherwise actions that we would have to take. So that's first and foremost. So top of mind for us is making sure that balance sheet is in check. And as you know, we put out a target goal for FFO to debt of 14% to 15%. That being said, to the extent that we will then be able to eliminate future equity needs, we don't have a significant amount of equity financing when you look out over the horizon. But if we're able to kind of pull that back a little bit and still hit the objective on the strong balance sheet, we'll absolutely do that. So no hidden message. Obviously, both of these are moving along, contractor renewables new for us. We know that, that will close in the second quarter. We believe that's the plan to close in the second quarter. And as you know, Kentucky is pending with its 203 application. So stay tuned. We just want to make sure that we got this completely right for you all and that you're not concerned."
},
{
"speaker": "Operator",
"text": "And next, we'll go to Jeremy Tonet with JPMorgan. ."
},
{
"speaker": "Jeremy Tonet",
"text": "I just want to pivot towards the retail business a little bit. And if you could just peel back, I guess, a little bit how that process stands at this point. Just wondering, any thoughts that are be considered here of why that would remain in the portfolio, what might prevent you from selling it? I'm just wondering if you might be able to provide a little bit more color of what's in that business, EBITDA earnings or anything else to wrap our heads around there?"
},
{
"speaker": "Julia Sloat",
"text": "Yes, absolutely. And I love the question because that's exactly what we're doing in our house right now is going through the paces to determine exactly does it fit -- if there's anything that does fit, what does that look like? Stay tuned. That will be a first half story for AEP. So expect us to be coming to you probably in the second quarter with a little more granular detail because we're literally going through that analysis now and working with the troops to make sure we have that finally, too, so we can get back out to you. As far as quantifying how big is this business and what does it mean currently to AEP, the net asset position or, I guess, equity position, if you strip out the liabilities, we're talking about $193 million -- the vast majority of that is working capital to the tune of about $150 million of the $193 million, and the rest is largely IT software, and then we have a little smidge of goodwill in there of about $1 million to give you some parameters. And then another thing that I would think about is what does that mean from an EPS perspective, in 2022, this retail business contributed $0.05 of EPS. And in 2023, we have $0.04 embedded in our guidance to give you that goalpost to. Hopefully, that helps."
},
{
"speaker": "Jeremy Tonet",
"text": "That's very helpful. And just going back to the renewables sale here. Was there an EBITDA number that you might be able to share with us or have shared on that?"
},
{
"speaker": "Julia Sloat",
"text": "We haven't disclosed an EBITDA number. I can tell you that in our guidance for 2023, we're looking at $0.01 that renewable business contributed, I think it was $0.08. Does that sound right, Ann? $0.08, yes?"
},
{
"speaker": "Ann Kelly",
"text": "$0.08, yes."
},
{
"speaker": "Julia Sloat",
"text": "$0.08 in 2022 to give you those parameters."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. And just one last one, if I could. Touching on what Shahriar was talking about with the fuel business what have you. And I guess if moving pieces here, getting back to what the agencies are looking at, how should we think about the cadence of fuel balance normalizing any other items as we get to the 14% to 15% FFO debt target range by year-end '23, I think?"
},
{
"speaker": "Julia Sloat",
"text": "That's right. We expect to get our -- up to the -- get the ball between the uprates in the last part of the year. We do expect to have a little bit of pressure on the front end as we continue to work through some of the fuel balances. As I mentioned, when you look at West Virginia stand-alone, it's about $520 million. Does that sound right, Ann?"
},
{
"speaker": "Ann Kelly",
"text": "Yes, $520 million. And as I mentioned, the securitization of that will take some time. So likely won't be done by the end of this year. But -- in terms of our other fuel balances in other jurisdictions, we have positive mechanisms to recover that. And also natural gas rates and power prices are declining, so that will help somewhat as well."
},
{
"speaker": "Operator",
"text": "And next, we'll go to Steve Fleishman with Wolfe Research."
},
{
"speaker": "Steven Fleishman",
"text": "Yes. So just kind of similar -- similar question on the deferred fuel. If you just looked at the year-end number on FFO to debt, how much do you think deferred fuel represents in terms of impact that's lowering that number? Looking at FFO to debt?"
},
{
"speaker": "Julia Sloat",
"text": "So we're at 13.2% as of year-end. And so if we get above that 14%-ish range by year-end 2023, I don't know that looks about -- I don't say entirely 100 basis points, but it's pretty significant."
},
{
"speaker": "Ann Kelly",
"text": "Yes. I think it actually might be a little bit less than 100 basis when you think about it because we have $1.7 billion of deferred fuel at the end of the year."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. That's very helpful. And then just on the ROE improvement to the 9.4 in this year's guidance. Is it -- is there any states that are really driving a lot of that? Are there any states that they're still kind of the most room to go after '23?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. So here's where I'll draw your attention to. And I know we have the little equalizer chart here in the slide deck somewhere. I think it's on Page 41. And so you can get a sense of kind of where we are hanging out on each of the respective operating company entities. But what we do have in play right now is that at PSO, so Oklahoma, we have a base case underway. So that should help us to begin to heal the ROE, the earned ROE at PSO. So stay tuned for that. So base case in play there. And then as I mentioned in my opening remarks, we recently were able to finalize our Louisiana base case and then reactivate this formula rate plan. So that will get underway to, again, to help move SWEPCO's ROE back up closer to its authorized levels. Kentucky, obviously, you know what we're doing with Kentucky. And APCo, I think APCo, that's why the legislation in Virginia becomes so important to us. because we're in an under-earning position right now. We got the outcome of the Virginia triennial case, which should be beneficial to us in 2023, but I would still expect APCo's ROE to be under pressure until we get, hopefully, some resolution around Virginia legislation that to the extent that we're able to modify the regulatory recovery methods that are being employed in that particular state, we'll begin to see some healing on that particular ROE, too. So our triennial versus say a biennial, AEP is going to lead more toward a biennial or an annual type look versus necessarily that triennial because unfortunately kind of tracks us in an under-earning position, so stay tuned. We'll see how the Virginia legislation process moved along. Our team is absolutely at the table with all the other stakeholders. So that sounds constructive. So we're hopeful and we'll see this developing situation through and then we would expect something to be in the improvement territory for APCo."
},
{
"speaker": "Steven Fleishman",
"text": "Just for clarity on that last point in Virginia, why does -- what are things that would help you in the Virginia law, it go into the biannual so you don't have to go so far between cases or something else?"
},
{
"speaker": "Julia Sloat",
"text": "Anything shorter, Steve, is going to be better for us -- so that will move us in a more productive situation or direction for APCo in particular. I mean an annual rate trout would be fine, too. But again, you can see the direction. So that will be important for us as we work through the different solutions that are being contemplated now because I know we have, I think, 3 bills that are being evaluated or at least shopped in Virginia. But as I mentioned, AEP is absolutely at the table, and we'll see how this ultimately shakes out. Obviously, the benefit needs to go to the customers, but then also our investors as we work to improve the ROE."
},
{
"speaker": "Operator",
"text": "Next, we can go to Nick Campanella with Credit Suisse."
},
{
"speaker": "Nicholas Campanella",
"text": "I guess just very clear from the filings that have been made so far on the Kentucky transaction that the parties are committed here and you're working towards closing and what is somewhat of a tight deadline. Can you just kind of give us a sense how that changes, if your funding strategy changes at all if this deal weren't to go through and how that would overall kind of change your strategy if it went there."
},
{
"speaker": "Julia Sloat",
"text": "Yes. Nick, I still appreciate the question, and I'll let Ann jump in here in a second on what our thoughts are on funding. But I have before I do that, I have to say, we're committed to the transaction. I know you point that out. And I know we do have a tight time line. That's precisely why I threw that out there in my opening comments. The objective is to, I'll say, push for the tape because I know we've got that April 26 date. But importantly, I need you guys to have this takeaway both the AEP and the Algonquin team members continue to have a regular dialogue and work closely together. So we're all in and we'll continue to push to try to do this as expeditiously as possible. But I think we're also in a good position from a financing perspective. Ann, you want to talk a little bit..."
},
{
"speaker": "Ann Kelly",
"text": "Yes, absolutely. So I mean should Kentucky not close, we would expect to keep our equity needs the same. So no new equity if that happens. We'll just be managing our FFO to debt as tightly as possible and don't expect any changes."
},
{
"speaker": "Nicholas Campanella",
"text": "Okay. That's helpful. I appreciate that. And then I guess just I know we talked a lot about deferred fuel, but we noticed that the CFO is slightly depressed in '23 versus kind of what you outlined at the Analyst Day. And I think you're making up for that in the back part of the plan. But is that purely just deferred fuel impacts? Or is there something else fundamental there? That would helpful."
},
{
"speaker": "Ann Kelly",
"text": "Yes, there's really 2 main drivers. Deferred fuel is the biggest piece, but the other piece is we've had some return of collateral from a mark-to-market due to the reduction in natural gas and power prices that has impacted that as well."
},
{
"speaker": "Operator",
"text": "Next, we can go to Bill Appicelli with UBS."
},
{
"speaker": "Unidentified Analyst",
"text": "Just going back to the Kentucky sale. I know you said that FERC provided for a 45-day comment period so that was look like it was going to be supportive of maybe an expedited ruling. But will we get further indications from FERC, if they will rule an expedited manner? Or do we just have to wait and see?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. So the next gating item for us is March 31. That ends the commentary period, and we'll just proceed from there. We know the other backdrop for us or backstop for us, as I mentioned in my comments, is the April 26 date. So that's top of mind for us as well. But here's where I continue to go in my mind. None of the benefits yet to the customer until we close the transaction. They don't start in advance. So that's incredibly important. And I think we've got everyone's attention. And Bill, the other thing that we were particularly sensitive to, and I know Darcy has probably shared this with you, if you've called in, in the interim here, but we really made an effort to take the FERC blueprint to make sure that we were accommodating or addressing the concerns that FERC voiced as it relates to taking care of customers and making sure there's no harm. And as a matter of fact, if you at the application. I think we go in pre through the new 203 application in pretty granular form. I think it's Pages 4, 5 and 6. Clearly, I've read this a few times. Take a look at that if you want to get a better sense of what the parties have come up with to be able to take care of the customers in the state of Kentucky and specifically Kentucky Power's footprint. So I think everybody is going to be working on an expedited basis and schedule. And clearly, we very much appreciated the shortened comment period because I do think it's indicative. So we'll continue to work through it and rest assured that both the AEP and Algonquin team members will continue to be in regular contact with one another because at this point, we're partners in all of this."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. No, that's very helpful. And then I guess, what happens if we get to the April 26 date, and we don't have a decision from FERC. Can that be extended or..."
},
{
"speaker": "Julia Sloat",
"text": "Excellent question, excellent question. And here's how we can answer that for you. I mentioned that the teams are in constant contact and regular contact. I would expect that if we get closer to that date, that the teams will be talking specifically about this. So stay tuned."
},
{
"speaker": "Operator",
"text": "And next, we'll go to Durgesh Chopra with Evercore. ."
},
{
"speaker": "Durgesh Chopra",
"text": "Just first, a quick clarification. The -- I think you mentioned $0.08 for the renewables business EPS. That's just half year, right? So that's what's embedded in the guidance and the full year earnings are double that to $0.16, right?"
},
{
"speaker": "Ann Kelly",
"text": "No, $0.08 is last year. So the 2022 EPS from renewables, as we mentioned, for 2023, we expect that to be $0.01."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. So that's the full year contribution for 2022?"
},
{
"speaker": "Julia Sloat",
"text": "That's correct. Yes, $0.08 for 2022, $0.01 for 2023. And so the way I would characterize it, and I think this is how we had the press release neutral to maybe slightly dilutive to the tune of $0.01. So from my chair, I'm not worried about it."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Okay. And then just, again, I want to go back to the sort of the financing slide. Can you just updated thoughts on use of proceeds here. Clearly, the renewable sale is on track and get $1.2 billion in cash. So how should we think about use of proceeds? Should that at least eliminate equity for 2024?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. So do you want to take that?"
},
{
"speaker": "Ann Kelly",
"text": "No. Right now, we are not going to reduce any equity in the outer years. But as Julie mentioned, once we close the Kentucky transaction, the renewables transaction, we're going to we reevaluate and see whether or not we can responsibly take out equity in the future while keeping in mind and having a strong balance sheet."
},
{
"speaker": "Operator",
"text": "And next, we can go to Paul Fremont with Ladenburg."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. So I guess the first question, right now, the sales proceeds from the 2 transactions actually are in excess of the equity that you had identified last year. So we should assume though that the sales proceeds don't eliminate your equity need, they just reduce it. Is that a fair characterization?"
},
{
"speaker": "Julia Sloat",
"text": "I think that's a fair characterization. And just as a reminder because Ann wasn't here when we made these announcements last year. But Paul, you may remember, we took out of the 2022 plan -- the 2022 plan, $1.4 billion of equity because we assume that the Kentucky transaction would have closed. We never put that equity back in. And so right now, we're just kind of waiting to have that particular transaction close. And then we introduced the contracted renewables transaction on top of that. So what you see today is versus what we originally had planned, we had already stripped out $1.4 billion of equity. So that's already assumed in this plan versus what we originally had when we announced Kentucky. And so as Ann mentioned, what you should anticipate is we've already assumed all the process both of these transactions are assumed in the multiyear forecast you have on Page 39. And that once we close on both of them, we like cash. We like cash coming in the door. So once we close on those, we'll be able to recalibrate to make sure we're doing -- hitting 2 objectives: number one, make sure that we're getting to that 15% -- 14% to 15% FFO-to-debt and then being able to tweak, meaning otherwise translation reduce any of those equity needs in those future periods. So don't anticipate us just piping all of that out because we've already assumed the Kentucky utilization was in there, but we may have some wiggle room here to take some additional dollars out in terms of equity once we close on the transaction. And so no hidden message there. We're just wait until we have the dollars, and we'll be right back to you to be able to take some of those equity needs out assuming we can get the metrics that we need to hit from an FFO-to-debt perspective, and I think we can do it."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. And then moving to Virginia. You guys -- or there's a bill, I think that's under duration SB 1075, would you expect that to survive, come out of conference and ultimately be adopted? Or I guess, what's your thought process on what will happen in Virginia?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. So here's what I have. I have that SB 1075 was amended in the house and then we -- it was transitioned to a biennial. And then we're continuing to work with our legislators and the governors to reach some consensus on the language. And if this does pass, what you should anticipate is that AEP or APCo would file its last triennial in 2023, and that would cover the period through 2022. So we'll see if we can get this across the goal line. I know we've got some other competing bills or legislation that is being proposed as well, also looks like a biennial situation."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. And can you break out for 2022, just the contribution from generation?"
},
{
"speaker": "Julia Sloat",
"text": "From all of our generating assets or the generation market..."
},
{
"speaker": "Unidentified Analyst",
"text": "In the G&M section, so the merchant -- in other words, the merchant generation contribution in 2022."
},
{
"speaker": "Julia Sloat",
"text": "Yes. I can give you the renewable part, that was $0.08. I have that off the top of my head. I can give you the -- so I'm going to work it a little bit backwards. I give you the retail piece of the business, and that's not the generation component. So that was $0.05. So then you've got, what, $0.13 there of the total earned. We can circle back with you, Paul, and get you that number, though. That would be no problem."
},
{
"speaker": "Unidentified Analyst",
"text": "That would be great. And maybe the last question for me. the income tax changes and other and corporate and other, can you maybe give a little flavor as to what drove those?"
},
{
"speaker": "Julia Sloat",
"text": "Hang on one second here. We're kind of running through my notes because I don't have that in front of me."
},
{
"speaker": "Ann Kelly",
"text": "Yes. So the income tax, there's a little bit of geography here with respect to the parent company loss that's driving that impact. And then -- the other is just a lot of very small items that are loan together."
},
{
"speaker": "Operator",
"text": "And with no further questions in queue, I'll hand the call back over to Darcy Reese."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Brad, would you please give the replay information."
},
{
"speaker": "Operator",
"text": "Certainly. Thank you. Ladies and gentlemen, this conference will be available for replay after 11:30 Eastern today and running through March 3 at midnight. You can access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code 3625886. International parties may dial 402-970-0847 with the access code 3625886. That does conclude our call for today. Thanks for your participation and for using the AT&T teleconference. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 3 | 2,022 | 2022-10-27 09:00:00 | Operator: Ladies and Gentlemen, thank you for standing by and welcome to the American Electric Power Third Quarter 2022 Conference Call. At this time all participants are in listen-only mode. Later we will conduct a question and answer session. [Operator Instructions]. And as a reminder, your conference is being recorded. I would now like to turn the conference over to you host Vice President of Investor Relations Darcy Reese. Please go ahead.
Darcy Reese : Thank you, Louis. Good morning, everyone and welcome to the third quarter 2022 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release presentation slides and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chair, and Chief Executive Officer; and Julie Sloat, our President Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay, thanks, Darcy. Welcome everyone to American Electric Powers third quarter 2022 earnings call. We continue to make significant progress on our commitments, we have leveraged our scale, our financial strength, portfolio management and transition to a pure play regulated utility. Over the past 10 years, we've had a great record of consistently exceeding our earnings projections and raising guidance, with this quarter being no exception. Today I'll provide a brief recap of the key financial highlights for the quarter, followed by updates on our Kentucky sale process, our unregulated contracted renewables portfolio sale, and the previously announced strategic review of our retail business, all of which are part of our strategy to simplify and derisk our business profile. I will then spend time discussing our carbon emission reduction goals, in addition to our continued emphasis on regulated renewables execution, and generation fleet transformation. I'll conclude by providing insights into our other ongoing regulatory activities. All of this summarized information can be found on slide six and seven of today's presentation with supporting details in the appendix. So, after the financials, we continue to build on our momentum delivering strong third quarter 2022, operating earnings $1.62 per share or $831 million. Today, we are reaffirming our 2022 narrowed full year operating guidance range, as well as our newly introduced 2023 operating earnings guidance range, both of which we had announced at our recent Analyst Day. As a reminder, we are going -- are guiding to a 2022 range of $4.97 to $5.07, with an increased midpoint of $5.02 per share, and our 2023 guidance range is $5.19 to $5.31, with a $5.29 per share midpoint. Our long term earnings growth rate guidance of 6% to 7% is underpinned by a robust $40 billion capital investment plan for 2023 to 2027, which includes $26 billion in wires and $9 billion in regulated renewables investments. Moreover, our dividend growth is in line with our long-term growth rate and within our targeted payout ratio of 60% to 70%. We continue to derisk our platform and execute our strategy to ensure that we are best positioned for value creation in the face of global economic uncertainty and inflationary pressures. As part of this effort, we are continuing to work with states to drive reliability and resiliency in our service territory amidst customer bill considerations and other macroeconomic factors. In order to lessen the impact on our capital investment plan, we have also diversified our mix of suppliers, which has minimized customer and business supply chain disruptions to date. Later in today's call, Julie will walk through our third quarter performance drivers and share thoughts on the positive load outlook in our service territory as well as on our targeted 14% to 15% FFO to debt range. So now talking about some of the strategic reviews. True to our steadfast commitment to execution, we're in the final stretch to complete the sale of our Kentucky operations celebrity. As we previously mentioned, FERC told their approval date to December 16, and we have, therefore, signed with Liberty to plan for a January 2023 closing date. This date is keyed off of FERC's process and should give confidence to all stakeholders, including employees, customers, communities and shareholders. It also enables our transition teams to adequately and efficiently plan for the closing. While our sale time line has shifted over the past year, we are not revising our earnings guidance or any of our equity needs. We are pleased to reach this point and are confident in our ability to close the transaction shortly after the start of the new year. Related to our unregulated contracted renewals portfolio, we launched the sale process for this 1,365 megawatt portfolio in late August 2022 with strong buyer interest from both financial and strategic investors. We recently accepted bids for Phase 1 of the auction process and are proceeding into Phase II due diligence with selected bidders. We are on pace for closing for a closing date in the second quarter of 2023. Selling the portfolio will allow AEP to shift focus and rotate capital towards regulated businesses as we continue to transform our generation fleet and enhance transmission infrastructure. As we announced earlier this month on our Analyst Day, we are pursuing a strategic review of our retail business as we adjust to how our interest in the competitive markets has changed over time. We'll keep you updated on our progress and expect to complete our review in the first half of 2023. We're always considering opportunities to enhance shareholder value, and we'll continue to evaluate potential value-additive opportunities for our regulated businesses against the backdrop of our goal to further simplify and derisk the business. Now regarding emission reduction goals, as we mentioned in the Analyst Day, AEP remains firmly grounded in our principles of resiliency, reliability and affordability, while recognizing the value of our diverse resource portfolio given today's world of energy-related volatility. We are undertaking one of the largest clean energy transformations in the country through our regulated renewable strategy, and we announced our enhanced and accelerated carbon emission reduction goals at our Analyst Day in early October, as I mentioned earlier. First, we have rebased our near-term emission reduction target of 80% by 2030 now pegged to a 2005 baseline instead of 2000. Second, we upgraded our near-term reduction target. And as such, all Scope one emissions are now included in our carbon emission reduction goals. Lastly, we accelerated our net zero goal by five years from 2050 to 2045. We are confident in our path forward and our ability to hit key milestones in a steady and timely manner. Importantly, these goals are aligned and supported by our latest integrated resource lands that are in the various states. We will continue our planned retirement and disposition of select fossil fuel units while adding renewables to our generation portfolio. Our 1.5-gigawatt North Central wind portfolio, which became fully operational in March of this year, represents only the beginning of our clean energy fleet transition. In addition, we have 17-gigawatts of potential generation additions across different resource types within our vertically-integrated utilities over the next 10 years. Combined, this represents 18.5-gigawatts of new generation, which will significantly contribute to AEP's reduced carbon emissions profile and put us on a path to achieve net zero -- our net zero goal by 2045. As an update, on October 19, related to SWEPCO's 999-megawatt renewables totaling $2.2 billion of investment, the Arkansas staff filed support of these resources subject to conditions. Commission orders are expected in 2023. As we look to the long term, we are committed to building a reliable and resilient grid to efficiently deliver clean energy to our customers, and we will continue to monitor new technologies that can help us close the gap to net zero, while maintaining the highly reliable and affordable delivery of energy that our customers expect. Moreover, newly passed provisions and the Inflation Reduction Act, which is foundational to our clean energy investment strategy should help bolster advancement of new carbon-free energy sources. The bill includes tax credits for technologies like clean hydrogen projection -- production and energy storage, in addition to the technology neutral tax credits for our carbon-free resources and we will continue to evaluate these resources through our integrated resource plans. With regard to our ongoing regulatory activities, our regulated ROE as of September 30, 2022, is 9.3% and continues to improve as we work through regulatory cases and continue to make strides in reducing our authorized versus actual ROE gap. In fact, as an update on SWEPCO on September 29, we filed notice to move the 88 megawatts of Turk Plant into rates in Arkansas. The full filing will occur within the November, December time frame, and we will seek a rider to place the 88-megawatt capacity in rates. With respect to our outstanding SWEPCO Louisiana rate case, we are expecting an order in the fourth quarter of 2022. We've also made notable progress on APCo's 2020 Virginia case. As many of you likely recall, we successfully appeal the triennial rate order the day following the issuance of the order in November 2020, giving confidence in our position that the order was inconsistent with Virginia statute. We are pleased that the court recently ruled in AEP's favor preserving our right to seek a retroactive adjustment in addition to the ongoing rate adjustment. Interim rates were implemented in Virginia on October First of this year. We've also actively managed the implications of increased fuel costs as we focus on maintaining a balance between cost recovery and customer impacts. As part of this effort, our operating companies continue to work with commissions, regulators and other stakeholders to educate customers about surges and put mechanisms in place to alleviate these pressures. For example, we have 6-month and 2-month clauses in I&M and SWEPCO Louisiana respectively, to help ease the effect of longer-term fuel classes. We also -- we were also able to lengthen the months of fuel recovery in Virginia and Oklahoma and are working with our customers and commissions to make sure we recover that over a longer period of time. As you all know, this will be my last earnings call as I will be transitioning from CEO to Executive Chair on January 1, and Julie will become CEO of AEP. We're very excited to have an executive of Julie's caliber to lead our company. I'm confident in her deep knowledge of AEP as well as the emphasis she places on consistency, quality of earnings and dividends and shareholder and customer value creation that will be instrumental to AEP's continued success. I'm also confident that she has the heart to be a strong leader. I'm reminded of the lyrics of Rush’s Closer to the Heart that I have always related to as a CEO, and it goes something like this. And the men and women who hold high places must be the ones who start to mold a new reality closer to the heart. The role of a CEO in the company, our communities and our country has changed during my tenure, Julie is the embodiment of the new CEO and will lead this company to even greater success. After 44 earnings call, my tenure will soon come to an end as CEO of this great company. So, I'll end this call with lyrics from a great Led Zeppelin song. And so today, my world at smiles. And song title is Merely Thank You. Julie?
Julie Sloat: Oh, my goodness, Nick. Thank you. Thank you. Well, yes, all heart and all in. Absolutely, absolutely. So, thanks, everyone, for joining us today. I know you have a real busy morning with multiple companies reporting. So, we'll try to be as efficient as possible. But I'm going to walk us through the third quarter year-to-date results, share some updates on our service territory load and economy and finish with commentary on credit metrics and liquidity, as well as some thoughts on our guidance, financial targets and recap our commitments to stakeholders. So, I'm going to start on Slide eight which shows the comparison of GAAP to operating earnings. GAAP earnings for the third quarter were $1.33 per share compared to $1.59 per share in 2021. GAAP earnings through September were $3.76 per share compared to $3.90 per share in 2021. For the quarter, I'd like to mention two reconciling items. First, there's a write-off of a Virginia regulatory asset associated with previously closed coal plants. This is a result of the Virginia Supreme Court opinion that affirmed the company's original write-down of those plants in 2019 and allowed APCo to increase its Virginia rates on a going-forward basis. The other reconciling item that I'd like to mention related to the sale of Kentucky Power. You'll recall that we announced on September 30, that we'd entered into an amendment to the stock purchase agreement with Liberty that among other items resulted in a reduced purchase price. We've reflected the additional loss on the expected sale of Kentucky Power and Kentucky Transco as a non-operating cost. There's a detailed reconciliation of GAAP to operating earnings on Pages 16 and 17 of the presentation today. Let's walk through our quarterly operating earnings performance by segment on Slide nine. Operating earnings for the third quarter totaled $1.62 per share compared to $1.43 per share in 2021. Operating earnings for the vertically-integrated utilities were $0.97 per share, up $0.10. Favorable drivers included rate changes across multiple jurisdictions, the impact of the Virginia Supreme Court ruling related to our APCo triennial review, which you'll see on the waterfall today is a $0.06 catch-up of the 2017 through 2019 under earnings, positive weather on our Western jurisdictions and increased transmission revenue. These items were somewhat offset by an increase in depreciation lower normalized load and increased income taxes. Just as a reminder on O&M and depreciation, as I mentioned on last quarter's call that included in our 2022 guidance details, we have a change in accounting related to the Rockport Unit 2 lease at I&M. We're seeing approximately $0.05 of favorable O&M offset by $0.05 of unfavorable depreciation in each quarter of 2022, but no consequential earnings impact. I'll talk a little bit more on load performance, but I'll get to that here in a minute. So, bear with me. The Transmission and Distribution Utilities segment earned $0.32 per share, up $0.01 compared to last year. Favorable drivers in this segment include rate changes and positive weather in Texas and Ohio and increased transmission revenue. Offsetting these favorable items were unfavorable O&M depreciation and income taxes. The AEP transmission Holdco segment contributed $0.33 per share flat compared to last year, favorable investment growth of $0.2 was somewhat offset by unfavorable income taxes. Generation and marketing produced $0.14 per share up $0.10 from last year. The positive variance is primarily due to higher retail margins, increased renewable wind production, higher market prices impacting generation margins and favorable income taxes. Finally, Corporate and Other was down $0.02 per share driven by unfavorable interest expense, mainly as a result of the increase in short-term debt rates and increased O&M partially offset by reduced investment losses. The reduced investment losses are largely related to charge point losses that we had in the third quarter of 2021, that have reversed this year. I'll note that we exited our position in charge point during the third quarter so a side from the year-over-year comparison, we will not have any new volatility in this particular aspect of corporate and the -- corporate and other segment relating to our direct ownership of charge point shares since the position has been liquidated. So, let's go to Slide 10, and I'll talk about our year-to-date operating earnings performance. Year-to-date operating earnings total to $4.04 per share compared to $3.76 per share in 2021. Operating earnings for vertically integrated utilities were $2.15 per share, up $0.28. Similar to the quarter, favorable drivers included rate changes across multiple jurisdictions, the resolution of the APCo triennial, positive weather in our western jurisdictions, increased transmission revenue and favorable normalized retail load. These items were somewhat offset by increased depreciation and lower off-system sales. Once again, the change in accounting around the Rockport Unit two lease results in $0.17 of favorable O&M offset by $0.17 of unfavorable depreciation. The Transmission and Distribution Utilities segment earned $0.95 per share, up $0.10 compared to last year. Favorable drivers in this segment included rate changes in Texas and Ohio, favorable weather and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M, property taxes and depreciation. The AEP Transmission Holdco segment contributed $0.95 per share, down $0.07 per share compared to last year. Favorable investment growth of $0. 06 was more than offset by an unfavorable true-up of $0.07 and increased income taxes. As I mentioned last quarter, this is entirely consistent with our guidance. Our 2022 guidance had this segment down by $0.08 year-over-year as a result of the investment growth being more than offset by the annual true-up that occurred last quarter and some unfavorable comparisons on the tax and financing side. Generation and Marketing produced $0.34 per share, up $0.14 from last year. The positive variance is primarily due to the sale of renewable development sites improved retail margins, increased wholesale margins and land sales in the depreciate generation segment. Finally, Corporate and other was down $0.17 per share, driven by lower investment gains, unfavorable interest and increased O&M. The lower investment gains are largely related to charge point gains that we had in 2021 that reversed this year. Turning to Slide 11. Let me provide an update on our normalized load performance for the quarter. Overall, AEP service territory has maintained significant momentum through the first three quarters of the year despite increasing headwinds impacting the macro economy. Starting in the lower right corner, normalized retail sales increased by 2.6% in the third quarter compared to last year. Once again, every operating company experienced positive year-over-year growth for the quarter. Furthermore, the growth in the commercial and industrial sales this quarter more than offset the modest decline in residential sales. For the year-to-date comparison, AEP's normalized retail sales increased by 3.1%, with growth spread across all major retail classes and operating companies. In fact, we're on pace to experience the strongest year for load growth since the mid-1990s. And that's on top of the recovery year we had last year when the load increased by 2.1%. Moving to the upper left corner, normalized residential sales decreased by 0.8% in the third quarter but remained up 0.3% through September compared to last year. For the quarter, residential accounts increased by 0.4%, but this was offset by a 1.2% decline in weather-normalized usage. This is not surprising when you consider that last year, many of our customers were receiving extra income from the fiscal stimulus that is not happening in 2022. While the results were mixed by operating company, the strongest residential growth for the quarter was at SWEPCO. Moving right, weather normalized commercial sales increased by 3.4% for the quarter and were up 3.8% for the year-to-date comparison. The growth in commercial sales was spread across nearly every operating company and eight of our top 10 commercial sectors. The fastest-growing commercial sector is data centers, where loads up 33% compared to last year for the quarter and for the year-to-date comparisons. Finally, focusing on the lower left corner, you'll see that the industrial sales posted another strong quarter, up 6% for the quarter and up 5.5% for the year-to-date comparison to last year. Industrial sales were up at nearly every operating company in most of our largest sectors. We continue to experience double-digit growth in a number of key industries this quarter, including chemicals, manufacturing and oil and gas extraction. We also saw robust growth in primary metals manufacturing, pipeline transportation, paper manufacturing and coal mining. To summarize, the AEP service territory has maintained significant momentum through the first nine months of the year despite the challenging headwinds of inflation, higher interest rates, supply chain disruptions and the labor shortage. We know the Federal Reserve's approach to address inflation is designed to slow down the economy, which will eventually work its way through our footprint. However, I'd like to remind you that there are things that we've done and will continue to do to help mitigate the impact of slowing economic conditions in our service territory specifically, we're talking about our economic development efforts. So, turning to Slide 12, I want to highlight how our commitment to economic development is helping to sustain load growth even in the face of challenging economic conditions. The chart on this slide illustrates why this strategy is so important to us. The blue bars on this chart show the growth in gross regional product or GRP, for the AEP service territory over the past year. So, you can see that it has been slowing over the period. In fact, for the third quarter, growth in AEP's GRP was essentially flat. However, the green bars here show that our industrial sales growth over the same period, you'll notice that they've maintained their strength, even improving 6% without the help from GRP. How does this happen? That's because of our consistent and disciplined approach to economic development over the years. A lot of the growth in industrial load that we're seeing today is a consequence of economic development projects from previous years that are coming online this year. Examples include a large steel plant and an LNG processing facility that are now online in the AEP Texas service territory, a new chemicals plant that is now operating in Tennessee or a paper plant that is now producing in Oklahoma. And these are just a few of the many examples that we could mention. But the key takeaway here is that AEP's commitment to economic development is what is allowing us to be on track to post our strongest year for load growth in decades despite an economy that is beginning to slow down. Another key point to remember is that you cannot turn it on or off like a light switch. Economic development projects take time to materialize, and the results that we see here today are largely the result of activities that occurred years ago. By making this a key component of our strategy, AEP is helping to mitigate the impact of economic downturns on our customers, our communities and our investors. And AEP's economic development team has a proven track record of helping bring these new customers to our service territory with an emphasis on jobs and load. In fact, the AEP service territory has added over 106,000 jobs this year. So, let's move down to Slide 13, to discuss the company's capitalization and liquidity position. We're doing well in this regard. On a GAAP basis, our debt-to-capital ratio held constant from the prior quarter at 61.4%. Taking a look at the left upper quadrant on this page, you'll see our FFO to debt metric stands at 14.5% on both the Moody's and a GAAP basis, which is an increase of 1.1% and 1.2%, respectively, the prior quarter. The primary reason for the increase is attributed to the completion of the PSO securitization efforts, which increased cash from operations. As we stated on our last earnings call, we anticipated trending toward our FFO debt targeted range of 14% to 15% as the year progressed, and we currently sit comfortably within that range. You can see our liquidity summer in the lower left quadrant on the slide, our 5-year $4 billion bank revolver and our 2-year $1 billion revolving credit facility to support our liquidity position, which remains strong at $3.6 billion. On the qualified pension front, while our funding status decreased 0.3% during the quarter, it remains comfortably strong at 105.3%. Negative returns on the risk seeking and fixed income assets during the quarter were primary drivers of the funded status decrease. However, rising interest rates cause plan liability to decrease, which provided a favorable offset to the negative asset returns. So, we're in a good place in terms of funding. Let's go to Slide 14, So I can do a quick recap of today's message. The third quarter continues to provide a solid foundation for the rest of 2022 and allowed us -- at our recent Analyst Day, in narrow and raise our operating earnings guidance range to $4.97 to $5.07 with a midpoint of $5.02. As you know, AEP offers steady and predictable growth driven by our low-risk regulated business, robust electric infrastructure investment pipeline and our proven track record of managing cost pressures over time while growing our rate base. This, along with the updated 2022 load forecast we provided at our October 4 Analyst Day and the Virginia Supreme Court ruling related to APCo's 2017 to 2019 triennial review, position us to navigate headwinds, remaining this year that you would expect, such as continued inflation, interest rates, weather risks, et cetera, which is why we maintained a $0.10 range when we recently lifted and tightened our 2022 guidance range. We continue to be committed to our long-term growth rate of 6% to 7%, continued dividend growth and a strong balance sheet while we are delisting the company, focusing on the customer and actively managing the portfolio. So, we really do appreciate your time and attention today and I know you guys are super busy with the all the earnings calls. So, with that, I'm going to kick it over to the operator, so we can hear what's on your mind and take your questions.
Operator: [Operator Instructions] Our first question is from Jeremy Tonet from JPMorgan. Please go ahead.
Jeremy Tonet: Good morning. I just wanted to pick up on one of the key themes at the Analyst Day talking about the transmission within AEP and the significant growth potential there as you see it and what appears to be a valuation disconnect with AEP stock relative to public comps and transactions. I'm just wondering if that conversation invited any reverse inquiries on your assets? I know you said these are core to you, but just kind of curious how that's developed and any other thoughts on that side you might share?
Nick Akins: Yes, I'll just follow up with the -- did I mention transmission. So I'll turn it over to Julie, who respond to that.
Julie Sloat: Thank you, Nick. Thanks, Jeremy. Thanks for the question. Let me tell you, we've certainly got a lot of attention from our investor base. And so I'll answer it that way. So we appreciate that because that means we're doing our jobs. I think we still need to do a lot of work here to make sure that we make it easy for you all to understand what the earnings stream is in the earnings potential of that particular business. And so as we were getting ready for this call today, I'm looking at the waterfalls on Pages 9 and 10 of the presentation today. And so let me go to Page 10 just for real quickly. So the AEP Transmission Holdco, which is our pure play transmission component contributed $0.95 of the $4.04 year-to-date. And as you know, we've got more transmission and play across this waterfall too, that shows up in the vertically integrated utilities in the T&D segment. So as a swag and we'll do better with this as we go into 2023 to give you a more granular view of the transmission component in the aggregate from AEP, but assume that roughly 50% of the earnings on the vertically integrated utilities and T&D utilities is essentially the part of the 95% -- or I'm sorry, adding $0.95 to another -- let me say it in another way, I'm totally tripping over myself here. $0.95 from the AEP Transmission Holdco, essentially double that. So that's about half. So half of our earnings are coming from that particular segment. The other half is coming from vertically integrated utilities and in T&D utilities. So not insignificant when you compare that just under $2 to the 404. So we'll do better, and I'll do better explain in the stuff as we go forward in 2023, but I wanted to have that number kind of in the back of my pocket here in case you asked the question, so I'm glad you did.
Nick Akins: But the overarching theme around transmission is that with -- certainly with the movement to clean energy economy, and the focus we have on renewables being put in place, you can't put these renewables in place without additional transmission, transmission, is becoming more constrained. So it turns out to be very positive from an AEP perspective from an opportunities to really focus on not only the development of transmission, which were the largest in the country but also in terms of the renewables build-out and in fact, distribution with distributed energy resources that will drive different resource needs as well. So all in good shape from that perspective. So we feel very, very bullish about our transmission.
Jeremy Tonet: Got it. That's helpful. And then just shifting gears a little bit. Rates moving up here. And so just wondering what you can say about that with regard to short-term rate moving higher and long-term debt issuance as being more expensive, just think about historic test years and lag in jurisdictions, wondering what could be done or how do you see that unfolding?
Nick Akins: Yes, Julie.
Julie Sloat: Yes. No, thanks again for the question. We're keeping a watchful eye on that. You're absolutely right. So let me kind of compare and contrast. The short-term debt rate that we were realizing last year through the first 9 months was about 27 basis points. Today, through the first 9 months, that was about 1.46%. So a significant uptick. And so what we'll be doing is continuing to manage across the different buckets of tenor and using kind of barbell strategies to do our financings going forward. We still have a little bit of work we have yet to do this year, and that's at the parent. I mentioned that at our Analyst Day back on October 4. And we're assuming that rates would adjust to on a longer-term basis to about 5% to 6% for us. That compares to through the year-to-date rate of about 3.34%. We will and do have that embedded in our 2023 guidance, but we'll continue to work with that. Let me give you another finer point to that what I pay attention to is how much of our debt is floating rate. We generally target somewhere between 15% and 20% of our total portfolio being floating rate. As of the end of the third quarter, we were at about 14.8%. About -- that equates to about the parent about $5. 7 billion, $1.95 billion of that being CP. So we've got a fair amount of fluctuation there, but that's already getting picked up in rates, and it's absolutely embedded in 2023 guidance. We'll have more for you to share and for your modeling efforts at the EEI conference when you get all the assumptions that we'll have behind the waterfall and details that you're typically used to seeing from us.
Operator: And the next question will come from the line of Durgesh Chopra -- I'm sorry, from Evercore ISI. Please go ahead.
Durgesh Chopra: Good morning. Congrats on a solid quarter here. I have two questions. The first one -- just maybe can you elaborate to the extent you can, you mentioned Phase 1 of the unregulated renewable sale. Just who are the interested parties here are the strategics are these privates? Or any -- any additional color you can share there?
Nick Akins: I would certainly say that the list was robust. And all the usual suspects that you would think of and beyond. But there were a lot. And I'd say it was still generally half and half, 60-40, whatever it was of strategics and others financials. And so -- and actually, the Phase 2, we're going into a list with strategics and financials and it's a well-balanced group. One that I'm sure will hold each other accountable during the process, but we're very happy with the responses we received.
Durgesh Chopra: Excellent. It sounds like you're making very good progress there.
Nick Akins: Yes. They'll go into the confidential rooms and all that kind of stuff and more due diligence will be done, and we'll go through the process with them. So that's just what the process is.
Julie Sloat: And Durgesh, this is Julie. We have a 2-step bid process, and we would expect to be in a position to have a PSA signed in early 2023. With the closing in the first half of next year. I think we shared that with you on October 4. And we get the question around who is the primary regulatory authority or body that will govern this, and that's FERC, as you know.
Durgesh Chopra: Got it. And then maybe just to pivot on to the second subpoena from SEC. Just how to read into that? What are the implications for you? I mean, does this increase the risk sort of potential?
Nick Akins: Yes. We view it as a continuing part of the process. And we said we would be transparent and we have been transparent and we'll continue to work in a positive fashion with the SEC during their investigation. And certainly, the issuance of a second subpoena is really -- they just need more information. So -- and we're going to supply it. So we're going to work with them and we'll continue doing so. So our response is essentially the same as the first one. We recognize there were governance issues we need to change relative to 501(c)4 and we made those changes. And certainly, from our perspective, we'll continue to work with them to get this thing resolved.
Operator: The next question is from Julien Dumoulin-Smith from Bank of America.
Julien Dumoulin-Smith: Good morning. Congrats, Nick, Absolutely. If I can pivot still on this -- if I can continue with the last question a little bit and can ask again about this second subpoena. Just what's your understanding of the process from here on out? Again, I get that they continue to inquire here. Just -- can you elaborate a little bit further here? Again, obviously, you're complying, you're submitting documentation, but just a little bit of the sense of what you get from here out.
Nick Akins: I mean there's not much else we can say about it, obviously, because it is a process with the SEC, and it's really up to the SEC what -- how they want to continue to analyze the information, ask for new information. And typically, I guess, whenever they need new information, they'll issue new subpoena. So it's just part of the process, and it's really up to the SEC. And our only -- I mean the only control we have is to continue to cooperate very positively and respond, and we'll continue to do that.
Julien Dumoulin-Smith: Excellent. Okay, perfect. And then if I can, just with respect to West Virginia, can you guys talk a little bit about the fuel situation there? I mean is there an ability to leverage securitization here to address the balance there? And just to what extent can that sort of fully address that balance?
Nick Akins: Yes, Julie?
Julie Sloat: Yes. No. Thanks for the question, Julien. And actually, as a matter of fact, that's exactly what we're contemplating. As you know, we've got a fair amount of exposure in excess of $400 million as of the end of the third quarter. of deferred fuel at West Virginia, in particular, we want to be very sensitive to customer bills. So the plan is to see what we can do around securitization of the outstanding balance and manage rates for customers. Right now, the current mechanism is we have a 12-month fuel cause to reset and account for the prior year. We're currently in hearing there, but we want to be extremely sensitive to our customer base as it relates to that particular area. So standby, we'll have more to tell you and more to share as we make some progress, but securitization is absolutely contemplated.
Julien Dumoulin-Smith: Got it right. So there's no qualification issues or needing to get clarification on legislation, right, that it should be directly applicable.
Nick Akins: That's right.
Julie Sloat: Yes. But we do need some clarification on the legislation because it's very specific to what you're trying to securitize. So that will be a critical path for us.
Julien Dumoulin-Smith: Okay. So we should look for that next in terms of getting this done?
Julie Sloat: Yes, yes, yes.
Operator: Your next question is from Ross Fowler from UBS. Please go ahead.
Ross Fowler: Good morning, Nick, good morning, Julie. How are you? Thank you for the quote. I very much appreciate that on this end of the phone, so.
Nick Akins: Good for you.
Ross Fowler: So I just had a couple of questions here. I was going to ask about this peanut, but we've kind of beaten that to death. But the retail strategic computing, that's going to happen within sort of the first half of next year. Are there other businesses that sort of fit into that same sort of potential strategic category? I'm thinking about wholesale services or distributed resources. Are they core to you? Or is that something we could see in the future?
Nick Akins: Yes. So obviously, we have 3 -- I guess, 3 of the normal 4 burners already loaded. One's Kentucky, one is the contracted renewables and then the retail after that. And we have to do really a strategic review around retail because it includes some of Ohio and that kind of thing. So we need to fully understand that. And we said that we would look at other parts of the business, if it fuels the growth that we're focused on relative to transmission and the movement to a clean energy economy. And so we'll continue to do that. I don't want to -- I really don't want to position business versus another at this point. But we'll continue to look at all of our business to make sure that we are being as efficient as possible to -- as Julie always says, actively manage the portfolio to ensure that we are moving forward from a growth perspective, but also from a derisking perspective, to ensure that we are spending our capital on the right things and O&M as well. So that's probably all I'll say at this point, and I'll leave it to Julie in the future to answer those questions.
Julie Sloat: Yes, yes. I would leave you with this thought. As it relates to on-site partners, which is our distributed energy solutions organization, and we have wholesale services as well when you look at the quadrants of our unregulated components of our total AEP business, I would submit to you that you should assume that they operate business as usual. Those are close to the customer. Those are things that we need to engage in to manage our day-to-day operations and we want to make sure that we're extracting all the intelligence we possibly can and taking care of the customer at the same time. But if there are things we can leverage to help us in the regulated envelope, we'll be doing that as well. So distributed energy solutions seems to scratch that itch. And we've gotten a lot of success and runway out of that. So business as usual. And we'll keep you apprised. Anything else that we put on deck like Nick said, we got all of our burners busy. You know what's on deck. But the point here is to get as efficient as we possibly can so that we can deliver the goods, take care of you, take care of our customer and then where we're good to go.
Ross Fowler: Right. Fantastically. And then just maybe one more around sort of the flexibility of your capital spend. As you kind of iterated at the Analyst Day, many times you win a lot of the capital is in transmission. We've seen some other companies maybe struggle to get transmission projects on schedule given the signing and permitting issues. Is that just a large-scale transmission project issue? And do you have sort of just a lot of smaller-scale stuff you can move around in that transmission and even in the distribution bucket?
Nick Akins: Yes. So obviously, we've had the same conversation relative to [indiscernible] in Congress. We -- our transmission of large block of our transmission is transmission within our service territory. And actually, the -- just basically the nuts and bolts of making sure that we have rehabilitation of the grid, replacement of old resources. We have some transmission lines. And I just -- every time we have our subcompany Board meeting, I always comment about these 100-year old lines that come up for replacement. And we're still in the process of doing that. We've talked a lot about the amount is the sheer magnitude of AEP's transmission system and the average age being 57 years old or some number like that. And the spend that we have ongoing now just increases by a year, every year it goes by like a 57 to 56 by spending $3 billion. So really -- we have not had issues with the construction of our transmission. Now if you do a new transmission with new large-scale transmission, that's where you really get into permitting and right-of-way issues. And that's really part of the permit legislation. And then when you cross over states, obviously, the cost allocation issues occur. So -- but by and large, almost all of our transmission is really related to transmission that either already exist or within our territory that we have. We certainly have the ability to move forward with. And we also have -- and this is probably more than you asked for, but from a transmission perspective, we've increased our planning associated with that. We used to do 120% of the capital plan. Now we do 130%. And we're also looking at distribution actually to do the same thing around 120%. So those are mechanisms where we continue to be able to use bottles, we continue to be able to adjust based upon different projects being either slowed down, sped up or whatever, and we continually adjust to that because we have thousands of projects to be able to work that through. So that really drives that element of consistency around our ability to provide capital for transmission and in fact, distribution.
Operator: [Operator Instructions] We will go to the line of Michael Lapides from Goldman Sachs.
Nick Akins: Looking for something from you, but go ahead.
Michael Lapides: Big weekend coming up Alabama LSU. We got 10 days. I hope that's not what you're looking for me from because you're going to get a big role tide at none of us go to Tiger's business. Hey, couple of questions. First of all, I love Slide 41. When I'm looking at Slide 41, Nick, it's a trailing 12-month earned ROE chart. Just curious, when I think about what's embedded in 2023 guidance, which of those get materially better in '23? Which of those face even a little bit more lag in '23 than they do right now?
Nick Akins: Yes. Julie?
Julie Sloat: Yes, yes. So Michael, what you should anticipate is movement on the PSO front. I mean we've got a little bit of momentum there. We've got the securitization taken care of now. We'll be making an application soon for a rate case. So anticipate that. We do expect over time that APCo is going to improve, too, particularly now that we've got the Virginia triennial behind us, and you're starting to see the fruits of that effort, already showing up in our waterfall slides. And then we've got activity, regulatory activity underway at SWEPCO 2. But we will give you more granular detail at the EEI conference on a company-by-company basis across the board. So stay tuned for that. But as you know, the entire objective is to move the needle and close the gap. And I would submit to you that that's how we describe another aspect of our active management. So we should be in good shape and moving in the right direction. Obviously, we're comfortable with the guidance we already put out there.
Michael Lapides: Got it. And then speaking of APCO and the court case in Virginia, and the $37 million pretax benefit you took this quarter, how should we think about that for 2023? I mean, is that just a nonrecurring onetime or should we smooth that out over 23 quarters? I'm just trying to think about how to actually model that.
Julie Sloat: Yes, yes. No, I love that question because fussing with that myself as we've got the good news. So yes, $0.06 that you saw in the third quarter, which is essentially like a catch-up from the under earnings from 2017 to 2019. So that's unique. So $0.06 this quarter. And I'll take it a step further. Let's go to the fourth quarter because you probably asked me about that, too. We should have about $0.01 of earnings associated with this particular outcome in the fourth quarter of 2022. So think about that when you're calibrating your model. And then for 2023, we'll have about $37 million of additional revenues from rate increases that effectively covers January of 2021 to September 2022 that in terms of what we should have been able to recognize, but we're spreading it over 16 months plus we have the going forward a benefit that starts October 2022. So what all does that mean? That means $0.06 spread across 2023, and that will be included in the waterfall guidance that we gave to you at EEI. So I hope that helps kind of in the word there for you.
Michael Lapides: That does help. And then finally, I last thing. Can you remind us what your cash tax position will be in the coming years?
Julie Sloat: Yes, cash tax gets really goofy with the BMT. So those numbers kind of floated all around, and we can always help you behind the scenes with modeling. But for cash tax in 2022, I want to say that the rate is something like 10.8% then go out to 2023. The way we're modeling it is just a little bit over 4%. But I would just direct you back to the GAAP annual effective tax rate. And so we're looking at the traditional 5.2% in 2022, and it pumps up a little bit to about 8.4% in 2023. And but we'll be able to give you more granular there, too, when we roll out all the backup to the 2023 guidance. Yes, the BMT -- it gets -- it almost looks geological when we're looking at some of the modeling -- I mean it works and it's accurate, but it just the rate kind of bounces all over the place from a cash perspective because you're using those tax credits.
Operator: And at this time there are no further questions in queue. Please continue.
Darcy Reese: Great. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Luis, please go ahead and give the replay information.
Operator: Thank you. And ladies and gentlemen, this conference will be available for replay beginning at 11:30 a.m. today and running through November 4 at midnight. You may access the AT& T replay system at any time by dialing 866-207-1041 and entering the access code 7723525. International callers can dial 402-970-0847. Again, the numbers are 1800- I'm sorry, 1866-207-1041 and 402-970-0847. Access code is 7723525. And that does conclude our conference for today. Thank you for your participation and for using AT&T conferencing service. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and Gentlemen, thank you for standing by and welcome to the American Electric Power Third Quarter 2022 Conference Call. At this time all participants are in listen-only mode. Later we will conduct a question and answer session. [Operator Instructions]. And as a reminder, your conference is being recorded. I would now like to turn the conference over to you host Vice President of Investor Relations Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Louis. Good morning, everyone and welcome to the third quarter 2022 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release presentation slides and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chair, and Chief Executive Officer; and Julie Sloat, our President Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay, thanks, Darcy. Welcome everyone to American Electric Powers third quarter 2022 earnings call. We continue to make significant progress on our commitments, we have leveraged our scale, our financial strength, portfolio management and transition to a pure play regulated utility. Over the past 10 years, we've had a great record of consistently exceeding our earnings projections and raising guidance, with this quarter being no exception. Today I'll provide a brief recap of the key financial highlights for the quarter, followed by updates on our Kentucky sale process, our unregulated contracted renewables portfolio sale, and the previously announced strategic review of our retail business, all of which are part of our strategy to simplify and derisk our business profile. I will then spend time discussing our carbon emission reduction goals, in addition to our continued emphasis on regulated renewables execution, and generation fleet transformation. I'll conclude by providing insights into our other ongoing regulatory activities. All of this summarized information can be found on slide six and seven of today's presentation with supporting details in the appendix. So, after the financials, we continue to build on our momentum delivering strong third quarter 2022, operating earnings $1.62 per share or $831 million. Today, we are reaffirming our 2022 narrowed full year operating guidance range, as well as our newly introduced 2023 operating earnings guidance range, both of which we had announced at our recent Analyst Day. As a reminder, we are going -- are guiding to a 2022 range of $4.97 to $5.07, with an increased midpoint of $5.02 per share, and our 2023 guidance range is $5.19 to $5.31, with a $5.29 per share midpoint. Our long term earnings growth rate guidance of 6% to 7% is underpinned by a robust $40 billion capital investment plan for 2023 to 2027, which includes $26 billion in wires and $9 billion in regulated renewables investments. Moreover, our dividend growth is in line with our long-term growth rate and within our targeted payout ratio of 60% to 70%. We continue to derisk our platform and execute our strategy to ensure that we are best positioned for value creation in the face of global economic uncertainty and inflationary pressures. As part of this effort, we are continuing to work with states to drive reliability and resiliency in our service territory amidst customer bill considerations and other macroeconomic factors. In order to lessen the impact on our capital investment plan, we have also diversified our mix of suppliers, which has minimized customer and business supply chain disruptions to date. Later in today's call, Julie will walk through our third quarter performance drivers and share thoughts on the positive load outlook in our service territory as well as on our targeted 14% to 15% FFO to debt range. So now talking about some of the strategic reviews. True to our steadfast commitment to execution, we're in the final stretch to complete the sale of our Kentucky operations celebrity. As we previously mentioned, FERC told their approval date to December 16, and we have, therefore, signed with Liberty to plan for a January 2023 closing date. This date is keyed off of FERC's process and should give confidence to all stakeholders, including employees, customers, communities and shareholders. It also enables our transition teams to adequately and efficiently plan for the closing. While our sale time line has shifted over the past year, we are not revising our earnings guidance or any of our equity needs. We are pleased to reach this point and are confident in our ability to close the transaction shortly after the start of the new year. Related to our unregulated contracted renewals portfolio, we launched the sale process for this 1,365 megawatt portfolio in late August 2022 with strong buyer interest from both financial and strategic investors. We recently accepted bids for Phase 1 of the auction process and are proceeding into Phase II due diligence with selected bidders. We are on pace for closing for a closing date in the second quarter of 2023. Selling the portfolio will allow AEP to shift focus and rotate capital towards regulated businesses as we continue to transform our generation fleet and enhance transmission infrastructure. As we announced earlier this month on our Analyst Day, we are pursuing a strategic review of our retail business as we adjust to how our interest in the competitive markets has changed over time. We'll keep you updated on our progress and expect to complete our review in the first half of 2023. We're always considering opportunities to enhance shareholder value, and we'll continue to evaluate potential value-additive opportunities for our regulated businesses against the backdrop of our goal to further simplify and derisk the business. Now regarding emission reduction goals, as we mentioned in the Analyst Day, AEP remains firmly grounded in our principles of resiliency, reliability and affordability, while recognizing the value of our diverse resource portfolio given today's world of energy-related volatility. We are undertaking one of the largest clean energy transformations in the country through our regulated renewable strategy, and we announced our enhanced and accelerated carbon emission reduction goals at our Analyst Day in early October, as I mentioned earlier. First, we have rebased our near-term emission reduction target of 80% by 2030 now pegged to a 2005 baseline instead of 2000. Second, we upgraded our near-term reduction target. And as such, all Scope one emissions are now included in our carbon emission reduction goals. Lastly, we accelerated our net zero goal by five years from 2050 to 2045. We are confident in our path forward and our ability to hit key milestones in a steady and timely manner. Importantly, these goals are aligned and supported by our latest integrated resource lands that are in the various states. We will continue our planned retirement and disposition of select fossil fuel units while adding renewables to our generation portfolio. Our 1.5-gigawatt North Central wind portfolio, which became fully operational in March of this year, represents only the beginning of our clean energy fleet transition. In addition, we have 17-gigawatts of potential generation additions across different resource types within our vertically-integrated utilities over the next 10 years. Combined, this represents 18.5-gigawatts of new generation, which will significantly contribute to AEP's reduced carbon emissions profile and put us on a path to achieve net zero -- our net zero goal by 2045. As an update, on October 19, related to SWEPCO's 999-megawatt renewables totaling $2.2 billion of investment, the Arkansas staff filed support of these resources subject to conditions. Commission orders are expected in 2023. As we look to the long term, we are committed to building a reliable and resilient grid to efficiently deliver clean energy to our customers, and we will continue to monitor new technologies that can help us close the gap to net zero, while maintaining the highly reliable and affordable delivery of energy that our customers expect. Moreover, newly passed provisions and the Inflation Reduction Act, which is foundational to our clean energy investment strategy should help bolster advancement of new carbon-free energy sources. The bill includes tax credits for technologies like clean hydrogen projection -- production and energy storage, in addition to the technology neutral tax credits for our carbon-free resources and we will continue to evaluate these resources through our integrated resource plans. With regard to our ongoing regulatory activities, our regulated ROE as of September 30, 2022, is 9.3% and continues to improve as we work through regulatory cases and continue to make strides in reducing our authorized versus actual ROE gap. In fact, as an update on SWEPCO on September 29, we filed notice to move the 88 megawatts of Turk Plant into rates in Arkansas. The full filing will occur within the November, December time frame, and we will seek a rider to place the 88-megawatt capacity in rates. With respect to our outstanding SWEPCO Louisiana rate case, we are expecting an order in the fourth quarter of 2022. We've also made notable progress on APCo's 2020 Virginia case. As many of you likely recall, we successfully appeal the triennial rate order the day following the issuance of the order in November 2020, giving confidence in our position that the order was inconsistent with Virginia statute. We are pleased that the court recently ruled in AEP's favor preserving our right to seek a retroactive adjustment in addition to the ongoing rate adjustment. Interim rates were implemented in Virginia on October First of this year. We've also actively managed the implications of increased fuel costs as we focus on maintaining a balance between cost recovery and customer impacts. As part of this effort, our operating companies continue to work with commissions, regulators and other stakeholders to educate customers about surges and put mechanisms in place to alleviate these pressures. For example, we have 6-month and 2-month clauses in I&M and SWEPCO Louisiana respectively, to help ease the effect of longer-term fuel classes. We also -- we were also able to lengthen the months of fuel recovery in Virginia and Oklahoma and are working with our customers and commissions to make sure we recover that over a longer period of time. As you all know, this will be my last earnings call as I will be transitioning from CEO to Executive Chair on January 1, and Julie will become CEO of AEP. We're very excited to have an executive of Julie's caliber to lead our company. I'm confident in her deep knowledge of AEP as well as the emphasis she places on consistency, quality of earnings and dividends and shareholder and customer value creation that will be instrumental to AEP's continued success. I'm also confident that she has the heart to be a strong leader. I'm reminded of the lyrics of Rush’s Closer to the Heart that I have always related to as a CEO, and it goes something like this. And the men and women who hold high places must be the ones who start to mold a new reality closer to the heart. The role of a CEO in the company, our communities and our country has changed during my tenure, Julie is the embodiment of the new CEO and will lead this company to even greater success. After 44 earnings call, my tenure will soon come to an end as CEO of this great company. So, I'll end this call with lyrics from a great Led Zeppelin song. And so today, my world at smiles. And song title is Merely Thank You. Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Oh, my goodness, Nick. Thank you. Thank you. Well, yes, all heart and all in. Absolutely, absolutely. So, thanks, everyone, for joining us today. I know you have a real busy morning with multiple companies reporting. So, we'll try to be as efficient as possible. But I'm going to walk us through the third quarter year-to-date results, share some updates on our service territory load and economy and finish with commentary on credit metrics and liquidity, as well as some thoughts on our guidance, financial targets and recap our commitments to stakeholders. So, I'm going to start on Slide eight which shows the comparison of GAAP to operating earnings. GAAP earnings for the third quarter were $1.33 per share compared to $1.59 per share in 2021. GAAP earnings through September were $3.76 per share compared to $3.90 per share in 2021. For the quarter, I'd like to mention two reconciling items. First, there's a write-off of a Virginia regulatory asset associated with previously closed coal plants. This is a result of the Virginia Supreme Court opinion that affirmed the company's original write-down of those plants in 2019 and allowed APCo to increase its Virginia rates on a going-forward basis. The other reconciling item that I'd like to mention related to the sale of Kentucky Power. You'll recall that we announced on September 30, that we'd entered into an amendment to the stock purchase agreement with Liberty that among other items resulted in a reduced purchase price. We've reflected the additional loss on the expected sale of Kentucky Power and Kentucky Transco as a non-operating cost. There's a detailed reconciliation of GAAP to operating earnings on Pages 16 and 17 of the presentation today. Let's walk through our quarterly operating earnings performance by segment on Slide nine. Operating earnings for the third quarter totaled $1.62 per share compared to $1.43 per share in 2021. Operating earnings for the vertically-integrated utilities were $0.97 per share, up $0.10. Favorable drivers included rate changes across multiple jurisdictions, the impact of the Virginia Supreme Court ruling related to our APCo triennial review, which you'll see on the waterfall today is a $0.06 catch-up of the 2017 through 2019 under earnings, positive weather on our Western jurisdictions and increased transmission revenue. These items were somewhat offset by an increase in depreciation lower normalized load and increased income taxes. Just as a reminder on O&M and depreciation, as I mentioned on last quarter's call that included in our 2022 guidance details, we have a change in accounting related to the Rockport Unit 2 lease at I&M. We're seeing approximately $0.05 of favorable O&M offset by $0.05 of unfavorable depreciation in each quarter of 2022, but no consequential earnings impact. I'll talk a little bit more on load performance, but I'll get to that here in a minute. So, bear with me. The Transmission and Distribution Utilities segment earned $0.32 per share, up $0.01 compared to last year. Favorable drivers in this segment include rate changes and positive weather in Texas and Ohio and increased transmission revenue. Offsetting these favorable items were unfavorable O&M depreciation and income taxes. The AEP transmission Holdco segment contributed $0.33 per share flat compared to last year, favorable investment growth of $0.2 was somewhat offset by unfavorable income taxes. Generation and marketing produced $0.14 per share up $0.10 from last year. The positive variance is primarily due to higher retail margins, increased renewable wind production, higher market prices impacting generation margins and favorable income taxes. Finally, Corporate and Other was down $0.02 per share driven by unfavorable interest expense, mainly as a result of the increase in short-term debt rates and increased O&M partially offset by reduced investment losses. The reduced investment losses are largely related to charge point losses that we had in the third quarter of 2021, that have reversed this year. I'll note that we exited our position in charge point during the third quarter so a side from the year-over-year comparison, we will not have any new volatility in this particular aspect of corporate and the -- corporate and other segment relating to our direct ownership of charge point shares since the position has been liquidated. So, let's go to Slide 10, and I'll talk about our year-to-date operating earnings performance. Year-to-date operating earnings total to $4.04 per share compared to $3.76 per share in 2021. Operating earnings for vertically integrated utilities were $2.15 per share, up $0.28. Similar to the quarter, favorable drivers included rate changes across multiple jurisdictions, the resolution of the APCo triennial, positive weather in our western jurisdictions, increased transmission revenue and favorable normalized retail load. These items were somewhat offset by increased depreciation and lower off-system sales. Once again, the change in accounting around the Rockport Unit two lease results in $0.17 of favorable O&M offset by $0.17 of unfavorable depreciation. The Transmission and Distribution Utilities segment earned $0.95 per share, up $0.10 compared to last year. Favorable drivers in this segment included rate changes in Texas and Ohio, favorable weather and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M, property taxes and depreciation. The AEP Transmission Holdco segment contributed $0.95 per share, down $0.07 per share compared to last year. Favorable investment growth of $0. 06 was more than offset by an unfavorable true-up of $0.07 and increased income taxes. As I mentioned last quarter, this is entirely consistent with our guidance. Our 2022 guidance had this segment down by $0.08 year-over-year as a result of the investment growth being more than offset by the annual true-up that occurred last quarter and some unfavorable comparisons on the tax and financing side. Generation and Marketing produced $0.34 per share, up $0.14 from last year. The positive variance is primarily due to the sale of renewable development sites improved retail margins, increased wholesale margins and land sales in the depreciate generation segment. Finally, Corporate and other was down $0.17 per share, driven by lower investment gains, unfavorable interest and increased O&M. The lower investment gains are largely related to charge point gains that we had in 2021 that reversed this year. Turning to Slide 11. Let me provide an update on our normalized load performance for the quarter. Overall, AEP service territory has maintained significant momentum through the first three quarters of the year despite increasing headwinds impacting the macro economy. Starting in the lower right corner, normalized retail sales increased by 2.6% in the third quarter compared to last year. Once again, every operating company experienced positive year-over-year growth for the quarter. Furthermore, the growth in the commercial and industrial sales this quarter more than offset the modest decline in residential sales. For the year-to-date comparison, AEP's normalized retail sales increased by 3.1%, with growth spread across all major retail classes and operating companies. In fact, we're on pace to experience the strongest year for load growth since the mid-1990s. And that's on top of the recovery year we had last year when the load increased by 2.1%. Moving to the upper left corner, normalized residential sales decreased by 0.8% in the third quarter but remained up 0.3% through September compared to last year. For the quarter, residential accounts increased by 0.4%, but this was offset by a 1.2% decline in weather-normalized usage. This is not surprising when you consider that last year, many of our customers were receiving extra income from the fiscal stimulus that is not happening in 2022. While the results were mixed by operating company, the strongest residential growth for the quarter was at SWEPCO. Moving right, weather normalized commercial sales increased by 3.4% for the quarter and were up 3.8% for the year-to-date comparison. The growth in commercial sales was spread across nearly every operating company and eight of our top 10 commercial sectors. The fastest-growing commercial sector is data centers, where loads up 33% compared to last year for the quarter and for the year-to-date comparisons. Finally, focusing on the lower left corner, you'll see that the industrial sales posted another strong quarter, up 6% for the quarter and up 5.5% for the year-to-date comparison to last year. Industrial sales were up at nearly every operating company in most of our largest sectors. We continue to experience double-digit growth in a number of key industries this quarter, including chemicals, manufacturing and oil and gas extraction. We also saw robust growth in primary metals manufacturing, pipeline transportation, paper manufacturing and coal mining. To summarize, the AEP service territory has maintained significant momentum through the first nine months of the year despite the challenging headwinds of inflation, higher interest rates, supply chain disruptions and the labor shortage. We know the Federal Reserve's approach to address inflation is designed to slow down the economy, which will eventually work its way through our footprint. However, I'd like to remind you that there are things that we've done and will continue to do to help mitigate the impact of slowing economic conditions in our service territory specifically, we're talking about our economic development efforts. So, turning to Slide 12, I want to highlight how our commitment to economic development is helping to sustain load growth even in the face of challenging economic conditions. The chart on this slide illustrates why this strategy is so important to us. The blue bars on this chart show the growth in gross regional product or GRP, for the AEP service territory over the past year. So, you can see that it has been slowing over the period. In fact, for the third quarter, growth in AEP's GRP was essentially flat. However, the green bars here show that our industrial sales growth over the same period, you'll notice that they've maintained their strength, even improving 6% without the help from GRP. How does this happen? That's because of our consistent and disciplined approach to economic development over the years. A lot of the growth in industrial load that we're seeing today is a consequence of economic development projects from previous years that are coming online this year. Examples include a large steel plant and an LNG processing facility that are now online in the AEP Texas service territory, a new chemicals plant that is now operating in Tennessee or a paper plant that is now producing in Oklahoma. And these are just a few of the many examples that we could mention. But the key takeaway here is that AEP's commitment to economic development is what is allowing us to be on track to post our strongest year for load growth in decades despite an economy that is beginning to slow down. Another key point to remember is that you cannot turn it on or off like a light switch. Economic development projects take time to materialize, and the results that we see here today are largely the result of activities that occurred years ago. By making this a key component of our strategy, AEP is helping to mitigate the impact of economic downturns on our customers, our communities and our investors. And AEP's economic development team has a proven track record of helping bring these new customers to our service territory with an emphasis on jobs and load. In fact, the AEP service territory has added over 106,000 jobs this year. So, let's move down to Slide 13, to discuss the company's capitalization and liquidity position. We're doing well in this regard. On a GAAP basis, our debt-to-capital ratio held constant from the prior quarter at 61.4%. Taking a look at the left upper quadrant on this page, you'll see our FFO to debt metric stands at 14.5% on both the Moody's and a GAAP basis, which is an increase of 1.1% and 1.2%, respectively, the prior quarter. The primary reason for the increase is attributed to the completion of the PSO securitization efforts, which increased cash from operations. As we stated on our last earnings call, we anticipated trending toward our FFO debt targeted range of 14% to 15% as the year progressed, and we currently sit comfortably within that range. You can see our liquidity summer in the lower left quadrant on the slide, our 5-year $4 billion bank revolver and our 2-year $1 billion revolving credit facility to support our liquidity position, which remains strong at $3.6 billion. On the qualified pension front, while our funding status decreased 0.3% during the quarter, it remains comfortably strong at 105.3%. Negative returns on the risk seeking and fixed income assets during the quarter were primary drivers of the funded status decrease. However, rising interest rates cause plan liability to decrease, which provided a favorable offset to the negative asset returns. So, we're in a good place in terms of funding. Let's go to Slide 14, So I can do a quick recap of today's message. The third quarter continues to provide a solid foundation for the rest of 2022 and allowed us -- at our recent Analyst Day, in narrow and raise our operating earnings guidance range to $4.97 to $5.07 with a midpoint of $5.02. As you know, AEP offers steady and predictable growth driven by our low-risk regulated business, robust electric infrastructure investment pipeline and our proven track record of managing cost pressures over time while growing our rate base. This, along with the updated 2022 load forecast we provided at our October 4 Analyst Day and the Virginia Supreme Court ruling related to APCo's 2017 to 2019 triennial review, position us to navigate headwinds, remaining this year that you would expect, such as continued inflation, interest rates, weather risks, et cetera, which is why we maintained a $0.10 range when we recently lifted and tightened our 2022 guidance range. We continue to be committed to our long-term growth rate of 6% to 7%, continued dividend growth and a strong balance sheet while we are delisting the company, focusing on the customer and actively managing the portfolio. So, we really do appreciate your time and attention today and I know you guys are super busy with the all the earnings calls. So, with that, I'm going to kick it over to the operator, so we can hear what's on your mind and take your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question is from Jeremy Tonet from JPMorgan. Please go ahead."
},
{
"speaker": "Jeremy Tonet",
"text": "Good morning. I just wanted to pick up on one of the key themes at the Analyst Day talking about the transmission within AEP and the significant growth potential there as you see it and what appears to be a valuation disconnect with AEP stock relative to public comps and transactions. I'm just wondering if that conversation invited any reverse inquiries on your assets? I know you said these are core to you, but just kind of curious how that's developed and any other thoughts on that side you might share?"
},
{
"speaker": "Nick Akins",
"text": "Yes, I'll just follow up with the -- did I mention transmission. So I'll turn it over to Julie, who respond to that."
},
{
"speaker": "Julie Sloat",
"text": "Thank you, Nick. Thanks, Jeremy. Thanks for the question. Let me tell you, we've certainly got a lot of attention from our investor base. And so I'll answer it that way. So we appreciate that because that means we're doing our jobs. I think we still need to do a lot of work here to make sure that we make it easy for you all to understand what the earnings stream is in the earnings potential of that particular business. And so as we were getting ready for this call today, I'm looking at the waterfalls on Pages 9 and 10 of the presentation today. And so let me go to Page 10 just for real quickly. So the AEP Transmission Holdco, which is our pure play transmission component contributed $0.95 of the $4.04 year-to-date. And as you know, we've got more transmission and play across this waterfall too, that shows up in the vertically integrated utilities in the T&D segment. So as a swag and we'll do better with this as we go into 2023 to give you a more granular view of the transmission component in the aggregate from AEP, but assume that roughly 50% of the earnings on the vertically integrated utilities and T&D utilities is essentially the part of the 95% -- or I'm sorry, adding $0.95 to another -- let me say it in another way, I'm totally tripping over myself here. $0.95 from the AEP Transmission Holdco, essentially double that. So that's about half. So half of our earnings are coming from that particular segment. The other half is coming from vertically integrated utilities and in T&D utilities. So not insignificant when you compare that just under $2 to the 404. So we'll do better, and I'll do better explain in the stuff as we go forward in 2023, but I wanted to have that number kind of in the back of my pocket here in case you asked the question, so I'm glad you did."
},
{
"speaker": "Nick Akins",
"text": "But the overarching theme around transmission is that with -- certainly with the movement to clean energy economy, and the focus we have on renewables being put in place, you can't put these renewables in place without additional transmission, transmission, is becoming more constrained. So it turns out to be very positive from an AEP perspective from an opportunities to really focus on not only the development of transmission, which were the largest in the country but also in terms of the renewables build-out and in fact, distribution with distributed energy resources that will drive different resource needs as well. So all in good shape from that perspective. So we feel very, very bullish about our transmission."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. And then just shifting gears a little bit. Rates moving up here. And so just wondering what you can say about that with regard to short-term rate moving higher and long-term debt issuance as being more expensive, just think about historic test years and lag in jurisdictions, wondering what could be done or how do you see that unfolding?"
},
{
"speaker": "Nick Akins",
"text": "Yes, Julie."
},
{
"speaker": "Julie Sloat",
"text": "Yes. No, thanks again for the question. We're keeping a watchful eye on that. You're absolutely right. So let me kind of compare and contrast. The short-term debt rate that we were realizing last year through the first 9 months was about 27 basis points. Today, through the first 9 months, that was about 1.46%. So a significant uptick. And so what we'll be doing is continuing to manage across the different buckets of tenor and using kind of barbell strategies to do our financings going forward. We still have a little bit of work we have yet to do this year, and that's at the parent. I mentioned that at our Analyst Day back on October 4. And we're assuming that rates would adjust to on a longer-term basis to about 5% to 6% for us. That compares to through the year-to-date rate of about 3.34%. We will and do have that embedded in our 2023 guidance, but we'll continue to work with that. Let me give you another finer point to that what I pay attention to is how much of our debt is floating rate. We generally target somewhere between 15% and 20% of our total portfolio being floating rate. As of the end of the third quarter, we were at about 14.8%. About -- that equates to about the parent about $5. 7 billion, $1.95 billion of that being CP. So we've got a fair amount of fluctuation there, but that's already getting picked up in rates, and it's absolutely embedded in 2023 guidance. We'll have more for you to share and for your modeling efforts at the EEI conference when you get all the assumptions that we'll have behind the waterfall and details that you're typically used to seeing from us."
},
{
"speaker": "Operator",
"text": "And the next question will come from the line of Durgesh Chopra -- I'm sorry, from Evercore ISI. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Good morning. Congrats on a solid quarter here. I have two questions. The first one -- just maybe can you elaborate to the extent you can, you mentioned Phase 1 of the unregulated renewable sale. Just who are the interested parties here are the strategics are these privates? Or any -- any additional color you can share there?"
},
{
"speaker": "Nick Akins",
"text": "I would certainly say that the list was robust. And all the usual suspects that you would think of and beyond. But there were a lot. And I'd say it was still generally half and half, 60-40, whatever it was of strategics and others financials. And so -- and actually, the Phase 2, we're going into a list with strategics and financials and it's a well-balanced group. One that I'm sure will hold each other accountable during the process, but we're very happy with the responses we received."
},
{
"speaker": "Durgesh Chopra",
"text": "Excellent. It sounds like you're making very good progress there."
},
{
"speaker": "Nick Akins",
"text": "Yes. They'll go into the confidential rooms and all that kind of stuff and more due diligence will be done, and we'll go through the process with them. So that's just what the process is."
},
{
"speaker": "Julie Sloat",
"text": "And Durgesh, this is Julie. We have a 2-step bid process, and we would expect to be in a position to have a PSA signed in early 2023. With the closing in the first half of next year. I think we shared that with you on October 4. And we get the question around who is the primary regulatory authority or body that will govern this, and that's FERC, as you know."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. And then maybe just to pivot on to the second subpoena from SEC. Just how to read into that? What are the implications for you? I mean, does this increase the risk sort of potential?"
},
{
"speaker": "Nick Akins",
"text": "Yes. We view it as a continuing part of the process. And we said we would be transparent and we have been transparent and we'll continue to work in a positive fashion with the SEC during their investigation. And certainly, the issuance of a second subpoena is really -- they just need more information. So -- and we're going to supply it. So we're going to work with them and we'll continue doing so. So our response is essentially the same as the first one. We recognize there were governance issues we need to change relative to 501(c)4 and we made those changes. And certainly, from our perspective, we'll continue to work with them to get this thing resolved."
},
{
"speaker": "Operator",
"text": "The next question is from Julien Dumoulin-Smith from Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Good morning. Congrats, Nick, Absolutely. If I can pivot still on this -- if I can continue with the last question a little bit and can ask again about this second subpoena. Just what's your understanding of the process from here on out? Again, I get that they continue to inquire here. Just -- can you elaborate a little bit further here? Again, obviously, you're complying, you're submitting documentation, but just a little bit of the sense of what you get from here out."
},
{
"speaker": "Nick Akins",
"text": "I mean there's not much else we can say about it, obviously, because it is a process with the SEC, and it's really up to the SEC what -- how they want to continue to analyze the information, ask for new information. And typically, I guess, whenever they need new information, they'll issue new subpoena. So it's just part of the process, and it's really up to the SEC. And our only -- I mean the only control we have is to continue to cooperate very positively and respond, and we'll continue to do that."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent. Okay, perfect. And then if I can, just with respect to West Virginia, can you guys talk a little bit about the fuel situation there? I mean is there an ability to leverage securitization here to address the balance there? And just to what extent can that sort of fully address that balance?"
},
{
"speaker": "Nick Akins",
"text": "Yes, Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Yes. No. Thanks for the question, Julien. And actually, as a matter of fact, that's exactly what we're contemplating. As you know, we've got a fair amount of exposure in excess of $400 million as of the end of the third quarter. of deferred fuel at West Virginia, in particular, we want to be very sensitive to customer bills. So the plan is to see what we can do around securitization of the outstanding balance and manage rates for customers. Right now, the current mechanism is we have a 12-month fuel cause to reset and account for the prior year. We're currently in hearing there, but we want to be extremely sensitive to our customer base as it relates to that particular area. So standby, we'll have more to tell you and more to share as we make some progress, but securitization is absolutely contemplated."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it right. So there's no qualification issues or needing to get clarification on legislation, right, that it should be directly applicable."
},
{
"speaker": "Nick Akins",
"text": "That's right."
},
{
"speaker": "Julie Sloat",
"text": "Yes. But we do need some clarification on the legislation because it's very specific to what you're trying to securitize. So that will be a critical path for us."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Okay. So we should look for that next in terms of getting this done?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, yes, yes."
},
{
"speaker": "Operator",
"text": "Your next question is from Ross Fowler from UBS. Please go ahead."
},
{
"speaker": "Ross Fowler",
"text": "Good morning, Nick, good morning, Julie. How are you? Thank you for the quote. I very much appreciate that on this end of the phone, so."
},
{
"speaker": "Nick Akins",
"text": "Good for you."
},
{
"speaker": "Ross Fowler",
"text": "So I just had a couple of questions here. I was going to ask about this peanut, but we've kind of beaten that to death. But the retail strategic computing, that's going to happen within sort of the first half of next year. Are there other businesses that sort of fit into that same sort of potential strategic category? I'm thinking about wholesale services or distributed resources. Are they core to you? Or is that something we could see in the future?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So obviously, we have 3 -- I guess, 3 of the normal 4 burners already loaded. One's Kentucky, one is the contracted renewables and then the retail after that. And we have to do really a strategic review around retail because it includes some of Ohio and that kind of thing. So we need to fully understand that. And we said that we would look at other parts of the business, if it fuels the growth that we're focused on relative to transmission and the movement to a clean energy economy. And so we'll continue to do that. I don't want to -- I really don't want to position business versus another at this point. But we'll continue to look at all of our business to make sure that we are being as efficient as possible to -- as Julie always says, actively manage the portfolio to ensure that we are moving forward from a growth perspective, but also from a derisking perspective, to ensure that we are spending our capital on the right things and O&M as well. So that's probably all I'll say at this point, and I'll leave it to Julie in the future to answer those questions."
},
{
"speaker": "Julie Sloat",
"text": "Yes, yes. I would leave you with this thought. As it relates to on-site partners, which is our distributed energy solutions organization, and we have wholesale services as well when you look at the quadrants of our unregulated components of our total AEP business, I would submit to you that you should assume that they operate business as usual. Those are close to the customer. Those are things that we need to engage in to manage our day-to-day operations and we want to make sure that we're extracting all the intelligence we possibly can and taking care of the customer at the same time. But if there are things we can leverage to help us in the regulated envelope, we'll be doing that as well. So distributed energy solutions seems to scratch that itch. And we've gotten a lot of success and runway out of that. So business as usual. And we'll keep you apprised. Anything else that we put on deck like Nick said, we got all of our burners busy. You know what's on deck. But the point here is to get as efficient as we possibly can so that we can deliver the goods, take care of you, take care of our customer and then where we're good to go."
},
{
"speaker": "Ross Fowler",
"text": "Right. Fantastically. And then just maybe one more around sort of the flexibility of your capital spend. As you kind of iterated at the Analyst Day, many times you win a lot of the capital is in transmission. We've seen some other companies maybe struggle to get transmission projects on schedule given the signing and permitting issues. Is that just a large-scale transmission project issue? And do you have sort of just a lot of smaller-scale stuff you can move around in that transmission and even in the distribution bucket?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So obviously, we've had the same conversation relative to [indiscernible] in Congress. We -- our transmission of large block of our transmission is transmission within our service territory. And actually, the -- just basically the nuts and bolts of making sure that we have rehabilitation of the grid, replacement of old resources. We have some transmission lines. And I just -- every time we have our subcompany Board meeting, I always comment about these 100-year old lines that come up for replacement. And we're still in the process of doing that. We've talked a lot about the amount is the sheer magnitude of AEP's transmission system and the average age being 57 years old or some number like that. And the spend that we have ongoing now just increases by a year, every year it goes by like a 57 to 56 by spending $3 billion. So really -- we have not had issues with the construction of our transmission. Now if you do a new transmission with new large-scale transmission, that's where you really get into permitting and right-of-way issues. And that's really part of the permit legislation. And then when you cross over states, obviously, the cost allocation issues occur. So -- but by and large, almost all of our transmission is really related to transmission that either already exist or within our territory that we have. We certainly have the ability to move forward with. And we also have -- and this is probably more than you asked for, but from a transmission perspective, we've increased our planning associated with that. We used to do 120% of the capital plan. Now we do 130%. And we're also looking at distribution actually to do the same thing around 120%. So those are mechanisms where we continue to be able to use bottles, we continue to be able to adjust based upon different projects being either slowed down, sped up or whatever, and we continually adjust to that because we have thousands of projects to be able to work that through. So that really drives that element of consistency around our ability to provide capital for transmission and in fact, distribution."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We will go to the line of Michael Lapides from Goldman Sachs."
},
{
"speaker": "Nick Akins",
"text": "Looking for something from you, but go ahead."
},
{
"speaker": "Michael Lapides",
"text": "Big weekend coming up Alabama LSU. We got 10 days. I hope that's not what you're looking for me from because you're going to get a big role tide at none of us go to Tiger's business. Hey, couple of questions. First of all, I love Slide 41. When I'm looking at Slide 41, Nick, it's a trailing 12-month earned ROE chart. Just curious, when I think about what's embedded in 2023 guidance, which of those get materially better in '23? Which of those face even a little bit more lag in '23 than they do right now?"
},
{
"speaker": "Nick Akins",
"text": "Yes. Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, yes. So Michael, what you should anticipate is movement on the PSO front. I mean we've got a little bit of momentum there. We've got the securitization taken care of now. We'll be making an application soon for a rate case. So anticipate that. We do expect over time that APCo is going to improve, too, particularly now that we've got the Virginia triennial behind us, and you're starting to see the fruits of that effort, already showing up in our waterfall slides. And then we've got activity, regulatory activity underway at SWEPCO 2. But we will give you more granular detail at the EEI conference on a company-by-company basis across the board. So stay tuned for that. But as you know, the entire objective is to move the needle and close the gap. And I would submit to you that that's how we describe another aspect of our active management. So we should be in good shape and moving in the right direction. Obviously, we're comfortable with the guidance we already put out there."
},
{
"speaker": "Michael Lapides",
"text": "Got it. And then speaking of APCO and the court case in Virginia, and the $37 million pretax benefit you took this quarter, how should we think about that for 2023? I mean, is that just a nonrecurring onetime or should we smooth that out over 23 quarters? I'm just trying to think about how to actually model that."
},
{
"speaker": "Julie Sloat",
"text": "Yes, yes. No, I love that question because fussing with that myself as we've got the good news. So yes, $0.06 that you saw in the third quarter, which is essentially like a catch-up from the under earnings from 2017 to 2019. So that's unique. So $0.06 this quarter. And I'll take it a step further. Let's go to the fourth quarter because you probably asked me about that, too. We should have about $0.01 of earnings associated with this particular outcome in the fourth quarter of 2022. So think about that when you're calibrating your model. And then for 2023, we'll have about $37 million of additional revenues from rate increases that effectively covers January of 2021 to September 2022 that in terms of what we should have been able to recognize, but we're spreading it over 16 months plus we have the going forward a benefit that starts October 2022. So what all does that mean? That means $0.06 spread across 2023, and that will be included in the waterfall guidance that we gave to you at EEI. So I hope that helps kind of in the word there for you."
},
{
"speaker": "Michael Lapides",
"text": "That does help. And then finally, I last thing. Can you remind us what your cash tax position will be in the coming years?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, cash tax gets really goofy with the BMT. So those numbers kind of floated all around, and we can always help you behind the scenes with modeling. But for cash tax in 2022, I want to say that the rate is something like 10.8% then go out to 2023. The way we're modeling it is just a little bit over 4%. But I would just direct you back to the GAAP annual effective tax rate. And so we're looking at the traditional 5.2% in 2022, and it pumps up a little bit to about 8.4% in 2023. And but we'll be able to give you more granular there, too, when we roll out all the backup to the 2023 guidance. Yes, the BMT -- it gets -- it almost looks geological when we're looking at some of the modeling -- I mean it works and it's accurate, but it just the rate kind of bounces all over the place from a cash perspective because you're using those tax credits."
},
{
"speaker": "Operator",
"text": "And at this time there are no further questions in queue. Please continue."
},
{
"speaker": "Darcy Reese",
"text": "Great. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Luis, please go ahead and give the replay information."
},
{
"speaker": "Operator",
"text": "Thank you. And ladies and gentlemen, this conference will be available for replay beginning at 11:30 a.m. today and running through November 4 at midnight. You may access the AT& T replay system at any time by dialing 866-207-1041 and entering the access code 7723525. International callers can dial 402-970-0847. Again, the numbers are 1800- I'm sorry, 1866-207-1041 and 402-970-0847. Access code is 7723525. And that does conclude our conference for today. Thank you for your participation and for using AT&T conferencing service. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 2 | 2,022 | 2022-07-27 09:00:00 | Operator: Welcome to the American Electric Power Second Quarter 2022 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later there will be an opportunity for questions-and-answers session. And as a reminder, your conference call is being recorded. I'll now turn the conference call over to your host, Vice President of Investor Relations, Darcy Reese. Go ahead.
Darcy Reese: Thank you Alan. Good morning, everyone and welcome to the second quarter 2022 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release presentation slides and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer; and Julie Sloat, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.
Nick Akins: Okay. Thanks Darcy. Welcome everyone to American Electric Power's second quarter 2022 earnings call. AEP continues to make progress on the strategic initiatives we announced earlier this year with strong execution against our plan resulting in another solid quarter. Later in the call Julie will walk you through our second quarter performance drivers including the strong load increases we're experiencing in our territory, as well as provide additional details surrounding our financial position. But I'll start with the key financial highlights for the quarter. We'll then move to an update on our Kentucky operations sale process and timeline. I will also spend time discussing the progress we are making in our transition to a clean energy future as we simplify and derisk our business profile by divesting unregulated renewable assets while maintaining focus on our responsible generation fleet transformation and regulated renewables execution. I will close by providing some additional insights into our ongoing regulatory activities including our transmission business. We are very pleased with our positive momentum this quarter, delivering operating earnings of $1.20 per share or $618 million. We are moving full speed ahead towards the increased operating earnings guidance range and long-term earnings growth rate we provided during our fourth quarter 2021 earnings call and we are reaffirming both financial targets this quarter. As a reminder we are guiding to an operating earnings guidance range of $4.87 to $5.07 per share for 2022 with a $4.97 midpoint and a long-term earnings growth rate of 6% to 7%. We are also continuing to ensure we are best positioned for value creation as we navigate the macro trends impacting our industry and the broader economy. We are working with states to drive expansion in our service territory while considering global economic uncertainty inflationary pressures and of course customer bills. We're also diversifying our mix of suppliers to minimize supply chain disruptions for our customers in business while also lessening the impact on our capital investment plan. We know that timing of the closing of the sale of Kentucky Power and AEP Kentucky Transco to Liberty as top of mind, and we have been working with Liberty to obtain the approvals necessary for closing this summer. A regulatory timeline of the sale can be found on slide seven of today's presentation. We are pleased to report the Kentucky Commission approved the key milestone in the transaction with an order approving the sales transfer in early May. As we have discussed previously a prerequisite in our contract of Liberty for closing the sale is approving the approval of new Mitchell operating agreements by both the Kentucky Public Service Commission and the West Virginia Public Service Commission. While we receive the related Mitchell orders from the Kentucky Commission on May 3 and the West Virginia Commission on July 1, the two states approved the operating agreement with different formats and some divergent post 2028 plant provisions. However, through the two proceedings, both commissions have indicated an ability to use the existing agreement as a basis to operate the plant going forward and accomplish their differing expectations for investment in operations. For that reason, on July 11, we made a compliance filing in West Virginia, and filed an update with Kentucky, providing an alternative way to move forward with Mitchell operations in the near term. We inform both commissions that we will operate under the existing agreement and manage the new operational focus of the two commissions through the operating committee. In the absence of any new agreements, the existing Mitchell operating agreement is still in effect and we believe, no additional regulatory approvals should be required. Since regulatory approval of the new Mitchell operating agreements is a prerequisite in our contract with Liberty for the closing. In the absence of such proposal, we are working with Liberty on the commercial solution for Mitchell-related operations and both parties remain optimistic about reaching a resolution and closing the transaction. At this time, the only regulatory matter currently pending is the 203 application at FERC related to the cell transfer, which FERC is currently considering. We are in the final stages of the Kentucky operations sale process and expect to close this summer. Moving to our unregulated renewable portfolio, in May, we closed on the sale of five unregulated development sites located in the Southwest Power Pool area, marking the successful divestiture of the majority of our wind and solar development assets. As we mentioned last quarter, we have also signed an agreement to sell a solar development site in Ohio, with that transition close expected also in the third quarter. In addition, we are in discussions with an interested party sale of our Flat Ridge II Wind Farm ownership, consisting of 235 megawatts, simplifying the resulting portfolio for our upcoming auctions. These milestones demonstrate our commitment to continued execution. As we announced during our fourth quarter earnings call in February, we are selling our unregulated contracted renewables portfolio in order to simplify and derisk the company and facilitate investment in our regulated businesses. We are in the final stages of preparation of the marketing materials for the auction and expect an official launch of the process no later than early September. After the removal Flat Ridge II, the portfolio consists of 1,365 megawatts of contracted renewable assets, consisting of 1,200 megawatts of wind and 165 megawatts of solar, geographically diversified throughout the US. There has been robust, inbound interest in the portfolio and we expect the process to proceed quickly. As a reminder, utilization of contracted renewable sale proceeds is not yet reflected in our multiyear financing plan. We remain focused on maximizing transaction proceeds and directing additional capital to our regulated businesses, where we have meaningful pipeline of investment opportunities to better serve our customers, as we push toward a clean energy future and enhanced transmission infrastructure. As always, we are open-minded and we'll evaluate all value-additive potential activities, as we focus on our regulated businesses, where we see meaningful long-term opportunities for growth. AEP continues to make significant progress in our transition to clean energy resources through our regulated renewables execution. Details regarding the specific actions we are taking can be found on slides eight and nine in today's presentation. We are also firmly grounded in our principles of resiliency, reliability and affordability while recognizing the increasing value of our diverse resource portfolio against the backdrop of energy-related volatility. SWEPCO is taking steps to secure renewable resources, making regulatory filings in May in Arkansas, Louisiana and Texas to own three renewable turnkey projects totaling 999 megawatts. This $2.2 billion investment is currently reflected in our five-year $38 billion capital plan. SWEPCO expects to issue another RFP in the near term consistent with its RFP for energy and capacity needs. APCo's 409 megawatts of owned solar and wind resources were approved by West Virginia and Virginia, marking an $841 million capital investment that is also included in our current capital plan. Request for a proposal are in process in APCo, O&M and PSO with expected in-service dates in the year-end 2024 and 2025 timeframe. We also expect to make regulatory filings to acquire additional renewable resources prior to year-end 2022. Finally the US Supreme Court ruling at the end of June related to the federal EPAâs regulation of greenhouse gas emissions will not require any changes to AEP's current generation and compliance planning. Our generation fleet transformation plans are well on track. We remain fully committed to our target of an 80% carbon reduction emission -- emission reduction rate by 2030 and net zero by 2050 and we are proud of the work well underway at AEP to help us achieve this goal. Reaching these targets is foundational to our long-term strategy and we believe we are on the right path toward prioritizing regulated investment opportunities and transitioning our generation fleet. Turning now to a brief update on our regulatory activity. Our regulated ROE as of the end of June 2022 is 9.2%. We continue to work through regulatory cases and maintain our focus on reducing our authorized versus actual ROE spreads. Additional regulatory activity in the quarter included a commission order received in May on SWEPCO's Arkansas rate case, including a 9.5% ROE, marking a net revenue increase of $28 million and a capital structure of 55% debt to 45% equity. We are also expecting a decision on SWEPCO's losing out a rate case in the third quarter. Oral arguments related to APCo's 2020 Virginia base case were held in March 2022 at the Virginia Supreme Court, with an anticipated final decision later this year. FERC recently initiated several rule-making proceedings related to transmission planning, cost allocation, generation interconnection to the transmission grid and extreme weather preparedness. We support the commission in these actions and are in full support -- full agreement that that reform is needed to build the infrastructure necessary to transition our generation fleet in the most efficient and cost-effective way possible, while also helping achieve our carbon reduction goals. These proposed rules align with AEPâs objectives of developing a more robust, reliable and flexible grid of the future that ultimately reduces cost to customers and strengthens economic development in our communities. Before I turn it over to Julie, I want to take a moment to thank our team for the incredible work that they are doing as we execute against our strategic objectives and deliver for our stakeholders. What's going on today at AEP is a perfect blend of the execution of BachmanâTurner Overdriveâs "Takin' Care Of Business" with the edge of Princeâs "Let's Go Crazy" in a good sense, of course. We have an incredible market position, a bold mission and the foundation in place to achieve our goals to deliver on our vision of further modernizing our energy grid in order to supply reliable, cleaner, low-cost resources for all the communities serve. As we think about the future and the next chapter of AEP, we're excited to share more about our plans at AEP's upcoming Analyst Day on October 4 in New York City. We will provide additional detail soon and look forward to seeing you there. Julie, over to you.
Julie Sloat: Thanks, Nick. Thanks, Darcy. It's good to be with everyone this morning. Good morning and thanks for dialing in. I'm going to walk us through our second quarter and year-to-date results, share some updates on our service territory load, and finish with commentary on our credit metrics and liquidity as well as some thoughts on our guidance, financial targets, and then recap our current portfolio management activities underway. So let's go to slide 10 which shows the comparison of GAAP to operating earnings. GAAP earnings for the second quarter were $1.02 per share compared to $1.16 per share in 2021. GAAP earnings through June were $2.43 per share compared to $2.31 per share in 2021. There's a detailed reconciliation of GAAP to operating earnings on pages 18 and 19 of the presentation today, but I'd like to call out three of the reconciling items that do not affect operating earnings, but relate to our asset optimization activities underway. Specifically, you'll see that we made an adjustment to arrive at our operating for the quarter and year-to-date periods consisting of Kentucky sale costs and the write-off of one of the unregulated universal scale wind projects that's included in the portfolio. We're in the process of preparing for sale. The Kentucky sale charge reflects an anticipated reduction in the sales price as we work with Liberty to accommodate adjustments for costs that have been identified through the regulatory approvals that we've received. Turning to the renewable investment write-off the Flat Ridge 2 projects specifically has continued to see deteriorating performance due to equipment issues and transmission congestions to avoid another otherwise necessary repowering investment to address the performance issue and complicate our portfolio sales process. We elected to write-off the equity investments are in discussions with an interested party for the sale of ownership interest in Flat Ridge 2. Consequently, this will remove the Flat Ridge 2 project from the portfolio we're preparing for auction, which should help improve the valuation opportunity as investors engage in the sales process, which is scheduled to launch no later than early September. Lastly, I'll mention that we monetize some mineral rights which give rise to a benefit to GAAP, but non-operating earnings, which helps offset the charges I just mentioned. So while I would typically not spend time walking through the GAAP to operating reconciliation, I thought it was appropriate at this time given the milestones we're clearing on the asset optimization front. And while these charges and gains are things that we need to recognize they are entirely driven by our efforts derisk, simplify and bring cash in the door to support our continued investment in the regulated business. So with that let's go to slide number 11 and walk through our quarterly operating earnings performance. Operating earnings for the second quarter totaled $1.20 per share or $618 million compared to $1.18 million per share or $590 million in 2021. Operating earnings for vertically integrated utilities were $0.59 per share up $0.14. Favorable drivers included rate changes across multiple jurisdictions, positive weather primarily in our western jurisdictions, increased transmission revenue and normalized retail load and income taxes. These items were somewhat offset by increased depreciation in O&M and lower off-system sales. Just as a reminder on the O&M and depreciation front, as I mentioned on the first quarter call and included in our 2022 guidance details because of a change in accounting related to the Rockport Unit 2 lease at I&M, we're seeing approximately $0.05 of favorable O&M offset by $0.05 of unfavorable depreciation in each quarter of 2022, but no consequential earnings impact. And so I'll have a little more to share on loan performance and I'll get to that in a minute here. So just hang with me. The Transmission and Distribution Utilities segment earned $0.32 per share, up $0.01 compared to last year. Favorable drivers in this segment included rate changes, load, positive weather in Texas and Ohio and increased transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. AEP Transmission Holdco segment contributed $0.27 per share, down $0.07 compared to last year, favorable investment growth of $0.03 was more than offset by an unfavorable true-up of $0.07. As I mentioned last quarter, this is consistent with our guidance. Our 2022 guidance had this segment down by $0.08 year-over-year as a result of the $0.12 of investment growth being more than offset by the annual true-up that occurred this quarter and some favorable on comparisons on the tax and financing side. This segment continues to be an important part of our 6% to 7% EPS growth as you well know. Generation and Marketing produced $0.18 per share, up $0.09 from last year. The positive variance is primarily due to the sale of renewable development sites as well as increased generation margins and land sales. Finally, Corporate and Other was down $0.15 per share driven by lower investment gains increased income taxes and unfavorable interest. The lower investment gains are largely related to charge point gains that we had in the second quarter of 2021 that have reversed this year. The increased income taxes are related to the reduction of a consolidating tax adjustment at the parent. Let's turn to Slide 12 and our year-to-date operating earnings performance. Year-to-date operating earnings totaled $2.42 per share or $1.234 billion, compared to $2.33 per share or $1.160 billion in 2021. Operating earnings for the vertically integrated utilities were $1.18 per share, up $0.18. Similar to the quarter, favorable drivers included rate changes across multiple jurisdictions, positive weather mainly in our western jurisdictions, increased transmission revenue and normalized retail load and income taxes. These items were somewhat offset by increased depreciation and lower off-system sales. Once again the change in accounting around the Rockport Unit 2 lease results in $0.11 of favorable O&M offset by $0.11 of favorable -- unfavorable depreciation. The Transmission & Distribution Utilities segment earned $0.62 per share, up $0.08 compared to last year. Favorable drivers in this segment included rate changes in Texas and Ohio and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. AEP Transmission Holdco segment $0.62 per share down $0.06 compared to last year. Favorable investment growth of $0.05 was more than offset by unfavorable true-up of $0.07 and increased property taxes. The Generation & Marketing segment produced $0.21 per share, up $0.05 from last year. The positive variance is primarily due to the sale of renewable development sites and increased wholesale margins offset by lower retail margins. Finally, Corporate and Other was down $0.16 per share driven by lower investment gains, unfavorable interest and increased O&M. The lower investment gains again are largely related to charge point gains that we had in 2021 that have reversed this year. Turning to Slide 13. I'm going to provide an update on our normalized load and performance for the quarter. And in general sense the AEP service territory has made significant momentum despite the well-publicized headwinds impacting the macro economy. Starting in the upper left corner, normalized residential sales increased by 1.2% in the second quarter and were up 1% year-to-date compared to 2021. This growth was comprised of growth in both customer counts and weather-normalized usage for both comparisons. While the results were mixed by operating the strongest residential growth was in the AEP Texas service territory, which consistently has the strongest customer growth across the AEP system due to favorable demographics. Moving to the right. Weather normalized commercial sales were up 4.1% compared to last year for both the quarter and year-to-date comparison. This consistent growth in 2022 is spread throughout the service territory. The growth in the commercial sales segment was spread across every operating company and nine of our 10 commercial sectors the only top commercial sector that is down versus last year's hospitals, which makes sense given that hospitalizations have dropped earlier in the pandemic. On the flip side, the fastest growing commercial sector is data centers were loaded up 32% compared to last year. Finally, focusing on the lower left corner, you see that industrial sales posted another strong quarter up 5% for the quarter, and up 5.3% year-to-date compared to last year. Industrial sales were up at every operating company in most of our largest sectors. We experienced double-digit growth in a number of key industries this quarter, including chemicals manufacturing and oil and gas extraction. We also saw robust growth in primary metals manufacturing, paper manufacturing, petroleum products, and coal mining. To summarize, we've experienced broad-based growth throughout the service territory on top of a recovery year. Every operating company has increased its sales in 2022 compared to last year. Growth is also consistent across every major retail class and most of the top commercial and industrial sectors served by AEP. We know the headlines are full of messages about a pending recession, but our sales statistics through the first half of the year show our service territory is still firmly in the expansion phase of the business cycle. We're mindful of the difficult monetary policy decisions being contemplated by the Federal Reserve to address inflationary pressures in the economy and recognize some of these decisions could impact our customer's growth opportunities going forward. But so far we're seeing little evidence that has dampened the economic activity within our footprint through the first two quarters of this year. Moving to slide 14, I want to provide additional context to the load we experience â we've experienced so far in 2022, and how it compares to our pre-pandemic sales levels. Starting with the chart on the left, the bars show how the second quarter sales compared to the pre-pandemic baseline in the second quarter of 2019. You'll notice that, the total retail sales are 3.6% above pre-pandemic levels. Furthermore, every class is showing higher sales than before the pandemic began. This means that every class is fully recovered and is in the expansion phase of the business cycle. The chart on the right shows the same comparisons for the year-to-date period. You'll notice that, while the numbers are slightly different the message is the same. Through June AEP's normalized sales are 2% above the pre-pandemic levels. And just like the quarter, every class has exceeded pre-pandemic levels on a year-to-date basis. Last year's strong growth numbers were expected considering it was a recovery year from the pandemic shutdowns. This year's growth is perhaps even more impressive considering, the growth as compared to a strong recovery year. We'll continue to monitor the economy and its impact on our load over the summer months and we'll provide the results of our updated load forecast this fall. So let's move on to slide 15 to discuss the company's capitalization and liquidity position. On a GAAP basis, our debt-to-capital ratio decreased 0.1% from the prior quarter to 61.4%. Taking a look at the upper right quadrant on this page, you'll see that our FFO to debt metric stands at 13.4% on a Moody's basis, and 13.3% on a GAAP basis, which is a decrease of 0.3% and 0.4% respectively from the prior quarter. The slight decrease can be attributed to an increase in deferred fuel balances, as well as a slight increase in balance sheet debt. As we stated on our last earnings call, we anticipate trending toward our targeted FFO to debt range of 14% to 15% as the year progresses. You can see our liquidity summary on the lower right of the slide our five-year $4 billion bank revolver and our two-year $1 billion revolving credit facility support our liquidity position, which remains strong at $4.7 billion. On the qualified pension front, while our funding status decreased 0.8% during the quarter, it remains comfortably strong at 105.6%. Negative returns on risk seeking and fixed income assets during the quarter were the primary drivers of the funded status decrease. However rising interest rates caused plan liabilities to decrease which provided a favorable offset to the negative asset returns. So, let's go to Slide 16 for a quick recap of today's message. The second quarter has provided a solid foundation for the rest of 2022 and we are reaffirming our operating earnings guidance range of $4.87 to $5.07. We continue to be committed to our long-term growth rate of 6% to 7%. We continue to work through the Kentucky Power sale to Liberty and are on-track for a closing later this summer and we'll be launching the auction process for our unregulated contracted renewables business, no later than early September. So, before I hand things over to the operator, I'd like to mention one thing. We had previously announced that we would be having an investor conference this year and we've set a date for that. As Nick mentioned we'll be hosting at our investor conference in New York City on October 4. So, we really do appreciate your time and attention today. With that I'm going to ask the operator to open the call so we can hear what's on your mind and take any questions that you have.
Operator: We'll first go to the line of Jeremy Tonet with JPMorgan. Go ahead.
Nick Akins: Good morning, Jeremy.
Jeremy Tonet: Just wanted to start off with load growth trends if I could. Just want to confirm here the full year load growth estimates have not been updated for year-to-date actuals or is there any reason to expect to fall off in the back half year?
Julia Sloat: That is correct. We have not updated anything yet. We are cautiously optimistic. We'll give you an updated view as we get closer to our Analyst Day or at our Analyst Day on October 4. So, stand by for that. As far as what you can expect for the second half, you know if I look at for example the residential load, obviously talk of recession and how inflation is outpacing wage growth could potentially have residential customers shift in their behavior a little bit. We'll see. So we're â again, we're cautiously optimistic there, but we do expect that it could be a little bit tempered on this particular customer segment by inflation energy cost, mortgage rates the lack of new stimulus those things that everybody knows about. So no surprise there but just general trends. So we're going to continue to keep a close eye on that particular segment. On the Commercial segment, I mentioned earlier that we had great performance in nine of the top sectors -- of our 10 top sectors with hospitals being the only one that was down. Again, we're keeping an eye on things like inflation, labor shortages, supply chain and borrowing costs. But again, at this point we don't have a reason to shift away and things continue to click along there. And similar on the industrial side, we see a lot of large customer expansions that are expected to come online throughout the rest of the year, which should support the momentum, but at the end weâre cautiously optimistic because we know that the federal reserve has a big job in front of it and it has to tap the brakes. So, we'll see how that ultimately impacts all of these. But so far, we're in a really good place a really good place. So hang tight and we'll be able to give you a little more granular view in terms of our expectations when we come to you this fall.
Nick Akins: We said, we told you I guess, it's probably a quarter or two ago, about reinforcing our service territory particularly, as it relates to energy and as it relates to onshoring. And our â certainly, our territory has been very strong in terms of both of those categories manufacturing as well. And that's clearly, become a benefit for us. So -- and really when you think about what's going on in the world today, associated with security aspects, that's really going to drive more towards the ability for onshoring to occur and certainly, for energy security. So it bodes well for our territory.
Jeremy Tonet: Got it. That's, great to hear there. And just want to pick up with -- I guess, we'll hear more details at the Analyst Day on these points with lower growth but also wanted to see what else, we might expect to hear at the Analyst Day. I suspect, the sales processes will get some more color there but is there anything else we should be looking for at the Analyst Day?
Nick Akins: Yes. There's â actually, you have the sales process. Obviously, everybody want to know about Kentucky, but also the unregulated contracted renewables there will be new data points on that as well. And then of course, a 2022 earnings guidance update, 2023 guidance range will be introduced and also we'll probably roll forward the five year capital and financing plans through 2027 and there could be other things too. So we will hold that till October 4.
Jeremy Tonet: Got it. We'll wait for that. And just the last one, if I could. Any thoughts on the renewable sale whether it makes more sense to do as an entire pack â package or in pieces I realize itâs very early stages here, but just wondering if thereâs any process share on that.
Nick Akins: Yes. The team is working at that. And certainly, I think the base case would be to sell all at one time. But if there are opportunities exist to stage that out with the capital needs, that would great. so weâre still going through that process and weâll go through as we talk earlier, we'll be going out to the market here in the September time frame. So we'll know a lot more at that point. So more to come October.
Jeremy Tonet: Got it. Great. Thank you for that.
Nick Akins: Yes.
Operator: Weâll go next to the line of Julien Dumoulin-Smith. Go ahead.
Nick Akins: Good morning., Julien.
Julien Dumoulin-Smith: Hi. Good morning, team. Thanks for the opportunity. Appreciate it. So maybe just a follow-up in brief on this operating arrangement in the two states here. I mean -- just what do you need to see from Liberty to be able to move forward here at this point in time? I just want to make sure I understand, exactly. Is this just about them acquiescing to sort of the updated position from the two states, or do you really need to resolve, say a specific transfer value et cetera here.
Nick Akins: Yes Julien. Certainly, Liberty has been great partners through this entire process. And we certainly, want to be fair to them because they were obviously, looking for certain things out of the transaction. We were looking for certain things. And I think, it's going to be just a matter of going through the process of defining risk, going forward. So it's not â obviously, it's not as cut and dry and saying it's going to be the existing agreements and tough luck will move on. It's really an issue, where there is an opportunity for us to get together with them and define that future, because we're going to be partners in that individual going forward. So we might as well get comfortable with that relationship. 100%.
Julien Dumoulin-Smith: Yes. Nick, I noticed in the comment -- the various comments you made in the prepared remarks on inflation. Can you elaborate a little bit more in just to, how that ties into both near and longer term? Again I get that you guys are providing an update in a couple of months here. But just elaborate a little bit on the pressure points that you are seeing of late just if you can define that and how that's cascading through. Maybe speak a little bit to the cadence of labor arrangements for instance et cetera?
Nick Akins: Yes, I missed the first part.
Julia Sloat: Yes. Yes. Yes. So, Julien I'll let Nick talk a little bit about supply and labor. But what we're also watching is in addition to our own costs and working with our individual parties around making sure we have material supplies equipment and folks that actually do the work. We're also paying attention to what's going on with our customers because as we talked earlier today load is a big piece of our driver for earnings year-to-date and this quarter so far and we hope to see that continue. But as we know as the Fed needs to take some action and tap on the brakes that could have some damn as it relates to actually all three of our individual customer segments. Now, as I mentioned earlier, Industrial segment looks reasonably healthy based on the customer expansions that we see in the pipeline, et cetera. But I don't think everyone can entirely escape the consequences. So, even from a commercial standpoint, if you look at the real estate segment, in particular, interest rates have a direct impact on that piece of that sector in that business and then of course, on the residential side that choose into the wallet because if you're sitting in a situation where your wage isn't growing as quickly as your costs are you may tend to want to tap the brakes there. Not to mention mortgage costs go up as well. So, keeping an eye on it from a customer perspective managing through it as it relates to our particular P&L. But I don't know Nick wanted to say anything about supply chain and labor?
Nick Akins: Yes. So -- and Julien sorry I missed the first part of your question. So, Julie filled in for me. Supply chain has certainly been an area of focus for the company and they've done a great job. The supply chain organization has done a great job of getting out ahead of that, understanding the delays that are occurring relative to delivery of transformers and those kinds of things. And then also size of inventories and other things come into question, but in our case we're a large electric utility with a lot of requirements, the largest transmission system in the country distribution obviously, wide spread. So, we have some -- we have abilities to really focus on the supply chain aspects in the positive way by expanding suppliers and certainly exerting the leverage we have associated with the large buying ability. So, we're in good shape from that perspective. Now, that being said, the entire industry and AEP are watching storm activity and those types of things and what implications that could have on the inventory levels and supply chain. So, we're watching that very closely. But we have time for the economy to really pick up and catch up from that perspective. Labor is an issue for everyone and certainly we continue to focus on that, particularly in our frontline employees to ensure that we're meeting the customers' requirements going forward. We're very tuned in to wage rates and those types of things that are changing dramatically. And certainly from a resource perspective we also have those relationships with not only attracting our own employees, but also contractors and so forth that we're able to pull from for various reasons. So, all-in-all, we're hanging in -- and the capital plan still remain secure in terms of the ability to move these projects forward. And we believe that AEP is in a great position to continue that process.
Julien Dumoulin-Smith: Super quick clarification on SPP, they're tweaked to the reserve margin. Does that impact your procurement efforts at all? I know you have a few things in flight just to clarify.
Nick Akins: No it doesn't. We're going through -- yeah we're going through regular as you've probably seen regular integrated resource planning processes with all of the Southwestern power approval states. And those processes will continue. I guess the good thing is that the things that we're putting in obviously we already talked about transmission and distribution in terms of supply chain activities. But in terms of resources, we're already putting integrated resource plans in for renewables. And the timing of those renewables, are such that we have time for the supply chain to catch-up relative to solar and wind components. So we're in good shape from that perspective.
Julien Dumoulin-Smith: Great. Thank you, guys.
Nick Akins: Sure.
Operator: We'll go next to the line of Shar Pourreza with Guggenheim Partners. Go ahead.
Nick Akins: Good morning, Shar.
Shar Pourreza: Good morning guys. How are you doing?
Nick Akins: Fine, how are you?
Shar Pourreza: Good. Nick just on the contracted renewable sales, we're kind of thinking about the process for the sale. There's obviously some conflicting data points out there right rates have picked up materially, there seems to be a few peers in the market selling as well. But on the other hand, just given supply chain issues deal on the ground is certainly more valuable. I guess, can you elaborate a bit more on the process when you plan on opening up the data rooms. And it's a tight time frame with the Analyst Day. So what data points can we get between September when you kick the process off in the Analyst Day which is only weeks process right? So I guess what's giving you a sense?
Nick Akins: Yeah. So these are well-known resources. And they're already there. And opened up a data room, can be done pretty quickly. And also review will be done quickly. I would say that the interest has been very robust and it will continue to be robust, because -- and you said it they have steel in the ground, but also the ability to continue on with these projects in a very positive sense. We took out Flat Ridge 2, so that makes the portfolio even better. And certainly from that perspective we expect the process to move very quickly. And when we bought the resources some of these resources from Sempra we visited sites and the data room was open. And we moved very quickly. And for these types of assets even though there may be others that are selling the assets, there is a robust focus by the market on certainly attracting these types of assets. So we feel very confident. We can move forward quickly and have certainly more information this year by the time we get to the Analyst Day.
Julie Sloat: Shar, this is Julie. As an anecdote, when we initially made this announcement, I can tell you that not only was I receiving calls Nick was receiving calls. Chuck Zebula whose team is running the process was receiving calls so a lot of inbound calls coming in. And as far as what you can anticipate, I get it it's a shorter time line assuming we launch at the very latest in early September we should be able to come back to you by October 4th with color on how that process is going. And you're right. I mean there are other folks in the market as well. That's why I think we need to get out there as soon as we can and get business taken care of. So that is absolutely the objective. And stay tuned we'll have more color to share with you.
Shar Pourreza: Do you think you could actually announce a deal on the fourth of the proceeds or the tight.
Nick Akins: No.
Shar Pourreza: Okay.
Nick Akins: Yeah, that will be too tough for that. Obviously and then that will depend on what we get back to in terms of one-time versus stage in all those types of things will have to be considered. And certainly we'll have more information, but we won't have a finalization of that'll be probably by the end of the year.
Shar Pourreza: Got it. Got it. Thanks. And just one last one on â I mean obviously your load growth and the backdrop in general has continued to show the ongoing strength, you highlight the fact that it's pre-pandemic levels. I guess how are you sort of thinking about 2022 in general and where you're within sort of that EPS range, especially given that we're kind of into the key months of the summer with Q3. I would think there's â obviously â this is a very strong tailwind for you especially as we're thinking about 2022, even though you guys are hedging ourselves a little bit on some of the uncertainties out there?
Nick Akins: Yes. It's always good to be ahead a little bit. Any time you go in the latter part of the year because summer is always good. And then you get in the fourth quarter with â you don't know where storm activity is going to go and that kind of thing. But we feel really good about the position that have right now. And certainly, if you look at the fundamentals of what's going on I mean, you take charge point out of it is a very, very positive quarter and certainly one in which we continue to grow and see it â our load guys are pretty optimistic. So â and if you knew our load guy, you know he's â it takes a long way for him to get there. But we feel really good about the position that we have. And I think as we see more towards the end of the year then we'll have more to say when it comes by the time the Analyst Day comes around.
Shahriar Pourreza: Okay. Terrific. Thank you, guys. Appreciate the color.
Operator: We'll go next to Steve Fleishman with Wolfe Research. Go ahead please.
Nick Akins: Good morning, Steve.
Steve Fleishman: Hey, good morning. Thanks. So just a question I think Julie mentioned the â on the Kentucky sale, the write-off you took of $0.15. Is that â should we read out is effectively reflecting your expectation of what kind of price change needs to be renegotiated for the this Mitchell issue? Is that kind of reflecting that or is that...
Nick Akins: No. That one was really focused on when Liberty and AEP got together to focus on the Kentucky transaction order itself and there were requirements associated with that. So â and we certainly were focused on making sure that that we completed that â that order and this requirement. So that's what that is.
Steve Fleishman: Okay. So I guess maybe then just on the difference between Kentucky and West Virginia and how Mitchell is treated. Could you just give a little more color on those differences and so we can kind of think about the value difference between the two?
Nick Akins: Yes. So â and I think it's pretty obvious that Kentucky had its view of valuation in 2028 and West Virginia has its view of valuation and 2028 and the two are in very different positions. And it's probably not something you're going to resolve today. So really it becomes an issue of okay, how do we get together and think about our continued operating partnership, which could be done through the operating committee of the existing operating agreements and then certainly focus on a later date to consider the risk issues associated with that. So â and I think for us I think it's sort of a realization that there will be no doubt that Kentucky Power will continue to be a partner in Mitchell. And then when the time comes before 2028, there'll have to be some reconciliation between what Kentucky wants and what the West Virginia Commission wants. And we just want to make sure those risk parameters are taken care of on the front end.
Steve Fleishman: Okay. But I guess what matters in terms of closing is really the arrangement between you and I guess Liberty in terms of
Nick Akins: Yeah. Thatâs right. Thatâs right.
Steve Fleishman: ⦠closing. So is that there would be some kind of just ability to negotiate some kind of certainty on that?
Nick Akins: Yeah. Because we have -- now we have an outside party involved with a third-party from AEP's perspective with Mitchell going forward. So that sort of drives a different view when everything was already owned by AEP companies. So you have to go through that process and determine okay, what's the right approach for Liberty to have that ownership and for AEP to have ownership at arm's length.
Steve Fleishman: Okay. But it sounds like you're confident this will be resolved with the buyer with the property relatively soon?
Nick Akins: Yeah. Yeah. Certainly, our people have been in constant contact on this issue. They're working very well together. I talked to Arun's as late as yesterday. So it's really both of us are very optimistic about this transaction.
Steve Fleishman: Okay. That's good.
Nick Akins: But always there was a difference there.
Steve Fleishman: Yeah. I'm sure he will when it's his chance for it to do a call. And then just on the -- on transmission, just anything that you kind of expect from FERC in the second half of the year to better identify both kind of their interest in getting a lot more transmission built, but at the same time still a little bit of kind of pressure on the ROEs. And just what are you watching there?
Nick Akins: Yeah. Obviously, reliability and resiliency is of central focus, not only to FERC, but the Congress as well. And I really believe they'll continue the process of all the areas of focus right now with NOPRs. They got several NOPRs out actually and they just put initiated around weatherization and making sure that we're as resilient as possible. And certainly from a transmission planning which was already done that NOPR along with they started the state process in terms of discussions relative to cost allocation those types of issues. So they're moving along. And when they issued that original NOPR under transmission, they made it clear that it wasn't going to be sequential. It's a multitasking opportunity for us to look at all these provisions. And then of course, the queues associated with the new resources and RTOs those are all being focused on. And I think FERC is doing a very credible job of marching through this and making sure that we are able to invest in transmission in a way that secures this country in so many ways. So I think that process will continue. Who knows what goes on with the ROEs, the 50 basis point adder and that kind of thing. That -- I mean that could take years to resolve. But, nevertheless, we'll continue moving forward with our investments and we'll continue to look forward to the rules, processes and procedures to be put in place where we as significant stakeholders in this process are allowed to make the investments that we need to make on a timely basis. There's no question that as we look at all the resources that are needed, the changes and the transmission system, fiber type issues that I'm sure that they'll be interested in as well in a regional activities associated with planning, ensuring that we're able to invest the way that we should on a timely basis with as little risk as possible. And that's really important because there are so many changes occurring. And for now you're seeing -- you really are seeing implications relative to resiliency and reliability. And I think everyone needs to take a pause and ensure that we're looking at that with our eyes wide open and that we're doing the right things at the right time. And that process continues. And I think FERC is doing a great job.
Steve Fleishman: Great. Thank you very much.
Nick Atkins: By the way most of those offers are pretty consistent with AEP's positions. So we feel really good about our role in enabling the policy to move forward.
Operator: We'll go next to the line of Durgesh Chopra with Evercore. Go ahead.
Nick Akins: Good morning Durgesh.
Durgesh Chopra: Hey, good morning team. Quick clarification on the Kentucky sale process is my first question. Just to be clear your discussions with Liberty on the Michel operating agreement and then the FERC approval. Those are two independent processes, right? So you don't have to go back to FERC with asking for a revised approval or something like that once you settle with Liberty on as it relates to Michel?
Nick Akins: Yeah. Certainly we believe with the original agreements and the ability to operate under the operating committee under that agreement, we can really focus on the status quo and ensuring that we're able to move forward with a partner that's a third party, so that the provisions of the agreement already provide for the ability to make those kinds of adjustments. So it's our belief that we do not need to go back to FERC for additional approvals.
Durgesh Chopra: Got it, okay. And then just maybe wanted to get your thoughts on valuation for your renewable assets. Maybe just -- how have they evolved since the first quarter call? It's been a volatile tape. Interest rates have been up. So just any color you can share with us there, you sort of, kick start this process in September?
Nick Akins: Well, obviously, we know that the headwinds of inflation and those types of things are areas of conflict with an increased valuation. But at the same time, you've got a lot of robust interest in these assets and the fact that continues to produce energy in a market that provides additional benefits for whoever winds up owning this asset. So, it's hard to tell what the valuations are going to look like right now. But I don't -- I mean certainly we're not concerned about all the macro issues that are involved because these assets stand pretty well in and out of itself and you have the positives and negatives. But now that -- and that's why we obviously took the adjustment on Flat Ridge 2, because we really wanted that out of the portfolio so that you wouldn't be arguing with bidders about what that valuation was and what the risks were of that particular project. The rest of them, or excellent projects that should bode well in the marketplace. So, like I said, I can't tell you any thoughts on what we see valuation to be. I think the market will tell us.
Julie Sloat: Just to provide you a little more color if you're trying to model, aside from giving you market price point. We did include in the presentation today on slide number 44, the breakdown of all of the projects that are included in the portfolio. You'll see that we've essentially removed Flat Ridge 2 like we talked about today, as it relates to asset value and that type of thing that's on our balance sheet. If you look at our balance sheet, today our asset value associated with the portfolio as it stands is about $2.1 billion. The equity position is about $1.4 billion. We do have some projects, debt and tax equity that totaled about $272 million. So, you can plug that into your model as well. And then, we do get the question around how much did this contribute to earnings. So, for 2022 for the Generation & Marketing segment, which is $0.31 total for our guidance, kind of that midpoint about $0.13 to $0.17 relates specifically to this portfolio. So you can kind of begin to back into whatever valuation you want to assign to it. And there is a very low tax basis associated with it, but we do have some capacity to absorb a tax gain, because we've got some credits sitting on the bench that we can use to offset that. So, don't view that as problematic or seriously gating for us because it's not -- we'll be able to hurdle over that.
Durgesh Chopra: Excellent. Thank you, both. Appreciate the color.
Nick Akins: Sure.
Operator: We'll go next to the line of Nick Campanella with Credit Suisse. Go ahead.
Nick Akins: Good morning, Nick.
Nick Campanella: Hey, good morning. Thanks for taking the questions.
Nick Akins: Sure.
Nick Campanella: Just a really quick follow-up on the Kentucky sale reduction. I noticed you have, like $1,400 of proceeds in the funding slides bill. So just, can you just reaffirm that are -- is everything going on in the past quarter that cash proceeds when you close to be unchanged.
Julie Sloat: We're good. You're good. No worries there. So, no change in that modeling or those assumptions. We're good.
Nick Campanella: Okay. Great, great. And then I guess just a question on strategy and Analyst Day. You've had some simplifying the business profile, the sale, the underwrite sales are on the horizon obviously. As we kind of think about funding this long-term CapEx plan, are you interested in pursuing further slated sales, unregulated sales, or are we kind of in the later innings of this portfolio rotation strategy?
Nick Akins: Yes. I'll say, obviously, we have a lot of capital to fund and we have a great plan to do it. I would probably look at the ownership levels of the new renewables projects and that's going to provide additional opportunity for us resilience and reliability certainly distributed energy resources. All these types of things in our plans are really providing us the opportunity to fine-tune our portfolio to match what the growth expectations we have around those areas. So, no, we're not done. We will continue to evaluate opportunities to add value from a shareholder perspective, but also to ensure that our customers are seeing the capital deployment that provides a better experience. And that's something that we're very focused on. So, this just going to â you're only seeing, really the beginning of the part of our business that is going to endure going forward, as we transition this company. And that process will certainly continue. That's why I sort of said, it's a continued execution around, and I use taking care of business, but adding a dash of let's go crazy that sort of says we're going to be thinking on the edge about what can be done to make sure that we fund these real opportunities we have ahead of us.
Nick Campanella: All right. Thank you very much. Weâll look to you in October. Thanks.
Nick Akins: Yeah.
Operator: And for our next question we'll go to the line of Stephen Byrd with Morgan Stanley.
Nick Akins: Good morning, Steve.
Dave Arcaro: Hi. It's Dave Arcaro on for Stephen. Thanks so much for taking our questions.
Nick Akins: Okay. Yeah. Hey, Dave.
Dave Arcaro: Wondering â hey, how are you doing? Wondering if you could give your latest expectations around federal climate policy here? Do you expect renewable tax credits to be in an extenders bill potentially towards the end of the year? And just generally anything you would expect in terms of deal climate legislation this year?
Nick Akins: Yeah. I think, it certainly it's going to be a challenge. And I think I said that, last quarter, it is going to be a challenge. And the way it appears to be coming together is there were some â there are some discussions going on. There may still be discussions going on. But right now, they're so focused on the healthcare pharmaceutical activities that may be bifurcated. And then â and certainly the Chips Act now, we're obviously for the Chips Act, because Intel is locating within our territory with two fabs, up to eight fabs, and that's a huge, huge positive. So you have things like that that are going on now not only that, but obviously the midterms are providing some overhang to getting even a smaller package done, although there has been discussions of working on that and trying to get something done by September 30. But even that is going to be a really hard thing to do. So again, I would say, post election you're probably dealing with either some form of a smaller package, or extenders which that's a typical thing that happens toward the end of the year, when ITCs, PTCs start to roll off, again, you'll see extenders or the IRS of supply chain activities being able to extend it for some period of time. You'll probably see some Band-Aid solutions until you see solid solution going forward. So I just think the environment is certainly very volatile right now, and it will take time to work itself out. And maybe even post election, again, you'll maybe have some sense of calmness to be able to focus in on some of these things that are important, because our industry. And by the way, our 16,000 megawatts does not include any extension of ITCs, PTCs. But we are definitely for those extensions and expansions to nuclear and as well to storage. Those are clear opportunities for us to redefine the resource plans going forward. Direct Pay is also very important us, but we -- that would make -- at least at this point, as a test sale, maybe later on we can convince everybody that that truly is a benefit to our customers. So anything we get from that perspective will ultimately be a benefit to our customers from an economic standpoint and that will be good for, not only our movement to a clean energy economy, but the options that we have available to us, namely with storage, nuclear, hydrogen hubs, those kinds of things need to continue to be looked at to make sure we're resilient and reliable going forward. So that's where we stand right now, I think.
Dave Arcaro: Got it. Thanks. That's helpful color. Maybe, just one just small follow-up. I was just wondering, at Flat Ridge, if the issues that you found there? Is that just an exclusive to that project? It didn't have any other -- or none of the other assets in the portfolio had similar issues asâ¦
Nick Akins: Thatâs right.
Dave Arcaro: -- going on at Flat Ridge and that was the only one you plan to extract.
Nick Akins: That's right. That's why we separated that one. Yes. The others are good.
Dave Arcaro: Understood. Okay, great. Thanks so much.
Operator: Okay. We will go next to the line of Andrew Weisel with Scotiabank. Go ahead, please.
Nick Akins: Good morning, Andrew.
Andrew Weisel: Thanks. Good morning, everyone. Just one for me about coal. So between reliability concerns in the Supreme Court ruling that you mentioned, do you see any potential -- some coal plants online beyond their current schedule dates, beyond Mitchell, which is a bit of a unique situation. But would you consider extending them? And if so, would they be potential back up as peakers went, or keep some as either intermediate or baseload resources.
Nick Akins: Well, I think, that's exactly why, certainly, we said a rational and reasonable approach to moving forward from a resource perspective. We have to be able to maintain reliability, resiliency and economics for the grid and to our customers. And certainly, for our units, we continue to progress along the path that we've already placed in line. And actually, you have to do that to be able to define the future. And we're very, very focused on the just transitional aspects of our communities as we make any transition. So you touched on a point that's particularly important, for resiliency and reliability reasons, the capacity provided by these units is extremely important. And whether the capacity factors move down, as you bring in and layer in more renewable energy and clean energy, that's fine, as long as you have the resource to be able to meet the demands. And then, eventually, we have to find a path that ensures the communities continue to thrive from a tax standpoint, fire protection, police protection, school boards, all that kind of stuff. We have to be able to look at that. We can't just shut down these communities and then decide something else. So in areas like West Virginia with the coal-fired generation, we have to define what that path is. It may be small modular reactors, if we can define what that risk is and limit it from a shareholder perspective. Certainly, DOE is very interested in that. And it just so happens, the jobs of a small modular reactor is the same as a coal plant and paying the same taxes and those types of things that's an opportunity to take a look at whether it's hydrogen hubs or storage or other activities. So we've got to be able to rationalize that. But coal has provided an important benefit in coal generation particularly during these summer months. And obviously, during the winter months as well and we've got to be mindful of how that process continues. So that's why we have to say it has to be rational reasonable and with the time frame that makes sense.
Andrew Weisel: Thanks. Itâs very helpful.
Nick Akins : Yes.
Operator: We'll go next to the line of Michael Lapides with Goldman Sachs. Go ahead.
Michael Lapides: Good morning. Nick I know you're excited about the Analyst Day even you're probably equally as excited as having Brian Kelly down in Baton Rouge.
Nick Akins : Yes.
Michael Lapides: I'm looking at the earned ROE versus authorized pivot. Just have a couple of questions about few of the subs. How are you thinking about what structural changes in rate making. Your team is going to seek in the next couple of years in a few of the jurisdictions that are earning a good bit below that. We think in PSO, we're honestly you fought under-earning for a number of years, but also thinking a little bit on APCo, a little bit on SWEPCO.
Nick Akins : Yes. So, obviously, there's been substantial opportunities there in those regions of the country, because actually when we put in renewables, the renewables is helping from an ROE perspective. So -- and obviously from -- as it reduces rates to customers from a fuel standpoint and overall in the savings gives us an opportunity to deploy capital investment in those areas. Sometimes obviously, we'll spend capital to make sure that we're doing those things to ensure resilience liability and all those activities. But particularly, from an ROE perspective, a ratemaking standpoint, equity layers has certainly been a big push of ours and certainly from a concurrent recovery standpoint with formula-based rates we have forward-looking rates in Indiana and Michigan. We like to see that in other jurisdictions with the massive amounts of capital that we're deploying. And then typically the renewables are tracked as part of the investment until we get it in rate base and that's worked out great for us. I think -- and you're also seeing opportunities for us to really get out ahead with the commissions on what we're trying to achieve in terms of not only benefits to our customers, but also the ability for our customers to use our product. I mean, I look at on the customer side with distributed energy resources with the analytics and all the equipment that can be put in place to enable customers to make wise judgments would be highly beneficial not just for the operations of the grid, but also to mitigate their own fuel costs and bills during periods of time and obviate the need for the securitization or other things that we have to do in huge storm-related environments. So, I think there's a lot of good things going on. And the trackers, I think, it's 85% of our recovery is tracker base. So we'd like to improve on that as well. I think there has to be a recognition that cash coming into the utility is particularly important and we always talk about FFO to debt and the utilities with all the massive investments necessary. We need to be able to see the cash coming in the door so that we can continue to make those kinds of investments. So that's going to be huge message for our regulators going forward as well. But we're doing good things. And as long as we're doing good things and spending on the right things, we believe we're aligned with our commissions and our customers on the right path forward and we feel very good about the path that we're on.
Julie Sloat: Michael, maybe a little more help there too on PSO in particular. We've got securitization that we'll be completing here next month. So in August for the storm Yuri cost, so that should help to alleviate some of this pressure as well. And we'll be filing another base case. So stay tuned for that as well. And as Nick mentioned, just some refinement around utilization of different rate adjustment clauses, et cetera, not only in West Virginia, Virginia but then also as we take a look at SWEPCO, we still have the outstanding component that's not included in rates. So we've got different ways to get after it and you'll see us talk more about that as we come at you here on October 4. So stay tuned.
Michael Lapides: That's great. And one quickly final up. Just Cardinal on the G&M segment had a big benefit during the quarter, just given where power prices were versus your delivered cost of coal. Can you remind us how you're thinking about the future for Cardinal going forward?
Nick Akins: Yes. So Cardinal, you're talking about the Cardinal plant. Yes. Soâ¦
Michael Lapides: Yes.
Nick Akins: So â we plan on completing a transaction with Buckeye related to that particular plant. So they would take ownership of the plant and we would take a PPA back for a certain period. So â and then that means we will not have any generation to speak of left in Ohio on the unregulated side. So â and that it's a long way from where we were in Ohio. But I think it's also there's a message for Ohio in terms of generation that needs to be placed in this state. So that's probably another issue I can get into it but I'll stop there. But I think that's all in the plans already.
Julie Sloat: Yes Michael. So that PPA with Cardinal goes I think through 2028 to give you a endpoint on that as well.
Michael Lapides: Got it. Thank you, guys. Thanks, Nick. Thanks, Julie. Much appreciate it.
Nick Akins: Sure. Thanks. Talk to your later.
Operator: We'll go to the line of Sophie Karp with KeyBanc. Go ahead.
Nick Akins: Good morning, Sophie.
Sophie Karp: Hi. Good morning. Thank you for squeezing me in. We have a lot has been discussed already, but if I may just ask a couple of questions. First on transmission. So you made a point of saying that transmission Transco remains one of your I guess key growth engines. So I don't want to miss quality base. But â and also at the same time you're talking about not being done with divestitures of something it's a non-core business. Can you maybe help us frame how you think about transmission? Is it â are you making these comments because you're getting questions about potential transmission sale? And how are you thinking about that, or should we not read too much in this.
Nick Akins: No I don't read too much into it because transmission is a key component for our not only for our investment in the company but also in terms of what we see relative to the transition to the future. Transmission is a key component for resiliency, reliability and optimization, as we move to a clean energy environment. So, no, we're -- from a transmission standpoint, we feel very good about our role relative to transmission. And actually, I see distribution continuing to grow and certainly the renewables transformation itself. So, no, don't read anything into that.
Sophie Karp: All right. Thank you for clarifying that. And then my second question was a little bit of a housekeeping question I guess. I'm looking at the -- related to new growth opportunity exhibit at slide 40. And it seems like for APCo, when the opportunity has been reduced a little bit and solar increase a little bit in the 2020 to 2030 time frame. I'm just kind of wondering, if that's just some project realignment, or should we be -- how should we be thinking about this?
Nick Akins: Yes. So the April integrated resource plan, certainly showed what was needed from an APCo perspective. So -- and I think there's probably more to come on that, but it's actually immaterial at this point.
Sophie Karp: All right. Thank you.
Operator: And speakers' we have no further lines in queue at this time.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Alan, would you please give the replay information?
Operator: Yes, I will. Ladies and gentlemen, this conference will be made available for replay beginning today. This is the 27th of July and that starts at 05:30 PM. You can access the AT&T replay service by dialing toll-free 866-207-1041. International participants may dial area code 402-970-0847. The access code is 9751677. That replay will be available until August 4, 2022 at midnight. Those numbers again are toll-free 1-866-207-1041, internationally area code 402-970-0847, the access code is 9751677. That will conclude your conference call for today. Thank you for your participation and for using AT&T Event Teleconferencing. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Welcome to the American Electric Power Second Quarter 2022 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later there will be an opportunity for questions-and-answers session. And as a reminder, your conference call is being recorded. I'll now turn the conference call over to your host, Vice President of Investor Relations, Darcy Reese. Go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you Alan. Good morning, everyone and welcome to the second quarter 2022 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release presentation slides and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer; and Julie Sloat, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick."
},
{
"speaker": "Nick Akins",
"text": "Okay. Thanks Darcy. Welcome everyone to American Electric Power's second quarter 2022 earnings call. AEP continues to make progress on the strategic initiatives we announced earlier this year with strong execution against our plan resulting in another solid quarter. Later in the call Julie will walk you through our second quarter performance drivers including the strong load increases we're experiencing in our territory, as well as provide additional details surrounding our financial position. But I'll start with the key financial highlights for the quarter. We'll then move to an update on our Kentucky operations sale process and timeline. I will also spend time discussing the progress we are making in our transition to a clean energy future as we simplify and derisk our business profile by divesting unregulated renewable assets while maintaining focus on our responsible generation fleet transformation and regulated renewables execution. I will close by providing some additional insights into our ongoing regulatory activities including our transmission business. We are very pleased with our positive momentum this quarter, delivering operating earnings of $1.20 per share or $618 million. We are moving full speed ahead towards the increased operating earnings guidance range and long-term earnings growth rate we provided during our fourth quarter 2021 earnings call and we are reaffirming both financial targets this quarter. As a reminder we are guiding to an operating earnings guidance range of $4.87 to $5.07 per share for 2022 with a $4.97 midpoint and a long-term earnings growth rate of 6% to 7%. We are also continuing to ensure we are best positioned for value creation as we navigate the macro trends impacting our industry and the broader economy. We are working with states to drive expansion in our service territory while considering global economic uncertainty inflationary pressures and of course customer bills. We're also diversifying our mix of suppliers to minimize supply chain disruptions for our customers in business while also lessening the impact on our capital investment plan. We know that timing of the closing of the sale of Kentucky Power and AEP Kentucky Transco to Liberty as top of mind, and we have been working with Liberty to obtain the approvals necessary for closing this summer. A regulatory timeline of the sale can be found on slide seven of today's presentation. We are pleased to report the Kentucky Commission approved the key milestone in the transaction with an order approving the sales transfer in early May. As we have discussed previously a prerequisite in our contract of Liberty for closing the sale is approving the approval of new Mitchell operating agreements by both the Kentucky Public Service Commission and the West Virginia Public Service Commission. While we receive the related Mitchell orders from the Kentucky Commission on May 3 and the West Virginia Commission on July 1, the two states approved the operating agreement with different formats and some divergent post 2028 plant provisions. However, through the two proceedings, both commissions have indicated an ability to use the existing agreement as a basis to operate the plant going forward and accomplish their differing expectations for investment in operations. For that reason, on July 11, we made a compliance filing in West Virginia, and filed an update with Kentucky, providing an alternative way to move forward with Mitchell operations in the near term. We inform both commissions that we will operate under the existing agreement and manage the new operational focus of the two commissions through the operating committee. In the absence of any new agreements, the existing Mitchell operating agreement is still in effect and we believe, no additional regulatory approvals should be required. Since regulatory approval of the new Mitchell operating agreements is a prerequisite in our contract with Liberty for the closing. In the absence of such proposal, we are working with Liberty on the commercial solution for Mitchell-related operations and both parties remain optimistic about reaching a resolution and closing the transaction. At this time, the only regulatory matter currently pending is the 203 application at FERC related to the cell transfer, which FERC is currently considering. We are in the final stages of the Kentucky operations sale process and expect to close this summer. Moving to our unregulated renewable portfolio, in May, we closed on the sale of five unregulated development sites located in the Southwest Power Pool area, marking the successful divestiture of the majority of our wind and solar development assets. As we mentioned last quarter, we have also signed an agreement to sell a solar development site in Ohio, with that transition close expected also in the third quarter. In addition, we are in discussions with an interested party sale of our Flat Ridge II Wind Farm ownership, consisting of 235 megawatts, simplifying the resulting portfolio for our upcoming auctions. These milestones demonstrate our commitment to continued execution. As we announced during our fourth quarter earnings call in February, we are selling our unregulated contracted renewables portfolio in order to simplify and derisk the company and facilitate investment in our regulated businesses. We are in the final stages of preparation of the marketing materials for the auction and expect an official launch of the process no later than early September. After the removal Flat Ridge II, the portfolio consists of 1,365 megawatts of contracted renewable assets, consisting of 1,200 megawatts of wind and 165 megawatts of solar, geographically diversified throughout the US. There has been robust, inbound interest in the portfolio and we expect the process to proceed quickly. As a reminder, utilization of contracted renewable sale proceeds is not yet reflected in our multiyear financing plan. We remain focused on maximizing transaction proceeds and directing additional capital to our regulated businesses, where we have meaningful pipeline of investment opportunities to better serve our customers, as we push toward a clean energy future and enhanced transmission infrastructure. As always, we are open-minded and we'll evaluate all value-additive potential activities, as we focus on our regulated businesses, where we see meaningful long-term opportunities for growth. AEP continues to make significant progress in our transition to clean energy resources through our regulated renewables execution. Details regarding the specific actions we are taking can be found on slides eight and nine in today's presentation. We are also firmly grounded in our principles of resiliency, reliability and affordability while recognizing the increasing value of our diverse resource portfolio against the backdrop of energy-related volatility. SWEPCO is taking steps to secure renewable resources, making regulatory filings in May in Arkansas, Louisiana and Texas to own three renewable turnkey projects totaling 999 megawatts. This $2.2 billion investment is currently reflected in our five-year $38 billion capital plan. SWEPCO expects to issue another RFP in the near term consistent with its RFP for energy and capacity needs. APCo's 409 megawatts of owned solar and wind resources were approved by West Virginia and Virginia, marking an $841 million capital investment that is also included in our current capital plan. Request for a proposal are in process in APCo, O&M and PSO with expected in-service dates in the year-end 2024 and 2025 timeframe. We also expect to make regulatory filings to acquire additional renewable resources prior to year-end 2022. Finally the US Supreme Court ruling at the end of June related to the federal EPAâs regulation of greenhouse gas emissions will not require any changes to AEP's current generation and compliance planning. Our generation fleet transformation plans are well on track. We remain fully committed to our target of an 80% carbon reduction emission -- emission reduction rate by 2030 and net zero by 2050 and we are proud of the work well underway at AEP to help us achieve this goal. Reaching these targets is foundational to our long-term strategy and we believe we are on the right path toward prioritizing regulated investment opportunities and transitioning our generation fleet. Turning now to a brief update on our regulatory activity. Our regulated ROE as of the end of June 2022 is 9.2%. We continue to work through regulatory cases and maintain our focus on reducing our authorized versus actual ROE spreads. Additional regulatory activity in the quarter included a commission order received in May on SWEPCO's Arkansas rate case, including a 9.5% ROE, marking a net revenue increase of $28 million and a capital structure of 55% debt to 45% equity. We are also expecting a decision on SWEPCO's losing out a rate case in the third quarter. Oral arguments related to APCo's 2020 Virginia base case were held in March 2022 at the Virginia Supreme Court, with an anticipated final decision later this year. FERC recently initiated several rule-making proceedings related to transmission planning, cost allocation, generation interconnection to the transmission grid and extreme weather preparedness. We support the commission in these actions and are in full support -- full agreement that that reform is needed to build the infrastructure necessary to transition our generation fleet in the most efficient and cost-effective way possible, while also helping achieve our carbon reduction goals. These proposed rules align with AEPâs objectives of developing a more robust, reliable and flexible grid of the future that ultimately reduces cost to customers and strengthens economic development in our communities. Before I turn it over to Julie, I want to take a moment to thank our team for the incredible work that they are doing as we execute against our strategic objectives and deliver for our stakeholders. What's going on today at AEP is a perfect blend of the execution of BachmanâTurner Overdriveâs \"Takin' Care Of Business\" with the edge of Princeâs \"Let's Go Crazy\" in a good sense, of course. We have an incredible market position, a bold mission and the foundation in place to achieve our goals to deliver on our vision of further modernizing our energy grid in order to supply reliable, cleaner, low-cost resources for all the communities serve. As we think about the future and the next chapter of AEP, we're excited to share more about our plans at AEP's upcoming Analyst Day on October 4 in New York City. We will provide additional detail soon and look forward to seeing you there. Julie, over to you."
},
{
"speaker": "Julie Sloat",
"text": "Thanks, Nick. Thanks, Darcy. It's good to be with everyone this morning. Good morning and thanks for dialing in. I'm going to walk us through our second quarter and year-to-date results, share some updates on our service territory load, and finish with commentary on our credit metrics and liquidity as well as some thoughts on our guidance, financial targets, and then recap our current portfolio management activities underway. So let's go to slide 10 which shows the comparison of GAAP to operating earnings. GAAP earnings for the second quarter were $1.02 per share compared to $1.16 per share in 2021. GAAP earnings through June were $2.43 per share compared to $2.31 per share in 2021. There's a detailed reconciliation of GAAP to operating earnings on pages 18 and 19 of the presentation today, but I'd like to call out three of the reconciling items that do not affect operating earnings, but relate to our asset optimization activities underway. Specifically, you'll see that we made an adjustment to arrive at our operating for the quarter and year-to-date periods consisting of Kentucky sale costs and the write-off of one of the unregulated universal scale wind projects that's included in the portfolio. We're in the process of preparing for sale. The Kentucky sale charge reflects an anticipated reduction in the sales price as we work with Liberty to accommodate adjustments for costs that have been identified through the regulatory approvals that we've received. Turning to the renewable investment write-off the Flat Ridge 2 projects specifically has continued to see deteriorating performance due to equipment issues and transmission congestions to avoid another otherwise necessary repowering investment to address the performance issue and complicate our portfolio sales process. We elected to write-off the equity investments are in discussions with an interested party for the sale of ownership interest in Flat Ridge 2. Consequently, this will remove the Flat Ridge 2 project from the portfolio we're preparing for auction, which should help improve the valuation opportunity as investors engage in the sales process, which is scheduled to launch no later than early September. Lastly, I'll mention that we monetize some mineral rights which give rise to a benefit to GAAP, but non-operating earnings, which helps offset the charges I just mentioned. So while I would typically not spend time walking through the GAAP to operating reconciliation, I thought it was appropriate at this time given the milestones we're clearing on the asset optimization front. And while these charges and gains are things that we need to recognize they are entirely driven by our efforts derisk, simplify and bring cash in the door to support our continued investment in the regulated business. So with that let's go to slide number 11 and walk through our quarterly operating earnings performance. Operating earnings for the second quarter totaled $1.20 per share or $618 million compared to $1.18 million per share or $590 million in 2021. Operating earnings for vertically integrated utilities were $0.59 per share up $0.14. Favorable drivers included rate changes across multiple jurisdictions, positive weather primarily in our western jurisdictions, increased transmission revenue and normalized retail load and income taxes. These items were somewhat offset by increased depreciation in O&M and lower off-system sales. Just as a reminder on the O&M and depreciation front, as I mentioned on the first quarter call and included in our 2022 guidance details because of a change in accounting related to the Rockport Unit 2 lease at I&M, we're seeing approximately $0.05 of favorable O&M offset by $0.05 of unfavorable depreciation in each quarter of 2022, but no consequential earnings impact. And so I'll have a little more to share on loan performance and I'll get to that in a minute here. So just hang with me. The Transmission and Distribution Utilities segment earned $0.32 per share, up $0.01 compared to last year. Favorable drivers in this segment included rate changes, load, positive weather in Texas and Ohio and increased transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. AEP Transmission Holdco segment contributed $0.27 per share, down $0.07 compared to last year, favorable investment growth of $0.03 was more than offset by an unfavorable true-up of $0.07. As I mentioned last quarter, this is consistent with our guidance. Our 2022 guidance had this segment down by $0.08 year-over-year as a result of the $0.12 of investment growth being more than offset by the annual true-up that occurred this quarter and some favorable on comparisons on the tax and financing side. This segment continues to be an important part of our 6% to 7% EPS growth as you well know. Generation and Marketing produced $0.18 per share, up $0.09 from last year. The positive variance is primarily due to the sale of renewable development sites as well as increased generation margins and land sales. Finally, Corporate and Other was down $0.15 per share driven by lower investment gains increased income taxes and unfavorable interest. The lower investment gains are largely related to charge point gains that we had in the second quarter of 2021 that have reversed this year. The increased income taxes are related to the reduction of a consolidating tax adjustment at the parent. Let's turn to Slide 12 and our year-to-date operating earnings performance. Year-to-date operating earnings totaled $2.42 per share or $1.234 billion, compared to $2.33 per share or $1.160 billion in 2021. Operating earnings for the vertically integrated utilities were $1.18 per share, up $0.18. Similar to the quarter, favorable drivers included rate changes across multiple jurisdictions, positive weather mainly in our western jurisdictions, increased transmission revenue and normalized retail load and income taxes. These items were somewhat offset by increased depreciation and lower off-system sales. Once again the change in accounting around the Rockport Unit 2 lease results in $0.11 of favorable O&M offset by $0.11 of favorable -- unfavorable depreciation. The Transmission & Distribution Utilities segment earned $0.62 per share, up $0.08 compared to last year. Favorable drivers in this segment included rate changes in Texas and Ohio and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. AEP Transmission Holdco segment $0.62 per share down $0.06 compared to last year. Favorable investment growth of $0.05 was more than offset by unfavorable true-up of $0.07 and increased property taxes. The Generation & Marketing segment produced $0.21 per share, up $0.05 from last year. The positive variance is primarily due to the sale of renewable development sites and increased wholesale margins offset by lower retail margins. Finally, Corporate and Other was down $0.16 per share driven by lower investment gains, unfavorable interest and increased O&M. The lower investment gains again are largely related to charge point gains that we had in 2021 that have reversed this year. Turning to Slide 13. I'm going to provide an update on our normalized load and performance for the quarter. And in general sense the AEP service territory has made significant momentum despite the well-publicized headwinds impacting the macro economy. Starting in the upper left corner, normalized residential sales increased by 1.2% in the second quarter and were up 1% year-to-date compared to 2021. This growth was comprised of growth in both customer counts and weather-normalized usage for both comparisons. While the results were mixed by operating the strongest residential growth was in the AEP Texas service territory, which consistently has the strongest customer growth across the AEP system due to favorable demographics. Moving to the right. Weather normalized commercial sales were up 4.1% compared to last year for both the quarter and year-to-date comparison. This consistent growth in 2022 is spread throughout the service territory. The growth in the commercial sales segment was spread across every operating company and nine of our 10 commercial sectors the only top commercial sector that is down versus last year's hospitals, which makes sense given that hospitalizations have dropped earlier in the pandemic. On the flip side, the fastest growing commercial sector is data centers were loaded up 32% compared to last year. Finally, focusing on the lower left corner, you see that industrial sales posted another strong quarter up 5% for the quarter, and up 5.3% year-to-date compared to last year. Industrial sales were up at every operating company in most of our largest sectors. We experienced double-digit growth in a number of key industries this quarter, including chemicals manufacturing and oil and gas extraction. We also saw robust growth in primary metals manufacturing, paper manufacturing, petroleum products, and coal mining. To summarize, we've experienced broad-based growth throughout the service territory on top of a recovery year. Every operating company has increased its sales in 2022 compared to last year. Growth is also consistent across every major retail class and most of the top commercial and industrial sectors served by AEP. We know the headlines are full of messages about a pending recession, but our sales statistics through the first half of the year show our service territory is still firmly in the expansion phase of the business cycle. We're mindful of the difficult monetary policy decisions being contemplated by the Federal Reserve to address inflationary pressures in the economy and recognize some of these decisions could impact our customer's growth opportunities going forward. But so far we're seeing little evidence that has dampened the economic activity within our footprint through the first two quarters of this year. Moving to slide 14, I want to provide additional context to the load we experience â we've experienced so far in 2022, and how it compares to our pre-pandemic sales levels. Starting with the chart on the left, the bars show how the second quarter sales compared to the pre-pandemic baseline in the second quarter of 2019. You'll notice that, the total retail sales are 3.6% above pre-pandemic levels. Furthermore, every class is showing higher sales than before the pandemic began. This means that every class is fully recovered and is in the expansion phase of the business cycle. The chart on the right shows the same comparisons for the year-to-date period. You'll notice that, while the numbers are slightly different the message is the same. Through June AEP's normalized sales are 2% above the pre-pandemic levels. And just like the quarter, every class has exceeded pre-pandemic levels on a year-to-date basis. Last year's strong growth numbers were expected considering it was a recovery year from the pandemic shutdowns. This year's growth is perhaps even more impressive considering, the growth as compared to a strong recovery year. We'll continue to monitor the economy and its impact on our load over the summer months and we'll provide the results of our updated load forecast this fall. So let's move on to slide 15 to discuss the company's capitalization and liquidity position. On a GAAP basis, our debt-to-capital ratio decreased 0.1% from the prior quarter to 61.4%. Taking a look at the upper right quadrant on this page, you'll see that our FFO to debt metric stands at 13.4% on a Moody's basis, and 13.3% on a GAAP basis, which is a decrease of 0.3% and 0.4% respectively from the prior quarter. The slight decrease can be attributed to an increase in deferred fuel balances, as well as a slight increase in balance sheet debt. As we stated on our last earnings call, we anticipate trending toward our targeted FFO to debt range of 14% to 15% as the year progresses. You can see our liquidity summary on the lower right of the slide our five-year $4 billion bank revolver and our two-year $1 billion revolving credit facility support our liquidity position, which remains strong at $4.7 billion. On the qualified pension front, while our funding status decreased 0.8% during the quarter, it remains comfortably strong at 105.6%. Negative returns on risk seeking and fixed income assets during the quarter were the primary drivers of the funded status decrease. However rising interest rates caused plan liabilities to decrease which provided a favorable offset to the negative asset returns. So, let's go to Slide 16 for a quick recap of today's message. The second quarter has provided a solid foundation for the rest of 2022 and we are reaffirming our operating earnings guidance range of $4.87 to $5.07. We continue to be committed to our long-term growth rate of 6% to 7%. We continue to work through the Kentucky Power sale to Liberty and are on-track for a closing later this summer and we'll be launching the auction process for our unregulated contracted renewables business, no later than early September. So, before I hand things over to the operator, I'd like to mention one thing. We had previously announced that we would be having an investor conference this year and we've set a date for that. As Nick mentioned we'll be hosting at our investor conference in New York City on October 4. So, we really do appreciate your time and attention today. With that I'm going to ask the operator to open the call so we can hear what's on your mind and take any questions that you have."
},
{
"speaker": "Operator",
"text": "We'll first go to the line of Jeremy Tonet with JPMorgan. Go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to start off with load growth trends if I could. Just want to confirm here the full year load growth estimates have not been updated for year-to-date actuals or is there any reason to expect to fall off in the back half year?"
},
{
"speaker": "Julia Sloat",
"text": "That is correct. We have not updated anything yet. We are cautiously optimistic. We'll give you an updated view as we get closer to our Analyst Day or at our Analyst Day on October 4. So, stand by for that. As far as what you can expect for the second half, you know if I look at for example the residential load, obviously talk of recession and how inflation is outpacing wage growth could potentially have residential customers shift in their behavior a little bit. We'll see. So we're â again, we're cautiously optimistic there, but we do expect that it could be a little bit tempered on this particular customer segment by inflation energy cost, mortgage rates the lack of new stimulus those things that everybody knows about. So no surprise there but just general trends. So we're going to continue to keep a close eye on that particular segment. On the Commercial segment, I mentioned earlier that we had great performance in nine of the top sectors -- of our 10 top sectors with hospitals being the only one that was down. Again, we're keeping an eye on things like inflation, labor shortages, supply chain and borrowing costs. But again, at this point we don't have a reason to shift away and things continue to click along there. And similar on the industrial side, we see a lot of large customer expansions that are expected to come online throughout the rest of the year, which should support the momentum, but at the end weâre cautiously optimistic because we know that the federal reserve has a big job in front of it and it has to tap the brakes. So, we'll see how that ultimately impacts all of these. But so far, we're in a really good place a really good place. So hang tight and we'll be able to give you a little more granular view in terms of our expectations when we come to you this fall."
},
{
"speaker": "Nick Akins",
"text": "We said, we told you I guess, it's probably a quarter or two ago, about reinforcing our service territory particularly, as it relates to energy and as it relates to onshoring. And our â certainly, our territory has been very strong in terms of both of those categories manufacturing as well. And that's clearly, become a benefit for us. So -- and really when you think about what's going on in the world today, associated with security aspects, that's really going to drive more towards the ability for onshoring to occur and certainly, for energy security. So it bodes well for our territory."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's, great to hear there. And just want to pick up with -- I guess, we'll hear more details at the Analyst Day on these points with lower growth but also wanted to see what else, we might expect to hear at the Analyst Day. I suspect, the sales processes will get some more color there but is there anything else we should be looking for at the Analyst Day?"
},
{
"speaker": "Nick Akins",
"text": "Yes. There's â actually, you have the sales process. Obviously, everybody want to know about Kentucky, but also the unregulated contracted renewables there will be new data points on that as well. And then of course, a 2022 earnings guidance update, 2023 guidance range will be introduced and also we'll probably roll forward the five year capital and financing plans through 2027 and there could be other things too. So we will hold that till October 4."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. We'll wait for that. And just the last one, if I could. Any thoughts on the renewable sale whether it makes more sense to do as an entire pack â package or in pieces I realize itâs very early stages here, but just wondering if thereâs any process share on that."
},
{
"speaker": "Nick Akins",
"text": "Yes. The team is working at that. And certainly, I think the base case would be to sell all at one time. But if there are opportunities exist to stage that out with the capital needs, that would great. so weâre still going through that process and weâll go through as we talk earlier, we'll be going out to the market here in the September time frame. So we'll know a lot more at that point. So more to come October."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Great. Thank you for that."
},
{
"speaker": "Nick Akins",
"text": "Yes."
},
{
"speaker": "Operator",
"text": "Weâll go next to the line of Julien Dumoulin-Smith. Go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning., Julien."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hi. Good morning, team. Thanks for the opportunity. Appreciate it. So maybe just a follow-up in brief on this operating arrangement in the two states here. I mean -- just what do you need to see from Liberty to be able to move forward here at this point in time? I just want to make sure I understand, exactly. Is this just about them acquiescing to sort of the updated position from the two states, or do you really need to resolve, say a specific transfer value et cetera here."
},
{
"speaker": "Nick Akins",
"text": "Yes Julien. Certainly, Liberty has been great partners through this entire process. And we certainly, want to be fair to them because they were obviously, looking for certain things out of the transaction. We were looking for certain things. And I think, it's going to be just a matter of going through the process of defining risk, going forward. So it's not â obviously, it's not as cut and dry and saying it's going to be the existing agreements and tough luck will move on. It's really an issue, where there is an opportunity for us to get together with them and define that future, because we're going to be partners in that individual going forward. So we might as well get comfortable with that relationship. 100%."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes. Nick, I noticed in the comment -- the various comments you made in the prepared remarks on inflation. Can you elaborate a little bit more in just to, how that ties into both near and longer term? Again I get that you guys are providing an update in a couple of months here. But just elaborate a little bit on the pressure points that you are seeing of late just if you can define that and how that's cascading through. Maybe speak a little bit to the cadence of labor arrangements for instance et cetera?"
},
{
"speaker": "Nick Akins",
"text": "Yes, I missed the first part."
},
{
"speaker": "Julia Sloat",
"text": "Yes. Yes. Yes. So, Julien I'll let Nick talk a little bit about supply and labor. But what we're also watching is in addition to our own costs and working with our individual parties around making sure we have material supplies equipment and folks that actually do the work. We're also paying attention to what's going on with our customers because as we talked earlier today load is a big piece of our driver for earnings year-to-date and this quarter so far and we hope to see that continue. But as we know as the Fed needs to take some action and tap on the brakes that could have some damn as it relates to actually all three of our individual customer segments. Now, as I mentioned earlier, Industrial segment looks reasonably healthy based on the customer expansions that we see in the pipeline, et cetera. But I don't think everyone can entirely escape the consequences. So, even from a commercial standpoint, if you look at the real estate segment, in particular, interest rates have a direct impact on that piece of that sector in that business and then of course, on the residential side that choose into the wallet because if you're sitting in a situation where your wage isn't growing as quickly as your costs are you may tend to want to tap the brakes there. Not to mention mortgage costs go up as well. So, keeping an eye on it from a customer perspective managing through it as it relates to our particular P&L. But I don't know Nick wanted to say anything about supply chain and labor?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So -- and Julien sorry I missed the first part of your question. So, Julie filled in for me. Supply chain has certainly been an area of focus for the company and they've done a great job. The supply chain organization has done a great job of getting out ahead of that, understanding the delays that are occurring relative to delivery of transformers and those kinds of things. And then also size of inventories and other things come into question, but in our case we're a large electric utility with a lot of requirements, the largest transmission system in the country distribution obviously, wide spread. So, we have some -- we have abilities to really focus on the supply chain aspects in the positive way by expanding suppliers and certainly exerting the leverage we have associated with the large buying ability. So, we're in good shape from that perspective. Now, that being said, the entire industry and AEP are watching storm activity and those types of things and what implications that could have on the inventory levels and supply chain. So, we're watching that very closely. But we have time for the economy to really pick up and catch up from that perspective. Labor is an issue for everyone and certainly we continue to focus on that, particularly in our frontline employees to ensure that we're meeting the customers' requirements going forward. We're very tuned in to wage rates and those types of things that are changing dramatically. And certainly from a resource perspective we also have those relationships with not only attracting our own employees, but also contractors and so forth that we're able to pull from for various reasons. So, all-in-all, we're hanging in -- and the capital plan still remain secure in terms of the ability to move these projects forward. And we believe that AEP is in a great position to continue that process."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Super quick clarification on SPP, they're tweaked to the reserve margin. Does that impact your procurement efforts at all? I know you have a few things in flight just to clarify."
},
{
"speaker": "Nick Akins",
"text": "No it doesn't. We're going through -- yeah we're going through regular as you've probably seen regular integrated resource planning processes with all of the Southwestern power approval states. And those processes will continue. I guess the good thing is that the things that we're putting in obviously we already talked about transmission and distribution in terms of supply chain activities. But in terms of resources, we're already putting integrated resource plans in for renewables. And the timing of those renewables, are such that we have time for the supply chain to catch-up relative to solar and wind components. So we're in good shape from that perspective."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Great. Thank you, guys."
},
{
"speaker": "Nick Akins",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "We'll go next to the line of Shar Pourreza with Guggenheim Partners. Go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Shar."
},
{
"speaker": "Shar Pourreza",
"text": "Good morning guys. How are you doing?"
},
{
"speaker": "Nick Akins",
"text": "Fine, how are you?"
},
{
"speaker": "Shar Pourreza",
"text": "Good. Nick just on the contracted renewable sales, we're kind of thinking about the process for the sale. There's obviously some conflicting data points out there right rates have picked up materially, there seems to be a few peers in the market selling as well. But on the other hand, just given supply chain issues deal on the ground is certainly more valuable. I guess, can you elaborate a bit more on the process when you plan on opening up the data rooms. And it's a tight time frame with the Analyst Day. So what data points can we get between September when you kick the process off in the Analyst Day which is only weeks process right? So I guess what's giving you a sense?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. So these are well-known resources. And they're already there. And opened up a data room, can be done pretty quickly. And also review will be done quickly. I would say that the interest has been very robust and it will continue to be robust, because -- and you said it they have steel in the ground, but also the ability to continue on with these projects in a very positive sense. We took out Flat Ridge 2, so that makes the portfolio even better. And certainly from that perspective we expect the process to move very quickly. And when we bought the resources some of these resources from Sempra we visited sites and the data room was open. And we moved very quickly. And for these types of assets even though there may be others that are selling the assets, there is a robust focus by the market on certainly attracting these types of assets. So we feel very confident. We can move forward quickly and have certainly more information this year by the time we get to the Analyst Day."
},
{
"speaker": "Julie Sloat",
"text": "Shar, this is Julie. As an anecdote, when we initially made this announcement, I can tell you that not only was I receiving calls Nick was receiving calls. Chuck Zebula whose team is running the process was receiving calls so a lot of inbound calls coming in. And as far as what you can anticipate, I get it it's a shorter time line assuming we launch at the very latest in early September we should be able to come back to you by October 4th with color on how that process is going. And you're right. I mean there are other folks in the market as well. That's why I think we need to get out there as soon as we can and get business taken care of. So that is absolutely the objective. And stay tuned we'll have more color to share with you."
},
{
"speaker": "Shar Pourreza",
"text": "Do you think you could actually announce a deal on the fourth of the proceeds or the tight."
},
{
"speaker": "Nick Akins",
"text": "No."
},
{
"speaker": "Shar Pourreza",
"text": "Okay."
},
{
"speaker": "Nick Akins",
"text": "Yeah, that will be too tough for that. Obviously and then that will depend on what we get back to in terms of one-time versus stage in all those types of things will have to be considered. And certainly we'll have more information, but we won't have a finalization of that'll be probably by the end of the year."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. Got it. Thanks. And just one last one on â I mean obviously your load growth and the backdrop in general has continued to show the ongoing strength, you highlight the fact that it's pre-pandemic levels. I guess how are you sort of thinking about 2022 in general and where you're within sort of that EPS range, especially given that we're kind of into the key months of the summer with Q3. I would think there's â obviously â this is a very strong tailwind for you especially as we're thinking about 2022, even though you guys are hedging ourselves a little bit on some of the uncertainties out there?"
},
{
"speaker": "Nick Akins",
"text": "Yes. It's always good to be ahead a little bit. Any time you go in the latter part of the year because summer is always good. And then you get in the fourth quarter with â you don't know where storm activity is going to go and that kind of thing. But we feel really good about the position that have right now. And certainly, if you look at the fundamentals of what's going on I mean, you take charge point out of it is a very, very positive quarter and certainly one in which we continue to grow and see it â our load guys are pretty optimistic. So â and if you knew our load guy, you know he's â it takes a long way for him to get there. But we feel really good about the position that we have. And I think as we see more towards the end of the year then we'll have more to say when it comes by the time the Analyst Day comes around."
},
{
"speaker": "Shahriar Pourreza",
"text": "Okay. Terrific. Thank you, guys. Appreciate the color."
},
{
"speaker": "Operator",
"text": "We'll go next to Steve Fleishman with Wolfe Research. Go ahead please."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Steve."
},
{
"speaker": "Steve Fleishman",
"text": "Hey, good morning. Thanks. So just a question I think Julie mentioned the â on the Kentucky sale, the write-off you took of $0.15. Is that â should we read out is effectively reflecting your expectation of what kind of price change needs to be renegotiated for the this Mitchell issue? Is that kind of reflecting that or is that..."
},
{
"speaker": "Nick Akins",
"text": "No. That one was really focused on when Liberty and AEP got together to focus on the Kentucky transaction order itself and there were requirements associated with that. So â and we certainly were focused on making sure that that we completed that â that order and this requirement. So that's what that is."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. So I guess maybe then just on the difference between Kentucky and West Virginia and how Mitchell is treated. Could you just give a little more color on those differences and so we can kind of think about the value difference between the two?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So â and I think it's pretty obvious that Kentucky had its view of valuation in 2028 and West Virginia has its view of valuation and 2028 and the two are in very different positions. And it's probably not something you're going to resolve today. So really it becomes an issue of okay, how do we get together and think about our continued operating partnership, which could be done through the operating committee of the existing operating agreements and then certainly focus on a later date to consider the risk issues associated with that. So â and I think for us I think it's sort of a realization that there will be no doubt that Kentucky Power will continue to be a partner in Mitchell. And then when the time comes before 2028, there'll have to be some reconciliation between what Kentucky wants and what the West Virginia Commission wants. And we just want to make sure those risk parameters are taken care of on the front end."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. But I guess what matters in terms of closing is really the arrangement between you and I guess Liberty in terms of"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Thatâs right. Thatâs right."
},
{
"speaker": "Steve Fleishman",
"text": "⦠closing. So is that there would be some kind of just ability to negotiate some kind of certainty on that?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Because we have -- now we have an outside party involved with a third-party from AEP's perspective with Mitchell going forward. So that sort of drives a different view when everything was already owned by AEP companies. So you have to go through that process and determine okay, what's the right approach for Liberty to have that ownership and for AEP to have ownership at arm's length."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. But it sounds like you're confident this will be resolved with the buyer with the property relatively soon?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Yeah. Certainly, our people have been in constant contact on this issue. They're working very well together. I talked to Arun's as late as yesterday. So it's really both of us are very optimistic about this transaction."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. That's good."
},
{
"speaker": "Nick Akins",
"text": "But always there was a difference there."
},
{
"speaker": "Steve Fleishman",
"text": "Yeah. I'm sure he will when it's his chance for it to do a call. And then just on the -- on transmission, just anything that you kind of expect from FERC in the second half of the year to better identify both kind of their interest in getting a lot more transmission built, but at the same time still a little bit of kind of pressure on the ROEs. And just what are you watching there?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Obviously, reliability and resiliency is of central focus, not only to FERC, but the Congress as well. And I really believe they'll continue the process of all the areas of focus right now with NOPRs. They got several NOPRs out actually and they just put initiated around weatherization and making sure that we're as resilient as possible. And certainly from a transmission planning which was already done that NOPR along with they started the state process in terms of discussions relative to cost allocation those types of issues. So they're moving along. And when they issued that original NOPR under transmission, they made it clear that it wasn't going to be sequential. It's a multitasking opportunity for us to look at all these provisions. And then of course, the queues associated with the new resources and RTOs those are all being focused on. And I think FERC is doing a very credible job of marching through this and making sure that we are able to invest in transmission in a way that secures this country in so many ways. So I think that process will continue. Who knows what goes on with the ROEs, the 50 basis point adder and that kind of thing. That -- I mean that could take years to resolve. But, nevertheless, we'll continue moving forward with our investments and we'll continue to look forward to the rules, processes and procedures to be put in place where we as significant stakeholders in this process are allowed to make the investments that we need to make on a timely basis. There's no question that as we look at all the resources that are needed, the changes and the transmission system, fiber type issues that I'm sure that they'll be interested in as well in a regional activities associated with planning, ensuring that we're able to invest the way that we should on a timely basis with as little risk as possible. And that's really important because there are so many changes occurring. And for now you're seeing -- you really are seeing implications relative to resiliency and reliability. And I think everyone needs to take a pause and ensure that we're looking at that with our eyes wide open and that we're doing the right things at the right time. And that process continues. And I think FERC is doing a great job."
},
{
"speaker": "Steve Fleishman",
"text": "Great. Thank you very much."
},
{
"speaker": "Nick Atkins",
"text": "By the way most of those offers are pretty consistent with AEP's positions. So we feel really good about our role in enabling the policy to move forward."
},
{
"speaker": "Operator",
"text": "We'll go next to the line of Durgesh Chopra with Evercore. Go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning Durgesh."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning team. Quick clarification on the Kentucky sale process is my first question. Just to be clear your discussions with Liberty on the Michel operating agreement and then the FERC approval. Those are two independent processes, right? So you don't have to go back to FERC with asking for a revised approval or something like that once you settle with Liberty on as it relates to Michel?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. Certainly we believe with the original agreements and the ability to operate under the operating committee under that agreement, we can really focus on the status quo and ensuring that we're able to move forward with a partner that's a third party, so that the provisions of the agreement already provide for the ability to make those kinds of adjustments. So it's our belief that we do not need to go back to FERC for additional approvals."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it, okay. And then just maybe wanted to get your thoughts on valuation for your renewable assets. Maybe just -- how have they evolved since the first quarter call? It's been a volatile tape. Interest rates have been up. So just any color you can share with us there, you sort of, kick start this process in September?"
},
{
"speaker": "Nick Akins",
"text": "Well, obviously, we know that the headwinds of inflation and those types of things are areas of conflict with an increased valuation. But at the same time, you've got a lot of robust interest in these assets and the fact that continues to produce energy in a market that provides additional benefits for whoever winds up owning this asset. So, it's hard to tell what the valuations are going to look like right now. But I don't -- I mean certainly we're not concerned about all the macro issues that are involved because these assets stand pretty well in and out of itself and you have the positives and negatives. But now that -- and that's why we obviously took the adjustment on Flat Ridge 2, because we really wanted that out of the portfolio so that you wouldn't be arguing with bidders about what that valuation was and what the risks were of that particular project. The rest of them, or excellent projects that should bode well in the marketplace. So, like I said, I can't tell you any thoughts on what we see valuation to be. I think the market will tell us."
},
{
"speaker": "Julie Sloat",
"text": "Just to provide you a little more color if you're trying to model, aside from giving you market price point. We did include in the presentation today on slide number 44, the breakdown of all of the projects that are included in the portfolio. You'll see that we've essentially removed Flat Ridge 2 like we talked about today, as it relates to asset value and that type of thing that's on our balance sheet. If you look at our balance sheet, today our asset value associated with the portfolio as it stands is about $2.1 billion. The equity position is about $1.4 billion. We do have some projects, debt and tax equity that totaled about $272 million. So, you can plug that into your model as well. And then, we do get the question around how much did this contribute to earnings. So, for 2022 for the Generation & Marketing segment, which is $0.31 total for our guidance, kind of that midpoint about $0.13 to $0.17 relates specifically to this portfolio. So you can kind of begin to back into whatever valuation you want to assign to it. And there is a very low tax basis associated with it, but we do have some capacity to absorb a tax gain, because we've got some credits sitting on the bench that we can use to offset that. So, don't view that as problematic or seriously gating for us because it's not -- we'll be able to hurdle over that."
},
{
"speaker": "Durgesh Chopra",
"text": "Excellent. Thank you, both. Appreciate the color."
},
{
"speaker": "Nick Akins",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "We'll go next to the line of Nick Campanella with Credit Suisse. Go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Nick."
},
{
"speaker": "Nick Campanella",
"text": "Hey, good morning. Thanks for taking the questions."
},
{
"speaker": "Nick Akins",
"text": "Sure."
},
{
"speaker": "Nick Campanella",
"text": "Just a really quick follow-up on the Kentucky sale reduction. I noticed you have, like $1,400 of proceeds in the funding slides bill. So just, can you just reaffirm that are -- is everything going on in the past quarter that cash proceeds when you close to be unchanged."
},
{
"speaker": "Julie Sloat",
"text": "We're good. You're good. No worries there. So, no change in that modeling or those assumptions. We're good."
},
{
"speaker": "Nick Campanella",
"text": "Okay. Great, great. And then I guess just a question on strategy and Analyst Day. You've had some simplifying the business profile, the sale, the underwrite sales are on the horizon obviously. As we kind of think about funding this long-term CapEx plan, are you interested in pursuing further slated sales, unregulated sales, or are we kind of in the later innings of this portfolio rotation strategy?"
},
{
"speaker": "Nick Akins",
"text": "Yes. I'll say, obviously, we have a lot of capital to fund and we have a great plan to do it. I would probably look at the ownership levels of the new renewables projects and that's going to provide additional opportunity for us resilience and reliability certainly distributed energy resources. All these types of things in our plans are really providing us the opportunity to fine-tune our portfolio to match what the growth expectations we have around those areas. So, no, we're not done. We will continue to evaluate opportunities to add value from a shareholder perspective, but also to ensure that our customers are seeing the capital deployment that provides a better experience. And that's something that we're very focused on. So, this just going to â you're only seeing, really the beginning of the part of our business that is going to endure going forward, as we transition this company. And that process will certainly continue. That's why I sort of said, it's a continued execution around, and I use taking care of business, but adding a dash of let's go crazy that sort of says we're going to be thinking on the edge about what can be done to make sure that we fund these real opportunities we have ahead of us."
},
{
"speaker": "Nick Campanella",
"text": "All right. Thank you very much. Weâll look to you in October. Thanks."
},
{
"speaker": "Nick Akins",
"text": "Yeah."
},
{
"speaker": "Operator",
"text": "And for our next question we'll go to the line of Stephen Byrd with Morgan Stanley."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Steve."
},
{
"speaker": "Dave Arcaro",
"text": "Hi. It's Dave Arcaro on for Stephen. Thanks so much for taking our questions."
},
{
"speaker": "Nick Akins",
"text": "Okay. Yeah. Hey, Dave."
},
{
"speaker": "Dave Arcaro",
"text": "Wondering â hey, how are you doing? Wondering if you could give your latest expectations around federal climate policy here? Do you expect renewable tax credits to be in an extenders bill potentially towards the end of the year? And just generally anything you would expect in terms of deal climate legislation this year?"
},
{
"speaker": "Nick Akins",
"text": "Yeah. I think, it certainly it's going to be a challenge. And I think I said that, last quarter, it is going to be a challenge. And the way it appears to be coming together is there were some â there are some discussions going on. There may still be discussions going on. But right now, they're so focused on the healthcare pharmaceutical activities that may be bifurcated. And then â and certainly the Chips Act now, we're obviously for the Chips Act, because Intel is locating within our territory with two fabs, up to eight fabs, and that's a huge, huge positive. So you have things like that that are going on now not only that, but obviously the midterms are providing some overhang to getting even a smaller package done, although there has been discussions of working on that and trying to get something done by September 30. But even that is going to be a really hard thing to do. So again, I would say, post election you're probably dealing with either some form of a smaller package, or extenders which that's a typical thing that happens toward the end of the year, when ITCs, PTCs start to roll off, again, you'll see extenders or the IRS of supply chain activities being able to extend it for some period of time. You'll probably see some Band-Aid solutions until you see solid solution going forward. So I just think the environment is certainly very volatile right now, and it will take time to work itself out. And maybe even post election, again, you'll maybe have some sense of calmness to be able to focus in on some of these things that are important, because our industry. And by the way, our 16,000 megawatts does not include any extension of ITCs, PTCs. But we are definitely for those extensions and expansions to nuclear and as well to storage. Those are clear opportunities for us to redefine the resource plans going forward. Direct Pay is also very important us, but we -- that would make -- at least at this point, as a test sale, maybe later on we can convince everybody that that truly is a benefit to our customers. So anything we get from that perspective will ultimately be a benefit to our customers from an economic standpoint and that will be good for, not only our movement to a clean energy economy, but the options that we have available to us, namely with storage, nuclear, hydrogen hubs, those kinds of things need to continue to be looked at to make sure we're resilient and reliable going forward. So that's where we stand right now, I think."
},
{
"speaker": "Dave Arcaro",
"text": "Got it. Thanks. That's helpful color. Maybe, just one just small follow-up. I was just wondering, at Flat Ridge, if the issues that you found there? Is that just an exclusive to that project? It didn't have any other -- or none of the other assets in the portfolio had similar issues asâ¦"
},
{
"speaker": "Nick Akins",
"text": "Thatâs right."
},
{
"speaker": "Dave Arcaro",
"text": "-- going on at Flat Ridge and that was the only one you plan to extract."
},
{
"speaker": "Nick Akins",
"text": "That's right. That's why we separated that one. Yes. The others are good."
},
{
"speaker": "Dave Arcaro",
"text": "Understood. Okay, great. Thanks so much."
},
{
"speaker": "Operator",
"text": "Okay. We will go next to the line of Andrew Weisel with Scotiabank. Go ahead, please."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Andrew."
},
{
"speaker": "Andrew Weisel",
"text": "Thanks. Good morning, everyone. Just one for me about coal. So between reliability concerns in the Supreme Court ruling that you mentioned, do you see any potential -- some coal plants online beyond their current schedule dates, beyond Mitchell, which is a bit of a unique situation. But would you consider extending them? And if so, would they be potential back up as peakers went, or keep some as either intermediate or baseload resources."
},
{
"speaker": "Nick Akins",
"text": "Well, I think, that's exactly why, certainly, we said a rational and reasonable approach to moving forward from a resource perspective. We have to be able to maintain reliability, resiliency and economics for the grid and to our customers. And certainly, for our units, we continue to progress along the path that we've already placed in line. And actually, you have to do that to be able to define the future. And we're very, very focused on the just transitional aspects of our communities as we make any transition. So you touched on a point that's particularly important, for resiliency and reliability reasons, the capacity provided by these units is extremely important. And whether the capacity factors move down, as you bring in and layer in more renewable energy and clean energy, that's fine, as long as you have the resource to be able to meet the demands. And then, eventually, we have to find a path that ensures the communities continue to thrive from a tax standpoint, fire protection, police protection, school boards, all that kind of stuff. We have to be able to look at that. We can't just shut down these communities and then decide something else. So in areas like West Virginia with the coal-fired generation, we have to define what that path is. It may be small modular reactors, if we can define what that risk is and limit it from a shareholder perspective. Certainly, DOE is very interested in that. And it just so happens, the jobs of a small modular reactor is the same as a coal plant and paying the same taxes and those types of things that's an opportunity to take a look at whether it's hydrogen hubs or storage or other activities. So we've got to be able to rationalize that. But coal has provided an important benefit in coal generation particularly during these summer months. And obviously, during the winter months as well and we've got to be mindful of how that process continues. So that's why we have to say it has to be rational reasonable and with the time frame that makes sense."
},
{
"speaker": "Andrew Weisel",
"text": "Thanks. Itâs very helpful."
},
{
"speaker": "Nick Akins",
"text": "Yes."
},
{
"speaker": "Operator",
"text": "We'll go next to the line of Michael Lapides with Goldman Sachs. Go ahead."
},
{
"speaker": "Michael Lapides",
"text": "Good morning. Nick I know you're excited about the Analyst Day even you're probably equally as excited as having Brian Kelly down in Baton Rouge."
},
{
"speaker": "Nick Akins",
"text": "Yes."
},
{
"speaker": "Michael Lapides",
"text": "I'm looking at the earned ROE versus authorized pivot. Just have a couple of questions about few of the subs. How are you thinking about what structural changes in rate making. Your team is going to seek in the next couple of years in a few of the jurisdictions that are earning a good bit below that. We think in PSO, we're honestly you fought under-earning for a number of years, but also thinking a little bit on APCo, a little bit on SWEPCO."
},
{
"speaker": "Nick Akins",
"text": "Yes. So, obviously, there's been substantial opportunities there in those regions of the country, because actually when we put in renewables, the renewables is helping from an ROE perspective. So -- and obviously from -- as it reduces rates to customers from a fuel standpoint and overall in the savings gives us an opportunity to deploy capital investment in those areas. Sometimes obviously, we'll spend capital to make sure that we're doing those things to ensure resilience liability and all those activities. But particularly, from an ROE perspective, a ratemaking standpoint, equity layers has certainly been a big push of ours and certainly from a concurrent recovery standpoint with formula-based rates we have forward-looking rates in Indiana and Michigan. We like to see that in other jurisdictions with the massive amounts of capital that we're deploying. And then typically the renewables are tracked as part of the investment until we get it in rate base and that's worked out great for us. I think -- and you're also seeing opportunities for us to really get out ahead with the commissions on what we're trying to achieve in terms of not only benefits to our customers, but also the ability for our customers to use our product. I mean, I look at on the customer side with distributed energy resources with the analytics and all the equipment that can be put in place to enable customers to make wise judgments would be highly beneficial not just for the operations of the grid, but also to mitigate their own fuel costs and bills during periods of time and obviate the need for the securitization or other things that we have to do in huge storm-related environments. So, I think there's a lot of good things going on. And the trackers, I think, it's 85% of our recovery is tracker base. So we'd like to improve on that as well. I think there has to be a recognition that cash coming into the utility is particularly important and we always talk about FFO to debt and the utilities with all the massive investments necessary. We need to be able to see the cash coming in the door so that we can continue to make those kinds of investments. So that's going to be huge message for our regulators going forward as well. But we're doing good things. And as long as we're doing good things and spending on the right things, we believe we're aligned with our commissions and our customers on the right path forward and we feel very good about the path that we're on."
},
{
"speaker": "Julie Sloat",
"text": "Michael, maybe a little more help there too on PSO in particular. We've got securitization that we'll be completing here next month. So in August for the storm Yuri cost, so that should help to alleviate some of this pressure as well. And we'll be filing another base case. So stay tuned for that as well. And as Nick mentioned, just some refinement around utilization of different rate adjustment clauses, et cetera, not only in West Virginia, Virginia but then also as we take a look at SWEPCO, we still have the outstanding component that's not included in rates. So we've got different ways to get after it and you'll see us talk more about that as we come at you here on October 4. So stay tuned."
},
{
"speaker": "Michael Lapides",
"text": "That's great. And one quickly final up. Just Cardinal on the G&M segment had a big benefit during the quarter, just given where power prices were versus your delivered cost of coal. Can you remind us how you're thinking about the future for Cardinal going forward?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So Cardinal, you're talking about the Cardinal plant. Yes. Soâ¦"
},
{
"speaker": "Michael Lapides",
"text": "Yes."
},
{
"speaker": "Nick Akins",
"text": "So â we plan on completing a transaction with Buckeye related to that particular plant. So they would take ownership of the plant and we would take a PPA back for a certain period. So â and then that means we will not have any generation to speak of left in Ohio on the unregulated side. So â and that it's a long way from where we were in Ohio. But I think it's also there's a message for Ohio in terms of generation that needs to be placed in this state. So that's probably another issue I can get into it but I'll stop there. But I think that's all in the plans already."
},
{
"speaker": "Julie Sloat",
"text": "Yes Michael. So that PPA with Cardinal goes I think through 2028 to give you a endpoint on that as well."
},
{
"speaker": "Michael Lapides",
"text": "Got it. Thank you, guys. Thanks, Nick. Thanks, Julie. Much appreciate it."
},
{
"speaker": "Nick Akins",
"text": "Sure. Thanks. Talk to your later."
},
{
"speaker": "Operator",
"text": "We'll go to the line of Sophie Karp with KeyBanc. Go ahead."
},
{
"speaker": "Nick Akins",
"text": "Good morning, Sophie."
},
{
"speaker": "Sophie Karp",
"text": "Hi. Good morning. Thank you for squeezing me in. We have a lot has been discussed already, but if I may just ask a couple of questions. First on transmission. So you made a point of saying that transmission Transco remains one of your I guess key growth engines. So I don't want to miss quality base. But â and also at the same time you're talking about not being done with divestitures of something it's a non-core business. Can you maybe help us frame how you think about transmission? Is it â are you making these comments because you're getting questions about potential transmission sale? And how are you thinking about that, or should we not read too much in this."
},
{
"speaker": "Nick Akins",
"text": "No I don't read too much into it because transmission is a key component for our not only for our investment in the company but also in terms of what we see relative to the transition to the future. Transmission is a key component for resiliency, reliability and optimization, as we move to a clean energy environment. So, no, we're -- from a transmission standpoint, we feel very good about our role relative to transmission. And actually, I see distribution continuing to grow and certainly the renewables transformation itself. So, no, don't read anything into that."
},
{
"speaker": "Sophie Karp",
"text": "All right. Thank you for clarifying that. And then my second question was a little bit of a housekeeping question I guess. I'm looking at the -- related to new growth opportunity exhibit at slide 40. And it seems like for APCo, when the opportunity has been reduced a little bit and solar increase a little bit in the 2020 to 2030 time frame. I'm just kind of wondering, if that's just some project realignment, or should we be -- how should we be thinking about this?"
},
{
"speaker": "Nick Akins",
"text": "Yes. So the April integrated resource plan, certainly showed what was needed from an APCo perspective. So -- and I think there's probably more to come on that, but it's actually immaterial at this point."
},
{
"speaker": "Sophie Karp",
"text": "All right. Thank you."
},
{
"speaker": "Operator",
"text": "And speakers' we have no further lines in queue at this time."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Alan, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Yes, I will. Ladies and gentlemen, this conference will be made available for replay beginning today. This is the 27th of July and that starts at 05:30 PM. You can access the AT&T replay service by dialing toll-free 866-207-1041. International participants may dial area code 402-970-0847. The access code is 9751677. That replay will be available until August 4, 2022 at midnight. Those numbers again are toll-free 1-866-207-1041, internationally area code 402-970-0847, the access code is 9751677. That will conclude your conference call for today. Thank you for your participation and for using AT&T Event Teleconferencing. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 1 | 2,022 | 2022-04-28 09:00:00 | Operator:
Nick Akins: …fourth quarter, we are maintaining that momentum and delivering strong results for the first quarter of 2022 with operating earnings for the first quarter coming in at $1.22 per share or $616 million. Earlier this year, we made a number of refinements to our strategic initiatives and financial targets. We raised our 2022 operating earnings guidance range and increased our long-term earnings growth rate and we have hit the ground running in 2022. Today we are reaffirming our 2022 full-year operating earnings guidance. As a reminder, we are guiding to a range of $4.87 to $5.07 per share for 2022 with a $4.97 midpoint and we also reaffirm our long-term earnings growth rate of 6% to 7%. As you'll recall, we announced several significant developments in connection with last quarter's earnings. In addition to lifting our 14% to 15% FFO to total debt targeted range, we announced on the decision to sell all or a portion of contracted renewable assets within the unregulated business. The announcement of this strategic divestiture allowed us to recalibrate our five-year capital plan of $38 billion with a $1.5 billion shift to transmission and the elimination of growth capital in the contracted renewables business. We are already seeing the positive impacts of these initiatives in quarter one, and we look forward to continue to execute in these important areas throughout the course of the year. We also expect to maintain positive momentum in our economic outlook as we work collaboratively with states to drive economic expansion in our service territory. There is more to come on all that, but I first want to take a step back and highlight some of the other proactive work our team has done. As macro trends continue to affect our industry in the economic landscape at large, we are focused on de-risking our platform and elevating our strategy to enhance shareholder value. For example, given lingering global supply chain issues, we are diversifying our mix of suppliers in order to reduce the impact on our capital investment plan. As a result, AEP has experienced minimal customer or business disruptions to-date. With these significant initiatives underway and a track record of thinking creatively, it is truly a team effort and we are lucky to have one of the most talented teams in the business. Regarding Kentucky, we expect to complete the sale of Kentucky Power and AEP Kentucky TransCo to Liberty in the second quarter of this year. A regulatory timeline of the sale is on Slide 7 of today's presentation. In 2021, we announced a comprehensive strategic review of our Kentucky operations resulting in an agreement to sell those assets for $2.846 billion enterprise value. Both parties have been steadily working to obtain the necessary approvals to complete this transaction, which is in the public interest. The Kentucky Public Service Commission hearing was held on March 28th and March 29th. We know that Liberty is well positioned to serve Kentucky customers and are confident our employees in Kentucky will continue to thrive within an organization that prioritizes safety and operational excellence. Based on the statutory requirements, we continue to expect to receive a decision from the commission on the sale transfer no later than May 4th. FERC approval on the sale transfer is also in process. Earlier this week, FERC notified us of a need for more information in the 203 transfer application. This request is not unusual as FERC looks to ensure its record is complete by seeking additional information. We do not believe this request will impact the closing of the deal in the second quarter. Once a decision is made by the state level next week, we will provide the requested information back to FERC, we'll plan to ask FERC to abide by the original approval timeline to ensure Kentucky customers receive benefits from this transaction in a timely manner. Another significant regulatory milestone for the transaction is gaining approvals on the Mitchell operating agreement, which were the condition of the final sale transfer. Both Kentucky and West Virginia are aware that updated Mitchell operating agreement approvals are needed to put in place the commission orders on environmental compliance issued 2021. The Kentucky Public Service Commission hearings were held on March 1st and March 30th and the West Virginia Public Service Commission was held on April 7th. Parties providing options allowing flexibility for both states to collaborate and reach a common agreement as Kentucky continues to wind down interest in Mitchell plant post 2028. We expect to receive commission decisions on the Mitchell agreements on an expedited basis in May of this year. We plan to file the related FERC application after State Commission approvals. Throughout this process, we have established a strong record of benefits of this transaction. Most notably, the clear and measurable customer benefits that we see. Okay. Now, moving onto the contracted renewable asset sale. During our fourth quarter earnings call in February, we announced the decision to sell all or a portion of our unregulated contracted renewables portfolio to simplify and de-risk the company and allow us to focus on our regulated business. Our portfolio consists of 1,600 megawatts of unregulated contracted renewables, the sale of which will help facilitate the investment of 16,000 megawatts of regulated renewables through 2030. In the last couple of months, we have made significant progress on this opportunity, including working with an advisor preparing outside consultant reviews of the technical and market aspects of our portfolio and evaluating our sales strategy and timing. Interest in the sale of the portfolio has been robust. The sale provides a unique opportunity to acquire large operating wind portfolio complemented with some solar operations as well. We expect to launch the sales process sometime during the second half of 2022, likely in the August-September timeframe and can be accelerated or deaccelerated as needed. Additionally, we are pleased to announce that we assigned a term sheet to sell most of our wind and solar development portfolio including five sites which are located in the Southwest Power Pool. We have also executed an agreement to sell a solar development site here in Ohio. Financial details of these upcoming sales are confidential and will not be disclosed, but demonstrate our commitment toward that execution. The reallocation of contracted renewables capital is assumed in our guidance, but utilization of proceeds is not yet reflected in guidance or our multi-year financing plan. We will seek to maximize transaction proceeds in the sale, avoid dilution and direct the proceeds to investments in our regulated business as we continue to enhance the transmission infrastructure and move forward with our generation fleet transformation. Looking ahead, we will continue our track record of optimizing the portfolio and reallocating capital to our regulated business where we continue to see a meaningful long-term opportunity for growth. AEP is making significant progress as well in our transition to a clean energy future. In fact, we already have several initiatives underway in line with our sustainability goals and through our regulated renewables execution. Details can be seen on Slides 8 and 9. In March we commissioned our third and final North Central Wind site Traverse Wind Energy Center, which is the largest single wind farm built at one time in North America and one of the largest wind facilities worldwide completing the $2 billion trifecta investment that includes Sundance and the Maverick Wind Energy centers. Combined, they are providing 14,084 megawatts of clean energy to our customers in Arkansas, Louisiana, and Oklahoma. North Central will save customers in an estimated $3 billion in electricity costs over the next 30 years. In March, we also issued a request for proposal at I&M for 800 megawatts of wind and 500 megawatts of solar. Additional RFPs are in process simultaneously at APCo, PSO and SWEPCO with expected in-service dates of 2024 to 2025. We expect to make a regulatory filing in the second quarter of this year related to the SWEPCO's June 2021 RFP. These are long-term investments, not just for our business in our local communities, but for the global environment as well. Through our current state of coal retirements, we are progressing towards our target of an 80% carbon emissions reduction rate by 2030 and net zero by 2050. Achieving this goal is an integral part of our long-term strategy to prioritize regulated investment opportunities and transition our generation portfolio. Our plans are a very well thought out, continue the movement to a clean energy economy, but remain firmly grounded in the principles of resiliency, reliability and affordability while recognizing the value of diverse portfolio of resources, particularly given today's world of energy related volatility. Last year we set regulatory foundations in a series of rate cases across multiple jurisdictions. Regulated ROE as of March 31st, 2022, is it a steady 9.2% as we continue to work through regulatory cases and focus on reducing authorized versus actual ROE spreads. I&M obtained Commission approval in February on our Indiana base case settlement. Ohio oral arguments of APCo's 2020 Virginia base case appeal were held in March at the Virginia Supreme Court with anticipated final decision this year. We expect to see Commission decisions as well on SWEPCO's rate cases this year in both Arkansas and Louisiana and look forward to keeping you informed on that progress too. Related to FERC, we command the commission for moving forward with proposed reforms to transmission planning and cost allocation. First proposed rulemaking aligns with our goals of developing a more robust reliable and flexible grid of the future that ultimately reduces cost to customers and strengthens economic development in the communities in which we serve. We believe many of these reforms are needed to build the infrastructure necessary to transition our generation fleet in the most efficient and cost-effective way possible and achieve our carbon reduction goals. We look forward to continuing to work collaboratively with the commission on this, and any subsequent rule makings and with the RTOs on implementing any new requirements. At the conclusion of our fourth quarter call, I told you all that AEP stood poised to make even greater headway in 2022 and I think it's fair to say we are making good on that promise. Capitalizing on our momentum from 2021, we have continued to execute against our strategic objective steadily and successfully. As we think about what's next for this year and beyond, we hope to further modernize our energy grid in order to supply a reliable cleaner low cost resources for all the communities we serve. We will also consider further asset rotation through the lens of de-risking and simplification and we'll evaluate any and all value additive potential activities as we focus on our regulated business. As I've said before, AEP is in a very unique position, the largest transmission system, one of the largest renewables build outs and the diverse territory to adjust from the risk of supply chain, load forecast, regulatory risks et cetera, AEP is the very definition of consistency and opportunity. We at AEP, as well as our shareholders and customers hold ourselves accountable on the continual execution of all of these strategic objectives. To paraphrase a big hit by the police, every breath you take, every move you make, every step you take, we'll be watching AEP, and as our CFO would say, we've got this, Julie?
Julie Sloat: Thank you Nick, thanks Darcy. It's good to be with you this morning. Thanks for dialing in everyone. I'm going to walk us through our first quarter results, share some updates on our service territory load and finish with commentary on our credit metrics, liquidity, as well as some thoughts on our guidance, financial targets and recap our current portfolio management activities underway. So let's go to Slide 10, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter were $1.41 per share compared to $1.16 per share in 2021. There is a reconciliation of GAAP to operating earnings on Page 16 of the presentation today. Let's walk through our quarterly operating earnings performance by segment on Slide 11. Operating earnings for the first quarter totaled $1.22 per share or $616 million compared to $1.15 per share or $571 million in 2021. Operating earnings for the Vertically Integrated Utilities were $0.59 per share, up $0.05, favorable drivers included rate changes across multiple jurisdictions, normalized load and O&M. These were somewhat offset by increased depreciation, lower off-system sales and wholesale load. I'd like to take a second to talk about O&M and depreciation in particular because of a change in accounting related to Rockport Unit II lease at I&M, we'll see approximately a $0.05 contribution of favorable O&M consequence offset by $0.05 of unfavorable depreciation in each quarter of 2022, but no consequential earnings impact. And to be clear, this is entirely consistent with the 2022 guidance details we posted in our investor presentations earlier this year. I have more to share on load and load performance here in a minute, so hang with me on this. The Transmission and Distribution Utilities segment earned $0.30 per share, up $0.07 compared to last year, favorable drivers in this segment included rate changes in Texas and Ohio, normalized load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. The AEP Transmission Holdco segment contributed $0.34 per share, down a $0.01compared to last year. Investment growth was favorable by $0.03, offset by $0.02 of mainly property taxes, driven by the increased investment and a penny of income taxes. This is in line with the guidance that we provided to you earlier this year. You'll recall that our 2022 guidance had this segment down by $0.08 year-over-year as a result of the $0.12 of investment growth being more than offset by the annual true up that will occur in the second quarter and some unfavorable comparisons on the tax and financing side. As you know, this segment continues to be an important part of our 6% to 7% EPS growth. Generation and marketing produced $0.03 per share, down $0.03 from last year. The improvement in wholesale margins was more than offset by lower retail margins and reduced generation. You may recall that storm Yuri had an unfavorable impact on wholesale margins in the first quarter 2021. Finally, Corporate and Other was down a $0.01 per share, driven by increased O&M, lower investment gains and unfavorable interest. These were offset by favorable income taxes, the lower investment gains are largely related to charge point gains that we had in the first quarter of 2021. Turning to Slide 12, I'll provide an update on our normalized load performance for the quarter. In a general sense the AEP service territory is extremely fertile for economic growth right now, in fact as of the first quarter, our load has officially fully recovered from the pandemic recession and has now transitioned into the expansionary phase of this business cycle. Starting in the upper left corner, normalized residential sales increased by eight tenths of a percent, compared to the first quarter 2021. This growth was composed of growth in both customer counts and weather normalized usage for the quarter. While results were mixed by operating company, the strongest residential growth was at the AEP - was in the AEP service - AEP Texas service territory, which was partially influenced by the year-over-year comparison, given the customer outages driven by storm Yuri in the first quarter of 2021. A final data point to share regarding residential sales is that our first quarter sales were still 1.1% above their pre-pandemic levels, over two years after the pandemic began. This is driven by number of factors including higher numbers of people who are able to work remotely that used to work in offices prior to the pandemic. Moving to the right, weather normalized commercial sales increased by 4.2% compared to the first quarter of 2021, while growth in commercial sales is spread across every operating company and most industries, the largest increase in commercial sales is coming from data centers whose load was up 33% compared to last year. In addition, we continue to see strong recovery in the sectors most impacted by the pandemic such as hotels, schools, and churches, while real-estate has been booming throughout the entire pandemic. AEP normalize - AEP's normalized commercial sales in the first quarter were 2.5% above their pre-pandemic levels which shows that we've gone beyond recovery and are now in full expansion mode across the territory. If I can now focus your attention on the lower left corner, you'll see that industrial sales posted another very strong quarter up 5.6% compared to last year, industrial sales were up, at most operating companies and many of our largest sectors in the first quarter. We experienced double-digit growth in a number of key industries this quarter, including chemicals, manufacturing, oil and gas extraction, petroleum and petroleum products, we also saw robust growth in primary metals manufacturing, coal mining and food manufacturing. Having said that, first quarter industrial sales are still 1.6% behind their pre-pandemic levels. However, we have a large number of customer expansions that are expected to come online later this year and still fully expect to eclipse our pre-COVID industrial sales levels in 2022. We can continue to be confident in our full-year 2022 guidance for normalized retail load. While we certainly did not anticipate the Russian invasion in Ukraine when we developed the 2022 forecast. I'd like to remind you that AEP's service territory is uniquely positioned to benefit from higher energy prices, given the concentration of energy production that is located throughout the AEP footprint. Energy producers in our footprint have responded to higher energy prices, which has resulted in increased economic activity throughout this service territory. Finally, when you pull it all together in the lower-right corner, you'll see that AEP's normalized retail sales increased by 3.2% for the quarter. As I mentioned earlier, our load has gone beyond recovery mode and is in full expansion mode. For the quarter, every operating company posted higher normalized sales than last year. Furthermore, our first quarter retail sales were up, were 1.5% above their pre-pandemic levels. So 50 basis points above pre-pandemic levels. To use a sports analogy, I would say our load performance in the first quarter was in the zone. While there are many factors outside of our control that could influence our results, I want to stress that the positive load story we shared with you today is largely the result of intentional efforts by our employees to promote economic development as a part of our long-term strategy to strengthen the communities that we serve. We're fully aware of the increased uncertainty that exists in the macro economy, but if put into work that it takes to ensure that we continue to see growth in our service territory going forward. So let's go to Page 13 to check on the company's capitalization and liquidity position. On a GAAP basis, our debt to cap ratio increased 60 basis points from the prior quarter to 61.5%, primarily due to an increase in equity from our issuance of AEP common stock in March, which is consistent with our 2022 guidance as the $805 million - or the $805 million of equity units we issued three years ago converted to equity. Let's talk about our FFO to debt metric. Taking a look at the upper right quadrant on this page, you'll see our FFO to debt metric stands at 13.7% on both the Moody's and a GAAP basis, which is an increase of 3.8% and 3 9% respectively from the prior quarter. The metrics are calculated off of the 12 month rolling FFO total, so the increase in FFO to debt is mainly a result of the fact that the cash flow drag from February 2021 winter storm Yuri has now dropped off the cash flow from operations calculations. This improvement has significantly narrowed the gap toward achieving our FFO to debt target range of 14% to 15% . As we stated on the last earnings call, we anticipate trending toward this target range as the year progresses. Let's take a quick moment to visit our liquidity summary on the lower right side of Slide 13. Our five-year $4 billion bank revolver and two-year $1 billion revolving credit facility support our liquidity position, which remained strong at $3.8 billion. Switching gears, our qualified pension funding increased 1.6% during the quarter 106.4%. The rise in interest rates, the decreased plan liabilities was the primary driver for this quarter's gain and funded status. Let's go to Slide 14. This quarter has provided a solid foundation for the rest of 2022 and we're reaffirming our operating earnings guidance range of $4.87 per share to $5.07 per share. We continue to be committed to our long-term growth rate of 6% to 7% that we updated on our last earnings call. We're working through the Kentucky Power sale to Liberty and expect to close in the second quarter. And as Nick mentioned, we've signed an agreement to sell a solar development site in Ohio and have entered into a term sheet to sell five additional wind and solar sites in SPP on the unregulated side of the business. Additionally, we're preparing to market the unregulated contracted renewables portfolio in the second half of this year and are receiving a significant amount of interest on this. Beyond the portfolio optimization activities underway, we remain focused on the fundamentals, which are executing on the regulated renewables plan, disciplined capital allocation, and securing positive regulatory outcomes. Before we break, I want to mention one last thing before we get to your questions. And that's to remind everyone that while we have not yet set the date, we will be hosting an Investor conference sometime in late September, early fall timeframe to give you a broader AEP update. We truly do appreciate your time and attention today. With that I'm going to ask the operator to open the call, so we can hear what's on your mind and answer the questions that you have.
Operator: Our first question comes from Julien Dumoulin-Smith at Bank of America. Please go ahead.
Julien Dumoulin-Smith: Maybe let's start with this, just in terms of the timing of the renewable sale here. Can you talk a little bit about how the AD/CVD steps could impact that, I mean is that on just your sense of the ability to get it done? Just any comments on that, and or implications again I assume that was separately related, how do you think about the timing of proceeds here, admittedly this is a little bit faster than what we had perceived, just talk about the proceeds from Liberty and this coming in perhaps little bit faster than perhaps the equity issuances in your forward plan what you would suggest?
Nick Akins: Yes Julien, so most of our assets are wind assets, so - and as we go forward with the transactions, we don't see any issues with that. And as a matter of fact, even on the regulated side, the timing of which we actually need assets for solar and that kind of thing comes later. So it's a 2024/2025 timeframe. So on both sides of the ledger we're in good shape from that perspective and these assets, obviously we're going to try to time it appropriately as we talked about the large portion of the 1.6 gigawatts or the 1,600 megawatts, they will be marketed in the third quarter. And I'd say, we're getting very robust. It's amidst very robust interest on - really on both sides, strategics and in terms of any type of private equity that kind of thing. So, it's really to us, the process will continue and there is nothing stopping us. So, we're in good shape from that perspective. And then your second part of your question, Julie, did you have that part?
Julie Sloat: Yes and Julien, let me know if I'm not answering this directly or if you need a little more granularity. Specifically as it relates to dollar flows associated with any type of transaction that we enter into, so today you're going to talk about the fact that we've had a term sheet in place for five development sites, those dollars are still small. And so, we'll see those, show up eventually priced second quarter or third quarter in operating earnings. But obviously - not even disclosing those not a needle mover for us and not going to change the earnings guidance or anything like that, so not to worry on that front. And then as it relates specifically to the broader unregulated renewables contracted portfolio, we'll start the marketing effort in the second half of this year. Obviously, we'll continue as we have a little more detail to share. We do have an upcoming on investor conference, so stay tuned for that, and then we'll be able to navigate any potential proceeds from transactions. As you know, we don't - even know exactly how that's ultimately going to look, do we sell them as an entire portfolio? Do we sell them in different pieces? So that's to be determined, so standby on that. And then obviously, we continue to work through the Kentucky process. We had expected to close that - we're trending toward the second quarter. As Nick mentioned and I mentioned in my opening remarks, that's already reflected as it relates to Kentucky bringing dollars in, in our plan. You may recall that we eliminated about $1.4 billion of equity that we originally had in our 2022 guidance. So I think we're moving on track. Let me know if there is something I didn't address there.
Nick Akins: Yes and since we're really moving on the universal scale assets, they're project specific. So we can go through that process and time at anyway that we wish to do it, so that's - and actually they are actual pretty quickly. So, we'll go through that process and will define that better and that will be part of our Analyst Day discussion.
Julien Dumoulin-Smith: Now speaking Analyst Day discussion, just super quick if I can, an important point. How do you think about just approaching your customers directly with energy prices environment, doing well on industrial and C&I sales growth, presumably your customers are interested. We heard this from Entergy, can you kind of elaborate how you're thinking about that opportunity here in this elevated environment as a further angle to your renewable aspiration?
Nick Akins: Well, certainly the renewables are a key part of being able to really mitigate cost to consumers going forward. So, from an industrial standpoint and manufacturing standpoint, we're going to see a lot of that movement to our territory, because when you think about onshoring, when you think about strategic reviews of supply chain actions that need to occur within this country, that's going to occur within our territory. So our focus will be, I think from the renewable side, particularly the regulated renewable side to be able to continue to progress on that is a benefit because a clear benefit for customers and certainly North Central showed that, but I think from an industrial standpoint, it's going to look very good for us. We have the resources for capacity and when you layer in the renewables for the incremental needs of capacity, it's really the best of both worlds to provide reliable secure supply to our industrials and really at a competitive price. So I think we're in great shape from that perspective going forward.
Operator: Next we'll go to Steve Fleishman with Wolfe Research.
Steve Fleishman: That is enthusiastic for me, sorry. So, just on the Kentucky process, there does seem to be a decent amount of people that want different things on the Mitchell operating agreement. Can you just talk to your confidence in resolving those issues by the second quarter and just because - and just maybe frame the issues and how you think they can get resolved?
Nick Akins: Yes, obviously there has been a lot of focus on the Mitchell agreements themselves and we've certainly tried to accommodate the multiple parties that are involved and made as flexible as possible and obviously the issue is 2028 and how you reconcile that going forward. And from a state perspective, I think we're in a good place, because it does provide the flexibility to find whatever value proposition there is at that point and there also is optionality around the ability to potentially separate the units to allow each individual commission to make their own decisions relative to these units. So, I think it's positioned very well. There's been a lot of dialog, lot of settlement discussions associated with that and a lot of - of course there's a lot of varied opinions, but at the end of the day, we have to do this because we have two commissions that are going in different directions relative to the life of the Mitchell plant. And I think what we've arrived to is a very credible balanced view that allows the optionality that the parties need going forward, so. And of course, we certainly will continue to focus on the ELG and CCR expense associated with that in the appropriate manner, and that will improve the optionality going forward to where decision is going to be made at the appropriate time. But I would say we're in a good place as we expect, we expect the Mitchell approvals to occur very quickly after the transaction approval.
Steve Fleishman: Okay, great. Thank you. And then just, you've been pretty good and right about Federal, the BBB legislation kind of to get done or whatever you want to call it these days, just curious if you have any latest thoughts and updates there - has anything changed?
Nick Akins: I'll say, I'll say this. Certainly, Senator Manchin is at the center of all of this, but there also is, I think from their original infrastructure package, a group of senators who were coming together to try to focus on some pretty substantial issues and really when you think about Senator Manchin being on both the Armed Services Committee and the Energy Committee and knowing the Ukraine situation and the focus on energy as it relates to it. I think you're going to see at least an attempt to a lot of focus on how to support natural gas, LNG, expansion for pipeline capability, and then of course he has also talked about the climate provisions, and I think there'll be a lot of interest too in the technologies of the hydrogen hubs and particularly in West Virginia. And then there is obviously Murkowski, Barrasso, there is others that they are engaging in that discussion. The ITCs, PTCs, the climate provisions that the industry is looking for, I think there is some bipartisan level of support for that. So the question really is, can they get together before - really before Memorial Day. And if there is still talking after Memorial Day it's probably a positive indication. My own personal belief is, if it's not successful, we'll probably see in the 11th hour type of - at the end of the year relative to ITCs and PTCs and perhaps Steve, an expansion of those. So I think you'll see us attempted a smaller bill, you'll still get hung up with the pay for, particularly with Manchin wanting to get it paid for and it's obviously a different, different view on that. So, but there is probably some element of recognition that something has to be done to have this country focus on the security of supply, not only for our sales that the Ukraine situation is demonstrated, but also for Europe and the rest of the world. So that's probably the impetus of getting something done and will define the framework of whether something gets done or not. If it doesn't after the election, I think like I said, it's the 11th hour or perhaps the RS and Treasury make adjustments based upon what's happened relative to supply chain activities. So, I think that would be my view of where things are going.
Operator: Next we will go to Shar Pourreza with Guggenheim Partners. Please go ahead.
Shar Pourreza: Just - Nick, I just want to question on sort of the renewable comments. As we're looking kind of at your current RFPs that are in progress, there sort of a fairly healthy mix between wind and solar and storage. As we're thinking about kind of the upcoming 2021, 2022 RFPs, how are you sort of thinking about the potential tail risks around solar with circumvention investigation as pricing uncertainties, there is a lot of constraints. I guess these tail risk impact the mix for 2021 and 2022 and do you see any risk to the $8.2 billion you've allocated to renewables. I mean, we've already seen two peers provided some warnings around this and one this morning, as well as delays. So I'm just curious how this fits in with your plan?
Nick Akins: Yes. I don't see a lot of risk and the reason why is, because ours is more 2030, a lot of these projects will come into play in the 2024, 2025 timeframe. So, we have time for not only for the reviews of solar that's occurring with the administration, but also in terms of the supply chain activities just to level out somewhat before we're actually out back in the market acquiring these types of resources. So, we have a little bit of time, I think probably by first quarter next year we want to see things start to levelize so that we can get that process rolling. In the meantime, we got the resource planning filings that are being made. And keep in mind too, I made this point originally. These plans are really fungible from year to year based upon what we see in terms of the value proposition of each type of resources. So a lot of its wind, some of it's solar, solar picks up in the later years from a resource plan perspective, so there is time for the solar thing to get resolved. But even if it doesn't, that sales is probably going to be more wind or other types of resources that are put in place to support these objectives, because remember, they're driven by capacity requirements and we'll continue to evaluate that process. And I'll take a step further too on this is, we've always said that if something were they happen relative to the renewables build out, we've got transmission and transmission we can soak up a lot of capital from that perspective because of the focus on providing better customer service, more resilient and reliable grid. So we have that optionality, but I'm not, I'm not even there yet. I think we're - we may be because the $8.2 billion we have in there assumes a certain percentage of those types of resources that we would own. That could be higher, transmission could be higher. So we have optionality around all of that. So I'm not concerned from an AEP perspective.
Shar Pourreza: Sure. The current gas price environment helps the economic argument.
Nick Akins: Absolutely, absolutely because the $3 billion for North Central was down on our previous gas forecast and if you look at that today, it's probably much larger. I think it's really looking good for customers.
Shar Pourreza: Got it, got it. And Nick, just from a financing perspective is, we're thinking about incremental spending that's going to come from these future RFPs. Can you just be a little bit more specific on your prepared comments around further asset sales, I mean, you look at all your OpCos that remain, I guess what could a structure look like, what remains?
Nick Akins: Yes, so - and the point I'm making is obviously we're going through the process step by step with the unregulated contracted renewables parts, so there is different parts of that business. And then of course, just - I think Kentucky was the first shot at it. There is a lot of optimization that can occur. We'll just have to evaluate against what the opportunities look like. And if we're - if we have, I mean, if we have underperforming utilities that don't figure prominently into the, into the clean energy transformation where we're actually attracting capital and being able to provide higher levels of return, then we have to look at it, so. So I'm just saying that, that process will continue regardless, not saying and actually we're already too deep, and I've talked about the number too deep. In terms of sales, Kentucky, we still have to get across and then the contracted renewables, we still get across. And then we'll see where we're at that point, based upon what we're getting in terms of the feedback of the RFPs because when these RFPs are ultimately get approved, they will know exactly what the ownership looks like, what the financial requirements are and we'll do what we've always done. We'll make sure that we're going through this process, making to invest in the right places and we will look at the portfolio and see what makes sense and what doesn't make sense for us to continue to optimize that for shareholder benefit.
Shar Pourreza: And then just one quick follow-up from Steve's question is, obviously we appreciate the confidence around the operating agreement in the Kentucky sale and reiterating the timing of the deal, but just to book ended, assuming there is maybe an adverse ruling or something that's not palatable. Can you just remind us, I think does Algonquin have a material adverse change clause? Is there a timeframe when they could walk away from the deal as we're just thinking about a book end?
Nick Akins: It's typical to have those kinds of provisions in that kind of agreement, but I can tell you that we and Algonquin are arm-in-arm getting this thing across the finish line. They very much want to own this property and they've actually - they've actually stepped up in a considerable way to provide customer benefits to make this transaction attractive to the policymakers and to the customers. So, and of course - I think a seminal event here obviously is May 4th where the commission will come out with an order and we will look at that order, we will make determinations on what conditions are in place and at that point in time, we'll make decisions on what it looks like. But I think from the public interest standpoint, the things that the commission also be looking at, this transaction is very, very good for Kentucky customers and if there are - I think everyone has to be sort of level headed about all of this because when you get through this process, you actually have a - you have a timeframe now for customer benefits to occur, substantial benefits and that's really a driver to get this thing done as quickly as possible, particularly in this energy related environment. So, I really don't anticipate that happening, but if it did, we'll do what we always do, we'll figure out what the options are and what the possibilities are and go from there. But right now we're not planning on that.
Operator: And next we'll go to the line of Jeremy Tonet with JPMorgan.
Jeremy Tonet: Just want to pivot a little bit towards transmission here, and given the MISO planning makes a little bit outside of you guys footprint, but also as you mentioned the FERC transmission planning and AEP stepping up CapEx towards Transmission here. Just wondering if you could dive in a little bit more as far as what's - which specific areas projects might materialize or any other color you can provide on specific transmission opportunities incremental at this point?
Nick Akins: Well, typically, and we've done this, we actually plan for around 130% of the budget for transmission. So we have 30% more projects that are occurring that we already have planned scoped ready to go. So layering in these multiple projects is a way for us to not only as opportunities arrive, as the metrics for financials continue to improve, we can layer in more of that, we can adjust to that based on projects that go one way or another. And then also, recently we were awarded in Texas - a large project in Texas that's also incremental. So, it was like $1.3 billion or so, but that - those are the kinds of things that will come to pass and we have every bit of opportunity related to transmission not only within our own system, but also in terms of the incremental systems around us, and that's why - and you asked about FERC and transmission, FERC obviously is taking the right steps relative to long-term planning, getting the framework for long-term planning put in place. That's an important part of the process to speed up some of the planning aspects to ensure that we are making the right investments at the right places. We continue and I think FERC will continue to look at, even in parallel, these issues of cost allocation of even the incentive mechanism, but also in terms of - and the regional planning which AEP will bode well in terms of that because just about everyone interfaces with us. So, as you look at some of these aspects, the more renewables that are needed, certainly the more retirements that are occurring across RTOs is all going to bode well for transmission investment. And we - what we see today is not we're going to see tomorrow. And then if FERC is doing the right thing, which we think they are, is going to bolster the ability for us to have a more consistent, congruent, clean-energy type system across this nation and you can't do that without AEP.
Jeremy Tonet: Got it, thank you for that. And just shifting gears towards O&M, just wondering what trends you're seeing there? It looks like it was a nickel benefit and Vertically Integrated a little bit of a headwind in transmission and distribution, and just wondering if you could dive in a little bit more as far as what different trends you're seeing in O&M across the business?
Julie Sloat: Yes, happy to, Jeremy, this is Julie. I did call specifically out, the O&M trend in Vertically Integrated Utilities. There's a little bit of a flipping and twitching going on between O&M and depreciation associated with the Rockport Unit II lease. That's included in that 2022 guidance that we had provided to you back in February, we've updated that page for your, so entirely consistent. Yes, and we're absolutely watching O&M as we continue to navigate inflationary pressures, et cetera. At this point, I would tell you, I think we're right in line with where we thought we'd be. So we're keeping our fingers crossed and the team is working like heck to make sure that we've got supply chain and supply chain is being addressed et cetera. But at this point, that guidance that we gave to you stands pat. So nothing new to report other than the fact that the team is working really hard to make sure that those numbers coming in line to the extent that we have many new developments, we will surely keep you apprised.
Operator: And next we'll go to Durgesh Chopra with Evercore ISI.
Durgesh Chopra: Congrats, this is a solid print here. Most of my questions have been asked and answered. I just had a quick clarification as it relates to the Kentucky sale. The May 4th is when we get the order for transfer and control. Do we need to get sort of the Mitchell operating plan agreement before then or how does that play into the May 4th order?
Nick Akins: No, that will likely come after shortly thereafter and the way we've looked at it is that, obviously you want the transfer agreement done. But as far as the Mitchell agreement approval, we expect that to occur shortly thereafter with both commissions because it's an important aspect of it and something I think that really helps for the transaction side as well.
Durgesh Chopra: I understand. So they can actually issue an order, the Kentucky commission can before actually - on the trend or before resolving the Michelle sort of ongoing dates of different things.
Nick Akins: That's right, that's right.
Operator: And next we will go to Sophie Karp with Keybanc.
Sophie Karp: Good morning. Thank you for including the names here at the end.
Nick Akins: Yes, sure.
Sophie Karp: I have a couple of questions here. So, first on the load growth, obviously very healthy numbers here. Above other industrial regions in the country, probably at this point. I'm not sure if two quarters is a trend, but let's say, how long do you need to see those numbers in this range that it would be enacting for maybe your reset in the long-term expectations for what this load should, does it make sense?
Nick Akins: Yes, it's great question, because you're right, two quarters doesn't, it doesn't make a trend. But when you look at the economy within our service territory, we're seeing some very positive indicators for continued expansion and continued economic development. We are - our economic development people are extremely busy with multiple opportunities that are coming throughout our territory actually. And so we look at that, we look at the sort of - if you were to look at our pipeline of potential opportunities, it is extremely robust and that gives us confidence in terms of where we think the economy is going to continue to go within our service territory. And of course, we don't see an end to the work from home environment. So we're feeling much better about the prospects of a more robust residential side of things. And then on the industrial, like I said, the onshoring, the security aspects, the energy play within our service territory. The other aspects of what's going on within the territory with chemicals manufacturing and so forth, that pace has picked up markedly with expansions and new developments and some of them are still years away, like the NTL manufacturing here in Ohio in our territory. It's substantial there'll be 20 to 40 more companies associated with that. It will be locating. So you see those types of prerequisites that are being put in place, that gives us a lot of positive views about where we think the economy is going. We'll watch it, we'll continue to evaluate it. If we go to the third quarter, see the same thing and fourth quarter, the same thing, then you'll probably see some adjusting going on relative to the 2023 forecast, but that's - our load guy will have to tell us that, he is very objective and he's is a professor at one of the universities and he - usually he is - let me put it this way, he is probably more optimistic now than I've ever seen him and that's a good thing.
Julie Sloat: Nick, if I can just jump in there with a finer point or two as well. And Sophie as I made comments in my opening remarks, we are still about 1.6% behind pre-pandemic levels on the industrial side of the house. But as I mentioned and as Nick mentioned, we do see expansions that are going to allow us to not only get pass that 1.6%, but to go beyond that. So we do expect to be beyond the pre-pandemic levels. And as a matter of fact, what we've seen so far this year in the first quarter is that six of our top 10 sectors were up. So that's a good indication. And then looking forward, we expect to see strong growth in oil and gas as new LNG operations ramp up in Texas and that began a few quarters back. So we're going to start to see the fruits of that efforts as well, but stay tuned. As you know, we typically, if we're going to revise guidance, we've historically done it once we get past our peak season, which is summer, but to be perfectly candid, we're looking at this constantly. So we will be back to you if there is anything that requires us to get new information in front of you, because we'll definitely want to take advantage of that.
Sophie Karp: Perfect. Thank you. My other question is on the RFPs, not to beat the dead horse, I guess, but I can appreciate the fact that the projects are expected to be commissioned in 2024, 2025 timeframe, which is a couple of years away to sort out the physical disruption of equipment availability, et cetera. But in terms of pricing, what should be - typically bid into those RFPs, like what do you think they should be coming in terms of pricing. Does that make it difficult with volatility in the pricing of equipment, particularly solar, and unpredictability really where we are with the solar market or storage market might be a year from now. Does it make the, I guess, the process more complicated or addressed with it.
Nick Akins: Yes, I think it will make it more complicated, but not insurmountable, because whatever increases you may see from a solar perspective, the overall project benefits will still be part of it. Now it may change the relationship between wind and solar in the integrated resource plan. Solar may come later than what we thought because if wind continues to continues to progress as you go in our resource plan, a lot of it was when to start and then eventually it's based on pricing and everything else, solar would start to pick up and at some point overcome the wind asset and then you move into other technologies. That condition may change based on that, but you also, I mean, you'll probably see that in the framework of increased gas prices too. So really the renewables will be relative to each other not in terms of relative to whether they'll get done or not. So, and I really think we'll be in good shape from that perspective. The other part two is that, when you look at the other resources, really what you're doing is, you're putting in renewables and you're also layering in some natural gas in the plan to really give it 24/7 supplier. Natural gas also is a placeholder for other types of resources, whether it's hydrogen, whether it's small modular reactors, whatever that comes about with new technologies and the grid optimization itself will be a major part of that as well with transmission. So there is a multitude of answers there that will occur. But, yes, you're right, you would suspect solar, there'll be some short-term perturbation from an increase perspective that we'll have to deal with. But in the overall scheme of things, when you look at long-term, it will still be positive.
Operator: And our last question comes from Michael Lapides with Goldman Sachs.
Michael Lapides: Nick, thanks for taking my questions. I have two and they are a little bit unrelated. I'm going to the appendices of your slide deck. I'm looking at what you used to call kind of, I don't know, the money chart, the ROE chart for trailing 12 month, the equalizer chart, thank you. And one of the things that stands out as public serve Oklahoma, just curious if you can talk a little bit about PSO and a little bit about maybe SWEPCO in APCo where the earned ROEs are decent bit below 8% and just kind of how you think about the trajectory of quote-unquote fixing the split between earned and authorized.
Nick Akins: Yes, so at SWEPCO we have rate cases there in two of the jurisdictions and PSO, we will have a rate case as well. And, but keep in mind too, we just brought in all of the renewables in play, particularly a large chunk of it for PSO and SWEPCO. So that's now rolling through rates and so we expect that to continue to pick up, those are - and really when you look at the industrial and manufacturing economic development part of what's going on in those jurisdictions, they are still very positive. So, and of course we continue to invest heavily in those jurisdiction so, and that's why we have equalizer chart that some of the peer lower until we file rate cases and when the investment changes itself, so we're not concerned by that at this point and actually we see PSO and the SWEPCO jurisdictions with Arkansas, Louisiana, in particular, very favorable.
Michael Lapides: Got it, okay. And then one follow-up and this may be just a checking in on what was in our original guidance, but just curious, for the transmission segment, how much do you think down a little bit on a net income and EPS perspective year-over-year for the first quarter. Can you remind me what you think the earnings growth trajectory is for the transmission segment in 2022 relative to 2021 and kind of the drivers behind that?
Julie Sloat: Yes, and so, Michael, I don't have my guidance sheet in front of me for 2022, it's in our presentation that we put out there and our fourth quarter call, but effectively and actually somebody is going to hand it well, and going to hand it to me. But effectively, what we were anticipating was that year-over-year we'd be up about $0.08 and that was driven by investment growth being up $0.12. I mentioned this actually in my opening comments as well and then we had a true up that would occur and we knew that was going to be embedded. That's why we have it in the guidance, that's associated with the fact --
Nick Akins: The true up was positive the previous year, and yes, sort of double count.
Julie Sloat: It would - so it's flipping back and forth so. So we had two reasons for that true up. I mean, we had spent just a little bit under our budget for the prior year and as you know, we got forward looking rate. So that's a catch up there and then we had higher load, so we had a catch up there too, so we get a little bit of a double-counting there. But that's why we had the 11% reduction in that true up. And then we had other financing and income taxes that kind of brought that number back down to, flip it to a negative $0.08. So in aggregate, for 2022, we assume that we'd have about $1.27 from that particular segment, again driven by investment growth, offset by a couple of these other bucket items that I threw out there. We are on that trajectory. And that's why I specifically called that out in my opening comments, because if I was trying to model this, that's exactly what I'd be asking.
Michael Lapides: So then the growth would be more into the year --?
Julie Sloat: It's, I guess, it's priced fair enough. We're a little short on the first quarter. But yes, I would just expect that we'll continue to see transmission investment continue to plug along through the remainder of the year, at this point, we don't have any changes as it relates to that specific guidance. And we have it out there year-by-year in our guidance forecast and assumptions pages in our traditional Investor Relations materials. Happy to walk through with you offline, if you'd like to do that too.
Michael Lapides: I appreciate it. Thank you guys. Super-duper helpful and much appreciated you taking the time to get to my questions.
Nick Akins: Sure thing. Thanks Michael.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Katie, would you please give the replay information.
Operator: Ladies and gentlemen, this conference will be available for replay after 11:30 Eastern Time today through May 5th at midnight. You may access the AT&T replay system at any time by dialing 1866-207-1041 and entering the access code 2732671. International participants dial 402-970-0847. Those numbers again are 1866-207-1041 and 402-970-0847, access code 2732671. That does conclude our conference for today. Thank you for being patient and for using AT&T Conferencing Services. You may now disconnect. | [
{
"speaker": "Operator",
"text": ""
},
{
"speaker": "Nick Akins",
"text": "…fourth quarter, we are maintaining that momentum and delivering strong results for the first quarter of 2022 with operating earnings for the first quarter coming in at $1.22 per share or $616 million. Earlier this year, we made a number of refinements to our strategic initiatives and financial targets. We raised our 2022 operating earnings guidance range and increased our long-term earnings growth rate and we have hit the ground running in 2022. Today we are reaffirming our 2022 full-year operating earnings guidance. As a reminder, we are guiding to a range of $4.87 to $5.07 per share for 2022 with a $4.97 midpoint and we also reaffirm our long-term earnings growth rate of 6% to 7%. As you'll recall, we announced several significant developments in connection with last quarter's earnings. In addition to lifting our 14% to 15% FFO to total debt targeted range, we announced on the decision to sell all or a portion of contracted renewable assets within the unregulated business. The announcement of this strategic divestiture allowed us to recalibrate our five-year capital plan of $38 billion with a $1.5 billion shift to transmission and the elimination of growth capital in the contracted renewables business. We are already seeing the positive impacts of these initiatives in quarter one, and we look forward to continue to execute in these important areas throughout the course of the year. We also expect to maintain positive momentum in our economic outlook as we work collaboratively with states to drive economic expansion in our service territory. There is more to come on all that, but I first want to take a step back and highlight some of the other proactive work our team has done. As macro trends continue to affect our industry in the economic landscape at large, we are focused on de-risking our platform and elevating our strategy to enhance shareholder value. For example, given lingering global supply chain issues, we are diversifying our mix of suppliers in order to reduce the impact on our capital investment plan. As a result, AEP has experienced minimal customer or business disruptions to-date. With these significant initiatives underway and a track record of thinking creatively, it is truly a team effort and we are lucky to have one of the most talented teams in the business. Regarding Kentucky, we expect to complete the sale of Kentucky Power and AEP Kentucky TransCo to Liberty in the second quarter of this year. A regulatory timeline of the sale is on Slide 7 of today's presentation. In 2021, we announced a comprehensive strategic review of our Kentucky operations resulting in an agreement to sell those assets for $2.846 billion enterprise value. Both parties have been steadily working to obtain the necessary approvals to complete this transaction, which is in the public interest. The Kentucky Public Service Commission hearing was held on March 28th and March 29th. We know that Liberty is well positioned to serve Kentucky customers and are confident our employees in Kentucky will continue to thrive within an organization that prioritizes safety and operational excellence. Based on the statutory requirements, we continue to expect to receive a decision from the commission on the sale transfer no later than May 4th. FERC approval on the sale transfer is also in process. Earlier this week, FERC notified us of a need for more information in the 203 transfer application. This request is not unusual as FERC looks to ensure its record is complete by seeking additional information. We do not believe this request will impact the closing of the deal in the second quarter. Once a decision is made by the state level next week, we will provide the requested information back to FERC, we'll plan to ask FERC to abide by the original approval timeline to ensure Kentucky customers receive benefits from this transaction in a timely manner. Another significant regulatory milestone for the transaction is gaining approvals on the Mitchell operating agreement, which were the condition of the final sale transfer. Both Kentucky and West Virginia are aware that updated Mitchell operating agreement approvals are needed to put in place the commission orders on environmental compliance issued 2021. The Kentucky Public Service Commission hearings were held on March 1st and March 30th and the West Virginia Public Service Commission was held on April 7th. Parties providing options allowing flexibility for both states to collaborate and reach a common agreement as Kentucky continues to wind down interest in Mitchell plant post 2028. We expect to receive commission decisions on the Mitchell agreements on an expedited basis in May of this year. We plan to file the related FERC application after State Commission approvals. Throughout this process, we have established a strong record of benefits of this transaction. Most notably, the clear and measurable customer benefits that we see. Okay. Now, moving onto the contracted renewable asset sale. During our fourth quarter earnings call in February, we announced the decision to sell all or a portion of our unregulated contracted renewables portfolio to simplify and de-risk the company and allow us to focus on our regulated business. Our portfolio consists of 1,600 megawatts of unregulated contracted renewables, the sale of which will help facilitate the investment of 16,000 megawatts of regulated renewables through 2030. In the last couple of months, we have made significant progress on this opportunity, including working with an advisor preparing outside consultant reviews of the technical and market aspects of our portfolio and evaluating our sales strategy and timing. Interest in the sale of the portfolio has been robust. The sale provides a unique opportunity to acquire large operating wind portfolio complemented with some solar operations as well. We expect to launch the sales process sometime during the second half of 2022, likely in the August-September timeframe and can be accelerated or deaccelerated as needed. Additionally, we are pleased to announce that we assigned a term sheet to sell most of our wind and solar development portfolio including five sites which are located in the Southwest Power Pool. We have also executed an agreement to sell a solar development site here in Ohio. Financial details of these upcoming sales are confidential and will not be disclosed, but demonstrate our commitment toward that execution. The reallocation of contracted renewables capital is assumed in our guidance, but utilization of proceeds is not yet reflected in guidance or our multi-year financing plan. We will seek to maximize transaction proceeds in the sale, avoid dilution and direct the proceeds to investments in our regulated business as we continue to enhance the transmission infrastructure and move forward with our generation fleet transformation. Looking ahead, we will continue our track record of optimizing the portfolio and reallocating capital to our regulated business where we continue to see a meaningful long-term opportunity for growth. AEP is making significant progress as well in our transition to a clean energy future. In fact, we already have several initiatives underway in line with our sustainability goals and through our regulated renewables execution. Details can be seen on Slides 8 and 9. In March we commissioned our third and final North Central Wind site Traverse Wind Energy Center, which is the largest single wind farm built at one time in North America and one of the largest wind facilities worldwide completing the $2 billion trifecta investment that includes Sundance and the Maverick Wind Energy centers. Combined, they are providing 14,084 megawatts of clean energy to our customers in Arkansas, Louisiana, and Oklahoma. North Central will save customers in an estimated $3 billion in electricity costs over the next 30 years. In March, we also issued a request for proposal at I&M for 800 megawatts of wind and 500 megawatts of solar. Additional RFPs are in process simultaneously at APCo, PSO and SWEPCO with expected in-service dates of 2024 to 2025. We expect to make a regulatory filing in the second quarter of this year related to the SWEPCO's June 2021 RFP. These are long-term investments, not just for our business in our local communities, but for the global environment as well. Through our current state of coal retirements, we are progressing towards our target of an 80% carbon emissions reduction rate by 2030 and net zero by 2050. Achieving this goal is an integral part of our long-term strategy to prioritize regulated investment opportunities and transition our generation portfolio. Our plans are a very well thought out, continue the movement to a clean energy economy, but remain firmly grounded in the principles of resiliency, reliability and affordability while recognizing the value of diverse portfolio of resources, particularly given today's world of energy related volatility. Last year we set regulatory foundations in a series of rate cases across multiple jurisdictions. Regulated ROE as of March 31st, 2022, is it a steady 9.2% as we continue to work through regulatory cases and focus on reducing authorized versus actual ROE spreads. I&M obtained Commission approval in February on our Indiana base case settlement. Ohio oral arguments of APCo's 2020 Virginia base case appeal were held in March at the Virginia Supreme Court with anticipated final decision this year. We expect to see Commission decisions as well on SWEPCO's rate cases this year in both Arkansas and Louisiana and look forward to keeping you informed on that progress too. Related to FERC, we command the commission for moving forward with proposed reforms to transmission planning and cost allocation. First proposed rulemaking aligns with our goals of developing a more robust reliable and flexible grid of the future that ultimately reduces cost to customers and strengthens economic development in the communities in which we serve. We believe many of these reforms are needed to build the infrastructure necessary to transition our generation fleet in the most efficient and cost-effective way possible and achieve our carbon reduction goals. We look forward to continuing to work collaboratively with the commission on this, and any subsequent rule makings and with the RTOs on implementing any new requirements. At the conclusion of our fourth quarter call, I told you all that AEP stood poised to make even greater headway in 2022 and I think it's fair to say we are making good on that promise. Capitalizing on our momentum from 2021, we have continued to execute against our strategic objective steadily and successfully. As we think about what's next for this year and beyond, we hope to further modernize our energy grid in order to supply a reliable cleaner low cost resources for all the communities we serve. We will also consider further asset rotation through the lens of de-risking and simplification and we'll evaluate any and all value additive potential activities as we focus on our regulated business. As I've said before, AEP is in a very unique position, the largest transmission system, one of the largest renewables build outs and the diverse territory to adjust from the risk of supply chain, load forecast, regulatory risks et cetera, AEP is the very definition of consistency and opportunity. We at AEP, as well as our shareholders and customers hold ourselves accountable on the continual execution of all of these strategic objectives. To paraphrase a big hit by the police, every breath you take, every move you make, every step you take, we'll be watching AEP, and as our CFO would say, we've got this, Julie?"
},
{
"speaker": "Julie Sloat",
"text": "Thank you Nick, thanks Darcy. It's good to be with you this morning. Thanks for dialing in everyone. I'm going to walk us through our first quarter results, share some updates on our service territory load and finish with commentary on our credit metrics, liquidity, as well as some thoughts on our guidance, financial targets and recap our current portfolio management activities underway. So let's go to Slide 10, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter were $1.41 per share compared to $1.16 per share in 2021. There is a reconciliation of GAAP to operating earnings on Page 16 of the presentation today. Let's walk through our quarterly operating earnings performance by segment on Slide 11. Operating earnings for the first quarter totaled $1.22 per share or $616 million compared to $1.15 per share or $571 million in 2021. Operating earnings for the Vertically Integrated Utilities were $0.59 per share, up $0.05, favorable drivers included rate changes across multiple jurisdictions, normalized load and O&M. These were somewhat offset by increased depreciation, lower off-system sales and wholesale load. I'd like to take a second to talk about O&M and depreciation in particular because of a change in accounting related to Rockport Unit II lease at I&M, we'll see approximately a $0.05 contribution of favorable O&M consequence offset by $0.05 of unfavorable depreciation in each quarter of 2022, but no consequential earnings impact. And to be clear, this is entirely consistent with the 2022 guidance details we posted in our investor presentations earlier this year. I have more to share on load and load performance here in a minute, so hang with me on this. The Transmission and Distribution Utilities segment earned $0.30 per share, up $0.07 compared to last year, favorable drivers in this segment included rate changes in Texas and Ohio, normalized load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. The AEP Transmission Holdco segment contributed $0.34 per share, down a $0.01compared to last year. Investment growth was favorable by $0.03, offset by $0.02 of mainly property taxes, driven by the increased investment and a penny of income taxes. This is in line with the guidance that we provided to you earlier this year. You'll recall that our 2022 guidance had this segment down by $0.08 year-over-year as a result of the $0.12 of investment growth being more than offset by the annual true up that will occur in the second quarter and some unfavorable comparisons on the tax and financing side. As you know, this segment continues to be an important part of our 6% to 7% EPS growth. Generation and marketing produced $0.03 per share, down $0.03 from last year. The improvement in wholesale margins was more than offset by lower retail margins and reduced generation. You may recall that storm Yuri had an unfavorable impact on wholesale margins in the first quarter 2021. Finally, Corporate and Other was down a $0.01 per share, driven by increased O&M, lower investment gains and unfavorable interest. These were offset by favorable income taxes, the lower investment gains are largely related to charge point gains that we had in the first quarter of 2021. Turning to Slide 12, I'll provide an update on our normalized load performance for the quarter. In a general sense the AEP service territory is extremely fertile for economic growth right now, in fact as of the first quarter, our load has officially fully recovered from the pandemic recession and has now transitioned into the expansionary phase of this business cycle. Starting in the upper left corner, normalized residential sales increased by eight tenths of a percent, compared to the first quarter 2021. This growth was composed of growth in both customer counts and weather normalized usage for the quarter. While results were mixed by operating company, the strongest residential growth was at the AEP - was in the AEP service - AEP Texas service territory, which was partially influenced by the year-over-year comparison, given the customer outages driven by storm Yuri in the first quarter of 2021. A final data point to share regarding residential sales is that our first quarter sales were still 1.1% above their pre-pandemic levels, over two years after the pandemic began. This is driven by number of factors including higher numbers of people who are able to work remotely that used to work in offices prior to the pandemic. Moving to the right, weather normalized commercial sales increased by 4.2% compared to the first quarter of 2021, while growth in commercial sales is spread across every operating company and most industries, the largest increase in commercial sales is coming from data centers whose load was up 33% compared to last year. In addition, we continue to see strong recovery in the sectors most impacted by the pandemic such as hotels, schools, and churches, while real-estate has been booming throughout the entire pandemic. AEP normalize - AEP's normalized commercial sales in the first quarter were 2.5% above their pre-pandemic levels which shows that we've gone beyond recovery and are now in full expansion mode across the territory. If I can now focus your attention on the lower left corner, you'll see that industrial sales posted another very strong quarter up 5.6% compared to last year, industrial sales were up, at most operating companies and many of our largest sectors in the first quarter. We experienced double-digit growth in a number of key industries this quarter, including chemicals, manufacturing, oil and gas extraction, petroleum and petroleum products, we also saw robust growth in primary metals manufacturing, coal mining and food manufacturing. Having said that, first quarter industrial sales are still 1.6% behind their pre-pandemic levels. However, we have a large number of customer expansions that are expected to come online later this year and still fully expect to eclipse our pre-COVID industrial sales levels in 2022. We can continue to be confident in our full-year 2022 guidance for normalized retail load. While we certainly did not anticipate the Russian invasion in Ukraine when we developed the 2022 forecast. I'd like to remind you that AEP's service territory is uniquely positioned to benefit from higher energy prices, given the concentration of energy production that is located throughout the AEP footprint. Energy producers in our footprint have responded to higher energy prices, which has resulted in increased economic activity throughout this service territory. Finally, when you pull it all together in the lower-right corner, you'll see that AEP's normalized retail sales increased by 3.2% for the quarter. As I mentioned earlier, our load has gone beyond recovery mode and is in full expansion mode. For the quarter, every operating company posted higher normalized sales than last year. Furthermore, our first quarter retail sales were up, were 1.5% above their pre-pandemic levels. So 50 basis points above pre-pandemic levels. To use a sports analogy, I would say our load performance in the first quarter was in the zone. While there are many factors outside of our control that could influence our results, I want to stress that the positive load story we shared with you today is largely the result of intentional efforts by our employees to promote economic development as a part of our long-term strategy to strengthen the communities that we serve. We're fully aware of the increased uncertainty that exists in the macro economy, but if put into work that it takes to ensure that we continue to see growth in our service territory going forward. So let's go to Page 13 to check on the company's capitalization and liquidity position. On a GAAP basis, our debt to cap ratio increased 60 basis points from the prior quarter to 61.5%, primarily due to an increase in equity from our issuance of AEP common stock in March, which is consistent with our 2022 guidance as the $805 million - or the $805 million of equity units we issued three years ago converted to equity. Let's talk about our FFO to debt metric. Taking a look at the upper right quadrant on this page, you'll see our FFO to debt metric stands at 13.7% on both the Moody's and a GAAP basis, which is an increase of 3.8% and 3 9% respectively from the prior quarter. The metrics are calculated off of the 12 month rolling FFO total, so the increase in FFO to debt is mainly a result of the fact that the cash flow drag from February 2021 winter storm Yuri has now dropped off the cash flow from operations calculations. This improvement has significantly narrowed the gap toward achieving our FFO to debt target range of 14% to 15% . As we stated on the last earnings call, we anticipate trending toward this target range as the year progresses. Let's take a quick moment to visit our liquidity summary on the lower right side of Slide 13. Our five-year $4 billion bank revolver and two-year $1 billion revolving credit facility support our liquidity position, which remained strong at $3.8 billion. Switching gears, our qualified pension funding increased 1.6% during the quarter 106.4%. The rise in interest rates, the decreased plan liabilities was the primary driver for this quarter's gain and funded status. Let's go to Slide 14. This quarter has provided a solid foundation for the rest of 2022 and we're reaffirming our operating earnings guidance range of $4.87 per share to $5.07 per share. We continue to be committed to our long-term growth rate of 6% to 7% that we updated on our last earnings call. We're working through the Kentucky Power sale to Liberty and expect to close in the second quarter. And as Nick mentioned, we've signed an agreement to sell a solar development site in Ohio and have entered into a term sheet to sell five additional wind and solar sites in SPP on the unregulated side of the business. Additionally, we're preparing to market the unregulated contracted renewables portfolio in the second half of this year and are receiving a significant amount of interest on this. Beyond the portfolio optimization activities underway, we remain focused on the fundamentals, which are executing on the regulated renewables plan, disciplined capital allocation, and securing positive regulatory outcomes. Before we break, I want to mention one last thing before we get to your questions. And that's to remind everyone that while we have not yet set the date, we will be hosting an Investor conference sometime in late September, early fall timeframe to give you a broader AEP update. We truly do appreciate your time and attention today. With that I'm going to ask the operator to open the call, so we can hear what's on your mind and answer the questions that you have."
},
{
"speaker": "Operator",
"text": "Our first question comes from Julien Dumoulin-Smith at Bank of America. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Maybe let's start with this, just in terms of the timing of the renewable sale here. Can you talk a little bit about how the AD/CVD steps could impact that, I mean is that on just your sense of the ability to get it done? Just any comments on that, and or implications again I assume that was separately related, how do you think about the timing of proceeds here, admittedly this is a little bit faster than what we had perceived, just talk about the proceeds from Liberty and this coming in perhaps little bit faster than perhaps the equity issuances in your forward plan what you would suggest?"
},
{
"speaker": "Nick Akins",
"text": "Yes Julien, so most of our assets are wind assets, so - and as we go forward with the transactions, we don't see any issues with that. And as a matter of fact, even on the regulated side, the timing of which we actually need assets for solar and that kind of thing comes later. So it's a 2024/2025 timeframe. So on both sides of the ledger we're in good shape from that perspective and these assets, obviously we're going to try to time it appropriately as we talked about the large portion of the 1.6 gigawatts or the 1,600 megawatts, they will be marketed in the third quarter. And I'd say, we're getting very robust. It's amidst very robust interest on - really on both sides, strategics and in terms of any type of private equity that kind of thing. So, it's really to us, the process will continue and there is nothing stopping us. So, we're in good shape from that perspective. And then your second part of your question, Julie, did you have that part?"
},
{
"speaker": "Julie Sloat",
"text": "Yes and Julien, let me know if I'm not answering this directly or if you need a little more granularity. Specifically as it relates to dollar flows associated with any type of transaction that we enter into, so today you're going to talk about the fact that we've had a term sheet in place for five development sites, those dollars are still small. And so, we'll see those, show up eventually priced second quarter or third quarter in operating earnings. But obviously - not even disclosing those not a needle mover for us and not going to change the earnings guidance or anything like that, so not to worry on that front. And then as it relates specifically to the broader unregulated renewables contracted portfolio, we'll start the marketing effort in the second half of this year. Obviously, we'll continue as we have a little more detail to share. We do have an upcoming on investor conference, so stay tuned for that, and then we'll be able to navigate any potential proceeds from transactions. As you know, we don't - even know exactly how that's ultimately going to look, do we sell them as an entire portfolio? Do we sell them in different pieces? So that's to be determined, so standby on that. And then obviously, we continue to work through the Kentucky process. We had expected to close that - we're trending toward the second quarter. As Nick mentioned and I mentioned in my opening remarks, that's already reflected as it relates to Kentucky bringing dollars in, in our plan. You may recall that we eliminated about $1.4 billion of equity that we originally had in our 2022 guidance. So I think we're moving on track. Let me know if there is something I didn't address there."
},
{
"speaker": "Nick Akins",
"text": "Yes and since we're really moving on the universal scale assets, they're project specific. So we can go through that process and time at anyway that we wish to do it, so that's - and actually they are actual pretty quickly. So, we'll go through that process and will define that better and that will be part of our Analyst Day discussion."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Now speaking Analyst Day discussion, just super quick if I can, an important point. How do you think about just approaching your customers directly with energy prices environment, doing well on industrial and C&I sales growth, presumably your customers are interested. We heard this from Entergy, can you kind of elaborate how you're thinking about that opportunity here in this elevated environment as a further angle to your renewable aspiration?"
},
{
"speaker": "Nick Akins",
"text": "Well, certainly the renewables are a key part of being able to really mitigate cost to consumers going forward. So, from an industrial standpoint and manufacturing standpoint, we're going to see a lot of that movement to our territory, because when you think about onshoring, when you think about strategic reviews of supply chain actions that need to occur within this country, that's going to occur within our territory. So our focus will be, I think from the renewable side, particularly the regulated renewable side to be able to continue to progress on that is a benefit because a clear benefit for customers and certainly North Central showed that, but I think from an industrial standpoint, it's going to look very good for us. We have the resources for capacity and when you layer in the renewables for the incremental needs of capacity, it's really the best of both worlds to provide reliable secure supply to our industrials and really at a competitive price. So I think we're in great shape from that perspective going forward."
},
{
"speaker": "Operator",
"text": "Next we'll go to Steve Fleishman with Wolfe Research."
},
{
"speaker": "Steve Fleishman",
"text": "That is enthusiastic for me, sorry. So, just on the Kentucky process, there does seem to be a decent amount of people that want different things on the Mitchell operating agreement. Can you just talk to your confidence in resolving those issues by the second quarter and just because - and just maybe frame the issues and how you think they can get resolved?"
},
{
"speaker": "Nick Akins",
"text": "Yes, obviously there has been a lot of focus on the Mitchell agreements themselves and we've certainly tried to accommodate the multiple parties that are involved and made as flexible as possible and obviously the issue is 2028 and how you reconcile that going forward. And from a state perspective, I think we're in a good place, because it does provide the flexibility to find whatever value proposition there is at that point and there also is optionality around the ability to potentially separate the units to allow each individual commission to make their own decisions relative to these units. So, I think it's positioned very well. There's been a lot of dialog, lot of settlement discussions associated with that and a lot of - of course there's a lot of varied opinions, but at the end of the day, we have to do this because we have two commissions that are going in different directions relative to the life of the Mitchell plant. And I think what we've arrived to is a very credible balanced view that allows the optionality that the parties need going forward, so. And of course, we certainly will continue to focus on the ELG and CCR expense associated with that in the appropriate manner, and that will improve the optionality going forward to where decision is going to be made at the appropriate time. But I would say we're in a good place as we expect, we expect the Mitchell approvals to occur very quickly after the transaction approval."
},
{
"speaker": "Steve Fleishman",
"text": "Okay, great. Thank you. And then just, you've been pretty good and right about Federal, the BBB legislation kind of to get done or whatever you want to call it these days, just curious if you have any latest thoughts and updates there - has anything changed?"
},
{
"speaker": "Nick Akins",
"text": "I'll say, I'll say this. Certainly, Senator Manchin is at the center of all of this, but there also is, I think from their original infrastructure package, a group of senators who were coming together to try to focus on some pretty substantial issues and really when you think about Senator Manchin being on both the Armed Services Committee and the Energy Committee and knowing the Ukraine situation and the focus on energy as it relates to it. I think you're going to see at least an attempt to a lot of focus on how to support natural gas, LNG, expansion for pipeline capability, and then of course he has also talked about the climate provisions, and I think there'll be a lot of interest too in the technologies of the hydrogen hubs and particularly in West Virginia. And then there is obviously Murkowski, Barrasso, there is others that they are engaging in that discussion. The ITCs, PTCs, the climate provisions that the industry is looking for, I think there is some bipartisan level of support for that. So the question really is, can they get together before - really before Memorial Day. And if there is still talking after Memorial Day it's probably a positive indication. My own personal belief is, if it's not successful, we'll probably see in the 11th hour type of - at the end of the year relative to ITCs and PTCs and perhaps Steve, an expansion of those. So I think you'll see us attempted a smaller bill, you'll still get hung up with the pay for, particularly with Manchin wanting to get it paid for and it's obviously a different, different view on that. So, but there is probably some element of recognition that something has to be done to have this country focus on the security of supply, not only for our sales that the Ukraine situation is demonstrated, but also for Europe and the rest of the world. So that's probably the impetus of getting something done and will define the framework of whether something gets done or not. If it doesn't after the election, I think like I said, it's the 11th hour or perhaps the RS and Treasury make adjustments based upon what's happened relative to supply chain activities. So, I think that would be my view of where things are going."
},
{
"speaker": "Operator",
"text": "Next we will go to Shar Pourreza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Shar Pourreza",
"text": "Just - Nick, I just want to question on sort of the renewable comments. As we're looking kind of at your current RFPs that are in progress, there sort of a fairly healthy mix between wind and solar and storage. As we're thinking about kind of the upcoming 2021, 2022 RFPs, how are you sort of thinking about the potential tail risks around solar with circumvention investigation as pricing uncertainties, there is a lot of constraints. I guess these tail risk impact the mix for 2021 and 2022 and do you see any risk to the $8.2 billion you've allocated to renewables. I mean, we've already seen two peers provided some warnings around this and one this morning, as well as delays. So I'm just curious how this fits in with your plan?"
},
{
"speaker": "Nick Akins",
"text": "Yes. I don't see a lot of risk and the reason why is, because ours is more 2030, a lot of these projects will come into play in the 2024, 2025 timeframe. So, we have time for not only for the reviews of solar that's occurring with the administration, but also in terms of the supply chain activities just to level out somewhat before we're actually out back in the market acquiring these types of resources. So, we have a little bit of time, I think probably by first quarter next year we want to see things start to levelize so that we can get that process rolling. In the meantime, we got the resource planning filings that are being made. And keep in mind too, I made this point originally. These plans are really fungible from year to year based upon what we see in terms of the value proposition of each type of resources. So a lot of its wind, some of it's solar, solar picks up in the later years from a resource plan perspective, so there is time for the solar thing to get resolved. But even if it doesn't, that sales is probably going to be more wind or other types of resources that are put in place to support these objectives, because remember, they're driven by capacity requirements and we'll continue to evaluate that process. And I'll take a step further too on this is, we've always said that if something were they happen relative to the renewables build out, we've got transmission and transmission we can soak up a lot of capital from that perspective because of the focus on providing better customer service, more resilient and reliable grid. So we have that optionality, but I'm not, I'm not even there yet. I think we're - we may be because the $8.2 billion we have in there assumes a certain percentage of those types of resources that we would own. That could be higher, transmission could be higher. So we have optionality around all of that. So I'm not concerned from an AEP perspective."
},
{
"speaker": "Shar Pourreza",
"text": "Sure. The current gas price environment helps the economic argument."
},
{
"speaker": "Nick Akins",
"text": "Absolutely, absolutely because the $3 billion for North Central was down on our previous gas forecast and if you look at that today, it's probably much larger. I think it's really looking good for customers."
},
{
"speaker": "Shar Pourreza",
"text": "Got it, got it. And Nick, just from a financing perspective is, we're thinking about incremental spending that's going to come from these future RFPs. Can you just be a little bit more specific on your prepared comments around further asset sales, I mean, you look at all your OpCos that remain, I guess what could a structure look like, what remains?"
},
{
"speaker": "Nick Akins",
"text": "Yes, so - and the point I'm making is obviously we're going through the process step by step with the unregulated contracted renewables parts, so there is different parts of that business. And then of course, just - I think Kentucky was the first shot at it. There is a lot of optimization that can occur. We'll just have to evaluate against what the opportunities look like. And if we're - if we have, I mean, if we have underperforming utilities that don't figure prominently into the, into the clean energy transformation where we're actually attracting capital and being able to provide higher levels of return, then we have to look at it, so. So I'm just saying that, that process will continue regardless, not saying and actually we're already too deep, and I've talked about the number too deep. In terms of sales, Kentucky, we still have to get across and then the contracted renewables, we still get across. And then we'll see where we're at that point, based upon what we're getting in terms of the feedback of the RFPs because when these RFPs are ultimately get approved, they will know exactly what the ownership looks like, what the financial requirements are and we'll do what we've always done. We'll make sure that we're going through this process, making to invest in the right places and we will look at the portfolio and see what makes sense and what doesn't make sense for us to continue to optimize that for shareholder benefit."
},
{
"speaker": "Shar Pourreza",
"text": "And then just one quick follow-up from Steve's question is, obviously we appreciate the confidence around the operating agreement in the Kentucky sale and reiterating the timing of the deal, but just to book ended, assuming there is maybe an adverse ruling or something that's not palatable. Can you just remind us, I think does Algonquin have a material adverse change clause? Is there a timeframe when they could walk away from the deal as we're just thinking about a book end?"
},
{
"speaker": "Nick Akins",
"text": "It's typical to have those kinds of provisions in that kind of agreement, but I can tell you that we and Algonquin are arm-in-arm getting this thing across the finish line. They very much want to own this property and they've actually - they've actually stepped up in a considerable way to provide customer benefits to make this transaction attractive to the policymakers and to the customers. So, and of course - I think a seminal event here obviously is May 4th where the commission will come out with an order and we will look at that order, we will make determinations on what conditions are in place and at that point in time, we'll make decisions on what it looks like. But I think from the public interest standpoint, the things that the commission also be looking at, this transaction is very, very good for Kentucky customers and if there are - I think everyone has to be sort of level headed about all of this because when you get through this process, you actually have a - you have a timeframe now for customer benefits to occur, substantial benefits and that's really a driver to get this thing done as quickly as possible, particularly in this energy related environment. So, I really don't anticipate that happening, but if it did, we'll do what we always do, we'll figure out what the options are and what the possibilities are and go from there. But right now we're not planning on that."
},
{
"speaker": "Operator",
"text": "And next we'll go to the line of Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "Just want to pivot a little bit towards transmission here, and given the MISO planning makes a little bit outside of you guys footprint, but also as you mentioned the FERC transmission planning and AEP stepping up CapEx towards Transmission here. Just wondering if you could dive in a little bit more as far as what's - which specific areas projects might materialize or any other color you can provide on specific transmission opportunities incremental at this point?"
},
{
"speaker": "Nick Akins",
"text": "Well, typically, and we've done this, we actually plan for around 130% of the budget for transmission. So we have 30% more projects that are occurring that we already have planned scoped ready to go. So layering in these multiple projects is a way for us to not only as opportunities arrive, as the metrics for financials continue to improve, we can layer in more of that, we can adjust to that based on projects that go one way or another. And then also, recently we were awarded in Texas - a large project in Texas that's also incremental. So, it was like $1.3 billion or so, but that - those are the kinds of things that will come to pass and we have every bit of opportunity related to transmission not only within our own system, but also in terms of the incremental systems around us, and that's why - and you asked about FERC and transmission, FERC obviously is taking the right steps relative to long-term planning, getting the framework for long-term planning put in place. That's an important part of the process to speed up some of the planning aspects to ensure that we are making the right investments at the right places. We continue and I think FERC will continue to look at, even in parallel, these issues of cost allocation of even the incentive mechanism, but also in terms of - and the regional planning which AEP will bode well in terms of that because just about everyone interfaces with us. So, as you look at some of these aspects, the more renewables that are needed, certainly the more retirements that are occurring across RTOs is all going to bode well for transmission investment. And we - what we see today is not we're going to see tomorrow. And then if FERC is doing the right thing, which we think they are, is going to bolster the ability for us to have a more consistent, congruent, clean-energy type system across this nation and you can't do that without AEP."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it, thank you for that. And just shifting gears towards O&M, just wondering what trends you're seeing there? It looks like it was a nickel benefit and Vertically Integrated a little bit of a headwind in transmission and distribution, and just wondering if you could dive in a little bit more as far as what different trends you're seeing in O&M across the business?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, happy to, Jeremy, this is Julie. I did call specifically out, the O&M trend in Vertically Integrated Utilities. There's a little bit of a flipping and twitching going on between O&M and depreciation associated with the Rockport Unit II lease. That's included in that 2022 guidance that we had provided to you back in February, we've updated that page for your, so entirely consistent. Yes, and we're absolutely watching O&M as we continue to navigate inflationary pressures, et cetera. At this point, I would tell you, I think we're right in line with where we thought we'd be. So we're keeping our fingers crossed and the team is working like heck to make sure that we've got supply chain and supply chain is being addressed et cetera. But at this point, that guidance that we gave to you stands pat. So nothing new to report other than the fact that the team is working really hard to make sure that those numbers coming in line to the extent that we have many new developments, we will surely keep you apprised."
},
{
"speaker": "Operator",
"text": "And next we'll go to Durgesh Chopra with Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"text": "Congrats, this is a solid print here. Most of my questions have been asked and answered. I just had a quick clarification as it relates to the Kentucky sale. The May 4th is when we get the order for transfer and control. Do we need to get sort of the Mitchell operating plan agreement before then or how does that play into the May 4th order?"
},
{
"speaker": "Nick Akins",
"text": "No, that will likely come after shortly thereafter and the way we've looked at it is that, obviously you want the transfer agreement done. But as far as the Mitchell agreement approval, we expect that to occur shortly thereafter with both commissions because it's an important aspect of it and something I think that really helps for the transaction side as well."
},
{
"speaker": "Durgesh Chopra",
"text": "I understand. So they can actually issue an order, the Kentucky commission can before actually - on the trend or before resolving the Michelle sort of ongoing dates of different things."
},
{
"speaker": "Nick Akins",
"text": "That's right, that's right."
},
{
"speaker": "Operator",
"text": "And next we will go to Sophie Karp with Keybanc."
},
{
"speaker": "Sophie Karp",
"text": "Good morning. Thank you for including the names here at the end."
},
{
"speaker": "Nick Akins",
"text": "Yes, sure."
},
{
"speaker": "Sophie Karp",
"text": "I have a couple of questions here. So, first on the load growth, obviously very healthy numbers here. Above other industrial regions in the country, probably at this point. I'm not sure if two quarters is a trend, but let's say, how long do you need to see those numbers in this range that it would be enacting for maybe your reset in the long-term expectations for what this load should, does it make sense?"
},
{
"speaker": "Nick Akins",
"text": "Yes, it's great question, because you're right, two quarters doesn't, it doesn't make a trend. But when you look at the economy within our service territory, we're seeing some very positive indicators for continued expansion and continued economic development. We are - our economic development people are extremely busy with multiple opportunities that are coming throughout our territory actually. And so we look at that, we look at the sort of - if you were to look at our pipeline of potential opportunities, it is extremely robust and that gives us confidence in terms of where we think the economy is going to continue to go within our service territory. And of course, we don't see an end to the work from home environment. So we're feeling much better about the prospects of a more robust residential side of things. And then on the industrial, like I said, the onshoring, the security aspects, the energy play within our service territory. The other aspects of what's going on within the territory with chemicals manufacturing and so forth, that pace has picked up markedly with expansions and new developments and some of them are still years away, like the NTL manufacturing here in Ohio in our territory. It's substantial there'll be 20 to 40 more companies associated with that. It will be locating. So you see those types of prerequisites that are being put in place, that gives us a lot of positive views about where we think the economy is going. We'll watch it, we'll continue to evaluate it. If we go to the third quarter, see the same thing and fourth quarter, the same thing, then you'll probably see some adjusting going on relative to the 2023 forecast, but that's - our load guy will have to tell us that, he is very objective and he's is a professor at one of the universities and he - usually he is - let me put it this way, he is probably more optimistic now than I've ever seen him and that's a good thing."
},
{
"speaker": "Julie Sloat",
"text": "Nick, if I can just jump in there with a finer point or two as well. And Sophie as I made comments in my opening remarks, we are still about 1.6% behind pre-pandemic levels on the industrial side of the house. But as I mentioned and as Nick mentioned, we do see expansions that are going to allow us to not only get pass that 1.6%, but to go beyond that. So we do expect to be beyond the pre-pandemic levels. And as a matter of fact, what we've seen so far this year in the first quarter is that six of our top 10 sectors were up. So that's a good indication. And then looking forward, we expect to see strong growth in oil and gas as new LNG operations ramp up in Texas and that began a few quarters back. So we're going to start to see the fruits of that efforts as well, but stay tuned. As you know, we typically, if we're going to revise guidance, we've historically done it once we get past our peak season, which is summer, but to be perfectly candid, we're looking at this constantly. So we will be back to you if there is anything that requires us to get new information in front of you, because we'll definitely want to take advantage of that."
},
{
"speaker": "Sophie Karp",
"text": "Perfect. Thank you. My other question is on the RFPs, not to beat the dead horse, I guess, but I can appreciate the fact that the projects are expected to be commissioned in 2024, 2025 timeframe, which is a couple of years away to sort out the physical disruption of equipment availability, et cetera. But in terms of pricing, what should be - typically bid into those RFPs, like what do you think they should be coming in terms of pricing. Does that make it difficult with volatility in the pricing of equipment, particularly solar, and unpredictability really where we are with the solar market or storage market might be a year from now. Does it make the, I guess, the process more complicated or addressed with it."
},
{
"speaker": "Nick Akins",
"text": "Yes, I think it will make it more complicated, but not insurmountable, because whatever increases you may see from a solar perspective, the overall project benefits will still be part of it. Now it may change the relationship between wind and solar in the integrated resource plan. Solar may come later than what we thought because if wind continues to continues to progress as you go in our resource plan, a lot of it was when to start and then eventually it's based on pricing and everything else, solar would start to pick up and at some point overcome the wind asset and then you move into other technologies. That condition may change based on that, but you also, I mean, you'll probably see that in the framework of increased gas prices too. So really the renewables will be relative to each other not in terms of relative to whether they'll get done or not. So, and I really think we'll be in good shape from that perspective. The other part two is that, when you look at the other resources, really what you're doing is, you're putting in renewables and you're also layering in some natural gas in the plan to really give it 24/7 supplier. Natural gas also is a placeholder for other types of resources, whether it's hydrogen, whether it's small modular reactors, whatever that comes about with new technologies and the grid optimization itself will be a major part of that as well with transmission. So there is a multitude of answers there that will occur. But, yes, you're right, you would suspect solar, there'll be some short-term perturbation from an increase perspective that we'll have to deal with. But in the overall scheme of things, when you look at long-term, it will still be positive."
},
{
"speaker": "Operator",
"text": "And our last question comes from Michael Lapides with Goldman Sachs."
},
{
"speaker": "Michael Lapides",
"text": "Nick, thanks for taking my questions. I have two and they are a little bit unrelated. I'm going to the appendices of your slide deck. I'm looking at what you used to call kind of, I don't know, the money chart, the ROE chart for trailing 12 month, the equalizer chart, thank you. And one of the things that stands out as public serve Oklahoma, just curious if you can talk a little bit about PSO and a little bit about maybe SWEPCO in APCo where the earned ROEs are decent bit below 8% and just kind of how you think about the trajectory of quote-unquote fixing the split between earned and authorized."
},
{
"speaker": "Nick Akins",
"text": "Yes, so at SWEPCO we have rate cases there in two of the jurisdictions and PSO, we will have a rate case as well. And, but keep in mind too, we just brought in all of the renewables in play, particularly a large chunk of it for PSO and SWEPCO. So that's now rolling through rates and so we expect that to continue to pick up, those are - and really when you look at the industrial and manufacturing economic development part of what's going on in those jurisdictions, they are still very positive. So, and of course we continue to invest heavily in those jurisdiction so, and that's why we have equalizer chart that some of the peer lower until we file rate cases and when the investment changes itself, so we're not concerned by that at this point and actually we see PSO and the SWEPCO jurisdictions with Arkansas, Louisiana, in particular, very favorable."
},
{
"speaker": "Michael Lapides",
"text": "Got it, okay. And then one follow-up and this may be just a checking in on what was in our original guidance, but just curious, for the transmission segment, how much do you think down a little bit on a net income and EPS perspective year-over-year for the first quarter. Can you remind me what you think the earnings growth trajectory is for the transmission segment in 2022 relative to 2021 and kind of the drivers behind that?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, and so, Michael, I don't have my guidance sheet in front of me for 2022, it's in our presentation that we put out there and our fourth quarter call, but effectively and actually somebody is going to hand it well, and going to hand it to me. But effectively, what we were anticipating was that year-over-year we'd be up about $0.08 and that was driven by investment growth being up $0.12. I mentioned this actually in my opening comments as well and then we had a true up that would occur and we knew that was going to be embedded. That's why we have it in the guidance, that's associated with the fact --"
},
{
"speaker": "Nick Akins",
"text": "The true up was positive the previous year, and yes, sort of double count."
},
{
"speaker": "Julie Sloat",
"text": "It would - so it's flipping back and forth so. So we had two reasons for that true up. I mean, we had spent just a little bit under our budget for the prior year and as you know, we got forward looking rate. So that's a catch up there and then we had higher load, so we had a catch up there too, so we get a little bit of a double-counting there. But that's why we had the 11% reduction in that true up. And then we had other financing and income taxes that kind of brought that number back down to, flip it to a negative $0.08. So in aggregate, for 2022, we assume that we'd have about $1.27 from that particular segment, again driven by investment growth, offset by a couple of these other bucket items that I threw out there. We are on that trajectory. And that's why I specifically called that out in my opening comments, because if I was trying to model this, that's exactly what I'd be asking."
},
{
"speaker": "Michael Lapides",
"text": "So then the growth would be more into the year --?"
},
{
"speaker": "Julie Sloat",
"text": "It's, I guess, it's priced fair enough. We're a little short on the first quarter. But yes, I would just expect that we'll continue to see transmission investment continue to plug along through the remainder of the year, at this point, we don't have any changes as it relates to that specific guidance. And we have it out there year-by-year in our guidance forecast and assumptions pages in our traditional Investor Relations materials. Happy to walk through with you offline, if you'd like to do that too."
},
{
"speaker": "Michael Lapides",
"text": "I appreciate it. Thank you guys. Super-duper helpful and much appreciated you taking the time to get to my questions."
},
{
"speaker": "Nick Akins",
"text": "Sure thing. Thanks Michael."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Katie, would you please give the replay information."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this conference will be available for replay after 11:30 Eastern Time today through May 5th at midnight. You may access the AT&T replay system at any time by dialing 1866-207-1041 and entering the access code 2732671. International participants dial 402-970-0847. Those numbers again are 1866-207-1041 and 402-970-0847, access code 2732671. That does conclude our conference for today. Thank you for being patient and for using AT&T Conferencing Services. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 4 | 2,023 | 2024-02-27 09:00:00 | Operator: Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Fourth Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead.
Darcy Reese : Thank you, Regina. Good morning, everyone. And welcome to the fourth quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our Interim President and Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks. I will now turn the call over to Ben.
Ben Fowke : Well, thank you, Darcy. Good morning and welcome to American Electric Power’s fourth quarter 2023 earnings call. It's great to have a chance to reconnect with you, although I never thought it would be under these circumstances. As you know the AEP board of directors made a decision to remove Julie Sloat from her duties as Chair, President and CEO. Taking this action was not easy, but the board believes it was in the best interest of AEP and its stakeholders to do so. On behalf of the board and the entire AEP family. I would like to wish Julie well and thank her for all her contributions. I would also like to assure everyone that Julie's departure was not due to any unethical behavior, disagreements of financial policy or because of any violation of AEP’s code of conduct. Now, as many of you are aware after my retirement from Xcel Energy, I joined the AEP board in February of 2022. I was attracted to this board because I was impressed with AEP’s business model, its strong asset base and the quality of its leadership team and board. I'm even more impressed two years later. In my tenure here, I've seen the AEP team rise to meet multiple challenges. Let me give you some examples starting with earnings. For 14 years in a row, AEP has met or exceeded earnings guidance, and 2023 is no exception. Our operating earnings came in at $5.25, that's within our guidance range despite $0.37 of unfavorable weather and $.45 of increased interest cost over the prior year. As you know, controlling O&M expense has been a challenge for the industry. And AEP has met that challenge, essentially keeping O&M flat for the last 10 years, while at the same time doubling its asset base. This team's continuous focus on O&M efficiency is nothing short of excellent. You may also recall that in early 2023, the Texas Commission denying a petition to be part of SWEPCO is 999-megawatt renewables project for $2.2 billion. But the team didn't miss a beat and put the project back on track with Arkansas and Louisiana ultimately stepping up to move forward with the full project. As a result, and including SWEPCO. Today, we have commission approval of $6.6 billion of new renewable projects throughout AEP’s service territory, representing a 70% achievement of our current 5-year $9.4 billion new generation capital plan. I hope you would agree with me that that is really solid execution. Initiatives to simplify and de-risk our portfolio are squarely in the focus of the board and the management team. And we are pleased with the great progress made. Last year, we completed the sale of our unregulated renewables portfolio, bringing in $1.2 billion of cash proceeds. We should be closing on our New Mexico renewable development solar portfolio within the next day or two. This in combination with the expected conclusion of our retail and distributed resources sales process in the second quarter, keeps us on schedule to achieve our 2024 asset sales targets. Now as we move forward, AEP will continue to be a disciplined portfolio manager and we will be willing to take action when price and the ability to execute intersect. To that end, we've made the decision to retain our ownership interest in both our Prairie Wind and Pioneer Transmission joint ventures. We also completed the review of Transource and ultimately determined that owning this joint venture fits strategically within our portfolio. We'd like our remaining assets. And we'll focus going forward on doubling down on our efforts to achieve constructive regulatory outcomes that will allow us to provide the quality of service our customers need and expect. Regarding Icahn Capital, our recent agreement came about from a combination of a constructive dialogue between AEP and the Icahn teams. Like us, the Icahn team believes AEP shares are undervalued and there's meaningful upside potential for our investors. The addition to AEP’s board will bring fresh perspective as we continue to execute on strategic priorities and enhance value for our stakeholders. Looking ahead, today, we are reaffirming our 2024 full year operating earnings guidance range of $5.53 to $5.73, as well as our long-term earnings growth rate of 6% to 7%, which is underpinned by a $43 billion 5-year capital plan, in addition to 14% to 15% FFO to debt target, which Chuck will expand upon shortly. You should know that I am committed to my role as Interim President and CEO. And I believe I can add value while the board works to identify a permanent successor. So before I turn it over to Peggy for regulatory updates and Chuck for financial review, let me also acknowledge that 2023 has been at times a challenging year at AEP. There's certainly been some twists and turns and a few bumps in the road. But I would encourage all of you to focus on the key opportunities that lie ahead. I have tremendous confidence in our team's ability to achieve our objectives as we work every day to deliver safe, reliable and affordable energies to our customer. With that, I'll turn it over to Peggy.
Peggy Simmons : Thanks, Ben. And good morning, everyone. Now I'd like to turn to update on our ongoing regulatory and legislative efforts. While we made important regulatory progress in 2023, it is clear that we can do even more to facilitate successful and constructive outcomes. Details of related activities can be found in the appendix on Slides 29 through 31. Closing the authorized versus earned ROE gap is a key area of focus for us. Our fourth quarter ROE came in at 8.8% a slight improvement over third quarter. This also reflects impacts of approximately 40 basis points from mild weather conditions in 2023. Our efforts to improve and bridge the ROE gap is supported by work we've done related to the recent passage of legislation that will help position us to provide safe and reliable service while managing costs and reducing regulatory lag. Most importantly, we obtained securitization in Kentucky, a biannual Distribution Cost Recovery Factor or DCRF in Texas, and rate reviews every two years in Virginia. On the regulatory front, we secured several important wins over the course of 2023, including achieving constructive base rate case outcomes in Louisiana, Oklahoma, and Virginia, reestablishing formula rate plans in Arkansas and Louisiana and reaching a settlement and our Ohio ESP V filings, which were waiting to commission order. Overall, in 2023, we secured $312 million and rate relief. We also filed new base cases in Indiana, Michigan and Kentucky in 2023. In Indiana, we have already reached a settlement, which we filed in December, and we expect the commission decision by June of this year. In Michigan, we continue to advance through the process and currently expect a ruling in the case in July. In Kentucky, the base case and securitization application was approved by the commission earlier this year. Other upcoming cases include a new Oklahoma base rate case for PSO, which we filed last month. Additional filings in the first quarter will include an AEP Texas base rate case and the APCo Virginia biennial rate review that should have the benefits of legislative changes attained in 2023. While we reached many constructive outcomes in 2023, we are disappointed in a couple disallowances recently received. First, in Texas, the commission issued a decision disallowing capitalization of AFUDC related to our Turk plant in mid-December 2023. And we filed a motion for reconsideration a week later. In West Virginia, last month, the commission disallowed a portion of our March 2021 to February 2023 under recovered fuel, and we recently filed an appeal with the West Virginia Supreme Court on February 8. We are also disappointed with the FERC order we received in January 2024 related to treatment of accumulated deferred income taxes associated with net operating loss carryforwards, or NOLC, mostly affecting our Transmission Holdco segment. We just filed for rehearing on February 20. Shortly, Chuck will discuss the related unfavorable net financial impact to 2023 operating earnings. Looking ahead, we know there is more work to be done as we advance our regulatory strategies in 2024 to achieve a forecasted regulated ROE of 9.1%. We are well on our way this year with almost 70% of rate relief either secured or related to mechanisms that are more administrative in nature. We look forward to continuing to engage constructively with our regulators and strengthening relationships at all levels. As Ben mentioned, this year, AEP continued to advance our 5-year $9.4 billion regulated renewables capital plan and now have a total of $6.6 billion approved by various state commissions. More detail of resource additions can be viewed in the appendix on Slides 32 through 34. As previously disclosed, we received approval for APCo's 143 megawatts of wind generation, totaling more than $400 million of investment. This is in addition to the previously approved 209 megawatts of solar and wind projects for approximately $500 million. In 2023, we also received commission approval in both Indiana and Michigan for I&M 469 megawatts of solar projects, representing $1 billion of investment, PSO's 995.5-megawatt renewables portfolio for $2.5 billion and SWEPCO's 999-megawatt renewables for $2.2 billion. Our fleet transformation goals are aligned with and supported by our integrated resource plan. We have pending requests for proposals for a diverse set of additional generation resources at I&M in Kentucky, PSO and SWEPCO, with more to come from other operating companies, including APCo. These generation investments are an integral part of our broader capital program, which is 100% focused on regulated assets and the production tax credits that are generated from our renewable energy projects, our path along to and provide great value to our customers. In addition to these projects, AEP is advancing an additional $27 billion in investments in our transmission and distribution systems to support reliability and resiliency. These combined investments underpin our 6% to 7% EPS growth commitment while mitigating customer bill impacts. With that, I'll pass it over to Chuck to walk through the performance drivers in details supporting our financial commitments.
Chuck Zebula : Thanks, Peggy. And good morning to everyone on the call. I'll walk us through the fourth quarter and full year results for 2023, share some updates on our service territory load, our outlook for this year and finish with commentary on credit metrics and liquidity. Let's go to Slide 9, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $0.64 per share compared to $0.75 per share in 2022. For the year, GAAP earnings were $4.26 compared to $4.51 in 2022. As we have highlighted throughout 2023, our year-to-date comparison of GAAP to operating earnings reflects the gain or loss related to the sale of certain businesses, regulatory outcomes as well as our typical mark-to-market adjustments as non-operating. Our team is committed to minimizing the variances between GAAP and operating earnings as we go forward. Detailed reconciliations of GAAP to operating earnings are shown on Slide 16 and 17 of the presentation today. Let's quickly cover the fourth quarter. Our fourth quarter earnings came in at $1.23 per share, which was a $0.18 improvement over the same period in 2022. Note that we had $0.25 of favorable O&M and strong performance in our Generation and Marketing segment, partially offset by $0.06 of unfavorable weather, $0.09 of higher interest costs and lower performance in Transmission Holdco. December weather, in particular, was the 28th warmest out of the last 30 years. For reference, the full details of our fourth quarter results are shown on Slide 15 of the presentation. Let's have a look at our full year results for 2023 on Slide 10. Operating earnings were $5.25 per share compared to $5.09 per share in 2022. Looking at the drivers by segment. Operating earnings for Vertically Integrated Utilities were $2.47 per share, down $0.09, mostly due to unfavorable weather, higher interest expense and higher income taxes. These items were partially offset by rate changes across various operating companies, increased transmission revenue, higher normalized retail load, favorable depreciation and lower O&M. Once again, depreciation is favorable at the Vertically Integrated segment, primarily due to the expiration of the Rockport Unit 2 lease in December 2022. The Transmission and Distribution Utility segment earned $1.30 per share, up $0.14 from last year. Positive drivers in this segment included increased transmission revenue, rate changes in Texas and Ohio and lower O&M. Partially offsetting these items were unfavorable weather, higher depreciation and higher interest expense. The AEP Transmission Holdco segment contributed $1.43 per share, up $0.11 from last year. Positive investment growth of $0.09 and favorable income taxes of $0.05 were the main drivers in this segment. As Peggy mentioned, we received the FERC NOLC order in January, resulting in an unfavorable net impact to consolidated earnings of $0.07 per share, with the majority of that impact occurring at the Transmission Holdco. The impact of this order to our 2024 plan is approximately $0.03 per share. Generation and Marketing produced $0.59 per share, up $0.09 from last year. The positive variance here is primarily due to improved retail and wholesale power margins, the sale of renewable development sites and favorable impacts associated with the contracted renewable sale in August. These items were partially offset by higher interest expense and unfavorable income taxes. Finally, Corporate and Other was down $0.09 per share, driven by higher interest expense, partially offset by a favorable year-over-year change in investment gains, largely due to investment losses that occurred in the fourth quarter of 2022. As we mentioned earlier, we are reaffirming our guidance range for 2024. For convenience, we've included an updated waterfall bridging our actual 2023 results to the midpoint of our guidance this year in Slide 24. While some variances changed due to last year's actual results, there is no change to our segments or overall guidance. Turning to Slide 11, I'll provide an update on weather normalized load performance. Overall retail load grew 2.5% in 2023. This was stronger than the 0.7% in our original guidance, thanks to an acceleration in data center growth and our commitment to economic development across our service territory. This is most apparent when looking at the incredible expansion in commercial load, shown in the upper right-hand quadrant of the slide. Commercial sales grew 7.8% for the year, and were again dominated by data centers. We are encouraged that the gains are becoming more geographically diverse. New projects have come online in Michigan, Kentucky and Oklahoma to supplement the development of what we see in Ohio and Texas. This is a trend we expect to continue over the next several years as the global demand for data storage and processing accelerates through the growth of AI and other technologies. We expect commercial load to continue to grow from its new higher base this year as projects work their way through the queue and commitments for 2025 are exceptionally robust. I believe that some of the 2025 load is going to accelerate and bleed into this year. Industrial sales grew at 1.6%, which you can see in the lower left-hand quadrant of the slide. This is mostly attributable to a number of large industrial loads we've recently added across our service territories, which are more than offsetting any economic challenges seen by our existing customers. We expect industrial load growth to continue to reflect the softness in manufacturing nationally, with only a modest increase this year. However, growth in industrial sales beyond this year should accelerate as borrowing costs moderate and several large loads currently under construction come online. In the upper left-hand corner of the slide, you'll see that residential load declined slightly in 2023. Usage per residential customer has declined for the past two years, as homes have become more energy efficient and workers spend more time in an office instead of at home. The negative impact of inflation on household budgets may be influencing usage as well. On a positive note, we've seen our residential customer base grow consistently in certain regions. In 2023, we added almost 31,000 net new residential customers across our footprint, resulting in a positive offset to this segment. Overall, we're optimistic about the positive trends in load over the next several years, especially from a commercial and industrial perspective. Our conservative approach to estimating large loads gives us a lot of confidence in the growth we forecasted. In our next update, however, I would expect to see some upside in this area. Let's move on to Slide 12 to discuss the company's capitalization and liquidity position. In the top left table, you can see the FFO to debt metric stands at 13.2% for 2023. Positive changes in FFO were as outlined on the third quarter call, and included favorable changes in cash collateral, fuel recovery and other various drivers. These positive changes were somewhat offset by an $830 million increase in debt during the quarter primarily due to the issuance of long-term debt to prefund our March 2024 AEP parent maturity. We are pleased that the team has overcome strong financial headwinds due to unfavorable weather and an unprecedented increase in interest rates to end the year above Moody's downgrade threshold of 13%. We expect our FFO to debt metric to continue to improve throughout 2024 as we progress towards our targeted range of 14% to 15%. This continued positive trend assumes normal weather for 2024 and continued growth in our cash flows through various regulatory activities, including recovery of our deferred fuel balances of approximately $425 million. Our debt to cap increased from the prior quarter by 60 basis points to 63%, and our parent debt to total debt is approximately 21.7%. In the lower left quadrant of this slide, you can see our liquidity summary, which remains strong at $3.4 billion, and is supported by our bank revolver and credit facility. Lastly, on the qualified pension front, our funding status remains unchanged from the prior quarter to end the year at just over 100%. While falling interest rates increased the liability during the quarter, this increase was offset by positive asset returns. Turning to Slide 13. I'll give a quick recap of today's message. We delivered on our commitments for 2023 despite the significant challenges we faced. Weather was one of the most mild years on record for the AEP system in the past 30 years, resulting in a negative $0.37 impact year-over-year and $0.21 versus normal weather. To put a little more context to those numbers, our heating degree days were down 36% compared to normal across the system. Also, interest expense was a $0.45 hurdle to overcome versus 2022 results. We work diligently throughout the year to reprioritize and balance our plan by adjusting the timing of discretionary spend while staying focused on meeting our core business needs. While admittedly facing some challenges on the regulatory front, we secured many rate outcomes that were critical in supporting our objectives to provide reliable service to our customers. Looking into this year, we are optimistic about the opportunities and prepared to face any challenges ahead of us. We reaffirm our guidance for 2024 of $5.53 to $5.73 per share, our long-term growth rate of 6% to 7% and an improved balance sheet while continuing to implement our capital program, taking care of the customer, earning our authorized return and executing on our strategic priorities. I would like to take a moment and thank Julie Sloat for her 23 years with AEP. Julie has made a positive impact on AEP and will be missed by many. Ben, we welcome you to the AEP management team. Your leadership in the industry is well respected, and you will be embraced by the employees of AEP. The entire management team looks forward to working with you and the board as we look to enhance value for all AEP stakeholders. Thank you for your time today. Operator, can you open up the call for questions.
Operator: [Operator Instructions] Our first question will come from the line of Shar Pourreza with Guggenheim Partners. Please go ahead.
Shar Pourreza : Hey, guys. Good morning.
Chuck Zebula : Good morning. So obviously, the slides are leaning on the successes of AEP. You've reiterated your earnings guidance, balance sheet targets, growth rate, CapEx numbers. I guess outside of some management shuffling, what do you see is broken? I guess, what's the goal of the review? What's on the table, what's off the table?
Ben Fowke : Well, this is Ben. And I can tell you that I don't think I would use the word broken. I think there's areas where we can do better. I think -- and I think we showed you in the script, many of the accomplishments we made. We also recognize that we can do better on getting constructive regulatory outcomes. So strategically, our priorities remain the same. We have completed, as we mentioned, a review of Transource. We want to keep that asset. We think it's a great asset. And I think given the various changes that FERC is looking at, I think it gives us a lot of optionality. We'll continue to be very disciplined portfolio managers. I said it on my scripted remarks, but always willing to transact where price and the ability to execute intersect, and that's a key point. And finally, though, if you step back, I think one of the ways you add value in this industry long term is by placing CapEx at one times book, investing in CapEx at one times book and getting constructive recovery of that. And again, we've done pretty good on that, but we can do better. And we're going to look at the people, the process and the planning that goes into that. Those constructive outcomes, and we're going to do it through the lens of what's important to our local leaders and stakeholders. Extremely important that we keenly listen to what they want and what they need at a local level. And I think you can translate that then to a much better chance for success, and then you get into that virtuous circle where invested capital not only is good for customers and the communities, but good for shareholders as well. So that's the plan going forward.
Shar Pourreza : And do you believe, sort of, do you believe there's some jurisdictions that AEP currently operates where you may not be able to hit those sort of targets as you're thinking about people, process, et cetera?
Ben Fowke : Well, I think there's areas where we have improvement, but I will turn it over to Peggy and/or Chuck to elaborate on that.
Peggy Simmons : I think as it relates from a regulatory perspective, I do think what we're going to do is continue to build on the constructive legislative and regulatory outcomes that we have had. We're going to further strengthen our regulatory relationships, and we're really going to be keenly focused on execution. I think that some of the disappointments that we had in 2023, we're going to learn from them, and we're going to go back out and focus on execution from that standpoint.
Shar Pourreza : Okay. Perfect. And then just lastly for me, just -- Ben, as you and the board are sort of thinking about where AEP stands today, I guess, what are you looking for in the next CEO? Are you kind of looking for a prior CEO or President of an OpCo, someone with a finance background, regulatory background, internal, external? I guess, can you just maybe specify exactly what you're looking for in the next successor?
Ben Fowke : Well, it's definitely an external search. I'll start with that. And I don't want to narrow down to any specific background, but ideally -- and by the way, I think we're going to get a very robust list of candidates. So AEP is a great company with great assets. And I think it's going to be an attractive destination for many, many talented people. So I think it's going to be great to pick from that talent. Ideally, you get a -- somebody that is a seasoned executive in the utility industry, is well known in the investor community. I think that's extremely important, has great leadership qualities. We've got a lot of talent at AEP, and we want to develop that talent. And ultimately, it would be ideal if they have multi-jurisdictional experience and the ability to achieve regulatory success. Those are -- that's a big wish list. But again, I think we're going to get a lot of great candidates.
Shar Pourreza : Got it. Terrific. Thank you, guys. I'll pass it to someone else, and good luck on Phase 2. I appreciate it.
Ben Fowke : Thank you.
Operator: Your next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead.
Ben Fowke : Hey, Jeremy.
Operator: Jeremy, your line is on mute.
Jeremy Tonet : Hi, good morning.
Ben Fowke : Good morning.
Jeremy Tonet : I just want to kind of continue along these lines, if I could. And I was wondering if you're able to comment, I guess, on the recent agreement AEP announced with Icahn Capital and kind of how that ties into the change at the top here given the relatively short tenure? And just wondering if there's anything else we should be expecting, I guess, along these lines looking forward with Icahn's recent announcement?
Ben Fowke : Yeah. I really just will probably just rehash what we've said in the press release and in our scripted remarks. I mean the Icahn -- additional board members came after discussions with the Icahn team and the AEP team. We actually welcome their perspective. They share the opinion as we do that AEP shares are undervalued, and we want to work together to unleash shareholder value. Regarding Julie's departure, I mean, I really can't go into any more details than what we've already said. It was a full board decision after discussions with Julie, and we decided that the best path forward is to transition to a new CEO. We're going to continue to work hard to deliver shareholder value. I think the Icahn board members will give us a fresh perspective as we pursue those goals.
Jeremy Tonet : Got it. That's very helpful. And just as we think about the strategic path going forward at this juncture, are all options on the table or any options off the table? Just want to kind of see the parameters of what we could expect going forward.
Ben Fowke : Well, we really like the assets we have, okay? We've completed the strategic reviews, but I mean, the price -- we're going to continue to look for opportunities to do the right thing for our shareholders. But I think we're in a -- an enviable position, that the assets we have can also achieve our strategic goals. And Chuck mentioned where we are with FFO to debt and those targets. So I think we're in a pretty good position, quite honestly. So again, as I said before, not to be redundant, but I guess it will be. We'll be good portfolio managers, and we'll continue to be open to transactions if the price is right and the ability to execute is viable. But in the meantime, we're going to do the blocking and tackling that in the long term, gets you the result that -- results that you're going to want to see.
Jeremy Tonet : Wonderful. Very helpful. Thank you for that.
Ben Fowke : You’re welcome.
Operator: Your next question will come from the line of Nick Campanella with Barclays. Please go ahead.
Nick Campanella : Hey, good morning, everyone. Thanks for the prepared remarks and taking my questions. Good morning. So I guess, you acknowledged in your remarks, there's been some twists and turns and some regulatory volatility in '23. You had some headwinds that you highlighted from the FERC order on taxes, the Oklahoma rate order, among a few other items. But just the 6% to 7% has been pretty resilient and unchanged this entire time. So can you just maybe help us all understand just what's kind of allowing AEP to absorb these issues and where the offsets have been kind of in the 5-year plan that allows you to continue to reaffirm?
Ben Fowke : Well, I mean, I'll kick it over to Chuck in a minute, but the $43 billion on the 5-year capital plan underpins the 6% to 7%. In the years where we might have unfavorable weather or other things like that, that's the resiliency of this AEP management team that I talked about. And it's not just one year. It's a -- look back, I mentioned 14 years of hitting what we said we were going to do. Yeah, sometimes you get regulatory bumps in the road and other things that might happen. But if you look back historically, and we look forward, we produce. I mean, we're in 11 jurisdictions. We're going to file rate cases. But if you look at history, we generally do pretty well. And when we have a bump in the road, we figure out how to absorb it and what we need to do better going forward. Chuck, I don't know if you want to add to that?
Chuck Zebula : Yeah. No, Ben, as you said, it's underpinned by the $43 billion 5-year capital plan. I'd also point to what Ben made an observation as a board member and in his opening remarks about our O&M. There's a chart in our deck that you can refer to, right? We've doubled the rate base of this company while basically keeping O&M flat over that entire 10-year period. I think that's a remarkable accomplishment and that's our plan going forward as we continue to grow this company and basically repurpose and reallocate O&M. I also talked in my remarks about the load opportunities. I tend to kind of take a measured approach to this. But we really are optimistic about the opportunities that we're seeing there. As I said, the commercial load growth is just amazing. And we're seeing some good opportunities in economic development activities in industrial as well. And then lastly, of course, underpinning that plan is improved returns. Right? We are not earning where we need to earn, and we need to have the regulatory execution and prudency reviewed to make sure, right, that we are hitting the mark there. So I think all in all, that kind of underpins the plan going forward.
Nick Campanella : Got it. And definitely appreciate the comments on diversification and the size of the overall plan as well as the O&M. Thank you for that. And then I guess, just -- I guess just sticking with the 6% to 7% CAGR, is there any kind of shaping to that over the 5-year plan? Is there anywhere that you kind of see yourself in that range right now? And then as we kind of think about a new CEO coming in, hopefully, in the back half of this year, is it your expectation that they would come in to embrace that plan? Or would they have more say in where they're taking the company? Thank you.
Chuck Zebula : Yeah. So I'll take the first question. Our 5-year plan is really based off the midpoint of the current year's guidance. And our plan is to grow basically on that midpoint between the 6% to 7% range with no real kind of ups and downs identified through there. I'll let Ben answer the --
Ben Fowke : Yeah. I mean I think, first of all, we'll take our time, and we'll find the absolute best successor permanent successor that we can. I think as part of that process, we obviously will have the strategic discussions. I mean, I think the board is very comfortable with our strategy and our strategic priorities. I suspect that the ultimate permanent successor CEO will also be comfortable with those strategies and perhaps can figure out a better way to execute on them. That would be the goal. But we're not looking at a complete dismantling of our strategic priorities.
Nick Campanella : Thanks a lot for answering the questions today. I appreciate it.
Ben Fowke : You’re welcome, Nick.
Operator: Our next question will come from the line of Carly Davenport with Goldman Sachs. Please go ahead.
Carly Davenport : Hey, good morning. Thank you for taking the questions. A bit of a shift on the asset sale program, I guess, in terms of the decision to retain the transmission JV. So could you just talk a little bit about the rationale there and how we should think about your view on transmission as part of the portfolio or potentially as an area of sort of value monetization going forward?
Ben Fowke : Well, I mean -- and I'll let Chuck -- this is Ben. I'll let Chuck augment what I'm going to say, which is pretty much what I said before. Transmission is a great asset. And we are, obviously, the largest transmission provider in the United States, and we like that position. We will be open to things that make sense that would do even better for shareholders. But we don't feel compelled we have to do anything. So I think that puts us in a better position as we move forward. Chuck, I don't know if you want to add to that.
Chuck Zebula : Yeah. I think you -- we're also referring maybe to pioneer in Prairie Wind and our decision to keep those assets. The reality is, right, these contribute earnings to AEP, their attractive returns. And overall, it was really insignificant, right, to our overall financing plan if we were planning on selling those assets. So it really goes back to the root of what Ben said, as we reviewed the opportunities before us in competitive transmission and then looked at other transmission assets that we have, we -- we're embracing it. It's time for us as the leader in transmission to continue, right, to lead that space, and that's what we plan to do.
Carly Davenport : That's helpful. Appreciate that. And then, Chuck, probably for you, just a little bit of a shift in tone around the FFO to debt metrics as well for '24. Can you just talk about what we should expect relative to that 14% to 15% range for 2024 on FFO to debt and what the moving pieces are that you're kind of watching that could move you outside of that range?
Chuck Zebula : Yeah. So thank you for that question. And our message has changed a bit there on the timing. But what I would tell you is really kind of timing is not what is most important. It's really the trend that we're on, and then it's hitting the mark of 14%. And it's the sustainability on staying in that range as we go through the 5-year plan. So let me comment on a couple of things. Right? We said we would be above 13% by year-end, and we were. And we didn't make any excuses for the soft weather that happened in 2023. Note also that 13% is the downgrade threshold at Moody's. And second, right, the trend is very positive. Right? This quarter, we're going to have another roll off of cash collateral in Q1. I think the number is around $390 million that will come out of the 12-month average. And also, we are working on down our deferred fuel balances. And then lastly, right, we clearly show our models and review those with the agencies. Those models indicate that we would be in the range this year and be in the range over the longer term. That's what's most important, right, hitting the mark, trending in that positive direction and staying in the range. So again, the timing, which month or which quarter is not important, it's the three things that I mentioned earlier.
Carly Davenport : Got it. Thanks very much for the time.
Operator: Your next question comes from the line of Ryan Levine with Citi. Please go ahead.
Ryan Levine : Good morning.
Ben Fowke : Good morning.
Ryan Levine : Given the focus on people and processes, how long do you view the company's review of its regulatory strategy to take? And in that context, how is the new review different from how AEP has reviewed its regulatory strategy historically?
Ben Fowke : Well, I'm going to turn it over to Peggy, who is the point on that. But this -- it isn't like this is something we're just initiating. This is something that I've heard discussed as a board member at the board level. It's something I'm going to get very much involved in with Peggy. We've got a good team, but we're going to have to -- we'll make sure that we do what we need to do to get better outcomes in the future. And I mean, there's a lot of blocking and tackling, that really behind the scene stuff that goes into the actual processing, executing and planning of a rate case. And it gets really down in the weeds pretty quickly, but those things add up. Peggy, I'll turn it over to you.
Peggy Simmons : Yeah. I would just add -- and looking forward to working with Ben and talking through the regulatory strategy. We've had positive regulatory outcomes in 2023. And when we shared some of those earlier, there were some disappointments that we highlighted. But I would bring forth the legislative work that we have done, and that's going to help to address lag. We've done work that's going to help to remove some of the lag in Virginia with our biannual rate review for Virginia, where it was three years before. We're going to also look at improving on -- we said with Kentucky that it was going to be a two-step process, and we very much view that we had a constructive outcome in the order that we received earlier in January with the securitization. So we're going to continue to build upon that. I agree, we do have a talented team, and we're just going to keep moving forward, and I look forward, again, as I said, to working with Ben on ways we can continue to improve there.
Ryan Levine : Great. And then unrelated, where do you see the biggest opportunities to benefit from the data center build-out in your service territory? And given your balance sheet constraints, do you have any reservations or concerns around that opportunity?
Ben Fowke : The biggest opportunity so far have been in Ohio and Texas. And in our forecast, for our 5-year plan, we have included the capital needed to serve those customers. If there is incremental growth beyond that, it would be an opportunity that we'd have to evaluate and figure out how we would smartly finance it. And meet the generation needs that come with it. Yeah.
Operator: Your next question comes from the line of Anthony Crowdell with Mizuho. Please go ahead.
Anthony Crowdell : Hey, good morning, Ben. Good morning, Chuck. Hopefully, two easy ones, one for you, Ben, one for Chuck. Just, Ben, I don't know what kind of insight you could provide. But just -- if I think about the -- excuse me, 1% position that Icahn has taken and it seems that there's been some major changes in the board. I don't think that would be a big position that yet, I think, two voting seats and then a non-advisory seat. Just thoughts on what change in the Board that maybe to expand the board?
Ben Fowke : Well, I mean, you're right. There's like -- I think there's 5.3 million shares that -- something like that that Icahn holds. And we had discussions with Icahn. And we settled on the two incremental board seats and advisory position. I think back to Julie, I'll just repeat what I said. This was a full board decision after discussions with Julie and the board, and we determined it was best for AEP to transition to a new CEO. So you can read what you want into that, but I think I'm just going to just keep it as it is. It's a full board decision, and you need the full board to make a decision to remove the CEO.
Anthony Crowdell : Great. And then, Chuck, two quick ones. It looks like the equity timing had moved. I understand your questions to Carly earlier on -- you are targeting to above the 13% threshold, but I think the equity may be slid off of the near term? And then lastly, on earned returns, what type of improvement could we expect each year? And I'll leave it there.
Chuck Zebula : Okay. Thanks, Anthony. Our equity needs haven't changed since EEI. You may be referring to maybe an older forecast we had some months back. But what you're seeing in our deck today is consistent, right, with what we've shown at EEI. I'll let Peggy go ahead and mark -- talk about the returns.
Peggy Simmons : Yeah. As it relates to -- for 2024, our ROE, we're projecting at 9.1% is what we're -- for our regulated segments. And we're going to continue to work on closing the gap, a lot of what I've already said earlier, just kind of building off with some of those legislative successes that we were able to have, reducing some of the lag from that perspective.
Anthony Crowdell : Great. Thanks for taking my questions. Appreciate it.
Chuck Zebula : Thank you.
Operator: Our next question comes from the line of Sophie Karp with KeyBanc. Please go ahead.
Sophie Karp : Hi, good morning. Thanks for taking my question.
Ben Fowke : Good morning.
Sophie Karp : Hi. Just a quick one for me. I guess like when you think about your jurisdictions, right? And the ones we've got constructive outcomes, regulatory and the ones where you got non-constructive outcomes. And how should we think about you allocating this increase in capital across these jurisdictions? Like, is there a strategy there to proactively reduce capital allocations to jurisdictions where you earned ROE just don't make a hurdle for what's attractive?
Ben Fowke : I'm going to turn it over to Peggy and Chuck in a minute, Sophie. But I mean, we're always going to look to put capital where we can get the best returns. There's baseline capital that you need to do to make sure that you never compromise resiliency, reliability or safety. So we -- but apart from that, I think it gets back to what I said. It's listening to what those local jurisdictions really want and need. And that can also shape your capital needs because, quite frankly, it can shape your regulatory outcomes. So I'll turn it over to the team if they have anything to add to that.
Peggy Simmons : I would just say, yeah, I echo Ben's comments there on -- there's a certain amount of capital we need to continue to be resilient and meet the reliability needs of our customers. And as well as from a safety perspective. Those where we have really constructive outcomes, clearly, we know in I&M, we have the forward-looking test years. We're able to continue to have that capital to allocate there to meet what those needs are. And we just continue to look at what our outcomes are by jurisdiction.
Sophie Karp : Okay. And then maybe going back to data centers, right? Do you see more attractive opportunities around incremental generation to support those customers or the T&D investment?
Chuck Zebula : Yeah, in Ohio and Texas, right? We're -- those are deregulated states. In our Indiana, Michigan territory, clearly, there would be opportunities for generation there to serve those customers.
Sophie Karp : Okay, thank you.
Ben Fowke : Thank you.
Operator: Our next question comes from the line of Paul Fremont with Ladenburg. Please go ahead.
Paul Fremont : Thank you very much. I guess first question would be on the '24 guidance. Does that continue to include contribution from the retail and the distributed resources as was sort of outlined at EEI?
Chuck Zebula : Yeah. Our EEI guidance, right, we kind of change the waterfall based on the actual, right? But what's in or out hasn't changed, Paul. As Ben mentioned, we're in the process that we plan to conclude here in the next several months on retail and distributed businesses. He also mentioned that we're closing NMRD today, which there'll be a benefit from that sale coming through. But everything is underpinned. Remember, too, when you look at the waterfall, we took the Generation and Marketing segment down to what we would call much more normal contributions. I'm not concerned that about the ability to take the proceeds, use them as appropriate to get that accretion as we go forward. But no, it's still the same plan, if you will, as we put out at EEI.
Paul Fremont : And then Chuck mentioned that the FERC decision is expected to have a $0.03 negative impact on '24. Is that going to be treated as operating EPS? Or is that going to be excluded as non-recurring?
Chuck Zebula: No, it's operating.
Paul Fremont : And then I guess the last question I have is, currently, there's a proceeding in Kentucky where, I guess, there's recommendations for potential disallowance of fuel and purchased power costs. I think there's also a fuel review that could take place or may be taking place in Louisiana. Can you give us, I guess, an update on what your expectations are and what's happening in those proceedings?
Peggy Simmons : Yeah. In Kentucky, we do have a 2-year fuel review that has been underway, and we are waiting, the outcome as it relates to that. We had a hearing earlier this month actually. And then from -- what was your other question with it related to SWEPCO?
Paul Fremont : Yeah. I think as part of that settlement on the renewables, there was, I guess, the ability of staff to do a review of the fuel?
Peggy Simmons : Yeah, that was part -- excuse me, sorry, go ahead, finish your question.
Paul Fremont : No, that's it.
Peggy Simmons : Yeah. That was part of the review, and that is ongoing as well. So -- but Darcy can definitely give you some more information on that, if that wasn't clear enough.
Paul Fremont : And last question for me. In terms of the 9.1% that you're targeting for this year, I think what type of an improvement do you see as being necessary in order to hit the 6% to 8%? I think in the past, you've talked about needing to improve the earned ROE as part of hitting your targeted growth rate?
Peggy Simmons : Yeah. So over our 5-year plan, we look to be typically to be in the 9.5% range. So what we're looking to do is increase by 10 basis points each year. And we think that that achieve ongoing. We continue to work through our regulatory outcomes to be able to close that gap.
Operator: [Operator Instructions] Your next question will come from the line of Paul Patterson with Glenrock. Please go ahead.
Paul Patterson : Hey, good morning. How are you? So just -- it doesn't sound to me like there really is much of a change in strategy with the new chapter and the managerial change that you're looking at. Am I thinking about this correctly?
Ben Fowke : Yeah, I think so. It's -- the strategy is great. We just have to execute, and that's what we're keenly focused on, Paul.
Paul Patterson : Okay. I just want to make sure I'm hearing -- and then the second thing that I guess -- and I think this was asked before, but is there any timing that we should be thinking about in terms of when a new CEO would be in place?
Ben Fowke : Well, let me just say I'm committed to stay as long as it takes. So no shortcuts. But I can't see it being shorter than six months, and hopefully, it doesn't take more than a year. But again, it's going to -- the process will take the time it needs to take to get the absolute right candidate in place.
Paul Patterson : Okay. And then finally, when we're talking about regulatory desires and goals, having watched the various jurisdictions, there are a number of jurisdictions that I get the sense -- and this isn't going to surprise you, Ben -- they want lower prices. And I'm just wondering, is there any sort of new or innovative way you're looking at the regulatory approach in terms of addressing maybe those concerns, increasing investment, but -- but addressing those two concerns other than obviously, the general concern that I'm sure you guys have. But do you follow what I'm saying in terms of making investments? And perhaps not seeing the resistance that I think if you look at a number of the AEP jurisdictions that they just ease to new investment leading to higher rates. Do you follow what I'm saying?
Ben Fowke : Yeah. I mean I think -- I mean I'm going to turn it over to the team, Paul, but the amount of load growth that we see in our jurisdictions, I mean that's a great opportunity, economic development that we can be a big part of, either helping to drive it or certainly providing the infrastructure to allow it. Those are great opportunities. And that's -- everybody wants that in all jurisdictions. But again, we're going to be -- very carefully listen to what our jurisdictions want and need and respond accordingly. Peggy or Chuck?
Peggy Simmons : And I'll just briefly add to that. In 2023, we landed 92 new customer load additions totaling about 5-gig and adding additional jobs to our service territory. So I think that that's certainly 1 area and aspect of how we're going to help with affordability as well.
Chuck Zebula : Yeah. And Paul, clearly, the data center load that we're experiencing is going to create an opportunity, right, to spread fixed costs, right, along a bigger base and improve the headroom opportunity there as well.
Paul Patterson : Okay. Great. And I appreciate it. And good to see you back, then hopeful as well.
Ben Fowke : Thank you. Thank you, Paul. I appreciate that.
Darcy Reese: Thank you for joining us on today’s call. As always, the Investor Relations team will be available to answer any additional questions you may have. Regina, would you please give the replay information?
Operator: Today's conference will be available for replay beginning approximately two hours after the conclusion of this call and will run through 11:59 p.m. Eastern Time on March 5, 2024. The number to dial to access the replay is 800-770-2030 and for international callers, 647-362-9199. The conference ID number for the replay is 9066570. This concludes today's conference call. Thank you all for joining. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Fourth Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Regina. Good morning, everyone. And welcome to the fourth quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our Interim President and Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks. I will now turn the call over to Ben."
},
{
"speaker": "Ben Fowke",
"text": "Well, thank you, Darcy. Good morning and welcome to American Electric Power’s fourth quarter 2023 earnings call. It's great to have a chance to reconnect with you, although I never thought it would be under these circumstances. As you know the AEP board of directors made a decision to remove Julie Sloat from her duties as Chair, President and CEO. Taking this action was not easy, but the board believes it was in the best interest of AEP and its stakeholders to do so. On behalf of the board and the entire AEP family. I would like to wish Julie well and thank her for all her contributions. I would also like to assure everyone that Julie's departure was not due to any unethical behavior, disagreements of financial policy or because of any violation of AEP’s code of conduct. Now, as many of you are aware after my retirement from Xcel Energy, I joined the AEP board in February of 2022. I was attracted to this board because I was impressed with AEP’s business model, its strong asset base and the quality of its leadership team and board. I'm even more impressed two years later. In my tenure here, I've seen the AEP team rise to meet multiple challenges. Let me give you some examples starting with earnings. For 14 years in a row, AEP has met or exceeded earnings guidance, and 2023 is no exception. Our operating earnings came in at $5.25, that's within our guidance range despite $0.37 of unfavorable weather and $.45 of increased interest cost over the prior year. As you know, controlling O&M expense has been a challenge for the industry. And AEP has met that challenge, essentially keeping O&M flat for the last 10 years, while at the same time doubling its asset base. This team's continuous focus on O&M efficiency is nothing short of excellent. You may also recall that in early 2023, the Texas Commission denying a petition to be part of SWEPCO is 999-megawatt renewables project for $2.2 billion. But the team didn't miss a beat and put the project back on track with Arkansas and Louisiana ultimately stepping up to move forward with the full project. As a result, and including SWEPCO. Today, we have commission approval of $6.6 billion of new renewable projects throughout AEP’s service territory, representing a 70% achievement of our current 5-year $9.4 billion new generation capital plan. I hope you would agree with me that that is really solid execution. Initiatives to simplify and de-risk our portfolio are squarely in the focus of the board and the management team. And we are pleased with the great progress made. Last year, we completed the sale of our unregulated renewables portfolio, bringing in $1.2 billion of cash proceeds. We should be closing on our New Mexico renewable development solar portfolio within the next day or two. This in combination with the expected conclusion of our retail and distributed resources sales process in the second quarter, keeps us on schedule to achieve our 2024 asset sales targets. Now as we move forward, AEP will continue to be a disciplined portfolio manager and we will be willing to take action when price and the ability to execute intersect. To that end, we've made the decision to retain our ownership interest in both our Prairie Wind and Pioneer Transmission joint ventures. We also completed the review of Transource and ultimately determined that owning this joint venture fits strategically within our portfolio. We'd like our remaining assets. And we'll focus going forward on doubling down on our efforts to achieve constructive regulatory outcomes that will allow us to provide the quality of service our customers need and expect. Regarding Icahn Capital, our recent agreement came about from a combination of a constructive dialogue between AEP and the Icahn teams. Like us, the Icahn team believes AEP shares are undervalued and there's meaningful upside potential for our investors. The addition to AEP’s board will bring fresh perspective as we continue to execute on strategic priorities and enhance value for our stakeholders. Looking ahead, today, we are reaffirming our 2024 full year operating earnings guidance range of $5.53 to $5.73, as well as our long-term earnings growth rate of 6% to 7%, which is underpinned by a $43 billion 5-year capital plan, in addition to 14% to 15% FFO to debt target, which Chuck will expand upon shortly. You should know that I am committed to my role as Interim President and CEO. And I believe I can add value while the board works to identify a permanent successor. So before I turn it over to Peggy for regulatory updates and Chuck for financial review, let me also acknowledge that 2023 has been at times a challenging year at AEP. There's certainly been some twists and turns and a few bumps in the road. But I would encourage all of you to focus on the key opportunities that lie ahead. I have tremendous confidence in our team's ability to achieve our objectives as we work every day to deliver safe, reliable and affordable energies to our customer. With that, I'll turn it over to Peggy."
},
{
"speaker": "Peggy Simmons",
"text": "Thanks, Ben. And good morning, everyone. Now I'd like to turn to update on our ongoing regulatory and legislative efforts. While we made important regulatory progress in 2023, it is clear that we can do even more to facilitate successful and constructive outcomes. Details of related activities can be found in the appendix on Slides 29 through 31. Closing the authorized versus earned ROE gap is a key area of focus for us. Our fourth quarter ROE came in at 8.8% a slight improvement over third quarter. This also reflects impacts of approximately 40 basis points from mild weather conditions in 2023. Our efforts to improve and bridge the ROE gap is supported by work we've done related to the recent passage of legislation that will help position us to provide safe and reliable service while managing costs and reducing regulatory lag. Most importantly, we obtained securitization in Kentucky, a biannual Distribution Cost Recovery Factor or DCRF in Texas, and rate reviews every two years in Virginia. On the regulatory front, we secured several important wins over the course of 2023, including achieving constructive base rate case outcomes in Louisiana, Oklahoma, and Virginia, reestablishing formula rate plans in Arkansas and Louisiana and reaching a settlement and our Ohio ESP V filings, which were waiting to commission order. Overall, in 2023, we secured $312 million and rate relief. We also filed new base cases in Indiana, Michigan and Kentucky in 2023. In Indiana, we have already reached a settlement, which we filed in December, and we expect the commission decision by June of this year. In Michigan, we continue to advance through the process and currently expect a ruling in the case in July. In Kentucky, the base case and securitization application was approved by the commission earlier this year. Other upcoming cases include a new Oklahoma base rate case for PSO, which we filed last month. Additional filings in the first quarter will include an AEP Texas base rate case and the APCo Virginia biennial rate review that should have the benefits of legislative changes attained in 2023. While we reached many constructive outcomes in 2023, we are disappointed in a couple disallowances recently received. First, in Texas, the commission issued a decision disallowing capitalization of AFUDC related to our Turk plant in mid-December 2023. And we filed a motion for reconsideration a week later. In West Virginia, last month, the commission disallowed a portion of our March 2021 to February 2023 under recovered fuel, and we recently filed an appeal with the West Virginia Supreme Court on February 8. We are also disappointed with the FERC order we received in January 2024 related to treatment of accumulated deferred income taxes associated with net operating loss carryforwards, or NOLC, mostly affecting our Transmission Holdco segment. We just filed for rehearing on February 20. Shortly, Chuck will discuss the related unfavorable net financial impact to 2023 operating earnings. Looking ahead, we know there is more work to be done as we advance our regulatory strategies in 2024 to achieve a forecasted regulated ROE of 9.1%. We are well on our way this year with almost 70% of rate relief either secured or related to mechanisms that are more administrative in nature. We look forward to continuing to engage constructively with our regulators and strengthening relationships at all levels. As Ben mentioned, this year, AEP continued to advance our 5-year $9.4 billion regulated renewables capital plan and now have a total of $6.6 billion approved by various state commissions. More detail of resource additions can be viewed in the appendix on Slides 32 through 34. As previously disclosed, we received approval for APCo's 143 megawatts of wind generation, totaling more than $400 million of investment. This is in addition to the previously approved 209 megawatts of solar and wind projects for approximately $500 million. In 2023, we also received commission approval in both Indiana and Michigan for I&M 469 megawatts of solar projects, representing $1 billion of investment, PSO's 995.5-megawatt renewables portfolio for $2.5 billion and SWEPCO's 999-megawatt renewables for $2.2 billion. Our fleet transformation goals are aligned with and supported by our integrated resource plan. We have pending requests for proposals for a diverse set of additional generation resources at I&M in Kentucky, PSO and SWEPCO, with more to come from other operating companies, including APCo. These generation investments are an integral part of our broader capital program, which is 100% focused on regulated assets and the production tax credits that are generated from our renewable energy projects, our path along to and provide great value to our customers. In addition to these projects, AEP is advancing an additional $27 billion in investments in our transmission and distribution systems to support reliability and resiliency. These combined investments underpin our 6% to 7% EPS growth commitment while mitigating customer bill impacts. With that, I'll pass it over to Chuck to walk through the performance drivers in details supporting our financial commitments."
},
{
"speaker": "Chuck Zebula",
"text": "Thanks, Peggy. And good morning to everyone on the call. I'll walk us through the fourth quarter and full year results for 2023, share some updates on our service territory load, our outlook for this year and finish with commentary on credit metrics and liquidity. Let's go to Slide 9, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $0.64 per share compared to $0.75 per share in 2022. For the year, GAAP earnings were $4.26 compared to $4.51 in 2022. As we have highlighted throughout 2023, our year-to-date comparison of GAAP to operating earnings reflects the gain or loss related to the sale of certain businesses, regulatory outcomes as well as our typical mark-to-market adjustments as non-operating. Our team is committed to minimizing the variances between GAAP and operating earnings as we go forward. Detailed reconciliations of GAAP to operating earnings are shown on Slide 16 and 17 of the presentation today. Let's quickly cover the fourth quarter. Our fourth quarter earnings came in at $1.23 per share, which was a $0.18 improvement over the same period in 2022. Note that we had $0.25 of favorable O&M and strong performance in our Generation and Marketing segment, partially offset by $0.06 of unfavorable weather, $0.09 of higher interest costs and lower performance in Transmission Holdco. December weather, in particular, was the 28th warmest out of the last 30 years. For reference, the full details of our fourth quarter results are shown on Slide 15 of the presentation. Let's have a look at our full year results for 2023 on Slide 10. Operating earnings were $5.25 per share compared to $5.09 per share in 2022. Looking at the drivers by segment. Operating earnings for Vertically Integrated Utilities were $2.47 per share, down $0.09, mostly due to unfavorable weather, higher interest expense and higher income taxes. These items were partially offset by rate changes across various operating companies, increased transmission revenue, higher normalized retail load, favorable depreciation and lower O&M. Once again, depreciation is favorable at the Vertically Integrated segment, primarily due to the expiration of the Rockport Unit 2 lease in December 2022. The Transmission and Distribution Utility segment earned $1.30 per share, up $0.14 from last year. Positive drivers in this segment included increased transmission revenue, rate changes in Texas and Ohio and lower O&M. Partially offsetting these items were unfavorable weather, higher depreciation and higher interest expense. The AEP Transmission Holdco segment contributed $1.43 per share, up $0.11 from last year. Positive investment growth of $0.09 and favorable income taxes of $0.05 were the main drivers in this segment. As Peggy mentioned, we received the FERC NOLC order in January, resulting in an unfavorable net impact to consolidated earnings of $0.07 per share, with the majority of that impact occurring at the Transmission Holdco. The impact of this order to our 2024 plan is approximately $0.03 per share. Generation and Marketing produced $0.59 per share, up $0.09 from last year. The positive variance here is primarily due to improved retail and wholesale power margins, the sale of renewable development sites and favorable impacts associated with the contracted renewable sale in August. These items were partially offset by higher interest expense and unfavorable income taxes. Finally, Corporate and Other was down $0.09 per share, driven by higher interest expense, partially offset by a favorable year-over-year change in investment gains, largely due to investment losses that occurred in the fourth quarter of 2022. As we mentioned earlier, we are reaffirming our guidance range for 2024. For convenience, we've included an updated waterfall bridging our actual 2023 results to the midpoint of our guidance this year in Slide 24. While some variances changed due to last year's actual results, there is no change to our segments or overall guidance. Turning to Slide 11, I'll provide an update on weather normalized load performance. Overall retail load grew 2.5% in 2023. This was stronger than the 0.7% in our original guidance, thanks to an acceleration in data center growth and our commitment to economic development across our service territory. This is most apparent when looking at the incredible expansion in commercial load, shown in the upper right-hand quadrant of the slide. Commercial sales grew 7.8% for the year, and were again dominated by data centers. We are encouraged that the gains are becoming more geographically diverse. New projects have come online in Michigan, Kentucky and Oklahoma to supplement the development of what we see in Ohio and Texas. This is a trend we expect to continue over the next several years as the global demand for data storage and processing accelerates through the growth of AI and other technologies. We expect commercial load to continue to grow from its new higher base this year as projects work their way through the queue and commitments for 2025 are exceptionally robust. I believe that some of the 2025 load is going to accelerate and bleed into this year. Industrial sales grew at 1.6%, which you can see in the lower left-hand quadrant of the slide. This is mostly attributable to a number of large industrial loads we've recently added across our service territories, which are more than offsetting any economic challenges seen by our existing customers. We expect industrial load growth to continue to reflect the softness in manufacturing nationally, with only a modest increase this year. However, growth in industrial sales beyond this year should accelerate as borrowing costs moderate and several large loads currently under construction come online. In the upper left-hand corner of the slide, you'll see that residential load declined slightly in 2023. Usage per residential customer has declined for the past two years, as homes have become more energy efficient and workers spend more time in an office instead of at home. The negative impact of inflation on household budgets may be influencing usage as well. On a positive note, we've seen our residential customer base grow consistently in certain regions. In 2023, we added almost 31,000 net new residential customers across our footprint, resulting in a positive offset to this segment. Overall, we're optimistic about the positive trends in load over the next several years, especially from a commercial and industrial perspective. Our conservative approach to estimating large loads gives us a lot of confidence in the growth we forecasted. In our next update, however, I would expect to see some upside in this area. Let's move on to Slide 12 to discuss the company's capitalization and liquidity position. In the top left table, you can see the FFO to debt metric stands at 13.2% for 2023. Positive changes in FFO were as outlined on the third quarter call, and included favorable changes in cash collateral, fuel recovery and other various drivers. These positive changes were somewhat offset by an $830 million increase in debt during the quarter primarily due to the issuance of long-term debt to prefund our March 2024 AEP parent maturity. We are pleased that the team has overcome strong financial headwinds due to unfavorable weather and an unprecedented increase in interest rates to end the year above Moody's downgrade threshold of 13%. We expect our FFO to debt metric to continue to improve throughout 2024 as we progress towards our targeted range of 14% to 15%. This continued positive trend assumes normal weather for 2024 and continued growth in our cash flows through various regulatory activities, including recovery of our deferred fuel balances of approximately $425 million. Our debt to cap increased from the prior quarter by 60 basis points to 63%, and our parent debt to total debt is approximately 21.7%. In the lower left quadrant of this slide, you can see our liquidity summary, which remains strong at $3.4 billion, and is supported by our bank revolver and credit facility. Lastly, on the qualified pension front, our funding status remains unchanged from the prior quarter to end the year at just over 100%. While falling interest rates increased the liability during the quarter, this increase was offset by positive asset returns. Turning to Slide 13. I'll give a quick recap of today's message. We delivered on our commitments for 2023 despite the significant challenges we faced. Weather was one of the most mild years on record for the AEP system in the past 30 years, resulting in a negative $0.37 impact year-over-year and $0.21 versus normal weather. To put a little more context to those numbers, our heating degree days were down 36% compared to normal across the system. Also, interest expense was a $0.45 hurdle to overcome versus 2022 results. We work diligently throughout the year to reprioritize and balance our plan by adjusting the timing of discretionary spend while staying focused on meeting our core business needs. While admittedly facing some challenges on the regulatory front, we secured many rate outcomes that were critical in supporting our objectives to provide reliable service to our customers. Looking into this year, we are optimistic about the opportunities and prepared to face any challenges ahead of us. We reaffirm our guidance for 2024 of $5.53 to $5.73 per share, our long-term growth rate of 6% to 7% and an improved balance sheet while continuing to implement our capital program, taking care of the customer, earning our authorized return and executing on our strategic priorities. I would like to take a moment and thank Julie Sloat for her 23 years with AEP. Julie has made a positive impact on AEP and will be missed by many. Ben, we welcome you to the AEP management team. Your leadership in the industry is well respected, and you will be embraced by the employees of AEP. The entire management team looks forward to working with you and the board as we look to enhance value for all AEP stakeholders. Thank you for your time today. Operator, can you open up the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question will come from the line of Shar Pourreza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Shar Pourreza",
"text": "Hey, guys. Good morning."
},
{
"speaker": "Chuck Zebula",
"text": "Good morning. So obviously, the slides are leaning on the successes of AEP. You've reiterated your earnings guidance, balance sheet targets, growth rate, CapEx numbers. I guess outside of some management shuffling, what do you see is broken? I guess, what's the goal of the review? What's on the table, what's off the table?"
},
{
"speaker": "Ben Fowke",
"text": "Well, this is Ben. And I can tell you that I don't think I would use the word broken. I think there's areas where we can do better. I think -- and I think we showed you in the script, many of the accomplishments we made. We also recognize that we can do better on getting constructive regulatory outcomes. So strategically, our priorities remain the same. We have completed, as we mentioned, a review of Transource. We want to keep that asset. We think it's a great asset. And I think given the various changes that FERC is looking at, I think it gives us a lot of optionality. We'll continue to be very disciplined portfolio managers. I said it on my scripted remarks, but always willing to transact where price and the ability to execute intersect, and that's a key point. And finally, though, if you step back, I think one of the ways you add value in this industry long term is by placing CapEx at one times book, investing in CapEx at one times book and getting constructive recovery of that. And again, we've done pretty good on that, but we can do better. And we're going to look at the people, the process and the planning that goes into that. Those constructive outcomes, and we're going to do it through the lens of what's important to our local leaders and stakeholders. Extremely important that we keenly listen to what they want and what they need at a local level. And I think you can translate that then to a much better chance for success, and then you get into that virtuous circle where invested capital not only is good for customers and the communities, but good for shareholders as well. So that's the plan going forward."
},
{
"speaker": "Shar Pourreza",
"text": "And do you believe, sort of, do you believe there's some jurisdictions that AEP currently operates where you may not be able to hit those sort of targets as you're thinking about people, process, et cetera?"
},
{
"speaker": "Ben Fowke",
"text": "Well, I think there's areas where we have improvement, but I will turn it over to Peggy and/or Chuck to elaborate on that."
},
{
"speaker": "Peggy Simmons",
"text": "I think as it relates from a regulatory perspective, I do think what we're going to do is continue to build on the constructive legislative and regulatory outcomes that we have had. We're going to further strengthen our regulatory relationships, and we're really going to be keenly focused on execution. I think that some of the disappointments that we had in 2023, we're going to learn from them, and we're going to go back out and focus on execution from that standpoint."
},
{
"speaker": "Shar Pourreza",
"text": "Okay. Perfect. And then just lastly for me, just -- Ben, as you and the board are sort of thinking about where AEP stands today, I guess, what are you looking for in the next CEO? Are you kind of looking for a prior CEO or President of an OpCo, someone with a finance background, regulatory background, internal, external? I guess, can you just maybe specify exactly what you're looking for in the next successor?"
},
{
"speaker": "Ben Fowke",
"text": "Well, it's definitely an external search. I'll start with that. And I don't want to narrow down to any specific background, but ideally -- and by the way, I think we're going to get a very robust list of candidates. So AEP is a great company with great assets. And I think it's going to be an attractive destination for many, many talented people. So I think it's going to be great to pick from that talent. Ideally, you get a -- somebody that is a seasoned executive in the utility industry, is well known in the investor community. I think that's extremely important, has great leadership qualities. We've got a lot of talent at AEP, and we want to develop that talent. And ultimately, it would be ideal if they have multi-jurisdictional experience and the ability to achieve regulatory success. Those are -- that's a big wish list. But again, I think we're going to get a lot of great candidates."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. Terrific. Thank you, guys. I'll pass it to someone else, and good luck on Phase 2. I appreciate it."
},
{
"speaker": "Ben Fowke",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Ben Fowke",
"text": "Hey, Jeremy."
},
{
"speaker": "Operator",
"text": "Jeremy, your line is on mute."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Ben Fowke",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "I just want to kind of continue along these lines, if I could. And I was wondering if you're able to comment, I guess, on the recent agreement AEP announced with Icahn Capital and kind of how that ties into the change at the top here given the relatively short tenure? And just wondering if there's anything else we should be expecting, I guess, along these lines looking forward with Icahn's recent announcement?"
},
{
"speaker": "Ben Fowke",
"text": "Yeah. I really just will probably just rehash what we've said in the press release and in our scripted remarks. I mean the Icahn -- additional board members came after discussions with the Icahn team and the AEP team. We actually welcome their perspective. They share the opinion as we do that AEP shares are undervalued, and we want to work together to unleash shareholder value. Regarding Julie's departure, I mean, I really can't go into any more details than what we've already said. It was a full board decision after discussions with Julie, and we decided that the best path forward is to transition to a new CEO. We're going to continue to work hard to deliver shareholder value. I think the Icahn board members will give us a fresh perspective as we pursue those goals."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful. And just as we think about the strategic path going forward at this juncture, are all options on the table or any options off the table? Just want to kind of see the parameters of what we could expect going forward."
},
{
"speaker": "Ben Fowke",
"text": "Well, we really like the assets we have, okay? We've completed the strategic reviews, but I mean, the price -- we're going to continue to look for opportunities to do the right thing for our shareholders. But I think we're in a -- an enviable position, that the assets we have can also achieve our strategic goals. And Chuck mentioned where we are with FFO to debt and those targets. So I think we're in a pretty good position, quite honestly. So again, as I said before, not to be redundant, but I guess it will be. We'll be good portfolio managers, and we'll continue to be open to transactions if the price is right and the ability to execute is viable. But in the meantime, we're going to do the blocking and tackling that in the long term, gets you the result that -- results that you're going to want to see."
},
{
"speaker": "Jeremy Tonet",
"text": "Wonderful. Very helpful. Thank you for that."
},
{
"speaker": "Ben Fowke",
"text": "You’re welcome."
},
{
"speaker": "Operator",
"text": "Your next question will come from the line of Nick Campanella with Barclays. Please go ahead."
},
{
"speaker": "Nick Campanella",
"text": "Hey, good morning, everyone. Thanks for the prepared remarks and taking my questions. Good morning. So I guess, you acknowledged in your remarks, there's been some twists and turns and some regulatory volatility in '23. You had some headwinds that you highlighted from the FERC order on taxes, the Oklahoma rate order, among a few other items. But just the 6% to 7% has been pretty resilient and unchanged this entire time. So can you just maybe help us all understand just what's kind of allowing AEP to absorb these issues and where the offsets have been kind of in the 5-year plan that allows you to continue to reaffirm?"
},
{
"speaker": "Ben Fowke",
"text": "Well, I mean, I'll kick it over to Chuck in a minute, but the $43 billion on the 5-year capital plan underpins the 6% to 7%. In the years where we might have unfavorable weather or other things like that, that's the resiliency of this AEP management team that I talked about. And it's not just one year. It's a -- look back, I mentioned 14 years of hitting what we said we were going to do. Yeah, sometimes you get regulatory bumps in the road and other things that might happen. But if you look back historically, and we look forward, we produce. I mean, we're in 11 jurisdictions. We're going to file rate cases. But if you look at history, we generally do pretty well. And when we have a bump in the road, we figure out how to absorb it and what we need to do better going forward. Chuck, I don't know if you want to add to that?"
},
{
"speaker": "Chuck Zebula",
"text": "Yeah. No, Ben, as you said, it's underpinned by the $43 billion 5-year capital plan. I'd also point to what Ben made an observation as a board member and in his opening remarks about our O&M. There's a chart in our deck that you can refer to, right? We've doubled the rate base of this company while basically keeping O&M flat over that entire 10-year period. I think that's a remarkable accomplishment and that's our plan going forward as we continue to grow this company and basically repurpose and reallocate O&M. I also talked in my remarks about the load opportunities. I tend to kind of take a measured approach to this. But we really are optimistic about the opportunities that we're seeing there. As I said, the commercial load growth is just amazing. And we're seeing some good opportunities in economic development activities in industrial as well. And then lastly, of course, underpinning that plan is improved returns. Right? We are not earning where we need to earn, and we need to have the regulatory execution and prudency reviewed to make sure, right, that we are hitting the mark there. So I think all in all, that kind of underpins the plan going forward."
},
{
"speaker": "Nick Campanella",
"text": "Got it. And definitely appreciate the comments on diversification and the size of the overall plan as well as the O&M. Thank you for that. And then I guess, just -- I guess just sticking with the 6% to 7% CAGR, is there any kind of shaping to that over the 5-year plan? Is there anywhere that you kind of see yourself in that range right now? And then as we kind of think about a new CEO coming in, hopefully, in the back half of this year, is it your expectation that they would come in to embrace that plan? Or would they have more say in where they're taking the company? Thank you."
},
{
"speaker": "Chuck Zebula",
"text": "Yeah. So I'll take the first question. Our 5-year plan is really based off the midpoint of the current year's guidance. And our plan is to grow basically on that midpoint between the 6% to 7% range with no real kind of ups and downs identified through there. I'll let Ben answer the --"
},
{
"speaker": "Ben Fowke",
"text": "Yeah. I mean I think, first of all, we'll take our time, and we'll find the absolute best successor permanent successor that we can. I think as part of that process, we obviously will have the strategic discussions. I mean, I think the board is very comfortable with our strategy and our strategic priorities. I suspect that the ultimate permanent successor CEO will also be comfortable with those strategies and perhaps can figure out a better way to execute on them. That would be the goal. But we're not looking at a complete dismantling of our strategic priorities."
},
{
"speaker": "Nick Campanella",
"text": "Thanks a lot for answering the questions today. I appreciate it."
},
{
"speaker": "Ben Fowke",
"text": "You’re welcome, Nick."
},
{
"speaker": "Operator",
"text": "Our next question will come from the line of Carly Davenport with Goldman Sachs. Please go ahead."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thank you for taking the questions. A bit of a shift on the asset sale program, I guess, in terms of the decision to retain the transmission JV. So could you just talk a little bit about the rationale there and how we should think about your view on transmission as part of the portfolio or potentially as an area of sort of value monetization going forward?"
},
{
"speaker": "Ben Fowke",
"text": "Well, I mean -- and I'll let Chuck -- this is Ben. I'll let Chuck augment what I'm going to say, which is pretty much what I said before. Transmission is a great asset. And we are, obviously, the largest transmission provider in the United States, and we like that position. We will be open to things that make sense that would do even better for shareholders. But we don't feel compelled we have to do anything. So I think that puts us in a better position as we move forward. Chuck, I don't know if you want to add to that."
},
{
"speaker": "Chuck Zebula",
"text": "Yeah. I think you -- we're also referring maybe to pioneer in Prairie Wind and our decision to keep those assets. The reality is, right, these contribute earnings to AEP, their attractive returns. And overall, it was really insignificant, right, to our overall financing plan if we were planning on selling those assets. So it really goes back to the root of what Ben said, as we reviewed the opportunities before us in competitive transmission and then looked at other transmission assets that we have, we -- we're embracing it. It's time for us as the leader in transmission to continue, right, to lead that space, and that's what we plan to do."
},
{
"speaker": "Carly Davenport",
"text": "That's helpful. Appreciate that. And then, Chuck, probably for you, just a little bit of a shift in tone around the FFO to debt metrics as well for '24. Can you just talk about what we should expect relative to that 14% to 15% range for 2024 on FFO to debt and what the moving pieces are that you're kind of watching that could move you outside of that range?"
},
{
"speaker": "Chuck Zebula",
"text": "Yeah. So thank you for that question. And our message has changed a bit there on the timing. But what I would tell you is really kind of timing is not what is most important. It's really the trend that we're on, and then it's hitting the mark of 14%. And it's the sustainability on staying in that range as we go through the 5-year plan. So let me comment on a couple of things. Right? We said we would be above 13% by year-end, and we were. And we didn't make any excuses for the soft weather that happened in 2023. Note also that 13% is the downgrade threshold at Moody's. And second, right, the trend is very positive. Right? This quarter, we're going to have another roll off of cash collateral in Q1. I think the number is around $390 million that will come out of the 12-month average. And also, we are working on down our deferred fuel balances. And then lastly, right, we clearly show our models and review those with the agencies. Those models indicate that we would be in the range this year and be in the range over the longer term. That's what's most important, right, hitting the mark, trending in that positive direction and staying in the range. So again, the timing, which month or which quarter is not important, it's the three things that I mentioned earlier."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Thanks very much for the time."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Ryan Levine with Citi. Please go ahead."
},
{
"speaker": "Ryan Levine",
"text": "Good morning."
},
{
"speaker": "Ben Fowke",
"text": "Good morning."
},
{
"speaker": "Ryan Levine",
"text": "Given the focus on people and processes, how long do you view the company's review of its regulatory strategy to take? And in that context, how is the new review different from how AEP has reviewed its regulatory strategy historically?"
},
{
"speaker": "Ben Fowke",
"text": "Well, I'm going to turn it over to Peggy, who is the point on that. But this -- it isn't like this is something we're just initiating. This is something that I've heard discussed as a board member at the board level. It's something I'm going to get very much involved in with Peggy. We've got a good team, but we're going to have to -- we'll make sure that we do what we need to do to get better outcomes in the future. And I mean, there's a lot of blocking and tackling, that really behind the scene stuff that goes into the actual processing, executing and planning of a rate case. And it gets really down in the weeds pretty quickly, but those things add up. Peggy, I'll turn it over to you."
},
{
"speaker": "Peggy Simmons",
"text": "Yeah. I would just add -- and looking forward to working with Ben and talking through the regulatory strategy. We've had positive regulatory outcomes in 2023. And when we shared some of those earlier, there were some disappointments that we highlighted. But I would bring forth the legislative work that we have done, and that's going to help to address lag. We've done work that's going to help to remove some of the lag in Virginia with our biannual rate review for Virginia, where it was three years before. We're going to also look at improving on -- we said with Kentucky that it was going to be a two-step process, and we very much view that we had a constructive outcome in the order that we received earlier in January with the securitization. So we're going to continue to build upon that. I agree, we do have a talented team, and we're just going to keep moving forward, and I look forward, again, as I said, to working with Ben on ways we can continue to improve there."
},
{
"speaker": "Ryan Levine",
"text": "Great. And then unrelated, where do you see the biggest opportunities to benefit from the data center build-out in your service territory? And given your balance sheet constraints, do you have any reservations or concerns around that opportunity?"
},
{
"speaker": "Ben Fowke",
"text": "The biggest opportunity so far have been in Ohio and Texas. And in our forecast, for our 5-year plan, we have included the capital needed to serve those customers. If there is incremental growth beyond that, it would be an opportunity that we'd have to evaluate and figure out how we would smartly finance it. And meet the generation needs that come with it. Yeah."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Anthony Crowdell with Mizuho. Please go ahead."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning, Ben. Good morning, Chuck. Hopefully, two easy ones, one for you, Ben, one for Chuck. Just, Ben, I don't know what kind of insight you could provide. But just -- if I think about the -- excuse me, 1% position that Icahn has taken and it seems that there's been some major changes in the board. I don't think that would be a big position that yet, I think, two voting seats and then a non-advisory seat. Just thoughts on what change in the Board that maybe to expand the board?"
},
{
"speaker": "Ben Fowke",
"text": "Well, I mean, you're right. There's like -- I think there's 5.3 million shares that -- something like that that Icahn holds. And we had discussions with Icahn. And we settled on the two incremental board seats and advisory position. I think back to Julie, I'll just repeat what I said. This was a full board decision after discussions with Julie and the board, and we determined it was best for AEP to transition to a new CEO. So you can read what you want into that, but I think I'm just going to just keep it as it is. It's a full board decision, and you need the full board to make a decision to remove the CEO."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. And then, Chuck, two quick ones. It looks like the equity timing had moved. I understand your questions to Carly earlier on -- you are targeting to above the 13% threshold, but I think the equity may be slid off of the near term? And then lastly, on earned returns, what type of improvement could we expect each year? And I'll leave it there."
},
{
"speaker": "Chuck Zebula",
"text": "Okay. Thanks, Anthony. Our equity needs haven't changed since EEI. You may be referring to maybe an older forecast we had some months back. But what you're seeing in our deck today is consistent, right, with what we've shown at EEI. I'll let Peggy go ahead and mark -- talk about the returns."
},
{
"speaker": "Peggy Simmons",
"text": "Yeah. As it relates to -- for 2024, our ROE, we're projecting at 9.1% is what we're -- for our regulated segments. And we're going to continue to work on closing the gap, a lot of what I've already said earlier, just kind of building off with some of those legislative successes that we were able to have, reducing some of the lag from that perspective."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. Thanks for taking my questions. Appreciate it."
},
{
"speaker": "Chuck Zebula",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Sophie Karp with KeyBanc. Please go ahead."
},
{
"speaker": "Sophie Karp",
"text": "Hi, good morning. Thanks for taking my question."
},
{
"speaker": "Ben Fowke",
"text": "Good morning."
},
{
"speaker": "Sophie Karp",
"text": "Hi. Just a quick one for me. I guess like when you think about your jurisdictions, right? And the ones we've got constructive outcomes, regulatory and the ones where you got non-constructive outcomes. And how should we think about you allocating this increase in capital across these jurisdictions? Like, is there a strategy there to proactively reduce capital allocations to jurisdictions where you earned ROE just don't make a hurdle for what's attractive?"
},
{
"speaker": "Ben Fowke",
"text": "I'm going to turn it over to Peggy and Chuck in a minute, Sophie. But I mean, we're always going to look to put capital where we can get the best returns. There's baseline capital that you need to do to make sure that you never compromise resiliency, reliability or safety. So we -- but apart from that, I think it gets back to what I said. It's listening to what those local jurisdictions really want and need. And that can also shape your capital needs because, quite frankly, it can shape your regulatory outcomes. So I'll turn it over to the team if they have anything to add to that."
},
{
"speaker": "Peggy Simmons",
"text": "I would just say, yeah, I echo Ben's comments there on -- there's a certain amount of capital we need to continue to be resilient and meet the reliability needs of our customers. And as well as from a safety perspective. Those where we have really constructive outcomes, clearly, we know in I&M, we have the forward-looking test years. We're able to continue to have that capital to allocate there to meet what those needs are. And we just continue to look at what our outcomes are by jurisdiction."
},
{
"speaker": "Sophie Karp",
"text": "Okay. And then maybe going back to data centers, right? Do you see more attractive opportunities around incremental generation to support those customers or the T&D investment?"
},
{
"speaker": "Chuck Zebula",
"text": "Yeah, in Ohio and Texas, right? We're -- those are deregulated states. In our Indiana, Michigan territory, clearly, there would be opportunities for generation there to serve those customers."
},
{
"speaker": "Sophie Karp",
"text": "Okay, thank you."
},
{
"speaker": "Ben Fowke",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Paul Fremont with Ladenburg. Please go ahead."
},
{
"speaker": "Paul Fremont",
"text": "Thank you very much. I guess first question would be on the '24 guidance. Does that continue to include contribution from the retail and the distributed resources as was sort of outlined at EEI?"
},
{
"speaker": "Chuck Zebula",
"text": "Yeah. Our EEI guidance, right, we kind of change the waterfall based on the actual, right? But what's in or out hasn't changed, Paul. As Ben mentioned, we're in the process that we plan to conclude here in the next several months on retail and distributed businesses. He also mentioned that we're closing NMRD today, which there'll be a benefit from that sale coming through. But everything is underpinned. Remember, too, when you look at the waterfall, we took the Generation and Marketing segment down to what we would call much more normal contributions. I'm not concerned that about the ability to take the proceeds, use them as appropriate to get that accretion as we go forward. But no, it's still the same plan, if you will, as we put out at EEI."
},
{
"speaker": "Paul Fremont",
"text": "And then Chuck mentioned that the FERC decision is expected to have a $0.03 negative impact on '24. Is that going to be treated as operating EPS? Or is that going to be excluded as non-recurring?"
},
{
"speaker": "Chuck Zebula",
"text": "No, it's operating."
},
{
"speaker": "Paul Fremont",
"text": "And then I guess the last question I have is, currently, there's a proceeding in Kentucky where, I guess, there's recommendations for potential disallowance of fuel and purchased power costs. I think there's also a fuel review that could take place or may be taking place in Louisiana. Can you give us, I guess, an update on what your expectations are and what's happening in those proceedings?"
},
{
"speaker": "Peggy Simmons",
"text": "Yeah. In Kentucky, we do have a 2-year fuel review that has been underway, and we are waiting, the outcome as it relates to that. We had a hearing earlier this month actually. And then from -- what was your other question with it related to SWEPCO?"
},
{
"speaker": "Paul Fremont",
"text": "Yeah. I think as part of that settlement on the renewables, there was, I guess, the ability of staff to do a review of the fuel?"
},
{
"speaker": "Peggy Simmons",
"text": "Yeah, that was part -- excuse me, sorry, go ahead, finish your question."
},
{
"speaker": "Paul Fremont",
"text": "No, that's it."
},
{
"speaker": "Peggy Simmons",
"text": "Yeah. That was part of the review, and that is ongoing as well. So -- but Darcy can definitely give you some more information on that, if that wasn't clear enough."
},
{
"speaker": "Paul Fremont",
"text": "And last question for me. In terms of the 9.1% that you're targeting for this year, I think what type of an improvement do you see as being necessary in order to hit the 6% to 8%? I think in the past, you've talked about needing to improve the earned ROE as part of hitting your targeted growth rate?"
},
{
"speaker": "Peggy Simmons",
"text": "Yeah. So over our 5-year plan, we look to be typically to be in the 9.5% range. So what we're looking to do is increase by 10 basis points each year. And we think that that achieve ongoing. We continue to work through our regulatory outcomes to be able to close that gap."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Your next question will come from the line of Paul Patterson with Glenrock. Please go ahead."
},
{
"speaker": "Paul Patterson",
"text": "Hey, good morning. How are you? So just -- it doesn't sound to me like there really is much of a change in strategy with the new chapter and the managerial change that you're looking at. Am I thinking about this correctly?"
},
{
"speaker": "Ben Fowke",
"text": "Yeah, I think so. It's -- the strategy is great. We just have to execute, and that's what we're keenly focused on, Paul."
},
{
"speaker": "Paul Patterson",
"text": "Okay. I just want to make sure I'm hearing -- and then the second thing that I guess -- and I think this was asked before, but is there any timing that we should be thinking about in terms of when a new CEO would be in place?"
},
{
"speaker": "Ben Fowke",
"text": "Well, let me just say I'm committed to stay as long as it takes. So no shortcuts. But I can't see it being shorter than six months, and hopefully, it doesn't take more than a year. But again, it's going to -- the process will take the time it needs to take to get the absolute right candidate in place."
},
{
"speaker": "Paul Patterson",
"text": "Okay. And then finally, when we're talking about regulatory desires and goals, having watched the various jurisdictions, there are a number of jurisdictions that I get the sense -- and this isn't going to surprise you, Ben -- they want lower prices. And I'm just wondering, is there any sort of new or innovative way you're looking at the regulatory approach in terms of addressing maybe those concerns, increasing investment, but -- but addressing those two concerns other than obviously, the general concern that I'm sure you guys have. But do you follow what I'm saying in terms of making investments? And perhaps not seeing the resistance that I think if you look at a number of the AEP jurisdictions that they just ease to new investment leading to higher rates. Do you follow what I'm saying?"
},
{
"speaker": "Ben Fowke",
"text": "Yeah. I mean I think -- I mean I'm going to turn it over to the team, Paul, but the amount of load growth that we see in our jurisdictions, I mean that's a great opportunity, economic development that we can be a big part of, either helping to drive it or certainly providing the infrastructure to allow it. Those are great opportunities. And that's -- everybody wants that in all jurisdictions. But again, we're going to be -- very carefully listen to what our jurisdictions want and need and respond accordingly. Peggy or Chuck?"
},
{
"speaker": "Peggy Simmons",
"text": "And I'll just briefly add to that. In 2023, we landed 92 new customer load additions totaling about 5-gig and adding additional jobs to our service territory. So I think that that's certainly 1 area and aspect of how we're going to help with affordability as well."
},
{
"speaker": "Chuck Zebula",
"text": "Yeah. And Paul, clearly, the data center load that we're experiencing is going to create an opportunity, right, to spread fixed costs, right, along a bigger base and improve the headroom opportunity there as well."
},
{
"speaker": "Paul Patterson",
"text": "Okay. Great. And I appreciate it. And good to see you back, then hopeful as well."
},
{
"speaker": "Ben Fowke",
"text": "Thank you. Thank you, Paul. I appreciate that."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today’s call. As always, the Investor Relations team will be available to answer any additional questions you may have. Regina, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Today's conference will be available for replay beginning approximately two hours after the conclusion of this call and will run through 11:59 p.m. Eastern Time on March 5, 2024. The number to dial to access the replay is 800-770-2030 and for international callers, 647-362-9199. The conference ID number for the replay is 9066570. This concludes today's conference call. Thank you all for joining. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 3 | 2,023 | 2023-11-02 09:00:00 | Operator: Thank you for standing by. My name is Eric, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Third Quarter 2023 Earnings Call. [Operator Instructions]. I would now like to turn the call over to Darcy Reese, Vice President of Investor Relations. Please go ahead.
Darcy Reese: Thank you, Eric. Good morning, everyone, and welcome to the third quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at AEP.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Julia Sloat, our Chair, President and Chief Executive Officer; and Chuck Zebula, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie.
Julia Sloat: Thanks, Darcy. Welcome to American Electric Power's third quarter 2023 earnings call. It's good to be with everyone this morning. Before I discuss our third quarter performance, I would like to introduce our CFO, Chuck Zebula, who will walk us through the results today. Chuck has been with the company for 25 years and has a deep understanding of our business. He hit the ground running in his new role, and we're grateful for his leadership. Many of you are familiar with Chuck, and I'm confident that you enjoy working with him in the CFO role. I'm pleased to share that the execution of our strategy is on track. AEP is well positioned to deliver on a robust and flexible 5-year $40 billion capital plan with an emphasis on our generation fleet transformation and investments in our energy delivery infrastructure as we need our customer needs. While our industry continues to transform amid this dynamic environment characterized by more extreme weather, rising interest rates and supply chain constraints, AEP has continued to adapt and take thoughtful actions to stay our course. We're keeping the customer at the center of every decision we make, while also balancing and listening to our stakeholders who are critical to our success. This quarter, we made progress on our ongoing efforts to simplify and derisk our business profile through portfolio management, directing all proceeds of those efforts to the regulated business and to balance sheet management, which I'll speak to in more detail in a moment. We've also been working hard on the regulatory front. I'll provide insight into our success in the addition of renewable store portfolio and the many positive developments on regulatory and legislative initiatives. A summary of our third quarter 2023 business updates can be found on Slide 6 of today's presentation. AEP reported strong third quarter operating earnings of $1.77 per share or $924 million. We have a flexible business plan that allows us to deliver on our financial commitments while taking into account mild weather in the first half of the year and the higher for longer interest rate environment. As we actively manage the business today, we're narrowing our guidance for 2023 full year operating earnings to a range of $5.24 to $5.34 while reaffirming the $5.29 midpoint and our long-term earnings growth rate of 6% to 7%. Moreover, last week, we announced an increase in our dividend, which is consistent with our earnings growth rate and within our targeted payout ratio of 60% to 70%. In a few minutes, Chuck will talk about the support we have for our narrow 2023 earnings guidance range, which includes O&M management and positive load outlook as we drive economic development within our service territory. While our FFO to debt was 11.4% this quarter, we expect that this metric will improve materially by year-end and fall within the targeted rate of 14% to 15% in early 2024. Chuck will also touch on the short path to this balance sheet target. We continue to make progress in our efforts to simplify and derisk our portfolio. In August, we announced the completion of the sale of our 1,365 megawatt unregulated renewables portfolio to IRG acquisition Holdings, which resulted in after-tax proceeds totaling $1.2 billion. A summary of this sale can be seen on Slide 7. We've also made headway on some of our other asset sales that we previously discussed. A summary of this can be referenced on Slide 8. In May, we announced the sale of our New Mexico renewable development solar portfolio, also known as NMRD. The book value of AP's investment as of September 30 was $119 million. We're currently on track with our 550 joint venture partner, PNM Resources, as we target to close on this transaction in the late fourth quarter of this year or early first quarter of next. We expect to continue the noncore business sales processes we have underway as we enter 2024. The sales of our retail and distributed resources businesses were launched in August with book value of $244 million and $353 million, respectively, as of the end of the third quarter. We expect to reach a sale agreement in the first quarter of next year with an anticipated closing in the first half of 2024. In July, we announced the sales of Prairie Wind transmission and Pioneer Transmission, our noncore transmission joint ventures, as of the end of the third quarter, AEP's portion of rate base associated with these investments was $107 million. We expect to launch the sales process soon and close in 2024. Finally related to , while there are no new updates for now. We anticipate completing the strategic review by the end of this year. So please stay tuned. AEP portion of rate base for this particular investment joint venture was $348 million as of quarter end. Let me shift gears and provide you with an update on our regulated renewables investment plan. The teams remain focused and made solid progress. As you know, we have $8.6 billion of regulated renewables in our 5-year capital plan. We now have a total of $6 billion of the investment plan approved and an additional $800 million currently before commissions for approval with each of these projects providing valuable fuel savings for our customers. More detail on our renewable resource additions can be viewed in the appendix on Slides 32 through 34. As we've previously disclosed, both PSO's 995.5-megawatt renewable portfolio for $2.5 billion and SWEPCO's 999-megawatt renewable portfolio over $2.2 billion were approved earlier this year. At a collective $4.7 billion, these two portfolios alone comprise a large component of the approved $6 billion amount I just mentioned. Additionally, in APCo service territory, we're also pleased to report a positive development. In September, Virginia approved 143 megawatts of owned wind for more than $400 million, building upon APCo's existing 29 megawatts of wind and solar projects that were approved last year, which totaled approximately $500 million. Moving across our service territory to I&M, we filed to seek approval for recovery of two investment -- of investment in two owned solar projects totaling 469 megawatts, which represents $1 billion of total investment. We're making progress on this front as we received commission approval last month in Indiana for both the 224-megawatt May Apple and 245-megawatt Lake Trout solar projects. In Michigan the Commission approved May Apple back in August, and we'll decide on Lake Trout in the first quarter of next year. We also await a commission order expected any time now for the 154-megawatt rock balls wind farm at PSO for approximately $150 million. Importantly, our regulated renewables plants are aligned with and supported by our integrated resource plans. We have issued a request for proposals for additional owned resources at APCo and IM with more to come from other operating companies in the near future as we listen and learn and respond to state preferences. Now I'd like to turn to updates on our ongoing regulatory and legislative initiatives. We've been engaged in efforts across our service territory to close the authorized versus earned ROE gap. Our third quarter ROE came in at 8.7%, driven in part by the unfavorable weather in the first half of 2023 that I mentioned earlier, which depressed this measure by 40 basis points. While this is a modest improvement over the last quarter, we are aware that more can be done and more needs to be done on this front. Closing the gap will remain a primary focus into 2024 as we take federal state and customer preferences top of mind, along with meeting the needs of our communities. We remain focused on reducing the gap going into year-end, while still meeting our earnings guidance. To that end, I'm happy to confirm that we have settlement in place for APCo Virginia's 2020 to 2022 triennial and APO Ohio's ESP5, both cases which were filed earlier this year. we're awaiting commission decisions in these states and Virginia's orders expected in the fourth quarter of this year and Ohio will likely be issued in the first quarter of 2024. In addition, we filed new base cases in Indiana and Michigan in the third quarter. Both filings we requested -- in both on we requested a 10.5% ROE and taste drivers included distribution investment in technology, enhanced reliability and grid modernization using 2024 forecast and test years. We anticipate the new rates will be an effective next year. The team has been active on the legislative front in Texas -- with Texas legislation pass and June allowing utilities to file the distribution cost recovery factor mechanism or DCRF twice per year, sit of once per year. This legislation also allows the DCRF mechanism to be used by utility, even if it has a pending rate case for seating underway. Consequently, the legislation will help improve AEP's regulatory lag in Texas to the tune of approximately 50 basis points and earned ROE starting in 2024. In fact, our April 2023 DCRF filing was approved and rates went into effect in September. For Kentucky Power, our June 2023 based base application incorporated the comprehensive rate review, a 9.9% ROE and a request to allow for the securitization of $471 million of regulatory assets, ensuring Kentucky Power is best positioned to provide safe and reliable service while managing costs. Constructive intervener testimony was filed in October, including support for securitization. By statute, implementation of interim rates is permissible in January 2024. Moving to PSO, you'll recall that in May, we reached a settlement with the commission staff, the attorney general and other parties in Oklahoma's PSO base case, which included a 9.5% ROE and provided for approval for more efficient cost recovery mechanisms. We implemented interim rates in June while we await a commission order, which is expected any time now. As you know, the management of fuel cost recovery is a top priority with AP's deferred fuel balance across our vertically integrated utilities shrinking sequentially and totaling $1.2 billion as of the end of the third quarter of this year. We have worked with stakeholders to intentionally adapt our fuel cost recovery mechanisms across our jurisdictions with the objective being to balance cost recovery with customer impact. So West Virginia fuel proceeding is approaching resolution. Recall in our April 2023 fuel recovery application, we filed two options for consideration. One option amortizes the fuel balance over 3 years. In the second option, we have respectively set forth for the West Virginia Commission consideration, the use of the 2023 securitization legislation to manage our $553 million deferred fuel balance along with securitizing store cost balances and net plant balances of generation assets. The generation assets are currently embedded in rate and assume to operate through 2040 and securitizing those assets nearly fully offset the fuel cost recovery impacts to customers. We appreciate the engagement with all the stakeholder parties as we work toward a conclusion in this case by year-end and a constructive path for West Virginia. More detail on regulated activities can be found in the appendix on Slides 35 through 38. I'm pleased with the progress we've made this quarter and by the great work underway to actively manage the business, deliver on our commitments and create value for our investors, all while keeping affordability and reliability for our customers at the center of everything we do. We have a strong team in place, and I'm confident that we'll continue to execute on our strategic priorities and advance our capital investment plan to deliver reliable, affordable power to our customers. I look forward to seeing many of you in person at the EEI Conference in a couple of weeks. At the conference in Phoenix will provide some additional color on our business strategy, share our 2024 guidance and other financial details, including our 2024 through 2028 capital plan and related 5-year cash flows. Now with that, I'll hand it off to Chuck, we'll walk through performance drivers and details supporting our financial targets. Chuck?
Charles Zebula: Thank you, Julie. It's good to be with you and everyone on the call this morning. As many of you know, I've been in many different roles at AP, but this is my first earnings call as the CFO. I'm truly honored to return to the exceptional finance team at AEP and lead this area as we embrace the opportunity to invest in our regulated utilities and serve our customers with affordable and reliable electric service. Today, I will discuss our third quarter and year-to-date results. share some updates on our service territory load and economy and finish with commentary on credit metrics and liquidity as well as confirming our guidance financial targets and a recap of our commitments to stakeholders. Let's go to Slide 9, which shows the comparison of GAAP to operating earnings GAAP earnings for the third quarter were $1.83 per share compared to $1.33 per share in 2022. Year-to-date GAAP earnings through September were $3.62 per share compared to $3.76 per share in 2022. As was mentioned on the second quarter earnings call, our year-to-date comparison of GAAP to operating earnings reflects the loss on the sale of the contracted renewables business as a nonoperating cost as well as an adjustment to true-up costs related to the terminated Kentucky transaction. In addition, we have reflected our typical mark-to-market adjustment and the impact of capitalized incentive compensation in Texas as nonoperating earnings as well. There's a detailed reconciliation of GAAP to operating earnings on Pages 17 and 18 of the presentation today. Moving to Slide 10. Operating earnings for the third quarter totaled $1.77 per share or $924 million compared to $1.62 per share or $831 million last year. The higher performance compared to last year was primarily driven by favorable rate changes and transmission project execution, increased retail load and favorable O&M across our segments. Operating earnings for vertically integrated utilities were $1 per share, up $0.03 from last year. Favorable drivers included rate changes across multiple jurisdictions, increases in retail load, depreciation, transmission revenue and O&M. These items were somewhat offset by higher interest expense and unfavorable weather year-over-year. the vertically integrated segment did see positive weather versus normal in the third quarter of about $0.04 per share, but this was compared to positive weather in the third quarter last year of about $0.06 per share. Consistent with our first and second quarter results, depreciation was favorable at the vertically integrated segment by $0.01 in quarter 3, primarily due to the expiration of the Rockport Unit 2 lease in December 2022. However, if we exclude the impact of the lease depreciation would have been about $0.02 unfavorable, which is consistent with incremental investment activity in our vertically integrated segment. INM should see an additional $0.02 favorable net depreciation in the fourth quarter as well. The Transmission & Distribution Utility segment earned $0.39 per share, up $0.07 compared to last year. Favorable drivers in this segment included increased retail load, transmission revenue, positive rate changes in Texas and Ohio and favorable O&M Partially offsetting these favorable items were higher depreciation and higher interest expense. The AEP Transmission Holdco segment contributed $0.39 per share, up $0.06 compared to last year. Favorable investment growth of $0.02, coupled with favorable income taxes of $0.02 are largely driving the change here. Generation and Marketing produced $0.18 per share, up $0.04 from last year. The positive variance is primarily due to favorable impacts associated with the contracted renewable sale in August, along with higher generation margins and land sales. These favorable items were partially offset by lower retail and wholesale power margins. Finally, Corporate and Other was down $0.05 per share, driven by unfavorable interest and partially offset by favorable O&M. Please note that our year-to-date operating earnings performance by segment is shown on Slide 16 in the appendix of our presentation today. Many of the positive drivers are the same for the year as for the quarter, and the negative year-to-date variance is driven largely by unfavorable weather and higher interest expenses. Before we move on, I want to add a few more comments on O&M, including our outlook for the remainder of the year. We saw favorable O&M in the third quarter compared to the prior year, which was consistent with our expectations. For the fourth quarter, we are expecting more than $100 million of favorable O&M versus the prior year, which would bring us to a net favorable position for the full year from a consolidated perspective. The favorable change anticipated in the fourth quarter is largely a result of the timing of O&M spending in the prior year, including employee-related expenses and a contribution to the AEP Foundation in the fourth quarter of last year, along with continued actions we have taken, such as holding employment positions open, reducing travel and adjusting the timing of discretionary spending. Turning to Slide 11. I will provide an update on whether normalized low performance for the quarter and our expectations through the end of the year. Overall, load has come in ahead of plan all year, and the third quarter was no exception. Looking to the bottom right-hand quadrant. Normalized retail load grew 2.1% in Q3 from a year earlier. You also noticed that we have updated our full year 2023 estimates based on the strong loan growth we've experienced year-to-date. Weather normalized retail load is now expected to finish this year 2.3% higher than 2022, an increase that is nearly 3x higher than our original expectations. This strength comes from exceptional growth in commercial load driven by data centers in Ohio, Texas and Indiana, but the third quarter also saw positive trends in our residential class, which is shown in the upper left-hand quadrant of the slide. Residential load increased for the first time in more than a year in Q3 with growth of 0.6% from a year earlier. The relationship between customer incomes and inflation is a key driver of residential usage and has begun to stabilize as expected in the second half of this year. This month's CPI data point was yet another encouraging sign that inflationary pressures on our residential customers are continuing to lessen. We note that residential usage per customer have seen slight declines this year as energy efficiencies increase, more workers return to offices and customers change behavior due to inflation. Fortunately, we are seeing strong enough growth in our customer base, especially in Texas and Ohio to help partially offset these trends. Year-to-date, we have added nearly 30,000 residential customers across our footprint. Moving to the lower left-hand quadrant of the slide, our investor load declined in the third quarter, driven by a pullback in usage by some of our key manufacturing customers. namely chemical, plastic and tire producers as well as downstream participants of the energy industry. This reflects some of the softness in manufacturing nationally as producers have slowed activity in response to uncertainty around the economic outlook. We expect this to reverse itself in the months ahead as recent inflation and jobs data have reduced the probability of a recession occurring in the next year. We are forecasting industrial load to remain positive through the end of next year and beyond. Moving to the upper right-hand quadrant of the slide, we see another impressive quarter for commercial load. In the third quarter, commercial load was 7.5% higher than a year ago, driven by the addition of new data center customers, mostly in Ohio, Texas and Indiana. We expect the pace of year-over-year growth in our commercial load to moderate some in 2024 as new projects work their way through the queue. Many of the large projects currently underway within our footprint won't come fully online until 2025. However, there is upside if a few of these projects move forward earlier than expected. Many of these gains are directly attributable to our ongoing efforts to facilitate more economic development across our operating footprint. We know that working with local stakeholders to attract more economic activity is a key strategy to providing value to the communities we serve. It allows us to prioritize investments that improve the customer experience while also mitigating rate impacts on our customer base. Moving to Slide 12. In the lower left corner, you can see our FFO to debt metric stands at 11.4%, which is an increase of 30 basis points from last quarter but continues to be well below our targeted range of 14% to 15%. The primary reason for the increase is a $1.8 billion decrease in debt during the quarter due to long and short-term debt retirements, driven by proceeds received from our contracted renewable sale and the successful completion of our planned equity units conversion, both of which occurred in August. We expect this metric will continue to improve throughout the remainder of this year and anticipate reaching our targeted range in early next year as we see an improvement in FFO during that time. We have included a table on the slide that shows the path to the targeted FFO to debt range early next year. These items -- these are items that impact both the 12-month rolling average as well as an estimated increase in the quarterly FFO. We anticipate a 180 to 190 basis point positive impact on FFO that enables the metric to be in the 13% to 14% range by year-end based on the following items: a roll-off of roughly $600 million in cash collateral, deferred fuel and other outflows from the fourth quarter of 2022 and continued cash recovery of deferred fuel balances in the fourth quarter of this year that total between $150 million and $200 million in accordance with the regulatory orders we have already received. Moving into 2024, the continued roll-off of prior year cash collateral outfall in the amount of $390 million in the first quarter of 2023 and a $90 million adjustment from unfavorable weather in the first quarter of this year to normal weather in our forecast for next year, will result in an incremental 100 basis point improvement put us within our target range of 14% to 15%. Also, please note that we have updated our 2023 cash flow, as shown on Page 29 in the appendix. An increase of $1.2 billion in required capital is shown versus the original forecast, mostly due to a decrease of $800 million in cash from ops largely due to fuel inventory and an increase of $300 million in capital expenditures. Please note that our equity needs for 2023 are unchanged. The remaining years 2024 to 2027, along with rebilling 2028, will be updated at the upcoming EEI conference. Expect that this update will be consistent with our prior equity meetings and disclosures. Moving to Slide 13. You can see our liquidity summary in the middle of the slide. Our 5-year $4 billion bank revolver and our 2-year $1 billion revolving credit facility to support our liquidity position, which remains strong at $3.5 billion. On a GAAP basis, our debt to cap decreased from the prior quarter by 220 basis points to 62.4%. This large change can be attributed to the large reduction in debt, driven by our contracted renewable sale and the completion of our planned equity units that I mentioned earlier. On the qualified pension front, our funding status decreased 1.9% during the quarter to 100.3%. This is largely due to equity and fixed income losses in the third quarter as interest rates increased and equity indices fell in both August and September. These losses are partially offset by a decreased liability due to rising interest rates. Let's go to Slide 14 for a quick recap of today's message. The third quarter produced growth in earnings well above the prior year, driven primarily by favorable rate changes, increased load and favorable O&M offsetting milder weather and increased interest expense. As we continue to move through the fourth quarter, we are focused on cost management efforts with the goal of mitigating the headwinds we have faced this year, primarily unfavorable weather and higher interest costs. The strong third quarter results and low growth, coupled with our proactive plan for the balance of the year, allow us to confidently narrow our operating guidance range to $5.24 to $5.34 per share. We also continue to be committed to our long-term growth rate of 6% to 7%. And as Julie mentioned earlier, our sales efforts to simplify and derisk the AEP portfolio remain on track. We really appreciate your time and our management team and I look forward to seeing you at the upcoming EEI Financial Conference in Phoenix. With that, I'm going to ask the operator to open the call so we can hear your questions or comments.
Operator: [Operator Instructions]. Your first question comes from the line of Nick Campanella with Barclays.
Nicholas Campanella: And congrats, Chuck on the new role. I wanted to actually start there, if I can. I know that there was just some language in the 8-K when you made the executive switch around the mandatory retirement age, in your interest in retiring before you reach that age. But I just wanted to ask, are your intentions here to stay on to the foreseeable future? Is this more temporary? Just how should we kind of think about your new role in company.
Charles Zebula: Yes. No, thank you for the question. And look, I am absolutely embracing this opportunity that we have before us. It's very energizing to enter into a role like this. And although -- the AK did indicate that I'm committed to Julie and AEP to write this out as long as needed. And as long as I'm adding value right to the opportunity. So thank you for the question.
Nicholas Campanella: I appreciate the answer. And then I appreciate the walk on the FFO. That's helpful. I just wanted to confirm because S&P did move you to negative outlook. And I think in your prepared remarks, you said as you get to EEI, you anticipate equity needs being somewhat unchanged. So is it the right understanding that if you are in a CapEx rate scenario that your equity needs to still be modest and unchanged versus your prior view? And then secondly, understanding that the 11.4% has some reduction in debt from the renewable proceeds. The cash flow from those renewal proceeds, I guess, would be rolling off into next year. And I just want to triple check, that even with the asset sales, cash flow dilution, you still see yourselves above 14%.
Charles Zebula: Yes. Yes, thanks for both questions. So yes, our equity needs will be consistent, right, with what we have disclosed prior. I mean, clearly, we'll be updating, right, the years in the cash flow forecast, but expect no surprises there. . On to your second question, yes, we tried to highlight right, on the slide, the FFO slide, the major drivers that you can point to and see what is rolling out as outflow. But absolutely, right, in our financial models, right? It takes into account, right, the absence of that cash flow. So we do expect to be in those ranges.
Operator: Your next question comes from the line of Jeremy Tonet with JPMorgan.
Jeremy Tonet: We've seen a bit of a regime change as it relates to interest rates out there, given the sharp moves recently. Just wondering if you could talk a bit more about that and how AP is able to affirm the 6% to 7% long-term CAGR there in what could be higher for longer interest rate environment? What impact do you see on EPS 2023? And kind of how do you think about offsetting those headwinds?
Charles Zebula: Yes. Joe, thank you for the question. I mean, look, we'll be giving you a walk right on 2024 at EEI. But there's no question that we are planning for an interest rate higher for longer environment. We've clearly been able to overcome those headwinds this year, but they will persist. So our plan is to, a, sensibly finance this company, right, continue to remain committed to mid-grade investment-grade credit. And our recovery mechanisms on interest rates, some of them are somewhat immediate or very near term, right? Some of them are kind of medium term and then some of them do have some lag associated with them. So the reality is some of this will begin to flow through. We remain committed to keeping parent debt in that range, well below 25%, 19% to 21% is ideal and offsetting those headwinds like with continued investment, we're seeing strong loan growth and the positive regulatory outcomes and closing the ROE gap that Julie just mentioned.
Jeremy Tonet: Got it. That's very helpful there. Maybe kind of picking up on that last point there. I think on the last call, we discussed a bit -- or there's some questions regarding outreach to commissions and just building regulatory relationships across the jurisdictions. I'm just wondering if you can provide a bit more detail, I guess, on specific initiatives done so far, where do you see that going? How you see that kind of transpiring so far?
Julia Sloat: Yes. Nick, thanks for the question. This is Julie. We continue on with that effort. In terms of engagement with our various state commissions as well as talking with folks at the FERC level. it's important to note that we do this in conjunction with our operating company presidents and leadership there. And my objective and your senior leadership team's objective is to clear the path operating company presidents and those teams so that they can have a very good traction with their respective commissions and their respective economies in the state. So those continue to occur. And honestly, just keeps me educated so that I can make sure that when we build the strategic plan at the aggregate level that it makes sense, and we're taking into consideration our customers' needs and also the economies that are driving all this magic that's happening across our entire footprint. So it continues as she goes in terms of those conversations, and we'll continue to stay out in front of folks and do our best to support our operating companies. So nothing super exciting to report other than the action is absolutely happening, and we'll see that embedded in the cases that we're filing.
Jeremy Tonet: Got it. And just to confirm, the plan is still for you to meet each of the commissions when you're able to do so?
Julia Sloat: Yes. Honestly, I enjoyed getting out anyway and talking with everybody. Like I said, I think it makes me better at my job. I'm making the round. And I got to be sensitive to what we've got going on in our respective jurisdictions. In some cases, I've got export issues I got to be sensitive to. But I'm absolutely making the rounds, and we'll continue to do that because the business is incredibly dynamic more so than ever. And we need to make sure that we're staying in touch with everything that's going on across the entire organization. So that will continue on.
Jeremy Tonet: Got it. That's very helpful. And just the last one, if I could. The waterfall chart through 9 months in the presentation today, it was a bit different than, I guess, what we saw on EEI. Just wondering if you could walk us through some of the puts and takes, the drivers to this, and across the different segments and what do you see, I guess, in the fourth quarter that maybe narrows the gap or just kind of the different trends happening such as in vertically integrated with renewables as well?
Julia Sloat: Yes. So I'll start and I'll hand it off the Chuck. So what gives us comfort in terms of narrowing the guidance range when you -- I look at Page 16, I sum that's where everybody is right now in terms of that waterfall chart. So what gives us a comfort is Chuck mentioned that we are able to effectively, I guess, take our low forecast predominantly driven by the commercial load that we're seeing. So that's going to be incorporated into our thoughts for the remainder of the year. We're trying to manage the interest expense that's also incredibly important. Another data point to throw out there. No question we keep getting is -- what percentage of your debt outstanding is floating rate is about 12.5%, if I remember correctly, as of the end of the third quarter. So that's something that we're being remindful of. We're also thinking about what regulatory cases that we have already in hand. As a matter of fact, you may recall that when we began the year, we had something like $290 million of new rate release embedded in our forecast. Actually well north of that. We're at about $303 million of secured rate relief in hand. So that gives us a little more confidence and comfort to as we proceed through the end of the year. So again, it's really just steady as she goes and plug in Chuck. I don't know, Chuck, had anything else you want to add to that?
Charles Zebula: Yes. Sure, Julie. Look, the other thing is the O&M Management. As I mentioned during my comments, if you look at Slide 16, right, you'll see that O&M is a drag two through three quarters, right? We expect that to completely reverse itself for year-end and actually have a net positive on O&M year-over-year, meaning that the fourth quarter will have a substantial difference in O&M versus last year.
Operator: Your next question comes from the line of Shahriar Purreza with Guggenheim Partners.
Jamieson Ward: It's Jamieson Ward on for Shar. Looking at your new FFO to debt pass side, could you give us a sense on what if anything could cause any potential slippage like the deferred fuel recovery? And what might dictate you being at the bottom or the top end of that 14% to 15% in 2024? I know you talked previously about being at the midpoint by the end of the year. But since we've got an updated disclosure here, I just wanted to ask that again here.
Charles Zebula: Yes. No, sure. When you look at the chart, several of these are just simply facts, right, that are going to come out. All the outflows, right, are no numbers, right, that are rolling out of the 12-month average. So then we're just subject to the normal variances. In FFO that would occur. It's a preworking capital number. And the reality is, right, softer weather, better weather, all those things will influence it. But I think we'll be solidly in both ranges, right, by the time frames that we talked about. .
Jamieson Ward: Got it. And one more from us. On load growth, what's driving the large -- I know you mentioned data centers, but -- if you could just talk a bit more about what's driving the large increase for the guidance this year? And then more specifically, as we think about the updated capital plan, which you'll be providing, just directionally, should we expect this higher load growth to be a driver of capital growth opportunities?
Julia Sloat: Yes. This is Julie. I'll pass off the Chuck here to we'll take him a little bit. But as Chuck mentioned, the primary driver for our loan growth as we go into the end of 2023 is all around that commercial segment. So if you look at Page #11, look in that upper right-hand quadrant, you're going to see a serious or material shift in what our updated guidance looks like versus what we originally had for 2023. The vast majority of that loan growth is coming from data centers located in Ohio, Texas and also in the [indiscernible]. And if you look across the rest of the segments there. So residential, a little soft. We talked a little bit about at the beginning of the call here on our monologue our prepared remarks about the fact that customers are feeling this in the wallet as it relates to inflation, et cetera. We expect that that's going to improve over time. But nevertheless, what's allowing us to get a little more comfort the residential side is we've added 30,000 customers year-to-date. So that offset a lot of the otherwise pressure we would have seen in that segment as usage for customers come off a little bit. And on the industrial side, it's really driven by interest rates. And the expectation, I guess, concerns that there could be some softening in the economy. So we've seen certain customer segments within that industrial aspect kind of come off a little bit. But we expect over time that will improve I don't know Chuck, is there anything else to come on hand?
Charles Zebula: You mentioned that the drive your capital forecast. And of course, the new data centers, of course, require capital to hook those customers up. We do have what is known and customers that are coming into our capital forecast going forward. And there are lots of discussions otherwise, right, in our economic development activities. But everything that we know of and its firm is in our capital forecast.
Jamieson Ward: Got you. Just one clarifying -- one last clariffying question. So question is really focused around that 7.3% guidance for '23 for commercial versus the 80 basis points originally, Presumably, the infrastructure necessary for those data centers to be receiving a load that they are in place, especially extremely about a couple months left in the year. And we obviously saw that you'll be providing '24 and '25 guidance on the EEI. So we're just directionally trying to think, is this a trend likely? Is this isolated to '23? Or is this something that could continue and could drive, therefore, capital opportunities as you look to sort of about increasing commercial data center load and then that's it for me.
Julia Sloat: No, I appreciate the question so much. Yes. That trend, we expect that to continue. I mean you see the fluctuation a little bit in the commercial segment up in the upper right quadrant that slide I mentioned earlier. We have projects in the Q so you kind of see those ebb and flow, but you're right the infrastructure is in place today the pending or incoming request for additional capacity from our customers. So that customer touch point or our economic development team is incredibly important because that allows us to not only have confidence around what our forecast is, but it also drives what the CapEx program needs to be. yes, we think that, that's going to continue, and we will keep a keen eye on that in particular because the infrastructure gotten be there. We got to make sure that we're communicating with our customers that they know exactly what the appropriate and realistic time line is for them to enter into our service territory so that the infrastructure is there because it's not something that's done overnight. So I appreciate that question so much because it is a fine orchestration that absolutely has to happen. .
Operator: Your next question comes from the line of Carly Davenport with Goldman Sachs.
Carly Davenport: Maybe to start, as we just think about the moving pieces on cash sources going forward, could you talk a little bit about how the asset sales processes are progressing in terms of interest that you're seeing but ask. And then on the timing side, it seems like a little bit of a narrowing of the time frame for NMRD. But anything else on the timing side that you highlight?
Julia Sloat: Yes, I can start in Chuck and jump here too because tucking really close to the optimization that we've been doing. Anyway, yes, so from an MRB perspective, we're getting close here. So I would anticipate a contract being signed in a not-too-distant future and isn't really going to be a story around when can you close? So that can be driven also by our regulatory and won't probably get FERC approval depending on who the purchaser is that can drive other issues that we'll need to address. So we can give you a more precise time on when we can land that jet. So stay tuned, that ones in the hopper and coming along here relatively quickly. And then Chuck, do you want to talk little bit about retail and distributed?
Charles Zebula: Yes, you did ask a question, I do want to address, right, what's the data asking, of course, we're not going to reveal anything like that in a public forum, but we are pleased with the response we received in some of the early results. that are indicative of course, but the process kind of goes on. Greg Hall and his team are leading that effort. There are in the queue remaining this year the typical process of management meetings and moving on to final bids either late this year or early next year. So the reality is, right, that's going to take some time to progress. I expect to complete that in the first half of next year. and the other sales processes are just shortly behind that.
Carly Davenport: Great. That's helpful. And then I appreciate the color on the drivers on O&M heading into 4Q and for the full year. I guess how are you thinking about managing O&M into 2024? Should we expect to see an uptick that kind of offset some of the efficiencies that you've driven this year that have addressed the mode weather and allow you to continue to execute on the earnings guidance for 2023?
Charles Zebula: Yes. So that's a good question. I can tell you what the discussion amongst the executive leadership team here are really focused on prioritizing O&M spend and spending both capital and O&M dollars that benefit and provide value to our customers. So we're really targeting the prioritization. We'll be giving guidance on O&M for next year in our waterfall at EEI, but expect us to be conservative, right? We're going to manage O&M to the levels, right, that are needed to run our business, right, but begin to eliminate things that are what we may consider to be discretionary going forward. .
Operator: Your next question comes from the line of David Arcaro with Morgan Stanley.
David Arcaro: I think thanks again for the disclosure around the [indiscernible] into the first quarter of 2021, and you've touched on this a little bit, but I was just wondering how you see that metric track after that point from getting to the range as a stable to rising from there and kind of staying within the target range going forward when you look at the core business outlook?
Charles Zebula: Yes. We absolutely plan to target and be in that 14% to 15% range. I will tell you that the introduction of large projects on a year-to-year basis, right, may swing that around some. So as you add renewable projects, in particular, if they come at the end of the calendar year, right? You have the financing costs related to that, but you don't have the FFO. The rating agencies are very well of that pattern. But absolutely, when you pro forma that, right, 14% to 15% is where we intend to be.
Operator: Your next question comes from the line of Anthony Crowdell with Mizuho.
Anthony Crowdell: Welcome back, Chuck. Great to hear from you again. Just only two quick ones. I think Nick touched on it earlier on recent S&P had revised their outlook on the holding company. I'm just curious I guess your discussions with the rating agencies. We appreciate the detail you provided in the slide deck specially on your credit improvement. But have you been in discussion how you unveil that previously to S&P prior to their rating to or their outlook change?
Charles Zebula: Yes. So Anthony, I talked to all three rating agencies since it's coming in and as well as our treasury team obviously talks to them all the time. I don't think the S&P move to negative outlook was a particular surprise, given the downgrade threshold and are rating a split, right? They're at a higher rating, right, than Moody's and Fitch currently. So it wasn't a surprise. We continue to work with the agencies to explain our business risk because we think as we continue to execute on exiting the unregulated businesses, our business makes sure to improve. And they should begin to reflect that in their evaluations. So not a surprise. If and when it is downgraded, their ratings would be on par with Moody's and Fitch. .
Anthony Crowdell: Great. And then just lastly, you laid out the two scenarios regarding West Virginia fuel cost recovery. One is an amortization over 2 years. The other one is the securitization, which also includes accelerating coal plant closures, Given, I guess, the impact of the balance sheet and all the other moving pieces, does the company have a preferred path in West Virginia? And then also, when do we get resolution on that from the regulator?
Julia Sloat: Yes, I appreciate that question. And let me just clarify the question as well right out of the gate here. To the extent that we've included securitization as an option, that does not assume an acceleration of coal plant closures, just to be very clear on that. We have those embedded in rates today going through 2040. So that is the current plan of thinking. So the idea of using securitization was entirely driven by how do we minimize the impact on customer rates. Period. And so that was the spirit of why we even contemplated the utilization of the securitization. And that second scenario option that I mentioned where we not only securitize the fuel, but we have, I think, a little bit of storm cost in there as well as those plant balances would effectively render customer rates neutral. So no impact, okay, de minimis. And then the other alternative was just a 3-year smoothing of those deferrals -- or those deferred costs. And that was to the two, I want to say it was maybe 12% increase in customer rates associated with that subject to check. So as far as our preference would be, our preference is to get it recover. Our preference is to be able to work with all the different stakeholders, which is precisely why we put out the different options and listen to the different stakeholders in the case just with complete appreciation sensitivity to the customers in West Virginia that the general median household income tends to be a bit lower than most definitely the national average, but even across AEP's footprint, it's lower. So we need to be incredibly sensitive to those wallets. As far as preference. Our preference simply is to work with it in the stakeholders and get it done. And as far as when we might be able to get that done, our expectation is that we get that done here in the fourth quarter. So tic tok, any time here, okay?
Operator: Your next question comes from the line of Andrew Weisel with Scotiabank.
Andrew Weisel: Good morning, everybody. Good morning. A lot of information already. So I've only got one less if you can clarify here. I want to ask about the three moving pieces between equity asset sales and CapEx. And I know you're going to talk about this at a couple of weeks, but my question is that if equity needs are generally going to be consistent, how do we think about how you'll finance incremental CapEx? You typically roll forward the CapEx plan, it tends to go up most years. It's currently $40 billion. Does that mean that cash proceeds from these asset sales should help to finance whatever upside there is on the CapEx plan? Or will you have additional equity until the asset sales are announced? How do you think about that bouncing act?
Julia Sloat: Yes. So I'll let my CFO jump in here. But first things first, we want to have a healthy balance sheet, okay? So dollars come in the door. We're going to make sure that our metrics work. We talked a little bit or a lot about 14% to 15% FFO to debt. We also pay attention to our debt-to-cap ratios, but 14% to 15% is our gating item for us in metric. So we will look to that metric to see where we're shaking out. Dollars will be placed accordingly as we bring those in the dollar associated with sales. As far as equity needs go, as Chuck mentioned, I guess, again, the free study issue goes on average, we're around $700 million, plus or minus any given year to see that in cash flow that we have out here on Page #29. We are going to continue on with a healthy CapEx program. You'll see that extended into 2028 when we talk to you at EEI. But there may be fluctuations like sequentially year-to-year. But I wouldn't anticipate any material shift or change, again, getting item dollars in the door, take care of the balance sheet, and then we'll fund the rest of the regulated business that way. And, Chuck, there anything as you add to that?
Charles Zebula: No. Julie, I think your answer is -- I really can't add anything. I would just say, embrace the capital opportunity and sensibly and smartly finance.
Andrew Weisel: Okay. Great. That's helpful. And if you can just remind us what are the downgrade thresholds for Moody's and Fitch?
Julia Sloat: 13% FFO to debt.
Operator: Your next question comes from the line of Durgesh Chopra with Evercore ISI.
Durgesh Chopra: Chuck will come the forward work with you. Just real quick on the FFO to debt metric. I just want to clarify the 13% to 14% target for end of this year. Are you assuming that Virginia fuel recovery that's resolved?
Julia Sloat: No. As a matter of fact, what is assumed in that forecast that walk as today is everything that we already have in hand. So West Virginia fuel outcome does not disrupt that path at all. That's prospective for us.
Durgesh Chopra: Got it. So okay. So any sort of -- any incremental sort of cash flow bump from that would be accretive to what you show on this slide, right, even for 2014?
Julia Sloat: That would be helpful, yes.
Durgesh Chopra: Okay. Perfect. And then maybe just one quick -- one real quick -- what's the balance the total deferred fuel cost balance that hasn't been covered as of the Q3, I know the $1.4 billion as of Q2? .
Julia Sloat: Yes. $1.2 billion as of the end of the third quarter, and that's in aggregate across the AEP footprint of fleet of utility companies. .
Durgesh Chopra: West Virginia roughly like $500 million, correct? .
Julia Sloat: West Virginia. Yes, West Virginia is what can be specific, $574.8 million. So call it $575 million. We're paying attention to this. So that's why a little bit of detail here. That's important.
Operator: Your next question comes from the line of Julien Dumoulin-Smith with Bank of America.
Julien Dumoulin-Smith: So just coming back to that O&M piece, obviously, you put some comments in the script here. 100 million. Look, I think that's a solid number. I'm just curious, how do you think about that annualizing here and the ability to annualize in those sectors? I get that some of them are kind of discrete in nature here, certain elections. But in an effort to kind of preview a little bit more on that '24 trajectory. I know you made a couple of allusions to it here. Can you perhaps lean in a bit further and describing how you think about what that could do for next year on the cost side?
Charles Zebula: So we're going to lead into that PEI in about 7 or 8 days or 9 days, whatever it is. But the folks right at the management team, as I said earlier, is really on prioritizing the spend and spending dollars where it matters most to our customers. That's the most important thing we can do in our O&M budget will reflect that.
Julien Dumoulin-Smith: Yes. No, I respect that, hence the interest. Okay. One while I'll leave it there. And you mind just on the low side just to clarify it a little bit further here. I mean, obviously, you have an updated load in the near year that is sensitively more robust and you have a backward dated load growth profile here for '24,'25. How do you think about the time line for revisions and the extent of those revisions as you see it today, again, I know this is probably more in the EEI 4Q conversation. But I mean, clearly, we see this kind of revisions across the PJM footprint. How do you think about that? And also maybe how does that tee up with PJM itself here and potential further transmission-oriented opportunities?
Charles Zebula: Yes. So as you can see, right, the low growth in particular in commercial is pretty robust. Those numbers will be updated when we on the EEI. And as I said earlier, it's embraced the opportunity. This is a good opportunity for us. I think you have to be smart about it and kind of vet out what is real and what is a real load is going to come on. and plan your capital investment profile around that. So lots of activity, lots of discussions. Our economic development team is very busy talking and dealing with the opportunity.
Operator: Your next question comes from the line of Sophie Karp with KeyBanc.
Sophie Karp: Can you please clarify, you mentioned that you could implement or that it's possible to implement interim rates in Kentucky in January? Do you actually intend to do that? Or how does it take sort of politically it would work out for you there?
Julia Sloat: Yes. Generally, we try to take advantage of that. So that would be the plan. And of course, we'll stay in close contact with all the stakeholders store case and the commission. And so other than that, just as we have done in say, for example, the PSO that is typical for us if there's an opportunity to implement rates. We go ahead and do that and kind of risk-adjusted in terms of our forecast and understand when cash has been coming the door alters items that are so important as we put the forecast out to you guys and have confidence around that. But short answer is, yes, generally speaking, that, we would expect to put those in place or implement the rates.
Sophie Karp: Got it. And then just a broad question, I guess. Is there any interest to approach state regulators in stake mechanisms to reduce weather volatility impact on your earnings. I know you're not decoupled in most of our jurisdictions. So kind of curious if you like that type of rate mechanisms or would you drive transition time to situation whether doesn't impact you earn that much.
Julia Sloat: Yes. We engage in those conversations. And again, that's more of a stakeholder discussion and see what the temperature and tolerance would be as it relates to not only just out preferences the preferences and tones of other party to the cases. That being said, we did have the coupling hi for a while that is installed by the wayside, but that's something that we have a regular conversation about. So I wouldn't say that we have a push or a thrust towards getting a decoupling in place, but it's absolutely a tool in the toolbag.
Darcy Reese: Thank you for joining us on today's call. always, IR team will be available to answer any additional questions you may have. Eric, would you please give the replay information?
Operator: Thank you. This call will be available for replay beginning today and approximately 2 hours after the completion and will run through until Thursday, November 9, 2023, at 11:59 p.m. Eastern Time. The number to access the replay is 800-770-2030 or 647-362-9199. The company's ID to access the replay is 906-6570. Thank you. Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Thank you for standing by. My name is Eric, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Third Quarter 2023 Earnings Call. [Operator Instructions]. I would now like to turn the call over to Darcy Reese, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Eric. Good morning, everyone, and welcome to the third quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at AEP.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Julia Sloat, our Chair, President and Chief Executive Officer; and Chuck Zebula, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie."
},
{
"speaker": "Julia Sloat",
"text": "Thanks, Darcy. Welcome to American Electric Power's third quarter 2023 earnings call. It's good to be with everyone this morning. Before I discuss our third quarter performance, I would like to introduce our CFO, Chuck Zebula, who will walk us through the results today. Chuck has been with the company for 25 years and has a deep understanding of our business. He hit the ground running in his new role, and we're grateful for his leadership. Many of you are familiar with Chuck, and I'm confident that you enjoy working with him in the CFO role. I'm pleased to share that the execution of our strategy is on track. AEP is well positioned to deliver on a robust and flexible 5-year $40 billion capital plan with an emphasis on our generation fleet transformation and investments in our energy delivery infrastructure as we need our customer needs. While our industry continues to transform amid this dynamic environment characterized by more extreme weather, rising interest rates and supply chain constraints, AEP has continued to adapt and take thoughtful actions to stay our course. We're keeping the customer at the center of every decision we make, while also balancing and listening to our stakeholders who are critical to our success. This quarter, we made progress on our ongoing efforts to simplify and derisk our business profile through portfolio management, directing all proceeds of those efforts to the regulated business and to balance sheet management, which I'll speak to in more detail in a moment. We've also been working hard on the regulatory front. I'll provide insight into our success in the addition of renewable store portfolio and the many positive developments on regulatory and legislative initiatives. A summary of our third quarter 2023 business updates can be found on Slide 6 of today's presentation. AEP reported strong third quarter operating earnings of $1.77 per share or $924 million. We have a flexible business plan that allows us to deliver on our financial commitments while taking into account mild weather in the first half of the year and the higher for longer interest rate environment. As we actively manage the business today, we're narrowing our guidance for 2023 full year operating earnings to a range of $5.24 to $5.34 while reaffirming the $5.29 midpoint and our long-term earnings growth rate of 6% to 7%. Moreover, last week, we announced an increase in our dividend, which is consistent with our earnings growth rate and within our targeted payout ratio of 60% to 70%. In a few minutes, Chuck will talk about the support we have for our narrow 2023 earnings guidance range, which includes O&M management and positive load outlook as we drive economic development within our service territory. While our FFO to debt was 11.4% this quarter, we expect that this metric will improve materially by year-end and fall within the targeted rate of 14% to 15% in early 2024. Chuck will also touch on the short path to this balance sheet target. We continue to make progress in our efforts to simplify and derisk our portfolio. In August, we announced the completion of the sale of our 1,365 megawatt unregulated renewables portfolio to IRG acquisition Holdings, which resulted in after-tax proceeds totaling $1.2 billion. A summary of this sale can be seen on Slide 7. We've also made headway on some of our other asset sales that we previously discussed. A summary of this can be referenced on Slide 8. In May, we announced the sale of our New Mexico renewable development solar portfolio, also known as NMRD. The book value of AP's investment as of September 30 was $119 million. We're currently on track with our 550 joint venture partner, PNM Resources, as we target to close on this transaction in the late fourth quarter of this year or early first quarter of next. We expect to continue the noncore business sales processes we have underway as we enter 2024. The sales of our retail and distributed resources businesses were launched in August with book value of $244 million and $353 million, respectively, as of the end of the third quarter. We expect to reach a sale agreement in the first quarter of next year with an anticipated closing in the first half of 2024. In July, we announced the sales of Prairie Wind transmission and Pioneer Transmission, our noncore transmission joint ventures, as of the end of the third quarter, AEP's portion of rate base associated with these investments was $107 million. We expect to launch the sales process soon and close in 2024. Finally related to , while there are no new updates for now. We anticipate completing the strategic review by the end of this year. So please stay tuned. AEP portion of rate base for this particular investment joint venture was $348 million as of quarter end. Let me shift gears and provide you with an update on our regulated renewables investment plan. The teams remain focused and made solid progress. As you know, we have $8.6 billion of regulated renewables in our 5-year capital plan. We now have a total of $6 billion of the investment plan approved and an additional $800 million currently before commissions for approval with each of these projects providing valuable fuel savings for our customers. More detail on our renewable resource additions can be viewed in the appendix on Slides 32 through 34. As we've previously disclosed, both PSO's 995.5-megawatt renewable portfolio for $2.5 billion and SWEPCO's 999-megawatt renewable portfolio over $2.2 billion were approved earlier this year. At a collective $4.7 billion, these two portfolios alone comprise a large component of the approved $6 billion amount I just mentioned. Additionally, in APCo service territory, we're also pleased to report a positive development. In September, Virginia approved 143 megawatts of owned wind for more than $400 million, building upon APCo's existing 29 megawatts of wind and solar projects that were approved last year, which totaled approximately $500 million. Moving across our service territory to I&M, we filed to seek approval for recovery of two investment -- of investment in two owned solar projects totaling 469 megawatts, which represents $1 billion of total investment. We're making progress on this front as we received commission approval last month in Indiana for both the 224-megawatt May Apple and 245-megawatt Lake Trout solar projects. In Michigan the Commission approved May Apple back in August, and we'll decide on Lake Trout in the first quarter of next year. We also await a commission order expected any time now for the 154-megawatt rock balls wind farm at PSO for approximately $150 million. Importantly, our regulated renewables plants are aligned with and supported by our integrated resource plans. We have issued a request for proposals for additional owned resources at APCo and IM with more to come from other operating companies in the near future as we listen and learn and respond to state preferences. Now I'd like to turn to updates on our ongoing regulatory and legislative initiatives. We've been engaged in efforts across our service territory to close the authorized versus earned ROE gap. Our third quarter ROE came in at 8.7%, driven in part by the unfavorable weather in the first half of 2023 that I mentioned earlier, which depressed this measure by 40 basis points. While this is a modest improvement over the last quarter, we are aware that more can be done and more needs to be done on this front. Closing the gap will remain a primary focus into 2024 as we take federal state and customer preferences top of mind, along with meeting the needs of our communities. We remain focused on reducing the gap going into year-end, while still meeting our earnings guidance. To that end, I'm happy to confirm that we have settlement in place for APCo Virginia's 2020 to 2022 triennial and APO Ohio's ESP5, both cases which were filed earlier this year. we're awaiting commission decisions in these states and Virginia's orders expected in the fourth quarter of this year and Ohio will likely be issued in the first quarter of 2024. In addition, we filed new base cases in Indiana and Michigan in the third quarter. Both filings we requested -- in both on we requested a 10.5% ROE and taste drivers included distribution investment in technology, enhanced reliability and grid modernization using 2024 forecast and test years. We anticipate the new rates will be an effective next year. The team has been active on the legislative front in Texas -- with Texas legislation pass and June allowing utilities to file the distribution cost recovery factor mechanism or DCRF twice per year, sit of once per year. This legislation also allows the DCRF mechanism to be used by utility, even if it has a pending rate case for seating underway. Consequently, the legislation will help improve AEP's regulatory lag in Texas to the tune of approximately 50 basis points and earned ROE starting in 2024. In fact, our April 2023 DCRF filing was approved and rates went into effect in September. For Kentucky Power, our June 2023 based base application incorporated the comprehensive rate review, a 9.9% ROE and a request to allow for the securitization of $471 million of regulatory assets, ensuring Kentucky Power is best positioned to provide safe and reliable service while managing costs. Constructive intervener testimony was filed in October, including support for securitization. By statute, implementation of interim rates is permissible in January 2024. Moving to PSO, you'll recall that in May, we reached a settlement with the commission staff, the attorney general and other parties in Oklahoma's PSO base case, which included a 9.5% ROE and provided for approval for more efficient cost recovery mechanisms. We implemented interim rates in June while we await a commission order, which is expected any time now. As you know, the management of fuel cost recovery is a top priority with AP's deferred fuel balance across our vertically integrated utilities shrinking sequentially and totaling $1.2 billion as of the end of the third quarter of this year. We have worked with stakeholders to intentionally adapt our fuel cost recovery mechanisms across our jurisdictions with the objective being to balance cost recovery with customer impact. So West Virginia fuel proceeding is approaching resolution. Recall in our April 2023 fuel recovery application, we filed two options for consideration. One option amortizes the fuel balance over 3 years. In the second option, we have respectively set forth for the West Virginia Commission consideration, the use of the 2023 securitization legislation to manage our $553 million deferred fuel balance along with securitizing store cost balances and net plant balances of generation assets. The generation assets are currently embedded in rate and assume to operate through 2040 and securitizing those assets nearly fully offset the fuel cost recovery impacts to customers. We appreciate the engagement with all the stakeholder parties as we work toward a conclusion in this case by year-end and a constructive path for West Virginia. More detail on regulated activities can be found in the appendix on Slides 35 through 38. I'm pleased with the progress we've made this quarter and by the great work underway to actively manage the business, deliver on our commitments and create value for our investors, all while keeping affordability and reliability for our customers at the center of everything we do. We have a strong team in place, and I'm confident that we'll continue to execute on our strategic priorities and advance our capital investment plan to deliver reliable, affordable power to our customers. I look forward to seeing many of you in person at the EEI Conference in a couple of weeks. At the conference in Phoenix will provide some additional color on our business strategy, share our 2024 guidance and other financial details, including our 2024 through 2028 capital plan and related 5-year cash flows. Now with that, I'll hand it off to Chuck, we'll walk through performance drivers and details supporting our financial targets. Chuck?"
},
{
"speaker": "Charles Zebula",
"text": "Thank you, Julie. It's good to be with you and everyone on the call this morning. As many of you know, I've been in many different roles at AP, but this is my first earnings call as the CFO. I'm truly honored to return to the exceptional finance team at AEP and lead this area as we embrace the opportunity to invest in our regulated utilities and serve our customers with affordable and reliable electric service. Today, I will discuss our third quarter and year-to-date results. share some updates on our service territory load and economy and finish with commentary on credit metrics and liquidity as well as confirming our guidance financial targets and a recap of our commitments to stakeholders. Let's go to Slide 9, which shows the comparison of GAAP to operating earnings GAAP earnings for the third quarter were $1.83 per share compared to $1.33 per share in 2022. Year-to-date GAAP earnings through September were $3.62 per share compared to $3.76 per share in 2022. As was mentioned on the second quarter earnings call, our year-to-date comparison of GAAP to operating earnings reflects the loss on the sale of the contracted renewables business as a nonoperating cost as well as an adjustment to true-up costs related to the terminated Kentucky transaction. In addition, we have reflected our typical mark-to-market adjustment and the impact of capitalized incentive compensation in Texas as nonoperating earnings as well. There's a detailed reconciliation of GAAP to operating earnings on Pages 17 and 18 of the presentation today. Moving to Slide 10. Operating earnings for the third quarter totaled $1.77 per share or $924 million compared to $1.62 per share or $831 million last year. The higher performance compared to last year was primarily driven by favorable rate changes and transmission project execution, increased retail load and favorable O&M across our segments. Operating earnings for vertically integrated utilities were $1 per share, up $0.03 from last year. Favorable drivers included rate changes across multiple jurisdictions, increases in retail load, depreciation, transmission revenue and O&M. These items were somewhat offset by higher interest expense and unfavorable weather year-over-year. the vertically integrated segment did see positive weather versus normal in the third quarter of about $0.04 per share, but this was compared to positive weather in the third quarter last year of about $0.06 per share. Consistent with our first and second quarter results, depreciation was favorable at the vertically integrated segment by $0.01 in quarter 3, primarily due to the expiration of the Rockport Unit 2 lease in December 2022. However, if we exclude the impact of the lease depreciation would have been about $0.02 unfavorable, which is consistent with incremental investment activity in our vertically integrated segment. INM should see an additional $0.02 favorable net depreciation in the fourth quarter as well. The Transmission & Distribution Utility segment earned $0.39 per share, up $0.07 compared to last year. Favorable drivers in this segment included increased retail load, transmission revenue, positive rate changes in Texas and Ohio and favorable O&M Partially offsetting these favorable items were higher depreciation and higher interest expense. The AEP Transmission Holdco segment contributed $0.39 per share, up $0.06 compared to last year. Favorable investment growth of $0.02, coupled with favorable income taxes of $0.02 are largely driving the change here. Generation and Marketing produced $0.18 per share, up $0.04 from last year. The positive variance is primarily due to favorable impacts associated with the contracted renewable sale in August, along with higher generation margins and land sales. These favorable items were partially offset by lower retail and wholesale power margins. Finally, Corporate and Other was down $0.05 per share, driven by unfavorable interest and partially offset by favorable O&M. Please note that our year-to-date operating earnings performance by segment is shown on Slide 16 in the appendix of our presentation today. Many of the positive drivers are the same for the year as for the quarter, and the negative year-to-date variance is driven largely by unfavorable weather and higher interest expenses. Before we move on, I want to add a few more comments on O&M, including our outlook for the remainder of the year. We saw favorable O&M in the third quarter compared to the prior year, which was consistent with our expectations. For the fourth quarter, we are expecting more than $100 million of favorable O&M versus the prior year, which would bring us to a net favorable position for the full year from a consolidated perspective. The favorable change anticipated in the fourth quarter is largely a result of the timing of O&M spending in the prior year, including employee-related expenses and a contribution to the AEP Foundation in the fourth quarter of last year, along with continued actions we have taken, such as holding employment positions open, reducing travel and adjusting the timing of discretionary spending. Turning to Slide 11. I will provide an update on whether normalized low performance for the quarter and our expectations through the end of the year. Overall, load has come in ahead of plan all year, and the third quarter was no exception. Looking to the bottom right-hand quadrant. Normalized retail load grew 2.1% in Q3 from a year earlier. You also noticed that we have updated our full year 2023 estimates based on the strong loan growth we've experienced year-to-date. Weather normalized retail load is now expected to finish this year 2.3% higher than 2022, an increase that is nearly 3x higher than our original expectations. This strength comes from exceptional growth in commercial load driven by data centers in Ohio, Texas and Indiana, but the third quarter also saw positive trends in our residential class, which is shown in the upper left-hand quadrant of the slide. Residential load increased for the first time in more than a year in Q3 with growth of 0.6% from a year earlier. The relationship between customer incomes and inflation is a key driver of residential usage and has begun to stabilize as expected in the second half of this year. This month's CPI data point was yet another encouraging sign that inflationary pressures on our residential customers are continuing to lessen. We note that residential usage per customer have seen slight declines this year as energy efficiencies increase, more workers return to offices and customers change behavior due to inflation. Fortunately, we are seeing strong enough growth in our customer base, especially in Texas and Ohio to help partially offset these trends. Year-to-date, we have added nearly 30,000 residential customers across our footprint. Moving to the lower left-hand quadrant of the slide, our investor load declined in the third quarter, driven by a pullback in usage by some of our key manufacturing customers. namely chemical, plastic and tire producers as well as downstream participants of the energy industry. This reflects some of the softness in manufacturing nationally as producers have slowed activity in response to uncertainty around the economic outlook. We expect this to reverse itself in the months ahead as recent inflation and jobs data have reduced the probability of a recession occurring in the next year. We are forecasting industrial load to remain positive through the end of next year and beyond. Moving to the upper right-hand quadrant of the slide, we see another impressive quarter for commercial load. In the third quarter, commercial load was 7.5% higher than a year ago, driven by the addition of new data center customers, mostly in Ohio, Texas and Indiana. We expect the pace of year-over-year growth in our commercial load to moderate some in 2024 as new projects work their way through the queue. Many of the large projects currently underway within our footprint won't come fully online until 2025. However, there is upside if a few of these projects move forward earlier than expected. Many of these gains are directly attributable to our ongoing efforts to facilitate more economic development across our operating footprint. We know that working with local stakeholders to attract more economic activity is a key strategy to providing value to the communities we serve. It allows us to prioritize investments that improve the customer experience while also mitigating rate impacts on our customer base. Moving to Slide 12. In the lower left corner, you can see our FFO to debt metric stands at 11.4%, which is an increase of 30 basis points from last quarter but continues to be well below our targeted range of 14% to 15%. The primary reason for the increase is a $1.8 billion decrease in debt during the quarter due to long and short-term debt retirements, driven by proceeds received from our contracted renewable sale and the successful completion of our planned equity units conversion, both of which occurred in August. We expect this metric will continue to improve throughout the remainder of this year and anticipate reaching our targeted range in early next year as we see an improvement in FFO during that time. We have included a table on the slide that shows the path to the targeted FFO to debt range early next year. These items -- these are items that impact both the 12-month rolling average as well as an estimated increase in the quarterly FFO. We anticipate a 180 to 190 basis point positive impact on FFO that enables the metric to be in the 13% to 14% range by year-end based on the following items: a roll-off of roughly $600 million in cash collateral, deferred fuel and other outflows from the fourth quarter of 2022 and continued cash recovery of deferred fuel balances in the fourth quarter of this year that total between $150 million and $200 million in accordance with the regulatory orders we have already received. Moving into 2024, the continued roll-off of prior year cash collateral outfall in the amount of $390 million in the first quarter of 2023 and a $90 million adjustment from unfavorable weather in the first quarter of this year to normal weather in our forecast for next year, will result in an incremental 100 basis point improvement put us within our target range of 14% to 15%. Also, please note that we have updated our 2023 cash flow, as shown on Page 29 in the appendix. An increase of $1.2 billion in required capital is shown versus the original forecast, mostly due to a decrease of $800 million in cash from ops largely due to fuel inventory and an increase of $300 million in capital expenditures. Please note that our equity needs for 2023 are unchanged. The remaining years 2024 to 2027, along with rebilling 2028, will be updated at the upcoming EEI conference. Expect that this update will be consistent with our prior equity meetings and disclosures. Moving to Slide 13. You can see our liquidity summary in the middle of the slide. Our 5-year $4 billion bank revolver and our 2-year $1 billion revolving credit facility to support our liquidity position, which remains strong at $3.5 billion. On a GAAP basis, our debt to cap decreased from the prior quarter by 220 basis points to 62.4%. This large change can be attributed to the large reduction in debt, driven by our contracted renewable sale and the completion of our planned equity units that I mentioned earlier. On the qualified pension front, our funding status decreased 1.9% during the quarter to 100.3%. This is largely due to equity and fixed income losses in the third quarter as interest rates increased and equity indices fell in both August and September. These losses are partially offset by a decreased liability due to rising interest rates. Let's go to Slide 14 for a quick recap of today's message. The third quarter produced growth in earnings well above the prior year, driven primarily by favorable rate changes, increased load and favorable O&M offsetting milder weather and increased interest expense. As we continue to move through the fourth quarter, we are focused on cost management efforts with the goal of mitigating the headwinds we have faced this year, primarily unfavorable weather and higher interest costs. The strong third quarter results and low growth, coupled with our proactive plan for the balance of the year, allow us to confidently narrow our operating guidance range to $5.24 to $5.34 per share. We also continue to be committed to our long-term growth rate of 6% to 7%. And as Julie mentioned earlier, our sales efforts to simplify and derisk the AEP portfolio remain on track. We really appreciate your time and our management team and I look forward to seeing you at the upcoming EEI Financial Conference in Phoenix. With that, I'm going to ask the operator to open the call so we can hear your questions or comments."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Your first question comes from the line of Nick Campanella with Barclays."
},
{
"speaker": "Nicholas Campanella",
"text": "And congrats, Chuck on the new role. I wanted to actually start there, if I can. I know that there was just some language in the 8-K when you made the executive switch around the mandatory retirement age, in your interest in retiring before you reach that age. But I just wanted to ask, are your intentions here to stay on to the foreseeable future? Is this more temporary? Just how should we kind of think about your new role in company."
},
{
"speaker": "Charles Zebula",
"text": "Yes. No, thank you for the question. And look, I am absolutely embracing this opportunity that we have before us. It's very energizing to enter into a role like this. And although -- the AK did indicate that I'm committed to Julie and AEP to write this out as long as needed. And as long as I'm adding value right to the opportunity. So thank you for the question."
},
{
"speaker": "Nicholas Campanella",
"text": "I appreciate the answer. And then I appreciate the walk on the FFO. That's helpful. I just wanted to confirm because S&P did move you to negative outlook. And I think in your prepared remarks, you said as you get to EEI, you anticipate equity needs being somewhat unchanged. So is it the right understanding that if you are in a CapEx rate scenario that your equity needs to still be modest and unchanged versus your prior view? And then secondly, understanding that the 11.4% has some reduction in debt from the renewable proceeds. The cash flow from those renewal proceeds, I guess, would be rolling off into next year. And I just want to triple check, that even with the asset sales, cash flow dilution, you still see yourselves above 14%."
},
{
"speaker": "Charles Zebula",
"text": "Yes. Yes, thanks for both questions. So yes, our equity needs will be consistent, right, with what we have disclosed prior. I mean, clearly, we'll be updating, right, the years in the cash flow forecast, but expect no surprises there. . On to your second question, yes, we tried to highlight right, on the slide, the FFO slide, the major drivers that you can point to and see what is rolling out as outflow. But absolutely, right, in our financial models, right? It takes into account, right, the absence of that cash flow. So we do expect to be in those ranges."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "We've seen a bit of a regime change as it relates to interest rates out there, given the sharp moves recently. Just wondering if you could talk a bit more about that and how AP is able to affirm the 6% to 7% long-term CAGR there in what could be higher for longer interest rate environment? What impact do you see on EPS 2023? And kind of how do you think about offsetting those headwinds?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. Joe, thank you for the question. I mean, look, we'll be giving you a walk right on 2024 at EEI. But there's no question that we are planning for an interest rate higher for longer environment. We've clearly been able to overcome those headwinds this year, but they will persist. So our plan is to, a, sensibly finance this company, right, continue to remain committed to mid-grade investment-grade credit. And our recovery mechanisms on interest rates, some of them are somewhat immediate or very near term, right? Some of them are kind of medium term and then some of them do have some lag associated with them. So the reality is some of this will begin to flow through. We remain committed to keeping parent debt in that range, well below 25%, 19% to 21% is ideal and offsetting those headwinds like with continued investment, we're seeing strong loan growth and the positive regulatory outcomes and closing the ROE gap that Julie just mentioned."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful there. Maybe kind of picking up on that last point there. I think on the last call, we discussed a bit -- or there's some questions regarding outreach to commissions and just building regulatory relationships across the jurisdictions. I'm just wondering if you can provide a bit more detail, I guess, on specific initiatives done so far, where do you see that going? How you see that kind of transpiring so far?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. Nick, thanks for the question. This is Julie. We continue on with that effort. In terms of engagement with our various state commissions as well as talking with folks at the FERC level. it's important to note that we do this in conjunction with our operating company presidents and leadership there. And my objective and your senior leadership team's objective is to clear the path operating company presidents and those teams so that they can have a very good traction with their respective commissions and their respective economies in the state. So those continue to occur. And honestly, just keeps me educated so that I can make sure that when we build the strategic plan at the aggregate level that it makes sense, and we're taking into consideration our customers' needs and also the economies that are driving all this magic that's happening across our entire footprint. So it continues as she goes in terms of those conversations, and we'll continue to stay out in front of folks and do our best to support our operating companies. So nothing super exciting to report other than the action is absolutely happening, and we'll see that embedded in the cases that we're filing."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. And just to confirm, the plan is still for you to meet each of the commissions when you're able to do so?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. Honestly, I enjoyed getting out anyway and talking with everybody. Like I said, I think it makes me better at my job. I'm making the round. And I got to be sensitive to what we've got going on in our respective jurisdictions. In some cases, I've got export issues I got to be sensitive to. But I'm absolutely making the rounds, and we'll continue to do that because the business is incredibly dynamic more so than ever. And we need to make sure that we're staying in touch with everything that's going on across the entire organization. So that will continue on."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful. And just the last one, if I could. The waterfall chart through 9 months in the presentation today, it was a bit different than, I guess, what we saw on EEI. Just wondering if you could walk us through some of the puts and takes, the drivers to this, and across the different segments and what do you see, I guess, in the fourth quarter that maybe narrows the gap or just kind of the different trends happening such as in vertically integrated with renewables as well?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. So I'll start and I'll hand it off the Chuck. So what gives us comfort in terms of narrowing the guidance range when you -- I look at Page 16, I sum that's where everybody is right now in terms of that waterfall chart. So what gives us a comfort is Chuck mentioned that we are able to effectively, I guess, take our low forecast predominantly driven by the commercial load that we're seeing. So that's going to be incorporated into our thoughts for the remainder of the year. We're trying to manage the interest expense that's also incredibly important. Another data point to throw out there. No question we keep getting is -- what percentage of your debt outstanding is floating rate is about 12.5%, if I remember correctly, as of the end of the third quarter. So that's something that we're being remindful of. We're also thinking about what regulatory cases that we have already in hand. As a matter of fact, you may recall that when we began the year, we had something like $290 million of new rate release embedded in our forecast. Actually well north of that. We're at about $303 million of secured rate relief in hand. So that gives us a little more confidence and comfort to as we proceed through the end of the year. So again, it's really just steady as she goes and plug in Chuck. I don't know, Chuck, had anything else you want to add to that?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. Sure, Julie. Look, the other thing is the O&M Management. As I mentioned during my comments, if you look at Slide 16, right, you'll see that O&M is a drag two through three quarters, right? We expect that to completely reverse itself for year-end and actually have a net positive on O&M year-over-year, meaning that the fourth quarter will have a substantial difference in O&M versus last year."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Shahriar Purreza with Guggenheim Partners."
},
{
"speaker": "Jamieson Ward",
"text": "It's Jamieson Ward on for Shar. Looking at your new FFO to debt pass side, could you give us a sense on what if anything could cause any potential slippage like the deferred fuel recovery? And what might dictate you being at the bottom or the top end of that 14% to 15% in 2024? I know you talked previously about being at the midpoint by the end of the year. But since we've got an updated disclosure here, I just wanted to ask that again here."
},
{
"speaker": "Charles Zebula",
"text": "Yes. No, sure. When you look at the chart, several of these are just simply facts, right, that are going to come out. All the outflows, right, are no numbers, right, that are rolling out of the 12-month average. So then we're just subject to the normal variances. In FFO that would occur. It's a preworking capital number. And the reality is, right, softer weather, better weather, all those things will influence it. But I think we'll be solidly in both ranges, right, by the time frames that we talked about. ."
},
{
"speaker": "Jamieson Ward",
"text": "Got it. And one more from us. On load growth, what's driving the large -- I know you mentioned data centers, but -- if you could just talk a bit more about what's driving the large increase for the guidance this year? And then more specifically, as we think about the updated capital plan, which you'll be providing, just directionally, should we expect this higher load growth to be a driver of capital growth opportunities?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. This is Julie. I'll pass off the Chuck here to we'll take him a little bit. But as Chuck mentioned, the primary driver for our loan growth as we go into the end of 2023 is all around that commercial segment. So if you look at Page #11, look in that upper right-hand quadrant, you're going to see a serious or material shift in what our updated guidance looks like versus what we originally had for 2023. The vast majority of that loan growth is coming from data centers located in Ohio, Texas and also in the [indiscernible]. And if you look across the rest of the segments there. So residential, a little soft. We talked a little bit about at the beginning of the call here on our monologue our prepared remarks about the fact that customers are feeling this in the wallet as it relates to inflation, et cetera. We expect that that's going to improve over time. But nevertheless, what's allowing us to get a little more comfort the residential side is we've added 30,000 customers year-to-date. So that offset a lot of the otherwise pressure we would have seen in that segment as usage for customers come off a little bit. And on the industrial side, it's really driven by interest rates. And the expectation, I guess, concerns that there could be some softening in the economy. So we've seen certain customer segments within that industrial aspect kind of come off a little bit. But we expect over time that will improve I don't know Chuck, is there anything else to come on hand?"
},
{
"speaker": "Charles Zebula",
"text": "You mentioned that the drive your capital forecast. And of course, the new data centers, of course, require capital to hook those customers up. We do have what is known and customers that are coming into our capital forecast going forward. And there are lots of discussions otherwise, right, in our economic development activities. But everything that we know of and its firm is in our capital forecast."
},
{
"speaker": "Jamieson Ward",
"text": "Got you. Just one clarifying -- one last clariffying question. So question is really focused around that 7.3% guidance for '23 for commercial versus the 80 basis points originally, Presumably, the infrastructure necessary for those data centers to be receiving a load that they are in place, especially extremely about a couple months left in the year. And we obviously saw that you'll be providing '24 and '25 guidance on the EEI. So we're just directionally trying to think, is this a trend likely? Is this isolated to '23? Or is this something that could continue and could drive, therefore, capital opportunities as you look to sort of about increasing commercial data center load and then that's it for me."
},
{
"speaker": "Julia Sloat",
"text": "No, I appreciate the question so much. Yes. That trend, we expect that to continue. I mean you see the fluctuation a little bit in the commercial segment up in the upper right quadrant that slide I mentioned earlier. We have projects in the Q so you kind of see those ebb and flow, but you're right the infrastructure is in place today the pending or incoming request for additional capacity from our customers. So that customer touch point or our economic development team is incredibly important because that allows us to not only have confidence around what our forecast is, but it also drives what the CapEx program needs to be. yes, we think that, that's going to continue, and we will keep a keen eye on that in particular because the infrastructure gotten be there. We got to make sure that we're communicating with our customers that they know exactly what the appropriate and realistic time line is for them to enter into our service territory so that the infrastructure is there because it's not something that's done overnight. So I appreciate that question so much because it is a fine orchestration that absolutely has to happen. ."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Carly Davenport with Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"text": "Maybe to start, as we just think about the moving pieces on cash sources going forward, could you talk a little bit about how the asset sales processes are progressing in terms of interest that you're seeing but ask. And then on the timing side, it seems like a little bit of a narrowing of the time frame for NMRD. But anything else on the timing side that you highlight?"
},
{
"speaker": "Julia Sloat",
"text": "Yes, I can start in Chuck and jump here too because tucking really close to the optimization that we've been doing. Anyway, yes, so from an MRB perspective, we're getting close here. So I would anticipate a contract being signed in a not-too-distant future and isn't really going to be a story around when can you close? So that can be driven also by our regulatory and won't probably get FERC approval depending on who the purchaser is that can drive other issues that we'll need to address. So we can give you a more precise time on when we can land that jet. So stay tuned, that ones in the hopper and coming along here relatively quickly. And then Chuck, do you want to talk little bit about retail and distributed?"
},
{
"speaker": "Charles Zebula",
"text": "Yes, you did ask a question, I do want to address, right, what's the data asking, of course, we're not going to reveal anything like that in a public forum, but we are pleased with the response we received in some of the early results. that are indicative of course, but the process kind of goes on. Greg Hall and his team are leading that effort. There are in the queue remaining this year the typical process of management meetings and moving on to final bids either late this year or early next year. So the reality is, right, that's going to take some time to progress. I expect to complete that in the first half of next year. and the other sales processes are just shortly behind that."
},
{
"speaker": "Carly Davenport",
"text": "Great. That's helpful. And then I appreciate the color on the drivers on O&M heading into 4Q and for the full year. I guess how are you thinking about managing O&M into 2024? Should we expect to see an uptick that kind of offset some of the efficiencies that you've driven this year that have addressed the mode weather and allow you to continue to execute on the earnings guidance for 2023?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. So that's a good question. I can tell you what the discussion amongst the executive leadership team here are really focused on prioritizing O&M spend and spending both capital and O&M dollars that benefit and provide value to our customers. So we're really targeting the prioritization. We'll be giving guidance on O&M for next year in our waterfall at EEI, but expect us to be conservative, right? We're going to manage O&M to the levels, right, that are needed to run our business, right, but begin to eliminate things that are what we may consider to be discretionary going forward. ."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of David Arcaro with Morgan Stanley."
},
{
"speaker": "David Arcaro",
"text": "I think thanks again for the disclosure around the [indiscernible] into the first quarter of 2021, and you've touched on this a little bit, but I was just wondering how you see that metric track after that point from getting to the range as a stable to rising from there and kind of staying within the target range going forward when you look at the core business outlook?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. We absolutely plan to target and be in that 14% to 15% range. I will tell you that the introduction of large projects on a year-to-year basis, right, may swing that around some. So as you add renewable projects, in particular, if they come at the end of the calendar year, right? You have the financing costs related to that, but you don't have the FFO. The rating agencies are very well of that pattern. But absolutely, when you pro forma that, right, 14% to 15% is where we intend to be."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Anthony Crowdell with Mizuho."
},
{
"speaker": "Anthony Crowdell",
"text": "Welcome back, Chuck. Great to hear from you again. Just only two quick ones. I think Nick touched on it earlier on recent S&P had revised their outlook on the holding company. I'm just curious I guess your discussions with the rating agencies. We appreciate the detail you provided in the slide deck specially on your credit improvement. But have you been in discussion how you unveil that previously to S&P prior to their rating to or their outlook change?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. So Anthony, I talked to all three rating agencies since it's coming in and as well as our treasury team obviously talks to them all the time. I don't think the S&P move to negative outlook was a particular surprise, given the downgrade threshold and are rating a split, right? They're at a higher rating, right, than Moody's and Fitch currently. So it wasn't a surprise. We continue to work with the agencies to explain our business risk because we think as we continue to execute on exiting the unregulated businesses, our business makes sure to improve. And they should begin to reflect that in their evaluations. So not a surprise. If and when it is downgraded, their ratings would be on par with Moody's and Fitch. ."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. And then just lastly, you laid out the two scenarios regarding West Virginia fuel cost recovery. One is an amortization over 2 years. The other one is the securitization, which also includes accelerating coal plant closures, Given, I guess, the impact of the balance sheet and all the other moving pieces, does the company have a preferred path in West Virginia? And then also, when do we get resolution on that from the regulator?"
},
{
"speaker": "Julia Sloat",
"text": "Yes, I appreciate that question. And let me just clarify the question as well right out of the gate here. To the extent that we've included securitization as an option, that does not assume an acceleration of coal plant closures, just to be very clear on that. We have those embedded in rates today going through 2040. So that is the current plan of thinking. So the idea of using securitization was entirely driven by how do we minimize the impact on customer rates. Period. And so that was the spirit of why we even contemplated the utilization of the securitization. And that second scenario option that I mentioned where we not only securitize the fuel, but we have, I think, a little bit of storm cost in there as well as those plant balances would effectively render customer rates neutral. So no impact, okay, de minimis. And then the other alternative was just a 3-year smoothing of those deferrals -- or those deferred costs. And that was to the two, I want to say it was maybe 12% increase in customer rates associated with that subject to check. So as far as our preference would be, our preference is to get it recover. Our preference is to be able to work with all the different stakeholders, which is precisely why we put out the different options and listen to the different stakeholders in the case just with complete appreciation sensitivity to the customers in West Virginia that the general median household income tends to be a bit lower than most definitely the national average, but even across AEP's footprint, it's lower. So we need to be incredibly sensitive to those wallets. As far as preference. Our preference simply is to work with it in the stakeholders and get it done. And as far as when we might be able to get that done, our expectation is that we get that done here in the fourth quarter. So tic tok, any time here, okay?"
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Andrew Weisel with Scotiabank."
},
{
"speaker": "Andrew Weisel",
"text": "Good morning, everybody. Good morning. A lot of information already. So I've only got one less if you can clarify here. I want to ask about the three moving pieces between equity asset sales and CapEx. And I know you're going to talk about this at a couple of weeks, but my question is that if equity needs are generally going to be consistent, how do we think about how you'll finance incremental CapEx? You typically roll forward the CapEx plan, it tends to go up most years. It's currently $40 billion. Does that mean that cash proceeds from these asset sales should help to finance whatever upside there is on the CapEx plan? Or will you have additional equity until the asset sales are announced? How do you think about that bouncing act?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. So I'll let my CFO jump in here. But first things first, we want to have a healthy balance sheet, okay? So dollars come in the door. We're going to make sure that our metrics work. We talked a little bit or a lot about 14% to 15% FFO to debt. We also pay attention to our debt-to-cap ratios, but 14% to 15% is our gating item for us in metric. So we will look to that metric to see where we're shaking out. Dollars will be placed accordingly as we bring those in the dollar associated with sales. As far as equity needs go, as Chuck mentioned, I guess, again, the free study issue goes on average, we're around $700 million, plus or minus any given year to see that in cash flow that we have out here on Page #29. We are going to continue on with a healthy CapEx program. You'll see that extended into 2028 when we talk to you at EEI. But there may be fluctuations like sequentially year-to-year. But I wouldn't anticipate any material shift or change, again, getting item dollars in the door, take care of the balance sheet, and then we'll fund the rest of the regulated business that way. And, Chuck, there anything as you add to that?"
},
{
"speaker": "Charles Zebula",
"text": "No. Julie, I think your answer is -- I really can't add anything. I would just say, embrace the capital opportunity and sensibly and smartly finance."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Great. That's helpful. And if you can just remind us what are the downgrade thresholds for Moody's and Fitch?"
},
{
"speaker": "Julia Sloat",
"text": "13% FFO to debt."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Durgesh Chopra with Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"text": "Chuck will come the forward work with you. Just real quick on the FFO to debt metric. I just want to clarify the 13% to 14% target for end of this year. Are you assuming that Virginia fuel recovery that's resolved?"
},
{
"speaker": "Julia Sloat",
"text": "No. As a matter of fact, what is assumed in that forecast that walk as today is everything that we already have in hand. So West Virginia fuel outcome does not disrupt that path at all. That's prospective for us."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. So okay. So any sort of -- any incremental sort of cash flow bump from that would be accretive to what you show on this slide, right, even for 2014?"
},
{
"speaker": "Julia Sloat",
"text": "That would be helpful, yes."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. Perfect. And then maybe just one quick -- one real quick -- what's the balance the total deferred fuel cost balance that hasn't been covered as of the Q3, I know the $1.4 billion as of Q2? ."
},
{
"speaker": "Julia Sloat",
"text": "Yes. $1.2 billion as of the end of the third quarter, and that's in aggregate across the AEP footprint of fleet of utility companies. ."
},
{
"speaker": "Durgesh Chopra",
"text": "West Virginia roughly like $500 million, correct? ."
},
{
"speaker": "Julia Sloat",
"text": "West Virginia. Yes, West Virginia is what can be specific, $574.8 million. So call it $575 million. We're paying attention to this. So that's why a little bit of detail here. That's important."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "So just coming back to that O&M piece, obviously, you put some comments in the script here. 100 million. Look, I think that's a solid number. I'm just curious, how do you think about that annualizing here and the ability to annualize in those sectors? I get that some of them are kind of discrete in nature here, certain elections. But in an effort to kind of preview a little bit more on that '24 trajectory. I know you made a couple of allusions to it here. Can you perhaps lean in a bit further and describing how you think about what that could do for next year on the cost side?"
},
{
"speaker": "Charles Zebula",
"text": "So we're going to lead into that PEI in about 7 or 8 days or 9 days, whatever it is. But the folks right at the management team, as I said earlier, is really on prioritizing the spend and spending dollars where it matters most to our customers. That's the most important thing we can do in our O&M budget will reflect that."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes. No, I respect that, hence the interest. Okay. One while I'll leave it there. And you mind just on the low side just to clarify it a little bit further here. I mean, obviously, you have an updated load in the near year that is sensitively more robust and you have a backward dated load growth profile here for '24,'25. How do you think about the time line for revisions and the extent of those revisions as you see it today, again, I know this is probably more in the EEI 4Q conversation. But I mean, clearly, we see this kind of revisions across the PJM footprint. How do you think about that? And also maybe how does that tee up with PJM itself here and potential further transmission-oriented opportunities?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. So as you can see, right, the low growth in particular in commercial is pretty robust. Those numbers will be updated when we on the EEI. And as I said earlier, it's embraced the opportunity. This is a good opportunity for us. I think you have to be smart about it and kind of vet out what is real and what is a real load is going to come on. and plan your capital investment profile around that. So lots of activity, lots of discussions. Our economic development team is very busy talking and dealing with the opportunity."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Sophie Karp with KeyBanc."
},
{
"speaker": "Sophie Karp",
"text": "Can you please clarify, you mentioned that you could implement or that it's possible to implement interim rates in Kentucky in January? Do you actually intend to do that? Or how does it take sort of politically it would work out for you there?"
},
{
"speaker": "Julia Sloat",
"text": "Yes. Generally, we try to take advantage of that. So that would be the plan. And of course, we'll stay in close contact with all the stakeholders store case and the commission. And so other than that, just as we have done in say, for example, the PSO that is typical for us if there's an opportunity to implement rates. We go ahead and do that and kind of risk-adjusted in terms of our forecast and understand when cash has been coming the door alters items that are so important as we put the forecast out to you guys and have confidence around that. But short answer is, yes, generally speaking, that, we would expect to put those in place or implement the rates."
},
{
"speaker": "Sophie Karp",
"text": "Got it. And then just a broad question, I guess. Is there any interest to approach state regulators in stake mechanisms to reduce weather volatility impact on your earnings. I know you're not decoupled in most of our jurisdictions. So kind of curious if you like that type of rate mechanisms or would you drive transition time to situation whether doesn't impact you earn that much."
},
{
"speaker": "Julia Sloat",
"text": "Yes. We engage in those conversations. And again, that's more of a stakeholder discussion and see what the temperature and tolerance would be as it relates to not only just out preferences the preferences and tones of other party to the cases. That being said, we did have the coupling hi for a while that is installed by the wayside, but that's something that we have a regular conversation about. So I wouldn't say that we have a push or a thrust towards getting a decoupling in place, but it's absolutely a tool in the toolbag."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. always, IR team will be available to answer any additional questions you may have. Eric, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Thank you. This call will be available for replay beginning today and approximately 2 hours after the completion and will run through until Thursday, November 9, 2023, at 11:59 p.m. Eastern Time. The number to access the replay is 800-770-2030 or 647-362-9199. The company's ID to access the replay is 906-6570. Thank you. Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect your lines."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 2 | 2,023 | 2023-07-27 09:00:00 | Operator: Ladies and gentlemen, thank you for standing by and welcome to the American Electric Power Second Quarter 2023 Conference Call. At this time, all parties are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded. I'd now like to turn the conference over to our host, Vice President of Investor Relations, Ms. Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Brad. Good morning everyone, and welcome to the second quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Ann Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie.
Julie Sloat: Thanks Darcy. Welcome everyone to American Electric Power's second quarter 2023 earnings call. Good to be with everyone this morning. It's a rapid time of change in our industry with new opportunities resulting from federal policy shifts and evolving state and customer priorities. We also continue to navigate a dynamic environment with rising interest rates and supply chain constraints. In short, it's definitely an exciting time to be at AEP as we make significant progress on our important stakeholder commitments and strategic objectives, including delivering on our 2023 operating earnings guidance and 6% to 7% annual operating earnings growth, providing dividend growth in line with earnings, strengthening our balance sheet as we move through the next few quarters, actively managing our portfolio, achieving net-zero by 2045 and central to our purpose, keeping our customer rates affordable. We recently made some organizational adjustments such as the restructuring of our Federal Affairs function, the realignment of our regulatory team, and the refreshment of some of our operating company presidents. These changes will help us to operate more effectively and facilitate our success in this ever-changing environment. As always, we keep the customer at the center of every decision we make. This is why we engage with our federal and state regulators so we know how to best support our operating companies while we balance investor preferences as we grow the business and invest $40 billion over the next five years in new generation resources and our energy delivery infrastructure. This morning, I'll provide a brief overview of our second quarter financial performance before getting into our measured and disciplined approach to simplifying and de-risking our business profile through our portfolio management activities. Related to this, I'll share some updates regarding our unregulated contracted renewables portfolio, retail and distributed resources businesses, and the status of our strategic review of our non-core transmission joint ventures. While we still have a lot of work to do on the regulatory front, I'll conclude by providing insight into the recent successes related to our renewables execution and developments on our regulatory and legislative initiatives as we keep our customers’ needs top of mind. A summary of our second quarter 2023 business highlights and a high level overview of our financial results can be found on Slide 6 of today's presentation. AEP delivered second quarter 2023 operating earnings of $1.13 per share or $582 million compared to $1.20 per share or $618 million last year. The year-over-year decline reflects the timing of higher interest rates in the reversal of last year's second quarter 2022 favorable weather. Today we're pleased to reaffirm our 2023 full year operating earnings guidance range of $5.19 to $5.39 with a $5.29 midpoint and long-term earnings growth rate is 6% to 7%. Given our line of sight at this point in the year, I believe we have the operational flexibility and leverage to pool to ensure that we will deliver on our commitment. Later on, Ann's going to talk or walk through our second quarter of 2023 performance drivers and share some perspectives on our load outlook as we drive economic development within our service territory. She'll also share some details supporting our targeted 14% to 15% FFO to debt range. While our FFO to debt is 11.1% this quarter, our forecasts show material improvement in this metric as we approach year-end and we fully expect to be in our targeted range in early 2024. As we continue to execute on our strategic objectives, we remain focused on simplifying and de-risking our business profile. To that end, you'll recall that in February of this year, we announced a signed agreement with IRG Acquisition Holdings for the sale of our 1,365 megawatt unregulated renewables portfolio. A summary of the renewable sale can be found on Slide 7. In the second quarter, we received FERC 203 approval and clearance from antitrust authorities. The only remaining approval is from the Committee on Foreign Investment in the U.S., which we expect to see receive in the near-term and subsequently close on the sale in August. As we've said, the proceeds from this transaction will be directed to our core regulated businesses and strengthening of our balance sheet. Turning to Slide 8, let's touch on some other asset sales that we have in progress. In May, 2023, we also announced the sale of our New Mexico Renewable Development Solar portfolio, also known as NMRD. We are currently on track with our 50/50 joint venture partner, PNM Resources to close on this transaction by the end of 2023. The sales of our retail and distributed resources businesses are also on schedule to close in the first half of 2024 as previously announced. Please keep in mind that other than the unregulated renewables portfolio proceeds of $1.2 billion, no other sales proceeds are reflected in our five year cash flow outlook. We’ll first obtain the signed sales agreements for NMRD and our retail and distributed resources businesses, and then incorporate the related proceeds into our cash flow outlook. As part of our commitment to portfolio management, I’m pleased to share some additional news with you today. We’re announcing that we’ve completed the strategic review of two of our three non-core transmission joint ventures and have determined that the sale of AEP’s interest in Prairie Wind Transmission and Pioneer Transmission as our preferred path forward. We expect to launch the sales processes soon and we’ll keep you updated on our progress. In the meantime, we continue our strategic review of Transource Energy and expect to complete that review by year end. Now let’s switch gears to AEP’s regulated renewables execution and recent successes. Through our five year $8.6 billion regulated renewables capital plan, we now have a total of $5.2 billion approved and an additional $1.7 billion currently before our commissions for approval. You can find more detail on activities to acquire additional generation resources in the appendix on Slides 31 through 33. In May 2023, the Oklahoma Commission approved PSO’s 995.5 megawatt renewables portfolio for $2.5 billion, which includes three wind and three solar projects. These projects are projected to be in service toward the end of 2025. For SWEPCO’s 999 megawatt renewables portfolio totaling $2.2 billion of investments, I’m happy to report that last month, both the Arkansas and Louisiana Commissions approved the full portfolio containing two wind projects and one solar project. We expect the projects will be going into service by the 2025 timeframe. Since the Texas Commission denied SWEPCO’s application related to these projects, Arkansas will move forward with the 20% of the portfolio total and Louisiana will flex up with 70% giving wholesale customers the remaining 10%. We’re excited to deliver the benefits of lowest reasonable cost and reliable energy to these communities we serve in Arkansas and Louisiana. We’re also currently awaiting for commission decisions expected as early as in the third quarter of 2023 for 151 megawatts of owned wind and energy storage at APCo, 469 megawatts of owned solar at I&M and 154 megawatts of owned wind at PSO. Importantly, our regulated renewables goals are aligned and supported by our integrated resources plans. Accordingly, we’ve issued requests for proposals for generation resources at APCo and I&M with more to come from operating companies soon. I’ll turn now to updates on several of our ongoing regulatory and legislative initiatives. More detail on our regulatory activities can be found in the appendix on Slides 34 through 36. We’re unquestionably focused on closing the gap between our authorized versus earned ROEs. While our second quarter ROE came in at 8.6%, this measure was depressed by 40 basis points due to mild weather. Closing this gap is going to take a little longer than we had anticipated in our 2023 guidance, which you may recall included a 9.4% ROE. But I’m confident that we’ll reduce this gap by year end and still meet our earnings guidance. As we make needed progress in this regard, we are continuing to prioritize federal, state and customer preferences to meet the needs of our communities that we serve. We look forward to building on our constructive relationships with all of our stakeholders and clearing the path for our operating companies to be effective and successful in their respective service territories. In fact, while being mindful of any ex-parte restrictions, I’m personally meeting with many commissioners across AEP’s footprint to engage in discussions about our company and what is top of mind for them in the way of priorities and expectations as we work together to do our best to provide this product that is the fundamental enabler for society. In June 2023, we filed a new base case in Kentucky to address the financial health of the company and established a path for future investment. The application incorporated a comprehensive rate review and a proposed 9.9% ROE with a request to allow for the securitization of $471 million of regulatory assets. This will help to ensure that Kentucky Power is best positioned to provide safe and reliable service, while managing costs to provide affordable service to our customers. We expect that the new rates will be in effect in early 2024. In May 2023, we settled PSO’s base case with the commission staff, attorney general and other parties in Oklahoma providing a path for approval for more efficient cost recovery mechanisms with continuation of the transmission tracker and reestablishment of a distribution tracker. While we await commission – a commission decision expected in the third quarter of 2023, we implemented interim rates starting in early June. For APCo Virginia’s 2022 – 2020 to 2022 triennial filed in March of 2023. We’re working through regulatory – the regulatory calendar and expect an order later this year. And Texas legislation was passed last month, which permits utilities to file the Distribution Cost Recovery Factor or DCRF twice per year instead of once per year. The bill also allows DCRF to be used by a utility even if it has a pending base case review proceeding. This important legislation will help improve AEP’s regulatory lag in Texas, as we make needed distribution investments to bolster the grid in this region. AEPs management of fuel cost recovery remains a top priority with deferred fuel balance at $1.4 billion as of the second quarter 2023. We’ve adapted fuel cost recovery mechanisms across most of our jurisdictions with a focus on balancing customer impact. Notably, we are awaiting a decision on our fuel case in West Virginia. Through this spring we were active at the state legislature and collaborated on a new securitization bill to provide an effective path forward on fuel recovery and other legacy costs while mitigating customer bill impact. In April, 2023, – in our April, 2023 fuel recovery application, we filed two options for consideration, one which amortizes the fuel balance over three years, and alternatively, in an effort to even further minimize cost impacts to customers, we requested West Virginia Commission approval to use securitization to manage our $553 million deferred fuel balance. We also proposed an opportunity within that second option to apply the securitization mechanism to $88 million of deferred storm costs and $1.2 billion of legacy coal plant balances with the intention of offering a solution that would essentially have a neutral impact on customer rate. Keep in mind; securitization is the mechanism we can use to address affordability in West Virginia. While it’s important that we addressed fuel and storm cost recovery in the state, let me be clear that the possible securitization of $1.2 billion for our Amos and Mountaineer coal plant balances is not required to hit our credit metrics, nor does it suggest that there’s a change in our current plant – our current plant retirement schedule of 2040 for these units. Rather, this is entirely driven by the desire to consider all options to mitigate impact to customer bills. The West Virginia Commission subsequently issued a procedural schedule in the fuel case, including the April, 2023 prudence [ph] report, which will be addressed in an evidentiary hearing beginning on September 5. This schedule provides an opportunity to ensure focus on cost concerns and a constructive future in West Virginia balancing customer and financial impacts. Pending the commission’s decision later this year, we could issue bonds to securitize a possible combination of the deferred fuel balance, deferred storm cost, and legacy coal plant balances in the first half of 2024. I’m pleased with the progress we’ve made so far. We still have a lot of work to do as we execute on our plans to meet our commitments, overcome challenges, reach our strategic objectives, engage with stakeholders, and keep customers a top priority. Together we deliver safe, clean, reliable, and affordable energy to our communities while creating value for our investors. With that, Ann will now walk you through our second quarter, 2023 performance drivers and details supporting our financial target. Ann?
Ann Kelly: Thank you, Julie and Darcy. It’s good to be with you all this morning. Thanks for dialing in. I’m going to walk us through our second quarter and year-to-date results, share some updates on our service territory load and finish with commentary on credit metrics and liquidity, as well as some thoughts on our guidance, financial targets and portfolio management activities underway. Let’s go to Slide 9, which shows the comparison of GAAP to operating earnings. GAAP earnings for the second quarter were a $1.01 per share compared to a $1.02 per share in 2022. Year-to-date GAAP earnings through June, were a $1.78 per share compared to $2.43 per share in 2022. In our year-to-date comparison of GAAP to operating earnings, we’ve reflected the expected loss on the sale of the contracted renewables business as a non-operating cost, as well as an adjustment true of cost related to the terminated Kentucky transaction in addition to our typical mark-to-market adjustment. Also due to new legislation in Texas allowing the recovery of incentive compensation, favorable entry was booked in the second quarter to capitalize previously incurred costs, which was almost entirely reflected as non-operating earnings. There is a detailed reconciliation of GAAP to operating earnings on Pages 16 and 17 of the presentation today. Let’s walk through our quarterly operating earnings performance by segment on Slide 10. Operating earnings for the second quarter totaled $1.13 per share or $582 million compared to a $1.20 per share, or $618 million in 2022. The lower performance compared to last year was primarily driven by weather, interest and O&M, partially offset by rate increases in our utility and transmission revenue growth in both our Utilities and the Transmission Holding Company segment. The unfavorable weather was largely due to positive weather we saw in the second quarter of 2022, while weather was mild begin in the second quarter of 2023; the unfavorable impact was less significant in comparison to the first quarter of this year. Interest continues to be unfavorable versus the prior year, and that is primarily driven by higher debt balances as well as the higher interest rates. The higher debt balance also has resulted in an increase in interest expense as compared to our guidance, but we continue to adjust in other areas to offset this impact. Again, we were expecting this variance to be more pronounced in the first half of 2023 as interest rates somewhat stabilized. We also expect the announced sale of our contracted renewables business to close this quarter and the conversion of the $850 million equity units in August to lessen the burden in the second half of the year. Finally, I’d like to note as well that we still expect to see favorable O&M in the second half of the year compared to the prior year, reflecting the timing of O&M spending and near term actions that we are taking to help offset the unfavorable weather, such as holding positions open, reducing travel, and adjusting the timing and of discretionary spending. These actions are in addition to our ongoing efficiency efforts that we target to offset the impact of inflation each year. Operating earnings for our vertically integrated utilities were $0.51 per share, down $0.08. Favorable drivers included rate changes across multiple jurisdictions, depreciation and off-system sales. These items were more than offset by the unfavorable weather interest expense, O&M and lower retail and wholesale load. I will touch on our retail load trends in a couple minutes. Consistent with our first quarter results, depreciation is favorable at the vertically integrated utility segment, primarily due to the expiration of the Rockport Unit 2 lease in December of 2022. I&M should continue to see about $0.055 net favorable depreciation in each of the first three quarters of 2023, plus an additional $0.035 in Q4. Including the impact of the Rockport lease, depreciation was $0.04 favorable in Q2. However, if we exclude the impact of the lease, depreciation would've been about $0.02 unfavorable, which is consistent with the incremental investment in this segment. I also want to mention that the favorable off system sales showing up again in the second quarter is due to the fact that Rockport Unit 2 margins are no longer shared with our retail customers. The Transmission and Distribution Utilities segment earned $0.30 per share, down $0.02 compared to last year. Favorable drivers in this segment including transmission revenue and rate changes largely due to the distribution investment rider in Ohio and the distribution cost recovery factor rider in Texas. Offsetting these favorable items were unfavorable weather, lower retail load, depreciation, O&M and interest. The AEP Transmission Holdco segment contributed $0.38 per share up $0.11 compared to last year. The main drivers here included favorable investment growth and a favorable year-over-year change in the true-up. You'll recall that we had a negative true-up in 2022. Generation & Marketing produced $0.13 per share down $0.05 from last year. The negative variance is primarily due to the development asset sale and other one-time favorable items in 2022 as well as higher interest expense in 2023. These unfavorable items were partially offset by higher retail power margins in 2023. Finally, corporate and other was down $0.03 per share, driven primarily by higher interest expense and O&M. These unfavorable items are partially offset by a favorable change in investment gain and income taxes. The favorable change in investment gain is primarily due to investment loss incurred in the second quarter of 2022. Before we move on to the next slide, to give an update on load, I want to briefly mention that the details of our year-to-date operating earnings performance will be shown in the appendix of supplemental information going forward. You can find these details on Slide 15 of the presentation today. Turning to Slide 11. I'll provide an update on our normalized load performance for the quarter. Overall load continues to come in ahead of budget, but we're closely monitoring key components of our retail sales in the context of the slowing economy, and we are seeing different trends between our retail customer classes. As we discussed last quarter, our projections already assume that economic conditions will slow in the second half of the year. Recent positive economic data on inflation supports that any slowdown will be in line with our previous expectations. Beginning in the upper left hand quadrant of the slide, we see a slowing in our residential load compared to a year ago. Our residential customer counts continue to grow, but we are seeing usage decline as many of our customers return to the office and even more squeezed by the relationship between inflation and income growth. That relationship is a key driver of residential usage and we expect to see it stabilize in the second half of the year. This month's CPI data point was an encouraging sign that inflationary pressures on our residential customers are continuing to lessen into the fall. Moving to the lower left hand quadrant of the slide, we can see a noticeable slowing in the industrial class. So still ahead of year end budget projections, industrial load is beginning to reflect the expected slowdown in the outlook for manufacturing across the country. This slowing has been broad based across industries and operating companies, but would've been even worse without an our ongoing commitment to economic development. We estimate that total industrial load through the quarter would've actually declined by 1.2% if not for growth tied to our economic development efforts. Even with these efforts, however, we do expect industrial load growth to remain subdued due to the tighter financial conditions and slowing levels of demand for finished goods through the end of the year. Offsetting this slowing is a significant boost to our normalized commercial sales that you can see in the upper right corner driven by new large customer volumes from our ongoing economic development efforts. Year-to-date commercial load has grown almost 8% year-over-year in each of the last two quarters. We expect our commercial load to continue to outperform through the end of the year. Thanks to ongoing technology development across our operating footprint. Gains in AEP Texas and AEP Ohio should continue to be especially robust with several new projects scheduled to come online through the end of the year. With the June CPI data, we've now seen a material deceleration in key components of inflation that the economy has been waiting to see. We think this progress on inflation coupled with continued resilience in the labor market dramatically reduces the probability of a severe economic contraction in 2023. Our near and long-term load projections are bolstered by our discipline commitment to economic development across the service area. We know that working with local stakeholders to attract more economic activity is a key strategy to providing value to our customers. This allows us to continue to prioritize investments that will improve customer experience while mitigating the rate impact on our customer base. Great examples of our recent successes are NL and Tulsa and GM and Samsung in Indiana. Both of these economic development wins will not only add load to our industrial segment, but each is also expected to bring more than a 1,000 full-time jobs that will ultimately benefit our residential segment and boost the local economy. Let’s move on to Slide 12 to discuss the company’s capitalization and liquidity position. Taking a look at the upper left quadrant in the page, you can see our FFO to debt metric stands at 11.1%, which is a decrease of 30 basis points from last quarter and continues to be below our target. The primary reason for this decrease is a $1.3 billion increase in debt during the quarter, partially due to long-term debt issuances at the operating company level to support our capital investments and the return of mark-to-market collateral positions associated with decline in natural gas and power prices. Return of collateral reduces our funds from operations, so hits us on both sides of the equation without the fluctuations in our mark-to-market collateral positions over the past 12 months and some remaining impact of deferred fuel, our FFO to debt metric will be closer to 13.7%. We expect that this metric will improve by year end as we reduce debt after the close of the announced renewable sale and our 2020 equity unit conversion and we see the improvement in funds from operations over prior year in the fourth quarter. We remain committed to our targeted FFO to debt range of 14% to 15% and we expect material improvement by the end of 2023 and to achieve our target in early 2024. You can see our liquidity summary in the lower left quadrant of the slide. Our five-year $4 billion bank revolver and two-year $1 billion revolving credit facility support our liquidity position, which remains strong at $3.1 billion. On a GAAP basis, our debt-to-capital ratio increased from the prior quarter by 50 basis points to 64.6%. We plan to reduce this percentage in the third quarter as we eliminate debt when we close our announced contracted renewable sale transaction and complete our previously planned equity unit conversion. On the qualified pension front, our funding status increased during the quarter to 102.2%. The funded status improved due to rising rates during the quarter that decrease the liability while solid equity returns positively impacted plan access. Let’s go to Slide 13 for a quick recap of today’s message. The unfavorable change in weather primarily due to positive effects in the second quarter of 2022 is a significant driver in our quarter-over-quarter earnings comparison. If we removed this effect, we would’ve been $0.05 favorable compared to the prior year and our results were roughly in line with our expectations for the company as a whole. I will note from a year-to-date perspective 2023 weather has been the most mild on record for the AEP system in the past 30 years, resulting in $0.29 EPS impacts year-over-year and about $0.20 versus normal weather. So as we progress through the remainder of the year, we will continue to focus on taking action to mitigate this and other headwinds. Overall, our business remains in a strong position and we are reaffirming our operating earnings guidance of $5.19 to $5.39 per share. We also continue to be committed to our long-term growth rate of 6% to 7%. As Julie previously addressed, we are on track to close the sale of our unregulated contracted renewables portfolio in the third quarter this year, and our retail and distributed resources business in the first half of 2024. We’ve concluded that the sale of our interest in two of our transmission joint ventures, Prairie Wind Transmission and Pioneer Transmission is our preferred path, and we continue a strategic review of our Transource Energy joint venture. These initiatives will help simplify and de-risk our business going forward. We really appreciate your time and attention today and with that and going to ask Brad to open the call, that we can hear what’s on your mind and answer any questions that you have.
Operator: Thank you. [Operator Instructions] Give us just a moment here. And I can go to Shar Pourreza with Guggenheim Partners. Please go ahead.
Shar Pourreza: Hey, good morning guys.
Julie Sloat: Good morning.
Shar Pourreza: Good morning. Just on the credit metrics, obviously, a little bit more slippage this quarter, which you highlighted. I guess can you talk about the pathway to get to that 14% to 15%, a little bit more detail? I think 300 basis points seems like a lot of improvement that’s needed in a short timeframe, being that it’s your early 2024 target. I mean, could we see incremental equity in plan? Is the asset sales enough to get you there? And how important is collecting the unrecovered fuel balance in terms of being able to hit that target, which I guess it still stands around $1.4 billion. Thanks.
Ann Kelly: Yes. Shar, I’ll take that. As we mentioned, the main impact to our FFO to debt is the timing of the collateral payment. So that’s about a 240 basis point impact to our FFO to debt, and so that should resolve itself by year end and result in a noticeable improvement. We also have about a 100 basis points of favorable impact from the proceeds of the contracted renewable sale and the equity unit conversion. So we are, confident that we are going to have measure improvement by the end of the year and be into the range by next year. In our forecast we don’t have any of the securitization in our cash flows. We do have recovery of deferred fuel, but that is not necessary to be able to get into our current range.
Shar Pourreza: Got it. Okay, perfect. And then maybe just a more of a strategic question for Julie. I mean, obviously, AEP is never CapEx constrained, right? I guess how do we sort of think about overall financing, especially given the current interest rate environment and kind of where the stock currently trades? Do you have ongoing; you do have ongoing needs, right? So as we’re thinking about parent leverage and equity are more non-core asset sales out there, or could we actually start to see some more core assets sales to kind of fund the plan and maybe further simplify the story? Thanks
Julie Sloat: Yes, no, Shar. I so appreciate the question. And you’re right, we have a lot of opportunity to put capital to work as it relates to taking care of the customer and delivering reliable, affordable service. But as you point out, we need to make sure that we’re hitting all the metrics too. So not only do you need to be real mindful of where customer rates are going, when we put money to work, I need to make sure that all my earnings growth targets are going to be hit. Because I think you guys would be upset with me if that didn’t happen, so we’ll make sure that happens. But I also need to make sure that my balance sheet’s really strong too. So let me get to your question around asset sales. We’ve really been focused on, as you know, the non-core related activities that when people buy AEP shares or invest in our bonds, they’re not necessarily looking to buy something that is not a traditional regulated utility type business. So to that end, that’s why you see us kind of going through the paces today where we’ve talked about the unregulated components of our business and, while we love transmission even looking at some of these transmission investments of the joint ventures that are off our footprint, because if we can channel all of our efforts and dollars to taking care of our customers that are regulated in our footprint, that’s where we want to play. So, I wouldn’t anticipate, a significant additional activity coming from us for a couple of reasons. I think we’re pretty cleaned up once we get some of this non-core stuff taken care of. I think we’re in a good place. I think that, there may be some opportunities, on the edges, but for the most part we’re – we should be in a really good space to be continuing to look at the regulated pieces of our business. But we also and very candid Shar, we don’t need to engage in asset sales to make the balance sheet work. What we need to do is make sure we’re being as efficient as possible, and that’s another reason why I want to make sure that every dollar we do put to work is one that a, makes sense for our customers, but also is something that makes sense for our service territories. And specifically why I am calling that out is another reason why I’m out talking with folks in our community. So whether its commissioners, customers, et cetera, need to make sure that we’re aligned or at least absolutely aware of one another’s priorities and then we can make refinements based on those conversations. So, I would never say that we’re not at all capital constraints because I think we naturally are because we put our own constraints on because we got to take care of customer rates and make sure that we’re going to have a really strong balance sheet. We’re working on that. As Ann just mentioned, we expect that FFO to debt to look a lot better once we get to year end and going into 2024. I think in the interim here, it’s going to be just a little bumpy as we work through a couple of the next few months. So I wouldn’t be too concerned about that. I feel comfortable with the numbers I’m seeing, but we’ll continue to be very disciplined around, which dollars we put to work where that it’s consistent with what our stakeholders need and want taking care of our customer and then just being as efficient as we can. So my focus is going to be more at this point on let’s close that gap on the ROE. That’s the piece that I can try to do my best to control.
Shar Pourreza: Got it, terrific. And then no, it does. And then we do appreciate some of the salient points you brought up in your prepared remarks as far as the outreach to the regulatory folks and various stakeholders. So thank you for that points.
Julie Sloat: Yep. Thank you for the coverage.
Operator: And next we go to Jeremy Tonet with JPMorgan. Please go ahead.
Jeremy Tonet: Hi, good morning.
Julie Sloat: Good morning.
Jeremy Tonet: I wanted to kind of follow up on some of the points that you were just touching on here because, some of the dockets and local media attention have highlighted some regulatory pushback in certain areas of ablate, and you mentioned, reaching out to local commissioners to build relations there. Just wondering over what timeframe, you expect to kind of meet all of them? Is this a change in regulatory strategy where they hear from headquarters more regularly here? Just wondering how you think about this type of outreach going forward?
Julie Sloat: Oh, Jeremy, I love that question. So I’m going to tell you from my perspective, this is coming from a former operating company president. So I keep that hat kind of in my back pocket that I got to throw on from time to time. And so let me start with this. What my hope to do, well I, what I hope to do or achieve is, pay [ph] the way or clear the path for our operating companies so that they can do the best they can do boots on the ground. And so my objective is to get out, to make sure that I’m talking with different commissioners. And by the way, that’s already underway. So, I’ve already been out talking with several folks and I’ve got my calendar lined up over the next few months to continue to that effort. So I’m not going to get into necessarily exactly who I’m talking to when, but that, that’s well underway. So rest assured that’s happening. But I just, I want to make sure that they’re hearing from me and that they understand that AEP, the parent or the service core is here to provide clearance and service and support for the individual operating companies. Really, that’s the only reason the service core exists, is to support the operating companies. And I need them to hear that from me. And more importantly I just want to be a really good listener so that I can be really good at my job so I can take care of our customers, take care of my team, and then ultimately take care of my investors and the other stakeholders that are party to everything that we're doing here. So I don't want people to think that I'm stepping in the way or thinking that something's not right because that's not the case at all. I just want to make sure that we're doing everything we can to support the teams so that they can be as successful as they possibly can be. Because here's the other point, right. You call out the fact that there are pressure points as it relates to regulatory activities. I think that's going to be what we're dealing with for the next several years. We got a lot of headwinds now. The game's changed, the industry's going through a material transition. Each of our states is in a different place as it relates to their economies. And so I think everybody is doing their jobs and that means we got to do ours too. We have been doing it, but we have to be really good listeners and learners and adjusters. And I think that goes for all the different stakeholders. So the more dialogue we can have, I think the smarter we're going to be and if nothing else that will – we only be able to take care of the customer and make sure we're keeping the lights on and delivering this product that make life possible. But I think we're going to be doing it in a much more effective way, and we're going to have to pick up the pace too. So we got to do it in a faster way than we've ever done it in our history. So I think it's exciting. I love getting out and talking with people. You guys know from The Street, I love getting out and talking with you too, so that's not going to stop. So I just got to work my calendar and I'll be out front and I'm happy to talk about any of the conversations that I've had.
Jeremy Tonet: Got it. That's very helpful. And just one more along these lines, dialing in a little bit more. In Kentucky, our local stakeholder conversations highlight a focus on increased distribution investment as a priority as opposed to the more recent, I guess, transmission investment which could help local stakeholder relations there with a focus on distribution. Just wondering how you see a Kentucky strategy evolving over time here?
Julie Sloat: Yes, I'll tell you, let me start with this. Again, having been a former CFO as well. At 1.6% ROE, yes, we got to work on that. And that to me, when I see that number that's not a financially healthy, sustainably healthy entity so that's why we're going through the case activities. So we're going to work on that and that's exactly why we went out and socialized the case well in advance with dozens of meetings with a variety of different stakeholders. So again, listening and learning so we understand where everybody's kind of shaken out, but also understanding what it is that we need to do so that we're successful, not only in taking care of our customers, but making sure we're doing everything we can to make sure that the stakeholders understand what our objectives are and are comfortable with it. So yes, the objective is to, A, get a plan in place that will allow us to improve the financial positioning of the company, which then enables us to make future investments to take care of the customers, they need the power too. It doesn't matter which state you're sitting in, but the idea is to engage in these activities, hopefully have a really good case. And I don't expect it to be easy. It's not supposed to be easy. If it was easy, everybody would be doing it. So we'll engage in those activities and hopefully get us on a path forward that enables us to continue to invest in a really smart way in the state that everybody can feel good about.
Jeremy Tonet: Got it. So there's room to pivot towards more distribution over transmission. Sounds like you're working with stakeholders there?
Julie Sloat: We, absolutely and so those are the conversations that we're having. We do know that transmission has been very important to the commission. And so that is top of mind for us as well. And we've worked that into the structures that we've essentially set forth in our case. But at the end of the day, it's the distribution that also matters because we got to keep the lights on.
Jeremy Tonet: Got it. I'll leave it there. Thank you very much.
Julie Sloat: You bet. Thank you.
Operator: And next, we'll move to Anthony Crowdell with Mizuho. Please go ahead.
Anthony Crowdell: Hey, good morning. Thanks for taking my question.
Julie Sloat: You bet.
Anthony Crowdell: Just – first off, Slide 12, maybe I've been following it too long, but I think over the last 10 years, the total debt to total capitalization has gone from 53%. Now it sits at 65%. I'm just wondering, does that stabilize or where do you see the sweet spot for total debt to total capitalization?
Ann Kelly: Yes, absolutely. Thanks for the question. So it has inched up, as you can see on the graph. I mean, 60% is our sweet spot and that's what we're targeting going forward. As you can see, we're above that right now. We do expect that to decrease with the contracted renewable sale proceeds and also the equity unit conversion. So that's a couple hundred basis points, that'll reduce that closer to the 60%, but we still have some work to do.
Anthony Crowdell: Great. And then if I stayed on the balance sheet here, I think you've talked about, you've planned to be in a target, and I hope this correct in 2024. If I could get real granular, when do you think you're going to get into the midpoint of your 14% to 15% range? Is that something you'd talk about?
Julie Sloat: Yes, I mean, I would say we're going to be, we say we're going to be in the target in 2024 and I think approaching the midpoint probably by the end of 2024. There are the fluctuations as I mentioned in FFO that we're experiencing. And that's just really due to timing of quarter-over-quarter fund flows. And so, you will see especially in 2023 that it will be press till the fourth quarter when we really see that switch in the collateral collections and improving our FFO there, so that's what's going to take some time. But we do expect it to increase, like I said, materially by the fourth quarter and then into next year. And Anthony, just to put a little finer point on it too, remember, our threshold that we're sensitive to is 13% as it relates to our Baa2 rating from Moody's. And so that's why we toggle to the 14% to 15% because what we want to have is cushion. So 14% definitely gives us some cushion, so keep that in mind as well. And the other thing I mentioned in my comments too is as we proceed through the rest of this year, you can expect maybe a little more pressure as we go through the next couple of months with some improvement as we get to the fourth quarter. Just want to manage those expectations.
Ann Kelly: Yes. The other thing just to highlight is that, we're talking a lot about the timing of collateral payments, but 80% of that volatility that we're seeing relates to our retail business, which as you know, is for sale. So once we sell that business, we would expect that reduction in volatility going forward.
Anthony Crowdell: And then just lastly, Julie, I appreciate all the commentary you've given on the regulatory strategy and especially Kentucky. And I know Kentucky's a very small piece, but when you look at the equalizer chart, I mean the ROE is pretty low. What’s a reasonable assumption for us to use? Where that ROE could go in 20 – by 2024? I mean, does that go to an allowed of 9.9%? I’m just curious, how long does it take to recover the regulated returns of the utility?
Julie Sloat: Yes, Anthony, it’s going to take a while. Do not expect a flash cut. And so remember in our case, we requested a 9.9% ROE, our current authorized is 9.3%. I’m looking at Page number 34 in the slide deck right now. It will be a walk. So that’s something we’re trying to manage our own expectations around as well as for you all, as you work to model. So stay tuned and let this case proceed and see how things move along and then we can continue to kind of dial that in and give you more direct guidance.
Anthony Crowdell: Great. Thanks so much for taking my questions. I really appreciate it.
Julie Sloat: You bet. Thanks for being on the call.
Operator: And we can go to Julien Dumoulin-Smith with Bank of America. Please go ahead.
Julien Dumoulin-Smith: Thank you Julie and team. Good morning. Appreciate it. Maybe to follow-up on some of the last few questions here, if I can. Just as you think about some of these headwinds here with respect to securitization heading into 2024, obviously you down fairly confident, not just in offsetting the weather year today, but in the 2024 items here. Can you talk about some of those tailwinds here or some of the forthcoming offsets? What else gives you the confidence in having that linear trajectory on the 6% to 7% here? If you can speak to that a little bit more. And maybe related to that, can you talk about maybe the timing of some of these items to the extent, which some of those headwinds on securitization bleed into 2025 as well? I don’t want to be too myopic on the next year.
Ann Kelly: Yes. I mean, what I’ll do is I’ll start with kind of addressing the 2023 earnings guidance question. As you look, we’re $0.18 below prior year and we guided to year-over-year for the full year it’s about $0.20 improvement. So that’s $0.38 that we need to outperform last year for the second half of the year. When I look at this, I think it’s helpful to break it down into components. So weather was $0.29 over 2022, about $0.20 of that impact is versus normal. And that’s where we’ve taken some action to offset those headwinds. Interest also is about $0.29 unfavorable year-to-date. It’s running a bit above expectations. We had guided to $0.20, but that also didn’t include interest on Kentucky, because we had expected to sell the business. So that’s about $0.10 per year and that’s covered in revenue. So we had anticipated much of our year-over-year increase to be in the first half of the year because of the timing of the Fed actions. So while we are a little bit short coming into the back half of the year, we also have the proceeds from the contracted renewable sale and equity unit conversion that’ll help reduce our debt somewhat. And we’ve taken other actions to offset the increase in rates because it has been – the Fed has been tightening a little bit longer. When you look at O&M, unfavorable to last year in the first half, but we expect this to reverse due to timing of our O&M spending. Our original guidance planned for reduction of O&M during the second half of the year because last year’s spending was a little bit robust on the O&M side in the back half. And so we had already anticipated a reduction and then we’ve taken additional actions like those that I’ve mentioned to be able to make up for the reduction in weather volumes. And then lastly, there’s a couple other things that we’re pointing to. One is the favorable trends in commercial load that we expect to continue. And then we’ve also seen favorable results in our generation and marketing business that’ll benefit us this year. So, putting that all together that what give us the confidence and our ability to meet our earnings guidance for this year. In terms of maintaining the 6% to 7% EPS growth going forward, it’s really a story on our capital deployment and we have a very robust capital pipeline that allows us to do just that.
Julie Sloat: And Julien, on that note, just to kind of put an end cap on this. I think the core is solid. And so when you look out in the next few years, as Ann mentioned, we got $40 billion we’re put into work in terms of capital investment over the next five years. We’ll continue to work with our regulators to make sure that we’re deploying the dollars where we all agree that they need to go. And then at that point it’s really around making sure that we also execute on not only the regulatory plans that we lay out there, but as you know, we’ve got some strategic asset sales that are underway. So we’ll deal with the fact that some of those businesses are falling away, rechanneling those dollars to the regulated pieces of the business that will help us from the math perspective and making sure that we’re hitting all of those other balance sheet metrics that we need to make sure that we hit, so people aren’t worried or concerned. And we got a little more flexibility. So when we have a weather event or something of that nature, we can easily sustain that. But the core is solid and at this point it’s around being efficient, putting the dollars to work where it makes sense and closing the gap on the ROEs.
Julien Dumoulin-Smith: Got it. All right. Excellent. And then if I could follow-up briefly on a couple details. Just with respect to PSO, obviously dynamic situation with the ALJ and settlement, can you talk a little bit about your expectations here and maybe about what you had been planning in interim rates? Just ultimately what happens, how you’ve been planning, what’s reflected in rates? If you don’t mind a little bit of an update there.
Julie Sloat: Yes. So we implemented interim rates in early June I think it was, as it relates to the settlement that we had put in place. And at this point, as you mentioned, the ALJ had its report that it is submitted and then file – exceptions were filed, I think it was yesterday to the ALJ report. So if you haven’t taken a look at that I would encourage you to take a look at that. But effectively the parties to the settlement agreement were absolutely supportive of the settlement agreement, which we would’ve expected anyway. So we felt good about that. And we’re going to let this thing play out over the next couple of weeks really, because we’re getting pretty close here. Parties have four days to response the exceptions that were filed. And that is effectively August 1st. And then we will have an oral argument of the exceptions that’s scheduled for mid-August and we would expect to get an order in September. So stay tuned. The process is working and like I mentioned, we’ve got inter rate – interim rates in effect. And we will keep you apprised, but do go take a look at the exceptions. I thought that was interesting.
Julien Dumoulin-Smith: Duly noted. Thank you. All right, I’ll leave it there. Good luck guys. Speak to you soon.
Julie Sloat: Excellent. Thanks, Julien.
Operator: Next we’ll go to David Arcaro with Morgan Stanley. Please go ahead.
David Arcaro: Hey, good morning. Thanks for the questions.
Julie Sloat: Good morning.
David Arcaro: Wanted to, let’s see – could you give some color on what your plans are going forward for Texas in terms of the generation outlook you’ve had some challenges there just with the repeat renewables proposal. I’m wondering how you’re thinking about that going forward in terms of strategy and generation pollution?
Julie Sloat: Yes, absolutely. Yes. So we did file for rehearing, because we need to make sure that we’re doing all we need to do from a traditional regulatory and administrative perspective. And then what you can anticipate AEP doing is essentially running another RFP and running another process so that we can make sure that we’re doing what we need to accommodate the capacity situation in Texas. I do believe that Texas understands there is an adequacy issue that we would otherwise have to deal with. So that’s something that we will be proceeding forward with. So standby and you’ll see what we come to the street with here in the not too distant future.
David Arcaro: Got it. And could there be a cell phone [ph] option in there? And to the extent there was, would that be, I guess, incremental to what’s currently in the renewable generation outlook for CapEx plan?
Julie Sloat: Yes, that’s a possibility. That’s a possibility. But what we would do is, accommodate any type of investment in the current CapEx forecast.
David Arcaro: Okay. Got it. Understood. And then you do have a couple other renewable projects out there for approval this quarter in several states. I was just wondering if you could give a sense of your confidence level in those before the proposals that you’ve put forth and what alternatives you might have if there end up being challenges in any of those?
Julie Sloat: Yes, and actually I’m trying to flip the page so we can kind of draw everyone’s attention to them. Right now, I’m looking at Page 32. So for example, we’ve got an application open in Virginia and we made the same filing in West Virginia. For Appalachian Power Company, we’re talking about 151 megawatts, about a $500 million investment for wind and storage capacity there. At this point the process is proceeding along as we would expect. So, I have nothing new to report. So, standby there. And trying to think of where else we have open cases in Indiana, Michigan. Looks like staff has been supportive on the Michigan side, through those applications. And Indiana order is expected in 3Q, so the third quarter of this year. So stay tuned there as well. But so far constructive and productive and we’re moving forward. Then of course we also have, I guess I should call out the wind out – the Wind investment Rock Falls that’s included in the base case at PSO. But that’s part of the base case settlement. So as you know, I just mentioned that we’re well underway in that proceeding.
David Arcaro: Got it. Okay. That’s helpful. Thanks so much.
Julie Sloat: Thank you.
Operator: And we can go to Sophie Karp with KeyBanc. Please go ahead.
Sophie Karp: Hi. Good morning and thank you for taking my questions. I have a couple of questions here. First is on the renewables, right? So clearly Texas maybe has lesser appetite for renewables at this point. And I’m just curious if you how much of the incremental appetite for this do you think is left in Louisiana and like other states that picked up slack in this particular instance? Is there risk in the near term, I guess in your mind, that those states would also turn down potential future proposals because of their perception that they have? They’re pretty much like full as far as renewable generation goes.
Julie Sloat: Sophie, I appreciate that question very much, because as you know, that’s been top of mind for us as we worked through that proceeding. So, we obviously got the approval for the 999 megawatts and Louisiana flexed up, so we’re moving along in that regard. You may recall that we also had another process that was underway for SWEPCO in particular, I want to say it was 2,400 megawatts that we were seeking interest in as it relates to how we would put that portfolio together. And so what we’ve done is, we’ve actually tabled that and we’ll be coming back to everyone to say, look, we want to look at this from an all source perspective, including PPAs. So stay tuned on that because there is absolutely a capacity need. It’s just going to take a little different shape than what we were initially expecting as we were running that RFP process. And remember when you probably heard me saying earlier here today on the call; we need to make sure that we’re listening to our regulators. And so this is exactly what we’re doing as it relates to the conversation and the experience that we just had in Louisiana, Arkansas, and Texas. And so we are adjusting and moving forward. So there will be more RFPs stay tuned for that. And they will be more all source oriented, no different than what we would be doing in Texas as you call out. Yeah, it looks like not a lot of interest in renewables there right now. So we need to think about what the other alternatives are, but we will work together with our regulators so that we can make sure that we’re doing what the state needs. Because at the end of the day, this is all about making sure that our customers have reliable, affordable electricity period.
Ann Kelly: Yes. And just to reiterate on our capital plan, so far $5.2 billion of projects have already been approved and we have another $1.7 billion that, that Julie just talked about in the regulatory process that’s out of our $8.6 billion. So we are well on our way and we also have flexibility with our transmission and distribution investments to fill in to the extent that anything else gets delayed a little bit in the process with these RFPs.
Sophie Karp: Great, great. Thank you. My other question was in the ROEs, maybe I’m referencing Slide 34 here, my reading this right, that the 40 bps – depressed by 40 bps per mild weather is sort of average across the board. So if it wasn’t for weather, all of these bubbles would be like roughly 40 bps higher or how should we think about this? There’s like a lot of numbers here.
Ann Kelly: Yes. That 40 bps is on average. Okay. So let me answer it this way though, because when I’m thinking about what does this mean for the rest of the year, and as I mentioned in my opening comments, we had initially anticipated or expected on a weighted average basis. We'd be about a 9.4% ROE across our operating companies in our 2023 guidance. And so now what we're suggesting is now that we have a little bit of a hole that is associated with weather on that ROE can't make all that up, I don't think, unless we had some ridiculous weather circumstance in the back half of this year. So we're not going to bet on that because we're going to bet on normal. And so what I would expect is we expect to improve from 8.6%, it will not get to that 9.4%. So even if you get closer to 9%, I think that's reasonable. And our point that we want to make today is despite the fact that we've had pressure as a result of weather, we're adjusting the sales and we fully well expect to be within our guidance range. And so that's the important key to take away today as it relates to our messaging. Then with also the understanding behind the scenes we just need to fundamentally do our very best to make sure we're earning as close as possible to those authorized ROEs beyond the weather situation.
Sophie Karp: Got it. So just to be clear, the 8.6% is the average with the Transmission Holdco?
Julie Sloat: Yes.
Sophie Karp: Of all distribution…
Julie Sloat: Weighted average. Yes.
Sophie Karp: Okay. Got it.
Julie Sloat: Thank you. You bet.
Ann Kelly: Thank you.
Operator: And next we go to Paul Patterson with Glenrock Associates. Please go ahead.
Julie Sloat: Hey, Paul.
Paul Patterson: [Indiscernible] I'm managing. So just – most of my questions have been answered. Only I have a question for you that's a little bit different and that is the Chevron's defense. It looks like that know that the Supreme Court might act on it. And I'm kind of scratching my head and I was thinking what you guys might be thinking about what might happen if in fact, the Chevron doctrine or whatever you want to call it is substantially changed or were repealed or what have you. Do – have you guys thought about this or I'm sure you've thought about it, but any ideas about what you think that might mean for you guys on the ground?
Julie Sloat: Paul, I don't have a lot of detail to share with you today. I do know that our legal team is looking into this and our strategy team. But for my day to day right now at the moment, not been top of mind I'm just taking comfort knowing that the rest of the team's working on it. But hey, if you have a conversation, I'm happy to circle back.
Paul Patterson: Okay, sure.
Julie Sloat: Yes.
Paul Patterson: It was my first question, but the rest were answered, so thanks so much and I'll follow up with you guys later.
Julie Sloat: That'd be great. Thank you.
Paul Patterson: Okay, great. Thank you
Operator: We'll go to Paul Fremont with Ladenburg. Please go ahead.
Paul Fremont: Thank you very much. I guess my first question is if you were to get the securitization proceeds, does that change the equity issuance plans that you lay out on Slide 28?
Julie Sloat: No. No, it really doesn't. So if we get the securitization proceeds, what we would do is reinvest that into the other areas within the AEP footprint. So not in APCo but in the other areas so that we're in making sure that we continue to earn on the investment while getting the benefits to the Appalachian Power customers.
Paul Fremont: And then my second question sort of related is if you were to get incremental CapEx, what percent should we assume would be equity funded versus let's say debt funded?
Julie Sloat: Yes, I mean I would assume just kind of the average of what we have in the current plant. Yes, Paul, we typically get, if we have an opportunity to invest more we're going to try to manage directly back to those target ratios that we throw out there and obviously be mindful of debt to cap as well. So at this point, we're focused entirely on executing on the plant that we already have out in front of you. The issue could be from time to time is how much slides from one year to the next. So you're kind of playing with the toothpaste tube, right? So you're just on passing the CapEx back and forth, because we got $40 billion that we're put into work. And again, at this point, while we always have more opportunities we need to make sure that this is affordable for our customers as well. So that's going to be another stopping point for us too because we're essentially trying to thread the needle, make sure the balance sheet stays strong, make sure those metrics are absolutely in place, but make sure that, our customers are able to afford what we're essentially providing. Our regulators definitely help us with that, but that's also precisely why we have to be really disciplined and not just continuing to spend CapEx that would be fun and nice to spend and actually absolutely make our system stronger and absolutely reliable. But is that what is necessary to keep the lights on and what customers can afford. So it is a constant balancing act for us.
Paul Fremont: Great. Thank you very much.
Julie Sloat: You bet. Thank you.
Operator: [Operator Instructions]
Darcy Reese: Thank you for joining us on today's call. As always, IR team will be available to answer any additional questions you may have. Brad, would you please give the replay information?
Operator: Certainly. Thank you. Replay will be available after 11:30 today and running through August 4 at midnight. You can access the AT&T replay system at any time by dialing 1-866-207-1041, and entering the access code 1289635. International parties may dial 402-970-0847. Those numbers again, 1-866-207-1041 and 402-970-0847 with the access code 1289635. That does conclude our call for the day. Thanks for your participation and for using at AT&T teleconference. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by and welcome to the American Electric Power Second Quarter 2023 Conference Call. At this time, all parties are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded. I'd now like to turn the conference over to our host, Vice President of Investor Relations, Ms. Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Brad. Good morning everyone, and welcome to the second quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Ann Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie."
},
{
"speaker": "Julie Sloat",
"text": "Thanks Darcy. Welcome everyone to American Electric Power's second quarter 2023 earnings call. Good to be with everyone this morning. It's a rapid time of change in our industry with new opportunities resulting from federal policy shifts and evolving state and customer priorities. We also continue to navigate a dynamic environment with rising interest rates and supply chain constraints. In short, it's definitely an exciting time to be at AEP as we make significant progress on our important stakeholder commitments and strategic objectives, including delivering on our 2023 operating earnings guidance and 6% to 7% annual operating earnings growth, providing dividend growth in line with earnings, strengthening our balance sheet as we move through the next few quarters, actively managing our portfolio, achieving net-zero by 2045 and central to our purpose, keeping our customer rates affordable. We recently made some organizational adjustments such as the restructuring of our Federal Affairs function, the realignment of our regulatory team, and the refreshment of some of our operating company presidents. These changes will help us to operate more effectively and facilitate our success in this ever-changing environment. As always, we keep the customer at the center of every decision we make. This is why we engage with our federal and state regulators so we know how to best support our operating companies while we balance investor preferences as we grow the business and invest $40 billion over the next five years in new generation resources and our energy delivery infrastructure. This morning, I'll provide a brief overview of our second quarter financial performance before getting into our measured and disciplined approach to simplifying and de-risking our business profile through our portfolio management activities. Related to this, I'll share some updates regarding our unregulated contracted renewables portfolio, retail and distributed resources businesses, and the status of our strategic review of our non-core transmission joint ventures. While we still have a lot of work to do on the regulatory front, I'll conclude by providing insight into the recent successes related to our renewables execution and developments on our regulatory and legislative initiatives as we keep our customers’ needs top of mind. A summary of our second quarter 2023 business highlights and a high level overview of our financial results can be found on Slide 6 of today's presentation. AEP delivered second quarter 2023 operating earnings of $1.13 per share or $582 million compared to $1.20 per share or $618 million last year. The year-over-year decline reflects the timing of higher interest rates in the reversal of last year's second quarter 2022 favorable weather. Today we're pleased to reaffirm our 2023 full year operating earnings guidance range of $5.19 to $5.39 with a $5.29 midpoint and long-term earnings growth rate is 6% to 7%. Given our line of sight at this point in the year, I believe we have the operational flexibility and leverage to pool to ensure that we will deliver on our commitment. Later on, Ann's going to talk or walk through our second quarter of 2023 performance drivers and share some perspectives on our load outlook as we drive economic development within our service territory. She'll also share some details supporting our targeted 14% to 15% FFO to debt range. While our FFO to debt is 11.1% this quarter, our forecasts show material improvement in this metric as we approach year-end and we fully expect to be in our targeted range in early 2024. As we continue to execute on our strategic objectives, we remain focused on simplifying and de-risking our business profile. To that end, you'll recall that in February of this year, we announced a signed agreement with IRG Acquisition Holdings for the sale of our 1,365 megawatt unregulated renewables portfolio. A summary of the renewable sale can be found on Slide 7. In the second quarter, we received FERC 203 approval and clearance from antitrust authorities. The only remaining approval is from the Committee on Foreign Investment in the U.S., which we expect to see receive in the near-term and subsequently close on the sale in August. As we've said, the proceeds from this transaction will be directed to our core regulated businesses and strengthening of our balance sheet. Turning to Slide 8, let's touch on some other asset sales that we have in progress. In May, 2023, we also announced the sale of our New Mexico Renewable Development Solar portfolio, also known as NMRD. We are currently on track with our 50/50 joint venture partner, PNM Resources to close on this transaction by the end of 2023. The sales of our retail and distributed resources businesses are also on schedule to close in the first half of 2024 as previously announced. Please keep in mind that other than the unregulated renewables portfolio proceeds of $1.2 billion, no other sales proceeds are reflected in our five year cash flow outlook. We’ll first obtain the signed sales agreements for NMRD and our retail and distributed resources businesses, and then incorporate the related proceeds into our cash flow outlook. As part of our commitment to portfolio management, I’m pleased to share some additional news with you today. We’re announcing that we’ve completed the strategic review of two of our three non-core transmission joint ventures and have determined that the sale of AEP’s interest in Prairie Wind Transmission and Pioneer Transmission as our preferred path forward. We expect to launch the sales processes soon and we’ll keep you updated on our progress. In the meantime, we continue our strategic review of Transource Energy and expect to complete that review by year end. Now let’s switch gears to AEP’s regulated renewables execution and recent successes. Through our five year $8.6 billion regulated renewables capital plan, we now have a total of $5.2 billion approved and an additional $1.7 billion currently before our commissions for approval. You can find more detail on activities to acquire additional generation resources in the appendix on Slides 31 through 33. In May 2023, the Oklahoma Commission approved PSO’s 995.5 megawatt renewables portfolio for $2.5 billion, which includes three wind and three solar projects. These projects are projected to be in service toward the end of 2025. For SWEPCO’s 999 megawatt renewables portfolio totaling $2.2 billion of investments, I’m happy to report that last month, both the Arkansas and Louisiana Commissions approved the full portfolio containing two wind projects and one solar project. We expect the projects will be going into service by the 2025 timeframe. Since the Texas Commission denied SWEPCO’s application related to these projects, Arkansas will move forward with the 20% of the portfolio total and Louisiana will flex up with 70% giving wholesale customers the remaining 10%. We’re excited to deliver the benefits of lowest reasonable cost and reliable energy to these communities we serve in Arkansas and Louisiana. We’re also currently awaiting for commission decisions expected as early as in the third quarter of 2023 for 151 megawatts of owned wind and energy storage at APCo, 469 megawatts of owned solar at I&M and 154 megawatts of owned wind at PSO. Importantly, our regulated renewables goals are aligned and supported by our integrated resources plans. Accordingly, we’ve issued requests for proposals for generation resources at APCo and I&M with more to come from operating companies soon. I’ll turn now to updates on several of our ongoing regulatory and legislative initiatives. More detail on our regulatory activities can be found in the appendix on Slides 34 through 36. We’re unquestionably focused on closing the gap between our authorized versus earned ROEs. While our second quarter ROE came in at 8.6%, this measure was depressed by 40 basis points due to mild weather. Closing this gap is going to take a little longer than we had anticipated in our 2023 guidance, which you may recall included a 9.4% ROE. But I’m confident that we’ll reduce this gap by year end and still meet our earnings guidance. As we make needed progress in this regard, we are continuing to prioritize federal, state and customer preferences to meet the needs of our communities that we serve. We look forward to building on our constructive relationships with all of our stakeholders and clearing the path for our operating companies to be effective and successful in their respective service territories. In fact, while being mindful of any ex-parte restrictions, I’m personally meeting with many commissioners across AEP’s footprint to engage in discussions about our company and what is top of mind for them in the way of priorities and expectations as we work together to do our best to provide this product that is the fundamental enabler for society. In June 2023, we filed a new base case in Kentucky to address the financial health of the company and established a path for future investment. The application incorporated a comprehensive rate review and a proposed 9.9% ROE with a request to allow for the securitization of $471 million of regulatory assets. This will help to ensure that Kentucky Power is best positioned to provide safe and reliable service, while managing costs to provide affordable service to our customers. We expect that the new rates will be in effect in early 2024. In May 2023, we settled PSO’s base case with the commission staff, attorney general and other parties in Oklahoma providing a path for approval for more efficient cost recovery mechanisms with continuation of the transmission tracker and reestablishment of a distribution tracker. While we await commission – a commission decision expected in the third quarter of 2023, we implemented interim rates starting in early June. For APCo Virginia’s 2022 – 2020 to 2022 triennial filed in March of 2023. We’re working through regulatory – the regulatory calendar and expect an order later this year. And Texas legislation was passed last month, which permits utilities to file the Distribution Cost Recovery Factor or DCRF twice per year instead of once per year. The bill also allows DCRF to be used by a utility even if it has a pending base case review proceeding. This important legislation will help improve AEP’s regulatory lag in Texas, as we make needed distribution investments to bolster the grid in this region. AEPs management of fuel cost recovery remains a top priority with deferred fuel balance at $1.4 billion as of the second quarter 2023. We’ve adapted fuel cost recovery mechanisms across most of our jurisdictions with a focus on balancing customer impact. Notably, we are awaiting a decision on our fuel case in West Virginia. Through this spring we were active at the state legislature and collaborated on a new securitization bill to provide an effective path forward on fuel recovery and other legacy costs while mitigating customer bill impact. In April, 2023, – in our April, 2023 fuel recovery application, we filed two options for consideration, one which amortizes the fuel balance over three years, and alternatively, in an effort to even further minimize cost impacts to customers, we requested West Virginia Commission approval to use securitization to manage our $553 million deferred fuel balance. We also proposed an opportunity within that second option to apply the securitization mechanism to $88 million of deferred storm costs and $1.2 billion of legacy coal plant balances with the intention of offering a solution that would essentially have a neutral impact on customer rate. Keep in mind; securitization is the mechanism we can use to address affordability in West Virginia. While it’s important that we addressed fuel and storm cost recovery in the state, let me be clear that the possible securitization of $1.2 billion for our Amos and Mountaineer coal plant balances is not required to hit our credit metrics, nor does it suggest that there’s a change in our current plant – our current plant retirement schedule of 2040 for these units. Rather, this is entirely driven by the desire to consider all options to mitigate impact to customer bills. The West Virginia Commission subsequently issued a procedural schedule in the fuel case, including the April, 2023 prudence [ph] report, which will be addressed in an evidentiary hearing beginning on September 5. This schedule provides an opportunity to ensure focus on cost concerns and a constructive future in West Virginia balancing customer and financial impacts. Pending the commission’s decision later this year, we could issue bonds to securitize a possible combination of the deferred fuel balance, deferred storm cost, and legacy coal plant balances in the first half of 2024. I’m pleased with the progress we’ve made so far. We still have a lot of work to do as we execute on our plans to meet our commitments, overcome challenges, reach our strategic objectives, engage with stakeholders, and keep customers a top priority. Together we deliver safe, clean, reliable, and affordable energy to our communities while creating value for our investors. With that, Ann will now walk you through our second quarter, 2023 performance drivers and details supporting our financial target. Ann?"
},
{
"speaker": "Ann Kelly",
"text": "Thank you, Julie and Darcy. It’s good to be with you all this morning. Thanks for dialing in. I’m going to walk us through our second quarter and year-to-date results, share some updates on our service territory load and finish with commentary on credit metrics and liquidity, as well as some thoughts on our guidance, financial targets and portfolio management activities underway. Let’s go to Slide 9, which shows the comparison of GAAP to operating earnings. GAAP earnings for the second quarter were a $1.01 per share compared to a $1.02 per share in 2022. Year-to-date GAAP earnings through June, were a $1.78 per share compared to $2.43 per share in 2022. In our year-to-date comparison of GAAP to operating earnings, we’ve reflected the expected loss on the sale of the contracted renewables business as a non-operating cost, as well as an adjustment true of cost related to the terminated Kentucky transaction in addition to our typical mark-to-market adjustment. Also due to new legislation in Texas allowing the recovery of incentive compensation, favorable entry was booked in the second quarter to capitalize previously incurred costs, which was almost entirely reflected as non-operating earnings. There is a detailed reconciliation of GAAP to operating earnings on Pages 16 and 17 of the presentation today. Let’s walk through our quarterly operating earnings performance by segment on Slide 10. Operating earnings for the second quarter totaled $1.13 per share or $582 million compared to a $1.20 per share, or $618 million in 2022. The lower performance compared to last year was primarily driven by weather, interest and O&M, partially offset by rate increases in our utility and transmission revenue growth in both our Utilities and the Transmission Holding Company segment. The unfavorable weather was largely due to positive weather we saw in the second quarter of 2022, while weather was mild begin in the second quarter of 2023; the unfavorable impact was less significant in comparison to the first quarter of this year. Interest continues to be unfavorable versus the prior year, and that is primarily driven by higher debt balances as well as the higher interest rates. The higher debt balance also has resulted in an increase in interest expense as compared to our guidance, but we continue to adjust in other areas to offset this impact. Again, we were expecting this variance to be more pronounced in the first half of 2023 as interest rates somewhat stabilized. We also expect the announced sale of our contracted renewables business to close this quarter and the conversion of the $850 million equity units in August to lessen the burden in the second half of the year. Finally, I’d like to note as well that we still expect to see favorable O&M in the second half of the year compared to the prior year, reflecting the timing of O&M spending and near term actions that we are taking to help offset the unfavorable weather, such as holding positions open, reducing travel, and adjusting the timing and of discretionary spending. These actions are in addition to our ongoing efficiency efforts that we target to offset the impact of inflation each year. Operating earnings for our vertically integrated utilities were $0.51 per share, down $0.08. Favorable drivers included rate changes across multiple jurisdictions, depreciation and off-system sales. These items were more than offset by the unfavorable weather interest expense, O&M and lower retail and wholesale load. I will touch on our retail load trends in a couple minutes. Consistent with our first quarter results, depreciation is favorable at the vertically integrated utility segment, primarily due to the expiration of the Rockport Unit 2 lease in December of 2022. I&M should continue to see about $0.055 net favorable depreciation in each of the first three quarters of 2023, plus an additional $0.035 in Q4. Including the impact of the Rockport lease, depreciation was $0.04 favorable in Q2. However, if we exclude the impact of the lease, depreciation would've been about $0.02 unfavorable, which is consistent with the incremental investment in this segment. I also want to mention that the favorable off system sales showing up again in the second quarter is due to the fact that Rockport Unit 2 margins are no longer shared with our retail customers. The Transmission and Distribution Utilities segment earned $0.30 per share, down $0.02 compared to last year. Favorable drivers in this segment including transmission revenue and rate changes largely due to the distribution investment rider in Ohio and the distribution cost recovery factor rider in Texas. Offsetting these favorable items were unfavorable weather, lower retail load, depreciation, O&M and interest. The AEP Transmission Holdco segment contributed $0.38 per share up $0.11 compared to last year. The main drivers here included favorable investment growth and a favorable year-over-year change in the true-up. You'll recall that we had a negative true-up in 2022. Generation & Marketing produced $0.13 per share down $0.05 from last year. The negative variance is primarily due to the development asset sale and other one-time favorable items in 2022 as well as higher interest expense in 2023. These unfavorable items were partially offset by higher retail power margins in 2023. Finally, corporate and other was down $0.03 per share, driven primarily by higher interest expense and O&M. These unfavorable items are partially offset by a favorable change in investment gain and income taxes. The favorable change in investment gain is primarily due to investment loss incurred in the second quarter of 2022. Before we move on to the next slide, to give an update on load, I want to briefly mention that the details of our year-to-date operating earnings performance will be shown in the appendix of supplemental information going forward. You can find these details on Slide 15 of the presentation today. Turning to Slide 11. I'll provide an update on our normalized load performance for the quarter. Overall load continues to come in ahead of budget, but we're closely monitoring key components of our retail sales in the context of the slowing economy, and we are seeing different trends between our retail customer classes. As we discussed last quarter, our projections already assume that economic conditions will slow in the second half of the year. Recent positive economic data on inflation supports that any slowdown will be in line with our previous expectations. Beginning in the upper left hand quadrant of the slide, we see a slowing in our residential load compared to a year ago. Our residential customer counts continue to grow, but we are seeing usage decline as many of our customers return to the office and even more squeezed by the relationship between inflation and income growth. That relationship is a key driver of residential usage and we expect to see it stabilize in the second half of the year. This month's CPI data point was an encouraging sign that inflationary pressures on our residential customers are continuing to lessen into the fall. Moving to the lower left hand quadrant of the slide, we can see a noticeable slowing in the industrial class. So still ahead of year end budget projections, industrial load is beginning to reflect the expected slowdown in the outlook for manufacturing across the country. This slowing has been broad based across industries and operating companies, but would've been even worse without an our ongoing commitment to economic development. We estimate that total industrial load through the quarter would've actually declined by 1.2% if not for growth tied to our economic development efforts. Even with these efforts, however, we do expect industrial load growth to remain subdued due to the tighter financial conditions and slowing levels of demand for finished goods through the end of the year. Offsetting this slowing is a significant boost to our normalized commercial sales that you can see in the upper right corner driven by new large customer volumes from our ongoing economic development efforts. Year-to-date commercial load has grown almost 8% year-over-year in each of the last two quarters. We expect our commercial load to continue to outperform through the end of the year. Thanks to ongoing technology development across our operating footprint. Gains in AEP Texas and AEP Ohio should continue to be especially robust with several new projects scheduled to come online through the end of the year. With the June CPI data, we've now seen a material deceleration in key components of inflation that the economy has been waiting to see. We think this progress on inflation coupled with continued resilience in the labor market dramatically reduces the probability of a severe economic contraction in 2023. Our near and long-term load projections are bolstered by our discipline commitment to economic development across the service area. We know that working with local stakeholders to attract more economic activity is a key strategy to providing value to our customers. This allows us to continue to prioritize investments that will improve customer experience while mitigating the rate impact on our customer base. Great examples of our recent successes are NL and Tulsa and GM and Samsung in Indiana. Both of these economic development wins will not only add load to our industrial segment, but each is also expected to bring more than a 1,000 full-time jobs that will ultimately benefit our residential segment and boost the local economy. Let’s move on to Slide 12 to discuss the company’s capitalization and liquidity position. Taking a look at the upper left quadrant in the page, you can see our FFO to debt metric stands at 11.1%, which is a decrease of 30 basis points from last quarter and continues to be below our target. The primary reason for this decrease is a $1.3 billion increase in debt during the quarter, partially due to long-term debt issuances at the operating company level to support our capital investments and the return of mark-to-market collateral positions associated with decline in natural gas and power prices. Return of collateral reduces our funds from operations, so hits us on both sides of the equation without the fluctuations in our mark-to-market collateral positions over the past 12 months and some remaining impact of deferred fuel, our FFO to debt metric will be closer to 13.7%. We expect that this metric will improve by year end as we reduce debt after the close of the announced renewable sale and our 2020 equity unit conversion and we see the improvement in funds from operations over prior year in the fourth quarter. We remain committed to our targeted FFO to debt range of 14% to 15% and we expect material improvement by the end of 2023 and to achieve our target in early 2024. You can see our liquidity summary in the lower left quadrant of the slide. Our five-year $4 billion bank revolver and two-year $1 billion revolving credit facility support our liquidity position, which remains strong at $3.1 billion. On a GAAP basis, our debt-to-capital ratio increased from the prior quarter by 50 basis points to 64.6%. We plan to reduce this percentage in the third quarter as we eliminate debt when we close our announced contracted renewable sale transaction and complete our previously planned equity unit conversion. On the qualified pension front, our funding status increased during the quarter to 102.2%. The funded status improved due to rising rates during the quarter that decrease the liability while solid equity returns positively impacted plan access. Let’s go to Slide 13 for a quick recap of today’s message. The unfavorable change in weather primarily due to positive effects in the second quarter of 2022 is a significant driver in our quarter-over-quarter earnings comparison. If we removed this effect, we would’ve been $0.05 favorable compared to the prior year and our results were roughly in line with our expectations for the company as a whole. I will note from a year-to-date perspective 2023 weather has been the most mild on record for the AEP system in the past 30 years, resulting in $0.29 EPS impacts year-over-year and about $0.20 versus normal weather. So as we progress through the remainder of the year, we will continue to focus on taking action to mitigate this and other headwinds. Overall, our business remains in a strong position and we are reaffirming our operating earnings guidance of $5.19 to $5.39 per share. We also continue to be committed to our long-term growth rate of 6% to 7%. As Julie previously addressed, we are on track to close the sale of our unregulated contracted renewables portfolio in the third quarter this year, and our retail and distributed resources business in the first half of 2024. We’ve concluded that the sale of our interest in two of our transmission joint ventures, Prairie Wind Transmission and Pioneer Transmission is our preferred path, and we continue a strategic review of our Transource Energy joint venture. These initiatives will help simplify and de-risk our business going forward. We really appreciate your time and attention today and with that and going to ask Brad to open the call, that we can hear what’s on your mind and answer any questions that you have."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Give us just a moment here. And I can go to Shar Pourreza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Shar Pourreza",
"text": "Hey, good morning guys."
},
{
"speaker": "Julie Sloat",
"text": "Good morning."
},
{
"speaker": "Shar Pourreza",
"text": "Good morning. Just on the credit metrics, obviously, a little bit more slippage this quarter, which you highlighted. I guess can you talk about the pathway to get to that 14% to 15%, a little bit more detail? I think 300 basis points seems like a lot of improvement that’s needed in a short timeframe, being that it’s your early 2024 target. I mean, could we see incremental equity in plan? Is the asset sales enough to get you there? And how important is collecting the unrecovered fuel balance in terms of being able to hit that target, which I guess it still stands around $1.4 billion. Thanks."
},
{
"speaker": "Ann Kelly",
"text": "Yes. Shar, I’ll take that. As we mentioned, the main impact to our FFO to debt is the timing of the collateral payment. So that’s about a 240 basis point impact to our FFO to debt, and so that should resolve itself by year end and result in a noticeable improvement. We also have about a 100 basis points of favorable impact from the proceeds of the contracted renewable sale and the equity unit conversion. So we are, confident that we are going to have measure improvement by the end of the year and be into the range by next year. In our forecast we don’t have any of the securitization in our cash flows. We do have recovery of deferred fuel, but that is not necessary to be able to get into our current range."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. Okay, perfect. And then maybe just a more of a strategic question for Julie. I mean, obviously, AEP is never CapEx constrained, right? I guess how do we sort of think about overall financing, especially given the current interest rate environment and kind of where the stock currently trades? Do you have ongoing; you do have ongoing needs, right? So as we’re thinking about parent leverage and equity are more non-core asset sales out there, or could we actually start to see some more core assets sales to kind of fund the plan and maybe further simplify the story? Thanks"
},
{
"speaker": "Julie Sloat",
"text": "Yes, no, Shar. I so appreciate the question. And you’re right, we have a lot of opportunity to put capital to work as it relates to taking care of the customer and delivering reliable, affordable service. But as you point out, we need to make sure that we’re hitting all the metrics too. So not only do you need to be real mindful of where customer rates are going, when we put money to work, I need to make sure that all my earnings growth targets are going to be hit. Because I think you guys would be upset with me if that didn’t happen, so we’ll make sure that happens. But I also need to make sure that my balance sheet’s really strong too. So let me get to your question around asset sales. We’ve really been focused on, as you know, the non-core related activities that when people buy AEP shares or invest in our bonds, they’re not necessarily looking to buy something that is not a traditional regulated utility type business. So to that end, that’s why you see us kind of going through the paces today where we’ve talked about the unregulated components of our business and, while we love transmission even looking at some of these transmission investments of the joint ventures that are off our footprint, because if we can channel all of our efforts and dollars to taking care of our customers that are regulated in our footprint, that’s where we want to play. So, I wouldn’t anticipate, a significant additional activity coming from us for a couple of reasons. I think we’re pretty cleaned up once we get some of this non-core stuff taken care of. I think we’re in a good place. I think that, there may be some opportunities, on the edges, but for the most part we’re – we should be in a really good space to be continuing to look at the regulated pieces of our business. But we also and very candid Shar, we don’t need to engage in asset sales to make the balance sheet work. What we need to do is make sure we’re being as efficient as possible, and that’s another reason why I want to make sure that every dollar we do put to work is one that a, makes sense for our customers, but also is something that makes sense for our service territories. And specifically why I am calling that out is another reason why I’m out talking with folks in our community. So whether its commissioners, customers, et cetera, need to make sure that we’re aligned or at least absolutely aware of one another’s priorities and then we can make refinements based on those conversations. So, I would never say that we’re not at all capital constraints because I think we naturally are because we put our own constraints on because we got to take care of customer rates and make sure that we’re going to have a really strong balance sheet. We’re working on that. As Ann just mentioned, we expect that FFO to debt to look a lot better once we get to year end and going into 2024. I think in the interim here, it’s going to be just a little bumpy as we work through a couple of the next few months. So I wouldn’t be too concerned about that. I feel comfortable with the numbers I’m seeing, but we’ll continue to be very disciplined around, which dollars we put to work where that it’s consistent with what our stakeholders need and want taking care of our customer and then just being as efficient as we can. So my focus is going to be more at this point on let’s close that gap on the ROE. That’s the piece that I can try to do my best to control."
},
{
"speaker": "Shar Pourreza",
"text": "Got it, terrific. And then no, it does. And then we do appreciate some of the salient points you brought up in your prepared remarks as far as the outreach to the regulatory folks and various stakeholders. So thank you for that points."
},
{
"speaker": "Julie Sloat",
"text": "Yep. Thank you for the coverage."
},
{
"speaker": "Operator",
"text": "And next we go to Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Julie Sloat",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "I wanted to kind of follow up on some of the points that you were just touching on here because, some of the dockets and local media attention have highlighted some regulatory pushback in certain areas of ablate, and you mentioned, reaching out to local commissioners to build relations there. Just wondering over what timeframe, you expect to kind of meet all of them? Is this a change in regulatory strategy where they hear from headquarters more regularly here? Just wondering how you think about this type of outreach going forward?"
},
{
"speaker": "Julie Sloat",
"text": "Oh, Jeremy, I love that question. So I’m going to tell you from my perspective, this is coming from a former operating company president. So I keep that hat kind of in my back pocket that I got to throw on from time to time. And so let me start with this. What my hope to do, well I, what I hope to do or achieve is, pay [ph] the way or clear the path for our operating companies so that they can do the best they can do boots on the ground. And so my objective is to get out, to make sure that I’m talking with different commissioners. And by the way, that’s already underway. So, I’ve already been out talking with several folks and I’ve got my calendar lined up over the next few months to continue to that effort. So I’m not going to get into necessarily exactly who I’m talking to when, but that, that’s well underway. So rest assured that’s happening. But I just, I want to make sure that they’re hearing from me and that they understand that AEP, the parent or the service core is here to provide clearance and service and support for the individual operating companies. Really, that’s the only reason the service core exists, is to support the operating companies. And I need them to hear that from me. And more importantly I just want to be a really good listener so that I can be really good at my job so I can take care of our customers, take care of my team, and then ultimately take care of my investors and the other stakeholders that are party to everything that we're doing here. So I don't want people to think that I'm stepping in the way or thinking that something's not right because that's not the case at all. I just want to make sure that we're doing everything we can to support the teams so that they can be as successful as they possibly can be. Because here's the other point, right. You call out the fact that there are pressure points as it relates to regulatory activities. I think that's going to be what we're dealing with for the next several years. We got a lot of headwinds now. The game's changed, the industry's going through a material transition. Each of our states is in a different place as it relates to their economies. And so I think everybody is doing their jobs and that means we got to do ours too. We have been doing it, but we have to be really good listeners and learners and adjusters. And I think that goes for all the different stakeholders. So the more dialogue we can have, I think the smarter we're going to be and if nothing else that will – we only be able to take care of the customer and make sure we're keeping the lights on and delivering this product that make life possible. But I think we're going to be doing it in a much more effective way, and we're going to have to pick up the pace too. So we got to do it in a faster way than we've ever done it in our history. So I think it's exciting. I love getting out and talking with people. You guys know from The Street, I love getting out and talking with you too, so that's not going to stop. So I just got to work my calendar and I'll be out front and I'm happy to talk about any of the conversations that I've had."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's very helpful. And just one more along these lines, dialing in a little bit more. In Kentucky, our local stakeholder conversations highlight a focus on increased distribution investment as a priority as opposed to the more recent, I guess, transmission investment which could help local stakeholder relations there with a focus on distribution. Just wondering how you see a Kentucky strategy evolving over time here?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, I'll tell you, let me start with this. Again, having been a former CFO as well. At 1.6% ROE, yes, we got to work on that. And that to me, when I see that number that's not a financially healthy, sustainably healthy entity so that's why we're going through the case activities. So we're going to work on that and that's exactly why we went out and socialized the case well in advance with dozens of meetings with a variety of different stakeholders. So again, listening and learning so we understand where everybody's kind of shaken out, but also understanding what it is that we need to do so that we're successful, not only in taking care of our customers, but making sure we're doing everything we can to make sure that the stakeholders understand what our objectives are and are comfortable with it. So yes, the objective is to, A, get a plan in place that will allow us to improve the financial positioning of the company, which then enables us to make future investments to take care of the customers, they need the power too. It doesn't matter which state you're sitting in, but the idea is to engage in these activities, hopefully have a really good case. And I don't expect it to be easy. It's not supposed to be easy. If it was easy, everybody would be doing it. So we'll engage in those activities and hopefully get us on a path forward that enables us to continue to invest in a really smart way in the state that everybody can feel good about."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. So there's room to pivot towards more distribution over transmission. Sounds like you're working with stakeholders there?"
},
{
"speaker": "Julie Sloat",
"text": "We, absolutely and so those are the conversations that we're having. We do know that transmission has been very important to the commission. And so that is top of mind for us as well. And we've worked that into the structures that we've essentially set forth in our case. But at the end of the day, it's the distribution that also matters because we got to keep the lights on."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. I'll leave it there. Thank you very much."
},
{
"speaker": "Julie Sloat",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "And next, we'll move to Anthony Crowdell with Mizuho. Please go ahead."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning. Thanks for taking my question."
},
{
"speaker": "Julie Sloat",
"text": "You bet."
},
{
"speaker": "Anthony Crowdell",
"text": "Just – first off, Slide 12, maybe I've been following it too long, but I think over the last 10 years, the total debt to total capitalization has gone from 53%. Now it sits at 65%. I'm just wondering, does that stabilize or where do you see the sweet spot for total debt to total capitalization?"
},
{
"speaker": "Ann Kelly",
"text": "Yes, absolutely. Thanks for the question. So it has inched up, as you can see on the graph. I mean, 60% is our sweet spot and that's what we're targeting going forward. As you can see, we're above that right now. We do expect that to decrease with the contracted renewable sale proceeds and also the equity unit conversion. So that's a couple hundred basis points, that'll reduce that closer to the 60%, but we still have some work to do."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. And then if I stayed on the balance sheet here, I think you've talked about, you've planned to be in a target, and I hope this correct in 2024. If I could get real granular, when do you think you're going to get into the midpoint of your 14% to 15% range? Is that something you'd talk about?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, I mean, I would say we're going to be, we say we're going to be in the target in 2024 and I think approaching the midpoint probably by the end of 2024. There are the fluctuations as I mentioned in FFO that we're experiencing. And that's just really due to timing of quarter-over-quarter fund flows. And so, you will see especially in 2023 that it will be press till the fourth quarter when we really see that switch in the collateral collections and improving our FFO there, so that's what's going to take some time. But we do expect it to increase, like I said, materially by the fourth quarter and then into next year. And Anthony, just to put a little finer point on it too, remember, our threshold that we're sensitive to is 13% as it relates to our Baa2 rating from Moody's. And so that's why we toggle to the 14% to 15% because what we want to have is cushion. So 14% definitely gives us some cushion, so keep that in mind as well. And the other thing I mentioned in my comments too is as we proceed through the rest of this year, you can expect maybe a little more pressure as we go through the next couple of months with some improvement as we get to the fourth quarter. Just want to manage those expectations."
},
{
"speaker": "Ann Kelly",
"text": "Yes. The other thing just to highlight is that, we're talking a lot about the timing of collateral payments, but 80% of that volatility that we're seeing relates to our retail business, which as you know, is for sale. So once we sell that business, we would expect that reduction in volatility going forward."
},
{
"speaker": "Anthony Crowdell",
"text": "And then just lastly, Julie, I appreciate all the commentary you've given on the regulatory strategy and especially Kentucky. And I know Kentucky's a very small piece, but when you look at the equalizer chart, I mean the ROE is pretty low. What’s a reasonable assumption for us to use? Where that ROE could go in 20 – by 2024? I mean, does that go to an allowed of 9.9%? I’m just curious, how long does it take to recover the regulated returns of the utility?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, Anthony, it’s going to take a while. Do not expect a flash cut. And so remember in our case, we requested a 9.9% ROE, our current authorized is 9.3%. I’m looking at Page number 34 in the slide deck right now. It will be a walk. So that’s something we’re trying to manage our own expectations around as well as for you all, as you work to model. So stay tuned and let this case proceed and see how things move along and then we can continue to kind of dial that in and give you more direct guidance."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. Thanks so much for taking my questions. I really appreciate it."
},
{
"speaker": "Julie Sloat",
"text": "You bet. Thanks for being on the call."
},
{
"speaker": "Operator",
"text": "And we can go to Julien Dumoulin-Smith with Bank of America. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Thank you Julie and team. Good morning. Appreciate it. Maybe to follow-up on some of the last few questions here, if I can. Just as you think about some of these headwinds here with respect to securitization heading into 2024, obviously you down fairly confident, not just in offsetting the weather year today, but in the 2024 items here. Can you talk about some of those tailwinds here or some of the forthcoming offsets? What else gives you the confidence in having that linear trajectory on the 6% to 7% here? If you can speak to that a little bit more. And maybe related to that, can you talk about maybe the timing of some of these items to the extent, which some of those headwinds on securitization bleed into 2025 as well? I don’t want to be too myopic on the next year."
},
{
"speaker": "Ann Kelly",
"text": "Yes. I mean, what I’ll do is I’ll start with kind of addressing the 2023 earnings guidance question. As you look, we’re $0.18 below prior year and we guided to year-over-year for the full year it’s about $0.20 improvement. So that’s $0.38 that we need to outperform last year for the second half of the year. When I look at this, I think it’s helpful to break it down into components. So weather was $0.29 over 2022, about $0.20 of that impact is versus normal. And that’s where we’ve taken some action to offset those headwinds. Interest also is about $0.29 unfavorable year-to-date. It’s running a bit above expectations. We had guided to $0.20, but that also didn’t include interest on Kentucky, because we had expected to sell the business. So that’s about $0.10 per year and that’s covered in revenue. So we had anticipated much of our year-over-year increase to be in the first half of the year because of the timing of the Fed actions. So while we are a little bit short coming into the back half of the year, we also have the proceeds from the contracted renewable sale and equity unit conversion that’ll help reduce our debt somewhat. And we’ve taken other actions to offset the increase in rates because it has been – the Fed has been tightening a little bit longer. When you look at O&M, unfavorable to last year in the first half, but we expect this to reverse due to timing of our O&M spending. Our original guidance planned for reduction of O&M during the second half of the year because last year’s spending was a little bit robust on the O&M side in the back half. And so we had already anticipated a reduction and then we’ve taken additional actions like those that I’ve mentioned to be able to make up for the reduction in weather volumes. And then lastly, there’s a couple other things that we’re pointing to. One is the favorable trends in commercial load that we expect to continue. And then we’ve also seen favorable results in our generation and marketing business that’ll benefit us this year. So, putting that all together that what give us the confidence and our ability to meet our earnings guidance for this year. In terms of maintaining the 6% to 7% EPS growth going forward, it’s really a story on our capital deployment and we have a very robust capital pipeline that allows us to do just that."
},
{
"speaker": "Julie Sloat",
"text": "And Julien, on that note, just to kind of put an end cap on this. I think the core is solid. And so when you look out in the next few years, as Ann mentioned, we got $40 billion we’re put into work in terms of capital investment over the next five years. We’ll continue to work with our regulators to make sure that we’re deploying the dollars where we all agree that they need to go. And then at that point it’s really around making sure that we also execute on not only the regulatory plans that we lay out there, but as you know, we’ve got some strategic asset sales that are underway. So we’ll deal with the fact that some of those businesses are falling away, rechanneling those dollars to the regulated pieces of the business that will help us from the math perspective and making sure that we’re hitting all of those other balance sheet metrics that we need to make sure that we hit, so people aren’t worried or concerned. And we got a little more flexibility. So when we have a weather event or something of that nature, we can easily sustain that. But the core is solid and at this point it’s around being efficient, putting the dollars to work where it makes sense and closing the gap on the ROEs."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. All right. Excellent. And then if I could follow-up briefly on a couple details. Just with respect to PSO, obviously dynamic situation with the ALJ and settlement, can you talk a little bit about your expectations here and maybe about what you had been planning in interim rates? Just ultimately what happens, how you’ve been planning, what’s reflected in rates? If you don’t mind a little bit of an update there."
},
{
"speaker": "Julie Sloat",
"text": "Yes. So we implemented interim rates in early June I think it was, as it relates to the settlement that we had put in place. And at this point, as you mentioned, the ALJ had its report that it is submitted and then file – exceptions were filed, I think it was yesterday to the ALJ report. So if you haven’t taken a look at that I would encourage you to take a look at that. But effectively the parties to the settlement agreement were absolutely supportive of the settlement agreement, which we would’ve expected anyway. So we felt good about that. And we’re going to let this thing play out over the next couple of weeks really, because we’re getting pretty close here. Parties have four days to response the exceptions that were filed. And that is effectively August 1st. And then we will have an oral argument of the exceptions that’s scheduled for mid-August and we would expect to get an order in September. So stay tuned. The process is working and like I mentioned, we’ve got inter rate – interim rates in effect. And we will keep you apprised, but do go take a look at the exceptions. I thought that was interesting."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Duly noted. Thank you. All right, I’ll leave it there. Good luck guys. Speak to you soon."
},
{
"speaker": "Julie Sloat",
"text": "Excellent. Thanks, Julien."
},
{
"speaker": "Operator",
"text": "Next we’ll go to David Arcaro with Morgan Stanley. Please go ahead."
},
{
"speaker": "David Arcaro",
"text": "Hey, good morning. Thanks for the questions."
},
{
"speaker": "Julie Sloat",
"text": "Good morning."
},
{
"speaker": "David Arcaro",
"text": "Wanted to, let’s see – could you give some color on what your plans are going forward for Texas in terms of the generation outlook you’ve had some challenges there just with the repeat renewables proposal. I’m wondering how you’re thinking about that going forward in terms of strategy and generation pollution?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, absolutely. Yes. So we did file for rehearing, because we need to make sure that we’re doing all we need to do from a traditional regulatory and administrative perspective. And then what you can anticipate AEP doing is essentially running another RFP and running another process so that we can make sure that we’re doing what we need to accommodate the capacity situation in Texas. I do believe that Texas understands there is an adequacy issue that we would otherwise have to deal with. So that’s something that we will be proceeding forward with. So standby and you’ll see what we come to the street with here in the not too distant future."
},
{
"speaker": "David Arcaro",
"text": "Got it. And could there be a cell phone [ph] option in there? And to the extent there was, would that be, I guess, incremental to what’s currently in the renewable generation outlook for CapEx plan?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, that’s a possibility. That’s a possibility. But what we would do is, accommodate any type of investment in the current CapEx forecast."
},
{
"speaker": "David Arcaro",
"text": "Okay. Got it. Understood. And then you do have a couple other renewable projects out there for approval this quarter in several states. I was just wondering if you could give a sense of your confidence level in those before the proposals that you’ve put forth and what alternatives you might have if there end up being challenges in any of those?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, and actually I’m trying to flip the page so we can kind of draw everyone’s attention to them. Right now, I’m looking at Page 32. So for example, we’ve got an application open in Virginia and we made the same filing in West Virginia. For Appalachian Power Company, we’re talking about 151 megawatts, about a $500 million investment for wind and storage capacity there. At this point the process is proceeding along as we would expect. So, I have nothing new to report. So, standby there. And trying to think of where else we have open cases in Indiana, Michigan. Looks like staff has been supportive on the Michigan side, through those applications. And Indiana order is expected in 3Q, so the third quarter of this year. So stay tuned there as well. But so far constructive and productive and we’re moving forward. Then of course we also have, I guess I should call out the wind out – the Wind investment Rock Falls that’s included in the base case at PSO. But that’s part of the base case settlement. So as you know, I just mentioned that we’re well underway in that proceeding."
},
{
"speaker": "David Arcaro",
"text": "Got it. Okay. That’s helpful. Thanks so much."
},
{
"speaker": "Julie Sloat",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "And we can go to Sophie Karp with KeyBanc. Please go ahead."
},
{
"speaker": "Sophie Karp",
"text": "Hi. Good morning and thank you for taking my questions. I have a couple of questions here. First is on the renewables, right? So clearly Texas maybe has lesser appetite for renewables at this point. And I’m just curious if you how much of the incremental appetite for this do you think is left in Louisiana and like other states that picked up slack in this particular instance? Is there risk in the near term, I guess in your mind, that those states would also turn down potential future proposals because of their perception that they have? They’re pretty much like full as far as renewable generation goes."
},
{
"speaker": "Julie Sloat",
"text": "Sophie, I appreciate that question very much, because as you know, that’s been top of mind for us as we worked through that proceeding. So, we obviously got the approval for the 999 megawatts and Louisiana flexed up, so we’re moving along in that regard. You may recall that we also had another process that was underway for SWEPCO in particular, I want to say it was 2,400 megawatts that we were seeking interest in as it relates to how we would put that portfolio together. And so what we’ve done is, we’ve actually tabled that and we’ll be coming back to everyone to say, look, we want to look at this from an all source perspective, including PPAs. So stay tuned on that because there is absolutely a capacity need. It’s just going to take a little different shape than what we were initially expecting as we were running that RFP process. And remember when you probably heard me saying earlier here today on the call; we need to make sure that we’re listening to our regulators. And so this is exactly what we’re doing as it relates to the conversation and the experience that we just had in Louisiana, Arkansas, and Texas. And so we are adjusting and moving forward. So there will be more RFPs stay tuned for that. And they will be more all source oriented, no different than what we would be doing in Texas as you call out. Yeah, it looks like not a lot of interest in renewables there right now. So we need to think about what the other alternatives are, but we will work together with our regulators so that we can make sure that we’re doing what the state needs. Because at the end of the day, this is all about making sure that our customers have reliable, affordable electricity period."
},
{
"speaker": "Ann Kelly",
"text": "Yes. And just to reiterate on our capital plan, so far $5.2 billion of projects have already been approved and we have another $1.7 billion that, that Julie just talked about in the regulatory process that’s out of our $8.6 billion. So we are well on our way and we also have flexibility with our transmission and distribution investments to fill in to the extent that anything else gets delayed a little bit in the process with these RFPs."
},
{
"speaker": "Sophie Karp",
"text": "Great, great. Thank you. My other question was in the ROEs, maybe I’m referencing Slide 34 here, my reading this right, that the 40 bps – depressed by 40 bps per mild weather is sort of average across the board. So if it wasn’t for weather, all of these bubbles would be like roughly 40 bps higher or how should we think about this? There’s like a lot of numbers here."
},
{
"speaker": "Ann Kelly",
"text": "Yes. That 40 bps is on average. Okay. So let me answer it this way though, because when I’m thinking about what does this mean for the rest of the year, and as I mentioned in my opening comments, we had initially anticipated or expected on a weighted average basis. We'd be about a 9.4% ROE across our operating companies in our 2023 guidance. And so now what we're suggesting is now that we have a little bit of a hole that is associated with weather on that ROE can't make all that up, I don't think, unless we had some ridiculous weather circumstance in the back half of this year. So we're not going to bet on that because we're going to bet on normal. And so what I would expect is we expect to improve from 8.6%, it will not get to that 9.4%. So even if you get closer to 9%, I think that's reasonable. And our point that we want to make today is despite the fact that we've had pressure as a result of weather, we're adjusting the sales and we fully well expect to be within our guidance range. And so that's the important key to take away today as it relates to our messaging. Then with also the understanding behind the scenes we just need to fundamentally do our very best to make sure we're earning as close as possible to those authorized ROEs beyond the weather situation."
},
{
"speaker": "Sophie Karp",
"text": "Got it. So just to be clear, the 8.6% is the average with the Transmission Holdco?"
},
{
"speaker": "Julie Sloat",
"text": "Yes."
},
{
"speaker": "Sophie Karp",
"text": "Of all distribution…"
},
{
"speaker": "Julie Sloat",
"text": "Weighted average. Yes."
},
{
"speaker": "Sophie Karp",
"text": "Okay. Got it."
},
{
"speaker": "Julie Sloat",
"text": "Thank you. You bet."
},
{
"speaker": "Ann Kelly",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "And next we go to Paul Patterson with Glenrock Associates. Please go ahead."
},
{
"speaker": "Julie Sloat",
"text": "Hey, Paul."
},
{
"speaker": "Paul Patterson",
"text": "[Indiscernible] I'm managing. So just – most of my questions have been answered. Only I have a question for you that's a little bit different and that is the Chevron's defense. It looks like that know that the Supreme Court might act on it. And I'm kind of scratching my head and I was thinking what you guys might be thinking about what might happen if in fact, the Chevron doctrine or whatever you want to call it is substantially changed or were repealed or what have you. Do – have you guys thought about this or I'm sure you've thought about it, but any ideas about what you think that might mean for you guys on the ground?"
},
{
"speaker": "Julie Sloat",
"text": "Paul, I don't have a lot of detail to share with you today. I do know that our legal team is looking into this and our strategy team. But for my day to day right now at the moment, not been top of mind I'm just taking comfort knowing that the rest of the team's working on it. But hey, if you have a conversation, I'm happy to circle back."
},
{
"speaker": "Paul Patterson",
"text": "Okay, sure."
},
{
"speaker": "Julie Sloat",
"text": "Yes."
},
{
"speaker": "Paul Patterson",
"text": "It was my first question, but the rest were answered, so thanks so much and I'll follow up with you guys later."
},
{
"speaker": "Julie Sloat",
"text": "That'd be great. Thank you."
},
{
"speaker": "Paul Patterson",
"text": "Okay, great. Thank you"
},
{
"speaker": "Operator",
"text": "We'll go to Paul Fremont with Ladenburg. Please go ahead."
},
{
"speaker": "Paul Fremont",
"text": "Thank you very much. I guess my first question is if you were to get the securitization proceeds, does that change the equity issuance plans that you lay out on Slide 28?"
},
{
"speaker": "Julie Sloat",
"text": "No. No, it really doesn't. So if we get the securitization proceeds, what we would do is reinvest that into the other areas within the AEP footprint. So not in APCo but in the other areas so that we're in making sure that we continue to earn on the investment while getting the benefits to the Appalachian Power customers."
},
{
"speaker": "Paul Fremont",
"text": "And then my second question sort of related is if you were to get incremental CapEx, what percent should we assume would be equity funded versus let's say debt funded?"
},
{
"speaker": "Julie Sloat",
"text": "Yes, I mean I would assume just kind of the average of what we have in the current plant. Yes, Paul, we typically get, if we have an opportunity to invest more we're going to try to manage directly back to those target ratios that we throw out there and obviously be mindful of debt to cap as well. So at this point, we're focused entirely on executing on the plant that we already have out in front of you. The issue could be from time to time is how much slides from one year to the next. So you're kind of playing with the toothpaste tube, right? So you're just on passing the CapEx back and forth, because we got $40 billion that we're put into work. And again, at this point, while we always have more opportunities we need to make sure that this is affordable for our customers as well. So that's going to be another stopping point for us too because we're essentially trying to thread the needle, make sure the balance sheet stays strong, make sure those metrics are absolutely in place, but make sure that, our customers are able to afford what we're essentially providing. Our regulators definitely help us with that, but that's also precisely why we have to be really disciplined and not just continuing to spend CapEx that would be fun and nice to spend and actually absolutely make our system stronger and absolutely reliable. But is that what is necessary to keep the lights on and what customers can afford. So it is a constant balancing act for us."
},
{
"speaker": "Paul Fremont",
"text": "Great. Thank you very much."
},
{
"speaker": "Julie Sloat",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]"
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, IR team will be available to answer any additional questions you may have. Brad, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Certainly. Thank you. Replay will be available after 11:30 today and running through August 4 at midnight. You can access the AT&T replay system at any time by dialing 1-866-207-1041, and entering the access code 1289635. International parties may dial 402-970-0847. Those numbers again, 1-866-207-1041 and 402-970-0847 with the access code 1289635. That does conclude our call for the day. Thanks for your participation and for using at AT&T teleconference. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 1 | 2,023 | 2023-05-04 09:55:00 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to American Electric Power First Quarter 2023 Earnings Conference Call. At this time, your telephone lines are in a listen-only mode. Later, there will be an opportunity for questions and answers. [Operator Instructions] As a reminder, your call today is being recorded. I'll now turn the conference call over to your host, Vice President of Investor Relations, Darcy Reese. Please go ahead.
Darcy Reese: Thank you, Alan. Good morning, everyone, and welcome to the first quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Ann Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie.
Julie Sloat: Thanks, Darcy. Welcome everyone to AEP's first quarter 2023 earnings call. It's good to be with everyone this morning. Our direction and strategy remain on track with an emphasis on our generation fleet transformation and continued investment in our energy delivery infrastructure, which is all embedded and our five-year $40 billion capital plan. I'll start with an overview of our financial performance for the first quarter before discussing our Kentucky operations following the termination of our transaction with Liberty. I'll then provide some updates on our unregulated contracted renewable sale, retail business review and other strategic plans before closing with some insight into our progress on the regulatory and legislative front as we work to implement important new initiatives to ensure our customers and communities' needs are met and continue to come first, which you know enables us to deliver on our financial stakeholder commitments as well. A summary of our first quarter 2023 business highlights can be found on Slide 6 of today's presentation. We have a long-standing history of consistently delivering on our strategic objectives, and we're pleased to share that this quarter is no different. Turning to a high-level overview of our financial results. I can tell you that AEP delivered first quarter 2023 operating earnings of $1.11 per share, or $572 million. Weather this quarter ranked as one of the mildest in the past 30 years resulting in an unfavorable impact of first quarter results. Despite this, our thoughtful and disciplined approach to managing the business enables us to reaffirm our 2023 full year operating guidance range of $5.19 per share to $5.39 per share, and with a $5.29 per share mid -- $5.29 per share midpoint and long-term earnings growth rate of -- growth rate range of 6% to 7%. We're confident in the built-in flexibility we have in our business to ensure that we successfully deliver on our financial commitments and continue AEP's strong track-record of financial performance. We're also pleased to report that AEP has experienced minimal financial and operational supply chain impacts to-date, primarily due to our successful efforts to diversify our mix of suppliers and increase our order quantities to minimize the impact on our robust capital investment plan. Ann I'll walk through our first quarter performance drivers and share some perspective on our positive load outlook, as we continue to drive our economic development and service territory expansion. She'll also review the drivers to support our targeted 14% to 15% FFO to debt range. While our FFO to debt is at 11.4% this quarter, I am confident this metric will improve materially by year-end. As I mentioned to you on last quarter's call, simplifying and derisking our business profile is one of our top strategic priorities. By actively managing our portfolio and demonstrating a clear commitment to a disciplined execution of initiatives and transactions, we continue to deliver significant benefits to our stakeholders. Actively managing our portfolio also means staying flexible and being ready to change our focus and adapt our strategy when it becomes clear that certain transactions or initiatives may no longer be viable. A few weeks ago, our team was faced with this very challenge. On April 17, we announced the termination of the sale of our Kentucky operations to Liberty. Ensuring the best outcome for stakeholders remains our top priority and we took a disciplined approach to evaluating the continued pursuit of a sale and what that would mean in terms of economics, regulatory expectations, timing uncertainty. We ultimately determined that the better outcome was to terminate the pending sale transaction and to continue our work to develop a clear strategy for our Kentucky operations. I'm thankful for the team's ability to react and adapt to shifting circumstances for the long-term benefit of our customers, employees and investors. After the termination of the sale, AEP met with the Kentucky commissioners and key stakeholders. We discussed Kentucky Power's future and the collaboration needed so that we may continue to serve our customers in a reliable manner while ensuring the financial health and discipline of Kentucky Power moving forward. In the near term, we're renewing our focus on the region and support -- and our support of the communities we serve. You'll see in the earnings call materials today that Kentucky Power's earned ROE for the 12-month period ending the first quarter of 2023 is 2.9%. This does not reflect a financially healthy utility, which needs to be resolved in consideration of the interest of all stakeholders. The underperformance is due in part to a number of unique issues that are and will be addressed for improvement over the course of the next year. As we think about the opportunities ahead for our Kentucky operations, the actions we will be engaged and include a refocus on economic development, enhanced local system reliability, and controlling customer cost. We plan to file a base case in Kentucky in June with an expected six-month commission approval process, with new rates taking effect in January 2024. Other factors that will be beneficial in improving the financial profile and performance include using securitization to recover deferred storm costs and legacy generating plant balances and rightsizing the rate base. While we pivot in Kentucky, we're focused on the successful execution of other key transactions. In February 2023, we announced an agreement with IRG Acquisition Holdings for the sale of our 1,360-megawatt unregulated renewables portfolio. A summary of the renewable sale can be found on Slide 7. All regulatory filings were made in March, and at this time, we're waiting on approval from FERC under section 203 and clearance from the Committee on Foreign Investment in the United States and Euro Antitrust. We already have cleared Hart-Scott-Rodino approval and China Antitrust. Consistent with our prior messaging, we expect the sale to close near the end of our second quarter 2023 depending on the timing of regulatory approvals. The proceeds from the transaction will be directed to our regulated businesses as we transform our generation fleet and enhance the electric delivery infrastructure. Furthering our commitment to simplify and derisk the company, and summarized on Slide 8, we've agreed with our joint venture partner PNM Resources to sell our portfolio of operating and developing solar projects in New Mexico. This 50/50 partnership is known as New Mexico Renewable Development, or NMRD. And we hold this within our unregulated operations portfolio, AEP. NMRD owns eight operating solar projects totaling 135 megawatts, 150 megawatt project currently under construction and six development projects totaling 440 megawatts. Last week, an adviser was selected to move forward with the sale process. We anticipate making a sale announcement early in the fourth quarter of this year and will target closing by the end of 2023, subject to timing of regulatory approvals. We also have some news to share with you today. As you know, in October 2022, we announced the strategic review of our AEP Energy retail business, which primarily operates in the PJM markets. We've completed that strategic review and decided that we will start a sales process for that business and will also fold into the process AEP OnSite Partners, which is our unregulated distributed resources business. We've hired an advisor to move forward, and we'll keep you updated on the progress. We expect to launch the sale process sometime this summer, and we'll update you with the details along the way, but currently expect the completion of this transaction in the first half of 2024. We're focused on our core regulated utility operations and continue to evaluate all value additive potential activities to enhance their performance and look for opportunities to recycle capital. As a consequence of this effort, we've decided to pursue a strategic review of three of our non-core transmission joint venture businesses, including AEP's interest in Prairie Wind Transmission, Pioneer Transmission, Transource Energy. These businesses total approximately $551 million in net plant investment for AEP and consists of 370 line miles and four substations of in-service assets, as well as various projects under development in PJM and SPP. We'll definitely keep you posted on our -- or updated on our progress, but we expect to complete our review by the end of 2023 with a conclusion that consists of remaining in or divesting some or all of the businesses. So, let's switch gears and talk about AEP's regulated renewables execution. I'm pleased to share that we continue to make significant progress on our transition to a clean energy economy that provides more stable and predictable cost to our customers. Through our five-year, $8.6 billion regulated renewables capital plan, we have a total of $6.7 billion approved or before our commissions. Most recently, in March to be specific, we made regulatory filings for $1 billion of investment at INM, representing 469 megawatts of solar energy and another 151 megawatts of owned, wind, storage at owned and -- owned, wind and storage at APCo for $466 million. Public Service of Oklahoma Company along with other parties filed a settlement in early April of 2023 in the fuel-free power plan case, which relates to PSO's 995.5-megawatt solar and wind portfolio for $2.5 billion. Like, in any other negotiation, this settlement we focused on the assurance of customer benefits without undue risk to the company. In this case, the settlement provided crucial capacity without fuel expense that'll help address PSO's large capacity need. The case took a positive step forward last week when the judge issued a preliminary opinion approving the settlement on April 27, and the commission has a case on its agenda for today, May 4. For SWEPCO's 999-megawatt renewables project, which represents a $2.2 billion investment, parties recently filed an Arkansas settlement in January for these owned, wind and solar resources. In another positive development in Texas, the administrative law judge that oversaw the evidentiary hearing issued the preliminary order which recommended project approval. And in Louisiana, we reached the settlement, however, we were disappointed that the Louisiana Commission did not approve the settlement on April 26, but we remain optimistic that the matter will be reconsidered at the next meeting this month. We look forward to the continued consideration in Louisiana and orders coming in Arkansas and Texas in the second quarter. It's important to note that our regulated renewables goals are aligned and supported by our integrated resource plans, focused on reliability and customer affordability. In accordance with these plans, we have requests for proposals issued or preparing to be issued for additional resources at each of our vertically integrated utilities. We plan to make related regulatory filings over the next year while taking into consideration commission preferences from previous RFP processes. Now, let me provide an update on several of our ongoing regular and legislative initiatives. We're focused on reducing our authorized versus ROE gap. Have some work to do on that as our ROE was at 8.8% this quarter, driven in part by the unfavorable weather conditions that I mentioned earlier. On the effort to close the gap, I am happy to report that we reached the settlement and gained commission approval in January 23 -- 2023 that closed out our SWEPCO Louisiana base case. A key to this case was the ability to reset rates and recover costs under a formula rate plan. And we have already put this into action as we filed under this provision last month. Similarly, in April, AEP filed a formula rate review in Arkansas, which was authorized by that commission in the last base case. As we advanced through 2023, the team is actively pursuing rider recovery of the 88 megawatts of the Turk plant not currently in Arkansas rates. And the current base case in Oklahoma is set for hearing on May 9. So, we're making progress on the regulatory front. We also worked closely with our stakeholders on the legislative front in Virginia to improve the former triennial rate case process. The new biennial rate process became law in April after active -- after an active legislative session, APCo filed its last triennial in March of 2023 for the 2020 through 2022 period. The new law will require APCo to file its first biennial in 2024 with the biennial continuing in subsequent two-year period. So, it's going to work like this. The pending triennial will put rates in place for 2024 while we litigate the biennial in 2024 for rates effective in 2025, and we can help you with your modeling needs once we get a little further down the line here. Pivoting to our fuel cost recovery efforts for a minute. Our management of fuel cost recovery is a top priority for us with our total deferred fuel balance at $1.6 billion as of our first quarter. We adapted our fuel cost recovery across all of our jurisdictions with a focus on balancing customer impacts. In Texas, the commission approved the $83 million special fuel surcharge filed in October of 2022 and was being recovered subject to review since February 2023. So, making progress there. We are aware of the staff prudence filing last Friday, April 28 in West Virginia that recommended a disallowance of certain fuel costs. The recommendation was rooted in the commission's prior reference to a 69% capacity factor at our coal facilities. Prudence review is a report produced by an outside consulting firm hired by the staff. The report relies on factors beyond AEP's control and takes issue with some of the practices taken to ensure that our power plants would have fuel available to provide electricity during the peak winter period. Those in the area are very familiar with how the historic swing of fuel cost over the past two years placed extreme pressure on the system and fuel recovery mechanisms. We advocated for the securitization legislation that recently passed in West Virginia knowing it provided an effective path to deal with those issues. In line with this strategy, APCo made a filing on April 28 seeking West Virginia Commission approval to utilize the new securitization tool to pay off the $553 million deferred fuel balance as February 28, 2023. The filing also proposes to apply the mechanism to certain storm costs and legacy coal costs in a manner that minimizes cost impacts to customers while still addressing these historical costs. Related to the consultant's prudence recommendation, the new APCo filing also lays out the environment APCo was operating in over this volatile fuel time or time in fuel cost and the actions taken to ensure coal would be available on the most extreme days on the system. Our plan is to collaborate with the commission to address customer and deferred fuel concerns together for constructive path forward in West Virginia. After receiving the commission approval, the plan would be to issue bonds to securitize a combination of deferred fuel balance, deferred storm costs, and legacy coal plan balances in the amount of $1.84 billion in the first half 2024. So, wrapping it up, I'm pleased with the progress we're making, capitalizing on our momentum from 2022. We continue to deliver on our commitments and execute against our strategic objectives. We're taking a thoughtful and disciplined approach to simplify and derisk our business and investments we make to support our positive earnings growth and outlook. I proudly lead a team whose experience and expertise have made it possible for AEP to lay new groundwork for future success while also responding and adapting to the rapid changes we're seeing in our industry. Together, we're delivering safe, clean, affordable, and reliable energy to our customers and communities, all while creating values for our investors. With that, Ann -- I will ask her to now walk through the first quarter performance drivers and provide us with some details on our financing targets. So to you, Ann.
Ann Kelly: Thank you, Julie and Darcy. It's good to be with you all this morning, and thanks for dialing in. I'm going to walk us through our first quarter results, share some updates on our service territory load and finish with commentary on credit metrics and liquidity, as well as some thoughts on our guidance, financial targets, and portfolio management. Let's go to Slide 9, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter were $0.77 per share compared to $1.41 per share in 2022. For the quarter, I'll mention that we reflected the loss on the expected sale of the contracted renewables business as a non-operating cost, as well as an adjustment to true-up expected cost related to the Kentucky transaction in addition to our typical mark-to-market adjustment. There's a detailed reconciliation of GAAP to operating earnings on Page 15 of the presentation deck. Let's walk through our quarterly operating earnings performance by segment on Slide 10. Operating earnings for the quarter totaled $1.11 per share or $572 million compared to $1.22 per share or $616 million in 2022. The lower performance was primarily driven by the unfavorable weather, as Julie mentioned. When looking at historical weather in the first quarter of the past 30 years, we've only seen one quarter with more mild weather than the first quarter of 2023. Operating earnings for our Vertically Integrated Utilities were $0.52 per share, down $0.07. Favorable drivers included rate changes across multiple jurisdictions, normalized retail load, off-system sales primarily associated with Rockport Unit 2, transmission revenue and depreciation. I have more to share and load and performance, and we'll get to that in a minute. These items were more than offset by unfavorable weather, higher O&M and income taxes largely related to timing differences between the years and interests. We expect the year-over-year interest variance to be more pronounced in the first half of the year, as interest rates have somewhat stabilized. We also expect to see favorable O&M in the second half of the year compared to prior year, reflecting the timing of O&M spending and near-term actions that we are taking to help offset the unfavorable weather, such as holding positions open, reducing travel and adjusting the timing of discretionary spending. These actions are in addition to our ongoing efficiency efforts that allow us to offset the impact of inflation each year. I would like to take a second to talk about the off-system sales and depreciation. Due to the purchase of Rockport Unit 2 in December, we are seeing $0.05 of favorable off-system sales year-over-year since the margins are no longer shared with our retail customers. Also, due to the expiration of Rockport Unit 2 lease, I&M will see approximately $0.055 net favorable depreciation each of the first three quarters of 2023, plus an additional $0.035 in Q4. Including the impact of the Rockport lease, depreciation was $0.02 favorable versus the first quarter of last year. However, if you exclude the impact of the lease, depreciation would have been about $0.04 unfavorable, which is consistent with the incremental investment and a higher depreciable base in our Vertically Integrated Utilities segment. The Transmission and Distribution Utilities segment earned $0.24 per share, down $0.06 compared to last year. Favorable drivers in this segment included rate changes from the distribution cost recovery factor rider in Texas and the distribution investment rider in Ohio, as well as transmission revenue. Offsetting these favorable items were unfavorable weather, unfavorable O&M largely due to higher distribution spending in the quarter, higher interest and lower normalized retail sales due to customer mix. The AEP Transmission Holdco segment contributed $0.35 per share, up $0.01 compared to last year, primarily driven by $0.02 of favorable investment growth. Generation & Marketing produced $0.09 per share, up $0.06 from last year. Favorable drivers here include a higher retail and wholesale power margins, favorable development site sales, depreciation, and taxes. And finally, Corporate and Other was down $0.05 per share, largely driven by unfavorable interest. I'll note that this is due to both an increase in interest rates as well as higher debt balances. I'd like to remind everyone that we reflected the higher interest rates in our guidance that we provided on our year-end 2022 earnings call. While the quarter was unfavorable to the prior year, we are taking actions to offset the unfavorable weather, including the O&M refinements that I just mentioned, that give us confidence to reaffirm our full year guidance range. Turning to Slide 11, I'll provide an update on our normalized load performance for the quarter. We've continued to see load growth outperform when it's proving to be a weak economy across our service areas. This is most evident when comparing load performance across retail classes. So, we are seeing some weakness in residential loads. Our commercial and industrial classes are benefiting from new large customer volumes from our ongoing economic development efforts. This provides some potential upside to the full year outlook. Beginning in the upper left hand corner of the slide, normalized residential load was down as customers continue to be squeezed by the relationship between inflation and income growth. That relationship is a key driver of residential usage, and we expect to see it stabilize over the rest of the year. While we are seeing a decline in residential uses for customer, total residential customer counts were up by 0.5%, demonstrating growth in our service territory. Looking through the rest of the slide, you'll see that this was substantially offset by gains in our commercial and industrial loads attributable to new large customer additions. Normalized commercial sales accelerated an exceptional 7.8% compared to the first quarter of 2022. Though the growth in commercial sales was spread across many of our operating companies, gains were especially robust in AEP Texas and AEP Ohio, attributable to the new data center projects coming online in the new year. Outside of data centers, commercial gains were driven primarily by real estate, general merchandise stores, and food and drink establishments as individuals continue to move more freely in the wake of the pandemic. If we look to the lower left hand corner, we see the industrial sales resume their healthy pace of growth, increasing 5.1% from a year ago. As with commercial sales, gains were most robust in AEP Texas, while SWEPCO also experienced double-digit growth in its industrial sales. Looking at individual sectors, gains are most pronounced among oil and gas extraction and primary metal. You'll note that despite our strong commercial and industrial results for the first quarter, our expectations for 2023 load growth are still muted. Probability of a national downturn is extraordinarily high, and it's clear that activity is already slowed to a point that it's having a material impact on our customers' finances. While we expect the pace of economic growth to slow further, we don't anticipate a severe economic contraction across our service area in 2023. Though weaker than they were a year ago, household finances are still healthy by historical standards. Furthermore, the labor market continues to be resilient in the face of Fed rate hikes, which will serve to limit the severity of a potential downturn. These assumptions have been baked into our full year guidance for some time allowing us confidence that our projected load growth for 2023 is very much achievable. Adding to that confidence is our believe that there is more upside to our load projections than downside, stemming from a disciplined commitment to economic development across our service area. We know that working with local stakeholders to attract more economic activity is a key strategy to providing value to our customers. This allows us to continue to prioritize investments that will improve the customer experience while mitigating the rate impacts on our customer base. So, let's move to Slide 12 to discuss the company's capitalization and liquidity position. Taking a look at the upper left quadrant on this page, you can see our FFO to debt metric stands at 11.4%, which is a decrease of 1.8% from year-end and below our long-term target. The primary reason for this decrease is a $1.9 billion increase in balance sheet debt during the quarter, partially due to the return of the mark-to-market collateral positions associated with the decline in natural gas and power prices. Return of collateral also reduces our funds from operations, so it hits us on both sides of the equation. Without the fluctuations in our mark-to-market collateral positions, our FFP to debt metric will be closer to 13%. We expect that this metric will improve by year-end as we reduce debt after the close of the announced renewable sale and our 2020 equity units conversion, and our funds from operation improve over prior year, predominantly in the fourth quarter. We remain committed to our targeted FFO to debt range of 14% to 15% and plan to trend back into this range early in 2024 as we continue to work through the regulatory recovery processes of our deferred fuel balances. You can see our liquidity summary in the lower left quadrant of the slide. Our five-year $4 billion bank revolver and two-year $1 billion revolving credit facilities that was just extended to March 2025 support our liquidity position, which remains strong at $3.4 billion. The $800 million increase in liquidity from last quarter is mainly due to a decrease in commercial paper outstanding from long-term debt issuances. On a GAAP basis, our debt to capital ratio increased from the prior quarter by 1.2% to 64.1%. We plan to trend back closer to 60% this year as we close our announced sale transaction and complete our previously planned equity units conversion. On the qualified pension front, our funding status decreased 1.1% during the quarter to 101.3%. Rates fell during the quarter, which caused the pension discount rate to decrease, driving an increase in the liability that was greater than the gain on assets. Now turning to Slide 13. The first quarter has brought a significant challenge our way in the form of unfavorable weather. As we progress through the remainder of the year, we will continue to take action to manage our business and mitigate this impact. Our core business remains in a strong position and we are reaffirming our operating earnings guidance range of $5.19 to $5.39. We also continue to be committed to our long-term growth rate of 6% to 7%. As Julie previously addressed regarding the terminated Kentucky sale transaction, we are establishing a new -- a renewed focus in long-term strategy in order to maximize the full potential of our Kentucky operations going forward. We are on track to close the divestiture of our unregulated contracted renewables portfolio in the second quarter of this year, have announced the sale of our retail and distributed resources businesses, and are embarking on a review of some transmission joint ventures. These initiatives will help us to simplify and derisk our business while we continue to focus on the fundamentals, executing the $40 billion transmission, distribution and regulated renewables capital plan, disciplined O&M management and positive regulatory outcome. We really appreciate your time and attention today. And with that, I'm going to ask Alan to open the call so we can hear what's on your mind and answer any questions that you have.
Operator: Thank you. [Operator Instructions] Our first question will come from the line of David Arcaro with J.P. Morgan. Go ahead.
David Arcaro: Hi, thanks so much for my question. Dave Arcaro at Morgan Stanley. Let's see, maybe starting on the transmission business, I was wondering if you could elaborate a little bit on your strategic thinking there. What makes those assets non-core? Why that size of assets? And wondering what you're thinking -- if it does come to a divestiture decision, what you would plan to do with the proceeds? Could that reduce equity needs in the plan from here?
Julie Sloat: Yeah, thanks so much. Appreciate the question. As we continue to talk about simplifying the business, I wouldn't necessarily put the transmission strategic review of the JVs as a derisking, because we are very comfortable with the risk profile of transmission, JV or otherwise. So that being said, this is more about simplification and really focusing on our ability to deal with customers in our footprint. So, nothing wrong with these assets. We love the assets. But we'd really like to take those dollars and channel them toward the traditional core utility business and transco utility business we have at American Electric Power. So -- and why Transource and Pioneer and Prairie Wind? Again, those are outside of our traditional footprint that we have today. ETT is a little different, and it is not necessarily under currently -- or not under current review at this point, as we focus on these pieces that are outside of our footprint. So, we'll see how this goes as far as utilizing any proceeds that we would have from a sale transaction should that occur. Again, this is a strategic review. We haven't made any decisions yet. What you should expect us to do is the same thing we've been talking about, dollars get channeled to traditional investment in the regulated utility operations. Clearly, have a lot to do on the transmission side. But when you bring dollars in the door, our expectation is to maintain a very healthy balance sheet. We've got a little bit of work to do. Ann talked about that in her opening comments. The metric should heal by the end of the year. So, we feel confident in that regard. But going out further in the timeline, we would always look to make sure the metrics are good. And then if we can, responsibly reduce equity issuances in future periods. But again, strategic review underway. We'll keep you apprised. And I would expect this would be more of a story as we get through the end of 2023 with the strategic review. And if anything were to occur, being 2024 story for us. So, thank you for the question.
Operator: We'll go next to line of Jeremy Tonet with J.P. Morgan. Go ahead.
Aidan Kelly: Hi. This is actually Aidan Kelly on for Jeremy. Good morning. So just shifting to the New Mexico and retail distributed resources sales, could you talk more about the prospective of buyer market you're seeing right now? Any insight on the type of buyer you would be interested here? Also, just any language on OnSite Partners as well with the G&M segment would be great. Thanks.
Julie Sloat: Yeah, you bet. So let me take a couple of different tacts at this. So number one, as you know, we've had a strategic review underway for the retail business. So that shouldn't be a surprise. Scooping in the OnSite Partners businesses is the new addition today. Those comprise about -- Energy Partners is about, I'd say, $0.04 of -- I'm sorry, I should say, retail business is about $0.04 of the component that we're talking about in terms 2023 guidance. OnSite Partners is about $0.02. So let me give you those parameters, so you know exactly what we're talking about. NMRD is about $0.01 of the 2023 guidance. You got a few pennies there that we're playing with. As far as who are the likely buyers, let me answer it this way. We're already dealing with a multitude of buyers from our unregulated contracted renewables business. So, we're very familiar with that space because we have that contract underway with that piece of the business. NMRD, I would think would fit more closely with that type of activity in terms of the parties that might be interested in that particular asset base. But then let's move to the retail business. I think you got a little bit more of a narrower or more unique buyer set for that particular piece of the business. And then -- and I won't go into any names, but just given the nature of the business, the field narrows just a touch. And then on the distributed part of the business, meaning OnSite Partners, it got hundreds of parties that could be potentially interested in that. The other thing that we're thinking about is when we start working with our financial advisor to move forward with the transaction, there could be a situation where you have a combined platform where both the retail and the distributed pieces of the business are put together and sold that way. But we're completely open to separating the [two tube] (ph) just because you've got different buyer bases. Can't really opine on it yet just because we're just getting started with it, but we will absolutely keep you apprised of what our progress is and what we're experiencing as we move through time here. So early stages, but well underway in terms of getting the financial advisor kicked off and then the process started.
Operator: We have a follow-up question from the line of David Arcara with Morgan Stanley. One moment, please. Apparently, that line is not in queue. We'll go next to the line of Shar Pourreza with Guggenheim Securities. Go ahead, please.
James Ward: Hi. This is James Ward on for Shar. Thank you for taking our questions. First, as you look towards your June rate case filing in Kentucky, how are you thinking about the key asks in this case? And as a follow-up, could you expand on how you see capital allocation to this jurisdiction developing in the context of your overall investment plans over the forecast period?
Julie Sloat: I still appreciate that. And I get it, you guys have a really busy morning. So, I know we have different names who don't typically cover us. So, I just -- I'm still appreciative of your time and attention today. Lots of companies reporting. So that being said, on the Kentucky front, stay tuned, because what you'll -- you should expect us to do is be in conversations with the different stakeholders, with the commission, and staff in particular in Kentucky to make sure we're scratching all the inches. We want to be successful in the arena. And we are going to absolutely have a very thoughtful approach in sensitivity to reliability. We need to make sure that we're keeping the lights on and keeping them affordable for the state of Kentucky and the area that we serve in particular. So, I have a lot of granularity to share with you today other than to assure you that we will be working collaboratively with the partners in that jurisdiction. So, extremely important to us particularly when you look at where the current ROE is. We need to get that up. We need that utility company to be in a healthy situation so we can continue to have low cost capital allocated to that particular piece of the business. And then, I'll ask Ann to talk a little bit about our capital allocation and how we're going to digest that from Kentucky.
Ann Kelly: Right. So, our capital plan, the $40 billion capital plan going forward is not going to change. We would just be reallocating from other areas within the same segment. So, you would expect to see the transmission, distribution, generation, all those planned numbers for the five-year timeframe will stay the same. We will just allocate within jurisdictions to Kentucky to make sure that they are focused on reliability, as Julie mentioned.
Operator: Our next question will come from the line of Durgesh Chopra with Evercore. Go ahead.
Durgesh Chopra: Hey. Good morning, team. Thanks for giving me time. Hey, just I know you gave us property plant and equipment number on the transmission assets, which are up for strategic review. Is there a rate base number that you have handy that you can share with us? If not, I'll just follow-up with Darcy.
Julie Sloat: You know what, Durgesh, thank you so much for your question. I don't have a rate base number in front of me. We can absolutely get that to you though. So, we'll circle back with you. But the $551 million, as you point out, is the net plant position that is attributable to AEP in particular.
Operator: We'll go next to the line of Andrew Weisel with Scotiabank. Go ahead.
Andrew Weisel: Hi, good morning. Thank you. First question on the balance sheet. Just to clarify, if none of these transactions move forward besides contracted renewables, what's your degree of confidence in the targeted credit metrics and FFO guidance, and over what time period?
Ann Kelly: Yeah. So what I talked about earlier was based on that scenario. We have not modeled in any additional asset sales transactions besides the contracted applicable. So, we would expect an improvement by year-end and getting it within our targeted metrics early next year.
Operator: We'll now go to the line of Anthony -- pardon me, Anthony Crowdell with Mizuho. Please go ahead.
Anthony Crowdell: Great. I guess two quick questions. One is on Slide 27 that shows the underearning gap. I guess when I look at the like five OPCos that are under earning anywhere between 90 to greater basis points. What's a reasonable assumption of underearning we could assume when you closed that gap and during what timeframe? And then the follow-up is -- and I may have not heard correctly. I think -- I don't know if it's a Turk plant or the Rockport plant, you've bought back or it's maybe not part of lease or maybe I didn't hear that correctly. Does that now move to the G&M segment in reporting? Thank you.
Julie Sloat: Yes. Thanks so much for the question. I'm going to take your first one on the ROEs. I'm going to back up the truck a little bit. You may recall when we provided 2023 earnings guidance, the average ROE across the system for our regulated businesses was going to be around 9.4%. Today, as you know, we're at 8.8%. So here's my expectation. I expect we're going to close that gap as we get toward the end of the year. And as you know, I mentioned several different regulatory filings and successes that we've had in 2023 that are going to help us close that gap. So we feel confident that gap will close, but I do expect that we'll be a little under that 9.4%. Importantly, we have not changed our earnings guidance, so we still plan to get within the goalpost on the earnings guidance and growth rates. So I'm not worried about that either, but it's going to take us a little longer to close the gap versus the 9.4% that we had in that 2023 guidance. So, I'll leave you with that. And as you know, we're not dependent on any single one utility company to get in a direct earning level relative to authorized, that's the benefit of having a portfolio of utilities. But boy, I surely would love to close that gap and be within 10s of basis points versus the authorized in each of our jurisdictions. That's an objective. It's just going to take us a little while to get there because, as you know, these things have a little bit of a lead time on them. So stand by and know the guidance is sound. And then on the Rockport unit, that actually it becomes a merchant unit. And I believe that's captured in, what, our Vertically Integrated Utilities segment, right? And that would be captured as off-system sales, okay? So, hopefully, that will help you with your modeling needs there, too.
Ann Kelly: And that's due to the ownership structure. So, we didn't want to move it because it's still owned by the Vertically Integrated Utilities.
Operator: We have a follow-up question from the line of Shar Pourreza with Guggenheim. Go ahead.
James Ward: Hi. James Ward here again. Thank you for this follow-up. Unrelated to the prior question, just wanted to ask, assuming the successful eventual sales of both your retail business, distributed resources and the three non-core transmission JVs you highlighted today, how should we think about the source of funds for future financing needs? And specifically, will asset sales and capital recycling always factor into your financing approach? Or is there a point at which you would no longer look to recycle assets? Thank you.
Julie Sloat: Yes, I -- this is Julie. I'll hand it to Ann here in a minute. Here's how I look at it. Simplification and derisking the business should be part of our fabric. So, we are going to continually look at where the best use and highest value is for each of the dollars that we put to work. So I think that's our job is to make sure that the portfolio of assets we have is the best we can have in the highest earnings. You go back to the question I just answered around earning your authorized ROE, we have to do better at that, and we'll continue to do better at that as we go down the path here. So, I do think you should keep that in back of the mind. We will continue to keep you updated on and signal to you if we think there's a business that might fit that profile that we would consider recycling it. But the ones that you see us talking about today are the ones that are absolutely those in terms of strategic review on the JV side of the house, transmission that -- we love transmission, but we may be able to put that to better use inside the traditional footprint. And then, clearly, on the unregulated side of the house, we want to derisk and simplify. It makes complete sense to move forward with those actions that we outlined today. So Ann, I don't know if you want to talk any more about or add any additional color to that?
Ann Kelly: Yeah, I mean you're absolutely right, Julie. And when we look at the cash flows, which are on Slide 24 that we've only modeled in the contracted renewables sale here. So any additional sales proceeds will also be able to strengthen the balance sheet. And as we mentioned, we could potentially selectively reduce the equity issuances going forward, while maintaining the same capital plan.
Operator: Our next question will come from the line of Sophie Karp with KeyBanc. Go ahead.
Sophie Karp: Hi. Good morning, and thank you for taking my question. I wanted to ask you about the Texas utilities and the ROE gap there. I guess in Texas, the regulatory recovery mechanisms are very constructive, right? So, you have your DCRF and TCOS and whatnot. So what needs to be, I guess, addressed there to close that gap specifically? Could you speak to that?
Julie Sloat: Yeah, I still appreciate that question. So thanks for being on the call today. We're working on it. So let me start with the backdrop on the story. As you know, we continue to channel a great deal of capital to AEP Texas. We do think the recovery mechanisms there are very good. We always think there's opportunity for improvement. So I'll talk about that here in a moment. But one of the things that we've gotten comfortable with, with the touch of underearning relative to authorized in Texas, is the amount of growth that we have in Texas. So on average, we can grow earnings there at 10%, but I got to take a little bit of a haircut because no regulatory recovery is perfect. But we're trying to work on that. And so for example, if you read on Page Number 27, there's some commentary under the little earnings bubble there that we talk about bi-annual TCOS filings to recover significant capital investment. Those good things. We love that. We do have some legislation that is in process and working through that relates specifically to the DCRF and the ability to shorten that timeframe. So maybe we can do that twice a year versus annually. So that will help to kind of close that gap a little bit. And then there's also some legislation around cap structures, too, that might be helpful to us. So, we're trying to work all the different angles. Not to mention the other thing that we're thinking about and continue to talk about is, a way to continue to use those excellent cost recovery mechanisms that are much more progressive in Texas throughout the period, even when you're in for a base case. So, we're trying to use the legislative aspects as well as just trying to be as efficient as possible to close that gap. But we've been comfortable in the near term, taking the little bit of a hit relative to authorized on the ROE because we can grow earnings there and the demand is there. So that was the rationale. But we love the business. We're just trying to make it better in terms of recovery.
Operator: We'll go now to the line of Julien Dumoulin-Smith with Bank of America. Go ahead.
Julien Dumoulin-Smith: Hey, good morning, team. Thank you guys very much. Appreciate the time. Just following up on a couple of the remarks earlier. Just can you elaborate a little bit more on next steps here as you think about Louisiana? Obviously, a little bit of a setback here, but you alluded to potentially putting this back on the -- or maybe not you all, but perhaps the commission electing to reconsider the matter next month. Can you elaborate on the procedural element there, but also some of the other avenues, there's a flex consideration here that can be pursued to the extent to which there may be different outcomes?
Julie Sloat: Yes. Julien, thank you for being on the call today. And that is absolutely top of mind for us. As you know, and I mentioned in my opening comments, we're able to get to a settlement agreement and the Louisiana staff filed constructive testimony with conditional approval, all that good stuff. So, we want to continue to work that angle. And actually, one of the commissioners suggested that the decision could be recalled at the next meeting for reconsideration once some additional information is shared. So, we have that top of mind for us. So here's what you should expect from SWEPCO. You should expect to see us seeking rehearing in which we continue to be optimistic that we can pool this across the goal line. So, stay tuned on that. I don't want to get too much in the weeds on it just yet because we're literally in game with that right now. And then specifically, we would hope that this is going to move forward, and we'll have all three jurisdictions stepping in line and be able to absorb with positivity, the applications that we have in front of them. But do we have flexibility in terms of flexing up in the other jurisdictions? On a discrete basis, we think that there is that opportunity with the different projects that we have that are included in that filing. So again, nothing specific to share today. But rest assured, we're looking at all the different tools and angles in the tool bag there that we're able to use should we need a different route if Louisiana can't get there. But we're optimistic and we're having conversations, so stay tuned.
Operator: We'll go next to the line of Paul Fremont with Ladenburg. Go ahead.
Paul Fremont: Thank you. I guess my first question is on FFO to debt. In order to hit the sort of the 14% to 15% targeted range, should we assume that you need to basically collect on the $1.6 billion in fuel deferrals? And can you give us a sense of the timing that you would expect to recover those amounts?
Ann Kelly: Yes, I'll take that, Julie. So, we would expect to collect over the extended timeframes that we have already agreed upon within our jurisdictions. And with respect to West Virginia, we have that model taking advantage of the securitization in the first quarter or the first half of next year.
Operator: We have a follow-up question from the line of Sophie Karp with KeyBanc. Go ahead.
Sophie Karp: Hi. Thank you for giving me more time. If I can ask a follow-up on Kentucky, right, like asked differently, when you spoke to regulators there, and clearly, you need to bring the ROE up, right? But what kind of a rate increase would that require for Kentucky rate payers? And like do you get the sense of kind of like the upper limit of the appetite that the regulators might have for rate increases in this environment?
Julie Sloat: Yeah. So, let me answer that this way. I don't have specific numbers to share with you today because when we actually had the conversation, we hadn't announced earnings yet, okay? So that's new information today, that's public today. And so this will be the go-back conversation that we'll have. And again, the plan is truly to collaborate, because I'm confident that the commission and the commissioners are interested in having a very sound -- financially sound utility company. And so we'll all be working in that same direction. Now as far as tools in the tool bag, obviously, we'll try to influence the top-line with economic development and things of that nature. That takes a little longer, as you know, because it's got a little longer lead time on it. But we know we're really successful with that, too. So stay tuned. And then, of course, we'll be very sensitive to cost as well. The other thing that will be top of mind for us is using the new tools in the tool bag is securitization, okay? So, we've got deferred storm costs that are sitting on the balance sheet. We have an opportunity to take care of net plant of legacy coal plants that's sitting on the balance sheet, too, to the tune of something like $290 million associated with Big Sandy. So those are things that we'll be able to securitize and then kind of back into what -- how we need to make that math work. And I mentioned that also talks about or at least strikes at the idea of kind of rightsizing the rate base. So, we work with the commission and all the various stakeholders in the state of Kentucky that we deal with to make sure that we're getting where we need to be. But honestly, from my seat and from a utility seat, just 2.9%, it's not healthy. We need to get it in a healthy situation. And that will be top of mind for us, because we've got to keep the lights on to and keep it affordable. So stay tuned. We don't have a lot of color to share today because we're literally in game. This is a new data point with 2.9%, okay? But Sophie, thank you for jumping back in line.
Operator: We have a follow-up question from Paul Fremont with Ladenburg. Go ahead.
Paul Fremont: Thanks. So, the assumption is that you will -- that you're assuming you'll get securitization in West Virginia as part of getting to the -- to that 14% to 15% FFO to debt?
Julie Sloat: Paul, this is Julie. Actually, securitization will be a great thing, and that helps us, give us a little more flexibility, more importantly, it's good for the customer. And so, when we filed for our new ENEC filing that we made on what was it like February -- I'm sorry, April 28, I think, was the date that we filed it. What you'll see is that we have two proposed options to recover the fuel balance in our filing. And one is to spread the recovery over three years, and the other is to use securitization for the under-recovered fuel balance. And as part of that, we also looked in as an option, again, with the idea and backdrop and motivation is to protect the customer rates because we can't have them trying to swallow a watermelon here is to essentially securitize plant balances from legacy coal plants, so Amos and Mountaineer in particular, and I think we have some storm costs in there as well. And so when I mentioned today, that $1.84 billion number that we would like to securitize, that's all in. And so, we're trying to give the commission options so that we can all work collectively to make sure that the citizens and customers of West Virginia are protected, but that we still have a healthy utility and we're able to hit the balance sheet metrics that we need. So, it's doable. It's absolutely doable, we'll just need to move through the process.
Ann Kelly: And one thing just to add on FFO to debt, when you think about just the quarterly dynamics, in Q4 of last year, due to market conditions, we did have a significant outflow of collateral as well as an increase in deferred fuel. So, as we get through that this year, and that quarter rolls off, that will significantly help our FFO to debt as well.
Operator: [Operator Instructions] We have a follow-up question from Paul Fremont with Ladenburg. Pardon me, that line did not open up. We have Bill Appicelli with UBS. Go ahead.
Bill Appicelli: Hi, good morning. Most of my questions have been asked and answered. But just a question around the timing of the approval for the contracted renewable sale. You made the filing on March 22. I guess what gives you the comfort that you'll get approval in Q2? And I guess what's the -- what do you need to demonstrate in those filings to get approval both at FERC and on the Committee on Foreign Investment?
Julie Sloat: Yes. So as far as FERC and the other two approvals that we'll need to get, let me answer it this way. When we made the filing initially, we had requested at FERC a 60-day approval process. So, we would like to get an order within 60 days. May 22 would be 60 days. And given that this is normal kind of traditional business unregulated, not tied to significant customers and multiple stakeholders, we don't anticipate any material roadblock as it relates to getting not only FERC approval, but the clearance from the Committee on Foreign Investment in the United States and/or approval under any of the applicable competition loss. So we're comfortable with where we are and expect that we should have that in pretty short order, which gives us confidence to say we think that we'll get this done by the end of the second quarter at the latest. But we'll keep you apprised if anything were to come up. But at this point, we're past commentary periods, and everything seems to be going relatively smoothly. So, anyway, I'll leave it at that, and suggest that if anything shifts, we'll be right in front of you immediately.
Operator: We have no further lines in queue at this time.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Alan, would you please give the replay information?
Operator: Thank you. Ladies and gentlemen, this conference will be made available for replay beginning today, May 4, 2023, at 11:30 a.m. Eastern Time through May 11, 2023, at midnight. During that time, you can access the AT&T Executive Playback service by dialing toll-free, 866-207-1041, internationally, you may dial area code 402-970-0847, and the access code is 2036342. Those numbers again are toll-free, 866-207-1041, internationally, area code 402-970-0847, and the access code 2036342. That will conclude your conference call for today. Thank you for your participation, and for using AT&T Event Teleconferencing. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. Welcome to American Electric Power First Quarter 2023 Earnings Conference Call. At this time, your telephone lines are in a listen-only mode. Later, there will be an opportunity for questions and answers. [Operator Instructions] As a reminder, your call today is being recorded. I'll now turn the conference call over to your host, Vice President of Investor Relations, Darcy Reese. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Alan. Good morning, everyone, and welcome to the first quarter 2023 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Ann Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie."
},
{
"speaker": "Julie Sloat",
"text": "Thanks, Darcy. Welcome everyone to AEP's first quarter 2023 earnings call. It's good to be with everyone this morning. Our direction and strategy remain on track with an emphasis on our generation fleet transformation and continued investment in our energy delivery infrastructure, which is all embedded and our five-year $40 billion capital plan. I'll start with an overview of our financial performance for the first quarter before discussing our Kentucky operations following the termination of our transaction with Liberty. I'll then provide some updates on our unregulated contracted renewable sale, retail business review and other strategic plans before closing with some insight into our progress on the regulatory and legislative front as we work to implement important new initiatives to ensure our customers and communities' needs are met and continue to come first, which you know enables us to deliver on our financial stakeholder commitments as well. A summary of our first quarter 2023 business highlights can be found on Slide 6 of today's presentation. We have a long-standing history of consistently delivering on our strategic objectives, and we're pleased to share that this quarter is no different. Turning to a high-level overview of our financial results. I can tell you that AEP delivered first quarter 2023 operating earnings of $1.11 per share, or $572 million. Weather this quarter ranked as one of the mildest in the past 30 years resulting in an unfavorable impact of first quarter results. Despite this, our thoughtful and disciplined approach to managing the business enables us to reaffirm our 2023 full year operating guidance range of $5.19 per share to $5.39 per share, and with a $5.29 per share mid -- $5.29 per share midpoint and long-term earnings growth rate of -- growth rate range of 6% to 7%. We're confident in the built-in flexibility we have in our business to ensure that we successfully deliver on our financial commitments and continue AEP's strong track-record of financial performance. We're also pleased to report that AEP has experienced minimal financial and operational supply chain impacts to-date, primarily due to our successful efforts to diversify our mix of suppliers and increase our order quantities to minimize the impact on our robust capital investment plan. Ann I'll walk through our first quarter performance drivers and share some perspective on our positive load outlook, as we continue to drive our economic development and service territory expansion. She'll also review the drivers to support our targeted 14% to 15% FFO to debt range. While our FFO to debt is at 11.4% this quarter, I am confident this metric will improve materially by year-end. As I mentioned to you on last quarter's call, simplifying and derisking our business profile is one of our top strategic priorities. By actively managing our portfolio and demonstrating a clear commitment to a disciplined execution of initiatives and transactions, we continue to deliver significant benefits to our stakeholders. Actively managing our portfolio also means staying flexible and being ready to change our focus and adapt our strategy when it becomes clear that certain transactions or initiatives may no longer be viable. A few weeks ago, our team was faced with this very challenge. On April 17, we announced the termination of the sale of our Kentucky operations to Liberty. Ensuring the best outcome for stakeholders remains our top priority and we took a disciplined approach to evaluating the continued pursuit of a sale and what that would mean in terms of economics, regulatory expectations, timing uncertainty. We ultimately determined that the better outcome was to terminate the pending sale transaction and to continue our work to develop a clear strategy for our Kentucky operations. I'm thankful for the team's ability to react and adapt to shifting circumstances for the long-term benefit of our customers, employees and investors. After the termination of the sale, AEP met with the Kentucky commissioners and key stakeholders. We discussed Kentucky Power's future and the collaboration needed so that we may continue to serve our customers in a reliable manner while ensuring the financial health and discipline of Kentucky Power moving forward. In the near term, we're renewing our focus on the region and support -- and our support of the communities we serve. You'll see in the earnings call materials today that Kentucky Power's earned ROE for the 12-month period ending the first quarter of 2023 is 2.9%. This does not reflect a financially healthy utility, which needs to be resolved in consideration of the interest of all stakeholders. The underperformance is due in part to a number of unique issues that are and will be addressed for improvement over the course of the next year. As we think about the opportunities ahead for our Kentucky operations, the actions we will be engaged and include a refocus on economic development, enhanced local system reliability, and controlling customer cost. We plan to file a base case in Kentucky in June with an expected six-month commission approval process, with new rates taking effect in January 2024. Other factors that will be beneficial in improving the financial profile and performance include using securitization to recover deferred storm costs and legacy generating plant balances and rightsizing the rate base. While we pivot in Kentucky, we're focused on the successful execution of other key transactions. In February 2023, we announced an agreement with IRG Acquisition Holdings for the sale of our 1,360-megawatt unregulated renewables portfolio. A summary of the renewable sale can be found on Slide 7. All regulatory filings were made in March, and at this time, we're waiting on approval from FERC under section 203 and clearance from the Committee on Foreign Investment in the United States and Euro Antitrust. We already have cleared Hart-Scott-Rodino approval and China Antitrust. Consistent with our prior messaging, we expect the sale to close near the end of our second quarter 2023 depending on the timing of regulatory approvals. The proceeds from the transaction will be directed to our regulated businesses as we transform our generation fleet and enhance the electric delivery infrastructure. Furthering our commitment to simplify and derisk the company, and summarized on Slide 8, we've agreed with our joint venture partner PNM Resources to sell our portfolio of operating and developing solar projects in New Mexico. This 50/50 partnership is known as New Mexico Renewable Development, or NMRD. And we hold this within our unregulated operations portfolio, AEP. NMRD owns eight operating solar projects totaling 135 megawatts, 150 megawatt project currently under construction and six development projects totaling 440 megawatts. Last week, an adviser was selected to move forward with the sale process. We anticipate making a sale announcement early in the fourth quarter of this year and will target closing by the end of 2023, subject to timing of regulatory approvals. We also have some news to share with you today. As you know, in October 2022, we announced the strategic review of our AEP Energy retail business, which primarily operates in the PJM markets. We've completed that strategic review and decided that we will start a sales process for that business and will also fold into the process AEP OnSite Partners, which is our unregulated distributed resources business. We've hired an advisor to move forward, and we'll keep you updated on the progress. We expect to launch the sale process sometime this summer, and we'll update you with the details along the way, but currently expect the completion of this transaction in the first half of 2024. We're focused on our core regulated utility operations and continue to evaluate all value additive potential activities to enhance their performance and look for opportunities to recycle capital. As a consequence of this effort, we've decided to pursue a strategic review of three of our non-core transmission joint venture businesses, including AEP's interest in Prairie Wind Transmission, Pioneer Transmission, Transource Energy. These businesses total approximately $551 million in net plant investment for AEP and consists of 370 line miles and four substations of in-service assets, as well as various projects under development in PJM and SPP. We'll definitely keep you posted on our -- or updated on our progress, but we expect to complete our review by the end of 2023 with a conclusion that consists of remaining in or divesting some or all of the businesses. So, let's switch gears and talk about AEP's regulated renewables execution. I'm pleased to share that we continue to make significant progress on our transition to a clean energy economy that provides more stable and predictable cost to our customers. Through our five-year, $8.6 billion regulated renewables capital plan, we have a total of $6.7 billion approved or before our commissions. Most recently, in March to be specific, we made regulatory filings for $1 billion of investment at INM, representing 469 megawatts of solar energy and another 151 megawatts of owned, wind, storage at owned and -- owned, wind and storage at APCo for $466 million. Public Service of Oklahoma Company along with other parties filed a settlement in early April of 2023 in the fuel-free power plan case, which relates to PSO's 995.5-megawatt solar and wind portfolio for $2.5 billion. Like, in any other negotiation, this settlement we focused on the assurance of customer benefits without undue risk to the company. In this case, the settlement provided crucial capacity without fuel expense that'll help address PSO's large capacity need. The case took a positive step forward last week when the judge issued a preliminary opinion approving the settlement on April 27, and the commission has a case on its agenda for today, May 4. For SWEPCO's 999-megawatt renewables project, which represents a $2.2 billion investment, parties recently filed an Arkansas settlement in January for these owned, wind and solar resources. In another positive development in Texas, the administrative law judge that oversaw the evidentiary hearing issued the preliminary order which recommended project approval. And in Louisiana, we reached the settlement, however, we were disappointed that the Louisiana Commission did not approve the settlement on April 26, but we remain optimistic that the matter will be reconsidered at the next meeting this month. We look forward to the continued consideration in Louisiana and orders coming in Arkansas and Texas in the second quarter. It's important to note that our regulated renewables goals are aligned and supported by our integrated resource plans, focused on reliability and customer affordability. In accordance with these plans, we have requests for proposals issued or preparing to be issued for additional resources at each of our vertically integrated utilities. We plan to make related regulatory filings over the next year while taking into consideration commission preferences from previous RFP processes. Now, let me provide an update on several of our ongoing regular and legislative initiatives. We're focused on reducing our authorized versus ROE gap. Have some work to do on that as our ROE was at 8.8% this quarter, driven in part by the unfavorable weather conditions that I mentioned earlier. On the effort to close the gap, I am happy to report that we reached the settlement and gained commission approval in January 23 -- 2023 that closed out our SWEPCO Louisiana base case. A key to this case was the ability to reset rates and recover costs under a formula rate plan. And we have already put this into action as we filed under this provision last month. Similarly, in April, AEP filed a formula rate review in Arkansas, which was authorized by that commission in the last base case. As we advanced through 2023, the team is actively pursuing rider recovery of the 88 megawatts of the Turk plant not currently in Arkansas rates. And the current base case in Oklahoma is set for hearing on May 9. So, we're making progress on the regulatory front. We also worked closely with our stakeholders on the legislative front in Virginia to improve the former triennial rate case process. The new biennial rate process became law in April after active -- after an active legislative session, APCo filed its last triennial in March of 2023 for the 2020 through 2022 period. The new law will require APCo to file its first biennial in 2024 with the biennial continuing in subsequent two-year period. So, it's going to work like this. The pending triennial will put rates in place for 2024 while we litigate the biennial in 2024 for rates effective in 2025, and we can help you with your modeling needs once we get a little further down the line here. Pivoting to our fuel cost recovery efforts for a minute. Our management of fuel cost recovery is a top priority for us with our total deferred fuel balance at $1.6 billion as of our first quarter. We adapted our fuel cost recovery across all of our jurisdictions with a focus on balancing customer impacts. In Texas, the commission approved the $83 million special fuel surcharge filed in October of 2022 and was being recovered subject to review since February 2023. So, making progress there. We are aware of the staff prudence filing last Friday, April 28 in West Virginia that recommended a disallowance of certain fuel costs. The recommendation was rooted in the commission's prior reference to a 69% capacity factor at our coal facilities. Prudence review is a report produced by an outside consulting firm hired by the staff. The report relies on factors beyond AEP's control and takes issue with some of the practices taken to ensure that our power plants would have fuel available to provide electricity during the peak winter period. Those in the area are very familiar with how the historic swing of fuel cost over the past two years placed extreme pressure on the system and fuel recovery mechanisms. We advocated for the securitization legislation that recently passed in West Virginia knowing it provided an effective path to deal with those issues. In line with this strategy, APCo made a filing on April 28 seeking West Virginia Commission approval to utilize the new securitization tool to pay off the $553 million deferred fuel balance as February 28, 2023. The filing also proposes to apply the mechanism to certain storm costs and legacy coal costs in a manner that minimizes cost impacts to customers while still addressing these historical costs. Related to the consultant's prudence recommendation, the new APCo filing also lays out the environment APCo was operating in over this volatile fuel time or time in fuel cost and the actions taken to ensure coal would be available on the most extreme days on the system. Our plan is to collaborate with the commission to address customer and deferred fuel concerns together for constructive path forward in West Virginia. After receiving the commission approval, the plan would be to issue bonds to securitize a combination of deferred fuel balance, deferred storm costs, and legacy coal plan balances in the amount of $1.84 billion in the first half 2024. So, wrapping it up, I'm pleased with the progress we're making, capitalizing on our momentum from 2022. We continue to deliver on our commitments and execute against our strategic objectives. We're taking a thoughtful and disciplined approach to simplify and derisk our business and investments we make to support our positive earnings growth and outlook. I proudly lead a team whose experience and expertise have made it possible for AEP to lay new groundwork for future success while also responding and adapting to the rapid changes we're seeing in our industry. Together, we're delivering safe, clean, affordable, and reliable energy to our customers and communities, all while creating values for our investors. With that, Ann -- I will ask her to now walk through the first quarter performance drivers and provide us with some details on our financing targets. So to you, Ann."
},
{
"speaker": "Ann Kelly",
"text": "Thank you, Julie and Darcy. It's good to be with you all this morning, and thanks for dialing in. I'm going to walk us through our first quarter results, share some updates on our service territory load and finish with commentary on credit metrics and liquidity, as well as some thoughts on our guidance, financial targets, and portfolio management. Let's go to Slide 9, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter were $0.77 per share compared to $1.41 per share in 2022. For the quarter, I'll mention that we reflected the loss on the expected sale of the contracted renewables business as a non-operating cost, as well as an adjustment to true-up expected cost related to the Kentucky transaction in addition to our typical mark-to-market adjustment. There's a detailed reconciliation of GAAP to operating earnings on Page 15 of the presentation deck. Let's walk through our quarterly operating earnings performance by segment on Slide 10. Operating earnings for the quarter totaled $1.11 per share or $572 million compared to $1.22 per share or $616 million in 2022. The lower performance was primarily driven by the unfavorable weather, as Julie mentioned. When looking at historical weather in the first quarter of the past 30 years, we've only seen one quarter with more mild weather than the first quarter of 2023. Operating earnings for our Vertically Integrated Utilities were $0.52 per share, down $0.07. Favorable drivers included rate changes across multiple jurisdictions, normalized retail load, off-system sales primarily associated with Rockport Unit 2, transmission revenue and depreciation. I have more to share and load and performance, and we'll get to that in a minute. These items were more than offset by unfavorable weather, higher O&M and income taxes largely related to timing differences between the years and interests. We expect the year-over-year interest variance to be more pronounced in the first half of the year, as interest rates have somewhat stabilized. We also expect to see favorable O&M in the second half of the year compared to prior year, reflecting the timing of O&M spending and near-term actions that we are taking to help offset the unfavorable weather, such as holding positions open, reducing travel and adjusting the timing of discretionary spending. These actions are in addition to our ongoing efficiency efforts that allow us to offset the impact of inflation each year. I would like to take a second to talk about the off-system sales and depreciation. Due to the purchase of Rockport Unit 2 in December, we are seeing $0.05 of favorable off-system sales year-over-year since the margins are no longer shared with our retail customers. Also, due to the expiration of Rockport Unit 2 lease, I&M will see approximately $0.055 net favorable depreciation each of the first three quarters of 2023, plus an additional $0.035 in Q4. Including the impact of the Rockport lease, depreciation was $0.02 favorable versus the first quarter of last year. However, if you exclude the impact of the lease, depreciation would have been about $0.04 unfavorable, which is consistent with the incremental investment and a higher depreciable base in our Vertically Integrated Utilities segment. The Transmission and Distribution Utilities segment earned $0.24 per share, down $0.06 compared to last year. Favorable drivers in this segment included rate changes from the distribution cost recovery factor rider in Texas and the distribution investment rider in Ohio, as well as transmission revenue. Offsetting these favorable items were unfavorable weather, unfavorable O&M largely due to higher distribution spending in the quarter, higher interest and lower normalized retail sales due to customer mix. The AEP Transmission Holdco segment contributed $0.35 per share, up $0.01 compared to last year, primarily driven by $0.02 of favorable investment growth. Generation & Marketing produced $0.09 per share, up $0.06 from last year. Favorable drivers here include a higher retail and wholesale power margins, favorable development site sales, depreciation, and taxes. And finally, Corporate and Other was down $0.05 per share, largely driven by unfavorable interest. I'll note that this is due to both an increase in interest rates as well as higher debt balances. I'd like to remind everyone that we reflected the higher interest rates in our guidance that we provided on our year-end 2022 earnings call. While the quarter was unfavorable to the prior year, we are taking actions to offset the unfavorable weather, including the O&M refinements that I just mentioned, that give us confidence to reaffirm our full year guidance range. Turning to Slide 11, I'll provide an update on our normalized load performance for the quarter. We've continued to see load growth outperform when it's proving to be a weak economy across our service areas. This is most evident when comparing load performance across retail classes. So, we are seeing some weakness in residential loads. Our commercial and industrial classes are benefiting from new large customer volumes from our ongoing economic development efforts. This provides some potential upside to the full year outlook. Beginning in the upper left hand corner of the slide, normalized residential load was down as customers continue to be squeezed by the relationship between inflation and income growth. That relationship is a key driver of residential usage, and we expect to see it stabilize over the rest of the year. While we are seeing a decline in residential uses for customer, total residential customer counts were up by 0.5%, demonstrating growth in our service territory. Looking through the rest of the slide, you'll see that this was substantially offset by gains in our commercial and industrial loads attributable to new large customer additions. Normalized commercial sales accelerated an exceptional 7.8% compared to the first quarter of 2022. Though the growth in commercial sales was spread across many of our operating companies, gains were especially robust in AEP Texas and AEP Ohio, attributable to the new data center projects coming online in the new year. Outside of data centers, commercial gains were driven primarily by real estate, general merchandise stores, and food and drink establishments as individuals continue to move more freely in the wake of the pandemic. If we look to the lower left hand corner, we see the industrial sales resume their healthy pace of growth, increasing 5.1% from a year ago. As with commercial sales, gains were most robust in AEP Texas, while SWEPCO also experienced double-digit growth in its industrial sales. Looking at individual sectors, gains are most pronounced among oil and gas extraction and primary metal. You'll note that despite our strong commercial and industrial results for the first quarter, our expectations for 2023 load growth are still muted. Probability of a national downturn is extraordinarily high, and it's clear that activity is already slowed to a point that it's having a material impact on our customers' finances. While we expect the pace of economic growth to slow further, we don't anticipate a severe economic contraction across our service area in 2023. Though weaker than they were a year ago, household finances are still healthy by historical standards. Furthermore, the labor market continues to be resilient in the face of Fed rate hikes, which will serve to limit the severity of a potential downturn. These assumptions have been baked into our full year guidance for some time allowing us confidence that our projected load growth for 2023 is very much achievable. Adding to that confidence is our believe that there is more upside to our load projections than downside, stemming from a disciplined commitment to economic development across our service area. We know that working with local stakeholders to attract more economic activity is a key strategy to providing value to our customers. This allows us to continue to prioritize investments that will improve the customer experience while mitigating the rate impacts on our customer base. So, let's move to Slide 12 to discuss the company's capitalization and liquidity position. Taking a look at the upper left quadrant on this page, you can see our FFO to debt metric stands at 11.4%, which is a decrease of 1.8% from year-end and below our long-term target. The primary reason for this decrease is a $1.9 billion increase in balance sheet debt during the quarter, partially due to the return of the mark-to-market collateral positions associated with the decline in natural gas and power prices. Return of collateral also reduces our funds from operations, so it hits us on both sides of the equation. Without the fluctuations in our mark-to-market collateral positions, our FFP to debt metric will be closer to 13%. We expect that this metric will improve by year-end as we reduce debt after the close of the announced renewable sale and our 2020 equity units conversion, and our funds from operation improve over prior year, predominantly in the fourth quarter. We remain committed to our targeted FFO to debt range of 14% to 15% and plan to trend back into this range early in 2024 as we continue to work through the regulatory recovery processes of our deferred fuel balances. You can see our liquidity summary in the lower left quadrant of the slide. Our five-year $4 billion bank revolver and two-year $1 billion revolving credit facilities that was just extended to March 2025 support our liquidity position, which remains strong at $3.4 billion. The $800 million increase in liquidity from last quarter is mainly due to a decrease in commercial paper outstanding from long-term debt issuances. On a GAAP basis, our debt to capital ratio increased from the prior quarter by 1.2% to 64.1%. We plan to trend back closer to 60% this year as we close our announced sale transaction and complete our previously planned equity units conversion. On the qualified pension front, our funding status decreased 1.1% during the quarter to 101.3%. Rates fell during the quarter, which caused the pension discount rate to decrease, driving an increase in the liability that was greater than the gain on assets. Now turning to Slide 13. The first quarter has brought a significant challenge our way in the form of unfavorable weather. As we progress through the remainder of the year, we will continue to take action to manage our business and mitigate this impact. Our core business remains in a strong position and we are reaffirming our operating earnings guidance range of $5.19 to $5.39. We also continue to be committed to our long-term growth rate of 6% to 7%. As Julie previously addressed regarding the terminated Kentucky sale transaction, we are establishing a new -- a renewed focus in long-term strategy in order to maximize the full potential of our Kentucky operations going forward. We are on track to close the divestiture of our unregulated contracted renewables portfolio in the second quarter of this year, have announced the sale of our retail and distributed resources businesses, and are embarking on a review of some transmission joint ventures. These initiatives will help us to simplify and derisk our business while we continue to focus on the fundamentals, executing the $40 billion transmission, distribution and regulated renewables capital plan, disciplined O&M management and positive regulatory outcome. We really appreciate your time and attention today. And with that, I'm going to ask Alan to open the call so we can hear what's on your mind and answer any questions that you have."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question will come from the line of David Arcaro with J.P. Morgan. Go ahead."
},
{
"speaker": "David Arcaro",
"text": "Hi, thanks so much for my question. Dave Arcaro at Morgan Stanley. Let's see, maybe starting on the transmission business, I was wondering if you could elaborate a little bit on your strategic thinking there. What makes those assets non-core? Why that size of assets? And wondering what you're thinking -- if it does come to a divestiture decision, what you would plan to do with the proceeds? Could that reduce equity needs in the plan from here?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah, thanks so much. Appreciate the question. As we continue to talk about simplifying the business, I wouldn't necessarily put the transmission strategic review of the JVs as a derisking, because we are very comfortable with the risk profile of transmission, JV or otherwise. So that being said, this is more about simplification and really focusing on our ability to deal with customers in our footprint. So, nothing wrong with these assets. We love the assets. But we'd really like to take those dollars and channel them toward the traditional core utility business and transco utility business we have at American Electric Power. So -- and why Transource and Pioneer and Prairie Wind? Again, those are outside of our traditional footprint that we have today. ETT is a little different, and it is not necessarily under currently -- or not under current review at this point, as we focus on these pieces that are outside of our footprint. So, we'll see how this goes as far as utilizing any proceeds that we would have from a sale transaction should that occur. Again, this is a strategic review. We haven't made any decisions yet. What you should expect us to do is the same thing we've been talking about, dollars get channeled to traditional investment in the regulated utility operations. Clearly, have a lot to do on the transmission side. But when you bring dollars in the door, our expectation is to maintain a very healthy balance sheet. We've got a little bit of work to do. Ann talked about that in her opening comments. The metric should heal by the end of the year. So, we feel confident in that regard. But going out further in the timeline, we would always look to make sure the metrics are good. And then if we can, responsibly reduce equity issuances in future periods. But again, strategic review underway. We'll keep you apprised. And I would expect this would be more of a story as we get through the end of 2023 with the strategic review. And if anything were to occur, being 2024 story for us. So, thank you for the question."
},
{
"speaker": "Operator",
"text": "We'll go next to line of Jeremy Tonet with J.P. Morgan. Go ahead."
},
{
"speaker": "Aidan Kelly",
"text": "Hi. This is actually Aidan Kelly on for Jeremy. Good morning. So just shifting to the New Mexico and retail distributed resources sales, could you talk more about the prospective of buyer market you're seeing right now? Any insight on the type of buyer you would be interested here? Also, just any language on OnSite Partners as well with the G&M segment would be great. Thanks."
},
{
"speaker": "Julie Sloat",
"text": "Yeah, you bet. So let me take a couple of different tacts at this. So number one, as you know, we've had a strategic review underway for the retail business. So that shouldn't be a surprise. Scooping in the OnSite Partners businesses is the new addition today. Those comprise about -- Energy Partners is about, I'd say, $0.04 of -- I'm sorry, I should say, retail business is about $0.04 of the component that we're talking about in terms 2023 guidance. OnSite Partners is about $0.02. So let me give you those parameters, so you know exactly what we're talking about. NMRD is about $0.01 of the 2023 guidance. You got a few pennies there that we're playing with. As far as who are the likely buyers, let me answer it this way. We're already dealing with a multitude of buyers from our unregulated contracted renewables business. So, we're very familiar with that space because we have that contract underway with that piece of the business. NMRD, I would think would fit more closely with that type of activity in terms of the parties that might be interested in that particular asset base. But then let's move to the retail business. I think you got a little bit more of a narrower or more unique buyer set for that particular piece of the business. And then -- and I won't go into any names, but just given the nature of the business, the field narrows just a touch. And then on the distributed part of the business, meaning OnSite Partners, it got hundreds of parties that could be potentially interested in that. The other thing that we're thinking about is when we start working with our financial advisor to move forward with the transaction, there could be a situation where you have a combined platform where both the retail and the distributed pieces of the business are put together and sold that way. But we're completely open to separating the [two tube] (ph) just because you've got different buyer bases. Can't really opine on it yet just because we're just getting started with it, but we will absolutely keep you apprised of what our progress is and what we're experiencing as we move through time here. So early stages, but well underway in terms of getting the financial advisor kicked off and then the process started."
},
{
"speaker": "Operator",
"text": "We have a follow-up question from the line of David Arcara with Morgan Stanley. One moment, please. Apparently, that line is not in queue. We'll go next to the line of Shar Pourreza with Guggenheim Securities. Go ahead, please."
},
{
"speaker": "James Ward",
"text": "Hi. This is James Ward on for Shar. Thank you for taking our questions. First, as you look towards your June rate case filing in Kentucky, how are you thinking about the key asks in this case? And as a follow-up, could you expand on how you see capital allocation to this jurisdiction developing in the context of your overall investment plans over the forecast period?"
},
{
"speaker": "Julie Sloat",
"text": "I still appreciate that. And I get it, you guys have a really busy morning. So, I know we have different names who don't typically cover us. So, I just -- I'm still appreciative of your time and attention today. Lots of companies reporting. So that being said, on the Kentucky front, stay tuned, because what you'll -- you should expect us to do is be in conversations with the different stakeholders, with the commission, and staff in particular in Kentucky to make sure we're scratching all the inches. We want to be successful in the arena. And we are going to absolutely have a very thoughtful approach in sensitivity to reliability. We need to make sure that we're keeping the lights on and keeping them affordable for the state of Kentucky and the area that we serve in particular. So, I have a lot of granularity to share with you today other than to assure you that we will be working collaboratively with the partners in that jurisdiction. So, extremely important to us particularly when you look at where the current ROE is. We need to get that up. We need that utility company to be in a healthy situation so we can continue to have low cost capital allocated to that particular piece of the business. And then, I'll ask Ann to talk a little bit about our capital allocation and how we're going to digest that from Kentucky."
},
{
"speaker": "Ann Kelly",
"text": "Right. So, our capital plan, the $40 billion capital plan going forward is not going to change. We would just be reallocating from other areas within the same segment. So, you would expect to see the transmission, distribution, generation, all those planned numbers for the five-year timeframe will stay the same. We will just allocate within jurisdictions to Kentucky to make sure that they are focused on reliability, as Julie mentioned."
},
{
"speaker": "Operator",
"text": "Our next question will come from the line of Durgesh Chopra with Evercore. Go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey. Good morning, team. Thanks for giving me time. Hey, just I know you gave us property plant and equipment number on the transmission assets, which are up for strategic review. Is there a rate base number that you have handy that you can share with us? If not, I'll just follow-up with Darcy."
},
{
"speaker": "Julie Sloat",
"text": "You know what, Durgesh, thank you so much for your question. I don't have a rate base number in front of me. We can absolutely get that to you though. So, we'll circle back with you. But the $551 million, as you point out, is the net plant position that is attributable to AEP in particular."
},
{
"speaker": "Operator",
"text": "We'll go next to the line of Andrew Weisel with Scotiabank. Go ahead."
},
{
"speaker": "Andrew Weisel",
"text": "Hi, good morning. Thank you. First question on the balance sheet. Just to clarify, if none of these transactions move forward besides contracted renewables, what's your degree of confidence in the targeted credit metrics and FFO guidance, and over what time period?"
},
{
"speaker": "Ann Kelly",
"text": "Yeah. So what I talked about earlier was based on that scenario. We have not modeled in any additional asset sales transactions besides the contracted applicable. So, we would expect an improvement by year-end and getting it within our targeted metrics early next year."
},
{
"speaker": "Operator",
"text": "We'll now go to the line of Anthony -- pardon me, Anthony Crowdell with Mizuho. Please go ahead."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. I guess two quick questions. One is on Slide 27 that shows the underearning gap. I guess when I look at the like five OPCos that are under earning anywhere between 90 to greater basis points. What's a reasonable assumption of underearning we could assume when you closed that gap and during what timeframe? And then the follow-up is -- and I may have not heard correctly. I think -- I don't know if it's a Turk plant or the Rockport plant, you've bought back or it's maybe not part of lease or maybe I didn't hear that correctly. Does that now move to the G&M segment in reporting? Thank you."
},
{
"speaker": "Julie Sloat",
"text": "Yes. Thanks so much for the question. I'm going to take your first one on the ROEs. I'm going to back up the truck a little bit. You may recall when we provided 2023 earnings guidance, the average ROE across the system for our regulated businesses was going to be around 9.4%. Today, as you know, we're at 8.8%. So here's my expectation. I expect we're going to close that gap as we get toward the end of the year. And as you know, I mentioned several different regulatory filings and successes that we've had in 2023 that are going to help us close that gap. So we feel confident that gap will close, but I do expect that we'll be a little under that 9.4%. Importantly, we have not changed our earnings guidance, so we still plan to get within the goalpost on the earnings guidance and growth rates. So I'm not worried about that either, but it's going to take us a little longer to close the gap versus the 9.4% that we had in that 2023 guidance. So, I'll leave you with that. And as you know, we're not dependent on any single one utility company to get in a direct earning level relative to authorized, that's the benefit of having a portfolio of utilities. But boy, I surely would love to close that gap and be within 10s of basis points versus the authorized in each of our jurisdictions. That's an objective. It's just going to take us a little while to get there because, as you know, these things have a little bit of a lead time on them. So stand by and know the guidance is sound. And then on the Rockport unit, that actually it becomes a merchant unit. And I believe that's captured in, what, our Vertically Integrated Utilities segment, right? And that would be captured as off-system sales, okay? So, hopefully, that will help you with your modeling needs there, too."
},
{
"speaker": "Ann Kelly",
"text": "And that's due to the ownership structure. So, we didn't want to move it because it's still owned by the Vertically Integrated Utilities."
},
{
"speaker": "Operator",
"text": "We have a follow-up question from the line of Shar Pourreza with Guggenheim. Go ahead."
},
{
"speaker": "James Ward",
"text": "Hi. James Ward here again. Thank you for this follow-up. Unrelated to the prior question, just wanted to ask, assuming the successful eventual sales of both your retail business, distributed resources and the three non-core transmission JVs you highlighted today, how should we think about the source of funds for future financing needs? And specifically, will asset sales and capital recycling always factor into your financing approach? Or is there a point at which you would no longer look to recycle assets? Thank you."
},
{
"speaker": "Julie Sloat",
"text": "Yes, I -- this is Julie. I'll hand it to Ann here in a minute. Here's how I look at it. Simplification and derisking the business should be part of our fabric. So, we are going to continually look at where the best use and highest value is for each of the dollars that we put to work. So I think that's our job is to make sure that the portfolio of assets we have is the best we can have in the highest earnings. You go back to the question I just answered around earning your authorized ROE, we have to do better at that, and we'll continue to do better at that as we go down the path here. So, I do think you should keep that in back of the mind. We will continue to keep you updated on and signal to you if we think there's a business that might fit that profile that we would consider recycling it. But the ones that you see us talking about today are the ones that are absolutely those in terms of strategic review on the JV side of the house, transmission that -- we love transmission, but we may be able to put that to better use inside the traditional footprint. And then, clearly, on the unregulated side of the house, we want to derisk and simplify. It makes complete sense to move forward with those actions that we outlined today. So Ann, I don't know if you want to talk any more about or add any additional color to that?"
},
{
"speaker": "Ann Kelly",
"text": "Yeah, I mean you're absolutely right, Julie. And when we look at the cash flows, which are on Slide 24 that we've only modeled in the contracted renewables sale here. So any additional sales proceeds will also be able to strengthen the balance sheet. And as we mentioned, we could potentially selectively reduce the equity issuances going forward, while maintaining the same capital plan."
},
{
"speaker": "Operator",
"text": "Our next question will come from the line of Sophie Karp with KeyBanc. Go ahead."
},
{
"speaker": "Sophie Karp",
"text": "Hi. Good morning, and thank you for taking my question. I wanted to ask you about the Texas utilities and the ROE gap there. I guess in Texas, the regulatory recovery mechanisms are very constructive, right? So, you have your DCRF and TCOS and whatnot. So what needs to be, I guess, addressed there to close that gap specifically? Could you speak to that?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah, I still appreciate that question. So thanks for being on the call today. We're working on it. So let me start with the backdrop on the story. As you know, we continue to channel a great deal of capital to AEP Texas. We do think the recovery mechanisms there are very good. We always think there's opportunity for improvement. So I'll talk about that here in a moment. But one of the things that we've gotten comfortable with, with the touch of underearning relative to authorized in Texas, is the amount of growth that we have in Texas. So on average, we can grow earnings there at 10%, but I got to take a little bit of a haircut because no regulatory recovery is perfect. But we're trying to work on that. And so for example, if you read on Page Number 27, there's some commentary under the little earnings bubble there that we talk about bi-annual TCOS filings to recover significant capital investment. Those good things. We love that. We do have some legislation that is in process and working through that relates specifically to the DCRF and the ability to shorten that timeframe. So maybe we can do that twice a year versus annually. So that will help to kind of close that gap a little bit. And then there's also some legislation around cap structures, too, that might be helpful to us. So, we're trying to work all the different angles. Not to mention the other thing that we're thinking about and continue to talk about is, a way to continue to use those excellent cost recovery mechanisms that are much more progressive in Texas throughout the period, even when you're in for a base case. So, we're trying to use the legislative aspects as well as just trying to be as efficient as possible to close that gap. But we've been comfortable in the near term, taking the little bit of a hit relative to authorized on the ROE because we can grow earnings there and the demand is there. So that was the rationale. But we love the business. We're just trying to make it better in terms of recovery."
},
{
"speaker": "Operator",
"text": "We'll go now to the line of Julien Dumoulin-Smith with Bank of America. Go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning, team. Thank you guys very much. Appreciate the time. Just following up on a couple of the remarks earlier. Just can you elaborate a little bit more on next steps here as you think about Louisiana? Obviously, a little bit of a setback here, but you alluded to potentially putting this back on the -- or maybe not you all, but perhaps the commission electing to reconsider the matter next month. Can you elaborate on the procedural element there, but also some of the other avenues, there's a flex consideration here that can be pursued to the extent to which there may be different outcomes?"
},
{
"speaker": "Julie Sloat",
"text": "Yes. Julien, thank you for being on the call today. And that is absolutely top of mind for us. As you know, and I mentioned in my opening comments, we're able to get to a settlement agreement and the Louisiana staff filed constructive testimony with conditional approval, all that good stuff. So, we want to continue to work that angle. And actually, one of the commissioners suggested that the decision could be recalled at the next meeting for reconsideration once some additional information is shared. So, we have that top of mind for us. So here's what you should expect from SWEPCO. You should expect to see us seeking rehearing in which we continue to be optimistic that we can pool this across the goal line. So, stay tuned on that. I don't want to get too much in the weeds on it just yet because we're literally in game with that right now. And then specifically, we would hope that this is going to move forward, and we'll have all three jurisdictions stepping in line and be able to absorb with positivity, the applications that we have in front of them. But do we have flexibility in terms of flexing up in the other jurisdictions? On a discrete basis, we think that there is that opportunity with the different projects that we have that are included in that filing. So again, nothing specific to share today. But rest assured, we're looking at all the different tools and angles in the tool bag there that we're able to use should we need a different route if Louisiana can't get there. But we're optimistic and we're having conversations, so stay tuned."
},
{
"speaker": "Operator",
"text": "We'll go next to the line of Paul Fremont with Ladenburg. Go ahead."
},
{
"speaker": "Paul Fremont",
"text": "Thank you. I guess my first question is on FFO to debt. In order to hit the sort of the 14% to 15% targeted range, should we assume that you need to basically collect on the $1.6 billion in fuel deferrals? And can you give us a sense of the timing that you would expect to recover those amounts?"
},
{
"speaker": "Ann Kelly",
"text": "Yes, I'll take that, Julie. So, we would expect to collect over the extended timeframes that we have already agreed upon within our jurisdictions. And with respect to West Virginia, we have that model taking advantage of the securitization in the first quarter or the first half of next year."
},
{
"speaker": "Operator",
"text": "We have a follow-up question from the line of Sophie Karp with KeyBanc. Go ahead."
},
{
"speaker": "Sophie Karp",
"text": "Hi. Thank you for giving me more time. If I can ask a follow-up on Kentucky, right, like asked differently, when you spoke to regulators there, and clearly, you need to bring the ROE up, right? But what kind of a rate increase would that require for Kentucky rate payers? And like do you get the sense of kind of like the upper limit of the appetite that the regulators might have for rate increases in this environment?"
},
{
"speaker": "Julie Sloat",
"text": "Yeah. So, let me answer that this way. I don't have specific numbers to share with you today because when we actually had the conversation, we hadn't announced earnings yet, okay? So that's new information today, that's public today. And so this will be the go-back conversation that we'll have. And again, the plan is truly to collaborate, because I'm confident that the commission and the commissioners are interested in having a very sound -- financially sound utility company. And so we'll all be working in that same direction. Now as far as tools in the tool bag, obviously, we'll try to influence the top-line with economic development and things of that nature. That takes a little longer, as you know, because it's got a little longer lead time on it. But we know we're really successful with that, too. So stay tuned. And then, of course, we'll be very sensitive to cost as well. The other thing that will be top of mind for us is using the new tools in the tool bag is securitization, okay? So, we've got deferred storm costs that are sitting on the balance sheet. We have an opportunity to take care of net plant of legacy coal plants that's sitting on the balance sheet, too, to the tune of something like $290 million associated with Big Sandy. So those are things that we'll be able to securitize and then kind of back into what -- how we need to make that math work. And I mentioned that also talks about or at least strikes at the idea of kind of rightsizing the rate base. So, we work with the commission and all the various stakeholders in the state of Kentucky that we deal with to make sure that we're getting where we need to be. But honestly, from my seat and from a utility seat, just 2.9%, it's not healthy. We need to get it in a healthy situation. And that will be top of mind for us, because we've got to keep the lights on to and keep it affordable. So stay tuned. We don't have a lot of color to share today because we're literally in game. This is a new data point with 2.9%, okay? But Sophie, thank you for jumping back in line."
},
{
"speaker": "Operator",
"text": "We have a follow-up question from Paul Fremont with Ladenburg. Go ahead."
},
{
"speaker": "Paul Fremont",
"text": "Thanks. So, the assumption is that you will -- that you're assuming you'll get securitization in West Virginia as part of getting to the -- to that 14% to 15% FFO to debt?"
},
{
"speaker": "Julie Sloat",
"text": "Paul, this is Julie. Actually, securitization will be a great thing, and that helps us, give us a little more flexibility, more importantly, it's good for the customer. And so, when we filed for our new ENEC filing that we made on what was it like February -- I'm sorry, April 28, I think, was the date that we filed it. What you'll see is that we have two proposed options to recover the fuel balance in our filing. And one is to spread the recovery over three years, and the other is to use securitization for the under-recovered fuel balance. And as part of that, we also looked in as an option, again, with the idea and backdrop and motivation is to protect the customer rates because we can't have them trying to swallow a watermelon here is to essentially securitize plant balances from legacy coal plants, so Amos and Mountaineer in particular, and I think we have some storm costs in there as well. And so when I mentioned today, that $1.84 billion number that we would like to securitize, that's all in. And so, we're trying to give the commission options so that we can all work collectively to make sure that the citizens and customers of West Virginia are protected, but that we still have a healthy utility and we're able to hit the balance sheet metrics that we need. So, it's doable. It's absolutely doable, we'll just need to move through the process."
},
{
"speaker": "Ann Kelly",
"text": "And one thing just to add on FFO to debt, when you think about just the quarterly dynamics, in Q4 of last year, due to market conditions, we did have a significant outflow of collateral as well as an increase in deferred fuel. So, as we get through that this year, and that quarter rolls off, that will significantly help our FFO to debt as well."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We have a follow-up question from Paul Fremont with Ladenburg. Pardon me, that line did not open up. We have Bill Appicelli with UBS. Go ahead."
},
{
"speaker": "Bill Appicelli",
"text": "Hi, good morning. Most of my questions have been asked and answered. But just a question around the timing of the approval for the contracted renewable sale. You made the filing on March 22. I guess what gives you the comfort that you'll get approval in Q2? And I guess what's the -- what do you need to demonstrate in those filings to get approval both at FERC and on the Committee on Foreign Investment?"
},
{
"speaker": "Julie Sloat",
"text": "Yes. So as far as FERC and the other two approvals that we'll need to get, let me answer it this way. When we made the filing initially, we had requested at FERC a 60-day approval process. So, we would like to get an order within 60 days. May 22 would be 60 days. And given that this is normal kind of traditional business unregulated, not tied to significant customers and multiple stakeholders, we don't anticipate any material roadblock as it relates to getting not only FERC approval, but the clearance from the Committee on Foreign Investment in the United States and/or approval under any of the applicable competition loss. So we're comfortable with where we are and expect that we should have that in pretty short order, which gives us confidence to say we think that we'll get this done by the end of the second quarter at the latest. But we'll keep you apprised if anything were to come up. But at this point, we're past commentary periods, and everything seems to be going relatively smoothly. So, anyway, I'll leave it at that, and suggest that if anything shifts, we'll be right in front of you immediately."
},
{
"speaker": "Operator",
"text": "We have no further lines in queue at this time."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Alan, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Thank you. Ladies and gentlemen, this conference will be made available for replay beginning today, May 4, 2023, at 11:30 a.m. Eastern Time through May 11, 2023, at midnight. During that time, you can access the AT&T Executive Playback service by dialing toll-free, 866-207-1041, internationally, you may dial area code 402-970-0847, and the access code is 2036342. Those numbers again are toll-free, 866-207-1041, internationally, area code 402-970-0847, and the access code 2036342. That will conclude your conference call for today. Thank you for your participation, and for using AT&T Event Teleconferencing. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 4 | 2,024 | 2025-02-13 09:00:00 | Rodger: My name is Rodger, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Company's conference. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press. At this time, I would like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead.
Darcy Reese: Good morning, and welcome to American Electric Power Company's fourth quarter 2024 earnings call. A live webcast of this teleconference and slide presentation are available on our website under the Events and Presentations section. We have a few members of our management team with us today, including William Fehrman, President and Chief Executive Officer, Trevor Michalek, Executive Vice President and Chief Financial Officer, and Kate Sturgis, Senior Vice President Controller and Chief Accounting Officer. We will be making forward-looking statements during the call. Actual results may differ materially from those projected in any forward-looking statement we make today. Factors that could cause our actual results to differ materially are discussed in the company's most recent SEC filings. Please refer to the presentation slides that accompany this call for a reconciliation to GAAP measures. We will take your questions following opening remarks. With that, please turn to slide four and let me hand the call over to William Fehrman.
William Fehrman: Thank you, Darcy, and good morning, everyone. Welcome to our fourth quarter 2024 earnings call. Let me start by saying that after six months on the job, I continue to get more excited about the very strong and comprehensive AEP value proposition. Our future is extremely bright, and we are committed to delivering on our promises to customers, regulators, and investors by putting our robust capital plan to work. We are building a platform of success by focusing on execution and accountability. These are exciting times at AEP, and I see incredible value in this, which I am confident can further unlock by advancing our long-term strategy and providing safe, affordable, and reliable service across our large footprint. Before we jump into our results, I'd like to start by introducing our new CFO, Trevor Michalek, who joined AEP last month and is on the call with me today. Trevor is a proven leader and an industry veteran. He's hit the ground running and is already considered a very strong, disciplined, and focused member of our senior leadership team. Structure by eliminating management layers, reorganizing and reducing the size and scope of the service corporation, and improving procurement processes to drive much higher value from suppliers. The leadership team is coming together to make AEP a premium traded utility that is highly respected and trusted by our many stakeholders. Lastly, I'd like to take a moment to thank Charles Zebula for his more than twenty-five years of dedicated service to AEP. We're grateful for his steady hand during the transition and will continue to benefit from his expertise until his well-earned retirement in March. In my remarks this morning, I will discuss our strategic focus and our results at a high level before passing it over to Trevor to walk through our financials in more detail. Today, we announced fourth quarter 2024 operating earnings of $1.24 per share, $660 million, bringing our full-year 2024 operating earnings to $5.62 per share. Recall as part of our commitment to continuing to deliver value to our shareholders, last October, we increased the quarterly dividend from $0.88 to $0.93 per share. In addition, today, we are reaffirming AEP's 2025 operating earnings guidance range of $5.75 to $5.95 per share and affirming our long-term operating earnings growth rate of 6% to 8%. All reinforced by our robust $54 billion capital plan from 2025 through 2029. As we have talked about previously, I'm committed to a strong balance sheet, and I believe it is critical to funding our robust capital plan. We will responsibly finance the great opportunities ahead of us from a position of strength. Trevor will address this further in his remarks. We will also be disciplined around portfolio management. In fact, last month, we announced the Ohio and INM minority interest transaction on the transmission business with KKR and PSP investments for $2.82 billion. The transaction is highly accretive at 2.3 times rate base and valued at 30.3 times price to earnings. Put this into another perspective, this is equivalent to issuing AEP common stock at $170 per share. Moreover, in the last couple of weeks, we filed for approval with FERC, and we expect to close in the second half of 2025, at which time we'll still retain 95% of AEP's total transmission assets. The proceeds from this transaction allow us to rotate capital into investments that benefit our customers as we enhance reliability and deliver on growing energy demand. In addition to the minority interest transaction, we also recycled almost half a billion dollars in net cash proceeds in 2024 through the sale of the New Mexico Renewable Development solar portfolio and distributed resources business. We continue to work with federal policymakers, state legislators, and regulators across our large service footprint to determine what their goals are so we can relentlessly deliver on them. I would also like to spend some time this morning walking through AEP's future growth, which is underpinned by four major drivers: large load in our service territories, including data center load that we appreciate having the chance to serve and are aggressively pursuing, economic development efforts in our states, investment across the system in our transmission and distribution infrastructure, and new generation. Our capital plan includes customer commitments for 20 gigawatts of incremental load by 2030, driven by data center demand, reshoring and manufacturing, and continued economic development. In fact, large load impacts are already being felt in many of AEP's service territories, especially in Ohio, Texas, and Indiana. As demonstrated in our fourth quarter results, we experienced commercial load growth of 12.3% over the fourth quarter and 10.6% growth on the full year compared to 2023. One of the reasons we are seeing such growth now is that we have an advanced transmission system that can help support current large loads, which is a significant advantage for us versus our peers. As we execute on our $54 billion capital plan to support customer needs, affordability remains top of mind, and we are committed to fair cost allocations associated with large loads. We proactively filed the data center tariff in Ohio and large load tariff modifications in Indiana, Kentucky, and West Virginia, and we look forward to commission decisions in Indiana and West Virginia, both states, unanimous settlements in the near future. The data center tariff hearing in Ohio concluded last month, and we should have a commission decision by the third quarter of this year. In addition to our efforts to support load growth, our current capital plan contemplates sustained and substantial investments across our distribution infrastructure to better meet our customers' energy needs and improve customer service. Since AEP's distribution system is one of the nation's largest, at approximately 225,000 distribution miles, these efforts include work to harden or replace poles, conductors, transformers, and other assets, as well as deploy automated technologies like AMI meters and GridSmart for enhanced operational performance. In total, we are investing more than $13 billion over the next five years in these areas to improve reliability and reduce both frequency and duration of outages. By advancing these initiatives, as well as an aggressive vegetation management program, we will increase customer satisfaction, strengthen our system's resilience to weather events, and reduce costs for operations and maintenance. Demand for power is growing at a pace not seen over my 44 years in this business. As we discussed last quarter, meeting this demand could require incremental investment of up to $10 billion, driven by additional transmission, distribution, and generation infrastructure not included in our current $54 billion capital plan. For example, in our three primary RTOs, we see an opportunity of approximately $4 billion to $5 billion of incremental transmission awards recently approved or expected to be approved in the near term, with additional upside on other initiatives. The remainder of the $10 billion of incremental capital upside is in transmission, distribution, and generation infrastructure across the business. In addition, as you'll recall, in November, we announced a partnership with Bloom Energy related to fuel cells. Our current capital plan does not include any investment in this custom solution, which will enable our large customers to quickly power their operations while the grid is built out to accommodate further demand. Once the necessary infrastructure is connected to these large customers, they can use the fuel cells as backup generation, further adding resiliency to their operations. This demonstrates our commitment to finding innovative customer solutions that let them power up much quicker, allowing their business to deliver service to their customers, which will generate profits much sooner than waiting for a grid connection. As a matter of fact, just this week, AEP Ohio filed with the Ohio Commission for approval of the first two customer projects using this fuel cell technology, totaling 100 megawatts. Not only is AEP working to bring solutions tailored to the current power needs of our customers, but we are leading efforts in the industry on the potential that small modular reactors, or SMRs, have to meet the growing needs of the future. We're looking to partner with the US Department of Energy to support the early site permit process for two potential SMR locations, one in Indiana and the other in Virginia. We are laying the groundwork to find solutions to support large loads and are fortunate for the opportunity to build these SMRs, but only with appropriate risk sharing. The tech companies are fast movers, and AEP will be there to support them with whatever tech solution they want to deploy. We need to ensure that we are protected and compensated. Moving on to regulatory, over the last six months, I have visited ten of our eleven states and have been actively engaged with various stakeholders, listening to their preferences as we invest more in resources at the local level. I firmly believe that by delivering for our states and the customers who live there, we can, over time, improve our earned ROEs and increase equity layers as states are more receptive to the need to attract capital. It is an absolute imperative that AEP listens closely to our states and then aggressively delivers on the agreed-upon commitments. That's my promise to them. When I look at 2024 in review, our operating company has achieved a number of positive regulatory developments, including receiving constructive base rate case outcomes in Indiana, Michigan, Oklahoma, Texas, and Virginia. Obtained commission approval of the Ohio Electric Security Plan, updated formula rates in Arkansas and Louisiana, and filed system resiliency plans in both of our operating companies in Texas. As we discussed on our last call, APCO files its base case in West Virginia while offering securitization as a concept to help mitigate the proposed base rate increase. Interviewer testimony in this case is set for April, with rebuttal testimony following in May and a hearing set to start in mid-June of this year. We look forward to working with everyone involved in this case to achieve a positive outcome for both our customers and shareholders. Shifting now to our generation fleet, we previously filed approval of PSO's Green Country 795 megawatt gas facility, SWEPCO's new Haulsville 450 megawatt natural gas plant, as well as SWEPCO's Welch 1,053 megawatt natural gas conversion project. These facilities and RFPs, which are currently in progress at APCO, INM, and DSO, in addition to future integrated resource plan filings over the next four years in Arkansas, Kentucky, Indiana, Michigan, Virginia, and West Virginia, support our capacity obligations and will go a long way in meeting our customers' energy needs. In summary, we are engaged with key stakeholders on the regulatory front as we keep affordability, system reliability, resiliency, and security top of mind. I'm excited to start the new year having made meaningful progress and will continue these important efforts as we advance on our commitment to excellence and deliver on what our states want. I'll close by thanking everyone at AEP for their hard work and dedication in 2024. I'm energized as we enter 2025 with a strong team and a more streamlined structure that is significantly driving efficiencies, reducing bureaucracy, and creating a much more nimble company that can quickly execute on opportunities. Also, having our employees who have been working from home return to the office full-time by June 1st. Put all hands on deck with a renewed focus on execution and accountability, that will serve us well as we advance our strategic priorities to enhance value for our stakeholders. With that, I'll now turn it over to Trevor.
Trevor Michalek: Thank you, Bill. Good morning to everyone on the call. I want to start today by thanking Bill and the board for placing their trust in me to help lead this organization into a bright and exciting future. I am honored and grateful for the opportunity to join a dynamic team that is focused on positioning the company for future success. And I'm committed to building on our momentum to create value for all of our stakeholders. As part of my transition, I have reviewed AEP's financial and capital plans, and I have confidence in executing on them with this team. Today, I will walk us through the fourth quarter and full-year results for 2024, expand on Bill's comments related to load growth, and discuss what we expect to see in the years ahead. I will finish with commentary on credit metrics, liquidity, and portfolio management, as well as my focus on disciplined capital allocation. Please turn to slide seven. This slide shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $1.25 per share, compared to $0.64 per share in 2023. GAAP earnings for the year were $5.60 per share, compared to $4.26 per share in 2023. Detailed reconciliations of GAAP to operating earnings are shown in the appendix on slides 25 and 26. Next, I will briefly cover fourth quarter operating results before moving on to a more detailed walkthrough of our year-to-date results by segment. Fourth quarter operating earnings came in at $1.24 per share, which was a one-cent improvement versus the prior year. We saw $0.22 of incremental rate changes across multiple jurisdictions along with higher normalized retail sales at both the vertically integrated and transmission and distribution segments. Partially offsetting these favorable drivers were higher O&M and lower margins at the generation and marketing segment. For reference, the full details of our fourth quarter results are shown on slide eight. Let's have a look at our year-to-date results. Operating earnings for 2024 totaled $5.62 per share, compared to $5.25 per share in 2023. This was an increase of $0.37 per share or about 7% year over year. Adding to AEP's long track record of delivering on its financial commitments for investors. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $2.63 per share, up $0.16 from a year earlier. Positive drivers included rate changes across multiple jurisdictions, notable outcomes in Virginia and Indiana, and a return to relatively normal weather in 2024 compared to the mild weather experienced in 2023. These items were partially offset by higher depreciation and higher O&M as we made investments to serve our customers. The transmission and distribution utility segment earned $1.51 per share, up $0.21 from last year. Favorable drivers in this segment included increased rates in Texas and Ohio, increased transmission revenue, a favorable year-over-year change in weather, and higher normalized retail sales. Partially offsetting these items were increased property taxes, depreciation, interest expense, and O&M. The AEP Transmission Holdco segment contributed $1.51 per share, up $0.08 from last year. Our continued investment in transmission assets, as the new loads are added to our system, was the main driver in the segment. Generation and marketing produced $0.48 per share, down $0.11 from last year. The reduced contribution from this segment was primarily driven by the sale of our universe of 2023, higher income taxes, and lower retail energy margins. These items were partially offset by lower interest expense and higher wholesale margins. Finally, corporate and others saw a benefit of $0.03 per share driven by lower income taxes and O&M, which are partially offset by higher net interest expense. As Bill mentioned earlier, we are reaffirming our operating earnings guidance range for 2025, of $5.75 to $5.95 per share. For convenience, we've included an updated waterfall bridging our actual 2024 results to the midpoint of our guidance for 2025 on slide 20. While some variances change due to the 2024 actual results, there is no change to our 2025 segment or overall guidance. Turning to slide nine. You can see more evidence of just how important load growth is to our financial story. Weather-normalized sales grew 3% in 2024, and we expect that to nearly triple in the years ahead. These are exciting times in the utility industry, as we incorporate this tremendous growth. As Bill mentioned, the load growth that I'm going to talk about is providing the opportunity to potentially add up to $10 billion of incremental capital over the next five years to our already sizable $54 billion plan. We are continuing to evaluate the magnitude and timing of this spend to meet the growth opportunities across our footprint. The gains we are seeing from the data centers and industrial customers represent a once-in-a-generational opportunity to shape and grow the system. So before I jump into the details, I want to emphasize a few key points about our confidence in the projections you see here. First, this isn't just a future story. This is a now story. We're already seeing these loads come online across our system. In December of 2024, we added almost 450 megawatts of hyperscale data center load in Ohio alone. Second, the load additions built into the forecast you see here are all backed by signed customer financial obligations demonstrating their commitment to bring these projects online. In fact, nearly all of these loads are backed by take-or-pay contracts and have already been accepted by certain RTOs, including PJM. This means that our customers are committed to paying for a minimum amount of power over a period of time. What's more, we've achieved tariff settlements in Indiana, Ohio, and West Virginia to strengthen and lengthen those commitments even further. Beyond those contracts, we have substantial interconnection queues waiting to sign additional commitments as well. Diving a little further into the details, you can see where the bulk of our growth is concentrated. New data centers drove double-digit growth in our commercial sales in 2024, with system-wide data processing load hitting a new high in December of 1.3 million megawatt hours. The gains are expanding beyond this transmission and distribution utilities into our higher-margin vertically integrated segment. Recently, we also connected the first of several hyperscale data center customers in Indiana, including AWS and Google. Across the entire system, we're contracted to see nearly 5 gigawatts of data processing load come online in 2025, representing almost a 25% increase from 2024. Beyond commercial load, our industrial sales are also set to accelerate after a resilient 2024. AEP's industrial load grew by more than 402,000 megawatt hours last year. This was punctuated by growth of almost 5% in Texas, highlighting the diversity of our service territory and giving us a lot of confidence going into the new year. We expect industrial sales growth to more than double in 2025 as several new large customers are contracted to come onto the system, like Cheniere in Texas. We also have several other large and well-publicized industrial projects set to come online in 2026 and 2027. More detailed load projections by class can be found on slide 13. As a reminder, we have more than 20 gigawatts of commercial and industrial load additions contracted to come onto our system through the end of the decade. Roughly half of those are in ERCOT, and the other half are spread across our PJM companies. As a result, we expect these quarterly sales numbers to continue their rapid growth for several years to come. Let's move on to slide ten to discuss the company's capitalization and liquidity. Our financial performance and strong balance sheet provided good credit metrics for the last twelve months. Our debt to capitalization remained largely consistent with our historical range. Our FFO to debt metrics stood at 14% for the twelve months ended December 31st, which was within our target range and well above our downgrade threshold of 13%. Available liquidity remained very strong at $4.6 billion and is supported by $6 billion in credit facilities. Our strong balance sheet and credit metric results, coupled with ample liquidity and the outcome of the minority interest transaction, expected to close in the second half of this year, have enhanced our financial flexibility. We can efficiently access the capital market to support the capital needs in front of us. We are committed to maintaining a strong balance sheet and credit metrics as we evaluate the upcoming capital spend opportunities and match them with optimal financing instruments. On a similar note, last week, I spoke directly with all three rating agencies and conveyed this leadership team's commitment to a strong balance sheet. Focused on executing the regulatory and financing plans, as well as disciplined allocation of O&M and capital to our companies. Finally, let's move on to slide eleven. Before we take your questions, I wanted to summarize what you heard from us today. First, you heard we had a strong year-over-year performance in 2024, growing our earnings roughly 7% with operating earnings coming in at $5.62 per share. We reinforced our commitments to stakeholders and built solid momentum heading into 2025. Second, you heard that we are absolutely focused on execution in 2025 to support one of the great load growth stories in our industry. We're executing on strategic investments and delivering our regulatory strategy, giving us confidence in our financing plans. Third, you heard we have $10 billion of incremental growth capital that we are currently evaluating. And fourth, you heard that the $2.82 billion pending minority interest transaction on the transmission assets is an exceptional value proposition to our shareholders. The transaction further boosts our earnings and credit profiles and helps to reduce near-term equity needs. Recall that the value we transacted on this is comparable to issuing equity at $170 per share. And we're still retained 95% of AEP's total transmission asset post-close. These components are key to our future success and reinforce our confidence in reaffirming our commitments, including our 2025 guidance range of $5.75 to $5.95 per share. Our long-term growth rate is 6% to 8% while targeting FFO to debt of 14% to 15%. We really appreciate your time and attention today. I'm gonna ask the operator to open the call so we can answer any of your questions that you may have. Thank you.
Rodger: Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your questions, simply press star one again. We'll take our first question from Shar Pourreza at Guggenheim Partners.
Shar Pourreza: Hey, guys. Good morning.
Trevor Michalek: Good morning, Shar.
Shar Pourreza: Morning. Just on the balance sheet, the forty-six to sixty basis points of FFO improvement, you highlight that kind of on the slides as a near-term target. Can you sustain that over the plan? And then on equity, any sense on the means of issuing the remaining $2.5 billion? Is it junior or is it asset optimization, a block? I mean, I know, Bill, in your comments, you did highlight portfolio management in your prepared remarks. So just wanna get a sense on that remaining equity as well.
Trevor Michalek: Sure. So here's Trevor. Sure. Appreciate the question. You know, we are targeting FFO to debt in that 14% to 15% range. And again, from our perspective, that is a target that we're looking at. I will note that, you know, we are going to have a revision to the way that Moody's calculates the deferred fuel. So, we will drop down probably forty, fifty bps, sixty bps depending on, you know, where things go with that, which I think it's gonna happen. But again, that's gonna be above the 13% threshold. And again, from our perspective, both Bill and I are very focused on issuing, you know, the or executing on the $54 billion capital plan with a strong balance sheet. So I think what you'll see is this will dip down a little bit in the current year, and then really the deferred fuel issue kind of rolls off by 2026. And so from that perspective, you know, we're really focused on getting that, you know, in that 14% to 15% range in the near term. Then getting to your financing question, you know, again, like you said, we put out that $5.35 billion of equity needs last year and kind of talked about that at EEI. The good news is with this transaction, the $2.8 billion goes a long way to solving that. So that really leaves then, like you said, the $2.5 billion of which there's, you know, call it $500 million over the five-year period, $100 million a year on the drip. So then it's a very manageable $2 billion. And then looking at various things that we have here to solve for that, you know, there's potential securitization that we're continuing to work on in some of our locations. But we'll also utilize, you know, hybrids or other equity-like instruments. And then if we need to issue equity, you know, we could do that. And I'm not opposed to issuing equity for growth, and we have a growth plan that is incredible here. Especially, you know, articulating around that incremental $10 billion, but we want to be very judicious with issuing equity, but we think there's a lot of different levers that we can pull, securitization, hybrids, and then potentially, you know, over the longer term, if we had to issue incremental equity, we would consider it. But again, very focused on FFO to debt, and also executing on, you know, this kind of historic $54 billion growth plan.
Shar Pourreza: Perfect. And then just lastly, obviously, a lot of load growth and you guys have that new CapEx upside disclosures. Specifically on the 20 gigs of load you're leaning on, just wanna get a sense on how much of that is in Ohio and on the dual tariff settlements that are out there. Can the differences be bridged? And what if the commission's order swings against your settlement? I know, Bill, you've been very active on the stakeholder engagement side. Just wanna get a sense there. Thanks.
William Fehrman: So we're very, obviously, focused on the rate case and on the tariff filing for data centers. A lot of discussion going on. We're clearly looking to try and find a solution for bringing these folks into our system and bringing the economic development opportunities with us. And so we're continuing to look. If you think about the data center story that we have, in December alone, AEP Ohio added nearly 450 megawatts of data center load from AWS and Meta. So very strong. Looking ahead, we anticipate adding similar amounts of load almost every month through 2025. We've got over 4.7 gigawatts of data processing load contracted to begin service this year. And then while most of this load, to your point, is concentrated in Ohio and actually Texas, we also have nearly a gigawatt contracted to come online in Indiana. So that's extending our growth into the vertically integrated utility segment as well. So I would note that both Google and AWS have recently begun service in Indiana. So that's very positive for us, and they're gonna continue to ramp up progressively over the next several years. So this growth certainly underscores our commitment to economic development and highlights significant opportunities ahead, but, clearly, we're going to make sure that this doesn't fall on the shoulders of our existing customers and make sure that the appropriate parties who are driving the incremental cost will pay for the incremental cost.
Shar Pourreza: Perfect. Trevor, big congrats to you and the AEP team. I know you're gonna do really fantastic there. Big congrats on phase two.
Trevor Michalek: Sure. I really appreciate it. Excited to be here. This is an incredible story, and quite the team here. So thank you.
Shar Pourreza: Great. Thanks, guys.
Rodger: We'll move next to Ross Fowler at Bank of America.
Ross Fowler: Morning.
Trevor Michalek: Thanks, Ross.
Ross Fowler: So just wanna dig into maybe the data center tariffs you talked about sort of protecting yourself around sort of stranded cost risk or minimum take risk. So in that tariff, you know, have you disclosed what that rate is versus maybe other industrial commercial rates? Is it, like, a minimum power take requirement that's in there? And what kind of terms are you looking at in those tariffs that you filed?
William Fehrman: So the tariffs are really driven by the cost of the incremental project. And so there's not a specific, say, price in the tariff until we understand what the cost of the incremental load is going to be or the incremental transmission is going to be to serve that load. And so it really is a case for us to protect the existing customer base and that the driver behind the data center cost will be covered essentially by the company that's requiring it. So we feel very good about where we sit. I would say there are a couple of differences in the tariffs if you look across the states. For instance, in Ohio, that tariff is very much focused on data centers, whereas if you look at the similar proposal in Indiana, that is a broader tariff that would apply to any and all large loads that are similar to a data center. So some minor differences across the states, but generally, the same purpose holds, which is make the customer who's driving the incremental cost pay for the incremental cost and put it in place for a longer period of time so that we know as we're building out this incredible investment that, oh, if the customer goes away in year six or seven, we still have coverage for some of those costs, and it's not stranded and placed on the shoulders of our existing customers. So very, very positive outcome for us. I think it sets us up, and I don't think that it's been a detriment to the economic growth we have if you look at the overall increases that are already signed up. We have significant growth in accordance with these tariffs. So very, very strong interest still even though these tariffs are going into place.
Ross Fowler: That's great, Bill. Thank you. And then Trevor, maybe one for you. You mentioned securitization as an avenue for maybe some of that equity need. Did you have a scaling of that versus the $2 billion you need in the current plan, or have you sort of not walked through all of that yet?
Trevor Michalek: Yeah. We're still working through that with the various states, Ross, but, you know, honestly, I think you could look at it and securitization could, if successful, could potentially, you know, be a big chunk of that remaining $2 billion. So, you know, right now, if you the way I think of it is we kind of laid out the $5.35 billion over a five-year period. The $2.8 billion from the sale transaction really takes care of a big chunk of that in the immediate term here, and then we have a lot of other levers to pull over the remaining, you know, four years of the plan to solve for that $2 billion. But securitization could be, if successful, you know, a real win because it could help the customers with regards to rates, but it can also help us with regards to the need for the cash that would fill that gap on the $54 billion plan that we laid out.
Ross Fowler: Perfect. Thank you. And then if we can squeeze one more in back to techy Bill. You mentioned SMRs and kind of how you're trying to very early stages looking at that, but, you know, under the right risk structure. In other states, we've sort of seen, like, this idea where, you know, the off-taker would put in a significant portion of the capital and take more of the risk into that project? Are you thinking about similar structures there or how far have you kind of walked down the thought process of what that structure would look like or might look like?
William Fehrman: Yeah. Thanks for that question. Obviously, very interested in SMRs as a technology, and that's really driven by the fact that our major customers are also interested in that as a solution. And as we noted, we've started with the early site permit work in Indiana and Virginia and have signed MOUs with various parties to support that type of work. We did put in our tier one application with the DOE for one of the sites and the tier two application for the other site to try and get some support for those. At a broader look, with regards to how we would think about this, clearly, I'm not going to put the company at risk in any type of a move as a first-of-a-kind type of technology. And so as we've been talking with potential customers, we haven't got to any specific arrangements or how this might look at this stage. But certainly, there's discussions ongoing to see if there's a way to do this. Clearly, the SMR technology providers, somebody needs to be first, and somebody needs to step up and figure out how they're going to deliver their product and back it. I mean, this is one of those situations where, to me, I'm buying a technology from somebody, and it should work. And it should be at a price that is very understandable and protected. And so I'm very excited about where we sit with regards to discussions, but I would say we're quite a ways away from having anything firmed up or really any firm structure at this point. But whatever we ultimately end up with, we'll be very principled and disciplined on our side of this to make sure that our shareholders and our customers are protected from any significant types of negative outcomes.
Ross Fowler: That's great. Thank you. And, Trevor, congratulations again on the new role. Wish you nothing but success.
Trevor Michalek: I really appreciate it, Ross. Thank you.
Rodger: We'll go next to Steven Fleishman at Wolfe Research.
Steven Fleishman: Hi. Good morning.
Trevor Michalek: Hey, Steve. Congrats, Trevor, as well. Let me echo that.
Steven Fleishman: So just on the, I guess, on the upside to the capital plan and particularly the transmission, so, for example, there's these PJM transmission that the joint venture that you have and the like that's being decided the next month or so. Is that that would be upside to the plan that's not in the plan? To things like that.
Trevor Michalek: Yeah, Steve. That's right. That would be upside to the plan. So, you know, here again, what we've got is, you know, the $54 billion plan that has very definitive things in it, and we really aren't putting things into the plan that aren't for sure. And so then when you look at this $10 billion, a lot of this is coming to fruition over the next, you know, kind of months here. And so we're gonna be pretty excited about rolling out kind of in a normal cadence on the third quarter call a revision to the $54 billion plan, but, yeah, that would be upside.
William Fehrman: And, Steve, just to add to that, yeah, just to add that a little bit specifically to PJM, you probably know we've announced the joint planning agreements with Dominion and FirstEnergy to propose those projects through the regional transmission expansion plan. We expect PJM approval in the first quarter on those projects. And so, again, as Trevor noted, all of those, if they would come to fruition, would be upside.
Steven Fleishman: Okay. And then I, you might have answered this, Trevor, and I missed it. But just in the event that you see that capital plan come up, how should we think about funding for incremental capital?
Trevor Michalek: Yeah. So again, yeah. You know, Steve, I think on the incremental capital side, we really do have a lot of positives here. Again, with the $2.8 billion coming in this year, that's gonna set us up really well for, you know, call it roughly half of the equity needs that we laid out before. And then with securitization and other things, that's really gonna kind of take us a long way to filling that gap. At the end of the day, I'm not opposed to, you know, issuing equity for growth, and this kind of growth I think that really makes sense. At the end of the day, you know, there's a lot of other things that we're working on internally as we rightsize this organization to get, you know, costs in line with where this is going. As well as other opportunities we're looking at that I want to be somewhat, you know, careful here in how we say it. But there is, you know, capital allocation internally looking to support this growth plan. And, you know, equity, we take equity very seriously here. We know it's very precious, but we're not opposed to issuing equity for growth purposes.
Steven Fleishman: Yep. Okay. And then, I guess, two questions on data centers. First, just a high level curious after the Eatsy kind of freak out. Just what kind of color are you getting from your customers on their plans? Is anything changed, good or bad? In terms of the commentary influenced by the customers?
William Fehrman: Really, no change in plan for us at all. It's been full speed ahead, and when the Eatsy came out, we had conversations with a number of our customers, and none of those individuals spoke in any way that we would be seeing a change. And so I think at least for us, I can't speak for others, obviously, but it continues to be full speed ahead.
Steven Fleishman: Okay. And then lastly, on the Bloom partnership, and the like, just you know, I think you had made a firm order for the 100 megawatts since it sounds like you have customers for that. Just how are you feeling about the likelihood to get, you know, into that full gigawatt, or is it too early to kind of say?
William Fehrman: Well, first, I'm really excited about customers that we have that have taken up the first 100 megawatts that we announced when we talked about the supply agreement with Bloom last November. I feel very good about where we're at with those customers. It's obviously proven that it's a viable opportunity for others to use in order to speed their ability to build their data centers and get online significantly sooner than waiting for perhaps five to seven years for a grid interconnect. And so I like where we're at with this technology. We're obviously on the leading edge from an innovation perspective. AEP is solving problems for these data centers that while others are maybe just issuing press releases, we're actually getting to solutions for these folks. And so I'll keep, we'll keep you updated, obviously, as our Greenwood Bloom allows for further expansions up to the one gigawatt mark and keep in mind, I would note also that this potential capital outlay is also not included in the current $54 billion capital plan. As we've talked about, but it is part of the $10 billion incremental investment opportunity that we're currently evaluating. And so, obviously, if more of that comes on, we'll have more updates for you. But overall, again, the feedback on this innovation and solution for customers has been extremely positive.
Steven Fleishman: Yep. Great. Thank you. Appreciate it.
William Fehrman: Thanks, Steve.
Rodger: We'll go next to Jeremy Tonet at JPMorgan.
Jeremy Tonet: Hi. Good morning.
Trevor Michalek: Good morning.
Jeremy Tonet: And, Trevor, congratulations as well.
Trevor Michalek: Jeremy, I appreciate it.
Jeremy Tonet: Just want to start off, I guess, picking up with the custom solutions as you outlined there, you know, being kind of bridge solutions. Is when if you could provide a bit more detail what it means from the AEP side potentially. Just if we could frame what that could look like from CapEx or any other way to kind of think about that, you know, potential in specifically just wires or other elements as well as it relates to AEPs.
William Fehrman: Sure. Well, first and foremost, again, in the spirit of protecting our existing customers for these deals, all costs for the fuel cell projects will be covered by the large customers that are under stand-alone contracts with AEP. And these are very customer-specific, and they'll need state commission approval. And so we're very excited about how this is rolling out and the fact that each of these individual customers, again, will cover the costs that are associated with the project. As far as the capital side now, Trevor, maybe you add a little bit on that or how we're thinking about it.
Trevor Michalek: Yeah. And then what I'd like to do on that, Jeremy, is roll that out, you know, if and when that comes to fruition, but that's all kind of part of that $10 billion upside. So we haven't really disclosed, you know, specifics around that, but expect more of that to come in the normal cadence. The only thing I would also add, Bill, is that, you know, I think AEP has had a rich history of, you know, being an innovator in this industry. You know, whether it's being the first to kind of have 765 kV lines, you know, all the way to this, you know, solution to help our commercial industrial load come on with this Bloom solution. But as Bill said, you know, we're gonna do it in a very disciplined way and, you know, it kind of talks to what AEP has done over the years to be a leader.
Jeremy Tonet: Got it. Thank you for that. And just pivoting here to West Virginia if you could. Just wondering if you could provide any incremental color on stakeholder conversations in just the state of, I guess, stakeholder relationships in the state at this point and how that has evolved over time.
William Fehrman: Yeah. I really appreciate that question. I've been very focused on West Virginia since I joined AEP last August. I spent a considerable amount of time in the state and talking with key stakeholders, including the prior administration as well as members of the current administration. I would say that right now, we were very innovative again in the filing that we put in. We corrected the deficiencies that we had and put in a very robust filing. But inside of that filing, we also offered the commission a separate solution for them to consider. As I noted in my remarks, the hearing is in June, and we expect a commission decision in the third quarter. We'll obviously see progress as the intervener testimony is due in April. Rebuttal testimony is due in May. And the proposed securitization option that we have on the table is not in our current financial plans. So, again, if it does come to pass, that would be a good adjustment. But we did include it in the filing as an option and really, purposely, to support customer affordability. This option is a very strong option that helps reduce the cost to customers. And so we really look forward to collaborating with all of the stakeholders there and achieving a favorable outcome for really all parties. And I think that so far, as the process has gone through, we've gotten positive feedback on how we approach this.
Jeremy Tonet: Got it. Thank you for that.
Rodger: We'll go next to Durgesh Chopra at Evercore ISI.
Durgesh Chopra: Hey. Good morning, Trevor. Welcome. I look forward to working with you. Listen, I just had two clarification questions, a lot of discussions on the topics I'm gonna ask you on. But just to clarify, Bill, I think you know, you discussed the large load tariff in Ohio and decision in Q3 by the commission. Is I understand it, the data center customers are not part of that settlement technology customers are not part of that settlement. Is that completely off the table, or could you still work in agreement with them? I guess, what I'm trying to get at with this is, is there an active dialogue conversations happening with them, or is it just now in the hands of the commission?
William Fehrman: So you're correct. There's actually two settlements that were being discussed. There was a settlement amongst the data centers themselves that they filed. And then there was a second settlement that was ourselves plus the commission staff plus some other large load entities that was filed. Both of those went through the hearing process. And then, as I said, there's basically now in the rebuttal and hearing, excuse me, intervener testimony and rebuttal process. I would say that there's continuing discussions going on as always as you go through these processes. But at this point, I would say we're really into waiting for the commission to issue their ruling, and we'll see what happens. Again, we're very open. These are our customers. We want to work with our customers. We want to find solutions for them just like we did with the Bloom Energy deal. And so we'll always try to find a way forward. But we do have certain principles that we want to make sure stay in place, which is good protection for our existing customer base.
Durgesh Chopra: Well, that's very helpful, Bill. Thank you. And then, Trevor, back to you, just a little bit more color on the 2025 financing plans. Obviously, congrats on the asset sale. That's a big bite at the apple from the overall equity in the plan. And then your commentary about, you know, the deferred fuel balance while taking your effort to get down, but still keeping you comfortably above the downgrade threshold. Should we take all that to mean that from an equity standpoint, you're done for 2025, or could you still kind of punch in, you know, more equity as you think about just I'm focused on 2025. Not sure if you can answer that or not, but just thinking about whether you're done for 2025 or not.
Trevor Michalek: Yeah. So I think, you know, Durgesh, the thing that I look at is, you know, the $2.8 billion of cash coming in the door when we close that transaction will really go a long way to, you know, getting what our needs are right now because really, you know, when we laid out that $5.35 billion, that was over a five-year period. So over half of that is coming in in year one. That being said, you know, again, we are really focused on this growth of the $10 billion and seeing how we can get that into our plan as quickly as possible. So, you know, and then there's other things we're dealing with as well, you know, with as Bill just mentioned, the potential securitizations. So a lot moving around right now, but, you know, I think we're in that great position with this transaction that, you know, I kind of got the benefit of stepping into after Chuck and Bill had kind of solved that issue that it really takes a lot of the pressure off of 2025 right now. But again, you know, my commitment is to, you know, be in a situation certainly where we would be above our downgrade thresholds. And this plan, fortunately, as we've got it right now with the $2.8 billion even with the deferred fuel adjustment mechanism keeps us above the 13%. And, you know, it puts us in a good position going forward. But again, a lot of moving parts around the growth, and that's what we're excited about right now is this incremental growth opportunity.
Durgesh Chopra: Got it. Appreciate that discussion there. Thanks, Trevor.
Trevor Michalek: Thanks, Durgesh.
Rodger: We'll move next to Nicholas Campanella at Barclays.
Nicholas Campanella: Hey. Good morning, and congrats to Trevor. Welcome to Columbus. And, you know, Chuck, if you're in the room, congrats on your retirement too. So hey. I just wanted to just a couple follow-ups. When you announced the transmission sale, you kind of said it's 1.7% accretive, like, on average to the plan. And can you just talk about the flexibility that that offers you as you work to kind of add this capital to the plan and strengthen the balance sheet and, you know, I guess where I'm heading is, when we get to the end of this year, like, is this transaction lengthening to six to eight, or do you expect kind of a step higher, you know, and at the 1.7% level? Thanks.
Trevor Michalek: Yeah. So, Nick, you know, to kind of convert that into an EPS, you know, that's roughly eleven or twelve cents of, on a full-year basis, that this transaction is accretive. But again, it depends on the timing of when we close it during the year, and so that will kind of, you have to take that into consideration as it gets towards the end of the year on what that really does. My view is I think we put out the range of $5.75 to $5.95, and, you know, we'll be at this point, in that range, you know, with the transaction and, you know, in good shape with regards to credit. So again, it probably the later it goes into the year, the less impact it has on 2025. With regards to the accretion, but it more really does help with where we're gonna be on the credit metrics.
Nicholas Campanella: Right. Okay. And then just how are you kind of thinking about further portfolio management at this point? I mean, the transmission sale is a great data point, and I definitely note, like, kind of the clear focus here on Indiana, Ohio, and Texas, and just do you guys still see opportunity to kind of prune things in the portfolio if it's accretive to your plan?
Trevor Michalek: Yeah. You know, again, I think on any type of M&A, we wouldn't really speak to it. But I tell you, the thing that we're most excited about is investing $54 billion at one time's rate base. And if you think about that, you know, that's basically the size of our market cap right now. With a potential upside of an additional $10 billion. So our view is we want to get scale and scope, and we believe we're growing this business and, you know, we think we are, we've got great footprints over a large area that helps us to mitigate risk. And so from the, at the end of the day, you know, I look across the portfolio and believe we've got a really good fit footprint relative to our competitors. And so I'm very, very positive about what I've stepped into here and feel that this is really good. But, Bill, I'm not sure if you want to add anything on this.
William Fehrman: I think, again, as Trevor noted, we've got a tremendous opportunity in front of us. And as a company, we're going to drive ourselves to be the biggest and the best energy infrastructure company in this country. I mean, again, it's in our name. We're American Electric Power. We're gonna power America. And as Trevor noted, the opportunity is almost unlimited for us going forward, and I have very strong confidence that we're gonna be able to deliver and execute.
Nicholas Campanella: Alright. That's great. Excited to see it, and have a great day. Thank you.
Rodger: We'll move next to Carly Davenport at Goldman Sachs.
Carly Davenport: Hey. Good morning. Thanks for squeezing me in. Maybe just one quick one for me. Just as you think about the generation needs across the portfolio to accommodate this load growth, I know you referenced some of the gas filings at PSO and SWEPCO in the opening comments. Can you just talk about the status of procurement of key equipment like turbines to execute on those plans?
William Fehrman: Sure. I appreciate the question. We have a very strong generation plan that has been developed within AEP and a bit of it also predated me with regards to looking at strategies around procuring turbines, procuring transformers, and other key equipment. I'm very confident in the plan that the team has. Our procurement strategy is strong. And we have a lot of activity out in the market right now. We're doing RFPs for a number of our states. We have significant IRP activity going on. And obviously, there's a growing energy demand out there, which is really why we're leading the efforts in the industry to try to find solutions for them, like in the near term bloom and in the longer term SMRs. And so we'll be all over this. I'm confident in our team, and I'm confident in the fact that we're going to deliver what our states want from a generation plan. And, clearly, as the year goes on, we'll be providing more updates in that area.
Carly Davenport: Great. Thanks so much for the call. I'll leave it there.
Rodger: And we have time for one more question, and that question comes from Julien Dumoulin-Smith at Jefferies.
Jamieson Ward: Hi, team. It's Jamieson Ward on for Julien. How are you?
Trevor Michalek: Yeah. Good. Good morning.
Jamieson Ward: Morning. Yeah. Thanks for fitting us in here at the end. Very thorough Q&A covered pretty much all the questions that we had. Did have one that was remaining, which is just on the ATM that you filed. It mentioned that $400 million had been already issued. In combination with the $2.8 billion of net cash proceeds that we'd expect to receive, you know, to see you receive it in the second half of the year. Do those two meet your 2025 equity needs? Or should we assume any further usage of the ATM in 2025? Is it just the 2026 and beyond tool? Thank you.
Trevor Michalek: Yeah. Look. As I said, you know, Jamieson, we're continuing to evaluate all of that. The good news is we do have access to the $1.3 billion that's remaining under the ATM. We can always hit that if we need to. But again, right now, I think we've got a very positive situation that we will be, you know, getting the $2.8 billion coming in later this year. And then as we look to the $10 billion growth opportunities here, you know, we will continue to evaluate that. But I think, you know, largely you've got it right with the ATM in place, and what we're doing with the drip program. And the cash coming in and the securitizations that potentially could come to fruition by the end of this year, we're in good shape.
Jamieson Ward: Gotcha. Gotcha. Really quick follow-up there. I guess the $2.55 billion that you had left, $500 million or so for the drip, $100 per year, the $1.7 for the ATM, that $350, it would seem kind of perfect for a JSN or some sort of equity content or equity-linked security. So I guess that kind of fits with what you've described. Is that a reasonable way to think about it? And then I just had one more on the $10 billion.
Trevor Michalek: Yeah. No. I think absolutely you're thinking about it correctly. There's a lot of levers for us to use here as we continue to look at things. And so, again, it's very positive with the $2.8 billion and then securitizations and other equity-like instruments are all very positive. And then if need be, we do have that $1.3 billion ATM. But again, we're in good shape here.
Jamieson Ward: Terrific. And the last one I'll leave you with, I know that you've answered one or two questions already on the $10 billion. Just wondered if there was a rule of thumb, you know, a couple of years ago at EEI that talk was all about 30% or 50% or whatever percent of incremental CapEx. And I get there's certain thresholds. If you get a billion of the $10 billion, it's a different scenario than if you get all $10 billion of the $10 billion. But any rule of thumb you can give us on high-level thinking about the amount of equity or equity-like portion that be looking to finance of that incremental CapEx versus debt financing?
Trevor Michalek: Yeah. The biggest thing that I would say is we're excited to roll that out, you know, in a normal cadence on our third-quarter call. And again, there's a lot of moving parts that we're managing here. And we are going to finance it in the most efficient way possible to ensure we can continue to meet the needs of our customers. But also to deliver on value to our shareholders, and that's what we're very focused on.
Jamieson Ward: Thank you so much. Appreciate it.
Rodger: And that concludes our Q&A session. I will now turn the conference back over to William Fehrman for closing remarks.
William Fehrman: Yeah. Thank you. We appreciate everyone joining us on the call today. I'd like to close with just a few summary remarks. First, very exciting times are ahead for AEP as we put our robust capital plan to work, as you've heard, and continue to grow the business while delivering shareholder value. Second, I'm very confident we can unlock the incredible value in this company by advancing our long-term strategy and providing safe, affordable, and reliable service across our large footprint. And then third, Trevor and Darcy will be hitting the road actually in March, meeting with many of you and discussing AEP's very strong and comprehensive value proposition. And finally, if there are any follow-up items, please reach out to our IR team with requests. So thank you again for joining us today. This concludes our call.
Rodger: And again, this concludes today's conference call. You may access the replay for today's conference by dialing 1-800-770-2030 and entering the conference ID of 1336080 followed by pound. The replay will be available until Thursday, February 20, 2025, at 11:59 PM Eastern Time. Thank you for your participation. You may now disconnect. | [
{
"speaker": "Rodger",
"text": "My name is Rodger, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Company's conference. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press. At this time, I would like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Good morning, and welcome to American Electric Power Company's fourth quarter 2024 earnings call. A live webcast of this teleconference and slide presentation are available on our website under the Events and Presentations section. We have a few members of our management team with us today, including William Fehrman, President and Chief Executive Officer, Trevor Michalek, Executive Vice President and Chief Financial Officer, and Kate Sturgis, Senior Vice President Controller and Chief Accounting Officer. We will be making forward-looking statements during the call. Actual results may differ materially from those projected in any forward-looking statement we make today. Factors that could cause our actual results to differ materially are discussed in the company's most recent SEC filings. Please refer to the presentation slides that accompany this call for a reconciliation to GAAP measures. We will take your questions following opening remarks. With that, please turn to slide four and let me hand the call over to William Fehrman."
},
{
"speaker": "William Fehrman",
"text": "Thank you, Darcy, and good morning, everyone. Welcome to our fourth quarter 2024 earnings call. Let me start by saying that after six months on the job, I continue to get more excited about the very strong and comprehensive AEP value proposition. Our future is extremely bright, and we are committed to delivering on our promises to customers, regulators, and investors by putting our robust capital plan to work. We are building a platform of success by focusing on execution and accountability. These are exciting times at AEP, and I see incredible value in this, which I am confident can further unlock by advancing our long-term strategy and providing safe, affordable, and reliable service across our large footprint. Before we jump into our results, I'd like to start by introducing our new CFO, Trevor Michalek, who joined AEP last month and is on the call with me today. Trevor is a proven leader and an industry veteran. He's hit the ground running and is already considered a very strong, disciplined, and focused member of our senior leadership team. Structure by eliminating management layers, reorganizing and reducing the size and scope of the service corporation, and improving procurement processes to drive much higher value from suppliers. The leadership team is coming together to make AEP a premium traded utility that is highly respected and trusted by our many stakeholders. Lastly, I'd like to take a moment to thank Charles Zebula for his more than twenty-five years of dedicated service to AEP. We're grateful for his steady hand during the transition and will continue to benefit from his expertise until his well-earned retirement in March. In my remarks this morning, I will discuss our strategic focus and our results at a high level before passing it over to Trevor to walk through our financials in more detail. Today, we announced fourth quarter 2024 operating earnings of $1.24 per share, $660 million, bringing our full-year 2024 operating earnings to $5.62 per share. Recall as part of our commitment to continuing to deliver value to our shareholders, last October, we increased the quarterly dividend from $0.88 to $0.93 per share. In addition, today, we are reaffirming AEP's 2025 operating earnings guidance range of $5.75 to $5.95 per share and affirming our long-term operating earnings growth rate of 6% to 8%. All reinforced by our robust $54 billion capital plan from 2025 through 2029. As we have talked about previously, I'm committed to a strong balance sheet, and I believe it is critical to funding our robust capital plan. We will responsibly finance the great opportunities ahead of us from a position of strength. Trevor will address this further in his remarks. We will also be disciplined around portfolio management. In fact, last month, we announced the Ohio and INM minority interest transaction on the transmission business with KKR and PSP investments for $2.82 billion. The transaction is highly accretive at 2.3 times rate base and valued at 30.3 times price to earnings. Put this into another perspective, this is equivalent to issuing AEP common stock at $170 per share. Moreover, in the last couple of weeks, we filed for approval with FERC, and we expect to close in the second half of 2025, at which time we'll still retain 95% of AEP's total transmission assets. The proceeds from this transaction allow us to rotate capital into investments that benefit our customers as we enhance reliability and deliver on growing energy demand. In addition to the minority interest transaction, we also recycled almost half a billion dollars in net cash proceeds in 2024 through the sale of the New Mexico Renewable Development solar portfolio and distributed resources business. We continue to work with federal policymakers, state legislators, and regulators across our large service footprint to determine what their goals are so we can relentlessly deliver on them. I would also like to spend some time this morning walking through AEP's future growth, which is underpinned by four major drivers: large load in our service territories, including data center load that we appreciate having the chance to serve and are aggressively pursuing, economic development efforts in our states, investment across the system in our transmission and distribution infrastructure, and new generation. Our capital plan includes customer commitments for 20 gigawatts of incremental load by 2030, driven by data center demand, reshoring and manufacturing, and continued economic development. In fact, large load impacts are already being felt in many of AEP's service territories, especially in Ohio, Texas, and Indiana. As demonstrated in our fourth quarter results, we experienced commercial load growth of 12.3% over the fourth quarter and 10.6% growth on the full year compared to 2023. One of the reasons we are seeing such growth now is that we have an advanced transmission system that can help support current large loads, which is a significant advantage for us versus our peers. As we execute on our $54 billion capital plan to support customer needs, affordability remains top of mind, and we are committed to fair cost allocations associated with large loads. We proactively filed the data center tariff in Ohio and large load tariff modifications in Indiana, Kentucky, and West Virginia, and we look forward to commission decisions in Indiana and West Virginia, both states, unanimous settlements in the near future. The data center tariff hearing in Ohio concluded last month, and we should have a commission decision by the third quarter of this year. In addition to our efforts to support load growth, our current capital plan contemplates sustained and substantial investments across our distribution infrastructure to better meet our customers' energy needs and improve customer service. Since AEP's distribution system is one of the nation's largest, at approximately 225,000 distribution miles, these efforts include work to harden or replace poles, conductors, transformers, and other assets, as well as deploy automated technologies like AMI meters and GridSmart for enhanced operational performance. In total, we are investing more than $13 billion over the next five years in these areas to improve reliability and reduce both frequency and duration of outages. By advancing these initiatives, as well as an aggressive vegetation management program, we will increase customer satisfaction, strengthen our system's resilience to weather events, and reduce costs for operations and maintenance. Demand for power is growing at a pace not seen over my 44 years in this business. As we discussed last quarter, meeting this demand could require incremental investment of up to $10 billion, driven by additional transmission, distribution, and generation infrastructure not included in our current $54 billion capital plan. For example, in our three primary RTOs, we see an opportunity of approximately $4 billion to $5 billion of incremental transmission awards recently approved or expected to be approved in the near term, with additional upside on other initiatives. The remainder of the $10 billion of incremental capital upside is in transmission, distribution, and generation infrastructure across the business. In addition, as you'll recall, in November, we announced a partnership with Bloom Energy related to fuel cells. Our current capital plan does not include any investment in this custom solution, which will enable our large customers to quickly power their operations while the grid is built out to accommodate further demand. Once the necessary infrastructure is connected to these large customers, they can use the fuel cells as backup generation, further adding resiliency to their operations. This demonstrates our commitment to finding innovative customer solutions that let them power up much quicker, allowing their business to deliver service to their customers, which will generate profits much sooner than waiting for a grid connection. As a matter of fact, just this week, AEP Ohio filed with the Ohio Commission for approval of the first two customer projects using this fuel cell technology, totaling 100 megawatts. Not only is AEP working to bring solutions tailored to the current power needs of our customers, but we are leading efforts in the industry on the potential that small modular reactors, or SMRs, have to meet the growing needs of the future. We're looking to partner with the US Department of Energy to support the early site permit process for two potential SMR locations, one in Indiana and the other in Virginia. We are laying the groundwork to find solutions to support large loads and are fortunate for the opportunity to build these SMRs, but only with appropriate risk sharing. The tech companies are fast movers, and AEP will be there to support them with whatever tech solution they want to deploy. We need to ensure that we are protected and compensated. Moving on to regulatory, over the last six months, I have visited ten of our eleven states and have been actively engaged with various stakeholders, listening to their preferences as we invest more in resources at the local level. I firmly believe that by delivering for our states and the customers who live there, we can, over time, improve our earned ROEs and increase equity layers as states are more receptive to the need to attract capital. It is an absolute imperative that AEP listens closely to our states and then aggressively delivers on the agreed-upon commitments. That's my promise to them. When I look at 2024 in review, our operating company has achieved a number of positive regulatory developments, including receiving constructive base rate case outcomes in Indiana, Michigan, Oklahoma, Texas, and Virginia. Obtained commission approval of the Ohio Electric Security Plan, updated formula rates in Arkansas and Louisiana, and filed system resiliency plans in both of our operating companies in Texas. As we discussed on our last call, APCO files its base case in West Virginia while offering securitization as a concept to help mitigate the proposed base rate increase. Interviewer testimony in this case is set for April, with rebuttal testimony following in May and a hearing set to start in mid-June of this year. We look forward to working with everyone involved in this case to achieve a positive outcome for both our customers and shareholders. Shifting now to our generation fleet, we previously filed approval of PSO's Green Country 795 megawatt gas facility, SWEPCO's new Haulsville 450 megawatt natural gas plant, as well as SWEPCO's Welch 1,053 megawatt natural gas conversion project. These facilities and RFPs, which are currently in progress at APCO, INM, and DSO, in addition to future integrated resource plan filings over the next four years in Arkansas, Kentucky, Indiana, Michigan, Virginia, and West Virginia, support our capacity obligations and will go a long way in meeting our customers' energy needs. In summary, we are engaged with key stakeholders on the regulatory front as we keep affordability, system reliability, resiliency, and security top of mind. I'm excited to start the new year having made meaningful progress and will continue these important efforts as we advance on our commitment to excellence and deliver on what our states want. I'll close by thanking everyone at AEP for their hard work and dedication in 2024. I'm energized as we enter 2025 with a strong team and a more streamlined structure that is significantly driving efficiencies, reducing bureaucracy, and creating a much more nimble company that can quickly execute on opportunities. Also, having our employees who have been working from home return to the office full-time by June 1st. Put all hands on deck with a renewed focus on execution and accountability, that will serve us well as we advance our strategic priorities to enhance value for our stakeholders. With that, I'll now turn it over to Trevor."
},
{
"speaker": "Trevor Michalek",
"text": "Thank you, Bill. Good morning to everyone on the call. I want to start today by thanking Bill and the board for placing their trust in me to help lead this organization into a bright and exciting future. I am honored and grateful for the opportunity to join a dynamic team that is focused on positioning the company for future success. And I'm committed to building on our momentum to create value for all of our stakeholders. As part of my transition, I have reviewed AEP's financial and capital plans, and I have confidence in executing on them with this team. Today, I will walk us through the fourth quarter and full-year results for 2024, expand on Bill's comments related to load growth, and discuss what we expect to see in the years ahead. I will finish with commentary on credit metrics, liquidity, and portfolio management, as well as my focus on disciplined capital allocation. Please turn to slide seven. This slide shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $1.25 per share, compared to $0.64 per share in 2023. GAAP earnings for the year were $5.60 per share, compared to $4.26 per share in 2023. Detailed reconciliations of GAAP to operating earnings are shown in the appendix on slides 25 and 26. Next, I will briefly cover fourth quarter operating results before moving on to a more detailed walkthrough of our year-to-date results by segment. Fourth quarter operating earnings came in at $1.24 per share, which was a one-cent improvement versus the prior year. We saw $0.22 of incremental rate changes across multiple jurisdictions along with higher normalized retail sales at both the vertically integrated and transmission and distribution segments. Partially offsetting these favorable drivers were higher O&M and lower margins at the generation and marketing segment. For reference, the full details of our fourth quarter results are shown on slide eight. Let's have a look at our year-to-date results. Operating earnings for 2024 totaled $5.62 per share, compared to $5.25 per share in 2023. This was an increase of $0.37 per share or about 7% year over year. Adding to AEP's long track record of delivering on its financial commitments for investors. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $2.63 per share, up $0.16 from a year earlier. Positive drivers included rate changes across multiple jurisdictions, notable outcomes in Virginia and Indiana, and a return to relatively normal weather in 2024 compared to the mild weather experienced in 2023. These items were partially offset by higher depreciation and higher O&M as we made investments to serve our customers. The transmission and distribution utility segment earned $1.51 per share, up $0.21 from last year. Favorable drivers in this segment included increased rates in Texas and Ohio, increased transmission revenue, a favorable year-over-year change in weather, and higher normalized retail sales. Partially offsetting these items were increased property taxes, depreciation, interest expense, and O&M. The AEP Transmission Holdco segment contributed $1.51 per share, up $0.08 from last year. Our continued investment in transmission assets, as the new loads are added to our system, was the main driver in the segment. Generation and marketing produced $0.48 per share, down $0.11 from last year. The reduced contribution from this segment was primarily driven by the sale of our universe of 2023, higher income taxes, and lower retail energy margins. These items were partially offset by lower interest expense and higher wholesale margins. Finally, corporate and others saw a benefit of $0.03 per share driven by lower income taxes and O&M, which are partially offset by higher net interest expense. As Bill mentioned earlier, we are reaffirming our operating earnings guidance range for 2025, of $5.75 to $5.95 per share. For convenience, we've included an updated waterfall bridging our actual 2024 results to the midpoint of our guidance for 2025 on slide 20. While some variances change due to the 2024 actual results, there is no change to our 2025 segment or overall guidance. Turning to slide nine. You can see more evidence of just how important load growth is to our financial story. Weather-normalized sales grew 3% in 2024, and we expect that to nearly triple in the years ahead. These are exciting times in the utility industry, as we incorporate this tremendous growth. As Bill mentioned, the load growth that I'm going to talk about is providing the opportunity to potentially add up to $10 billion of incremental capital over the next five years to our already sizable $54 billion plan. We are continuing to evaluate the magnitude and timing of this spend to meet the growth opportunities across our footprint. The gains we are seeing from the data centers and industrial customers represent a once-in-a-generational opportunity to shape and grow the system. So before I jump into the details, I want to emphasize a few key points about our confidence in the projections you see here. First, this isn't just a future story. This is a now story. We're already seeing these loads come online across our system. In December of 2024, we added almost 450 megawatts of hyperscale data center load in Ohio alone. Second, the load additions built into the forecast you see here are all backed by signed customer financial obligations demonstrating their commitment to bring these projects online. In fact, nearly all of these loads are backed by take-or-pay contracts and have already been accepted by certain RTOs, including PJM. This means that our customers are committed to paying for a minimum amount of power over a period of time. What's more, we've achieved tariff settlements in Indiana, Ohio, and West Virginia to strengthen and lengthen those commitments even further. Beyond those contracts, we have substantial interconnection queues waiting to sign additional commitments as well. Diving a little further into the details, you can see where the bulk of our growth is concentrated. New data centers drove double-digit growth in our commercial sales in 2024, with system-wide data processing load hitting a new high in December of 1.3 million megawatt hours. The gains are expanding beyond this transmission and distribution utilities into our higher-margin vertically integrated segment. Recently, we also connected the first of several hyperscale data center customers in Indiana, including AWS and Google. Across the entire system, we're contracted to see nearly 5 gigawatts of data processing load come online in 2025, representing almost a 25% increase from 2024. Beyond commercial load, our industrial sales are also set to accelerate after a resilient 2024. AEP's industrial load grew by more than 402,000 megawatt hours last year. This was punctuated by growth of almost 5% in Texas, highlighting the diversity of our service territory and giving us a lot of confidence going into the new year. We expect industrial sales growth to more than double in 2025 as several new large customers are contracted to come onto the system, like Cheniere in Texas. We also have several other large and well-publicized industrial projects set to come online in 2026 and 2027. More detailed load projections by class can be found on slide 13. As a reminder, we have more than 20 gigawatts of commercial and industrial load additions contracted to come onto our system through the end of the decade. Roughly half of those are in ERCOT, and the other half are spread across our PJM companies. As a result, we expect these quarterly sales numbers to continue their rapid growth for several years to come. Let's move on to slide ten to discuss the company's capitalization and liquidity. Our financial performance and strong balance sheet provided good credit metrics for the last twelve months. Our debt to capitalization remained largely consistent with our historical range. Our FFO to debt metrics stood at 14% for the twelve months ended December 31st, which was within our target range and well above our downgrade threshold of 13%. Available liquidity remained very strong at $4.6 billion and is supported by $6 billion in credit facilities. Our strong balance sheet and credit metric results, coupled with ample liquidity and the outcome of the minority interest transaction, expected to close in the second half of this year, have enhanced our financial flexibility. We can efficiently access the capital market to support the capital needs in front of us. We are committed to maintaining a strong balance sheet and credit metrics as we evaluate the upcoming capital spend opportunities and match them with optimal financing instruments. On a similar note, last week, I spoke directly with all three rating agencies and conveyed this leadership team's commitment to a strong balance sheet. Focused on executing the regulatory and financing plans, as well as disciplined allocation of O&M and capital to our companies. Finally, let's move on to slide eleven. Before we take your questions, I wanted to summarize what you heard from us today. First, you heard we had a strong year-over-year performance in 2024, growing our earnings roughly 7% with operating earnings coming in at $5.62 per share. We reinforced our commitments to stakeholders and built solid momentum heading into 2025. Second, you heard that we are absolutely focused on execution in 2025 to support one of the great load growth stories in our industry. We're executing on strategic investments and delivering our regulatory strategy, giving us confidence in our financing plans. Third, you heard we have $10 billion of incremental growth capital that we are currently evaluating. And fourth, you heard that the $2.82 billion pending minority interest transaction on the transmission assets is an exceptional value proposition to our shareholders. The transaction further boosts our earnings and credit profiles and helps to reduce near-term equity needs. Recall that the value we transacted on this is comparable to issuing equity at $170 per share. And we're still retained 95% of AEP's total transmission asset post-close. These components are key to our future success and reinforce our confidence in reaffirming our commitments, including our 2025 guidance range of $5.75 to $5.95 per share. Our long-term growth rate is 6% to 8% while targeting FFO to debt of 14% to 15%. We really appreciate your time and attention today. I'm gonna ask the operator to open the call so we can answer any of your questions that you may have. Thank you."
},
{
"speaker": "Rodger",
"text": "Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your questions, simply press star one again. We'll take our first question from Shar Pourreza at Guggenheim Partners."
},
{
"speaker": "Shar Pourreza",
"text": "Hey, guys. Good morning."
},
{
"speaker": "Trevor Michalek",
"text": "Good morning, Shar."
},
{
"speaker": "Shar Pourreza",
"text": "Morning. Just on the balance sheet, the forty-six to sixty basis points of FFO improvement, you highlight that kind of on the slides as a near-term target. Can you sustain that over the plan? And then on equity, any sense on the means of issuing the remaining $2.5 billion? Is it junior or is it asset optimization, a block? I mean, I know, Bill, in your comments, you did highlight portfolio management in your prepared remarks. So just wanna get a sense on that remaining equity as well."
},
{
"speaker": "Trevor Michalek",
"text": "Sure. So here's Trevor. Sure. Appreciate the question. You know, we are targeting FFO to debt in that 14% to 15% range. And again, from our perspective, that is a target that we're looking at. I will note that, you know, we are going to have a revision to the way that Moody's calculates the deferred fuel. So, we will drop down probably forty, fifty bps, sixty bps depending on, you know, where things go with that, which I think it's gonna happen. But again, that's gonna be above the 13% threshold. And again, from our perspective, both Bill and I are very focused on issuing, you know, the or executing on the $54 billion capital plan with a strong balance sheet. So I think what you'll see is this will dip down a little bit in the current year, and then really the deferred fuel issue kind of rolls off by 2026. And so from that perspective, you know, we're really focused on getting that, you know, in that 14% to 15% range in the near term. Then getting to your financing question, you know, again, like you said, we put out that $5.35 billion of equity needs last year and kind of talked about that at EEI. The good news is with this transaction, the $2.8 billion goes a long way to solving that. So that really leaves then, like you said, the $2.5 billion of which there's, you know, call it $500 million over the five-year period, $100 million a year on the drip. So then it's a very manageable $2 billion. And then looking at various things that we have here to solve for that, you know, there's potential securitization that we're continuing to work on in some of our locations. But we'll also utilize, you know, hybrids or other equity-like instruments. And then if we need to issue equity, you know, we could do that. And I'm not opposed to issuing equity for growth, and we have a growth plan that is incredible here. Especially, you know, articulating around that incremental $10 billion, but we want to be very judicious with issuing equity, but we think there's a lot of different levers that we can pull, securitization, hybrids, and then potentially, you know, over the longer term, if we had to issue incremental equity, we would consider it. But again, very focused on FFO to debt, and also executing on, you know, this kind of historic $54 billion growth plan."
},
{
"speaker": "Shar Pourreza",
"text": "Perfect. And then just lastly, obviously, a lot of load growth and you guys have that new CapEx upside disclosures. Specifically on the 20 gigs of load you're leaning on, just wanna get a sense on how much of that is in Ohio and on the dual tariff settlements that are out there. Can the differences be bridged? And what if the commission's order swings against your settlement? I know, Bill, you've been very active on the stakeholder engagement side. Just wanna get a sense there. Thanks."
},
{
"speaker": "William Fehrman",
"text": "So we're very, obviously, focused on the rate case and on the tariff filing for data centers. A lot of discussion going on. We're clearly looking to try and find a solution for bringing these folks into our system and bringing the economic development opportunities with us. And so we're continuing to look. If you think about the data center story that we have, in December alone, AEP Ohio added nearly 450 megawatts of data center load from AWS and Meta. So very strong. Looking ahead, we anticipate adding similar amounts of load almost every month through 2025. We've got over 4.7 gigawatts of data processing load contracted to begin service this year. And then while most of this load, to your point, is concentrated in Ohio and actually Texas, we also have nearly a gigawatt contracted to come online in Indiana. So that's extending our growth into the vertically integrated utility segment as well. So I would note that both Google and AWS have recently begun service in Indiana. So that's very positive for us, and they're gonna continue to ramp up progressively over the next several years. So this growth certainly underscores our commitment to economic development and highlights significant opportunities ahead, but, clearly, we're going to make sure that this doesn't fall on the shoulders of our existing customers and make sure that the appropriate parties who are driving the incremental cost will pay for the incremental cost."
},
{
"speaker": "Shar Pourreza",
"text": "Perfect. Trevor, big congrats to you and the AEP team. I know you're gonna do really fantastic there. Big congrats on phase two."
},
{
"speaker": "Trevor Michalek",
"text": "Sure. I really appreciate it. Excited to be here. This is an incredible story, and quite the team here. So thank you."
},
{
"speaker": "Shar Pourreza",
"text": "Great. Thanks, guys."
},
{
"speaker": "Rodger",
"text": "We'll move next to Ross Fowler at Bank of America."
},
{
"speaker": "Ross Fowler",
"text": "Morning."
},
{
"speaker": "Trevor Michalek",
"text": "Thanks, Ross."
},
{
"speaker": "Ross Fowler",
"text": "So just wanna dig into maybe the data center tariffs you talked about sort of protecting yourself around sort of stranded cost risk or minimum take risk. So in that tariff, you know, have you disclosed what that rate is versus maybe other industrial commercial rates? Is it, like, a minimum power take requirement that's in there? And what kind of terms are you looking at in those tariffs that you filed?"
},
{
"speaker": "William Fehrman",
"text": "So the tariffs are really driven by the cost of the incremental project. And so there's not a specific, say, price in the tariff until we understand what the cost of the incremental load is going to be or the incremental transmission is going to be to serve that load. And so it really is a case for us to protect the existing customer base and that the driver behind the data center cost will be covered essentially by the company that's requiring it. So we feel very good about where we sit. I would say there are a couple of differences in the tariffs if you look across the states. For instance, in Ohio, that tariff is very much focused on data centers, whereas if you look at the similar proposal in Indiana, that is a broader tariff that would apply to any and all large loads that are similar to a data center. So some minor differences across the states, but generally, the same purpose holds, which is make the customer who's driving the incremental cost pay for the incremental cost and put it in place for a longer period of time so that we know as we're building out this incredible investment that, oh, if the customer goes away in year six or seven, we still have coverage for some of those costs, and it's not stranded and placed on the shoulders of our existing customers. So very, very positive outcome for us. I think it sets us up, and I don't think that it's been a detriment to the economic growth we have if you look at the overall increases that are already signed up. We have significant growth in accordance with these tariffs. So very, very strong interest still even though these tariffs are going into place."
},
{
"speaker": "Ross Fowler",
"text": "That's great, Bill. Thank you. And then Trevor, maybe one for you. You mentioned securitization as an avenue for maybe some of that equity need. Did you have a scaling of that versus the $2 billion you need in the current plan, or have you sort of not walked through all of that yet?"
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. We're still working through that with the various states, Ross, but, you know, honestly, I think you could look at it and securitization could, if successful, could potentially, you know, be a big chunk of that remaining $2 billion. So, you know, right now, if you the way I think of it is we kind of laid out the $5.35 billion over a five-year period. The $2.8 billion from the sale transaction really takes care of a big chunk of that in the immediate term here, and then we have a lot of other levers to pull over the remaining, you know, four years of the plan to solve for that $2 billion. But securitization could be, if successful, you know, a real win because it could help the customers with regards to rates, but it can also help us with regards to the need for the cash that would fill that gap on the $54 billion plan that we laid out."
},
{
"speaker": "Ross Fowler",
"text": "Perfect. Thank you. And then if we can squeeze one more in back to techy Bill. You mentioned SMRs and kind of how you're trying to very early stages looking at that, but, you know, under the right risk structure. In other states, we've sort of seen, like, this idea where, you know, the off-taker would put in a significant portion of the capital and take more of the risk into that project? Are you thinking about similar structures there or how far have you kind of walked down the thought process of what that structure would look like or might look like?"
},
{
"speaker": "William Fehrman",
"text": "Yeah. Thanks for that question. Obviously, very interested in SMRs as a technology, and that's really driven by the fact that our major customers are also interested in that as a solution. And as we noted, we've started with the early site permit work in Indiana and Virginia and have signed MOUs with various parties to support that type of work. We did put in our tier one application with the DOE for one of the sites and the tier two application for the other site to try and get some support for those. At a broader look, with regards to how we would think about this, clearly, I'm not going to put the company at risk in any type of a move as a first-of-a-kind type of technology. And so as we've been talking with potential customers, we haven't got to any specific arrangements or how this might look at this stage. But certainly, there's discussions ongoing to see if there's a way to do this. Clearly, the SMR technology providers, somebody needs to be first, and somebody needs to step up and figure out how they're going to deliver their product and back it. I mean, this is one of those situations where, to me, I'm buying a technology from somebody, and it should work. And it should be at a price that is very understandable and protected. And so I'm very excited about where we sit with regards to discussions, but I would say we're quite a ways away from having anything firmed up or really any firm structure at this point. But whatever we ultimately end up with, we'll be very principled and disciplined on our side of this to make sure that our shareholders and our customers are protected from any significant types of negative outcomes."
},
{
"speaker": "Ross Fowler",
"text": "That's great. Thank you. And, Trevor, congratulations again on the new role. Wish you nothing but success."
},
{
"speaker": "Trevor Michalek",
"text": "I really appreciate it, Ross. Thank you."
},
{
"speaker": "Rodger",
"text": "We'll go next to Steven Fleishman at Wolfe Research."
},
{
"speaker": "Steven Fleishman",
"text": "Hi. Good morning."
},
{
"speaker": "Trevor Michalek",
"text": "Hey, Steve. Congrats, Trevor, as well. Let me echo that."
},
{
"speaker": "Steven Fleishman",
"text": "So just on the, I guess, on the upside to the capital plan and particularly the transmission, so, for example, there's these PJM transmission that the joint venture that you have and the like that's being decided the next month or so. Is that that would be upside to the plan that's not in the plan? To things like that."
},
{
"speaker": "Trevor Michalek",
"text": "Yeah, Steve. That's right. That would be upside to the plan. So, you know, here again, what we've got is, you know, the $54 billion plan that has very definitive things in it, and we really aren't putting things into the plan that aren't for sure. And so then when you look at this $10 billion, a lot of this is coming to fruition over the next, you know, kind of months here. And so we're gonna be pretty excited about rolling out kind of in a normal cadence on the third quarter call a revision to the $54 billion plan, but, yeah, that would be upside."
},
{
"speaker": "William Fehrman",
"text": "And, Steve, just to add to that, yeah, just to add that a little bit specifically to PJM, you probably know we've announced the joint planning agreements with Dominion and FirstEnergy to propose those projects through the regional transmission expansion plan. We expect PJM approval in the first quarter on those projects. And so, again, as Trevor noted, all of those, if they would come to fruition, would be upside."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And then I, you might have answered this, Trevor, and I missed it. But just in the event that you see that capital plan come up, how should we think about funding for incremental capital?"
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. So again, yeah. You know, Steve, I think on the incremental capital side, we really do have a lot of positives here. Again, with the $2.8 billion coming in this year, that's gonna set us up really well for, you know, call it roughly half of the equity needs that we laid out before. And then with securitization and other things, that's really gonna kind of take us a long way to filling that gap. At the end of the day, I'm not opposed to, you know, issuing equity for growth, and this kind of growth I think that really makes sense. At the end of the day, you know, there's a lot of other things that we're working on internally as we rightsize this organization to get, you know, costs in line with where this is going. As well as other opportunities we're looking at that I want to be somewhat, you know, careful here in how we say it. But there is, you know, capital allocation internally looking to support this growth plan. And, you know, equity, we take equity very seriously here. We know it's very precious, but we're not opposed to issuing equity for growth purposes."
},
{
"speaker": "Steven Fleishman",
"text": "Yep. Okay. And then, I guess, two questions on data centers. First, just a high level curious after the Eatsy kind of freak out. Just what kind of color are you getting from your customers on their plans? Is anything changed, good or bad? In terms of the commentary influenced by the customers?"
},
{
"speaker": "William Fehrman",
"text": "Really, no change in plan for us at all. It's been full speed ahead, and when the Eatsy came out, we had conversations with a number of our customers, and none of those individuals spoke in any way that we would be seeing a change. And so I think at least for us, I can't speak for others, obviously, but it continues to be full speed ahead."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And then lastly, on the Bloom partnership, and the like, just you know, I think you had made a firm order for the 100 megawatts since it sounds like you have customers for that. Just how are you feeling about the likelihood to get, you know, into that full gigawatt, or is it too early to kind of say?"
},
{
"speaker": "William Fehrman",
"text": "Well, first, I'm really excited about customers that we have that have taken up the first 100 megawatts that we announced when we talked about the supply agreement with Bloom last November. I feel very good about where we're at with those customers. It's obviously proven that it's a viable opportunity for others to use in order to speed their ability to build their data centers and get online significantly sooner than waiting for perhaps five to seven years for a grid interconnect. And so I like where we're at with this technology. We're obviously on the leading edge from an innovation perspective. AEP is solving problems for these data centers that while others are maybe just issuing press releases, we're actually getting to solutions for these folks. And so I'll keep, we'll keep you updated, obviously, as our Greenwood Bloom allows for further expansions up to the one gigawatt mark and keep in mind, I would note also that this potential capital outlay is also not included in the current $54 billion capital plan. As we've talked about, but it is part of the $10 billion incremental investment opportunity that we're currently evaluating. And so, obviously, if more of that comes on, we'll have more updates for you. But overall, again, the feedback on this innovation and solution for customers has been extremely positive."
},
{
"speaker": "Steven Fleishman",
"text": "Yep. Great. Thank you. Appreciate it."
},
{
"speaker": "William Fehrman",
"text": "Thanks, Steve."
},
{
"speaker": "Rodger",
"text": "We'll go next to Jeremy Tonet at JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi. Good morning."
},
{
"speaker": "Trevor Michalek",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "And, Trevor, congratulations as well."
},
{
"speaker": "Trevor Michalek",
"text": "Jeremy, I appreciate it."
},
{
"speaker": "Jeremy Tonet",
"text": "Just want to start off, I guess, picking up with the custom solutions as you outlined there, you know, being kind of bridge solutions. Is when if you could provide a bit more detail what it means from the AEP side potentially. Just if we could frame what that could look like from CapEx or any other way to kind of think about that, you know, potential in specifically just wires or other elements as well as it relates to AEPs."
},
{
"speaker": "William Fehrman",
"text": "Sure. Well, first and foremost, again, in the spirit of protecting our existing customers for these deals, all costs for the fuel cell projects will be covered by the large customers that are under stand-alone contracts with AEP. And these are very customer-specific, and they'll need state commission approval. And so we're very excited about how this is rolling out and the fact that each of these individual customers, again, will cover the costs that are associated with the project. As far as the capital side now, Trevor, maybe you add a little bit on that or how we're thinking about it."
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. And then what I'd like to do on that, Jeremy, is roll that out, you know, if and when that comes to fruition, but that's all kind of part of that $10 billion upside. So we haven't really disclosed, you know, specifics around that, but expect more of that to come in the normal cadence. The only thing I would also add, Bill, is that, you know, I think AEP has had a rich history of, you know, being an innovator in this industry. You know, whether it's being the first to kind of have 765 kV lines, you know, all the way to this, you know, solution to help our commercial industrial load come on with this Bloom solution. But as Bill said, you know, we're gonna do it in a very disciplined way and, you know, it kind of talks to what AEP has done over the years to be a leader."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Thank you for that. And just pivoting here to West Virginia if you could. Just wondering if you could provide any incremental color on stakeholder conversations in just the state of, I guess, stakeholder relationships in the state at this point and how that has evolved over time."
},
{
"speaker": "William Fehrman",
"text": "Yeah. I really appreciate that question. I've been very focused on West Virginia since I joined AEP last August. I spent a considerable amount of time in the state and talking with key stakeholders, including the prior administration as well as members of the current administration. I would say that right now, we were very innovative again in the filing that we put in. We corrected the deficiencies that we had and put in a very robust filing. But inside of that filing, we also offered the commission a separate solution for them to consider. As I noted in my remarks, the hearing is in June, and we expect a commission decision in the third quarter. We'll obviously see progress as the intervener testimony is due in April. Rebuttal testimony is due in May. And the proposed securitization option that we have on the table is not in our current financial plans. So, again, if it does come to pass, that would be a good adjustment. But we did include it in the filing as an option and really, purposely, to support customer affordability. This option is a very strong option that helps reduce the cost to customers. And so we really look forward to collaborating with all of the stakeholders there and achieving a favorable outcome for really all parties. And I think that so far, as the process has gone through, we've gotten positive feedback on how we approach this."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Thank you for that."
},
{
"speaker": "Rodger",
"text": "We'll go next to Durgesh Chopra at Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey. Good morning, Trevor. Welcome. I look forward to working with you. Listen, I just had two clarification questions, a lot of discussions on the topics I'm gonna ask you on. But just to clarify, Bill, I think you know, you discussed the large load tariff in Ohio and decision in Q3 by the commission. Is I understand it, the data center customers are not part of that settlement technology customers are not part of that settlement. Is that completely off the table, or could you still work in agreement with them? I guess, what I'm trying to get at with this is, is there an active dialogue conversations happening with them, or is it just now in the hands of the commission?"
},
{
"speaker": "William Fehrman",
"text": "So you're correct. There's actually two settlements that were being discussed. There was a settlement amongst the data centers themselves that they filed. And then there was a second settlement that was ourselves plus the commission staff plus some other large load entities that was filed. Both of those went through the hearing process. And then, as I said, there's basically now in the rebuttal and hearing, excuse me, intervener testimony and rebuttal process. I would say that there's continuing discussions going on as always as you go through these processes. But at this point, I would say we're really into waiting for the commission to issue their ruling, and we'll see what happens. Again, we're very open. These are our customers. We want to work with our customers. We want to find solutions for them just like we did with the Bloom Energy deal. And so we'll always try to find a way forward. But we do have certain principles that we want to make sure stay in place, which is good protection for our existing customer base."
},
{
"speaker": "Durgesh Chopra",
"text": "Well, that's very helpful, Bill. Thank you. And then, Trevor, back to you, just a little bit more color on the 2025 financing plans. Obviously, congrats on the asset sale. That's a big bite at the apple from the overall equity in the plan. And then your commentary about, you know, the deferred fuel balance while taking your effort to get down, but still keeping you comfortably above the downgrade threshold. Should we take all that to mean that from an equity standpoint, you're done for 2025, or could you still kind of punch in, you know, more equity as you think about just I'm focused on 2025. Not sure if you can answer that or not, but just thinking about whether you're done for 2025 or not."
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. So I think, you know, Durgesh, the thing that I look at is, you know, the $2.8 billion of cash coming in the door when we close that transaction will really go a long way to, you know, getting what our needs are right now because really, you know, when we laid out that $5.35 billion, that was over a five-year period. So over half of that is coming in in year one. That being said, you know, again, we are really focused on this growth of the $10 billion and seeing how we can get that into our plan as quickly as possible. So, you know, and then there's other things we're dealing with as well, you know, with as Bill just mentioned, the potential securitizations. So a lot moving around right now, but, you know, I think we're in that great position with this transaction that, you know, I kind of got the benefit of stepping into after Chuck and Bill had kind of solved that issue that it really takes a lot of the pressure off of 2025 right now. But again, you know, my commitment is to, you know, be in a situation certainly where we would be above our downgrade thresholds. And this plan, fortunately, as we've got it right now with the $2.8 billion even with the deferred fuel adjustment mechanism keeps us above the 13%. And, you know, it puts us in a good position going forward. But again, a lot of moving parts around the growth, and that's what we're excited about right now is this incremental growth opportunity."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Appreciate that discussion there. Thanks, Trevor."
},
{
"speaker": "Trevor Michalek",
"text": "Thanks, Durgesh."
},
{
"speaker": "Rodger",
"text": "We'll move next to Nicholas Campanella at Barclays."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey. Good morning, and congrats to Trevor. Welcome to Columbus. And, you know, Chuck, if you're in the room, congrats on your retirement too. So hey. I just wanted to just a couple follow-ups. When you announced the transmission sale, you kind of said it's 1.7% accretive, like, on average to the plan. And can you just talk about the flexibility that that offers you as you work to kind of add this capital to the plan and strengthen the balance sheet and, you know, I guess where I'm heading is, when we get to the end of this year, like, is this transaction lengthening to six to eight, or do you expect kind of a step higher, you know, and at the 1.7% level? Thanks."
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. So, Nick, you know, to kind of convert that into an EPS, you know, that's roughly eleven or twelve cents of, on a full-year basis, that this transaction is accretive. But again, it depends on the timing of when we close it during the year, and so that will kind of, you have to take that into consideration as it gets towards the end of the year on what that really does. My view is I think we put out the range of $5.75 to $5.95, and, you know, we'll be at this point, in that range, you know, with the transaction and, you know, in good shape with regards to credit. So again, it probably the later it goes into the year, the less impact it has on 2025. With regards to the accretion, but it more really does help with where we're gonna be on the credit metrics."
},
{
"speaker": "Nicholas Campanella",
"text": "Right. Okay. And then just how are you kind of thinking about further portfolio management at this point? I mean, the transmission sale is a great data point, and I definitely note, like, kind of the clear focus here on Indiana, Ohio, and Texas, and just do you guys still see opportunity to kind of prune things in the portfolio if it's accretive to your plan?"
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. You know, again, I think on any type of M&A, we wouldn't really speak to it. But I tell you, the thing that we're most excited about is investing $54 billion at one time's rate base. And if you think about that, you know, that's basically the size of our market cap right now. With a potential upside of an additional $10 billion. So our view is we want to get scale and scope, and we believe we're growing this business and, you know, we think we are, we've got great footprints over a large area that helps us to mitigate risk. And so from the, at the end of the day, you know, I look across the portfolio and believe we've got a really good fit footprint relative to our competitors. And so I'm very, very positive about what I've stepped into here and feel that this is really good. But, Bill, I'm not sure if you want to add anything on this."
},
{
"speaker": "William Fehrman",
"text": "I think, again, as Trevor noted, we've got a tremendous opportunity in front of us. And as a company, we're going to drive ourselves to be the biggest and the best energy infrastructure company in this country. I mean, again, it's in our name. We're American Electric Power. We're gonna power America. And as Trevor noted, the opportunity is almost unlimited for us going forward, and I have very strong confidence that we're gonna be able to deliver and execute."
},
{
"speaker": "Nicholas Campanella",
"text": "Alright. That's great. Excited to see it, and have a great day. Thank you."
},
{
"speaker": "Rodger",
"text": "We'll move next to Carly Davenport at Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"text": "Hey. Good morning. Thanks for squeezing me in. Maybe just one quick one for me. Just as you think about the generation needs across the portfolio to accommodate this load growth, I know you referenced some of the gas filings at PSO and SWEPCO in the opening comments. Can you just talk about the status of procurement of key equipment like turbines to execute on those plans?"
},
{
"speaker": "William Fehrman",
"text": "Sure. I appreciate the question. We have a very strong generation plan that has been developed within AEP and a bit of it also predated me with regards to looking at strategies around procuring turbines, procuring transformers, and other key equipment. I'm very confident in the plan that the team has. Our procurement strategy is strong. And we have a lot of activity out in the market right now. We're doing RFPs for a number of our states. We have significant IRP activity going on. And obviously, there's a growing energy demand out there, which is really why we're leading the efforts in the industry to try to find solutions for them, like in the near term bloom and in the longer term SMRs. And so we'll be all over this. I'm confident in our team, and I'm confident in the fact that we're going to deliver what our states want from a generation plan. And, clearly, as the year goes on, we'll be providing more updates in that area."
},
{
"speaker": "Carly Davenport",
"text": "Great. Thanks so much for the call. I'll leave it there."
},
{
"speaker": "Rodger",
"text": "And we have time for one more question, and that question comes from Julien Dumoulin-Smith at Jefferies."
},
{
"speaker": "Jamieson Ward",
"text": "Hi, team. It's Jamieson Ward on for Julien. How are you?"
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. Good. Good morning."
},
{
"speaker": "Jamieson Ward",
"text": "Morning. Yeah. Thanks for fitting us in here at the end. Very thorough Q&A covered pretty much all the questions that we had. Did have one that was remaining, which is just on the ATM that you filed. It mentioned that $400 million had been already issued. In combination with the $2.8 billion of net cash proceeds that we'd expect to receive, you know, to see you receive it in the second half of the year. Do those two meet your 2025 equity needs? Or should we assume any further usage of the ATM in 2025? Is it just the 2026 and beyond tool? Thank you."
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. Look. As I said, you know, Jamieson, we're continuing to evaluate all of that. The good news is we do have access to the $1.3 billion that's remaining under the ATM. We can always hit that if we need to. But again, right now, I think we've got a very positive situation that we will be, you know, getting the $2.8 billion coming in later this year. And then as we look to the $10 billion growth opportunities here, you know, we will continue to evaluate that. But I think, you know, largely you've got it right with the ATM in place, and what we're doing with the drip program. And the cash coming in and the securitizations that potentially could come to fruition by the end of this year, we're in good shape."
},
{
"speaker": "Jamieson Ward",
"text": "Gotcha. Gotcha. Really quick follow-up there. I guess the $2.55 billion that you had left, $500 million or so for the drip, $100 per year, the $1.7 for the ATM, that $350, it would seem kind of perfect for a JSN or some sort of equity content or equity-linked security. So I guess that kind of fits with what you've described. Is that a reasonable way to think about it? And then I just had one more on the $10 billion."
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. No. I think absolutely you're thinking about it correctly. There's a lot of levers for us to use here as we continue to look at things. And so, again, it's very positive with the $2.8 billion and then securitizations and other equity-like instruments are all very positive. And then if need be, we do have that $1.3 billion ATM. But again, we're in good shape here."
},
{
"speaker": "Jamieson Ward",
"text": "Terrific. And the last one I'll leave you with, I know that you've answered one or two questions already on the $10 billion. Just wondered if there was a rule of thumb, you know, a couple of years ago at EEI that talk was all about 30% or 50% or whatever percent of incremental CapEx. And I get there's certain thresholds. If you get a billion of the $10 billion, it's a different scenario than if you get all $10 billion of the $10 billion. But any rule of thumb you can give us on high-level thinking about the amount of equity or equity-like portion that be looking to finance of that incremental CapEx versus debt financing?"
},
{
"speaker": "Trevor Michalek",
"text": "Yeah. The biggest thing that I would say is we're excited to roll that out, you know, in a normal cadence on our third-quarter call. And again, there's a lot of moving parts that we're managing here. And we are going to finance it in the most efficient way possible to ensure we can continue to meet the needs of our customers. But also to deliver on value to our shareholders, and that's what we're very focused on."
},
{
"speaker": "Jamieson Ward",
"text": "Thank you so much. Appreciate it."
},
{
"speaker": "Rodger",
"text": "And that concludes our Q&A session. I will now turn the conference back over to William Fehrman for closing remarks."
},
{
"speaker": "William Fehrman",
"text": "Yeah. Thank you. We appreciate everyone joining us on the call today. I'd like to close with just a few summary remarks. First, very exciting times are ahead for AEP as we put our robust capital plan to work, as you've heard, and continue to grow the business while delivering shareholder value. Second, I'm very confident we can unlock the incredible value in this company by advancing our long-term strategy and providing safe, affordable, and reliable service across our large footprint. And then third, Trevor and Darcy will be hitting the road actually in March, meeting with many of you and discussing AEP's very strong and comprehensive value proposition. And finally, if there are any follow-up items, please reach out to our IR team with requests. So thank you again for joining us today. This concludes our call."
},
{
"speaker": "Rodger",
"text": "And again, this concludes today's conference call. You may access the replay for today's conference by dialing 1-800-770-2030 and entering the conference ID of 1336080 followed by pound. The replay will be available until Thursday, February 20, 2025, at 11:59 PM Eastern Time. Thank you for your participation. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 3 | 2,024 | 2024-11-06 09:00:00 | Operator: Thank you for standing by. My name is Danica and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power's Third Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would like to turn the conference over to Darcy Reese, Vice-President of Investor Relations. Please go ahead.
Darcy Reese: Thank you, Danica. Good morning, everyone, and welcome to the third quarter 2024 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discussion of these factors. Joining me this morning for opening remarks are Bill Fehrman, our President and Chief Executive Officer and Chuck Zebula, our Executive Vice President and Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Bill.
William Fehrman: Thank you, Darcy and good morning everyone. I'm happy to be with you for my first earnings call as AEP's President and CEO. In my remarks this morning, I'll discuss our results and outlook before turning to the key pillars of our strategy to enhance value for customers and investors. I'll then cover regulatory updates before handing it over to Chuck to walk through our financials in more detail. You can find a summary of third quarter 2024 business highlights on Slide 4 of our presentation. We have a lot of exciting ground to cover today, but first I'd like to briefly introduce myself to those I haven't had the opportunity to meet yet. I spent my entire career in the utility and energy business. Most recently I was at Berkshire Hathaway Energy, which has an asset base 1.4 times the size of AEP, operates in 11 states but also in Canada and Great Britain and has a diverse group of regulatory interests. While I'm familiar with most of the industry players, bankers, regulators, companies and debt investors, I am new to many of the AEP shareholders and I look forward to delivering for you. With that, I'm honored to join a leader like AEP at a pivotal time for both the organization and our industry. Since assuming the role of CEO, I've met our many stakeholders and the AEP team across our 11 state footprint, including four governors and over 30 regulators and legislators. We've had robust discussions about critical initiatives and I've appreciated the opportunity to engage, listen and learn over the past three months to help shape our vision for the future. AEP has built a strong foundation for growth, including our robust transmission system, which represents 55% of AEP's total earnings stream. However, we can improve reliability, streamline cost, use technology better, and put power in the hands of local leaders to build financially strong utilities in our communities. I look forward to the future and working with the many talented people across the company to drive operational excellence, best-in-class service earnings growth and overall success. I'll begin with our financial results. Today we report third quarter 2024 operating earnings of $1.85 per share, or $985 million. Building on our strong momentum this year we are confident in narrowing our 2024 full year operating earnings guidance range to $5.58 to $5.68, maintaining the original $5.63 midpoint. As referenced on Slide 5, today we also formally introduce our 2025 operating earnings guidance range of $5.75 to $5.95. We have thought a lot about this range, especially since I've been in the CEO role for just three months. The foundation of our 2025 earnings guidance range is based on robust growth in our regulated utilities. This range also reflects lower contributions from our generation and marketing segment due to reduced scope of activities going forward and lower retail and wholesale margins likely to be realized. While AEP's earnings range rose 4% in 2025, you have my commitment that we will do significantly better in 2026 and beyond after we go through an optimization exercise and we retool our personnel and processes over the coming months. As the new CEO at AEP, I need to establish a record of delivering on promises to you while demonstrating goodwill to our regulators and customers as we focus on service, reliability and enhanced vegetation management to reduce customer outages. My objective is to improve our customer experience and stakeholder relationships which over time will result in more positive regulatory outcomes and enable a stable platform for growth. AEP's future growth opportunities are very significant as we embrace the large load opportunity in our service territory as well as substantial upgrades to the distribution system. We are focusing on economic development efforts in our states to help address affordability and investing in our energy delivery infrastructure to improve reliability in addition to new generation to support resource adequacy. Because of this tremendous growth, today we are unveiling AEP's new long-term earnings growth rate of 6% to 8% off a 2025 base year and a $5.85 midpoint, all reinforced by a balanced and flexible $54 billion capital plan from 2025 through 2029. When I look at this newly raised $54 billion capital plan, which is up more than 25% over the prior $43 billion plan, there is even more upside to go. In fact, we see significant opportunity to capture $10 billion in incremental transmission and generation infrastructure investment to satisfy all of the load growth. We will provide more details at EEI regarding these investment opportunities that drive our updated 8% rate base CAGR. Note that during the 2025 through 2029 timeframe, we also expect our customer rates will go up by less than 3% annually on a system wide basis due to built headroom created from economic development activities and new generation. Understand that this customer rate impact could change due to effects of potential future generation needs. Please refer to slides 5 and 6. As you know, maintaining a strong balance sheet is critical to funding the increased capital spend associated with these growth rates and we remain committed to responsibly financing our capital needs. In addition to equity and equity like tools, we will explore asset monetization opportunities to the extent they can be executed upon while achieving the right price. If we do explore asset sales, we won't tell you about them until they happen. Our newly rolled forward five year capital and financing plans can be seen in the appendix on slides 13 and 14. Turning to slide 7, our robust financial outlook will be underpinned by a culture of accountability and execution. This business is transforming rapidly and we recognize the need for change to better serve our customers. Since joining the company in August, we have made several changes to align and simplify the organizational structure to ensure we have the right talent and the right roles to execute our strategy and achieve our objectives. For example, our operating company Presidents and Chief Nuclear Officer now report directly to me, while power plants and site managers will report directly to our operating Company Presidents. We have streamlined the leadership structure by eliminating management layers and reorganizing the service corporation. These actions move decision making closer to customers, all to ensure our money making businesses have the authority they need to accelerate improved performance. I'm confident our new structure will help us drive value as we advance three core areas of strategic focus, growth and financial strength, customer service and regulatory integrity. I'd like to spend a few minutes walking through each of these areas. First, AEP's future growth potential and financial strength is significant with customer commitments for 20 gigawatts of load additions through 2029 driven by data center demand and we have updated our load growth forecast accordingly through 2027. In fact, large load impacts are already being felt in our service territories, predominantly in Ohio, Texas and Indiana. This is demonstrated in our third quarter results in which we realized commercial load growth of 7.9% compared to the third quarter of last year and 10.1% growth year-to-date in 2024 compared to 2023. We are committed to supporting this new load growth in our service territory, but we also remain focused on ensuring affordability by fairly allocating costs resulting from associated incremental investments. This is why we proactively filed the data center tariff in Ohio, the large load tariff modifications in Indiana, Kentucky and West Virginia, and a complaint with FERC related to a co-located load arrangement. Load growth from data center demand has the potential to benefit all stakeholders including investors, customers and local communities, but only with fair and proper cost allocation. While some may think that our FERC complaint is anti-data center, it is actually the opposite. We are trying to welcome all data centers to our service territory by making sure that those data centers help all customers. The second area of focus for us is best-in-class customer service. We will leverage technology to enhance service and better meet our customers’ energy needs through reliability and outage reductions while transforming our processes with a focus on efficiency and accountability. Business transformation and technology innovation will also drive O&M discipline to help keep customer rates affordable amid rising costs and a growing rate base. The last pillar of our strategy is regulatory integrity. We will listen to and respect the preferences of our regulators, policymakers and communities to achieve positive regulatory outcomes. If our states want renewables, we will work with them to deliver. If they want continued operation of coal or investment in gas or nuclear, we will work with them to deliver. As long as our states pay for what they want and we are treated fairly, we will deliver. At the same time, we will work closely with key stakeholders to advance affordability, system reliability, resiliency and security. To that end, we have aligned our organizational structure to strengthen our focus at the state level, and we continue to prioritize improving our earned ROEs as we listen to each of our states and their preferences. While it will take time for this work to bear fruit, this is headed in the right direction. Continuing on our operating companies achieved a number of other positive regulatory developments in the third quarter as well. Starting with AEP Texas, last month, the Commission issued an order approving a unanimous and unopposed comprehensive settlement which included a 9.76% ROE. The order was effective October 1st. In Oklahoma, major parties reached a settlement agreement with a 9.5% ROE in early October, and the ALJ recommended approval of the settlement without any modifications. While PSO awaits a commission decision, interim rates were implemented on October 23rd. In Virginia, a hearing was held in September related to the biennial filing, focusing primarily on incremental investment. A Commission order is required in November, with rates going into effect in early January 2025. Last week, APCO refiled its base case in West Virginia, requesting a 10.8% ROE while also offering securitization as the rate mitigation concept to the proposed $250.5 million base rate increase. This securitization option includes $2.4 billion of undepreciated plant balances, CCR and ELG investments, fuel deferrals and storm expenses. While reduced rate base of $1.9 billion would result from securitizing the plant balances and environmental investments, any earnings impact would be dependent on how quickly we redeploy capital throughout the business. That said, we should have an early indication from the Commission if securitization is preferred and we would plan capital redeployment accordingly. But let me be very clear, securitization is not included in our new five year capital and financing plans introduced today and is not needed to hit our credit metrics. Rather, securitization is driven by the desire to consider alternative rate case options to mitigate customer bill impacts. I was highly disappointed by the initial rate case filing that was rejected by West Virginia. Be assured that going forward, additional internal quality control checks and leadership changes have been implemented to ensure that each of our operating companies filings meet all requirements. A rate case rejection should not happen like it did in West Virginia, and I won't accept this kind of performance from our team. Moving on to SWEPCO, updated formula rates went into effect in early August for Louisiana, in mid-October for Arkansas. And finally, I&M issued new requests for proposals or RFPs for both owned resources and PPAs seeking to secure up to 4,000 megawatts of diverse generation resources for target completion by year end 2028 or 2029 to support new load growth in the region. As such, we expect to make the applicable regulatory filings in 2025. So in short, while the team is making progress towards achieving positive regulatory outcomes, we do have more work to do. We look forward to continuing to engage constructively with our regulators and strengthen new relationships, including by investing more resources at the local level and focusing on delivering what our individual states want as outcomes. The bottom line here is we have made progress transforming the business over the past three months, but we have significantly more wood to chop. Before wrapping up, I'd like to briefly update you on a legal item. AEP and the Security Exchange Commission are engaged in discussions about possible resolution of the SEC's ongoing investigation and we recorded a loss contingency of $19 million in the third quarter. Given this is an active matter, we don't plan on making any further comments on this matter. I'd now like to close by reiterating my strong confidence in the tremendous potential for AEP's growth and success well into the future. With the support, dedication and hard work of the entire AEP team, we are well positioned to continue providing safe, reliable and affordable service while advancing our long-term strategy to deliver value to our stakeholders. Related to our new vision statement of improving customer’s lives with reliable, affordable power, we will accomplish this together through commitment and execution. I look forward to seeing many of you in a few days at EEI where we'll be happy to discuss our newly released financial plans in even more detail. I'll now give the floor to Chuck.
Charles Zebula: Thank you, Bill. It's been a pleasure working with you over the past three months. Your leadership and passion for operational excellence and customer service is infectious, and everyone at AEP looks forward to working with you to capture the incredible opportunities that we have before us. Good morning everyone. Let me move on with the discussion of the third quarter results. Slide 8 shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the third quarter were $1.80 per share compared to $1.83 per share in 2023. Year-to-date, GAAP earnings are $4.35 per share versus $3.62 per share last year. There's a detailed reconciliation of GAAP to operating earnings for the third quarter and year-to-date results on pages 20 and 21, respectively. Let's walk through our operating earnings performance by segment for the third quarter on Slide 9. Operating earnings for the third quarter totaled $1.85 per share, or $985 million, compared to $1.77 per share, or $924 million in 2023. Operating earnings for vertically integrated utilities were $1.08 per share, up $0.08. Positive drivers included rate changes across multiple jurisdictions driven by outcomes in Virginia and Indiana, higher normalized retail sales and lower income taxes. These items were partially offset by higher depreciation and O&M. The transmission and distribution utility segment earned $0.46 per share, up $0.07 compared to last year. Positive drivers in this segment include rate changes driven by the distribution cost recovery factor in Texas and the distribution investment rider in Ohio along with higher transmission revenue. These items were partially offset by lower normalized retail sales and higher depreciation. The AEP transmission Holdco segment contributed $0.40 per share, up a penny compared to last year, primarily driven by investment growth. Generation and marketing produced $0.19 per share, up a penny from last year. Favorable drivers included higher retail margins and lower interest expense. These items were partially offset by lower wholesale margins and higher income taxes compared to last year. Finally, Corporate and Other was down $0.09 compared to the prior year, primarily driven by higher interest expense, timing of other operating revenue, higher income taxes and O&M. The year-to-date operating earnings segment detail is shown on page 16 of the presentation. Note that year-to-date, operating earnings are up $0.36 per share this year, increasing from $4.02 per share in 2023 to $4.38 per share this year or about a 9% increase year-to-date. The data on Slide 10 shows continued strong growth in load. Weather normalized retail sales grew 2.1% in the third quarter. This marks the 14th consecutive quarter of load growth across our system, and year-to-date overall weatherized normalized retail sales grew 2.9%. Declining residential sales have been offset by double-digit growth of 10.1% in commercial sales. Thanks to the game changing developments around data centers and AI. Also, our industrial sales have consistently grown despite challenging economic conditions for many of our customers. Our companies have attracted a steady pipeline of economic development projects over the past several years and those projects are beginning to come to fruition. Besides the data centers, we also see companies investing in energy, manufacturing and primary metals driving consistent growth in our industrial sales. Industrial sales grew 1/2 of 1% in the quarter, propelled by nearly 5% growth in Texas. Looking ahead to 2025 and beyond, you'll notice that we have updated our sales projections out to 2027 in this presentation. Looking first at 2025, we are projecting overall sales to increase by an additional 8.3% over our estimate for this year. Flat residential sales will continue to be offset by double-digit growth in the commercial segment. This growth is propelled by a mix of new and existing customers spread across our Ohio, Indiana and Texas service territories. In the T&D segment, we estimate about 30% year-over-year growth in commercial sales each in AEP Ohio and AEP Texas. And in the vertically integrated segment, our projections have commercial sales at I&M up nearly 60% year-over-year. Note this is happening now, and in the next several years, not later this decade. New customer growth will also support a projected increase in industrial sales of 1.6% next year, with most of that growth expected to be powered by ongoing economic development in Texas. We have several large energy and manufacturing loads slated to come online within the next year. While these numbers are substantial, we take a lot of comfort in the fact that the large load additions reflected in these forecasts are all backed by signed customer financial commitments. In AEP Ohio and I&M, nearly all of these loads are backed by take or pay contracts. This means that customers are locked in to pay for a minimum amount of power over the next several years depending on their local tariff. Also, the impact of higher loads will enable our fixed costs to be spread over a higher base, benefiting all customers. As Bill mentioned, based on contract activity across the system, we expect about 20 gigawatts of additional load to come online through the end of the decade. For context, our summer peak load at the end of last year was 35 gigawatt. This represents about a 60% increase in peak load in the next six years. That magnitude of increase in peak load is driving the sales projections that you see in Slide 10. We expect consistent retail growth above 8% over the next three years, driven by not only double digit commercial load increases, but accelerating gains in the industrial space. Roughly half of the additions are located in our PJM footprint, mostly hyper scale data centers in Ohio and Indiana. The other half are located almost entirely in AEP Texas. However, the growth in Texas is more diverse and spread across both data processors and large industrial customers. The last time we have seen sustained years of load growth in the 8% range. The Beatles in the late 1960s were still making music. Truly, this is a pivotal and transformational time for our company as we work to capture this opportunity. Let's move on to slide 11. In the top left table you can see the FFO to Debt Metric stands at 14.7% for the 12 months ended September 30, which is a 10 basis point increase from the prior quarter. Our debt-to-cap decreased slightly from last quarter and was 62.1% at quarter end. We understand that in its next credit opinion in March, Moody's intend to change how it treats deferred fuel impacts to align the consolidated view of AEP without how our subsidiary company metrics are calculated. Importantly, based on discussions with Moody's in our annual management meeting last week, their view of AEP's credit is not changing and we will continue to exceed our downgrade threshold of 13% in all forecasted periods. We are committed to a goal of being in the 14% to 15% FFO-to-debt range and regardless the impact of deferred fuel on our metrics will dissipate to a normal state over the next two years. Again, importantly, this does not change our cash inflows or Moody's view of our credit profile. In the lower left part of this slide you can see our liquidity summary which remains strong at 5.5 billion and is supported by 6 billion in credit facilities. Lastly, on the qualified pension front, our funding status remains stable at 99%. In summary, our third quarter and year-to-date financial results put us in a strong position to meet our goals this year and we are tightening our 2024 guidance range to $558 to $568 per share and also in the quarter, I'll note that we completed the sale of AEP on site partners with approximately $320 million of net proceeds received at the end of September. For 2025, we have set our operating earnings guidance range at $575 to $595 per share with a guidance midpoint of $585 roughly 4% growth from our 2024 midpoint guidance estimate. Our 2025 earnings guidance is based on a strong foundation of growth in our regulated businesses and lower contributions in the generation and marketing segment due to the reduced scope of activities as well as lower expected retail and wholesale margins in the segment. Going forward, we expect improved performance in our vertically integrated utility segment as we work to narrow the gap between our earned and authorized ROEs and invest where we have alignment with our regulators. We have also introduced a robust long-term growth rate of 6% to 8% from the 2025 guidance midpoint. This is supported by a $54 billion capital plan which is more than a 25% increase from our previous five year plan. These investments with 63% related to wires and 26% related to new generation result in a five year rate base CAGR of nearly 8%. Future updates to capital are more likely to go up as we continue to see economic development activities in our territories due to our high voltage 765 transmission backbone, our attractive industrial footprint in Texas, as well as the incremental transmission and generation infrastructure that Bill described earlier. Our 5-year cash flow and financing plan forecast is shown in the Appendix on Slide 14. We have consolidated the forecast over the five year period as impacts in individual years due to large loads, generation investments and tax credits will have inter-period movement over time. Note however, the plan is supported with equity, equity like instruments, opportunities to explore, portfolio optimization as well as efficiently monetizing tax credits related to our investments in renewable generation and from our existing nuclear facility. In addition, we will decouple our dividend growth rate from our earnings growth rate resulting in a lower dividend payout ratio over time in the range of 55% to 65%. This will allow us to retain additional cash flow to fund our increased capital plan and new growth objectives while maintaining a market competitive shareholder return. Access to the capital markets is critical and we will finance sensibly to protect and maintain our balance sheet solidly in the investment grade category. We appreciate everyone's time today and your interest in AEP. We look forward to seeing many of you at the EEI conference next week. Operator, can you open the call so that we can address your questions? Thank you.
Operator: Thank you. [Operator Instructions] Your first question comes from Shar Pourezza with Guggenheim Partners. Please go ahead.
Shar Pourezza: Hey, guys. Good morning.
William Fehrman: Morning.
Shar Pourezza: Morning, Bill. So, obviously, big update this morning. Cleared the decks and rebased as we're thinking about your new 6% to 8% growth rate. Asset sales haven't helped, but anything you can point to that can be maybe incremental to your 2025 guide. Any tailwinds that aren't in plan, like maybe on the cost side and as we're thinking about maybe the longer range, you have material load growth driven by the data centers. Has the 20 gigawatts of customer commitments hit any of your numbers? Or could some of those opportunities become further accretive as we saw with some of your peers during this earnings season? Thanks.
William Fehrman: Yes, thanks, Shar. With regards to additional opportunities, clearly this year we've done a number of things across the company. We had a voluntary separation plan that was put in place to help offset inflation. And as we're looking at transforming the company, I did bring on an expert in transformation who's worked with me for many years, who will help us continue to look for opportunities to take costs out of the business, look for more opportunities to reduce layers of management and expand span of control of the management team. All in the effort to remove bureaucracy out of the company and reduce bloat. And so clearly there's opportunities for that. I've just been here three months, so we've got a lot yet to do. As I noted in my comments, a lot of wood to chop yet around the company. And so we've looked at what we were able to do and made sure that we were confident in what we put into those numbers at this time. But clearly more to do with regards to the 20 gigawatts that is essentially in the plan. 12 gigawatts of that is in the first three years of the plan, with the remainder towards the end of the plan. But we've got more opportunities out there. As I noted, $10 billion of transmission potential generation development. Again, as I was sorting through the numbers here with the $54 billion capital plan that we have, making sure that that was fully understood and that we could deliver it. But there's much more load growth to come for this company and I would say we're only really limited by our ability to execute on the opportunities that are in front of us. Chuck, anything to add?
Shar Pourezza: Okay, got it. And then just lastly on the funding source. So 5.35 billion in equity needs. You obviously kind of mentioned asset sales. Can you just give us a sense on the asset? Is it transmission as media has been reporting, or the off goes an opportunity and just maybe a sense of timing? When do you need the equity? Thanks.
William Fehrman: Yes, with regards to potential asset sales and stuff, we won't comment on those until something might happen, but we're clearly going to consider sort of all of the above to get us to where we need. Chuck, you want to.
Charles Zebula: Yes, sure. I would just add to that, in our plan we also will pursue equity like products out there, instruments that give us equity credit. You'll note in my comments, we are looking to decouple our dividend growth rate from our earnings growth rate as well, which would drift the payout ratio lower as well. We do have PTC and ITC monetization and as far as any asset monetization opportunities, as Bill said, we are looking holistically at all alternatives. As you look at the needs that we have and the timing of such, we will need equity support in 2025 and how and how that comes it could come in any of the forms that I just talked.
Shar Pourezza: Okay, that's perfect. Thanks, guys. We'll see you in a couple days. Appreciate it.
William Fehrman: Yes. Thanks, Shar.
Operator: All right, our next question comes from Steve Fleischman with Wolfe Research. Please go ahead.
Steven Fleischman: Yes, hi. Good morning. Thanks for the time. So first, the new kind of outlook. What are you seeing in terms of earned returns across the utilities over the period? Are you you've had the issue with the earning below? Do you have that improving over the period by how much? Any sense on that?
William Fehrman: So as we look at our regulatory opportunities right now for the regulated utilities, we're looking at a 9.1% ROE tend to plan. As I've gone around and met with the states, as I noted in my comments, our focus is changing to where we will be working with them to understand what they want to be able to achieve, and we will work to deliver that with them. And through that, then we would hope to continue to improve the relationship that we have with the regulator. And hopefully that then also then turns into more positive outcomes with regards to ROE and the general relationship that we have. As part of that, we also have to significantly improve our customer service. I've noted that we have to put more investment into the distribution side of the business, vegetation management, reduce outage time, and all of that will then go to helping us with regards to our regulatory relations and customer service. So we're very, very focused on that. I've made it around now to seven of our states in the three months I've been here to meet with the regulators, and we're continuing to build those relationships. And as I noted in West Virginia, we made the new filing very disappointed in the quality of our prior filing. We've made changes internally to correct that. And so we'll be very much focused on these returns. And I know how much it adds to our business as we're able to get those closer to our allowance.
Steven Fleischman: Thank you. One other question just on the balance sheet. I appreciate the clear commentary on the Moody's and the deferred fuel. I just want to maybe restate or to clarify what you said. So they are going to make the adjustment. It sounds like you might be temporarily below the 14 to 15 target, but above the 13% downgrade threshold. And that overall the general view of the credit is that it's stable. Is that fair?
William Fehrman: I think that's an accurate representation of what I said.
Steven Fleischman: Okay. Okay, thank you.
Operator: All right, our next question comes from Jeremy Tonet with JPMorgan. Please go ahead.
Jeremy Tonet: Hi, good morning.
William Fehrman: Good morning.
Jeremy Tonet: Just wanted to speak to the data centers in Ohio, I guess, a little bit more. And given the challenge there, could you speak to settlement dynamics in your data center tariff proposal, given, all the stakeholder, I guess, views on this?
William Fehrman: Sure. As we've looked at the data center opportunities in Ohio, one of our fundamental principles around all of this is to ensure that our existing customer base is not negatively impacted by the significant increase in data center load that is being proposed for the state. And as such, we filed a tariff in Ohio that would essentially put more pressure on the data centers to stand up for the costs that they're creating on the system. And that filing has been going through the process. There's been settlements filed by the data center coalition, as well as ourselves with a number of other parties, including the staff from the commission. And right now that's moving the hearing on December 3rd, and we would expect to get an outcome from the commission shortly after that. But conversations are still going. We want that load in Ohio. We definitely want it to be on our system and we want to see that growth, but we also want to make sure that our existing customer base is not negatively impacted by this. And so we'll do what we need to ensure that we protect that customer base. And I think, honestly I've worked with data centers for a long time. In my prior role at Berkshire and Iowa in particular, we had a significant customer base of data centers there. And I've seen how the load comes on and what the commitments are, and so got a pretty good feeling for how this is going to potentially play out. And we want to make sure that we have everything in place to serve that load, but bottom line is only if we can protect the rest of the customer base.
Jeremy Tonet: Got it. Understood. That's helpful there. Thanks. And was just wondering if you could talk a little bit as well on the AEP on your JV proposal with FirstEnergy and Dominion as it relates to the transmission project and I guess what you see as unique or beneficial to this offering versus others.
William Fehrman: So that was a great partnership led by our transmission team, Antonio Smith and the rest of the team there to pull that coalition together and go in and bid on these projects. Obviously, PJM is putting forth a significant amount of potential transmission investment and it was our view that we're stronger together as entities and that we would have a very, very good chance of winning these projects. And so that JV came together really well and we're working well together and we're excited about hearing where we might end up later next year. But I have confidence in our team and the team from FirstEnergy and Dominion that we're going to come out of this with some really strong opportunities to grow our transmission business.
Jeremy Tonet: Got it. Thank you. One quick last one, if I could just on G&M, seems like 2024 is going to notably outperform initial guidance there and AEP is on the midpoint. So just wondering if there's other segments of the business that are kind of underperforming expectations there. Do you expect them to kind of bounce back next year and also the G&M step down next year given the lower scope of the business, as you said, is that to indicate that there could be sales more likely in this segment than others, knowing that you're not going to identify specific asset sales in advance of them happening?
William Fehrman: So the G&M segment we're reflecting about $0.24 and lower contributions over 2024 and 2025, which is obviously a significant change for us. But we are seeing good improvement across the rest of our lines of business. We're obviously also going to be going after the transmission projects that I noted in my opening comments. And then as far as other potential asset sales as again I said I will consider all things and if they make sense we'll take a look at them, but we'll talk about those at the time.
Jeremy Tonet: Got it. Thank you for that.
Operator: Our next question comes from David Arcaro with Morgan Stanley. Please go ahead.
David Arcaro: Good morning. Thanks so much for taking my question.
William Fehrman: Yes, good morning.
David Arcaro: Morning. Just a bit of a follow up on that. Could you just help me understand the 26 EPS outlook? Is there no G&M earnings contribution there just so I could make sure I understood that and maybe specifically what's driving it to zero there? Is that an implied sale or exit of those businesses or something else?
William Fehrman: Yes, thanks for the question. And perhaps the slide you're looking at may not make that clear. We're just showing the change in G&M from 2024 to 2025. There would still be a contribution from that segment in 2026 and beyond.
David Arcaro: Got it, got it. Okay, thanks for that. Yes, that's more clear. And then could you touch on how you're thinking about the incremental new generation in terms of the CapEx that has come into the plan? I would assume a lot of that is going to be gas. I'm wondering kind of where, where and when you'd be investing in that kind of what the process is to firm that capital up.
William Fehrman: So we do have a lot of gas coming into the system. We've got a number of RFPs out on the street as I mentioned, particularly at I&M, and we’ll see what kind of prices come in for those projects. The CapEx will be spread obviously as those projects come into play. But I'll also say that as we continue to work with some of our other states, particularly say West Virginia, there's a lot of opportunity yet to be sorted through in those states with regards to the economic development that they are pushing forward. And so be happy to talk more about these things in detail at the EEI meeting coming up. But really excited about the potential opportunities we have across a number of our states.
David Arcaro: Got it. Okay, great. Well, thank you so much.
Operator: All right, our next question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead.
Julien Dumoulin-Smith: Hey, good morning team guys. Thank you very much. Appreciate it.
William Fehrman: Hey, good morning.
Julien Dumoulin-Smith: Good morning. Doing quite well, thank you. A couple things real quickly. First off on the G&M piece, I know you elaborated a little bit what's reflected through the course of the plan. Is that more of a static expectation off the 2025 baseline or further moderation there? Again, I know you clarified the 9:1 on the utility component, but just on the other piece there if you can.
William Fehrman: Yes, Julien, I think that the business supports the level that we would see in 2025.
Julien Dumoulin-Smith: Okay, all right. Through the plan. Excellent. Thank you for that. Appreciate all the details. And then related here, you know, 765 has really caught a lot of attention across all the RTOs. I just want to make sure I understand what's reflected in this new CapEx baseline as far as 765 adoption goes across the various footprints. And again, I know you provided particularly detail on this coalition here in PGM. But to what extent can we see sort of comparable efforts emerge, say in ERCOT or what have you, as some of the 765 details become a little bit more formalized here, if you will.
William Fehrman: So obviously we have a big opportunity in ERCOT around the 765 down there in the event that they decide to go that way. We've put in our proposals for that significant opportunity in the Permian area, significant opportunity on the various backbone growth areas for, for Texas. That just alone is a good $4 billion or $5 billion of opportunity potential there for us on the 765 front. We've also got good 765 opportunities in PJM and SVP as well. And so the fact that AEP is essentially the only U.S. Company that knows how to build and operate 765 gives us a strong competitive advantage in these situations and certainly something that I'm very excited about to pursue. That's one of the really strong strategic things that frankly AEP has done over the years is build out this 765kV backbone because it's paying huge dividends right now as all of this load growth is starting to combine. And I think that's being seen by some of the other decision makers around who are looking for ways to significantly increase their ability to move energy. And so with the 765kV experience that we have, I'm very excited about the opportunity to engage with ERCOT, SVP and PJM and maybe a little bit in MISO.
Julien Dumoulin-Smith: Yes, it's pretty exciting, actually. Quick clarification on the utility ROE. You're moderating it to 9:1 seemingly from your earlier plan despite the accelerating load. Is there something else disintermediating that relationship? I mean, I could imagine a few things, but I'm curious if there was anything purposeful there.
William Fehrman: Nothing really purposeful. We're trying to continue to increase the ROE and work diligently with the regulators. If you blend in, the transmission component of this, we're at 9:3. Obviously we want to continue to get up closer to our allowance, but frankly, we have to earn our way up. As I said, we've had some mishaps in West Virginia that we've now corrected with the most recent filing, and we've got some significant work to do on the customer service side to put us in a better position with our regulator so they're not getting complaints from customers. And so as this continues to move forward, we've got a tremendous amount of wood to chop in this area, but we're very focused on it. We've taken our board through the details of reliability and where we sit, and we've essentially created a new foundation and we're going to blast off from there to really accelerate our improvements in customer service.
Julien Dumoulin-Smith: Excellent, guys. Talk soon.
William Fehrman: Thank you.
Operator: Our next question comes from Nick Campanella with Barclays. Please go ahead.
Nicholas Campanella: Hey, good morning. Thanks for taking my questions today.
William Fehrman: You bet. Good morning.
Nicholas Campanella: I wasn't around for the Beatles, but I'm excited to be here for the load growth and I wanted to come back to the generation comments? I think you talked about working with regulators and policymakers on whatever solutions can facilitate this higher load outlook. You talked a lot about gas, but in your prepared remarks you also talked about nuclear. And Bill, I know you talked about your love for nuclear in the past, and maybe you can kind of just expand on your thoughts of how nuclear kind of fits into the AEP strategy, if at all. Thanks.
William Fehrman: Sure. Well, first and foremost, a number of our customers are pursuing projects based on nuclear power plants, and those are many, many years out, as far as I can tell. But we need to continue to work with our customers and if they want to pursue a small modular reactor type of co-location approach, then we'll work with them and we'll continue to work with developers of the various technologies that are out there. But this is going to require a very significant approach to risk mitigation. It will take a combination of the federal government, state government, input from the customer and ourself to build some risk mitigation such that our existing customer base isn't carrying the full exposure of something like this. And we'll, with our nuclear team that we have here, we'll continue to follow the various technologies that are being built in Canada with regards to the BWRX and the new scale plant that's being built in Romania. We'll follow those as well as the GE Hitachi project at TVA and watch how these are progressing. But ultimately if our customers want this and our states want this, then we'll have to figure out a way to deliver it. That's what we do. And so I'm fairly favorable that there'll be one or two designs that make it through the NRC process and will start to be built. But we have to figure out the first of a kind risk and make sure that we are not carrying that, that load and that there's a very broad base of people engaged in this that can help push this along.
Nicholas Campanella: Hey, I really appreciate your thoughts there. And just to tie things off on the 6% to 8% growth rate, so you have 8% rate base growth net of some financing drag. You could also be raising CapEx here too, I hear you on the 10 billion. Where do you kind of think you're trending in this new 6% to 8% range? Over the long-term, do you kind of grow linearly off this midpoint? Could you be kind of higher or lower in certain years? Just trying to understand that. Thank you.
Charles Zebula: Yes, thanks Nick. The 6% to 8% right is based off the 2025 new midpoint. And as you can imagine, as Bill described, the kind of components of our capital plan and the addition of load over time, I don't expect it to be completely linear like it may have been in the past. So I do expect all years to be in that range. But I certainly don't expect a --if our guidance was linear, we would have just said 7%. Our guidance is 6% to 8%. I think that does mean over the long-term we would average somewhere in between there, but I don't expect it necessarily to be linear.
Nicholas Campanella: Very helpful though, still within the ranges. I appreciate the time today. Thanks so much.
Operator: Our next question comes from Carly Davenport with Goldman Sachs. Please go ahead.
Carly Davenport: Hey, good morning. Thanks so much for taking the questions. Maybe just to start a quick follow up on transmission as we look at the new capital plan, obviously significant increases on that side relative to the prior plan. Just as you think about some of the opportunities in PJM that you ran through in I think Jeremy's question, are those all upside to the plan or is there any spend built in in the back end of this plan related to those opportunities?
Charles Zebula: Yes, this is all basically upside to the plan. And as I mentioned in my remarks, the potential for $10 billion of additional transmission and new generation build out is what we would be chasing with regards to not only just PJM, but ERCOT, MISO and SPP as well.
Carly Davenport: Got it. Great, that's helpful. And then just lastly, with the increase in the long-term earnings growth rate to that 6% to 8% range, could you just talk a little bit about how you're thinking about dividend growth relative to that range going forward?
Charles Zebula: Yes. So Carly, we have followed a pattern of pretty much matching dividend growth, right. With our earnings growth, with the increased capital needs, the cash right from decoupling. Right. The dividend growth from the earnings growth will help fund that. And we would be targeting, a payout ratio in the 55% to 65% range. Our old policy was 60% to 70%. I think right now our payout ratio is in that 63%, 64% range. So we will provide a market competitive total shareholder return opportunity for our shareholders. But that will be decoupled going forward.
Carly Davenport: Got it. Great. Thank you so much for the color.
Operator: Our next question comes from Andrew Wiesel with Scotiabank. Please go ahead.
Andrew Wiesel: Hi. Thank you. Good morning everyone. If I could first follow up on that dividend question. Are you able to indicate how quickly you expect to go from the roughly 64% to roughly 60%? Or said differently, if earnings are growing at 6% to 8%, what would be a good expectation for dividend growth? Would it be 6% like we've seen, or potentially something slower?
Charles Zebula: Well, that's a discussion, Andrew. That is, as you know that the board, approves the dividend and we will drift down in that range. It won't be anything significantly abrupt to expect there, but you could imagine, right. That we would just drift down in that range as we go through time.
Andrew Wiesel: Okay, so sounds like something fairly gradual then. If that's maybe a fair way to put it. Okay. Then on the -- great, thank you. Then on equity, I just want to better understand, I see this slide shows 100 million per year of drip and I fully understand your commentary that asset sales or something like a hybrid might mitigate the need. But for modeling purposes, should we take that 5.35 billion and straight line it over five years? Maybe you could give a little more guidance in terms of timing per year and if this would be an ATM or a block in the absence of one of those alternatives. Thank you.
Charles Zebula: Yes, so it's a good question. Obviously, consolidating the five year cash flow, just indicates that there's a lot of options on the table. What I would tell you that as I said earlier, we do need equity support in some form in 2025 and 2026 to continue to hit our credit metrics. So I think, as you maybe looked at last year's kind of shape and think of it in a similar way, is a good way to perhaps look at it because we do need support in 2025 in some form or fashion. And we are holistically looking at all of the options, including the equity like securities which wouldn't show up in the true equity line on the cash flow.
Andrew Wiesel: Okay, can that be a little more direct? What's embedded in the assumption for share count for 2025?
Charles Zebula: I don't have that specifically. We could talk about that at EEI.
Andrew Wiesel: Okay, sounds good.
Charles Zebula: You could follow up with Darcy later.
Andrew Wiesel: Very good.
Operator: Our next question comes from Bill Appicelli with UBS. Please go ahead.
William Appicelli: Hi, good morning. Just a question about the. You talked about some of the funding over the years and with the efficient monetization tax credits, can you speak to the magnitude of the tax credits or these going to be contributing to earnings or is this utilization of transferability to provide funding?
Charles Zebula: Yes, it's just transferability to provide funding. It's neutral to earnings largely. And over the 2025 to 2027 period, it's roughly $300 million a year. In the latter two years there's some ITC opportunities with some solar projects. So you'd be some big, bigger numbers, but in the next three years, about an average of 300 per year.
William Appicelli: Okay, thank you. And then on the sales outlook on residential, so that had been, trailing a little bit behind expectations, but you are assuming some improvement, back to relatively flatter or slightly positive next year maybe. Can you speak to what's driving that?
Charles Zebula: Yes, I mean, it's a trend I think that we and others are seeing in the industry as well as people have returned to work as inflation has crept in and the share of the wallet becomes more critical. I think you're just seeing reduced usage. We are seeing increased customer counts, in places like Texas and Oklahoma and Ohio and other areas. But it's not offsetting, right. The existing customer decline in usage. We do think that that levels off at some point in time. I think there's also probably some energy, continued energy efficiency things creeping in there. But nonetheless, we're as we, as you see in our forecast, after some years of decline, we're now assuming it flat going forward pretty much.
William Appicelli: Okay. All right. And then just lastly, maybe just you can speak to the colocation issues, that FERC has recently addressed. You guys did intervene in the case. Maybe can you just highlight what you think next steps are, coming out of FERC or some of the policy issues more broadly?
William Fehrman: Yes sure. So this is a very simple issue in our mind. If you use the transmission system, you should pay for it. It's really that simple. And our view of colocation is that we don't have an issue with colocation. We don't have an issue with data centers looking to use nuclear power plants as an energy source. But what we do have an issue with is when they use the transmission system and try not to pay for it. That's a problem for us because that cost gets shifted to other customers. And so as this process continues to go through the FERC decision making process, we'll continue to reiterate our concerns around cost allocation. And at the end of the day for us it's, it's just a simple principle. If you use the transmission system, pay for it. And that's really where we're at.
William Appicelli: Okay, great. See you next week. Thank you.
William Fehrman: Thank you.
Operator: Our next question comes from Anthony Crowdell with Mizuho. Please go ahead.
Anthony Crowdell: Hey, good morning. Hey, Nick. Did. I'm sorry, Chuck, did Nick have you write that Beatles reference?
Charles Zebula: I think he may have. I think he may have.
Anthony Crowdell: Well, that's great. Just two cleanups. I think one of them to Julien's question on the ROE improvement that you're seeing, 9.1%. What's a fair assumption where we should start baking in that improvement? Is it gradual over time or is that something you think we could bake in a certain year?
Charles Zebula: Yes. So trailing 12 months, as you could see in the deck, we're at 9.0% for the entire regulated complex. So I think as you think about going into next year, you should think about that. The regulated utilities in the range of 9.1% and the Transco right in that 10.5% range, which then averages things to 9.3%.
Anthony Crowdell: Great. And then you talk about the load growth, the data centers, great tailwinds. I'm just curious. It was maybe something investors were asking about maybe six months ago, but even with all this demand, is it taking longer to connect these large customers to the system or. It's at a very manageable pace for the company. I'm just thinking that with all this load coming on, whether it's supply chain or just labor connecting all these large customers, but it doesn't appear to be an issue.
William Fehrman: Well, it's certainly a challenge for us to get everyone connected at the speed that they would like to be connected, which is tomorrow for the most part. And we're working with data centers to try to find creative ways to allow them to continue to build out and get the power that they need. But this is going to be a long-term build out for us and we'll try to connect as many data centers as we can onto the system. We'll try to come up with other creative options for those data centers while we get transmission built. But it's going to be an evolution of working with the customer, working with particularly PJM and then our ability to get the construction done. I don't foresee significant supply chain issues at this time. The construction is fairly well spread out and I think we can manage the supply chain side of this. But we certainly have a very high demand coming on from the data center crowd and will work hard to try to accomplish what they want as quickly as we can.
Anthony Crowdell: Thanks for taking my questions. See you in EEI.
William Fehrman: Thank you.
Operator: All right, and our final question from today with Ryan Levine with Citi. Please go ahead.
Ryan Levine: Thanks for taking my questions. I guess a couple one, in terms of your confidence level and these load forecasts, how confident are you and when do you think you that could evolve?
William Fehrman: Well, as we stated earlier, we've got essentially signed contracts for all of this load, so we feel very confident about the load coming on. Certainly we're in discussions with a number of other economic development opportunities across a number of our states. Those clearly are not in our plan, nor do we know if they'll come to fruition. But for what we're showing you, we have signed agreements and our confidence level is quite high.
Ryan Levine: And then in terms of the recent election, with federal tax rates potentially to change in coming years, how exposed is your free cash flow and credit outlook to changes in federal policy And I guess on a similar vein, you have generation build out and ownership expected in your plan. Is there any exposure to tariffs that you're thinking through?
William Fehrman: Yes, I mean, it's a question we're going to have to evaluate here as we go through time and see what the platform for the new administration is going to be. So give us some time to absorb that.
Ryan Levine: Okay. Thanks for taking my questions.
William Fehrman: Yes. Thank you.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Danica, would you please give the replay information?
Operator: Thank you. This concludes today's conference call. A replay of the call will be available for one week. The North American toll free phone number is 1-800-770-2030 and you must enter the playback ID as 133-6080 for today's recording. Thank you. You may now disconnect. | [
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"speaker": "Operator",
"text": "Thank you for standing by. My name is Danica and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power's Third Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would like to turn the conference over to Darcy Reese, Vice-President of Investor Relations. Please go ahead."
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"speaker": "Darcy Reese",
"text": "Thank you, Danica. Good morning, everyone, and welcome to the third quarter 2024 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discussion of these factors. Joining me this morning for opening remarks are Bill Fehrman, our President and Chief Executive Officer and Chuck Zebula, our Executive Vice President and Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Bill."
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{
"speaker": "William Fehrman",
"text": "Thank you, Darcy and good morning everyone. I'm happy to be with you for my first earnings call as AEP's President and CEO. In my remarks this morning, I'll discuss our results and outlook before turning to the key pillars of our strategy to enhance value for customers and investors. I'll then cover regulatory updates before handing it over to Chuck to walk through our financials in more detail. You can find a summary of third quarter 2024 business highlights on Slide 4 of our presentation. We have a lot of exciting ground to cover today, but first I'd like to briefly introduce myself to those I haven't had the opportunity to meet yet. I spent my entire career in the utility and energy business. Most recently I was at Berkshire Hathaway Energy, which has an asset base 1.4 times the size of AEP, operates in 11 states but also in Canada and Great Britain and has a diverse group of regulatory interests. While I'm familiar with most of the industry players, bankers, regulators, companies and debt investors, I am new to many of the AEP shareholders and I look forward to delivering for you. With that, I'm honored to join a leader like AEP at a pivotal time for both the organization and our industry. Since assuming the role of CEO, I've met our many stakeholders and the AEP team across our 11 state footprint, including four governors and over 30 regulators and legislators. We've had robust discussions about critical initiatives and I've appreciated the opportunity to engage, listen and learn over the past three months to help shape our vision for the future. AEP has built a strong foundation for growth, including our robust transmission system, which represents 55% of AEP's total earnings stream. However, we can improve reliability, streamline cost, use technology better, and put power in the hands of local leaders to build financially strong utilities in our communities. I look forward to the future and working with the many talented people across the company to drive operational excellence, best-in-class service earnings growth and overall success. I'll begin with our financial results. Today we report third quarter 2024 operating earnings of $1.85 per share, or $985 million. Building on our strong momentum this year we are confident in narrowing our 2024 full year operating earnings guidance range to $5.58 to $5.68, maintaining the original $5.63 midpoint. As referenced on Slide 5, today we also formally introduce our 2025 operating earnings guidance range of $5.75 to $5.95. We have thought a lot about this range, especially since I've been in the CEO role for just three months. The foundation of our 2025 earnings guidance range is based on robust growth in our regulated utilities. This range also reflects lower contributions from our generation and marketing segment due to reduced scope of activities going forward and lower retail and wholesale margins likely to be realized. While AEP's earnings range rose 4% in 2025, you have my commitment that we will do significantly better in 2026 and beyond after we go through an optimization exercise and we retool our personnel and processes over the coming months. As the new CEO at AEP, I need to establish a record of delivering on promises to you while demonstrating goodwill to our regulators and customers as we focus on service, reliability and enhanced vegetation management to reduce customer outages. My objective is to improve our customer experience and stakeholder relationships which over time will result in more positive regulatory outcomes and enable a stable platform for growth. AEP's future growth opportunities are very significant as we embrace the large load opportunity in our service territory as well as substantial upgrades to the distribution system. We are focusing on economic development efforts in our states to help address affordability and investing in our energy delivery infrastructure to improve reliability in addition to new generation to support resource adequacy. Because of this tremendous growth, today we are unveiling AEP's new long-term earnings growth rate of 6% to 8% off a 2025 base year and a $5.85 midpoint, all reinforced by a balanced and flexible $54 billion capital plan from 2025 through 2029. When I look at this newly raised $54 billion capital plan, which is up more than 25% over the prior $43 billion plan, there is even more upside to go. In fact, we see significant opportunity to capture $10 billion in incremental transmission and generation infrastructure investment to satisfy all of the load growth. We will provide more details at EEI regarding these investment opportunities that drive our updated 8% rate base CAGR. Note that during the 2025 through 2029 timeframe, we also expect our customer rates will go up by less than 3% annually on a system wide basis due to built headroom created from economic development activities and new generation. Understand that this customer rate impact could change due to effects of potential future generation needs. Please refer to slides 5 and 6. As you know, maintaining a strong balance sheet is critical to funding the increased capital spend associated with these growth rates and we remain committed to responsibly financing our capital needs. In addition to equity and equity like tools, we will explore asset monetization opportunities to the extent they can be executed upon while achieving the right price. If we do explore asset sales, we won't tell you about them until they happen. Our newly rolled forward five year capital and financing plans can be seen in the appendix on slides 13 and 14. Turning to slide 7, our robust financial outlook will be underpinned by a culture of accountability and execution. This business is transforming rapidly and we recognize the need for change to better serve our customers. Since joining the company in August, we have made several changes to align and simplify the organizational structure to ensure we have the right talent and the right roles to execute our strategy and achieve our objectives. For example, our operating company Presidents and Chief Nuclear Officer now report directly to me, while power plants and site managers will report directly to our operating Company Presidents. We have streamlined the leadership structure by eliminating management layers and reorganizing the service corporation. These actions move decision making closer to customers, all to ensure our money making businesses have the authority they need to accelerate improved performance. I'm confident our new structure will help us drive value as we advance three core areas of strategic focus, growth and financial strength, customer service and regulatory integrity. I'd like to spend a few minutes walking through each of these areas. First, AEP's future growth potential and financial strength is significant with customer commitments for 20 gigawatts of load additions through 2029 driven by data center demand and we have updated our load growth forecast accordingly through 2027. In fact, large load impacts are already being felt in our service territories, predominantly in Ohio, Texas and Indiana. This is demonstrated in our third quarter results in which we realized commercial load growth of 7.9% compared to the third quarter of last year and 10.1% growth year-to-date in 2024 compared to 2023. We are committed to supporting this new load growth in our service territory, but we also remain focused on ensuring affordability by fairly allocating costs resulting from associated incremental investments. This is why we proactively filed the data center tariff in Ohio, the large load tariff modifications in Indiana, Kentucky and West Virginia, and a complaint with FERC related to a co-located load arrangement. Load growth from data center demand has the potential to benefit all stakeholders including investors, customers and local communities, but only with fair and proper cost allocation. While some may think that our FERC complaint is anti-data center, it is actually the opposite. We are trying to welcome all data centers to our service territory by making sure that those data centers help all customers. The second area of focus for us is best-in-class customer service. We will leverage technology to enhance service and better meet our customers’ energy needs through reliability and outage reductions while transforming our processes with a focus on efficiency and accountability. Business transformation and technology innovation will also drive O&M discipline to help keep customer rates affordable amid rising costs and a growing rate base. The last pillar of our strategy is regulatory integrity. We will listen to and respect the preferences of our regulators, policymakers and communities to achieve positive regulatory outcomes. If our states want renewables, we will work with them to deliver. If they want continued operation of coal or investment in gas or nuclear, we will work with them to deliver. As long as our states pay for what they want and we are treated fairly, we will deliver. At the same time, we will work closely with key stakeholders to advance affordability, system reliability, resiliency and security. To that end, we have aligned our organizational structure to strengthen our focus at the state level, and we continue to prioritize improving our earned ROEs as we listen to each of our states and their preferences. While it will take time for this work to bear fruit, this is headed in the right direction. Continuing on our operating companies achieved a number of other positive regulatory developments in the third quarter as well. Starting with AEP Texas, last month, the Commission issued an order approving a unanimous and unopposed comprehensive settlement which included a 9.76% ROE. The order was effective October 1st. In Oklahoma, major parties reached a settlement agreement with a 9.5% ROE in early October, and the ALJ recommended approval of the settlement without any modifications. While PSO awaits a commission decision, interim rates were implemented on October 23rd. In Virginia, a hearing was held in September related to the biennial filing, focusing primarily on incremental investment. A Commission order is required in November, with rates going into effect in early January 2025. Last week, APCO refiled its base case in West Virginia, requesting a 10.8% ROE while also offering securitization as the rate mitigation concept to the proposed $250.5 million base rate increase. This securitization option includes $2.4 billion of undepreciated plant balances, CCR and ELG investments, fuel deferrals and storm expenses. While reduced rate base of $1.9 billion would result from securitizing the plant balances and environmental investments, any earnings impact would be dependent on how quickly we redeploy capital throughout the business. That said, we should have an early indication from the Commission if securitization is preferred and we would plan capital redeployment accordingly. But let me be very clear, securitization is not included in our new five year capital and financing plans introduced today and is not needed to hit our credit metrics. Rather, securitization is driven by the desire to consider alternative rate case options to mitigate customer bill impacts. I was highly disappointed by the initial rate case filing that was rejected by West Virginia. Be assured that going forward, additional internal quality control checks and leadership changes have been implemented to ensure that each of our operating companies filings meet all requirements. A rate case rejection should not happen like it did in West Virginia, and I won't accept this kind of performance from our team. Moving on to SWEPCO, updated formula rates went into effect in early August for Louisiana, in mid-October for Arkansas. And finally, I&M issued new requests for proposals or RFPs for both owned resources and PPAs seeking to secure up to 4,000 megawatts of diverse generation resources for target completion by year end 2028 or 2029 to support new load growth in the region. As such, we expect to make the applicable regulatory filings in 2025. So in short, while the team is making progress towards achieving positive regulatory outcomes, we do have more work to do. We look forward to continuing to engage constructively with our regulators and strengthen new relationships, including by investing more resources at the local level and focusing on delivering what our individual states want as outcomes. The bottom line here is we have made progress transforming the business over the past three months, but we have significantly more wood to chop. Before wrapping up, I'd like to briefly update you on a legal item. AEP and the Security Exchange Commission are engaged in discussions about possible resolution of the SEC's ongoing investigation and we recorded a loss contingency of $19 million in the third quarter. Given this is an active matter, we don't plan on making any further comments on this matter. I'd now like to close by reiterating my strong confidence in the tremendous potential for AEP's growth and success well into the future. With the support, dedication and hard work of the entire AEP team, we are well positioned to continue providing safe, reliable and affordable service while advancing our long-term strategy to deliver value to our stakeholders. Related to our new vision statement of improving customer’s lives with reliable, affordable power, we will accomplish this together through commitment and execution. I look forward to seeing many of you in a few days at EEI where we'll be happy to discuss our newly released financial plans in even more detail. I'll now give the floor to Chuck."
},
{
"speaker": "Charles Zebula",
"text": "Thank you, Bill. It's been a pleasure working with you over the past three months. Your leadership and passion for operational excellence and customer service is infectious, and everyone at AEP looks forward to working with you to capture the incredible opportunities that we have before us. Good morning everyone. Let me move on with the discussion of the third quarter results. Slide 8 shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the third quarter were $1.80 per share compared to $1.83 per share in 2023. Year-to-date, GAAP earnings are $4.35 per share versus $3.62 per share last year. There's a detailed reconciliation of GAAP to operating earnings for the third quarter and year-to-date results on pages 20 and 21, respectively. Let's walk through our operating earnings performance by segment for the third quarter on Slide 9. Operating earnings for the third quarter totaled $1.85 per share, or $985 million, compared to $1.77 per share, or $924 million in 2023. Operating earnings for vertically integrated utilities were $1.08 per share, up $0.08. Positive drivers included rate changes across multiple jurisdictions driven by outcomes in Virginia and Indiana, higher normalized retail sales and lower income taxes. These items were partially offset by higher depreciation and O&M. The transmission and distribution utility segment earned $0.46 per share, up $0.07 compared to last year. Positive drivers in this segment include rate changes driven by the distribution cost recovery factor in Texas and the distribution investment rider in Ohio along with higher transmission revenue. These items were partially offset by lower normalized retail sales and higher depreciation. The AEP transmission Holdco segment contributed $0.40 per share, up a penny compared to last year, primarily driven by investment growth. Generation and marketing produced $0.19 per share, up a penny from last year. Favorable drivers included higher retail margins and lower interest expense. These items were partially offset by lower wholesale margins and higher income taxes compared to last year. Finally, Corporate and Other was down $0.09 compared to the prior year, primarily driven by higher interest expense, timing of other operating revenue, higher income taxes and O&M. The year-to-date operating earnings segment detail is shown on page 16 of the presentation. Note that year-to-date, operating earnings are up $0.36 per share this year, increasing from $4.02 per share in 2023 to $4.38 per share this year or about a 9% increase year-to-date. The data on Slide 10 shows continued strong growth in load. Weather normalized retail sales grew 2.1% in the third quarter. This marks the 14th consecutive quarter of load growth across our system, and year-to-date overall weatherized normalized retail sales grew 2.9%. Declining residential sales have been offset by double-digit growth of 10.1% in commercial sales. Thanks to the game changing developments around data centers and AI. Also, our industrial sales have consistently grown despite challenging economic conditions for many of our customers. Our companies have attracted a steady pipeline of economic development projects over the past several years and those projects are beginning to come to fruition. Besides the data centers, we also see companies investing in energy, manufacturing and primary metals driving consistent growth in our industrial sales. Industrial sales grew 1/2 of 1% in the quarter, propelled by nearly 5% growth in Texas. Looking ahead to 2025 and beyond, you'll notice that we have updated our sales projections out to 2027 in this presentation. Looking first at 2025, we are projecting overall sales to increase by an additional 8.3% over our estimate for this year. Flat residential sales will continue to be offset by double-digit growth in the commercial segment. This growth is propelled by a mix of new and existing customers spread across our Ohio, Indiana and Texas service territories. In the T&D segment, we estimate about 30% year-over-year growth in commercial sales each in AEP Ohio and AEP Texas. And in the vertically integrated segment, our projections have commercial sales at I&M up nearly 60% year-over-year. Note this is happening now, and in the next several years, not later this decade. New customer growth will also support a projected increase in industrial sales of 1.6% next year, with most of that growth expected to be powered by ongoing economic development in Texas. We have several large energy and manufacturing loads slated to come online within the next year. While these numbers are substantial, we take a lot of comfort in the fact that the large load additions reflected in these forecasts are all backed by signed customer financial commitments. In AEP Ohio and I&M, nearly all of these loads are backed by take or pay contracts. This means that customers are locked in to pay for a minimum amount of power over the next several years depending on their local tariff. Also, the impact of higher loads will enable our fixed costs to be spread over a higher base, benefiting all customers. As Bill mentioned, based on contract activity across the system, we expect about 20 gigawatts of additional load to come online through the end of the decade. For context, our summer peak load at the end of last year was 35 gigawatt. This represents about a 60% increase in peak load in the next six years. That magnitude of increase in peak load is driving the sales projections that you see in Slide 10. We expect consistent retail growth above 8% over the next three years, driven by not only double digit commercial load increases, but accelerating gains in the industrial space. Roughly half of the additions are located in our PJM footprint, mostly hyper scale data centers in Ohio and Indiana. The other half are located almost entirely in AEP Texas. However, the growth in Texas is more diverse and spread across both data processors and large industrial customers. The last time we have seen sustained years of load growth in the 8% range. The Beatles in the late 1960s were still making music. Truly, this is a pivotal and transformational time for our company as we work to capture this opportunity. Let's move on to slide 11. In the top left table you can see the FFO to Debt Metric stands at 14.7% for the 12 months ended September 30, which is a 10 basis point increase from the prior quarter. Our debt-to-cap decreased slightly from last quarter and was 62.1% at quarter end. We understand that in its next credit opinion in March, Moody's intend to change how it treats deferred fuel impacts to align the consolidated view of AEP without how our subsidiary company metrics are calculated. Importantly, based on discussions with Moody's in our annual management meeting last week, their view of AEP's credit is not changing and we will continue to exceed our downgrade threshold of 13% in all forecasted periods. We are committed to a goal of being in the 14% to 15% FFO-to-debt range and regardless the impact of deferred fuel on our metrics will dissipate to a normal state over the next two years. Again, importantly, this does not change our cash inflows or Moody's view of our credit profile. In the lower left part of this slide you can see our liquidity summary which remains strong at 5.5 billion and is supported by 6 billion in credit facilities. Lastly, on the qualified pension front, our funding status remains stable at 99%. In summary, our third quarter and year-to-date financial results put us in a strong position to meet our goals this year and we are tightening our 2024 guidance range to $558 to $568 per share and also in the quarter, I'll note that we completed the sale of AEP on site partners with approximately $320 million of net proceeds received at the end of September. For 2025, we have set our operating earnings guidance range at $575 to $595 per share with a guidance midpoint of $585 roughly 4% growth from our 2024 midpoint guidance estimate. Our 2025 earnings guidance is based on a strong foundation of growth in our regulated businesses and lower contributions in the generation and marketing segment due to the reduced scope of activities as well as lower expected retail and wholesale margins in the segment. Going forward, we expect improved performance in our vertically integrated utility segment as we work to narrow the gap between our earned and authorized ROEs and invest where we have alignment with our regulators. We have also introduced a robust long-term growth rate of 6% to 8% from the 2025 guidance midpoint. This is supported by a $54 billion capital plan which is more than a 25% increase from our previous five year plan. These investments with 63% related to wires and 26% related to new generation result in a five year rate base CAGR of nearly 8%. Future updates to capital are more likely to go up as we continue to see economic development activities in our territories due to our high voltage 765 transmission backbone, our attractive industrial footprint in Texas, as well as the incremental transmission and generation infrastructure that Bill described earlier. Our 5-year cash flow and financing plan forecast is shown in the Appendix on Slide 14. We have consolidated the forecast over the five year period as impacts in individual years due to large loads, generation investments and tax credits will have inter-period movement over time. Note however, the plan is supported with equity, equity like instruments, opportunities to explore, portfolio optimization as well as efficiently monetizing tax credits related to our investments in renewable generation and from our existing nuclear facility. In addition, we will decouple our dividend growth rate from our earnings growth rate resulting in a lower dividend payout ratio over time in the range of 55% to 65%. This will allow us to retain additional cash flow to fund our increased capital plan and new growth objectives while maintaining a market competitive shareholder return. Access to the capital markets is critical and we will finance sensibly to protect and maintain our balance sheet solidly in the investment grade category. We appreciate everyone's time today and your interest in AEP. We look forward to seeing many of you at the EEI conference next week. Operator, can you open the call so that we can address your questions? Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Your first question comes from Shar Pourezza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Shar Pourezza",
"text": "Hey, guys. Good morning."
},
{
"speaker": "William Fehrman",
"text": "Morning."
},
{
"speaker": "Shar Pourezza",
"text": "Morning, Bill. So, obviously, big update this morning. Cleared the decks and rebased as we're thinking about your new 6% to 8% growth rate. Asset sales haven't helped, but anything you can point to that can be maybe incremental to your 2025 guide. Any tailwinds that aren't in plan, like maybe on the cost side and as we're thinking about maybe the longer range, you have material load growth driven by the data centers. Has the 20 gigawatts of customer commitments hit any of your numbers? Or could some of those opportunities become further accretive as we saw with some of your peers during this earnings season? Thanks."
},
{
"speaker": "William Fehrman",
"text": "Yes, thanks, Shar. With regards to additional opportunities, clearly this year we've done a number of things across the company. We had a voluntary separation plan that was put in place to help offset inflation. And as we're looking at transforming the company, I did bring on an expert in transformation who's worked with me for many years, who will help us continue to look for opportunities to take costs out of the business, look for more opportunities to reduce layers of management and expand span of control of the management team. All in the effort to remove bureaucracy out of the company and reduce bloat. And so clearly there's opportunities for that. I've just been here three months, so we've got a lot yet to do. As I noted in my comments, a lot of wood to chop yet around the company. And so we've looked at what we were able to do and made sure that we were confident in what we put into those numbers at this time. But clearly more to do with regards to the 20 gigawatts that is essentially in the plan. 12 gigawatts of that is in the first three years of the plan, with the remainder towards the end of the plan. But we've got more opportunities out there. As I noted, $10 billion of transmission potential generation development. Again, as I was sorting through the numbers here with the $54 billion capital plan that we have, making sure that that was fully understood and that we could deliver it. But there's much more load growth to come for this company and I would say we're only really limited by our ability to execute on the opportunities that are in front of us. Chuck, anything to add?"
},
{
"speaker": "Shar Pourezza",
"text": "Okay, got it. And then just lastly on the funding source. So 5.35 billion in equity needs. You obviously kind of mentioned asset sales. Can you just give us a sense on the asset? Is it transmission as media has been reporting, or the off goes an opportunity and just maybe a sense of timing? When do you need the equity? Thanks."
},
{
"speaker": "William Fehrman",
"text": "Yes, with regards to potential asset sales and stuff, we won't comment on those until something might happen, but we're clearly going to consider sort of all of the above to get us to where we need. Chuck, you want to."
},
{
"speaker": "Charles Zebula",
"text": "Yes, sure. I would just add to that, in our plan we also will pursue equity like products out there, instruments that give us equity credit. You'll note in my comments, we are looking to decouple our dividend growth rate from our earnings growth rate as well, which would drift the payout ratio lower as well. We do have PTC and ITC monetization and as far as any asset monetization opportunities, as Bill said, we are looking holistically at all alternatives. As you look at the needs that we have and the timing of such, we will need equity support in 2025 and how and how that comes it could come in any of the forms that I just talked."
},
{
"speaker": "Shar Pourezza",
"text": "Okay, that's perfect. Thanks, guys. We'll see you in a couple days. Appreciate it."
},
{
"speaker": "William Fehrman",
"text": "Yes. Thanks, Shar."
},
{
"speaker": "Operator",
"text": "All right, our next question comes from Steve Fleischman with Wolfe Research. Please go ahead."
},
{
"speaker": "Steven Fleischman",
"text": "Yes, hi. Good morning. Thanks for the time. So first, the new kind of outlook. What are you seeing in terms of earned returns across the utilities over the period? Are you you've had the issue with the earning below? Do you have that improving over the period by how much? Any sense on that?"
},
{
"speaker": "William Fehrman",
"text": "So as we look at our regulatory opportunities right now for the regulated utilities, we're looking at a 9.1% ROE tend to plan. As I've gone around and met with the states, as I noted in my comments, our focus is changing to where we will be working with them to understand what they want to be able to achieve, and we will work to deliver that with them. And through that, then we would hope to continue to improve the relationship that we have with the regulator. And hopefully that then also then turns into more positive outcomes with regards to ROE and the general relationship that we have. As part of that, we also have to significantly improve our customer service. I've noted that we have to put more investment into the distribution side of the business, vegetation management, reduce outage time, and all of that will then go to helping us with regards to our regulatory relations and customer service. So we're very, very focused on that. I've made it around now to seven of our states in the three months I've been here to meet with the regulators, and we're continuing to build those relationships. And as I noted in West Virginia, we made the new filing very disappointed in the quality of our prior filing. We've made changes internally to correct that. And so we'll be very much focused on these returns. And I know how much it adds to our business as we're able to get those closer to our allowance."
},
{
"speaker": "Steven Fleischman",
"text": "Thank you. One other question just on the balance sheet. I appreciate the clear commentary on the Moody's and the deferred fuel. I just want to maybe restate or to clarify what you said. So they are going to make the adjustment. It sounds like you might be temporarily below the 14 to 15 target, but above the 13% downgrade threshold. And that overall the general view of the credit is that it's stable. Is that fair?"
},
{
"speaker": "William Fehrman",
"text": "I think that's an accurate representation of what I said."
},
{
"speaker": "Steven Fleischman",
"text": "Okay. Okay, thank you."
},
{
"speaker": "Operator",
"text": "All right, our next question comes from Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "William Fehrman",
"text": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to speak to the data centers in Ohio, I guess, a little bit more. And given the challenge there, could you speak to settlement dynamics in your data center tariff proposal, given, all the stakeholder, I guess, views on this?"
},
{
"speaker": "William Fehrman",
"text": "Sure. As we've looked at the data center opportunities in Ohio, one of our fundamental principles around all of this is to ensure that our existing customer base is not negatively impacted by the significant increase in data center load that is being proposed for the state. And as such, we filed a tariff in Ohio that would essentially put more pressure on the data centers to stand up for the costs that they're creating on the system. And that filing has been going through the process. There's been settlements filed by the data center coalition, as well as ourselves with a number of other parties, including the staff from the commission. And right now that's moving the hearing on December 3rd, and we would expect to get an outcome from the commission shortly after that. But conversations are still going. We want that load in Ohio. We definitely want it to be on our system and we want to see that growth, but we also want to make sure that our existing customer base is not negatively impacted by this. And so we'll do what we need to ensure that we protect that customer base. And I think, honestly I've worked with data centers for a long time. In my prior role at Berkshire and Iowa in particular, we had a significant customer base of data centers there. And I've seen how the load comes on and what the commitments are, and so got a pretty good feeling for how this is going to potentially play out. And we want to make sure that we have everything in place to serve that load, but bottom line is only if we can protect the rest of the customer base."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Understood. That's helpful there. Thanks. And was just wondering if you could talk a little bit as well on the AEP on your JV proposal with FirstEnergy and Dominion as it relates to the transmission project and I guess what you see as unique or beneficial to this offering versus others."
},
{
"speaker": "William Fehrman",
"text": "So that was a great partnership led by our transmission team, Antonio Smith and the rest of the team there to pull that coalition together and go in and bid on these projects. Obviously, PJM is putting forth a significant amount of potential transmission investment and it was our view that we're stronger together as entities and that we would have a very, very good chance of winning these projects. And so that JV came together really well and we're working well together and we're excited about hearing where we might end up later next year. But I have confidence in our team and the team from FirstEnergy and Dominion that we're going to come out of this with some really strong opportunities to grow our transmission business."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Thank you. One quick last one, if I could just on G&M, seems like 2024 is going to notably outperform initial guidance there and AEP is on the midpoint. So just wondering if there's other segments of the business that are kind of underperforming expectations there. Do you expect them to kind of bounce back next year and also the G&M step down next year given the lower scope of the business, as you said, is that to indicate that there could be sales more likely in this segment than others, knowing that you're not going to identify specific asset sales in advance of them happening?"
},
{
"speaker": "William Fehrman",
"text": "So the G&M segment we're reflecting about $0.24 and lower contributions over 2024 and 2025, which is obviously a significant change for us. But we are seeing good improvement across the rest of our lines of business. We're obviously also going to be going after the transmission projects that I noted in my opening comments. And then as far as other potential asset sales as again I said I will consider all things and if they make sense we'll take a look at them, but we'll talk about those at the time."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Thank you for that."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Arcaro with Morgan Stanley. Please go ahead."
},
{
"speaker": "David Arcaro",
"text": "Good morning. Thanks so much for taking my question."
},
{
"speaker": "William Fehrman",
"text": "Yes, good morning."
},
{
"speaker": "David Arcaro",
"text": "Morning. Just a bit of a follow up on that. Could you just help me understand the 26 EPS outlook? Is there no G&M earnings contribution there just so I could make sure I understood that and maybe specifically what's driving it to zero there? Is that an implied sale or exit of those businesses or something else?"
},
{
"speaker": "William Fehrman",
"text": "Yes, thanks for the question. And perhaps the slide you're looking at may not make that clear. We're just showing the change in G&M from 2024 to 2025. There would still be a contribution from that segment in 2026 and beyond."
},
{
"speaker": "David Arcaro",
"text": "Got it, got it. Okay, thanks for that. Yes, that's more clear. And then could you touch on how you're thinking about the incremental new generation in terms of the CapEx that has come into the plan? I would assume a lot of that is going to be gas. I'm wondering kind of where, where and when you'd be investing in that kind of what the process is to firm that capital up."
},
{
"speaker": "William Fehrman",
"text": "So we do have a lot of gas coming into the system. We've got a number of RFPs out on the street as I mentioned, particularly at I&M, and we’ll see what kind of prices come in for those projects. The CapEx will be spread obviously as those projects come into play. But I'll also say that as we continue to work with some of our other states, particularly say West Virginia, there's a lot of opportunity yet to be sorted through in those states with regards to the economic development that they are pushing forward. And so be happy to talk more about these things in detail at the EEI meeting coming up. But really excited about the potential opportunities we have across a number of our states."
},
{
"speaker": "David Arcaro",
"text": "Got it. Okay, great. Well, thank you so much."
},
{
"speaker": "Operator",
"text": "All right, our next question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning team guys. Thank you very much. Appreciate it."
},
{
"speaker": "William Fehrman",
"text": "Hey, good morning."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Good morning. Doing quite well, thank you. A couple things real quickly. First off on the G&M piece, I know you elaborated a little bit what's reflected through the course of the plan. Is that more of a static expectation off the 2025 baseline or further moderation there? Again, I know you clarified the 9:1 on the utility component, but just on the other piece there if you can."
},
{
"speaker": "William Fehrman",
"text": "Yes, Julien, I think that the business supports the level that we would see in 2025."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Okay, all right. Through the plan. Excellent. Thank you for that. Appreciate all the details. And then related here, you know, 765 has really caught a lot of attention across all the RTOs. I just want to make sure I understand what's reflected in this new CapEx baseline as far as 765 adoption goes across the various footprints. And again, I know you provided particularly detail on this coalition here in PGM. But to what extent can we see sort of comparable efforts emerge, say in ERCOT or what have you, as some of the 765 details become a little bit more formalized here, if you will."
},
{
"speaker": "William Fehrman",
"text": "So obviously we have a big opportunity in ERCOT around the 765 down there in the event that they decide to go that way. We've put in our proposals for that significant opportunity in the Permian area, significant opportunity on the various backbone growth areas for, for Texas. That just alone is a good $4 billion or $5 billion of opportunity potential there for us on the 765 front. We've also got good 765 opportunities in PJM and SVP as well. And so the fact that AEP is essentially the only U.S. Company that knows how to build and operate 765 gives us a strong competitive advantage in these situations and certainly something that I'm very excited about to pursue. That's one of the really strong strategic things that frankly AEP has done over the years is build out this 765kV backbone because it's paying huge dividends right now as all of this load growth is starting to combine. And I think that's being seen by some of the other decision makers around who are looking for ways to significantly increase their ability to move energy. And so with the 765kV experience that we have, I'm very excited about the opportunity to engage with ERCOT, SVP and PJM and maybe a little bit in MISO."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes, it's pretty exciting, actually. Quick clarification on the utility ROE. You're moderating it to 9:1 seemingly from your earlier plan despite the accelerating load. Is there something else disintermediating that relationship? I mean, I could imagine a few things, but I'm curious if there was anything purposeful there."
},
{
"speaker": "William Fehrman",
"text": "Nothing really purposeful. We're trying to continue to increase the ROE and work diligently with the regulators. If you blend in, the transmission component of this, we're at 9:3. Obviously we want to continue to get up closer to our allowance, but frankly, we have to earn our way up. As I said, we've had some mishaps in West Virginia that we've now corrected with the most recent filing, and we've got some significant work to do on the customer service side to put us in a better position with our regulator so they're not getting complaints from customers. And so as this continues to move forward, we've got a tremendous amount of wood to chop in this area, but we're very focused on it. We've taken our board through the details of reliability and where we sit, and we've essentially created a new foundation and we're going to blast off from there to really accelerate our improvements in customer service."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent, guys. Talk soon."
},
{
"speaker": "William Fehrman",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Nick Campanella with Barclays. Please go ahead."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey, good morning. Thanks for taking my questions today."
},
{
"speaker": "William Fehrman",
"text": "You bet. Good morning."
},
{
"speaker": "Nicholas Campanella",
"text": "I wasn't around for the Beatles, but I'm excited to be here for the load growth and I wanted to come back to the generation comments? I think you talked about working with regulators and policymakers on whatever solutions can facilitate this higher load outlook. You talked a lot about gas, but in your prepared remarks you also talked about nuclear. And Bill, I know you talked about your love for nuclear in the past, and maybe you can kind of just expand on your thoughts of how nuclear kind of fits into the AEP strategy, if at all. Thanks."
},
{
"speaker": "William Fehrman",
"text": "Sure. Well, first and foremost, a number of our customers are pursuing projects based on nuclear power plants, and those are many, many years out, as far as I can tell. But we need to continue to work with our customers and if they want to pursue a small modular reactor type of co-location approach, then we'll work with them and we'll continue to work with developers of the various technologies that are out there. But this is going to require a very significant approach to risk mitigation. It will take a combination of the federal government, state government, input from the customer and ourself to build some risk mitigation such that our existing customer base isn't carrying the full exposure of something like this. And we'll, with our nuclear team that we have here, we'll continue to follow the various technologies that are being built in Canada with regards to the BWRX and the new scale plant that's being built in Romania. We'll follow those as well as the GE Hitachi project at TVA and watch how these are progressing. But ultimately if our customers want this and our states want this, then we'll have to figure out a way to deliver it. That's what we do. And so I'm fairly favorable that there'll be one or two designs that make it through the NRC process and will start to be built. But we have to figure out the first of a kind risk and make sure that we are not carrying that, that load and that there's a very broad base of people engaged in this that can help push this along."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey, I really appreciate your thoughts there. And just to tie things off on the 6% to 8% growth rate, so you have 8% rate base growth net of some financing drag. You could also be raising CapEx here too, I hear you on the 10 billion. Where do you kind of think you're trending in this new 6% to 8% range? Over the long-term, do you kind of grow linearly off this midpoint? Could you be kind of higher or lower in certain years? Just trying to understand that. Thank you."
},
{
"speaker": "Charles Zebula",
"text": "Yes, thanks Nick. The 6% to 8% right is based off the 2025 new midpoint. And as you can imagine, as Bill described, the kind of components of our capital plan and the addition of load over time, I don't expect it to be completely linear like it may have been in the past. So I do expect all years to be in that range. But I certainly don't expect a --if our guidance was linear, we would have just said 7%. Our guidance is 6% to 8%. I think that does mean over the long-term we would average somewhere in between there, but I don't expect it necessarily to be linear."
},
{
"speaker": "Nicholas Campanella",
"text": "Very helpful though, still within the ranges. I appreciate the time today. Thanks so much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Carly Davenport with Goldman Sachs. Please go ahead."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thanks so much for taking the questions. Maybe just to start a quick follow up on transmission as we look at the new capital plan, obviously significant increases on that side relative to the prior plan. Just as you think about some of the opportunities in PJM that you ran through in I think Jeremy's question, are those all upside to the plan or is there any spend built in in the back end of this plan related to those opportunities?"
},
{
"speaker": "Charles Zebula",
"text": "Yes, this is all basically upside to the plan. And as I mentioned in my remarks, the potential for $10 billion of additional transmission and new generation build out is what we would be chasing with regards to not only just PJM, but ERCOT, MISO and SPP as well."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Great, that's helpful. And then just lastly, with the increase in the long-term earnings growth rate to that 6% to 8% range, could you just talk a little bit about how you're thinking about dividend growth relative to that range going forward?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. So Carly, we have followed a pattern of pretty much matching dividend growth, right. With our earnings growth, with the increased capital needs, the cash right from decoupling. Right. The dividend growth from the earnings growth will help fund that. And we would be targeting, a payout ratio in the 55% to 65% range. Our old policy was 60% to 70%. I think right now our payout ratio is in that 63%, 64% range. So we will provide a market competitive total shareholder return opportunity for our shareholders. But that will be decoupled going forward."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Great. Thank you so much for the color."
},
{
"speaker": "Operator",
"text": "Our next question comes from Andrew Wiesel with Scotiabank. Please go ahead."
},
{
"speaker": "Andrew Wiesel",
"text": "Hi. Thank you. Good morning everyone. If I could first follow up on that dividend question. Are you able to indicate how quickly you expect to go from the roughly 64% to roughly 60%? Or said differently, if earnings are growing at 6% to 8%, what would be a good expectation for dividend growth? Would it be 6% like we've seen, or potentially something slower?"
},
{
"speaker": "Charles Zebula",
"text": "Well, that's a discussion, Andrew. That is, as you know that the board, approves the dividend and we will drift down in that range. It won't be anything significantly abrupt to expect there, but you could imagine, right. That we would just drift down in that range as we go through time."
},
{
"speaker": "Andrew Wiesel",
"text": "Okay, so sounds like something fairly gradual then. If that's maybe a fair way to put it. Okay. Then on the -- great, thank you. Then on equity, I just want to better understand, I see this slide shows 100 million per year of drip and I fully understand your commentary that asset sales or something like a hybrid might mitigate the need. But for modeling purposes, should we take that 5.35 billion and straight line it over five years? Maybe you could give a little more guidance in terms of timing per year and if this would be an ATM or a block in the absence of one of those alternatives. Thank you."
},
{
"speaker": "Charles Zebula",
"text": "Yes, so it's a good question. Obviously, consolidating the five year cash flow, just indicates that there's a lot of options on the table. What I would tell you that as I said earlier, we do need equity support in some form in 2025 and 2026 to continue to hit our credit metrics. So I think, as you maybe looked at last year's kind of shape and think of it in a similar way, is a good way to perhaps look at it because we do need support in 2025 in some form or fashion. And we are holistically looking at all of the options, including the equity like securities which wouldn't show up in the true equity line on the cash flow."
},
{
"speaker": "Andrew Wiesel",
"text": "Okay, can that be a little more direct? What's embedded in the assumption for share count for 2025?"
},
{
"speaker": "Charles Zebula",
"text": "I don't have that specifically. We could talk about that at EEI."
},
{
"speaker": "Andrew Wiesel",
"text": "Okay, sounds good."
},
{
"speaker": "Charles Zebula",
"text": "You could follow up with Darcy later."
},
{
"speaker": "Andrew Wiesel",
"text": "Very good."
},
{
"speaker": "Operator",
"text": "Our next question comes from Bill Appicelli with UBS. Please go ahead."
},
{
"speaker": "William Appicelli",
"text": "Hi, good morning. Just a question about the. You talked about some of the funding over the years and with the efficient monetization tax credits, can you speak to the magnitude of the tax credits or these going to be contributing to earnings or is this utilization of transferability to provide funding?"
},
{
"speaker": "Charles Zebula",
"text": "Yes, it's just transferability to provide funding. It's neutral to earnings largely. And over the 2025 to 2027 period, it's roughly $300 million a year. In the latter two years there's some ITC opportunities with some solar projects. So you'd be some big, bigger numbers, but in the next three years, about an average of 300 per year."
},
{
"speaker": "William Appicelli",
"text": "Okay, thank you. And then on the sales outlook on residential, so that had been, trailing a little bit behind expectations, but you are assuming some improvement, back to relatively flatter or slightly positive next year maybe. Can you speak to what's driving that?"
},
{
"speaker": "Charles Zebula",
"text": "Yes, I mean, it's a trend I think that we and others are seeing in the industry as well as people have returned to work as inflation has crept in and the share of the wallet becomes more critical. I think you're just seeing reduced usage. We are seeing increased customer counts, in places like Texas and Oklahoma and Ohio and other areas. But it's not offsetting, right. The existing customer decline in usage. We do think that that levels off at some point in time. I think there's also probably some energy, continued energy efficiency things creeping in there. But nonetheless, we're as we, as you see in our forecast, after some years of decline, we're now assuming it flat going forward pretty much."
},
{
"speaker": "William Appicelli",
"text": "Okay. All right. And then just lastly, maybe just you can speak to the colocation issues, that FERC has recently addressed. You guys did intervene in the case. Maybe can you just highlight what you think next steps are, coming out of FERC or some of the policy issues more broadly?"
},
{
"speaker": "William Fehrman",
"text": "Yes sure. So this is a very simple issue in our mind. If you use the transmission system, you should pay for it. It's really that simple. And our view of colocation is that we don't have an issue with colocation. We don't have an issue with data centers looking to use nuclear power plants as an energy source. But what we do have an issue with is when they use the transmission system and try not to pay for it. That's a problem for us because that cost gets shifted to other customers. And so as this process continues to go through the FERC decision making process, we'll continue to reiterate our concerns around cost allocation. And at the end of the day for us it's, it's just a simple principle. If you use the transmission system, pay for it. And that's really where we're at."
},
{
"speaker": "William Appicelli",
"text": "Okay, great. See you next week. Thank you."
},
{
"speaker": "William Fehrman",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Anthony Crowdell with Mizuho. Please go ahead."
},
{
"speaker": "Anthony Crowdell",
"text": "Hey, good morning. Hey, Nick. Did. I'm sorry, Chuck, did Nick have you write that Beatles reference?"
},
{
"speaker": "Charles Zebula",
"text": "I think he may have. I think he may have."
},
{
"speaker": "Anthony Crowdell",
"text": "Well, that's great. Just two cleanups. I think one of them to Julien's question on the ROE improvement that you're seeing, 9.1%. What's a fair assumption where we should start baking in that improvement? Is it gradual over time or is that something you think we could bake in a certain year?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. So trailing 12 months, as you could see in the deck, we're at 9.0% for the entire regulated complex. So I think as you think about going into next year, you should think about that. The regulated utilities in the range of 9.1% and the Transco right in that 10.5% range, which then averages things to 9.3%."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. And then you talk about the load growth, the data centers, great tailwinds. I'm just curious. It was maybe something investors were asking about maybe six months ago, but even with all this demand, is it taking longer to connect these large customers to the system or. It's at a very manageable pace for the company. I'm just thinking that with all this load coming on, whether it's supply chain or just labor connecting all these large customers, but it doesn't appear to be an issue."
},
{
"speaker": "William Fehrman",
"text": "Well, it's certainly a challenge for us to get everyone connected at the speed that they would like to be connected, which is tomorrow for the most part. And we're working with data centers to try to find creative ways to allow them to continue to build out and get the power that they need. But this is going to be a long-term build out for us and we'll try to connect as many data centers as we can onto the system. We'll try to come up with other creative options for those data centers while we get transmission built. But it's going to be an evolution of working with the customer, working with particularly PJM and then our ability to get the construction done. I don't foresee significant supply chain issues at this time. The construction is fairly well spread out and I think we can manage the supply chain side of this. But we certainly have a very high demand coming on from the data center crowd and will work hard to try to accomplish what they want as quickly as we can."
},
{
"speaker": "Anthony Crowdell",
"text": "Thanks for taking my questions. See you in EEI."
},
{
"speaker": "William Fehrman",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "All right, and our final question from today with Ryan Levine with Citi. Please go ahead."
},
{
"speaker": "Ryan Levine",
"text": "Thanks for taking my questions. I guess a couple one, in terms of your confidence level and these load forecasts, how confident are you and when do you think you that could evolve?"
},
{
"speaker": "William Fehrman",
"text": "Well, as we stated earlier, we've got essentially signed contracts for all of this load, so we feel very confident about the load coming on. Certainly we're in discussions with a number of other economic development opportunities across a number of our states. Those clearly are not in our plan, nor do we know if they'll come to fruition. But for what we're showing you, we have signed agreements and our confidence level is quite high."
},
{
"speaker": "Ryan Levine",
"text": "And then in terms of the recent election, with federal tax rates potentially to change in coming years, how exposed is your free cash flow and credit outlook to changes in federal policy And I guess on a similar vein, you have generation build out and ownership expected in your plan. Is there any exposure to tariffs that you're thinking through?"
},
{
"speaker": "William Fehrman",
"text": "Yes, I mean, it's a question we're going to have to evaluate here as we go through time and see what the platform for the new administration is going to be. So give us some time to absorb that."
},
{
"speaker": "Ryan Levine",
"text": "Okay. Thanks for taking my questions."
},
{
"speaker": "William Fehrman",
"text": "Yes. Thank you."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Danica, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's conference call. A replay of the call will be available for one week. The North American toll free phone number is 1-800-770-2030 and you must enter the playback ID as 133-6080 for today's recording. Thank you. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 2 | 2,024 | 2024-07-30 09:00:00 | Operator: Thank you for standing by. My name is JL and I'll be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power's Second Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would like to turn the conference over to Darcy Reese, President of Investor Relations. You may begin.
Darcy Reese: Thank you, JL. Good morning, everyone, and welcome to the second quarter 2024 earnings call for American Electric Power. We appreciate you taking time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our President and Interim Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer; and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks. I will now turn the call over to Ben.
Ben Fowke: Good morning, and welcome to American Electric Power's second quarter 2024 earnings call. Shortly, Peggy will provide a regulatory update, followed by Chuck, who will review our financial results in more detail. A summary of our second quarter 2024 business highlights can be found on slide 6 of today's presentation. Before I dive into our results, I would like to start by welcoming Bill Furman to AEP as our new President and CEO, effective August 1st. Bill brings decades of utility operational leadership experience and in-depth knowledge of the energy industry, most recently serving as President and CEO of Century Holdings, and prior to that, President and CEO of Berkshire Hathaway Energy. With Bill's expertise and diverse background, you can anticipate a smooth transition and continuity of strategic direction. Expect more focus on execution, and Bill has the background to do just that, including capturing growth, listening and responding to our regulators and investors, and using innovation to mitigate inflationary pressures. While I will be serving as Senior Advisor for several months to ensure a smooth transition, it's been an honor to lead AEP as Interim President and CEO, and I'm proud of what the team has accomplished so far this year. Now, turning to AEP's financial results. Today, we announced second quarter 2024 operating earnings of $1.25 per share, a $0.12 increase over one year ago. Our operational execution through the first half of the year, combined with our efforts to efficiently manage the business, have put us well on track to achieve our targets. Today, we reaffirm our 2024 full-year operating earnings guidance range from $5.53 to $5.73, and our long-term earnings growth rate of 6% to 7%. Regarding data center load, we have commitments from customers for more than 15 gigawatts of incremental load by the end of this decade, mostly driven by large load opportunities. To put this in perspective, AEP's system-wide peak load at the end of last year was 35 gigawatts. We continue to work with data center customers to meet their increased demand, while ensuring contracts and new initiatives are fair and beneficial for all of our customers. In the fall, we will provide an update on what this large load opportunity means for our capital spend, including generation and transmission investment, and on our plan to responsibly finance this growth initiative. While we certainly encourage innovation when it comes to meeting the energy needs of our customers, data centers included, I want to emphasize that it is critically important that costs associated with these large loads are allocated fairly, and the right investments are made for the long-term success of our grid. For this reason, we filed new data center tariffs in Ohio and large load tariff modifications in Indiana and West Virginia, and it's the reason why we filed a complaint with FERC related to a co-located load agreement. We will know soon what FERC decides, but this is the rationale we used. Given the co-located load agreement is an active case before FERC, I don't plan on making any further comments. I'd also like to note that large load impacts are already being felt here in AEP's service territories, primarily Ohio and Texas, as our commercial load grew an impressive 12.4% over the second quarter of last year. Looking ahead, we expect the incremental load I just mentioned to move forward in these states and others, including Indiana. Moving to another example of capital opportunities, PSO announced an agreement at the end of June to purchase a 795-megawatt natural gas generation facility conditioned on regulatory approval. The facility, known as Green Country, is located in Jenks [ph] Oklahoma, and will ensure PSO customers continue to benefit from reliable and affordable resources. For this resource adequacy-driven capital, PSO plans to seek regulatory approval this fall, at which time the economics of this acquisition will be made public. As you know, maintaining a strong balance is critical to fund increased capital spend to support our growth initiatives. We will sensibly finance our capital needs, and we're open to incremental growth equity and equity-like tools, in addition to portfolio optimization. On a similar portfolio note, the sale of AEP on-site partners remains on track to close in the third quarter following FERC approval. Now let's move on to the Federal EPA's Coal Combustion Residual Rule, or CCR, which was finalized in the second quarter and expanded the scope of the rule to include inactive impoundments at existing and inactive facilities. We continue to evaluate the applicability of the rule to current and former plant sites, and have developed preliminary estimates of compliance costs. While we are working with others and looking at potential legal challenges to the revised rules, as appropriate, we do plan to seek cost recovery through new and or existing regulatory mechanisms. Chuck will have more information on this shortly. Before I turn it over to Peggy for additional updates, I'd like to thank all of you for your support during my time as AEP's interim CEO. I've been privileged to serve AEP over the past five months, and the board and I are confident that Bill is the right person to build on the momentum underway and to lead AEP into its next chapter. On a related note, we are planning an informal meet and greet in New York City soon, so analyst investors can say hello to Bill in person. We are targeting something in August, so stay tuned for more information coming your way in the next couple of days. Finally, I'm excited about what the future holds for AEP as we execute on our strategic priorities and enhance value for all of our stakeholders. Peggy?
Peggy Simmons: Thanks, Ben, and good morning, everyone. Now let's turn to an update on several of AEP's ongoing regulatory initiatives. We are engaged in our regulatory and legislative areas, continuing to strengthen relationships, including implementation of our investment in more people and resources at the local level. And as the utility industry is changing, now more than ever, AEP's operating company leaders are staying increasingly engaged with regulators amidst this dynamic environment. Customer bills and affordability remain top of mind for AEP, in addition to system reliability and resiliency. We are focused on advancing interest in each of the states we operate, which includes economic development, work across service or service territory to bring jobs and create Bill headroom from a larger load perspective, and to ultimately achieve the regulatory outcomes that are good for AEP's customers, communities, investors, and employees. We continue to work through regulatory items with the focus on our authorized versus earned ROE gap, which remained flat at 8.9% for the past 12 months as of second quarter 2024. Turning to some positive rate case development, let's start with INM. I'm pleased to report that in May, we received an order in Indiana approving all key items in our settlement, including an improved 9.85% ROE. In June, we received a constructive order in Michigan maintaining our existing 9.86% ROE, with new rates taking effect in mid-July. Just last week for AEP Texas, parties filed a unanimous and unopposed comprehensive settlement with the ALJ increasing our authorized ROE to 9.76%, with rates effective in early October pending commission approval. As you know, earlier this year, we filed an APCo biennial rate review in Virginia and a base rate case for PSO in Oklahoma, where we received intervener testimony in the PSO case last evening. We're at the beginning of the procedural schedules in both cases and expect commission orders in the fourth quarter. We look forward to sharing updates on our progress in the coming months. Relative to future cases, APCo plans to file a base rate case in West Virginia in the next week. While we have many trackers in place to help mitigate regulatory lag, we have not had a rate case here in a few years and look forward to working with the parties to achieve a balanced and fair result. Looking ahead, I am proud of the progress we continue to make on the regulatory front and I remain excited about advancing our regulatory strategies in 2024 and beyond. Let's discuss AEP's recent fleet transformation activities and the progress we made on that important initiative. In May, APCo issued requests for proposals for 800 megawatts of wind or solar owned resources with regulatory filing anticipated in 2025. Finally, as Ben mentioned, PSO signed an agreement in June to purchase Green Country's 795 megawatt natural gas generation facility to help ensure resource adequacy. The agreement is conditioned on regulatory approval and we plan to make the related filings with the Oklahoma Commission in the fall. This is an example of a proactive approach by the team in meeting ever increasing resource needs and we're enthusiastic about the opportunity as we advance our fleet transformation. To wrap up, I'd like to thank Ben for his leadership and welcome Bill to the AEP team. This is an exciting time here at AEP and when I think about the future, I'm motivated by the opportunities we have ahead of us, embracing large loads, advancing our regulatory strategy, and driving overall long-term success. I'll now turn things over to Chuck who is going to walk through second quarter 2024 performance drivers and details supporting our financial results. Chuck?
Charles Zebula: Thank you, Peggy, and good morning, everyone. Let's jump right into our second quarter results. Slide seven shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $0.64 per share compared to $1.01 per share in 2023. Year-to-date GAAP earnings are $2.55 per share for this year versus $1.78 per share last year. There's a detailed reconciliation of GAAP to operating earnings for the second quarter and year-to-date results on pages 13 and 14 respectively. Let's briefly highlight a few of the non-operating items for the quarter that mostly make up the difference between GAAP and operating earnings. First, as disclosed in an 8-K in May, an after-tax provision of $126 million for customer refunds was recorded based on recent developments in the remand proceeding related to the cost cap associated with the Turk plant that has been debated over the last decade. Secondly, we incurred a $94 million expense associated with a voluntary severance program that we completed in the second quarter. And finally, as Ben mentioned, the final revised EPA CCR rule became effective in May. We recorded a $111 million accrual for compliance costs largely related to our Ohio properties where generation is deregulated. We also updated our asset retirement obligations for sites in our regulated entities where we intend to seek cost recovery. Let's walk through our quarterly operating earnings performance by segment on slide eight. Operating earnings for the second quarter totaled $125 per share or $662 million compared to $113 per share or $582 million in 2023. This results in an increase of $80 million or $0.12 per share, which is a 10.6% increase over last year. Operating earnings for vertically integrated utilities were $0.46 per share, down $0.05. Positive drivers included favorable year-over-year weather and rate changes across multiple jurisdictions, with the 2022 PSO base case and the 2023 Virginia proceeding being the most significant. These items were offset by higher income taxes, which are largely a reversal of favorable income taxes in the first quarter, lower normalized retail sales, and higher depreciation. Note the year-to-date results in this segment consolidate the income tax loss that is shown in this quarter, resulting in an immaterial year-to-date income tax variance versus last year. The transmission and distribution utility segment earned $0.41 per share, up $0.11 compared to last year. Positive drivers in this segment included favorable weather, increased transmission revenue, rate changes primarily from the distribution cost recovery factor in Texas, and higher normalized retail sales. These items were partially offset by increased property taxes and depreciation. The AEP transmission Holdco segment contributed $0.39 per share, up a penny compared to last year, primarily driven by investment growth. Generation and marketing produced $0.12 per share, down a penny from last year. Recall that AEP renewables was sold in the third quarter last year, which has two impacts, a negative earnings variance due to the business being sold and removal of the interest costs for financing these assets. Additional drivers were lower retail margins offset by higher generation margins and lower taxes. Finally, corporate and other was up $0.06 compared to the prior year, primarily driven by lower income taxes and increased other operating income related to timing in the prior year. These items were partially offset by higher interest expense and lower interest income from the GNM segment. Let's turn to slide nine, which shows weather normalized retail sales of 4% in the quarter from a year ago, headlined by a double-digit 12.4% increase in commercial sales, which is where our data processing customers are classified. I'll note that in our T&D segment, the increase in commercial load was over 20% for the quarter. This is a trend that will continue over the coming years based on already signed customer commitments. Our operating footprint and robust transmission system position us perfectly to grow along AI and other technologies and industries in need of access to affordable and reliable power. Through the remainder of this year, data processing gains will remain mostly concentrated in Ohio and Texas. But beyond this year, we are seeing strong commitments from new customers looking to connect at some of our vertically integrated companies as well. Outside of data processors, our industrial sales have remained resilient in the face of a slowing economy. Industrial sales were strongest in Texas, driven by an influx of new customers, mainly in the energy industry. Thanks to our success over the past few years on the economic development front, we expect to see our industrial sales continue to be resilient in the next few years as several new large customers in steel, energy, renewable energy, and semiconductors come online across our footprint. In the residential segment, we continue to see growth in customer count and load in Texas, but residential load remains weak in most of our territories, likely due to the cumulative effects of inflation. Bottom line, the amount of demand from new large loads we're seeing across our system is unprecedented. We are excited, challenged, and poised to embrace this opportunity. Let's move on to slide 10. In the top left table, you can see the FFO to debt metric stands at 14.6% for the 12 months ended June 30th, which is a 40 basis point increase from the prior quarter. Our debt-to-cap decreased slightly from last quarter and was 62.6% at quarter end. We took credit-supportive financing actions in the second quarter by issuing $400 million of equity under our at-the-market program and by issuing $1 billion in junior subordinated notes at the parent, which qualified for 50% equity credit at all three rating agencies. In the lower left part of this slide, you can see our liquidity summary, which remains strong at $5.4 billion and is supported by $6 billion in credit facilities. Lastly, on the qualified pension front, our funding status is near 99%. In summary, our second quarter results provide additional momentum this year, bringing year-to-date earnings up to $2.52 per share, an increase of $0.28, or 12.5% compared to the same period last year. We reaffirm our operating earnings guidance range of $553 to $573 and remain committed to our long-term growth rate of 6% to 7%. And as we move through the balance of the year, our focus is on providing reliable and affordable service to our customers, executing our plan, and embracing the growth opportunities that we have ahead of us. Also, a quick update on the sale of AEP on-site partners. We expect the transaction to close in the third quarter and result in approximately $315 million in net proceeds to the company. I'd be remiss if I didn't acknowledge the skilled leadership of Ben Folk during this time of transition at AEP. Ben told you that this company would not be in neutral during the transition, and I can say that that is absolutely true. Ben, while I know you'll still be engaged as an advisor and board role going forward, I want you to know that the AEP team appreciates your engagement and contributions over the past five months. Finally, the AEP team looks forward to the arrival of our new CEO and President, Bill Furman. We all look forward to Bill bringing his accomplished leadership to AEP and working with him as we take on the exciting opportunities that we have before us. Thank you for your interest in American Electric Power. Operator, can you open the call so we can address your questions? Thank you.
Operator: Thank you. [Operator Instructions] Your first question comes from the line of Shar Pourezza of Guggenheim Partners. Your line is open.
Shar Pourezza: Hey, guys. Good morning.
Ben Fowke: Morning. Morning.
Shar Pourezza: Just firstly, obviously, you guys highlighted in the deck, “the direction and strategy” kind of remain on track. I guess how much latitude will Bill have to make kind of strategic changes if need be to accrue value? Or is the plan kind of the plan and any kind of changes you expect will likely be more on the fringe, given your and the board's comfort level with the trajectory, with obviously the latter kind of being a similar situation to one of your other Ohio peers in the state when they had an incoming CEO? Thanks.
Ben Fowke: Yes. I think that was a lot different circumstance, Shar, but Bill's very familiar with our strategy. We clearly had conversations with Bill about our strategy. So I think it's, I think we're on the right strategic direction. I do think Bill's going to come in and focus very much on execution. He's got a ton of experience, as we mentioned. And so I mean he'll take some time, assess where we are and I'm sure he's going to make some changes, but I don't see significant changes in the strategic direction. It's not like we gave him a plan, a to-do list, and you do all these things. He's going to be a dynamic leader. But the path we're on is, I think we're all in agreement, it's the right path and we need to execute on it.
Shar Pourezza: Okay, perfect. And then last time, obviously we've talked about higher CapEx coming, driven by customer growth, data centers, etcetera. As we're kind of thinking about that incremental CapEx, potentially with a 3Q update and a funding source, the balance sheet doesn't have a material amount of capacity. You touched on this a little bit on your preparedness, but maybe you can elaborate on how you're kind of thinking about incremental equity versus asset sales, and with asset sales, how you're thinking about distribution versus transmission. Thanks, guys.
Ben Fowke: Yes, I mean, clearly we're going to have an update in the fall, either at or right before EEI, that incorporates what it means to CapEx to fund this low growth, both in generation and transmission, and of course, what it means to make sure the balance sheet is strong in terms of equity and equity-like products, including portfolio optimization. Regarding portfolio optimization, you've heard me say it before, we're always open to it, but price has to be there, and the ability to execute has to be there. And the regulated utility spaces, those are two hard things to put together at the same time, but we're open to it. Chuck, I don't know if you want to add anything to it.
Charles Zebula: Ben, the only thing I would add is, right, it's so important as we are a regulated utility and have significant capital needs not only today, but going forward right, to maintain investment credit ratings, and we will defend that right in our plan.
Shar Pourezza: Got it. Perfect. Thank you. And by the way, just a real big congrats on Bill. He's one of the best hires. Thanks, guys.
Charles Zebula: Thanks. You did mention, Shar asked the mix between distribution and transmission. So, it's going to, there's obviously going to be a lot of transmission that needs to be built, as well as distribution.
Operator: Thank you. Your next question comes from the line of Jeremy Tonet of JPMorgan. Your line is open.
Jeremy Tonet: Hi, good morning.
Ben Fowke: Hey, Jeremy.
Jeremy Tonet: Hey, I know you're not going to give us the full details here, but I was just wondering if there's any way you could help us think through size and shaping of this incremental CapEx, as you talked about, with the incremental wires needs here. It just seems like everything is materializing quicker than expected. And so, just wondering if you could comment, I guess, any shaping there that would be helpful.
Ben Fowke: Yes. Well, as I mentioned, with Shar's comment, I mean, you're definitely going to see a lot of increase in transmission spent. There's got to be something to plug into, so we're going to have generation, as well, and we recognize the need to make sure we have reliable distribution grid. So, I think if I had to rate it, it would be transmission increases, followed by generation, followed by distribution.
Charles Zebula: Jeremy, I would say you'll note, in our materials that we raised our CapEx this year already by $500 million. That largely is in T&D, right? It's for reliability spend, also customer hookups, and then storm-related capital. So the shape of it right, is going to be as these customer additions, come online. And again, as Ben mentioned, we'll be laying all that out in the fall.
Jeremy Tonet: Got it. So, it sounds like there's an opportunity for more near-term, as opposed to just later data at this point, if I understand correctly.
Charles Zebula: I think that that's true.
Jeremy Tonet: Got it. I was just wondering if you could talk a bit more on PSO's natural gas generation purchase there. To what extent do you see the need for incremental gas generation, across Oklahoma, other service territories? Just wondering if you expect to see more of this.
Peggy Simmons: So, I would say, this is Peggy, and I would say with the increased reserve margins that we're seeing from the RTOs and the additional load that we're starting to see across our system, we are going to need some additional generation. And this was a very proactive approach that the team took as I mentioned in my comments earlier, to go out and find some affordable assets that we could bring onto the system. And we plan to make that filing at the Commission later this fall.
Ben Fowke: Yes. Peggy mentioned proactive. It really, I think, was creative. It was outside of the RFP process, but we have an RFP process to compare the pricing to, and it's clearly very favorable. So, we're really excited about it. I think it'll be great for our customers.
Jeremy Tonet: Got it. Thank you for that.
Operator: Your next question comes from the line of Steve Fleischman of Wolfe Research. Your line is open.
Ben Fowke: Hey, Steve.
Steven Fleishman: Hey, good morning. Sorry, I've got several questions on data center, or data processing, as you called it. So first of all, just in the quarter, you had the very strong commercial sales growth, but then your normalized sales growth between the two subs, I think was actually down $0.04. When you kind of look at both vertical and T&D, could you just talk to how we should think about that?
Ben Fowke: Yes, in T&D, Steve, normalized sales were up $0.02.
Steven Fleishman: Right. But then the vertical was down $0.06, I think. So I guess just thinking, when I look at the whole picture, it's not kind of, at least in that line item, doesn't seem to be showing up as a benefit.
Ben Fowke: Yes. So, let me comment on the negative $0.06 in vertically integrated. That's largely due to in vertically integrated, we had in the quarter, but a 4.9% decrease over last Q2 in residential sales. And that's largely what drove that number. In our SWEPCO territory, we had in kind of mid to late May into early June, we had a number of repeated storm activity, tornadic activity that took, large swaths of customers out for significant amounts of times that drove that number down. We've seen that start to normalize back in June and July. So I expect that to return to a more normal state.
Steven Fleishman: Okay. Thanks. And then on the 15 gigawatts of committed data center sales to 2030, could you just maybe better define what committed means when you give that data point?
Ben Fowke: Yes. I mean, it basically means that we have a letter of agreement, and those letter of agreements, Steve, start the clock running, if you will, for us to do work that pretty quickly can go into the millions, which that customer who signed the letter of agreement is required to pay. So that's how we define it. As we look forward, we look at a number of filtering criteria, ownership of sites, etcetera, that we use. So these are far from just inquiries. These are, serious customers that want to get on the grid and are willing to financially commit to do what it takes to get on the grid.
Steven Fleishman: Okay. And are those customers kind of committing to these new tariffs you filed, or are we not at the point where they've made the agreement that those tariffs work for them when they've kind of done this?
Ben Fowke: Yes. Those tariffs, as you know they haven't been approved yet, but they will need depends where they are in the signing process as to whether or not they will be held to those tariffs or not. But going forward, customers, if approved, will all be required to step up to the tariffs.
Steven Fleishman: Okay. And then….yes.
Ben Fowke: Which, as you know, I mean, well, as Steve was just going to say, it's just, it's really important. We're going to see more growth than we've seen in maybe generations. And it's going to be really important that that growth is beneficial for all customers and at the worst case, at least neutral. And that's exactly why we're trying to, that's exactly why we're so keenly focused on making sure that we have these tariffs and the modifications I mentioned in Indiana and West Virginia. And it's just, we got to get it right.
Steven Fleishman: Okay. And then maybe just in terms of helping to frame the capital needs, just, can you give us some rough sense of that 15 gigawatts, how much might be related to vertically integrated parts of AEP versus the transmission only parts?
Ben Fowke: Yes, Steve. So the way to think about it is, think of it as a 50-50 split between Texas and PJM. 50%, or of course, Texas, right, is our wires company and PJM, take that 50% and basically split it 50-50 between INM, which is vertically integrated and AEP Ohio, right, which is wires only.
Steven Fleishman: Okay. So that would be kind of 75-25, I guess, roughly, I think. Yes.
Ben Fowke: Okay. I think I've, yes. But we are seeing additional interest amongst other vertically integrated utilities, but that interest is not as firm yet.
Steven Fleishman: Amongst some of your other vertically integrated.
Ben Fowke: Yes, that's correct.
Steven Fleishman: Yes. Okay. Great. I'll leave it there. Thank you very much.
Ben Fowke: Thanks, Steve.
Operator: Your next question comes from the line of Nick Campanella of AEP [ph]. Your line is open.
Unidentified Analyst: Nick Campanella at Barclays here. Thanks for the time.
Ben Fowke: Did we just hire Nick?
Unidentified Analyst: I never got the call. I never got the call, but thanks for the time. A lot of my questions have been answered, but I just, curious as we kind of try to think about the magnitude of capital that the plan can handle here. I know that there's financing considerations, but there's also kind of bill growth considerations. Just how high do you think your rate-based growth can get before you have to start thinking about customer bill impact, especially as some of this load should be able to supplement that, but just trying to see, where this rate-based CAGR could go at the end of the day. Thank you.
Ben Fowke: Yes, I think the incremental CapEx will be driven to support new load growth. And that's why we're just so keenly focused on making sure we get the rules right. And our modeling suggests that it will be good for all customers. And that's, I mean, that's what makes me so excited about this is that everybody can benefit, load's good for all, and it's going to, there are certainly pressures, on the grid and the resiliency and things like that, but I think the load's going to be beneficial to mitigate cost increases.
Unidentified Analyst: Okay. Thanks. And then I guess, since you've kind of taken over, you have kind of pulled some strings on this involuntary, this voluntary severance program, just where are there other opportunities in the plan to cut costs today, or just things that maybe we're not thinking about that could be incremental to the positive?
Ben Fowke: Again, as I mentioned, I think, you've got Bill Furman coming in, he's got a track record of innovation. The companies in the Berkshire Hathaway portfolio were extremely well run. Bill is extremely well respected. So I think he's going to bring a lot of great ideas. It's a lot of blocking and tackling, and also taking advantage of innovation, smart technologies, etcetera, that'll get us there. But, the team has done a really good job, if you look back, in keeping O&M in check. So, again, I think the biggest way we keep costs down on our customers is to bring this new load on and bring it on in ways and rules and tariffs that are fair to all.
Unidentified Analyst: Thank you.
Ben Fowke: Thanks.
Operator: Your next question comes from the line of Carly Davenport of Goldman Sachs. Your line is open.
Carly Davenport: Hey, good morning. Thanks for your time. Just a couple of clarification questions, if I could. First, just on the 15 gigawatts of incremental load by the end of the decade, could you just clarify, is all of that related to data centers, or is there anything else in there? And then, is there anything you can provide on how to think about the cadence of that load materializing from a timing perspective?
Ben Fowke: Yes, the 15 gigawatts refers to all data centers, and we're not announcing the cadence of that at this time. But it's already, as you can see, it's already showing up in our numbers. So we are hooking up, folks, and you'll see continued increases, over the next several years.
Carly Davenport: Great. Thank you for that. And then, just a follow-up is just on the earned versus authorized ROE gap. I know you mentioned the earned ROE sort of flatted at 8.9% on a trailing 12-month basis. Do you have that comparable weather normalized number similar to what you've provided in previous quarters?
Peggy Simmons: Oh, we're looking forward to be at 9.1% for this year. As I mentioned, over the past 12 months, I mean, on a rolling average right now, we’re at 8.9% [ph] which is flat to where we were last quarter, but continuing to make progress on that front.
Carly Davenport: Got it. Great. Thanks so much for the time.
Ben Fowke: Thank you.
Operator: Your next question comes from Andrew Wiesel of Scotiabank. Your line is open.
Ben Fowke: Good morning.
Andrew Weisel: Hi, good morning. First, a quick governance question. Can you please talk about the outlook for the board, and specifically what roles will Ben and Bill each have? Who will be chair of the board, and will it be executive or non-executive? And how large will the board ultimately be?
Ben Fowke: Okay. Well, I will go back after my time as advisor, I'll go back to being a board member, and I will keep my independence. Bill obviously will be on the board. He'll be a non-independent director. Sara Martinez Tucker, or Sara Martinez Tucker will be the chair, and she will remain chair, and she's independent. Size of the board, we are basically at full size, and so there won't be any change to the size of the board. I don't know. Did I get all those questions?
Andrew Weisel: Yes. That's great. Thank you very much. And then just a quick question on the cash flow slide, page 22. Some moving parts in 24 has led to slightly higher equity needs this year by about $100 million. Can you elaborate a little bit on that? And then looking to 2025 and beyond, I see no changes. Would I be right to assume that sort of just waiting for the update in three months? And just to clarify your comment on the equity-like tools, are you referring to the junior subordinates, or could there be something else in there, like equity units perhaps?
Ben Fowke: So, Andrew, first question. You also note in 2024, we had a $500 million increase in CapEx, and versus our plan for the year, we had additional asset sales that were part of the original plan that ended up changing through the year. So, in our financing, in our cash, we received less proceeds because of that change in plan. So, those two things basically drove the opportunity for the increase in equity, and just being opportunistic in the market as well. You're right, going forward, we have not updated those cash flows yet for our annual update, which we'll do at EEI.
Andrew Weisel: Okay. The equity-like, was that just referring to the junior subordinates, or was there more to it?
Ben Fowke: Yes, that refers to the notes that we issued in June. But we would look at various forms of equity alternatives and be holistic in our approach.
Andrew Weisel: Very good. Appreciate the details. Thank you.
Operator: Your next question comes from the line of Durgesh Chopra of Evercore ISI. Your line is open.
Durgesh Chopra: Hey, team. Good morning. Good morning, Ben. Andrew actually asked my question on the financing slide. Chuck, maybe a little sort of more color, there were kind of more negatives to positives in that cash flow slide. I mean, the asset sale proceeds were lower, right, and the CapEx is higher. Just assuming normal weather for the rest of the year, are you going to be below 14.6 where you said, or should we kind of think about 14.6 as strong as going into the end of the year?
Charles Zebula: Yes, our plan is to be in the 14% to 15% range. I'll just note, right, that we're well above the 13% downgrade threshold. So, yes, we plan to be in that range.
Durgesh Chopra: Okay. Thank you. Appreciate the time.
Operator: Your next question comes from the line of Sophie Karp of KeyBanc Capital Markets. Your line is open.
Sophie Karp: Hi. Good morning. Thank you for squeezing me in. If I could quickly go back to the 15 gigawatts of data center load, I guess, could you provide some color on how much of that can be connected without any incremental investment in your system versus how much would they require incremental investments to facilitate that?
Peggy Simmons: Right now, none of that can be connected at this point in time, but as we look at our LOA process, that's why we are looking at any initial upgrades that are needed as we prepare to plan the system to connect this load over that period of time.
Sophie Karp: Got it. Got it. Thank you. And then maybe a little bit more of an open-ended question. Your current outstanding RFPs don't have any gas in them. It's mostly renewables. And I'm just curious of how you think about the cadence of needing to add dispatchable generation there. And when it comes to gas, will you continue to have a bias towards acquiring existing assets or will we see some new builds potentially?
Peggy Simmons: So, our RFPs are all-source RFPs, so we're evaluating all technologies that come in. And we do believe the dispatchable resources are needed to be added to the grid as well, and they will be part of the plan.
Sophie Karp: Okay. Thank you.
Peggy Simmons: You're welcome.
Operator: Your next question comes from the line of Bill Appicelli of UBS. Your line is open.
William Appicelli: Hi. Good morning. Thanks for taking my questions. Just want to dig into a little bit more on the sales growth trends. So, on the residential side, you commented that Texas looks strong, but that more broadly, the cumulative effects of inflation have been weighing on it. So, any more color there? Are you expecting an improvement in the second half of the year?
Ben Fowke: Yes. So, Bill, in Texas, right, there is customer growth as well as, increase in use or as a result, increase in usage. In vertically integrated year-to-date, residential is down 1.3%, and T&D is actually up 0.3%, largely due to Texas. So, we are seeing, I think, in Appalachian Power, in Kentucky Power, in SWEPCO in particular, and I mentioned, some of the weather occurrences that we had in the SWEPCO area, weaker residential sales in those areas in particular.
William Appicelli: Okay. I mean, I guess we think about the EPA activities here, right, because you've got the, tremendous growth in the commercial side, right, tracking well above plan, but that's going to be lower margin volumes. And then maybe on the residential side, going back sort of four of the last five quarters, sort of as a negative, and that's obviously a bit of a higher margin, but, smaller overall change. What, we sort of reconcile that a little bit as we think about the EPA's impact.
Ben Fowke: Yes. I mean, clearly the residential sales are higher margin, but, again, I think it's, in particular, the effects of inflation. So, if inflation comes in tame, tamer as we begin to, as we've begun to see if wage growth, continues to close that gap. And as Ben mentioned, right, the opportunity to bring on large loads to spread fixed costs, right, over a much larger denominator, right, should mitigate, right, some of those customer rate impacts as well. So the combination of those things, right, should begin to, slow that decline. But, clearly, the effects of inflation have hit home for a lot of customers.
William Appicelli: Right. Okay. And then I guess the other question is, it's come up a little bit, but on the episode of debt, under, I guess, the Moody's methodology, do you know what that number would be?
Ben Fowke: Yes, it's 14.6 under Moody's.
William Appicelli: Oh, it's under Moody's. Okay. All right. Thank you very much.
Operator: Your next question comes from the line of Julian Smith of Jefferies. Your line is open.
Julian Smith: Hey, good morning, team. Thank you guys very much for the time. I appreciate it. Going back. Thank you very much. Appreciate it. Maybe going back to some of the conversation on the layoffs and severance bit. I just want to understand the extent to which this process is finalized, right? You've given very specific jurisdictional level details. And given that, how are you thinking about rebuilding and devolving some decision-making power and some of the roles to the local OpCo’s? Can you speak to perhaps what seems like perhaps a strategic shift in looking at local level decision-making and really what level or what quantity of the roles in terms of overall layoffs will actually be ultimately recreated, if you will, at the local level here? So both the financial question in terms of what's the sort of ongoing net savings and B, how do you think about this fitting within the strategic question of devolvement?
Ben Fowke: Yes, I'm going to turn it over to Peggy in a second. But just as a recap, we did hit our targets that we laid out under that voluntary severance program. And we plan to hold as much of those gains as possible. Probably have to do some hiring back, but try to keep that minimized. Remember, there was two-pronged approach for this. One, we wanted to mitigate some of the inflationary pressures that we were seeing, higher interest rates, just overall increase in supply chain, etcetera, and take a portion of that, albeit a smaller portion, and start putting those, some of those resource, some of that money back into our local communities with more boots on the ground, if you will, more community leadership positions and that sort of thing. So Peggy, do you want to?
Peggy Simmons: Yes, Ben. So yes, that's exactly, Julian, what we're looking to do. We are, some of those positions were leadership positions that report to some of our Presidents. We are making sure that we are getting those filled and we're adding additional resources in the regulatory and legislative space, because we know that as dynamic as our industry is and as much change as is occurring, we want to make sure that we have that enhanced engagement at those levels. So you'll see more of that.
Julian Smith: Excellent. All right. Looking forward to that. And then related, you talk about these staggering levels of the 15 gigawatts of firm commitments at this point. How do you think about that marrying up, especially in your wires businesses against an effort to address generation needs? I know this has been an ongoing tension, but given what seems like yet an accelerating backdrop of generation needs, how do you think about your utilities, especially in the buyers only businesses, potentially re-engaging in that narrative? And in what ways?
Ben Fowke: Well, I mean, I think that would take legislation clearly in Ohio. I guess it would take it in Texas, too, but I don't see that happening. I think it's probably a long shot in Ohio as well. So, we are going to have to rely on the market, but our vertically integrated utilities are all going to need generation and in different timeframes. But I think Peggy mentioned, we've got, we do have more with the changes in the reserve margin requirements, for example, in SPP. It creates a resource need, and we're developing our plans to fill that, which will require increased CapEx, which I think is a good thing. And we're really, again, excited about Green Country. The load is tremendous, and it's primarily data centers, but of course we'd be remiss if we didn't mention we've seen industrial load in Texas as well. And I think when we think about economic development, we're going to continue to look for opportunities to bring industry back on shore. And I'm right here in Columbus today, and the Intel has just been an enormous success, and we're going to keep looking for opportunities for our communities, and, again, all customers benefit from that.
Julian Smith: All right, guys. Thank you very much. I appreciate it.
Ben Fowke: Thank you.
Operator: Your last question comes from the line of Paul Patterson of Glenrock. Your line is open.
Paul Patterson: Good morning. How are you doing?
Ben Fowke: I'm doing good.
Paul Patterson: Great. So I asked this question some time ago about Chevron, and we now have a Supreme Court decision. And I'm just wondering how you guys see it potentially impacting either EPA or FERC regulation or anything else you might, if you think it has any potential impact on AEP, I guess.
Ben Fowke: I think it's early, but, yes I think it could potentially be helpful as courts have more discretion not to have to rely on the agencies, which that was the whole point of that. And I just think it doesn't bind the courts as much as it probably did in the past. Now, whether that, how the courts interpret it, what, the rulings are, we'll have to wait and see. But Paul, I think in general it's going to be helpful. And we are going to challenge a lot of these EPA rules, as you know, the CCR rule, the ELG rule, the 111 rules. I guess all of the rules that have come out we're going to challenge and for good reason.
Paul Patterson: Okay, great. And then just on FERC, do you see anything happening there maybe?
Ben Fowke: I don't know. I think, I know there's some, there's some thought that it would, but I think that really, I'm not convinced it will. So, I think that remains to be seen.
Paul Patterson: Okay. The rest of my questions have been answered. Thanks so much. Have a great one.
Ben Fowke: All right, Paul. Thank you.
Darcy Reese: That concludes it. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. JL, would you please give the replay information?
Operator: Certainly. Echo replay will be available in two hours until August 6th at 1-800-770-2030. That's 1-800-770-2030 using playback ID 6645529. That's replay playback ID 6645529 followed by the pound key. This concludes today's conference call. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Thank you for standing by. My name is JL and I'll be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power's Second Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would like to turn the conference over to Darcy Reese, President of Investor Relations. You may begin."
},
{
"speaker": "Darcy Reese",
"text": "Thank you, JL. Good morning, everyone, and welcome to the second quarter 2024 earnings call for American Electric Power. We appreciate you taking time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our President and Interim Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer; and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks. I will now turn the call over to Ben."
},
{
"speaker": "Ben Fowke",
"text": "Good morning, and welcome to American Electric Power's second quarter 2024 earnings call. Shortly, Peggy will provide a regulatory update, followed by Chuck, who will review our financial results in more detail. A summary of our second quarter 2024 business highlights can be found on slide 6 of today's presentation. Before I dive into our results, I would like to start by welcoming Bill Furman to AEP as our new President and CEO, effective August 1st. Bill brings decades of utility operational leadership experience and in-depth knowledge of the energy industry, most recently serving as President and CEO of Century Holdings, and prior to that, President and CEO of Berkshire Hathaway Energy. With Bill's expertise and diverse background, you can anticipate a smooth transition and continuity of strategic direction. Expect more focus on execution, and Bill has the background to do just that, including capturing growth, listening and responding to our regulators and investors, and using innovation to mitigate inflationary pressures. While I will be serving as Senior Advisor for several months to ensure a smooth transition, it's been an honor to lead AEP as Interim President and CEO, and I'm proud of what the team has accomplished so far this year. Now, turning to AEP's financial results. Today, we announced second quarter 2024 operating earnings of $1.25 per share, a $0.12 increase over one year ago. Our operational execution through the first half of the year, combined with our efforts to efficiently manage the business, have put us well on track to achieve our targets. Today, we reaffirm our 2024 full-year operating earnings guidance range from $5.53 to $5.73, and our long-term earnings growth rate of 6% to 7%. Regarding data center load, we have commitments from customers for more than 15 gigawatts of incremental load by the end of this decade, mostly driven by large load opportunities. To put this in perspective, AEP's system-wide peak load at the end of last year was 35 gigawatts. We continue to work with data center customers to meet their increased demand, while ensuring contracts and new initiatives are fair and beneficial for all of our customers. In the fall, we will provide an update on what this large load opportunity means for our capital spend, including generation and transmission investment, and on our plan to responsibly finance this growth initiative. While we certainly encourage innovation when it comes to meeting the energy needs of our customers, data centers included, I want to emphasize that it is critically important that costs associated with these large loads are allocated fairly, and the right investments are made for the long-term success of our grid. For this reason, we filed new data center tariffs in Ohio and large load tariff modifications in Indiana and West Virginia, and it's the reason why we filed a complaint with FERC related to a co-located load agreement. We will know soon what FERC decides, but this is the rationale we used. Given the co-located load agreement is an active case before FERC, I don't plan on making any further comments. I'd also like to note that large load impacts are already being felt here in AEP's service territories, primarily Ohio and Texas, as our commercial load grew an impressive 12.4% over the second quarter of last year. Looking ahead, we expect the incremental load I just mentioned to move forward in these states and others, including Indiana. Moving to another example of capital opportunities, PSO announced an agreement at the end of June to purchase a 795-megawatt natural gas generation facility conditioned on regulatory approval. The facility, known as Green Country, is located in Jenks [ph] Oklahoma, and will ensure PSO customers continue to benefit from reliable and affordable resources. For this resource adequacy-driven capital, PSO plans to seek regulatory approval this fall, at which time the economics of this acquisition will be made public. As you know, maintaining a strong balance is critical to fund increased capital spend to support our growth initiatives. We will sensibly finance our capital needs, and we're open to incremental growth equity and equity-like tools, in addition to portfolio optimization. On a similar portfolio note, the sale of AEP on-site partners remains on track to close in the third quarter following FERC approval. Now let's move on to the Federal EPA's Coal Combustion Residual Rule, or CCR, which was finalized in the second quarter and expanded the scope of the rule to include inactive impoundments at existing and inactive facilities. We continue to evaluate the applicability of the rule to current and former plant sites, and have developed preliminary estimates of compliance costs. While we are working with others and looking at potential legal challenges to the revised rules, as appropriate, we do plan to seek cost recovery through new and or existing regulatory mechanisms. Chuck will have more information on this shortly. Before I turn it over to Peggy for additional updates, I'd like to thank all of you for your support during my time as AEP's interim CEO. I've been privileged to serve AEP over the past five months, and the board and I are confident that Bill is the right person to build on the momentum underway and to lead AEP into its next chapter. On a related note, we are planning an informal meet and greet in New York City soon, so analyst investors can say hello to Bill in person. We are targeting something in August, so stay tuned for more information coming your way in the next couple of days. Finally, I'm excited about what the future holds for AEP as we execute on our strategic priorities and enhance value for all of our stakeholders. Peggy?"
},
{
"speaker": "Peggy Simmons",
"text": "Thanks, Ben, and good morning, everyone. Now let's turn to an update on several of AEP's ongoing regulatory initiatives. We are engaged in our regulatory and legislative areas, continuing to strengthen relationships, including implementation of our investment in more people and resources at the local level. And as the utility industry is changing, now more than ever, AEP's operating company leaders are staying increasingly engaged with regulators amidst this dynamic environment. Customer bills and affordability remain top of mind for AEP, in addition to system reliability and resiliency. We are focused on advancing interest in each of the states we operate, which includes economic development, work across service or service territory to bring jobs and create Bill headroom from a larger load perspective, and to ultimately achieve the regulatory outcomes that are good for AEP's customers, communities, investors, and employees. We continue to work through regulatory items with the focus on our authorized versus earned ROE gap, which remained flat at 8.9% for the past 12 months as of second quarter 2024. Turning to some positive rate case development, let's start with INM. I'm pleased to report that in May, we received an order in Indiana approving all key items in our settlement, including an improved 9.85% ROE. In June, we received a constructive order in Michigan maintaining our existing 9.86% ROE, with new rates taking effect in mid-July. Just last week for AEP Texas, parties filed a unanimous and unopposed comprehensive settlement with the ALJ increasing our authorized ROE to 9.76%, with rates effective in early October pending commission approval. As you know, earlier this year, we filed an APCo biennial rate review in Virginia and a base rate case for PSO in Oklahoma, where we received intervener testimony in the PSO case last evening. We're at the beginning of the procedural schedules in both cases and expect commission orders in the fourth quarter. We look forward to sharing updates on our progress in the coming months. Relative to future cases, APCo plans to file a base rate case in West Virginia in the next week. While we have many trackers in place to help mitigate regulatory lag, we have not had a rate case here in a few years and look forward to working with the parties to achieve a balanced and fair result. Looking ahead, I am proud of the progress we continue to make on the regulatory front and I remain excited about advancing our regulatory strategies in 2024 and beyond. Let's discuss AEP's recent fleet transformation activities and the progress we made on that important initiative. In May, APCo issued requests for proposals for 800 megawatts of wind or solar owned resources with regulatory filing anticipated in 2025. Finally, as Ben mentioned, PSO signed an agreement in June to purchase Green Country's 795 megawatt natural gas generation facility to help ensure resource adequacy. The agreement is conditioned on regulatory approval and we plan to make the related filings with the Oklahoma Commission in the fall. This is an example of a proactive approach by the team in meeting ever increasing resource needs and we're enthusiastic about the opportunity as we advance our fleet transformation. To wrap up, I'd like to thank Ben for his leadership and welcome Bill to the AEP team. This is an exciting time here at AEP and when I think about the future, I'm motivated by the opportunities we have ahead of us, embracing large loads, advancing our regulatory strategy, and driving overall long-term success. I'll now turn things over to Chuck who is going to walk through second quarter 2024 performance drivers and details supporting our financial results. Chuck?"
},
{
"speaker": "Charles Zebula",
"text": "Thank you, Peggy, and good morning, everyone. Let's jump right into our second quarter results. Slide seven shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $0.64 per share compared to $1.01 per share in 2023. Year-to-date GAAP earnings are $2.55 per share for this year versus $1.78 per share last year. There's a detailed reconciliation of GAAP to operating earnings for the second quarter and year-to-date results on pages 13 and 14 respectively. Let's briefly highlight a few of the non-operating items for the quarter that mostly make up the difference between GAAP and operating earnings. First, as disclosed in an 8-K in May, an after-tax provision of $126 million for customer refunds was recorded based on recent developments in the remand proceeding related to the cost cap associated with the Turk plant that has been debated over the last decade. Secondly, we incurred a $94 million expense associated with a voluntary severance program that we completed in the second quarter. And finally, as Ben mentioned, the final revised EPA CCR rule became effective in May. We recorded a $111 million accrual for compliance costs largely related to our Ohio properties where generation is deregulated. We also updated our asset retirement obligations for sites in our regulated entities where we intend to seek cost recovery. Let's walk through our quarterly operating earnings performance by segment on slide eight. Operating earnings for the second quarter totaled $125 per share or $662 million compared to $113 per share or $582 million in 2023. This results in an increase of $80 million or $0.12 per share, which is a 10.6% increase over last year. Operating earnings for vertically integrated utilities were $0.46 per share, down $0.05. Positive drivers included favorable year-over-year weather and rate changes across multiple jurisdictions, with the 2022 PSO base case and the 2023 Virginia proceeding being the most significant. These items were offset by higher income taxes, which are largely a reversal of favorable income taxes in the first quarter, lower normalized retail sales, and higher depreciation. Note the year-to-date results in this segment consolidate the income tax loss that is shown in this quarter, resulting in an immaterial year-to-date income tax variance versus last year. The transmission and distribution utility segment earned $0.41 per share, up $0.11 compared to last year. Positive drivers in this segment included favorable weather, increased transmission revenue, rate changes primarily from the distribution cost recovery factor in Texas, and higher normalized retail sales. These items were partially offset by increased property taxes and depreciation. The AEP transmission Holdco segment contributed $0.39 per share, up a penny compared to last year, primarily driven by investment growth. Generation and marketing produced $0.12 per share, down a penny from last year. Recall that AEP renewables was sold in the third quarter last year, which has two impacts, a negative earnings variance due to the business being sold and removal of the interest costs for financing these assets. Additional drivers were lower retail margins offset by higher generation margins and lower taxes. Finally, corporate and other was up $0.06 compared to the prior year, primarily driven by lower income taxes and increased other operating income related to timing in the prior year. These items were partially offset by higher interest expense and lower interest income from the GNM segment. Let's turn to slide nine, which shows weather normalized retail sales of 4% in the quarter from a year ago, headlined by a double-digit 12.4% increase in commercial sales, which is where our data processing customers are classified. I'll note that in our T&D segment, the increase in commercial load was over 20% for the quarter. This is a trend that will continue over the coming years based on already signed customer commitments. Our operating footprint and robust transmission system position us perfectly to grow along AI and other technologies and industries in need of access to affordable and reliable power. Through the remainder of this year, data processing gains will remain mostly concentrated in Ohio and Texas. But beyond this year, we are seeing strong commitments from new customers looking to connect at some of our vertically integrated companies as well. Outside of data processors, our industrial sales have remained resilient in the face of a slowing economy. Industrial sales were strongest in Texas, driven by an influx of new customers, mainly in the energy industry. Thanks to our success over the past few years on the economic development front, we expect to see our industrial sales continue to be resilient in the next few years as several new large customers in steel, energy, renewable energy, and semiconductors come online across our footprint. In the residential segment, we continue to see growth in customer count and load in Texas, but residential load remains weak in most of our territories, likely due to the cumulative effects of inflation. Bottom line, the amount of demand from new large loads we're seeing across our system is unprecedented. We are excited, challenged, and poised to embrace this opportunity. Let's move on to slide 10. In the top left table, you can see the FFO to debt metric stands at 14.6% for the 12 months ended June 30th, which is a 40 basis point increase from the prior quarter. Our debt-to-cap decreased slightly from last quarter and was 62.6% at quarter end. We took credit-supportive financing actions in the second quarter by issuing $400 million of equity under our at-the-market program and by issuing $1 billion in junior subordinated notes at the parent, which qualified for 50% equity credit at all three rating agencies. In the lower left part of this slide, you can see our liquidity summary, which remains strong at $5.4 billion and is supported by $6 billion in credit facilities. Lastly, on the qualified pension front, our funding status is near 99%. In summary, our second quarter results provide additional momentum this year, bringing year-to-date earnings up to $2.52 per share, an increase of $0.28, or 12.5% compared to the same period last year. We reaffirm our operating earnings guidance range of $553 to $573 and remain committed to our long-term growth rate of 6% to 7%. And as we move through the balance of the year, our focus is on providing reliable and affordable service to our customers, executing our plan, and embracing the growth opportunities that we have ahead of us. Also, a quick update on the sale of AEP on-site partners. We expect the transaction to close in the third quarter and result in approximately $315 million in net proceeds to the company. I'd be remiss if I didn't acknowledge the skilled leadership of Ben Folk during this time of transition at AEP. Ben told you that this company would not be in neutral during the transition, and I can say that that is absolutely true. Ben, while I know you'll still be engaged as an advisor and board role going forward, I want you to know that the AEP team appreciates your engagement and contributions over the past five months. Finally, the AEP team looks forward to the arrival of our new CEO and President, Bill Furman. We all look forward to Bill bringing his accomplished leadership to AEP and working with him as we take on the exciting opportunities that we have before us. Thank you for your interest in American Electric Power. Operator, can you open the call so we can address your questions? Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Your first question comes from the line of Shar Pourezza of Guggenheim Partners. Your line is open."
},
{
"speaker": "Shar Pourezza",
"text": "Hey, guys. Good morning."
},
{
"speaker": "Ben Fowke",
"text": "Morning. Morning."
},
{
"speaker": "Shar Pourezza",
"text": "Just firstly, obviously, you guys highlighted in the deck, “the direction and strategy” kind of remain on track. I guess how much latitude will Bill have to make kind of strategic changes if need be to accrue value? Or is the plan kind of the plan and any kind of changes you expect will likely be more on the fringe, given your and the board's comfort level with the trajectory, with obviously the latter kind of being a similar situation to one of your other Ohio peers in the state when they had an incoming CEO? Thanks."
},
{
"speaker": "Ben Fowke",
"text": "Yes. I think that was a lot different circumstance, Shar, but Bill's very familiar with our strategy. We clearly had conversations with Bill about our strategy. So I think it's, I think we're on the right strategic direction. I do think Bill's going to come in and focus very much on execution. He's got a ton of experience, as we mentioned. And so I mean he'll take some time, assess where we are and I'm sure he's going to make some changes, but I don't see significant changes in the strategic direction. It's not like we gave him a plan, a to-do list, and you do all these things. He's going to be a dynamic leader. But the path we're on is, I think we're all in agreement, it's the right path and we need to execute on it."
},
{
"speaker": "Shar Pourezza",
"text": "Okay, perfect. And then last time, obviously we've talked about higher CapEx coming, driven by customer growth, data centers, etcetera. As we're kind of thinking about that incremental CapEx, potentially with a 3Q update and a funding source, the balance sheet doesn't have a material amount of capacity. You touched on this a little bit on your preparedness, but maybe you can elaborate on how you're kind of thinking about incremental equity versus asset sales, and with asset sales, how you're thinking about distribution versus transmission. Thanks, guys."
},
{
"speaker": "Ben Fowke",
"text": "Yes, I mean, clearly we're going to have an update in the fall, either at or right before EEI, that incorporates what it means to CapEx to fund this low growth, both in generation and transmission, and of course, what it means to make sure the balance sheet is strong in terms of equity and equity-like products, including portfolio optimization. Regarding portfolio optimization, you've heard me say it before, we're always open to it, but price has to be there, and the ability to execute has to be there. And the regulated utility spaces, those are two hard things to put together at the same time, but we're open to it. Chuck, I don't know if you want to add anything to it."
},
{
"speaker": "Charles Zebula",
"text": "Ben, the only thing I would add is, right, it's so important as we are a regulated utility and have significant capital needs not only today, but going forward right, to maintain investment credit ratings, and we will defend that right in our plan."
},
{
"speaker": "Shar Pourezza",
"text": "Got it. Perfect. Thank you. And by the way, just a real big congrats on Bill. He's one of the best hires. Thanks, guys."
},
{
"speaker": "Charles Zebula",
"text": "Thanks. You did mention, Shar asked the mix between distribution and transmission. So, it's going to, there's obviously going to be a lot of transmission that needs to be built, as well as distribution."
},
{
"speaker": "Operator",
"text": "Thank you. Your next question comes from the line of Jeremy Tonet of JPMorgan. Your line is open."
},
{
"speaker": "Jeremy Tonet",
"text": "Hi, good morning."
},
{
"speaker": "Ben Fowke",
"text": "Hey, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"text": "Hey, I know you're not going to give us the full details here, but I was just wondering if there's any way you could help us think through size and shaping of this incremental CapEx, as you talked about, with the incremental wires needs here. It just seems like everything is materializing quicker than expected. And so, just wondering if you could comment, I guess, any shaping there that would be helpful."
},
{
"speaker": "Ben Fowke",
"text": "Yes. Well, as I mentioned, with Shar's comment, I mean, you're definitely going to see a lot of increase in transmission spent. There's got to be something to plug into, so we're going to have generation, as well, and we recognize the need to make sure we have reliable distribution grid. So, I think if I had to rate it, it would be transmission increases, followed by generation, followed by distribution."
},
{
"speaker": "Charles Zebula",
"text": "Jeremy, I would say you'll note, in our materials that we raised our CapEx this year already by $500 million. That largely is in T&D, right? It's for reliability spend, also customer hookups, and then storm-related capital. So the shape of it right, is going to be as these customer additions, come online. And again, as Ben mentioned, we'll be laying all that out in the fall."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. So, it sounds like there's an opportunity for more near-term, as opposed to just later data at this point, if I understand correctly."
},
{
"speaker": "Charles Zebula",
"text": "I think that that's true."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. I was just wondering if you could talk a bit more on PSO's natural gas generation purchase there. To what extent do you see the need for incremental gas generation, across Oklahoma, other service territories? Just wondering if you expect to see more of this."
},
{
"speaker": "Peggy Simmons",
"text": "So, I would say, this is Peggy, and I would say with the increased reserve margins that we're seeing from the RTOs and the additional load that we're starting to see across our system, we are going to need some additional generation. And this was a very proactive approach that the team took as I mentioned in my comments earlier, to go out and find some affordable assets that we could bring onto the system. And we plan to make that filing at the Commission later this fall."
},
{
"speaker": "Ben Fowke",
"text": "Yes. Peggy mentioned proactive. It really, I think, was creative. It was outside of the RFP process, but we have an RFP process to compare the pricing to, and it's clearly very favorable. So, we're really excited about it. I think it'll be great for our customers."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. Thank you for that."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Steve Fleischman of Wolfe Research. Your line is open."
},
{
"speaker": "Ben Fowke",
"text": "Hey, Steve."
},
{
"speaker": "Steven Fleishman",
"text": "Hey, good morning. Sorry, I've got several questions on data center, or data processing, as you called it. So first of all, just in the quarter, you had the very strong commercial sales growth, but then your normalized sales growth between the two subs, I think was actually down $0.04. When you kind of look at both vertical and T&D, could you just talk to how we should think about that?"
},
{
"speaker": "Ben Fowke",
"text": "Yes, in T&D, Steve, normalized sales were up $0.02."
},
{
"speaker": "Steven Fleishman",
"text": "Right. But then the vertical was down $0.06, I think. So I guess just thinking, when I look at the whole picture, it's not kind of, at least in that line item, doesn't seem to be showing up as a benefit."
},
{
"speaker": "Ben Fowke",
"text": "Yes. So, let me comment on the negative $0.06 in vertically integrated. That's largely due to in vertically integrated, we had in the quarter, but a 4.9% decrease over last Q2 in residential sales. And that's largely what drove that number. In our SWEPCO territory, we had in kind of mid to late May into early June, we had a number of repeated storm activity, tornadic activity that took, large swaths of customers out for significant amounts of times that drove that number down. We've seen that start to normalize back in June and July. So I expect that to return to a more normal state."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. Thanks. And then on the 15 gigawatts of committed data center sales to 2030, could you just maybe better define what committed means when you give that data point?"
},
{
"speaker": "Ben Fowke",
"text": "Yes. I mean, it basically means that we have a letter of agreement, and those letter of agreements, Steve, start the clock running, if you will, for us to do work that pretty quickly can go into the millions, which that customer who signed the letter of agreement is required to pay. So that's how we define it. As we look forward, we look at a number of filtering criteria, ownership of sites, etcetera, that we use. So these are far from just inquiries. These are, serious customers that want to get on the grid and are willing to financially commit to do what it takes to get on the grid."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And are those customers kind of committing to these new tariffs you filed, or are we not at the point where they've made the agreement that those tariffs work for them when they've kind of done this?"
},
{
"speaker": "Ben Fowke",
"text": "Yes. Those tariffs, as you know they haven't been approved yet, but they will need depends where they are in the signing process as to whether or not they will be held to those tariffs or not. But going forward, customers, if approved, will all be required to step up to the tariffs."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And then….yes."
},
{
"speaker": "Ben Fowke",
"text": "Which, as you know, I mean, well, as Steve was just going to say, it's just, it's really important. We're going to see more growth than we've seen in maybe generations. And it's going to be really important that that growth is beneficial for all customers and at the worst case, at least neutral. And that's exactly why we're trying to, that's exactly why we're so keenly focused on making sure that we have these tariffs and the modifications I mentioned in Indiana and West Virginia. And it's just, we got to get it right."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And then maybe just in terms of helping to frame the capital needs, just, can you give us some rough sense of that 15 gigawatts, how much might be related to vertically integrated parts of AEP versus the transmission only parts?"
},
{
"speaker": "Ben Fowke",
"text": "Yes, Steve. So the way to think about it is, think of it as a 50-50 split between Texas and PJM. 50%, or of course, Texas, right, is our wires company and PJM, take that 50% and basically split it 50-50 between INM, which is vertically integrated and AEP Ohio, right, which is wires only."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. So that would be kind of 75-25, I guess, roughly, I think. Yes."
},
{
"speaker": "Ben Fowke",
"text": "Okay. I think I've, yes. But we are seeing additional interest amongst other vertically integrated utilities, but that interest is not as firm yet."
},
{
"speaker": "Steven Fleishman",
"text": "Amongst some of your other vertically integrated."
},
{
"speaker": "Ben Fowke",
"text": "Yes, that's correct."
},
{
"speaker": "Steven Fleishman",
"text": "Yes. Okay. Great. I'll leave it there. Thank you very much."
},
{
"speaker": "Ben Fowke",
"text": "Thanks, Steve."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Nick Campanella of AEP [ph]. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"text": "Nick Campanella at Barclays here. Thanks for the time."
},
{
"speaker": "Ben Fowke",
"text": "Did we just hire Nick?"
},
{
"speaker": "Unidentified Analyst",
"text": "I never got the call. I never got the call, but thanks for the time. A lot of my questions have been answered, but I just, curious as we kind of try to think about the magnitude of capital that the plan can handle here. I know that there's financing considerations, but there's also kind of bill growth considerations. Just how high do you think your rate-based growth can get before you have to start thinking about customer bill impact, especially as some of this load should be able to supplement that, but just trying to see, where this rate-based CAGR could go at the end of the day. Thank you."
},
{
"speaker": "Ben Fowke",
"text": "Yes, I think the incremental CapEx will be driven to support new load growth. And that's why we're just so keenly focused on making sure we get the rules right. And our modeling suggests that it will be good for all customers. And that's, I mean, that's what makes me so excited about this is that everybody can benefit, load's good for all, and it's going to, there are certainly pressures, on the grid and the resiliency and things like that, but I think the load's going to be beneficial to mitigate cost increases."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. Thanks. And then I guess, since you've kind of taken over, you have kind of pulled some strings on this involuntary, this voluntary severance program, just where are there other opportunities in the plan to cut costs today, or just things that maybe we're not thinking about that could be incremental to the positive?"
},
{
"speaker": "Ben Fowke",
"text": "Again, as I mentioned, I think, you've got Bill Furman coming in, he's got a track record of innovation. The companies in the Berkshire Hathaway portfolio were extremely well run. Bill is extremely well respected. So I think he's going to bring a lot of great ideas. It's a lot of blocking and tackling, and also taking advantage of innovation, smart technologies, etcetera, that'll get us there. But, the team has done a really good job, if you look back, in keeping O&M in check. So, again, I think the biggest way we keep costs down on our customers is to bring this new load on and bring it on in ways and rules and tariffs that are fair to all."
},
{
"speaker": "Unidentified Analyst",
"text": "Thank you."
},
{
"speaker": "Ben Fowke",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Carly Davenport of Goldman Sachs. Your line is open."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thanks for your time. Just a couple of clarification questions, if I could. First, just on the 15 gigawatts of incremental load by the end of the decade, could you just clarify, is all of that related to data centers, or is there anything else in there? And then, is there anything you can provide on how to think about the cadence of that load materializing from a timing perspective?"
},
{
"speaker": "Ben Fowke",
"text": "Yes, the 15 gigawatts refers to all data centers, and we're not announcing the cadence of that at this time. But it's already, as you can see, it's already showing up in our numbers. So we are hooking up, folks, and you'll see continued increases, over the next several years."
},
{
"speaker": "Carly Davenport",
"text": "Great. Thank you for that. And then, just a follow-up is just on the earned versus authorized ROE gap. I know you mentioned the earned ROE sort of flatted at 8.9% on a trailing 12-month basis. Do you have that comparable weather normalized number similar to what you've provided in previous quarters?"
},
{
"speaker": "Peggy Simmons",
"text": "Oh, we're looking forward to be at 9.1% for this year. As I mentioned, over the past 12 months, I mean, on a rolling average right now, we’re at 8.9% [ph] which is flat to where we were last quarter, but continuing to make progress on that front."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Great. Thanks so much for the time."
},
{
"speaker": "Ben Fowke",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Your next question comes from Andrew Wiesel of Scotiabank. Your line is open."
},
{
"speaker": "Ben Fowke",
"text": "Good morning."
},
{
"speaker": "Andrew Weisel",
"text": "Hi, good morning. First, a quick governance question. Can you please talk about the outlook for the board, and specifically what roles will Ben and Bill each have? Who will be chair of the board, and will it be executive or non-executive? And how large will the board ultimately be?"
},
{
"speaker": "Ben Fowke",
"text": "Okay. Well, I will go back after my time as advisor, I'll go back to being a board member, and I will keep my independence. Bill obviously will be on the board. He'll be a non-independent director. Sara Martinez Tucker, or Sara Martinez Tucker will be the chair, and she will remain chair, and she's independent. Size of the board, we are basically at full size, and so there won't be any change to the size of the board. I don't know. Did I get all those questions?"
},
{
"speaker": "Andrew Weisel",
"text": "Yes. That's great. Thank you very much. And then just a quick question on the cash flow slide, page 22. Some moving parts in 24 has led to slightly higher equity needs this year by about $100 million. Can you elaborate a little bit on that? And then looking to 2025 and beyond, I see no changes. Would I be right to assume that sort of just waiting for the update in three months? And just to clarify your comment on the equity-like tools, are you referring to the junior subordinates, or could there be something else in there, like equity units perhaps?"
},
{
"speaker": "Ben Fowke",
"text": "So, Andrew, first question. You also note in 2024, we had a $500 million increase in CapEx, and versus our plan for the year, we had additional asset sales that were part of the original plan that ended up changing through the year. So, in our financing, in our cash, we received less proceeds because of that change in plan. So, those two things basically drove the opportunity for the increase in equity, and just being opportunistic in the market as well. You're right, going forward, we have not updated those cash flows yet for our annual update, which we'll do at EEI."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. The equity-like, was that just referring to the junior subordinates, or was there more to it?"
},
{
"speaker": "Ben Fowke",
"text": "Yes, that refers to the notes that we issued in June. But we would look at various forms of equity alternatives and be holistic in our approach."
},
{
"speaker": "Andrew Weisel",
"text": "Very good. Appreciate the details. Thank you."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Durgesh Chopra of Evercore ISI. Your line is open."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, team. Good morning. Good morning, Ben. Andrew actually asked my question on the financing slide. Chuck, maybe a little sort of more color, there were kind of more negatives to positives in that cash flow slide. I mean, the asset sale proceeds were lower, right, and the CapEx is higher. Just assuming normal weather for the rest of the year, are you going to be below 14.6 where you said, or should we kind of think about 14.6 as strong as going into the end of the year?"
},
{
"speaker": "Charles Zebula",
"text": "Yes, our plan is to be in the 14% to 15% range. I'll just note, right, that we're well above the 13% downgrade threshold. So, yes, we plan to be in that range."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. Thank you. Appreciate the time."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Sophie Karp of KeyBanc Capital Markets. Your line is open."
},
{
"speaker": "Sophie Karp",
"text": "Hi. Good morning. Thank you for squeezing me in. If I could quickly go back to the 15 gigawatts of data center load, I guess, could you provide some color on how much of that can be connected without any incremental investment in your system versus how much would they require incremental investments to facilitate that?"
},
{
"speaker": "Peggy Simmons",
"text": "Right now, none of that can be connected at this point in time, but as we look at our LOA process, that's why we are looking at any initial upgrades that are needed as we prepare to plan the system to connect this load over that period of time."
},
{
"speaker": "Sophie Karp",
"text": "Got it. Got it. Thank you. And then maybe a little bit more of an open-ended question. Your current outstanding RFPs don't have any gas in them. It's mostly renewables. And I'm just curious of how you think about the cadence of needing to add dispatchable generation there. And when it comes to gas, will you continue to have a bias towards acquiring existing assets or will we see some new builds potentially?"
},
{
"speaker": "Peggy Simmons",
"text": "So, our RFPs are all-source RFPs, so we're evaluating all technologies that come in. And we do believe the dispatchable resources are needed to be added to the grid as well, and they will be part of the plan."
},
{
"speaker": "Sophie Karp",
"text": "Okay. Thank you."
},
{
"speaker": "Peggy Simmons",
"text": "You're welcome."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Bill Appicelli of UBS. Your line is open."
},
{
"speaker": "William Appicelli",
"text": "Hi. Good morning. Thanks for taking my questions. Just want to dig into a little bit more on the sales growth trends. So, on the residential side, you commented that Texas looks strong, but that more broadly, the cumulative effects of inflation have been weighing on it. So, any more color there? Are you expecting an improvement in the second half of the year?"
},
{
"speaker": "Ben Fowke",
"text": "Yes. So, Bill, in Texas, right, there is customer growth as well as, increase in use or as a result, increase in usage. In vertically integrated year-to-date, residential is down 1.3%, and T&D is actually up 0.3%, largely due to Texas. So, we are seeing, I think, in Appalachian Power, in Kentucky Power, in SWEPCO in particular, and I mentioned, some of the weather occurrences that we had in the SWEPCO area, weaker residential sales in those areas in particular."
},
{
"speaker": "William Appicelli",
"text": "Okay. I mean, I guess we think about the EPA activities here, right, because you've got the, tremendous growth in the commercial side, right, tracking well above plan, but that's going to be lower margin volumes. And then maybe on the residential side, going back sort of four of the last five quarters, sort of as a negative, and that's obviously a bit of a higher margin, but, smaller overall change. What, we sort of reconcile that a little bit as we think about the EPA's impact."
},
{
"speaker": "Ben Fowke",
"text": "Yes. I mean, clearly the residential sales are higher margin, but, again, I think it's, in particular, the effects of inflation. So, if inflation comes in tame, tamer as we begin to, as we've begun to see if wage growth, continues to close that gap. And as Ben mentioned, right, the opportunity to bring on large loads to spread fixed costs, right, over a much larger denominator, right, should mitigate, right, some of those customer rate impacts as well. So the combination of those things, right, should begin to, slow that decline. But, clearly, the effects of inflation have hit home for a lot of customers."
},
{
"speaker": "William Appicelli",
"text": "Right. Okay. And then I guess the other question is, it's come up a little bit, but on the episode of debt, under, I guess, the Moody's methodology, do you know what that number would be?"
},
{
"speaker": "Ben Fowke",
"text": "Yes, it's 14.6 under Moody's."
},
{
"speaker": "William Appicelli",
"text": "Oh, it's under Moody's. Okay. All right. Thank you very much."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Julian Smith of Jefferies. Your line is open."
},
{
"speaker": "Julian Smith",
"text": "Hey, good morning, team. Thank you guys very much for the time. I appreciate it. Going back. Thank you very much. Appreciate it. Maybe going back to some of the conversation on the layoffs and severance bit. I just want to understand the extent to which this process is finalized, right? You've given very specific jurisdictional level details. And given that, how are you thinking about rebuilding and devolving some decision-making power and some of the roles to the local OpCo’s? Can you speak to perhaps what seems like perhaps a strategic shift in looking at local level decision-making and really what level or what quantity of the roles in terms of overall layoffs will actually be ultimately recreated, if you will, at the local level here? So both the financial question in terms of what's the sort of ongoing net savings and B, how do you think about this fitting within the strategic question of devolvement?"
},
{
"speaker": "Ben Fowke",
"text": "Yes, I'm going to turn it over to Peggy in a second. But just as a recap, we did hit our targets that we laid out under that voluntary severance program. And we plan to hold as much of those gains as possible. Probably have to do some hiring back, but try to keep that minimized. Remember, there was two-pronged approach for this. One, we wanted to mitigate some of the inflationary pressures that we were seeing, higher interest rates, just overall increase in supply chain, etcetera, and take a portion of that, albeit a smaller portion, and start putting those, some of those resource, some of that money back into our local communities with more boots on the ground, if you will, more community leadership positions and that sort of thing. So Peggy, do you want to?"
},
{
"speaker": "Peggy Simmons",
"text": "Yes, Ben. So yes, that's exactly, Julian, what we're looking to do. We are, some of those positions were leadership positions that report to some of our Presidents. We are making sure that we are getting those filled and we're adding additional resources in the regulatory and legislative space, because we know that as dynamic as our industry is and as much change as is occurring, we want to make sure that we have that enhanced engagement at those levels. So you'll see more of that."
},
{
"speaker": "Julian Smith",
"text": "Excellent. All right. Looking forward to that. And then related, you talk about these staggering levels of the 15 gigawatts of firm commitments at this point. How do you think about that marrying up, especially in your wires businesses against an effort to address generation needs? I know this has been an ongoing tension, but given what seems like yet an accelerating backdrop of generation needs, how do you think about your utilities, especially in the buyers only businesses, potentially re-engaging in that narrative? And in what ways?"
},
{
"speaker": "Ben Fowke",
"text": "Well, I mean, I think that would take legislation clearly in Ohio. I guess it would take it in Texas, too, but I don't see that happening. I think it's probably a long shot in Ohio as well. So, we are going to have to rely on the market, but our vertically integrated utilities are all going to need generation and in different timeframes. But I think Peggy mentioned, we've got, we do have more with the changes in the reserve margin requirements, for example, in SPP. It creates a resource need, and we're developing our plans to fill that, which will require increased CapEx, which I think is a good thing. And we're really, again, excited about Green Country. The load is tremendous, and it's primarily data centers, but of course we'd be remiss if we didn't mention we've seen industrial load in Texas as well. And I think when we think about economic development, we're going to continue to look for opportunities to bring industry back on shore. And I'm right here in Columbus today, and the Intel has just been an enormous success, and we're going to keep looking for opportunities for our communities, and, again, all customers benefit from that."
},
{
"speaker": "Julian Smith",
"text": "All right, guys. Thank you very much. I appreciate it."
},
{
"speaker": "Ben Fowke",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Your last question comes from the line of Paul Patterson of Glenrock. Your line is open."
},
{
"speaker": "Paul Patterson",
"text": "Good morning. How are you doing?"
},
{
"speaker": "Ben Fowke",
"text": "I'm doing good."
},
{
"speaker": "Paul Patterson",
"text": "Great. So I asked this question some time ago about Chevron, and we now have a Supreme Court decision. And I'm just wondering how you guys see it potentially impacting either EPA or FERC regulation or anything else you might, if you think it has any potential impact on AEP, I guess."
},
{
"speaker": "Ben Fowke",
"text": "I think it's early, but, yes I think it could potentially be helpful as courts have more discretion not to have to rely on the agencies, which that was the whole point of that. And I just think it doesn't bind the courts as much as it probably did in the past. Now, whether that, how the courts interpret it, what, the rulings are, we'll have to wait and see. But Paul, I think in general it's going to be helpful. And we are going to challenge a lot of these EPA rules, as you know, the CCR rule, the ELG rule, the 111 rules. I guess all of the rules that have come out we're going to challenge and for good reason."
},
{
"speaker": "Paul Patterson",
"text": "Okay, great. And then just on FERC, do you see anything happening there maybe?"
},
{
"speaker": "Ben Fowke",
"text": "I don't know. I think, I know there's some, there's some thought that it would, but I think that really, I'm not convinced it will. So, I think that remains to be seen."
},
{
"speaker": "Paul Patterson",
"text": "Okay. The rest of my questions have been answered. Thanks so much. Have a great one."
},
{
"speaker": "Ben Fowke",
"text": "All right, Paul. Thank you."
},
{
"speaker": "Darcy Reese",
"text": "That concludes it. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. JL, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Certainly. Echo replay will be available in two hours until August 6th at 1-800-770-2030. That's 1-800-770-2030 using playback ID 6645529. That's replay playback ID 6645529 followed by the pound key. This concludes today's conference call. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 1 | 2,024 | 2024-04-30 09:00:00 | Operator: Good morning, ladies and gentlemen, and thank you for standing by. My name is Abby, and I will be your conference operator today. At this time I like to welcome everyone to the American Electric Power First Quarter 2024 Earnings Conference Call. [Operator Instructions]
Thank you. And I would now like to turn the conference over to Darcy Reese, Vice President of Investor Relations. You may begin.
Darcy Reese: Thank you, Abby. Good morning, everyone, and welcome to the First Quarter 2024 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com.
Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our President and Interim Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer; and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks.
I will now turn the call over to Ben.
Benjamin Gwynn Fowke: Well, good morning, and welcome to American Electric Power's First Quarter 2024 Earnings Call. Shortly, Peggy will give a regulatory update, followed by Chuck, who will provide more detailed financial review.
The summary of our first quarter 2024 business highlights can be found on Slide 6 of today's presentation. Beginning with AEP's financial results, today, we announced first quarter 2024 operating earnings of $1.27 per share, a $0.16 increase over 1 year ago. We are also reaffirming AEP's 2024 full year operating earnings guidance of $5.53 to $5.73. And the long-term earnings growth rate of 6% to 7%.
I'm pleased to note, we achieved a 14.2% FFO to debt ratio this quarter, which is within our stated range. Let me assure you that AEP's direction and strategy remain on track as this team is fully engaged, energized and working well together to enhance the customer experience and investor value. I've reviewed AEP's financial targets, and I have total confidence in the plan's achievability.
It's hard to believe it's been just 2 months, since I stepped into the role of interim CEO, and it has been a busy and productive 60 days. I've had the opportunity to meet with many different stakeholders, including elected officials, regulators, community leaders, customers, investors and, of course, the team right here at AEP. All of these meetings have been very useful in helping shape the initiatives I will discuss shortly.
Before I dive into other business, I want to give you a brief update on the search for a permanent CEO. The process is well underway, and I am certain, based on the talent pool that we're looking at that we will find the right person to lead AEP. As I mentioned, when we first talked at the end of February, the search will probably take between 6 to 12 months. We will take the time necessary to find the best candidate, and we're committed to keeping you informed.
So across the AEP system, I see the need to increase capital spend in the future, including incremental investment related to commercial load growth from data centers and resiliency spend. Specific to load growth, the amount of service request is truly staggering and ranges between 10 to 15 gigawatts of incremental load by the end of the decade, in addition to many, many more gigawatts from hundreds of inquiries.
The key to capturing this commercial and industrial growth is to work with parties to make sure that commitments are real and secure, the tariffs and contracts are fair to all customers and growth is self-funded. And of course, that the load can be met. A couple of great examples of new commercial commitments can be evidenced by last week's announcements from both Amazon Web Services and Google to build large data centers in I&M's Northern Indiana service territory.
At AEP, we have the largest transmission system in the United States with a high-voltage backbone in the Midwest. We expect more transmission investment possibilities driven by this data center growth, specifically in substations and customer connections. As a side note, I'd like to call attention to AEP's commercial load in the first quarter of 2024 which grew at 10.5% over the first quarter of last year.
In addition, we will file our system resiliency plan in Texas, no later than the third quarter of this year, related to legislation passed in 2023, including investment related to hardening and modernizing the grid, expanding vegetation management and, of course, wildfire mitigation.
Clearly, a strong balance sheet is critical as we look to fund potential increased capital spend. And I believe incremental growth equity needed to fund smart capital is a positive thing.
That said, we are open to equity alternatives through portfolio optimization, looking at opportunities where price meets execution, while at the same time, staying focused on our efforts to achieve constructive regulatory outcomes. On a similar note, I'd now like to provide a brief update on the sales of our AEP Energy Retail and AEP OnSite Distributed Resources businesses, both of which are included in the Generation & Marketing segment.
We are working through final phases of the process and expect to conclude that process by our second quarter earnings call. Now let's move on to last week's newly published federal EPA rules on greenhouse gas standards, coal combustion residuals or CCR, Effluent Limitation Guidelines or ELG.
Although our team is still reviewing the rules, we will likely pursue legal challenges, while working with others, including our states who are aligned with AEP's commitment to provide customers with reliable and affordable energy. These new regulations in some cases, require the use of unproven technologies, are extremely expensive and establish unreasonable compliance schedules.
We are at a time when our nation needs to add dispatchable generation to support grid reliability and growth, and these rules have the potential to not only prematurely accelerate plant closures, but also discourage new dispatchable generation from being built.
Now turning to labor management. We announced a voluntary severance program earlier this month, taking effect July 1. We expect this initiative will save labor cost of approximately $100 million and will assist us in managing our cost to better serve our customers, allow us to redeploy resources locally in our regulated footprint and finally, mitigate impacts from inflationary pressures and interest rates.
Of course, we will do it so in a way that is fair and equitable to all of our valued employees. So as I mentioned, it's been a busy and productive couple of months. Have confidence in our strategy and team. I'm excited about the opportunities ahead to drive growth and create value for our investors. We look forward to providing you even more positive updates as we move forward in the year, further solidifying stakeholder confidence in our financial targets.
Before we turn to Peggy for additional updates, know that I am aware of AEP's regulatory successes and some of our challenges. We continue to review plans to strengthen our regulatory compacts as we work through the past and are ready for the future. Peggy?
Peggy Simmons: Thanks, Ben, and good morning, everyone. Now let's go to an update on several of AEP's ongoing regulatory initiatives. We are currently focused on investing more in people resources at the local level, particularly in regulatory and legislative areas.
The utility industry is changing and more now than ever, it's critical that we enhance our engagement in this dynamic environment. More details of our related regulatory activity can be found in the appendix beginning on Slide 23. AEP's operating company leaders are running the business and engaged with our state regulators. Higher costs for materials and frequency of cases shines a spotlight on affordability and customer builds are top of mind for us.
We are focused on advancing interest in each of the states we operate to achieve outcomes that are good for our customers, our communities and our investors. This includes economic development work across our service territory, which brings jobs and creates headroom from larger load perspectives.
We continue to reduce our authorized versus actual ROE gap. We're doing the work and our ROE improved slightly this quarter to 8.9%. Even considering this measure is depressed by approximately 30 basis points from mild weather conditions. Staying with the recent positive developments, I'm pleased to report AEP Ohio's Electric Security Plan V settlement obtained last summer -- excuse me, last September was approved by the commission earlier this month.
This ESP covers a 4-year term of June 2024 through May 2028. As we shared previously, we filed new base cases in Indiana and Michigan in the latter half of 2023. In Indiana, we reached settlement, which was filed in December, and we expect the commission decision by June of this year.
In Michigan, we completed the procedural schedule and expect a relief in that case in July. The team has been busy in 2024 so far, filing an Oklahoma base case for PSO in January and an AEP Texas case in February. Last month, we filed the APCo Virginia biennial rate review, required by statute from legislative changes attained in 2023.
Earlier this month, in SWEPCO, Arkansas and Louisiana jurisdictions we filed the annual formula rate plan. Now on to the regulated resource additions. We continue to advance our 5-year, $9.4 billion regulated renewable capital plan and have a total of $6.6 billion approved by state commissions at APCo, I&M, PSO and SWEPCO. As you can see, we're making great progress. We are also considering the renewables market local input, as well as evolving reserve margins and resource adequacy as we meet the needs of our customers.
We are advancing toward our fleet transformation targets, which are aligned with and supported by our integrated resource plan. We have pending requests for proposals for a diverse set of additional generation resources at I&M, Kentucky Power, PSO and SWEPCO with more to come from other operating companies, including APCo.
These generation investments are an integral part of our broader capital program, which is 100% focused on regulated assets. Looking ahead, we know there is more work to be done as we advance our regulatory strategies in 2024 to achieve a forecasted regulated ROE of 9.1%. We look forward to continuing to engage constructively with our regulators and strengthening relationships.
With that, I'll pass it over to Chuck to walk through the performance drivers and details supporting our financials.
Charles Zebula: Thanks, Peggy, and good morning, everyone. Today, I'll review our financial results for the first quarter, build on Ben's comments about our service territory load and finish with commentary on our financial metrics and portfolio management activities.
Let's go to Slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter, were $1.91 per share compared to $0.77 per share last year. There is a detailed reconciliation of GAAP to operating earnings on Page 13 of the presentation today.
One significant item I want to highlight in our GAAP to operating earnings walk is the onetime positive adjustment of $260 million, primarily for the remeasurement of a regulatory liability for excess deferred taxes, due to guidance recently received from the IRS, related to the stand-alone treatment of taxes for ratemaking purposes.
Let's walk through our quarterly operating earnings performance by segment on Slide 8. Operating earnings for the first quarter totaled $1.27 per share or $670 million, compared to $1.11 per share or $572 million in 2023. This results in a quarter-over-quarter increase of $98 million or $0.16 per share.
Operating earnings for Vertically Integrated Utilities were $0.57 per share, up $0.05. Positive drivers included rate changes across multiple jurisdictions with the PSO base case and the Virginia proceeding being the most significant favorable year-over-year changes in weather and income taxes. These items were partially offset by higher interest, higher depreciation and other taxes.
The Transmission & Distribution Utilities segment earned $0.29 per share, up $0.05 compared to last year. Positive drivers in this segment included rate changes, primarily from the Distribution cost recovery factor in Texas, and the distribution investment rider in Ohio, increased transmission revenue, higher normalized retail load and favorable year-over-year changes in weather. These items were partially offset by higher depreciation, other taxes and interest.
Please note that although weather was a positive variance quarter-over-quarter, in both the Vertically Integrated and T&D segments, weather for the first quarter 2024 was very mild. Compared to normal weather, our estimate of the variance is roughly $80 million unfavorable, which is about $0.12 per share.
The AEP Transmission Holdco segment contributed $0.40 per share, up $0.05 compared to last year, primarily driven by investment growth and favorable income taxes. Generation & Marketing produced $0.12 per share, up $0.03 from last year. Positive drivers included higher generation and retail margins, along with favorable interest expense. These items were partially offset by lower wholesale margins, higher income taxes and lower distributed and renewable generation results compared to the prior year, largely due to the sale of the universal scale assets in the third quarter of 2023.
Finally, Corporate and Other was down $0.02 compared to the prior year, primarily driven by higher interest costs. Moving to Slide 9. Overall retail load continues to accelerate ahead of expectations. This is due to our ongoing success in economic development, as well as the rapidly increasing demand from the many data centers finding a home within our footprint.
Weather normalized retail load grew 2.9% in the first quarter, highlighted by a remarkable 10.5% increase in our commercial load, which is where the data center load is classified. This is a trend we expect to continue over the next several years as the growth of AI and other technologies boost the need for additional data storage and processing. Driving the demand our existing and new projects that have ramped up more quickly than first anticipated, especially with some of our largest customers in Ohio and Texas.
As we refine our forecast for the remainder of this year and next, expect that those projections to move higher to reflect the rapidly evolving situation, as Ben had outlined in his comments. Outside of data centers, our economic development efforts are also helping us maintain growth in industrial load despite softness in manufacturing activity nationally. Industrial load grew 0.4% in the first quarter, roughly in line with expectations for the full year. This was driven primarily by increased activity amongst our plastics, tire and paper manufacturing customers.
We are keeping a close eye on our industrial customers, given the higher interest rates for longer environment. However, the number of large new loads anticipated to come online in the next 2 years, provides us with confidence that demand will remain steady in the face of any economic challenges for our existing customers.
The main takeaway on load, however, is the significant growth in large customers that we continue to bring online across our footprint. As I mentioned earlier, beyond the lookout for higher load projections, as we provide additional guidance later this year.
Let's move on to Slide 10 to discuss the company's capitalization and liquidity position. In the top left table, you can see the FFO to debt metric, stands at 14.2% for the 12 months ended March 31, which is a 100 basis point increase from year-end and in alignment with what I discussed on the last 2 earnings calls.
Our debt to cap decreased slightly from year-end and was at 62.8% at quarter end. In the lower left part of this slide, you can see our liquidity summary. Which remains strong at $3.4 billion and is supported by $6 billion in credit facilities that were recently renewed and upsized by $1 billion to support our liquidity.
Lastly, on the qualified pension front, our funding status has remained relatively flat, since the end of the year and ended the first quarter at 100.6%. Let's go to Slide 11 for a wrap up of today's message. The first quarter has provided a solid foundation for the rest of the year with a $0.16 increase in earnings per share, compared to the first quarter of last year despite the mild weather conditions that we experienced this winter.
We remain focused on achieving our objective, which include improving the financial performance of our utilities, offsetting cost increases due to inflation to keep electricity affordable and embracing the opportunity to bring economic development to our communities by serving large loads.
As an update, we successfully closed on the sale of our New Mexico solar assets for $107 million in cash proceeds in February, and we continue to work through the final phases of the AEP Energy and AEP OnSite Partners process. We expect to announce the results of the process by our second quarter earnings call.
Our first quarter results give us the confidence to reaffirm our operating earnings guidance range of $5.53 to $5.73 per share. We remain committed to our long-term growth rate of 6% to 7% and FFO to debt solidly in the 14% to 15% range. We appreciate your investment and interest in American Electric Power.
Operator, can you open the call so we can address your questions?
Operator: [Operator Instructions] And your first question comes from Jeremy Tonet with JPMorgan.
Jeremy Tonet: Just wanted to peel in maybe a little bit more on the data center points that you laid out there. And just wondering, we see a lot of forecasts out there on the time line of how quick some want to come to market, and we're trying to figure out how that matches against the system's ability to provide the power there in the connects. And just wondering how you see those 2 aligning? What does that mean for AEP over time versus plan?
And just how do you think about, I guess, structuring rates in the right way so that other rate payers don't bear more of a burden?
Benjamin Gwynn Fowke: Yes, those are all really good questions, Jeremy. And our team has done a tremendous amount of work thinking this through. I mean, first of all, I like to say, here at AEP that really wired for growth. And as you know, we've been making significant transmission investments over the years, and that's going to allow us, I think, to accommodate this first wave of growth we're seeing from data centers.
And -- so in our next 5 years, you will see that load coming on, and you'll see some of the capital spend -- the incremental capital spend to support it. As we get out further in the decade, I think, it's going to be a function of an additional transmission and perhaps even generation that will need to get built to meet it all.
But this team is working really hard. We have a great economic development team, very supportive business community in States and we've done a lot of groundwork to put ourselves in this position. And you're also seeing, Jeremy, data center load ramp up at the same time. So that's a natural trend, too.
Now to your latter question, this is one I've been keenly focused on. And the good news is we believe that the load growth that will be coming on, will be fair to all customers and in fact, will help us keep our rates affordable across all of our jurisdictions. We are developing new tariffs. Tariffs that require longer-term commitments. Tariffs that require the data centers to deliver on the load expectations that we're building for obviously, credit quality, et cetera.
And when you do the math, that load growth then benefits all customers. And that's what I'm really excited about because that was really important to myself and the team that we do keep rates affordable and this growth will do just that.
Jeremy Tonet: Got it. That's helpful. And maybe just to dive in a little bit more as we think about data center load sensitivity. Should we be thinking that more along the lines of commercial sensitivity or industrial sensitivity, as provided in your guidance if you think about demand outstripping the forecast?
Benjamin Gwynn Fowke: Go ahead, Chuck.
Charles Zebula: Yes. So I would think of it, Jeremy, more like an industrial customer and that sensitivity there.
Jeremy Tonet: Got it. That's helpful. And then just the last one, if I could. As it relates to the external CEO search. Just wondering, has anything changed with regards to, I guess, the characteristics that are in focus for a candidate? How is the pool building at this point? Just wondering if there's any other color that you might be able to share on how the process is going?
Benjamin Gwynn Fowke: Well, I can just tell you that the attributes and the qualities we're looking for remain unchanged from what I described on the fourth quarter call. We are well underway now. We've got some really good candidates, impressive candidates. It takes time to sort it all out. And there's other obviously, things that we need to look at.
But the timetable that I outlined for you just a couple of months ago was 6 to 12. So truncate 2 months off of that, and it's 4 to 10. And -- but that said, we'll take as much time as we need to get the right person in place, and I'm very confident that we'll do just that.
Jeremy Tonet: Got it. And actually, if I could just sneak 1 last in. Just wondering on overall corporate strategy, could you talk more about where things stand for AEP decentralization efforts. And looking to kind of more closely align P&L to the end decision maker at the local levels. Just wondering how that's progressing?
Benjamin Gwynn Fowke: Well, I think it's -- this is a focus of ours. And one of the -- and I'm going to turn it over to Peggy, she's developing -- has developed a detailed plan. But one of the things we want to do is put those local resources in our communities. And I know that's the right thing to do, just talking to stakeholders.
It costs money to do that which is one of the reasons why we did the voluntary severance, so we can free up some of those resources going forward to make those critical investments in our communities. Peggy, I don't know if you want to add anything.
Peggy Simmons: Yes, Ben, I think you pretty much covered. We have worked with the team and looking at how we can get some more of those -- enhance the resources from a regulatory and legislative perspective, having more boots on the ground.
As I mentioned in the opening statement, there's a lot of change in our industry and having folks out there having these ongoing conversations is really important. So we're working through that process and more to come on that topic.
Operator: And we will take our next question from Steve Fleishman with Wolfe Research.
Steven Fleishman: So just in Ohio and Texas, your wires company, but in Indiana, where these last 2 announcements, I think you've got generation too. And are you -- so in some of these recent deals that announced -- the past week, are you supplying the generation as well? And is there going to be a generation need in Indiana related to those?
Benjamin Gwynn Fowke: Well, we do have RFPs outstanding. Peggy, do you want to take that?
Peggy Simmons: Yes. We do have RFPs outstanding in I&M. But to answer your question, yes, and are vertically integrated like Indiana, we will have to serve the generation component, and we are working with those large loads that are coming to us on what that would look like. And we are also focused on, as Ben mentioned earlier, redefining and looking at our tariffs as well. So that will be part of our strategy.
Steven Fleishman: Okay. And just to kind of clarify back to the initial question. So the transmission grid is built up and has capacity to take on these customers near term. But is there still, even near term, is there more capital needed? Or is it more of this after this 5 years?
Charles Zebula: No, Steve, there'll be more capital needed, but I don't think it will be those massive 765 lines, it can take a long time to get built. We believe the team has done a lot of work on how we could accommodate that load within our footprint, working with PJM and others. And so yes, there'll be more spend, but it will be manageable and doable to the point.
Steven Fleishman: Okay. And then on the FFO to debt, you're in the target range now. Is there anything about that that's kind of -- are you in there for good, do you think now? Is there any -- was there any timing reason? Or is it you're in that and expect to be in it throughout the year?
Charles Zebula: We were in the range. We expect to be in that range now. Our forecast that we review internally and with the agencies show us being in that range. So that's the plan, and we plan to defend that.
Operator: We will take our next question from Shar Pourezza with Guggenheim Partners.
Jamieson Ward: It's actually Jamieson Ward on for Shar. He's on the road and regrets that he's not able to join you today, but we have a couple of questions for you here. The first was just on the annual customer bill increase, the pace there, you reduced it to 3% increases per year through 2028, which is great to see. Does that already take into account the anticipated infrastructure investment needed to support any future data center growth? Or could we see that number be revised as well?
Charles Zebula: Well, I mean -- the answer is the incremental stuff we're talking about and the incremental transmission investment, it's not included in that, but it's not going to be -- it's not going to drive that from 3 to 4. If anything, it should keep it level and perhaps even drop it a bit.
Obviously, there's other things that go into that other inflationary factors, supply chain pressures, et cetera. But as I mentioned, this -- we've done a lot of work, making sure that the incremental investment that we would need to make over the forecast 5-year time frame is actually at a level that is accretive, if you will, to keeping customer rates affordable. And that's why I'm very confident of moving forward with it.
Jamieson Ward: Got it. Terrific. And then expanding on Jeremy's earlier question, how are you approaching some of the more unique issues presented by data centers, for example, those who want to be behind the meter but still want to have an emergency tariff with the utility or data centers, which, as you mentioned, want to socialize the cost of interconnection through all rate classes but which may not have a major economic impact. If we can just get a bit more detail there.
Benjamin Gwynn Fowke: I'm going to turn it over to Peggy in a second. But listen, it's got to be fair to all customers now, okay? I mean this is a big deal. It's an exciting big deal. But growth needs to be as close to self-funded as possible. And that's what I think we'll get with these tariffs and some of the other analysis that we're looking at.
Peggy Simmons: Yes. So what I would add to Ben's comment there is that on our tariffs, we are looking at what minimum demands are. Most of the large loads are wanting to be connected to the system. But if they want some form of self-generation, we are asking so that we understand that, and we can include that, as part of our planning.
So we're trying to get all of that information on the front end. So that we can appropriately serve customers and make sure that it's fair and balanced for all customers and everyone is paying their fair share, as Ben has mentioned.
Benjamin Gwynn Fowke: Yes. I mean the worst case scenario, and this is what -- to Peggy's point, what we're preventing is the load doesn't show up consistent with how we built the infrastructure. And when it does show up, it doesn't use, especially on a peak basis, the energy that we built for.
So -- and -- but if you control that, which, by the way, I think, we also have to be very careful, too, that these large, large loads are -- don't jeopardize good reliability. And so these tariffs address that, too. If you do all those things, then growth is good for all. And that's what we're pushing for.
Jamieson Ward: That's very clear. And then on the updated load growth forecast coming later this year, should we assume that at a high level, that means the EEI or are there particular IRPs or other proceedings that we should maybe watch out for? Which could come say, before EEI that would be driving that?
Benjamin Gwynn Fowke: I mean I think the big update will come -- well, I understand EEI in the third quarter's earnings call right on the same, but it would either come on the third quarter or EEI unless there might be drips and drabs that get released before that, but that's what we're planning to do right now.
Jamieson Ward: Understood. Got you. Last question from us is just on asset sales. In the deck, you mentioned remaining committed to simplifying the business in the immediate term with a focus on continued execution of the sale processes. So how should we think about the potential for any additional sales announcements, following the conclusion in the second quarter of the current process for the Retail and Distributed Resources businesses?
Benjamin Gwynn Fowke: It would be on an opportunistic basis. We're going to look at -- we're always open to ideas. Chuck and I and the team have been around a while. We know that sometimes good ideas sound good on paper, but you can't execute on them. So we do filter that through the regulatory screening process, as you can imagine.
And then we like our assets. So obviously, the price has to be right. But -- what you're not going to see from us is like strategic review, too, and preannounced kind of things that we're looking at. If the opportunity arises and we can execute on it, then you'll hear about it.
But -- in the meantime, our status quo plan, I think, is a pretty darn good plan. And to the extent that we issue equity to fund additional incremental CapEx, this is going to be smart CapEx, good growth for all and we'll keep our balance sheet strong, which I think is so important as you enter, I think, an extended era of higher CapEx growth.
Operator: And we will take our next question from Carly Davenport with Goldman Sachs.
Carly Davenport: Maybe just going back to the balance sheet. As you think about your financing needs for the remainder of the year, can you just give us an update there? And if you expect to see any impacts relative to your initial plan with the move that we've seen in rates year-to-date?
Benjamin Gwynn Fowke: Yes. Carly, the plan that we laid out at EEI is still intact. Other than I think at EEI, we had the West Virginia securitization in the plan, and that has been replaced by a Kentucky securitization, nearly of equal amounts.
So the plan is still intact. There's been no significant changes, and we're proceeding on that plan.
Carly Davenport: Great. And then just going back to the commercial load and data centers. As you think about that and the expectation to raise later this year. Could you just talk a little bit about sort of what surprised the plan to the upside so materially thus far? Is it just sort of more success on the economic development front or more consumption from existing customers? Just any color on that would be helpful.
Charles Zebula: Yes. Carly, it's just mainly the ramp rates of the customers that have hooked up, have come on more rapidly than we anticipated. And so that's why you're seeing those big bumps in commercial load, as we go through the quarters here.
Operator: And we will take our next question from Nicholas Campanella with Barclays.
Nicholas Campanella: I'll try to keep it to 2. So I guess you talked about this need for growth equity. Can you just elaborate when you anticipate needing that? And what part of this 5-year plan would that be? And then I guess, just -- you do have $700 million to $800 million, I think, a year in your financing walk here of equity needs. Just why not do something sooner than later to kind of knock that out if the opportunity presents itself? I know you don't want to preannounce and go into a strategic review around 2, like you said, but maybe you can kind of give us some additional thoughts on how you're thinking about that.
Benjamin Gwynn Fowke: I'll turn it over to my esteemed colleague here, Chuck.
Charles Zebula: No, Nick, it's a good question. I mean, look, as we said earlier, right? We're formulating, right, the changes to our plan and how ultimately, right, how financing is going to affect that.
You are right. We have $400 million in equity this year, followed by $800 million in equal amounts in the following 2 years. So I think the point that I tried to make earlier on FFO to debt, look, we're going to defend our BBB credit.
Right? We're going to maintain a strong balance sheet. So as we put out additional capital forecast, I think, you could assume, right, that strong balance sheet is going to remain intact. So just kind of wait for that update on CapEx, and you should be able to figure that out pretty clearly.
Nicholas Campanella: Okay. I appreciate that. And then Chuck, I know that weather at VIU is kind of a $0.10 drag versus normal, but you also have some of these tax items in there as well. Just on the tax item benefits, is that normalizing from last year? Or is that one time in nature, as we kind of think about year-over-year into '25?
Charles Zebula: Yes. So Jeremy, about half of that will normalize throughout the year and the other half is onetime. Things that happened in '23 that won't happen again in '24. So it's a true increase.
Operator: We will take our next question from Durgesh Chopra with Evercore ISI.
Durgesh Chopra: I wanted to go back on your commentary, Ben, on portfolio optimization, new financing plan. Just to be clear, the financing plan, the CapEx update, the load board updates. Is that sort of -- should we think of that as a separate process and the CEO search? I'm just thinking about the 2 and are those 2 independent processes that we should think about? Or are they somehow tied? I'm thinking about the cadence of your updates, your new plan and then the parallel CEO search?
Benjamin Gwynn Fowke: I mean, if I understand your question right, are we holding things back until the new CEO gets in place? Is that what you mean?
Durgesh Chopra: That's right, Ben. Yes.
Benjamin Gwynn Fowke: No, no. I mean, no. I mean, we typically -- as you know, we typically update all our CapEx and financing plans and all those sorts of things at the time of EEI. And if there's something major in between, obviously, we give you updates. But we're not -- no, I mean I -- this company is not in neutral. I mean we really -- we're moving forward.
This team is -- they share my belief that this growth is here. We need to accommodate it. We need to talk about it, and we need to make sure it's fair to all. So we're really, really focused on that. Focused on, I think, the strategy of putting more control at the local level, more resources at the local level.
So -- and we just announced a voluntary severance. So we're not kind of just putting it in neutral and coast until a permanent CEO gets in there. I honestly think these are all no regret type decisions that the new CEO will ultimately benefit from. But did I answer your question?
Durgesh Chopra: You did. That's exactly what I wanted to ask you, a very clear response. And then second question then, again, like you mentioned challenging the EPA proposed ruling. Maybe can you share a little bit more color there? Is it the carbon capture technology that you are referring to? And then you mentioned the accelerated plant retirements? Was that directed towards coal? Just any color you can share there.
Benjamin Gwynn Fowke: Yes. Well, it's a great question. And again, I just -- I harken back to Steve Fleishman's report that came out a couple of months ago, where he talked about our industry, which if you aggregate market cap of somewhere around $0.5 trillion, being responsible for this -- we want our onshore data centers, artificial intelligence, reshoring of manufacturing. And it's our industry that has to do it. And we're going to build all the transmission we possibly can. That's not easy to get built either, but we are going to have to plug in to something.
And as you know, in my former role, I'm a big advocate for renewable energy. I think it's great, particularly when it's economic. Now some of that changes over time and regionally. But to think that we don't need dispatchable generation, I mean, it's -- we need it. And I'd love to see things like SMRs and other things develop, but they're not going to happen overnight. And in the meanwhile, we can't -- we have to be willing to move forward realistically.
And yes, it's not just the carbon capture rules. I mean there's -- we're looking at all the other rules, the CCR rules, the ELG rules, which by the way, we just spent a lot of money coming into compliance on that, and that was only a couple of years ago. And now it's a completely different role, which would require different technologies.
So it's -- our industry has come so far in carbon reduction. And I think we're willing to do so much more, but it has to be with affordability, reliability and resiliency in mind. And I'm just -- I'm really passionate about that. And you never like to have to sue, but we're going to do what we have to do to defend our grid and our customers that use that grid every single day.
Operator: And we will take our next question from Andrew Weisel with Scotiabank.
Andrew Weisel: Two quick ones here, please. First, to elaborate on the commentary on load growth. Ben, I think, you mentioned that the incremental 10 to 15 gigawatts by the end of the decade. I assume that's across the entire portfolio. Can you talk a bit about the Vertically Integrated Utilities? You have about 20 gigawatts identified through the current IRPs. My question is, how soon might we see more filings to include the new expected load, which there is no doubt coming quickly.
Benjamin Gwynn Fowke: Yes. So when I look at those incremental loads, I mean, Ohio, within the PJM footprint, Ohio is the biggest driver of it, although Indiana is definitely getting its share. And I suspect we will have to do incremental RFPs to capture that load. I can't give you the exact timing of when that would be.
Peggy Simmons: We have -- so Indiana, we have an IRP that's coming up that's going to be later in November. But -- so that will be part of the process as we start to look at how we accommodate some of this load as we start to see it to come on as well. We'll be using those same types of process.
Benjamin Gwynn Fowke: And just maybe outside of data centers, if you look down at SPP, that's a very constrained region as it is right now. They haven't seen a tremendous amount of data center growth today. It doesn't mean they won't. But in the meantime, we've got to make sure we've got adequate load to serve the load that we do know we have.
In Ohio, again, we don't have generation in Ohio, so the incremental investment will be Transmission. There's lot of talk here in Ohio in the business community, at the state level do Regulated Utilities need to be back in the generation game? I don't know. I think -- honestly, I think that would take legislation, at least from my perspective. So that we'd be assured of good recovery and potentially any kind of stranded cost risk because we've seen that play out before. Doesn't mean we're not -- we wouldn't be open to it, but it would probably require legislation.
ERCOT. ERCOT, we don't own generation, but we would obviously, need to be building a lot of transmission and ultimately needing something to plug into.
Andrew Weisel: Okay. Great. That's very helpful. And one quick one on the voluntary separation program. Would there be any kind of meaningful onetime cash outflow associated with that? And if so, how would you finance it?
Benjamin Gwynn Fowke: Yes. I think the -- so it would go into effect midyear, July 1, and so the annual savings that we would see this year would just about offset the severance cost. And then, of course, then on an annualized basis, '25 and beyond would benefit from that. And again, this is about -- yes, okay, I'll just stop there.
Operator: And we will take our next question from Ryan Levine with Citi.
Ryan Levine: On rate design for data center load what duration commitments and load ramp, are you assuming or looking for to help protect residential customers? Any differences on rate design between jurisdictions to call out? Any color is appreciated.
Peggy Simmons: Yes. So I'll take that. Thank you for the question. I mean, generally, we need -- we'd have to be building long-term assets. So we need some commitments that are longer in nature. So I mean, we would think somewhere around the 10-plus, 15-plus year range, but we're working through that process now.
Ryan Levine: And then in the prepared remarks, you're seeing higher load and potential new investments. In terms of funding that potential new investments in the back half or outside of plan. Any -- how are you thinking about what tools are most advantageous to execute on that potential opportunity?
Charles Zebula: Well, as Ben mentioned, we would consider everything. Everything is on the table. But I think the underlying tenet is that we will defend our BBB credit.
Operator: And we will take our final question from Paul Patterson with Glenrock Associates.
Paul Patterson: I wanted to circle back on the onetime gain associated with the PLR ruling that you got -- or the letters that you got. What's the ongoing impact of that? And could you just elaborate a little bit more on -- I did read the 10-Q and that section of it, but I just wanted to make sure I fully understood it.
Charles Zebula: Yes. So thanks for the question, Paul. So that stand-alone ratemaking for tax purposes has really been on our radar for some time now. Really kind of results from some of our affiliates today generate taxable income and others generate tax losses, which has really kind of created the issue for us.
And really, kind of compounding that is our significant capital program over the last 5 years, as well as bonus depreciation has extended that dynamic. So we were concerned that if we did not address that, we may have a normalization issue. So we asked the IRS for a private letter ruling. Interestingly, some of our jurisdictions support the stand-alone approach, either in legislation or in their own rate making. And other utilities also endorsed and use the stand-alone approach as well.
So we received the PLRs in the first quarter. And the PLR really kind of boil down to 4 key facts. One is the stand-alone NOL must be included in rate base. The second, which addressed the gain in our adjustment from GAAP to operating is that the NOL must be included in the calculation of excess ADIT.
So that reduced the overall regulatory liability for excess ADIT, which, of course, was created due to tax reform. And then any adjustment to offset the NOL would constitute a normalization violation. So we took corrective action. We're glad that we did to avoid a normalization violation. And our plan now is to work with regulators to make the appropriate adjustments to rates so that we can include that going forward.
Paul Patterson: Okay. So that should be a positive going forward, assuming the regulators agree?
Charles Zebula: Once we're able to go through our jurisdictions and get it into rates. Yes.
Paul Patterson: And when I read the 10-Q, it said West Virginia was -- they've agreed to the stand-alone approach, correct? In the past, they've been a little bit -- is that right?
Benjamin Gwynn Fowke: Yes, that's correct.
Paul Patterson: Okay. And then just with respect to transmission, FERC has some stuff coming out in a few weeks. And I was wondering if you had any idea about -- if you know what I'm talking about, it's the planning and what have you, sort of long-awaited reforms.
Do you guys have any sense as to what you might -- we might see there? And then sort of a related question on grid-enhancement technologies. Do you -- how do you see those playing with your large transmission system? Just any thoughts you have with respect to that?
Benjamin Gwynn Fowke: Yes. As far as the planning, I am told from our experts -- in-house experts that we don't anticipate having much of an impact on us. The grid-enhancing technologies, I'm not quite sure about that one.
Peggy Simmons: So we do use grid-enhancing technologies. And as it relates to the planning information at FERC. I mean, our team has been very involved in it. I mean, I think they're looking at longer planning horizons and things of that nature. So our team has been at the table the whole time working with FERC on those.
Darcy Reese: Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Abby, would you please give the replay information?
Operator: Thank you. This call will be available for replay today approximately 2 hours after the conclusion of the call and will run through Tuesday, May 7, 2024 at 11:59 p.m. Eastern Time. The number to access the replay is 1 -800-770-2030 or 1 -609-800-9909. The conference ID to access the replay is 79-39-795#. Thank you, ladies and gentlemen. This concludes today's call. We appreciate your participation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning, ladies and gentlemen, and thank you for standing by. My name is Abby, and I will be your conference operator today. At this time I like to welcome everyone to the American Electric Power First Quarter 2024 Earnings Conference Call. [Operator Instructions]"
},
{
"speaker": "Darcy Reese",
"text": "Thank you, Abby. Good morning, everyone, and welcome to the First Quarter 2024 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Well, good morning, and welcome to American Electric Power's First Quarter 2024 Earnings Call. Shortly, Peggy will give a regulatory update, followed by Chuck, who will provide more detailed financial review."
},
{
"speaker": "Peggy Simmons",
"text": "Thanks, Ben, and good morning, everyone. Now let's go to an update on several of AEP's ongoing regulatory initiatives. We are currently focused on investing more in people resources at the local level, particularly in regulatory and legislative areas."
},
{
"speaker": "Charles Zebula",
"text": "Thanks, Peggy, and good morning, everyone. Today, I'll review our financial results for the first quarter, build on Ben's comments about our service territory load and finish with commentary on our financial metrics and portfolio management activities."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And your first question comes from Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"text": "Just wanted to peel in maybe a little bit more on the data center points that you laid out there. And just wondering, we see a lot of forecasts out there on the time line of how quick some want to come to market, and we're trying to figure out how that matches against the system's ability to provide the power there in the connects. And just wondering how you see those 2 aligning? What does that mean for AEP over time versus plan?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes, those are all really good questions, Jeremy. And our team has done a tremendous amount of work thinking this through. I mean, first of all, I like to say, here at AEP that really wired for growth. And as you know, we've been making significant transmission investments over the years, and that's going to allow us, I think, to accommodate this first wave of growth we're seeing from data centers."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. And maybe just to dive in a little bit more as we think about data center load sensitivity. Should we be thinking that more along the lines of commercial sensitivity or industrial sensitivity, as provided in your guidance if you think about demand outstripping the forecast?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Go ahead, Chuck."
},
{
"speaker": "Charles Zebula",
"text": "Yes. So I would think of it, Jeremy, more like an industrial customer and that sensitivity there."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. That's helpful. And then just the last one, if I could. As it relates to the external CEO search. Just wondering, has anything changed with regards to, I guess, the characteristics that are in focus for a candidate? How is the pool building at this point? Just wondering if there's any other color that you might be able to share on how the process is going?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Well, I can just tell you that the attributes and the qualities we're looking for remain unchanged from what I described on the fourth quarter call. We are well underway now. We've got some really good candidates, impressive candidates. It takes time to sort it all out. And there's other obviously, things that we need to look at."
},
{
"speaker": "Jeremy Tonet",
"text": "Got it. And actually, if I could just sneak 1 last in. Just wondering on overall corporate strategy, could you talk more about where things stand for AEP decentralization efforts. And looking to kind of more closely align P&L to the end decision maker at the local levels. Just wondering how that's progressing?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Well, I think it's -- this is a focus of ours. And one of the -- and I'm going to turn it over to Peggy, she's developing -- has developed a detailed plan. But one of the things we want to do is put those local resources in our communities. And I know that's the right thing to do, just talking to stakeholders."
},
{
"speaker": "Peggy Simmons",
"text": "Yes, Ben, I think you pretty much covered. We have worked with the team and looking at how we can get some more of those -- enhance the resources from a regulatory and legislative perspective, having more boots on the ground."
},
{
"speaker": "Operator",
"text": "And we will take our next question from Steve Fleishman with Wolfe Research."
},
{
"speaker": "Steven Fleishman",
"text": "So just in Ohio and Texas, your wires company, but in Indiana, where these last 2 announcements, I think you've got generation too. And are you -- so in some of these recent deals that announced -- the past week, are you supplying the generation as well? And is there going to be a generation need in Indiana related to those?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Well, we do have RFPs outstanding. Peggy, do you want to take that?"
},
{
"speaker": "Peggy Simmons",
"text": "Yes. We do have RFPs outstanding in I&M. But to answer your question, yes, and are vertically integrated like Indiana, we will have to serve the generation component, and we are working with those large loads that are coming to us on what that would look like. And we are also focused on, as Ben mentioned earlier, redefining and looking at our tariffs as well. So that will be part of our strategy."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And just to kind of clarify back to the initial question. So the transmission grid is built up and has capacity to take on these customers near term. But is there still, even near term, is there more capital needed? Or is it more of this after this 5 years?"
},
{
"speaker": "Charles Zebula",
"text": "No, Steve, there'll be more capital needed, but I don't think it will be those massive 765 lines, it can take a long time to get built. We believe the team has done a lot of work on how we could accommodate that load within our footprint, working with PJM and others. And so yes, there'll be more spend, but it will be manageable and doable to the point."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And then on the FFO to debt, you're in the target range now. Is there anything about that that's kind of -- are you in there for good, do you think now? Is there any -- was there any timing reason? Or is it you're in that and expect to be in it throughout the year?"
},
{
"speaker": "Charles Zebula",
"text": "We were in the range. We expect to be in that range now. Our forecast that we review internally and with the agencies show us being in that range. So that's the plan, and we plan to defend that."
},
{
"speaker": "Operator",
"text": "We will take our next question from Shar Pourezza with Guggenheim Partners."
},
{
"speaker": "Jamieson Ward",
"text": "It's actually Jamieson Ward on for Shar. He's on the road and regrets that he's not able to join you today, but we have a couple of questions for you here. The first was just on the annual customer bill increase, the pace there, you reduced it to 3% increases per year through 2028, which is great to see. Does that already take into account the anticipated infrastructure investment needed to support any future data center growth? Or could we see that number be revised as well?"
},
{
"speaker": "Charles Zebula",
"text": "Well, I mean -- the answer is the incremental stuff we're talking about and the incremental transmission investment, it's not included in that, but it's not going to be -- it's not going to drive that from 3 to 4. If anything, it should keep it level and perhaps even drop it a bit."
},
{
"speaker": "Jamieson Ward",
"text": "Got it. Terrific. And then expanding on Jeremy's earlier question, how are you approaching some of the more unique issues presented by data centers, for example, those who want to be behind the meter but still want to have an emergency tariff with the utility or data centers, which, as you mentioned, want to socialize the cost of interconnection through all rate classes but which may not have a major economic impact. If we can just get a bit more detail there."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "I'm going to turn it over to Peggy in a second. But listen, it's got to be fair to all customers now, okay? I mean this is a big deal. It's an exciting big deal. But growth needs to be as close to self-funded as possible. And that's what I think we'll get with these tariffs and some of the other analysis that we're looking at."
},
{
"speaker": "Peggy Simmons",
"text": "Yes. So what I would add to Ben's comment there is that on our tariffs, we are looking at what minimum demands are. Most of the large loads are wanting to be connected to the system. But if they want some form of self-generation, we are asking so that we understand that, and we can include that, as part of our planning."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes. I mean the worst case scenario, and this is what -- to Peggy's point, what we're preventing is the load doesn't show up consistent with how we built the infrastructure. And when it does show up, it doesn't use, especially on a peak basis, the energy that we built for."
},
{
"speaker": "Jamieson Ward",
"text": "That's very clear. And then on the updated load growth forecast coming later this year, should we assume that at a high level, that means the EEI or are there particular IRPs or other proceedings that we should maybe watch out for? Which could come say, before EEI that would be driving that?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "I mean I think the big update will come -- well, I understand EEI in the third quarter's earnings call right on the same, but it would either come on the third quarter or EEI unless there might be drips and drabs that get released before that, but that's what we're planning to do right now."
},
{
"speaker": "Jamieson Ward",
"text": "Understood. Got you. Last question from us is just on asset sales. In the deck, you mentioned remaining committed to simplifying the business in the immediate term with a focus on continued execution of the sale processes. So how should we think about the potential for any additional sales announcements, following the conclusion in the second quarter of the current process for the Retail and Distributed Resources businesses?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "It would be on an opportunistic basis. We're going to look at -- we're always open to ideas. Chuck and I and the team have been around a while. We know that sometimes good ideas sound good on paper, but you can't execute on them. So we do filter that through the regulatory screening process, as you can imagine."
},
{
"speaker": "Operator",
"text": "And we will take our next question from Carly Davenport with Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"text": "Maybe just going back to the balance sheet. As you think about your financing needs for the remainder of the year, can you just give us an update there? And if you expect to see any impacts relative to your initial plan with the move that we've seen in rates year-to-date?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes. Carly, the plan that we laid out at EEI is still intact. Other than I think at EEI, we had the West Virginia securitization in the plan, and that has been replaced by a Kentucky securitization, nearly of equal amounts."
},
{
"speaker": "Carly Davenport",
"text": "Great. And then just going back to the commercial load and data centers. As you think about that and the expectation to raise later this year. Could you just talk a little bit about sort of what surprised the plan to the upside so materially thus far? Is it just sort of more success on the economic development front or more consumption from existing customers? Just any color on that would be helpful."
},
{
"speaker": "Charles Zebula",
"text": "Yes. Carly, it's just mainly the ramp rates of the customers that have hooked up, have come on more rapidly than we anticipated. And so that's why you're seeing those big bumps in commercial load, as we go through the quarters here."
},
{
"speaker": "Operator",
"text": "And we will take our next question from Nicholas Campanella with Barclays."
},
{
"speaker": "Nicholas Campanella",
"text": "I'll try to keep it to 2. So I guess you talked about this need for growth equity. Can you just elaborate when you anticipate needing that? And what part of this 5-year plan would that be? And then I guess, just -- you do have $700 million to $800 million, I think, a year in your financing walk here of equity needs. Just why not do something sooner than later to kind of knock that out if the opportunity presents itself? I know you don't want to preannounce and go into a strategic review around 2, like you said, but maybe you can kind of give us some additional thoughts on how you're thinking about that."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "I'll turn it over to my esteemed colleague here, Chuck."
},
{
"speaker": "Charles Zebula",
"text": "No, Nick, it's a good question. I mean, look, as we said earlier, right? We're formulating, right, the changes to our plan and how ultimately, right, how financing is going to affect that."
},
{
"speaker": "Nicholas Campanella",
"text": "Okay. I appreciate that. And then Chuck, I know that weather at VIU is kind of a $0.10 drag versus normal, but you also have some of these tax items in there as well. Just on the tax item benefits, is that normalizing from last year? Or is that one time in nature, as we kind of think about year-over-year into '25?"
},
{
"speaker": "Charles Zebula",
"text": "Yes. So Jeremy, about half of that will normalize throughout the year and the other half is onetime. Things that happened in '23 that won't happen again in '24. So it's a true increase."
},
{
"speaker": "Operator",
"text": "We will take our next question from Durgesh Chopra with Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"text": "I wanted to go back on your commentary, Ben, on portfolio optimization, new financing plan. Just to be clear, the financing plan, the CapEx update, the load board updates. Is that sort of -- should we think of that as a separate process and the CEO search? I'm just thinking about the 2 and are those 2 independent processes that we should think about? Or are they somehow tied? I'm thinking about the cadence of your updates, your new plan and then the parallel CEO search?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "I mean, if I understand your question right, are we holding things back until the new CEO gets in place? Is that what you mean?"
},
{
"speaker": "Durgesh Chopra",
"text": "That's right, Ben. Yes."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "No, no. I mean, no. I mean, we typically -- as you know, we typically update all our CapEx and financing plans and all those sorts of things at the time of EEI. And if there's something major in between, obviously, we give you updates. But we're not -- no, I mean I -- this company is not in neutral. I mean we really -- we're moving forward."
},
{
"speaker": "Durgesh Chopra",
"text": "You did. That's exactly what I wanted to ask you, a very clear response. And then second question then, again, like you mentioned challenging the EPA proposed ruling. Maybe can you share a little bit more color there? Is it the carbon capture technology that you are referring to? And then you mentioned the accelerated plant retirements? Was that directed towards coal? Just any color you can share there."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes. Well, it's a great question. And again, I just -- I harken back to Steve Fleishman's report that came out a couple of months ago, where he talked about our industry, which if you aggregate market cap of somewhere around $0.5 trillion, being responsible for this -- we want our onshore data centers, artificial intelligence, reshoring of manufacturing. And it's our industry that has to do it. And we're going to build all the transmission we possibly can. That's not easy to get built either, but we are going to have to plug in to something."
},
{
"speaker": "Operator",
"text": "And we will take our next question from Andrew Weisel with Scotiabank."
},
{
"speaker": "Andrew Weisel",
"text": "Two quick ones here, please. First, to elaborate on the commentary on load growth. Ben, I think, you mentioned that the incremental 10 to 15 gigawatts by the end of the decade. I assume that's across the entire portfolio. Can you talk a bit about the Vertically Integrated Utilities? You have about 20 gigawatts identified through the current IRPs. My question is, how soon might we see more filings to include the new expected load, which there is no doubt coming quickly."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes. So when I look at those incremental loads, I mean, Ohio, within the PJM footprint, Ohio is the biggest driver of it, although Indiana is definitely getting its share. And I suspect we will have to do incremental RFPs to capture that load. I can't give you the exact timing of when that would be."
},
{
"speaker": "Peggy Simmons",
"text": "We have -- so Indiana, we have an IRP that's coming up that's going to be later in November. But -- so that will be part of the process as we start to look at how we accommodate some of this load as we start to see it to come on as well. We'll be using those same types of process."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "And just maybe outside of data centers, if you look down at SPP, that's a very constrained region as it is right now. They haven't seen a tremendous amount of data center growth today. It doesn't mean they won't. But in the meantime, we've got to make sure we've got adequate load to serve the load that we do know we have."
},
{
"speaker": "Andrew Weisel",
"text": "Okay. Great. That's very helpful. And one quick one on the voluntary separation program. Would there be any kind of meaningful onetime cash outflow associated with that? And if so, how would you finance it?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes. I think the -- so it would go into effect midyear, July 1, and so the annual savings that we would see this year would just about offset the severance cost. And then, of course, then on an annualized basis, '25 and beyond would benefit from that. And again, this is about -- yes, okay, I'll just stop there."
},
{
"speaker": "Operator",
"text": "And we will take our next question from Ryan Levine with Citi."
},
{
"speaker": "Ryan Levine",
"text": "On rate design for data center load what duration commitments and load ramp, are you assuming or looking for to help protect residential customers? Any differences on rate design between jurisdictions to call out? Any color is appreciated."
},
{
"speaker": "Peggy Simmons",
"text": "Yes. So I'll take that. Thank you for the question. I mean, generally, we need -- we'd have to be building long-term assets. So we need some commitments that are longer in nature. So I mean, we would think somewhere around the 10-plus, 15-plus year range, but we're working through that process now."
},
{
"speaker": "Ryan Levine",
"text": "And then in the prepared remarks, you're seeing higher load and potential new investments. In terms of funding that potential new investments in the back half or outside of plan. Any -- how are you thinking about what tools are most advantageous to execute on that potential opportunity?"
},
{
"speaker": "Charles Zebula",
"text": "Well, as Ben mentioned, we would consider everything. Everything is on the table. But I think the underlying tenet is that we will defend our BBB credit."
},
{
"speaker": "Operator",
"text": "And we will take our final question from Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"text": "I wanted to circle back on the onetime gain associated with the PLR ruling that you got -- or the letters that you got. What's the ongoing impact of that? And could you just elaborate a little bit more on -- I did read the 10-Q and that section of it, but I just wanted to make sure I fully understood it."
},
{
"speaker": "Charles Zebula",
"text": "Yes. So thanks for the question, Paul. So that stand-alone ratemaking for tax purposes has really been on our radar for some time now. Really kind of results from some of our affiliates today generate taxable income and others generate tax losses, which has really kind of created the issue for us."
},
{
"speaker": "Paul Patterson",
"text": "Okay. So that should be a positive going forward, assuming the regulators agree?"
},
{
"speaker": "Charles Zebula",
"text": "Once we're able to go through our jurisdictions and get it into rates. Yes."
},
{
"speaker": "Paul Patterson",
"text": "And when I read the 10-Q, it said West Virginia was -- they've agreed to the stand-alone approach, correct? In the past, they've been a little bit -- is that right?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes, that's correct."
},
{
"speaker": "Paul Patterson",
"text": "Okay. And then just with respect to transmission, FERC has some stuff coming out in a few weeks. And I was wondering if you had any idea about -- if you know what I'm talking about, it's the planning and what have you, sort of long-awaited reforms."
},
{
"speaker": "Benjamin Gwynn Fowke",
"text": "Yes. As far as the planning, I am told from our experts -- in-house experts that we don't anticipate having much of an impact on us. The grid-enhancing technologies, I'm not quite sure about that one."
},
{
"speaker": "Peggy Simmons",
"text": "So we do use grid-enhancing technologies. And as it relates to the planning information at FERC. I mean, our team has been very involved in it. I mean, I think they're looking at longer planning horizons and things of that nature. So our team has been at the table the whole time working with FERC on those."
},
{
"speaker": "Darcy Reese",
"text": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Abby, would you please give the replay information?"
},
{
"speaker": "Operator",
"text": "Thank you. This call will be available for replay today approximately 2 hours after the conclusion of the call and will run through Tuesday, May 7, 2024 at 11:59 p.m. Eastern Time. The number to access the replay is 1 -800-770-2030 or 1 -609-800-9909. The conference ID to access the replay is 79-39-795#. Thank you, ladies and gentlemen. This concludes today's call. We appreciate your participation, and you may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AEP | 1 | 2,025 | 2025-05-06 09:00:00 | Operator: Hello and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power First Quarter 2025 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead.
Darcy Reese: Good morning and welcome to American Electric Power's first quarter 2025 earnings call. A live webcast of this teleconference and slide presentation are available on our Website under the Events and Presentations section. Joining me today are Bill Fehrman, President and Chief Executive Officer and Trevor Mihalik, Executive Vice President and Chief Financial Officer. In addition, we have other members of our management in the room to answer questions if needed, including Kate Sturgess, Senior Vice President and Chief Accounting Officer. We will be making forward-looking statements during the call. Actual results may differ materially from those projected in any forward-looking statements we make today. Factors that could cause our actual results to differ materially are discussed in the company's most recent SEC filings. Please refer to the presentation slides that accompany this call for a reconciliation to GAAP measures. We will take your questions following opening remarks. With that, please turn to Slide 4, and let me hand the call over to Bill.
Bill Fehrman: Thank you, Darcy and good morning, everyone. Welcome to American Electric Power’s first quarter 2025 earnings call. We are off to an exceptional start to the year where we delivered strong results and have advanced our long-term strategy to drive robust growth, enhance the customer experience and achieve positive regulatory outcomes. We remain committed to investing $54 billion of capital over the next five years, an impressive amount close in size to our current market capital invasion to meet the needs of 5.6 million customers across 11 states. We are actively managing our supply chain to ensure we deliver on our commitments, specifically related to current fine tariffs, we estimate that the direct tariff exposure on our $54 billion base capital plan for 2025 to 2029 is minimal at approximately 0.3%. We have a sizable generation portfolio and one of the largest transmission and distribution businesses in the nation. In fact, AEP owns and operates more 765kV transmission lines than all other utilities in the United States combined, and we were recently awarded construction to build one of the first 765kV lines in Texas. We are enabling extraordinary economic development in high growth states like Indiana, Ohio, Oklahoma and Texas and stand to benefit from these once in a lifetime opportunities presented by the Associated Load Growth. Trevor will go into this in more detail shortly. Our story continues to be one of consistency and commitment to delivering for our customers, states, regulators and investors as we center on execution and accountability and we offer a compelling value proposition to our investors as we target 10% to 12% total annual shareholder return. We have a lot of exciting ground to cover today. I'll begin with a recap of our financial results at a high level before turning to strategic growth opportunities ahead and our recent regulatory and legislative successes. I'll then hand the call over to Trevor to walk through our financial results in more detail. Please refer to today's presentation for our quarterly business highlights and achievements starting on Slide 5. This morning we announced first quarter 2025 operating earnings of $1.54 per share or $823 million. With this strong performance, we are reaffirming our 2025 operating earnings guidance range of $5.75 to $5.95 per share and long-term operating earnings growth rate of 6% to 8%. This guidance is reinforced by a balanced and flexible $54 billion five-year capital plan with the potential for incremental investments of up to $10 billion over that same period. As we have communicated in the past, maintaining a strong balance sheet is vital to funding these capital spending needs. Later in the call we'll go into more detail about AEP's commitment to credit quality and proactive actions we have taken in the first three months of 2025 to address AEP's equity needs. As we move forward, we will remain disciplined in sourcing efficient forms of capital to manage our needs in support of incremental investment opportunities. We remain excited about the significant growth opportunities ahead, including the load growth in many parts of our service territory. This growth is not a show me story, it is happening. AEP's total retail load growth has already been favorable over the past few years, primarily driven by commercial customers. In the first quarter of 2025, our commercial load grew 12.3% compared to the first quarter of last year. As we look ahead, AEP is extremely well positioned to participate in future growth across our footprint. We see opportunities to invest in critically needed infrastructure to support increasing electric demand. Our current capital plan includes customer commitments for over 20 gigawatts of incremental load by 2030, driven by data center demand, reshoring, manufacturing and continued economic development. This incremental 20 GW is about a 55% increase over 2024 system wide summer peak load. As we have consistently said, we are absolutely committed to fair cost allocation associated with this large load growth. To that end, we proactively filed the data center tariff in Ohio and large load tariff modifications in Indiana, Kentucky, Virginia and West Virginia. In the first quarter, we received commission approvals in Indiana, Kentucky and West Virginia related to large load tariffs. The data center tariff hearing in Ohio also concluded in January and we expect to have a commission decision in the second half of this year. These are all strong indications of our state's continuing commitment to attracting large loads with their economic impacts on local communities while also protecting our existing customer base. As we have previously discussed, meeting this incredible demand could require incremental investments of up to $10 billion underpinned by four major large load in some of our bigger service territories, continued economic development in our states, investment across the system in our transmission and distribution infrastructure, and new generation. One of the reasons we are seeing such growth now is due to investments we made over the past decade to build an advanced 40,000 mile transmission system that can help support current large loads. Our transmission system also includes the nation's largest network of 765kV and 345kV lines. These ultra high voltage lines position us exceedingly well in attracting hyperscalers to our system who need consistent large load bulk power. We also continue to invest in our distribution system, which is one of the nation's largest at approximately 225,000 miles. This includes work to harden infrastructure, build or rebuild poles, conductors, transformers and other assets as well as deploy automated technologies for enhanced operational performance. These efforts will help to increase customer satisfaction, strengthen our systems resilience to weather events and enhance the efficiency of our operations. As our generation needs increase to meet growing demand, we are engaging with key stakeholders and making thoughtful investments in new generation to align with their needs and state policies. Our team has worked diligently to develop creative energy solutions that keep our customer’s needs top of mind. We have already shared our plans to begin the early site permit process in Indiana and Virginia for small modular reactors or SMRs that can generate clean, reliable energy to support significant load growth in our service territory and we recently filed integrated resource plans or IRPs in both Arkansas and Indiana. These IRPs, in addition to other planned IRP filings over the next year in Kentucky, Michigan, Virginia and West Virginia will help meet our customers energy needs and support AEP's generating capacity obligations, reinforcing our incredible growth. The fact is that demand for power is growing at a pace not seen in decades and our expansive footprint enables us to significantly participate in this electric infrastructure super cycle. Now let's pivot to some traditional regulatory and legislative updates. In my nine months here at AEP, I have been actively engaged with stakeholders to underscore the importance of our customers and communities and how we work to meet their needs. Building on our meaningful progress in achieving positive regulatory developments in the second half of 2024, we are off to a great start in 2025 with approximately 80% of our rate related revenue already secured for this year. In fact, AEP's first quarter earned ROE for our regulated businesses was 9.3%, up from 9.05% at year-end. As a reminder, some recent regulatory successes include a recent Commission decision approving construction in ERCOT's Permian Basin for one of the first 765kV transmission lines in Texas, opening up tremendous investment opportunities for AEP Texas, PJM transmission system upgrades awarded to AEP affiliates including Transource Energy and our Transmission Companies. System resiliency plans approved at AEP Texas and a unanimous settlement reached at SWEPCO Texas. Base cases approved in Oklahoma and Virginia and recovery of annual transmission expense approved in Kentucky. In late March, we also filed a new base case in Arkansas requesting a rate increase of $114 million. This ask is primarily to align regulatory recovery of certain wind projects, including rate implementation of the diversion and wagon wheel projects. Our application includes an ROE request of 10.9% and SWEPCO anticipates an order and new rates effective in the first quarter of 2026. Previously, APCO filed its base case in West Virginia while offering securitization of up to $2.4 billion as a tool to mitigate the bill impact of a proposed $250 million base rate increase. The procedural schedule just kicked off last month with intervener testimony and rebuttal testimony will follow later this month. The hearing is set to start in mid-June. We look forward to working with everyone in this case to achieve a positive and balanced outcome later this year. We are intently focused on reducing regulatory lag and have made a number of other timely filings so far in 2025, including the AEP, Texas TCOs and DCRF biannual filings as well as SWEPCOs annual Foreign Reload Rate Plan in Louisiana For I&M, the team recently filed to acquire an 870 megawatt natural gas plant in 2026 which is located in Oregon, Ohio that will help I&M customers continue to benefit from reliable and affordable resources. We are also working diligently at the legislative level in a number of jurisdictions to advance policy changes to improve both recovery and customer affordability. For example, in Ohio the recent passage of House Bill 15 positively results in multiyear forward looking test years for future rate cases and includes grandfathering language for two behind the meter fuel cell contracts. Trevor will go into further detail on the OVEC related impacts. And in Virginia we supported securitization legislation that will both reduce customer bills and support critical investments in the system. You can expect to see us continue to work with federal policymakers, regulators and state legislators as we further modernize our energy grid. We firmly believe that the best way to create value for investors is by delivering safe, affordable and reliable energy to our customers and communities, and we are engaging with stakeholders to support efforts to do just that. I am increasingly confident in our exciting growth potential as opportunities to benefit our customers, communities and investors come into focus, and I look forward to building on our track record of value creation in the months and years ahead. With that, I'll turn it over to Trevor, who will walk us through AEP's first quarter performance, drivers and other financial information.
Trevor Mihalik: Thank you, Bill. Today I'll review our financial results for the first quarter, build on Bill's remarks about our exceptional load growth, comment on our credit metrics, further discuss the recent successful $2.3 billion forward equity issuance that completes our anticipated equity needs through 2029, and address our thoughts on federal tax legislation. Let's go to slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter were $1.50 per share compared to $1.91 per share in 2024. There is a detailed reconciliation of GAAP to operating earnings for the quarter on slide 26 of today's presentation. In the quarter, due to the passage of Ohio House Bill 15, we recorded a charge of $28 million related to the write-off of previously deferred OVEC costs, which we no longer believe are probable of recovery. From an operating earnings perspective and effective upon becoming law this summer, House Bill 15 removes AEP Ohio's ability to recover losses or record gains from the sale of OVEC power. Historical losses recovered from customers were approximately $40 million in 2024. However, we expect the earnings impact going forward to be significantly muted given upcoming capacity prices in PJM. Prospectively, the impact is manageable and less than $10 million of earnings on an annualized basis. Let's walk through our quarterly operating earnings performance by segment on Slide 8. Operating earnings for the first quarter total $1.54 per share compared to $1.27 per share in 2024. This was an increase of $0.27 per share or about 20% quarter-over-quarter, highlighting a strong start to the year and creating solid momentum for the rest of 2025. I would note that weather accounted for about $0.18 of the quarter-over-quarter variance. This was driven by the cold weather that most of our service areas experienced in the first quarter of this year, which was contrasted with the exceptionally mild weather seen in the same period of 2024. Looking at the drivers by segment, operating earnings for the vertically integrated utilities were $0.66 per share, up $0.09 from a year earlier. Positive drivers included favorable changes in weather and rate changes across multiple jurisdictions. The transmission and distribution utilities segment earned $0.36 per share, up $0.07 from last year. Favorable drivers in this segment included rate changes driven by rider recovery of distribution investments in Ohio and the base rate case in Texas, favorable weather and higher transmission revenue. The AEP Transmission Holdco segments contributed $0.44 per share, up $0.04 from last year. Our continued investment in transmission assets as new loads are added to our system remained a key driver in the segment. Generation and marketing produced $0.14 per share, up $0.02 from last year. Favorable retail and wholesale margins were partially offset by lower distributed generation margins due to the sale of the OnSite Partners business in September of 2024. Finally, Corporate and Other saw a benefit of $0.05 per share, primarily driven by the timing of income taxes, of which $0.03 is expected to reverse by the end of the year. Moving to slide 9, I want to highlight the significant increases in load we continue to see across our system. As Bill mentioned, the increasing load growth coming to the system is providing the opportunity to add up to $10 billion of incremental capital over the next five years to our already sizable $54 billion plan. Since our last call, both Amazon Web Services and Google have connected hyperscale data centers to our system in Indiana representing billions of dollars in customer investment. This comes on top of the existing data center customers in Ohio and Texas who continue to ramp up at a double digit pace. We also saw new large industrial load continue to come online in Texas across a variety of customers and industries. All of this puts us on track to nearly triple the pace of our retail sales growth from 3% in 2024 to almost 9% in 2025. That represents the largest acceleration of load at AEP since the late 1960s, a truly once in a generation opportunity. In fact, we expect that step change in growth to be maintained well into the future. Our current forecast supports annual retail load growth of between 8% and 9% through 2027. That's equivalent to roughly 52 million incremental megawatt hours that we expect to serve relative to our current load of 182 million megawatt hours, or nearly a 30% increase. More than offsetting the decline in our residential sales is a massive and sustained increase in demand from our C&I customers. Based on our current contracted lows, our C&I sales mix will grow from roughly two thirds of total retail to nearly three quarters over the next several years. There is a slide in the appendix that shows a bit more detail on first quarter sales by class. Those growth rates are one of the best in the industry and we have confidence that these lows are going to show up. We have a significant amount of demonstrated and diverse demand across our system, but I think it's also important to highlight what that demand looks like and how we're incorporating it into our projections. You will see on slide 10 a piece of that demand through some illustrative examples of the types of projects we're adding to our system. First and foremost, let's start with a number of overall requests to connect to the system. Across our 11 state operating footprint, we currently have more than 500 existing and potential customers actively requesting to connect almost 180 gigawatts of load to our transmission system. For context, our system wide summer peak was just under 37 gigawatts last year, so we have nearly five times that amount active in the queue. Now obviously we know that not all of the requests will come online, which is why we take great care in using a probability based approach to determine the likelihood of these loads as part of our annual load forecast. So far we've committed to adding just over 20 gigawatts onto the system over the next five years, which in the context of our queue is relatively conservative. Given the dynamic nature of AI driving the surge of data centers and large industrials coming online, we think it's vital to rely on demonstrated customer demand to build out our planning forecast. We believe the best mechanisms to demonstrate the demand are executed contracts backed by financial commitments, including electric service agreements, or EFAs, and letters of agreement, or LOAs, showing how firm these loads really are. Every megawatt in the forecast you see here is supported by LOAs. In addition to LOAs and PJM, 80% of the load growth in this region is also backed by ESAs, which are take or pay contracts requiring customers to pay for power as of a certain start date, irrespective of their offtake. This not only helps confirm that customer’s projects are real, but also incentivizes customers to stick to the schedule, reducing the risk to our existing customers and investors from a project not coming online. This is also why we've been very active in working with our regulators to strengthen and lengthen the tariff provisions in those contracts. Our contract terms, coupled with a queue that is nearly 10 times the size of our current increased load forecast, gives us great confidence that this demand will show up, which in turn makes us confident in our $54 billion capital plan with incremental upside. Should any of these projects be canceled or postponed in addition to the protective financial provisions in the contracts, our Q [ph] means that we have other active customers to slot right into place and take up that capacity. In addition to the demonstrated demand that we're seeing across the system, it is also important to note the diversity in that demand. While data centers are driving a majority of the load growth in the coming years, we are also contracted to add roughly 6 gigawatts of industrial load across a number of diverse industries, including steel, autos and energy. This diversity reassures us that the demand behind our capital plan is solid and can hold up across several different economic environments, including those with tariff impacts that we may find ourselves in over the next several years. Let's move on to slide 11 to discuss AEP's liquidity and commitment to credit quality. Recall that AEP's funding plan supporting our capital spend through 2029 originally included $5.35 billion sourced from equity. In January, we secured a minority equity interest investment in the Ohio and I&M Transcos with KKR and PSP Investments for $2.82 billion. This deal is value accretive at 2.3 times rate base and 30.3 times price to earnings. We expect to close in the coming months and the only remaining item outstanding is FERC approval, which we filed for on February 3rd. In March, we saw a compelling opportunity to further derisk our funding needs through a $2.3 billion forward equity transaction, including the greenshoe that allowed us to capitalize on known market conditions and manage the timing of proceeds. In combination with the expected proceeds from the minority transaction, I am pleased that we now have completed our anticipated equity needs through 2029 associated with our $54 billion capital plan. Those two transactions are equivalent to issuing common stock at approximately $140 per share, a 25% premium to our current share price. Moving on to federal tax legislation and specific to transferability impacting FFO, we believe a complete retroactive IRA repeal is unlikely based on our many conversations with policymakers. If there is a repeal, we would expect any potential legislation to provide business certainty by protecting the qualifying tax incentives for existing projects as well as safe harbor projects currently under construction. This would give us the ability to monetize tax credits in a timely manner and meet our financial commitments. You can see the FFO-to-debt metric stands at 13.2% for the 12-month ended March 31, which is a 0.2% decrease from the prior quarter. However, the minority interest transaction is expected to improve near term FFO to debt by 40 to 60 basis points, which sets us up to be well above our credit threshold and puts us on a path to be in the targeted 14% to 15% FFO to debt window. Finally, let's move on to slide 12 before we take your questions, I wanted to summarize what you heard from us today. First, you heard that we have taken significant actions to derisk our financial plan through the highly attractive and accretive minority interest transmission transaction which is expected to close in the coming months. Coupled with the $2.3 billion equity offering completed in late March prior to the current market turbulence, these transactions combined complete our anticipated equity needs through 2029 to support our current $54 billion capital plan. Second, you heard that we delivered strong financial results in the first quarter, growing earnings substantially compared to last year. Positive regulatory developments have set a strong foundation and are paving the way for a successful 2025. Third, you heard about our remarkable low growth story underpinned by major economic development activities across our footprint, providing significant investment opportunities in our utilities and creating an attractive growth profile for our investors. We highlighted the regulatory progress on retail tariffs that we've made to enable these load additions to result in a fair allocation of costs and protections for our existing customers. Fourth, you heard about our continued focus on the execution of our unprecedented $54 billion capital plan with the potential for incremental investments of up to $10 billion. In summary, our confidence in achieving our 2025 commitments remains strong and we are reaffirming our operating earnings guidance range of $5.75 to $5.95 per share, our long-term growth rate of 6% to 8%, and targeted FFO to debt of 14% to 15%. With that, I'm going to ask the operator to open the call so we can take your questions.
Operator: [Operator Instructions] Our first question will come from the Shar Pourreza with Guggenheim. Please go ahead.
Shar Pourreza: Hey guys, good morning.
Bill Fehrman: Good morning, Shar. How are you?
Shar Pourreza: Good morning. Oh, well, very well, Bill. Just I know West Virginia is one of the first rate cases you kind of rolled up your sleeves for, after, that prior bad outcome which obviously predated you, I guess. How are conversations going there, especially around securitization? Can you settle this before the mid June hearings? Thanks.
Bill Fehrman: Yes, really appreciate the question. We've been having first of all, at a high level really good luck with a lot of our regulatory outcomes across the system. And I'm really pleased with the work that the team has been doing to focus closer in on our local communities and our states and pushing us to do what our states want. And in the case of West Virginia, I'm excited with where we're at. The hearing is scheduled for June with the commission decision later on this year. We've incorporated securitization as an option to enhance customer affordability. We've worked with the teams there and we believe that this offers a really significant benefit to our customers by potentially reducing the impact on their bills by almost 75%. So I think there's really some interesting opportunities here because that would essentially decrease the increase we're looking for to around 3.8%. But ultimately the decision rests with the commission and we look forward to working with all of the stakeholders to achieve a favorable outcome for everyone and we'll participate in discussions as they come up. But right now overall though, I'm very, very excited with how the organization is responding in our states. And I think as you hopefully listen to all of the positive regulatory outcomes we've had over the past few months, you'll see that we're really moving in the right direction and I'm really excited about where we're at.
Shar Pourreza: Perfect. Fantastic. And then just lastly, the 20 gigawatts of load you have out there. We've seen some pullback with at least one hyperscaler in Ohio. Microsoft, I think, is the notable, I think in your service territory, I guess. How are conversations going with the hyperscalers? More specifically, are you seeing any kind of sense of pullbacks? Just trying to get a sense with that customer class specifically. There seems to be some conflicting data points out there with the caveat you guys have a diversified load environment. Right, but specific on hyperscalers. Thanks.
Bill Fehrman: Sure. Well, of course, overall on our system, demand remains really robust. And as Trevor noted, we've got over 500 existing and potential customers that are looking to connect 180 gigawatts of load on the transmission system. And so despite the fact that Microsoft made a decision to delay their projects, we've got an incredible backlog that want to come onto our system and we're very excited about working with those customers and getting them connected. I don't really see a reduction in our other load coming from data centers or hyperscalers or the industrials for that matter, because we've contracted that about 6 gigawatts of industrial load as well across the system and really given us a diversity that will strengthen the company overall for us going forward. And so I think we're in a very strong position. This diversity provides confidence that the demand supporting our capital plan is really resilient and capable of enduring these various economic outcomes, so whether Microsoft is with us or not, we see really significant demand coming forward and we've got plenty of folks who want to jump in if they want to jump out.
Shar Pourreza: Got it. Perfect. Fantastic, guys. Congrats. See you soon.
Operator: Our next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead.
Aidan Kelly: Hey, good morning. This is actually Aidan Kelly on for Jeremy. Just focusing on the load growth again. It looks like total retail sales were up around 3.2% versus the 8.8% 2025 target. And then also with the commercial up 12% versus 24% target. How do you reconcile, like the sales trends we've seen this quarter against your 2025 forecast, would this imply a strong pickup later in the year? And are there any sensitivities we should think about here in general?
Trevor Mihalik: Yes, Aidan, thanks for the question. This is Trevor. So I would start by saying the anticipated load growth, particularly the rapid 8% to 9% increase that we're seeing over the next several years does open up substantial capital investment opportunities. And we expect that to drive consistent and robust earnings growth, especially in the second half of the decade. So to your specific question, while near term earnings impacts are somewhat muted due to the general lower profit margins of the C&I customers compared to the residential customers, I would say the rapid addition of C&I load really does create additional headroom and further enhances customer affordability. Just kind of as a rule of thumb or an example, the margins from the vertically integrated residential customers are roughly five times larger than those of our data center customers. And for our T&D customers, that ratio is almost 8:1. So, you'll see a little bit of a decline in margins as we see some efficiencies on the residential side but overall this is really just a very positive growth story around C&I and what we're able to do to deploy capital over the long term. So we feel very good about it.
Aidan Kelly: Got it. That's helpful. Thanks, Trevor. And then just maybe switching gears to kind of the opening remarks on Ohio. Could you just walk through the puts and takes, from shifting away from ESPs into NYPs and to what extent does this impact your regulatory strategy in the state and future rate case timing in General?
Bill Fehrman: Sure. Well, HB15 was a legislation that ultimately received approval from both chambers, it has not been sent to the Governor yet. We expect that to happen really any day now. Once that happens, the governor has 10 days to sign the bill and then we anticipate that the bill will become law thinking early August, which is 90 days after his approval. My view of this legislation is that it's highly constructive. It supports capital investment growth in Ohio and really actually provides benefits to our customers. For us, the main provisions that impact our business, first and foremost is the new legislation that ends ESP and it introduces a multi-year forward looking test year with a true UP [ph] mechanism. So that is a significant advantage for us. It promotes timely recovery of our investments and then unlike other Ohio utilities, our transition from ESP5 to the new construct will proceed seamlessly with no gaps in our timing. And so really looking forward to moving through that transition, it's going to be an incredible advantage for us going forward. And then the second piece was the behind the meter components of the legislation. So this legislation, again we're happy with the outcome here. It basically grandfathers the two projects that we had in flight with our Bloom Energy solution for the data centers that we previously have discussed. This will preserve those existing agreements and then we have basically the flexibility to deploy future fuel cell purchases to other affiliates. And so we're going to continue to offer that as an alternative in our other areas and then make sure that we deliver on our commitments to the two customers that we have in Ohio. And then the third piece of this is, is the OVEC issue and I'll turn that over to Trevor to describe, but I think overall it's something that we'll be able to manage through. So Trevor.
Trevor Mihalik: Yes, terrific. Thanks, Bill. Yes, so with regards to the OVEC situation, historically we've indicated that ending the cost recovery would result in roughly a $40 million impact, and that's what it's done in years past. Again, as we said in our prepared remarks, given the upcoming capacity prices in PJM, we expect the earnings impact to be really significantly muted to the tune of about potentially $0.02 or we said roughly $10 million of earnings. And that's something that I think is very manageable and we can incorporate prospectively. As Bill also just mentioned here, this will probably most likely become law and take effect in mid-August. And so we will get recovery up through that date. And so I think this is one of those things that is really not a huge earnings driver for us and we can deal with this going forward.
Aidan Kelly: Appreciate the color. I'll leave it there. Thanks.
Trevor Mihalik: Absolutely. Thanks, Aidan.
Aidan Kelly: Yes, thanks.
Operator: Our next question comes from the line of David Paz with Wolfe Research. Please go ahead.
David Paz: Hey, good morning.
Bill Fehrman: Morning.
David Paz: I know you addressed this, I think on the previous question to a certain degree, but maybe on the commercial sales in particular for 2025, see that they're tracking at least year-over-year, 12%, but your target a little higher for the full year. Just are you seeing any delays? Is there a specific shaping that you may have talked about previously that's playing out in terms of just back end loaded for the year for 2025 on commercial sales?
Bill Fehrman: Yes, David. So I think the good thing, and we mentioned this in the prepared remarks, is with the commercial load growth, what we're seeing is a lot of these counterparties are signing the LOAs and entering into firm contracts with us. And so, these are again, really take or pay contracts that are enabling us, irrespective of what their load looks like, to ensure that they are starting to pay under those contract terms. And so while the step up of 12% is really positive, we continue to see people signing these take or pay type contracts and I think you'll continue to see additional load coming on over the next several years and so this is all very positive in that regard. But I wouldn't say it's shaped towards the back end or anything to that regard. I think it's really more just a steady increase in commercial load coming on that we have seen over the last several months here.
David Paz: Okay, so for 2025, you still anticipate about 23%.
Bill Fehrman: That's right.
David Paz: Year end 25 versus year end 24, okay.
Bill Fehrman: Yes.
David Paz: And then just you just touched on this, the previous question on the Bloom partnership. But will, will there be a -- how should we think about the deployment versus what you have before the Ohio law understanding it's not, the Ohio Market, AP Ohio Market is not there. But will this change any type of schedule of deployment for the remaining one gig?
Bill Fehrman: Well, we're in the market to sell those to customers who are interested in this technology. It will not affect at all the two projects that we have in flight. Those will go forward as planned and those are well underway. So for the remaining 900 megawatts that we have available to us, we do have a number of customers that we're in conversations with and feel optimistic that there may be deals coming down the road. So we'll see where this all heads and can certainly report on this more as future calls come this year.
Trevor Mihalik: And let me add just one thing, Bill, if I could on that. The remaining 900 megawatts is really an option for us, we are not obligated to take those fuel cells. And so if we can find capacity and customers to take them, that makes sense. We will do that. But again, we're not obligated to.
David Paz: Yes, the original 100 megawatts that we did contract are taken care of.
Bill Fehrman: Yes.
David Paz: Great. Thank you. Yep.
Operator: Our next question comes from the line of Julien Dumoulin-Smith with Jefferies. Please go ahead.
Julien Dumoulin-Smith: Hey, good morning team. Thank you guys very much. Appreciate it. Nicely done here. Just wanted to follow up on the 10 billion upside number here. I just wanted to say a little bit of what's already approved here. What do you have line of sight even within that $10 billion bucket? It seems like there could be some various pieces there. And then also what are you waiting for in terms of line of sight to formally introduce that? As you say, it's within the five year program. You comment several different times about this being tied to the load growth and the relative degree of confidence you have on the load growth. So effectively, what are we waiting for? What are the sub pieces there that would enable you the confidence to more formally integrate that into the plan?
Trevor Mihalik: Yes, Julien, it's Trevor. Appreciate the question. I would say what we're really doing is we're setting the cadence where we want to come out with a formal growth plan on an annual basis. And we'll generally do that around call the third quarter call right before we go into EEI, unless there's something material that would increase that $10 billion plan or $10 billion potential upside to the $54 billion plan. That being said, I think, it's important to note that the recently awarded 765 transmission lines, for example, in Texas, that's roughly $1 billion to $2 billion. That's not in the current plan. And so as things firm up, we will continue to look at how we manage the overall portfolio spend relative to what our customer’s needs and what the states want and that'll impact a large part of what that 10 billion looks like. I think roughly, if you wanted to kind of take a look at that 10 billion, we've said publicly that roughly about half of that 10 billion relates to transmission and the remaining is a majority of that is generation projects in the various service territories as we file and look at the various capacity and needs in the states. But again, we have great opportunities not only in ERCOT, we also have opportunities in PJM and we continue to flesh those out and we'll come with more definitive answers when we roll out our revised five year capital plan in the third quarter.
Julien Dumoulin-Smith: Got it. Okay, fair enough. And maybe just to elaborate a little bit further, what is in that 5 billion generation bucket? Can you speak a little bit to how you think about that versus the load growth numbers that you have? Is this just about line of sight on RFPs coming out of anticipated load growth or is there something further within that here?
Trevor Mihalik: No, it's largely what you just said there. It's the RFPs. It's also looking at potential wind projects or other renewable projects in various states. It's also related to potentially some combined cycles as we look at what the overall capacity needs are and the generation needs are in our service territory, so these are items that we have a line of sight to but we have not firmly committed to yet.
Julien Dumoulin-Smith: Oh, actually just to clarify, you've got two acquisitions out there, one potentially in Oklahoma and one in Indiana or Ohio specifically. Those are included in the plan and you intend to move forward with those?
Trevor Mihalik: That's right, that's correct. Those were items that were included and we do have, the needs in those states for that generation. And so those, those are in there.
Julien Dumoulin-Smith: Awesome. All right, I'll leave it there. I'll pass it on. Thank you guys very much. Done again, thanks.
Trevor Mihalik: Thanks.
Operator: Our next question comes from the line of Durgesh Chopra with Evercore. Please go ahead.
Durgesh Chopra: Hey team, good morning. Thanks for giving me time. I just wanted to start-off with the Q1 earnings performance. So the report numbers are higher than where we thought you would end up in the quarter. You mentioned the weather benefit, but you also reaffirmed guidance for the year. I appreciate there are three more quarters to go with third quarter being the largest. Maybe just comment on how first quarter turned out, what's your expectations? Are you going into the balance of the year higher than where you expect it to be, just any color there would be helpful. Thank you.
Bill Fehrman: Yes, thanks Durgesh. So as you did highlight, weather was a significant driver as was some of the rate impacts as we rolled out the revised rates in certain jurisdictions. But weather was a significant opportunity for us in the quarter. I will say, that's roughly in line with where we anticipated we would be and we feel very good about laying out our full year guidance range and staying within that guidance range. And as you indicated it's still fairly early with just the first quarter but we're going to be very disciplined in our capital allocation. We are looking for ways to ensure we are doing things efficiently at the operating companies as well as at the corporate center to drive efficiencies and to drive affordability for our customers. But I feel good about the 560 or the 575 to 595 guidance range that we put out in the 6% to 8% long-term growth rate and certainly would anticipate that we would again talk to that in the second quarter as we continue to see some of the successful regulatory outcomes rollout that we've seen over the last few months here.
Durgesh Chopra: Got it. Sounds like things are on track. Okay. Then switching gears to just the per colocation process here. A couple weeks ago the IPP came out and sort of suggested settlement talks any color you can share there on what might be happening behind the curtains and timeline for a potential settlement if it's reached.
Bill Fehrman: This is Bill. Sure. So this is Bill on the co-location issues. We've said many times on this is that we're not against colocation. What we are wanting to make sure is that anyone doing that sort of arrangement pay their appropriate fees on the transmission system and so we're continuing to follow the process at FERC and that's moving forward and will continue to be engaged fully. But at the end of the day on this it's really more about ensuring that if you use the transmission system you pay your fair share. And so we'll continue to monitor this and see where it goes.
Durgesh Chopra: Got it. Thanks Bill. Thanks Trevor and congrats on start to the year.
Bill Fehrman: Yes, thank you.
Trevor Mihalik: Thanks Durgesh.
Operator: Our next question comes from the line of Nick Campanella at Barclays. Please go ahead.
Nick Campanella: Hey, thanks for all the updates.
Bill Fehrman: Good morning.
Nick Campanella: Hey. Just wanted to follow up on the CapEx upside. I'm just curious if you could talk about how you would plan on financing the 10 billion, if you were to kind of wrap it into the plan into next year, like do you have additional levers to pull on the asset sales side or could the securitization that's pending in West Virginia impact the company's overall equity needs in any way? I guess just do you have any levers to kind of mitigate what's been more of a more traditional, I don't know, 40% to 50% of funding across the industry.
Bill Fehrman: Yes. So Nick, one of the things we did, and we said on the year end call in February that we had the 5.35 billion of overall equity that we needed over the five year plan and 2.8 billion of that was taken care of already with the sale of the Transcos. And then given where Bill and I were in March, we anticipated we'd rather take the market we know and so we went out with the remaining $2.3 billion, which really effectively takes all the equity, the marketed equity, off the table over the five year plan. So when you look at the incremental $10 billion, even if we needed to fund that with some level of growth equity, that would be on the back end of the plan because we've already pre funded a lot of that equity on the 2.8 billion on the sale and then the 2.3 billion is done under the forward through December 2026. And so when you look at that, we've really taken care of all the equity needs even with the forward in really the first two years of the five year plan, and so if we were to come back and firm up the 10 billion, I think we would really be in a situation where we would not need to issue incremental equity in the near term and then we will come back at a later time as to how we would fund that. To some of the points you raised specifically, again you mentioned the securitization. And while we believe that securitization is highly beneficial for our customers in modulating the rates, it also allows us to take approximately $2.4 billion of cash and deploy that cash elsewhere, and so there's a lot of levers like that. And then lastly, I would say we also would look at potential hybrids that we have out there, whether it's junior subordinated debt and I know others in the market have been utilizing those structures as well, and so we do have a lot of other levers to pull. That being said, I think we do like our assets and from our perspective, I don't think you're going to see us sell down any more transmission or anything to that effect, but rather we would look at ways to finance the growth in a very, very shareholder friendly way.
Nick Campanella: Hey, that was great color. I appreciate that. Thanks for that. And then just one quick clarification. I know you kind of mentioned in your prepared remarks your comments on IRA. Is there just any quantifiable exposure if transferability did go away? Would that impact your plans whatsoever? Do you have any exposure there? Thanks.
Bill Fehrman: Yes. So I would say again, on the whole IRA walking it back and I think this kind of gets back to some of the comments we made in our prepared remarks. But we really do believe that a complete retroactive repeal of IRA is pretty unlikely and that if a repeal does occur, we would expect the tax incentives for the existing projects and Safe harbor projects that are under construction will be protected. I think really when you look at this, all of AEP's existing tax credits, along with really all the anticipated tax credits through 2027 are safe harbored and would not be impacted by this proposal. And so then people have kind of questioned us with regards to the specific dollar amounts. And I would say transferability in our plan is manageable. It's roughly $200 million currently and then over the next several years it averages about $300 million. But all of that really pertains to Safe harbor and pre IRA projects that are expected to continue to qualify under the transferability. So again, very limited exposure in that regard from the IRA repeal language that's being talked about right now.
Nick Campanella: Appreciate all those details. Thank you again.
Bill Fehrman: Thanks, Nick.
Operator: Our next question comes from the line of Carly Davenport with Goldman Sachs. Please go ahead.
Carly Davenport: Hey, good morning. Thanks for taking the questions. Maybe to start. Just to follow up, Trevor, on some f your comments earlier on the margin contribution from RESI versus C&I ocustomers. Can you just talk a little bit about the RESI dynamics driving that to track negative over the last several quarters here? Is that something you're watching and do you anticipate something shifting there to get you back towards that full year forecast for 25?
Trevor Mihalik: Yes. Carly, thanks for the question. And we certainly are focused on residential customers. And I think what you're seeing is we do have slight increases in residential and actual meter count. But what we're seeing is that's being more than offset by the decline in throughput on the residential side, mostly from efficiency and people really focusing on the costs to go through a cold winter like we just had, so from our perspective, I think we do watch it. We do see that C&I is adding a lot of growth that is helping to offset that. But again, as I mentioned, the C&I really margins are a lot less than residential and so we continue to monitor that. But what we need to do is continue to find ways to deliver very high quality service to our residential customers at an affordable price and then that will continue to be something that will offset some of the efficiencies that they're doing or the use that they're declining in.
Carly Davenport: Got it. Great. That's helpful. Thank you. And then could you maybe talk a little bit about the 765kV Permian opportunity set? Just any color on how we could think about sizing what that CapEx could look like or the timing to deploy it? And is that something that is in the $10 billion of identified upside to the plan?
Bill Fehrman: Yes, good morning. So first of all, we're very, very excited about that outcome in Texas when we think about the opportunities there going to 765 was a very strong message by the government and regulators in Texas that they foresee a very strong future for the business climate there and the need for energy, and the fact that they moved to 765 is an incredibly strong statement about what they view as their potential in Texas. And so for us, of course, we were the original innovator of 765 back in 1960 and have been building it and perfecting it for many years, and in fact, really the only company in the country that has the capabilities to do this. And so we're incredibly well positioned in Texas for this. We're excited about this first project and firmly believe that it will open up additional ones going forward for this one. We think it's in the $1 billion to $2 billion range and the work on this project will begin in the very near future and of course it will take some time to deploy. But overall, the fact that we are the leader in this country for 765 and the fact that Texas is looking at a significant increase in that type of transmission bodes well for AEP.
Carly Davenport: Thank you so much for the color.
Bill Fehrman: Thank you.
Trevor Mihalik: Thanks, Carly.
Operator: Our next question comes from the line of Andrew Wiesel with Scotiabank. Please go ahead.
Andrew Wiesel: Hey, good morning everyone. Appreciate all the detail on the call here. I've just got one follow up on the FFO to Debt. I might have misheard some of what you said in the commentary, but based on the slides, it looks like it was 13.2% on a TTM basis through March, that's down from 14% last year. Can you just talk a little bit about the moving pieces. Then, of course, as you mentioned, the minority interest sale will add 40 to 60 basis points later this year. That won't quite get you to 14%. Can you talk about what will get you over the hurdle? So you've got the 100 basis point cushion over the 13% downgrade threshold, please. Thank you.
Trevor Mihalik: Yes, thanks, Andrew. So we ended last year at 14% FFO to debt, but that was also prior to the change in methodology with regards to the deferred fuel. And that took about 40 to 50 basis points off of that 14% FFO to debt. Now, I will say that the deferred fuel, as we're collecting the deferred fuel balances, we're really not putting that or the new methodology does not put that into the numerator. That rolls off and will be largely done by the end of 2026. So that's where we really were with regards to the deferred fuel and the end of the year. So the 14% was under the old methodology and call it 13.5, 13.6 under the new methodology. And then we're at 13.2, you're right, with the trailing 12 months, but what we're anticipating is the minority interest transaction will raise that by 40 to 60bps. So that'll take us to 13.6% to 13.8% once we close that transaction and then just continued focus on execution around efficient operations and increasing the numerator will be a big part of how we're going to ultimately get into that 14% to 15% targeted range that Bill and I really feel we want to be in so that, you know, we can have a level of cushion well above our 13% downgrade threshold. So hopefully that gives you a little bit of color.
Andrew Wiesel: Yes, that's very helpful. Okay, great, Great. And then one, just to clarify, of the recent regulatory wins, were they all included in the CapEx plan already? Specifically, I'm talking about the 1.1 billion of transmission from Transource Energy and the 600 million through AEP Transcos as well as the Texas Resilience plans.
Trevor Mihalik: Yes, look, I would say from our perspective, within the plan, we laid out what we thought was a very good plan at the beginning of the year. I came in as the new CFO, certainly pressed on what the planning assumptions were, and we're still very committed to our 575 to 595 and there's going to always be some puts and takes, but at the end of the day. We feel very good about where we are on the 575 to 595 and the overall 6% to 8% long-term growth rate.
Andrew Wiesel: Okay, I guess my question was, were those projects included in the $54 billion five year plan?
Trevor Mihalik: Yes. And again, I would say yes, there are some projects that are included, there are some projects that fall away. So there's always puts and takes, but generally, yes.
Andrew Wiesel: Okay, got it. But you're saying there's flexibility for projects over time. Understood. Okay, thank you so much.
Trevor Mihalik: Absolutely. Yes.
Andrew Wiesel: Thanks.
Operator: And that will conclude our question and answer session. I will now hand the call back over to Bill Fuhrman for closing remarks.
Bill Fehrman: Yes, thank you. We appreciate everyone joining us on today's call. I'd like to close with just a few summary remarks. First, I'm very excited when I think about the opportunities ahead at AEP as we advance the long-term strategy to drive growth, enhance the customer experience and achieve positive regulatory outcomes. We are putting our robust capital plan to work and continue to grow the business across our large footprint while delivering shareholder value. I'd also like to reinforce the incredible support we've had from our board to keep pushing forward with our plan to really strengthen the balance sheet, improve our regulatory outcomes and execute around what our states want. And I couldn't be more excited to be with this team and see where we're taking the company. So if there's any follow up items, please reach out to our IR team with your questions. This now concludes our call. Thank you.
Operator: Today's conference will be available for replay beginning approximately two hours after the conclusion of this call and will run through 11:59 Eastern Time on Tuesday, May 13, 2025. The number to dial to access the replay is 800-770-2030 or 647-362-9199 for international callers. The conference ID number for the replay is 786-4240. This concludes today's conference call. Thank you all for joining. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Hello and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power First Quarter 2025 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"text": "Good morning and welcome to American Electric Power's first quarter 2025 earnings call. A live webcast of this teleconference and slide presentation are available on our Website under the Events and Presentations section. Joining me today are Bill Fehrman, President and Chief Executive Officer and Trevor Mihalik, Executive Vice President and Chief Financial Officer. In addition, we have other members of our management in the room to answer questions if needed, including Kate Sturgess, Senior Vice President and Chief Accounting Officer. We will be making forward-looking statements during the call. Actual results may differ materially from those projected in any forward-looking statements we make today. Factors that could cause our actual results to differ materially are discussed in the company's most recent SEC filings. Please refer to the presentation slides that accompany this call for a reconciliation to GAAP measures. We will take your questions following opening remarks. With that, please turn to Slide 4, and let me hand the call over to Bill."
},
{
"speaker": "Bill Fehrman",
"text": "Thank you, Darcy and good morning, everyone. Welcome to American Electric Power’s first quarter 2025 earnings call. We are off to an exceptional start to the year where we delivered strong results and have advanced our long-term strategy to drive robust growth, enhance the customer experience and achieve positive regulatory outcomes. We remain committed to investing $54 billion of capital over the next five years, an impressive amount close in size to our current market capital invasion to meet the needs of 5.6 million customers across 11 states. We are actively managing our supply chain to ensure we deliver on our commitments, specifically related to current fine tariffs, we estimate that the direct tariff exposure on our $54 billion base capital plan for 2025 to 2029 is minimal at approximately 0.3%. We have a sizable generation portfolio and one of the largest transmission and distribution businesses in the nation. In fact, AEP owns and operates more 765kV transmission lines than all other utilities in the United States combined, and we were recently awarded construction to build one of the first 765kV lines in Texas. We are enabling extraordinary economic development in high growth states like Indiana, Ohio, Oklahoma and Texas and stand to benefit from these once in a lifetime opportunities presented by the Associated Load Growth. Trevor will go into this in more detail shortly. Our story continues to be one of consistency and commitment to delivering for our customers, states, regulators and investors as we center on execution and accountability and we offer a compelling value proposition to our investors as we target 10% to 12% total annual shareholder return. We have a lot of exciting ground to cover today. I'll begin with a recap of our financial results at a high level before turning to strategic growth opportunities ahead and our recent regulatory and legislative successes. I'll then hand the call over to Trevor to walk through our financial results in more detail. Please refer to today's presentation for our quarterly business highlights and achievements starting on Slide 5. This morning we announced first quarter 2025 operating earnings of $1.54 per share or $823 million. With this strong performance, we are reaffirming our 2025 operating earnings guidance range of $5.75 to $5.95 per share and long-term operating earnings growth rate of 6% to 8%. This guidance is reinforced by a balanced and flexible $54 billion five-year capital plan with the potential for incremental investments of up to $10 billion over that same period. As we have communicated in the past, maintaining a strong balance sheet is vital to funding these capital spending needs. Later in the call we'll go into more detail about AEP's commitment to credit quality and proactive actions we have taken in the first three months of 2025 to address AEP's equity needs. As we move forward, we will remain disciplined in sourcing efficient forms of capital to manage our needs in support of incremental investment opportunities. We remain excited about the significant growth opportunities ahead, including the load growth in many parts of our service territory. This growth is not a show me story, it is happening. AEP's total retail load growth has already been favorable over the past few years, primarily driven by commercial customers. In the first quarter of 2025, our commercial load grew 12.3% compared to the first quarter of last year. As we look ahead, AEP is extremely well positioned to participate in future growth across our footprint. We see opportunities to invest in critically needed infrastructure to support increasing electric demand. Our current capital plan includes customer commitments for over 20 gigawatts of incremental load by 2030, driven by data center demand, reshoring, manufacturing and continued economic development. This incremental 20 GW is about a 55% increase over 2024 system wide summer peak load. As we have consistently said, we are absolutely committed to fair cost allocation associated with this large load growth. To that end, we proactively filed the data center tariff in Ohio and large load tariff modifications in Indiana, Kentucky, Virginia and West Virginia. In the first quarter, we received commission approvals in Indiana, Kentucky and West Virginia related to large load tariffs. The data center tariff hearing in Ohio also concluded in January and we expect to have a commission decision in the second half of this year. These are all strong indications of our state's continuing commitment to attracting large loads with their economic impacts on local communities while also protecting our existing customer base. As we have previously discussed, meeting this incredible demand could require incremental investments of up to $10 billion underpinned by four major large load in some of our bigger service territories, continued economic development in our states, investment across the system in our transmission and distribution infrastructure, and new generation. One of the reasons we are seeing such growth now is due to investments we made over the past decade to build an advanced 40,000 mile transmission system that can help support current large loads. Our transmission system also includes the nation's largest network of 765kV and 345kV lines. These ultra high voltage lines position us exceedingly well in attracting hyperscalers to our system who need consistent large load bulk power. We also continue to invest in our distribution system, which is one of the nation's largest at approximately 225,000 miles. This includes work to harden infrastructure, build or rebuild poles, conductors, transformers and other assets as well as deploy automated technologies for enhanced operational performance. These efforts will help to increase customer satisfaction, strengthen our systems resilience to weather events and enhance the efficiency of our operations. As our generation needs increase to meet growing demand, we are engaging with key stakeholders and making thoughtful investments in new generation to align with their needs and state policies. Our team has worked diligently to develop creative energy solutions that keep our customer’s needs top of mind. We have already shared our plans to begin the early site permit process in Indiana and Virginia for small modular reactors or SMRs that can generate clean, reliable energy to support significant load growth in our service territory and we recently filed integrated resource plans or IRPs in both Arkansas and Indiana. These IRPs, in addition to other planned IRP filings over the next year in Kentucky, Michigan, Virginia and West Virginia will help meet our customers energy needs and support AEP's generating capacity obligations, reinforcing our incredible growth. The fact is that demand for power is growing at a pace not seen in decades and our expansive footprint enables us to significantly participate in this electric infrastructure super cycle. Now let's pivot to some traditional regulatory and legislative updates. In my nine months here at AEP, I have been actively engaged with stakeholders to underscore the importance of our customers and communities and how we work to meet their needs. Building on our meaningful progress in achieving positive regulatory developments in the second half of 2024, we are off to a great start in 2025 with approximately 80% of our rate related revenue already secured for this year. In fact, AEP's first quarter earned ROE for our regulated businesses was 9.3%, up from 9.05% at year-end. As a reminder, some recent regulatory successes include a recent Commission decision approving construction in ERCOT's Permian Basin for one of the first 765kV transmission lines in Texas, opening up tremendous investment opportunities for AEP Texas, PJM transmission system upgrades awarded to AEP affiliates including Transource Energy and our Transmission Companies. System resiliency plans approved at AEP Texas and a unanimous settlement reached at SWEPCO Texas. Base cases approved in Oklahoma and Virginia and recovery of annual transmission expense approved in Kentucky. In late March, we also filed a new base case in Arkansas requesting a rate increase of $114 million. This ask is primarily to align regulatory recovery of certain wind projects, including rate implementation of the diversion and wagon wheel projects. Our application includes an ROE request of 10.9% and SWEPCO anticipates an order and new rates effective in the first quarter of 2026. Previously, APCO filed its base case in West Virginia while offering securitization of up to $2.4 billion as a tool to mitigate the bill impact of a proposed $250 million base rate increase. The procedural schedule just kicked off last month with intervener testimony and rebuttal testimony will follow later this month. The hearing is set to start in mid-June. We look forward to working with everyone in this case to achieve a positive and balanced outcome later this year. We are intently focused on reducing regulatory lag and have made a number of other timely filings so far in 2025, including the AEP, Texas TCOs and DCRF biannual filings as well as SWEPCOs annual Foreign Reload Rate Plan in Louisiana For I&M, the team recently filed to acquire an 870 megawatt natural gas plant in 2026 which is located in Oregon, Ohio that will help I&M customers continue to benefit from reliable and affordable resources. We are also working diligently at the legislative level in a number of jurisdictions to advance policy changes to improve both recovery and customer affordability. For example, in Ohio the recent passage of House Bill 15 positively results in multiyear forward looking test years for future rate cases and includes grandfathering language for two behind the meter fuel cell contracts. Trevor will go into further detail on the OVEC related impacts. And in Virginia we supported securitization legislation that will both reduce customer bills and support critical investments in the system. You can expect to see us continue to work with federal policymakers, regulators and state legislators as we further modernize our energy grid. We firmly believe that the best way to create value for investors is by delivering safe, affordable and reliable energy to our customers and communities, and we are engaging with stakeholders to support efforts to do just that. I am increasingly confident in our exciting growth potential as opportunities to benefit our customers, communities and investors come into focus, and I look forward to building on our track record of value creation in the months and years ahead. With that, I'll turn it over to Trevor, who will walk us through AEP's first quarter performance, drivers and other financial information."
},
{
"speaker": "Trevor Mihalik",
"text": "Thank you, Bill. Today I'll review our financial results for the first quarter, build on Bill's remarks about our exceptional load growth, comment on our credit metrics, further discuss the recent successful $2.3 billion forward equity issuance that completes our anticipated equity needs through 2029, and address our thoughts on federal tax legislation. Let's go to slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter were $1.50 per share compared to $1.91 per share in 2024. There is a detailed reconciliation of GAAP to operating earnings for the quarter on slide 26 of today's presentation. In the quarter, due to the passage of Ohio House Bill 15, we recorded a charge of $28 million related to the write-off of previously deferred OVEC costs, which we no longer believe are probable of recovery. From an operating earnings perspective and effective upon becoming law this summer, House Bill 15 removes AEP Ohio's ability to recover losses or record gains from the sale of OVEC power. Historical losses recovered from customers were approximately $40 million in 2024. However, we expect the earnings impact going forward to be significantly muted given upcoming capacity prices in PJM. Prospectively, the impact is manageable and less than $10 million of earnings on an annualized basis. Let's walk through our quarterly operating earnings performance by segment on Slide 8. Operating earnings for the first quarter total $1.54 per share compared to $1.27 per share in 2024. This was an increase of $0.27 per share or about 20% quarter-over-quarter, highlighting a strong start to the year and creating solid momentum for the rest of 2025. I would note that weather accounted for about $0.18 of the quarter-over-quarter variance. This was driven by the cold weather that most of our service areas experienced in the first quarter of this year, which was contrasted with the exceptionally mild weather seen in the same period of 2024. Looking at the drivers by segment, operating earnings for the vertically integrated utilities were $0.66 per share, up $0.09 from a year earlier. Positive drivers included favorable changes in weather and rate changes across multiple jurisdictions. The transmission and distribution utilities segment earned $0.36 per share, up $0.07 from last year. Favorable drivers in this segment included rate changes driven by rider recovery of distribution investments in Ohio and the base rate case in Texas, favorable weather and higher transmission revenue. The AEP Transmission Holdco segments contributed $0.44 per share, up $0.04 from last year. Our continued investment in transmission assets as new loads are added to our system remained a key driver in the segment. Generation and marketing produced $0.14 per share, up $0.02 from last year. Favorable retail and wholesale margins were partially offset by lower distributed generation margins due to the sale of the OnSite Partners business in September of 2024. Finally, Corporate and Other saw a benefit of $0.05 per share, primarily driven by the timing of income taxes, of which $0.03 is expected to reverse by the end of the year. Moving to slide 9, I want to highlight the significant increases in load we continue to see across our system. As Bill mentioned, the increasing load growth coming to the system is providing the opportunity to add up to $10 billion of incremental capital over the next five years to our already sizable $54 billion plan. Since our last call, both Amazon Web Services and Google have connected hyperscale data centers to our system in Indiana representing billions of dollars in customer investment. This comes on top of the existing data center customers in Ohio and Texas who continue to ramp up at a double digit pace. We also saw new large industrial load continue to come online in Texas across a variety of customers and industries. All of this puts us on track to nearly triple the pace of our retail sales growth from 3% in 2024 to almost 9% in 2025. That represents the largest acceleration of load at AEP since the late 1960s, a truly once in a generation opportunity. In fact, we expect that step change in growth to be maintained well into the future. Our current forecast supports annual retail load growth of between 8% and 9% through 2027. That's equivalent to roughly 52 million incremental megawatt hours that we expect to serve relative to our current load of 182 million megawatt hours, or nearly a 30% increase. More than offsetting the decline in our residential sales is a massive and sustained increase in demand from our C&I customers. Based on our current contracted lows, our C&I sales mix will grow from roughly two thirds of total retail to nearly three quarters over the next several years. There is a slide in the appendix that shows a bit more detail on first quarter sales by class. Those growth rates are one of the best in the industry and we have confidence that these lows are going to show up. We have a significant amount of demonstrated and diverse demand across our system, but I think it's also important to highlight what that demand looks like and how we're incorporating it into our projections. You will see on slide 10 a piece of that demand through some illustrative examples of the types of projects we're adding to our system. First and foremost, let's start with a number of overall requests to connect to the system. Across our 11 state operating footprint, we currently have more than 500 existing and potential customers actively requesting to connect almost 180 gigawatts of load to our transmission system. For context, our system wide summer peak was just under 37 gigawatts last year, so we have nearly five times that amount active in the queue. Now obviously we know that not all of the requests will come online, which is why we take great care in using a probability based approach to determine the likelihood of these loads as part of our annual load forecast. So far we've committed to adding just over 20 gigawatts onto the system over the next five years, which in the context of our queue is relatively conservative. Given the dynamic nature of AI driving the surge of data centers and large industrials coming online, we think it's vital to rely on demonstrated customer demand to build out our planning forecast. We believe the best mechanisms to demonstrate the demand are executed contracts backed by financial commitments, including electric service agreements, or EFAs, and letters of agreement, or LOAs, showing how firm these loads really are. Every megawatt in the forecast you see here is supported by LOAs. In addition to LOAs and PJM, 80% of the load growth in this region is also backed by ESAs, which are take or pay contracts requiring customers to pay for power as of a certain start date, irrespective of their offtake. This not only helps confirm that customer’s projects are real, but also incentivizes customers to stick to the schedule, reducing the risk to our existing customers and investors from a project not coming online. This is also why we've been very active in working with our regulators to strengthen and lengthen the tariff provisions in those contracts. Our contract terms, coupled with a queue that is nearly 10 times the size of our current increased load forecast, gives us great confidence that this demand will show up, which in turn makes us confident in our $54 billion capital plan with incremental upside. Should any of these projects be canceled or postponed in addition to the protective financial provisions in the contracts, our Q [ph] means that we have other active customers to slot right into place and take up that capacity. In addition to the demonstrated demand that we're seeing across the system, it is also important to note the diversity in that demand. While data centers are driving a majority of the load growth in the coming years, we are also contracted to add roughly 6 gigawatts of industrial load across a number of diverse industries, including steel, autos and energy. This diversity reassures us that the demand behind our capital plan is solid and can hold up across several different economic environments, including those with tariff impacts that we may find ourselves in over the next several years. Let's move on to slide 11 to discuss AEP's liquidity and commitment to credit quality. Recall that AEP's funding plan supporting our capital spend through 2029 originally included $5.35 billion sourced from equity. In January, we secured a minority equity interest investment in the Ohio and I&M Transcos with KKR and PSP Investments for $2.82 billion. This deal is value accretive at 2.3 times rate base and 30.3 times price to earnings. We expect to close in the coming months and the only remaining item outstanding is FERC approval, which we filed for on February 3rd. In March, we saw a compelling opportunity to further derisk our funding needs through a $2.3 billion forward equity transaction, including the greenshoe that allowed us to capitalize on known market conditions and manage the timing of proceeds. In combination with the expected proceeds from the minority transaction, I am pleased that we now have completed our anticipated equity needs through 2029 associated with our $54 billion capital plan. Those two transactions are equivalent to issuing common stock at approximately $140 per share, a 25% premium to our current share price. Moving on to federal tax legislation and specific to transferability impacting FFO, we believe a complete retroactive IRA repeal is unlikely based on our many conversations with policymakers. If there is a repeal, we would expect any potential legislation to provide business certainty by protecting the qualifying tax incentives for existing projects as well as safe harbor projects currently under construction. This would give us the ability to monetize tax credits in a timely manner and meet our financial commitments. You can see the FFO-to-debt metric stands at 13.2% for the 12-month ended March 31, which is a 0.2% decrease from the prior quarter. However, the minority interest transaction is expected to improve near term FFO to debt by 40 to 60 basis points, which sets us up to be well above our credit threshold and puts us on a path to be in the targeted 14% to 15% FFO to debt window. Finally, let's move on to slide 12 before we take your questions, I wanted to summarize what you heard from us today. First, you heard that we have taken significant actions to derisk our financial plan through the highly attractive and accretive minority interest transmission transaction which is expected to close in the coming months. Coupled with the $2.3 billion equity offering completed in late March prior to the current market turbulence, these transactions combined complete our anticipated equity needs through 2029 to support our current $54 billion capital plan. Second, you heard that we delivered strong financial results in the first quarter, growing earnings substantially compared to last year. Positive regulatory developments have set a strong foundation and are paving the way for a successful 2025. Third, you heard about our remarkable low growth story underpinned by major economic development activities across our footprint, providing significant investment opportunities in our utilities and creating an attractive growth profile for our investors. We highlighted the regulatory progress on retail tariffs that we've made to enable these load additions to result in a fair allocation of costs and protections for our existing customers. Fourth, you heard about our continued focus on the execution of our unprecedented $54 billion capital plan with the potential for incremental investments of up to $10 billion. In summary, our confidence in achieving our 2025 commitments remains strong and we are reaffirming our operating earnings guidance range of $5.75 to $5.95 per share, our long-term growth rate of 6% to 8%, and targeted FFO to debt of 14% to 15%. With that, I'm going to ask the operator to open the call so we can take your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question will come from the Shar Pourreza with Guggenheim. Please go ahead."
},
{
"speaker": "Shar Pourreza",
"text": "Hey guys, good morning."
},
{
"speaker": "Bill Fehrman",
"text": "Good morning, Shar. How are you?"
},
{
"speaker": "Shar Pourreza",
"text": "Good morning. Oh, well, very well, Bill. Just I know West Virginia is one of the first rate cases you kind of rolled up your sleeves for, after, that prior bad outcome which obviously predated you, I guess. How are conversations going there, especially around securitization? Can you settle this before the mid June hearings? Thanks."
},
{
"speaker": "Bill Fehrman",
"text": "Yes, really appreciate the question. We've been having first of all, at a high level really good luck with a lot of our regulatory outcomes across the system. And I'm really pleased with the work that the team has been doing to focus closer in on our local communities and our states and pushing us to do what our states want. And in the case of West Virginia, I'm excited with where we're at. The hearing is scheduled for June with the commission decision later on this year. We've incorporated securitization as an option to enhance customer affordability. We've worked with the teams there and we believe that this offers a really significant benefit to our customers by potentially reducing the impact on their bills by almost 75%. So I think there's really some interesting opportunities here because that would essentially decrease the increase we're looking for to around 3.8%. But ultimately the decision rests with the commission and we look forward to working with all of the stakeholders to achieve a favorable outcome for everyone and we'll participate in discussions as they come up. But right now overall though, I'm very, very excited with how the organization is responding in our states. And I think as you hopefully listen to all of the positive regulatory outcomes we've had over the past few months, you'll see that we're really moving in the right direction and I'm really excited about where we're at."
},
{
"speaker": "Shar Pourreza",
"text": "Perfect. Fantastic. And then just lastly, the 20 gigawatts of load you have out there. We've seen some pullback with at least one hyperscaler in Ohio. Microsoft, I think, is the notable, I think in your service territory, I guess. How are conversations going with the hyperscalers? More specifically, are you seeing any kind of sense of pullbacks? Just trying to get a sense with that customer class specifically. There seems to be some conflicting data points out there with the caveat you guys have a diversified load environment. Right, but specific on hyperscalers. Thanks."
},
{
"speaker": "Bill Fehrman",
"text": "Sure. Well, of course, overall on our system, demand remains really robust. And as Trevor noted, we've got over 500 existing and potential customers that are looking to connect 180 gigawatts of load on the transmission system. And so despite the fact that Microsoft made a decision to delay their projects, we've got an incredible backlog that want to come onto our system and we're very excited about working with those customers and getting them connected. I don't really see a reduction in our other load coming from data centers or hyperscalers or the industrials for that matter, because we've contracted that about 6 gigawatts of industrial load as well across the system and really given us a diversity that will strengthen the company overall for us going forward. And so I think we're in a very strong position. This diversity provides confidence that the demand supporting our capital plan is really resilient and capable of enduring these various economic outcomes, so whether Microsoft is with us or not, we see really significant demand coming forward and we've got plenty of folks who want to jump in if they want to jump out."
},
{
"speaker": "Shar Pourreza",
"text": "Got it. Perfect. Fantastic, guys. Congrats. See you soon."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Aidan Kelly",
"text": "Hey, good morning. This is actually Aidan Kelly on for Jeremy. Just focusing on the load growth again. It looks like total retail sales were up around 3.2% versus the 8.8% 2025 target. And then also with the commercial up 12% versus 24% target. How do you reconcile, like the sales trends we've seen this quarter against your 2025 forecast, would this imply a strong pickup later in the year? And are there any sensitivities we should think about here in general?"
},
{
"speaker": "Trevor Mihalik",
"text": "Yes, Aidan, thanks for the question. This is Trevor. So I would start by saying the anticipated load growth, particularly the rapid 8% to 9% increase that we're seeing over the next several years does open up substantial capital investment opportunities. And we expect that to drive consistent and robust earnings growth, especially in the second half of the decade. So to your specific question, while near term earnings impacts are somewhat muted due to the general lower profit margins of the C&I customers compared to the residential customers, I would say the rapid addition of C&I load really does create additional headroom and further enhances customer affordability. Just kind of as a rule of thumb or an example, the margins from the vertically integrated residential customers are roughly five times larger than those of our data center customers. And for our T&D customers, that ratio is almost 8:1. So, you'll see a little bit of a decline in margins as we see some efficiencies on the residential side but overall this is really just a very positive growth story around C&I and what we're able to do to deploy capital over the long term. So we feel very good about it."
},
{
"speaker": "Aidan Kelly",
"text": "Got it. That's helpful. Thanks, Trevor. And then just maybe switching gears to kind of the opening remarks on Ohio. Could you just walk through the puts and takes, from shifting away from ESPs into NYPs and to what extent does this impact your regulatory strategy in the state and future rate case timing in General?"
},
{
"speaker": "Bill Fehrman",
"text": "Sure. Well, HB15 was a legislation that ultimately received approval from both chambers, it has not been sent to the Governor yet. We expect that to happen really any day now. Once that happens, the governor has 10 days to sign the bill and then we anticipate that the bill will become law thinking early August, which is 90 days after his approval. My view of this legislation is that it's highly constructive. It supports capital investment growth in Ohio and really actually provides benefits to our customers. For us, the main provisions that impact our business, first and foremost is the new legislation that ends ESP and it introduces a multi-year forward looking test year with a true UP [ph] mechanism. So that is a significant advantage for us. It promotes timely recovery of our investments and then unlike other Ohio utilities, our transition from ESP5 to the new construct will proceed seamlessly with no gaps in our timing. And so really looking forward to moving through that transition, it's going to be an incredible advantage for us going forward. And then the second piece was the behind the meter components of the legislation. So this legislation, again we're happy with the outcome here. It basically grandfathers the two projects that we had in flight with our Bloom Energy solution for the data centers that we previously have discussed. This will preserve those existing agreements and then we have basically the flexibility to deploy future fuel cell purchases to other affiliates. And so we're going to continue to offer that as an alternative in our other areas and then make sure that we deliver on our commitments to the two customers that we have in Ohio. And then the third piece of this is, is the OVEC issue and I'll turn that over to Trevor to describe, but I think overall it's something that we'll be able to manage through. So Trevor."
},
{
"speaker": "Trevor Mihalik",
"text": "Yes, terrific. Thanks, Bill. Yes, so with regards to the OVEC situation, historically we've indicated that ending the cost recovery would result in roughly a $40 million impact, and that's what it's done in years past. Again, as we said in our prepared remarks, given the upcoming capacity prices in PJM, we expect the earnings impact to be really significantly muted to the tune of about potentially $0.02 or we said roughly $10 million of earnings. And that's something that I think is very manageable and we can incorporate prospectively. As Bill also just mentioned here, this will probably most likely become law and take effect in mid-August. And so we will get recovery up through that date. And so I think this is one of those things that is really not a huge earnings driver for us and we can deal with this going forward."
},
{
"speaker": "Aidan Kelly",
"text": "Appreciate the color. I'll leave it there. Thanks."
},
{
"speaker": "Trevor Mihalik",
"text": "Absolutely. Thanks, Aidan."
},
{
"speaker": "Aidan Kelly",
"text": "Yes, thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Paz with Wolfe Research. Please go ahead."
},
{
"speaker": "David Paz",
"text": "Hey, good morning."
},
{
"speaker": "Bill Fehrman",
"text": "Morning."
},
{
"speaker": "David Paz",
"text": "I know you addressed this, I think on the previous question to a certain degree, but maybe on the commercial sales in particular for 2025, see that they're tracking at least year-over-year, 12%, but your target a little higher for the full year. Just are you seeing any delays? Is there a specific shaping that you may have talked about previously that's playing out in terms of just back end loaded for the year for 2025 on commercial sales?"
},
{
"speaker": "Bill Fehrman",
"text": "Yes, David. So I think the good thing, and we mentioned this in the prepared remarks, is with the commercial load growth, what we're seeing is a lot of these counterparties are signing the LOAs and entering into firm contracts with us. And so, these are again, really take or pay contracts that are enabling us, irrespective of what their load looks like, to ensure that they are starting to pay under those contract terms. And so while the step up of 12% is really positive, we continue to see people signing these take or pay type contracts and I think you'll continue to see additional load coming on over the next several years and so this is all very positive in that regard. But I wouldn't say it's shaped towards the back end or anything to that regard. I think it's really more just a steady increase in commercial load coming on that we have seen over the last several months here."
},
{
"speaker": "David Paz",
"text": "Okay, so for 2025, you still anticipate about 23%."
},
{
"speaker": "Bill Fehrman",
"text": "That's right."
},
{
"speaker": "David Paz",
"text": "Year end 25 versus year end 24, okay."
},
{
"speaker": "Bill Fehrman",
"text": "Yes."
},
{
"speaker": "David Paz",
"text": "And then just you just touched on this, the previous question on the Bloom partnership. But will, will there be a -- how should we think about the deployment versus what you have before the Ohio law understanding it's not, the Ohio Market, AP Ohio Market is not there. But will this change any type of schedule of deployment for the remaining one gig?"
},
{
"speaker": "Bill Fehrman",
"text": "Well, we're in the market to sell those to customers who are interested in this technology. It will not affect at all the two projects that we have in flight. Those will go forward as planned and those are well underway. So for the remaining 900 megawatts that we have available to us, we do have a number of customers that we're in conversations with and feel optimistic that there may be deals coming down the road. So we'll see where this all heads and can certainly report on this more as future calls come this year."
},
{
"speaker": "Trevor Mihalik",
"text": "And let me add just one thing, Bill, if I could on that. The remaining 900 megawatts is really an option for us, we are not obligated to take those fuel cells. And so if we can find capacity and customers to take them, that makes sense. We will do that. But again, we're not obligated to."
},
{
"speaker": "David Paz",
"text": "Yes, the original 100 megawatts that we did contract are taken care of."
},
{
"speaker": "Bill Fehrman",
"text": "Yes."
},
{
"speaker": "David Paz",
"text": "Great. Thank you. Yep."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Julien Dumoulin-Smith with Jefferies. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey, good morning team. Thank you guys very much. Appreciate it. Nicely done here. Just wanted to follow up on the 10 billion upside number here. I just wanted to say a little bit of what's already approved here. What do you have line of sight even within that $10 billion bucket? It seems like there could be some various pieces there. And then also what are you waiting for in terms of line of sight to formally introduce that? As you say, it's within the five year program. You comment several different times about this being tied to the load growth and the relative degree of confidence you have on the load growth. So effectively, what are we waiting for? What are the sub pieces there that would enable you the confidence to more formally integrate that into the plan?"
},
{
"speaker": "Trevor Mihalik",
"text": "Yes, Julien, it's Trevor. Appreciate the question. I would say what we're really doing is we're setting the cadence where we want to come out with a formal growth plan on an annual basis. And we'll generally do that around call the third quarter call right before we go into EEI, unless there's something material that would increase that $10 billion plan or $10 billion potential upside to the $54 billion plan. That being said, I think, it's important to note that the recently awarded 765 transmission lines, for example, in Texas, that's roughly $1 billion to $2 billion. That's not in the current plan. And so as things firm up, we will continue to look at how we manage the overall portfolio spend relative to what our customer’s needs and what the states want and that'll impact a large part of what that 10 billion looks like. I think roughly, if you wanted to kind of take a look at that 10 billion, we've said publicly that roughly about half of that 10 billion relates to transmission and the remaining is a majority of that is generation projects in the various service territories as we file and look at the various capacity and needs in the states. But again, we have great opportunities not only in ERCOT, we also have opportunities in PJM and we continue to flesh those out and we'll come with more definitive answers when we roll out our revised five year capital plan in the third quarter."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Okay, fair enough. And maybe just to elaborate a little bit further, what is in that 5 billion generation bucket? Can you speak a little bit to how you think about that versus the load growth numbers that you have? Is this just about line of sight on RFPs coming out of anticipated load growth or is there something further within that here?"
},
{
"speaker": "Trevor Mihalik",
"text": "No, it's largely what you just said there. It's the RFPs. It's also looking at potential wind projects or other renewable projects in various states. It's also related to potentially some combined cycles as we look at what the overall capacity needs are and the generation needs are in our service territory, so these are items that we have a line of sight to but we have not firmly committed to yet."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Oh, actually just to clarify, you've got two acquisitions out there, one potentially in Oklahoma and one in Indiana or Ohio specifically. Those are included in the plan and you intend to move forward with those?"
},
{
"speaker": "Trevor Mihalik",
"text": "That's right, that's correct. Those were items that were included and we do have, the needs in those states for that generation. And so those, those are in there."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Awesome. All right, I'll leave it there. I'll pass it on. Thank you guys very much. Done again, thanks."
},
{
"speaker": "Trevor Mihalik",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Durgesh Chopra with Evercore. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey team, good morning. Thanks for giving me time. I just wanted to start-off with the Q1 earnings performance. So the report numbers are higher than where we thought you would end up in the quarter. You mentioned the weather benefit, but you also reaffirmed guidance for the year. I appreciate there are three more quarters to go with third quarter being the largest. Maybe just comment on how first quarter turned out, what's your expectations? Are you going into the balance of the year higher than where you expect it to be, just any color there would be helpful. Thank you."
},
{
"speaker": "Bill Fehrman",
"text": "Yes, thanks Durgesh. So as you did highlight, weather was a significant driver as was some of the rate impacts as we rolled out the revised rates in certain jurisdictions. But weather was a significant opportunity for us in the quarter. I will say, that's roughly in line with where we anticipated we would be and we feel very good about laying out our full year guidance range and staying within that guidance range. And as you indicated it's still fairly early with just the first quarter but we're going to be very disciplined in our capital allocation. We are looking for ways to ensure we are doing things efficiently at the operating companies as well as at the corporate center to drive efficiencies and to drive affordability for our customers. But I feel good about the 560 or the 575 to 595 guidance range that we put out in the 6% to 8% long-term growth rate and certainly would anticipate that we would again talk to that in the second quarter as we continue to see some of the successful regulatory outcomes rollout that we've seen over the last few months here."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Sounds like things are on track. Okay. Then switching gears to just the per colocation process here. A couple weeks ago the IPP came out and sort of suggested settlement talks any color you can share there on what might be happening behind the curtains and timeline for a potential settlement if it's reached."
},
{
"speaker": "Bill Fehrman",
"text": "This is Bill. Sure. So this is Bill on the co-location issues. We've said many times on this is that we're not against colocation. What we are wanting to make sure is that anyone doing that sort of arrangement pay their appropriate fees on the transmission system and so we're continuing to follow the process at FERC and that's moving forward and will continue to be engaged fully. But at the end of the day on this it's really more about ensuring that if you use the transmission system you pay your fair share. And so we'll continue to monitor this and see where it goes."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Thanks Bill. Thanks Trevor and congrats on start to the year."
},
{
"speaker": "Bill Fehrman",
"text": "Yes, thank you."
},
{
"speaker": "Trevor Mihalik",
"text": "Thanks Durgesh."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Nick Campanella at Barclays. Please go ahead."
},
{
"speaker": "Nick Campanella",
"text": "Hey, thanks for all the updates."
},
{
"speaker": "Bill Fehrman",
"text": "Good morning."
},
{
"speaker": "Nick Campanella",
"text": "Hey. Just wanted to follow up on the CapEx upside. I'm just curious if you could talk about how you would plan on financing the 10 billion, if you were to kind of wrap it into the plan into next year, like do you have additional levers to pull on the asset sales side or could the securitization that's pending in West Virginia impact the company's overall equity needs in any way? I guess just do you have any levers to kind of mitigate what's been more of a more traditional, I don't know, 40% to 50% of funding across the industry."
},
{
"speaker": "Bill Fehrman",
"text": "Yes. So Nick, one of the things we did, and we said on the year end call in February that we had the 5.35 billion of overall equity that we needed over the five year plan and 2.8 billion of that was taken care of already with the sale of the Transcos. And then given where Bill and I were in March, we anticipated we'd rather take the market we know and so we went out with the remaining $2.3 billion, which really effectively takes all the equity, the marketed equity, off the table over the five year plan. So when you look at the incremental $10 billion, even if we needed to fund that with some level of growth equity, that would be on the back end of the plan because we've already pre funded a lot of that equity on the 2.8 billion on the sale and then the 2.3 billion is done under the forward through December 2026. And so when you look at that, we've really taken care of all the equity needs even with the forward in really the first two years of the five year plan, and so if we were to come back and firm up the 10 billion, I think we would really be in a situation where we would not need to issue incremental equity in the near term and then we will come back at a later time as to how we would fund that. To some of the points you raised specifically, again you mentioned the securitization. And while we believe that securitization is highly beneficial for our customers in modulating the rates, it also allows us to take approximately $2.4 billion of cash and deploy that cash elsewhere, and so there's a lot of levers like that. And then lastly, I would say we also would look at potential hybrids that we have out there, whether it's junior subordinated debt and I know others in the market have been utilizing those structures as well, and so we do have a lot of other levers to pull. That being said, I think we do like our assets and from our perspective, I don't think you're going to see us sell down any more transmission or anything to that effect, but rather we would look at ways to finance the growth in a very, very shareholder friendly way."
},
{
"speaker": "Nick Campanella",
"text": "Hey, that was great color. I appreciate that. Thanks for that. And then just one quick clarification. I know you kind of mentioned in your prepared remarks your comments on IRA. Is there just any quantifiable exposure if transferability did go away? Would that impact your plans whatsoever? Do you have any exposure there? Thanks."
},
{
"speaker": "Bill Fehrman",
"text": "Yes. So I would say again, on the whole IRA walking it back and I think this kind of gets back to some of the comments we made in our prepared remarks. But we really do believe that a complete retroactive repeal of IRA is pretty unlikely and that if a repeal does occur, we would expect the tax incentives for the existing projects and Safe harbor projects that are under construction will be protected. I think really when you look at this, all of AEP's existing tax credits, along with really all the anticipated tax credits through 2027 are safe harbored and would not be impacted by this proposal. And so then people have kind of questioned us with regards to the specific dollar amounts. And I would say transferability in our plan is manageable. It's roughly $200 million currently and then over the next several years it averages about $300 million. But all of that really pertains to Safe harbor and pre IRA projects that are expected to continue to qualify under the transferability. So again, very limited exposure in that regard from the IRA repeal language that's being talked about right now."
},
{
"speaker": "Nick Campanella",
"text": "Appreciate all those details. Thank you again."
},
{
"speaker": "Bill Fehrman",
"text": "Thanks, Nick."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Carly Davenport with Goldman Sachs. Please go ahead."
},
{
"speaker": "Carly Davenport",
"text": "Hey, good morning. Thanks for taking the questions. Maybe to start. Just to follow up, Trevor, on some f your comments earlier on the margin contribution from RESI versus C&I ocustomers. Can you just talk a little bit about the RESI dynamics driving that to track negative over the last several quarters here? Is that something you're watching and do you anticipate something shifting there to get you back towards that full year forecast for 25?"
},
{
"speaker": "Trevor Mihalik",
"text": "Yes. Carly, thanks for the question. And we certainly are focused on residential customers. And I think what you're seeing is we do have slight increases in residential and actual meter count. But what we're seeing is that's being more than offset by the decline in throughput on the residential side, mostly from efficiency and people really focusing on the costs to go through a cold winter like we just had, so from our perspective, I think we do watch it. We do see that C&I is adding a lot of growth that is helping to offset that. But again, as I mentioned, the C&I really margins are a lot less than residential and so we continue to monitor that. But what we need to do is continue to find ways to deliver very high quality service to our residential customers at an affordable price and then that will continue to be something that will offset some of the efficiencies that they're doing or the use that they're declining in."
},
{
"speaker": "Carly Davenport",
"text": "Got it. Great. That's helpful. Thank you. And then could you maybe talk a little bit about the 765kV Permian opportunity set? Just any color on how we could think about sizing what that CapEx could look like or the timing to deploy it? And is that something that is in the $10 billion of identified upside to the plan?"
},
{
"speaker": "Bill Fehrman",
"text": "Yes, good morning. So first of all, we're very, very excited about that outcome in Texas when we think about the opportunities there going to 765 was a very strong message by the government and regulators in Texas that they foresee a very strong future for the business climate there and the need for energy, and the fact that they moved to 765 is an incredibly strong statement about what they view as their potential in Texas. And so for us, of course, we were the original innovator of 765 back in 1960 and have been building it and perfecting it for many years, and in fact, really the only company in the country that has the capabilities to do this. And so we're incredibly well positioned in Texas for this. We're excited about this first project and firmly believe that it will open up additional ones going forward for this one. We think it's in the $1 billion to $2 billion range and the work on this project will begin in the very near future and of course it will take some time to deploy. But overall, the fact that we are the leader in this country for 765 and the fact that Texas is looking at a significant increase in that type of transmission bodes well for AEP."
},
{
"speaker": "Carly Davenport",
"text": "Thank you so much for the color."
},
{
"speaker": "Bill Fehrman",
"text": "Thank you."
},
{
"speaker": "Trevor Mihalik",
"text": "Thanks, Carly."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Andrew Wiesel with Scotiabank. Please go ahead."
},
{
"speaker": "Andrew Wiesel",
"text": "Hey, good morning everyone. Appreciate all the detail on the call here. I've just got one follow up on the FFO to Debt. I might have misheard some of what you said in the commentary, but based on the slides, it looks like it was 13.2% on a TTM basis through March, that's down from 14% last year. Can you just talk a little bit about the moving pieces. Then, of course, as you mentioned, the minority interest sale will add 40 to 60 basis points later this year. That won't quite get you to 14%. Can you talk about what will get you over the hurdle? So you've got the 100 basis point cushion over the 13% downgrade threshold, please. Thank you."
},
{
"speaker": "Trevor Mihalik",
"text": "Yes, thanks, Andrew. So we ended last year at 14% FFO to debt, but that was also prior to the change in methodology with regards to the deferred fuel. And that took about 40 to 50 basis points off of that 14% FFO to debt. Now, I will say that the deferred fuel, as we're collecting the deferred fuel balances, we're really not putting that or the new methodology does not put that into the numerator. That rolls off and will be largely done by the end of 2026. So that's where we really were with regards to the deferred fuel and the end of the year. So the 14% was under the old methodology and call it 13.5, 13.6 under the new methodology. And then we're at 13.2, you're right, with the trailing 12 months, but what we're anticipating is the minority interest transaction will raise that by 40 to 60bps. So that'll take us to 13.6% to 13.8% once we close that transaction and then just continued focus on execution around efficient operations and increasing the numerator will be a big part of how we're going to ultimately get into that 14% to 15% targeted range that Bill and I really feel we want to be in so that, you know, we can have a level of cushion well above our 13% downgrade threshold. So hopefully that gives you a little bit of color."
},
{
"speaker": "Andrew Wiesel",
"text": "Yes, that's very helpful. Okay, great, Great. And then one, just to clarify, of the recent regulatory wins, were they all included in the CapEx plan already? Specifically, I'm talking about the 1.1 billion of transmission from Transource Energy and the 600 million through AEP Transcos as well as the Texas Resilience plans."
},
{
"speaker": "Trevor Mihalik",
"text": "Yes, look, I would say from our perspective, within the plan, we laid out what we thought was a very good plan at the beginning of the year. I came in as the new CFO, certainly pressed on what the planning assumptions were, and we're still very committed to our 575 to 595 and there's going to always be some puts and takes, but at the end of the day. We feel very good about where we are on the 575 to 595 and the overall 6% to 8% long-term growth rate."
},
{
"speaker": "Andrew Wiesel",
"text": "Okay, I guess my question was, were those projects included in the $54 billion five year plan?"
},
{
"speaker": "Trevor Mihalik",
"text": "Yes. And again, I would say yes, there are some projects that are included, there are some projects that fall away. So there's always puts and takes, but generally, yes."
},
{
"speaker": "Andrew Wiesel",
"text": "Okay, got it. But you're saying there's flexibility for projects over time. Understood. Okay, thank you so much."
},
{
"speaker": "Trevor Mihalik",
"text": "Absolutely. Yes."
},
{
"speaker": "Andrew Wiesel",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "And that will conclude our question and answer session. I will now hand the call back over to Bill Fuhrman for closing remarks."
},
{
"speaker": "Bill Fehrman",
"text": "Yes, thank you. We appreciate everyone joining us on today's call. I'd like to close with just a few summary remarks. First, I'm very excited when I think about the opportunities ahead at AEP as we advance the long-term strategy to drive growth, enhance the customer experience and achieve positive regulatory outcomes. We are putting our robust capital plan to work and continue to grow the business across our large footprint while delivering shareholder value. I'd also like to reinforce the incredible support we've had from our board to keep pushing forward with our plan to really strengthen the balance sheet, improve our regulatory outcomes and execute around what our states want. And I couldn't be more excited to be with this team and see where we're taking the company. So if there's any follow up items, please reach out to our IR team with your questions. This now concludes our call. Thank you."
},
{
"speaker": "Operator",
"text": "Today's conference will be available for replay beginning approximately two hours after the conclusion of this call and will run through 11:59 Eastern Time on Tuesday, May 13, 2025. The number to dial to access the replay is 800-770-2030 or 647-362-9199 for international callers. The conference ID number for the replay is 786-4240. This concludes today's conference call. Thank you all for joining. You may now disconnect."
}
] | American Electric Power Company, Inc. | 135,470 |
AES | 4 | 2,020 | 2021-02-25 09:00:00 | Operator: Good day and welcome to the AES Corporation Q4 2020 Financial Review Conference Call. Today, all participants will be in a listen-only mode. [Operator Instructions] As a further reminder, today's event is being recorded. At this time, I would like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Please go ahead, sir.
Ahmed Pasha: Good morning, everyone, and welcome to our fourth quarter and full year 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can also be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; and Gustavo Pimenta, our Chief Financial Officer. With that, I will turn the call over to Andrés. Andrés?
Andrés Gluski: Good morning, everyone, and thank you for joining our fourth quarter and full year 2020 financial review call. This morning, I will provide an update on our major financial and strategic accomplishments, which position us well for the future. Some of you may recall that last year, I set out three short-term catalysts for our stock: hitting our numbers, getting a second investment-grade rating, and becoming Norges Bank coal generation compliant. In 2020, we delivered on all three metrics and set ourselves up for continued progress. First, let me talk about hitting our numbers. We delivered adjusted earnings per share of $1.44, which was above our guidance range of $1.32 to $1.42. Our parent free cash flow came in at $777 million, which also exceeded the top end of our range of $725 million to $775 million. Second, in November, S&P upgraded us to an investment grade rating of BBB-, joining Fitch, which had upgraded us in 2019. Third, by selling a retiring coal plant and building new renewables, we will reduce the percentage of megawatt hours being produced by coal plants to 25% on a pro forma basis, which is comfortably below Norges Bank threshold of 30%. All of these results reflect the resilience of our business model, which is anchored on long-term dollar denominated contracts with investment grade off-takers and U.S. regulated utilities. In addition to these achievements, in 2020 we continue to advance our leadership in innovation and new green technologies. We signed 3 gigawatts of long-term contracts for renewables, which is also at the top end of our range of guidance of 2 gigawatts to 3 gigawatts. As you can see on Slide 4, these 3 gigawatts of new renewable PPAs are mostly in the U.S. and South America. In the U.S., we have merged our two development companies AES Distributed Energy and sPower into one entity, AES Clean Energy, to better take advantage of synergies and economies of scale. In South America, our renewables growth was fueled in part by the continued success of our Green Blend and Extend negotiations, which combined new renewables with existing long-term conventional capacity contracts. With the addition of these 3 gigawatts of new PPAs, our current backlog of projects reached 6.9 gigawatt as shown on Slide 5. About half of the total solar and most of the remainder is wind and energy storage; 100% of our backlog is renewable. We expect to bring almost 4 gigawatts of this backlog online in 2021, one of the largest capacity additions in AES' history. Finally, turning to Slide 6. Fluence, our joint venture with Siemens to provide energy storage systems, maintained its global leadership position and signed 785 MW of new capacity. Its revenues grew 400% versus the prior year and they acquired AMS' leading AI-enabled bidding software business. A capital raise was also announced with the Qatar Investment Authority, which will provide funds to further accelerate the development of its digital product offerings and the deployment of its systems around the world. As you can see, we are very well positioned to continue our solid renewables growth, aggressive decarbonization and deployment of leading technology innovations. The electricity sector is changing rapidly and we will be providing a comprehensive view of AES' long-term plans and opportunities in this new environment, next Wednesday, March 3 at our Investor Day. Now let me turn the call over to Gustavo, who will provide more color on our financial results for 2020 and guidance for 2021.
Gustavo Pimenta: Thank you, Andrés, and good morning everyone. Today, I'll cover the following key topics: our financial performance during the fourth quarter and full year 2020, our capital allocation initiatives in 2020, and our 2021 guidance. As Andrés mentioned, our results for 2020 highlighted the resilience of our business model. We delivered a strong financial performance while navigating challenging macro conditions, including the impacts of lower demand due to COVID-19 and a record dry hydrology in Colombia. We finished the year on a strong note, setting a solid foundation for continued growth. Turning to Slide 8. Full year adjusted EPS of $1.44 exceeded the top end of our guidance range and was at the midpoint of our regional pre-COVID guidance range. As I noted, the key negative impacts on our results were from lower demand and adverse hydrology. Our generation business, which accounts for more than 80% of our earnings, is largely insulated from demand fluctuations. However, as we have discussed in the past, our U.S. utilities did experience a reduction in demand due to the economic impact of the pandemic. Although there has been a gradual recovery in demand in the second half of 2020, the impact on a full year basis was approximately $0.04. Regarding hydrology, we experienced average hydrology in most of our markets, except in Colombia, where it was one of the worst hydrological years on record. The total impact of hydrology on our full year results was approximately $0.05 in South America, primarily in Colombia. We expected the hydrological conditions to be normal in Colombia in 2021, in line with the long-term historical average and have already observed this trend in the year-to-date. Despite the headwinds from these two areas, we are able to deliver on our full year guidance as a result of higher contributions from new businesses and improved operating performance in South America. We also benefited from our cost savings initiatives, interest expense savings, resulting from $7 billion of refinancings across the portfolio and a lower adjusted tax rate. Turning to Slide 9. Adjusted pretax contribution, or PTC, was $1.2 billion for the year, an increase of $7 million versus 2019. I will cover our results in more detail over the next four slides, beginning with the U.S. and Utilities SBU on Slide 10. As you may have seen yesterday, we have rebranded our U.S. Utilities, DP&L and IPL, to align with the new AES brand. So now on, these businesses will be known as AES Ohio and AES Indiana, respectively. In 2020, lower PTC at our U.S. and Utilities SBU reflects the impact of the reversion to ESP1 rates at AES Ohio in 2019 and lower demand at our utilities due to the impact of COVID-19 and milder weather. These impacts were partially offset by the benefit from the commencement of PPAs at the Southland Energy CCGTs as well as the contributions from new renewable projects. Higher PTC at our South America SBU was largely driven by higher contributions from AES Gener and a favorable revision of regulatory charge at AES Tiete in Brazil. These impacts were partially offset by drier hydrology and a planned major outage at the Chivor hydro plant in Colombia and the regulatory changes in Argentina in 2019. Lower PTC at our MCAC SBU primarily reflects the impact from insurance recovery in prior year as well as outages incurred in 2020 in Dominican Republic, partially offset by improved availability in hydrology in Panama. Finally, in Eurasia, higher results reflect lower interest expense due to the debt repayment in 2020 in Bulgaria, partially offset by the impact of businesses sold in the United Kingdom in 2019. Now turning to our credit profile on Slide 14. Our significantly reduced parent debt and growing free cash flow enabled us to improve our credit metrics by 400 basis points since 2018. At the end of 2020, our parent free cash flow to net debt ratio was 23%, well above the 20% threshold required for an investment-grade rating. Strong credit metrics remain one of our top priorities, and we continue to take steps to maintain and further improve upon current levels. Furthermore, we took advantage last year of a low interest rate environment and refinanced approximately $7 billion of debt across our portfolio, extending maturities and capturing annualized interest savings of $90 million. Now to our 2020 parent capital allocation on Slide 15. Beginning on the left-hand side, sources reflect $1.3 billion of total discretionary cash. Asset sales of $530 million reflect the net proceeds from the sale of OPGC and the sell-down of 35% of our interest in the Southland Repowering projects. Parent free cash flow of $777 million exceeded the top end of our expectation. Moving to uses on the right-hand side. Roughly, 1/3 of our discretionary cash was allocated to shareholder dividend and debt repayment. We invested $812 million in our subsidiaries, primarily in our renewables backlog, Southland repowering and AES Ohio. Approximately 90% of the total investments in subsidiaries were in the U.S., contributing to our goal of increasing the proportion of earnings from the U.S. to about half. Turning to our guidance on Slide 16. Today, we are initiating guidance for 2021 adjusted EPS of $1.50 to $1.58, in line with our average annual growth target of 7% to 9%. Parent free cash flow for 2021 is expected to be $775 million to $825 million, which is based on 7% growth from the midpoint of our 2020 expectation of $750 million. Key drivers of our expected growth in adjusted EPS in 2021 include: a full year of operations of our 1.3 gigawatt Southland Repowering project, which came online in mid-2020; continued growth in renewables, including 4 gigawatts expected to reach commercial operation this year; efficiency gains from cost savings in our digital initiatives; and an interest savings due to refinancing benefits and completed that reduction. We look forward to discussing our long-term growth rates and drivers with you all at our Investor Day next week. With that, I'll turn the call back over to Andrés.
Andrés Gluski: Thank you, Gustavo. Before we take your questions, let me summarize today's call. Thanks to the extraordinary dedication of our people and the resilience of our business model, we've met or exceeded all of our strategic and financial goals in 2020. We are very well positioned to capitalize on significant growth opportunities arising from the rapid transformation of our sector. As always, our primary focus is to continue to deliver superior returns to shareholders. We look forward to discussing our strategy and longer-term financial outlook with you at our Investor Day next Wednesday, March 3. With that, I would like to open up the call to your questions.
Operator: [Operator Instructions] Today's first question comes from Angie Storozynski with Seaport Global.
Agnieszka Storozynski: So two quick questions, one on your of 21 guidance, what effective tax rate is embedded in that guidance and is this an indication that you are actually expecting lower effective tax going forward?
Gustavo Pimenta: So Angie, Gustavo. No, I think we are - I mean, we had a - this year, 2020 was particularly lower, around 23%. For 2021, we're expecting to go back to our original expectation on the mid-20s to high 20s.
Agnieszka Storozynski: And then one of the points, a drag, year-on-year drag on your '21 guidance is some GSF adjustment in Brazil. Could you explain?
Gustavo Pimenta: Yes. So we had this positive gain there, but we also had especially in Colombia, some negative, call it, one-timer hit. So we had a life extension project there that was about $0.05 to $0.06 negative. So when you look at both businesses, they pretty much net each other out. So I wouldn't expect any drag from the hydro businesses in 2021.
Agnieszka Storozynski: Okay. And I know that you're going to be talking about strategy and longer-term growth plans only next week, but do you have any sense when Moody's could review your rating?
Gustavo Pimenta: Look, they came earlier this year and with a positive update on their credit view for AES, basically lowering the overall FFO to debt on a consolidated basis to 14% versus 16%. We are seeing us there, very close to these ratios. So we are positive. I think they will - we expect them to make a move hopefully this year. We'll see what is exactly the move that they make. But the ratios are there, and we think we're in a positive moment with them.
Agnieszka Storozynski: And then again, I know the Analyst Day is next week, but can you comment if you see yourself issuing equity any time soon, like, say, over the next 5 years?
Andrés Gluski: Yes. Hi. Angie, this is Andrés. Look, that's one of the tools available to us. And it depends, we'll see the growth rates we have. We have a lot of opportunities. So that's one of the tools in our kit.
Operator: The next question comes from Richard Sunderland with JPMorgan.
Richard Sunderland: Just want to start off maybe on the events in Texas last week. What do you see as the role for storage in the state going forward? And how might AES benefit from the deployment of storage locally?
Gustavo Pimenta: Sure. Look, storage can be used to make a more resilient grid definitely. And so I think that storage, the potential for growth in storage is enormous. What particularly happened in Texas, of course, was that you don't have capacity payments. So you didn't have really an incentive to winterize a lot of the existing plants into fossil plants and also, quite frankly, the wind turbines. Interestingly, solar performed very well. So I think the follow-on is, yes, people are going to be concerned about more resilient networks and storage can play a part, transmission, it can also play a part locally. So I do think that this will cast more light, more attention on energy storage as part of a more resilient grid.
Richard Sunderland: So do you see kind of a different opportunity for solar than for solar plus storage or just storage in general going forward as a result of the events? Or do you think it's more markets dying issues and kind of other specific factors that may be due to change?
Andrés Gluski: Well, my own personal opinion is that when you have a market where you don't remunerate capacity, I think is one of the key sources. Having said that, and of course, energy storage has many uses. It's not only solar plus storage, wind plus storage, stand-alone storage, but also to make improved transmission with existing lines, so you don't have to upgrade the whole line. So all of these, attention to the robustness of the grid and the network, is a positive for future sales of energy storage.
Richard Sunderland: And then just one specifically on the '21 guidance here. Any way to frame assumptions around asset sales, coal sales baked into '21 guidance versus what has been announced last year into this year?
Gustavo Pimenta: Yes, this is Gustavo. So all of the announced asset sales and retirements are incorporated. Effectively, we have India that closed late last year, so it's in here. We've said Vietnam, which was the other large one, would probably close between the end of this year, early next year. So it doesn't hit 2021. But effectively, all of the announced asset sales and retirements are incorporated in this 2021 guidance.
Richard Sunderland: And are there placeholders for incremental sales as well?
Gustavo Pimenta: I mean, if they happen, they'll probably close later. So specifically for 2021, wouldn't make any difference here.
Operator: The next question comes from Stephen Byrd with Morgan Stanley.
Stephen Byrd: I wanted to explore your corporate partnership with Google and just get your overall views on the degree of interest you're seeing from other companies to partner with AES, given AES' global reach in renewables and storage capabilities to help those corporates to achieve zero emissions. Is that an area you're encouraged by?
Andrés Gluski: Very much so, very much so. We've talked in the past about our relationship and partnership with Google, that continues to progress. But we're also seeing interest from other similar players, about - 24x7 renewables. So definitely, we're encouraged by this. And the fact that we have presence in other markets is an additional plus, not immediately, but down the road.
Stephen Byrd: Okay. So it sounds like something in the long term you're excited about, but nothing near term, but something we could see over time. Okay.
Andrés Gluski: No, I wouldn't say so long term.
Stephen Byrd: Okay. That's great. And then I guess just stepping back, maybe building a little bit on Angie's question on financing. You have a really great growth outlook in many different asset classes. And I was just curious, just at a high level as you think about just innovative financing approaches, financing tools out there, there certainly - strikes me, there's a lot of folks who love to provide capital to high-quality clean energy and storage projects. Are you seeing anything sort of new in terms of innovation? And as AES gets bigger and bigger in renewables, just different approaches to financing all of this growth?
Gustavo Pimenta: Well, it's a great question. Over the past, let's say, 8 years or so, we've sold about $6 billion of assets. And we have churned that money, right? And that's provided impetus for a lot of our new growth. We've also done partnerships. So those continue to - we'll continue to do asset sales, and we continue to do partnerships. So you're right. We're seeing a lot of interest in people co-investing with us in different shapes or forms. So this is very positive. I think we have a good reputation as a partner, who really looks at all shareholders in these joint ventures. So you're absolutely right, we're seeing a lot of new things. As you know, in the past, I'd say the one thing that did not come to fruition really was the effort that Tom led for about a year. Honestly, without COVID, it would have come to fruition, which was quite innovative. But as I always said back then, this was extra. We didn't need it to finance our growth. That was just a plus. So we're seeing, again, a lot of people who are interested in partnering with us and are different technology plays.
Operator: Today's next question comes from Julien Dumoulin-Smith with Bank of America.
Julien Dumoulin Smith: Congratulations, again. Perhaps, just to kick it off here on '21, and I'm going to try to hold back ahead of next week, obviously. But can you talk about the renewables contribution here in earnings as well as Fluence? How are you thinking about those two pieces? And especially, as you try to refine your expectations and given the success on renewable backlog here, I get renewables are not necessarily homogenous. But how do you think about renewable earnings contributions here? And I know this is getting a little bit ahead of next week, but can you speak to it especially in the context of '21, for both Fluence and renewables?
Andrés Gluski: Yes. Let me start it, and then I'll pass it over to Gustavo. So look, next year is very interesting just from a cutting ribbon point of view. We have 4 gigawatts that's coming online. So that represents PPAs, which were signed in the past. And this is one of the highest additions to our fleet in our history in a single year. So that we feel very good about. So the second thing is, as you correctly pointed out, our renewables come in different flavors. So about half is outside the U.S. and about half is solar, and about half is - there is some hydro coming online but there is mostly wind, some energy storage. Regarding Fluence, I would say that Fluence will not be a contributor to earnings next year because it's in a very rapid growth phase. What we see is a big increase, an acceleration in demand for energy storage as more uses are seen. And there were some questions about - prior on this call about grid stability. And then yes, it can play an important role in that. So we see growth accelerating in Fluence. And basically, as a result of that, it's harder to hit that break-even. But I would say that in terms of - it's just a little bit postponed in time because you're gearing up. Now we came out with the new cube stack. We also bought the AI-enabled bidding platform from AMS and that's a very interesting addition. And we've had sales of AMS bidding engine, actually not using Fluence's hardware. So generally, I would say that this kind of software platforms have less capital-intensive than building the cube stack itself. So that will help us turn profitability sooner. But there's this trade-off between very rapid growth and starting to break-even. But we feel very good about the company. So I'll pass it now to Gustavo to talk a little bit about the breakdown of our earnings. Now I realize a lot of these things are somewhat tied together because you have like Green Blend and Extend. So you basically have a capacity contract with a fossil plant plus renewables being added on to that. So with that, I'll pass it on to Gustavo.
Gustavo Pimenta: Thanks, Andrés. So Julien, I would say that 2021 is mostly driven by new additions. So remember, we had just half of the year for Southland, so we're going to have a full year of Southland, that's about $0.04. And then renewables altogether - we are bringing 4 gigawatts online, as Andrés said. Renewables altogether is about $0.05. So the delta 2021 is mostly driven by those additions. And then you have some items that offset each other. So there was a drag on tax. Tax was particularly lower. But we have recovered, for example, in the demand side from the Utilities, we're expecting some recovery there. We have the cost cuttings also that will offset some of the drag from tax. So if you clean all of that, I would say mostly of the growth of - primarily the growth is coming from the new additions, being Southland full year and $0.05 from renewables.
Julien Dumoulin Smith: Excellent. If I can ask you the obvious question here. Your target for annual development, I suppose, is 2 to 3 gigs, [technical difficulty] 4 gigawatts next year. Obvious question is, how do you think about that long-term target? And then related, given your comment on continued drag on Fluence, why hold on to a business that continues to drag your primary valuation metric in light of accelerating and improving outlook?
Gustavo Pimenta: Sure. Let's see. Let me take the first question, which was about the renewables growth. So we have 2 years where we've basically been about 3 gigawatts. Now when we talk about that, that's PPA signed. So those will be brought online normally in a period within 24 months, probably the average is about 18 months. So there's a lag there. So we have had two very strong years. So 4 gigawatts are going to come online, that means they're actually coming online. So the goal is sign PPAs. The second is - which are actually going to start contributing to your earnings. So we see continued acceleration, let's say, in the renewables business. So we feel very comfortable. It's no longer sort of 2 to 3, it's more a 3-plus going forward. And this could - we'll be talking about this on Wednesday, I don't want to get too ahead of us. Now regarding Fluence, and really we do have a number of unicorns that we've done. It started with Athimos in Brazil, which was the telecom fiber optic rings, that we had distributed energy, Fluence is one. And we have another - some more potential ones that we're developing. So I would say that we're creating a lot of, lot of value with Fluence in two different ways. First, half of our renewable PPAs that we're signing have an energy storage component. So right there, it makes us competitive, really understanding how to use energy storage and how to be very creative. I mean, what we did in Hawaii, as you know, we won a prize for that. We have other projects coming on in Hawaii. We have the world's first virtual reservoir. We have a number of new uses. So AES is part of that engine of growth affluence because we are creating many new applications and that is helping Fluence. And then we're getting it through the valuation of Fluence itself. So if you look at the valuation of Fluence, I expect it to do very well. We started with the Qatari Investment Authority. Qatar is a particularly excellent partner at this stage for its investments in other technologies, from batteries to potential clients like NABROS in the Middle East. So this is kind of somewhere between the financial and a strategic investor here. So no, I don't think the time is now to get rid of Fluence in any way. I think we're in it for the long term. I think there are opportunities in the future that we will evaluate. But, no, we're very pleased with it. And I think we're just starting to see the real inflection point here for energy storage.
Operator: [Operator Instructions] Our next question comes from Charles Fishman with Morningstar.
Charles Fishman: Good morning. Andrés, I know you were targeting Alto Maipo for commercial operation by end of the year, did you make it?
Andrés Gluski: It will be this year. We were targeting this year, 2021 - maybe originally. But I'd say over the last year or so, we've been targeting 2021. It's coming along very well, and we are very close to completing all the tunneling work, and we've already done a lot of work in terms of putting in the turbines in the machine room. So Alto Maipo is proceeding nicely, and it will come online this year. And as you know, you basically complete construction, then you got to fill up all the various tunnels with water before you start producing. But we're very pleased with construction at Alto Maipo.
Charles Fishman: Okay. And then on dividend policy, I'm just looking back over the last 6 years, it looks like you've been pretty consistent on the dividend being 50% of the parent free cash flow. Is that still the first metric the Board looks at? Is that still the primary tool they're going to use or metric they're going to use for determining the dividend going forward?
Andrés Gluski: We really look to see if we have a dividend that we think is competitive for our investors. So what we're targeting going forward is a growth between 4% to 6% in our dividend. I think if you go in the past 5 years, we probably had the fastest-growing dividend of - or 7 years, we've had the fastest-growing dividend of anybody, really, if you take the longer time frame. So we're happy with our growth that we've been forecasting as 7% to 9% in the past, and we'll continue to grow our dividend 4% to 6%, which we think is competitive in our sector.
Charles Fishman: So the fact that it's been about 50% of free cash flow is just - I won't say coincidental, but it's just secondary importance?
Gustavo Pimenta: That's correct. We're not targeting a payout of our free cash flow in that sense. So that's really not the target. It's really to make sure that we have an attractive dividend payment for our shareholders.
Operator: At this time, we are showing no further questions in the queue and this concludes our question-and-answer session. At this time, I would like to turn the conference back over to Ahmed Pasha for any closing remarks.
Ahmed Pasha: Thanks. Thanks, everybody, for joining us on today's call. As always, the IR team will be available to answer any questions you may have. Next week, we look forward to speaking with you again at our Virtual Investor Day. Thank you, and have a nice day.
Operator: The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day and welcome to the AES Corporation Q4 2020 Financial Review Conference Call. Today, all participants will be in a listen-only mode. [Operator Instructions] As a further reminder, today's event is being recorded. At this time, I would like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Ahmed Pasha",
"text": "Good morning, everyone, and welcome to our fourth quarter and full year 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can also be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; and Gustavo Pimenta, our Chief Financial Officer. With that, I will turn the call over to Andrés. Andrés?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone, and thank you for joining our fourth quarter and full year 2020 financial review call. This morning, I will provide an update on our major financial and strategic accomplishments, which position us well for the future. Some of you may recall that last year, I set out three short-term catalysts for our stock: hitting our numbers, getting a second investment-grade rating, and becoming Norges Bank coal generation compliant. In 2020, we delivered on all three metrics and set ourselves up for continued progress. First, let me talk about hitting our numbers. We delivered adjusted earnings per share of $1.44, which was above our guidance range of $1.32 to $1.42. Our parent free cash flow came in at $777 million, which also exceeded the top end of our range of $725 million to $775 million. Second, in November, S&P upgraded us to an investment grade rating of BBB-, joining Fitch, which had upgraded us in 2019. Third, by selling a retiring coal plant and building new renewables, we will reduce the percentage of megawatt hours being produced by coal plants to 25% on a pro forma basis, which is comfortably below Norges Bank threshold of 30%. All of these results reflect the resilience of our business model, which is anchored on long-term dollar denominated contracts with investment grade off-takers and U.S. regulated utilities. In addition to these achievements, in 2020 we continue to advance our leadership in innovation and new green technologies. We signed 3 gigawatts of long-term contracts for renewables, which is also at the top end of our range of guidance of 2 gigawatts to 3 gigawatts. As you can see on Slide 4, these 3 gigawatts of new renewable PPAs are mostly in the U.S. and South America. In the U.S., we have merged our two development companies AES Distributed Energy and sPower into one entity, AES Clean Energy, to better take advantage of synergies and economies of scale. In South America, our renewables growth was fueled in part by the continued success of our Green Blend and Extend negotiations, which combined new renewables with existing long-term conventional capacity contracts. With the addition of these 3 gigawatts of new PPAs, our current backlog of projects reached 6.9 gigawatt as shown on Slide 5. About half of the total solar and most of the remainder is wind and energy storage; 100% of our backlog is renewable. We expect to bring almost 4 gigawatts of this backlog online in 2021, one of the largest capacity additions in AES' history. Finally, turning to Slide 6. Fluence, our joint venture with Siemens to provide energy storage systems, maintained its global leadership position and signed 785 MW of new capacity. Its revenues grew 400% versus the prior year and they acquired AMS' leading AI-enabled bidding software business. A capital raise was also announced with the Qatar Investment Authority, which will provide funds to further accelerate the development of its digital product offerings and the deployment of its systems around the world. As you can see, we are very well positioned to continue our solid renewables growth, aggressive decarbonization and deployment of leading technology innovations. The electricity sector is changing rapidly and we will be providing a comprehensive view of AES' long-term plans and opportunities in this new environment, next Wednesday, March 3 at our Investor Day. Now let me turn the call over to Gustavo, who will provide more color on our financial results for 2020 and guidance for 2021."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thank you, Andrés, and good morning everyone. Today, I'll cover the following key topics: our financial performance during the fourth quarter and full year 2020, our capital allocation initiatives in 2020, and our 2021 guidance. As Andrés mentioned, our results for 2020 highlighted the resilience of our business model. We delivered a strong financial performance while navigating challenging macro conditions, including the impacts of lower demand due to COVID-19 and a record dry hydrology in Colombia. We finished the year on a strong note, setting a solid foundation for continued growth. Turning to Slide 8. Full year adjusted EPS of $1.44 exceeded the top end of our guidance range and was at the midpoint of our regional pre-COVID guidance range. As I noted, the key negative impacts on our results were from lower demand and adverse hydrology. Our generation business, which accounts for more than 80% of our earnings, is largely insulated from demand fluctuations. However, as we have discussed in the past, our U.S. utilities did experience a reduction in demand due to the economic impact of the pandemic. Although there has been a gradual recovery in demand in the second half of 2020, the impact on a full year basis was approximately $0.04. Regarding hydrology, we experienced average hydrology in most of our markets, except in Colombia, where it was one of the worst hydrological years on record. The total impact of hydrology on our full year results was approximately $0.05 in South America, primarily in Colombia. We expected the hydrological conditions to be normal in Colombia in 2021, in line with the long-term historical average and have already observed this trend in the year-to-date. Despite the headwinds from these two areas, we are able to deliver on our full year guidance as a result of higher contributions from new businesses and improved operating performance in South America. We also benefited from our cost savings initiatives, interest expense savings, resulting from $7 billion of refinancings across the portfolio and a lower adjusted tax rate. Turning to Slide 9. Adjusted pretax contribution, or PTC, was $1.2 billion for the year, an increase of $7 million versus 2019. I will cover our results in more detail over the next four slides, beginning with the U.S. and Utilities SBU on Slide 10. As you may have seen yesterday, we have rebranded our U.S. Utilities, DP&L and IPL, to align with the new AES brand. So now on, these businesses will be known as AES Ohio and AES Indiana, respectively. In 2020, lower PTC at our U.S. and Utilities SBU reflects the impact of the reversion to ESP1 rates at AES Ohio in 2019 and lower demand at our utilities due to the impact of COVID-19 and milder weather. These impacts were partially offset by the benefit from the commencement of PPAs at the Southland Energy CCGTs as well as the contributions from new renewable projects. Higher PTC at our South America SBU was largely driven by higher contributions from AES Gener and a favorable revision of regulatory charge at AES Tiete in Brazil. These impacts were partially offset by drier hydrology and a planned major outage at the Chivor hydro plant in Colombia and the regulatory changes in Argentina in 2019. Lower PTC at our MCAC SBU primarily reflects the impact from insurance recovery in prior year as well as outages incurred in 2020 in Dominican Republic, partially offset by improved availability in hydrology in Panama. Finally, in Eurasia, higher results reflect lower interest expense due to the debt repayment in 2020 in Bulgaria, partially offset by the impact of businesses sold in the United Kingdom in 2019. Now turning to our credit profile on Slide 14. Our significantly reduced parent debt and growing free cash flow enabled us to improve our credit metrics by 400 basis points since 2018. At the end of 2020, our parent free cash flow to net debt ratio was 23%, well above the 20% threshold required for an investment-grade rating. Strong credit metrics remain one of our top priorities, and we continue to take steps to maintain and further improve upon current levels. Furthermore, we took advantage last year of a low interest rate environment and refinanced approximately $7 billion of debt across our portfolio, extending maturities and capturing annualized interest savings of $90 million. Now to our 2020 parent capital allocation on Slide 15. Beginning on the left-hand side, sources reflect $1.3 billion of total discretionary cash. Asset sales of $530 million reflect the net proceeds from the sale of OPGC and the sell-down of 35% of our interest in the Southland Repowering projects. Parent free cash flow of $777 million exceeded the top end of our expectation. Moving to uses on the right-hand side. Roughly, 1/3 of our discretionary cash was allocated to shareholder dividend and debt repayment. We invested $812 million in our subsidiaries, primarily in our renewables backlog, Southland repowering and AES Ohio. Approximately 90% of the total investments in subsidiaries were in the U.S., contributing to our goal of increasing the proportion of earnings from the U.S. to about half. Turning to our guidance on Slide 16. Today, we are initiating guidance for 2021 adjusted EPS of $1.50 to $1.58, in line with our average annual growth target of 7% to 9%. Parent free cash flow for 2021 is expected to be $775 million to $825 million, which is based on 7% growth from the midpoint of our 2020 expectation of $750 million. Key drivers of our expected growth in adjusted EPS in 2021 include: a full year of operations of our 1.3 gigawatt Southland Repowering project, which came online in mid-2020; continued growth in renewables, including 4 gigawatts expected to reach commercial operation this year; efficiency gains from cost savings in our digital initiatives; and an interest savings due to refinancing benefits and completed that reduction. We look forward to discussing our long-term growth rates and drivers with you all at our Investor Day next week. With that, I'll turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Gustavo. Before we take your questions, let me summarize today's call. Thanks to the extraordinary dedication of our people and the resilience of our business model, we've met or exceeded all of our strategic and financial goals in 2020. We are very well positioned to capitalize on significant growth opportunities arising from the rapid transformation of our sector. As always, our primary focus is to continue to deliver superior returns to shareholders. We look forward to discussing our strategy and longer-term financial outlook with you at our Investor Day next Wednesday, March 3. With that, I would like to open up the call to your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Today's first question comes from Angie Storozynski with Seaport Global."
},
{
"speaker": "Agnieszka Storozynski",
"text": "So two quick questions, one on your of 21 guidance, what effective tax rate is embedded in that guidance and is this an indication that you are actually expecting lower effective tax going forward?"
},
{
"speaker": "Gustavo Pimenta",
"text": "So Angie, Gustavo. No, I think we are - I mean, we had a - this year, 2020 was particularly lower, around 23%. For 2021, we're expecting to go back to our original expectation on the mid-20s to high 20s."
},
{
"speaker": "Agnieszka Storozynski",
"text": "And then one of the points, a drag, year-on-year drag on your '21 guidance is some GSF adjustment in Brazil. Could you explain?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Yes. So we had this positive gain there, but we also had especially in Colombia, some negative, call it, one-timer hit. So we had a life extension project there that was about $0.05 to $0.06 negative. So when you look at both businesses, they pretty much net each other out. So I wouldn't expect any drag from the hydro businesses in 2021."
},
{
"speaker": "Agnieszka Storozynski",
"text": "Okay. And I know that you're going to be talking about strategy and longer-term growth plans only next week, but do you have any sense when Moody's could review your rating?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Look, they came earlier this year and with a positive update on their credit view for AES, basically lowering the overall FFO to debt on a consolidated basis to 14% versus 16%. We are seeing us there, very close to these ratios. So we are positive. I think they will - we expect them to make a move hopefully this year. We'll see what is exactly the move that they make. But the ratios are there, and we think we're in a positive moment with them."
},
{
"speaker": "Agnieszka Storozynski",
"text": "And then again, I know the Analyst Day is next week, but can you comment if you see yourself issuing equity any time soon, like, say, over the next 5 years?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Hi. Angie, this is Andrés. Look, that's one of the tools available to us. And it depends, we'll see the growth rates we have. We have a lot of opportunities. So that's one of the tools in our kit."
},
{
"speaker": "Operator",
"text": "The next question comes from Richard Sunderland with JPMorgan."
},
{
"speaker": "Richard Sunderland",
"text": "Just want to start off maybe on the events in Texas last week. What do you see as the role for storage in the state going forward? And how might AES benefit from the deployment of storage locally?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Sure. Look, storage can be used to make a more resilient grid definitely. And so I think that storage, the potential for growth in storage is enormous. What particularly happened in Texas, of course, was that you don't have capacity payments. So you didn't have really an incentive to winterize a lot of the existing plants into fossil plants and also, quite frankly, the wind turbines. Interestingly, solar performed very well. So I think the follow-on is, yes, people are going to be concerned about more resilient networks and storage can play a part, transmission, it can also play a part locally. So I do think that this will cast more light, more attention on energy storage as part of a more resilient grid."
},
{
"speaker": "Richard Sunderland",
"text": "So do you see kind of a different opportunity for solar than for solar plus storage or just storage in general going forward as a result of the events? Or do you think it's more markets dying issues and kind of other specific factors that may be due to change?"
},
{
"speaker": "Andrés Gluski",
"text": "Well, my own personal opinion is that when you have a market where you don't remunerate capacity, I think is one of the key sources. Having said that, and of course, energy storage has many uses. It's not only solar plus storage, wind plus storage, stand-alone storage, but also to make improved transmission with existing lines, so you don't have to upgrade the whole line. So all of these, attention to the robustness of the grid and the network, is a positive for future sales of energy storage."
},
{
"speaker": "Richard Sunderland",
"text": "And then just one specifically on the '21 guidance here. Any way to frame assumptions around asset sales, coal sales baked into '21 guidance versus what has been announced last year into this year?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Yes, this is Gustavo. So all of the announced asset sales and retirements are incorporated. Effectively, we have India that closed late last year, so it's in here. We've said Vietnam, which was the other large one, would probably close between the end of this year, early next year. So it doesn't hit 2021. But effectively, all of the announced asset sales and retirements are incorporated in this 2021 guidance."
},
{
"speaker": "Richard Sunderland",
"text": "And are there placeholders for incremental sales as well?"
},
{
"speaker": "Gustavo Pimenta",
"text": "I mean, if they happen, they'll probably close later. So specifically for 2021, wouldn't make any difference here."
},
{
"speaker": "Operator",
"text": "The next question comes from Stephen Byrd with Morgan Stanley."
},
{
"speaker": "Stephen Byrd",
"text": "I wanted to explore your corporate partnership with Google and just get your overall views on the degree of interest you're seeing from other companies to partner with AES, given AES' global reach in renewables and storage capabilities to help those corporates to achieve zero emissions. Is that an area you're encouraged by?"
},
{
"speaker": "Andrés Gluski",
"text": "Very much so, very much so. We've talked in the past about our relationship and partnership with Google, that continues to progress. But we're also seeing interest from other similar players, about - 24x7 renewables. So definitely, we're encouraged by this. And the fact that we have presence in other markets is an additional plus, not immediately, but down the road."
},
{
"speaker": "Stephen Byrd",
"text": "Okay. So it sounds like something in the long term you're excited about, but nothing near term, but something we could see over time. Okay."
},
{
"speaker": "Andrés Gluski",
"text": "No, I wouldn't say so long term."
},
{
"speaker": "Stephen Byrd",
"text": "Okay. That's great. And then I guess just stepping back, maybe building a little bit on Angie's question on financing. You have a really great growth outlook in many different asset classes. And I was just curious, just at a high level as you think about just innovative financing approaches, financing tools out there, there certainly - strikes me, there's a lot of folks who love to provide capital to high-quality clean energy and storage projects. Are you seeing anything sort of new in terms of innovation? And as AES gets bigger and bigger in renewables, just different approaches to financing all of this growth?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Well, it's a great question. Over the past, let's say, 8 years or so, we've sold about $6 billion of assets. And we have churned that money, right? And that's provided impetus for a lot of our new growth. We've also done partnerships. So those continue to - we'll continue to do asset sales, and we continue to do partnerships. So you're right. We're seeing a lot of interest in people co-investing with us in different shapes or forms. So this is very positive. I think we have a good reputation as a partner, who really looks at all shareholders in these joint ventures. So you're absolutely right, we're seeing a lot of new things. As you know, in the past, I'd say the one thing that did not come to fruition really was the effort that Tom led for about a year. Honestly, without COVID, it would have come to fruition, which was quite innovative. But as I always said back then, this was extra. We didn't need it to finance our growth. That was just a plus. So we're seeing, again, a lot of people who are interested in partnering with us and are different technology plays."
},
{
"speaker": "Operator",
"text": "Today's next question comes from Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Congratulations, again. Perhaps, just to kick it off here on '21, and I'm going to try to hold back ahead of next week, obviously. But can you talk about the renewables contribution here in earnings as well as Fluence? How are you thinking about those two pieces? And especially, as you try to refine your expectations and given the success on renewable backlog here, I get renewables are not necessarily homogenous. But how do you think about renewable earnings contributions here? And I know this is getting a little bit ahead of next week, but can you speak to it especially in the context of '21, for both Fluence and renewables?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Let me start it, and then I'll pass it over to Gustavo. So look, next year is very interesting just from a cutting ribbon point of view. We have 4 gigawatts that's coming online. So that represents PPAs, which were signed in the past. And this is one of the highest additions to our fleet in our history in a single year. So that we feel very good about. So the second thing is, as you correctly pointed out, our renewables come in different flavors. So about half is outside the U.S. and about half is solar, and about half is - there is some hydro coming online but there is mostly wind, some energy storage. Regarding Fluence, I would say that Fluence will not be a contributor to earnings next year because it's in a very rapid growth phase. What we see is a big increase, an acceleration in demand for energy storage as more uses are seen. And there were some questions about - prior on this call about grid stability. And then yes, it can play an important role in that. So we see growth accelerating in Fluence. And basically, as a result of that, it's harder to hit that break-even. But I would say that in terms of - it's just a little bit postponed in time because you're gearing up. Now we came out with the new cube stack. We also bought the AI-enabled bidding platform from AMS and that's a very interesting addition. And we've had sales of AMS bidding engine, actually not using Fluence's hardware. So generally, I would say that this kind of software platforms have less capital-intensive than building the cube stack itself. So that will help us turn profitability sooner. But there's this trade-off between very rapid growth and starting to break-even. But we feel very good about the company. So I'll pass it now to Gustavo to talk a little bit about the breakdown of our earnings. Now I realize a lot of these things are somewhat tied together because you have like Green Blend and Extend. So you basically have a capacity contract with a fossil plant plus renewables being added on to that. So with that, I'll pass it on to Gustavo."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thanks, Andrés. So Julien, I would say that 2021 is mostly driven by new additions. So remember, we had just half of the year for Southland, so we're going to have a full year of Southland, that's about $0.04. And then renewables altogether - we are bringing 4 gigawatts online, as Andrés said. Renewables altogether is about $0.05. So the delta 2021 is mostly driven by those additions. And then you have some items that offset each other. So there was a drag on tax. Tax was particularly lower. But we have recovered, for example, in the demand side from the Utilities, we're expecting some recovery there. We have the cost cuttings also that will offset some of the drag from tax. So if you clean all of that, I would say mostly of the growth of - primarily the growth is coming from the new additions, being Southland full year and $0.05 from renewables."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Excellent. If I can ask you the obvious question here. Your target for annual development, I suppose, is 2 to 3 gigs, [technical difficulty] 4 gigawatts next year. Obvious question is, how do you think about that long-term target? And then related, given your comment on continued drag on Fluence, why hold on to a business that continues to drag your primary valuation metric in light of accelerating and improving outlook?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Sure. Let's see. Let me take the first question, which was about the renewables growth. So we have 2 years where we've basically been about 3 gigawatts. Now when we talk about that, that's PPA signed. So those will be brought online normally in a period within 24 months, probably the average is about 18 months. So there's a lag there. So we have had two very strong years. So 4 gigawatts are going to come online, that means they're actually coming online. So the goal is sign PPAs. The second is - which are actually going to start contributing to your earnings. So we see continued acceleration, let's say, in the renewables business. So we feel very comfortable. It's no longer sort of 2 to 3, it's more a 3-plus going forward. And this could - we'll be talking about this on Wednesday, I don't want to get too ahead of us. Now regarding Fluence, and really we do have a number of unicorns that we've done. It started with Athimos in Brazil, which was the telecom fiber optic rings, that we had distributed energy, Fluence is one. And we have another - some more potential ones that we're developing. So I would say that we're creating a lot of, lot of value with Fluence in two different ways. First, half of our renewable PPAs that we're signing have an energy storage component. So right there, it makes us competitive, really understanding how to use energy storage and how to be very creative. I mean, what we did in Hawaii, as you know, we won a prize for that. We have other projects coming on in Hawaii. We have the world's first virtual reservoir. We have a number of new uses. So AES is part of that engine of growth affluence because we are creating many new applications and that is helping Fluence. And then we're getting it through the valuation of Fluence itself. So if you look at the valuation of Fluence, I expect it to do very well. We started with the Qatari Investment Authority. Qatar is a particularly excellent partner at this stage for its investments in other technologies, from batteries to potential clients like NABROS in the Middle East. So this is kind of somewhere between the financial and a strategic investor here. So no, I don't think the time is now to get rid of Fluence in any way. I think we're in it for the long term. I think there are opportunities in the future that we will evaluate. But, no, we're very pleased with it. And I think we're just starting to see the real inflection point here for energy storage."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Charles Fishman with Morningstar."
},
{
"speaker": "Charles Fishman",
"text": "Good morning. Andrés, I know you were targeting Alto Maipo for commercial operation by end of the year, did you make it?"
},
{
"speaker": "Andrés Gluski",
"text": "It will be this year. We were targeting this year, 2021 - maybe originally. But I'd say over the last year or so, we've been targeting 2021. It's coming along very well, and we are very close to completing all the tunneling work, and we've already done a lot of work in terms of putting in the turbines in the machine room. So Alto Maipo is proceeding nicely, and it will come online this year. And as you know, you basically complete construction, then you got to fill up all the various tunnels with water before you start producing. But we're very pleased with construction at Alto Maipo."
},
{
"speaker": "Charles Fishman",
"text": "Okay. And then on dividend policy, I'm just looking back over the last 6 years, it looks like you've been pretty consistent on the dividend being 50% of the parent free cash flow. Is that still the first metric the Board looks at? Is that still the primary tool they're going to use or metric they're going to use for determining the dividend going forward?"
},
{
"speaker": "Andrés Gluski",
"text": "We really look to see if we have a dividend that we think is competitive for our investors. So what we're targeting going forward is a growth between 4% to 6% in our dividend. I think if you go in the past 5 years, we probably had the fastest-growing dividend of - or 7 years, we've had the fastest-growing dividend of anybody, really, if you take the longer time frame. So we're happy with our growth that we've been forecasting as 7% to 9% in the past, and we'll continue to grow our dividend 4% to 6%, which we think is competitive in our sector."
},
{
"speaker": "Charles Fishman",
"text": "So the fact that it's been about 50% of free cash flow is just - I won't say coincidental, but it's just secondary importance?"
},
{
"speaker": "Gustavo Pimenta",
"text": "That's correct. We're not targeting a payout of our free cash flow in that sense. So that's really not the target. It's really to make sure that we have an attractive dividend payment for our shareholders."
},
{
"speaker": "Operator",
"text": "At this time, we are showing no further questions in the queue and this concludes our question-and-answer session. At this time, I would like to turn the conference back over to Ahmed Pasha for any closing remarks."
},
{
"speaker": "Ahmed Pasha",
"text": "Thanks. Thanks, everybody, for joining us on today's call. As always, the IR team will be available to answer any questions you may have. Next week, we look forward to speaking with you again at our Virtual Investor Day. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] | The AES Corporation | 35,312 |
AES | 3 | 2,020 | 2020-11-06 09:00:00 | Operator: Good morning and welcome to the AES Corporation Third Quarter Financial Review. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the call over to Mr. Ahmed Pasha, Treasurer and Vice President of Investor Relations. Please go ahead.
Ahmed Pasha: Thank you, and good morning, everyone. Welcome to our third quarter 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?
Andrés Gluski: Good morning, everyone, and thank you for joining our third quarter financial review call. Today, I will cover both our near-term priorities and the progress we have made on our larger strategic goals. On our last call, I outlined three top priorities: first, achieving our 2020 guidance; second, attaining a second investment-grade rating; and third, decarbonizing our portfolio. We see all three of these goals, both individually and collectively, as catalysts for attracting a wider investor base. Perhaps more importantly, we see all three as clear demonstrations of our ability to thrive in today's evolving landscape. Today, I am pleased to report that we're making great progress on all of these objectives and have several exciting developments to discuss. First, as Gustavo will review in his remarks, our portfolio continues to prove its resiliency in the face of COVID-19, and we're on-track to achieve our full year guidance. In fact, we expect to be at the top end of the ranges for both adjusted EPS and parent free cash flow. Turning to our goal of attaining a second investment-grade rating. I'm proud to say that we were upgraded by S&P earlier this week. This reflects the low level of risk inherent in our current business model. Two investment-grade ratings will help us reduce our overall cost of capital and enable us to attract a broader investor base. Following this milestone, we remain committed to further strengthening our balance sheet and increasing the percentage of our business in the U.S. Now to our third priority of aggressive decarbonization on Slide 4. As you may recall, we set a near-term target to reduce our coal generation to below 30% of total generation by the end of this year, and to below 10% by 2030. I'm happy to report that with today's announced retirement of an additional 1.2 gigawatts, we have reduced our coal generation to 29% on a pro forma basis. 3/4 of these retirements are in the U.S. and the remainder are in Chile. Importantly, these retirements were already anticipated in our guidance, and we will achieve our decarbonization targets while delivering on our financial commitments. We see the transformation of our portfolio as an ongoing process, and we expect to announce additional coal retirements and asset sales in the near term. However, this milestone is significant and that it puts us in compliance with the environmental criteria of several large investors, including Norges Bank. In the longer term, we expect to produce net zero carbon emissions by 2050. Moving to our long-term strategy and the progress we've made to date. As we have discussed previously, our strategy revolves around three core themes: one, investing in sustainable growth; two, offering innovative solutions; and three, delivering superior results. Turning to Slide 5. We are well positioned to meet our strategic and financial objectives. So far this year, we have signed PPAs for 2.1 gigawatts of wind, solar and energy storage projects, which is the most we have signed in the first three quarters of any given year. On to Slide 6. We now have a backlog of 6.8 gigawatts, which is also the largest in our history. Approximately 1/3 is under construction, with the majority expected to come online through 2022. Almost half of this backlog is in the U.S., which we expect to grow as a proportion of our business going forward. Our backlog includes a mix of solar, wind, energy storage and our Alto Maipo hydro project in Chile. We continue to make good progress at Alto Maipo, where construction is more than 96% complete. As you can see on Slide 7, renewables are now nearly 40% of our installed capacity. And this proportion will grow materially as we complete the 6.8 gigawatts in our 100% renewable backlog and sell and retire additional coal plants. In addition to our renewables backlog, we see significant growth opportunities at our 2 U.S. utilities. DP&L and IP&L. We are pleased with the recent developments at IP&L, where we reached a constructive settlement on various pending regulatory proceedings. Gustavo will provide additional details shortly, but this settlement is truly a milestone for DP&L and it grows its rate base and its network. Turning to Slide 8. I have previously discussed that our Green Blend and Extend, strategy, where we work with existing customers to convert the power sold from thermal to renewable generation while extending the contract life. This approach allows all parties to meet their financial and environmental objectives. Since our last call, we signed an additional 410 megawatts of solar capacity under a 17-year contract in Chile, bringing our total Green Blend and Extend, execution to more than 2 gigawatts. As a demonstration of the strength of our existing coal contracts, in August AES had handed reached an agreement with BHP for early termination, resulting in a payment of $720 million, which we will use in part to fund our renewables growth in Chile. While we only report on our projects with signed PPAS, as you can see on Slide 9, we have a robust development pipeline, which we believe is one of our key differentiators. We currently have a development pipeline of 25 gigawatts in key markets, of which 12 gigawatts are in the U.S. Over the past couple of months, we have been solidifying our pipeline by securing land and interconnection rights. We already have very capable solar and energy storage development teams, and we recently acquired a group of experienced wind developers. Expected renewables growth in the U.S. is currently 20 gigawatts per year. However, this rate could accelerate. We are very well positioned to take advantage of any increase in the rate of growth in demand for renewables. Furthermore, we also could benefit from an extension of ITC and PTC incentives for renewables as well as the potential for new incentives for stand-alone storage. Turning to Slide 10 and our LNG strategy. We see the expansion of our LNG infrastructure business as complementary to our renewables growth by offering a clean, predictable and low-cost fuel that provides capacity and flexibility to the system. We are focusing our LNG business in 3 markets: the Caribbean, Central America and Southeast Asia. In all of these markets, there is rapidly growing demand for natural gas to supply new generation and to displace coal and higher-cost fuel oils. As you may know, we're developing an efficient 2.2 gigawatt combined cycle gas facility and a 450 tera BTU LNG terminal in Vietnam. We have hit key milestones towards closing these projects, which will help meet Vietnam's rapidly growing electricity demand. Last week, we signed a term sheet for the LNG terminal in partnership with PV Gas, the state-owned gas utility. In parallel, we have seen strong interest from potential lenders to finance the majority of the capital costs. In Central America and the Caribbean, we continue to lead the transition to cleaner natural gas. We currently have a total of 150 tera BTus of LNG storage capacity, and an additional 50 tera BTUs is under construction in the Dominican Republic. We now have contracted 60% of this storage capacity, and we're in advanced discussions for an additional 20%. This would bring our total contracted volume to 80% in 2023 and beyond. For context, 200 tera BTU LNG volume can serve approximately 3 gigawatts of natural gas generation. Moving on Slide 11. The second component of our strategy is offering innovative solutions. We see the energy needs of our clients, like Google, evolving to achieve the highest standards in clean energy. We are leading the transition through our unique integration of renewables with our scalable platforms of Fluence, 5B and Uplight. Our technological innovation gives us a key competitive advantage. An example is energy storage, where we have access to the latest technology in the sector and combine it with our unique industry insights to create transformative clean energy solutions. As a reminder, working closely with our customer, Kiuc in Hawaii, we were the first company to develop a true 24/7 solar and energy storage project, and we continue to advance new applications. In fact, we recently inaugurated the world's first virtual reservoir in Chile, which combines run of the river hydro with battery-based energy storage, allowing us to sell our energy when prices are highest. Turning to Slide 12. Fluence, our joint venture with Siemens that sells energy storage technology to third parties, continues to maintain its position as the market leader in the sector. This year, Fluence has been awarded 690 megawatts of contracts, increasing their awarded or delivered capacity to 2.4 gigawatts. Fluence's revenue is expected to reach $500 million this year, an increase of 400% compared to last year. While rapidly growing their backlog, Fluence continues to enhance their digital capabilities and to complement their suite of solutions. To that end, Fluence acquired AMS, the leading provider of AI-enabled bidding software for storage and generation assets. Through the AMS acquisition, Fluence now has ongoing contracts for digital bidding services for more than 2.4 gigawatts, and most of it additional to Fluence's fleet. The integration of this technology to Fluence's current offerings will help optimize the use of energy storage and to ensure the greatest value for their clients. We're also looking to additional new products and innovation that could transform the sector, as shown on Slide 13. With our recent investment in 5B, a prefabricated solar solution company, solar projects can be built in 1/3 of the time and on half as much land. We believe that being able to double solar energy output from a given area will become a great differentiator as solar penetration increases, especially near urban and congested areas. In addition to 5B's potential pipeline of more than 10 gigawatts of third-party projects in Australia, we see an addressable market of 5 gigawatts across our own development pipeline. We aim to be the most competitive solar operator and developer by using 5B to reduce time to build and increase energy density in combination with our ongoing robotic and digital initiatives. One example of how we are integrating all of these technologies to improve customer outcomes is the Andes IIb project in Chile. This project consists of 180 megawatts of solar incorporates 10 megawatts of 5B's technology and includes 560 megawatt hours of energy storage, the largest in Latin America. Another example of our leading innovations is our Uplight platform, which is helping utilities improve energy efficiency and balance system demand. Both of these capabilities are increasingly relevant to Uplight's 100 million end users and 80 utility customers in the U.S. Finally, as I previously discussed, we continue to be on the forefront of new technologies. To that end, we have been running tests on hydrogen at several thermal plants in Latin America. We consider ourselves to be well positioned to be a leader to incorporate green hydrogen if and when it becomes economic sometime in the future. Turning now to the third component of our strategy, which Gustavo will spend more time on: delivering superior results. By investing in our development pipeline, we are earning attractive risk-adjusted returns. As you can see on Slide 14, in the U.S we're earning low double-digit returns, while internationally we're earning mid- to high-teen returns. Before concluding, I would like to note that last week, we launched a new brand with a new logo, as you can see on our slides. We have transformed AES into a leader in clean energy, and our new brand symbolizes our position at the forefront of the technological and commercial changes that are redefining our industry. Now, I would like to turn the call over to Gustavo Pimenta, our CFO, so he can provide more color on our results, debt profile and guidance.
Gustavo Pimenta: Thank you, Andres, and good morning, everyone. Today, I'll cover 3 key topics: our resilient business model, our performance during the third quarter, and our capital allocation plan. Let me start with our resilient business model. Over the last decade, we have proactively transformed our portfolio. And now 85% of our earnings are from utilities and long-term contracted generation with an average contract life of 14 years, supported by creditworthy offtakers. At the same time, more than 80% of our earnings are now in dollars. This provides significant stability to earnings and cash flow. Turning to Slide 16. You can see how our portfolio has performed during these challenging times. As you know, a majority of our customers are large industrials and export-oriented mining companies that continue to operate despite COVID-19 as they are deemed essential. As a result, Q3 receivables and days sales outstanding remained stable and very much in line with historical levels. Moving on to Slide 17. The impact of the global lockdown on our financial results has been mostly limited to our utilities. Our generation businesses have been largely unaffected due to the take-or-pay nature of contracts and customers being deemed essential. As you may recall, in our first quarter call we had anticipated an extended U-shaped recovery in energy demand across our markets. Since then, demand performance has been better than our expectation. For Q3, our initial projection was for a demand drop of about 5% to 7% at our U.S. utilities. While the actual result was significantly less severe than anticipated, on a weather-normalized basis, the net combined volume at DPL and IPL is mostly flat. Demand at DPL was up 3% and largely driven by the higher load from residential customers, while demand at IPL was down 3% as the load from commercial and industrial customers has yet to reach pre-COVID levels. Accordingly, the total net impact of the lower demand on our utilities was only $0.01 on adjusted EPS for the quarter, better than our initial expectation of $0.02 to $0.03. Now turning to our quarterly results on Slide 18. Adjusted EPS was $0.42 for the quarter versus $0.48 last year. Our quarterly results reflect an $0.11 impact most related to last year's insurance recovery and outage that occurred this quarter at one of our facilities in Dominican Republic, which is already back in operations. Results also reflect the regulatory changes that were implemented at DP&L and in Argentina in Q4 2019. These headwinds were partially offset by higher contributions from the Southland repowering project, our Eurasia SBU, our cost savings and deleveraging initiatives as well as a lower tax rate. Turning to Slide 19; adjusted pretax contribution or PTC was $331 million for the quarter, a decrease of $95 million versus the third quarter of 2019. I'll cover our results in more detail over the next 4 slides beginning on Slide 20. In the U.S. and utilities SBU, PTC remained relatively flat. The benefit from the commencement of PPAs at Southland Energy CCGTs was mostly offset by the reversion to ESP 1 rates at DPL in 2019 as well as lower demand at our utilities due to the impact of COVID-19. Before moving on, I would like to take a moment to update you on recent regulatory developments at DP&L on Slide 21. I'm very pleased to announce that we have reached a successful settlement with PUCO staff and key intervenors, resolving 4 open proceedings, significantly reducing regulatory uncertainty and allowing us to move forward with our smart grid investments. More specifically as a result of this settlement, DP&L committed to file a new ESP by October 1, 2023, and will continue to recover its approximately $80 million annual rate stabilization charge until the new ESP becomes effective. DP&L will make smart grid investments of $249 million over the next 4 years, to earn a return through the investment infrastructure rider. Resolution was reached on the 2 pending retroactive SEET tests related to 2018 and 2019. And DP&L passed the SEET and MFA regulatory tests filed earlier this year. Now turning back to our third quarter results on Slide 22. At our South America SBU, lower PTC was primarily driven by dry hydrology at the Chivor hydro plant in Colombia, resulting in lower generation and high energy purchases. Lower PTC at our MCAC [ph] SBU primarily reflects the outage-related impacts I discussed previously as well as the arbitration settlement at Changuinola this year. Finally, in the region, higher results reflect lower maintenance and outages as well as lower interest expense due to debt repayment in 2020. It also includes a favorable variance in India given the OPGC COD delay last year. Now to Slide 25. To summarize our performance in the first 3 quarters of the year, we earned adjusted EPS of $0.96 versus $1.02 last year. We are reaffirming our 2020 adjusted EPS guidance range of $1.32 to $1.42. In fact, based on our strong year-to-date performance and outlook for the remainder of the year, we are now expecting to be at the top end of this range. Now turning to our credit profile on Slide 26. As we have discussed on our prior calls, since 2011 we reduced our parent debt by approximately $3 billion or about 50%. As Andrés mentioned, we recently received our second investment-grade rating. We are very pleased that S&P has recognized the underlying quality and strength of our portfolio. As you can see on this slide, we have improved our ratings by 2 to 3 notches over the last 4 years. Strong credit metrics remain one of our top priorities, and we'll continue to take steps to maintain and further improve upon current levels. Now to 2020 parent capital allocation on Slide 27. We expect to have $1.5 billion of discretionary cash this year, which is roughly $100 million higher than our prior disclosure. Regarding asset sales, today we are very pleased to announce a sell-down of 35% of our interest in the Southland repowering projects for $424 million to Yulico, expanding from our successful partnership at SPower. This transaction demonstrates the substantial intrinsic value of our portfolio and how we benefit from our platform and long-term contracted assets. As you may recall, Southland has a 20-year contract and was commissioned early this year. This sell-down implies a total equity value of more than $1.2 billion. With this transaction, combined with our previously announced asset sales, we have exceeded our proceeds target for the year by approximately $100 million for a total of $650 million. Further, based on our year-to-date performance and our outlook for the remainder of the year, we now also expect parent free cash flow to come in at the top end of our range of $725 million to $775 million. Moving to the right-hand side, uses are largely unchanged from the last quarter, except the investments in our subsidiaries, which are roughly $200 million higher. The increase primarily reflects a temporary cash injection at Southland and higher investments in renewables. Approximately 90% of the $900 million of investments in subsidiaries are in the U.S., contributing to our goal of increasing the proportion of earnings from the U.S. to about half. Next, moving to our capital allocation from 2020 through 2022 beginning on Slide 28. We continue to expect our portfolio to generate $3.4 billion in discretionary cash. 3/4 of this is expected to be generated from parent free cash flow, with the remaining $900 million come from asset sale proceeds. Turning to the uses of this discretionary cash on Slide 29. Roughly 1/3 will be allocated to shareholder dividends. Subject to any review by the Board, we continue to expect it to increase the dividend by 4% to 6% per year, in line with the industry average. We also expected to use $1.9 billion to invest in our backlog, new projected PPAs, T&D investments at IPL, the partial funding of our Vietnam LNG project, and the investment in Gener. Once completed, these projects will contribute to our growth through 2022 and beyond. With that, I'll turn the call back over to Andrés.
Andrés Gluski: Thank you, Gustavo. Before we take your questions, let me summarize today's call. We have made great progress on our key objectives. Specifically, we secured a second investment-grade rating. We reduced our generation from coal to below 30%. We signed 2.1 gigawatts of new renewable contracts, increasing our backlog to a record 6.8 gigawatts. And we are growing our development pipeline and deploying new technologies, such as Fluence, 5B and Uplight. Finally, with our year-to-date financial performance, we now expect to be at the top end of our guidance ranges for both adjusted EPS and parent free cash flow. With that, I would like to open the call to your questions.
Operator: [Operator Instructions] First question comes from Richard Sunderland of JPMorgan.
Richard Sunderland: Maybe starting -- just starting off with the Fluence process, could you update us on the latest timing and expectations around the sale of the minority interest?
Andrés Gluski: Sure. The capital raise at Fluence is going very well. We have strong interest, and we expect to get it done by the end of this year.
Richard Sunderland: So namely kind of no impacts from the elections or considerations around there specifically to the sale?
Andrés Gluski: Not really. I mean this capital raise, people are looking at the long term. And certainly, lithium ion-based energy storage has a great future ahead of it. As the -- as I said in my remarks, it's growing very rapidly and it's the leader in the sector. So it really is a unique investment opportunity. So no, we've seen no impact whatsoever.
Richard Sunderland: And has there been any shift in the kind of interest or type of parties evaluating Fluence?
Andrés Gluski: None whatsoever.
Richard Sunderland: Got it. Great. And then just quick on the outage cited on the quarter. I know you said one of the facilities back in operations. Any color around the outage itself and I guess risks going forward?
Gustavo Pimenta: No, it was -- this is Gustavo, Rich. No, it was an outage that we had in there in one of our facilities there. It's about $0.02 impact in the quarter, but the facility is back in operation already.
Operator: Next question comes from Julien Dumoulin-Smith, Bank of America.
Julien Dumoulin-Smith: Congratulations on a -- a litany of developments here, it's hard to know where to start. At the outset here, how about this? So you've had a lot of success across your businesses here. When you think about the earnings trajectory of the renewables business altogether, how would you characterize that, right? Given the backlog, given the success year-to-date, given the capital available to deploy back into it, how in aggregate would you kind of describe its attribution or contribution to the EPS growth rate? And then relate it to Fluence as well, if you can. I know it's still small.
Andrés Gluski: Okay. Let me start sort of big picture. Most of our business, most of our earnings is coming from the traditional businesses. So this is sort of an add-on, and we're retiring some of the thermal assets. So it's a transition. So it's going to be growing over time. We feel very good about the way it's sort of blending in. Something like Green Blend and Extend it's blending in to this growth. So we have a backlog of 7 gigawatts. It's a good mix of U.S. and outside, and it has good returns. And there's a variety of regulatory schemes under which they operate. So we feel good about it. It's going to be growing, and it's going to -- it's replacing some of the older thermal assets that we're retiring. Second part of your question regarding Fluence, well realize that as I've said in the past, the faster Fluence grows, to some extent it pushes off a little bit positive earnings. We're creating an enormous amount of value. But all R&D for example or all upgrading of our teams around the world, that's expensed. So when you're growing 400% this year, we expect a 40-plus growth rate going forward. We have a backlog of 1 gigawatt; so that's still up. So there's no -- right now, Fluence is a drag of around $0.02. So it will -- everything has a positive margin. We expect this to turn around, but it's a little bit of a function of how fast we grow. So ironically the more value we create and the faster we grow, that may take a little bit more time.
Julien Dumoulin-Smith: Now, if I can pivot this slightly more specifically to your guidance, when you think about this roll forward coming up with fourth quarter, and I know I'm kind of asking for guidance without getting it explicitly, how are you thinking about some of the major puts and to pick here? Because as best I see it, it seems like you resolved a number of these issues. And so I just want to make sure we're on the same page about this, whether it's DPL, whether it's related to Gener, or frankly whether it relates to your execution on backlog on renewables. But can you give us at least a sense for some of the bigger puts and takes here and/or other factors that you've mentioned?
Andrés Gluski: Yes, you've mentioned most of the factors. I mean we have rapid renewable growth, Green Blend and Extend,. We have DP&L, IPL, growing their rate base. I think the one that you did not mention was the growth of LNG. So you realize that we are doing very well on contracting more really tolling of gas in the Dominican Republic. We're very -- actually we have the contracts there. We're very optimistic about doing more in Panama. And as I said in my speech, those will all contribute to our earnings at 23 and beyond. So most of the investment is made. So having said that, that's how we see it. So we feel optimistic. And that's why we've included the retirement of -- or part of that guidance. So we can't give you guidance before the fourth call. Gustavo, do you want to add something?
Gustavo Pimenta: Yes. I would just add, Julien, in addition to what Andrés just said, I think California, the extension of the legacy unit is another important driver, right? So -- And also the incremental cost cutting. Remember, we had talked about $100 million of cost-cutting through 2022, half of that through 2021. So those will be helpful, and eventually we'll be able to capture more post that period. And I think to your question on renewables, probably the best way to think about it is most of our free cash is going to renewables nowadays. So it's about $350 million to $400 million of investment in new renewables going forward. And you put low double-digit to mid-teen returns, and you see that this is going to be an important driver of earnings going forward.
Julien Dumoulin-Smith: And just -- sorry to clarify this. When you were speaking on LNG, can you elaborate briefly on Panama on the IMO piece of this in terms of bunkering and the upside potential?
Andrés Gluski: Well, basically our current facility, especially the storage tank in Panama, is about 30% utilized. All the capital investment has been made. So to the extent that we can contract more gas passing through it, that goes straight to our bottom line. And so we feel good about the possibility of contracting more gas in Panama and increasing that utilization. In the case of the Dominican Republic, we had talked about this for many years, that actually we filled up the tank, to the extent that we're actually having to build a somewhat smaller but second tank there to meet all the demand. So realize this is contracted. It's tolling. We're not taking commodity risk. So our gas strategy in the Caribbean and Central America is playing out as planned.
Julien Dumoulin-Smith: One more clarification, on Indiana, I didn't hear you say anything about PUCO and renewables. I know there's an RFP out there. Apologies, if I could.
Gustavo Pimenta: Yes, there is an RFP as we speak, so the team is finalizing. And it's one of the opportunities that we have to sign up for more renewable growth there and rate base. So stay tuned, we'll be talking about that shortly.
Julien Dumoulin-Smith: Got it. Not yet in there. All right, great.
Gustavo Pimenta: Not yet in there.
Andrés Gluski: Thanks, Julien.
Operator: Next question comes from Stephen Byrd with Morgan Stanley.
Stephen Byrd: Congratulations on progress on a lot of fronts. I agree with Julien, it's kind of hard to know where to start.
Andrés Gluski: Thank you very much.
Stephen Byrd: So I wanted to maybe start at a high level and just talk about your renewables business globally, and thinking about sort of how to realize the full value of the business. The business has become very large. It's one of the biggest backlogs globally. How do you think about ensuring that you realize the full value, given that it's housed within AES? And this has always been sort of a question in terms of highlighting the values of these businesses. And I think it's just really accentuated, given the trading levels of pure clean energy companies. Just curious how you're thinking about the long-term strategy there.
Andrés Gluski: That's a great question. We think about that a lot. So really what we see is that there is a true competitive advantage of combining our existing platforms with the new. And I say that because it's easy to talk about renewables, but really that's just energy. And what the market is demanding is capacity. So you're going to get that capacity in the short term from your existing traditional facilities and then with energy storage. So thinking about that, nobody is in a better position than us to do that because we really are the leader in the -- not only the amount of energy storage, but more important, I think the new applications, finding new ways to use this. So I feel very good about this sort of leading this transition in a very responsible way retiring our coal plants, selling coal plants, providing that capacity to some extent in other new markets in -- with gas. Because quite frankly not all markets are capable with today's technology of efficiently providing capacity. Even with batteries, it would be too expensive with renewables. So we're leading that transition to a lower-carbon future. But at the same time, I think we're uniquely integrating, be it energy storage, innovative renewables. I mean I think 5B, that technology will play a greater role in the future as you get greater really penetration of solar in some areas. And so being able to do it in a smaller space is very valuable. Being able to do it faster is very valuable. We're really doing some very interesting things on robotics. We're doing some very interesting things in digital, digital controls. And so Uplight is one aspect of it. But so is for example, the purchase of AMS by Fluent. So that's a little bit how I see it. So while it's true that there is a premium today for pure renewable plays, we think there'll be a premium tomorrow for those companies that truly satisfy what customers need. So it's not only energy. It's energy plus capacity. And we will lead the way into providing capacity, energy and customer-facing solutions into the future. So it's a very interesting transition, even though it's a little bit complicated story.
Stephen Byrd: Those are good points about capacity and integration. I take those points. Maybe shifting over to the corporate customer side. The Google arrangement makes a lot of sense. I was just curious your latest thoughts in terms of additional appetite from other corporate or potential corporate customers to do something along those lines, given AES' global platform?
Andrés Gluski: That's a great question. So we have a, say, arrangement with Google. We're exploring several fronts. As you know, we do have an RFP out for a gigawatt and PJM. We will, we believe, making announcements into the future in terms of how we will be working together, as I said, several fronts. But this is not something that will not exclude other clients, potential clients. So as we find ways to provide the capacity people need and the low carbon that people need, plus a digital overlay. That is certainly something that we believe will be attractive to a lot of clients. So Green Blend and Extend, for example was an interesting solution for a lot of the big mining companies that wanted to lower their carbon footprint and have cheaper energy. And again, that can transition over time to net 0 solution, but it's going to take some time to get there.
Stephen Byrd: Understood. So it sounds like while there's a lot of opportunities, it's going to take some time to really to get traction with a lot of corporate customers, to the point where this is a more meaningful part of your overall business mix. Is that fair?
Andrés Gluski: No. I would say that -- I guess what I'm saying is that I expect to do more with corporate customers. What I'm saying is that depending on what the situation is. It may take longer or less long. It depends, on the market they're in, depends on the availability of renewables in that market, and it depends exactly what the customer wants. I mean what we're really working with is sort of co-creating with clients and co-creating what they want. And I think again we're also uniquely positioned to do that, not only because of the various technologies we're involved in, but also, quite frankly our modus operandi with the client. So, if you think of something like KIUC in the first sort of 24/7 renewables, load-following renewable solution in Hawaii, that was codeveloped with them. So the same way we like we're working with Google, we are working with other people. What we've done in Chile, we've also worked with the client. So I hope that answers your question. So no, I don't see this way off in the future. I see there's a certain relatively short term and growing over time as the clients become more clear exactly what they want, and some of the technologies get cheaper.
Stephen Byrd: Sorry, I misunderstood. Great.
Andrés Gluski: Thanks, Steve.
Operator: Next question is from Charles Fishman of Morningstar.
Charles Fishman: Andrés, the PPAs awarded and signed year-to-date, Slide 53, a big win for Gener on solar. You picked up another project to that power solar. Why if I compare this exhibit to the 2Q exhibit, AES distributed energy actually went lower on solar [ph]? is that you lost the projects just moved it around to a different subsidiary? Or what -- you don't agree with that?
Andrés Gluski: Yes. Sorry, are you looking at, what, the Annex Page 53?
Charles Fishman: Yes. Slide 53 has the AES DE, distributed energy, right, I believe? Yes. And you could see that, okay, you got solar 91 megawatts you signed year-to-date, storage 97. But then if I go back to 2Q, I see AEs Distributed Energy [indiscernible], both of those quite a bit higher.
Ahmed Pasha: Yes. Charles, this is Ahmed. I think Charles, some of these projects that we show in the backlog, they are only either in construction or we have signed -- if the project is completed, then that goes back to operations. That's no longer part of our backlog.
Charles Fishman: Okay. So this is something -- they were projects that went in operation in the quarter that you moved off this line.
Ahmed Pasha: Yes.
Charles Fishman: Okay.
Andrés Gluski: Once it's in operation, it's no longer backlog.
Ahmed Pasha: Yes.
Andrés Gluski: It's been fulfilled.
Ahmed Pasha: Backlog, the way we define backlog is either is in construction. Or we have signed the PPA, but it's not yet in construction. But if it is completed, it gets out.
Charles Fishman: Even though it was signed this year [indiscernible] operation, you take it off this list.
Ahmed Pasha: Yes.
Charles Fishman: Okay, got it. Now another question previously asked on Indiana IPL, if I could maybe push a little harder on that. We've recently seen two other utilities in Indiana really go all in on solar. And yes quite frankly, AEs has more solar experience than both those other utilities combined plus some. Do you have the opportunity at IPL to retire from coal or old gas plants that we should expect some movement like that? It seems like the Indiana Commission is very receptive to that direction.
Andrés Gluski: Yes. Well, we have an RFP for 1.2 gigawatts of renewable, so stay tuned for the results of that. And in those numbers that I gave in this call of 1.2 gigawatts of retirement, there's some of the older coal plants in Indiana. So as a regulated, we have to get approval for this transition. But you're right, we have a whole lot of experience on that, and that's what we're going to do.
Charles Fishman: Okay, that's helpful. Thank you; that's all I had.
Andrés Gluski: Thank you, Charles.
Operator: Next question is from Steve Fleishman of Wolfe Research. Please go ahead.
Steven Fleishman: Hi, good morning. Just wanted to clarify on the coal getting below the 30% announcement. Was there something that didn't get done in terms of an asset sale or something? Because the -- I think these shutdowns were already planned for a while and they're not happening until '21 or '23. So I guess I'm just trying to figure out how that fits into meeting it by the end of '20?
Andrés Gluski: Yes. No. Thanks for the question. No look, what we have in there in our pro forma are sales that we already have a signed contract with, or a plant that we've already programmed to retire. Now that does not exclude additional sales. Now we're not behind on any additional sales or additional shutdowns. And as we said, we expect more in the near term. So we're saying it's 29 already in the third quarter. We had said we would do it by the end of the year. So stay tuned. We think we'll be comfortably below the 30% threshold. And remember, that's megawatt hours. It's actual generation. So actually capacity, we're already at about 26% and will be -- continue to decline. So honestly we haven't missed any of our internal milestones.
Steven Fleishman: Okay. I'm sorry, Andrés, I need to clarify this. But these plants we've known they are going to be shut down for a while. It's not like new, I think, and they're not actually being shut down by the end of 2020. So I'm confused...
Ahmed Pasha: No. I think -- Steve, Ahmed here. Most of these plants I think we got approvals, like Hawaii they just passed the law. We've got the regulatory approval in Hawaii. Then also [indiscernible] as well; so I think these are all the developments that we just announced. So these are not some things that got improved...
Steven Fleishman: Indiana too; because I thought...
Ahmed Pasha: Which one, Indiana? It's about 500 megawatts. I think this also got approval. We just made that filing, I think it's about a month ago or so. So Steve...
Steven Fleishman: Okay. And in terms of meeting the target, it doesn't matter if they don't shut by the end of 2020 or you don't sell by then, as long as you're shutting a few years from now?
Andrés Gluski: Yes. I mean we've been in discussions with ESG investors like Norges Bank. And it really was like, "Show me a path how you're going to get there in the near term." So really this is reflecting what they've asked us to do. We're going to overperform, I assure you of that. And we've been somewhat cautious in terms of our announcements. Because as Ahmed said, what we've shown this time is what we've actually gotten approvals to do. These aren't just, "Gee, I wish -- I'm going to shut this down." Well, can you really shut it down? And you need to have the approval of the regulator of the network operator. So that's where we're at. So honestly this is exactly what we discussed with people like Norges Bank, exactly what they asked us to do. And if anything, we're upfront about it. Now, it is pro forma because in some cases, you -- the retirement, they still need it for, say, another year in some cases. But stay tuned. We'll -- I assure you that we will...
Steven Fleishman: You announced that Petersburg retirement a couple like years ago or we've had that...
Andrés Gluski: No, no, we did not.
Steven Fleishman: I guess that's helpful. it was the --
Andrés Gluski: And I think the punchline is, Steve, just to be clear, we have not seen any delays in the transactions we are working on as far as the sell-downs are concerned on the coal side. So I think we still continue to see the interest. So I don't think there's you need to read anything between the lines.
Steven Fleishman: Okay, that's helpful. And then just the -- on the DPL settlement, the path there, it looks like you -- your -- it allows you now to invest the money and get the rate base growth from that. That's going and keep -- and also keep the current of the old ESP rate. And then I guess at the end of the period, the old ESP rate goes away, but you can then keep growing the rate base from thereon. Can you -- is there any way you can kind of extend this old ESP rate that's still in through 23?
Gustavo Pimenta: I think the -- our expectation is that October 23, we'll file ESP for. It will probably take 12 to 18 months to get approval, and then we're going to get into a new ESP without the RSC. But the plan is we will build up the rate base in the meantime, so we can continue to post growth post that period.
Steven Fleishman: Yes. Okay, great.
Operator: [Operator Instructions] Next question comes from Chopra, Evercore ISI.
Unidentified Analyst: I have one clarification and then just one big picture question. Just going back to - maybe, Gustavo, maybe this is for you. But just going back to Slide 28 here when we sort of look at the cash generation, and you have about $250 million left of the $900 million, $650 million announced. I just want to be clear, the Fluence transaction, any proceeds there are not on this slide, correct?
Gustavo Pimenta: Not on this slide. It's all going to be kept at Fluence.
Unidentified Analyst: Okay. And it will be kept just at Fluence. I mean there's not user proceeds in terms of with your other businesses.
Gustavo Pimenta: No, none.
Unidentified Analyst: Okay. And then maybe just big picture, obviously this year you've executed strongly. But 7% to 9%, can you just high level talk about what gets you to 9% versus what gets you to 7%?
Andrés Gluski: I would say that the difference will have to be in terms of the projects that we have, how fast for example we fill up the gas tanks at Panama and the DR. It will have to be a little bit in terms of demand growth at our utilities and probably execution of our renewable projects. I'd say those are the 3 drivers. As Gustavo said, we have cost cuts inherent. We have lower financing costs as well. So all those are pluses. So I'd say the ones that are outside of our control, to some extent a little bit would be the demand growth in the utilities, and a little bit the timing of filling up the tolling capacity in Central America and Carribbean.
Unidentified Analyst: Got it. Helpful, guys. Maybe just one quick one Just as you think long term, Andrés, I mean you have a pretty good competitive advantage here with storage and with renewables. Just how do you think about balancing, growing internationally, versus sort of your renewable portfolio internationally, versus being 50% earnings from the U.S., that's your long-term target?
Andrés Gluski: That's a great question. Look, our objective is to be an investment-grade company, continue to strengthen our balance sheet and the mix of our businesses. We move very strongly towards investment-grade, dollar long-term contracted business. And that's why we've been so resilient this year in an uncertain environment. I think we've proven that. And we've improved our credit rating in the midst of COVID. I think that says a lot for the strength of our business. We think the optimal mix, also given market conditions probably, is about half U.S. and half outside. And we think that's optimal. We have big corporate opportunities in the U.S. It's a strong market for us. We also think that we have good corporate demand internationally and somewhat unique to us. And we do get higher returns in general internationally. So we think a sort of 50-50 split would be ideal. It's not we can orient it in one direction or the other. Part of it will have to do where our clients demand and where we have competitive advantages. But we think we're developing really global competitive advantages. So it's not only international. We have them here in the U.S..
Unidentified Analyst: That's great. Great quarter.
Andrés Gluski: Thank you
Operator: That concludes our answer -- question-and-answer session. I'd now like to turn the conference back over to Mr. Ahmed Pasha for closing remarks. Please go ahead.
Ahmed Pasha: Thanks, everybody, for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Next week, we look forward to seeing many of you at the EEI Conference. Thanks again, and have a great day.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning and welcome to the AES Corporation Third Quarter Financial Review. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the call over to Mr. Ahmed Pasha, Treasurer and Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, and good morning, everyone. Welcome to our third quarter 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone, and thank you for joining our third quarter financial review call. Today, I will cover both our near-term priorities and the progress we have made on our larger strategic goals. On our last call, I outlined three top priorities: first, achieving our 2020 guidance; second, attaining a second investment-grade rating; and third, decarbonizing our portfolio. We see all three of these goals, both individually and collectively, as catalysts for attracting a wider investor base. Perhaps more importantly, we see all three as clear demonstrations of our ability to thrive in today's evolving landscape. Today, I am pleased to report that we're making great progress on all of these objectives and have several exciting developments to discuss. First, as Gustavo will review in his remarks, our portfolio continues to prove its resiliency in the face of COVID-19, and we're on-track to achieve our full year guidance. In fact, we expect to be at the top end of the ranges for both adjusted EPS and parent free cash flow. Turning to our goal of attaining a second investment-grade rating. I'm proud to say that we were upgraded by S&P earlier this week. This reflects the low level of risk inherent in our current business model. Two investment-grade ratings will help us reduce our overall cost of capital and enable us to attract a broader investor base. Following this milestone, we remain committed to further strengthening our balance sheet and increasing the percentage of our business in the U.S. Now to our third priority of aggressive decarbonization on Slide 4. As you may recall, we set a near-term target to reduce our coal generation to below 30% of total generation by the end of this year, and to below 10% by 2030. I'm happy to report that with today's announced retirement of an additional 1.2 gigawatts, we have reduced our coal generation to 29% on a pro forma basis. 3/4 of these retirements are in the U.S. and the remainder are in Chile. Importantly, these retirements were already anticipated in our guidance, and we will achieve our decarbonization targets while delivering on our financial commitments. We see the transformation of our portfolio as an ongoing process, and we expect to announce additional coal retirements and asset sales in the near term. However, this milestone is significant and that it puts us in compliance with the environmental criteria of several large investors, including Norges Bank. In the longer term, we expect to produce net zero carbon emissions by 2050. Moving to our long-term strategy and the progress we've made to date. As we have discussed previously, our strategy revolves around three core themes: one, investing in sustainable growth; two, offering innovative solutions; and three, delivering superior results. Turning to Slide 5. We are well positioned to meet our strategic and financial objectives. So far this year, we have signed PPAs for 2.1 gigawatts of wind, solar and energy storage projects, which is the most we have signed in the first three quarters of any given year. On to Slide 6. We now have a backlog of 6.8 gigawatts, which is also the largest in our history. Approximately 1/3 is under construction, with the majority expected to come online through 2022. Almost half of this backlog is in the U.S., which we expect to grow as a proportion of our business going forward. Our backlog includes a mix of solar, wind, energy storage and our Alto Maipo hydro project in Chile. We continue to make good progress at Alto Maipo, where construction is more than 96% complete. As you can see on Slide 7, renewables are now nearly 40% of our installed capacity. And this proportion will grow materially as we complete the 6.8 gigawatts in our 100% renewable backlog and sell and retire additional coal plants. In addition to our renewables backlog, we see significant growth opportunities at our 2 U.S. utilities. DP&L and IP&L. We are pleased with the recent developments at IP&L, where we reached a constructive settlement on various pending regulatory proceedings. Gustavo will provide additional details shortly, but this settlement is truly a milestone for DP&L and it grows its rate base and its network. Turning to Slide 8. I have previously discussed that our Green Blend and Extend, strategy, where we work with existing customers to convert the power sold from thermal to renewable generation while extending the contract life. This approach allows all parties to meet their financial and environmental objectives. Since our last call, we signed an additional 410 megawatts of solar capacity under a 17-year contract in Chile, bringing our total Green Blend and Extend, execution to more than 2 gigawatts. As a demonstration of the strength of our existing coal contracts, in August AES had handed reached an agreement with BHP for early termination, resulting in a payment of $720 million, which we will use in part to fund our renewables growth in Chile. While we only report on our projects with signed PPAS, as you can see on Slide 9, we have a robust development pipeline, which we believe is one of our key differentiators. We currently have a development pipeline of 25 gigawatts in key markets, of which 12 gigawatts are in the U.S. Over the past couple of months, we have been solidifying our pipeline by securing land and interconnection rights. We already have very capable solar and energy storage development teams, and we recently acquired a group of experienced wind developers. Expected renewables growth in the U.S. is currently 20 gigawatts per year. However, this rate could accelerate. We are very well positioned to take advantage of any increase in the rate of growth in demand for renewables. Furthermore, we also could benefit from an extension of ITC and PTC incentives for renewables as well as the potential for new incentives for stand-alone storage. Turning to Slide 10 and our LNG strategy. We see the expansion of our LNG infrastructure business as complementary to our renewables growth by offering a clean, predictable and low-cost fuel that provides capacity and flexibility to the system. We are focusing our LNG business in 3 markets: the Caribbean, Central America and Southeast Asia. In all of these markets, there is rapidly growing demand for natural gas to supply new generation and to displace coal and higher-cost fuel oils. As you may know, we're developing an efficient 2.2 gigawatt combined cycle gas facility and a 450 tera BTU LNG terminal in Vietnam. We have hit key milestones towards closing these projects, which will help meet Vietnam's rapidly growing electricity demand. Last week, we signed a term sheet for the LNG terminal in partnership with PV Gas, the state-owned gas utility. In parallel, we have seen strong interest from potential lenders to finance the majority of the capital costs. In Central America and the Caribbean, we continue to lead the transition to cleaner natural gas. We currently have a total of 150 tera BTus of LNG storage capacity, and an additional 50 tera BTUs is under construction in the Dominican Republic. We now have contracted 60% of this storage capacity, and we're in advanced discussions for an additional 20%. This would bring our total contracted volume to 80% in 2023 and beyond. For context, 200 tera BTU LNG volume can serve approximately 3 gigawatts of natural gas generation. Moving on Slide 11. The second component of our strategy is offering innovative solutions. We see the energy needs of our clients, like Google, evolving to achieve the highest standards in clean energy. We are leading the transition through our unique integration of renewables with our scalable platforms of Fluence, 5B and Uplight. Our technological innovation gives us a key competitive advantage. An example is energy storage, where we have access to the latest technology in the sector and combine it with our unique industry insights to create transformative clean energy solutions. As a reminder, working closely with our customer, Kiuc in Hawaii, we were the first company to develop a true 24/7 solar and energy storage project, and we continue to advance new applications. In fact, we recently inaugurated the world's first virtual reservoir in Chile, which combines run of the river hydro with battery-based energy storage, allowing us to sell our energy when prices are highest. Turning to Slide 12. Fluence, our joint venture with Siemens that sells energy storage technology to third parties, continues to maintain its position as the market leader in the sector. This year, Fluence has been awarded 690 megawatts of contracts, increasing their awarded or delivered capacity to 2.4 gigawatts. Fluence's revenue is expected to reach $500 million this year, an increase of 400% compared to last year. While rapidly growing their backlog, Fluence continues to enhance their digital capabilities and to complement their suite of solutions. To that end, Fluence acquired AMS, the leading provider of AI-enabled bidding software for storage and generation assets. Through the AMS acquisition, Fluence now has ongoing contracts for digital bidding services for more than 2.4 gigawatts, and most of it additional to Fluence's fleet. The integration of this technology to Fluence's current offerings will help optimize the use of energy storage and to ensure the greatest value for their clients. We're also looking to additional new products and innovation that could transform the sector, as shown on Slide 13. With our recent investment in 5B, a prefabricated solar solution company, solar projects can be built in 1/3 of the time and on half as much land. We believe that being able to double solar energy output from a given area will become a great differentiator as solar penetration increases, especially near urban and congested areas. In addition to 5B's potential pipeline of more than 10 gigawatts of third-party projects in Australia, we see an addressable market of 5 gigawatts across our own development pipeline. We aim to be the most competitive solar operator and developer by using 5B to reduce time to build and increase energy density in combination with our ongoing robotic and digital initiatives. One example of how we are integrating all of these technologies to improve customer outcomes is the Andes IIb project in Chile. This project consists of 180 megawatts of solar incorporates 10 megawatts of 5B's technology and includes 560 megawatt hours of energy storage, the largest in Latin America. Another example of our leading innovations is our Uplight platform, which is helping utilities improve energy efficiency and balance system demand. Both of these capabilities are increasingly relevant to Uplight's 100 million end users and 80 utility customers in the U.S. Finally, as I previously discussed, we continue to be on the forefront of new technologies. To that end, we have been running tests on hydrogen at several thermal plants in Latin America. We consider ourselves to be well positioned to be a leader to incorporate green hydrogen if and when it becomes economic sometime in the future. Turning now to the third component of our strategy, which Gustavo will spend more time on: delivering superior results. By investing in our development pipeline, we are earning attractive risk-adjusted returns. As you can see on Slide 14, in the U.S we're earning low double-digit returns, while internationally we're earning mid- to high-teen returns. Before concluding, I would like to note that last week, we launched a new brand with a new logo, as you can see on our slides. We have transformed AES into a leader in clean energy, and our new brand symbolizes our position at the forefront of the technological and commercial changes that are redefining our industry. Now, I would like to turn the call over to Gustavo Pimenta, our CFO, so he can provide more color on our results, debt profile and guidance."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thank you, Andres, and good morning, everyone. Today, I'll cover 3 key topics: our resilient business model, our performance during the third quarter, and our capital allocation plan. Let me start with our resilient business model. Over the last decade, we have proactively transformed our portfolio. And now 85% of our earnings are from utilities and long-term contracted generation with an average contract life of 14 years, supported by creditworthy offtakers. At the same time, more than 80% of our earnings are now in dollars. This provides significant stability to earnings and cash flow. Turning to Slide 16. You can see how our portfolio has performed during these challenging times. As you know, a majority of our customers are large industrials and export-oriented mining companies that continue to operate despite COVID-19 as they are deemed essential. As a result, Q3 receivables and days sales outstanding remained stable and very much in line with historical levels. Moving on to Slide 17. The impact of the global lockdown on our financial results has been mostly limited to our utilities. Our generation businesses have been largely unaffected due to the take-or-pay nature of contracts and customers being deemed essential. As you may recall, in our first quarter call we had anticipated an extended U-shaped recovery in energy demand across our markets. Since then, demand performance has been better than our expectation. For Q3, our initial projection was for a demand drop of about 5% to 7% at our U.S. utilities. While the actual result was significantly less severe than anticipated, on a weather-normalized basis, the net combined volume at DPL and IPL is mostly flat. Demand at DPL was up 3% and largely driven by the higher load from residential customers, while demand at IPL was down 3% as the load from commercial and industrial customers has yet to reach pre-COVID levels. Accordingly, the total net impact of the lower demand on our utilities was only $0.01 on adjusted EPS for the quarter, better than our initial expectation of $0.02 to $0.03. Now turning to our quarterly results on Slide 18. Adjusted EPS was $0.42 for the quarter versus $0.48 last year. Our quarterly results reflect an $0.11 impact most related to last year's insurance recovery and outage that occurred this quarter at one of our facilities in Dominican Republic, which is already back in operations. Results also reflect the regulatory changes that were implemented at DP&L and in Argentina in Q4 2019. These headwinds were partially offset by higher contributions from the Southland repowering project, our Eurasia SBU, our cost savings and deleveraging initiatives as well as a lower tax rate. Turning to Slide 19; adjusted pretax contribution or PTC was $331 million for the quarter, a decrease of $95 million versus the third quarter of 2019. I'll cover our results in more detail over the next 4 slides beginning on Slide 20. In the U.S. and utilities SBU, PTC remained relatively flat. The benefit from the commencement of PPAs at Southland Energy CCGTs was mostly offset by the reversion to ESP 1 rates at DPL in 2019 as well as lower demand at our utilities due to the impact of COVID-19. Before moving on, I would like to take a moment to update you on recent regulatory developments at DP&L on Slide 21. I'm very pleased to announce that we have reached a successful settlement with PUCO staff and key intervenors, resolving 4 open proceedings, significantly reducing regulatory uncertainty and allowing us to move forward with our smart grid investments. More specifically as a result of this settlement, DP&L committed to file a new ESP by October 1, 2023, and will continue to recover its approximately $80 million annual rate stabilization charge until the new ESP becomes effective. DP&L will make smart grid investments of $249 million over the next 4 years, to earn a return through the investment infrastructure rider. Resolution was reached on the 2 pending retroactive SEET tests related to 2018 and 2019. And DP&L passed the SEET and MFA regulatory tests filed earlier this year. Now turning back to our third quarter results on Slide 22. At our South America SBU, lower PTC was primarily driven by dry hydrology at the Chivor hydro plant in Colombia, resulting in lower generation and high energy purchases. Lower PTC at our MCAC [ph] SBU primarily reflects the outage-related impacts I discussed previously as well as the arbitration settlement at Changuinola this year. Finally, in the region, higher results reflect lower maintenance and outages as well as lower interest expense due to debt repayment in 2020. It also includes a favorable variance in India given the OPGC COD delay last year. Now to Slide 25. To summarize our performance in the first 3 quarters of the year, we earned adjusted EPS of $0.96 versus $1.02 last year. We are reaffirming our 2020 adjusted EPS guidance range of $1.32 to $1.42. In fact, based on our strong year-to-date performance and outlook for the remainder of the year, we are now expecting to be at the top end of this range. Now turning to our credit profile on Slide 26. As we have discussed on our prior calls, since 2011 we reduced our parent debt by approximately $3 billion or about 50%. As Andrés mentioned, we recently received our second investment-grade rating. We are very pleased that S&P has recognized the underlying quality and strength of our portfolio. As you can see on this slide, we have improved our ratings by 2 to 3 notches over the last 4 years. Strong credit metrics remain one of our top priorities, and we'll continue to take steps to maintain and further improve upon current levels. Now to 2020 parent capital allocation on Slide 27. We expect to have $1.5 billion of discretionary cash this year, which is roughly $100 million higher than our prior disclosure. Regarding asset sales, today we are very pleased to announce a sell-down of 35% of our interest in the Southland repowering projects for $424 million to Yulico, expanding from our successful partnership at SPower. This transaction demonstrates the substantial intrinsic value of our portfolio and how we benefit from our platform and long-term contracted assets. As you may recall, Southland has a 20-year contract and was commissioned early this year. This sell-down implies a total equity value of more than $1.2 billion. With this transaction, combined with our previously announced asset sales, we have exceeded our proceeds target for the year by approximately $100 million for a total of $650 million. Further, based on our year-to-date performance and our outlook for the remainder of the year, we now also expect parent free cash flow to come in at the top end of our range of $725 million to $775 million. Moving to the right-hand side, uses are largely unchanged from the last quarter, except the investments in our subsidiaries, which are roughly $200 million higher. The increase primarily reflects a temporary cash injection at Southland and higher investments in renewables. Approximately 90% of the $900 million of investments in subsidiaries are in the U.S., contributing to our goal of increasing the proportion of earnings from the U.S. to about half. Next, moving to our capital allocation from 2020 through 2022 beginning on Slide 28. We continue to expect our portfolio to generate $3.4 billion in discretionary cash. 3/4 of this is expected to be generated from parent free cash flow, with the remaining $900 million come from asset sale proceeds. Turning to the uses of this discretionary cash on Slide 29. Roughly 1/3 will be allocated to shareholder dividends. Subject to any review by the Board, we continue to expect it to increase the dividend by 4% to 6% per year, in line with the industry average. We also expected to use $1.9 billion to invest in our backlog, new projected PPAs, T&D investments at IPL, the partial funding of our Vietnam LNG project, and the investment in Gener. Once completed, these projects will contribute to our growth through 2022 and beyond. With that, I'll turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Gustavo. Before we take your questions, let me summarize today's call. We have made great progress on our key objectives. Specifically, we secured a second investment-grade rating. We reduced our generation from coal to below 30%. We signed 2.1 gigawatts of new renewable contracts, increasing our backlog to a record 6.8 gigawatts. And we are growing our development pipeline and deploying new technologies, such as Fluence, 5B and Uplight. Finally, with our year-to-date financial performance, we now expect to be at the top end of our guidance ranges for both adjusted EPS and parent free cash flow. With that, I would like to open the call to your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] First question comes from Richard Sunderland of JPMorgan."
},
{
"speaker": "Richard Sunderland",
"text": "Maybe starting -- just starting off with the Fluence process, could you update us on the latest timing and expectations around the sale of the minority interest?"
},
{
"speaker": "Andrés Gluski",
"text": "Sure. The capital raise at Fluence is going very well. We have strong interest, and we expect to get it done by the end of this year."
},
{
"speaker": "Richard Sunderland",
"text": "So namely kind of no impacts from the elections or considerations around there specifically to the sale?"
},
{
"speaker": "Andrés Gluski",
"text": "Not really. I mean this capital raise, people are looking at the long term. And certainly, lithium ion-based energy storage has a great future ahead of it. As the -- as I said in my remarks, it's growing very rapidly and it's the leader in the sector. So it really is a unique investment opportunity. So no, we've seen no impact whatsoever."
},
{
"speaker": "Richard Sunderland",
"text": "And has there been any shift in the kind of interest or type of parties evaluating Fluence?"
},
{
"speaker": "Andrés Gluski",
"text": "None whatsoever."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. Great. And then just quick on the outage cited on the quarter. I know you said one of the facilities back in operations. Any color around the outage itself and I guess risks going forward?"
},
{
"speaker": "Gustavo Pimenta",
"text": "No, it was -- this is Gustavo, Rich. No, it was an outage that we had in there in one of our facilities there. It's about $0.02 impact in the quarter, but the facility is back in operation already."
},
{
"speaker": "Operator",
"text": "Next question comes from Julien Dumoulin-Smith, Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Congratulations on a -- a litany of developments here, it's hard to know where to start. At the outset here, how about this? So you've had a lot of success across your businesses here. When you think about the earnings trajectory of the renewables business altogether, how would you characterize that, right? Given the backlog, given the success year-to-date, given the capital available to deploy back into it, how in aggregate would you kind of describe its attribution or contribution to the EPS growth rate? And then relate it to Fluence as well, if you can. I know it's still small."
},
{
"speaker": "Andrés Gluski",
"text": "Okay. Let me start sort of big picture. Most of our business, most of our earnings is coming from the traditional businesses. So this is sort of an add-on, and we're retiring some of the thermal assets. So it's a transition. So it's going to be growing over time. We feel very good about the way it's sort of blending in. Something like Green Blend and Extend it's blending in to this growth. So we have a backlog of 7 gigawatts. It's a good mix of U.S. and outside, and it has good returns. And there's a variety of regulatory schemes under which they operate. So we feel good about it. It's going to be growing, and it's going to -- it's replacing some of the older thermal assets that we're retiring. Second part of your question regarding Fluence, well realize that as I've said in the past, the faster Fluence grows, to some extent it pushes off a little bit positive earnings. We're creating an enormous amount of value. But all R&D for example or all upgrading of our teams around the world, that's expensed. So when you're growing 400% this year, we expect a 40-plus growth rate going forward. We have a backlog of 1 gigawatt; so that's still up. So there's no -- right now, Fluence is a drag of around $0.02. So it will -- everything has a positive margin. We expect this to turn around, but it's a little bit of a function of how fast we grow. So ironically the more value we create and the faster we grow, that may take a little bit more time."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Now, if I can pivot this slightly more specifically to your guidance, when you think about this roll forward coming up with fourth quarter, and I know I'm kind of asking for guidance without getting it explicitly, how are you thinking about some of the major puts and to pick here? Because as best I see it, it seems like you resolved a number of these issues. And so I just want to make sure we're on the same page about this, whether it's DPL, whether it's related to Gener, or frankly whether it relates to your execution on backlog on renewables. But can you give us at least a sense for some of the bigger puts and takes here and/or other factors that you've mentioned?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes, you've mentioned most of the factors. I mean we have rapid renewable growth, Green Blend and Extend,. We have DP&L, IPL, growing their rate base. I think the one that you did not mention was the growth of LNG. So you realize that we are doing very well on contracting more really tolling of gas in the Dominican Republic. We're very -- actually we have the contracts there. We're very optimistic about doing more in Panama. And as I said in my speech, those will all contribute to our earnings at 23 and beyond. So most of the investment is made. So having said that, that's how we see it. So we feel optimistic. And that's why we've included the retirement of -- or part of that guidance. So we can't give you guidance before the fourth call. Gustavo, do you want to add something?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Yes. I would just add, Julien, in addition to what Andrés just said, I think California, the extension of the legacy unit is another important driver, right? So -- And also the incremental cost cutting. Remember, we had talked about $100 million of cost-cutting through 2022, half of that through 2021. So those will be helpful, and eventually we'll be able to capture more post that period. And I think to your question on renewables, probably the best way to think about it is most of our free cash is going to renewables nowadays. So it's about $350 million to $400 million of investment in new renewables going forward. And you put low double-digit to mid-teen returns, and you see that this is going to be an important driver of earnings going forward."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "And just -- sorry to clarify this. When you were speaking on LNG, can you elaborate briefly on Panama on the IMO piece of this in terms of bunkering and the upside potential?"
},
{
"speaker": "Andrés Gluski",
"text": "Well, basically our current facility, especially the storage tank in Panama, is about 30% utilized. All the capital investment has been made. So to the extent that we can contract more gas passing through it, that goes straight to our bottom line. And so we feel good about the possibility of contracting more gas in Panama and increasing that utilization. In the case of the Dominican Republic, we had talked about this for many years, that actually we filled up the tank, to the extent that we're actually having to build a somewhat smaller but second tank there to meet all the demand. So realize this is contracted. It's tolling. We're not taking commodity risk. So our gas strategy in the Caribbean and Central America is playing out as planned."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "One more clarification, on Indiana, I didn't hear you say anything about PUCO and renewables. I know there's an RFP out there. Apologies, if I could."
},
{
"speaker": "Gustavo Pimenta",
"text": "Yes, there is an RFP as we speak, so the team is finalizing. And it's one of the opportunities that we have to sign up for more renewable growth there and rate base. So stay tuned, we'll be talking about that shortly."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Not yet in there. All right, great."
},
{
"speaker": "Gustavo Pimenta",
"text": "Not yet in there."
},
{
"speaker": "Andrés Gluski",
"text": "Thanks, Julien."
},
{
"speaker": "Operator",
"text": "Next question comes from Stephen Byrd with Morgan Stanley."
},
{
"speaker": "Stephen Byrd",
"text": "Congratulations on progress on a lot of fronts. I agree with Julien, it's kind of hard to know where to start."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you very much."
},
{
"speaker": "Stephen Byrd",
"text": "So I wanted to maybe start at a high level and just talk about your renewables business globally, and thinking about sort of how to realize the full value of the business. The business has become very large. It's one of the biggest backlogs globally. How do you think about ensuring that you realize the full value, given that it's housed within AES? And this has always been sort of a question in terms of highlighting the values of these businesses. And I think it's just really accentuated, given the trading levels of pure clean energy companies. Just curious how you're thinking about the long-term strategy there."
},
{
"speaker": "Andrés Gluski",
"text": "That's a great question. We think about that a lot. So really what we see is that there is a true competitive advantage of combining our existing platforms with the new. And I say that because it's easy to talk about renewables, but really that's just energy. And what the market is demanding is capacity. So you're going to get that capacity in the short term from your existing traditional facilities and then with energy storage. So thinking about that, nobody is in a better position than us to do that because we really are the leader in the -- not only the amount of energy storage, but more important, I think the new applications, finding new ways to use this. So I feel very good about this sort of leading this transition in a very responsible way retiring our coal plants, selling coal plants, providing that capacity to some extent in other new markets in -- with gas. Because quite frankly not all markets are capable with today's technology of efficiently providing capacity. Even with batteries, it would be too expensive with renewables. So we're leading that transition to a lower-carbon future. But at the same time, I think we're uniquely integrating, be it energy storage, innovative renewables. I mean I think 5B, that technology will play a greater role in the future as you get greater really penetration of solar in some areas. And so being able to do it in a smaller space is very valuable. Being able to do it faster is very valuable. We're really doing some very interesting things on robotics. We're doing some very interesting things in digital, digital controls. And so Uplight is one aspect of it. But so is for example, the purchase of AMS by Fluent. So that's a little bit how I see it. So while it's true that there is a premium today for pure renewable plays, we think there'll be a premium tomorrow for those companies that truly satisfy what customers need. So it's not only energy. It's energy plus capacity. And we will lead the way into providing capacity, energy and customer-facing solutions into the future. So it's a very interesting transition, even though it's a little bit complicated story."
},
{
"speaker": "Stephen Byrd",
"text": "Those are good points about capacity and integration. I take those points. Maybe shifting over to the corporate customer side. The Google arrangement makes a lot of sense. I was just curious your latest thoughts in terms of additional appetite from other corporate or potential corporate customers to do something along those lines, given AES' global platform?"
},
{
"speaker": "Andrés Gluski",
"text": "That's a great question. So we have a, say, arrangement with Google. We're exploring several fronts. As you know, we do have an RFP out for a gigawatt and PJM. We will, we believe, making announcements into the future in terms of how we will be working together, as I said, several fronts. But this is not something that will not exclude other clients, potential clients. So as we find ways to provide the capacity people need and the low carbon that people need, plus a digital overlay. That is certainly something that we believe will be attractive to a lot of clients. So Green Blend and Extend, for example was an interesting solution for a lot of the big mining companies that wanted to lower their carbon footprint and have cheaper energy. And again, that can transition over time to net 0 solution, but it's going to take some time to get there."
},
{
"speaker": "Stephen Byrd",
"text": "Understood. So it sounds like while there's a lot of opportunities, it's going to take some time to really to get traction with a lot of corporate customers, to the point where this is a more meaningful part of your overall business mix. Is that fair?"
},
{
"speaker": "Andrés Gluski",
"text": "No. I would say that -- I guess what I'm saying is that I expect to do more with corporate customers. What I'm saying is that depending on what the situation is. It may take longer or less long. It depends, on the market they're in, depends on the availability of renewables in that market, and it depends exactly what the customer wants. I mean what we're really working with is sort of co-creating with clients and co-creating what they want. And I think again we're also uniquely positioned to do that, not only because of the various technologies we're involved in, but also, quite frankly our modus operandi with the client. So, if you think of something like KIUC in the first sort of 24/7 renewables, load-following renewable solution in Hawaii, that was codeveloped with them. So the same way we like we're working with Google, we are working with other people. What we've done in Chile, we've also worked with the client. So I hope that answers your question. So no, I don't see this way off in the future. I see there's a certain relatively short term and growing over time as the clients become more clear exactly what they want, and some of the technologies get cheaper."
},
{
"speaker": "Stephen Byrd",
"text": "Sorry, I misunderstood. Great."
},
{
"speaker": "Andrés Gluski",
"text": "Thanks, Steve."
},
{
"speaker": "Operator",
"text": "Next question is from Charles Fishman of Morningstar."
},
{
"speaker": "Charles Fishman",
"text": "Andrés, the PPAs awarded and signed year-to-date, Slide 53, a big win for Gener on solar. You picked up another project to that power solar. Why if I compare this exhibit to the 2Q exhibit, AES distributed energy actually went lower on solar [ph]? is that you lost the projects just moved it around to a different subsidiary? Or what -- you don't agree with that?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Sorry, are you looking at, what, the Annex Page 53?"
},
{
"speaker": "Charles Fishman",
"text": "Yes. Slide 53 has the AES DE, distributed energy, right, I believe? Yes. And you could see that, okay, you got solar 91 megawatts you signed year-to-date, storage 97. But then if I go back to 2Q, I see AEs Distributed Energy [indiscernible], both of those quite a bit higher."
},
{
"speaker": "Ahmed Pasha",
"text": "Yes. Charles, this is Ahmed. I think Charles, some of these projects that we show in the backlog, they are only either in construction or we have signed -- if the project is completed, then that goes back to operations. That's no longer part of our backlog."
},
{
"speaker": "Charles Fishman",
"text": "Okay. So this is something -- they were projects that went in operation in the quarter that you moved off this line."
},
{
"speaker": "Ahmed Pasha",
"text": "Yes."
},
{
"speaker": "Charles Fishman",
"text": "Okay."
},
{
"speaker": "Andrés Gluski",
"text": "Once it's in operation, it's no longer backlog."
},
{
"speaker": "Ahmed Pasha",
"text": "Yes."
},
{
"speaker": "Andrés Gluski",
"text": "It's been fulfilled."
},
{
"speaker": "Ahmed Pasha",
"text": "Backlog, the way we define backlog is either is in construction. Or we have signed the PPA, but it's not yet in construction. But if it is completed, it gets out."
},
{
"speaker": "Charles Fishman",
"text": "Even though it was signed this year [indiscernible] operation, you take it off this list."
},
{
"speaker": "Ahmed Pasha",
"text": "Yes."
},
{
"speaker": "Charles Fishman",
"text": "Okay, got it. Now another question previously asked on Indiana IPL, if I could maybe push a little harder on that. We've recently seen two other utilities in Indiana really go all in on solar. And yes quite frankly, AEs has more solar experience than both those other utilities combined plus some. Do you have the opportunity at IPL to retire from coal or old gas plants that we should expect some movement like that? It seems like the Indiana Commission is very receptive to that direction."
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Well, we have an RFP for 1.2 gigawatts of renewable, so stay tuned for the results of that. And in those numbers that I gave in this call of 1.2 gigawatts of retirement, there's some of the older coal plants in Indiana. So as a regulated, we have to get approval for this transition. But you're right, we have a whole lot of experience on that, and that's what we're going to do."
},
{
"speaker": "Charles Fishman",
"text": "Okay, that's helpful. Thank you; that's all I had."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Charles."
},
{
"speaker": "Operator",
"text": "Next question is from Steve Fleishman of Wolfe Research. Please go ahead."
},
{
"speaker": "Steven Fleishman",
"text": "Hi, good morning. Just wanted to clarify on the coal getting below the 30% announcement. Was there something that didn't get done in terms of an asset sale or something? Because the -- I think these shutdowns were already planned for a while and they're not happening until '21 or '23. So I guess I'm just trying to figure out how that fits into meeting it by the end of '20?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. No. Thanks for the question. No look, what we have in there in our pro forma are sales that we already have a signed contract with, or a plant that we've already programmed to retire. Now that does not exclude additional sales. Now we're not behind on any additional sales or additional shutdowns. And as we said, we expect more in the near term. So we're saying it's 29 already in the third quarter. We had said we would do it by the end of the year. So stay tuned. We think we'll be comfortably below the 30% threshold. And remember, that's megawatt hours. It's actual generation. So actually capacity, we're already at about 26% and will be -- continue to decline. So honestly we haven't missed any of our internal milestones."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. I'm sorry, Andrés, I need to clarify this. But these plants we've known they are going to be shut down for a while. It's not like new, I think, and they're not actually being shut down by the end of 2020. So I'm confused..."
},
{
"speaker": "Ahmed Pasha",
"text": "No. I think -- Steve, Ahmed here. Most of these plants I think we got approvals, like Hawaii they just passed the law. We've got the regulatory approval in Hawaii. Then also [indiscernible] as well; so I think these are all the developments that we just announced. So these are not some things that got improved..."
},
{
"speaker": "Steven Fleishman",
"text": "Indiana too; because I thought..."
},
{
"speaker": "Ahmed Pasha",
"text": "Which one, Indiana? It's about 500 megawatts. I think this also got approval. We just made that filing, I think it's about a month ago or so. So Steve..."
},
{
"speaker": "Steven Fleishman",
"text": "Okay. And in terms of meeting the target, it doesn't matter if they don't shut by the end of 2020 or you don't sell by then, as long as you're shutting a few years from now?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. I mean we've been in discussions with ESG investors like Norges Bank. And it really was like, \"Show me a path how you're going to get there in the near term.\" So really this is reflecting what they've asked us to do. We're going to overperform, I assure you of that. And we've been somewhat cautious in terms of our announcements. Because as Ahmed said, what we've shown this time is what we've actually gotten approvals to do. These aren't just, \"Gee, I wish -- I'm going to shut this down.\" Well, can you really shut it down? And you need to have the approval of the regulator of the network operator. So that's where we're at. So honestly this is exactly what we discussed with people like Norges Bank, exactly what they asked us to do. And if anything, we're upfront about it. Now, it is pro forma because in some cases, you -- the retirement, they still need it for, say, another year in some cases. But stay tuned. We'll -- I assure you that we will..."
},
{
"speaker": "Steven Fleishman",
"text": "You announced that Petersburg retirement a couple like years ago or we've had that..."
},
{
"speaker": "Andrés Gluski",
"text": "No, no, we did not."
},
{
"speaker": "Steven Fleishman",
"text": "I guess that's helpful. it was the --"
},
{
"speaker": "Andrés Gluski",
"text": "And I think the punchline is, Steve, just to be clear, we have not seen any delays in the transactions we are working on as far as the sell-downs are concerned on the coal side. So I think we still continue to see the interest. So I don't think there's you need to read anything between the lines."
},
{
"speaker": "Steven Fleishman",
"text": "Okay, that's helpful. And then just the -- on the DPL settlement, the path there, it looks like you -- your -- it allows you now to invest the money and get the rate base growth from that. That's going and keep -- and also keep the current of the old ESP rate. And then I guess at the end of the period, the old ESP rate goes away, but you can then keep growing the rate base from thereon. Can you -- is there any way you can kind of extend this old ESP rate that's still in through 23?"
},
{
"speaker": "Gustavo Pimenta",
"text": "I think the -- our expectation is that October 23, we'll file ESP for. It will probably take 12 to 18 months to get approval, and then we're going to get into a new ESP without the RSC. But the plan is we will build up the rate base in the meantime, so we can continue to post growth post that period."
},
{
"speaker": "Steven Fleishman",
"text": "Yes. Okay, great."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Next question comes from Chopra, Evercore ISI."
},
{
"speaker": "Unidentified Analyst",
"text": "I have one clarification and then just one big picture question. Just going back to - maybe, Gustavo, maybe this is for you. But just going back to Slide 28 here when we sort of look at the cash generation, and you have about $250 million left of the $900 million, $650 million announced. I just want to be clear, the Fluence transaction, any proceeds there are not on this slide, correct?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Not on this slide. It's all going to be kept at Fluence."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. And it will be kept just at Fluence. I mean there's not user proceeds in terms of with your other businesses."
},
{
"speaker": "Gustavo Pimenta",
"text": "No, none."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. And then maybe just big picture, obviously this year you've executed strongly. But 7% to 9%, can you just high level talk about what gets you to 9% versus what gets you to 7%?"
},
{
"speaker": "Andrés Gluski",
"text": "I would say that the difference will have to be in terms of the projects that we have, how fast for example we fill up the gas tanks at Panama and the DR. It will have to be a little bit in terms of demand growth at our utilities and probably execution of our renewable projects. I'd say those are the 3 drivers. As Gustavo said, we have cost cuts inherent. We have lower financing costs as well. So all those are pluses. So I'd say the ones that are outside of our control, to some extent a little bit would be the demand growth in the utilities, and a little bit the timing of filling up the tolling capacity in Central America and Carribbean."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it. Helpful, guys. Maybe just one quick one Just as you think long term, Andrés, I mean you have a pretty good competitive advantage here with storage and with renewables. Just how do you think about balancing, growing internationally, versus sort of your renewable portfolio internationally, versus being 50% earnings from the U.S., that's your long-term target?"
},
{
"speaker": "Andrés Gluski",
"text": "That's a great question. Look, our objective is to be an investment-grade company, continue to strengthen our balance sheet and the mix of our businesses. We move very strongly towards investment-grade, dollar long-term contracted business. And that's why we've been so resilient this year in an uncertain environment. I think we've proven that. And we've improved our credit rating in the midst of COVID. I think that says a lot for the strength of our business. We think the optimal mix, also given market conditions probably, is about half U.S. and half outside. And we think that's optimal. We have big corporate opportunities in the U.S. It's a strong market for us. We also think that we have good corporate demand internationally and somewhat unique to us. And we do get higher returns in general internationally. So we think a sort of 50-50 split would be ideal. It's not we can orient it in one direction or the other. Part of it will have to do where our clients demand and where we have competitive advantages. But we think we're developing really global competitive advantages. So it's not only international. We have them here in the U.S.."
},
{
"speaker": "Unidentified Analyst",
"text": "That's great. Great quarter."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you"
},
{
"speaker": "Operator",
"text": "That concludes our answer -- question-and-answer session. I'd now like to turn the conference back over to Mr. Ahmed Pasha for closing remarks. Please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thanks, everybody, for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Next week, we look forward to seeing many of you at the EEI Conference. Thanks again, and have a great day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | The AES Corporation | 35,312 |
AES | 2 | 2,020 | 2020-08-06 09:00:00 | Operator: Good morning. Welcome to the AES Corporation Second Quarter 2020 Financial Review Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask question. Please note that this event is being recorded. I would now like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Go ahead.
Ahmed Pasha: Thank you, Operator. Good morning, everyone. And welcome to our second quarter 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?
Andrés Gluski: Good morning, everyone. And thank you for joining our second quarter financial review call. Today, I will spend some time on three near-term priorities, achieving our 2020 guidance, attaining a second investment grade rating and decarbonizing our portfolio. We believe that progress in these three key areas will allow us to reach a larger investor base in the near-term. They will also advance our longer term strategic and financial objectives. After discussing these three themes, I will provide an update on our sustainable growth initiatives and our efforts to create a technological competitive edge. Last quarter I indicated that we were well-positioned to withstand the impacts of the COVID-19 pandemic due to the resilience of our business model. I am pleased to report that our second quarter results demonstrate this resilience and keep us on track to achieve our full year guidance. We delivered adjusted EPS of $0.25 in the second quarter in line with last year. This reflects the strength of our business model, which is based on long-term take or pay contracts with credit worthy customers. As a result, we are very confident that we will achieve our 2020 adjusted EPS guidance of $1.32 to $1.42 and our expected parent free cash flow of $725 million to $775 million. At the same time, we have continued to grow our free cash flow. We ended the second quarter with the apparent free cash flow to debt ratio of 24%, which is comfortably above the 20% threshold required for investment grade ratings. As a reminder, we have already received one investment grade rating from Fitch and remain optimistic that we will attain our second investment grade rating later this year. Turning to our aggressive carbonization goals on slide four. As we have said before, we are very focused on reducing our generation from coal to less than 30% of total generation to comply with Norges Bank Environmental Investment criteria. On this front, we have made great progress over the past two months, signing binding agreements to sell OPGC in India and Itabo in the Dominican Republic. These sales will reduce our generation from coal by 11 percentage points to 34%. We are working on a couple of additional transactions that combined with our growth in renewables will allow us to easily comply with Norges Bank criteria by next year. To further our reduction in coal exposure, AES Gener is negotiating with several of off-takers in Chile to delink PPAs from physical assets and be able to monetize the value of long-term totaling agreements. These transactions will demonstrate that the real value of the business is in this contracts and customers, while providing funding for AES Gener successful Green Blend & Extend Renewables Growth Strategy. Turning to slide five and sustainable growth. I am happy to announce that since our last call, we have been awarded or signed 852 megawatts of new renewable PPAs. This brings our year-to-date total to 1.5 gigawatts, including 346 megawatts of energy storage. As a result, our backlog of new renewables projects increased to 6.2 gigawatts, about half of this backlog is in the U.S. and the majority is expected to come online between 2021 and 2024. Therefore, we remain on track to continue to add 2 gigawatts to 3 gigawatts of new renewables per year by capitalizing on our business platforms and our growing technological expertise. In addition, to our 6.2 gigawatt backlog, we have a pipeline of 15 gigawatts of renewable projects under active development in the U.S. This considerable pipeline positions us very well for an acceleration in U.S. renewables growth if the federal policies change following the November elections. Turning to slide seven. We are also consolidating our position in existing renewable platforms. To that end, we recently acquired additional shares of AES Tietê, increasing our ownership from 24% to 43%. We will finance this acquisition mostly through non-recourse debt in Brazil and it is accretive from day one. We plan to upgrade AES Tietê’s listing to Novo Mercado under Bovespa, where companies trade at significant premiums due to best-in-class governance. This move is expected to further unlock the value of AES Tietê for the benefit of all of its shareholders. We continue to actively pursue new technologies to support our growth in renewables and innovative products that meet the changing needs of our customers. As you can see on slide eight, Fluence, our joint venture with Siemens that sells energy storage technology to third parties, continues to be the global market leader in this sector. This leadership is based on our track record of deploying more than 2 gigawatts of energy storage, presence in 22 countries and offering more than 40 digital applications to our customers. This year Fluence’s revenue is expected to reach $500 million, an increase of 400% in relation to last year. We believe that energy storage will play a major role in the global transition to a low carbon economy. As a result, we expect Fluence’s revenue to grow at 40% compounded annually to reach $3 billion by the end of 2025. Turning to slide nine. We are already experiencing this acceleration of growth in demand for energy storage. In June Fluence launched its sixth-generation product, which includes a modular and factory-assembled cube design that is safer, more reliable and lower cost. Fluence’s new cube already has orders for more than 800 megawatts to be delivered over the next three years. As you may know, Fluence is currently running a private placement for a minority partner in order to capitalize this high growth business. We are encouraged by the strong interest we are seeing from potential investors and we expect to have concrete details to share with you before the end of the year. Together, AES and Fluence continue to pioneer new applications for lithium-ion based energy storage technology. One example is a virtual reservoir for run-of-the-river hydropower projects, utilizing energy storage that charges when power prices are low and discharges during peak hours. As shown on slide 10, at the Alfalfal hydro complex in Chile, we just commissioned the world’s first such virtual reservoir with 10 megawatts or 50-megawatt hours of energy storage. We can further expand this facility to 250 megawatts or 1,250-megawatt hours over the next couple of years. Today, about half of all our renewable projects have an energy storage component. Now moving on to slide 11. We continue to pursue new technologies that have the potential to provide us with a competitive advantage in our markets. To that end, we recently acquired a 25% stake in 5B, a prefabricated solar solution company in Australia. With 5B’s patented technology, solar projects can be built in a third of the time and in half the space. We believe that being able to double solar energy output from a given area will become increasingly important as solar penetration increases especially near urban or congested areas. In addition to 5B’s potential pipeline of more than 10 gigawatts of third-party projects in Australia, we see an additional addressable market of 5 gigawatts across our developing pipeline. As part of this strategic agreement, we have exclusive rights to develop utility scale projects using 5B’s technology in our key markets, including the U.S. We have already started the deployment of 2 megawatts in Panama and 10 megawatts in Chile. We aim to be the most competitive solar developer by using 5B to reduce time-to-build and increase energy density, while combining it with our robotic and digital solar initiatives. Turning to slide 12. In 2018, AES invested in Uplight to improve our customer experiences by a digital cloud-based technology. In addition, Uplight provides cloud-based services to third parties to improve energy efficiency and balance system demand. This fast growing business already reaches more than 100 million households and businesses in the U.S., and expects a 20% increase in annual revenue in 2020. Finally, regarding our partnership with Google, it is progressing well, and as you might have seen, we recently launched an RFP for 1-gigawatt of carbon free energy in PJM. We are working on several other significant initiatives with Google and we will share additional details as this firm up. In summary, our ongoing leading technology efforts aim to give us a competitive edge to deliver the products and services required by our customers in a rapidly evolving and growing market. Now, I would like to turn over the call to Gustavo Pimenta, our CFO, so he can provide more color on our results, debt profile and guidance.
Gustavo Pimenta: Thank you, Andrés. Today, I will cover three key topics, our resilient business model, our performance during the second quarter and our capital allocation plan. Let me start with our resilient business model on slide 14. As you can see 85% of our earnings are from Utilities and long-term contracted generation, with an average contract life of 14 years. This provides significant stability to earnings and cash flow. We have also reduced our exposure to volatility in foreign currency by growing the portion of our U.S. dollar earnings. As you can see on side 15, today 85% of our earnings are in U.S. dollars, as compared to approximately 60% a few years ago. For context through 2022, a 10% appreciation of the U.S. dollar would reduce our annualized EPS by only 1.5% or $0.02. Looking at Latin America specifically, almost all of our businesses in that region are contracted, as you can see on slide 16. Nearly 60% of these businesses have no volumetric risk as a result of the take or pay nature of the contracts. The remaining capacity is mostly contracted with large industrials and export-oriented mining companies that continued to operate despite COVID-19 as they are deemed essential. We intentionally work with high quality off takers and business strategy is also contributing to the resilience of our business model. For example, as you can see on the slide 17, roughly two-third of our customers in Latin America have investment grade profiles. The remaining customers are largely backed by government and institutions. The result of this resilient contracting structure and customer base can be seen in our collections performance on the slide 18, with Q2 receivables and days sales outstanding remains very much in line with historical levels. Moving on to the impact of global lockdowns on our financial results on slide 19. As you may recall, we had anticipated an extended U-shaped recovery in managed demand across our markets. This assumed the second quarter would be the hardest hit with a demand drop about 10% to 12% at our U.S. Utility businesses, and between 7% and 15% internationally. The actual result was not as severe as anticipated, with volume at our U.S. Utilities dropped mid-single digits and demand in other markets declining in the range of low-single digits to low-double digits. As I have noted, our Generation businesses, we did not experience any material impact on earnings from lower demand. Our Utility business, where most of our volume exposure is experienced any back of about $0.02 on adjusted EPS for the quarter, better than our initial expectation of $0.03 to $0.04. Despite this encouraging results, we continue to assume an extended U-shaped recovery for guidance purpose, given the overall uncertainty around the macro environment. Now turning to our quarterly results on slide 20. Adjusted EPS was $0.25 for the quarter versus $0.26 last year. This reflects the lower demand at our regulated utilities as discussed and the regulatory changes that were implemented at DPL in Argentina in 2019. We are able to offset these headwinds through higher contributions from our South America and Eurasia SBUs, as well as our cost savings and deleveraging initiatives. Turning to slide 21. Adjusted pre-tax contribution or PTC was relatively flat at $238 million for the quarter, with a decrease of only $2 million versus the second quarter of 2019. I will cover our results in more detail over the next four slides beginning on slide 22. In the U.S. and Utilities SBUs lower PTC reflects the lower regulated tariff implemented in Q4 2019 due to the reversion to AES Gener rate at the DPL, as well as lower demand at Utilities due to the impact of COVID-19. Additionally at Southland, we have had lower capacity of revenues as a result of the retirement of some of our legacy units in 2019. At our South America SBU higher PTC was primarily driven by higher contributions from AES Gener, including better operating performance at our Guacolda plant and recovery of previously expensed payments from customers in Chile. Higher PTC at our MCCS will reflect improved availability at our Changuinola hydro plant in Panama, following extended major outage last year. We also benefited from improved hydrology in Panama following a very dry year in 2019. This was partially offset by outage-related insurance proceeds in the Dominican Republic last year. Finally in Eurasia, high results reflect improved operational performance in Vietnam and the impact of the sale of our loss making business in the United Kingdom. Now to slide 26 to summarize our performance in the first half of the year, we earned adjusted EPS of $0.54 versus $0.53 last year. We are reaffirming our 2020 adjusted EPS guidance range of $1.32 to $1.42. Relative to the first half of 2020, performance in the second half of the year will benefit from contributions for our new businesses, including the 1.3-gigawatt Southland Repowering project for which the 20-year contract began in the second quarter and about 1-gigawatt of renewables coming online. Now turning to our credit profile on slide 27. As we discussed on our first quarter call, since 2011 we reduced our parent debt by approximately $3 billion or about 50%. At the end of the second quarter, our parent leverage was 3.5 times and our parent free cash flow to debt ratio was 24%, comfortably within the investment grade thresholds of 4 times and 20%, respectively. This highlights once more our credit strength and give us confidence in attaining our second investment grade rating later this year. Moving on to liquidity on slide 28. We have $3.5 billion in available liquidity, two-thirds of which is in cash. As you may recall from our prior call, we had taken a conservative approach to enhance our liquidity at the beginning of the COVID-19 outbreak by drawing in about $500 million of our revolvers. As a result of the strong collection we experienced in the quarter, we decided to pay back most of this facility, lowering the overall interest expense for our businesses. Next, I would like to provide an update on our refinancing on slide 29. As you know, we have been proactively strengthening our debt maturity profile. Since last year, we executed more than $7 billion in liability management across our portfolio. In the second quarter alone, by taking advantage of a low interest rate environment, we refinanced more than $2 billion of debt, significantly reducing our interest costs, while eliminating any mature refinancing needs at both AES Corp. and DPL for the next five years. Now to 2020 parent capital allocation on slide 3. We expected $1.4 billion of discretionary cash this year, which is largely consistent with our previous disclosure. Regarding asset sales, we have already announced agreement to sell 2-gigawatt of coal generation, achieving roughly half of our target for 2020. We are working on a few other transactions and feel good about the prospect of achieving our targeted asset sales of $550 million for this year. Moving to uses on the right-hand side, including the 5% dividend increase we announced in December, we expected to return $381 million to shareholders this year. We plan to invest $700 million in our subsidiaries, 90% of which is in the U.S., demonstrating our proactive actions to grow the portion of earnings coming from the U.S. to about half by 2022. These investments includes, funding our renewables backlog, the equity for the Southland Repowering and the investment in rate-based growth at our utilities. Regarding AES Gener, as Andrés mentioned, we are in negotiations to delink the PPAs from the coal assets and monetize the value of some of its storing agreement. As a result, we now expect the capital increase in our contribution of equity to happen in 2021. This leaves us with up to $370 million to be allocated in 2020. Next, moving to our capital allocation from 2020 through 2022 beginning on slide 31. We continue to expect our portfolio to generate $3.4 billion in discretionary cash. Three quarters of this is expected to be generated from parent free cash flow, with the remaining $900 million coming from asset sale proceeds. Turning to the uses of the discretionary cash on slide 32, roughly one-third will be allocated to shareholder dividends. Subject to annual review by the Board, we continue to expect to increase the dividend by 4% to 6% per year, in line with the industry average. We are also expected to use $1.9 billion to invest in our backlog, new projected PPAs, T&D investments at IPL, the partial funding of our Vietnam LNG project and the investment in AES Gener. This $1.9 billion also includes the $300 million infrastructure investment in the P&L. Once completed, this project will contribute to our growth through 2022 and beyond. In summary, we are very encouraged by our solid financial performance today, despite being in the middle of an unprecedented global crisis. Our performance and position validate the actions we have taken over the last several years to materially improve the quality and resilience of our business model and we remain very confident in our ability to continue delivering on our strategic and financial objectives. With that, I will turn the call back over to Andrés.
Andrés Gluski: Thank you, Gustavo. Before we take your questions, let me close today’s call by saying that we remain very confident in achieving our guidance for 2020 and growth rates through 2022, attaining a second investment grade rating before year end and realizing our decarbonization goals to meet Norges Bank’s threshold by the end of the year. At the same time, we continue to make progress on the point innovative technologies that we believe will give us a competitive edge in today’s rapidly evolving and growing market. With that, I would like to open up the call to your questions.
Operator: [Operator Instructions] Our first question is from Julien Dumoulin-Smith from Bank of America. Go ahead.
Julien Dumoulin-Smith: Thank you, Operator. Good morning, everyone. Thanks so much for the time. I appreciate it and congratulations on continued execution here. Perhaps just going back to the 2020 guidance and I know you guys just commented here in your prepared remarks about a little bit of your positioning, but I’d like to dig a little bit further into that. So you are saying that you are a few pennies ahead relative to initial expectations for the utility after last quarter’s update. You are saying your power outlook is not appreciably impacted from lower demand. Just help frame where you are within that ‘20 guidance range as a consequence of these updated assumption. And then, thirdly, I didn’t see you comment specifically on how the asset sales and our expected asset sales impact -- and the potential dilution from those impacts where you are within that range, if that make sense?
Andrés Gluski: Yeah. Okay. Let’s put this into two objects, the first half and Gustavo can take the second half. Look, we feel confident that we are going to hit our numbers. We feel very good. We have a lot of good things happening. We are still, I think, all of us in uncharted territories. This has to play out through the second half of the year. I think our business model has demonstrated its resilience. I think very importantly both earnings and cash, our accounts receivable are very much in line from where they were last year. So we feel good about it and we have a lot of positive things, but there is some uncertainty. So we -- what we are saying is, we feel very confident we will hit these numbers and the model is resilient and let’s see what plays out in the second half of the year. With that, I will pass it over to Gustavo to talk a little bit about asset sales.
Gustavo Pimenta: So, Julien, yes. Those asset sales there were already incorporated in our long-term forecast. So the associated dilution is already in the 7% to 9%, so no impact to our forecast.
Julien Dumoulin-Smith: Nor the impact that in perspective further so…
Gustavo Pimenta: No.
Andrés Gluski: That’s already assumed...
Gustavo Pimenta: The additional was to reach the $500 million are also in this plan the 7% to 9% growth.
Andrés Gluski: Yeah. In other words they are assumed in our forecast.
Julien Dumoulin-Smith: And if I can ask you just a step further here, I mean, you guys made a further commitment in Brazil in recent weeks. Can you talk to your thought process about realizing the full value there, I mean, as per this unique situation in backdrop where you all are, I suppose your peer shareholders just receiving a premium bid and you all are stepping into to basically, say, we see greater value. So can value -- can you elaborate on where you see that value coming and maybe further next steps in realizing that?
Andrés Gluski: Sure. Look we have a, I think, a very good track record in Brazil of creating values in our separate company, if you think of the sale of Fluence, sale of Eletropaulo, of the sale of our telecom Angamos. So what we are doing here is, we -- BNDS [ph] wanted to sell part of its shares. So by buying BNDS’ shares we go from 24% ownership to around 43% ownership. This will allow us to list AES Gener on the novel Mercado. In the novel Mercado generally companies trade at a 10%, 20% premium versus where they trade on ordinary listing, say in Brazil you have your preferred shares, which actually don’t have a vote and receive a 10% dividend, then you have normal ordinary shares, which have votes. So our shares and BNDS’ shares are ordinary shares. So what we see here is an upgrade of the company, in terms of its market listing, in terms of who can invest in the company and we are able to go to novel Mercado, because now we own a much larger percentage of the company. So with one share one vote we still control this company. I say furthermore you might have seen there the Tietê is actually the good platform for growth. It has now almost 4 gigawatts or 100% renewable energy and we have been able to do some very innovative things there. So in terms of our big strategy it makes sense as well. So it makes sense from me money point of view, because we are buying it accretive. We are --it’s accretive at these prices. Second, I would say that, it’s a platform for growth and fits into our overall strategy of reducing our carbon intensity -- the carbon intensity of our footprint.
Julien Dumoulin-Smith: Sorry. Last quick clarification, what’s the contribution from renewables in aggregate in 2020 and beyond just getting this question consistently.
Andrés Gluski: Look, right now including again renewables for hydro, it’s about a third of our fleet.
Julien Dumoulin-Smith: On earnings terms?
Andrés Gluski: Earnings.
Gustavo Pimenta: It’s the same.
Andrés Gluski: Yeah. I think it’s pretty much in line.
Julien Dumoulin-Smith: All right. I won’t press further. Thank you very much.
Andrés Gluski: Sure.
Operator: Our next question is from Angie Storozynski from Seaport Global. Go ahead.
Andrés Gluski: Hello, Angie.
Gustavo Pimenta: Angie.
Operator: Angie? Our next question is from Stephen Byrd from Morgan Stanley. Go ahead.
Stephen Byrd: Hey. Good morning. I hope you all are doing well.
Andrés Gluski: Hey, Steve.
Stephen Byrd: Great update on a lot of fronts. Just on the storage side of things obviously the size of this business and the growth is impressive. Could you just speak maybe generally to the capital needs for this business, strategically how you think about the growth of this business within AES and just it’s just an unusual business given the incredibly rapid growth rate. I am just curious sort of strategically how are you thinking about this business?
Andrés Gluski: Well, we started 12 years ago. So we have a long history of energy storage and we have really been an innovator in applications. So we have decided to sell it to third-party via by Fluence and we are very happy with the partnership with Siemens, because it allows us to sell it in 160 countries. So what we are seeing saying is that there’s a very rapidly growing market. So Fluence itself we see a lot of new applications, not only the virtual reservoir, but I can see grid booster, which really reduces significant long-distance transmission expenses or investment. So that I think is the next front. So, I think, this is an area that’s going to grow very quickly. So how does it fit into, yeah, well, first and of course, we are happy with the investments we have made in Fluence. I think time will show that that was a very good investment. But it’s also good for us in the sense we are one of the big customers of Fluence. So today half of our product offerings have an energy storage component. So we have standalone storage, but we also have it integrated into solar as our award winning project out in Kovai. But we also have it in corporate, for example, wind. So when we talk about Green Blend & Extend and meeting customers’ future needs, if customers want a 24x7, for example, renewables, energy storage plays a big component. Now I am a believer in lithium ion batteries for -- our batteries, let’s say, electrical batteries because they don’t have to be lithium ion for the next five years to 10 years for many of the applications. And the reason is that it’s very -- as the batteries become more efficient, it become cheaper, you are basically going from electric to an elect -- in some cases a chemical back to electric and the losses are very low. There’s been a lot of talk about hydrogen, for example. Hydrogen has advantages and it has much greater energy density. So we see much -- many more applications in transportation where the weight of batteries precludes long distance, say, big truck using batteries. So I think this is a very interesting area. But if you are talking about sort of combining renewables with storage or day-to-day applications, we really think that battery seems to be the killer app. Now we have put a toe in the water into hydrogen as well. We have actually run some tests on old coal plants in Chile, basically cracking the hydrogen using renewable energy in around $35 a megawatt hour and it still comes out quite expensive. We do see it could be -- we have also run some tests on diesel and it might be interesting for micro-grids. So, we do have a electrolyzer in Chile where we -- actually in Argentina, excuse me, where we actually produce hydrogen for our own needs at the San Nicolas plant. So we have a foot into this. We are looking into this. But I just mention this, because there’s some people say, well, hydrogen will replace battery-based energy storage. And the reason we don’t see that is, at least in the short-term, is because you are going from electric to produce a chemical -- a chemical reaction then you have to store it cryogenically then you have to transport it, then you basically have to burn it again. So if you look at the energy from the original electricity losses to electricity again, you are talking about at least half, whereas with the battery you are talking about a much smaller percentage. Now of course, batteries don’t work for inter-seasonal differences. So, we are looking into it and we have some small experiments in some of our different units. And as I said, the one that looks more promising really are diesel units and we are certainly a believer of green hydrogen for transportation.
Stephen Byrd: That’s a great description of market potential of storage versus hydrogen. Thank you. And I wanted to shift over maybe just to your corporate relationships. Maybe we could just briefly touch on Google to make sure we just talk through the sort of the commercial relationship. I guess, there’s sort of an element of near-term fees plus longer term margin potential. But then also just thinking more broadly and maybe more importantly just about the potential for other such corporate relationships given AES’ global footprint and ability to help customers globally to decarbonize, if you could just talk to that opportunity broadly as well, please?
Andrés Gluski: Yeah. Thank you for that question. I mean, we are investing very heavily into the U.S., as Gustavo says about 90% of what we are investing but we do have this wonderful global footprint. So if a client has global needs, we can satisfy those. So when you talk about the relationship with Google, we are -- we do our supply them with renewable energy in Chile and we did have the RFP. We have the RFP out for 1 gigawatt of zero carbon energy in PJM. We are also, as I mentioned in my speech, looking at other possibilities with them. I really can’t comment on them -- about them at this time. But it goes beyond just a single sort of RSP or a single PPA in one country, because we are doing I think a lot of innovative things like they are and so we have commonality of interests in some areas. But just like Google, I mean, of course, there are other companies that are also interested in our global footprint and having a, let’s say, common high-tech approach to reducing carbon emissions among multiple countries and we can certainly supply that.
Stephen Byrd: That’s great. Thank you so much.
Andrés Gluski: Thank you.
Operator: [Operator Instructions] Our next question is from Charles Fishman from Morningstar. Go ahead.
Charles Fishman: If I could firstly ask a housekeeping question on slide 18, while I guess, it’s a little more a housekeeping. But your receivable balance is going lower. Now, first of all, I assume that’s apples-to-apples, in other words you adjusted that from any businesses you divested between Q4 and Q2?
Gustavo Pimenta: That’s correct Charles. This is Gustavo. That’s correct.
Charles Fishman: Okay. I assume that, but just wanted to ask it now. And then, I guess, more of a big picture question, why do -- is there any particular reason you see your receivable balance going actually lower which is certainly great considering the environment, where among your -- there was nobody really appeared you guys, but other utilities, let’s say, which I realize are different businesses, most of them have T-Mobile balances going in the other direction. Anything that you are doing differently or I -- you probably have more contracted type generation I realize that, but is there anything else going on?
Andrés Gluski: Yeah. No. I think you hit the nail on the head. It’s -- 85% of our business is contracted generation and we have creditworthy off-takers. So there are situations, for example, where say a currency depreciates, but the -- what they are exporting is actually then more attractive because they have a portion of their cost whether it be mining or other such things that they are exporting. So in general, our clients are doing well, much better than the markets than they are in. So I think that’s very important. But we are 85% contracted generation and that’s the big difference. So if you actually see why we got it down initially and we correctly forecast it that we would have a drop in demand with the quarantines at our utilities, at our distribution businesses. So that’s what’s going on. But other than that our plans are critical. So in those cases where we are selling to the creator or selling to which is in many cases backed by the government, we are make sure that we get paid, because we are absolutely critical to the grid or the low cost generator in that market. So we are very well-positioned in this crisis. So we don’t expect that to change certainly in the generation business given, say, the current outlook.
Charles Fishman: Okay. And then, Andrés, if I can ask you one strategic question with respect to Fluence. Why a minority partner at this point? What is the thinking behind that?
Andrés Gluski: Yeah. That’s a great question. Because this is a rapidly growing business and we think it has a great future and it’s coming up with new products. Part of it is that, both of us, Siemens and AES we would like to have a marker from a transaction. We are not going to sell down a very large stake we are talking around a 10% stake. So we think it would be just good to have to capitalize it, maybe 10% with an outside partner, and obviously, work towards a bigger sell down perhaps in two years, three years of an IPO, but ---- and then we will have to reassess strategically how we feel about this business. But we feel very good about that business. And as I said, I think that this is a market, which is growing very rapidly. Now something that people haven’t talked about, I think, so much is, if you do have a change in federal policies in the U.S. to promote green or carbon free generation, we are very well-positioned, Fluence is very well-positioned. But specifically, AES, because we have a pipeline of 15 gigawatts of potential projects in the U.S. and those run the range from quite advanced to medium advanced. If we looked at just hypothetical projects it’s a much bigger number. So we feel good that we have a pipeline that we could execute on and potentially double our rate of growth of renewable build in the U.S. should there be such a change.
Charles Fishman: Okay. And the partner then very well could be financial rather than just somebody like yourself that’s also selling the Fluence product?
Andrés Gluski: No. No.
Charles Fishman: Correct?
Andrés Gluski: Yeah. No. No. Absolutely. Absolutely.
Charles Fishman: Okay.
Andrés Gluski: So a lot of people are looking at just financials. We are looking at a good investment with an eye towards a potential IPO two years to three years from now?
Charles Fishman: Got it. Okay. That’s all I have. Thank you.
Andrés Gluski: Thank you, Charles.
Operator: Our next question is from Angie Storozynski from Seaport Global. Go ahead.
Angie Storozynski: Thank you. So sorry I missed my first presenter [ph]. So I have a number of questions. So first on Fluence, I mean, incredible results by the way. But on Fluence, so the attempts to monetize the business, which I don’t think that you are being paid in the current stock price for Fluence among others. So is there any EPS contribution for Fluence in 2020 or even in 2022?
Andrés Gluski: No. No. I mean, this year it will -- it should be probably about 1 -- $0.01…
Angie Storozynski: Okay.
Andrés Gluski: And the reason for that is even though it’s like margin positive and we haven’t been putting more money in as that is very rapid growth is because R&D you have to spend. So, for example, all the design work…
Angie Storozynski: Yeah.
Andrés Gluski: … the production work of the next-generation of the sixth-generation, well, that is expense. So we have talked probably, I’d say, around two years for it to turn positive in terms of EPF and what basically happens is the fastest growth, the more new profit you have to come out with, you delay that turning to positive. So it’s a business. It could be positive if that was the objective but the objective is to create value. So we think of sales down, as you say, will give us a marker. So people say, well, how much does it worth, well, somebody just paid extra, like we did…
Angie Storozynski: Yeah.
Andrés Gluski: … for example with the gas business in the Dominican Republic, people weren’t giving us much value and we were able to show what it was worth to the third parties.
Angie Storozynski: And the second question, so it’s a two part question. So one, is there’s like a rule of thumb that I can, say, for example, to 2021 you will have additional 2,000 megawatts of renewables in operation and granted it’s probably going to be scattered throughout the year. But can I say for instance that 100 megawatts adds X in EPS?
Andrés Gluski: Well, it will depend a little bit, because it depends what you are inaugurating, right, and where. So there’s a difference between solar and wind, and there’s a difference outside of the U.S. because of tax. So it’s, there’s no rule of thumb for just like 100 megawatts. I don’t know Gustavo can comment.
Gustavo Pimenta: No. What I will do is, we are putting on average $300 million, $350 million per year, right? So that’s our …
Angie Storozynski: Okay.
Gustavo Pimenta: … equity in the project, we have been partners so and so. If you assume, call it, 12% return on average, you are going to come up with the EPS accretion that those deals are bringing to us.
Andrés Gluski: Yeah.
Angie Storozynski: Awesome. Awesome. And now a bigger picture question, so I have been actually looking at it. So, as you become investment grade, I know you are already investment grade, by such, but you get those additional investment grade ratings, would you ever consider not a project finance but corporate level debt to fund the growth, I understand that there is the issue of finite life of the contract for the renewables, but I think that there is this growing conviction even among investors that the useful life of these assets is going to be longer than the duration of the original contract and under project financing you are in a sense the debt amortization, most the cash flows of the project and so the real equity attrition is only at the end of this contract. So in a sense you could help you help quite meaningfully from a cash flow perspective if you were started to rely on corporate level debt -- on corporate debt?
Andrés Gluski: Yeah. Let me soft of answer philosophically and then I will pass it to Gustavo. Look, philosophically we like doing project level debt, because it’s an acid test. So since I have been CEO almost all of our major projects, I think, with the exception of Southland, we brought in a partner. And the reason was that bankers have first debt on the cash flow. So you have to convince somebody a third-party that you are going to operate this and that they think it’s a good project as well. So given that philosophically we like using project level debt and so I don’t see that changing for the time, there are advantages of certain roll ups. We can aggregate at the sublevel. Gener has debt, for example, Tietê has debt, which would get some of those advantages. But we think that the discipline of having to project finance is good and having to bring in partners is good. So…
Gustavo Pimenta: I think, Andrés you covered well. I mean, it brings more discipline to the process. It also allows us to amortize the debt within the PPA timeframe, which we like. We don’t want to count on post-PPA period to pay for debt quite frankly. So it’s just more disciplined. I think the projects are more sustainable when we validate them at the project level, right, with the debt there and all the amortization within the PPA flow.
Angie Storozynski: And just one follow-up if I can on Fluence, so we saw the results of the investigation by APS on the root cause of the storage system accident, and we also saw some response from LG and APS seems to suggest that their need to some changes in the configuration of those storage systems going forward. I haven’t necessarily seen the response on Fluence. But is there any fundamental change and how you think those storage designs need to be adjusted and if there is any need to make adjustments to your already existing operating systems?
Andrés Gluski: Yeah. I think, look, that was a unit that was inaugurated in 2017. We are two generations away from that. The issue as we see it was with a series of LG Chem batteries, a specific series that we are produced in some factories. So we have operated for 12 years. This is the first, I will say, serious incident we have had. But really the best standards are, for example, UL 9045A and if you look at the best-in-class standards, the sixth-generation incorporates all these. So if you look at, for example, it doesn’t require -- it’s not contained, so it’s actually outside. The modules are separated, so you don’t have contagion. It has enhanced fire suppression systems on it. And in the worst case, should there be any type of thermal event since it’s not enclosed the heat and the any gases would rise. So, definitely we feel that, we have taken all the lessons learned from this event. We have incorporated into the new design and really safety was one of our number one priority. So, again, we have 12 years of operating these and we -- this is the one really event that we have had. Now regarding those cases which weren’t that many, I think, you can count on them one hand that all those units that had that series of battery in them. We immediately put out instructions of not to charge them like -- instructions you get on your Tesla car, not to charge them above 75% and we have taken corrective actions and we have given more information, more training for like local fire units, et cetera. So, yeah, we -- as you know, safety is number one value, super important for us. We have been very serious and very diligent, I think, about looking into this and supporting our clients and supporting our local fire departments on this. But I feel very good that the sixth-generation cube is the safest unit out there and incorporates all of the suggestions that are out there technically.
Angie Storozynski: Perfect. Thank you very much.
Andrés Gluski: Thank you, Angie.
Operator: Our next question is from Richard Sunderland from JP Morgan. Go ahead.
Richard Sunderland: Good morning. Thanks for taking my questions here.
Andrés Gluski: Good morning, Richard.
Richard Sunderland: Just starting off, with the opportunity around delinking PPAs, could you provide a little bit more color around that opportunity versus your current financing plan and you may be assumed asset sales as well. Is there an inter-player offset potentially with this new consideration or is it more of another tool in the tool bag down the road?
Andrés Gluski: We have always said that and there had a lot of tools to address its financing needs, because it’s growing so fast, they have been so successful on Green Blend & Extend. We really can’t comment on some of these transactions until they close. But there are several transactions where we are delinking the PPA, which in some cases was specific to a given asset. So like this power plant has this PPA, we are delinking them and allowing us greater flexibility in terms of how we satisfy their demand or requirements of the customers. So I really can’t give you too much color on it other than saying that it will help us, it will help Gener with its financing plan. And so it’s very likely that any capital contribution from us will be in 2021 instead of 2020 this year. So we tend to be very conservative, so we saw that these have been advancing. So prior to having these as advanced as they are today, we had talked about AES putting in the money this year. So that I think is the main change. So I’d say stay tuned and we can give you more color as these transactions close.
Richard Sunderland: Great. We will look forward to that. And then just a quick clean up question, the inclusion this quarter I believe it was recovery of expense payments from customers in Chile. Just -- was this in your plan specifically in the 2020 plan included in guidance?
Gustavo Pimenta: Yeah. I mean this is at the AES Crop level, I mean this is above couple cents in this quarter when you normalized partnership adjustment and so on. It was included -- this is a good guy meaning cash and earnings from prior expenses, pass-through cost that we have with some particular clients and we are able to firm up those receivables back.
Richard Sunderland: Yeah. But this was baked into the original guidance?
Gustavo Pimenta: Yes.
Richard Sunderland: Okay. Thank you very much.
Andrés Gluski: Thank you, Richard.
Operator: This concludes our question-and-answer session. I would now like to turn the call back to Ahmed Pasha for closing remarks.
Ahmed Pasha: Thank you. Thanks everybody for joining us on today’s call. As always, the IR will be available to answer any follow-up questions you may have. Thanks. Thanks again and have a nice day.
Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning. Welcome to the AES Corporation Second Quarter 2020 Financial Review Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask question. Please note that this event is being recorded. I would now like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, Operator. Good morning, everyone. And welcome to our second quarter 2020 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone. And thank you for joining our second quarter financial review call. Today, I will spend some time on three near-term priorities, achieving our 2020 guidance, attaining a second investment grade rating and decarbonizing our portfolio. We believe that progress in these three key areas will allow us to reach a larger investor base in the near-term. They will also advance our longer term strategic and financial objectives. After discussing these three themes, I will provide an update on our sustainable growth initiatives and our efforts to create a technological competitive edge. Last quarter I indicated that we were well-positioned to withstand the impacts of the COVID-19 pandemic due to the resilience of our business model. I am pleased to report that our second quarter results demonstrate this resilience and keep us on track to achieve our full year guidance. We delivered adjusted EPS of $0.25 in the second quarter in line with last year. This reflects the strength of our business model, which is based on long-term take or pay contracts with credit worthy customers. As a result, we are very confident that we will achieve our 2020 adjusted EPS guidance of $1.32 to $1.42 and our expected parent free cash flow of $725 million to $775 million. At the same time, we have continued to grow our free cash flow. We ended the second quarter with the apparent free cash flow to debt ratio of 24%, which is comfortably above the 20% threshold required for investment grade ratings. As a reminder, we have already received one investment grade rating from Fitch and remain optimistic that we will attain our second investment grade rating later this year. Turning to our aggressive carbonization goals on slide four. As we have said before, we are very focused on reducing our generation from coal to less than 30% of total generation to comply with Norges Bank Environmental Investment criteria. On this front, we have made great progress over the past two months, signing binding agreements to sell OPGC in India and Itabo in the Dominican Republic. These sales will reduce our generation from coal by 11 percentage points to 34%. We are working on a couple of additional transactions that combined with our growth in renewables will allow us to easily comply with Norges Bank criteria by next year. To further our reduction in coal exposure, AES Gener is negotiating with several of off-takers in Chile to delink PPAs from physical assets and be able to monetize the value of long-term totaling agreements. These transactions will demonstrate that the real value of the business is in this contracts and customers, while providing funding for AES Gener successful Green Blend & Extend Renewables Growth Strategy. Turning to slide five and sustainable growth. I am happy to announce that since our last call, we have been awarded or signed 852 megawatts of new renewable PPAs. This brings our year-to-date total to 1.5 gigawatts, including 346 megawatts of energy storage. As a result, our backlog of new renewables projects increased to 6.2 gigawatts, about half of this backlog is in the U.S. and the majority is expected to come online between 2021 and 2024. Therefore, we remain on track to continue to add 2 gigawatts to 3 gigawatts of new renewables per year by capitalizing on our business platforms and our growing technological expertise. In addition, to our 6.2 gigawatt backlog, we have a pipeline of 15 gigawatts of renewable projects under active development in the U.S. This considerable pipeline positions us very well for an acceleration in U.S. renewables growth if the federal policies change following the November elections. Turning to slide seven. We are also consolidating our position in existing renewable platforms. To that end, we recently acquired additional shares of AES Tietê, increasing our ownership from 24% to 43%. We will finance this acquisition mostly through non-recourse debt in Brazil and it is accretive from day one. We plan to upgrade AES Tietê’s listing to Novo Mercado under Bovespa, where companies trade at significant premiums due to best-in-class governance. This move is expected to further unlock the value of AES Tietê for the benefit of all of its shareholders. We continue to actively pursue new technologies to support our growth in renewables and innovative products that meet the changing needs of our customers. As you can see on slide eight, Fluence, our joint venture with Siemens that sells energy storage technology to third parties, continues to be the global market leader in this sector. This leadership is based on our track record of deploying more than 2 gigawatts of energy storage, presence in 22 countries and offering more than 40 digital applications to our customers. This year Fluence’s revenue is expected to reach $500 million, an increase of 400% in relation to last year. We believe that energy storage will play a major role in the global transition to a low carbon economy. As a result, we expect Fluence’s revenue to grow at 40% compounded annually to reach $3 billion by the end of 2025. Turning to slide nine. We are already experiencing this acceleration of growth in demand for energy storage. In June Fluence launched its sixth-generation product, which includes a modular and factory-assembled cube design that is safer, more reliable and lower cost. Fluence’s new cube already has orders for more than 800 megawatts to be delivered over the next three years. As you may know, Fluence is currently running a private placement for a minority partner in order to capitalize this high growth business. We are encouraged by the strong interest we are seeing from potential investors and we expect to have concrete details to share with you before the end of the year. Together, AES and Fluence continue to pioneer new applications for lithium-ion based energy storage technology. One example is a virtual reservoir for run-of-the-river hydropower projects, utilizing energy storage that charges when power prices are low and discharges during peak hours. As shown on slide 10, at the Alfalfal hydro complex in Chile, we just commissioned the world’s first such virtual reservoir with 10 megawatts or 50-megawatt hours of energy storage. We can further expand this facility to 250 megawatts or 1,250-megawatt hours over the next couple of years. Today, about half of all our renewable projects have an energy storage component. Now moving on to slide 11. We continue to pursue new technologies that have the potential to provide us with a competitive advantage in our markets. To that end, we recently acquired a 25% stake in 5B, a prefabricated solar solution company in Australia. With 5B’s patented technology, solar projects can be built in a third of the time and in half the space. We believe that being able to double solar energy output from a given area will become increasingly important as solar penetration increases especially near urban or congested areas. In addition to 5B’s potential pipeline of more than 10 gigawatts of third-party projects in Australia, we see an additional addressable market of 5 gigawatts across our developing pipeline. As part of this strategic agreement, we have exclusive rights to develop utility scale projects using 5B’s technology in our key markets, including the U.S. We have already started the deployment of 2 megawatts in Panama and 10 megawatts in Chile. We aim to be the most competitive solar developer by using 5B to reduce time-to-build and increase energy density, while combining it with our robotic and digital solar initiatives. Turning to slide 12. In 2018, AES invested in Uplight to improve our customer experiences by a digital cloud-based technology. In addition, Uplight provides cloud-based services to third parties to improve energy efficiency and balance system demand. This fast growing business already reaches more than 100 million households and businesses in the U.S., and expects a 20% increase in annual revenue in 2020. Finally, regarding our partnership with Google, it is progressing well, and as you might have seen, we recently launched an RFP for 1-gigawatt of carbon free energy in PJM. We are working on several other significant initiatives with Google and we will share additional details as this firm up. In summary, our ongoing leading technology efforts aim to give us a competitive edge to deliver the products and services required by our customers in a rapidly evolving and growing market. Now, I would like to turn over the call to Gustavo Pimenta, our CFO, so he can provide more color on our results, debt profile and guidance."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thank you, Andrés. Today, I will cover three key topics, our resilient business model, our performance during the second quarter and our capital allocation plan. Let me start with our resilient business model on slide 14. As you can see 85% of our earnings are from Utilities and long-term contracted generation, with an average contract life of 14 years. This provides significant stability to earnings and cash flow. We have also reduced our exposure to volatility in foreign currency by growing the portion of our U.S. dollar earnings. As you can see on side 15, today 85% of our earnings are in U.S. dollars, as compared to approximately 60% a few years ago. For context through 2022, a 10% appreciation of the U.S. dollar would reduce our annualized EPS by only 1.5% or $0.02. Looking at Latin America specifically, almost all of our businesses in that region are contracted, as you can see on slide 16. Nearly 60% of these businesses have no volumetric risk as a result of the take or pay nature of the contracts. The remaining capacity is mostly contracted with large industrials and export-oriented mining companies that continued to operate despite COVID-19 as they are deemed essential. We intentionally work with high quality off takers and business strategy is also contributing to the resilience of our business model. For example, as you can see on the slide 17, roughly two-third of our customers in Latin America have investment grade profiles. The remaining customers are largely backed by government and institutions. The result of this resilient contracting structure and customer base can be seen in our collections performance on the slide 18, with Q2 receivables and days sales outstanding remains very much in line with historical levels. Moving on to the impact of global lockdowns on our financial results on slide 19. As you may recall, we had anticipated an extended U-shaped recovery in managed demand across our markets. This assumed the second quarter would be the hardest hit with a demand drop about 10% to 12% at our U.S. Utility businesses, and between 7% and 15% internationally. The actual result was not as severe as anticipated, with volume at our U.S. Utilities dropped mid-single digits and demand in other markets declining in the range of low-single digits to low-double digits. As I have noted, our Generation businesses, we did not experience any material impact on earnings from lower demand. Our Utility business, where most of our volume exposure is experienced any back of about $0.02 on adjusted EPS for the quarter, better than our initial expectation of $0.03 to $0.04. Despite this encouraging results, we continue to assume an extended U-shaped recovery for guidance purpose, given the overall uncertainty around the macro environment. Now turning to our quarterly results on slide 20. Adjusted EPS was $0.25 for the quarter versus $0.26 last year. This reflects the lower demand at our regulated utilities as discussed and the regulatory changes that were implemented at DPL in Argentina in 2019. We are able to offset these headwinds through higher contributions from our South America and Eurasia SBUs, as well as our cost savings and deleveraging initiatives. Turning to slide 21. Adjusted pre-tax contribution or PTC was relatively flat at $238 million for the quarter, with a decrease of only $2 million versus the second quarter of 2019. I will cover our results in more detail over the next four slides beginning on slide 22. In the U.S. and Utilities SBUs lower PTC reflects the lower regulated tariff implemented in Q4 2019 due to the reversion to AES Gener rate at the DPL, as well as lower demand at Utilities due to the impact of COVID-19. Additionally at Southland, we have had lower capacity of revenues as a result of the retirement of some of our legacy units in 2019. At our South America SBU higher PTC was primarily driven by higher contributions from AES Gener, including better operating performance at our Guacolda plant and recovery of previously expensed payments from customers in Chile. Higher PTC at our MCCS will reflect improved availability at our Changuinola hydro plant in Panama, following extended major outage last year. We also benefited from improved hydrology in Panama following a very dry year in 2019. This was partially offset by outage-related insurance proceeds in the Dominican Republic last year. Finally in Eurasia, high results reflect improved operational performance in Vietnam and the impact of the sale of our loss making business in the United Kingdom. Now to slide 26 to summarize our performance in the first half of the year, we earned adjusted EPS of $0.54 versus $0.53 last year. We are reaffirming our 2020 adjusted EPS guidance range of $1.32 to $1.42. Relative to the first half of 2020, performance in the second half of the year will benefit from contributions for our new businesses, including the 1.3-gigawatt Southland Repowering project for which the 20-year contract began in the second quarter and about 1-gigawatt of renewables coming online. Now turning to our credit profile on slide 27. As we discussed on our first quarter call, since 2011 we reduced our parent debt by approximately $3 billion or about 50%. At the end of the second quarter, our parent leverage was 3.5 times and our parent free cash flow to debt ratio was 24%, comfortably within the investment grade thresholds of 4 times and 20%, respectively. This highlights once more our credit strength and give us confidence in attaining our second investment grade rating later this year. Moving on to liquidity on slide 28. We have $3.5 billion in available liquidity, two-thirds of which is in cash. As you may recall from our prior call, we had taken a conservative approach to enhance our liquidity at the beginning of the COVID-19 outbreak by drawing in about $500 million of our revolvers. As a result of the strong collection we experienced in the quarter, we decided to pay back most of this facility, lowering the overall interest expense for our businesses. Next, I would like to provide an update on our refinancing on slide 29. As you know, we have been proactively strengthening our debt maturity profile. Since last year, we executed more than $7 billion in liability management across our portfolio. In the second quarter alone, by taking advantage of a low interest rate environment, we refinanced more than $2 billion of debt, significantly reducing our interest costs, while eliminating any mature refinancing needs at both AES Corp. and DPL for the next five years. Now to 2020 parent capital allocation on slide 3. We expected $1.4 billion of discretionary cash this year, which is largely consistent with our previous disclosure. Regarding asset sales, we have already announced agreement to sell 2-gigawatt of coal generation, achieving roughly half of our target for 2020. We are working on a few other transactions and feel good about the prospect of achieving our targeted asset sales of $550 million for this year. Moving to uses on the right-hand side, including the 5% dividend increase we announced in December, we expected to return $381 million to shareholders this year. We plan to invest $700 million in our subsidiaries, 90% of which is in the U.S., demonstrating our proactive actions to grow the portion of earnings coming from the U.S. to about half by 2022. These investments includes, funding our renewables backlog, the equity for the Southland Repowering and the investment in rate-based growth at our utilities. Regarding AES Gener, as Andrés mentioned, we are in negotiations to delink the PPAs from the coal assets and monetize the value of some of its storing agreement. As a result, we now expect the capital increase in our contribution of equity to happen in 2021. This leaves us with up to $370 million to be allocated in 2020. Next, moving to our capital allocation from 2020 through 2022 beginning on slide 31. We continue to expect our portfolio to generate $3.4 billion in discretionary cash. Three quarters of this is expected to be generated from parent free cash flow, with the remaining $900 million coming from asset sale proceeds. Turning to the uses of the discretionary cash on slide 32, roughly one-third will be allocated to shareholder dividends. Subject to annual review by the Board, we continue to expect to increase the dividend by 4% to 6% per year, in line with the industry average. We are also expected to use $1.9 billion to invest in our backlog, new projected PPAs, T&D investments at IPL, the partial funding of our Vietnam LNG project and the investment in AES Gener. This $1.9 billion also includes the $300 million infrastructure investment in the P&L. Once completed, this project will contribute to our growth through 2022 and beyond. In summary, we are very encouraged by our solid financial performance today, despite being in the middle of an unprecedented global crisis. Our performance and position validate the actions we have taken over the last several years to materially improve the quality and resilience of our business model and we remain very confident in our ability to continue delivering on our strategic and financial objectives. With that, I will turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Gustavo. Before we take your questions, let me close today’s call by saying that we remain very confident in achieving our guidance for 2020 and growth rates through 2022, attaining a second investment grade rating before year end and realizing our decarbonization goals to meet Norges Bank’s threshold by the end of the year. At the same time, we continue to make progress on the point innovative technologies that we believe will give us a competitive edge in today’s rapidly evolving and growing market. With that, I would like to open up the call to your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question is from Julien Dumoulin-Smith from Bank of America. Go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Thank you, Operator. Good morning, everyone. Thanks so much for the time. I appreciate it and congratulations on continued execution here. Perhaps just going back to the 2020 guidance and I know you guys just commented here in your prepared remarks about a little bit of your positioning, but I’d like to dig a little bit further into that. So you are saying that you are a few pennies ahead relative to initial expectations for the utility after last quarter’s update. You are saying your power outlook is not appreciably impacted from lower demand. Just help frame where you are within that ‘20 guidance range as a consequence of these updated assumption. And then, thirdly, I didn’t see you comment specifically on how the asset sales and our expected asset sales impact -- and the potential dilution from those impacts where you are within that range, if that make sense?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. Okay. Let’s put this into two objects, the first half and Gustavo can take the second half. Look, we feel confident that we are going to hit our numbers. We feel very good. We have a lot of good things happening. We are still, I think, all of us in uncharted territories. This has to play out through the second half of the year. I think our business model has demonstrated its resilience. I think very importantly both earnings and cash, our accounts receivable are very much in line from where they were last year. So we feel good about it and we have a lot of positive things, but there is some uncertainty. So we -- what we are saying is, we feel very confident we will hit these numbers and the model is resilient and let’s see what plays out in the second half of the year. With that, I will pass it over to Gustavo to talk a little bit about asset sales."
},
{
"speaker": "Gustavo Pimenta",
"text": "So, Julien, yes. Those asset sales there were already incorporated in our long-term forecast. So the associated dilution is already in the 7% to 9%, so no impact to our forecast."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Nor the impact that in perspective further so…"
},
{
"speaker": "Gustavo Pimenta",
"text": "No."
},
{
"speaker": "Andrés Gluski",
"text": "That’s already assumed..."
},
{
"speaker": "Gustavo Pimenta",
"text": "The additional was to reach the $500 million are also in this plan the 7% to 9% growth."
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. In other words they are assumed in our forecast."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "And if I can ask you just a step further here, I mean, you guys made a further commitment in Brazil in recent weeks. Can you talk to your thought process about realizing the full value there, I mean, as per this unique situation in backdrop where you all are, I suppose your peer shareholders just receiving a premium bid and you all are stepping into to basically, say, we see greater value. So can value -- can you elaborate on where you see that value coming and maybe further next steps in realizing that?"
},
{
"speaker": "Andrés Gluski",
"text": "Sure. Look we have a, I think, a very good track record in Brazil of creating values in our separate company, if you think of the sale of Fluence, sale of Eletropaulo, of the sale of our telecom Angamos. So what we are doing here is, we -- BNDS [ph] wanted to sell part of its shares. So by buying BNDS’ shares we go from 24% ownership to around 43% ownership. This will allow us to list AES Gener on the novel Mercado. In the novel Mercado generally companies trade at a 10%, 20% premium versus where they trade on ordinary listing, say in Brazil you have your preferred shares, which actually don’t have a vote and receive a 10% dividend, then you have normal ordinary shares, which have votes. So our shares and BNDS’ shares are ordinary shares. So what we see here is an upgrade of the company, in terms of its market listing, in terms of who can invest in the company and we are able to go to novel Mercado, because now we own a much larger percentage of the company. So with one share one vote we still control this company. I say furthermore you might have seen there the Tietê is actually the good platform for growth. It has now almost 4 gigawatts or 100% renewable energy and we have been able to do some very innovative things there. So in terms of our big strategy it makes sense as well. So it makes sense from me money point of view, because we are buying it accretive. We are --it’s accretive at these prices. Second, I would say that, it’s a platform for growth and fits into our overall strategy of reducing our carbon intensity -- the carbon intensity of our footprint."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Sorry. Last quick clarification, what’s the contribution from renewables in aggregate in 2020 and beyond just getting this question consistently."
},
{
"speaker": "Andrés Gluski",
"text": "Look, right now including again renewables for hydro, it’s about a third of our fleet."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "On earnings terms?"
},
{
"speaker": "Andrés Gluski",
"text": "Earnings."
},
{
"speaker": "Gustavo Pimenta",
"text": "It’s the same."
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. I think it’s pretty much in line."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "All right. I won’t press further. Thank you very much."
},
{
"speaker": "Andrés Gluski",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "Our next question is from Angie Storozynski from Seaport Global. Go ahead."
},
{
"speaker": "Andrés Gluski",
"text": "Hello, Angie."
},
{
"speaker": "Gustavo Pimenta",
"text": "Angie."
},
{
"speaker": "Operator",
"text": "Angie? Our next question is from Stephen Byrd from Morgan Stanley. Go ahead."
},
{
"speaker": "Stephen Byrd",
"text": "Hey. Good morning. I hope you all are doing well."
},
{
"speaker": "Andrés Gluski",
"text": "Hey, Steve."
},
{
"speaker": "Stephen Byrd",
"text": "Great update on a lot of fronts. Just on the storage side of things obviously the size of this business and the growth is impressive. Could you just speak maybe generally to the capital needs for this business, strategically how you think about the growth of this business within AES and just it’s just an unusual business given the incredibly rapid growth rate. I am just curious sort of strategically how are you thinking about this business?"
},
{
"speaker": "Andrés Gluski",
"text": "Well, we started 12 years ago. So we have a long history of energy storage and we have really been an innovator in applications. So we have decided to sell it to third-party via by Fluence and we are very happy with the partnership with Siemens, because it allows us to sell it in 160 countries. So what we are seeing saying is that there’s a very rapidly growing market. So Fluence itself we see a lot of new applications, not only the virtual reservoir, but I can see grid booster, which really reduces significant long-distance transmission expenses or investment. So that I think is the next front. So, I think, this is an area that’s going to grow very quickly. So how does it fit into, yeah, well, first and of course, we are happy with the investments we have made in Fluence. I think time will show that that was a very good investment. But it’s also good for us in the sense we are one of the big customers of Fluence. So today half of our product offerings have an energy storage component. So we have standalone storage, but we also have it integrated into solar as our award winning project out in Kovai. But we also have it in corporate, for example, wind. So when we talk about Green Blend & Extend and meeting customers’ future needs, if customers want a 24x7, for example, renewables, energy storage plays a big component. Now I am a believer in lithium ion batteries for -- our batteries, let’s say, electrical batteries because they don’t have to be lithium ion for the next five years to 10 years for many of the applications. And the reason is that it’s very -- as the batteries become more efficient, it become cheaper, you are basically going from electric to an elect -- in some cases a chemical back to electric and the losses are very low. There’s been a lot of talk about hydrogen, for example. Hydrogen has advantages and it has much greater energy density. So we see much -- many more applications in transportation where the weight of batteries precludes long distance, say, big truck using batteries. So I think this is a very interesting area. But if you are talking about sort of combining renewables with storage or day-to-day applications, we really think that battery seems to be the killer app. Now we have put a toe in the water into hydrogen as well. We have actually run some tests on old coal plants in Chile, basically cracking the hydrogen using renewable energy in around $35 a megawatt hour and it still comes out quite expensive. We do see it could be -- we have also run some tests on diesel and it might be interesting for micro-grids. So, we do have a electrolyzer in Chile where we -- actually in Argentina, excuse me, where we actually produce hydrogen for our own needs at the San Nicolas plant. So we have a foot into this. We are looking into this. But I just mention this, because there’s some people say, well, hydrogen will replace battery-based energy storage. And the reason we don’t see that is, at least in the short-term, is because you are going from electric to produce a chemical -- a chemical reaction then you have to store it cryogenically then you have to transport it, then you basically have to burn it again. So if you look at the energy from the original electricity losses to electricity again, you are talking about at least half, whereas with the battery you are talking about a much smaller percentage. Now of course, batteries don’t work for inter-seasonal differences. So, we are looking into it and we have some small experiments in some of our different units. And as I said, the one that looks more promising really are diesel units and we are certainly a believer of green hydrogen for transportation."
},
{
"speaker": "Stephen Byrd",
"text": "That’s a great description of market potential of storage versus hydrogen. Thank you. And I wanted to shift over maybe just to your corporate relationships. Maybe we could just briefly touch on Google to make sure we just talk through the sort of the commercial relationship. I guess, there’s sort of an element of near-term fees plus longer term margin potential. But then also just thinking more broadly and maybe more importantly just about the potential for other such corporate relationships given AES’ global footprint and ability to help customers globally to decarbonize, if you could just talk to that opportunity broadly as well, please?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. Thank you for that question. I mean, we are investing very heavily into the U.S., as Gustavo says about 90% of what we are investing but we do have this wonderful global footprint. So if a client has global needs, we can satisfy those. So when you talk about the relationship with Google, we are -- we do our supply them with renewable energy in Chile and we did have the RFP. We have the RFP out for 1 gigawatt of zero carbon energy in PJM. We are also, as I mentioned in my speech, looking at other possibilities with them. I really can’t comment on them -- about them at this time. But it goes beyond just a single sort of RSP or a single PPA in one country, because we are doing I think a lot of innovative things like they are and so we have commonality of interests in some areas. But just like Google, I mean, of course, there are other companies that are also interested in our global footprint and having a, let’s say, common high-tech approach to reducing carbon emissions among multiple countries and we can certainly supply that."
},
{
"speaker": "Stephen Byrd",
"text": "That’s great. Thank you so much."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question is from Charles Fishman from Morningstar. Go ahead."
},
{
"speaker": "Charles Fishman",
"text": "If I could firstly ask a housekeeping question on slide 18, while I guess, it’s a little more a housekeeping. But your receivable balance is going lower. Now, first of all, I assume that’s apples-to-apples, in other words you adjusted that from any businesses you divested between Q4 and Q2?"
},
{
"speaker": "Gustavo Pimenta",
"text": "That’s correct Charles. This is Gustavo. That’s correct."
},
{
"speaker": "Charles Fishman",
"text": "Okay. I assume that, but just wanted to ask it now. And then, I guess, more of a big picture question, why do -- is there any particular reason you see your receivable balance going actually lower which is certainly great considering the environment, where among your -- there was nobody really appeared you guys, but other utilities, let’s say, which I realize are different businesses, most of them have T-Mobile balances going in the other direction. Anything that you are doing differently or I -- you probably have more contracted type generation I realize that, but is there anything else going on?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. No. I think you hit the nail on the head. It’s -- 85% of our business is contracted generation and we have creditworthy off-takers. So there are situations, for example, where say a currency depreciates, but the -- what they are exporting is actually then more attractive because they have a portion of their cost whether it be mining or other such things that they are exporting. So in general, our clients are doing well, much better than the markets than they are in. So I think that’s very important. But we are 85% contracted generation and that’s the big difference. So if you actually see why we got it down initially and we correctly forecast it that we would have a drop in demand with the quarantines at our utilities, at our distribution businesses. So that’s what’s going on. But other than that our plans are critical. So in those cases where we are selling to the creator or selling to which is in many cases backed by the government, we are make sure that we get paid, because we are absolutely critical to the grid or the low cost generator in that market. So we are very well-positioned in this crisis. So we don’t expect that to change certainly in the generation business given, say, the current outlook."
},
{
"speaker": "Charles Fishman",
"text": "Okay. And then, Andrés, if I can ask you one strategic question with respect to Fluence. Why a minority partner at this point? What is the thinking behind that?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. That’s a great question. Because this is a rapidly growing business and we think it has a great future and it’s coming up with new products. Part of it is that, both of us, Siemens and AES we would like to have a marker from a transaction. We are not going to sell down a very large stake we are talking around a 10% stake. So we think it would be just good to have to capitalize it, maybe 10% with an outside partner, and obviously, work towards a bigger sell down perhaps in two years, three years of an IPO, but ---- and then we will have to reassess strategically how we feel about this business. But we feel very good about that business. And as I said, I think that this is a market, which is growing very rapidly. Now something that people haven’t talked about, I think, so much is, if you do have a change in federal policies in the U.S. to promote green or carbon free generation, we are very well-positioned, Fluence is very well-positioned. But specifically, AES, because we have a pipeline of 15 gigawatts of potential projects in the U.S. and those run the range from quite advanced to medium advanced. If we looked at just hypothetical projects it’s a much bigger number. So we feel good that we have a pipeline that we could execute on and potentially double our rate of growth of renewable build in the U.S. should there be such a change."
},
{
"speaker": "Charles Fishman",
"text": "Okay. And the partner then very well could be financial rather than just somebody like yourself that’s also selling the Fluence product?"
},
{
"speaker": "Andrés Gluski",
"text": "No. No."
},
{
"speaker": "Charles Fishman",
"text": "Correct?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. No. No. Absolutely. Absolutely."
},
{
"speaker": "Charles Fishman",
"text": "Okay."
},
{
"speaker": "Andrés Gluski",
"text": "So a lot of people are looking at just financials. We are looking at a good investment with an eye towards a potential IPO two years to three years from now?"
},
{
"speaker": "Charles Fishman",
"text": "Got it. Okay. That’s all I have. Thank you."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Charles."
},
{
"speaker": "Operator",
"text": "Our next question is from Angie Storozynski from Seaport Global. Go ahead."
},
{
"speaker": "Angie Storozynski",
"text": "Thank you. So sorry I missed my first presenter [ph]. So I have a number of questions. So first on Fluence, I mean, incredible results by the way. But on Fluence, so the attempts to monetize the business, which I don’t think that you are being paid in the current stock price for Fluence among others. So is there any EPS contribution for Fluence in 2020 or even in 2022?"
},
{
"speaker": "Andrés Gluski",
"text": "No. No. I mean, this year it will -- it should be probably about 1 -- $0.01…"
},
{
"speaker": "Angie Storozynski",
"text": "Okay."
},
{
"speaker": "Andrés Gluski",
"text": "And the reason for that is even though it’s like margin positive and we haven’t been putting more money in as that is very rapid growth is because R&D you have to spend. So, for example, all the design work…"
},
{
"speaker": "Angie Storozynski",
"text": "Yeah."
},
{
"speaker": "Andrés Gluski",
"text": "… the production work of the next-generation of the sixth-generation, well, that is expense. So we have talked probably, I’d say, around two years for it to turn positive in terms of EPF and what basically happens is the fastest growth, the more new profit you have to come out with, you delay that turning to positive. So it’s a business. It could be positive if that was the objective but the objective is to create value. So we think of sales down, as you say, will give us a marker. So people say, well, how much does it worth, well, somebody just paid extra, like we did…"
},
{
"speaker": "Angie Storozynski",
"text": "Yeah."
},
{
"speaker": "Andrés Gluski",
"text": "… for example with the gas business in the Dominican Republic, people weren’t giving us much value and we were able to show what it was worth to the third parties."
},
{
"speaker": "Angie Storozynski",
"text": "And the second question, so it’s a two part question. So one, is there’s like a rule of thumb that I can, say, for example, to 2021 you will have additional 2,000 megawatts of renewables in operation and granted it’s probably going to be scattered throughout the year. But can I say for instance that 100 megawatts adds X in EPS?"
},
{
"speaker": "Andrés Gluski",
"text": "Well, it will depend a little bit, because it depends what you are inaugurating, right, and where. So there’s a difference between solar and wind, and there’s a difference outside of the U.S. because of tax. So it’s, there’s no rule of thumb for just like 100 megawatts. I don’t know Gustavo can comment."
},
{
"speaker": "Gustavo Pimenta",
"text": "No. What I will do is, we are putting on average $300 million, $350 million per year, right? So that’s our …"
},
{
"speaker": "Angie Storozynski",
"text": "Okay."
},
{
"speaker": "Gustavo Pimenta",
"text": "… equity in the project, we have been partners so and so. If you assume, call it, 12% return on average, you are going to come up with the EPS accretion that those deals are bringing to us."
},
{
"speaker": "Andrés Gluski",
"text": "Yeah."
},
{
"speaker": "Angie Storozynski",
"text": "Awesome. Awesome. And now a bigger picture question, so I have been actually looking at it. So, as you become investment grade, I know you are already investment grade, by such, but you get those additional investment grade ratings, would you ever consider not a project finance but corporate level debt to fund the growth, I understand that there is the issue of finite life of the contract for the renewables, but I think that there is this growing conviction even among investors that the useful life of these assets is going to be longer than the duration of the original contract and under project financing you are in a sense the debt amortization, most the cash flows of the project and so the real equity attrition is only at the end of this contract. So in a sense you could help you help quite meaningfully from a cash flow perspective if you were started to rely on corporate level debt -- on corporate debt?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. Let me soft of answer philosophically and then I will pass it to Gustavo. Look, philosophically we like doing project level debt, because it’s an acid test. So since I have been CEO almost all of our major projects, I think, with the exception of Southland, we brought in a partner. And the reason was that bankers have first debt on the cash flow. So you have to convince somebody a third-party that you are going to operate this and that they think it’s a good project as well. So given that philosophically we like using project level debt and so I don’t see that changing for the time, there are advantages of certain roll ups. We can aggregate at the sublevel. Gener has debt, for example, Tietê has debt, which would get some of those advantages. But we think that the discipline of having to project finance is good and having to bring in partners is good. So…"
},
{
"speaker": "Gustavo Pimenta",
"text": "I think, Andrés you covered well. I mean, it brings more discipline to the process. It also allows us to amortize the debt within the PPA timeframe, which we like. We don’t want to count on post-PPA period to pay for debt quite frankly. So it’s just more disciplined. I think the projects are more sustainable when we validate them at the project level, right, with the debt there and all the amortization within the PPA flow."
},
{
"speaker": "Angie Storozynski",
"text": "And just one follow-up if I can on Fluence, so we saw the results of the investigation by APS on the root cause of the storage system accident, and we also saw some response from LG and APS seems to suggest that their need to some changes in the configuration of those storage systems going forward. I haven’t necessarily seen the response on Fluence. But is there any fundamental change and how you think those storage designs need to be adjusted and if there is any need to make adjustments to your already existing operating systems?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. I think, look, that was a unit that was inaugurated in 2017. We are two generations away from that. The issue as we see it was with a series of LG Chem batteries, a specific series that we are produced in some factories. So we have operated for 12 years. This is the first, I will say, serious incident we have had. But really the best standards are, for example, UL 9045A and if you look at the best-in-class standards, the sixth-generation incorporates all these. So if you look at, for example, it doesn’t require -- it’s not contained, so it’s actually outside. The modules are separated, so you don’t have contagion. It has enhanced fire suppression systems on it. And in the worst case, should there be any type of thermal event since it’s not enclosed the heat and the any gases would rise. So, definitely we feel that, we have taken all the lessons learned from this event. We have incorporated into the new design and really safety was one of our number one priority. So, again, we have 12 years of operating these and we -- this is the one really event that we have had. Now regarding those cases which weren’t that many, I think, you can count on them one hand that all those units that had that series of battery in them. We immediately put out instructions of not to charge them like -- instructions you get on your Tesla car, not to charge them above 75% and we have taken corrective actions and we have given more information, more training for like local fire units, et cetera. So, yeah, we -- as you know, safety is number one value, super important for us. We have been very serious and very diligent, I think, about looking into this and supporting our clients and supporting our local fire departments on this. But I feel very good that the sixth-generation cube is the safest unit out there and incorporates all of the suggestions that are out there technically."
},
{
"speaker": "Angie Storozynski",
"text": "Perfect. Thank you very much."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Angie."
},
{
"speaker": "Operator",
"text": "Our next question is from Richard Sunderland from JP Morgan. Go ahead."
},
{
"speaker": "Richard Sunderland",
"text": "Good morning. Thanks for taking my questions here."
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, Richard."
},
{
"speaker": "Richard Sunderland",
"text": "Just starting off, with the opportunity around delinking PPAs, could you provide a little bit more color around that opportunity versus your current financing plan and you may be assumed asset sales as well. Is there an inter-player offset potentially with this new consideration or is it more of another tool in the tool bag down the road?"
},
{
"speaker": "Andrés Gluski",
"text": "We have always said that and there had a lot of tools to address its financing needs, because it’s growing so fast, they have been so successful on Green Blend & Extend. We really can’t comment on some of these transactions until they close. But there are several transactions where we are delinking the PPA, which in some cases was specific to a given asset. So like this power plant has this PPA, we are delinking them and allowing us greater flexibility in terms of how we satisfy their demand or requirements of the customers. So I really can’t give you too much color on it other than saying that it will help us, it will help Gener with its financing plan. And so it’s very likely that any capital contribution from us will be in 2021 instead of 2020 this year. So we tend to be very conservative, so we saw that these have been advancing. So prior to having these as advanced as they are today, we had talked about AES putting in the money this year. So that I think is the main change. So I’d say stay tuned and we can give you more color as these transactions close."
},
{
"speaker": "Richard Sunderland",
"text": "Great. We will look forward to that. And then just a quick clean up question, the inclusion this quarter I believe it was recovery of expense payments from customers in Chile. Just -- was this in your plan specifically in the 2020 plan included in guidance?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Yeah. I mean this is at the AES Crop level, I mean this is above couple cents in this quarter when you normalized partnership adjustment and so on. It was included -- this is a good guy meaning cash and earnings from prior expenses, pass-through cost that we have with some particular clients and we are able to firm up those receivables back."
},
{
"speaker": "Richard Sunderland",
"text": "Yeah. But this was baked into the original guidance?"
},
{
"speaker": "Gustavo Pimenta",
"text": "Yes."
},
{
"speaker": "Richard Sunderland",
"text": "Okay. Thank you very much."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Richard."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would now like to turn the call back to Ahmed Pasha for closing remarks."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you. Thanks everybody for joining us on today’s call. As always, the IR will be available to answer any follow-up questions you may have. Thanks. Thanks again and have a nice day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect."
}
] | The AES Corporation | 35,312 |
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